Policy Papers

  • 03.02.2014

    Evaluating the options to diversify gas supply in Ukraine


    Ukraine is economically dependent on natural gas imports from Russia. This allows Russia to arbitrarily set the price or demand for economic (and political) concessions. In the past, Ukraine was able to use its significant role as a transit country for Eurasian gasto Europe to, nevertheless, negotiate relatively moderate prices. But this role isvanishing. After the completion of the first two strings of Nord Stream, 64% of theexports to Europe could circumvent Ukraine. If either South Stream or the next twostrings of Nord Stream are completed, Ukraine could be fully circumvented.

    Consequently, Ukraine could choose between three strategies:

    Strategy 1: Paying a very high price for natural gas (in the order of 400-500 USD/tcmunder current market conditions)

    Strategy 2: Obtaining lower prices in return for political and economic concessions

    Strategy 3: Reducing the price of gas imports by reducing its unilateral dependence

    In this paper we review main technical and economic options to reduce dependence, andthus to implement Strategy 3. Concretely, we look at three possibilities: i. diversifysupplies, ii. increase domestic production and iii. reduce demand. We quantify theindividual options in terms of available volume, investment needs, variable cost andimplementation time (see overview table on the following page).

    Obviously, implementing all available options independently from each other is not wiseas the combined volume would substantially exceed the demand of Ukraine and the costsof many of the options are quite substantial. This implies that a simple ‘all of the above’approach (i.e. implementing all options at the same time without taking into accountinterdependencies) would not be economic. Consequently, Ukraine must determine anoptimal portfolio of options under political, technical and economic uncertainties.

    Thereby, timing is important, as some of the options can be implemented quickly, whileothers might take up to ten years.

    The private sector can help to shoulder the (often) substantial investment cost. However,private investors require a firm commitment of the government to a sourcing and pricingstrategy. Increasing transparency in the setting of import prices and domestic pricesbased on supply and demand would substantially reduce the political/regulatory risk forinvestors. On the other hand, a volatile strategy towards price discounts for concessionsrisks shying off private investors. And without transparent and non-discriminatory accessto infrastructure is also an issue.

    In some cases, investments that are beneficial for Ukraine will not be conducted by theprivate sector. For example, investing in new import infrastructure (LNG or pipeline)could help to create competition for gas imports to Ukraine and hence might also forcethe incumbent supplier to lower prices in order to maintain its market share. This mightbe hugely beneficial for Ukraine, but might at the same time render the investment innew import infrastructure uneconomic. Consequently, private investors will at bestunderinvest, unless they are given the right incentives (for example, in the form ofoption contracts with the government).

    Finally, we caution that an import price below the European price will be difficult toachieve, as all potential exporters to Ukraine would reroute their volumes to Europe incase the price there is substantially higher.

    Attached file  (827.5 kb)
    Authors:  Georg Zachmann,
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