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Cablegate: Tymoshenko Turns Up Heat On Gas Middleman Ukrhazenerho

VZCZCXYZ0007
RR RUEHWEB

DE RUEHKV #0162/01 0251222
ZNR UUUUU ZZH
R 251222Z JAN 08
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC 4791
INFO RUCNCIS/CIS COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHZG/NATO EU COLLECTIVE
RHEBAAA/DEPT OF ENERGY WASHINGTON DC

UNCLAS KYIV 000162

SIPDIS

SENSITIVE
SIPDIS

DEPT FOR EUR/UMB
EEB/EEC/IEC-GALLOGLY/WRIGHT
DOE FOR LEKIMOFF, CCALIENDO, EMCGINNIS
USDOC FOR 4231/ITA/OEENIS/NISD/CLUCYK

E.O. 12958: N/A
TAGS: ENRG EPET ETRD PREL UP
SUBJECT: TYMOSHENKO TURNS UP HEAT ON GAS MIDDLEMAN UKRHAZENERHO

REF: KYIV 0014

Treat as Sensitive but Unclassified. Not for Internet.

1. (SBU) Summary. Tymoshenko's new government recently launched its
first strike against intermediaries connected to RosUkrEnergo (RUE)
in the gas trade with Russia. The National Electricity Regulatory
Commission (NERC) of Ukraine limited UkrHazEnerho's (UHE) (Note: a
joint venture between RUE and NaftoHaz.) license to supply gas at
unregulated tariffs - those to the lucrative industrial sector -- to
5.04 bcm/year, an amount equal to roughly 10% of its 2007 sales.
Should this cap survive a UHE lawsuit, UHE presumably would lose the
bulk of its direct industrial customers and the associated profits
to other gas suppliers. NaftoHaz's poor financial standing has
often been attributed to UHE, as UHE inherited gas delivery profits
that had previously been earned by NaftoHaz, although it is not
certain the new restrictions on UHE will benefit NaftoHaz. Adding
to the pressure on UHE, an interagency commission is attempting to
scrutinize UHE's financial operations. Tymoshenko's bold move
against UHE's dominance in the domestic market might have the
additional benefit of weakening RUE, which she promised to remove
from the gas deal in her September 2007 campaign. End Summary

The Roles of the Intermediaries
-------------------------------

2. (U) Two controversial intermediaries exist in the Ukrainian gas
market - RUE and UHE. RUE, a joint venture nominally owned by
Russia's Gazprom (50%) and Ukrainian businessmen Dmytro Firtash and
Ivan Fursin (with a reported 45% and 5% share respectively), is the
monopoly supplier of natural gas to Ukraine since January 2006. As
part of the January 2006 deal, UHE, a joint venture owned in equal
shares by RUE and NaftoHaz, was created to purchase gas from RUE and
sell it to NaftoHaz and directly to consumers.

NERC Restricted UHE's Supply License from Outset, but Lost Court
Battles
-------------

3. (U) After the creation of UHE, the NERC initially issued it a
five-year license to supply up to 5.04 bcm/year gas at unregulated
tariffs, thereby giving it limited access to the lucrative
industrial segment of the market. UHE appealed the decision and, in
May 2006, Kyiv's economic court upheld their complaint and ordered
the restrictions lifted. The NERC attempted to have the ruling
reversed in the court of appeals, but the ruling was upheld.
Shortly after the appointment of the Yanukovych government in August
2006, the then-head of the NERC, Sergiy Titenko, removed all
restrictions on gas volumes supplied by UHE. As a result, UHE
quickly dominated the industrial segment of Ukraine's domestic gas
market.

UHE's Gains are NaftoHaz's Losses
---------------------------------

4. (U) In 2007, UHE sold up to 40bcm of gas to industrial customers
at a considerable profit, according to press reporting. Its
profitability came at the expense of NaftoHaz, which had
historically used revenues from the unregulated industrial sector to
compensate for its losses in the regulated residential and district
heating sector. Sales to industry had been its second largest
source of revenue (after its gas transit business); from the first
half of 2006 to that of 2007, NaftoHaz's net income reportedly
dropped by more than 50% while debts accumulated. To prevent
NaftoHaz from sinking into bankruptcy, the GOU recently provided
state guarantees on NaftoHaz's outstanding debts (reftel).

NERC Reinstates Limit on UHE; Cites Court Case
--------------------------------------------- -

5. (U) On January 8, 2008, the NERC passed a resolution that
reinstated the 5.04 bcm limit on UHE's supplies to the unregulated
(industrial) sector. According to press reports, the NERC's
newly-appointed Chairman Valerii Kalchenko explained that the Higher
Economic Court had overturned the earlier court decisions a year
ago. He also stressed that UHE is a structure affiliated with
NaftoHaz and that, according to Ukrainian legislation, the total
share a business group possesses in the gas market could not exceed
35%. Given the existing licenses belonging to other NaftoHaz
enterprises, Kalchenko argued the remaining volume of gas available
for delivery by UHE was 5.04 bcm. According to Kalchenko, UHE is
free to sell any additional volume to other suppliers.

UHE Will Sue------------

6. (U) UHE disputed that any court decision exists allowing NERC to
revoke previous licenses and stated it intends to sue NERC to
reverse its decision. It has warned that disruptions in supply, and
to gas transit from Russia to the EU, could occur if the restriction
was upheld. However, UHE's spokesman stated that it had signed
agreements until 2012 with more than 200 Ukrainian customers and
would do its best to fulfill them until the issue is resolved in the
courts.

UHE also Protests Scrutiny of its Financial Operations
--------------------------------------------- ---------

7. (U) Earlier this week, members of the interagency commission to
audit NaftoHaz twice attempted to enter UHE offices to scrutinize
its financial operations. UHE refused them entry, stating that the
attempt violated the constitution, the Civil Code, and other laws of
Ukraine and was an attempt to exert administrative pressure on the
company. UHE has reportedly written a letter requesting resolution
of the issue to the Chair of the Commission, First Deputy Prime
Minister Oleksandr Turchynov.

8. (SBU) Comment. Tymoshenko has repeatedly stated her intention to
eliminate UHE and RUE as intermediaries in the gas market - a goal
the USG has long supported. Based on recent activity, she appears
determined to keep those campaign promises. She seems to be
focusing the initial assault on UkrHazEnerho, although she has
publicly continued to call for removing RUE as well. Capping UHE's
operations would deal a serious blow not only to UHE but, due to its
ownership stake, RUE. (Note: The direct financial effect on RUE is
unclear, since it is completely murky what financial flows and
dividends move between UHE and RUE. Reportedly, UHE has yet to pay
2006 dividends to NaftoHaz, even though NaftoHaz owns a 50% share.
End note.) Another sign of this pressure on UHE was the recent
removal of Ihor Voronin, UHE's CEO, from his position as a deputy
chairman of NaftoHaz. What is not clear is who will step into the
void created by the NERC's new limits on UHE's direct sales. It is
possible that NaftoHaz or regional gas distributors could take over
this role, but some observers have speculated that other gas traders
could begin supplying industry, which up to now had been virtually
monopolized by UHE.
Taylor

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