Ukrainian Corridor Remains the Most Convenient Route for Russian Gas

August 19, 2015 | 00:00
Ukrainian Corridor Remains the Most Convenient Route for Russian Gas
Ukrainian Corridor Remains the Most Convenient Route for Russian Gas
Nicholas Tymoshchuk, advocating the interests of Ukrainian companies in the EU, said that “a long-term sustainable solution should be boosting domestic production” to improve Ukraine's energy independence, in the first part of the interview. In this second part, he elaborates on the role of Naftogaz and its potential privatisation, competing Turkish Stream and the painful increase of domestic gas bills.

JB: Could Naftogaz, the national oil and gas Champion at some point join the same league as national oil companies (NOCs) like Russian Gazprom, Chinese CNPC or Saudi Aramco?

NT: No, unfortunately. Naftogaz cannot, I’m afraid, join this league whatsoever. There are a few reasons for that.

Ukraine does not have resources comparable to those countries you mentioned: abundant, easy-to-access deposits of hydrocarbons.

Those companies, before becoming heavy-weight, have spent decades working with International Oil Companies. That means learning, getting the expertise, know-how, and, the most important technologies from them. This is an additional answer to your previous question about obstacles to growth of the Ukrainian oil and gas market. The tax reform and monopoly of state owned companies is one part of the problem. Another part is that even those state companies, including Naftogaz, are not applying new technologies. They don’t have them. They do not invite specialists, companies, sub-contractors to bring those technologies in. Therefore, it is impossible for Ukraine to significantly increase its domestic production at this moment. You have to invest a lot to modernise and sustain even current production from ageing fields.

Just to give you an example. When I was working at TNK-BP, the company that was formed in 2003, it was only in 2011 when we officially announced that our increase in production came from greenfields, which means from newly explored fields. Can you imagine that from 2003 till 2010, big annual increase in production came only from existing, previously declining fields? TNK had resources and BP modern technologies working together on existing fields, which were basically unplugged back in the Soviet ‘70s. And every year we gained a significant boost in production both of oil and gas thanks to simply application of advance technological solutions.

What I am saying by this is that by applying cutting edge technologies, even to already producing or ageing fields, we can significantly increase production of hydrocarbons in Ukraine. And I do know that, for instance, the US Department of Energy has been in negotiations with Ukrgazvydobuvannya (UGV) and other state companies in Ukraine for many, many years to seeking ways to provide finance, experts, and technologies for revival of existing fields. The only thing they have required from UGV, a state-owned extraction company, and other companies has been certain transparency and sharing of control over those fields and wells with foreign investors. Unfortunately, for the time being, they have not been able to agree.

Nicholas Tymoshchuk
Nicholas Tymoshchuk

JB: Some politicians and experts in Ukraine speak about Naftogaz's privatisation. What is your view?

NT: When you talk about a potential privatisation of Naftogaz, you have to speak about its unbundling first. You have to make sure that production, storage and transit facilities are separated from supply and trading activities. I fully understand when they say that the transportation system or underground storages are strategic objects of national security. Therefore, it cannot be fully in control of private entities, especially in such sensitive geopolitical region. This doesn’t apply to exploration and production companies, which can - and should - be fully private because this is the only way to drive them forward. This is the only way to make this industry profitable and growing.

Speaking about the transportation system or underground gas storages, the control package of 51% can certainly stay with the state. But through selling shares of those state enterprises you could attract additional investment because the state doesn’t have enough resources to sustain and modernise them in a proper way. You can also do it by taking long-term low-interest loans from international financial institutions, but of course they have to be paid back anyway. Hence, I don’t think it is enough. It is necessary to at least partially involve private investors who can also bring effectiveness to the management. Currently, these state-owned enterprises are being very ineffectively managed. Part of that lies in lack of experience and understanding of how to do that. Part of that is due to the out-dated legislation.

JB: You speak about a partial privatisation of strategic objects, such as the transit pipelines. But will investors be willing to pour money into the transit via Ukraine in the context of the Russia's intention to end gas flows via Ukraine in 2019? That is where the money is and if gas supply to Europe is rerouted from Ukraine to Turkey how will Naftogaz and potential investor be profitable?

NT: Look, I don’t think Russia will stop gas transit via Ukraine in the foreseeable future. Why? Because it is still a significant volume of gas and oil being transported via the Ukrainian system and it remains the cheapest, shortest and most convenient route for Russia to transport its hydrocarbons to the EU. And in this industry, like in any other business, economics reigns. If the economic model says that this route is more profitable, shorter and reliable, then this route will be utilised, regardless of temporary political complications which, of course, may take place. So I do not see Russia bypassing Ukraine with its gas supply to Europe in the foreseeable future.

JB: Ok, but once Russia finishes building Turkish Stream, they will most probably use it as much as possible in order to pay it back. How do you see this threat for Ukraine?

