Confrontation with Russia may make Ukraine energy reforms more urgent

Russia’s Nov. 25 seizure of three Ukrainian patrol vessels and their crews in the Kerch Strait near the Black Sea provided a dramatic reason as speakers at a Nov. 28 discussion at the Atlantic Council in Washington called for more changes in Ukraine’s energy system if the government in Kiev is serious about wanting the country to break free of Russian influence.

“There’s chatter in some parts of Moscow about cutting Ukraine off from the Black Sea altogether,” said Ariel Cohen, a senior fellow at the AC’s Eurasia Center. “Russia is committed to starving Ukraine from revenue. It also wants to finish building the Nord Stream 2 natural gas pipeline because it will put billions of dollars in the correct pockets.”

Former US ambassador Richard Morningstar, who founded and chairs the AC’s Global Energy Center, said, “US sanctions against Russia are more of a possibility than a week ago. Unless there’s a rapid deescalation of what’s taken place there, several concerns in Congress could fall by the wayside and there could be bipartisan support for imposing sanctions. Russia has made a strategic mistake by denying Ukraine access to the Black Sea.”

But other speakers maintained that continuing to restructure Ukraine’s energy system should be pursued aggressively so the country can attract the necessary outside investments to increase its gas production and build transportation systems to reach European markets. Officials from Ukraine’s Razumkov Center also presented a report, “The State of Ukraine’s Energy Sector,” which described steps in the country’s energy independence strategy through 2035.

Ukraine plans to integrate its power system by 2019, which potentially could attract the $200 billion of outside investment that will be needed through the 2020s, noted Volodymy Omelchenko, who directs energy programs at the Razumkov Center. This comes as Russia’s influence in Central Europe is increasing as countries increase imports from Gazprom, he said. “Europe and the US are providing financial assistance, but if it doesn’t increase, much of the region as well as Ukraine will come under more Russian influence,” Omelchenko said.

Progress, challenges

Under the 2015 Gas Market Law, legislation largely exists, wholesale markets have become competitive and supplies more diverse, and production incentives are in place, the report said. But challenges remain because consumers can’t choose their retail suppliers, networks are showing wear and tear, property rights issues need to be addressed, and debt continues to grow, it indicated.

“Our reforms have been very successful, but we realized more needs to be done,” said Vadym Pozharsky, board director at the Burisma Group, Ukraine’s largest gas producer. “We need to be careful not to take steps in the opposite direction by encouraging investments in more coal capacity because alternatives look too expensive. Our energy enterprises are undervalued under the current structure. Markets need to be integrated more closely with the rest of the world.”

Pozharsky said he has been in conversations with several midsized producers, including a few from Texas, who have shown interest in Ukraine’s gas potential with help from the US Department of Commerce. Still, 80% of Ukraine’s gas production is from state-owned operators although Pozharsky said that could change as more foreign investment occurs.

“We’ve seen energy studies and strategies before in Ukraine, but the question always seems to be what’s missing. One important piece could be political will. If you have a system conducive to corruption, it’s only a matter of time before it returns,” suggested Edward C. Chow, a nonresident senior associate in energy and national security at the Center for Strategic & International Studies.

Questions include whether reforms can take place in Ukraine’s licensing establishment, the national government’s share of energy production can come down from 75% and involve more independent producers, how incumbent participants are dealt with, and how to attract more domestic investments to modernize operations and create more foreign interest, he said.

Engaging voters

“Dismissing 2019 as a year for energy reform because national elections are taking place is a mistake,” Chow said. “It’s the perfect time to engage the public and explain why changes are necessary for Ukraine’s energy sector to move forward.”

Anders Aslund, a senior fellow at the AC’s Eurasia Center who moderated the first of two panels, said, “Ukraine has undertaken a massive anticorruption program, but it needs to do more. There are independent supervisory boards for big state companies now, which are bringing in outside voices and making the government show it’s taking corruption reform seriously. But there needs to be more political candidates discussing why reforms are necessary so voters will demand that changes take place.”

Morningstar said that even if Naftogaz, Ukraine’s state-owned gas company, can’t enact reforms in an election year, it still needs to be ready to move ahead with changes once voters have cast their ballots. “It needs to start working now to do this,” he said.

Omelchenko said, “Ukraine needs a minimum 60 billion cu m/year of transit to remain profitable. The absence of a Ukraine transit system could cost European customers money.”

Maksym Billavskyi, a leading energy programs expert at the Razumkov Center, said, “If we look at this from a technology point of view, there’s also transportation to Poland and connection to the rest of Europe through the North-South line there. Similarly, natural gas from Romania could come to customers in Ukraine. Today, the interconnection to Poland exists only on paper, but it’s not that expensive.”

Contact Nick Snow at [email protected].