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PP RUEHDBU RUEHSL
DE RUEHKV #1981/01 3171116
ZNY CCCCC ZZH
P 131116Z NOV 09
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC PRIORITY 8802
INFO RUCNCIS/CIS COLLECTIVE PRIORITY
RUEHZG/NATO EU COLLECTIVE PRIORITY
RHEHAAA/NSC WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
RHMFISS/DEPT OF ENERGY WASHINGTON DC PRIORITY

C O N F I D E N T I A L SECTION 01 OF 04 KYIV 001981 
 
SIPDIS 
 
DEPT FOR S/EEE, EUR/UMB, EB/ESC/IEC 
DOE PLEASE PASS TO JELKIND, LEKIMOFF, CCALIENDO 
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E.O. 12958: DECL: 11/11/2010 
TAGS: ECON EFIN ENRG EREL PGOV PREL PINR UA RU
SUBJECT: UKRAINE: NAFTOHAZ OPTIONS FOR GAS PAYMENTS 
 
REF: A. KYIV 1916 
     ¶B. KYIV 421 
     ¶C. KYIV 1878 
     ¶D. KYIV 1943 
 
Classified By: ECON Counselor Edward Kaska for reasons 1.4 (b,d). 
 
¶1. (C) Summary.  Ukraine is expected to need about $1 billion 
to cover gas purchased from Russia in November and December. 
Prime Minister Tymoshenko has called on President Yushchenko 
to allow the National Bank of Ukraine (NBU) to make its 
foreign currency reserves available for the gas payments. 
However, it is unlikely that the President will allow the NBU 
to do so, which will force the Prime Minister to find 
alternative sources of funding.  GOU officials have said 
Ukraine will again use IMF Special Drawing Rights (SDRs) to 
cover the payment for November gas purchases, but predict 
difficulty making the payment for December gas purchases 
without IMF stand-by program "fourth tranche" funds. 
Naftohaz is also in talks with Gazprom Bank to secure 
alternative financing to cover gas payments.  The gas payment 
situation is unlikely to improve in 2010, even though rates 
for the transit of Gazprom gas through Ukrainian pipelines to 
Europe will increase.  If Ukraine does miss a gas payment, it 
will be forced to make prepayments for gas and could be 
threatened with close to $9 billion in "take-or-pay" 
penalties from Russia.  End summary. 
 
November 7 Payment for October Gas 
---------------------------------- 
 
¶2. (C) Per the terms of the January 19, 2009 contract 
Naftohaz signed with Gazprom, payments are due by the seventh 
of each month following the month of supply.  Ukraine on 
November 6 paid Gazprom approximately $461 million for 2.2 
billion cubic meters (bcm) of gas purchased in October. 
According to Naftohaz Spokesman Valentyn Zemlyansky, around 
$61 million came from Naftohaz revenues, with the rest coming 
from IMF SDRs (Ref A).  Naftohaz transferred approximately 
UAH 3.25 billion in treasury bills (from the UAH 18.6 billion 
that the Cabinet of Ministers allocated to Naftohaz in the 
summer) to the Ministry of Finance, which in turn transferred 
$400 million to a commercial bank for Naftohaz. Zemlyansky 
claimed that the company earned UAH 3.5 billion ($435 
million) in revenues in October but that a significant 
portion of the revenues are going to pay Naftohaz's tax 
burden and service domestic debts.  Others estimate that 
Naftohaz's monthly revenues are significantly less, at around 
$130 million. 
 
