Philosophical notes on pricing in the Ukrainian electricity and gas markets.

Systemic nature of the pricing problem

Currently, the question of electricity and natural gas price setting is high on the agenda in Ukrainian society, since the debts of energy companies at the current price level rapidly grow, in absence of sources to cover the resulting deficit. This negative trend may endanger the energy supply for the Ukrainian economy soon.

Even if individual price parameters are revised in the coming months, this will not change the general long-term trend of the energy infrastructure degradation. This problem cannot be solved by provisional decisions of the government and NEURC, as it is systemic, for socio-political, ideological and historical reasons. 

After Ukraine’s declaration of independence in 1991, a change in the philosophy of pricing should become a key element of the Ukrainian economy transformation from administrative-command methods and centralized planning to market instruments. The first attempts to introduce market prices in the energy sector were made in mid-1990s, when relevant programs were launched by the Ukrainian government together with the World Bank and the IMF. 

Reasons for energy market liberalization failure 

Based on the above logic, President L. Kuchma in December 1994 by his decree set up a national energy regulator (NERC). This body was supposed to support transition to transparent and competitive energy markets in accordance with the EU legislation. According to the roadmap of reforms, prices were no longer to be determined by orders or resolutions, as at the time of the USSR State Planning Committee.

The role of the Regulator was to be confined to the formation of market rules based on the EU Directives in the energy sector and control of their compliance. Removal of political influence, primarily populism, was also a key requirement during the NERC formation.

However, despite numerous IMF, World Bank and EU programmes, on which billions of dollars and euros were spent over the past 28 years with the aim of ultimate transition of the energy sector to market pricing and the European model, Ukraine is still quite far from this goal. 

Prices for households are set administratively, as in the Soviet era, and for the commercial sector — set within the given parameters with minimum and maximum limits (price caps), privileges for some economic entities and permanent numerous changes to market rules introduced by NERC.

As a result, investments in the energy infrastructure modernization were extremely low before the large-scale Russian aggression, and its degradation has reached such a scale that it posed a threat to the national security. The war strongly accelerated this trend.

What is the reason for such strong resistance to the transition to market pricing in the electricity and natural gas sectors, despite the obvious need to do so? In my opinion, the answer lies in the remaining vestiges of the "Soviet thinking", which are still preserved in the Ukrainian "elites" and many rank-and-file Ukrainians.

Historical perspective. As we know, energy and food prices in the Soviet (Stalinist) economic model were primarily considered a political and ideological factor, and only secondarily, an economic one. CPSU presented bread, housing and utility prices as a huge advantage of the socialist system over the capitalist one.

The Soviet planned economy was unable to provide the population with basic daily necessities and even a primitive set of foodstuffs in sufficient quantity. Wages were by an order of magnitude lower than in the West, people lacked political and civil rights but had cheap bread, electricity and gas, for which people were to be infinitely grateful to the party and the government.

On the one hand, one should not underestimate the market changes that have taken place in Ukraine since 1991, but on the other, the Ukrainian authorities never abandoned the Soviet state economic model of "low wages - low electricity and gas prices." After all, such a policy allowed and allows businessmen close to government to exploit human and natural resources to the maximum extent, and politicians – to score political points.

As we know, during the great privatization, the best industrial enterprises went to representatives of the Soviet party-economic leadership and its close circle. These people never engaged in entrepreneurship and only possessed the art of distributing state resources and manipulating public consciousness. After "perestroika", the former representatives of the Soviet state machinery realized that an innovative and transparent market economy is no good for them. Instead, redistribution of state property and energy resources to their advantage through opaque privatization and price manipulation allowed them to quickly turn from staunch communists into wealthy bourgeois.

As a result, many newly-made businessmen, while being fabulously rich personally, were not able to capitalize the Ukrainian industry even to the level of the WhatsAPP company, founded by Jan Koum, a native of Fastiv, over the three decades of their turbulent entrepreneurial activity.

The new-old Ukrainian "elite" did not want to reckon with the fact that Ukraine does not have such gigantic energy resources as the USSR, and the Ukrainian economy's ability to maintain low prices is limited and risky, due to critical underfunding of the energy infrastructure, redistribution of State Budget funds, cross-subsidies and exchange of political sovereignty for "cheap" Russian energy carriers. Such a pricing model could not lead to anything other than a socio-economic abyss.

Political consequences of the failure of price liberalization

The consequences of preserving the vestiges of the Soviet pricing policy are terrifying. Over the years of Independence, state finances lost trillions of hryvnias, which could be spent on social programmes, national defence and infrastructure development. The inability of the Ukrainian "elites" and society to get rid of the remnants of the Soviet mentality in pricing in the energy markets and their focus on a raw material economy with low added value contributed to the collapse of the entire post-Soviet socio-economic model. 

The policy of "cheap" gas, even under President L. Kuchma, contributed to the dependence on Russian energy carriers and the actual change of the European vector of state development for deeper cooperation with Russian "partners". Exactly in that period the Russian political influence on Ukraine began to steadily grow, which eventually led to power a group of Kremlin puppets led by V. Yanukovych in 2010. 

