НАК „НАФТОГАЗ УКРАЇНИ“. Річний звіт англійською (2018 рік) - 3

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2018

MARKET AND REFORMS

ANNUAL REPORT 2018

UNBUNDLING

In February 2018 awards in transit case 

against Gazprom were rendered by the 

Arbitration Institute of the Stockholm 

Chamber of Commerce. Arbitration rul-

ings provided more clarity with regard to 

feasible unbundling options. Stockholm 

tribunal unfortunately rejected Naf-

togaz’s request to review the contract in 

respect of the transfer of rights and ob-

ligations to the designated TSO without 

Gazprom's consent. Given that Gazprom 

does not agree this transfer of rights 

until the transit contract expiration on 

1 January 2020, Naftogaz should main-

tain control over GTS, including core and 

enabling functions. With this being said, 

the Company has always been a strong 

supporter of the OU model, which has 

been consensus “Plan A” for unbundling. 

As a result of these arbitration awards, 

due implementation of OU model is not 

possible at least until the termination of 

the current transit contract by 2020. 

In 2018, international legal advisers EY 

analyzed unbundling options, available 

for Ukraine given existing limitations 

as to the transfer of assets, personnel 

and resources from Naftogaz to an 

independent TSO. The analysis confirmed 

that implementing each of the models, 

allowed by the Gas Market Law, e.i., 

OU and Independent System Operator 

(ISO), would require changes to the 

laws of Ukraine. In turn, OU model, that 

presumes possibility of private ownership 

of the gas transmission system, would 

require changes, which seem unrealistic 

over the next year.

The idea of “quasi-ownership” based on 

rudimentary concept commercial use of 

gas transmission infrastructure is largely 

advertised as compliant ownership 

unbundling. Such “quasi-ownership” is 

incompatible with an OU model, as TSO 

cannot exercise ownership rights duly, i.a. 

pledge the assets would be  

forbidden.

Another arbitration proceeding between 

Gazprom and Naftogaz, initiated in 2018, 

is a critically important limitation to 

be considered while implementing the 

unbundling model. This case is based on 

Naftogaz claim against Gazprom to revise 

the transit tariff in 2018-2019. Such 

revision is also connected with potential 

compensation of nearly USD 12 billion 

impairment charges by Gazprom, if no 

Russian transit beyond 2019. Naftogaz is 

the only entity, which has legal grounds 

to claim this compensation being the 

only transit contract holder through 

Ukraine. In order to demonstrate 

eligibility for the impairment charges 

Naftogaz needs to continue to be entitled 

to receiving economic benefits from the 

GTS in the future. 

In the above context, ISO model is the 

one that allows protecting Naftogaz and 

Ukraine’s interests and claim respective 

damages from Gazprom.

The overall negative effect of 

implementation of unbundling 

structuring under the OU model as 

set out in the CMU Resolution #484 

of 05.06.2019 may result in direct 

losses and lost profits of about 

USD 18 billion for the company (and 

by extension, the state budget).

Any other model can potentially put 

Ukraine in a situation similar to 2011, 

when Russia launched Nord Stream   

and moved significant gas flows  

from Ukraine without any compensation. 

It would also give the Ukrainian side an 

effective bargaining power in post-2019 

transit contract negotiations. 

It should be noted that the company 

has always advocated the ownership 

unbundling model, which was unanimously 

adopted as Plan A for TSO unbundling. 

However, the current arbitration 

proceedings against Gazprom, complicated 

political situation in 2019 and required 

amendments to the legal framework make 

the proper implementation of OU model 

Naftogaz, as a vertically integrated 

company, has a sole responsibility for 

correct implementation of unbundling 

according to the current Ukrainian law.  

With this being said, Naftogaz fulfills a 

number of very important functions. 

The CMU imposed a responsibility on 

Naftogaz to ensure (i) security of natural 

gas supply to consumers in Ukraine and 

(ii) uninterrupted natural gas transit to 

EU countries. This responsibility rests 

with Naftogaz until 1 January 2020. 

For the unbundling process, this means 

that any GTS functions, assets, and 

technical and human resources cannot 

be transferred outside Naftogaz’s control 

till 1 January 2020.

Naftogaz is even more interested in clean 

unbundling, which is essentially ensuring 

non-discriminatory access to the GTS, 

and sustainable and efficient future TSO. 

That is why Naftogaz heavily engages 

its executive and supervisory boards, 

international stakeholders and  

reputable independent consultants to 

deliver on unbundling  

commitments.

In 2018 Naftogaz proposed unbundling 

roadmap and unbundling structure, 

which  envisages creation TSO as a 

new separate company, initially within 

Naftogaz group on a preparation 

stage and legally unbundled in future 

with engagement of GTS partner. 

The roadmap was presented to the 

government in January 2019.

Incompliant or belated 

unbundling can become the 

formal reason for Gazprom to 

scuttle post 2019 transit contract 

conclusion.

Naftogaz role and proposed unbundling structuring

Stage 1.  Separation of storage activity 

(SSO) from the transmission 

system (TSO). 

The unbundled TSO should not engage 

in storage activities for a number of 

reasons, in particular, in order to release 

the unbundled TSO from legacy problems 

regarding the disputable stock of gas, 

avoid cross-subsidizing storage business 

and increase investment attractiveness.

In 2018, Naftogaz completed the first 

stage. The Branch SSO was established as 

a separate branch of UTG and transferred 

there all storage-related assets, revenue-

generating contracts, processes and 

1800 employees. Separation was also 

accomplished for operational gas 

metering, ERP systems, internal policies 

and regulations within UTG. 

