Exclusive interview with Yuriy Vitrenko, CEO Naftogaz, for the Interfax-Ukraine Agency

Text: Dmytro Koshovyy, Oleksiy Yehorov

A few weeks before the start of the heating season, you wrote on your Facebook page about balancing groups in the gas market. How will these changes help people get through the winter?

We are facing a large-scale task to provide Ukrainian consumers, households, organizations supported by the state budget, and heating companies. The task is extremely serious, given all the circumstances, and we are treating it as such.

We see that this contractual campaign is a difficult process, the tools for each segment are different.

Of course. The first is the segment of households that directly consume gas for cooking, hot water and heating. There are several aspects here, and we will provide a sufficient amount of gas to meet the needs of such consumers at a reasonable price.

One of them is an annual product. From May, there is a requirement that all suppliers to households by default set the price for the year. At the same time, the consumer can choose contracts with a price that will change monthly. This will be their choice, and not as it was last summer when consumers were simply transferred to monthly prices without their consent. I proposed this last December, when I started working as acting Minister of Energy. This is a European practice that has proven to be very successful for Ukraine as well.

The next consideration is the price under these annual contracts. Naftogaz, under the leadership of Andriy Kobolyev, was selling gas to traders, with the bulk of the volume being traded to Dmytro Firtash’s trader “Ye Enerhiya”. They received gas from Naftogaz at UAH 7.4 per cubic meter, for households – as they said, but then part of it, as we have seen, did not go to households. And the problem is not that the state wanted Naftogaz to provide gas to households in the wholesale market at a fixed price at an adequate level, but how the then leaders of Naftogaz built the process of concluding and structuring contracts, and as a result it was their actions that Firtash had special conditions and preferences.

To what extent is this a market mechanism in general?

Annual prices for households are a market mechanism. If you ask about the price level, I will answer that at the time when prices were fixed from May to year, our international partners had no questions about the marketability of the wholesale price at UAH 7.4 and the retail price at UAH 8. This decision was made by Kobolyev, and his de facto deputy and Naftogaz Board member Otto Waterlander, who directly took care of the matter. This was also the position of the Supervisory Board, which endorsed all these contracts.

But the way Kobolyev and Waterlander organized the sale of gas for household needs, to the same Firtash’s company, on preferential terms, without a guarantee that these volumes will go only to households, even without a guarantee of payment – it is difficult to call it a market mechanism.

As a reminder, Kobolyev was dismissed for losses and other failures at the end of April. The Supervisory Board left in September and Waterlander was dismissed for absenteeism not earlier than at the end of September. Immediately after that, we changed the mechanism of gas sales for household needs – we moved to the so-called “balancing group”.

Creating a balancing group solved several problems. This is the resale of gas, when gas was purchased from Naftogaz at UAH 7.4 and resold to industry at the current market price of UAH 30-40-50. These are unfair, different conditions for suppliers, preferences including for Firtash. This is the risk that households and the gas transmission system operator will suffer from the defects of the previous mechanism. In the balancing group, we cover all consumption only by households. Volumes are accounted for by the state operator for each household consumer. That is, you can’t buy gas and resell it to whoever you want. And in the balancing group you find equal conditions for all, Firtash has no preferences.

Is the balancing group a market mechanism?

The balancing group itself is an absolutely market mechanism. One can find it in the European codes (law or regulations?). It is bad that it has not been used in our country before.

The price of UAH 7.4 was transferred from the old contracts with Firtash to new contracts for everyone within the group, so our international partners should not have any claims about the marketability of this price, at least I have not heard their claims to the price for Firtash.

What is important: at this price we actually sell gas on the wholesale market. That is, we sell gas for UAH 7.4 to those who have supplied the respective volumes to households. Since we have a free retail market, suppliers can determine the price at which they sell and supply gas to the final consumer, that is the households. We monitor the market, see that there is a certain range of their prices. Of course, LLC “Gas supply company “Naftogaz of Ukraine” kept the price at UAH 7.96.

Experience suggests that other suppliers can set any price. What should happen next?

The Antimonopoly Committee of Ukraine has finally had the opportunity to look at the margins of all dominant players in this market and determine whether they are abusing their position and to what extent. It is now clear that the wholesale price is the same for everyone – UAH 7.4.

