Gas sales to industrial consumers and budget organizations
(non-regulated prices)
Market share
(in bcm, 2015)
Preliminary segment results for Naftogaz
(in UAH bn, 2015)
7.4
29.8
Gross profit
Revenues
Naftogaz24%
Other76%
1
Gas sales to industrial consumers and budget organizations
(non-regulated prices)
2.7
1.5
1.3
1.2
0.4
0.3
0.2
1.5
Naftogaz
Ukrnafta
DTEK
Burisma Holdings
Ukrnaftoburinnya
Geo-Aliance
JKX
Other private producers
Gas sales to non-regulated segment, bcm Gas production, bcm
2
2015
Roadmap to efficient gas market in Ukraine
3
New Law
on the Regulator
New Regulator: insulated from political meddling
+ not influenced by oligarchs + competent
= trusted by market participants
1
Roadmap to efficient gas market in Ukraine (cont’d)
4
Amend Secondary Legislation to
Implement EU Network Codes etc.
Liquid daily market:
OTC/Exchange
Counterparty
risk
management
Access to forex
+ capital
2
Is secondary legislation 100 % compliant with 3EP?
Developed by the European Commission
DIRECTIVE 2009/73/ECby Energy Community
REGULATION (EC) No 715/2009
by Energy Community
Transposed by the Energy Community
• COMMISSION REGULATION (EU) No 312/2014
Network Code on Gas Balancing of GTS
• COMMISSION REGULATION (EU) No 984/2013
Network Code on Capacity Allocation Mechanisms
• COMMISSION DECISIONS (EU) 2015/715
amending Annex I to Regulation (EC) No 715/2009
on conditions for access to the natural GTS
• COMMISSION REGULATION (EU) 2015/703
Network Code on interoperability and data
exchange
DIRECTIVE 2009/73/EC
Concerning common rules
for the internal market in
natural gas
REGULATION (EC) No
715/2009
on conditions for access to
the natural gas transmission
networks
3EP
Secondary
Legislation
5
Roadmap to efficient gas market in Ukraine (cont’d)
6
Amend Transit Contract with Gazprom
to comply with EU Rules
Shipping code
pairs
Interconnection
agreements
Unrestricted
entry/exit to
Ukrainian GTS,
inc. VRFs*
Non-
discriminatory
application of
new entry/exit
tariffs
Unbundling of
the TSO
Western Partner
for the TSO
Western
partners for
UGSs
* – Virtual Reverse Flows
3
Backhaul will enable additional West-to-East capacity
EU neighbouring countryAvailable for backhaul
as of July 2014
Expected in
July 2017*
Poland 0 4
Hungary 0 6
Slovakia 0 38
Romania 0 19
Total 0 67
Notes: * estimates based on actual physical gas flows from Ukraine to Poland, Hungary, Slovakia and Romania in 2015
Interconnection
Agreements signed
between UA and TSOs
of all neighboring
countries
No Interconnection
Agreements
bcm / year
Improves energy security of Eastern and Southeastern Europe
Leads to fair market pricing for regional buyers
Opens access for EU companies to Ukraine’s vast underground storages
Interconnection Agreement (already signed between UA and HU TSO) improved
cooperation and expanded opportunity for security gas supply of EU countries (firstly SK,
PL, HU, BG)
Backhaul:
7
Roadmap to efficient gas market in Ukraine (cont’d)
8
Amend Supply Contract with
Gazprom to comply with EU rules
“Hub minus Transportation” prices
for Russian gas in UA
Non-regulated
household prices
Competition in retail
4
Source: Bloomberg. Energy conversion for NCG and CEGH prices as 1 tcm = 10,41 MWh (GCV) – for calorific parity with Gazprom's price for Naftogaz
* – Future prices are based on estimated cost of transportation as of Mar-2016
Cost of transportation from NCG to Ukrainian border is calculated for average private importer for booked capacities for 1 month.
