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Energy sector reform in Ukraine (2014-2016)

Eugenia Gusilov   |   Research Paper  |   06/15/2016   |   13 Pages

The paper tracks the unfolding domestic reform in Ukraine. Despite Crimea’s annexation and the war in the East, Ukraine made genuine progress in implementing much delayed economic reform, but starting slow-walking through the process in 2016 drawing the ire of its foreign partners and domestic civil society. The analysis maps the stakeholders involved in this accelerated modernization process, assesses the relation with the International Financial Institutions, the EU, the USA and Energy Community, and makes an inventory of achievements and failures of this steep reform process. The paper takes stalk of the progress in the energy sector and looks into status of institutional reforms with a focus on energy sector: changes in policy, in governance of state-owned enterprises, involvement of young Ukrainians/expats. A particular focus is devoted to bilateral relations with Ukraine’s EU Member State neighbors – Poland, Slovakia, Hungary, and Romania – in an effort to see how they evolved since the 2014 Revolution of Consciousness as well as what exactly each of these countries did to assist Ukraine since. Finally, it offers a quick assessment on current state, mood and direction of Ukraine’s energy relation with Russia.


Domestic reform:
the point of no return has not yet been passed(Aivaras Abromavicius)

Over a 2 year span, Ukraine had changed 3 governments: the first Yatseniuk government (interim, February-December 2014), the second Yatseniuk government (December 2014 – April 2016), and its 3rd – the present Groysman government (since April 2016). The country has become a hotspot for reform, but after initial big steps, things have slowed down, and reform has stalled against the political deadlock. Soon after assuming the premiership, PM Groysman stated that his goal is to “to ensure the effective continuation of reforms” and that “today the question is not about creating new nice documents the question is about the implementation of those programs that have already been elaborated”.1 According to First Deputy Minister of Economic Development and Trade Yulia Kovaliv, there are no significant changes in the reform agenda under the new government, but the pace does need to re-gain speed: “Last year we presented to the Cabinet of Ministers a big action plan of deregulation, which will lead Ukraine to Top 20 of the Doing Business rating in 2 years. (…) But it is still not approved by our Parliament. And each new day delays positive changes in our society”.2 The scope of reform is very ambitious, with tough deadlines, and the government has to quickly exit the “stasis period” induced by the political stalemate in the first months of 2016. There are many stakeholders involved in reform and, what is remarkable, there is heavy involvement of Civil Society Organizations (CSOs). For instance, the Reanimation Package of Reforms (RPR), a joint initiative of civic activists and experts, born, according to Hennady Maksak, during Maidan, now has 300 members from NGOs, think tanks and volunteer projects, and is consulted on a regular basis and even drafting legislation! 25 working groups are in place under the RPR umbrella.3 Reform is conducted in all areas: decentralization (seen as the most advanced one), fight against corruption, justice sector, public administration, energy sector, business climate, etc. The process requires many resources and when Ukraine lacked them, foreign experts were brought in to close the skills & reform knowledge gap. Such was the case of 3 non-Ukrainian ministers in the second Yatseniuk government:

  • Aivaras Abromavicius, Economic Development and Trade Minister; country of origin: Lithuania.
  • Alexander Kvitashvili, Health Minister; country of origin: Georgia
  • Natalia Jaresko, Finance Minister; country of origin: USA

Abromavicius and Jaresko were seen as the staunchest reformers of the Yatseniuk cabinet. Abromavicius’s resignation in February 2016 triggered the crisis. When he resigned, the following statement was posted on the Ministry’s website:

“Me and my team, we do not want to be a cover for blatant corruption or controlled puppets for those who want to establish control over public funds in style of the old government. I don’t want to come to Davos to meet with foreign investors and partners, telling them about our successes, while certain issues in the interests of certain individuals are solved behind my back.”4

Furthermore, pressure and “lawlessness in personnel issues” is exerted specifically on energy sector and state owned enterprises (SOEs). Abromavicius was not shy to point the finger to Ihor Kononenko (Poroshenko’s ally and former business partner5 that has enjoyed a “gray cardinal” status) accusing him of wanting “to have his “own” deputy minister in the Ministry of Economy, who would be responsible for Naftogaz and other state-owned enterprises” writes UNIAN.6 Therefore, it is clear from this that the de-oligarchization of the energy sector has not even begun. After Abromavicius resigned, the IMF has further delayed payment for 3rd (US$1.7 billion) and 4th installments of funds for Ukraine, citing the slow pace of reform and lack of tax reform.7

It must be noted that the new Groysman government has no foreigners at all. Confidence or hubris? Remains to be seen. The fact of the matter is that there are big reservations regarding the ability of the new government to pursue the reform agenda (de-monopolization and fight against corruption), especially given the background of Groysman’s appointment to premiership (agreement between Poroshenko and the oligarchs, namely the Ihor Kolomoyskiy and Rinat Akhmetov groups).8 Moreover, some ministers of the new government cast long shadows on the ability of the new cabinet to engage in or push through meaningful reform:

the new finance minister Oleksandr Danyluk – who is the government’s main interlocutor with the International Monetary Fund – was associated in the past with the former President Viktor Yanukovych. The choice as Energy Minister of Ihor Nasalyk, an experienced parliamentarian, but also a millionaire businessman in the fuel industry, also raises the question of whether he will work in the interests of the country, and not those of individual businesses.” (Tadeusz A. Olszański and Tadeusz Iwański, OSW, April 20, 2016)

