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НАК „НАФТОГАЗ УКРАЇНИ“. Річний звіт англійською (2018 рік) - 1

2017 2018

2017 2018

2017 2018

2017 2018

2017 2018

2017 2018

2017 2018

2017 2018

2017 2018

2017 2018

2017 2018

REVENUES

ASSETS

NOPLAT

Integrated

gas

Oil midstream

and downstream

Gas transit

Gas domestic

transmission

Gas

storage

Ukrnafta

Other

118.4

137.8

73.9

72.3

1.0

1.8

27.0

36.1

1.4

211.0

96.3

190.0

200.0

162.1

30.0

21.6

8.6

11.0

189.0

29.0

6.7

10.4

-1.3

-2.7

-3.2

-0.9

-2.4

9.3

4.0

0.6

28.0

2017 2018

27.6

27.2

2017 2018

2017 2018

11.3

13.0

15.0

30.2

2.0

0.9

18.3

28.8

NAFTOGAZ

FINANCIAL

RESULTS

256.3

227.5

603.7

723.1

38.6

41.2

2017

2018

2017

2018

2017

2018

Net

profit

Dividend

payments for 2017

UAH billion

11.6

29.5

Tax

payments

109.1

Capital investments

(+80%)

30.6

Net cash generated

by operating activities

71.6

includes elimination of UAH 33.3 billion for operations within the group

unallocated assets - UAH 25.3 billion

adjusted operating result net of income taxes

-------------------------------------------------------------------------------------------------------------------------------------------------------------

INTRODUCTION

Address of supervisory board chair ��

CEO's address ��

MARKET AND REFORMS

Macroenvironment: a year of big challenges ��

Global gas market ��

Global oil market ��

Unbundling ��

Key regulatory changes ��

OPERATIONS

Naftogaz transformation ��

Integrated Gas Business Unit ��

Oil Unit ��

Technical Business Enabling Unit ��

Gas transmission and Storage Business Delivery Unit ��

Gas Transit ��

Ukrnafta PJSC ��

New businesses� Energy service ��

Arbitration proceedings: Gazprom, Crimea, Ukrnafta ��

CORPORATE GOVERNANCE AND CSR

Report of Naftogaz supervisory board ��

Corporate governance ��

105

Key managers and their remuneration ��

106

Risk management at Naftogaz group ��

108

Human resources management ��

112

Health and safety ��

118

Interaction with local communities ��

124

Investments in energy efficiency ��

128

Ecology and environment protection ��

132

Procurement management��

142

FINANCIAL STATEMENTS

Financial stability ��

146

Key performance indicators in 2018

��

148

Auditor’s qualifications and related comments ��

152

Consolidated Financial Statements ��

153

Independent Auditor’s Report ��

154

Consolidated statement of financial position��

158

Consolidated statement of profit or loss ��

159

Consolidated statement of comprehensive income ��

160

Consolidated statement of changes in equity ��

161

Consolidated statement of cash flows��

162

ADDITIONAL INFORMATION

Determination of the content and the

material topics of the report ��

210

Material topics under GRI Standard ��

212

Terms and abbreviations ��

217

Contacts ��

218

CONTENTS

2018

-------------------------------------------------------------------------------------------------------------------------------------------------------------

ADDRESS

OF SUPERVISORY

BOARD CHAIR

It is great privilege for me to chair

Naftogaz supervisory board in such a

difficult and important period for both

the company and Ukraine�

I had hoped to be part of crucial reforms

to improve the quality of life for tens of

millions of people and to enhance the

energy security of a young democracy

fighting for its independence. The job

carries huge responsibilities.

The board’s key priority is to help

Naftogaz create great wealth for the

Ukrainian people. To do that, we need

professional management and immunity

to political interference.

Over the past few years, Naftogaz has

become a showcase of successful reforms

in a big Ukrainian state-owned company�

Naftogaz was the first state-owned

company to obtain an independent

supervisory board and swiftly progressed

from a loss-generating black hole to the

biggest taxpayer�

Unfortunately, these reforms have

recently been largely reversed� This

reversal puts at risk the great strides

Naftogaz has been making in ensuring

it is internationally competitive and is

maximizing the value of its assets.

