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Weekly analytical report April 29 – May 19, 2012

1. As the EU leaders are preparing to consider energy issues on the highest level, the European institutions and experts are talking about the existing problems of the industry. The European Commission President J.M.Barroso urged member states to actively work on the single energy market. The former president of the European Parliament J.Buzek also emphasized such necessity, and the Visegrad Group countries agree on creation of regional gas market. The main obstacle to the completion of energy market in Europe is called the delayed implementation of the Third Energy Package, so the Commission published detailed guidelines on its certain provisions. In addition, experts address the EU to review energe strategy and involve the public. At the summit, the EU leaders will also discuss energy prices: the issue of reducing gas prices for Eastern Europe is widely debated in the media, and the IEA experts indicate higher prices in Europe compared to China and the U.S. The chairman of the Eurogas industry association pointed to the difficult situation in the sector, and the European Council President H. Van Rompuy expressed his concern of gas dependence.

2. While the EU strengthens nuclear safety measures at the global and continental scale, new nuclear projects continue to develop in the Baltic-Black Sea region. In Europe, professionals to combat illegal trade of radioactive materials will be trained. At the same time, another round of negotiations with Iran brought only a decision to continue the dialogue. Meanwhile, Turkey defined a consortium which will build its second NPP, and one of its shareholders can be attracted by the Russian company which will construct the first NPP. In Lithuania, scientists warned that the construction of the Visaginas NPP can be unprofitable.

3. Prior to a final decision on the route to transport Caspian gas to Europe, one of the competing projects intensifies information campaign. Romania has announced interest in the success of the Nabucco West project, and asked Turkey for support. Meanwhile, gas supply to Europe was the main issue of the visit to Austria of the Azerbaijan's president, who met with the head of OMV – one of the main Nabucco shareholders. Latvia also stated its interest in energy transit. National regulators in Austria, Hungary and Romania continued the partial exemption of Nabucco from the EU legislation on third-party access, and the representatives of the project emphasize the interest in reserving capacity of the future pipeline. Russia showed its position on the Southern Gas Corridor by activity in the oil sector, terminating the agreement on transportation of Azeri oil. Meanwhile, Azerbaijan announced that it has enough alternative routes and will continue to transport oil via the Russian route only if economically feasible.

4. Because of the lack of flexibility and politically motivated projects, Gazprom is facing economic problems. Gazprom proposal on the Yamal-Europe II pipeline bypassing Ukraine ran into opposition of Poland: CEO of the PGNiG was dismissed. Russia is trying to provide arguments that its intentions are DiXi Group, 2013 Energy information ● Analysis ● Consulting

serious, but in Poland they are called a joke. Despite the growth of export in April, in the last year Gazprom’s gas sales decreased by almost 12%, while net profit fell by 10%. According to media reports, the company has become a political tool and needs urgent reform. The European Commission, which conducted searches at the offices of Statoil, Shell, BP and Platts, plans to publish results of its investigation against Gazprom in a year and warned Russians of compliance with European rules. The Accounts Chamber of the Russian Federation has also initiated the inspection of Gazprom finances.