The unbundling action plan pursued by Naftogaz covers three stages:

Allow a similar right based on operational control

to the Law On pledge in order to enable pledging the GTS
to the Law On natural gas market to enable OU for an entity that is not the GTS owner
to the Law On pipeline transport, the Commercial Code in order to enable the GTS partnership

ISO

OU

Following the government’s decision to implement ISO 

Allow concession

(foreseen in CMU Unbundling Plan #496)

To make some  amendments and adopt the 
draft Law On concession approved by the 
government and by the Parliament in 
the first reading in 2018

Changes needed regardless

of the selected model:

to the laws and CMU rules on the Cabinet of Ministers and on central executive bodies in order to ensure 
independent decision-making by an executive body acting on behalf of the state as MGU shareholder
to Law On Permits system and the Law On Permits system Licensing in order to ensure 
uninterrupted gas transmission until new permits and supplementary licenses are granted

Allow privatization of the GTS

to the Law On privatization 
On pipeline transport (article 7)
in order to transfer the GTS ownership to the TSO to the Law On natural gas market 
In order to engage a GTS Partner
or

Amendments to the laws are required under both models

UTG*

New

TSO

New

TSO

International

partner

UTG transfers 100% of shares

in the New TSO to MGU

* UTG may be the company authorized to manage the GTS if UTG’s independence in accordance with the 3EP is properly ensured.

  Otherwise, a separate new company (GTS Co) would need to be used for this purpose.

CMU

Ministry

MGU 

Legal

and functional

independence

Control

100%

100%

51%

49%

100%

100%

Proposed unbundling structuring 

Use of the GTS

Delegation of the

exercise of the owner’s

rights over the GTS

USD 

18

 billion

now highly unlikely. Naftogaz therefore had 

to consider alternatives that would comply 

the Third Energy Package. 

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2018

MARKET AND REFORMS

ANNUAL REPORT 2018

Given the nature, complexity and strict 

timeline of the required changes, the 

success of unbundling and related gas 

market transformation strongly depends 

on actions that are outside Naftogaz 

control and to be done by Ukrainian state 

institutions:

I.  The CMU needs to make a decision 

on the model and other critical 

requirements for unbundling:

1)  Select the ISO model stipulated in 

Article 27 of the Gas Market Law as the 

unbundling model for the operator of 

the transmission system, which is state-

owned and is not subject to privatization.

2)  Assign the entity to apply for certification 

with the Ukrainian Regulator.

3)  Grant the concession for TSO assets 

to the new TSO as of 1 January 

2020 (pursuant to the a.7 of the Gas 

Pipeline Transport Law).

4)  Terminate or amend CMU Resolution 

of 01.07.2016 #496 and the previous 

Naftogaz Restructuring Plan.

5)  Authorize the State Property Fund of 

Ukraine, Naftogaz and UTG  to amend 

agreements on the GTS use, with 

1 January 2020 as the effective date.

6)  Assign Transmission System Operator 

LLC (TSO LLC) established by UTG as the 

entity to apply for certification with the 

Ukrainian Regulator.

II.  Conflicting assets must be transferred 

to another government body

The CMU needs to hand over the 

authority to manage corporate rights 

in legal entities operating in production 

and/or supply  of natural gas and/

or electricity from  the Ministry of 

Energy and Coal Industry (upon the 

request of the Ministry of Economic 

Development and Trade ) OR assign 

another government body to act as MGU 

shareholder (e.g., Ukrenergo case).

III.  Parliament needs to adopt the Draft 

Concession Law

Such adoption would allow executing 

of the 4 agreements required for Legal 

unbundling (Exhibit XX) and business 

entity assigned by the CMU - to apply for 

certification with the Ukrainian Regulator.

 

IV. Adoption of cost-reflective entry and 

exit transmission tariffs by the Regulator

The Ukrainian Regulator must adopt new 

transmission tariffs for the next regulatory 

period and ensure that these tariffs are 

cost–reflective thus helping the new TSO to 

become financially viable.

Call for urgent and decisive actions

Naftogaz suggests that the unbundling of GTS would be accomplished with a transfer to MGU of both: a) Gas TSO LLC 

and b) property rights for transmission related assets on 1 January 2020. These transfers, a.k.a., the unbundling, will be 

governed by agreements, listed below:

(i)  Sales and Purchase Agreement, concluded between UTG and MGU to transfer the corporate rights in the Gas TSO LLC 

with the effective date of 1 January 2020.

(ii)  Service Level Agreement between UTG and the TSO for UTG to provide service functions, for the allowed period, to 

the unbundled TSO; and.

(iii)  Concession Agreement between UTG and the new TSO with an effective date of 1 January 2020 to equip the latter 

with all the necessary transmission-related assets to conduct transmission function.

Stage 2.  Expansion and optimization of 

Branch TSO.

Naftogaz established a Branch TSO in 

UTG  Following the recommendations of 

international advisors and the European 

Commission Naftogaz implements 

TSO target operating model. Naftogaz 

established a Branch TSO in UTG 

according to the recommendations of 

the international consulting company 

WECOM and EC provided in 2018, is 

systematically filling it with functions 

and personnel in preparation for spin-

off into an unbundled TSO. Our target 

is to have a fully-fledged entity capable 

of carrying out all activities as a new 

TSO, responsible for both international 

(transit) and domestic natural gas 

transmission via the high-pressure 

pipelines. As of now, Naftogaz has 

transferred all transmission-related assets 

and have started transferring people.

