Ukraine takes another step towards free gas market

Author: Aura Sabadus

2020/06/30

BUCHAREST (ICIS)--Over 8 billion cubic metres of natural gas will enter the free market from 1 July as Ukraine takes another step towards full liberalisation.

From Wednesday, the incumbent Naftogaz which had been required to sell volumes to retailers for onward supplies to households and district heaters will be able to sell the volumes freely at a price reflecting market fundamentals.

Speaking to ICIS, Aliona Osmolovska, Naftogaz’ director for government, regulatory and stakeholder affairs, said the state company was considering several options for selling natural gas.

SELLING OPTIONS

A first option would be to continue selling to retailers at market prices. Under existing arrangements, Naftogaz, was expected to buy locally produced volumes from its production subsidiaries such as Ukrgasvydobuvannya (UGV) and sell it on to retailers for onward supplies to households, religious establishments and district heaters.

Up until this year, Naftogaz was selling to retailers at regulated tariffs, which were historically below market levels.

From January 2020, the government changed the methodology for the calculation of regulated tariffs, allowing it to be pegged to an European hub-linked formula.

This means that Naftogaz may continue selling under this arrangement, even when the public service obligation (PSO) for households is removed from 1 July 2020.

A second option would be for Naftogaz to take part in a government tender for supplier of last resort.

Osmolovska said the government was in the process of organising such a tender shortly and noted that Naftogaz was keen to take part.

Some of the targeted areas would be the eastern Donetsk or Luhansk regions as well as large cities such as Kyiv or Odessa, which are not controlled by RGC, currently Ukraine’s most powerful gas retail group.

A third option for Naftogaz would be to sell some of the volumes on the exchange UEEX. Already in the first half of 2020, Naftogaz sold 0.25bcm of gas, more than throughout the whole of 2019, Osmolovksa said.

Finally, Naftogaz also has the option to sell on a spot and long-term bilateral basis.

EXPECTED CHANGES

Although the PSO will only be partially lifted from 1 July, with another 8bcm currently sold to district heaters being freed up in May 2021, the current phase is of significance to the Ukrainian reform process as a whole.

On the one hand, the removal of the PSO has been one of the key conditions imposed by the International Monetary Fund and the World Bank in their negotiations for financial support for Ukraine.

Ukraine started deregulating industrial and commercial tariffs when it pledged to reform the gas sector some five years ago. However, the removal of the PSO for households and district heaters had always been unpopular because politicians were concerned about losing electoral support if gas was sold at free market prices.

With the record drops in market prices recently, the removal of subsidies for households became easier to accept.

This means that from 1 July, three quarters of Ukraine’s gas market will be free.

Another spin-off of the partial removal of the PSO is the fact that more retailers could enter the market.

So far, the retail gas sector had been dominated by the RGC group, which controls some 70% of the market. Retail and distribution was formally unbundled in 2015, but critics say this has never happened in practice.

From 1 July, more retailers, including Naftogaz, could establish a presence, offering more competition and implicitly expectations of cheaper prices for end consumers.

Osmolovska said the regulator NERC as well as the competition authority should also be empowered to ensure that retail and distribution sectors are properly separated and that consumers should be offered a real chance to switch suppliers depending on their offers.

She also pointed out that given the current supply glut, sellers would be targeting a variety of buyers including gas retailers, large consumers as well as electricity retailers.

A third side effect of the removal of the PSO is an expected clampdown on the unauthorised off-take of natural gas.

Naftogaz had complained that under the previous PSO arrangements many retailers were off-taking volumes at below-market prices for supplies to households but some volumes were in fact diverted to higher-paying industrial consumers, effectively creating significant problems in the daily balancing market.

Furthermore, Naftogaz was also faced with mounting debt from district heaters which were receiving natural gas but often could not pay for it. The law did not allow suppliers to switch them off for failure of payment.

As volumes are now sold on the free market and price differences between various categories of consumers plugged, there are expectations that practices would improve so that the unauthorised off-take of gas would be reduced or eliminated and retailers would seek better ways to collect the money.

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