: 24-09-2003
Roman Kupchinsky: The Common Economic Zone within The CIS

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On 19 September the presidents of Russia, Ukraine, Kazakhstan and Belarus, who had gathered in Yaltas Livadiya Palace for the annual CIS summit, signed the founding document to establish a "Common Economic Zone" (CEZ). Ukrainian President Kuchma signed the document with the stipulation that the agreement would not contravene the constitution of Ukraine.

Prior to the signing a lively public debate took place in Ukraine (apparently no such debates were held in Russia, Belarus or Kazakhstan) about the legality of the accord, the need for Ukraine to join such a zone as well as the consequences this might have for Ukraines possible future membership in the European Union and the World Trade Organization.

Despite some strong initial opposition to the formation of CEZ on the grounds that it contravened the Constitution by allowing a supranational body to formulate certain policies for Ukraine and that by signing the agreement Ukraine was forfeiting its chances of joining the European Union and the World Trade Organization; opponents were soon convinced by the presidential administration that it was in their, and the nations, interests to join the zone.

Ukrainian President Leonid Kuchma, an active proponent of the CEZ, was quoted in the 15 September issue of "Kontekst" stating that : "Ukraine will never take any steps which will counter its policy of euro-integration and the CEZ must be seen as a framework for accelerated economic cooperation, the first step of which will be the creation of a free trade zone" However, speaking in Yalta on the day of the signing, Kuchma, was shown on Ukrainian television that same evening changing direction as he stated that "Europe does not want us" and therefore Ukraine was fully justified in joining the CEZ.

The parliament gave its conditional approval on 17 September, and stipulated that Kuchma could sign with the proviso that the agreement did not violate the constitution. Victor Yushchenkos "Nasha Ukraina" bloc and Yulia Tymoshenkos party left the hall in protest prior to the vote. The proposal was supported by the traditionally opposition Communists and the socialist party led by Oleksander Moroz, as well as the pro-Presidential majority.

The CEZ can be seen as the stepchild of the Commonwealth of Independent States (CIS), a Commonwealth which never elicited much support from any of its members since its founding in December 1991. Its decisions were never implemented and by 2003 it existed mostly on paper and its military quasi-alliance was largely a myth.

At the beginning of 2002 it became evident that Russian foreign policy had taken a new direction. The overriding reason being the strategic need for Russia to gain control over the transportation routes for oil and gas to the West in order to insure its continued economic growth and to gain control of Caspian oil reserves.

In February 2002 Vladimir Putin proposed a "single export channel" for gas exports from Central Asia, immediately placing himself at odds with American policy which preferred multiple channels of export. And while there were other regional economic issues such as quotas on steel pipes, sugar and grains, energy was the common denominator which led to the creation of the CEZ. The key to success of this policy lie in Russians ability to bring Ukraine into line. The two other partners, Belarus and Kazakhstan, were not deemed capable of putting up any opposition to Russias plans.

The preparatory steps for the formation of the CEZ came in early 2003 with Leonid Kuchmas election, at Putins initiative, as head of the CIS. And while Ukraine was not a full member of the Commonwealth, this tactical move did not elicit much opposition in Kyiv and was seen more as a supportive gesture by Putin towards Kuchma who was then under attack by the West for his intent to sell a radar system to Iraq. With his election, Ukraine was drawn into a leading role in the CIS which, in Moscows eyes, became a serious test of Ukrainian resolve. Seeing little fallout, Russia was given the green light to proceed.

The first signal that this new policy was being implemented came in late 2002 when Russias Gazprom suddenly pushed out Itera, an independent gas company which had been involved in transporting Turkmen gas to Ukraine and other former Soviet republics. On 6 December 2002 Itera lost its contract to transport Turkmen gas to Ukraine in favor of Eural Trans Gas (ETG), a shady shell company set up in a farm house outside Budapest by Gazprom and Naftohaz Ukraine in league with an alleged Mafioso from Moscow. ETG in fact did not transport any gas, this was done by Gazprom itself and ETG was merely a convenient money laundry and tax shelter. Itera, it seems, was standing in Gazproms way of gaining control over the pipelines and had to be neutralized. Despite US protests about this development, Gazprom pushed forward. Itera was given a minor contract to supply gas to the Saratov region in Russia at Russian domestic prices and told to stay out of the CIS market.

In order to further control the flow of gas to Ukraine, Gazprom then signed a contract in April 2003 with Turkmenistans Turkmenneftegaz by which it obtained virtually exclusive rights to purchase Turkmen gas as of 2006 for 25 years.

The current Ukrainian contract with Turkmenistan expires in 2005 and then Ukraine might be forced to turn to Gazprom to buy the 36 billion cubic meters of gas it had been buying from Turkmenistan. It is presently impossible for Turkmenistan to simultaneously sell both Ukraine and Gazprom the quantities of gas they need because of limitations on how much gas the Central Asian "Center" pipeline can carry.

The CEO of Ukraines state owned gas monopoly, Naftohaz Ukraine, Yuriy Boyko, came to Asgabat on 15 September, 4 days before the signing of the CEZ, to negotiate a new 25 year contract for gas purchases but was sent home empty handed. This information was withheld from the Ukrainian media since it might have been detrimental to Ukraines signing of the agreement in Yalta. Boyko himself later claimed, according to "Kommersant" on 16 September, that this was merely "a delay" and that the contract would be signed during Kuchmas visit to Asgabat in October.

