THE REFORM OF UKRAINE'S ENERGY COMPLEX

AS A PRECONDITION OF ELIMINATING

UKRAINE'S ENERGY DEPENDENCE

Only 16 per cent of Ukraine's gas and 13 per cent of its oil is produced domestically and more than half of Ukraine's imports consist of energy.[i]
Most of energy imports originate in Russia. This energy dependence upon Russia and problems to pay for energy deliveries is perceived as a big threat to Ukraine's sovereignty. Unauthorised siphoning of gas destined for Western Europe urged Russian Gazprom to start negotiations about a gas pipeline bypassing Ukraine. This would bereave Ukraine of a major source of income, i.e. between one quarter and one third of its domestic gas consumption.

Ukraine's energy dependence upon Russia and security threats involved are investigated in this contribution.

It is argued that with a reform of the energy economy, energy dependence would be very limited. The level of energy dependence is, among others, dependent upon the levels of domestic energy consumption and production. Energy consumption is very high due to lack of incentives to economize on energy consumption. Domestic energy production could be more efficient and much more cheaper if proper incentives would be in place. The payments crisis and the parasitic role of energy traders constitute the root of the current energy crisis. The obstacles that prevent a reform of the energy economy are the same that prevent Ukraine reducing its energy dependence.

First problems of energy consumption, trade in energy and the energy payments crisis are analysed. Subsequently domestic energy production is looked at. Then the results of the reform of the energy sector of the Yushchenko government are dealt with. Finally, energy imports and energy dependence upon Russia are analysed.

1. Wastage of energy

In Soviet times, enterprises and households did not have any incentive to economise on energy consumption. All houses had central heating and costs of heating were included in the very low fixed rent. Enterprises consumed huge amounts of energy that was delivered for a very low price because the Soviet Union had enormous amounts of energy reserves. Moreover, all enterprises were faced with soft budget constraints: the state would automatically cover losses. It made the Soviet Union one of the most energy intensive economies in the world.

After the independence of Ukraine the situation changed. Ukraine imported more than half of the energy it consumed and soon Ukraine had to pay the world market price for the oil and gas that was mainly delivered by Russia. In three years time the price went up from approximately 15 per cent of the world market price to the world market level. Although not all delivered energy was paid for (Russia continued to subsidise Ukraine although regularly cutting of supplies) and Ukraine started to indebt itself, the change-over had an enormous impact upon the economic situation in Ukraine. It contributed to the economic collapse (a 65 per cent production decline from 1991-1996) and partly explains why Ukraine was performing so much worse compared to Russia.

Although Ukraine had to pay much more for the energy it consumed, the wasteful attitude of households and enterprises towards energy use hardly changed. Households still generally do not have thermo-regulators and do not have individual gas meters.

Although households had to pay more for the energy they consumed they were not given the means to diminish energy consumption.[ii]
The local energy providers reacted upon lack of energy resources by switching on the heating later in winter and switch it off earlier in springtime. As far as cut-offs occurred, they were usually arbitrary and often not directly related to non-payment.

Enterprises had to pay more for energy but the budget constraints of big state owned enterprises and many privatised enterprises remained rather soft and non-payment of the energy bill often did not result in cutting off of energy. In 2000, 13 000 debtor companies continued to receive energy. On the other hand, new private enterprises had incentives to take energy saving measures.

The industrial structure of Ukraine changed. The share of energy intensive industries like heavy metallurgy and chemical industry increased. Heavy metallurgy as a share of total industrial production increased from 14.4 per cent in 1990 to 26 per cent in 1999, mainly as a result of increased exports. Thirteen per cent of total gas consumption is by heavy metallurgy and 11.3 per cent by chemical industry.[iii]
The energy intensity of heavy metallurgy is such that if costs of energy would be reflected in the export product, it would not be competitive. Most steel enterprises produce steel in open-hearth furnaces (Martin ovens) that are already several decades ago abandoned in the Western world. Therefore Ukrainian steel enterprises use up to 60 per cent more energy as their foreign competitors. However, steel enterprises do not pay for all the energy they use. This is the reason that Ukrainian steel exported abroad is often faced with anti-dumping procedures.

Although Ukrainian steel enterprises often managed to make some profit, revenues are hardly used for new investments, among others in energy saving measures.

During the 1990s Ukraine became the most energy inefficient country in the world.[iv]
International comparison of GNP per kg oil equivalent (US dollars) shows that Ukraine produced in 1996 only 0.5 dollars per kg/oil equivalent, while it was 3.0 dollars for South Korea, 5.4 for the Netherlands and 7.0 for Germany.[v]

Little has been done hitherto to reduce the energy intensity of production. President Kuchma complained that there is no governmental activity in the sphere of energy conservation.[vi]
With a more efficient use of electricity, 20-25 per cent could be saved on the electricity bill, according to the Energy Center of the European Union, 40 per cent according to the Energy Research Institute of the Ukrainian Academy of Sciences.[vii]
Yet, energy intensity of industrial production has increased during the 1990s, because generally, decline of power consumption has been less than the general decline of industrial production. In 1994, electric power use per unit GDP was 4-4.5 times higher in Ukraine than in Western Europe. This ratio was 2.5-3 times in the 1980s.

