Posted on March 31, 2015 by Gary Lakes
Ukraine’s conflict with Russia is as much about energy prices as it is about Moscow’s attempt to establish political control over eastern Ukraine. Our editor Gary Lakes talks to Sergiy Oleksiyenko, chief adviser to Kiev’s state-owned Naftogaz, about attempts to solve a problem that has been simmering since the end of the Soviet era.
EUROPEAN analysts have long argued that Ukraine can only escape from Russia’s iron grip on westward-bound gas supplies by first reforming its extraordinarily corrupt domestic industry. Russia supplies Europe with 30 percent of its gas – around 130 billion cubic meters per year – and 40 percent of it flows through Ukraine’s pipelines.
Ukraine’s Sergiy Oleksiyenko. [Photo: Athens Energy Forum]
Sergiy Oleksiyenko, chief adviser to the chairman of the state-owned Naftogaz Ukraine, told Global Sources Magazine during a discussion in Athens that his country understands the problem and is taking steps to address it, but it is challenging a well-entrenched system.
Oleksiyenko said the most important issues Ukraine faces in trying to win energy independence from Russia are getting rid of subsidies, reforming the pricing system, and developing Ukraine’s own extensive gas resources.
“Fifty percent of the overall problem that Naftogaz is facing is tariff reform,” Oleksiyenko said. “The sector is so inefficient, there are so many subsidies in the energy sector that nobody cared about saving gas or saving energy – you are getting it for free, so why bother to save it?”
He said that industries in Ukraine pay the market price for gas and they are not the problem. The real problem is that public utilities and the general population simply don’t pay their bills ? or don’t even get sent a bill. If the utility companies do not get paid by their customers, they just ask for a subsidy and the government pays it,” he added.
“The major challenge is to turn this around – to make it really efficient,” Oleksiyenko said. “If you don’t pay, you don’t get gas. The price of gas must be market driven.”
He said Ukrainian utilities and the public pay less than 20 percent of the market price, the idea from years ago being that domestically-produced, relatively cheap gas would meet the needs of the public utilities and the people. “But this was a biased approach. How do you calculate the cost of production?”
Like many regional subsidy systems, Ukraine’s has its roots in the Soviet era, but current policy is based on decisions taken 10 to 15 years ago when it attempted to establish a modern welfare state. Oleksiyenko said the system was in place before the Orange Revolution, whose leaders committed to change it, but never did.
“The subsidized tariffs for the population and the gas utilities make domestic production inefficient,” Oleksiyenko said. “Domestic gas production is still controlled 90 percent by government-owned companies and they do not invest enough because they don’t have the cash flow from gas sales that to put into domestic exploration.”
He said a recent study showed that if state-owned firms operated at anything near the efficiency of European oil and gas companies, they could quickly double gas domestic production just from traditional sources that don’t include shale and offshore resources.
“There is enough gas in Ukraine that can be extracted in a relatively short period of time,” Oleksiyenko said. “We need investment, we need new technologies. With already explored fields we could improve production relatively quickly.”
Kiev has set the cost of gas production at $20 per 1,000 cubic meters, which means state firms get $20, plus some money for transportation costs, for what they produce.
“This has no relationship whatsoever to the true economic cost of production,” Oleksiyenko said. “The true economic cost of production cannot be significantly different in Ukraine from that in Romania or Poland, where there is a similar geological situation.”
Real costs would be around $300 per 1,000 cubic meters if there were an intense effort to modernize the industry, he said. A modest effort in new equipment and development would mean a price of $200.
By comparison, Russia’s Interfax news agency reported in late March that Ukraine paid an average price of $322.50 per 1,000 cubic meters for imports from Europe during January, down from $341.20 in December last year. Gas imported from Russia cost Ukraine $335.70 for January, down from $384.9 in December. Ukraine’s statistics department gas supplies from Europe were 1.07 billion cubic meters in January – at a rate of $344, Interfax said.
Last year, Ukraine and the European Union arranged “reverse-flow” gas deliveries from Slovakia, Poland, Hungary and Romania, and also some from Norway’s Statoil. Much of the gas that flows into Ukraine from Europe is still Russian gas and media reports say Russia has reduced gas supplies to some East European countries, to inhibit the volume of gas they can send to Ukraine.
Oleksiyenko acknowledged that Ukraine is buying gas from countries that get the bulk of their supplies from Russia, but added there there is no real way to test its origin. “The positive thing about the Third Energy Package is that it really levels the playing field in the European Union in terms of cost of gas. Eventually the ideal efficient market is that the cost of the gas country-to-country depends only on the transportation options and the transportation costs rather than political agreements with Gazprom.”
Moscow has told Europe it will stop shipping gas through Ukraine once it builds an alternative transport route. The EU insisted that Moscow must adhere to the terms of the Third Energy Package and Russia said in December that it would scrap the South Stream gas pipeline project. Instead it would redirect the gas pipeline under the Black Sea to the European side of Turkey, from where European customers would have to take delivery of their Russian gas supplies through some infrastructure that doesn’t yet exist.
“Last year the situation was unstable, but gradually we are putting more and more structure into a new energy system,” Oleksiyenko said. “Now we are more or less secure in the sources of diversification. It is not a perfect import balance. It’s a basket, but we’re getting there. We need to interconnect with Poland, expand our capacity to import from Slovakia, increase our interconnections with Hungary and Romania. We are thinking of an LNG terminal in Odessa, which could be done relatively quickly, and then we would be diversified on several fronts.”
Naftogaz is working with the European Bank for Reconstruction and Development (EBRD), the World Bank and the International Finance Corporation (IFC) to improve its working capital, which should be done by the end of this year, Oleksiyenko said. Once completed, that would enable Naftogaz to handle purchases from the EU efficiently.
He said that a market response to tariff reforms effort might be visible this summer. “It’s not ideal for Naftogaz, but it is better than last year’s situation. We are going in the right direction for a stable tariff system.”
“We must also improve domestic production. There is a huge reserve that can contribute to national energy market stability. We see that the reserves are there and that they can be explored, but this requires investment in production technology, efforts from the private sector and other things – and so this also is a work in progress.”