Market is the Key for Energy Independence

By the Editorial Board of VoxUkraine

Energy is at the core of the Russia-EU and Russia-Ukraine relationships. Since the 2009 gas dispute, which led to a 13-day interruption of the natural gas exports from Russia to the EU, European politicians have started publicly talking about reducing Europe’s dependence on Russian energy supplies. A lot more has been said than done on that front, admittedly. Yet, the issue has resurfaced recently, as Russia’s blatant disregard for international law and its aggression against Ukraine brought about fresh fears that the country will once again be leveraging the energy as a “diplomacy tool”.

The good news for both Europe and Ukraine is that a new player – USA – will be entering the European energy scheme. The currently ongoing shale oil and gas boom in that country is turning the United States into an oil exporter, and will likely bring US gas to Europe as soon as the relevant infrastructure is ready. A possibility of increased gas supplies from the Middle East could also change the balance in the European energy sector. It is our belief that:

• The EU and Ukraine need to confront Russia’s energy bullying by uniting their forces;
• In the short run, the EU and Ukraine should appoint a single agent to negotiate with Gazprom, with the European Commission taking a leading role. A preferred solution will be to sell Russian gas at the Russia-Ukraine border;
• In the medium run, Europe needs to actively pursue and encourage shale gas exploration and development. This will require striking a balance with the active environmentalist lobby movement (or culture) on the continent;
• In the long run, the EU and Ukraine should review their gas pipeline network, with the view of creating a structure similar to that present in the United States. The end goal should be redesigning of this infrastructure to facilitate creation of a single European natural gas market. This market will allow for a better substitutability between the energy suppliers, and will diminish the abuse of market power by Gazprom (or any other entity, for that matter);
• Ukraine needs to actively utilize market mechanisms and incentives to encourage development of energy saving technologies throughout the economy.

Ukraine: Strategic considerations.

By Andrei Kirilenko (Sloan School of Management, Massachusetts Institute of Technology)

In this essay I outline a strategic vision for the state of Ukraine. I begin with the main principles of the role of the state. I then argue that the Ukrainian state has largely failed to fulfill its role. I rejoice in seeing spontaneous volunteer efforts outside the failed state structures and suggest that instead of trying to administer a multitude of these efforts, the state needs to set a strategic overall direction so that its people can rally behind it. I suggest that this direction is ensuring independence from direct foreign interference now and in the future. Then, I argue that the place to start is with energy independence. I show that there are not enough resources in the entire domestic financial system to support Naftogaz in its current incarnation and that it cannot continue without external technological and financing resources. I argue that because of their systemic importance, the decisions on Naftogaz are inherently political and then outline options on dealing with the decision paralysis at the top, as well as a possible process for getting things started. I then suggest that once a political decision is made, the process would start with a standard problem of valuing risky cash flows. I outline the main sets of cash flows and describe potential but not insurmountable difficulties in valuing them. I then remark that once the risky cash flows are valued, policymakers can be presented with the recommendations about what to keep, what to sell off and for how much, and what to get rid of. I conclude with thoughts on other types of independence that need to be achieved in tandem.

How Ukraine has lost the policy making capacity

By Anton Shevchenko (Ukraine)

Summary (by the editorial board of VoxUkraine)

Recently, the parliament passed a law that taxes several industries. The law attracted a lot of attention because of its controversy: the prime minister threatened to resign, and media speculated about a conflict within the government. The public perceives the law as a success for the prime minister and, more generally, the government in its fight with the oligarchs.   

This post argues that the law is ill-advised and counterproductive. The law taxes the very industires that have been the engine of the economic growth in Ukraine in the recent years and thus harms the ability of the country to resist the looming economic crisis. Furthermore, the law makes evident the time-inconsistency problem of the Ukrainian government policy, reducing the capacity of the government to influence economy and investors. Finally, it taxes industries not the oligarchs: jobs will be destroyed, investment in the infrastructure discountinued, the tax revenues will dry up, while the oligarchs will move away from developing healthy industries towards rent-seeking activities within the state.  

This law is an example of a myopic and non-systemic approach to reforms in the times of economic and political crisis, which may do more harm than good. 

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Imagine a country with a projected 6 to 10% GPD decline. Economists play football with arguments (here and here) discussing whether or not the country needs state-funded stimulus. And here the arbiter comes: the government files a bill with a proposal to tax five industries which were the engines of economic growth in last couple years. Yes, you are in Ukraine.

So, the Ukrainian government filed a bill to parliament in the end of July, with an aim to raise short-term tax revenues because economy slowdown and inability to reduce budget expenses were increasing state’s deficit. In the proposal, the government suggested to increase mineral extraction tax for natural gas to 70% (from 28%), to prolong indirect duties on grain export of about 20% (through non-refund of export VAT) for a year and cancel certain subsidies for agriculture (on average 5-7% of revenues) thereafter. Construction industry had to lose the ability to postpone income tax payments until real estate is completed, hotel industry was due to forget about its income tax break until 2020 (granted as stimulus before EURO 2012), green electricity projects were also losing their ten-years income tax break introduced just four years ago. All suggested tax policy changes were due to come into effect either on 1 October 2014 or on 1 January 2015.