Streetwise Professor

April 28, 2010

Good Deal or Bad?

Filed under: Economics,Energy,Politics,Russia — The Professor @ 3:15 pm

The Ukraine-Russia gas-lease deal is hugely controversial within Ukraine.  The passage of the bill in the Rada was accompanied by civil disobedience, not to say near riot.  It is also somewhat controversial in Russia.  Putin has claimed that it will be extremely expensive for his country, but that it is necessary to cement ties between the two countries.

Independent commentary is broadly split.  Alexander Golts argues that Yanukovich took Medvedev and Putin to the cleaners:

The Duke of Wellington used to say some victories are worse than defeat. I suspect that President Dmitry Medvedev’s “brilliant diplomatic victory” in Kharkiv on behalf of Russia’s Black Sea Fleet will in reality create very serious problems for Russia in the future.

. . . .

Mindful of how they got burned by Bakiyev and Lukashenko, Medvedev and Putin decided not to fall in the same trap with Yanukovych. But this is exactly what happened. With the lower gas prices to take effect immediately, Ukraine can now save roughly $4 billion annually, whereas the lease extension will only take effect only after the current agreement expires in 2017.

At the same time, Ukrainian opposition parties have made it clear that once they come to power, they will annul the agreement.

. . . .

Yanukovych has already made the Kremlin a hostage to his hold on power — and he has been in office for only two months. Now Moscow has a deeply vested interest in seeing that Yanukovych or another member of the Party of the Regions remains in power right up through 2042. And the $4 billion per year in gas discounts that Russia has already promised Ukraine could turn out to small potatoes compared with the sums Yanukovych could demand from Russia in the years ahead, knowing that he has the upper hand in the relationship.

Conversely, Stephen Blank (whom I consider the most trenchant American commentor on Russia), believes this is a major coup for Russia:

However, in numerous ways this short-term deal represents a defeat for Ukraine and a massive victory for Russia. Kyiv loses because the BSF and its accompanying socio-political-economic-cultural infrastructure enable Russia to keep the Crimea, and thus Ukraine, in a permanent condition of de facto circumscribed and limited sovereignty. Moscow will retain all its points of leverage over Kyiv and gain more because the deal allows Russia to build two nuclear reactors in Ukraine and preserve its nuclear monopoly there (as an alternative to gas). Apart from this limitation on Ukraine’s effective sovereignty, Moscow also reinforces its tangible leverage over Kyiv by restoring its dependence on Russian subsidies and preserving Ukraine’s non-transparent gas economy. Third, it prevents Ukrainian democratization and market reforms. Fourth, it thereby inhibits Kyiv’s moves towards the IMF, and ultimately the EU. Fifth, given the lease’s duration of 25 years, with an option to renew for another five years, this deal all but ensures that future Ukrainian governments will be stuck with a minority controlled by Moscow in the Crimea, and will find it very difficult to move westwards towards the EU or NATO until 2042, if not later.

This deal also has profound implications for Ukrainian and European gas supplies. Russia is intensifying its work with Ukraine on the aforementioned consortium to restructure its gas network (RIA Novosti, April 22). Nonetheless, with Ukraine firmly dependent on Russia, Moscow will gain more leverage upon it because it is pushing hard for South Stream, which will essentially bypass Ukraine as regards supplying Central and Southeastern Europe. If South Stream proceeds, as Moscow hopes, it will isolate Ukraine from Europe even more.

The fundamental difference between Golts’s analysis and Blank’s is that Golts believes that the deal isn’t worth the paper it was written on, whereas Blank’s opinion is predicated on the assumption that Ukraine and Russia will adhere to the agreement.

In my initial take on the deal, I raised repeatedly the issue of performance on the agreement.  Consequently, I am very sympathetic to Golts’s take (although, unlike him, I view it as a potential feature rather than a definite bug).  There is a serious asynchronicity in performance under the deal.  Ukraine’s obligations don’t kick in until 2017, but Russia’s take effect immediately.  And with the uncertainty about what will happen in the gas markets in the coming years, with all the pipeline projects and shale gas and LNG, getting immediate price relief while retaining the option to act opportunistically in the future makes good sense for Ukraine.