The known saying that "all great fortunes in Ukraine were earned on Russian gas" is not so far from the truth. Due to huge non-payments by large Ukrainian industrial enterprises and low prices for the population, in the late 1990s a large debt for Russian gas to Gazprom and its traders arose. The Ukrainian authorities at the time found nothing better than to pay off this debt with strategic bombers and missiles that from February 24, 2022, were used to destroy Ukrainian cities and kill civilians. 

After the Orange Revolution in 2004 and formation of a democratic government led by V. Yushchenko, there seemed a good chance for liberalization of energy markets and their integration in the EU legal space, but even this chance was lost after the then government in exchange for "cheap" gas admitted to the market RosUkrEnergo company, owned by the Russian agent of influence D. Firtash and the Russian Gazprombank.

As a result of D. Firtash's corrupt schemes, European integration reforms stalled, and Ukraine was never able to free itself from Moscow's influence. This led to public disappointment in the democratic forces’ abilities and election of an open promoter of the Russian World, V. Yanukovych, as the President of Ukraine. 

The fact that a significant part of the Ukrainian political "elite" spared nothing for its enrichment is eloquently evidenced by the agreements signed in 2010. The Kharkiv Agreements, in exchange for gas discounts, extended the Russian fleet stationing in Sevastopol from 2017 till 2042. These agreements laid foundation for the Russian occupation of Ukrainian Crimea in 2014.

As we can see, the main beneficiaries of "cheap" energy carriers for Ukrainian consumers were Kremlin imperialists and a significant part of Ukrainian oligarchs - in this matter, their interests coincided. The topic of "cheap" gas from the Kremlin was promoted in Ukraine by pro-Russian media and the local oligarchs, as an important element of a powerful informational and psychological special operation (IPSO) aimed at dismantling the Ukrainian state. It relied on the inertia of archaic Soviet thinking of many Ukrainian citizens.

By the way, a similar IPSO was actively promoted in the Ukrainian media under a similar scheme immediately after its launch of the new electricity market model in July 2019 and lasted until February 24, 2022. In this regard, it is worth admitting that the IPSO worked, because electricity imports from Russia and Belarus tanked the prices on the Ukrainian market, which significantly undermined the financial stability of Ukrainian electricity producers. Also, some Ukrainian oligarchs — owners of the most energy-intensive enterprises with low added value — contributed to the deformation of the new market model. 

In this case, the interests of the owners of low-tech Ukrainian enterprises coincided with the Kremlin goals in Ukraine. The consequences of distortion of the new model have not been overcome until now. The distorted market monthly generates billions in losses, which is fully in line with Moscow's desire to undermine the stability of the Ukrainian energy sector.

The last attempts to switch to the European pricing system in the gas market were made in 2016, and in the electricity market – in 2019, but the vestiges of Soviet consciousness prevailed in the corridors of power and public attitudes. Against the background of strengthening European integration slogans, the policy of strict administrative influence continues.

In this connection, the opinion of the prominent economist and one of the theorists of "Reaganomics" F. Hayek comes to mind, that state intervention in pricing on natural markets is always caused by the desire to redistribute national wealth in favour of business close to the government and has nothing to do with social justice. This, in turn, undermines the democratic foundations of society and shatters its rights and freedoms. The Ukrainian practice of pricing on energy markets is the best confirmation of this thesis.

Change of thinking as a prerequisite for modernization

I do not call for an urgent transition to European prices for electricity and natural gas, since this cannot be done in wartime due to low solvency demand. Instead, Ukraine should immediately start moving towards a market model that meets the EU requirements and its obligations in the framework of cooperation with the European Community. This requires elimination of market distortions and gradual achievement of market prices for all consumers, with account of the solvent demand and targeted subsidies to the poor.

However, there is another problem along the way. In case of implementation of the classic scenario of market prices setting on the basis of supply and demand, they may turn out to be much lower than the production and delivery costs. Such a paradox is explained by the critically low solvency of consumers in the conditions of a crippled economy. So, without the resumption of sustainable economic growth, the transition to prices adequate to the needs of modernization of energy enterprises seems unlikely. However, this does not mean that the movement towards market liberalization should not be started now. 

In any case, the biggest challenge for Ukrainian society after the war on the thorny road of socio-economic progress will be to transform consciousness through overcoming the vestiges of Soviet thinking and the Russian World. It requires the awareness of the majority of citizens that politicians are unable to provide them with cheap energy resources without violating the basic principles of the modern economy.

The task of political leaders is to ensure fair and transparent conditions for market functioning, a favourable investment climate and social protection for low-income families. Before that, all attempts to modernize the energy infrastructure will be futile, as will hopes for the transition from a resource-based to a knowledge-based economy, as a prerequisite for sustainable development. A society that cannot get rid of Soviet chimeras in its consciousness and expects "manna from heaven" from political leaders is fundamentally incapable of progress.

However, there are strong hopes that Ukraine's victory in the war will give a powerful impetus to the formation of a new way of thinking in society. Under this scenario, the creation of a new political system and a competitive economy based on efficient market models will be only a matter of time.

https://razumkov.org.ua/statti/nove-myslennia-osnovnyi-faktor-perebudovy-energetychnykh-rynkiv