NAFTOGAZ OF UKRAINE 2014 ANNUAL REPORT

New Ukraine Europe New rules Market Transparency Naftogaz Reform Europe New Ukraine Europe New rules Naftogaz

Market Europe New UkraineNew Transparency Reform Ukraine Naftogaz New rules Europe Naftogaz New Ukraine Market Naftogaz Europe New Ukraine Reform Transparency Naftogaz EuropeReform Europe Naftogaz New Ukraine New rules Transparency New rules Transparency New rules Europe Transparency New Ukraine Naftogaz New rules Europe Market Reform Reform Naftogaz Market Reform TransparencyNew rules Reform Europe New rules Market Reform Transparency New Ukraine Transparency Transparency Naftogaz New Ukraine Naftogaz New rules Reform NaftogazTransparency Market New rules Reform Europe Reform Naftogaz New rules Europe Naftogaz New Ukraine Transparency Market Transparency New rules Naftogaz Transparency Reform Europe New rules Market New Ukraine New Ukraine Transparency New rules New rules Market Market New Ukraine Europe Transparency Reform Europe New Ukraine New Ukraine Naftogaz Transparency New rules Reform New rules Naftogaz New rules New Ukraine Reform Market Europe New rules ReformNaftogaz Transparency Europe Reform Naftogaz Transparency Reform MarketNaftogaz Reform Naftogaz New rules Naftogaz New Ukraine Market Market Naftogaz Transparency Transparency Reform Europe Transparency New rules New rules New rules Reform New Ukraine Market Transparency New rules Naftogaz Market Europe

Changing for the future Ukraine’s gas transmission Entry capacity: EUROPE’S LARGEST GAS MARKETS, 2014, bcm NAFTOGAZ AT A GLANCE pipelines are long enough 288 bcm/year to circumvent the globe GROUP STRUCTURE BY SEGMENT, 2014, UAH billion 76.2 Gas transmission Exit capacity in EU 71.5 gas 24.2 239.7 consumption direction: 151 bcm/year volumes Gas storage 1.4 146.2 60.7 Gas upstream 4.8 42.4 Operating revenues (UAH 78.4 billion, net of inter-group operations) UKRAINE’S GAS 47.5 42.6 Gas trading TRANSMISSION 53.3 Assets (UAH 515.0 billion) 38.6 28.3 SYSTEM Underground gas storage Oil transmission 34.8 capacity, bcm 2.0 20.0 27.9 Hydrocarbon Oil refining deposits 5.2 5.0 Oil upstream Oil business Gas transmission 0.3 Italy 10% Spain 3.4 31% 1 300 Turkey France Ukraine Segment Germany Other results Netherlands 0.8 310 Revenues 10.6 nonregulated United Kingdom 18.8 by segment, - 88.9 regulated Investments 2014, % 1 500 OPERATING REVENUES AND ASSETS 11.2 1 900 NAFTOGAZ AND EUROPEAN GAS MARKET, 2010-2014, % Gas trading, gas upstream 1 920 1 000 59% and gas storage 400 Gas volumes supplied by Naftogaz in Ukraine to total gas consumption in the EU-28 UAH billion 700 420 Gas volumes transmitted to Europe (excl. Moldova) across Ukraine to total gas consumption in the EU-28 2 150 25 % OPERATING REVENUES AND ASSETS 17 050 21 20 % IN 2013 AND 2014, UAH billion 18 18 2 300 17 15 15 % Operating revenues 9 10 10 % 70.1 7.5 0.8 8 2014 7 7 0.5 2013 67.5 7.4 5 % 1 000 Assets 0 % 27.3 19.3 11.2 2014 457.1 2010 2011 2012 2013 2014 2013 192.1 24.0 11.7 9.9 Sources: Naftogaz, Eurogas

Gas Oil Other Investments SUPPLY ROUTES OF RUSSIAN GAS TO EUROPE, 2014, bcm*

UKRAINE’S OIL Ukraine’s GTS TRANSMISSION SYSTEM Entry capacity: 151/62 114 million t oil/year Total Transmitted Nord Stream capacity volume 55/34 Exit capacity: Yamal-Europe 58 million t oil/year 38/37 GAS IN STORAGE AT THE BEGINNGING OF THE HEATING SEASON Blue Stream 16/14 16 757 Volumes stored in underground gas storages as at October 2014, bcm 30 950 Stored volume Total capacity 20 923 *excluding the Baltics, including Turkey 21 898 Source: IEA 16 065 16 558 10 964 11 956 4 307 4 499 4 519 6 330 3 067 3 270 2 515 4 707 4 585 2 266 3 313 3 272 2 524 974 2 274 736 484 500 995 770 205 550 510 239

Italy Spain France Poland Ukraine Austria Slovakia Belgium Germany Hungary Denmark Bulgaria Portugal Great Britain Netherlands Czech Republic Source: GIE Additional sources: Naftogaz, State Statistics Service of Ukraine Naftogaz of Ukraine

CONTENTS

Annual report 2014

OVERVIEW CORPORATE, SOCIAL AND Mission and values...... 6 ENVIRONMENTAL RESPONSIBILITY

Statement of Andriy Kobolyev, Chief Executive Officer...... 8 Employees...... 104 Timeline...... 12 Corporate code of conduct...... 107

Environment and safety...... 108 STRATEGY AND REFORM Responsibility to consumers...... 110 Statement of Yuriy Vitrenko, Director for Business Energy efficiency...... 112 Development...... 14 Russian military aggression against Ukraine...... 114 Strategy overview...... 18 Crimea...... 116 Creating an efficient gas market ...... 22 Donbas...... 118 Security of supply...... 24

Operational efficiency...... 28

Gas independence for Ukraine...... 31 MANAGEMENT REVIEW

Reform risks and challenges...... 32 OF FINANCIAL RESULTS

Gas prices for households ...... 34 Statement of Sergiy Konovets, Deputy Chairman...... 120

Current costs and revenues...... 36 Management comments on the auditor’s opinion...... 124

Market-based pricing for Ukrainian gas...... 44 Operating and financial highlights...... 126 Corporate governance overview...... 48 Review of the financial performance...... 128 Executive board structure and remuneration...... 52 Regulated business segments...... 130 Other top executives...... 54 Non-regulated business segments...... 133 Corporate governance reform...... 55 Net loss factors...... 136 Transparency and disclosure policy...... 58 Review of the financial position...... 137 BUSINESS OVERVIEW Review of changes in equity...... 140 Statement of Sergiy Pereloma, First Deputy Chairman...... 60 Review of cash flows...... 141

Operating environment...... 62 Risk management...... 143

Business structure...... 64 2015 forecast...... 146

Oil and gas reserves...... 65 Group structure by operating revenues and assets...... 66 FINANCIAL STATEMENTS

Operations: gas...... 68 Independent auditor’s opinion...... 152 Ukrainian gas market history...... 68 Consolidated financial statements...... 155 Gas imports and wholesale trading...... 74 Statement of financial position...... 155 Gas transmission...... 78 Statement of profit or loss...... 156 Underground gas storage...... 84 Statement of changes in equity...... 158 Gas production...... 86 Statement of cash flows...... 159 Gas distribution and retail supply...... 90 Notes...... 160 Operations: Oil...... 94

Crude oil transmission...... 94 Extraction of crude oil and condensate, production of ADDITIONAL INFORMATION

petroleum products and LPG...... 99 Terms and abbreviations...... 194

Oil and gas production in Egypt...... 102 Contacts...... 196 4 5 OVERVIEW

MISSION AND VALUES

MISSION VALUES

Naftogaz sees itself as the driving force behind reform of the Dedication Ukrainian gas market and creation of a competitive business Naftogaz is the driver of change in Ukraine’s gas sector, working environment based on European best practices. The company is to replace the old corruption-prone regulated environment with committed to ensuring security of gas supply for Ukrainian and modern competitive market rules in the entire gas industry, with European consumers and strives to do it on appropriate terms an inevitable reduction of the company’s role from a state monop- and in a financially sustainable way oly to a regular market participant

Responsibility

Naftogaz creates added value for its customers and for the society striving to preserve each of the six capitals (human, social, intel- lectual, manufacturing, natural and financial)

Accountability

Naftogaz is guided in its activities by both strategic long-term and tactical short-term interests of the Ukrainian society as a whole, as the concurrent owner of the group and user of its activities

Efficiency

Naftogaz aims to achieve maximum results with minimal resources

6 7 OVERVIEW

STATEMENT OF OUR FIRST STEPS AND RESULTS For the first time ever, Naftogaz CHIEF EXECUTIVE We had to address a range of systemic ensured a real diversification of and operational problems immediately. OFFICER Widespread corruption, an outdated corporate gas imports to Ukraine governance model originating in the Soviet Andriy Kobolyev era, distorted pricing dictated by political or As a result, the share of Gazprom supplies to corrupt goals are just some of them. We also Ukraine fell from 92% in 2013 to 75% in 2014 and faced a record deficit of UAH 109 billion, were 37% in the first half of 2015. Europe is the main gas almost entirely dependent on imports from supplier for us this year. Russia, and had to confront Gazprom’s ability to dictate discriminating supply terms to us. Once it was evident that we were able to substitute Gazprom with European suppliers, the Russians

revised their offer to match the European prices. We did not have the luxury Market forces came into play, and gas turned from of choosing priorities. We a political tool into a regular commodity. Dear readers, assets were revalued. We engaged international Our next challenge is to address the long-term companies Ryder Scott and EY, respectively, to had to deal with all the issues within Ukraine and introduce market Thank you for your interest in our annual report. perform these valuations. mechanisms in the local market as well. For a standard corporate report, this is quite an problems at the same time unusual document. WHO PREPARED THIS REPORT REFORMING NAFTOGAZ AND THE UKRAINIAN GAS MARKET WHAT YOU WILL FIND IN THIS REPORT At the end of March 2014, I returned to Naftogaz For many years, Naftogaz supplied gas for AND WHY IT IS SO LONG as Chairman of the executive board. I knew the households at absurdly low prices. This price Changing Naftogaz is inseparable from the ongoing company from within, having previously worked distortion was the key reason behind the huge gas market reform that is designed to replicate This report is not typical because the actual results there for eight years, and had no illusions about the deficit of Naftogaz and led to a number of European rules in Ukraine and make the local of Naftogaz in 2014 are only a small portion of what challenges the new team was facing. critically adverse effects. market competitive, transparent, and efficient. we discuss. The document explains in detail the development strategy we have chosen for Naftogaz I knew the strengths of Naftogaz, most notably the The group gas upstream division experiences and the company’s changing role in the overall professionalism of our technical staff. For many stagnation in production. Households had no context of the gas market reform in Ukraine. years, sometimes in extreme conditions, these incentive to use gas and heat efficiently. The For the market to become people have been ensuring the stable functioning resulting losses of Naftogaz were covered by Not only do we formally disclose the group’s results competitive, Naftogaz will of Ukraine’s gas transportation system. It was the state budget. but also try to present this information to the wider crucial to maintain this technological expertise, and have to give up its monopoly public in a clear and rational way. This document Until the last year, Russia was the key we made efforts to retain the best and the most contains concise descriptions of our key markets beneficiary of these conditions, as it was position, becoming one of experienced personnel. (upstream, transmission and supply of gas and oil) practically the only source of imported gas that many market participants and explains our place and role in each of these Ukraine needed, and in huge volumes. Russia markets. charged Ukraine 30% to 50% more compared However, I also realized that to the prices paid by other Gazprom clients of This key change is required to complete the reform. In this report we present an analysis of the in Europe. This drained Ukraine’s finances and The new Law on the Natural Gas Market in Ukraine corporate governance system of Naftogaz (what the deep changes required made it dependent on the Kremlin. stipulates that it will take place in the nearest it is and what it should be, in our opinion), discuss in Naftogaz were impossible future. In this report, we explain what has been recent changes in our human resources policy, To correct this situation, we immediately set done to make this happen, and what remains to be our new transparency and disclosure policy, our without new people in the about revising our relations with Gazprom. done. social initiatives, as well as our strong commitment company’s management We engaged the European Commission in our to follow the highest standards of industrial and negotiations, filed court claims and opened the PRICE LIBERALIZATION AND DIRECT environmental safety. new supply route from Slovakia. SUBSIDIES TO LOW-INCOME HOUSE- It was essential to introduce new values and HOLDS IS THE ONLY SOLUTION In the last section of the report, you will find managerial best practices that would turn Naftogaz In addition to creating alternative supply consolidated financial statements of Naftogaz into the driver of change in the gas sector. My vision capacities, we increased the number of our A key component of the reform is the transition to for 2014. They were audited by Deloitte and are therefore was to combine new faces with existing suppliers significantly. We started cooperation the market-based pricing model, where the price accompanied by a management discussion and employees, creating a team with the desire and with Statoil, Europe’s largest gas producer, as of gas is set by supply and demand. In this model, analysis in this document. For the first time since ability to reform, on the one hand, and profound well as with most of the leading gas shippers the low-income households are supported by 2009, the group’s hydrocarbon reserves and fixed expertise in the oil and gas industry, on the other. active in the EU gas market. direct subsidies from the state and high-income

8 9 OVERVIEW

consumers pay full market price for gas they If we want Ukraine to remain on the map as a Our current cooperation with Western partners our mutual confidence in pursuing the path of consume. sovereign state, there is no alternative to this is vital in reforming Naftogaz and Ukraine’s gas reform. With the available political support, we can choice; the only question is the pace of this industry. plan and execute strategic changes. It is priceless We realize that over the last year and a half the transition. The more time it takes us to switch to in the current conditions, and I appreciate every financial position of almost every Ukrainian We continue to fight for a fair price of imported gas market pricing, the more expensive the transition manifestation of this support. family has significantly deteriorated. Currency for Ukraine. This work continues not only during will be for each of us and for the country. devaluation, inflation of consumer prices, the commercial negotiations but also in diplomatic and I want to thank to the team for their work. Sleepless economic crisis, unemployment and the war The pricing issue is extremely important for the legal dimensions. nights, late meetings, and unexpected challenges have been very real trials for everyone. Against success of reform, and that is why we have devoted – this is our routine. We have a shared vision that Ukraine has wasted a lot of time. Ten years ago, the backdrop of the crisis, the sharp hike in utility to it a full section in this document. justifies sacrificing our personal lives and comfort: we have proclaimed our European choice but we prices is certainly very frustrating and seems unfair. our success lies in security and in a chance of a WHAT WE DID TO GAIN YOUR TRUST did not start working toward improving energy better tomorrow for every Ukrainian. efficiency, which is an integral part of the modern From the very first days of the new team in European culture. Governments one by one have I appreciate the invaluable assistance we receive Naftogaz, we began fighting corruption in our The trouble is, however, that continued to simulate the old ways to please or to from Ukraine’s friends and partners in the West. industry. It is an extremely difficult task as there is trick the voters. Years of populism and corruption Our fight would be futile without this support. if the pricing issue is not hardly a single industrial group in Ukraine which have led Ukraine’s gas upstream to a critical would not have a certain interest in preserving the I am grateful to the activists and experts who addressed now, the situation condition. old structures of a non-transparent gas market. criticize and support us. will only get worse Today we have another chance to carry out the In just months, we changed almost the entire crucial gas market reform that will bring us closer management team of Naftogaz. We engaged new to Europe – both in terms of the rules of the game In this report, we explain why the transition to leaders without a “history” in gas to head divisions The criticism has helped us and, eventually, in the quality of life for each of our market-based gas prices accompanied by targeted where technical expertise in oil and gas was not citizens. make balanced decisions. The subsidies for the poor is the only strategy now required. The transformation of management available to Ukraine. teams now continues in our subsidiaries as well. It would certainly be an exaggeration to say that support has inspired us and the process of change is going smoothly and there Such a transition will initiate development and Our tender announcements are now published not was sometimes decisive in are no unexpected, sometimes very discouraging, growth in the country. It will create the much only on specialized websites but are distributed in failures. However, it is also impossible to deny that overcoming challenges needed incentives for investments in energy the media for the public as well. Recently Naftogaz today there are more reform-oriented people in the efficiency and for increasing domestic gas and our upstream subsidiary Ukrgasvydobuvannya government and public sector enterprises than ever production. It will eliminate opportunities for joined ProZorro, the new state e-procurement I thank our customers for their understanding. before. corruption created by the difference of prices. Gas system that offers increased transparency and wide Ukraine is as strong as each Ukrainian makes it. suppliers will compete for customers offering them reach to numerous suppliers. Other companies of Following the rules, efficient energy consumption better service on better terms. Other sectors where the group are preparing to join the system as well. and paid bills – these are the contemporary customers are free to choose with whom they do We are laying the foundation manifestations of patriotism and of a genuine love business work this way. The gas market should for sustainable growth in the for Ukraine. work this way too. In some cases, by changing coming years that will make Together we can do it! Our country has a lot to fight for. Unlike most contractors and suppliers, Ukraine strong and truly European countries, Ukraine could completely we were able to reduce costs stop importing gas within 10 years. To achieve independent this, it is necessary to attract investment for fivefold improving energy efficiency and boosting local gas production. THANKS Our strategy of increasing transparency does not To achieve both of these strategic objectives, a I am grateful to all those who have been and only help us to make our local operations more market gas price for all consumers is a necessary remain involved. efficient. It has also been a key in building trust condition. People who can afford paying the full and improving our relations with the international I am grateful to the country's leaders for their trust ANDRIY KOBOLYEV price for gas they consume should pay it. community and our Western partners. in me and our team. This trust means that we Chairman of the Board, Then the state will help those who need assistance sometimes have disputes. However, it also reflects Naftogaz of Ukraine Naftogaz now cooperates with counterparts in covering utility bills, investing in the installation a normal business way, has got rid of murky of meters, boilers replacement and buildings intermediaries and has become far more open to insulation. This will lower demand for imported gas the world. Following this operating policy change, and will significantly alleviate the pressure on the we have gained the crucially important support hryvnia. from the West for a closer integration with the EU.

10 11 TIMELINETIMELINE 2013 2013 2014 2014 2015 2015 21.11.2013 17.12.201321.11.2013 16-19.01.201417.12.2013 18-20.02.201416-19.01.2014 18-20.02.201423-27.02.2014 23-27.02.2014February-March February-March21.03.2014 26.03.201421.03.2014 26.03.201427.03.2014 April27.03.2014 2014 30.04.2014April 201425.05.201430.04.201427.06.201425.05.2014Aug27.06.2014ust 2014 26.10.2014August 2014 21.11.201426.10.2014 March21.11.2014 2015 AprilMarch 2015 2015 JulyApril 2015 2015AuguJulyst 2015 2015 August 2015

Ukrainian USDUkrainian 15 billion RatificationUSD 15 billion of TensRatification of protesters of TensPower of protesterschange: PowerIntervention change: of PoliticalIntervention ofThe CabinetPolitical of TheThe Cabinet UN General of Russia’sThe UN GeneralUSD 3.2Russia’s billion UkrainianUSD 3.2 billionRemaining Ukrainian USD 1.4Remaining billion ParliamentaryUSD 1.4 billionCoalition Parliamentary USDCoalition 5.0 billion TheUSD 5.0 billionThe firstThe USDThe 1.7 first billion USD 1.7 billion Government “RussianGovernment the“Russian anti- arethe shot anti- in the areparliament shot in the parliamentRussian troops provisionsRussian troopsMinisters provisions MinistersAssembly adopts armedAssembly adoptsreceived armed under Presidentialreceived underUkraine-EU Presidential received Ukraine-EU electionsreceived agreementelections receivedagreement Internationalreceived US-UkraineInternational receivedUS-Ukraine under received under suspends signing Eurobond”suspends signing constitutionalEurobond” centerconstitutional of Kyiv centerappoints of Kyiv a new appointsand occupation a new of andthe Ukraine-occupationappoints of the new Ukraine- appointsa resolution new in aggressiona resolution IMFin Stand-Byaggression elections IMF Stand-By held AA provisionselections underheld AA IMF provisions heldunder IMF signedheld including undersigned a new including Support under for a new BusinessSupport Forum for IMFBusiness SBA Forum IMF SBA the Ukraine-EU agreed,the Ukraine-EU “Dictatorshipagreed, “Dictatorship government governmentof Crimea EUof Association Crimea managmentEU Association at managmentsupport of at insupport Eastern of Arrangementin Eastern Arrangementand DCFTA SBA and DCFTA SBA a provision for IMFa provisionSBA for UkraineIMF SBA held Ukrainein held in KEY EVENTS KEY EVENTSAssociation USDAssociation 3 billion Laws”USD and3 billion the Laws” and the Agreement NaftogazAgreement NaftogazUkraine’s UkraineUkraine’s (SBA) Ukraine (SBA) signed signed structural reform structural reformConference WashingtonConference D.C. Washington D.C. IN UKRAINE IN UKRAgreement;AINE start borrowedAgreement; by start beginningborrowed of by beginning of (AA) signed (AA) signed territorial beginsterritorial begins of energy sector of energy sectorheld in Kyiv held in Kyiv of the Revolution theof endthe Revolution activethe end protests active protests integrity integrity and liberalization and liberalization of Dignity ofof 2013 Dignity of 2013 of gas market of gas market

14.04.2014 14.04.201428.04.2014 28.04.201406.05.2014 06.05.201402.09.2014 02.09.201425.09.2014 25.09.2014October 2014 October 2014 09.10.2014 09.10.2014 1-15.12.14 1-15.12.1417.12.2014 17.12.201410.01.2015 10.01.201529.05.2015 29.05.201510.07.2015 10.07.201515.07.2015 15.07.2015

Cooperation agreementCooperation MOU signed agreement in Bratislava MOU signed Ukrtransgaz in Bratislava joins a leadingUkrtransgaz Commercial joins a leading launch Commercial of Hungary stopslaunch supplying of Hungary Statoil stops starts supplying StatoilGovernment starts adopts GovernmentEBRD adopts and EIB agree toEBRD andUkrtransgaz EIB agree to and PolishUkrtransgaz Gas flowsand Polish to GasUkrtransgaz flows to and UkrtransgazIn Croatia, and 15 EU MemberIn Croatia, European 15 EU Member European updated between updatedto enable between reverse gasto enableEU reverse underground gas gas EU undergroundSlovakia-Ukraine gas gasSlovakia-Ukraine gas to Ukraine aftergas gas to Ukrainesupplying after gas to supplyingresolution gas to requiring toresolution bring requiringprovide €300 to bring million provideto €300Gaz-System million to sign a Gaz-SystemUkraine sign viaa UkraineHungarian via FGSZ signHungarian an States FGSZ and sign Energy an States andCommissioner Energy for Commissioner for Ukrtransgaz and Ukrtransgazflows from and Slovakiaflows to fromstorage Slovakia transparency to storage flowstransparency via a new flowsGazprom via a new officials visitGazprom Naftogaz officials visit Naftogaztransmission of Russiantransmission gas in modernize of Russian the gas principal in modernize cooperation the principal agreement cooperation Hungary agreement restored Hungaryinterconnection restored interconnectionCommunity countriesCommunity of Energy countries Union of Š efčoviEnergyč: Union Šefčovič: Gaz-System S. A. Gaz-SystemUkraine, S. A.including Ukraine, platformincluding AGSI+ of GIEplatformpipeline. AGSI+ of FirstGIE directpipeline. Budapest First direct Budapest compliance with the 3compliancerd sectionwith the of 3 rdUkraine’s GTS.section ofenvisaging Ukraine’s GTS. construction envisaging construction agreement fully agreementCentral, fully Eastern, and Central, Eastern,Russia’s and plans to Russia’s plans to reverse flow via existingreverse flow via existing interconnection interconnection Energy Package Energy PackageIncludes provisions forIncludes ofprovisions a new interconnector for of a new interconnector compliant with 3rd Energycompliant South-Eastern with 3rd Energy Europe, South-Eastern abandon Europe, transiting abandon transiting DIVERSIFICATIONDIVERSIFICATION pipelines pipelines agreement (DIA) onagreement the (DIA) on the reforming Naftogaz andreforming to Naftogaz expand andPoland-Ukraine to expand Poland-Ukraine Package and newly Packageincluding and newly Ukraine, signincluding a gasUkraine, through sign Ukraine a gas through Ukraine OF GAS IMPORTS:OF GAS IMPORTS: new pipeline signednew pipeline signed Ukrtransgaz, as well asUkrtransgaz, gas flowas well capacity as 6-foldgas flow to capacity 6-fold to adopted EU gas networkadopted memorandum EU gas network on gasmemorandum endangers on gas European endangers European between Ukrtransgazbetween Ukrtransgaz transparent tenderingtransparent nearly tendering 10 bcm/year nearly 10 bcm/year codes codes markets integration andmarkets integrationenergy security and and isenergy security and is EU INTEGRATIONEU INTEGRATION and Eustream and Eustream requirements requirements diversification of supplydiversification unacceptable of supply for unacceptable for sources sources the EU the EU

17.12.2013 17.03.201417.12.20131-2.04.2014 17.03.2014 April-May1-2.04.2014 2014 April-May 28.04.2014 2014 1-2.05.2014 28.04.201416.06.2014 1-2.05.2014 17-23.06.1416.06.2014 17-23.06.1416.10.2014 31.10.201416.10.2014 November31.10.2014 2014 November December 2014 December 31.01.2015 2014 February 31.01.2015 2015 FebruaryFebruary-March 2015 2015February-March 01.04.2015 2015 30.04.201501.04.2015 01.07.201530.04.2015 01.07.2015 Russia USRussia Commerce USNaftogaz Commerce sends Ukraine-EU-RussiaNaftogaz sends Ukraine-EU-Russia Gazprom Gazprom Russian gas OccupyingRussian gas Occupying Naftogaz and Naftogaz and Naftogaz The NaftogazWinter NaftogazThe Winter covers 2014Naftogaz Naftogaz covers covers2014 Naftogaz Naftogaz submits covers GazpromNaftogaz submits GazpromGazprom repeatedly GazpromNaftogaz repeatedly and NaftogazNaftogaz files and a NaftogazNaftogaz stops files a Naftogaz stops unilaterally Departmentunilaterally places DepartmentGazprom placestrilateral Gazprom trilateral unilaterally unilaterally price for governmentprice for of government of Gazprom Gazprom initiates Package,initiates a USDPackage, 1.45 billion a of USDUSD 1.65 1.45 billion billion of of USDa Statement 1.65 billion of of announcesa Statement startof announcesbreaches the start Winter breachesGazprom the Winter StatementGazprom of buyingStatement gas of buying gas increased gas Chernomornefte-increased gas Chernomornefte-pre-arbitration negotiationspre-arbitration negotiations cancels balancing cancels balancing Naftogaz cut to CrimeaNaftogaz confiscates cut to Crimea confiscates initiate initiate arbitration trilateralarbitration disputedtrilateral bills for disputeddisputed bills bills for for disputedClaim in bills the for gas ofClaim alleged in the gas gas ofPackage alleged by gas failing to fulfillPackage byextend failing the to fulfill Claimextend in the the fromClaim Gazprom in the from Gazprom price for gazprice on its for “Entity gaznotice on regardingits “Entity commencenotice regarding on commence on agreement with agreement with USD 268.5/tcm assetsUSD of 268.5/tcm assets of arbitration arbitration proceedings at agreementproceedings Russianat agreement gas RussianRussian gas gas pursuant Russian supply gas arbitration pursuant deliveriessupply arbitration to deliveriesNaftogaz’ prepaidto gasNaftogaz’ supply Winter prepaid Package gas supply gas Winter transit Packageuntil gas gastransit until gas Naftogaz by List”Naftogaz restricting by List”gas supply restricting termsgas ofsupply Russian terms of Russian Ukrtransgaz that Ukrtransgaz that Chornomornaftogaz Chornomornaftogaz proceedings proceedings the Arbitration regulatingthe Arbitration pursuant regulating to the topursuant the Winter to the to againstthe Winter Gazprom occupiedagainst Gazprom occupiednominations in full andnominations by through in full theand by arbitrationthrough the supplyarbitration supply 80%+ to nearly trading80%+ activities; to nearly tradingcontract activities; gascontract supply to gas supply to enabled Gazprom enabled Gazprom and creates and creates regarding gas regarding gas Institute of the interimInstitute terms of theWinter interim Package terms Package,Winter Package thereby Package,in Stockholm thereby territoriesin Stockholm of territoriesviolating contractual of violating contractualend of againstend of conditionsagainst are conditions are USD 500/tcm. theUSD EU 500/tcm.imposes the EU imposes Ukraine. Nearly ten Ukraine. Nearly tento request use of to request use of Crimean Republican Crimean Republican supply contract supply contract Stockholm for RussianStockholm gas for Russian gasfulfilling all of its fulfilling all of its Donbas through Donbasprocedures through for raising procedures its June for 2015. raising its GazpromJune 2015. in agreed.Gazprom in agreed. European sanctionsEuropean on sanctions on trilateral meetings trilateral meetings Ukrainian gas to Ukrainian gas to Enterprise Enterprise at the at the Chamber of supplyChamber to of supply to obligations obligations uncontrolled uncontrolledtransmission nominations.transmission Gazprom nominations. offers StockholmGazprom offersRussian Stockholm gas Russian gas imports cost Chernomornefte-imports cost Chernomornefte- held over the held over the cover demand cover demand Chernomorneftegaz Chernomorneftegaz Arbitration Arbitration Commerce to UkraineCommerce until to Ukraine until entry points. entryMatter points. resolved throughMatter resolvedgas price through in line gas price in linetransmission transmission Naftogaz USD gazNaftogaz as well USD gaz as well following five following five spikes in Europe spikes in Europe to manage them. to manage them. Institute of the Institute of the bring the gas 31 Marchbring the2015, gas 31 March 2015, Naftogaz does not Naftogazrapid response does not mechanisms rapid response with the mechanisms with the to the EU to the EU 370/tcm 370/tcm months months DIVERSIFICATIONDIVERSIFICATION The company later The company later Stockholm Stockholm transmission signedtransmission in signed in recognize such recognizeincluded in such the trilateralincluded Europeanin the trilateral European continues in continues in OF GAS IMPORTS:OF GAS IMPORTS: reregistered under reregistered under Chamber of Chamber of contract with Brusselscontract with Brussels deliveries as its deliveriesBrussels agreements as its Brussels levelsagreements levels accordance accordance Commerce Commerce RELATIONS WITHRELATIONS WITH the jurisdiction of the jurisdiction of Gazprom in Gazprom in contractual contractual with the with the the Russian the Russian line the 3rd line the 3rd imports imports contractual contractual RUSSIA RUSSIA Federation under Federation under Energy Energy terms terms the name of “State the name of “State Package Package Unitary Enterprise Unitary Enterprise of the Republic of of the Republic of Crimea Crimea Chernomor- Chernomor- neftegaz” neftegaz”

14.08.2014 14.08.2014 19.10.2014 19.10.2014 26.11.2014 26.11.2014 09.04.2015 09.04.2015 10.04.2015 10.04.2015 08.05.2015 08.05.2015 14.07.2015 14.07.2015 14.07.2015 14.07.2015 Parliament passes Parliamenta law opening passes a16.8 law bcm opening of gas accumulated16.8 bcm in of gasGovernment accumulated passes in controversialGovernment passesParliament controversial passes Parliamenta ground passes a ground - 7.6 bcm of gas remain- 7.6 in bcm Ukraine’s of gas remain in Ukraine’s The Natural Gas MarketThe Natural Law Gas MarketNaftogaz Law and FronteraNaftogaz Resources and Frontera ResourcesTrailstone announcesTrailstone its intention announces its intention way to form a partnershipway to form with a partnershipUkraine’s with UGSs at theUkraine’s start of the UGSs decree at the #647 start settingof the limitationsdecree #647 in thesetting breaking limitations Natural in the Gasbreaking Market Natural Gas Market UGSs at the end of theUGSs heating at the end of the heating comes into effect; mostcomes into effect; mostsign a memorandumsign of a memorandum of to enter the Ukrainianto gas enter market the Ukrainian gas market EU and US companiesEU andto manage US companies heating to manage season heating seasonwholesale gas marketwholesale for three gas marketLaw for set three to reform Ukraine’sLaw set to gas reform Ukraine’s gas season season provisions come intoprovisions force come into forceunderstanding on cooperationunderstanding in on cooperationafter thein new legislationafter comes the new legislation comes Ukraine’s GTS Ukraine’s GTS months in order to preservemonths securityin order to marketpreserve in security full compliance market within full compliance with on 1 October 2015 on 1 October 2015 exploration and developmentexploration of oiland developmentinto forceof oil in October into2015 force in October 2015 GAS GAS of supply to Ukrainianof consumers supply to Ukrainian in the consumers 3rd Energy in Package the 3rd Energy Package and gas in Ukraine andand potential gas in Ukraine and potential the emergency situationthe emergency situation implementation of LNGimplementation deliveries of LNG deliveries MARKET REFORMMARKET REFORM from Frontera’s gas fieldsfrom inFrontera’s Georgia gas fields in Georgia

28.03.2014 31.03.201428.03.2014 March-August31.03.2014 2014March-August 10.07.2014 2014 08.08.201410.07.2014Octob 08.08.2014er 2014 OcOctobtoberer 2014 2014 NovemberOctober 2014 NovemberJanuar 2014y 2015 MarchJanuar y2015 201503.03.2015 March 2015 19.03.201503.03.2015 April19.03.2015 2015 14.05.2015 April 2015 Ju14.05.2015ne 2015 17.06.2015June 2015 24.07.2015 17.06.2015July 24.07.2015 2015 JulyJuly 2015 2015 July 2015

Naftogaz UkrainianNaftogaz ChangesUkrainian in Naftogaz ChangesAppointment in Naftogaz of DepartmentAppointment for of NaftogazDepartment pays for ActionNaftogaz plan paysto UkrtransgazAction plan starts to UkrtransgazTenders forstarts NaftogazTenders for NationalNaftogaz ParliamentNational AppointmentParliament of ParliamentAppointment ofAppointment Parliament of NaftogazAppointment joins ofParliament Naftogaz joinsBaker Parliament & GeneralBaker & General makes USD regulatormakes USD management.regulator Numbermanagement. new Number Reformnew and outReform USD 1.7 and bringout USDNaftogaz’ 1.7 disclosingbring Naftogaz’ daily disclosingrevaluation daily of releasesrevaluation of regulatorreleases reducesregulator newreduces adoptsnew a law newadopts management a law ProZorro,new management a adopts ProZorro, changes a McKenzieadopts changesand Shareholder McKenzie and Shareholder 75.8 million NERC75.8 brings million ofNERC executive brings board of executivemanagement board in Businessmanagement in billionBusiness corporatebillion gas corporatetransmission gas Naftogaz’transmission 2012-2013Naftogaz’ NERC2012-2013 adopts shareholderNERC adopts managementshareholder in onmanagement stabilizing inin Ukrgasvydobu-on stabilizing newin Ukrgasvydobu- to communalnew PWCto proposedcommunal MeetingPWC proposedof Meeting of Eurobond gas pricesEurobond for membersgas prices reduced for frommembers Ukrtransgaz reduced from DevelopmentUkrtransgaz as EurobondDevelopment and as governanceEurobond and datagovernance on the datahydrocarbon on the consolidatedhydrocarbon higherconsolidated gas meetinghigher gas Ukrtransnaftameeting theUkrtransnafta financial vannya;the thefinancial new transparentvannya; the newservice transparent industry a detailedservice industry Ukrnafta a detailed votes Ukrnafta votes coupon publiccoupon sector 14public to 5 sector 14 to 5 well as Energy couponwell as Energy systemcoupon in line Europeansystem in line Europeanreserves and financialreserves and pricesfinancial for quorumprices for quorum state of CEOstate appointed of electronicCEO appointed regulationselectronic actionregulations plan of foraction a new CEO.plan of for a new CEO. payment consumerspayment to consumers to Efficiency Efficiency with OECD transparencywith OECD transparencyfixed assets statementsfixed assets householdsstatements requirementhouseholds requirement Naftogaz throughNaftogaz a new systemthrough for a new designedsystem to for Naftogaz’designed to TheNaftogaz’ candidate is The candidate is the level of the level of Department are Department are standards platformstandards ENTSOG platformannounced ENTSOG auditedannounced by fromaudited 1 April by thusfrom paving 1 April thus paving aimed at transparentaimed at statetransparent reducestate corporatereduce selectedcorporate through selected through industrial industrial created in created in proposed proposed Deloitte 2015Deloitte and heat way2015 for and heat way for reducing the nominationreducing the procurementnomination consumerprocurement debt governanceconsumer debta transparentgovernance a transparent CURBING CURBING ones ones Naftogaz Naftogaz producers for Naftogazproducers to for Naftogaz to company’s procedurecompany’s procedure to Naftogaz systemto Naftogaz reform publicsystem procedure reform public procedure households regainhouseholds control regain control deficit and deficit and based on OECD andbased proposed on OECD by and proposed by CORRUPTION ANCODRRUPTION AND from 1 May overfrom Ukrnafta 1 May over Ukrnafta improving improving standards a Nominationstandards a Nomination IMPROVING IMPROVING 2015 2015 consumer consumer Committee Committee OPERATIONAL OPERATIONAL payment payment combined of combined of discipline discipline government government EFFICIENCY EFFICIENCY representatives representatives and independent and independent experts experts

12 13 STRATEGY AND REFORM

4. Achieving gas independence for Ukraine through with international partners and creditors, a a combination of raising efficiency of gas decision was made to attempt saving Naftogaz. STATEMENT consumption and developing domestic upstream The most urgent task following the appointment sector OF DIRECTOR FOR of the new management team headed by Andriy BUSINESS DEVELOPMENT 2014 was probably the most challenging period in the Kobolyev was to stabilize Naftogaz operations. history of Naftogaz. Several critical threats coincided We had to make sure that the company was able Yuriy Vitrenko that year, including: to meet its obligations and accumulate necessary volumes of gas for Ukrainian consumers. • unpaid gas bills amounting to UAH billions My team was responsible for gas supplies to abrupt and politically motivated unilateral • Ukraine from the West. We negotiated with increase of Gazprom gas price by more than 80%, European suppliers and participated in launching almost absolute dependence on Russia for gas Dear readers, corrupt; these corrupt individuals caused public the new interconnector between Ukraine and imports, and the complete halt of gas supplies distrust by their actions in the government, and led Slovakia. Now Ukraine’s needs of imported gas Both in our country and abroad the Ukrainian from Russia for almost six months to the rise of yet another group of populists during can almost entirely be covered by supplies from gas sector is firmly lodged in the public opinion the next election. sizeable loans coming due, including USD 1.6 Europe. as an area plagued by large-scale corruption and • billion in Eurobonds and associated coupon uncontrolled theft. Incomplete and indecisive attempts of reforms FIXING IMBALANCES AND BUILDING payments lead to no result. In fact, they only cause irritation THE FOUNDATION FOR GROWTH Changing this perception to gain the trust of the and further distrust within the society, and no cash for transit services for most of 2014 society is both extremely important and challenging • However, the bulk of our work is aimed at bringing subsequently generate further demand for because of the advances received and spent years for anyone involved in reforming Naftogaz and the rules of the game for each of our business populism. ago building the gas market in Ukraine. segments in line with international best practices. Breaking out of this circle is a hefty challenge. I loss of a considerable part of upstream assets • Together with our international partners we are now understand that in order to earn trust, we have to because of the Russian aggression creating a solid foundation for the development talk less about the need to adjust gas prices, and Whatever progressive laws the rapid devaluation of the hryvnia in a situation of Ukrainian gas industry and reforming Naftogaz. more about the change that we are implementing • when most payments were in dollars and The issues this cooperation covers include may the parliament pass, and at Naftogaz. revenues in hryvnia expansion of local gas production, anti-corruption whatever positive effects the INITIAL CHALLENGES initiatives in gas industry, integration with the • the distortion between the purchase and selling AND FIRST RESULTS European gas market, bringing our relations proposed changes may bring gas price for households and the challenge for the with Gazprom to normal commercial terms and The new management team that came to Naftogaz authorities to reduce this gap at the time of the to Ukraine, without the public improving operational efficiency at Naftogaz and its last year has achieved important results in several economic recession and war subsidiaries. support, the gas reform will areas and is progressing in others. the political uncertainty and a series of elections • When (or if) the proposed legal and operating be illegitimate and will never The tasks on which our team works can be grouped which negatively affected the pace and the depth framework becomes effective, our market will into four strategic areas: of change materialize function in accordance with standard EU principles. 1. Reforming the Ukrainian gas market: moving • effects of years of corrupt practices that led to However, it is important to make these changes away from excessive administrative control, a critical loss of confidence in Naftogaz, both in comprehensive and sustainable. CORRUPTION BREEDING POPULISM inefficient monopolies and regulated gas prices Ukraine and internationally Corruption leads to populism. The previous set on the basis of political slogans instead of generation of Ukraine’s top-politicians defrauded economic rationale — to an efficient market If the reform is fully the country and let the others below them use with the non-discriminatory access to the Naftogaz has never been so implemented, it will protect opportunities to steal — directly or indirectly — in infrastructure for gas suppliers and the ability close to bankruptcy as in 2014 order to secure their own positions. to freely choose a supplier for gas consumers the interests of Ukrainian The public felt the injustice of the government and, 2. Ensuring security of gas supply to Ukrainian citizens both as consumers as a result, the people did not trust the politicians. consumers and across Ukraine to the EU: In fact, bankruptcy was one of the options our team This mistrust led the voters to simply demand including full-scale integration with the EU gas proposed when the decision was made on the new and the ultimate owners of lower prices for basic commodities and more social market and bringing relations with Gazprom to management and the future of Naftogaz. public assets — regardless of benefits. In such a situation, there is no use in standard European business practices However, it was essential to prepare for the 2014- explaining the public why the country cannot afford who heads the government or 3. Improving the operational efficiency of the 2015 heating season in time and to ensure the it — because there is no trust in such explanations. group: curbing corruption, tackling financial reliable transit of gas to European consumers. manages Naftogaz at any given Ukraine was going around in circles: the people deficit and introducing best governance Considering these tasks and following discussions moment elected populists, these populists were usually practices based on OECD standards 14 15 STRATEGY AND REFORM

The reform of corporate governance system These business functions The new legal framework The corporate governance is crucial to ensure the irreversibility of these changes. It is a vital tool for overcoming corruption should be transferred to converts gas from a social reform we advocate together and improving the operational efficiency of the a much more advanced benefit, abused and distributed with Ukraine’s international group. As with any other state-owned enterprise in Ukraine, the corporate governance system at system of coordination of unfairly, to a regular partners provides for an Naftogaz requires urgent revision. interests — the free market, commodity, priced on the basis independent supervisory Before the reform start in 2014, executive positions where the competition of supply and demand board, which would include in Naftogaz were often filled based on political While the state continues to oversee natural loyalty, not professionalism. Control over Naftogaz motivates industry independent members monopolies in gas transmission and distribution, and its subsidiaries was split among a limited participants to create the each family will now have the right to choose their with years of professional number of interest groups, each trying to maximize gas supplier independently of their gas distribution their gains during their period of control. maximum value using experience, impeccable company. This is a major change for the Ukrainian While efficiency and the maximization of profits minimum resources gas market and it finally makes the industry reputations and high levels of for the owners’ benefit are typical private business consumer-focused. public trust objectives, these goals have never before been an A civilized and efficient market requires The new gas market law has created the necessary Reforming corporate governance is vital for official priority for Naftogaz. On the contrary, the development and implementation of rules that legal framework. However, scores of secondary overcoming corruption and improving the permanent losses were expected, because of the encourage competition and ensure fair dealing documents needed to be developed and enacted operational efficiency of the group. Through paternalistic social contract that guaranteed "cheap by all market participants. to ensure an effective implementation of the independent supervisory boards the Naftogaz gas" for every consumer. The losses were covered new law and a smooth transition to the new and its subsidiaries will receive the opportunity by the state budget, i.e. ultimately, by the citizens THE NEW GAS MARKET LAW rules. Over the past months, Naftogaz has been to implement long-term strategies focused on of Ukraine. Last year, Ukraine’s counterparts in the Energy actively participating in the development of these maximizing value for the public, within their mission Ukraine’s gas industry was governed by a Soviet- Community proposed a new draft law on documents with a team of European and national and mandate. style centralized system which implied active gas market that corresponded to the current experts. THE FUTURE OF NAFTOGAZ state intervention. Given the limited tradition European energy legislation. The document SAFEGUARDING CHANGE: of authorities’ accountability to the society and was drafted in good faith; however it had little For a certain period of time Naftogaz will have THE CORPORATE GOVERNANCE the lack of an established civil service culture, chance to pass through the state authorities to stay in its present legal form. The company is REFORM this structure resulted in a classic double agency and the parliament. It infringed on the interests needed until retail gas prices for all consumers are problem. of several industrial groups and was contrary The history of gas industry transformation in other deregulated and a competitive market develops. to the regular agenda of populists. The number European countries shows that the chances for a Another reason for Naftogaz to exist is its arbitration At the highest level, the authorities were used to of educated reformers in the parliament was successful reform increase dramatically when the with Gazprom where the company disputes billions utilizing Naftogaz for their own purposes which insufficient for a successful vote. incumbent state company actively supports it. of dollars excessively paid for Russian gas and most often did not correlate with the interests of demands this money to be refunded. the Ukrainian people. We took on the job of advocating and defending In Ukraine, Naftogaz is one of the drivers of the the provisions of the law. Uniting efforts with reform. Last year we laid the foundation which is Then, if we do it right, within a few years the present At the lower level, the management of Naftogaz the civil society, reform-minded members now begins to transform the market. Naftogaz will have evolved into a set of market often sought to secure their own interests in of parliament and market players, as well as rules. The Ukrainians will have reliable sources of addition to serving the interests of those in power When the reform is fully implemented, the decision- partners from the EU and the US led to a wide gas supply at competitive prices and will not have to at the time, and this did not match the societal making process in companies that now form public discussion and, eventually, won support sacrifice a portion of national sovereignty in return. interests either. Such a structure created vast Naftogaz group is going to be based on economic for the new law. It was submitted by the Cabinet Our European counterparts will have a transparent opportunities for abuse. rationale rather than political reasoning. of Ministers, adopted by the Verkhovna Rada partner offering mutually beneficial opportunities Today Naftogaz has an unprecedented reform- and signed by the President. Starting from To make the reform irreversible, a new concept of for integration and growth. minded team of managers who genuinely believe 1 October 2015, Ukrainian gas market is to corporate governance of Naftogaz was developed This is a future worth changing for and fighting for. that their highest priority should be serving the operate according to the new rules. with the support of the EBRD. It is based on the citizens of Ukraine as the ultimate owners of the OECD best practices for corporate governance in Under the new system, the national regulator company. However, there is no guarantee that state-owned companies. now does not have the authority to set gas positive changes will not be halted or rolled back if prices, except for the standard public service The proposed system creates checks and balances the political will for reform wanes for any reason or YURIY VITRENKO obligations provisions. The regulator sets that will ensure coordination of interests of various if the management changes. tariffs for gas transmission (Ukrtransgaz) and stakeholders in the decision-making process while Director for Business Development In the past years, most business functions of gas distribution (regional gas companies) and avoiding the group paralysis. Naftogaz of Ukraine Naftogaz were at the discretion of a few people is responsible for regulating the market, most who were not accountable to the Ukrainian society. notably, for safeguarding free competition.

16 17 STRATEGY OVERVIEW

Unbundle Naftogaz in accordance Ensure the implementation of Assist in reforming the system with the new gas market law, other provisions of the new gas of protecting vulnerable establishing an independent market law consumers gas transmission system Encourage price liberalization, operator (TSO) and ensure liquidity and unobstructed that all market participants competition in all segments of have equal and transparent the market that are not natural access to the gas transmission monopolies CREATING AN EFFECTIVE capacities GAS MARKET BASED ON EUROPEAN BEST PRACTICES

Ensure reliable gas supply to Defend the interests of Naftogaz Ensure integration with the EU Ukrainian consumers and in litigation with Gazprom: bring gas market through political, uninterrupted gas transmission the current contracts in line legislative, infrastructural and across Ukraine to other with relevant legislation and marketing processes European countries receive compensations for SECURITY OF SUPPLY: excessive gas payments and lost Attract partners to manage the gas transmission revenue DIVERSIFICATION, gas transmission system and underground gas storage Create opportunities to diversify INTEGRATION WITH THE EU, LIBERALIZATION facilities on conditions optimal transmission routes and RELATIONS WITH RUSSIA OF GAS PRICES for Ukraine sources of imported gas COUPLED WITH EFFICIENT DIRECT SUBSIDIES SYSTEM

Optimize internal business Introduce new transparency Manage the company’s accounts processes, eliminate potentially standards, regularly disclose receivable and accounts payable CORPORATE corrupt practices financial and operating OPERATIONAL EFFICIENCY: information, encourage GOVERNANCE Support the corporate independent analysis RAISING TRANSPARENCY, REFORM governance reform and other CURBING CORRUPTION, legislative changes necessary to create efficient and sustainable IMPROVING FINANCIAL business models in Naftogaz POSITION and group companies

Maintain the highest possible Develop an investment program Encourage the use of alternative level of gas production by the to maximize gas production sources of gas GAS INDEPENDENCE group until retail gas prices are following price liberalization liberalized FOR UKRAINE Develop and implement an Develop and initiate a program action plan to reduce gas of replacing obsolete heating consumption within the group systems for consumers which use gas the least efficiently

18 19 STRATEGY AND REFORM

STRATEGY SUMMARY

Strategic changes in Ukraine’s gas market European best practices, with transparent for Ukraine. Naftogaz is taking an are not possible without changing rules of access to the infrastructure for active role in promoting legislative Naftogaz itself. In the same time, systemic all market participants and freedom for and structural changes in Ukraine that changes within Naftogaz are impossible consumers to choose their suppliers. will attract investments in upstream without a comprehensive reform of the to increase local gas production and During the transition period, Naftogaz market. The group’s position in Ukraine’s in energy efficiency to reduce gas should continue to perform its functions, gas industry imposes on it a responsibility consumption. specifically to ensure reliable gas to lead the market reform. supplies to Ukrainian consumers and The implementation of Naftogaz strategy stable transmission of Russian gas to is highly dependent on two key changes European consumers. An important part in the group operating environment The strategic goal of this task is the diversification of routes which Naftogaz actively advocates and of Naftogaz is the and sources of gas imports to Ukraine, supports. integration with the EU energy market, as Of particular concern is ensuring that development of a well as bringing relations with Gazprom to gas is available for socially vulnerable European market standards. competitive gas market households during the transition period. in Ukraine Naftogaz also strives to increase the Recognizing the critical importance operational efficiency of the group of gas prices liberalization for the companies, which must be transformed reform’s success, Naftogaz supports An efficient market will ensure security under the new market conditions. The key the state subsidy system reform and of gas supply and competitive gas prices objective is to optimize internal business communication of these changes to the for consumers in a financially sustainable processes to eliminate potentially corrupt consumers. way and will create the necessary practices and introduce best practices Of equal concern is reforming the conditions to attract investment to of transparency and financial disclosure. corporate governance of Naftogaz in increasing local gas production and This transformation should also address line with the OECD standards to ensure improving energy efficiency in Ukraine. liquidity and solvency issues of Naftogaz sustainability of changes introduced and its subsidiaries. The current gas market model with by the market reform. Naftogaz excessive government intervention and The long-term goal dependent on the supports the development, discussion inefficient monopolies should be replaced implementation of the gas market and implementation of the corporate by a competitive market modeled on the reform is to achieve gas independence governance reform.

20 STRATEGY AND REFORM

CREATING AN EFFECTIVE GAS MARKET BASED ON EUROPEAN BEST PRACTICES

The old ways of the Ukrainian gas market cross-subsidized by the state. To address Finally, the transparent rules consistent are unacceptable and require change. this issue, the transformation will be with the European gas market and immune This understanding unites the Ukrainian implemented in stages, alongside the to political instability, will promote long- public, policy makers, industry experts reform of the state subsidies system for term investment in gas production and and market participants. vulnerable consumers and development energy efficiency in Ukraine. of programs to improve energy efficiency The goal of the gas market reform Implementing such reforms is in line in housing. advocated and led by Naftogaz is to create with Ukraine’s obligations as a member conditions for a sustainable development Successful implementation of the reform of the Energy Community and with the of the industry and improvement of the will have several important consequences. Association Agreement with the EU. quality of life for Ukrainian citizens as the Firstly, competition will appear in all The first important steps in this direction ultimate beneficiaries of this development. segments of the market. Inefficient were made in the spring of 2015, when The new system should eliminate barriers companies will be forced to either the Verkhovna Rada of Ukraine passed, that previously hindered development transform themselves or leave the market. and the President approved, a new law and led to an opaque and inefficient use on the natural gas market. This legislation of resources. Secondly, the gas transmission and was developed and promoted by distribution infrastructure will be representatives of the Energy Community independent of gas suppliers. An open Secretariat, Naftogaz and market market with clear rules on infrastructure The central idea of participants, industry experts, reform- access will promote the diversification of minded politicians and other stakeholders. reform is to introduce suppliers and thus strengthen the security The law is fully compliant with the 3rd of gas supplies to Ukrainian consumers. transparent rules for all Energy Package of the EU. Thirdly, the functions of the market participants based on Most provisions of the new law come and the state will be clearly separated, into effect on 1 October 2015. This the EU best practices. As protecting the sector from political framework document thoroughly changes meddling and graft. The functions of the in the EU, consumers’ the rules of the gas market In Ukraine. state which are not typical for a regular Its full implementation requires changes interests are the business, including support for the socially and amendments to dozens of existing vulnerable families, will be performed only cornerstone of this reform regulations. During the past months, on the basis of clearly defined conditions active work on this secondary legislation within the framework of public service was performed by the government, the However, the initial implementation of obligations (PSO). The cross-subsidizing National Energy and Utilities Regulation the reform requires socially sensitive of gas for all consumers will be replaced Commission, the Energy Community and unpopular moves, including the by direct state subsidies for low income Secretariat, Naftogaz and other industry elimination of regulated retail gas prices families only. stakeholders. 22 STRATEGY AND REFORM

SECURITY OF SUPPLY: DIVERSIFICATION, INTEGRATION WITH THE EU AND RELATIONS WITH RUSSIA

gas transmission system that allows for a is the first step to using the full potential achieve this goal is to implement Ukraine’s quick increase of gas flows is one of the of the interconnector between Ukraine gas market reform. The reform foresees main goals of the EU Energy Union. and Hungary, including the virtual reverse liberalization of retail gas prices for flows (see Gas transmission). all consumers and adoption of a new Naftogaz and Ukrtransgaz continue to Energy security is a daily challenge not only DIVERSIFICATION OF GAS The current capacity of the new route is 15 regulatory environment that is consistent work on unlocking the full potential of the The ultimate goal of Naftogaz is to sign for Ukraine but also for other European SUPPLY ROUTES bcm/year. It connects Ukraine to the liquid with the EU energy legislation. These existing interconnectors between Ukraine and implement standard interconnection countries. The EU is implementing a new gas markets of the Western Europe and changes will stimulate entry of new gas Until 2014, Ukraine could import gas from and the EU. Not only will this work further agreements with TSOs of all the energy security strategy which involves has been the main route for Ukrainian gas suppliers to Ukraine. the West via Poland (1.5 bcm/year) and strengthen Ukraine’s energy security but neighboring EU member states, including creating a unified gas market and imports in 2015. Hungary (5.5 bcm/year). These routes were will also benefit other countries of Central Slovakia, Poland and Romania. For a full The first results of the adoption of the eliminating physical or administrative cross- not sufficient for Ukraine because of their Ukraine’s current demand for imported and Eastern Europe. and unobstructed cooperation between new gas market law are already visible. border barriers to bidirectional gas flows limited and interruptible capacity, and gas is estimated at 15-18 bcm/year. the neighboring markets, it is also In July 2015, Trailstone, one of suppliers within the framework of the Energy Union. Russia has lost its dominant position in because they lack connection to the liquid Therefore, with the launch of the Slovak necessary to normalize relations between to Naftogaz in the European market, the Ukrainian market and is no longer Diversification of both gas supply routes gas markets of the Western Europe. route Ukraine has eliminated its critical Ukrtransgaz, Naftogaz and Gazprom, and has expressed its intention to enter the able to use gas to extort political or and sources minimizes a country’s political dependence on Russian gas imports. adapt Ukrainian legislation appropriately. Ukrainian market after the new regulatory commercial concessions from Ukraine. and technological risks and strengthens its environment is introduced. Other However, because gas demand is uneven Since April 2015 Russian gas has been Another focus of the group is to increase energy security. It also inevitably leads to European gas traders are preparing to Thanks to the throughout the year and strongly depends offered to Ukraine at prices that generally the physical capacity of the interconnector an increased competition among suppliers, enter the market as well. on the weather conditions, it is important match prices at which Naftogaz can buy between Poland and Ukraine. Ukrtransgaz higher liquidity and fair gas prices for collaboration between to have sufficient transmission capacity to gas in the EU. If the interconnectors and the Polish TSO GAZ-SYSTEM develop consumers. In a successfully diversified the Ukrainian and Slovak cover not only the total annual demand between Ukraine and the EU are fully a joint project to build a new gas pipeline market, any state should have access to at but also seasonal demand spikes. utilized, the same results are possible that will increase the capacity of the Polish In 2014, Naftogaz least three independent sources of gas. transmission system for other countries of the region which interconnector by 8 bcm/year to 9.5 bcm/ If the infrastructure allows for a free significantly expanded In the short term, removing transmission operators (TSOs) as well currently significantly depend on Gazprom year in Ukraine’s direction. movement of large volumes of gas to cover system bottlenecks and achieving effective as their source of gas supply. the number of its gas as the active support of the peak demand, security of gas supplies in DIVERSIFICATION OF GAS diversification of gas supplies may require the region significantly increases. Sufficient In June 2015, a direct interconnection SUPPLIERS suppliers in Europe. investments in infrastructure or restrictions European Commission, transmission capacity allows to reduce the agreement was signed between to the volume of purchases from a single Besides developing alternative gas In particular, the group the Slovak gas supply route need to store excessive volumes of gas Ukrtransgaz and FGSZ, the Hungarian source. In its policy for security of gas supply routes, an important element of and makes the market more stable and TSO. This agreement fully complies with started to buy gas from supply Ukraine follows the same strategy. to Ukraine was launched diversification is increasing the number efficient. Creating a well-interconnected the new European Gas Network Codes. It Statoil in 2014 of suppliers. The most reliable way to 24 25 STRATEGY AND REFORM

negotiations, Naftogaz and Gazprom setting provisions, are invalid based Under the conditions of the winter package Gas transmission and storage initiated arbitration proceedings at the on the applicable competition and Naftogaz has paid USD 3.1 billion for 11.5 Ukraine’s gas transmission system, Arbitration Institute of the Stockholm energy law. These provisions must bcm of gas delivered by Gazprom in 4Q operated by Ukrtransgaz, remains a Chamber of Commerce (SCC) in June be replaced pursuant to the contract, 2013 and 2Q 2014 at USD 268.5/tcm. The reliable transit route for Russian gas to the 2014. The two claims were subsequently with retroactive effect. Naftogaz claims Russian side provided a gas price discount EU: over 40% of Russian gas delivered to combined into one proceeding. a compensation for incurred losses and undertook an obligation to supply up Europe and Turkey in 2014 was transmitted related to the actually transmitted to 114 mcm/day based on Naftogaz’ daily Naftogaz requests a repayment of more through Ukraine. Ukraine has the largest volumes. nominations on a prepaid basis. The take- than USD12 billion charged by Gazprom underground gas storages in Europe with or-pay provision did not apply during this above prevailing market prices between Naftogaz also demands a compensation a total capacity of over 30 bcm. The largest period. 2010 and 2014. Naftogaz refers to its for Gazprom’s failure to supply negotiated of these storage facilities are located at the contractual right for a revision of the price gas volumes for transit, given that the The final ruling in the pricing dispute border of Ukraine and the EU. to reflect the actual market conditions. transmission tariffs depend on the between Naftogaz and Gazprom will be Ukraine’s gas transmission system can be Naftogaz repeatedly applied for such a volume of gas transported. Gazprom has made by the SCC. The Brussels agreements used to transport gas from suppliers in revision over the previous years. committed to transit no less than 110 are temporary and do not affect the Western Europe to customers in Central, bcm per year via Ukraine. Instead, the positions of the parties in court. Gazprom requests a payment of Eastern and Southern Europe. Ukraine’s annual transmitted gas volume in 2009- approximately USD 26.7 billion by The winter package was an important and existing gas infrastructure interconnects 2013 averaged 94 bcm. In 2014, Gazprom Naftogaz. Approximately USD 2.1 billion effective tool which alleviated the risk of otherwise fragmented gas transmission transited just 62 bcm of gas through of this amount relates to the disputed interruption of gas supplies by Russia to systems of the region and can help to Ukraine. difference between the justified and European consumers during the winter significantly decrease the dependence of contractual prices for gas supplied to Finally, Naftogaz requests that its rights season of 2014-2015. It also gave Ukraine an these countries on Russian gas supplies. Naftogaz in 4Q 2013 and 2Q 2014. The and obligations under the contract are opportunity to source the necessary volumes Ukraine is interested in optimizing the remaining portion of Gazprom’s claim transferred to Ukraine’s gas transmission of gas to cover its demand. Naftogaz did use of its gas infrastructure and invites refers to the “take or pay” provision and is system operator in accordance with the not buy gas from Gazprom in 3Q 2015. The Naftogaz also buys directly from a number to Ukraine (see Gas imports and wholesale western partners to jointly operate the a demand to pay for gas which was never 3rd Energy Package. parties continue negotiations of a similar of leading European gas traders, including trading). Ukraine's gas transmission system Ukrainian gas transmission system and supplied. Naftogaz insists that the “take trilateral package for the 2015-2016 winter ones from Germany and France. In order is the primary delivery route for Russian The total monetary claims of Naftogaz underground storage facilities. Relevant or pay” provision combined with other season. to maximize the range of its potential gas to the EU, Gazprom’s largest export under this contract exceed USD 11.7 amendments to the legislation enabling provisions of the contract (including the suppliers, Naftogaz has adopted a number market (see Gas transmission). Following billion. These claims relate to the period INTEGRATION WITH THE EU GAS such partnerships were passed in 2014. pricing mechanism and the prohibition of of trading tools and principles common Russia’s military aggression, Naftogaz has prior to 2015 and will be extended to cover MARKET re-exporting the gas) is discriminatory and Gas upstream for the EU market, including standardized lost control over some of its assets, and losses incurred in 2015. cannot be applied. Ukraine's relations with the European Union EFET contracts with delivery to the virtual Gazprom announced the commencement Ukraine ranks third in proven natural Naftogaz is ready to continue negotiations and other European countries on gas issues trading point (VTP) and nominated in of unauthorized gas supplies to the Contract for gas transit gas reserves in Europe after Norway and on both contracts. are based on the principle of mutually energy units. occupied territories of Donbas (see Military the Netherlands. Naftogaz’ subsidiary The gas transit contract between Naftogaz beneficial partnership. aggression of Russia against Ukraine). Interim agreements on Russian gas Ukrgasvydobuvannya is the largest player Liquefied natural gas (LNG) could become and Gazprom requires revision as well. Naftogaz aims to bring relations with supplies to Ukraine Ukraine aims to facilitate its own gas industry in Ukrainian upstream market. The gas a potential new source of gas for Ukraine. Naftogaz has raised this issue repeatedly Gazprom to standard market terms and transformation utilizing the experience market reform, industry deregulation and Given that Turkey currently opposes both in bilateral discussions with Gazprom Until the conclusion of the arbitration to minimize political influence on these gained by all other European countries — liberalization of retail gas prices will open the passage of LNG-terminals through and during trilateral negotiations involving proceedings, the terms of Russian gas relations. from the United Kingdom to Slovakia. this market for investment. Upstream the Bosphorus, LNG can be sourced by representatives of Ukraine, Russia and the supplies to Ukraine are regulated by investment needs in public and private Ukraine from the countries of the Black There are two contracts between Naftogaz European Commission. In October 2014 interim agreements, which are mediated If the reform is implemented successfully sectors are estimated at approximately Sea basin. Alternatively, LNG could be and Gazprom: one covers gas supply Naftogaz initiated arbitration proceedings and monitored by the European and Ukraine is fully integrated with the USD 5.6 billion over the next 5 years. sourced from the terminals in Lithuania to Ukraine and the other — transit of in SCC regarding this contract and Commission. The so-called “winter European gas market, attractive new and Poland, subject to the development Russian gas to European consumers. submitted a statement of claim in April package” signed in Brussels on 31 October opportunities will open for Western partners Energy efficiency of appropriate gas transmission Both contracts require revision based on 2015. 2014 set out the terms of Russian gas in at least four new markets. In addition to gas supply, transmission infrastructure. Naftogaz explores a Ukraine's commitments as a member of supply till the end of March 2015. The In a report of 3 December 2014, the Gas supply and upstream markets, the proposed number of possible options in this regard. the Energy Community, newly adopted package consisted of a trilateral binding Energy Community Secretariat concluded reform creates investment opportunities legislation and changes in the market protocol between the governments Ukraine is one of the largest markets for RELATIONS WITH GAZPROM that the gas transit contract between in the market of energy efficiency projects. environment. In addition, both companies of Ukraine, Russia and the European natural gas in Europe, with imports in 2014 AND RUSSIA Naftogaz and Gazprom may be considered Ukraine is one of the least efficient gas have concerns regarding the application of Commission, as well as a bilateral amounting to 19.5 bcm and the consumption incompliant with European competition consumers in Europe. Modern technologies Relations with Gazprom and the Russian certain provisions of the contracts. supplemental agreement to the contract to 42.6 bcm. Given Ukraine’s desire to and energy law. provide a huge energy saving potential for Federation significantly impact the energy between Naftogaz and Gazprom. The diversify gas supplies following the Russian Contract for gas supply both households and industrial consumers. security of Ukraine and operations of In its statement of claim, Naftogaz bilateral agreement was later extended military aggression, European suppliers have The market size is estimated between Naftogaz. Prior to 2014, Gazprom was Having failed to agree on issues related indicates that a number of provisions to cover the period until the end of June an opportunity to increase their market USD 10 to 15 billion over the next 5 years. virtually the only supplier of imported gas to the contract for gas supply through of the contract, including tariff 2015. share in Ukraine. 26 27 STRATEGY AND REFORM

