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4 April, 2014  ▪  Lyubomyr Shavalyuk

Mykhailo Honchar: “Ukraine is paying a huge price because its politicians do not know the basics of economics and security”

The energy sector was always the sore spot that Russia hit every time Ukraine went “too far” in exercising its independence. And the Kremlin was always able to bring the “unruly” Ukrainians into line again. This is how it was, but now things have changed: Ukrainians are no longer afraid of pain and have a chance to fundamentally reform the energy sector in the interests of society. The Ukrainian Week talks to Mykhailo Honchar, one of the few Ukrainian experts who view this sector from the standpoint of Ukrainian society and national security rather than personal gain

U.W.: In connection with the recent revolutionary events in Ukraine, the European Union has announced it has a serious intention of helping Ukraine overcome energy-related problems. Can the EU offer anything new?

In my opinion, nothing new will be offered. There is no need for that, because the agenda for Ukraine-EU energy cooperation was set nearly nine years ago and is still valid today. It was first formulated in a strategic document, the Yushchenko-Blair memorandum of 1 December 2005, and established forms of cooperation in the energy sector. Cooperation was launched nine years ago, but today there is little to show for it. Less than a third of the plan has been realized. At the least, the to-do list is longer than the list of what has been done. There is essentially just one question that has been resolved: secure operation of Ukrainian nuclear power-generating units, which was a sensitive issue in Ukraine-EU relations.

On the issue of oil and gas and the respective markets, there has been minimum progress and even that largely on paper. For example, Ukraine acceded to the treaty of the European Economic Community (EEC) as late as in 2011, even though it had to be done earlier. But this step did not bring any significant results anyway. The reason is that the Ukrainian government – regardless of who was the president and prime minister – largely imitated action rather than acted.

Take, for example, the very practical project to modernize Ukraine’s gas transportation system (GTS). The Brussels declaration to this effect was signed (incidentally, when Yulia Tymoshenko was the prime minister) on 23 March 2009 in what was Europe’s almost immediate reaction to the 2009 gas crisis. Nothing has been done since then to implement it. If Ukraine had tackled this project right away and the EBRD and the European Investment Bank (EIB) had provided financing, we would now be speaking about its final stage, because its most time-consuming subprojects, such as the replacement of the pipeline infrastructure and gas compressing units, were to take seven years.

U.W.: Why has Ukraine chosen to imitate activity rather than make real changes?

In the conditions of the economic and political system that was in Ukraine until very recently – I hope it will now be transformed – the leadership of the country had other priorities. An oligarchic economy must have a shadow sector to replicate itself. It needs large public contracts to extract the lion’s share of their budgets and non-transparently redistribute money within a coterie of players. European projects financed by the European Commission, the EBRD and the EIB are transparent. You cannot steal anything there, because all expenses are clearly specified. That is why these initiatives are a priori unattractive to the key Ukrainian players, and not only in the energy sector.


U.W.: So it appears that if Ukraine now launches similar transparent projects, they will be a litmus test for the maturity of Ukraine’s political system?

Absolutely. Ukraine is paying a huge price because its politicians do not know the basics of economics and security. Let me give you just two examples. First, one of the cornerstones of doing business is diversification. It applies not only to energy resources but to the entire economy in general. Your business must be diversified if you want to keep it afloat when one sector fails. Second, the minister of defence recently announced that Ukraine is not ready to contain Russia militarily, because we have never expected a threat from there. But the government and the military cannot ever think like that. They must be prepared for anything, including a threat from the least likely direction. There are no permanent friends, just permanently changing interests.

Thus, in the 23rd year of independence, we are finally beginning to sense what price we are going to pay if we remain ignorant of the fundamentals. All of these things are in the textbooks read by all masters of public administration, people with degrees and those who graduated from the academies run by the General Staff. However, in their practical activity, they were guided by blind faith in luck, so now entire society has to pay a price. It has allowed people like that to come to power, distribute social resources and pursue this kind of policy.

U.W.: The EU is ready to help Ukraine upgrade GTS and invest into its underground gas storage facilities. In which of the two does the EU see its bigger interest?  

GTS and facilities make an integral complex technologically so they are always discussed as one. The EU, however, has a different approach to running the business: gas transportation is one thing, storage is another thing, i.e. different companies should deal run these two businesses. Europeans are interested in using the potential of Ukraine’s GTS for transportation, including reverse delivery, and for storing gas in summer to consume it in winter. The German RWE, for instance, became a pioneer in reverse gas flows to Ukraine. On the day when Gazprom CEO Alexey Miller cancelled discounts for Ukraine in compliance with Putin’s instructions starting from Q2, RWE FEO said his company was prepared to resume reverse gas flows to Ukraine. So, we already see the benefits of a liberalized European market, something Russia has always resisted. This market is oriented at consumers rather than the interests of suppliers – monopoly suppliers like Gazprom.

