Ukrainian gas sector: a case study of Russian weaponization of energy

Research Questions

  1. Who are the crucial stakeholders of the Ukrainian gas sector?
  2. What are the vulnerabilities of the Ukrainian gas sector?
  3. What is the role of the Ukrainian gas sector in the Russian hybrid strategy?

1. Executive Summary

  • Ukraine has been an important country for transit of Russian gas further to Central Europe with Russia aware of this fact and weaponizing energy to influence Ukrainian stability. Widespread corruption along with two decades of general mismanagement have created a situation where the gas sector has become a domain of a few oligarchs with significant influence over Ukrainian politics and economy. A state-owned Naftogaz has been the predominant gas company with an unclear structure, while pro-Russian oligarchs have emerged as crucial gas stakeholders with Dmytro Firtash being the most significant one. Those realities have proved to be the main vulnerabilities for the Ukrainian gas sector, in conjunction with Russian intentions to build new routes bypassing Ukraine and possible cyber threats against critical infrastructure. In general, an instrumentalization of gas has been a significant instrument of the Russian hybrid campaign against Ukraine, though with decreasing tendencies.
  • The main hypotheses considering the gas sector of Ukraine are as follows:
    • H1: The Ukrainian gas sector has been monopolized by oligarchs with major influence on domestic and foreign policies.
    • H2: The biggest vulnerabilities of the Ukrainian gas sector are a dependence on Russian imports along with a widespread corruption.
    • H3: The gas sector has been an important element for the Russian hybrid strategy since it is one of the instruments to control Ukrainian economy and destabilize the country.

2. Analysis

2.1 Stakeholders

  • The main hypothesis considering the crucial stakeholders of the Ukrainian gas sector is as follows: The Ukrainian gas sector has been monopolized by oligarchs with major influence on domestic and foreign policies.

Gas has been the most important energy resource ever since Ukraine proclaimed its independence in 1991. It has been a strategic branch of Ukrainian economy, thus has attracted attention both from various actors. A major problem has been that some have been exploiting it for profiteering, while others weaponized gas in order to pursue other than purely economic goals.

Ukraine experienced a shady privatization of state-owned enterprises with the gas and generally energy sector being the most desired. However, the authoritarian presidency of Leonid Kuchma along with a general mismanagement of successive administrations or widespread corruption have allowed a small group of businessmen, labeled as oligarchs, to assume full control over the most profitable enterprises and create their personal fiefdoms with a major influence over politics. The first oligarchs with strong political positions had been former prime ministers Pavlo Lazarenko and Yulia Tymoshenko, herself being nicknamed “gas princess”, nevertheless they were later overshadowed by others with Rinat Akhmetov, Viktor Pinchuk, Ihor Kolomoyskyi, Petro Poroshenko, and Dmytro Firtash being the most influential ones.

All of those oligarchs, except Petro Poroshenko, have had stakes in energy business. Dmytro Firtash, considered to be the most main gas oligarch in Ukraine, has owned several gas companies as well as has had strong links with Gazprom. Others have had stakes in energy too, though focusing their business on other economic branches than gas, as demonstrated by Rinat Akhmetov controlling a coal industry in Donbass, Viktor Pinchuk supplying steel for Gazprom and Rosneft, and Ihor Kolomoyskyi with certain interests in oil.

The oligarchs are “private entities”, nevertheless they have managed to create a system where Ukraine was essentially captured by them. Dmytro Firtash is the best example of how this system has been keeping Ukraine as a captive of their interests. He came to be known once his company RosUkrEnergo reached an agreement with Gazprom to import gas from Turkmenistan to Ukraine and selling it for much higher prices to the consumers. Nevertheless, Yulia Tymoshenko reached an agreement with Russia five years later in 2009 that deprived the RosUkrEnergo of those profitable stakes and both actors became antagonized, with Dmytro Firtash eventually supporting pro-Russian Viktor Yanukovych to keep his business.

