A mantra about the "real prime cost" of gas of 3-4 hryvnias became viral in Ukrainian social networks as well as that "gas oligarchs" are pulling the wool over consumers' eyes. There is even a bill No.4680 “On the direction of gas accumulated in the unheated period, and domestic production for the needs of the population" under consideration in the Verkhovna Rada
Kosatka.Media asked Ukrainian energy experts to comment on the theses of this bill and explain whether it is possible for Ukraine to fully provide itself with its own gas, what needs to be done to achieve it and whether it will become cheap after that. Like, 3 hryvnias.
On the "prime cost of gas"
There is a popular social networks thesis underneath the words of the bill about the "real prime cost" of gas production in Ukraine of UAH 3.4 per cubic meter. Whether it’s manipulation or not?
In fact, experts say, there is not even such a thing as the "prime cost of gas " in the oil and gas industry because most of the money (billions of dollars) is spent on exploration and research. They are not included in the prime cost of gas as a commodity. It is correct to talk about the so-called gas to surface cost. However, these are not the final costs incurred by the producing company during gas production.
Yevhen Palienka, ex-head of mining companies, independent energy expert:
“There is no concept of production costs in the oil and gas industry. There are four types of industries, where it is incorrect to talk about the prime cost: space industry, nuclear power, pharmaceuticals and oil and gas.
For instance, in pharmaceuticals, you can spend billions of hryvnias on researching some drugs, and then discover that these drugs can be made from a plant that grows everywhere, and their production will cost three cents, plus another two cents – the cost of electricity, only 5 cents. But the billions spent on research will not be included in the prime cost. Therefore, the talk is about the cost of manufacturing drugs, vaccines.
It's all the same in the oil and gas industry. Gas production companies invest huge amounts of money in licenses, greenfield. Money is spent on exploration, seismic research. And even the wells drilled do not always yield production. Therefore, there are refusals from licenses, which never became fields. And these costs are also not included in the production cost.
That is why talking about the prime cost in the production of hydrocarbon is inaccurate. But we can talk about the average cost of exploration and lifting 1000 cubic meters gas mixture to surface. After that, it still needs to be brought to a saleable condition - divided into oil, gas, condensate, wax products, etc. As for gas, it is also needed to provide the appropriate pressure to supply it to the gas transmission system.
The average cost of lifting 1,000 cubic meters of gas to the surface in Ukraine (data of 2015) is $100 – $200, excluding production rent, which formally refers to the cost of production in accounting. Now the rent is paid at a rate that is tied to the price of customs clearance of imported gas, in other words, to the price of gas in Europe. And now it amounts to 26-27%.
But the cost of lifting gas to the surface is very different, depending on the type of field. For private companies, it is higher because they did everything at their own expense – equipment and depreciation of equipment, but it's easier to calculate.
Ukrgasvydobuvannya may have a lower cost of lifting, but it is more difficult to calculate because the fields were discovered in Soviet times and some of the costs were already depreciated or were not fixed in foreign currency.”
Andrian Prokip, energy expert, Institute for the Future:
“There is a big issue, what is the “prime cost” of gas. The cost of lifting it out of the well is nothing because the full prime cost is exploration, drilling, and significant expenses. Taking into account the costs of exploration and drilling, gas will never cost 3 hryvnias. Otherwise, it may happen that state-owned companies will not have funds for exploration, drilling and replenishment of reserves. This means that the resource base will go down again.”
On the profitability of Ukrgasvydobuvannya
The mentioned bill states that “artificially overstating the price of natural gas produced domestically has had a positive effect on the profitability of domestic gas producing companies. In 2016, the profitability of the largest state-owned gas production company Ukrgazvydobuvannya JSC was almost 99%; in 2017 – almost 332%, in 2018 – 177.3%.
This suggests that the UGV is receiving huge revenues. However, is it so? The expert explained that this is simply an incorrect indicator to even discuss profitability, and not to claim significant profits.
“These are numbers from the financial statements. It is prepared according to the classic standards for any enterprise. And these are not cash flows. Besides, this is profitability, excluding depreciation costs. But depreciation in Ukrgazvydobuvannya is estimated at almost zero because they still have Soviet equipment and wells that have already been depreciated. And this equipment has already outlived its life two or three times – there is a need to buy a new one. And depreciation charge in any case, even if there is no corruption component, will not be enough to purchase new equipment.
Yes, Ukrgazvydobuvannya receives money, but it has to invest significantly more in new wells and new equipment. Low depreciation gives such super profitability, but in reality, there is none of it.
That is why I consider the figures of Ukrgasvydobuvannya concerning the cost and profitability are not conclusive and cannot be analyzed, and professionally discussed.”
To save all the Ukrainian gas for the population
Next, we will analyze bill No.4680.
The bill proposes to supplement the Law “On the gas market” with a new article "On the direction of natural gas accumulated in gas storage facilities during the non-heating period and domestic production by state enterprises for the needs of the population." Is this possible, and what will be the consequences for all market participants?
