Why rising gas prices could boost Ukraine energy security

Russia is raising the price it charges Ukraine for its natural gas, and the interim Ukrainian government is upping the price of its own subsidized, domestic gas. Higher energy costs will hit Ukraine's economy hard during a delicate transition, but it could prove valuable further down the road.   

It's about to get a lot more expensive for Ukrainians to heat their homes and power their factories. That might be a good thing.

The price industrial consumers pay for domestic natural gas in Ukraine will rise nearly 30 percent starting Tuesday, according to the Ukrainian government. Meanwhile, Russia's state-owned gas company said Tuesday it will also raise the price of the gas it sells to Ukraine starting this quarter – by 40 percent.

Those are painful propositions for Ukrainian consumers, particularly for low-income populations who have come to rely on government-subsidized gas. It could erode some public support during a delicate, transitional time in Ukraine. But the price hikes are long overdue, analysts say, and necessary for Ukraine to assert its energy independence from Russia. 

Cheap Russian natural gas, combined with a corrupt energy market at home, have long kept Ukraine dependent on Moscow for energy, instead of developing its own domestic supplies. By boosting the price of its own gas, Ukraine's interim government hopes to make the country's energy use more efficient, and incentivize investment in its significant oil and gas resources. The decision by Russia to raise the price of its gas will only accelerate Ukraine's efforts to diversify its energy mix.

Energy sector reforms were a key part of an agreement signed last week between Ukraine and the International Monetary Fund (IMF) to loan the financially unstable nation up to $18 billion in aid from the West. Boosting domestic Ukrainian gas prices will help meet the IMF's terms, and elevated Russian gas prices will make Ukraine less likely to commit to tenuous, long-term deals with Moscow and more likely to look elsewhere for new sources of supply.  

"A key step is the commitment to step-by-step energy reform to move retail gas and heating tariffs to full cost recovery, along with early action towards that goal," Nikolay Gueorguiev, the IMF's mission chief for Ukraine, said in a statement regarding last week's agreement. "Importantly, this will be accompanied by scaled up social protection to mitigate the impact on the most vulnerable."

Ukraine bought about half of its natural gas from Russia in 2013, and the country serves as a vital transit route for Russia's gas exports to Europe. The two countries have a history of pricing disputes, with Moscow shutting off the gas twice in the past decade after Ukraine amassed large debts to Russia's state-owned Gazprom. Still, Russia and Ukraine remain reliant on one another for crucial parts of their respective economies. 

In many ways, it was Russia's discounted natural gas that sparked the ongoing tensions in Eastern Europe today. Last fall, Ukraine was making headway toward possible European Union membership when the country's deposed President Viktor Yanukovych canceled the deal and instead accepted an offer for discounted gas from Russian President Vladimir Putin. The move riled the country's Western-leaning population, sent protesters to the streets, and forced Mr. Yanukovych from office.

Ukraine has continued to amass debts to Gazprom totaling $1.7 billion, Gazprom's chief executive Alexei Miller said Tuesday in an announcement officially canceling the discounted rate. That will raise the price Ukraine pays for Russian gas from $268.50 per 1,000 cubic meters of gas to $385.50 per 1,000 cubic meters of gas. Before last year's discount, Ukraine paid a price of around $400 per 1,000 cubic meters of gas, according to Reuters.   

"The 'December' gas [price] discount cannot be applied," Mr. Miller told the press Tuesday, as reported by Interfax-Ukraine. "This is decided and is due to Ukraine not paying its debt for gas deliveries in 2013 and the absence of 100 percent payment for current deliveries and, accordingly, the increased debt for delivered gas."

The Ukrainian government has also long supplied natural gas at an artificially low price. That makes domestic producers less interested in exploring and developing local gas resources. The opaque, multitiered pricing system also encourages corruption and energy waste among wealthier recipients of the natural gas subsidy. 

It's why Ukraine's interim government is raising prices in an effort to end the negative effects of a gas subsidy. Industrial consumers will now pay about 29 percent more at $365.50 per 1000 cubic meters, while government agencies will pay about 64 percent more at $354.18 per 1,000 cubic meters.