Ukraine's Economic Predicament: The Role of the Energy Market in State Corruption and the War in Donbas

October 23, 2015
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Ukraine's Economic Predicament: The Role of the Energy Market in State Corruption and the War in Donbas

Live streaming from the Danyliw Research Seminar on Contemporary Ukraine is available at

The fourth panel of the 2015 Danyliw Seminar explored the murky economic and political realities that shape (and are shaped by) Ukraine’s gas market.

Margarita Balmaceda offered a historical analysis of a phenomenon she calls “Ukraine’s rent swamp.” Her inquiry stems from the observation that Ukraine, despite its recent post-Maidan civic revival, remains a weak state mired in public distrust. She addressed several extant economic theories, which might explain this trend, but ultimately argued that a closer look at the structural and cultural factors at the time when Ukraine’s ‘foundational bargains’ were made would be most illuminating.

Margarita Balmaceda

Balmaceda focused on three historical elements that still contribute to state weakness, distrust, and corruption in Ukraine. The first of these is a set of Soviet legacies, especially policies that led to production of goods with little regard for prices. This created many different prices for a single commodity in a single market. These informal asymmetries allowed for the easy capture of rents by select groups.

Second, the early policies of the newly independent states created multiple markets that were separately controlled. This opened the doors to further rent capture by elite groups, as well as the administrative tools to facilitate that capture for those with the right connections.

Finally, Russian policies, especially the act of supplying commodities at non-market prices, actively support the survival of these multiple markets. Collectively, Balmaceda argues, these stubborn trends make improvements in transparency, regulation, and commercialization impossible.

Balmaceda also argued that these very structural seeds of corruption directly fueled (or even caused, as Rosaria Puglisi suggested in the Q&A) the military conflict in Donetsk and Luhansk oblasts. “The manipulation of boundaries and borders may create synergies,” she argued, “not for the resolution of the conflict, but for those energies accruing resources…in a way that supports the continuation of the conflict by making it a mutually profitable stalemate.”

Next, Thane Gustafson asked a simple and highly practical question: “is Ukraine going to be ready for the winter?” He argued that gas production by independent agents is continuing to grow, but tax legislation, which the Verkhovna Rada in Ukraine is currently refusing to deal with, will determine whether that production can continue.

There are several obstacles in the way of this. First, Ukraine has not found a viable alternative to Russian gas. More gas is being imported from European sources, but most of the infrastructure, the physical pipes that run across Ukraine, are designed to flow from east to west. Pushing gas through in the opposite direction requires, for engineering reasons, tacit agreement with Russia’s Gasprom.

Second, Ukraine’s role as a transit state is decreasing. A significant pipeline network exists in Ukraine, but less and less gas is flowing through them. Ultimately, Gustafson argued, this is a good thing, as it removes Ukraine as a bargaining chip in gas negotiations and allows contracts between Russia and its purchasers to be more commercial. It does, however, mean lost opportunities to capture rents in Ukraine.

Thane Gustafson

Gustafson closed his presentation with an observation that gas has started entering the separatist areas in Donetsk and Luhansk oblasts through two pipelines that run across the Russian border—pipelines so underused that Gustafson joked that Ukraine’s Naftogas might have forgotten they even exist. This gas kept the lights on in separatist areas, but the question of who is paying for that gas remains entirely unanswered.

Much of the early discussion at this panel centered on the role of the gas market and the large gas companies that control the commodity in Russia and Ukraine in the conflict in Donbas. In particular, the question of why gas is being shuttled across the Russian border into separatist areas was thoroughly debated.

Joshua Tucker suggested that it might be an error to treat Russia as a singular actor, that it might be more prudent to interpret that the movement of gas as an indicator of Gasprom officials’ attention to their bottom line rather than an enactment of the Kremlin’s current Ukraine policy. Gustafson agreed, noting that Gasprom is a business with a more than fifty-year legacy and an international reputation to protect; those business interests should not be discounted—especially when political events tempt us to view Gasprom as a political pawn.

Jesse Driscoll proposed that Russia could be sending gas to the separatist regions for strategic purposes—namely, to undercut Kyiv’s ability to use positive incentives to lure residents of the DNR and LNR back into Kyiv’s sphere of influence. In a word, by giving free gas to these regions, Russia makes it too expensive for Kyiv to “buy back” these regions by producing noticeable improvements in the quality of life through government expenditure.

Driscoll noted that a similar storyline has played out in Moldova and Georgia, both of which also harbor separatist, de facto states supported by Russian military presence. The international community, Driscoll noted, has been “trying to make [these countries] richer” so that they can offer a better life to residents of these regions than separatist government could. “But,” he concluded, “they are not yet rich enough [to succeed].”

Mychailo Wynnyckyj closed the discussion by returning the seminar’s focus to the most vulnerable actors in Ukraine’s current economy: household gas consumers in the fractured Donbas. He noted, “when we try to interpret the relationship between Ukraine and Russia, particularly from the point of view of economics, as western observers, we sometimes make, too often make, an assumption, which is that someone actually cares about the well-being of people in the DNR and the LNR, that someone actually cares about the economic interests of the people on the ground. My experience has been, quite frankly, that no one cares about their interests. People care about their own pockets. They care about wielding power or about political optics.”

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