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    Ukraine: What Next?


Having successfully pushed for the unbundling of the Ukrainian grid, the EU must now make sure that the revenues are spent on transportation, not cross-subsidies [Table format corrected].

by: Thierry Bros

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Ukraine: What Next?

The Russia-Ukraine deal signed December 29 provides for a minimum 225bn m³ of transit spread over five years and a total revenue of $7.2bn. As it is not exactly a standard EU contract[1] and involves several players, it is worth looking at the financial flows behind it.

In fact, there are “actually three agreements regulating the transit issue, including the agreed annual capacities and regulated tariffs: one between Naftogaz and Gazprom, the other between the new operator Gas Transmission System Operator of Ukraine (GTSOU) and Naftogaz and the last being the interoperator agreement between Gazprom and GTSOU (...) As a result, Naftogaz (being no longer the owner of the operator of Ukrainian gas network) becomes a kind of intermediary between Gazprom and the new operator GTSOU, and as such is responsible for organising the transit on behalf of the Russian company (...) It also seems to go contrary to the logic behind the unbundling process, which has just been completed and approved by the EC as compliant with EU requirements: they are primarly aimed at separating gas transmission activities from Naftogaz.”[2]

Gazprom has agreed to pay Naftogaz a total revenue of $7.2bn (or $32/'000 m³), based on a ship-or-pay formula. For the 65bn m³ to be transited this year at a uniform flow of 178mn m³/d[3], this means $2.1bn in revenue. To calculate the tariff, we see that in 2018, 71% of the gas entered at Sudzha and 29% from the other four points near the Russia-Ukraine border[4] and exited at Uzhgorod (57%), Orlivka (21%), Beregovoye (14%) and 'others' in the west (8%).

As the 15bn m³ for Turkey do not enter at Sudzha and exit only at Orlivka, with TurkStream operating this year the split should be entry Sudza (86%) and others (14%), and exit Uzhgorod (72%), Beregovoye (16%) Orlivka (6%) and others (6%). Applying the regulated tariffs[5] the GTSOU transit revenue is $1.814bn, leaving $266mn profit for Naftogaz (or a commission of 12.8% for covering Gazprom's risk by booking capacity itself).

Out of this $1.814bn regulated transit revenue, the operator GTSOU needs to cover its additional operating expenses, which is mostly the cost of fuel gas. In 2018, this amounted to 4.7bn m³[6] for domestic consumption of 32.3bn m³ and a transit of 86.8bn m³[7]. But, according to the CEO of GTSOU, the transporter had to take care of “unpaid gas withdrawals”[8]. This means that around 2bn m³/yr are unpaid for and accounted in the fuel operating needs instead of extra consumption.

We can therefore assume that the fuel cost is 2.2% and should be 1.4bn m³ in 2020 for transiting of 65bn m³. If we assume GTSOU buys its gas at the wholesale price in Ukraine[9], those 1.4bn m³ should cost $290mn.This leaves GTSOU with a theoretical profit of $1.524bn. A small portion (about $10mn) should cover for the cost of MGU, the owner of GTSOU unless some costly staff duplication is decided, leaving more than $1.5bn for distribution to the Ukrainian state, the sole shareholder.

But again, according to GTSOU CEO: “Imbalances, or, more simply, unpaid gas withdrawals by regional gas companies and state and municipal enterprises, are the main risk to the business of the newly independent operator. If we do not solve this, then in 2020 we will have up to hryvnia 10bn ($410mn) of unauthorised offtakes. In fact, a significant portion of the transit revenue we receive from Gazprom will go to unbalances.”[10]

Hence $400mn could go as a cross-subsidy to pay for unpaid gas taken out of the system. So, from the $2.1bn revenue, the Ukrainian state would get only $1.1bn at best…

  $m for 2020 $m for 2021 Notes 2020-24 total $mn
Revenue provided by Gazprom to Naftogaz 2,080 1,280 Ship or pay contract 7,200
Vol transit (bn m³) 65 40 As disclosed  
GTSOU transit revenue 1,814 1,116 As defined by regulator 6,279
Naftogaz profit 266 164 12.8% profit 921
Fuel cost for transit (bcm) 1.4 0.9 2.2% of fuel 5.0
Fuel cost for transit 290 178   978
Theoretical GTSOU transit margin 1,524 938   5,301
Unpaid gas 400 400 Disclosed 2,000
MGU cost 10 10 Estimated 50
Back to Ukraine government 1,114 528   3,251

It is worth also mentioning that, following the Gazprom deal, the Ukrainian regulator slashed the cost for local producers to access the grid, from the proposed hryvnia 406.68 [11] hryvnia 101.93 [12] /'000 m³ from 2020. For the 16.6bn m³ produced by Naftogaz in 2018[13], the added 2020 benefit could be $208mn. This should not be problematic as long as: 1/GTSOU transports gas within Ukraine profitably; 2/the liberalised market allows competitors to thrive relative to the dominant incumbent; and 3/it can be adapted depending on the future of the Gazprom contract.

Now that the EU has successfully pushed for the unbundling of the Ukrainian grid, it is time for the EU to continue to push for the cross-subsidy to stop and for a well-functioning market to develop. If this is not solved in 2020, from 2021, more than 40% of GTSOU theoretical transit margin[14] will go on covering unpaid gas, leaving the system in a precarious position once more, whereby Gazprom's transit fee is used for unpaid gas and transport subsidies… The stability of the transit system can only be guarantee if full transparency is provided. It would also help to keep track of the financial flows.


Thierry Bros

Advisory Board Member Natural Gas World

23 January 2020

[1] For more on the specific structure of the contract, please refer to “Unpicking the Russia-Ukraine Agreements” available at https://www.naturalgasworld.com/unpicking-the-russia-ukraine-agreements-75810

[2] Ibid

[3] https://interfax.com.ua/news/interview/635485.html

[4] Naftogaz 2018 Annual Report map on p78 using 2016 to 2018 data available at http://www.naftogaz.com/files/Zvity/Annual-Report-2018-engl.pdf

[6] https://naftogaz-europe.com/article/en/gasconsumptioninukraine20172018

[7] https://naftogaz-europe.com/article/en/naturalgastransitviaukraine2018

[8] https://interfax.com.ua/news/interview/635485.html

[9] In Naftogaz 2018 Annual Report p27, data available until November 2018 shows wholesale gas pricing reaching a peak of hryvnia 11/m³ in September 2018. If we assume the same evolution as the TTF (€28/MWh then compared with €12/MWh for 2020), then in 2020 the wholesale Ukrainian price should be around 200$/1,000cm.

[10] https://interfax.com.ua/news/interview/635485.html

[11] Proposed tariff in case of no transit http://www.nerc.gov.ua/data/filearch/Proekty/2019/pr_295/pr_295-2019.pdf

[12] http://www.nerc.gov.ua/data/filearch/postanovy/2019/p3013-d-2019.pdf

[13] http://www.naftogaz.com/www/3/nakweben.nsf/0/766A875E671BD2FBC2258391002E90F1?OpenDocument&year=2019&month=01&nt=News&

[14] We assumed a cheap wholesale price in Ukraine of $200/'000 m³ for the 2020-2021 period