Calculations and conclusions were verified by the Centre for Economic Strategy (CES)Download the conclusion by CES
In December 2019 I was sitting at a round table in the Élysée Palace opposite Putin. The night before, the President of Ukraine had requested my presence at negotiations on the vital question of the transit of Russian gas through our country.
When my president looked at me and silently invited me to take on Putin, my first thought was that I had not expected to be one-on-one with the President of Russia. But the second was that we had always known that Putin was the decision-maker, and we had been preparing for an opportunity like this for five years: so maybe I should take a deep breath and just do my best. We crossed swords for about 20 minutes in an intense exchange. However, we were interrupted in full flight because President Macron and Chancellor Merkel had been waiting for the presidents at the dinner table for more than an hour. I went to face the press but all I could say was that we had agreed to continue negotiations.
Later that month, in Vienna hotels, resplendent with imperial grandeur, we conducted almost week-long negotiations with Gazprom – Putin’s favorite geopolitical tool disguised as the world’s largest gas company. They ended with me signing two agreements with Alexey Miller, Gazprom’s CEO. The first was a settlement agreement under which Gazprom paid Ukraine USD 2.9 bln as compensation. It also closed all disputes around the USD 300 bln contracts signed in 2009 for supply and transit of gas. The second agreement was a new transit deal for the next five years with guaranteed revenues for Ukraine amounting to USD 7.2 bln, as well as other important benefits.
If you had asked five years earlier if such a turn of events was possible, people would have thought you crazy. In 2014 the Ukrainian state had been on the brink of the abyss. And one of the major reasons why it was saved are these game-changing victories over Gazprom and corruption in the gas sector.
One could say that Ukraine has still not moved far enough away from the abyss. Indeed, there are renewed concerns, that it may move backwards, not forward. A valid point – but that is exactly why we have to draw the right conclusions from these events. Needless to say, given the importance of the gas sector for Ukraine, the country’s ongoing war with Russia and its reform agenda, this story is about much more than natural gas.
On the Brink of the Abyss
In 2014, just as it proved unable to defend the nation against Russia’s military aggression which led to the loss of Crimea and part of Donbas, the Ukrainian state was on the verge of failing to ensure security of gas supply to its people.
Ukraine was critically dependent on Gazprom’s natural gas, a vital essential for 87% of Ukrainian households. Gas supply and transit were controlled personally by Putin; he had made it one of his most important geopolitical weapons; in the case of Ukraine it was a noose just waiting to be tightened.
As soon as the Revolution of Dignity of 2014, a popular uprising, changed Ukraine’s geopolitical vector, from Russia to Europe, overnight Gazprom virtually doubled the price – well beyond the level that Ukrainian consumers could afford to pay. It also claimed billions of debt that Ukraine did not have. Subsequently, Gazprom interrupted supplies and went to arbitration to collect the debts.
What this meant was either an economic and humanitarian catastrophe for already enfeebled Ukraine, or having to yield to Russia and return to a de-facto colonial status. The memory of how in 2009 people froze to death because the supply of Russian gas was interrupted, or of the misery faced by the Ukrainian city of Alchevsk in the winter of 2006, was still fresh in the mind.
Inside Ukraine there was a fight too: between New Ukraine and Old Ukraine. The former stood for an open society, a level playing field, fair competition – what political scientists call “inclusive’ institutions.The latter for their opposite – “extractive institutions”.
The Revolution of Dignity allowed New Ukraine to advance, but the ruling elite was still dominated by representatives of Old Ukraine who did not hesitate to hire, as puppets, those ready to switch sides from New Ukraine.
Ukraine’s Naftogaz, a national gas company at the centre of these events, was not an exception. It was controlled, in effect captured, by Dmytro Firtash, a notorious oligarch with ties to Gazprom and even Russian organized crime, who was a partner of Yuriy Boyko, a former energy vice prime minister, and Serhiy Lyovochkin, a former head of the presidential administration. During his last months in office, Viktor Yanukovich, the President of Ukraine, before he fled to Russia in February 2014, fell out with this group. This group was linked to Arseniy Yatsenyuk, the politician who became the new prime minister through his close partner, Mykola Martynenko, a head of the parliamentary energy committee. Yes, it was complicated. At first, the new Cabinet tried to retain the previous Head of Naftogaz, Yevhen Bakulin. But he was suddenly arrested on accusations of complicity in siphoning USD 4 bln out of the company. Later, the authorities found and froze USD 60m in his Swiss bank accounts. Not surprisingly for modern Ukraine, he did not serve a term in prison, but also fled to Russia.
