VZCZCXYZ0007
RR RUEHWEB

DE RUEHKV #0162/01 0251222
ZNR UUUUU ZZH
R 251222Z JAN 08
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC 4791
INFO RUCNCIS/CIS COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHZG/NATO EU COLLECTIVE
RHEBAAA/DEPT OF ENERGY WASHINGTON DC

UNCLAS KYIV 000162 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
DEPT FOR EUR/UMB 
EEB/EEC/IEC-GALLOGLY/WRIGHT 
DOE FOR LEKIMOFF, CCALIENDO, EMCGINNIS 
USDOC FOR 4231/ITA/OEENIS/NISD/CLUCYK 
 
E.O. 12958: N/A 
TAGS: ENRG EPET ETRD PREL UP
SUBJECT: TYMOSHENKO TURNS UP HEAT ON GAS MIDDLEMAN UKRHAZENERHO 
 
REF: KYIV 0014 
 
Treat as Sensitive but Unclassified.  Not for Internet. 
 
¶1. (SBU) Summary.  Tymoshenko's new government recently launched its 
first strike against intermediaries connected to RosUkrEnergo (RUE) 
in the gas trade with Russia.  The National Electricity Regulatory 
Commission (NERC) of Ukraine limited UkrHazEnerho's (UHE) (Note: a 
joint venture between RUE and NaftoHaz.) license to supply gas at 
unregulated tariffs - those to the lucrative industrial sector -- to 
5.04 bcm/year, an amount equal to roughly 10% of its 2007 sales. 
Should this cap survive a UHE lawsuit, UHE presumably would lose the 
bulk of its direct industrial customers and the associated profits 
to other gas suppliers.  NaftoHaz's poor financial standing has 
often been attributed to UHE, as UHE inherited gas delivery profits 
that had previously been earned by NaftoHaz, although it is not 
certain the new restrictions on UHE will benefit NaftoHaz.  Adding 
to the pressure on UHE, an interagency commission is attempting to 
scrutinize UHE's financial operations.  Tymoshenko's bold move 
against UHE's dominance in the domestic market might have the 
additional benefit of weakening RUE, which she promised to remove 
from the gas deal in her September 2007 campaign.  End Summary 
 
The Roles of the Intermediaries 
------------------------------- 
 
¶2. (U) Two controversial intermediaries exist in the Ukrainian gas 
market - RUE and UHE.  RUE, a joint venture nominally owned by 
Russia's Gazprom (50%) and Ukrainian businessmen Dmytro Firtash and 
Ivan Fursin (with a reported 45% and 5% share respectively), is the 
monopoly supplier of natural gas to Ukraine since January 2006.  As 
part of the January 2006 deal, UHE, a joint venture owned in equal 
shares by RUE and NaftoHaz, was created to purchase gas from RUE and 
sell it to NaftoHaz and directly to consumers. 
 
NERC Restricted UHE's Supply License from Outset, but Lost Court 
Battles 
------------- 
 
¶3. (U) After the creation of UHE, the NERC initially issued it a 
five-year license to supply up to 5.04 bcm/year gas at unregulated 
tariffs, thereby giving it limited access to the lucrative 
industrial segment of the market.  UHE appealed the decision and, in 
May 2006, Kyiv's economic court upheld their complaint and ordered 
the restrictions lifted.  The NERC attempted to have the ruling 
reversed in the court of appeals, but the ruling was upheld. 
Shortly after the appointment of the Yanukovych government in August 
2006, the then-head of the NERC, Sergiy Titenko, removed all 
restrictions on gas volumes supplied by UHE.  As a result, UHE 
quickly dominated the industrial segment of Ukraine's domestic gas 
market. 
 
UHE's Gains are NaftoHaz's Losses 
--------------------------------- 
 
¶4. (U) In 2007, UHE sold up to 40bcm of gas to industrial customers 
at a considerable profit, according to press reporting.  Its 
profitability came at the expense of NaftoHaz, which had 
historically used revenues from the unregulated industrial sector to 
compensate for its losses in the regulated residential and district 
heating sector.  Sales to industry had been its second largest 
source of revenue (after its gas transit business); from the first 
half of 2006 to that of 2007, NaftoHaz's net income reportedly 
dropped by more than 50% while debts accumulated.  To prevent 
NaftoHaz from sinking into bankruptcy, the GOU recently provided 
state guarantees on NaftoHaz's outstanding debts (reftel). 
 
NERC Reinstates Limit on UHE; Cites Court Case 
--------------------------------------------- - 
 
¶5. (U) On January 8, 2008, the NERC passed a resolution that 
reinstated the 5.04 bcm limit on UHE's supplies to the unregulated 
(industrial) sector.  According to press reports, the NERC's 
newly-appointed Chairman Valerii Kalchenko explained that the Higher 
Economic Court had overturned the earlier court decisions a year 
ago.  He also stressed that UHE is a structure affiliated with 
NaftoHaz and that, according to Ukrainian legislation, the total 
share a business group possesses in the gas market could not exceed 
35%.  Given the existing licenses belonging to other NaftoHaz 
enterprises, Kalchenko argued the remaining volume of gas available 
for delivery by UHE was 5.04 bcm.  According to Kalchenko, UHE is 
free to sell any additional volume to other suppliers. 
 
UHE Will Sue------------ 
 
¶6. (U) UHE disputed that any court decision exists allowing NERC to 
revoke previous licenses and stated it intends to sue NERC to 
reverse its decision.  It has warned that disruptions in supply, and 
to gas transit from Russia to the EU, could occur if the restriction 
was upheld.  However, UHE's spokesman stated that it had signed 
agreements until 2012 with more than 200 Ukrainian customers and 
would do its best to fulfill them until the issue is resolved in the 
courts. 
 
UHE also Protests Scrutiny of its Financial Operations 
--------------------------------------------- --------- 
 
¶7. (U) Earlier this week, members of the interagency commission to 
audit NaftoHaz twice attempted to enter UHE offices to scrutinize 
its financial operations. UHE refused them entry, stating that the 
attempt violated the constitution, the Civil Code, and other laws of 
Ukraine and was an attempt to exert administrative pressure on the 
company.   UHE has reportedly written a letter requesting resolution 
of the issue to the Chair of the Commission, First Deputy Prime 
Minister Oleksandr Turchynov. 
 
¶8. (SBU) Comment.  Tymoshenko has repeatedly stated her intention to 
eliminate UHE and RUE as intermediaries in the gas market - a goal 
the USG has long supported.  Based on recent activity, she appears 
determined to keep those campaign promises.  She seems to be 
focusing the initial assault on UkrHazEnerho, although she has 
publicly continued to call for removing RUE as well.  Capping UHE's 
operations would deal a serious blow not only to UHE but, due to its 
ownership stake, RUE.  (Note:  The direct financial effect on RUE is 
unclear, since it is completely murky what financial flows and 
dividends move between UHE and RUE.  Reportedly, UHE has yet to pay 
2006 dividends to NaftoHaz, even though NaftoHaz owns a 50% share. 
End note.) Another sign of this pressure on UHE was the recent 
removal of Ihor Voronin, UHE's CEO, from his position as a deputy 
chairman of NaftoHaz.  What is not clear is who will step into the 
void created by the NERC's new limits on UHE's direct sales.  It is 
possible that NaftoHaz or regional gas distributors could take over 
this role, but some observers have speculated that other gas traders 
could begin supplying industry, which up to now had been virtually 
monopolized by UHE. 
Taylor