NT: To be honest, I am not very familiar with this plan but I can tell you one thing. This project, first of all, can encounter some additional complications because it is not only about Russia, Turkey and Ukraine; it is also about the EU. Moreover, commodity transported via this route will not necessarily go to the same consumers as gas volumes that are now being shipped through the Ukrainian system. Again, logistics and additional distance mean a lot in terms of pricing. Therefore, those European customers that are now mostly dependent on the Ukrainian route, I think, will continue to see this route as the most convenient one. And the supplier will continue to supply via this route to meet the clients´ demands and, most importantly, to secure predictability of its income.

JB: So you do not you consider Turkish Stream to be a realistic project, do you?

NT: I just don’t see room for such a significant increase of gas consumption if everything the EU has been doing lately is trying to reduce its gas consumption in general, but especially from Russia. What we are looking at is economics. People are trying to calculate this alternative project and what they find is a tiny, if any, margin plus no even preliminary confirmed contracts… We see that the European gas consumption will not grow by such volumes as are to be offered through this additional pipeline. On top of that Russian production is not growing to such extent either.

JB: Verkhovna Rada (the Ukrainian parliament) has recently adopted the Energy Community legislation on price liberalisation and unbundling of Naftogaz. As a result prices for final consumers should be slowly rising to reach market level. Price increases could be harsh for some social groups and opposition politicians can score easy points by criticising this step, don’t you think so?

NT: Yes, I fully agree. To put it simple, Ukraine has no other way than to increase its tariffs. Unfortunately, it is inevitable and irreversible process that the country has to go through. The Ukrainian population has been told for decades that low household tariffs is a normal thing, though they are much higher even in neighbouring Belarus, Russia and Kazakhstan. It has been continuously sold to people as an achievement of one government or another. On the other hand, it has never been admitted that this achievement is being basically paid for by tens of billions of hryvnias and dollars of taxpayers’ money that doesn't go to education, social and medical care or new infrastructure projects. Just the opposite, it goes to cover this enormous deficit that Naftogaz has been accumulating every year of its existence due to providing gas subsidies given to the Ukrainian public sector and households. Everything has to be paid for. There is no such thing as a free lunch. If you are importing expensive gas or producing it at the same costs as in other countries you cannot sell it for 10 times less than elsewhere in the world. If you do that, somebody has to compensate remaining 90%. In Ukraine it was always perceived that some ephemeral state paying for it. I was always shouting that it is not the state, but the people who are paying for it by their taxes. Of course, there is a large part of the population that cannot afford paying more expensive bills and the government has announced a 12.5 billion hryvnias compensation package for such families. On the other hand, the citizens, instead of paying a higher bill, should start thinking about using less gas. Currently, the citizens and public institutions don’t have an incentive to become more efficient, to invest, for instance, in insulation or switching to alternative heating and power sources.

JB: Speaking about Ukraine, we cannot omit a reverse flow question. Currently, Gazprom has been carrying out some tasks of Ukrtransgaz, the Ukrainian TSO, which in fact hinders Ukrainian attempts to utilise a big reverse flow to Slovakia (and Slovak TSO - Eustream is struggling to sign an interconnection agreement with Ukrtransgaz over the interconnector in Veľké Kapušany). Do you think unbundling provisions on Naftogaz could finally solve this problem?

NT: Theoretically yes, if the Ukrainian transportation system represented by Ukrtransgas becomes a single, separate entity with which you can negotiate on a transparent basis. However, everything connected to Gazprom is very politicised at the moment. Therefore, even if you have, on the Ukrainian side, a brand new company, with private investment, unbundled, transparent, etc. there is no guarantee that there will be no additional problems. Complications of big reverse flow lie beyond economics. No doubt that unbundling of Naftogaz and more transparency in Ukrtransgaz would be an essential factor for this to happen. But that wouldn't be the only requirement. As a major gas supplier to the EU, Gazprom doubtlessly enjoys significant influence in Europe, especially on its most dependent consumers and countries. Consequently, Gazprom could undertake a lot of measures to directly (e.g. using its right of “prima note” in booking spare transit capacities envisaged by some contracts with its European consumers) and indirectly disrupt reverse flows of gas to Ukraine. Therefore, unfortunately, this option of reverse supplies is still quite vulnerable in the current reality of Ukraine’s war with Russia and a geopolitical crisis triggered by this conflict.

Nicholas Tymoshchuk serves as Director of the Representative Office to the EU for the Ukrainian League of Industrialist and Entrepreneurs (ULIE) – the biggest association of the Ukrainian business – based in Kyiv and Brussels. Prior to ULIE, Nicholas managed Government Affairs activity for the world's second biggest public energy company Chevron in Ukraine. Before Chevron, he spent five years in Russian-British oil and gas giant TNK-BP on a position of Director for International Affairs, and before that five years in American-based political and charitable NGOs.

Image: Kiev, Ukraine ~ Apartments across from Opera House. By: Vasenka Photography. CC-BY license

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