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Russia Pays $40 Billion to End Ukraine `Gas War,' Extend Navy Base Deal

President Dmitry Medvedev agreed to spend $40 billion to cement Moscow’s ties with Kiev after five years of tension by cutting gas prices to Ukraine in return for an extended Russian naval presence in the Black Sea.

Russia will cut the natural-gas prices it charges Ukraine by 30 percent in a deal that obliges Ukraine to import more gas from its neighbor to the east. As part of the accord, Russia will keep its Black Sea Fleet base 25 years longer than the existing lease allows.

“We’ve been waiting for this step for a long time,” Medvedev said after striking the deal with his Ukrainian counterpart Viktor Yanukovych in Kharkiv, Ukraine, yesterday.

Yanukovych took office in February pledging to refresh ties with the Kremlin after relations soured under his predecessor, Viktor Yushchenko, who had sought membership in the North Atlantic Treaty Organization and tried to reduce Ukraine’s dependence on Russia. Moscow-based gas exporter OAO Gazprom cut deliveries during annual price disputes, twice disrupting supplies to European customers dependent on Ukraine’s pipeline network.

“It looks like a peace treaty after a war,” said Mikhail Korchemkin, director of East European Gas Analysis in Malvern, Pennsylvania. “This deal will be valid as long as Ukraine behaves. If they do something the Kremlin doesn’t like, the discount will be canceled.”

Geopolitics

The $40 billion is to be considered “investment aid” in Ukraine’s economy, Yanukovych said. The lease on Russia’s Black Sea Fleet base on the Crimean peninsula was extended until 2042, with the possibility of a five-year extension.

“This is a geopolitical success,” said Fyodor Lukyanov, editor of Russia in Global Affairs magazine. “The naval base itself isn’t worth that much, but it’s a sign that Russia will remain the major power in the post-Soviet space.”

Russian Prime Minister Vladimir Putin today welcomed the agreement as a “breakthrough.” He said the gas price discount will come from the Russian budget and warned other recipients of Russian gas that further gas contracts won’t be reviewed.

Yulia Tymoshenko, the former prime minister who lost to Yanukovych in a run-off election, said the agreement violates Ukraine’s constitution, according to her Web site. Yanukovych declined to rule out a referendum on the issue.

Citizens’ View

“As soon as we adopt the necessary legislation for conducting a referendum, there will be many questions and we will have to check our view against the view of the citizens,” Yanukovych told reporters in Kiev today.

Given that Yushchenko held power until recently and the economy is in dire straits, the opposition’s options are limited, Lukyanov said.

Cheaper Russian gas will let the government end subsidies to households and utilities, a condition the International Monetary Fund has said must be fulfilled before it resumes its bailout.

The deal is “technical and not political,” Medvedev said, echoing Gazprom’s past insistence that its disagreements with Ukrainian state energy company NAK Naftogaz Ukrainy were business disputes.

Putin personally negotiated an end to last year’s cut-off and met with his new Ukrainian counterpart Mykola Azarov the day before Medvedev sealed the deal.

‘Severed’

The last gas price agreement of January 2009 helped move the two countries’ energy relationship to market pricing and “severed the geopolitical strings attached to previous deals,” said Timothy Ash, head of emerging market research at Royal Bank of Scotland Plc in London.

“Clearly, this agreement is a step back in terms of the latter point in particular,” he said, adding that the discount is still a “significant positive.”

The yield on Ukraine’s dollar-denominated 7.65 percent note maturing 2013 slipped 2 basis points to 6.18 percent at 2:45 p.m. in Kiev. The hryvnia gained 0.6 percent against the dollar to trade at 7.8662.

Gazprom agreed to a 30 percent discount on 30 billion cubic meters of gas this year, as long as the savings don’t exceed $100 per 1,000 cubic meters. It will increase imports to Ukraine to 36.5 billion cubic meters in 2010, Chief Executive Officer Alexei Miller said in Kharkiv.

The discount “makes sense,” Korchemkin said, since Ukraine was paying the highest price for Russian gas among European consumers in the first quarter. Gazprom’s stipulation that the existing price formula remains in place will give Russia leverage over Ukraine in the future, he said.

Transit fees for Russian gas headed to European markets remain unchanged, Gazprom spokesman Sergei Kupriyanov said by phone. Yanukovych’s suggestion earlier this year that Gazprom participate in an international consortium to operate Ukrainian pipelines wasn’t discussed, according to Kupriyanov.

Yanukovych said today his country wants to construct a civil nuclear facility with Russia’s assistance, without specifying a timeline. Ukraine is in talks with Russia on the matter, he said in Kiev.

To contact the reporter on this story: Lucian Kim in Moscow at lkim3@bloomberg.net

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