About key steps made towards sustainable development of the Ukrainian gas market and household gas supply

We conclude this week with a revolutionary announcement regarding impactful new reforms in the gas market.

From now on, almost the entire segment of household gas supply will operate as a part of the Balancing Group created by Naftogaz as a national company.

This has been a difficult but important step in the right direction towards sustainable development of the gas market.

This change will be critical to the security of household gas supply, with no direct government regulation such as PSO (public service obligations). It will also shut down opportunities for free arbitration (risk-free profits) in the market.

Without overstating it this breaks new ground on after:

  • planned system of the Soviet Union;
  •  post-Soviet state regulation;
  • direct state regulation since 2015, dubbed by the European term “PSO” (it’s like chicory coffee, i.e. without the real coffee);
  • monopolistic “liberal” market until the first price hike;
  •  direct state-imposed price cap;
  • and the framework of contracts, first of all with Firtash’s company, entered into during Kobolyev’s management of Naftogaz.

I would like to know acknowledge all of the people who worked immensely and had sleepless nights in order to make this mini-revolution possible.

I would like to express my gratitude to the teams of Naftogaz Trading under the leadership of Iryna Zhuravliova and Slava Romanyak; Vitaliy Volynets for his expert support; Roman Chumak for assistance in managing the process; Vladyslav Volovyk and the entire legal team of Naftogaz; Svitlana Ivanchuk for her analytical work; and Pavlo Kondyk for overseeing the organization of this project.

Many thanks to the team Gas TSO of Ukraine led by Sergiy Makogon; Nataliya Boyko for her professionalism, energy, positivity, and interaction with the Cabinet;  the entire Cabinet of Ministers of Ukraine and the Prime Minister Denys Shmyhal; the teams of the Ministry of Economy of Ukraine and the Ministry of Energy of Ukraine; the regulators and Valeriy Tarasyuk.

The structural changes we have made have demanded considerable work under significant time pressure. We received all the necessary approvals on the last day, although we should have had at least two weeks to manage the large amount of technical work. Many, including the gas sector behemoths, did not believe we would make this mini-revolution happen, especially in this time frame.

Some background on the problem.

First, a brief digression. Last winter, a crisis broke out due to the rapid rise in gas prices and distribution tariffs. At the same time, the monopolists, Firtash’s companies, in particular, were selling gas 30-40% more expensive than their competitors, and the consumers could not promptly opt out of their services.

At that time, I became acting Minister of Energy and suggested the following solutions:

  • switch to annual price;
  • gas offer by Naftogaz at a fair market price on the wholesale market;
  • plus, regulation of the monopolists’ margin by the AMCU.

I.e., an all-out market-based (not to be confused with the bazaar) European approach.

Instead, the then CEO of Naftogaz suggested an administrative price cap for two months, as if it was a more market-based mechanism, and was saying that the price would go down in spring. His words were taken heed of, and, frankly, it went sideways for everyone. As the IMF was against the price cap, the regional gas companies took the gas that they were still unable to pay for, and the prices spiked even more in the spring.

Back then, at least I managed to get across the idea of ​​the need to switch to annual price for the household “by default”.

Then, the previous management signed contracts with Firtash’s trader for a huge amount of gas at a yearly fixed price (UAH 7.42). In public, they maintained that the Government had been involved in this decision.

Let’s imagine that they were receiving political directives to secure annual gas prices for the needs of the household at an “affordable” price.

If you look at their rhetoric after they have been dismissed, they should have resented the very assumption that the President’s Office they allegedly hated was giving them instructions and protested that the state wanted to set prices instead of following the market. But nope, they’ve started personal negotiations with the odious oligarch Firtash and signed the contract. As well as assigning contracts with other suppliers.

What is the problem with the contracts signed by my predecessors?

They have no barriers against reselling the gas purported for the households to the industry. That is, it is possible to buy from Naftogaz at 7.4, and to sell at 30, with limited financial risks.

Naftogaz had different prices for different counterparties, even if the contracts were signed on the same day and for the same period of supply. The difference in price was justified by counterparties allegedly addressing the company at different times. However, for some reason this is not documented anywhere. It is clear that a simple address has no legal consequences. At the same time, market participants were in unequal conditions in terms of being informed.    

In some communities, the situation created grounds for social unrest, as they were forced to pay significantly more simply because the regional supplier allegedly addressed Naftogaz later.

Security of supply. The volume fixed in advance meant that in some periods suppliers received more gas than the households consumed. Then they could resell some of the gas, earning excess profits and at the same time distorting pricing in the market of industrial consumers with the “shady” volumes. In this case, there may not be enough gas in some periods. The naïve or inexperienced may believe that in this situation, counterparties will buy gas on the market at the spot price (UAH 30) and supply the households at the annual one (UAH 8). But in reality, they will take gas from the TSO and then go to court.  Consumers can be switched to the SLR (supplier of last resort), which is Naftogaz according to the results of a “tender” conducted by the predecessors. For consumers, this means at least twice the price. You can predict the social and political consequences yourself. 

The SLR status for Naftogaz also turns into unacceptable conditions: consumers are transferred, but their personal data is required for billing – not mandatory. That is, Naftogaz could irritate everyone with higher prices and simultaneously remain unable to receive funds.  

Predecessors then said that allegedly the sanctions introduced by the National Security and Defense Council against Firtash allowed them to terminate their contracts without any problems. This is not true, because the sanctions were introduced against Firtash personally, not against his companies. At least, according to a conclusion of lawyers hired by the predecessors themselves. Accordingly, termination of these contracts carries the risk of penalties, as well as the risk of non-payments, as the contracts allowed a payment delay. In other words, the predecessors say: “you terminate the contracts we signed because we wrote that they can be terminated in FB. Yet our lawyers will write you that this cannot be implemented without losses for the company (and criminal cases for managers)”. No, thank you:)

 What has changed?

Advantages of the new approach – of the Balancing Group:

  • It is a European market instrument per se;
  • Security of supply – enough gas for all households;
  • Resale impossibility. Although, a risk of “deadheads”, problems with accruals (allocations) due to lack of online meters, dishonesty of both consumers and regional gas companies remains. These problems are not new ones and should now be addressed as one of the priorities.
  • Equal conditions. Fair competition. Suppliers’ margins being transparent for antimonopoly regulation, for communities and politicians.

What is important to understand:

  • The price could not be increased, because then the counterparties would not switch from the old contracts with the old annual price. The price has become the same for everyone. It is at the price level for Firtash’s companies – UAH 7.42.
  • The new contracts are valid until May. According to the plan, then everyone will switch to exchange trading. I will note that this requires centralized clearing and liquidity of annual contracts, without which such a transition will only be an imitation. Also, we need to ensure full data integration and digitalization of processes in the “bill – targeted aid – consumer solvency” triangle.

There are also several other game-changing initiatives that we are working on:

  • monthly bills based on annual profile recalculated once a year;
  • switch to one utility bill;
  • a single distribution tariff for consumers with subsequent redistribution between operators;
  • incentive tariffs that reflect only the costs of the “efficient operator”;
  • payment for the use of networks without tariff increases;
  • allocation agreements;
  • the principle of balancing neutrality;
  • and most importantly, incentives and opportunities to improve energy efficiency.

I will discuss our approach to problems relating to gas for state-paid employees and district heating in future posts.

It is impossible to fix everything at once, it takes a little more time for miracles 🙂 Just this week we have returned to normal work. I will write about this at a later date. It is Friday now, my family and I are sitting together, our youngest daughter is in front of us watching some skimble-skamble on an iPad. Everything will be fine.