НАК „НАФТОГАЗ УКРАЇНИ“. Річний звіт англійською (2018 рік) - 2

MARKET AND REFORMS

2018

ANNUAL REPORT 2018

EUGAL

A permit was granted for construction and operation of a planned
pipeline in the territorial waters of Germany, as well as on the
coast in Lubmin near Greifswald

A permit for the construction and operation of the pipeline system
Nord Stream 2 in the German exclusive economic zone (EEZ) was received

The second permit required for the construction and operation of the Nord
Stream 2 gas pipeline in the Finnish Exclusive Economic Zone (EEZ) was
obtained and the procedure for obtaining permits in Finland was completed

Works on deep-water laying of the first string of
the TurkStream gas pipeline has been completed

Works on the construction of the coastal part of
the TurkStream gas pipeline began

Nord Stream 2 AG launched marine pre-construction works for further
pipe laying in Greifswald Bay

The Swedish Government granted Nord Stream 2 AG a permit for laying a gas
pipeline on the continental shelf within the Swedish economic zone of the
Baltic Sea

Nord Stream 2 AG decided to lay a pipeline
outside Danish waters and applied for
construction along with an Environmental
Impact Assessment

Nord Stream 2 AG began laying pipes in the
Gulf of Finland and the construction of the
gas pipeline began

More than 200 km of pipeline has been laid in the Baltic Sea

The marine section of the TurkStream gas pipeline is
completed. According to Alexey Miller, the gas
pipeline will be commissioned at the end of 2019

Nord Stream 2 AG started
laying pipes in the territorial
waters of Germany

Mecklenburg-Western Pomerania
became the third federal unit that
provided everything that was
needed to approve the EUGAL pipeline

Saxon permit authorities issued a
decision to approve project design
for the northern part of the pipeline

All necessary permits for laying
pipelines in the Brandenburg region
were obtained

Permission for the construction
of a 114-kilometer section of the
pipeline in Russian territorial
waters was obtained

January

March

April

May

June

July

August

September

October

November

Nord Stream 2

TURKISH STREAM

Progress in construction of bypass pipelines for Russian gas supply to the EU in 2018

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MARKET AND REFORMS

2018

ANNUAL REPORT 2018

In view of the termination of the gas

transit contract between Naftogaz and

Gazprom in 2019, several rounds of trilat-

eral negotiations and expert consultations

between the Ukrainian and Russian sides

with the participation of the EU took place

in 2018. At the time of writing this report,

no agreement has been reached as to the

terms of the transit contract after 2019.

The

Ukrainian side is open to discussing

all possible proposals for the transit

of Russian gas in future, given

that the new contract should be based on

the norms of European law.

At present, the Ukrainian side is in a

completely different situation to that

of 2009. The national legislation has

changed, the new Law of Ukraine "On the

Natural Gas Market" has been adopted,

the Association Agreement between

Ukraine and the EU has been concluded,

secondary legislation has been developed

based on European norms, and the

extension of the current gas transit

contract is legally impossible. Therefore,

future relations between the Ukrainian

and Russian sides in negotiating gas

transit agreements should be based

solely on European rules and regulations.

This will ensure transparency, stability

and predictability for each of the parties.

In addition, future agreements with

Gazprom should not conflict with the

Stockholm arbitration awards rendered

in 2017-2018, which means that the

Russian party shall fulfill its obligations

imposed by the arbitration.

To meet the expectations embedded

in the Framework for Gas Production

Increase in 2016-2020, each year,

Naftogaz group needed 10 new

exploration permits to be covered with

seismic, studied, assess and select the

most promising for further prospects

to be tested by up to 13 exploration

well each year. Then, Naftogaz group

would have ensured a sufficient

increase in recoverable reserves and

their further development, drilling

more than 10 wells in each new field.

Deliberate blocking of new licenses

by local authorities increases the risk

of a 5.5 bсm underproduction by

Ukrgasvydobuvannya by the end of

2020.

In 2018, 20.95 bcm of natural gas was

produced in Ukraine, which is 450 mcm

more than in the previous year.

A 2.2% growth was due to:

- a 245 mcm increase in production by

Ukrgasvydobuvannya, a key production

company of Naftogaz group;

- a 233 mcm increase by private

producers.

The year 2018 was marked by an increase

in Ukrgasvydobuvannya’s operating

performance. The company reached a

nine-year record in daily production (43

mcm per day) and a 25-year record in

annual production (15.50 bcm).