It is also quite reasonable to conclude that Ukraine really didn’t give up anything.  Fast forward to 2017, and the expiration of the existing lease.  Can you imagine the potential for conflict?  Do you really think Russia would pick up and leave, willingly and meekly?  Don’t you think that there would be brinksmanship, blackmail, threats, bribery, political chicanery?  I would say that it was doubtful, at best, that Russia would leave, and if it did, it would only be after a period of substantial tension and uncertainty.

Most of the things Blank mentions would have remained with or without the deal.  Russia would have retained leverage over Ukraine (due to energy, and other things) without the deal.  Ukraine’s move west was pretty much a dead letter anyways, all the more because of Obama’s cosmic indifference to it, and his self-deluding man crush on Medvedev.

You also have to consider the alternatives.  Blank mentions three:

It had three alternatives: the first, which it pursued, was to offer Moscow a share in a consortium alongside Ukraine and the EU, to manage the reorganization of the Ukrainian gas distribution network. Moscow turned this down, not wanting to be part of a consortium in regard to reforming the Ukrainian gas network, because it would not have a controlling share and, equally importantly, opportunities for corruption in the current status quo constitute the foundation of much of Russia’s gas wealth and leverage upon Ukraine and other East European states. If there is to be a consortium, Moscow wants it to be one that it controls.

Kyiv’s second alternative was to bite the bullet and institute reforms within its gas economy (Kyiv Post, April 15). Yet, that course alienates President Yanukovych’s power base, which depends on cheap gas and non-transparent deals.

The third alternative is the deal that was struck.

Given that Ukraine is a deeply divided, and even more than typically dysfunctional ex-Sov polity, Blank’s second alternative (reform) is, no pun intended, a pipe dream.  Yes, it would be nice, but ain’t gonna happen.

Blank’s scorn of the Europeans is well merited.  They are hopeless when it comes to a robust, united stance on Russia.  Moreover, with the fissioning fiscal situation (Greece today, Portugal tomorrow, then maybe Spain, and Italy), Europe will be even more distracted, and less interested in getting involved in messy intrigues in the FSU.  Combine that with the don’t-give-a-damn attitude of the US, Russia will have little foreign opposition in its efforts to restore its suzerainty over its former dominions.  If the US doesn’t take the lead, nobody will.

The biggest risk to Russia in the deal is that Ukraine reneges–although, given that possession is nine points of the law, even absent a deal getting Russia out of Crimea would be dicey at best.

The biggest risk to Ukraine is that Russia reneges.  Indeed, I think that is almost inevitable.  This deal does not change the bilateral monopoly situation that characterizes the Russian and Ukrainian gas systems.  And any likely changes in the near term, e.g., the completion of South Stream, will enhance Moscow’s bargaining power.  There is little on the horizon that would enhance Kiev’s.  Russia will find many excuses to jack the price in the future, when it suits it.

So, my view is that this is just an interlude in the ongoing battle of bilateral opportunism between two fundamentally corrupt and unprincipled states.  Remember the old Soviet joke: “We pretend to work and they pretend to pay us”?  Well, I’d characterize this deal as “We pretend to give them a price break, and they pretend to extend our lease.”  All this deal does is create more promises to be broken.  And broken they will be.

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19 Comments »

  1. Our view:

    http://larussophobe.wordpress.com/2010/04/22/editorial-ukraine-suckers-russia-but-good/

    Comment by La Russophobe — April 28, 2010 @ 6:13 pm

  2. [...] Professor reviews some of the expert opinion on the issue and concludes: […] Remember the old Soviet joke: “We pretend to work and they pretend to pay us”? [...]

    Pingback by Global Voices Online » Ukraine: Chaotic Ratification of the Gas-for-Fleet Deal — April 28, 2010 @ 8:59 pm

  3. Anyone with an interest in learning more about shale gas and other unconventional gas resources and the potential impact on European energy independence may wish to visit a website on this topic http:///www.naturalgasforeurope.com

    Comment by Cladd — April 28, 2010 @ 10:49 pm

  4. Conclusion: Russia – stupid. Russia – evil. Or both.
    Analysis: To reach the above.

    BTW, Ukraine is not a real country. Never was, never will be. The sooner this absurdity is resolved, the better for all concerned. The Austrians may keep Lemberg, though.

