The electrifying issue of power prices

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The West is happy with the reform of the Ukrainian energy sector. However, according to the auditors, the tariffs for customers are inflated.

The transit of Russian gas to the West is financed by consumers. The budget is not profiting either. Big companies and politicians from the top levels of the Ukrainian government are winning once again.

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“We welcome the ongoing substantial energy policy reforms in Ukraine, and strongly urge it to pursue further ambitious reforms of its energy sector”, announced the leaders of the G-7 in a communique issued at the conclusion of the May summit.

For the time being “substantial reforms” can mainly be seen in the prices. Electricity prices rose by 25 per cent from March 1st, and the next increase is planned for September 1st. In total, as a result of the “tariff reform” launched last April, they will have increased by 350 per cent by next March.

In April, the Ukrainians were hit by another increase – this time relating to the prices of natural gas. In accordance with a regulation of the Ukrainian government of April 2014, gas prices for individual consumers were supposed to grow for three consecutive years: by 40 per cent in 2015, and by 20 per cent in 2016 and 2017.

As indicated by the government document, in principle the increases in gas prices were supposed to lead to a situation in which they would reach “an economically justified level securing the full coverage of the weighted average price of purchase of natural gas”. However, this provision has long been forgotten in Ukraine.

After a series of increases a Ukrainian recipient currently pays UAH6,879 (approx. USD275) per one thousand cubic meters of gas. The authorities made an exception for religious organizations – they pay only about half as much.

Critics of the government’s tariff policy are reminding that in accordance with Article 13 of the Ukrainian Constitution natural resources, including gas extracted in the country, belong to the citizens who are entitled to freely use these resources. And that, in their opinion, means that gas from domestic extraction cannot be treated as a commodity and that citizens may only be required to pay a charge covering the costs of extraction and distribution, and not for gas itself. This was once confirmed by the former Prime Minister, Arseniy Yatsenyuk.

“Each of us should receive gas from the Ukrainian domestic extraction. The citizens of Ukraine consume 18 billion cubic meters and we extract 20 billion cubic meters. Its maximum value is currently USD70-100, depending on where it is extracted. But it is not provided to the citizens at that price. They sell it to companies at the price of USD300-400 and they put the margin into their pockets. And then they siphon this margin off to tax havens”, he commented http://finance.obozrevatel.com/business-and-finance/97085-vremennaya-amneziya-chto-rasskazyival-yatsenyuk-o-povyishenii-tarifov-chut-bolee-goda-nazad.htm on the tariff policy of the team of Viktor Yanukovych in November 2013.

According to the data of the state-owned gas company NAK Naftogaz Ukraine, last year Ukraine extracted 19.9 billion cubic meters of natural gas. Currently Ukraine is using 18 billion cubic meters for the needs of individual customers and utility services.

In spring last year, the news service “Obozrevatel” commissioned an audit firm to investigate what should the market price of gas be. It turned out that last year’s tariff was already 180 per cent higher than that estimated by the auditors. Among other things, the government did not include the annexation of the Crimea, or the occupation of a part of the Donbass region in its calculations regarding gas consumption by individual consumers. The amount of gas supposedly consumed by citizens was artificially overstated by including the consumption of social organizations and religious groups.

“Obozrevatel” also quoted the then Deputy Finance Minister Denis Fudashkin who admitted that the profitability of the business of gas extraction in Ukraine at the price levels applicable before last year’s increase was 775 per cent.

The fact that the price of gas that the government established for citizens in the internal market is overstated was indirectly confirmed by the Ukrainian Deputy Minister of Economy, Yuliya Kovaliv, who presented calculations in May, according to which the “economically justified” price of imported gas is now USD257 per 1,000 cubic meters, which includes: the cost of the raw material in the German hub – USD146, the cost of transport to the border with Ukraine – USD39, and USD72 of distribution costs and VAT.

She informed that the government decided that gas extracted in Ukraine should be sold at the “market price”, that is, the price of imported gas, lowered by the cost of transport from Germany to the border, which means USD218 per 1,000 cubic meters. The current price – USD275 per 1,000 cubic meters – is therefore much higher than even the price calculated by the government. As a result of the “tariff reform”, a significant portion of Ukrainians simply ceased paying their bills. And Ukrainians are still facing yet another price hike next year.

According to the data of the State Statistics Service of Ukraine published at the end of May, only in April – the first month of the new tariffs – the debt of individual consumers in respect of municipal services more than tripled – from UAH4.3bn to UAH13.4bn. Out of that UAH6.3bn are heating and hot water debts, associated with the increases in gas prices, and UAH2.8bn are electricity debts.

According to Ukrstat, there are no debts in respect of the supplies of gas itself, because they are covered by a system of state subsidies – the regional distribution companies belonging to the oligarchs have received a lot more funds from the state budget in this respect than individual customers actually owe. A record was set in the Kirovohrad Oblast, where the distributor received 386% in excess of the actual amount due.

EU transit paid for from the pockets of Ukrainians

It is easy to understand the satisfaction of the heads of Western states with the Ukrainian ”tariff reform” – the EU consumers of Russian gas are their biggest beneficiaries alongside the Ukrainian oligarchs. This was indicated by the calculations presented recently by a famous Kiev-based political scientist, Sergey Gaidai. According to him, the real price of gas for the citizens which is economically justified is approx. UAH 2,000 per one thousand cubic meters.