The government needs to reinstate good

corporate governance at Naftogaz and

then safeguard those achievements

and make the changes irreversible� To

do this, OECD recommendations on the

corporate governance reform at Naftogaz

should be implemented�

In its report State-Owned Enterprise

Reform in the Hydrocarbons Sector

in Ukraine issued in 2019, the OECD

highlighted a number of positive changes

in Ukraine, including the following:

• enacting the natural gas market

law, which aimed to facilitate the

implementation of the Third energy

Package and other elements of the EU

acquis, and introducing transparent

public service obligation (PSO) regime for

categories of protected consumers; with

plans to align gas prices with the market;

• specifying a gas transit operator as

part of its unbundling and certification

requirements, while also introducing

opportunities for more investment

and private participation in the energy

sector;

• transforming the corporate governance

of Naftogaz, including establishing the

first-ever independent supervisory

board using as a benchmark the OECD

Guidelines on Corporate Governance

of SOEs;

• progressive upgrading of the SOE

corporate governance frameworks,

including independent board

requirements and external

independent audit; annual aggregate

reporting by the state-owner; passing

the long-awaiting Law “On privatization

of state and communal property”; and

professionalizing board nomination

practices.

The OECD also notes that the Ukrainian

government needs to make a series

of important regulatory decisions to

accomplish the corporate governance

reform at Naftogaz. First and foremost,

to empower the supervisory board with

the necessary authority to carry out core

functions of hiring/firing of CEO, approve

strategy, financial and investment plans

as well as to assign an appropriate

level of operational autonomy to the

executive board and the CEO. The latter

includes eliminating the requirement

for the government to approve business

transactions in the presence of a proper

system of internal controls�

For more effective governance, Naftogaz

should have control over its assets,

including those that are owned by fully-

owned subsidiaries. The organizational

transformation of Naftogaz group

with the transition from separate legal

entities to business divisions will ensure

relevant functions are not duplicated in

individual subsidiaries and facilitate the

implementation of best international

practices in finance, human resource,

strategy, legal, IT and other functions.

Every year’s production depletes

our oil and gas fields. To maintain

production requires new investment,

and increasing production requires

additional investment on top. With the

government’s take of Naftogaz profits,

which was 50% in 2017, rose to 75%

in 2018 and is proposed to be 90% in

2019 the company cannot fund the

level of investment required even to

maintain production. It can only get the

funds necessary to invest in increasing

production from external sources. Recent

deterioration in Naftogaz’s charter and

its new dependence on government

make the said sources somewhat less

accessible, though this funding option

remains top priority for production

increase�

Naftogaz’ transit contract with Gazprom

terminates at the end of 2019� There is

no new contract currently in place� This

means we have to plan for the worst-case

scenario – the termination of Russian

gas transit after 2019 – and design an

emergency plan for complete loss of the

transit revenue�

In order to ensure domestic and

international gas flows in 2020 we will

require additional cushion gas. This

requires capital to purchase more

gas. Again, just as with investment for

production, Naftogaz will need capital to

enable it to buy the necessary gas� Gas

will have to be purchased and come into

storage over 2019 to be available for

2020�

Since becoming Chair of Naftogaz su-

pervisory board I have taken personal

responsibility to deliver TSO unbundling

alongside our CEO, Andriy Kobolyev. To

ensure everyone can hold Naftogaz to

account we hold quarterly stakeholder

meetings to report on progress. We are

committed to delivering an unbundled

TSO by June of this year, allowing time for

the necessary legal and legislative actions

to be out in place to ensure a fully un-

bundled TSO by 1 January 2020 when the

current contract with Gazprom expires.

In order to maintain our ability to pursue

our ongoing arbitration with Gazprom,

which could be worth USD 10�4-14�8

billion, it is important for Naftogaz to

continue to have an economic interest

in the assets of the TSO� This requires an

ISO model for unbundling�

To be a true ISO it is essential for

customers of the pipeline network that

the new unbundled TSO treats them

in the same non-discriminatory way as

they would be treated if the TSO were in

fact ownership unbundled. Naftogaz is

committed to ensuring that this will be

customers reality and we will work with

the regulator to deliver this outcome�

TSO and SSO branches are already op-

erating within Ukrtransgaz; and the

consortium of potential partners for the

Ukrainian GTS has been formed. We ex-

pect secondees from the consortium to be

embedded into the TSO well before June.