    Comment by So? — April 29, 2010 @ 1:08 am

  5. [...] Professor reviews some of the expert opinion on the issue and concludes: […] Remember the old Soviet joke: “We pretend to work and they pretend to pay us”? [...]

    Pingback by Official Russia | Ukraine: Chaotic Ratification of the Gas-for-Fleet Deal — April 29, 2010 @ 2:00 am

  6. So?

    Wishful thinking may help a worried mind, but leads nowhere. Russia surely knows that questioning Ukraine’s independence would do nothing but to strenthen Yanukovych’s more west-oriented opponets in the country and by that would risk even Russia’s current level of influence in Ukraine. Therefore this deal, actually, buys Ukraine more time to develope as an individual country. And the longer ít exists as such, the harder it is to keep repeating the mantra about Ukraine not being a real country. Each year of its de jure independence strengthens its de facto independence too…

    Comment by Dixi — April 29, 2010 @ 3:40 am

  7. “BTW, Ukraine is not a real country. Never was, never will be.”

    I recall some work by the American Academy of Sciences, describing the fundamental mistake Ukrainian elites made prior to independence. Using the Soviet price system, they concluded that Ukraine had been subsidizing the rest of the USSR, and thus should do well economically once independent.

    Then in 1992 they found out about global market prices for energy and other raw materials.

    They’ve been trying to square that circle ever since. Yanuk has merely come to understand reality. Yush and the gas Princess remain in denial.

    Comment by rkka — April 29, 2010 @ 3:56 am

  8. Yeah, I remember how Ukraine was forecast to be the post-Soviet star. Agriculture, full spectrum of heavy and light industry, educated population, climate, geographical location, etc.. All pointed to a bright future. Yet it trails everybody but the god-foresaken southern *stans. It’s the nature of the place. It’s never been a state in its own right. Deyification of Bandera and Shukhevich does not an identity make.

    Comment by So? — April 29, 2010 @ 4:40 am

  9. I’m not going to debate about whether Ukraine is a country. It is one now whether people like it or not and most of the people in Ukraine, east or west, want it to be a country, so no use whining about it.

    As for the actual topic, was the deal good or bad, I’d say it depends on what measuring stick you use. There could be a good argument that Ukraine got a better deal from an economic standpoint. They save a bunch of money on gas and keep the lease agreement for a long time to come which provides them a steady revenue stream. This relieves some strain on the decrepit financial state that Ukraine is in. Putin admitted the price was high for Russia and so it is. Now Ukraine just needs to spend the money wisely which breeds a whole other conversation that could attract cynics here like flies. For another view of the economic advantages, you can look at Yevgeny Kiselyov’s latest oped at http://www.themoscowtimes.com/opinion/article/a-new-lease-on-a-fleet-and-a-new-lease-on-life/405084.html.

    If you look at the deal from a political perspective, then Russia clearly wins. Now they have their naval base locked up indefinitely, they can coo their Russia-friendly Crimean population, and then potentially woo them all the way back to Russia now that they have more time. The loss of the naval base would have cost a lot of Crimeans their jobs, so Russia looks like the savior now. Another potential issue relates to NATO. I didn’t look this up but only recall something from memory that NATO membership cannot happen if there is a foreign military presence on an applicant’s soil. If that is indeed the case, then Russia got a sweet and easy deal to keep NATO out for a long, long time. SWP mentions other political advantages that I won’t repeat.

    From purely an aspirational perspective, and I suppose it’s my own, it seems that Ukraine needs to stand up on its own at some point. The ending of the lease could have been a good milestone. The risk would be high, as SWP mentioned. I’m not even sure Russia started to build a replacement port for Sevastopol, so it’s certainly the case where they wouldn’t have left without causing an enormous stink. However, if there was ever a time to do it, it was now. The other aspiration is that Ukraine could get out of the vicious cycle of subsidizing gas prices and removing any incentive to reform the system. At some point, the real market has to emerge in the country or they’ll never get on solid footing and only live on somebody else’s promises and fake prices. Resisting real prices catches up to you.

