Oil for food:

Which model Ukraine could ap­ply in its fur­ther eco­nomic in­ter­ac­tion with Rus­sia

The Ukrainian Week - - CONTENTS - Oles Kra­mar

How Ukraine should be­have in fur­ther eco­nomic in­ter­ac­tion with Rus­sia

For the last 25 years, Rus­sia has me­thod­i­cally fil­tered bi­lat­eral trade flows with Ukraine in its own in­ter­ests un­der var­i­ous pre­texts, grad­u­ally clos­ing ac­cess to its mar­ket for fin­ished prod­ucts from a va­ri­ety of Ukrainian in­dus­tries, from pipes and sugar to dairy and con­fec­tionery. As a re­sult, bi­lat­eral trade was grad­u­ally re­stricted ex­clu­sively or mainly to what Rus­sia needs.

Al­most all Ukrainian ex­ports of alu­mina – a raw ma­te­rial for the pro­duc­tion of alu­minium in Rus­sia that is then sup­plied mainly to Ukraine – are di­rected to­wards the Rus­sian mar­ket (95.9% of ex­ports from Ukraine in the first 5 months of 2017 for $200.8 mil­lion). All ex­ports of ra­dioac­tive el­e­ments and iso­topes ($36.6 mil­lion) – the raw ma­te­rial for the pro­duc­tion of nu­clear fuel, which Ukraine then buys at a sig­nif­i­cantly higher price from Rosatom, Rus­sia’s state nu­clear power com­pany – also go to Rus­sia. It re­ceives 40.8% of Ukrainian kaolin clay ($7.4m in the same pe­riod) and even larger amounts of other clays and gravel.

For now, cer­tain com­po­nents re­quired by Rus­sian pro­duc­ers (turbo en­gines, train parts, en­gines, etc.) are sent there. But this will only last un­til they find a sub­sti­tute. As soon as it be- came pos­si­ble to opt out of im­port­ing com­po­nents or en­gi­neer­ing prod­ucts from Ukraine, Moscow did this, re­gard­less of the state of bi­lat­eral po­lit­i­cal re­la­tions and who was in power in Kyiv. For ex­am­ple, it was dur­ing Yanukovych's regime that Rus­sia be­gan to re­duce lo­co­mo­tive pur­chases from Ukraine and sab­o­taged pre­vi­ously agreed-on projects to co­op­er­ate in avi­a­tion, in­sist­ing on the use of French en­gines in joint projects in­stead of the usual Mo­tor Sich units from Za­por­izhia.

On the other hand, Ukrainian ap­proaches to trade with Rus­sia were chaotic and in­con­sis­tent, mainly boil­ing down to re­flex re­ac­tions to stim­uli from Rus­sia in­stead of im­pos­ing its own agenda in bi­lat­eral trade. There­fore, the neg­a­tive con­se­quences of such poli­cies of­ten out­weighed the pos­i­tive ef­fect.

Both man­i­fes­ta­tions of this chaotic and im­pul­sive ap­proach – from the com­plete sus­pen­sion of trade in cer­tain types of goods to un­con­trolled "mu­tu­ally ben­e­fi­cial" co­op­er­a­tion in sen­si­tive ar­eas be­cause of a vul­ner­a­bil­ity to Rus­sian black­mail – are equally wrong. It is nec­es­sary to ei­ther im­pose a to­tal em­bargo on trade with Rus­sia or subor­di­nate pol­icy to a long-term strate­gic goal – con­sol­i­da­tion of its raw-ex­ports sta­tus in bi­lat­eral trade. It is nec­es­sary to ap­ply the ap­proaches to deal­ing with pariah states that lead­ing Western coun­tries de­vel­oped long ago. For ex­am­ple, the fa­mous "oil-for-food" pro­gramme for trade with Iraq dur­ing Sad­dam Hus­sein's rule. Or at least pur­su­ing the same ap­proaches to trade pol­icy that Moscow it­self has used for de-

