Reliability and Indicators of the Ukrainian Banking System: Growth Driver or Burden?

The banking system is a source of economic growth in the developed countries, but in Ukraine not-efficient and badly managed banks became a burden for Ukrainian taxpayers – or even a tool for stealing the funds. The recent news on increasing number of non-performing loans and related NBU reports have been a new serious alert that urgent actions to fix the situation are on the agenda again. Current actions of Ukrainian authorities have not been effective so far, therefore new efficient strategy of how to develop  the banking sector is urgently needed. According to the quarterly "Survey on lending conditions", that was conducted by the National Bank of Ukraine on the results of the 1st quarter of 2018, the increase of banks' activity in approving the applications for loans to enterprises and for consumer loans was noted. At the same time, 76% of banks expect an increase in the loan portfolio of businesses throughout the year, and 69% of banks forecast an increase in loans to individuals. However, it should be noted that the volume of non-performing loans in Ukrainian banks remains unchanged and sometimes it even shows a tendency to increase, despite the NBU's requirements to solve the problem. Accordingly, even after the "purification" of the banking system in 2014-2016, the risk of non-repayment of loans has not decreased in any way. Moreover, 31 out of 82 functioning banks violate the norms set by the National Bank of Ukraine (data on compliance of banks with the economic norms of the NBU) that only complicates the situation and may lead to further actualization of the problem of non-performing loans, together with a growing distrust in banks. At the same time, instead of effectively addressing the issue, the government continues to writing off the non-performing bank loans. In particular, only "PrivatBank" in 2017 wrote off ₴ 5.863 billion of unpaid loans issued prior to the nationalization of the bank that became known from its financial statements. What do we have today? Traditionally, the leaders in terms of the amount of non-performing loans are Ukrainian state banks. Moreover, the ratio of "non-working" to "working" loans is also an issue. It turns out that while the standard is not more than 30%, in Ukraine, every second loan is not returned - in average, this ratio is equal to 56%. The total volume of such "assets" reaches ₴ 630 billion. At the same time, according to the deputy chairman of the National Bank of Ukraine Kateryna Rozhkova, almost 70% of "bad" debts are concentrated by 20% of borrowers. Banks, in turn, cover non-performing loans with an increase of interest rate on issued loans, which reduces their attractiveness and shallows the prospects for economic growth of the country.   Name of the bank Banking group (by origin of banks' capital) The percentage of non-performing loans Non-performing loans, thousand UAH 1 PJSC "BTA Bank" Bank of foreign bank groups 98,63% 753983 2 PJSC "VTB BANK" Bank of foreign bank groups (Russia) 94,60% 20108232 3 JSC "BM BANK" Bank of foreign bank groups (Russia) 94,36% 2095905 4 PJSC "JSCB Trust-Capital" The bank with private capital 88,90% 125562 5 PJSC "PRIVATBANK" Bank with a state share 86,69% 235555104 6 PJSC "UKRSOTSBANK" Bank of foreign bank groups 84,54% 36516685 7 PJSC "BANK FAMILNIY" The bank with private capital 80,89% 55850 8 PJSC "Prominvestbank" Bank of foreign bank groups (Russia) 76,65% 35445306 9 "CLEARING HOUSE" The bank with private capital 72,76% 803570 10 PJSC "CREDIT EUROPE BANK" Bank of foreign bank groups 68,50% 611500 11 JSC "Ukreximbank" Bank with a state share 64,92% 83072616 12 JSC "OSCHADBANK" Bank with a state share 64,38% 80235272 13 PJSC "BANK CREDIT DNIPRO" The bank with private capital 62,46% 4091593 14 PJSC "VS Bank" The bank with private capital (Russia) 58,40% 1179665 15 PJSC "SBERBANK" Bank of foreign bank groups (Russia) 56,65% 32835471 16 JSC "City Bank" The bank with private capital 54,53% 746337 17 PJSC "UNEKS BANK" Kyiv The bank with private capital 53,65% 276818 18 Polycombank The bank with private capital 47,80% 169758 19 PJSC "UNIVERSAL BANK" The bank with private capital 47,25% 2257838 20 PJSC "BANK FORWARD" Bank of foreign bank groups 46,70% 813759 Source: calculations according to the NBU data The NBU's actions to keep inflation under control is important  in this situation. As a result of NBU actions the discount rate has recently reached 17% and, according to the latest decision, remained unchanged, while affecting the interest rate on the issued loans. In turn, high interest rates frighten the business. Taking that into account, banks are lending money to questionable projects, which allegedly guarantee higher returns. Nevertheless, there is a hope that the increase of inflation processes will be stopped, resulting in the decrease of the discount rate over the next three years and, accordingly, in the decrease of interest rates on issued loans.   