The government has pushed a law through parliament that purports to liberalize Ukraine’s lucrative but infamously murky natural gas market along European Union lines.
But some fear that, instead of extending European rules right up to the borders of Russia, the new reforms could lead to greater control by the Kremlin over the economy of Ukraine, while badly needed international investment into domestic Ukrainian production is sidelined.
Market watchers welcome the de-monopolization of Ukraine’s international pipeline system and the unbundling of moribund state-owned energy giant Naftogaz Ukraine – both envisioned by the new law.
However, in the light of the new Ukrainian authorities’ proclaimed drive toward economic reintegration with Moscow, these measures might serve as preludes to a Russian takeover of Ukraine’s gas business. Moreover, the new legislation, which was served up alongside other government reforms intended to loosen up International Monetary Fund lending, also leaves in place non-market practices such as state price fixing on gas sales.
“The government conveniently ignored endorsement of a July 2009 EU directive on energy market security, which warns against further encroachment by monopolistic suppliers such as Russia into the EU gas market.”
– Volodymyr Omelchenko, a gas expert with Kyiv’s Razumkov think tank and a former Naftogaz insider.
The law “On the principles of the functioning of the gas market” was approved by over 320 out of 450 Ukrainian lawmakers on July 8, less than a week after parliament gave it a first reading. According to an Energy Ministry statement, the “law aims at bringing Ukrainian legislation in line with EU gas-market legislation,” but there are signs that it falls far short of this aim.
Volodymyr Omelchenko, a gas expert with Kyiv’s Razumkov think tank and a former Naftogaz insider, called the new law a positive step for Ukraine’s gas market, but questioned its adherence to European standards.
“The government conveniently ignored endorsement of a July 2009 EU directive on energy market security, which warns against further encroachment by monopolistic suppliers such as Russia into the EU gas market,” Omelchenko said. The energy ministry said its law is aimed to fulfill a much earlier EU directive from 2003, when the Kremlin’s campaign to dominate its neighbor through gas exports was in its infancy.
The unbundling of state-owned Naftogaz into separate entities that oversee transit, production, sales and distribution has long been advocated by the EU as a means of demonstrating financial transparency. But if the move makes Naftogaz subsidiaries such as Ukrgazvudobuvania (Ukrainian Gas Production), Gaskrainy (state gas sales company) and especially Ukrtransgas (state gas transit company) vulnerable to a Russian takeover, Ukraine could suffer further loss of energy independence.
Oleksandr Hudyma, an energy expert and opposition lawmaker called the new gas market reform law a good thing in itself. But he warned that some in the current government may try to corrupt liberalization efforts in favor of Russia and individual government members’ personal gain.
“They could pass this law with one hand, and then give away the gas transportation system to the Russians with another,” Hudyma said.
Ukraine’s Moscow-friendly president, Viktor Yanukovych, Prime Minister Mykola Azarov and some Cabinet ministers have repeatedly entertained Russian offers to invest in Ukraine’s international gas pipeline system, which supplies Europe with more than 20 percent of its gas. But they have also set a requirement for European companies to join Russia’s Gazprom in a three-party consortium that would balance out the interests of gas producers, consumers and Ukraine as the transit country.
The current authorities in Kyiv have also entertained Russian proposals to integrate Gazprom with the cash-strapped Naftogaz, which controls Ukraine’s pipelines, although plans are still sketchy and official statements self-contradictory.
An energy ministry insider said Russian investment would likely take the form of some kind of joint venture. However, the Kremlin has been clear that it would only enter such an agreement for a majority stake. In return for Russian investment, Ukraine is looking forward to gas exploration and production rights in Russia, the insider said.
Hudyma, a fierce opponent of the Ukrainian government’s current energy team, dismisses such a deal as unrealistic. “Russia doesn’t let anyone export its gas, or even touch its pipes. They don’t even let British and American oil companies, who have invested billions of dollars into Russia, use their pipes,” he said.
Razumkov’s Omelchenko said the current authorities in Kyiv are divided over the desirability for Russian investment into Ukraine’s gas sector. “There is one group of influence in the government led by [Prime Minister] Azarov which wants more Gazprom investment, while the industrialists are against it,” he said.
Russian control over the production, distribution and transit of Ukrainian gas would amount to control over Ukrainian industries that use gas, he added.
