VZCZCXRO7713
RR RUEHBW RUEHIK RUEHLN RUEHPOD RUEHVK RUEHYG
DE RUEHKV #0951/01 1401601
ZNR UUUUU ZZH
R 191601Z MAY 08
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC 5617
INFO RUCNCIS/CIS COLLECTIVE
RUEHZG/NATO EU COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC
RHEBAAA/DEPT OF ENERGY WASHINGTON DC

UNCLAS SECTION 01 OF 03 KYIV 000951 
 
SENSITIVE 
SIPDIS 
 
DEPT FOR EUR/UMB, EEB/EEC/IEC - LWRIGHT 
DOE FOR LEKIMOFF, CCALIENDO 
USDOC FOR 4231/ITA/OEENIS/NISD/CLUCYK 
 
E.O. 12958: N/A 
TAGS: EPET EINV ENRG PGOV UP
SUBJECT: UKRAINE: SCENESETTER FOR SPECIAL ENVOY BOYDEN 
GRAY'S VISIT TO UKRAINE 
 
REF: KYIV 904 
 
Treat as Sensitive but Unclassified.  Not for Internet 
Distribution. 
 
¶1. (SBU) Summary.  Your visit to Ukraine comes as the fragile 
two-vote majority coalition struggles to move ahead with an 
ambitious agenda as dissension between the two parties 
increases.  All eyes are on whether Prime Minister Tymoshenko 
and President Yushchenko can work together better than they 
did in 2005 when Tymoshenko was dismissed after seven months 
of infighting; in the past few weeks, their relationship has 
become particularly strained amid mutual recriminations that 
the other is trying to sabotage the government's work. 
Nevertheless, Yushchenko and Tymoshenko have made numerous 
public statements noting that the orange coalition will 
remain in place.  Both are also working separately on 
amending the constitution, which has become a key political 
issue.  Economic growth is likely to remain strong this year, 
but inflation has surged and inflationary expectations are 
growing rapidly.  Although Ukraine on May 16 joined the WTO, 
it still has a long way to go to improve its business 
climate.  The energy sector is still marked by corruption and 
mismanagement, and is badly in need of new investment. 
Nearly all policy makers agree that Ukraine needs to 
modernize the sector and diversify its sources of energy, yet 
no government has been able to develop and implement a 
coherent long-term strategy to achieve this goal.  Recent 
moves by the GOU to undercut its only Production Sharing 
Agreement (PSA) with the U.S. company Vanco are causing some 
to question whether the GOU is sincere about attracting 
foreign investment to develop domestic energy resources.  End 
summary. 
 
Major Parties Already Focusing on Presidential Elections 
--------------------------------------------- ----------- 
 
¶2.  (SBU) Although all three main political parties in the 
Rada (parliament) advocate similar approaches to economic 
reform and a foreign policy that calls for greater 
integration into Europe, their main focus is on the 
Presidential election, now less than two years away, which 
has prevented them from cooperating on many issues.  After 
the MAP letter was disclosed, opposition Party of Regions 
used the NATO issue as a pretext to block the Rada's work for 
most of February and pander to their Eastern Ukrainian 
electorate which is suspicious of closer ties with NATO.  A 
political compromise was finally reached on March 6 and the 
Rada returned to work.  Now, infighting within the ruling 
coalition between the Prime Minister's faction BYuT and the 
President's faction Our Ukraine-People's Self Defense 
(OU-PSD) has once again derailed the Rada's work - a new 
compromise is needed to pass key legislation, such as needed 
budget amendments and remaining WTO-related bills. 
 
A New Government Starts Quickly, Then Stalls 
-------------------------------------------- 
 
¶3.  (SBU)  Pre-term elections in September 2007, held to end 
months of political stalemate, saw Tymoshenko's BYuT faction 
pick up a large number of seats, leading to a new coalition 
and establishment of a new Government.  PM Tymoshenko hit the 
ground running after her December 18 confirmation; she got a 
budget passed in eight days, completed her government program 
for the upcoming year, which was sent to the Rada for 
approval, and made some progress in fulfilling campaign 
promises, such as to return lost savings from the defunct 
Soviet-era state savings bank.  In forming the coalition, 
BYuT and Our Ukraine split the government portfolios evenly, 
resulting in the surprise election of Yushchenko loyalist 
Arseniy Yatsenyuk, then the 33-year old Foreign Minister, as 
Speaker of the Rada in mid-December. 
 
