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In Ukraine, Energy Safety Remains in Question After the Crimea Crisis

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The Ukrainian revolution, the annexation of Crimea with its fuel resources and undeclared war between pro-Russian separatists and Ukrainian army forces in the eastern part of the country have revealed a set of strategic problems for the Ukrainian economy. Energy safety and dependence on Russian gas remain the key issues for Ukraine’s politics and economics.

The new government, elected after ex-President Viktor Yanukovych was ousted and fled to Russia, is clearly leaning toward Europe. In response to Ukraine’s new policy, Russia, after the annexation of Crimea, canceled its special tariff for gas exports, which had been set partially in exchange for the presence of the Russian fleet in the Crimean city of Sevastopol. Now Ukraine is among the European countries paying the highest price for Russian gas.

Gas supply problems

Dobrotvir power plant in Western Ukraine.

flickr / bankwatch under Creative Commons

Dobrotvir power plant in Western Ukraine.

Ukraine is the second largest country in Europe. Because of its strategic location between Russia and Europe, it’s a key transit country for energy resources, Russian natural gas in particular. According to the International Energy Agency, in 2011 Ukraine was dependent on imported energy products by at least 40 percent. This number has remained more or less the same for the past couple of decades. The country has to import around 30 billion cubic meters (about 1,000 billion cubic feet) of natural gas yearly to keep its heavy industries up and running. At the same time, Ukraine transports up to 50 percent of the Russian gas imported by the European Union.

The problem of Europe’s energy dependence on Russian supplies is not new. During the 2006 and 2009 gas disputes, Russia briefly cut off its gas supplies to Ukraine, which largely affected Eastern European countries dependent on the importation of the fuel. And the Russian government has been accused numerous times of using the country’s energy resources as a political tool.

According to Yuriy Korolchuk, an energy analyst at the Institute for Energy Strategies in Kiev, for the past 20 years the Ukrainian governments did almost nothing to reduce this dependence. “For Ukraine, the key mission for upcoming years is not to give up Russian gas entirely, but to develop our own gas production. There’s no other choice,” he said.

Gas supply problems reflect the situation in the Ukrainian energy sector in general. Depreciation of energy systems, extensive usage of heat and electricity networks built during the Soviet era, and inefficient use of energy cause huge monetary loses for the national budget. More than 40 percent of energy resources is consumed through power supplied by utilities, according to the Ukrainian State Department of Statistics.

The main issue here is that national company Naftogaz buys Russian gas for a higher price than it is then sold for to domestic companies. When the price for Russian gas was $268 per thousand cubic meters ($7.59 per cubic feet), domestic utility companies would buy it from Naftogaz for 1,409 hryvnias, or $120 per thousand cubic meters. The rest had to be compensated for by the government.

Director of the Institute of Energy Research Dmytro Marunych said the difference in price is a direct loss for the Ukrainian budget. “If we are going to build a European model of a natural gas market, all participants should pay the same price for gas. Now it’s $517—the price for Russian gas for the fourth quarter plus taxes and transportation costs.”

Korolchuk estimates that Ukraine loses around 10 billion cubic meters (350 billion cubic feet) of gas yearly due to the depreciation of energy systems. “This is a catastrophe,” he said. “Ukrainian power plants are worn by 90 percent. All blocks are depreciated, and gas blocks are out of usage already. All of them use coal to generate electricity and need modernization badly.” 

The Burshtyn coal power plant in Western Ukraine was commissioned in the 70's. It is one of the many plants in Ukraine running way past their lifetimes.

flickr / bankwatch under Creative Commons

The Burshtyn coal power plant in Western Ukraine was commissioned in the 70’s. It is one of the many plants in Ukraine running way past their lifetimes.

Unpopular remedy

Under Ukrainian law, households must use only gas produced inside the country. This amount is often not enough to meet all household needs, such as heating and supplying hot water and gas for kitchens. Some utility companies also use coal for these purposes, but it is not efficient either. The system is complicated and corrupt: Naftogaz, Ukraine’s only importer, purchases Russian gas and then resells it to government-owned and private companies, which in turn provide gas, hot water and heat to households and industries. The system can be, and often is, used for money laundering.

According to Transparency International, former Minister of Energy and Coal Industry Eduard Stavitsky tops the list of Ukrainian officials whose estimated spending exceeded declared income. While working for the government, Stavitsky spent 500 times more than he officially earned. Now the ex-minister has been put on a wanted list and is accused of misuse and misappropriation of property by using his office’s powers.

All of the country’s major energy sectors, including electricity, gas, oil and coal production, as well the utility system need global and immediate investment, which Ukraine cannot afford now after the revolution and with the ongoing fighting in the East, where most of the coal mines are located.

Electricity generation in Ukraine is closely tied to coal mining, which is unprofitable at the vast majority of government-owned coal mines. In 2013, Ukraine spent almost $1.1 billion subsidizing unprofitable coal production in the Donetsk, Luhansk and Lviv regions. No business can afford such losses. According to Korolchuk, at some point Ukraine will have to shut down these mines. However, closing or suspending production at government-owned and private mines will cause a social disaster. As the head of the Independent Trade Union of Miners of Ukraine, Mykhailo Volynets, estimates, closing the unprofitable mines would leave roughly 100,000 people without jobs.

Korolchuk estimates that to raise domestic gas production by 1 billion cubic meters a year, the government should invest at least $1 billion. And to receive loans from international organizations, Ukraine will have to raise utilities’ prices. For nine years, from 1997 to 2006, Ukraine didn’t revise gas prices for its citizens. To date, the real price for gas might be two to three times higher than the price Ukrainians are paying. Of course, a price increase will hurt citizens, many of whom are living on very small wages, but there isn’t any other way.

“We need to go through a deep reform of the gas market,” said Ukrainian energy expert Bogdan Sokolovskiy. “It is necessary to adopt new rules and equate the cost of domestic gas to imported gas, in any case. Then many problems may disappear.”

Escaping from Russia’s embrace

Increasing utility prices domestically and phasing out natural gas subsidies are the key conditions that the International Monetary Fund set for Ukraine before giving it a $17 billion loan. Ukrainian experts say this move makes sense, as it might push Ukrainian consumers to save energy and make the government modernize systems and build more energy-efficient consumption models. If Ukraine had raised prices for natural gas starting in the ’90s, it wouldn’t have to struggle now, as it would have collected funds for modernizing its energy assets over time. Now, a 50 to 100 percent increase in prices will hit Ukrainians where it hurts most.

A month ago, as a result of unsuccessful negotiations, Russian energy giant Gazprom halted gas deliveries to Ukraine for not paying a $4.5 billion bill. The country has about four months until the heating season starts to find a solution to this energy problem and resolve the military conflict in the eastern part of the country. Sokolovskiy said there’s no place for negotiations unless Russia “gets its boots out of Crimea and the East.”

However, Ukraine’s and Europe’s dependence on the importation of Russian sources of energy means adjustments to international politics and EU-Russia relations will be hard to avoid, while the EU so far has been reluctant to impose any strict sanctions on Russia.

Featured image credit Sasha Maksymenko under Creative Commons

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