Summer Breakthrough:

Ukraine moves one step closer to opening its retail gas market to competition

A summer breakthrough is coming to Ukraine’s retail gas market.

The highly regulated segment of the market (unlike prices for industrial players, prices for retail consumers have long been set by the government – see chart), is set to be opened up to competition – with a promise of greater choice, better service, and protection against baseless price hikes for consumers.

The changes have been a long time coming. When the transformation of Ukraine’s gas sector began in earnest, the PSO or Publish Service Obligation legislation that was implemented mandated that gas deliveries to households be subject to a regulated (and de facto subsidized) price.

Introduced in 2015, this move to protect consumers hard-hit by an economic downturn was supposed to last until April 2017. However, it was extended by a cabinet worried about the political fallout.

Despite further delays in implementing regulations – which both follow European standards and have been promised to the International Monetary Fund – it looks like Ukrainians are finally going to get a competitive retail gas market.

This move could mark a step-change for Ukraine’s energy sector. Wojciech Jakobik, a Warsaw based energy analyst has previously noted that the split of the market has discouraged investors, deprived the industry of know-how and capital to modernize, and stalled progress on improving efficiency (a major headache for Ukraine, which despite significant improvements remains one of the world’s least energy-efficient economies).

...it looks like Ukrainians are finally going to get a competitive retail gas market.

Creating a truly competitive market – where players would compete in terms of service and provide a competitive price for consumers – could have benefits than just price, noted Nataliya Katser-Buchkovska, an energy and investment advisor at the Ukrainian Institute for the Future.

During last week’s Energy Thursday, an energy-focused webinar, Katser-Buchkovska explained how increased competition can ensure a better level of quality and energy-content of the supplied gas.

In order to make this a reality, the government needs to ensure consumers have an easy and accessible way to change suppliers, that a supplier of last resort can back-up the system, that debts are settled through courts rather than shutting people off and finally that all suppliers have equal access to infrastructure and consumers.

The first two of these have already been implemented, albeit with some challenges. In particular, consumers need to use their individual codes to change suppliers – these could be found on gas bills in the past but have recently disappeared.

The latter two, however, are still pending. In practice, regional gas suppliers linked to distribution network operators continue to freeride on a system where they have preferential access to the “last miles” of the network, while avoiding any of the risks involved.

Transforming the system would mean that these gas suppliers take on the full responsibilities of their role and have to face competition.

Transforming the system would mean that these gas suppliers take on the full responsibilities of their role and have to face competition.

Currently, these companies only work on the consumer-end of the spectrum, collecting payments and late fees. Thanks to the PSO arrangement, they can obtain volumes they need at a fixed price from Naftogaz. They do not have to pay for gas in advance, and their requests may not be declined even if some of their past supplies remain unpaid

If competition is opened up, however, they will need to stock up on supplies over the summer, forecast demand, and secure working capital – in short, bear the full risks involved in their lucrative business.

One of the most important – but also most contentious – elements involved in setting up a truly competitive market is selecting a so-called supplier of last resort (also referred to as SLR).

The idea is relatively simple. Customers who decide to switch their gas providers need to know they will not be left out in the cold during the transition. Ukraine’s legislation sets out a timeframe of up to 60 days during which consumers are supplied by the supplier of last resort if their regular supplier fails on its obligations.

In order to ensure that the supplier of last resort is able to both withstand a national crisis the selection process emphasized the requirement of being able to leverage 3.5 billion cubic meters in reserves of gas – or slightly more than a month’s worth of supplies.

This matters because the supplier of last resort also acts as a form of insurance for the market – should Ukraine experience a nationwide shock due to, for example, a cut to supplies, as well as a crisis at a systemically important distributor.

According to Mykhailo Honchar, President of the Centre for Global Studies "Strategy XXI", Naftogaz is the only player than can back this claim up with “real reserves”. All the other bidders have just “virtual reserves,” meaning contracts or pledges that they can call upon.

Nonetheless, the final stage of the process came down to price, as competitors had to submit a cost formula that would offer the best possible deal to consumers.

Naftogaz is the only player than can back this claim up with

Maksym Rabinovych, Naftogaz’s Head of Retail and CEO of its Gas Supply Company (a part of the Naftogaz group), explained the selection process: “Those participants who went through pre selection were supposed provide their price for being a supplier of last resort.”

“The cost formula was based on the hub costs, that is NCG [NetConnect Germany, one of Germany’s two main gas hubs], the spread – the cost to transport from border to border, and thirdly the mark-up. While the hub and spread where the same for everyone, the fight was about the mark-up,” he explained during the Energy Thursday webinar.

“Who gives the lowest mark-up, becomes of the supplier of last resort,” he noted. “We gave a mark-up of 0%.”

Mykhailo Honchar

While the hub and spread where the same for everyone, the fight was about the mark-up

Maksym Rabinovych

The coronavirus pandemic has provided a unique opportunity to move forward. Indeed, the global slowdown in economic activity (particularly in energy- and labour-intensive segments like construction or industry) has depressed gas prices, which had already been trailing downwards due to increased competition and a relatively warm winter.

“For the first time for Ukraine we’ve seen prices fall rather than rise due to the crisis,” Katser-Buchkovska, noted.

On July 10 the Ministry of Energy selected Naftogaz of Ukraine Gas Supply Company to be the supplier of last resort, moving the process of opening up the market closer to the finish line. The decision is waiting for approval from the Cabinet of Ministers. There are currently some risks, as companies that are part of the Regional Gas Company, a de facto distribution monopolist, are challenging the results and the selection process. Without a supplier of last resort, the whole system is exposed to systemic risk.

However, if finalized, this may end up becoming a historic summer for the energy market, and most importantly ordinary consumers.

For the first time for Ukraine we’ve seen prices fall rather than rise due to the crisis

That means that market prices – which would directly translate into costs for consumers – are in fact lower than they have been for a long time. consumers.

Katser-Buchkovska