Stage 3.  Legal unbundling preparation 

and implementation.

The new TSO company is expected to 

be certified prior to 1 January 2020 and 

its corporate rights to be transferred to 

MGU (or another entity, designated by 

the State).

In 2019, UTG established a separate 

legal entity to manage restructuring and 

TSO certification within the following 

year, Naftogaz established a separate 

company (Gas TSO Ukraine LLC), where 

the required personnel and functions will 

be moved.

In early April 2019, Naftogaz, Ukrtransgaz 

and MGU signed a framework agreement 

with five leading European TSOs that 

are interested in providing support 

to the Ukrainian unbundling process 

and in future involvement in operating 

Ukraine’s GTS. The cooperation aims at 

helping the Ukrainian side to establish an 

independent TSO according to European 

law after which the European partners 

could be engaged in the TSO operation. 

The working group includes GRTgaz 

S.A. (France), N.V. Nederlandse Gasunie 

(the Netherlands), Snam S.p.A. (Italy), 

Eustream a.s. (Slovakia) and Fluxys S.A. 

(Belgium).

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2018

MARKET AND REFORMS

ANNUAL REPORT 2018

Measures to resume the activities of the State Joint Stock 

Company “Chornomornaftogaz” were taken

The Law of Ukraine #2320-VIII “On the Introduction 

of Amendments to Certain Laws of Ukraine on the 

Stabilization of the Activity of the State Joint Stock Company 

“Chornomornaftogaz”  in Connection with the Temporary 

Occupation of the Territory of Ukraine” of 13 March 2018 

stipulates that bankruptcy proceedings against the State Joint 

Stock Company “Chornomornaftogaz” (hereinafter referred to 

as “Chornomornaftogaz”) shall not be initiated until 1 January 

2019, and bankruptcy proceedings initiated before 1 January 

2017 shall be dismissed, unless the liquidation is carried out by 

the owner’s decision.

In addition, the Law allows Chornomornaftogaz to retain special 

permits for subsurface use at sites located in temporarily 

occupied territory that will ensure the effective protection 

of the Company’s rights in international court jurisdictions, 

substantiation of losses caused as a result of armed aggression 

by the Russian Federation, since the validity period of permits 

affects the calculation of the Company’s lost profits.

A positive event for Naftogaz group

These laws create conditions for the resumption of 

Chornomornaftogaz natural gas extraction activities. 

Tariffs for oil and petroleum product transportation 

services, as well as natural gas storage services (injection, 

withdrawal) in underground gas storage facilities were 

established

NCREU Resolution #480 of 19 June 2018 established tariffs 

for natural gas storage services (injection, withdrawal) in 

Ukrtransgaz’s underground gas storage facilities.

NCREU Resolution of #1150 “On Approval of Amendments to 

the Procedure for Formation of Tariffs for Oil and Petroleum 

Products Transportation by Main Pipelines” of 4 October 

2018 addressed the procedure for calculating tariffs for oil 

transportation by main pipelines to Ukrainian consumers during 

a three-year transitional period, calculated on a simplified basis 

using an annual tariff growth rate.

A positive event both for the oil and gas market and for 

Naftogaz group companies

New tariffs create positive conditions for the oil and gas 

market, allowing companies to plan their business activities, 

finance operating and capital expenses, and receive revenues 

from the provision of oil, petroleum products and natural gas 

transportation services, and as well as natural gas storage 

services (injection, withdrawal) in underground gas storage 

facilities.

The Regulator established temporary tariffs for 

transportation

NCREU Resolution #2001 “On the Establishment of Temporary 

Tariffs for JSC “Ukrtransgaz” for Natural Gas Transportation 

Services for Entry/Exit Points for the First Year of the Second 

Regulatory Period and the Invalidation of Certain Resolutions 

of the NCREU” established temporary tariffs for the Company 

for natural gas transportation for entry/exit points for 2019. 

These tariffs were calculated using methodology which is not 

in compliance with European standards, specifically: European 

Commission Regulation (EU) 2017/460 of 16 March “On 

Establishing a Network Code on Harmonised Transmission Tariff 

Structures for Gas”.

A negative event for the GTS operator

Taking into account the established tariffs, expected revenues 

will not cover all the GTS operator’s projected costs. The use of 

temporary tariffs along with the unresolved issue of payment 

for imbalances will result in a deficit of about UAH 22 billion. 

According to Ukrtransgaz’s calculations, if no standing charges 

proposed by the GTS Operator are established as soon as 

possible, the company’s financial position will be so critical that 

it may result in bankruptcy during the year.  

Moreover, the NCREU’s approach applied in calculating tariffs 

will further result in tariffs being raised by almost half for 

interior points for 2020-2023 due to the necessity to include 

Ukrtransgaz’s expenses related to the return of invested capital.

In 2018, despite a number of positive changes, the trend of slowing down the process of harmonization 

of Ukrainian legislation with the European rules of the natural gas market and the Law of Ukraine “On 

the Natural Gas Market”, continued. The transition to daily balancing in the natural gas market was 

delayed, while no natural gas market liberalization for the population occurred. The activities of the state 

authorities focused on the adoption of regulatory acts to comply with the requirements of laws and the 

improvement of previously adopted subsidiary legislation. 

KEY REGULATORY CHANGES

Conditions created for transparency in extractive industries 

The Law of Ukraine #2545-VIII “On Ensuring Transparency 

in Extractive Industries” of 18 September 2009 defines the 

organizational and legal framework for information disclosure 

in extractive industries, establishes specific obligations and 

methods of information disclosure, and implies responsibility 

for disclosing entities.

