Ukraine is fight­ing for en­ergy se­cu­rity but cor­rup­tion gets in way

Kyiv Post Legal Quarterly - - Contents - BY MATTHEW KUPFER KUPFER@KYIVPOST.COM

Ukraine’s natural gas in­dus­try won a land­mark case against Rus­sia on Feb. 28, when a Stock­holm ar­bi­tra­tion court ruled that Gazprom, Rus­sia’s state-con­trolled gas com­pany, owed its Ukrainian coun­ter­part Naftogaz $4.6 bil­lion for fail­ing to de­liver gas to Ukraine for tran­sit on­ward to Europe. Af­ter tak­ing into ac­count a pre­vi­ous rul­ing re­quir­ing it meant the Naftogaz Ukrainian to pay state debts com­pany to Gazprom, was owed nearly $2.6 bil­lion by Rus­sia’s gi­ant, state-con­trolled gas com­pany. It was a stun­ning vic­tory for Kyiv. But ex­perts say this is just one bat­tle in a broader war to pro­tect Ukraine’s en­ergy se­cu­rity — and the coun­try isn’t nec­es­sar­ily win­ning.

struct­ing Rus­sia and Nord Ger­many Stream have 2, a gas started pipe­line con­run­ning un­der the Baltic Sea that would cir­cum­vent Ukraine. Mean­while, the Turk­stream pipe­line from south­ern Rus­sia to Turkey is near com­ple­tion. Both could deny Ukraine gas tran­sit fees worth at least two per­cent of the coun­try’s gross do­mes­tic prod­uct. The front line in Kyiv’s strug­gle for en­ergy se­cu­rity is re­form of the sec­tor. But pol­i­tics is in­creas­ingly stand­ing in the way. And some doubt that Ukraine has the will to push through re­forms and fight en­trenched cor­rupt prac­tices. “I was struck — even when I was in Kyiv at the end of last year — by how much peo­ple were talk­ing about elec­tions,” says Ed­ward Chow, an en­ergy ex­pert at the Cen­ter for Strate­gic and In­ter­na­tional Stud­ies, or CSIS, think tank. “And elec­tions seem to be stalling the process.”

Gas tran­sit cor­ri­dor

De­spite four years of war with Moscow, Ukraine re­mains deeply de­pen­dent on Rus­sian en­ergy: gas, crude oil, petrol, and coal. The coun­try also plays the role of a tran­sit cor­ri­dor for Rus­sian gas sold to Europe. In 2017, Ukraine trans­ported around 93 bil­lion cu­bic me­ters of Rus­sian gas through its pipe­lines, only slightly more than the pro­jected ca­pac­ity of Rus­sia’s cur­rent pipe­line projects. Moscow uses 80 per­cent of Ukraine’s gas trans­porta­tion ca­pac­ity, ac­cord­ing to Ukr­transgaz, Ukraine’s state gas trans­port sys­tem op­er­a­tor. Since 1991, so-called “gas wars” have re­peat­edly flared up be­tween Naftogaz and Gazprom over gas prices and out­stand­ing debts, threat­en­ing gas sup­plies to both Ukraine and Europe. At times, the con­flicts have even led to tem­po­rary shut-offs. The case heard in Stock­holm dealt with two agree­ments that Naftogaz and Gazprom reached in Jan­uary 2009. But the con­flict over them erupted as part of the broader col­lapse of re­la­tions be­tween Kyiv and Moscow in 2014. Af­ter the start of Rus­sia’s oc­cu­pa­tion of Ukraine’s Crimea and the Krem­lin’s mil­i­tary in­ter­ven­tion in the Don­bas that year, Ukraine’s de­pen­dence on Rus­sian gas be­came a se­cu­rity risk for the coun­try. Mean­while, de­te­ri­o­rat­ing re­la­tions with Kyiv made Nord Stream 2 a more ex­pe­di­ent project for Moscow. In Novem­ber 2015, Ukraine stopped pur­chas­ing gas from Rus­sia, and be­gan im­port­ing it from Europe in a process known as “re­verse flow.” How­ever, while th­ese gas mol­e­cules are con­trac­tu­ally Euro­pean, they are ge­o­log­i­cally Rus­sian — sold to Kyiv af­ter be­ing trans­ported from Rus­sia through Ukraine’s vast net­work of pipe­lines. Real en­ergy in­de­pen­dence will re­quire some­thing more than re­verse flow, par­tic­u­larly with Nord Stream sched­uled for com­ple­tion in 2019. Ariel Co­hen, an ex­pert on en­ergy se­cu­rity af­fil­i­ated with the At­lantic Coun­cil, sug­gests the cur­rent Ukrainian pipe­line sys­tem helps pre­vent an all-out war be­tween Ukraine and Rus­sia. If Nord Stream and Turk­stream come into op­er­a­tion, “Rus­sia can do in Ukraine what­ever it wants and not suf­fer any se­ri­ous eco­nomic con­se­quences,” Co­hen said at a con­fer­ence in Washington on June 14.