cades against Ukraine. In other words, grad­u­ally re­strict­ing im­ports from Rus­sia to the types of raw ma­te­ri­als, in­ter­me­di­ate prod­ucts and com­po­nents that will make im­por­tant in­dus­tries and man­u­fac­tur­ing more cost-ef­fec­tive in Ukraine, with­out al­low­ing them to reach crit­i­cal amounts in their share of to­tal im­ports and con­sump­tion in or­der to avoid threats to Ukraine's eco­nomic se­cu­rity. At the same time, it makes sense to phase out trade wher­ever it is more prof­itable for Rus­sia than for us, as long as this will not cause se­ri­ous prob­lems for Ukraine or, on the con­trary, will fa­cil­i­tate the trans­fer of the pro­duc­tion/as­sem­bly fa­cil­i­ties of multi­na­tional cor­po­ra­tions from Rus­sia onto our ter­ri­tory.

CHEM­I­CAL WARS

In­stead, we now have, by all ap­pear­ances, the op­po­site sit­u­a­tion. The Ukrainian chem­i­cal in­dus­try is a par­tic­u­larly re­veal­ing ex­am­ple. Much of it has long been con­trolled di­rectly by Rus­sian cap­i­tal or through Ukrainian agents. For ex­am­ple, Dmytro Fir­tash's busi­ness em­pire was es­tab­lished with Rus­sian money and was al­ways con­trolled by the oli­garch's Rus­sian masters. Af­ter not be­ing par­tic­u­larly con­cerned about up­grad­ing fa­cil­i­ties or cre­at­ing new types of pro­duc­tion that are less vul­ner­a­ble to ex­ter­nal shocks for decades, the own­ers are try­ing to com­pen­sate for this by lob­by­ing for pro­tec­tion­ist mea­sures. Re­cently, struc­tures that are es­sen­tially Rus­sian (for­mally or prac­ti­cally), such as the I Prize group or Dmytro Fir­tash's Ostchem have been very suc­cess­fully and cyn­i­cally us­ing the nat­u­ral anti-Rus­sian sen­ti­ments in the coun­try to en­hance their own mo­nop­o­lies and make wind­fall prof­its at the ex­pense of Ukrainian con­sumers.

Anti-dump­ing mea­sures on im­ports of Rus­sian am­mo­nium ni­trate to Ukraine were first in­tro­duced in May 2008. In 2014, they were ex­tended for 5 years – un­til July 2019. In June 2015, the In­ter­de­part­men­tal Com­mis­sion on In­ter­na­tional Trade (ICIT) launched an­other in­ves­ti­ga­tion on im­ports of min­eral fer­tilis­ers from Rus­sia based on a com­plaint from com­pa­nies that be­long to Dmytro Fir­tash's Ostchem group: Azot in Cherkasy, the Severodonetsk Azot As­so­ci­a­tion and the Sty­rol con­cern in oc­cu­pied Hor­livka. On 27 De­cem­ber 2016, the ICIT set new du­ties at 4.19%, 18.78% and 31.84% for var­i­ous Rus­sian man­u­fac­tur­ers. De­spite that fact that in Au­gust 2016 rep­re­sen­ta­tives of a large num­ber of as­so­ci­a­tions of agri­cul­tural pro­duc­ers, in­clud­ing farm­ers' as­so­ci­a­tions (Agrar­ian Union of Ukraine, Ukrainian Agrar­ian Con­fed­er­a­tion, Ukrainian Agrar­ian Coun­cil, Ukrainian Club of Agrar­ian Busi­ness, Ukrainian As­so­ci­a­tion of Farm­ers and Pri­vate Landown­ers), wrote an open let­ter to the gov­ern­ment op­pos­ing non-mar­ket price reg­u­la­tion meth­ods and de­mand­ing not only that ad­di­tional du­ties on urea and ure­aam­mo­nia com­pounds not be in­tro­duced, but also that ex­ist­ing anti-dump­ing du­ties on am­mo­nium ni­trate be re­moved.

