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: Date: November 23, 2015 Topic: Energy & Climate

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 by this author
 

Blog Post

An appropriate European Union response to tensions in the Eastern Mediterranean

If the European Union can mediate effectively to resolve current Greek-Turkish tensions over energy in the Eastern Mediterranean, it could also provide an opportunity to tackle more deep-rooted problems.

By: Michael Leigh Topic: Energy & Climate, Global Economics & Governance Date: August 28, 2020
Read article More on this topic
 

Blog Post

Ukraine: trade reorientation from Russia to the EU

Over the past five years conflict has led to a deterioration of Russo-Ukrainian economic relations while ties with the EU have been deepened. This shift is evident in trade flows: the European Union has become Ukraine’s biggest trading partner, while China is poised to overtake Russia as its second. Natural gas imports from Russia, Ukraine’s prior Achilles heel, have been partially replaced by reverse deliveries from the EU and reduced as result of reform of the gas sector.

By: Marek Dabrowski, Marta Domínguez-Jiménez and Georg Zachmann Topic: European Macroeconomics & Governance Date: July 13, 2020
Read article Download PDF More on this topic More by this author
 

External Publication

The impact of the global energy transition on MENA oil and gas producers

Endowed with half of the world's known oil and gas reserves, the Middle East and North Africa (MENA) region is cornerstone of the global energy architecture. This article argues that – together with the pressing need to create jobs opportunities for a large and youthful population – the possibility of the world moving more aggressively towards a low-carbon future should represent a key argument for the implementation of economic reform programmes.

By: Simone Tagliapietra Topic: Energy & Climate Date: August 5, 2019
Read article More on this topic More by this author
 

Podcast

Podcast

Deep Focus: Energy transition in the next EU institutional cycle

Bruegel fellow Simone Tagliapietra speaks to Sean Gibson in this instalment of 'The Sound of Economics', on the matter of the European energy transition and how the EU should proceed in the new institutional cycle.

By: The Sound of Economics Topic: Energy & Climate Date: July 10, 2019
Read article More on this topic More by this author
 

Podcast

Podcast

Backstage: Ukraine's economic and political outlook

In this episode of ‘The Sound of Economics’, Giuseppe Porcaro hosts Hlib Vyshlinsky, executive director of the Centre for Economic Strategy, and Bruegel fellow Marek Dabrowski to discuss what the new Ukrainian government should do to meet the challenges facing the country’s economy.

By: The Sound of Economics Topic: Global Economics & Governance Date: May 31, 2019
Read about event More on this topic
 

Past Event

Past Event

The Ukrainian economy: the way forward after a year of political turbulence

What can Ukraine do to foster economic growth? How can the EU and other international partners help Ukraine with this process?

Speakers: Olena Carbou, Marek Dabrowski, Elena Flores, Ivan Miklos and Hlib Vyshlinsky Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 28, 2019
Read article More on this topic More by this author
 

Podcast

Podcast

Deep Focus: Reforming and rejuvenating Russia’s economy

Bruegel fellow Marek Dabrowski talks to Sean Gibson about the underlying causes of Russia's slow emergence from economic crisis, in an episode of the Deep Focus podcast series.

By: The Sound of Economics Topic: Global Economics & Governance Date: May 9, 2019
Read article More on this topic More by this author
 

Opinion

An opportunity for natural gas in the eastern Mediterranean

After a decade of false starts, producers should grab the chance to co-operate as exporters.

By: Simone Tagliapietra Topic: Energy & Climate Date: March 12, 2019
Read article More on this topic More by this author
 

Opinion

The geopolitical implications of the global energy transition

Energy has traditionally played an important role in global geopolitics, contributing to the rise of great powers, the formation of alliances and, in many cases, also to the emergence of wars and conflicts. Every international order in modern history has been based on an energy resource. This piece discusses how the ongoing low-carbon energy transformation could reshape global geopolitics in the future.

By: Simone Tagliapietra Topic: Energy & Climate Date: March 7, 2019
Read article Download PDF More by this author
 

External Publication

A new strategy for EU-Turkey energy cooperation

Cooperation over energy and climate issues could be one of the components of the EU-Turkey Positive Agenda. Simone Tagliapietra proposes a new strategy for EU-Turkey energy cooperation, which envisions a shift of focus from gas and electricity to fields such as renewables and nuclear energy.

By: Simone Tagliapietra Topic: Energy & Climate, Global Economics & Governance Date: December 5, 2018
Read article Download PDF More on this topic More by this author
 

External Publication

The impact of global decarbonisation policies and technological improvements on oil and gas producing countries in the Middle East and North Africa

Simone Tagliapietra contributed to the IEMED Mediterranean Yearbook 2018 with a chapter on the impact of decarbonisation policies on oil and gas producing countries in the MENA region.

By: Simone Tagliapietra Topic: Energy & Climate Date: October 3, 2018
Read article Download PDF More on this topic More by this author
 

External Publication

LNG and Nord Stream 2 in the context of uncertain gas import demand from the EU

Georg Zachmann sees the development of import demand for natural gas in the EU as uncertain. In case of strongly increasing import demand, both Nord Stream 2 and liquified natural gas imports could contribute to ensure European supply.

By: Georg Zachmann Topic: Energy & Climate Date: September 27, 2018
Load more posts