Ukraine Update: Moscow will be looking for a sweet deal from Poroshenko

(Business New Europe – bne.eu – Tim Ash, Standard Bank – May 28, 2014) Ukraine’s Central Electoral Commission has confirmed that Petro Poroshenko has in effect won the presidential election, with over 54% of votes, after 95% of votes have been tallied.

The president elect has promised to engage in talks to bring peace to Ukraine Ð but not with the terrorists currently slugging it out with Ukrainian troops in Donetsk and Luhansk.

Poroshenko will make his first foreign visit to Poland, on June 3-4, which is significant as Warsaw has been amongst the most ardent of supporters of an independent Ukraine, and pushed sanctions against Russia for its destructive role in Ukraine. Poroshenko has confirmed that he will maintain Ukraine’s EU orientation, and this was not negotiable with Russia, while he would push Moscow for the return of Crimea Ð even seeking international arbitration for losses incurred.

Poroshenko is also promising a trip to Moscow in the first half of June Ð presumably after the visit to Warsaw, a symbolic gesture to the effect that Ukraine will still be oriented first towards the West, and then East. Interestingly, Russian FM this morning signalled that a Poroshenko visit to Moscow was not under discussion Ð again suggesting that Russia is playing hard to get.

Moscow seems to be keeping its options open with respect to Ukraine and the new Poroshenko presidency, seeing what he offers in terms of compromises to Russia. But Moscow has indicated that it favours bilateral talks Ð rejected by PM Yatseniuk this morning, in favour of broader talks over the future of Ukraine, involving the EU and US.

Russian FM Lavrov, again called today for an end to Ukrainian military action in SE Ukraine, and a return to the principals of the Geneva accord Ð that said, all sides seem to concur that separatists went on the offensive yesterday in capturing Donetsk airport, and it is a bit difficult to see how the Ukrainian military could not have replied to such a high profile assault.

Fighting has continued in Donetsk overnight Ð after rebels appeared to try and seize the initiative and confront the new president by attempting to seize Donetsk airport. The Ukrainian military have seemingly responded in force, inflicting significant casualties on the separatists Ð anywhere from 50 Ð 200 fighters reported to have been killed. Fighting has spread from Donetsk airport to downtown Donetsk with clashes at the railway station and reports that the “Druzhba” (“Friendship”) ice hockey stadium was destroyed Ð the latter was only built in 2010, and this just underscores that the conflict is already exacting a significant impact in terms of the loss of lives (hundreds now), damage to infrastructure and lost economic output (Donetsk and Luhansk account for around 15% of the economy).

In another worrying development today, border guards reported that they repelled an attempt by around 40 large Kamaz trucks to cross the border from Russia into Luhansk oblast in Ukraine, presumably carrying armed separatists/supplies. Several of the trucks managed to cross, and border guards inflicted some losses on the occupants. Separatists from Donetsk and Luhansk have called for backing from Russia, but Moscow seems to be avoiding giving formal support thus far Ð perhaps fearful of sanctions Ð but the government in Kyiv would likely still argue that Moscow is not doing enough to stop cross border incursions by irregular fighters from Russia.

In recent weeks the EU has been trying to broker a gas deal between Moscow and Kyiv, which will avert Moscow’s threat to stop gas supplies to/thru Ukraine from June 4. The EU has offered a framework agreement whereby Ukraine pays USD2bn, of the currently USD3.5bn outstanding, by May 30, and then another USD500m by June 7, pending an eventual agreement over gas pricing. The authorities in Kyiv have indicated that they have the funds to meet payment for arrears on gas supplied, but appear in no rush to make the payment without a broader agreement on gas pricing. Ukraine is still claiming that it should continue to pay USD268.5 per 1,000 cu metres, as agreed by the Yanukovych regime with Russia in December, while Moscow is arguing that the price should be USD485, i.e. taking off discounts for the Black Sea Fleet, et al. Moscow is threatening to cut off gas supplies unless the outstanding debts are paid, and Ukraine makes a pre-payment of USD1.7bn for gas scheduled to be delivered in June. A deal will probably be settled at USD385 or thereabouts, but this could still take time, and energy supplies still disrupted. PM Yatseniuk has argued that Russia stole 2.2 billion cu metres of gas upon the annexation of Crimea Ð affirming the complexity of the issues.

Poroshenko has called for early parliamentary elections, presumably to cement his own high personal popularity into dominance in parliament, via his newly created Solidarity party. Note that under the returned 2004 constitution, much power has moved from the presidency to the parliament and executive. Solidarity is currently also topping the polls with a 20-25% share of the vote, and should do well in early parliamentary elections Ð albeit my sense is that parliament could still end up fairly fractured, as many people appeared to back Poroshenko in the presidential vote as a vote for unity, to ensure a first round victory, rather than being ardent supporters of the “Candyman”. In parliamentary elections, the vote might be much more split across the political spectrum.

It is still somewhat unclear whether electoral reform will be rolled out pre-election, away from the split PR/constituency system, to a straight PR system. Poroshenko might well do better in the current system, which tends to favour oligarchic business interests/leaders. That said, some might argue that the current split regime will be better for unity, as it will likely ensure that local business leaders are elected/dominate, more likely to be able to keep a lid on fractured local political/security situations, e.g. in SE Ukraine.

Poroshenko himself is a fairly remarkable character Ð perhaps one of the most well qualified people for the job of President of Ukraine at this incredibly trying time. Much has been made of the fact that he made his fortune in trading cocoa and then built the Roshen chocolate empire, which also has manufacturing and distribution facilities in Russia Ð seemingly subject to retaliatory sanction by the Russian authorities. However, alongside his proven business acumen Poroshenko also knows a thing or two about economics, having served as head of the Council of the National Bank of Ukraine Ð I can vouch for this, having had a session or two with him there over the intricacies of monetary/exchange rate policy on which he could certainly hold his own. He also counts a number of Western bankers amongst his personal friends. His political CV is equally impressive, having served as minister of economy/trade, foreign minister, and also head of the National Security Council under President Yushchenko, and in a government headed by Yanukovych. Indeed, Poroshenko, was a former founding member of Yanukovych’s Party of Regions, so he has strong ties/relations into the South-East business elites which were the mainstay of the former Yanukovych regime Ð the latter was perhaps seen with the “surprise” Vienna meeting between the pro-Russian energy oligarch, Dmitry Firtash, Poroshenko and Vitaly Klitchko, the newly elected Mayor of Kyiv and former Maydan leader. Poroshenko was though one of the first oligarchs to switch allegiance at the onset of the Maydan protests Ð famously appearing atop a JCB to prevent violence at Maydan protests getting out of hand last year. He was also an early an ardent supporter of the signing of the AA/DCFTA with the EU, and he is still maintaining this line. Net-net, if anyone has the tools to pull Ukraine around, and out of the current mess, it is probably Poroshenko Ð he is a shrewd business and political operator, perhaps reflected in his decision to remain out of the first Maydan administration to ensure a clear path to be elected as president.

The above said, Poroshenko’s room to compromise has been limited, by events over the past 6 months and Russia’s destructive approach towards Ukraine Ð the bulk of the population now appear unwilling to compromise on Ukraine’s independence, a non-Federal structure, and its European integration/orientation, which sets the country still at loggerheads with Russia.