Why is this important? Last winter, before the price cap was introduced upon Kobolyev’s proposal, that is a non-market restriction of retail prices for all, we discussed with the Antimonopoly Committee possible measures against regional monopolists who supplied gas at prices 30-40 percent higher than Naftogaz. The AMCU then said that they had the opportunity to regulate not the price but the margin of the monopolists, and they could not decide where to start from, what is the level of the wholesale price. Now they have it.

Will there be sanctions against gas retailers reselling gas that was intended for households?

We do not sell this gas to traders, so it cannot be officially resold. The only possibility left is to falsify figures at the level of regional gas companies. On our part, sanctions are possible – termination of contractual relations within the balancing group. As soon as we see signs of manipulation, we will refuse to cooperate with such a rogue supplier.

Has everyone agreed to the new conditions yet? Have you re-signed contracts with all companies?

Contracts were re-signed with 31 out of 45 suppliers, i.e. with the majority (as of October 8 – IF). I can say that all Firtash Group distribution companies have switched to work within the balancing group. As they no longer have a single cubic meter of gas under the old contracts, they cannot resell it on the market. Other major suppliers have also switched. There are remaining relatively small companies, but they are also in the process of re-signing.

Contracts are signed until 30 April 2022, is any extension possible?

Yes, the contracts were signed at the same time as the previous ones – by the end of April. Next, we will determine the structure that should replace the relationship within the balancing group. There are various possible components of the new solution – and gas release program, an option to sell on the stock exchange. One of them is normal exchange trade, where the so-called yearly products, i.e. gas with a fixed yearly price, will be traded on the wholesale market. But at the same time, it is necessary that clearing is provided – a guarantee of settlements, that there was a liquid market. We are talking about a real exchange, a real trade with a real central clearing counterparty. There is no such thing in Ukraine yet, it is necessary to create it all.

Another element is allocation agreements. There are many real European mechanisms that  need to be used. This was not the case before, partly because large-scale tasks require a completely different level of professionalism. We are talking about the professional market.

How much gas intended for the households under the old contracts was resold by traders?

Law enforcement agencies are already investigating this. We have some indirect calculations, but I am not a prosecutor and I would not like to deal with this. According to Otto Waterlander, the contracts allow for resale. It seems that otherwise Naftogaz would have violated antitrust laws. Law enforcement agencies have a different point of view, which is obvious, given the criminal proceedings, in Zaporizhzhia region in particular.

What volumes are we talking about?

Not such a critical volume that “everything is lost”, but it affected the market and created certain threats. In particular, because of this in the summer the price on the Ukrainian market was relatively low compared to the Europe, because free volumes were resold. They went to the market, knocked down the price, this reduced the incentives to import in the summer, when it was necessary to do so. Now everyone pays for it.

Let's return to another important market segment – heat producers. How did you manage to resolve the situation with them during this heating season?

This is a large segment, perhaps even more problematic than the segment of direct gas supplies for the needs of households.

The situation was resolved by determining the price within the three-year contracts with DHCs under the so-called fixed volume. Although it is not possible to make gas molecules at a fixed price go only for heat generation for the needs of households, but the contract is structured in such a way that we looked at the historical consumption of gas for heat generation for the needs of households, and then recorded this volume. Based on it we offered a price for a year, which will then be indexed. The same mechanism has been in place for three years. 

The price for the first year is set at UAH 7.4. Again, it would be wrong, unfair and illogical if the price of gas for heat generation for households was higher for wholesale consumers than Naftogaz sold to Firtash ostensibly to supply the households.

Now the market price is many times higher, we will have to compensate for the difference…

The state does not oblige Naftogaz to sell at such a price, so it is not formally obliged to compensate Naftogaz. And when we recorded volumes at a price of UAH 7.4, we took into account the volumes that we have at a net cost not exceeding UAH 7.4. That is, we do not trade gas at a loss. 

At the same time, you can look at it from the other side. In order to prevent the rise in tariffs for district heating for the households this winter, the state through the national company and state budget covers 90% and sometimes 99% of the difference between the price imbedded in the heat tariff for the needs of households and the current monthly market price. Now the monthly price fluctuates very much, we understand it can be UAH 30/m3, then it can be UAH 60, and then again, tentatively speaking, UAH 40. But this is now in the range of UAH 30-60. 