OPERATIONAL EFFICIENCY: TACKLING CORRUPTION, ­RAISING TRANSPARENCY, ADDRESSING ­FINANCIAL ISSUES

The gas market reform currently especially in matters that concern proving for Ukraine, has initiated arbitration implemented in Ukraine aims to create and recovering past losses. proceedings related to old disputes and an efficient competitive environment continues actions to regain control over its in each segment of the gas industry. key subsidiaries. Naftogaz group companies need to adapt Naftogaz cooperates Steps are also taken to tackle less to the new conditions by improving their prominent manifistations of corruption operational efficiency. with investigators and abuse. Naftogaz now uses transparent TACKLING CORRUPTION AND on a number of cases bid solicitation process whereby its tender RAISING TRANSPARENCY associated with the announcements are widely distributed in local media to maximize the selection of For a long time, Naftogaz has been past management of potential suppliers. In 2015, Naftogaz and synonymous with ubiquitous corruption. Ukrgasvydobuvannya joined ProZorro, an To remedy the situation and gain trust the group and ensures e-procurement system for public sector of its stakeholders, Naftogaz introduces full access to related which enables access to a wide range of comprehensive changes in its internal private sector suppliers and ensures a operating policies and procedures. The information and internal and international stakeholders. standards, Naftogaz was able to receive Changing the rules of the gas market transparent bidding procedure. group management also advocates documents The group now publishes a comprehensive support of the European Commission and in Ukraine and reforming Naftogaz introduction of European standards The new management team has taken selection of regular operating statistics to gain trust of the group’s partners from corporate governance can aid this process. and regulatory best practices in all unprecedented steps to imrpove related to gas imports, production, Europe and the USA. At the same time, Historically, Naftogaz has sold gas at below segments of Ukraine’s gas market to In its strategy for building an effective gas disclosure of Naftogaz operating and transmission, storage and consumption. relations with Gazprom have become more market prices, leading to substantial losses remove distortions which made Naftogaz market in Ukraine, Naftogaz takes the financial data and introduce new Naftogaz has joined leading European gas pragmatic and business-oriented. and making the company dependent on unavoidably loss-making and created responsibility beyond its normal scope transparency standards. The group has infrastructure transparency platforms of state support. ADDRESSING FINANCIAL ISSUES ample opportunities for corruption. of duties and drives the change — in released audited consolidated financial GIE and ENTSOG, whereby it established For years, selling price for particular, in streamlining the regulatory statements for 2012-2013 and 2014. automated daily updates of gas storage All Naftogaz companies should be managed The negative perception of Naftogaz was Ukrgasvydobuvannya gas has been framework and reforming its corporate Naftogaz now publishes quarterly and transmission data. in the interests of the people of Ukraine, formed by both internal and external administratively set below market prices. governance system. audited stand-alone financial results. The the ultimate owner of the Naftogaz group. factors. The group management has For the first time Naftogaz has disclosed The company has therefore been unable to management continues to modernize and The key management objective thefore varying influence on processes which Naftogaz has also introduced or data on the structure of its executive raise sufficient investments to modernize its rationalize the internal reporting systems needs to be increasing the market value of determine the effectiveness of tackling is implementing changes within board and management remuneration. production facilities and technologies and within the group to enable the preparation the group’s assests. Tailored approaches corruption within Naftogaz and related to its direct control. In particular, the The personnel selection process has to eventually increase its output. of consolidated financial statements on a are required for each assets, with options Naftogaz. new management has eliminated become transparent and is now based on quarterly basis. including development in existing markets, Group companies operating in other sectors intermediaries in gas imports and internal professional merits (see Personnel). Some factors are outside of Naftogaz expansion into new markets, restructuring, of the gas market face similar structural gas supply, created conditions that led Naftogaz has initiated a public discussion control and relate to the functions of the Thanks to the radical improvements in privatization or liquidation. challenges and regulatory distortions. The to reduction of prices of imported gas of its strategy and activities both with law enforcement and judicial systems, its transparency and general governance ongoing gas market reform should create 28 29 STRATEGY AND REFORM

favorable conditions for the development of (DHCs), as well as regional gas distribution and additional UAH 10.7 billion in penalties these assets. and supply companies (oblgazes). In this and fines category, the largest accumulated debt is Another important challenge for the group Almost half of the total amount of these GAS INDEPENDENCE associated with Dnipropetrovsk and Kharkiv is managing its vast accounts receivable and claims is related to 21 clients, with each regions, the city of Kyiv, the Anti-Terrorist FOR UKRAINE accounts payable. Having repaid its Eurobond having outstanding debts of more than Operation area in east Ukraine, and the in 2014, Naftogaz significantly reduced UAH 0.5 billion. Approximately 100 occupied Crimea. 18% of debt relats to its current obligations. Most of remaining clients with debts of UAH 0.05 billion to industrial users, of which 2/3 is from current loans were restructured in 2014-2015 UAH 0.5 billion account for 42% of the total chemical enterprises in the three oblasts of (see Financial Statements Review). debt owed to the group. The remaining Luhansk, Rivne and Cherkasy. Another 10% debtors (nearly 2 300 companies with At the end of 2014, the accumulated debt of the debt has been accrued by gas traders debts of less than UAH 50 million) account of consumers to Naftogaz and its trading and other companies, with the largest for less than 10% of total debt. subsidiary Gas of Ukraine amounted to debtor in this category being the Crimea UAH 38.7 billion. 60% of this debt dated registered entity GazUkrayina-Commerce. During this period, court decisions were back to before 2014. made regarding claims which amount to Unlike many countries in Europe, Between 2010 and 2015, Naftogaz and Gas approximately UAH 36.7 billion, Ukraine could potentially abandon 72% of the debt was owed to Naftogaz and of Ukraine filed more than 5 000 lawsuits with a positive ruling issued regarding importing gas and fully meet the Gas of Ukraine by district heating companies related to debts totaling UAH 38.8 billion UAH 27.7 billion (or 67% of the total country’s gas demand through domestic amount claimed). However, as of July 2015, production alone. In order to achieve only UAH 5.2 billion have been paid. this goal, it is necessary to bring DEBT TO NAFTOGAZ AND GAZ OF UKRAINE, BY ORIGINATION DATE investments to increase both energy Solving the issue of gas debts owed to efficiency and domestic gas production. Naftogaz and Gas of Ukraine requires not only active steps by the companies but Achieving this goal depends on 60% prior to 2014 certain amendments to the legislation. As successfully reforming the gas market a guaranteed gas supplier, Naftogaz had and on other steps the government the obligation to conclude gas contracts has initiated to create a favorable and supply gas to virtually any consumer in investment climate in Ukraine. It 40% in 2014 Ukraine. However, Naftogaz did not have is estimated that Ukraine needs effective tools to recover debts from de- USD 40 billion of investments into linquent customers. The policy of guaran- energy saving and gas production in teed supply led to an increase of Naftogaz order to abandon gas imports within the DEBT TO NAFTOGAZ AND GAS OF UKRAINE, deficit and made it reliant on additional next ten years. To put this amount into BY CONSUMER CATERGORY support from the state budget. context, Ukraine paid over USD 80 billion for Russian gas over the past ten years. In May 2015, within the package of bills agreed with the IMF, the parliament voted Naftogaz management is certain that 10% Other 51% DHCs in favor of legislative amendments aimed the most practicable way to achieve to correct the situation and stabilize the gas independence for Ukraine is to fully finances of Naftogaz. When these amend- implement the gas market reform and 18% Industry ments are fully operational, Naftogaz will safeguard unobstructed competitive 21% Regional gas supplers have the right to suspend gas supplies to environment in the country’s gas sector. consumers in arrears and can refuse to Naftogaz energy efficiency division enter into contracts and to supply gas to is developing programs to increase According to Naftogaz estimates, cubic meters and are among the largest in companies that are bankrupt. Additionally, DEBT TO NAFTOGAZ AND GAZ OF UKRAINE, BY AMOUNT OWED efficiency of gas use by the group's comprehensive energy efficiency Europe. Ukraine’s reserves-to-production the moratorium on the forced sale of prop- Total: UAH 16.4 billion enterprises, as well as a program measures can decrease households ratio is above 30, being the highest in erty of district heating companies to cover 42% of debt to replace old and inefficient demand from about 22 bcm in 2014 Europe and indicating that Ukraine their gas debts will be lifted, and an im- Total: UAH 3.5 billion 98 clients boilers for the poorest consumers. to 10 bcm/year by 2025. According to depletes its resources comparatively proved process for the execution of court 9% of debt Ukrgasvydobuvannya is also currently preliminary estimates, modernization of the slowly. An estimated USD 5.6 billion of UAH 50-500 million/client decisions will be implemented. Naftogaz 2298 clients analyzing the possibility of increasing heating equipment and networks, installing investments is required to increase gas will have an opportunity to publicly auction gas production and evaluating meters and insulating buildings requires production to 12-14 bcm per year by Less than Total: UAH 18.8 billion debts owed to it. Full implementation of investment needs. Naftogaz supports nearly USD 36 billion of investments. 2020. Taking into account the anticipated UAH 50 million/client 49% of debt these changes requires the adoption of the use of alternative sources of gas depletion of existing wells, it may 21 clients certain secondary regulations and rulings Conventional natural gas reserves in (including biogas) and alternative fuel bring Ukraine’s total gas production to by the Cabinet of Ministers. Ukraine are estimated at over 1 trillion Debt to Naftogaz as at 31 Desember 2014 Over UAH 500 million/client sources. ­27-29 bcm per year by 2020. 30 31 STRATEGY AND REFORM

REFORM RISKS implementation. The process of constitutional separation of economy has always been an important priority for of powers between the parliamentary coalition, the those who engaged in corrupt practices. AND CHALLENGES government and the President has not been finalized. Through the energy sector, corrupt groups have influenced Meanwhile, the ongoing decentralization reform adds the political, economic and social development of the to the confusion, creating ambiguity over the levels of country for many years. Large-scale overpriced gas imports responsibility the local authorities are going to assume. from Russia and heavily subsidized gas for households The participation of internal and external stakeholders have served as instruments of power and created a The proposed market reform is not limited to Naftogaz economy. The situation is complicated by the fact that is extremely important to resolve these challenges. corruption-prone system. Without control over Naftogaz itself; it encompasses the entire Ukrainian gas industry. Ukrainians rely on the state but do not trust it. The Ukrainian civil society now actively monitors the and its subsidiaries, the old groups of influence lose their The reform requires significant changes in the industry government decisions and actions. Ukraine’s foreign competitive advantage against more effective private Social surveys of confidence in institutions show single- governance in general, shifting the government policy from creditors and international partners have clearly articulated sector players. digit levels of trust to the state institutions. At the same control to regulation. the terms of their support, with special emphasis placed time, the speed with which reforms are taking place The array of tactics deployed to hinder the reform on the previously failed attempts to reform the energy The proposed changes are designed to encourage and the uncertainty generated by the lack of, and often include defamation, sabotage, blocking changes through sector. An unreformed energy sector in Ukraine presents more efficient business models focused on longer term contradictory, government communication on the reform court decisions, lobbying legislation that undermines a potential security risk, both for the EU and for Ukraine. strategies by the gas market participants. process and its goals, creates a confusing environment for the reform integrity and even using threats of physical Given the lack of resources and time constraints, reforming the public, leading to stress and distrust. violence against individuals responsible for the reform A successful implementation of the reform will also result the market requires determination of all parties involved. implementation. in a shift to more energy conscious behavior for millions Populist political leaders oppose reforms, using a chance of Ukrainians. The most challenging part of the reform is to increase their political influence. By opposing the gas As long as Ukraine’s public institutions are weak and the the need to move the center of responsibility for efficient sector reform in general or some of its elements, they can In order to address this challenge, public support for the unpopular changes is limited, the energy use from the top to the bottom, creating an undermine the integrity of the changes Naftogaz seeks to alliance of corrupt interests and paternalistic expectations environment where citizens are responsible for making implement. the Ukrainian authorities have can pose a threat not only to the gas market reforms, but better energy consumption choices. to the country as a whole. Communicating these threats However, the Ukrainian society is not entirely paternalistic. launched a number of joint to the society and explaining the logic behind the reform Naftogaz sees three key challenges which can hinder The reforms initiated by Naftogaz enjoy the support of initiatives that bring together process are therefore crucial steps. the reform process, namely, demand for paternalism, many within Ukrainian civil society. poor coordination between various governmental representatives of different bodies implementing the reform and corruption-induced ministries and organizations The strong political will within resistance to change. The 2013-2014 Revolution of involved in the reform process to Ukraine and the voice of Ukraine’s PATERNALISTIC EXPECTATIONS Dignity has demonstrated that improve coordination between OF THE PUBLIC Western partners are critical for Ukrainians are willing and able to them A significant number of Ukrainians still have paternalistic moving the reform forward. The expectations originating from the Soviet system. During take responsibility for changing the the Soviet era, the citizens had no effective instruments to increased role of the Ukrainian civil country Of particular importance in moving the reform forward is influence the governance of the state or their communities. the National Reforms Council established by the President society helps to curb corruption In the result, avoiding individual responsibility has become An effective communications strategy, together with the of Ukraine, which unites representatives of the parliament, a common behavioral pattern. Basic commodities and block decisions aimed to stop support of the ruling parliamentary coalition, should help the government and the presidential administration, as subsidized by the state traded off for selective justice and to reduce public anxiety. The 2015-2016 winter will likely well as relevant NGOs and experts. the reform implementation the non-accountability of the authorities were components be the most challenging and decisive period for the reform of the paternalistic culture that evolved over many Another important cross-ministerial group was formed success and will show how the country adapts to the new decades. by the government to coordinate the development and Naftogaz believes that the corporate governance reform conditions. implementation of state-supported energy efficiency based on OECD best practices for public sector companies The European choice that the Ukrainians have proclaimed LACK OF COORDINATION AMONG programs as well as the reform of the system of utility is one of the most effective ways to combat corruption requires a completely different model of behavior. THE REFORMERS subsidies for low-income consumers. in the energy sector. In particular, an independent The transition to this model is a challenge for millions supervisory board in Naftogaz needs to be formed to of Ukrainians. Some citizens reject the necessity to The lack of coordination among various entities CORRUPTION-INDUCED RESISTANCE FROM protect the company from potential political meddling, invest in energy efficiency and to take the full financial and governmental bodies that participate in the THE MARKET safeguard against nepotism, improve control over the responsibility for their energy consumption. For others the implementation of the reform poses a major threat to the The third key challenge to the gas market reform is group’s finances and guarantee that management transition is complicated because it requires evaluation of reform process. At least one member of the ruling coalition corruption. Energy sector is associated with significant decisions reflect the interests of all Ukrainians as the different consumption patterns and forecasting of future openly opposes the currently implemented reform. The capital flows and is an effective way of securing political ultimate owners of Naftogaz, not of a limited group of consumption — tasks never done before. This shift is vision of the gas market reform and its elements is not leverage and influence. Therefore, control over this sector individuals. particularly difficult against the backdrop of a struggling unified across various participants responsible for its 32 33 WHY GASWHY SHOULD GAS SHOULD BE SOLD BE SOLD AT MARKET AT MARKET PRICE PRICE Gas marketGas reform market results reform results

GAS PRICEGAS PRICE INEFFECIENTINEFFECIENT MORE GASMORE GAS GAZPROMGAZPROM SOLD SOLD LACK OFLACK FUNDS OF FUNDS ACCUMULATIONACCUMULATION GAS DEPENDENCEGAS DEPENDENCE ADMINISTRATIVELYADMINISTRATIVELY GAS CONSUMPTIONGAS CONSUMPTION IMPORTED IMPORTED FROM FROM GAS TOGAS UKRAINE TO UKRAINE AT ATTO PAY TOFOR PAY GAS FOR GAS OF DEBTSOF TODEBTS BE TO BE ON THEON AGGRESSOR THE AGGRESSOR CAPPEDCAPPED BELOW BELOW BY HOUSEHOLDSBY HOUSEHOLDS RUSSIARUSSIA INFLATEDINFLATED PRICES PRICES IMPORTSIMPORTS PAID OUTPAID BY OUT THE BY THE COUNTRYCOUNTRY MARKETMARKET LEVEL LEVEL NEXT GENERATIONNEXT GENERATION

MARKET-DRIVENMARKET-DRIVEN COMPETITIONCOMPETITION ENERGYENERGY ELIMINATIONELIMINATION DOMESTICDOMESTIC LAUNCHLAUNCH OF ENERGY OF ENERGY GAS PRICEGAS PRICEAND AND AND MARKETAND MARKET SECURITYSECURITY OF CONDITIONSOF CONDITIONS PRODUCTIONPRODUCTION EFFICIENCYEFFICIENCY THE REFORMTHE REFORM TRANSPARENCYTRANSPARENCY FOR CORRUPTIONFOR CORRUPTION INCREASEINCREASE PROGRAMSPROGRAMS

SOCIAL SOCIALJUSTICE: JUSTICE: FINANCIALFINANCIAL GAS INDUSTRYGAS INDUSTRY THE AFFLUENTTHE AFFLUENT PAY, PAY, SUSTAINABILITYSUSTAINABILITY REVIVAL,REVIVAL, NEW JOBS, NEW JOBS, THE UNDERPRIVILEGEDTHE UNDERPRIVILEGED R&D ANDR&D NEW AND NEW ARE SUPPORTEDARE SUPPORTED TECHNOLOGYTECHNOLOGY

CREATINGCREATING VALUE VALUE SUPPORTSUPPORT FROM FROM FUNDAMENTALFUNDAMENTAL FOR FUTUREFOR FUTURE THE DEMOCRATICTHE DEMOCRATIC REFORMS, REFORMS, A REAL ASTEP REAL STEP ENERGYENERGY GENERATIONSGENERATIONS WORLDWORLD TOWARDTOWARD EUROPEAN EUROPEAN INDEPENDENCEINDEPENDENCE INTEGRATIONINTEGRATION FOR UKRAINEFOR UKRAINE

34 35 STRATEGY AND REFORM

policies of the country’s political parties infrastructure. This means that retail price The citizens of Ukraine have covered this HOW MUCH SHOULD UKRAINIAN and the paternalistic expectations among for gas produced domestically should be difference through the taxes they paid to HOUSEHOLDS PAY FOR GAS? significant segments of the population. in line with the cheapest rates available for the state budget, and they will continue Instead of market rates, a sliding scale of imported gas. In the second part of this covering it while Ukraine pays out the loans cross-subsidized retail prices has been chapter, factors that drive domestic gas raised to cover this difference in the past the norm, creating an environment where production are explained. years. This burden on the state budget and corruption has flourished. the society will continue until the practice of GAS SUPPLY FOR HOUSEHOLDS: non-market pricing is ended. Despite all the difficulties, the chances of COSTS AND REVENUES a successful Ukrainian gas sector reform HOW MUCH NAFTOGAZ For over 10 years, Naftogaz paid more to are now greater than ever. It is crucial to SPENDS AND WHAT IT RECEIVES purchase gas than the price it received properly inform the public about the issues FOR SUPPLYING UKRAINIAN from consumers. Even if 100% of consumer at stake. Ukrainians need to realize that they CONSUMERS energy bills were paid, Naftogaz would still are already paying more than the market have required additional funds in order to Naftogaz covers 100% of gas needs of rate for gas in numerous indirect ways, due finance the purchase of gas for the needs Ukrainian households, including gas for to the fallacy and inefficiency of the current of households. individual use and gas for centralized heat cross-subsidy system and the burdens production for households supplied to The price of gas is one of the most hotly supplies to domestic consumers, reducing this places on the national budget. Funds Over the past decade, the negative From Ukrainian district heating companies (DHCs). debated topics in the Ukrainian society. opportunities for corruption, and creating which could otherwise be used to cover the difference between the price paid for gas This debate is complicated by populist the conditions for greater domestic gas consumers, except financing of schools, hospitals, roads and consumed by Ukrainian households (using About 60% of the required volumes is gas politics and by a lack of public awareness production (see Сreating an effective gas the low-income other vital infrastructure are being diverted gas either directly or through centralized produced in Ukraine, which Naftogaz buys about the economic realities underpinning market in Ukraine). to cover the difference between subsidized heating), and the actual cost of purchasing from its subsidiary Ukrgasvydobuvannya the gas market. Expectations for households, a successful and market gas prices for both low-income the gas, has exceeded USD 20 billion. The (UGV) at a reduced price. Supplying this gas This reform process is far from painless. unrealistically low gas prices have served families and the affluent consumers. issue has been further complicated by the results in a minor positive difference for For Naftogaz, it should result in a implementation of the as a barrier to true energy independence below-100% payment rate. Naftogaz. significant reduction in its role in the Gas sector reform does not mean of Ukraine for decades. The artificially reform requires paying domestic gas market. Other gas market abandoning support for the most low, administratively capped prices participants will have to adjust to greater market prices for gas vulnerable people. Those in need will GAS SUPPLY FOR HOUSEHOLDS: COSTS* AND REVENUES, 2014 have damaged Ukraine’s wider national transparency requirements and a more continue to receive support directly from interests and stunted the country’s they consume competitive marketplace. The reform the state. However, public funds must not bcm Revenues, Cost of sales, Revenues- economic development. process will also force the Ukrainian be used to help consumers who are quite UAH billion UAH billion cost, UAH This transition to market rates must take Ukrainians have long been dissatisfied government to abandon non-market tools capable of paying market rates for gas they billion place in a timely fashion. Previous attempts Ukrainian gas 13.9 6.7 4.9 1.8 with the lack of transparency in the as a way of finding temporary solutions to consume. have failed, in large part due to the populist Imported gas 8.2 6 26.5 -20.5 country’s domestic gas sector, which is socially sensitive energy sector challenges. Introducing market rates to the domestic Total 22.1 12.7 31.4 -18.7 widely viewed as a source of corruption BRINGING RETAIL PRICES TO MARKET LEVEL: PROMISES NO LONGER WORK gas market will not only kick start the *does not include adjustments according to IAS 2 and a key factor behind inadequate public Tymoshenko Azarov Yatseniuk development of the entire industry — it services. For many households, gas and GAS FOR HOUSEHOLDS: HOW MUCH CONSUMERS COVERED, government: government: government: will also help to eradicate corruption and USD BILLION heat consumption meters remain the reach market prices reach market prices reach market prices prevent suppliers such as Gazprom from exception rather than the rule. in 3 years by 2012 in 2.5 years by May 2013 in 2 years by May 2017 6 500 using energy prices as a political weapon. 5.1 The sale of gas at prices below the market USD 16.4 billion USD 15.5 billion USD 17.5 billion IMF program IMF program IMF program There are two constituents to determining 5 rate has necessitated a policy of state 4.7 400 what the retail gas price should be. First, it subsidies that has drained funds and is hardly debateable that the price of gas 4 prevented Naftogaz from addressing 3.8 should cover the cost of its purchase and other strategically important issues. Years 300 3.2 delivery to the consumer. The first section 3.6 of underfunding have also resulted in a 3 3.2 2.7 of this chapter looks at these costs and 2.1 2.4 decrease in the volume of gas produced by 2.3 200 explores the expenditures and revenues 2.1 Naftogaz. 2 1.6 0.8 of Naftogaz related to the supply of gas to 1.6 1.7 0.6 1.0 Retail gas prices for households, USD/tcm 1.7 Ukraine’s energy sector requires urgent households. 1.0 1.0 0.4 0.1 1.6 1.5 1.5 100 1 1.3 1.5 1.6 and fundamental reform. Naftogaz is 0.4 0.3 1.1 1.6 The second constituent in determining fair 1.0 currently carrying out far-reaching reforms gas prices for households is the notion 0.6 0.7 designed to introduce European standards 0 0 that the price should be set by supply 2005 2007 2009 2011 2013 2015F to the domestic gas market. Key goals 01.2007 11.2008 09.2010 03.2015 05.2017 and demand, provided that all suppliers 2003 2006 2008 2010 2012 2014 include establishing a framework for Covered by the state or loans have a non-discriminatory access to the reliable and economically sustainable gas Actual prices Government obligations within IMF program Covered by consumers (given 100% payment rate) 36 37 STRATEGY AND REFORM

The company’s deficit is formed by offset the losses incurred in supplying gas Finally, in April 2017, the prices should heating) at the weighted average price of GAS SUPPLY FOR HOUSEHOLDS: COSTS AND REVENUES, 1Q 2015 supplying the remaining 40% of gas to households. become completely unregulated in all UAH 2 834/tcm or USD 131/tcm. bcm Revenues, Cost of sales, Revenues- for households. This gas is imported at segments of the market. This will make UAH billion UAH billion cost, UAH Gas is Ukraine’s largest type of imports The weighted average purchase price market rates. By selling it to consumers at supplying gas to households financially billion by value, and it is a significant factor of imported and Ukrainian gas for a discounted price, Naftogaz loses more attractive for non-state traders. Naftogaz Ukrainian gas 3.2 1.1 1.9 0.8 affecting the country’s balance of Naftogaz is forecasted at UAH 3 120 or than it earns in trading Ukrainian gas. In will face the competition in this market Imported gas 5.4 22.9 3.6 -19.3 payments. The foreign exchange USD 144/tcm. The price for UGV gas is set 2014, for Naftogaz the negative difference from other suppliers from Ukraine and Total 8.6 24.0 5.5 -18.5 reserves of the National Bank of Ukraine at UAH 1 590/tcm and covers nearly 60% of between the cost of sales and revenues abroad. At the same time, UGV will be in January-February 2015 dropped to the total needs of households. The price of FINANCIAL RESULTS OF SUPPLYING GAS FOR HOUSEHOLDS related to supplying gas for households, able to sell its gas at market prices, a 10-year low. The hryvnia reached a imported gas is forecasted at USD 250/tcm IF 10% OF GAS WERE SOLD AT MARKET PRICE, 1Q 2015 amounted to UAH 18.7 billion. The deficit invest in increasing production, and rate of UAH 30 per USD. Ukraine faced or UAH 5 424/tcm at UAH 21.7 per USD. caused by supplying imported gas to become one of the largest taxpayers in bcm Revenues, Cost of sales, Revenues- an acute risk of underfunding not only this category of consumers was 11 times Ukraine. GAS DEMAND BY UKRAINIAN UAH billion UAH billion cost, UAH essential gas purchases but also other greater than the positive difference from HOUSEHOLDS billion budget expenditures, including public WHAT IS INCLUDED IN RETAIL trading gas produced in Ukraine. sector salaries and pensions. Naftogaz GAS PRICE FOR HOUSEHOLDS? It is estimated that the households will Gas sold at subsidized prices, 90% 19.9 28.3 11.4 -16.8 Gas supplied directly to households and to deficit became comparable to the state consume nearly 21.3 bcm of gas for heating Naftogaz receives from 60% to 70% of the of the total volume DHCs for producing heat for households budget deficit. In this situation, raising and cooking in the gas year from 1 April Gas sold at market price, 10% 2.2 3.1 11.2 8.1 post-tax total gas prices paid by Ukrainian account for nearly 70% of Naftogaz gas gas prices for households — the largest 2015 to 31 March 2016. Naftogaz expects of the total volume households. sales by physical volume. In 2014, retail gas consumer of gas in Ukraine — was to purchase 12.8 bcm of this volume Total 22.1 31.4 22.6 -8.8 prices for these categories were up to 10 unavoidable. In the current gas year (from 1 April 2015 to domestically at a price below the market times below the market price. 31 March 2016), Naftogaz is selling gas for rate, and to import the remaining 8.5 bcm RETAIL GAS PRICE (NET OF TRANSPORTATION, In February 2015, Ukraine secured households (for direct use and centralized at market prices. DELIVERY AND TAXES), UAH/TCM, 2014 Naftogaz uses foreign currency to import international funding necessary to cover 7 000 gas and sells it in hryvnia. Therefore, the urgent budget needs and to stabilize POST-TAX TOTAL GAS PRICE VS. GAS PRICE RECEIVED BY NAFTOGAZ when the hryvnia depreciated and the the hryvnia. The government managed to Received by gas Sales volumes retail prices set by the regulator were not negotiate with the creditors the mildest Received by 6 000 5 900 by category transportation, Received by Naftogaz adjusted accordingly in time, Naftogaz possible terms for the pace of the gas the state distribution and Industry and other budget 5 000 ~30% losses significantly increased. In 1Q 2015, prices deregulation. supply companies (9.1 bcm) when the national currency was extremely Ukraine committed to a three-stage 4 000 volatile, the deficit of Naftogaz from process of moving from cross-subsidies Paid by consumers supplying gas to households amounted to for all households to unregulated (post-tax total price) 3 000 USD 18.5 billion and almost matched the Public sector and DHCs retail gas prices combined with direct for public sector deficit for the entire 2014. 2 000 subsidies to the vulnerable consumers PRICE RECEIVED BY NAFTOGAZ AND POST-TAX TOTAL PRICE, ~70% If just 10% of gas for households were sold who cannot afford market prices for gas. Households (22.1 bcm) STARTING FROM 2Q 2015 1 000 DHCs for households (weighted-average) to the richest consumers at full market 710 In spring 2015, gas prices for households 580 price, and the remaining 90% continued were raised to cover nearly 60% of the 0 to be subsidized, Naftogaz revenues from DHCs for households 1 803 2 994 32% Weighted market rate on average. 01.14 07.14 12.14 this segment would increase by more than average price for UAH 10 billion. This would cover more In April 2016, gas prices for households Reduced price 2 167 3 600 41% Naftogaz: GAS SOURCES FOR NAFTOGAZ than half of the deficit. It is estimated that will be set to cover nearly 75% of the for households UAH Ukrainian gas subsidies may be necessary for nearly 45% market level. This will make gas trading supplied exclusively of households. for Naftogaz deficit-free but the price for Full price 2 834/tcm 5 042 7 188 27% to Ukrainian households UGV gas will still be capped below the for households (13.9 bcm) The volume of gas Naftogaz sources from market rate. UGV at administratively capped prices 0 4 000 8 000 covers only 40% of the company’s total ~40% traded volume. The positive balance related STRUCTURE OF RETAIL PRICES FOR GAS FOR HOUSHOLDS, UAH/TCM to UGV gas does not cover the losses Full price Reduced price Price for DHCs for ~60% related to imported gas for Naftogaz. Imported gas Ukrainian gas available households supplied to households, Other categories of consumers (industry, Post-tax total price 7 188 3 600 2 994 DHCs for households to Naftogaz at low price incl. 20% VAT 1198 600 499 and other consumers public sector and other institutions) pay is not sufficient to cover incl. 4% special tax to the state budget 202 87 36 (17.3 bcm) prices that cover the cost of imported gas. the needs of households incl. costs of transportation, delivery and supply to the consumer 746 746 656 Naftogaz has a positive balance with these in gas and heat Price of gas received by Naftogaz (UAH/tcm) 5 042 2 167 1 803 consumers but it is not sufficient to fully Share of total gas sold for households at each rate 27% 41% 32% 38 39 STRATEGY AND REFORM

HOW MUCH GAS WILL According to the Ukrainian legislation, Naftogaz, the price of this gas is UAH 3.75 CONTRACTION OF VOLUMES OF DOMESTICALLY PRODUCED GAS revenue. In 2014, Naftogaz had to find HOUSEHOLDS NEED?* any company in which the state directly billion, a figure which is reflected in the AVAILABLE TO NAFTOGAZ FOR SUPPLY TO HOUSEHOLDS* sources to both finance gas purchases Consumption volumes or indirectly owns 50% must sell all of its financial statements of Naftogaz for 2012- for the next winter and cover its 20 18 Households DHCs Total marketable gas monthly to Naftogaz in 2013 and 2014. This assessment is based 18 17 maturing loans. 17 16 16 14.5 6.8 21.3 order to meet the needs of the Ukrainian on prices set by the national regulator for 15 15 14 IS IT POSSIBLE NOT TO PAY Sources of gas households. Before the new gas market the relevant period. Since the beginning of 15 13 FOR GAS IF FUNDING IS Ukraine Import Total legislation comes into effect, the sales price 2012, Naftogaz is not buying gas produced DIFFICULT TO FIND? 12.8 8.5 21.3 for each such producer are established by by Ukrnafta. *forecast for 12 months starting from 1 April 2015, bcm the National Energy and Utilities Regulatory 10 It is technically possible, but eventually In the first years of Ukraine’s WHY DOES UKRAINE NOT USE Commission. the payment must be made in some independence, all gas was produced by ALL OF ITS DOMESTICALLY alternative way. Conscious of the fact Marketable gas is defined as total state companies. Since 2000, some state 14 14 14 15 14 14 14 13 13 13 PRODUCED GAS TO MEET THE 5 that Ukraine had no choice but to buy produced gas less the volumes used in gas assets have been sold or transferred NEEDS OF HOUSEHOLDS? gas from Gazprom, Russia periodically production and mainitenance of the gas to private producers in return for allowed Naftogaz to receive gas “on In accordance with Article 13 of the producer (within norms) as well as volumes commitments to invest. Naftogaz can now 0 credit”. As a result, Ukraine was often Ukrainian Constitution, Ukraine’s subsoil of gas used for refinery and processing. buy only about 2/3 of gas produced in 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015F confronted by excessive gas bills at belongs to the people of Ukraine. In order Ukraine at reduced prices for the needs of UGV Ukrnafta Chornomornaftogaz In the result of the occupation of prices that were sometimes two times to take advantage of these resources and the households. The remaining volumes the Crimea, Naftogaz does not *According to Ukrainian gas market legislation higher than the price at which Gazprom deliver them to end consumers, investments are produced by private companies, who currently receive marketable gas sold gas to its European customers. are required. The state provides gas sell this gas at market prices to industrial Because of the need to keep the sales IS IT POSSIBLE TO FINANCE from Chornomornaftogaz. In 2015, all producers with the right to develop mineral consumers. price for domestic state-owned producers THE PURCHASE OF GAS FROM Knowing that the Ukrainian authorities marketable gas for households was resources in the form of licenses, and, in low in order to ensure low gas prices for OTHER SOURCES? had driven themselves to a standstill, delivered by UGV only. This change occurred for two reasons. addition to the ordinary income tax, it also the households, the state had no money Russia used this situation to secure The first factor, hardly doubted by the The limit on prices is set by the state, charges royalties. This royalty is transferred A separate note is required for gas to extract this gas. This gas cannot be political dividends such as the public, was corruption. It is likely that so the difference between the real cost to the state budget and is then spent on produced by Ukrnafta. According to simply taken away from private producers prolongation of the agreement allowing some of the proven deposits discovered of gas and its price for consumers is, social needs such as pensions, wages legislative amendments adopted in June and given to the Ukrainian citizens at low Russian military forces to remain on by the state companies passed into by law, covered by the state budget of and defense. The royalty level for UGV is 2011, Ukrnafta has no marketable gas to cost. If such measures were attempted, Ukrainian territory, forcing Ukraine’s private hands at a price much lower than Ukraine. currently set at 70% of revenues. sell to Naftogaz for resale to households. Ukraine would lose not only gas which rejection of the European integration, the fair market value. Furthermore, the Instead, some of the gas produced by is too expensive for the state companies Historically, this compensation was and the transfer of a portion of beneficiaries of such arrangements still Ukrnafta is designated as gas used for to extract, but also the support from the not always timely received from the Ukrainian sovereignty under the terms have their representatives in the Ukrainian processing in production of ammonia at international community. state, so Naftogaz often had to search of the customs union with Russia. By paying the royalty, gas parliament and can hinder market reform the leased facilities of Dnipro Azot. The use for other sources of money to buy through them. The solution to this problem Instead of investing billions of dollars in producers pay the people of this gas for households would require gas for households. The deficit also is the adoption of a law that will force the replacing boilers, installing meters and changes to the current legistlation. accumulated in the form of foreign of Ukraine for the use of final beneficiaries to reveal themselves, For many years prior insulating buildings, for years Ukraine currency loans raised by Naftogaz over Naftogaz and Ukrnafta have varying as well as independent investigations of paid Gazprom. This situation must the subsoil. Gas produced to 2014, the policy of a number of years. The company had opinions regarding the proper execution all suspicious cases of gas asset transfers change. Those who can afford to pay the to pay out most of these international in the result of these of the transfer and payment for 10.1 bcm from the state to private producers. providing “cheap” gas full market price for gas must pay it. loans, including Eurobonds with of marketable natural gas produced by activities belongs to the The second reason is less obvious to the to all households while interest, in 2014, resulting in cash WOULD THE DEFICIT Ukrnafta and consumed by the households public. Extraction of gas requires constant outflow of more than UAH 20 billion. PROBLEM BE SOLVED gas producers between 2006 and 2011. According to subsidizing it via the investment. In the past decade, because BY THE LIQUIDATION Another method used to finance the of the populist, and sometimes corrupt, state budget has been OF NAFTOGAZ? purchase of gas for households during DOMESTICALLY PRODUCED GAS AVAILABLE TO NAFTOGAZ COVERS policy of keeping the retail gas price at too heavy a burden for the past years was receiving advance In 2014, Naftogaz administrative costs APPROXIMATELY 60% OF HOUSEHOLD NEEDS artificially low levels, state enterprises Ukraine. However, the old payments of transit fees from Gazprom. including salaries of employees, the 35 32 bcm were unable to invest enough money in 28 28 This method was used in 2010 and cost of international legal support, audit 30 25 26 26 26 25 gas production. government lacked the 22 2012, and the money was spent for and valuation services, rental costs, 25 19 21 20 17 18 17 18 17 17 17 To stimulate gas extraction in Ukraine, political will to publicly the purchase of gas from Gazprom in utilities and other expenses amounted 15 14 15 some fields were sold to true investors, admit this and begin to the same periods. As a result, in 2014 to nearly UAH 0.5 billion. This amount 10 18 18 often foreign, who have been investing Naftogaz did not receive cash payments corresponds to approximately 12 hours- 17 17 16 16 15 15 14 5 13 into the development of these assets for reform the market — for the transit of Russian gas to Europe worth of gas consumed by Ukrainian many years and have achieved a significant until October. consumers in January 2015. 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015F* because it would require Imported gas supplied by Naftogaz for households increase in gas production. In many cases As a result of these practices, the Despite the devaluation of the hryvnia Domestically produced gas available to Naftogaz these were geologically complex fields with fundamental changes in Demand by households (direct use and for central heating) illusion of “cheap” gas for households in 2014, administrative expenses of high extraction costs. Demand by households (direct use only) *forecast for 12 months starting from 1 April 2015, bcm 40 the government itself was generated by spending future Naftogaz remained at the same level as 41 GAS SUPPLYGAS SUPPLY FOR HOUSEHOLDSFOR HOUSEHOLDS CurrentCurrent retail prices retail pricesdo not do fully not cover fully Naftogazcover Naftogaz ForecastForecast for the periodfor the fromperiod 1 Aprilfrom 20151 April to 2015 31 March to 31 2016*March 2016* costs tocosts supply to supply gas for gas households for households

GAS VOLUMESGAS VOLUMES POST-TAXPOST-TAX TOTALTOTAL GAS GAS GAS SOURCES,GAS SOURCES, PURCHASE PURCHASE RESULTSRESULTS TOTALTOTAL FOR HOUSEHOLDSFOR HOUSEHOLDS TOTALTOTAL PRICES PRICESVOLUMESVOLUMES CONSUMED CONSUMED AND SALESAND SALESPRICES PRICES

2.5 2.5Cooking andCooking and Weighted Weighted Purchase Purchase Revenues Revenues bcm bcmwater heatingwater heating average average price, UAH/tcmprice, UAH/tcm Cost of salesCost of sales sales price, sales price, UAH/tcm UAH/tcm Heating aboveHeating above 7UAH/tcm 1887UAH/tcm 188 12.8 12.8 the social normthe social norm bcm bcm 3.3 3.3 of marketableof marketable bcm bcmof 200 cubicof 200 cubic POSITIVE POSITIVE Ukrainian gasUkrainian gas 42.542.5 meters per metersmonth per month BALANCE BALANCE available available on supplyingon supplying to Naftogazto Naftogaz Ukrainian gasUkrainian gas 2 834 2 834 DEFICIT DEFICIT 14.514.5 20.420.4 bcm bcm 1 590 1 590 for direct usefor direct use by householdsby households Heating withinHeating the within the social normsocial of 200 norm of 200 8.7 8.7cubic meterscubic per meters per 3 6003 600 bcm bcm UAH/tcm UAH/tcm 6.16.1 month month 21.321.3 bcm bcm UAHUAH billion billion of gas necessaryof gas to necessary to cover the needscover ofthe needs of householdshouseholds and and 17.917.9 DHCs to produceDHCs to produce gas for householdsgas for households8.5 8.5 bcm bcm of importedof imported 2 834 2 834 NEGATIVE NEGATIVE gas gas BALANCE BALANCE on supplyingon supplying 46.146.1 imported gasimported gas 6.7 6.7 bcm bcm 2UAH/tcm 9942UAH/tcm 994 for DHCs tofor produce DHCs to produce 5 425 5 425 heat for householdsheat for households

*Assumptions: *Assumptions: USD 250/tcm USD weighted 250/tcm average weighted price average for imported price for gas; imported UAH 21.7 gas; per UAH USD 21.7 exchange per USD rate. exchange rate. Abbreviations:Abbreviations: UAH/tcm — UAH/tcm hryvnia per— hryvnia thousand per cubic thousand meters cubic meters

in the previous year. This is a significant In the overall structure of Naftogaz gas for the consumers. Additional (UAH 11 billion) on taxes (see Management would neither bring any noticeable structure will need to exist in order achievement, taking into account the expenses as a stand-alone company 21% (UAH 39 billion) was spent on review of financial statements). savings to consumers nor improve the to buy gas at market prices and sell it fact that in 2013 the company did in 2014, the administrative costs payments on debt generated in the situation. at cheaper rates to the households, Liquidating Naftogaz without the not pay for the international audit or amounted to less than 0.32% of cash previous years. Approximately 6% (UAH receiving compensation from the state implementation of the gas market As long as the state subsidizes gas for for legal services in arbitration with spent. In 2014, 66% (UAH 119 billion) 11 billion) of funds was spent to pay budget to purchase gas at market prices reform and deregulation of retail prices households, Naftogaz or another similar Gazprom. of cash payments was spent on buying for gas transmission, and another 6% again. 42 43 STRATEGY AND REFORM

COST OF GAS PRODUCTION DEPENDS ON WELL TYPE, USD/TCM obtaining relevant licenses, exploration and MARKET-BASED PRICING drilling 2 to 3 years prior the anticipated 400 250-350 FOR UKRAINIAN GAS 300 180-280 start of production at the well. Not 200 every drilled well is productive, even if 50-80 100 25-30 research has determined that chances are 0 Conventional gas Conventional gas Tight gas reservoirs Shale gas reasonably high. Some newly drilled wells from existing wells from new wells within new deposits (estimate) will not be successful. within developed deposits To drill new wells, the company has to invest appropriately. The investment enjoy the benefits of more reasonable Market mechanisms thus determine the needs depend on the type of the field, the government spending and of the price of gas, resulting in the maximum depth of the productive strata, and other If retail prices in effect since spring 2015 expand production, and procure goods finance utility subsidies following the economic growth, including the growth economically justified level of gas geological and technical conditions. The were introduced at the time when the and services from the local economy. price increase. In the case of imported of the gas industry. production within the country and reducing company management decides if they exchange rate was nearly UAH 11 per USD, gas, Ukraine cannot collect royalties from the share of imported gas to the minimum should acquire new licenses, explore and The state can regulate the portion of By moving from cross-subsidies for all the current prices would cover the foreign gas producers; the money paid for reasonable level. drill wells depending on the forecasted revenues it extracts from national gas households to targeted direct subsidies full market price of gas, including gas this gas leaves Ukraine. price at which this gas will be sold. producers balancing its current financing for the underprivileged, the government Costs associated with extracting gas differ produced by UGV. By this time, new needs with longer-term investment Another positive effect of charging will be able to increase funding for depending on deposit and well types. A higher sales price allows producers to go suppliers would be competing in gas plans of the companies. For instance, market prices for Ukrainian gas is the other important projects, for instance, after gas with higher extraction costs. This, supply to households and the state-owned Extracting conventional gas from existing in 2014, the royalties amounted to redistribution of wealth from wealthy ensuring 100% gas and heat metering, in turn, increases gas production volumes. gas producer might well be discussing wells does not require substantial capital 20% of the selling price, while in 2015 citizens to the vulnerable through as well as energy efficiency programs. terms with international investors. investment: USD 25-35/tcm may cover the It is considered economically justifiable they were increased to 70% for UGV targeted state subsidies. Citizens whose If this shift is accepted by the society, it associated costs. However, these wells have for a country that imports gas to develop At the current exchange rate of nearly in order to provide the state budget financial means allow them to pay will have a legitimate reason to demand a limited operating period as the rate of fields where extraction costs are even USD UAH 22 per USD, gas prices for households with a guaranteed source of funding to market prices for gas they consume will improvements in the quality of state extraction declines over time. 1 less than the cost of imported gas. The cover just over a half of Naftogaz expenses governance at all levels. excess earnings generated from low-cost associated with the purchase of this gas. In order to increase output of such a well, WHAT WOULD CHANGE IF UKRAINIAN GAS WERE SOLD COST OF GAS PRODUCTION IN extraction can be redirected to the state The price paid for UGV gas, after 70% the producer may install a compressor AT MARKET RATES IN 2014? UKRAINE budget by means of licensing fees, royalties royalties and other taxes, hardly covers the station to pump the gas from the or other taxes and fees. company’s operating expenses and does not IN 2014 NAFTOGAZ BOUGHT IF THE UKRAINIAN GAS WAS PRICED There is a common belief in Ukraine that underground deposits or implement other allow for the exploration of new deposits. AT MARKET RATES IN 2014, NAFTOGAZ retail price of gas should be linked to its measures, all of which require additional Deregulation of prices for gas stimulates 13.7 19.3 WOULD PAY UAH 51 BILLION MORE TO production cost rather than determined by investment. Eventually the well will be the development of the maximum number If Ukrainian gas is sold at market rates, bcm bcm THE LOCAL PRODUCER supply and demand. In reality, the average depleted to such a degree that additional of fields where extraction is economically several important benefits arise for of Ukrainian of imported gas gas cost of production ultimately depends on measures aimed at increasing production justified, and thus maximizes tax revenues Ukrainian citizens. Firstly, UGV will be able of this amount: 42% 58% additional the expected selling price of the extracted are no longer economically justified. to the state budget. to modernize and expand its production UAH 37 billion would gas. The higher the expected selling price which will lead to an increase in output be paid to the state When this happens, the only way to Limiting domestic gas prices at around net of taxes, the more money is available in 2-3 years. Therefore, the need for budget (assuming 70% maintain the production volumes is the cost of extraction from existing wells royalty rate) to invest in production, and the more gas is imported gas will decrease. This in turn switching to new wells. To have such wells will negatively impact decisions to drill subsequently extracted. will lead to a reduction in the demand for NAFTOGAZ PAID FOR THIS GAS additional 58% available in time, a company must invest in new wells, despite the fact that the gas foreign currency to pay for the imported UAH 6.0 billion UAH 85 billion UAH 20 billion would In a competitive market where a portion of commodity. As a result, the pressure on to UGV to foreign be received by UGV gas is imported, the price of domestically OPTION 1: PRICE FOR DOMESTIC GAS AT THE LEVEL OF IMPORTED suppliers and invested in gas 6% GAS PRICE, USD/TCM the exchange rate will be reduced. production in Ukraine produced gas is limited by the lowest 250-350 94% price of imported gas. Should a domestic 350 The money that Naftogaz pays for producer set the price above that of 300 180-280 Ukrainian gas remains in the country RESULTS: Imported gas price imported gas, consumers will purchase 250 and continues to benefit the Ukrainian 1. Affluent citizens support the disadvantaged: the imported gas. 200 economy. The state budget receives a of this amount: of this amount: state budget receives additional funding to finance portion of this money in the form of Similarly, in a competitive market, if a 150 UAH 2 billion returned UAH 0 returned to the subsidies, pensions and other social needs 50-80 to the state budget of state budget of Ukraine 100 royalties and taxes which, in turn, can 2. Growth of local gas production and reduction consumer offers to pay less than other Ukraine as royalties and as royalties and taxes 25-30 be used to finance subsidies, install buyers, the supplier will sell its gas to 50 taxes of gas imports share within 2-3 years of new gas meters and fund energy efficiency investment consumers who are willing to pay more. 0 Conventional gas Conventional gas Tight gas reservoirs Shale gas UAH 4 billion was spent UAH 85 billion was programs. In this way, the price is ultimately set at from existing wells from new wells within new deposits (estimate) by UGV in Ukraine to paid abroad and will 3. The state regulates the share of revenues paid as within developed cover its expenses not benefit Ukraine’s royalties: 20% in 2014, 70% in 2015 a compromise level acceptable for both deposits The remainder of the money is spent by economy Development consumers and suppliers. economically the producers to create jobs in Ukraine, Maximum possible tax revenues for the state budget Note: less than 1% of the total retail price is directed to cover Naftogaz expenses other than gas purchase unjustified 44 45 STRATEGY AND REFORM

production costs are times lower than These loans and associated interest STATE ASSISTANCE TO AN AVERAGE HOMEOWNER OPTION 2: PRICE FOR DOMESTIC GAS AT THE LEVEL those of private enterprises working in will have to be paid back by the current ASSUMPTIONS: OF EXTRACTION COST FROM EXISTING WELLS, USD/TCM similar geological conditions. generation of Ukrainians and their children. Heated area, square meters: 90 250-350 Number of residents: 4 350 Strikingly, the same populists who are UGV cost of drilling — one of the largest 300 180-280 campaigning for cheap gas have earned Consumption norms Imported gas price cost factors in gas production — is three Heating, cubic meters of gas per 1 square meter of heated area per month: 3.6 250 huge fortunes in gas trading, often serving Cooking and warming water, metered, cubic meters of gas per 1 person per month: 9 times lower than the average among as intermediaries between Ukraine and Consumed volumes per year, cubic meters: 2 700 200 private gas producers in Ukraine and 4.6 Gazprom. 150 times lower than that of producers in GAS EXPENSES, UAH PER YEAR 50-80 100 25-30 other European countries. WHO BENEFITS MOST FROM RegulatedРегульована gas цінаprice 50 CHEAP GAS? 30 000 It takes UGV 9 months to drill a 4 500 m 0 11 000 Conventional gas Conventional gas Tight gas reservoirs Shale gas well with the obsolete and unreliable A World Bank report shows that the richest 20 000 from existing wells from new wells within new deposits (estimate) 21 000 21 000 within developed equipment currently available to Ukrainians receive on average twice as much 10 000 10 000 deposits Development the company. Private Ukrainian gas state aid in the form of cheap gas as the 0 4 800 4 800 4 800 economically Retail gas prices Retail gas prices Market-based Maximum possible tax revenues for the state budget producers drill such wells in 3 months poorest. According to research and data unjustified as at May 2014 as at May 2015 gas prices and foreign companies can drill to similar of Naftogaz, this gap may in fact be much depths in 1.5 months. larger. Covered by the state through cross-subsidizing gas price (support to both rich and poor consumers) COST BENCHMARKING: WELL DRILLING, USD/M Covered by the state through direct subsidies (support only to vulnerable consumers) UGV’s selling price net of 70% royalty is Average Ukrainian families live in homes up Paid by the consumer Romania slightly higher than USD 20/tcm. Such to 100 square meters large and consume STATE ASSISTANCE TO A LARGE PROPERTY OWNER Netherlands revenues can hardly cover the operating an average of 2 500-3 000 cubic meters of costs associated with the functioning gas per year. The difference between the ASSUMPTIONS: Poland wells. Private gas producers receive full price of gas and the prices that were Heated area, square meters: 588 Number of residents: 6 Kazakhstan up to USD 130/tcm net of royalties for seen on household bills before 1 April 2015, their gas. Even at this level, most of the averaged UAH 21 000 per year (marked in Consumption norms Australia Heating, cubic meters of gas per 1 square meter of heated area per month: 7 private companies have announced a blue on the chart). Cooking and warming water, cubic meters of gas per 1 person per month: 18 Oman reduction in their investment programs. When the transition is made to the full Consumed volumes per year, cubic meters: 30 108 For comparison, in the second quarter Columbia market prices, low-income families become of 2015 Ukraine imported gas at about GAS EXPENSES, UAH PER YEAR eligible for the same amount of targeted Private producers in Ukraine USD 268/tcm. 300 000 subsidies from the state (marked in green 80 000 UGV If pricing and taxation policies for the on the chart). 200 000 180 000 0 500 1 000 1 500 2 000 2 500 largest gas producer in Ukraine are not 290 000 Wealthy people tend to live in much larger 100 000 210 000 © 2015 IHS revised, the development of new fields properties, and their large estates can use 110 000 by UGV will be impossible. Without over 30 000 cubic meters of gas per year. 0 Retail gas Retail gas Market-based extracted from them would be cheaper investments, the total production volume DRILLING TIME FOR Accordingly, through cheap gas these prices as prices as gas prices than imported gas. As a result, the state of UGV (including its joint ventures) will at May 2014 at May 2015 A 4 500 M WELL affluent consumers receive nearly 10 loses a significant amount of tax revenue decrease from about 15 bcm in 2014 to Covered by the state through cross-subsidizing gas price months times more of state aid than the average Paid by the consumer and spends more money on gas imports. 10 bcm in 2020. The weighted average 9 consumer. cost of extracted gas will remain low but THE LOW UGV COSTS SET STATE ASSISTANCE TO RESIDENTS OF A LARGE PROPERTY Ukraine will spend much more money on In addition, wealthy families sometimes ALARM BELLS RINGING VS. AN AVERAGE HOME purchasing imported gas than it could own several properties, which exponentially For a certain period of time, a company’s have done. increases the amount of state aid they Covered by the state through cross-subsidizing gas price for everybody Covered by the state through direct subsidies to vulnerable consumers costs can be kept down if it relies receive. After the transition is made to full UAH “CHEAP” GAS FOR EVERYONE exclusively on existing wells and does not market prices for gas, wealthy consumers 180 000 IS TOO EXPENSIVE FOR UAH UAH make necessary investments to prepare will not be eligible for subsidies and will have per year UAH UKRAINIANS 21 000 21 000 new wells. However, within a few years, to cover the full value of gas they consume. per year 0 per year per year ̴3 such a policy will inevitably lead to a Over the years, the illusion of cheap When the reform is fully implemented, decrease in production. Ukrainian gas was touted by populist the state support will only be provided to politicians, while at the same time they ̴1.5 Because gas prices for households those people who cannot afford paying the drained the state budget and took on in Ukraine were kept absurdly low, market price. The remaining funds should Situation prior to 1 April 2015 Target outcome billions of dollars in loans to cover the UGV, Ukraine's largest gas producer, be allocated to modernize heating systems, UGV Private International difference between the actual cost of RAISING RETAIL PRICES FOR ALL AND PROVIDING DIRECT SUBSIDIES has been compelled to implement insulate buildings and boost gas production producers good gas and the prices people saw in their FOR THE UNDERPRIVILEGED IS NECESSARY SO THAT THE STATE DOES in Ukraine practice such a detrimental policy for years. Its in Ukraine. bills. NOT SUPPORT THE RICH AT THE EXPENSE OF THE REST 46 47 STRATEGY AND REFORM

CORPORATE GOVERNANCE OVERVIEW

Supervisory board Inspection (SFI) service, conducts control Three of them have been approved by the over the activities of Naftogaz on a daily Energy Ministry and formally appointed The function of monitoring the activities basis. The company has allocated separate as members of the executive board by the of Naftogaz is formally assigned to the permanent rooms for officials of the SFI Cabinet of Ministers. The other four top supervisory board. However, since 2005 within its offices. managers have responsibilities similar to this body has been controlled by the those of the board members. However, Energy Ministry. The supervisory board is According to the statutory documents of they have not been appointed to the comprised of three officials from the Energy Naftogaz, the examination of the company executive board. Ministry, seven employees from six other financial and operating activities should ministries, and a representative of the State be carried out by the revision commission Engaging top managers who possess 2014 was a transformational year for CORPORATE GOVERNANCE: capital and to approve important Property Fund. appointed by the GM for a term of five skills and qualifications required to deal Naftogaz. Changes in the company's CURRENT STATUS AND transactions (including transfer of assets). years and consisting of five members. with the issues now facing Naftogaz is activities were mainly the result of CHALLENGES Furthermore, within the framework of This structure makes the supervisory board The current members of the revision a major challenge for the group. The the dedicated professionalism of the the government, the Cabinet of Ministers dependent on the political influence and The current system of corporate commission were appointed in October matter is further complicated by the fact new management, who took on the formally has superiority over the Energy prone to conflicts of interest. The regulatory governance at Naftogaz is a legacy of 2013. The commission is comprised of that currently Naftogaz cannot offer a responsibility for solving the numerous Ministry. As a result, decisions regarding or social functions these ministries perform the past, when the company was used representatives of the Energy Ministry, the competitive remuneration comparable to challenges that have accumulated at Naftogaz activities have often been based in the government may contravene as a tool to provide social benefits and National Energy Regulation Committee, that in the private sector to executive board Naftogaz during many years. on orders and exposed to the political business goals of Naftogaz or the interests redistribute state budget funds. It was the SFI and the Ministry of Revenues and members and other senior managers. influence of the Cabinet of Ministers. of the citizens of Ukraine as the ultimate However, the current format of also an instrument of political influence. Duties. Because the head of the revision Following the Revolution of Dignity, the owners of the company. corporate governance is far from Since the founding of Naftogaz, a The current vagueness in the definition commission has been dismissed from group succeeded in attracting a number perfect: the national reform of the gas significant share of both internal and of the ownership structure raises the risk In addition to these structural concerns, the the Energy Ministry, meetings of the of executives and other highly qualified market requires clear and transparent external issues related to the group’s that management of Naftogaz will act supervisory board of Naftogaz is currently commission cannot be held at present time. employees who are motivated by the desire mechanisms of interaction between the operations is directly regulated by the in the interests of the government and, not operational. The current composition to implement the much-needed reforms in The management of Naftogaz has applied company, the ultimate owners (Ukrainian parliament and the government. consequently, certain political groups, of the board was approved in August the Ukrainian gas market. However, there to the Energy Ministry with a request to citizens), and their representatives instead of acting in the interests of the 2013. Most of its members, including the is a high risk that Naftogaz will not be able Owners of Naftogaz terminate the current revision commission (the Cabinet of Ministers and related Ukrainian people. In fact, the citizens of chairman, have since been dismissed from to retain these employees, especially if the and reform this function in Naftogaz in ministries). Naftogaz is a national joint-stock Ukraine have no direct impact on the their positions in the government. As a government forgoes its commitment to line with the OECD principles of corporate company, and the people of Ukraine are, operations and strategy of the company result, no supervisory board meetings conducting fundamental reforms. Taking into account the social and governance, in accordance with the action in essence, the ultimate shareholders because they cannot participate in general convened in 2014 or 2015. Recently, issues economic importance of Naftogaz plan of the gas industry reform approved Approving contracts with the executive (owners) of Naftogaz. In turn, the Cabinet shareholder meetings or influence the within the responsibility of the board have operations, it is essential that the group’s by the government in March 2015. board members and determining their of Ministers and the Ministry of Energy supervisory board in any meaningful way. been resolved in practice by the GM. management and supervisory board are remuneration is the exclusive competence and the Coal Industry (the Energy To improve internal controls over appointed and operate independently General meeting of shareholders The management of Naftogaz has applied of the supervisory board of Naftogaz. Ministry) are the government agencies its operating activities, Naftogaz has based on professional merits rather than to the Energy Ministry with a request to The terms of contracts with the current that are responsible for representing The general meeting (GM) of shareholders established a new internal audit department, their affiliation with political groups. terminate the current supervisory board members of the executive board have the citizens' interests in the company. is responsible for approving the strategy subordinate directly to the Chairman of the and elect a new board following the not been approved. The terms of the The reform of the Ukrainian gas market However, in practice, these two public of Naftogaz, appointing and dismissing executive board (Chief Executive Officer, implementation of the OECD principles employment contract with the CEO have is possible only with an adequate bodies act as owners of Naftogaz and, board members and management, as CEO). To ensure independent review of the of corporate governance in Naftogaz, in been approved by the Energy Ministry. transformation of Naftogaz as its largest for management of Naftogaz, they act as well as approving the annual report and company activities, the management has accordance with the action plan of the player. Therefore, improving the system direct superiors. budget of the company. In practice, the conducted an open tender and engaged The Cabinet of Ministers and the Energy gas industry reform approved by the of corporate governance of the company Energy Ministry performs the functions of Deloitte to conduct regular reviews of stand- Ministry have the ability to influence In the statutory documents of Naftogaz, government in March 2015. is a key element in efforts to reform the the GM. alone and consolidated financial statements day-to-day management of Naftogaz. The the Cabinet of Ministers is formally entire market. Revision commission and audit of Naftogaz. The company now issues appointment of the top management defined as the founder, while the Energy In addition, the annual budgets of audited stand-alone financial reports on a of Naftogaz subsidiaries depends on The current management team of Ministry is defined as a shareholder of Naftogaz and its subsidiaries also A combination of the public mistrust and quarterly basis. the Cabinet of Ministers as well. This Naftogaz is aware of the need for change, the company. However, the governance require approval by the Finance Ministry. populist political decisions has resulted in governance structure increases the risk of and is prepared to implement it together functions are not clearly divided This provision duplicates some of the numerous ad-hoc and ongoing inspections Management and the executive board political meddling and can cause a revision with other subjects of reform — the between these two bodies. The Cabinet key functions of the GM and provides of Naftogaz by various government Operations of the company are managed of the operating strategy of Naftogaz and Cabinet of Ministers, the Verkhovna Rada of Ministers has certain exclusive rights an additional mechanism of direct agencies. These inspections and audits by the CEO and seven top executives group companies based on politically and other government agencies and including the right to amend constituent influence of the state on the company often overlap and duplicate each other. responsible for different functional areas. motivated factors. international institutions. documents of the company, the share management. The state, through the State Financial 48 49 CORPORATE GOVERNANCE SYSTEM CURRENT PROPOSED STRUCTURE STRUCTURE

The people of Ukraine have no motivation to protect their People of People of interests as the ultimate owners Ukraine Ukraine of Naftogaz: Appoint and dismiss • Shares of Naftogaz are not (through the Parliament) listed • Few or no mechanisms to Represents and reports, Appoint and dismiss participate in decision guided mostly by short-term Represents and reports, spends (through the Parliament) making political agenda rather than dividends on social programs long-term business goals (within its scope of responsibility) OWNERSHIP • Limited availability and interpretation of financial Appoints representatives and operating data to the committee (minority of members) Independent representatives Independent Cabinet of Ministers from business regulator community Safeguarding against Supervisory infringements and non-market board Cabinet of Ministers practices Ministry of Energy nomination and Coal Industry committee Clearly defined functions as a representative of Decision-making process the ultimate owners is complicated and politicized: • Selects and recommends candidates • Unclear separation of for supervisory board members to • Implements public • Prepares high-quality authority between the Cabinet of Ministers governing agencies Other ministries service obligations detailed annual report • Recommends remuneration clearly defined by • Releases quarterly and • Conflicting roles of the of supervisory board members the law founder and the shareholder annual audited financial • Focuses on professional merits • Pays out dividends statements • Potential conflict of the rather than political loyalty to the state budget economic goals for Naftogaz • Regularly discloses other with social and regulatory Appoints Appoints supervisory board members operating information based on OECD function of the government Represents based on transparent procedures transparency guidelines • High risk of political meddling and reports and pre-defined criteria and graft SUPERVISION AND CONTROL Represents Revision and reports committee Revision Independent de facto committee Supervisory Auditor does not exist board de facto does not exist Supervisory Supervisory Board Board Management is not efficiently Goal: • Approves strategy motivated: Recommends • Motivate management to and business plan increase operational efficiency • Extremely low remuneration and oversees of Naftogaz compared to market levels and ensure asset value growth • Appoints executive in the interests of the people • Appoints executive • Extremely high level of board members of Ukraine board and sets responsibility • Approves financial plans its remuneration • Implements • Eliminate political meddling approved • No liability insurance • Oversees strategy • Compensates difference and graft strategy and between the subsidized implementation, key • Low level of operational • Separate the functions of expenditures business plan autonomy and market gas prices regulator and shareholder MANAGEMENT • Ensures integrity of • Performs • Conflict of political and • Can approve decisions Reports • Implement OECD best day-to-day Reports on accounting systems economic interests based on short-term political practices for corporate management achievement and appointment of agenda, rather than strategic governance in state owned • No motivation for pursuing on objectives independent auditors • Reports interests of the people enterprises long-term strategy of Ukraine and goals because of dependence on the political landscape Naftogaz Naftogaz

Executive Executive 50 Board Board 51 STRATEGY AND REFORM

EXECUTIVE BOARD STRUCTURE AND REMUNERATION

Sergiy Pereloma Consulting Group, Bunge, Deloitte and EY. envoy of Ukraine for the realization of the Euro-Asian Oil Transport Corridor First Deputy Sergiy holds an MBA degree from the and served as an adviser to the State Chairman since International Institute for Management The executive board of Naftogaz changed Previous executive raising, debt restructuring and corporate Secretary of the President of Ukraine. He August 2014 Development (IMD) in Lausanne, radically in 2014. In the first quarter of reorganizations of large enterprises and also held the position of Coordinator for board Switzerland. 2014, the executive board consisted of 14 holdings. Sergiy has more the Realization of the Ukraine-EU Energy Chairman: Y. Bakulin members. After the dismissal of Yevhen than 13 years Yuriy Kolbushkin Memorandum (INOGATE) and was a Board members: Andriy holds a master's degree in Bakulin, the previous CEO of Naftogaz, and V. Franchuk, O. Lopushansky, A. Katsuba, experience in the oil member of the Expert Council of the World international economic relations with Member of the the appointment of Andriy Kobolyev as D. Mormul, V. Trikolich, V. Chuprun, G. Yuriev, and gas industry and manages divisions Economic Forum. V. Vinokurov, R. Zahorodniy, P. Polishchuk, honors from the Institute of International executive board the new CEO in March 2014, all members responsible for transit and supply of E. Shvydkyy, S. Vinokurov, Y. Kolbushkin Relations at Kyiv Shevchenko National since February 1999 In his role as Deputy Chairman of Naftogaz, of the previous board except Yuriy natural gas, customs clearance, gas sales University. Oleksandr was in charge of the production Kolbushkin were dismissed and left the and gas balancing. He has extensive Yuriy has worked division and security of gas and oil company. Ihor Prokopiv experience in finance, banking and at Naftogaz since transmission. He and was also responsible New executive insurance sectors. Sergiy is Chairman of the company was In the second quarter of 2014, Ihor First Deputy for capital investment programs, the Supervisory Board of the Odessa Port founded. He is responsible for taxation, Prokopiv, Sergiy Konovets and Oleksandr board Сhairman from April international cooperation, research and Plant. pricing policy, budgeting and economic Todiychuk (passed away in March 2015) Chairman: A. Kobolyev to August 2014 industrial safety. Previously Oleksandr relations. Before moving to oil and gas joined the executive board. In August Board members: Sergiy graduated from the Institute headed Ukrtransnafta for five years. I. Prokopiv (April to August 2014), For many years industry, he worked for 15 years in the 2014, Ihor Prokopiv moved to head of International Relations at Kyiv S. Pereloma (since August 2014), S. Konovets, Ihor worked in Finance Ministry of Ukraine. He received a degree in business Ukrtransgaz, and his position in Naftogaz Y. Kolbushkin, O. Todiychuk* Shevchenko National University. management positions administration at the Kyiv International executive board was subsequently filled by Yuriy graduated from the Kyiv Institute in industrial enterprises, commercial Sergiy Konovets Institute of Management. Sergiy Pereloma. *To the great regret of the staff of the company of National Economy, holds a doctoral structures, and enterprises of housing and the wider professional community of the oil Deputy Chairman degree in economics and is a member Oleksandr passed away on 3 March 2015. Andriy Kobolyev and gas industry Oleksandr Todiychuk passed and communal services in Ivano-Frankivsk since April 2014 (academic) of the Ukrainian Academy for Chief Executive away on 3 March 2015. region. He headed Ivano-Frankivsk district REMUNERATION OF BOARD Oil and Gas. Officer (Chairman of heating company, Ivano-Frankivskgaz, Sergiy is responsible MEMBERS the executive board) and other industrial enterprises. for financial Oleksandr Todiychuk In 2014, the total remuneration of Naftogaz since 25 March 2014 On joining Naftogaz, Ihor managed management in Deputy Chairman executive board members, including salaries divisions responsible for gas sales, asset Naftogaz. The Andriy began worked at Naftogaz, rising from a chief from April 2014 to and bonuses, amounted to UAH 6.2 million management and procurement. In scope of his responsibilities includes his career at the specialist to Adviser to the Chairman. March 2015 before taxes. Of this amount, UAH 3.3 million August 2014 he was appointed as head of budgeting, investment analysis, financial international Following the appointment of Yevhen was the remuneration of executive board Ukrtransgaz. and management reporting. Sergiy has A recognized expert audit and consulting group Bakulin as Chairman of the executive members who had worked at Naftogaz at the 20 years of professional experience in oil and gas industry PriceWaterhouseCoopers (PWC), board in 2010, he left the company. After Ihor studied engineering at the Ivano- beginning of 2014 and were subsequently in strategy development, business with more than where he specialized in issues of leaving Naftogaz, Andriy co-founded AYA Frankivsk Oil and Gas Institute and dismissed during the year. UAH 2.9 million development, finance and audit. 35 years of professional experience, strategic management and corporate Capital investment banking group where economics in the Ternopil Academy of is the total remuneration of the members of He worked for a number of leading Oleksandr worked at the Institute of Oil transformation. From 2002 to 2010 he he focused on debt and equity capital National Economy. the new executive board. international companies including Boston Transportation, was appointed special 52 53 STRATEGY AND REFORM