    Lastly, many here know the lens I look from. What I don’t understand, after living in Ukraine for the past year, is why Ukraine would want to look at Russia as a model to follow? My entire experience there reveals that Ukrainians just don’t know how to do much properly. They’ve been walled off for centuries from the modern world and are always two steps behind the West (i.e. they are one step behind Moscow who is one step behind the West… well, maybe more than one). If I were Ukrainian, it would seem that I could learn a lot more about improving their economy and quality of life from Europe than they ever could learn from Russia. I also lived in Russia for 5 years and know for a fact, that Russians don’t care much about Ukrainians. They only want Ukraine to shut up and behave. Just look at the comments above from the usual cast of characters. The condescension for their Ukrainian “brothers” stinks to high heaven. Staying close together due to cultural and historical commonalities doesn’t work for me either. I think it’s just an unhealthy addiction on Ukraine’s part, frankly.

    In summary, I think Ukraine will benefit from the extra cash in the short-term but this fast money will keep supporting their bad habits in the long-term. I think Russia won politically big time and they’ve got things locked in for a long while. Whether either one holds to the deal is certainly an interesting question, but I think that this agreement will always be the template used in any discussion between them for the indefinite future. They’ve crossed a threshold that Russia will hold Ukraine to. They did this to Obama with missile defense so doing what they want with Ukraine is even easier.

    Comment by Howard Roark — April 29, 2010 @ 6:12 pm

  10. I’m not going to debate about whether Ukraine is a country. It is one now whether people like it or not and most of the people, east or west, want it to be a country, so no use whining about it.

    As for the actual topic, was the deal good or bad, I’d say it depends on what measuring stick you use. There could be a good argument that Ukraine got a better deal from an economic standpoint. They save a bunch of money on gas and keep the lease agreement for a long time to come which provides them a steady revenue stream. This relieves some strain on the decrepit financial state that Ukraine is in. Putin admitted the price was high for Russia and so it is. Now Ukraine just needs to spend the money wisely which breeds a whole other conversation that could attract cynics here like flies. For another view of the economic advantages, you can look at Yevgeny Kiselyov’s latest oped at http://www.themoscowtimes.com/opinion/article/a-new-lease-on-a-fleet-and-a-new-lease-on-life/405084.html.

    If you look at the deal from a political perspective, then Russia clearly wins. Now they have their naval base locked up indefinitely, they can coo their Russia-friendly Crimean population, and then potentially woo them all the way back to Russia now that they have more time. The loss of the naval base would have cost a lot of Crimeans their jobs, so Russia looks like the savior now. Another potential issue relates to NATO. I didn’t look this up but only recall something from memory that NATO membership cannot happen if there is a foreign military presence on an applicant’s soil. If that is indeed the case, then Russia got a sweet and easy deal to keep NATO out for a long, long time. SWP mentions other political advantages that I won’t repeat.

    From purely an aspirational perspective, and I suppose it’s my own, it seems that Ukraine needs to stand up on its own at some point. The ending of the lease could have been a good milestone. The risk would be high, as SWP mentioned. I’m not even sure Russia started to build a replacement port for Sevastopol, so it’s certainly the case where they wouldn’t have left without causing an enormous stink. However, if there was ever a time to do it, it was now. The other aspiration is that Ukraine could get out of the vicious cycle of subsidizing gas prices and removing any incentive to reform the system. At some point, the real market has to emerge in the country or they’ll never get on solid footing and only live on somebody else’s promises and fake prices. Resisting real prices catches up to you.

    Lastly, many here know the lens I look from. What I don’t understand, after living in Ukraine for the past year, is why Ukraine would want to look at Russia as a model to follow? My entire experience there reveals that Ukrainians just don’t know how to do much properly. They’ve been walled off for centuries from the modern world and are always two steps behind the West (i.e. they are one step behind Moscow who is one step behind the West… well, maybe more than one). If I were Ukrainian, it would seem that I could learn a lot more about improving their economy and quality of life from Europe than they ever could learn from Russia. I also lived in Russia for 5 years and know for a fact, that Russians don’t care much about Ukrainians. They only want Ukraine to shut up and behave. Just look at the comments above from the usual cast of characters. The condescension for their Ukrainian “brothers” stinks to high heaven. Staying close together due to cultural and historical commonalities doesn’t work for me either. I think it’s just an unhealthy addiction on Ukraine’s part, frankly.

