HUDSON WHITE PAPER INSTITUTE Energy Security: Zeyno Baran & Emmet Tuohy Ukraine’s CENTER FOR EURASIAN Existential POLICY Challenge JULY 2006 HUDSON INSTITUTE 1015 15th Street, NW Sixth Floor Washington, DC 20005 202-974-2400 www.hudson.org Hudson Institute is a non-partisan policy research organization dedicated to innovative research and analysis. Energy Security: Ukraine’s Existential Challenge By Zeyno Baran and Emmet Tuohy Center for Eurasian Policy, Hudson Institute ISBN 1-55813-152-3 Copyright © 2006 Hudson Institute, Inc. All rights reserved. No part of this publication may be reproduced, by any process or technique, without the express written consent of the publisher, except in the case of brief quotations embodied in critical articles and reviews. About Hudson Institute Hudson Institute is a non-partisan policy research organization dedicated to innovative research and analysis that promotes global security, prosperity, and freedom. 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For more information, visit http://www.hudson.org The authors are grateful for the support of interns Benjamin Fidler (who contributed editing, research, and writing) and Diana Marongiu (who provided research assistance). Table of Contents Authors’ Note . .3 Introductory Note . .3 Political and Economic Review . .4 Foreign Policy . .8 Energy . .10 Gas: The New “Political Weapon” . .11 Oil Production, Refining, and Transportation . .18 Key Players . .27 Conclusions and Recommendations . .27 Endnotes . .34 Authors’ Note On July 11, as we went to press, Speaker of Parliament Oleksandr Moroz officially submitted the nomination of Viktor Yanukovych to become the next Prime Minister of Ukraine. This nomination came after a tumultuous series of events that saw the collapse of the projected Orange coalition and the formation of a new alliance between the Socialist Party, the Party of Regions, and the Com- munist Party. At the time of writing, it is possible that this new coalition itself may not survive; sev- eral alternate possibilities still remain. One thing remains certain, however: if a new Yanukovych-led government comes to power, the chances of Ukraine achieving meaningful energy independence are slim. We remain confident that only an Orange coalition has the ability and will to implement the necessary reforms to Ukraine’s economic and political system. Regardless of the final outcome, the recommendations in this paper are certainly still applicable. Introductory Note ver the last year and a half, Ukraine has lost election, followed by the Our Ukraine bloc of President —and continues to lose—valuable time in Viktor Yushchenko; the two parties were expected to O which to develop a comprehensive energy form a solid Orange-Blue coalition, and continue bus- security strategy. More than three months after the iness as usual. When Tymoshenko’s party took second March 2006 parliamentary elections, Ukrainian politi- place, such an arrangement was no longer possible. cal parties have struggled to reach agreement on a new While Our Ukraine showed great reluctance to once governing coalition. The nature and the future of the again enter into a coalition with Tymoshenko, and may government and of Ukraine itself will depend to a large still choose to partner with the PR, the new Orange degree on the decisions reached in the coming months coalition represents the best possible outcome for the in the energy sector, especially concerning natural gas. country—especially for its energy security. The cutoff of gas supplies to Ukraine by Russia on This paper builds on Zeyno Baran’s March 2005 New Year’s Day in 2006 came as a major wake-up call study, entitled “Energy Reform in Ukraine: Issues and to the West—and a major rallying point for large num- Recommendations”.1 bers of Ukrainians, who had previously been relatively It consists first of a review of recent political and complacent about their country’s energy dependence economic developments, followed by a discussion of on its northern neighbor. In March, large numbers of key issues in the oil and gas sectors. It does not focus these voters cast their ballots for former Prime Min- on other important energy sources, such as hydroelec- ister Yulia Tymoshenko, who was the leading oppo- tricity and coal, as the primary purpose of this paper is nent of the non-transparent January and February gas to address the critical interplay between energy and agreements reached with Russia. Many had previously domestic and international politics. The third and last assumed that the Party of Regions (PR) led by Viktor section