OTHER CORPORATE SENIOR MANAGERS GOVERNANCE REFORM

Yuriy Vitrenko Andriy Pasishnyk Yaroslav Teklyuk

Director for Business Executive Director for Development Director, Legal Affairs and since April 2014 Acting Deputy Government Relations Chairman since April 2014 Yuriy is responsible for of the executive strategic development Yaroslav is responsible board and reform of Naftogaz for legal matters and since July 2014 and for the diversification of gas supplies government relations. He has 15 years of The current structure of corporate independent and accountable to the REFORMING THE CORPORATE to Ukraine. Andriy is responsible for issues related to professional experience in legal practice. governance of Naftogaz has a number of GM). GOVERNANCE SYSTEM Naftogaz assets in the oil industry. Yaroslav has provided legal advice and He has cooperated with Naftogaz as a staff significant flaws: represented corporate clients in banking, There is no transparent procedure In March of 2015, the Cabinet of member or external advisor since 2002, He also oversees asset management and • financial, and telecommunications sectors. The people of Ukraine, as the ultimate for nomination and election of the Ministers approved the gas industry and was responsible for international debt investment divisions. • Prior to joining Naftogaz he spent eight years owners of Naftogaz, are currently supervisory board members. There reform plan which requires that the capital raising and debt restructuring. Andriy is an oil business professional and at Vasil Kisil and Partners, a leading Ukrainian represented by government agencies are no mechanisms and instruments corporate governance of Naftogaz and Yuriy began his career in the has experience in crisis management in law firm, including four years as a partner. that have a direct influence on daily in place that would enable engaging its subsidiaries be aligned with the OECD international audit and consulting group large corporations, economic security operations of the group. This structure highly qualified professionals with principles of corporate governance. Yaroslav has graduated in International Law PriceWaterhouseCoopers (PWC), where matters, financial controlling and quality does not guarantee that the group is an impeccable reputation to the This requirement is also a condition from the Institute of International Relations he advised major Ukrainian companies on management. governed in the interests of the ultimate board. The professional requirements precedent for the European Bank for at Kyiv National Shevchenko University. financial management. owners. Instead, it may be influenced for supervisory board members Reconstruction and Development (EBRD) Prior to joining Naftogaz, he worked in Vitaliy Shcherbenko by political interests. Any change of the are minimal, and so is the level of and European Investment Bank (EIB) He has 12 years of experience in management positions at WOG RETAIL government means a de facto change of remuneration. The current procedure loans for the modernization of the investment banking and finance in and Zolotiy Ekvator. Director of Energy Naftogaz shareholder. does not allow for the establishment of Urengoy-Pomary-Uzhhorod pipeline. Ukraine, Russia, and the UK. Efficiency and Andriy started his career at Ukrtatnafta, a qualified and independent supervisory Procurement Governance functions of the Cabinet With the EBRD support, Baker & Yuriy headed the international investment where he worked for 10 years. • board. since April 2015 of Ministers, the Energy Ministry, the McKenzie and PWC have performed a fund Amstar Europe, and worked for He holds a degree with honors Finance Ministry and other government There is no procedure for approval and review of the current state of corporate Merrill Lynch investment bank in London Vitaliy heads the • in Business Administration from agencies are not clearly defined, and revision of Naftogaz strategy focused on governance at Naftogaz and developed (UK). He is a co-founder and partner AYA energy efficiency and the Institute of Economy and New their areas of responsibility often the business goals of the company and a new model of corporate governance Capital investment banking group. procurement divisions in Naftogaz. He has Technologies and in Chemical Fuel and overlap or intersect. This problem is the interests of its ultimate owners (the compliant with the OECD best practices more than 20 years of experience in senior In 2004 Yuriy graduated from the MBA Hydrocarbon Materials Technology from particularly evident in the functions of people of Ukraine). for state-owned enterprises. The reform management positions in the financial program at the INSEAD Business School the Ukrainian State Chemical Technology internal audit and revision commission. plan includes recommendations for: sector. Prior to joining Naftogaz Vitaliy held Decisions on appointing, dismissing and (France, Singapore). University. • various executive positions, including the • Some functions that should be remunerating management of Naftogaz • an efficient corporate structure He holds a master’s degree in International He also holds a degree in Organic position of the president of an insurance performed independently are in fact and its subsidiaries are executed by establishment of the supervisory Business Management from Kyiv National Substances Production from the company. performed by the same body. In the government agencies and not by • board, the composition of which Economic University, and is an Associate Chemical Technology College of particular, the Energy Ministry acts as a independent boards, which results Vitaliy studied Economics at Kyiv National would include a majority of of the London Securities and Investment Dneprodzerzhinsk State Technical shareholder at the GM and also controls in a conflict of interest and can affect Economic University. independent directors Institute (ASI). University. the supervisory board (which must be management decisions. 54 55 • concluding a contract between • control the effectiveness of Naftogaz order to ensure that the industry regulator Naftogaz and a state government governance and adapt it according performs this function, it is necessary agency (the Cabinet of Ministers and/ to the best practices of similar to develop and implement appropriate or the Energy Ministry) that will define companies legislation. the responsibilities of Naftogaz; in define success indicators for Naftogaz At the same time, the Cabinet of Ministers particular, this should address the • management and monitor their can meet its social obligations and can execution of certain state functions achievement incorporate Naftogaz into this activity by (such as gas supplies for social needs specifically listing relevant measures and at regulated prices) carry out monitoring of spending, • instruments (for example supplying gas to purchases and sales strategic in terms establishing clear success performance the utilities sector). • of volume and nature of counterparts indicators and for Naftogaz In other words, the government should management nominate and appoint executive board • perform its social policy through a clear members of Naftogaz In order to ensure the independent and public service obligation mechanism. objective nomination and appointment • define the objectives and During the transition period, the of supervisory board members, a board remuneration of the Naftogaz government should gradually switch nomination committee should be set up. management according to the long- over from the model, in which subsidies The committee shall be independent of term interests of the company and the are indirectly provided to all households the government agencies, the current people of Ukraine through below-market prices, to a free supervisory board and the executive market pricing, at the same time providing manage potential conflicts of interest board. Its mandate should include: • direct subsidies to low-income households. of executive board members nominating and presenting The following three factors have a • assume responsibility for the integrity recommendations on the supervisory • significant impact on the success of the of accounting and financial reporting, board candidate members to the corporate governance reform: including the independent audit of Cabinet of Ministers for review, at least Naftogaz the engagement of a sufficient number during the transitional phase • of reform-motivated professionals, ensure the planned and transparent proposing remuneration for • both within and outside the company • work of appropriate control systems supervisory board members (potential new members of the (including risk management, financial supervisory board, of the board Based on the recommendations of and operational control, and their nomination committee, government independent consultants, members of the compliance with laws and standards) representatives) supervisory board nomination committee carry out other work for increasing shall be elected for a term of two years. • the political will of government bodies the level of trust in the company and • Most members of the committee should and international institutions to facilitate cooperation with national and be professionals with experience in implement reforms international partners investment banking, finance, audit or the introduction of committees within clearly delineating the roles and providing abroad mandate for the the continuous work and dedication • • • similar fields, and only a minority, during During the transitional phase of • the supervisory board responsibilities of the Cabinet independent supervisory a board and of people implementing the reform the transition phase, can be government approximately one and a half to two of Ministers as the legitimate management of Naftogaz throughout its expected completion in the distribution and balancing of representatives. years, it is proposed that the supervisory • representative of the ultimate owners the end of 2017 powers among the governance bodies developing and implementing a board should be composed of a majority — the people of Ukraine • The supervisory board members should at all levels transparent nomination policy for of independent members, as well as one The current Naftogaz management is be nominated according to transparent clearly defining the areas of influence supervisory board candidates representative of the President of Ukraine, fully aware of the corporate governance The reform is aimed at bringing the • procedures and clear criteria disclosed of other government agencies and, one representative of the Cabinet of reform importance for the overall industry current system in line with international setting up an effective supervisory well in advance. ideally, restricting this influence • Ministers, and one representative of the restructuring process and will continue standards in the areas described below. board and establishing supervisory FULLY EMPOWERED AND trade unions. to take all the steps within their power EXERCISING OWNERSHIP board committees, including an audit POLITICAL INSULATION INDEPENDENT SUPERVISORY to have the proposed plan approved and RIGHTS committee and a nomination and REGULATORY AND SOCIAL BOARD implemented. Naftogaz must adopt the best practices remuneration committee, as well as a POLICY According to the developed model, the of companies in the global oil and gas corporate secretary section The newly established supervisory board The management hopes for the same role of the owner must be performed by a The corporate governance reform of industry. This implies: will have the following functions: dedication from other participants in single government body. strengthening internal control by Naftogaz and its subsidiaries can only • the oil and gas sector reform. Above establishing mechanisms that would establishing risk management, review and approve Naftogaz strategy, succeed if an independent national • The exercise of the rights of the ultimate • all, this means the commitment of the ensure that Naftogaz is protected from compliance and internal financial risk management policy, business regulator of the industry safeguards equal shareholder should be ensured through: government authorities and the support of political interference control units plans and annual budgets conditions for all market participants. In international partners. 56 57 STRATEGY AND REFORM

Accordingly, information on the company's During 12 months for media representatives at its events. development strategy and significant events It is unacceptable for representatives of TRANSPARENCY that affect the implementation of this from March 26 2014 Naftogaz to make insulting comments strategy or activities of the group must be (appointment of new or remarks regarding representatives of AND DISCLOSURE POLICY timely, accurate, objective and complete. mass media and/or NGOs, nor to express management team), unsubstantiated criticism of published The management of Naftogaz endeavors to materials. ensure the presentation of this information Naftogaz: in a manner that is concise, visual and easily released 216 press statements and interviews In turn, Naftogaz expects objective, understood by the general public. (during the preceding 12 months: 35) substantiated and fair representation in the publications or materials of the media, expert DISCLOSURE CHANNELS participated in 25 press conferences or television programs (during the preceding 12 months: 1) community or NGOs. Naftogaz also expects Own resources to be granted the opportunity to comment on launched a new website with data for analysis: information relating to the company or the An integral part of the reform proposed income or assets of the group (which recent published annual consolidated Naftogaz discloses information on its www.naftogaz-europe.com reform of the gas market of Ukraine. by Naftogaz is ensuring a high level of may lead to more than 10% change in the statements corporate websites as well as through its transparency and accountability of the operating income or assets of the group official Facebook and Twitter accounts. opened official accounts in social networks: Cooperation with the professional • The annual declaration of property and company. In line with the strategic objectives based on the latest released consolidated Official information is also regularly www.facebook.com/NaftogazUA, community and transparency industry income of the CEO of Naftogaz twitter.com/NaftogazUkraine of the new management team, Naftogaz has annual financial statements) distributed to subscribers from the press platforms already significantly changed its approach to • Information that is not material to the service e-mail address [email protected]. Information about decisions or initiated quarterly audited IFRS reporting Naftogaz participates in conferences relevant transparency and disclosure. • financial performance of the company or events which, in the opinion of the Official information is also included in annual to the development of Ukraine’s oil and gas the implementation of its strategy, but The ultimate owners of Naftogaz are the management, have or may have a reports, financial statements issued according launched quarterly reports on import prices and markets and/or attracting investment to is believed by the management to be of citizens of Ukraine, and the activities of the material impact on the implementation to IFRS standards, and other periodic volumes these sectors. significant public importance company significantly influence the energy of any of the key areas of the strategy of reports and materials which are published started daily disclosure of gas balances in UGS In May 2014, Ukrtransgaz joined AGSI+, security of Ukraine. Therefore, Naftogaz the holding company or its subsidiaries Information that is not subject to public on the corporate website of Naftogaz and and gas flows the leading European platform for management is aware of its duty to fully disclosure includes: distributed by Naftogaz to the media and • Regular statistical information about transparency of underground gas storage inform the public about the activities within other stakeholders. started publication of spot gas prices in European the company, its subsidiaries and the 1. Information that is defined as confidential facilities operated by Gas Infrastructure the scope of its responsibilities in a timely hubs oil and gas market in Ukraine (either under the terms of agreements with The group cautions against using information Europe (GIE). GIE is a major association of manner. in aggregated or expanded form, as counterparties. In particular, data obtained from other sources without making disclosed its constituent documents European operators of gas transmission The management is voluntarily implementing decided by management), including concerning the names of counterparties, an inquiry to the company. Naftogaz is systems, underground storage facilities a disclosure policy the key principles of which information on the gas reserves disaggregated information on prices subject to numerous ongoing and ad-hoc disclosed the declaration of property and income and liquefied natural gas systems. The are based on the disclosure requirements for in underground storage facilities, and volumes of gas purchases or sales inspections by a number of agencies. To of the CEO association publishes information on public companies listed on major European transmission of gas through the by individual counterparties, except in meet their specific requests, the group may residual gas volumes in underground disclosed the composition of executive board and stock exchanges. Thus, in its disclosure and territory of Ukraine, gas production situations where such disclosure was prepare reports presenting information in information about senior managers storage facilities in Europe on its platform. other policies, Naftogaz is implementing the volumes, the volumes and cost of officially permitted by the counterparty. line with assumptions and requirements Ukraine became the first non-EU member OECD best practices. imported gas, gas sales volumes and The company discloses the necessary set by such agencies. The resulting reports restarted disclosure of data on debtors (was country to voluntarily publish data on the dynamics of gas payments from information to supervisory and statistical may not be complete and representative, abandoned in 2012) residual gas volumes in its underground DISCLOSURE CRITERIA consumers, etc. agencies as required by law unlike the officially released audited financial storage facilities. This information is updated Information that meets the following criteria statements prepared in line with the IFRS. on a daily basis and is available online at Information about transactions for 2. Other information that is not required is subject to public disclosure: • The management is ready to provide https://transparency.gie.eu. procurement of goods or services with for publication under the law and the comments on data related to Naftogaz in 1. Information that is subject to mandatory related parties, which are defined as disclosure of which, in the reasonable In November 2014, Ukrtransgaz also started order to avoid possible distortion of facts disclosure under Ukrainian law. This entities that are not subsidiaries of opinion of the management, would to disclose data at the transparency platform and ensure an objective interpretation in the includes financial and statistical reports, Naftogaz, and whose owner or owners prejudice the interests of the company in abroad, conduct press conferences and of the European Network of Transmission appropriate context. information regarding the procurement are board members in Naftogaz or the process of negotiations or business participate in relevant television and radio System Operators for Gas (ENTSOG). of goods and services above specified its subsidiaries, except when such activities Mass media and NGOs programs. When working with the media, Information on this platform enables tracking thresholds, data subject to disclosure transactions are concluded following a the company focuses on the demographic gas flows from the point of entry into Ukraine INFORMATION QUALITY The mass media is the key channel of under the legislation on access to public public tender or a tender through the structure of the audience of each media, the through to the point of exiting Ukraine’s GUIDELINES communication for Naftogaz. Cooperation information, etc.; or e-procurement system ProZorro relevance of a particular message for such gas transportation system. This data is also with NGO’s is also gaining increasingly more Naftogaz provides information to and audience, and the format of the publication updated daily and is available online at 2. Information not subject to public Information about changes in the importance. Authorized representatives of • solicits feedback from the civil society, or program. https://transparency.entsog.eu. disclosure, voluntarily disclosed by composition of the executive board Naftogaz and its subsidiaries regularly explain representatives of government, professional, Naftogaz: of Naftogaz or its subsidiaries whose the group strategy and other important Naftogaz respects the professional Naftogaz is open to joining other leading scientific and expert communities, involving value exceeds 5% of the value of the issues in their interviews with leading print duties of journalists and attempts to transparency platforms associated with the Information about activities or events them in this manner in the analysis and • group assets according to the most and online media both in Ukraine and create appropriate working conditions activities of the company or its subsidiaries. that have a material effect on operating discussion of its strategy and decisions. 58 59 BUSINESS OVERVIEW

One of the critical operational challenges for Naftogaz is the far management promotes changes that will inevitably lessen the LETTER OF FIRST DEPUTY CHAIRMAN: from 100% level of payments for the consumed gas. The losses of role of Naftogaz in this market. Only a handful of vertically OPERATIONS Naftogaz arose not only because the expensive imported gas was integrated state giants in Europe have actively supported a sold below cost. A large portion of major consumers abused the similar de-monopolization of the market. We understand that flaws in the regulations and did not pay for the gas they consumed this reform is critical not only for consumers, who will be able to Sergiy Pereloma at all. Naftogaz had no legal right to cease supply or require a choose their suppliers and receive the highest quality of service. collateral. It is also necessary for the energy security of Ukraine.

Now, thanks to the recent changes in legislation, we have more Market reforms are important for us as well. In recent years, opportunities to influence debtors. We will be able to disconnect Naftogaz practically lost its position in the market of gas supply them, and file claims for the seizure and sale of their property to for industrial customers because of legislative distortions. In recover the amount in arrears. In the near future, we should see summer, when demand for gas is the lowest, private traders debt auctions, where we should be able to sell our debt for others attract industrial clients with tangible discounts. Before the to collect. Thus, Naftogaz expects to replenish its working capital introduction of the new market rules, Naftogaz could not and to be able to settle its own obligations. compete for these customers, as it risked investigation for selling gas at prices below those set by the regulator. We began reforms in Ukraine by starting with ourselves, in changing the tone of the relationship with the rest of the Starting from 1 October 2015, the market regulations change. market participants, making integrity one of the most important Naftogaz will enjoy the same rights as other market participants. cooperation criteria for ourselves and our partners. As a result, Following the implementation of the new legislative framework, the avalanche of complaints toward Naftogaz ceased, and we the state will intervene in our activities only through the clearly can now better communicate our position to our partners in defined public service obligations mechanism, for instance, in Ukraine and the West. supplying gas to households. Dear readers! to Ukraine, and to convince our partners in the EU of the importance Over the past year and a half, Naftogaz has significantly and feasibility of this step. The past year and a half was the time improved relationships with its own subsidiaries. Ukrtransgaz, of hard work at Naftogaz. When I Ukrtransnafta and Ukrgasvydobuvannya already have new The everyday work of Naftogaz is joined the new management team, We opened the Slovak reverse flow in leaders who share the values of the new Naftogaz. We hope developing a clear vision of what the company was in a desperate state. to be able to normalize the situation with the management of the new market should be, and the Naftogaz had suffered huge financial five months after the new team took Ukrnafta soon. losses. Almost all the gas we bought implementation of civilized European was coming from Russia, despite the over management of Naftogaz rules in Ukraine fact that they had already occupied The key objective of the new leaders of Crimea, and we were seeing events The new transmission route and the ability to choose gas rapidly unfolding in the Donbas. Naftogaz did not speak with one suppliers have made it possible to achieve a substantial our subsidiaries is, first and foremost, For us this has meant numerous meetings — and sometimes voice: the interests of the management of the company and its reduction in the price of imported gas for Ukraine. From the boosting operational efficiency of the fierce discussions — with the diverse groups in the Parliament, subsidiaries diverged. The situation was further complicated by the beginning of April 2014, and until the signing of the trilateral with representatives of the Cabinet of Ministers and the distorted regulatory environment in which the company operated agreements in Brussels in late October 2014, Russia was companies as well as improving their Presidential Administration, as well as with international for many years. demanding that we pay a price that was 25-30% higher than accountability and transparency organizations and European governments. In addition to the price at which we bought gas in Europe. Now Gazprom is promoting the legislative changes, we make efforts to see The situation demanded quick and decisive action. With the pricing its gas for us at the level at which we buy gas in Europe. new instruments of cooperation in the gas industry. The gas support of the government of Ukraine and its Western partners, the All of our key subsidiaries are strategic players in their respective We initiated arbitration proceedings in Stockholm, where one exchange and the gas spot market have finally begun to take company began a complex transformation. markets. Ensuring that these companies are managed on the of our conditions is setting a fair price for gas for Ukraine based shape. The first steps have been taken. We go forward. grounds of integrity and professionalism will help Ukraine We are moving in two directions simultaneously. On the one hand, on European prices minus transportation cost from the border to quickly strengthen its energy security. More transparent we are working to ensure that consumers pay the full cost of the gas between Ukraine and Russia to European gas hubs. management should also ensure that resources are used they consume – either independently or with the support of targeted rationally and help improve the financial performance of these subsidies from the state. On the other hand, we are working hard to companies. lower gas prices so that Ukraine does not overpay for its gas as had Concurrently with the work to reduce SERGIY PERELOMA been the case for years before. the imported gas price for Ukraine, Naftogaz is a very active advocate of the Ukrainian gas market First Deputy Chairman of the executive board, reform which is based on the European standards. The group Naftogaz of Ukraine We can already see the first result: a drastic reduction in dependence on Russia. In 2013, Russia supplied 92% of our imported gas. In 2014, we have stepped up actions on the that number dropped to 74%. In the first half of 2015, only 37% of huge debt of Ukrainian consumers to our imported gas came from Russia. This result required hard work from the entire team to enable the transmission of gas from Slovakia Naftogaz

60 61 BUSINESS OVERVIEW

NEGATIVE CONSEQUENCES OF THE MILITARY 2014-2015 DECLINE IN GLOBAL ENERGY PRICES AGGRESSION, 2014, % OPERATING ENVIRONMENT As an importer of gas into Ukraine, Naftogaz benefited from the Donetsk region Luhansk region reduction of global energy prices in 2014. The negative impact OF NAFTOGAZ 0 of the oil price correction was only felt in the oil extraction and -31.5 refinery projects of UGV and Naftogaz projects in Egypt. However -32.2 the result of these divisions had little impact compared to the Industrial production -42.0 -46.3 overall positive effect on other businesses of the group. -50 Exports Source: State Statistics Service of Ukraine At the same time, terms of the existing contracts with Gazprom, WEIGHTED AVERAGE INTERBANK EXCHANGE prevented Naftogaz from taking the full advantage of the decline RATE, UAH PER 1 USD in global oil prices for most of 2014. Having occupied Crimea, Russia unilaterally raised the price of gas for Naftogaz by 35 USD 100/tcm. Protracted negotiations on pricing and other terms of Russian gas supplies to Ukraine resulted in the initiation of an arbitration between Naftogaz and Gazprom. The interim terms of supply of the Russian gas are regulated by the so-called “winter package” – a set of trilateral and bilateral agreements with the 0 participation of Ukraine, Russia and the European Commission. January 2013 September 2015 Naftogaz eventually managed to take advantage of a drop in Source: National Bank of Ukraine global energy prices by significantly expanding the volume of gas purchases from the EU starting from September 2014. This ECONOMIC OUTCOMES OF 2012-2013 INDUSTRIAL PRODUCTION INDICES CHANGE, % CHALLENGES OF 2014-2015 development has helped the company to reduce its working capital financing requirements. In 2012-2013, the Ukrainian industry entered a recession The inevitable adjustment of the accumulated economic period. The subsequent contraction of the external trade and Coke and petroleum imbalances combined with the Russian military intervention in growth in the government spending have predetermined the products 2014 caused an unprecedented financial crisis in Ukraine. devaluation of the national currency. Chemicals In 2014, the pace of the decline in GDP accelerated to 6.8%. 2014-2015 BRENT OIL PRICE DYNAMICS, By the end of 2013, Ukraine's economy had been in recession According to the IMF forecasts, the GDP decline will continue into USD/BARREL for six consecutive quarters, and the decline in the production Metallurgy 2015 and will reach 9%. 140 index of basic industries had continued for 17 consecutive 2012-2013 The Russian occupation of the Autonomous Republic of Crimea months. The output volume of the processing industry Processing industry 105 2014 (Crimea) and the hostilities in the Donbas deepened the decreased by 9.2%, and the fall in the chemical industry, recession, which in turn negatively affected domestic demand for traditionally large-scale consumer of gas, amounted to 22.5%. -30 -20 -10 0 70 Source: State Statistics Service of Ukraine natural gas. The decline in production in the processing industry These factors led to a substantial reduction in Naftogaz in 2014 amounted to over 9%, resulting in a further reduction in 35 revenues. NBU FOREIGN EXCHANGE RESERVES, demand for natural gas by industrial customers. 2012-2015, USD BILLION 0 The external trade significantly deteriorated during this January 2014 September 2015 40 Because of the occupation of a portion of Ukraine’s territory, period. The slowdown in economic growth of the emerging Source: Bloomberg Naftogaz lost a part of its resource base, including the markets resulted in a reduction of Ukrainian exports. At the prospective reserves in Crimea. The sharp devaluation of the same time, the cost of energy for Ukraine remained high, and 30 national currency had a detrimental effect on the finances of the the so-called trade wars with Russia began. GAS PRICES IN EUROPE AND GAZPROM’S group. PRICES FOR NAFTOGAZ, 2013-2015, USD/TCM These factors aggravated the devaluation pressure which The recession and currency devaluation, together with the blow reached its climax in 2014 and 2015. The deterioration of the 20 600 to the overall economy caused by the armed conflict, made external trade led to an increase in the current account deficit to internal and external capital markets inaccessible to Ukrainian over 9% of GDP. In turn, the unfavorable business climate and 450 10 companies. This factor has greatly limited the possibilities of the bleak prospects for the economic growth resulted in a drop Naftogaz to refinance its debt and increased its dependence on of the net foreign direct investment to less than 2% of GDP. 300 the state funding. This combination of factors caused a significant balance of 0 NCG Month Ahead In order to overcome the economic crisis, Ukraine needs deep 150 payments deficit, boosted devaluation expectations and Interim price agreed in the winter package structural reforms which are partially reflected in the measures Price based on contractual formula

drained the reserves of the National Bank of Ukraine (NBU), 12 June 13 June 14 June 15 June (discounts cancelled in 2Q 2014) April 12 April 13 April 14 April 15 April agreed between the government of Ukraine and the International 0 which made numerous interventions to keep the exchange 12 August 13 August 14 August 15 August October 12 October 13 October 14 October

February 12 February Monetary Fund (IMF). The reform of the gas market and Naftogaz February 13 February 14 February 15 February January 2013 September 2015 rate unchanged. The country’s foreign exchange reserves 11 December 12 December 13 December 14 December itself constitute an important part of these undertakings. declined by 35% over 2012-2013. Source: National Bank of Ukraine Source: Bloomberg, Naftogaz, public sources 62 63 BUSINESS OVERVIEW

SUMMARY OF OIL AND GAS RESERVES OF NAFTOGAZ, AS AT 31 DECEMBER 2014 (EXCLUDING BUSINESS STRUCTURE CRIMEA) Oil and Natrual gas (bcm) Oil and condensate Natural gas Total all products condensate (million barrels)1 (million boe)2 (million boe) (million t)

Proven oil and gas reserves Proven developed in Ukraine (excl. Crimea) 3.62 256.03 26.35 1 514.94 1 541.30 Ukrgasvydobuvannya 3.52 255.70 25.60 1 513.02 1 538.62 Naftogaz 0.10 0.33 0.75 1.92 2.67 in Egypt 0.47 0.30 3.40 1.75 5.16 Total proven developed 4.09 256.32 29.76 1 516.70 1 546.45

Proven undeveloped in Ukraine (excl. Crimea) 0.40 11.14 2.94 65.91 68.85

Ukrgasvydobuvannya 0.18 11.13 1.30 65.88 67.18 Naftogaz is a vertically integrated KEY BUSINESS DIVISIONS Naftogaz 0.23 0.00 1.64 0.03 1.67 group whose activities span from gas in Egypt 0.35 0.12 2.57 0.69 3.26 Total proven undeveloped 0.76 11.26 5.51 66.60 72.11 extraction, import and supply through gas GAS OIL transmission and storage. The companies IMPORTS AND WHOLESALE TRADING Proven developed and undeveloped in which Naftogaz owns shares are major UPSTREAM Naftogaz Ukrnafta1 in Ukraine (excl. Crimea) 4.02 267.16 29.29 1 580.85 1 610.15 players in the gas and oil markets. Ukrgasvydobuvannya (UGV) Ukrgasvydobuvannya 3.70 266.83 26.90 1 578.90 1 605.81 Zakordonnaftogaz Naftogaz 0.33 0.33 2.39 1.95 4.34 EXTRACTION AND PROCESSING 2 Nearly 90% of Naftogaz assets and Ukrgasvydobuvannya (UGV) Chornomornaftogaz in Egypt 0.82 0.41 5.97 2.44 8.41 1 revenues are related to the gas business. Ukrnafta Total Proven developed and 4.84 267.58 35.27 1 583.30 1 618.56 Chornomornaftogaz2 TRANSMISSION Separate subsidiaries operate in each Ukrtransnafta undeveloped market segment. Ukrspetstransgaz TRANSMISSION Chornomornaftogaz2 Naftogaz3 Probable oil and gas reserves 3 • In 2014, Naftogaz supplied to the Ukrtransgaz in Ukraine (excl. Crimea) 2.16 24.07 15.70 142.43 158.13 Chornomornaftogaz2 STORAGE Ukrainian market gas volumes which Ukrtransnafta Ukrgasvydobuvannya 0.59 23.91 4.32 141.45 145.78 are equivalent to 7% of Europe’s total Ukrnafta1 Naftogaz 1.56 0.16 11.38 0.98 12.36 Ukrtatnafta5 consumption STORAGE in Egypt 0.31 0.19 2.27 1.11 3.38 Ukrtransgaz REFINERY Total not proven probable 2.47 24.26 17.97 143.54 161.51 • Ukrtransgaz operates a major gas Ukrgasvydobuvannya (UGV) 5 transportation system (GTS) with the DISTRIBUTION AND SUPPLY Ukrtatnafta Total Proven and probable Regional gas distribution and supply in Ukraine (excl. Crimea) 6.18 291.23 45.00 1 723.28 1 768.28 entry capacity of 288 bcm/year and the companies4 DISTRIBUTION AND SUPPLY Ukrgasvydobuvannya 4.29 290.74 31.23 1 720.36 1 751.59 exit capacity of 151 bcm/year in the Naftogaz (supply) Ukrnafta1 Ukravtogaz Chornomornaftogaz2 Naftogaz 1.89 0.49 13.77 2.92 16.69 direction of the EU. The annual volume in Egypt 1.13 0.60 8.24 3.55 11.79 of gas transmitted to Europe in 2014 Total proven and probable 7.31 291.83 53.24 1 726.83 1 780.07 was 62.2 bcm Naftogaz is one of the largest groups European consumers. This contract violates • SUMMARY OF OIL AND GAS RESERVES OF NAFTOGAZ IN CRIMEA, AS AT 31 DECEMBER 20133 • Ukrtransgaz also operates Europe's in Ukraine by a number of parameters, the requirements of the 3rd Energy Package largest system of underground gas including asset value and revenues. currently implemented by Ukraine. Oil and Natrual gas (bcm) Oil and condensate Natural gas Total all products 1 2 storage (UGS) facilities. It consists of 12 Naftogaz is the largest taxpayer in Naftogaz has initiated an arbitration to condensate (million barrels) (million boe) (million boe) separate facilities with a total capacity Ukraine bring this contract into accord with relevant (million t) of about 31 bcm (over a quarter of the national legislation, Ukraine's international 1Naftogaz owns 50%+1 share of Ukrnafta EU-28 UGS capacity) and the injection commitments and the standard market Proven developed 0.43 14.02 3.11 82.99 86.10 but did not exercise control over the capacity of 280 mcm/day practices of the Energy Community of Proven undeveloped 4.27 13.25 31.07 78.43 109.50 company in 2014 and started to recover it Total proven 4.70 27.28 34.18 161.41 195.60 which Ukraine is a member • Ukrgasvydobuvannya (UGV) is in 2015 Ukraine’s largest company in gas 4Naftogaz owns minority stakes in some Probable 1.39 14.20 10.14 84.01 94.15 2As a result of the occupation of Crimea by upstream and second largest in oil of regional gas distribution and supply Total proven and probable 6.09 41.48 44.32 245.43 289.75 Russia in 1Q 2014, Naftogaz currently does upstream. In 2014, the company companies, except for Kirovohradgaz not control assets in Crimea produced nearly 14 bcm of gas, where Naftogaz owns 51% of shares 1Oil/condensate volumes are converted to barrel using a factor of 7.28 bbl per 1 t accounting for 2/3 of the market 3Naftogaz is a party to the contract with 2Natural gas volumes are converted to oil equivalent using a factor of 169 cubic metres per 1 bbl 5Naftogaz owns a minority stake Gazprom on of gas tranmisstion to 3Estimation of reserves in Crimea as at 31 December 2014 was impossible because of the Russian occupation of the peninsula 64 Source: Report on estimation of Naftogaz proven, probable and possible hydrocarbon reserves (SPE-PRMS) by Ryder Scott Company 65 GROUPGROUP STRUCTURE STRUCTURE BY BYOPERATING OPERATING REVENUES REVENUES AND AND ASSETS ASSETS 2014,2014, UAH UAH billio binllion OPERATINGOPERATING REVENUES REVENUES ASSETSASSETS

239.7239.7 146.2146.2 53.353.3 24.224.2 Gas transmissionGas transmission Gas storageGas storage WholesaleWholesale and retail and retail Gas transmissionGas transmission gas tradinggas trading 2.4 2.4 Public Publicsector sector

7.4 7.4 DHCs forDHCs5.3 for 5.3 NationalNational householdshouseholds

DHCs forDHCs other for other5.7 5.7 -13.6-13.6 consumersconsumers 24.7 24.7 16.8 16.8 AdjustmentAdjustment IndustryIndustry InternationalInternational for inter-groupfor inter-group 7.4 7.4 transactionstransactions HouseholdsHouseholds (elimination)(elimination) GASGAS 0.3 0.3 7.8 7.8 ExternalExternal clients clients GroupGroup companiescompanies

1.1 1.1 GroupGroup companies companies 42.442.4 28.328.3 Gas productionGas production WholesaleWholesale and retailand retail gas tradinggas trading 4.84.8 1.41.4 Gas Gas Gas storageGas storage productionproduction

5.05.0 2.02.0 RefineryRefinery of crude of crude oil oil 5.25.2 CrudeCrude oil transmission oil transmission and gasand condensate gas condensate RefineryRefinery of crude of crude oil oil and gasand condensate gas condensate 20.020.0 Oil Oil 0.30.3 transmissiontransmission CrudeCrude oil production oil production1 1 3.43.4 ProductionProduction of crude of crude OILOIL 1 1 oil andoil gas and condensate gas condensate

OTHEROTHER2 2 0.80.8 30.030.0

1 1 66 Does notDoes include not include Ukrnafta Ukrnafta 67 2Segment2Segment assets assetsinclude include administrative administrative and non-core and non-core assets, assets, investments investments (including (including Naftogaz Naftogaz share inshare Ukrnafta) in Ukrnafta) and assets and assetsof auxiliary of au subsidiariesxiliary subsidiaries OPERATIONS: GAS

UKRAINIAN GAS MARKET HISTORY: FROM EXPORTS TO IMPORTS

The development history of the Ukrainian on average have access to gas in the EU gas demand peaking at almost 119 bcm with the active development of gas Unfortunately, because of the abundant on the path to energy efficiency and gas industry and related sectors helps to member states. in 1990. production in what is now Russia and availability of gas for decades, a large frugal consumption. Ukraine still has understand the current structure of the in Central Asia, as well as with the portion of the society believes that gas considerable gas resources and can As a result of the rapid development of By the late 1970s, the majority of gas market and the challenges the industry is construction of the supersized gas is a very inexpensive and a virtually regain its former status as a net exporter the industrial and household segments fields were depleted and production facing now. transmission pipelines from these unlimited resource. if it manages to create an environment of the market, Ukraine turned into one started to decline rapidly. The demand deposits to Central and Western Europe. necessary to attract investments into gas From the 1950s until the mid-1970s, of the largest gas consumers in the for gas, on the contrary, continued Both the industrial and residential sectors production. The gas market reform that Ukraine was one of the leading gas world. By the end of the Soviet era, to grow. Thus Ukraine gradually The powerful pipelines crossed the of the Ukrainian economy have evolved involves the deregulation of retail gas producing countries in the region and Ukraine ranked third in gas consumption transformed from an exporter to an territory of Ukraine and made it a key in an environment of gas abundance. prices is a prerequisite for achieving gas an exporter of gas. It was the golden globally after Russia and the USA, with importer of gas. This change coincided transit country for Russian gas to Europe. This fact underlines the depth of the independence for Ukraine. age of the Ukrainian gas industry. Gas In the same time, they also provided challenges that Ukraine must overcome produced in Ukraine was used to satisfy Ukraine with an opportunity to buy the local demand as well as supply GAS DEMAND AND IMPORTS IN UKRAINE, BCM virtually unlimited volumes of gas at to consumers in the current Russian any time. Gas consumption continued Gas demand in Ukraine, 2005-2014, bcm Federation, Belarus, Moldova, the to grow, and the country became 120 118 then Czechoslovakia, Austria, Hungary, Gas demand Gas imports increasingly dependent on gas imports. -55% 2005 2014 Romania, Bulgaria, and Poland. In 1975 By the time when the Soviet Union the total volume of gas extracted from 100 collapsed, Ukraine's own gas production fields in western and eastern Ukraine and covered only about 20% of the national -12% in the Crimean region reached a historic 80 76 demand. high and totaled 68.1 bcm. -49% During almost 25 years of Ukraine’s -57% Alongside the rapid development of the 60 independence, the consumption Ukrainian gas production, industries that 43 has dropped by about three times, -35% intensively use natural gas, like chemicals primarily due to structural changes in 40 and metallurgy, evolved as well. Gas was the economy. Gas demand from the also made widely available to individual households declined at a significantly consumers – in this regard, Ukraine is still 20 slower pace, and now more than half of Industry Households District heating Public sector Gas industry operating one of the European leaders. Almost 60% gas consumed in the country is used to companies needs (production, transmission, of Ukrainian households have access to 0 satisfy the needs of the residential sector. distribution) gas, while less than 40% of households 1991 2004 2015 68 69 UKRUKRAINEAINE’S G’SAS GAS BALANC BALANCE INE I201N 2014 4 bcmbcm Gas pricesGas prices for the for the publicpublic sector sector (direct (direct and heating)and heating) were were broughtbrought to the to market the market level onlevel 3 Aprilon 3 2014April 2014 In 2014,In 2014,gas prices gas prices for householdsfor households (direct (direct and heating)and heating) were were 4-10 times4-10 timesbelow below the the ImportedImported gas gas price ofprice imported of imported gas gas comprisescomprises 40% of 40% gas of gas used byused households by households (directly(directly or through or through centralizedcentralized heating) heating)

NATNAURATURAL L NUCLNUCLEAREAR RENERENEWABLEWABLE COACOAL L OILOIL GASGAS ENEENERGYRGY ENEENERGYRGY 4242.6.6

In 2014In 2014Naftogaz Naftogaz was was the onlythe supplier only supplier of of gas forgas the for needs the needs of of householdshouseholds SOURCSOURCES ES USEUSSES

14.014.0 UGV,UGV incl,u indiclngu:ding: 15.115.1HousehoHouseholds (dirldsec (dirt useect) use) 13.4 ma13.4rketa mablrketae gabls e gas (consume (consumed by househod by households) lds)

0.6 oper0.6at oiperng neeatingds nee of UGVds of an UGVd and producti production of onLPG of LPG

20.520.5 DistricDitst heatrict iheatng ciomng pcanomies,pan ies, PrivatePri vateproducers, producers, ProductionProduction 1.1 1.1 in whicinh whUGVich ho UGVlds hoa mldisno ari mtyino stakritye stake 8.6 8.6 incluindiclng:udi ng: 7.1 fo7.1r househo for households lds 1.7 1.7 UkrnaftUkranafta 1.1 fo1.1r pu foblicr pu sebliccto rse ctor 0.4 fo0.4r ind foustr indrialust anridal othe andr otheconsumer consumers r s 3.7 3.7 OtheOr theprivater pri vateproducers* producers* 0.7 0.7 PublicPu sebliccto ser ctor OperOpatierngat neeingd nees ofd gass of prgasoducers, producers, 3.6 3.6 operoperatorsato ofr gass of tgasransm transmissioniss aniond and distribdistutribionut systemion systems s 14.514.5 RussRiaussia 19.519.5 ImportsImports 14.214.2OtheOr theindrust indriustal crionsumeal consumers rs 5.0 5.0 EuropeEurope

70 UnauthoUnauthorizedri wizethd drwiawalthdr awalin th ien the 71 Net cNhangeet change in 201 in4 2014 0.4 0.4 2.6 2.6Undergr Undergroundoun gasd sto gasrage stosrages occuopiccedu piteedrri toterirriesto ofries the of ATOthe ATOarea area

NumbeNumbers may rnsot may add n otup add due u top rouduendi to roung nding *including*including 0.3 bcm 0.3 from bcm Chornomornaftogaz from Chornomornaftogaz before thebefore occupation the occupation of Crimea of Crimea Source:Sou Naftogarce: Naftogaz z UKRAINE’S GAS MARKET IN 20141 bcm 100% OF THE MARKET Ownership structure Ultimate gas users Households Share directly or indirectly owned DHCs for households 1.1 by Naftogaz Public sector and 2.8 DHCs for public sector 1.9 to Moldova Operating needs of Ukrtransgaz and UGV 7.1 Share not owned Industrial and other users by the group 5.3

The circle size corresponds to gas Naftogaz, volumes in bcm direct agreements Flow of gas that 15.4 bcm The column height Ukrtransgaz, total transmission belongs to corresponds to Naftogaz 59.4 to the EU and Moldova to the EU Naftogaz share of the market 62.2 bcm segment 5.3

potentially: 151 bcm UGV operating needs 0.6 1.9 1.8 0.6 15.1 3.4 10.1 to ultimate 15.1 13.4 Stored balance as at 7.1 consumers for households 31 December 2014: 34.8 11.4 bcm 4.9 to distribution Potentially: 31.0 bcm from Europe networks UGV 1.6 14.0 bcm Naftogaz from other transmission 0.7 31.2 bcm , including to networks 14.4 non- group customers from Russia Ukrtransgaz, 29.3 bcm 34.8 transmission to from Ukrtransgaz Ukrainian consumers 38.2 bcm Oblgazes and other 16.8 traders not controlled Ukrnafta2 Naftogaz at the beginning of by Naftogaz, direct 1.7 bcm 19.3 bcm the heating season agreements 2014-2015 25.9 bcm Ukrtransgaz5 10.1 Total: 100.4 bcm Gas distribution and supply companies (oblgazes)8 36.4 bcm Ukrtransgaz Private gas suppliers not Other companies, controlled by Naftogaz Other producers3 Other importers to Ukrainian consumers 10 .1 bcm 4.8 bcm 0.2 bcm 1.6 bcm

SUPPLY TO ULTIMATE GAS PRODUCTION GAS IMPORTS GAS TRANSMISSION GAS STORAGE WHOLESALE TRADING GAS DISTRIBUTION CONSUMERS

TOTAL BY SEGMENTS rd 102.0 Infrastructure that should be unbundled from trading functions according to the 3 Energy Package bcm

7 4 6 41.3 41.3 20.5 19.5 16.8 36.4 SOURCES INFRASTRUCTURE TRADING INFRASTRUCTURE TRADING 1Includes data on Crimea prior to the occupation 2Naftogaz did not exercise control over Ukrnafta in 2014 3Including 1.1 bcm produced by companies where UGV holds a minority stake; 5Ukrtransgaz spent an additional 1.8 bcm of gas for its operating needs; indicated volume includes 0.4 bcm of gas illegally withdrawn in the ATO area 62014 maximum level prior to the start 72 including 0.3 bcm of gas produced by Chornomornaftogaz prior to the occupation and sold to the households in 2014 40.9 bcm of gas used by gas producers for their own operating needs of the heating season in October 2014 7 Excludes 0.4 bcm of gas illegally withdrawn in the ATO area; not accounting for possible secondary market 8 Naftogaz holds minority stakes in some oblgazes 73 and for production of LPG did not enter external transmission systems and was not traded (25%+1 share or less excluding Donetskoblgaz (39%) and Kirovohradgaz (51%); additional 0.9 bcm of gas used for operating needs of oblgazes; transmission volume includes 0.4 illegally withdrawn in the ATO area. Abbreviations: UGV – Ukrgasvydobuvannya, DHCs – district heating companies Sources: Naftogaz, Ministry of Energy and Coal Industry, State Statistics Service, specialized media, company data Numbers may not add up due to rounding OPERATIONS: GAS

GAS IMPORTS AND WHOLESALE TRADING

excessive reliance on a single supplier LARGEST MARKETS IN EUROPE BY GAS CONSUMPTION, 2014, BCM made gas an instrument of political and Ukraine ranks fifth among the largest industrial consumers through direct than in the previous year: 14.9 bcm vs. economic pressure on Ukraine. Being 90 76.2 gas consumers in Europe (including contracts. 16.2 bcm. This is the first substantial charged inflated prices compared to 80 71.5 Turkey). In 2014, Ukrainian consumers reduction in consumption in this the European levels for several years, MARKET CONTRACTION IN 70 60.7 purchased 42.6 bcm of gas. Nearly half category over the last 10 years. DHCs Naftogaz overpaid billions of dollars to 2014 60 47.5 of this amount (19.5 bcm) was imported. (excluding Crimea) have reduced the Gazprom. In 2014, Naftogaz has taken 50 42.6 38.6 In 2014, public and private companies In 2014, gas demand in Ukraine use of gas to produce heat for all this claim to court. 34.8 40 27.9 in Ukraine produced about 20.5 bcm decreased by 15% to 42.6 bcm from categories of consumers by 14% over In December 2013, following years of 30 of gas. The balance was covered by 50.4 bcm in 2013. Excluding data from the same period. Considering that the 16.0 15.0 negotiations and on the backdrop of 20 reserves in underground storage Crimea for the entire 2013 and two winter of 2014 was not significantly mass public protests in Ukraine over 10 facilities. months of 2014, the demand shrank by warmer than 2013, this decrease in the previous government’s decision 0 14% compared to 2013. The demand fell consumption might be explained by an Naftogaz accounts for the majority to sacrifice Ukraine’s ambition of the in all regions of Ukraine and across all increased efficiency. Italy share in almost every segment of the European integration for a tighter Spain consumer categories. Turkey France Poland Ukraine gas market in Ukraine, except for gas GAS IMPORTS alliance with Russia, Gazprom agreed to Germany Belgium distribution and retail supply (see Excluding gas consumption in Crimea, bring the gas price to a justified level. Netherlands The contraction of the domestic Ukraine’s gas market in 2014). the largest reduction in demand demand resulted in a reduction of Following the change of the government United Kingdom (20%) occurred among industrial Sources: Eurostat, Naftogaz Naftogaz is the major importer of gas imports. Compared to 2013, gas in February 2014, Ukraine officially customers because of the hostilities in Russian and European gas to Ukraine. imports in 2014 decreased by almost a resumed the process of the European the industrial area of Donbas and the All marketable gas produced by UGV third, from 28 bcm to 19.5 bcm. In the integration. Consequently, the price overall deterioration of the economy. GAS DEMAND REDUCTION IN UKRAINE, is purchased by Naftogaz to form gas same time, the volume of imports from of Gazprom gas for Ukraine was The significant reduction in national BY CONSUMER CATEGORY resources for households. Europe increased almost 2.5 times: from unilaterally increased by Russia in and transit gas transmission volumes 2.1 bcm in 2013 to 5.0 bcm in 2014. 2Q 2014 by 80% to a level that was 2013 2014 % Naftogaz sells this and imported gas resulted in a 10% reduction of gas Gas imports from Russia decreased by 25-30% higher than the price at which Total gas demand in Ukraine 50.4 42.6 -15% to regional gas distribution and supply volumes used by gas transmission and Total gas demand in Ukraine (excluding Crimea) 48.7 42.1 -14% almost 50%: from 25.8 bcm to 14.5 bcm. Naftogaz bought gas in Europe in the companies (oblgazes) to be sold on distribution system operators for their Households 16.8 15.1 -10% same period. After Naftogaz refused Households (excluding Crimea) 16.2 14.9 -8% to households and public sector operating needs. In 2013, Ukraine imported 92% of to cover the inflated bills, Gazprom DHCs (all categories) 10.2 8.6 -16% institutions. Naftogaz also sells gas to its gas from Gazprom with the rest DHCs (all categories excluding Crimea) 9.8 8.4 -14% In 2014, residential consumers stopped supplying gas to Ukraine for Industrial consumers 18.2 14.2 -22% district heating companies (DHCs) and coming from European suppliers. The (excluding Crimea) used 8% less gas almost six months. Industrial consumers (excluding Crimea) 17.6 14.0 -20% 74 75 OPERATIONS: GAS

ORIGINS OF GAS IMPORTED INTO UKRAINE, BY VOLUME, % gas prices for this category to the level the long-term underfunding of capital Prior to the introduction of the no longer be regulated. This change 2013 2014 of prices for industrial consumers. investments in UGV may lead to a rapid new market rules starting from 1 in regulations will allow Naftogaz to output decline in the coming years. October 2015, the national regulator compete in this sector on transparent Reduction in In 2014, the volume of gas sold to set maximum gas prices for other market conditions. imported volumes consumers that paid full market prices consumers. In most cases, these prices and were not members of Naftogaz The recent legislative changes help covered the costs associated with Russia group amounted to nearly 15.4 bcm. Despite the low price to resolve another distortion in the gas purchase but the prices were Russia The share of Naftogaz in this market Naftogaz operating framework. In 2014, of locally produced nonetheless regulated. was below 35% (5.3 bcm). Other legislation was in force which required suppliers sold 10.1 bcm of gas to these gas, supplying gas for Because of the particularities of Naftogaz, as the guaranteed supplier, to Europe customers. households is the most the interpretation of the Ukrainian sell gas to virtually any buyer, regardless Russia 92% Russia 74% legislation by certain controlling bodies, of their financial status or payment Naftogaz sold a further 1.9 bcm to loss-making business Europe 8% Europe 26% Naftogaz could not sell gas to industrial history. its group companies to cover their Total 100% Total 100% consumers at a price below the operating needs, specifically to segment for Naftogaz The regulatory amendments approved established maximum. This significantly Ukrtransgaz for transporting gas to in 2015 will allow Naftogaz to assess weakened Naftogaz position in the Ukrainian and European consumers. client financial status, reject signing new In 2014, following the launch of the Almost 70% of total gas volume sold by These losses are caused by the commercial gas market and led to a This gas was priced at the industrial contracts with indebted customers and Slovak gas transmission route in Naftogaz was priced at a level that did obligation of Naftogaz to sell large reduction of the company share in this rate. increase the efficiency of debt recovery. September 2014, gas imports from not cover the weighted average cost of volumes of imported gas at prices profitable market sector. These measures are designed to reduce Russia fell to 75% of the total. In the purchasing this gas. GAS TRADING IS A significantly below the cost of this Following the implementation of the Naftogaz losses, stabilize the company's first half of 2015, the share of Russia LOSS-MAKING SEGMENT gas. The losses are not covered by the Naftogaz was the only supplier who new gas market law in October 2015, financial condition and lessen the need contracted to 37% of Ukraine’s gas FOR NAFTOGAZ positive result achieved from supplying covered the needs of Ukrainian gas prices for industrial consumers will for the state support. imports. locally produced gas to households. households (15.1 bcm for individual In 2014, Naftogaz was entitled to buy Determined to diversify sources of gas use and 7.1 bcm for DHCs to produce marketable gas from state-owned gas In 2014, the situation further imports to Ukraine, in October 2014 heat for households). Naftogaz received producers to create gas reserves to deteriorated because of the occupation AVERAGE PURCHASE PRICES PAID FOR IMPORTED GAS Naftogaz started buying gas from Europe's only 13.9 bcm from Ukrainian state- cover the needs of households. The of Crimea. In previous years, Naftogaz AND UGV GAS EXCLUDING VAT, UAH/TCM largest gas supplier, the Norwegian owned producers at a regulated price balance of these needs not covered bought marketable gas produced by 3 389 2012 Statoil. Furthermore, in 2014 Naftogaz set below the market level. To cover by gas produced by state-owned Chornomornaftogaz at a low regulated 350 Price of imported gas adjusted its trading operations to the remaining needs of households, companies is covered by imported gas. price. A portion of this gas was used to Price paid to UGV 3 169 become compatible with the established Naftogaz imported about 8.2 bcm of gas In order to minimize the compensations supply to households in Crimea. The 2013 European market rules and standards. at market prices in 2014. from the state budget to Naftogaz, the rest was used by Naftogaz to cover the 349 In particular, the company started using regulator priced the marketable gas needs of households in other regions of Naftogaz supplied another 7.2 bcm of 3 408 EFET contracts and trade on the VTP. produced by state-owned companies Ukraine. Because this resource was not 2014 gas to other categories of customers 349 These transformations helped Naftogaz to significantly below its market value. available in 2014, Naftogaz was forced to (industry, DHCs, public sector and significantly expand its range of suppliers import 1.3 bcm of additional gas in order 6 551 others). In this way, Ukraine's largest gas 2015 in Europe and buy gas for Ukraine under to meet the needs of households. producer UGV sold its gas at a price 1 273 increasingly favorable terms. In 1Q 2014, the gas price for public that was more than ten times below the DHCs use only imported gas to produce sector entities was nearly 20% below the 0 1 000 2 000 3 000 4 000 5 000 6 000 7 000 8 000 In the second quarter of 2015, Gazprom price of imported gas in 2014. Because centralized heating for households but price charged to industrial consumers. offered to supply Russian gas to of the low selling price, UGV was not the price of this gas is capped below the In April 2014, the National Energy and Naftogaz at a price which matched able to increase production at the rate market. In 2014, the Naftogaz sold this Utilities Regulatory Commission brought REVENUES AND EXPENSES RELATED TO GAS SUPPLY those of Ukraine’s European suppliers. of private gas producers. Moreover, gas more than 5 times cheaper than it FOR HOUSEHOLDS*, 2014, UAH BILLION had paid to acquire this gas. 30 5 In 2014, Naftogaz share in the total – Revenues from gas sales 26.5 1.8 volume of imported gas to Ukraine Trading locally produced gas results WEIGHTED AVERAGE PRICE OF GAS IMPORTED BY NAFTOGAZ, 25 + Cost of gas 0 amounted to 99% (19.3 bcm). Another BY QUARTER, USD/TCM in a positive difference. In 2014, it 20 -5 0.2 bcm were imported into Ukraine by amounted to UAH 1.8 billion. However, Period Weighted average price Weighted average price Weighted 15 -10 private suppliers. Naftogaz continues of gas imported from of gas imported from average price of this profit covers only 9% of the losses 10 -15 actions aimed at expanding the share of all directions, including Europe, including cost gas purchased incurred from selling imported gas for 6.7 4.9 6 5 -20 private suppliers and end consumers in cost of transportation to transportation to the in Europe, at the households, which in 2014 amounted -18.7 gas imports to Ukraine. to UAH 20.5 billion. In this way Naftogaz 0 +–– + -25 -20.5 the border of Ukraine border of Ukraine delivery point 13.9 8.2 2Q 2015 268 275 267 lost UAH 18.7 billion from supplying gas Positive balance on local gas WHOLESALE GAS TRADE 1Q 2015 315 301 293 for households. These losses could not bcm bcm Negative balance on imported gas Deficit In wholesale gas trade, the share of 4Q 2014 353 353 348 be fully offset by the profit Naftogaz Ukrainian gas Imported gas * excluding adjustment in line with IAS 2 Naftogaz in 2014 was nearly 75%. 3Q 2014 360 355 346 made supplying commercial users. 76 77 OPERATIONS: GAS

GAS TRANSMISSION

quality of gas is monitored at all points OPERATING EXPENSES PER VOLUME OF TRANSMITTED GAS, USD/TCM where it exits the Ukrainian GTS and enters the transmission systems of the 25.0 21.8 neighboring European countries. The The Ukrainian gas transmission system and 702 gas pumping units with a total Most of the maintenance work is measurements are carried out at gas 20.0 (GTS) is one of the most powerful in the capacity of 5 448 MW. performed in-house. In particular, the metering stations (GMS) at the eastern 17.2 world. Its entry capacity is above 288 bcm/ internal divisions of Ukrtransgaz: and the western borders of Ukraine. Ukrtransgaz has implemented an 15.0 year and the exit capacity in the European Each GMS is equipped with high- integrated quality management and operate, maintain and renovate 8.6 9.7 direction is over 151 bcm/year. Ukraine's • precision automatic devices for gas flow environmental control system in pipelines, compressors and other 10.0 GTS links the systems of the neighboring measurement and quality control. accordance with ISO 9001, OHSAS 18000 system components Russia, Belarus, Poland, Slovakia, Hungary and ISO 14001. The measurement of volumes and 5.0 Romania and Moldova, and through them diagnose, test and certify the 1.8 • quality of gas entering the Ukrainian it is integrated into the wider European Since November 2014, Ukrtransgaz equipment 0.0 transmission system is conducted by gas network. publishes daily disaggregated data NET4GAS Snam Ukrtransgaz Transgaz S.A Gaz-System S.A. construct and install high and low employees of Ukrtransgaz at GMS (Czech Republic) (Italy) (Ukraine) (Romania) (Poland) on transported gas volumes at the • The operator of Ukraine's GTS is pressure gas pipelines located in Russia close to the Ukrainian Note: operating expenses before amortization and depreciation ENTSOG transparency platform. Sources: ENTSOG, Naftogaz, company data Ukrtransgaz, which is 100% owned by border. Ukraine recognizes delivery of The data is publicly available at conduct research, engineering Naftogaz. According to the 3rd Energy • only those volumes of gas which are transparency.entsog.eu. and design works related to gas Package and Ukraine’s current legislation, measured at GMS where Ukrtransgaz CAPACITY UTILIZATION OF SELECTED GAS TRANSMISSION SYSTEMS: transmission and storage the transmission system operator (TSO) In 2014, the volume of gas transited has its permanent representatives. This PIPELINE LENGTH VS. 2014 TRANSMISSION VOLUMES must become legally and organizationally through Ukraine decreased by 25%, from Despite of the large amount of allows for control of the volume and 120 102 independent from other activities in the 86.1 bcm in 2013 to 62.2 bcm in 2014. maintenance work done internally, the quality of the delivered gas. Because 100 38.6 40.0 gas market which are not related to gas Because of a declining domestic demand operating costs of Ukrtransgaz per unit there are no Ukrtransgaz representatives 32.3 80 32.2 30.0 transmission. The new gas market law for gas, the internal transmission of transmitted gas are below those of at Platove and Prokhorivka GMS, the 62 56 requires for the unbundling of the TSO volumes decreased as well, to nearly neighboring European counterparts. quality and quantity of gas allegedly 60 47 39 13.2 20.0 38 and Naftogaz by June 2016. 40 bcm. supplied by Gazprom to the occupied 40 10.3

GAS IS MEASURED ON ENTRY 10.3 30 14 10.0 territory in eastern Ukraine cannot be 20 UKRTRANSGAZ Despite the decline of the transmission AND EXIT 3.8 4.1 16 5.1 verified. Ukraine does not recognize 0 0.0 volumes in 2014, the capacity utilization Ukrtransgaz GRTgaz Fluxys Transgaz S.A TIGF The pipelines that comprise the Ukrainian Gas volumes entering the Ukrainian GTS any such alleged deliveries within (Ukraine) (France) (Belgium) (Romania) (France) of the Ukrainian GTS is higher than Snam NET4GAS Enagás Gaz-System S.A. GTS are 38.6 thousand kilometers long. as well as the physical and technical the framework of the existing gas (Spain) that of a number of European gas (Italy) (Czech Republic) (Poland) The system consists of 72 compressor characteristics of this gas are carefully supply contract between Naftogaz and transmission systems and is comparable Transmitted gas volumes, bcm (lhs) stations, 1 458 gas distribution stations measured. Similarly, the volume and Gazprom. to the French TIGF. Pipeline length, thousand km (rhs) 78 79 UKRAINIAN GTS CONNECTS EU NETWORKS LITHUANIA RUSSIA Gas storages Gas hubs

Existing pipelines

Planned pipelines BELARUS Key interconnector blocked by Gazprom POLAND Possible directions of gas flows

LNG terminal

LNG terminal under construction GERMANY Planned LNG terminals

UKRAINE

CZECH REP. SLOVAKIA RUSSIA

AUSTRIA MOLDOVA ROMANIA HUNGARY

BULGARIA 2013 2014 1H 2015 UKRAINE’S SOURCES OF IMPORTED GAS 92% 74% 37%

RUSSIA single supplier 63%

EUROPE 8% 26% 80 several suppliers OPERATIONS: GAS

UKRAINE DIVERSIFIES SUPPLY Accordingly, buyers received the Naftogaz aims to minimize the influence In May 2015, Ukrtransgaz and FGSZ, RUSSIAN GAS TRANSMISSION ROUTES TO EUROPE, ROUTES OF IMPORTED GAS purchased gas at the USSR border. of politics both in the domestic gas market the Hungarian TSO, signed a direct BCM, 2000-2014 After the collapse of the Soviet Union, and its relations with foreign partners. interconnection agreement. It was Given Ukraine's dependence on gas Europeans started buying gas from Russia, To achieve this goal, the company works the first agreement between the TSOs supplies from Russia and the non-market Ukrainian GTS Yamal-Europe Nord Stream Baltics Blue Stream and Finland but continued to receive it, as before, on on bringing its relations with neighboring of Ukraine and an EU member state terms at which this gas was supplied, 200 the border of the former Soviet Union TSOs into accord with the 3rd Energy which fully complies with the EU energy launching the new powerful gas delivery 150 — that is, on Ukraine’s border with the Package. legislation. This agreement is the first route via Slovakia was a top priority for 100 EU. Therefore, the European buyers of step for Ukrtransgaz to establish the the new Naftogaz management team Russian gas do not control the gas they comprehensive and unobstructed in 2014. The Slovak GTS is the shortest 50 have purchased until it exits Ukraine. cooperation with its neighboring TSOs. and the most powerful link that connects 0 Launching unobstructed Ukraine with liquid gas hubs of the 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Gazprom does not provide Ukraine with bidirectional cross- Direct interconnection agreements are Western Europe. Source: RBC the so-called shipper codes, the data the only legal basis for cooperation about the individual gas shipments that border gas flows between between TSOs in the Energy Community. On 28 April 2014, Ukrtransgaz and are transported through Ukraine. At On the basis of these contracts, the Eustream, the Slovakian TSO, signed of the agreement would result in an EU through Ukraine since 2011. To this Ukraine and the EU will the gas metering stations on Ukraine's neighboring TSOs exchange information a memorandum of understanding increase of gas flow capacity from Poland end, Gazprom built the bypass route western border the entire volume of gas enable gas trade between on gas flows, their direction, volume, facilitated by the European Commission. to Ukraine by 8 bcm/year to 9.5 bcm/ Nord Stream and continues to attempt is transferred to Gazprom’s subsidiary timing, gas owners and recipients, The document set out the intention year. The agreement also covers the two other projects that would do little the Western Europe and Gazprom Export. This company then etc. In the absence of the standard of the parties to enable unrestricted intention of the parties to store European more than duplicate the capacity of the transfers the gas to the TSOs of the the countries of Central, interconnection agreement, this bidirectional gas flows between Slovakia gas in Ukraine's underground gas Ukrainian GTS. Russia explains the alleged neighboring countries, revealing the information is not exchanged. Naftogaz and Ukraine, including physical and virtual storage facilities and to deliver this gas to need to build excessive gas transmission Southern and Eastern shipper codes to them. continues preparations to sign similar gas flows at all pipelines interconnecting consumers in the EU. routes by the need to diversify European Europe agreements with Slovak, Polish and the two countries. gas supplies. However, in the same time, In this cooperation with the European GAZPROM'S BYPASS PIPELINES Romanian TSOs. it has effectively blocked the supply of TSOs, Gazprom performs a number of On 2 September 2014, a new gas pipeline THREATEN EUROPEAN SECURITY Central Asian gas to Ukraine and the EU. important TSO functions, which violates In particular, Bulgaria, Greece, Romania, In addition to carrying out commercial for physical supply from Slovakia to OF SUPPLY the EU energy legislation. The existing Hungary, Bosnia, Macedonia and Serbia and diplomatic negotiations on this Ukraine was launched. Over the next few There is no doubt that the construction For almost 50 years the Ukrainian gas arrangement hinders the cooperation will be able to buy gas in the Western issue, in October 2014 Naftogaz initiated months, its capacity was increased from of bypass gas pipelines reduces the transmission system has been the main between operators of the neighboring European market. Suppliers from proceedings with the Arbitration Institute the initial 8 bcm/year to 10 bcm/year. importance of traditional transit countries route for transporting natural gas from countries of the Energy Community. Germany, France, Norway and other of the Stockholm Chamber of Commerce Finally, starting from January 2015, for Russian gas, such as Ukraine, Slovakia Ukraine and Russia to European countries. countries will have access to European on its current gas transmission contract the capacity of the new route reached and Poland. In the 1980s, new transit pipelines were markets now dominated by Gazprom. with Gazprom. Naftogaz requests 15 bcm/year. This route can therefore built to transport gas from Western However, the main threat of the excessive The implementation of this project does that the relations between the parties cover up to 90% of Ukraine’s annual gas The existing scheme at Siberia and Central Asia to Central and transmission capacity from a single source not demand any additional investment be brought into compliance with the imports needs. Eastern Europe. The Ukrainian gas is that European buyers are not able to Ukraine’s western border in infrastructure: the Ukrainian GTS is national legislation that implements Naftogaz continues to work on creating transmission system has a low rate of choose their preferred delivery route for artificially obstructs technically prepared to function in this the 3rd Energy Package in Ukraine and additional gas transmission routes and accidents is robust and flexible. It remains Russian gas. If these Gazprom controlled manner. This solution does not require with the international obligations of expanding those currently used by the optimal route for supplying gas from pipelines are built, Russia will have a bidirectional cross- European consumers to make any changes the country as a member of the Energy Ukraine. Russia and Central Asia to Europe and stronger negotiating position and will be border gas flows between to their existing contracts with Gazprom. Community. Turkey. able to command terms to its customers. In particular, Naftogaz pursues Ukraine and the EU, commercial, diplomatic and legal routes to In December 2014, Ukrtransgaz signed The Ukrainian gas transmission system is UNBLOCKING THE INTERCONNECTOR ENABLES VIRTUAL GAS FLOWS enable full and unrestricted bidirectional loan agreements with the EBRD and the a direct, reliable and competitive route for including virtual reverse EU border gas flows at the interconnection point EIB for a total amount of EUR 300 million delivering Russian gas to the EU. It is also Blocks virtual flows reverse flows between Ukraine and Slovakia as well earmarked for the modernization of the the only delivery route for Russian gas to Violates EU Gazprom energy Slovakia Ukraine as at the cross-border points between Ukrainian section of Urengoy-Pomary- the EU that is not controlled by Gazprom. legislation Export 100 Currently, European clients of Gazprom Ukraine and other EU member states. Uzhhorod pipeline. This funding will UNLOCKING THE cannot choose the delivery route for help to improve the energy efficiency An expansion of the physical cross border INTERCONNECTORS BETWEEN gas they purchase from Russia. They 30 100 mcm of this key component of Ukraine’s gas gas transmission capacities is also on the UKRAINE AND THE EU WILL are also unable to use gas they bought bought by transmission system, and will further 30 mcm bought an EU shipper agenda. In December 2014, Ukrtransgaz INCREASE SECURITY OF SUPPLY while it crosses Ukraine. This deprives the by a Ukrainian increase the competitiveness of this route. shipper and GAZ-SYSTEM S.A., the Polish TSO, IN THE REGION European companies of the opportunity 70 mcm is physically transmitted from Ukraine to the EU signed a cooperation agreement to Driven by political rather than economic to benefit from the largest underground Decades ago, Soviet gas was sold to The balance is swapped without being physically transmitted integrate the gas transmission systems considerations, Russia has been reducing storage facilities in Europe and limits their Each party receives the full purchased volume of gas at its side Europe through a purchase agreement of the two countries. The implementation the volume of gas transmitted to the ability to trade in Ukraine. 70 of the border made with the Soviet state company.

