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    Ukraine's Gas Market Rewards Balance the Risks

Summary

Ukraine’s gas market is showing promising signs of reform but there is still a long way to go.

by: Mykola Voytiv

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Ukraine's Gas Market Rewards Balance the Risks

Ukraine’s gas market is showing promising signs of reform but there is still a long way to go before it may be declared fit for purpose. Ukraine has stopped contracting gas from Gazprom in favour of western European traders, but the gas still comes from Russia. The market has opened for new international traders and suppliers but the legal framework is not attractive for international energy companies.

First, the amendment of the law cutting the royalty on gas production to 12% has yet to be passed, even though the cabinet of ministers agreed the rate, after discussion with the gas producing community including various associations, think-tanks and parliamentarians. The cut could help attract upstream investments of $1bn, leading to a 30-35% growth in production from UkrGazVydobyvannya by 2020 – about 8bn m³/yr.

The draft law amending the Tax Code to balance the budget this year was adopted by parliament and approved by the president of Ukraine on December 30, but missing was the reference to the new, lower 12% royalty, which is the average royalty rate in Europe. This rate was approved in the first reading of the law and there were no doubts that it would be approved in the second and final reading. However, the parliamentary tax committee abruptly revoked the amendment. Current royalty rates are as follows: for gas wells up to 5,000 metres deep, 29%; and for gas wells deeper than 5,000 metres, 14%.

Nevertheless, the cabinet of ministers is keen to support gas production, as is confidentially stated in the “Concept For Development Of Ukraine’s Gas Production Industry to 2020”. This document was drafted under the auspices of the prime-minister Volodymyr Kistion, who has responsibility for energy, ecology and subsoil use issues in the cabinet of ministers.

A second problem is that Ukraine’s national energy regulator NEURC is planning to impose an entry charge for gas producers who want to bring gas into the pipeline system, at a rate of $12.47/’000 m³. 

Gas producers are greatly concerned about the tariff as it will decrease their revenue and limit funding for upstream activity, and they argue that this charge, under the third energy package, is not mandatory. They say regulatory authorities (NRA) have a lot of discretion regarding “transparent criteria, transmission or distribution tariffs or their methodologies”, “to increase efficiencies, foster market integration and security of supply” (Articles 41(1) and 41(8) of the Directive). “Tariffs, or the methodologies used to calculate them (…) shall facilitate efficient gas trade and competition (…) avoiding cross-subsidies between network users and providing incentives for investment (…) set separately for every entry point into or exit point out of the transmission system (Article 13 of the Regulation)."

These provisions require non-discriminatory pricing for all traders, domestic and foreign, under the General Agreement on Tariffs and Trade, which Ukraine joined in 2008. So, if an importer pays an entry point tariff, that means a domestic trader has to as well. So the NEURC has to respect the EU legislation’s reasoning for an adequate and up dated tariff policy (by fostering gas market liquidity) and on the other hand, ensure budgetary revenues are adequate.

A third problem is gas exports from/imports into Ukraine. At a forum in mid-October, speakers stressed the fact that the Ukrainian transposition of the EU Third Energy Package appears to be slow; furthermore that the activities of the state monopoly Naftogaz threatened the creation of a competitive gas market. Its upstream subsidiary UkrGazVydobuvannya controls 74% of gas production while Ukrtransgaz  controls all the gas transportation and storage.

Naftogaz meanwhile controls 76% of the supply market while state-owned regional distribution companies (Oblgazes) control 85% of gas distribution. Naftogaz controls 73% of gas imports. As an output of all that, Naftogaz controls three quarters of the market. Other obstacles include a high exit point tariff.

Gas importers have to pay VAT in advance or on the day of the transaction. Companies have therefore to accumulate money before performing a contract on gas supply. Reserve requirement. In September, 2016, according to amendments to the Law of Ukraine “On the natural gas market” and the later cabinet of ministers' decree, traders need to store at least 10% of their committed gas sales. According the Gas Transmission System Code (chapter VIII, clauses VIII.2, VIII.3) network users have to produce as collateral a minimum financial equivalent to 20% of their monthly supplies and at least their monthly transmission fee.

New amendments to the Gas Transmission System Code, aiming to change those financial guaranties, have been developed by NEURC and are under public consultation.

About 20 importers and around 50 producers are struggling to make any money from the market. Some Polish companies are interested not only in exporting gas to Ukraine and trading but also supplying end-users. The Ukraine-Poland interconnector is expected to provide the stimulus for this. However, the legal framework is not adequate to create a make market or encourage all market players to  trade.

A fourth issue is the “Concept For Development Of Ukraine’s Gas Production Industry 2020”. The concept, approved by the cabinet of ministers Resolution No. 1079 at the end of 2016 officially came into force on February, 24, 2017 when it was published in the official journal Uryadovyi Kurier. It is considered the road-map for the Ukrainian gas market, bringing in transparency, integrity, efficiency and liquidity.

The focal point is to increase national gas production by drilling new wells, using enhanced technology. Ukraine’s annual production is far lower than its reserves of 900bn m³ suggest it could be.

