Round Table NJSC Naftogaz of Ukraine restructuring concept … · 2016-03-02 · In January 2016, a...

160118_Naftogaz_StrategicPlan_v14.pptx AA : BB : CA : DU : EG

Round Table

NJSC "Naftogaz of Ukraine" restructuring concept aimed at

unbundling of natural gas transportation from gas production

and supply activities

NJSC Naftogaz of Ukraine

19 February 2016


1. FULFILLING EU REQUIREMENTS

REGARDINGTHE UNBUNDLING OF

TRANSMISSION SYSTEM OPERATOR

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AA : BB : CA : DU : EG

“In view of the delay already occurred, the decisions on unbundling should be taken rather quickly

in order to respect the deadlines set in the gas sector development plan and notably the gas law.

Klaus-Dieter Borchardt, Director – Internal Energy Market, European Commission (EC), an official letter

to the Ministry of Energy and Coal Industry (MECI), 1 February 2016.

The Third Energy Package (3EP), in particular Directive 2009/73/EC outlines a clear mechanism to eliminate discrimination in

third-party access to the gas transmission system (GTS) – it requires to effectively separate networks (transmission) from activities of

production and supply. This is called effective unbundling.

In joining the Energy Community (EnC), Ukraine has taken on an obligation to implement key EU energy legislation. The Law of

Ukraine “On the Natural Gas Market” (the Law) introduces EU requirements regarding unbundling and independence of the natural

gas transmission system operator (TSO) into the Ukrainian legislation.

Gas Sector Reform Action Plan (Reform Plan), adopted by the Decree of the Cabinet of Ministers of Ukraine (CMU) on 25 March

2015 № 375-р and approved by the World Bank, envisages development of the Naftogaz restructuring plan aimed at unbundling of

the natural gas transmission activities in accordance with the Law.

The Law paves the road for the next phase of the TSO restructuring – engaging a reliable foreign partner in GTS operation.

The priority objectives of the Naftogaz restructuring plan at this stage are reaching compliance with the Law with respect to the TSO unbundling, establishing basis for foreign partnership in operating TSO, use of the best practices of the natural

monopolies regulation.

These goals do not envision other forms of Naftogaz restructuring not related to unbundling of the gas transmission business.

Unbundling of gas transmission segment or full Naftogaz restructuring?

4


Ukraine’s fundamental choice of European integration requires modification of the role of the MECI in the energy markets – from an entity managing state property in companies to a “policy maker” for the entire sector.

MECI* role in regulating

TSO operations

2

The MECI has to implement objectives specified in the Law effectively and carry out its mandate in the energy market (ensuring security supply, monitoring market environment, determining technical standards, responding to crisis situations);

The MECI must relinquish its responsibilities of managing the state property in energy sector;

Strategic decisions regarding the TSO should be taken by the CMU.

What are the implications of choosing of the OU unbundling model?

In January 2016, a broad consensus was reached regarding the Ownership Unbundling (OU) model.

Out of the three possible options, OU presents the most stringent requirements regarding the independence of the TSO.

The restructuring plan must ensure their fulfilment so that the operator can obtain a final decision on certification from the Regulator.

The selected model must ensure that “the same person or persons are not entitled to either directly or indirectly exercise over a production or supply undertaking and, at the same time, exercise control or any right over a TSO or transmission system” (Article 9 of Directive 2009/73/EC).

How to ensure the absence of control?

Management of the state assets in TSO must be transferred to a competent government body which is the most independent from the vertical of power that controls Naftogaz. Considering that Naftogaz is controlled by the Ministry of Economic Development and Trade of Ukraine (METD) – a part of the Cabinet of Ministers of Ukraine (CMU) – this requirement is fulfilled if the TSO is not controlled by any of the Ministries.