The international consortium’s involve-

ment is expected to continue into 2020

which should help to ensure both good

governance in the new unbundled TSO,

and that the new TSO treats all customers

in a non discriminatory way regardless of

the economic interests in its assets�

For Naftogaz to continue generate profit

and create value for its ultimate owner –

the people of Ukraine – the government

as a shareholder needs to ensure both

the financial stability of the company

and the company’s independence from

government�

Without both these conditions, the

company will not be able to borrow

from international markets on beneficial

terms. Without capital Naftogaz cannot

deliver adequate levels of investments

into upstream or fill underground gas

storages before the winter season�

I am grateful for the immense support

we get from Ukrainian reformers and

international stakeholders in changing

Naftogaz. The group’s success could be

an important driver in the reform of

the overall SOE sector in Ukraine and

produce far-reaching implications for the

society, citizens’ everyday life and other

businesses�

Clare Spottiswoode

Supervisory board chair

-------------------------------------------------------------------------------------------------------------------------------------------------------------

CEO’S ADDRESS

Over the last five years, Ukraine has done

more to reform its energy sector than

during the entire previous period since

independence in 1991. Naftogaz is an ex-

ample of these changes. Unlike in 2014,

we no longer pose a threat to Ukraine's

independence. Instead, the company is

now central to safeguarding Ukraine’s

energy security�

Due to these changes, the Kremlin can no

longer dictate to Ukraine over the avail-

ability of gas and heat in Ukrainian homes�

The reliability of Ukraine’s gas transmis-

sion system has helped create a powerful

international coalition in the fight against

Russian aggression. Meanwhile, modern

Western technologies have finally reached

Ukraine, helping us to compensate natural

declines and increase gas production.

Unlike many previous years, Naftogaz is

now the largest contributor to the state

budget and supports the Ukrainian gov-

ernment in their efforts to maintain mac-

rofinancial stability.

We now face the challenge of preserving

these achievements and unlocking the

true potential of Naftogaz group. This

challenge is crucial, especially as we look

ahead to unbundling and the separation

of gas transmission activities from Naf-

togaz group from 1 January 2020.

Our vision for the future

Our objective is to transform Naftogaz

from a highly bureaucratic structure into

the most efficient energy company in the

region. We aim to become flexible, con-

sumer-oriented and competitive in our

key markets� The goal is to ensure that

the value created by our group is clear

and tangible for Ukrainian consumers�

We strive to become a company that

deserves to be admired�

To reach these objectives, we launched

the structural transformation of Naf-

togaz last year. We have thoroughly

analyzed all group assets, risks and

opportunities in the markets where we

operate. We believe that in the event

of successful transformation, Naftogaz

can provide Ukraine with an additional

5% of GDP annually and increase the

company's value by USD 35 billion in the

medium term�

From 2019, our units will be grouped

into business units: Integrated Gas, Oil,

Technical, Transmission and Storage

and others� Specific goals and clear

performance targets will be set for

each division� Individual division man-

agers will be personally responsible for

the operational and financial results of

their division�

In order to be successful, we must be-

come the most attractive employer in

Ukraine for gifted and ambitious profes-

sionals. We strive to be a transparent and

trustworthy employer where personal

responsibility is encouraged and where

everybody adheres to the highest ethical

standards�

In pursuit of these goals, we aim to build

a long-term partnership with leading

international companies. This will help

Naftogaz to integrate into the global

economy, paving the way for our coun-

try’s continued integration.

Why this is important

First, transformation is a national priority.

Given Naftogaz's size and the attention

focused on the group, we have a unique

opportunity to lead the way towards

Ukraine's energy independence. We are

sufficiently visible to become a model for

reform, and to attract significant invest-

ment on reasonable terms� I regard this

as both an opportunity and a responsibil-

ity for Naftogaz.

Second, Ukrainian society stands to ben-

efit directly from our success because

we are a 100% state-owned company� By

earning money for Ukraine, we help the

government do more for all our compa-

triots�

Third, the transformation process is also

important for our customers. We provide

gas and energy services, directly or indi-

rectly, to about 90% of Ukrainian homes.

In the process of transformation, we plan

to increase the number of customers

we provide services. We strive to offer

reliable delivery, transparent and fair

rules, as well as high-quality service to

Ukrainian consumers. Such service is still

far too uncommon in the Ukrainian utility

market�

And finally, successful transformation is

also important for our team� It will allow

them to work in an environment where

quality is recognized and rewarded. This is

an opportunity for each of us to take re-

sponsibility and to change the situation for

the better. It is a chance to do something

important for Ukraine while developing

personally and growing professionally�

How to reach our goals

Making a success of this transformation

requires considerable efforts. We plan to:

• Ensure a smooth and timely unbundling

of the GTS operator, which will help

Ukraine to maintain gas transit and im-

prove the efficiency of the domestic gas

market

• Continue developing gas extraction,

both independently and together with

international partners

• Achieve complete liberalization and

transparency of the national gas market

• Become a direct supplier of utilities. We

aim to take advantage of our experience

and position in the market to serve the

end user without intermediaries, while

at the same time making the utility mar-

ket more transparent and efficient

• Enter the energy efficiency market. We

plan to offer energy services to house-

holds that will help reduce inefficient

energy use and decrease customer gas

and heat expenditures

• Enter the renewable energy market

using our extensive infrastructure in an

optimal way

• Upgrade infrastructure by implementing

the highest IT and automation stan-

dards, increasing operational efficiency,

and developing our technical capacities.

