Gas Storage 0.4 2

HISTORICAL VICTORY AND THE BEGINNING OF TRANSFORMATION ANNUAL REPORT 2017 NAFTOGAZ FINANCIAL RESULTS 2017 DYNAMICS AND STRUCTURE OF THE GROUP'S REVENUE, UAH bn net cash flows from adjusted operating result net BY BUSINESSES operating activities (ОСF) of income taxes (NOPLAT) UAH bn

Gas production, import and sales to RSC's for 11.2 resale to households 16.7 1. Gas production, import and sales to RSC's for resale to households – 54.3/48.9 2. Gas production, imports and supply to MHE's for the needs of households – 22.8/18.9 227.5 3. Gas production, imports and supply to other customers under PSO – 7.8/4.6 Gas transit 38.3 2017 4. Gas imports and supply to other customers outside PSO – 4.1/12.9 11.9 5.9 Oil and gas condensate sales 192.8 4.6 2016 3 4 Gas production, imports and supply to MHE's for 1.2 the needs of households 3.2

Petroleum products sales 1.6 2.8 Gas domestic transmission 3 89.0 Oil transit 1.4 1.6 and storage Gas production, imports 2.3 and supply to other customers under PSO 1.3 2 Gas business 1 2 Gas imports and supply to other customers 2.8 outside PSO 0.4 25.0 -4.9 Gas domestic transmission 14.8 0.003 85.3 1 Oil domestic transmission -0.2 -0.6 1. Gas domestic transmission – 24.8 /14.7 Gas storage 0.4 2. Gas storage – 0.2 /0.1 -0.3

Other 0.9 -0.1 Oil and petroleum products transmission GROUP’S NET PROFIT RECONCILIATION FOR 2017 and sales 73.9 UAH bn Without positive effect of Gas Transit 4 Arbitration, the group would incur net loss 3 of UAH 7.4 bn* for 2017 Gas transit 34.8 12.6 9.1 60.0 1 41.5 39.4 -6.7 28.0 2 -3.4 -13.1 -0.6

1. Petroleum products sales – / NOPLAT Net result Finance Impairment of Deferred Current Other Net 18.1 13.5 of Gas Sales and income/ property, plant and income income tax profit 2. Oil and gas condensate – 12.9/11.1 Gas Transit (expense) equipment tax benefit expense** 3. Oil transit – 3.6/3.3 Arbitrations Other 4. Oil domestic transmission– 0.2/0.1

*Net profit of UAH 39.4 bn adjusted for income recognised per results of Gas Transit Arbitration of UAH 57.1 bn and related income tax 4.9 expense of UAH 10.3 bn. **Current income tax expenses consist of taxable income less allowed deductible expense both from operating and non-operating activities taxed at 18%. 4.7 CONTENT

INTRODUCTION CORPORATE GOVERNANCE Statement of the chairperson Corporate governance �� 144 of the supervisory board ��8 Report of Naftogaz supervisory board 2017 �� 146 Statement of chief executive officer ��9 Executive board structure and remuneration �� 154 Risk management at Naftogaz group ��157 OUR MARKET AND REFORMS Macroeconomic environment: trapped by old institutional problems ��14 OUR RESPONSIBILITY Human resources �� 162 European natural gas market ��22 Company occupational and safety policy ��170 Global oil market ��34 Contribution to the social development of Histrorical victory for Ukraine: local communities ��177 Stockholm Arbitration ��44 Energy efficiency �� 185 Unbundling of gas transmission function ��48 Ecology and environment protection ��190 Liberalization of gas supply to household consumers, PSO and subsidies system ��51 Important regulatory changes ��56 FINANCIAL STATEMENTS Auditor’s qualifications and related comments �� 201 OUR PERFORMANCE Consolidated Financial Statements ��202 Businesses of Naftogaz group ��62 Independent Auditor’s Report ��204 Sales to regional gas supply companies for Consolidated statement of financial position �� 208 the needs of households ��66 Consolidated statement of profit or loss ��209 Gas production, imports and supply to Consolidated statement of comprehensive income �� 210 MHE's for the needs of households ��71 Consolidated statement of changes in equity ��211 Gas production, imports and supply to other customers under PSO �� 74 Consolidated statement of cash flows ��212 Gas imports and supply to other customers outside PSO ��77 Gas business: performance summary �� 81 Oil and gas condensate ��90 ADDITIONAL INFORMATION Determining report content Gas transit ��96 and significant aspects ��272 Gas domestic transmission ��104 Company disclosures required by law ��278 Underground gas storage ��110 Terms and abbreviations ��282 Oil transit and domestic transmission ��115 Material topics under GRI Standard ��284 Petroleum products sales ��124 Contacts ��289 Analysis of other activities �� 130 Procurements by Naftogaz group companies in 2017 �� 138

5 Courage: We believe that determination is better than resigna tion. Naftogaz can stand its ground even when faced by far larger opponents. We do not quietly accept injustices and prefer to call things by their proper names. Naftogaz is not afraid of change and seeks to serve as a model for both the public and private sectors

Openness: We work honestly and openly. We believe that this approach prevents corruption and encourages effective co operation in the market as well as within the company itself. Transparency is key to earning the trust of Ukrainians for whom we generate profit

OUR MISSION IS TO BECOME THE DRIVING FORCE FOR Conscientiousness: We believe that each team member should MODERNIZATION AND have their share of responsibility for the result. Naftogaz PROFESSIONALISM IN THE appreciates good work, a willingness to act, initiative and honesty UKRAINIAN ENERGY SECTOR INTEGRATED WITH THE EUROPEAN MARKET, ENSURING SECURITY OF Fairness: Naftogaz is a national company and important con ENERGY SUPPLIES AT COMPETITIVE tributor to the common good. We stand for equal opportunities, PRICES WHILE MAXIMIZING THE targeted support for those who need it most, and for adequate remuneration for those who take on responsibility and deliver MISSION AND VALUES VALUE OF NATIONAL RESOURCES outstanding results. We believe this is reasonable and fair

6 7 STATEMENT OF THE CHAIRPERSON STATEMENT OF CHIEF EXECUTIVE OF THE SUPERVISORY BOARD OFFICER

Our goal is to transform Naftogaz into an efficient and profitable European energy corporation

The new supervisory board was of progress in completion of Our historical victory over WHAT WAS DONE elected in December 2017, at the corporate governance reform. Gazprom in the finale of IN 2014-2017: very end of this reporting year. We, as the new board, took the Stockholm arbitration our appointments on a clear proceedings was definitely the 1. Zero tolerance towards In brief, the working of the promise and commitment of major event in 2017-2018. corruption and transparent supervisory board and its the shareholder that matters We have eliminated Gazprom’s procurement committees in 2017 focused pertaining to delegation of claim to pay more than on the issues which are a required competencies to USD 56 billion for gas that The fight against corruption primary need of any national supervisory boards of Ukrainian we did not actually buy in was our priority when we oil and gas company: corporate state-owned enterprises will be 2009-2017 and have been started as a new management strategy, long-term planning, promptly and properly resolved. awarded nearly USD 4.7 billion team in spring 2014. We cut liquidity, increase of domestic in compensation. Four years off unnecessary intermediaries production and last but not Unfortunately, as of the date of of effort removed the risk from gas imports and wholesale least – preparation of Naftogaz this report, things are still where of bankruptcy and debt, operations and changed group for the unbundling of the they started and as a supervisory which would have equaled the procurement system to transmission business. We know board we lack efficient tools to three quarters of Ukraine’s encourage producers rather how much progress has been bring Naftogaz and its group annual GDP if the take-or- than resellers to participate in made on these and many other companies to where they pay provision had not been our tenders. Naftogaz initiated matters due to joint efforts of the need to be. However, we are canceled. litigation to restore its position supervisory and executive boards determined to complete the where diverse “partners” of the bringing the company and reform and govern the company However, the opportunity former government have been Naftogaz group to where they and Naftogaz group to increase to appeal successfully to parasitically engaging our assets were when we joined. their value for the benefit of the international arbitration for years. Naftogaz was one people of Ukraine. over four years would have of the first participants in the Unfortunately, having invested been impossible without a ProZorro e-procurement system a lot of time and effort in number of steps made by and remains one of the system’s these complex matters, the Naftogaz and the Ukrainian biggest buyers. We have started previous supervisory board Chairperson of the government. I would like to disclosing an unprecedented resigned at the end of the supervisory board emphasize the most important amount of data regarding our reporting year due to the lack Clare Spottiswoode actions. operations.