¶4.  (SBU) Yushchenko and Tymoshenko's historically rocky 
relationship and mutual distrust between their parties have 
raised questions about the long-term stability of their 
coalition.  In recent weeks, Yushchenko and Tymoshenko have 
been attacking each other publicly, eventually leading 
Tymoshenko's BYuT to blockade the Rada session hall. 
Nevertheless, both insist their is no alternative to the 
current coalition.  The coalition managed to pass the budget, 
but has since failed to get its 228 (out of 450) MPs into 
their seats for several key votes, leaving a number of bills 
and nominations hanging.  Both Tymoshenko and Yushchenko have 
 
KYIV 00000951  002 OF 003 
 
 
reached out to Yanukovych, the former prime minister and now 
leader of the opposition, but thus far his Party of Regions 
has not been a constructive opposition.  The Rada Qent the 
final two weeks of January and most of February hamstrung as 
Regions blockaded the rostrum following the public disclosure 
of the letter requesting a MAP for Ukraine at the Bucharest 
Summit, arguing that the Speaker did not have the right to 
sign such a request without explicit parliamentary approval. 
All parties are looking ahead to the next presidential 
elections in late 2009/early 2010, and calculating their 
alliances and their policy views accordingly. 
 
Economy Growing, but Hyperinflation Looms 
----------------------------------------- 
 
¶5.  (SBU) Ukraine's economy remains buoyant despite ongoing 
political turmoil.  Real GDP growth was 7.2 percent in 2007, 
and is expected to reach between 5.5 and 6.5 percent this 
year.  However, inflation is now at close to 20 percent, with 
April's inflation figures (note:  nominally 30 percent April 
07 to April 08, but distorted by low April 07 figures.) 
marking a ten-year high.  Rapid income growth has caused a 
surge in imports and a widening of the current account 
deficit.  The central bank has accumulated ample foreign 
exchange reserves to defend the currency, and is now allowing 
the currency to strengthen in an attempt to combat inflation. 
 The outlook for the economy remains positive as incomes are 
still growing and Ukrainian companies are investing heavily 
to modernize their productive capacity.  A major drop in 
world steel and chemical prices, contagion from the worldwide 
credit crisis and/or runaway inflation now pose the main 
risks to the economy in the mid-term. 
 
¶6.  (U)  In their public rhetoric, the country's top 
politicians all promise pro-business regulatory reforms and 
advocate integration into the world economic system.  Ukraine 
became the 152nd member of the WTO on May 16.  The actual 
pace of economic reform remains slow and political leaders 
have resorted to administrative measures, such as restricting 
exports of grain and sunflower oil, to combat rising food 
prices.  The World Bank recently ranked Ukraine 139th out of 
178 countries as a place to do business.  Looking forward, 
however, the ongoing modernization of commercial life and the 
opening of the economy to the outside world will likely lead 
to a gradual, if uneven, adoption of economic reform. 
 
Ukraine and Energy 
------------------ 
 
¶7.  (SBU)  The geopolitics and economics of energy continue 
to play a central role in Ukraine.  Energy consumption per 
capita remains the highest in the world, and the energy 
infrastructure is decaying.  Ukraine remains heavily 
dependent on gas and oil imports from Russia and Central 
Asia, and is the main transit country for Russian gas 
shipments to central and western Europe.  Nominal import 
prices for gas have increased almost fourfold in the past 
three years, and Russia has signaled it wants to eventually 
move to price levels charged to Western European customers. 
Most Ukrainian policymakers agree that Ukraine must diversify 
its sources of energy and move towards a market-based energy 
relationship with Russia, but Kyiv has yet to develop a 
long-term strategy to achieve these goals. 
 
¶8.  (SBU) The USG has encouraged Ukraine to open its energy 
market to more foreign investment.  Few Ukrainian energy 
companies have the technical and financial resources to bring 
domestic production up to potential.  Houston-based Vanco in 
October 2007 signed Ukraine's first-ever production sharing 
agreement (PSA) for oil and gas exploration in the Black Sea. 
 In May of this year, however, the GOU revoked Vanco's 
subsoil permit, citing specious reasons.  Ukraine's already 
poor investment climate image is likely to worsen if the GOU 
fails to reinstate Vanco's permit (reftel).  There are some 
bright spots, however.  Within the framework of the 
USG-supported Nuclear Fuels Qualification Project, 
Westinghouse has signed a contract with Ukrainian reactors 
starting in 2011.  This will help Ukraine diversify its 
sources of fuels for its nuclear power plants, all of which 
currently get their fuel from Russia.  New Jersey-based 
Holtec in September signed a $250 million deal to build a 
spent nuclear fuel storage facility at the Chornobyl Nuclear 
Power Plant.  Forces within the Ukrainian energy 
establishment, likely acting at the behest of Russian 
 
KYIV 00000951  003 OF 003 
 
 
interests, had been trying to torpedo these projects.  These 
projects' success, or lack thereof, will be important signals 
whether Ukraine has the will to move towards more energy 
diversity in the face of Russian geopolitical and economic 
interests. 
Taylor