All this proves that the old system not only has survived Maidan, but is quite resilient, very much alive and kicking. In a Testimony before the U.S. Senate Foreign Relations Committee, Victoria Nuland, had this to say, in March: “Ukraine’s European future is put at risk as much by enemies within as by external forces. The oligarchs and kleptocrats who controlled Ukraine for decades know their business model will be broken if Maidan reformers succeed in 2016. They are fighting back with a vengeance, using all the levers of the old system: their control of the media, state owned enterprises, Rada deputies, the courts and the political machinery, while holding old loyalties and threats over the heads of decision-makers to block change.”9

At local level, the most known foreigner is Mikhail Saakashvili, former president of Georgia, now a Ukrainian citizen who, since May 30, 2015, is governor of Odessa oblast. His mission is to turn Odessa around and make it an example worth following by the rest of Ukraine. He recruited reformers from Georgia, Ukraine and Russia (among them Maria Gaidar) and took on the corrupt customs department and the civil aviation authority10, but the people of the old regime are pushing back hard. Two years after Maidan, Odessa symbolizes at micro level all the systemic problems Ukraine is facing at macro level: “rudimentary reforms or no reforms at all, strong resistance to any changes from the administration, strong local political-business connections, the lack of consolidation among post-Maidan groups and corruption inherent in the system” believes OSW expert Tomasz Piechal.11 In fact, a level playing field, high quality public administration, less corruption are still very distant goals for Odessa, given the fact that Odessa’s mayor since May 2014 is Gennadiy Trukhanov (known to have strong connection to the local organized crime and rumored to have been the personal bodyguard of local mafia boss Aleksander Argent in the 1990s12). Despite winning the sympathy of the Ukrainian public, Mr. Saakashvili is not however the most popular politician in Ukraine. According to polls, Saakashvili comes second on the list of best liked Ukrainian politicians, after Andriy Sadovyi, the mayor of Lviv and founder of Samopomich, on whom Der Spiegel did a profile in May.13 Sadovyi has the reputation of a man who “can’t be bought” and embodies everything that Ukraine could become if reform succeeds. The Sadovyi-Saakashvili tandem is not so far-fetched of a political project either, both men being credited by pundits with real chances to occupy one day the presidency (Sadovyi) and PM seat (Saakashvili).


Ukrainian reform stakeholder map

On the side of those backing and pushing for reform in Ukraine is an alliance of usual culprits: the International Financial Institutions (IFIs), the European Union, the U.S.A, and the Energy Community Secretariat. Of the IFIs, the most important stakeholders are the World Bank and the IMF.

The IMF is Ukraine’s key creditor. Upon conclusion of its recent visit in May 2016, the IMF praised Ukraine for “considerable progress in restoring macroeconomic stability over the past year under difficult circumstances”.14 An Agreement on a 4-year cooperation program under the Extended Fund Facility for Ukraine (USD 17.5 bln) was concluded in March 2015.15 This new agreement cancels and replaces the 2-year Stand-By Arrangement (SBA) of USD 17 Billion approved on April 30, 2014.

Financial support from the World Bank (selection, not exhaustive)

Loan Value Year committed In order to
Up to US$3.5 billion 2014 US $2.9 billion through 7 projects (basic public services – water,
sanitation, heating, power and health services.), including
US$1.25 billion in budget support (some lending was postponed
and was included in the 2 Bn provided for 2015); The 3.5 billion
was new money, on top of the ongoing investment and guarantee
program of $3.7 billion.
US$2 billion 2015 support reforms and investment projects (in health and public
infrastructure);
US$ 500 million 2015 Development Policy Loans (DPL) to:
(i) promote good governance, transparency, and accountability in
the public sector;
(ii) strengthen the regulatory framework and reduce the cost of
doing business;
(iii) reform inefficient and inequitable utility subsidies while
protecting the poor.

Source: http://www.worldbank.org/en/news/speech/2015/08/25/world-bank-assistance-to-ukraine; and http://www.worldbank.org/en/news/speech/2014/05/22/q-a-with-qimiao-fan-world-bank-country-director-for-belarus-moldova-and-ukraine-on-world-bank-support-to-ukraine

The European Union (EU) has granted what it calls “unprecedented” support to a non-EU country. There are for instance the 3 Macro-Financial Assistance packages for Ukraine:

EU-Ukraine MoUs for Macro-Financial Assistance (MFA III) package for Ukraine

MoU for Loan Value Granted based on In order to
decisions from
MFA I €610 million 2002 and 2010 support economic reforms and address
persistent external financing difficulties
MFA II € 1 billion 2014 “ease Ukraine’s urgent external financing
constraints, alleviate its balance of payments
and budgetary needs and strengthen its
foreign exchange reserve position”
MFA III €1.8 billion 2015 Same as for MFA II

Source: http://ec.europa.eu/economy_finance/international/neighbourhood_policy/ukraine_en.htm

Conditionalities for disbursement of the loan included measures in the energy sector. For instance, under MFA II of 2014 (Annex 1), point 8 lists the obligation for Naftogaz to prepare an Annual Financial Report of the company and its subsidiaries, according to IFRS. The Report was to be structured as follows: 1) production, 2) import/supply, 3) network management and storage.16 A different example: the MoU for the third MFA package conditions the loan on the successful fulfillment of Structural Reform Policy Measures, among which the establishment of a “National Anti-Corruption Bureau, a specialized Anti-Corruption

Prosecution Office and a National Agency for the Prevention of Corruption” or the adoption and entry into force of “the legislative package on the Civil Service” in order to “depoliticize and professionalize the civil service”.