Gaidai wrote on Facebook: ”UAH1,590 is the fee for gas production for the state-owned company UkrGas Vydobuvannya – here everything is clear, the company carries out prospecting works, extracts the gas, operates the devices, pays the salaries of the workers. And the rest of the money? UAH2,000 goes to NAK Naftohaz Ukraine. On what basis? They have nothing to do with gas extraction. This is a company which is responsible for the transportation of Russian gas through our gas pipelines to Europe.”

“So what are we paying Naftohaz for? It turns out that the operation of gas pipelines and equipment requires expenditures. And the state has decided to pay for them out of our pocket. Ukraine is transporting gas from Russia to Europe at a loss. And this loss will be covered by our citizens. I thought that the state was supposed to make money and use that money for the benefit of the citizens. And here, it turns out, that we should be paying for the loss-making activity of our state, so that Europeans could use the gas from the country which attacked us, which is killing our citizens and which took a part of our territory.”

New Homo Sovieticus

For Yevhen Holovakha, deputy director of the Institute of Sociology at the National Academy of Sciences of Ukraine, there is no doubt that the tariff policy of the government and the resulting need for massive subsidies for the citizens will have catastrophic consequences for Ukraine. He warns that as a result of this policy, the government is creating a ghetto in Ukraine, just like 40 years ago in the United States.

According to his data, out of the 45 million Ukrainians, 4 million families, that is approx. 10 million people, are already benefiting from the government subsidy program. If the tariffs continue to grow, this number could soon reach 15-20 million. As a result, nearly every other Ukrainian will be dependent on the money provided to him by state officials.

“Rent for an apartment in Europe can amount to two hundred euro. But in our country the average salary was EUR250 in 2014, and now it is EUR150. Unlike the rest of the reforms, the government is carrying out the program of tariff increases with great resolve and persistence,” he commented in an interview with the “Ukrainskyi Tyzhden” weekly.

Holovakha draws attention to the dangers associated with the system of subsidies developed by the government in connection with the increases. This is an economically barren system, employed in order to siphon off money from the budget – money which was previously taken away from citizens as a result of price hikes. He warns that the effect will be the transformation of the average Ukrainian into a homo sovieticus.

“The more citizens receive state aid, the more of them become socially dependent people, who hate their benefactors. And at some favorable moment, these people will bite the hand that feeds them. They admit that they are not able to protect themselves and their family. These people will take the money but by further reinforcing dependence and jealousy we are creating a class of people ready to do anything to preserve their free benefits,” says Yevhen Holovakha. According to the chairman of the Committee of Economists of Ukraine Andriy Novak, Kiev will soon experience an explosion of social unrest: “The Ukrainian government is confidently marching towards a «tariff Maidan».”

The citizen is paying and the elite is profiting

Journalists from the investigative anti-corruption project Nashi Groshi described a mechanism through which a Donetsk oligarch and certain financial structures associated with the president made significant profits on the reforms in the energy sector.

As they reminded, the energy company DTEK, owned by the oligarch Rinat Akhmetov (who is indicated as a sponsor of the pro-Russian militants in the Donbass region, and is also accused of links with the Donetsk mafia), recently had serious financial problems – at the turn of 2015 and 2016 the Eurobonds issued by DTEK reached junk level, and in March the Fitch ratings agency downgraded the company to the level of “limited insolvency”, indicating that the company has not repaid its debts within the maturity dates.

The situation of DTEK has changed dramatically due to the decision of the National Commission for the Regulation of Energy and Public Utilities (NKREKP). In April, the NKREKP approved a new method of determining prices for electric energy – the so-called “Rotterdam formula”. The price of coal in the port of Rotterdam plus costs of transportation to Ukraine were adopted for the calculations. The adoption of such a price was motivated by the necessity of becoming independent of coal from Donbass and from Russia, and in connection with the imports of this raw material from South Africa. Several weeks later, the Ministry of Energy informed that it would not import coal from South Africa as before, because there is plenty of domestic coal available and it also announced its intention to buy anthracite from the mines controlled by the pro-Russian militants in the Donbass region.

However, the formula for the setting of tariffs was not changed and a price of coal which is UAH1,500 higher than the price on the domestic market was adopted for the determination of electricity prices. Practically, the decision of the NKREKP means that Ukrainians will pay for energy produced from local coal, as if it was produced using the much more expensive imported raw material. The money extracted in this way from the pockets of taxpayers will go to the local oligarchs, Nashi Groshi concludes. According to estimates, this amount could reach UAH9.5bn, or approx. USD400m. Nashi Groshi also drew attention to the suspicious activities regarding DTEK’s debt securities, taking place simultaneously with the strange decisions of the NKREKP. As the journalists pointed out, after the decision to maintain the “Rotterdam formula” for domestic coal, the price of DTEK’s Eurobonds increased by 40 per cent in just two weeks.

In total on the market there are bonds released by DTEK with a total nominal value of USD750m and a redemption date in 2018. According to information provided by General Director Maxim Tyshchenko, they were purchased by investment funds Ashmore and VR Capital, the Russian bank WTB and the  company ICU, founded by the head of the Ukrainian Central Bank, Natalia Gontareva, which handled, among others, the investments of Petro Poroshenko.

Dmytro Vovk, head of the NKREKP, adopting decisions favourable to DTEK, was previously a manager at the Moscow branch of the confectionery company Roshen belonging to Poroshenko. He also worked at the ICU.

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