U.S.-UA Economic Security: The Issue of Odessa-Brody

U.S.-Ukraine Security Dialogue

U.S.-UA Economic Security: The Issue of Odessa-Brody

Ilan Berman

Remarks by Ilan Berman, Vice President for Policy American Foreign Policy Council, delivered during the U.S.-Ukraine Security Dialogue, Washington DC, June 23, 2005.

Let me begin on a cautionary note. All too often, official Washington tends to have a fairly short attention span. Despite major gains over the past year, there is the lingering thought that, now that Ukraine finally has a truly representative government, our work is done.

But the Orange Revolution is not the end of the story. It is only the beginning. There is little doubt that, with sufficient pressure from Moscow, and without adequate and sustained attention from Washington, the substantial gains made by Ukraine can still be rolled back.

And, in many ways, energy is the key. Ukraine today remains deeply dependent on Russia”s good graces. Ninety percent of Ukraine”s oil supplies come from Russia. So does 80% of its natural gas and 100% of its nuclear fuel. The detrimental effects of this dependence can be seen in the gas crisis that is now brewing between Moscow and Kyiv.

The Kuchma regime found this state of affairs acceptable. The Yuschenko government, to its credit, does not. Kyiv has declared repeatedly in recent weeks that energy independence from Russia is a national priority. The enduring question is how to achieve it.

Here, two realizations are important.

First, Ukraine”s strategic position between East and West makes it a key transit point for oil flowing into Europe. Ukraine, in other words, has the potential to be an energy powerhouse. Not in the same way as Saudi Arabia, of course. But Ukraine can play a more decisive role in dictating the geo-politics and geo-economics of the post-Soviet space” and Eastern Europe than it currently does.

Second is the fact that, despite the Orange Revolution, a struggle is still underway over Ukraine”s ultimate energy direction. Whether Ukraine remains dependent on Moscow, or definitively turns toward the West, will go a long way toward determining not only its own political and economic future, but that of its neighborhood as well.

That”s where Odessa-Brody comes in. Odessa-Brody is the most important pipeline you have never heard of.

When it was begun back in 1993, Odessa-Brody was envisioned as a much-needed independent energy conduit for the Caspian region-one that was capable of linking Central Asian producers with European markets. The result, completed in the spring of 2002, was a 674-kilometer pipeline stretching northwest from the Black Sea port of Odessa to Brody in western Ukraine, with the capacity to carry up to 14.5 million tons of oil a year. The ultimate plan is to extend the pipeline by 500 kilometers, to the Polish port city of Gdansk, and use it to supply tankers bound for Western and Northern Europe with Caspian crude.

Odessa-Brody is a key component in Ukraine”s economic development, and an important asset for Kyiv in its evolving relationship with NATO and Europe. But, since its completion, Odessa-Brody has remained mostly idle.

This has allowed Russia to step in. Ever since the pipeline”s completion, Moscow has intensively lobbied Kyiv for a reversal” of its flow – basically, to use it in the opposite direction of the one initially intended: instead of shipping oil northwest, to Poland, and from there to European markets, it would be used to ferry Russian oil south to the Black Sea.

Moscow”s interest has been consistent: it wants to prevent Ukraine from gaining energy independence. There are a number of reasons why:

Ukraine is essential to Russian energy plans.

An estimated 90 percent of Russian natural gas exports currently transit Ukraine on their way to European markets. Moreover, if Ukraine wanted to, it could exert substantial leverage over Russian energy supplies. This is a vulnerability that Russian officials are acutely aware of, and are actively trying to prevent. Their reasoning is that if Kyiv remains dependent on Russia economically and politically, it will be less likely to act assertively on the energy front.

Odessa-Brody will definitively determine Ukraine”s political orientation.

Kyiv”s major partner in the extension of Odessa-Brody is Warsaw, which has emerged as a key U.S. ally in New Europe,” and in the Global War on Terror. Ukraine”s partnership with Poland can therefore nudge Kyiv much deeper into the American and NATO fold – and away from Russia.