The pipeline in Ukraine which delivers Gazproms gas to Western Europe has been a longstanding strategic target for Russia. In the past the Ukrainian leadership of Naftohaz had often been accused of siphoning off huge amounts of Russian gas and illegally selling it to customers in Poland and Slovakia. At one point Gazprom threatened to retaliate and build a prohibitively expensive new pipeline by-passing Ukraine. This would have meant a severe loss of revenue for Ukraine which was charging Gazprom for transit fees. But the idea of a new pipeline never got off the ground and seems to have been more of a bluff due to the costs involved. So an alternative plan was conceived an international consortium which would run the aging pipeline and renovate it.

The members of this consortium were to be Russia, Ukraine and Germany. The German partner, Ruhrgas, however, never committed itself to joining (either by choice or because of prodding by Gazprom not to get involved in exchange for the right to buy a larger share of Gazprom stock). The Ukrainian side, despite rhetorical commitment to the idea of a consortium, never took any serious steps to see it implemented. By the summer of 2003 the consortium idea was put on hold.

The next major factor was transport of oil.

The Odessa-Brody oil pipeline was built in the 1990s to transport oil from the Caspian to the West. At first Russia was opposed to this route, but when the British Petroleum (BP)-Tyumen Oil Company (TNK) deal to form a giant joint oil company was in the making, Russia changed its mind about Odessa-Brody. The need to transport BP-TNK oil to market made the Odessa-Brody pipeline an ideal solution. This meant that it would have to pump oil south, in reverse, from Brody to Odessa then onto tankers heading for the Mediterranean through the narrow and crowded Bosphorus. Kuchma began actively lobbying BP-TNKs interests to the dismay of America and in the face of opposition by his energy ministers. A final decision has not yet been made, but the smart money is on the "reverse direction" Kuchmas (and BP-TNKs, as well as Putins) preferred route.

A key factor in the formation of the CEZ was Kazakhstans need to find a transit route to deliver its oil and gas from the Caspian fields to Western markets. This coincided with Russias desire to neutralize the U.S. backed Baku-Tbilisi-Ceyhan oil pipeline and the Baku-Tbilisi-Erzurum gas pipeline as part of the "multi-directional" routes for Caspian energy to the West which were a cornerstone of American policy in the region designed to prevent possible energy blackmail by Russia. When Kazakhstan signed the CEZ accord on September 19th these American plans suffered a serious setback.

In 2003 Russia began concerted pressure on Georgia to reconnect its pipeline to Russias. Then Russia obtained the right to transport nearly all of Kazakhstans current and projected oil production through Russian pipeline networks. But for this oil to get to Western European markets it had to enter a pipeline system not controlled by Russias Transneft, but by Ukraine and Belarus. By bulldozing the later into a common economic zone, Russia would have the legal framework with which to establish at first control over these pipelines and eventually to discuss their ownership.

In the case of Belarus, the Russians employed less then subtle tactics. On the eve of the CEZ signing ceremony, Gazprom announced that in light of Belarus refusal to let Gazprom have control over its gas pipeline, Gazprom would be forced to charge the CIS price for gas and not the domestic Russian price it had charged Belarus thus far. This would have created an enormous debt and the danger that gas deliveries might end altogether.

A few days before the signing, Gennadi Seleznov, the speaker of the Russian Duma, told the press that Russia might consider abolishing the newly imposed tariff on Russian gas to Ukraine if the Ukrainians signed on to CEZ. This was not a promise, which Seleznov was not empowered to make, but a virtual carrot. The newly imposed tariff would create new financial problems for Ukraine, but at the same time, Gazprom announced that Ukraine would now be allowed to earn money by selling Russian and its own gas directly to Western Europe, provided they did so using the offices of Gazexport, a fully owned Gazprom subsidiary. This, in theory would compensate the Ukrainians for the newly imposed tariff and leave them some pocket cash.

By 19 September the groundwork for the CEZ signing was ready. It was only the first step of what promises to be a long and possibly turbulent process. The next phase of the CEZ will most likely come after the Russian Duma and Presidential elections.

In order for CEZ to function and achieve its goals, it will need an executive and the power to make and enforce new regulations within the economic zone. The idea of a common currency, the ruble, has already been floated to judge the extent of opposition to it. A CEZ executive body with legal powers to legislate economic policy would necessitate a revisal of the Ukrainian constitution to reflect this new reality. Given the nature of the pro-Presidential majority in the Ukrainian parliament, this might not be a problem, but it will create deep divisions in the country and could lead to a serious backlash. With presidential elections scheduled in 2004, the current proposal by Kuchma to have parliament elect a president seems more of a maneuver to prolong the status quo and prevent any future revisions to membership in the CEZ.

It cannot be excluded that in the future the CEZ executive might decide that they should manage the Ukrainian and Belarus pipeline systems through "Transneft" or some future CEZ controlled multinational pipeline company which would insure that all concerned parties share in the proceeds, commensurate to their economic might and input. Given that the bulk of the oil and gas transiting these corridors would be Russian and Kazakh, the Ukrainians and the Belarusians could very well be left holding a bag of air.

As to the question of Ukraine eventually joining the EU or WTO, despite the optimism voiced by some Ukrainian officials that one does not contradict the other, the reality seems to be different. By taking an active position on the side of Russia in the "Great game" of Caspian oil, the Ukrainians might well have preempted their chances of membership at this stage. What will happen as the CEZ evolves remains to be seen.

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