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Yesterday's Gas Deal: Another Nail in Ukraine's Coffin

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This post first appeared on Russia Insider

The facts on yesterday's deal:

Existing Debt
Ukraine will pay $2 billion straight away on the existing debt it owes Russia. It will then pay a further $1.1 billion in instalments before the end of year. This is lower than Russia's earlier demands that Ukraine pay $5 billion off in debt, it is unclear how Russia has positioned itself regard this $1.9 billion. 

<figcaption>Natural Gas Ukraine's Flaming Hot Potato </figcaption>
Natural Gas Ukraine's Flaming Hot Potato

Natural Gas Supplies
Russia has agreed to sell Ukraine gas at a price of 385 dollars per 1000cm once the initial 2 billion debt tranche is paid off. The price is considered to be a 100 dollar discount to the actual price which will restart again after 6 months. Meaning, 485 dollars per 1000cm of gas from March 2015.

Government approval 
Both parties must now have the deal approved by their respective governments. 


Paying back the debt will put significant strain on the currency as the dollars will have to be bought from the market. It is most likely that the dollars will come from the IMF loan. But given that most of the loan will now be used simply to pay for the gas, the loan size is hugely inadequate. If the IMF are serious about supporting Ukraine they will have to significantly increase the loan size as has already been reported.

The deal to sell gas at 385 dollars for 6 months simply delays the crisis past winter to allow Ukraine to survive. In exchange for allowing Ukraine to have gas through the winter, Russia will have received money back on its debts which Ukraine previously held at ransom. Ukraine though as already mentioned does not have enough money to pay for the old gas debt, let alone the new gas itself. 

Government approval in Russia is not an issue. In Ukraine, however, there is a good chance that the deal gets blocked by the Rada and extreme parties who are jockeying for votes ahead of the upcoming election. The IMF bailout and current legislation would remove the subsidies on the gas price and hence this is a price Ukrainian consumers cannot afford to pay. 

Ukraine is again being forced to make a choice between Europe and Russia. If Ukraine continues down its path towards Europeanization, Russia will make it as expensive as possible for Ukraine. Ultimately, the IMF and the US will have to pick up the tab for that. If the West is serious about backing Ukraine then a bailout package which is three or four times the size or even more is needed. 

Ukraine's most fundamental economic issue going forward is a balance of payments one. Ukraine must sell goods to pay for the energy it imports. Traditionally it has sold these goods to Russia. But if Ukraine chooses a path of Europeanization, it cannot sell to Russia, it must therefore change its economy to sell to Europe - a process which will take more than five years to execute. Thus, in the mean-time the IMF must give Ukraine free money, grants not loans, so that it can finance itself while the economy adjusts. 

Yet, therein lays the problem - free money. If Ukraine was not a corrupt country this would not be such a hard issue to get around. However, when free money gets handed out it is inevitably always stolen as is already happening with IMF money in Ukraine, as we discussed in a previous article.

The West has yet to realize that firstly it will need to pay a figure closer to 100 billion to keep Ukraine afloat and that secondly the money may not solve anything and just be stolen. The IMF will at some point be forced to pull the plug. 

Once the IMF has pulled the plug on Ukraine, then Ukraine has no choice but to go back to Russia cap in and hand and join the Customs Union and not the European Union. That is of course if Ukraine will not have already overthrown the current government and chosen the Russian path itself for pure economic survival.

Greece has seen government after government during its IMF and EU bailout and they did not have to contend with a civil war and with the option of having an easy way out (with Russia).

The notion that the Ukrainian government can survive in its current state is pure fiction of the most imaginary kind. 


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