ISSUE 14

31. 10. - 13. 11. 2022

• Kherson liberation and situational update
• The end of the oligarch’s era in Ukraine?
• Investment screening as part of Ukraine’s economic security
• Special Tribunal for the Kremlin’s top leadership
• Russia raises gas tariffs for its population

On 11-13 November, the Armed Forces of Ukraine (AFU) completed the liberation of the western (right) bank of the Dnipro River in Kherson Oblast, including the city of Kherson, the only Ukrainian regional centre captured by the Russian army (RAF). Stabilization measures are ongoing in the liberated settlements of the Kherson oblast. It was reported that the local administration, evacuated in early March, resumed its functioning in the region, along with Ukrainian law enforcement institutions and security agencies. Ihor Klymenko, chief of the National Police of Ukraine, said about 200 officers were at their posts in Kherson and that checkpoints had been set up. National TV and radio broadcasts had resumed in the strategic southern city and officials said aid supplies had begun to arrive from nearby regions. The tempo of the AFU advancement has been impressive and exceeded the expectations over the last two weeks following Russia’s withdrawal.

However, the RAF continue the fortification equipment of the defensive lines on the left bank of the Dnipro. Also, OSINT sources report that their military equipment and weapons are re-deployed from the Kherson direction to the Eastern front, where the intensity of the fight remains extremely high, claiming the lives of many Ukrainian soldiers. There the AFU continued counteroffensive operations towards Kreminna and Svatove, Luhansk Oblast. The RAF continued ground assaults around Bakhmut, Avdiivka, and Vuhledar. In addition to that, Russia continues to attack Ukrainian residential areas and civilian infrastructure with regular missile strikes, causing unsystematic and massive blackouts across the country.

ANALYSIS

The liberation of Kherson significantly changes the operational situation in the southern part of the front. It gives Ukraine an opportunity to apply additional forces on other directions. Russia is also likely to re-deploy its units to the Eastern, or even Northern front, from the territory of Belarus. Being aware of the growing risk of repeated attack from the Belarusian territory, Ukraine launched the construction of the wall along the entirety of the border between Ukraine and Belarus. Made of reinforced concrete and topped with barbed wire, the wall will be an additional fortification line created by Ukraine to prevent the scenario of advancement of the Russian, and potentially, Belarusian forces aimed at cutting important logistical communications with the West. In addition, an important factor in the liquidation of the bridgehead in Kherson is the possibility to conduct deeper damage to the positions of the Russian army (see map):

An important area remains a Kinburn Spit below Mykolayiv and Ochakiv, where AFU continue to push the Russian artillery out, to secure outskirts of Mykolayiv from regular devastating shelling and ease the situation for Odesa. Ukraine’s advancement in Kherson also means that Russian bases, supply depots, rear points of permanent deployment and rembases are most likely moved beyond similar limits to the Chonhar-Melitopol conditional line. As a result, almost the entire left-bank part of Kherson oblast has turned into a front-line zone for occupiers. In practice, this leads to a significant increase in the logistics shoulder and the deterioration of support for the group, and with it to a decrease in combat potential.

Under these circumstances, Ukrainian political and military leadership has already confirmed that liberation of the occupied territories will continue, despite the fears that the international partners of Ukraine will put pressure on Kyiv to deal a compromise with Russia at this point. The U.S. national-security adviser Jake Sullivan denied those rumours and claimed that “Russia, not Ukraine, was the side that has to decide whether or not to go to the table”, as it continues to make “outlandish claims” about its self-declared annexations of Ukrainian lands, even as it retreats from Ukrainian counterattacks.

For the first time in the history of Ukraine, five strategically important enterprises for security and defense were immediately returned to the sphere of state management. Among them are Ukrnafta, Ukrtatnafta, Motor Sich, AvtoKrAZ and Zaporizhztransformator. From now on, they will be under the control of the Ministry of Defense. Many perceive this as a sign of the end of the era of classical oligarchy in Ukraine.

ANALYSIS

The actual owners of the first two companies are oligarchs Ihor Kolomoiskyi and Gennadiy Boholyubov. The companies are not related, but they are the core of the oil business of the two partners. According to available information, back in the summer, the President’s Office had an idea about the need to create a single-state oil company. To ensure this, the profile deputy head of the Office of the President (OP) Rostyslav Shurma tried to establish contact with Ihor Kolomoiskyi regarding the possible sale of Ukrnafta by him, but constructive negotiations did not take place. Currently, the Kremenchuk oil refinery, which is owned by Ukrtatnafta, has already been accused of not paying hundreds of millions of hryvnias in taxes. If the claims of the security forces are proven in court, it may well end with the need to pay more than UAH 700 million to the state budget, taking into account inflation. At the same time, instead of Kolomoiskyi-Boholyubov’s people, others directly related to the head of OP Andriy Yermak entered the supervisory board of the companies.

