Meeting in Minsk

Map of Western CIS/FSU and European Environs

(Business New Europe – bne.eu – Ben Aris – August 26, 2014) Ukrainian President Petro Poroshenko and Russian peer Vladimir Putin are due to sit down in Minsk on August 26 for their first formal meeting since the fighting in eastern Ukraine kicked off. Expectations for a peace deal are low, but what exactly can each side put on the table to try to end a conflict that is killing thousands and smashing to pieces the most productive part of the country?

The goals of both sides are pretty clear. For Ukraine, any deal has to start with a ceasefire followed by the withdrawal of Russian support for the insurgents fighting the Ukrainian army and pro-Kyiv militias.

This should be the easiest bit to agree on. The fight is not going the separatist’s way; the rebels have steadily been losing ground in the face of a renewed onslaught by Kyiv’s forces. At the same time, the endemic support for Russia in the region is evaporating in the face of the mounting casualties and destruction being rained down on residents.

To save face, Russia would likely demand the right to send more humanitarian aid into the region. Russian Foreign Minister Sergei Lavrov announced on August 25 that a second such convoy is already being prepared. Another Russian demand is likely to be an amnesty for all separatist fighters so that it is not seen to be leaving its proxies in the lurch.

For his part, Poroshenko needs peace as soon as possible as the economy is flat on its back and he needs to start an Augean stable-sized reform program. Ukraine is one of only two countries in the former Soviet Union that has yet to recover its 1991 level of GDP. (The other is Kyrgyzstan.)

Much more difficult will be to reach agreement over Crimea, and Ukraine’s future relations with the EU and Nato.

Moscow got into this fight as it has two extremely important strategic assets in Ukraine: the main pipeline carrying gas exports to Europe and Russia’s only warm water naval port at Sevastopol. There are few countries in the world (the US the least of them) that would be willing to lose control over its major energy and military assets without a fight.

Of the two, as far as the Kremlin is concerned the naval port is now secure after Russia annexed Crimea in March. However, no sovereign nation will ever willingly concede territory to a neighbour unless forced. That said, the consensus in Europe seems to be that the Crimea is lost. If Poroshenko is ready to concede this, then rhetoric will turn to the “eventual” return of the peninsula.

A workable-fudge over Ukraine’s possible membership of the EU and Nato will also be hard. Putin has repeatedly expressed alarm (rightly or wrongly) over Nato expansion, and this cuts to the core of the current showdown.

On the one hand is the principle of self determination. Every country should have the right to decide how to run its economy and which partners it wants to tie up with. Ukraine has clearly decided to move westward and adopt European values.

On the other hand there are the demands of realpolitik. Small or weak countries ignore the interests of their larger more powerful neighbours at their peril. Finding a workable deal with Russia will depend on how successfully Ukraine can strike a balance between these two extremes.

The Germans, which are leading Europe’s effort to resolve the crisis, have said repeatedly that neither Nato nor EU membership are on the cards for Ukraine. However, the Kremlin wants stronger assurances than that.

The problem is that neither the EU nor Nato can sign a piece of paper saying “never”; that would defy the principle of self determination for Ukraine. Kyiv has to have the right to apply, even if rejection is a forgone conclusion. Professor Mark Galeotti at New York University suggests that both institutions could fudge the issue by ruling out a Ukrainian application for “technical reasons” for a few years, and this might be acceptable to the Kremlin.

That still leaves the problem of how to organise trade relations between Russia, Ukraine and the EU. An increasing number of commentators (albeit still in the minority) have pointed out recently that the decision by the EU to offer an exclusive deal to Ukraine that precluded any sort of partnership with Russia was naive.

Softened

German Chancellor Angela Merkel has softened her tone on the eve of the meeting in Minsk. “I want to find a way, as many others do, which does not damage Russia,” she said on August 23. “We [Germany] want to have good trade relations with Russia as well. We want reasonable relations with Russia. We are depending on one another and there are so many other conflicts in the world where we should work together, so I hope we can make progress.”

Importantly a delegation from the EU will attend the talks in Minsk, including Brussels’ foreign affairs chief Catherine Ashton, trade commissioner Karel De Gucht, and energy commissioner Gunther Oettinger, so there is no reason why the three-way trade talks cannot thrash out a special regime to govern tariffs. Indeed, the attendance of the EU officials is a climb down by Brussels from its previous us-or-Russia offer to Ukraine. Ukraine’s now-deposed president Viktor Yanukovych suggested three-way talks in November, as the row cranked into life, only to see it rejected out of hand.

Moreover, a new element has been introduced into the discussion on trade. Ukraine has already signed an EU free trade deal (DCFTA) which expressly precludes Ukraine’s membership of Russia’s Customs Union. However, this week the EU hinted that while Ukraine can’t join the Customs Union, it may be able to join the Russian-lead Eurasia Economic Union that will replace the CIS trade club at the start of 2016.

A second plank of restraining Ukraine’s momentum towards the West is Russia’s insistence on some sort of federalisation, giving more autonomy to the regions, especially those in the east. This would allow Russia to build up relations with the friendlier bits of Ukraine, rather than the whole country, and would also stymie the full accession of the country with the EU.

Ilooks like Kyiv might concede on this point too after German chancellor Angela Merkel called for Kyiv to consider a federal solution to end the fighting at the weekend – a big concession to the Kremlin. Russia’s foreign minister Sergei Lavrov echoed the call for a federated solution to the Ukraine crisis this week, so the issue seems to be on the agenda today.

The last issue is gas. Russia will be looking for transit guarantees for its pipeline, but the issue will become moot is the EU stops blocking Russia’s proposed construction of the South Stream pipeline that will by pass Ukraine altogether. Last week Bulgaria said it was halting construction work on the pipeline due to EU complaints.

The thornier issue is the row over Ukraine’s outstanding gas bill and the price is supposed to pay for gas. The gas war died down over the summer as demand fell off, but now that Moscow is being drenched by torrential rain in the last few days and temperatures are already falling the gas wars are about to restart.

Striking a deal over gas is going to be hard. Russia’s state-owned gas monopolist Gazprom claims that Ukraine still owes $5bn from the start of the year. Ukraine has pumped some 15 billion cubic meters (bcm) into its storage facilities ready for winter, but analysts estimate that it will still need another 10bcm of gas that will cost just under $2bn. The Ukrainian government is strapped for cash and even if Kyiv accepts Russia’s compromise price of $385 per thousand cubic meters, down from the $485 Ukraine agreed to under the terms of its 2009 deal, but more than the $$268.5 Kyiv is holding out for.

Kyiv will struggle meet this bill regardless of what the price is. There is going to be no easy resolution to this issue as Kyiv can make any agreement it likes with Russia, but the problem of where to get the money from. Last week Kyiv asked the IMF to concertina its next two tranches from its $27bn stand by programme together and increase the overall size of the package. But that is going to be a whole different set of negotiations.

So while the talks on all these issue will start today, no one is expecting any of them to be resolved. Merkel said on August 25 Ukrainian “decentralisation”, a deal on gas prices, and Ukraine’s “trade relations” with Russia as elements that could bring about an accord, but deliberately played down expectations. At best observers are hoping for a deal that will end the bloodshed and destruction and set out a road map for remaking relations between Russia and Ukraine.