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25 July, 2018  ▪  Oleksandr Kramar

The energy two-step: first forward, now backward

How corrupt oligarchic lobbying by a Russian monopoly on Ukraine’s electricity market is destroying the country’s energy security and making Ukrainians pay more for energy than they should

An anti-Ukrainian comeback in all areas of the energy sector is one way to call what’s been going on in Ukraine’s fuel and energy complex (FEC) over the past year. In the interests of Rinat Akhmetov’s business empire and corrupt business schemes for the supply of energy from Russia by other oligarchic entities, and with the active support of government agencies, a number of phenomena have been picking up pace:

(1) artificial restrictions on the production of inexpensive power at the country’s AESs and the obstruction of diversified supplies of nuclear fuel for them;

(2) artificial increases in power generation at TESs or CHPs operating on anthracite imported almost exclusively from the Russian Federation, including coal from Russian-occupied ORDiLO;

(3) the obstruction of a switch from coal to coal gas at such TESs;

(4) protracted failure on the part of the central government to act to stop years long sabotage by local governments and Geonadra, possibly also under influence from the aggressor country, which has been aimed at disrupting the expansion of domestic extraction of natural gas;

(5) increased domestic dependence on Russian petroleum products and gasoline.

The systemic and large-scale nature of these developments and the threat that they present to the country’s energy security indicate that this is deliberate sabotage aimed against Ukraine.

The corrupt oligarchic pushback that has been growing since the partial success of recent years, especially spring 2017, has already thrown Ukraine off track on the path to increased energy independence, even compared to the levels that had been reached in the first half of 2017. Things are only likely to get worse further.

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Starting with a 20/20 vision 

Ukraine is unique in that it has all the resources necessary to cover domestic demand for natural gas, yet it is not only not using these resources but has remained hostage to imported Russian gas ever since it declared independence.  As a result, all these years Ukrainians have not only suffered economic losses but also political and security risks, by becoming the target of blackmailing external players instead of taking advantage of their own natural wealth.

In May 2016, the new management of Ukrgazvydobuvannia, the state gas extraction conglomerate, finally presented its 20/20 program, which had the support of the Cabinet and aimed to increase extraction of natural gas to 20 billion cu m by 2020 from the then 14.5bn cu m. Together with private companies, output would have reached 27bnn cu m. With gas consumption on a positive trend towards reduction in 2015-2016, this level of extraction would have allowed Ukraine, if not to completely stop importing gas to at least keep imports within a relatively symbolic range of 5-10% of domestic demand. That kind of level would clearly no longer represent an energy security threat to the country. 

The successful implementation of the 20/20 program was especially significant as it would have removed the biggest risk: Gazprom’s threatened shut-off of transit gas through Ukraine’s GTS once it completed its bypass pipelines to Europe through the Baltic and Black Seas. This had constantly provided a means for serious blackmail as long as Ukraine had a huge shortfall in gas for domestic needs. But most importantly, had there been a successful balance between domestic extraction and domestic consumption, the window of opportunity would have opened for a considerable reduction in the price of gas for Ukrainian consumers as the price formula “European hubs + transport” would change to “European hubs - transport.”

At this point, however, it’s clear that the 20/20 program has been thoroughly disrupted because of the actions and inaction of government agencies, and mainly because of the destructive emergence of an internal struggle among different interest groups in the current government. In their eyes, stopping their rivals out-trumped the other factors: undermining national security, weakening Ukraine’s position in the face of pressure from Gazprom, discrediting the idea of the country becoming gas independent and instituting market reforms in its gas sector.

 

Ending with 20/17?

External evidence of this catastrophic situation on the gas market was when information about the volumes and dynamics of natural gas extraction in the country suddenly became unavailable. A section called “information in the form of open data” appeared on the Ministry of Power and Coal website and the websites of companies like Naftogaz, Ukrgazvydobuvannia and Ukrtransgaz, which had regularly been posting information about their successes in increasing the extraction of natural gas prior to the start of 2018 suddenly stopped doing so. Finding very generalized information about what’s actually going on in the sector, let along across individual companies is still possible, but it now takes more of an effort and so this information has become accessible to a smaller circle.

The explanation is quite simple. After extraction numbers reached a certain level in 2016-2017, starting in February 2018, the gas extraction industry suddenly began to extract less: 1.59 bcm instead of 1.6 bcm compared to February 2017, and 1.61 bcm in 2016. This trend grew more noticeable in March, when it was 1.74 bcm vs 1.78 bcm in 2017, and by May 2018, it was at 1.73 bcm vs 1.76 bcm in 2017. Between June 1 and 23, total extraction was down 9 million cu m compared to the same period of 2017. In short, not only was extraction not increasing in 2018, as planned in the 20/20 program, but it was down 110mn cu m compared to the previous year. Financially, compensating for this quantity of natural gas at current import prices meant that Ukraine would have to pay UAH 85 million.

