Tales from the American Aid Experience in Iraq and Pakistan

EWI President Cameron Munter draws on his experience as head of the Provincial Reconstruction Team (PRT) in Mosul, Iraq in 2006 and as ambassador of the United States to Pakistan in Islamabad in 2011 to reflect on lessons learned about the successful distribution of U.S. assistance. His work is part of a Brookings seminar on Reconstituting Local Orders and the Order From Chaos Project.   

Introduction to the paper: 

For more than a decade, government assistance to Afghanistan, Iraq, and Pakistan (the so-called AIP countries) has dominated United States aid efforts. And nowhere have the results of these billions of dollars of expenditure been so hard to measure and the impact of such effort so elusive. As the examples below illustrate, American institutions and mindsets found it extraordinarily difficult to adjust to aid in unsafe places.

For the U.S. government, the unusual experiences of the AIP countries may be an anomaly. If, as many hope, we are no longer involved in major conflicts or conflict areas in these ways, we may be able to go back to a less overheated, less politicized kind of assistance that may be quieter and more effective. But a note of caution: my United States Agency for International Development (USAID) friends who romanticize the old days when they were engineers and social workers out among foreign friends should remember that even the one-size-fits-all assistance of the 20th century was not always a big success. Therefore, it’s time for a very hard look at the way we organize assistance: it’s one thing to measure our commitment to a cause (peace in Sri Lanka or public health in Ghana) by how much we spend, and quite another to figure out how to do it right.

I draw on my experience as the head of the Provincial Reconstruction Team (PRT) in Mosul, Iraq in 2006 and as Ambassador of the U.S. to Pakistan in Islamabad in 2011. What follows is less a systematic assessment than a description of U.S. reconstruction and state-building, from which we may find lessons to consider in the future. Both of these experiences were, in a sense, “start-ups”: later work by PRTs throughout Iraq doubtless learned from our mistakes and misconceptions in 2006, and the final implementation of projects in Pakistan doubtless benefited from our experiences in the early days of Kerry-Lugar-Berman applications. But should we choose again to engage in major assistance projects in war zones, the process is certainly going to be difficult.

To read the entire paper on Brookings, click here

How Russia Can Make Nord Stream-2 Acceptable to the EU

EWI Senior Fellow Danila Bochkarev discusses possible ways the highly contested Nord Stream-2 could become legally acceptable for the EU. 

Roughly ten years ago Russia began reconsidering its energy transit policy. The Commonwealth of Independent States (CIS) summit in Kazan, Russia, in 2005 was an important turning point. An important policy shift — known as the “strategy of transit avoidance” — was implemented in order to directly link Russian oil and gas resources to Moscow’s major clients in Europe, bypassing potentially unstable transit countries in the former Soviet space.

In this context, a reduction in the natural gas transit via Ukraine became an issue of strategic importance for both the Kremlin and Gazprom, which consider Ukraine’s gas transmission system the weakest link in Russia’s gas supply chain. Naftogaz’s recent decision to breach its transit contract with Gazprom and to impose a 50 percent increase in transit fees for exporting Russian gas across its territory to Europe seems to confirm Gazprom’s suspicions. It undoubtedly further increases Moscow’s desire to build the Nord Stream 2 gas pipeline in order to circumvent Ukraine.

The decision to put the Turkish Stream gas pipeline on hold announced in early December 2015 further increases the strategic importance of Nord Stream 2 as the only new natural gas route circumventing Ukraine and shifting the transit fees into construction of the Nord Stream 2.

Should a new transit fee ($4.5/1000 cubic metres (cm)/100 km) be implemented by Naftogaz, Gazprom will have to pay over $50 per 1000 cm for the transit of its gas via Ukraine. The re-direction of these volumes to the Nord Stream 2, will allow Gazprom to save up to $2.75 billion per year in transit fees. From the CAPEX point of view, the Nord Stream 2 pipeline is an expensive undertaking, but the project’s OPEX will not be so high: the main compressor station in Russia can be fueled by cheap gas supplied at domestic prices.

Quite expensive

Apart from saving on (excessively) high transit fees, there is an additional economic rationale justifying investment in this otherwise quite expensive transportation project. Most of domestic gas supplies in the EU originate from the rapidly depleting fields situated in the United Kingdom and the Netherlands. UK gas production declined from 96.4 billion cubic metres (bcm) in 2004 to 36.6 bcm in 2014. Despite an unprecedented increase in UK natural gas production in 2015 – to an estimated 44 bcm – UK output is likely to significantly decrease in the nearest future.

