Ukraine’s Naftogaz in the Context of Ukraine’s Political Economy, International Competition and the Problems of Globalization

Ukraine’s Naftogaz in the Context of Ukraine’s Political Economy, International Competition and the Problems of Globalization

Dealing with the Ukrainian political economy is an intellectual challenge due to her relatively unique position in world affairs and her oddly distorted economy deriving from the old Soviet central planning and its inherent corruption. Ukraine is neither here nor there–seemingly permanently in a state of reform, with major oligarchic actors claiming the desire to reform, but frustrating it at every turn. This paper will deal specifically with the state-owned gas monopoly, Naftogaz and its position in the broader Ukrainian and regional political economy, dealing with the distortions in Ukraine’s political life relative to the position of the gas firm and the structure of the economy in general.

Naftogaz was created in 1998 for the purpose of streamlining gas relations with Russia and her own gas monopoly, Gazprom (World Bank, 1999, 60). According to the company’s official documents, the purpose of Naftogaz is to stabilize gas and oil production in order to meet Russian demands, which means in real terms the shift from subsidized Soviet prices to a semi-market means of pricing gas (cf. In addition, more money is being diverted to exploration in the Black Sea and the Sea of Azov regions as well as improving the technologies of transportation systems. Most important, however, especially in Ukraine’s relations to Russia, Naftogaz was supposed to develop a prototypical system of completely transparent accounting that was to attract foreign investors and avoid the “missing” natural gas supplies that so soured relations with Russia. These objectives, as of this writing, are abject failures. This paper seeks to give some clues as to why.

The main structural problems in Ukraine’s relation to Russia with respect to natural gas are the distinction between the old subsidized gas prices of the Soviet era, and the new “market” price of gas that has become dominant in the post-Soviet era. Not trusting its own private sector, Naftogaz was put together to have the state as the primary determinant of gas delivery systems and exploration. Earlier gas firms such as RosUkrEnergo was so riddled with corruption and mafia organizations internally that the Russians refused to do business with them, and demanded immediate payment for gas supplies that may or may not have been siphoned off, leaving Ukraine in a major crisis (Jolly, 2008, A5). Missing gas has never been recovered or any arrests made. In fact, the Ukrainians hold that they are unsure whether foul play was involved at all, it may merely be incompetence (Jolly, 2008, A5).

The gas that was being regularly siphoned off (according to most) and sold on the black market has never been found and no culprits have been caught. It is also important to note that the Ukrainian state, especially former prime minister Julia Tymoshenko has protected any suspects from being brought to justice. These facts should give a startling picture of the nature of Ukrainian political economy and the field on which firms must play (D’Anieri, 1999, 170). The fact remains that Naftogaz has not lived up to its potential in any respect. It operates at a loss, it is subsidized by the state and is protected from all charges of wrongdoing. Its operations are not transparent and Russia regularly expresses its exasperation at the Ukrainian lack of compliance with basic norms of doing business in this strategic area. Ukrainian nationalists have claimed exploitation and dependency, which is part of the problem, but Ukraine itself is still suffering through the shock of its Soviet past and the failures of reform in the early 1990s.

Ukraine: The Politics of Economics

But the nature of the social and economic environment must be dealt with in detail if these problems are to be fully understood. The basic thesis here is that all economics is political, and in reality, there is no distinction in real terms between political power, economic rent seeking and clan relations. At the present time, there is no major scholar who would dispute this. But analyzing this is centrally important to understand the nature of Naftogaz, its failures and hence, its failure to prosper globally. Naftogaz has a handful of global projects (most notably on Egypt), but financial failures and lack of transparency have made this firm persona non grata globally.

The initial package of internal economic reforms after Ukrainian independence in 1991 was typical for the day. A freeing of wages and prices, deregulation of much of the economy, privatization auctions and freeing of credit was the basic package in Russia and Ukraine. Most of these were done at the insistence of the International Monetary Fund and the United States. All forms of reform were abysmal failures in every respect, especially when the hyperinflation of 1994 is taken into account. Theories of laissez faire economics were merely imposed on a former command system that had no knowledge of such ideas, and even less interest. As is relatively well known, the economy went into a tailspin. Former clans of bureaucrats and technocrats with an unhealthy sprinkling of mafia figures took over the economy and ran them identically as they had been run in the Soviet era. The freeing of credit just meant that these men had the full access to state credit without regard to performance, leading to massive inflation. At the same time, taxes were not being collected and law enforcement collapsed. With all this, there was no transparent accounting in the state sector or the semi-private sector (D’Anieri, 1999, 170-177). Wages collapsed and energy prices skyrocketed as a result of deregulation and the end of Moscow’s subsidies. But the basic norms of doing business were laid out in the early 1990s and are still relevant and active today.