9 2. Diversification of gas routes GAS MARKET REFORM MUST What we have achieved and what has changed in the past four years and suppliers CONTINUE Having won the trust of Western Before Now partners and creditors, we man- Our objective is to fully aged to open the Slovak route integrate the Ukrainian Gazprom was the only source of imported gas for Ukraine. For about 950 days, we have been living without Russian gas gas market into the Naftogaz used to be a debtor to Gazprom and Ukraine was forced supplies. Naftogaz is able to purchase gas on transparent and find alternative suppliers and into political concessions in order to maintain gas supply. non-political terms and conditions from dozens of large Western funds for purchasing gas in record European market and companies that compete with each other. short time. We would not have transform Naftogaz into Gazprom owes Naftogaz USD 2.6 billion. been able to finalize the arbitra- a powerful and efficient European energy company. Naftogaz used to be a black hole in the Ukrainian state budget. The Naftogaz got rid of corrupt intermediaries, demonstrated record tion process without this progress. state has spent tens of billions of dollars to support the company, profits and is the largest source of revenues to the state budget, but much of that money has been stolen due to inefficiency and providing about 15% of state revenues in 2017. 3. Kick-starting European-style Ukraine has made significant corruption in which senior politicians were involved. gas market reform progress in gas market reform, but changes need to be finalized in all Being a guaranteed supplier, Naftogaz automatically satisfied the Naftogaz provides gas only for social consumers, the segment Wholesale gas import and sales market segments. needs of all customers regardless of status or solvency. of commercial consumers has been liberalized. are now open for competition in Ukraine. The segment has already The first and the most important Gas production was funded by the residual principle, because The price of gas for production units increased, though not up been integrated into EU markets. precondition for Ukraine’s Naftogaz had to buy significant volumes of gas from Gazprom at an to the market level. Naftogaz transfers more than 98% of the Dozens of new players, success in the gas sector is the overcharge price, and the sale price to households was 85% lower gas selling price. including major European elimination of corruption in gas than the purchasing price. and global gas suppliers, have supply for households and the entered the Ukrainian market Accordingly, an extremely low price was set for gas produced by For the first time in many years, Ukrhazvydobuvannya received establishment of a transparent Naftogaz, which, coupled with corruption in procurement, led to a new licenses and reached a record level of daily extraction for and are competing. Leading competitive market in this decline of the mining units of the group and the depletion of its the last 24 years. producers from the US, EU and segment. resource base. China are participating in tenders announced by Naftogaz. Presence A significant part of the group’s output was taken by so-called joint Due to a dramatic change in the procurement system, billions The second precondition is the venture partners who accessed the "partnership" through their po of hryvnias were saved. New suppliers and manufacturers now of these players is the best way completion of TSO unbundling litical relations, failed to fulfill their investment obligations, and most participate in tenders. to ensure irreversible reforms and in a way that would ensure probably were involved in siphoning off money. All joint venture agreements have been challenged in court, diversification. significant use of the system’s seven out of eight have already been terminated, and gas is capacity and non-discriminatory diverted to the needs of households. 4. Corporate governance reform access for all players. LPG was sold at a low price on the single exchange then controlled LPG is sold at auctions. according to OECD standards by the state’s leadership. Naftogaz is the first Ukrainian The third precondition for success is the completion of Shebelynka refinery carried out only the basic oil refining process. Shebelynka refinery has been modernized and switched to the state-owned enterprise with production of Euro-5 fuels. a professional independent corporate governance reform at supervisory board. Though yet to both Naftogaz and other SOEs. be fully empowered, it has already Purchases of works, goods and services in Ukrtransgaz were Ukrtransgaz joined ProZorro's purchase system. With the facilita become an effective barrier to NAFTOGAZ HAS TO BE non-transparent. tion of the General Prosecutor’s Office, Ukrtransgaz managed to corruptive political interference in TRANSFORMED get rid of duty to pay for goods under a fictitious agreement. Naftogaz’s operations. The state of filling the UGS was unclear, which gave grounds for The information on the company's website about residual An integrated Naftogaz leads Gazprom manipulation. volumes of gas in the underground storage facilities is updated Perhaps for the first time in the his- straight to the creation of a on a daily basis. tory of Naftogaz, its management capital market in Ukraine and is pursuing the interests of the its growing welfare. The loan agreement with the EBRD and the EIB to upgrade the The loan agreement with international financial institutions has Urengoy–Pomary–Uzhhorod pipeline (UPU) has been blocked for been concluded. The German concern Ferrostaal has begun company and its ultimate owner – more than five years. reconstruction of the Bar station, with financial support via the Ukrainian people – rather than Naftogaz is currently representing a loan from Deutschebank. the interests of financial-industrial Ukraine’s interests in the oil and groups, politicians, or other vested gas sector. It is an effective tool Naftogaz was able to influence the work of the transmission The unbundling process was launched to separate interests. This shift paves the way to for the government during mar- system operator and other market players the TSO function. achieving previously unattainable ket reform, ensuring reliable gas results in arbitration, courts, pro- supply. Naftogaz did not resist the construction of by-pass gas pipelines, Naftogaz takes every opportunity to defend its interests in the curement, fundraising fundraising did not implement the reforms required to get the EU support and European market, including relations with Gazprom and coun- deliberately lost the litigations initiated by Gazprom. teractions related to the bypass gas pipelines. and development of the group’s Ukraine needs investments and assets. new technologies to unleash its potential in the energy sector. But it’s just the beginning. The experience of other countries

10 11 shows that the engagement of of Naftogaz as a state-owned powerful international players enterprise, but also to trade its in joint projects is yet another shares using them as a personal guarantee of political support and investment tool. OUR MARKET AND security. We believe that the development A transformed and powerful of a capital market in Ukraine Naftogaz will help Ukraine to is key to fueling substantial REFORMS achieve this goal, as potential economic growth, which implies investors and creditors are more bet-ter quality of life for all willing to engage with big and Ukrainian citizens. stable national players. Over the past four years, we have Being an integrated national completed a business turnaround company, Naftogaz is also a and achieved much. The next noteworthy and natural partner step is to transform Naftogaz for international oil and gas into a transparent and effective companies and professional national corporation that will investors from other countries. serve as a role model for others and drive Ukraine’s economic We have set ourselves an growth. It is a big goal worth ambitious goal to prepare every effort. Naftogaz for IPO within the next several years. While the ultimate I would like to thank the team decision on the placement lies of Naftogaz group for their hard within the competence of the work in line with our core values, Cabinet of Ministers of Ukraine which are courage, openness, and the Verkhovna Rada of conscientiousness and fairness. Ukraine, it takes much time and I believe that our corporate goals changes within Naftogaz to make can be achieved exclusively by the company IPO-ready. We have the team with common values. begun this process. We appreciate the attention and Naftogaz’s IPO may be held support from all who care about simultaneously on one of what we are doing. We believe the major international stock that common values and deter- exchanges and in Ukraine if the mination to develop our country government decides that it is enable us to achieve the most viable and the market conditions ambitious goals. are favorable. In that case, all Ukrainians will be able to be CEO not only the ultimate owners Andriy Kobolyev OUR MARKET AND REFORMS ANNUAL REPORT 2017 MACROECONOMIC ENVIRONMENT: Real GDP growth rate estimate in 2017, % Average growth rate in 2014-2017 in the recent 10 years TRAPPED BY OLD INSTITUTIONAL Global economy 3.62% 3.45% 3.33% PROBLEMS Developing countries 4.64% 4.48% 5.07% European developing countries 4.50% 4.05% 3.46%

Developed countries 2.17% 2.03% 1.20% • Ukraine's real GDP has been • The country's economy • The risk of rising inflation, growing for the second remains weak frozen military conflict, EU 2.34% 2.12% 0.84% consecutive year – however negative demographic the pace is very slow, so • International partners note trends and the risk of Ukraine 2.50% –3.03% –2.05% gap between Ukraine and the problems related to activating populists on developed countries – as the pace of reforms and the eve of a new political Source: IMF, State Statistics Service of Ukraine, calculations by Naftogaz of Ukraine well as most of developing perceptions of corruption cycle countries – is increasing A crucial gap between Ukraine economies of comparable areas shows that Ukraine by these and the EU can be seen if its and population such as Spain indicators is more comparable In 2017, the price situation on the main commodity markets of Ukrainian exports improved economy is compared with the and France. The chart below to some countries in Africa (due to an increase in average annual prices for steel, iron ore and grain), while domestic demand was supported by the restoration of expenditure of the public administration (and loosening of fiscal policy) and the maintenance of high rates of nominal wage growth. Population, area and GDP comparison of European and African countries

90 Average annual price index of key Ukrainian export products

320 The size of the bubble France 60 corresponds to 300 nominal GDP in 2017 Kenya Spain Ukraine 280 Morocсo Population, million Population, +21% 30

260

240 0 0 400 800 220 Country area, thousand sq. km 01.01.15 01.01.16 01.01.17 African countries European countries

Source: Thomson Reuters, State Statistics Service of Ukraine, calculations by Naftogaz of Ukraine Notes: The index is calculated as the weighted average price of key products exported by Ukraine (iron ore, steel, wheat and corn). The weights used for Source: IMF, UN, CIA factbook, State Statistics Service of Ukraine calculation corresponded to the share of relevant products in the total export of goods.