A positive event for the market

The Law introduces international standards to Ukraine and best 

practices of the information disclosure in extractive industries 

in accordance with the Extractive Industries Transparency 

Initiative (EITI). 

Measures deregulating the oil and gas industry were taken

The Law of Ukraine #2314-VIII “On the Introduction of 

Amendments to Certain Laws of Ukraine On Deregulation in the 

Oil and Gas Industry” was adopted, simplifying the procedure 

for obtaining permits for oil and gas extraction.

Subsurface users were allowed to independently dispose of 

geological information in their ownership taking into account 

the requirements of the Laws of Ukraine “On State Secret” and 

“On Sanctions”. 

A positive event for the market

The deregulation would facilitate the development of the 

extractive industry.

In addition, Resolution of the Cabinet of Ministers of Ukraine 

#939 “Issue of the Disposal of Geological Information” of 

7 November 2018 was adopted that simplified access to 

geological information that is state property and the procedure 

for the transfer of rights to geological information owned by 

legal entities and individuals. 

A positive event for the market

The resolution should facilitate access to geological information 

for foreign investors and those interested in implementing 

projects on extraction of mineral resources in Ukraine.

Resolution of the Cabinet of Ministers of Ukraine #848 “On the 

Implementation of a Pilot Project on the Launch of Auctions 

for the Sale of Special Permits for the Use of Subsoil Through 

Electronic Auctions” of 17 October 2018. 

A positive event for the market

The introduction of electronic auctions as part of auctions for 

the sale of special permits for subsurface use will increase 

transparency and attract new investors to the Ukrainian 

extractive industry.  

REGULATORY CHANGES

IMPACT OF CHANGES

REGULATORY CHANGES

IMPACT OF CHANGES

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2018

MARKET AND REFORMS

ANNUAL REPORT 2018

Ten-year plans for the development of the gas 

transportation system and GTS Operators’ and Ukrtransgaz’s 

UGSFs

NCREU Resolution #956 “On Approval of the Plan for 

Development of the Gas Transportation System of Ukrtransgaz, 

a GTS Operator, for 2018-2027” of 4 September 2018 

provides for planned sources to finance this plan with 

UAH 60.043 billion, net of VAT, including UAH 6.027 billion, 

net of VAT, for 2018.

NCREU Resolution #808 “On Approval of the Plan for 

Development of the Gas Storage Facilities of Ukrtransgaz, a 

GTS Operator, for 2018- 2027” of 2 August 2018 provides for 

planned sources to finance this plan with UAH 13.1 billion, net 

of VAT.

A positive event for Naftogaz group

The plan makes possible development of Ukraine’s GTS and 

UGS facilities, as well as contributing to a better understanding 

of future infrastructure, potential routes and capacities on 

natural gas transportation and storage and, accordingly, allows 

for long-term planning of the group’s activities in a proper 

manner.  

The introduction of daily balancing in the Ukrainian natural 

gas market was postponed  

NCREU Resolution #788 of 27 July 2018 postponed the term 

of daily balancing introduction till 1 October, and on 28 

September 2018 the NCREU introduced amendments to the 

said resolution which postponed daily balancing introduction 

till 1 December 2018. NCREU Resolution #1573 of 30 November 

2018 postponed for the third time the date of introduction of 

daily balancing in the Ukrainian natural gas market till 1 March 

2019.

A negative event of the market and the company

The introduction of daily balancing should reduce load on 

the GTS Operator, insofar as in the daily balancing system 

the transportation service customers become responsible for 

system balancing, and the GTS operator only performs residual 

balancing.  

The indebtedness of transportation service customers for any 

imbalance continues to grow: in 2018, it increased by 70.7% 

up to UAH 34.3 billion. In 2018, Ukrtransgaz’s actual expenses 

for natural gas for balancing amounted to UAH 15.5 billion 

inclusive of VAT. Indebtedness for imbalance results in a 

significant decrease in Ukrtransgaz’s working capital. 

Public service obligations were imposed on the company and 

gas extraction companies of the Naftogaz group 

CMU Resolution #867 “On the Approval of the Provisions for 

Imposing Public Service Obligations on the Natural Gas Market 

Entities for Ensuring the General Public Interests in the Process 

of Functioning of the Natural Gas Market” of 19 October 2018 

(hereinafter referred to as the “PSO”), imposed public service 

obligations on the gas extraction companies of the Naftogaz 

Group to sell gas of their own extraction to the company to 

make a natural gas resource for household consumers, religious 

organizations and heat energy producers (within the defined 

natural gas consumption categories), and the obligation to sell this 

gas to suppliers to meet the demands of household consumers, 

religious organizations and heat energy producers (subject to 

fulfillment of established conditions thereby) was imposed on the 

company.

These public service obligations (PSO) have been imposed on 

natural gas market entities by the government since October 2015.

Unlike the public service obligations effective before (as imposed 

by virtue of CMU Resolution #758 of 1 October 2015 and CMU 

Resolution #187 of 22 March 2017), CMU Resolution #867 is 

essentially different in defining a single natural gas price for all 

consumers/buyers entitled to purchase natural gas under PSO.

