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Battle of the Ukrainian Oligarchs: the Chocolate King versus the Gas Princess

At the end of my second blog on democracy and oligarchy in Ukraine, I came to a gloomy conclusion that there would be no real effort to curb the power of the oligarchs, and that it will be the common Ukrainians who will have to bear the costs of reforms. All this came to pass even faster than I expected.

The International Monetary Fund (IMF) bailout of Ukraine, which was announced last week, will result in an already very low living standards in Ukraine crashing even lower.

The Ukrainian government has already increased the price that the population pays for gas by 50 percent (and further increases may occur down the road). This raises the specter of thousands of people unable to pay for heating their apartments during the coming winter. These are likely to be the old folks whose only source of income is a state pension. Pensions will be cut drastically, perhaps halved, because the IMF requires the government to balance its books. Many state employees will be fired, and the salaries of the rest reduced.

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So popular immiseration in Ukraine is set to deepen dramatically. What about the other end of the wealth scale? Things there look very grim, too.

A unifying message of the Maidan uprising in Ukraine was that people had it enough with the oligarchic rulers of Ukraine. One of the leaders of Maidan, the retired boxer Vitaly Klichko, has been a vocal critic of the corrupt Ukrainian politics. Klichko, is not your common Ukrainian (with an estimated wealth of $65 million), but he is small potatoes, compared to real oligarchs (with fortunes of at least $1 billion).

But the latest news is that Klichko decided to step down as a presidential candidate. Although there are other candidates, it is generally acknowledged that the race now is between just two individuals, Petro Poroshenko and Yulia Tymoshenko. I have already written about Tymoshenko, who made a huge fortune (estimated at $1 billion) from murky gas-trading deals during the chaotic 1990s. Poroshenko, on the other hand, made his fortune in the confectionery industry.

Not anybody who is super wealthy is an “oligarch,” of course. The sources of true oligarchic power must include both a huge fortune and the access to the highest levels of political power. Both Tymoshenko and Poroshenko fit this definition perfectly, since both have been in and out of government, occupying a variety of posts. Since 1999 Tymoshenko has been the Deputy Prime Minister for Fuel and Energy and Prime Minister (twice). Poroshenko hasn’t climbed quite as high as that, but he occupied the two next most powerful posts in the government: Minister for Foreign Affairs and Minister of Trade and Economic Development. Just as Kevin Philips wrote, political power begets economic power, and economic power begets more political power. At least, that’s how it works in oligarch-dominated countries.

It’s highly ironic that when the corrupt Yanukovich fell, crowds of Ukrainians flocked to marvel at his palatial residence.

The problem is that the next Ukrainian president is likely to be even more of an oligarch than Yanukovich (who must be a very wealthy man, but unlikely to be in the same league as Poroshenko and Tymoshenko).

 

As the French say, plus ça change, plus c’est la même chose (or, less elegantly in English: the more it changes, the more it’s the same thing). Are we going to see another insurrection, this time against Poroshenko (or Tymoshenko, whoever wins the elections)? If so, at least we will get to see the interiors of their palaces…

22 Comments

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22 Comments

  1. Misha says:

    Accumulation of the errors by EU can change situation dramatically next weeks.All recent attempts to suggest that Russia must pay for Ukraine economy rebirth is consodered as systemic nonsense in Russia. Thus, two conflicting points created by EU in Febr 2014 may produce new unexpected catastrophes ( in Thom’s sense ) beyond horizon of prediction.Easy and soon.

  2. O.Voron says:

    What else is new?

    First two powerful elite groups clash, then the victors have to sort it out between themselves.
    The little guy is first used as a cannon fodder, then left to pick up the bill. No much difference from Egypt ‘revolution’ situation described in the previous blog. Only some cultural details differ.

  3. dashui says:

    They are just plantation managers.
    The big winners will be the western corporations and banks.

    • Richard says:

      The “plantation managers” are pretty frickin’ rich. I’d like to be such a plantation manager.

      Poroshenko is estimated to be worth about 1.3B, which is more that the wealth of any one of the CEO’s of every single major American or European bank.

  4. pjricherson says:

    Isn’t a likely prognosis that Putin sits back for a while until IMF austerity and oligarch greed and incompetence do such damage to the economy that in a year or two first the Southeast and then the West of Ukraine beg Putin to come in and fix the economy? NATO seems to have bitten off more than it can chew economically and politically as well as militarily. I’d be interested to know what portion of Ukrainian troops in Crimea too up the Russian offer to join Russian and double their pensions and salaries. Maybe, just maybe, the Ukrainians will elect a president that can bring the oligarchs to heel and start to manage the economy competently. As Peter says, there is no such hopeful sign in the reportage I’ve seen.

