Ukraine: The price of addiction

18 Feb

“The only free cheese is in the mousetrap.” Who profits from politicizing gas prices in Ukraine? How much is a country’s sovereignty worth?

Guest post by András György Deák, Associate Fellow at the Hungarian Institute of International Affairs.

Though many people may have already forgotten, the current wave of protests in Ukraine (“Euromaidan”) broke out when President Yanukovych first backtracked from signing an association agreement with the EU, then received a $15 bn loan and a roughly 30% discount on gas prices from Moscow. The loan itself was already below market interest rates, but the latter discount went even further; it would be quite an exaggeration to call it a conventional financial bailout. Or at least the International Monetary Fund would hardly have offered anything similar.

 maidan1Clashes in Kiev. Source:

It remains yet to be seen who is making a sacrifice for whom. Can this be interpreted as the price of “empire-building”, whereby Russia willingly concedes its own revenues just to enslave Ukraine? Or is it actually the other way around: will Russia now be able to freely poke around in the Ukrainian “family silver”, and acquire its most valuable industrial assets? As Arseniy Yatsenyuk, one of the leaders of the Ukrainian opposition said: “The only free cheese is in the mousetrap”. Who profits from politicizing gas prices?

The cost of addiction

Indeed, the political nature of gas prices in the post-Soviet sphere is more a constraint than a choice. This is because at current consumption rates, these countries would be hard-pressed to pay European-level prices. As the chart below shows, gas imports are a much greater macroeconomic burden in post-Soviet countries than, say, in Hungary or the more developed parts of Europe. This remains the case even considering that in 2011 the three post-Soviet countries (Ukraine, Belarus and Moldova) all paid a lower price for their gas imports than Germany; the discount in the case of Belarus, for example, was over 30%. It is therefore no surprise that the post-Soviet gas importers – partly due to their high level of imports – have massive current account deficits. In Moldova and Belarus this was around 9-11% of their GDP in 2011; even Ukraine has been catching up from a level slightly above 6%.

gas_imports_andrasdeak1Sources: IEA, IMF, BAFA, own data collection and calculation

Of course we cannot ignore the fact that these countries are heavily gas dependent, meaning that gas plays a much greater role in their energy mix than in most other places. In 2011 natural gas imports  accounted for 57.6% of energy use in Belarus and 67.7% in Moldova, but – contrary to popular belief – just 28.6% in Ukraine. (In comparison, this was 24.6% in Hungary.) But if we were to disregard this fact and just look at unit gas import costs, the picture changes only slightly. Although the ranking of post-Soviet countries is altered, their relative situations and dependency remain the same.

The explanation is fairly simple. The post-Soviet countries – and, to a lesser degree, the former socialist countries as well – have succeeded in pulling off the trick of simultaneously having a relatively high energy consumption and a low GDP. The former is the heritage of the soviet-style planned economy, when low energy prices and resource abundance meant that efficiency always took the backseat. The main products of Ukraine and Belarus’ economies are still from the energy-intensive metallurgy, heavy industry and fertilizer sectors, and most of the population lives in soviet-style block housing with bad insulation and outdated heating systems.

gas_imports_andrasdeak2The share of gas imports corresponding to 1% of total primary energy supply in the GDP. Sources: IEA, IMF, BAFA, own data collection and calculation

Meanwhile, with the possible partial exception of Belarus, these economies collapsed with the fall of the Soviet Union. Ukraine’s GDP in 2012 was still only 78% of its 1992 level, and even this was an improvement considering it stood at just 46% in 1999. Per capita GDP is roughly half of the Hungarian level in Belarus, a quarter in Ukraine, and merely a sixth in Moldova. The international oil price boom and its knock-on effects in the post-Soviet sphere quickly destroyed these economies. At the moment, the Ukrainian economy requires six times as much energy to produce one unit of GDP as the Hungarian one. And – despite all efforts to date – this situation is unlikely to change in the near future. Especially not in light of the low negotiated gas price, so dependency remains.

Money or sovereignty

Given their addiction, these countries do have their reasons for saying that they cannot pay European gas prices. On the other hand, the Russians can rightfully ask: why should we sell cheaper? It is obvious that the countries will have to offer something else in exchange.

