Naftogaz gets sales exclusivity, creating risk for private producers

Обзоры по компаниям и отраслям 13.11.2014 The Cabinet of Ministers of Ukraine adopted a resolution, made public on Nov. 11, that makes state holding Naftogaz of Ukraine the exclusive supplier of natural gas to the 90 biggest consumers in Ukraine. The companies included in the list are prohibited from buying gas from any other supplier between Nov. 11, 2014 and Feb. 28, 2015. The list of the biggest consumers encompasses all thermal power plants, some heat and power stations, as well as selected factories that produce steel, iron ore, cement, machinery, confectionery goods, beverages and poultry. The list does not contain most of Ukraine’s fertilizer producers, except the Odesa Portside Plant. The top management of the Poltava Gas and Oil Company, a Ukrainian subsidiary of JKX Oil & Gas (JKX LN), announced on Nov. 12 that it “does not rule out stoppage of gas production” due to the implementation of this resolution, as cited by the Interfax-Ukrayina news agency. According to the CEO, the resolution forces the company, or traders it deals with, to sell gas to consumers who use no more than 10 tcm per month, compared to 20,000 tcm of gas that the company produces monthly. On top of that, the regulation might grant Naftogaz the authority to block the pumping of private producers’ gas into the underground storage tank system. Alexander Paraschiy: The regulation is raising suspicions of politics, given that the list of “large gas consumers” does not look complete. For instance, it excludes Yenakiyeve Steel (ENMZ UK) and steel mills based in the city of Donetsk, while it includes all the other big steel mills, including Alchevsk Steel (ALMK UK), located deep in the territory occupied by Russian-separatist forces. We also see little logic in omitting Azovmash, Ukraine’s biggest railway machinery holding, but including Kryukiv Railcar (KVBZ UK). Also questionable is the inclusion of all the subsidiaries of DTEK (DTEKUA), the holding that can satisfy about half of its gas needs with internal production. Clearly, the regulation doesn’t bring any positives for independent gas producers in Ukraine, like the subsidiaries of JKX Oil & Gas, Serinus Energy (SEN PW) and Regal Petroleum (RPT LN). At the same time, we do not see any reason why it should lead to the interruption of their production. Most of gas produced by these companies is being sold to gas traders, who, in turn, sell it to end-consumers. To avoid any risk of production disruption after the resolution is adopted, the companies (or traders they deal with) will have to sell their gas to Naftogaz. Clearly, the main negative effect will be a possible decrease in the price that the producers will get for their gas. Coupled with high gas production taxes that were introduced in August 2014, the new regulation will negatively affect gas producers’ profit in 4Q14, at minimum. For that reason, the regulation demotivates any increase in private gas production in Ukraine, which undermines the Ukrainian government’s plans to improve energy security. On top of that, this regulation creates good ground for corruption. In particular, Naftogaz is now becoming a near monopoly buyer of gas from private producers, meaning it’s a price setter. In an environment in which its buying prices are not regulated, Naftogaz has the ability to discriminate against some gas sellers, e.g. based on their willingness to bribe a procurement manager.