Despite these factors, real developing countries. Taking remain unsatisfactory. An than European countries. This remains a small economy, is one future growth rates of real GDP GDP increased by only 2.5% into account that in the last 10 increase in GDP of 2.5% per gap can be seen, if Eastern of the poorest in comparison are not enough to overcome in 2017 – that is, the growth years the Ukrainian economy year is not sufficient to close Europe and the CIS countries with other European countries, Ukraine's current lag in the rate of the Ukrainian economy decreased on average 2-3% the gap between the economy are observed, which are often and is at high risk of increasing medium-term. According to IMF was slower than the growth annually (while all other regions of Ukraine and the EU and, compared to our economy. this gap if Ukraine's current forecasts, Ukraine's real GDP rates of the global economy of the world grew), the growth consequently, between the The data presented on the economic growth does not will grow by an average of 3.7% in general, and in particular, rates achieved in 2016-2017 relative standards of living. chart below shows that Ukraine improve. Even the expected every year during 2018-2022,

14 15 OUR MARKET AND REFORMS ANNUAL REPORT 2017 which is similar to the world Under such conditions, the share in the global economy Ukraine’s sovereign debt (including guaranteed debt) repayment time schedule for 2018-2021, economy as a whole, but much Ukrainian economy can be decreased from 1% in 1992 to USD billion lower than the expected growth referred to as an example of the less than 0.3% in 2017. 4.5 rates for developing countries. so-called "growth disaster" – its 4.0 3.8 3.4 3.4 The gap between the Ukrainian economy and its peers 3.5 3.2 2.9 3.0 3.0 2.9 8 2.7 2.5 7 1.9 2.0 1.8 1.8

6 Poland The size Kazakhstan 1.5 Romania Slovakia of the bubble Belarus Turkey 1.0 0.8 5 corresponds to 0.6 the population of 0.5 Hungary 0.5 0.3 4 the country Russia 0 3 Q1 Q2 Q3 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 as per PPP, 1992-2017, % 1992-2017, as per PPP, 2018 2019 2020 2021

Average GDP growth rate per capita rate growth GDP Average 2 Interest payment Loan payment Bond payment Ukraine 1 Source: Bloomberg (as of 11.04.2018), calculations by Naftogaz of Ukraine

0 5 000 10 000 15 000 20 000 25 000 30 000 35 000 For 2017 and early 2018, the corresponding inflow of capital, • Ratings of populist minded poli- persistence or even exacerbation acceleration of economic growth tician grew up. GDP per capita per PPP, USD of other problems for the and revaluation pressure on the Source: IMF, UN, State Statistics Service of Ukraine, calculations by Naftogaz of Ukraine Ukrainian economy was observed, hryvnia. Instead, an escalation in Low rates of implementation Source: 2017 S&P Global Platts Top 250 Global Energy Company Rankings, Naftogaz including those that influenced hostilities could lead to worsening of structural and institutional Naftogaz group operations: expectations and negative socio- reforms in the country and, • Inflationary pressures remained economic implications. consequently, low economic Given the small size of the high corruption perception car- international donors, and a lack significant. Consumer inflation in economy and its low growth ries considerable risks of reversal of progress in the areas specified 2017 amounted to 13.7% yty and rates, several statements by of the reforms achieved. The only by them may lead to disruption Total Ukrainian population aged 15-70 and the share of Ukrainian thus exceeded the target of the international partners of Ukraine solution is ensuring the rule of of cooperation with them. In turn, migrants3 NBU by 8% ± 2 pp. at the end of pronounced in 2017 are relevant. law of the country. This will help this will increase sovereign risk, the year. In view of the strength- The IMF and the US Department eliminate high transaction costs in will negatively affect the percep- ening of inflationary risks in the 40 of State noted that the problem the economy, create a favorable tion of Ukraine's development 35.4 fourth quarter of 2017, the NBU 34.1 of corruption perceptions remains investment climate, and stimulate by investors in terms of Ukrainian 2 switched to tightening monetary 28.8 a significant obstacle to ensuring domestic investment demand. companies entering European (estimate) policy, raising the discount rate 30 economic growth and improving markets, and would limit the twice. living standards in Ukraine. In Position of these organizations opportunities for Ukrainian com- • The labor market still their statements1, they noted that is relevant, in particular because panies to enter the international experiences imbalances between Total Ukrainian fighting corruption is necessary to Ukraine, due to significant repay- capital market in 2018 (despite 20 supply and demand and there population aged ensure sustainable and equitable ments of sovereign debt in 2018- the return of Ukraine to the Euro- was an increase in migration 15-70, million economic growth. The problem of 2020, remains dependent on bond market in September 2017). persons processes, which also stimulated +3.5 10 further wage growth despite (estimate) Share of migrants maintaining a high level of 4.2 3.4 4.5 in the Ukrainian unemployment. population aged 0 15-70, % 1 See, for example: • Continued Russia's armed • https://nv.ua/opinion/Yovanovich/muzhestvo-dvihatsja-vpered--2443217.html aggression and occupation of the Survey period Survey period Survey period • https://www.state.gov/r/pa/prs/ps/2017/12/276235.htm from 01.01.2005 from 01.01.2010 from 01.01.2015 part of Ukraine's territory. In the • https://www.imf.org/en/News/Articles/2017/12/07/pr17473-ukraine-imf-statement-on-the-efforts-to-fight-corruption tо 01.06.2008 tо 17.06.2012 tо 18.06.2017 • IMF, “Ukraine: Selected Issues”, April 2017 case of favorable developments for 2 According to a study by the European Business Association, the main obstacles to investing in Ukraine are still corruption, insecurity of property rights, state Ukraine (and institutional reforms capture by oligarchs and the war in the east. For more details see. http://ces.org.ua/en/wp-content/uploads/2017/09/2017_InvestorSurveyResults.pdf. Economic inside the country), the reduction Source: SSSU, Institute of Demographics and Social Policy named after Ptukha of the NAS of Ukraine experts expect all these obstacles to remain even if they do not increase in 2018. In the expert environment, it is also noted that there is a significant risk that of the risk premium would increase pre-election populism will add to these obstacles, which will lead to an increase in the budget deficit and inflation (with a corresponding devaluation pressure on 3 Since 2014 – without AR Crimea and the city of Sevastopol, since 2015 – without certain areas of Donetsk the hryvnia). investment attractiveness with a and Luhansk regions.

16 17 OUR MARKET AND REFORMS growth rates affect the activities Revenue of the biggest global oil and gas companies and of the oil and gas sector and Naftogaz group, USD billion Naftogaz group. Given the small size of the Ukrainian economy, it Sinopec 284 becomes more understandable why Naftogaz group has such 238 a large share in the Ukrainian PetroChina economy (providing 14% of the state budget revenues and Shell 234 a contribution to GDP at the level of 6-7% in 2017). This is Exxon Mobil 198 not because Naftogaz group is a large company comparable BP 183 to international integrated oil and gas companies, but TOTAL S.A. 128 reflects the fact that Ukraine's economy is relatively small. Gazprom 107 As far as Naftogaz group is concerned, it remains much Chevron 103 smaller than the leading global oil and gas companies, and is LUKOIL 92 more comparable to national companies of a relatively small Rosneft 84 size. Naftogaz group 7 International organizations emphasize weak progress in institutional reforms in Ukraine. Source: 2017 S&P Global Platts Top 250 Global Energy Company Rankings, Naftogaz An example is the response of international organizations the preservation of political opposition to gas market and creditors to the demarche influence on the company, the reform, including the failure to of Naftogaz supervisory board lack of progress in the corporate approve the corporate strategy in September 2017, caused by governance reform, and the of Naftogaz group.