82 83 OPERATIONS: GAS

UNDERGROUND GAS STORAGE

Ukrtransgaz operates Europe's most Ukrtransgaz offers gas storage services agglomerate as a foundation for powerful system of underground gas for both gas suppliers and consumers. an Eastern European gas hub. This storages (UGS) which comprises ten Five major facilities are located at the project is being discussed with various depleted gas fields facilities and two western border of Ukraine at the key stakeholders, and is included into aquifer facilities with a total active intersection of gas pipelines which the cooperation agreement between capacity of nearly 31 bcm. The total connect Poland, Slovakia, Hungary and Ukrtransgaz and GAZ-SYSTEM S.A. signed capacity of the facilities operated by Romania. Most of gas delivered from in 2014. Ukrtransgaz equals to nearly a quarter of Russia to the Western Europe passes this Ukraine offers not only the largest the EU-28 total UGS capacity. strategic pipeline intersection. storage capacity but also the most An additional underground gas storage Ukraine has proposed to use this competitive storage rates in Europe. facility with the capacity of 1 bcm is powerful gas transmission and storage located in Crimea and was operated by Chornomornaftogaz prior to the GAS STORAGE COST IN EUROPEAN UGS FACILITIES, 2012, EURO/MWH occupation of the peninsula by Russia. 10 In May 2014, Ukrtransgaz started to 8 provide disaggregated data on gas balances in its UGS facilities at AGSI+, the 6 transparency platform operated by Gas 4 Infrastructure Europe. The information 2 is updated daily and is available at transparency.gie.eu. 0 (RAG) Because the total capacity of Ukraine’s Czech (OMV) (E.ON) (Nafta) Austria Austria Austria Austria Austria (Astora) Ukraine Slovakia Slovakia Bulgaria Hungary Republic UGS facilities is so large, the country can Romania Romania (Poza Gaz) (Poza (Gazprom) offer almost 15 bcm of spare capacity to (Tirgu Mures) European consumers. Source: REKK, company and regulator data 84 85 OPERATIONS: GAS

GAS PRODUCTION

UKRGASVYDOBUVANNYA GAS PRODUCTION VOLUMES IN EUROPE, 2014, BCM (UGV) UGV is the largest gas production company Norway 109 in Ukraine. It also ranks second in oil and Netherlands 56 condensate production and is the largest United Kingdom 37 producer of liquefied petroleum gas (LPG) 19 in the country. Ukraine Romania 11 Proven oil and gas reserves of UGV amount Germany 8 to 1 606 boe (including 1 579 boe of 7 proven gas reserves). By this parameter Italy the company is one of the largest gas Denmark 5 producers in Europe. 4 Poland Великобританія 0 20 40 60 80 100 120 In 2014, Ukraine ranked fourth in Selling prices for gas produced by state- As of the beginning of 2015, the company’s State companies lose Source: BP (based on BP methodology) Europe by volume of produced gas. owned companies in Ukraine were operational assets included 2 441 gas wells Ukraine also ranks third in Europe, historically capped below market rates. gas production market and 194 oil wells, and 82 drilling rigs. The after Norway and the Netherlands, by Setting discriminating price limitations for share to private ones, company develops over 130 fields. PROVEN GAS RESERVES IN EUROPE, BCM proved gas reserves. By increasing the state-owned gas producers served as an The depletion of the company’s initial efficiency of gas consumption and the additional tool to cover the deficit resulting which operate in more recoverable reserves at existing fields 1 922 volume of its production, Ukraine has from supplying imported gas to households Norway liberal conditions and is estimated at almost 72% in gas, 21% the opportunity to eliminate the need to for less than its market value. Netherlands 800 can sell their gas at market in oil and 63% in condensate (for more import gas completely. Ukraine 640 As a result, major gas producers in Ukraine, information on non-gas business segments However, to extract gas abundant in the including Ukrgasvydobuvannya, were not rates of UGV, see section Extraction of crude oil, United Kingdom 241 Ukrainian subsoil, gas producers have able to finance their investment program in condensate and LPG). Romania 110 to actively explore deposits, drill new full, which led in turn to a gradual reduction Poland 98 The underinvestment of production Financing of exploration, drilling and and intensify existing wells. Each well in output by state-owned companies. In programs is reflected in the company intensification Hungary 80 has its own capacity and is gradually many cases, the technologies to which these financial results. Compared to other gas Italy 49 depleted. Therefore, keeping production companies are constrained are morally and For a number of years, UGV was unable to producing companies both in Ukraine and 43 Germany Великобританія at a stable level requires constant technically obsolete, and the exploration fund exploration, drilling and intensification in other countries, Naftogaz invests much investment. activities have slowed down. operations at required levels. 0 500 1 000 1 500 2 000 less capital per unit of extracted product. Source: BP (based on BP methodology) 86 87 OPERATIONS: GAS

financial management system within CAPITAL INVESTMENTS, USD PER PRODUCED BOE Consequently, the company estimates permits (licenses) for subsoil use. team’s strategy focuses on two primary UGV that in 2015 it will be able to produce at From 1999 through 2007, the company goals. Firstly, they should develop and Maximize income from non-gas Naftogaz (Ukraine) 2.3 least 0.4 bcm of gas less than in 2014. received an average of 14 new licenses implement measures to stabilize gas • segments. Petroleum products and Purchasing this volume of gas abroad per year. During the period of 2007 to production and establish conditions for LPG sales account for approximately Novatek (Russia) 3.8 will cost Ukraine nearly UAH 3 billion. 2013 the company obtained only four output growth. Secondly, they should 30% of the group’s revenues This amount is half of what UGV received special permits. modernize UGV, creating a transparent for 13.4 bcm of gas it sold to Naftogaz in and efficient company able to attract Promote deregulation and Romgaz (Romania) 3.9 Only in 2014 did the number of new • 2014 at prices set by the state (for more international investments. necessary legislative changes. UGV licenses start to increase. Last year UGV detail see section Market-based pricing for intends to initiate amendments to Petroceltic (Ireland) 4.8 received nine new licenses, and in 2015 The new management team pursues the Ukrainian gas). the Land Code to streamline land it expects to receive 21 licenses. following goals: allocation procedures for holders of The company management expects to Misen Energy (Ukraine) 6.3 The exploration drilling is further Stabilize and gradually increase special permits and tackle corruption be able to raise sufficient investment as • complicated by the lengthy and gas production. This task related to the land allocation retail prices are gradually liberalized by Nostrum (Kazakhstan) 18.8 complicated land allocation procedures includes renovation of existing April 2017. Raise investments to modernize for gas companies which have obtained fields and wells, intensification of • production. Realization of this Taxation and decline in oil prices special permits for subsoil use. UGV the extraction, hydro-fracturing, Centrica (United Kingdom) 22.2 goal is contingent on the ongoing and other gas producers make efforts installation of new compressor In March 2015, the Verkhovna Rada price liberalization for households to promote a rationalization of the land stations as well as active exploration Bonavista Energy (Canada) 22.7 adopted the Law "On Amendments to and the amendments to laws allocation procedure for permit holders. of new deposits the Tax Code of Ukraine." This decision regulating royalty rates. However, the 24.0 raised royalty rate for UGV from 20% Because of the armed conflict in • Conduct operational diagnostics. preliminary analysis and appropriate Eni (Italy) in 2014 to 70% of revenue in 2015. The Donbas, UGV lost gas production A comprehensive diagnostic study transformation of UGV internal royalty hike was adopted to provide the facilities with a total capacity of nearly is currently ongoing to identify the business practices need to be started OMV Petrom Group (Romania) 24.2 government with a guaranteed source 200 mcm/year. most efficient modernization projects in advance for financing utility subsidies following in terms of output increase per unit 25.3 Estimated production volumes in 2016 Build a strong and qualified team. MOL (Hungary) the substantial gas price increase for of invested funds • UGV focuses on upgrading personnel households. If UGV is not able to secure investments Upgrade efficiency measurement recruitment and development Statoil (Norway) 26.2 in drilling new wells and intensification • Under the new regulations, UGV receives policy. Success of extraction policy, supporting relevant research, of existing wells, the amount of gas UAH 477/tcm net of royalties (nearly activities should be measured by developing a system of internal OMV (Austria) extracted in 2016 will be set to fall. The 34.7 USD 22/tcm) for its gas. This amount is the effect on gas volumes extracted communications, creating a full-scale rate of this reduction is estimated at hardly sufficient to cover the company’s relative to the costs incurred, rather research division, which would i.a. 1.2 bcm of gas per year. Serinus Energy (Ukraine) 35.9 operating expenses and rules out capital than on the number of drilled meters analyze the competitiveness of prices investments in the development of new UGV has launched a comprehensive for goods and services offered to UGV Implement new transparent Birchcliff Energy (Canada) 36.6 deposits. performance audit of its wells and fields • procurement procedures. Increase operational safety. The in order to determine the most cost- • The company’s finances were further Procuring goods and services in group makes efforts to improve 40.1 and time-efficient ways of increasing the BG Group (United Kingdom) negatively affected by the decline in oil a transparent and cost efficient informational security and workplace output. UGV intends to use the results prices during 2014-2015. The oil segment manner in line with international safety at its industrial sites. of this research to defend minimum FX Energy (Poland) 66.7 is unregulated, and UGV income from best practices is a matter of survival sales prices that would enable the CHORNOMORNAFTOGAZ its non-gas business is used to cover the for the company given its current company at least to stabilize the output. company’s administrative and financing resource constraints. Making steps In 2014, Naftogaz lost control over the TransAtlantic Petroleum (Turkey) 76.9 expenses. According to the preliminary estimates, to implement this goal, UGV has assets of Chornomornaftogaz in Crimea 0 10 20 30 40 50 60 70 80 the minimum amount UGV should recently joined the newly developed because of the Russian occupation of The combination of the regulated gas Sources: Naftogaz, company data retain, after the deduction of all taxes e-procurement system ProZorro. the peninsula. It was expected that prices, the increased royalty rate and the and subsoil charges, is approximately the company produces approximately decline of prices for oil and petroleum Improve financial management. UAH 3 000/tcm (nearly USD 135/tcm). • 2 bcm of gas in 2014. Proven oil and gas products results in an extremely The work is in progress to enable The resulting revenue stream should reserves of Chornomornaftogaz as at network of 90 filling stations (including approximately 0.2% of the country’s challenging operating environment for the preparation of IFRS-based enable the company to secure necessary 31 December 2013 were estimated at 9 stations located in currently occupied total gas consumption. The sales volume UGV. financial statements on a quarterly funding for its urgent investment almost 200 million boe, or approximately territories). Naftogaz owns 100% of declined by 26% in 2014 compared to 2013. basis. Implementation of this goal Other factors influencing operations: programs. 10% of total proven reserves of Naftogaz. Ukravtogaz. The UAH-denominated market prices for also requires standardization and special permits, land allocation, losses gas used by Ukravtogaz increased sharply Future development unification of accounting policies UKRAVTOGAZ In 2014, the company sold approximately related to military actions in 2014 and have negatively affected across the UGV group, conducting 97 mcm of gas as fuel for motor vehicles, In June 2015, Naftogaz appointed a The company produces compressed the competitiveness of compressed gas The pace of exploration activities at UGV a revision of the group’s assets which represents nearly a third of new management at UGV. The new natural gas and distributes it via its compared to other fuel types. also depends on obtaining new special and liabilities, as well as reforming compressed gas sales in Ukraine, and 88 89 ACCESS TO GAS FOR HOUSEHOLDS AND GAS METERING Ivano- Frankivsk as at 31 December 2014 Share of households in the region 82% that have access to gas Share of households in SUMY the region that use gas for: 93% 69% cooking only, % VOLYN warming water CHERNIHIV and cooking, % 66% heating, warming water RIVNE 62% and cooking, % Share of households 78% with gas meters in place, % 64% ZHYTOMYR 77% Share of households with 62% KYIV access to gas in the region: 77% 50-60% 91% 60-80% 86% 80-95% KYIV CITY 88%

70% POLTAVA KHARKIV

87% 76% LUHANSK** 88% 16% LVIV 71% 87% TERNOPIL KHMELNYTSKY 80% 72% VINNYTSIA CHERKASY 74% 53% 80% 56% 66%

87% 93% 78% 77% ZAKARPATTYA IVANO-FRANKIVSK 90% 67% 82% CHERNIVTSI KIROVOHRAD DNIPROPETROVSK DONETSK** 87% 67% 51% 86% 62% 97% 93% ODESA 88% 58% 67% 52% SHARE OF HOUSEHOLDS THAT USE GAS WITH GAS METERS IN PLACE, % per region, ordered by gas use type MYKOLAYIV KHERSON ZAPORIZHZHYA

100 73% 59% 73% 68% 80 80% 80% 59% Ukrainian legislation requires that gas meters are installed: 60 by 1 January 2012 for households that use gas for heating, warming water 40 and cooking CRIMEA* by 1 January 2016 for households that use gas for warming water and cooking 20 73% by 1 January 2018 for households that use gas for cooking 0 Including households that 79% use gas for: Lviv Kyiv VolynSumy Rivne Kharkiv Odesa Poltava cooking, % Kyiv City Crimea* Kherson Vinnytsia Ternopil Chernihiv Cherkasy Mykolayiv Zhytomyr Donetsk** UKRAINE Luhansk** Chernivtsi Kirovohrad Zakarpattya warming water and cooking, % Zaporizhzhya Khmelnytsky Dnipropetrovsk Ivano-Frankivsk heating, warming water and cooking, % 90 Share of households with gas meters in place, % 91

*As at 1 March 2014 Sources: Ministry of Energy and Coal Industry, Ministry of Regional Development, Construction and Housing and Communal Services, State Statistics Service, regional gas **As at 1 July 2014 distribution and supply companies, Naftogaz OPERATIONS: GAS

GAS DISTRIBUTION AND RETAIL SUPPLY

National gas consumption per region, Region % 2009-2013 average (bcm) Donetsk 14% Dnipropetrovsk 12% Following the privatization of regional 1. District heating companies and heat and The Ukrainian legislation required the Luhansk 7% Chernihiv gas distribution and supply companies power plants for: regional gas distribution companies to Kyiv city 7% Volyn 0.64 Rivne 0.91 Kharkiv 6% 1.21 Sumy (oblgazes) Naftogaz is no longer a significant create new companies that will supply gas Zhytomyr 1.10 producing heat for the households Kyiv region 5% player in the gas distribution market. • to consumers and unbundle this business 0.92 Kyiv city Odesa 5% 3.4 Naftogaz continues to own minority stakes producing heat for the public sector by 1 July 2015. The oblgazes will continue • Cherkasy 4% Kyiv region in a number of oblgazes (25%+1 share to deliver gas to end consumers. New Poltava 4% Lviv 2.54 Poltava 2.07 Khmelnytsky 2.20 • producing electric power Lviv 4% Kharkiv or less, except for Donetskoblgaz where supply companies can be part of vertically Ternopil 1.00 3.21 Zaporizhzhya 4% 0.86 Cherkasy it owns 39%). The only gas distribution 2. Industrial consumers integrated companies, but should be 2.27 Luhansk Crimea 4% Vinnytsia 1.14 3.51 and supply company consolidated in legally and organizationally separated from Mykolayiv 2% Ivano-Frankivsk Dnipropetrovsk 3. Transmission and distribution Zakarpattya 1.13 Kirovohrad 5.96 Naftogaz group is Kirovohradgaz, where functions related to the distribution of gas. Rivne 2% 0.70 Chernivtsi 0.66 system operators to cover their operating Vinnytsia 2% 0.51 Donetsk Naftogaz owns 51% of shares. The share 6.90 needs This unbundling was introduced to Ivano-Frankivsk 2% of Kirovohradgaz in the gas distribution Sumy 2% Mykolayiv create conditions that would encourage 1.26 Zaporizhzhya market was less than 1% in 2014. In addition, Naftogaz sells gas to the Khmelnytsky 2% competition among retail suppliers Odesa 1.85 oblgazes that then in turn sell this gas to: Zhytomyr 2% 2.53 Prior to 2011, Gas of Ukraine (a Naftogaz of gas. The new legislation enables Kherson Chernihiv 2% Total consumption, bcm Total consumption, bcm 0.57 Ternopil (including gas for operating needs (excluding gas for operating needs subsidiary) sold gas purchased by Naftogaz • Households Ukrainian consumers to buy gas form any 2% of gas production transmission of gas production transmission and distribution) and distribution) to end consumers. Today, Gas of Ukraine’s supplier they choose. The liberalization Zakarpattya 1% Public sector and religious Kirovohrad 1% 2009 51.9 2009 47.3 main function is debt recovery. As of the • of gas prices for households expected to organizations Volyn 1% 2010 57.7 2010 53.5 Crimea end of 2014 the total amount of debt of complete in April 2017 is going to bring Kherson 1% 2011 59.3 2011 55.0 1.76 consumers to Gas of Ukraine including the • Certain industrial consumers and competition and improved level of service Chernivtsi 1% 2012 54.8 2012 51.7 6.0-7.0 bcm/year 1.8-3.8 bcm/year accumulated fees and penalties amounted district heating companies into this market. 2013 50.4 2013 46.9 <1.3 bcm/year to nearly UAH 10 billion. Other private gas traders supply Naftogaz is considering an entry into the Now Naftogaz sells gas directly to the gas to industrial consumers directly market of retail supply for households in following consumers: as well. the future. 92 93 CRUDE OIL, PETROLEUM PRODUCTS AND LPG MARKET LEGEND: IN UKRAINE1 Ownership structure 2014, thousand t Share owned by Share owned by non-group companies group companies

Ukrnafta sells crude oil and condensate to wholesale traders via auctions; the Ownership information products are then refined by Ukrtatnafta absent or incomplete The size of the circle corresponds to volumes of oil, p etroleum products or L PG in thousand t

Ukrnafta 1 888 Ukrtransnafta, transit transmission 15 013

Ukrtatnafta buys crude M P RODUC TS UGV Ukrtatnafta* oil and condensate 535 from wholesale Ukrnafta buys oil products from wholesale 1 155 traders, and sells traders and supplies to end consumers via refined petroleum its network of fuel stations products to wholesale traders Ukrtransnafta, national transmission 1 847 UGV 364 Others 308 AND PET ROL EU OIL 2 731 16 860 1 519 6 896 n/a 8 578 636

EXTRACTION OF CRUDE CRUDE OIL TRANSMISSION PRODUCTION OF PETROLEUM IMPORT OF WHOLESALE TRADING OF RETAIL SUPPLY OF PETROLEUM EXPORT OF PETROLEUM OIL AND CONDENSATE PRODUCTS (OIL REFINERY) PETROLEUM PETROLEUM PRODUCTS PRODUCTS TO END CONSUMERS PRODUCTS PRODUCTS IN UKRAINE

*Total capacity at Kremenchuk refinery:

18.6 thousand t of crude oil per year GA S

UGV Ukrnafta 177 163 M QU EFIE D Ukrtatnafta Others LI 63 37 PET ROL EU 440 451 n/a 901

LPG LPG SUPPLY IMPORTS LPG WHOLESALE TRADING LPG SUPPLY TO END CONSUMERS IN UKRAINE 94 95

1Excluding Crimea; Sources: Naftogaz, Ministry of E nergy and Coal Industry, State Statistics Ser vice, specialized media, company data, Ukrainian LPG association n/a – data n ot available OPERATIONS: OIL

CRUDE OIL OIL TRANSMISSION SYSTEM OF UKRAINE TRANSMISSION

Holovashivka Pleshchivka Hlynsko- Rozbyshevska

Chyzhivka Hnidyntsi Novyny

Brody Velykotsk Drohobych Kurovychy Kremenchuk Lysychansk Pereshchepyne Boryslav Novoaidar Zhulyn Oriv Chykalivka Dolyna Kamyanohirka Luhanska Proletarska Karpaty Solochyn Shyroke

Stepova Andriivka LEGEND Mykolayivska existing oil pipelines Snihurivka

planned oil pipelines Avgustivka Pivdenny oil refineries

existing oil pumping stations

planned oil pumping stations

UKRTRANSNAFTA approximately 90% of transported of the company to generate a timely and of transit countries in its oil business. The oil refinery market in Ukraine was volumes. In addition, the oil transmission adequate response to these systemic Instead, Russia focuses on promoting the hit by the competition from Russian Ukrtransnafta operates the 4 700 km long network transports locally produced crude changes in the operating environment. development of its own networks and and Belarusian refineries. Belarusian Ukrainian oil transmission network. The oil from oil fields to the Kremenchuk maximizing use of marine export terminals. refineries process Russian Urals oil company is a 100% subsidiary of Naftogaz. Since 2009, the volume of oil transported Refinery. This segment accounts for nearly The consequences of this strategy have and achieve higher level of refining Ukrtransnafta comprises three affiliates: through the Ukrainian system decreased 10% of the volumes transmitted in 2014. already been felt by transit countries such depth compared to most facilities Prydniprovsky Main Oil Pipelines (central from almost 40 million t to nearly as Belarus, Poland, Ukraine and Lithuania. in Ukraine. In addition, Russian and and eastern regions of Ukraine), Druzhba KEY OPERATING CHALLENGES 17 million t, including the oil transit, which Belarusian refineries enjoy favorable Main Oil Pipelines (northern and western decreased from 29 to 15 million t over The internal demand for oil transmission Decline in demand for oil transmission customs conditions. Before the customs regions of Ukraine), as well as Southern this period. The drastic decline in transit services contracted as well primarily services restrictions were lifted by Ukraine in 2005, Main Oil Pipelines (southern regions of volumes was a result of the redirection because of the reduction of oil production Ukrainian refineries processed more than Ukraine). The biggest challenge for Ukrtransnafta of export flows of Russian and Kazakh oil and refinery levels in Ukraine. Currently 22 million t of crude oil per year, and a is the 50% decline in demand for oil toward alternative transmission routes. only the Kremenchuk Refinery continues Ukraine’s oil transmission system delivers portion of produced petroleum products transmission services in recent years, as well to operate in Ukraine, and only 10% of its Russian oil to Central and Western Russia has adopted and implemented was exported. as the failure of the previous management capacity was used in 2014. Europe. Transit deliveries account for a strategy aimed at minimizing the role 96 97 OPERATIONS: OIL

VOLUME OF PRODUCTION AND TRANSMISSION OF CRUDE Ensure secure and stable system OIL AND OIL PRODUCTS IN UKRAINE MILLION T, 2010-2014 operation 40 38.5 EXTRACTION OF CRUDE OIL AND Extraction of crude oil and condensate • Develop and approve an investment 35 31.1 Transportation of crude oil (incl. transit) plan for Ukrtransnafta till 2020 CONDENSATE, PRODUCTION 30 27.5 Production of petroleum products OF PETROLEUM PRODUCTS AND 25 • Complete the renovation of oil 18.9 20 18.6 16.9 reservoirs with the capacity of 110 tcm LPG 15 • Return technological oil from storages 10 9.2 8.7 7.5 4.0 back into the pipelines 5 3.5 3.3 3.3 3.7 3.1 2.5 2.7 1.5 0 • Promote legislative changes to improve 2009 2010 2011 2012 2013 2014 protection of the oil transmission Source: Ministry of Energy and Coal Industry of Ukraine network from unauthorized access • Develop and implement investment program to improve safety and security Ukrtransnafta and the Ukrainian refinery Transparency and operational at oil facilities, including technologies for businesses were so far unable to efficiency issues early detection of unauthorized access effectively address the systemic changes An important issue the new team in the market. All but one oil refineries in Improve operational efficiency of Ukrtransnafta has to deal with Ukraine suspended their operations. More is making the company more Initiate the publication of annual IFRS Naftogaz owns shares in Ukrnafta, Ukrgasvydobuvannya (UGV) and Ukrtatnafta which than 1300 km of oil transmission pipelines • transparent and accountable to regain financial statements were transferred to the standby mode. operate in the Ukrainian market for oil, petroleum products and liquefied petroleum confidence of the company’s partners, More than 600 thousand t of technological • Develop and adopt new tariff setting potential employees, the public and gas (LPG). In addition, Chornomornaftogaz owns the rights to a number of assets in oil was pumped out of the pipelines. In system for oil transmission, improve the other stakeholders. In particular, particular, one of the two lines of the efficiency of internal oil transportation oil upstream in Crimea. The company does not currently have access to these assets Ukrtransnafta intends to initiate regular Mozyr-Brody pipeline, Ukraine’s primary routes preparation of IFRS-based financial because of the occupation of the peninsula. oil transit route, was put on hold. statements audited by a reputable • Suggest changes to the legislation Insufficient funding of capital international firm. The company also necessary to improve the operating investment programs needs to deal with retaining its most environment of the company UGV Refinery qualified personnel and rebuilding its Another challenge for Ukrtransnafta is • Raise the level of public confidence reputation of an attractive employer. Oil and condensate extraction UGV largest refinery facility is Shebelynsky Refinery. In addition, the insufficient funding of the required through regular and timely the company has the following refinery capacities: LPG producing maintenance works to ensure safe and CURRENT GOALS communications UGV is the largest gas production company in Ukraine and second Yuliyivska and Tymofiivska facilities for the advanced extraction of reliable operation of the network. This in the production of oil and condensate: in 2014 the company's In the spring of 2015, Naftogaz Develop and implement a modern hydrocarbons, the Bazylivschyna plant producing LPG and stabilized situation continued for several years • share in the total gas production was 68%, and it had a 20% share in succeeded in changing Ukrtransnafta personnel selection and development gas condensate, the Yabluniv division producing LPG and dry gas, before the management was changed in crude oil and condensate extraction in Ukraine. management. The new management policy and the Orhovytska plant, which produces bitumen. 2015. is addressing the challenges that the As of the beginning of 2015, the company’s operational assets UKRSPETSTRANSGAZ UGV is the largest producer of LPG (a mixture of propane and Instead of investing in the system company now faces and aims to achieve included 2 441 gas wells, 194 oil wells, and 82 drilling rigs. There butane) in Ukraine. In 2014, the company produced 187 thousand maintenance and repair, the previous a number of short- and long-term goals: The company transports liquefied petroleum are presently 139 hydrocarbon fields under development, located t of LPG, a 17% reduction compared to 2013. The company also management placed the company cash in gas (LPG) by rail using its own railway in Kharkiv, Poltava, Sumy, Donetsk, Dnipropetrovsk, Luhansk, Lviv, Analyze opportunities to increase produced 206 thousand t of gasoline (30% less than in 2013), and term deposits in banks. wagons from manufacturers to consumers Ivano-Frankivsk, Volyn, Chernivtsi and Zakarpattya regions. demand 118 thousand t of diesel fuel (21% less than in 2013). The production in Ukraine and abroad. Ukrspetstransgaz is During the past years, 22 oil reservoirs The depletion of the company’s initial recoverable reserves at decrease was caused by the reduced extraction of key raw materials. Develop and adopt Ukrtransnafta 100% owned by Naftogaz. with a nominal capacity of 225 tcm were • existing fields is estimated at almost 72% in gas, 21% in oil and strategy till 2020 to reflect changes Petroleum products supply put on standby. With these reservoirs not In 2014, the company shipped 240 63% in condensate. in the operating environment ready for operation, in 2014 and 2015 the thousand t of liquefied gas, which is 28% UGV covers nearly 4% of the total demand for petroleum products In March 2015, the parliament increased the royalty rate for oil previous management of Ukrtransnafta Increase the oil transit capacity to less than in 2013. The reduction in LPG and nearly 21% of the total LPG demand in Ukraine. • and gas companies, and for UGV it was set at 70% of revenues to concluded contracts for storage of the the EU by re-launching the Mozyr- transportation volumes is caused by a ensure the state has sufficient reserves to finance utility subsidies The company has a network of 15 filling stations in the Kharkiv company’s technological oil at the facilities Brody pipeline section which is corresponding decrease in LPG production for households following the gas price hike. The increased royalty region. In 2014, this network sold 5% of the petroleum products of third parties at prohibitively high currently in standby mode and consumption in Ukraine. rate, albeit introduced for plausible reasons, negatively affects the produced by UGV. The remaining oil products were sold by the costs. The outcomes of the past strategy Market Ukrtransnafta transit Ukrspetstransgaz is the only provider of finances and production rate of UGV and, if extended for a long company at public auctions or through direct contracts. resulted in unjustified expenses for • capacities to potential clients outside LPG railway transportation services for LPG period of time, can lead to a sharp reduction in the production of oil Ukrtransnafta. Between June 2015 and April 2016, oil products produced by UGV of Ukraine producers in Ukraine. and gas in Ukraine. will be sold through its retail network of filling stations, at public 98 99 OPERATIONS: OIL

condensate extraction was 69%, and it accounted for 6% of gas oil by 15%. This problem was corrected in January 2015 when auctions, or through tenders where it will exclusively produced in Ukraine. the Cabinet of Ministers made appropriate changes to auction supply the Defense Ministry, Interior Ministry, Security regulations. Service, Foreign Intelligence Service and other As of the beginning of 2015, Ukrnafta operated 1 949 oil wells and government agencies responsible for the military 185 gas wells and 58 drilling rigs. The company has extraction Ukrnafta produces LPG at three processing plants: Kachaniv, operation, or as prescribed by decrees of the Cabinet of facilities in Poltava, Chernihiv, Sumy, Kharkiv, Dnipropetrovsk, Lviv, Hnidyntsiv and Dolyna. In 2014 a total of 163 thousand t of LPG Ministers of Ukraine. Ivano-Frankivsk and Chernivtsi regions. was produced, which is 4.8% less than the previous year.

UKRNAFTA The depletion of the company’s initial recoverable reserves at Petroleum products supply existing fields is estimated at almost 83% in oil and 81% in gas. Naftogaz is the major shareholder in Ukrnafta, holding Ukrnafta owns one of the largest networks of filling stations in a 50% + 1 stake in the company. However, in 2014 In 2014, the volume of oil and condensate extracted by Ukrnafta Ukraine, with more than 500 facilities in most of the regions across Naftogaz did not exercise control of the company decreased by 7% compared to 2013, and amounted to 1 888 the country. and Ukrnafta was not consolidated in the financial thousand t. Production of oil gas reached 449 million cubic meters, The share of Ukrnafta filling stations in the total sales of gasoline statements of the group for 2012-2013 and 2014. The which is 7% more than in 2013. and diesel fuel in Ukraine in 2014 reached 15%, and the network share of Naftogaz in Ukrnafta operations is reflected Refinery had an 18% market share in LPG sales in Ukraine. in the consolidated financial statements under ‘Investments in associates’. By law, Ukrnafta sells crude oil and condensate it extracts through LPG Ukrnafta sells is mostly of its own production. In supplying public auctions. Kremenchuk Refinery, which belongs to Ukrtatnafta gasoline and diesel fuel, the company uses products from external On 10 October 2014, an extraordinary meeting of the (43% owned by Naftogaz), is now the only oil refinery operating in suppliers. The Ukrnafta audit committee discovered that in 2014 shareholders of Ukrnafta approved the distribution of Ukraine. Ukrnafta suffered UAH 800 million in losses in this market segment, the company profits for 2011-2013. The dividend share primarily because it was buying gasoline and diesel fuel above the of Naftogaz should have been transferred to the state Because of distorted regulations, in 2014, Ukrnafta crude oil was market rate. budget. However, the executive body of the company sold with a de facto discount factor, reducing the selling price of has not fulfilled this decision as of October 2015.

In March 2015, the Verkhovna Rada adopted the law ‘On Amendments to the Law of Ukraine On Joint Stock Companies’, which reduced the requirements for a shareholder quorum to 50%. Naftogaz is currently Drohobych Refinery (Halychyna) Kremenchuk Refinery (Ukrtatnafta) Shebelynsky Refinery examining how this reduction will influence the Total capacity, million t per year Total capacity, million t per year Total capacity, million t per year 8.7 18.6 1.0 group’s ability to regain control of and, therefore, the Refined in 2014 Year production halted Refined in 2014 Year production halted Refined in 2014 Year production halted consolidation of Ukrnafta. - 2012 1.2 – 0.4 – Maximum refinery quality Refinery depth Maximum refinery quality Refinery depth Maximum refinery quality Refinery depth Oil and condensate extraction of gasoline of diesel fuel 63% of gasoline of diesel fuel 74% of gasoline of diesel fuel 63% Euro-1 Euro-1 Euro-4 Euro-3 Euro-3 Euro-3 Ukrnafta is one of the largest oil and gas companies in the country. In 2014, the company share in oil and

Nadvirna Refinery EXTRACTION OF CRUDE OIL AND CONDENSATE, PRODUCTION OF PETROLEUM PRODUCTS AND (Naftohimik Prykarpattya) LPG BY COMPANIES WHERE NAFTOGAZ OWNS SHARES, 2014 Total capacity, million t per year 2.6 Company Crude oil and Petroleum products LPG Refined in 2014 Year production halted – 2011 condensate (gasoline, diesel, fuel oil) Maximum refinery quality Refinery depth of gasoline of diesel fuel 60% thou- % of total thou- % of total % of total thou- % of total % of total Euro-1 Euro-1

sand t extraction sand t production consump- sand t production consump- in Ukraine in Ukraine tion in in Ukraine tion in Ukraine Ukraine Odesa Refinery Kherson Refinery Lysychansk Refinery (LINIK) % owned by by % owned Naftogaz Total capacity, million t per year Total capacity, million t per year Total capacity, million t per year UGV 100% 533 20% 378 25% 4% 187 42% 21% 2.8 1.1 7.0 Ukrnafta* 50% + 1 888 69% - - - 163 36% 18% Refined in 2014 Year production halted Refined in 2014 Year production halted Refined in 2014 Year production halted 1 share – 2014 – 2005 – 2012

Ukrtatnafta* 43% - - 1 155 75% 14% 63 14% 7% Maximum refinery quality Refinery depth Maximum refinery quality Refinery depth Maximum refinery quality Refinery depth of gasoline of diesel fuel 74% of gasoline of diesel fuel 48% of gasoline of diesel fuel 71% Total - 2421 89% 1533 100% 18% 413 92% 46% Euro-3 Euro-4 Euro-1 Euro-1 Euro-4 Euro-5

*not consolidated in the financial statements of Naftogaz for 2014 Source: Ministry of Energy and Coal Industry of Ukraine 100 101 00X_PULL OUT MAP_Front_EGYPT_2015.qxp_Layout 1 02/03/15 17:23 Page C

EGYPT 2015 CONCESSIONS AND LICENCES

CONCESSIONS/LICENCES 167 213 245 282 327 Baltim East (267 square kilometres) North Matruh Disouq (500 square kilometres) West Sitra (17 square kilometres) North Gamasa O˜shore Block 0 (Baltim North, (798 square kilometres) RWE Dea (OP, 50 percent) Sitra Petroleum Company (281 square kilometres) Abu Madi (197 square kilometres) North East 1 and 2, South) Shell Egypt (OP, 100 percent) LEBANON EGPC (50 percent) (OP, 100 percent) (Block 1a and 1b) Petrobel Belayim Petroleum Mediterranean Gas Company Awarded: November 2012 SYRIA Awarded: May 2011 Shell Egypt (0 percent*) BG Egypt (OP, 100 percent) Company (OP, 100 percent) (OP, 100 percent) Expires: November 2015 Expires: May 2031 Awarded: November 2012 Awarded: April 2009 Awarded: July 1977 Awarded: January 1996 Expires: November 2032 Expired/Renewal: April 2012 Expired/Renewal: December 2013 Expires: January 2016 214 (Ghazalat), 248 350 283 329 Ghazalat (45.8 square kilometres) Shushan (153 kilometres squared) 1 168 Apache Oil Egypt (OP, 67 percent) Alam El Shawish West North Damietta O˜shore (A and B) 349 GENERAL PETROLEUM COMPANY Sinopec (33 percent) (296 square kilometres) (1,604 square kilometres) (a and b) El Gelf El Kebeir Concession El Temsah (175 square kilometres) HBS International Egypt 2015 BIDDING ROUND Alam Al Shawish Petroleum BP Egypt (OP, 33.33 percent) Ganoub El Wadi Holding Petroleum PetroTemsah Petroleum Company Awarded: May 2005 (OP, 100 percent) 334 .oN Namemk 2 Expired/Renewal: May 2014 Company (OP, 100 percent) Shell Egypt (33.33 percent) Company (OP, 100 percent) Awarded: July 2011 335 Awarded: February 2009 Petronas Carigali Overseas IEOC (0 percent*) Expires: July 2036 A rduS 36 249 Expires: February 2029 (33.33 percent) 8/75/127 Awarded: March 1996 Mediterranean Sea B amrataM 7 West Kanayis Awarded: February 2010 El Qaraa (186 square kilometres) Expires: March 2026 215 348 C lsA 52 (1,524 square kilometres) 284 Expired/Renewal: February 2013 Nile Delta Oil Company East Beni Suief 336 Apache Oil Egypt (OP, 67 percent) Alam El Shawish East (OP, 100 percent) 172 (7,625 square kilometres) Sinopec (33 percent) (165 square kilometres) 330 International Egyptian Oil Company North Alexandria GANOUB EL WADI HOLDING PETROLEUM COMPANY Awarded: May 2005 Naftogaz Ukrainy (OP, 100 percent) South Idko Onshore Apache Oil Egypt (OP, 33.5 percent) 2014 BIDDING ROUND (IEOC) (0 percent*) (274 square kilometres) Dana Petroleum (50 percent) Expired/Renewal: May 2014 Awarded: December 2006 (1,575 square kilometres) Awarded: January 1991 BP Egypt (OP, 30 percent) 333 .oN Namemk 2 Expired/Renewal: December 2013 Petroceltic International Sinopec (16.5 percent) (OP, 75 percent) Expires: January 2021 Egyptian General Petroleum Awarded: June 1996 250 Corporation (EGPC) (50 percent) 1 West Gabal El Zeit (reverse) 132 North Tarek (311 square kilometres) 285 Edison International (25 percent) Expired/Renewal: June 2012 329 28/29/112/139 RWE Dea (20 percent) 2 Southeast Ras El Ush (reverse) 68 Apache Oil Egypt (OP, 67 percent) Abu Sannan Awarded: January 2014 202 198 277 (1,130 square kilometres) Expires: January 2017 Merged Khalda Operating Leases Awarded: April 2003 264 332 West Bank 3 Northeast Geisum (reverse) 257 Sinopec (33 percent) 216 199 Kuwait Energy (OP, 50 percent) Khalda Petroleum Company Expires: April 2023 4 North Magawish (reverse) 194 Awarded: May 2005 Badr El Din-1 (107 square kilometres) 240 Expired/Renewal: May 2014 Dover Investments (28 percent) 331 (OP, 100 percent) 5 Northwest Shadwan (reverse) 286 181 Badr El Din Petroleum Company 228 Beach Petroleum (22 percent) South Desouq Onshore (OP, 100 percent) 268 6 Northwest Sea Bird (reverse) 191 252 Awarded: June 2006 (1,275 square kilometres) 41 Qarun (80 square kilometres) 244 168 Expired/Renewal: June 2012 Sea Dragon Energy (OP, 100 percent) Meleiha (654 square kilometres) Apache (OP, 100 percent) Awarded: January 1983 7 North Al Baraka 11,680 East Kanayes (72 square kilometres) Expired/Renewal: January 2013 322 8/75/127 267 8 South Al Baraka (a, b and c) 10,900 IEOC (OP, 50 percent) Awarded: April 2013 [East A, East B] Awarded: August 1995 302 172 286 Agiba Petroleum Company Expires: August 2015 167/191 239 9 Southeast Qena 15,745 EGPC (50 percent) 207 166 Alamein – Yidma 332 (OP, 100 percent) 217 327 10 Kharit 14,270 Awarded: March 2012 South Ghazalat A, B and C 289 201 265 Expired/Renewal: March 2032 (582 square kilometres) North El Arish O˜shore – Block 6 Awarded: August 1986 182 213 347 194 El Hamra Oil Company (2,980 square kilometres) (1,883 square kilometres) 266 0 269 264 Gaza Strip Expires: August 2016 West Abu El Gharadig 140 Exploration lease (OP, 100 percent) Dana Gas Egypt (OP, 100 percent) TransGlobe Egypt (OP, 100 percent) 131 228 245 253 (50.8 square kilometres) 250 Development lease Awarded: November 1963 Awarded: April 2013 45 Raml Petroleum Company Awarded: November 2013 162 El Fayum (1920 square kilometres) Expires: August 2030 Expires: April 2017 Expires: November 2016 195 Restricted area (El Fayum West) West Razzak (OP, 100 percent) 138 281 Merlon Petroleum El Fayum Agiba Petroleum Company Awarded: December 1996 225 Bidding area 287 333 101/137 195 248 212 Company (OP, 100 percent) (OP, 100 percent) Expires: December 2016 218 248 132 287 Alexandria 149 Alamein – Yidma North El Arish O˜shore East Ras Qattara 195 249 Maritime border Awarded: July 2004 (582 square kilometres) (2,980 square kilometres) Awarded: December 1989 259 204 146 235 234 ISRAEL Expires: July 2016 Expires: December 2019 191 (4,326 square kilometres) National border Apache (OP, 100 percent) Edison International OPERATIONS: OIL Petroshahd (OP, 0 percent*) 286 330 104 Awarded: 2013 (OP, 100 percent) Baltim (84.4 square kilometres) 41/208 225 346 Disputed border 254 Sipetrol (50.5 percent) 270 345 311 Awarded: April 2013 51 IEOC (OP, 50 percent) 252 106 340 278 National capital West Wadi El Rayan 1, 2 and 3 East Alamein (100 square kilometres) EGPC (50 percent) Kuwait Energy (49.5 percent) 299 289 Expires: April 2017 259 195 City (4,200 square kilometres) North El Amyria

Alamein Petroleum Company Awarded: March 2013 Awarded: 2004 344 45 Petro Fayoum Company (1,000 square kilometres) 334 (OP, 100 percent) Expired/Renewal: March 2029 Expires: 2024 343 51 (OP, 100 percent) 342 331 RWE Dea (OP, 100 percent) Shorouk O˜shore Awarded: February 1984 230 Sinai Awarded: October 2009 Awarded: July 2006 (3,765 square kilometres) Expired/Renewal: February 2014 194 219 133 214 300 Expires: January 2033 195 220 301 Expires: July 2015 IEOC (OP, 100 percent) El Manzala O¢shore North Alam El Shawish 216 JORDAN Awarded: April 2013 52/89/123 (630 square kilometres) (2,164 square kilometres) 206 318 255 261 182 206 Cairo 290 Sitra (322 squareOIL kilometres) AND BG GAS Egypt (OP, 50 perPRODUCTIONcent) Shell Egypt (OP, 100 percent) 195 344 54/88/123 218 Komombo (50 square kilometres) South Siwa 335 Sitra Petroleum Company Dana Petroleum (50 percent) Awarded: November 2012 220 181 3033 Dana Gas Egypt (OP, 25 percent) (25,000 square kilometres) North Tennin O˜shore 101/137 EGPC (50 percent) (OP, 100 percentIN) EGYPTAwarded: July 2005 Expires: November 2015 219 206 205 Al Thani Corp Ltd (OP, 100 percent) (5,195 square kilometres) (a and b) Shell Egypt (0 percent*) Expired/Renewal: July 2013 254 Sea Dragon Energy (25 percent) Awarded: January 2007 BP Egypt (OP, 100 percent) 231 A Awarded: December 1985 220 341 283 B Awarded: December 2007 Expired/Renewal: December 2013 Awarded: April 2013 Expires: December 2015 195 South Dabaa 217 344 Expires: December 2027 Khalda (980 square kilometres) (204 square kilometres) 54/88/123 291 336 217 253 259 54/88/123 Khalda Petroleum (OP, 100 percent) (1, 2, 3, 7, 9, 10) 253 C West Komombo North El Max O˜shore Badr El Din (107 square kilometres) Awarded: April 1981 282 285 West Kalabsha (23,640 square kilometres) (4,680 square kilometres) (a and b) South Dabaa Petroleum Company 52/89/123 (298 square kilometres) (A, B and C) Badr El-Din Petroleum Expires: November 2016 (OP, 100 percent) 104 205 Energean Egypt (OP, 70 percent) BP Egypt (OP, 100 percent) (OP, 100 percent) Khalda Petroleum (OP, 100 percent) Karl Thomson Energy (20 percent) Awarded: April 2013 Awarded: February 1999 241 205 Awarded: November 2008 Awarded: January 1983 198 280 See reverse side for details. Groundstar Resources (10 percent) Expires: February 2019 319 215 Expires: November 2028 Expires: January 2013, September East Delta Deep Marine Awarded: September 17 2006 338 28/29/112/139 Expired/Renewal: September 17, West Dakhla 1 2017 (365 square kilometres) 225 261 2014 (15,368 square kilometres) Deep Marine (OP, 100 percent) East Yidma Siwa (6,320 square kilometres) Dana Petroleum (OP, 100 percent) 101/137 Awarded: October 2007 (4,326 square kilometres) Apache Oil Egypt (OP 33.5 percent) 299 Awarded: December 2013 West Qarun (46.2 square kilometres) Expires: October 2027 INA-Industrija Nafte 304304 Tharwa Petroleum (50 percent) South Alamein Expires: December 2017 Oasis Petroleum Company Sinopec (16.5 percent) (1,423 square kilometres) (A and C) (OP, 100 percent) 215 (OP, 100 percent) 199 Renegotiated: 2012 Awarded: June 2004 TransGlobe Egypt –Cepsa 339 Sahara Petroleum (0 percent*) Ras El Barr (184 square kilometres) Approved: October 2013 Concessions Expired/Renewal: June 2012 (OP, 100 percent) West Dakhla 2 Awarded: July 1993 (Seth) of Naftogaz Gulff of Aqaba SAUDI ARABIA Awarded: April 2007 (15,322 square kilometres) Expired/Renewal: July 2013 Pharaonic Petroleum Company 228 264 Expired/Renewal: April 2014 Dana Petroleum (OP, 100 percent) (OP, 100 percent) North Idku A and B Theqah (1,760 square kilometres) Awarded: December 2013 106 BP (0 percent*) (300 square kilometres) (North & North West) 300 Expires: December 2017 Concessions IEOC (OP, 50 percent) East Badr El Din South Razzak Awarded: July 1997 North Idku Petroleum Company (355 square kilometres) Expires: July 2017 290 of Naftogaz Tharwa Petroleum (50 percent) (82.5 square kilometres) 340 Khalda Petroleum (OP, 100 percent) (OP, 100 percent) Awarded: July 2004 Apache Oil Egypt (OP, 67 percent) Northwest Gindi Awarded: July 1975 201 Awarded: November 2005 (Zakordonnaftogaz) Expired/Renewal: July 2012 Sinopec (33 percent) (1,955 square kilometres) Expires: December 2024 Rosetta – North East, South West, Expires: November 2025 LIBYA Awarded: April 2006 Edison International West (295 square kilometres) 265 Expired/Renewal: April 2014 (OP, 100 percent) 131 Rashid Petroleum Company 230 Burullus O˜shore Awarded: September 2014 Obaiyed West (OP, 100 percent) North Ras Qattara (400 square kilometres) 301 (18 square kilometres) BP Egypt (OP, 100 percent) East Ghazalat 341 (555 square kilometres) BG Group (0 percent*) (366 square kilometres) Northwest Sitra Obaiyed Petroleum Company Awarded: July 1997 Apache Oil Egypt (OP, 23.45 percent) Awarded: June 2005 IPR TransOil (15 percent) HurghadaHurghada Expired/Renewal: June 2014 Vegas Oil & Gas (OP, 50 percent) (1,946 square kilometres) (OP, 100 percent) Expires: July 2017 Transglobe Egypt (50 percent) Transglobe (OP, 100 percent) Awarded: November 1994 Sinopec (11.55 percent) EGPC (50 percent) Legend 266 North Petroleum (0 percent*) Awarded: September 2013 Expired/Renewal: January 2015 202 West Burullus O˜shore Awarded: June 2007 Expires: September 2020 West Delta Deep Marine Awarded: July 2007 Concessions/Licenses: Expired/Renewal: October 2014 Expires: July 2027 (800 square kilometres) 132 (1,676 square kilometres) Exploration lease Gaz de France Exploration Egypt – 342 Matruh (900 squa Inre 2014 kilometr andes) 2015, NaftogazBurullus Gas continued (OP, 100 percent to) Eight wells were brought online in 2014. As at July 2015, the project produced 146 326 302 Southwest Meleiha 231 Development lease GDF Suez (OP, 50 percent) Khalda Petroleumdevelop (OP, 100 itsper centoverseas) Aw investmentarded: February projects 1999 Average daily oil production from the mcm of gas. Dana Petroleum (50 percent) West Obayed (910 square kilometres) (2,058 square kilometres) North Bahariya East and West Restricted area Awarded: Novemberin Egypt, 1994 namely theExpir Alames: JuneEl Shawish 2027 East project increased by 26% compared to Awarded: September 2005 Vegas Oil & Gas (OP, 70 percent) Eni (OP, 100 percent) Expires: December 2022 (119 square kilometres) SOUTH WADI EL-MATHAREETH Bidding area Expired/Renewal: September 2013 Hellenic Petroleum (30 percent) Awarded: September 2014 project in the Western Desert and projects 2013,North amounting Bahariya Petroleum to 6 Compan 354 barrelsy per day Awarded: June 2007 204 AND WADI EL-MATHAREETH 133 South Wadi El-MathareethRas El Hekma and (22 Wadi squa reEl- kilometres) compared(OP, 100 perc toent) 5 043 barrels per day in 2013. 267 Expired/Renewal: June 2014 343 Ras Qattara Khalda Petroleum (OP, 100 percent) Sahara Petroleum (0 percent*) PROJECTS EGYPTEgypt El Burg O˜shore Southwest Alamein (331 square kilometres)Mathareeth in the EasternAwarded: Desert. January 2002 In Awtotal,arded: during August 2005 2014 1.93 million barrels Red Sea (1,000 square kilometres) 303 (2,888 square kilometres) Ras Qattara Petroleum Company Expired/Renewal: January 2022 wereExpires: produced August 2025 compared to 1.73 million These projects are implemented (O˜shore 1 and O˜shore 2) East Lagia (2,989 square kilometres) HBS International (OP, 100 percent) ALAM EL SHAWISH PROJECT Vegas Oil & Gas (OP, 100 percent) Awarded: November 2014 (OP, 100 percent) barrels in 2013. under concession agreements signed BG Egypt (OP, 70 percent) IEOC (0 percent*) 205 234 Petronas Carigali Overseas Awarded: November 2012 The project was strated in 2007 under in 2012 between Naftogaz subsidiary 7 Expires: November 2015 344 Awarded: January 1993 East Bahariya El Qantara (3.5 square kilometres) 9 (30 percent) As at July 2015, 44 wells were drilled from Dakhla Oasis Awarded: July 2005 North Ghazalat Expired/Renewal:a concession June 2027 agreement(37.8 square to conduct kilometres) oil Qantara Petroleum Company Zakordonnaftogaz, the Arab Republic Luxor 304 (25 square kilometres) Qarun Petroleum (OP, 100 percent) the(O Pstart, 100 pe ofrc ent)the project, of which 33 are investment areas, namely construction of coal Expired/Renewal: July 2013 exploration and extraction between of Egypt, and the state-owned Egyptian OTHER ACTIVITIES Block 12 El Qa’a Plain HBS International Egypt 138 Apache (0 percent*) productive.Awarded: June 6.5 200 million3 barrels of oil were gasification facilities and modernization of heat and (1,824 square kilometres) (OP, 100 percent) Umbaraka (420Naftogaz, square kilometres) the Arab AwRepublicarded: June of 200 Egypt,3 Expires: June 2023 Petrochemicals Holding Company. These 268 extracted, including 1.1 million barrels On 25 December 2012, Naftogaz and China electricity producing facilities in Ukraine, including North El Burg O˜shore (Block 1 and 2) Awarded: July 2011 Khalda Petroleumand (OP, the 100 Egyptianpercent) GeneralExpires: June Petroleum 2023 agreements cover a period of 28 years. Dana Petroleum (OP, 27.5 percent) Expires: July 2036 Awarded: December 1963 extracted235 in 1H 2015. Development Bank (CDB) signed a general loan combined heat and power plants. No funds have (617 square kilometres) Petroceltic International Expired/Renewal:Corporation. December 2013 The project206 is realized by BP Egypt (OP, 50 percent) El Mansoura The initial exploration period is currently agreement to finance projects aimed towards the been drawn so far. IEOC (50 percent) (37.5 percent) 345 Petrosannan company.Northeast This Abu joint El Gharadig venture Following(2,175 square the kilometres) construction of a pipeline Beach Energy (25 percent) North El Salhiya Onshore underway, and equipment for a 2D substitution of natural gas for domestically produced Awarded: June 2005 140 was created by Naftogaz(161 square and kilometres) the Egyptian thatPetroceltic connected (OP, 100 thepercent project) with the In early 2015, Ukraine confirmed its willingness Awarded: November 2012 (1,527 square kilometres) Ras Kanayis (208 square kilometres) Tiba Petroleum Company Expired/Renewal: June 2012 Expires: November 2016 Dana Gas Egypt (OP, 100 percent) Awarded: June 2013 seismic study has been mobilized. The 339 338 coal. Under the terms of the agreement, signed (A and B) General Petroleum (OCorporation,P, 100 percent) with the T-ariaExpire (GPC)d/Renewal: point June and 2033 the launch of gas to continue the cooperation under the CDB loan. Awarded: September 2014 project team has laid 1 125 linear km between the Ministry of Finance and CDB, Ukraine 255 269 311 Expires: September 2021 Khalda Oil Companytwo parties having equalAwarded: shares. April 2004 preconditioning facility at the Karima field, Now the government and Naftogaz negotiate an West El Manzala (OP, 100 percent) Expires: April 2024 of seismic profiles, conducted geodetic issued sovereign state guarantees for the amount of North El Maghara the23 project9 started to produce natural expansion of project types where these funds can be (527 square kilometres) (2,334 square kilometres) 346 Awarded: DecemberIn 2014, 1992 Naftogaz invested USD 43 million North Bardawil research on 1 840 linear km and the loan, which can amount up to USD 3.65 billion. Dana Gas Egypt (OP, 100 percent) Expired/Renewal: December 2012 207 gas and condensate in September 2014. applied. Ukraine suggested using the loan to finance National Petroleum Company North El Mahala Onshore in this project and it generated revenues of (13 square kilometres) prepared 2 472 linear km for seismic Awarded: June 2005 (OP, 100 percent) (1,028 kilometres) North East Obayed In Paddition,etrobardawil a P etpipelineroleum Company was built to the In 2012, Vuhlesyntezhaz Ukraine, a 100% subsidiary Khargamore Oasis urgent projects in the oil and gas industry, Expired/Renewal: June 2012 146 USD 69 million, resulting(801 square in akilometres) positive cash profiling. Seismic exploration continues Awarded: July 2007 Total E&P Egypte (OP, 100 percent) Tammam(OP, 100 per depositcent) and Tammam-1 gas and of Naftogaz, was created as a dedicated project including additional gas interconnectors between 10 Expired/Renewal: July 2013 Awarded: September 2014 Burg El Arab (80flow squar ofe kilometres) USD 26 million.Shell Egypt (OP, 100 percent) Awarded: March 2006 in 2015. 270 (North and South) Awarded: November 2012 condensateExpires: March well 2026 was launched. entity to invest the funds granted under this Ukraine and the EU, natural gas production or energy West El Qantara 318 347 Burg El Arab Petroleum Expires: November 2015 (421 square kilometres) loan. Initially, the parties agreed to focus on two efficiency projects in Ukraine. Aswan Hallif (17.9 square kilometres) El Matariya Onshore (OP, 100 percent) 240 Dana Gas Egypt (OP, 100 percent) HBS International Egypt (1,028 square kilometres) Awarded: December 1996 208 West Mediterranean Deep Water Awarded: June 2005 (OP, 100 percent) BP (OP, 50 percent) Expires: December 2016 Meleiha Deep Drilling 8 Expired/Renewal: June 2012 102 (210 square kilometres) 103 Awarded: April 2007 Dana Gas Egypt (50 percent) (654 square kilometres) BP Egypt (OP, 40 percent) Expired/Renewal: April 2013 Awarded: September 2014 149 277 IEOC (OP, 76 percent) EGPC (50 percent) Expires: September 2021 East Delta (North and South) Lukoil (24 percent) North Tineh O˜shore RWE Dea (10 percent) 319 (79.8 square kilometres) Awarded: August 1986 (2,400 square kilometres) East Abu Sennan 348 Petrodelta Company Expires: August 2016 Awarded: October 2007 BP Egypt (OP, 100 percent) (640 square kilometres) North Port Fouad O˜shore Expires: October 2027 291 Awarded: November 2009 (OP, 100 percent) 0125 50 00 Tharwa Petroleum (OP, 100 percent) (3,397 square kilometres) Awarded: October 1994 210 Expired/Renewal: November 2012 Awarded: April 2007 Edison International (OP, 50 percent) Expires: June 2026 Wadi El Mahareeth 241 Expired/Renewal: April 2013 Petroceltic (50 percent) (11,427 square kilometres) El Diyur (15 square kilometres) Kilometres 278 Awarded: September 2014 162 Naftogaz Ukrainy (OP, 100 percent) Diyur Petroleum (OP, 100 percent) 1 South East El Mansoura 322 Port Said North Awarded: February 2012 Awarded: July 2005 (2,175 square kilometres) Abu Qir (West, North Abu Qir) 349 (950 square kilometres) Expires: July 2025 Melrose Petroleum (OP, 100 percent) (300 square kilometres) Karawan O˜shore Awarded: June 2005 Abu Qir Petroleum Company (4,565 square kilometres) PetroSaid Petroleum Company 211 Expired/Renewal: June 2014 (OP, 100 Percent) Wadi El Mahareeth South 241 (OP, 100 percent) Eni (OP, 50 percent) El Diyur (14,115 square kilometres) Edison International (0 percent*) BP (50 percent) IEOC (0 percent*) (9,316 square kilometres) 280 Awarded: February 1974 Awarded: January 2015 Awarded: February 1994 Naftogaz Ukrainy (OP, 100 percent) IPR Group (OP, 100 percent) Awarded: May 2000 North El Diyur (12 square kilometres) Expires: January 15 2029 Expires: February 2014 Awarded: February 2012 Diyur Petroleum (OP, 100 percent) 350 Expires: May 2020 Awarded: February 2006 326 North Leil O˜shore 166 212 Expires: February 2026 El Ghazaliyat – Block 11 (5,105 square kilometres) O¢shore North Sinai North Alamein (West Mediterranean 244 (7,137 square kilometres) Eni (OP, 100 percent) (371 square kilometres) Sea Block 1) (20 square kilometres) West Baltim O£shore 281 RAK Gas (OP, 20 percent) Awarded: January 2015 North Sinai Petroleum Company Khalda Petroleum Company (804 square kilometres) East Obaiyed (244 square kilometres) Arabiyya Lel Istithmaraat (OP, 100 percent) (OP, 100 percent) IEOC (OP, 100 percent) IEOC (OP, 100 percent) (80 percent) *Participating in a joint venture that Awarded: April 1998 Awarded: September 1998 Awarded: June 2004 SUDAN Awarded: February 2005 Awarded: June 2009 forms the operating company. Expires: April 2018 Expires: September 2018 Expired/Renewal: June 2013 Expired/Renewal: February 2014 Expires: December 2015 Source: EGPC, Egypt Oil & Gas © 2015 The Oil & Gas Year Ltd., The Oil & Gas Year Egypt 2015. All rights reserved. CORPORATE, SOCIAL AND ENVIRONMENTAL RESPONSIBILITY

Specialized internal divisions are headed by plans, reform concepts and legislation drafts. EMPLOYEE ENGAGEMENT EMPLOYEES specialists with long employment records Several projects with the European Bank for in their respective fields who have been Reconstruction and Development (EBRD), the Motivated, engaged and highly professional selected on the criteria of professionalism World Bank (WB), the European Commission personnel is a prerequisite for top-quality and reputation. and other international donors have already performance of Naftogaz and thus of the been implemented. value maximization for the company ultimate The company continues to optimize its owners — the people of Ukraine. The code of organizational structure, business processes This cooperation provides access to conduct adopted in 2014 sets out the group and the management system. knowledge and practices which have proven strategy, mission, values, norms of business to be effective in other countries that have RECRUITMENT POLICY conduct, basic principles and professional successfully implemented similar reforms standards for all Naftogaz employees. The For the first time in the history of Naftogaz, in the past. It allows Naftogaz to develop code of conduct is a guideline for all company transparent policies are used in personnel efficient initiatives in areas where Ukraine employees regardless of their position. selection and recruitment, guaranteeing currently lacks qualified personnel. This equal opportunities to all interested interim measure allows Naftogaz to ensure a Continuous efforts are made to establish candidates. Vacancy announcements high quality of the developed solutions and vertical communication and open dialogue are posted on the company's website to expand cooperation with the international between staff and management. The goal and specialized recruitment resources. community. of this work stream is to ensure efficient Selection of new employees is carried out based on interviews, assessment of NUMBER OF EMPLOYEES AND GENDER COMPOSITION OF THE professional qualifications and competences GROUP of candidates. During 2014, approximately thirty professionals were recruited to the 17 519 Female holding company via publicly announced ORGANIZATIONAL EFFICIENCY PERSONNEL STRUCTURE selection, including nearly twenty at senior During 2014, Naftogaz was reorganized executive positions. Naftogaz is one of the largest employers to reflect its new strategic goals. Fifteen in Ukraine. The group (including its Naftogaz cooperates with professional 62 743 Male departments underwent profound revision consolidated subsidiaries and Ukrnafta) associations and international initiatives or were established, including the newly employs more than 80 thousand people. to select and recruit employees. The most created departments for energy efficiency Including regional gas distribution companies prominent addition to the team in this sense and energy saving, for business development where Naftogaz holds minority shares, this was Sergiy Konovets, the CFO and Deputy and reforms, and for business, industrial and number reaches more than 100 thousand Chairman, who was recommended by the EMPLOYEE STRUCTURE BY EDUCATION informational security and risk management. employees. Professional Government platform which More than fifty positions were eliminated unites Ukrainians who have graduated from On 25 March 2014, the Cabinet of Ministers following the reorganization. The number of leading foreign universities. This is one of the 35 778 Other 221 Postgraduate degree appointed Andriy Kobolyev as Chief the executive board members reduced from top positions a participant of this initiative Executive Officer of Naftogaz. Key strategic fourteen to five, of which four members has ever filled. goals of the new management include joined the company after the management reforming Naftogaz and the broader Transparent and competitive recruitment change took place in March 2014. In total, Ukrainian gas market based on European procedures are also implemented in 44 263 Graduate degree approximately 2/3 of senior executives and best practices, as well as ensuring security of Naftogaz subsidiaries. The goal of Naftogaz division managers have been replaced. natural gas supply to consumers in Ukraine is to develop the group in the interests of the and in the EU. In order to improve the management people of Ukraine. A core prerequisite for efficiency and prevent potential corruption, this is attracting experienced professionals With the appointment of the new EMPLOYEE STRUCTURE BY AGE Naftogaz hired experienced executives from motivated to be leaders of change in their management and the adoption of the other sectors to head functions that do not units. new strategy, the company’s HR policies 21 666 younger than 35 require specific technical knowledge in oil underwent fundamental changes as well. COOPERATION WITH THE and gas. Senior managers responsible for A new HR strategy has been developed. INTERNATIONAL PROFESSIONAL finance, legal issues, property management, It is based on the principles of increasing COMMUNITY procurement, communications and organizational efficiency, building lean HR internal audits have been hired on this In view of the resource constraints and the 35 449 35 to 50 23 142 older than 50 processes, improving management practices basis. The company succeeded in engaging scope of challenges now facing Naftogaz, and raising the level of motivation and graduates of top-tier Western institutions the group actively cooperates with the engagement of employees. with valuable international experience. international community in developing action Number of employees, as at 31 Desember 2014 104 105 CORPORATE, SOCIAL AND ENVIRONMENTAL RESPONSIBILITY

FUNCTIONAL STRUCTURE OF NAFTOGAZ HEADQUARTERS

CEO

Operations and Investments, General and Finance Development Sales AM, Legal Administrative

Gas Asset Accounting Reform Internal Audit Balancing Management CORPORATE CODE OF CONDUCT Capital Gas Sales Planning R&D Procurement Investments

Energy External Gas Trading Tax and Regulatory Legal Efficiency Relations

Oil Trading Treasury Communications

Production HR

Security and ІТ Environmental Safety Administrative

One of the main priorities in reforming Naftogaz is the employees, partners, competitors, the state and the society. implementation of modern corporate governance standards. This code determines reliability, professionalism, responsibility The company believes the corporate ethics is integral to and development as core values of cooperation. the quality of organizational management. Ethical norms in governance establish a framework for proper business conduct. Under the new code of conduct, Naftogaz undertakes to information exchange within the company Employees of Naftogaz and its subsidiaries recreational programs for workers and • Contemporary standards of the corporate ethics allow companies respect personal freedoms, rights and dignity, and forbids any and to engage all employees in developing have the opportunity to improve their their children to be more effective in achieving their targets and create form of harassment or behavior that could be seen as offensive and implementing the group strategy. professional qualifications in specialized special support for pensioners, veterans possibilities for self-actualization based on merit, which positively and unacceptable. Management is obliged to act in a way that centers of extended education. The company • During 2014, a number of development and and disabled employees impacts both motivation and the productivity of employees. respects the human dignity of all staff members. views engaging qualified and proactive training programs were offered to unlock the personnel as key to implementing its strategy. support of disabled children and orphans internal potential and to develop professional • Citizens, partners and local authorities, media and other Discrimination on the basis of origin, social or economic status, qualifications of employees. These programs Naftogaz continues developing professional • other social benefits external stakeholders are entitled to expect ethical business race, nationality, age, sex, language, political opinion, religion, focused on: training initiatives, corporate programs for conduct from Naftogaz. Despite a complicated history, occupation, sexual orientation, place of residence or other Naftogaz group has thirty two recreational learning English and employee engagement the current management of Naftogaz seeks to build circumstances is unacceptable at Naftogaz. professional orientation for recent centers for staff members and their families, • programs. relationships with its stakeholders on the principles of legality, graduates, attracting top students and including three child health care centers. professionalism, integrity, mutual trust and adherence to Qualifications, professional skills, actual professional graduates of leading universities SOCIAL PROTECTION During 2014, 3 247 staff members and contractual obligations. achievements and other criteria associated with professional OF EMPLOYEES 4 360 children benefited from recreation and cooperation with universities and merits of a person are the core criteria for personnel selection. • rehabilitation programs sponsored by the other academic institutions in training Efficient operations depend on a good team By implementing modern corporate ethics standards, Naftogaz Naftogaz supports and encourages proactiveness and creativity group. faculty members by providing hands-on spirit which itself depends on safe and seeks to bolster the reputation of the company so that its among its employees, and supports the development and understanding of oil and gas production comfortable workplace conditions, relevant In April 2015, Naftogaz ranked fifth employees could take pride in their personal achievements, implementation of the skills and abilities of individual staff processes, equipment and technologies, remuneration levels and adequate social among the most attractive employers for the overall company results, as well of the means by which members. as well as participation of Naftogaz protection of staff members. In addition professionals in technical and scientific these results were achieved. It is important for Naftogaz to employees in diploma and thesis to the monetary remuneration, Naftogaz fields, according to a study conducted by be a respected employer in order to preserve the unique Naftogaz also considers corporate social responsibility an committees provides the following social benefits for its HeadHunter, a leading regional recruitment competencies of workers and to attract new highly qualified important element of cooperation of the group with the employees: portal. This result is a valuable recognition professionals. society, the state and the business community. The company acceleration of the adaptation process for • of the company’s efforts to modernize aims to institute socially responsible practices toward its new employees through special guidance meal subsidies • its personnel management policies and In 2014, Naftogaz developed and approved a corporate code employees and members of their families, the residents of at the early stages of employment • tuition coverage corporate governance. of conduct in order to outline rules for interaction between localities where it operates, and the society in general. 106 107 CORPORATE, SOCIAL AND ENVIRONMENTAL RESPONSIBILITY