Nowadays, Ukraine surpasses virtually all Western European countries in per capita electric power consumption.[viii]
Ukraine, with 49 million inhabitants, burns the same amount of gas as affluent Germany with 80 million inhabitants.

According to O. Khraban, of the Danish energy-technology firm Danfoss, ‘the potential market for energy saving technology is huge, but the real market is much smaller, mostly because there is little awareness of the problem
.’[ix]
There is also the misconception that energy saving technology is expensive.

Some energy conservation projects clearly show the problem. With the help of a USA agency a school in Lviv insulated windows and accomplished herewith 43 per cent energy savings. Also a new heating control system was installed. Before the upgrade has been made, the school paid 900 000 hryvnas monthly for energy, while two years after the work has been completed the school pays 544 000 hryvnas monthly. The costs of the works were 29 000 dollars. Two years after completion Lviv got 10 000 dollars back and is saving 5000 dollars a year.[x]

Unfortunately, very few institutions followed this example. For example, hospitals still spend on average 20 to 30 per cent of their budget for heating, while economizing on energy could free money for salaries and equipment.[xi]

2. Energy payments crisis

Energy trade is one of the most profitable business in Ukraine, despite the fact that there is a payments crisis in the energy sector. Official statistics about the financial situation in the energy sector are not reliable because most actors involved are opposed to transparency. In many ways tax-authorities are cheated. The fact that large part of energy is traded in barter deals makes energy trade very opaque. Barter gives ample opportunities to siphon of profits and hide revenues for tax authorities. This situation is further complicated by the fact that energy traders often get the exclusive right to provide energy to designated enterprises. This gives them the opportunity to squeeze these enterprises, usually with the collaboration of these manufacturing enterprises.

For example, a steel enterprise buys gas from a trader that is imposed upon the enterprise by political authorities. The trader delivers the gas for a high price and receives in exchange, apart from a small amount of cash, the larger part in the form of undervalued steel. On paper, the steel enterprise pays only for part of the delivered energy. The energy trader sells the undervalued steel for a low price to an off shore steel trader, owned by the energy trader. Subsequently the offshore company makes big profits selling the undervalued steel for the world market price abroad.

On paper, both the steel enterprise and the energy trader are making losses with this deal. On paper, the energy trader receives only payments for part of the delivered gas. The steel enterprise becomes indebted with the energy trader.

In many cases, steel enterprises are loss making (on paper) and receive direct or indirect subsidies from the state. Energy traders are often on paper also loss making and do not pay for all energy delivered by energy producers. Often, the state jumps in and subsidises the energy traders and energy producers. Energy traders often bought from energy producers energy on loans, guaranteed by the state. When the energy trader failed to pay, the state paid back the loan.

Independent energy traders can buy cheap gas, for example by paying immediately in cash and bypassing Gazprom. According to Yulia Timoshenko, in such a case gas could be bought for 25-30 dollars per 1000 m3, while Ukraine buys gas from Gazprom for 80 dollars in barter deals. Itera, the Russian/Ukrainian joint venture can, according to her, sell gas at 60 dollars per 1000 m3. The advantage of paying by cash gives the small private traders enormous profits. [xii]

The whole set up favours the energy traders, not the energy producers. As President Kuchma said in early 2000: 'By getting hold of and monopolising the (energy) market, countless intermediaries are making super-profits, looting energy facilities and enterprises.'[xiii]
Unfortunately, the president himself helped to create such a situation.[xiv]
The energy producers are all state owned, therefore the state pays here the bill. Despite the fact that energy traders are the winners in the equation, they do not invest in the energy transportation infrastructure, because non-reported profits are channelled abroad. The deteriorating state of the electricity grid generates each year more power outages. Gas leakage increases each year due to bad maintenance of the pipeline system.

Government placed a lot of enterprises and institutions on a list of entities that can not be disconnected from the energy grid under any circumstances. Among these are the most chronic non-payers of energy. This further aggravates the payments crisis.

3. Energy production

Almost half of the energy Ukraine consumes is produced domestically. Almost all consumed coal is produced in Ukraine. An important asset is the nuclear power stations that produce almost half of the electricity consumed in Ukraine.

Of all Ukrainian energy needs, 26 per cent are accounted for by oil, 35 per cent by gas, 34 per cent by coal and 4 per cent by nuclear power and hydroelectric power. [xv]

The output of coal, the major part mined in South-Eastern Ukraine, declined from 216 million tons in 1975, to 189 million tons in 1985, 165 million tons in 1990, 84 million tons in 1995 and 81 million tons in 1999. Since the independence of Ukraine, 1991, coal production declined by more than half while employment dropped by more than one third. While the coal industry employed 650 000 employees in 1995, the beginning of restructuring, it counted 410 200 employees in January 2000.[xvi]

Table 1 Energy production in Ukraine

1990 1995 1999

coal (million tons) 165 83.8 81.7

electric energy (kWh) 298 194 172

gas (m3) 28.1 18.2 18.1

oil (million tonnes) 5.3 4.1 3.8

Source: Ukraine v Tsifrax 1999, p. 65

The loss making coal mining sector is still for the larger part not privatized and receives large direct and indirect subsidies.[xvii]
Coal mines are being kept afloat that produce coal twice the world market price while conditions for coal mining are deteriorating, given the prospect of even more expensive coal in the future.