Gas production in Ukraine

oduction, bc

14.5

13.5

12.6

11.6

10.7

0.7

1.0

1.4

1.5

0.5

0.7

0.9

1.1

1.7

2.3

1.2

2.0

3.0

1.0

1.7

2.8

14.6

15.3

16.5

18.3

20.1

Done

0.3

0.6

0.4

1 bcm in 2018

and 5.5 bcm till the end of 2020

Impossible due to the lack

of licenses for new fields

0.4

2015

2016

2017

2018

2019

2020

0.1

0.3

Campaign for exploration
and development of new fields

Drilling program
for existing fields

Production enhancement
program

Pressure optimization
program

Wells recovery
program

Basic production

17.3

9.7

The framework for gas production increase under the shortage of new fields

During the year, Ukrgasvydobuvannya

successfully completed a program

to offset the natural decline in gas

production of about 1 bcm per year

through the implementation of

numerous technological initiatives.

Ukrgasvydobuvannya has procured

575 units of new equipment, thus

upgrading 12% of its own equipment

fleet. In 2018, 97 wells were drilled, and

64 new wells were put into operation.

Ukrgasvydobuvannya managed to

maintain gas production and slightly

increase daily and annual output

from the existing portfolio of deposits

through the comprehensive upgrade

of its technical capacity, involvement

of external drill contractors and

technological fleets for the rehabilitation

of wells (well workover operations),

and enhancement of production (coiled

tubing and fracturing). The company

also concluded memorandums and

multiservice contracts with leading

service companies such as Schlumberger,

Halliburton, Weatherford and Baker

Hughes. Partnership with these

companies provides access to cutting-

edge technological solutions, which

will open up a new scope of works at

wells that have been idle for years as

plugged and abandoned or killed wells

and deposits that were classified as

off-balance or were ignored because

previously their development had been

assessed as unfeasible.

2015

2016

2017

2018

3.9

19.9

20.1

20.5

21.0

1.5

14.5

14.6

1.3

4.2

15.3

4.1

1.1

15.5

1.1

4.4

+1.0%

-3.0%

+2.3%

+2.2%

Ukrgasvydobuvannya

Ukrnafta

Private companies

Change in gas production, year-to-year, %

Gas production structure in Ukraine

The program exploration and

development of new fields has been

put at risk, as it takes 3-6 years to

start commercial development after

obtaining a license. In 2016-2017,

Ukrgasvydobuvannya applied for new

exploration licenses or extend the

existing ones more than 145 times

and received 135 refusals. As a result,

Ukrgasvydobuvannya does not have a

sufficient number of new fields to swiftly

increase gas production.

In 2018, the government announced

an unprecedented number of new

exploration permits to be tendered

in 2019 through ProZorro electronic

system for transparent bidding, as

well as the launch of production-

sharing agreements (PSAs). For the

first time in the history of independent

Ukraine, the government initiated a

transparent process to engage investors

in exploration for new oil and gas fields,

using best international practices. The

State Service of Geology and Subsoil of

Ukraine has prepared more than 30 oil

and gas exploration permits with a total

area of 4.63 thousand sq. km for online

bidding procedures (ProZorro) to be

held in 2019. The government decided

on bidding terms and conditions for

12 blocks with a total area of almost

20 thousand sq. km to be offered

for production-sharing agreements

(PSAs).

Naftogaz group consistently transforms

and improves its gas production

companies, strengthening their technical

units, which is demonstrated by the

implementation of programs that do not

depend on external approvals. Achieving

energy independence in the conditions

when the reserves and resources of the

most promising southern oil and gas

province of Ukraine in the Black Sea

and Azov Sea cannot be used, requires

synergy between the state authorities

on the one hand, and Naftogaz group

and private extractive companies on

the other. The extractive industry is one

of the most sluggish, so initiatives and

transformations introduced last year will

yield results in the form of produced

cubic meters of natural gas only in a

few years. Naftogaz group is optimistic

about the prospects for the effective

development of Ukraine's hydrocarbon

resources and is ready to work together

with all stakeholders: state agencies,

independent E&P companies and local

municipalities of gas-rich regions.