Timeline about setback in reforms

Naftogaz's supervisory board EBRD limits access to Energy Community Independent Charles to VPM Kistion regarding their the loan because of Secretariat to VPM directors of Proctor’s intention to resign due to unapproved financial plan Kistion regarding Naftogaz to resignation lack of progress of corporate and delays in corporate Draft Law 6778 and V. Kistion note governance reform governance reform unbundling resignation note

April July August September 2017 2017 2017 2017

Energy Community Secretariat IMF's First EBRD President EBRD's president to President and World Bank regarding the Deputy Chairman regarding lack of of Ukraine Poroshenko monopolization of gas supplies to regarding risks progress in the regarding lack of progress of households and setback in of setback of reform of state- corporate governance reform Gas market law impelemenation IMF program owned enterprises

18 UKRAINE’S GAS BALANCE 2017 bcm

8.7 5.4 1.9** 0.5 9.3 11.2 4.6*** Naftogaz Private Heat producers Public sector Industrial Households Heat producers importers for public sector, and religious consumers (direct use) for households from Europe religious organizations, organizations industrial sector

14.1 Imports 27.5 Gas consumed 34.6 31.9 by users Sources Gas 15.8 of gas usage Households 20.5 Production 4.4 Operating needs

15.3 4.1 1.1 2.7 0.1 0.3 0.8 1.0* 2.2 Ukrgazvydobuvannya Other Ukrnafta UGS stock change Other Ukrnafta UGV Gas Ukrtransgaz distribution networks * including unauthorized gas withdrawals (≈0,8 bcm) ** including unauthorized gas withdrawals (≈1 bcm) *** Source: NJSC Naftogaz of Ukraine Gas Sales Department OUR MARKET AND REFORMS ANNUAL REPORT 2017

In 2017, LNG supplies to EU Dynamics of LNG supplies and prices countries increased on average on the Asian market in 2017 EUROPEAN NATURAL GAS by 5%. At the same time, the seasonality trend of supplies 1 600 12 and their dependence on prices 1 400 10 MARKET on the Asian market continued, 1 200 8 which in turn does not allow LNG supplies to compete fully 1 000 6 In early 2017, due to weather EU gas production with pipelines on the European 800 4 factors, a sharp increase in the market. 600 2 volume of pipeline imports began 14 400 0 in the European market, which 13 Last year, the global supply of July May

LNG increased by 38 bcm or 11% June according to the results of Q1 12 April March August January due to the launch of new gas October of 2017, increased by about 9% 11 February December November liquefaction projects in Australia September compared with the same period bcm 10 LNG supplies, TWh (left axis) in 2016. This trend persisted 9 and the United States. However, 4 Spot price of LNG on the Asian market, USD/MMBtu (right axis) throughout 2017 . 8 LNG spot prices in Northeast 7 Asia grew significantly above Gas stored in the EU UGS It should be noted that the 6 2016 levels as China, which is increase in demand for natural now the second largest liquefied 1 000 July May June gas in Europe and the growth April natural gas consumer in the 900 March August January October February February world, absorbs huge volumes 800 December in consumption resulted in a November September further increase in the share of supplies under an intensive 700 of natural gas from Russia in 2016 2017 program of coal substitution for 600 the total volume of imports to gas in contaminated and densely TWh 500 European countries. Gazprom EU gas gross imports populated cities along the eastern 400 has a monopoly right to export coast of the country7. 300 200 gas from Russia through piplenes 70 100 and remains the main supplier 60 After steadily high supplies of of natural gas to European LNG from the North African 0 50 1 27 53 79 105 131 157 183 209 235 261 287 313 339 365 5 countries in Q1 2017, they countries . 40 days

bcm dropped by 30% compared in Q2 30 2016 2017 Russia is projected to continue and Q3 2017 compared to the strengthening its dominant 20 same period in 2016. This trend position in the coming years, 10 is driven by a combination of while Norwegian natural gas 0 factors, namely the high prices northeast of China supported the period of 20168, which led to an production will decrease. The of natural gas supplied by North demand for LNG and triggered a increase in demand for imported July May June April

March African countries under long-term annual volume of production of August significant rise in prices by 85% natural gas supplies in the spring- January October February February December November several key natural gas deposits in September contracts with anchoring to the from USD 6.05/ MMBtu at the summer period. The gas injection Norway – Ormen Lange, Asgard 2016 2017 price of petroleum products, as end of August to the three-year to the UGS started earlier than and Quietbjorn – is expected well as a more favorable price for maximum of USD 11.20 / MMBtu usual, but due to the low level to decrease by 2020 by 10 bcm LNG during the specified period. by the end of 2017. of filling at the end of the compared to 2017. To some Gas imports to EU by the country of origin in 2016-2017 heating season as of the end of extent, this trend will be offset From September to the end of We should specially consider September 2017, the filling level by an expected increase by 8.6 2017, the spot price of LNG in the situation that has arisen was about 90% of the indicator 13% 13% billion in gas production at Asta the Asian market was gradually with the use of gas volumes in for the corresponding period of Gastin field6. increasing, despite the new offer underground storage facilities 2016. 14% 13% from the US terminals (Sabine) (UGS). During the winter, as

4 46% 47% and the start of supplies from Eurostat. Supply of gas – monthly data 2016 2017 a result of long-term low- The price situation on the main [nrg_103m] Australia (Wheatstone) and the temperature regimes, higher European hubs during the 5 Based on data from the Reuters Eikon (total Russian Yamal project. Lower air pumping rates of natural gas summer months has encouraged 27% 27% monthly European import GWH/D). The share temperature in Q4 2017, nuclear from UGS for use in the energy market participants to postpone of Russian Federation is calculated as a sum of supplies through the main pipelines, and power plant accidents in South sector were observed. At the end their plans for increasing supplies to Poland. Korea, and the intensive coal of the heating season, the UGS 6 Rystad Energy https://www.rystadenergy.com/ Russia (Gazprom) Norway North Africa substitution policy for gas in the filling level was about 25%, which 8 Reuters Eikon. (daily stock levels UK,SLO, POL, newsevents/news/press-releases/Norway- is 10% less than for the same POR, NLD, ITA, HUN, FRA, ESP, DK, DEU, CZE, BUL, Russia-gas-volumes/ LNG (Europe, Africa, Аsia, USA) 7 LNG OUTLOOK 2018 Reuters BEL, AUT)

22 23 OUR MARKET AND REFORMS ANNUAL REPORT 2017 pumping volumes, since in Relative dynamics in prices for natural gas in TTF hub point of view of supplying trends in the European markets by Naftogaz and will require summer the price for gas with in 2016-2017 (TTFD1 price as of January 1, 2016 and 2017 = 100%) natural gas for the needs of will complicate the process continuous analysis and delivery on the next day (day- Ukrainian consumers and of choosing a strategy for adjustment of the pricing ahead) included a premium to 140 filling Ukrainian UGS, such the purchase of natural gas mechanism. the price of forward contracts. 130 The effect of “deferred” demand 120 has led to increased demand 110 for natural gas for injection in Gas transit to the European market the UGS in the autumn and the % 100 9 90 relevant level of price support . According to the European 80 Gas transit volumes through the territory of Ukraine, Commission in 2017, the volume 2014–2017 Changes in the European energy 70 of gas transit to the EU was market, which will continue to 60 as follows: Ukraine 44% (43% 100 have an impact on the natural 50 in 2016), Nord Stream – 30%

gas consumption volumes and July May June April (28% in 2016) and Belarus 24% 80 March August January transport flows, include the October February February (26% in 2016). The volumes December November following: September transported through Ukraine 60 – As a result of lengthy 2016 2017 that are traditionally the main 62.2 67.1 82.2 93.5

source of Russian gas supplies bcm/year discussions in Italy, a 40 legislative act (Italian Energy Changes in prices for natural gas on TTF hub in 2017, EUR/MWh to the EU, increased in 2017 Strategy) was adopted by 14% compared to 2016. 20 which states that by 2050 25 2.5 Supplies through Nord Stream increased by 17%, and transit the country intends to 2.0 decommission all coal power supplies through Belarus rose by 0 20 1.5 generation capacity. 6%. Utilization of Nord Stream 2014 2015 2016 2017 1.0 was nearly 87%, with 130 days - The countries in the Baltic 15 0.5 when it reached almost 100%. region have taken another Physical flows in points/ pipelines: Greifswald/ OPAL and 0 The pipeline was out of service Uzhhorod /Velké Kapušany (SK) step towards the creation of 10 during 10 days in September a competitive and liberalized –0.5 for scheduled maintenance. 2 500 market. Lithuania, Latvia and 5 –1.0 Moreover, in 2017, the EU court Estonia have established a –1.5 allowed using full capacity of common regional exchange, 2 000 0 –2.0 OPAL pipelines, which transmits where the market participants gas from Nord Stream to the July May June are able to trade on natural April 1 500 March August Czech Republic. This increased January October gas on a daily basis and on February December November September utilization of Nord Stream. Yamal a monthly basis and use this pipeline was more than 96% 1 000 tool for balancing. Finland TTFD1 premium to the price with delivery in the next month (right axis) loaded, going lower than 90% intends to join this platform by only during maintenance in TTFD1 price with delivery on the next day (left axis) 500 2020. summer and being almost fully TTF price delivery in winter 2017 (left axis) - Starting from 1 October 2017, stopped in July 2017 because of the Trading Region Upgrade poor quality of gas at the entry to 0