The easily available coal had been extracted so that what remained lay in thin and sloping seems, often more than 1200 meters deep with each passing year average depth of the coal faces increased by 10-15 meters. Quality of coal was declining. Mining technology is very primitive: 75 per cent of all jobs in the mines are done manually (from the mid-seventies onwards investments in coal mining were channeled to other regions than South Eastern Ukraine). One third of the mines is more than 50 years old, and some date of the 19th century. Many key pieces of equipment, including one third of the ropes hauling the mine elevators, are well beyond their service time.[xviii]

Miners found themselves in a downward spiral of declining rates of productivity and investment leading to the increasing hazards of their work. In 1998 every thousand tons of coal cost the lives of four miners.[xix]

The United Kingdom produces with only 3.8 per cent of miners 57.9 per cent of coal produced in Ukraine. Labor productivity of American miners is 58.7 times as high as that of Ukrainian miners. Here we do not take into account the fact that on average, Ukrainian coal contains 4000-5000 kcal/kg, while internationally, 7000 kcal/kg is usual.[xx]

On average, in Ukraine production costs of coal are 40 dollars per ton compared with a world price of 35 dollars a ton, requiring huge government subsidies. According to the former minister of coal industry, Mr Tulub, coal enterprises owed late 1998 8.5 billion hryvnas to creditors and 63 per cent of mines were operating at extreme losses.[xxi]

Support by the state is provided to cover 'accounting losses' which equals to 'profit on paper', reduced by the sum of operational losses. 'Profit on paper' is calculated by multiplying listed prices by the sales amount, provided by financial estimation. In fact, the real price of coal sold by the mines is much less than the listed price. That is why the mines which fulfil their production plan can not cover the operation costs, even when subsidized by the state.

Well functioning mines are punished by siphoning off profits while badly performing mines are rewarded with subsidies. In Donetsk, fifty per cent of mines, all loss making, produce only 15 per cent of coal output. These mines take, however, two thirds of all subsidies to the coal mining sector.[xxii]

A lot of (expensive) coal is consumed by electricity power stations. There the economic situation is disastrous as many clients, including industrial clients, do not pay, or have big payment arrears. In Ukraine as a whole, only 7 per cent of delivered electricity is paid in cash, half is paid in barter, and the rest is not paid for at all (1999).[xxiii]
Electricity tariffs are still below cost price. On top of that, government has denominated 645000 energy consumers as privileged energy payers. The government does not compensate the energy enterprises for these discounts.[xxiv]
As a result, electricity power stations do not pay for a large part of coal supplies.

Also, big state enterprises, like cokes and steel enterprises, consume a lot of coal that is only partially paid.

End 1998, 60 per cent of paid coals was paid in barter, down from 77.5 per cent in early 1997.[xxv]
In January/February 1999, just 20 per cent of coal sold to consumers was paid for using cash. This contributed to wage arrears.

Private middlemen selling coal, keep one third of the proceeds from coal sales, according to federal tax police.[xxvi]

In 1998 a middleman sold 6.3 million m3 gas to Krasnodonugol, a local mining company at a price of 88.7 dollars per 1000 m3. However, other suppliers sold for 66 dollars. Gas sold at auctions sold even lower. However, in 1998 Krasnodonugol shipped 33, 457 tons of coal to the middleman for a total amount of 564 722 dollars.[xxvii]

Another example: a fiscal report of government dated 1998, showed the case of a middleman who sold a piece of machinery to a mine six times the market price.[xxviii]

It means that the performance of coal mines is on paper worse than it would be in a situation of open competition. Of course, other factors are involved, such as hidden and open state subsidies, that makes an assessment of the performance of coal mines even more complicated. However, is it safe to say that with the elimination of corruption in the coal sector, many more coal mines would be profitable and less state subsidies would be needed.

An important mineral resource is the methane accumulated near coal seams. Estimates of reserves vary from 1 to 20 trillion cubic metres (depending on the depth of occurrence). The problem is that big investments are needed to extract methane. Foreign investors could do the job but are not interested due to bad investment climate in Ukraine.[xxix]

Ukrainian gas consumption was 90 billion m3 in 1999. 18 billion m3 was domestically produced. Within Ukraine the state owned company Naftogaz, founded in 1998 to unite all state oil and gas enterprises, is responsible for all gas and oil extraction. (5-96).

Early 1998, the gas price was 83 dollars for industrial consumers and 66 dollars for budgetary organizations and households. Von Hirschhausen calculated that under competitive conditions the price could be 40 per cent lower. One cost factor is the salaries of workers in the Ukrainian gas sector where employment is 20 to 30 times higher than in comparable market economies.[xxx]
By mid 2000, the gas market was divided among Naftogaz and 10 private firms who accounted for 80 per cent of gas turnover. All private firms depended heavily on government protection.[xxxi]
Naftogaz supplies a large part of gas consumed in Ukraine. However, only 34 per cent of gas is paid, 11 per cent is paid in cash.[xxxii]
As a result, Naftogaz accumulated huge debts with the government.