The EU-Ukraine Association Agreement is the main instrument helping Ukraine to open new markets for its products, to harmonize its laws with the view of aligning Ukrainian economy to EU standards and gradually integrate it into the EU single market. The Ukrainian Parliament ratified the Association Agreement in September 2014. Provisional application started as of 1 November 2014 and the Deep and Comprehensive Free Trade Agreement (DCFTA) section of the agreement is applicable as of 1 January 2016. Energy is one of the 10 short priorities for the EU-Ukraine Association Agenda (renewed in March 2015). Last year alone, 238 Ukrainian enterprises got permissions to supply food products to EU markets.

In allocating funds to the ENP countries, the EU uses the “more for more” and “less for less” principles, meaning that those countries that show more progress in achieving reforms receive more funding and more integration. Other instruments of support also exist such as, for instance the EU Support to Ukraine to Re-launch the Economy – EU SURE (€55 million) or DCFTA Facility for SMEs (launched at the Eastern Partnership Summit in Riga in May 2015) to provide some €200 million worth of grants from the EU budget over the next 10 years.

The U.S.A support for Ukraine was and remains key. Since the crisis began, America committed $760 million in assistance (of which $266 million in the security field) and provided two $1 billion sovereign loan guarantees as well as critical non-financial support in the form of advisers embedded in Ukrainian Ministries and relevant state institutions.17 For instance, American experts advised on energy-related social safety net reform, tariff regulation, energy efficiency, Naftogaz reform. Also, U.S. assistance contributed to increase in production at exiting energy fields and develop contingency plans for winter period in 2014.18 The American assistance program for 2016, as stated by Assistant Secretary Nuland in her March 2016 Testimony to the U.S. Senate, has six priority areas, of which the top one is cleaning up the energy sector (specifically “passing legislation to establish an Independent Energy Regulator, reduce unsustainable energy subsidies, and accelerate de-monopolization of the gas market, efficiency of procurement and revenue management, and the unbundling of services”19).


Energy sector reform: the wheels are spinning

According to Hennady Maksak, during the Yanukovych presidency (2010-2014), the energy sector was captured by the oligarchic group called “Family Group” led by Oleksandr Yanukovych, the eldest son of the President, and some proxies. This group, along with Dmytro Firtash (Group DF) and Rinat Akhmetov (System Capital Management), controlled “procurement schemes and almost all budget flows”.20 The Economist gave an excellent description of the extent of corruption in Ukraine in an article from September 2015: “The biggest threat to Ukraine is now not a Russian invasion, but corruption so pervasive that it long ago ceased to be a disease of the post-Soviet system and became the system itself. Police and prosecutors are in effect commercial structures used to gain wealth and power.” Although in Ukraine corruption is everywhere, it is most certainly concentrated in monopoly sectors, energy being both a prime target for and a key source of corruption. Because of the central role energy plays in the economy and because this sector has traditionally been a corruption hotbed, success there can speed the pace of reform elsewhere.

After the revolution of Dignity, and the subsequent election of Petro Poroshenko, Ukraine has pursued a New energy independence policy(Нова політика енергетичної незалежності), adopted in December 201421, and defined along the following lines:

  • Reform of Naftogaz;
  • Market liberalization (market prices + safety net for most poor); Diversification of supply;
  • Increased nuclear capacity (further cooperation with Westinghouse);
  • Establishment of a Public Joint Stock Company (PJSC) for Ukraine’s main gas pipelines and a PJSC for Underground Gas Storage (UGS) facilities; up to 49% of shares in these companies can be owned by foreign investors from EU and the U.S.. Earlier, on August 14, 2014, a Law was passed introducing the possibility to form partnerships with EU and U.S. companies for management of the Gas Transmission System;
  • Integration of national power system into ENTSO-E network; Implement energy efficiency measures.

The goal is to make Ukraine energy independent in 10 years (by 2025). The reform agenda is indeed huge, but Ukrainians have managed in just 2 years to build an impressive track record: implement the Third Energy Package (with the help of Energy Charter Secretariat – ongoing), pass the new Law ‘On Natural Gas Market’ and successfully arrange reverse flows with Slovakia (with assistance in negotiations from European Commission).

Ukraine – key institutional actors in energy

Institution Website
Ministry of Energy and Coal Industry http://www.kmu.gov.ua
Ministry of Economic Development and Trade
National Energy and Utilities Regulatory Commission http://www.nerc.gov.ua
State Agency on Energy Efficiency and Energy Saving of Ukraine http://saee.gov.ua

A comprehensive Gas Sector Reform Implementation Plan was drafted and agreed by Ukraine with the World Bank, European Commission and the Energy Community Secretariat. The plan was approved by Ukraine’s Cabinet of Ministers in March, 2015 (CMU Resolution No 375-p dated 25 March 2015) and outlines the main government measures (and deadlines) to be taken in 4 key areas22:

  1. Increase of domestic gas production;
  2. Unbundling of transmission and distribution system operators;
  3. Prices and Social Assistance Program;
  4. Transparency and gas metering.