    • O.Voron says:

      ‘ I’d be interested to know what portion of Ukrainian troops in Crimea too up the Russian offer to join Russian and double their pensions and salaries.’

      According to Ukrainian officials, less than one quarter returned to Ukraine. So, more than three quarters switched sides and joined Russian troops.

      • Peter Turchin says:

        That’s what I also read. Having your salary quadruple was one factor; another was that in Ukraine many troops serve near their homes, so many Ukrainian soldiers in Crimea were Crimeans.

    • Peter Turchin says:

      Pete, I prefer not to psychoanalyze Putin, but to look more broadly at what kind of views are expressed by the elites and the general population. In my view, the only ones beating the drum to seize eastern and southern Ukraine are the extreme nationalists, who are in small minority, and they don’t include Putin and his inner circle. For the majority of the elites and population there is a big difference between Crimea and eastern Ukraine. Crimea, and Sevastopol in particular, is Sacred Land. Donetsk or Kharkov are not. Putin and Lavrov have been insisting that they have no intention to expand further into Ukraine, and I tend to think they mean it. I think they will wait for Ukraine to fall to pieces, economically speaking, and then try to bring it into a more pro-Russian, or at least more neutral stance. They have also been pushing for a federalization of Ukraine.

    • Richard says:

      “beg Putin to come in and fix the economy”

      To subsidize it, you mean? Russia, however, is not exactly in great economic shape to fix or subsidize anything else of size, however.

  5. Peter I have enjoyed your analysis of the Crimea conflict but in the summary above it sounds as if you are dismayed at the decision to partially remove the gas subsidies. However, given that the Ukraine is facing bankruptcy and that the gas subsidies accounted last year for a massive 7.5% of GDP, it seems inevitable that they have to be removed. They are a hangover from the soviet era and the state cannot support them, so what alternative is there?

    • Peter Turchin says:

      The reason they are removed now is to balance the state budget. But there are other ways to balance the budget, for example, to make the oligarchs pay taxes. Right now they evade taxes on most of their income. At the very least, shouldn’t the pain be spread more evenly?

      • On that point I definitely agree but cracking down on tax evasion would be something that requires time before Ukraine could receive the benefit and it would still ultimately need to do something about the subsidies. It’s a terrible situation for the average people in Ukraine but I think the cuts are unavoidable given their current economic situation.

        • radek says:

          Under some circumstances “austerity” – for example, in US last September – is a matter of choice. One can evaluate the costs and benefits of it and pick yes/no. In those circumstances, basically, you want to do “austerity” when you’re economy is booming and “anti-austerity” when it’s doing bad.

          But there are also circumstances when “austerity” is just what’s going to happen one way or another, and the only choice you have is how you’re going to implement it. There’s basically three ways that government can fund its spending. Taxes, borrowing or printing money. Printing money to finance a government deficit leads to very high inflation very quickly, and if the country tries to manage its exchange rate, to an attack on the currency, a drastic depreciation and the resulting balance sheet effect which increases your outstanding debt and can actually make your deficit worse (as long as your debt is denominated in foreign currency – which for most countries it is). What about borrowing? To be able to borrow, you’ve got to have someone willing to lend. If no one’s willing to lend, then this isn’t an option and you’re faced with increasing taxes/cutting spending: austerity. In a situation that Ukraine finds itself in, even if it is able to borrow, it’s at very high interest rates (reflecting the underlying risk) which spell more trouble down the road.

          Increasing taxes is a form of austerity (although in the case of taxing the oligarchs, especially if this tax is on investment abroad, it would be a very mild form of it). Unfortunately this is hard to implement for both political and logistic reasons (tax collection isn’t cheap). The taxes which are easiest to implement (logistically) often tend to also be the most distortionary, growth-killing, ones. Or very unpopular (a tax on spirits? taxing the people who’s political support you desperately need in a crisis?). Of course reforming the tax system and getting the oligarchs to pay a higher share is a desirable goal, but it’s a long term one. When a patient is lying on a table in an emergency room experiencing cardiac arrest, it doesn’t help much for the doctor to tell them that they need to change their diet, quit smoking, and exercise more. Of course, the patient should do that – but they need to survive first;. And that means restoring fiscal stability. Which means, one way or another, cutting spending. And given the chunks of the budget taken up by pensions and subsidies, it’s very hard to cut spending without touching these two categories.