Against the background of the arrest of the Head of Naftogaz, and under pressure from mobilized society and political rivals, the new Cabinet decided to appoint a “fresh face”. It found one – Andriy Kobolyev, a young chap with no real management experience and no business or industry education. Why him? Because his friend from playing poker together knew he had been employed by Naftogaz before. This friend worked for a petty oligarch, Igor Yeremeyev, who was a partner of the above-mentioned big oligarch and the head of the parliamentary energy committee, who in turn was very close to the new prime minister, who was responsible for appointing a new head of Naftogaz. Besides, the young chap seemed docile and knew how to make friends with powerful people in Ukraine. Remember, we are talking about a huge industrial company in the middle of a gas war with Russia. Maybe in the West one would call such an appointment dodgy, but it was, and still is, the way it’s done in Ukraine.
As the newly appointed Head of Naftogaz, this chap was immediately sent to Moscow to meet with Gazprom. Reportedly, this meeting was arranged by Yuriy Boyko, the partner of Dmytro Firtash, as a part of a plan to steer Ukraine towards a lucrative deal for this oligarch, whereby he would again become an intermediary in gas supply between Russia and Ukraine. But, apparently, at that time Gazprom’s real boss, Putin, had a different plan for Ukraine – he was annexing Crimea and invading Eastern Ukraine. Hardly surprisingly, negotiations with Gazprom failed. Ukraine was in mortal danger.
Roots of the crisis
Before we look at how Ukraine managed to pull back from the abyss, let’s first briefly analyze how it got there. We need to go back to the very beginning of the third millennia, to the time when Putin, as a recently elected president, started his march to restore Russia’s geopolitical influence. Naturally, it started with Ukraine, which historically was by far the most important de-facto colony of Russia. It is often still not fully understood that the weakness of the Ukrainian state in 2014 was a result of deliberate actions by Russia after Putin’s consolidation of his power. This included the encouragement of corruption in Ukraine, most prominently in the gas sector.
You may not be aware that a couple of years before becoming president Putin even wrote a doctoral thesis on how companies like Gazprom should serve as pillars of the Russian state. Therefore, it should not be a surprise that on assuming power he replaced the management of Gazprom with people he trusted, including a man who shared the same office with him at the KGB.
Along with the new Gazprom management, there were changes in the relationship between Russia and Ukraine in the gas sector, which had hitherto had a long history of successful partnership. The formal link between Russian gas supply to Ukraine and Russian gas transit to Europe through Ukraine was deliberately broken. Gas supplies from Central Asia to Ukraine that went through Russia were first blocked and then placed under the control of an intermediary owned by Gazprom and Dmytro Firtash, the notorious Ukrainian oligarch already mentioned, which allowed him to buy major TV channels and establish numerous “friends” in the government. Russian propaganda soon flourished in Ukraine and even in Europe.
Gazprom became more and more dominant; Ukraine lost its leverage and became an easy target for disinformation and intimidation. Billions of dollars every year again started to go from Ukraine to Russia – a textbook example of a colonial policy restored by other means.
All this worsened the already difficult situation for the young Ukrainian state. Its society is composed of several distinct groups. One, a big one, adheres to traditional Ukrainians values of survival and kinship and distrusts state power. Another significant group is composed of paternalists. And there is a smaller, but constantly growing, group upholding modern European values. When the state oversteps society’s pain threshold, and the latter feels it can and should make a difference, it somehow mobilizes which, roughly once a decade, results in a popular uprising.
On the other hand, there is the state power vertical. In fact, it is not a vertical since it looks more like a Hydra with two heads – a government and oligarchs. It may sound bad, but when there are no free markets, oligarchs, as a parallel mechanism to centralize and allocate resources, are an important counterweight to the state. At least they somehow introduce a modicum of pluralism and competitiveness. Otherwise, Ukraine would regress to the centralized planning system of Soviet times. The problem is that this Hydra requires only a limited development of free markets and other “inclusive” institutions so that its privileged position is not challenged. All in this regard results in a vicious cycle of corruption, superficial reforms and populism.