The 3rd Energy Package (TEP or 3EP) in the gas sector was transposed by the new Gas Market Law. Adopted on April 9, 2015, and entered into force on 1 October 2015, it aligns Ukraine’s legal framework with EU legislation, introducing unbundling, entry-exit tariff zone, and new network codes, among other things. In November 2015 was adopted the Transmission Network Code which transposes the capacity allocation (CAM) and congestion management (CMP) requirements of Regulation (EC) 715/2009. The TSO (Ukrtransgaz) and the regulator (NERC) participate in discussion conducted within ACER Gas Regional Initiative South South-East on implementation of EU CAM and CMP Network Codes with Poland and will start discussions with Hungary, Slovakia, Romania and Moldova during 2016.23 According to the latest Ukraine CESEC Monitoring Report (April 2016), “entry-exit transmission tariff methodology was adopted in November 2015 and implemented from January 2016 for cross-border points.”

Reform of Naftogaz lies at the center of energy market reform, in fact one is not possible without the other. The company enjoys the support of all the key stakeholders in this process. The Energy Community Secretariat (ECS) offers key assistance with implementation of the Third Energy Package, for instance, it plays an instrumental role in unbundling Naftogaz. In order for Ukraine to meet its Energy Community Treaty obligations (implementation of the energy acquis in electricity and natural gas), Ukrtransgaz (now a subsidiary of Naftogaz) has to become an independent entity. The energy acquis offers 3 possible unbundling models, but Ukraine’s new gas market law only allows 2 (Ownership Unbundling (OU) and Independent System Operator (ISO)). Ukrtransgaz is not a full TSO, since Gazporm refuses to give its shipper codes for Gazprom gas flowing through interconnection points on Ukrainian Western border, therefore the issue of unbundling is not only about selecting the appropriate unbundling model. The Ukrainian Ministry of Energy and Coal Industry proposed an unbundling plan for Naftogaz (submitted to the EC Secretariat on 15 February 2016). The ECS “called on the Ministry to submit the amended unbundling plan for adoption to the Cabinet of Ministers of Ukraine without any delay so as to ensure that a firm roadmap for the unbundling process comes into effect not later than 1 June 2016.”24

The U.S. State Department offers support for a number of ongoing projects, including one for modernizing the drilling equipment of Naftogaz upstream division – Ukrgazvydobuvannya (UGV) – and one for analysis of the company’s gas deposits.25 EBRD supported Naftogaz to draft and implement a corporate governance system26 (based on OECD best standards in governance of SOEs). An independent audit of Naftogaz was conducted and the company has recruited a new corporate board. An independent supervisory board was established on April 22, 2016,27 in which 3 out of 5 members are foreigners. The corporate governance action plan foresees a transitional period until April 1, 2017, after which the power and responsibilities of the supervisory board will be further expanded and strengthened.

The Law on Privatization of SOEs was passed by the Rada in February 2016. An est. 4,000 state owned enterprises (from various sectors) are in state property. The Privatization Law excludes from the process companies registered in the aggressor country and companies on the ‘black list of offshore jurisdictions’. A list of 345 companies subject to privatization was passed last year (2015), as well as list of 913 state-owned enterprises, not subjected to privatization, was approved and submitted to the Parliament. Already, the Fund for State Property kicked off the process by putting Odesa Portside Chemical Plant (OPZ) – one of the largest – up for sale. It also plans to put up for privatization this year regional thermal-power plants (TPP) (oблэнерго): Herson, Nikolaevsk and Odessa TPPs, 51% of Ternopol and 70% of Hmelnitzki TPPs, Dneprodzerjinski, and Center TPP (one of the largest power generating companies), 70% of Nikolaev and Harikov TPP, 71% of Cherkassov TPP, and 60% of Zoporojie TPP.28 Both America and the European Union support the privatization process which could contribute up to $5 billion to the state budget.

Reform of energy tariffs and social assistance: Ukraine has committed to hike natural gas prices for households and district heating, so as to reach market prices in May 2017, a most steep increase plan:

Source: Naftogaz Annual Report for 2014 (published in October 2015)

Natural gas price deregulation for households was to be conducted in 3 stages:

  1. Spring 2015: prices are raised to cover 60% of avg. market rate
  2. April 2016: price hike to cover 75% of market level (Note: price for domestically produced gas by UGV still capped below market rate)
  3. April 2017: prices are to be 100% unregulated in all segments (Note: price for UGV = deregulated)

However, a single gas market price ($275/1,000 m3) for household was introduced from May 1, 2016. The measure was described by president Poroshenko as an “anti-corruption measure” and was based on a Cabinet decision dated April 27, 2016.29 Thus, full gas price liberalization was achieved ahead of schedule, earning the praise of the IMF delegation visiting Ukraine in mid-May.

