Can Ukraine Gain Energy Independence?

Last month, Ukraine announced that it had exported its own natural gas to Europe for the first time in 15 years. Although the amount was small – practically the minimum viable amount for a gas transfer – Ukraine believes its symbolic significance is far larger. Officials say the transfer provided a test of their ability to export gas, a crucial milestone as the country moves towards energy independence.

Having already passed several pro-European reforms to decouple itself from Moscow, Ukraine is now striving to wean itself off Gazprom, Russia’s state-owned gas giant. To Ukrainians, severing ties with Gazprom is a matter of national security; Moscow has long weaponized its monopoly by turning off the gas pipes during the freezing winter months, forcing Ukraine into political concessions. After five years of Russian aggression in the Donbass, Kiev is more desperate than ever for economic freedom.

But if Ukraine is to achieve energy independence – something both President Petro Poroshenko and his main rival Yulia Tymoshenko have promised ahead of the country’s elections this spring – it must negotiate a labyrinth of logistical problems. Indeed, Russia’s gas supply has fostered a strange symbiosis between Kiev and Moscow ever since the collapse of Communism. On the one hand, Ukraine has long relied on Russia to heat its homes and business. Yet, on the other, Russia requires its neighbor to provide a conduit to Europe. Of the 193 billion cubic meters of gas Russia sent west in 2017, around 40 percent transited through Ukraine.

This relationship has come under ever-increasing scrutiny in Ukraine ever since the 2014 revolution. Against the backdrop of repeated antagonism from Putin, Poroshenko has helped steer Ukraine closer to Europe, changing its constitution to facilitate EU membership while passing key linguistic and clerical reforms to dilute Muscovite influence. Energy is very much a final frontier; Ukrainians bitterly recall the ruinous gas deal struck by Tymoshenko herself back in 2009, which committed Ukraine to buy Russian gas at inflated prices and earned her the sobriquet “the gas princess”. Related: Texas Oil Production Breaks New Record

Ten years on, both Tymoshenko and the Ukrainian energy sector have performed a volte-face. The veteran politician is currently leading the presidential polls, partly on her promise to get tough on Moscow. State-owned Naftogaz, meanwhile, has won a landmark victory over Gazprom in a Stockholm courtroom, whose judges nullified the gas prices agreed by Tymoshenko and ruled that Ukraine no longer has to buy a fixed amount from Gazprom every year. In a further sign of defiance, Ukraine has begun taking gas from Europe by reversing the pipeline flow, providing a way to beat Russian supply clamps. Naftogaz claims that Ukraine has gone from importing 74 percent of its gas from Russia to 100 percent from Europe.

Short-term measure

But if Ukraine wants real energy independence, this defiance is merely a stepping stone. Rather than simply rerouting the pipes, Kiev must tap into its own huge untapped gas stores. According to BP, Ukraine harbors 600 bcm of proven reserves, enough to cover its energy needs for the next 20 years. Yet the country has been neglecting these reserves ever since the 1970s, when the Soviet Union turned to Siberia as its primary extraction source. Today, it realizes just 3 percent of its deposits every year.

To address this problem, Poroshenko’s government plans to hike domestic gas production from 20bcm in 2016 to 27.6bcm by 2020. Efforts have already been made to demonopolize the sector, adopting EU rules guaranteeing equal access to all suppliers which should, in theory, entice new traders. Taxes on well-diggers have been slashed to encourage exploration, and an international auction on 30 new concessions is slated for this year.

But will this activity be enough? So far, Ukraine has only managed to increase production by around 1bcm; even if it does hit the 2020 target, that’s still some way short of the country’s total gas consumption, which exceeds 30 bcm (that’s with much of the country under the control of Russia-backed separatists).

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To bridge this gap, Ukraine urgently needs to upgrade its gas pipelines and compressor stations, the majority of which date back to the Soviet era. But this won’t come cheap; analysts say that Ukraine needs to invest $6 billion to bring the sector up to speed, not easy given that public debt has already reached 65 percent of GDP.

Counter-threat

Underpinning all this, of course, there’s a strong political current. While Ukraine talks of turning Gazprom off, Moscow is making provocative noises of its own. The Kremlin is pushing ahead with construction of the Nord Stream II pipeline, which, when complete, will reroute Russian gas to Europe via the Baltic – and could cut Ukraine out of the loop. The two countries are currently discussing the renewal of their current transit contract, which expires at the end of the year, but so far Russia has been coy about its intentions.

If Russia decides to bypass Ukraine, it will be disastrous for Kiev, and not just because of the $3 billion it will lose in transit fees. The current energy contract with Gazprom may be a source of oppression, but it also offers an insurance policy. The transit routes give Russia a vested interest in Ukraine, a reason to refrain from actually invading – the risk of which would otherwise rise sharply. With Putin already harassing Ukrainian vessels in the Kerch Strait, and massing troops on the Ukrainian border, it’s troubling to think what he might do if that vested interest were removed.

So, as the negotiations continue, Ukraine faces a delicate balancing act. While reducing its exposure to Russian influence, it must avoid provoking Putin unduly, a dilemma which will sorely test the country’s next president – whoever that is. Given the starkly different tone between the two candidates in relation to the recent reforms, a change in leadership at this juncture could very well put the fate of those milestones into doubt. But, having controlled Ukraine’s energy market for decades, Russia won’t let its former satellite wriggle free without a fight.

By Christopher Stakhovksy for Oilprice.com

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