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The Battle for Ukraine's Energy Allegiance

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The Battle for Ukraine's Energy Allegiance >> POLICY BRIEF ISSN: 1989-2667 Nº 55 - SEPTEMBER 2010 The battle for Ukraine’s energy allegiance Natalia Shapovalova As the main route for Russian gas into Europe, Ukraine is vital to >> both European and Russian energy security. The European Union (EU) seeks to secure gas supplies through Ukraine by integrating its east - HIGHLIGHTS ern neighbour into the European energy market.Russia is seeking to pre - vent EU-led reforms in Ukraine in order to secure stable gas export • Ukraine has taken some steps incomes and continue exerting power over its ‘sphere of privileged inter - to reform its energy sector and est’. Ukraine’s elite does not wish for reform, but maintaining the status integrate in the EU market, but quo is no longer tenable either. Ukraine is increasingly forced to choose reform goes too slowly; the between the energy security guarantees of the EU and Russia. country's energy sector remains ineffective, opaque and corrupt. UKRAINE MOVES CLOSER TO EUROPEAN ENERGY MARKETS... • Russia is looking to take over Ukraine's energy market: Ukraine’s new president Victor Yanukovych is often represented as pro- energy-inefficient Ukraine Russian in contrast with his predecessor Victor Yushchenko and ex- remains one of Gazprom’s prime minister Yulia Tymoshenko. But in terms of relations with the largest client s. EU, his government has managed to fulfil some promises that were not upheld by his ostensibly pro-European predecessors. In July, the • Energy is in the centre of Ukrainian parliament adopted a new law on the Ukrainian gas sector, EU policy and aid to Ukraine, aligning Ukraine with EU requirements and legislation. but the EU's inconsistent external energy policy weakens Transposition of this law was necessary for Ukraine’s membership of the its leverage in the country. European Energy Community. The latter initiative was established between the EU and a number of countries in south-eastern Europe in order to extend the EU’s internal energy market beyond the bloc’s borders. The law harmonises Ukrainian legislation with EU gas market regulations (Directive 2003/55/EC concerning common rules for the internal market in natural gas and Regulation 1775/2005 on conditions for access to the THE BATTLE FOR UKRAINE’S ENERGY ALLEGIANCE 2 >>>>>> natural gas transmission networks) and enables the that came with the 25-year prolongation of the creation of a more competitive gas market. The new Russian Black Sea Fleet’s stationing in the law envisages unbundling of gas exploration, trans - Crimea. portation and supply, and guarantees equal access of operators to gas networks. It is also set to strength - en independence of the national regulatory body in ...BUT RENT-SEEKING REMAINS order to eliminate political influence on the energy market. It remains to be seen whether the law will be imple - mented as fully as it should be. Experts point to a The adoption of this law means that Ukraine risk of hidden monopolisation. Unbundling and will become a member of the European Energy independent regulation of the gas market may exist Community in the next six months to a year, on paper only. This occurred previously with the according to the EU energy commissioner. As national regulator, which was in practice highly part of its membership obligations, by 2018 dependent on the government, even though legis - Ukraine will have to implement other elements lation envisages the opposite. of EU energy policy which regulate the electric - ity market and energy-related environmental Analysts say revenues from the gas price hike are issues. Membership will ensure the competitive - not slated to go towards government investment ness and transparency of Ukraine’s energy mar - into energy saving and infrastructure modernisa - ket, investments in modernisation of tion. The Ukrainian state oil and gas monopoly infrastructure and new technologies and thus Naftogaz is preparing to pay a gas debt worth 3 will reduce consumption and dependency on gas billion dollars – equivalent to 12.1 billion cubic imports. For the EU it will mean stable gas sup - meters, or 20 per cent of Ukraine’s annual gas plies from Russia through Ukraine. consumption – to RosUkrEnergo, a ‘middleman’ jointly owned by Gazprom and Ukrainian oli - Despite this advance, the state has maintained garch Dmyro Firtash. The latter was allegedly one its control over state-owned gas exploration of the main sponsors of Yanukovych’s presidential companies. They will be forced to sell gas to a campaign. RosUkrEnergo was established as an government company at a regulated price. This intermediary selling Russian and Central Asian allows the state to manipulate household energy gas to Ukraine back in 2004, when Yanukovych prices, which will further impede the develop - was prime minister and the current energy minis - ment of the gas exploration market. Further - ter, Yurii Boyko, was a key player