It is noteworthy that after the withdrawal, a single director was appointed to Ukrnafta and the Kremenchuk oil refinery - Serhiy Koretskyi, which confirms the mentioned sources' data about the state's intention to merge them. As for Motor Sich, its main profile is the production of helicopter engines, which it was still supplying to Russia until very recently (this autumn). Its founder and main owner, Vyacheslav Bohuslayev, was recently detained on suspicion of treason. Therefore, the logic behind withdrawing Motor Sich is quite clear.

AvtoKrAZ manufactures cars, including for defense needs. Since the spring, the Ukrainian military has complained en masse about the quality of the plant's products and refused to buy them. The owner of the plant, Kostyantyn Zhevago (who controls the stake in the Espresso TV channel, which is opposed to the current government), has long been declared an internationally wanted man and, according to available information, is in the south of France.

Zaporizhzhitransformator manufactures equipment for the energy infrastructure, which Russia is methodically attacking and which needs to be replaced. The actual owner is Konstantin Grigorishin, who has been living in London for a long time.

Commenting on these events, President Zelenskyy noted that it is not about nationalization, but about the temporary seizure of assets during the period of martial law (the relevant law allows this). Perhaps in the future, they will be returned.

We should expect lawsuits from the owners of the objects that were temporarily seized - first at national, and then at international level. The formal reason is the seizure not of property (which had yet to be properly described), but of company shares.

Zelenskyy called the fight against oligarchs one of the priorities of his presidency. Shortly before the beginning of the acute phase of the war, the law "about oligarchs" was adopted in Ukraine. In May 2022 (later postponed until the summer) the so-called "register of oligarchs" was supposed to work. Inclusion in such a register would involve significant restrictions on a person (for example, the inability to participate in large-scale privatization, engage in political activities, etc.) To be included in the "register of oligarchs", a person had to meet three of the four prescribed criteria. The total amount of capital is also an important factor, but it is currently impossible to calculate precisely, since many assets are either destroyed in the east and south of the country, or "frozen" or are still under occupation.

Strategic enterprises owned by Viktor Pinchuk, Petro Poroshenko, and Rinat Akhmetov have not yet been included in the list of confiscations, but President Zelenskyy has not ruled out the expansion of this list if necessary.

The Ukrainian government launched the initiative Advantage Ukraine aimed at attracting foreign investments in the key sectors of the economy. As of November, the platform received 370 requests. Investors are mainly interested in innovation and technology, agro-industrial complexes, and infrastructure as well as the energy and defense industry. In addition, the Ukrainian government established cooperation with the largest investment company Black Rock regarding the creation of a platform for attracting private capital to Ukraine. These investment initiatives are most welcome as they would help Ukraine to upgrade its economy to the level of a western style technology-based economy. For that, the government will need to create a conducive environment to attract foreign direct investment and ensure rule of law and transparency. On the other hand, it would be important to ensure economic security and protect the national economy from corrosive capital.

ANALYSIS

Corrosive capital is defined as state or private financing that lacks transparency and accountability, originates from authoritarian regimes, and aims to pursue its foreign policy agenda and advance its political and economic influence in recipient countries.

For example, China tries to establish control of so-called “dual-use” (civil-military integration of technology) technology as well as the transfer of advanced technologies from investment recipient countries and collecting intelligence data. A vivid example of this in Ukraine was the case of the military helicopter engine producer Motor Sich which a Chinese government-controlled business was trying to acquire in 2020 to advance the transfer of advanced technologies to China. The deal was canceled by the Ukrainian government on national security grounds.

To protect national economies from the malign influences of corrosive capital, investment screening mechanisms are established. Foreign direct investment (FDI) screening is the process where the recipient government identifies, reviews, and if necessary, rejects foreign investments. These mechanisms give recipient governments greater control over national security-threatening or potentially problematic foreign investments.

Countries in the Indo-Pacific region, located close to China, such as Japan and Taiwan, have established strong FDI screening mechanisms. Japan has a negative list of sectors for FDI, such as weapons, cyber, and certain infrastructure sectors, such as rail and water. In August 2022, amidst Russia’s invasion of Ukraine and growing tensions in the Indo-Pacific region, Japan introduced a new law strengthening economic security. Taiwan goes even further as it uses stricter regulations towards Chinese investments in sensitive sectors than towards investments originating from other countries.

The EU introduced its FDI screening mechanism which currently only requires the EU member states to report their screening activities while the FDI screening itself remains a national competence of member states. Therefore, on its way to EU accession Ukraine will have to adopt its own FDI screening regulations.

In conclusion, it is advised to establish an FDI screening mechanism for investments in the reconstruction of Ukraine. One of the first steps could be developing a list of sensitive investment sectors where investments could be limited or restricted. At the same time, FDI screening should in no way hinder economic development or the foundations of the free-market economy in Ukraine. This should be ensured by proper communication and explanatory work with potential investors by the government. However, given the nature of Russia’s war against Ukraine and the existence of other malign actors, it will be needed to protect the national economy from possible security interference.

