The rights of gas market players restricted again

December 3, 2014

The former Cabinet of Ministers donated free market principles and commitments to the EU in order to solve the financial problems of Naftogaz of Ukraine. Officials limited the rights of private mining companies in the implementation of the gas and industrial consumers – in its procurement.

Government of Arseniy Yatsenyuk, still in its previous composition, obliged to major industrial consumers of natural gas in February 2015 to buy it only in Naftogaz of Ukraine on an advance payment. The decision on this was taken in November, and the use of a new procedure began on December 1.

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The wording of the document was changed by officials three times. “There is a lack of experience among experts responsible for the preparation of the text, which remained in the state apparatus after the entry into force of the law on lustration. Permanent trading between business and government has influenced itself the process”- shared with Forbes spokesman at the Ministry of Energy.

“Triple Overcoat”

In the version of November 7, the date of entry into effect of the decision was determined by 1 December 2014. Five days later, on November 12, the Prime Minister Yatsenyuk signed a new version of the document that defined that particular day as the date of entry into force of the new rules for the sale of gas in the domestic market, in order to consumers in the list had submitted requests for gas to “Naftogaz” and conclude supply contracts with state holding in December. And on 28 November, the government expanded the list of companies that had come under the restrictions in the procurement of natural gas for its work: there were not 90, but 167 subjects.

The list was added, in particular, with chemical plants, controlled by Dmitry Firtash and Dnipropetrovsk governor Igor Kolomoisky, who previously were missing in it.

Back in September, the Cabinet of Ministers has prohibited Firtash companies to select their own fuel (more than 3 billion cubic meters) from underground storage facilities before the end of the heating season. But the Group DF, the management company of businessman, could still support the work of Cherkassy Azot and Rivneazot without new purchases. The Company challenged in court the decision of the government, so its acting was suspended, and Ukrtransgaz continued to transport energy resources to those companies. Two other chemical plant of Firtash – “Severodonetsk Association Azot and Concern Stirol – were shut down in May because of the armed conflict in the Donbas.

Dniproazot controlled by Privat Group managed without purchases from Naftogaz. Despite deficit of Ukrainian gas for the needs of the population (according to the results of IV quarter of 2014, according to the Ministry of Energy and Coal Inductry, it will be 2.137 billion cubic meters and will be compensated by expensive imports), domestic production of natural gas at this plant was delivered by state-owned company Ukrnafta which controlled by the Privat management.

Initially, the “forbidden” list of the Cabinet of Ministers included the most energy-intensive state-owned enterprises (for instance, the Odessa Portside Plant, Zorya – Mashproekt, Ukrspirt), as well as plants, controlled, in particular, by Rinat Akhmetov, Viktor Pinchuk, Roman Abramovich, Constantine Zhevago, Vyacheslav Boguslayev.

Thanks to their guaranteed payments Naftogaz expected to cover deficit of funds to pay for imported gas from the EU and Russia in the winter (from June 16 due to price differences, “Gazprom” has stopped supplies to Ukraine, but issue of their renewal had been settled through the EU mediation on the October 31).

Private Opposition

It is more profitable to work with private suppliers than with National JSC – they have a more flexible pricing. Therefore, individual consumers, which the government is limited in the choice of gas supplier, exploring the possibility to defend their interests in court. “The Cabinet of Ministers uses again non-market instruments and unreasonably interferes with the economic activities of enterprises, establishing discriminatory rules. We consider possible claim as a way to protect the rights of business and instrument of influence on the un-considered decisions of officials, “- said to Forbes Sergey Tkachenko, the Industrial Union of Donbass Legal Department Corporation Director (controlled Alchevsk Metallurgical complex and Dneprovskyi Metallurgical complex named after Dzerzhinskyi which the Cabinet of Ministers transferred into obligatory gas purchase from Naftogaz).

Private gas producers are also ready to defend their interests. On November 14, several companies filed a lawsuit in the District Administrative Court of Kyiv against the government and Naftogaz. The claims are supported by key industry players Naftogazvydobuvannia of Rinat Akhmetov, Burisma Holdings of Nikolai Zlochevsky, Poltava Petroleum Company (it is controlled by the British JKX Oil & Gas), Geo-Alliance of Viktor Pinchuk, Kub-Gas and Tysagaz of Pole Jan Kulczyk.

 “The Cabinet of Ministers has exceeded its authority, illegally invaded the activities of private companies and violated the international obligations of Ukraine”, – said Vitaliy Radchenko, partner of law firm CMS Cameron McKeena, which represents the interests of the gas industry. According to him, other mining companies and consumers, whose interests are violated by the Cabinet of ministers may join lawsuit.