Ukraine has six oil refineries, four of which have halted production, due to insufficient supplies of oil. Only half of the rude oil is refined into benzene, diesel and other clean fuels while half of it is forwarded to thermal power stations for fuel. With modern refining methods 80 to 90 per cent of crude oil could be transformed into high quality fuels.[xxxiii]

About half of Ukraine’s electricity is provided by nuclear power stations. As all power stations, they are faced with non-payment of the energy bills. This resulted, among others, in non-payment of wages, lack of investment funds, lack of funds for maintenance and even non-payment of supplied fuels from Russia. The Ukrainian government sought to remedy the situation by designating the most liquid industrial enterprises as privileged customers of Enerhoatom, that is the umbrella organisation for all nuclear power stations in Ukraine. It was argued that in such a way, Enerhoatom could get cash payments for delivered energy and so generate the cash needed to buy fuel supplies in Russia.[xxxiv]
This drained liquid consumers from the thermal power stations.

However, Enerhoatom is still in big financial problems. This is partly related to corruption in Enerhoatom. Vice premier Timoshenko accused Enerhoatom of embezzlement.[xxxv]
A ministry's report calculated that 40 per cent of Enerhoatom's costs had nothing to do with the actual production of energy.[xxxvi]
Intermediary companies supplying nuclear fuel charge 30 per cent commission. Also, 23 per cent commission is charged for sending spent fuel to Russia. Also, Enerhoatom supplied electricity for 20 per cent of the market price.[xxxvii]
According to president Kuchma, Enerhoatom provided in 1999 intermediaries worth 1.5 billion hryvnas (approximately 300 million dollars) worth of electricity at a one third discount.[xxxviii]
Timoshenko accused Ukrainian Credit bank of squeezing Enerhoatom by levying an interest rate of 1 per cent a day for loans provided to Enerhoatom.[xxxix]
In 1999, Enerhoatom recorded a 1.4 billion hryvnas loss that was covered by the state.

The situation in thermal power stations is even worse. They are mostly built in the 1950s and 1960s and already passed their anticipated service life. Operating expenses are very high.[xl]
Increasingly the electricity power stations are overloaded with the result that nuclear power stations are automatically switched off due to too low frequency in the electricity grid, As a result thermal power stations are even more overloaded and forced to cut off energy supplies to part of customers, especially in the countryside. In Kharkiv, the second town of Ukraine, electricity is cut off twice or three times a day.[xli]

A general problem with energy producers is that Ukraine depends on former Soviet republics, primarily Russia, for a range of electricity transforming and transmission equipment, units of refinery equipment, pumping stations and parts of nuclear reactors. The disruption of the Soviet division of labour affected the Ukrainian energy complex very much. For example, uranium is extracted in Ukraine, it is processed into fuel for nuclear power stations in Russia, then sent to Ukraine. Subsequently, the used fuel is again sent to Russia for processing.

The conclusion is that energy producers are squeezed by intermediaries and do not get incentives to invest. A reformed energy sector and better investment climate could lead to less subsidies and turning loss making energy companies into profitable ones. In some areas, like methane and nuclear power, production could be enhanced. To replace the nuclear power station Chernobyl, two new nuclear power stations will be finished, in Rivne and Khmelnytsky, with Western help.

4. Reform of the energy sector

It was mainly under the pressure of IMF, World Bank and other international financial donors, that the government under Prime Minister Victor Yushchenko embarked upon a reform of the energy sector in early 2000. Surprisingly, it was Yulia Timoshenko, head of United Energy Systems of Ukraine during 1995-1997, who became the vice prime minister responsible for energy. While being Prime Minister, Pavel Lazarenko gave United Energy Systems in 1996 monopoly rights and a tax break for five years. This gave the company and Lazarenko, who is now prosecuted in the United States for money laundering, hundreds of millions of dollars profit.

The energy sector reform was aimed at boosting cash receipts for the energy producers and distributors by forbidding barter trade and forcing the settlement of energy deals through special, government controlled accounts in the Oshchad bank. All consumers must deposit electricity payments into special accounts at Oshchad bank. Subsequently the cash is distributed among oblenergos and energy generators.[xlii]

The impact of these reforms is difficult to assess given contradictory information from government sources. When Timoshenko presented before parliament figures about payments in the energy sector, in October 2000, she told parliament that cash payments of energy consumers increased considerably since the onset of reforms. She claimed that tax authorities received much more in 2000 compared to 1999. However, these claims were denied by the tax authorities and a commission investigating these conflicting claims came to the conclusion that Timoshenko misinformed parliament. It was stated that payments to the budget from the side of actors in the energy consumers did not increase in 2000. Debt for electricity deliveries rose in 2000, according to tax authorities. [xliii]
The consumer debt to Naftogaz was up from 2.6 to 4.4 billion hryvnas in the first 9 months of 2000.[xliv]
Electricity supplied by state owned generators was only half paid in cash

Conflicting figures were, among others, based on the fact that Timoshenko allowed oblenergos to offset debts owed to energy providers with tax debts of these energy providers. The Cabinet of Ministers permits mutual settlements of government financed entities' energy debts.[xlv]
Also, government ordered Oshchad bank to provide government backed loans to oblenergos to allow them to pay for energy supplies. In this way, the payments record of oblenergos was artificially boosted. The World Bank expressed concern about this.[xlvi]

Moreover, Yevhen Marchuk, the director of the national security service, accused Yulya Timoshenko that she used credits of Oshchad bank to purchase expensive energy from offshore companies.[xlvii]

Oblenergos started to pay more to electricity providers, but do not collect any more from their customers.[xlviii]
With Lvivoblenergo. the collection rate increased from 60 to 70 per cent from 1999 to 2000. However, there are cash flow problems because of increased payments to the energy providers. Therefore, there is less money for salaries and basic supplies. Formerly, energy providers were paid with goods and promisory notes.

