Orange Devolution
Ukraine's Orange Revolution has run aground. Investors are sidelined, hopes have soured, and old rivals are battling for power.
By Brett Forrest, FORTUNE

(FORTUNE Magazine) - Yulia Tymoshenko's motorcade slices through Odessa, roof lights spinning, Klaxons barking. It's campaign season again, and Ukraine's "samurai in a skirt" is railing against official mendacity. Which may seem odd to anyone who last checked in on Ukraine during the citrus glow of its so-called Orange Revolution a year and a half ago.

Back then Tymoshenko and President Viktor Yushchenko were partners in a populist uprising. But what looked like a fundamental change hasn't turned out that way. Yushchenko's honeymoon lasted about as long as a shackup at Niagara Falls, the bold aspirations of his revolution ground down by the realities of what remains a troubled country.

Tymoshenko was forced out as Prime Minister last fall in a dispute over undoing an earlier wave of privatizations. The man Yushchenko beat in the 2004 election, Viktor Yanukovich, is back in the picture. And a gas deal with Russia's largest company has cast doubt on the viability of clean governance in Kiev. Stability hangs in the balance, and the big foreign money is sitting on the sidelines, waiting to see what happens in what may be Europe's last great growth market.

But with Ukraine's political parties fractured, its Parliament, up for election March 26, is destined to be administered by a slipshod coalition of forces that will have difficulty getting anything done, let alone pushing through reforms that were supposed to be well underway by now.

A year of frustrations has darkened the sunny disposition of Ukraine's onetime hero President, who survived a mid- campaign poison attack that left his face disfigured. The meanest cut came on New Year's Day, when Russia's gas monopoly, Gazprom, turned down the pressure in a pipeline, freezing out Kiev during the coldest winter in decades. Russia was finished subsidizing a country that covets EU and NATO membership, and it demanded a fivefold increase in the price of gas.

Although Yushchenko's government forged what appeared to be a favorable agreement with Gazprom--prices only doubled, to $95 per 1,000 cubic meters, still well below European rates--it turned out the deal didn't guarantee prices much beyond the elections. And it interposed a third party that had little to recommend itself aside from the proper connections: a gas broker called RosUkrEnergo (RUE). Gazprom owns half of RUE, while the other half is controlled by Austria's Raiffeisen Investments on behalf of clients it has refused to identify.

RUE has a dozen employees and no physical assets, yet it earned $500 million last year working with Gazprom across Russia and Central Asia. The Ukraine deal made RUE one of Europe's biggest energy traders overnight, exactly the sort of cynical pact Yushchenko had pledged to bust. Russia was all too happy to let the gas dispute ensnare the faltering President, whose party, Our Ukraine, has slipped below 20% in the polls.

Things grew even stranger when Naftogaz Ukrainy, Gazprom's opposite number in Ukraine, signed a joint-venture agreement with RUE that authorizes an entirely new firm, Ukrgaz-Energo, to handle selling the gas, further muddying the water. The deal is so convoluted that anyone you meet in Kiev inevitably grabs paper and pen and sketches a diagram that fills the page with chicken scratch from here to Ashgabat, the capital of Turkmenistan, from which a good portion of the gas emanates.

It appears there is little the President can do to uncover the owners of RUE's dark half, which many have speculated falls under the control of those same pocket-lining phantoms who have controlled business in Ukraine for the past 15 years. "We can start digging in this direction," says Konstantin Borodin, director of the Energy Research Center of Ukraine. "But as a result, we can meet a mine that will blow up all the diggers, together with Ukraine's economy."

Someone has succeeded in making what should be a simple energy deal between bordering nations into a tangled web that thwarts all scrutiny. But the agreement begs for analysis because Yushchenko signed off on the deal. "What the Kremlin is doing," says Borodin, "is teaching Ukrainians how to treat Russians." Or how to be Russians.

The lesson comes at an inopportune moment for Yushchenko, who has proved unable to fight on so many fronts. Now he is struggling to retain the power of his office, reneging on an agreement he made to cede some presidential powers to the Prime Minister, who will be selected by the ruling parliamentary faction. Yushchenko has called for a referendum on the issue, but support is flagging. If he gets his way, says Tymoshenko, "I'm afraid the only Orange person left in this country will be the President."

Tymoshenko is sitting tranquilly on a divan in an Odessa hotel suite, protected by a cadre of security guards. She has just returned from the Black Sea port of Illichivsk, where she pumped up a crowd of several thousand. The words she uttered--about sticky fingers in the government, Russia's enduring influence--sounded familiar. It was the exact fare she and Yushchenko had dished out during a revolution designed to eradicate all that. "Ukraine has changed today," Tymoshenko says, her yellow braids spiraling back off the crown of her skull. "But it's wrong to think that just because we won the elections, we have won a victory against all those clans. Immediately after it happened, they were a little stunned. But then they survived, got back into shape, and now they're ready to get back into office."

The poster boy for this trend is Ukraine's richest man, Rinat Akhmetov, a steel and coal billionaire running for Parliament under the flag of the Party of the Regions, Yanukovich's group. Akhmetov claims that, if elected, he'll relinquish business in favor of politics. Yanukovich has said that, should his party gain control of Parliament, he may put forth Akhmetov for Prime Minister.

With that possibility not far from reality, many are blaming Tymoshenko for having taken a vindictive approach to business during her seven months in office. "You don't take all the oligarchs out of power who control 60% of GDP," says John David Suggitt, managing partner of Concorde Capital, a Ukraine investment bank. "You don't try to throw them in jail. You don't try to take away their businesses and expect them to invest $1 billion in new machinery."

To be fair, Yushchenko hasn't shied away from reform. His biggest achievement so far may be reselling the Kryvorizhstal steel complex, which former President Leonid Kuchma's son-in-law, Viktor Pinchuk, and Akhmetov had purchased for $800 million. In a televised auction, Mittal Steel bought a 93% stake in Kryvorizhstal for $4.8 billion, nearly double the expected price. But for every Kryvorizhstal there comes a RosUkrEnergo, killing the momentum.

Was it too much to ask Yushchenko to transform this wild country into something compatible with the West? "There's nothing worse than a fallen hero," says Roland Nash, head of research for Renaissance Capital, Russia's largest independent bank, chatting on the sidelines of a Ukrainian investor conference in Kiev. "A year ago Yushchenko was one of the most popular leaders in the world. He had the will of the people behind him. He could have made changes, but he didn't. He disappointed absolutely." Top of page

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.