Sunday, May 2, 2010

Ukraine and the Expansion of the Russian Government

Ukrainian citizens who thought the era of intervention from the Russian government was over are second guessing that notion this week.

According to Catherine Belton over at the Financial Times,
"Vladimir Putin has proposed the merger of Gazprom, the Russian state gas company, with Naftogaz, the Ukrainian state energy company, as part of its efforts to reintegrate the former Soviet republic’s economy following the election of Viktor Yanukovich, the pro-Moscow president."
This comes after the Ukrainian parliament ratified a 25-year time extension on Tuesday, April 27th to a lease contract the Ukrainian government has with the Russian government under which Russia's Black Sea Fleet may utilize the Ukrainian port of Sevastopol until 2017. Now the Fleet may remain at Sevastopol until 2042. In exchange for the time extension, the Kremlin, via Gazprom, has promised to cut the price of natural gas in the Ukraine by 30%. The deal had been brokered by President Yanukovich and President Medvedev

In addition to this, on Monday April 26th Prime Minister Vladimir Putin offered yet another deal with the Ukrainian government "to establish a major holding, which would unite our generation, nuclear engineering and nuclear fuel cycles." According to Roman Olearchyk of the Financial Times, "The unexpected offer would produce a European nuclear giant based on the vast nuclear power industries inherited by both nations from the USSR."

These events alone should be sufficient to remove any doubts as to whether or not the Russian government is attempting to expand its influence throughout Ukraine, at the expense of the Ukrainian people of course. Take the lease-for-oil deal. At first glance, particularly from an economic perspective, the deal seems reasonable. As Tomas Valasek, director of foreign policy and defence at the Centre for European Reform, states,
"Ukraine’s economy is in deep trouble (it contracted by 12 per cent in 2009), and Kiev’s policy of subsidising domestic gas sales is breaking the treasury. It seems like a simple calculation: why not give Russia something it already has (the right to station forces in Ukraine) in return for something the country badly needs (cheaper gas)?"
Well, if a decrease in the price of natural gas is an end sought by President Yanukovich, then there are far superior alternative means towards the fulfillment of that end. First of all, Ukraine contains a great deal of natural gas itself. As the U.S. Energy Information Administration states, "According to the Oil and Gas Journal Ukraine has roughly 40 trillion cubic feet (Tcf) of natural gas reserves, from which roughly 0.68 Tcf was produced in 2005." Thus, the price of natural gas in Ukraine can be reduced by exploiting those reserves and increasing the supply. Furthermore, if reserves dwindle from production, then surely it's the case that different goods can be introduced as substitutes since extracted natural gas isn't the only factor that can produce electricity and heat.

Substitutes for natural gas increase the elasticity of the demand for natural gas. As the elasticity of natural gas increases, the degree to which the quantity of natural gas demanded will change in response to a change in the price of natural gas increases. Thus, with an increase in substitutibility and therefore elasticity, the high price of natural gas will shift money and therefore demand away from natural gas and into the natural gas substitutes, increasing the demand and therefore the prices of those goods. If the prices of the natural gas substitutes are sufficiently low to begin with, then large-scale substitution can serve to expose demanders of heat and electricity to lower prices.

Oil is a substitute for gas. Coal is a substitute as well, a commodity in plentiful supply in Ukraine. Substitute natural gas (SNG) can be produced from lignite coal and, according to BP, Ukraine contains 17,829 teragrams of subbituminous and lignite coal. The Ukraine need not focus on consuming one primary fossil fuel.

As a matter of fact, Ukraine need not resort exclusively to hydrocarbons. Nuclear power is (in addition to being my personal favorite source of energy) not unavailable to the Ukrainians. The country contains its own uranium deposits as well as 15 operating reactors producing half of its electricity, so its obviously not a nuclear-adverse nation, even with its troubling past with Soviet reactors. Why not add additional reactors?

These suggestions raise many questions however?

How can natural gas production increase in the Ukraine? How can the production of substitutes begin as well, especially nuclear power?

The cause of Ukraine's destitution, aside from years of grinding economic abjection as a member of the Soviet Union, is its spectacular lack of economic freedom. According to the 2010 Index of Economic Freedom,
"Ukraine’s economic freedom score is 46.4, making its economy the 162nd freest in the 2010 Index [out of 179]. Its score is 2.4 points lower than last year, reflecting reduced scores in six of the 10 economic freedoms. Ukraine is ranked 43rd out of 43 countries in the Europe region, and its overall score is lower than the world average."
According to the Index, Ukraine suffers from a severe lack of business, financial, and labour freedom, exorbitant government spending, rising inflation, and an abysmal lack of governmental respect for private property rights. According to Transparency International, Ukraine also suffers from prolonged corruption, ranking 134th out of 179 countries in its Corruption Perceptions Index of 2008. But, most importantly, Ukraine's investment freedom is its worst category. According to the Index,
"The laws provide equal treatment for foreign investors, but certain sectors are restricted or barred. Burdensome bureaucracy and regulations are the primary deterrents to investment. Contracts are not always upheld by the legal system, and privatization has slowed. Resident and non-resident foreign exchange accounts may be subject to restrictions and government approval. Payments and transfers are subject to various requirements and quantitative limits. Some capital transactions are subject to controls and licenses. Foreign investors may not own farmland."
These are the very things that ensure Ukraine's continued stagnation, especially its miserable investment freedom. It cannot be overemphasized that Ukraine requires foreign investment in order to finance increases in gas production as well substitute production; economic freedom is a necessary condition for large-scale investment. Foreign investors will not distribute scarce financial capital to enterprises within economically inhospitable environments, let alone foreign economically inhospitable environments. Ukraine's price controls, capital controls, bureaucratic and regulatory atmosphere, and uncertainty regarding protection of private property and contractual agreement, seriously constrain the profitability of Ukrainian undertakings, and therefore, firmly delimit the amount of foreign investment money it receives.

Moreover, economic freedom would enable nuclear power firms to operate in the Ukraine, offering both electricity and jobs to the Ukrainian economy. Unfortunately, given the nature of the Russian government and its new nuclear proposal, the future of foreign investment into nuclear power in the Ukraine is at best uncertain.

Now, if the Gazprom-Naftogaz merger occurs as well as the nuclear cooperation between both governments, the Kremlin will further its ability to assert itself in Ukraine as well as Europe by possessing greater control over the distribution of natural gas.

-Belton, Catherine, and Roman Olearchyk. "Anger in Kiev at Putin Gas Merger Proposal." Financial Times. 30 Apr. 2010. Web. 02 May 2010.

"BP Statistical Review of World Energy June 2007." British Petroleum. 22 Oct. 2007. Web. 02 May 2010.

-Harding, Luke. "Eggs and Fists Fly in Parliament as Russia given New Naval Base Lease | World News | The Observer." The Guardian. 02 May 2010. Web. 02 May 2010.

-Olearchyk, Roman. "Russia Offers Kiev Nuclear Deal." Financial Times. 27 Apr. 2010. Web. 02 May 2010.

-"Ukraine Information on Economic Freedom | Facts, Data, Analysis, Charts and More." 2010 Index of Economic Freedom. 2010. Web. 02 May 2010.

"Ukraine." U.S. Energy Information Administration: Independent Statistics and Analysis. Aug. 2007. Web. 02 May 2010. .

-Valasek, Tomas. "A Bad Deal for Ukraine and Yanukovich." Financial Times. 27 Apr. 2010. Web. 02 May 2010.

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