I see European rules as a challenge for the Russian business. Therefore, the latest developments in Ukraine fuelled by the Kremlin reflect its reluctance to allow rules that are different from the ones set up by Moscow into the post-Soviet territories. Transparency, accountability, competition and consumer orientation are not what Russia needs. With all that, it will have to run its business just like others do, and that means inevitable defeat for it. The Kremlin’s systemic game is aimed at undermining Eastern Partnership, EEC and the EU overall. It has succeeded in fragmenting Europe’s single voice in negotiations on fuel supplies by exploiting bilateral relations with the leading players, such as Germany, France and Italy, to quickly kill the initiative.

U.W.: Does it make sense for Ukraine to build an LNG terminal?

 The prospect of building our own terminal in Ukraine is quite murky. We only have access to the Black Sea, and that raises the issue of Bosporus. Turkey is now abusing its exclusive right to maintain security in the Bosporus and that will be a tough issue to solve. However, it is risky to build the terminal before the solution is found. Plus, it is obvious now that the LNG terminal project lobbied by the Yanukovych regime was only needed for massive corruption. Even Russia did not use it as a trump in its bargaining game over gas price.

There are other options, too. Poland is launching its LNG terminal in Świnoujście at the end of this year. Its capacity can expand to 7.5bn cu m from the current 5bn, and more. This is sufficient for Polish consumption so they will look for clients to pay off the project cost. Ukraine can join in and buy the fuel from this terminal. For this, it needs a short pipeline in addition to the ones we already have.

RELATED ARTICLE: The Third Gas Revolution

U.W.: Who has had more influence on Ukraine’s failure at energy security, Ukrainian oligarchs or Russia?

Business puts a premium on profits, but not at any cost! In normal economies, national interests and priorities, as well as security issues, draw the lines that cannot be crossed even in pursuit of big profits. In the past years in Ukraine, business operated under a totally corrupt government, and these lines were either moved or completely removed using certain channels.

Russia did not only exploit it – it cultivated this approach. Russia also has an oligarchic economy, and the only difference between Ukrainian and Russian nouveaux riches is that the Russians, just like the Russian government, have a certain geopolitical vision of “Great Russia” and “gathering of the Russian lands”. Meanwhile, to our oligarchs Ukraine is just a territory in which money can be made, so they easily betrayed national interests in exchange for profits. And Russia stimulated this attitude through schemes like RosUkrEnergo in the gas sector and earlier through Eural TransGas. It enabled certain businessmen to do highly profitable business but always with strings attached, namely political tasks. By pressing this button over and over again, the Russians forced the Ukrainian government into disadvantageous decisions that were contrary to Ukraine’s interests but in line with Russia’s geopolitical vision. The Kharkiv Treaties and the mysterious Moscow accords in December 2013 are two cases in point. Few people remember that the scheme involving RosUkrEnergo emerged after Leonid Kuchma removed a clause about Ukraine’s aspirations to join NATO from the country’s military doctrine. Kuchma’s edit came out two weeks before his meeting with Putin in Yalta in July 2004.

So here is a conjunction of business, corruption, big politics for Russia and the “pragmatic” policy of the Ukrainian government. Now we can say what it has led to. Ukraine is a non-aligned state which no-one wants to defend. And we have been incapable of creating our own armed forces and building a security and defence system. We have lacked an understanding that non-aligned status demands even more expenses on defence, because every other country must be viewed as a potential enemy. The following mantras have been repeated to us: we are strategic partners with Russia; the Russians are a brotherly nation; there can be no aggression and so on. Nevertheless, the Tuzla incident was the first wake-up call.

U.W.: Russia has recently said that it may stop delivering gas to Ukraine. What is the likelihood of this happening, considering that Russia has contract obligations before European countries which it must honour?

