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20 August, 2015  ▪  Tetiana Omelchenko

Volodymyr Demchyshyn: “Things aren’t critical in the energy sector. It’s just highly politicized”

Ukraine’s Minister for the Power and Coal Industries talks about the gas balance, the chances of modernizing this sector, and the role of oligarchs in the Fuel & Energy Complex in an exclusive interview for The Ukrainian Week

Today, Ukraine’s gas storage system contains 1.8bn cu m less natural gas than it did one year ago. Thanks to a warm winter, Ukraine was able to get through the last heating season more-or-less without losses. What factors might ensure an equally normal heating season this year, if the winter happens to be cold?

Comparing to last year is not an indicator. To understand how the heating season works and estimate how much gas will be needed, you have to look at a different indicator, consumption. And this depends both on how cold the winter is and on the economic activity and energy efficiency of consumers. Today, 40 million cu m are being consumed a day by residential and industrial users. In winter, this can go up to 200mn cu m/day and even 300mn cu m/day during severe cold spells. Based on the average winter, the math goes like this: we use 200mn cu m/day, we extract 55mn cu m of our own every day, we can pump up to 60mn cu m/day through reverse flows, as long as there are funds for that—right now we’re only buying 30-40mn cu m/day. This means we need to use a maximum of 120mn cu m/day of the gas that’s in storage. In this case, we get through the winter without renewing deliveries from the Russian Federation.

But I’m pretty certain that the decision will be made to renew gas deliveries from Russia any day now. Last year, gas was coming in from Russia and we didn’t have to take the maximum quantities of fuel from storage every day. And so we didn’t need much in the way of reserves. On the other hand, 2bn cu m were supplied to the occupied territories and no one paid for them. So the fact that there’s 1.8bn cu m less gas in the underground gas storage system (UGS) this year is not a problem. We can fill it up in 15 days if the money’s there.

What alternatives are there?

Well, if Russia offers us a decent price and guaranteed deliveries, then we will be getting gas from three different sources at the same time: reserves (60mn cu m/day) and RF gas (114mn cu m/day is the maximum that we can buy from them), plus 55mn cu m of our own gas. If this happens, we will cover all our demand and won’t have to dip into the UGS at all. Ukraine has a huge UGS system. It can handle super large volumes from both Russia and Europe and pump major volumes in and out of the UGS on a daily basis. We can do fine with any of the alternative, with one caveat. If the winter turns out to be really cold, we will need the flow from Russia. We can survive the winter without Russian gas, but only if the temperatures aren’t extreme. If there is a serious chill, it won’t matter what we have in storage, even if there’s 30bnn cu m there. When the temperature drops really low, demand rises to such a point that we can’t get the gas out of the storage tanks fast enough.

RELATED ARTICLE: How Ukraine can survive the next heating season without Russian gas and coal

You said that plans are to have 19bn cu m in the UGS before the heating season starts. Experts say they don’t see this happening without deliveries from Russia.

That’s true. Without Russian deliveries, it won’t be possible to put away 19bn cu m. But prior to this, I talked about daily consumption to demonstrate one point—that there’s no force-majeure situation with supplies right now. This sense of force-majeure is being blown out of proportion in order to spur Ukraine to accept Russia’s conditions and buy gas at US $247.17 per 1,000 cu m. We refuse to do this on principle, not just because of the price, but also because of Russia’s rigid stance. Firstly, it refuses to set a price for the entire heating season and to sign a three-way contract with the participation of the EU. For us, this is extremely important: we not only need a low price, but also guarantees that the price won’t change for the entire heating season. Otherwise, we could find ourselves without a contract in the middle of the winter and that would be a serious problem.

But I’m confident that we will reach an agreement: we buy Russia’s nuclear rods, coal and power from Russia. We need to develop normal commercial relations, despite the war. We have no choice.  Otherwise, we’ll have to cut power and heating. If, in the end, there won’t be any deliveries of Russian gas, we’ll have to start looking at a force-majeure situation. That’s where the 19bn cu m figure comes from, that’s what we need. Right now, we have 13.2bn cu m of natural gas in the UGS.

How prepared is Ukraine to pay for the missing volume of gas?

Theoretically, we can pump 4.8bn cu m without Russia for US $255, as that’s what reverse-flow gas is costing us. This is US $1.2bn and it’s money that we don’t have right now. We are looking to cover at least 63 days in advance. Every day, we’re pumping in 75mn cu m at US $255 because we can’t afford any more than that. That works out to US $18.8mn a day.

What happened that Ukraine refused to pump imported gas from Europe during the first half of 2015, when Russian gas was being delivered? Surely you were aware of the risk that Russia might stop sending gas our way at any time.

This was not a particular position. All we were concerned with was getting gas at the lowest possible price. At some points, Russian prices were cheaper than European ones and Naftogaz has been doing everything to buy gas at the cheapest available price. Incidentally, European gas prices go down the minute Ukraine stops taking deliveries, so sometimes it’s better that we buy less in Europe so that the price stabilizes.

RELATED ARTICLE: Russia’s energy war and devaluation of hryvnia will force Ukrainians to use gas and electricity differently

What steps is the government taking to increase domestic extraction?

We raised the price for Ukrgazvydobuvannia, the main extracting company, by 70%. For it to do a better job, money has to be invested in drilling equipment, exploration work, and upgrading infrastructure, because our deposits are old. And everything is limited by the budget, of course. In order to extract more gas, we need investment capital. Some capital can be gained by increasing the price, using budget revenues, or finding investors. Needless to say, investors won’t come to a country at war. The budget is empty, with all its resources going to social needs and defense. The only option is to raise the price for Ukrgazvydobuvannia. Taking a small amount of money, repairing the old wells and increasing extraction is less costly than drilling new wells. And that’s what we’re doing now.

Private drilling companies have seen their leasing costs go from 28% to 55% of extraction value for wells up to 5 km deep, which is most of the wells in Ukraine. These companies also pay the VAT and other taxes. The top seven Ukrainian companies in Ukraine extract a total of 3.5bn cu m annually and these terms are not convenient for them. The risk is that they will stop extracting and exploring altogether because they are not making any profits. We’ve been proposing them lower rates to give them incentive to extract and offset general revenues. We persuaded the Finance Ministry that the optimal rate is 29%. We also need to streamline the procedure for issuing permits. Right now, you need more than 80 permits at various levels of government just to commission a well. We’ve reviewed the list and plan to cut it considerably and institute timeframes for issuing the documents.

What kind of numbers does the Government have to show the results of energy conservation measures this past year, in terms of reduced consumption levels?

Most of the savings have come from industrial users, who have reduced consumption and become more energy efficient. Consumption went down 2bn cu m in the last period, which is worth US $500mn. Firtash’s companies have begun producing fewer farm chemicals, the Odesa Port Plan is using less ammonia, and some furnaces are being switched from gas to hard fuel. Everybody is trying to cut down consumption and this is the result of equalizing rates.

Deputy PM Voshchevskiy has said that you could be dismissed in the fall. When the miners came to Kyiv and launched huge protest rallies, they were demanding your resignation because they aren’t being paid and the coal industry isn’t being reformed at all. Premier Yatseniuk has also publicly expressed dissatisfaction with your work and referred to the situation in the fuel and energy complex as “critical.” How long do you think you will hang on in this position?

The situation is not critical in the energy sector. There’s just a lot of criticism, politicking and private interests around it. Things are “bad” in the sector because I have a strong position against the monopolists, who are lobbying their interests at a certain level. For years, key positions in the Ministry were like a petting zoo that simply protected certain financial interests. I brought nearly 35 independent specialists who managed to stabilize the situation with the heating season within 20 days and to put an end to rolling blackouts. What’s more, this team paid no attention to those who were covering—and in places are still covering—various corrupt schemes.

Of course, nobody is happy about this, so in public, Demchyshyn is the bad guy. My job is to be a lightning rod so that my team can do their job. If my position were taken by the protégé of some populist politician, he’d already have been awarded a heroic order. We could have all had a chestful of medals if we had just raised the rate from UAH 0.80/ cu m to UAH 1.20/cu m, which is what DTEK, the monopolist on the cogeneration market [Rinat Akhmetov’s company], wanted us to do. People would be paying even higher rates now and the press would be calling me the best minister ever. DTEK spends US $10mn a year on PR for good reason. All I can do is remind the Government, every two weeks, that DTEK still owes the state UAH 400mn for coal deliveries and that’s why the Ministry is unable to pay miners their wage arrears. But no one is paying attention to any of this.

RELATED ARTICLE: Alan Riley: Ukraine has enough potential to turn itself into the center of gas trading for Central Eastern Europe and Baltic States

How would you assess the situation in the energy sector?

The energy sector is a key segment of the domestic economy, providing 30% of GDP, yet people have been robbing it for the last 20 years, because it has a constant cash flow thanks to people paying for electricity every day. But instead of developing, the market is stagnant, money is not being invested but wasted—either in poorly managed state-owned enterprises or in the accounting machinations of private companies. For instance, DTEK miners are standing outside our walls begging us to raise the price of coal and electricity rates. Nobody has bothered to remind them that, after the last increase in 2014, their salaries actually fell 5%, rather than being raised, because their wages depend on a private owner who spends the money coming in from the power stations and mines he owns, not on salaries but on private planes, property and the acquisition of more oil and gas enterprises. If the state does raise electricity rates, all of us will simply be paying Rinat Akhmetov’s debts back for him.

Why? Because no one has been putting anything into modernizing in the past few years, only into acquiring new assets. His management has come to me for help in covering a US $3bn debt that is owed to creditors. But they can’t explain where all the money went. If we were just allocated UAH 1 billion—which is not a lot of money for the state—, to modernize the equipment in our mines, they could be operating in the black within half a year. We’d have both coal and wages for miners and the need to take money out of public coffers would disappear. Today, these mines are costing the state UAH 250mn a month. Wages need to be paid, equipment’s outdated and worn, and there goes the economy...