          Of course, one could argue for more generous loan packages and such, but the thing about lenders is that they – even, or maybe especially, the ones who lend to high risk economies at below market interest rates like the IMF – like it when you pay them back. So while one can wish for the lenders to be a bit more generous, it’s also understandable where the stinginess is coming from.

    • vdinets says:

      Note also that Russia is sharply increasing the price of gas it’s selling to Ukraine, and it’s hardly an unexpected move.

      • misha says:

        30% DISCOUNT WAS REJECTED BECAUSE FLEET AGREEMENT IS NOT VALID NOW.

        • vdinets says:

          That’s irrelevant. The point is, natural gas will now be more expensive, and the government has no choice but to pass the increase to end users.

          • O.Voron says:

            It is relevant. The price increase for customers has been the IMF requirement for the Ukraine to get credits for years, as you well know. It has nothing to do with Russia.

            Russia is in its full right to withdraw the “brotherly” price discounts since relations between Ukraine and Russia have turned hostile.
            If Ukraine does not like it, it can shop around for a better price. It can import gas from the EU via Hungary, Poland or Slovakia, for instance. In this case Ukraine will have to pay for gas, that’s a minus…

          • vdinets says:

            Actually, Russia has no right to increase the price, because the discount was part of a treaty by which Russia was paying for having a navy base on Ukrainian territory. Since occupying the Crimea was illegal, so is cancelling the rental payment.

            The price increase demanded by the IMF has, indeed, been around for years, but note that Ukraine only agreed to it when it became obvious that the cost of importing gas is doubling.

      • O.Voron says:

        vdinets,

        Fully expected, indeed. But does it matter what the price is if Ukraine does not pay whatever the price?:)

  6. Hunter says:

    A very, very interesting (if a little depressing) analysis.

    I know your background is cliodynamics, but in this paragraph you only hinted at some of the economic misery that is likely to affect Ukrainians in the short-term (and possibly long-term if the reforms are not successful):

    The Ukrainian government has already increased the price that the population pays for gas by 50 percent (and further increases may occur down the road). This raises the specter of thousands of people unable to pay for heating their apartments during the coming winter. These are likely to be the old folks whose only source of income is a state pension. Pensions will be cut drastically, perhaps halved, because the IMF requires the government to balance its books. Many state employees will be fired, and the salaries of the rest reduced.

    Now while the government HAS increased the price that the population pays for gas by 50%, the amount that Ukrainians now pay as a portion of the true cost of energy has probably not changed from January when they were reportedly only paying about a quarter of the true cost due to the subsidies. How so? Well back in early January the Ukrainian Hryvnia was worth around 8.24 to 1 US dollar. And Naftogaz (the national oil and gas company of Ukraine) has to pay for gas imports in US dollars, but collects revenue from consumers in Ukraine in Ukrainian hryvni. And back in January they were reportedly only collecting about a quarter of the true cost of the gas. So for every US$400 they spent on obtaining gas they only collected US$100 (UAH 824) from customers.

    However, starting in January and accelerating through February the Hryvnia lost a lot of its value. So much so that by the time the government announced the 50% increase in the cost of fuel that it was now around 11 to 1 US dollar. This would have meant that just before the announced increase that if Naftogaz was still collecting UAH 824 on every US$400 it spent on gas then it was in reality only collecting US$75 instead of US$100. So Ukrainians ended up only paying for a fifth of the actual cost of natural gas. The 50% increase would mean Naftogaz would be collecting UAH 1,236 on every US$400 in spent on gas (or around US$112) at the time of the announced increase (so between a quarter and a third or rather 28% of the true cost).

    BUT, since then the Ukrainian Hryvnia has depreciated even more until it is now somewhere between 12.70 and 12.97 to 1 US dollar. This means that now when Naftogaz collects from customers based on the 50% increase it would be collecting UAH 1,236 on every US$400 it spent on gas, but this would now amount to between US$95 and US$97. So now we are back where we started, except Ukrainians have probably not seen a 50% increase in their salaries between January and April and so have to pay more money in order to contribute to the same portion of the costs of the gas as they were before the increase. AND they will have to face up to the prospect that removing the subsidies will entail price increases in the future that will also have to outstrip any devaluation of the Ukrainian currency. And for the past 28 days the Hryvnia has lost about 10.5 kopiyky (or kopecks I guess it might be called in English) a day in value against the US dollar. If that rate of depreciation were to keep up (let alone accelerate) then Ukrainians could be looking at an exchange rate of 17 Hryvni to 1 US dollar by the time of the May 25 elections. This would see Naftogaz only receiving US$72 from consumers for every US$400 it spent on natural gas and the government would have to increase prices again by 37.5% just to bring the price consumers pay back up to being a quarter of the costs that Naftogaz incurs. I’m not quite sure how consumers would be expected to cover a potential 100% increase on the original costs they used to pay in January without such increases as yet actually having any impact on removing the subsidy…..