Data Forecast 2014 2015 2016 2017 2018 2019 2020 Interest rate for loans in national currency, at the end of the year, % per annum 16,6 20,4 15,2 17,5 17,0 15,0 14,0 Source: "Economic Analysis and Current Trends: Forecast for 2018-2020", ICPS, 2018     The problem of unprofitability of some banks also remains important. According to the results of the 1st quarter of 2018, the banking system of Ukraine in general reached the profitable level (₴ 8.672 billion), however 14 out of 82 working banks still remained unprofitable. Profitable banks, top 3 Loss-making banks, top 3 Profit, UAH billions Loss, billions UAH "PrivatBank" 3,654 "Prominvestbank" 0,294 "Raiffeisen Bank Aval" 1,381 "Ukrsotsbank" 0,290 "OTP Bank" 0,612 "Credit Dnipro" 0,117 Source: according to the NBU data In this regard, further competition for the profit and market share will push the banks to risk activities and will worsen their loan portfolio. In addition, there is a share of consumer lending in the portfolio of many banks. Under conditions of insufficient growth of the Ukrainian economy and high level of inflation, the prospects of returning such loans are worsening. On the other hand, such loans are the easiest way for the banks to earn money and therefore, in the absence of the required demand from the business side, the share of consumer loans is steadily increasing, although it is not yet significant. In general, according to the monitoring conducted by the International Center for Policy Studies together with the Independent Association of Ukrainian Banks, the most widespread and accessible Ukrainian banks are not ranked first in the financial health rating. This fact only emphasizes the systematic problems of Ukrainian banks.   Top 10 banks for compliance with standards   Top 10 banks for the ability to generate profits   Top 10 banks for the overall indicator of financial health 1 Ukr. Bank for Reconstr. and Development 1 PJSC "Idea Bank" 1 PJSC "Idea Bank" 2 PJSC "ALPARI BANK" 2 PJSC "A-BANK" 2 PJSC "A-BANK" 3 PJSC "AP BANK" 3 PJSC "SITIBANK" 3 PJSC "SITIBANK" 4 PJSC "CREDIT EUROPE BANK" 4 PJSC "MIB" 4 PJSC "CREDIT AGRICOLE BANK" 5 PJSC "SEB CORPORATE BANK" 5 PJSC "ALFA-BANK" 5 PJSC "ALFA-BANK" 6 PJSC "BANK 3/4" 6 JSC "TASKOMBANK" 6 JSC "TASKOMBANK" 7 PJSC CB "Center" 7 PJSC "CREDIT AGRICOLE BANK" 7 JSC "Raiffeisen Bank Aval" 8 PJSC "BANK" PORTAL" 8 JSC "OTP BANK" 8 PJSC "BANK AVANGARD" 9 PJSC "BANK FAMILNIY" 9 JSC "Raiffeisen Bank Aval" 9 JSC "UkrSibbank" 10 JSC "ALTBANK" 10 PJSC "KREDOBANK" 10 PJSC "BANK ALLIANCE"   Source: "The Rating of Financial Health of Ukrainian Banks", ICPS and NABU, 2018 What to do? It is clear that problem loans are the consequence of the careless and sometimes "purposeful" policy of the banks. The recent creation of a "Credit register" (where the debtors that owe the bank more than ₴ 372 300 will be listed) will simplify the client verification process for the bank. However, it will not solve the problem with the existing non-performing loans. The issue can not be also solved by the adopted law (in the first reading) "On Amendments to Certain Legislative Acts of Ukraine Regarding Restoration of Lending", since this document is more focused on simplifying the process of collecting the debts, rather than overcoming the root causes of the appearance of the "problem" loans. Therefore, as long as the banking market is not sufficiently transparent and open, the NBU's monitoring systems will be bypassed by financially unhealthy banks, that conduct risky operations, and businesses, that create "fake" companies or deliberately declare themselves bankrupt. Moreover, the share of such "bankrupts", according to the message of the chairman of the Committee on financial policy Mykhailo Dovbenko, has reached 80% of the total number of legal entities-borrowers. Accordingly, today, mainly the problem loans are the funds that companies have fraudulently taken out abroad through the banking system or consider not necessary to return. Taking into account the above-mentioned aspects and the insufficient financial health of the key Ukrainian banks, it is necessary: - to conduct in-depth monitoring and audit of not only the allocated funds, but also the borrowed funds; - to adopt the experience of sustainable foreign banks in risk management and loan portfolio management; - to invest in training of staff for proper assessing the solvency of bank clients; - to implement the corporate social responsibility practices; - to increase the market share of foreign banks in order to ensure the healthy competition; - to avoid the emergence of informational "fakes" that are created due to the "war" between debtors and creditors; - to implement legislative improvements that will improve the business climate in Ukraine; - to support the NBU's independence from political decisions and fraudulent actions of the market participants. Unless the banks will qualitatively invest in government securities instead of the business projects, while not being the "blood system" of the real sector of economy, and unless the banks will be used for money laundering and withdrawal, while undermining the confidence, the population will have nothing else but to keep its money in a "glass jar", thus deepening the "financial starvation" of the banking system and its burden of non-performing loans, as a result, slowing down the economic development of Ukraine. And the only way, in the absence of qualitative Ukrainian management, will be selling the banks with a portfolio of bad loans, while on the one hand, attracting investments, and on the other hand, losing the remedies to somehow positively affect the banking market and its development strategy in the long run....

