…Ukraine has been on a dangerous path toward energy insecurity, which has accelerated in the last two years. All the pity as Ukraine has enormous potential as an energy producer, efficient consumer, and key transit partner for Russia/Central Asia and Europe.
Until the discovery and major development of West Siberian gas fields in the 1970s, Ukraine was a net exporter of gas to the Soviet Republic of Russia. Ukrainian gas production peaked at 69 billion cubic meters in 1975 … Today Ukraine’s domestic gas production has stagnated below 20 billion cubic meters and it is two-thirds dependent on gas imports from Russia.
… If proper policies and investment conditions were in place, domestic gas production can easily increase by 50 percent in a few short years. Together with energy efficiency improvements, Ukraine can be more than 50 percent self-sufficient in gas. However, today, Ukraine … consumes two-thirds as much gas as Germany does, while its gross domestic product is less than 5 percent of Germany’s.
Ukraine’s oil and gas sector is operated in a totally dysfunctional manner. This, as they say in this part of the world, is not accident. Various state energy assets have been hijacked by rent seekers for their private gain.
Regulation and pricing are left deliberately murky in order to benefit private interests. This is not a particular indictment of the current government of Ukraine. In fact these conditions of Ukraine’s incomplete transition from its Soviet command economy have remained through the terms of four different presidents and many more prime ministers and cabinet of ministers. Franchises on control of energy assets may shift, but the business model never changed.
In fact, if you were to design an energy system that is optimized for corruption, it might look very much like Ukraine’s.
You would start with a wholly state-owned monopoly that is not accountable to anyone except the head of the country who appoints the management of this company. It would operate non-transparently without being held accountable by shareholders (who might demand legal rights as owners) or capital markets since its chronic indebtedness is periodically repaid by the state treasury.
Domestic production would be priced artificially low, ostensibly for social welfare reasons, leading to a large grey market in gas supply that is allocated by privileged access rather than by price. Low gas prices suppress domestic production and energy efficiency improvement, thereby necessitating the import of large volumes of gas which coincidentally is controlled by the same state monopoly or its chosen middleman company.
The opaque middleman is frequently paid handsomely in kind, rather than in cash, which allows him to re-export the gas or to resell to high-value domestic customers, leaving the state company with the import debt and social obligations.
Similarly Ukraine has eroded its major advantages as a major oil and gas transit country between Russia/Central Asia and European markets from its geographic location and Soviet legacy pipeline infrastructure.
Ukraine inherited Soviet gas transit pipelines, which had a nameplate capacity of 175 billion cubic meters per year, as well as ample and ideally located gas storage capacity. Oil transit pipelines also have a capacity of more than one million barrels per day, linking Russian and Central Asian oil production with landlocked markets in Central Europe.
Yet today Russian gas transit amounts to less than 100 billion cubic meters from a post-Soviet average of 120 billion cubic meters and Russia is busy building and planning pipelines that bypass Ukraine, namely Nord Stream and especially South Stream. When the second line of Nord Stream is completed by the end of this year, it will bring capacity to 55 billion cubic meters per year.
If Russia proceeds next year with South Stream at 63 billion cubic meters by 2016, it would have bypass pipeline capacity that completely replaces current gas transit through Ukraine, which represented about 80 percent of the gas Russia sells to Europe or 20 percent of European gas demand.
This developed because Ukraine has proven itself over the last 20 years as an unreliable transit partner for both Russia and Europe …The root causes of Ukraine’s energy insecurity are well known to all, as are their remedies…These recommendations basically come down to modernizing the business practices of this large and non-transparent sector of the Ukrainian economy, which has served as an exclusive playground for Ukrainian leaders for the past 20 years.
This means the end of rent seeking in this sector that leaks billions of dollars per year; transparent and fair rules of the game for investors in the sector that do not favor special and politically-connected interests; and above all energy pricing reform…
…For the moment, Russia and Ukraine are supposedly at an impasse in their gas price negotiations, after the disastrous decision Yanukovych and his government made on gas agreement with Russia signed in Kharkiv in April 2010 soon after his ascendency to the presidency.
Ironically, the Kharkiv agreement essentially confirmed and locked his government into the terms of the agreement made by then-Prime Minister Yulia Tymoshenko and Prime Minister Vladimir Putin in January 2009, the unfairness for which she is currently accused and jailed.
The most likely scenario is an agreement … that cedes partial control and or ownership of Ukraine’s international gas transit system to [Russia’s] Gazprom in exchange for another so-called discount on gas pricing. Concessions on penetration into Ukraine’s domestic gas market may also be made to Gazprom and/or its chosen middleman company.
…Russia may expect to gain full control of Ukraine gas transit system over time, as Ukraine continues to mismanage its energy sector, as it has already done in Belarus under rather similar circumstances…The result of this possible scenario is that Ukraine becomes an energy appendage of Russia’s.
Edward C. Chow is a senior fellow in the energy and national security program for the Center for Strategic and International Studies in Washington, D.C.