The energy producers profited from the energy reforms and received initially more cash that was used to pay wage arrears. The financial situation of coal mines improved. Cash payments for electricity supplied by state generators was 50 per cent paid for in cash during the first nine months of 2000, while it was only 19 per cent during the same period in 1999.[xlix]
Government figures show that, on paper at least, losses of coal mines gradually diminished over the first 10 months of 2000 and turned into profits in July and August. During the first three months approximately half of all payments was in cash, but this ratio declined subsequently to approximately 8 per cent in October 2000. The share of mutual settlement rose to 10-20 per cent during July-October 2000. The share of barter rose from approximately 50 per cent of all payments during the first three months of 2000 till approximately three quarters during August-October 2000.[l]

Also, it seems that households are paying more, The population paid 75 per cent of housing services in Jan-Sept 2000, while it was 48 per cent for the same period in 1999. However, in some oblasts, like Kharkiv, the collection rate went down.[li]

One part of the reform of the energy sector is the privatisation of oblenergos. Early 2000 six oblenergos have been privatised. However, the effect was that privatised oblenergos paid only 7 per cent of delivered electricity while state owned oblenergos paid 60 to 98 per cent (also with help of the government- see above).

Energorynok, that got the role of state owned electricity wholesaler and overseeer of the electricity market, profited from the new arrangement.

The ban on barter hit the energy traders who based their shadowy profitable deals on barter trade. Many members of parliament derived profits from energy trade and energy traders financed the re-election of president Leonid Kuchma. Therefore the energy reforms were under continuous attack and reform efforts were undermined by the state bureaucracy and parliament. Moreover, the judiciary failed to tackle corruption in the energy sector. Yulia Timoshenko complained that the general prosecutor failed to instigate criminal proceedings against embezzlement in the energy sector.[lii]

Generally, the situation in the energy sector continued to deteriorate, owing to insufficient liquidity and political disagreement. In autumn 2000, Ukrainian government had to resort to external borrowing to secure energy supplies. 100 million dollars was provided by the EBRD for the purchase of fossil fuels, while 300 million dollars was provided by the bank Credit Suisse First Boston. [liii]
Total debts of the fuel and energy sector increased during the first 9 months of 2000 by 1.1 billion hryvnas and totalled 13.6 billion hryvnas in October 2000. [liv]

Power outages are occurring more frequently, often blamed on bad weather. Large part of customers in Ukraine is regularly disconnected from the energy supply.

Although Timoshenko urges for enhancement of payment discipline, she said that she would not allow electricity cut offs to the population.[lv]
This may be related to the fact that households are not the worst offenders with respect to non-payments of energy. Nevertheless electricity cut offs occurred, for example in Kharkiv.

Also, 42 per cent of energy indebted enterprises continued to function.[lvi]

The position of the thermal power stations worsened as they were forced to pay more for coal deliveries. As a result, their payments for gas deliveries worsened. In September, Itera told that thermal power stations paid for only 27.4 per cent of the gas supplied.[lvii]

Nevertheless, Timoshenko claims that, due to more cash payments. 178 million dollars has been paid for fresh fuel for nuclear power stations, and half of the gas debt for Turkmenistan has been paid while the debt to Itera has been slashed by more than 40 per cent.[lviii]

Although the energy reform was half hearted and obstructed by many in the energy sector, oligarchs who made their fortunes with energy trade felt threatened and tried to undermine the position of the Yushchenko government and more in particular Yulia Timoshenko. Her husband has been arrested, being accused of embezzlement. Also, the Russian prosecutor opened a case against her involving bribes in dealing with Russian officials. This is noticeable as it happens so many years after the assumed bribing took place (1996). Some argue that Russia is not interested in energy reforms and market oriented reforms in Ukraine as this may allow Ukraine to turn to the West. The argument is that Russia can better deal with a non-reformed Ukraine.

The attempts to reform the energy sector show how deeply rooted vested interests are that profited from the non-reformed energy sector, based on barter trade.

5. Energy imports

During the 1990s, on average half of domestically consumed energy was imported and between 35 and 50 per cent of imports consisted of energy, mainly delivered by Russia.

During 1991-1994, Ukraine had great difficulties in paying for delivered oil and gas and Ukraine accumulated debts with Russia despite the fact that Russia continued to deliver gas and oil below world market prices and on favourable conditions. Nevertheless, Russia tried to use its leverage and linked energy deliveries to political demands, especially during 1993-1994 when interruptions of energy deliveries led to closures of enterprises and schools. October 1993, the energy crisis had forced the closure of half of Kyiv's industrial enterprises. Through the winter of 1993-4, most public buildings were not heated, most streetlights were turned out and Ukrainian television began operating on a reduced schedule in order to conserve energy. [lix]

In the early 1990s, Ukrainian government put priority in developing coal mining and nuclear power in order to diminish energy dependence.

