Gas transit is a sensitive issue, particularly in a crisis-prone region such as the former Soviet Union. Strategic power games and geopolitical issues seem to dominate ‘pure’ economic theory when it comes to determining transit fees, capacities, investment projects, and the like. Privatisation and deregulation become highly sensitive issues as well. It may have come as a surprise, therefore, that amidst the political, economic and social upheaval of the post-Soviet transformation crisis, the transit of Russian gas to Central and Western Europe has continued smoothly, and even expanded. Indeed, recent contracts and economic forecasts seem to foresee an increasing role of Russian gas on the expanding Western European market.
Ukraine is a strategic link in this relationship. Until recently, it exercised monopolistic power for gas transit from Russia to Central and Western Europe and the Balkans, influencing prices and quantities. Gas also plays a dominant role in the development of the Ukrainian economy, transit revenues representing almost 10% of total exports. However, the quick fortunes to be made in this sector also contribute to the general political climate of rent-seeking and corruption, making the state reluctant to let go of this windfall and to introduce efficient corporate governance. While few changes have occurred in the gas sector during the first decade of independence, the pressure on Ukraine to modify the functioning of its gas transit activities is increasing:
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The technical state of the pipeline is said to be very poor. Indeed the under-investment of the last ten years is now beginning to show, be it in increasing compressor fuel consumption, or with corrosion problems. Estimates of investment requirements for the transit system alone vary between 0.5-2.0 billion USD;
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The issue of Ukrainian debt towards Russia stemming from unpaid energy bills is increasingly challenging the country’s independence, and thus the gas sector’s independence. As of late 2000, unpaid bills to Russia have reached about 1.4 and 2.0 billion USD. Russia is intensifying its lobbying efforts towards debt-equity deals, seeking ownership of the transit pipeline and of two strategic underground storage facilities;
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After several fruitless attempts to increase the transparency within the vertically integrated state owned gas monopoly Naftogaz Ukrainy (formerly Ukrgazprom), the Government is now seeking solutions to reduce the information asymmetry and extract more of the company’s rent. Several options are being considered, such as privatising Ukrtransgaz, which is actually a subsidiary of Naftogaz, or offering a long-term concession for the operation of the transit pipeline (most likely to a foreign company);
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The Northern connection from Russia through Belarus into the European Union, after having progressed slowly, now seems to be picking up speed, the new Yamal-1 pipeline linking Belarus (Minsk-Nesvizh) to Poland (Kondratki-Wloclawek) having been finished in November 1999. Its present capacity of 10 bcm (billion cubic meters), it is supposed to reach 28 bcm within 3 years and 56 bcm at a later date. The next step to bypass Ukraine would be the Yamal-2 pipeline connecting Kondratki (Poland) to Velke Kapusany (Slovakia) and thus to join the central corridor (the Brotherhood pipeline, see Graph 1). These developments put even more pressure on Ukraine’s negotiating power, and thus the profits resulting from gas transit.
This Chapter analyses the perspectives of Ukrainian gas transit given the recent developments, and potential repercussions on Russia and Western Europe. Our hypothesis is that unless Ukraine quickly puts in place a stable and reliable framework for gas transit, it will loose a large part of its current market share and profits from gas transit between Russia and Central/Western Europe.
The Chapter is structured as follows: Section 2 presents the current status of the Ukrainian transit pipeline system, both from a technical/economic and a political perspective. We discuss costs, spare capacity, investment requirements, and estimate the profits from the monopolistic gas transit in 1999. Section 3 provides an analytical framework for a concession of the International Gas Transit System of Ukraine (IGTS) to a Ukrainian or a foreign operator, currently under debate. Keeping in mind the negative experience with management contracts in Kazakhstan, some proposals for the design of a concession are laid out. The critical issue is the value of the pipeline for which we provide quantitative estimates. Finally in Section 4, we discuss options for external coalitions for the Ukrainian gas industry, including the role of Belarus as a competitor in the ‘market’ for transit. Conclusions are formulated in Section 5.