Gas Volumes for the Rest of the Year 
------------------------------------ 
 
¶3. (C) While Ukraine's gas purchase volumes for the rest of 
2009 will depend somewhat on how cold the winter is, Naftohaz 
will take far less than it agreed to in the January 19 
contract.  On October 14 Naftohaz Deputy Director Yaroslav 
Marchuk stated in the press that Naftohaz would purchase 
between 7-8 bcm of gas from Gazprom in the fourth quarter. 
Presidential Envoy for Energy Security Bogdan Sokolovsky told 
us on November 9 that Naftohaz had earlier planned to take 
3.5 bcm in both November and December, but now would likely 
take around 3 bcm or less, if the winter was mild.  Others, 
however, believe Ukraine could take substantially less gas. 
Independent energy expert and former Naftohaz official 
Oleksandr Todiichuk estimated that Ukraine would purchase 
only 4.5 bcm for the rest of the year.  Naftohaz's Zemlyansky 
told us that Naftohaz would take up to 5 bcm in the last two 
months of 2009, and could take even less.  Minister of Fuel 
and Energy Yuriy Prodan told the press on November 10 that 
Ukraine would take between 2.5-2.7 bcm in November.  Assuming 
that the working estimate at Naftohaz is still to take 
between 7-8 bcm for the fourth quarter, Ukraine will need to 
purchase between 4.8-5.8 bcm total in November and December 
at a cost of $957 million to $1.17 billion. 
 
Likely Shortfalls 
----------------- 
 
¶4. (C) The financial situation at Naftohaz will not improve 
in the final months of the year, and the company will again 
need some sort of intervention to make its monthly gas 
payments.  Although Zemlyansky's estimate of Naftohaz's 
revenues was much larger than what others have told us, he 
also made it clear that the company would not be able to use 
 
KYIV 00001981  002 OF 004 
 
 
all of its revenues to make the gas payments.  Assuming 
Naftohaz could contribute $100 million per month from 
revenues and Ukraine takes on the low side in both November 
and December, Naftohaz will need approximately $340 million 
each month to make up the shortfall.  If the winter is colder 
and Ukraine has to take more gas, the shortfall could grow to 
approximately $500 million each month. 
 
Payment Options--National Bank of Ukraine Help Unlikely 
--------------------------------------------- 
 
¶5. (SBU) Ukraine has limited options for coming up with the 
payments, but should be able to make each payment if it has 
the political will to do so.  Yushchenko advisors have 
repeatedly stated that the President will block any further 
use of NBU reserves for gas payments.  His action rules out 
the financing scheme Ukraine used for at least three monthly 
payments earlier this year wherein the NBU provided financing 
to state-owned banks, which in turn lent the funds to 
Naftohaz (Ref B).  Deputy Presidential Secretariat head 
Oleksandr Shlapak said in the press that without the IMF 
releasing the fourth tranche ($3.8 billion) of the Stand-By 
Arrangement, Ukraine would have difficulty making the 
December 7 payment for November gas purchases.  Shlapak 
stated "What do the President and the National Bank have to 
do with this?  It is not the President's duty to pay for gas. 
 It is the duty of the Government." 
 
IMF SDRs Could Be Used 
---------------------- 
 
¶6. (C) The Prime Minister's office also predicts difficulty 
in making gas payments if the IMF does not give Ukraine the 
fourth tranche of its Stand-By Arrangement (Ref C), but has 
stated that Ukraine will be able to make the December 7 
payment.  Deputy Prime Minister Hryohriy Nemyria stated on 
November 9 that Ukraine would again use a portion of the IMF 
SDRs to make the December 7 payment for November gas 
purchases.  He continued by stating that Ukraine would face 
difficulties making the January 7 payment for December gas 
purchases if the IMF has not resumed its stand-by program 
before then.  Assuming Ukraine purchases up to $1.20 billion 
worth of gas in November and December, the $2 billion SDR 
allocation could cover gas purchases for the rest of the 
year. 
 
¶7. (C) The GOU, however, could choose to use the SDR funds to 
cover its own budget gap rather than make the gas payments 
(Ref D).  Sokolovsky told us on November 6 that the SDRs 
would need to be distributed in a way to "keep happy" Russia, 
Naftohaz, and the budget.  He subsequently told us on 
November 9 that the SDRs would not necessarily be used to 
make the December 7 and January 7 payments.  Zemlyansky also 
told us he doubted that the SDRs would be made available to 
Naftohaz again. 
 