Also, CMU Resolution #867 has introduced the following new 

obligations (currently terminated by court:

•  for Naftogaz – to supply natural gas to household consumers, 

to religious organizations (other than the natural gas used to 

maintain their production and business operations) and to the 

state enterprise of Ukraine “International children`s center 

Artek” - where the gas supplies in the respective period (month of 

supply) are not made by another supplier (including by another 

supplier with public service obligations);

•  for gas distribution system operators – to provide the 

information required to continuously supply natural gas to 

household consumers and religious organizations (other than 

the natural gas used to maintain their production and business 

operations) and to the state enterprise of Ukraine “International 

children`s center Artek”.

A negative event for both the market and Naftogaz group

This newly adopted Resolution damages competition in the retail 

natural gas market by creating preferences for specific consumer 

categories, as well as bringing considerable financial losses to the 

company resulting from a high level of debt subject to be paid to 

the company for natural gas sold under PSO.

Provisions of the Gas Transportation System Code and Gas 

Storage Facilities Code improved

NCREU Resolution #1079 “On Adoption of the NCREU 

Resolution “On Approval of Amendments to the Gas 

Transportation System Code” of 25 September 2018 introduced 

amendments to the GTS Code establishing a sufficient level 

of financial support, clarifying the definition and details 

of commercial notification, and introducing a clear and 

transparent mechanism for the termination of transportation. 

NCREU Resolution #1281 “On the Introduction of Amendments 

to the Gas Storage Facilities Code and Approval of Amendments 

to a Standard-Term Contract for Natural Gas Storage (Injection, 

Withdrawal)” has regulated relations between the gas storage 

facilities operator and storage service customers in terms of the 

provision of natural gas storage services related to gas having 

foreign good customs status under the customs regime of a 

customs warehouse.

A positive event for the Naftogaz group

These amendments are aimed at mitigating financial risks for 

Ukrtransgaz, specifically those related to unauthorized gas 

withdrawal from the GTS by gas distribution system operators.

REGULATORY CHANGES

IMPACT OF CHANGES

REGULATORY CHANGES

IMPACT OF CHANGES

The procedure for financing benefits and housing subsidies 

was changed

Starting 1 January 2018, CMU Resolution #951 of 8 November 

2018 (together with Decree of the Ministry of Finance of 

Ukraine #1) has cancelled the mechanism of “clearing” 

settlements on benefits and housing subsidies, which required 

a preliminary joint protocol resolution of all the settlement 

participants (CMU Resolution #20 of 11 January 2005), and 

introduced a mechanism to transfer benefit and subsidy 

amounts using treasury accounts, which allows that providers 

of housing and utility services make their own decisions on the 

amounts and timing of subsidy transfers to other settlement 

participants.  

A negative event for both the market and Naftogaz group

The newly adopted Resolution introduced as “subsidy 

monetization” has in practice put on hold the subsidy 

settlement system effective since 1 January 2018, which in fact 

hampered the natural gas market competition. In addition, this 

Resolution has created preferences for providers of housing 

and utility services allowing them independent calculations 

of amounts, timing and targets of subsidy funds within 

the defined list of settlement participants, which does not 

contribute to the fair allocation of funds. 

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2018

MARKET AND REFORMS

ANNUAL REPORT 2018

Gas procurements by heat generating entities under PSO 

have been liberalized

CMU Resolution #942 of 14 November 2018 extended the 

effect (from 1 April 2019 to 1 January 2020) of the maximum 

rate of transfer of funds to DHC (“teplokomunenergo”) 

accounts, which used to restrict the adjusting factor effect and 

did not allow increases in the rate of fund transfers from DHC 

special purpose accounts for gas-related debt settlements; it 

allows the purchase of gas under PSO with a lower rate of gas 

settlements (78% for all DHC and 60% for the DHC under the 

management of the State Property Fund of Ukraine, instead of 

90% for all DHC) during the period from 1 December 2018 to   

1 April 2019.

A negative event for both the market and Naftogaz group

This newly adopted Resolution has created preferences for 

specific consumer categories – heat energy producers - and 

shifted responsibility for their operations from the government 

to the company as an entity, as well as brought considerable 

financial losses to the company resulting from the decreased 

rate of settlements between the heat energy producers and the 

company for natural gas sold under PSO. 

The procedure for transferring subsidies in 2019 was 

changed

CMU Resolution #1176 “On Certain Issues of Granting Housing 

Subsidies to the Population in Cash” of 27 December 2018 

provides for a phased change of settlements on benefits and 

housing subsidies from treasury accounts to Oschadbank 

accounts in 2019 with the simultaneous retention of the model 

for subsidies transfers to service providers, but not directly to 

the subsidy recipient.

A negative event for both the market and Naftogaz group

The newly adopted Resolution introduced as “subsidy 

monetization” in practice provides for the retention and 

relief of settlement systems effective in 2018, which in fact 

hampered natural gas market competition. In addition, the 

updated procedure does not stipulate the obligatory entering 

of subsidies to special accounts of housing and public utility 

service providers, which creates the threat of unfair distribution 

of subsidies or their improper use.

2019

1

The procedure for financing benefits and housing subsidies 

for the population in March-May 2019 was changed

CMU Resolution #62 of 6 February 2019 concerning the 

monetization of subsidies which:

•  provides for the payment of subsidies for February-April 2019 

in March-May 2019 in cash: 

- to pensioners - to pension accounts or via Ukrposhta; 

-  to other subsidy recipients - through the cash desk or 

current accounts at Oschadbank. 

