UKRAINE'S EFFICIENT GAS MARKET
At the Flame conference in Amsterdam, the Netherlands, Yuriy Vitrenko, Managing Director, Head of International Business at Naftogaz of Ukraine, said that Naftogaz's role is the creation of an efficient gas market in Ukraine. Other speakers conceded some progress, but pointed out more pressing problems.
For one, Mr. Vitrenko said that Ukraine is finally concentrating on real diversification, "something we've been talking about for 23 years."
He reported, "One year ago, we had roughly 5 bcm of interruptible capacities to get gas from the West to Ukraine. It's very unreliable because they were dependent on a number of technical and political factors."
In that one year, he explained, that capacity had been increased to 20 bcm, 10 bcm of which is a firm capacity irrespective of Russian gas flows. He said that Ukraine consumes 40-50 bcm of gas per year.
"Our total import needs are roughly 20-25 bcm, so currently we have reverse flow capacity that covers almost all our needs."
Still, he added that half are interruptible capacities. Meanwhile, he expressed Naftogaz's desire to buy more gas in summer to fill Ukraine's 30 bcm of storage capacity.
Negotiation with Gazprom, said Mr. Vitrenko, is the second area for Naftogaz, a "necessary activity." With the help of the European Commission, he recalled that Ukraine began the so-called trilateral negotiations that resulted in the Winter Package, which had ensured a smooth winter both for Ukraine and Europe. But, he added, the price for Russian gas was still much higher than that of Western markets.
He noted Ukraine's financial inefficiencies, but said there had been no problems and said that the country had been able to buy from reverse-flows.
"We saved more than $3 million – that's the price difference compared to the contract we signed in 2009 and the prices we paid."
Mr. Vitrenko pointed out the need for the creation of a national market as a sustainable solution for oil and gas prices in Ukraine, defining it a strategic priority. "We've worked together with the Energy Community secretariat to develop a new draft of the gas market law, a transposition of the Third Energy Package into Ukrainian legislation," he reported, adding that Naftogaz had helped push the law through the Ukrainian parliament, which recently adopted it.
"We are sometimes surprised it was passed, because it's really against the interests of some powerful oligarchs in Ukraine," he explained. "It's really about fighting corruption and the liberalization of the market, so we are very optimistic about Ukraine's future in regards to this law."
Intermediaries, he said, have also been removed from gas purchases and Ukraine can now deal with major European producers and traders.
In the past, according to Mr. Vitrenko, Naftogaz had been forced to sell gas at 15-20 times below the actual market price, so it could not afford to produce more.
"If this market reform is done right we can see some huge potential to increase production," he said, adding that Ukraine's reserve to production ration is 52 years, one of the highest in Europe.
Independents, he said, could increase their production by 25-30 bcm and Ukraine might even export 5 bcm by 2019.
Gazprom, said Mr. Vitrenko, has made it clear that gas volumes to Ukraine will not be delivered beyond 2019. "We think it's not critical, quite frankly. First of all, the European market is developing in the right direction with energy initiatives; the Ukrainian market will be a part of it and we're working hard to make it happen," he said.
According to him, there is sufficient infrastructure and regulation not to let Hungary, Poland, Serbia and others freeze in the winter.
Mr. Vitrenko alleged that Gazprom is engaged in illegal projects with Slovakia's Eustream, "effectively blocking all the gas flows on major pipelines between Ukraine and Slovakia."
He added that this is also an obstacle to energy security in the region, but that Ukraine had consulted the European Commission on the issue.
"Now, basically, it's clear that it's not compliant and we have to be cautious in dealing with that because there are some potential risks for the energy security of the region."
Meanwhile, he said that following proper actions by the government, Ukraine can expect significant increases in gas production.
But that sentiment was not necessarily shared by Philip Vorobyov, Commercial Executive, JKX Oil & Gas Plc, a small gas producer which was the first foreign investor in Ukraine's oil and gas industry.
Calling himself the "party pooper" in the room, Mr. Vorobyov said last year had been JKX's most difficult one in Ukraine, despite the fact that private gas production had increased in the country in 2014 by 30%. "If you had gas, you could actually sell it."
Still, of a high increase in taxation, he commented, "I'm not sure that these pieces of legislation and those to be passed later this year are enough to raise gas production in Ukraine. It's not a great way to attract investment."
Mr. Vorobyov admitted the potential is huge: "If everything's done right, Ukraine could actually be exporting gas within the next 10 years – this is not a terrible exaggeration of the reality of the potential."
Still, he contended that there needs to be more focus in Ukraine on upstream reform.
"More challenging will be to change the prevailing attitude of the country, in the government, towards the industry and how it's viewed in general," he explained, offering that measures taken by the government last year should be repealed.
The government, he said, had also created a monopoly that sold gas to industrial consumers in Ukraine.
"At a time when the country needs gas," he said, "it is being imported and is staying in the ground, because it's impossible to sell the gas when the taxes are very high."
He reported that many producers like JKX are cancelling investment programs and making layoffs; meanwhile, he added, Shell and Chevron had wrapped up their projects in Ukraine.
Of the government's attitude, he explained, "They still view the industry as a cash cow, where a lot of the gas went for free or for very little to the population; now it is viewed as an easy way to put money into the budget, which is strained.
"The cow doesn't have a whole lot of milk left," he continued. "Yes, Ukraine has tremendous resources, but that's what it is: resources."
Investment is needed, he explained, to take on the technical and financial risks of exploration. This calls for a flexible and stable tax regime, according to Mr. Vorobyov.
Addressing the perception that gas in Ukraine is a "dirty businesss," he offered that the government should not shoot down the entire industry, but just deal with the individuals in the sector they consider unsavory.
Addressing a query regarding the success of the Winter Package from Russia and Gazprom, Mr. Vitrenko said, "We do hope that it's a sign of them not treating gas as a political instrument but behaving rationally and from a pure commercial point of view. It will be better for the gas industry as a whole."
Regarding investments in Ukraine, Paul Shapiro, Senior Banker, European Bank for Reconstruction and Development (EBRD) explained that Ukraine had pretended to cooperate on reform and the bank had pretended to give the country money, but by the end of 2014 there had been the signing of a real agreement which included a very long list of conditionalities, like the independence of the regulator and Third Energy Package compliance.
He said, "This will mean that this is possible in the future for this to be a 2-way street, where it also makes it easy for Western gas to enter Ukraine, not just as reverse flow for their own needs, but to reach customers."
EBRD, said Mr. Shapiro, had made Ukraine a loan for the country's gas transit system for specific stations.
Showing a laundry list of remaining challenges, he offered: "We are aware that the situation is extremely precarious: there's a lot of infighting, oligarchs that are entrenched or out and causing trouble.
"It's important for Russia, for Europe to not let this fail," said Mr. Shapiro, who admitted that the answer ultimately has to come from inside Ukraine.
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