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29 August, 2011  ▪  Oleh Lutsenko

The Energy (In)Security of Ukraine

Throughout all 20 years of the new history of Ukraine, schemes have been used for energy resource supplies, to the detriment of the country, but which made specific people much richer

Energy security has never been a purely economic issue for Ukraine. On the one hand, the ill-balanced industrial structure with its dominating energy-guzzling production generates an extremely high demand for energy resources. On the other hand, Ukraine has been part of the geopolitical and geoeconomic distribution system of oil and gas flows ever since the USSR began to construct pipelines, seeking to win the largest share of the West European market during the Brezhnev era. Europe’s energy dependence on the Soviet Union allowed it to use oil and gas leverage to exert political influence over the West. But it turned into a strategic defeat when plummeting fuel prices undermined the USSR’s economy and speeded up its collapse.

Independent Ukraine could have used its portion of the soviet heritage for a geopolitical game of its own. Yet none of its leaders were able to think on such a scale. Instead, the country’s leadership hurried to exploit the energy sector, specifically the transit of energy as a source of its own excess profit. Most of the richest Ukrainians earned their first billions in the oil and gas industry. At the same time, the country is still ridiculously dependent on Russian oil and gas, reaching a level of 75-80%, extracting only 10-12% of the oil 20-25% of gas required on its own territory. The history of the Ukrainian energy sector over the past decades is actually a sequence of alternating opaque scams.

THE SHOCK AND THE MUDDY WATER

The increase of prices for Russian energy supplies came as a shock to all post-soviet economies mentioned in all publications about that time. Recollections of this became a mandatory attribute of materials from that time. The Western world survived the same challenge in the 1970s and grew accustomed to it, introducing protection systems ranging from national reserves of energy supplies to the culture of energy efficiency. Future EU-member states followed the same path accepting high price as a given and in spite of them, managed to revive economic growth fairly quickly.

By contrast, Ukraine ended up in unfavorable circumstances during the early years of independence, which hampered the making of strategically correct decisions. “Red directors” emerged as the most powerful lobbying group, since they were, in fact, running enterprises with the most excessive energy-consumption, thus suffered the most from the growing prices. With no reforms coming either from the government or the opposition, politicians replaced politics with the promotion of their own interests. This resulted in two trends that shaped the energy market in Ukraine for many years to come. Firstly, the supply of energy resources to large enterprises turned into one of the most profitable businesses. Secondly, this generated another type of business, i.e. services to red directors in the areas that were unattainable in soviet times, such as trade, financial transactions and so on. The intersection of these two trends offered great prosperity and virtually every oligarch of today was either directly involved in the energy supply trade or a patron of this business. The first half of the 1990s was characterized by the emergence of oil and fuel barons, gas monopolists and owners of oblast energy companies. Certain energy clans were established, that distributed quotas among themselves for received energy supplies and energy markets.

At that time, the Ukrainian gas sector was dominated by several powerful players. The first of them were the Respublika (The Republic) Corporation, headed by Ihor Bakai and Intergas CJSC supported by Oleksandr Volkov, the then advisor to ex-president Leonid Kuchma. The Spivdruzhnist (Commonwealth) Corporation owned by the Tymoshenko family and Viktor Pinchuk was the second most powerful player on the market, and after the alliance collapsed, it turned into the PFK Single Energy Systems of Ukraine Ltd (YeESU). The third player was International Trade and Energy Resources Association (ITERA), a Russian-American corporation established in Florida in 1992. This was the most stable company and the one that Dmytro Firtash, who participated in barter schemes – gas in exchange for commodities, who at that was taking his first steps towards becoming an oligarch, chose to work with. Prior to this, Mr. Firtash used to do similar business with Mr. Bakai and for the most part, lived in Ashgabat until the early 1990s. In 1994, another player emerged called OLgas, an industrial and financial company connected to Oleksiy Ishchenko, registered on 15 December 1994 in Kyiv as a closed joint stock company. Ukrgasprom and RAO Gazprom owned 31% each of the company’s shares, while the rest of shares were distributed between commercial OLBank and OlPetroleum SysteM company, which is also a founder of the Russian-Ukrainian RUNO oil company based at the Lysychansk Oil Refinery.  