Ukrainians decided not to give in to Russia's demands and refused, among others, the hand over of a majority stake in the transit gas pipeline. From mid 1994 the situation began to stabilise and Western lending to Ukraine helped Ukraine in paying its energy bill. Especially the USA realised that Ukrainian independence was at stake. In the meantime, Russia enhanced further the price of delivered gas. The average price of Russian gas increased from 45.2 dollars per 1000 cubic metres in 1993 to 80 dollars per 1000 cubic metres in 1996.

Ukraine did not react by reforming the energy sector and despite Western assistance, difficulties arose around securing energy supplies from Russia, although Russia was pressed by the West to be lenient towards Ukraine. Russia accepted barter arrangements that were not always favourable for Russia.

Gazprom accepted in 1994 and 1995 settlement of gas debts worth 1.4 million dollars with the delivery of paper.[lx]
Later, gas was delivered in exchange for eleven strategic bombers and food. Payment arrears were accepted.

The fee Russia paid for the transit of Russian gas had declined since 1996 to offset a drop in gas import prices.[lxi]
Ukrainian service surplus in 1999 had fallen by more than 50 per cent since 1996.

Since the advent of president Vladimir Putin, in December 1999, Russia became less lenient towards Ukraine and demanded higher prices for delivered gas. Prompt cash payment was expected. Also, a value added tax was levied on the export of oil and gas (a 30 per cent excise duty on gas, per 1 June 2000). Russia protested against the unauthorised siphoning of gas. Russian vice prime minister Viktor Khryshenko complained about the fact that 'Russia practically subsidises Ukrainian industry'.[lxii]

According to media reports in March 2000, Russia proposed in the negotiations about settling the outstanding gas debts, to offset debts with stakes in strategic Ukrainian enterprises. According to the Eastern Economist, Russian vice prime minister Kasyanov handed over a list with Ukrainian enterprises.[lxiii]
In December 2000, this issue surfaced again.

It became more difficult to negotiate a settlement about gas deliveries with Russia. The main negotiator in 2000 was Yulia Timoshenko. United Energy Systems, that she headed in 1995-97, had an outstanding debt with Gazprom worth 334 million dollars. As a minister, Timoshenko tried to settle this debt.

From 1999 onwards, Ukraine siphoned of large quantities of gas destined for Central, Western Europe and Turkey. According to President Kuchma, during the first nine months of 2000, 700 million m3 have been stolen [lxiv]
It caused great problems. Altogether, for 1.4 billion dollars worth of gas was siphoned of in 1999.

For example, in 1999, Turkey got 40 per cent less gas from Russia than foreseen. Three big power stations had to stop working and big industrial enterprises had to interrupt production. Turkey protested with the Ukrainian government.[lxv]

At the same time, Ukraine continued to re-export gas. In 1999, 8.5 of Ukraine's exports consisted of fuels. Ukraine Russia protested against this re-export (17 November 2000).

Ukrainian government was unable to prevent the unauthorised siphoning of gas by Naftogaz, despite the fact that Itera, an Ukrainian-Russian joint venture, got the exclusive right to buy gas from Gazprom. Ukraine reached an agreement with Russia that siphoned of gas would automatically be added to the state debt of Ukraine.[lxvi]

Ukraine responded to Russia's demands by trying to diversify gas and oil deliveries. This was difficult because earlier Ukraine failed to pay for gas from Turkmenistan. May 1999 Turkmenistan halted gas deliveries to Ukraine due to non-payment of gas worth 315 million dollars. Mid 2000, President Kuchma secured a gas deal with Turkmenistan, to be delivered through a gas pipeline passing Russia. Under this deal, former gas debts were settled and new gas would be delivered by immediate payment in cash, goods and investment projects, through Naftogaz. (40 per cent in cash, 60 per cent in goods and investments).[lxvii]

In December 2000 it has been agreed in Minsk that in 2001 30 billion cubic metres of gas will be provided by Russia (including gas delivered as transit fee) and another 30 billion cubic metres by Turkmenistan. Turkmenistan is interested in joining the GUUAM group, consisting of a group of CIS states that want to distance from Russia (Georgia, Azerbaizjan, Moldova, Ukraine, Turkmenistan). On the other hand, Russia founded recently the Eurasian Economic Community, consisting of Russia, Belarus, Kazachstan, Kyrgysistan and Tajikistan.

Russia responded to the continuing stealing of gas by Ukraine by proposing a gas pipeline through Belarus, bypassing Ukraine. Re-routing gas supplies to Western Europe through Belarus would deprive Ukraine of transit fees, worth one third of the natural gas consumed by Ukraine. It would it also make easier to cut gas supplies to Ukraine all together. Nowadays this is very difficult given the fact that gas destined for customers in Western Europe has to go through Ukrainian pipelines.

Ukraine reckons with the co-operation of Poland that is interested in diminished Russian influence in Central Europe. However, also Poland suffered from the stealing of gas by Ukraine, destined for Poland. The European Union expects a doubling of gas imports from Russia and EU firms are involved in plans for a new pipeline through Belarus. The pipeline could be laid within two years. It means that within two years Ukraine could be faced with a loss of transit fee worth 18 billion cu m3 annually.