Given the above, the gas crisis of 2009 did not surprise experts. Putin demanded a shift to what he called “European market pricing”. In fact, Russia was cherry-picking and distorting “market” and “European” terms in pursuit of unfair benefits. Naftogaz had a well-grounded position, developed by me a year before, how to shift to real European principles. But the Ukrainian state failed to defend this position vis-à-vis Putin. The West also did not help much in this regard.
Negotiations were heading nowhere. Russia first stopped supplies to Ukraine, and then transit to Europe. European media were reporting cases of people freezing to death in countries like Poland that depended on this gas. Putin met with Ukrainian Prime Minister, Yulia Tymoshenko. She went to Moscow and basically accepted Russia’s position on pricing of gas and transit, with a concession only for the first year. This immediately made their 11-year deal heavily skewed towards Russia’s interests.
Later it transpired that the biggest problem of the contracts was not even the pricing, but a so called “take-or-pay” provision – an obligation by Naftogaz to pay for huge volumes of gas even if Ukraine did not need them. Moreover, Ukraine was prohibited from re-selling the gas. According to the Naftogaz management of that time, Gazprom simply deceived them. The devil was in the details. Although there was indeed a general principle of “take-or-pay” in standard European long-term gas contracts, the wording in the Gazprom’s contract, especially in combination with other provisions, did not comply with European norms.
Importantly, from the point of view of history and politics, an internal “expert” of Naftogaz, who was supposed to check the “take-or-pay” provision, but failed to do so properly, was the very same young chap, Andriy Kobolyev, who was later appointed Head of Naftogaz in 2014. The issue here is therefore not just about individual competence and conscientiousness, but rather that it alludes to a much bigger problem – questions concerning governance, meritocracy and culture. Ironically, these contracts had a total value of 1/3 trillion dollars, making them probably the biggest contracts in world history.
As the management of Naftogaz, who signed the contracts, once pointed out, reasonably enough, what matters is not just the contract itself, but how it is executed. And here there are other telling examples.
First, the same young chap, Kobolyev, failed to follow the contract on how to substantiate a tariff revision request. Gazprom declined the request prepared by him and later we lost on this point in the subsequent arbitration (otherwise we could have won up to USD 12,3 bln more). But in 2014 we at least understood that we could pursue further arbitration, challenging Gazprom’s claims, as well as claiming compensation from it. The management of Naftogaz in 2010-2013, controlled by the notorious oligarch and his partners in the government, persuaded president Yanukovich, that Naftogaz was not capable of doing this. Was it incompetence or treason? I do not know, but instead of revising the gas price through arbitration, Ukraine ended up making ruinous geopolitical concessions to Russia in return for gas price “discounts”.
The last concession, the refusal by our pro-Russian president at that time, to sign the Association Agreement with the European Union, led to student protests, and when the students were beaten by police, to a popular uprising which became known as the Revolution of Dignity.
Getting out of the Abyss
Now we return to 2014, when the new Head of Naftogaz was appointed. We had worked together, and he knew my strengths and competencies. He asked me to partner him in handling the crisis. Because those behind his appointment hoped he would serve as their puppet, I realized the need to make him politically stronger and more independent.
I understood that a senior state functionary, which he in effect had become, is a two-faced Janus. One face looks at what people need from a state. The other looks at what ruling elites want to take from people. When he is not a puppet, at least his formal powers can be used for the good. Thus, a two-faced Janus seemed a better option than one simply serving his political masters.
I was in charge of teams doing rather different stuff. We replaced supplies from Gazprom with ones from the European market, saving money along the way; defended Ukraine against Gazprom’s claims in the arbitration totalling USD 47 bln (together with potential claims and interest of USD 50 bln it is comparable with Ukraine’s GDP in some recent years, and, as I have already mentioned before, we even made Gazprom pay USD 2.9 bln compensation and sign a new 5-year transit contract with USD 7.2 bln guaranteed revenues and other benefits for Ukraine. Among other things, we also were behind targeted fights with corruption and oligarchs, as well as the gas market and corporate governance reforms necessary for these successes.
At first we felt as if we were guerrilla groups; later, more like special operations units. We typically initiated, planned and executed the core operations ourselves, in a rather autonomous mode. My western education and market experience meant that often I and my closest team had to be mavericks, for better or worse.
Of course, since we are talking about large scale reforms and many actions at different levels, from our workers who carried out emergency repairs of major gas pipelines, to heads of state who helped us to reach a deal with Gazprom, there are many people who have a full right to claim credit for these victories. I am grateful to all of them.
