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Key Enemies of Energy Reforms in Ukraine

Andrian Prokip

BY ANDRIAN PROKIP

Since the Euromaidan, Ukraine has made enormous progress with reforms in the energy sphere. However, these efforts have not been radical enough and were not implemented fast enough to launch a modern and effective energy sector in Ukraine.

Before the dissolution of the USSR, Ukraine’s energy system was among the most developed in Europe. But after 1991, now independent Ukraine and its emerging energy market became reliant on importing many energy resources from other former Soviet states; there was no longer “free energy.” Ukraine therefore needed new rules for the energy sector that would ensure a balanced price and a predictable schedule for the international transit of energy resources from suppliers to end-users. For this, the role of state in establishing and enforcing the rules was critical.

Together with a developed energy system, Ukraine inherited some specific features of the Soviet social contract that prevented the energy market from becoming more efficient. According to this contract, citizens pay unfairly low prices for goods and services, including energy services, in exchange for loyalty to the “caring” government. For more than twenty years the Ukrainian government’s intent to let energy prices be shaped by market forces was constrained by the ruling party’s fear of losing voters’ support. Thus the social contract promoted populism among rulers and paternalism among the ruled.

This perverse situation made the energy sector inefficient. And the country became vulnerable to political pressure from energy-exporting countries, especially Russia. Inefficiency also provided an opportunity for corrupt rent seeking at the international level.

A good example of the tortuous impact of such a situation is that during the 1993–1994 Ukraine-Russia talks on division of the former Soviet Black Sea fleet in Crimea, Ukraine’s gas debt to Russia worsened Kyiv’s negotiating position. Later, in 2010, high prices for Russian gas and Ukraine’s energy inefficiency drove Kyiv to sign the Kharkiv Pact, which stipulated that Ukraine would receive discounted gas from Russia in return for extending the contract allowing Russia to base its Black Sea fleet in Crimea until 2042.

In early 2011, Ukraine joined the European Energy Community. As a requirement for joining, Ukraine had to introduce energy regulations similar to the ones in the EU and other states participating in the Energy Community. Among other steps, the Ukrainian government had to finally form an energy market and revoke subsidies to households. However, the government was in no hurry to execute its obligations and fulfill its commitments. In early 2013, President Yanukovych criticized the EU for its lack of support in Kyiv’s conflict with Gazprom and even floated a balloon about possibly abandoning the Energy Community, opining that membership in it contradicted Ukraine’s national interests (which were understood within the context of the usual populist/paternalist expectations).

A new era in Ukraine’s efforts to reform the energy sector (and others) started after the Revolution of Dignity. The radical nature of the reforms was caused by the conflict with Russia and the political-economic crisis of 2014. At that time, more than a quarter of Ukraine’s energy came from abroad, mostly from Russia. All nuclear fuel and 92 percent of imported natural gas came from Russia. Russia and Belarus were major suppliers of oil and petroleum.

The Donbas war and the annexation of Crimea worsened Ukraine’s energy dependency. Ukraine lost access to many coal reserves in the Donbas, thus becoming dependent on coal imports. Ukraine also lost about 10 percent of its domestic gas production with Russia’s annexation of Crimea. The threat of further conflict with Russia in the military and energy spheres led to a further deterioration in Ukraine’s security posture and challenged the government to acquire additional energy supplies before the upcoming 2014–2015 winter. All these factors together finally supplied the needed propulsion for serious efforts toward reforming the energy sector.

Since 2014, the Ukrainian government has promoted plans for gas self-sufficiency, for enhanced energy efficiency, for gas substitution, and for the development of renewable energy sources. In 2014 the government started taking the drastic step of canceling subsidies and increasing energy prices to consumers.

Despite the security and economic challenges, the government has managed to avoid disaster in the energy sector. The disruption of coal deliveries from the Donbas was addressed by increasing imports. Some nuclear fuel was purchased from the US-Swedish Westinghouse company, and the trilateral EU-Ukraine-Russia talks on gas supply were successful for Kyiv. Also, Russia’s intended South Stream pipeline project, which would have bypassed Ukraine, thereby reducing revenues from transiting gas, was canceled, which somewhat improved Ukraine’s role in Russian gas transit while also signaling a shift in Russia’s longtime goal of delivering gas directly to Europe.

Later, in 2015–2016, when it became clear that an energy disaster had been avoided, the government got cold feet, again exhibiting more sensitivity to public attitudes in regard to energy prices. This shift coincided with the slowing of reform efforts and a reemergence of the traditional populist-paternalist social contract, followed by a renewal of the oligarchic consensus, whereby some governmental decisions are made not on behalf of the energy sector but to benefit specific business groups. Had these factors not reappeared, Ukraine’s energy sector today would be in a much better position.

The reforms in the energy sector have currently stalled. In part this is the result of a deficit in strategic thinking. Several different energy sector reform strategies and a plan for the entire sector have been proposed over the past two decades. But none of these were ever fully implemented, nor were they adequately tied in to other economic reform plans, sometimes even seeming to work at cross purposes.

Now Ukraine must learn from its mistakes and achievements in planning and carrying out reforms. The reforms proposed for the energy sector must be realistic and connected to other sectoral reforms. In addition, a clear strategic vision uniting reforms in the economic and energy sectors is needed, one that recognizes each sector’s specific needs and goals and is based on well-grounded calculations. And we need to overcome the curse of the post-Soviet social contract and the oligarchic consensus. The energy sector can help boost Ukraine’s economic development. It just requires the reforms to be revisioned, replanned, and fully implemented in a reasonably short time.

The opinions expressed in this article are those solely of the author and do not reflect the views of the Kennan Institute.

About the Author

Andrian Prokip

Andrian Prokip

Senior Associate, Ukraine;
Energy Expert, Ukrainian Institute for the Future
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Kennan Institute

The Kennan Institute is the premier U.S. center for advanced research on Russia and Eurasia and the oldest and largest regional program at the Woodrow Wilson International Center for Scholars. The Kennan Institute is committed to improving American understanding of Russia, Ukraine, and the region though research and exchange.  Read more