25th February 2014

Gas imports: Ukraine’s expensive addiction – a ‘cold-turkey’-strategy is even more difficult than it already sounds

by Georg Zachmann on 25th February 2014

This opinion was published by La Razón.

Ukraine is economically dependent on natural gas imports from Russia which accounted for about 8 percent of Ukrainian GDP in 2012. This unidirectional dependence allows Russia to rather arbitrarily set the price or demand for economic (and political) concessions. In the past, Ukraine was able to use its significant role as a transit country for Eurasian gas to Europe to, nevertheless, negotiate relatively moderate prices. But this role is vanishing. After the completion of the first two strings of Nord Stream about two-thirds of the exports to Europe could circumvent Ukraine. If either South Stream or the next two strings of Nord Stream are completed, Ukraine could be fully circumvented. The declining importance of Ukraine as a transit country as well as other factors allowed and encouraged Russia to move away from preferential pricing for Ukraine. Consequently, natural gas import prices from Russia to Ukraine increased from below 100 USD/tcm before 2005 to about 400 USD/tcm in 2013. This is more than Germany currently pays for Russian gas. In December 2013, however, Ukraine was granted a temporary price of 268.5 USD/tcm. Policy-makers and media are speculating about what promises Russia obtained in return for this discount that was granted shortly before Ukraine rejected to sign an Association Agreement with the European Union. As this – low – price is subject to quarterly renegotiations, it will only be granted as long as Ukraine behaves in line with Russian interest.

The vulnerability of Ukraine towards Russian gas could be drastically reduced if the heavily subsidised domestic gas prices were increased to market levels. This would encourage consumers to reduce consumption and help gas producers to invest in Ukraine – a country that is expected to hold enough gas resources to become a significant gas exporter. This would allow Ukraine to withstand the temptation of using political concessions to obtain lower gas prices from Russia. Rising prices from Russia in turn would make alternative import sources – such as gas imports from the EU (‘reverse flows’) – competitive, reducing the Ukrainian dependence further.

However, such a ‘cold-turkey’-strategy is even more difficult than it already sounds. Existing contracts oblige Ukraine to pay for massive amounts of Russian gas even if it does not use them, Gazprom does side-deals on cheap gas with influential Ukrainian businessmen and subsidised energy prices are seen as an important pillar of social policy in a country with an ill-functioning social security system.