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War and Energy in Ukraine

The following is an interview with Margarita Balmaceda, Professor of Diplomacy and International Relations at Seton Hall University. She is the author of The Politics of Energy Dependency: Ukraine, Belarus and Lithuania Between Domestic Oligarchs and Russian Pressure.

MOTYL: In your books you maintain that independent Ukraine inherited a highly inefficient energy system centered on the Donbas that became increasingly controlled by regional elites and oligarchs who used subsidies to line their pockets while producing less energy for domestic consumption and neglecting the needs of Donbas residents and Ukrainians. How has the ongoing war with Russia affected this system?

BALMACEDA: The war has affected this system in three key ways. First, Kyiv has stopped financing the coal mines located in the secessionist territories. 

Second, the conflict has disturbed the coal-coke-metal vertical integration systems built by eastern Ukrainian oligarchs since 1991. In some cases, parts of these integrated systems, such as coke plants, are located inside secessionist territory, while the metallurgical plants they supply are in in Kyiv-controlled territory. This has required owners to develop “creative” solutions to keep their plants and the system operational. It has also meant significant losses. In many cases owners have kept plant workers employed to support a modicum of good will as well as safeguard their assets. In some cases, plant workers have practically moved onto plant premises because these properties are safer than others.

Third, the conflict has also disturbed the Donetsk Basin geographically interconnected coal-coke-metal system accounting for more than half of Ukraine’s coal-and-metallurgy industry components. Many of the system’s components are located in the “gray zone” between government- and secessionist-controlled areas, as well as in the Russian side of the border. The war has made it significantly more difficult to move raw materials and products across internal boundaries and international borders with Russia. Just last week, the Donetsk Steel Works owned by Viktor Nusenky’s Donetskstal had to stop operations due to problems with the rail transportation of raw materials and finished products.

These are complex issues. For example, secessionist leaders in Donetsk have put pressure on the company to re-register in the so-called DNR so as to oblige the company to pay taxes to the DNR authority, but managers have refused because if they reregistered there, the EU, its main export market, would refuse their products.

MOTYL: How has the war affected the way Ukraine produces, purchases, and consumes energy?

BALMACEDA: There are three developments of note. The poor relations between Ukraine and Russia have forced Kyiv to purchase so-called “reverse supplies” of gas from Poland, Slovakia, and Hungary—this is gas that originated in Russia but is purchased from secondary countries. Given this arrangement, and given the recent mild winter, Ukraine has not purchased gas directly from Gazprom since November 2015. But Ukraine continues to depend on coal imports from Russia as it has largely lost access to coal produced in areas currently under “DNR” and “LNR” control. And, third, it’s noteworthy that Ukraine’s demand for energy imports declined with its declining GDP, which fell by 7 percent in 2014 and 12 percent in 2015 and has reduced demand considerably.

MOTYL: How has the war affected the power of eastern Ukrainian elites and oligarchs?

BALMACEDA: One of the key impulses for Ukraine’s Revolution of Dignity was the fight against corruption. Corruption was personified by President Yanukovych’s “family,” with various eastern oligarchs such as Rinat Akhmetov closely tied to that system. The war has diminished, but not erased his power. Akhmetov continues to have influence in the so-called “DNR” and “LNR” secessionist areas and he uses it as a bargaining chip with Kyiv.

More broadly, though the power of individual oligarchs such as Akhmetov may have declined, the oligarchic system is alive and well, as shown by the growing power of individuals like Ihor Kolomoisky. Some of these oligarchs are involved in property battles with the state–as in the struggle for control of the state-owned company Ukrnafta—yet, at the same time the state depends on their support of anti-secessionist operations. Needless to say, this complicates matters for the state.

MOTYL: Coal continues to play a key role in Ukraine’s economy. Could you describe how the war has affected that role?

BALMACEDA: Coal accounts for around 40% of electricity generation in Ukraine. The role of coal in Ukraine’s economy today has been driven largely by the legacy of the Soviet economic organization. The Donetsk Basin has been an important coal mining center since the 19th century. The Soviet industrialization and electrification drive capitalized on this to build a mighty coal and metallurgical complex in the area. The quest for rapid electrification led to the construction of many power plants that provide electrical power for Ukraine, each of which was designed to use the specific grades of coal available in the region. These specifications have limited the ability of some power plants to operate because the type of coal (mainly anthracite) traditionally used to fuel them is produced in mines now beyond the reach of Kyiv and under “DNR” and “LNR” control. And, given popular demand that no purchases be made from the separatist regions, Kyiv has turned to alternative supplies in South Africa which have been riddled with allegations of corruption.

MOTYL: What is the impact of coal subsidies in Ukraine?

BALMACEDA: In 2013 nearly two thirds of Ukraine’s state-owned mines were receiving state subsidies to offset the difference between the low price of coal and the much higher (at times nearly three times higher) cost to produce it. At the time, Ukraine spent nearly 3.5 percent of its budget on coal subsidies.

MOTYL: Is it fair to say that Ukraine derives no particular economic benefit from the occupied Donbas? Could one go so far as to say that Ukraine would be richer without the occupied Donbas—especially if it’s true that rebuilding the Donbas would cost $20 billion?

BALMACEDA: This is a difficult question to answer, as the whole system of prices and payments to Donbas mines has been and continues to be highly untransparent. In addition, Ukraine is a historical and economic unit and its regions are highly interdependent on one another, so it is hard to say that one region “costs” more than another. More generally, the desirability and appropriateness of the reintegration of Donbas cannot be reduced to an economic advantage issue.

MOTYL: How should Ukraine restructure its energy system?

BALMACEDA: Given the historically poor management of the coal industry and non-reversible geological conditions (difficult-to-mine resources, exhausted stocks, etc.), it will be impossible for Donbas to return to a coal-centered economy without significant costs to the state. Ukraine would be well advised to use the reintegration of the Donetsk and Luhansk regions now under separatist control as an opportunity to move their economy into forward-looking, high-tech areas rather than attempt a return to the previous status quo.

With respect to the national energy system important progress has been made on the top priority—reducing the country’s direct dependence on Russian supplies. Key measures have included modifying gas pipelines for reverse use, the importation of contractually non-Russian gas, the adoption of EU-conforming energy legislation, and the elimination of price differences between gas for residential and industrial consumers. The move to market-determined energy prices is unavoidable, but it needs to be accompanied by targeted subsidies for the most vulnerable sectors of the population, as well as an effective system of oversight that safeguards against corruption. In the long term, however, only a move towards greater energy efficiency and use of renewable resources can provide the basis for a more stable and sustainable energy system. 

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