During the same period, Netherlands’ gas output fell from 68.5 bcm to 55.8 bcm, mostly due to an earthquake–related production cap imposed on the Groningen gas field. Overall indigenous production in Europe (EU plus Norway) has decreased from 345.6 bcm in 2004 to estimated 258.8 bcm in 2015.

Natural gas from Nord Stream 2 could close the gap between gas supply and demand in the Northwest of Europe. Currency devaluation also had a positive impact on Gazprom’s lifting costs, thus increasing the competitiveness of Russian gas in Europe. Gazprom’s lifting cost (excluding MET) went down  from $17.7 per 1000 cm in 2014 to (estimated) $14.1 per 1000 cm in 2015.

These numbers allow Gazprom to easily compete with US Liquefied Natural Gas (LNG) supplies (expected in 2016) even with high transportation/taxation cost and at current pricing conditions in the U.S. (NYMEX at around $70–75/1000 cm and average LNG transportation costs at $35/1000 cm).

Bureaucratic hurdles

However, it must be noted that all is not so rosy for this trans-Baltic undersea pipeline. Economic crisis and low energy prices affect Gazprom and other consortium members’ ability to finance the construction of Nord Stream 2. Furthermore, economic sanctions imposed by the EU and the US on Moscow – although not directly aimed at Nord Stream 2 – affect the pipeline’s ability to raise long-term financing through debt capital markets, while funds are also becoming scarce in Russia.

In addition, the project might face a number of bureaucratic hurdles linked with its (in)compatibility with the EU 3rd Energy Package, while a number of new EU Member States have called upon Brussels to take action to ban the pipeline altogether.

In his article “Why Nordstream 2 risks failure”, published on Energy Post in December, Alan Riley mentions the fact that EU energy law might be also applied to the Baltic’s seabed. Professor Riley mentions the fact that the “European Court of Justice in Commission v. United Kingdom (case)  in discussing the application of the EU Habitats Directive, was clear that EU law applied with respect to territorial seas.”

Gazprom already faces similar problems with the full unrestricted access to the OPAL gas pipeline in Germany and the company is likely to face similar difficulties with both onshore and offshore segments of Nord Stream 2. Should this option become reality, Nord Stream 2 will be forced to keep 50% of its capacity reserved for non-Gazprom suppliers both in submarine offshore and onshore pipelines. Needless to say this will seriously undermine the commercial viability of the new pipeline.

Elegant solution

An elegant solution to this problem is one that requires less time and work than trying to get an exemption from the existing EU energy rules. Russia has already liberalized its LNG exports and no one prevents Moscow from allowing Russian independent gas producers to book 50% of the Nord Stream-2 transportation capacity.

Such a decision might become a win-win situation to all parties concerned: the project will be fully compatible with the EU Law; Gazprom will have its guaranteed share of gas supplies (minimum 27.5 bcm) and could also share the pipeline construction bill with Russian independent gas suppliers; the participation of non-Gazprom suppliers will allow Russia to export more Russian gas to Europe and consequently increase the Government’s revenues.

Last but not least: export liberalisation for Nord Stream 2 may also allow foreign buyers to purchase some volumes on Russia’s largest commodity exchange SPIMEX (St. Petersburg International Mercantile Exchange).  SPIMEX launched its first trading in natural gas in October 2014. Despite relatively small volumes – 8.2 bcm between Oct. 2014 and Dec. 2015 – SPIMEX already offers month- and day-ahead physical trading and plans to launch forward (for 2-6 month period) and futures (2-72 month period) trading in 2017-18. Thus by 2020, SPIMEX will transform itself into an important trading hub offering a fair price-setting mechanism for natural gas both in Europe and Russia.

Could this usher in the end of the endless discussion on the pricing of Russian gas?

To read this article on Energy Post, click here

Despite Commodities Boom Years, Mongolia Still Faces Capacity Gap

Speaking to World Politics Review, Jonathan Miller, EWI's China, East Asia and United States fellow, discusses Mongolia's challenges amid the current commodities slump and calls for diversification of their economy.