(TRU) project, which aims Poland. . 2017 11 . 2017 12 . 2017 10 . 2017 02 . 02 .

to create a single market for capacity of regasifying LNG oil and coal prices will support 02 . 02 . 07 02 . 01 2017 02 . 01 2018 02 . 2017 02 . 03 2017 02 . 05 2017 02 . 04 2017 02 . 06 2017 02 . 09 2017 02 . 08 2017 natural gas in Austria and the plants in France today is about the price of natural gas on the The volume of gas transit Czech Republic, entered the 37 bcm / year. main European hubs in 2018. through the territory of Ukraine Greifswald/OPAL Uzhgorod (UA) – Velké Kapušany (SK) pilot phase. The proposed Taking into account planned in 2017 reached a record high for mechanism will allow the Major fundamental factors stops for the maintenance the last 6 years and amounted to market participants to trade gas such as the low level of filling of natural gas pipelines from 93.5 bcm of natural gas, which the entry point to the Ukrainian Ukrtransgaz should involve through virtual supply points, of underground gas storage Russia in July 2018 and the is 14% more than in 201610. GTS. Such an approach used by additional production resources passing Slovakia. facilities in Europe at the technical limitation of natural This high result is even more Gazprom regarding the creation and incur unplanned expenses. valuable, given the fact that of daily requests for transit Meanwhile, average utilization - The Dunkirk LNG terminal in beginning of the filling season, gas production in Norwegian Gazprom failed to comply with of gas through the territory of the Ukrainian route was 54%, France began operations in uncertainty about production deposits, significant price contractual pressure levels at of Ukraine is contrary to the with daily fluctuation between January 2017. The total volumes in the Netherlands, fluctuations that are generally the steadily growing demand typical for the summer season terms of the existing contract, 35% and 70%. Average utilization 9 Reuters Eikon. for natural gas, and high world can be expected. From the 10 Data of Ukrtransnafta. and for its implementation of the major transit direction

24 25 OUR MARKET AND REFORMS ANNUAL REPORT 2017

(entry point to Slovakia) made up Dynamics of share of the natural gas transit routes early October. At that time, gas 73 GW) a year in the long run 2016, the number of importers 52% fluctuating between 25% from Russia in 2016-2017, % volumes transported through the (until 2039) was purchased at who competed with Naftogaz and 71% of maximum capacity, NEL and OPAL pipelines increased the auction14. Natural gas will be increased to 33. This growth while the southern direction was 80 during the last days of September received from the Nord Stream 2 continued in 2017, reaching 66 loaded 68% on average, with daily and early October, and the trend pipeline and will be further importers by the end of the year. fluctuation between 22% and 70 continued until the end of 2017 transported to the European The emergence of new market 94%. 60 and early 2018. market through the EUGAL participants has led to a reduction pipeline and other existing gas in Naftogaz’s share of imports 50 The main reason for the increase Analysis of the operations of all pipelines directly linked to EUGAL. from 74% in 2016 to 62% in 2017. in transit was the growth in 40 routes for the transportation of demand for natural gas in 30 Russian gas to Central European In 2017 Naftogaz imported Europe, especially in the first countries shows that, unlike Natural gas from the European market months of 2017 and in summer 20 almost 100% the load of Yamal imports to Ukraine 8.7 bcm of gas, which is 0.5 bcm due to unusual heat and low 10 (Russia-Belarus-Poland-Germany) (6%) more than the previous electricity generation at European and Nord Stream (Russia-Germany year. The number of European hydroelectric plants. 0 via the Baltic Sea), Ukraine’s GTS is In 2017, imported gas was only suppliers from which Naftogaz used by Gazprom not as a priority, supplied to Ukraine from the purchased natural gas in 2017 European gas market. Compared July 2017 July 2016 May 2017 May May 2016 May June 2017 April 2017 June 2016 At the same time, the volume April 2016 but as a gas transportation decreased to 13 companies (from March 2017 March March 2016 March August 2017 August August 2016 August to 2016, gas imports increased by January 2017 January 2016 October 2017 October October 2016 October February 2017 February of transit through Ukraine could 2016 February orridor for balancing gas supplies 15 companies in 2016). None of December 2017 December November 2017 November December 2016 December November 2016 November September 2017 September have been even higher in 2017. 2016 September to the EU. 27% – from 11.1 bcm to 14.1 bcm. these companies supplies more Thus, according to the decision than 25% of the total imported Ukraine’s GTS Yamal-Europe Nord Stream of the European Commission of Without an onshore connection, Despite the fact that Naftogaz gas. 28 October 2016, on the increase the new gas pipeline Nord is the largest importer, it has faced increased competition in the share of utilization of Share of natural gas supplied through different Stream 2 would not make sense. It should be noted that during OPAL pipeline capacities, the gas Like its predecessor, the pipeline from independent importers that the last three years, the use of flow through the specified gas routs from Russia August – October 2017, % will end in the German city of deliver products to consumers natural gas in Ukraine has been pipeline, after the corresponding Greifswald just a few meters from on a liberalized market. In rapidly decreasing, which has led 80 auctions had been conducted, the coast – far from any existing 2014, besides Naftogaz, only to a decrease in imports. Overall, 71% 5 companies imported natural began to increase and in January 70 gas transportation networks and in 2017, the use of natural gas in gas to Ukraine. At the end of 2017 reached its maximum. The 60 potential consumers of Russian Ukraine decreased by 1.3 bcm. Polish company PGNiG Supply & gas. Therefore, the OPAL and 45% 46% Trading and Naftogaz of Ukraine 50 44% NEL pipelines were specially NJSC appealed to the General 40 laid for Nord Stream, and the Gas imports to Ukraine in 2015–2017 Court of the European Court of EUGAL gas pipeline is planned Justice against the European 30 for Nord Stream 2. Its length 21% 21% 21% 25% 18 Commission and requested the 20 will be 485 km, it will pass from annulment of its decision of 28 Greifswald to the south through 16 10 October 2016. the territory of three eastern 14 0 German regions to the border At the end of July 2017, with the Czech Republic in the 12 10 . 2017 Düsseldorf Court in Germany 10 . 2017 area of Doichodorf. The total 10 bcm 10 . 03 . 12 . 09 2017 19 . 09 2017 15 . 08 2017 01 . 08 2017 22 . 08 2017 26 . 09 2017 29 . 08 2017 05 . 09 2017 08 . 2017 rejected a lawsuit by the Polish capacity of its two branches will 8 company and ruled that there be 51 bcm of gas per year. Ukraine’s GTS Yamal-Europe were no reasons to restrict 6 Gazprom’s access to the OPAL Nord Stream OPAL Nord Stream NEL On 6 March 2017, at the annual 4 pipeline. The court stated that auctions on the PRISMA platform, sale/ reservation of transportation Reduced physical flows of Russian 2 the plaintiffs failed to prove a new capacity was sold with capacities, which respectively led gas transit through Ukraine were 0 irreversible damage caused to the maximum level of loading observed immediately after the delivery to GASPOOL zone and by Gazprom access to OPAL’s from GASPOOL to the west and 2015 2016 2017 both of the OPAL pipeline and restoration of the Nord Stream 13 capacities. As a result, starting the North Stream gas pipeline12. gas pipeline after its annual south . At the new network point Naftogaz's imports from Europe Other imports from Slovakia from August 2017, auctions for maintenance. On 22 September of Lubmin II (the exit point of Naftogaz's imports from Russia Other imports from Poland the sale of “additional” capacities 12 ENSOG data, REUTERS Eikon. The Yamal oil Nord Stream 2 and the start of the (which is the final date for the Other imports from Hungary of the OPAL gas pipeline11 pipeline maintenance in the first and second EUGAL gas pipeline), transport parts of August was balanced by increase in maintenance of the North Stream started on the platform for physical flows through the Nord Stream and gas pipeline), the transit flow capacity up to 55 bcm (about the Ukrainian route. Nord Stream maintenance 14 https://www.gascade.de/en/press/press- 11 https://platform.prisma-capacity.eu/#/ in September was balanced by increase in gas through Ukraine began to decline 13 https://platform.prisma-capacity.eu/#/ releases/press-release/news/successful- network-point/details/5865472 flow through Yamal and Ukraine’s GTS. and reached a minimum level in network-point/details/6193154 booking-of-new-transport-capacities/