ENVIRONMENT AND SAFETY

OCCUPATIONAL HEALTH AND SAFETY In 2014 investment in occupational health programs amounted to UAH 87.2 million. The funding of The code of conduct of Naftogaz includes a special occupational safety programs of its subsidiaries section dedicated to occupational safety. This section amounted to the equivalent to 1.58% of the group incorporates the Seven Golden Rules of occupational total payroll for 2013. All employees of Naftogaz safety management widely implemented in the and its subsidiaries are employed on the basis of OCCUPATIONAL European Union. an employment agreement (contract) and insured SAFETY SPENDING, Special regulations on occupational health are at the against accidents at work and occupational health 2014, UAH MILLION moment being developed by the companies of the hazards. The company also implements a five-tier group. These will be based on the national standard operating system for monitoring occupational health prevention measures stored in specifically designed guarded facilities with of Ukraine DSTU OHSAS 18001:2010 Systems for and safety measures, including regular inspections of • alarm systems and duly marked by radiation hazard Occupational Health and Safety Management: production units and work places. improving environmental education and culture • signs. Naftogaz companies have obtained licenses Requirements (OHSAS 18001: 2007, IDT) and Employees are the core asset of Naftogaz and their open access to information and transparency of for conducting operations with IRS issued by the 87.2 international norms (such as the Seven Golden Rules • safety and well-being are of utmost importance to decisions special agency of ecology and natural resources and the Zero Accident Vision). the group. of Ukraine, while the state committee for nuclear In 2014, the combined emissions of pollutants at all The main objectives of the health and safety regulation has also issued licenses to undertake ENVIRONMENTAL PROTECTION production facilities of Naftogaz did not exceed the regulations at Naftogaz are: nuclear waste transportation. Naftogaz group maximum allowable levels established by relevant The business practices of Naftogaz are designed operates decontaminating and sanitizing facilities for the implementation of international best permits, and the total emissions of the group • to meet European environmental protection personnel safety. practices in occupational health and safety companies decreased by 19%. In the first period policies and basic safety standards in radiation and management of the Kyoto Protocol, the emissions of all group Group does not operate radioactive waste storages. environmental protection. The code of conduct companies fell by more than 20 million tons of CO Waste and sources of ionizing radiation (tubing, staff training adopted in 2014 contains a section on environmental 2 • equivalent which enabled additional investment in equipment, etc.) are temporarily stored in specially protection. • unconditional adherence to approved health and the modernization of the technological equipment. equipped facilities (5 operating units at Ukrnafta; and safety standards, including proper organization The basic principles of the environmental policy of one at UGV). These items are periodically transported of operations and work places the group are: by special purpose certified vehicles for long term Each company within the group considers storage, recycling or disposal at SSD Radon in • adequate funding for occupational safety • responsibility and awareness ecological safety in and around the workplace Kharkiv. mandatory medical examinations of workers balance between economic, environmental and • • Naftogaz considers the environmental protection social interests as its core obligation. effective support of company health care facilities of all work places extremely important. The group’s • Group companies use safety measures for effective environmental management activities are undertaken in strict compliance cooperation with international organizations • equipment containing ionizing radiation sources • with environmental protection requirements and in issues of occupational safety in order to implementation of modern environmentally safe (IRS). All IRS equipment is used for the purpose • standards. implement international best practices technologies prescribed by relevant sanitary certificates and is 108 109 CORPORATE, SOCIAL AND ENVIRONMENTAL RESPONSIBILITY

• monitoring the implementation of gas quality supplied to distribution net- In May 2015, Ukrtransgaz held a dedicat- regulatory norms for technical super- works and to international consumers at ed event in Uzhhorod to familiarize mass RESPONSIBILITY vision, industrial safety, civil protec- Ukraine’s borders. The gas delivered by the media and expert community with quality tion and fire safety, and prevention group must meet state standards as well control processes at the gas transmission TO CONSUMERS and handling of emergency situations as the technical requirements established system. The company is preparing further in supply contracts with domestic distri- steps to build public awareness and trust developing and implementing training • bution companies and in transit contracts. in gas quality control measures employed systems for emergency repair teams, Quality control takes place at every stage by the group. emergency dispatcher services, and of gas transmission, from the entry into linear-operational services for target- MEDIA COVERAGE AND PUBLIC the gas transmission system of Ukraine, ed missions AWARENESS either from non-Ukrainian or from local One of the major roles of Naftogaz is to ensure a reliable and stable supply of natural • coordinating and implementing train- producers, up until the point where gas The implementation of Naftogaz strate- ing programs in civil defense leaves the system outside of Ukraine, or gy largely depends on fostering greater gas to consumers. Military actions in the Donbas have significantly complicated the enters local distribution networks for sup- understanding of gas market principles Naftogaz companies regularly conduct ply to consumers in Ukraine. amongst consumers and other stakehold- performance of this function. During 2014 and 2015, employees of Naftogaz in the training sessions to prepare professionals ers of the company. To this end, one of for possible emergencies on gas pipelines. Starting from March 2015, Ukrtransgaz re- region have put their health and lives at risk on numerous occasions to perform their the key areas of informational activities of leases monthly measurements data on the For instance, in September 2014, Ukrtrans- Naftogaz is encouraging the media, market duties and ensure safe and stable gas supplies to Ukrainian households and industrial quality of gas in the transportation system gaz held anti-terrorist training exercises in experts and the public to participate in broken down by region of Ukraine. De- consumers. cooperation with the Ministry of Internal events discussing changes in the oil and pending on the proximity of the wells from Affairs and the State Emergency Service of gas market of Ukraine and raising public which gas is extracted, to entry points for Ukraine, with participation of international awareness. imported gas and to the underground observers, at the Oparske underground storage facilities, the calorific value of gas, In addition to general communications storage facility. In accordance with the SAFETY AND SECURITY three instances of category one emergency ­October 2014. This division was tasked being one of the key quality indicators, activities, group companies operate a training plan, participants were required OF SUPPLY situations on gas pipelines and several hun- with the following functions: fluctuates in the range of 7.950 to 8.600 number of gas industry museums aiming to localize and neutralize an unauthorized dred smaller scale emergencies to deal with. kilocalories per cubic meter depending to raise public understanding in the way Because of the abrupt loss of assets in development of a policy for resolution intervention at one of the facility’s gas • on the region, but in any event the quality the industry operates. Regular guided Crimea and military actions in eastern In response to these significant security of complex issues related to technical storage wells. meets the state standard of calorific value tours to operational facilities are offered Ukraine, 2014 was a year of tremendous challenges, Naftogaz created a division supervision and industrial safety GAS QUALITY MONITORING set at the level of 7.600 kilocalories per as well to help media and other stakehold- technological challenges for Naftogaz. As a re- of industrial security within the depart- supporting the Unified State System cubic meter (based on the lower calorific ers understand the history, principles and sult of deliberate attacks or collateral damage ment of economic, industrial and infor- • Another area of responsibility of Naftogaz for the prevention and early response value). challenges of the oil and gas industry in caused by the hostilities, there have been mation security and risk management in is to ensure continuous monitoring of to emergencies Ukraine. 110 111 CORPORATE, SOCIAL AND ENVIRONMENTAL RESPONSIBILITY

ENERGY EFFICIENCY

Improving energy efficiency is an In August 2014 the company established aimed at rationalizing the use of important pillar of the gas market reform a new department for energy efficiency energy, promoting the energy in Ukraine. Naftogaz actively implements and energy saving with the following efficiency and increasing the use of energy efficiency improvements at its objectives: alternative energy sources companies and subsidiaries. The group to create conditions for the to monitor and analyze payments for focuses its efforts on the development of • • sustainable use of energy resources and the use of thermal energy energy saving solutions in two key areas: by consumers to create incentives for producers of extraction, processing, storage and • • to implement measures improving thermal energy to implement energy transportation of hydrocarbons • energy efficiency and promoting the efficient technologies and facilitate • consumption of natural gas for use of alternative energy sources in alternative and renewable energy thermal energy production (heating Naftogaz, its subsidiaries and related sources and hot water supply) by individual entities to develop similar processes for households and heat producing • to develop and implement a unified subsidiaries of Naftogaz engaged in companies • investment policy for the company the delivery of energy services

TEN MONTHS • The heat distribution system reform • The Naftogaz energy efficiency Energy profile questionnaires have fuel boilers replacing natural gas restructuring the gas transmission concept has been developed program for 2015-2020 has been been compiled to help determine the operating devices in households. It system and increasing the AFTER THIS targeting to improve the system’s developed most energy-consuming production is anticipated that this subsidiary professional skills of Ukrainian energy efficiency and security processes and to develop measures will be funded by Naftogaz, specialists’, the GIZ project (energy DEPARTMENT WAS Internal rules on minimization • to increase energy efficiency dedicated loans, grants and other efficiency in the communities), the The use of energy resources by the of natural gas consumption by ESTABLISHED: • resources International Financial Corporation group companies in 2014 declined Naftogaz production units have been Energy audit and energy saving • project ‘Energy efficiency in the by 200 thousand t of fuel, including developed and implemented assessment standards have been Cooperation has been improved • residential sector of Ukraine’, and the 152 mcm of natural gas, 24 million updated. The establishment of within the framework of a number Naftogaz has also initiated INOGATE project ‘Support for energy kW/h of electricity and 87 thousand • the new energy service subsidiary of international energy efficiency development of a system of energy market integration and sustainable Gcal of thermal energy is in process. Its activities will be initiatives including the USAID management within the company. energy (SEMISE)’. focused on the installation of solid Program ‘Energy efficiency:

112 113 CORPORATE, SOCIAL AND ENVIRONMENTAL RESPONSIBILITY

RUSSIAN MILITARY AGGRESSION AGAINST UKRAINE

Naftogaz group incurred significant losses of natural gas to consumers in Crimea of Ukrtransgaz, Ukrgasvydobuvannya, as a result of Russia’s military intervention after the peninsular was occupied by Ukrtransnafta and other subsidiaries in Crimea, Donetsk and Luhansk regions. Russian military in 1Q 2014. who faced and resolved these emergency In 2014 these losses amounted to situations for their dedicated work and The abrupt loss of control over a part of over UAH 26 billion, as reflected in the heroism. They succeeded in renewing the company’s assets created significant consolidated financial statements of the damaged gas infrastructure and restoring issues for the group, including the group. These losses included the loss of supplies to consumers in the toughest challenge of maintaining the integrity of property and inventories as well as net conditions imaginable. the gas transportation system of Ukraine. differences between accounts receivable Thanks to the dedicated work of the AIDING THE CASUALTIES and accounts payable. group employees, as well as the structural OF MAIDAN AND SUPPORTING The occupation of Crimea resulted in reliability and flexibility of the Ukrainian THE UKRAINIAN MILITARY losing natural gas stock amounting gas transportation system, Naftogaz has In February 2014, Naftogaz employees to approximately 1.4 bcm. The been able to ensure the uninterrupted unanimously agreed to support the expected volume of gas production by transit of Russian gas to European families of the fallen heroes of the Chornomornaftogaz in 2014 was 2.1 bcm, consumers as well as stable supply to Heavenly Hundred (protesters killed 0.7 bcm of which should have been consumers in Ukraine in practically all during anti-government rallies at Maidan) supplied to households in Crimea, and locations now controlled by the Ukrainian by collecting approximately UAH 360 000 the remaining 1.4 bcm to households in authorities. in donations and directing this money to other regions of Ukraine. The loss of this RELIABLE SUPPLY IN the families of the deceased. resource forced Naftogaz to replace these A CHALLENGING ENVIRONMENT volumes with imported gas at much higher As the hostilities unraveled in the eastern prices. The employees of Naftogaz operating gas Ukraine, Naftogaz employees began to facilities near the frontlines in the Donbas regularly donate a portion of their income to In addition to these losses, the group lost faced extreme challenges. Throughout support the Ukrainian Army. As of July 2015, a portion of income in 2014 due to the 2014 and 2015, these professionals Naftogaz staff have donated more than Russian intervention in Crimea and eastern repeatedly risked their lives to perform UAH 4.3 million to the needs of the national Ukraine. Prior to the Russian aggression, their duties and ensure stable gas supply military. The company and trade union also the aggregate gas demand of consumers to consumers. provide financial support to employees who located in Donetsk and Luhansk regions have joined the Ukrainian Armed Forces. (including the territories currently As a result of the armed conflict in the controlled by the government of Ukraine) region, gas supplies in the area of the In February 2015, Gas of Ukraine, a and Crimea amounted to approximately Anti-Terrorist Operation controlled by subsidiary of Naftogaz, donated 174 25% of the total consumption in Ukraine Ukrainian authorities were cut off in 501 vehicles to the Ministry of Infrastructure (14%, 7% and 4% per year on average over locations. Naftogaz employees have been and the Security Service of Ukraine for use the period of 2009-2013, respectively). able to restore supplies to 486 of these in the area of the Anti-Terrorist Operation, Compared to 2013, sales in these regions locations as at July 2015. including passenger cars and cargo fell in aggregate by 38% in 2014 (including vehicles, excavators, gasoline stations, The management and staff of Naftogaz 26% in Donetsk, 40% in Luhansk and 71% radio stations and other technical products express deep gratitude to the employees in Crimea). The group discontinued supply equipment. 114 115 CORPORATE, SOCIAL AND ENVIRONMENTAL RESPONSIBILITY OIL AND GAS RESERVES AND PROSPECTIVE RESOURCES OF THE UKRAINIAN SECTOR OF THE BLACK SEA AND THE SEA OF AZOV

N

Бердянськ Пвн.-Олімпійська MOLDOVA Олімпійська

Низова Херсон Приазовське Ударна

CRIMEA Білосарайська UKRAINE Матроська Одеса Пвд.-Бердянська Центральна Морське-1 Невелика Обіточна-2 Геофізична

Обіточна-1 Морська

Пвн.-Бірюча ЧНГ З.-Бірюча Обручева Скадовськк Північний блок Армянсрмянрмянснськ Сх.-Бірюча

Пвд.-Бірюча Південний блок Тендровська S e a o f A z o v Дністровська Дніпровська

Криловська Скадовська Бортова-2 З’їздівська Бортова-1 Скромна Біостромна Стрілкове ЧНГ ЧНГ ЧНГ ПервомайськеП е Алібейська Пвд-Голіцинське ЧНГ Погранична Голіцинське Тетянівське Пвн.-Керченське ЧНГ ЧНГ ЧНГ Пвн.-Казантипське Шмідта Джанкойське Джанкойнк Міжводненська ЧНГ Гордієвіча Серебрянське Азовськ Сх.-Шмідтівська Сх.-Казантипське ЧНГ Ярилгачське ЧНГ Зах. Голицінська Кіровське Пвн.-Булганацьке ЧНГ Карлавське ЧНГ Медуза Чорноморське Задорненське Безіменне Розломна Навчальна ЧНГ Шатського Глібовське ПСГ Красногвардійськйськькекее Акташське Зміїна Краснополянське ЧНГ Малобабчинське Сулінська Лебедина ЧНГ ЧНГ Нижнегорсиж горсрськийрсрс Семенівське Борзовське Одеське ЧНГ Зх.-Октябрське Осетрова Архангельське Оленівське Октябрське Советськийтсьтськийький Поворотне Kerch Рифтова ЛеніноЛе Придорожне Зах.-Крейдяна ОктябрскеОкк Прибойна Олексіївське ЧНГ Кіровське Фонтанівське о. Зміїний Янтарна Кутова Штормове Кримська Тарханкутська Гамбурцева Куйбишевське ЄвпаторіяЄЄв я Владіславівське Оливкова Агат RUSSIA Приозерне 70 Гвардійське Мошкарівське ЧНГ Берил Сакі Губкіна ROMANIA Анісімова Маячна Зональна Пвн-Керченська Нахімова Карбишева Керченська Корнілова Simferopol Каламітська Керченська Личагіна ЧНГ (УРП) Прирозломна Лучицького Абіха Пвд.-Керченська Мушкетова Крайова КольчугКол гіно Субботінське Альмінська-2 Олімпійська Якірна Союзна Якірна-1 Комсомольська 70 Моряна Глибока Глибинна Алуштата Альмінська-3 Кавказька Соколова-Пвд Глотова Нептун Форум 500 500 1000 Вікторія Sevastopol Палласа Латеральна Херсонеська Ялта Судакська

1000

Тетяєва-1

Тетяєва-2

Ялтинська 2000

B l a c k S e a Лазурна

LEGEND

Андрусова Local structures: discovered and prepared Fields: Gas and gas condensate 2000 Oil Licensed to Naftogaz

Licensed to Naftogaz subsidiary 0525 0 100 км ЧНГ Chornomornaftogaz

Gas pipelines as at 1 January 2014

Department of Commerce in April 2014. the grounds of a criminal offense CRIMEAN ASSETS IN This company was also the first on the list specified by clause 3 of article 206 of the CONSOLIDATED FINANCIAL of persons and entities sanctioned by the Criminal Code of Ukraine and for illegal STATEMENTS EU starting from May 2014. extraction of natural gas by officials of Considering the temporary inability to Chernomorneftegaz on the grounds of At the same time, the PJSC National Joint control the assets of Chornomornaftogaz a criminal offense specified by clause Stock Company Chornomornaftogaz, a in Crimea and in order to conservatively 2 of article 240 of the Criminal Code of subsidiary of Naftogaz, was re-registered reflect the current status of the Naftogaz Ukraine. In particular, Chornomornaftogaz in Kyiv. As of August 2015, this company group, the management decided to planned to extract 2.4 bcm of natural gas, RUSSIAN OCCUPATION OF Ukraine and the international democratic of the property of Chornomornaftogaz in controls the Strilkove gas field located near transfer the net assets related to 58.5 thousand tons of gas condensate and CRIMEA community treat Crimea as a temporarily Crimea and its transfer to the share capital the village of Strilkove in the Henichesk Chornomornaftogaz to discontinued 7.2 thousand tons of oil during 2014. occupied territory of Ukraine. The status of a newly founded Crimean Republican district of Kherson region (control was operations as at 1 January 2014. For this In late February 2014, the Russian Armed of this territory is regulated by a special Enterprise Chernomorneftegaz. On regained in December 2014). The European Court of Human Rights reason, in 2014 Naftogaz recorded losses Forces began their undeclared invasion of law of Ukraine. Under section 9 of this law, 2 December 2014, the company was is considering a claim filed by the from these discontinued operations of Ukraine and deployed troops across the Chornomornaftogaz is currently working all authorities and their officials operating re-registered in the Russian Federation Ministry of Justice of Ukraine against UAH 13.8 billion. In addition, the group Crimean peninsula. On 16 March 2014, on restoring its legal documentation, in the temporarily occupied territory are and changed its name to State Unitary Russia. This claim concerns recognition recognized the impairment of other Russia staged a hastily prepared and re-registration of its special permits for considered illegal, if these authorities Enterprise of the Republic of Crimea of the occupation of Crimea as illegal, assets (property and receivables) located unconstitutional “referendum” on the subsoil use on the peninsula and adjacent or officials were established, elected or Chernomorneftegaz. and seeks compensation for damages in Crimea amounting to UAH 5.8 billion status of Crimea. The voting was held with shelf, re-registration of its marine vehicles appointed in violation of the laws of Ukraine. caused by the occupation and violation in other operating expenses in 2014. significant violations of both electoral The nationalization of Chornomornaftogaz in Odesa commercial sea port, and is Any act (decision, document) issued by these of the constitutional rights of citizens law and the rights of voters. In particular, assets by the occupation forces of Crimea engaged in numerous litigation processes. Nevertheless, Naftogaz continues authorities and/or officials is null and void. by the seizure of power in Crimea by citizens of Russia who have never resided was and continues to be a violation of to undertake all possible legal and On 10 October, 2014, the Prosecutor the Russian Federation and by further in Crimea, were allowed to participate in LOSS OF CONTROL OVER ASSETS international law. diplomatic actions aimed at both General of Ukraine made a record activities of the occupation forces. the voting. On 18 March 2014, the Russian IN CRIMEA regaining control over the assets in The newly founded Chernomorneftegaz in the Unified Registry of Prejudicial The claim identifies damages inflicted authorities declared the annexation of Crimea and receiving reimbursement for On 17 March 2014, the occupation forces was included in the list of persons and Investigations for the illegal appropriation against 4 000 business entities including Crimea and Sevastopol. losses incurred. in Crimea announced the nationalization entities sanctioned by the United States of Chornomornaftogaz property on Chornomornaftogaz.

116 117 CORPORATE, SOCIAL AND ENVIRONMENTAL RESPONSIBILITY

RUSSIAN GAS SUPPLY ROUTES

Sudzha DONBAS 100% of transit gas flows 52% bypass occupied territory

Valuyky RUSSIA Pysarivka 22% 12%

Sokhranivka to Slovakia 14%

UKRAINE RUSSIA

MATERIAL LOSSES IN EASTERN The coordinated efforts of the belonging to this entity have been stolen UKRAINE Ukrtransgaz team, the Ukrainian Army, since the beginning of the hostilities. ATO the local authorities and consumers Naftogaz group recognized losses resulting ILLEGAL SUPPLIES TO THE enabled the timely repair of the critically Prokhorivka from the occupation of parts of Donetsk OCCUPIED TERRITORIES BY Local grid damaged pipelines. An emergency and Luhansk regions and the military GAZPROM never used termination of gas supply, which would Platove 0% actions ongoing in these regions since the for transit to the EU require months of work to restore gas Neither Naftogaz nor Ukrtransgaz have spring of 2014 in amount of UAH 7.2 billion 0% flows, was avoided. personnel at gas metering stations (GMS) in its consolidated financial statements to Romania in the Anti-Terrorist Operation (ATO) area. for 2014. Naftogaz created a provision As a result of the conflict, the Because of the occupation of the southern to reflect conservatively the uncollected Severodonetsk site for the Donbas and the ongoing hostilities, the revenues from customers in the occupied extraction of gas and condensate group is unable to ensure the presence GMS that have not been approved Ukraine is committed to be a reliable via the Ukrainian territory have proved territories. Naftogaz also recognized a partially suspended operations of of technical experts at gas pipelines in by the operator of the Ukrainian gas partner for the European Union. secure for decades. There is no reason loss of approximately 400 mcm of gas in 6 gas processing plants: Vilhivska, the area as this would pose a risk to their transportation system in breach of the to use the longer route that passes the 2014, which was illegally taken out of the Lobachivska, Kondrashivska, Markivska, At the same time, Naftogaz would like to lives. As a result, there are no authorized contract. Such supplies would rely on military actions area for supplying gas to gas transportation system in the occupied Kruzhylivska and West Verhunska. bring to the attention of the international representatives of Naftogaz at Prokhorivka infrastructure located in the military the EU. territories. Shebelynkagasvydobuvannya’s losses community a risk related to the GMS and Platove GMS to verify the action zone and may lead to catastrophic in extraction of natural gas incurred as unauthorized gas supplies by Russia to Such unauthorized supplies would 14 gas pipelines, 4 compressor stations, volumes and quality of gas which Gazprom outcomes. No adequate maintenance a result of the hostilities as of July 2015 the occupied territories of Donbas. violate the contract as well. Nevertheless, three gas distribution stations and the claims to supply to the occupied territory. can be guaranteed in the occupied area amounted to 636 tcm of gas per day. considering Gazprom’s readiness to Verhunske underground gas storage facility because of the shelling, asset seizure and Naftogaz is concerned that the Russian The contract between Naftogaz and deviate from the contract in its alleged were damaged as a result of the armed The infrastructure of oil pipelines of damage inflicted by illegal armed groups. counterparty may declare that it has Gazprom specifies that technical operators supplies to Donbas, the situation when conflict, and 3 gas distribution stations were the Dnipro Main Oil Pipelines branch sent certain volumes of gas destined for Ukrtransgaz and Gazprom agree on the Naftogaz is not in a position to accept Russia claims supply of gas for transit cut off from electricity. In June 2015, the (Vovchoyarivka, Popasna district, Luhansk transit to its European clients through scope and terms of gas supply. In this the delivery of such supplies because through the occupied region, announces gas pipeline that delivers gas to the eastern region) was also hit. Technological and the uncontrolled territories. Such a regard, Gazprom sends its total transit they were not nominated and are neither unauthorized withdrawals by Ukraine and part of Zaporizhzhia and Donetsk regions auxiliary equipment, buildings and claim would pose a serious threat to volume nomination to its Ukrainian certified nor controlled by the group’s completely terminates supplies on this was severely damaged by shelling. structures, and vehicles of the Lysychansk the stability of gas flows to Europe since counterpart indicating gas volumes it authorized personnel. ground, cannot be ruled out. linear supply control station were Naftogaz would not be in a position to would like to receive at specific exit points. damaged. GAS FLOW FROM RUSSIA TO retrieve such volumes of gas from the Directing gas flows nominated for transit Ukrtransgaz then indicates specific entry EUROPE: UKRAINE CONTINUES territories occupied by the illegal armed to the EU via territories that are not Mariupol, Berdiansk and Illegal armed groups captured nine vehicle points where the nominated volumes of gas TO BE TRANSPARENT AND groups. controlled by the Ukrainian authorities, gas filling compression stations of Naftogaz for both transit and use in Ukraine (if any) other settlements in the RELIABLE PARTNER specifically, through Prokhorivka GMS subsidiary Ukravtogaz, namely: Donetsk-2, should be directed by Gazprom for entry Gas supplied for transit to Moldova and and Platove GMS, is unreasonable, region could have faced a Donetsk-3, Horlivka-1, Horlivka-2, into the Ukrainian gas transmission system. Naftogaz continues to ensure the EU has never passed through the economically inefficient and threatens Makiyivka-1, Makiyivka-2 Amvrosiyivka, uninterrupted gas flow to Europe despite region now occupied in Donbas. Existing prolonged disruption in Starting from February 2015, Gazprom the security of supplies to European Yenakiyeve and Luhansk. 47 vehicles the Russian aggression against Ukraine. routes of gas flows from Russia to the EU gas supplies claims to allegedly supply gas through consumers. 118 119 MANAGEMENT REVIEW OF FINANCIAL RESULTS

STATEMENT OF DEPUTY CHAIRMAN

As a result of this unsustainable practice, The issue of systemic losses should be resolved in three ways: Sergiy Konovets for many years Naftogaz has been selling 1. Bringing the purchase price of imported gas down to fair market levels. Throughout 2014, the group's management imported gas to consumers for less than demonstrated not only the intent to do so, but also an ability to its cost, thus requiring more and more significantly reduce the cost of imported gas. compensations from the state budget Unlike in April 2014, when most of Ukraine's needs in imported gas could only be met by importing gas from Russia, at a price and accumulating multi-billion dollar 30% higher than European customers were paying, today we debts have the opportunity to purchase significant volumes of gas from EU countries. As a result, Gazprom now offers us gas at a price level comparable to the prices at which we are able to buy from In particular, in 2014 the imported gas used for production of heat for European suppliers. households cost Naftogaz from USD 270/tcm to USD 380/tcm while 2. Increasing domestic production by raising the selling prices its selling price during the same year decreased from USD 95/tcm to of gas produced by UGV to a level that would ensure sustainable USD 48/tcm because of the devaluation of hryvnia. The total negative levels of investment. Starting from April 2015, the sale price of gas difference between the purchase price of gas for Naftogaz and produced by UGV was increased by 4.6 times. However, much of the sale price of the same gas for the needs of households in 2014 this increase has been offset by a simultaneous increase in royalty amounted to tens of billions of hryvnias. rates associated with hydrocarbon extraction from 20% to 70% of Over the last five years, financial results of Naftogaz have also the gas price. In April 2016, the gas price for UGV will be increased Dear readers! TRANSFORMING THE LOSS-MAKING deteriorated because the selling price of Ukrainian gas produced by to accommodate necessary investments in production growth. BUSINESS MODEL I would like to address the financial aspects of Ukrgasvydobuvannya (UGV), a subsidiary that provides about 60% of 3. Gradual bringing of retail prices for all categories of the operations of Naftogaz and its subsidiaries. The main underling factor behind the systemic gas for households, was administratively set at a level more than 10 consumers to a fair market level. Even with the decrease of the losses of Naftogaz is the populist policy of previous times lower than fair market price. In 2014, the administratively set Like most of my colleagues who took the prices of imported gas to market levels and domestic production governments to maintain below-the-market retail price was only UAH 349/tcm. responsibility to lead Naftogaz, I joined the growth, the only way to ensure Naftogaz operating profitability is gas prices for certain categories of consumers. company in early April 2014. I learned of the As a result, UGV has been unable to invest in the development of to allow the group to sell gas at market prices. Instead of the conventional model of developed opportunity via the Professional Government its own production for years and the need for imported gas has countries, where targeted subsidies are provided This task is one of the key elements of the gas market reform initiated initiative of Ukrainians who have graduated remained consistently high. by the state only to vulnerable consumers, by the government and strongly supported by Naftogaz. The reform from Western universities. Ukrainian politicians subsidized all consumers Global energy prices rose rapidly for several years, and Ukraine process foresees the gradual shifting of retail gas prices towards fair The new management team took over a through low gas prices. had to pay a high price for imported gas due to a combination of market levels. strategic company, and along with this dependence on one supplier (Gazprom) and various schemes with great responsibility we have also inherited intermediaries built in the past around the purchase of Russian gas. a legacy of accumulated challenges and Such a system skews the very At the same time, retail gas prices for households remained almost This is the beginning of the transition problems. In the aftermath of numerous years unchanged, which resulted in growth of Naftogaz losses from year to of unresolved issues, the Naftogaz group principle of social justice: from the existing practice of multi- year. In 2007, the negative difference between the purchase and sale faced huge losses (UAH 88.4 billion) and an the government subsidies in prices of gas for households in Ukraine was USD 300 million, or 0.2% billion injections by the state budget to enormous deficit (UAH 108.6 billion) in 2014. the form of low gas prices are of GDP, while in 2012 it grew to USD 3.6 billion, or 2% of GDP. cover Naftogaz losses towards direct state To address the group’s challenges related to finance, we are taking steps in three main obtained not only by the poor, assistance to the vulnerable categories areas: but also by those who are For many years, the accumulation of of consumers through effective and • eliminating the reasons behind systemic financially secure operational losses of Naftogaz was an transparent targeted subsidies mechanism losses of Naftogaz inherent feature of the business model ensuring the sustainable solvency of the • This model has led not only to shifting actual Successful implementation of these steps will allow Naftogaz, for group and restaring its liquidity of the group. This business model, in expenditures of the state budget to Naftogaz, but our view, is inefficient and should be the first time in many years, to break even. As a consequence, the • securing the group’s transparency and also served as a stimulus for corruption in the gas company’s activities will ensure sufficient tax payments to the state improving its operational efficiency sector. changed budget to finance targeted subsidies programs. 120 121 MANAGEMENT REVIEW OF FINANCIAL RESULTS

ADDRESSING LIQUIDITY AND SOLVENCY ISSUES transferred to Naftogaz share capital in the form of domestic ENSURING TRANSPARENCY AND OPERATING Furthermore, we strongly believe that another important way government bonds. EFFICIENCY to improve operational effectiveness is the implementation of a The second challenge for the efficient management of the group’s transparent procurement system. finances is restoring liquidity, both in terms of the group’s ability For many years the state did not fully compensate Naftogaz The third challenge for the efficient management of the group’s to pay to external and internal creditors, and financing sufficient for the difference between the purchase and sale prices of gas finances, in addition to addressing the loss-making business model In particular, Naftogaz now solicits bids for goods and services not levels of working capital. consumed by households. As a result, the group covered the and the liquidity crisis, is overcoming the consequences of corrupt only in specialized publications but also through the mass media. In deficit by accumulating loans and other liabilities. The time to practices, lack of transparency and inefficient corporate governance, 2015, Naftogaz and UGV joined ProZorro, the newly developed system pay these bills eventually came in 2014. form which the group has suffered for years. of e-procurement for public sector companies.

By the beginning of 2014, Naftogaz The transparency and availability of information about Naftogaz had accumulated multi-billion dollar Addressing the issue of the Naftogaz One of the most striking examples of the procurement allows us to reach a wide range of potential contractors liabilities, mostly denominated in and thus to ensure we get the optimal terms. A small example is the deficit through direct support from poor governance is the fact that before we tender for cleaning services in Naftogaz headquarters. A subsidiary of foreign currency, consisting of loans and the state budget is an unsustainable joined Naftogaz, independent audits of Naftogaz, which had performed this function for many years, offered outstanding invoices for imported gas its services for UAH 11 million, which was almost five times higher and irrational strategy. It could only the group’s financial statements had not than the best bid from external contractors that met the qualification criteria. Consequently, the independent company won the contract, be justified in emergency cases, like been conducted for two consecutive years and currently performs the same job at a much lower price. Because of the prepayments for gas transmission services Naftogaz received from Gazprom and spent in 2010-2012, we started to the one Naftogaz faced in 2014 As a result of correcting the business model and the improving receive cash from this segment only in late 2014. There were also It is highly possible that the main reason for such a delay in the operational efficiency of Naftogaz, we expect to see a unresolved issues regarding the terms of supply of gas from Russia preparation of financial statements could be a reluctance of the substantial reduction in the deficit of the group in 2015. Successful This decision to provide the record volume of state support to after 1Q 2014. previous management to reveal certain decisions and activities to the implementation of the reform of the gas market in Ukraine will enable Naftogaz was difficult. However, it was necessary to guarantee public. Naftogaz to become profitable and deficit-free by 2017. Economic and political developments in Ukraine in 2014 also sufficient gas supplies to Ukrainian consumers during the negatively affected the performance of the group. Because of winter of 2014-2015 and the stability of gas transmission to In particular, in the notes to the consolidated financial statements for We will continue to work on improving the transparency of Naftogaz hryvnia devaluation and the loss of gas production capacities in the EU. In addition, most of the accumulated past liabilities of 2012-2013 and 2014, we expressed doubt as to the reasonableness of and its subsidiaries by publishing annual audited consolidated Crimea and in the area of the Anti-Terrorist Operation (ATO) in Naftogaz were guaranteed by the state. costs incurred totaling about UAH 29.5 billion according to the primary financial statements and by starting to publish interim (quarterly) eastern Ukraine, Naftogaz cash outflows increased by more than documents related to 2012, 2013 and the first quarter of 2014. consolidated financial statements starting from 2016. UAH 47 billion. The funds received from the state We also have doubts about the completeness of the recorded revenues from the sale of liquefied petroleum gas in 2012-2013, which In two years, Naftogaz and its Under these conditions, the deficit in 2014 allowed us to purchase the amounted to UAH 4.6 billion, according to the primary documents. necessary volumes of imported gas Information on each of these cases was properly reported to the subsidiaries will be transformed from of the group in 2014 could have relevant law enforcement authorities. In the opinion of the current a ‘black hole’ of the state budget to a amounted to UAH 142 billion. To (both from Russia and from Europe) management, the counterparties in these transactions could be to make sure that Ukrainians have companies and individuals associated with the former group transparent and profitable group of address this extreme liquidity crisis, management and the former government. gas and heat during the winter companies that can compete successfully the new Naftogaz management team We also question the validity of the storage costs for technological on the market and ensure stable tax implemented a number of measures season oil approved by the former management of Ukrtransnafta in 2014, totaling UAH 164 million. revenue stream for the state budget which resulted in a 24% reduction of Until the completion of the respective investigations and enforcement Along with addressing the issue of debt repayments, an of court decisions, all of the above mentioned transactions have been the deficit important challenge for our team has always been and still recorded based on the primary documents and accompanied by our remains securing sufficient working capital. The business model comments in the corresponding notes to the consolidated financial SERGIY KONOVETS developed before 2014 (where the imported gas was paid for After numerous rounds of trilateral negotiations involving Ukraine, statements. The auditor’s report also makes relevant comments on Deputy Chairman of the executive board, upon delivery, the operations were financed through advances, the Russian Federation and the EU, an agreement with Gazprom these issues. Naftogaz of Ukraine and consumers where allowed to accumulate huge debts) was reached on the reduction of Russian gas prices. Furthermore, changed dramatically in 2014. In particular, Naftogaz had to Naftogaz also secured supply of imported gas from Europe at prepay any gas it imports. market prices, implemented certain measures to improve cash collection from domestic customers, and restructured some The timely repayment of Eurobonds and the restructuring of existing loans. other debt has significantly improved the solvency of the group. This allowed Naftogaz to start negotiations on the working The remainder of the deficit (UAH 108.6 billion) was covered by capital financing with international financial institutions, at attracting loans totaling UAH 12 billion and through funding by interest rates much lower than at the domestic market. the state budget totaling UAH 96.6 billion. The latter funds were 122 123 MANAGEMENT REVIEW OF FINANCIAL RESULTS

MANAGEMENT COMMENTS ON THE AUDITOR’S OPINION

At the time of the change in management in spring 2014, audited AUDITOR’S QUALIFICATIONS AND RELATED COMMENTS consolidated financial statements of Naftogaz had last been prepared in 2011. The process of preparing the group’s financial Effect on : statements for 2012 and 2013 had not begun. No auditor had been Auditor’s qualification Statement of Statement of appointed to carry out a financial audit for this period. (the qualification number in the auditors financial position profit or loss Management comments Thus, preparation of the consolidated financial statements for 2012 report indicated in brackets) as of 31 December 2014* and 2013 and recpective audit began only in the second quarter 2014 of 2014. Failure to carry out necessary audit procedures at the Technical accounting issues: end of the reporting period was the main reason for the auditor’s Absence of revaluation of property, plant and equipment no yes As at 31 December 2014, an independent revaluation of disclaimer of opinion on Naftogaz financial statements for 2012 at the beginning of the reporting period, and related (12% of net loss) property, plant and equipment was carried out by Ernst & and financial results for 2013. As to the financial position as at 31 impact of revaluation reserve in 2013 and 2014 (1) Young. Hydrocarbon reserves were evaluated by Ryder Scott. December 2013, the auditors expressed a qualified opinion with six Absence of independent revaluation of hydrocarbon no Yes qualifications. reserves at the beginning of the reporting period, and (3% of net loss) related impact of revaluation on depletion in 2014 (2)

The auditor expressed a qualified opinion on Naftogaz financial Use of different accounting policies by the group and the yes yes The company has started the process to unify accounting position and financial performance for 2014. Major part of the group’s associates and joint ventures (5) (2% of assets) (3% of net loss) policies for the purpose of preparing consolidated financial modifications in the auditors’ report for 2014 were carried forward statements. It should be noted that the ability to influence the accounting from the respective modifications for 2013 results as comparatives, policies of companies not controlled by Naftogaz is limited. and should not impact the auditors’ report for the year 2015. Loss of access to the financial information of Chornomornaftogaz: Loss of access to the financial information and primary no yes Management continues to take all possible legal and diplomatic documents of Chornomornaftogaz (3) (16% of net loss) measures to obtain a reimbursement of losses and renew control over the group’s assets in Crimea OPINIONS OF THE INDEPENDENT AUDITOR ON THE CONSOLIDATED FINANCIAL STATEMENTS OF Late appointment of auditor for 2013 audit: NAFTOGAZ Unconfirmed inventory quantities as of the beginning of no yes Inventory stock-take as at 31 December 2014 was carried out the reporting period (4) (1% of net loss) with the participation of the auditors 2012 2013 2014 Presentation and accuracy of the consolidated financial statements and impact of possible alleged fraud by the previous management: Nature of certain expenses may not be reflected no yes State prosecutor officials initiated criminal proceedings STATEMENT OF Disclaimer 6 qualifications, 1 qualification, in their legal form. Exposure to this issue amounts to (3% of gross loss) in respect of the possible alleged fraud by the previous FINANCIAL POSITION of opinion qualified opinion qualified opinion UAH 2.3 billion for the 1st quarter of 2014 and management that may have resulted in certain costs UAH 8.8 billion for the year 2013 (6)

Lack of sufficient evidence regarding completeness of no no 6 qualifications, revenue on sales of petroleum in the amount of UAH 2.8 STATEMENT OF PROFIT billion for the year 2013 (7) Disclaimer Disclaimer related to 2013 financial OR LOSS of opinion of opinion report, qualified opinion *The impact on the result of operations was calculated with reference to the total line in the consolidated statement of profit or loss where the qualified amount was included 124 125 MANAGEMENT REVIEW OF FINANCIAL RESULTS 2013 2014 +/- % Statement of cash flows of the group, in UAH million unless otherwise stated Net cash used in/generated from operating activities (1) 7 155 (59 738) (66 893) -935%

Net cash used in investing activities (2) (3 231) (3 959) (728) 23%

Cash outflow from financing activities (repayment of borrowings, interest paid (29 122) (43 873) (14 751) 51% OPERATING and mandatory budget contribution of profit share) (3) Net change in cash balance (4) (109) (1 002) (893) 819% AND FINANCIAL HIGHLIGHTS Net cash flow before deficit financing and other sources (25 307) (108 572) (83 265) 329% (deficit) (5 = 1 + 2 + 3 + 4)

Sources to cover the deficit 25 307 108 572 83 265 329%

- proceeds from borrowings 19 483 11 962 (7 521) -39%

- proceeds from sale of state treasury bonds contributed to share capital 5 824 96 610 90 786 1559%

* operating indicators do not include information on SJSC Chornomornaftogaz, as the group has lost control over the assets after the occupation of Crimea by the Russian Federation ** regulated businesses are activities where sales prices and tariffs are regulated by the state

2013 2014 +/- % Key operating highlights of the group* Proven hydrocarbon reserves (SPE-PRMS), million boe N/A 1 618.56

Gross natural gas production (excluding production sharing agreements), mcm 14 021 14 034 13 0%

Gross production of crude oil and gas condensate, thousand t 738 637 (100) -14%

In Ukraine 645 535 (110) -17%

In Egypt 93 102 10 11%

Volume of natural gas sold, mcm 32 123 29 232 (2 891) -9% Transportation of natural gas under the contract with Gazprom, mcm 86 126 62 197 (23 929) -28% Entity Operating profit / Net Profit / ROE ROA Liquidity Total in- Cash-flow from Domestic transportation of natural gas in Ukraine, mcm 44 097 38 122 (5 975) -14% (loss), % to revenues (loss), % to ratio debtedness / operations / Capital

Transmission of crude oil, mcm 17.6 16.9 (1) -4% revenues Total assets expenditure

Sales of petroleum products, thousand t 687 403 (284) -41% Naftogaz Sales of LPG, thousand t 206 177 (29) -14% 2013 -9.0% -23.8% -15.7% -7.1% 44.4% 25.0% 195.7% Sales of natural gas via petrol stations, mcm 130 97 (33) -26% Key financial highlights of the group, in UAH million unless otherwise stated 2014* -39.9% -112.7% -24.8% -17.2% 70.7% 11.8% -2053.6% Revenue 75 374 78 444 3 070 4%

Gross loss (752) (8 507) (7 755) 1031% Peers (2014) EBITDA (1 426) (63 792) (62 366) 4373%

Loss before tax, including (15 492) (77 603) (62 111) 401% Total 4.3% 2.0% 4.5% 1.8% 145.3% 24.6% 97.3%

Loss before tax from the regulated businesses** (26 765) (88 893) (62 128) 232% BP 5.1% 1.1% 3.1% 1.3% 137.2% 18.6% 145.3% Production of natural gas (1 163) (4 696) (3 533) 304% Petrochina 6.7% 5.2% 9.4% 4.9% 67.5% 22.4% 122.2% Storage of natural gas (661) (2 986) (2 325) 352%

Wholesale distribution and trading of natural gas (24 941) (81 211) (56 270) 226% Conoco 13.5% 13.1% 13.2% 5.9% 130.6% 19.4% 98.0%

Loss before tax from the non-regulated businesses 11 165 10 575 (590) -5% CNOOC 16.0% 12.9% 12.3% 7.1% 109.5% 25.4% 210.1% Transmission of natural gas 9 435 7 448 (1 987) -21% Gazprom 23.7% -2.4% 2.1% 1.5% 170.0% 17.7% 103.8% Refinery of crude oil and gas condensate 1 437 1 995 558 39%

Transmission of crude oil 435 1 115 680 156% GAS NATURAL 12.9% 5.9% 10.6% 3.1% 128.5% 40.8% 207.5%

Other (142) 17 159 -112% NOVATEK 35.7% 10.4% 9.9% 5.8% 155.9% 35.1% 189.1% Unallocated income and expenses 108 715 607 562% Kazmunaigaz 17.2% 5.6% 3.5% 3.1% 191.6% 0.5% 215.6% Loss from discontinued operations (874) (13 786) (12 912) 1477% ENI 7.2% 1.2% 2.3% 0.9% 150.0% 17.7% 141.2% Net loss (17 957) (88 433) (70 476) 392% Statement of financial position of the group, in UAH million unless otherwise stated PGNiG 13.9% 8.2% 9.6% 5.8% 176.3% 11.9% 179.0% Total assets, including 237 918 514 979 277 061 116% OMV 2.9% 1.0% 3.1% 1.1% 93.6% 21.6% 95.6% - property, plant and equipment 181 428 454 991 273 563 151% MOL 0.8% 0.1% 0.3% 0.1% 92.3% 20.7% 81.6% Equity 106 975 356 958 249 983 234%

Borrowings, including 130 883 158 001 27 118 21% Average 13.7% 7.4% 7.9% 4.2% 134.5% 20.5% 138.2%

- long term 14 388 26 188 11 800 82% Median 12.9% 5.7% 9.6% 3.1% 137.2% 20.7% 127.4% - short term 45 170 34 820 (10 350) -23%

Working capital (11 108) 12 320 23 428 -211%

Capital expenditure 4 234 3 672 (562) -13% * ROE and ROA are calculated with reference to the total equity and total assets as at 31 December 2014 126 127 MANAGEMENT REVIEW OF FINANCIAL RESULTS

REVIEW OF THE FINANCIAL PERFORMANCE

REVENUE AND GROSS LOSS by regulated businesses, accounting for compared to 2013, and reached 42%. 59% of the total revenue in 2014, because This change was mainly driven by the Despite the decline in sales volumes, of the distortion between selling prices increase in gross profit margin of crude oil the group’s revenue increased by 4% for gas and gas storage tariffs and their transmission segment (explained by the in 2014 compared to the previous year economically justified levels. devaluation of hryvnia) and the segment of and amounted to UAH 78.4 billion. The production of petroleum products and LPG structure of the revenue was as follows: The gross profit margin of non-regulated (explained by the 2.7 times increase in LPG businesses improved by 5% in 2014 • Revenue from regulated businesses prices). (wholesale supply and trading of natural gas, production of natural gas and REVENUE BY SEGMENT, 2013, % REVENUE BY SEGMENT, 2014, % storage of natural gas) increased by 23% and amounted to UAH 46 billion, due to Wholesale Wholesale the increase in tariffs and selling prices supply supply for natural gas and gas storage services Transmission Transmission and trading of natural gas and trading of natural gas of natural gas of natural gas • Revenue from non-regulated 40% 31% businesses (production of crude oil and 48% 58% natural gas condensate, transmission of natural gas, transmission of crude oil, refinery of crude oil and concentrate, Regulated segments Non-regulated segments and other segments) decreased by 15% and amounted to UAH 32.4 billion. The 75.4 78.4 decrease of the revenue from non- UAH billion UAH billion regulated activities is mainly explained by a decline in gas transmission volumes

The share of the revenue from regulated 11% 10% gas production Natural gas storage Natural Wholesale supply and gas of natural trading Total of crude oil Production and condensate gas Natural transmission oil transmission Crude oil and Crude condensate refining Other Total businesses increased by 9% in 2014 2013 compared to 2013, and comprised 59% of Revenue, UAH million 446 443 36 447 37 336 207 30 131 1 411 5 778 511 38 038 Gross profit/(loss), UAH million (97) (612) (13 946) (14 655) 207 11 696 548 1 574 (122) 13 903 the group's total revenue. 1% 1% Gross margin -22% -138% -38% -39% 100% 39% 39% 27% -24% 37% The gross loss of the group in 2014 (gross profit (loss)/revenue),% Regulated Non-regulated Regulated Non-regulated 2014 amounted to UAH 8.5 billion (2013: UAH businesses businesses businesses businesses Revenue, UAH million 130 338 45 493 45 961 320 24 171 1 957 5 197 838 32 483 0.8 billion). The gross loss was formed 49% 51% 59% 41% Gross profit/(loss), UAH million (241) 222 (22 100) (22 119) 320 9 482 1 110 2 182 520 13 614 Gross margin -185% 66% -49% -48% 100% 39% 57% 42% 62% 42% 128 (gross profit (loss)/revenue),% 129 MANAGEMENT REVIEW OF FINANCIAL RESULTS

WHOLESALE SUPPLY AND TRADING OF NATURAL GAS VOLUME AND SELLING PRICE FINANCIAL RESULTS FOR NATURAL GAS SOLD TO BY SEGMENTS Key segment highlights, in UAH million 2013 2014 +/- % CONSUMERS IN UKRAINE, unless otherwise stated BCM; UAH/TCM Volume of natural gas sold, mcm 32 123 29 232 (2 891) -9% Segment assets 29 869 28 347 (1 522) -5% -2.7 Revenue, including: 46 275 53 257 6 982 15% 32.1 29.2 sales to third parties 36 447 45 493 9 046 25% 6.9 3 444 UAH/tcm Gross profit/(loss) (13 727) (18 426) (4 699) 34% 7.1 4 614 UAH/tcm

% of revenue -30% -35% -5% 17% 8.3 792 UAH/tcm 7.1 756 UAH/tcm Segment result (loss before tax) (24 941) (81 211) (56 270) 226%

% of revenue -54% -152% -99% 183% 16.9 15.0 ROA (segment result/assets), % -84% -286% -203% 243% 372 UAH/tcm 491 UAH/tcm Capital expenditure 30 262 232 773% 2013 2014 Households Heat generating entities (no impairment was recognized in 2013), increase in natural gas selling price for Industrial consumers for heat produced REGULATED BUSINESS production, gas used for own needs VAT during 2013-2014. This is almost by an increase in foreign exchange households effective from 1 May 2014, and for households SEGMENTS (production premises heating, etc.), and 10 times lower than the market price at losses of UAH 0.8 billion, and by a fall in a 1.9 times increase in natural gas selling sales of low condition gas). which natural gas was sold to industrial revenues of UAH 0.3 billion. price for industrial customers executed in UAH 4.7 billion and amounted to UAH customers. Revenues from natural gas several steps during the year. The revenue According to the Law ‘On the natural Wholesale gas supply and trading 18.4 billion in 2014. The main reason for Gas upstream sales to Naftogaz amounted to UAH decreased by UAH 3 billion because of the gas market functioning’ (in effect till 1 the increased gross loss is the regulated 4.7 billion in 2014, and stayed at the Natural gas consumption in Ukraine lower volumes of sold gas and increased by The volume of natural gas produced by October 2015), UGV is required to sell its selling price of imported natural gas to same level as in 2013. (excluding gas consumed for UAH 12 billion due to sale price adjustment. the group in 2014 amounted to 14 bcm, marketable gas (all natural gas produced households set by the NEURC, which is technological needs) in 2014 decreased which is in line with the corresponding less gas used for technological and other Losses in the production of natural However, the sale price increase was significantly lower than the purchase by 16% compared to 2013 as a result figure for 2013. own needs), to households via Naftogaz. gas in 2014 increased almost fourfold not able to fully offset the increase in price at which this gas was imported. of the economic crisis and industrial Naftogaz purchase price of natural gas compared to 2013, and reached UAH the natural gas import price in UAH Gas production reflected in this segment production decline, occupation of Crimea Households consume nearly 20 bcm of produced by UGV has been set by the 4.7 billion. This negative increase equivalent due to the devaluation of the is performed by one subsidiary of the and the military conflict in the east of natural gas annually for cooking and National Energy and Utilities Regulatory was driven mainly by impairment of national currency. As a result, the gross group – Ukrgasdobuvannya (UGV), it Ukraine. At the same time, volume of heating, including consumption via Committee (NEURC). This price remained property, plant and equipment totaling loss from natural gas sales increased by excludes gas production under product natural gas sold by the group decreased at the level of UAH 349.2/tcm excluding UAH 2.4 billion as a result of revaluation sharing agreements of UGV and gas by only 9% compared to 2013, and production of Ukrnafta. amounted to 29.2 bcm. As a result, the PROFIT/LOSS FROM NATURAL GAS SALES BY CONSUMER GROUPS PRODUCTION OF NATURAL GAS group's share of the natural gas market IN 2013, UAH BILLION As a result of the occupation of 18.4 Key segment highlights, (in UAH million, 2013 2014 +/- % increased by 6% in 2014 due to an 20 14.6 Crimea by the Russian Federation, 12.9 unless otherwise stated) increased share of industrial customers. 10.1 Naftogaz lost control over assets of Gross natural gas production (excluding product sharing agree- 14 021 14 034 13 0% 10 6.5 5.7 6.4 6.1 Chornomornaftogaz in Crimea 1Q 2014. Revenue from sales of natural gas to third 3.3 2.7 2.6 ments and Chornomornaftogaz), mcm 0.3 0.6 1.7 Consequently, the financial results of including: parties increased by 25% in 2014 compared 0

Chornomornaftogaz have been excluded technological needs 422 445 24 6% to the previous year and amounted to UAH 2013 -4.4 from these consolidated financial as raw material for LPG production 92 92 (0) 0% 45.5 billion (2013: UAH 36.4 billion). Despite -10 -11.9 statements for 2013 and 2014. At the own needs 84 88 4 5% a decline in the volume of sales, revenues -20 -16.3 same time, Naftogaz purchased natural for selling to households 13 423 13 409 (14) 0% in monetary terms increased due to a 56% 30 24.6 24.7 gas from Chornomornaftogaz for further Segment assets 30 053 42 367 12 314 41% 20 15.4 17.0 sale to households of 1.6 bcm and 0.3 Revenue, including 5 133 4 815 (318) -6% 5.3 7.4 5.7 8.9 NATURAL GAS SALES 10 4.8 2.4 2.1 7.7 bcm in 2013 and 2014 respectively. sales to Naftogaz 4 687 4 685 (2) 0% 0.9 0.3 TO UKRAINIAN CONSUMERS, 0 Revenue and cost of such sales are sales to other entities 110 130 20 18%

BCM 2014 included in the ‘wholesale supply and services* 336 (336) -100% -10 -8.0 Gross profit/(loss) (97) (241) (144) 148% -16% trading of natural gas’ segment. -20 -19.3 % of revenue -2% -5% -3% 165% 46.1 38.5 -30 -27.3 The volume natural gas sold on by the Segment result (loss before tax) (1 163) (4 696) (3 533) 304% 30% Heat produced Regional gas Total for Heat produced Regional gas Industrial and Total, net of 24% for households distribution households for other distribution other households group in 2014 amounted to 13.6 bcm % of revenue -23% -98% -75% 330% entities for consumers entities for consumers resale to resale to other (gross natural gas production volumes ROA (segment result/assets), % -4% -11% -7% 186% 70% 76% households customers less gas used for technological needs, Capital expenditure 2 053 2 598 545 27% 2013 2014 gas used as raw material for LPG Group Other suppliers Revenue Cost of sales Gross profit / loss * such revenues moved to the “other” segment in 2014 130 131 MANAGEMENT REVIEW OF FINANCIAL RESULTS

heat generating entities. This demand AVERAGE RETAIL GAS customers. Prices are reviewed monthly STORAGE OF NATURAL GAS The volume of domestic gas is partially covered by domestic supply PRICES FOR HOUSEHOLDS and adjusted for changes in import gas transmission in Ukraine was 14% lower Key segment highlights, UAH million 2013 2014 +/- % amounting to nearly 60% (UGV and (EXCLUDING SALES VIA HEAT prices and UAH devaluation, ensuring in 2014 compared to the previous year unless otherwise stated Chornomornaftogaz up until Q2 2014). GENERATING ENTITIES) positive gross margins of 11% and 27% as a result of the economic crisis, the Tariffs for underground storage services, net of VAT*, 16.50 42.83 26.33 160% Imported natural gas supplies covered for 2013 and 2014, respectively. occupation of Crimea, and the military 627 UAH/tcm 37% of the household demand in 2014 conflict in the eastern regions of The gross profit from gas sales to Revenue, including 868 1 430 562 65% (for cooking and heating, including Ukraine. non-household consumers in 2014 Sales to other segments 443 338 (105) -24% consumption via heat generating 372 amounted to UAH 8.9 billion (2013: UAH Segment result (661) (2 986) (2 325) 352% The decline in the revenue was caused entities), direct sales to households 2.6 billion). However, this gross profit Segment assets 70 304 146 195 75 891 108% by the following factors: included 1.6 bcm of imported gas. was not sufficient to cover the loss from ROA (segment result/assets), % -1% -2% -1% • Decrease in volumes of transmission As a result, additional gains from the gas sales to households. As a result, the *tariff used to calculate the total price of services for natural gas pumping services, is calculated as the price of pumping (both international gas transmission sale price increase for households segment posted a gross loss. services + ½ of tariff for gas underground storage services under the contract with Gazprom effective from 1 May 2014 (from $47 $40 Underground gas storage business and domestic transmission) UAH 372/tcm to UAH 627/tcm) were 31.12.2013 31.12.2014 31.12.2013 31.12.2014 the segment loss posted in 2013. The beginning and at the end of 2014) was contributed UAH 7.9 billion to the eliminated by the hryvnia devaluation. UAH/tcm USD/tcm In 2014, the price of underground gas main reasons for the negative result an additional factor that contributed to revenue decline In fact, the weighted average gas price storage services increased by 2.6 times were the UAH devaluation leading to the decline in international gas transit via for households in dollar equivalent on average. As a result of this increase, • Decrease of the transit fee under the Gas sales to other groups of consumers increases in the cost of imported gas Ukraine. decreased by 15% during 2014 (from revenues increased by 65% reaching contract with Gazprom by 10% in USD (heat generating entities for heat used for technological purposes, and USD 47/tcm to USD 40/tcm). UAH 1.4 billion. A major part of the produced for other customers, regional the recognition of impairment loss underground storage services are NATURAL GAS TRANSMISSION Therefore, despite the sale price gas distribution entities for resale to for property, plant and equipment of consumed within the group (in 2014: increase, the gross losses from natural other customers, direct contracts with UAH 2.3 million as a result of revaluation Key segment highlights, UAH million 2013 2014 +/- % 76%, in 2013: 49% of segment revenue). gas sales for households grew to UAH industrial and other consumers) posted (no such losses were recognized in unless otherwise stated

27.3 billion in 2014 (2013: UAH 16.3 a positive margin. Based on regulations Despite this revenue increase, the 2013). At the same time, the revaluation Transmission of gas under the contract with Gazprom, mcm 86 126 62 197 (23 929) -28% billion). in effect till 1 October 2015, the NEURC segment faced a UAH 3 billion loss in of property, plant and equipment was Domestic transmission of natural gas, mcm 44 097 38 122 (5 975) -14% sets maximum selling price for such 2014, which is 4.5 times higher than partially reflected as an increase in Segment assets 61 917 239 746 177 829 287% revaluation reserves in equity. Revenue, including: 30 131 24 228 (5 903) -20% Negative segment results indicate that LOSSED INCURRED FROM GAS SUPPLIES FOR HOUSHOLDS, UAH BILLION international transmission 22 732 16 831 (5 901) -26% the current level of storage tariffs is 23.6 35.1 2013 2014 below their economically justified levels. domestic transmission 7 399 7 340 (59) -1% Naftogaz group plans to switch to the Gross profit/(loss)1 11 696 9 482 (2 214) -19%

RAB methodology of calculating gas % of revenue 39% 39% 0% 1% 7.0 storage prices during 2016, in order 5.1 4.8 6.7 6.0 Segment result (profit before taxes) 9 435 7 448 (1 987) -21% 4.9 to ensure a fair return on assets and % of revenue 31% 31% -1% -2% improve the results of this segment. Revenue Cost of sales Revenue Cost of sales Revenue Cost of sales Revenue Cost of sales ROA (segment result/assets), % 15% 3% -12% -80% per accounting per accounting per accounting per accounting records* records* records* records* NON-REGULATED BUSINESS Capital expenditure 1 195 295 (900) -75% 15.2 volume of 10.0 13.9 volume of 8.2 SEGMENTS gas sales gas sales *Including instate costs of the group bcm bcm bcm bcm Gas transmission Gas of own production** Imported gas Gas of own production** Imported gas The volume of natural gas transmission KEY INDICATORS OF DOMESTIC AND INTERNATIONAL under the contract with Gazprom TRANSMISSION, UAH BILLION Gross loss from Gross loss from declined by 28% in 2014 compared to sales of imported gas sales of imported gas 22.7 2013 as a result of the policy of Russia 16.8 0.3 1.8 to minimize the use of the Ukrainian gas 15.7 11.9 transmission system to deliver gas to the 7.4 7.0 7.3 EU. The share of the international transit 4.9 Gross profit from sales 3.6 3.8 3.0 4.3 Gross profit from sales + – of gas of own + from Russia to the EU and Turkey via the of gas of own -16.6 production Nord Stream and Blue Stream pipelines production – Domestic Transmission under Domestic Transmission under which bypass Ukraine increased from transmission the contract with transmission the contract with -29.1 23% to 35% in 2014, according to Loss of 16.3 Loss of 27.3 Gazprom Gazprom Gazprom official data. Decreased gas 2013 2014 *cost of sales per accounting records includes inventory net realisable value adjustment according to IAS 2. This cost cannot be fully compared to the economic cost demand in the European countries as a of sales, as it is not adjusted for the cost of capital, revaluation of property, plant and equipment and depreciation, depletion and amortisation. Revenue Cost of sales2 Gross profit **gas produced by Ukrgasvydovbuvannya and Chornomornaftogaz result of the warm winter (both at the 2 Not including internal costs of the group 132 133 MANAGEMENT REVIEW OF FINANCIAL RESULTS

equivalent in 2014 compared to 2013 REFINERY OF CRUDE OIL AND CONDENSATE OF CRUDE OIL TRANSMISSION The development period under the resulted in a UAH 1.6 billion decrease in concession agreement is limited to a Key segment highlights, UAH million Key segment highlights, UAH million (unless revenues 2013 2014 +/- % 2013 2014 +/- % maximum of 25 years from the date of unless otherwise stated otherwise stated) commercial oil discovery or from the On the other hand, the following factors Sales of petroleum products, thousand t 687 403 (284) -41% Transportation of crude oil, million t 17.6 16.9 -1 -4% date of the first natural gas deliveries, have partially offset the negative trend in Including Including: which started in 2011. the segment’s revenue: petroleum products of own production 474 364 (110) -23% international transmission 15.6 15.0 -1 -4% The concession agreement includes the • Increase in tariffs for domestic gas other sales 214 39 (174) -82% transmission in Ukraine 2.0 1.8 0 -10% following conditions: transmission, set by the NERC, by Sales of LPG, thousand t 206 177 (29) -14% almost 1.5 times effective from 1 June Revenue 1 411 1 957 546 39% • The company shall recover on a Sales of natural gas via petrol stations, mcm 130 97 (33) -26% 2014. This resulted in a UAH 0.8 billion Segment result 435 1 115 680 156% quarterly basis all exploration and Revenue, including: 5 778 5 197 (581) -10% revenue increase Segment assets 12 283 19 959 7 676 62% development costs to the extent Sales of petroleum products of own production and LPG 3 472 4 190 718 21% and out of 25% of all petroleum • UAH devaluation had an insignificant ROA (segment result/assets), % 4% 6% 2% Sales of natural gas via filling stations 688 659 (29) -4% produced and saved from positive impact on the revenue, Other sales of petroleum products 1 618 348 (1 270) -78% production areas and not used in resulting in UAH 2.2 billion increase Segment results 1 437 1 995 558 39% petroleum operations in the revenue from international gas Out of 6 refineries in Ukraine, only the domestic crude oil transmission fee has transmission, as up to October 2014 the Segment result margin (segment result/revenue), % 25% 38% 14% • The remaining 75% of the petroleum Kremenchuk Refinery is operating today. been increased by 6 times on average, revenue was posted against advances Segment assets 2 387 5 007 2 620 110% produced is shared by the company This refinery uses locally produced effective from 1 July 2015. made by Gazprom in 2010-2013 at a ROA (segment result/assets), % 60% 40% -20% and EGPC depending on the volume crude oil and light oil from the Caspian lower exchange rate Production of crude oil and gas of production. The company's share region delivered by railway transport. condensate varies from 15% to 19% As a result of the revenue decline, the The main reason for other Ukrainian overall gas transmission segment result in refineries to stop their activities was The revenue of this segment is formed • EGPC shall become the owner of petroleum products produced from revenues, while the increased prices 2014 decreased by 21% or by UAH 2 billion the competition from Belarusian, by sales made by the division in Egypt. all the company’s assets acquired purchased raw materials by Naftogaz resulted in almost 40% revenue growth compared to 2013. Russian and Baltic refineries, which All crude oil and gas condensate and owned within the concession and Ukrtransnafta by UAH 1.3 billion. in 2014 compared to 2013. take advantage of duty-free imports of produced in Ukraine is refined and sold agreement The significant decline in the ROA (return These activities are not core to Naftogaz Ukravtogaz revenue declined by oil products, close location to natural within the segment of refining crude oil on assets, or ratio of the segment results to and Ukrtransnafta, and they earned low Revenue increased by UAH 0.1 billion in UAH 0.03 billion in 2014 compared to resources in the Russian Federation, and gas condensate. the segment assets) after the revaluation margins, while freezing significant levels 2014 compared to 2013, and reached 2013 because of a reduction of sales the absence of Russian export duty and of property, plant and equipment in 2014 of working capital in inventory stock. The company entered into a concession UAH 0.3 billion. This increase in revenue volumes caused by the military conflict high level of technological development, indicates that the transmission fee under Consequently, the management of the agreement for oil exploration and is caused by an increase in crude in eastern regions of Ukraine. allowing them to produce higher output the contract with Gazprom is lower than group has decided to cease this line of development with the Arab Republic of oil production volumes (+UAH 0.02 of light oil products from Russian Urals economically justified levels. activity. The segment result improved by 39% Egypt (ARE) and the Egyptian General billion) and the change in the UAH/ crude oil. in 2014 to UAH 2 billion. The segment Petroleum Corporation (EGPC) covering USD exchange rate (+UAH 0.1 billion). In October 2014, Naftogaz management As a result, the revenue of this segment profit margin reached 38%, showing The segment revenue rose to UAH 2.0 the area of the Alam El Shawish East Meanwhile, the revenue decreased by initiated arbitration proceedings at the is formed largely by the sale of a 14% increase from 2013 results. billion in 2014, showing a 39% increase in the Western Desert (concession UAH 0.03 billion because of a decline in Arbitration Institute of the Stockholm petroleum products and LPG produced These results demonstrate that the compared to 2013 despite the decline agreement) on 13 December 2006. crude oil prices in 2014. Chamber of Commerce (SCC) regarding from own raw materials by UGV and terminating operations with petroleum in transmitted volumes. The main the gas transmission contract between sale of compressed natural gas via filling products produced from purchased raw reason for this growth was the UAH Naftogaz and Gazprom in order to bring the stations of Ukravtogaz. materials by Naftogaz and Ukrtransnafta devaluation, as oil transit charges are transit fee to an economically justified level. PRODUCTION OF CRUDE OIL AND CONDENSATE UGV revenue from this activity increased was economically sound. set in euros. Revenues increased by In addition, the NEURC plans to shift to RAB- by UAH 0.8 billion in 2014 compared 43% as a result of UAH/EUR exchange Key segment highlights, UAH million Crude oil transmission 2013 2014 +/- % methodology in determining transmission to 2013, despite a decrease in volumes rate changes, while the decrease unless otherwise stated fees starting from 4Q 2015, in order to of petroleum products and LPG sold Over the recent years volumes of crude in volume led to a 4% reduction in Gross oil and condensate production in Egypt*, thousand t 92.6 102.4 10 11% ensure fair return on assets, which will have by 110 thousand t and 29 thousand t, oil transmission have continuously revenues. Including a positive effect on the segment results. respectively. declined. This is explained by both a cost recovery portion 59.4 65.9 7 11% ROA for the crude oil transmission decrease in volumes of oil transmission profit sharing portion 33.2 36.5 3 10% Refining of crude oil and gas The revenue growth is explained by segment indicates the low level of to domestic refineries, and a decrease in Average oil price, USD/t 780 708 (72) -9% condensate, LPG production the increase in LPG prices: 75% of the return on the assets employed. The oil oil transit volumes. The total volume of Revenue** 207 320 113 55% total LPG volume in 2013 was sold to transmission fee to Ukrainian refineries The revenue of the segment amounted crude oil transmission decreased by 4% households at low regulated prices, is approved by the NEURC and was Segment results** 207 291 84 41% to UAH 5.2 billion, demonstrating a 10% in 2014 compared to 2013 (including a while 77% of the total LPG volume in set at the level of 2007. To improve Segment assets** - 3 424 3 424 decrease in 2014 compared to 2013. 4% decline in crude oil transit and a 10% 2014 was sold via commercial auctions the operating efficiency of Ukraine’s ROA (segment result / assets), % - 8% This decrease in segment revenue was decline in the crude oil transmission to at market prices. Reduction of sold domestic crude oil transmission * Naftogaz share in gross output, excluding EGPC share mainly driven by a decline in sales of domestic refineries). volumes resulted in a 20% decline in network and infrastructure, the **results earned in Egypt 134 135 MANAGEMENT REVIEW OF FINANCIAL RESULTS

