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Alexander Khurshudov: terminating gas transit causes the Ukraine financial rather than technical problems

Alexander Khurshudov, expert Oil and Gas Information Agency
November 05/ 08:16

New Year is getting closer, while Naftogaz and Gazprom are as far from agreeing on gas contracts as they were a couple of years ago. Europe, fearing disruption in Russian gas supply, filled up all storage facilities to the full, has bought futures, and seems to have calmed down. The absence of a contract no longer threatens to disrupt gas supplies - about half of them will go through Turkey, the rest can be temporarily compensated by liquefied gas from Yamal, Sakhalin, Qatar or even the United States. LNG can be bought in different parts of the world, and the EU regasification facilities are never full. Let us think about how the termination of transit will affect the operation of the Ukrainian gas transport system (GTS).

1. Technical aspects

Picture 1 shows the GTS.

Pic.1. The Ukraine’s GTS layout

The Ukraine’s gas transport system’s total length is 37.6 thousand km. This is slightly less than the length of the equator. Its annual capacity is 290 billion m3 at the inlet and 175 billion m3 at the outlet. The GTS includes 81 compressor stations (CS) with 765 gas pumping units (GPU) with a total capacity of 5.6 million kW. The GTS also includes 1,600 gas distribution stations and 12 underground gas storages, 6 border gas-metering stations and 89 road tank gas-loading stations. The system is operated by a 100% subsidiary of Ukrainian Naftogaz Ukrtransgaz.

A couple of years ago, it compiled a list of gas transport facilities that had not been used in gas transportation process over the recent years. They aren’t used as it is. The list includes 18 compressor stations with a total of 134 GPUs and 2 gas treatment plants. In case Russian transit is terminated after 2020, according to the estimation of Ukrtransgaz, the list will almost triple - to 47 CSs and 282 GPUs. Less than half of the compressor stations will remain in operation.

In Figure 1, I circled red seven CSs that would lose their purpose; there will be no gas for them at the inlet from Russia and at the outlet to Poland, Slovakia, Hungary and Romania. Five western compressor stations will be put in reverse for gas import. The rest, with a 4-5 times decrease in gas flow will not be needed and will have to be suspended. Since 70% of the compressor units have exhausted their performance, their abandonment also costs some money and is unlikely to pay back with the scrap metal received.

It is harder to decide what to do with the main gas pipelines. They are laid in two or even three strings. Now that the Ukraine consumes 30.5 billion m3 of gas per year, last year’s transit amounted to 86.8 billion m3, therefore, the gas pipelines’ capacity will decline four times. One pipe would be enough, but it is impractical – if, God forbid, there is an accident with the pipe, hundreds of consumers will not receive gas. Therefore, two strings will be operated. While the third pipe can be disassembled, even with a profit. Used large-diameter pipes are used in construction and are quite valuable.

The gas pipelines’ operation cost will certainly reduce, but not proportionately to the gas flow volume. For even the pipes used at reduced capacity need electrochemical protection, regular detours and other control measures. Gas consumption for fueling compressors will also decrease, but the specific consumption (per 1000 m3 of gas pumped) will increase. With limited flow rate compressor efficiency is reduced.

Gas flows will change direction. Now (see Fig. 1) all the gas flows from east and north to west and south. Ukraine’s gas fields are located mainly in the northeast, in the Poltava, Kharkov, Sumy regions. Meanwhile imported gas will come from the west, from Slovakia and Poland. Counter flows are more difficult to regulate.

Ukrtransgaz also operates 12 underground gas storages (UGS) with a storage capacity of 31 billion m3. More than 80% of the capacity (including Europe’s largest Bilche-Volitsk-Uherskoye UGS, 17 billion m3) is in the west of the country. With a constant transit flow from Russia, they are very convenient for the EU countries. Last year the Ukraine even earned about 1.5 billion hryvnias for gas storage. European consumers used a “virtual reverse” - they did not receive their gas at the border, but transferred it to Ukrainian underground gas storage with a benefit for both parties. Without transit these manipulations will stop and the Ukrainian underground storage facilities will lose appeal to foreigners.