To achieve this, we need to tackle many

issues, from implementation of large-

scale IT systems to small but important

innovations that will improve the oper-

ations of our drilling, mining and trans-

port departments

• Comprehensively transform our orga-

nization, including systems, processes,

culture and people. We are developing

a new performance management sys-

tem that will attract and retain talented

professionals, give them the opportu-

nity to demonstrate results and receive

due recognition

• Continue corporate governance reform

in line with OECD recommendations

so that decisions are made quickly, in a

transparent way, and in the best inter-

ests of the company

We will continue to adhere to our core

values of openness, fairness, courage and

conscientiousness in everything we do.

They will drive the changes in the group

from the inside�

In addition to internal transformation,

we need to reboot relations with the

government and to enhance constructive

cooperation with civil society and other

stakeholders�

We are well aware that without this step,

any further progress in the reforms initi-

ated at Naftogaz is impossible.

As early as in July 2019, we will have

to deal with unprecedented challenges

caused by a potential liquidity shortage.

In order to cope with these challenges,

we need support and combined efforts

of a wide range of stakeholders, in

order to:

• Change the rules of the game in the

national gas market so that Naftogaz

does not have to finance the failure to

pay by some if its counterparties.

• Ensure that Naftogaz is able to raise

debt on attractive terms. Since 2014,

our loan portfolio has decreased 6.6

times and is currently unnaturally low

for an oil and gas company�

• Ensure high-quality unbundling and

preserve gas transit through Ukraine�

I sincerely believe that by working

together, being passionate about our

business, open and accountable to

each other, we are able to make a

significant contribution to the develop-

ment of Ukraine and the well-being of

its citizens. I am sure that together, we

will make Naftogaz a better company

and achieve results that Ukrainians can

take pride in�

Andriy Kobolyev

Chief Executive Officer

-------------------------------------------------------------------------------------------------------------------------------------------------------------

MARKET AND REFORMS

ANNUAL REPORT 2018

2018

MACROENVIRONMENT:

A YEAR OF BIG CHALLENGES

At first glance, last year’s results i.e. the

key macroeconomic indicators give no

rise for pessimism. They appear to be the

best in the last five-year period – since

the Revolution of Dignity, the annexation

of the Crimea, and the occupation of

territories in eastern Ukraine:

• GDP growth rate exceeded that of 2017

by almost 0.8 percentage points.

• Inflation, for the first time in 5 years, is

not within the two-digit range, reaching

a mark of 9.8%.

• Gold and foreign exchange reserves,

for the first time in the last five years,

returned to USD 21 billion.

• The unemployment rate according

to ILO methodology, for the first time

since 2013, was less than 9%.

• Real average monthly salaries kept

growing for the third consecutive year

(+ 12.5% in 2018).

However, a more detailed analysis reveals

that in 2019-2020, Ukraine will face a

number of dangerous challenges to the

economy, while the changes achieved

by the end of 2018 are insufficient to

confront them. In addition to risks related

to the political election cycle, including

parliamentary elections in October this

year

, in 2019, the Ukrainian economy

will face a number of significant external

threats and unresolved old domestic

problems. Primarily, this means Ukraine

further lagging behind the global

economy and the threat of an economic

crisis due to the loss of transit in 2020:

• The economy keeps on growing at rates

below the growth rates of developing

countries. In 2018, Ukraine's real GDP

increased by 3.3%, while average

growth rates in developing countries

amounted to 4.5%. Ukraine is not

reducing, but rather increasing the gap

even compared with the neighbouring

Eastern European countries, which

grew by an average of 3.6%.

• According to the IMF, the accumulated

gap between the Ukrainian economy

and the global economy is not expected

to decrease: the average growth rate

of Ukraine's economy in 2019-2024

(3.1%) will be less than the growth

rate in 2018, and also less than the

global expected average growth rate

(3.6%). As a result, even in 2024, the

share of the Ukrainian economy in the

global economy, according to the IMF

forecast (0.18%) will not reach the level

recorded in the period before 2014

(0.23% in 2013).

• Even this non-optimistic forecast does

not take into account the negative effect

of the expected termination of transit

in 2020, which will trigger an economic

downturn [See. section "Gas transit").

