Ukrainians have suffered dearly at the Kremlin’s hand. Russian President Vladimir Putin refuses to release the 24 Ukrainian sailors captured in the Kerch Strait last year, thousands of Ukrainian civilians have died in the War in the Donbass, and 2 million more live under Russian occupation in Crimea.

But the threat to Ukraine also comes from within: If Russia ceased its aggression tomorrow, many of Ukraine’s problems—bureaucratic inefficiency, corruption, and lack of transparency—would persist. These problems are particularly prevalent in the energy sector, which is directly linked to economic growth and national security.

As it enters the fifth year after the Euromaidan Revolution, Ukraine must advance its energy reforms to safeguard its economy and sovereignty. This year’s upcoming presidential and parliamentary elections provide the opportunity for candidates to demonstrate their dedication to this task.

Sustained progress would benefit all Ukrainians: Consumers would enjoy better energy services and lower prices; the domestic energy sector would create high-skilled jobs and boost economic output; and the government would secure new revenue streams that could bolster national priorities such as defense and social services. The alternative is the status quo: unrelenting threats from Moscow and sluggish economic growth at 2 percent, which spells continued stagnation.

After Euromaidan, energy reform became central to the new Ukrainian government’s anti-corruption campaign. This was partly due to International Monetary Fund (IMF) conditionality, but also because of the enduring mismanagement of the energy sector, which had generated pernicious budget deficits, jeopardized energy security, and limited economic potential. The National Anti-Corruption Bureau of Ukraine found that corruption is more prevalent in the energy sector than anywhere else in the Ukrainian economy.

Today, the reform process has stalled. For example, Ukraine moved to close the gap between natural gas prices for households and industrial consumers, reducing subsidies that were a major budgetary drain. However, import prices have increased over the last two years while household prices have stayed the same, crowding out other budgetary priorities like social welfare and defense as the government foots the bill. Compounding this problem, illicit arbitrage—illegally selling low-priced household gas to industrial consumers at higher prices—further runs up unnecessary government spending and begets corruption that the Kremlin can exploit. In the past, out-of-control subsidy spending left Ukraine at Moscow’s mercy: In 1993, Ukraine had to cede part of its Black Sea Fleet to Russia in exchange for energy debt relief.

Growing Disparity Between Wholesale Natural Gas Prices for Households and Industrial Consumers, in Ukrainian Hryvnia
(Source: Naftogaz)

Because of entrenched elite interests, no policy is in place to prevent the government from fully reintroducing subsidies, despite the current government’s recent promises to the contrary. Former Prime Minister Yulia Tymoshenko, who currently leads polls for the presidency, has already declared she would reinstate subsidies, making it a centerpiece of her campaign.

But Ukrainian politics still leave some room for surprise. Tymoshenko’s lead currently gives her only 20 percent of the vote, leaving room for other candidates to enter the race. Volodymyr Zelenskiy, Ukraine’s most famous comedian, announced his bid in a New Year’s address. Reputable polls see the actor second to Tymoshenko or besting her in a run-off vote. Perhaps tellingly, Zelenskiy is best known for his role on Servant of the People, a popular TV series in which he plays a teacher who accidentally becomes President after a video of his rant about government corruption goes viral. Others with name recognition like Svyatoslav Vakarchuk, former Member of Parliament (MP) and lead vocalist for the popular Ukrainian band Okean Elzy, would have an immediate edge if they entered the race.

Regardless of who ultimately wins, the next Ukrainian President will face the same set of domestic and international pressures as current President Petro Poroshenko: namely, balancing macroeconomic stability with the resurgence of economic populism. Simply put, Ukraine must continue to meet the domestically unpopular conditions of its IMF loan without ceding to populist demands to keep utility bills low.

For Ukraine’s leaders, the dilemma is acute. On the one hand, Ukraine has little choice about meeting the terms of its IMF loan, which enshrines energy reforms including fossil fuel subsidy cuts. Although there are myriad examples of countries that flout aid conditionality, few, if any, can do so without holding strategic importance to a major donor country or significant resource endowments. Ukraine has neither advantage, making the IMF’s threat to refuse aid credible. Kyiv has buckled to its demands in the past.

Even absent the IMF, cutting subsidies would strongly benefit Ukraine. Although subsidies are always politically popular, economists widely regard them as a poor form of social assistance because the wealthiest receive the most benefit. Cutting them instead would encourage domestic energy production, reduce opportunities for corruption, and decrease deficits.

On the other hand, cutting subsidies—however wise and necessary—is a politically toxic move amid economic stagnation. In the years after Euromaidan, utility bills have constituted an increasing share of household expenses for the average Ukrainian: as much as one-third of monthly salaries. For these voters, higher utility bills are directly felt, while appeals to the benefits of macroeconomic stability are vague and unconvincing. Steep, indiscriminate price hikes risk a repeat of the Orange and Euromaidan Revolutions.

