Ukraine’s track record of massive corruption in energy is a sadly familiar story. Billions of dollars have been siphoned off annually into political largesse and party war chests. Successive administrations have proclaimed reform even as insiders fought over energy franchises. Unless corrected, the energy sector will continue to corrupt Ukrainian politics and make the country vulnerable to external threats.
Ukraine’s energy sector is also crucial to its neighbours. Although its advantages in energy transit have been eroded, Ukraine still transports nearly half of Russia’s gas exports to Europe, at least until additional bypass pipelines – Nord Stream 2 and Turkish Stream – can be built. Russia has steadfastly built new pipelines to bypass Ukraine, and employed transit deals to compromise its leaders and to demonstrate to European customers that Ukraine is an unreliable transit partner.
Energy, therefore, is a key indicator of progress in economic reform that is closely watched by the Ukrainian public and by its international supporters. The stakes go beyond reducing energy inefficiency in a moribund economy and the drain on the national treasury.
Unfortunately, more than two and half years after Euromaidan, Ukraine’s energy economy is still plagued by a lack of market competition and of transparent regulation.
The new government under Prime Minister Volodymyr Groysman should be applauded for equalising domestic gas prices as one of its first actions this spring. However, gas subsidies are by no means the only area where energy corruption thrives. Bringing new management, including young western-trained Ukrainians and even westerners, into state energy companies is only effective if there is real improvement in corporate governance and transparency in areas like procurement and transfer pricing. The ultimate goal should be to break up state-owned energy monopolies to promote competition and market efficiency, release the economic value of state assets, and remove the temptation for special interest groups to control energy franchises.
One unhelpful claim is that reverse flows of Russian gas from Europe somehow offer a long-term remedy. Certainly they are useful in the face of Russian aggression and recalcitrance in negotiations while the gas market is oversupplied. However, this means nothing if Russia actually cuts gas flows to and through Ukraine and European countries have no gas to spare at a time of shortage.
Furthermore, the value of Ukraine’s gas transit system depends on normalising its relations with Gazprom. Taking Gazprom to international arbitration and threatening capriciously to increase pipeline tariffs are perilous paths to take, unless one wants to help Gazprom justify its bypass pipelines.
Of course, the long-term answer is for Ukraine to improve energy efficiency and investment conditions for increasing domestic production. The Groysman government has a limited window to pursue energy reform earnestly or its political legitimacy will go the way of its predecessors’. The Ukrainian public recognises recent signs of a return to business as usual and political infighting over control of energy assets.
Even given the political will, the Ukrainian government still lacks financial resources and the capacity to implement reforms in an effective manner. Western governments and international financial institutions would have to offer much bigger carrots and wield bigger sticks than what has so far been considered. Economic assistance has been meagre for a nation of 45m people at war and conditionality has not been strictly enforced. This feeds into the natural inclination of Ukraine’s political class to muddle through and to believe that Ukraine is so important that the west will allow them to get away with business as usual.
The good news is that, unlike other corrupt sectors such as education and health care, energy reform can more than pay for itself. It would improve Ukraine’s economic competitiveness and contribute resources and impetus for overall reform.
But no agreed energy reform plan currently exists. A committed, Ukrainian team must design such a plan with the help of international commercial, industrial and regulatory experts. There must be a realistic order of play that is not driven by special interest considerations. Most importantly, such a plan must be communicated to the Ukrainian public and accepted by their elected representatives in parliament. Too often, Ukrainian governments see legislators as obstacles to executive action rather than as partners in reform, whose trust must be earned.
Energy reform can only be sustained with unity of purpose and a unified team inside the Ukrainian government. The west must help with significant funding and capacity building in a well-coordinated way. Otherwise, Ukrainian officials have a way of playing one donor against another to settle their internal conflicts, which are based on interest group politics and not economic merit. A greater commitment to assistance must be accompanied by a greater willingness by the west to enforce conditionality if Ukrainian authorities fail to fulfil their commitments. Enabling bad behaviour will only lead to a more urgent crisis down the road, as has happened too often in the past.
Edward C Chow is a senior fellow at the energy and national security programme of the Center for Strategic and International Studies in Washington. He has 40 years of experience in the international oil and gas industry and advised previous Ukrainian governments on energy, including immediately after the Orange Revolution of 2004.