USD / ’000 m3
Russian gas price for Naftogaz and market prices
9
0
100
200
300
400
500
600
Ja
n'1
0
Ma
y'1
0
Sep'1
0
Ja
n'1
1
Ma
y'1
1
Se
p'1
1
Ja
n'1
2
Ma
y'1
2
Se
p'1
2
Jan'1
3
Ma
y'1
3
Se
p'1
3
Ja
n'1
4
Ma
y'1
4
Se
p'1
4
Ja
n'1
5
May'1
5
Se
p'1
5
Ja
n'1
6
Ma
y'1
6
Se
p'1
6
Ja
n'1
7
Ma
y'1
7
Se
p'1
7
Ja
n'1
8
Ma
y'1
8
Se
p'1
8
Russian gas price for Ukraine (according to the contract with Gazprom)Russian gas price for Ukraine with agreed discounts (including "winter packages")NCG price netted back to Eastern Ukrainian border*NCG price plus cost of transportation to Western Ukrainian border
Expected costs of transportation from UA/RU border to NCG in Mar-2016 is about 82-85 USD/’000 m3
Expected costs of transportation from NCG to UA/SK border in Mar-2016 is about 40-45 USD/’000 m3
Roadmap to efficient gas market in Ukraine (cont’d)
10
Competition in retail
Non-regulated household prices
Privatization of gas production
Corporate Governance
reform of Naftogaz
0% Royalty Tax + Fair Auctions
for new gas production licenses
Supervisory Board: insulation
from political meddling and
graft
Increase in Production
5
Roadmap to efficient gas market in Ukraine (cont’d)
11
New Regulator:
insulated from political
meddling + not influenced by oligarchs + competent
Counterparty risk
management
Access to forex + capital
Unrestricted entry/exit to
UA GTS, incl. VRFs
Non-discriminatory application of new entry/exit
tariffsWestern
Partner for the TSO
Western partners for
UGSs
Competition in retail
Privatization of gas
production
Increase in Production
Development of a hub
EU off-takers of Gazprom have economic incentives to change
delivery points to UA/RU border
6
12
Gas Market Law is a framework
Implemented through the secondary
legislation:
Network Codes, Rules of Supply,
Tariffs, Rules of Security of Supply,
National Prevention Plan, etc.
Gas Market Law impact on local gas market liberalization
New Market, Old Regulator?
13
• Fair Regulator: competent, independent from other
market participants and from political meddling
• Efficient market needs a Fair Regulator
• The Law on Regulator was supposed to be adopted
simultaneously with Gas Market Law. And?
Case study: Gas Market Law vs Secondary Legislation
Gas Market Law Secondary Legislation
Completely new law drafted by the Energy
Community Secretariat (ECS)
Key concepts developed by World Bank
consultants
Regulator, regional distribution companies
(DSO):
a) claimed that the Law wouldn’t work due
to local specifics;
b) suggested to amend existing legislation
Regulator, DSOs:
a) claimed that it wouldn’t work due to local
specifics;
b) Insisted on using their drafts
Minister of Energy Y.Prodan made political
decision to use the ECS draft
Energy Minister V.Demchyshyn made
political decision to take the Regulator’s side
Amendments to the ECS draft were possible
only if proved that provisions wouldn’t work
otherwise, as required by the Deputy
Minister of Energy I.Didenko, head the
working group
No consensus was reached between the
World Bank consultants and Naftogaz on
one side and the Regulator and DSOs on
the other side. Minister V.Demchyshyn
chaired the working group
Naftogaz role: show viability of the ECS draft Naftogaz role: scream about problems
Amendments subject to ECS confirmation ECS could raise their objections ex-post
Result: Success Result: ?
14
The ultimate goals of restructuring at this stage are reaching compliance with the Law in respect of the TSO separation, establishing framework for foreign partnership in the
TSO, employment of the best practices of the natural monopolies regulation.
All other forms of restructuring of Naftogaz lie within the competence of the Naftogaz supervisory board
Separation of transmission activities or full Naftogazrestructuring?
