November 10, 2014

Energy Management in Ukraine—With And Without Gas

Reuters/Scanpix
Gas pipes are pictured at Oparivske gas underground storage in Lviv region September 30, 2014.
Gas pipes are pictured at Oparivske gas underground storage in Lviv region September 30, 2014.

No one can really be completely sure whether and how Ukraine will cope in the coming heating season.

Ukraine starts the heating season, which lasts from October to April, with its lowest gas reserves since gaining independence. The main reasons are the price disputes with Gazprom and the suspension of gas deliveries, as well as the loss of Crimea to Russia, which deprived Ukraine of the most promising offshore natural gas fields.
How can Ukraine increase existing reserves and replace natural gas in order to survive the coming winter with the minimum possible losses?

1. The Importance of Natural Gas to Ukraine

In 2012, natural gas and coal each accounted for approximately 35% of the primary energy of Ukraine, nuclear energy 19.1%, and petroleum and petroleum products 9.5%.1
The high percentage of natural gas is due to its comparative cost advantage—compared to other fuels, gas has been extremely cheap in Ukraine the whole time it has been independent. For example, a Ukrainian consumer pays almost one-tenth as much as a German consumer for a cubic metre of natural gas, and approximately 60% of what a Russian consumer pays for it. Natural gas is about five times more expensive for Ukrainian industry (including the power generators) than for its population.2
Despite the cost advantage, the consumption of natural gas in Ukraine has continuously decreased. While approximately 96 billion cubic metres (bcm) was consumed in 2004, this fell to only about 50 bcm in 2013. As natural gas production in Ukraine itself has remained almost at the same level for the last decade, the decrease in consumption is related to the reduction in imports,3 which in turn is caused by the continuous increase in the price of natural gas imported from Russia.
The following table gives an overview of the production, consumption and import of natural gas in Ukraine and the average price of imported natural gas.
Table 1. Consumption, import and production of natural gas in Ukraine (billion cubic metres).

 

2010

 

 

2011

 

 

2012

 

 

2013

 

 

Production

 

 

20.5

 

 

20.1

 

 

20.2

 

 

21.0

 

 

Imports

 

 

36.5

 

 

44.8

 

 

32.9

 

 

27.9*

 

 

From reserves**

 

 

-1.1

 

 

-5.6

 

 

1.7

 

 

1.1

 

 

Consumption

 

 

55.9

 

 

59.3

 

 

54.8

 

 

50.4

 

 

Price (US$/1,000 m3)

 

 

260

 

 

309

 

 

426

 

 

414

 

* Of which 25.8 bcm was imported from Russia and 2.1 bcm from Europe.
** Negative numbers show the volume of gas in storage facilities, while positive numbers show the volume of gas withdrawn for consumption.
Sources: НАК Нафтогаз України; Michael Gonchar, “Die Achillesferse der Ukraine”, Ukraine-analysen nr. 127, 11.02.2014, p. 6.; www.vedomosti.ru/special/gaspriceschange.shtml In 2012, the largest consumers of natural gas were the generation of electric power and heat (38%), residential (32%) and industry (energy production and as a raw material—23.5% in total).4

2. Natural Gas Imports from Russia

The price of natural gas imported from Russia has increased sevenfold—while Naftogaz paid Gazprom US$59 per 1,000 cubic metres in 2005, it paid as much as $426 in 2012.5
Whereas price disputes were resolved by political agreement until 2014, the situation changed last spring, because the new government of Ukraine refused to collaborate with Moscow or to spend the money received from the West on purchasing natural gas, especially after Russia annexed Crimea and started an armed conflict in eastern Ukraine.
On 16 June 2014, Gazprom halted natural gas deliveries to Ukraine, because Naftogaz refused to pay the debt that had begun to accumulate since the end of last year. Naftogaz also refused to make advance payments for the delivered gas, because agreement had not been reached over the price.
In order to settle the dispute, both Gazprom and Naftogaz filed a claim with the Arbitration Institute of the Stockholm Chamber of Commerce. Gazprom demands that Naftogaz settle its debt and Naftogaz wants a fair price from Gazprom.
Despite the dispute, the Ukrainian government is considering buying at least 5 bcm of natural gas from Gazprom this year.6 There are three reasons for this. Firstly, they want to avoid using the buffer gas from underground storage facilities (additional natural gas needs to be imported to replenish buffer gas). Secondly, it cannot be ruled out that the European Commission will insist that some of the natural gas reserves be used for balanced transit (Ukrtransgaz does not currently have such an obligation—see below). And thirdly, they want to mitigate the restrictions imposed on industry (the government’s plan stipulates that industry is restricted to half as much gas as last year7).

