Ukraine and EU Energy Security
Viktor Yanukovych has taken steps to reform Ukraine's energy sector, and that may be good for Europe and bad for Russia.
Gas disputes between Ukraine and Russia have damaged the EU's energy security on three occasions over the past five years, most acutely in January 2009, when Russia cut supplies to Ukraine for two weeks. European governments had to scramble to find gas supplies to keep their people warm through a cold winter.
Brussels and other European capitals found the attitude of the then Ukrainian government opaque, unhelpful and infuriating. The election of Viktor Yanukovych as Ukraine's president in February has not eased Western commentators' concerns. Yanukovych's better relationship with Russia lowers the chances of bilateral gas disputes, but has created worries that Russia's leverage might increase.
The early signs, however, are that Yanukovych's government is intent on energy reform. Indeed, Yanukovych may do more to increase Ukraine's energy independence than any of his predecessors. His government's first major energy-related step has been to seek to end the multi-billion dollar dispute with the US firm Vanco over the seizure of drilling rights in the Black Sea. Negotiations are progressing.
The second step was to move away from the subsidised pricing system that made Ukraine one of the most inefficient users of gas in the world. The right to set prices and collect bills has been moved from local to central government; as a result, prices should rise and become more transparent.
Its third step was to become a full member of the EU's Energy Community. Adoption of EU rules on liberalisation should boost investment and encourage the Ukrainian energy sector to become more competitive and resilient.
Critics can argue that, to date, these changes are limited. They can also point to an amendment that effectively removes from production-sharing agreements (PSAs) a stabilisation clause fixing the rules for a PSA as those that applied at the time of the agreement. Without this stabilisation clause, no investor will risk signing a PSA.
However, a broader global trend should provide reformers with leverage: the surge in production of unconventional gas in the US has lowered demand for liquified natural gas (LNG), with the result that the spot price for LNG in Europe is now lower than the price for Russian gas at Germany's border.
Gazprom challenges
This is bad news for Russia's Gazprom – and the news will worsen. Commitments already made will increase global LNG production to 410 billion cubic metres (bcm) by 2013 (up from 240bcm in 2008). Russia's supplies to Europe could be challenged by the export of US unconventional gas to Europe (in the form of LNG) and the development of Europe's own shale-gas reserves (see Page 23). Gazprom is also facing depletion of some ‘super-giant' fields, forcing it to consider developing more difficult and expensive fields in Yamal. Gazprom will find itself delivering even pricier gas down expensive pipelines into an increasingly competitive European market.
Where is the risk to Ukraine? If Gazprom's market share erodes significantly, it may opt to supply gas via newer and better-maintained pipelines – Nordsteam (via the Baltic Sea) and Yamal I (via Belarus and Poland) – rather than through Ukraine's creaking network.
In such hostile market conditions, Ukraine is very likely to lose transit fees. Moreover, as Ukraine currently lacks alternatives to Russian gas, Gazprom might hike prices to relieve the pressure in more competitive markets.
With Ukraine facing the loss of transit fees, higher gas prices, and obligations to the Energy Community, reforming voices in the government have a better chance of being heeded.
The pressure to develop Ukraine's own oil and gas resources will also become intense. As well as generating revenue, developing its own fields would provide Ukraine with some political leverage over Moscow and Brussels.
Most EU officials would be happy enough if the Yanukovych administration merely ended Ukrainian-Russian gas disputes. Surprisingly, though, the prospects of something of greater benefit to Ukraine and the EU may be emerging: the possibility of Ukraine adding to the EU's energy security by developing its own energy resources.
Alan Riley is a professor of law at City University, London and an associate research fellow at the Centre for European Policy Studies in Brussels.