is made up of recommendations to the new Yanukovych would finish first in the parliamentary government as well as the EU and the United States. I HUDSON INSTITUTE 1 Center for Eurasian Policy Political and Economic Review s he pledged to “defend the unity of Ukraine” ters were such parties as Our Ukraine, the Yulia Tymo- at his inauguration in January 2005, Viktor shenko Bloc, PORA/Party of Reforms and Order, the AYushchenko basked in the applause2 of the Socialist Party, and the Party of Kostenko and Plyushch. hundreds of thousands of supporters gathered to cele- Meanwhile, the so-called “Blue” parties included the brate the success of the Orange Revolution. Shortly Party of Regions, the Natalia Vitrenko Bloc, Ne Tak, thereafter, eager for the cheers to continue, Yushchen- and the Communist Party. Most pundits concluded that ko sought to capitalize on the momentum of his his- despite the proliferation of choices, voters would toric victory by seeking adulation abroad. In this choose to continue supporting the parties best associat- respect, the West was happy to oblige; Yushchenko ed with the 2004 presidential candidates. graced the covers of newspapers and magazines, re- The morning after the election, it became clear that ceived a variety of honorary degrees and awards3, and this prediction was only half true. The Party of the most of all, was loudly cheered by Western legislators. Regions vanquished almost all of its competitors (ex- During Yushchenko’s address to a joint session of the cept for the Communists, which due to the dogged sup- US Congress, legislators chanted his name, while Euro- port of pensioners from the south and east, was able to pean Parliament members waved orange scarves dur- squeak past the 3% threshold), thus establishing itself ing his later visit to Brussels. as the leading opposition party in Ukraine. It is impor- Yet back home—in a country still reeling from the tant to note, however, that the PR’s claims to have bitterly-fought election—Yushchenko would soon be “won” the election are exaggerated, as the total “Blue” hearing no cheers at all. Despite the best intentions and share of the vote remained roughly constant from 2004 efforts of the new president, the end of his first year in to 2006. The most salient aspect of the election was the office revealed him unable to even “defend the unity” extraordinary performance of the Yulia Tymoshenko of his own political supporters, let alone the entire Bloc—which showed itself by a significant margin to nation. Soon enough, the cheers of foreign crowds also be the leading Orange party, winning all but three of died away, as investors lost confidence in the Ukrainian the oblasts that had voted for Yushchenko in 2004. economy and as doubts increased about the govern- Thanks to this performance, Yulia Tymoshenko is ment’s true commitment to political reform, especially perhaps now best positioned to provide the needed the fight against corruption. Now, over eighteen months leadership—even though she faces major challenges later, Ukraine has clearly fallen short of its potential, both at home and abroad. Indeed, she is considered to and remains a divided country—one in continuing be populist and unpredictable, was derided in Russia need of strong leadership that can consolidate the as a “criminal” (due to outstanding arrest warrants gains made by the Orange Revolution. during her term as premier, she was unable to enter the Consolidation seemed furthest from the minds of country for the first months of her premiership)4, and Ukraine’s political elite during the divisive March 2006 is criticized in Western capitals as an “oligarch”. parliamentary election, which bewildered voters with She is also the country’s most charismatic leader, one an array of 45 registered parties appearing on ballots. who worked hard to be seen as trying to fill the de- Rather than targeting the entire electorate, most of these mands made by the Ukrainians on Kyiv’s Maidan Nez- factions competed only within the broader “color” alezhnosti (Independence Square) during the Orange groupings. Striving for the votes of “Orange” suppor- Revolution in 2004. HUDSON INSTITUTE 2 Center for Eurasian Policy As prime minister and subsequently as an opposition the killers of journalist Heorhiy Gongadze (allegedly candidate, Tymoshenko tried to do so in three ways: murdered on the orders of high-ranking officials in the first, by seeking to establish the economy on sound previous regime, including Kuchma himself) within footing; second, by adopting a fierce stance against cor- two months of his inauguration.