ICPS Press

How deep is transatlantic split?

The unity of the West has always been a kind of an axiom for Ukrainian foreign policy. The West is associated with democracy, prosperity, stability and, among other things, unity, based on common values, history and strategic interests. Such a West requires Ukraine as a guide, a field of gravity and a counterbalance to Russian influence. Integration or even cooperation with such a West today - when non-alignment and multipolarity are discredited, and Russia has become a systemic threat - looks like a foreign policy paradigm without serious competitors. It is within its framework that the talks and declarations of accession to NATO and the EU, which largely replaced the complex foreign policy planning, fall into place. Under such conditions, the least that Ukrainians would like is a violation of the unity of the West. It generates a number of unpleasant questions, from the capabilities of NATO to maintenance of an anti-Russian sanctions regime. In the long run, the probability of facing one of the largest difficulties which is the choice between those who we consider allies is increasing. If the strategic interests of the United States and the European Union are dispersed, then, of course, not only Ukraine will feel the consequences. A strategic alliance between the two poles of the modern world remains a guarantee of global stability and security, or at least that they have been left behind. In this context, events of recent months gain added value. The sharp difference between the positions of the United States and major European powers over the agreement on Iran's nuclear program, the US's decision to relocate the Embassy to Jerusalem, and the real prospects of a US-EU trade war make us recall the last-year events and declarations. Donald Trump gave a lecture to NATO's European allies on how they should consider security; and Angela Merkel responded by saying that the times when Europe and the United States could rely on each other went by. This march, Donald Trump announced the imposition of a duty on imports of steel and aluminum, postponing the entry into force of this EU decision by June 1. Such a step could be the beginning of a conflict between the two largest economies in the world, trade between which reached a mark of 1.1 trillion dollars. Interdependence among them is even better illustrated by the impressive volumes of total sales of American companies affiliated to Europe and European companies affiliated to those of the US, reaching 5.5 trillion dollars. If the decision on the imposition of American duties will come into force, and Europeans will respond symmetrically - we are talking about the imposition of mirror-image duties on American goods, so far on clothes, orange juice, motorcycles, but the list can be expanded - the effect will be even stronger than the one, which was accompanied by the collapse of the Transatlantic Trade and Investment Partnership project (TTIP). Of course, this effect will be negative for a strategic partnership between the United States and Europe. But will it affect political cooperation? To this end, it is worth adding exceptionally deep differences in the views on the issue of international security. Europeans have responded critically to the transfer of the American embassy to Jerusalem - a step that, in the opinion of many, violates the balance and prospects of the Middle East conflict settlement. The situation with a nuclear deal with Iran deeply criticized by Trump, which has not, however, stroke a chord among European partners, is even more potentially dangerous. As a result, the United States came out of a multilateral agreement, providing Iran with an opportunity to set uneasy conditions for Europeans if they want to keep it in place. In some way what has happened can be seen as a shifting the problem from the US to the EU. This is rather risky not only concerning the Middle East, but also in the non-proliferation regime. Differences in the views and attitudes of Europeans and Americans seem to become commonplace. To what extent can they cross the line? For Ukraine, this issue is of practical importance in view of at least two factors - the effectiveness of NATO and support for the anti-Russian sanctions regime. They are the basis of a non-alternative foreign policy strategy of recent years. The good news is that NATO will remain as effective as it has been, even in the wake of the deteriorating global climate of transatlantic relations. Saving a uniting front of anti-Russian sanctions will be harder. But - and here the news is not so good - a simple strategy "trying to be friends with the West against Russia" will work worse. Despite the deepening of the contradictions in certain spheres, the transatlantic alliance holds together strategic interests. The balance of power in the world is changing rapidly: in the 15-20 years, China and India will play a leading role, and the EU will try to keep its place in the club of great powers. Historical and normative unity makes the United States and Europe almost natural allies, and a long period of peaceful and constructive cooperation gives reason to trust each other. NATO, as an embodiment of this trust, is also beneficial to all, as it creates a sufficient deterrent potential. For Europe, NATO is the best way to strengthen its own security. The US, no matter how much talk about the burden of spending on the common good, also gets from NATO more than it spends on it. Pragmatic interests will ensure the continued functioning of both NATO and other key institutions of the West. Truth be told, this does not mean that Ukraine will easily join them. The future of the anti-Russian sanctions regime looks vaguer. Intensifying disputes between Europe and the United States will lead to a revision of priorities and a temptation to turn positions on sanctions into a subject for trading on other issues. Europe is likely to suffer more from the imposition of trade duties, and the US position on sanctions looks more coherent and consistent. Against the backdrop of worsening relations and economic losses in Europe, demand for rhetoric about weakening or abolishing sanctions imposed on Russia may well increase. The danger of a tariff war between the United States and the EU for Ukraine is precisely the fact that, struggling for the economic interests of Europeans, it will strengthen the positions of those who want to compensate loss by deeper cooperation with Russia. The civilization split in the West or the destruction of its key institutions will not happen: even the Kremlin is unlikely to dream about that. However, concerning temporary exacerbation of contradictions and contradictory positions on important issues for Ukraine it is quite possible. In these circumstances, we will probably need a more subtle approach to the western vector of our foreign policy....

