Russia Wields $40 Billion to End Ukraine Gas War, Win Black Sea Navy Deal

President Dmitry Medvedev awarded Ukraine $40 billion in natural-gas subsidies in return for a new lease on the Russian Black Sea Fleet’s naval base as the Kremlin strengthens ties with its neighbor after five years of tension.

“We’ve been waiting for this step for a long time,” Medvedev said after reaching the agreement with Ukrainian counterpart Viktor Yanukovych in the eastern Ukrainian city of Kharkiv today.

Yanukovych took office in February pledging to refresh links with Russia after relations soured under Yanukovych’s predecessor, Viktor Yushchenko, who sought membership in the North Atlantic Treaty Organization and appealed to Ukrainian nationalism. Russia’s 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.”

Today’s accord will free up $40 billion in “investment aid” to the Ukrainian economy, Yanukovych said. The lease on Russia’s Black Sea Fleet in the Crimean peninsula was extended by 25 years until 2042, with the possibility of a five-year extension.

Geopolitics

“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.”

The “radical and sweeping” arrangement is likely to meet political opposition within Ukraine, said Lukyanov. Still, given that Yushchenko was recently in power and the economy is in dire straits, the opposition’s options are limited, he said.

Yulia Tymoshenko, the former prime minister who lost to Yanukovych in a run-off election, said the agreement violates the constitution, according to her Web site. She urged citizens to protest in front of the parliament in Kiev on April 24 and said she doesn’t recognize Yanukovych as the lawful president.

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.

‘Step Back’

Some analysts disagreed with Medvedev’s comment that today’s deal was “technical” and “not political.”

The previous gas price agreement in January 2009 “was commended for normalizing the gas supply relationship between the two countries, by moving pricing to market pricing by 2010, and severing 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,” though “in terms of budget/balance of payments financing, the discount is a significant positive.”

Gazprom insisted all disagreements with Ukrainian state energy company NAK Naftogaz Ukrainy were business disputes, even though Prime Minister Vladimir Putin personally negotiated an end to last year’s cut-off. Ukrainian Prime Minister Mykola Azarov flew to Moscow yesterday for talks with Putin.

The Russian company 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 today.

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.

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

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