Implication of the selected TSO

unbundling model

1

* MECI – Ministry of Energy and Coal Industry of Ukraine

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OU – Naftogaz restructuring proposal compliant with the requirements of the 3EP

100%

Existing structure Target structure

State State

100%

All of

GTS

PJSC Ukrtransgaz All of

GTS

State Property Fund METD METD State Property Fund

NJSC Naftogaz of Ukraine NJSC Naftogaz of Ukraine PJSC “MGU” (TSO for

the whole GTS, transmits

gas to domestic and

international customers)

100% 100% 100%

All

UGSFs*

Naftogaz acts as a TSO for transit services under the contract with Gazprom.

UTG is the TSO for transmission for local customers on the territory of Ukraine.

Certain

UGSFs

PJSC Ukrtransgaz

UTG is the SSO* for certain UGSFs. Thorough analysis and

strategy are developed for individual UGSFs.

Servicing

functions

The JSC “Main Gas Pipelines of Ukraine” (“MGU”) shall be the designated TSO, 100% of the shares will be owned by the state;

Management of the state corporate rights in MGU shall be exercised by the State Property Fund of Ukraine (SPFU);

The independence of the TSO shall be ensured by an appropriate corporate governance according to the OECD standards;

The GTS, as the state property not subject to privatization, shall be transferred by SPFU to MGU under the right of commercial

management;

MGU shall perform all functions and obligations of the TSO under the Law without attracting resources of vertically integrated

undertakings;

Analysis of individual Underground Gas Storage Facilities (UGSFs) shall be conducted to determine the optimal development

strategy. As a result, some UGSFs may be privatized, European or American partners may be engaged to operate others.

* UGSF – Underground Gas Storage Facility * SSO – Storage System Operator


2. WHY STORAGE SYSTEM OPERATOR AND

TRANSMISSION SYSTEM OPERATOR

SHOULD BE SEPARATE ENITIES

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Why should a foreign partner be engaged in the operating GTS?

The investment attractiveness and the likelihood of involving a foreign partner are the principal evaluation criteria of the TSO unbundling plan, as such participation would permit to increase the value of this asset for the state. This appears impossible

if an independent TSO company is not established and if the transmission and storage infrastructure is combined in one entity and this entity operates both.

We want to unbundle the TSO not to “imitate reforms” but to increase the value of the

Ukrainian GTS, an asset, to the people of Ukraine. Engaging a foreign partner in the

operating GTS will: bring the necessary commercial and technical know-how to enhance cost efficiency and trust of international

customers and the European policy makers via to prompt detection and dealing with corruption;

provide a chance to settle dispute with Gazprom and ensure more effective utilization of the Ukrainian GTS;

allow to attract significant additional investments to the GTS modernization;

require transparent business operations and would thus be an effective tool to fight corruption and power abuse.

Why a foreign

partner is needed

for the TSO?

What else needs to

be in place to

engage foreign

partner to running

the TSO?

Western companies will be interested to invest in the company with:

• transparent and clear cash flows generated from regulated tariffs according to the standard European practices

and based on booked capacity of 110 bcm/y till 2020;

• an independent supervisory board;

• reformed corporate management system;

• management which is resistant to political pressure.

Is it possible to

engage a foreign

partner if TSO and

SSO are combined?

NO, since Western companies are interested in natural gas transmission business, not in developing the gas storage segment, currently unprofitable both in Ukraine and Europe (due to excessive gas supply, smaller spread between winter and summer prices etc.);

No, since the cost of our UGSFs (the largest in Europe) is very high, and investors are not interested in making significant investments in this segment – since it is unprofitable, lacks strategy, and Gazprom is blocking interconnectors;

No, since Ukraine has no transparent and clear tariffs for gas storage.

Results of the gas storage segment (Naftogaz IFRS reporting), billion UAH

-0,5 -0,7

-3,0

2012 2013 2014

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Can the TSO operate separately from the SSO? Experience of the EU countries

▪ During the working mission to

Ukraine, the World Bank

consultants held a series of work

meetings with the management

team and technical specialists of

Ukrtransgaz and came to the

conclusion that there are no

technical complications or

obstacles for separating the

TSO and SSO.

