Ukraine’s next entry into the Guinness Book of World Records should be for the transformation of its gas industry.  No other European country can compete with the achievements of Ukraine: the market share of Russian gas has been reduced from 100 percent to zero, and the country is now buying gas from EU countries only.

The whole process was done very quickly (less than three years) and in a size that is unimaginable for most European countries (the January 2017 monthly gas consumption of Ukraine was twice as much as the total annual gas consumption of Bulgaria in 2016).  If you were to ask, for example, Serbia to repeat the same somersault (Serbia imports 100 percent Russian gas), it is not certain whether SerbijaGas would know where to start the process (never mind finish it successfully within three years), even though Ukraine’s gas sector is more than ten times bigger than Serbia’s.

It would be useful to write up the story of this success story, while most decision-makers are still around.  Demand for the book is guaranteed: Russian gas dependency in Central and South-East Europe is over 50 percent, on average.  But this average is mis-leading: in addition to Serbia (as mentioned above), Macedonia and Bosnia import Russian gas only.

The Visegrad countries (Poland, Czech, Slovakia and Hungary) also have only the illusion that they buy gas from non-Russian sources:  what these countries import from their Western borders tends to be Russian gas that was transported to Austria and then turned around.  These countries are in the same mess, as Ukraine, only the Eastern facade had been maintained better: the Visegrad countries still officially buy from Russia under long-term contracts.  Whether EU members or not, Bulgaria, Serbia, Bosnia, Hungary, etc. will not be truly independent until after the over-dependency on Russian gas has been remedied.  Only Hungary is naïve enough to believe that Russian gas (and nuclear technology) comes with no political strings attached (see last week’s Russia – Hungary meeting in Budapest).

But this article is not about celebrating the great transformation of the Ukrainian gas sector.  I would rather highlight two points that might bring the funfair to a sudden stop.

Security of gas supply is a question of three factors in any European country: physical flow, regulation and general attitude.  Each country is special in the sense how the three factors mix, for (geo)political and/or historic reasons.

I have discussed physical flow above.  Ukraine switched the direction of gas import from the East (Russia) to the West (EU).  This is the biggest about-face in the history of European gas supply.  It must be noted here that without the support of EBRD and EFET (European Federation of Energy Traders) Ukraine would not have had a chance to complete this turn-around so quickly.

The changing of the physical flow was only a necessary, but not sufficient precondition for guaranteeing the security of the gas supply to Ukraine.  The other two factors (regulation and general attitude) may create as much chaos as Russia’s turning off the gas import valve did in 2009.

Compared to the physical flow point, Ukraine’s performance regarding regulation and general attitude is less impressive.  Ukraine gas regulation is notoriously “impulsive”.  New rules are introduced, then amended without any notion of the rule of law.  For example, UktTransGas introduced a $12.47/thm3 “tariff for entry points” at short notice.  Neither Ukrainian gas buyers, nor Western European importers had a proper chance to comment on this new tariff.

In plain language, this $12.47/thm3 fee is an import penalty.  Everything what is wrong with Ukrainian regulation is summarized in this fee: both the currency (the U.S. dollar, as opposed to Ukrainian hryvnia) and the unit (thm3 is not a unit of energy, as will be discussed below) are wrong, plus the number (12.47) is arbitrary (it might equally be set at 12.55, and then at least the last two digits would be a Fibonacci number).

Some commentators claim that this export penalty is only applicable to private importers: NAK, the state-owned gas importer is either not subject to this tariff or is simply paying from one departmental pocket to another (NAK 100 percent own UkrTransGas).  In short, this entry point tariff is hindering gas import to Ukraine.  If Ukraine really cares about security of its gas supply, the import penalty must be abolished – and quickly.

Unfortunately, the import penalty is only one of many regulatory mistakes.  Another example is about the storage obligation of Ukrainian gas importers (i.e. if you are selling 100 units of gas to your customers, how many units of gas you must have in storage at any given time).  Regulation about the storage obligation of private importers had been amended several times within a period of one Gas Year.  When the obligation was set at 50 percent (the highest in Europe), Ukrainian gas prices went through the roof – private importers were buying from Europe just to fulfill the storage obligation.

Later, the obligation was reduced and suddenly there was too much gas in Ukraine.  Import gas pipelines remained empty and potential European gas importers were struggling to sell their gas (originally bought to be imported to Ukraine) in Europe.  This is a classic example of how regulatory mistakes can lead to price volatility (sudden price movement, not necessarily underlined by changes in the market fundamentals).

The general attitude to gas importing is not improving either.  For example, no EU country is using the thm3 format anymore to measure gas.  This is not a unit of energy; it is a memorabilia confirming that Ukraine built up its gas industry, while a member of the Soviet Union.  Every time government decrees and/or regulatory documents determine prices as hryvnias per thm3, Ukraine is actively confirming that the country has not left the Soviet sphere of gas influence, as yet.  This is a big PR mistake.

Also the administrative burden of importing gas is prohibitive.  Several original documents to be signed and stamped so many times, and delivered to various Ukrainian state agencies.  If you miss the deadline, serious penalties have to be paid.  And what is the social benefit of this excessive administration?  Nothing.  The only winners are those employees of the state agencies involved who might sell such data to journalists.

Ukraine has more “unofficial” gas import statistical publications, than any other European country.  This gives the illusion of transparency; in fact, this looks like a misuse of public office.  The solution is very simple: administrative requirements for gas importing should be reduced to the standard EU level: there are regulatory reporting obligations, but price sensitive information and names of counter-parties are never disclosed.

Finally, few words about corruption.  It is a historical fact that the Ukrainian gas sector had its fair share of corrupt deals.  Yet this background should not create corruption hysteria today.  For example, a national newspaper reported last week that a private gas producer sold gas to the company of an incumbent politician.  Any Ukrainian reader would read the following message into the article: yet more corruption, the gas producer sold cheap gas to the politician in exchange for future favors.

But not a single fact was published supporting the above, hidden message.  Articles without hard facts damage the reputation of the emerging Ukrainian gas sector: at the sub-conscious level, gas and corruption are coupled terms in Ukraine.  This hysteria does not help to create the right atmosphere for the emerging gas import sector of Ukraine.  Potential Western European traders will be scared off.  Fewer importers mean less competition, which will convert into higher import prices.

This is the second winter during which Ukraine has not bought a single unit of gas from Russia.  Everything has worked out perfectly: no system-wide gas interruption was reported, storage volume is still around 30 percent in early February, and extra gas could be imported, especially from Hungary, at short notice.

This early success should not blind Ukrainian decision makers to what might happen if there are no radical improvements in the areas of regulation and general attitude.  Long-term security of supply is not only about making sure that gas is physically flowing; Ukraine has plenty to do in the areas of regulation and general attitude.

This second part of the journey from Russian gas dependency to real security of supply is less spectacular, than the first (switching the import gas flow) was.  Nevertheless, Ukrainian decision makers must tackle issues like regulatory mistakes and general attitude to trading with the same speed and determination as they had demonstrated during the last two winters.