However, the oligarchic system has not managed to destroy the state involvement in the gas sector with the Naftogaz being its main representative. Nevertheless, the company has been plagued with a corruption as well as overshadowed by oligarchs until the Euromaidan, as demonstrated by the case when Dmytro Firtash was selling gas to end-users, but was refusing to pay the Naftogaz its revenues that is estimated to cost Ukraine about 2bn. USD. On the other hand, it should be noted that the Naftogaz had begun to gain a stronger role during the administration of Petro Poroshenko (2014-2019) that focused its attention on reforming the corrupted energy sector, including making the activities of the Naftogaz more transparent. An unbundling, simply meaning a market liberalization with objective to introduce competitive environment, is considered to be a main challenge for the company.

The gas sector of Ukraine has been plagued not only by oligarchs or the corrupted state system, but also by its main gas supplier, namely Russia. Gazprom has been a main instrument to exert the Russian influence in the Ukrainian economy and indirectly also in politics. The gas disputes between Ukraine and Russia have been occurring since the 1990s and the latter one realized that gas could be simply weaponized in order to influence the stability of the former one. The oligarchs and state-owned Naftogaz were linked with Russian subversion since all of them formerly constituted a nexus rewarding themselves with various advantages.

 

2.2 Vulnerabilities

  • The main hypothesis considering the vulnerabilities of the Ukrainian gas sector is as follows: The biggest vulnerabilities of the Ukrainian gas sector are a dependence on Russian imports along with a widespread corruption.

Ukraine used to be dependent on the Russian gas transmission system as it had been importing gas either from Russia proper or from Central Asia. It allowed Russia to effectively weaponize a gas in order to have a powerful instrument against Ukraine, encompassing blackmailing, destabilizing, or influencing local decision-making process. However, the events after the Euromaidan meant that relations between Ukraine and Russia have become almost frozen, thus the former one began to diversify its gas importers and the latter one began to diversify its transit routes in order to potentially disconnect Ukraine from Russian gas.

Both countries have had several disputes over gas transit with the most serious one occurring in 2009, when Gazprom halted the supplies to Ukraine since state-owned Naftogaz had owed an amount of money to the former one. Yulia Tymoshenko and Vladimir Putin reached an agreement then, but Ukraine realized that gas could be simply weaponized by Russia. An exaggerated dependence continued to be a vulnerability afterwards, mostly once Viktor Yanukovych assumed the presidency in 2010 and subsequently signed the Kharkiv Pact. It was nicknamed “gas for naval base” since it assured Russian supplies in exchange for an extension of its naval presence in Crimea, though it was highly unfavourable for Ukraine as it preserved formerly negotiated high prices.

On the other hand, there could be a strong counter-argument that a dependence on Russia has had a downward trend. Ukraine accessed to the Energy Community in 2011, thus adopting the internal energy market legislation, as well as has begun to negotiate deals on reverse gas flow with Hungary, Poland, and Slovakia. It has been importing more gas from the EU than from Russia in the last few years, though this gas usually originated in Russia, but was coming indirectly. Furthermore, there was a proposal to build an LNG terminal in Odessa and Ukraine also began to intensify an extraction of its shale gas deposits. Also the threat of the construction of Nord Stream II along with a potential halt of gas supplies across Ukraine should not be overestimated since the EU has demanded their continuation and potentially is possible to use a reverse flow.

Another vulnerability has been an extremely high level of corruption resulting in the inefficiency of the gas sector. The problem has been closely linked with the unreformed Naftogaz and the oligarchs preferring their business interests over Ukrainian strategic interests. Furthermore, a state-owned Naftogaz had been largely politicized entity until Petro Poroshenko assumed the presidency and began some necessary reforms of the energy sector. However, a market liberalization has not been reached to date and an unbundling is a goal to be reached to make the gas sector efficient and competitive against external pressures.

A new vulnerability for the Ukrainian gas sector may be the cyber threats in spite of the fact that it has not happened so far. However, the APT28, known also under a nickname Fancy Bear, which has been allegedly linked with the GRU, breached the systems of several electricity power distribution companies across Ukraine in 2015, thus causing a blackout for over 200,000 people. A natural gas transmission system may be targeted too, especially once Russia will not need Ukraine to transport its gas or to destabilize the country.