These forms of doing business are rooted in the Soviet past, and little modification of behavior has been seen among the elite in Ukraine in terms of adjusting to markets. All major elite actors in the economy are close to the state, and form cells of influence where most deals, including loans and subsidies, are done in secret through client networks. The connection between clientelism and credit is alone responsible for the inflation that has hounded Ukraine since independence. Naftogaz is no exception in this respect (D’anieri, 1999, 182). It seems that there is no autonomous concept of economics, since all economics is political in the sense that it is based on elite patronage networks, all close to the state. The specific distortion here is the misallocation of credit to those enterprises who have the greatest economic clout. Credits or subsidies have no relation to performance, and this led to mass hyper-inflation in 1994 which, in turn, turned many against any further reform, thus increasing the oligarchical system of control and hence, market distortion.

State Corporatism

Paul Kubicek holds that this form of distortion can be called “state corporatism” (Kubicek, 1999, 58). In post-Soviet Ukraine, he argues, the state has been the only actor that has been able to mold civic life, leading to state created growth and state created social life. Clans of oligarchical elites are part of the state apparatus (in effect), and hence, are not autonomous actors. Therefore, it is the state, however conceived, that controls the economy. These clans are largely taken from the older bureaucratic and technocratic elites in Soviet and early reform Ukraine, and hence shut out any competitors. This environment has suffocated the necessary foreign investment that firms such as Naftogaz was supposed to attract (Kubicek, 1999, 60). Even organized labor is a state organization, operating in secret and through client networks and personal contacts. Hence, for the moment, labor is bought off, and hence, there is no real reason for Naftogaz to spend on civic minded affairs and social activism.

In fact, the current social environment is that there are no autonomous groups of any significance and the state is seen as the only important social actor. Hence, groups that would be civic minded in the west become attached to the state, or at least seek to become so attached and hence receive the largesse that political loyalty can buy. As of this writing, no substantial change has been seen. The result is irrational economics, the destruction of pluralism and civic life, lack of transparency and a constant struggle with inflation. Even more, the real struggle is with the nature of economic reform itself, since no substantial faction in Ukrainian politics has a stake in reform. Hence, in an eccentric way, the perennial misallocation of resources has become institutionalized and a pillar of oligarchic power.

But in this vein, writers like Marta Dyczok hold that there is really no “state” in the common sense of the word. The “state” is really a term of convenience that applies to the inner workings of the economic elites who have a monopoly over state forms of coercion. Hence, there is no autonomous state, the bureaucratic elites dominate the economy because they dominate the state, and they dominate the state because they dominate the economy (Dyczok, 2000, 95). This implies firms like Naftogaz are part of a semi-private world where state actors are actually economic rent seekers, and hence, state monopolies benefit from this world of subsidies and secret deals. Needless to say, Naftogaz, in her view, was a scam from the start, since it was created by the same people who were condemned in earlier gas disputes with Russia. Needless to say, there is no “social responsibility” in an environment where there are no consequences for ones actions and no real oversight.

Alexander Motyl, an important commentator on Ukrainian economics, holds that dependence on Russian forms is responsible for the oligarchic dominance of the Ukrainian economy. In other words, classic dependency theory holds that the economic dependency of Ukraine on Russia promotes the existence of a state-centered elite that has good financial reason to continue to cooperate with the forms of exploitation engaged in by the metropole, in this case, Moscow (Motyl, 1993, 126-127). While this work is an early one, its insights have not gone away as of 2009.

Dependency is at the center of Motyl’s analysis, and holds that the long historical patterns of forced industrialization of Ukraine under Soviet auspices created automatic and serous structural imbalances, and even a strong sense of “artificiality” to the Ukrainian economy, itself the creation of foreign sources of power. Motyl agrees with writers like Dyczok in that the state is a prisoner of the oligarchic clans, and hence, has limited means of introducing reform. This also means that aid from the west or from the IMF immediately go to “state” actors who are in realty part of the problem and deeply invested in the current system. Though interested in applying dependency to Ukraine, he shies away from the convenient view that all can be blamed on Russia. This is not the case, and is a regular cop out of the Ukrainian elites. But this playing field means, worst of all, that small business is strangled. Entrepreneurs without state or crime connections cannot function, and hence, oligarchy and monopoly are the order of the day (Motyl, 1993, 141).