By now, domestic extraction is back down at 2016 levels and not because of objective obstacles that lie outside the control of the Ukrainian government. It has happened exclusively as the result of a tug-o-war among various centers of power inside the Ukrainian government and the failure of the government to react to open sabotage and damage on the part of specific local government agencies and regulatory bodies. In this case, the Poltava Oblast Council sabotaged Ukraine’s largest, fully state-owned company, Ukrgazvydobuvannia, which should have been the main engine establishing Ukraine’s independence from foreign gas suppliers and had all the necessary investment capital to increase extraction. Over the last two years, the Poltava Council rejected requests from the company for special permits 54 times, completely without justification or reason. As a result, Ukrgazvydobuvannia was unable to exploit subsoil resources in one of the country’s key gas fields.

Blatant sabotage

Meanwhile, on May 30, 2018, Ukrgazvydobuvannia was forced to stop extracting hydrocarbons at its working wells at the Southern Kolomatskiy deposits in Kharkiv because Derzhgeonadr, the state subsoil resources agency, held up the renewal of the company’s license. All told, this agency has failed to issue extensions on a total of 39 special extraction permits to the state company for a stated reason, “lack of forms for extending special permits,” that screams of corruption.

As a result, instead of the planned 16.6 bcm of extraction in the 20/20 program, Ukrvydobuvannia management has lowered its projections to 16.0 bcm, although the negative dynamic so far this year suggests that the company may not be able to reach even this figure. The company is already preparing the public to understand that, post factum, 20/20 will likely turn out to be 20/17: General Manager Oleh Prokhorenko recently announced that “delayed decisions to issue new special licenses, the continuing absence of a streamlined permit system, and the blockage of hydraulic fracturing and other operations under our existing licenses mean that 3 bcm of extraction is currently at risk by 2020.”

The country’s leadership has shown itself incapable, or else uninterested in confronting this sabotage by local and central agencies. Possibly it is even helping disrupt the operations of specific companies that are associated with political rivals. For instance, Ukrnafta reduced its extraction of gas by 17% in 2017, from 1.3 bcm to 1.1 bcm. This year, it continued to cut production. The main reason here was again the blocking of extensions on Ukrnafta’s special permits by Derzhgeonadr. Moreover, extraction at private companies also shrank in 2017, from 4.2 bcm to 4.1 bcm, although they, too, had been raising output steadily over the previous few years. Since the beginning of 2018, data on their output volumes and trends were removed from public access and are no longer being published in the “open data” section on the Ministry website.

Instead of moving towards energy self-sufficiency and eliminating its dependence on Russian imports of natural gas, the government today appears to be taking the country in the opposite direction, to a variation of “Dutch disease” and a time when rents and other revenues from extraction slowly turn into a key source for budget funds. For instance, from January 1 until June 21, Naftogaz Group companies contributed over UAH 60bn to the state budget in the form of taxes and dividends. Revenues from the group amounted to 18.4% of all the revenues in the state budget for January – May 2018.

Meanwhile, over the last two years, systematic blocking of the switch to fully market prices for natural gas has meant that the old system of cross-subsidizing within Naftogaz that encouraged wasteful consumption of energy prior to 2013 has simply been modified and is being covered through the state budget. Naftogaz has been paying tens of millions of hryvnia in taxes for domestic gas that it sells for close to market prices and then this money is transfused through the Social Policy Ministry via the household subsidy mechanism.

Together with the Treasury’s dependence on revenues coming from taxes on imports, this all sets up a dangerous mixture that will destroy any incentive for those in power to work on the development of the country’s economy. When the nation’s budget relies more and more on taxes on the extraction of energy resources and imports that are paid for more and more by money transfers from migrant workers and cheap credits from international financial institutions, this slowly establishes a closed circle that harms the country and any incentives for domestic growth.

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The anthracite two-step

The situation in the power industry is no better. All the positive changes of spring 2017 seem to have been completely cancelled out. In some aspects, the situation is even worse. Over February-June 2017, the country reduced its imports of anthracite from ORDiLO, sharply increased power generation using gas coal, which is mined in non-occupied parts of Ukraine, and, most importantly, began generating 60% of its electricity at its AESs. Lately, however, there has been a full-scale comeback of the oligarchic corrupt schemes at the expense of the nation’s energy security and consumer interests.

