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Russia/Ukraine: Moscow Reaches Energy Accord With Kyiv

Russia's gas giant Gazprom has found a way to avoid $700 million in taxes as it collects $1.4 billion in debt from Ukraine. So far, the Russian government has taken little notice of the revenue loss, and it may see bigger benefits in letting the deal go ahead.

Boston, 23 April 2003 (RFE/RL) -- Ukraine has ended a three-year argument with the Russian gas monopoly Gazprom, but the solution may cost the Russian budget $700 million.

So far, Moscow appears willing to forgo an enormous amount of budget revenue in order to close the books on one of the longest-running disputes in the Commonwealth of Independent States (CIS), as it consolidates control over the region's gas supplies.

Last week, officials announced that the Ukrainian state petroleum company Naftohaz Ukrayiny had agreed with Gazprom to pay $1.4 billion in debt for Russian gas with eurobonds.

Ukraine ran up the huge bill in 1999 and 2000 by diverting gas from the former Soviet pipelines that cross its territory on the way to Europe, which relies on Russia for one-fourth of its gas.

The problem of Ukraine's gas debt has ruffled relations with Russia for years. Officials previously announced they had settled the issue in October 2001, but eight months passed before they disclosed that they had overlooked a massive tax liability that stopped the debt deal dead in its tracks.

After nearly two years of negotiating the agreement, someone at Gazprom apparently realized that if it accepted Ukraine's bonds as payment, the company would owe $700 million in taxes to the Russian state. The discovery caused Gazprom to refuse acceptance of the bonds for more than a year.

It has taken that long for officials to figure out how Gazprom can collect Ukraine's debt while ducking the tax. On 18 April, Yuriy Boyko, Naftohaz's chief executive, told reporters in Kyiv: "We will transfer the papers by 1 July. We have found a scheme which is convenient for Gazprom."

The scheme involves transferring the bonds to Gazprom at a discount, while Gazprom will pay for much of its gas transit to Europe through Ukraine with gas instead of cash.

The murky details may matter less than the results, because the debt problem has been holding up the formation of an international consortium that will manage Ukraine's gas-transit system. The pipelines are Russia's main export route for gas to the European Union and a lifeline for EU energy supplies.

The consortium plan could end a decade of tension over Russia's ability to secure its export routes after the Soviet breakup, when Ukraine gained unexpected leverage through control of the pipelines.

The consortium plan will fudge the control question because neither country will hold a majority of the shares, although the group will be organized under Ukrainian law. If the gas companies of Germany and France join the consortium, as expected, it can be argued that Gazprom's power will be diluted even more, while billions of dollars in investment can be channeled to improving the Ukrainian lines.

On the other hand, Ruhrgas of Germany and Gaz de France are also top Gazprom customers and partners, making it a close call as to who will wield power. Fifty-one percent of Gazprom shares are owned by the Russian state and Gazprom itself. Ukrainian President Leonid Kuchma seems to see the benefit of proceeding anyway, in part because Russia has spent years planning bypass routes for gas transit around Ukraine.

Moscow now seems to be as ready to gloss over the tax question as Kyiv is willing to fudge the control issue. Both may see overriding benefits in going ahead.

But so far, there has been surprisingly little notice given to the size of Russia's tax loss. By comparison, the amount is almost as large as the $775 million that the government was supposed to get from the sale of its 5.9 percent stake in oil giant LUKoil on the London share market in December 2002. Last month, the Russian State Duma launched an inquiry after reports that those funds also never reached the state treasury.

But Gazprom's $700 million in taxes may be written off in the midst of a sweeping consolidation from which Russia may emerge as master of nearly all the region's gas. This month, Russia signed a 25-year import and cooperation deal with Turkmenistan that seems likely to dominate that country's gas sector.

This week, Naftohaz's Boyko gave assurances that Ukraine would also sign a 25-year gas pact with Ashgabat, but Turkmen President Saparmurat Niyazov said that Kyiv's supplies will depend on building a new $1 billion pipeline, because commitments to Russia will fill all existing lines. Russia's move may again raise questions of energy security for Ukraine, making it eager to put the debt and consortium issues to rest.

Russia's deal with Turkmenistan follows a 10-year gas cooperation pact with Kazakhstan signed in late 2001 and the formation of a Gazprom joint venture last June for transit and foreign sales. In December, Uzbekistan also signed a cooperation and sales agreement with Gazprom, which is good through 2012.

In one sense, the consolidation may be a natural product of the geography that the Soviet Union left behind, making it hard for CIS countries to export without Russia. But there are also signs that Moscow wants to maximize its role in tangential spheres.

One example is President Vladimir Putin's call last week for CIS countries to coordinate policies on joining the World Trade Organization (WTO) as they move toward creating a unified economic space. Speaking at a meeting of officials from Belarus, Ukraine, and Kazakhstan, Putin said, "We know how to reach the goal, but there are major obstacles on our road to it," the RIA-Novosti news agency reported. "I mean the four countries must coordinate their stances as they join the WTO," Putin added.

The EU's demand that Russia raise its domestic gas prices to world levels remains the biggest roadblock to Russian membership. The EU is upset that its gas prices are kept high so that Russia's can stay low. But Russia's growing control over gas in all the neighboring countries could turn into a unified front to resist the EU's demand.

If Russia can hold the line on gas prices, $700 million in lost taxes might be a small price to pay.