They also de­manded an an­titrust in­ves­ti­ga­tion of the do­mes­tic fer­tiliser mar­ket and sanc­tions for price fix­ers. In fact, af­ter the in­tro­duc­tion of an­tidump­ing du­ties on am­mo­nium ni­trate in 2014, Ukrainian prices for all ma­jor ni­tro­gen fer­tilis­ers in­creased sig­nif­i­cantly, ex­ceed­ing ex­port prices by 1417%. De­spite the fact that there are ad­di­tional costs when ex­port­ing, es­pe­cially for lo­gis­tics, so do­mes­tic prices should be lower. As a re­sult, the to­tal losses of Ukrainian farm­ers in 2014-2016 from the dif­fer­ence

AGAINST THE BACK­GROUND OF THE "CHEM­I­CAL WARS", THE CON­TIN­UED DE­PEN­DENCE OF UKRAINE ON SUP­PLIES OF A NUM­BER OF EN­ERGY SOURCES FROM RUS­SIA IS MUCH MORE CRIT­I­CAL, VIR­TU­ALLY MAK­ING THE COUN­TRY LIVE WITH A CON­STANT THREAT TO ITS ECO­NOMIC SE­CU­RITY

in ni­tro­gen fer­tiliser prices alone can be es­ti­mated at $400 mil­lion. For its part, the Anti-Mo­nop­oly Com­mit­tee of Ukraine (AMCU) has al­ready con­firmed the mo­nop­oly po­si­tion of the two Azot en­ter­prises in Dmytro Fir­tash's Ostchem on the urea mar­ket. In 2015, it be­gan pro­ceed­ings on the grounds that the com­pany NF Trad­ing Ukraine is abus­ing its dom­i­nant po­si­tion on the am­mo­nium ni­trate mar­ket by set­ting prices in a way that would not be pos­si­ble if there were sig­nif­i­cant com­pe­ti­tion.

Fol­low­ing a re­quest from the Agri­cul­ture Min­istry, on Fe­bru­ary 13 the ICIT de­ter­mined that "na­tional in­ter­ests re­quire the sus­pen­sion of an­tidump­ing mea­sures for im­ports to Ukraine of cer­tain ni­tro­gen fer­tilis­ers orig­i­nat­ing in the Rus­sian Fed­er­a­tion" and can­celled the du­ties in­tro­duced in De­cem­ber 2016. How­ever, af­ter Fir­tash re­sorted to rad­i­cal black­mail meth­ods and com­pletely stopped the pro­duc­tion and ship­ment of ni­tro­gen fer­tilis­ers, the In­ter­de­part­men­tal Com­mis­sion on In­ter­na­tion-

al Trade nev­er­the­less de­cided to estab­lish 31.84% du­ties on im­ports to Ukraine of cer­tain ni­tro­gen fer­tilis­ers (urea and urea-am­mo­nia com­pounds) from Rus­sia.

An­other Rus­sian struc­ture on the Ukrainian chem­i­cal prod­ucts mar­ket op­er­ates in the same way. KarpatS­moly in Kalush, which is con­trolled by the Rus­sian I Prize group of com­pa­nies, ini­ti­ated an anti-dump­ing in­ves­ti­ga­tion on im­ports to Ukraine of urea-formalde­hyde prod­ucts from Rus­sia. Com­pared to the first half of 2014, the pro­por­tion of im­ports from Rus­sia in Ukrainian con­sump­tion has in­creased in the sec­ond halves of 2014-15 and the first half of 2016 by 21%, 13% and 5% re­spec­tively. While the com­plainant's sales fell by 17%, 20% and 58% re­spec­tively. In April 2017, the Com­mis­sion adopted a de­ci­sion to launch an anti-dump­ing in­ves­ti­ga­tion on im­ports to Ukraine of urea-formalde­hyde resin and urea-formalde­hyde con­cen­trate.