The Third Energy Package (3EP), i.e. Directive 2009/73/EC
sets a clear mechanism to eliminate discrimination regarding
access to the GTS – it requires effective separation of
transmission from production and supply activities
EU
The Gas Market Law introduces EU requirements regarding
separation and independence of the TSO into the Ukrainian
legislation
Gas Sector Reform Plan, adopted CMU and approved by the
World Bank, provides for Naftogaz restructuring aimed at
separation of transmission activities in compliance with the Law
15
• Naftogaz should get a right to assign the transit contract
with Gazprom to the unbundled TSO
• The TSO should get a new state owner with sufficient
independence from the CMU
• If somebody wants to consider finding a private owner for
the TSO, he should look at legislative limitations for
private control over GTS
Critically important factors to be considered selecting the model
Naftogaz pointed out three legal problems, that should be
addressed when deciding on the model (FOU, ISO or ITO) or
timing of the unbundling:
16
Why a foreign partner is needed for the TSO?
bring the necessary commercial and technical know-
how to enhance cost efficiency
defend Ukraine’s interests as a transit country, incl. in
debates over Nord Stream-2
facilitate raising capital for GTS modernization
fight potential corruption and fraud
TSO is unbundled not to “imitate reforms”, but to:
• help developing an efficient gas market;
• increase the value of the Ukrainian GTS as an asset to the people
of Ukraine.
Engaging a western partner in the operating GTS will:
17
Source: McKinsey & Company, EY
NO technical hurdles for separation
Technical perspective
No cross-subsidization stimulates
efficiency improvement
Transparency of TSO and SSO
Market-based relations between TSO
and SSO mitigate potential
corruption and fraud
TSO and SSO should be separate entities
UGS in Ukraine vscountries where TSO and SSO are one entityin bcm
No effect. Ministry of Energy enforces
security of supply via the Rules and the
National Preventive Plan
Security of Supply
• Almost 140 UGSFs in Europe
• 2/3 of SSOs are separated, only in 4 states
SSOs are together with TSOs
Transmission business is more
attractive
Investment attractiveness
Capital needed to “enter” the market will
be much smaller for TSO partner
Unbundling of Storage System Operator
RO
UK
ES
BG
EL
IT
FR
NLDE
DK
PL
CZ
AT HU
IE
PT
BE
SK
LT
LV
EE
FIN
SE
UA
Total EU-28,
108
UA, 31
LV, 2.3
BE, 0.7BG, 0.6
SE, 0.01
n/aTSO and SSO single entity Separated Both
18
Has the consensus on the future unbundling been reached?
• The “Trust Fund” project led by the World Bank but financed by
the EU was supposed to find solutions to key problems
• The project started in May’14
• Our concern was that the selected consultants did not have
experience in unbundling under the EU legislation
• Ministry of Energy insisted that these consultants should advise
the government on unbundling
• EC provided a consultant with a relevant practical experience but
as we understand this consultant had a very limited role, if any
• WB consultants presented their final report on February 9
• The report contains no answers on how to deal with the
mentioned legal problems
19
Has the consensus on the future unbundling been reached?
• Ministry of Energy, instead of working on the core problems
of unbundling (incl. legal ones), focused on taking as many
as possible of Naftogaz subsidiaries from its control.
• Ministry of Energy was to develop and agree with the ECS
the concept of unbundling by November 2015 and submit a
plan to CMU till February 2016.
• It is only in February that the Ministry presented a
misfocused concept
• EC already raised valid concerns about the submitted
concept
No consensus on the future unbundling, structure and composition
of Naftogaz of Ukraine has been reached. Is splitting up of
transportation and production and storage the most effective
approach?
20
3EP has neither requirements nor recommendations regarding
separation of upstream from trading activities
• absence of the gas sales function in UGV
• PSO mechanism whereby UGV sells all its gas to Naftogaz
• sales price is regulated by PSO Act until April 2017
• significant tax liabilities for Naftogaz if UGV is unbundled.
Separation of UGV from Naftogaz lacks commercial rationale due to:
This “idea” of separation ignores obvious benefits of vertical integration
McKinsey working for the National Reform Council advised to increase
the role of the corporate center (next slide).
Why Ukrgazvydobuvannya (UGV) may not be currently separated?
21
Level of operational control for corporate center
Strategic Architect
Portfolio Manager
Focused Operator
▪ CC focuses on maintaining financial control and result
▪ CC issues guidelines and enables linkages across BUs
▪ CC enforces standard processes and ensures synergies
▪ CC drives integration, leverages common skills and executes
▪ NG lacks control over subsidiaries and effective centralization of relevant activities
▪ NG needs to tighter control to overcome transition challenges and improve efficiency
▪ More decentralized model may be built as NG would consider exiting from some assets
Today
Transition
period
Long-
term
Low High
Strategic Controller
Impli-
cations
▪ Key subsidiaries have
independent Boards
▪ NG performs strategic oversight
of subsidiaries via boards, no
interference in day-to-day
operations
▪ No separate Supervisory
Boards: subsidiaries act as
business units of NG
▪ NG is actively engaged in day-
to-day operations of subsidiaries
Has the consensus on the future unbundling been reached?
