Deteriorating relations with Russia, a traditional gas monopolist, has propelled Ukraine to reduce its gas imports through increased reliance on domestic production and belt-tightening.
We speak with Mykhailo Honchar, director of energy programmes at the NOMOS Centre, on perspectives of Ukrainian gas producing sector, its challenges, and the new opportunities arising with Ukraine’s integration into the European energy community. He is one of the initiators of an EU-funded project devoted to making Ukrainian gas production more transparent: “Independent monitoring of resource and financial flows from developing conventional and unconventional deposits of hydrocarbons under production sharing agreements.”
Under the Association Agreement, Ukraine has committed to bringing its own practices in line with EU standards in the energy sector. What does this mean for us?
It means that Ukraine has to adopt a number of legislative and regulatory acts arising from the Energy Community Treaty, which Ukraine joined in February 2011. This means adopting at least three basic laws: law on the gas market, law on the electricity market, and law on the national regulator.
The law on the gas market was adopted in 2010, but it is somewhat outdated: it does not include the provisions of the Third EU Energy Package. Now there is a new bill that encompasses the Second and Third Energy Packages that will be adopted in the very near future.
What do these energy packages mean for Ukrainians?
Implementing this legislation in Ukraine, as we have seen in many EU member states in the past, will make the Ukrainian energy sector transparent and similar to the European sector. Ukrainian consumers will be able to choose their energy supplier and energy suppliers will be able to choose consumers. So there will be a mechanism for competition, where consumers are able to choose products under better conditions.
When can we expect this mechanism to function in Ukraine?
There will inevitably be a period of transition during the implementation of these laws. You shouldn’t expect this to happen overnight. The problem is that these three laws should have been adopted together in one packagebut instead, they are being adopted separately and this has created some procedural difficulties.
What does your project stand for?
It is a joint project conducted by the NOMOS Centre and the Kyiv International Energy Club (Q-Club), which was launched in 2013 with a grant of over €200,000 from the European Commission. It aims to establish a system for the independent monitoring of the resources and financing associated with gas production projects under agreements on production sharing.
To put it simply, the idea is to build mechanisms for civil control of gas revenues and to direct them toward the common good. Today all the public revenues stemming from gas production go to the central budget, but the gas-producing territories usually don’t see the profits of their work or receive the funds to cope with ecological problems arising from gas production.
Our team prepared an algorithm to allocate gas production taxes at a local level. We based our idea on the Constitution of Ukraine, which states that Ukrainian resources belong to the people of Ukraine. To this end, we suggest establishing a National Development Fund, which would collect tax from gas production and distribute these funds for the common good. For instance, tax revenues could be used on environmental projects.
When can this be put into practice in Ukraine?
Certainly, our proposal cannot be implemented immediately. Russian aggression has caused a slowdown in the Ukrainian gas producing industry. Many investors have left Ukraine due to the risks associated with the ongoing conflict. But we are creating a platform for national discussion. When Norway established similar a National Development Fund, it took seven years from initial discussions to its implementation. Our main mission today is to develop a foundation for discussions and improvements. We presented a concept note to the public of a draft law on a National Development Fund as a basis for future legislation.
Does Ukraine have the potential to decrease its dependence on Russian gas through the development of its own gas production industry?
Yes, Ukraine can increase gas production by 3-3.5 billion cubic metres by 2020 over and above today’s 20.5 billion cubic metres. Other calculations suggest the potential increase to be 5-6 billion cubic metres.
In 2014, Ukraine imported an unprecedentedly small amount Russian gas – only 14.5 billion cubic metres, which is one-third of its imports five or six years ago.
Why has there been such a change in gas imports?
This change is caused by economizing, reverse gas flows and, unfortunately, the failure of some gas-consuming industries as a result of Russian aggression.
Another reason is that 2014 was the first time that Ukraine produced more gas than it imported. In total we imported 19.6 billion cubic metres of natural gas, of which 14.5 billion cubic metres were imported from Russia and 5.1 billion cubic metres of reverse gas flows from EU countries. At the same time, Ukraine produced 20.5 billion cubic metres. In each of the last ten years, Ukraine produced the same amount of gas, but it consumed 73-76 billion cubic metres.
What are the challenges facing Ukraine in developing its own gas production?
The main challenges are the high royalties for subsoil use that were adopted by the Verkhovna Rada. All the private investors say that they will not continue investing under such conditions. Currently, the t maximum royalties for gas production are 70%, while last year they were limited to55%. So, investors will cut their investments in gas sector of Ukraine. This will cause a reduction in gas production in the upcoming years unless Ukrainian MPs pass amendments to the current law. Another problem, however, is that the state has now lost the confidence of investors.
What are the prospects for the development of unconventional gas production in Ukraine? And how will the current crisis affects these prospects?
This issue is now very uncertain because big gas production projects in the Black Sea were halted due to the Russian annexation of Crimea. Another project in Eastern Ukraine was frozen as a result of military actions in the area.
Does Ukraine have opportunities to integrate its gas transportation system with the European energy system?
Yes. There is a window of opportunity for Ukraine, because Ukraine signed the Association Agreement with the EU and joined the European Energy Community. Under article 284 of the Association Agreement, Ukraine and the EU are committed to cooperating in the energy sector while Ukraine develops its strategies and policies.
This means that the EU will consider the potential of Ukraine’s gas storage and transportation system for benefitting Ukrainian and European consumers. Today, nearly half of Ukraine’s gas storage facilities are free for use, so it would be beneficial for Ukraine to rent them out.
What do you think about the increase in utility tariffs?
As a consumer, I don’t like it [laughing]. Obviously this is unpopular, but it is a necessary step. Many presidents and governments avoid taking this step for long time, and society pays for the delay.
If it was done gradually, there wouldn’t have been such a shock effect from the raising of taxes. But politicians used social populism, which discouraged domestic gas producers from making investments to increase production. A gas producer used to sell gas to the public practically at cost. So now this practice is changing through the increasing utility tariffs.
The most important thing at the moment is that the government and the monopolist Naftogas act transparently and build trust among consumers and producers.