1. Marc-Antoine Eyl-Mazzega Centre d’Etudes et de Recherches Internationales (CERI / Sciences-Po) Ukraine, between Russia and the EU: Strengthening regional stability through an effective and reformed gas market in Ukraine Presentation for the Regional Security Conference Lviv, 15-16/04/2010

2. Building an effective gas market Challenges and constraints -Gas market has not been adapted to market prices -Important level of gas consumption, especially public sector -Important value of state subsidy to the public sector -Single external gas supply source, hardly any other reachable as real alternative and diversification -Naftogaz near monopoly of imports, production and distribution though in a fragile situation due to intrigues and economics of gas imports -No rule of law, inefficient state regulation, conflicts between various private interests leading to instability -Rules of the game are political -No or hardly any credits available for the Ukrainian market Marc-Antoine Eyl-Mazzega – Lviv conference on regional security, 15-16/04/2010

3. Building an effective gas market Assets -Unique storage facilities, well located -Relatively important domestic production and existing reserves -Important transit volumes providing huge revenues -One of the world’s leading gas producer and exporter is the neighour -Many possible alternatives to gas available, just need to be developped -Ukraine draws attention from investors, far more could come in Marc-Antoine Eyl-Mazzega – Lviv conference on regional security, 15-16/04/2010

4. Building an effective gas market Key issue Having a liquid gas market, with relatively optimal and reasonable market prices, efficient, predictible, depoliticized and secure regulation through competition of actors, security of supply and mitigation of strategic risks Key risks: Price setting by dominant external actor and political and economic influence taking through gas supplies; Deterioration of infrastructure; Contradiction between private interests and state interests and use of state ressources for private interests; Ruin of state budget; Intransparency Marc-Antoine Eyl-Mazzega – Lviv conference on regional security, 15-16/04/2010

5. Building an effective gas market The check list (1) Is diversification of supplies possible ? No Is reduction of state subsidy to public sector possible? Yes Is reduction of public sector’s gas consumption possible? Yes Can gas be substitueted by alternatives fuels? Yes Is reduction of Ukrtransgaz gas consumption possible? Yes Is increase of internal production possible ? Yes Is improvement of market conditions possibles? Yes Is development of alternative fuels possible? Yes Marc-Antoine Eyl-Mazzega – Lviv conference on regional security, 15-16/04/2010

6. Building an effective gas market The check list (2) Is a gas market without Russian participation possible? No Can Ukraine afford continuing under the same system? No Can the state budget further support the current level of subsidy? No Can Naftogaz survive its indebtness? Hardly Should the Ukrainian citizen be satisfied with the current system? No Marc-Antoine Eyl-Mazzega – Lviv conference on regional security, 15-16/04/2010

7. Building an effective gas market The agenda of reforms (1)  EU lead reform agenda usefull, but not the one and only task  Increase domestic gas production to increase competition with Russian gas  Decrease public sector’s gas consumption to decrease burden on state budget and free up domestic gas for the industry  Increase the regulated prices, also for electricity! Differentiate consumers on the basis of their status: retired, or active  Use transit revenues to modernise gas pipeline system and finance the remaining state subsidy  Provide for exceptionnal investment conditions for foreign, private investor in the energy sector (otherwise no money will come and nothing will happen) Marc-Antoine Eyl-Mazzega – Lviv conference on regional security, 15-16/04/2010

8. Building an effective gas market The agenda of reforms (2)  Let Russian actors in: the more, the better !  Provide for innovative market access conditions and licence obligations for new actors on the distribution market: supply at least 15% of gas at regulated prices, store 20% of domestic supplies, pay taxes in Ukraine, provide for strong financial guarantees, and for long term gas supply contracts  Provide for transparent, stable and predictible working conditions for gas actors: rule of law is key, clear competition law with benchmarks, same as an independant regulator, with extensive energy security responsibilities and capacities to act Marc-Antoine Eyl-Mazzega – Lviv conference on regional security, 15-16/04/2010

9. Building an effective gas market The agenda of reforms (3) -Get a workable deal with Russia: greater flexibility of supplies, better price, in exchange for direct access to domestic consumers and relative advantage on the gas transit price -Make Naftogaz ready for competition and reforms, separe the gas from the oil function to make it more efficient in turning Naftogaz into a holding with two branches, NeftUkrajina and GazUkrajina and transform it into a dynamic gas actor -Rather to think about an LNG terminal, think about acceeding to Baumgarten gas -Establish a predictible, attractive and secure market and political environment to attract European companies in Ukrainian storage Marc-Antoine Eyl-Mazzega – Lviv conference on regional security, 15-16/04/2010

10. Building an effective gas market A Gas consortium? Objectives: secure funding for modernisation; strengthen trust as a gas transit corridor; improve transparency; ensure best level of revenues for state budget; develop opportunities for creating value through the gas storage facilities. The increase of volumes in transit or attempts to avoid alternative pipelines is irrealistic ! What to do? Unbundling; project of concession; new study of pipeline system technical state; decide whether investors will make money or just provide for stability; calculate what it may cost and benefit the state What should Ukraine not do? Consider the consortium issue in view of other stakes (gas price) and mix up short term arrangements with long term interests Marc-Antoine Eyl-Mazzega – Lviv conference on regional security, 15-16/04/2010

11. Building an effective gas market Future actors on Ukraine’s reformed gas market  Production: At least two international majors working under PSA Increased number of Joint production agreements with Naftogaz  Imports and distribution: 50% of industrial sector to be supplied by two Russian companies; 20% by Naftogaz; 20 % by private, Ukrainian companies; 5% by non Russian, foreign companies  Infrastucture and networks: Naftogaz/Private companies, even Russian, provided that strong regulatory framework providing for energy security, transparency and third party access  Exports/transit Gazprom, private Ukrainian and foreign companies, Naftogaz Marc-Antoine Eyl-Mazzega – Lviv conference on regional security, 15-16/04/2010

12. Building an effective gas market Future of Naftogaz in the gas sector -Be the country’s most important gas producer -Possibly, be the operator of gas transit infrastructure and storage facilities, or co-operator (if consortium) -Rely on a long term supply contract from Gazprom with reduced volumes (10-15 bcma) -Obtain a better market price from Gazprom in exchange for direct access to final consumer in Ukraine -Supply gas to about 70% of public sector at regulated, though increased prices and thus benefit from increased revenues -Supply gas to about 20% of industrial consumers at market price -Provide for budget revenues to cover the remaining subsidy Marc-Antoine Eyl-Mazzega – Lviv conference on regional security, 15-16/04/2010

13. Conclusion (1) Russia may be difficult partner, EU may be disappointing, but:  The ball lies in Ukraine’s hands. Urgent action needed, no further complaints, or irrealistic projects Ukraine should prepare for a different external gas equilibrium within the next 5 years. Ukraine will in no case transit more than current gas supplies. Important decrease of gas volumes in transit is likely (at least, 20%) Ukraine should change its gas market before it gets into further, heavy trouble and will suffer irreversible losses Marc-Antoine Eyl-Mazzega – Lviv conference on regional security, 15-16/04/2010

14. Conclusion Bring market rules in ! Bring foreign investors in ! Bring new players in the distribution and production! Let the market do its job ! Be prepared to suffer some inevitable costs at first ! Change before it’s too late ! Start developing a real gas policy ! Marc-Antoine Eyl-Mazzega – Lviv conference on regional security, 15-16/04/2010

15. Thank you! marcantoine.eylmazzega@sciences-po.org Marc-Antoine Eyl-Mazzega – Lviv conference on regional security, 15-16/04/2010