Resumption of gas transit may be part of the agreements to end the war – Serhiy Makogon

Author

Valery Moisieiev

Ukraine is a significant importer of gas, so European traders are interested in selling us gas. For our part, we can offer them our underground gas storage facilities (UGS) and gas transportation system (GTS). In addition, Ukraine has great potential for exporting biomethane, the first batches of which have already been delivered to the EU. It is possible that in 8-10 years the country will be able to export both regular natural gas and even hydrogen. Serhiy Makogon, former head of the "Gas Transportation System Operator of Ukraine" (GTSU), told this in an interview with .

Ukraine's place in the European gas market

If we talk about Ukraine becoming part of the European gas market, is it "beneficial" or "vitally necessary" for us?

– We have been part of the EU gas market for a long time. Since 2015, we have not imported gas from the Russian Federation, but have been purchasing it in the EU. Almost all European rules for operating in the gas market apply to us. Almost all well-known Western traders already have experience working with our GTS and UGS operators, as well as with local gas suppliers and buyers. Many Western companies opened offices in Ukraine even before the war.

Is it possible to resume Russian gas transit through Ukraine?

– Ukraine’s decision not to continue transit was very correct, because it deprived Russia of $6 billion in annual income, which was then returned to us in the form of mercenaries, UAVs and missiles.

I do not see much economic sense for Ukraine in resuming such transit, and besides, the EU has announced plans to completely abandon Russian gas by 2027.

Serhiy Makogon

But Russia has already stated that one of the requirements for ending the war is the resumption of gas transit through Ukraine. Therefore, I assume that the resumption of transit may become part of the general agreements on ending the war. In this case, Ukraine and the EU should take a tough position on the conditions for such resumption. First, Russia should sell gas to Europeans not inside Europe, but on the Ukraine-Russia border, and at anonymous auctions. This will deprive the Kremlin of the opportunity to offer different prices: lower to loyal governments, and higher to disloyal ones. This is a standard practice of the Kremlin's political corruption. Second, Ukraine should receive 15-20% of Russia's revenues from Russian gas exports through the country. These funds should go to restore Ukraine's destroyed economy. Third, Russia should return the Zapadnaya NPP to Ukrainian control.

The attractiveness of Ukrainian underground storage facilities for Europeans has been talked about for a long time. But they are talked about more here than "over there." In your opinion, why are Europeans in no hurry to use our storage facilities? Is it just a matter of the security risk associated with the war?

- Europeans already have experience using our storage facilities — in 2020, foreign traders stored 12.8 billion cubic meters of gas with us. And they will store it again when there are no military risks of losing gas due to Russian strikes and there is economic sense, which arises when the difference between the price of gas in winter and summer exceeds the cost of storage. Therefore, Ukraine has already done its homework and we need to wait for the end of the war.

Providing Ukraine with gas

Do you believe that Ukraine can fully satisfy its needs with gas of its own production? What is needed for this?

– It would be great to extract all the necessary gas in Ukraine and even export it to earn money on it. But Ukraine has imported gas since independence and will still import 3-5 billion cubic meters of gas for the next 5-8 years. And I do not see the presence of gas imports as something critical for the development of our country. There are many countries that import gas, but at the same time they are developing stably and rapidly. For example, Poland imports 75-80% of gas, but in recent decades it has been developing rapidly and its GDP is already more than four times higher than Ukraine's GDP.

Our path to energy independence is to reduce energy consumption through energy efficiency measures, as well as to increase production primarily on the Black Sea shelf. That is where there are large new gas reserves. Romania, Bulgaria, and Turkey are already actively developing offshore gas fields. Unfortunately, we can only start doing this after the war is over.

Domestic gas market in Ukraine

If we talk about the domestic gas market, what are its main pain points, bottlenecks?

– The main problem in the gas market is very significant state regulation. Currently, the government actually regulates prices for 80% of the gas market: Naftogaz is obliged to supply gas at lower than market prices to the population, district heating companies, energy companies, regional gas companies, etc. Therefore, there is no competition at all. I hope that after the war the state will reduce the level of intervention in pricing on the gas market, because investments will not go into the development of gas production if the production companies are not sure that they will be able to freely sell gas at market prices, including for export.