Social Safety Net Modernization project (Guaranteed Minimum Income program) is supported through a 300 million loan from the World Bank (approved in July 2014).30 The government implemented a system of subsidies for low-income citizens under which cca. 4.8 mln households received support and some 64,981 so called ‘heat loans’ have been issued for energy efficiency programs (see “Reform is happening. Ukraine is changing”). The new PM confirmed recently that the “entire system of social assistance is subject to reform”, as only 25% of assistance recipients are actually poor.31

Bilateral relations

Ukraine borders with 3 out of 4 Visegrad countries: Poland, Slovakia, and Hungary. The Visegrad-4 platform is a key cooperation format for Ukraine with these countries. In historical terms, the cooperation of V4 countries with Ukraine in the realm of natural gas was “limited to the absolute minimum”, being “shallow and erratic” (Daborowski, 2015). Ukraine’s ability to diversify its natural gas supplies in the past two years is due to the acceleration of EU gas market integration in CEE, to specific and concrete measures taken by V4 countries after 2009 as part of the Third Energy Package that have allowed these countries to become energy security exporters to Ukraine. According to Daborowski, the following infrastructure developments, on aggregate, are responsible for the improved energy position of V4 countries:32

  • Reverse flow on Brotherhood pipeline (2011): allowed 24 Bcm/year to flow from Czech Republic to Slovakia (where annual domestic demand is only 5-6 Bcm);
  • Reverse flow on Yamal-Europe (2011): allowed Poland to import from Germany, initially 2.3 Bcm, and, as of 2015, up to 8 Bcm (half of Poland’s annual domestic consumption);
  • North-South Gas Corridor:
  1. Polish-Czech Interconnector (operational: 2011)
  2. Slovakia-Hungary Interconnector (operational: 2015)
  3. Polish LNG terminal @Swinoujscie (operational: 2015);
  4. Polish-Slovakia Interconnector (to become operational in: 2019).
  • Ukrainian-Slovak relations: to date, Slovakia has played the most important role in Ukraine’s ability to diversify its gas supplies. Despite the breakthrough achieved in September 2014, Ukraine has aggressively pushed for possibility to use the spare capacity of one of four main pipelines at the Uzhgorod-Veľké Kapušany gas transit points) and even has complained to the EU about it in a letter last year.33 This episode is part of the larger issue of Big reverse” – full Slovak reverse flow – for which Ukraine is pushing vs. “Small reverse” (Vojany-Uzhgorod pipeline-Budince, 14.5 Bcm capacity). For now, only the small reverse option was made available to Ukraine in 2014, as Eustream (the Slovak TSO) insists that Gazprom Export has exclusive rights for utilizing the Uzhgorod-Veľké Kapušany under a legacy contract. The Uzhgorod-Veľké Kapušany interconnection point consists of 4 lines with a combined capacity of 92.6 Bcm/year, of which Gazprom has booked 74 Bcm/year. A “big reverse” would allow the use of the spare capacity on Veľké Kapušany without affecting Gazprom’s legacy booking, thus increasing the volume of natural gas that Ukraine can receive from 14.5 Bcm to 24 Bcm. However, Slovakia refuses to consider it, while Eustream refuses to sign the interconnection agreement with Ukrtansgaz. Therefore, in practice we have a situation where the role of the Ukrainian TSO has been high jacked by Gazprom Export, in disrespect and, in breach of applicable EU legislation (TEP).34
  • Ukrainian-Polish relations: Poland has an excellent relationship with Ukraine, a very vibrant bilateral cooperation (not only intergovernmental, but at interregional level), a significant Ukrainian diaspora (up to 1 million economic migrants35), and high media interest towards Ukraine. Approx. 1,250 companies with Polish capital were active in Ukraine in 2012. Together with Belarus, Poland and Ukraine formed the Bug Euroregion back in 1995. Both Poland and Ukraine are also part of the Carpathia Euroregion (1993). Poland has been the most active supporter of Ukraine’s Euro-Atlantic aspirations and the initiator (together with Sweden) of the Eastern Partnership in 2008. In addition, Poland has become the top choice for Ukrainian students going to study abroad who see Poland as a model corruption-free country. In terms of natural gas, Poland has achieved great flexibility by expanding its gas network connectivity and becoming compliant with the “N-1 standard” (ability to continue supply of natural gas for 30 days in the event of a disruption from a gas pipeline/production facility). However, volumes imported by Ukraine from Poland are marginal: only 0.9 Bcm (in 2014) and 0.1 Bcm (in 2015). Inauguration of the Świnoujście LNG terminal in 2015 will further reinforce Poland’s energy position and allow it to scale up its gas supplies to Ukraine.
  • Ukrainian-Hungarian relations: back in the 1990s Hungary was the first country to open an embassy in Kiev, similarly, Ukraine’s first diplomatic representation was in Budapest. Political contacts have been frequent and high level, but did not translate into significant international cooperation.36 On regional level, Ukraine and Hungary, together with Poland, Slovakia and Romania, have created the Carpathia Euroregion in which Ukraine is participating with 4 oblast (Zakarpattia, Lviv, Ivano-Frankivsk, and Chernivtsi). Also, both Hungary and Ukraine participate in the former (2007-2013) and current (2014-2020) European Neighborhood Instrument (ENI) Cross-border cooperation (CBC) program for Hungary-Slovakia-Romania-Ukraine. Approx. 474 companies with Hungarian capital were active in Ukraine in 2012, accounting for 686 million USD worth of FDI. Ukraine in turn was much less active in Hungary (cca. 100 million USD investment).37 It is worth noting that Hungary issues the highest number of multiple entry long term visas to Ukrainians (2012 level), with record high numbers in the cities of Uzhgorod and Beregovo (in Zakarpattia). As far as energy is concerned, the Hungarian TSO (FGSZ) signed an interconnection agreement with Ukrtransgaz in June 2015, the first such agreement signed by Ukraine. However, natural gas volumes imported by Ukraine from Hungary remain marginal: 0.6 Bcm (2014) and 0.5 Bcm (in 2015) still well below the annual available capacity of 5.4 Bcm of cross-border flow.
  • Ukrainian-Romanian relations: in the first two post-communist decades, Ukrainian-Romanian relations have been outright underwhelming (weak bilateral chambers of commerce and low level of cross-border economic relations), but they have registered a significant thaw since the Revolution of Dignity. Until 2014, Ukraine was far from a priority for Romania (despite being its largest neighbor). A recent analysis by OSW38 offers a faithful diagnostic noting that until recently “political contacts have been rare and characterized by suspicion; at times Romania’s policy has been characterized in Ukraine as hostile”, but takes stalk of progress by acknowledging that “although there is still a catalogue of unresolved issues, a long-time barrier of distrust has been broken through”. In 2014, after years of delay, an agreement on small border traffic was signed. Political contacts have intensified too, culminating with President Petro Poroshenko official state visit to Romania in April 2016 during which an Agreement on bilateral cooperation for military transports and one on joint patrol of the Romanian-Ukrainian border were signed.39 As far as energy is concerned, in the context of this visit, PM Cioloṣ said that “he clearly felt and understood Ukraine’s desire to continue the efforts to connect to Romania’s energy infrastructure, for gas as well as for electricity”.40 However, the missing link (bidirectional flows on interconnection points) issue remains. Romanian gas experts consider this topic hostage to: 1) availability of financing and 2) current specifics of Romanian national GTS characterized by low pressure.