As a commodities-exporting country deeply linked to the Chinese market, Mongolia faces heightened risks from the current commodities slump and China’s economic slowdown. In an email interview, Jonathan Berkshire Miller, director of the Council on International Policy, discusses the impact of the commodities slump on Mongolia.

WPR: How important are commodities for Mongolia’s economy, and what effect have falling commodities prices had on public spending and, by consequence, political stability?
Jonathan Berkshire Miller: Commodities, and their prices, remain a critical valve for the Mongolian economy. After years of soaring economic growth, the Mongolian economy has precipitously cooled over the few past years with a sharp decline in GDP growth and a looming deficit of foreign direct investment (FDI). Indeed, Ulaanbaatar remains heavily dependent on the mining sector for its economic fortunes, which have been battered over the past three years due to the sinking price of coal as global supply outpaced demand. But while the demand for coal is once again slated to surpass supply in the coming years, Mongolia’s FDI numbers remain low. The fall in prices has impacted public spending on critical infrastructure and filling crucial capacity gaps.

In addition to these issues, the government is also struggling, under the brunt of decreased revenue, to keep up a steady flow of fuel subsidies to offset the cost of energy. Energy costs have an effect more broadly, but it is especially acute toward businesses and large consumers of energy in Mongolia. That said, the last budget, approved in November 2015, for the most part did not touch fuel subsidies and social welfare benefits. Going forward, however, it will be difficult for Ulaanbataar to maintain this position if growth continues to be limited. 

WPR: How effectively did Mongolia use the revenue windfalls of the commodities boom to develop infrastructure and address poverty and social welfare issues?
Miller: During its boom years, Mongolia did take significant efforts to develop its infrastructure, especially in the “key need” areas such as energy, water, transportation and telecommunications. The problem is that the need and capacity gap is so large that these efforts, spearheaded by both the private and public sector, remain insufficient. Infrastructure capacity remains poor in Mongolia, and while there have been improvements, universal access to water and especially electricity remains a distant goal. In addition to the lack of potable water supply, there are also major infrastructure issues with regard to access of adequate sewage collection and waste disposal. Ulaanbaatar similarly lacks the necessary infrastructure on railways and roads, critical for the transit of goods. The problem of transportation infrastructure needs to be addressed in order to facilitate commodity trade between Mongolia and its two neighbors, China and Russia. 

On social welfare issues, the government has a well-established system, but it has underperformed due to a poor targeting strategy. According to the World Bank’s most recent report, the poorest 20 percent of people in Mongolia received 34 percent of total social welfare transfers, while approximately 30 percent of the benefits were received by the richest two quintiles. This standard lags behind other countries in Central Asia and Europe. ?

WPR: What steps has Mongolia taken to diversify its economy, and how effective have they been?
Miller: Diversification of the Mongolian economy is desperately needed in order to reduce its exposure to commodity price shocks. While it will be impossible to eliminate this exposure, lessening the blow is achievable with more diversification. Right now, Mongolia remains highly vulnerable due to its export dependence. Mining continues to dominate the export sector and represents a large share of the Mongolian GDP. The government has been looking at diversifying and recognizes the need to skirt the “resource curse.” Some targeted areas have been effective, especially in sectors such as agriculture and tourism, which account for a combined 25 percent of Mongolia’s GDP. Ulaanbaatar should focus even more efforts on boosting tourism, especially as an eco-tourism location. On agriculture, there is a need for new capacity on biotechnology as well as for learning best practices from international companies. Diversification of its energy supply is another area of interest, with the question of potentially looking at nuclear power in the future.

To read this article on World Politics Review, click here.

Ukraine’s Energy Future Lies in Good Governance, Not in Diversification

In a piece for Russian International Affairs Council, EWI Senior Fellow Danila Bochkarev analyzes Ukraine's dependence on foreign sources of energy. 

Diversification at any cost is still perceived as a ‘silver bullet’ for Ukraine’s energy security. The country’s dependence on Gazprom is seen as the key challenge for ensuring the country’s national security. However, inefficiency, mismanagement, the selective application of reform packages, and war in its eastern regions are Ukraine’s biggest threats. Settling internal disputes in a way that guarantees respect for the legitimate interests of all social and political groups is therefore a clear “must.” Doing so will lay the foundation for successful energy reforms and transparent governance, thereby paving the way for future investments.