UkrGasVydobuvannya has to fulfill challenging perspectives in the upstream – from output of 14.5bn m³ in 2016 to 20.1bn m³ by 2020. For the private producers the goal is to go from 4.3bn m³ to 7.4bn m³ over the same period. But this can only happen if the fiscal policy, licensing conditions and contractual protection exist to encourage investors.

Fifth, does the gas exchange attract and force gas market liquidity? Despite Naftogaz’ monopoly, the Ukrainian gas market is quite diverse. According to the Gas Transmission System Code, UTG has a virtual delivery point. There are also private gas exchanges, which aim to match gas supply and demand. So far, trade volume at these platforms is small compared to those in bilateral contracts. Bilateral contracts account for the majority of the market. There are Ukrainian gas exchanges but there is no information available about who are the founders or managers.

The issue of creating a trading platform has recurred. The gas market (or as it often called “gas hub/exchange”) has to be independent from government control such as the UK National Balancing Point or the Dutch Title Transfer Facility.

Supporters of the other approach stress that it has to be regulated and controlled by the state (State Treasury for instance). As an example, we may look at the Polish Power Exchange (POLPX). Indeed, the prospective gas exchange could create a market worth $7.8bn/yr. But whoever runs and regulates the exchange, for it to succeed it must be reliable and transparent.

 

Mykola Voytiv is head of energy projects at non-governmental organisation New Generation Management.

References

Interviews with domestic and international gas producers/traders.

“Gas Transmission System Code”

http://utg.ua/GTS%20Code%20part%201.pdf 

http://utg.ua/GTS%20Code%20part%202.pdf (eng., unofficial translation)

http://zakon3.rada.gov.ua/laws/show/z1378-15 (ukr.) “Code of gas distribution systems”

http://zakon5.rada.gov.ua/laws/show/z1379-15 (ukr.) Law of Ukraine “On the natural gas market”

http://www.naftogaz.com/files/Information/Ukraine%60s%20Natural%20Gas%20Market%20Law_engl.pdf (eng., unofficial translation)

The Order by the Ministry of Energy and Coal Industry of Ukraine “On conditions of exporting commodity natural gas” (17.12.2012)

http://zakon2.rada.gov.ua/laws/show/z0017-13#n13 (ukr.)

The Resolution of the Cabinet of Ministers of Ukraine (CMU) #1176 (30.12.2015), which approves the List of goods which are subject to import licensing in 2016

http://zakon3.rada.gov.ua/laws/show/1176-2015-%D0%BF  (ukr.)

The CMU Decree #758 (01.10.2015) approves the “Regulations on assignment of special obligations on subjects of the natural gas market for providing public concerns in the course of functioning of the natural gas market”

http://zakon2.rada.gov.ua/laws/show/758-2015-%D0%BF/page  (ukr.)

Draft Law on amendments to the Tax Code (12% royalty rate)

http://w1.c1.rada.gov.ua/pls/zweb2/webproc4_1?pf3511=60035

Directive 2009/73/EC of the European Parliament and of the Council of 13 July 2009, concerning common rules for the internal market in natural gas

http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2009:211:0094:0136:en:PDF

Regulation (EC) No 715/2009 of the European Parliament and of the Council of 13 July 2009, on conditions for access to the natural gas transmission networks

http://eur-lex.europa.eu/legal-content/EN/ALL/?uri=CELEX%3A32009R0715

General Agreement on Tariffs and Trade

https://www.wto.org/english/docs_e/legal_e/gatt47_e.pdf

Розпорядження Кабінету Міністрів України № 1079-р (від 28 грудня 2016 р.) «Про схвалення Концепції розвитку газовидобувної галузі України”/CMU Decree on adoption of “Concept For Development Of Ukraine’s Gas Production Industry 2020”.

http://www.kmu.gov.ua/control/uk/cardnpd?docid=249766439 (ukr.)

Policy Paper Series [PP/01/2017] “Boosting gas trading in Ukraine”

http://www.beratergruppe-ukraine.de/wordpress/wp-content/uploads/2017/02/PP_01_2017_en.pdf

The evolution of European traded gas hubs, the Oxford Institute for Energy Studies, December, 2015

https://www.oxfordenergy.org/wpcms/wp-content/uploads/2016/02/NG-104.pdf

The Study on Tariff Design for Distribution Systems commissioned by Directorate General for Energy (EC) to the consortium of AF‐Mercados, REF‐E and Indra.  

https://ec.europa.eu/energy/sites/ener/files/documents/20150313%20Tariff%20report%20fina_revREF-E.PDF

Article on the issues of royalty and other rents in adopted amendments to the Tax Code of Ukraine.

http://www.epravda.com.ua/publications/2016/12/28/616125/ (ukr.)

Ukrainian gas market. Prospects of boosting (expert view)

http://utg.ua/en/utg/media/news/2016/10/ukrainian-gas-market-prospects-of-boosting-expert-view.html

Article on issues of the royalty rate for gas wells.

http://agpu.org.ua/en/news/the-parliament-has-primarily-approved-the-12-royalty-on-gas-produced-from-new-wells.htm

Article on Ukraine to boost gas production.

http://en.interfax.com.ua/news/economic/405431.html

https://www.ukrnafta.com/en/kopiya-ukraine%E2%80%99s-rent-on-oil-and-gas-how-to-share-revenues-fairly-and-make-sure-they-grow