Sadly, in the year and half since EuroMaidan, little progress has been made in energy reform by the new government, in spite of repeated declarations of intent. Limited steps in energy pricing reform have been justified on the grounds that they are demanded by the International Monetary Fund rather than explained to a newly engaged citizenry as critical to modernize the Ukrainian economy, improve energy efficiency and increase domestic energy production. A truly independent energy regulatory body has yet to be formed. State-owned energy assets are still controlled by various oligarchic groups. Little has changed in the wholly state-owned oil and gas monopoly Naftogaz. Verkhovna Rada and its energy committee are still controlled by the same politicians who previously failed to pass reform legislation and to provide proper legislative oversight. Consequently, neither transparent regulation nor market competition is present still in the energy sector, which is left as fertile ground for corruption.
The Ukrainian public sees their government authorities as still captured by special interest groups and, therefore, unable or unwilling to reform the energy sector and other parts of the economy. Ukrainians are asked to make painful economic sacrifices without being presented with a credible plan for improvement in the future, with concrete actions and target dates instead of ad hoc and temporary solutions.
The only party, which appears to be satisfied, is Ukraine’s international supporters who sugarcoat the lack of progress in energy sector reform. Recognizing reality would necessarily compel urgent action on the part of international donors to assist Ukraine in economic reform with significant financial and capacity-building resources over a period of five to ten years, not the stopgap measures that have been taken so far in emergency loans (not grants) and reform in form (not substance).
Ironically, the conflict in eastern Ukraine is often cited as an excuse for the slow pace of reform by both Ukrainian authorities and their international supporters. In fact, long-delayed energy reform has persistently given Russia undue leverage over Ukraine. Reverse flows from central Europe of surplus Russian gas is only a temporary solution until Ukraine rectifies its dysfunctional energy sector to promote energy efficiency and domestic gas production. The nontransparent operation of Ukraine still-critical international gas transit system continues to encourage gas suppliers from Russia and the Caspian region and gas consumers from Europe to seek alternative routes in order to bypass Ukraine altogether. The threat of Russian aggression should be a strong impetus for energy reform, not a reason for delay.
In order to finally address the country’s energy vulnerability, Ukrainian leaders have to summon the political will to fix Ukraine’s dysfunctional and corrupt energy sector from which many of them benefited and to trust their public to embrace change in order to preserve the nation. This requires the government to communicate honestly about the challenges involved and realistic measures to mitigate painful adjustments. Constant delay in addressing these real issues till the onset of local elections and of winter has already cost this government dearly in loss of credibility with its public. Ukraine’s civil society has proven to be stronger than its political leadership. Wishful thinking and meager support by international donors concerned about Ukraine’s survival and consequences of its potential collapse have enabled dismal performance instead of providing this government with the incentive to sustain energy reform with substantial assistance.
There is no time left. An order of battle must be formulated for energy reform that deserves support from the Ukrainian public and substantial financial commitment from international donors. Urgent areas that require attention include:
Long-term energy pricing reform leading to market-clearing prices by defined date;
Energy subsidy reform to target the truly needy rather than the politically well connected;
Energy regulator independent of immediate political influence;
Plan to break up Naftogaz over time to promote competition and reduce corruption, while capturing or recapturing full economic value for state-owned assets;
Stabilizing gas supply and transit relations with Russia by professional conduct of negotiations according to international commercial norms, at least on the Ukrainian side;
Creating conditions for success story of investment in domestic energy production without waiting for long-term reform of the dysfunctional system for licensing of exploration and production.
The Ukrainian government can take many actions without waiting for legislation by Verkhovna Rada. For example, UkrTransGaz can be directed to keep separate financial accounts and operating records and publishing them, after independent audit, even before the breakup of its parent Naftogaz, a black hole which drains billions of dollars from government finances annually that will take years to restructure properly. This would build confidence in the transparent operations of Ukraine’s international gas transit system, which still ships 40-50% of the gas Russia supplies to European customers, and its crucial gas storage facilities so that this trade can be placed on a normal commercial footing rather than the brinkmanship regularly exercised by both Ukraine and Russia to achieve economic or political advantages. It would help remove the incentive and argue against the high cost of bypassing gas transit through Ukraine. Another example is the confusing and false signals the new government sent by increasing taxation on domestic gas production, only to follow by stating its intent to provide incentives to increase investment in domestic production. Unstable investment conditions favor political insiders who can seize depressed assets for their own use.
The impression is left that the Ukrainian energy sector has not changed much at all in spite of agreement by all sides that it needs urgent, fundamental reform. If the government convincingly demonstrates political will, foremost to its own public, then it will need tens of billion dollars and sustained capacity building assistance to reform the Ukrainian economy, including the energy sector. Western governments do not yet publicly acknowledge this reality. The current pathway is not sustainable. The geopolitical and tragic human consequences of the failure to act now will become the responsibility for all.