3. Natural Gas Transit to Europe

The transit of natural gas through Ukraine to Europe has gone smoothly; not even the explosion on the Urengoy–Pomary–Uzhgorod pipeline affected it.8
The GTS operator Ukrtransgaz joined the European Association of Gas Transmission System and Storage System Operators on 25 May and all movements of gas volumes in Ukraine are now visible online in the association’s information system AGSI+.9 This enables Ukraine to nip accusations of illegal consumption of natural gas in the bud.
Gas transit to Europe can be influenced by Gazprom’s decision to terminate the contract with Ukrtransgaz for balanced transit with effect from 23 June 2014.10 According to the contract, Ukrtransgaz compensated for the rapid increase in gas consumption in Europe during the winter with its reserves from underground storage facilities, and Gazprom paid Ukrtransgaz for the relevant volume.11 Ukrtransgaz now has no contractual liability to smooth out seasonal fluctuations in consumption.

4. Natural Gas Imports from Europe

Ukraine has been buying natural gas from Europe for the second year in a row, made possible by a pipe connection that enables the flow to be reversed, free space on the transit route, and lower prices for natural gas on the European spot transaction markets.
As long as a decade ago, the European Commission annulled the clauses in delivery arrangements that forbade reselling gas, so that when a volume of gas changes ownership, the new owner can sell the gas to whomever and wherever he wants. 12
Ukraine made the first attempt to start reverse flows from Europe at the end of 2012, when the German energy company RWE sold Naftogaz the first volumes of gas through Poland.13
In 2013, there were additional reverse flows from Hungary, and Naftogaz bought over 2 bcm of natural gas from RWE (see Table 1). This year, reverse flows also started from Slovakia and, from 2 September, 26.3 million cubic metres per day (mcm/d) has been continuously delivered from there.14
The maximum volume of the reverse flow from Poland is 4 mcm/d and from Hungary 16 mcm/d. The average volumes are substantially smaller: for example, the Hungarian route is only loaded to 75% of capacity,15 even though Ukrtransgaz extended the pipeline route last August.16
On 10 September, Gaz-System SA, the Yamal–Europe pipeline operator in Poland, announced routine repairs on the route and the suspension of reverse flows.17 Reverse flows were restored two days later.
Reverse flows of natural gas from Hungary were reduced by approximately half in July, when the Hungarian GTS operator FGSZ increased the reserves in its underground storage facilities.18

5. Gas Reserves in Underground Storage Facilities in Ukraine

The halt in imports from Russia has had an effect on natural gas reserves in Ukraine. During the first half of 2014, storage facilities were filled faster—14.3 bcm had been stored by 16 June, while the volume of reserves had increased only by 2 bcm by 18 September.19
The volume of reserves is increased chiefly through the importation of natural gas from Europe. The Ukrainian government hopes that the gas reserves will reach at least 17 bcm by mid-October.
In previous years, there has been no need for such a high volume of reserves due to the continuous deliveries from Russia. Based on preliminary estimates, Ukraine will fall short by about 3 bcm this year.20 A shortage in natural gas may emerge when Ukraine needs to use its reserves in the winter to contribute to the sudden increase in consumption in Europe.
A relatively small volume of the gas produced in Ukraine reaches the underground storage facilities, as it covers everyday consumption.