▪ The relations between two

independent operators should be

solely commercial and should be

regulated by the adopted

Network Codes and

corresponding legislation.

Romania

Great Britain

Spain

Bulgaria (0,6 bcm)*

Greece

Italy France

Netherlands

Germany

Denmark

Poland

Czech Republic

Austria Hungary

Ireland

Portugal

Gibraltar

Belgium

( 0,7 bcm)* Slovakia

Slovenia

Lithuania

Latvia (2,3 bcm)*

Estonia

Finland Sweden

(0,01 bcm)*

* UGS active volume in countries where the TSO and the SSO are not separated

n/a

TSO and SSO not separated TSO and SSO separated

Both

It is a common practice to separate gas transmission from gas storage business in Europe. 2/3 of the SSOs are separated from the TSOs.

Only in four European countries the SSOs are not separated from the TSOs.

~2,3 bcm

– Latvia has the largest storage volume among countries where

the TSO and SSO are not separated

~31 bcm

– in Ukraine the active storage volume is

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Why in Ukraine the TSO should be operated separately from the SSO

The Ukrainian UGSF system is composed of 12 underground storages with the total volume of 31 bcm. The gas storage activity is loss-

making, hence it is cross-subsidized at the expense of gas transmission. No new storage tariffs have been developed yet. There is

significant uncertainty as to the future cash flows.

Criteria Positive effect for the TSO Positive effect for the SSO

Investment attractiveness and cost-

effectiveness.

Attracting a foreign investor is the key

condition to ensuring sufficient revenue

and capital investments, bringing new

technologies, and overcoming fraud

and corruption.

• Transmission business is more attractive for

potential partners from Europe and the USA. Taking

into account the existing market situation, interest in

operating storages is low.

• Capital needed to “enter” the market will be much smaller

if the investment asset does not include the UGSF.

• Volatility and decreasing demand of the gas storage

segment would not affect the investment attractiveness of

the GTS.

• Establishment of MGU presupposes that the new

company will be a transparent and effective structure,

free of non-essential operating assets and personnel.

• Involvement of reputable independent directors with

required skills and experience.

• Improvement of internal controls system.

• Leaving historical risks and problems, indebtedness,

lawsuits aside.

• Naftogaz is currently the only market actor

with sufficient experience, expertise and

“institutional capacity” to fundamentally

reform the natural gas storage business.

• Establishment of an independent supervisory

board formed exclusively of professionals

with high level of trust will facilitate

development and approval of an appropriate

UGS strategy.

• Nondiscriminatory access to UGS will be

regulated by an independent regulator.

• Without cross-subsidization, incentive for

efficiency improvement will increase, finally

resulting in greater investment attractiveness

of UGS.

Transparency • Contracts will fully comply with the 3EP, resulting in significant decrease of the corruption element in the

development market relations between the independent TSO and SSO.

Technical aspects

There are no technical conditions prohibiting separation TSO and SSO or diminishing security of

supply after such a separation:

• Ensuring transit, meaning covering the 36-hour difference from nomination to physical gas delivery at the

western border is a commercial issue (currently done by UTG free of charge) and is to be settled

separately.


3. MANAGING NAFTOGAZ : ROLE OF THE

STATE AND THE OECD PRINCIPLES

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Role of the state

in creation and promotion of an

efficient market

Credibility Free competition

Ensuring transparency

Gas market examples:

▪ Fair regulation of tariffs for operators of transmission and distribution pipelines;

▪ Promoting establishment of a hub and exchange trading;

▪ Ensuring disclosure of financial and operational statements, data on flows and capacities etc. by market participants;

▪ Adoption and implementation of the security of supply legislation.

Ensuring market integrity


▪ Administering an effective subsidy system;

▪ Encouraging diversification of supply

sources through political means;

▪ Development of the necessary infrastructure and ensuring equal access thereto;

▪ Removing barriers to integration with liquid markets.