According to our estimates, no revenues

from transit will result in decrease in

GDP by about 4%, with conservative

estimations of any possible multiple

effect. Since the IMF expects GDP growth

in 2020 of only 3%, then if you subtract

4% from the loss of transit, GDP will show

a 1% drop. Therefore, if no compensation

from Gazprom is received, the situation

with the termination of transit will lead to

an economic crisis in 2020. At the same

time, it may lead to a shortage of gas in

the country, which will further adversely

affect both energy security and economic

growth. In such a case, Ukraine would no

longer be important for Europe as a gas

transmission country to the European

market, leading many experts to conclude

that it will increase the threat of full-

scale military aggression by the Russian

Federation

• In addition to the negative effect

of transit termination, another

significant risk to the economy is the

deterioration of external conditions

due to the possible shift of the world

economy to a downturn phase,

which international experts

warn

about, as well as an increase in world

commodity prices volatility. The risks

of a more rapid downturn of the

world economy have been increasing

recently in the context of increasing

geopolitical conflicts and "trade wars",

uncertainty about Brexit, decreases in

the growth rate of the Eurozone, and

"deleveraging" the Chinese economy,

together with increasing volatility in

financial markets.

Another potential risk, often mentioned

throughout 2018, is the period of peak

According to NBU survey in January 2019, 56% of respondents believed that presidential and parliamentary elections were a major challenge for Ukraine’s economy in 2019. Top 3 challenges
also included protection of investors’ rights and freedom of entrepreneurship (19%) and the upcoming peak of foreign debt repayment by Ukraine (13%).

See, for example: https://www.rbc.ua/ukr/news/tranzit-gaza-cherez-ukrainu-sderzhivaet-agressiyu-1526099213.html

See, for example: https://www.theguardian.com/business/2018/dec/11/imf-financial-crisis-david-lipton

7.2%

9.3%

9.1%

9.3%

9.5%

8.8%

0.5%

24.9%

43.3%

12.4%

13.7%

9.8%

10%

20%

30%

40%

50%

2013

2014

2015

2016

2017

2018

Unemployment rate according to ILO methodology (right axis), %
Inflation rate, % December-to-December (left axis)

Real GDP change rate, % (left axis)
International reserves by the end of December, USD billion (right axis)

Ukraine

Developing countries

European developing countries

World

Developed economies

Ukraine

Developing countries

European developing countries

World

Developed economies

0.0%

-6.6%

-9.8%

2.4%

2.5%

3.3%

-12%

-10%

-8%

-6%

-4%

-2%

2013

2014

2015

2016

2017

2018

3.1%

4.8%

2.6%

3.6%

1.7%

3.3%

4.5%

3.6%

2.2%

Inflation and unemployment rates in 2013-2018

GDP growth rates and size of international reserves

Actual real GDP growth in 2018

Average expected real GDP growth rates

in 2019-2024 (according to the IMF)

foreign debt repayment. After Ukraine

agreed with the IMF on a new stand-by

credit program and received the first

tranche under it, the experts began

pointing out this problem much less

often. However, the aforementioned

potential slowdown in the world

economy will directly and indirectly

affect revenues to the state budget,

in view how dependent Ukraine is

on export earnings and the share of

commodities in exports. In turn, a

decrease in state budget revenues from

export-oriented industries, as well as the

risk of losing tax revenues associated

with gas transit, may adversely affect

the country’s capability to repay and

service sovereign debt.

GDP growth rate in 2020

0.00%

0.05%

0.10%

0.15%

0.20%

0.25%

0.30%

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

2.99%

-1.01%

...according to IMF forecast

in case of termination of transit

In 2019

4.5%

In 2021

25.6%

Not in the next 5 years

18.8%

In 2020

51.1%

When do you expect the next global economic crisis?

(% of the respondents’ replies)

Ukraine’s share in the global economy

Data: IMF, State Statistics Service of Ukraine, calculations of Naftogaz analytical department

Data: NBU, State Statistics Service of Ukraine, calculations of Naftogaz analytical department

Data: IMF, State Statistics Service of Ukraine, calculations of Naftogaz analytical department

Data: IMF, calculations of Naftogaz analytical department

Data: Results of the survey during the 9th CFA Society Ukraine Investment Forum

-------------------------------------------------------------------------------------------------------------------------------------------------------------

MARKET AND REFORMS

ANNUAL REPORT 2018

2018

The decline in oil prices, which is usually

observed when the world economy

slows down, entails lower prices for

other commodities like grain, which is

one of the main Ukrainian exports. As a

result, the already high deficit of balance

of trade, which is close to the pre-crisis

figures for 2008 and 2013, may increase

even more due to a possible fall in prices

for export commodities produced in

Ukraine. If these factors are combined

with the loss of more than USD 2.5 billion

in transit revenues, it is most likely that

in the absence of significant inflows to

the financial account of the balance

of payments, a currency crisis will be

triggered.

