Ukrainian distributors affiliate is created to boost flow security and payments

ICIS Heren, "European Gas Markets", 24 August 2009

 NAK Naftogaz Ukrainy has announced that it is creating an affiliate, Naftogazme¬rezhi, to which grid assets currently on the balance sheets of 43 regional gas distributors and suppliers will be transferred. The move is in accordance with a decision of the Ukrain¬ian ministerial cabinet No. 775, June 2009, "on increasing the efficiency of the operation of state-owned gas distribution grids". The move will affect 43 regional distribution and supply companies (oblgazes and gorgazes) and some Naftogaz affiliates. Naftogaz said. "In this way, the obligation to provide secure and continuous gas supply and transport to the population, budget [government and local authority] entities and other state-run entities will be performed by DK Gaz Ukrainy and DP Naftogazmerezhi".

Vitaly Gnatushenko, deputy chairman of the Naftogaz Ukrainy board, has been ap¬pointed CEO of Naftogazmerezhi. A working group has also been formed at Naftogaz under the chairmanship of the company's first deputy chairman, Andrei Lopushanski, to handle the implementation of the ministerial decision. There are around 50 regional gas dis¬tributors in Ukraine, including 27 large ones. They supply the residential, communal and small and medium industrial sector. Large industrials tend to take gas direct from high pressure lines. The distributors engage both in gas distribution and supply with the end-user tariff bundling the commodity cost of gas and transport. Transport charges through the distribution grids are set by the Ukrain¬ian regulator NKRE and vary from company to company depending on the condition of the grid, distances covered and other fac¬tors. The average distribution charge comes to around Ukrainian grivnas 100/100km (Ђ8.24/100km).

Complex ownership structure
The ownership of the distributors is complex: NAK controls 17 of the larger ones, with the rest generally controlled by private companies. In Ukrainian law gas pipelines belong to the . state - the regional distributors operate them on leasing agreements.

Those agreements are due to expire this September, according to Roman Storozhev, president of the Association of Ukrainian gas traders. While state ownership is indisputable with respect to pipelines built before the breakup of the Soviet Union, the status of lines built after that is not clear, and could cause problems for the consolidation of Naf¬togazmerezhi.

Ukrainian distributors supplying residential and communal users, such as district heating plants, buy their gas exclusively from the Naftogaz affiliate Gaz Ukrainy. This tends to be a loss-making sector of the market, with poor payment performance leading to losses for Naftogaz. The more profitable industrial sector is supplied not only by Gaz Ukraina but also by independent traders and gas produc¬ers and Gazprom Sbyt - a 100% Gazprom affiliate with a licence to supply up to 25% of the industrial market. Total industrial gas consumption in the Ukraine came to 4.7Gm3 in the first quarter (Q1) 2009, sharply down from the 9.4Gm3 in Q1 2008.

Naftogaz said it hoped that the creation of Naftogazmerezhi would "facilitate the efficient utilisation and development of the gas distribution grids, improve financial and payment discipline in the area of gas distribu-' tion and supply and create the conditions for a transparent functioning of the domestic gas market."

The Association of Ukrainian gas traders took a different view. Storozhev said the creation of Naftogazmerezhi "would allow the state holding to centralise financial flows to its own advantage and increase its own capitalisation."

Storozhev believed that the consolidation of the grids into Naftogazmerezhi would be difficult and slow, partly because of the varying ownership structure of the grids. This included "corporate ownership, i.e. grids built by the oblgazes themselves, as well as state and communal ownership. For example - a town may at one time have built a grid but did not transfer it to the balance sheet of the local oblgaz which subsequently used the grid". The process would be delayed by the necessity of making a grid inventory, which would take at least a year according to Storozhev.

"Even if the specially formed entity Naftogazmerezhi is to directly handle gas transport, someone will have to document the gas and service and maintain the grid infrastructure. In Ukraine, there is no alternative to using staff employed by the oblgazes to achieve this."

Nevertheless, Strozhev did not believe that the creation of Naftogazmerezhi would bring about a sudden halt in the activities of the distributors. He thought the least disruptive way to proceed would be for gas pipelines in state ownership to be put on the balance sheet of Naftogazmerezhi which would then take over the distribution and sale of gas.

But technical maintenance should be carried out exclusively by employees of the oblgaz's. That would more or less continue things as they were, just changing the flow of finance, with gas transport charges going direct to Naftogazmerezhi rather than via the oblgazes.

The oblgazes would receive payment for servicing the grids. Distributors that had independently constructed their own grids should maintain ownership of their assets and continue to operate them. "According to Ukrainian law it is not possible to take ownership [of the grids] away from them," Storozhev said.

Naftogaz tried to create a similar entity to Naftogazmerezhi a few years ago - it was called Ukrgaz Merezha. One of the reasons Naftogaz had for creating that entity was to improve the payment performance of its customers - there had long been a feeling in Ukraine that the oblgazes had not passed on in full to Naftogaz the payment they had received from their customers.

The contracts with Ukrgaz Merezha also required the distributors to invest part of their earnings in improving their gas infrastructure. How successful Ukrgaz Merezha was in achieving its aims is debatable. Naftogaz still complains of poor payment performance on the part of many of its customers. Now that Naftogazmerezhi is being brought into being, the likelihood is that Ukrgaz Merezha will be liquidated, Naftogaz told ICIS Heren. Whether Naftogazmerezhi is any more successful than its predecessor remains to be seen.