UAH 7,2 is imbedded on average, tentatively speaking, in the tariff of heat producers. There are those who have even less or a little more. That is, the difference with the monthly market price is huge. The main part of this difference is covered by the national company, selling gas at UAH 7.4. 

And recently a memorandum was signed that since the state, the central government, the national company still cover 90% of this difference, if someone's price was set at UAH 7.2, and Naftogaz sells at UAH 7.4, this small difference may already be covered by the local budget. And if the local budget does not have enough funds, the central budget will redistribute, that is, the central government will make sure that the local budget has more money. This is an important detail.

Are volumes in contracts tied to some kind of temperature coefficient?

No, these are the volumes that correspond statistically to the households’ consumption over the last three years. We have to import additional volumes, and there the price is many times higher. But we give an incentive to the DHC: if you reduce the use of gas, then, accordingly, you will have more gas at a lower price. Naftogaz also now has a direct economic incentive to invest in reducing consumption by heat producers. Then the volumes of gas that Naftogaz can sell at a much higher price or not import will be released. From an economic point of view, these are the same things.   

What is the situation with the contract campaign here?

It is still going on. 786 heat producers have signed contracts, of which almost 200 are DHCs – the vast majority (as of 8 October – IF).

Will the company have enough gas to supply households?

There is enough gas for this. If you look at how much the households consume directly and through heating producers, that exceeds domestic production. Unfortunately, under the previous management of Naftogaz, the last three years we have seen a clear trend of declining production. In particular, the 20/20 program has not been implemented, not only under the new licenses, but also under the old ones: only under them would there be plus 3 bcm per year. This would allow us not to import gas.

How much of our own produced gas is still lacking to cover the needs of the households?

Approximately half a billion to one billion cubic meters, including households’ gas consumption directly as well as gas for central heating for the households.

That is UGV provides 14 billion cubic meters, and the households directly and through DHCs consume about...

- It’s not 14 billion for Ukrgasvydobuvannya any more, if we are talking about commercial gas. Now it is somewhere between 12.7-12.8 billion. The households, even if we count in a conservative way, consume about 13.4-13.6 billion, depending on temperature.

There is yet another segment – it’s organizations supported by the state budget.

If you make any conditional virtual calculations, where gas for the needs of the households is provided through own production, then organizations supported by the state budget are certainly lacking the gas, so they are in a different situation.

However, in this case we also met the communities half way. As part of the preparation of the memorandum, they stated that there was a critical situation. On the one hand, there are certain requirements for procurements in Prozorro, where long-term tenders are required to be held. Even though the communities held tenders and procured gas from certain suppliers, the latter refused to sell it. Where there were contracts, the price kept on increasing and state organisations are lacking both the required amount of money and the mechanism for quick budget switching.

That’s why we have created a product that offers the opportunity to sell gas at a fixed price until the end of next year: UAH 13.7/m3 excluding VAT and transportation, which costs 16.8 UAH including VAT and transportation, and they can even already include this price in next year’s budget.

That is, not UAH 30-45, and not even UAH 19-20 as someone claimed, which is a way to manipulate.

Is this a market approach?

Yes, this is also a market approach. Even though the price is  two to three times lower than the monthly price, due to the fact that it is fixed until the end of next year, we need to focus not on monthly prices on the European market, but on prices moving forward for the entire period until the end of the year. Then the market price level corresponds to exactly UAH 16.8/m3.

So it's not pulled out of thin air?

No, it’s not.

What volumes of gas are we talking about here?

Approximately 1-2 bcm of gas per year.

Did Naftogaz manage to import gas before the record price increase? And will those volumes available in storages suffice?

Now there are almost 19 bcm of gas in storage. As we understand it,  10-15% of these volumes belong to non-residents and can be transferred to Europe or be sold here, if prices in our market will not be lower than in Europe. But even without these volumes, there should be enough gas for optimal passage of the heating season - precisely due to the fact that we, Naftogaz, imported gas.