6. Natural Gas Production in Ukraine

Natural gas production in Ukraine has remained at the same level—about 50 to 55 mcm/d—compared to last year21 (the same applies to monthly figures22).
Private companies have increased production,23 because production by the national gas company Ukrgazvydobuvannya (which produces approximately 75% of Ukrainian natural gas)24 is decreasing. During the first five months of 2014, the company produced 5.9 bcm of natural gas, i.e. 1.5% less than in the same period last year. The production of the second national gas company Ukrnafta (approximately 10% of Ukrainian natural gas) has decreased by as much as 8% this year.
The increase in natural gas production in Ukraine is restricted by a state-regulated price at which state-owned producers are obliged to sell gas. Ukrnafta and Ukrgazvydobuvannya can sell natural gas at UAH 350 per 1,000 m3, while private companies can sell at UAH 4,700 per 1,000 m3.25 This is why national companies have reduced prospecting activities and the utilisation of new fields. National companies use corrupt schemes to sell cheaply produced natural gas at a higher price.26
The fighting in the Donetsk and Luhansk Oblasts have begun to affect natural gas production, because the separatists and terrorists supported by Russia have occupied or destroyed production equipment.27 According to the largest Ukrainian gas producer, Ukrgazvydobuvannya, some of the boreholes need to be closed for safety reasons,28 and this is another reason less natural gas is being produced.

6.1 Offshore Natural Gas Fields

In recent years, Chornomornaftogaz, a subsidiary of Naftogaz, has utilised several new fields in the Sea of Azov and the Black Sea situated off the coast of the Crimean Peninsula, and bought two modern floating rigs for producing natural gas.29
By using offshore fields, Ukraine wanted to compensate for the decrease in gas production on dry land. According to earlier plans, Chornomornaftogaz should have produced 3 bcm of natural gas in 2015 from the fields off the coast of Crimea.30
However, the Crimean authorities have now occupied all Chornomornaftogaz possessions on the peninsula and its coastal sea and are planning to hand them over to Russian companies.31 The government of Ukraine considers such activities illegal, but has so far done nothing to protect the forfeited possessions or to take them back.
The Ukrainian government has awarded three licences for prospecting natural resources in the deep waters of the Black Sea.32 Vanco Prykerchenska Ltd has a licence for activity in the Prykerchenska area south-east of Crimea. EDF and Eni received a shared activity licence in the area south of the Kerch Peninsula (the largest field is Subbotina).33 In 2012, a consortium led by Exxon Mobil, Shell and OMV Petrom won the tender for the Skifska area south-west of Crimea.34 Prospecting activities have been stopped in all these areas.

6.2 Shale Gas and Coal-bed Methane Projects

The government of Ukraine has given permission for prospecting shale gas in two fields—Yuzivska and Olesska—through a deal with Shell and Chevron signed in 2013.
Shell halted test drilling in the Yuzivska field due to the fighting in eastern Ukraine.35 Shell has not resumed prospecting activities, even though the city of Sloviansk, which is situated in the middle of the field, is once again controlled by the Ukrainian armed forces. Chevron has not even started test drilling in the Olesska field.36 The U.S. ambassador has given assurances that the company will not stop prospecting for and producing shale gas in western Ukraine.37Shale gas will not help satisfy current gas demand in Ukraine because, even in the best-case scenario, it will take three years to start production.38
Ukraine tried out coal gasification, but did not get past test drilling, because the expected volume of methane was not obtained from any of the boreholes. This is why the Ukrainian Ministry of Fuel and Energy decided to halt the project in Lysychansk funded by the China Development Bank and supported by Shell technology.39

7. Natural Gas Replacement

Since 2009, as natural gas has become more expensive, Ukrainian entrepreneurs and energy producers have been replacing it with other fuels, chiefly coal. Increasing the role of nuclear power plants in the generation of electric power has been considered.

