In most countries, the debts owed by consumers for gas would be an economic issue. In Ukraine, it's a political one as well
In most countries, the debts owed by consumers for gas would be an economic issue. In Ukraine, it’s a political one as well.
Why? Because much of the gas comes from Russia, a former colonial master that sees the energy issue as a lever of influence on its newly independent neighbor.
To break that level – as Kyiv has stated in the past it wishes to do – will take foreign investment to boost domestic gas production and reduce waste from Ukraine’s creaky, leaky gas pipeline network, experts say.
Of the 75 billion cubic meters of gas Ukraine consumes every year, only 18 billion cubic meters are produced by the country itself. The rest comes mostly from Russia.
Ukraine receives some 30 billion cubic meters per year in fees for transporting Russian natural gas to consumers in western Europe. The remaining 27 billion cubic meters of gas used every year is supposed to be paid for by Ukraine, but broke Kyiv has let payments lapse for years, building up a massive debt to Russia.
However, Kyiv and Moscow disagree on just how massive that debt is. Kyiv says it’s no more than $1.4 billion, while Moscow insists the figure is over $2 billion.
Trying to pay off the debt in kind, Ukraine has shipped food and even 11 strategic bombers to Russia. But Kyiv’s failure to pay off all the debt still angers Russia, and it recently handed the government a list of Ukrainian enterprises that Russia would accept as payment for the gas debt.
Although the government denies that it will swap state property for debt forgiveness, several recent privatization deals in Ukraine are widely seen as just that.
And as Russia works on re-routing part of its gas exports to the West, analysts say it’s high time for Ukraine to address the gas issue.
“Increasing domestic gas production and halting wasteful gas usage would have significant macroeconomic consequences for Ukraine in the long run,” said Konstantyn Skorik of the World Bank.
Low domestic gas extraction
BP Amoco’s decision last year not to develop a number of natural gas fields in Ukraine was widely seen as a blow to the country’s hopes of easing its dependence on Russian gas.
The British-American oil and gas giant said the company’s research did not confirm that gas deposits in central and eastern Ukraine were large enough to be worth extracting. BP Amoco was reportedly looking for at least 300 billion cubic meters of recoverable gas in the area.
The need to increase domestic gas production is partially fueled by a common perception that Russian gas earmarked for Ukraine is overpriced.
Volodymyr Saprykin, gas expert at Ukrainian Center for Economic & Political Studies, said 1,000 cubic meters of Russian gas cost $80 for Ukraine, while the same amount of gas costs only $77 on the French and Italian borders, despite a longer transit route. Saprykin said the price of Russian gas for Ukraine includes a penalty for future non-payment and a substantial mark-up for the political independence enjoyed by the country.
Saprykin, also a former energy adviser to the government, said Ukraine has recoverable gas reserves of about 1,100 billion cubic meters, with about a third of that lying in the Azov and Black Sea. Using tougher western criteria for estimating gas reserves, the figure would be half that, or 550 billion cubic meters.
And that figure hasn’t proven much of a draw to foreign gas companies, so far.
Britain’s JKX Oil & Gas is one of the few foreign players on the market. With a total investment of more than $92 million, the company’s joint venture with the Ukrainian government has extracted just 1.4 billion cubic meters of gas over the last five years. However, JKX has long squabbled with its Ukrainian partners in the venture and is now less certain it will increase gas production in the country.
Indeed, analysts say Ukraine’s domestic gas extraction may plummet soon, if small and middle-sized foreign companies don’t pick up slack left by the country’s oil and gas giant Naftohaz Ukrainy. Naftohaz’s gas production will fall to just 14 billion cubic meters a year in 2010 from the 17.5 billion cubic meters planned this year, if the company doesn’t increase its spending on gas extraction.
But Ukraine took a huge step forward in attracting foreign investment last year, when parliament passed a law on production sharing, analysts said. Though lawmakers are yet to compile a list of gas fields that fall under the law, which stipulates how costs and profits from joint ventures are to be shared out, western gas companies are already taking a second look at the country.
And some are already investing. Canada’s Epic Energy is planning to start developing some gas fields on the Crimean peninsula this year, according to Epic Energy country manager Brian Cormick.
Cormick said Epic plans to produce some 50 billion cubic meters of gas over about 20 years. He said his company may become a beacon for others looking to follow.
“I know that a lot of people are watching [Ukraine] closely,” he said. “If they see that the first companies are successful, they will come.”
Cutting waste
Ukraine’s energy woes are exacerbated by waste and inefficiency. Ukraine is the world’s sixth largest gas consumer, burning the same amount every year as affluent Germany.
Aging, inefficient industry is the most to blame. Some Soviet era industrial behemoths survive only by passing their gas debts on to the government. As of the start of the summer, consumers owed the government Hr 20 billion for gas, according to officials.
Little-known to many, the gas transport network itself is a huge consumer of gas. According to Skorik, the transport system uses 8 billion cubic meters of gas a year, or more than a tenth of Ukraine’s total annual consumption.
Saprykin said a third of the transport network’s 708 gas compressors have outlived their working life and need to be replaced. The compressors raise gas to transport pressure and consume gas themselves in the process. Saprykin said that by replacing 197 gas compressors Ukraine would save some 2 billion cubic meters of gas a year.
However, to save money, Ukraine needs to spend money.
Sumy-based NPO Frunze machine-building plant is capable of constructing more efficient compressors, Saprykin said, but the government can simply not afford to finance the project. Ukraine replaced only eight compressors 1998 and seven in 1999, he said.
The World Bank has repeatedly recommended that the government allow an international consortium manage the country’s gas pipelines, a move that would bring much-needed investment to the industry, Skorik said.
But that’s been tried before – and failed. The British-Dutch company Shell in 1999 offered $600 million to manage the Ukrainian gas transport network for 40 years, Saprykin said. He said the government turned down the offer as too small.
Now, as Ukraine’s aging pipelines start to spring more leaks – two-thirds of the network of pipes needs to be replaced soon – the government may become more willing to leave the management and upkeep of the network to a foreign company.
“I think we’ll return to this,” Saprykin said.
