Happy New Year! Celebrating 2010 and my return to blogging, I present the top four energy sphere issues that Ukraine’s new president — likely to be determined on a February 7th runoff election — will face in the coming year.
- At #4, modernizations across the board. Ukraine’s coal mines are notoriously unsafe, its gas transportation system is in need of investment, and its refining sector is facing massive technological deficits. Modernizations at an industrial level can improve energy efficiency and boost the competitive positioning factories facing difficult times. How the government incentivizes locally-based investments and how it finds the money and partnerships for large-scale modernizations (particularly for the gas pipeline system) will be key.
- At #3, inflation and gryvna depreciation. While not specifically energy-related, the potential for continued inflation and further depreciation of the gryvna have a range of implications to Ukraine’s energy sphere. In particular, the majority of Ukraine’s energy sources are imported and bought with dollars while they are sold domestically on a gryvna basis. For institutions like Naftogaz that are based on relatively strict gryvna-based budgets, any increase in the exchange rate makes payment for gas imports that much more difficult. ¶ For consumers, this is most evident with the price of gasoline, given Ukraine’s high reliance on crude imports. Oil is bought with dollars, largely refined locally (where companies must pay gryvna wages) and the products are sold in gryvna terms. As the exchange rate weakens, the nominal price of gasoline increases for consumers, a trend that can be particularly vexing if they notice global oil prices not rising in a similar fashion.
- At #2, oil supply issues to refineries. Ukraine’s refining capacity is woefully underutilized and hampered by problems in securing adequate crude supply. Kremenchug no longer receives Russian crude after Privat seized it in late 2007. Neither of the two Privat-owned western refineries get Russian crude either, and both are operating at very low utilization rates due both to the supply issue as well as low complexity hampering the quality of product output. Lisichansk gets fairly stable crude deliveries from TNK-BP, but is still only at about 40% of its potential capacity. Odessa was near full utilization until a dispute with Ukrtransnafta forced a disruption and a new pipeline supply scheme in October 2009. ¶ If crude supplies stabilize, particularly for the key refineries, then an important industrial segment will have a stronger operating environment to push the recovery, and will be better prepared to make the investments in order to transition to higher fuel specification (see above). Also, on a macroeconomic basis, the country’s current account balance should strengthen as oil product imports decline. It would likely also represent a step towards more genial energy cooperation with Russia, since that is the most likely source of crude for Ukraine.
- At #1, recalculating gas tariffs. Ukraine’s government needs to fix Naftogaz’s finances so it no longer relies on cash injections from the central bank or IMF funds. The only way for this to happen is to bring revenues more closely in line with costs. While the NERC (the regulating body) has been willing to pass along increases to industrial consumers, sometimes even at unjustified levels, pushing them onto residential and “budget” users has been more difficult. It’s been impossible to do politically, with Tymoshenko being unwilling to take on the damage to her popularity such increases would bring. Meanwhile, the IMF is screaming down Naftogaz’s door, essentially demanding a more realistic tariff for the currently subsidized users. ¶ While technically under the purview of the Prime Minister, how the new President (and likely the new PM) handles this issue will be very important for bringing Ukraine out of perpetual “crisis” mode, particularly given the monthly account settling Naftogaz faces with Gazprom. A few different tactics need to be pursued, including increased energy efficiency to lower demand (current demand drops are relatively temporary due to slowed economic activity), a push toward individual gas metering to better measure consumption, and a shift away from blanket subsidies to a system of income-based assistance. No one wants babushka to freeze, but that doesn’t mean that the middle-class family living three doors down should get the same discount that she does.