Is Ukraine really committed to EU-style gas reform?

DISCLAIMER: All opinions in this column reflect the views of the author(s), not of EURACTIV Media network.

Emergency training near gas compressor station near western Ukrainian urban settlement of Volovets [Roman Pilipey/EPA]

Ukraine has promised to reform its gas sector. But do the government, or the national gas company, really mean it, questions Danila Bochkarev.

Danila Bochkarev is a Senior Fellow at the EastWest Institute. The opinions expressed in this article solely reflect the views of the author, not of his organisation

As a party to the Energy Community, Ukraine committed to transpose the 3rd Energy Package into its legislation and unbundle its national gas company Naftogaz, and, in July 2016, the Ukrainian government approved the Resolution ‘On unbundling of operations for transportation and storage (injection, withdrawal) of natural gas’.

However, the Cabinet of Ministers and Naftogaz have disagreed on the unbundling process from the very beginning. The government clearly preferred the “ownership unbundling model” with the ownership of Ukraine’s gas infrastructure being transferred to a new Transmission System Operator (known as “The Main Gas Pipelines of Ukraine” or “MGU”). Naftogaz, on the contrary, is eager to proceed with the “independent system operator” (ISO) model.

This has prompted some analysts to accuse the government of incompetence. Olexandr Kharchenko, in his publication for the Atlantic Council blog, said: “The officials who should solve the issue, namely Deputy Prime Minister Volodymyr Kistion and Energy Minister Ihor Nasalik, aren’t up to the task. The only team in Ukraine that has proven its ability to deal with thorny issues on such a large-scale—it provided Ukraine with gas in 2014-15 and won the Stockholm arbitration litigation against Gazprom—is the management team of the state-run enterprise Naftogaz.  This “competition” has obviously led to some delays with the reform of the national energy sector.

The lack of progress unbundling natural gas infrastructure and the politicisation of the reform process was criticised by Ukraine’s key partners – the EU and the Energy Community.  In October 2017, Hugues Mingarelli, head of the EU delegation to Ukraine, stressed that “Ukraine’s prospects of maintaining its role as a transit country for Russian gas hinges on its ability to unbundle the TSO from Naftogaz – and not on fighting competition from planned pipeline routes, such as Nord Stream 2, which would create alternative transit routes for Gazprom.”

At the FLAME gas conference in May 2019, Energy Community Secretariat Director Janez Kopac said that Naftogaz was being slow to finalize the unbundling process and that the government in Ukraine “talks a lot about unbundling but is doing nothing”.  Kopac added there was “still time” to reach a deal before end-2019, but that there needed to be the “political will” on the Ukrainian side.

What is the reasoning behind Naftogaz’s preference for the ISO model?

Firstly, it wants to prevent lower transit tariffs. In an interview to Glavkom, Naftogaz’s Executive Director said that the ISO model will help “to keep the GTS on the company’s balance and incorporate the infrastructure amortization and depreciation into Naftogaz expenses. Otherwise, continues Vitrenko, our expenses will be found lower and the transit rate will be even lower that the current tariff paid by Gazprom.”

It also wants to strengthen the company’s position with the past and running arbitration claims against Gazprom. The (Stockholm) Arbitration Tribunal “may find that Gazprom overpaid for transit, and we will be forced to repay $3 billion to Gazprom…  so far, we incorporate GTS amortization and depreciation into our expenses and are therefore able to claim that our expenses are higher than the rate, thereby justifying our demand for Gazprom to pay an additional $11-14 billion”.

Naftogaz adds that “ownership unbundling” will require the Ukrainian Parliament “allowing privatization” and the Transmission System Operator oversight in the ISO model — lobbied by Naftogaz – excludes the government, thus reducing the risk of “potential political interference”.

The last point immediately contradicts the statement made by the MGU. The TSO welcomed the decision of the Government of Ukraine to proceed with the ownership unbundling model. This decision “does not require additional changes to the existing laws, for example the adoption of the Law on concession that is needed for implementation of ISO model,” – stressed the MGU press release.  Furthermore, some independent observers doubt the motives of Naftogaz’s management. Critics say Naftogaz may be reluctant to “relinquish control over the lucrative TSO business, which accounts for around $2bn (€1.7bn) of the company’s profits.” Is that really in the spirit of unbundling?

The relations between Naftogaz and Ukrtransgaz also raise more questions than answers.

First of all, the shipping tariff paid by Naftogaz to its’ transportation subsidiary was significantly lower than the transit fees received by Naftogaz from Gazprom. In an interview with the Ukrainian daily Ekonomicheskaya Pravda published in February 2017 Igor Prokopiv, head of Ukrtransgaz between July 2014 and March 2017 confirmed that out of 750-800 UAH/1000 cm Naftogaz receives from Gazprom, Ukrtransgaz gets only 237 UAH/1000 cm. These numbers were confirmed in a recent interview with the executive director of Naftogaz Yuriy Vitrenko.

Secondly, the Ukrainian daily Ekonomicheskaya Pravda reported in May  that the Anti-Monopoly Committee of Ukraine had launched a case against Naftogaz and Ukrtransgaz claiming the average price of natural gas sold by Naftogaz to Ukrtransgaz in 2017-2018 was above the price set (by Naftogaz) for the industrial consumers and also higher than the price of gas at the “Ukrainian Energy Stock Exchange”.

Seen from abroad, the unbundling process looks very politicised and highjacked by narrow-defined commercial and political interests. The explanations provided by Naftogaz make external observers think that the company is making  excuses to keep hold of the pipeline because it is a source of significant profit.

Naftogaz is also sending mixed signals: is the company really interested in safeguarding Europe’s supply security – or is this about money? And if it is about income for Ukraine – is it simply about whose hands this money goes through? This is hardly market-based behaviour and it threatens the continuation of a stable and reliable natural gas transit via Ukraine.

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