Opinion

Helping Ukraine to reform Naftogaz’s gas transmission business

Reform of Ukraine’s gas sector is under threat. The European Bank for Reconstruction and Development should step in.

By: and Date: November 23, 2015 Topic: Green economy

kyivpostThis op-ed was originally published in the Kyiv Post. It will also be published in Vox Ukraine.

Naftogaz, the giant publically-owned Ukrainian oil and gas company with 80,000 employees, used to be a synonym for wastage, corruption and opacity. But it looks like it might have turned a corner. Thanks to a new management team, a fourfold increase in gas prices and the beginning of legal reforms, its losses in 2015 will be down to 3.1 percent of Ukraine’s GDP, from 5.5 percent in 2014, according to the International Monetary Fund. The impact on the deficit could fall to 0.2 percent in 2016, and Ukraine’s dependence on Russian gas has been markedly reduced.

But just as skies were clearing, new clouds appear. The reform of Naftogaz is stalling. Though they adopted a gas law in April,Ukraine’s politicians have not been able to agree a model for the unbundling of Naftogaz’s different business lines, or on which should be prepared for privatization. The risk is that if Naftogaz is not quickly and comprehensively reformed, the bad old habits of redistribution and political corruption will resurface. Because of the importance to Ukraine of Naftogaz, this could undermine the country’s association process with the European Union. In addition, the income from gas transit, from which Naftogaz currently earns about $2bn, might drop to zero should Russia’s Gazprom finalize its attempts to circumvent Ukraine’s gas transit system via the Nord Stream II pipeline.

The only sensible response to both challenges is to complete the reform of the regulatory framework and to fully unbundle Naftogaz. The gas transmission arm should become a fully independent business that is regulated like its peers in the EU and shielded from political control, in order to convince European suppliers that any new alternative to Ukrainian gas transit would be a waste of money. This is urgent, because uncertainties over gas transit through Ukraine are a pretext for Nord Stream II. And it is also crucial in the longer term, because the badly needed investment in Ukrainian gas production requires non-discriminatory access to the pipelines.

Unbundling the gas transmission business and freeing it from political control implies significant political cost for the oligarchs and politicians that will lose influence over the main Ukrainian rent-generating machine. Moreover, the benefits of reform will only accrue over time – but Ukraine places more value on income today than on future benefits. Furthermore, the obvious solution – privatising the gas-transit business and regulating it according to the EU rules that Ukraine has signed up to (the famous ‘third package’), is problematic. It is not feasible because an immediate privatisation will look like a sell-out of the country. No sensible western investor without political leverage in Ukraine would invest money and time in Naftogaz’s gas transmission business, only for their investment to be implicitly expropriated when the revenues start flowing. And the plan is not credible for transit customers, because there are strong incentives for future governments to use the regulatory tools at its disposal to extract economic or political rents from gas transit.

But there could be a solution. Ukraine could sell a share in its gas transmission business to a benevolent investor that has an interest in a prosperous Ukraine and stable gas transit. One candidate could be the European Bank for Reconstruction and Development (EBRD) which has built up expertise in Ukraine’s gas sector over two decades and has experience of pre-privatisation deals. From the perspective of the mainly European taxpayers that fund the EBRD, such a transaction is justified by self-interest. The EU would stabilise gas transit through Ukraine, enable gas sector reforms that are crucial for Ukraine’s political stability and might even extend its internal gas market to a country with significant gas storage and production potential.

To enable the deal, the Ukrainian government would have to commit to a regulatory framework enabling the EBRD to make profits if the gas transmission business is well managed. Based on this commitment, the EBRD could bring in western expertise and money to restructure the business. The aim of the operation would be full privatisation of the state and the EBRD shares some years down the road. The expected revenues when this final privatization step takes place would be a major incentive for the Ukrainian government to stick to its commitments to the EBRD.

Selling the gas transport system to a ‘foreign’ investor at a price that might appear low compared to private transactions of similar assets in the west could be unpopular in Ukraine, especially as household energy costs are set to rise. To address this concern, a fixed share of the profit that the EBRD makes when privatisation takes place would be returned to the Ukrainian budget. This would also increase the incentives for the Ukrainian government to develop a regulatory framework that increases the privatisation value of the gas transmission business.

 


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read article More on this topic More by this author
 

Blog Post

REPowerEU: will EU countries really make it work?

