Ukraine Enters Final Russia Gas Push as Yanukovych Seeks to Duck Demands

Ukraine’s talks with Russia over cheaper natural-gas imports failed to make a breakthrough as it seeks to avoid the increases in household fuel costs needed to revive a $15.6 billion bailout.

Energy and Coal Minister Yuriy Boyko met the head of OAO Gazprom (GAZP), Russia’s gas export monopoly, in Moscow today without reaching a deal, according to company statement. Negotiations will continue, Gazprom, the world’s largest gas producer, said.

Ukraine must agree on a lower price with Russia within a month or bow to International Monetary Fund demands for a 30 percent jump in household gas fees, Deputy Prime Minister Serhiy Tigipko said Jan. 11 amid signs of rising tensions between the two nations. The government, which faces $8.2 billion in debt payments in 2012, wants to bolster state finances after the current-account deficit widened and reserves dwindled.

“To get through the year, the government must agree on a lower gas price, sell assets or do a deal with the IMF,” Barbara Nestor, emerging-market strategist at Commerzbank AG in London, said Jan. 13. “We expect market pressure to increase on Ukraine.”

While raising household gas tariffs would reduce losses at state energy company NAK Naftogaz Ukrainy, higher heating costs may prove unpopular as President Viktor Yanukovych’s ruling party braces for elections in October.

Credit-default swaps to insure the country’s debt against non-payment for five years have jumped 72 basis points this year to 928 points on Jan. 16, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers.

No Date Set

No date has been set for the next meeting between Ukraine and Gazprom officials, Sergei Kupriyanov, a spokesman for the Moscow-based company, said by phone. Boyko and Chief Executive Officer Alexey Miller had a “constructive meeting” and agreed to continue negotiations, Gazprom said in an e-mailed statement.

Ukraine was granted its second IMF bailout in two years in July 2010. Having disbursed $3.4 billion, the Washington-based lender froze the program last March after the government refused to raise household gas tariffs to trim a budget deficit that reached 4.3 percent of gross domestic product in 2011, according to the Finance Ministry.

The gap was 2.7 percent of GDP, excluding a 20.6 billion- hryvnia ($2.6 billion) shortfall at Naftogaz and measures to recapitalize banks, the ministry said Jan. 14 on its website.

Pipeline Offer

Instead, Ukraine wants to reduce the price it pays Russia for gas by a third to $250 per 1,000 cubic meters, Yanukovych said Dec. 21. Under the current contract, the price will rise to $416 per 1,000 cubic meters this quarter from $400 in the previous three months, Boyko said Jan. 13.

Gazprom has sought to acquire Ukraine’s pipelines, which carry Russian gas to the European Union, in exchange for cheaper energy supplies, according to Boyko. Belarus reduced its payments to Russia under a similar deal in November.

“Ukraine won’t consider selling its pipelines,” Boyko said. “If we find a model that satisfies both sides, we’ll make a deal. Otherwise, we’ll work under the current contract.”

Gazprom has agreed on revised tariffs with five more European customers, including GDF Suez SA and its Wingas venture with BASF SE, to reflect the gas market, Deputy CEO Alexander Medvedev said today. Lower spot-market prices have spurred European demands for cuts in Gazprom’s long-term contract rates.

International Arbitration

Ukraine may seek international arbitration if talks with Russia fail, the Interfax news service cited Ukrainian Premier Mykola Azarov as saying today.

Ukraine’s economy grew about 5 percent in 2011, the fastest pace since 2007, helped by a good harvest and exports, Azarov said Jan. 11. Growth may slow to 3.9 percent this year, the government forecasts.

The current-account deficit widened to $8.75 billion in the first 11 months of last year compared with $2.13 billion in the same period of 2011 because of increased gas imports and strong demand for foreign equipment, the central bank said Jan. 4.

Gold and foreign-exchange reserves shrank to $30.4 billion at the end of 2011 from $38.2 billion in August as the central bank supported the hryvnia. The currency slid to 8.0435 per dollar yesterday, its lowest level in almost two years, before strengthening 0.2 percent to 8.0253 today.

Depleting Reserves

Without an IMF deal, “the government will have to continue depleting its limited foreign-currency reserves to meet its external debt obligations,” Liza Ermolenko, an emerging-markets economist at Capital Economics Ltd. in London, said Jan. 13 by e-mail. “With over $50 billion in short-term external debt to be repaid this year by both the government and private sector and a hefty gas bill, this is hardly a sustainable strategy.”

The yield on Ukrainian government dollar bonds maturing in 2017 fell for a second day to 10.901 percent, according to data compiled by Bloomberg.

Ukraine relies on Russia for more than 70 percent of its gas needs. Should talks fail, it plans to cut 2012 imports to 27 billion cubic meters from 40 billion last year, Boyko said.

That would violate a contract signed after Russia cut gas supplies to Ukraine for almost three weeks in January 2009, leading to disrupted deliveries to the EU amid freezing temperatures, Gazprom said Jan. 12.

$14 Billion Compromise

“Gazprom and Ukraine differ sharply on how much gas Ukraine should buy in 2012, with the value of the difference being $10 billion,” analysts at UralSib Financial Corp. led by Alexey Kokin said in a report today. “We expect a compromise, with Russia supplying about 35 billion cubic meters of gas at $400 for a total value of $14 billion.”

Yanukovych says that deal is detrimental to Ukraine’s financial health. A court in Kiev in October sentenced former Prime Minister Yulia Tymoshenko, who signed the contract with her Russian counterpart Vladimir Putin, to seven years in prison for abuse of office. She denies wrongdoing.

Ukraine may also be able to increase domestic gas and coal production and shift utilities to coal, saving 6 billion cubic meters of gas a year, according to Boyko.

The government has sufficient resources to sustain itself until the parliamentary elections without turning to the IMF or raising gas prices, according to Ivan Tchakarov, chief economist for Russia and the Commonwealth of Independent States at investment bank Renaissance Capital in Moscow.

Not ‘Sufficiently Dire’

“Irrespective of how the negotiations with Russia evolve, the Party of Regions is not yet in a sufficiently dire position to surrender to the IMF’s requirements,” he wrote yesterday in an e-mailed note. “The government macroeconomic and budget framework is already based on the new high import gas price.”

Support for Yanukovych’s Party of Regions fell to 13.9 percent support in December from 16.6 percent three months earlier and 39.1 percent in April 2010, the Razumkov Center for Economic and Political Studies in Kiev said Dec. 27. Backing for Tymoshenko’s party rose to 15.8 percent from 13.8 percent. The survey of 2,008 voting-age Ukrainians was conducted Dec. 9-16 and had a margin of error of 2.3 percentage points.

Yanukovych last week ruled out higher household gas prices. While steps must be taken to address Ukraine’s financial position, selling the pipeline infrastructure may be preferable for the president as voters focus on their own fortunes.

“Economic growth won’t catch up with the gas-price increase,” Alexander Pecherytsyn, head of research at ING Groep NV in Kiev, said Jan. 13 by phone. “Voters look at their pockets first of all. They don’t care about gas pipelines.”

To contact the reporters on this story: Daryna Krasnolutska in Kiev at dkrasnolutsk@bloomberg.net; Anna Shiryaevskaya in Moscow at ashiryaevska@bloomberg.net.

To contact the editor responsible for this story: Balazs Penz at bpenz@bloomberg.net; Will Kennedy at wkennedy3@bloomberg.net.

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