Russia can do it. Moreover, I believe they have made technical preparations to reduce or discontinue deliveries to Ukraine without affecting gas transit volumes to Europe. But this is precisely where the trap is. The next step, as we already know, will be an allegation that Ukraine is syphoning off gas from the pipeline. What will happen in reality, however, will be a pressure drop-off in the pipeline which will cause the system to use more power gas to sustain the flow. Moscow will then try to redirect as much gas as possible via the Nord Stream. It has the capacity of 55bn cu m per year, but less than 20bn cu m is being pumped. Moreover, under the EU’s Third Energy Package, 50% of the maximum capacity must be reserved for access by other suppliers. Russia will press the European Commission to make an exception for the OPAL pipeline, which is an extension of the Nord Stream and runs north of Germany. Russia will demand that it be operated at full capacity in order to save Europe from the “unreliable and unpredictable” Ukraine. Russia is prepared to pull off this manoeuvre but doubts its efficiency. First, few countries now believe the Russians. Second, the timing is off: it’s not January but a warm March outside. Third, Europe has surplus gas in its storage facilities. Experts estimate that these reserves will last 40 days, so there will be no catastrophic consequences.

Therefore, the EU is calm about this threat, but the problem will persist for the next heating season and the Europeans can see that. They understand that Russia will do everything to show Ukraine as the guilty party and persuade the European Commission to change its policy on the South Stream. Things that have been brought up again include the third and fourth strands of the Nord Stream, the Yamal-Europe-2 gas pipeline bypassing Ukraine and so on. Russia will try to push through all of this, but I believe that they have a case of overkill here. The other day, the European Commissioner for Energy clearly said that negotiations over the OPAL pipeline and South Stream have been postponed indefinitely. Russia believed that by provoking a crisis in Ukraine it would urge the EU to make quick decisions. In late January, the European Commission was essentially ready to pass them but took a pause to see what was really going on. This is a case when European bureaucracy has benefited both the EU and Ukraine.

RELATED ARTICLE: A Pipe of Discord

U.W.: The Customs Unions is imposing sanctions on petroleum product deliveries to Ukraine. Moreover, due to the schemes run by Serhiy Kurchenko and Viktor Yanukovych’s Family, the official imports of petroleum products to Ukraine fell nearly 80% in 2013. Is there a risk of petrol shortages in Ukraine?

I view this as one of the levers of pressure on Ukraine. In addition to military pressure, Ukraine is now facing a wave of economic pressure: higher gas prices and now disruption of oil deliveries. The Russians understand that we largely consume imported ready-to-use petroleum products, because our own refineries are standing still thanks to their Russian owners who have rendered them unprofitable. The bulk of petroleum products, up to 40%, are being imported from Belarus, which is a member of the Customs Union and is making these products from Russian oil. That is the reason why Russia is putting pressure on Belarus to obtain the desired effect. However, there was no catastrophe last year when the Mozyr Oil Refinery, the biggest supplier of petroleum products to Ukraine, was shut down for a month-long overhaul. If this is any indication, nothing bad will happen in the future. In 2013, Belarus imports were replaced with Lithuanian imports. If the channel from Lithuania is blocked, Ukraine can bring imports through Poland. In other words, we can neutralize this threat. There may be temporary price hikes, but nothing more. Ukraine has also imported petroleum products by sea from a Romanian refinery owned by Russian Lukoil. The situation may become problematic if the Russian Black Sea Fleet blocks Ukrainian ports or if there is intervention into Ukraine’s southern oblasts (Kherson, Mykolaiv and Odesa) and access to the sea is blocked. In this case, we will only have the Western direction from which to receive petroleum products. We should be thinking about this now.

U.W.: How quickly can Ukraine build a plant to produce nuclear fuel? In the light of recent events, is it feasible to resume uranium enrichment in order to restore nuclear status for Ukraine?

As far as nuclear status is concerned, it takes time and a lot of money. Moreover, many international legal issues arise. We have acceded to the Non-Proliferation Treaty as a non-nuclear state. Naturally, the behaviour of the states that have guaranteed our security de facto unties our hands but they remain tied de jure. It is a question of big money and a lot of time. That is why I view such talk not as an incentive to real action but as a means of creating a kind of political-psychological counter-pressure. There is also an option of obtaining nuclear weapons illegally, but this requires a highly functional government apparatus. As of today, Ukraine is not prepared to handle nuclear weapons.

As far as nuclear fuel is concerned, there has been an understanding – ever since the discussions in the 1990s – that this project is much needed. However, my assessment has been unchanged: we cannot and have no right to do it jointly with Russia. In nuclear power generation, we have strategic dependence in on Russia, so why increase it? It would mean returning to where we started… A Russian company was chosen as Ukraine’s partner. What else is there to say? Will this company be implementing this project now? And if it will, in what condition will this plant be, and what will it be producing? There is no doubt in anyone’s mind that they want to burn the money and shift the debt onto Ukraine. We can now see that projects of this kind cannot be purely business projects – other aspects also need to be taken into consideration.

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