On the surface, it was a technical change.
On Aug. 1, Ukraine was scheduled to implement several provisions of the gas transportation system — or GTS — code that it passed in 2016. One of the most important changes would be the daily balancing of the system. Supporters say it would allow gas trading based upon daily contracts and add liquidity to the gas market.
But as with many reform issues in Ukraine, this one has turned into a flashpoint of conflict among key players with different visions of their industry.
Ukraine’s National Commission for State Regulation of Energy and Public Utilities and the private Regional Gas Company insisted that these GTS code provisions be implemented on schedule. Meanwhile, the state natural gas company Naftogaz strongly objected, suggesting the code risked collapsing the gas market for social consumers and legalizing gas theft.
Ultimately, the National Commission decided to delay implementation until Oct. 1, raising hopes that the problem can be resolved. But the division remains deep and the accusations swirling around the code dispute are serious.
Unfair bargain?
What does it mean when Ukraine’s state gas company suggests elements of the GTS code will legalize gas theft?
Naftogaz could not be reached for comment. But Oleksandr Kharchenko, managing director of Ukraine’s Energy Industry Research Center, which has done consulting work for the gas company, laid the risks out in an article for the Atlantic Council’s Ukraine Alert blog.
Gas provision in Ukraine is handled by regional gas distribution companies colloquially known as “oblgazes.” Globally, local distributors are a common part of many energy systems. But, in Ukraine, roughly 75 percent of oblgazes belong to exiled oligarch Dmytro Firtash through his Regional Gas Company, and they are often regarded as avenues of corruption.
Firtash is currently under house arrest in Vienna and fighting extradition to the United States on bribery charges, but still plays to key role in Ukraine’s gas market.
Ukraine’s oblgazes owe around $1 billion in debt to Naftogaz subsidiary UkrTransGaz, which handles the withdrawal and transportation of gas. The GTS code will allow these oblgazes to start over with a blank slate and not pay back these debts, according to Kharchenko.
But Firtash’s Group DF challenges this assessment. In a written statement to the Kyiv Post, it said that the Regional Gas Company’s debt was exaggerated. In reality the company has 5 billion hryvnia ($184.4 million) of debt as of the first quarter of 2018, which Group DF blamed on “economically unjustified tariffs” that make it impossible for oblgazes to cover expenses.
The GTS code will also require large gas consumers — for example, industrial enterprises — to pay capacity booking tariffs through the oblgazes. Previously, such consumers paid the tariffs, worth close to $130 million in total, directly to UkrTransGaz. Sending them through the oblgazes increases the likelihood they won’t reach UkrTransGaz, Kharchenko believes.
Additionally, if a consumer does not pay its bills to Naftogaz, the code will require the company to impose the cost on all consumers.
Finally, since 2016, when companies take more gas from the system than they are assigned without paying, it is considered “balancing services.” Previously, it was regarded as a crime. This regulatory shift has caused the oblgazes’ debts to UkrTransGaz to jump from roughly $370 million to $1 billion in two years, Kharchenko told the Kyiv Post.
Kharchenko believes these changes are a real victory for the oblgazes, and suggests Firtash lobbied for their inclusion in the code.
Group DF did not deny lobbying, stressing that it is a stakeholder with a legal right to advocate for its interests.
But Kharchenko is not the only one with objections.
Yuri Hollyak, a former member of the National Commission, says the commission broke the law when creating the code. It excluded his contributions from the code, its chairperson de facto removed him from the development process, and the commission signed thousands of documents bypassing him, Hollyak writes in an op-ed for Novoye Vremya.
The current code grants preference to oblgazes, and blocks new players from entering the market. It also allows the oblgazes not to report who is consuming the gas, Hollyak writes, echoing a complaint Naftogaz previously expressed to the Kyiv Post.
If allowed to continue in its current form, the code will cause UkrTransGaz to accumulate catastrophic amounts of debt, Hollyak concludes.
Unfair system
At the core of this issue is a stark fact about Ukraine’s energy system: it often appears as if it was designed to promote corruption.
Between 2004 and 2009, RosUkrEnergo, a company co-owned by Firtash, was the sole and lucrative intermediary in gas deals among Russia, Ukraine, and Europe. In 2006, the anti-corruption organization Global Witness questioned what service the Swiss-registered firm could be providing to justify its existence. Both Naftogaz and Russia’s state-controlled Gazprom company were capable of gas trades without a middleman, the organization wrote.
The gas industry has also seen its share of political nepotism. In 2012, a virtually unknown businessman named Serhiy Kurchenko shot to wealth and fame by importing and selling gas, aided by then President Viktor Yanukovych.