ICPS Press

Nuclear disarmament: Ukrainian-Korean lessons

Ukraine and North Korea which are so different and distant were connected within the context of nuclear non-proliferation. There was a time when Ukraine made a significant contribution to strengthening this regime by nuclear disarmament. On the contrary, North Korea consistently undermines this regime by demonstrating to the whole world by its own example, the opportunities and risks of the acquisition of nuclear weapons. In recent weeks, given the rhetoric of nuclear disarmament on the Korean peninsula following the summit of the leaders of the DPRK and the Republic of Korea, the parallels have become too obsessive; and the question of whose choice will eventually turn out to be the right one is a matter of interest to many. According to the conditions of the Budapest Memorandum of 1994 which has been so often mentioned in the last years, Ukraine has acceded to the Treaty on the Non-Proliferation of Nuclear Weapons as a non-nuclear-weapon state, thus getting rid of the nuclear arsenal that remained on its territory after the collapse of the USSR. Ukraine, Belarus and Kazakhstan were not the pioneers on this complicated and controversial path: several years ago, the South African republic rejected the nuclear weapons. Unlike the post-Soviet republics, South Africa fully controlled its small nuclear arsenal - for this reason it could be considered a model for future nuclear disarmament cases. Current nuclear states are primarily interested in increasing the number of such cases, but the paradox is that they are often seen as a source of threats pushing other states to obtain nuclear weapons. In case of Ukraine this paradox transformed four years ago from an intellectual puzzle to a key issue of foreign policy. The strategic challenges faced by the leadership of the DPRK today differ significantly from those that the leaders of the Ukrainian state tried to resolve a quarter of a century ago. The international environment and the international security situation are fundamentally different. Thus, such cases are more interesting to compare. Could Ukraine get the best, in words of Donald Trump, deal? And will North Korea follow the example South Africa? What are the starting points for a serious talk about nuclear disarmament in the modern world as a whole? In the early 1990's, optimism and faith in the future without conflicts prevailed worldwide. Against this backdrop, nuclear weapons seemed not to be the relic of the past, with which it is impossible to solve the challenges of the future: to accelerate economic development, to change the social model, or to build an effective democracy. Membership in NATO seemed rather reachable, moving towards Europe simple, and the neighborhood with Russia good. Rejecting nuclear weapons was much easier twenty five years ago: the deal seemed to be to exchange of unnecessary military resources for such necessary legitimacy, Western support and money. North Korea makes its decisions in other circumstances. The period of romantic perception of international security has past long ago, and events in Ukraine have considerably deepened the crisis of world order. The demand for hard power has suddenly emerged again, and nuclear weapon is considered by many as a "great counterpart" in the military capabilities of the various potential states. It seems that Ukrainian experience has been useful for many, including the DPRK. Its key lesson is that exchanging nuclear weapons is reasonable only if reliable security assurances are provided. A number of states which were technologically capable of creating nuclear weapons, from Australia to Japan, and from Sweden to South Korea used to go that way. The fact is that for the United States, the non-proliferation of nuclear weapons is a priority of the foreign policy strategy since the 1940s. Sanctions and preventive military strikes appeared to be less effective instruments than the proliferation of security assurances: and over the past 70 years, US security commitments have been expanded exponentially, in both multilateral formats, such as NATO or ANZUS, and in bilateral agreements concluded with Japan or South Korea. Nearly always the motive behind such commitments is the desire of the United States to prevent their allies from gaining nuclear capability. Ukraine in its time did not learn this lesson. Nuclear weapons should not be exchanged for money or for any other non-security related resources. Indeed, Ukraine did not control nuclear weapons on its own territory and it weakened its position in negotiations with Washington. However, it didn’t mean that Ukraine could not demand more. In 1994, this could be a security treaty with the United States, which including an obligation to protect Ukraine, which is not provided in the Budapest memorandum. Today, in a crisis of international security and lack of trust, such an agreement is not enough....

