Thoughts on energy pricing in Ukraine

Dear Morgan Williams:

The thoughtful articles of Yulia Tymoshenko and Olexandr Chalyi as items 1 and 2 in the Action Ukraine Report (AUR) #731 (July 13, 2006), coupled with discussions on European energy security at the G8 conference in St. Petersburg, July 15/16, 2006, has prompted me to examine the issue from a broader perspective.

Desirability of high prices of crude oil, natural gas and gasoline:

At the present time, the price of crude oil in North America is hovering around US $75.00/barrel [$479.49/m3 = $12.26/GigaJoule]. This abnormally high price is obviously due to fear of disruption of supplies by wars, rather than actual shortages of crude oil or its cost of recovery.

Similarly, due to an unusually mild winter in North America and high inventories in storage, the price of natural gas since December 2005 has dropped from $15.00 to US $5.86/1000ft3 [$206.94/1000m3 = $5.41/GJ]. In Edmonton, Canada, the price of gasoline has recently climbed to about Cdn $1.08/litre, while in April 2006 in Ukraine, it was about 3.50 hryvni/litre [Cdn $0.83/litre].

Historically, the price of crude oil and natural gas in energy terms (i.e. GigaJoules) are about the same. Thus, we can expect the price of crude oil to drop and/or the price of natural gas to rise. The price of gasoline will adjust accordingly.

In Ukraine, the highly subsidized price of natural gas for consumers was increased by 25% on May 01 and by another 85% on July 01, 2006. Presumably, the price is still substantially below the world price. Although this will cause an extremely painful adjustment for consumers, everyone agrees that gas (or gasoline or electricity) should not be sold to consumers below cost.

People must realize that these high prices are necessary to encourage conservation, as well as to stimulate the development and utilization of alternate energy products. For example, synthetic oil, ethanol and gas can now be produced economically from vegetation and farm products. Nuclear energy can be used to produce electricity, as well as for district or industrial heating.

Indeed, should world energy prices drop below an optimum level, I would suggest that governments impose an energy tax to ensure efficient utilization. Revenues from this tax could be used to improve the transportation/distribution infrastructure, as well as to fund appropriate research and development projects.

Transit fees for oil and gas pipelines:

The European Energy Charter, initiated in 1991 to facilitate the transport of natural gas from Eurasia to Europe, now has over 50 member countries and many observers. A study on Gas Transit Tariffs at provides an overview of the types and magnitude of the transit fees charged by various countries.

Although comparisons are not straightforward, it seems that transit fees are substantially higher within the European Union than in Ukraine, Belarus, Russia and countries further east.

The authors suggest that appropriate fees for a "model high pressure transit line" of 56" [1442 mm] diameter would be 1.6 $/1000m3/100km, but substantially higher at 3.3 $/1000m3/100km for a smaller 36" [914 mm] diameter line. (I believe the diameter of the gas pipeline through Ukraine is 1000 mm.)

Thus, for a 950 km pipeline transporting 120E09 m3 of gas through Ukraine, revenues should range from US $1.82E09 to US $3.76E09. [Note: E09 = 109 = billion; m3 = m^3 = cubic metres.] At the current gas price quoted above, this represents from 7.3 to 15.1% of the value of the 120E09 m3 of gas typically transported through Ukraine.

It is instructive to crunch the numbers for the years 2004, 2006 and the higher proposed transit fee. We assume that Ukraine transmits 120E09 m3 of gas, consumes 24E09 m3 and the pipeline length is 950 km, then calculate the difference between the transit fees received and the consumption costs expended.
2004: $1.09/1000m3/100km - $50/1000m3 = $1.24E09 - $1.20E09 = +$0.04E09
2006: $1.60/1000m3/100km - $95/1000m3 = $1.82E09 - $2.28E09 = -$0.46E09
Prop: $3.30/1000m3/100km - $206.94/1000m3 = $3.76E09 - $4.97E09 = -$1.21E09

We note that from a slight surplus from the 2004 formula, there is a deficit of almost $0.5 billion according to the 2006 formula, rising to a deficit of $1.2 billion for the proposed formula using the present world price.

Although not proposed in the above study, I like the idea that a portion of the transit fee be calculated on the difference between the selling price and the extraction costs at the source. This would make the transit tariff somewhat dependant on the value of the commodity being transported.

Thus, during times of high world prices, the profits of the selling entity would be somewhat curtailed, while the net cost of gas or oil to the transit-consuming country would be somewhat lowered. Should the price of oil and gas plummet below production costs the situation would be reversed.

Optimum Eurasian economy:

For better or for worse, Ukraine is sandwiched between the European Union to the west and the Russian Federation to the east. Consequently, it has little choice but to try to develop good working relationships in both directions.

Vast quantities of oil, natural gas and other raw materials are found on the territory of the Russian Federation and other countries of Eurasia, which were part of the FSU.

As noted above, the Russian Federation exports 80% of its natural gas (120E09 m3) through Ukrainian pipelines to various countries within the European Union. Recent high oil and gas prices have been a boon to its monetary reserves allowing it to repay foreign loans ahead of time. The economy of the Russian Federation is very much based on the export of depletable natural resources.

Many years ago (1974), I wrote a treatise titled "An Industrial Strategy towards an optimum Canadian Economy", in which I insisted that money earned from the export of depletable raw materials be treated differently than money earned from the export of renewable resources or from the export of manufactured products. In my opinion, my argumentation therein is directly applicable to Ukraine, the Russian Federation and other Eurasian countries.

The strength and stability of a country is not measured in terms of monetary reserves, military hardware, opulent buildings, the wealth of its oligarchs or even the wages earned by its inhabitants with which to buy foreign-produced products, but by the establishment of industries capable of producing manufactured products for home use and export. This requires investment in and development of appropriate infrastructures and an educational system continuously upgrading the capabilities of its citizens.

We cannot predict the results of the G8 conference on "energy security", but it is to be hoped that any EU - Ukraine - Eurasia agreement will go beyond simply establishing pricing formulas and transit fees. It is to be hoped that the agreement will outline a rational plan for the economic development of the whole region.

For the past 15 years, "oligarchs" have siphoned off trillions of dollars into foreign bank accounts (often with the collusion of Western institutions), rather than investing this money in the economies of Ukraine, the Russian Federation and other Eurasian countries. That is not acceptable.

It is not acceptable that Gazprom signs long-term contracts for Turkmenistan gas by investing in the foreign bank accounts of that country's dictator. No country or corporate entity should be allowed to buy gas or oil from a foreign country for re-export to a third country. In this case, the contract must be between Turkmenistan and the receiving European country with the Russian Federation acting as a transit country.

It is not acceptable that the profits of oil and gas extracted in remote regions of the Russian Federation do not accrue to the inhabitants of these regions, but end up in Moscow, St. Petersburg or foreign bank accounts instead.

Respectfully submitted
Will Zuzak; 2006-07-17
Archived as zuzak20060719AUR735.doc

NOTE: The energy-volume conversions are 38.4484E09 J/m3 for crude oil and 38.2650E06 J/m3 for natural gas.
NOTE: Dr. William Zuzak is a retired plasma physicist, who worked in the fields of nuclear fission and controlled thermonuclear fusion for many years. He was recently a Canadian election observer for the March 26, 2006 parliamentary elections in Ukraine. His 1974 treatise mentioned above is archived at