Source: Ukrgasvydobuvannya

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MARKET AND REFORMS

2018

ANNUAL REPORT 2018

32.3

Gas sources

20.9

Production

10.6

Imports

7.0

Naftogaz

15.5

Ukrgasvydobuvannya

4.4

Other

1.9

Ukrtransgaz

0.5

Public sector

and religious organizations

2.3**

Heat producers for public

sector, religious organizations,
industrial sector

1.0*

Gas distribution operations

1.4

Ukrgasvydobuvannya

0.3

Ukrnafta

0.1

Other

1.1

Ukrnafta

-0.8

UGS

32.3

Gas

usage

27.6

Gas consumed

by users

15.4

Households

9.4

Industrial consumers

10.6

Households

(direct use)

4.8***

Heat producers for

households

3.6

Private importers

GAS BALANCE

* including unauthorized gas withdrawals (~0.9 bcm)
** including unauthorized gas withdrawals (~0.6 bcm)
*** Source: NJSC Naftogaz of Ukraine Gas Sales Department

2018, bcm

Own needs

and technological

losses

4.7

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MARKET AND REFORMS

2018

ANNUAL REPORT 2018

In 2018, Ukraine imported gas

exclusively from the European gas

market. Compared to 2017, gas imports

decreased by 25%, from 14.1 bcm to

10.6 bcm. At the same time, the share

of Naftogaz in the total gas imports to

Ukraine increased to 66% in 2018 from

61% in 2017.

In 2018, Naftogaz purchased natural gas

from 18 European suppliers (in 2017 –

13). None of these companies supplied

more than 30% of the volume imported

by Naftogaz.

65 companies imported gas to Ukraine

in 2018 (67 companies in 2017). In the

second and third quarters of 2018,

private importers significantly reduced

the volume of imports of natural gas

compared to Naftogaz's imports

In 2018, the Slovak direction remained

the major gas supply route to Ukraine

while the share of supplies through

Hungary increased for the second

consecutive year, from 9% in 2016 to 32%

in 2018.

Although Ukraine's annual need in gas

imports is fully covered by the available

reverse capacities, gas supplies to

Ukraine from neighbouring countries

are still not in line with European rules:

relations with operators of the adjacent

gas system and Gazprom are not in line

with European and Ukrainian energy

legislation. For instance, the EU's

standard interconnection agreements

have not been fully applied.

Gas imports to Ukraine

Gas consumption

m/year

8.2

8.7

7.0

2.9

5.4

3.6

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2016

2017

2018

Other importers (left axis)

Naftogaz (left axis)

Naftogaz’s share in total gas imports (right axis)

Gas imports to Ukraine in 2016-2018

Naftogaz imports
Other companies

January

February

Mar

April

June

July

August

Sep

tember

Oct

ober

vember

December

200

400

600

800

1 000

1 200

1 400

Distribution of gas imports in 2018

Ukraine’s total gas consumption in 2018

increased by 1.3% (from 31.9 to 32.3 bcm)

compared to 2017.

Households used 10.6 bcm of gas, which

is 0.6 bcm less than in 2017 (-5.4%) due to

the following factors:

• the number of subsidy recipients more

than halved in autumn and winter;

• social consumption standards for subsidy

recipients were cut by nearly 10% since

1 May 2018;

• the end user gas price grew by 22.9%

since 1 November 2018

Meanwhile, gas consumption by district

heating companies for household needs

amounted to 4.8 bcm in 2018, which is

0.2 bcm more than in 2017 (+4.3%) due to

the following factors:

• lower temperature in 2018 compared to

2017;

• households are largely not able to reg-

ulate the use of heat in their homes (or

such regulation in individual apartments

has little effect on the apartment block

due to redistribution of heat among the

rest of the apartments). This is why the

said gas-saving factors by households are

insignificant when it comes to gas use for

household heating.

Heat generation for public institutions and

the industrial sector accounted for 2.3 bcm,

which is 0.4 bcm more than in 2017. Higher

gas consumption by this category was not

only due to weather conditions but also

due to the price factor. This customer cate-

gory is subject to the PSO Resolution, which

means buying gas at regulated prices. In

2017, gas prices for heat producers (to

cover the needs of commercial customers)

were 1.6 times higher than the prices for

household needs, but since November

2018, gas prices for heat production equal-

ized for all customers. This was due to a

21% decrease in the wholesale gas price

for heat producers to cover the needs

of commercial customers. Other market

segments increased their gas consumption

by 0.4 bcm from 14.2 bcm to 14.6 bcm.

Against the background of economic recov-

ery, the industrial sector posted a 0.2 bcm

growth, having used 9.4 bcm.

http://www.naftogaz.com/files/Information/Dynamika-cina-2014-2018-Naselennya.pdf

From Poland (Hermanowice)

From Hungary (Beregdaroc)

From Slovakia (Budince)

82%

20%

71%

32%

61%

2016

2017
2018

Distribution of gas imports by entry point in 2016-2018

http://www.nerc.gov.ua/data/filearch/monitoryng/gas/2018/monitoryng_gaz_II-2018.pdf

Debts for unauthorized withdrawal of

natural gas continued to accumulate in

2018. In 2018, the debt for unauthorized

withdrawal of natural gas grew by

UAH 14 billion and amounted to

UAH 34 billion as of the end of the year.