 

 

 

 

 

 

 

 

 

1 

In the first months of 2019 prior to the publication of this report, there have 
been a number of changes to laws that will significantly affect market func-
tioning and Naftogaz group activities. The respective information is included 
in this 2018 report

 

A positive event for the market

•  for the first time in Ukraine’s history, housing subsidies 

for Housing and Public Utility Services (about 4.5 million 

households) are paid in cash. This changes the settlement 

principles for a significant part of the retail gas market 

segment, as well as having a significant impact on the 

behavioral model of subsidy recipients (regarding the subsidy 

allocation for payment for Housing and Public Utility Services);

•  the desire of subsidy recipients to retain as much money as 

possible at their disposal may result in a significant reduction 

of natural gas consumption in the PSO segment;

•  money in the subsidy recipient’s hands will encourage the 

consumer to be more meticulous about the verification 

of gas volumes accrued to him/her that should result in a 

decrease in manipulations with gas consumption in the PSO 

segment.

A positive event for the company

•  the subsidy payment directly to the subsidy recipient and 

the opportunity for the subsidy recipient to dispose of these 

funds on their own will contribute to the development of 

competition among natural gas suppliers;

•  refusal of settlements through treasury accounts and a 

single Oschadbank account will mitigate the risks of corrupt 

schemes among gas utility companies;

•  an increase in liquidity will result in the Company receiving 

more ready cash;

•  a decrease in gas consumption by subsidy recipients 

will result in a decrease in the volumes of imported gas 

purchases for the household needs. 

REGULATORY CHANGES

IMPACT OF CHANGES

49

48

OPERATIONS

ANNUAL REPORT 2018

2018

NAFTOGAZ  

TRANSFORMATION

Naftogaz has achieved significant progress on a number 

of fronts through the four-year turnaround stage. The 

Stockholm arbitration decisions resulted in Gazprom’s 

net liability to pay Naftogaz USD 2.8 billion and lower the 

price until the end of the existing supply contract. Market 

liberalization and the switch from hidden to target subsi-

dies has reduced opportunities for corruption, stimulated 

a decrease in natural gas consumption, and lowered im-

ports. Elimination of rent seeking by vested interests (in 

procurement, joint activity agreements, gas supply etc.) 

has allowed Ukraine’s national interests to be put first and 

work for the benefit of the people of Ukraine. Turning 

around the domestic production decline at Ukrgasvydobu-

vannya to growth trajectory was an important step to-

wards the objective of reaching natural gas self-sufficiency 

and independence from imports. We are proud that Naf-

togaz is no longer an instrument against Ukraine’s energy 

independence, but has once again become the backbone 

of national energy security, of the oil and gas industry, and 

of the Ukrainian economy.  Thanks to these reforms, we 

as Ukrainians are no longer dependent on Russian gas. 

Instead, Naftogaz is now a major contributor to the state 

budget and helps the government to ensure microfinancial 

stability.independence.

The transformation of Naftogaz into 

an integrated and properly governed 

national oil and gas company is the way 

forward for Naftogaz to address key 

issues and the potential market risks of 

the Ukrainian oil and gas market. The 

group can potentially create additional 

value for its shareholder  – the people of 

Ukraine, if it is successful in its strategy.

This transformation will touch all 

businesses of the group. The pillars of 

this transformation include: 

•  Continue increasing gas production 

through development of in-house 

capacities and entering into 

partnerships with international players.

•  Ensure full gas market liberalization 

and abolishment of PSO along with 

implementation of fully monetized 

subsidy system for those who truly 

need state support.

•  Ensure smooth and timely TSO 

unbundling that will help both 

preserving future transit gas flow 

through Ukraine and improving 

efficiency of domestic gas market.

•  Become a utilities company. Naftogaz 

will use its skills and position in the 

market to serve the end customer 

directly, providing them with a superior 

customer experience while at the same 

time bringing transparency, efficiency 

and healthy competition to the utilities 

market.

•  Enter the energy efficiency market. We 

will start offering energy services to 

households.

•  Enter the renewable energy 

market capitalizing on vast existing 

infrastructure.

•  Substantially improve the group’s 

presence in the oil segment by 

developing a financially viable 

downstream presence and enhancing 

customer experience of interacting with 

Naftogaz brand.

From turnaround to transformation 

Next phase: transformation

Turnaround

Transformation

Transition

2014-2017

From losing to winning 

2018-2020

From winning battles

to winning the war

2021-...

To decarbonized

“smart” world

In 2018, Naftogaz group entered a 

new phase of its development to 

preserve the gains it had made and 

to achieve its full potential.

•  Modernize infrastructure, achieving 

excellence in IT and digitalization, 

driving operational efficiency and 

developing the group’s technical 

capabilities. This means addressing 

challenges large and small – from 

large IT systems to small but important 

improvements to the gear that 

Naftogaz drillers, production and 

transport workers work with every day.

•  Create a technical business unit, which 

will become a center of excellence for 

complex investment projects.

•  Holistically transform organization, 

including Naftogaz systems, processes, 

culture and personnel.

•  Achieve world-class performance 

benchmarks and make sure decisions 

regarding Naftogaz are in the 

company’s best interest.

In order to achieve the above, the 

Naftogaz management took on board a 

new organizational concept following the 

successful examples of leading oil and gas 

companies such as BG Group (UK) and 

Statoil (Norway). The selected operating 

model means organizing the operations 

of Naftogaz group into Business Delivery 

Units, Business Enabling Units and 

corporate functions based on a portfolio 

of assets and processes. Business 

Delivery Units (BDUs) deliver on the 

group’s principal activities. They create 

most value to Naftogaz and focus on 

achieving financial and operational goals. 

