Ukraine has a $1 billion plan to wean itself off Russian gas

PutinREUTERS/RIA Novosti/PoolEU Commision President Manuel Barroso (L) and Russian Prime Minister Vladimir Putin address reporters in Moscow February 6, 2009.

Ukraine announced plans to spend $US1 billion to build up a strategic gas reserve in order to reduce its reliance on fuel imports from Russia.

Prime Minister Arseniy Yatsenyuk said on Saturday that the country would borrow the money using government guarantees in order to shift the country to European suppliers of natural gas, according to The Moscow Times.

Gas imported from Russia accounted for 58% of Ukraine’s total consumption in 2013, while the country’s state-owned company Navtogaz also generates large revenues from fees it charges to transport Russian gas to Europe. In 2011 Navtogaz received transit fees equivalent to 1.9% of GDP.

The latest plan to diversify Ukraine’s energy supply comes following repeated threats by Moscow to recall a $US3 billion loan made to the previous administration in Kiev. Under the terms of the deal, former President Viktor Yanukovych committed to capping Ukraine’s national debt at 60% of GDP.

However, with the ongoing civil war in the east of the country and a stand-off between its two major trading blocs in Russia and the EU, its debt ballooned to around 72% of GDP in 2014 and could reach over 80% this year.

And now President Vladimir Putin wants his money back — by requiring the imiediate repayment of the $US3 billion loan.

Negotiations over gas deals have proven a source of continuous friction between Kiev and Moscow in recent years. In 2006 Gazprom, Russia’s state-owned gas company, cut off supplies to Ukraine in a row over accusations that Kiev was syphoning off gas destined for European markets to supply its domestic market. The move led to shortages in France, Italy, Germany and Poland.

And Gazprom turned off the taps again in 2009 over a dispute over non-payment of debts by its Ukrainian partners. The deal brokered between then Ukrainian Prime Minister Yulia Tymoshenko and Putin to get gas flowing again in the aftermath of that crisis would ultimately cost her a sentence of seven years in prison and a bill of $US200 million.

These gas standoffs have tended to occur during periods where there have been administrations in Kiev that lent towards Europe and away from Russia. Following the election of pro-Russian President Viktor Yanukoych in 2010, the Russian government had a sudden change of heart and decided to cut gas prices to the Ukraine by 30% in return for an extension of the lease on its Sevastopol naval base to 2042, at a cost of some $US40 billion in revenues over a decade.

Ukraine’s reliance on its neighbour for fuel offers the Kremlin a powerful political lever that it can pull whenever it deems necessary. As such, diversifying its domestic suppliers is a necessary, but not sufficient, step in achieving political independence from Moscow.

However, the other problem for Yatsenyuk’s government is the country’s ruinous gas subsidy for households. Prices in Ukraine are 4 to 9 times lower than in neighbouring gas-importing economies and almost half what they are in Russia, the region’s largest gas exporter. The subsidies are estimated to have cost the country around 7.5% of GDP in 2012 (and with the sharp contraction of GDP over the past year are likely taking up an even larger share of output now).

As the IMF puts it (emphasis added):

The policy is proving financially and economically unaffordable. It drains government finances, sustains energy over-consumption, dampens investment in delivery systems, and undermines incentives for domestic production expansion into gas reserves that could significantly reduce Ukraine’s need for gas imports.

These reforms are a key condition for the IMF continuing to extent financial support to the government in Kiev but they will also come at a political cost. Whether the government is strong enough to see them through where so many previous administrations have failed is likely crucial to its long term independence. At the moment, the jury is still out.

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