Naftohaz Could Seek Russian Financing 
-------------------------------------- 
 
¶8. (C) Another option, which Zemlyansky told us Naftohaz is 
actively pursuing, would be to borrow from commercial banks. 
Zemlyansky said specifically that Naftohaz is holding talks 
with Gazprom Bank to cover gas payments.  He said that recent 
statements made in the press (some made by Zemlyansky 
himself) that Naftohaz was holding negotiations with Gazprom 
over changes in the gas contracts were simply cover for the 
actual talks--securing financing from Gazprom Bank--that were 
ongoing.  Zemlyansky did not comment on the loan terms being 
discussed or what Naftohaz might offer as collateral. 
Naftohaz Deputy Chairman Igor Didenko, reported to be 
Tymoshenko's man at Naftohaz, has frequently shuttled between 
Kyiv and Moscow over the last month. 
 
Growing Debts Owed to Naftohaz 
------------------------------ 
 
¶9. (SBU) Naftohaz could also seek to collect growing arrears 
owed to the company from municipal heating companies and 
Oblgas companies (regional gas distributors).  Prime Minister 
Tymoshenko has stated that municipal heating companies have a 
50-60% payment rate to Naftohaz.  Heating companies still owe 
Naftohaz UAH 2.7 billion ($330 million) from gas purchased in 
¶2008.  With the continued economic slump and the lack of 
political will at the municipal government level to raise 
heating tariffs, it is unlikely that heating company debts 
 
KYIV 00001981  003 OF 004 
 
 
will be paid off to Naftohaz this year. 
 
¶10. (SBU) Over the summer the Cabinet of Ministers 
established a financing program intended to provide loans 
from state-owned banks to cities to repay municipal heating 
company gas debts.  According to Zemlyansky, the program has 
not been very successful as the banks have little liquidity 
and are not extending loans to municipalities. 
 
¶11. (SBU) Zemlyansky also told us that Oblgas companies are 
refusing to pay for gas sold to them and have amassed UAH 12 
billion ($1.47 billion) in debts.  Oblgas companies' refusal 
to pay for gas supplies is linked to a decision passed by the 
Cabinet of Ministers on June 10 to strip the gas distribution 
business from them and give it to a new subsidiary of 
Naftohaz, Naftohaz Merezhi, at the beginning of 2010.  If 
Naftohaz or the government were able to enforce payment 
discipline by heating and Oblgas companies, Naftohaz would 
have enough resources to make the payments for gas taken in 
November and December. 
 
Payment Problems Will Continue 
------------------------------ 
 
¶12. (SBU) Ukraine's ability to pay for Russian gas will 
continue to be limited in 2010.  The January 19 contract 
envisions a marked increase in gas volumes delivered to 
Ukraine from 40 bcm in 2009 to 52 bcm in 2010.  The 
government and Naftohaz reportedly have begun talks with 
Gazprom to lower the contracted volume for 2010 to 33 bcm. 
On January 1, gas prices will also increase as Ukraine loses 
the 20% discount it had in 2009, and as the new quarter 
begins.  The first quarter price will be at least $260 per 
thousand cubic meters (tcm) compared to $208/tcm for the 
fourth quarter of 2009.  The draft 2010 budget submitted by 
the Cabinet of Ministers to the Rada on September 15 uses an 
average gas price of $260/tcm for 2010 to calculate subsidies 
for Naftohaz.  Zemlyansky, however, told us that Naftohaz 
estimates that the average price for 2010 will be $295/tcm 
(compared to an average price of $235/tcm in 2009).  Assuming 
Ukraine purchases 33 bcm in 2010, at an average price of 
$260/tcm, Ukraine will need to pay Gazprom $8.58 billion. 
Assuming an average price of $295/tcm, the bill would jump to 
$9.74 billion.  Ukraine's total gas bill in 2009 will be 
approximately $5.6 billion for around 24 bcm. 
 