7.1. Coal

In 2013, 83.7 million tonnes (Mt) of coal was produced in Ukraine, approximately 70% in Donbass.40
The armed conflict in eastern Ukraine has forced entrepreneurs to halt mining coal in at least 30 shafts in the Donbass coalmining region due to the destruction of infrastructure during fighting (interruptions in electric power stopped pumps from working and shafts became flooded) and shortage of equipment (the delivery of explosives to the mines has been stopped).
In the first eight months of 2014, coal production in Ukraine has decreased by about 14%.41
The Ukrainian government is considering importing coal for power generation,42 because existing reserves are limited.43 Ukraine has signed an agreement for the delivery of 1 Mt of coal from South Africa. Ukraine is also considering importing coal from Europe, mainly from Poland. DTEK, the largest power company in Ukraine, wants to purchase cheaper coal from Russia.44
Coal can be imported through large coal terminals located in six ports:45 Mariupol (capacity 3.3 Mt per year) 46, Mykolaiv (2.5 Mt/yr), Izmail (1.4 Mt/yr), Yuzhny (1.4 Mt/yr), Berdyansk (1.2 Mt/yr) and Ilyichevsk (0.7 Mt/yr). There are also three smaller ones, the total turnover of which is 0.15 Mt/yr.
As coal reserves in thermal power stations47 have decreased below 2 Mt,48 Ukraine is preparing to restrict the use of electric power.49

7.2. Nuclear Energy

There are 15 power units located at four nuclear power plants in Ukraine. Some of these are not operating at full capacity, because there are not enough transmission lines for the distribution of electric power. The Ukrainian government is exceptionally funding the establishment of additional power connectors50 in order to reduce the percentage of natural gas and increase the role of nuclear plants in the generation of electric power.
Ukraine mines uranium and produces enriched concentrated uranium oxide,51 but the necessary nuclear fuel is produced in Russia. So far, the fighting in eastern Ukraine has not affected nuclear fuel deliveries from Russia.52
In collaboration with Rosatom, the establishment of a nuclear fuel factory in Ukraine was planned, but the undertaking has dragged on without progress.53
In the spring, Energoatom (Ukraine’s state nuclear power enterprise) signed an agreement with Westinghouse for the diversification of nuclear fuel deliveries.54 In future, Ukraine wants to supply three power units with nuclear fuel from Westinghouse. According to the plans, the first batch of Westinghouse nuclear fuel rods will be loaded into the third power unit of the Yuzhnoukrainsk nuclear power plant around the end of this year.55

Conclusion

No one can really be completely sure whether and how Ukraine will cope in the coming heating season.
Even if the Ukrainian government manages to liberalise the gas market tomorrow, it will take at least a year to increase domestic production. The utilisation of shale gas and the offshore fields will take even longer.
Alternative import channels either have a limited capacity (reverse flows from Europe) or are still being established (the LNG terminal56), and cannot compensate for current gas imports from Russia any time soon.
In the winter, imports from Europe will depend on whether neighbours in the West have enough natural gas to send the surplus back to Ukraine.
There may be more reserves than last year, but their use depends firstly on how strictly economising measures are followed, and secondly on ambient temperatures. It cannot be ruled out that part of Ukraine’s gas reserves will still need to be used to balance consumption in e.g. Bulgaria, which lacks its own reserves.
The replacement of natural gas is limited firstly by technical possibilities (e.g. the availability of solid-fuel boilers) and secondly by access to alternative fuels such as coal.
According to the Ukrainian online publication ЛІГАБізнесІнформ, in the event of strict economising as well as continuous reverse flows and domestic gas production, Ukraine can survive the winter without importing gas from Russia (see Table 2).57
Table 2. Demand for, production and reserves of natural gas and imports from Europe from 2014 to 2015 (billion cubic metres).

 

Consumption

 

 

Production

 

 

Reverse

 

 

Production

+ reverse

 

 

Balance

 

 

Reserves

 

 

August

 

 

1.75

 

 

2.26

 

 

0.26

 

 

2.52

 

 

0.77

 

 

15.72

 

 

September

 

 

2.10

 

 

2.26

 

 

0.56

 

 

2.82

 

 

0.72

 

 

16.44

 

 

October

 

 

3.70

 

 

2.39

 

 

0.86

 

 

3.25

 

 

-0.45

 

 

15.99

 

 

November

 

 

4.30

 

 

2.39

 

 

0.86

 

 

3.25

 

 

-1.05

 

 

14.94

 

 

December

 

 

6.01

 

 

2.39

 

 

0.86

 

 

3.25

 

 

-2.75

 