Steps to re­form

Deal­ing with the Rus­sian threat thus means re­form­ing the gas sec­tor. But, for a coun­try used to years of cheap gas and reli­able tran­sit fees, that means both clear­ing out en­trenched in­ter­ests, and mak­ing or­di­nary house­holds pay a more re­al­is­tic, mar­ket-based price. In May 2015, Ukraine passed the law “On the Natural Gas Mar­ket,” which would help to cre­ate a com­pet­i­tive gas mar­ket based on EU leg­is­la­tion. The law was one of the re­quire­ments Ukraine had to meet to re­ceive aid from the In­ter­na­tional Mone­tary Fund. This is one of sev­eral im­por­tant steps Ukraine has taken since 2015, says Gen­nady Kobal, di­rec­tor of the Ex­pro con­sult­ing firm. Ukraine from in pro­gram tion 27.6 new per­cent, plo­ration This “From 2016, bil­lion from gas Poland, year, the has a to the wells and roughly move cu­bic ratchet Cabi­net le­gal rapidly in­vest­ment Ukraine Slo­vakia, from in­tended me­ters point 20 up of in­creased bil­lion 14.29 do­mes­tic Min­is­ters de­creased of and by in view, to 2020. per­cent cu­bic the Hun­gary. stim­u­late gas Ukraine gas sec­tor. launched me­ters taxes pro­duc- im­ports to And, 12.5 has ex- on to a done en­ergy per But The than a break­ing 2020 lot,” has in proven re­al­ity. Kobal do­mes­tic its says. eas­ier de­pen­dence ex­trac­tion for Ukraine on goal Rus­sian on is now pa­clearly slowly, Kobal be­lieves while im­pos­si­ble. in­vest­ment the sec­tor Ex­trac­tion suf­fers re­mains is from grow­ing lim­ited. a lack of More equip­ment, con­crete spe­cial­ists, re­forms and have tech­nol­ogy. also prov­elu­sive. In March, Prime Min­is­ter en Volodymyr Groys­man de­layed in­creas­ing the price of gas for house­hold con­sumers to mar­ket lev­els, a con­di­tion for In­ter­na­tional Mone­tary Fund fi­nanc­ing. Ukraine’s ar­ti­fi­cially low gas prices ben­e­fit cor­rupt busi­ness peo­ple, who buy do­mes­tic gas and re­sell it at mar­ket lev­els. pany with Pack­age Plans the Ukr­transgaz to also Euro­pean un­bun­dle appear from to Union’s gas have dis­tri­bu­tion Naftogaz stalled. Third in En­ergy com- line re­quested In April, that Naftogaz Groys­man CEO de­lay An­driy un­bundling Kobolyev for two years, un­til the com­pany’s con­tract with Gazprom — which it is re­quired to com­plete un­der the Stock­holm ar­bi­tra­tion — con­cludes. The next re­form set to come into force is daily balanc­ing, which will al­low gas trad­ing us­ing daily — rather than monthly — con­tracts. If that doesn’t hap­pen, it will mean “re­forms of the mar­ket have stopped” and Naftogaz has come into con­flict with the state en­ergy reg­u­la­tory com­mis­sion, Kobal says. “That’s a very bad sig­nal be­cause th­ese are the struc­tures that should pull the mar­ket along.”

He pre­dicts daily balanc­ing won’t hap­pen in Au­gust.