In 2019, Ukraine remains exposed to the

risks of further intensive labor migration

with its negative impact on the level of

skills of the labor force in a situation when

wages and salaries are under pressure.

According to experts, labor migration

may be aggravated due to the plans of

Germany

and the Czech Republic

make employment conditions for foreign

nationals more favorable.

Experts say that the effective allocation

and use of available resources in the

country, as well as creating conditions

for more active involvement of direct

international investors with their

knowledge, technology and financial

capital, is critically important in the

current situation. These issues are

interconnected and their solution will

have a positive impact on macroeconomic

indicators:

a) attracting investors both with financial

resources and relevant technical

expertise would allow for the most

effective deployment of Ukraine’s

competitive advantages, since modern

technologies enable more effective use

of the resources available in the country;

b) new technologies that are available to

international investors would help to

cover the shortage of skilled labor force;

c) attracting well-known international

investors in various sectors, including

in the oil and gas sectors, would

contribute to a reduction in the risk of

full-scale military aggression by Russia;

d) direct investments would cover part

of foreign currency deficit that will

arise due to possible lack of gas transit

revenues.

For example, the hypothetical loss of

gas transit revenues could be offset

by the development of Ukraine’s own

gas production and energy efficiency

improvements. As factual data reveals

this scenario is difficult to achieve, so

Naftogaz, in order to increase the chances

of success, can become a platform to

attract international investors to specified

segments. As the world practice shows

that the major international players in

the oil and gas market are very cautious

about investing in the Ukrainian economy

on their own and need a strong and

trustworthy local partner.

See https://www.dw.com/cda/uk/на-роботу-до-німеччини-що-зміниться-з-майбутнім-міграційним-законом /a-46803394

See https://politeka.net/ua/news/economics/878330-chehija-gotovit-zakon-o-trudoustrojstve-ukraincev-polsha-ne-nuzhna/

Along with the elimination of corruption schemes in retail gas supply through the market liberalization according to European rules

100

200

300

400

500

2019

2020

2021

2022

2023

2024

2025

2026

2027

2028

2029

Domestic debt

Foreign debt

Scheduled sovereign debt repayments as of 01.04.2019, UAH billion

-14.4

-2.0

-4.0

-10.1

-14.3

-15.6

-4.6

-2.4

-6.5

-8.6

-11.2

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

Balance of goods and services, USD billion

Data: Ministry of Finance of Ukraine

Data: NBU

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MARKET AND REFORMS

2018

ANNUAL REPORT 2018

TWh

2016
2017
2018
2019

Jan

uar

Febr

ril

May

Jun

Jul

Augu

Sep

temb

tob

vemb

cemb

200

400

600

800

1000

1200

kWh/d

EUR/

-h

1000

2000

3000

4000

5000

6000

Volumes in 2017 (left axis)

Volumes in 2018 (left axis)

NCG hub price in 2018 (right axis)

April

May

June

July

August

September

October

Change in European UGS reserves in 2016-2019

Injection into European UGS in 2017-2018

-10%

-17%

kWh/d

500

1000

1500

2000

2500

3000

3500

4000

4500

5000

January 2017

February 2017

Mar

ch 2017

April 2017

y 2017

June 2017

July 2017

August 2017

Sep

tember 2017

Oct

ober 2017

vember 2017

December 2017

January 2018

February 2018

Mar

ch 2018

April 2018

y 2018

June 2018

July 2018

August 2018

Sep

tember 2018

Oct

ober 2018

vember 2018

December 2018

January 2019

February 2019

Nord Stream

Mallnov (Yamal-Europe)

Uzhgorod-Velké Kapušany

Transit flows from Russia in 2017-2019

GLOBAL GAS MARKET

One of the key events at the beginning of

2018, producing an impact on the market

throughout the year, was the sharp rise in

prices against the backdrop of anomalous

cold spell due to the anticyclone from

Siberia (Beast from the East). During

the week of late February – early

March 2018, prices in European hubs

temporarily increased by several times.

At the German NCG, the average daily

price jumped from around € 20 / MWh to

€ 70 / MWh.

Since the beginning of February 2018,

the natural gas consumption rate

by households in the countries of

Northwest Europe

was higher than the

average consumption rate for the same

period in 2016 and 2017 and increased

significantly at the end of February. A

10° C drop in temperature below normal

average for that time of year, while UGS

stocks were seasonally runout, reduced

available resources to cover the growing

demand by several times.