at Naftogaz. more, the new law does not prevent foreign Experts say the company was founded to create monopolies, such as Russian Gazprom, from extra revenue for its stakeholders, both within the operating in the Ukrainian market. Ukrainian and Russian ruling elites. RosUkrEner - go’s already advantageous position in the Ukrain - The new Ukrainian government has also ful - ian market strengthened after the Ukraine-Russia filled another requirement set by the EU and ‘gas war’ of 2006. In 2009, Yulia Tymoshenko’s other international organisations such as the government reached a deal with Gazprom to International Monetary Fund (IMF). From remove the company from Ukraine-Russia gas August 2010, gas prices for domestic consumers trade. As part of the agreement, the government have increased by half, and a further hike is fore - gained possession of 11 billion cubic meters of its cast for 2011. In a desperate bid to secure an gas, located in Ukrainian gas storage. When the IMF loan and reduce the budget deficit, the gov - government in Kiev changed, RosUkrEnergo ernment dared to do what its predecessor did sued Naftogaz at the Arbitration Tribunal of the not. Yanukovych raised gas prices despite his Stockholm Chamber of Commerce, winning the April 2010 statement that an increase would not case. be necessary due to the ‘discounted’ gas price POLICY BRIEF - Nº 55 - SEPTEMBER 2010 3 Analysts believe that the government will now pay Instead, Ukraine suggested creating a tripartite out, as it barely attempted to defend Ukraine’s inter - EU-Ukraine-Russia consortium, an idea that was ests in the courtroom. Presumably, under pressure discussed in president Kuchma’s time. The gov - from Gazprom, any evidence pointing to a link ernment indicated it was ready to implement a between RosUkrEnergo and the Russian monopoly joint EU-Ukraine declaration signed by Yulia – or, more accurately, to the latter’s control over the Tymoshenko in March 2009, in which Ukraine former – was discarded from the case, weakening promised to reform the energy sector and the EU Naftogaz’s position. Moreover, a Ukrainian court to participate in modernising Ukraine’s gas tran - approved the Stockholm court ruling, meaning that sit system. The EU has not yet reacted to Ukrainian authorities are obliged to comply. Yanukovych’s consortium proposal. If the claimed gas is returned to RosUkrEnergo, Unlike the EU, Russia does not ask for liberalis - Ukraine will have to purchase more from Russia. An ing reforms. On the contrary, Russia benefits energy advisor for the opposition estimated that from an opaque and uncompetitive gas market in Gazprom would earn over 1 billion dollars as owner Ukraine. However, despite the leanings of the of half of RosUkrEnergo. Moreover, Naftogaz’s government, Ukraine feels insecure about Russian financial situation would decline still further. energy policy. Having lost control of the pipelines, the Ukrainian government will have no bargaining power over establishing prices for RUSSIA: STALLING UKRAINE’S ENERGY imported gas, and will be deprived of this impor - MODERNISATION tant source of rent. This explains why Yanukovych, despite his moves towards Russia’s The gas wars between Ukraine and Russia in 2006 outstretched arms, has not been eager to accept and 2009 led to Russian energy giant Gazprom edg - Putin’s proposal. ing into Ukraine’s Analysts say domestic market. Yanukovych’s soft ‘no’ has not prevented Russia Responding to the new from insisting on a merger between the Russian revenues from Ukrainian govern - and Ukrainian energy sectors. The two countries ment’s Russia-friendly have increased their cooperation vis-à-vis nuclear the gas price hike policy, the Kremlin has energy. Russia has offered Ukraine a 2 billion dol - are not slated to go changed its tactics lar credit to construct two additional reactors on from waging war to the Soviet-built nuclear power plant, which will towards government attempting a peaceful allow Russia to install its own technologies and takeover. In April supply uranium to Ukraine. The Ukrainian gov - investment into 2010, when the ink on ernment is also considering Russian investment in energy saving the gas-for-fleet deal the construction of a factory to produce nuclear had barely dried, Russ - fuel. and infrastructure ian prime minister Vladimir Putin offered Russia will keep looking for other ways gradually modernisation. Ukraine a Gazprom to edge its way into the Ukrainian gas market. It and Naftogaz merger may draw on its experiences in Belarus, where nominally as a means to invest in the modernisation state energy assets were acquired in lieu of Belaru - of Ukraine’s gas transit system. Yanukovych rebutted sian debts to Gazprom. Even though a merger has the proposal with a joke that such a deal would been discounted, Ukraine and Russia have be possible only if the two companies exchanged 50 launched talks on a possible joint venture per cent of their stocks – irrational given Gazprom’s between Naftogaz and Gazprom, to which the size.
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