By acting together, the European Union can optimise its response to the energy crisis in all scenarios but each country will have to make concessions.

By: Simone Tagliapietra Topic: Green economy Date: May 18, 2022
Read article
 

Blog Post

The EU needs transparent oil data and enhanced coordination

The EU lacks the coordination structure and transparent data necessary to most effectively navigate an embargo on Russian oil.

By: Agata Łoskot-Strachota, Ben McWilliams and Georg Zachmann Topic: Global economy and trade, Green economy Date: May 16, 2022
Read article
 

Blog Post

Now is not the time to confiscate Russia’s central bank reserves

The idea of confiscating the Bank of Russia’s frozen reserves is attractive to some, but at this stage in the Ukraine conflict confiscation would be counterproductive and likely illegal.

By: Nicolas Véron and Joshua Kirschenbaum Topic: Banking and capital markets, Global economy and trade Date: May 16, 2022
Read article More on this topic
 

Opinion

For Europe, an oil embargo is not the way to go

Even at this late hour, the European Union should consider taking a different path.

By: Simone Tagliapietra, Guntram B. Wolff and Georg Zachmann Topic: Global economy and trade Date: May 9, 2022
Read article More on this topic
 

Opinion

A tariff on imports of fossil fuel from Russia

A tariff on imports of Russian fossil fuels would allow Europe to hit Russia's energy sector without great suffering.

By: Guntram B. Wolff and Georg Zachmann Topic: Global economy and trade Date: May 2, 2022
Read article More on this topic
 

External Publication

How to weaken Russian oil and gas strength

Letter published in Science.

By: Ricardo Hausmann, Agata Łoskot-Strachota, Axel Ockenfels, Ulrich Schetter, Simone Tagliapietra, Guntram B. Wolff and Georg Zachmann Topic: Global economy and trade Date: May 2, 2022
Read article More on this topic
 

Opinion

A phase out of Russian oil may be less effective than a tariff at reducing Putin’s rents

A punitive tariff on all energy imports from Russia would be a better choice than a gradually phased-in embargo on selected fuels.

By: Simone Tagliapietra, Guntram B. Wolff and Georg Zachmann Topic: Global economy and trade Date: May 2, 2022
Read article
 

Blog Post

How a European Union tariff on Russian oil can be designed

The European Union should apply a tariff on imports of Russian oil; it can be accompanied by a quota for a gradual, conditional phase-out of all Russian oil imports.

By: David Kleimann, Ben McWilliams and Georg Zachmann Topic: Global economy and trade, Green economy Date: April 29, 2022
Read article
 

Opinion

EU risks letting Putin’s gas divide-and-rule strategy win

The 2 May meeting of EU energy ministers should deliver strong and common EU action. Failing to do so would undermine Europe’s unity, energy security and foreign policy.

By: Agata Łoskot-Strachota, Simone Tagliapietra and Georg Zachmann Topic: Global economy and trade, Green economy Date: April 29, 2022
Read article More by this author
 

Opinion

Europe must get serious about cutting oil and gas use

As energy security risks increase, European governments must stop subsidising oil and gas, and ask people to consume less.

By: Simone Tagliapietra Topic: Global economy and trade, Green economy Date: April 29, 2022
Read article Download PDF
 

Policy Contribution

European governance

Fiscal support and monetary vigilance: economic policy implications of the Russia-Ukraine war for the European Union

Policymakers must think coherently about the joint implications of their actions, from sanctions on Russia to subsidies and transfers to their own citizens, and avoid taking measures that contradict each other. This is what we try to do in this Policy Contribution, focusing on the macroeconomic aspects of relevance for Europe.

By: Olivier Blanchard and Jean Pisani-Ferry Topic: European governance, Macroeconomic policy Date: April 29, 2022
Read article Download PDF
 

Working Paper

Cutting Putin’s energy rent: ‘smart sanctioning’ Russian oil and gas

The most efficient way for Europe to sanction Russian energy would not be an embargo, but the introduction of an import tariff that can be used flexibly to control the degree of economic pressure on Russia.

By: Ricardo Hausmann, Agata Łoskot-Strachota, Axel Ockenfels, Simone Tagliapietra, Ulrich Schetter, Guntram B. Wolff and Georg Zachmann Topic: Global economy and trade, Green economy Date: April 28, 2022
Load more posts