Editor’s Note: This op-ed was originally published by the U.S.-Ukraine Foundation and is reprinted with permission.
Ukraine’s energy sector suffered from the post-Soviet legacy of state control and state capture by private interests, overregulation, and monopolization. The desire of authorities to control energy manually led to massive underinvestment and pervasive corruption. In a capital-intensive industry, neither producers nor consumers can invest long term without sound and predictable government policy.
The result is Ukraine has the lowest energy efficiency in Europe, damaging its economic competitiveness, and an energy sector that fails to fulfill ample production potential. Given this track record, the Ukrainian public is naturally suspicious of any changes and sees past reforms as synonymous with higher prices, poor energy services, and shortages, which were designed to favor the politically well-connected.
The current cyclical downturn in global energy prices is a golden opportunity to rejuvenate energy reform in Ukraine.
Price distortions can be removed without disproportionally increasing end-user costs, which are already the lowest in Europe. Subsidies can be paid directly to the truly needy in society instead of serving special interests. If Ukraine is to modernize its energy economy and integrate economically with Europe, it has to fundamentally reform its energy systems by freeing market forces, promoting competition by privatizing state assets, eliminating market distortions such as price controls, establishing transparent and stable regulatory mechanisms, and prosecuting energy corruption and market abuse.
First, the government has to formulate its vision, strategy, and implementation plan for energy reform. Then, to dispel public distrust and resist vested interests, the government must explain its energy program to a suspecting public and convince the parliament of the need for structural reform. Merely placing new officials, as well-meaning and professional as they may be, into the old dysfunctional system will not lead to a better outcome. Discredited institutions and practices have to be replaced by new ones with public support – only then can reform be sustained, and vested interests be forced to compete in a free and fair market or be eliminated.
For almost three decades, successive Ukrainian governments proclaimed energy reform whenever massive international assistance was required urgently. Considerable resources have been expended by international financial institutions and Western governments on energy assistance without achieving desired lasting outcomes. Once an immediate crisis was over, manual controls had a way of returning, which guaranteed the next crisis. It is time also for the donor community to reassess its efforts.
Structural reform starts necessarily with political will from Ukrainian leaders and unity of purpose among Ukrainian authorities, which were both missing in the past. International donors can help with expert advice for comprehensive energy reform and by providing resources to build capacity in new institutions for implementation. Anything else is merely working at the margins without addressing the fundamental problems in Ukraine’s energy sector. In fact, any energy assistance should be conditioned on the overhaul of the current system with Ukrainian authorities held accountable for the implementation of their own plan. Foreign donors should also engage in open dialogue with NGOs, think tanks, and other parts of the vibrant civil society in Ukraine in support of energy reform.
Among the critical areas that need attention are:
- The current crisis of imbalance in the electricity market, which has been evident since last autumn, with massive circular debt including to/by/among state agencies and potential state default on renewable energy tariff;
- Truly independent and transparent regulatory bodies, including the National Commission for State Regulator in Energy and Utilities (NEURC) and Anti-Monopoly Commission, without interference in their daily workings by the government and parliament;
- Stable tariff methodology that provides for full cost recovery and a reasonable return on investment, including for much-needed modernization and resiliency of energy systems;
- Removal of public service obligation (PSO) in the electricity and gas markets, to be substituted by direct subsidies to targeted consumers;
- Defining the role of state enterprises in the energy sector; whether they should be reorganized or broken up, whether some assets should be privatized, how should parastatal companies be governed;
- De-monopolization of the energy market, including by state companies;
- The revival of the moribund oil refining sector, which necessarily means eliminating contraband petroleum products imported by special interests;
- Policy on incentives to attract private capital, including foreign direct investment;
- Fair tender procedures, equal access to geologic data, taxes, and royalties in licensing system for energy extraction that meets international standards and business practice; and
- Policies on addressing opportunities and threats presented by the European Green Deal that will affect trade relations with Ukraine’s largest export market
The above list is by no means exhaustive but illustrates the depth and breadth of Ukraine’s energy challenges that remain to be met. Not every issue can be addressed at the same time. What is important is to start the process in an orderly way rather than to hesitate and regress. The new Cabinet of Ministers must seize the moment, then international donors together can and should help in a significant and meaningful manner.
Edward C. Chow is a senior associate in the energy security and climate change program at the Center for Strategic and International Studies.
