Ukrainian Death Spiral

  • Russia has raised natural gas prices to Ukraine twice this week. The total rise is 80% bringing the price for gas in Ukraine to $485 per 1000 cubic meters [1]* which is well above the European average of $380 in 2013 [2].
  • Prior to the recent geopolitical crisis Ukraine was in a mess. With a population of 45 million, per capita GDP of $2100 is on a par with Egypt (Figure 1) and the country had crippling and mounting debts.
  • Since the dissolution of the Soviet Union in 1991, Ukraine has been in reverse gear. Energy rich Russia has seen relative prosperity on the back of a recovery in its energy industries and rising energy prices (Figure 1). Energy poor Ukraine, on the other side of the coin, has only seen its energy bills rise to the point it could no longer pay them. The gas price action this week is Russia’s response to sanctions imposed by America and the EU.

* subject to verification

[Note added 5th April: Commenter Syndroma points out that the strategy here is to force Ukraine to buy gas from Europe. Ukraine has to pay full market price and Russia gets paid full market price and the bad debt risk is transferred to European suppliers. The gas still comes down the pipe from Russia.]

Figure 1 This chart of per capita GDP versus energy consumption is a work in progress. Since its last outing I have added data for Turkey and Ukraine. Each data set represents a time series that shows how a country’s GDP and energy consumption evolves with time. Generally speaking, successful countries’ per capita GDP grows with time (economic growth) but to achieve this its per capita energy consumption also grows. A steep gradient on this chart is a symbol of efficiency (Turkey is my next post). The former Soviet republics are an aberration where energy consumption was extremely high and productivity relatively low. Where Russia declined following the collapse it has since recovered whereas Ukraine has continued in a post-Soviet death spiral of falling GDP and energy consumption that is going to be severely exacerbated by gas price rises of this week. Data from BP [3] and the UN [4].

It is challenging to get up to date information on European natural gas prices and to understand exactly what has been going on in Ukraine. Figure 2 shows the evolution of gas prices to Ukraine from 2004 to 2008, published by the FT. It shows that Ukraine has enjoyed gas prices well below market prices that have risen in line with energy price inflation since 2004. Russia seems to have decided it is now time for Ukraine to pay the full price of independence.

Figure 2 Gas prices in Ukraine and Germany, 2004 to 2008. Published in the FT, attributed to Oxford Institute for Energy Studies and UBS. Price hikes by Russia this week takes the gas price in Ukraine to $485 according to Reuters [1].

In an earlier post I drew attention to how energy poor Ukraine is [5] (Figure 3) with most energy imports in the form of gas from Russia. It has just become significantly more energy poor this week. Well done Europe and America.

Figure 3 During the Soviet era Ukraine imported large amounts of oil and gas from Russia whilst exporting a small amount of coal. All this lost in the internal accounting system of the Soviet Union. Since the dissolution of the Soviet Union energy imports and prosperity have fallen whilst debts have escalated. Independence from dependency is a serious challenge as every junkie knows. Chart data from BP [3], chart from “Ukraine, Russia holds all the aces” [5].

Figure 4 Ukraine’s economy is pathetically weak made worse by the fact that it has little to offer in the way of high added value exports whilst needing to import nearly all its energy from Russia. The cumulative trade deficit of $52 billion (2005 $) has crippled the economy. 

Post-Soviet trouble in Ukraine began in 2004, the year of the Orange Revolution. And while it may be tempting to blame Russia for punishing Ukraine then, the slide into trade deficit (Figure 4) and debt is more likely due to the run up in international energy prices. But Russia is punishing Ukraine and Europe now.

Since 1990, Ukraine has run up a trade deficit with the rest of the world amounting to $52 billion, a figure not too different to its debts. The IMF has just unlocked between $14 and $18 billion to keep Ukraine afloat [6]. The deal from Russia is designed to sink it.

EU foreign policy is in tatters. Unelected bureaucrats at the European Commission are more interested in the CO2 footprint of producing straight bananas than they are in critical issues of security on Western Europe’s door step. The pathetic unelected puppet of The European Council, Van Rompuy, is no match for Putin. The data shown in Figure 1 shows clearly that true commercial assistance for Ukraine has been required for many years. Why has Europe not acted?

The way forward is to send a clear signal to Russia that Ukraine has no prospect in the foreseeable future of joining the EU or NATO and that its future lies in neutral status akin to Finland. At the same time proper commercial ties (bilateral trade) between Ukraine and the EU need to be developed. Russia should be asked to contribute to a stable and prosperous buffer zone through guaranteeing energy supplies and relaxing energy prices to the extent that guarantees Ukraine’s prosperity and stability. This is clearly in the best interests of all. Exceedingly poor Ukraine has recently become much poorer through the loss of Crimea and the hike in energy prices. There is a risk of mounting chaos.

[1] UPDATE 3-Russia raises gas prices for Ukraine by 80 percent
[2] Gazprom Hits Record Gas Exports to Europe
[3] BP: Statistical Review of World Energy 2013
[4] UN: National Accounts Main Aggregates Database
[5] Ukraine: Russia holds all the aces
[6] IMF unlocks up to $18 bn for Ukraine’s shattered economy

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27 Responses to Ukrainian Death Spiral

  1. Euan Mearns says:

    Europe versus Russia – who is going to win? Google van Rumpoy and you will see I selected a flattering image.