Naftogaz in the Corporatist Environment

All of this serves as the backdrop to the nature of Naftogaz and its operations in Ukraine and elsewhere. The World Bank’s 1999 report on the natural gas industry is highly significant in this regard, as it pronounced Naftogaz a failure. Few commentators, 10 years later, would disagree with this assessment. The basic findings of the World Bank, using the writing and research skills of Suzanne Smith, are central to this paper and the nature of Ukrainian political economy.

First of all, it is held that Naftogaz was created as a state monopoly for the specific purpose of streamlining the payment structure to Russia. Hence, as mentioned above, this firm is itself the creation of foreign forces and hence, strongly supports the dependency ideas of Motyl. The theories put forth in elite Ukrainian circles was that a state monopoly would be able to reallocate profits, diversify Ukrainian industry and make certain that all policies were centrally located and decided from one source. Just as important, this centralized approach to the gas industry would provide a certain sense of comfort to foreign investors that were and are encouraged to invest in Ukraine’s gas transport sector (World Bank, 1999, 67-68). It may be the case that some foreign funding would increase the pressure for some socially significant policies from this firm, but since little has come into the country, socially responsible spending is non-existent.

Not surprisingly, the World Bank holds that few of these objectives were met. First of all, it is clear that the closeness to state forms of credit made certain that performance was not taken into consideration when loans were applied for. Secondly, there was no real incentive to correct bad performance or a lack of transparency, since the state itself had chartered and protected this company, and hence, saw fit to ignore the complete financial failure of the firm itself. Foreign investors did not invest and were very leery of the firm. And lastly, the creation of Naftogaz meant that oligarchs merely took control of the gas industry and dominated any other attempt at diversification. The Ukrainian gas industry, in short, is as bad in 2009 as it was in 1992.

But it remains that more recent work, such as Bugajsky (2002) holds that Naftogaz might be a state chartered monopoly, but the Russians have been taking shares of the firm in exchange for non-payment of gas supply fees. Bugajsky is the major writer in the “blame Russia” school of Ukrainian political economy, holding that Russian influence has never ceased over Naftogaz and it continues to control most of the inner workings of the firm itself (Bugajsky, 2002, 86). He holds that even as early as 1999, Naftogaz had become a client of the Russian gas monopoly, Gazprom. Naftogaz is not, hence, Ukrainian and not controlled by the Ukrainian “state” in any form. In fact, the Ukrainian oligarchy has had no problem in permitting Russian control over the firm in exchange for actual payment for natural gas from Russia. This has permitted the Ukrainian oligarchy to completely ignore any kind of transparency in keeping records. The distinction in currencies between Russia and Ukraine have become irrelevant in that it has been control over the firm rather than cash payments that have been the basic form of exchange in this sphere. The Russian ruble is valued at 24 to the dollar, while the Ukranian Hryvnia is at five to the dollar. This distinction in the exchange rate is dependent upon Ukraine’s determination to avoid the hyperinflation of the early 1990s and Russia’s dependence on the export economy, which keeps the ruble valued low compared both to the dollar and to the Hryvnia and this has held steady since 2004 (CIA, 2009), nevertheless, the overvaluation of the Ukrainian currency is not helping exports in any respect, leading to regular budget deficits and trade deficits that are nowhere to be found in Russia.

Nevertheless, Bugajsky holds that the relations between Naftogaz and Gazprom are almost totally secret, and the means by which Ukraine pays its debts to Russia is also a secret. However, it was the Ukrainian socialist party that publically condemned the Ukrainian government in that relations between the two gas monopolies were opposed to the constitution in that it severely hampered Ukrainian independence. What began as a means to control the Ukrainian gas industry by an independent Ukrainian state has ended as a means of Russia to take control of the most strategic element of the Ukrainian economy. The basis of Russian domination, according to Bugajsky are threefold: first, access to credit, access to energy supplies and finally, access to trade, as most Ukrainian trade goes through Russia (Bugajsky, 2002, 88).

