Another strategic dimension is to increase energy efficiency and minimize corruption in energy markets. But all our strategies, plans, and steps should pursue the common goal – to ensure that the energy sector becomes a model for its national economic contributions, sustainable development, economic and environmental efficiency, responsible attitude to resources, and transparency of all payments.
In 2015, Ukraine adopted new energy laws and lowered royalty rates for oil and gas extraction, opening the space for the development of our energy sector. But, unfortunately, these efforts have not been enough. In this article, I will prioritize the 10 steps that we need to take over the next 12 months in order to continue developing the energy sector over the next 5 to 10 years.
The main priorities for Ukraine’s energy sector in 2016 are the following:
1. Create an effective and independent regulator as the cornerstone of an open, transparent energy market.
Adopting the Law on Gas Market was the first step to creating an independent gas market under the Third Energy Package and was a great victory.
However, we will soon have to face the second and equally important phase: monitoring the newly established gas market’s efficiency, eliminating possible shortcomings, preparing the secondary legislation necessary to implement the law, and filling in any details that the legislation may lack.
I have already mentioned the importance of developing an energy regulator in one of my previous pieces, but I want to stress again that even the best legal actions can not work properly without a regulator that is well resourced and resistant to political interference. The Parliament is currently reviewing a bill on this topic (#2960), but unfortunately there had been a lack of political will surrounding its adoption.
2. Outline the future for state-owned companies in the energy sector and begin corporate governance reform.
It will be vital to determine the future for Ukraine’s state-owned natural resource companies. There are many attractive models for SOE governance around the world, but data and developed countries’ experiences reveal that the state is not always the best manager of these assets. Even countries whose economies are based on oil and gas revenue frequently lean toward privatizing assets (as is the case with Saudi Arabia and Aramco). In due course, Ukraine will also face the option to privatize state assets. To ensure that Ukraine and its people get the maximum benefits from any future privatizations, we have to make drastic changes today in regards to the management of these assets.
It is worth mentioning an important initiative by Ukraine’s Ministry of Economic Development and Trade to reform corporate governance of state owned companies in accordance with the OECD Guidelines on Corporate Governance. These reforms include establishing independent supervisory boards, removing public officials from management positions, and creating a state holding company that will professionally manage the largest and most important companies. There is a bill (#3062) that aims to change these facets of SOE governance and will soon be adopted by the Parliament of Ukraine in the second reading.
By the end of the year, we may already have professional and effective supervisory boards in major state-owned energy companies. These new boards would present strategic plans for their companies based on what is best for Ukraine’s economy and people. However, there are a number of companies that are already ready for privatization including Centrenergo, some power plants, and regional power distribution companies. Their counterparts have already been privatized and further delays may only increase problems and losses for the state. An open and transparent privatization of these assets in 2016 would be the best evidence of a comprehensive policy to address energy issues.
3. The de-monopolization of gas and electricity sectors and further reforms in these markets.
To accelerate the process of de-monopolizing the gas market, we have to finalize the division between gas transportation and storage (unbundling) in accordance with the already adopted Law on the Natural Gas Market and the requirements under the Third Energy Package. This is the task of the Cabinet of Ministers of Ukraine, but all market participants, international partners, and regulators should join the process. The separation model will affect not only the future of Naftogaz assets (GTS and storage) but will also attract investors to develop these assets and improve overall market efficiency.
The de-monopolization of the gas market will only work if new gas importers and suppliers enter the market. If transportation and storage stay under Naftogaz’s control, then the company will remain the key market player with the privilege to decide whether other actors can enter the market and on what conditions. In 2016 there should be legislative changes, but also new outcomes, e.g. 5 to 10 additional players in the gas market that could provide more competitive prices.
Following the adoption of the Law on the Natural Gas Market, there are still a number of issues that require special attention, and in 2016 we will have to focus on resolving them. Bill #3325, which is pending before the Parliament, aims to deal with some of these issues. For instance, the bill tackles the problem of distribution networks’ usage: they should be used by non-state entities on a paid basis but there is no clear legal mechanism to do this.
As for the electricity market, the key precondition for reform will be the adoption of the Bill, which is currently pending before the Government and will be introduced to the Parliament in the near future. For the electricity market reform this is the first step toward following the requirements laid out in the Third Energy Package.
4. Stabilize the extractive industry taxation system and create conditions for gradually transitioning to a model of taxation that promotes the industry’s long-term development.
Such a system should be based on the lowest possible rental payment rates and a simultaneous additional surcharge on the income tax (as stipulated in Bill #3630). Providing this system is an essential prerequisite for attracting new investments to projects where commercial production won’t start for 2 to 3 years.
At the end of last year the Verkhovna Rada of Ukraine adopted a Law that significantly reduced royalties on natural resource extraction. But this was only a move back to previously stipulated rates (prior to 2014). At the same time the world has changed and the prices for oil and gas have dropped significantly. Therefore in order to increase domestic production and lower Ukraine’s dependence on imported foreign gas, more comprehensive measures have to be taken.
Besides reconsidering tax rates, a number of relevant issues concerning tax administration will also have to be addressed, e.g. employing a cash-basis method of tax collection for state-owned companies that carry gas to meet public needs. Special attention has to be paid too for specific provisions on the PSA (production sharing agreements) taxation regime (Bill #3027).