26 27 OUR MARKET AND REFORMS ANNUAL REPORT 2017

Sources of gas supply and its consumption in Ukraine retail prices, which in turn reduces Gas production in Ukraine in 2015-2017, bcm the commercial attractiveness 60 of this segment for new market 24 participants. 22 50 20 18 3.9 4.2 4.1 16 40 Natural gas 1.5 1.3 1.1 14 production 12 30 10 bcm 14.5 14.6 15.3 In 2017, Ukraine produced 8 20 20.5 bcm of gas (in 2016 – 6 20.1 bcm). The increase in gas 4 10 production compared to 2016 2 amounted to 0.45 bcm, or 2%. 0 2015 2016 2017 0 In 2017, Ukrgazvydobuvannya 2009 2010 2011 2012 2013 2014 2015 2016 2017 Ukrgazvydobuvannya Private producers produced 15.25 bcm of gas Domestic production Naftogaz imports Total imports Consumption (73% of the total production Ukrnafta in Ukraine). This volume In 2017, Slovakia remained the The Herfindahl-Hirschman Index (HHI) by number of importing also includes joint venture permits15. If the special permits At the same time, in Q4 main transit country for supplying companies* agreements and gas extracted were prolonged on time, the 2017, Ukrnafta increased its natural gas to Ukraine from by the enterprise for its own level of oil, condensate and hydrocarbon production. The 5 000 Europe. Hungary became the technological needs. gas production would remain average daily oil and condensate The company managed to stable during the year. Due to output increased by 15% from second largest transit route for 4 000 gas supplies to Ukraine in 2017. achieve stabilization of gas the forced end of production 3.3 thousand tons per day in production due to the measures at six fields, Ukrnafta lost over October to 3.8 thousand tons 3 000 envisaged by the Strategy 20/20. 92 thousand tons of oil and per day in December. During Diversifying the supply of 2 500** HHI condensate and 76 mcm of the same period, the level of gas imported gas has contributed 2 000 to the increase in the number Chornomornaftogaz in 2017 gas. extraction increased by 12% from of private suppliers and 1 000 produced 10.5 mcm of gas, 2.6 mcm to 2.9 mcm per day, and which is about the level of 2016 the average daily production of strengthening competition in the 15 In 2017, 9 Ukrnafta’s licenses expired. Attempts market, which in turn makes the 0 (10.4 mcm). The company is by the company to extend the special permits liquefied gas increased by 30% domestic market more efficient 2015 2016 2017 developing one deposit, Strilkove, were blocked by the State Geology and Mineral to 325 tons per day. The increase Resources Service (DerzhGeonadra) from * The index can range from 100 to 10 000, where 100 corresponds to a very large number of small companies, and its gas satisfies the needs of in production figures became and helps end users to benefit April to June 2017 Ukrnafta was forced to stop and 10 000 – to a single monopoly. Decrease in HHI means increased competition and reduced market power. from acceptable competitive the city of Genichesk in Kherson mining at six deposits. The company won a possible after the prolongation prices. The market has become ** The HHI of 2,500 or greater indicates a highly concentrated marketplace among importing companies region. number of lawsuits challenging the inaction of of special permits and recovery In 2017, Ukrnafta reduced the the regulator in the issue of special permits of production in 6 fields where significantly more competitive, extension. At the end of October and November, as the HH index has dropped Natural gas supplies from Slovakia and Hungary in 2017 volume of gas production after the extension of special permits and it was suspended during 2017. from over 4,800 in 2015 to about 1 400 by 17% from 1.3 to 1.1 bcm. obtaining land allotment, Ukrnafta was able to resume production at the suspended deposits. 2,500 in 2017. Therefore, both The main reason for the The volume of gas production 1 200 By the end of 2017, Ukrnafta submitted an the reduction of the Naftogaz’ reduction of hydrocarbon application to the DerzhGeonadra for the by private producers in 2017 extension of 27 special permits which expire in market share and the fall of 1 000 production by Ukrnafta was amounted to 4.1 bcm which 2018 and which account for 24% of annual oil the HH index evidence the fact the suspension by the state and condensate production and 18% of annual is almost equal to the level of that the supply of gas over the 800 of the company’s special gas production of the company. 2016 (4.2 bcm). mcm past three years has become 600 significantly more competitive. However, it concerns only the 400 Use and sale of gas supply of gas in the liberalized 200 natural gas market segment, as The statistical data evidence consumers used 11.2 bcm of energy for the population, used the competitive environment 0 shows a significant decrease in gas, which is 0.7 bcm less than 4.6 bcm of gas, which is 1.1 bcm in the retail gas supply segment gas use in Ukraine during 2014– in 2016 (–6%). less than in 2016 (–19%). July May June April March for households has not changed August 2017, both in the regulated and January October February February December November dramatically due to the continued September unregulated market segments. District heating companies The volume of gas supplied by existence of regulated marginal From Slovakia GMS Budince From Hungary GMS Beregdaroc During 2017, household (DHC) which produce heat the DHC to produce heat for

28 29 OUR MARKET AND REFORMS ANNUAL REPORT 2017 budget institutions and public Naftogaz wholesale prices since January 2015, a competitive environment of structural disproportions in the consumption, limits investment sector amounted to 1.0 bcm. UAH net of VAT/tcm, weighted average by category for retail suppliers, without a industry and the economy of the in the exploration of new oil and transparent and comprehensive country and unreasonable use of gas reserves, and reorientation Religious institutions consumed market mechanism – these are capital. Such a situation provides of wholesalers to the segment 19 mcm last year compared to 10 000 prerequisites for the formation no incentives for a decrease in gas of sales to end-users. 17 mcm in 2016. The use of gas 9 000 by this category of consumers in the total gas consumption 8 000 is 0.06%. 7 000 UGS 6 000 According to the law, namely, Ukraine entered 2018 with the largest, compared to the beginning of the last 5 years, gas reserves in Article 11 of the Law of Ukraine 5 000 underground storage facilities – 14.7 bcm. “On the Natural Gas Market”, 4 000 Ukrgazvydobuvannya shall 3 000 In 2017, Ukrtransgaz pumped during abrupt changes in gas sufficient level of filling UGS had sell extracted natural gas to 9.2 bcm of gas into underground supply volumes in the short run. played a key role in balancing the 2 000 Naftogaz, while Naftogaz is storage facilities, which is by In addition, UGS are essential for operation of the Ukrainian gas required, pursuant to its public 1 000 43.2% more than in 2016. In balancing the system due to their transmission system in early March service obligations (PSO), January-December 2017, 6.4 billion flexibility and the ability to quickly 2018 during a critical situation that 0 to ensure the sale of gas to cubic meters were selected from respond to the changes in gas arose due to failure of Gazprom regional gas suppliers, religious Ukrainian UGS. This is 23.2% less flows. to comply with the terms and than in 2016. conditions of the contracts,

organizations and DHC, and July 2017 July 2015 July 2016 May 2017 May May 2015 May May 2016 May March 2017 March March 2015 March March 2016 March The choice of a policy which is failure to comply with Stockholm January 2017 January 2015 serving households. The former January 2016 November 2017 November November 2015 November November 2016 November arbitration, and another pressure September 2017 September September 2015 September gas supply regime under PSO 2016 September Underground gas storage facilities different from the typical policy of was established by the Cabinet play an important role in ensuring EU countries regarding the rates reduction (down to 49.8 atm the security of gas supply, especially and volumes of filling UGS in 2017 instead of 60 atm stipulated in the of Ministers’ Decree No. 758 Industrial comsumers Households Heat producers in winter. They provide coverage for in Ukraine proved to be the right contract) in the main gas pipelines of 1 October 2015, and it was the temporary growth in demand one given the development of the at the entry point of GMS Sudzha. due to expire on 1 April 2017. in peak periods, and also guarantee price situation during the heating However, the regime was equivalence. By the end of 2017, Naftogaz at prices regulated by a certain level of security of supply season in 2017. Subsequently, a extended until 1 June 2018, and the difference was 50%. the state in accordance with then – until 31 May 2018. PSO assigned to the company, Under the existing conditions, and without ensuring equal The establishment of PSO has led when natural gas for the needs of access to gas distribution Volumes of natural gas injected to and withdrawn from the UGSFs, April – December 2017 to a tangible difference between households, DHCs and religious networks for new market the regulated price and their CIF organizations is supplied by participants, without establishing 25 INJECTION

Dynamics in difference between the market and regulated price of natural gas, % 20

120

100 15

60 10

20 5 WITHDRAWAL 0

0 July 2017 July 2016 May 2017 May

May 2016 May April May June July August September October November December June 2017 April 2017 June 2016 April 2016 March 2017 March March 2016 March August 2017 August August 2016 August January 2017 January 2016 October 2017 October October 2016 October February 2017 February February 2016 February December 2017 December November 2017 November December 2016 December November 2016 November Injection/withdrawal of gas, mcm (right axis) Price NCG hub, EUR/MWh (left axis) September 2017 September September 2016 September

