Ukrainian 2012 Budget already unrealistic?

There is a possibility that the Ukrainian budget will not be met already.

The reason as always is gas and Russia.

It is already acknowledged by the government themselves that the budget is ambitious when it comes to the budget cutting.

Now the authorities state that they will cope in 2012 and cite the budget deficit of 1.7% GDP in 2011 as proof of fiscal determination. Undoubtedly, if 1.7% is true then it is far better than in recent years.

It is also true that the Ukrainian budget was passed allowing for the current, very high tariff it pays to Russia since the 2009 agreement made by the previous government. Ukrainian/Russian negotiations continue with Ukraine attempting to reduce the tariff without giving much to Russia in return (or at least nothing Russia wants in return).

The Russian pressure on Ukraine to cede partial or complete control of the Ukrainian Gas Transport System is immense with an immediate $8-9 billion price reduction should the Ukrainian government roll over and crumble.

Thus far, I have to give credit to the Ukrainian government for standing its ground and even muting taking the current contract to an independent tribunal for resolution whilst still adhering to such a crippling agreement. Needless to say, Russia is not overly keen to have the route of an independent tribunal getting involved in a bilateral agreement.

How long Ukraine can withstand such huge economic stresses caused by the gas agreement remains to be seen, but it can’t go on forever. To be honest I am surprised Ukraine has stood its ground for so long.

The options for Ukraine seem limited. It has announced it will reduce its importation of Russian gas to 27 billion cubic meters in 2012 which is almost half the usual annual quantity. This done of course to reduce costs and provide some wriggle room in a very tight budget.

Simple eh?

Well no. The 2009 agreement obliges Ukraine to buy a minimum of 33 billions cubic meters of gas whether it uses it or not. This contract runs until 2019. That additional 6 billion cubic meters of gas is more than small change when Ukraine is paying $416 per cubic meter, a price well above its EU neighbours.

So why has Ukraine stated it will only buy 27 billion cubic meters of gas, clearly in contravention of the 2009 agreement?

Well, despite Ukraine’s seemingly weak negotiating position, should Russia insist on Ukraine paying for the other contractually obliged 6 billion cubic meters it would have to take Ukraine to arbitration. If Russia will not move on the negotiated price or to a pay as you use amendment, as Ukraine has already muted the idea of arbitration, Ukraine would get what it wants and Russia would be doing something it doesn’t want to do.

If Russia was to turn off the taps, the EU, which has done all it can to stay outside this contractual squabble would then be sucked in. The options for the EU would be to either back Ukraine and state the contract is flawed somehow, which would not do the perception of Ms Tymoshenko’s innocence much good, to side with Russia which does nothing for the EU’s geopolitical battle with Russia over Ukraine, or to get involved with a Ukrainian/Russian/EU troika over the GTS which is something the current Ukrainian authorities have been pushing for since they came to power with little response from the EU.

In the meantime, the $800 million gas exploration joint venture between Ukraine and RD Shell breaks ground in Ukraine in the immediate future. How fast that will come on-line remains to be seen. What benefits it has to Ukraine given the contractually guaranteed purchase of 33 billion cubic meters from Russia, use or not use, in the immediate future is also subject to conjecture. Long term it can only be a good thing.

One suspects that there will be a relative push from the Ukrainian government to get as many gas exploration JV’s started immediately to get them on-line long before the 2019 agreement expires if renegotiations fails, the EU sides with Russia over the contract leaving Ukraine with no options other than to honour the contract or simply break it. If it is to be the latter then Ukraine needs to be in a position to be far more self-sufficient as soon as possible.

In the meantime, Ostchem, a company controlled by Dmitry Firtash, arch enemy of Ms Tymoshenko who duly removed him from the gas-loop as an officially sanctioned intermediary with her 2009 agreement with Russia, has increased gas import into Ukraine by 35% (7 billion cubic meters) at a considerably lower price than that negotiated by Ms Tymoshenko. I’ll say no more and leave you to think about why Russia would sell to him (and the EU countries) far cheaper than to Ukraine.

The question for the 2012 budget remains however. Was it drawn up on the current very high price but with the purchasing of only 27 billion cubic meters of gas from Russia, ignoring the contractual guaranteed minimum purchase agreement, or was it drawn up to meet the minimum contractual necessities by way of price and volume?

As the year progresses and if negotiations don’t progress, I expect we will find out.