Experts argue for complete implementation of compensatory mechanisms to ensure gas reform success

Experts argue for complete implementation of compensatory mechanisms to ensure gas reform success
August 26, 2015.

Kyiv, August 26, 2015. An analysis of the impact of market and reduced gas prices demonstrates that the positive effects of introducing market pricing will significantly outweigh the negative. Gas reform will be successful only under the condition of its complete implementation while applying the necessary compensatory mechanisms. This means providing direct subsidies for utilities, programs to promote energy efficiency, creating conditions for free market competition, and effective independent energy market regulations. Economic Strategy Centre experts Mariya Repko, Ivan Miklosh, Hlib Vyshlinskiy and Andriy Boytsun presented the results of the research, “Should the Gas Price be a Market One?” during a press briefing at Ukraine Crisis Media Center. Experts have compared two alternative approaches to pricing in terms of their impact on key economic and social issues, and considered important compensatory mechanisms for implementing the reforms.

Today, gas prices for Ukrainians are regulated by the state and artificially reduced. This causes a number of problems both for the economy and people’s welfare, according to the experts. These low prices do not cover Naftogaz’s costs for purchasing gas for the population. The state has to cover the deficit, which in 2014 constituted 5.7 per cent of GDP. The difference in price for the general population was more than five times less than the price charged to industries at the end of 2014, which, according to the experts, stimulates corruption. Also, reduced prices could lead to a drop in domestic production and an increase in dependence on imports. “Low prices do not motivate saving, so the utility sector energy efficiency is extremely low,” said Deputy Director of the Economic Strategy Center Maria Repko.

Tbe analysis of two alternative approaches to pricing demonstrates that reduced prices for gas cause an imbalance in public finances and macro-financial instability. The introduction of market prices should eliminate imbalances for both Naftogaz and state budget, even with subsidized consumption and energy efficiency, which experts believe will constitute a net gain. They stated that indirect subsidies to wealthy households and losses from corruption will become lower, while the costs of debt servicing will decrease. Improvement of the mining sector and related industries is expected to lead to more income from rents, taxes and dividends. A side effect of reducing imports will have a positive impact on the payment balance and eliminate pressure on the hryvnia.

In terms of corruption, any underestimation of the gas price for Ukrainians encourages misappropriation, as it becomes profitable to redistribute this gas for industrial needs. An effective way to fight corruption related to the use of the difference in gas prices, then, is the establishment of market prices for all consumers. “Efficient reform eliminates the possibility to earn money on arbitration and receive corruption rent,” said Repko.

In addition, if prices are low and regulated, domestic production is likely to continue declining, but dependence on imports will remain. In the case of the market price, after paying rents, state-owned company that specializes on gas extraction, Ukrgasvydobuvannya, would have funds that correspond to the marginal costs of traditional gas production from new wells in cultivated fields and stimulate the increase of production volume.

As for the impact on energy efficiency, the experts emphasize that as long as artificially low prices subsidize excessive consumption and the cost of installing metering and insulation modernization is paid 10-15 years later, the population cannot be motivated to save energy.  More responsible consumption is expected to appear after gas prices rise to market levels. In this way, gas consumption by the population in Ukraine can be reduced by 20 to 60 per cent.

“Regarding the social aspects of this change, introducing market prices will increase the cost of utility services for the population. Households with an average income will especially feel it. The government should develop targeted programs to stimulate energy efficiency, such as grants, tax refunds, and state aid to pay loans and so on. Low-income households will receive direct cash subsidies. The operating subsidy system does not reduce incentives for energy savings because it allows reducing the amount of future payments for public utilities, consuming less than in the current period,” said Repko.

The full version of the analysis can be viewed here: http://ces.org.ua/gas-price/

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