Ukraine’s Unpaid Gas Bills Dwarf U.S. Aid as Tensions Mount

Apr 23, 2014 12:12 pm ET

(Updates with comments from Stratfor starting in the 20th paragraph. For more on the Ukraine conflict, see EXT2 <GO>)

April 23 (Bloomberg) -- Ukraine’s best hope for keeping furnaces and factories running through next winter is to store as much natural gas as it can after a U.S. aid pledge fell far short of the nation’s needs.

Energy supplies have given Russian leader Vladimir Putin powerful economic leverage in his battle with Ukraine. The former Soviet republic gets half its gas from Russia, and it’s the transit route for 50 to 60 percent of the gas Russia sells to other European nations.

U.S. Vice President Joe Biden told Ukrainian leaders this week that the U.S. would provide help so that “Russia can no longer use energy as a weapon.” Biden announced $50 million in aid, an unspecified part of which would go to develop the country’s gas reserves, explore alternative energy and improve efficiency.

Russia responded yesterday, when Prime Minister Dmitry Medvedev said Ukraine would have to prepay for gas shipments unless it starts paying down the $2.2 billion debt it’s accumulated through March.

Tensions escalated today as Ukrainian military units moved against pro-Russia separatists in several eastern cities, prompting Russian Foreign Minister Sergei Lavrov to threaten retaliation if his country’s “legitimate interests” are “attacked directly.”

The immediate danger facing Ukraine is a cutoff of Russian gas shipments for nonpayment of its debt. Medvedev told the Duma, the lower house of Russia’s parliament, yesterday that Ukraine’s only option is, “Gas for cash.”

Limited Options

“The near-term options are limited, so if supplies were cut off tomorrow, they’d be in a pretty difficult spot,” Jason Bordoff, who heads Columbia University’s Center on Global Energy Policy and is a former energy and climate adviser to the Obama administration, said in an interview yesterday. “Before next winter, they really want to be building up as much storage as possible.”

Saddled with aging electric generators, leaky furnaces and drafty apartment blocks that date back to the Soviet era, Ukraine lacks the infrastructure to curb energy demand enough to make a significant dent in its dependence on Russia. Exploiting new petroleum discoveries beneath the Black Sea will take years of drilling and pipeline construction to bear fruit.

Modernizing Ukraine’s energy infrastructure and attaining supply independence would take 16 years and require $170 billion euros ($234 billion) in investment, a figure that dwarfs its annual economic output, the Paris-based International Energy Agency said in an October 2012 report.

Waiting Game

Despite Medvedev’s warning and rising violence in eastern Ukraine, the U.S. wants to see how the situation plays out in coming weeks before deciding whether and how to fund the energy initiatives, according to a U.S. official who requested anonymity to describe internal policy deliberations.

Of the $50 million Biden pledged, $11.4 million is committed to funding Ukraine’s May 25 elections. If every penny of the remaining $38.6 million were used to help solve the country’s energy problems, it would be only about 1.7 percent of Ukraine’s $2.2 billion gas bill -- representing less than 2 cents toward every dollar of debt.

To reduce Russia’s leverage, Biden outlined a U.S. offer to advise Ukrainians about accessing gas from other European neighbors, developing domestic fields and accelerating extraction of gas from shale formations. The U.S. also would send experts to advise on energy conservation and regulatory change.

Additional Sources

Technical teams will visit Poland, Hungary and Slovakia to evaluate pipeline flow reversals, which are meant to “provide Ukraine with additional immediate sources of energy,” according to a White House fact sheet.

Matt Sagers, managing director of Russian and Caspian energy research at the consultancy IHS Inc., said that would have little impact. “About the only alternative source of gas available for Ukraine in the near term is reverse imports from eastern Europe,” Sagers said in an e-mailed response to questions. “But the total amount will remain relatively small” because of pipeline capacity and supply limitations.

Ukraine relied on Russia for 25.8 billion cubic meters, or 90 percent, of its gas imports in 2013, compared with just 2 billion cubic feet sourced from Hungary and Poland, according to IHS data.

Reduced Prices

The Hungarian and Polish deliveries halted during the first quarter of this year when Russia was providing the fuel at reduced prices to help prop up the regime of then-President Viktor Yanukovych. The pro-Russia Yanukovych was deposed in February amid violent street protests.

Experts from the U.S. Department of Energy and the Agency for International Development also will travel to Ukraine in May to advise officials there on maximizing energy efficiency, the White House said. The U.S. will work with the European Bank for Reconstruction and Development to help Ukraine attract private companies to increase output from domestic gas fields, according to the U.S. official.

Developing the country’s gas resources in both conventional fields and shale formations will take two to five years, said the administration official. Russia sees a longer-term threat in U.S. measures that suggest Russia won’t be able to use energy to bully eastern Europe 10 years from now, the official said, and that, in turn, gives Europe more strength in dealing with Russia today.

Changing Laws

Any company’s interest in operating in Ukraine has to be measured against the hurdles. First up would be changing laws to encourage oilfield technology providers such as Schlumberger Ltd., based in Houston and Paris, and Houston-based Halliburton Co., to want to work there, Ken Medlock, director of Rice University’s Center for Energy Studies at the Baker Institute said yesterday in a phone interview.

Additionally, U.S.-based drillers and exploration companies may have too much to lose in Russia, home to some of the world’s biggest untapped reserves, to risk angering the Kremlin by helping Ukraine resurrect its faltering energy sector, said Marc Lanthemann, Eurasia analyst at Stratfor, the private intelligence consultancy to governments and corporations based in Austin, Texas.

Commercial Decision

Explorers also would be reluctant to work on one of Ukraine’s largest shale formations because it sits in the eastern part of the country, where violence between government forces and pro-Russia separatists has been most intense, said Lanthemann, whose firm was described in a 2001 Barron’s article as “the shadow CIA.”

“All of that points to it being a very slim chance that you can actually see any meaningful assistance from the United States to Ukraine that would help them in any way,” Lanthemann said in a telephone interview today. “For the time being, the risks continue to outweigh the rewards.”

Ukraine’s manufacturing industry is “crippled” by aging facilities and equipment, and the housing stock is poorly built and insulated, contributing to energy wastage, the IEA said. Foreign energy explorers won’t invest significant sums in the country without “a vast improvement in the business climate,” according to the report.

Ukraine’s economic output is smaller than Ireland’s, which has 1/10th the population. The former Soviet possession is also perceived as one of the most corrupt societies in the world, ranking 144th out of 177 in Transparency International’s Corruption Perception Index last year.

Even if the regulatory issues get worked out over time, the geology for unconventional resources in Ukraine is still relatively unknown, Medlock said.

“You have to drill to know what you have,” he said. “There’s very little information.”

--With assistance from David Wethe in Houston and Daryna Krasnolutska, Daria Marchak and Volodymyr Verbyany in Kiev.