    In summary, I think Ukraine will benefit from the extra cash in the short-term but this fast money will keep supporting their bad habits in the long-term. I think Russia won politically big time and they’ve got things locked in for a long while. Whether either one holds to the deal is certainly an interesting question, but I think that this agreement will always be the template used in any discussion between them for the indefinite future. They’ve crossed a threshold that Russia will hold Ukraine to. They did this to Obama with missile defense so doing what they want with Ukraine is even easier.

    Comment by Howard Roark — April 29, 2010 @ 6:25 pm

  11. Russia is not a real country, never was, never will be.

    No national ideal, no national cuisine, collapse after collapse after collapse after collapse. A “real” nation isn’t the biggest murderer of its own citizens. A real nation doesn’t choose to repeat past mistakes. Even most monkeys avoid that.

    Russia is not a real country, never was, never will be.

    Comment by La Russophobe — April 29, 2010 @ 7:02 pm

  12. Phoby, Phoby, Phoby…

    “No national ideal, no national cuisine, collapse after collapse after collapse after collapse.”

    Um, yeah… Let me guess, no State-forming Aryan racial element either. One good kick and the whole rotten structure will collapse.

    It seems I’ve heard of this stuff before.

    Things didn’t work out the way your intellectual ancestors planned that time. Won’t this time either.

    Comment by rkka — April 29, 2010 @ 7:46 pm

  13. If so-called “Ukrainians” realised that they are Russian, they’d have no inferiority complex.

    Comment by So? — April 29, 2010 @ 8:23 pm

  14. So?,

    Wishful thinking and if and if and if…

    Comment by Dixi — April 30, 2010 @ 2:01 am

  15. Russia is not a real country, never was, never will be.

    No national ideal, no national cuisine, collapse after collapse after collapse after collapse. A “real” nation isn’t the biggest murderer of its own citizens.

    Russia was grouped together with Venezuela and China as countries in which “[s]ophisticated techniques are being used to censor and block access to particular types of information, to flood the internet with antidemocratic, nationalistic views, and to provide broad surveillance of citizen activity.”

    Russia took 175th place on a ranking of global press freedom, just beating out Vietnam, Saudi Arabia, and China, and trailing slightly behind Congo and Yemen.

    Except for in the Baltic states, analysis from the rest of the former Soviet Union was not much more encouraging. Only Ukraine and Georgia were deemed to be “partially free,” while the remaining countries were ranked as “not free.” Among those, the only countries that fared worse than Russia were Belarus (taking 189th place), Uzbekistan (tied for 189th), and Turkmenistan (194th). The report also calls Russia “a model and patron for a number of neighboring countries,” indirectly implying that its bad influence is partially to blame for the low rankings of fellow former Soviet states.

    Comment by Boris — April 30, 2010 @ 12:47 pm

  16. Apartheid Baltics are certainly free.

    Comment by So? — April 30, 2010 @ 7:55 pm

  17. I agree with La Russophobe. She is as smart as usual. Indeed, Russia is not a real country, because it no national cuisine. Period.

    Russia should learn from a REAL country like USA, that has a great national cuisine: italian pizza, macaroni, german frankfurters, mexican tacos, french fries, belgian waffles, english muffins, english cheddar, russian piroshki, russian blintzes and bagels, ukrainian pierogis, sushi, and filet mignon. Oh, and the yummy Chinese food!

    Comment by RTR — April 30, 2010 @ 9:26 pm

  18. Yeah, Russkies are so poor, they invented Service à la russe. That way the diner is not reminded that everything is made from sour cabbage and sawdust. BTW, it’s Freedom Fries, you cheese-eating surrender monkey.

    Comment by So? — May 1, 2010 @ 12:32 am

  19. Left a comment for the Prof on how if he dislikes Ukrainian and Russian economic integration so much, why the soft spot for the EU (4th Reich, cough cough)

    Comment by Mr. X — May 1, 2010 @ 11:58 am

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