8. UKRAINE- EFFECTS OF THE GAS CRISIS

ANALYSIS: Dr. Edilberto Segura

Director & Chief Economist, SigmaBleyzer
President, Advisory Board, The Bleyzer Foundation
Kyiv, Ukraine, Friday, December 30, 2005
The possible increase in gas from Russia would have a major impact on the
Ukrainian economy over the short term. But it should have healthy economic
effects over the longer term.

Ukraine imports about 25 billion m3 of gas per year from Russia. If the
price of gas were to be increased from $50 per 1000 m3 to $230 per 1000 m3,
Ukraine would spend about $4.5 billion more in gas imports from Russia (
[$230-50]/th m3 x 25 bn m3 = $4.5 bn).

On the other hand, Ukraine should be able to increase transit fees from the
current level of $1.09 per 1000 m3 per 100 km to a “European” level of about
$3.00 per 1000 m3 per 100 km. Since about 130 billion m3 of Russian gas
passes through about 850 Km of Ukrainian territory, the increase of $1.91
per 1000 m3 per 100 km would result in additional transit fees of about $2.1
billion ([$1.91 /th m3 x 100 km] x 130 bn x 850 km.

Therefore, the net increase in the gas bill for Ukraine would be about $2.4
billion per year ($4.5 billion – $2.1 billion). This increase represents
about 3% of GDP. Therefore, GDP would decline by 3% pa, ceteris paribus.
Since Ukraine has now a current account surplus of $2.7 billion, the
additional gas bill of $2.4 billion would bring Ukraine’s current account
into about balance, ceteris paribus. It would be a major increase, but not
a catastrophic one.

According to these calculations, the impact of gas price increases could be
manageable, ceteris paribus. But the impact on the balance of payments and
GDP would be more substantial, since many highly energy intensive exporters
may become unviable. It is difficult to predict the impact on exports and
GDP of the increase in gas prices to these industries, as it would depend on
the ability of these companies to retain their markets. Gas price increases
would also increase utility fees for everybody, further increasing costs.

But a catastrophic effect would occur if Turkmenistan, which provides 38
billion m3 of gas to Ukraine were to raise its gas price from the recently
agreed level of $60 per 1000 m3 to international levels. The import bill for
Turkmenistan gas would increase from $2.3 billion to about $9 billion in
2006.
MEDIUM TO LONG TERM EFFECTS
However, over the longer term, bringing gas prices to international levels
should have major economic benefits to the country. In fact, the
availability of cheap gas in the past has had a negative effect on Ukraine
similar to the “Dutch Decease” effect that has negatively affected so many
oil/gas-producing countries.

In these countries, the increased availability of foreign exchange through
cheap oil/gas prices has over-valued exchange rates and made other less
energy-intensive economic activities less attractive to investors. This has
led to a major misallocation of resources in the country, lowering the level
of efficiency – particularly energy efficiency – of the economy as a whole
over the long term.

It is no coincidence that the major industries developed in Ukraine over the
last decades (such as metals, fertilizer, etc) relied on cheap gas. It is
also no coincidence that Ukraine uses three times more energy per unit of
GDP that most European countries. The investments used in these industries
may have been better channeled to other industries in which Ukraine has a
competitive advantage (such as food processing or IT).

An increase in the price of gas should lead to a diversification of the
economy and improvements in energy conservation. But for these to take
place, substantial economic reforms would be needed to attract investments
in these sectors. The country would require a rapid and fundamental change
in its economic policies to give more emphasis to the creation of a
favorable business environment that would be attractive to investors.

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