When in early 2014 Andriy Kobolyev became the chief executive of Naftogaz, Ukraine’s biggest oil and gas company, he inherited an enterprise mired in corruption and trapped in a battle with Russia over energy prices.

Both issues affected Europe’s energy security. Recurrent disputes with Russian energy giant Gazprom created serious gas shortages in 2005 and 2009, especially for some Central European countries and Bulgaria.

At issue for Kobolyev is how to free Ukraine from the political grip of Gazprom. For him, integrating Ukraine’s energy sector into the EU via interconnectors and reverse gas flows would end that stranglehold. That will demand major reforms at home.

Dempsey is a nonresident senior associate at Carnegie Europe and editor in chief of <em>Strategic Europe</em>.
Judy Dempsey
Nonresident Senior Associate
Carnegie Europe
Editor in chief
Strategic Europe
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Ukraine has one of the most important transit pipelines for Russian gas exports to the rest of Europe. Fifteen percent of the EU’s imported gas flows through Ukraine. At the same time, Ukraine is dependent on Russia for half of its own annual gas demand of around 50 billion cubic meters. Since 2005, Naftogaz and Gazprom have been locked in a bitter political battle over prices and transit fees.

Kobolyev believes reforms are needed in four areas. “The first pillar is integration into the EU so that Ukraine’s gas transmission system and the Ukrainian gas market become part of the European gas market,” he told Carnegie Europe.

Naftogaz has begun to diversify its source supply and now has at least six suppliers from EU countries, according to Kobolyev. With diversification underway, the next step is to integrate Naftogaz into the EU’s energy network by enabling Ukraine to receive virtual reverse gas flows from neighboring Slovakia through interconnectors.

“Virtual reverse flows would allow Naftogaz to import large quantities of gas from European energy companies, fill its gas storage facilities, and avoid any gas disruption over the winter,” Kobolyev explained. That would also sever Ukraine’s dependence on Gazprom. No wonder, then, that Gazprom continues to block Ukraine from receiving such reverse gas flows from Slovakia, citing contractual arrangements with Bratislava.

Kobolyev’s counterargument is that the EU’s Third Energy Package, which aims to open up the bloc’s gas and electricity markets to third-party access, should be applied to Slovakia. If the principle of the Third Energy Package were implemented, Kobolyev believes that Ukraine would be the last piece in the European gas puzzle.

“Ukraine could be added as a big market. It could be added as a place where you can store gas,” he continued. “It could be added as a transit route to Hungary, to Bulgaria. That would increase energy security. Our aim is to fully integrate Ukraine into the European energy structures.”

Kobolyev sees no need to build new pipelines. “You just need to implement EU legislation. The Third Energy Package destroys gas borders,” he added. Ultimately, the package of measures will remove Gazprom’s grip over parts of Europe.

The second and politically more sensitive reform is to raise prices to market level. “The current system of lower prices is unfair. It’s like a tax subsidy for everyone. If I have a house, I consume much more gas than a person in a small apartment,” Kobolyev said. Under the reforms he envisages, there will be a direct state subsidy for people who cannot afford higher prices as well as a system of cheap loans.

Reforms would give #Ukraine an efficient and transparent gas market.
 
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For Kobolyev, diversification and price rises go hand in hand. If such reforms were pushed through, Ukraine would have an efficient and transparent gas market. “You can’t have an efficient market without diversifying your source supply. And you can’t have a transparent market without market prices,” he argued.

The third pillar of reform is energy efficiency, sorely needed for a country that has one of the lowest efficiency levels in Europe, according to the European Bank for Reconstruction and Development.

The fourth priority is tackling Naftogaz’s endemic corruption. To that end, Kobolyev has embarked on a massive anticorruption campaign. The first step was to get rid of intermediaries controlled by the oligarchs. “There is no intermediary now between Naftogaz and Gazprom,” Kobolyev insisted. “There is no intermediary now between Naftogaz and the EU.”

He knows that this alone will not end the graft. “Corruption has existed in Ukraine for many years, even in Soviet times. And the ideology of corruption is derived from paternalism,” Kobolyev explained.

“Many of those who ran the country took a position that ordinary people were being taken care of. And as long as the people were being taken care of, those in charge could do what they liked.” That would lead people to think: “If those in charge can steal billions, we can steal hundreds.”

Naftogaz was part of this vicious circle. “If you ran Naftogaz and you were stealing, how can you charge your consumers the market price?” Kobolyev said. “You would give them a low price and say, ‘Look, you have a very low price, lower than in Russia.’”

Naftogaz has some 175,000 employees on its payroll. Kobolyev said many of them had been affected by corruption. To fight this problem, he has taken a top-down approach. “We removed all corruption at the top level and are slowly removing it at the middle level. And we’ve started dealing with people who have been engaging in corruption on a small scale.”

For example, an employee who is responsible for monitoring the high-pressure pipeline at a meter station can make $50 if he lets through part of the gas without passing it through the meter. “Probably, in a year, we can remove such things. We won’t remove 100 percent of it. But I would say 80 percent is dealt with already,” Kobolyev reckoned.

Kobolyev has now invited EU officials to monitor the meters on the Ukrainian side of the border with Russia. “So, if Gazprom tries to accuse us of something [corrupt], there is always a way to check who is right. Now there are data available that prove we are a reliable transit partner.”

.@kobolyev has no illusions about the difficulties of implementing reforms.
 
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The Naftogaz CEO has no illusions about the difficulties of implementing reforms. The situation in eastern Ukraine, where fighting has again erupted, doesn’t help matters. “But we can’t wait forever,” he said.

“Indeed, we believe that these are exactly the tactics of [Russian President Vladimir] Putin,” Kobolyev said. “Putin would like us not to carry out the reforms but to focus on the war. He doesn’t want Ukraine to be economically successful.”