It is commonly assumed that the main economic challenge facing Ukraine is its dependence on energy supplies, especially natural gas, imported from Russia. Russia, it is true, has a powerful lever that it can use to extract political concessions from Kyiv‚ as it did when President Viktor Yanukovych was forced to renege on his pledge to sign the Association Agreement with the European Union last November.
But Ukraine's dependency on Russian gas is only half the story. Equally troubling has been Ukraine's dependency on cheap gas; gas that just happens to be from Russia. Ukraine inherited from the Soviet Union an economy hooked on cheap hydrocarbons. Until last week's price increases, residential consumers only paid about 25% of what the gas is worth on the European market: industrial consumers pay about 75%. At the same time, coal produced in Ukraine's Donbas is sold to domestic customers at about half the extraction cost.
This cheap energy, together with the existence of parallel markets for energy, has generated a huge flow of economic rents, up to 5% of the country's GDP (approximately £3.5 billion) in peak years, which Ukraine's political and economic elites were able to capture for themselves. The rents have been turned into hard cash either through the re-export of Russian gas to European customers, or through the manufacture of energy-intensive products such as steel or fertilizers for export.