Hitherto, it seems that Russia has not been able to use its leverage with respect to energy dependence of Ukraine adequately. Ukraine did not concede to Russia's demands with respect to handing over shares in the transit pipeline, improved payments discipline and the Russian wish to acquire major stakes in strategic Ukrainian enterprises. However, it seems that with the new gas pipeline bypassing Ukraine, the Russian leverage may increase significantly.

Ukraine pretends to be at the crossroads of Europe. However, increasingly transporters try to avoid Ukraine. The Odessa-Brody oil pipeline that would connect the Black Sea with Poland was for 85 per cent ready in 1996 but was never finished due to lack of funds. This is another missed opportunity. There appears to be no interest from the side of foreign investors. This makes it more difficult to diversify oil supplies. In 1999, almost all oil imports originated in Russia (8.5 million tonnes) and Kazachstan (1.37 million tonnes). [lxviii]

End 2000, energy reforms are obstructed by the presidential administration, state bureaucracy and major players in the energy market and, moreover, undermined by inconsistent government policies.

Conclusion

During ten years of regular reductions of energy supplies from Russia and continuous shortfalls of energy supplies, especially during winter time, Ukraine has done very little to promote energy conversation measures that could diminish energy dependence significantly and has done very little to reform the energy sector, that could free billions of hryvnas yearly.

The energy reform, embarked upon early 2000, was half hearted and failed to raise significantly collection rates of energy payments. It highlighted bottlenecks in the energy sector and deeply rooted vested interests that block energy reform.

Under President Putin, Russian attitude towards accumulating energy debts of Ukraine and non-authorised siphoning of gas by Ukraine became tougher. Diversification of energy supplies is rendered difficult by the bad payments record of Ukraine. This is making import prices of gas higher. Lack of reform in the energy sector will further undermine Ukrainian sovereignty while giving Russia more economic leverage.

Literature

Bojcun, M. (1999) The Ukrainian economy since independence.

Clover, C. (2000), 'Le Donbass: une йconomie de prйdation', Le courrier des pays de l'Est.
Nr 1002, February.

Cornelius,P.K.,Lenain,P. (Eds) (1997) Ukraine: Accelerating the Transition to Market
. Washington: IMF.

D'Anieri, P.J. (1999) Economic Interdependence in Ukrainian-Russian Relations
. Albany: State University of New York Press.

Hirschhausen, C. von, Lunina, I., Vachnenko, T. (1997) ‘Die Energiewirtschaft der Ukraine - Bestandsaufnahme und Reformbedarf zur Unternehmisierung’, in Hoffman, L. and Siedenberg, A., pp. 144-62.

Hirschhausen, C. von, (1999) ‘Gas Sector Restructuring in Ukraine: Analysis of Import Dependence, Price Formation and Socio-Economic Effects’ in Hoffmann, L. and Siedenberg, A., pp. 391-408.

Hoffman, L. and Siedenberg, A., (1999) Ukraine at the Crossroads.
(Berlin: Physica Verlag.

International Monetary Fund (1997), Ukraine - Recent Economic Developments.
Staff Country Report, no 97/109.October.

Ukraine u tsifrax u 1999 rotsi. (2000) Kyiv.

Zon, Hans van (2000) ‘The political economy of independent Ukraine’ MacMillan, UK.

Zon, Hans van; Batako, Andre; Kreslavska, Anna (1998), 'Social and Economic Change in Eastern Ukraine - the example of Zaporizhzhya’, Ashgate. UK.

Notes

[i]
During the first half of 2000, 50.2 of Ukraine imports consisted of fuels.

[ii]
Households pay a fixed amount for housing services related to the number of persons living in the house and the useful living space. For example, a household, with one adult and one pensioner, that owns a house that formerly belonged to Zaporozhstal in Zaporizhzhya and still profits from its housing services regime, with discount, with 31 square meters useful living space, pays for housing services (tax, electricity, gas, warm water and central heating) 37 hryvnas (approximately 7 dollars) per month. A household with two children, one adult and on top one pensioner with discount, with 66.4 square meters living space, pays 26.5 hryvnas a month for hot water and 38.5 hryvnas for central heating. On top of that 24 hryvnas is paid if 200 kWh electricity is consumer (payments for electricity varies between 24 and 48 hryvnas a month. (December 2000). It means that this family pays for energy between 89 and 113 hryvnas (between 17.8 and 20.5 dollars). It is obvious that in the first case mentioned amount, if paid, can not cover real costs of energy consumption. Still many houses fall under special housing services regimes. In the second case, when energy costs are based on commercial calculations, in most cases families can not pay the full bill.

An average household in the UK consumes 250 cub. m of gas a month, and pays for it 40 pounds, i.e. 58 dollars. Assuming the average consumption per household in Ukraine is also 250 m3, charging 80 dollars per 1000 cubic metres, means 20 dollars per month, i.e. 110 hryvnas.

[iii]
Energobiznes, Nr 34-35, 5 September 2000.

[iv]
EIU, Ukraine Country Report, October 2000, p. 29

[v]
World Development Report 1999/2000, p. 249.

[vi]
The Day, 13 June 2000.

