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Europe Project Paper #3 European Energy Strategy for Ukraine

by Dr. Sergiy Korsunsky, Director-General of the Economic Department, Ukraine Ministry of Foreign Affairs.


The new century put the old problem of reliable supply of oil and gas on the radars of the world’s most developed economies. Discussion of the issue took up half the G-8 Summit in St. Petersburg this past summer. There could not be better place for such a discussion. Last winter Ukraine and Moldova, Georgia and Turkey, Germany, several central European states and other members of the EU were shocked with Russia’s brutal attempt to cut off the gas supply to Ukraine for political reasons. Disruption was not caused by a war like in 1973 or in the 1990s; it was not related to growing consumption by China and India; or to unresolved financial issues with consumers. It simply was punishment for Ukraine’s democratic development and pro-western foreign policy. We need look no further than the media reports earlier this year, and figures speak for themselves.

Analysts and some government officials in Moscow acknowledge a correlation between gas prices and political ties in the former Soviet Union, though Russia’s state-owned natural gas monopoly disputes that its pricing is politically motivated. Eastern European and Caucasus countries that signed contracts with set prices for fuel range from benign Belarus being charged $47 per 1,000 cubic meters of natural gas to Moldova, which aspires to join the EU and is battling Russia-backed separatists, charged $160 per 1,000 cubic meters of natural gas. Ukraine, which aspires to join NATO and the EU, was offered the price of $220 per 1,000 cubic meters of natural gas. Kiev refused and delivery of fuel stopped.

Arguments about the necessity to raise prices for Ukraine four-fold because of the “market conditions” which suddenly became important in December 2005 could not be accepted seriously for a very simple reason – there is no gas market in our part of the world. In Western Europe you can argue about some market conditions since there are at least two or three suppliers besides Russia (Norway, Great Britain and Algeria), but in the eastern and central Europe it is Russia only. Gazprom has bought out all available gas from Central Asia and constitutes now an almost 100 percent monopoly both for natural gas resources and its transit in the FSU region up to the Ukrainian border.

Tensions on the oil and gas markets due to increasing energy consumption in Asia, political instability in Venezuela and Nigeria, terrorism-related disruptions in Iraq and Middle East, decreasing availability of resources in Europe facilitated by the above-mentioned unexpected move by the Russian Federation made energy security a top priority for all major consumers, particularly in Europe. Ukraine occupies an important if not key position in the energy-supply chain between Russia and Europe with more than 80 percent of the EU’s import of Russian natural gas and oil transiting through its territory and must decide what kind of policy would serve best national interests of Ukraine and those of Europe.

The geopolitical reasons for Ukraine’s choice are simple. It is difficult to be a servant with two masters, particularly if they pray to different Gods. On the one hand there is a major trade area for Ukraine, the European Union of which Ukraine hopes to be part one day. The EU believes in a transparent market approach and an integrated diversified network of suppliers, transit facilities and consumers, although it is true that the EU has not been able to formulate a coherent energy strategy until now. On the other hand there is a major single trade partner – Russia – which believes in a government-controlled energy sector and monopoly on export and transit routes with a very clear and coherent energy strategy formulated in 2003. It says that energy will be an important foreign policy tool aiming to bring Russia back to super-power status. It is a sovereign right of every country to decide how to use its resources, but maintaining normal business relations with Russia in the energy sector should not prevent Ukraine from participating as profoundly as possible in formulating a common European Energy Policy, which must include Ukraine.

Adopted earlier this year the EU’s Green Paper “A European Strategy for Sustainable, Competitive and Secure Energy” is not as perfect, as some scholars think, and needs further elaboration. But this is a very important document and it is encouraging that Ukraine is mentioned in it as an “essential strategic partner”. And yet it says little about the connection between a common European energy strategy, which is being elaborated and the facilitation of Caspian oil and gas supplies to the EU through Ukraine and Turkey. Apparently, the Black Sea region and Caspian basin are crucial in securing the most real diversification projects for the EU and therefore deserve full attention.

