Some of that may seem to be true: the long-awaited law on liberalization of the natural gas market was adopted and so, starting from Oct. 1, the gas market players should have followed the new market rules.
However, in reality, the government measures have so far appeared to be ambivalent, inconsistent and incomplete. Many players on the market argue that, under the cover of market liberalization. the government and Naftogaz in fact are still tightening the knot for the gas production industry.
Investors complain that the government is not sufficiently trying to improve the investment climate in order to boost domestic gas production.
The exorbitant taxes on private gas producers (55 percent on natural gas produced out of wells above 5,000 meters depth and 28 percent on wells deeper than 5,000 meters, being the highest in the European Union) have not been cancelled yet. Originally the rate hikes were supposed to be only a temporary measure and apply only in 2014.
Prime Minister Arseniy Yatsenyuk personally promised investors not to apply such high tax rates permanently, but private gas producers remain under this enormous tax burden.
In July parliament registered the government’s so-called draft law on royalty rates. It reduces royalty rates to 29 percent for natural gas extracted from deposits up to 5,000 meters in depth, and 14 percent for natural gas extracted from deeper deposits.
Starting from Jan. 1, 2018, the applicable royalty rates are supposed to be further decreased to 20 and 10 percent, respectively.
At the same time the royalty rate imposed on state-owned gas producers would remain at the level of 70 percent to provide sources to finance subsidies for vulnerable consumers.
Since July the draft law has been improved, polished and finally obtained approvals to put to a vote. However, on Oct. 6 the legislature rejected the bill.
Instead, lawmaker Yulia Tymoshenko’s bill on royalty rates was approved in the first reading. As a co-author, Tymoshenko suggested decreasing royalty rates both for private gas producers and state-owned companies (including gas extracted under joint activity agreements) to 29 percent for gas extraction from deposits up to 5,000 meters in depth, and 14 percent for deeper deposits.
Lawmakers argue that lowering the rates for state gas producers should lead to lower households gas prices.
This is one of the hottest issues since prices for natural gas consumed by individual customers and the public sector recently has increased by around 300 percent.
It is still not clear how the royalty rates would affect the gas price for the residential consumer, as the gas price has never been in direct relation to the taxes paid by state companies. Gas prices for households were increased by the government in an attempt to reform Ukraine’s public finances and to end the practice of indirect and opaque cross-subsidies.
Moreover, lawmakers pretend to “forget” that a threefold increase was forced upon Ukraine by the International Monetary Fund. The lender’s bailout package was conditional upon bringing gas prices for households closer to market level.
Thus, parliament’s adoption of Tymoshenko’s bill is nothing but a populist campaign prior to the Oct. 25 local elections. Meanwhile, private gas producers are still hovering on the verge of extinction.
To make matters even worse, starting from Jan. 1, producers which supply extracted natural gas to end consumers must also keep, in underground storage, the monthly volume of natural gas that they plan to supply to their consumers – the so-called “mandatory stock reserve.”
Experts believe that such an “innovation” would freeze the available cash that private gas producers have and halve their available gas for supply, which will lead to further erosion of the gas sector, as the industry will have to turn to Naftogaz for those halved volumes. According to some estimates, private gas producers supply some 350-400 million cubic meters of gas per month. Hence, the relevant volume will have to be now withdrawn from the market and kept in storage. Gas producers furthermore are still required to pay the royalty for the gas upon its production, rather than at moment of sale.
The depressed position of private gas producers is actively used or abused by Naftogaz, which has recently offered its gas to consumers at historically low gas prices. The rates suggested by the state monopoly in October appear to be 12-15 per cent less than its pre-October prices and 5-10 per cent less than private gas traders can afford. The state monopoly knows full well that private gas companies are in a worse position to bargain on gas prices. It’s no wonder that Naftogaz is now seizing a significant “piece of the market pie” in the segment of industrial consumers, traditionally served by private gas suppliers and producers.
These facts reveal the government’s failure to deliver on its promises to the few remaining oil and gas investors. Temporary taxes have become permanent. The bill to decrease tax rates has been spoiled by populist attempts to swing votes. The new gas market rules put more pressure on suppliers, while Naftogaz still abuses its dominant position to win market share.
A few days ago Yatsenyuk made a statement that “gas corruption in the energy sector of Ukraine has been eradicated,” but there is nothing to support that just yet. Ignorance and contempt reign supreme in the government overseeing this sector. Reform and leadership are non-existent. The beneficiaries of the old system oppose the reforms. A strong political will is necessary for full-fledged implementation of gas sector reforms, but the government lacks strategic vision and consistency to make radical change.
The government’s policy in the gas sector remains sporadic and non-transparent.
Robert Bensh is the managing shareholder of Leadville Resources Inc, and the managing partner of Pelicourt LLC., a private equity firm focused on the energy sector in Ukraine and eastern Europe.
