The Time Bomb. According to the new Russian gas price formula, with the recovery of a world economy, the economy of Ukraine will feel worse.

In the comment to my last post, Leopolis mentioned (very reasonably) that the reliance on a cheap gas has harmed Ukraine’s energy security. It harmed Ukrainian economy as well. Yes, that’s true that Ukraine lost a lot of time, not taking any significant measure to ensure the development of energy saving programmes. As a result, Ukrainian industry is extremely energy consuming, and Ukrainian economy is one of the most energy intensive on the continent. But it is not a fault of Viktor Yushchenko as a President (though he could do something in this field instead of just talking). The problem is that Ukrainian and foreign (mostly Russian) oligarchs who privatised big powerful plants and factories – at a very low price actually – didn’t care at all about any energy saving during all the 17 years of independence of Ukraine. These people, together with Ukrainian politicians, just used low gas prices to earn millions, or even billions of dollars. Business climate is so co-dependent with political situation in Ukraine that it’s really more reasonable for businessmen to have a fast profit today than to invest in an uncertain future.

Anyway, to switch to the market gas prices at the peak of the world economy crisis is also an evil for the country. Ukrainian industry simply doesn’t have time and financial strength for quick modernization and re-equipment. As a result, thousands of workers will lose jobs, provoking the social crisis. It opens a room for some radical or extremist ideas to override the common sense, which is really dangerous.

But the main problem with Russia-Ukraine gas agreement is that it contains a delayed-action bomb – according to the gas price formula, with the recovery of a world economy, Ukrainian economy will feel worse. Everyone noticed that the base gas price for that formula (which nobody have seen) is $450 per tcm. So, de facto Ukraine agreed for the raise of the price of Russian gas almost in three times – in December 2008 Kiev still paid $179.5 per tcm of gas from Russian pipeline.

$450 is really a very high level, taking to the account the geographical closeness of Ukraine to Russia. For example, in the first quarter-2009 Germany will pay $470/tcm, but the cost of transit of gas from Russia-Ukraine border to Germany costs not less than $50/tcm (only Ukrainian transit fee is around $20/tcm). One more example: according to the information of the Secretariat of the President of Ukraine, Hungary will pay for Russian gas only $400/tcm in the first quarter-2009. Romania pays $470, but buys only around 4 bcm of gas every year.

So, if we take these “European averages” together, we will have a base price for Ukraine around $400-420, but not $450.

Ukraine will not suffer a lot from the new gas price in 2009, as it will be presented with 20% discount. Meanwhile, it is still not clear, how much will Kiev pay in average during the year. Gazprom officials made public only the price for the first quarter 2009 – $360/tcm, and mentioned that the average price “may be less than $250”. The Prime Minister of Ukraine Yulia Tymoshenko said that the average figure is $228.8. It’s still $50 more than a price-2008, but Ukraine will definitely survive.

Well, Ukrainian industry will survive in 2009, but not develop. European industry instead will have a unique opportunity to use low gas prices for future growth of its potential. Ukrainian plants and factories will definitely lose their market competitiveness. I have to mention here that – according to the Moscow agreements – the GazpromSbytUkraine Company will control up to 25% of the domestic industry gas market of Ukraine, so, Russians will have a possibility to support loyal and “punish” competitive Ukrainian enterprises.

But the most important changes are expected not in short-term, but in mid-term prospects. What will happen, when the world economy will start recovering from the current crisis? Oil price will grow. As oil price will grow, gas for Ukraine will be more and more expensive. I would like to inform that the gas price of $450 corresponds not with a peak oil price of 2008 - $140/barrel – but with the price of Brent at the level of $111,4, according to the Naftogaz source. So, in 1,5-2 years time Ukraine will unfortunately face its own big economy crisis. …But it’s not an important question for Ukrainian politicians: all the worst is going to happen AFTER the presidential election.