Last spring, 842,000 t of anthracite were used, whereas this spring, it jumped to 1,303,000 t. A monthly comparison of the power generated at AESs and TESs, and the quantity of anthracite used these last two springs shows that 60% of anthracite actually burned off and the nearly 70% imported from Russia over this time were really not necessary (see The Anthracite Lobby). They could easily have been replaced by power generated at AESs, which was sold by Energoatom at a price that was nearly four times cheaper at UAH 0.55/kWh ex VAT, than at TESs at UAH 1.90/kWh or CHPs with their UAH 2.15/kWh pricetag, all of which operate using Russian anthracite. Instead, the country’s AESs were operating at barely over half capacity: 57% vs a still-low 72% in the same month of 2017.

Moreover, anthracite is being imported almost exclusively from the Russian Federation, possibly including coal from ORDiLO coming via Russia. The latest figures for January-April 2018 show that Russian coal was over 91% of all 1.34mn t imported during this period, despite the fact that, as Derzhstat data shows, Russian coal cost US $104.00/t, slightly more than South African coal at US $101.70/t. In other words, Ukraine could easily have diversified its supplies of anthracite, but this was not done. On the contrary, the share of Russian anthracite imported grew further compared to 2017 or 2016, when only 68% came from there.

In short, using Russian anthracite can only be explained as the result of government lobbying by business interests tied to Russia. Given that it had no economic justification but, on the contrary, worked against the competitiveness of Ukraine’s economy because it led to an inflated cost of electricity and harmed the standard of living of ordinary Ukrainians through higher-than-necessary electricity rates. The only way to explain this away is through the corrupt interests of the country’s leadership.

The main instrument currently harming the country’s energy security and corrupting its top officials remains the Sloviansk TES, with its mysterious beneficiary owner or those who lobby its interests in Ukraine’s corridors of power. For instance, over March-April 2017, the plant was effectively shut down and its capacity was successfully compensated for by coal-fired TESs and the Zaporizhzhia AES. By contrast, in April 2018, it fired more than 37% of 319,000 t of all the anthracite used across Ukraine’s entire power grid—not including the Luhansk TES, which is cut off from the rest of the national grid—and nearly 50% of all the anthracite used by all of Ukraine’s TESs, less LTES. For 24 days of June, the Sloviansk TES used up nearly two thirds of 74,400 t out of 113,100 t of total anthracite used by all of Ukraine’s TESs and nearly half of the 151,400 that was used by Ukraine’s entire power grid—both less LTES. What’s more, unlike the anthracite used at DTEK TESs, all the anthracite for SLES was bought exclusively from the enemy.

The Ukrainian Week has noted in the past that the shortfall of anthracite in Ukraine that is generally imported from a hostile country should only be used when there is a lack of capacity and there is the risk of a wave of blackouts. However, lately it has once again begun to be burned as though there were plenty of it being extracted on non-occupied Ukrainian territory. If this continues further, Ukraine will completely artificially become more and more dependent on the enemy and electricity will remain very overpriced for end users. Clearly, the only proper solution to this situation is to completely forbid the import of anthracite from Russia or for the public to block its delivery from there.

Significantly, the anthracite-based TESs of Ukraine’s southeast are competing, not just with cheap electricity from AESs but specifically with AESs that use fuel rods from Westinghouse, a US corporation. In short, Ukraine’s looking at a disruption in the diversification of sources of nuclear fuel as well, because American-made fuel rods are used exclusively at the Pivdennoukrainskiy and Zaporizhzhia AESs. Moreover, more recently the fuel is being actively unloaded at the Zaporizhzhia AES. For instance, in June 2016, nuclear fuel rods from Westinghouse was delivered to the operational area of ZAES’s 5thpower unit and then was moved to the mixed zone: 75% “Russian” rods and 25% "American." In June 2017, additional Westinghouse rods were delivered and accounted for 50%. By September-October, Westinghouse nuclear fuel rods were delivered to the operational areas of the 1st, 3rdand 4thunits of ZAES. These power units were switched to a mixed use of 75% Russian and 25% Westinghouse fuel. The 5thpower unit at ZAES will already be loaded with 75% American fuel and only 25% with Russian rods. At two of the units, the share of American fuel rods is expected to reach 50% this year

Truthfully, the replacement of Russian fuel at Ukraine’s AESs is painfully slow. Rosatom’s share is once again growing while Westinghouse’s is shrinking. To compare, in the first four months of 2017, Russian monopolist’s share fell to 53% in value, whereas in January-April 2018, it was back up to 78.3%, while the American share was down to 21.7%. ZAES’s 2ndand 6thunits are not even planning to use Westinghouse fuel rods, while the western Ukrainian AESs, Rivne and Khmelnytsk, continue to operate exclusively on Russian fuel and the process of switching has no even begun.

In this way, inaction, lack of coordination and the open lobbying of government agencies by business interests linked to power generation at TESs and primarily the import of anthracite from Russia mean that Ukrainian consumers are once again being made overly dependent overpriced electricity from DTEK, Donbasenergo and the CHP, because it’s generated using anthracite.

Translated by Lidia Wolanskyj

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