The volume of gas used for balancing

decreased to 1.5 bcm in 2018 from 1.8 bcm

in the previous year, which was due to the

extension of the PSO Resolution to all heat

producers starting from April 2017 and

alleviated requirements to heat producers

when concluding supply agreements with

Naftogaz.

Under the current PSO regime, the dif-

ference between the price for industrial

customers and the regulated price contin-

ued to be tangible in 2018. As of the be-

ginning of the heating season 2018/2019,

this difference in prices reached a record

130%, the highest since 2017.

UAH, V

AT exc

l./ t

2 000

4 000

6 000

8 000

10 000

12 000

January 2015

Mar

ch 2015

y 2015

July 2015

Sep

tember 2015

vember 2015

January 2016

Mar

ch 2016

y 2016

July 2016

Sep

tember 2016

vember 2016

January 2017

Mar

ch 2017

y 2017

July 2017

Sep

tember 2017

vember 2017

January 2018

Mar

ch 2018

y 2018

July 2018

Sep

tember 2018

vember 2018

Households

Industrial sector

Naftogaz wholesale prices since January 2015

Source: Ukrtransgaz

Source: Ukrtransgaz, Naftogaz calculations

2018
2017

11.2

4.6

1.9

0.5

9.3

4.4

10.6

4.8

2.3

0.5

9.4

4.7

Households (direct use)

Heat producers for households***

Heat producers

for public sector, religious

organizations and industrial sector**

Public sector and religious organizations

Industrial sector

Operating needs (gas production,

transmission and distribution),

LPG production*

* including unauthorized gas withdrawals (~0.9 bcm)

** including unauthorized gas withdrawals (~0.6 bcm)

*** Source: Naftogaz calculations

Ukraine's gas consumption 2017-2018, bcm

Source: Ukrtransgaz, Naftogaz calculations

Source: Naftogaz

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MARKET AND REFORMS

2018

ANNUAL REPORT 2018

20%

40%

60%

80%

100%

120%

140%

January 2017

February 2017

Mar

ch 2017

April 2017

y 2017

June 2017

July 2017

August 2017

Sep

tember 2017

Oct

ober 2017

vember 2017

December 2017

January 2018

February 2018

Mar

ch 2018

April 2018

y 2018

June 2018

July 2018

August 2018

Sep

tember 2018

Oct

ober 2018

vember 2018

December 2018

Change in the difference between market and regulated gas prices, %

In 2018, the Ukrainian government

extended the terms of the PSO

several times. The latest decision of

the government, as of the time of

preparation of this report, enshrined

in the Resolution of the Cabinet of

Ministers of Ukraine dated 19 October

2018 (#867) provided for the extension

of the PSO until 30 April 2020

. After

long negotiations with the IMF, the

government made a compromise and

increased the price of natural gas for

household consumers. Meanwhile, even

with the decrease in the market price

at the end of the year, the difference

between market and regulated price as

of December 2018 was about 50%.

In 2018, hidden subsidies (the difference

between market and regulated prices)

accounted for 6% of state budget

revenues. Such hidden subsidies

lead to the following negative

consequences:

1. The seller’s proceeds are lower than

they are supposed to be (meaning

financial losses).

2. Encouraging inefficient consumption of

the subsidized product: the lower the

price, the more the consumption.

3. Poor people get less benefit from

hidden subsidies than those who are

richer and consume more.

4. Higher decline in production, since

lower the prices usually contribute

to lower output.

5. If hidden subsidies are provided only

to certain categories of buyers on the

market, it stimulates speculation and

corruption. Certain buyers purchasing

at a price reduced in an administrative

way will try to resell it at the market

price. Administrative restrictions on

these black market transactions will

lead to more scheming in order to

bypass restrictions.

According to international experts,

Ukraine traditionally relied on hidden

subsidies for gas, although it would be

worthwhile to create conditions for the

growth of wages and pensions, which

would allow customers to pay market

prices.

The gas distribution segment is the "last

mile," the interface with the end user.

