Hallmarks of a modern economy and of European energy sector reform include promoting market competition through unbundling of services controlled by monopoly energy providers and enacting transparent regulation where this is not possible or desired.
Lately Russian leadership has elevated modernization to the highest goal of state policy. The new Ukrainian authorities have insisted that integration with Europe remains their greatest objective. However, none of this applies seemingly for either government when it comes to their bilateral energy relations.
First, in April, Presidents Dmitry Medvedev and Viktor Yanukovych surpised the world by coupling a 25-year extension of the Black Sea Fleet lease in Sevastopol with affirmation of the fundamentally-flawed 10-year gas supply and transit agreements brokered by Prime Minister Vladimr Putin and then-Prime Minister Tymoshenko in January 2009. In theory, the latest deal comes with a 30 percent discount in gas pricing.
Conveniently forgotten was that Tymoshenko also obtained a 20 percent “discount” in 2009 or that, by the beginning of 2010, Gazprom had already renegotiated its major gas supply contracts with European gas consumers to reflect lower market prices.
So Ukraine pays a similar import price as West European consumers of Russian gas in spite of its geographic advantage.
The difference is the so-called discount for Ukraine does not come from Gazprom, but from an exemption on export duty by the Russian government which, of course, is subject to review. Bundling two sensitive issues – the Black Sea Fleet lease and gas supply and transit – that both deserve careful consideration has the effect of destabilizing both in the long run.
Putin immediately upped the ante by proposing the merger of Gazprom and Naftogaz, which apparently stopped short even Yanukovych. Gazprom continues to work on what assets Naftogaz might contribute to a joint venture between the two state monopolies, such as pipelines and storage facilities.
Producing deposits, offshore exploration prospects, chemical plants, nuclear power and other assets are on offer for reintegrating key Ukrainian industrial sectors with Russia.
Mixed-up bundles will become ever larger with even greater “discounts” and economic valuations decipherable only to insiders.
Meanwhile, the Ukrainian government appears startled by recent discoveries. Last week Prime Minister Mykola Azarov belatedly recognized that the pricing formula for the gas supply agreement with Russia is unfair.
At the same time, energy minister Yuriy Boyko was in Moscow asking for a minimum volume guarantee from Gazprom under the gas transit agreement.
Such major defects were highlighted by numerous observers immediately after the January 2009 agreements were concluded. Y
et the new Ukrainian authorities not only reaffirmed the terms of these bad agreements in April by merely adding a short addendum – thus relinquishing objections they rightly raised during the presidential campaign – they also provided their own guarantee to buy 40 billion cubic meters of gas per year for the remainder of the 10-year term.
This volume is higher than what Ukraine will have imported annually in 2009 and 2010, thereby belying the government’s stated objectives of improving energy efficiency and increasing domestic gas production.
Simultaneously the Ukrainian government is busy working to settle an arbitration case with RosUkrEnergo (RUE), a gas trader 50 percent owned by Gazprom, over what was judged to be unlawful taking of 11 billion cubic meters of stored gas during the 2009 crisis settled by Putin and Tymoshenko.
Since Boyko was a founder of RUE’s middleman role when he was Naftogaz head in 2004, this controversy could not have escaped his attention. Suffice it to say that billions of dollars are at stake and Ukrainian taxpayers are faced with the real possibility of paying for some of the same gas twice because of the negligence or incompetence of their government officials, past and present, to the benefit of private interests.
So a reasonable question is why such critical issues as proper gas pricing formula, gas transportation volumes and RUE settlement were not essential elements of the grand bargain struck in Kharkiv in April. Was the bundling of disparate items bungled or deliberately opaque in order to obscure? Will we see more sweetheart deals?
The Ukrainian public that suffers from non-transparent operations of the energy sector and improper use of state assets has the most to lose. It should also matter to international creditors, starting with the International Monetary Fund.
To date the Ukrainian government has invested little of its own political capital to explain to the public why a 50 percent increase in gas utility rates is beneficial for the country’s development other than to say that it is required by the IMF under the new standby loan of $15.2 billion.
Without public education and broad-based political support, long-delayed energy sector reform and urgently needed restructuring of Naftogaz cannot be sustained.
The government may just be kicking this can of worms down the road as other Ukrainian governments have repeatedly done in the past. It can only be hoped that IMF will hold the Yanukovych administration to task better than it did with ex-President Viktor Yushchenko and Tymoshenko.
So far, Western governments with their own important relationships with Russia and Ukraine have been conspicuously silent on these energy shenanigans, dazed perhaps by their speed and audacity.
They are faced with an old question best formulated by Marx – the brothers, not Karl. To paraphrase, who are they going to believe, Moscow and Kyiv or their own eyes?
Edward C. Chow is a senior fellow in the energy and national security program of the Center for Strategic and International Studies in Washington, D.C.
