Meanwhile, Naftogaz has filed claims with the European Commission, complaining Gazprom is abusing its dominance in the European gas market.

"They are not paying," Naftogaz executive director Yuriy Vitrenko said. He warned Gazprom might try to squeeze out Ukraine based transit altogether, severely limiting supplies to Europe and potentially cutting off Ukraine altogether.

"The law is Ukraine's shield," says Wojciech Jakobik, a Warsaw-based energy analyst at the Jagellonian Institute and chief editor of energy publication BiznesAlert. He praised Ukraine's efforts to partner with European allies and leverage institutions as the best bet to win against Russia – as evidenced by ongoing challenges that have delayed construction, potentially forcing Gazprom to cut a deal for at least winter 2019-2020.

Gazprom can ignore rulings for some time, Jakobik explained, but ultimately its reliability in Western eyes takes a hit. Consequences might be tolerable in "domestic or regional cases" such as Yukos, a Moscow-based oil and gas company that was controversially seized and broken up by Russian authorities, Jakobik added, but when it comes to Western partners they prefer to comply.

"It is critical that Ukraine shows it is part of this first category, of European partners, and here the role of allies in Europe and the European Commission itself is essential," Jakobik summed up.

Internal transformation

While the fight with the Russian gas giant continues, an arguably equally challenging one is taking place below the surface.

As one of Ukraine's largest state-owned enterprises, Naftogaz is an ocean liner that cannot be easily turned around. Founded in the early 1990s, the company of over 70,000 employees (down from over 82,000 in 2014) has been criticized for being clunky, overly bureaucratic and mismanaged.

This is by no means unique. A 2018 report by the OECD, an intergovernmental economic organisation, found that most Ukrainian state firms were inefficient, with many continuing to operate at a loss due to "corruption, mismanagement and/or onerous public policy objectives."

Public entities are infamous for operating assets completely unrelated to their primary objectives. These include company newspapers, hotels, holiday resorts and restaurants. The OECD study even identified one case in which a regional Naftogaz minority subsidiary owned a sausage factory.

Improving efficiency and reorganization was a priority for the management team that took over in 2014, headed by CEO Andriy Kobolev and then chief advisor Yuriy Vitrenko.
Working with top-tier global advisory firms and leveraging their backgrounds in finance and consulting, they aimed to implement best international practices, modernising processes and streamlining governance. As a result, Naftogaz was branded a "flagship of corporate governance reform" by the OECD, even serving as a roadmap for others.

But the pace of transformation slowed by 2015-2016, according to John Lough, an associate fellow at think tank Chatham House, as government interference grew and core structural questions about how Naftogaz should function became politicized. Some experts fear progress achieved could easily be lost and opaque schemes could return.

"I believe these [reforms] will ultimately hold because of IMF pressure," Lough warned, "but management changes could complicate the situation."

Key problems to be addressed, according to the OECD, are government intervention in operations, interference in subsidiary companies, and a lack of commitment to corporate governance reform in general. The recommended path is instead to emphasize transparency – providing clear controlling mechanisms for regional subsidiaries, transferring authority to executive governance bodies, and continuing to implement the corporate governance roadmap.

Building a competitive market

The ongoing internal and external battles make it easy to miss the core mission of Naftogaz – to build a competitive market in Ukraine, and thereby improve the cost and quality of products delivered to ordinary Ukrainians, argues Vitrenko.

According to a study by global advisory firm PwC, Ukraine's relatively abundant gas reserves and critical infrastructure make it a potentially promising location for a European gas hub for EU-based importers and traders.

This would help strengthen energy security, reduce prices, increase transparency and integrate Ukraine into the European Energy Community. To deliver this, however, the country needs to continue liberalising its gas market, make it easily accessible to third parties, and unbundle gas transmission.

The apex of opportunities would be to allow EU based traders to purchase gas directly on the Russian-Ukrainian border, rather than the EU-Ukraine border as now. This change – a potential, if still distant, consequence of the competition claims filed by Naftogaz with the European Commission – would allow traders to purchase transport gas directly via Ukrainian territory and sell to Ukrainian consumers directly, completing forgoing the need to deal with Gazprom.

"This would be a real breakthrough," Alexander Paraschiy, head of research at investment bank Concorde Capital, wrote in a note to investors, adding that it could make prices much cheaper for Ukrainian consumers.

In the meantime, further boosts to domestic production would be helpful. The country currently has one of the lowest extraction rates in Europe, despite having the second biggest reserves (see graph). Bringing the rate up to that of Poland or the Netherlands could provide Ukraine with almost 60 billion cubic meters a year – almost twice its current annual consumption.

All these plans all require international partnerships – for know-how, access to capital and policy support. Importantly, the role of reliable local players, operating in accordance with best global practices and a national interest mandate, is key to ensuring Ukraine derives as many advantages from these partnerships as possible.

A few players have been signalling their interest in Ukraine: Halliburton, an oil and gas energy services provider, recently signed a memorandum with Naftogaz that aims to bring advanced technologies to hydrocarbon field development in Ukraine, most notably hydraulic fracturing. Similarly, Canada's Vermilion signed a memorandum on joint participation in production distribution agreements.

However, a lack of transparency and worries about policy direction is holding back many more. Investors, including Poland's top energy player PGNiG, are ready to move back to Ukraine but are waiting for a clear signal that the administration of freshly elected president Volodymyr Zelensky will continue and even accelerate earlier reforms, argues Jakobik.

There are many ongoing discussions, but most players remain wary about limited transparency, licensing difficulties and potential corruption, particularly among regional entities.

"We don't know what to expect," says Jakobik, "the more transparency the better."