Therefore, the operation of this segment

under market rules is important for the

development of an efficient market. The

publication of the Council of European

Regulators for Energy

identified some

characteristics of a well-functioning

retail gas market. From the supply side,

there should be a low concentration of

market power of any market participant,

which allows consumers to benefit

from competition and innovations. In

addition, entry barriers should be as

low as possible, allowing new vendors

to enter the market. Finally, there

should be a close connection between

wholesale and retail prices. This

includes transparent pricing for gas as a

commodity, giving market participants

input in setting retail gas prices. As for

demand, it is important that consumers

have access to information about

offers from different suppliers and the

supplier changing procedure. Currently,

Ukraine continues fundamental reforms

of its gas market. Many of major

disadvantages of the previous market

model have been completely or almost

fully eliminated, but a number of

problems remain unresolved. The key

remaining problems include lack

of competition in retail, accumulation

of debt for unauthorized offtake,

and administrative regulation of gas

prices.

https://zakon.rada.gov.ua/laws/show/867-2018-%D0%BF#n91

https://biz.nv.ua/ukr/naftogaz-protiv-gazproma/shcho-take-prihovani-subsidiji-i-chomu-ce-nebezpechno-dlya-derzhavi-50008684.html

Noorlander, M. (February 2016). What should a well-functioning retail energy market look like? The Council of European Regulators of Energy, CEER.

Source: Naftogaz calculations

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MARKET AND REFORMS

ANNUAL REPORT 2018

2018

GLOBAL OIL MARKET

In 2018, like in previous periods,

political factors played one of the key

roles in shaping prices. In mid-April,

the president of the United States

voiced criticism towards OPEC – he

accused the organization of artificially

inflated oil prices, calling such actions

unacceptable

. The statement concerned

the deal between members of the

Organization of Petroleum Exporting

Countries (OPEC) and other non-member

states, including Russia, with regard to

the curtail oil production. The deal was

reached at the end of 2016 and were

repeatedly extended. Then on 8 May

2018, the United States announced their

withdrawal from the nuclear agreement

with Iran and their readiness to impose

sanctions on the country. It was also

claimed that the United States would

resume economic sanctions against Iran,

which were relieved under the terms

of the agreement, and would introduce

new restrictions that would come into

force in 90 and 180 days. The commodity

market responded to such events by the

growth of oil quotations to the level of

November 2014, and subsequently for

several months in view of uncertainty as

to the possible effect of the imposition

of sanctions, prices remained at a rather

high level, in the range USD 72 to 80 per

barrel.

Existing expectations that the world

economy could slow down and,

consequently, lead to a possible reduction

in demand for oil in the future periods

coincided with the decision of OPEC

countries in June 2018 to increase

production by 1 million barrels per day.

This led to a minor decrease in prices

in the beginning of the second half of

2018 to USD 65-67 per barrel. However,

in the autumn, the market was rather

uncertain about the assessment of the

real economic consequences of the US

withdrawal from the nuclear agreement

and the possible reduction of supply

on the market due to the imposition of

sanctions on Iran, including in the energy

sector. These factors contributed to a

gradual increase in prices to USD 85 per

barrel in November 2018.

At the end of 2018, the price of oil

was formed under the influence of

a new round of trade wars between

China and the United States

which caused, among other things,

negative expectations regarding the

transformation of the conflict into a

global trade war and further downturn

of the global economy

. In addition

to the trade conflict, an increase in

interest rates in developing countries

and the deterioration of economic

growth in the EU led to a decline in IMF

forecasts for global economic growth in

2018 and 2019 by 0.2%. The difficulties

faced by the US in adopting a budget

added to fears of recession. All this

meant that demand for oil could drop

significantly – and such expectations

led to a sharp drop in prices.

In addition, a significant gap between

supply and demand persisted for

several months. Relatively high

prices established back in May have

contributed to world growth of oil

production – from May to November

2018, this has grown by 2.5 million

barrels per day. Meanwhile, oil exports

from Iran began to decline during the

summer, indicating that pressure from

the United States and expectations of

possible sanctions in the energy sector

had an impact. However, the pace of

decline in production and export of

oil by Iran, which was expected as a

result of the introduction of sanctions,

appeared to be overestimated, and the

pace of decline in production appeared

to be slower. According to the OPEC

Secretariat, oil production in Iran in

2018 amounted to 3.56 million barrels

per day, compared to 3.8 million barrels

per day in 2017. The final negative

factor for prices was the granted waivers

for purchase of Iranian oil for eight

countries, which reduced the effect of

sanctions.

Unlike 2017, which had been successful

for European refineries due to high

margins and capacity utilization level,

the situation changed in 2018. The

relatively high oil prices in the first to

third quarter of 2018 led both to a

decrease in the consumption levels of

petroleum products, and to a decrease

in the profitability of European refineries

(which, as a rule, are not able to entirely

transfer the increase in raw material

prices into a comparative increase in

prices for petroleum products).

https://www.bloomberg.com/news/articles/2018-06-05/u-s-said-to-ask-opec-for-1-million-barrel-a-day-oil-output-hike

https://uk.reuters.com/article/uk-oil-prices-kemp/commentary-global-economic-slowdown-is-likely-and-necessary-later-in-2018-or-2019-idUKKBN1K815G

On September 17, the United States imposed duties on the largest portion of Chinese imports worth USD 200 billion a year. Soon China replied that they would impose import duties on US imports worth USD 60 billion a

year.