At the same time, I’d also like to note that the financial plan for 2021, developed by the former management of the Company and approved by the former Executive Board and the Supervisory Board, does not provide for gas imports at all. And Naftogaz sold gas of its own production on the stock exchange - these volumes were sold for industry purposes. When I came, I refused to sell these volumes of gas of our own production for industry needs so that we had enough gas to supply for the households. And we started importing gas in the summer. That is, Naftogaz’s funds, which by the way were borrowed, not earned, had been spent to procure gas, and not for the “Great Construction”, as some claimed. We procured gas at prices lower than the current monthly prices on the market.

But there is a nuance. Otto Waterlander was responsible for implementing gas import decisions. As it turned out, he himself changed the plan approved by the Executive Board, which was accepted when I took over as the CEO. And this change aimed at import cutting. Unfortunately, the former Supervisory Board and the Executive Board gave Otto such right, and he did take the advantage of it.

How much less?

Significantly less. To put it tentatively, Otto believed that the August price was too high. Hence, as he thought at that time it was not necessary to import more. But then the cost of gas has increased. That is, if it was not for Otto Waterlander’s decision we would now have had more gas purchased at a price below the current one.

What about gas for production and technological needs (VTP) for regional gas retailers? What is the decision regarding this segment?

We are exactly in the middle of changing the mechanism. Regional gas retailers will be clearly required to have a supplier and they must be ready to be one of such suppliers. Unfortunately, there was no mechanism before to clearly regulate this.

Regional gas retailers have a problem: gas included in the tariff affects both their ability to pay and the time when they receive payment from the subscribers. It also affects the potential schedules of payments for gas. We say that we will adapt to the schedule of settlements, which will be objectively fixed in the decision of the regulator. We are ready to undertake such commitments and meet the difficult conditions in which regional gas retailers operate. Other suppliers, possibly, too. Let’s see.

When will this mechanism be offered?

Possibly even this month. We now cooperate with various regional gas retailers in this regard. Naftogaz has its own regional gas retailers. I do not understand why this issue was not addressed earlier. We see all the problems associated with the fact that there is a certain mechanism for setting the tariff for gas distribution, and a completely different one for gas pricing, which is required by regional gas retailers to cover their production and technological costs. There must be compliance.

Gas of own production and the gas in underground storages – will it be enough for all these categories that we have listed?

We have enough gas, but our plan also provides for certain imports during the heating season. Because sometimes there is such a technological specifics, when the capacity to withdraw gas from the storage is limited and it is necessary that there was enough gas already in the pipe. Also, we cannot predict exactly how much gas we will need to supply to the industry through the “last resort” mechanism.  I’d like to note that additional volumes will have to be imported at monthly or even daily prices on the market.

Now the price of Naftogaz’s gas imports is around USD 1300-1400?

I can’t reveal sensitive information, but we do not import at this price.  We are reasonable people after all. For example, when the price reached $ 1900-2000, we said “wait a second”, and we did right thing because the next day the price already reached $ 1300. We monitor the prices closely.

Importing requires money. Naftogaz submitted a letter to the Cabinet of Ministers of Ukraine on the need for funds to purchase the gas and the need to enter into an agreement with the Gas TSO of Ukraine. How much is being discussed in this agreement?

The agreement has already been signed. The letter in question refers to the following: there was a financial plan approved by the government as our shareholder. If there are any significant payments in excess of a plan, it sounds logically to notice those who approved it and inform them about the sources of money funds for these payments.

It was a very pragmatic document that read: look, we have significant excess funds needs (for instance, the import was not budgeted at all), we are importing additional volumes and the prices are much higher than before.

If you take a look at the annual price for those same budget organisations, unprofitability is not an issue for them in general, but we need to invest and purchase gas now. This requires investment in working capital, because, for example, we purchased gas in the summer and will receive funds for it next year. We say that there is a certain liquidity problem.

At the same time, we have a contract signed at the end of 2019 for the sale of Gas TSO of Ukraine, for which we are to receive money. We draw the government's attention to the fact that the operator has excess liquidity:

For clarity, there were over UAH 30 billion in its accounts.  It is not the business of the TSO to make money off the deposits. Therefore, we offer to balance accounts with us earlier than expected. Meanwhile, we have business arrangements to review the terms of the contract and to change some provisions in favour of the buyer. That is, we will generally get paid less, but faster, and it is more comfortable for all parties. Moreover, most of the operator's income is generated by the money paid by Naftogaz.