How­ever, the econ­omy is a com­plex or­gan­ism. The in­tro­duc­tion of such re­stric­tions, of course, may help to main­tain and even in­crease pro­duc­tion at KarpatS­moly, but the higher prices for its prod­ucts will jeop­ar­dise the com­pet­i­tive­ness of their con­sumers. This not only threat­ens sig­nif­i­cantly higher eco­nomic losses in sec­tors with higher added value, but could also negate the pos­i­tive ef­fect of in­tro­duc­ing pro­hib­i­tive du­ties: the share of Ukrainian man­u­fac­tur­ers on the mar­ket could rise, but in con­trast to a sig­nif­i­cant re­duc­tion in con­sump­tion of more ex­pen­sive prod­ucts.

Many Ukrainian chem­i­cal plants, above all fer­tiliser pro­duc­ers, have re­ally been go­ing through hard times over the last decade and es­pe­cially in the past few years. Both the un­usu­ally sharp drop in prices for fin­ished prod­ucts on the world mar­ket and the ad­just­ment of gas prices on the do­mes­tic mar­ket have made them­selves felt. The lat­ter, if it did not put an end to them, at least sub­stan­tially un­der­mined the schemes to burn nat­u­ral gas "saved" by re­gional gas sup­pli­ers con­trolled by Dmytro Fir­tash and writ­ten off for the needs of the public at dis­counted prices at Ostchem plants that be­long to the same oli­garch. The above fac­tors made the very prospect of sur­vival du­bi­ous for Ukrainian ni­tro­gen fer­tiliser pro­duc­ers in the con­text of a global mar­ket where they have to com­pete mainly with sup­pli­ers from coun­tries with ex­ces­sive do­mes­tic gas pro­duc­tion and ac­cord­ingly low prices for it (see Against the Cur­rent). Rev­enues from the sale of fer­tilis­ers abroad de­creased al­most four­fold in re­cent years: the first quar­ter of 2014 brought in €160 mil­lion, while the fig­ure for the first quar­ter of 2017 was only €42 mil­lion. In 2013, 3.69 mil­lion tonnes of ni­tro­gen fer­tilis­ers were ex­ported for €0.85 bil­lion, but in 2016 half of this amount (1.81 mil­lion tonnes) made only a third of the for­mer rev­enues – €0.29 bil­lion. The sit­u­a­tion on the do­mes­tic mar­ket also be­came more com­plex.

It is also true that de­pen­dence on im­ports of Rus­sian ni­tro­gen and par­tic­u­larly com­pound fer­tilis­ers had in­deed reached a dan­ger­ous level. Specif­i­cally, 78.1% (80.6% in value) of ni­tro­gen fer­tilis­ers came from Rus­sia in 2016. The lion's share of the rest is from Be­larus, where en­ter­prises are to­tally de­pen­dent on Rus­sian gas sup­plies for pro­duc­tion.

Nev­er­the­less, it is im­por­tant to avoid pro­hib­i­tive tar­iffs and other mech­a­nisms that cre­ate prob­lems for cus­tomers and ar­ti­fi­cial pref­er­ences for cer­tain mo­nop­o­lies. Es­pe­cially if we do not want the ob­jec­tive loss of in­ter­na­tional com­pet­i­tive­ness by the Ukrainian chem­i­cal in­dus­try, es­pe­cially pro­duc­ers of ni­tro­gen fer­tilis­ers, to pull other sec­tors of the Ukrainian econ­omy, in­clud­ing the agri­cul­tural sec­tor, into the abyss with it. Pro­hib­i­tive du­ties are a bad path if we want to pro­tect our eco­nomic se­cu­rity with­out un­der­min­ing the sec­tors of the na­tional econ­omy that con­sume the cor­re­spond­ing prod­ucts.

Un­for­tu­nately, it is a fact that the world mar­ket for ni­tro­gen fer­tilis­ers is an arena for com­pe­ti­tion be­tween pro­duc­ers from coun­tries that have sig­nif­i­cant do­mes­tic re­sources of nat­u­ral gas at prices be­low the world av­er­age (see. Against the Cur­rent). Apart from China, none of the coun­tries that set the tone on the global ni­tro­gen fer­tiliser mar­ket buys gas for this pur­pose at world prices.