Europe and its energy partners are interdependent and with respect to Ukraine it is clearly stated in a bilateral Memorandum of Understanding on Co-operation in the Field of Energy between Ukraine and the European Union signed on December 1, 2005. Additionally, the EU encourages Ukraine together with Turkey to join the South East European Energy Community Treaty transforming it into a truly pan-European Energy Community. Ukraine is a member of the Energy Charter and unlike Russia has ratified its Transit Protocol. Those documents set up necessary preconditions for the development of a truly pro-European energy strategy for Ukraine. It must include an appropriate legal environment, market-based energy policy, practical steps in developing real projects like Odessa-Brody-Gdansk.

The reality is such that the EU is relatively poor in conventional energy reserves. Therefore Europe’s economic future depends on a secure, affordable and sustainable energy supply. But to achieve this goal it is no longer adequate to assure simple physical availability of energy sources. Supply policy needs to consider the immediate and longer-term availability of energy products at a price which is affordable to all consumers (individuals and industrial), while respecting environmental and other requirements for sustainable development. It also needs to take into account trends in demand in Europe and Asia as well. Analysis done by the European experts confirms that under current patterns of energy production and energy use, the European Union is consuming limited reserves at a rate which compromises the availability of energy to future generations and threatens the local and global environment.

For the EU, energy supply has an internal dimension and an external dimension. Internally, as everybody agrees, Europe needs to balance supply and demand, while respecting environmental, consumer, safety, political and economic conditions. But Europe is increasingly dependent on imports and therefore the external dimension prevails. Best available estimates show that under the current assumptions the community’s overall import dependency will rise from today’s 50 percent to about 60 to 70 percent in 2020. Especially critical is import share of oil and natural gas. Imported oil is likely to increase from 80 percent of total EU oil supply in 1997 to 87 percent in 2010. Gas imports are forecast to rise from 40 percent today to 66 percent in 2020. Growing imports are not in themselves a threat to security supply, but they highlight the importance of good trade links, communication and political relationships with external partners. Therefore, as the Green Paper says, in recent years the objective of independence from external energy suppliers has been replaced by the objective of managing external dependence. European energy supply faces different forms of risk and its analysis worth separate consideration. But risk from transit could be easily eliminated through inclusion of major transit partners, like Ukraine, into the European energy policy framework.

On the Ukrainian side contribution into a common European policy means that security of supply, competitiveness and sustainability in the energy sector is to be provided. In this connection the energy security principles set by the International Energy Agency are to be reinforced, particularly concerning upholding of contractual commitments and application of market-based principles at all stages of the energy supply chain. At the recent U.S.-EU Summit it was noted that “diversifying sources of energy and modes/routes of transit, and ensuring non-discriminatory third-party access to transit infrastructure will improve the functioning of energy markets worldwide” while “open, transparent, non-discriminatory and stable legal conditions that ensure fair and equitable treatment for energy investment and trade are essential to helping producing and transit countries meet market demands”. It is difficult to question that further development of production and export capacities in producer countries in a safe and secure environment, and the upgrading of existing and development of new energy transportation infrastructures by producer and transit countries as well as further development of refinery capacity in all countries are critical. As well, it is very important to create a legal framework and technological monitoring mechanisms to deal with emergency external supply events, no matter who is the supplier or consumer. This might include, in particular, emergency oil and gas reserves to compensate for unforeseen supply disruptions, such as those caused by natural disasters or politically motivated decisions.

But well before any strategic moves are in progress much simpler things could be done right away. Namely, proper accounting of quantity and quality of gas and oil transporting through the Ukrainian territory must be guaranteed. It is hard to believe but a project to install measurement gadgets at the entrance and exit points of the Ukraine’s pipelines was started only recently with appropriate assistance from the European Commission. Similarly it was agreed last year with the EU to set a special internationally certified quality-assessing centre not far from Kyiv to monitor the quality of gas crossing Ukraine to Europe. Once both projects are completed Gazprom will not be able to blame Ukraine for “illegal siphoning” of gas and Europeans will know who is to blame if gas of improper quality is received.