In January 2019, China reported its largest monthly drop in exports over two years, which led to the collapse of Asian stocks and subsequently European stocks. Exports from China dropped sharply by 4.4% in December

compared to the same month in a previous year.

D/ barr

.01

.02

.03

.04

.05

.06

.07

.08

11.

.09

.10

.11

.12

Development of Brent oil spot prices in 2018

European oil refining market

million barr

el/da

Supply

100

101

102

103

Jan

uar

Febr

ril

May

Jun

Jul

Augu

Sep

temb

tob

vemb

cemb

Demand

Global oil demand and supply in 2018

78%

80%

82%

84%

86%

88%

90%

92%

94%

2015

2016

2017

2018

EU-16 refineries capacity utilization level (right axis)

Brent oil refining margin, North-Western Europe (left axis)

78%

80%

82%

84%

86%

88%

90%

92%

94%

2015

2016

2017

2018

Brent oil price (left axis)
EU-16 refineries capacity utilization level (right axis)

EU-16 refineries capacity utilization level, Brent oil price

EU-16 refineries capacity utilization level and refining margin

Source: S&P Global Platts

Source: EIA, Eikon Thomson Reuters

Source: OPEC Monthly Report, S&P Global Platts, IEA/KBC Monthly Global Indicator Refining Margins

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MARKET AND REFORMS

ANNUAL REPORT 2018

2018

A striking trend in 2018 was that during

the summer season, the margins for oil

refineries were kept at the same level

due to the sale of gasoline fractions. Due

to increased demand in the African and

US East Coast markets, gasoline stocks

decreased significantly and oil refiners

could supply gasoline to these markets at

higher prices.

In recent years, long-term expectations

tend to prevail in the market. This means

that the trend in Europe to increase the

consumption of energy from renewable

sources will hold back the development

of the oil refining industry. In addition,

the more stringent environmental

standards introduced by the European

Union and national governments can

further reduce demand for oil in the

region and accordingly affect the margin

of oil refining in European countries,

which is already lower than in other

regions

The trend towards reducing oil refining

capacities in Europe is clearly traced

against the background of global trends.

The global capacity of Fluid Catalytic

Cracking Unit of refineries (FCCU) has

increased from 19.65 million barrels per

day in 2013 to 20.64 million barrels per

day in 2018 (an annual increase of about

1%). This rate is expected to increase

to 25.76 million barrels per day in 2023

(+ 4.4%)

. Unlike global trends, FCCU

capacity in Europe has actually dropped

from 2.47 million barrels per day in 2013

to 2.34 million barrels per day in 2018,

with a negative average annual growth

rate of -1.1%. This trend is expected to

continue.

At present, Kremenchuk oil refinery

(Ukrtatnafta)

accounts for almost all oil

imports. According to the State Fiscal

Service, imports of oil to the country

decreased in 2018 by 25% to 0.87

million tons from 1.01 million tons in

2017. Despite a number of statements

about the possibilities to fully provide

Ukraine with high-quality fuels, in

2018 Ukrtatnafta failed to increase the

amount of raw material processing.

According to the company's reports

this was due to the anticompetitive

actions of oil producers in the Russian

Federation and Belarus which, in turn,

buy oil in Russia at a price that does

not include export duty, this is in turn

boost refinery margins of Russian

and Belarusian refineries. Due to the

protectionist policy of Customs Union

countries with regard to refineries and

logistic proximity, the latter manage to

maintain a high share of the Ukrainian

fuel market. In 2018, Shebelynka

gas processing plant (Shebelynske

VPGKN), the main oil refining asset of

Ukrgasvydobuvannya, continued its

systematic work on the implementation

of projects aimed at intensification of

hydrocarbon commodities processing

using modern deep processing

technology, increasing Euro-5 gasoline

production volumes and optimizing

its product portfolio. The volume of

petroleum raw material processing at

the plant in 2018 decreased due to the

reduction of gas condensate and oil

production by Ukrgasvydobuvannya.

The domestic oil market, as in previous

periods, was commoditized both through

the domestic extraction of oil and

through the import of oil. According to

the company, the volume of processing

of oil, gas condensate and other raw

materials at the Kremenchuk oil refinery

and Shebelynka refinery amounted to

2.7 million tons, which was roughly 80%

covered by oil of Ukrainian origin.

