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Ukraine: The Energy To Change Course

By Scott Belinksi | Sun, 04 August 2013 00:00 | 0

Twenty-two years after breaking free from the USSR, Ukraine is now attempting to do the unthinkable and permanently shake Russia’s hold on the country. The plan? Looking westward to the European Union and building an energy hub that might just revolutionize the region’s geopolitical status quo.

When Ukrainian President Viktor Yanukovych came to power after a vigorous election race in February 2010, the country had just spent 5 years under their most avowedly pro-Europe President so far, Viktor Yushchenko, and yet had made few concrete steps to edging out of the Soviet shadow. While Yushchenko rode the wave of the Orange Revolution into office promising integration with the EU, relations with Brussels subsequently grew cold, half due to his inaction and half to the EU’s preoccupation with its own economic crisis.

Meanwhile, Ukraine’s dependency on big brother Russia reached new levels when, in 2009, the Kremlin cut off all gas transfers going through Ukrainian territory after a dispute over prices. To defuse the situation, the smaller country ended up signing a 10-year contract agreeing to pay exorbitant gas prices to Russian giant Gazprom, prices completely unrelated to market value.

Such disadvantageous terms of trade have dominated Ukraine since its independence despite the country’s strategic geographical position. Ukraine is quite literally a bridge between the East and West, with pipelines that transfer 70% of the gas shipped from Russia to the European Union. The country is equipped with an envious level of large-scale infrastructure to store and transfer gas and also endowed with promising hydrocarbon resources onshore and offshore in the Black Sea.

Decades of missed opportunities

So why has Ukraine failed to capitalize on its comparative advantage? The first reason is a complete lack of transparency in the energy policy-making process. Deals between Gazprom and the Ukrainian state-owned gas company Naftogaz often take place between individuals who operate under serious conflicts of interest. Contracts that are often bad for Ukraine the country are good for Ukrainian business tycoons with close ties to Russia, extremely influential figures that lobby to keep Ukraine closer to Moscow than to the Western world.

Moreover, Naftogaz dominates the domestic market despite its chronic insolvency. The company is currently looking at its third government bailout since 2008 and yet still does not seem prepared to fundamentally change its management. Naftogaz is the epitome of a company that is too big to fail and knows it; with executives refusing to learn from their mistakes while the public pays for them. Now, though, the Yanukovych government is looking to once and for all break free of the reaches of Russia and rent-seeking Ukrainian elites, using energy policy as their weapon of choice.
 
Westward and forwards

The vision is a liberalized, EU-style “energy hub” according to Ukrainian Energy Minister Eduard Stavytsky, investing in the exploitation of natural resources at home and partnering with Western companies instead of relying on Naftogaz. It’s an ambitious goal, and yet a monumental first step was taken last January with the signing of a $10 billion gas deal with Royal Dutch Shell. The energy giant will commence exploration this year of the Yuzivska fields of Eastern Ukraine, which are estimated to hold at least 1.2 trillion cubic meters (42 trillion cubic feet) of natural gas.

Six months later, Exxon Mobil Corp followed suit, announcing an investment of $735 million in Ukraine to drill two deep-water wells off the coast of the largely unexploited Black Sea. The deals have been lauded inside and outside of Ukraine as a landmark move away from dependence on Russian fuel – a calculation that is just as political as economic.

In order to effectively meet the Yanukovych administration’s objective of making Ukraine a progressive new energy hub, though, many serious reforms of the sector will have to take place, including great strides in transparency. The opaqueness of decision-making in the energy sector continues to drive down the level of outside investment in Ukraine. As the Kiev-based European Business Association recently stated, “on-going instability and lack of transparency around monthly balancing undermine longer-term market sustainability and ultimate confidence in [the] success of Ukrainian gas market reforms”. The sheer scope of the reforms needed is intimidating and would require a degree of political will that so far has not existed in Ukraine.

The government has rightly recognized a rapprochement with the EU as the best strategy forwards for Ukraine. As it has been noted in other Eastern European counties, EU integration can act as a powerful means to wrest control of the state from vested interests and bring the rule of law to an acceptable standard. In 1994, Poland was declared an associate member of the EU despite having recently emerged from the USSR, lacking even a constitution. In the decade that followed, however, the country has made immense strides economically and in terms of human rights.

Ukraine hopes to match Poland’s transformation into a fully functioning Western state by signing its own Association Agreement with the EU at the Vilnius Summit in Lithuania this November. With energy as its motor and the EU as its guide, Ukraine appears to finally be poised to break with a history of domination from the East. Now it remains to be seen whether the EU will extend its hand to this new strategic partner.

By. Scott Belinksi
 

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