A successful Ukraine needs to both continue receiving IMF assistance while acknowledging the concerns of poorer Ukrainians. Happily, there is a politically viable set of policies that any future Ukrainian President—including Tymoshenko—should adopt to advance reform. In a paper published last month by the Council on Foreign Relations, we recommend that Ukraine do so by depoliticizing gas prices, firmly establishing regulatory independence, and carefully dismantling energy-sector monopolies.

Most importantly, Ukrainian policymakers should cede the authority to price natural gas to an independent regulator. It is well-documented that countries that attempt fossil fuel subsidy reform without ceding pricing authority reverse course under political pressure—from Namibia, compelled by its powerful constituency of taxi drivers, to France amid the “Yellow Vests” protests today. In cases where governments ceded pricing authority like South Africa in the 1950s and Turkey in the 1990s, subsidy reform remains intact.

To maintain fiscal stability while preserving social welfare, Ukraine should also improve its targeted subsidy program. Instead of subsidizing gas for all households, Ukraine has been attempting to introduce a targeted system for only those in need. However, population-wide subsidies remain intact, and the current “targeted” system, under which 60 percent of Ukrainians qualify, is hardly better than a universal scheme. Further, there is no unified customer registry to verify whether recipients actually qualify for assistance or even exist. As a result, subsidy payments are made to oligarch-run intermediary firms rather than directly to consumers, making the system easy to exploit.

The next Ukrainian Parliament should follow through on legislation that would transfer payments as cash directly to consumers to decrease the risk of graft. Second, the Ukrainian government should create a comprehensive registry of social subsidy recipients to verify payments. Actively maintaining, updating, and auditing this database would help reduce subsidy spending without sacrificing social assistance and losing public credibility.

The new Ukrainian government should also focus on public messaging around the benefits of subsidy reform. These include mitigating corruption and inefficiency, cementing independence from Russian gas, and creating jobs and business opportunities in Ukraine’s energy sector. With a public information campaign and visible action on reform, the next Ukrainian President can head off civic discontent.

Besides eliminating subsidies, an admittedly politically sensitive move, the future President can take other measures to crack down on corruption and inefficiency. For example, the President should strengthen Ukraine’s national energy regulator, which was ostensibly redesigned to align with EU energy legislation. In reality, Ukraine has yet to establish a body to effectively and independently enforce market rules that encourage competition. Ukraine should reinforce the commission by ensuring it is funded by user fees, eliminating direct presidential appointments of commissioners, and taking input from civil society and—for a limited time—the international donor community in selecting commissioners. A firmly independent regulator would help instill confidence in Ukraine’s energy market for foreign and domestic private companies looking to invest. 

Another problem is that private companies that do attempt to produce gas in Ukraine face a byzantine licensing system that impedes new participants and strengthens existing players. Simplifying licensing would go a long way to helping firms without an inside track enter the market, raising Ukraine’s energy production. Cautious, transparent privatization of state gas production assets would also open more space for independent producers. All these policies would prove popular among the international donor community and those looking to do business in the country. If the new government demonstrates quick action on reform without abridging welfare, these policies could also earn the support of the average Ukrainian.

Ukraine must ultimately decide its own fate, but the United States should support Kyiv by increasing diplomatic pressure paired with technical assistance.

The U.S. government should elevate energy reform to the top of its diplomatic agenda with Ukraine, acknowledging, as former Secretary of State Tillerson put it, that “it serves no purpose for Ukraine to fight for its body in [the] Donbass if it loses its soul to corruption.” Absent action from the Trump Administration, Congress should proactively extend its targeted sanctions program against Russian oligarchs to include their Ukrainian counterparts, and press the IMF for more stringent compliance for loan disbursements.

To complement this pressure, the United States should provide technical assistance. Specifically, the Federal Energy Regulatory Commission (FERC), the Department of Interior, and State Department should work with their Ukrainian partners to design independent regulatory agencies, formulate simplified licensing procedures, develop unconventional gas resources, collect royalty revenues, and combat corruption. Assistance on energy efficiency programs would be particularly popular with any future Ukrainian President.

The United States would benefit from a prosperous, energy-secure Ukraine, capable of standing up to Russian aggression. Supporting Ukraine’s energy reforms is a low-risk, high-reward strategy for Washington to counter Moscow’s influence at NATO’s border without overcommitting to military options that antagonize Russia.

But any future Ukrainian policymaker should not expect U.S. support without demonstrated progress. It is important for them to acknowledge that keeping gas prices low allowed corruption to spread and weakened Ukraine’s economy in the first place. Nevertheless, the future Ukrainian President can advance a successful energy reform agenda that satisfies both international and domestic needs. With a push in the right direction from its leadership and U.S. allies, Ukraine can put its energy reforms back on track.