Independence Day 2006: fifteen years, and a gas bill that changed the arithmetic

Fifteen years of independence, and the most consequential thing to happen this year was a change in the price of a commodity. On 1 January the gas supply was interrupted; when it resumed, the import price for Ukraine had moved from around fifty dollars per thousand cubic metres to ninety-five. Every industrial cost model in the country was rewritten in the first week of January, and the political consequences have been arriving ever since.

Start with the arithmetic, because it is the part that stays true regardless of who is in office. Ukraine's economy uses roughly three times as much energy per unit of output as the EU average. That was survivable, even profitable, when gas cost fifty dollars. At ninety-five it removes the margin from chemical production outright and takes a serious bite out of metallurgy, which uses gas in reheating and in coke substitution. At the European price — where this is obviously heading over several years — a large part of the Soviet-era industrial base is not viable in its current form.

Why the shock is structural, not cyclical

The temptation is to treat this as a dispute that will be settled. It will be settled, repeatedly, and each settlement will be temporary. The underlying change is that gas has stopped being an implicit subsidy and become a priced input, and no negotiation reverses that direction for long.

What follows from it is a decade of adjustment that has barely started. Energy efficiency investment in Ukrainian industry has been almost nil since 1991 because there was no price signal to justify it. There is one now. The companies that respond early — replacing open-hearth furnaces, installing heat recovery, switching chemical feedstock — will still be here in 2015. The ones that lobby for a subsidy instead will consume political capital and then close anyway.

For equipment suppliers this is the clearest commercial opening in Ukraine in years. Anything that reduces gas consumption per tonne of output now has a payback period that a Ukrainian CFO can defend to a sceptical board. That was not true in 2004.

The political result and what it means

The March parliamentary election produced no clear winner and four months of coalition negotiation. Earlier this month Viktor Yanukovych was confirmed as prime minister — the same person defeated in the repeat vote of December 2004, now heading the government under a constitution that has just transferred substantial powers from the president to parliament.

The reflex reading is that the revolution has been reversed. That is not what the institutional record shows. The transfer of power happened through a normal election and a normal coalition process, both of which were competitive and neither of which required anyone to occupy a square. That is the more significant fact, and it is genuinely new for this region.

The practical reading for business is a period of cohabitation between a president and a prime minister who disagree about most things, in a system that now requires them to co-sign much of what either wants to do. Expect slower legislation, more litigation over competences, and a strong preference among officials for doing nothing that could later be characterised as a mistake.

The numbers underneath

Growth has recovered to somewhere around seven per cent this year, which surprised most forecasters who assumed the gas shock would be worse than it has proved. The reason is that steel prices held up and that domestic demand, fuelled by wage growth and a rapidly expanding consumer credit market, is now doing real work. Retail lending is growing at a rate that would concern any supervisor looking closely, much of it denominated in dollars and Swiss francs to borrowers earning hryvnia.

That last detail deserves a mark in the margin. A household taking a ten-year mortgage in a foreign currency at a fixed exchange rate is making a bet on the National Bank's ability to hold that rate for ten years. In 2006 nobody frames it that way. In 2009 everybody will.

Fifteen years in

The anniversary reading is straightforward. Ukraine has spent fifteen years with an economic model inherited rather than chosen — energy-intensive, export-concentrated, dependent on a subsidy that was never written down as one. This year that model received the first bill it could not ignore. The response over the next five years determines whether the second fifteen years look different from the first.

Related in this archive

• Independence Day 2007: governing in the gaps between elections
• Independence Day 2005: the year after, and the bill for it
• Independence Day 2004: a country counting down to an election
• Ukraine Annual Review 2006: the year the cost base changed