Russia wants to retain its preferential status in the Caspian.

This requires derailing plans for independent energy routes capable of lessening Russia”s economic clout and political leverage among the Caspian states.

As proof positive of this fact, consider the following: During the course of its negotiations with the Ukrainian government over reversal,” the Kremlin turned down a more logical, eastern route for Russian crude offered by Kyiv as a substitute to Odessa-Brody. That pipeline, dubbed Kremenchuk-Sniherivka,” runs south to Odessa through eastern Ukraine, and is capable of carrying nearly double the capacity of Odessa-Brody at $3 less per ton than Odessa-Brody. The only logical explanation is that the Kremlin cared more about preventing Ukraine”s economic and political independence than about output.

So far, it has been successful. In September 2004, after much diplomatic back-and-forth, Ukraine acquiesced to reversal.”

Fast forward almost two years, and not much has changed. Reversal is still a reality. Oil is still flowing from Brody to Odessa, rather than the other way around, despite the fact that Kyiv has made serious efforts to engage Caspian suppliers like Azerbaijan and Kazakhstan. For all practical purposes, however, the Kuchma government”s original Russia-friendly energy policy remains in force.

If the Yuschenko government is committed to changing this, and I believe it is, then there are a few factors to consider.

Russia still has substantial leverage over Ukraine”s energy trajectory.

Moscow has made no secret of the fact that it prefers that reversal” continue, and that Odessa-Brody continue to pump north-south. To make sure it gets what it wants, the Kremlin has engaged in a number of strong-arm economic tactics, including substantially delaying the signing a 15-year agreement for transporting oil through Ukraine, linking it to the reversal” issue. Given this vulnerability, diversification of Ukrainian oil and gas supplies – including through expanded energy cooperation agreements with Caspian producers – should be a serious and long-term priority.

Greater international economic attention is needed.

From the start, Odessa-Brody has struggled to stay solvent. In fact, the ultimate decision for reversal, to hear at least some Kuchma-era officials tell it, was predominantly an economic one.

The bottom line is that Ukraine needs oil to flow through Odessa-Brody. If there is no international attention, then Kyiv will have to look to Russia. In the first half of 2004, the Kuchma government held open the prospect of reversing reversal,” but no international takers stepped forward to underwrite such a move. The rest is history.

Today, the question is the underwriting of a consortium to extend Odessa-Brody to Gdansk. If there is not enough funding for this, reversal” will remain the logical economic choice.

Kazakhstan is key.

To paraphrase one analyst, without Kazakh oil, Odessa-Brody becomes Brody-Odessa.” What this means is that, without Kazakh participation and a continued Kazakh commitment to ship oil to fill the pipeline, westward flow is not economical. Kyiv should keep close watch over diplomatic moves from Russia – and from China, for that matter – that would prevent Kazakhstan from shipping oil to Odessa.

Regional politics play a large role.

Increasingly, Odessa-Brody has become linked with other regional economic and strategic issues, such as the Single Economic Space (SES) now under development by Russia. In fact, Kazakhstan recently signaled that its participation in Odessa-Brody is contingent upon Ukraine”s participation in the SES, and in all sorts of side energy deals with Russia.

Pipeline politics are an issue as well. In the wake of the late-May launch of the Baku-Ceyhan pipeline, Ukrainian officials should only expect energy pressure from Russia to increase, as the Kremlin struggles to maintain control over Caspian resources.

New momentum needed.

The Polish government remains a willing partner in Odessa-Brody extension. The pace of the project, however, depends on political will in Kyiv, and on the ability of Ukraine to grab international political and economic attention for it. Ukraine should articulate that it is in its interest for Poland to become an independent energy hub.

Energy orientation is important to other security issues.

Odessa-Brody has enormous political significance. Its south-north operation would send a clear signal to the countries of the EU and NATO that Kyiv is fully committed to Westward integration. Conversely, continued acquiescence to reversal,” and to Russian manipulation, could call that commitment into question among Ukraine”s new partners.