In connection to the reverse flows, the latest CESEC report on Ukraine41 states that there is no progress:

“Ukraine maintains a dialogue on reversibility with Poland, Slovakia, Hungary and Romania. Final agreements depend also on the progress achieved by the relevant EU Member States, which is still pending.” It is clear that these efforts to diversify supplies depend more on the neighboring countries than on Ukraine. According to the same report, the latest situation on the interconnection agreements presents itself in this way: Ukrtransgaz concluded interconnection agreements with the Polish and Slovakian operators for pipelines where physical reverse flows take place and with the Hungarian operator for all interconnection points. Discussions for the other interconnection agreements are ongoing with Eustream (Slovakia) and Gaz System (Poland) and were expected to be concluded by May 2016. Discussion with Moldovatransgaz (Moldova) started, the agreement was expected to be signed in March 2016, but “did not happen”. Discussions for all interconnection points started with Transgaz (Romania), but without much progress.

Interesting enough, it is worth noting that within V4, the countries have agreed on a division of tasks regarding assistance for reform offered to Ukraine. For instance, Poland focuses on decentralization (local administration) and finance reform, Hungary – on SMEs and implementation of DCFTA, Czech Republic –on civil society, education, and media, while Slovakia – on energy security and security reforms.

Ukrainian-Russian relations: in brief, deteriorated severely in all spheres. According to a presentation by Ukrainian government42, in 2015 the share of Ukrainian food products exported to Russia decreased to 2%; 4 interstate lawsuits against Russia were filed in the European Court of Human Rights. In energy, the lawsuits filed in the Stockholm arbitration court to review contracts with Gazprom are ongoing, a decision is expected in mid or second half of 2016. Overall, natural gas consumption in Ukraine dropped by 25% as did the gas imports. Since December 2015, Ukraine imported zero natural gas from Russia on account of a warm winter and lower global gas prices:

Volume and origin of monthly gas imports (April 2015-March 2016)

Source: Naftogaz statistics for Q1, 2016

On the other hand, Gazprom suggested recently that Naftogaz should pay 0.67 billion for natural gas allegedly supplied to Donetsk and Luhansk for the period Febr. 2015-April 2016. Naftagaz does not recognize the supplies made through Prokhorivka and Platovo gas metering stations (located in territory that Ukraine does not control) and considers these volumes “not subject to payment by Naftogaz”.43

Conclusion

Despite public dissatisfaction with the pace of reforms lately, in energy they are not only positive, but quite remarkable: the enabling primary legislation is in place, reverse flow with a few EU Member States (and notably with Slovakia) allowed Ukraine to break free from single source gas import dependency, price regulation for natural gas was ended ahead of schedule (2016 instead of 2017), Naftogaz has become the driver of energy market reform in Ukraine, privatization of SOEs looks like it will finally start this year. However, breaking free from the “unholy alliance of dirty money and dirty politics” (Nuland) will require continued resolve. The year 2016 is about staying the course on domestic reform to retain the confidence placed in Ukraine by its allies and partners. Among the pressing issues still ahead in energy: drafting the secondary energy legislation, completing unbundling, ending over-regulation.