It is well known that gas rep­re­sents up to 80% of the cost of fer­tiliser. So when pro­hib­i­tive du­ties of over 30% in­crease pro­duc­tion costs to 130% of the mar­ket price that would ex­ist if com­pe­ti­tion were pre­served, this ac­tu­ally means that Ukrainian con­sumers would pay more for the im­ported gas used to pro­duce it (80% of the 130% cost of im­ported fer­tiliser = 104%) than for ready-made fer­tilis­ers. What is the point in mak­ing fer­tilis­ers if for each tonne of their pro­duc­tion Ukraine will have to im­port gas for the same amount of money that could buy a tonne of fer­tiliser?

In­stead, Ukrainian con­sumers are forced to fund this "life sup­port" for fer­tiliser pro­duc­ers, or more pre­cisely their own­ers' prof­its and wages that are a very small share of the fi­nal out­put. Then these Ukrainian con­sumers of fer­tilis­ers – agri­cul­tural pro­duc­ers – have to com­pete on the global mar­ket with agri­cul­tural com­pa­nies from other coun­tries who buy fer­tilis­ers at world prices (see Against the Cur­rent), which are lower than those set for the Ukrainian mar­ket by do­mes­tic mo­nop­o­lies.

Af­ter all, the agri­cul­tural sec­tor is more im­por­tant for Ukraine than the ar­ti­fi­cially sup­ported pro­duc­tion of fer­tilis­ers. The shares of the chem­i­cal in­dus­try and agri­cul­ture in GDP and em­ploy­ment are sim­ply not com­pa­ra­ble. While com­pa­nies that pro­duce ni­tro­gen fer­tilis­ers em­ploy only around 23,000 peo­ple and the en­tire chem­i­cal in­dus­try (pro­duc­tion of ni­tro­gen fer­tilis­ers is only part of it) pro­vides less than 1% of GDP, the cor­re­spond­ing fig­ures for agri­cul­ture are dozens of times larger. Only count­ing full-time em­ploy­ees, over 430 thou­sand peo­ple work in agri­cul­tural en­ter­prises and their share in 2015 GDP reached 12.5%. In 2015, gross value added (i.e. of­fi­cially recorded gross profit and em­ploy­ees' salaries) in the chem­i­cal in­dus­try was only 8.2 bil­lion hryv­nias com­pared to 239.8 bil­lion in agri­cul­ture. Fi­nally, agri­cul­tural prod­ucts ac­count for nearly half of all ex­ports from Ukraine and there­fore the lion's

share of for­eign cur­rency rev­enues that en­sure sta­bil­ity of the na­tional cur­rency.

More­over, the few com­pa­nies in the chem­i­cal in­dus­try (in­clud­ing the three Azot plants in Cherkasy, Rivne and Severodonetsk be­long­ing to Dmytro Fir­tash's Ostchem) stand no com­par­i­son with the tens of thou­sands of agri­cul­tural en­ter­prises, in­clud­ing more than 30,000 farms, that are con­sumers of fer­tilis­ers and whose costs – and ac­cord­ingly com­pet­i­tive­ness on the global mar­ket – de­pends on their prices.

A THREAT­EN­ING "THOUGHTLESSNESS"

Against the back­ground of the "chem­i­cal wars", the con­tin­ued de­pen­dence of Ukraine on sup­plies of a num­ber of en­ergy sources from Rus­sia is much more crit­i­cal, vir­tu­ally mak­ing the coun­try live with a con­stant threat to its eco­nomic se­cu­rity. Af­ter all, in its hy­brid war against Ukraine the Rus­sian side has re­peat­edly demon­strated a will­ing­ness to use lim­i­ta­tions not only on sup­plies of our goods that are largely de­pen­dent on ex­ports to the Rus­sian mar­ket, but also on de­liv­er­ies to Ukraine of raw ma­te­ri­als and en­ergy sources, a short­age of which would threaten the Ukrainian econ­omy with se­ri­ous prob­lems.