Property rights protection


▪ Creating a competent and independent regulator;

▪ Elimination of corruption within courts, law enforcement and tax authorities, etc;

▪ Transition to predictable, fair and efficient tax regime.

What should the role of the state be: ensuring market effectiveness instead of ad-hoc management

An efficient market cannot emerge spontaneously. In fact, creation of an efficient market and promoting its operation is an essential role of the state.

12


How should the OECD principles be applied in managing Naftogaz?

OECD Principles Content Application to Naftogaz restructuring

Role of state-

owned

enterprises

(SOEs)

on the market

The legal and regulatory framework should ensure a level playing

field and fair competition in the marketplace when SOEs undertake

economic activities. (Principle III). In particular, the state should

separate functions of: :

• Managing ownership rights and conflicting functions;

• market regulation and sector policy that may influence the

conditions for SOEs (Principle III.A).

MECI develops the sectoral policy for the fuel and energy

complex. It may propose policy which would equally affect

all enterprises within the sector, not a particular entity.

Decision regarding restructuring a particular state

company should be approved by an authority with an

ownership mandate (currently – METD).

Role of the State

as an owner

The state should act as an informed and active owner, ensuring

that the governance of SOEs is carried out in a transparent and

accountable manner, with a high degree of professionalism and

effectiveness (Principle II). In particular:

• The state should let SOE boards exercise their

responsibilities and should respect their independence

(Principle II.C);

• The exercise of ownership rights should be clearly identified

within the state administration. In particular, the exercise of

ownership rights should be centralized in a single ownership

entity. (Principle II.D).

MECI proposals regarding separation of Naftogaz

eliminate independence of its supervisory board.

Centralized ownership function means that MECI may not

affect decisions regarding Naftogaz restructuring in any

way.

Naftogaz

supervisory

board, its

responsibilities

The board should be fully accountable for its actions, thus it should

be assigned a clear mandate (Principle VII.A), based on broad

mandates and objectives set by the government (Principle VII.B).

Shaping strategy should be one of the Naftogaz

supervisory board functions, and any restructuring

decision should be a consequence of the strategy.

Attempts of the MECI to restructure Naftogaz violate not only the rights of the shareholder (METD), but also the principles of sectoral policy development and implementation – MECI should determine not the restructuring model of a separate group of

companies, but the policy for the entire sector, regardless of ownership structure.

Decision on Naftogaz restructuring – within the limits of the ownership rights management framework determined by the state – lies within the competence of the company Supervisory Board.


4. EXPECTED TRANSFORMATION OF THE

NAFTOGAZ GROUP

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Natogaz Mission: сreating value for clients in a “financially sustainable” way

During the transitional period, Naftogaz will use its incumbent position to ‘jump-start’ an efficient gas market in Ukraine.

After creation of an effective legal and regulatory environment, the Naftogaz group assets should be completely or partially privatized.

What it means for consumers

(economy)

Highest return on equity 2

Energy independence 1 What it means for the

shareholder

(state / people of Ukraine)

Reliability of gas supply 1

2

The lowest acceptable price

(due to subsidies, gas affordable

even for the poorest)

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Restructuring: expected Naftogaz Group transformation

2016-2019

Independent

Board

Privatization

JV / Sale of minority stake

Privatization

JV / Sale of minority stake

Privatization

Privatization

Privatization

Privatization

Privatization

UGV

UTG (SSO)

UN

UTN

GU

USTG

UAG

ZNG

NNG

UNGK Privatization

– as nominal

shareholder

Independent

Board

– sale of up

to 49%

2020

Fully privatized:

Partially

privatized / JV:

Naftogaz Group is dissolved

UGV

UN

USTG

UAG

GU

MGU (TSO)

SSOs

UTN

2015

Naftogaz Naftogaz

Ukrtransgaz (UTG)

Ukrgazvydobuvannya (UGV)

