Naftogaz group has released its annual report for 2017 along with consolidated financial statements independently audited by Deloitte. The full version of the report is available in Ukrainian and English on the group’s website.

Naftogaz remains Ukraine's biggest budget contributor

Naftogaz has remained the biggest contributor to Ukraine’s state budget for the second consecutive year. In 2017, Naftogaz group paid UAH 110 billion (USD 3.9 bn) to the state budget, accounting for about 15% of revenues of the Ukrainian state, compared to UAH 74 billion and nearly 10% of revenues respectively in 2016.

The historical victory in the Stockholm arbitration process was a key factor underpinning Naftogaz’s profitability

The success in the arbitration against Gazprom was a major factor behind the group’s profit in 2017 — Naftogaz posted the highest net profit in its 20-year history: UAH 39.4 billion (USD 1.4 bn) compared to UAH 17.8 billion in 2016. If not for a positive outcome in the transit case, the group would have suffered a net loss of UAH 7.4 billion.

“Years of hard work finally resulted in the historical Stockholm Arbitration victories in December 2017 and February 2018. We managed to eliminate the risk of an unprecedented debt burden from the country’s shoulders and were awarded almost USD 4.7 billion in compensation,” commented CEO Andriy Kobolyev.

In line with the results of the two arbitration proceedings, Gazprom must now pay Naftogaz USD 2.56 billion adjusted to a USD 2.1 billion set-off for gas delivered in 2014.

Improved operational efficiency and systemic elimination of corruption contributed to rising profits

Last year's record profits were also possible thanks to an increase in gas production, better conditions for transit growth, efficient debt enforcement, and the newly-introduced procurement system:

• Thanks to more investments, UGV posted record gas production of 15.3 bcm - the highest in 24 years of operation.
• Shebelynka refinery was modernized and switched to production of Euro-5 fuels.
• As an active participant in the ProZorro procurement system, the group saved UAH 6.9 billion in 2017, with a total of UAH 119.2 billion spent through the system.
• The total amount of loans of the group during 2017 decreased by UAH 11.5 billion or by 16.3% and amounted to UAH 59.3 billion by the end of 2017.
• Average servicing cost of Naftogaz debt continued to decline in 2017. The interest rate for UAH loans decreased from 19.0% in 2016 to 17.7% in 2017, and that for USD and EUR loans — from 7.8% to 6.7% and from 7.2 to 2.3% respectively.
• A system of internal controls was established within the company.

Gas production and sales to regional gas supply companies for resale to households yielded only a 3% margin

Gas production and sales to regional gas supply companies for resale to households under the public service obligations is an important element of the group’s operations. Opaque intermediaries between Naftogaz and households remain the major problem of this line of business. Because of the debt generated by regional supply companies (more than USD 1 billion over the past two years), the average margin in this segment based on net cash flow in 2016–2017 was a mere 3%.

Next steps: full integration of Ukraine’s gas market into the EU and profound transformation of Naftogaz

The initiated shift to a European legal framework and principles of doing business helped Ukraine to complete a turnaround in its gas supply and enabled Naftogaz to beat Gazprom in arbitration hearings. These changes need to be finalized.

“Our objective is to fully integrate the Ukrainian gas market into the European market and transform Naftogaz into a powerful and efficient European energy company. An integrated Naftogaz leads straight to the creation of a capital market in Ukraine and a growing welfare of its people,” Andriy Kobolyev noted. He outlined an action plan for attaining these goals.

Firstly, Ukraine needs to finalize the transition to European rules in all segments of the national gas market, including gas supply to households. Under the current PSO regime, neither Naftogaz nor the government have reliable information about volumes of gas actually consumed by households. The company has reasons to believe that some of the gas supposedly consumed by the protected consumers is instead sold by intermediaries on the commercial market. As a result, Naftogaz loses money while the government funds excessive subsidies.

Secondly, the TSO unbundling process needs to be finalized quickly and properly. The process should aim to achieve two goals: to maintain significant transit through Ukraine after the expiration of the current contract with Gazprom, and ensure transparent, fair and non-discriminatory access of all market participants to the Ukrainian gas infrastructure. Ukraine should legally and practically become an integral part of the integrated European gas market.

Thirdly, Naftogaz needs to go through a profound transformation in order to achieve operational excellence and become a strong national company maximizing value for Ukraine. Based on best international practices, Naftogaz continues to introduce unified standards for reporting, procurement, corruption prevention, HR management and HSE across the group. If transformed successfully, Naftogaz may encourage substantial foreign investment, enhance gas production and contribute to the development of adjacent markets in Ukraine.

Finally, it is impossible to continue the transformation of Naftogaz without the completion of the corporate governance reform. A new and independent supervisory board assumed office in late 2017, though it is still to be duly empowered according to OECD standards and Ukraine’s international obligations. The completion of this reform process is key to preventing corruption and political interference in the operation of Ukraine’s biggest state-owned enterprise, as well as to encouraging investments into the development of these assets.