It’s not just about numbers. It’s about keeping homes of Ukrainians warm, and about industry working, and jobs. It’s about real independence, when we do not need to trade part of it in exchange for gas imports. Also about the dignity of Ukrainians who proved Moscow’s propaganda false: Russia did not subsidize Ukraine, as Moscow wanted the world to believe. About lower gas bills, allowing consumers to have more money to spend on other things. And about the ability of the state budget to allocate more to defense and social care. A more competitive economy – economic growth and, again, even more money in the state budget. And let’s not forget it’s also about contributing to energy security and lower prices for the EU, and even reducing the chances that Russia will wage a full-scale war against Ukraine.
Our opponents, and we have many of them, can’t stop trying to find “reasons” why these victories are not “real”.
A popular one is that while Ukraine stopped getting Russian gas directly, it still receives the same gas indirectly – meaning that this gas goes first from Russia through Ukraine to Europe and is then reversed back to Ukraine. Thus, nothing has changed, just Ukraine is paying more because of intermediaries. But let’s look at facts. According to a leading Russian information agency, in winter 2014/15, Gazprom spent USD5 bln on vain attempts to block supplies from Europe to Ukraine. This clearly demonstrates that such supplies do improve security of supply for Ukraine. Besides, in case of the interruption of the transit of “Russian” gas through Ukraine to Europe, flows of gas inside the EU will be re-routed and Ukraine will be able to get gas from other sources available in the EU.
As far as the price is concerned, while direct supplies of Russian gas should be cheaper than supplies from the EU, Gazprom simply refused to provide gas to Ukraine even at the European market price. Since Gazprom is currently the monopoly exporter of pipeline gas from Russia, one should look at real, not hypothetical, prices offered by Gazprom and then it will be clear that imports from the EU in fact were cheaper.
Another myth is that “cheap” domestically produced gas can cover the needs of households, thus Naftogaz was robbing Ukrainians by charging a price well above production costs. Leaving aside the fundamentals of economics, which say that if gas is imported to a market, a fair market price will be equal to the import price since it balances supply and demands, I would just point out that the only reason why domestically produced gas currently can cover the needs of households is that the price is not set at an artificially low level and it results in more efficient (economic) consumption.
When I think about what unites the key success factors inherent in our victories, it is impossible not to acknowledge the primary role and direct effect of the market, as opposed to political instruments. It is the market that was at the center of our success. With all due respect, state institutions, Ukrainian and Western, as well as international financial organizations, played a support role. Do not take me wrong, such a role had a critically important indirect effect – when they supported putting the market and its instruments at the center, as well as when they supported my team at Naftogaz. I should also note another important factor – the indirect role of mobilized society in putting pressure on Ukrainian state institutions to make them do the right things.
These victories did not come easily. There were also internal conflicts involving constant clashes at different levels. I do not mean interactions with Gazprom – that is a separate big drama. I mean the fights inside Naftogaz and with other Ukrainian state institutions. It created a lot of tension and often led to sub-optimal compromises.
We always had to watch our back. I will give you an example. According to the arbitral tribunal, Gazprom had to pay USD 2.9 bln (this amount includes interest accrued by year-end 2019) as compensation. It was black on white, even the arbiter, appointed by Gazprom, decided so. For Russia not paying such compensation was less a matter of money; it was about the unwillingness to recognize our victory, ruinous for their narrative about Ukraine. Putin did not want to lose, especially to “nobody”. As crazy as it may sound, but Russia tried to make us “give up” the right to get compensation from Gazprom. It even secured silent support from some representatives of state institutions in Ukraine and in Europe. As usual, it was combined with a lot of manipulation, outright disinformation and even intimidation. As a countermeasure, I had to launch a stakeholder engagement campaign.
This helped protect our interests and Gazprom finally had to pay up. At the same time, some politicians were helping Putin to “save face”, presenting our triumph as a political deal and detracting from Ukraine’s victory.
On a separate note, our success often rested on our ability to surprise, and sometimes even ambush, a much more powerful opponent. Remember, we were a small team of non-conformists fighting the Russian state as well as the “Old Ukraine” within the Ukrainian state, including oligarchs. Remember also that Naftogaz is de-facto part of the state. Every “surprise” had to be carefully prepared, which required competence and integrity on the part of the core team behind it. But once we attacked our opponents, we needed to be extremely open in our communications to the outside world in order to secure at least some level of external support during the fight.