Therefore, in the letter submitted to the Cabinet of Ministers of Ukraine, we actually say: look, we have payments for imported gas in excess of the budget. We have used all the borrowed money for this purpose and now we are speeding up the payment for our sale of the GTSOU and we will invest these funds in the working capital.

We also have significant over-plan payments to the state budget. Now the implementation of the so-called “anti-crisis” law is to begin, when the state budget covers the difference in tariffs of the heat producers, which resulted long ago from the decision of the state, and the heat producers must use all the funds received to settle the debts to us for gas. And we earlier saw it this way: since such expenses are over the plan for the state budget, so in order to balance it, we will return these funds as a dividend prepayment. And now we say that it is more logical that these excess state revenues are to be received as over-plan rental payment, not as a dividend prepayment. These are all technical matters that may and should be resolved relatively easily between state institutions, that's what it's about.

What are the risks of Nord Stream 2 for this heating season?

- Because of NS2 and the blackmail of Gazprom we have unfortunately already seen the result.

Then the hardball question: if NS2 is launched and the price goes down – is it beneficial for us in the short-term perspective?

Some may think that if Putin gets a green light to launch NS2 in disregard of the European laws, there will be more gas in Europe and, accordingly, the prices will be lower. But this is not a fact, even if Putin had promised to do so.

So should we believe Putin? He has already mentioned that it is necessary to revive the practice of entering into long-term contracts. And long-term contracts are always about take-or-pay principle. Let me remind you that if we did not win the arbitration, we would have to pay more than USD 80 billion upon this principle. He will then say, if he has not already said, that it is necessary to come back to the practice of linking the gas price to the oil price. Please be reminded that according to the relevant formulas, prices in Europe were extremely high at one time, just before the hubs started to develop, and gas prices were no longer linked to oil prices. And Putin keeps saying that Russian gas cannot be resold to other countries. What does it mean for Ukraine? Only one thing -- a return to the onerous contract terms. I wish just to recall that before I became responsible in 2014 for switching gas supplies from Russia, which Putin cut off in the summer of 2014, to the supplies from Europe, as well as accountable for the Stockholm arbitration, in average Ukraine paid Gazprom for gas USD 5 billion more than received for transit. We definitely don't need to go back in time, but Putin wants us to.

On the contrary, we are interested in US sanctions being imposed right now. So that clear conditions are to be set for Putin by the United States, the EU and Germany. He must stop using gas as a weapon, I stress it once again, stop, because he is doing it now. It is evidenced by the fact that this year Gazprom transits 1.5 times less gas to Europe via Ukraine. And that Gazprom refuses to sell gas to the European companies on the border between Russia and Ukraine. Gazprom has de facto blocked access to transit to Europe via Ukraine for other suppliers. Gas transit from Central Asia is blocked. Until he fulfils these conditions, it is impossible to expect that NS2 may be commissioned.

Putin resorts to blackmail when he believes he has a good chance of getting his way. It is clear that he saw the standpoint of the new US administration and the Merkel administration as such giving him a chance at successful blackmail. 

Therefore, we benefit from the opposite – the United States and Europe shall take a hard-line stance, for Putin to understand that his blackmail has provoked a backlash. And then Putin would be forced to change his standpoint. For Gazprom to transit bigger gas volume through Ukraine, since the price would decrease. We insist that the European companies should be able to purchase this gas at the Ukrainian-Russian border. Then they will be able to book the capacity of the Ukrainian GTS, which reduces the risks of transit termination. In the same way, Gazprom would show the German regulator considering the certification of the Nord Stream-2 operator, that Russia is ready to comply with the European laws and see gas as a commodity, not a weapon or a tool of blackmail.

Let's discuss the worst case scenario for this winter: the Russians launch NS2 and remove transit through Ukraine completely. What happens then?

This is the worst scenario for Ukraine. There will be no more gas in Europe, but we will face technical problems and the price of gas will increase in Slovakia, where we purchase it.

In such a case what is the plan?

Of course we have a plan. We model different scenarios: how much gas is there in the UGS facilities, when it may be withdrawn, and if the UGS capacity is limited, what production we have, what are the restrictions, how much gas should be taken from the pipe, how much to supply, and so on… And we plan how to go through this heating season, in particular, to meet the gas needs of all our customers.