When Pavlo Lazarenko was appointed Prime Minister in 1996, YeESU got powerful support and turned into a wholesale importer of Russian gas, supplying 9bn cubic metres of gas to nearly 70 companies in 7 oblasts. That was when the major war for gas unfolded. There was no-one to think about saving energy, developing Ukrainian gas resources or getting gas from alternative sources, other than Russian and Turkmenistan, which can only transit gas via Russian territory.

TUG OF WAR  

The late 1990s to early 2000s saw the redistribution of the market, gas wars and tug of war by the strongest players. What is interesting, is that contacts in Russia were used to win back positions on the Ukrainian market. After a short period of being out of favour with the new government, Ihor Bakai managed to sign a separate contract with Gazprom in 1995 determining his quota on the market.

In 1997, the political and economic climate changed abruptly as Mr. Kuchma changed his attitude towards Pavlo Lazarenko and his company. After Mr. Lazarenko’s resignation, YeESU’s rivals gained weight. Having refused to join the parliament, Mr. Bakai was appointed Chairman of the Board of Naftogaz of Ukraine National Joint Stock Company on 1 June 1998. The newly-appointed Naftogaz Chairman of the Board commented “The strongest one becomes the sheriff and puts things in order”. In fact, though, someone sounding like Mykola Azarov on the Melnychenko tapes characterized Mr. Bakai’s actions at Naftogaz as “dumb and stupid”.

On 1 September, Mr. Bakai removed all existing intermediary traders from gas supplies. The only company left to fulfill the contract between Gazprom and the Ukrainian party was Naftogaz’s subsidiary, the Gas of Ukraine Trading House. This decision hit Single Energy Systems of Ukraine and OLgas the hardest, leading to their decline. Moreover, the Russian Military Prosecutor initiated a case on abuse by YeESU when supplying gas to Russia’s Defense Ministry at prices that were allegedly too high. The Tymoshenko family faced an investigation in Ukraine for smuggling currency and other things. But Ms. Tymoshenko hit back as soon as she became Vice Prime Minister for Energy, accusing Mr. Bakai of concealing Naftogaz’s debt to Gazprom in the amount of USD 2.8bn. This forced him to resign in March 2000. In addition, Ms. Tymoshenko approved legislation on the energy market to stop non-transparent barter schemes in the industry thus raising revenues from the power supply sector to the state budget.

INTERNATIONAL SHADOW SCHEMES

In early 2001, Ms. Tymoshenko found herself behind bars and Yushchenko’s Cabinet was dissolved in April. The only companies that got access to the gas market were only the ones linked to those in power. This was the time of secretive and opaque deals between the Ukrainian and Russian parties. As a result, some interstate intermediaries, such as Eural Trans Gas, and RosUkrEnergo, emerged on the market.

As Gazprom’s management changed in 2001 and people from Mr. Putin’s circle replaced the “long-time gas experts” in the company, ITERA was no longer an intermediary, supplying gas from Turkmenistan. It was replaced by Eural Trans Gas, registered in a small Hungarian town. Both Gazprom and Naftogas claimed that it was a transitional entity which both companies would later acquire. However, when news surfaced about Eural’s connections to criminal Semion Mogilevich, it caused an international scandal. Eventually, the companies decided to replace the intermediary with the no less mysterious RosUkrEnergo, which was set up in 2004. Gazprom owned 50% RosUkrEnergo, the remaining 50% being owned by a “Ukrainian party”. It later emerged that the Ukrainian party was in fact Dmytro Firtash, a friend of Yuriy Boiko, the new CEO of Naftogaz, and the owner of Eural Trans Gas.