Widely known as “Yanukovych’s wallet” for passing money onto his patron, Kurchenko fled to Russia in 2014 after the EuroMaidan Revolution ousted Yanukovych. Shortly thereafter, Ukraine accused him of shirking $130 million in tax obligations and embezzling $180 million from bank investors, Reuters reported.
More recently, in 2017, when Naftogaz took managerial control of Kirovogradgaz, the oblgaz servicing Kropyvnytsky Oblast, from its Firtash-affiliated minority shareholder, it discovered the company had used fictional consumers residing at 384 fictional addresses across the region to illegally obtain 9.8 million cubic meters of natural gas subsidized for domestic consumers — a haul worth roughly $2.9 million. Such stolen gas is often used to fuel the production of blackmarket alcohol, cigarettes, or mineral fertilizer, Yuri Vitrenko, Naftogaz’s business development director, told the Kyiv Post in a July interview.
The Ukrainian energy market has “neither market competition, nor transparent regulation,” says Edward Chow, an energy expert at the Center for Strategic and International Studies. Much of that non-transparency and rent-seeking occurs at the level of the oblgazes.
“It’s a system set up for non-transparency, with one group of companies that holds a very large market share and they happen to be controlled by Firtash,” Chow told the Kyiv Post. “So that’s suspicious.”
Backroom struggle
But not everyone agrees that this is a battle between Naftogaz and corruption.
Gennady Kobal, director of the ExPro consulting firm, paints a more complicated picture. He says the flaws in the GTS code are clear. Currently, as the code stands, a company can take gas and there will be no guarantee that it will pay for it.
“Naftogaz wants a guarantee and wants to control this process so that it can defend itself financially,” Kobal says.
He believes the problem extends beyond the code. Many of the oblgazes’ debts are actually the debts of municipal heating companies that purchased gas without a contract or nomination. As a result, they should formally not receive subsidized gas. But these local enterprises are poor and serve a social function. If forced to pay these debts at market price and above, they will go bankrupt.
Group DF also identified the heating companies as a major source of non-payments. It accused Naftogaz of illegally trying to manipulate the data to convert the nonpayment into “fictitious balancing services.”
“In order to legalize its activities, Naftogaz is proposing to change the [GTS] code in a way that will place responsibility for the actions of [municipal heating companies] on the oblgazes,” Group DF said in a statement.
According to Kobal, there are currently 15 cases in court related to this issue. He believes they will have to determine who owes money to whom.
In the meantime, implementing the GTS code provisions now under debate would be a big win for market openness, a change that is in everyone’s interest, he adds.
Kobal believes Naftogaz is currently horse-trading with other market players to get perceived flaws in the code corrected. But he criticizes the company for waiting until the last minute to raise these issues.
That is more than just Kobal’s opinion. In July, the National Commission fined Naftogaz for failing to prepare the critical electronic platform needed for daily balancing. This became the official reason to delay implementation until October.
Now, Kharchenko hopes that this two-month delay will allow for corrections to be made to the GTS code. Specifically, he believes the oblgazes must be required to provide information about their consumers. Otherwise, the shift to daily balancing will be just a “timeline change.”
“Daily balancing is good, but they have to include the shipper’s code,” he says, using a slang term for the consumer information.
But Roman Nitsovych, program manager at the DiXi Group think tank, is less optimistic. He says that, at the end of July, the National Commission passed a decree proposing changes to the code to address issues raised by Naftogaz. Now these alterations can be discussed and potentially approved over the next two months.
“But the main stumbling block between the gas market players and the regulator — financial responsibility for an ‘unbalance’ — remains unresolved,” he says.
This means that UkrTransGaz could still face significant debt even if the proposed changes come into effect.
Furthermore, Nitsovych believes the oblgazes will continue to resist providing the company with information about their consumers — a move motivated by business concerns. As the “incumbent” local distributors, they don’t want to open up about this information because they believe Naftogaz wants to enter their market.
“If this database goes to one of the providers, it will be seen by the [Regional Gas Company] as losing to a future competitor, and they are against this,” he says. As a result, the oblgazes argue this data is their intellectual property.
A solution might be to provide this information to UkrTransGaz, but ensure that no one else — including Naftogaz — sees it, Nitsovych says.
But that would likely require another reform: the unbundling of distributor UkrTransGaz from Naftogaz in line with Europe’s Third Energy Package.
That’s on Ukraine’s agenda. But like many reforms, it is stalled.