 

12.19

 

 

January

 

 

6.59

 

 

2.53

 

 

0.86

 

 

3.39

 

 

-3.20

 

 

8.99

 

 

February

 

 

5.57

 

 

2.26

 

 

0.86

 

 

3.12

 

 

-2.45

 

 

6.54

 

 

March

 

 

4.30

 

 

2.26

 

 

0.86

 

 

3.12

 

 

-1.18

 

 

5.36

 

 

April

 

 

2.70

 

 

2.13

 

 

0.86

 

 

2.99

 

 

0.29

 

 

5.65

 

Source: biz.liga.net
Economising means reducing room temperatures for residents, and stoppages for industry dependent on natural gas. The government has decided that, in the coming winter, state institutions (hospitals, schools etc.) must manage with 10% less natural gas than last year and public utilities (basically boiler houses) with 30% less.
Industry faces the greatest need to economise. This is why the government is considering giving companies permission to purchase natural gas directly from Russia and Europe, rather than through Naftogaz. Ukraine’s previous experience of issuing import licences for natural gas has quite a corrupt flavour, because purchasing cheaper gas from Russia is only possible with the approval of the local authorities.
______
1 The energy balance as of 2012 is available at the website of the State Statistics Service of Ukraine. See www.ukrstat.gov.ua/operativ/operativ2013/energ/en_… 2 gazeta.zn.ua/energy_market/cena-gazovoy-nezavisimo… 3 About 66 bcm of natural gas was imported from or through Russia each year between 2003 and 2005, about 51 bcm between 2006 and 2008, about 40 bcm between 2009 and 2011, and about 31 bcm between 2012 and 2013.
4 See www.ukrstat.gov.ua/operativ/operativ2013/energ/en_… 5 Лелюк О. В., Аналіз особливостей українського ринку видобутку та споживання природного газу – БІЗНЕСІНФОРМ № 11 ’2013 (www.business-inform.net), pp. 170–179.
6 www.reuters.com/article/2014/08/22/us-ukraine-cris… 7 gazeta.zn.ua/energy_market/kak-my-budem-zimovat-_…. 8 Транзитный газопровод через Украину взорвался – Коммерсантъ, 17.06.2014; Газовый теракт на Украине, РБК daily, 18.06.2014
9 www.capital.ua/ru/publication/21025-ukrtransgaz-ob… 10 economics.unian.net/energetics/930726-gazprom-eksp… 11 “Газпром” исключил Киев из транзита –Коммерсантъ, 20.06.2014
12 E.g. Nicolò Sartori, “The European Commission vs. Gazprom: An Issue of Fair Competition or a Foreign Policy Quarrel?” – IAI Working Paper 13/03, January 2013, p. 5.
13 Naftogaz made a delivery arrangement with RWE in the spring of 2012 (see Украина нарушит монополию “Газпрома” с помощью Германии, lenta.ru, 11.03.2012). The first volumes of natural gas were transported to Ukraine through Poland in November the same year (see Веселящий Украину газ, Александр Поливанов, lenta.ru, 14.11.2012).
14 Discussion with the Slovak GTS operator Eustream dragged on, because it did not want to violate the transit agreement with Gazprom Export, which had reserved the entire Slovak transit volume until 2029 without leaving room for reverse flows to Ukraine (see e.g. Узлы словацкого реверса, svoboda.org, 29.04.2014, www.svoboda.org/content/article/25366802.html).
15 www.platts.com/latest-news/natural-gas/london/ukra… 16 Украина после двухнедельного перерыва возобновила поставки газа из Венгрии, РИА Новости, 15.08.2013
17 www.naftogaz.com/www/3/nakweb.nsf/0/BDFDD7F4E80984…; 18 У Европы нет газа для Киева – Коммерсантъ, 24.07.2014