It seems that the state would like to subordinate not only the main gas pipelines, but also the distribution networks. To what extent can such a conditional nationalization be justified?

– Gas distribution networks have always been state-owned. Private companies simply took them over from the state for management. At the same time, without paying a single hryvnia to the state for this. But they were very inefficient managers. The debts of regional gas companies to the State Gas Distribution Company alone amounted to over UAH 16 billion, and even larger debts were to Naftogaz. Therefore, the government's decision to take the networks from the Regional Gas Company (RGC) and others was understandable.

I do not see a problem in returning the networks to state management, because distribution network operators are natural monopolies in their regions, so competition there is even theoretically impossible, and their activities and profitability are strictly regulated by the National Commission for the Regulation of Energy and Utilities of Ukraine.

But it would be more correct to transfer these distribution networks not to Naftogaz, which is also a gas supplier, but to the independent "GTS Operator of Ukraine". This would guarantee equal treatment of distribution network operators both to Naftogaz and to other private suppliers. European directives also recommend separating distribution network operators from gas suppliers.

I have long advocated transferring state gas storage facilities and distribution networks from Naftogaz to the Ukrainian Gas Transmission and Distribution Company in order to create a single company that would manage the entire gas infrastructure of the country. This would not only significantly reduce administrative costs, but most importantly, quickly make decisions on the development of the infrastructure and its optimization.

Our gas infrastructure was built for the transit of 145 billion cubic meters per year, and for consumption of 100 billion. Such volumes will never be available again, so we need to quickly optimize the entire infrastructure for the new reality. Because supporting all the excess infrastructure is very expensive, and it also falls on the shoulders of end consumers in the form of tariffs for operator services. And why pay for something that will never be needed again?

Currently, there is no single strategy for optimizing the entire gas infrastructure, and each operator of the gas transmission system, underground storage facilities, and distribution networks works separately and exclusively in its own interests. A single infrastructure operator could unite everyone and promptly make decisions on optimization.

And this is not a violation of European directives. In many countries, there are precisely unified gas transmission system and underground storage facilities operators. For example, in Poland last year, storage facilities were transferred to the gas transmission system operator, which previously also managed an LNG terminal. They realized that it was the unified operator that would be able to quickly make decisions and ensure the necessary development of the entire infrastructure, understanding the needs of the gas transmission system, underground storage facilities, and LNG terminals. And here we have a "swan, a crayfish, and a pike."

In addition, it would be easier for such a large, single infrastructure operator to attract financing from international financial institutions. Agree that it is easier for the EBRD to deal with one large, powerful operator than with each of the 26 separate regional gas stations, the underground storage facility operator, and the gas transmission system operator. And over time, such a large operator could go on an IPO to attract additional investments into the country. I do not think that a separate regional gas company will ever be able to go on an IPO, because the scale of the business is insufficient.

Why is Naftogaz of Ukraine needed?

And why does the market and the state need Naftogaz now? To own the corporate rights of production and gas transportation companies and non-transparently accumulate and distribute money across the industry?

– Currently, Naftogaz performs an important social function of supplying gas to the population and heating and power utilities at regulated prices (the so-called special obligations). I hope that after the war we will return to the introduction of market pricing even in these segments.

I agree with you that now Naftogaz has again turned into a large and non-transparent company. I do not understand how the board and supervisory board of Naftogaz can devote time to managing dozens of different businesses: from oil and gas production and trade, to managing CHPs, a network of gas filling stations, etc. Therefore, to increase its transparency and efficiency, Naftogaz needs to be gradually disaggregated.

As a first step, I would propose transferring state gas storage facilities and distribution networks to the management of the State Gas Transport and Distribution Company. This is not Naftogaz's property, but state property, so the government can make such a transfer quite quickly. Then, it would be logical to remove Ukrnafta from Naftogaz's management. This has long been a completely separate business. Non-core businesses will be privatized over time.

Such disaggregation would not only increase the company's transparency, but would also allow Naftogaz's management to focus on its main business areas: the development of gas production and gas trading.