    • Peter Turchin says:

      Hunter, thanks for pointing this out. I am afraid things are even worse, because Gasprom has doubled the price at which it is willing to sell gas to Ukraine. While the EU has started delivering gas to Ukraine, this gas would, presumably, have to be paid at the EU prices, which are the same, or similar enough, to the price Gasprom set. So the combination of plunging hrivnya and rising gas prices spells serious problems for the Ukrainians.

      And that’s just the gas. In other aspects the Ukrainian economics has been crashing (many factories being closed down, for example) as well as the insurrection in eastern Ukraine. I don’t see how Ukraine is going to avoid the default before to the end of the year.

      • Hunter says:

        You’re welcome Peter,

        The doubling of the gas price by Gazprom (to $485 per 1,000 cubic metres) is in actuality a return to the pre-2014 pricing formula. Under the 2009 contract negotiated by Tymoshenko (with Yuriy Prodan being energy minister then as he is now incidentally), the gas price that Ukraine agreed paid was supposed to increase to the “European market price” in 2010 (with a 20% discount only applying in 2009).

        Now from 2011, Gazprom’s chief executive had been forecasting that the price of gas could increase to $500 per 1,000 cubic meters (link to 3e-news.net). While it is claimed that the price charged to Ukraine of $485 per 1,000 cubic metres is supposedly “higher than that paid by other European countries”, we have reports that Lithuania was paying $490 per 1,000 cubic metres from 2012 (link to cnbc.com) and Turkey was paying the same amount for Iranian gas and about $425 per 1,000 cubic metres for Russian gas in 2013/2014 (link to al-monitor.com). So if the price Ukraine agreed to pay was that of an average of the price paid in Europe (and crucially if the Ukrainian negotiators agreed to pay the average price of all gas supplied to Europe and not just the gas supplied by Gazprom to Europe) then quite naturally the price might end up being “higher than that paid by some EU members”.

        So under the 2009 contract and even under the 2010 Kharkiv Accords the price Ukraine actually agreed to pay would have been well over $400 per 1,000 cubic metres come 2013. And this was the case as Ukraine was paying around $430 per 1,000 cubic metres until the 2013 agreements between Russia and Ukraine negotiated by Yanukovych. These 2013 agreements then slashed the price of gas to $268 per 1,000 cubic metres but the agreement didn’t last long since Yanukovych was overthrown.

        How those who overthrew Yanukovych and attempted to distance themselves from his legacy can then turn around and demand to only pay $268 per 1,000 cubic metres while having declared by the 2010 and 2013 agreements of questionable legitimacy is a mystery to me. If you wish to disavow those agreements you have to do so in full. So logically Ukraine has to fall back on the 2009 contract which would still be in effect and not the modifications to the contract in 2010 and 2013.

        So for Naftogaz the price they pay for gas isn’t that much worse than it was for most of 2013 actually. That’s why I used the nice figure of $400 in my examples above (because it is easy to work with when dealing the fact that Ukrainians only pay a quarter of the true cost of natural gas and because it approximates the price per 1,000 cubic metres Naftogaz would have been paying anyway).

        The re-exportation of gas to Ukraine from its EU neighbours though would merely shift the payment headache from Gazprom to EU companies. If Ukraine was too broke to even pay $268 per 1,000 cubic metres how are they going to pay any EU companies which re-export gas they originally obtained from Gazprom to Ukraine? Naturally those companies will also not be doing this for free so they will have to charge Ukraine the price they obtained the gas from Gazprom at (at least $400 per 1,000 cubic metres) plus the cost of shipping the gas back to Ukraine as well as the charging them extra for their own profit. Ultimately Ukraine might well pay the same price Gazprom is charging now or more (maybe even $500 per 1,000 cubic metres) for the “privilege” of “getting” gas from the EU rather than Russia.