Naftogaz by the Numbers

The manifestation of the failure of Naftogaz might be better seen in the last available financial report, prepared, significantly, by Ernst and Young, an American firm. The Consolidated Financial Report of 2007 makes the following observations about Naftogaz’s performance:

With little variation over time, Naftogaz runs a regular budget deficit of roughly 16 billion hryvnias every year. In the 2007 financial disclosure statement, the deficit was H16.7 billion. Even more, this shortfall is predicted to grow more and more as the firm reports regular revenue diminution since that time. As Russian oil firms have flourished, Ukrainian transport facilities have languished, suggesting that it is not the market as such, but rather the nature of the system that is keeping this firm in the red.

Interestingly, this official report holds that the firm pays H1.5 billion in taxes every year, receiving in turn H1.7 billion in subsidies and other favors from the state. Ernst and Young holds that this is the result of increasing taxes in Ukraine plus increasing costs of litigation with numerous private actors, including Russian ones. But the result of all this has been increases in the amount and number of subsidies and trade privileges that this monopoly has received from the state, a state that sees no other alternative to this monopoly position.

Therefore, from the point of view of 2007, there is little hope for this firm. Revenues continue to fall, taxes and litigation rises, and the state does little but grant the firm more subsidies. But this is explained by the structure of the Ukrainian social space seen above. On July 8, Reuters reports that the Ukrainian government is going to more than quadruple the capital base for this firm, from $740 million to $3.2 billion. This may be interpreted to mean that Russia is being paid off, or that no other alternatives can be found. State bonds will back this transfer of money from the state to the Naftogaz firm. Even more disturbing, the Reuters report says, “International lenders, the EU, Russia and Ukraine are in talks about a possible loan to Kiev to help pay for Russian gas. Tymoshenko said those talks were proceeding” (Zawadzki, 2009). Hence, as is typical in this environment, the firm is being rewarded for its past lack of performance.


The Naftogaz tragedy is just another reminder of the failure of market reform in much of eastern Europe. While state capitalist governments like Belarus and Russia are exploding economically with high growth rates and low unemployment, states like Ukraine and Georgia, close to the west, are struggling. This paper has listed and described several reasons for this:

a. The liberal reforms of 1991-1992 were market reforms that ultimately benefitted a handful of well-connected oligarchs in Ukraine, mostly from the bureaucratic or security services. There was no market in Ukraine, and the IMF reforms were naive to say the very least, since the market, given the political circumstances of the time, could only have benefitted those with the connections to take advantage of them.

b. The above has led to the squashing of entrepreneurship in Ukraine. The oligarchic and statist nature of the regime has made sure that access to investment credits exists only for either the well connected or criminal, and this line is vague.

c. Even more, dependency on Russia has distorted the Ukrainian economy. Nowhere is that better described than in the life history of Naftogaz itself, which exists solely to provide the Russian government with a single actor to deal with in terms of gas transport and pipeline security. The very history of Ukrainian industrialization is Russian based, and Ukraine remains as it always was, a dependent appendage to either western loans or Russian imperialism.

d. The result is a socially irresponsible Naftogaz firm that is condemned by Russia, unprofitable at home and a drain on the Ukrainian treasury. The result is a Ukrainian economy, wealthy on paper and saturated with natural resources, destroyed slowly by corruption and mafia-like structures of political economy.


Bugajsky, Janusz (2002) The Cold Peace. Greenwood

Central Intelligence Agency (2009) Ukraine: Economy. CIA Factbook

D’Anieri, Paul (1999) Politics and Society in Ukraine. Westview

Dyczok, Marta (2000) Ukraine: Movement without Change, Change without Movement. Routledge

Ernst and Young (2007) The Consolidated Financial Statement of Naftogaz. (Pdf can be found at

Kubicek, Paul (1999) “Ukrainian Interest Groups, Corporatism and Economic Reform” State and Institution Building in Ukraine, ed Taras Kuzio. Palgrave

Jolly, David (January 8, 2009) “Deal Struck to End Energy Cutoff?” New York Times, A5

Smith, Suzanne (2000). The Natural Gas Industry. World Bank Publications

Zawadzki, Sabrina (July 8, 2009) “Ukraine Says to Boost Naftogaz Capital to $3.2 Billion.” Reuters India

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