Guest post: energy reform is Ukraine’s best weapon against Putin

Listen to this article

00:00
00:00

By David Clark of the Russia Foundation

For all the attention given to the fighting in Donetsk and Luhansk, it is clear that Ukraine cannot solve its problems by military means alone. If there is a route to national salvation it lies in the field of domestic reform and the quest to find a new model of internal development. It is only by emulating the achievement of neighbouring Poland and becoming a well-governed country with a strong, dynamic economy that Ukraine can hope to escape from its current predicament. As a ‘Slavic tiger’ it could provide a source of attraction strong enough to regain eventual control over the territories it has lost and perhaps even become a catalyst for change in Russia itself. Stuck in a post-Soviet rut of dysfunctional institutions and economic stagnation, it will remain weak and vulnerable to Putin’s policy of divide and rule.

The list of measures required for Ukraine to make that transition is long. But there is one reform that holds the key to many of the other changes needed and should therefore be thought of as a litmus test of Ukraine’s ability to take charge of its own future; it is the proposal to raise household energy prices to full market rates.

Perhaps as much as any other policy, the liberalisation of energy tariffs has been the key to the successful transition of former communist countries. It is a striking fact that all the countries that have taken this step have become stable democracies with functioning market economies, while those that haven’t have remained stubbornly post-Soviet in their modes of business and politics.

Energy policy certainly isn’t the only reason for this divide but the consequences of applying a multi-level price structure explain why the correlation is so strong. Often justified as a nod to the pro-poor welfare policies of the communist era, its retention has in fact provided a ramp for the very worst kind of crony capitalism. Setting a below-market rate for household energy use created opportunities for a select group of oligarchs to become staggeringly rich. In energy exporting countries like Russia, the gap between domestic and global prices allowed oil and gas to be sold abroad at a huge profit by those with the connections to get an export licence. In Ukraine, oligarchs have used political influence and a lack of transparency to buy energy at the household rate and sell to their competitors at the higher, industrial rate, making a fortune on the black market.

The existence of corrupt revenue streams has polluted politics and subordinated it to the interests and machinations of a tiny elite. Parliamentarians, presidential candidates and entire political parties have been bought and traded in order to achieve a division of the spoils in favour of one oligarch or another. This influence has been used to maintain an opaque and inefficient energy sector entirely contrary to Ukraine’s national interests. Why push to maximise the exploitation of Ukraine’s own energy resources and lower overall costs when you already have preferential access to cheap supplies, while dependence on expensive Russian imports offers another opportunity to divert public resources for private gain by acting as an undisclosed intermediary?

Collapsing the current multi-level pricing structure – there are 11 different rates – into a single rate, set by the market, would sweep away the single biggest source of corruption at a stroke. This is what the national energy supplier, Naftogaz, is urging the government to do. It wants a ‘big bang’ reform in the spring rather than the phased approach suggested by some. Along with the deregulation of planning rules to kick-start investment in energy efficiency and a new law on the gas market to bring Ukraine into line with EU competition policy, it argues that household energy consumption could be cut in half and domestic production radically increased with the introduction of new incentives to invest. Advocates of this approach say Ukraine could cease imports of Russian gas by 2017 and become self-sufficient in energy by 2018-20, strengthening the country’s fiscal position.

The main argument against liberalising household prices is the impact it would have on the poorest at a time when the Ukrainian economy is in a severe downturn. It is worth recalling how a toxic combination of inflation and recession contributed to the current crisis by turning ordinary Russians against democratic politics in the 1990s. With this in mind, plans are being put in place to compensate the worst affected and provide generous subsidies for a transitional period. Even a relatively indiscriminate system of subsidies would be worth the expense if it allowed the creation of a transparent, functioning market, because greater efficiency and higher domestic production would bring down prices in the longer term and allow subsidies to be phased out.

There will be justified scepticism that any of this is about to happen, even now. On three previous occasions – 2008, 2010 and 2014 – Ukraine promised to liberalise household energy prices in exchange for IMF support. Each time prices remained exactly where they were. The difference now is that the oligarchs who blocked change in the past have been largely discredited by association with the Yanukoich era and there is a growing realisation that many of Ukraine’s deepest problems – rampant corruption, the weakness of its public finances, vulnerability to Russian influence, the privatisation of state power – can be traced to the energy sector.

Energy price reform won’t solve these problems overnight but it is the indispensable first step without which the country will not be able to make a decisive break with its own past. The imperative of national survival may just be enough to make it happen.

David Clark is chair of the Russia Foundation

Back to beyondbrics

Copyright The Financial Times Limited 2017. All rights reserved. You may share using our article tools. Please don't copy articles from FT.com and redistribute by email or post to the web.