ICPS Press

ICPS will start accepting applications for participation in the project "Integration of Internally Displaced Persons into local communities. Workshop program in Germany"

The International Center for Policy Studies, in cooperation with Cultural Vistas (Germany) and with the support of the German Ministry of Foreign Affairs, is launching a project to support Ukrainian activists and experts involved in the integration of internally displaced persons (IDPs) in local communities in Ukraine. To this end, 13 participants from different regions of Ukraine selected on a competitive basis will attend a six-day training course in Berlin where they will have the opportunity to improve skills of promoting the integration of IDP into local communities. Since 2015, Germany has been actively testing various initiatives to improve the integration of migrants, many of which are based on cooperation with local or regional organizations and the commitment of individuals to help migrants to adapt to new environments. At the same time, Germany faced a wave of negative perception, which caused many misunderstandings and cultural stereotypes. To minimize the effects of such trends, civil society representatives have been actively involved in Germany to support "newcomers to society", regardless of their native region of origin, political preferences, religion, etc. In order to exchange experience on this issue, ICPS initiates a training program for Ukrainian colleagues. Participants will be able to get acquainted with the experience of German colleagues in overcoming the perceptions, stereotypes, misunderstandings, and to develop their own decisions to improve the integration of IDP taking into account the Ukrainian context. In addition, the curriculum provides for the study of the German reunification model of 1990-1991 and the implementation of decisions aimed at bringing together two socio-political cultures (East and West Germany) of that time. Duration of studies in Germany: September 24-29, 2018 Upon returning to their communities in Ukraine, participants will have to organize events involving the IDP and representatives of host communities to discuss their experience and find ways to overcome the challenges faced by IDP in Ukraine. Language of training: English, German. Synchronous translation into Ukrainian is provided. Transportation costs as well as living expenses are covered by program sponsors. In order to participate in the project you need: - to be involved in the process of integration of the IDP in the local community; participate in projects aimed at improving the integration of the IDP; to be actively interested in and explore this issue; seek to improve the situation with the interaction of the IDP and host communities in Ukraine; - to speak English at the basic speaking level; - have a valid biometric passport. Otherwise - the participant will have to undergo the procedure for obtaining a German visa on his or her own; - send a resume and a motivational letter justifying your interest in the program and describing the relevant experience by e-mail Limitations on participation in the program: civil servants and representatives of local authorities cannot be participants of the project. Deadline for submitting applications is June 4, 2018 If you have any questions, do not hesitate to contact us: +38 044 253 52 29; +38 068 194 94 04....