Transit to Increase, But Won't Cover Growing Gas Payments 
--------------------------------------------- -- 
 
¶13. (SBU) Per the January 19 transit contract, the pipeline 
transit rate should also increase beginning January 1, 2010. 
Naftohaz estimates that the rate will increase from the 
current rate of $1.70/tcm per 100 kilometers to $2.70/tcm per 
100 kilometers.  Ukraine could earn around $3-3.5 billion in 
transit revenues for 2010, an extra $1-1.5 billion compared 
to 2009, depending on volumes shipped to Europe.  However, as 
Russia advanced Ukraine close to $2 billion for transit at 
the beginning of 2009, Naftohaz will not start collecting 
transit revenue again until sometime in the spring of 2010, 
at the earliest in March. 
 
What Would a Missed Payment Mean? 
--------------------------------- 
 
¶14. (SBU) If Ukraine misses a payment, per the terms of the 
contract, Naftohaz will be forced to prepay for gas 
deliveries before the beginning of each month.  Already in 
dire financial straits, Naftohaz would probably not be able 
to prepay Gazprom.  A missed payment could also spark Russia 
to threaten Ukraine once again with "take-or-pay" penalties 
for the under-purchase of gas in 2009.  Gazprom estimates 
that total penalties from January-September 2009 total $5.9 
billion.  According to the Presidential Secretariat, total 
penalties in 2009 could reach $8.7 billion.  While Putin and 
Tymoshenko have agreed in principle that Ukraine would not be 
penalized for under-purchase of gas, this agreement has not 
been formalized in writing.  Most analysts in Kyiv expect 
that Russia will not sign a legal agreement ceding Gazprom's 
rights to impose penalties.  Indeed, many here expect that 
Russia would threaten Ukraine with penalties should Ukraine's 
new president act against Moscow's interests. 
 
¶15. (C) Putin also has again warned that Russia would turn 
off the gas to Ukraine if Ukraine siphons off transit gas for 
its own use.  If Russia turned off gas to Ukraine, transit to 
 
KYIV 00001981  004 OF 004 
 
 
Europe would be threatened.  Ukraine has enough gas in its 
underground storages to meet domestic needs over the winter, 
but it would not be able to meet its own needs and transit 
gas to Europe if Russia turns off the gas flows.  Hans Rhein, 
the EC Delegation's energy expert, told us that a growing 
concern for the EU was that Ukraine would siphon gas off the 
transit pipeline if the winter is particularly harsh.  He 
said that while Ukraine has enough gas in storage to replace 
whatever gas it might siphon from the transit pipeline, the 
transit system might not have the capability to evenly "swap" 
the gas in storage with the gas Ukraine would take off the 
pipeline.  If it seemed that Ukraine might start to siphon 
off gas from the pipeline, the EU could consider placing 
monitors in Kyiv as it had done in January in an effort to 
avoid a shut off, according to Rhein. 
 
Comment 
------- 
 
¶16. (C) Although Ukraine has significantly reduced the 
volumes of gas it plans to purchase from Russia, political 
infighting between the President and the Prime Minister and 
the dire straits of the government's budget could lead to gas 
payment problems over the winter.  Yushchenko looks 
determined to reject the Prime Minister's request to use NBU 
reserves for the gas payment, and by so doing, to create more 
problems for Tymoshenko.  For Tymoshenko, making the gas 
payment with SDRs or other government revenues could mean 
increasing the risk that pensions and wages could go into 
arrears, just ahead of the presidential election.  Tymoshenko 
could be willing to deepen Ukraine's dependency on Russia by 
forcing Naftohaz to take Russian loans for gas purchases as a 
short-term tradeoff to forestall a gas payment crisis and 
keep the government's budget afloat.  Tymoshenko could also 
be playing chicken with the IMF and the EU by threatening 
that Ukraine could miss a payment without their fiscal 
support.  Gazprom meanwhile has again ramped up its public 
relations campaign to assign blame to Ukraine for any 
possible future gas crisis.  Russia, by repeatedly warning 
that Ukraine might miss a payment, is reviving its theme that 
Ukraine is an unreliable transit partner.  Russia also seems 
to be setting the stage to blame the EU, at least in part, 
for a future gas crisis by criticizing the EU's decision not 
to extend financing to cover Ukrainian gas purchases. 
PETTIT