  2. Joe Public says:

    In another beauty contest, the Crimea has appointed its new Attorney General Natalia Polonskaya, to counter the the EU’s stunning High Representative of the Union for Foreign Affairs and Security Policy, Cathy Ashton.

    • Euan Mearns says:

      Joe, it is of course intellect, knowledge, character and legitimacy that counts. Putin and Van Rumpoy have strengths and weaknesses on all of these points. Where does the truth and the balance lie? I happen to like fishing and ski mountaineering and stuff like that. I can imagine spending a weekend with Putin and having a good time… fishing that is 😉

    • Euan Mearns says:

      Baroness Ashton: according to Wikipedia:

      “Between 1977 and 1983, Ashton worked for the Campaign for Nuclear Disarmament (CND) as an administrator and in 1982 was elected as its national treasurer and subsequently as one of its vice-chairs. From 1979 to 1981 she was business manager of the Coverdale Organisation, a management consultancy.[14][15] As of 1983 she worked for the Central Council for Education and Training in Social Work.[16] From 1983 to 1989 she was director of Business in the Community, working with business to tackle inequality, and she established the Employers’ Forum on Disability, Opportunity Now, and the Windsor Fellowship.[citation needed] For most of the 1990s, she was a freelance policy adviser.[10][17] She chaired the Health Authority in Hertfordshire from 1998 to 2001 and she became a vice-president of the National Council for One-Parent Families.[citation needed]”

    • Syndroma says:

      Yeah, Poklonskaya is all the rage now. 🙂

  3. Roger Andrews says:

    Nothing to worry about. We’ll lend you our guy:

  4. Roger Andrews says:

    In a more serious vein, what happens if Ukraine is unable to pay, or refuses to pay, and the Russians cut off the gas flow through the trans-Ukraine pipelines? Does the EU jump in and pay the Russians to keep the gas on?

    • Euan Mearns says:

      Unable to pay? – I think the $14 to $18 billion newly provided by the IMF will counter that argument. Our money will go straight into the coffers of Moscow to help fund their military build up – our leaders really are smart aren’t they! Refuses to pay? I guess they will shut off the gas which is not so serious as it once was and / or at this time of year. The Nord Stream pipeline has capacity of 55 bcm per annum, enough to supply most of N Europe. And our mild winter means that storage has remained full. It is Italy and Turkey in the south that need to worry and they are also dependent upon N African supplies. What would Europe do? EU members who have hit upon bad times have been prescribed austerity. There has been very little media coverage of exactly how bad things are in Ukraine for its people. But with no GDP growth for 25 years and per capita income of $2000 things must be pretty bad for many people – I realise the PPP measure is more valid – but still.

      • Roger Andrews says:

        According to the EU External Action Service “the EU is seeking an increasingly close relationship with Ukraine that goes beyond mere bilateral cooperation, encompassing gradual progress towards political association and economic integration.”

        I have a dumb question.


        By assimilating Ukraine the EU acquires an ethnic, political and economic basket case with a GDP over 100 times smaller than EU27 GDP, and because Russia has Ukraine by the short and curlies the EU is forced to dance to the Russian tune if it wants to do anything with it. (This had already led to the West imposing sanctions on Russia while at the same time planning to lend money to Ukraine so that Ukraine can send it to Russia to pay its unpaid gas bills. Mad Magazine couldn’t do better.)

        I also have a dumb solution:

        Forget about Ukraine. Let it fall into the Russian orbit, which to all intents and purposes is where it already is. Let the Russians sort out the mess. The likelihood is that Ukraine will eventually become like Belarus, which while it may not be a model of democracy at least has a per-capita GDP almost twice that of Ukraine. And Belarus threatens nobody.

        • Euan Mearns says:

          Why? Why do the Europeans want to face down Russia, have tanks on the border and inflame the situation over a bread basket case? The solution is of course to let Ukraine remain in the Russian sphere, I don’t think they would try to sort it out, just let it fester. All they want is a buffer between Europe and themselves. One of many April first posts I had in mind was The Fourth Reich – thought it may have been a bit close the bone. But Germany still has a plan….

          I may be proved wrong, but throughout all this it seems to me Russia’s main interests are security and looking after Russian’s in Ukraine.

    • Syndroma says:

      Ukraine gas contracts are all smoke and mirrors. I wouldn’t be surprised if Russia raised the price to $485 to force Ukraine to buy gas in Europe. What it means? Ukraine will have to pay $385 to an European company, which will buy the gas with a discount in Russia. It’ll be the same gas, but Russia will always be paid in full.

  5. Tom Belstler says:

    Great set of charts! Congratulations on putting this together!

  6. Syndroma says:

    To be fair, Ukraine still has a lot of high-tech manufacturing. Just a few examples:

    – Reactor vessels for nuclear icebreakers. Ukraine shipped one a few months ago, it’ll be used in Russia’s brand new LK-60 project
    Now I’m sure they’ll be glad to produce reactor vessels for European nuclear icebreakers.