Ukraine’s dependence on foreign energy supplies is an issue of major concern for the current government and is perceived to be one of the key threats to the country’s national security. Attitudes toward this problem have remained the same before and after February 2014. In fact, virtually all of proposed diversification solutions – both under the Yanukovich and Poroshenko presidencies – have one element in common: an obsessive fixation on diversifying energy imports and shifting away from natural gas from Gazprom. Ukraine has already made several attempts, both successful and not, to find alternative sources of supply by building a physical reverse flow interconnector with Slovakia, mulling the re-gasification terminal option, and even exploring new alternative pipeline routes.

Alternative pipelines remain ‘pipe dreams’, while attempts to build a Liquefied Natural Gas (LNG) import terminal have so far been unsuccessful due to a number of significant logistical and supply challenges. Turkey will most likely veto the passage of LNG tankers via the Bosporus, and the cost of such deliveries will not permit Ukraine’s re-gasification terminal to compete with pipeline gas supplies from the EU and Russia.

In addition, the examples of Poland and Lithuania have shown that new LNG contracts - even with lower spot prices - are more expensive than traditional pipeline supplies. In November 2014, Reuters reported that Lithuania would pay at least 10% more for Norwegian LNG than for Russian pipeline gas in 2015. Norwegian LNG will cost almost $400 per 1,000 cubic meters, while Gazprom's shipments cost about $40 less.

Theoretically, Azeri LNG supplies might be a feasible commercial option but would require the construction of a liquefaction plant on the Georgia’s Black Sea coast and the commitment of gas reserves for supply to Ukraine. The future of this option is rather bleak, especially taking into account the current oversupply of competing pipeline projects focused on receiving Azerbaijani gas supplies.

Reverse flow – the only operational solution

Until now, only reverse flow options to Ukraine from the EU have been accessible and operational. According to Ukrtransgaz data, reverse flow shipments launched in 2012 accounted respectively for 2.13 billion cubic meters (bcm) in 2013 and 5.1 bcm in 2014 of gas supplies. In 2014, reverse flow supplies covered 12.7 % of Ukraine’s domestic gas consumption. The oversupply of natural gas in Europe led to competitive price offers for reverse flow shipments, especially when compared to the undiscounted price offered by Gazprom to Ukraine during the spring/summer period (April 1 to September 30, 2015). However, the fall of oil prices changed the overall price dynamics in the wider Europe - Gazprom’s price for Ukraine fell to $247/1000 cubic meters for the second quarter of 2015. This number offers a pricing advantage over reverse flow shipments from the EU.

Gazprom: too expensive for Ukraine?

Between 2010 and 2013, the price charged by Gazprom to Ukraine’s national energy company Naftogaz - considered by Kiev as excessive and unjust – was used as a main argument for diversification away from Russia. According to Ukraine’s State Statistics Committee data, Gazprom shipped 37.5 bcm in 2011, while billing Naftogaz $11.35 billion. Imports decreased to 33 bcm in 2012, falling a further 15.5% to 27.9 bcm in 2013. The cost of Russian gas imports reached respectively $10.2 billion in 2012 and $10.68 billion in 2013. This was a significant financial burden for Naftogaz; indeed, while supplies dropped by more than 25% between 2011 and 2013, the total amount paid to Gazprom decreased only by 5 %.

Inefficiency and mismanagement at the heart of the matter

Political turmoil, economic crisis, and armed conflict have led to a significant reduction in primary energy and natural gas consumption in Ukraine. In 2014, the country’s gas consumption fell from 50.3 bcm to 42.6 bcm, imports also decreased from 27.8 bcm in 2013 to 19.6 bcm in 2014, while imports of Russian gas fell to 14.5 bcm (2014). The bulk of Russian gas supplies – 13.93 bcm – was shipped in the first half of 2014 [1].

This sharp decrease in both consumption and imports was mostly due to the collapse of the country’s industrial sector (consumption fell from 20.06 bcm in 2013 to 15.7 bcm in 2014) and supply restrictions for district heating companies (consumption decreased from 8.29 bcm in 2013 to 7 bcm in 2014) and the residential sector (consumption reduced from 16.84 bcm in 2013 to 15.1 bcm in 2014). Ukraine’s natural gas import bill also dropped from $12 billion in 2013 to $8.8 billion in 2014. In 2014, total financial transfers from Naftogaz to Gazprom were only $7.2 billion, including $1.45 billion in debt payments for 2013 supplies, and a $1 billion pre-payment to Gazprom wired in December 2014 (also used for gas purchases in January 2015) [2].