How to further disarm Putin and make Ukraine a better place
Ukraine could have moved even further away from the abyss. If we look at the situation constructively, there are still opportunities to make this happen.
For example, opportunities to significantly reduce energy bills for Ukrainian consumers while increasing both security of supply and state budget revenues. It means happier Ukrainians and a less dangerous Putin regime. For this purpose, Naftogaz could ensure Russia allows European companies to buy gas on the Ukrainian-Russian border, unblock exports of other gas producers in Russia, as well as transit of gas from Central Asia. There are market and legal tools available for this.
Inside Ukraine, inefficient consumption of gas could be significantly decreased through a combination of investments and market instruments. Indigenous production could be increased through the application of new technologies, and in general, efficiency of management of public assets could be radically increased.
Naftogaz could also sue those responsible for schemes that resulted in multi-billion losses for the state, like that of RosUkrEnergo, where the same notorious oligarch and Gazprom were behind the transaction in question.
And Naftogaz should win the arbitration against the Russian state in respect of assets in Crimea, where my team has already substantiated claims amounting to USD 9 bln (including accrued interest), and then make Russia pay.
Yes, there are hurdles on the way to realizing these opportunities. There is an urgent need to significantly improve transparency, market integrity and the rule of law. In particular, to ensure full compliance with EU rules and to confront unnatural monopolies, the majority of which are controlled by the notorious oligarch. The business model of Naftogaz should be changed – to become an efficient platform for developing markets and attracting international partners with direct investments, technology and management know-how.
Interconnected with the tasks above, corporate governance of Naftogaz should be drastically improved. This includes the need for much better insulation from political meddling and graft, enforced accountability, a new board of directors with a proper set of skills and integrity, as well as merit-based due process for management appointments, starting with the CEO.
As an option, a National Wealth Fund with professional asset managers, as a centralized ownership entity for public assets, could drive progress in the governance of Naftogaz and other state-owned enterprises.
And a word of caution: don’t be tempted to draw the wrong conclusions from Naftogaz’s successes.
Don’t be blinded by headline numbers. Indeed, Naftogaz reported profits of USD 2.45 bln in 2019, and it is a remarkable accomplishment, especially compared to losses of USD 7.44 bln in 2014. But if we deduct profits of just one business unit, Gas Transit, managed by me, there will be losses of USD 0.20 bln in 2019. As explained before, I and my closest team were mavericks, and thus it makes sense to look at the rest of Naftogaz when making conclusions about general management of the company. And then we will see that, as Sheakspeare puts it in Hamlet, “Something is rotten in the state of Denmark”. Most regrettably, from 2019 things have been moving into a wrong direction.
After engaging Putin directly, I wanted to share my emotions with the press but had to keep them inside me. What I really wanted to tell the journalists was that after our successes in arbitration against Gazprom we had turned the tables on Russia. We were talking for the first time with the Kremlin tsar not as underdogs or vassals, but from a position of equality. When I was staring into Putin’s eyes, I could see that he was upset and irritated, but not really depressed. He was losing a battle, but not a war. And it is vital to be aware that this war on all fronts is still far from over.
We can figure out what he is hoping for. An agenda wherein at least some Ukrainian state institutions are dominated by the interests of oligarchs and populism. Sadly, but this should change, there is a lack of understanding of why markets and the fight with Russia should be a priority. The West often has the wrong focus and supports cargo cults, in many cases outright window dressing (Potemkin villages). And support from mobilized society is often not there as consistently and forcefully as it is required, especially because of the amount of demoralizing disinformation and manipulation being generated, as well as the lack of resources for communication to get through.
These are the reasons why I am leaving Naftogaz. Apparently, as Friedrich Schiller put it: “The Moor has done his duty, the Moor can go”.
After reversing the tide, we should be wiser and stronger. Those of us who made this possible and realize the historical and strategic significance of what we accomplished have no intention of giving in to Putin and his de facto proxies in Ukraine and beyond. We have passed a major milestone, but much more needs to be done on the long road before us. Understanding what’s at stake, solidarity and purposeful activity are the key to our brighter and more secure future.
Calculations and conclusions were verified by the Centre for Economic Strategy (CES)Download the conclusion by CES