    – Engines for Mi- and Ka- helicopters. Russia was increasing production of the helicopters recently, but now the engines can be fitted to European gunships instead. Europe will become military stronger, Russia will become weaker, and Ukraine will get the money. Win-win-win.

    – Zenit launch vehicles. Ukraine can make money launching satellites to space. Europe can help them sort out some issues with the rocket, like the fact that 70% of its components come from Russia (including the main engine) and the fact that Russia controls the only two existing launch pads for the rocket.

    • Euan Mearns says:

      I don’t know if you’ve heard that Eurocopter (owned by Airbus) has real problems with their helicopters falling out of the sky. Two recent fatal crashes and at least two non-fatal ditchings in the N Sea. So maybe we need a new manufacturer. It is a serious problem for N Sea oil and gas production. Every time there is a crash the fleet is grounded making it difficult for continuing offshore operations.

      I’m guessing that key components for Ukraine helicopter engines are made in Russia?

      • Syndroma says:

        Actually, no. I guess this is the only thing Russia really depends on Ukraine for. Ukraine produces engine.
        Russia starts production of the engine. Plans are to produce 50 such engines in Russia in 2014, but each helicopter needs two engines and Russia produced 300 helicopters in 2013. Obviously the dependency will continue for some years until the local production matures. Another interesting fact: few weeks ago – at the peak of the crisis – Russian and Ukrainian helicopter engine manufacturers agreed to create a common engine design center in Moscow. Some people think it’s a soft ‘evacuation’ of key personnel from Ukraine.

    • I hope they have improved since I visited and negotiated with them to convert a military sophisticated telecom factory into a telecom civil factory in the Lvov city. They certainly had interesting technology. For instance, when we were in the Western world with PBA’s with 6 layers, they had PBA’s with up to 20 layers, but once we checked at home with XRays, the 90% of the samples had the circuits cut and were useless. We asked for that and they happily answered they did not care much about the discarded ones; just use the ones functioning. They were very unaware of the manufacturing costs. It seems that the development of many more layers per PBA than in Western designs was mainly due to a much poorer CAD-CAM systems and poorer circuitry designs, forcing them to multiply the layers to get the same result and board compacity (but more weight). Meanwhile, in Lvov there were not even the essentials, but they were proud to show that this factory had in the pharmacy of the factory nursing bottels and dummies for children’s employees, which of course were not available in the city. A little bit difficult to trust in companies with these problems and lack of continuity and stability in the supply chain.

      In another move, a man used to cross the border with Poland almost every week with a bag full of nails. The custom officers asked for the goods and the answer invariably was “nails”. Ok. One day, they asked him with more detail and he was smuggling titanium nails for alpinism (very edxpensive in the soprt Western shops). They were producing them in the submarine factory in Ukraine as they were idle.

      They better handle first the problem of Tchernobyl (if they may), which is the most important one of this country and continues to crumble coffin after coffin, like a horrrendouds game of brittled matriuskas, unable to contain its untouchable warm melted corium heart. With Kiev some 100 km downstream the Dniepper.

  7. Hi Euan,

    Very timely. Ukraine also fits the typical pattern of exaggerated coal reserves late in the production cycle. Their R/P ratio in the BP Statistical Review is 384 years. If that number were realistic, it should have been easy to increase production and substitute coal for gas.But that is not happening. Production is down 60% from what it was 40 years ago.


    • Euan Mearns says:

      Andrew McKillop (who has guest posted here) reckons Ukraine has ROP in gas of 125 years while BP reckon 12. McKillop reckons Ukraine just can’t be bothered producing their gas either.

      Ukraine – the country has about 125 years of its current bloated natural gas consumption in the form of unexploited and ignored – but real – domestic conventional gas reserves.

      • Hi Euan,

        I am reading 34.6 years for Ukraine’s gas R/P ratio in the BP workbook. In any event, interpreting the gas reserves is more your territory than mine..

        “just can’t be bothered producing their gas either.”

        I am not suggesting that the lack of increased coal production in Ukraine is simply a matter of not “bothering producing.” I am arguing that the coal in Ukraine’s reserves is classified incorrectly. Much of it is not economically interesting and should be classified as an occurrence.


        • Euan Mearns says:

          I checked BP again and get 600 BCM in reserves and 18.6 BCM per annum in production = 32 years. I must have made a mistake earlier.

          But the debate goes on about folks miss understanding reserves and how they are often not a reliable indicator of what may be economically developed.

  8. Luís says:

    Euan, I have some suspicions over that 385 $/dam3 figure. This might include existing contract, for new contracts the ballpark value is usually quoted as 450 $/dam3.

  9. Euan Mearns says:

    Lui, taking the price from this source – $10.8 per million BTU and dividing by 0.028 to go to 1000M3 I get $386. I’m not sure what your point is?

  10. charlie says:

    Good post Euan.

    I just added you to my “must read folder, along with Ron P.s ” the peak oil barrel” it should give me a better prospective of “peak energy” than I was getting before.

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