The decrease of energy imports/domestic gas consumption and lower prices should have reduced the deficit of national energy company Naftogaz. In reality, the company’s losses increased from 17.96 billion UAH in 2013 ($2 billion) to 85.45 billion UAH ($7.59 billion) in 2014 [3]. Though non-payments and national currency devaluation have contributed to Naftogaz’ shortfall, they cannot explain the threefold increase in the company’s deficit. Residential gas prices went up 50% as of May 2014 and industrial consumers continued to pay market-based tariffs, higher than the average price of imported gas - all of which should have helped to alleviate the company’s deficit. In fact, Naftogaz’s relatively cheap domestic gas production (17.2 bcm in 2014) covered an essential part of socially significant consumption (residential and district heating – 22.1 bcm) and in 2014, a (partial) cross-subsidy was required only for 5.1 bcm. The transit of Russian gas via Ukraine – requiring the usage of natural gas as a fuel for compressor stations – was one of key sources of Ukrtransgaz’ (transportation subsidiary of Naftogaz) income. In 2014, transit of Gazprom gas to Europe generated 17.42 billion UAH ($1.5 billion) in profits.

According to various media reports, part of Ukraine’s deficit was due to mismanagement of production and gas flows. For example, in December 2014, the Ukrainian national weekly ZN.UA published the summary conclusions of the Audit Chamber of Ukraine. The report claimed that between 2011 and 2014, some 2 billion cubic meters per annum (bcma) produced by Ukrnafta – an upstream subsidiary of Naftogaz – were sold to private entities at the highly discounted price of $15 - $26/1000 cubic metres, representing only a fraction of Ukraine’s industrial tariffs. Naftogaz was forced to source these volumes abroad by paying on average $700 million per year. It is estimated that at least 3 bcm of gas produced by Naftogaz and its subsidiaries do not reach intended customers in the residential/heating sector.

Mismanagement in the state-owned company is combined with the over-taxation of the private (‘independent’) gas producers. Ukraine’s 'independents' are an important domestic source of natural gas supplies. Ukraine produced 20.5 bcm of gas in 2014, down 1.0 bcm when compared to 2013. Private producers, however, increased their output by 18 % to 3.3 bcm. ‘Independents’ holding 100 bcm of proved gas reserves could in theory quickly increase their production to 5-6 bcm/year [4].

While the Ukrainian leadership took some steps to show its commitment to reforms – such as adopting the Third Energy Package compliant gas market law (Law N. 2250) and thus breaking Naftogaz’s monopoly – Kiev has still a long way to go. However, further steps towards reform should be coherent with a general fiscal and energy policy. New laws should also be efficient in practice and not only on paper. For example, while adopting market liberalization reforms in theory, the Ukrainian government often chooses a different path in practice, for instance, by sharply increasing gas taxation for private producers in December 2014. The new fiscal regime clearly favors the license–holder of the large fields (e.g. Naftogaz) over smaller private enterprises and risks undermining both the growth of “independents” and the liberalization of Ukraine’s gas market. Subsoil fees (the equivalent of royalties) jumped from 28% to 55% for shallow fields (above 5,000 m) and from 15% to 28% for deep fields (below 5,000 m). New taxation might kill the goose that laid the golden eggs and undermine the prospects for domestic natural gas production.

Energy efficiency is another area where Ukraine is lagging behind both its eastern and western neighbors. Ukraine's energy-saving potential could be as much as 40% - 50% of its current energy consumption. According to the World Energy Council, energy consumption within Ukraine's GDP reached 0.47 million British thermal units (Btu) last year, three and a half times higher than the average for countries in the Organization for Economic Cooperation and Development (OECD). While some energy-saving and energy-efficiency measures were implemented by previous governments, the introduction of such policies were effectively blocked by lobbies of domestic energy intensive industries. In 2008-2013, the energy intensity of Ukraine's GDPdecreased only by 3.5% - a meager result even if compared to rather modest progress made by neighboring Russia and Belarus. Energy-efficiency measures are particularly cheap to implement in Ukraine. In 2000 - 2013, per unit energy consumption of the Russian economy decreased by 34%, 5 % alone in 2011 - 2013 [5].