22
Corporate governance reform of the TSO and priority actions
Progress of the reform of the management structure of the
Ukrainian gas transmission system and priority actions
• CGAP for the TSO was developed by EBRD but put on hold at the
request of the WB – it should provide for professional management
insulated from political meddling and graft
• Technical assistance from western partners is being discussed
Priority actions
• Set up new “bankable” TSO
• Start developing efficient operating model
• Corporate governance compliant with OECD guidelines
• Amend transit contract with Gazprom
• Complete the unbundling
• Attract reputable western partner to operate GTS
23
Modernization of the Gas Storage and the GTS as a key condition to create regional gas hub
Secured by the EBRD and EIB loans
Key conditions:
• Economics: Russian gas in Ukraine priced at hub – transport, not hub +
transport (100 vs 200 USD tcm)
• Rule of law: EU Regulation, Independent Regulator and TSO with a
Western partner, trusted courts and law enforcement
• Market integrity: currency controls, credit risk etc.
But it is a misconception that modernization of infrastructure is a
key condition
24
Is vertically integrated national oil company a workable concept?
Is the proposed vertically integrated national oil company (on the basis of government stakes in Ukrnafta, Ukrtransnafta and Ukrtatnafta) a
workable model and could it raise efficiency, output and create value for public purse?
• Arguably makes economic sense
• Unlikely agreement between Kolomoyskiy and the government
• We are not working on this proposal
• Would rather suggest privatization of Ukrnafta
25
Old transit tariff vs New entry/exit plus RAB tariff
Effect from implementation of new entry/exit tariffs on cost of transit via Ukraine
(for Gazprom) in 2016 when current non-regulated contract between Gazprom
and Naftogaz for transit of 110 bcm is converted (from 01.01.16) into a regulated
contract for capacity booking of 110 bcm pa till 2019, and Gazprom utilizes 110
bcm of the booked capacities in 2016.
Notes: own preliminary estimates as of Mar-2016 (including fuel component).
* – until Jan’2016 gas transit services were exempt from VAT. According to December 2015 changes in Tax Code of Ukraine, these
services are already taxed by VAT.
“Transit assets” are fully
depreciated by the date of the
transit contract expiration, given
little reasons to expect material
volumes of Russian gas transit
through Ukraine beyond 2020
USD bn.
26
3.17
6.35
0.40
0.72
2.06
Costs based on old tariff
Switch to RAB
VAT*
Use of accelerated depreciation
Costs based on new tariffs
+12,7%
+20%
+48,0%
Notes: own preliminary estimates as of Mar-2016 (including fuel component)
* – Calculations assume that in 2020 under the ship-or-pay clause Gazprom will pay for capacity booked with SK and CZ TSOs. This is the opportunity cost of the Nord Stream-2
** – Though Gazprom pays app. 0 for transit through Belarus, these costs are estimated given "hidden subsidy" for Russian gas (i.e. import price for Belarus is much lower)
*** – Costs of fuel gas used for Portovaya Compressor Station (pumps gas through Nord Stream -1) are artificially allocated to Russian consumers thus decreasing transit costs
278
146
73
74
103
58
66
54
48
0 50 100 150 200 250 300
Nord Stream-2 (exp. in 2018 - 2% utilization)
Nord Stream-2 (2019 - 20% utilization)
Nord Stream-2 (2020 - 90% utilization)
Ukrainian route (old tariff)
Ukrainian route (new tariffs, 2016)
Ukrainian route (new tariffs, 2020)
Yamal-Europe**
Nord Stream-1 *** (2015 - 71% utilization)
Nord Stream-1 *** (90% utilization)
Transportation through Russian territory
Transportation via other pipelines controlled byGazpromTransportation through Ukraine (pipelines notcontrolled by Gazprom)Transportation from UA/SK border to Germanborder
Transportation costs for Gazprom of Russian gas delivered to Germany via different routes
Ukrainian route vs Nord Stream-2: economics should come first
Doubling of Gazprom's Nord Stream pipe is a politically motivated concept.