ICPS Press

Expert discussion: “Anti-Russian sanctions: the instrument of influence or demonstration of weakness”

On April 25, the International Center for Policy Studies held an expert discussion on "Anti-Russian sanctions: an instrument of influence or demonstration of weakness?" The regime of sanctions has been implemented for four years, and the preservation or expansion of its scope has become a peculiar criterion for the success of foreign policy in general. How valid is this criterion? What can be achieved through sanctions and what is the best way of their application? «Sanctions can help prevent further violations and the use of violence – here there are more chances of success. And this is exactly what worked in the sanctions of the West against Russia. From my point of view, the main role played by Western sanctions is precisely the suspension of further Russian aggression, "said ICPS expert Mykola Kapitonenko. "Sanctions are an instrument, part of a strategy aimed at achieving priority goals. "And sanctions are the instrument that has its own price and fairly limited effectiveness which leads to creating complex dilemmas over time because it has rather  controversial consequences," he said. As a rule, sanctions are imposed to influence a country that violates agreed norms, international principles with a view to changing its behavior. They are relatively frequent: among 26 sanction programs currently conducted by the United States 12 were initiated over the past 10 years; the United Nations has imposed sanctions more than 20 times since the end of the Cold War, however before only twice. Today in the vast majority of cases there are imposed the so-called "targeted" sanctions as opposed to comprehensive sanctions, which were much more popular until the 20th century. The key difference between them is to differentiate between those responsible for implementing a particular policy of groups or individuals from the rest of the population, the expert said. According to ICPS research, statistics of recent decades indicate that only in one of every fourth case, economic sanctions have led to significant changes in the behavior of the state against which it was imposed. The highest effectiveness of sanctions - about 50% - is observed in the case of destabilization of the political regime. But in such a case there are significant reservations: external factors can become a factor in consolidating society around the ruling power. Meanwhile, according to Kapitonenko, the sanction policy of the West is now not aimed at changing the regime in Russia. Speaking about the recommendations on the application of sanctions against Ukraine by Russia, the expert emphasized the importance of maintaining meaningful dialogue with the partner states: the more profound is the understanding of the interests and controversial assessments / positions of the partners regarding anti-Russian sanctions, the more productive and prolonged cooperation will be in this direction. It is important to create a hierarchy of goals that need to be realistic, taking into account the potential and the limit of the effectiveness of sanction policy. Alongside this, restrictive measures against the Russian Federation should be expanded, as long as the emphasis be made on target sanctions, in particular personal, he said. In addition, asymmetry in relations between Ukraine and Russia should be taken into account, because, according to the expert, in this case Ukraine is a weak and vulnerable party that essentially distinguishes Ukrainian anti-Russian sanctions from the West. Also, economic sanctions should have a transparent procedure and control over their implementation in order not to become an instrument of internal political struggle with competitors, "Kapitonenko noted. The International Center for Policy Studies has prepared recommendations on the strategy for applying sanctions: Supporting a more meaningful dialogue with partner countries. The more profound the understanding of their interests and contradictory assessments / positions regarding anti-Russian sanctions is, the more productive and lasting will be cooperation in this direction; Create a hierarchy of goals. The sanction strategy - like any other - cannot be effective without identifying the primary goals. They need to be realistic, taking into account the potential and limit of the effectiveness of sanction policies; Determination of optimal characteristics of the sanction regime; An important and effective instrument is the combination of sanctions with threats of subsequent sanctions, as well as with other instruments of pressure; A more in-depth study of a multilateral format of anti-Russian sanctions is needed. On the one hand, the common stance of as many countries as possible concerning the issue of anti-Russian sanctions makes their use not so expensive or risky for each of them individually; Asymmetry in relations between Ukraine and Russia must be taken into account; Sanctions should be state policy instrument followed by clear and understandable application of logic and transparent rules. Transforming them into a means of combating competitors will discredit not only Ukrainian sanctions against Russia, but also undermine the effectiveness and credibility of sanctions in general; The use of sanctions – the complex and sometimes contradictory instrument with due regard to the asymmetry of Ukrainian-Russian relations is rather expensive. Therefore, it should be an element of two strategies: the settlement of the conflict in eastern Ukraine and the determination of the format of bilateral relations with Russia....