So who benefits? Well, it is a matter of taste. In the Kharkiv Russian-Ukrainian agreement in 2010, Kiev negotiated a discount of $4 billion per year on gas prices (equal to 3% of the Ukrainian GDP at the time). In exchange, they leased the port of Sevastopol for another 25 years to the Russians. It seems to be an advantageous deal for a military base, even more so, if we think about what else the Russians could have asked for. Belarus had to sell its complete gas pipeline system for cheaper gas prices, and nowadays the Russians are cherry-picking from Belarusian factories and banks. If you do not have enough money, you have to put some of your sovereignty into the pot – no problem!

The only difficulty is that sovereignty is hard to price. The price changes from country to country, depending on how much it is worth to the population. Belarus and Armenia chose to become part of the Eurasian Customs Union and deepen military cooperation with Russia, and they both got their rewards from Moscow. Ukraine is apparently divided on this matter. Moldova, on the other hand, chose to be independent so far, and they were ready to pay the quasi-European prices (even though the local situation is complicated there by the fact that most of the energy consumption is concentrated in the breakaway state of Transnistria, for which Chisinau refuses to pay).

It seems that in these countries the price of sovereignty is too high for the political-economic elite or for a significant part of the local population. Obviously, it is still a question whether the reluctance to giving up their sovereignty eventually leads to bankruptcy. Does the majority of the population understand how much they would have to pay for sovereignty in their everyday lives? It seems dubious, if we consider Ukrainian household gas bills, which have not changed for three years, while state subsidies lavished on the sector have grown exponentially.

If we take a look at the state of Maidan square in Kiev, President Yanukovych clearly faces a tough choice: either to force the country to pay next month’s gas import bill or to make a concession towards Moscow. Now it seems he is trying both at the same time, but neither is working. He cannot complain: he had plenty of time in the last 4 years to come clean to the public about the contradiction between sovereignty and low household gas prices, yet nothing happened.

Eventually a Western counteroffer always arrives…

Even though on the supplier side of gas the Russians are alone, the demand side of sovereignty seems to be more competitive. But do not overestimate the enthusiasm of Western countries. Georgia, which managed to break free from the Russian energy grip, is dithering just like the others, even though it wants to get closer to the EU and would be able to do so without the fear of severe countermeasures from Russia (as opposed to Ukraine).

Still, eventually a Western counteroffer always arrives to Kiev or Chisinau that saves them from a too heavy deal with Russia. Even though these packages are often even more temporary than the Russians’ offers (and indirectly the money ends up on the bank account of Gazprom), still in many cases they proved to be the easier choice for Ukraine or Moldova.

Naturally, this is frustrating most of all for the Russians. Whatever they do, they end up being seen as the lousy imperialists: either because they sell the gas at market prices or (even more so) because they give a discount. Do not get us wrong: they are not saints – it is not very polite to start a customs war as a consequence of foreign policy decisions – but the economic logic stands behind them: if the buyer has no money on its account, they can ask for the “family silver”.

Social sensitivity does not exist in the dictionary of trade. Russians keep saying that, but it seems no one really believes it. Yulia Tymoshenko, the former prime minister of Ukraine is in jail now, because she managed to sign a European-styled contract with Gazprom (a very similar design has been working in the neighboring Hungary for 20 years now). The solely market-driven solution does not seem to be viable, European-style pricing is a market failure in itself (or at least it has very serious political preconditions). It’s as if only Gazprom was driving in the right direction on a highway, and everyone else would be coming the opposite way.

Regarding Ukraine, it may be the case that they are actually protesting for the most painful EU-partnership so far. Even if we forget about the customs retaliations that Russia would enact, high gas prices would remain. These prices, together with very low energy efficiency (inherited from the Soviet past) would lead Ukraine to bankruptcy. If they reject the Russian price discount, that forces a 2.5% GDP adjustment right away in itself. This is the price of sovereignty today. If they are willing to pay it, they do not have to negotiate with Russia and they can try their luck in the West. Is it worth the price? We are about to see…

If you liked the post, follow Barrelperday on Facebook!

Or subscribe to our Twitter feed or Newsletter

Tags: , , , , ,

No comments yet

Leave a Reply