Private gas producers have something to fight for: the decision is fraught with the loss of a large proportion of their working capital. “Such a measure may lead to losses of companies that will minimize investment projects, to freeze production and the state expects difficulties in reducing dependence on expensive imported gas and increased energy dependence,” – says Yuri Korolchuk, a member of the Supervisory Board of the Institute of Energy Strategies.

Burisma Holdings, the largest independent gas producer in Ukraine, supposes to prevent the development of negative scenario, with the help of the court. “The government has violated the rules of national law, radically changed the rules of the gas market, monopolizing it and excluded from the sales to industrial consumers all private gas companies in Ukraine. The initiatives of the Cabinet of Ministers do not allow gas companies to build long-term strategy,” – said Burisma Holdings CEO Taras Burdeinyi.

National Security “Agents”

Despite the criticism of the business, the Cabinet of Ministers is sure that they have taken adequate decision. “The outcome of the proceedings in the present, in fact, military situation, is more likely to be not in favor of private investors. It is clear that the government’s argument about the protection of national energy security and the court will have more weight, “- said the source in the Ministry of Energy to Forbes. He also drew attention to another thing: if gas supplies to large solvent customers, Naftogaz will be able to improve their financial situation, because it is possible to increase the income from the so-called “surcharge” for the maintenance of NJSC which is included in the cost of supplies and can as high as 7% of its total sum.

“The military expediency” risks provoking the fall of production by private companies. They have traditionally accounted for about 15% annual gas production in Ukraine, but record is expected to at the end of 2014: not less than 3 billion cubic meters as estimated by the Ministry of Energy and Coal Industry, against the traditional 2.4-2.6 billion cubic meters. (Buying a similar amount in the Russian Federation at an agreed price of $ 385 per 1,000 cubic meters would cost the country more than $ 1.1 billion). In the first half of 2014, private companies produced 1.5 billion cubic meters of gas – 32% more than in the same period in 2013.

 

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Calculation at the end of 2014 was made on the basis of planned income and distribution of natural gas to Ukraine in 2014, composed by Naftogaz of Ukraine.

The basis was laid in previous years: the business invested in exploration, drilling, development of infrastructure. The industry was consolidating assets, due to which the market may appear large players with annual production of more than 1 billion cubic meters. Naftogavydobuvannia and Burisma Holdings management stated about such plans for the next year, but could refuse them now. And not just for the reason that the Cabinet has restricted the possibility of private producers in the choice of consumers. In 2015, the government plans to increase the tax burden on subsoil users. As a result, the profitability of gas production will fall sharply from the current 250-300% to 20%. But the final decision on tax reform will make the Cabinet of Ministers in December, following consultations with the International Monetary Fund experts.

Price Issue

In November, the limit price of gas for industrial consumers, which established by National Commission on a monthly basis, carrying out state regulation in the energy and utilities (NKREKU), decreased up to 5,100 hryvnia per 1,000 cubic meters or 4.64% compared with October.

This was due to the increase in the cost of imported gas. The rise in price of fuel for Ukrainian industry is theoretically increases the attractiveness of the mining sector to the private sector, which has the right to sell the resource industrial consumers – in contrast to the state-owned enterprises or companies involved with them in joint activities. The latter is obliged to sell its gas only to the population and budget organizations at prices set by the state, with a minimum profitability up to 10%.

But now the industry supplies are actually monopolized by Naftogaz, which the Cabinet of Ministers also delegated exclusive authority for import purchases until the spring (among last year importers of gas there were, for example, Ostchem Holding of Dmitry Firtash and DTEK of Rinat Akhmetov).

Methods of “kamikaze government” to solve the financial problems of Naftogaz were criticized not only by investors, but also by the European Energy Community. Janez Kopacz, the head of the secretariat of the organization, wrote a letter to the Prime Minister Arseniy Yatsenyuk, in which he demanded to explain the “non-transparent and non-motivated decision”.

The distribution of reserves and prospective resources of natural gas in Ukraine to subsoil users (as of January 1, 2014)

Компания Количество спецразрешений (геологическое изучение) Количество спецразрешений (добыча) Балансовые (добывающие) ресурсы (млн куб. м) Доля в запасах Украины (%) Перспективные ресурсы (млн куб. м) Доля в запасах Украины (%)
НАК «Нафтогаз Украины» 49 216 857249 86,31 322689 42,66
НАК «Надра Украины» 20 7519 0,76 15364 2,03
Коммерческие структуры 137 62 94382 9,5 164589 21,76
Нераспределенный фонд 34101 3,43 253827 33,55