A stable and competitive regulatory regime, coupled with internal political stability, can pave the way for an expansion of durable and stable domestic energy supplies in Ukraine. Yet energy reform is not merely a function of relevant policy measures – it also depends on internal peace and stability in Ukraine. The loss of Crimea has not impacted Ukraine’s energy system, but the expansion of hostilities in Donbass – Ukraine’s industrial heartland - could lead to a full-scale nationwide energy catastrophe. There is a high risk that if unrest continues, it will spread from the industrial regions to the energy heart of Ukraine – to Dnepropetrovsk, Kharkov and Poltava regions. It is important to note that 80% of Ukraine’s natural gas output is extracted in Poltava and Kharkov regions. Only the peaceful resolution of internal tensions, taking into account the interests of all regions and parties, will help to revive Ukraine’s economy and its energy sector.

From a purely commercial prospective, energy cooperation between Russia and Ukraine make perfect sense, especially taking into account the remaining economic interdependence between the two countries. For example, despite a political crisis nuclear energy ties between the two countries remain strong. In 2014, Ukraine bought nuclear fuel for $628.176 million. An essential part - worth $588.831 million – came from Russia. The cooperation persists despite (often unconstructive) interference of politics in the business processes.

The future of gas cooperation is more uncertain and heavily depends on the position of Ukrainian government. From a purely rational economic point of view, cooperation with Gazprom – especially in the time of low prices – is commercially viable and outcompetes all available or planned diversification options. However, politics in nowadays Ukraine interferes with business and not always in a positive way. Leaders in Ukraine’s business and civil society should prevent politicians from going down the ‘blind alley’ of threat scenarios and concentrate on a de-politicized energy dialogue between the two countries on a technical and business level.

To read this article at the Russian International Affairs Council, click here.

1. Natogaz & Ukrtransgaz data.

2. Author’s estimates based on Gazprom and Naftogaz statistics.

3. Naftogaz’ corporate data.

4. Estimates provided by Philip Vorobyov, commercial executive at JKX Oil & Gas, an important Ukranian ‘independent’ gas producer.

5. Data provided by Sergey Abyshev Deputy Head, Office for Administrative and Legal Affairs, Ministry of Energy of the Russian Federation. Quoted in “Energoemkost’ VVP RF za 13 let snizilas’ na 34 %”, Neft Rossii, December 4, 2014.

2014 Annual Report

The EastWest Institute is proud to release its 2014 Annual Report, highlighting the actions we took and progress we made addressing tough challenges during a year when the world become more complex and dangerous. As EWI celebrates its 35th anniversary and we begin a new chapter in our history, we carry on delivering the enduring value our late founder John Edwin Mroz created and championed. 

We recommit ourselves to reducing international conflict, taking on seemingly intractable problems that threaten world security and stability. Remaining resolutely independent, we continue to forge new connections and build trust among global leaders and influencers, help create practical new ideas and take action through our network of global decision-makers.

Transparent Regulation and Fair Play Rules are the Only Salvation for Ukraine’s Energy Sector

EWI Fellow Danila Bochkarev analyzes Ukraine's energy policies in light of recent reductions in energy consumption in the European Energy Review. 

Economic and political turmoil in Ukraine has led to a significant reduction in energy consumption which should have eased the country’s key economic burden—its heavy dependence on dollar-priced hydrocarbon imports. In 2014 natural gas consumption alone went down by 16 % to 42.6 bcm, and imports fell by 8.3 bcm to 19.5 bcm. Falling demand and cheap crude also decreased Ukraine’s natural gas bill which went down from $12 billion in 2013 to $8.8 billion in 2014.

The country nevertheless continues to depend on energy imports—the energy import bill is indeed one of the most important internal economic and political challenges Ukraine faces. Almost all the proposed solutions have one common point: diversification and a shift away from dependence on Gazprom. However, these policy ideas still lack a realistic implementation plan and sound cost-benefit analysis: a fixation on import diversification has led to the neglect of domestic energy resources and a failure to promote energy saving.

So what is the solution?