According to politicians from Yushchenko’s circle, Mr. Firtash allegedly met with Mr. Yushchenko to discuss the preservation of RosUkrEnergo-based gas schemes in the heat of the Orange Revolution. To the surprise of many, the schemes were used after the Ukrainian-Russian gas conflict in early 2006 to supply gas from Russia and Turkmenistan. Essentially, this meant that to buy back-out the intermediary, the strategic energy relations of the country and huge cash flows that should have been channeled to the state budget, were given away. It was only possible to rid the market of RosUkrEnergo in 2009. At the same time, Ukraine ended up with one of the highest gas rates and lowest transit rates in Europe, accompanied by unequal liability terms. This was the outcome of the history of an energy dependent country where the government tried to cut gas prices using non-transparent schemes and gave temporary subsidies to the big business instead of providing predictable pricing, the systemic streamlining of energy consumption and searching for alternative fuel sources. This energy policy, or rather the lack thereof, weakened the country and made it more vulnerable to pressure and blackmailing from Russia.

ENERGY CONTROL

At the end of the 1990s, the distribution of electrical energy was virtually controlled by one group. Total control over Ukraine’s economy was only prevented by a conflict among the owners of oblast energy companies.

November, 1998

A group of off-shore companies, Court Holding, property of Konstantin Grigorishin from Russia, have accumulated majority interests in three and a considerable share of the stock of five energy firms, such as Sumy Oblenergo (58% of the statutory fund), Prykarpattia Oblenergo (59%), Chernihiv Oblenergo (51%), Kherson Oblenergo (25%), Kirovohrad Oblenergo (26%), Poltava Oblenergo (23%), Lviv Oblenergo (24%), and Ternopil Oblenergo (22%).

1999

Grigorishin bought 40% of the shares of the Poltava, Chernihiv, Sumy, Lviv, and Prykarpattia oblast energy companies; according to open sources, Grygoriy Surkis bought 35% in each. However, Surkis and Medvedchuk deny their involvement in oblenergo deals.

Grigorishin’s group also purchased from 1 to 40% of shares in 19 other energy companies, in an attempt to get a blocking stockholding and to influence the operation of these firms.

February, 1999

Lviv, Poltava, Sumy and Prykarpattia oblenergos were incorporated as stockholders of Joint-Stock Commercial Bank Zeus (associated with the Surkis brothers).

April 1999

Following the conclusions made by the Attorney General’s office, President Leonid Kuchma commissioned the government to revise decisions concerning the transfer of the shares of Kirovohrad, Ternopil, and Kherson oblenergos to the control of Ukrainian Credit Bank (Grygoriy Surkis and Medvedchuk supposedly being its co-founders).

May 1999

The Attorney General’s office filed claims to the Higher Arbitration Court, demanding the annulment of sales agreements concerning the shares of Sumy, Chernihiv, Lviv, and Prykarpattia oblenergos, made in commercial tenders. The buyer companies refused not provide information concerning their experience in such operations and management in the energy sector.

April 2001

The Slovak company Vychodoslovenske Energeticke Zavody SP (observers pointed out its connections with Grygoriy Surkis and the Russian oligarch, Aleksandr Babakov) won tenders to buy 64 percent of the shares of Kherson, 51 percent of Kirovohrad, and 70 percent of Sevastopol oblenergos. The transaction totaled approximately a mere UAH 290mn.

June 2002

Grigorishin and the SDPU(o) group split. Grigorishin cites his refusal to finance this political force as a reason, while observers believe that the real reason was the attempt takeover of Grigorishin’s business by Surkis and Medvedchuk.

October 2002

Grigorishin was detained by agents of Organized Crime Police Unit, only to be released later, due to “lack of evidence.” He blamed his arrest on Grygoriy Surkis and Viktor Medvedchuk.

November 2004

Grigorishin sold half of his shares (20%) in the Poltava, Chernihiv, Sumy, Lviv, and Prykarpattia oblenergos to Ihor Kolomoisky.


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