NET LOSS REVIEW OF FACTORS THE FINANCIAL POSITION

ASSETS ASSETS BY SEGMENT ASSETS BY SEGMENT 2013*, % 2014*, % The group reported significant losses in or 22% of total net losses. The group additional UAH 5.8 billion losses from As at 31 December 2014, the total assets 2014 compared to the previous year. The has faced UAH 13.8 billion losses in the loss of other assets located in that Gas Gas transmission of the group amounted to UAH 515 billion Gas storage net loss for 2014 amounted to UAH 88.4 2014 related to the temporary loss region. Additionally, the group has Gas 48% transmission 29% (including UAH 495.5 billion of segment storage billion, which is almost five times higher of control over the activities of its lost about 1.4 bcm of natural gas of 28% assets). This amount is UAH 277.1 billion 32% 216.9 than the net loss for the previous year subsidiary Chornomornaftogaz, and domestic production that Naftogaz had UAH or two times higher than total assets as 130.2 (UAH 18 billion). In the total net result, to replace with natural gas imports 91.5 Billion at 31 December 2013. The increase in the UAH 221.7 496.0 74% of net losses were caused by external LOSSES OF THE GROUP IN 2014, billion UAH 4. Losses incurred in the ATO area – total assets is explained by an increase in UAH billion UAH factors beyond the group's management UAH BILLION, % Billion billion UAH 7.2 billion, or 8% of total net non-current assets from UAH 194.8 billion Other control: these included UAH devaluation 8% Gas 279.1 4.1 7.2 losses. These losses were incurred up to UAH 471.7 billion (+143%) following production UAH and the loss of control over assets in 18.4 (5%) (8%) 9% 19.6 because of unauthorized consumption a revaluation of property, plant and Gas Oil transmission billion Crimea and in the area of the Anti-Terrorist (21%) production 5% Wholesale Other (22%) Wholesale of gas and further payment of VAT equipment. Compared to the previous 14% gas trading 4% Operation (ATO) in the eastern Ukraine. ATO gas trading 74% on such consumption, overdue revaluation performed in 2009, the key 13% 6% Oil transmission 75% 4% The main factors that contributed to the Crimea receivables for gas consumed by those factors of this asset value increase were as Regulated segments 44% Non-regulated segments Regulated segments Non-regulated segments net loss in 2014 are as follows: 88.4 customers who stay on the territories follows: 41% 56% UAH billion Exchange rate 59% fluctutations beyond the control of the Ukrainian 1. Net foreign exchange loss: • Increase in prices of steel products, *Not including unallocated assets and investments of UAH 16.2 billion in 2013, UAH 19.0 billion in 2014 Losses from authorities, and losses of natural gas UAH 39.2 billion, or 44% of total net including pipes and steel structures the sale of stored in the occupied regions losses. The group's indebtedness in 39.2 natural gas • Increase in fuel prices foreign currency at the beginning of (44%) Other factors 2014 amounted to approximately • Increase in salary of construction and EFFECT OF REVALUATION ON THE VALUE OF PROPERTY, PLANT USD 7 billion. During 2014 the installation staff AND EQUIPMENT, UAH BILLION FACTORS OF DEFICIT, UAH BILLION UAH/USD exchange rate changed from 2013 2014 • Increase in prices for both domestic and 35.1 UAH 7.99 per USD 1 at the beginning 8.9 1.8 +296.2 -22.6 imported equipment 66% 41.2 146.1 of the year to UAH 15.77 per USD 1 in 9.9 27.6 17.4 57% 15.9 December 2014, resulting in significant • Changes in the macroeconomic situation 70.3 foreign exchange losses related to -29.1 -8.5 and oil and gas market forecasts 27.9 184.1 revaluation and settlement of the 181.4 331% 455.0 Overall loss from The share of assets of regulated businesses UAH UAH indebtedness denominated in foreign sales of natural gas to decreased from 59% as at 31 December 2013 currencies households and -39.2 billion billion heating comanies for to 44% as at 31 December 2014. The main 112% 78.8 -19.6 2. Loss on natural gas sales of UAH households factor contributing to the increase of share -7.2 55.7 Asset Other factors* UAH 27.3 billion -9.0 232.6 18.4 billion, or 21% of total net losses 4.9 -88.4 of non-regulated businesses in total assets revaluation Profit from gas Profit from Profit from the sale of Gross loss Net loss due to Losses due to Losses in ATO Financial Other Gross loss transmission sales of gas to self-produced imported gas exchange rate the area expenditure expenditure was the revaluation of property, plant and and other industrial gas to to households fluctuations occupation of (interest on Gas storage Gas transmission Gas production 3. Losses incurred due to the loss of activities consumers households and municipal Crimea loans) Other heating equipment of the gas transmission segment. companies assets in Crimea – UAH 19.6 billion, *Receipt and transfer of fixed assets, disposal, calculation of depreciation, reclassification etc. 136 137 MANAGEMENT REVIEW OF FINANCIAL RESULTS

LOANS, GROUPED BY CURRENCY The total amount of the current assets did CAPITAL EXPENDITURE, In 2014, the group had the lowest rate of actively sought to diversify sources of supply not change significantly during 2014. At the capital expenditures in gas production and UAH billion USD million of gas and to review the conditions of the UAH BILLION 2% 61.0 same time, their structure has changed: the 4.3 transmission among the group’s domestic 59.6 current gas supply contract with Gazprom. Growth of debt due amount of inventories and trade receivables and international peers in oil and gas 32.3 Effective 36.0 to exchange rate This led to the signing of an amendment interest decreased, while the amount of prepayments 0.9 3.7 industry. $4.1 $2.3 change -48% to the gas supply contract for the period 0.5 rate 9% 17.6 UAH billion, 48% increased. of deliveries during the 2014-2015 heating The underfinancing of capital expenditure $7.5 0.3 season (in the framework of the so-called CAPITAL EXPENDITURE was mainly caused by the misbalance 1.2 0.3 27.3 Effective 25.0 trilateral ‘winter package’ between Ukraine, between the selling price for gas produced interest $3.9 Naftogaz group's capital expenditure rate 14-15% Russia and the EU). As a result, the group 0.1 by the group and market prices for gas. decreased by 14% in 2014 compared to 2013 prepays gas deliveries from both European Another contributing factor and the necessity and amounted to UAH 3.7 billion. In 2014, 01.01.2013 01.01.2014 01.01.2013 01.01.2014 suppliers and Gazprom. 2.6 to finance the accumulation of large volumes Loans in foreign currency Loans in UAH cash outflow related to capital expenditure 2.1 of gas in underground gas storage facilities These changes to the operating conditions amounted to UAH 2.9 billion, a decline of to ensure secure supply of gas to domestic led to the following changes in the working UAH 0.7 billion compared to 2013. CHANGES IN CREDIT PORTFOLIO OF THE GROUP IN 2014, UAH MILLION consumers during the heating season. capital: 25.3 61.0 The priority for capital expenditures of the 59.6 -35.9 2013 2014 BORROWINGS • Inventories decreased by UAH 7 billion group is the natural gas production segment. Other regulated* Other non-regulated** Mostly Eurobonds as at 31 December 2014, and In 2014, the capital expenditure in this Naftogaz group's loans amounted to UAH 61 USD 1.6 million / Gas production Gas transmission 23.9 UAH 20.7 million amounted to UAH 10 billion. The main segment amounted to UAH 2.6 billion. The billion as at 31 December 2014 (31 December 34.8 *Other regulated segments: gas production and storage component of inventories (80%) is main direction of capital expenditures within 2013: UAH 59.6 billion). This amount 57% **Other nonregulated segments: production of crude oil 45.2 gas – the so-called ‘active gas’ (held this sector was exploration and development and condensate, crude oil transmission and refining of decreased by 48% from USD 7.5 billion to crude oil and condensate, etc. 76% in underground storage facilities and drilling. USD 3.9 billion in USD terms. 12.0 12.0 available for sale to consumers), as well In 2014, Naftogaz: 26.2 as gas in the gas transmission system CAPITAL INVESTMENTS TO NETWORK LENGTH, Refinancing (nearly 1 bcm). The main factors • Repaid loans amounting to of loans from 43% USD MILLION/KILOMETER, 2014 14.4 behind the decrease in the inventory UAH 23.9 billion, including USD 1.6 billion Ukrainian banks Gazprom (Russia) 24% balance were a decrease in the volume 65.8 or UAH 20.6 billion in Eurobonds of natural gas by 2.3 bcm, as well as GAZ-SYSTEM (Poland) 37.7 Paid loans New loans Influence • Refinanced loans from Ukrainian banks 31.12.2013 of currency exchange 31.12.2014 a decrease in the weighted average Fluxys Belgium (Belgium) 32.6 amounting to UAH 12 billion cost of gas in the UGS and the gas Short-term loans Long-term loans GRTgaz (France) 27.4 transportation system. In addition, the • Restructured loans that resulted in TIGF (France) 27.1 positive changes in the loan capital upon delivery according to the terms of the Enagas (Spain) 17.1 structure: long-term loans increased from GAS TRANSMISSION UNDER THE CONTRACT WITH GAZPROM current agreement. NET4GAS (Czech Republic) 6.2 UAH 14.4 billion to UAH 26.2 billion, while REWENUES AND CASH FLOWS, USD BILLION Eustream (Slovakia) 6.1 short-term liabilities decreased from In 2013, due to a lack of available funds, the Remaining advance for transit UAH 45.2 billion to UAH 34.8 billion previous Naftogaz management negotiated Transgaz (Romania) 3.4 Cost of transit services less a payment deferral with Gazprom for discount Naftogaz However, due to the devaluation of hryvnia, 0.6 gas supplies for 4Q 2013 that resulted the amount of loans denominated in foreign 5.3 Revenue in an increase in accounts payable to currencies increased to UAH 25.3 billion. CAPITAL INVESTMENTS TO PRODUCTION, USD 2.8 billion as at 31 December 2013. Transmission volume, bcm 3.8 USD/BOE 2014 Consequently, despite the fact that loans The group partially covered its deficit by 3.1 in USD terms decreased by 48% in 2014 advances received from Gazprom for 3 3 Dragon Oil 21.8 2.8 2.8 compared to 2013, loans in UAH equivalent transportation services. Advances received 1.9 JKX (UK) 1.7 increased by 2%. as at the beginning of 2014 amounted to USD 1.8 billion. 1 WORKING CAPITAL RomGaz (Romania) 8.6 0.4* 104.2 As a result of the outstanding accounts 98.6 Naftogaz group's working capital structure Petroceltic International payable to Gazprom for gas supplies and 84.3 86.1 4.8 depends on the conditions of natural gas -0.3 the advances received for gas transmission -0.8 sales and purchases and the conditions for -1.3 62.2 Gazprom (Russia) 4.6 services, the group had a negative working -1.6 providing natural gas transportation services -1.8 capital of UAH 11.2 billion as at 31 December under the existing contract with Gazprom. Novatek (Russia) 3.6 2013. In 2013, Gazprom was the main supplier -3.6 Naftogaz 2.3 of imported natural gas to the company. In 2014, because of the dispute between 2010 2011 2012 2013 2014 31.12.2014 Payments for the imported gas were made Naftogaz and Gazprom, the management *Including the cost of services for December, for which revenue was obtained in January 2015 138 139 MANAGEMENT REVIEW OF FINANCIAL RESULTS

WORKING CAPITAL STRUCTURE, UAH BILLION which is UAH 249.9 billion or 2.3 times higher -11.2 than the total equity as at 31 December 2013. REVIEW +23.6 12.4 Decrease in volume of natural gas in UGS and in the transmission system by 2.3 bcm, decrease in weighted This increase was caused by the following OF CASH FLOWS Inventories 17 10 average cost of natural gas, decrease due to net -7.0 realizable value adjustment factors: 15.1 Increase in gross trade account receivables of plus Trade accounts UAH 7.1 billion and additional provision for doubtful • Contribution of state treasury bonds receivable 20.5 -5.4 receivables of minus UAH 1.7 billion to the share capital of Naftogaz in the Prepayments 12.5 Increase in prepayments for natural gas imports made and other 2.8 +9.7 current assets amount of UAH 96.6 billion -14.1 Decrease in accounts payable to Gazprom for natural gas supplies Trade accounts +15.4 • Revaluation of fixed assets resulting in -29.5 payable an increase in revaluation reserves of -11.1 Decrease in advances received from Gazprom for transmission services UAH 240.5 billion Advances received and other +10.9 On the other hand, the group incurred a net current liabilities -22.0 loss in 2014 that resulted in an increase of the accumulated deficit by UAH 88.6 billion. CASH DEFICIT FACTORS UAH 7.9 billion and mandatory budget - Accumulation of payables to 31.12.13 31.12.14 contribution of profit share paid Gazprom at the beginning of 2014 The company receives financial support In 2014, the group’s cash deficit amounted amounting to UAH 0.2 billion (USD 2.8 billion for natural gas group performed net realizable value in 2013 amounting to USD 2.3 billion or from the state in the form of state treasury to UAH 108.6 billion and was caused by and USD 1.8 billion as advances and impairment adjustments. UAH 24.2 billion. bonds in exchange for new share issues. The the following factors: • As at 31 December 2014, cash balance received for gas transmission purpose of these funds is to cover the cash decreased by UAH 1 billion compared • Trade accounts receivable decreased by • During 2014, natural gas transmission • Net cash used in the operating services) deficit of Naftogaz although in fact they can to 31 December 2013. UAH 5.4 billion in 2014, and amounted to services provided to Gazprom were activities amounted to also be viewed as a form of compensation - Accumulation of loans maturing UAH 15.1 billion at of 31 December 2014. performed against advance payments UAH 59.7 billion. The negative cash The cash deficit was covered by: for the losses incurred by Naftogaz from in 2014 for a total amount of At the same time, the nominal value of received in 2010-2013, to the amount of flow from the operating activities was supplying gas for households at prices • Contribution of state treasury bonds UAH 36.1 billion trade accounts receivable (i.e. before the USD 1.5 billion or UAH 12 billion. the result of: administratively capped by the state below to the company’s share capital in the provision for doubtful debts) increased - A contract with Gazprom on The group has invested UAH 23.6 billion the market level. However, this interpretation - Loss-making activities of the amount of UAH 96.6 billion by UAH 1.7 billion and amounted to natural gas supply on economically into its working capital in 2014 as a result of is currently not legally supported by the group: net losses before taxes UAH 34.1 billion as of 31 December, • Proceeds from loans amounting to unjustified terms the changes in the operating model. Those current legislation. In addition, there is no amounted to UAH 77.6 billion 2014. This increase resulted from an UAH 12 billion funds were mainly directed to prepayments reconciliation act or a similar document as adjusted for certain non- - Accumulation of significant increase in sale prices that affected the for natural gas imports and the settlement between the company and the government cash items, depreciation, losses EFFECT OF MANAGEMENT volumes of overdue accounts receivables from customers paying their of payables to Gazprom incurred in of Ukraine where such compensation would on the disposal of fixed assets ACTIONS ON THE REDUCTION receivable for gas sold to bills one month in arrears (households, prior periods (both for gas supplies and be confirmed. and adjusted for financial costs OF THE CASH DEFICIT consumers municipal heat generating entities, advances for gas transmission services). As amounting to UAH 35.0 billion government bodies). At the same time, Had Naftogaz received the compensation of The factors contributing to the cash flow - Decline in natural gas inventories a result, the working capital turned positive the average settlement level increased to the price differences in cash and not in the - Investment in working capital deficit of the group in 2014 include: in the underground storage and amounted to UAH 12.4 billion as at 94% in 2014, compared to 82% in 2013. form of state treasury bonds, this money amounting to UAH 23.6 billion: facilities 31 December 2014. • Short-sighted financial Additionally, the provision for impairment would be recognized as income. This would prepayments made for natural gas management in the previous years The basic scenario of cash flow deficit increased by UAH 7.1 billion, or from UAH REVIEW OF CHANGES IN EQUITY also result in a reduction of the accumulated imports, settlement of accounts leading to: (assuming the exchange rate of UAH 7.993 11.9 billion as at 31 December 2013 to losses and in an increase of the group’s payable and advances from Gazprom The group’s total equity amounted to UAH 19.0 billion as at 31 December 2014, taxable profit, increasing the amount of UAH 357 billion as at 31 December 2014 - Payment of corporate income tax leading to an overall reduction in the net income tax payments to the state budget. FACTORS CONTRIBUTING TO NAFTOGAZ DEFICIT AND SOURCES amounting to UAH 1.4 billion book value of trade accounts receivable OF DEFICIT FINANCING, 2014, UAH BILLION - Interest received amounting to • Prepayments made increased in 12.0 Loans UAH 0.3 billion 2014, mainly due to an increase in -59.7- prepayments to suppliers of gas from EQUITY STRUCTURE, UAH BILLION • Net cash used in investing activities the EU countries that amounted to 357 amounted to UAH 4 billion. This Contribution Contribution of state treasury of state treasury UAH 12.5 billion as at 31 December 2014 165 +97 amount includes investment cash 96.6 bonds to the share capital -4.0- bonds to share (31 December 2013: UAH 2.8 billion). flows of UAH 2.9 billion on capital capital -43.9- 107 expenditure and UAH 1.2 billion on the • Trade accounts payable amounted to Revaluation of property, 68 367 +241 bank deposits of Ukrtransnafta -1.0 UAH 14.1 billion as at 31 December 2014, plant and equipment 126 -108.6 which is UAH 15.4 billion less than as at • Cash outflows in financing activities -87 31 December 2013. This change was due -175 -88 Net loss for 2014 amounted to UAH 43.9 billion, Operatintg Investment Financing Net change Total Sources of activites activites activites in cash cash deficit to the settlement of outstanding trade including repayment of loans totaling and cash deficit financing payables to Gazprom for gas supplied +250 UAH 35.9 billion, interest payments of equivalents 31.12.13 31.12.14 140 141 MANAGEMENT REVIEW OF FINANCIAL RESULTS

IMPACT OF MANAGEMENT ACTIONS ON GROUP'S CASH • Reducing the price of natural gas supplied by Gazprom and RISK MANAGEMENT DEFICIT, UAH BILLION Base deficit adjusted significantly increasing natural Base Effect of hryvnia for negative factors deficit devaluation gas supplies from Europe, which Actual -94.5 deficit resulted in a reduction of cost of gas imports by UAH 18.2 billion

- 34.6 7.6 -108.6 • Improving the collection of Maturity extensions payments for gas supplied to +33.3 on loans RISK MANAGEMENT SYSTEM performance, cash flows and financial sign similar agreements with TSOs of 18.2 consumers (trade receivables Crimea -47.4 position, are described below. other neighboring EU countries. Such increased by UAH 1.7 billion in The group implements risk management -10.4 agreements will increase the level of Lower natural gas price from 2014, compared to an increase of system at all levels of its operations. АТО 7.5 Gazprom and natural gas KEY RISK FACTORS Base scenario -2.4 supplies received form Europe cooperation between Ukraine’s TSO Improved cash UAH 9.1 billion in 2013) Although Naftogaz currently has no - exchange rate 7.993 UAH/USD -141.9 collections from RISKS ASSOCIATED WITH and the TSOs of Poland, Slovakia, - Imported gas price 416 USD/tcm customers separate risk management division, the - Level of payments for natural gas Negative • Extending maturity of loans RELIANCE ON A SINGLE Hungary and Romania on the equal to 2013 levels factors Management risk management work is integrated into - Loan repayments in accordance amounting of UAH 7.6 billion SUPPLIER FOR NATURAL GAS exchange of information about free with initial contracts 2014 actions other processes of the company within the IMPORTS transmission capacity and booking on As a result of these measures, the existing organizational structure. a non-discriminatory basis, provide group’s cash deficit declined by Under the legislation in effect until 1 October In the beginning of 2014, the group had flexibility and speed up operations, per USD, the purchase of gas under the marketable gas produced by UAH 33.3 billion to UAH 108.6 billion 2015, Naftogaz is the guaranteed gas supplier significant issues with the effectiveness of and, to some degree, reduce the power initial contract conditions with Gazprom Chornomornaftogaz and 0.7 bcm for industrial customers with an annual gas CASH SPENDING internal controls. The new management of the current monopoly holder of starting from 2Q 2014 at an average consumed by households in consumption of more than three mcm and STRUCTURE made the creation of an internal risk capacity at the interconnectors. Finally, price of USD 415/tcm and payment upon Crimea). As a result, the group had enterprises engaged in the production of control system one of its key priorities, as these agreements enable the use the delivery) was forecasted at the level of to import 1.4 bcm gas more at a General and administrative costs heating energy. These groups of customers part of establishing an effective system interconnectors for both physical and UAH 94.5 billion at the beginning of 2014. higher price to cover the needs of of Naftogaz as a holding company are supplied with natural gas which the of corporate governance in Naftogaz. virtual reverse flow operations, thus households in Ukraine amounted to approximately 0.3% of the company is obliged to import. In addition, • Negative factors which appeared in Currently internal control functions are contributing to the diversification of total cash outflows of the group in 2014. for industrial and technological needs, 2014, including: - Unauthorized consumption of mainly performed by the internal audit sources of imported gas Ukrtransgaz also uses imported natural gas. gas in the ATO area, leading to a Spending for natural gas supplies department reporting directly to the CEO. - UAH devaluation that led to a Since 2009, Naftogaz purchased almost all • In June 2014, Naftogaz initiated UAH 2.4 billion increase in cash accounted for 58.7% of total outflows, UAH 34.6 billion increase in the Risk management process is structured to of its imported gas from Gazprom under arbitration proceedings in the outflow. The group lost 0.4 bcm and the repayment of loans raised in cash flow deficit, largely due to ensure continuous monitoring and control, long-term contracts at prices that did not Arbitration Institute of the Stockholm of natural gas worth UAH 2 billion previous years accounted for nearly the increased outflows for gas the timely detection and consistent correspond to market prices. Dependence Chamber of Commerce (SCC) regarding and UAH 0.4 billion in unpaid VAT 23.5% of the total outflows. In addition, imports in UAH equivalent totaling management of risks associated with the on one supplier for such long-term contracts its gas supply contract with Gazprom for this illegally consumed natural 9.8% of cash outflows were taxes paid UAH 41.5 billion, and cash outflows activities of the group in order to maintain could adversely affect not only the ability of and submitted a statement of claim in gas. to the state budget. The remaining on interest and loan repayments an unobstructed channel of information Naftogaz to provide Ukrainian customers January 2015. The group claims that portion of the group outflows consisted totaling UAH 9 billion. On the other When adjusted to take into account these and communication on existing, identified with natural gas, but also the continuity and the import price for gas delivered in of payroll of subsidiaries, payment for hand, revenues from gas sales to negative factors, the cash deficit for 2014 or potential risks. The various elements of reliability of the gas transmission system, the period 2010-2014 was overstated. gas distribution services and for booking industrial customers increased should have reached to UAH 141.9 billion. risk management include job descriptions, increasing political risks and worsening the Naftogaz expects that as a result of of transmission capacities, capital by UAH 15.9 billion. Prices for this regulations, rules of corporate culture, financial condition of the company. this arbitration, it will import gas from New management of the company has and financial expenditure, production group of customers were reviewed as well as operating methods and Gazprom at fair market-based prices taken a number of steps to reduce the expenses and other expenses. Risk management on a monthly basis and included procedures. group’s cash deficit: • The group aims to maximize the adjustment for foreign currency risk. • Naftogaz is actively taking steps to Components of the system include: volume of domestic gas production, diversify the sources of imported - Loss of the gas source in Crimea, and has made this segment of activity STRUCTURE OF THE GROUP’S SPENDING • Detection and assessment of risks natural gas. The share of imports from resulting in a UAH 10.4 billion the top priority for capital investments the EU increased from 8% in 2013, to increase of cash outflows. The • Development of alternative ways to Loan repayments and interest 26% in 2014. As of 31 July 2015, Ukraine • The group is promoting and group lost 0.7 bcm of gas stored 23.5% manage identified risks has a capacity to receive 61.1 mcm/ encouraging special projects to in the Crimean underground 9.8% Taxes • Risk management according to the day in gas deliveries from within the improve energy efficiency to reduce storage facility operated by Other chosen methodology EU, including 4.3 mcm from Poland, the need for imported gas. A Chornomornaftogaz, and 186.4 Gas transmission 1.5% 16.8 mcm from Hungary, and 40 number of projects concerning the 1.4 bcm of gas produced by 7.7% Capital and financial investments 1.7% • Monitoring and control Other 2.0% mcm from Slovakia. On 29 May 2015, development of alternative energy Chornomornaftogaz which was UAH billion Salaries 2.5% • Information and communication a direct interconnection agreement sources are also being considered intended for households in Costs for maintaing Naftogaz 0.3% was signed between Ukrtransgaz and other regions of Ukraine (the The main risks that could cause materially • Naftogaz has actively supported the FGSZ, the Hungarian gas transmission difference between 2.1 bcm of Purchase of natural gas adverse effects on the group’s operating adoption of the new gas market law 58.7% system operator. Ukraine plans to

142 143 MANAGEMENT REVIEW OF FINANCIAL RESULTS

which comes into effect on 1 October • Ukraine introduces a new tariff material adverse effect on the company’s • Under the terms of the 3rd Energy entities producing heat for households) - The company is obligated to stop 2015. In particular, the changes it methodology that is in line with European operations. Package, which Ukraine now implements, is reviewed by the regulator on a natural gas supplies in cases of introduces will significantly liberalize the principles and is based on the ‘entry/exit’ operators of gas transmission and monthly basis, adjusting prices for overdue payments for natural gas In 1998, the company entered into an company’s position in supplying gas to tariff-setting system and RAB-principles distribution systems will be unbundled changes in the purchase price of agreement on the use of state-owned - The moratorium on the forced industrial consumers (which implies a certain level on income from the vertically integrated enterprises imported natural gas and currency property not subject to privatization with property sale for entities where the on the TSO’s regulatory asset base). It is engaged in the production and supply fluctuations. RISKS RELATED TO THE RELIANCE the State Property Fund of Ukraine, and state holds at least 25% of shares in expected that the market regulator will of natural gas, as well as gas storage ON A SINGLE CUSTOMER FOR received the right to operate oil and gas • Market prices are expected to be order to repay debts for natural gas switch to this methodology for calculating operators. Thus the state property will INTERNATIONAL TRANSMISSION transmission systems. This agreement was applied for all groups of customers consumed in previous years has been gas transmission tariffs before the end of be used by independent operators of gas SERVICES signed for one year, and its term is prolonged upon the implementation of the cancelled 2015. transmission and distribution systems. automatically each year unless terminated Law of Ukraine ‘On the Natural Gas The most profitable sector for the group is Therefore, the company believes that the - The company should have the STATE REGULATION OF THE OIL by notice from either party, and is binding on Market’. The law deregulates the prices the gas transmission. The group provides group will be able to continue its activities opportunity to sell its receivables AND GAS INDUSTRY the legal successor of each party. Historically, for industrial and other commercial international transmission services to with regard to state property over the through auctions the agreement has been prolonged consumers starting from 1 October Gazprom in accordance with the contract State regulation of the oil and gas industry near term automatically, as neither party initiated its 2015. By April 2017 it gradually These legislative changes are expected concluded in 2009 for 10 years. The contract in Ukraine is carried out by the Cabinet of termination. As state property not subject to TAXATION RELATED RISKS deregulates the prices for households to reduce the accounts in arrears from determines the transmission fee based on Ministers of Ukraine and the NEURC, covering privatization forms a substantial part of the and heat generating companies that customers and prevent their accumulation in a specific volume of gas to be transmitted both technical and financial aspects: Ukraine’s tax environment is characterized group’s business, the future operations and produce heat for households the future annually. The actual volume of transmitted by complexity in tax administration, arbitrary • Technical measures concerning efficiency financial performance of the group depends gas in the 2010-2014 was well below the interpretations by tax authorities of tax laws LIQUIDITY RISKS • Naftogaz group takes measures for in the use of gas resources, ensuring on the prolongation of this agreement. base amount specified in the contract. The and regulations that, inter alia, can increase a gradual transition to payment for safe operations of the gas transmission The activities of Naftogaz are seasonal. transmission fees have never been revised, The state controls oil and gas exploration fiscal pressure on taxpayers. Inconsistent imported gas upon delivery, and for system, correct and safe delivery, Sales of natural gas and transmission contrary to the European principles of gas and production activities in Ukraine via application, interpretation, and enforcement raising credit resources from foreign distribution and consumption of gas services during the heating season transmission pricing, leading to losses for issuing relevant licenses. According to the of tax laws can lead to litigation which, as a financial markets to finance the injection constitute about 70% of the total annual the group. However, no other consumers • Financial measures mainly concerned current legislation, separate licenses are consequence, may result in the imposition of of natural gas into the underground gas volume. As a result, revenues for goods of the international transmission services with setting prices and tariffs and issued for exploration, development and additional taxes, penalties, and interest, and storages at interest rates which are lower and services increase considerably during of via Ukraine’s gas transmission system maintaining relevant financial measures production activities for each oil and gas field. these amounts could be material. than in the Ukrainian market the heating season. On the other hand, are currently available. Gazprom declares a for the market division between its Separate licenses are issued for oil and gas Risk management during the summer when the group RISKS ASSOCIATED WITH ASSET policy of bypassing Ukraine for natural gas participants transmission, supply and storage. Licenses receives less operating cash flow from SECURITY AND SAFETY transmission (in 2015, the transport volumes are provided for periods of from two to • The group complies with the The group acts as a guaranteed supplier of sales, there is a need for additional funding are expected to fall by 20% compared to 2014 twenty years, and could be prolonged for the requirements of Ukrainian tax law, Naftogaz activities are associated with natural gas to certain groups of customers to finance the injection of natural gas and by 42% compared to 2013), which could same period. continuously monitors the changes and operating risks of a technological, technical in Ukraine, but its ability to adjust prices into the underground storage facilities. In negatively affect the group’s operations. additions made to the relevant laws and and climatic nature. Additionally, actions of to end consumers in accordance with the Risk management addition, the poor payment discipline by regulations, evaluates and estimates personnel and third parties could lead to Risk management fluctuations in the price of imported gas is consumers of natural gas and switching to • In April 2015, Ukraine adopted the Law the degree of possible impact of such negative consequences, including results of limited, as these prices are regulated by the prepayment for imported natural gas in • In October 2014, Naftogaz initiated ‘On the Natural Gas Market’ aimed at changes on its activities human errors, theft, terrorist acts, sabotage, NEURC at every stage from gas production to 2014 led to a decrease in cash flow from arbitration proceedings in the Arbitration the implementation of the EU Directive etc. the supply to end consumers. • The group focuses on cooperation with operating activities of the company. Institute of the Stockholm Chamber of 2009/73/EC and Regulation 715/2009 state agencies to ensure compliance with Risk Management Commerce (SCC) regarding its gas transit In 1998, upon the creation of the company, in Ukraine. Naftogaz has actively Risk Management currency control regulations and tax law contract with Gazprom and submitted a the government contributed certain shares supported this process. The law • Implementing modern methods • The group finances its working capital statement of claim in April 2015. Among of joint-stock companies to the share becomes effective on 1 October 2015. CURRENCY RISKS of diagnosis, reconstruction and needs through raising loans and receiving other demands, Naftogaz requests to set capital of the company. These joint-stock As a result, the activities of the NEURC modernization at Ukraine's gas Naftogaz operates in Ukraine and its government support (government bonds the transmission fee at an economically companies included JSC Main Pipelines and other state authorities regulating transmission system exposure to foreign currency risk is transferred to the share capital). justified level. The process should also Druzhba and JSC Prydniprovskiy Main the natural gas market are to be determined mainly by the fact that its gas • Auditing existing systems of infrastructure lead to a decision on the validity of Pipelines that were reorganized in 2001 into conducted in accordance with standard • During 2015, Ukraine’s parliament purchases are mainly foreign currency protection, including the use of drones claims regarding the basic volume of gas JSC Ukrtransnafta, JSC Ukrspetstransgaz, European practice, which should adopted a series of amendments to denominated and its sales are denominated and the capabilities for remote sensing of transportation guaranteed by Gazprom Chornomornaftogaz National JSC, JSC enable establishment of an efficient, existing legislation to enhance the in hryvnia. The group also raises foreign the State Space Agency of Ukraine Ukrnafta, as well as fifty-four regional gas open and liquid natural gas market in liquidity of the group including, but not • The company contributes to creating currency loans. The group does not hedge its distribution entities. The government may Ukraine limited to the following: • Constant interaction with the Ministry a single gas infrastructure and trading foreign currency positions. transfer ownership or control over all or part of Internal Affairs of Ukraine and its area between Ukraine, Poland, Slovakia, • Naftogaz group takes all due steps to - The company has the right not to of the company’s equity interest in those Risk Management structural divisions, and in some areas, Hungary and Romania, as well as creating extend the validity of special permits enter into contracts for the supply of joint-stock companies and/or other state- with the Ministry of Energy and Coal a single East European gas hub that will for subsoil use through appropriate • The price on imported natural gas for natural gas with costumers that have owned oil and gas transmission and storage Industry of Ukraine, and the state security allow for a diversification of customers for applications to the central government almost all groups of customers (except filed for bankruptcy or who cannot by facilities to other companies or government agency to ensure greater safety and gas transmission and storage services. and local authorities households and heat generating gas on the prepaid basis agencies, and those actions could have a security 144 145 MANAGEMENT REVIEW OF FINANCIAL RESULTS

FORECAST FORECAST HIGHLIGHTS ON GROUP ACTIVITY FOR THE YEAR 2015

2015 2013 2014 2015 Key 2015 operating highlights, forecast*

Gross gas production (excluding production sharing agreements), mcm 14 021 14 034 13 212

Gross production of crude oil and gas condensate, thousand t 738 637 662

In Ukraine 645 535 501

In Egypt 93 102 161

Volume of natural gas sold, mcm 32 123 29 232 25 675

Gas transmission under the contract with Gazprom, mcm 86 126 62 197 50 000

Domestic gas transmission, mcm 44 097 38 122 34 428

Transmission of crude oil, mcm 17.6 16.9 16.9

Petroleum products supply, thousand t 687 403 346

LPG supply, thousand t 206 177 168

OPERATING ENVIRONMENT determined. The state budget for 2015, and • Implement other measures necessary to Gas supply via filling stations, mcm 130 97 68 the Cabinet of Ministers decision of June 24 restore the financial viability of Naftogaz Expected weighted average cost of gas imports, USD/tcm $396.46 $293.81 $295.42 Planned gas sources and uses 2015, have provided Naftogaz a possibility In April 2015, Ukraine adopted a new Key financial highlights of the group, in UAH million unless otherwise stated** According to the forecasted balance of to obtain state guarantees on loans totaling Law ‘On the Natural Gas Market’ which Revenue 75 374 78 444 131 542 gas sources and planned consumption in USD 1 billion for the formation of strategic is fully compliant with the provisions of Ukraine for 2015, approved by the Cabinet gas reserves in UGS. Gross profit/(loss) (752) (8 507) 9 434 the 3rd Energy Package and with the IMF of Ministers on April 15 2015 by Decision Profit/(loss) before tax, including: (15 492) (77 603) (32 480) Given the cash-flow constraints, Naftogaz Memorandum. The law provides for: #410, which takes into account actual expects to reduce the amount of gas Loss before tax from regulated businesses (26 765) (88 893) (51 385) data for the first four months of 2015, gas • Ensuring non-discriminatory access to imports in 2015 to nearly 17.3 bcm. Profit before tax from non-regulated businesses 11 165 10 575 19 592 consumption in Ukraine is expected to Ukraine’s gas transmission infrastructure Accordingly, the volume of gas stored Unallocated income and expenses 108 715 (687) fall by 13% compared to 2014. As a result, in the underground gas storages as • Integration with the European gas Naftogaz sales are expected to decrease by Net profit/(loss) (17 957) (88 433) (34 351) at 31 December 2015 is estimated at market 12% compared to the previous year. The approximately 12.2 bcm (of which 10.6 bcm Cash flows of Naftogaz group, in UAH million unless otherwise stated** projected reduction in gas consumption • Restructuring of Naftogaz in accordance is expected to belong to Naftogaz). Net cash from operating activities (1) 7 155 (59 738) (25 716) is explained by the general decline in the to the requirements of the 3rd Energy Net cash from investing activities*** (2) (3 231) (3 959) (6 784) economy, the armed conflict in eastern Major changes in legislation and their Package with respect to the separation of Ukraine, as well as a decrease in gas expected impact on the group natural gas transmission pipelines from Cash outflow from financing activities (3) (29 122) (43 873) (22 657) consumption by households (for cooking other activities, including the production (repayment of loans, payment interest and mandatory budget contribution of profit share) In February 2015, an agreement was and heating) because of the higher prices. and supply of natural gas. Net change in cash balance (4) (109) (1 002) 1 533 reached between Ukraine and the Net cash flow before budget financing and other sources (25 307) (108 572) (53 624) The volume of domestically produced gas International Monetary Fund regarding • Approval of tariff-setting principles (Deficit) (5 = 1 + 2 + 3 + 4) will reach 12.6 bcm in 2015, which will the Extended Finance Facility (EFF) which for services of natural monopolies consist exclusively of gas produced by resulted in the signing of a Memorandum (transportation and storage of natural Sources to cover the deficit 25 307 108 572 53 624 Ukrgasvydobuvannya. on Economic and Financial Policies stating gas) in line with European standards - Proceeds from loans 19 483 11 962 23 924

the following obligations of the Ukrainian - Proceeds from sale of state treasury bonds contributed to share capital 5 824 96 610 29 700 The volume of gas in underground storage The implementation of certain provisions government: facilities in Ukraine at the beginning of 2015 of the new law requires adoption of the amounted to 11.5 bcm including 8.5 bcm of • Gradually bring natural gas prices for appropriate secondary legislation and gas owned by Naftogaz. all customers and heating tariffs for the regulations. * Operating indicators do not include information on SJSC Chornomornaftogaz as the group lost control over these assets after the occupation of Crimea by the Russian Federation households to full parity with the price ** The forecast for 2015 is based on the following documents and assumptions: the draft financial plan draft of Naftogaz for 2015 agreed by the governmental committee for economic The approved gas balance indicates that In May 2015, the Law ‘On Amendments of imported gas by 2017 development and European integration (paragraph 36 of the protocol #17 dated 05/06/2015); the financial plan of Ukrtransgaz for 2015 approved by the Cabinet of Ministers Decision #851 by the end of 2015, the volume of gas to Certain Laws of Ukraine to Stabilize the dated 19/08/2015; the draft financial plan of Ukrgasvydobuvannya for 2015; the approved financial plans (or draft plans) of other subsidiaries of the group; estimated UAH/USD exchange rate accumulated in underground gas storages • Adopt the law on the natural gas market Financial State of the National Joint Stock of 21.7. should amount to 17 bcm. In order to and reform the gas sector Company Naftogaz of Ukraine’ was adopted, ***Expenditure on capital investment for 2015 corresponds to the planned figures, however untimely approval of financial plans of the group companies may lead to a significant reduction in ensure such volumes in storage, Naftogaz in accordance with the conditions of the • Adopt appropriate laws and regulations actual expenditure on capital investment because of the Cabinet of Ministers Decree no. 899 (which prohibits carrying out capital expenditure prior to the approval of a financial plan). would have to buy 23 bcm of gas. However, IMF Memorandum. This law envisages that will lead to an improvement on the the sources of financing the corresponding the termination of the moratorium on the collection of receivables for Naftogaz volumes of imported gas were not enforcement of proceedings and court

146 147 MANAGEMENT REVIEW OF FINANCIAL RESULTS

decisions regarding energy sector companies It is further expected that in 2015 • Loss of assets in the ATO area of and unconditional cessation of gas supplies compared to 2014: UAH 2.6 billion. to municipal heating enterprises if they The Public Company “The • the average tariff for gas transmission • Financial expenses amounting to violate the conditions of the concluded will increase by 108% UAH 12.5 billion, or UAH 3.5 billion National Joint Stock Company agreements, as well as the ability to more compared to 2014, because of sell receivables at auction starting from • the average tariff for gas storage will “Naftogaz of Ukraine” the devaluation of hryvnia and the 1 September 2015. The implementation increase by 31% forecasted increase in loans of certain provisions of this law requires Assumptions regarding currency the adoption of appropriate secondary Cash deficit of the group Consolidated Annual devaluation and losses in the ATO area legislation and regulations. Naftogaz expects that in 2015 the group’s Financial Statement Ending At the beginning of 2015, the group’s debts in Assumptions regarding gas prices cash deficit (net cash flows before deficit foreign currency amounted to nearly 31 December 2014 and tariffs for gas transmission and financing) will amount to approximately USD 3 billion, and the exchange rate was storage UAH 53.6 billion. UAH 15.77 per USD. At the same time, the According to the draft financial plan average exchange rate in 2015 is forecasted It is expected that the cash deficit will be of Naftogaz prepared in 2Q 2015, the at UAH 21.7 per USD, which will lead to an financed by: average purchase price of imported increase the group’s payables in hryvnia terms • State treasury bonds to be contributed gas (including transmission costs) is and will result in foreign exchange losses to the share capital of Naftogaz forecasted at USD 295/tcm in 2015 amounting to approximately UAH 20 billion. amounting to UAH 29.7 billion (already (2014: USD 294/tcm). Unauthorized consumption of gas in the received) In the draft financial plan of Naftogaz, ATO area during January and February • Loans amounting to approximately the following assumptions were used 2015 amounted to nearly 0.4 bcm which UAH 23.9 billion, mostly secured by on retail gas prices for households caused losses amounting to UAH 2.6 billion, state guarantees foreseen in the state (both direct use and for centralized heat including the cost of illegally withdrawn gas budget for 2015 in the amount of production), net of the VAT and other (UAH 2.2 billion) and VAT which is paid to USD 1 billion. taxes, transmission and distribution the budget along with the sale of natural charges: gas (UAH 0.4 billion). Compared to 2014, the cash deficit from operating and investing activities in 2015 is • as of 1 April 2015, for households, EXPECTED RESULTS expected to decrease by almost 50%. the first 200 cubic meters per month Based on these assumptions, the group during the heating season: In 2014, the settlement of obligations expects the following results. UAH 2 166.83/tcm incurred in the previous years accounted for Net loss of the group almost 60% of the deficit. These obligations • as of 1 April 2015, for households, in included payment for imported gas, excess of 200 cubic meters per month The net loss of the group for 2015 is providing gas transmission services against during the heating season and all gas forecasted at UAH 34.4 billion. the advances received from Gazprom, and in other months of the year: The primary factor contributing to the net the redemption of Eurobonds together with UAH 5 041.83/tcm loss is the losses from the sale of gas to the associated interest. • as of 1 May 2015, for heat generating households (for direct consumption and In 2015, the deficit is expected to be caused entities for heat production for centralized heat production), which is primarily by the group’s loss-making households: UAH 1 802.99/tcm expected to amount to UAH 32.2 billion. regulated activities (estimated net loss of The selling price for marketable gas It is expected that the group will make a UAH 34.4 billion), as well as the working produced by Ukrgasvydobuvannya is profit on gas sales to industrial consumers, capital financing needs. changed from UAH 349.20/tcm to public sector enterprises and other In particular, the group needs to finance UAH 1 590/tcm net of VAT as of customers. Including the expected income the expected growth in trade accounts 1 April 2015. from other activities, the group expects to receivable associated with the retail price receive a gross profit of UAH 9.4 billion. It is assumed in the draft financial plan increase, as well as to fund the accumulation that prices for gas supplied to industrial The gross profit will not be sufficient to of gas in the underground gas storages. It consumers are adjusted on a monthly compensate for other expected losses, is expected that the volume of stored gas basis, according to the purchase price of including: owned by the group will increase by 2.1 bcm imported natural gas and exchange rates as at 31 December 2015 compared to the • Foreign exchange losses of (in fact the prices for this category are level as at the previous year end. approximately UAH 20 billion liberalized starting from 1 October 2015). 148 149 CONTENTS

INDEPENDENT AUDITOR’S REPORT...... 152

CONSOLIDATED FINANCIAL STATEMENTS

Consolidated Statement of Financial Position...... 155

Consolidated Statement of Profit or Loss...... 156

Consolidated Statement of Comprehensive Income...... 157

Consolidated Statement of Changes in Equity...... 158

Consolidated Statement of Cash Flows...... 159

Notes to the Consolidated Financial Statements

1. THE ORGANISATION AND ITS OPERATIONS...... 160 2. OPERATING ENVIRONMENT...... 160 3. SEGMENT INFORMATION...... 163 4. BALANCES AND TRANSACTIONS WITH RELATED PARTIES...... 167 5. PROPERTY, PLANT AND EQUIPMENT...... 168 6. INVESTMENTS IN ASSOCIATES AND JOINT VENTURES...... 169 7. OTHER NON-CURRENT ASSETS...... 171 8. INVENTORIES...... 171 9. TRADE ACCOUNTS RECEIVABLE...... 171 10. PREPAYMENTS MADE AND OTHER CURRENT ASSETS...... 172 11. CASH AND BANK BALANCES...... 172 12. SHARE CAPITAL...... 172 13. BORROWINGS...... 173 14. PROVISIONS...... 173 15. ADVANCES RECEIVED AND OTHER CURRENT LIABILITIES...... 174 16. COST OF SALES...... 175 17. OTHER OPERATING EXPENSE...... 175 18. FINANCE COSTS...... 175 19. INCOME TAX...... 175 20. DISCONTINUED OPERATIONS...... 177 21. CONTINGENCIES, COMMITMENTS AND OPERATING RISKS...... 177 22. FINANCIAL RISK MANAGEMENT...... 179 23. FAIR VALUE...... 181 24. SUBSEQUENT EVENTS...... 183 25. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES...... 183 26. CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS...... 191 27. ADOPTION OF NEW OR REVISED STANDARDS AND INTERPRETATIONS...... 192 150 151 INDEPENDENT BASIS FOR QUALIFIED AUDITOR’S REPORT OPINION

To the shareholder of Public Joint Stock Company “National Joint Stock 1) As discussed in Note 25 to the consolidated financial adjustments to these amounts were necessary. Company “Naftogaz of Ukraine”: statements, the Group has adopted the revaluation model 3) As discussed in Note 20 to the consolidated financial for measurement of property, plant and equipment, which We have audited the accompanying consolidated financial statements of statements, in March 2014 the Group lost control over one requires revaluations to be carried out with sufficient Public Joint Stock Company “National Joint Stock Company “Naftogaz of of its subsidiaries, JSC Chornomornaftogaz, the majority of regularity so that the carrying amount of property, plant Ukraine” (the “Company”) and its subsidiaries (collectively, the “Group”), whose assets are located on the territory of the Autonomous and equipment as at the reporting date does not differ which comprise the consolidated statement of financial position as at Republic of Crimea. As we were not provided with access to materially from its fair value. The Group has revalued its 31 December 2014, and the consolidated statement of profit or loss, the the financial information of this subsidiary as at 31 December property, plant and equipment as at 31 December 2014 and consolidated statement of comprehensive income, the consolidated state- 2013, we were not able to obtain sufficient and appropriate the revaluation demonstrated that the fair value of ment of changes in equity and the consolidated statement of cash flows audit evidence about carrying value of the total assets and property, plant and equipment was materially different from for the year then ended, and a summary of significant accounting policies liabilities (net of intercompany balances) of this subsidiary as its carrying amount before revaluation. Given the significant and other explanatory information. at that date in the amounts of UAH 15 711 million and UAH 1 economic developments since previous revaluation as 925 million, respectively, and its total revenues and expenses MANAGEMENT’S RESPONSIBILITY FOR THE at 31 December 2009, including changes in natural gas for the year ended 31 December 2013 in the amounts CONSOLIDATED FINANCIAL STATEMENTS transportation tariffs and costs, selling prices of the Group’s of UAH 525 million and UAH 1 399 million, respectively. own produced natural gas and construction costs, we Management is responsible for the preparation and fair presentation of Additionally, we were not able to observe other assets of the believe the difference between the fair value and carrying these consolidated financial statements in accordance with International Group located on the territory of the Autonomous Republic amount of property, plant and equipment was also material Financial Reporting Standards, and for such internal control as manage- of Crimea stated at UAH 2 898 million as at 31 December as at 31 December 2013. Since no revaluation of property, ment determines is necessary to enable the preparation of consolidated 2013. The Group deconsolidated the assets and liabilities of plant and equipment was performed as at that date, we financial statements that are free from material misstatement, whether JSC Chornomornaftogaz and fully impaired the other assets were unable to obtain sufficient and appropriate audit due to fraud or error. located in Crimea during the year ended 31 December 2014. evidence about the impact of this matter on the Group’s Since the carrying amounts of such assets and liabilities as AUDITOR’S RESPONSIBILITY property, plant and equipment with the carrying amount at 31 December 2013 affect the determination of the loss of UAH 89 526 million and related impact on revaluation Our responsibility is to express an opinion on these consolidated financial from discontinued operations and operating expenses for the reserve as at 31 December 2013 and the depreciation, statements based on our audit. We conducted our audit in accordance year ended 31 December 2014, we were unable to determine depletion and amortisation expense for the years ended with International Standards on Auditing. Those standards require that whether adjustments to the results of operations were 31 December 2014 and 2013. Consequently, we were unable we comply with ethical requirements and plan and perform the audit to necessary. to determine whether any adjustments to these amounts obtain reasonable assurance about whether the consolidated financial were necessary. 4) Because we were appointed auditors of the Group in 2014, statements are free from material misstatement. we were not able to observe the counting of the physical 2) As discussed in Note 25 to the consolidated financial An audit involves performing procedures to obtain audit evidence about inventories as at 31 December 2013 or satisfy ourselves statements, the Group’s oil and gas assets are depleted using a the amounts and disclosures in the consolidated financial statements. concerning inventory quantities as at 31 December unit‑of‑production method in proportion to proved developed The procedures selected depend on the auditor’s judgment, including 2013 (except for the natural gas in stock) by alternative hydrocarbon reserves. Management engaged an independent the assessment of the risks of material misstatement of the consolidated means. Since these inventories stated at UAH 607 million expert to conduct a valuation of the Group’s hydrocarbon financial statements, whether due to fraud or error. In making those risk affect the determination of the results of operations for the reserves as at 31 December 2014. Thus, such valuation was assessments, the auditor considers internal control relevant to the entity’s years ended 31 December 2014 and 2013, we were unable to inconsistent with the valuation as at 31 December 2013 as preparation and fair presentation of the consolidated financial statements determine whether adjustments to the results of operations the 2014 valuation involved an independent expert, while the in order to design audit procedures that are appropriate in the circum- for respective years were necessary. 2013 valuation was based on internal management estimates stances, but not for the purpose of expressing an opinion on the effec- only. Due to inconsistency of the valuations, we were unable 5) As discussed in Note 6 to the consolidated financial tiveness of the entity’s internal control. An audit also includes evaluating to obtain sufficient and appropriate audit evidence about statements, the Group has investments in associates and the appropriateness of accounting policies used and the reasonableness the impact of this matter on the Group’s oil and gas assets joint ventures, which are accounted for using the equity of accounting estimates made by management, as well as evaluating the stated at UAH 20 416 million as at 31 December 2013, and the method of accounting. We were unable to obtain sufficient overall presentation of the consolidated financial statements. related impact on the depreciation, depletion and amortisation and appropriate audit evidence regarding recoverability We believe that the audit evidence we have obtained is sufficient and expense for the years ended 31 December 2014 and 2013. of trade and other receivables of one of the associates as appropriate to provide a basis for our qualified audit opinion. Consequently, we were unable to determine whether any at 31 December 2014 with the Group’s share amounting

152 153 PUBLIC JOINT STOCK COMPANY to UAH 515 million and substance of certain expenses QUALIFIED OPINION incurred by one of the associates during the years ended “NATIONAL JOINT STOCK COMPANY In our opinion, except for the possible effects of the matters 31 December 2014 and 2013 with the Group share of such described in the Basis for Qualified Opinion paragraphs, the “NAFTOGAZ OF UKRAINE” expenses amounting to UAH 179 million and UAH 925 million, consolidated financial statements present fairly, in all material respectively. Also, some of the associates and joint ventures CONSOLIDATED STATEMENT OF FINANCIAL respects, the financial position of the Group as at 31 December did not adopt the revaluation model for measurement of 2014, and its financial performance and its cash flows for the year POSITION AS AT 31 DECEMBER 2014 their property, plant and equipment, which constitutes a then ended in accordance with International Financial Reporting departure from IAS 28 “Investments in Associates and Joint Standards. Ventures” requiring use of uniform accounting policies with Group. The effect of this departure on the carrying value of EMPHASIS OF MATTER the Group’s investments in its associates and joint ventures The accompanying consolidated financial statements have as at 31 December 2014 and 2013, and related impact on been prepared assuming that the Group will continue as a the Group’s share of their after‑tax results for the years then going concern. As discussed in Note 2 and Note 21 to the ended is not reasonably determinable. consolidated financial statements, the excess of the Group’s 6) As discussed in Notes 16, 17 and 25, during the first quarter of current liabilities over its current assest as at 31 December the year ended 31 December 2014 and during the year ended 2014 and 2013 amounted to UAH 17 908 million and UAH 31 December 2013, the Group has incurred expenditures for: 53 893 million, respectively, and for the years then ended the Group incurred net losses in the amounts of UAH 88 • Purchases of services and inventories amounting to UAH 433 million and UAH 17 957 million, respectively, and there In millions of Ukrainian Note 31 December 31 December In millions of Ukrainian Note 31 December 31 December 334 million and UAH 1 082 million, respectively, included into is uncertainty as to the outcome of significant ongoing hryvnias 2014 2013 hryvnias 2014 2013 cost of sales and research; development and exploration litigations for the Group. These conditions raise substantial Non-current liabilities costs amounting to UAH 160 million and UAH 455 million, ASSETS doubt about the Group’s ability to continue as a going Borrowings 13 26 188 14 388 respectively, included into other operating expenses, for which Non-current assets concern without continuing support from the Government of Provisions 14 1 852 1 601 the primary documents were sequestered and are under Property, plant and equipment 5 454 991 181 428 Ukraine. Management's plans concerning these matters are Deferred tax liabilities 19 68 726 17 521 investigation by the office of State Prosecutor of Ukraine; Investments in associates and joint 6 11 169 9 942 discussed in Note 2 to the consolidated financial statements. ventures Other long-term liabilities 49 378

• Purchases of property, plant and equipment of UAH The consolidated financial statements do not include any Prepaid corporate income tax 1 195 709 Total non-current liabilities 96 815 33 888

660 million and UAH 4 335 million, respectively; and adjustments that might result from the outcome of this Other non-current assets 7 4 346 2 737 uncertainty. Our opinion is not qualified in respect of this • Purchases of services and inventories included into cost of Total non-current assets 471 701 194 816 matter. Current liabilities sales and other operating expenses of UAH 1 102 million UAH Borrowings 13 34 820 45 170

2 927 million, respectively. We also draw your attention to Note 21 to the consolidated Provisions 14 778 304 financial statements, which describes uncertainty with regard Current assets As stated in the Notes indicated above the substance of these Trade accounts payable 14 137 29 478 to claim in the Arbitration Institute of the Stockholm Chamber Inventories 8 9 983 17 024 expenditures may not reflect their legal form according to the Advances received and other current 15 11 124 22 016 of Commerce issued by the Company to JC “Gazprom” and Trade accounts receivable 9 15 097 20 539 primary documents. We were unable to obtain sufficient and liabilities counterclaim from JC “Gazprom” to the Company. Our opinion is Prepayments made and other 10 12 501 2 823 appropriate audit evidence to satisfy ourselves as to the amounts Corporate income tax payable 327 27 not qualified in respect of this matter. current assets and nature of the above expenditures and their classification in the Prepaid corporate income tax 942 378 Total current liabilities 61 186 96 995 consolidated financial statements for the years ended 31 December We further draw your attention to Note 2 to the consolidated Cash and bank balances 11 4 361 2 138 TOTAL LIABILITIES 158 001 130 883 2014 and 2013. Consequently, we were unable to determine financial statements, which describes that the impact of the Restricted cash 394 200 whether any adjustments to these amounts were necessary. continuing economic crisis and political turmoil in Ukraine and TOTAL LIABIITIES AND EQUITY 514 979 237 918 Total current assets 43 278 43 102 their final resolution are unpredictable and may adversely affect 7) We were unable to obtain sufficient and appropriate audit TOTAL ASSETS 514 979 237 918 the Ukrainian economy and the operations of the Group. Our evidence regarding completeness of revenue recorded in opinion is not qualified in respect of this matter. the accompanying consolidated financial statements of the EQUITY Group on sales of petroleum products to certain customers 31 July 2015 Share capital 12 59 997 53 997 in the amount of UAH 2 853 million for the year ended PJSC Deloitte and Touche Revaluation reserve 366 204 125 663 31 December 2013. As a result of this matter, we were unable Unregistered contributed capital 12 104 610 14 000 These consolidated financial statements were authorised for issue to determine whether any adjustments to this amount were Cumulative exchange difference 1 405 - on behalf of the Board of the Company on 31 July 2015. necessary. Our audit opinion on the consolidated financial Accumulated deficit (175 258) (86 685) statements for the year ended 31 December 2013 was Equity attributable to owners of the 356 958 106 975 Andriy Kobolyev Sergiy Konovets modified accordingly. Our opinion on the current period’s Parent Chairman of the Board Deputy Chairman of the Board consolidated financial statements is also modified because of Non-controlling interest in equity 20 60 the possible effect of this matter on the comparability of the TOTAL EQUITY 356 978 107 035 current period’s figures and the corresponding figures. 154 155 PUBLIC JOINT STOCK COMPANY PUBLIC JOINT STOCK COMPANY “NATIONAL JOINT STOCK COMPANY “NATIONAL JOINT STOCK COMPANY “NAFTOGAZ OF UKRAINE” “NAFTOGAZ OF UKRAINE” CONSOLIDATED STATEMENT OF PROFIT OR LOSS CONSOLIDATED STATEMENT OF COMPREHENSIVE FOR THE YEAR ENDED 31 DECEMBER 2014 INCOME

In millions of Ukrainian Note 2014 2013 hryvnias Continuing operations: Revenue 3 78 444 75 374

Compensation of price difference 2 - - from the State Budget Cost of sales 16 (86 951) (76 126) In millions of Ukrainian In millions of Ukrainian Note 2014 2013 Note 2014 2013 hryvnias hryvnias Gross loss (8 507) (752) Net loss for the year (88 433) (17 957) Items that may be reclassified subsequently to profit or loss, net of income tax: Other operating income 808 749 Other comprehensive income Cumulative exchange difference 1 405 - Other operating expense 17 (23 621) (6 778) Reclassification adjustments relating to disposal of available-for-sale - (44) Items that will not be reclassified subsequently to profit or loss, investments in the year (net of (31 320) (6 781) Operating loss net of income tax: income tax of UAH 8 million) Finance costs 18 (9 003) (8 868) Gain/(loss) on revaluation of Other comprehensive income/(loss) 241 922 (5 191) Finance income 417 206 property, plant and equipment (net for the year 19 240 975 (5 199) of income tax of UAH 55 254 million Share of after-tax results of Total comprehensive income/ 6 1 488 536 (2013: UAH 987 million) 153 489 (23 148) associates and joint-ventures (loss) for the year Share of other comprehensive Net foreign exchange loss (39 185) (585) Total comprehensive income/ income of associates (net of income 19 (171) 19 (loss) is attributable to: tax of UAH 38 million (2013: UAH Loss before income tax* (77 603) (15 492) 4 million) Equity holders of the Company 153 529 (23 139) Remeasurement of defined benefit Non-controlling interest (40) (9) obligation (net of income tax of UAH 19 (294) 33 Total comprehensive income/ Income tax benefit/(expense) 19 2 956 (1 591) 153 489 (23 148) 64 million (2013: UAH 5 million) (loss) for the year

Remeasurement of decommissioning Net loss from continuing (74 647) (17 083) liability (net of income tax of UAH 19 7 - operations 1 million)

Discontinued operations: Loss for the year from discontinued 20 (13 786) (874) operations In millions of Ukrainian Net loss for the year (88 433) (17 957) Note 2014 2013 hryvnias from regulated businesses (88 893) (26 765)

Net loss is attributable to: from non-regulated businesses 11 290 11 273 Equity holders of the Company (88 373) (17 948) Total loss before tax (77 603) (15 492) Non-controlling interest (60) (9)

Regulated businesses are activities where sales prices and tariffs and purchase prices Net loss for the year (88 433) (17 957) are regulated by the State (as described in Note 2), and include (loss)/profit before tax of the reporting segments “Production of natural gas”, “Storage of natural gas”, and

* (Loss)/profit before tax from regulated and non-regulated businesses was as follows: “Wholesale distribution and trading of natural gas” as described in Note 3. 156 157 PUBLIC JOINT STOCK COMPANY PUBLIC JOINT STOCK COMPANY “NATIONAL JOINT STOCK COMPANY “NATIONAL JOINT STOCK COMPANY “NAFTOGAZ OF UKRAINE” “NAFTOGAZ OF UKRAINE” CONSOLIDATED STATEMENT OF CHANGES IN CONSOLIDATED STATEMENT OF CASH FLOWS EQUITY FOR THE YEAR ENDED 31 DECEMBER 2014 FOR THE YEAR ENDED 31 DECEMBER 2014

Unregistered Cumulative Non- In millions of Ukrainian Share Revaluation Accumulated Total contributed exchange Total controlling hryvnias capital reserve deficit equity In millions of Ukrainian In millions of Ukrainian capital difference interest Note 2014 2013 Note 2014 2013 hryvnias hryvnias Balance at 31 December 2012 53 997 131 238 6 000 - (69 076) 122 159 69 122 228 CASH FLOWS FROM OPERATING ACTIVITIES CASH FLOWS FROM INVESTING ACTIVITIES Loss for the year - - - - (17 948) (17 948) (9) (17 957) (77 603) (16 089) Purchase of property, plant and Loss before income tax (2 909) (3 657) Other comprehensive income/(loss) for Adjustments for: equipment and intangible assets - (5 219) - - 28 (5 191) - (5 191) Depreciation of property, plant and Proceeds from sale of property, the year 125 588 equipment and amortisation of 5 5 225 5 959 plant and equipment Total comprehensive income/(loss) - (5 219) - - (17 920) (23 139) (9) (23 148) intangible assets Withdrawal of restricted cash - (200) for the year Loss on disposal of property, plant Placement of bank deposits 11 (1 221) - Transfer of revaluation reserve - (356) - - 356 - - - 17 7 105 and equipment Cash attributable to discontinued 20 (6) - Transfer of investments to the State Impairment of property, plant and operations - - - - (2) (2) - (2) 17 5 625 852 Property Fund equipment Dividends received 52 38 Write down of inventories 8 12 485 422 Net cash used in investing State treasury bonds received (Note 12) - - 8 000 - - 8 000 - 8 000 (3 959) (3 231) Net movement in provision for activities Profit share payable to the State Budget trade accounts receivable and - - - - (43) (43) - (43) (Note 12) prepayments made, other current 17 9 839 2 335 assets, financial investments and VAT CASH FLOWS FROM FINANCING ACTIVITIES receivable Balance at 31 December 2013 53 997 125 663 14 000 - (86 685) 106 975 60 107 035 Change in provisions 14 430 358 Proceeds from borrowings 11 962 19 483 Write off of accounts payable and Loss for the year - - - - (88 373) (88 373) (60) (88 433) (110) (139) Repayment of borrowings (35 844) (22 367) other current liabilities Other comprehensive income/(loss) for Share of after-tax results of - 240 791 - 1 405 (294) 241 902 20 241 922 6 (1 488) (536) Interest paid (7 873) (6 710) the year associates and joint-ventures Total comprehensive income/(loss) Unrealised foreign exchange loss 25 901 - Mandatory budget contribution of - 240 791 - 1 405 (88 667) 153 529 (40) 153 489 (156) (45) for the year Finance costs, net 8 586 8 704 profit share paid Operating cash flows before Net proceeds from sale of State Transfer of revaluation reserve - (250) - - 250 - - - (11 103) 1 971 working capital changes treasury bonds contributed to share 96 610 5 824 capital State treasury bonds received (Note 12) - - 96 610 - - 96 610 - 96 610 (Increase)/decrease in other non- (249) 677 Net cash generated from/(used in) current assets 64 699 (3 815) Registration of shares (Note 12) 6 000 - (6 000) - -- - - financing activities (Increase)/decrease in inventories (5 857) 10 015 Profit share payable to the State Budget Increase in trade accounts receivable (2 136) (9 809) Net increase in cash and cash - - - - (156) (156) - (156) 1 002 109 equivalents (Note 12) (Increase)/decrease in prepayments (12 684) 2 086 CASH AND CASH EQUIVALENTS AT made and other current assets 2 138 2 029 THE BEGINNING OF THE YEAR Increase/(decrease) in other long- 59 997 366 204 104 610 1 405 (175 258) 356 958 20 356 978 10 (3) CASH AND CASH EQUIVALENTS Balance at 31 December 2014 term liabilities 11 3 140 2 138 AT THE END OF THE YEAR Decrease in provisions 14 (126) (214) (Decrease)/increase in trade (15 765) 17 448 accounts payable Decrease in advances received and Significant Non-Cash Transactions (10 694) (12 730) other current liabilities Contribution of the State treasury Cash (used in)/generated from 12 96 610 8 000 (58 604) 9 441 bonds to the share capital operations Income taxes paid (1 432) (2 295) Interest received 298 9 Net cash (used in)/generated by (59 738) 7 155 operating activities