Will the government actually give you UAH 1 billion to modernize?

The Cabinet of Ministers keeps stating that there’s no money. As I’ve explained, this is a game with only one net: state mines need to be competitive. Otherwise DTEK, as a monopolist, will dictate all the rules of the game unilaterally. All the coal that Ukraine needs can easily be supplied from this company’s mines. Once it squeezes the state out as a market player, DTEK will be able to dictate the “production cost” and set rates as it wishes. There won’t be any competition. And so, I keep trying to persuade my colleagues that this situation needs to be broken once and for all, regardless of the arsenal of pressure being placed, from paid-off deputies to the paid-off press.

In other words, you have no intention of quitting, come fall.

I have plenty of issues that need working on every single day in order to maintain the situation and not lose the energy to implement reforms. Of course, the Verkhovna Rada could vote to dismiss me, but I will not resign of my own accord. That’s not what I’ve been digging to clear this mess up for, for the last six months. I won’t give up so easily.

How likely is it that the miners will strike again? How easily can the oligarchs—specifically Rinat Akhmetov—manipulate them?

If people are prepared to come to Kyiv, sleep in a bus and yell whatever someone tells them to yell all day long for UAH 500,  then yes, it’s possible. To make miners’ lives safer, money has to be spent. Over the last half-year, the state hasn’t allocated a single kopiyka to the mines so that they can develop. It’s barely paying out wages.

RELATED ARTICLE: Transition from oligarch economy to EU membership for Ukraine

But you’re not saying anything about Akhmetov’s own role in possible future strikes…

Let’s hope that during the previous series of campaigns he understood how little benefit they brought him. And they cost him a pretty penny: a minimum of UAH 30mn.

What can you say about the state of Ukrtransnafta, the state oil transport company?

Ukrtransnafta is a 10% state-owned corporation that issued UAH 409mn in dividends in the last three months, it opened its books to investors, it cut costs and it ended up with an estimated more than UAH 1.5bn in profits. What’s more, we raised the fees for transporting petroleum, so there are some positive results for the state. We’ve been slowly changing the management: the board of directors and key regional representatives in Kremenchuk, Brody, Kherson and Odesa. In short, the company is under state control again and it’s in the black. Ukrtransnafta has nearly UAH 2bn on deposit with PrivatBank[1] that will only become available in April 2016, which is clearly a bit of a problem. We sometimes hear threats from the company’s former president, Oleksandr Lazorko, who signed the contract to store technological petroleum for a year at a 0 rate and then changed his mind and signed it at a rate of UAH 6 per tonne per day. This alone already amounts to more than UAH 650mn. In short, Lazorko has caused the country considerable losses and I’m not sure why there hasn’t been an investigation so far.

What about Ukrnafta? Has Ihor Kolomoyskiy’s resistance been overcome?

Here, the situation is a lot more difficult because ownership is nearly 50/50. Because there’s no love lost for Kolomoyskiy in certain quarters, there have been calls to take away his ownership rights to the company. But we’re supposed to be building a democratic country, and he owns 50% of the company, which he acquired on the open marked. I’m often accused of “cooperating” with Kolomoyskiy simply because I state the facts, but I simply favor solving problems using professional methods, not going to war.

Kolomoyskiy has legitimate beefs against us: the government used some of his gas and never replaced it. We, on the other hand, have the opposite complaint: he hasn’t been paying any fees and we suspect that the volume of extracted gas that was published is underestimated—which means that not all the company’s profits are transparent. In addition, some of the natural gas that was supposed to go to Naftogaz Ukrainy was refined at Kolomoyksiy’s Azot plant instead. And finally, he reported that last year UAH 2bn was spent on geological exploration, but then told the market that no such work ever took place... All these issues have to be carefully investigated.

RELATED ARTICLE: A Road Map for Economic De-Sovietization

How much more effective will this new management be?

I should hope it is. If it turns out not to be any better, it will have to be replaced. Its first task is to do a thorough audit of the company’s activities over the last two-three years and to determine the situation with dividends, profits and liabilities. I’m confident that, in time, Ukrnafta will pay taxes, rent [A1] and VAT. Right now, the law is being changed and the Supervisory Board, which includes six individuals representing state interests, has the opportunity to make binding decisions. This is a serious instrument for influencing the minority shareholder. Mr. Kolomoyskiy understands that and I expect him to meet us half-way.

BIO

Volodymyr Demchyshyn was born in 1974 in Lviv. He graduated with a degree in international relations from Ivan Franko National University in Lviv and received an MBA in international finance from the University of Kansas Business School in the US. Demchyshyn was director of Investment and Banking Services at Investment Capital Ukraine. Prior to ICU, he was vice-president of ING Bank, and Corporate Finance manager with Ernst&Young. From August to December 2004, he chaired the National Electricity and Residential Services Regulatory Commission. Since December 2014, Demchyshyn has been Minister of the Energy and Coal Industry.

 

[1] Kolomoyskiy’s bank and the biggest in Ukraine.


 [A1]I’m not sure if this is what is meant by ренти...


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