30 31 2.5 PROVEN RECOVERABLE GAS RESERVES AS UKRAINE IN THE EUROPEAN GAS MARKET 8.2 2.5 OF THE END OF 2016, BCM 0.1 (SOURCE: BP) 0.01 Continental Asia Europe USE OF DOMESTICALLY PRODUCED GAS, Finland 52 947 0.1 3 745 IMPORTS FROM OTHER SOURCES IN 2017, BCM 122.8 South and 114.6 Central America (SOURCES: EUROPE – THE EUROPEAN COMMISSION, UKRAINE - NAFTOGAZ) Sweden Norway 0.5 7 589

0.5 North America Estonia 5.6 11 129 91.3 1.1 0.7 1.1 4.8 Latvia Africa 48.5 Denmark 2.3 17 536 42.8 43.3 2.3 Lithuania 5.0 2.0 Middle East UK 104.9 18.7 79 377 46.4 Asia and Pacific 2.0 3.0 Germany 14.5 17 536 Ireland Poland 35.4 17.8 The Netherlands 4.2 90.7 8.2 34.6 Italy Others 97.1 Poland Romania Denmark 34.9 203 17.8 7.8 8.0 110 13 14.1 UK Belgium 0.2 0.9 Czech 4.4 20.5 207 Republic 0.8 Germany 4.3 15.3 Ukraine 0.01 0.09 49.1 Luxembourg 14.1 Slovakia 1.2 10.3 11.1 Austria 49.1 8.6 1.4 Ukraine 0.8 590.9 0.04 1.7 9.7 Norway 0.8 Hungary Romania 1 763.4 France Slovenia 2.9 1.3 1.6 3.2 33.6 Croatia 3.1 69.3 0.09 33.6 5.1 Bulgaria 0.06 The Netherlands 5.1 63.6 4.1 696.7 5.6 4.1 COUNTRIES WITH BIGGEST GAS RESERVES Spain Portugal 0.01 Italy Greece Norway 1 763 Nigeria 5 284 China 5 366 Venezuela 5 702 TOTAL UGS CAPACITY, BCM, 2017 USA 8 714 (SOURCE: UNDERGROUND GAS STORAGE IN THE WORLD – 2017 PUBLISHED BY CEDIGAZ) Russia 32 271 5.1 gas consumption Iran 33 500 gas imports gas production gas exports

30.9 23.9 17.2 14.3 11.7 8.4 6.3 3.5 3.4 3.2 2.6 1.4 1

UKRAINE GERMANY ITALY THE NETHERLANDS FRANCE AUSTRIA HUNGARY CZECH REPUBLIC SLOVAKIA POLAND SPAIN UK DENMARK OUR MARKET AND REFORMS ANNUAL REPORT 2017

The agreements that were Global oil demand and supply balance and price for oil GLOBAL OIL MARKET declared in 2017 to reduce oil production by OPEC member 2.5 120 countries in coordination with 2.0 other countries including the 100 Russian Federation resulted in 1.5 In 2017, the global oil Global oil demand and supply 80 a reduction of oil production 1.0 demand growth trend 60

and, therefore, excess supply Mb/d remained unchanged; it 0.5 98 on the market16. This situation USD/barrel has been recorded for the 40 enabled the launch of the 0 third consecutive year, 97 process to balance the 20 and last year demand 96 –0.5 market, which eventually growth amounted to about 95 –1.0 0 led to certain equilibrium in 1.6 million barrels per day 94 the market and the gradual 2013 2014 2015 2016 2017 (Mb/d). Global oil demand Mb/d 93 reduction of commercial at the end of 2017 was close Demand and supply balance (left axis) Price for Brent crude oil (right axis) 92 global oil reserves. to the 97.0 Mb/d mark. Against the background of 91 At the same time, the growth the overall recovery and 90 in production and supply by Commercial stocks of crude oil in OECD countries and oil on the growth of the world 89 the USA, Brazil, Iran, Libya and water for the period, thousand barrels economy in 2014-2017, the 2013 2014 2015 2016 2017 Nigeria somewhat limited growth in demand for oil Oil demand Supply 3.100 1.120 the pace of the restoration of 1.100 was about 5 Mb/d. Source: OPEC Monthly Oil Market Report December 2017 3.050 equilibrium in the market. 1.080 3.000 1.060 OPEC nations faltered in their efforts to comply with oil-cut targets Unlike 201617, the price 2.950 1.040 situation in the market was 2.900 1.020 1.000 more stable during Q1-Q3 2.850 January 2017 99% 980 2017. However, after the 2.800 960 February 2017 97% market participants received 2.750 940 clear evidence of a reduction Q1 2017 Q1 2016 Q2 2017 Q3 2017 Q4 2017 Q4 2015 Q2 2016 Q3 2016 March 2017 109% in market surplus and a Q4 2016 reduction in commercial oil April 2017 104% reserves, the prices began to Commercial stocks of crude oil in storages (left axis) increase at Q4. In tankers (oil on water) (right axis) May 2017 109% The gradual recovery of crude Source: OPEC Monthly Oil Market Report December 2017 June 2017 82% oil prices from the summer of 2017 and the emergence of Brent crude oil price, 2017 July 2017 86% confidence in this long-term trend led to the launch of 70 0.6 August 2017 96% financing by the world's oil 0.4 60 companies of 18 previously 0.2 September 2017 93% suspended large production 50 0 projects.18 –0.2 October 2017 103% 40 –0.4 Mb/d

November 2017 USD/barrel 30 129% 16 Oil-producing countries (OPEC members and –0.6 others) combined efforts through entering –0.8 December 2017 OPEC members 135% into a Declaration of Cooperation agreement 20 maintain a production to reduce oil supply to the global market by –1.0 target of 1.8 Mb/d. 10 January 2018 1.176 Mb/d 136% 17 The prices for crude oil in 2016 dropped –1.2 to the lowest level in the last 12 years. The 0 –1.4 February 2018 148% average Brent oil price was USD 44 per barrel. In addition, the crude oil price was quite volatile Q1 Q2 Q3 Q4 in 2016, ranging from $ 26 to $ 55 per barrel. March 2018 164% 18 Rystad Energy (http://www.offshore-mag.com/ Price for Brent oil Demand and supply balance articles/2018/01/analyst-finds-18-delayed- Source: https://www.bloomberg.com/graphics/2017-opec-production-targets/ projects-reached-fid-last-year.html) Source: Platts

34 35 OUR MARKET AND REFORMS ANNUAL REPORT 2017

Global conventional discoveries, billion boe Major events that impacted the price situation on the oil market in 2017 6

70 7 5 65 60 1 4 6 4 55

50 3 45 2 3 40 5 2.5 2

January February March April May June July August September October November December 1.3 1.3 1.3 1 0.6 0.6 1. For most of the first quarter of 2017, prices were stable against the background of the agreement reached by 0 OPEC member countries at the end of 2016 on "freezing" the level of oil production. July July July July July July 2. Prices began to decline in March 2017 after the publication of several consecutive reports of the US Energy April April April April April April January January January January January January Information Administration on increases in the US commercial reserves of oil. October October October October October October 3. As a result of the shutdown of a number of major refineries in the United States and other parts of the world for 2012 2013 2014 2015 2016 2017 maintenance, another fall in prices occurred in May 2017 and buildup of commercial crude oil reserves in the United States. TOTAL VOLUME 4. In June 2017, prices began to increase based on the expectations of market participants for further reduction of oil PER YEAR 30 16 15 15 8 6.7 production by OPEC member countries in order to balance the market. 5. The market response to the OPEC decision to maintain oil production at the current level was a rapid drop in Gas Liquids Year average prices in July 2017. 6. Since the beginning of the third quarter of 2017, there has been evidence that proved the effectiveness of the OPEC member states agreement on the oil output cut. In addition, a high level of loading of refineries and European market for oil and petroleum products demand for refined products was observed. The level of loading of European refineries grew from 89% in Q2 2017 to 92% in Q3 2017; overall the global oil increase in Q3 was 1.1%. 2017 can be considered a success of new oil refineries on other and located outside of Europe. 7. In November 2017, OPEC member states at their regular meeting decided to extend the decision to restrict oil for European refineries. Due to continents23; The European oil refineries production until the end of 2018. the oil refining margin, which was process lightweight petroleum, higher than in 2016, the European – an increase in the share of which is logistically available for refineries utilization rate was imports of finished petroleum delivery (oil from Kazakhstan, stable during 201721. products in Europe against the Azerbaijan, Libya and Nigeria background of reduction of is not within the scope of European oil refining capacities emission quotas for harmful petroleum output cut agreed by At the same time, 2017 in 2012. Such a low reserve is a net importer of oil and dropped by 15% between 2010 substances. the OPEC member countries). demonstrated a record low replacement level can have a oil refining products, Ukraine and 2017 (from 865 million t/ year capacity of new discovered negative impact on the supply is forced to spend additional to 740 million t/year)22 and in One of the factors that positively In Q3 and Q4 2017, the oil reserves, with the average side over the next decade, currency resources for their 2017 they comprised about 14% impacted the operations of the petroleum products price capacity of about 550 million which will accordingly affect purchase. For instance, in 2017 of global capacity. In view of European refineries was the trend in Europe was much barrels of oil equivalent per world energy prices. alone, the total expenditures world trends, further reduction in decrease in production and in slower than the global oil price month19. Most alarming is of the country on oil and production capacities is possible excess supply on the market after trend. For instance, the oil the fact that the reserve Overall, a steady trend towards petroleum product imports in the period to 2025 due to: the 2017 agreement between price growth during August- replacement ratio20 (for oil and rising prices on the oil market increased by 33%. In case of the OPEC member states was December 2017 amounted to gas) reached only 11% in 2017 was observed in 2017, which further growth of the world oil – an increase in petroleum reached. This factor operates about 30% (from 49 to 64 USD/ compared to more than 50% is primarily due to the freezing prices and without building up products and construction in a way that the reduction of barrel), while the petroleum of oil production volumes domestic production of oil and production was mainly due to products price growth in 19 Rystad Energy https://www.rystadenergy. com/newsevents/news/press-releases/ by OPEC countries. The petroleum products in Ukraine, 21 Monthly OPEC Report (2017), IEA Global Margin heavy grades of oil, which are European countries amounted all-time-low-discovered-resources-2017/ current high oil prices make this trend will negatively affect Conversion Indicator usually processed by refineries to about 10% for gasoline and 20 The reserve replacement ratio is the ration investments in oil production the balance of payments of 22 International Refining and Petrochemical with a high level of complexity diesel fuel, which impacted the of the number of reserves discovered during more attractive, including in the country and can lead to a Conference (IRPC) in Europe in 2017 (from the oil refining margin curve for the year to the global hydrocarbon production speech of Manfred Litner, member of executive during the year. Ukraine. However, since Ukraine reduction in GDP. board of OMV AG) 23 Global Data European refineries.

