Ukraine on the Brink

The gas supply crisis between Russia and the EU has been resolved; the larger crisis in Ukraine has just begun. In what has become a regular ritual, gas deliveries to Europe via Ukraine were halted for two weeks in January as the Russian and Ukraine argued over debt, shipment fees, and the price of gas sold to Ukraine. With EU intervention, Russia and Ukraine agreed to resume shipments to Europe. Europe is now breathing a sigh of relief, but Ukraine is wincing at the new price it will have to pay for domestic gas and implications for its economy.
Ukraine has traditionally received gas from Russia at a highly subsidized price, an institutional relic from the Soviet Union. That was a boon for Ukraine’s domestic economy, which has grown strongly since 2000. But in the agreement reached last week, Ukraine lost its favorable energy position with Russia; though the country will receive a 20% discount on the European price of gas for 2009, all subsidies will end on January 1, 2010. Gas prices have already more than doubled in Ukraine, from $179.50 per 1,000 cubic meters to $380.

The timing could not be worse for Ukraine’s economy. Ukraine’s major export industries, chemicals and steel, are large consumers of energy and the rise in price has significantly increased costs. But this rise in costs comes at a time when the price of steel has plummeted by over fifty percent since last summer. Higher costs and lower revenues is a recipe for economic disaster. In September 2008, analysts projected that 2009 GDP growth would be five percent; now analysts expect the economy to contract by at least five percent.

The new gas price may very well bankrupt the country. Already the country is living on life support, having received an emergency $16.4 billion loan from the IMF in November. With declining exports, and rising gas prices, the current account balance of the country has quickly turned unstable leading to a large depreciation of the national currency against the dollar. Yields on Ukrainian dollar-denominated debt are now the second highest in the world, after Ecuador which defaulted in December.

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