ICPS Press

Energy interests and economic security of Ukraine

The decision of Germany and other EU countries to permit the construction of the “North Stream-2” gas pipeline again raised the issue of the future of Ukraine's gas transportation system and energy security of the country as a whole. Despite certain tactical achievements (reducing the volume of Russian gas consumption, the acceptable for “Naftogaz” decision of the Stockholm arbitration, etc.), the question of a strategy for achieving the energy security in general remains one of the most important challenges for Ukraine's national interests. At the same time, the government announced plans for achieving energy independence of Ukraine in 2020 and its sustainable development in 2035, however the way towards remains blurred. In addition, the implementation of Russian alternative gas pipeline projects may leave Ukraine at the edge of such an important element of economic activity as gas transit, leading to significant financial and political losses. Main figures and trends In 2017, “Gazprom” increased its exports of gas to Europe by 8.1%, reaching 193.6 billion cubic meters. In total, EU consumption in 2017 is estimated at 560.5 billion cubic meters of gas. Thus, “Gazprom's” market share in Europe has reached 34.7%. At the same time, Germany remained its largest market, while having imported 53.4 billion cubic meters of gas. Ukraine's GTS in 2017 provided 44% of Russian gas supplies to the EU. The transit of gas through Ukraine last year amounted up to 93 billion cubic meters. Compared to the volumes of 2016, transit has increased by 13.7%. This allowed Ukraine to earn nearly $ 3 billion due to the transit of Russian gas. Given that the country's GDP in 2017 was equal to $ 110 billion, this amount has made up to 2.7% of its volume. At the same time, in mid-January 2018, “Gazprom” received permission from Turkey for the construction of the second line of the "Turkish Stream" gas pipeline. Later, on March 26, Germany allowed to construct the “Nord Stream-2” in the Baltic Sea. The Russian gas monopolist has also made concessions to change the gas prices for the markets of Central and Eastern Europe. Such actions can have a positive impact on the European Commission's decision to address “Gazprom's” antitrust legislation in the European markets, which is expected in late April. These facts indicate that, despite complicated political relations, the EU Member States' own interests in the sphere of economic cooperation and, especially, energy, remain crucial. The construction of new gas pipelines, alternative to the Ukrainian GTS, can marginalize Ukraine's role in the issue of gas transit, transforming such a strategic national resource as a gas transportation system into a scrap in the future. In order to avoid the implementation of such a scenario, fast and effective actions are needed to preserve the role and place of the Ukrainian gas pipeline in the transit of gas from Russia to European countries. Consequences of Russian gas streams “North Stream-2” and “Turkish Stream” projects envisage the launch of a gas pipeline with a total throughput of about 85 billion cubic meters of gas per year. Given the recent data on transit through the Ukrainian GTS, the launch of the above-mentioned streams can take away nearly 90% of Ukrainian transit or nearly $ 2.7 billion in revenue per year. Main gas pipelines from the Russian Federation to Europe TITLE OF THE GAS TRANSPORT SYSTEM STATUS CAPACITY “Ukrainian GTS” Functioning 288 billion cubic meters per year 142,5 billion cubic meters per year (near EU border) “Yamal – Europe” Functioning 32,9 billion cubic meters per year “Nord Stream” Functioning 55 billion cubic meters per year “North Stream 2” Project The launch is planned in 2019-2020 55 billion cubic meters per year “Turkish Stream” Project The launch is planned in 2019-2020 31,5 billion cubic meters per year “South Stream” Project Frozen 63 billion cubic meters per year Source: Information from public sources Approximately the same figures are announced by “Naftogaz”, which estimates the financial losses at $ 3-3.5 billion dollars from the launch of alternative gas pipelines by Russia and from the complete stop of the Ukrainian GTS. In addition, the term of the current contract with “Gazprom” on the gas transit expires in 2019. According to the head of the Russian company, Alexei Miller, “Gazprom” can provide transit through Ukraine in the amount of 10-15 billion cubic meters per year, which is up to 10% of its capacity and less than 20% of the current volume of transit. For that, according to the head of the Russian monopolist, Ukraine must justify the "economic feasibility" of a new transit contract. In turn, the Ukrainian side announced that its main goal would be to preserve the transit of Russian gas through Ukraine after the expiration of the contract with “Gazprom”. However, it has not informed yet in what volumes and how it is planned to be reached. Nevertheless, the Cabinet of Ministers of Ukraine has already said that it is looking for a company to manage the Ukrainian gas transportation system. It also presented the idea that Ukraine would be able to further operate the gas transportation system by importing or transiting gas from Romania, however it is unlikely that the Romanian transit would be able to replace the vacuum created due to the redirection of the current transit flows. Additional aspects of energy relations In addition to the gloomy prospects in relations with the Russian Federation on gas transit and while taking into the account the blockade of the Donbas, Ukraine has to solve the issue of own energy supply and the reduction of its import dependence. This is confirmed by the fact that in 2017 Ukraine significantly increased the volume of imports of natural gas, coal and petroleum products. Moreover, Slovakia, Belarus and Russia were the main energy resource supply countries in 2016-2017.                                                                  