158 159 PUBLIC JOINT STOCK COMPANY In 2014, the economy of Ukraine displayed characteristics of being NEURC approves procedures of setting sales prices for natural in recession. Since the end of 2013, Ukraine has been in a political gas for natural gas production entities, sales prices for natural “NATIONAL JOINT STOCK COMPANY and economic turmoil. As a result of a number of protests, the gas for households, and setting transportation, distribution and “NAFTOGAZ OF UKRAINE” President was dismissed and newly formed Parliament majority storage tariffs for natural gas. Additionally, NEURC is responsible coalition was formed. In February 2014 the new Prime Minister for protection of the customer rights in the area of tariff setting, NOTES TO THE CONSOLIDATED FINANCIAL STATE- and new Government were appointed. Following the changes in security of supplies and quality of services. the Government, the Company’s management had been changed MENTS FOR THE YEAR ENDED 31 DECEMBER 2014 The following tariffs and prices were set: in March‑June 2014, and new Board was formed. 30 June 31 December The Group is a guaranteed supplier of natural gas in Ukraine to 2015 2014 certain groups of customers, and its ability to adjust prices to the 1. THE ORGANISATION AND ITS OPERATIONS Name/Segment % Interest held Country of Retail prices of natural gas for households Effective from From UAH 1.18 to end customers, together with increased prices for the imported as at registration depend on the volume of consumption 1 April 2015: UAH 4.01 per cubic Public Joint Stock Company “National Joint Stock Company gas, is limited, since such prices are regulated at each stage from and availability of gas meters (UAH per UAH 7.19 per cubic meter, effective 31 December “Naftogaz of Ukraine” (“Naftogaz of Ukraine”, the “Parent” or exploration to end customers by the National Energy and Utilities cubic meter), including VAT, duties in the meter; from May 2014 2014 2013 the “Company”) was founded in 1998 in accordance with the Regulatory Commission (“NEURC”, before 27 August 2014 – form of additional levy to the existing UAH 3.6 per cubic tariffs, tariffs for transportation and meter within Resolution of the Cabinet of Ministers of Ukraine №747 dated Ukrtransnafta, PJSC 100.00 100.00 Ukraine National Committee for Energy Regulation, NCRE). The domestic distribution of natural gas under the 200 cubic meters 25 May 1998. Ukrspetstransgaz, PJSC 100.00 100.00 Ukraine natural gas supply in Ukraine satisfies at about half of the total regulated tariffs. per month for demand. Consequently, significant level of gas import is required Starting from 1 April 2015, differentiation customers using Naftogaz of Ukraine and its subsidiaries (hereinafter collectively to meet needs of domestic consumption. During 2014 there were depending on the volume of consumption gas in a single referred to as the “Group”) are beneficially owned by the State Wholesale and retail distribution of oil, gas and refinery significant fluctuations in natural gas purchase prices in Ukrainian and availability of gas meters is no longer package during of Ukraine. The Government of Ukraine, as represented by the products applied. Two types of prices are used: the period from hryvnia equivalent due to destabilisation of the Ukrainian hryvnia Cabinet of Ministers of Ukraine, controls the Company through Gaz Ukraiiny, Subsidiary 100.00 100.00 Ukraine regular and preferential, the latter applied 1 October to against major foreign currencies. participation in the shareholders’ meetings and the Supervisory Enterprise in the period from 1 October to 30 April 30 April (heating (heating season) for customers using gas season) Board meetings, as well as through the appointment of the The Government of Ukraine controls the Group’s operations Naftogaz Overseas S.A. 100.00 100.00 Switzerland in a single package of 200 cubic meters Chairman of the Board and the Board members. Kirovogradgaz, Open JSC 51.00 51.00 Ukraine through its ownership rights in the Company. Such an impact per month. may result in social and economic initiatives that may lead to an Naftogaz of Ukraine is a vertically integrated oil and gas company Ukravtogaz, Subsidiary 100.00 100.00 Ukraine Maximum purchase price of natural UAH 6 600 per UAH 4 020 per adverse effect on the Group’s operations. Management is unable gas for industrial customers, net of VAT, thousand cubic thousand cubic engaged in full cycle of operations in gas and oil field exploration Enterprise to predict a potential impact of such initiatives on the Group’s duties in the form of additional levy to the meters starting meters and development, exploratory drilling and production, gas and consolidated financial position and its performance. existing tariffs, tariffs for transportation from 1 June oil transportation and storage, supply of natural gas and liguefied Other and distribution of natural gas under the 2015 (from 1 April petroleum gas (“LPG”) to customers. State regulation of the natural gas market in Ukraine regulated tariffs. 2015 to 1 June Vuglesyntezgaz Ukraiiny, 100.00 100.00 Ukraine The following maximum purchase prices 2015 – UAH 7 200) The Company holds stakes in various entities that form Subsidiary Enterprise State regulation of the natural gas market in Ukraine is performed of natural gas for industrial customers and the national system of production, refinery, distribution, Ukrnaftogazkomplekt, 100.00 100.00 Ukraine by the Cabinet of Ministers of Ukraine and by the NEURC. State entities financed from the state and local budgets, net of VAT, duties in the form of transportation, and storage of natural gas, condensate, and oil. Subsidiary Enterprise regulation covers both technical and financial aspect of the market additional levy to the existing tariffs, and functioning. Technical measures relate to effective use of natural The Company is registered at 6 B. Khmelnytskoho Street, Kyiv, * As discussed in Note 20, during 2014 the Company has lost control over the assets of tariffs for gas transportation, distribution, gas resources, ensuring secure technical exploitation of the gas and supply services at the regulated tariffs. Ukraine. its subsidiary Chornomornaftogaz located in Crimea due to occupation of Autonomous transportation system, maintaining correct and safe supply, Total tariff for storage (storage and 112 112 Republic of Crimea by the troops of the Russian Federation. The Group conducts its business and holds its production facilities distribution and consumption of the natural gas. Financial measures pumping services), net of VAT, UAH per mainly in Ukraine. The principal subsidiaries are presented as 2. OPERATING ENVIRONMENT mainly relate to the tariff and price setting and to the keeping the thousand cubic meters per one season follows: correct financial means allocation between the market participants. of storage. Emerging markets such as Ukraine are subject to different risks Total tariff for transportation services via 656.20 from 1 April 287.00 Name/Segment % Interest held Country of than more developed markets, including economic, political and The Cabinet of Ministers of Ukraine must approve annual forecast transmission and distribution pipelines 2015 as at registration social, legal and legislative risks. Laws and regulations affecting of natural gas supply and its distribution. within Ukraine, net of VAT, UAH per 31 December businesses in Ukraine continue to change rapidly, tax and thousand cubic meters. NEURC performs regulation of tariffs and prices set at the 2014 2013 regulatory frameworks are subject to varying interpretations. Maximum natural gas prices for entities UAH 2.99 per cubic UAH 1.31 per cubic each stage from production to sales of natural gas, by setting generating heat for household needs, meter from 1 April meter Production of gas, oil and refinery products The future economic direction of Ukraine is heavily influenced appropriate prices and tariffs and approving procedures of including VAT and duties in the form of 2015 by the fiscal and monetary policies adopted by the government, Ukrgasvydobyvannia, PJSC 100.00 100.00 Ukraine calculating those prices and tariffs. Accordingly, NEURC approves additional levy, UAH per cubic meter. together with developments in the legal, regulatory, and political Chornomornaftogaz, 100.00 100.00 Ukraine the maximum sales price of natural gas for entities financed from According to the Law of Ukraine “On the natural gas market environment. State‑owned JSC* the State and local budgets, the maximum sales price of natural functioning”, the total volume of natural gas produced in Ukraine, (“Chornomornaftogaz”) In 2014, the Ukrainian hryvnia has devalued against major foreign gas for industrial customers and other entities (including heat net of natural gas used for technological purposes and other Zakordonnaftogaz, Subsidiary 100.00 100.00 Ukraine currencies. The National Bank of Ukraine introduced a range of generating entities, producing heat for households), retail sales needs as stipulated by this law, by the entities owned 50% and Enterprise stabilisation measures aimed at limiting outflow of customer prices of natural gas for households, tariffs for transportation more by the State, should be sold to the households via the deposits from the banking system, improving liquidity of banks services via transmission and distribution pipelines within Company at regulated prices. If the demand of the households Oil and gas transportation and supporting of the exchange rate of the Ukrainian hryvnia Ukraine, tariffs for distribution and supply of natural gas under exceeds the production volumes, it is satisfied from the other Ukrtransgaz, PJSC 100.00 100.00 Ukraine against major foreign currencies. the regulated tariffs, tariffs for storage and pumping services. sources of supply, including imports. Natural gas volumes 160 161 consumed by households are reported via the gas meters. If no In millions of Ukrainian 2014 2013 Additionally, as a result of occupation of Crimea by the primarily from European companies through gas meters are available the sales volume is reported at the average hryvnias Russian Federation, the Group has lost control over its transportation networks of Slovakia, Poland and Hungary. In normal consumption rates set by the respective regulations. Estimated price difference for the 12 802 6 264 assets located at this area. To reflect the temporary inability addition, the Group can reasonably expect that market prices period to control its business activities in Crimea, the Group has for gas will go down following a substantial reduction of oil All customers, except for heat generating companies, settle presented respective part of net assets of its subsidiary prices that occurred in the end of 2014 and onwards. their debts on natural gas consumed via special purpose bank Financial support from the State: Chornomornaftogaz as discontinued operations (Note 20). accounts. The list of banks creating such accounts is approved Compensation of price difference ‑ ‑ • During 2014 and 2015 the Government of Ukraine has received in cash during the period Management assumes that as control over Crimea or the net by the Cabinet of Ministers of Ukraine. According to current provided to the Company State treasury bonds amounting to State treasury bonds received from the 96 610 8 000 assets of the Group located in Crimea is renewed in the future, procedure, guaranteed natural gas suppliers and distributors UAH 96.6 billion and UAH 29.7 billion (received up to the date Government in exchange for the new these net assets will be restored in the consolidated financial of natural gas for all groups of customers should open special of these consolidated financial statements were authorised for share issue during the period statements in respective period. Additionally, the Group purpose bank accounts to receive payments for natural gas issue), respectively, in exchange for the new share issue. The Total financial support received 96 610 8 000 reflected impairment of assets (property, plant and equipment, consumed. Amounts accumulated on the special purpose bank Company registered share capital increase of UAH 6.0 billion in from the State receivables and inventories) located in Crimea amounting to accounts are allocated to current accounts of the transmission 2014, and received a temporary share registration certificates Estimated price difference is calculated as a difference in fair UAH 5 809 million at 31 December 2014 (Note 17). Management pipelines operator, distribution pipelines operators and for UAH 104.6 billion. The bonds received in 2014 and import prices and NEURC sales tariffs of gas sold to regional gas continues to pursue available legal and diplomatic routes aiming guaranteed suppliers according to ratios calculated by the 2015 were sold for cash, except for treasury bonds amounting distribution entities and heat generating companies for selling to to recover damages and restore control over the Group’s assets guaranteed suppliers and approved by NEURC. Balances on the to UAH 1.5 billion, received in 2015. households. As described in Note 21, the Company has requested in the affected regions. special purpose accounts could not be arrested or blocked. the Arbitral Tribunal to render an award in relation to the level • During 2015 the Parliament enacted a series of amendments Going Concern Heat generating companies also open special purpose banks of the natural gas import prices for 2010‑2014. The price actually to existing laws to improve the Group’s liquidity position, accounts for the settlement of debts for heat supplied. Cash received paid to JSC “Gazprom” (“Gazprom”), is higher than the fair price as The excess of current liabilities over current assets as including but not limited to: the right of the Company not to by heat generating entities on their special purpose bank accounts claimed by the Company. Had the Company calculated the price at 31 December 2014 amounted to UAH 17 908 million conclude contracts for the sale of natural gas with customers then allocated, among others, to current bank accounts of the difference at amounts actually paid to Gazprom, the estimated (31 December 2013: UAH 53 893 million); for the year ended declared bankrupt and those which cannot provide any guaranteed suppliers of natural gas according to ratios approved price difference for 2014 and 2013 would be UAH 19 091 million 31 December 2014 negative cash flow from operating activities security for future natural gas sales; the obligation of the by NEURC monthly. The special purpose bank accounts of heat and UAH 20 753 million, respectively. amounted to UAH 59 738 million; for the year then ended the Company to stop natural gas sales in case of non‑timely generating companies also could not be blocked or arrested. Group incurred net losses in the amount of UAH 88 433 million payments for natural gas sold etc. These amendments became Together with the compensation of price difference, the (2013: loss of UAH 17 957 million). effective on 6 June 2015. A set of secondary legislation shall be Compensation of price difference between sales tariffs and Company receives financial support from the State in the form put in place to make them operational. price of imported gas and other types of financial support by of the State treasury bonds received in exchange of new share Management of the Group believes that it is appropriate to the State issue of the Company (Note 12). The funds received are aimed prepare these consolidated financial statements on a going • The Parliament also cancelled the moratorium on the forced to cover the current liquidity gap of the Company. It could concern basis as the Group and the Government of Ukraine has property sale in respect of entities with the State shareholding As described above, the Company imports significant amount of be claimed that the amount of State treasury bonds received undertaken several initiatives aimed to improve the financial of 25 and more per cent which had not settled their debts to the natural gas to meet the domestic demand. The price of imported by the Company in exchange of the new share issue partially performance and liquidity of the Group, including, but not limited Company and its subsidiary, Gaz of Ukraine, for gas sold in past gas is significantly higher than the sales tariff set by NEURC covers compensation of the price difference, however, there by the following: periods. This change allows the forced sale of property of such and invoiced by the Company to certain groups of domestic is no legal support or documents confirming this statement, companies in order to settle their gas debts to the Company customers, namely households and heat generating companies. • Since the beginning of 2014, the Government of Ukraine has and there is no reconciliation act or similar document signed and its subsidiary, Gaz of Ukraine. The procedure for the forced The negative difference is compensated by the State to the undertaken a number of measures aiming to gradually bring between the Company and the Government of Ukraine, property sale in such cases shall be approved by the Cabinet Company, as prescribed by the Resolution of the Cabinet of the retail gas and heating prices to cost recovery levels based stating the outstanding amount of compensation of the price of Ministers of Ukraine. The Company and its subsidiary, Gaz Ministers of Ukraine No.605 dated 29 April 2006 (“compensation on international gas prices. The Government announced difference. As a result, the Group’s capital structure is not of Ukraine, are entitled to claim debt settlements from such of price difference”). Historically, such compensation of price its plans to change energy subsidy system by increasing balanced, representing significant amount of share capital and customers in the court following cancellation of the respective difference covered 70‑75% of the price of imported gas. The the direct subsidies to final consumers (mainly households accumulated losses. moratorium from 1 September 2015. timing and legal form of such compensation is not set in the and heat producing entities) and reducing the extent of the Ukrainian legislation. The actual amount of price difference to be Political instability and military actions in Eastern regions of price regulation. Successful implementation of these plans Management believes that the combination of the above compensated in respective period is approved by the State as an Ukraine would significantly reduce the Group’s financial deficit in mentioned and other measures from the Government of Ukraine expense in the Law on the State Budget for respective period. 2015‑2016 and completely eliminate it by 2017. As mentioned will enable the Group to continue as a going concern. These In early 2014 Ukraine has suffered from the armed aggression above in this Note, retail prices for natural gas for households, consolidated financial statements do not include any adjustments The Company calculates the full amount of price difference of the Russian Federation resulting in occupation of the maximum purchase price of natural gas for industrial relating to recoverability and classification of the recorded assets accumulated during each year and submits it to the Government. Autonomous republic of Crimea (“Crimea”) and occupation of the customers and tariffs for storage were increased several times amounts, or to the amounts and classification of liabilities that However, during the reporting periods and up to the date of parts of Luhansk and Donetsk regions by terrorist formations in 2014 and 2015. Additionally, following recent changes to may be necessary if the Group is unable to continue as a going these consolidated financial statements there were no documents armed, controlled, directed and financed by the Russian the legislation in July 2015, the Parliament of Ukraine adopted concern. stating the amount of compensation of price difference due Federation as well as in the result of an overt intervention of changes to the current legislation that prohibits setting heat to the Company. The Company recognises income from the regular military forces of the Russian Federation. Part of the 3. SEGMENT INFORMATION tariffs below the economically justified level. This measure compensation actually received on a cash basis. Group’s assets is located in these regions. As a result of these should enhance liquidity and profitability of the heat generating The Board is the Group’s chief operating decision maker. actions, the Group has reflected impairment of assets (property, The following information summarises the information on the entities, improving their ability to settle debts due to the Group. Management has determined the operating segments used for plant and equipment, receivables and inventories) located at price difference estimated by the Company for compensation, disclosure by the Group based on reports reviewed by the Board occupied territories of Luhansk and Donetsk regions amounting • The Government of Ukraine and the Group have been and financial support provided by the Government to the and the Ministry of Energy and Coal Industry of Ukraine for to UAH 7 203 million as at 31 December 2014 (Note 17). undertaking steps to diversify the sources of gas supplies Company in 2013‑2014 (unaudited): assessing their financial performance. 162 163 Management assesses the performance of the operating • Storage of natural gas. Ukrainian gas transportation system segments based on the amount of net profit/(loss) before income includes 11 underground gas storage facilities located in tax from continuing operations. Reportable segments are defined mainland Ukraine. The total capacity of the underground gas Segment information for the reportable business segments of the Group for the year ended 31 December 2014 is as follows: by management in accordance with the type of activity as follows: storage system located in Ukraine is 31 billion cubic meters of gas. Whole- • Production of natural gas. Natural gas production is mainly Produc- Refinery sale performed in Poltava, Kharkiv, Sumy, Dnipropetrovsk, Lviv and • Transportation of crude oil. This segment is presented by tion of Trans- Trans- Produc- of crude distri- Zakarpattya regions. Exploration works are mainly performed the transmission oil pipelines operated by the Group. The total crude porta- Storage porta- In millions of Ukrainian tion of oil and bution Elimi- in Carpathian and Dniprovs’ko‑Donetsk regions. The Group length of oil transmission pipelines in Ukraine is 4.7 thousand oil and tion of of natu- tion of Other Total hryvnias natural gas and nation controls about 70% of all natural gas produced in Ukraine. km. Segment also includes oil storage, presented by 11 oil gas natural ral gas crude gas conden- trading reservoirs with total capacity of 1.1 million tonnes of oil. conden- gas oil • Production of crude oil and gas condensate. Oil exploration sate of natu- sate was performed in Crimea. After occupation of Crimea by the • Refinery of crude oil and gas condensate. This segment is ral gas Russian Federation in early 2014, the Company has lost its presented by 5 oil and gas refineries. The refinery products Sales – external 130 320 24 171 338 1 957 5 197 45 493 838 - 78 444

control over the assets located there and respective cash flows mainly include gasoline and diesel fuel, and LPG. Sales to other segments 4 685 - 57 1 092 - 27 7 764 - (13 625) - (Note 20). Production of gas condensate is performed in the • Wholesale distribution and trading of natural gas. As area of natural gas exploration. described in the Note 2 above, the natural gas producers in Compensation of price difference ------• Transportation of natural gas. This segment is presented by Ukraine, owned 50% and more by the State, should sell total Total revenue and Compensation 4 815 320 24 228 1 430 1 957 5 224 53 257 838 (13 625) 78 444 the gas transmission and distribution pipelines operated by volume of natural gas produced, net of natural gas used for of price difference the Group. Ukrainian gas transportation system is one of the technological purposes and other needs as stipulated by the Segment result (4 696) 291 7 448 (2 986) 1 115 1 995 (81 211) (274) - (78 318) largest in the world in terms of its transportation capacities. law, to the households via the Company. Unallocated income/(expense), net 715 The total length of gas transmission pipelines in Ukraine is Loss before income tax (77 603) • Other. Revenues of this segment include revenues from sales 38.5 thousand km. Over 40% of natural gas supplied from the of material and services by supporting Group entities, mainly Management considers segments “Production of natural gas”, “Storage of natural gas”, and “Wholesale distribution and trading of Russian Federation to European countries was transported supporting services. natural gas” as regulated businesses as sales prices and tariffs and purchase prices in those types of business are regulated by the through Ukrainian transmission gas pipelines in 2014 (2013: State (as described in Note 2). All other segments are considered as non‑regulated businesses as they are fully or their major parts are over 50%). The accounting policies of the reportable segments are the same independent of special price and tariff regulations by the State. as the Group’s accounting policies described in Note 25.

Material non-cash items included in segment results: Depreciation, depletion and (2 210) - (2 344) (257) (139) (111) (12) (152) - (5 225) amortisation

Net movement in provision for trade and other receivables and (135) - 29 - (18) - (9 715) - - (9 839) prepayments made and other current assets

Impairment of property, plant and (2 394) - (52) (2 725) (134) (78) (141) (101) - (5 625) equipment and intangible assets

Net foreign exchange (loss)/gain (783) - (548) - 468 - (38 322) - - (39 185)

Capital expenditure 2 598 - 295 28 120 106 262 263 - 3 672

Segment assets 42 367 2 317 239 746 146 195 19 959 5 007 28 347 10 968 - 496 013

Investments in associates and joint 11 169 ventures

Unallocated assets 7 797

Total assets 514 979

Sales – external 446 207 30 131 443 1 411 5 778 36 447 511 - 75 374

Sales to other segments 4 687 - - 425 - - 9 828 - (14 940) -

Compensation of price difference ------

Total revenue and Compensation of 5 133 207 30 131 868 1 411 5 778 46 275 511 (14 940) 75 374 price difference

Segment result (1 163) 207 9 435 (661) 435 1 437 (24 941) (349) - (15 600)

Finance costs, not included in segment - result

Unallocated income/(expense), net 108

Loss before income tax (15 492) 164 165 Whole- 31 December 2013 Significant transactions and balances with related parties as Produc- Refinery sale at and for the years ended 31 December 2014 and 2013 are tion of Trans- Trans- Produc- of crude distri- presented in the table below. crude por-ta- Storage por-ta- amount amount In millions of Ukrainian tion of oil and bution Elimi- Revenue oil and tion of of natu- tion of Other Total Revenue, trade accounts receivable, prepayments made and hryvnias natural gas and nation gas natural ral gas crude other current assets

gas conden- trading accounts Trade for impairment conden- gas oil gross receivable, ceivable, carrying ceivable,

Gross (loss)/ profit Gross In millions 2014 2013 Trade accounts re- Trade Trade accounts re- Trade

sate of natu- provision ceivable, sate millions In of Ukrainian hryvnias ral gas of Ukrainian Heat generating 6 487 (11 875) 9 085 (1 367) 7 718 hryvnias tate Material non-cash items included in segment results: entities for heat Depreciation, depletion and produced for Associates (2 309) - (2 393) (312) (162) (157) - (348) - (5 681) Associates

amortisation households of the S of the State

Net movement in provision for Heat generating 6 401 338 5 689 (856) 4 833 controlled enti- controlled enti- controlled ‑ trade and other receivables and entities for heat ‑ (5) - (238) - (25) - (1 888) - - (2 156)

prepayments made and other current produced for other significant influence significant influence State State assets customers ties and entities under ties and entities under

Impairment of property, plant and Regional gas 5 668 (4 460) 2 138 (322) 1 816 Revenue 6 982 11 628 6 439 10 480 - - (837) - - - - (15) - (852) equipment and intangible assets distribution entities – Share of after‑tax ‑ 1 488 ‑ 536 for reselling to Capital expenditure 2 053 429 1 195 75 58 250 30 144 - 4 234 results of households Segment assets 30 053 9 402 61 917 70 304 12 283 2 387 29 869 5 513 - 221 728 associates and Regional gas 3 333 623 174 (26) 148 Investments in associates and joint joint‑ventures 9 942 distribution entities – ventures for reselling to other Trade accounts 5 052 3 723 7 640 764 Unallocated assets 6 248 customers receivable

Total assets 237 918 Industrial and other 14 558 1 647 10 762 (7 218) 3 544 Provision for (3 051) (73) (1 351) (57) customers impairment of trade accounts Total 36 447 (13 727) 27 848 (9 789) 18 059 receivable Main sales prices and tariffs for the Group’s sales of natural gas Other non‑current 488 27 468 28 External customers concentration, exceeding 10% of total Revenues, gross (loss)/profit and receivables of the segment are set out in Note 2. assets revenues ‘Wholesale distribution and trading of natural gas’ by main groups Geographical information Prepayments 466 628 205 423 of customers are as follows: During the years ended 31 December 2014 and 2013 the only In millions of Ukrainian 2014 2013 made and other current assets external customer with concentration of revenue exceeding 31 December 2014 hryvnias 10% of total revenues was Gazprom. Amount of revenue Provision for (258) (180) (129) (171) Ukraine 61 292 52 434 from Gazprom related to transportation of natural gas in impairment of The Russian Federation 16 831 22 732 prepayments amount 2014 amounted to UAH 16 831 million (2013: UAH 22 732 million). amount Revenue Egypt 320 207 made and other Revenues, gross profit and receivables of the segment Europe 1 1 current assets Trade accounts Trade accounts Trade for impairment

‘Transportation of natural gas’ by main types of transportation gross receivable, Total revenue and Compensation of 78 444 75 374 Cash and bank 2 075 ‑ 1 033 Gross (loss)/ profit Gross Trade accounts re- Trade services are as follows: provision ceivable, price difference balances receivable, carrying receivable, In millions of In hryvnias Ukrainian Allocation of sales in the table above is made based on the Purchases, trade and other payables and borrowings 31 December 2014 Heat generating 5 341 (19 329) 5 249 (2 327) 2 922 entities for heat country of residence of the Group’s customers. In millions 2014 2013 In millions of Ukrainian Revenue Gross Trade accounts produced for of Ukrainian households 4. BALANCES AND TRANSACTIONS WITH RELATED hryvnias profit receivable, car- tate hryvnias rying amount Heat generating 5 653 856 7 208 (3 268) 3 940 PARTIES

entities for heat the S the State Associates Domestic transportation 7 340 4 310 449 Associates produced for other Parties are generally considered to be related if one party has the International transit 16 831 11 891 1 729 customers ability to control the other party, is under common control, or can controlled enti- controlled enti- controlled Total 24 171 16 201 2 178 Regional gas 7 390 (7 968) 1 897 (429) 1 468 exercise significant influence or joint control over the other party ‑ ‑ distribution entities – in making financial and operational decisions. In considering each State State

31 December 2013 ties and entities under ties and entities under for reselling to possible related party relationship, attention is directed to the significant influence of significant influence of households In millions of Ukrainian Revenue Gross Trade accounts substance of the relationship, not merely the legal form. Cost of purchased ‑ ‑ ‑ 1 024 Regional gas 2 380 324 1 608 (28) 1 580 hryvnias profit receivable, car- oil, natural gas distribution entities – As discussed in the Note 1, The Group is ultimately controlled by and petroleum rying amount for reselling to other the Government of Ukraine, and therefore, all state‑controlled products Domestic transportation 7 399 3 798 2 282 customers Cost of purchased ‑ ‑ ‑ 1 024 entities are considered as related parties under common control. International transit 22 732 15 722 ‑ Industrial and other 24 729 7 691 8 328 (6 088) 2 240 oil, natural gas customers Total 30 131 19 520 2 282 Transactions with related parties are performed on terms that and petroleum Total 45 493 (18 426) 24 290 (12 140) 12 150 products would not necessarily be available to unrelated parties. 166 167 In millions 2014 2013 In millions 2014 2013 In millions Pipelines Oil and gas Machinery Buildings Techno- Drilling Other fixed Construc- Total of Ukrainian of Ukrainian of Ukrainian and related producing and logical oil and ex- assets tion in hryvnias tate hryvnias tate hryvnias equipment properties equipment and gas ploration progress

the S the State the S the State equipment Associates Associates Associates Associates Additions and 354 1 712 526 (177) - 18 101 687 3 221 transfers controlled enti- controlled enti- controlled enti- controlled enti- controlled ‑ ‑ ‑ ‑ Revaluation 124 679 12 232 61 536 36 260 56 852 169 4 501 - 296 229

State State State State Disposals - - (1) (100) (23) - (8) - (132) ties and entities under ties and entities under ties and entities under ties and entities under significant influence of significant influence of significant influence of significant influence of Depreciation charge (1 990) (1 608) (970) (760) - (28) (285) - (5 641) Other purchases 683 1 341 150 1 147 Borrowings 30 304 ‑ 27 261 ‑ Other operating 31 239 12 4 Advances received 875 61 751 966 Reclassification (4 275) (968) (2 295) - (800) (216) (25) (5 910) (14 489) expense and other current to discontinued Net movement (1 819) (25) 227 146 liabilities operations (Note 20) Impairment (1 637) (347) (660) (201) (404) (1) (65) (2 310) (5 625) in provision for Key management remuneration. Key management personnel trade accounts during 2014 consisted on average of 8 Board members (2013: Net book value 165 426 30 668 68 702 46 147 132 168 317 5 683 5 880 454 991 receivable, prepayments 14 Board members). Compensation to the key management at 31 December made and other personnel included into other operating expense consists of 2014 current assets and salary and additional current bonuses and comprises UAH Cost or valuation 165 447 30 668 68 827 46 172 132 168 317 5 900 8 669 458 168 direct write‑offs 6 million for the year ended 31 December 2014 (2013: UAH Accumulated (21) - (125) (25) - - (217) (2 789) (3 177) Finance costs 3 265 ‑ ‑ ‑ 11 million). As at 31 December 2014 key management personnel depreciation and Trade accounts 461 4 239 389 3 997 impairment payable consisted of 5 Board members.

The Group engaged independent appraisers to determine the Had the Group’s property plant and equipment been measured fair value of its property, plant and equipment as at 31 December on a historical cost basis, their carrying amount would have been 2014. Fair value was determined with reference to depreciated as shown in the table below: replacement cost or market‑based evidence, in accordance with 5. PROPERTY, PLANT AND EQUIPMENT In millions of Ukrainian 31 December 31 December International Valuation Standards. hryvnias 2014 2013 Movements in the carrying amount of property, plant and equipment were as follows: Taking into account the nature of the Group’s property, plant Oil and gas producing properties 8 480 9 553 Pipelines and related equipment 6 520 13 119 In millions Pipelines Oil and gas Machinery Buildings Techno- Drilling Other fixed Construc- Total and equipment, fair value was determined using depreciated of Ukrainian and related producing and logical oil and ex- assets tion in replacement cost for specialised assets, and using market‑based Machinery and equipment 5 934 8 417 hryvnias equipment properties equipment and gas ploration progress evidence for non‑specialised assets. Consequently, the fair value Buildings 5 446 5 835 equipment of main producing properties and equipment was primarily Technological oil and gas 1 131 1 017 determined using depreciated replacement cost. This method Drilling and exploration equipment 153 360 At 31 December 2012 considers the cost to reproduce or replace the property, plant Other fixed assets 882 989 Cost or valuation 56 026 24 885 13 938 14 526 83 077 732 3 510 16 263 212 957 and equipment, adjusted for physical, functional or economic Total 28 546 39 290 Accumulated (6 324) (4 904) (3 210) (3 054) - (304) (1 788) (2 127) (21 711) depreciation and depreciation, and obsolescence. The depreciated replacement impairment cost was estimated based on internal sources and analysis of 6. INVESTMENTS IN ASSOCIATES AND JOINT available market information for similar property, plant and Net book value 49 702 19 981 10 728 11 472 83 077 428 1 722 14 136 191 246 VENTURES equipment (published information, catalogues, statistical data at 31 December The Group’s investments in associates and joint ventures were as etc.), and industry experts and suppliers. 2012 follows: Additions 919 1 476 1 077 449 - 26 269 119 4 335 Included in oil and gas producing properties carrying value of gas In millions of Ukrainian hryvnias 31 December 31 December Revaluation - - - - (6 186) - - - (6 186) producing licenses as at 31 December 2014 of UAH 343 million 2014 2013 Disposals (7) - (20) (23) (348) - (148) (147) (693) (31 December 2013: UAH 325 million). Investments in associates 9 739 9 165 Depreciation charge (2 265) (1 810) (1 174) (763) - (79) (379) - (6 470) Investments in joint ventures 1 430 777 In 2014, the depreciation expense of UAH 5 126 million (2013: Impairment (54) - (45) (10) - - - (695) (804) Total 11 169 9 942 UAH 5 847 million) was included in cost of sales, UAH 99 million 48 295 19 647 10 566 11 125 76 543 375 1 464 13 413 181 428 Investments in associates Net book value (2013: UAH 70 million) in other operating expense, and UAH at 31 December 428 million (2013: UAH 553 million) were capitalised in the cost of Details of each of the Group’s associates at the end of the 2013 property, plant and equipment. reporting period are as follows: Cost or valuation 56 936 26 361 14 931 14 928 76 543 758 3 486 16 235 210 178

Accumulated (8 641) (6 714) (4 365) (3 803) - (383) (2 022) (2 822) (28 750) As at 31 December 2014 and 2013 the Group has pledged its depreciation and property, plant and equipment with carrying amount of UAH impairment 15 240 million and UAH 7 794 million, respectively, to secure its borrowings (Note 13).

168 169 Name of Prin- Place of in- Proportion of ownership In millions of Ukrainian hryvnias 31 December 31 December The above amounts of assets and liabilities include the following: Restructured accounts receivable of gas consumers. In May associate cipal corporation interest 2014 2013 Cash and cash equivalents 297 ‑ 2011, the Law of Ukraine “On certain matters on indebtedness activity and princi- 31 31 Current liabilities 8 256 5 397 Current financial liabilities (excluding trade (483) (418) for natural gas and electricity consumed” #3319‑VI was approved. pal place of December December Non‑current liabilities 206 170 accounts payable and provisions) According to this Law, accounts receivable due from entities business 2014 2013 Non‑current financial liabilities (excluding (52) (221) supplying natural gas under the regulated tariff that were “Ukrnafta” Oil and gas Ukraine 50.00%+ 50.00%+ 8 462 5 567 trade accounts payable and provisions) originated in 2010, were restructured for the period from 1 to PJSC production 1 share 1 share In millions of Ukrainian hryvnias 31 December 31 December 20 years and are stated at amortised cost using effective interest “Ukrtatnafta” Oil refinery Ukraine 43.05% 43.05% In millions of Ukrainian hryvnias 2014 2013 PJSC 2014 2013 rate which at the restructuring dates varied from 14% to 15% per Revenue 3 942 1 676 annum. All of the above associates are accounted for using the equity Revenue 20 647 18 398 Profit for the year 1 228 643

method in these consolidated financial statements. Profit for the year 350 251 Other comprehensive income for the year ‑ ‑ During the year ended 31 December 2014 the Group recognised additional provision in respect of restructured accounts Summarised financial information in respect of each of the Other comprehensive (loss)/income for the (33) 19 Total comprehensive income for the year 1 228 643 receivable of gas customers in the amount of UAH 95 million Group’s associates is set out below. The summarised financial year Dividends received from the joint venture ‑ ‑ during the year (2013: additional provision of UAH 21 million). information below represents amounts shown in the associate’s Total comprehensive income for the year 317 270 financial statements prepared in accordance with IFRS. The above profit for the year include the Other non‑current assets. As at 31 December 2014 and Reconciliation of the above summarised financial information following: 2013, included in other non‑current assets are research and “Ukrnafta” PJSC to the carrying amount of the interest in “Ukrtatnafta” PJSC Depreciation and amortisation (96) (18) development expenditures amounting to UAH 525 million and recognised in the consolidated financial statements: Finance income 9 ‑ In millions of Ukrainian hryvnias 31 December 31 December UAH 200 million, respectively, that were incurred within the 2014 2013 In millions of Ukrainian hryvnias 31 December 31 December Finance costs (429) (11) concession agreement for oil exploration and development with Current assets 14 983 9 118 2014 2013 Income tax expense (285) (108) the EGPC on 13 December 2006, but not yet claimed for recovery Non‑current assets 18 227 19 123 Net assets of the associate 997 681 Reconciliation of the above summarised financial information to (Note 25). 33 210 28 241 the carrying amount of the interest in the joint venture recognised Current liabilities 15 922 8 703 Proportion of the Group’s ownership interest 43.05% 43.05% 8. INVENTORIES Non‑current liabilities 2 468 1 795 in “Ukrtatnafta” PJSC in the consolidated financial statements: 18 390 10 498 Carrying amount of the Group’s interest 429 293 In millions of Ukrainian hryvnias 2014 2013 The Group’s inventories were as follows: in “Ukrtatnafta” PJSC In millions of Ukrainian hryvnias 31 December 31 December Net assets of the joint venture 2 730 1 534 In millions of Ukrainian hryvnias 31 December 31 December 2014 2013 Investments in joint ventures Proportion of the Group’s ownership interest 49.99% 49.99% 2014 2013 in the joint venture Revenue 27 892 21 101 Natural gas 7 885 14 146 Details of the Group’s material joint venture at the end of the Contribution to capital 9 ‑ Profit for the year 1 265 190 Spare parts 844 1 388 reporting period are as follows: Other adjustments 25 (25) Other comprehensive (loss)/income for the year (389) 31 Crude oil and petroleum products 363 459 Name of Prin- Place of in- Proportion of ownership Carrying amount of the Group’s interest 1 390 742 Total comprehensive income for the year 876 221 associate cipal corporation interest in the joint venture Raw materials 327 704 Reconciliation of the above summarised financial information to activity and princi- 31 31 Other 564 327 the carrying amount of the interest in “Ukrnafta” PJSC recognised 7. OTHER NON‑CURRENT ASSETS pal place of December December in the consolidated financial statements: Total 9 983 17 024 business 2014 2013 In millions of Ukrainian hryvnias 31 December 31 December Management estimates the necessity of write‑down of inventories In millions of Ukrainian hryvnias 31 December 31 December Misen Oil and gas Ukraine 49.99% 49.99% 2014 2013 to their net realisable value taking into consideration the ageing 2014 2013 Enterprices production Accounts receivable on product sharing 2 176 903 AB (LLC of inventories and indications of economical, technical and Net assets of the associate 14 820 17 743 agreement Carpatygas) physical obsolescence. In 2014 total write‑down adjustment Dividends declared by associate but not yet 3 799 ‑ Restructured accounts receivable of gas 1 122 1 130 amounted to UAH 3 893 million, included in other operating paid Summarised financial information in respect of the Group’s consumers expense and UAH 8 592 million included in cost of sales (2013: material joint venture is set out below. The summarised financial Intangible assets 371 376 Proportion of the Group’s ownership interest 50.00% UAH 422 million included in other operating expense). in “Ukrnafta” PJSC information below represents amounts shown in the joint Other 677 328

+1 share venture’s financial statements prepared in accordance with IFRS Total 4 346 2 737 As at 31 December 2014 and 2013 inventories with carrying value not adjusted by the Group for equity accounting purposes. of UAH 5 308 million and UAH 11 803 million, respectively, were +1 share Accounts receivable on product sharing agreement. The pledged as a collateral for borrowings (Note 13). Carrying amount of the Group’s interest 9 310 8 872 Misen Enterprices AB (LLC Carpatygas) Company entered into a concession agreement for oil exploration in “Ukrnafta” PJSC In millions of Ukrainian hryvnias 31 December 31 December and development with the Arab Republic of Egypt and Egyptian 9. TRADE ACCOUNTS RECEIVABLE “Ukrtatnafta” PJSC General Petroleum Corporation (“EGPC”) on 13 December 2006. 2014 2013 In millions of Ukrainian hryvnias 31 December 31 December Under the terms of the concession agreement the Company In millions of Ukrainian hryvnias 31 December 31 December Current assets 935 1 141 2014 2013 have the right to recover all exploration and development costs 2014 2013 Non‑current assets 2 906 1 819 incurred in connection with the concession agreement (Note 25). Trade accounts receivable 34 095 32 424 Current assets 7 411 4 302 3 841 2 960 The amount presented in the table above represents such costs Less: provision for impairment (18 998) (11 885) Non‑current assets 2 048 1 946 Current liabilities 1 025 1 199 claimed by the Group for recovery, and which are expected to be Total 15 097 20 539 Non‑current liabilities 86 227 9 459 6 248 refunded after one year since the reporting date. 1 111 1 426 Out of total carrying value of trade accounts receivable as at

170 171 31 December 2014 there are UAH 12 150 million of accounts Movements in provision for impairment of prepayments made Profit share payable to the state budget The Group’s bank borrowings were secured by the following receivable for natural gas (31 December 2013: UAH 18 059 and other current assets were as follows: pledged assets: In accordance with the Budget Code of Ukraine and the Law of million) (Note 3). In millions of Ukrainian hryvnias 2014 2013 Ukraine “On Management of State‑owned Items”, the Company, 31 December 31 December Movements in provision for impairment of trade accounts Balance at 1 January 5 714 5 248 being a state‑owned enterprise, has to transfer to the state 2014 2013 receivable were as follows: Provision for impairment recognised during 1 812 802 budget 30% of its statutory net profits calculated under Ukrainian Proceeds from future sales 108 603 81 145 the year Accounting Standards. For the year ended 31 December 2014, the Property, plant and equipment (Note 5) 15 240 7 794 In millions of Ukrainian hryvnias 2014 2013 Reversal of provision (86) (103) obligatory profit amount payable to the State Budget amounted Inventories (Note 8) 5 308 11 803 Balance at 1 January 11 885 11 222 Amounts written off during the year as (1 225) (233) to UAH 156 million (2013: UAH 43 million). Total 129 151 100 742 Provision for impairment recognised during the year 8 027 2 047 uncollectible Balance at 31 December 6 215 5 714 Distribution of profits Guarantees. As at 31 December 2014 the Group’s borrowings Reversal of provision (611) (808) were guaranteed by the State in the amount of UAH 11 Profits available for distribution to the owner in respect of any Amounts written off during the year as uncollectible (227) (576) 11. CASH AND BANK BALANCES 611 million (31 December 2013: UAH 24 381 million). reporting period are determined by reference to the statutory Transfer to discontinued operations (Note 20) (76) ‑ In millions of Ukrainian hryvnias 31 December 31 December financial statements prepared in accordance with Ukrainian Compliance with borrowing terms. As at 31 December 2014 the Balance at 31 December 18 998 11 885 2014 2013 Accounting Standards. Under Ukrainian legislation, dividends carrying amount of bank borrowings past due comprised UAH Analysis of credit quality of trade accounts receivable is as follows: are limited to the net profits of the reporting year or any other 939 million. Before the date of these consolidated financial Cash in banks 2 475 1 697 distributable reserves not exceeding retained earnings as set out statements the borrowings in amount of UAH 710 million were In millions of Ukrainian hryvnias 31 December 31 December Term deposits 1 869 416 in the statutory financial statements. settled. As at 31 December 2013, the Group did not comply with 2014 2013 Other 17 25 certain covenants on borrowings from third party banks, with the Neither past due nor impaired 9 921 4 814 Total 4 361 2 138 13. BORROWINGS carrying amount of UAH 15 073 million. Those borrowings were Past due but not impaired: Included in term deposits are bank deposits amounting to UAH The Group’s borrowings were as follows: classified as short‑term as at 31 December 2013. Less than 30 days overdue 2 258 4 263 1 221 million with original maturity of more than three months In millions of Ukrainian hryvnias 31 December 31 December 14. PROVISIONS 31 to 90 days overdue 913 5 486 and less than one year, which are excluded from cash and cash 2014 2013 91 to 180 days overdue 325 669 equivalents for the purpose of cash flow statement. Movements in provisions for the year were as follows: Non‑current 181 to 365 days overdue 1 606 3 288 12. SHARE CAPITAL Bank borrowings 26 188 14 388 In Provisions Employee Decom- Total Over 365 days overdue 74 2 019 Total non‑current portion 26 188 14 388 millions of for benefit missioning As at 31 December 2014 the registered, issued and fully paid Past due and individually impaired (gross): Current Ukrainian litigations obligations provision share capital of the Company was UAH 59 997 million, comprising Less than 30 days overdue 1 263 68 Bank borrowings 34 274 31 734 hryvnias 55 840 905 ordinary shares with a par value of UAH 1 000 per Eurobonds ‑ 12 749 Balance at 231 1 253 161 1 645 31 to 90 days overdue 322 53 share (31 December 2013: UAH 53 997 million, comprising 49 840 31 December 91 to 180 days overdue 177 113 Interest accrued 546 717 905 ordinary shares with a par value of UAH 1 000 per share). 2012 Unamortised issuance costs ‑ (30) 181 to 365 days overdue 1 872 125 Charge for the 304 54 ‑ 358 As at 31 December 2014 and 2013 share capital of the Company Total current portion 34 820 45 170 Over 365 days overdue 15 364 11 526 year has been adjusted for the effect of hyperinflation in accordance Total 61 008 59 558 Less: provision for impairment (18 998) (11 885) with IAS 29 “Financial Reporting in Hyperinflationary Economies” Unwinding of ‑ 142 20 162 The effective interest rates and currency denomination of Total 15 097 20 539 by UAH 4 156 million. discount (Note borrowings were as follows: 18) 10. PREPAYMENTS MADE AND OTHER CURRENT During 2014 the Company has completed a new share issue, In millions 31 December 2014 31 December 2013 Used or paid (64) (142) (8) (214) ASSETS started in 2013, of UAH 6 000 million to the Government of of Ukrainian Balance % per Balance % per during the year Ukraine in return of the State treasury bonds with maturities up The Group’s prepayments made and other current assets were as hryvnias annum annum Unused amount ‑ ‑ (8) (8) to 2015 with nominal coupon rates in a range of 9.45%‑9.95% per follows: UAH 25 014 15% 27 232 14% reversed annum. In millions of Ukrainian hryvnias 31 December 31 December US Dollars 35 919 9% 32 326 9% Remeasure- ‑ (38) ‑ (38) ments 2014 2013 Unregistered contributed capital EUR 75 12% ‑ ‑ Total 61 008 59 558 Balance at 471 1 269 165 1 905 Prepayments to suppliers for natural gas 11 083 ‑ In 2014 and 2013, according to several Resolutions of the 31 December Promissory notes receivable 1 698 1 513 Cabinet of Ministers of Ukraine, the Government issued UAH Pledges 2013 Prepayments to suppliers for materials, works 1 463 2 646 96 610 million and UAH 8 000 million, respectively, of the Non‑current 176 1 269 156 1 601 and services State treasury bonds in exchange to the new share issue The Group’s borrowings in the context of secured and Current 295 ‑ 9 304 Receivables under assignation agreements in 1 384 1 737 of the Company. The State treasury bonds have maturities non‑secured balances were as follows: respect of natural gas sales Charge for the 323 115 ‑ 438 in 2018‑2024 and bear 12.5%‑14.3% coupon rates. As at 31 December 31 December Taxes prepaid, other than income tax 473 798 year 31 December 2014 the Company has sold these State treasury 2014 2013 VAT recoverable 35 300 bonds for cash at price equal to face value or above. Unwinding of ‑ 148 21 169 Secured 61 008 58 839 Other 2 580 1 543 discount (Note As at 31 December 2014 new share issues were not registered Non‑secured ‑ 719 18) Less: Provision for impairment (6 215) (5 714) and presented as unregistered contributed capital. Total 61 008 59 558 Total 12 501 2 823

172 173 In Provisions Employee Decom- Total occur in isolation of one another as some of the assumptions may 16. COST OF SALES prepayments made and other current assets of UAH 3 848 million, millions of for benefit missioning be correlated. In millions of Ukrainian hryvnias 2014 2013 write down on inventories of UAH 1 473 million, and VAT written Ukrainian litigations obligations provision off of UAH 339 million. Furthermore, in presenting the above sensitivity analysis, the Cost of purchased natural gas 69 587 54 283 hryvnias present value of the employee benefit obligations has been Depreciation, depletion and amortisation 5 126 5 568 Included in losses incurred in Crimea are net movement in Used or paid (17) (107) (2) (126) calculated using the projected unit credit method at the end Taxes, other than on income 4 354 4 433 provision for trade accounts receivable, prepayments made during the year of the reporting period, which is the same as that applied Staff costs and related social charges 4 178 4 098 and other current assets of UAH 3 057 million, write down on Unused amount ‑ ‑ (8) (8) in calculating the obligation recognised in the consolidated Oil and gas transportation costs 1 967 2 584 inventories of UAH 1 925 million, impairment loss on property, reversed statement of financial position. Repair and maintenance costs 667 794 plant and equipment of UAH 799 million, and VAT written off of Transferred to ‑ (58) (48) (106) Cost of purchased oil and petroleum products 359 2 993 UAH 28 million. discontinued There were no changes in the methods and assumptions used in Other 713 1 373 operations preparing the sensitivity analysis from prior years. Both losses incurred on occupied territories in Crimea, Luhansk Total 86 951 76 126 Remeasure- ‑ 358 ‑ 358 and Donetsk regions were recognised by the Group as a result Decommissioning Provision ments Rent charge, included in taxes, other than on income, is calculated of the armed aggression of the Russian Federation including the

Balance at 777 1 725 128 2 630 In accordance with the legislation requirements, the Group is with reference to the volume of crude oil, gas condensate or occupation of Crimea and military invasion and occupation of 31 December obliged to restore the lands that underwent changes in the relief natural gas produced, and volume of crude oil and natural gas Luhansk and Donetsk regions in early 2014 (Note 2). 2014 structure, environmental state of soils and parent rocks, as well as transportation. Included in research, development and exploration costs are Non‑current 16 1 725 111 1 852 hydrological regime due to drilling, geological survey, constructing Included in cost of sales are expenses incurred on works expenditures on geological survey amounting to UAH 160 million and other works. The decommissioning provision represents Current 761 ‑ 17 778 performed by contractors and inventory used in the amounts for the first quarter of 2014 (year ended 31 December 2013: present value of decommissioning costs relating to oil and gas Provisions for Litigations of UAH 334 million for the first quarter of 2014 (year ended UAH 455 million). The Group paid respective amounts to the properties. 31 December 2013: UAH 1 082 million). Current management of contractors to perform those works and recognised them as The Group is involved into a number of litigations both as a The principal assumptions used in determining the the Group does not have enough evidence to prove the nature expense when incurred and as was evidenced by the primary plaintiff and as a defendant. Provision for litigations represents decommissioning provision were as follows: of those expenditures, and recognises them as expense when documents. In respect of these expenses criminal proceedings management assessment of the probable outflow of the Group’s incurred and as was evidenced by the primary documents. In were initiated in 2014 and primary documents were withdrawn by resources arising from a negative (adverse) outcome of the court 31 December 31 December respect of certain expenses criminal proceedings were initiated the state prosecutor officials. and arbitration procedures. 2014 2013 in 2014, and primary documents were withdrawn by the state Pre‑tax discount rate, % 18.0 18.0 Included in other operating expense are oil storage costs of Employee Benefit Obligations prosecutor officials. Long‑term inflation rate, % 9.0 9.0 UAH 164 million for 2014 related to the Company’s subsidiary The Group companies have certain obligations to its employees, 17. OTHER OPERATING EXPENSE “Ukrtransnafta” PJSC. Management of the Group believes that 15. ADVANCES RECEIVED AND OTHER CURRENT prescribed by the collective agreements. Those benefits include these costs are overstated as a result of subsidiary’s management LIABILITIES In millions of Ukrainian hryvnias 2014 2013 lump sum benefits payable upon retirement and post‑retirement override of controls. Subsequently, subsidiary’s management was Losses incurred on occupied territories 7 203 ‑ benefit programs. Those employee benefits plans are not funded, The Group’s advances received and other current liabilities were (Note 2) replaced in the first half 2015. and there are no plan assets. as follows: Losses incurred in Crimea (Note 2) 5 809 ‑ 18. FINANCE COSTS In millions of Ukrainian hryvnias 31 December 31 December Impairment of property, plant and equipment 3 283 852 Of the current service cost expensed in 2014, an amount of UAH In millions of Ukrainian hryvnias 2014 2013 Net movement in provision for trade accounts 2 382 2 009 107 million (2013: UAH 48 million) was included to cost of sales 2014 2013 Interest expense on bank borrowings 6 325 7 323 receivable, prepayments made and other and UAH 8 million (2013: UAH 6 million) was included to other Advances for natural gas transportation 2 366 15 241 Interest expense on Eurobonds 1 256 1 211 current assets and direct write‑offs operating expense. Advances for natural gas supplies 793 1 694 Interest on payment deferral 1 106 ‑ Staff costs and related social charges 1 129 923 Other advances received 1 070 299 Unwinding of discount on employee benefit 148 142 The principal actuarial assumptions used were as follows: Write down on inventories to net realisable 494 426 obligations (Note 14) Total advances received 4 229 17 234 value Unwinding of issuance costs 30 40 2014 2013 VAT payable 3 227 210 Impairment of cash 336 ‑ Unwinding of discount of decommissioning 21 20 Nominal discount rate, % 14.1‑14.5 12.8‑13.0 Liabilities for purchase of property, plant and 1 061 1 182 provision (Note 14) Change in provision for litigations (Note 14) 323 304 Nominal salary increase rate, % 7.0‑15.0 5.6‑11.0 equipment Other finance costs 117 132 Fines and penalties 221 163 Staff turnover ratio, % 2.0‑8.9 2.4‑8.6 Taxed payable other than income tax 744 1 240 Total 9 003 8 868 Impairment of VAT receivable 185 146 Wages, salaries and related social charges 442 728 Interest expense on payment deferral represents interest on late The sensitivity of the employee benefit obligations to changes in Research, development and exploration costs 184 543 payable payment to a natural gas supplier. the principal assumptions is as follows: Accrual of employees’ unused vacations 269 261 Professional fees 130 94 19. INCOME TAX 2014 2013 Other current liabilities 1 152 1 161 Charity and social assets maintenance 91 160 Nominal discount rate increase/decrease by (10.5) / 11.9 (7.1) / 8.2 Total 11 124 22 016 Loss on disposal of property, plant and 7 105 The components of income tax expense for the years ended equipment 1%, % 31 December were as follows: Nominal salary increase/decrease by 1%, % 10.0 / (8.5) 6.2 / (5.5) Out of total carrying value of advances for natural gas Other 1 844 1 053 In millions of Ukrainian hryvnias 2014 2013 Staff turnover increase/decrease by 1%, % (3.9) / 4.4 (6.9) / 7.9 transportation as at 31 December 2014 there were UAH 2 Total 23 621 6 778 306 million of advances received from single customer for natural Current tax expense 665 1 867 The sensitivity analysis presented above may not be Included in losses incurred on occupied territories are impairment gas transportation services via main gas pipelines through the Deferred tax benefit (3 621) (276) representative of the actual change in the employee benefit loss on property, plant and equipment of UAH 1 543 million, territory of Ukraine (31 December 2013: UAH 14 293 million). Income tax (benefit)/expense (2 956) 1 591 obligations as it is unlikely that the change in assumptions would net movement in provision for trade accounts receivable,

174 175 The Group is subject to taxation in Ukraine. In 2014 Ukrainian In millions of In millions of Ukrainian hryvnias 31 December 31 December In millions of Ukrainian hryvnias 31 December 2013 corporate income tax was levied on taxable income less allowable Ukrainian hryvnias 2014 2013 Property, plant and equipment (Note 5) 14 489 or loss expenses at the rate of 18% (2013: 19%). Trade accounts payable 314 699 Other non‑current assets 64 Inventories 413 Reconciliation between the expected and the actual taxation Property, plant and equipment 62 ‑ Trade accounts receivable 32 charge is provided below. Available‑for‑sale investments ‑ 14 000 31 December 2013 31 December 2014 prehensive income prehensive Prepayments made and other current assets 690 In millions of Ukrainian hryvnias 2014 2013 in profit Recognised Advances received and other current liabilities ‑ 3 263 Prepaid corporate income tax 17

Loss before income tax from continuing (77 603) (15 492) 20) (Note ued operations Transferred to discontin- Transferred Recognised in other com- Recognised Other non‑current assets ‑ 940 Cash and cash equivalents 6 operations Provisions 261 21 63 ‑ 345 Borrowings ‑ 273 Deferred tax liabilities (Note 19) (327) Income tax at statutory rate of 18% (2013: 19%) (13 969) (2 943) Inventories 74 225 ‑ ‑ 299 Other 330 ‑ Provisions (Note 14) (106) Adjustments to deferred tax attributable to tax (121) (51) Other long‑term liabilities (339) rates different from tax rates effective as at Prepayments made and 6 67 ‑ ‑ 73 68 915 52 671 31 December 2014 other current assets Borrowings (504) According to provisions of the Tax Code of Ukraine tax losses Indexation of property, plant and equipment for (149) ‑ Trade accounts payable 6 (1) ‑ ‑ 5 Trade accounts payable (572) accumulated by the Group as at 31 December 2014 can be carried tax purposes Other non‑current assets (58) 62 ‑ ‑ 4 Advances and other current liabilities (77) forward for unlimited periods of time. Tax effect of items not deductible or assessable for taxation purposes: Net deferred tax liability (17 521) 3 621 (55 153) 327 (68 726) Net assets at the date of loss of control 13 786 ‑ Non‑deductible expenses 8 426 815 20. DISCONTINUED OPERATIONS Net deferred tax liability as at 31 December 2013 related to the Chornomornaftogaz’s financial results for the year from ‑ Non‑taxable income (206) (86) following: Since November 2013, Ukraine has been subject to political discontinued operations: Tax effect of items taxed at a rate different from ‑ 1 520 unrest. On 27 February 2014, pro‑Russian fractions under 19% In millions of In millions of Ukrainian hryvnias 2014 2013 military support of the regular forces of the Russian Federation Additional income tax accrued based on a lost 139 557 Ukrainian hryvnias Revenue ‑ 525 or loss illegally took control over the Parliament of the Autonomous court decision Other gains ‑ 24 republic of Crimea, an autonomous region of Ukraine, which then Change in unrecognised deferred tax asset 2 924 1 779 ‑ 549 voted to hold a pseudo‑referendum on the status of Crimea in Income tax (benefit)/expense (2 956) 1 591 Expenses ‑ (1 146) March 2014. Following this pseudo‑referendum and having the 31 December 2012 31 December 2013

prehensive income prehensive Loss before income tax ‑ (597)

Parent and its subsidiaries are separate tax payers and, therefore, in profit Recognised region under military occupation of the Russian regular forces, Attributable income tax expense (277) the deferred tax assets and liabilities are presented on an Crimea was unlawfully annexed by the Russian Federation. On ued operations (Note 20) (Note ued operations Transferred to discontin- Transferred Recognised in other com- Recognised Loss on disposal of operation (13 786) ‑ individual basis. The deferred tax liabilities and assets reflected in 17 March 2014, Crimean occupational authorities announced the consolidated statement of financial position after appropriate Property, plant and (19 518) 217 987 ‑ (18 314) the nationalisation of the assets of Chornomornaftogaz, the Loss for the year from discontinued (13 786) (874) operations (attributable to owners of the set off are as follows: equipment Company’s subsidiary, located in Crimea. Parent) Trade accounts receivable 83 (1) ‑ ‑ 82 In millions of Ukrainian hryvnias 31 December 31 December These events led to a loss of control of the Group over Cash flows from discontinued operations: Investments in associates (593) (38) 4 ‑ (627) Chornomornaftogaz’s assets in Crimea. 2014 2013 and joint ventures In millions of Ukrainian hryvnias 2014 2013 Deferred tax asset ‑ ‑ Cash flows from discontinued operations Advances received and other 1 176 (127) ‑ ‑ 1 049 According to paragraph 9 of the Law of Ukraine “On protecting Deferred tax liability (68 726) (17 521) current liabilities citizen rights and law enforcement on the temporarily occupied Net cash inflows from operating activities ‑ 212 Net deferred tax liability (68 726) (17 521) Net cash outflows from investing activities ‑ (235) Provisions 265 1 (5) ‑ 261 territory of Ukraine”, any authority, its officials and activities on the temporarily occupied territory are considered as unlawful, Net cash outflows from financing activities ‑ (33) Net deferred tax liability as at 31 December 2014 related to the Inventories (100) 174 ‑ ‑ 74 if this authority and officials are created or elected in order not Net cash inflows ‑ (56) following: Prepayments made and (9) 15 ‑ ‑ 6 prescribed by the law of Ukraine. Any document issued by such other current assets 21. CONTINGENCIES, COMMITMENTS AND In millions of authorities or officials are not legally binding and do not create OPERATING RISKS Ukrainian hryvnias Trade accounts payable 3 3 ‑ ‑ 6 any legal consequences. or loss Other non‑current assets (67) 9 ‑ ‑ (58) Tax legislation. Ukraine’s tax environment is characterised The Group had no access to financial statements, by complexity in tax administering, arbitrary interpretation by Net deferred tax liability (18 760) 253 986 ‑ (17 521) primary documents or any other financial information of tax authorities of tax laws and regulations that, inter alia, can As at 31 December 2014 and 2013 unrecognised deductible Chornomornaftogaz for period from 1 January 2014 to date 31 December 2013 31 December 2014 prehensive income prehensive increase fiscal pressure on tax payers. Inconsistent application, Recognised in profit Recognised temporary differences and unused tax losses are as follows: of loss of control in 2014. Based on this fact management of interpretation, and enforcement of tax laws can lead to litigation the Group decided to account for loss of control based on ued operations (Note 20) (Note ued operations Transferred to discontin- Transferred Recognised in other com- Recognised In millions of Ukrainian hryvnias 31 December 31 December which, as a consequence, may result in the imposition of Chornomornaftogaz’s net assets as of 31 December 2013. 2014 2013 additional taxes, penalties, and interest, and these amounts could Property, plant and (18 314) 904 (55 254) 327 (72 337) equipment Tax losses carried forward 43 484 2 906 Management continues to pursue available legal and diplomatic be material. Facing current economic and political issues, the

Trade accounts receivable 82 2 853 ‑ ‑ 2 935 Inventories 14 157 9 367 routes aiming to recover damages and restore control over the Government has implemented certain reforms in the tax system Investments in associates (627) 116 38 ‑ (473) Group’s assets in Crimea. of Ukraine by adopting the Law of Ukraine “On Amending the Tax Trade accounts receivable, prepayments made 10 099 20 975 and joint ventures Code of Ukraine and Certain Laws of Ukraine” which is effective and other current assets Chornomornaftogaz’s net assets as at the date of loss of control Advances received and other 1 049 (626) ‑ ‑ 423 from 1 January 2015, except for certain provisions which will take Provisions 469 248 were as follows: current liabilities effect at a later date.