5. Eliminate regulatory barriers to the industry.
Ensuring that energy markets are sufficiently free and competitive requires, as I have mentioned before, the existence of numerous energy producers and traders. All investors are interested in gaining quick, effective, and economically feasible market access. Unfortunately, they currently (and especially producers) face significant barriers. In this regard we propose the following:
→Reform land access legislation with the possibility for the oil and gas industry to purchase/rent agricultural land (Bill #3096);
→Adopt new Rules for Oil and Gas Fields Development that are adjusted to best international practices (the current rules were accepted in 1984);
→Adopt a new Subsoil Code. Existing Ukrainian legislation is disperse and contradictory, such as with the Oil and Gas Law and Subsoil Code, and there are numerous other regulatory acts (Resolution of the Cabinet of Ministers of Ukraine #615 “On Approval of the Procedure for Granting Special Permits for the Use of Mineral Resources”) that create uncertainty. Codification of these legal provisions into a single piece of legislation – Subsoil Code – would help unify the permitting regime and promote transparency in the oil and gas sector;
→ Reconsider the volume of natural gas reserve stocks that producers/traders are required to hold. The current obligations impose a double burden on gas suppliers: obligating them to provide reserve stocks in accordance to the rules established by the Cabinet of Ministers of Ukraine and to receive a financial assurance through a bank guarantee.
Besides these challenges, 2016 should bring a reboot of relations between energy market players and the government. This can be stated in separate act, e.g. Memorandum of Understanding, signed by industry representatives and the Cabinet of Ministers of Ukraine. Even declarative documents can help alleviate distrust and attract investment.
6. Enhance the role of local communities in energy sector governance.
First off, the role of the central government and local communities in governing natural resources must be well defined to avoid any conflicts of interest or responsibility gaps. Local communities should have clearly defined and legally stipulated incentives for collaborating with energy companies. Only if this is the case will we avoid any breaking news stories about local authorities extorting companies for energy facility permits in their regions.
Bill #3038, which is under consideration in the Verkhovna Rada of Ukraine, is tackling this challenge by reallocating 5 percent of oil and gas rental payments to local budgets (currently 100 percent of the payments go to the national budget). Adopting this legislative initiative will encourage the development of resource-rich regions, and foster greater cooperation among oil and gas enterprises, state agencies, and local governments. Similar initiatives for electricity and alternative energy should also be highly valued.
7. Create a centralized database of environmental and energy information to attract investors, including foreign ones, to Ukraine’s extractive industries (e.g. by signing production sharing agreements).
The State Service of Geology and Mineral Resources of Ukraine (Derzhheonadra) and the Ministry of Ecology and Natural Resources of Ukraine share the common responsibility for holding transparent auctions and tenders to attract investors to develop natural resource deposits. This year we should create databases, presentation materials, geological data, and other information that could attract potential investors. Otherwise the government can still seeks ways to allocate licenses among certain holders.
One more issue is to establish and introduce integrated state and regional inventories of natural resources.
The best way to run auctions and tenders in order to maximize potential revenues is to hold them in the same way that a private owner would: announcing them in advance, providing proper advertising, and involving the maximum number of participants that possess the relevant extraction experience and expertise.
8. Continue implementing initiatives and mechanisms to ensure transparency and competitiveness.
Ukraine has published its first report on the Extractive Industries Transparency Initiative, but we now have to prepare the next report. This coming year’s report should cover data on most extractive companies and provide more information about the industry. At this time the special bill on disclosure of payments in extractive industries is being processed. It is worth creating special mechanisms that incentivize companies to provide complete, complementary sets of information for the report, e.g. certain auction advantages, etc.
In 2015, the database of special permits for gas, oil, and other natural resources was made available on the Internet (and also in interactive form – see this Map of special permits). However there is no relevant database on JAAs (joint activities agreements) or for the compliance audits for each of these special permits that were made by the Cabinet of Ministers of Ukraine. When ineffective, licenses should be transferred to other companies through auctions. In 2016, the objective should be to resolve JAA issues and transfer the special permits that are not being properly used.
9. Transition to more efficient subsidies that would encourage citizens to save energy.
Subsidies of 2015 became a pilot project that reduced social tension by lifting tariffs. We proved that public subsidies are a better choice than cross-subsidizing industry. But the situation, in which more than 5 million Ukrainian families received subsidies, has to be scrutinized with regard to their relevance, the prices/tariffs for public utilities, the criteria used for providing subsidies, and the public policy in the income regulation.
In the future, we truly hope that the number of families who need help, as well as the amount of such help, will gradually decrease.
In this context the regulator’s significance and influence in shaping public opinion regarding tariffs and consumers’ quality of services is increasing drastically. In addition to reconsidering the subsidy criteria we have to provide relevant legislative provisions that stimulate energy saving and encourage the state and citizens to invest in energy efficiency measures.
10. Provide an honest answer to miners: what is the future of Ukraine’s coal industry?
Miners’ recent pickets and strikes over Ukraine’s external coal purchases is the result of flip-flopping government policy. This year should be one of transition to a transparent system for setting electricity and heating tariffs that reflect the real costs for the coal industry.
If Ukrainian mines are to continue producing coal and competing with global manufacturers, it will require a new energy tariff calculation based on fair coal prices and not by the subsidies given to the coal industry. Further coal industry development must also take place in accordance with Ukraine’s overall strategy for developing the energy sector. It is crucial that in 2016 we adopt the Strategy of the Energy Sector Development for the next 10 years.
If it is not reasonable to keep the Ukrainian coal industry in its current form then we should be honest with the miners and close the mines without promising the impossible. But any mine closure should be preceded by in-depth policies that solve any social, environmental, and economic issues that would arise.