Calculations show that by the time the Nord Stream-2 becomes fully operational,
taking gas to Germany through Ukraine will cost 20% less. Route through Ukraine
remains the only one fully operational and not controlled by Gazprom
USD/'000 m3
In 2020 the cost of transportation
through Ukraine will be lower
27
Cost of gas transportation via different routes
10.00
20.80
2.49
3.60
2.55
5.12
3.50
2.57
Expected cost of transit via Nord Stream-2 (2019, 20% utilizationof 55 bcm capacity)
Expected cost of transit via Nord Stream-2 (2018, 2% utilization of27,5 bcm capacity)
Nord Stream-1 (expected average cost in 2015)
Nord Stream-1 (average cost in 2014)
Slovakia (2016) *
Ukraine - average expected cost in 2016 based on approved tariffs(RAB, accelerated amortization) and 116,6 bcm of actual transit
(incl. fuel component)
Ukraine - average expected cost in 2016 based on RAB, normalamortization and 116,6 bcm of actual transit (incl. fuel component)
Ukraine - old tariff for Q1'16 (incl. fuel component)
Average cost of transit
USD/’000m3/100km
Notes: own preliminary estimates as of Mar-2016.
* – transmission cost is calculated for 5 years contract from 01/01/16 till 31/12/20 in the amount of 214 GWh / day (20 mcm/day), input data is taken from the website
of the Slovakian TSO, forecasted prices for fuel gas as of 14/01/16; forecasted Bloomberg currency exchange rates for 2016-2020; forecasted indicator of GCV at
10.7 MWh/kcm and forecasted adjustment of tariff for inflation.
28
Booked
capacities,
bcm/year
Entry tariff after 2019,
USD/'000m3 of
booked capacity (incl.
VAT)
Average exit tariff
after 2019,
USD/'000m3 of
booked capacity
(incl. VAT)
30 3.3 10.4
50 2.5 7.2
70 2.0 5.6
90 1.7 4.6
110 1.4 3.8
120 1.4 3.6
150 1.1 2.9
Expected transit tariffs after 2019
Notes: own preliminary estimates as of Feb-2016.
Change in depreciated cost of transit gas transmission assets (V), used for
calculation of gas transportation tariffs
2014 2020 2035-2045
V After Gazprom
statements
Before Gazprom
statements
~10 times lower than
current approved tariffs
“Gas transit assets” will be fully depreciated by 2020, values of the “regulated return on assets” and “depreciation” components in the
structure of tariffs are expected to become low. Tariffs will be reset at a much lower level starting from January 2020.
29
Evolution of market conditions from 2016 to 2020 +
NON-COMPETITIVE price of gas
imported from Russia
2009 Contract terms with Gazprom
COMPETITIVE price from the EU
EU oriented gas imports
Supply from EU dominates, can fully
substitute supplies from Russia in
2016
LOW flexibility for flows across the
borders
Contractual bottlenecks at all but
one IPs at the border with EU;
Backhaul is not possible under
existing contracts structure
COMPETITIVE Price of gas imported
from Russia
Hub-minus-transportation
NON-COMPETITIVE price from EU
HIGHER import from Russia due to
attractive pricing
+ Possibility to re-export surplus of
imported Russian natural gas
DEBOTTLENECKING at all
interconnection points
Backhaul operations are introduced;
Bidirectional gas flows at all IPs
NO RUSSIAN GAS
Under conservative scenario
Imports from EU to cover peak
consumption
FREE flows of gas across the borders
Full infrastructural, legal and
contractual integration with the EU
transmission system
2016 2017-2019 2020
+
GTS and UGS are not attractive for
investments
Infrastructure is used inefficiently due
to uncompetitive practices by
Gazprom => future cash flows are
uncertain;
GTS and UGS are attractive for investments
Given predictable cash flows, TSO becomes attractive for Western partners;
Very cost-attractive Ukrainian transit route of the East-to-West gas corridor; Attractive capacity products are offered by SSO + competitive gas price from RF =>
shippers are incentivized to store gas in UGS and trade during the periods of peak
consumption
30
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