Editor’s Note: The following op-ed is adapted from remarks made by Edward Chow, an independent U.S. energy expert, on Feb. 26 at the Ukrainian Energy Forum in Kyiv.
Excellencies, ladies and gentlemen. It is my great pleasure to be back in Kyiv and to speak at the 10th Ukrainian Energy Forum, before this distinguished panel and audience. It is now five years since the Revolution of Dignity, or EuroMaidan Revolution, ousted President Viktor Yanukovych.
Progress in economic reform has been made, including in the energy sector. However, it is also accurate to say that no one, including the officials on this panel, is satisfied totally with the pace of reform and the results achieved so far. In a democratic society on the eve of important elections, it is critical to discuss why this is and what can be done to accelerate energy reform.
It is in this spirit and as a friend of Ukraine that I offer some thoughts based on 40 years of experience working in and studying energy sectors around the world.
Every country thinks it is unique and indeed countries live under very different conditions. However, there are universal principles that cannot be ignored without consequence and international lessons that have been learned for formulating sound policy. There is no reason for Ukraine to repeat mistakes that have been made in the past.
In the United States, we’ve had reason to rethink these lessons recently. Within one decade, the unconventional oil and gas revolution – tight oil and shale gas – has made the world’s most mature petroleum region the largest oil and gas producer. The question is why did this revolution take place in the United States and not somewhere else? It cannot only be a matter of geology or that God really blesses America.
What we have learned is that competition promotes innovation and drives efficiency. The shale revolution was led by dozens of small to medium-size companies operating alongside a highly competitive oilfield service and equipment industry. It was not led by major companies like ExxonMobil or Chevron, which missed the boat and are busy trying to catch up.
In the U.S., we had price controls in the 1970s in a misguided policy to fight inflation and to protect consumers. We learned that distorting the price signal leads to misallocation of resources, declining production, wasteful use of energy, and shortages. It is also an open invitation for corruption. Consequently, we decontrolled oil and gas prices, without which the shale revolution would never have happened.
In a market economy, government’s job is to protect the public interest and to provide stable conditions for private investment. It is not the state’s job to engage directly in economic activity. All over the world, we see ineffective and corrupt national oil companies that crowd out more productive private investment. The latest example is Venezuela.
Foreign investment is useful not just for offering capital and technology, but more importantly to demonstrate modern business practices and operations to domestic industry. International capital chases the highest risk-adjusted return. The riskier the country, either because geology or business conditions, the higher the rate of return needed to justify an investment. After all, the same, say, billion-dollar investment in Ukraine has to be compared against opportunities in Australia, Brazil and elsewhere.
In order to attract capital for an energy sector that has suffered rent-seeking and underinvestment ever since independence, it is government’s responsibility to lower the perceived risks by providing fair access to market and data, stable fiscal and regulatory regime, and properly targeted and time-limited subsidies that do not favor politically-connected interests.
Suffice it to say in Ukraine there is much room for improvement.
I made a few more slides on a simple analysis of the Ukrainian energy sector’s strengths, weaknesses, opportunities, and threats, bearing in mind international lessons learned. I do not have time to go through all of these factors, many of which are well-known to this informed audience. So, I will make just a few observations on the slides, which will be made available by the conference organizers.
Democracy should be an asset to reform, not a liability. I do not understand (or rather I do not accept) the conventional wisdom that 2019 will be a lost year for reform in Ukraine. Elections provide the opportunity to discuss issues critical to society and to build political consensus. Reforms that last have public support and cannot be pushed through opportunistically or behind the public’s back. In order to instill public trust, there should be a genuine debate in the election campaign and not sloganeering for temporary political advantage. A vibrant civil society should be enlisted as part of the process and not seen as an obstacle to reform.
There are many more weaknesses than strengths in Ukraine’s energy economy, which is why much-needed investments have not yet materialized.
The good news is that means there is ample opportunity for improvement: Structural reform and overhaul of the Soviet-legacy system is needed to modernize. It is not sufficient just to put good people in charge of a system that is designed for political interference and privileged access, not for economic efficiency.
I have not met a single Ukrainian or Western geologist who does not think Ukraine can be gas self-sufficient and indeed become a gas exporter again. If price is liberalized and Ukraine exports gas, the domestic market-clearing price will be European gas hub price minus transportation instead of hub price plus transportation today.
An energy sector that releases economic value, rather than asset strip and rent seek, can help build public confidence in overall reform and fund reforms in underinvested public sectors such as education, health, and roads. No one should be satisfied with 2-3 percent economic growth. Ukraine should grow at 5-8 percent and the energy sector can be an engine of that growth, rather than a drag.
One of the handicaps to Ukrainian reform is the near-term absence of membership perspective in the European Union and NATO. Success in energy reform can transform Ukraine from what is seen currently in Europe as a liability to its energy security into an asset and make membership prospective more promising.
This is why donors are eager to assist Ukraine’s energy reform. Assistance must focus on building capacity to visibly improve the performance of the energy economy. Emphasis should be placed on creating success stories to build momentum for reform and not in drafting more strategic plans and long-term goals that collect dust in government bookshelves in Ukraine and in the West.
Lastly, you may have noticed that I focused on improvements that are within Ukraine’s own power to make. I have not talked about external threats, as I believe they are often used as distraction from real reform or as excuses for not doing more, faster. There is little that Ukraine can do to change its adversaries, other than to become stronger and less vulnerable to attack. The bigger threat is the absence of political will to enact long-needed reforms and vested interests trying to preserve a dangerously antiquated system.
Ukrainians must own the energy reform process and not merely appease foreign donors like the International Monetary Fund. Americans really do believe God bless America, but just in case, we also believe that God help those who help themselves.