The volume of oil and gas condensate

production in the country increased by

4% to 2.1 million tons in 2018. For the

first time in 12 years, the downward

trend in oil and condensate production

was reversed. At the same time,

according to the results of 2018, the

largest oil company in Ukraine, PJSC

"Ukrnafta", increased its production by

5% compared to the previous year (to

1.45 million tons). In 2018, Ukrnafta

carried out 17 hydraulic fracturing

operations, completed workovers of

121 wells, and conducted 93 production

intensification operations. As a result

of these workovers, an additional 58.4

thousand tons of oil and condensate

were extracted in 2018, while

intensification operations resulted in

an additional 27.2 thousand tons of oil.

The volume of gas condensate and oil

production by Ukrgasvydobuvannya (454

thousand tons) is lower than the same

indicator in 2017 by 3%.

Despite the improvement in Ukrnafta's

production figures, the overall oil

production trend demonstrated by

Naftogaz group in recent years has

remained negative due to, among

other things, the accumulated tax

debt problem, which makes any active

investment program aimed at the

development of the company’s reserves

impossible.

According to the IEA data on oil refining margin indicators

According to GlobalData

Ukrgasvydobuvannya is engaged in gas condensate processing

https://www.ukrtatnafta.com/news.php?id=526

With adjusted figures the volume of processing in 2017 amounted to 516.000 tons of oil and gas condensate and components

http://enkorr.com.ua/a/news/Ukrainskiy_rinok_avtogaza_za_god_viros_na_9/235318

The starting auction price is calculated based on average quotations for the 15 days preceding the date

of registration of applications for the auction

Oil and petroleum market of Ukraine

In view of the fact that Ukrnafta does

not have its own oil refining capacity,

the company, in accordance with

Article 4 of the Law of Ukraine "On Oil

and Gas," sells oil and gas condensate,

its own production, at auction.

Ukrgasvydobuvannya processes oil and

gas condensate using its own production

facilities.

The results of these auctions show that

the trend in oil and condensate sale

prices corresponded to the trend of

changes in world oil prices. Taking into

account the peculiarities of the formation

of the starting price for auctions for

the sale of oil and condensate

, the

price of oil sales was lower than the

average monthly price of Brent oil in

the first three quarters of 2018 (when

the average price on the world market

increased) and higher than Brent prices

in the fourth quarter of 2018 (when the

price in the world market declined).

In 2018, growth in the estimated

balance (general consumption) of the

Ukrainian petroleum products market

was observed. While the production

volume remained almost unchanged,

demand on the petroleum products

market was satisfied due to an increase

of petroleum product imports to the

country. The main trend in recent

years, including in 2018, is the decline

in consumption of automotive gasoline

and its replacement with Liquefied

petroleum gas. According to industry

publications

, the import of Liquefied

petroleum gas in 2018 grew by 12.7%

from 1.17 to 1.32 million tons.

ill

n t

0,00

0,50

1,00

1,50

2,00

2,50

3,00

2013

2014

2015

2016

2017

2018

Ukrgasvydobuvannya

Ukrnafta

CAGR - 5,5%

100

150

200

250

300

350

nd t

Jan

uar

Febr

ril

May

Jun

Augu

Sep

temb

tob

vemb

cemb

Sales of oil (right axis)

Average monthly Brent oil price (left axis)

Estimated average auction sale price normalized to USD/barrel (left axis)

Sales of oil and gas condensate by Ukrnafta in 2018

Oil and gas condensate production

by Naftogaz group companies, 2013-1018

473

515

516

481

100

150

200

250

300

350

400

450

500

550

2015

2016

2017

2018

Shebelynka refinery: dynamics of processing volumes in 2015-2018

84%

12%

84%

11%

86%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Light petroleum products

Heavy petroleum products

Liquefied gas

Losses

2016

2017

2018

Shebelynka refinery: structure of petroleum products in 2016-2018

-2.00

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

Export

Production

Import

Balance

2016

2017

2018

Indicative balance of the Ukrainian

petroleum products market, 2018-2018, million tons

Source: UICE, S&P Global Platts, in-house calculations

Source: Ukrgasvydobuvannya, Ukrnafta

Source: The State Fiscal Service, in-house calculations

Source: Ukrgasvydobuvannya (processing volumes including components, additives, etc)

Source: Ukrgasvydobuvannya, in-house calculations

-------------------------------------------------------------------------------------------------------------------------------------------------------------

MARKET AND REFORMS

ANNUAL REPORT 2018

2018

Despite the relatively tangible success

of domestic refineries in improving

the quality of petroleum products,

the domestic market continues to be

significantly dependent on imported

supplies of petroleum products. In

2018, approximately 76% was imported.