In particular, BDUs should operate across 

each of the key stages of the gas and oil 

value chain, including gas prospecting, 

exploration and production, hydrocarbon 

preparation, treatment and processing, 

gas transmission, gas storage, and the 

sale and supply of gas, oil, petroleum 

products, LPG and CNG.

The Business Delivery Units are four 

core businesses of the group: Integrated 

Gas, Gas Transmission & Storage, Oil 

Midstream & Downstream, and Gas 

Transit.  The Business Enabling Unit 

(Technical) is to act as an internal 

From net importer 

to net exporter

From declining to

growing gas production

From losing

to making money

From net recipient 

to the biggest donor to

the state budget of Ukraine

Why we call it a “turnaround”

2014

2014

2015

2018

2018

2014

2018

2014

2018

-4.7

-88.4

-7.9

0.6

15.1

14.5

15.5

11.6

5.0

Revenues from gas
transit minus costs
of gas import, USD billion

Gas production by UGV 
(gross), bcm

Net profit/(loss) 
of Naftogaz group,  
UAH billion

Contribuition to the
state budget of Ukraine, 
USD billion

Source: Naftogaz Financial statements, Ukrgasvydobuvannya  

51

50

OPERATIONS

ANNUAL REPORT 2018

2018

contractor providing services to Business 

Delivery Units. The group also differentiates 

new businesses as a separate category. 

These new businesses are Energy 

Efficiency and Renewables. In the course 

of transformation, business units and 

functions shall be organized as follows.

Corporate functions should support BDUs 

in order to maximize the value of the 

group. These functions are responsible 

for developing most of the competences 

across the value chain and therefore 

should be central to how the group 

operates. 

During the first quarter of 2019, 

following approval from the Naftogaz 

supervisory board, Integrated Gas 

Business delivery Unit, Oil Midstream and 

Downstream Business Delivery Unit and 

Technical Business Enabling Unit were 

established. Selection and appointment 

of leaders followed the presentation 

of their vision for the future business 

unit and respective five-year business 

plan to promote ongoing performance 

improvement.

The transformation of Naftogaz requires 

an efficient organizational model, which 

would enable sufficient control over busi-

nesses grouped into respective business 

units to drive growth and achieve syn-

ergies. The model assumes significantly 

strengthening the role of the corporate 

center – both in terms of technical and 

functional capability and from the com-

pliance and control perspective.

The key pillars of the new organization:

•  Individual accountability for results: 

organization of business units and 

functions in such a way that each 

leader has a clear responsibility to 

achieve financial results and/or create 

value, allowing it to measure its own 

performance covering both operating 

activity and strategic initiatives.

•  Clarity of roles and responsibilities: 

strengthening of key roles in the 

organization while spelling out the 

authority and responsibility for 

achieving Naftogaz goals. Streamlined 

decision-making: strengthening the 

role for leaders of business delivery and 

enabling units, limited span of control 

and building out standardized efficient 

business processes.

•  Focus on value-creation: delivering 

better product, better service or 

better result, constantly creating value 

propositions in a financially sustainable 

way, development of efficient 

performance management system.

•  Ensure national interest: develop 

national market, technical and business 

infrastructure, local ecosystems and 

human capital, establish international 

partnerships with clear and transparent 

risk and benefit sharing.

•  Focus on synergies: understanding 

and duly accounting for transaction 

costs, economies of scale, scope and 

skill. Exploring benefits from vertical 

integration within the group.

Integrated 

Gas

Production

Gas trading

Gas supply

Bad debts

collection

Exploration

Business delivery and enabling units of Naftogaz group 

Business Delivery Units

Technical Business Enabling Unit 

and corporate functions

Technical

Corporate 

functions

Finance

HSE

Security

Other

Legal

HR

Communications

New businesses

Renewables

Energy

efficiency

Oil Mid -

and Downstream

Oil transmission

 and transit

Refining

and sales

LPG transmission

Gas transit

Gas transmission

and storage

Transmission

Storage

Well 

workover and 

stimulation

Drilling

and completion

Capital

projects

Procurements

R&D

Courage:  We believe that determination is better than resignation. Naftogaz can stand its 

ground even when faced by far larger opponents. We do not quietly accept injustices 

and prefer to call things by their proper names. Naftogaz is not afraid of change and 

seeks to serve as a model for both the public and private sectors.

Openness:  We work honestly and openly. We believe that this approach prevents 

corruption and encourages effective cooperation in the market as well 

as within the company itself. Transparency is key to earning the trust of 

Ukrainians for whom we generate profit. 

Conscientiousness:  We believe that each team member should have their share of responsibility for 

the result. Naftogaz appreciates good work, a willingness to act, initiative and 

honesty. 

Fairness:  Naftogaz is a national company and important contributor to the common good. We 

stand for equal opportunities, targeted support for those who need it most, and for 

adequate remuneration for those who take on responsibility and deliver outstanding 

results. We believe this is reasonable and fair.

MISSION AND VALUES

Our mission

Our values

Our mission is to become the driving force for modernization and professionalism in the Ukrainian energy sector integrated 

with the European market, ensuring security of energy supplies at competitive prices while maximizing the mission and 

values value of national resources. 

53

52

2018

OPERATIONS

ANNUAL REPORT 2018

Andrew Favorov   

INTEGRATED 

GAS BUSINESS UNIT

The Gas Business Unit was created to 

integrate all businesses related to gas 

production and sales, and to ensure 

material increases in each of them and 

achieve synergies.

Our focus is managing gas production, trad-

ing and retail assets, while other services 

like construction of wells, access roads and 

pipelines will be sourced from our in-house 

contractor – the Technical Unit.