176 177 In the ordinary course of business the Group is engaged in the Agreement on gas purchase, are calculated using the formula. contingent liabilities under such disputes at the level of UAH for exploration, development and production activities for each transactions that may be interpreted differently by the Group and The Company claims that the formula components were not 382 million. Management cannot reliably estimate amount of oil and gas field. Separate licenses are issued for oil and gas tax authorities. Where the risk of outflow of financial resources calculated properly, the formula stipulated by the Agreement on potential losses on these obligations, if any. transportation, supply and storage. Licenses are provided for the associated with this is deemed to be probable and the amount is gas purchase does not reflect current level of gas market prices period from two to twenty years, and could be prolonged for the Possible transfer of the Company’s equity interest in measured with sufficient reliability, the Group provides for those and that the import prices should be revised downturns. As at same period. the subsidiaries to the State. In 1998, upon creation of the liabilities. Where management of the Group estimates the risk 31 December 2014, management of the Group believes that it has Company, the Government of Ukraine contributed certain shares Certain licenses for exploration, development and production of financial resources outflow as possible, the Group makes a settled all its liabilities for natural gas supplied during 2010‑2014, of joint‑stock companies to the share capital of the Company. activities were transferred as a contribution to joint ventures. disclosure of these contingent liabilities. As at 31 December 2014, and requests a compensation of excessively paid amounts of USD These joint‑stock companies included JSC Long‑Distance Pipeline However, this is not allowed according to the current legislation management estimated possible tax exposures in total amount 12 billion. “Druzhba” and JSC “Prydniprovskiy” Long‑Distance Pipeline and the State has the right to suspend such licenses. Currently of UAH 6 175 million (2013: UAH 5 553 million) with respect to the In June 2015 Gazprom submitted its Statement of Defense and that were reorganised in 2001 into JSC Ukrtransnafta, JSC no licenses of the Group were suspended due to this reason following: Counterclaim to the arbitration, updating and qualifying its claim Ukrspetstransgaz, Chornomornaftogaz National JSC, JSC Ukrnafta and there are no litigations in respect of the matter. The Group • Corporate income tax amounting to UAH 3 122 million (2013: for payments of USD 26.7 billion (USD 18.5 billion as claimed and fifty‑four regional gas distribution entities. management believes that licenses will not be suspended due to UAH 2 421 million) and related penalties amounting to UAH before) for natural gas which Gazprom did not deliver but the the matter in the foreseeable future. The Government of Ukraine may transfer ownership or control 863 million (2013: UAH 745 million); Company allegedly was obliged to pay for pursuant to the current over all or part of the Company’s equity interest in those Capital commitments. Capital commitments for purchase of contract (so‑called take‑or‑pay provision in the Agreement on • Value added tax amounting to UAH 1 514 million (2013: joint‑stock companies and/or other state‑owned oil and gas property, plant and equipment, and exploration and development gas purchase). Management cannot predict the final outcomes UAH 1 656 million) and related penalties amounting to UAH transportation and storage facilities to other companies or of oil and gas fields comprise UAH 400 million as at 31 December of those claims, and does not recognise any obligation or related 538 million (2013: UAH 429 million); Government agencies, and those actions could have a material 2014 (31 December 2013: UAH 742 million). provisions in this respect. adverse effect to the Company’s operations. • Other taxes amounting to UAH 138 million (2013: UAH: 22. FINANCIAL RISK MANAGEMENT In October 2014, the Company has also requested the Stockholm 302 million). State property not subject to privatisation. In 1998, the Arbitral Tribunal to render an award in respect of the natural gas The Group’s activities expose it to a variety of financial risks: Company entered into an agreement “On use of State owned Management believes that it is not likely that any significant transit charge through the territory of Ukraine according to the market risk (including currency risk and interest rate risk), property not subject to privatisation” (“Agreement”) with the State settlement will arise from the above cases and, therefore, the agreement on gas transit between the Company and Gazprom. concentration risk, credit risk and liquidity risk. The Group reviews Property Fund of Ukraine, and received oil and gas transportation Group’s consolidated financial statements do not include any The actual transit charge was calculated for the certain volume of and agrees risk management policies to minimise the potential system into the operational control. The Agreement was signed amount of provision in this respect. the natural gas transit from the Russian Federation via Ukraine adverse effects on the Group’s financial performance for those for one year, and its term is prolonged automatically for one year, (“basic transit volume”). Expenditures of the Ukrainian natural risks. The Group conducts transactions with its subsidiaries. It is unless terminated by notice from either party, and is binding gas transmission pipelines operator Ukrtransgaz are mainly possible with evolution of the interpretation of tax law in Ukraine on the legal successor of each party. Historically, the agreement Major categories of financial instruments: fixed costs, and thus, decrease in volume of transit should cause and changes in the approach of tax authorities under the new Tax has been prolonged automatically, as neither party initiated its higher transit charge per unit. However, taking that the actual In millions of Ukrainian Note 31 December 31 December Code, that such transactions could be challenged in the future. termination. As the State property not subject to privatisation transit volumes in 2010‑2014 were significantly lower than the hryvnias 2014 2013 The impact of any such challenge cannot be estimated, however, forms an essential part of the Group’s business, the future basic transit volume, the natural gas transit charge has never Trade accounts receivable 9 15 097 20 539 management believes that it should not be significant. operations and financial performance of the Group depends on been revised. The Company requests a compensation for unpaid Other non‑current assets 7 3 309 2 130 the prolongation of the Agreement. The Company’s management Starting from 1 September 2013 the Tax Code of Ukraine revenues from international transit above USD 11.7 billion. believes that the Group will continue to operate with this property Prepayments made and other 10 588 1 427 introduced new, based on the OECD transfer pricing guidelines, current assets Legal proceedings. From time to time and in the normal course in the foreseeable future. rules for determining and applying fair market prices, which of business, claims against the Group arise. Where the risk Сash and bank balances 11 4 361 2 138 significantly changed transfer pricing (“TP”) regulations in Pursuant to the Agreement, the Company is required, inter alia, of outflow of financial resources associated with such claims Restricted cash 394 200 Ukraine. The Group exports refinery products and transportation to handle oil and gas transmission and distribution pipelines is assumed as probable, a respective liability is recognised Total financial assets 23 749 26 434 services, performs intercompany transactions and is involved in owned by the State of Ukraine, keep the state property in as a component of provision for litigations (Note 14). Where transactions with related parties, which may potentially be in the adequate operational condition, and transfer 50% share of profits management estimates the risk of outflow of financial resources scope of the new Ukrainian TP regulations. Part of the Group’s received from using those assets to the State. The amount of such associated with such claims as possible, or amount of outflow Borrowings 13 (61 008) (59 558) companies has submitted the controlled transaction report within transfer could be reduced by the amount of capital investments cannot be measured reliably, no provision is recognised, and Trade accounts payable (10 384) (25 725) the required deadline. Another part of the Group’s companies has in those assets. The Agreement does not provide a mechanism respective amount is disclosed in the consolidated financial Advances received and other 15 (1 772) (2 171) prepared all necessary documentation on controlled transactions of such calculations, and historically there were no payments statements. Management believes that it has provided for all current liabilities as required by legislation and plans to submit the reports. from the Group to the State in respect of using such assets. The material losses in these consolidated financial statements. Management believes that the Group is in compliance with TP Group believes that had the mechanism for calculating the state Other long‑term liabilities (49) (378) requirements. The Group and certain natural gas suppliers have disputes in share in profits from using the assets been determined by the Total financial liabilities (73 213) (87 832) respect of volumes and/or prices for natural gas supplied to the State, the capital investments performed by the Group would Arbitral Tribunal requests. In June 2014 the Company has Market risk. The Group takes on exposure to market risks. Group. Management assesses its contingent liabilities under such be greater, and no payment in favour of the State would occur. requested the Arbitration Institute of the Stockholm Chamber Market risks arise from open positions in (a) foreign currencies, disputes at the level of UAH 4 681 million. Management cannot Accordingly, no liability for such payment was recognised in these of Commerce to render an award in respect of the price (b) interest bearing assets and liabilities and (c) equity reliably estimate amount of potential losses on these obligations, consolidated financial statements. determination according to the Agreement on gas purchase investments, all of which are exposed to general and specific if any. between the Company and Gazprom. The Company claims that Licenses. The State controls the oil and gas exploration and market movements. the import prices for natural gas supplied during 2010‑2014 are The Group and certain suppliers have disputes in respect of production activities in Ukraine via issuing respective licenses. Currency risk. The Group operates within Ukraine and its overstated. The import prices for natural gas, as prescribed by payables not settled by the Group. Management assesses its According to the current legislation, separate licenses are issued exposure to foreign currency risk is determined mainly by 178 179 purchase of natural gas from foreign suppliers, which are Interest rate risk. The Group normally has no significant both liquidity and credit risks. The Group analyses ageing In millions of Ukrainian hryvnias 31 December 31 December denominated in USD. The Group also receives borrowings in interest bearing assets, and its income and operating cash flows of its assets and maturity of its liabilities and plans liquidity 2014 2013 foreign currencies. The Group does not hedge its foreign currency are substantially independent of changes in market interest depending on their expected repayment. The Group has capital Total borrowings (Note 13) 61 008 59 558 positions. rate. The Group’s interest rate risk exposure arises from construction programs which are funded both through existing Less: cash and cash equivalents (Note 11) (3 140) (2 138) borrowings at variable interest rates. Borrowings at fixed rate business cash flows and borrowed funds. Borrowed funds are Total Net Debt 57 868 57 420 The Group’s exposure to foreign currency risk is as follows, based expose the Group to fair value interest rate risk. also used to finance the Group’s working capital needs. Total Equity 356 978 107 035 on carrying amounts of respective currency assets and liabilities: Total Equity plus Total Net Debt 414 846 164 455 In 31 December 2014 31 December 2013 The Group mainly attracts borrowings at fixed rate. The following table analyses the Group’s financial liabilities into Gearing ratio 0.14 0.35 relevant maturity groupings based on the remaining period millions of USD EUR Others USD EUR Others The borrowing activities are reviewed on an annual budget. 23. FAIR VALUE at the reporting date to the contractual maturity date. The Ukrainian Long‑term investing activities and associated funding are amounts disclosed in the table are undiscounted cash flows IFRS defines fair value as the price that would be received to sell hryvnias considered separately, and are subject on the Government of of principal and interest payments. The maturity analysis of an asset or paid to transfer a liability in an orderly transaction Restricted 394 ‑ ‑ 200 ‑ ‑ Ukraine approval. cash financial liabilities as at 31 December 2014 was as follows: between market participants at the measurement date. Сash and bank 507 71 9 21 110 ‑ The maturity dates and effective interest rates of financial In The estimated fair values have been determined by the Group balances instruments are further disclosed in this note. millions of Bank deposits 94 1 124 ‑ ‑ ‑ ‑ using available market information, where it exists, and Concentration risk. The Group is exposed to concentration Ukrainian appropriate valuation methodologies. However, judgement is Trade 2 356 ‑ ‑ ‑ ‑ ‑ 12 2 years 5 years ‑ ‑ ‑

hryvnias to Up 6 months 6 months 1 2 Over 5 years Total accounts risk on advances received and revenues from natural gas necessarily required to interpret market data to determine the receivable transportation, other current liabilities and trade accounts Borrowings 29 879 8 703 14 977 14 077 ‑ 67 636 estimated fair value. Management has used all available market Other ‑ ‑ 49 ‑ ‑ 49 Prepayments 495 4 ‑ ‑ ‑ ‑ payable as 54% of all total advances received and 50% of trade information in estimating the fair value. The estimates presented long‑term made and accounts payable as at 31 December 2014 (31 December 2013: liabilities herein are not necessarily indicative of the amounts the Group other current 83% and 93%, respectively) comprise advances received from could realise in a market exchange from the sale of its full holdings assets Trade 10 384 ‑ ‑ ‑ ‑ 10 384 and trade payables to a single supplier (Note 15). Concentration accounts of a particular instrument or pay in the transfer of liabilities. Other 2 176 81 ‑ ‑ ‑ ‑ payable non‑current on revenues from natural gas transportation is disclosed in Advances 1 772 ‑ ‑ ‑ ‑ 1 772 Fair value of the Group’s financial assets and financial assets Note 3. received and liabilities measured at fair value on a recurring basis and fair Borrowings (35 919) (75) (32 326) ‑ ‑ Credit risk. The Group takes on exposure to credit risk, which other current value of property, plant and equipment Advances (363) ‑ (96) ‑ ‑ ‑ liabilities received and is the risk that one party to a financial instrument will cause Total 42 035 8 703 15 026 14 077 ‑ 79 841 The Group’s available‑for‑sale investments and property, plant other current a financial loss for the other party by failing to discharge and equipment are measured at fair value at the end of each liabilities an obligation. Exposure to credit risk arises as a result of The maturity analysis of financial liabilities as at 31 December reporting period. The following table provides information about Trade (7 107) (120) (2) (22 067) ‑ ‑ the Group’s sales of products on credit terms and other 2013 was as follows: accounts how the fair values of these assets are determined (in particular, transactions with counterparties giving rise to financial assets. In Total payable the valuation techniques and inputs used): The Group’s policy is that the customers that wish to pay on millions of Net (short) (37 367) 1 085 (89) (54 172) 110 ‑ credit terms are subject to the solvency check. Significant Ukrainian Assets Fair value Valuation techniques and key inputs

long 12 2 years 5 years ‑ ‑ ‑

Up to Up 6 months 6 months 1 2 Over 5 years hierarchy currency outstanding balances are also reviewed on an ongoing basis. hryvnias Borrowings 27 678 22 637 12 610 5 745 ‑ 68 670 position At the same time, the Group must follow the state regulations Property, 3 The Group engages professional independent appraisers Other ‑ ‑ 349 29 ‑ 378 as a guaranteed supplier of natural gas to the population and plant and to determine the fair value of its property, plant and long‑term The following table presents sensitivities of profit or loss and equip- equipment by using a replacement cost method for the state‑owned entities irrespective whether they are delinquent liabilities equity to reasonably possible changes in exchange rates applied ment majority of groups. The fair value is determined as the or not. Trade 25 725 ‑ ‑ ‑ ‑ 25 725 cost of construction of these items at current prices less at the reporting date, with all other variables held constant. accounts the economic obsolescence and physical tear and wear to The Group establishes a provision for impairment that payable The exposure was calculated only for monetary balances date. The main parameter used in this valuation technique represents its estimate of incurred losses in respect of trade Advances 1 820 351 ‑ ‑ ‑ 2 171 denominated in currencies other than the functional currency of received and are current prices on construction. accounts receivable. The main component of this provision is a the Group’s entities. other current For items for which there are market analogs (mainly specific loss component that relates to individually significant liabilities buildings), the sales comparison method is used, the In millions At 31 December At 31 December exposures. Total 55 223 22 988 12 959 5 774 ‑ 96 944 prices of market‑based sales of comparable properties of Ukrainian 2014 2013 in the immediate proximity are adjusted with reference The maximum exposure to credit risk as at 31 December 2014 is Gearing ratio. Consistent with others in the industry, the Group to differences in main parameters (such as floor space of hryvnias Impact Impact Impact Impact UAH 23 749 million (31 December 2013: UAH 26 434 million). monitors capital on the basis of gearing ratio. This ratio is the property). The main parameter used in this valuation on on on on calculated as net debt divided by total capital under management. technique is the price per square meter of a property. The Group does not hold any collateral as security. profit or equity profit or equity Net debt is calculated as total borrowing (current and non‑current Property, 2 The fair value of technological oil and gas is determined by loss loss Liquidity risk. Prudent liquidity management implies as shown in the consolidated statement of financial position) plant and application of the market price of oil and gas at the end of equip- the reporting date to the volume of technological oil and USD strengthening by 10% (3 737) (3 737) (5 417) (5 417) maintaining sufficient cash and the availability of funding to less cash and cash equivalents. Total capital under management ment gas. The main parameters used in this valuation technique USD weakening by 10% 3 737 3 737 5 417 5 417 meet existing obligations as they fall due. The Group’s objective equals equity as shown in the consolidated statement of financial are market prices for oil and gas at the end of the reporting is to maintain a balance between the continuity of funding and position plus net debt. EUR strengthening by 10% 109 109 11 11 period. The market value of the technological gas equal flexibility through the use of credit terms provided by suppliers to the market price of gas less costs of it’s pumping and EUR weakening by 10% (109) (109) (11) (11) The gearing ratio at the end of the reporting period was as and banks. Prepayments are commonly used to manage transportation to the point of sale. following: 180 181 The following table summarises financial instruments and Other assets of Group’s property, plant and equipment comprise Liabilities Fair value Valuation techniques and key inputs access policy. Also was announced Ukraine’s decision to cancel property, plant and equipment recognised at fair value after initial other fixed assets of level 3 and amounted to UAH 3 489 million. hierarchy the Stand‑By Arrangement (“SBA”) for Ukraine that was approved recognition using a fair value hierarchy: Borrowings 2 Discounted cash flows. on in April 2014. In March 2015, IMF had provided Ukraine with Fair value of financial assets and financial liabilities that are Future cash flows are estimated based SDR 3.5 billion tranche (equivalent to USD 4.9 billion). 31 December 2014 not measured at fair value on a recurring basis (but fair value on the inputs that are observable, either directly disclosures are required) or indirectly, and the estimates use one or more Stabilisation of the economic and political situation depends, to a In millions of Ukrainian Level 2 Level 3 Total observable quoted prices for orderly transactions large extent, upon success of the Ukrainian government’s efforts, hryvnias The Group’s management believes that, except for item included in the markets that are not considered active. Fair yet further economic and political developments are currently in the table below, the carrying amounts of financial assets value of borrowings was determined applying range Property, plant and equipment 132 168 316 943 449 111 difficult to predict. and financial liabilities recognised in the consolidated financial of interest rates for UAH denominated borrowings from 17.0% p.a. to 20.0% p.a. (31 December Total 132 168 316 943 449 111 statements approximate their fair values due to short‑term Effect of gas transportation unbundling obligations. Pursuant 2013: 12.5% p.a. to 14.5% p.a.) and for USD 31 December 2013 nature: denominated borrowings from 9.5% p.a. to 12.0% p.a. to Ukraine’s commitments under the Energy Community Treaty (31 December 2013: 8.5% p.a. to 10.5% p.a.). and the Ukraine – European Union (“EU”) Association Agreement, In millions of Ukrainian Level 2 Level 3 Total In millions 31 December 2014 31 December 2013 by 1 June 2016 operators of gas transmission systems of Ukraine hryvnias of Ukrainian 24. SUBSEQUENT EVENTS Carrying Fair Carrying Fair must be effectively unbundled from activities related to gas hryvnias Property, plant and equipment 76 543 91 472 168 015 amount value amount value Share capital increase and State treasury bonds received. In production and supply per one of the allowed unbundling Borrowings 61 008 59 185 59 558 59 495 Total 76 543 91 472 168 015 July 2015 the Company has registered a new share capital issue models. Currently, a new gas market law initiated by the Total 61 008 59 185 59 558 59 495 amounting to UAH 104 610 million out of unregistered share Government is undergoing adoption in the Cabinet of Ministers of Details of the Group’s property, plant and equipment and capital existed as at 31 December 2014, taking total nominal Ukraine, which envisages two options for unbundling (ownership information about the fair value hierarchy as at 31 December The following table provides information about how the fair registered and fully paid share capital to UAH 160 451 million as unbundling and the ISO model) in line with the EU laws in that 2014 are as follows: value of borrowings is determined (in particular, the valuation at 31 July 2015 (or UAH 164 607 million together with adjustment respect. The owner of the state‑owned gas transmission system techniques and inputs used): for the effect of hyperinflation of UAH 4 156 million, Note 12). (i.e. the state acting through its authorised bodies) is responsible for selecting the applicable unbundling model. Certain Description Group of assets Valuation Unobservable inputs Range of Interrelationship between key In July 2015, according to the Resolution of the Cabinet of preliminary steps were taken by the Ukrainian state authorities technique unobservable unobservable Ministers of Ukraine, the Company’s share capital was increased in connection with the contemplated unbundling (Government’s inputs inputs and fair value by UAH 29 700 million. New share issue was made to the authorisation for establishing two Public Joint‑Stock Companies, measurement Government of Ukraine in return of the State treasury bonds Magistralni Gazoprovody Ukrayiny and Pidzemni Gazoshovusha Gas transmission Pipelines and related Depreciated Date of implementation of Regulatory Asset The later the implementation of new tariff maturing in 2020 and bearing nominal interest of 14.5% per Ukrayiny; amendments to the current natural gas market law system and gas equipment replacement cost incentive tariff regulation system Base (RAB) start in system, the lower the fair value annum. As at the date of these consolidated financial statements allowing for foreign investments into the operator of the Unified storages method using the 2016 the Company has sold UAH 28 200 million of these State treasury income approach Gas Transmission System). As a result, the structure of the Group, Buildings Rates of return on Regulatory Same rates of return The higher the rate, the lower the fair value bonds for cash. for economic Asset Base for old and new its assets, liabilities and activities might undergo certain changes, obsolescence capital Changes to the Ukrainian legislation related to quorum of the the scope of which will be determined by the selected unbundling determination Machinery and equipment Nominal WACC for USD- 8% The higher the WACC, the lower the fair value General meetings of shareholders. In March 2015, according model. denominated cash flow to changes in the Law of Ukraine “On Joint‑Stock Companies”, Loans repayment and prolongation. In 2015 the Group has quorum of the General meetings of shareholders was lowered Other fixed assets obtained new loan of UAH 554 million due in 2016, to restructure from 60%+1 share down to 50%+1 share. Currently, management Gas extraction Pipelines and related Depreciated The remaining period of the 0 – 35 The lower the period, the lower the fair value its liabilities to other banks, which were payable in 2015. assets equipment replacement cost deposit extraction, years (based because of lower remaining useful life of of the Group estimates the effect of these changes to the method using the on proven and probable reserves infrastructure assets accounting for the Group’s associates. Also the Group has prolonged successfully to 2016‑2020 loans in income approach determined by independent total amount of UAH 18 238 million, which were due in 2015. for economic expert) Profit share payable to the State Budget.The obsolescence Oil and gas producing Gas sale price Market price based The higher the gas sale price, the higher the General shareholders’ meetings held in June 2015, PJSC Subsequent to 31 December 2014 and up to the date of these determination properties on a parity with the fair value Ukrgasvydobyvannia and PJSC Ukrtransgaz, 100% subsidiaries consolidated financial statements, the Group has repaid loans import gas price of the Company, has approved profit distribution to the State amounting to UAH 9 016 million. Budget of Ukraine amounting to UAH 277 million payable within Buildings Royalty tax rate long-term 29% The higher the taх rate, the lower the fair 25. SUMMARY OF SIGNIFICANT ACCOUNTING projection (as calculated on sale value 6 months after the date of respective meeting. price) POLICIES Economic instability in Ukraine. During the first half 2015, the Machinery and equipment Nominal WACC for UAH- 20,55% The higher the WACC, the lower the fair value Statement of compliance. These consolidated financial Ukrainian hryvnia continued to devalue against the US Dollar. denominated cash flow statements have been prepared in accordance with International According to the National Bank of Ukraine, the average exchange Other fixed assets Financial Reporting Standards (“IFRS”). rate for the first half 2015 amounted to UAH 21.36 for USD 1.00. Oil transmission Pipelines and related Depreciated Cumulative factor of physical and 0,79 The higher the factor, the lower the fair value Basis of preparation. The consolidated financial statements have system and equipment replacement cost functional depreciations In March 2015, International Monetary Fund (“IMF”) approved storages method using the been prepared on the historical cost basis except for property, Buildings Nominal WACC for UAH- 16,4% The higher the WACC, the lower the fair value a four‑year extended arrangement under the Extended Fund income approach plant and equipment and certain financial instruments that are denominated cash flow Facility for Ukraine. The arrangement amounts to the equivalent for economic measured at revalued amounts or fair values at the end of each Machinery and equipment of SDR (Special Drawing Rights) 12.3 billion (equivalent to USD obsolescence reporting period, as explained in the accounting policies below. Other fixed assets determination 17.5 billion) and was approved under the Fund’s exceptional 182 183 Historical cost is generally based on the fair value of the Ukrainian hryvnia. Foreign currency can be easily converted at a subsequently accounting for the retained interest as an associate, When a group entity undertakes its activities under joint consideration given in exchange for goods and services. rate close to the National Bank of Ukraine rate. At present, UAH is joint venture or financial asset. In addition, any amounts operations, the Group as a joint operator recognises in relation to not freely convertible outside Ukraine. previously recognised in other comprehensive income in respect its interest in a joint operation: Fair value is the price that would be received to sell an asset of that entity are accounted for as if the Group had directly or paid to transfer a liability in an orderly transaction between Basis for consolidation. Subsidiaries are those companies • Its assets, including its share of any assets held jointly; disposed of the related assets or liabilities. This may mean that market participants at the measurement date, regardless of over which the Group has control. The Group controls an entity amounts previously recognised in other comprehensive income • Its liabilities, including its share of any liabilities incurred whether that price is directly observable or estimated using when the Group is exposed to, or has rights to, variable returns are reclassified to profit or loss. jointly; another valuation technique. from its involvement with the entity and has the ability to affect those returns through its power over the entity. Subsidiaries are If the ownership interest in an associate is reduced but significant • Its revenue from the sale of its share of the output arising Included in assets (mainly property, plant and equipment) consolidated from the date on which control is transferred to the influence is retained, only a proportionate share of the amounts from the joint operation; and expenses for the first quarter 2014 are expenditures and Group (acquisition date) and are deconsolidated from the date previously recognised in other comprehensive income are expenses related to purchase of services and inventories (except • Its share of the revenue from the sale of the output by the that control ceases. reclassified to profit or loss where appropriate. for expenses related to purchase of natural gas and crude oil, joint operation; and and staff costs and related social charges) amounting to UAH Inter‑company transactions, balances and unrealised gains Investments in associates. Associates are entities over which • Its expenses, including its share of any expenses incurred 660 million and UAH 938 million, respectively (year 2013: UAH or losses on transactions between the Group companies are the Group has significant influence but not control. Investments jointly. 4 335 million and UAH 2 927 million, respectively). Classification eliminated. Accounting policies of subsidiaries have been changed in associates are accounted for using the equity method of and disclosure of these expenses and expenditures in the where necessary to ensure consistency with the policies adopted accounting. The Group’s investment in associate includes goodwill The Group accounts for the assets, liabilities, revenues and consolidated financial statements have been made on the basis of by the Group. identified on acquisition, net of any accumulated impairment loss. expenses relating to its interest in a joint operation in accordance the relevant primary documents. However, given the information with the IFRSs applicable to the particular assets, liabilities, The Company reassesses whether or not it controls an investee if The Group’s share of its associates’ post‑acquisition profits or available to current management of the Group, there are certain revenues and expenses. facts and circumstances indicate that there are changes to one or losses is recognised in the statement of profit or loss, and its grounds to believe that the nature of these expenditures could be more of the three elements of control listed above. share of post‑acquisition movements in other comprehensive When a group entity transacts with a joint operation in which a different from their legal form according to primary documents. income is recognised in other comprehensive income. The group entity is a joint operator (such as a sale or contribution of When the Group has more than a majority of the voting rights These policies have been consistently applied to all periods cumulative post‑acquisition movements are adjusted against assets), the Group is considered to be conducting the transaction of an investee, it still considers whether the voting rights are presented, unless otherwise stated. the carrying amount of the investment. When the Group’s with the other parties to the joint operation, and gains and losses sufficient to give it the practical ability to direct the relevant share of losses in an associate equals or exceeds its interest in resulting from the transactions are recognised in the Group’s Functional and presentation currency. Items included in the activities of the investee unilaterally and, thus, has the power over the associate, including any other unsecured receivables, the consolidated financial statements only to the extent of other financial statements of each of the Group’s entities are measured the investee. Group does not recognise further losses, unless it has incurred parties’ interests in the joint operation. using the currency of the primary economic environment in which The Group considers all relevant facts and circumstances in obligations or made payments on behalf of the associate. the Group operates (“the functional currency”). The consolidated When a group entity transacts with a joint operation in which a assessing whether or not the Group’s voting rights in an investee Unrealised gains on transactions between the Group and its financial statements are presented in Ukrainian hryvnias (“UAH”), group entity is a joint operator (such as a purchase of assets), the are sufficient to give it power, including: associates are eliminated. which is the Company’s functional and the Group’s presentation Group does not recognise its share of the gains and losses until it currency. All amounts presented in the consolidated financial • The size of the Group’s holding of voting rights relative to the Accounting policies of associates have been changed where resells those assets to a third party. statements are presented in UAH, rounded to the nearest million, size and dispersion of holdings of the other vote holders; necessary to ensure consistence with the policies adopted by the Concession agreement (product sharing agreement). The if not otherwise stated. Group. • Potential voting rights held by the Group, other vote holders Company entered into a concession agreement for oil exploration Transactions denominated in currencies other than the relevant or other parties; Dilution gains and losses arising on investments in associates are and development (“Concession Agreement”) with the Arab functional currency are translated into the functional currency, recognised in the consolidated statement of profit or loss. Republic of Egypt and Egyptian General Petroleum Corporation • Rights arising from other contractual arrangements; and using the exchange rate prevailing at the date of the transaction. (“EGPC”) on 13 December 2006. Interest in joint ventures. A joint venture is a joint arrangement Foreign exchange gains and losses, resulting from settlement of • Any additional facts and circumstances that indicate that the whereby the parties that have joint control of the arrangement The Concession Agreement includes the following conditions: such transactions and from the translation of foreign currency Group has, or does not have, the current ability to direct the have rights to the net assets of the joint arrangement. Joint denominated monetary assets and liabilities at year end, are relevant activities at the time that decisions need to be made, • Subject to the auditing provisions under the Concession control is the contractually agreed sharing of control of an recognised in the consolidated statement of profit or loss. including voting patterns at previous shareholders’ meetings. Agreement, the Company shall recover on a quarterly basis all arrangement, which exists only when decisions about the relevant Translation at year end does not apply to non‑monetary items exploration and development costs to the extent and out of Transactions with non‑controlling interests. The Group activities require unanimous consent of the parties sharing including equity investments. The effects of exchange rate 25% of all petroleum produced and saved from all production treats transactions with non‑controlling interests as control. changes on the fair value of equity securities are recorded as part areas and not used in petroleum operations (“Cost Recovery”). transactions with equity owners of the Group. For purchases of the fair value gain or loss. The Group recognises its interest in the joint venture using the Petroleum products under the Concession Agreement include from non‑controlling interests, the difference between any equity method applied as described above in the paragraph crude oil or gas and LPG. As at 31 December, the exchange rates used for translating consideration paid and the relevant share acquired of the Investment in associates. foreign currency balances were: carrying value of net assets of the subsidiary is recorded in • Remaining 75% of the petroleum produced is shared by the In Ukrainian hryvnias 2014 2013 equity. Gains or losses on disposals to non‑controlling interests Interest in joint operations. A joint operation is a joint Company and EGPC depending on the volume of production USD 1.00 15.76 7.99 are also recorded in equity. arrangement whereby the parties that have joint control of and the product type (crude oil or gas and LPG). The EUR 1.00 19.23 11.04 the arrangement have rights to the assets, and obligations for Company’s share varies from 15% to 19%. When the Group ceases to have control or significant influence, RUB 10.00 3.00 2.45 the liabilities, relating to the arrangement. Joint control is the the retained interest in the entity is remeasured to its fair value, • EGPC shall become the owner of all the Company’s assets Exchange restrictions in Ukraine are limited to compulsory contractually agreed sharing of control of an arrangement, which with the change in carrying amount recognised in profit or loss. acquired and owned within the Concession Agreement, receipt of foreign receivables within 90 days of sales and to the exists only when decisions about the relevant activities require The fair value is the initial carrying amount for the purposes of which assets were charged to Cost Recovery by the Company compulsory conversion of 75% of proceeds in foreign currency to unanimous consent of the parties sharing control. 184 185 in connection with the operations carried out by the benefits associated with the item will flow to the Group and measured at cost and capitalised within property, plant and Intangible assets. Intangible assets have definite useful lives Company: land shall become the property of EGPC as soon the cost of the item can be measured reliably. All other repairs equipment in the consolidated statement of financial position: and primarily include capitalised computer software. Acquired as it is purchased; title to fixed and movable assets shall be and maintenance are charged to the statement of profit or loss computer software are capitalised on the basis of the costs • Acquisition of rights to explore; transferred automatically and gradually from the Company to during the financial period in which they are incurred. Property, incurred to acquire and bring them to use. Intangible assets are EGPC as they become subject to the Cost Recovery. plant and equipment are derecognised upon disposal or when • Topographical, geological, geochemical and geophysical carried at cost less accumulated amortisation and impairment no future economic benefits are expected to be received from studies; losses, if any. If impaired, the carrying amount of intangible assets The development period under the Concession Agreement is the continued use of the asset. Gains and losses on disposal is written down to the higher of value in use and fair value less limited to maximum 25 years from the date of commercial oil • Exploratory drilling; determined by comparing proceeds with carrying amount of costs to sell. discovery or from the date of first gas deliveries, started in 2011. property, plant and equipment are recognised in the consolidated • Trenching, sampling; and Leases. Leases in which a significant portion of the risks and Accounting for all exploration and evaluation and other costs and statement of profit or loss. When revalued assets are sold, the • Activities in relation to evaluating technical feasibility and rewards of ownership are retained by the lessor are classified as incomes related to the product sharing agreement is similar to amounts included in other reserves are transferred to retained commercial viability of extracting a mineral resource. operating leases. Payments made under operating leases (net the accounting for a normal production process, as described in earnings. of any incentives received from the lessor) are charged to the this Note. Exploration and evaluation assets are carried forward during Property, plant and equipment includes technological oil and consolidated statement of profit or loss on a straight‑line basis the exploration and evaluation stage and are not amortised but Segment reporting. Operating segments are reported in a gas which is required to be held in the pipelines and storage over the period of the lease. Finance leases are capitalised at the assessed for impairment in accordance with the indicators of manner consistent with the internal reporting provided to facilities for the operating activities of the Group companies in lease commencement at the lower of the fair value of the leased impairment as set out in IFRS 6 Exploration for and Evaluation the Group’s chief operating decision maker. Segments whose transportation segment. property and the present value of the minimum lease payments. of Mineral Resources. In circumstances where a property is revenue, results or assets are ten percent or more of all the Construction in progress includes also prepayments for property, abandoned, the cumulative capitalised costs relating to the Decommissioning liabilities. The Group’s assessment of the segments are reported separately. Segments falling below this plant and equipment. property are written off in the period. No amortisation is charged decommissioning liabilities is based on the estimated future costs threshold can be reported separately at management decision. prior to the commencement of production. expected to be incurred in respect of the decommissioning and site Exploration expenses. Exploration expenses comprise the costs Property, plant and equipment. The Group uses the revaluation restoration, adjusted for the effect of the projected inflation for the associated with unproved reserves. These include geological and In circumstances where a property is identified as containing model to measure property, plant and equipment. Fair value upcoming periods and discounted using interest rates applicable geophysical costs for the identification and investigation of areas economically recoverable resources then the accumulated was based on valuations made by external independent valuers. to the provision. Estimated costs of dismantling and removing an with possible oil and gas reserves and administrative, legal and exploration and evaluation costs associated with that property The frequence of revaluation depends on the movements in the item of property, plant and equipment are added to the cost of an consulting costs in connection with exploration. They also include are transferred to oil and gas producing properties and are fair values of the assets being revalued. The last independent item of property, plant and equipment when the item is acquired, all impairments on exploration wells where no proved reserves presented within the property, plant and equipment in the valuation of the fair value of the Group’s property, plant and and corresponding obligation is recognised. Changes in the could be demonstrated. consolidated statement of financial position. equipment was performed as at 31 December 2014. Subsequent measurement of an existing decommissioning liability, that result additions to property, plant and equipment are recorded at cost. Research and development expenses. Research and Depreciation and depletion. Depreciation is charged to the from changes in the estimated timing or amount of the outflows, Cost includes expenditure directly attributable to acquisition of development (R&D) expenses include all direct and indirect consolidated statement of profit or loss on a straight‑line basis to or from changes in the discount rate used for measurement, are the items. The cost of self‑constructed assets includes the cost materials, personnel and external services costs incurred in allocate costs of individual assets to their residual value over their recognised in the statement of profit or loss or, to the extent of of materials, direct labour and an appropriate proportion of connection with the focused search for new development estimated useful lives. Depreciation commences on the date of any revaluation balance existence in respect of the related asset, production overheads. Сost of acquired and self‑constructed techniques and significant improvements in products, services acquisition or, in respect of self‑constructed assets, from the time other reserves. Provisions in respect of decommissioning activities qualifying assets includes borrowing costs. and processes and in connection with research activities. an asset is completed and ready for use. are evaluated and re‑estimated annually, and are included in the Expenditure related to research activities is shown as R&D consolidated financial statements at each reporting date at their Any increase in the carrying amounts resulting from revaluations Oil and gas assets, including oil and gas producing properties expenses in the period in which it is incurred. Development costs expected present value, using discount rates which reflect the are credited to revaluation reserve in equity through other are depleted using a unit‑of‑production method. The cost are capitalised if the recognition criteria according to IAS 38 are economic environment in which the Group operates. comprehensive income. Decreases that offset previsouly of producing wells is amortised over proved developed fulfilled. recognised increases of the same asset are charged against reserves. Licence acquisition, common facilities and future Interest expense related to the provision is included in finance revaluation reserve in equity through other comprehensive Exploration and evaluation assets. Oil and gas exploration and decommissioning costs are amortised over total proved and costs in profit or loss. income; all other decreases are charged to the consolidated evaluation expenditures are accounted for using the successful probable reserves. Impairment of non‑financial assets. Assets are reviewed for statement of profit or loss. To the extent that an impairment efforts method of accounting. Costs are accumulated on a Other property, plant and equipment are depreciated on a impairment whenever events and changes in circumstances loss on the same revalued asset was previously recognised in field‑by‑field basis. Costs directy associated with an exploration straight line basis over its expected useful life. The typical useful indicate that the carrying amount may not be recoverable. An the consolidated statement of profit or loss, a reversal of that well, and exploration and proprety leasehold acquisition costs, lives of the Group’s other property, plant and equipment are as impairment loss is recognised for the amount by which the assets impairment loss is also recognised in the statement of profit or are capitalised as long as the following conditions are satisfied: follows: carrying amount exceeds its recoverable amount. The recoverable loss. Each year the difference between depreciation based on the • Sufficient oilnd a gas reserves have been discovered that amount is the higher of fair value less cost to sell and value in use. revalued carrying amount of the asset charged to the statement Useful lives in years would justify completion as a production well; For purposes of assessing impairment, assets are grouped to the of profit or loss and depreciation based on the asset’s original Pipelines and related equipment 9‑60 lowest levels for which there are separately identifiable cash flows cost is transferred from revaluation reserve to retained earnings. • Sufficient progress is being made in assessing the economic Machinery and equipment 3‑60 (cash generating unit). Non‑financial assets that have suffered and technical feasibility to justify beginning field development Buildings 3‑60 Expenditure incurred to replace a component of an item of impairment are reviewed for possible reversal of the impairment in the near future. Drilling and exploration equipment 3‑30 property, plant and equipment that is accounted for separately, is at each reporting date. Other fixed assets 3‑30 capitalised with the carrying amount of the replaced component If it is determined that commercial exploitation has not been Classification of financial assets. The Group classifies its being derecognised. Subsequent costs are included in the achieved, these costs are charged to expense. Construction in progress and technological oil and gas are not financial assets into the following measurement categories: (a) asset’s carrying amount or recognised as a separate asset, as depreciated. Expenditures related to the following activities are initially loans and receivables; (b) available‑for‑sale financial assets. appropriate, only when it is probable that future economic 186 187 Loans and receivables include financial receivables created by the income is removed and included in the determination of net without needing to impose additional restrictions on the sale. amortised cost using the effective interest method, less provision Group by providing money, goods or services directly to a debtor, profit, even though the assets have not been derecognised. The Group derecognises financial liabilities when, and only for impairment. other than those receivables which are created with the intention when, the Group’s obligations are discharged, cancelled or they Interest income on available‑for‑sale debt securities is Prepayments made and other current assets. Prepayments to be sold immediately or in the short term, or which are quoted expire. The difference between the carrying amount of the calculated using the effective interest method and recognised are carried at cost less provision for impairment. A prepayment in an active market. Loans and receivables comprise primarily financial liability derecognised and the consideration paid and in the consolidated statement of profit or loss. Dividends on is classified as non‑current when the goods or services relating loans, trade accounts receivable including purchased loans and payable is recognised in profit or loss. available‑for‑sale equity instruments are recognised in the to the prepayment are expected to be obtained after one year, promissory notes. All other financial assets are included in the consolidated statement of profit or loss when the Group’s right Income taxes. Income taxes have been provided for in the or when the prepayment relates to an asset which will itself be available‑for‑sale category. to receive payment is established and the inflow of economic consolidated financial statements in accordance with Ukrainian classified as non‑current upon initial recognition. Initial recognition of financial instruments. Financial assets benefits is probable. Impairment losses are recognised in the legislation enacted or substantively enacted by the end of Other prepayments are charged to the consolidated statement and financial liabilities are initially measured at fair value. consolidated statement of profit or loss when incurred as a result reporting date. The income tax charge comprises current tax and of profit or loss when the goods or services relating to the of one or more events that occurred after the initial recognition of deferred tax and is recognised in the consolidated statement of The Group’s principal financial instruments comprise prepayments are received. If there is an indication that the assets, available‑for‑sale investments. A significant or prolonged decline profit or loss unless it relates to transactions that are recognised, available‑for‑sale investments, borrowings, cash and cash goods or services relating to a prepayment will not be received, in the fair value of an instrument below its cost is an indicator that in the same or a different period, in other comprehensive income. equivalents and short‑term deposits. The Group has various the carrying value of the prepayment is written down accordingly it is impaired. The cumulative impairment loss measured as the other financial instruments, such as trade receivables and trade Current tax is the amount expected to be paid to or recovered and a corresponding impairment loss is recognised in the difference between the acquisition cost and the current fair value, payables, which arise directly from its operations. from the taxation authorities in respect of taxable profits or consolidated statement of profit or loss. less any impairment loss on that asset previously recognised in losses for the current and prior periods. Taxes other than on All purchases and sales of financial instruments that require the consolidated statement of profit or loss, is removed from Promissory notes. Some purchases may be settled by income are recorded within operating expenses. delivery within the time frame established by regulation or market equity and recognised in the consolidated statement of profit or promissory notes or bills of exchange, which are negotiable convention (“regular way” purchases and sales) are recorded at loss. Deferred income tax is provided using the balance sheet liability debt instruments. Purchases settled by promissory notes are trade date, which is the date that the Group commits to deliver a method for tax losses carried forwards and temporary differences recognised based on management’s estimate of the fair value to Impairment losses on equity instruments are not reversed financial instrument. All other purchases and sales are recognised arising between the tax bases of assets and liabilities and their be given up in such settlements. The fair value is determined with through the consolidated statement of profit or loss. If, in a on the settlement date with the change in value between the carrying amounts for financial reporting purposes. In accordance reference to observable market information. subsequent period, the fair value of a debt instrument classified commitment date and settlement date not recognised for assets with the initial recognition exemption, deferred taxes are not as available‑for‑sale increases and the increase can be objectively Cash and cash equivalents. Cash and cash equivalents carried at cost or amortised cost, and recognised in equity for recorded for temporary differences on initial recognition of related to an event occurring after the impairment loss was include cash in hand, deposits held at call with banks, and other assets classified as available‑for‑sale. an asset or a liability in a transaction other than a business recognised in the consolidated statement of profit or loss, the short‑term highly liquid investments with original maturities of combination if the transaction, when initially recorded, affects Subsequent measurement of financial instruments. impairment loss is reversed through current period’s consolidated three months or less. Cash and cash equivalents are carried at neither accounting nor taxable profit. Deferred tax liabilities are Subsequent to initial recognition, the Group’s financial liabilities, statement of profit or loss. amortised cost using the effective interest method. Restricted not recorded for temporary differences on initial recognition of loans and receivables are measured at amortised cost. Amortised balances are excluded from cash and cash equivalents for the A provision for impairment of loans and accounts receivable is goodwill and subsequently for goodwill which is not deductible cost is calculated using the effective interest method and, for purposes of the consolidated cash flow statement. Balances established when there is objective evidence that the Group will for tax purposes. Deferred tax balances are measured at tax financial assets, it is determined net of any impairment losses. restricted from being exchanged or used to settle a liability for at not be able to collect all amounts due according to the original rates enacted or substantively enacted at the reporting date Premiums and discounts, including initial transaction costs, are least twelve months after the reporting date are included in other terms. Significant financial difficulties of the debtor, probability which are expected to apply to the period when the temporary included in the carrying amount of the related instrument and non‑current assets. that the debtor will enter bankruptcy or financial reorganisation, differences will reverse or the tax losses carried forwards will be amortised based on the effective interest rate of the instrument. and default or delinquency in payments are considered to be utilised. Deferred tax assets and liabilities are netted only within Share capital. Ordinary shares are classified as equity. The face values of financial assets and liabilities with a maturity indicators that the trade receivable is impaired. The amount the individual companies of the Group. Deferred tax assets for Incremental costs directly attributable to the issue of new shares of less than one year, less any estimated credit adjustments, of the provision is the difference between the asset’s carrying deductible temporary differences and tax losses carried forwards are shown in equity as a deduction, net of tax, from the proceeds. are assumed to be their fair values. The fair value of financial amount and the present value of estimated future cash flows. are recorded only to the extent that it is probable that future Dividends and mandatory budget contribution of profit liabilities is estimated by discounting the future contractual cash The carrying amount of the asset is reduced through the use of taxable profit will be available against which the deductions can share. Dividends and mandatory budget contribution of profit flows at the current market interest rate available to the Group a provision account, and the amount of the loss is recognised be utilised. share are recognised as a liability and deducted from equity at the for similar financial instruments. in the consolidated statement of profit or loss. When receivable Inventories. Inventories are recorded at the lower of cost reporting date only if they are declared before or on the reporting is uncollectible, it is written off against the provision account Gains and losses arising from a change in the fair value of and net realisable value. The cost of inventories includes date. Dividends are disclosed when they are proposed before the for receivables. Subsequent recoveries of amounts previously available‑for‑sale assets are recognised directly in other expenditures incurred in acquiring the inventories, production reporting date or proposed or declared after the reporting date written off are credited in the consolidated statement of profit comprehensive income. In assessing the fair value of financial or coversion costs and other costs incurred in bringing them but before the consolidated financial statements are authorised or loss. instruments, the Group uses a variety of methods and makes to their existing location and condition. Cost of manufactured for issue. assumptions based on market conditions existing at the reporting Derecognition of financial instruments. The Group inventories includes an appropriate share of production Value added tax (“VAT”). In Ukraine VAT is levied at two rates: date. derecognises financial assets when (i) the assets are redeemed overheads based on normal operating capacity. The cost of 20% on sales and imports of goods within the country, works and or the rights to cash flows from the assets have otherwise inventories is determined on the first in first out basis and When available‑for‑sale assets are sold or otherwise disposed of, services and 0% on the export of goods and provision of works expired or (ii) the Group has transferred substantially all the weighted average cost. Net realisable value is the estimated the cumulative gain or loss recognised in other comprehensive or services to be used outside Ukraine. A taxpayer’s VAT liability risks and rewards of ownership of the assets or (iii) the Group selling price in the ordinary course of business, less the cost of income is included in the determination of net profit. When equals the total amount of VAT collected within a reporting has neither transferred nor retained substantially all risks and completion and selling expenses. a decline in fair value of available‑for‑sale assets has been period, and arises on the earlier of the date of shipping goods to rewards of ownership but has not retained control. Control recognised in equity and there is objective evidence that the Trade accounts receivable. Trade and other receivables are a customer or the date of receiving payment from the customer. is retained if the counterparty does not have the practical assets are impaired, the loss recognised in other comprehensive recognised initially at fair value and subsequently measured at A VAT credit is the amount that a taxpayer is entitled to offset ability to sell the asset in its entirety to an unrelated third party 188 189 against his VAT liability in a reporting period. Rights to VAT credit a finance cost. are reclassified as repurchase receivables. The corresponding Critical judgements in applying accounting policies. The arise when a VAT invoice is received, which is issued on the liability is presented within amounts due to other banks or other following are the critical judgements, apart from those involving Other liabilities. Other financial liabilities are recognised earlier of the date of payment to the supplier or the date goods borrowed funds. estimations, that the Group management has made in the initially at fair value, net of transaction costs incurred, and are are received. VAT related to sales and purchases is recognised process of applying the Group’s accounting policies and that have subsequently stated at amortised cost using the effective interest Employee benefits: Defined Contributions Plan. The Group in the consolidated statement of financial position on a gross the most significant effect on the amounts recognised in the method. Other non‑financial liabilities are measured at cost. makes statutory unified social contributions to the Pension basis and disclosed separately as an asset and liability. Where consolidated financial statements. Fund of Ukraine in respect of its employees. The contributions provision has been made for impairment of receivables, the Contingent assets and liabilities. A contingent assets are not are calculated as a percentage of current gross salary and are Investment in “Ukrnafta” PJSC. The Group holds 50% + 1 share impairment loss is recorded for the gross amount of the debtor, recognised in the consolidated financial statements but disclosed expensed when incurred. Discretionary pensions and other of voting rights in “Ukrnafta” PJSC. The rest is owned by limited including VAT. when an inflow of economic benefits is probable. post‑employment benefits are included in labour costs in the number of investors. According to the Law of Ukraine “On Joint Borrowings. Borrowings include bank borrowings and bonds. Contingent liabilities are not recognised in the consolidated consolidated statement of profit or loss. The Company makes Stock Companies” General Meeting of Shareholders is a superior financial statements unless it is probable that an outflow of contributions to the State Pension Fund in Ukraine in respect management body of the Public Joint Stock Company. The General Borrowing costs. Borrowing costs directly attributable to the economic resources will be required to settle the obligation and it of its employees in the amount of UAH 1 324 million and UAH Meeting of Shareholders, among other things, mandatory deals with acquisition, construction or production of qualifying assets, which can be reasonably estimated. Contingent liabilities are disclosed 1 269 million for the years ended 31 December 2014 and 2013, election of the Supervisory Board members, approves decisions on are assets that necessarily take a substantial period of time to unless the possibility of an outflow of resources embodying respectively. The contributions are calculated as a percentage significant legal actions. As at 31 December 2014, according to the get ready for their intended use or sale, are added to the cost economic benefits is remote. of current gross salary, and are expensed when incurred. Other Ukrainian law, the General Meeting of Shareholders is legitimate of those assets, until such time as the assets are substantially post‑employment benefits are included in labour costs in the if it is attended by the shareholders owing in aggregate not less ready for their intended use or sale. All other borrowing costs Revenue recognition. Revenues from sales of goods are statement of comprehensive income. than 60%+1 of the company's voting shares. Due to the fact that are recognised in profit or loss in the period in which they are recognised at the point of transfer of risks and rewards the Group has no unilateral ability to conduct legitimate General incurred. associated with ownership of goods. If the goods are transported Employee benefits: Defined Benefit Plan.The Group provides Meeting of Shareholders, management believes that the Group does to a specified location, revenue is recognised when the goods are lump sum benefits, payments on reaching certain age, and other Borrowings are recognised initially at fair value, net of transaction not have control over “Ukrnafta” PJSC. Accordingly, the investment passed to the customer at the destination point. benefits as prescribed by the collective agreement. The liability costs incurred. Borrowings are subsequently stated at amortised in “Ukrnafta” PJSC is accounted for as investment in associate (Note recognised in the consolidated statement of financial position in cost using the effective interest method. Bank overdrafts are Revenue from sale and resale of natural gas are recognised at the 6). Subsequent to the balance sheet date, there were changes to respect of the defined benefit pension plan is the present value of included into borrowings line item in the consolidated statement point of transfer of risks and rewards associated with ownership the Ukrainian legislation that lowered the percentage of the voting the defined benefit obligation at the reporting date. The defined of financial position. of these goods. Revenues are measured at the fair value of the rights from 60%+1 share to 50%+1 share to allow for the legitimate benefit obligation is calculated annually using the projected unit consideration received or receivable, and are shown net of value General Meeting of Shareholders (Note 24). Trade accounts payable. Trade accounts payable are recognised credit method. added tax and discounts. and initially measured under the policy for financial instruments Impairment of trade accounts receivable. Management estimates The present value of the defined benefit obligation is mentioned above. Subsequently, instruments with a fixed Recognition of expenses. Expenses are recorded on an accrual the likelihood of the collection of trade accounts receivable determined by discounting the estimated future cash outflows maturity are re‑measured at amortised cost using the effective basis. The cost of goods sold comprises the purchase price, based on an analysis of individual accounts. Factors taken into using interest rates of high‑quality corporate bonds that are interest method. Amortised cost is calculated by taking into transportation costs, commissions relating to supply agreements consideration include an ageing analysis of trade accounts receivable denominated in the currency in which the benefits will be paid, account any transaction costs and any discount or premium on and other related expenses. in comparison with the payment history, credit terms allowed and that have terms to maturity approximating the terms of the settlement. to customers and available market information regarding the Finance income and costs. Finance income and costs comprise related pension liability. counterparty’s ability to pay. Should actual collections be less than Advances received. Advances received are carried at amounts interest expense on borrowings, losses on early repayment of Actuarial gains and losses arising from experience adjustments management’s estimates, the Group would be required to record an originally received. Amounts of advances received are expected to loans, interest income on funds invested, income or loss on and changes in actuarial assumptions are charged or credited to additional impairment expense. be realised through the revenue received from usual activities of origination of financial instruments, unwinding of interest of the other comprehensive income in the period in which they arise. the Group. pension obligation and provisions, and foreign exchange gains Key sources of estimation uncertainty. The following are the Past service costs are recognised immediately in the consolidated and losses. key assumptions concerning the future, and other key sources of Provisions. Provisions are recognised when the Group has statement of profit or loss. estimation uncertainty at the end of the reporting period, that have a present obligation (legal or constructive) as a result of a Borrowing costs that relate to assets that take a substantial 26. CRITICAL ACCOUNTING ESTIMATES AND a significant risk of causing a material adjustment to the carrying past event and it is probable that an outflow of resources period of time to construct are capitalised as part of the cost of JUDGEMENTS amounts of assets and liabilities within the next financial year. embodying economic benefits will be required to settle the the asset. All other interest and other costs incurred in connection obligation and a reliable estimate can be made of the amount with borrowings are expensed using the effective interest In the application of the Group's accounting policies, Employee benefit obligations. Management assesses of the obligation. method. management is required to make judgements, estimates and post‑employment and other employee benefit obligations assumptions about the carrying amounts of assets and liabilities using the projected unit credit method based on actuarial Where the Group expects some or all of a provision to be Interest income is recognised as it accrues, taking into account that are not readily apparent from other sources. The estimates assumptions which represent management’s best estimates of reimbursed, for example under an insurance contract, the the effective yield on the asset. and associated assumptions are based on historical experience the variables that will determine the ultimate cost of providing reimbursement is recognised as a separate asset but only when Sale and repurchase agreements and lending of securities. and other factors that are considered to be relevant. Actual post‑employment and other employee benefits. The present the reimbursement is virtually certain. Sale and repurchase agreements (“repo agreements”) which results may differ from these estimates. value of the pension obligations depends on a number of factors The expense on any provision is presented in the consolidated effectively provide a lender’s return to the counterparty are that are determined on an actuarial basis using a number of The estimates and underlying assumptions are reviewed on an statement of profit or loss net of any reimbursement. If the effect treated as secured financing transactions. Securities sold under assumptions. The major assumptions used in determining the net ongoing basis. Revisions to accounting estimates are recognised of time value of money is material, provisions are discounted such sale and repurchase agreements are not derecognised. The cost (income) for pensions include the discount rate and expected in the period in which the estimate is revised if the revision using a current pre‑tax rate that reflects, where appropriate, securities are not reclassified in the consolidated statement of salary increases. Any changes in these assumptions will impact affects only that period, or in the period of the revision and future the risks specific to the liability. Where discounting is used, the financial position unless the transferee has the right by contract the carrying amount of pension obligations. Since there are no periods if the revision affects both current and future periods. increase in provision due to the passage of time is recognised as or custom to sell or repledge the securities, in which case they long‑term, high quality corporate or government bonds issued in 190 191 Ukrainian hryvnias, significant judgement is needed in assessing appropriate cash‑generating unit. The assessment of whether there • Amendment to IAS 27 “Separate Financial Statements” (revised Management is currently evaluating the impact of the adoption an appropriate discount rate. Key assumptions are presented in are any indicators of a potential impairment are based on various 2011) – Investment entities; of Amendments to IAS 19 “Employee Benefits”, IFRS 9 “Financial Note 14. assumptions including market conditions, asset utilisation and the Instruments”, Amendments to IAS 1: Disclosure Initiative, • Amendments to IAS 32 “Financial instruments: Presentation” – ability to utilise the asset for alternative purposes. If an indication Amendments to IFRS 10 and IAS 28: Sale or Contribution of Assets Deferred tax asset recognition. The deferred tax asset, recognised Application guidance on the offsetting of financial assets and of impairment exists, the Group estimates the recoverable value between an Investor and its Associate or Joint Venture, Amendments in the consolidated statement of financial position, represents financial liabilities; (greater of fair value less cost to sell and value in use) and compares to IFRS 11, Amendments resulting from Annual Improvements Cycles income taxes recoverable through future deductions from taxable it to the carrying value, and records impairment to the extent the • Amendments to IAS 36 “Recoverable amounts disclosures for and IFRS 15 “Revenue from contracts with customers”. profits. Deferred tax assets are recorded to the extent that carrying value is greater than the recoverable amount. The value non‑financial assets”; realisation of the related tax benefit is probable. In determining For other Standards and Interpretations management anticipates in use is based on estimated future cash flows that are discounted future taxable profits and the amount of tax benefits that are • Amendments to IAS 39 “Novation of derivatives and continuation that their adoption in future periods will not have a material effect to their present value. The estimated future cash flows require probable in the future, management makes judgements and applies of hedge accounting”; on the consolidated financial statements of the Group in future management to make a number of assumptions including customer estimation based on historic taxable profits and expectations of periods. demand, production capacities, future growth rates and the • IFRIC 21 “Levies”. future taxable income that are believed to be reasonable under the appropriate discount rate. Any change in these estimates may result circumstances. Adoption of these Standards and Interpretations did not have in impairment in future periods. significant impact on the amounts reported in these consolidated Tax legislation. Ukrainian tax, currency and customs legislation The Group did not identified any indicators of impairment as at financial statements. continues to evolve. Conflicting regulations are subject to varying 31 December 2014. interpretations. Management believes its interpretations are Standards and Interpretations in issue, but not yet effective. At the appropriate and sustainable, but no guarantee can be provided Useful lives of other property, plant and equipment. Group’s date of authorisation of these consolidated financial statements, the against a challenge from the tax authorities (Note 21). property, plant and equipment, except oil and gas assets are following Standards and Interpretations, as well as amendments to depreciated using straight‑line method over their estimated useful Standards were in issue but not yet effective: Decommissioning costs. The decommissioning provision lives, which are based on management’s business plans and represents the present value of the decommissioning costs relating Standards/Interpretations Effective for annual operational estimates. to oil and gas properties, which are expected to be incurred in accounting period the future (Note 14). These provisions were recognised, based on The factors that could affect the estimation of the useful life of the beginning on or after Amendments to IAS 19 “Employee Benefits” – 1 July 2014 Group’s internal estimates. asset and its residual value include the following: Defined Benefit Plans: Employee Contribution Main estimates includes future market prices for the necessary • Changes in technology; Amendments to IFRSs – “Annual Improvements to 1 July 2014 IFRSs 2010‑2012 Cycle” decommissioning costs, and are based on market conditions • Changes in maintenance technology; Amendments to IFRSs – “Annual Improvements to 1 July 2014 and factors. Additional uncertainties relates to the timing of the IFRSs 2011‑2013 Cycle” decommissioning costs, which depends on depletion of the fields, • Changes in regulations and legislation; and Amendments to IFRS 7 “Financial instruments: 1 January 2015 future oil and gas prices and as a result – expected point of time, Disclosures” – Disclosures about the initial • Unforeseen operational issues. when there are no further economic benefit in the production. application of IFRS 9 Any of the above could affect the prospective depreciation of IFRS 14 “Regulatory Deferral Accounts” 1 January 2016 Changes in these estimates can lead to the material changes in the Amendment to IFRS 10, IFRS 12 and IAS 28: property, plant and equipment and their carrying and residual 1 January 2016 provisions recognised in the consolidated statement of financial Investment Entities: Applying the consolidation values. The Group reviews the estimated useful lives of property, position. exception plant and equipment at the end of each annual reporting period. Amendments to IAS 1: Disclosure Initiative 1 January 2016 Depreciation and depletion of the oil and gas assets. Oil and gas The review is based on the current condition of the assets and the Amendments to IAS 27: Equity Method in Separate 1 January 2016 assets are depleted using a unit‑of‑production method. The cost estimated period during which they will continue to bring economic Financial Statements of producing wells is amortised over proved developed reserves. benefit to the Group. Any change in estimated useful life or residual Amendments to IAS 16 and IAS 41: Bearer plants 1 January 2016 Licence acquisition, common facilities and future decommissioning value is recorded on a prospective basis from the date of the change. Amendments to IAS 16 and IAS 38: Classification 1 January 2016 of Acceptable Methods of Depreciation and costs are amortised over total proved reserves. Changes in estimates Latest review of useful lives was performed during the revaluation Amortisation regarding the volumes of production, proved developed reserves of property, plant and equipment performed as at 31 December Amendments to IFRS 10 and IAS 28: Sale or 1 January 2016 and total proved reserves either downward or upward, can result 2014 (Note 5). Contribution of Assets between an Investor and its in the change of related assets utilisation accounting. A reduction Associate or Joint Venture 27. ADOPTION OF NEW OR REVISED STANDARDS in proved developed reserves, as result of future inspections and Amendments to IFRS 11: Accounting for acquisitions 1 January 2016 AND INTERPRETATIONS of Interests in Joint Ventures production will increase depreciation, depletion and amortisation Amendments to IFRSs – “Annual Improvements to 1 July 2016 expenses. Adoption of new and revised International Financial Reporting IFRSs 2012‑2014 Cycle” Standards Impairment of property, plant and equipment. Management IFRS 15 “Revenue from contracts with customers” 1 January 2017 reviews the carrying amounts of assets to determine whether there The following standards have been adopted by the Group for the IFRS 9 “Financial Instruments” 1 January 2018 are any indicators that those assets are impaired. Latest review was first time for the financial year beginning on or after 1 January 2014: performed during the revaluation of property, plant and equipment • Amendments to IFRS 10, IFRS 12 and IAS 27 – “Consolidated performed as at 31 December 2014 (Note 5). Financial Statements, Joint Arrangements and Disclosure of In making the assessment for general impairment, assets that Interests in Other Entities: Transition Guidance”; do not generate independent cash flows are allocated to an 192 193 ADDITIONAL INFORMATION

TERMS AND ABBREVIATIONS

BCM — billion of cubic meters GAZ-SYSTEM S.A. — Polish gas transmission system operator NAFTOGAZ (NJSC NAFTOGAZ OF UKRAINE) — Na- STATE COMPANY GAS OF UKRAINE, GAS OF tional Joint Stock Company Naftogaz of Ukraine UKRAINE — a subsidiary of the National Joint Stock Company BP — British Petroleum, a transnational oil and gas, petrochemi- GDS — gas distribution station Naftogaz of Ukraine cal and coal corporation NAFTOGAZ OVERSEAS S.A. — Joint Stock Company Naf- GENERAL MEETING, GM — General Meeting of Sharehold- togaz Overseas S.A. (Switzerland) STATE ENTERPRISE ZAKORDONNAFTOGAZ, ZA- CDB — China Development Bank ers KORDONNAFTOGAZ — a subsidiary of NJSC Naftogaz of NEURC (PREVIOUSLY NERC) — National Energy and Utili- CABINET OF MINISTERS — The Cabinet of Ministers of GMS — gas measuring station Ukraine ties Regulatory Commission Ukraine GROUP — a group of companies that consists of NJSC Naftogaz SPF — State Property Fund of Ukraine NISS — National Institute for Strategic Studies under the Presi- CHP PLANT — combined heat and power plant of Ukraine, PJSC Ukrgasvydobuvannya, PJSC Ukrtransgaz, JSC dent of Ukraine SUBSIDIARIES — subsidiary companies of the National Joint Ukrtransnafta, SC Gas of Ukraine, SE Uktavtogaz, PJSC Chorno- CRIMEA — The Autonomous Republic of Crimea, a region of Stock Company Naftogaz of Ukraine mornaftogaz, OJSC Kirovohradgaz, SE Zakordonnaftogaz, PJSC OECD — Organization for Economic Co-operation and Develop- Ukraine currently occupied by the Russian Federation Ukrspetstransgaz, Naftogaz Overseas SA, SE Vuhlesyntez Ukraine, ment T — ton DHC — district heating company (same as “teplokommunener- SE Ukrnaftogazkomplekt, SE Naukanaftogaz, SE Naftogazobsluh- OJSC KIROVOHRADGAZ, KIROVOHRADGAZ — Open TCM — thousand cubic meters go”) ovuvannya, SE LIKVO, SE Naftogazbezpeka, SE Budivelnyk Joint Stock Company Kirovohradgaz, a regional gas distribution TEPLOKOMUNNENERGO — enterprises, producing heat DSNS, SESU — State Emergency Service of Ukraine GSE — Gas Storage Europe, the association of European opera- and supply company and energy, district heating comanies tors of underground gas storage facilities EBRD — European Bank for Reconstruction and Development OBLGAZ — a regional gas distribution and supply company TSO — transmission system operator GTS — gas transportation system EC — the European Commission PJSC UKRGASVYDOBUVANNYA — Public Joint Stock UGS — underground gas storage IEA — International Energy Agency Company Ukrgasvydobuvannya EFET — European Federation of Energy Traders UGV — Public Joint Stock Company Ukrgasvydobuvannya IFRS — International Financial Reporting Standards PJSC UKRSPETSTRANSGAZ, UKRSPETSTRANSGAZ — EGPC — Egyptian General Petroleum Corporation Public Joint Stock Company Ukrspetstransgaz URENGOY-POMARY-UZHHOROD GAS PIPELINE IAS — International Accounting Standards EIB — European Investment Bank (UPU) — the gas export route connecting the Urengoy gas field PJSC UKRTRANSNAFTA, UKRTRANSNAFTA — Public IMF — International Monetary Fund, a special UNO agency and northern gas fields of Western Siberia to Uzhhorod at the EU — the European Union Joint Stock Company Ukrtransnafta western border of Ukraine INTERCONNECTOR — a joint cross-border gas pipeline EUSTREAM — Slovak gas transmission system operator RUSSIA — the Russian Federation USD — United States Dollar LNG-TERMINAL — a liquefaction terminal, receiving and FGSZ — Hungarian gas transmission system operator RESOLUTION 510 — the Resolution of the Cabinet of Min- regasification of liquefied natural gas VTP — virtual trading point isters of Ukraine Resolution #510 of 03 September 2014 “On Im- FRONTERA RESOURCES — US oil and gas company MCM — million of cubic meters provement of State Policy in the Field of Regulation of the Natural WORLD BANK — the organization that provides assistance for GAS — natural gas, unless stated otherwise Gas Transportation Pipelines Through Ukraine” development ENERGY MINISTRY — the Ministry of Energy and the Coal GAZPROM — Public Joint Stock Company Gazprom, a Russian Industry of Ukraine RESOLUTION 583 — the Resolution of the Cabinet of Minis- energy company ters #583 of 03 March 2015 “On Establishment of Retail Prices for Natural Gas Used for the Needs of Households” 194 195 ADDITIONAL INFORMATION

CONTACTS

Naftogaz of Ukraine 6 B. Khmelnytskoho Street 6, Kyiv 01601 Ukraine Phone: +380 (44) 586-33-30, +380 (44) 586-39 63 e-mail: [email protected] , [email protected] web: www.naftogaz.com, www.naftogaz-europe.com https://www.facebook.com/NaftogazUA https://twitter.com/naftogazukraine

Ukrgasvydobuvannya Ukrtransnafta 26/28 Kudryavska Street, Kyiv 04053 Ukraine 18/7 Kutuzova Street, Kyiv 01133 Ukraine Phone: +380 (44) 461-27-23 Phone: +380 (44) 201-57-01, +380 (44) 201-57-76 e-mail: [email protected] e-mail: [email protected] web: www.ugv.com.ua web: www.ukrtransnafta.com

Ukrnafta Gas of Ukraine 3-5 Nestorivskyy Provulok, Kyiv 04053 Ukraine 1 Sholudenka Street 1, Kyiv 04116 Ukraine Phone: +380 (44) 503 0386, +380 (44) 506-10-03 Phone: +380 (44) 537-05-38 e-mail: [email protected] e-mail: [email protected] web: www.ukrnafta.com web: www.gasukraine.com.ua

Chornomornaftogaz Ukravtogaz 62 B. Khmelnytskoho Street, office 505, Kyiv 01601 Ukraine 2 Hryhorovycha-Barskoho Street, Kyiv 03134 Ukraine Phone: +380 (44) 220-14-64 Phone: +380 (44) 291-28-01, +380 (44) 291-28-05, +380 (44) 291-28-11 e-mail: [email protected] e-mail: [email protected] web: www.naftogaz.com web: www.ukravtogaz.com

Ukrtrnasgaz Ukrspetstransgaz 9/1 Klovskyy Uzviz, Kyiv 01021 Ukraine 3 Promyslova Street, Dolyna 03477 Ukraine Phone: +380 (44) 254-34-38 Phone: +380 (3477) 2-53-10, +380 (3477) 2-53-11 e-mail: [email protected] e-mail: [email protected] web: www.utg.ua web: www.ustg.com.ua NAFTOGAZ OFFICES ABROAD:

Office in the Arab Republic of Egypt Office in Hungary 3 A st. 259, New Maadi Cairo 11311 Egypt Népfürdő u. 22/B. 12. em. Phone: +201 272 47 77 72, +201 220 88 57 76 Budapest 1138 Hungary e-mail: [email protected] Phone: +36 (30) 630-45-56, +36 (30) 755-11-72 www.naftogaz.com, http://naftogaz-europe.com/en e-mail: [email protected] www.naftogaz.com, www.naftogaz.hu Office in the Kingdom of Belgium 40 Rue Breydel, Brussels 1040 Belgium Office in Turkmenistan Phone: +32 2 235-86-45, +32 2 235-86-44 ş.Aşgabat, Arçabil şaýoly, Biznes-Merkezi "ABC" e-mail: [email protected] Phone: +99 312 48 01 86, +99 312 48 03 10 www.naftogaz.com, www.naftogaz.eu e-mail: [email protected] www.naftogaz.com, http://naftogaz-europe.com/ru Office in the Russian Federation 24 Academyka Pilyugina Street, Moscow 117393 Russia Phone: +7 (985) 997 68 77 e-mail: [email protected] www.naftogaz.com, http://naftogaz-europe.com/ru 196