Fixing Naftogaz’s deficit and improving the governance of this national champion must be the main priority of Ukraine's energy policy. The decrease of energy imports should have reduced the deficit of the national energy company Naftogaz. In reality, the deficit went up from $2 billion in 2013 to at least $7-$8 in 2014. Though non-payments and national currency devaluation have contributed to Naftogaz’s shortfall – they cannot explain the fourfold increase in the company’s deficit. Residential gas prices went up 50 % as of May 2014, industrial consumers continued to pay market-based tariffs, higher than the average price of imported gas - all this should have helped to alleviate Naftogaz’s deficit. Furthermore Naftogaz produces enough cheap gas to cover over 90% of Ukraine’s residential/heating demand. According to various media reports part of the deficit was linked to the mismanagement of production and gas flows. For example, in December 2014, Ukrainian national weekly ZN.UA published summary conclusions of the Audit Chamber of Ukraine. The report claimed that in 2011-14 period around 2 billion cubic meters per annum (bcma) produced by Ukrnafta—an upstream subsidiary of Naftogaz—were sold to private entities at the highly discounted price of $15 - $26/mcm, representing only a fraction of Ukraine’s industrial tariffs. Naftogaz was forced to source these volumes abroad paying in average $700 million per year. It is estimated that at least 3 bcm of gas produced by Naftogaz and its’ subsidiaries do not reach intended customers in residential/heating sector. Putting the house in order is therefore a clear “must”. Introduction of transparent governance is in the case is the only solution able to boost Naftogaz’s financial results and decrease its deficit.

Improvement of energy efficiency is also extremely important for Ukraine, which is in dire need of affordable energy supplies to re-launch its economic and industrial growth. According to the World Energy Council, the energy consumption of Ukraine's GDP reached 0.47 million British thermal units last year, almost four times higher than the average within the Organization for Economic Cooperation and Development. While some policy measures were implemented by the previous governments, introduction of energy-saving and energy-efficiency measures had been effectively blocked by lobbies of domestic energy intensive industries. In the last five years, the energy intensity of Ukraine's economy decreased only by 3.5 percent—a meager result even if compared with rather modest progress made even by its’ eastern neighbors. Energy saving is a low hanging fruit in Ukraine—it is cheap and will bring immediate results. Ukraine's energy-saving potential could reach as much as 40 - 50 percent of its current energy consumption.

Ukraine’s 'independents' is an important source of natural gas which should not be underestimated. In June-November 2014 period, Ukraine’s gas production rose by 2.1% year on year to 18.1 Bcm. This was mostly due to the performance of independent companies, whose output rose by 26.7% to 2.67 Bcm; conversely, Naftogaz’ production fell by 1% to 15.43 bcm. Independents’ output could reach 5.7 bcm by 2017 under a favorable investment-friendly tax regime.

Ukrainian government chose a different path, sharply increasing gas taxation for private producers in December 2014. The new fiscal regime clearly favours the license–holder of the large fields (e.g. Naftogaz) over smaller private enterprises and risks to undermine both the growth of independents and liberalization of Ukraine’s gas market.

These examples show that the energy reform in Ukraine stalls due to the lack of real reforms and some of the government’s actions even against the spirit of the Energy Community and liberalized energy market. While the Ukrainian leadership took some steps which shows its commitment to reforms—e.g. adoption of Third Energy Package compliant gas market law (Law N. 2250), thus breaking Naftogaz’s monopoly—Kiev has still a long way to go. However these steps should be coherent with a general fiscal and energy policy. New laws should also be working in practice and not only on paper. Increasing transparency, strengthening institutions and reducing the complexity of the legal system should be given high priority. It is up to Kiev to fully play by the European rules and not just applying them selectively.


To read the article at the European Energy Review, click here.

Triggering Cooperation Across the Food-Water-Energy Nexus in Central Asia

Triggering Cooperation Across the Food-Water-Energy Nexus in Central Asia is a report on meetings, held in Istanbul, Turkey, July 15-17, 2014, that brought together 50 experts from the Central Asian region and international community in order to address integrated resource challenges in the Amu Darya Basin, and to develop potential solutions to address these challenges. This report contains a summary of the discussions, including five individual Nexus Action Plans and recommendations for next steps. 

Download the report


Subscribe to RSS - Food-Water-Energy