A bad deal for Ukraine and Yanukovich

The new Ukrainian president has got off to a bad start in foreign policy terms. Last week, Viktor Yanukovich signed a lease agreement with Moscow that will allow the Russian Black Sea Fleet to stay in Ukraine for at least another 32 years. In doing so, the new president gave up an important piece of Ukrainian sovereignty.

Mr Yanukovich probably thinks he got a good deal. In exchange for the lease extension, Russia promised to cut gas prices to Ukraine by 30 per cent. This is important: Ukraine’s economy is in deep trouble (it contracted by 12 per cent in 2009), and Kiev’s policy of subsidising domestic gas sales is breaking the treasury. It seems like a simple calculation: why not give Russia something it already has (the right to station forces in Ukraine) in return for something the country badly needs (cheaper gas)?

There are at least two good reasons. The presence of the fleet, with its many soldiers and intelligence operatives, allows Moscow to put pressure on Kiev. Whenever Ukraine crosses Russia – as the previous president Viktor Yushchenko did by applying for Nato membership – Moscow responds by hinting at Ukraine's disintegration. Crimea, the home of the Black Sea Fleet and a largely Russian-populated area, is the most likely place to split off. The fleet's staff – especially its intelligence operatives – are the catalyst that could stir up unrest on command (not unlike South Ossetian leaders did, leading to the Russo-Georgian war of 2008). Ukraine will not be truly independent until it is free to make its own foreign policy choices, and the presence of the fleet guarantees that it will not have that freedom for a few more decades. That is the true cost of the lease.

Mr Yanukovich is also wrong on the potential benefits of the deal. There was a better way to control the gas bill: he should have sought to reduce demand rather than decrease the cost of supply. Ukraine is one of the most gas-thirsty places on earth. It consumes about $900m worth of gas a month in winter, when demand is at its highest – three times as much as neighbouring Poland, another former communist country of comparable size. Ukraine's recent governments have not done enough to replace old, energy-inefficient housing or to modernise gas-intensive steel mills and fertiliser plants. If they had, Ukraine could be close to self-sufficiency (it produces much gas domestically).

Last year, the European Union lined up key international finance institutions – the World Bank, the European Bank for Reconstruction and Development and the European Investment Bank – to help finance gas-sector reforms. The then- Ukrainian prime minister, Yulia Tymoshenko, balked at the offer because she would have had to raise gas prices right before presidential elections, in which she herself was a candidate. But the offer has remained on the table and represents a much better way for Ukraine to control its runaway gas bill than the recent agreement with Russia.

So why did the president extend the lease? Some will argue that signing bad deals with Moscow is what pro-Russian leaders do. But contrary to the frequent descriptions of Mr Yanukovich in the media, he is not "pro-Russian"; his foreign policy can be best described as one of balancing between the west and Russia. Seasoned Ukraine watchers, including in the European institutions, did not expect Mr Yanukovich to give in so easily to Moscow's demand.

It appears that the new president is simply not playing his balancing game very well. He could hardly have chosen a worse time to bargain. Ukraine is dealing from a position of unprecedented weakness: not only has its economy contracted dramatically but the country also needs to roll over some $30bn in debt this year; it badly needs foreign help.

Given the circumstances, the president should have started by shoring up Ukraine's strengths: reducing its addiction to cheap gas, building a more effective government and undertaking economic reforms to secure help from the International Monetary Fund and the EU with Ukraine's loan burden. Extending the lease does the opposite: it deepens Ukraine's weaknesses and prolongs its dependency on discounted energy from Russia. It gives Mr Yanukovich fewer options in his future dealings with Moscow and the west. It is a bad deal for Ukraine, and a bad start for his presidency. But its impact can be mitigated if Ukraine starts to tackle its gas consumption. This is what Europe and the US must urge Ukraine to do and where they should focus their diplomacy.