Beast from the East

2000

4000

6000

8000

10000

12000

05.

07.

11.0

17.

.02

27.

.03

05.

07.

11.0

17.

27.

Actual consumption in 2018
Average consumption in 2016-2017
Maximum consumption in 2016-2017

kWh/d

January 2018

February 2018

Mar

ch 2018

April 2018

y 2018

June 2018

July 2018

August 2018

Sep

tember 2018

Oct

ober 2018

vember 2018

December 2018

January 2019

EUR/

МW

-h

Change in natural gas price in 2018-2019, NCG hub

Gas consumption by households in Northwest Europe

Calculated based on household consumption data for Germany, France, Belgium and Holland sourced from Thomson Reuters.

Source: Thomson Reuters Eikon

Source: Ukrtransgaz

On 2-3March 2018, the pressure at the entrance to Ukraine’s GTS from Russia remained critically law. For example, at Suja gas metering station, it was 50-51 kgf/cm

, while the contractual pressure is

60-65 kgf/cm

: http://utg.ua/utg/media/news/2018/03/gazproms-actions-has-provoked-an-emergency-in-a-stable-gas-transit-to-eu-countries.html

Furthermore, Russian gas supply

to Europe was very low in January

and early February 2018. Unlike

the Ukrainian route, other routes

for Russian gas transit to Europe

(the Yamal and the Nord Stream gas

pipelines) operated at maximum

capacity. Therefore, demand for natural

gas in Slovakia, the Czech Republic and

Italy was partially satisfied by exports

from Germany. With a sharp drop in air

temperature, the distribution of transit

flows changed significantly. Since only

Ukraine’s transit route has sufficient

capacity and flexibility, gas transmission

through the Ukrainian GTS began

to increase gradually and reached

155 mcm per day at the Uzhgorod /

Velke Kapushani point by the end of

March, which was almost three times

higher than in early February

Besides the mentioned change in

transit flows, the surge in prices caused

by the unusual drop in temperature

affected the Ukrainian market even

more because of a gas shortage during

the said period. At the end of February

2018, Naftogaz made a prepayment

to Gazprom for gas that should have

been delivered in March 2018 under

the Stockholm arbitration award in

the supply case. However, the Russian

side again decided to use gas as a

"political weapon", and Gazprom did

not supply the pre-paid gas to Naftogaz.

This caused a critical situation with

gas supply to consumers in Ukraine,

and Naftogaz had to urgently purchase

natural gas from European countries

to replace the Russian gas that had not

been supplied. During the period of

sharp cooling, increasing consumption

and reducing trans-border gas flows in

Europe, Naftogaz suffered losses due to

the increased purchase price.

The threat of a disruption in the heating

season that arose because of Gazprom’s

failure on both gas supply and transit

contracts

was eliminated thanks to

the rapid purchase of gas in Europe, an

increase in the volume of natural gas

withdrawal from UGS, and the flexibility

of Ukraine's pipeline system.

Impact on the Ukrainian market

2.2

20.0

22.

02.2

2.2

10.0

62% 62% 60% 59% 60% 61% 62% 62% 64% 61% 62% 63%

64%

65%

70% 69%

60%

60% 59% 59%

54% 51% 50%

47% 45%

39%

43%

47% 46%

100

150

200

250

300

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Gas from UGS (right axis)

Import (right axis)

Own production (right axis)

Share of gas from UGS in supply (left axis)

Sources of gas supply to Ukrainian consumers in February-March 2018

Europe closed the winter heating season

at a record low level of gas reserves in UGS

facilities. Gas demand should have therefore

remained rather high during the summer

season to ensure maximum replenishment of

UGS reserves.

Right after the end of the heating season,

market participants maximized injec-

tion into underground storage facilities.

The injection rate in April-May 2018

increased by 35% compared to the same

period of 2017, and the highest injection

rate was recorded in May 2018.

Source: Gas Infrastructure Europe (GIE), AGSI+

Source: Gas Infrastructure Europe (GIE), AGSI+, Thomson Reuters

The expected increase in injection into the

UGS facilities contributed to the growing

demand and consequently boosted spot

prices with spread tightening under the

contracts with delivery in summer to the

prices of the contracts with delivery in

winter 2018/2019.

Market after the March shock

According to ENTSOG, Thomson Reuters.