Main energy resources: import, export, transit   Import, 2017 Change in imports to the previous year Export, 2017 Change in exports to the previous year Transit, 2017 Change in transit to the previous year Natural gas 14,6 billion cubic meters +49% - - 93 billion cubic meters +13,7% Coal 19,777 million tons + 26,4% $105,5 million +200% - - Petroleum products 9,7 million tons +11% 0,8 million tons +100% 16,4 million tons +1% Nuclear fuel $533,4 million -2,9% - - - - Electricity 0,05 billion kW per year -38% 5,2 billion kW per year +37% 1,4 billion kW per year +218% Source: According to the data of Energy Customs and State Fiscal Service On the other hand, the development of the renewable energy sector is positive for Ukraine. In particular, according to the State Department of Energy Efficiency, its total launched capacity reached 121 MW in 2016 and 257 MW in 2017. At the same time, only during the 1st quarter of 2018 Ukraine launched nearly 159.4 MW of renewable energy. In general, since 2015 more than 550 million euro has been invested in "green energy" and the total capacity of renewable energy entities is now equal to 1.5 GW. At the same time, in the near future, renewable energy will not replace the traditional energy sources, and only the implementation of real market conditions in the energy sector while promoting investments, increasing own gas production and strengthening the energy-saving technologies, will allow the country to approach the minimum acceptable standards of energy security. The ways of balancing the energy interests The nearest tasks for the Ukrainian government in the energy sector include: liberalization and opening the energy markets; preservation of the transit infrastructure of the state, restoration of confidence of external partners and financial organizations in the reliability of Ukraine as a transit country; well-balanced tariff policy for the transit of energy resources and domestic energy consumption; the fulfillment of requirements of the Third Energy Package, namely the separation of the “Naftogaz” activities for the transportation and distribution of natural gas; "Energy Euro-integration", synchronization of the energy systems with the European market (ENTSO-E, ENTSOG); diversification of sources of the energy resources; decreasing the energy consumption for own production, increasing the energy efficiency of the country; growth of Ukrainian energy resources production; stimulating the alternative renewable energy. In the near future, Ukraine has to settle the issues of “Gazprom's” supply of 2 billion 427 million cubic meters of gas to the occupied Donbass area and the $ 1.3 billion invoice. In addition, the decision result of the Court of appeals in the County of Svea (Sweden) on the dispute between “Naftogaz” and “Gazprom” about $ 2.5 billion of fines due to the Stockholm arbitration is being expected. The solution of the above-mentioned issues will eliminate the possible risks of Ukraine's energy and economic security. Otherwise, Ukraine risks losing a significant share of transit, which will result in the further increase in tariffs for the population and in the disruptions in functioning of its GTS. However, even under these circumstances, there is a hope that the growing demand in the European market and the interests of “Gazprom” to constantly increase its market presence there (as evidenced by data - its market share reached only 26% in 2012) may partly save Ukraine from the total loss of the GTS. Thus, the chess game on the energy interests of all interested parties has not finished yet. The fact that “Gazprom” will not be able to completely stop the transit of gas through the Ukrainian territory plays in favor of Ukraine. This is supported by the growing demand for gas in Europe, by the load of gas pipelines branches, by the relative loyalty of neighbors and by the favorable infrastructure of the Ukrainian GTS. However, it is not possible to win due to only these factors. Therefore, in order to ensure the transit of gas after 2019 in the amount not less than 40 billion cubic meters per year (minimum economically profitable volume) and to attract investments in modernizing the Ukrainian GTS, the government should not continue the only rhetoric of confrontation and should not feed the illusion of independence, but it should take the concrete steps, negotiate with all parties and propose alternatives to achieve long-term goals rather than short-term benefits. Otherwise, the levers of influence can finally disappear and economic security together with the energy interests will be once again solved at the expense of the Ukrainian population....

ICPS Press