On 31 October, in Kyiv, the Czech government supported establishing a Special Tribunal for Russia for the crime of aggression committed against Ukraine. On 20 October, the Dutch Parliament proposed to create a special tribunal in The Hague. According to Prosecutor General of Ukraine Andriy Kostin, almost 16 countries support the creation of a Special International Tribunal for the Kremlin's top leadership. Earlier, the foreign ministers of Estonia, Latvia, and Lithuania had issued a joint statement calling on the EU to support Ukraine in setting up this institution. Today, Kyiv has significant international political support in this issue: two PACE resolutions, a resolution from the Lithuanian Parliament, and a resolution from the European Parliament. The number of signatures of the corresponding petition is already almost 2 million people.

ANALYSIS

Proposals for creating a special tribunal for the crime of aggression have been heard since the first months of Russia's invasion. Ukraine and the international community are looking for every opportunity to legally prosecute Putin and top Kremlin officials who decided to attack Ukraine. The difficulty is that more than the available international legal instruments are needed. The International Criminal Court (ICC) is already investigating war crimes and crimes against humanity in Ukraine. However, due to legal restrictions, the ICC in the Hague cannot work with the crime of aggression. That is why there is a need to create a new institution. The international community generally supports such an initiative, but its implementation requires an individual mandate from each state. The most realistic way of creating a special tribunal is to sign an international treaty between countries that support this idea. It is important that the tribunal's establishment be supported by as many EU member states as possible, as well as the US, and others will join in following the example. This is one of the key issues in Kyiv's negotiations with partners at the bilateral and multilateral levels. The Baltic States and the countries of Central Europe are the most active supporters of a special tribunal for the Russian Federation. However, this is still not enough. Currently, work is underway aiming at agreeing on the format of the tribunal, its participants, and the development of the agreement. The Office of the President of Ukraine plans to complete the negotiations in January next year, after which the procedure for concluding an agreement will begin.

Recognition of the crime of aggression is also essential because, currently, the processes of seizure of Russian Federation assets, aiming at sending them to victims of war, take place in different countries of the world. Russian lawyers appeal for the "unproven fact of aggression." After such a tribunal, there will be legal frames on this issue. Creating a special tribunal against the Russian leadership is necessary to restore justice, and security and prevent the repeat of acts of aggression in the future. It will also be a powerful signal for all other potential aggressors in the world.

The Federal Antimonopoly Service of Russia, unexpectedly proposed to increase the regulated gas price by 8.5% from 1 December for all consumers. Originally the hike in gas tariffs was planned for July 2024. These funds will help to fill a federal budget.

The government claims that the tariff’s hike for the population are below inflation, and it is needed for the gasification program. In reality the main goal is to decrease the growing budget. The government also introduced a tax increase for raw material exporters. The proposed measures should provide an additional $50 billion revenues in 2023-2025. In 2023 the government plans to collect an additional $23.25 billion. A series of tax measures were proposed for additional revenues from the mining industry.

ANALYSIS

Gas prices in Europe have been steadily declining since August, which means lower income for Russia. The steps taken by the EU to overcome the crisis worked well for the EU, but not for Russia. As of 1 November, Gazprom has reduced production by more than 18%. In addition, the company's gas demand on the domestic market decreased by 5.6% during the same period. Exports decreased by 42.6%. Russia gradually cut off gas supplies to the EU, not hiding its pressure and demonstrating a direct relation to worsening situation of RAF. Continuing to shoot itself in the foot, Russia has started to put pressure on Moldova. In November, Gazprom cut half the supplies to Moldova. Companies affected by Russia’s gas blackmail are not passive. The Czech energy company ČEZ is preparing an international arbitration against Gazprom. ČEZ will demand compensation for interruptions in gas supplies. The same arbitration proceedings were initiated by several other EU countries and Ukraine.

Although Russia is still earning substantial profit from deliveries of Russian oil to Europe, which last week reached a five-month high, it is only temporary. Tankers are rushing to deliver as much oil as possible before the EU sanctions come into effect in December.  Even the growing exports to China and Turkey cannot compensate for lost EU markets. Russia is burning gaswhich cannot be delivered to the EU, and at same time it is raising the tariffs for its domestic consumers. Gazprom during the first nine months of 2022 generated a record profit due to inflated gas prices. However, this situation has changed. Russia's loss of the EU gas market means not only a loss of revenues but also the loss of hundreds of thousands of jobs and the degradation of the mining industry.

The revenues of Russia’s federal budget are falling for the third month in a row - in September they decreased by approximately 4% (YOY), in August by 11%, and in July by 26%. At the same time, for the third month in a row, both oil and gas revenues and non-oil and gas revenues are decreasing. Earlier it became known that Russia began spending funds from the Russian National Wealth Fund (RNWF) to cover the budget deficit. Only in September, $8.65 billion from RNWF were spent. The total volume of RNWF was $187.98 billion (on 1 October). According to Russia’s forecast, the budget deficit in 2022 will exceed the previously forecasted 0.9% of GDP due to "new tasks". These "new tasks" obviously include spending on the war against Ukraine. Almost one quarter ($112 billion) of the draft budget for 2023 was made secret.

The war is slowly taking its toll on Russia's economy, and the increase of gas tariffs is a significant, but far from the last impact ordinary Russians will feel in the near future.

CZK:   Transparent account

AN:     2300405420/2010

VS:     2022

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