Annex I: Achievements and failures in economy

Pluses:

  • establishment of Anti-Corruption Bureau, a specialized Anti-Corruption Prosecution Office and National Agency for Corruption Prevention (NAPC);
  • E-data for transparency of government spending launched: http://spending.gov.ua
  • E-services for citizens: over 20% of documents available online
  • Business in Ukraine can be registered within 24 hours (online registration available)
  • Red tape reduction: number of taxes and fees cut from 22 to 11; number of controlling bodies reduced from 56 to 28; number of permits reduced from 143 to 84, licenses from 56 to 30; compulsory certificates for 13 items of products were abolished;
  • Law ‘On Ensuring Transparent Activity of the Antimonopoly Committee of Ukraine’ was adopted;
  • Number of public tax inspections was reduced by 50%;
  • Electronic VAT administration was introduced;
  • Moratorium on inspections of small-sized business was introduced for 2 years;
  • Taxes and rents on the so-called oligarchic types of business was raised, such as: gas extraction, ore production, bio-ethanol production;
  • Law ‘On Transfer Pricing’ was adopted;
  • First stage of deregulation and simplification of procedures for cargo registration in seaports was completed;
  • For the first time, financial statements of the 100 largest state-owned enterprises were prepared and a financial audit was mandated to carry out;
  • Competitive selection of 277 heads of state enterprises was implemented.

Minuses:

  • SOEs not privatized in 2015, foreign investor kept at bay; privatization promises are slow to materialize;
  • Delay in adopting laws, for instance, Law on Regulatory Authority (developed in 2015 in line with independence requirements of TEP) and submitted to Parliament). Only on April 12, 2016, the law on independent regulator for energy market was finally adopted;
  • Public enemy no. 1 remain: corruption and the oligarchs;
  • The release of the Panama Papers discredit President’s Poroshenko in the fight against corruption. Earlier in May, Poroshenko canceled his participation in an Anti-Corruption conference that was taking place in London, as a result of information disclosed by the Panama Papers investigation;
  • Parliament (where oligarchs wield significant influence) is seen as a main obstacle to reform.

Source: various sources used, but main source is “Reform is happening. Ukraine is changing”, a presentation of Key achievements of the Government for December 2014 – December 2015

 



FOOTNOTES:

  1. Introductory statement by Prime Minister of Ukraine Volodymyr Groysman during the presentation of the Action Program of the Cabinet of Ministers of Ukraine at the session of the Verkhovna Rada of Ukraine, April 18, 2016, available at: http://www.kmu.gov.ua/control/en/publish/article?art_id=248968121&cat_id=244851734
  2. Ukraine Today, Kovaliv: What stands in Ukraine’s way to prosperity?, interview, May 17, 2016, available at: http://www.unian.info/economics/1348023-kovaliv-what-stands-in-ukraines-way-to-prosperity.html
  3. Hennady Maksak, A Focus on Ukraine, in Eastern Partnership Revisited, Fundacja Batorega and FES, p. 73.
  4. Ukraine Today, http://www.unian.info/economics/1253799-ukraine-finance-minister-decides-to-resign.html
  5. Ukraine Today, http://www.kyivpost.com/article/content/ukraine-politics/corruption-allegations-mount-against-kononenko-407393.html
  6. Ibidem.
  7. https://www.fas.org/sgp/crs/row/RL33460.pdf , p. 5.
  8. Tadeusz A. Olszański and Tadeusz Iwański, Ukraine: A new government, as a result of a compromise between the President and the oligarchs, April 20, 2016: available at: http://www.osw.waw.pl/en/publikacje/analyses/2016-04-20/ukraine-a-new-government-a-result-a-compromise-between-president-and
  9. Ukrainian Reforms Two Years After the Maidan Revolution and the Russian Invasion – Testimony by Victoria Nuland, Assistant Secretary, Bureau of European and Eurasian Affairs Before the U.S. Senate Foreign Relations Committee, March 15, 2016: http://www.state.gov/p/eur/rls/rm/2016/mar/254707.htm
  10. The Economist, Mr. Saakashvili goes to Odessa, September 26, 2015, available at: http://www.economist.com/news/europe/21667967-georgian-reformer-tackles-ukraines-real-public-enemy-number-one-corruption-mr-saakashvili-goes
  11. OSW Commentary, Tomasz Piechal, Odessa Oblast: Governor Saakashvili’s superficial changes, February 9, 2016.
  12. Ibidem, p. 4.
  13. Christian Neef, Changing the System: An Outsider Takes on Political Corruption in Ukraine, Der Spiegel, May 12, 2016, available at: http://www.spiegel.de/international/europe/ukraine-political-corruption-targeted-by-mayor-of-lviv-a-1091846.html
  14. https://www.imf.org/external/np/sec/pr/2016/pr16227.htm
  15. IMF Executive Board Approves 4-Year US$17.5 Billion Extended Fund Facility for Ukraine, US$5 Billion for Immediate Disbursement, Press release no. 15/107, March 11, 2015, available at: https://www.imf.org/external/np/sec/pr/2015/pr15107.htm
  16. Memorandum of Understanding between the European Union and Ukraine for Macro-Financial Assistance for Ukraine of up to EUR 1 billion, signed in April/May 2015, available at: http://ec.europa.eu/economy_finance/eu_borrower/mou/mfa_2mou_eu_ukraine_signed_en.pdf
  17. See Footnote 9 |Testimony by Victoria Nuland before the U.S. Senate Foreign Relations Committee, March 15, 2016.
  18. US Department of State, Office of Coordinator of U.S. Assistance to Europe and Eurasia, Foreign Operations Assistance Fact Sheet 2014 – Ukraine, available at: http://www.state.gov/p/eur/rls/fs/2014/240772.htm
  19. Ibidem.
  20. See Footnote 3, Hennady Maksak, A Focus on Ukraine, p. 78.
  21. http://www.kmu.gov.ua/control/en/publish/printable_article?art_id=247807118
  22. Ukraine: Government adopts robust Gas Market Reform Implementation Plan, April 30, 2015, available at: http://www.cms-lawnow.com/ealerts/2015/04/ukraine-government-adopts-robust-gas-market-reform-implementation-plan
  23. Ukraine, Energy Community CESEC Report, April 2016, available at: https://www.energy-community.org/portal/page/portal/ENC_HOME/DOCS/4132432/31DA795DFBEE3B26E053C92FA8C04930.pdf
  24. Secretariat requests substantial changes to Naftogaz unbundling plan, May 9, 2016: https://www.energy-community.org/portal/page/portal/ENC_HOME/NEWS/News_Details?p_new_id=12842
  25. Naftogaz team discussed cooperation with the US Department of State delegation, May 19, 2016, available at: http://www.naftogaz.com/www/3/nakweben.nsf/0/CE3B8C78C1165578C2257FB800208D78?OpenDocument&year=2016&mont h=05&nt=News&
  26. http://www.naftogaz.com/files/Information/EBRD-Action-Plan-engl.pdf
  27. http://naftogaz-europe.com/article/en/naftogazsupervisoryboardengl
  28. http://zn.ua/ECONOMICS/deystvuyuschaya-v-ukraine-sistema-oblenergo-eto-dazhe-ne-proshlyy-vek-eto-vremena-dinozavrov-bilous-214070_.html
  29. http://uatoday.tv/news/ukraine-cancels-gas-price-benefits-for-households-as-of-may-1-641951.html 30http://www.worldbank.org/en/news/press-release/2014/07/03/world-bank-social-protection-reform-ukraine-new-loan
  30. http://www.worldbank.org/en/news/press-release/2014/07/03/world-bank-social-protection-reform-ukraine-new-loan
  31. http://www.unian.info/economics/1351832-weeks-balance-satisfied-imf-mission-groysmans-plan-and-struggle-with-freight-trucks.html
  32. Visegrad Fund, Tomasz Daborowski, Difficult path towards gas partnership: Visegrad Group countries’ gas cooperation with Ukraine, 2015, p. 4.
  33. Ukraine complains to EU over Eustream, June 25, 2015, available at: http://spectator.sme.sk/c/20058396/ukraine-complains-to-eu-over-eustream.html
  34. Wikborg Rein Memo of June 2, 2015: “Facilitating reverse flow from West to East”, available at: http://www.naftogaz.com/files/Information/2015-06-02%20-%20Facilitating%20Reverse%20Flow%20Capacity%20from%20West%20to%20East.pdf
  35. Reuters, January 20, 2016: http://uk.reuters.com/article/uk-europe-migrants-poland-ukraine-idUKKCN0UY2BN
  36. Фонд им. Фридриха Эберта, Состояние и перспективы отношений Украины с соседними государствами, АНАЛИЗ | КИЕВ, Ноябрь 2012, c. 16.
  37. Ibidem, p. 17-18.
  38. Tomasz Dąborowski, Tadeusz Iwański, Breaking through distrust in relations between Romania and Ukraine, OSW, April 27, 2016: http://www.osw.waw.pl/en/publikacje/analyses/2016-04-27/breaking-through-distrust-relations-between-romania-and-ukraine
  39. Alexandru Moise, România şi Ucraina au semnat un acord privind colaborarea în domeniul transporturilor militare, Mediafax, April 21, 2106: http://www.mediafax.ro/politic/romania-si-ucraina-au-semnat-un-acord-privind-colaborarea-in-domeniul-transporturilor-militare-15268202
  40. Alexandru Moise, Cioloş: Am simţit foarte clar dorinţa Ucrainei de conectare energetică cu reţelele României, Mediafax, April 26, 2016: http://www.mediafax.ro/politic/ciolos-am-simtit-foarte-clar-dorinta-ucrainei-de-conectare-energetica-cu-retelele-romaniei-ue-trebuie-sa-dezvolte-cu-statele-din-est-colaborarea-economica-15273308
  41. Energy Community, Ukraine: Energy Community CESEC Report, April, 2016, available at: https://www.energy-community.org/portal/page/portal/ENC_HOME/DOCS/4132432/31DA795DFBEE3B26E053C92FA8C04930.pdf
  42. “Reform is happening. Ukraine is changing” – Report on key government achievements during Dec 2014- Dec. 2015, December 17, 2015, available at: http://www.kmu.gov.ua/control/en/publish/article?art_id=248714324&cat_id=247511908
  43. Naftogaz did not receive gas from Gazprom through uncontrolled entry points and has no intention to pay for it, May 18, 2016, available at: http://www.naftogaz.com/www/3/nakweben.nsf/0/F313D21A9F59E31DC2257FB7004FE1EB?OpenDocument&year=2016&mont h=05&nt=News&

 

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