2. Financial matters

Five years ago a quarter of the country's budget was spent to support the Ukrainian Naftogaz. Since the good old days when the Ukraine bought Russian gas 2-5 times cheaper than global prices (Fig. 2) were over, and gas import from Europe, even virtually, turned out to be much more expensive. Since then, the domestic gas price has increased 10 times and reached 6.2-8.5 hryvnas / m3 ($ 167-230 for 1000 m3). It is not surprising that import has declined from 55 to 10.6 billion m3 per year over the past 10 years.

Pic.2

The financial indicators of Naftogaz and Ukrtransgaz have changed dramatically over the past 5 years, so they need clarification. Ukraine has long dreamed of finding Naftogaz a strategic (meaning western) investor. Two factors interfered. Firstly, the Ukrainian deputies, led by the fighter Yulia Tymoshenko ceaselessly anathematized these plans. Secondly, somehow no one was willing to buy 49% of Naftogaz.

Then they came up with an idea to sell only the transport system, that is Ukrtransgaz. Four years ago, its fixed assets grew from 15 to 356 billion hryvnas ($ 15.5 billion). The GTS depreciation period has long passed; it seems to have been overestimated again. They wanted to raise its price, instead it turned from bad to worse – the GTS had to be depreciated. As a result, Ukrtransgaz’s feeble profit turned into 65% losses (Fig. 3).

Pic.3

The losses certainly did not come only from manipulating with the assets’ estimations. A heavy burden for Ukrtransgaz is the non-payment from regional gas supply systems for gas transportation. As of mid-year, it amounted to 10.4 billion hryvnas ($ 395 million). Note also that there is a transit agreement between Gazprom and Naftogaz, and the latter is already allocating some money to its subsidiary. It doesn’t pay enough though. As a result, Ukrtransgaz has a tax debt of 55.5 billion hryvnas ($ 2.1 billion).

So, it turns out that in order to privatize Ukrtransgaz, according to the EU regulations one must first pay its debts and write off the tax debt, which it is not small, 5.4% of the Ukraine’s annual budget. Thus, the rosy plans to privatize Ukrtransgaz this year are not going to come true. I doubt they ever will.

Though Naftogaz seems to have burst into bloom after these manipulations. Last year they reported a record contribution to the budget (138 billion hryvnas). However, its annual financial statement shows no such figures. With the revenue of 256 billion hryvnas, the company's expenses amounted to 234.5 billion, making the net profit 11.6 billion hryvnas. While after re-estimating fixed assets (which seems to be a favorite pastime of the management), the company even incurred 18.6 billion losses. They also have huge non-payments, mainly for gas, in the amount of 65.9 billion hryvnas ($ 2.5 billion).

If Russian transit ceases, Ukrtransgaz will lose about $ 1.6 billion. Naftogaz - $ 2.5 billion in revenue. This is 5.3% of the country's exports, 26% of its foreign trade deficit. So, the company will lay all its hopes on increasing gas prices for industry and people. If they can cope with the rise.

  1. Summary

From the technical side, the termination of gas transit won’t cause the Ukraine any serious trouble. There will be many annoying changes, staff cuts, skirmish between officials, but none of them fatal.

Financial side will be worse. Naftogaz will lose 30-35% of revenue, the budget - 1.5-2% of income. What did you expect, gentlemen? Money goes to those who accurately fulfill their obligations. It goes to the one who smiles at the customers, but not to the one who curses them behind their backs invents absurd fines. Your business reputation is tarnished and you will have to work hard to restore it. It's time you already mastered this simple truth.

P.S. Here is a curious detail. Naftogaz’s annual report shows the income from Stockholm arbitration decision on disputes with Gazprom in the amount of 57,125 million hryvnas. Below there is the costs of arbitration, which amounted to 44,528 million hryvnas ($ 1.65 billion):

European arbitrators cost a lot to litigators ...

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