Ukrnafta (UN)

Ukrtransnafta (UTN)

Gas of Ukraine (GU)

Ukrspetstransgaz (USTG)

Ukravtogaz (UAG)

Zakordonnaftogaz (ZNG)

Naukanaftogaz (NNG)

Ukrnaftogazkomplekt (UNGK)

Cabinet of

Ministers

State Property

Fund of

Ukraine

Cabinet of

Ministers

Centralized

Ownership

Entity

‘MGU’ (TSO) Ministry of

Energy

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5. WHY AT THIS POINT

UKRGAZVYDOBUVANNYA SHOULD REMAIN

NAFTOGAZ SUBSIDIARY

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UGV operating cycle

Why Ukrgazvydobuvannya may not be currently separated from Naftogaz

Drilling

Exploration

Production

Processing

Sales

Ukrgazvydobuvannya has no sales function – gas is sold through NJSC Naftogaz of Ukraine,

proceeds from these sales amount to over 70% of the total UGV revenue.

According to the CMU Resolution on public service obligations, prior to 1 April 2017 UGV is required

to sell Naftogaz all gas it produces in order to establish the natural gas resource for household

consumers, religious organisations and heat energy producers.

Before October 2015, the price of gas sold by UGV to

Naftogaz was regulated and determined by the Regulator. Low

regulated price was the reason behind the lack of funding for

the UGV capital investments, which caused a 4% drop in

company’s production in 2015.

Over the past years, Naftogaz has not required dividend

payments from UGV; UGV’s available funds were used to

develop the company.

Under the public service obligation, from October 2015 the

UGV natural gas sale price was regulated and determined by

the Cabinet of Ministers (UAH 1,590 per 1 mcm VAT excluded

till 01.04.16, expected to be USD 150 per 1 mcm from

01.04.16 till 01.04.17).

Price regulation and lack of gas sales function currently

prevent market players from investing in UGV.

The 3EP has neither requirements nor recommendations regarding separation of upstream from trading activities. Moreover, the separation of Ukrgazvydobuvannya (UGV) from Naftogaz lacks commercial rationale due to: (1) absence of gas sales function in UGV; (2) public service obligation (PSO) mechanism requiring UGV to sell all gas it produces to Naftogaz; (3) sales price regulated under the PSO mechanism, precluding investors engagement before April 2017; and (4) significant tax liabilities for Naftogaz if UGV is unbundled.

2,3

3,6

4,6

4,8

8,6

11,7

21,8

Naftogaz

Novatek(Russia)

Gazprom(Russia)

PetrocelticInternational

Romgaz(Romania)

JKX (UK)

Dragon Oil

USD/BOE

Capital investments in the gas production segment, 2014

Source: Bloomberg, companies’ data, own assessments

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Jun

2015

Sep

2015

Dec

2015

Feb

2016

Jun

2016

2H 2017

2020

Development of long-term investment and restructuring Strategy 20/20 and its approval by Naftogaz supervisory

board

Hiring a financial advisor for further privatization

‘Quick wins’ by new management

Deep transformation (implementation of Strategy 20/20)

Privatization through staged public offerings in 4-6 years (by placing up to 25% shares annually) after price liberalization in April

2017

Sale of up to 25% of shares via IPO will be the first step of the UGV privatization, expected in 2H’2017 (after the market is liberalized and the strategy approved by the Naftogaz supervisory board is implemented).

Relations between UGV and Naftogaz

Currently the new UGV management team has full support of the Naftogaz leadership, and this situation led to significant improvements

2015 production plan accomplished. Sales effectiveness increased – effect > UAH 100 mln.

On crucial supplies, intermediaries were removed and contracts amended. Effect > UAH 500mln savings in 2H’2015.

Financial stabilization achieved via savings on procurement and sales, this allowed to salvage the defaulted PIB credit.

Modernization and equipment procurement program launched (coil tubing, drilling).

Management and technical team strengthened at all levels.

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