In an opinion piece published by the Kyiv Post on Aug. 23, I asked the rhetorical question of “whether they (Ukrainian authorities since 2019) seek to preserve manual control and attendant non-transparency or to build a competitive and open energy market with competent regulation, independent of day-to-day political interference.”
Since then, we appear to have the answer, unfortunately. The president, prime minister, and other government officials continue to talk about setting electricity or gas prices rather than letting market forces decide and supporting the truly needy by direct transfer payments. Manual control is very much the order of the day, as well as abandoning the price signal in the market economy Ukraine is building supposedly.
The latest outrage is a public discussion by President Volodymyr Zelensky’s ruling Servant of the People party to ban private gas producers from selling gas at commercial prices and to require them instead to sell gas at cost with minimal markup.
It is as if some Ukrainian politicians learned nothing from the failed Soviet economy and its legacy, which continues to plague Ukraine’s energy sector. At a time of runaway global gas prices, it is natural for politicians to be nervous about public reaction and economic impact. However, the solution for Ukraine is to accelerate much-delayed systemic reform of its dysfunctional energy sector and not to further distort its domestic market through manual control.
Private investors in gas development have increased their production in Ukraine while the volume from state companies, which represent the vast majority of production, continues to decline. Without private investors, Ukrainian gas production would have dropped even further. Ukraine has ample gas resources. It should be self-sufficient in gas with much higher energy efficiency and investment in production. Price controls work against both. Even if the proposed legislative initiative is stopped, it sends the wrong signal from the ruling party and reveals the lack of sensible economic thinking.
Energy is a long-term capital-intensive industry. Significant investment projects take years to plan and complete. Faced with political uncertainty, the natural response by private investors is to slow down or cancel capital spending for enhancing production since there is no opportunity to achieve a reasonable financial return. Without ongoing investment, gas production will drop not just for the temporary period the ban is planned ostensibly, but for the next three to five years. It may take longer to restore investor confidence.
This is the problem with public musings of bad policy that run counter to the existing Ukrainian law on the natural gas market and commitments the Ukrainian government made repeatedly to international donors to liberalize the natural gas market. The timing is most unfortunate after the conclusion of the European Union-Ukraine Summit in Kyiv this week and the upcoming U.S.-Ukraine Strategic Partnership Commission meeting.
Ukraine’s international partners want to see improvement in investment conditions through the application of rule of law and protection of property rights so that Western companies can increase their business activities. The proposed legislative initiative does the opposite. Price control is an open invitation for well-known nontransparent business practices in the Ukrainian gas sector under which well-connected parties gain access to “cheap” gas to the disadvantage of the rest of the economy. Such parties still owe hundreds of million dollars of the unpaid debt to Ukrainian state gas-producing companies.
When I was in Kyiv in September, I was surprised by how short-term political calculation is influencing policymaking. Since general elections are more than two years away, I thought that the authorities would focus on achieving concrete and sustainable results to run on a favorable record. If the Verkhovnia Rada, Ukraine’s parliament, wishes to improve the economic condition of the gas sector in Ukraine, it will do well to streamline the licensing process and speed up the process for acquiring new acreage for exploration and production. There are thirteen different royalty rates in Ukraine, which strike me as ten too many. Bureaucratic barriers, inherited from the Soviet Union, invite capricious government action and enable corruption.
For Ukraine to grow realistically above the current anemic level of 3-4% per year to 6-8% economically, Ukraine needs much more investment, from foreign and domestic capital. The energy sector can be converted from a cautionary tale for investors to a success story, given Ukraine’s geology, geography, and human capital, with the help and not hindrance of the Rada and other Ukrainian authorities.
Let’s score a goal for the home side.