[vii]
Hirschhausen, C. von, et al, 1997, p. 159. According to the World Bank, the energy intensity of production in Ukraine was in 1995 even 0.2 dollar per kg oil equivalent.

[viii]
IMF, 1997, p.11.

[ix]
Kyiv Post, 28 March 1999.

[x]
Kyiv Post, 18 May 2000.

[xi]
IMF, April 1999, p. 19.

[xii]
Eastern Economist, 22 May 2000.

[xiii]
The Day, 22 February 2000.

[xiv]
The system of regionally based gas monopoly rights that Prime Minister Lazarenko created is still in place and protected by President Kuchma. Kuchma vetoed a law that would give rights to the accounting chamber to inspect budget revenues, so protecting the gas traders who suck the Ukrainian economy, giving nothing in return but allowing these traders to transfer huge sums on foreign bank accounts.(Financial Times, 27 October 2000)

[xv]
d'Anieri, 1999, p. 73.

[xvi]
Eastern Economist, 24 February 2000.

[xvii]
Subsidies to coal mining amounted in 1992 to 2.29 per cent of GDP, in 1993 3.36 per cent of GDP, in 1994 3.02 per cent, in 1995 0.66 per cent, in 1996 1.55 per cent, in 1997 2.01 per cent (Zerkalo Nedeli, 6 February 1999).

[xviii]
Kyiv Post, 28 March 1999.

[xix]
BBC/SWB, 5 January 1999.

[xx]
Hirschhausen, C. von, et al, 1997, p. 155.

[xxi]
Kyiv Post, 30 December 1998.

[xxii]
According to P. McInally, coal mining engineer working as consultant for TACIS in Donetsk. 30 January 1999.

[xxiii]
According to a report of the European Investment Bank, The Guardian, 17 February 1999. According to Kyiv Post 6 April 1999, 18 per cent of industrial enterprises pay their energy bill in cash. Only half of the delivered energy remained unpaid. According to BBC/SWB, FSU, 26 March 1999, during January-February 1999 power stations paid only 1.6 per cent of the value of coal consumed.

[xxiv]
In 1996, residential natural gas prices were at 77 per cent of international prices, residential coal prices at 85 per cent and industrial coal prices at 93 per cent (World Bank, 1996, Ukraine - The Real Economy and its Sectors; Kyiv).

[xxv]
BBC/SWB, FSU, 12 March 1999.

[xxvi]
Radio Free Europe, 3 June 1998.

[xxvii]
Golos Ukrainy, 11 February 2000

[xxviii]
Clover, C.,2000, p. 29.

[xxix]
Zerkalo Nedeli, 12 June 2000.

[xxx]
Hirschhausen, C. von, 1999, p. 404.

[xxxi]
Zerkalo Nedeli, 8 May 1999.

[xxxii]
EIU, Ukraine country report 1999, 4^th
quarter.

[xxxiii]
Bojcun, M. 1999.

[xxxiv]
The Day, 13 June 2000.

[xxxv]
Eastern Economist, 12 June 2000.

[xxxvi]
Kyiv Post, 17 February 2000.

[xxxvii]
Zerkalo Nedeli, 4 November 2000.

[xxxviii]
The Day, 22 February 2000.

[xxxix]
Kyiv Post, 22 June 2000.

[xl]
Radio Free Europe, 29 April 1998.

[xli]
Zerkalo Nedeli, 4 Augustus 2000.

[xlii]
Kyiv Post, 1 November 2000.

[xliii]
The Day, 17 October 2000.

[xliv]
Zerkalo Nedeli, 14 October 2000.

[xlv]
Kyiv Post, 22 November 2000.

[xlvi]
BBC, 3 November 2000.

[xlvii]
Kyiv Post, 6 November 2000.

[xlviii]
Kyiv Post, November 2000.

[xlix]
Kyiv Post, 16 October 2000.

[l]
Zerkalo Nedeli, 9 December 2000.

[li]
Zerkalo Nedeli, 20 May 2000.

[lii]
Radio Free Europe, 11 October 2000.

[liii]
EIU, Country Report Ukraine, October 2000, p. 26.

[liv]
The Day, 17 October 2000.

[lv]
Kyiv Post, 11 September 2000.

[lvi]
Zerkalo Nedeli, 10 June 2000.

[lvii]
Kyiv Post, 2 October 2000.

[lviii]
Kyiv Post, 16 October 2000.

[lix]
D'Anieri, 1999, p. 80.

[lx]
Kyiv Post, 17 November 2000.

[lxi]
EIU, Country Report Ukraine, October 2000, p. 31.

[lxii]
Eastern Economist, 6 June 2000.

[lxiii]
Eastern Economist, 24 February 2000.

[lxiv]
Radio Free Europe, 12 October 2000.

[lxv]
Zerkalo Nedeli, 14 October 2000.

[lxvi]
The Day, 21 November 2000.

[lxvii]
Kyiv Post, 4 October 2000.

[lxviii]
Zerkalo Nedeli, 14 October 2000.

Hans van Zon

School of Humanities and Social Sciences

University of Sunderland, UK

Contribution to the conference

'Geopolitical and Geoeconomical problems

of Russian-Ukrainian relations',

St Petersburg, 22-24 January 2001

Draft, 8 December 2000

Not for quotation