It is known that the volume of gas that Ukraine is currently producing (about 20 billion cubic meters) would be enough for the needs of household consumers. But if you do as the bill proposes, this will finally kill the domestic gas production. And ill create a corruption "trough", because of the risks that cheap gas "for the population" with a surcharge will be sold to industrial consumers. And by the way, Ukraine has been through this before.
“I am strongly opposed to dividing gas for the needs of the population and industry. Any product must have the same market price in Ukraine because this is a separate market, not European or Russian, where its own gas price is formed.
It can be different when you buy a large or small batch, depending on the terms of payment, like any product. Gas is the same commodity as potatoes or cabbage.
And everyone involved in the gas market must buy and sell gas at open market prices. What is going on now, when we have a different price for the population through selected traders – UAH 7.4, UAH 7.96 for the population, there will also be a different price for district heating companies – UAH 7.4 for certain volumes of gas, for others – hub + 12-13 - this is no longer a market, but attempts to manipulate the market or an attempt to sell gas “from under the counter”, as in Soviet times.
The gas price should be formed on the Ukrainian market, to which both all consumers and all sellers and traders have access.
But since we have an initial level of the market, certain government regulation is a must. I would suggest, and such an idea was discussed, to use the model of the National Bank of Ukraine. Now both an individual and any enterprise can buy a dollar at UAH 27 in the bank. In the gas market, if we compare, it is proposed that enterprises buy at UAH 27, and the population at UAH 8. Yes, this is good for the population, you can buy goods cheaper than the market price. But under such conditions, will it be possible for the population to buy and resell to the industry? Yes. This is no longer a market.
We currently have free currency conversion. The National Bank plays the role of a balance sheet: when there is a great demand for currency, it sells it, when, on the contrary, it buys it. Thus, the NBU maintains the hryvnia exchange rate at a certain level. But it is the same for all market participants and there are no overflows.
It would be correct if the same approach was applied to the gas market. From May to September, we produce more gas than we consume, in October and April there is about zero difference, and from November to March we consume more than we produce. Therefore, a certain role of the state in regulating these waves is necessary to maintain a certain level of gas prices. And it should be affordable for the population, for district heating companies and the industry.
And it would be interesting to have NJSC Naftogaz in the role of the NBU, which would neutralize these waves and protect the market.
Besides, we have an open energy war with the Russian Federation against the European Union and Ukraine; the Russian Federation artificially made the price of gas on the European market very high and reduced supplies. And they will wage this war next winter against Europe and Ukraine.
Therefore, we need to decide which enterprise or government body will be responsible for balancing the gas market system in Ukraine and would carry out certain operations to stabilize prices at an affordable level for Ukraine, for which all consumers could pay."
“The first issue of such a decision is that it does not correspond to the obligations undertaken by Ukraine on the formation of a natural gas market similar to that which operates in Europe. This means a violation of obligations to the European Energy Community and all further conflicts.
Then there is a need to come up with new models. And to say that we fulfil our obligations to join the European Energy Community with one hand, and come up with new models with the other.
The second issue: if a state-owned company (of majority owner) also has a minority owner and if it supplies all gas of its own production to the population at a price that is not a market price, but some different – such a requirement is to beat the interests of the minority owner. There will be a conflict, as it was with Ukrnafta. The minority owner will block such decisions, there will be courts demanding compensation, etc.
Statistically, state-produced gas will be enough to cover the needs of household consumers. But there are negative consequences like a significant price reduction, which means a reduction in incentives for lean gas consumption. It will mean an increase in gas consumption. Then there will not be enough gas for household consumers, budgetary organizations and district heating companies. Besides, it turns out that those who are richer and consume more gas will receive greater preferences than the poor.
But on the other hand, only those who do not have money to pay for gas should be subsidized. And those who can pay must pay. Then this price would cover the capital expenditures as well.
In general, the idea of transferring all the gas of our own production to household consumers looks like a blessing today, but in 5 years we will have a lot of problems."
Mykhaylo Honchar, expert on international energy and security relations, President of the Center for Global Studies "Strategy XXI":
“We have already had it; we have been through this before. And it reeked of primitive socialism. If we say this is a concern for household consumers, we will lose our gas production. This will become the basis for corruption schemes. This is how simply gas with a low social price was then simply sold to commercial consumers.
And going back to this has nothing to do with market mechanisms and no perspective. This is such a "path of Venezuela": given that it is a large oil country, oil products cost almost nothing. And now this country is not functional, it led the country nowhere."
Artem Petrenko, Executive Director of the Association of Gas Production Companies of Ukraine:
“In recent years, a lot has been done in Ukraine aimed at creating transparent market rules. And when some kind of price regulation is introduced, it negatively affects the institutional capacity of the sector.
We are convinced that a free and transparent market is the key to getting new players to come. And the internal ones to see clarity and stability, and can count on their work, because gas production is a very expensive investment business. An increase in production, increase in deductions and economic growth are the most accurate path along which the whole world is going.
Will Ukraine be able to fully provide itself with the gas of its own production?
Currently, Ukraine produces about 20 billion cubic meters of gas and consumes about 30 (industry, the population and heat producers). One can ask a question: will we be able to produce the 10 billion m3 that we lack, and most importantly – when?
Here the opinions of experts diverged. Someone is sure that it is possible to extract 30 billion. Someone that it is too expensive and does not make sense. And yet, an increase in own production is necessary and will have a positive effect on the entire Ukrainian economy. However, under certain conditions.
“It is essential for Ukraine to increase production indicators.
With a stable increase in production, which is possible due to the introduction of various tax incentives and simplification of permitting activities, it is possible to reduce the volume of imports and replace it with our own production. This can have a positive effect on prices.
Besides, the gas production sector has a positive effect on the economy: it is one of the main fillers of the state budget. It also acts as a multiplier, because each hryvnia invested in gas production brings 4-5 hryvnias to the budget. It creates jobs, attracts new technologies.
Ukraine is rich in oil and gas deposits. According to the state balance in Ukraine, there are almost 800 billion cubic meters of gas in the deposits. With the development of technology and the introduction of incentives and the invariability of taxation, we will see positive effects. I hope that the difficult situation of the last year would not recur.”
“If the current level of gas consumption was 30 billion cubic meters, then we would be able to maintain the level of 20 billion gas of our own production the following 5 years.
But I do not expect a serious increase in gas production, because there is a natural decline. New deposits that may be discovered will only replace the current ones. The only major project is the Black Sea shelf. But the effect of it can only be seen in 5 years, and these are super risky projects.
It is better to look at investments in the direction of reducing consumption, in modernizing heating systems, in technologies to increase the efficiency of use as an energy carrier. To get as many calories as possible from 1000 cubic meters of gas. This is a huge opportunity for district heating companies.”
Will Ukrainians be provided with gas by their own production for 3 hryvnias?
Imagine that Ukraine was still able to produce 30 billion cubic meters of gas per year. Will we get cheap gas, how quickly and what does it depend on?
Experts say that it is possible to obtain such gas, but not immediately. First you need to invest a lot of money. In other words, gas will be expensive. But experts do not advise completely abandoning gas imports, since the complete isolation of the gas market can subsequently hurt everyone.
“The issue of the prime cost of gas production is very complex and depends on the operating conditions of the company, on what technologies are involved in production, how deep the deposits are.
It is now impossible to determine what its absolute value will be. However, provided that production increases, when Ukraine does not depend on imports, the price will become attractive to consumers.
And the increase in production is the development of the economy as a whole. Then the consumers of Ukraine will become richer and the issue of gas prices will not matter so much.
“Ukraine currently has 1 trillion m3 of known gas reserves. Of these, production of about 300 billion m3 will cost up to $350- $400 per 1000 m3.
The cost of lifting the remaining 70% of gas is more than $400, sometimes up to $1500 per 1000 m3. The question is: is it worth investing such state funds when we can buy imported gas for $300?
And when we buy imported gas, it is one hundred percent that we will receive this gas. And when we invest in the development of mining, we play in a casino with nature. Therefore, one of the features of the industry is that there is no guarantee that there will be production. There is a hope that there is gas there, and there are attempts to raise it technically. But these are risks: geological – we can see gas at the seismic cut, but in reality there is water, or mistakes can be made during drilling, and the well will not work."
“If the market is saturated, prices will decline. But there is no need to harbour illusions that as soon as they begin to extract something additionally, the price will immediately collapse. No. On the contrary, it will grow immediately. Since when the question what money to invest in production arises, the answer is the money of consumers who pay for the gas consumed.
In this respect, the market mustn't be an isolated one (although we do not have it yet), since there may be situations when imported gas will be cheaper. Like last year, the unprecedented price of about $50 per 1000 cubic meters. That was the price for gas on European markets in the early 2000s. This will help to balance our domestic market. Last year there were such large volumes of gas injection into storage facilities, because there was cheap gas, which will help us this winter season as well.
But politicians and authorities often take a populist stance and try to appease the electorate with promises of cheap energy resources, primarily gas. But it is not something that should be done because the market conditions are very changeable. Gas can be cheap, or it can rise sharply.
If the market is working, the price is not set by "wishlist" in government offices or political parties but is set by market players. We are not used to this. Everyone wants cheap gas and electricity. It is the natural desire of any consumer to pay less and get more.
But the authorities should not deceive either consumers or themselves because any additional gas production means additional costs. Let them not be from the state budget, but then from the budget of the state company like Ukrgasvydobuvannya. If it is a private investment, it must still be returned. And they are returned at the expense of the tariff.
We have good production prospects. But they were there before. However, largely due to populist policies, they were not implemented. Especially, when there were different gas prices. When gas of our own production was at a social price, and at the same time we paid Gazprom $12-14 billion annually, at the peak of oil and gas prices in the early 2010s. And its own gas production remained underinvested because no one wanted to invest there, because you will not get anything. But Gazprom and Russia received money to wage aggression against us later.
The authorities are afraid to explain these things (so as not to scare the voters), one way or another, before we achieve market self-regulation, the price of energy resources will stabilize. First there will be a rise in prices. But there's no need to be afraid of it because it is necessary to make both investments in production and modernize the infrastructure. Especially now when we are not isolated."