Ukraine’s energy sector occupies a strategic place in the national economy and internationally. By cumulative power generation Ukraine is twelfth in the world. Our proven gas reserves and its production are comparable with those of Azerbaijan or Kazakhstan but at the same time we consume more gas than Italy, France, the Netherlands. To satisfy its own needs, Ukraine has to import up to 60 percent of the necessary hydrocarbons from Russia with some “input” from Kazakhstan, Azerbaijan and Turkmenistan. (Here it seems appropriate to note that in spite of some statements in the media, not a molecule of the Central Asian gas reaches Ukraine or Europe. Buying good quality Turkmen or Kazakh gas, Russia consumes it itself, while consumers in Europe receive literally Russian gas only). Having in mind that Russia maintains a monopoly on the production of nuclear fuel for the Soviet-designed nuclear power plants, we must recognize that the Ukrainian energy sector has a very low level of diversification. It is Ukraine’s transit capacity of 35,600 km of gas pipelines, which is practically unmatched in the world, that constitutes the only lever to fight for fair prices and honest contracts with the Russian monopoly. The transportation capacity of 170 billion cubic meters annually with underground storage reservoirs with a total capacity of 32 billion cubic meters can satisfy the current and growing needs in Europe. Therefore any concession to Gazprom on the issue of a gas transportation consortium without major international participation will have a disastrous effect on our ability to secure national and European interests vis-à-vis Russia.

Geographically Ukraine is well-situated to serve as a transit bridge between the Caspian basin and Central Asia with it growing production of hydrocarbons and Europe with its growing consumption. And quite naturally, Ukraine is to be an active participant of the major transportation projects in the region. The Baku-Tbilisi-Ceyhan (BTC) pipeline is a huge step toward real diversification of export routes for the land-locked Caspian states, particularly Azerbaijan and Kazakhstan. But if it was not easy with oil, then doubled efforts are required to develop another diversification project for natural gas which would bring alternative resources to consumers in Balkan and central European countries. Such a project exists; it is the NABUCCO pipeline. Recently the European Commission named this project among the most strategic for the European Community. It is envisioned that numerous countries will contribute the necessary volumes – among them Azerbaijan, Iraq, Egypt, probably Iran, and an even longer list will serve as a transit route, including Georgia, Turkey, Romania, Bulgaria, Hungary and Austria. For this project it is very important to bring Turkmenistan and Kazakhstan on board to secure a stable balance of gas supply. Ukraine can contribute pipes and equipment and construction experience into joint efforts and hope to diversify its sources of gas through NABUCCO as well.

Experience in many countries around the globe proves that oil and gas reserves alone can not bring prosperity and security. The Soviet Union with its energy might set the best example. The majority of leading producers and exporting countries can hardly be recognized as stable and democratic. The Gulf economies are highly dependent on oil revenues and with no exception lack a vibrant private sector. Russia shears now leading place with Saudi Arabia in terms of oil export but oil-dollars brought almost nothing to the average Russian not to mention technological reconstruction of the Russian industry or social infrastructure. West Africa has the highest rate of discovery in the world mostly in the Gulf of Guinea, and the majority of the growth comes from Nigeria and Angola. But ethnic clashes inside those countries prevent fair and stable flow of oil revenues to the economy. Venezuela does not belong to the most prosperous countries of South America in spite of huge oil and gas reserves. Probably, only major European producers - Norway and Great Britain - constitute an exception to this rule. It is apparent that it is not enough to have oil and gas reserves and maintain energy infrastructure. It must be combined with investment and implementation of modern technologies and those two are strongly connected with political stability. Only through cooperation, transparent and market-based dialogue and real partnership will the goals of sustainable development in Europe be achieved. Ukraine will contribute its part, no doubt about it.

The views and opinions expressed in this Europe Project Paper do not necessarily reflect those of JINSA.


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