In­side Naftogaz

Kobal’s cord­ing ness de­vel­op­ment pre­dic­tion to Yury Vitrenko, di­rec­tor. is a likely Naftogaz’s out­come, busi- acVitrenko But the says. short­fall Rather, isn’t his Naftogaz’s team has fault, been fight­ing for re­form, but has not al­ways been suc­cess­ful going up against en­trenched cor­rup­tion. Af­ter Ukraine passed the 2015 “Natural Gas Mar­ket” law, its next step was to de­velop sec­ondary leg­is­la­tion. Vitrenko’s team pushed for Ukraine to adopt Euro­pean net­work codes, in­clud­ing daily balanc­ing, which gov­ern Europe’s elec­tric­ity mar­ket. Lo­cally pro­duced norms could in­clude loop­holes and ex­cep­tions that would al­low vested in­ter­ests and cor­rup­tion to re­main in Ukraine’s en­ergy mar­ket, Vitrenko says. But Ukraine’s en­ergy reg­u­la­tor and re­gional gas dis­tri­bu­tion com­pa­nies, largely con­trolled by natural gas oli­garch Dmytro Fir­tash, in­sisted on adopt­ing Ukrainian norms. “We’ve been fight­ing — and now it’s for more than four years — to adopt a truly Euro­pean net­work code,” Vitrenko told the Kyiv Post. In June, the Ukrainian gov­ern­ment ap­pointed a new reg­u­la­tor, Ok­sana Kryvenko. Now, Naftogaz is ap­peal­ing to her to im­ple­ment the Euro­pean net­work codes. Vitrenko says his hands are even more tied with un­bundling. In or­der to sep­a­rate Ukr­transgaz from Naftogaz, the com­pany must amend its trans­fer con­tract. How­ever, as early as 2014, Gazprom re­fused to amend. Naftogaz then asked the Euro­pean Com­mis­sion to make Gazprom amend the con­tract, but it di­rected the Ukrainian state com­pany to ar­bi­tra­tion. And the in­ter­na­tional ar­bi­tra­tion tri­bunal claimed to have no ju­ris­dic­tion over the mat­ter. “The only stake­holder who can do it is the Euro­pean Com­mis­sion, but they’re not do­ing it,” Vitrenko says. “You ei­ther make Gazprom amend the con­tract and play by Euro­pean rules, or it leads to the de­lay in un­bundling.” Ukraine’s only lever­age would be halt­ing tran­sit to force Gazprom’s hand, Vitrenko says. But Europe op­poses this move, and it would both dam­age Ukraine’s rep­u­ta­tion as a reli­able part­ner and likely in­crease sup­port for Nord Stream 2.

Lit­tle sym­pa­thy

Few claims. en­ergy Ex­pro’s ex­perts Kobal be­lieves sup­port time Vitrenko’s is of the essence in Ukraine’s en­ergy re­forms. “We can’t con­stantly put things off,” he says. “We need to do as much as pos­si­ble be­fore elec­tions.” And the At­lantic Coun­cil’s Co­hen sees lit­tle rea­son why the Stock­holm de­ci­sion should af­fect un­bundling. The po­lit­i­cally con­nected state-owned com­pany’s role as an oil and gas mo­nop­oly and in­volve­ment in ex­plo­ration cre­ates room for cor­rup­tion, he says. Co­hen also be­lieves Ukraine should change its tar­iffs to at­tract in­vest­ment, im­prove con­di­tions for al­ter­na­tive en­ergy, and bet­ter main­tain and ren­o­vate the coun­try’s mas­sive nu­clear power po­ten­tial. Fi­nally, it should reg­u­lar­ize its pur­chases of coal and find a sup­plier other than Rus­sia. CSIS’S Chow sug­gests that Ukraine must ur­gently in­crease do­mes­tic gas pro­duc­tion. But the con­di­tions for this are poor. Do­mes­tic pro­duc­tion has long been stuck at roughly 20 bil­lion cu­bic me­ters an­nu­ally, and there haven’t been ten­ders for new ex­plo­ration ogy: 70 its to That’s con­sump­tion be bil­lion in ex­ported the not li­censes cu­bic 1970s, be­cause me­ters to needs, in other Ukraine two of with — years, un­fa­vor­able Soviet enough pro­duced some he re­publics. says. left to cover geol- over over Rather, says. “It’s With­out all the a prob­lem sys­tem re­form, wired is no cor­rup­tion. for one in­sid­ers,” will in­vest Chow un­less they feel they have “in­sider help.” But with re­forms largely stalled, Chow sees only one so­lu­tion in Ukraine: tough love from the in­ter­na­tional com­mu­nity. “As I al­ways say to the IMF peo­ple, the time to get tough is on the first (aid) tranche, not the third.”

Yuri Vitrenko, Naftogaz's busi­ness de­vel­op­ment di­rec­tor, says that his team has fought for re­forms to make Ukraine's en­ergy sec­tor more pro­duc­tive and trans­par­ent, but of­ten strug­gles to over­come vested in­ter­ests and en­trenched cor­rup­tion. (Kostyan­tyn Ch­er­nichkin)

Yuri Vitrenko ex­am­ines one of over 100 tomes that make up Naftogaz's in­ter­na­tional ar­bi­tra­tion case against Rus­sian state-con­trolled gas com­pany Gazprom. (Kostyan­tyn Ch­er­nichkin)

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