For ex­am­ple, in Jan­uary–April 2017 279,750 tonnes of an­thracite coal out of a to­tal of 283,030 were im­ported from Rus­sia, 2.95 mil­lion tonnes out of 4.42 mil­lion of cok­ing coal and 176,000 out of 393,000 tonnes of coke. Over the same pe­riod, 323,200 out of 330,500 tonnes of liq­ue­fied gas (propane-bu­tane) and 1.8 mil­lion out of 2.25 mil­lion tonnes of petroleum prod­ucts were im­ported from Rus­sia and Be­larus (which in this case are the same thing). This is a real in­stru­ment for en­ergy and eco­nomic black­mail that we are leav­ing in the Krem­lin's hands. All these prod­ucts could be sub­sti­tuted by pur­chases else­where, but it would be prob­lem­atic to do this quickly with cur­rent im­ports from Rus­sia (some­times to­gether with Be­larus) at 60-99% of re­quired amounts. There­fore, it is nec­es­sary to re­duce de­pen­dence on Rus­sian im­ports of these prod­uct groups right now.

How­ever, there has not been any no­tice­able de­ci­sive ac­tion from the gov­ern­ment. In April 2017 the Min­istry of En­ergy, ac­cord­ing to state­ments from min­is­ter Ihor Nasalyk, submitted a draft res­o­lu­tion to the Cab­i­net on ban­ning the im­port of power-gen­er­at­ing coal from Rus­sia, how­ever, look­ing at DTEK Gen­eral Di­rec­tor Maksym Tim­chenko's com­ments, the com­pany's lob­by­ing was able to pre­vent the adop­tion of such a de­ci­sion by the gov­ern­ment. More­over, in May 2017 418,700 out of 446,300 tonnes of power-gen­er­at­ing coal came from Rus­sia. De­liv­er­ies are pri­mar­ily con­tin­u­ing from DTEK's Rus­sian coal mines Obukhovskaya and Dal­nyaya to the Luhansk com­bined heat and power plant be­long­ing to the same com­pany. What's more, such a sup­ply scheme works fully in the in­ter­ests of Rus­sia. In­deed, ac­cord­ing to the afore­men­tioned Mr. Tim­chenko, the Obukhovskaya mine is in fact man­aged solely by DTEK. How­ever, it is pledged to the Rus­sian Sber­bank as se­cu­rity and ev­ery­thing that it earns goes to pay back loans is­sued by that bank. In this way, the Luhansk com­bined heat and power plant is ac­tu­ally work­ing for Sber­bank Rus­sia and the en­ergy it pro­duces at the enor­mous rate of 2 hryv­nias ex­clud­ing VAT is paid for by Ukrainian en­ergy mar­ket.

If an un­ex­pected sus­pen­sion of Rus­sian sup­plies of cer­tain goods could pro­voke prob­lems in Ukraine for po­lit­i­cal rea­sons, strict lim­its on the pro­por­tion of im­ports that come from Rus­sia are re­quired, as well as an ur­gent shift to other trad­ing part­ners. In this case, the eco­nomic cost is not of fun­da­men­tal im­por­tance. A re­stric­tion on de­liv­er­ies of a cer­tain prod­uct from one source (for in­stance, no more than 25% or 35% of im­ports) could be a uni­ver­sal long-term tool against the coun­try's dan­ger­ous de­pen­dence on Rus­sian sup­pli­ers. How­ever, the ac­tual and not for­mal coun­try of ori­gin should be taken into ac­count.

This ap­proach would not only solve se­cu­rity is­sues, but also ob­jec­tively raise do­mes­tic prices to a level that would in­ter­est al­ter­na­tive sup­pli­ers that are far­ther away from the Ukrainian mar­ket than the Rus­sians are. Af­ter all, the cur­rent ap­proach of high tar­iffs on fer­tilis­ers from Rus­sia has not been able to dis­rupt the mo­nop­oly held on the Ukrainian mar­ket by pro-Rus­sian oli­garch Fir­tash in tan­dem with his Rus­sian com­peti­tors, de­spite the re­bal­anc­ing of do­mes­tic mar­ket shares be­tween them.

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