5. Despite the opportunity to achieve common ground on key issues, Ukraine and the EU still differently see the future cooperation in the gas sector. Following the roundtable held in Brussels on May 3, the two parties decided to establish a joint consultative committee. The Ukrainian government expects that it will speed up the decision of the EBRD and the EIB to finance the modernization of the Urengoy-Pomary-Uzhgorod pipeline, namely to sign the loan agreement already in September. According to the Minister of Energy E.Stavytskyi, Ukraine is ready to become a gas hub as the EU is very interested in using Ukrainian gas storages. According to experts, Ukraine can store 10 bcm of gas for European companies and earn up to 15 bln USD, but the media point out that storage capacity expansion will require more gas purchases. However, in order to make an informed decision, the European party seeks to understand Ukraine's intentions on the future of the gas transportation system. Against this background, Russia continues to defend the idea of a bilateral consortium and refused to participate in the meeting, being present only by its embassy. According to media reports, during the Ukrainian-Russian talks in Moscow on May 16, the parties discussed selling part of the GTS in exchange for a price discount. Moreover, the intentions to reform the Naftogaz NJSC do not give a clear vision on the GTS future. The governmental draft law will be considered in the next 2 weeks, despite the Scientific and Expert Department of the Verkhovna Rada recommended to improve the document. According to the Vice Prime Minister Y.Boyko, the reform of Naftogaz will end after its privatization. Officials are hoping for a positive vote of the parliament, while the opposition factions announced they will resist the privatization of Naftogaz and some MPs called the draft law "legally false" and "fraud scheme". The media share different opinions: some report on the preparation to shadow privatization, while the others believe it does meet the European requirements. The EU position is that the GTS shall serve the interests of Ukraine in any case, so it is appropriate to study the experience of other countries. Meanwhile, the financial condition of Naftogaz continues to degrade. In Q1, net losses of the holding increased to 7.75 bln UAH. According to the media, the reasons for this are decrease of gas transit and termination of supply to industrial consumers. The court decision to return 4.8 bcm of gas, continued confrontation with IUGAS, as well as extension of the moratorium on debt repayment of the energy companies by 2014 have contributed to the situation getting worse. According to the Energy Minister E.Stavytskyi, the Naftogaz financial plan for the current year will be approved soon.

6. While it is impossible to quickly solve the "gas issue" with Russia, Ukraine continues efforts to diversify supplies. The Vice Prime Minister Y.Boyko said that there is no grounds to cancel the contract with Russia in the Stockholm arbitration court, and the Kyiv District Administrative Court rejected the government in closing the case on the termination of gas contracts. Meanwhile, the Cabinet of Ministers approved the projected gas balance for the current year at 60 bcm, though - according to the media - it was planned at 63.3 bcm. According to the Energy Minister E.Stavytskyi, gas imports will amount 30-32,5 bcm. As the Ministry of Energy and Coal Industry reported, in Q1 Ukraine has reduced DiXi Group, 2013 Energy information ● Analysis ● Consulting

gas consumption (-9.6%) and imports (-17.3%). Such data is also recorded by the Naftogaz NJSC, which almost did not import Russian gas in May. The company said it has officially notified Gazprom of reducing purchases this year, which was confirmed by Y.Boyko. Against this background, Ukraine increased reverse supply from Poland fourfold and started test supply from Slovakia, which was confirmed by its system operator. According to the head of the EU Delegation J.Tombinski, reverse gas supply has a positive impact on Ukraine’s sovereignty. However, the government does not expect direct gas supplies from Turkmenistan by at least 2014. The same distant future has the project of LNGterminal: according to the State Agency for Investment and National Projects officials, technical report on the FSRU-platform and a consortium to build the facility will be launched in the current year. Meanwhile, the negotiations with Turkey on LNG-tankers passing through the Black Sea straits continue.

7. Unconventional gas remains one of the options in the planning of the EU energy mix. In the U.S., there is an ongoing debate on shale gas exports, while the EU is also going to discuss shale gas, but in the context of increasing its competitiveness. At the same time, key officials of the European Commission consider unconventional hydrocarbons a tool in negotiations with Gazprom and an attractive option for energy. The UK, which emphasized the key role of oil and gas industry, prepares to import gas from Texas and is ready for further unconventional drilling. In France, where hydraulic fracturing is still banned, continues search for alternative technologies. Even Romania changed its position and allowed Chevron exploratory drilling for shale gas. In Poland, where two big companies left exploration, the government is rushing to adopt a special law which should improve the conditions for investors. Despite this fact, the consulting firm A.T. Kearney predicts that Ukraine and Poland will lead the development of shale gas in Europe. Ukraine, where even the production of traditional hydrocarbons becomes profitable, also continues to discuss the prospects of gas production from new sources. The State Service for Geology and Mineral Resources will hold an auction for the sale of special permits for 4 onshore fields with hydrocarbon reserves. Offshore production also looks promising: DTEK has officially increased its share in Vanco to 50%, and one of the "Boyko rigs" started operation at the Odeske field. The growth of production was announced by Chornomornaftogaz, Kuwait Energy, JKX Oil&Gas, while Kulczyk Oil, Nadra Ukrayny and Ukrnafta reported profits. It is projected that with unconventional gas Ukraine will refuse from imports by 2035. The Minister of Environment O.Proskuryakov argued on reducing risks of extraction, while Shell announced the launch of environmental review of the Yuzivska field. According to the U.S. Ambassador J.Tefft, Chevron is close to signing the production sharing agreement for the Oleska field. Cadogan Petroleum also declared its intention to focus on unconventional gas exploration. Economic and environmental aspects of exploration and production were discussed on the scientific roundtable at the Kharkiv University, as well as at the hearings in the Verkhovna Rada fuel and energy committee.

8. Against the background of price fluctuations on the global market, Ukrainian market of oil products continues to shrink. Oil on world markets mostly became cheaper on the news from the U.S. and China, but in the last week it started to grow. At the same time, both the OPEC and the IEA raised their forecasts for global oil consumption. As expected, a significant impact on the market balance will have shale oil from the U.S., sanctions against Iran, and the rise of shipping supplies. In Ukraine, the cost of A-95 petroleum continues to decrease, on the background of reduced export duties in Russia and Belarus. However, along with growing fuel sales, a significant part of the market goes in the "shadow": DiXi Group, 2013 Energy information ● Analysis ● Consulting

in Q1, the revenues from excise taxes fell by 36.2%. The fact of liquidation of the working group on the oil and oil products market may indicate unwillingness to continue the dialogue with traders. At the same time, efforts to restore oil refining do not give the expected results: oil imports decreased 4.5 times. According to media reports, the government memorandum with Karpatnaftokhim (which is preparing to resume work within two months) contains a number of customs and tax concessions.

9. Moving towards low-carbon energy future, the EU protects its internal market. According to Eurostat, the share of renewables is growing, and some countries (Estonia, Spain) are close approach the 2020 target. However, the ministers of energy and environment of the EU member states plan to agree on binding targets by 2030. Against this background, the EU has accused China of dumping on the market of solar panels’ components and will impose restrictive duties on their imports from the PRC. In Ukraine, along with the development of energy efficiency projects, solar and wind energy (including investments), bioenergy sector achieves new dynamics. The National Energy Regulatory Commission approved the first feed-in tariff for electricity from landfill gas, and energy willow is actively cultivated in the Rivne region. However, it seems that government refuses to support the industry: the Finance Ministry rejected the cost-allocating application for the conversion of distilleries, and sector associations criticize the legislation and export orientation of the solid biofuels production. In this context, experience of other countries, including Finland, could be useful.

10. Government actions to stimulate the consumption of coal do not affect the correction taking place on the market. According to the head of the State Property Fund O.Riabchenko, privatization of coal mines is necessary for their preservation and development, and the President V.Yanukovych has promised to start the construction of synthetic gas production facilities. Meanwhile, in the first 4 months of the year, coal production fell by 5% and the losses of state mines increased by 41.8%. At the same time, the problems of the sector – non-competitive state procurement, accidents, non-market constraints, illegal extraction – remain unresolved.

11. On the issue of tariff reform regulators give conflicting signals which may indicate the absence of a final decision. The National Energy Regulatory Commission keeps maximal gas prices at the current level, but the draft law to clarify its authority to set tariffs was interpreted as a move to higher prices for gas and electricity. The regulator denied this information and assured that tariffs will not increase. At the same time, member of the National Commission for the Regulation of Utility Services V.Kalchenko said that heating tariffs must be feasible, but also promised that they will not increase.

DiXi Group, 2013 Energy information ● Analysis ● Consulting

Weekly analytical report: April 29 - May 19, 2013  

Weekly analytical report: April 29 - May 19, 2013

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