-------------------------------------------------------------------------------------------------------------------------------------------------------------

MARKET AND REFORMS

2018

ANNUAL REPORT 2018

Change in trend

Source: Thomson Reuters, in-house calculations

April

May

June

July

August

September

October

NCG hub price in 2017 (01.04.2017 = 100%)
NCG hub price in 2018 (01.04.2018 = 100%)

80%

90%

100%

110%

120%

130%

140%

150%

160%

Relative price change at the NCG hub

during gas-injection season 2017 and 2018

As of the start of the gas off-take season

in Europe (October 2018), total gas

stocks were almost 2 bcm less against the

same period in 2017. Meanwhile, higher

temperatures throughout continental

Europe in November-December 2018

and the extension of the injection period

made UGS stocks as of 31 December

2018 almost 6 bcm higher than in 2017.

These factors, combined with increased

LNG supplies in the second half of

2018 and the situation in other energy

markets, became drivers for lower gas

prices.

The change in volumes of LNG supplies

to the European market needs a more

detailed discussion. Starting from

Q4 2018, after the launch of new transfer

lines at LNG terminals in Yamal in Russia,

Ichthys in Australia, and Sabine Pass and

Corpus Christi in the US, supply on the

LNG market gradually increased. At the

same time, moderate temperatures in

Asian regions at the beginning of the

winter season and a rather comfortable

level of gas stocks led to a decrease in

demand and prices. In addition, the

specified period demonstrated a record

high freight rates for LNG shipping. All

of these factors led to the redirection of

LNG freight flows from the Asia-Pacific

region to Europe.

The comfortable level of resource supply

to the European market and higher

than normal temperatures impacted on

natural gas prices.

In general, the change in natural gas

prices in the European market during the

injection season 2018 had an upward

trend, which, in addition to the above

factors, was due to the following:

- a decrease in LNG imports in the

summer due to high premiums on Asian

markets compared with the price of

natural gas in Europe;

- a gradual increase in oil and coal prices,

as well as the prices for European

quotas for greenhouse gas emissions;

- low water levels in the main shipping

rivers of Europe, which made the

prompt delivery of coal to coal-fired

plants impossible.

Jan

uar

Febr

Mar

April

June

July

August

Sep

tember

Oct

ober

vember

December

2017

2018

-h

0,0

5,0

10,0

15,0

20,0

25,0

30,0

ril 2

ay 2

ne 2

ly 2

st 2

Sep

temb

r 2

cemb

y 2

ry 2

Average price at NCG hub, summer 2018
Average price at NCG hub, winter 2018 - 2019

Average monthly price at NCG hub

- 9 EUR/MW-h

LNG imports to Europe in 2017-2018

Price change at NCG hub in summer-winter 2018-2019

The volume of transit in 2018 amounted

to 86.8 bcm, which is 6.7 bcm (or 7.2%)

less than in 2017.

The transit flow decreased unevenly by

exit points – about 65% or 4.3 bcm of

total decline in transit volume was due

to a decrease in transmission to Slovakia

(due to more intensive use of Nord

Stream).

The volumes of transit flows in 2018

were higher than those of 2017 in only

two periods – during a cold snap in

March 2018, and during the maintenance

of the Yamal and the Nord Stream

pipelines in July 2018. In Q1 2018, the

Nord Stream became the main route for

supplying Russian gas to the EU (36% of

total supply), slightly exceeding transit

through Ukraine (34%)

In 2018, the Russian Federation and

its partners made a number of steps

towards the implementation of the

Nord Stream 2 project and its land

extension – the EUGAL pipeline. Gazprom

is also implementing TurkStream – a

gas pipeline project that runs through

the Black Sea to Turkey and will have

two strings with a total capacity of

31.5 bcm / year, which threatens to stop

transit through Ukraine in the southern

direction.

Gas transit through Ukraine

bcm

62.2

67.1

82.2

93.5

86.8

100

2014

2015

2016

2017

2018

Transit volume

Change compared to previous year

23%

14%

-7%

Volumes of natural gas transit through Ukraine in 2014-2018

bcm

53.5

20.2

11.7

4.7

2.7

0.7

49.2

18.1

11.8

4.0

2.9

0.7

Uzhgorod

(Slovakia)

Orlovka

(Romania)

Berehove

(Hungary)

Drozdovychi

(Poland)

Moldova

Tekove

(Romania)

2017

2018

Distribution of transit flows by exit points in 2017-2018

m/da

January

February

Mar

April

June

July

August

Sep

tember

Oct

ober

vember

December

100

150

200

250

300

350

2017

2018

Change gas volumes via the Ukrainian GTS in 2017-2018

EC Quarterly report on European Gas Markets issue 1, quarter

of 2018

Source: Thomson Reuters

Source: Ukrtransgaz

Source: Thomson Reuters

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