19 Data can be viewed on the Ukrtransgaz website. See www.utg.ua/uk/activities/opinfo/ 20 tek.rbc.ua/rus/dlya-komfortnogo-prohozhdeniya-zimy… 21 tek.rbc.ua/rus/ukraina-dobyvaet-50-55-mln-kub-m-ga… 22 tek.rbc.ua/rus/dobycha-gaza-v-ukraine-v-mae-uvelic…; tek.rbc.ua/rus/dobycha-gaza-v-ukraine-v-avguste-uv… 23 biz.liga.net/all/tek/stati/2768951-ruka-rynka-chas… 24 tek.rbc.ua/rus/-ukrgazdobycha-v-mae-2014-g-snizila… 25 gazeta.zn.ua/energy_market/licom-k-svoim-nedram-_…. 26 gazeta.zn.ua/energy_market/ukrgazdobycha-demping-p… 27 uaenergy.com.ua/post/18911/boeviki-na-donbasse-raz…; www.ukrinform.ua/rus/news/separatisti_srivayut_dob… 28 tek.rbc.ua/rus/-ukrgazdobycha-prognoziruet-sokrash… 29 In 2011, Naftogaz purchased two drilling rigs for US$400 million each, but it later became clear that it paid $150 million above the actual price for the first one and $200 million more for the second (see e.g. gazeta.zn.ua/POLITICS/korruptsionery_yanukovicha__…).
30 tek.rbc.ua/rus/-chernomorneftegaz-za-10-mes-2013-g… 31 www.theinsider.ua/business/532339463f7a1 32 uaenergy.com.ua/post/18080/gazprom-poluchit-gazovy… 33 In 2014, ENI withdrew from the agreement due to the political instability in Crimea and Ukraine.
34 In 2014, Shell gave up its involvement, because the Ukrainian authorities did not sign the promised agreement with the consortium. Exxon Mobil postponed signing the agreement due to the political instability in Crimea and Ukraine.
35 www.bloomberg.com/news/2014-06-03/ukraine-crisis-f… 36 According to a Chevron representative, Ukraine’s parliament (Verkhovna Rada) is expected to make changes to the legislation concerning shale gas (see e.g. www.turkishweekly.net/news/170623/ukraine-violence…)
37 news.liga.net/news/economics/1956315-chevron_ne_ot… 38 transport.rbc.ua/rus/tolko-cherez-3-goda-budet-izv… 39 interfax.com.ua/news/economic/207187.html 40 gazeta.zn.ua/energy_market/kak-dela-s-nashim-uglem… 41 economics.unian.net/industry/986541-dobyicha-uglya… 42 In 2012, Ukraine exported 5.9 Mt of coal used for power generation and imported 11.7 Mt of coke for the metallurgical industry.
43 tek.rbc.ua/rus/ukraina-planiruet-uvelichit-zakupku… 44 economics.unian.net/energetics/961382-kompaniya-ah… 45 With the annexation of Crimea, Ukraine lost the Kerch coal terminal (with a capacity of 1.87 Mt/yr).
46 If the armed forces that invaded from and are supported by Russia manage to occupy Mariupol, the chances of Ukraine importing coal by sea will decrease by about 30%.
47 40% of Ukrainian thermal power stations are coal-fired.
48 uaenergy.com.ua/post/19927/zapasy-uglya-na-tes-ukr… 49 economics.unian.net/energetics/958553-ekspert-po-e… 50 tek.rbc.ua/rus/kabmin-utverdil-proekty-rekonstrukt… 51 In 2013, Ukraine produced 922 tonnes of concentrated uranium oxide, one-third of the annual requirements of the nuclear power plants in Ukraine (see e.g. vostgok.com.ua/node/208; forbes.ua/business/1374079-vtoroj-zahod-na-yaderno…)
52 tek.rbc.ua/rus/rf-prodolzhaet-postavlyat-toplivo-n… 53 tek.rbc.ua/rus/-rosatom-konstatiruet-otstavanie-v-… 54 toplivo.rbc.ua/rus/westinghouse-i-energoatom-dogov… 55 interfax.com.ua/news/economic/201708.html 56 Even the establishment of a floating terminal, as planned by the stevedoring company Transinvestservice in the port of Yuzhny, takes at least four months. gazeta.zn.ua/energy_market/kak-gazprom-plombiruet-… 57 biz.liga.net/all/tek/stati/2806017-energoraschet-s…

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