Ukraine: is discounted gas good?

Gas matters. The embassy follows closely talks between Kyiv and Moscow on gas supplies; and between the Ukrainian authorities and the IMF about prices for domestic gas. We care because these talks can affect security of gas supplies to Europe; the Ukrainian economy; Ukraine’s domestic politics; and international relationships. According to the International Energy Agency, global gas demand will increase by more than 35% between now and 2035. Gas is also one of the cleanest hydrocarbon fuels – and will play an important role as we work to minimise the impact of global climate change on economic growth and energy security.

The concept of discounted gas is important to understanding the debate about gas in Ukraine. There are two broad types. The first kind is gas which a country can persuade other countries to sell it at a discount, for whatever reason. The second type of discounted gas is that sold within a country when eg domestic consumers pay less than industrial users. This blog is about the first kind.

Gas is an unusual commodity. It is less fungible than other commodities and harder to transport than eg steel, coal or grain. Traditionally it’s been traded on long-term fixed bilateral contracts and transported by expensive, fixed pipelines. There is less of a world spot market for gas than there is for other commodities (but see below). Pipelines create powerful ties between producers and consumers, and difficult negotiations. Naturally, producers want the highest prices they can negotiate; consumers want the lowest. In the case of Ukraine, securing cheap gas supplies could potentially benefit the economy by reducing inflation; saving money to the budget; and making Ukrainian industry which uses gas more internationally competitive.

But there are problems in negotiations of this kind. The first is what Ukraine has to give up in return for securing potential discounted gas supplies. This is a familiar issue which is at the forefront of the minds of everyone engaged in gas negotiations, so I won’t go into it further here. A second issue is that, if most of Ukraine’s supplies come from a single supplier, that weakens Ukraine’s negotiating position. Some theorists argue that gas-importing countries can become “hostages” of their suppliers during price negotiations.

So what can Ukraine do? There is some good news. New sources of “unconventional gas” are diversifying supply around the world. It is becoming cheaper to transport gas by ship. Gradually, a spot market is developing, making it easier to secure gas more cheaply from alternative suppliers. These developments by themselves mean that Ukraine could, in theory, have a stronger negotiating position than in the past by diversifying gas suppliers. Ukraine could strengthen its position further by forging ahead with energy efficiency – thus consuming less gas; by encouraging domestic gas production; and by diversifying into energy sources other than gas.

Some of these measures have already been announced. But progress remains challenging. This is where the second type of “internal” discounting comes in. If domestic gas prices were increased, this would have a big impact on the willingness of consumers to invest in energy-saving technology and to turn down their thermostats. It would also give producers more incentives and resources to invest in exploration and exploitation of gas resources inside Ukraine. I hope to blog more about this shortly.