Another Ukrainian gas analyst, Mykhailo Gonchar, said the speed with which the government’s energy reform law was passed by the government controlled parliament raises suspicions about the intentions of the law. “Parliament is turning into a rubber stamp,” he said.
Gonchar, like other sector analysts, further questions the need for Russian investment into Ukraine’s gas sector – particularly its much coveted international pipelines – in the first place. “Ukrtrangas is completely autonomous and doesn’t need any outside financing,” he said.
He estimated that Ukrtransgas makes from $2 billion to $2.5 billion in revenues a year, with profits that could be used for infrastructural investment coming to around $1 billion.
The most immediate and obvious problem with the government’s new draft law, however, is that it continues to allow the authorities to sell gas at below-market prices for political gain, analysts agree. Although subsidizing of gas bills for vulnerable segments of the population is not unusual in most European countries, Ukrainian governments of past and present have spoiled voters and industrial backers with below-market prices for gas – even the expensive kind imported from Russia.
“Naftogaz imports gas from Russia for $230 per 1,000 cubic meters, while its subsidiary Ukrgazvydobuvania is paid $50 for every 1,000 cubic meters it produces, and select industries such as chemical makers can buy from either for as low as $170,” Gonchar said.
Razumkov’s Omelchenko said state subsidies to industry total anywhere from $1 billion to $1.5 billion a year, although figures are no longer published by the government. “Particularly favored oligarchs don’t pay anything at all” for some of the gas they obtain through murky schemes, he added.
Under current opposition leader Yulia Tymoshenko, who headed the government until losing her presidential bid to Yanukovych earlier this year, the situation was little different, Omelchenko said. “Subsidies are a great way to get political support,” he added.
“The sector is falling apart under state interference. Ukraine can produce a lot more of its own gas.”
– Volodymyr Omelchenko, a gas expert with Kyiv’s Razumkov think tank and a former Naftogaz insider.
But with presidential and parliamentary elections years away, and Yanukovych continuing to scale back democracy and media freedom as he goes along, subsidizing the average Ukrainian who uses gas to heat his apartment is taking a back seat to industrialists’ profits.
Acting under pressure from the IMF, from which Ukraine stands to continue receiving billions of dollars in aid, on July 14 the government announced a 50 percent hike on the price households (but not industry) pays for its gas starting August 1.
In addition to serious losses to the state through Naftogaz, continuing gas subsidies also hurt Ukraine’s chances for foreign investment into the sector, thus playing into the hands of gas importer Russia.
“The sector is falling apart under state interference. Ukraine can produce a lot more of its own gas,” according to Razumkov’s Omelchenko, who said the first six months of 2010 saw more than a 6 percent drop in gas production year on year.
State-owned producers account for around 35 percent of Ukrainian gas consumption, and Russian imports make up almost all the rest, with a tiny fraction of the country’s gas is pumped out of the ground by a few insignificant and embattled private companies traded in London.
More significant energy investors such as Royal Dutch Shell, which boasts retail assets and exploration rights in Ukraine but which still isn’t a player in production, are discouraged by Ukraine’s slanted playing field, according to Omelchenko.
In a recent interview to Ukrainian energy.com, which offers independent research, information and advisory services on all aspects of the Ukrainian energy sector, Shell’s country manager in Ukraine Patrick van Daele, said: “We constantly stay in touch with the Ukrainian authorities and try to convince them how important it is to attract foreign investments into the fuel and energy sector that can ensure more energy independence for the country.”
According to analyst Gonchar, the government’s new law still has benefits for a company like Shell, which will now have equal access to Ukraine’s international pipelines. “The main thing for a major is to have access to pipes,” he said.
A spokesperson for Shell as well as the European Bank for Reconstruction and Development, which is funded by EU states, declined to comment for this article, pending further study of the new Ukrainian law.
For its part, Ukraine’s energy ministry said the law that it authored is fully in line with EU norms. According to the ministry, passage of the new Ukrainian legislation was “long awaited by Ukraine’s partners in the EU, and, in particular, the issue was one of the key ones discussed during the meeting of Fuel and Energy Minister Yury Boyko with European Commission for Energy Issues Guenther Ottinger on June 23, 2010.”
Kyiv Post staff writer John Marone can be reached at [email protected]
