Reform Risks and Challenges


The proposed market reform is not limited to Naftogaz itself; it encompasses the entire Ukrainian gas industry. The reform requires significant changes in the industry governance in general, shifting the government policy from control to regulation.

The proposed changes are designed to encourage more efficient business models focused on longer term strategies by the gas market participants.

A successful implementation of the reform will also result in a shift to more energy conscious behavior for millions of Ukrainians. The most challenging part of the reform is the need to move the center of responsibility for efficient energy use from the top to the bottom, creating an environment where citizens are responsible for making better energy consumption choices.

Naftogaz sees three key challenges which can hinder the reform process, namely, demand for paternalism, poor coordination between various governmental bodies implementing the reform and corruption-induced resistance to change.

Paternalistic expectations of the public

A significant number of Ukrainians still have paternalistic expectations originating from the Soviet system. During the Soviet era, the citizens had no effective instruments to influence the governance of the state or their communities. In the result, avoiding individual responsibility has become a common behavioral pattern. Basic commodities subsidized by the state traded off for selective justice and the non-accountability of the authorities were components of the paternalistic culture that evolved over many decades.

The European choice that the Ukrainians have proclaimed requires a completely different model of behavior. The transition to this model is a challenge for millions of Ukrainians. Some citizens reject the necessity to invest in energy efficiency and to take the full financial responsibility for their energy consumption. For others the transition is complicated because it requires evaluation of different consumption patterns and forecasting of future consumption — tasks never done before. This shift is particularly difficult against the backdrop of a struggling economy. The situation is complicated by the fact that Ukrainians rely on the state but do not trust it.

Social surveys of confidence in institutions show single digit levels of trust to the state institutions. At the same time, the speed with which reforms are taking place and the uncertainty generated by the lack of, and often contradictory, government communication on the reform process and its goals, creates a confusing environment for the public, leading to stress and distrust.

Populist political leaders oppose reforms, using a chance to increase their political influence. By opposing the gas sector reform in general or some of its elements, they can undermine the integrity of the changes Naftogaz seeks to implement.

However, the Ukrainian society is not entirely paternalistic. The reforms initiated by Naftogaz enjoy the support of many within Ukrainian civil society.

The 2013-2014 Revolution of Dignity has demonstrated that Ukrainians are willing and able to take responsibility for changing the country

An effective communications strategy, together with the support of the ruling parliamentary coalition, should help to reduce public anxiety. The 2015-2016 winter will likely be the most challenging and decisive period for the reform success and will show how the country adapts to the new conditions.

Lack of coordination among the reformers

The lack of coordination among various entities and governmental bodies that participate in the implementation of the reform poses a major threat to the reform process. At least one member of the ruling coalition openly opposes the currently implemented reform. The vision of the gas market reform and its elements is not unified across various participants responsible for its implementation. The process of constitutional separation of powers between the parliamentary coalition, the government and the President has not been finalized. Meanwhile, the ongoing decentralization reform adds to the confusion, creating ambiguity over the levels of responsibility the local authorities are going to assume.

The participation of internal and external stakeholders is extremely important to resolve these challenges. The Ukrainian civil society now actively monitors the government decisions and actions. Ukraine’s foreign creditors and international partners have clearly articulated the terms of their support, with special emphasis placed on the previously failed attempts to reform the energy sector. An unreformed energy sector in Ukraine presents a potential security risk, both for the EU and for Ukraine. Given the lack of resources and time constraints, reforming the market requires determination of all parties involved.

In order to address this challenge, the Ukrainian authorities have launched a number of joint initiatives that bring together representatives of different ministries and organizations involved in the reform process to improve coordination between them

Of particular importance in moving the reform forward is the National Reforms Council established by the President of Ukraine, which unites representatives of the parliament, the government and the presidential administration, as well as relevant NGOs and experts.

Another important cross-ministerial group was formed by the government to coordinate the development and implementation of state-supported energy efficiency programs as well as the reform of the system of utility subsidies for low-income consumers.

Corruption-induced resistance from the market

The third key challenge to the gas market reform is corruption. Energy sector is associated with significant capital flows and is an effective way of securing political leverage and influence. Therefore, control over this sector of economy has always been an important priority for those who engaged in corrupt practices.

Through the energy sector, corrupt groups have influenced the political, economic and social development of the country for many years. Large-scale overpriced gas imports from Russia and heavily subsidized gas for households have served as instruments of power and created a corruption-prone system. Without control over Naftogaz and its subsidiaries, the old groups of influence lose their competitive advantage against more effective private sector players.

The array of tactics deployed to hinder the reform include defamation, sabotage, blocking changes through court decisions, lobbying legislation that undermines the reform integrity and even using threats of physical violence against individuals responsible for the reform implementation.

As long as Ukraine’s public institutions are weak and the public support for the unpopular changes is limited, the alliance of corrupt interests and paternalistic expectations can pose a threat not only to the gas market reforms, but to the country as a whole. Communicating these threats to the society and explaining the logic behind the reform process are therefore crucial steps.

The strong political will within Ukraine and the voice of Ukraine’s Western partners are critical for moving the reform forward. The increased role of the Ukrainian civil society helps to curb corruption and block decisions aimed to stop the reform implementation

Naftogaz believes that the corporate governance reform based on OECD best practices for public sector companies is one of the most effective ways to combat corruption in the energy sector. In particular, an independent supervisory board in Naftogaz needs to be formed to protect the company from potential political meddling, safeguard against nepotism, improve control over the group’s finances and guarantee that management decisions reflect the interests of all Ukrainians as the ultimate owners of Naftogaz, not of a limited group of individuals.