 

2.3 Ukrainian gas sector in the Russian hybrid strategy

  • The main hypothesis considering the role of the Ukrainian gas sector in the Russian hybrid strategy is as follows: The gas sector has been an important element for the Russian hybrid strategy since it is one of the instruments to control Ukrainian economy and destabilize the country.

The period from regaining independence in 1991 until the Euromaidan in 2014 was characterized by many disputes when Ukraine had been unable to pay high prices and Russia had been halting its gas supplies in order to destabilize the former one. Ukraine perceived the gas supplies as instrumental to ensure a relative social stability, thus managed to reach some agreement with Russia all the time even if it was usually very unfavourable to the domestic consumers. A major case of this hybrid strategy were developments during 2009-2010 when Russia had firstly halted all supplies in order to reach new conditions unfavourable to Ukraine and later signing the Kharkiv Pact that provided Russian military with long-term stationing in Crimea, which eventually resulted into its annexation later in 2014.

Russia, or more precisely Gazprom, was also instrumentalizing Ukrainian oligarchs in order to pursue own goals. The major case is that of Dmytro Firtash, who used to be the main Russian “gas asset” in Ukraine through his company RosUkrEnergo. Russia was applying its influence also over the Naftogaz through its political clients with the clique around Viktor Yanukovych being the most significant one.

However, the Euromaidan followed by pro-Western changes meant that Russia began losing an influence over the Ukrainian gas sector. Many oligarchs were sidelined and the Naftogaz has been experiencing the changes towards transparency. Generally, a market liberalization, albeit still unfinished, has proved to decrease Russian hybrid capabilities against the Ukrainian gas sector. On the other hand, Russia partially changed its hybrid strategy by building routes bypassing Ukraine, thus trying to threaten it with possible halting of supplies, which could be harmful for Ukrainian economy, thus acting psychologically on the local population too.

 

3. Forecast

Ukraine will be importing gas of mostly Russian origin even in the foreseeable future, though a majority of those imports will be coming by a reverse flow from its Western partners, mostly from Hungary, Poland, or Slovakia. Only a smaller portion of the gas imports will be coming directly from Russia or through its transmission network from Central Asia, thus further limiting a dependence of Ukraine on its eastern neighbour. A complete halting of the gas supplies from Russia would be also solvable, though it is improbable to happen since the Nord Stream II will not be finished until the beginning of 2020 and there have been negotiations on further gas imports even afterwards when Ukraine will remain an important transit country.

On the other hand, it is not realistic that Ukraine will be trying to diversify its suppliers significantly. Azerbaijan cannot be a viable option due to the lack of infrastructure and decreasing gas resources. It will also apply for Central Asian exporters since there is a poor infrastructure and there would be a necessity to use Russian gas network, unless building completely new routes through the Caspian Sea. Thus, Russia will remain an important actor in the Ukrainian gas sector, though its influence has been constantly weakening in the last few years.

 

4. Strategy options

The biggest threat is that the Ukrainian gas sector would be forgotten once the gas supplies from Russia will be imported by alternative routes. The EU needs to sustain its energy relations with Ukraine since a gas flowing from the member states of the former one has been crucial for the economy and stability of the latter one. Furthermore, those imports have been keeping Ukraine out of the Russian sphere of influence as well as limiting operational capabilities of the oligarchs or their foreign patrons, thus making the Ukrainian gas sector more transparent and viable.

The following strategy options should be considered in order to react effectively on above-mentioned threats:

  • The EU should insist on its former conditions that Ukraine will be supplied by Russian gas even once the Nord Stream II is completed. It would strengthen a position of the EU against Russia as well as preserve the direct imports to Central Europe through Ukraine. 
  • The EU or the Energy Community should support the ongoing reforms of the Ukrainian gas sector, such as its unbundling, to make it more competitive and transparent according to the European standards.
  • Ukraine should accelerate the reforms of the gas sector in order to reach a market liberalization, thus destroying the monopoly of the Naftogaz and some oligarchs. It would strengthen a Ukrainian position among its Western partners as well as make the gas sector more viable in economic terms.

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