Comparing Naftogaz to European peers shows gas transmission and storage is indeed a key area where the Ukrainian player stands out – a challenge regularly highlighted
by international experts as a top priority. "I would still argue for strong ownership unbundling and divestment of Naftogaz to create viable competition to ensure the best service at fair prices for Ukrainian consumers," summed it up Georg Zachmann, an energy analyst from the Bruegel think tank in Brussels.
The question of the right model has been stuck, however, due to a deadlock over energy policy between Naftogaz and the former government of Prime Minister Volodymyr Groysman. The government favored a "full ownership unbundling" model (with an option to revoke the status of the operator), while Naftogaz pushed for the "independent system operator" model, whereby an independent operator worked as part of an international consortium, a common practice that offers greater protection to foreign partners. Importantly, the former option could damage a claim by Naftogaz against Gazprom in the Stockholm international arbitration court – resulting in gridlock.
According to Edward Chow, an expert at the Washington DC-based Center for Strategic and International Studies, the underlying problem was a lack of united vision inside the Ukrainian government on what energy policy to set or "how energy reform should proceed." The right model for Ukraine?
Persistent threats to supply from Russia's Gazprom – which is trying to circumvent Ukraine via building the Nord Stream 2 pipeline under the Baltic – as well as large groups of price sensitive consumers have defined the priorities for building a Ukrainian model.
Ability to attract international expertise and investment is particularly relevant given Ukraine's sizable gas deposits, which could see the country become a potential energy exporter. "We are building the Ukrainian Statoil [now renamed Equinor]," the CEO Andriy Kobolev said of the company's ambitions.
However, vertical integration and unbundling are not contradictory – quite the opposite argues Alex Vedeneyev, head of market research and analytics at Naftogaz. The has set the strategy to strengthen integration irrespective of what unbundling model is picked (and the potential benefits that might arise from it. "The issues of unbundling and improving vertical integration are linked, but should be considered independently," Vendeneyev argued.
That is fine and well as long as it doesn't come through excluding third parties from different segments of the market. Indeed, Naftogaz has faced challenges from the Anti-Monopoly Committee of Ukraine about the ability of new players to enter the gas market.
In response, the company points to the growing number of private players in such areas as gas imports. Indeed, the number of importers has increased from 18 in 2015 to 65 in 2018, while Naftogaz's share of the liberalised market (the non-regulated part on which competition is focused) has fallen below the 35 percent share defined as dominance in Ukrainian and European legislation. This is even further underscored when considering neighbouring countries, with whose markets Ukraine is closely integrated, that present additional sources of competition.
"Naftogaz has in effect ceded most of the market for industrial players," stated Simon Pirani in a report for think tank Oxford Energy.
Although initially designed to protect households from market fluctuations and rising prices, the legislation has come under criticism. According to Volodymyr Omelchenko, head of the energy programs at Razumkov think tank, this approach is fundamentally flawed and does little to prevent populism. "It is far from market principles, Omelchenko argued. "There is a law on the natural gas market and commission which should keep an eye on these issues. The government wants to play political games and to show good intentions."
On the other hand, the regulated formula tends to be one-sided in delivering benefits. Indeed, consumers who benefit from special prices don't see prices drop whenever the market trends downward. Earlier this year, Naftogaz CEO Andriy Kobolev pointed to this feature while arguing to lift restrictions and completely liberalize the gas market in discussions with the Cabinet of Ministers. New forms of moral hazard
Excessive subsidies and the ensuing deficits were not the only problem with the previous regime. Indeed, one of the key challenges regularly brought up was that the subsidies ended up benefitting big buyers of gas (effectively making them the main beneficiaries).