According to the State Fiscal Service,

in 2018 Ukraine imported 8.06 million

tons

of petroleum products worth

USD 5.54 billion, which is 33% more than

in 2017 in monetary terms.

Since the Ukrainian petroleum product

market is dependent on imports, the

price of petroleum products on the

domestic market is formed based on price

quotations in the major European hubs in

South and North Western Europe.

-40%

-30%

-20%

-10%

10%

20%

30%

40%

A-95 gasoline (Ukraine), net of taxes and duties

Eurobob quotations (North West Europe)

Jan

uar

Feb

ril

May

Jun

Jul

Augu

emb

tob

Comparative dynamics of wholesale gasoline prices in Ukraine

and North West Europe in 2018 (price as of 04.01.2018 = 100%)

Transportation of oil via the main

pipelines in Ukraine is carried out

exclusively by Ukrtransnafta, which is

part of Naftogaz group. In 2018, the total

volume of transported oil amounted

to about 15.4 million tons. A decline in

volumes of transportation is observed

both in transit flows (due to reduced

utilization of European refineries

capacities), and transportation of oil

that is imported to Ukraine. At the same

time, records showed the growth of

transportation of oil produced in Ukraine

(from 1.25 million tons in 2017 to

1.34 million tons in 2018).

Reducing the volume of oil transit has

been a long-term trend. Over the past

ten years, the volume of transit through

the Ukrainian oil transportation system

has decreased by more than half. In

view of the fact that the volume of oil

transit depends on Russia's policy as

the main customer of oil transportation

services through Ukraine, as well as on

the resource supply and diversification

of oil supplies to the refineries of the

Czech Republic, Slovakia and Hungary,

the operator of the oil transportation

system of Ukraine is considering the

extension of the number of customers

of transportation services. One of the

steps towards achieving this goal is the

implementation of a project that would

enable transportation of different types

of oil to European refineries using the

“Southern Friendship” pipeline, which

involves the use of existing infrastructure

and available stranded oil transit

capacities. On 29 November 2018,

the project was assigned the status of

PMI (Project of Mutual Interest) in a

resolution from the Energy Community

Ministerial Council. This decision was

the result of cooperation between

Ukrtransnafta and other stakeholders

during the selection of projects

nominated for the status of PMI.

Another important issue is the

establishment of economically feasible

tariffs for oil transportation services for

Ukrainian consumers, which still remains

a loss-making segment of Ukrtransnafta's

operations.

Back in the summer of 2017, the NCREU

adopted a resolution approving a new

procedure for the formation of tariffs for

the transportation of oil and petroleum

products via the main pipelines

Ukrtransnafta, for its part, based on

the approved procedure, developed

a package of documents for changing

the existing tariffs for oil transportation,

which would allow the introduction of

an effective and economically sound tariff

policy. However, when the proposed

changes were discussed, domestic oil

producing and oil refining companies

expressed their unwillingness to adopt

a new tariff mechanism.

Taking into account the position of the

enterprises of the oil extracting and oil

refining sectors, Ukrtransnafta offered

a phased recalculation of tariffs within

three years. At the beginning of 2018,

the company submitted its proposals

to NCREU. The NCREU Resolution of

10.10.18 #1150 approved changes

to the procedure, including the

envisaged transition period of three

years. During this period, the tariffs for

oil transportation through the main

pipelines for consumers in Ukraine

shall be calculated using a simplified

methodology and the annual tariff

growth rate. By the end of the transition

period, the tariff for the transportation

of oil through the main pipelines

for each route should reach the

target level.

Oil transit and transportation

Excluding the volume of imported crude oil and liquefied petroleum gas

The procedure for the formation of tariffs for oil and petroleum product transportation through the main pipelines, approved by the resolution of the National Commission for State Regulation in Energy and Utilities

Sector, dated 25 May 2017, #690

1.4

2.1

2.0*

2016

2017

2018

ill

n t

13.8

13.9

13.3

2016

2017

2018

ill

n t

Volumes of domestic transportation of imported

oil and domestically produced oil in 2016-2018

Volumes of oil transit

in 2016-2018

Source: UPECO, S&P Global Platts, in-house calculations

Source: Ukrtransnafta

*excluding volumes of oil transmission by Ukrtransnafta

-------------------------------------------------------------------------------------------------------------------------------------------------------------

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