This approach has several advantages. 

For instance, we are going to abandon 

measuring efficiency of the gas business 

in meterage or wells drilled. In line 

with the world’s leading companies, we 

will focus on more important aspects, 

namely the profitability of the business 

and benefits for the shareholder.

Naftogaz supervisory board has 

approved a comprehensive development 

strategy for the Gas Business Unit. 

If implemented successfully, the 

Unit’s estimated value may rise to 

USD 14 billion within five years. What 

do we need to do to achieve this goal?

Firstly, we need to ensure production. 

It will be quite a challenge, considering 

existing fields are 80-85% exhausted 

and natural production is decreasing 

by 1.2-1.5 bcm per year.

We have to maximize the output 

and efficiency of existing fields. A 

real breakthrough in gas production 

nevertheless requires much more, 

including new licensed fields and their 

proper development within a short-

term period. Naftogaz has a substantial 

amount of geological information in 

need of updating. We are planning to 

invest in seismic surveys to ensure a 

dedicated decision-analytic framework 

on drilling operations. This requires 

partnerships with the world’s  

best service providers, modern 

technology and, of course, huge 

investments.

The Unit’s Investment Program 2019 will 

amount from UAH 20 to UAH 40 billion, 

depending on the compensation for 

PSO to be paid by the government to 

Naftogaz. However, we need much 

more. We must therefore engage 

partners that are capable of funding our 

projects.

We have started to conclude production 

enhancement contracts aimed at 

engaging investors for gas production 

enhancement. Naftogaz group is open 

to dialogue to establish partnerships 

in all other domains with all reputable 

companies in technology and 

manufacturing.

Another important goal, besides gas 

production, is building transparent and 

effective sales channels. We have two 

basic elements here – exchange trading 

and retail.

A clear and liquid commodity exchange 

is important for us and for gas 

consumers as well. It would guarantee 

that pricing is market-based rather 

than regulated. Several exchanges are 

currently operating in Ukraine. Naftogaz 

group has successful experience of 

selling oil products through one of 

them. The Gas Unit will start to trade 

natural gas there in the near future.

The key task for 2019 is to ensure that 

all exchange trading tools, processes 

and procedures are in place. The next 

step, planned for 2020, is to establish 

our own exchange.

We also seek to enter the retail market. 

As a gas producer and importer, we 

often sell to intermediaries, which 

quite often turn out to be dishonest. 

To be successful, we need to offer 

our end-users not just gas, but an 

interesting product with high quality and 

convenient service.

Whatever we do, safety is our top 

priority. We need to introduce high 

HSE standards. Priorities also include 

the professional growth of our 

employees, their training with modern 

equipment and new methodologies, and 

comprehensive development of staff 

members.

In Ukraine, we should be innovators and 

pioneers in all of the abovementioned 

areas. This requires persistence, 

commitment, openness, initiative, 

and outside-the-box solutions. The 

goal is worth the effort. Following 

transformation, Naftogaz group can 

become a technology leader, market 

maker and excellent provider of energy 

products. Everyone would benefit 

from this, including the entire team of 

Naftogaz and ultimately the Ukrainian 

people. We should remember that 

every Ukrainian citizen is not just our 

consumer, but also our owner. Naftogaz 

is the country’s biggest taxpayer, having 

contributed 75% of its profits to the 

state budget last year. This year, the 

government wants us to contribute 

90%. The effective work of the Gas 

Business Unit and Naftogaz group as a 

whole means prosperity for citizens and 

development for Ukraine.

Andrew Favorov 

head of the integrated gas business unit

•  JSC Ukrgasvydobuvannya (excluding refining, sales of 

oil products and services);

•  Gas of Ukraine Subsidiary Company;

•  Naftogaz of Ukraine Gas Supply Company LLC;

•  Naftogaz Trading Gas Supply Company LLC;

•  Naftogaz Teplo Gas Supply Company LLC;

•  Naftogaz Trading Europe AG;

•  Tsentrgaz, JSC Kirovogradgaz subsidiary;

•  NJSC Naftogaz of Ukraine departments: gas balance, 

dispatching, metrology and metering; gas sales; gas 

imports and customs clearance; gas trading.

The Integrated Gas Business 

Unit includes the following 

entities and departments:

•  The largest business of Naftogaz group by size 

(accounting for 42.3% of total consolidated revenues in 

2018).

•  Domestic production by Ukrgasvydobuvannya (which 

increased by 1.3% to a 25-year maximum in 2018 to 

almost 15.5 bcm) is the main source of gas for this 

segment.

•  Sales volumes to retail supply companies in 2018 were 

10.4 bcm. Direct supply to households amounted to 

0.2 bcm.

•  Sales volumes to DHCs supplying heat to households in 

2018 were 4.8 bcm (4.6% more compared to 2017). This 

segment sources gas from both imports and domestic 

production by the group.

•  In 2018, Naftogaz continued to accumulate debts from 

suppliers under PSO, which reached UAH 57.8 billion by 

the end of the year. The share of receivables from DHCs 

is UAH 20.4 billion, the share of retail supply companies 

equals UAH 30.3 billion. A further UAH 7.1 billion was 

accumulated by other PSO consumers.

•  ROIC of this business in 2018 was more than three times 

lower than the estimated UAH denominated cost of capital 

(6.9% against 18.9%). This gap suggests that the current 

model of this business does not unlock the potential for 

creating additional value for the company's shareholder.

Key results: