Ukraine’s success in liberalising its gas market hinges on structural changes in the distribution sector, Oleg Nykonorov, CEO of the Regional Gas Company (RGC), the country’s largest distribution company told ICIS.
From 1 July, Ukraine is expected to reach a milestone as 12 billion cubic metres of gas, or nearly half of the country’s annual consumption, which were hitherto sold to households at regulated tariffs are expected to be offered on the free market.
The lifting of the public service obligation (PSO), a scheme whereby the incumbent Naftogaz has been required to sell volumes to households and district heaters at below-market values is one of the single most important steps towards establishing a liquid, functional free market in Ukraine.
However, distribution companies say the successful switchover, which would happen in two stages – for households from 1 July and for district heaters from Q2 ’21 – would have to be accompanied by a number of changes in the distribution sector.
These would have to include an overhaul of the distribution tariff methodology and enforced penalties for non-payment of delivered gas.
For years distribution companies and Naftogaz have been embroiled in a dispute over claims of “unauthorised off-takes” of gas. There have been concerns that thanks to the PSO, distribution companies received volumes at below market prices for delivery to households or district heaters, some of which, critics said, may have been resold to industrial consumers at a markup.
Nykonorov said the description of “unauthorised off-takes” was misleading since all volumes were accounted for, being billed for distribution and transmission.
However, he conceded there were several underlying problems such as the non-payment of gas deliveries primarily by large state-owned district heaters and gas leakages, which have led to mounting debt of nearly UAH20bn (€680m).
All these helped create imbalances in the gas market not only for distribution companies, but also for the grid operator GTSO, which is responsible for balancing the transmission system.
Nykonorov said companies such as RGC had sought to overhaul the system so that the distribution grid could be broken down into smaller parts to facilitate the detection of leakages.
Even so, gas leaks from the distribution sector account for 1.5bcm/year, or nearly 5% of national annual consumption. RGC, which distributes 14.5bcm/year estimates that its leaks amount to 1bcm/year.
He said the Ukrainian transmission system was designed to handle over 100bcm/year, but with annual demand falling to around 30bcm in the last five years, gas leaks of 1.5bcm represented an important portion of those volumes.
“Right now, we’re using a huge Soviet vehicle to deliver pizza,” he said.
Nykonorov also said the distribution system required investments but added that even though tariffs had been raised this year and would further increase from 1 July, the hikes were still insufficient to allow them to make a profit.
“We have calculated that in Poland, they [distribution companies] invest €40-€50.00/MWh per customer per year. In Ukraine we [distribution companies] invest €1.00/MWh per customer per year,” he said, pointing out that the distribution tariff in Ukraine was three times lower than those in central and eastern Europe.
Since the beginning of the year, the regulator NERC raised the distribution tariff from UAH0.56/KWh (€0.019/MWh) to UAH0.73/KWh. This would further increase to 0.86/KWh from 1 July, bringing the tariff close to distribution companies’ break-even level.
Even so, Nykonorov said the increase would just allow distribution companies to cover wages and purchase gas for balancing purposes, noting that the tariff would have to increase to an estimated UAH1.20/KWh to help distribution companies to rake in sufficient revenue to allow for significant investments.