36 37 OUR MARKET AND REFORMS ANNUAL REPORT 2017

Overall, we expect that the more EU-16 refineries capacity utilization level, Brent price of purchasing prices in Ukraine. Relative developments in oil price and European refining margin stringent norms and targets for As noted above, the increased in 2017 compared to Q4 2016 carbon monoxide and higher 65 94 environmental requirements and 35 9 biofuel quotas in the short and 60 92 stiffer competition may lead to medium run will have a significant further reduction of production 30 8 55 90 impact on European refineries. A capacity in Europe and, 25 7 50 88 new restriction on the use of high consequently, greater volatility 45 86 20 6 sulfur fuels from 1 January 2020, % of prices for petroleum products, 40 84 15 5 USD/barrel introduced by the International including in Ukraine. % 35 82 10 4 Maritime Organization (IMO) to USD/barrel decrease sulfur oxide emissions 30 80 5 3 from ships to reduce air pollution 25 78 0 2 and protect the environment, Ukrainian oil and –5 1 Q1 2017 Q1 2015 Q1 2016 Q2 2017 Q3 2017 Q4 2017 D2 2015 Q3 2015 Q4 2015 Q2 2016 Q3 2016 prompts European refineries to Q4 2016 –10 0 upgrade their production facilities, petroleum market

change the configuration of Q4 2016 July 2017 May 2017 May June 2017 EU-16 refineries capacity utilization level (right axis) April 2017 March 2017 March refinery technological processes, 2017 August January 2017 The total volume of oil and 2017 October February 2017 February December 2017 December November 2017 November and start processing crude oil Brent oil price (left axis) gas condensate production in 2017 September with lower sulfur content (light Ukraine has been decreasing Price for Brent oil Northwest European refining crude oils). All the above listed EU-16 refineries capacity utilization level, refining margin for the fifth consecutive year. In Price for diesel fuel (left axis) margin (right axis) factors will undoubtedly increase 2017, Ukraine produced about Price for A-95 gasoline the capital and operating costs 94 10 2.1 million tons of oil and gas of the refineries and accordingly 92 condensate, which is 6% less increase the cost and price of 9 90 than in 2016. The main cause gas production would remain At the same time, the extraction petroleum products for end users. 8 88 was the reduction of Ukrnafta’s stable during the year, and of oil and condensate by other 7 production by about 9%. the reduction in production enterprises that do not belong to 86

Given the fact that the import % 6 in 2017 compared to the pre- the Naftogaz group grew by 6% purchasing and domestic 84 5 USD/barrel At Ukrnafta, the average vious year would have been in 2017. wholesale prices for petroleum 82 daily production of conden- three times lower. Due to the 4 products in Ukraine are formed 80 sate oil increased by 2% to suspension of production in 6 Ukrgazvydobuvannya processes based on the European 78 3 4.1 thousand tons per day fields, as a result of the forced oil and gas condensate at its own quotations for petroleum from January to June 2017, time-out Ukrnafta lost more production facilities, and Ukrnafta Q1 2017 Q1 2015 Q1 2016 Q2 2017 Q3 2017 Q4 2017 D2 2015 Q3 2015 Q4 2015 Q2 2016 Q3 2016 products, the European refineries Q4 2016 and in July-October it dropped than 92 thousand tons of oil sells oil and gas condensate of utilization level and, accordingly, to about 3.3 thousand tons a and condensate and 76 mcm its own production at auctions the sufficient supply of petroleum EU-16 refineries capacity utilization level (left axis) day due to forced stoppage of gas. in accordance with Article 4 of products in the European of production in six fields. The market directly affects the level Brent oil refinery margin, NW Europe (right axis) daily production level was restored, although not fully, in Structure of oil and condensate market by E&P companies, November-December 2017. 2013–2017 Global distribution of refining capacities by region (Mb/d) The main reason for the reduction in volumes of hydrocarbon 3.50 140 South America production by Ukrnafta was the blocking of the company’s 3.00 120 Oceania special permits extension CAGR –6.75% North America 24 2.50 100 process . If the special permits had been prolonged on time, Middle East 2.00 80 the level of oil, condensate and Former Soviet Republics 1.50 60 24 The validity of the company’s 9 special permits Europe 1.00 expired in 2017. Attempts to extend the special Million tons a year 40 permits were blocked by DerzhGeonadra and Caribbean the company was forced to stop production at 6 0.50 fields during the period from April to June 2017. The 20 Asia company won a number of lawsuits challenging 0.00 the inaction of the regulator on the issue of 0 Africa prolongation of special permits. At the end of 2013 2014 2015 2016 2017 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 October and November 2017, after the special permits were extended, Ukrnafta restored its Source: GLOBAL DATA suspended operations at the 6 deposits. Ukrnafta Ukrgazvydobuvannya Other

38 39 OUR MARKET AND REFORMS ANNUAL REPORT 2017 the Law of Ukraine "On Oil and Sales of oil and condensate by Ukranafta in 2017 USD 4.159 billion in 2017, which consumption increased by 5% In view of the Ukraine’s Gas" and the procedure for the is 27.3% more than in 2016. to 548 thousand tons, while dependence on imports, organization and holding of 65 350 At the same time, in volume the volume of consumed LPG the growth of world oil and exchange auctions for the sale of 300 terms, imports of petroleum for the same period increased petroleum product prices crude oil and gas condensate of 60 products to the country in the by 9%. resulted in an increase in 250 its own extraction and liquefied past year increased by 5.6% to 55 gas, approved by the Cabinet 200 7.8 million tons. of Ministers of Ukraine (dated 150 50 Developments in Shebelynka refinery output in 2015–2017 16.10.14, No. 577). Since the 100 The main trend on the market thousand t thousand sale of oil and gas condensate barrel USD/ 45 of petroleum products in produced by Ukranafta in 50 Ukraine in recent years Ukraine is subject to the strict 40 0 including 2017 is a decrease 520 515 regulation, the situation on the July in consumption of automotive May June April

March 510 510 August January oil market is rather tough. In October gasoline and its replacement February December November 2017-2018, twelve auctions for September with LPG (in the period 500 the sale of crude oil and gas from 2014 to 2017, the condensate were recognized Sales, thousand tons (right axis) consumption of LPG increased 490 by the auction committee as Calculated average sale price at auction, rebased per 1 barrel, USD (left axis) by about 65%). According to t thousand 480 void. The main reasons for this Platts Urals price (monthly), USD/ barrel (left axis) the State Statistics Service of 470 473 situation are: Ukraine, the sale of gasoline 1) extremely limited demand for through gas stations in 460

oil, since today Kremenchuk oil 2017 decreased by 12.3% to 450 refinery is the only operating Balance of the Ukrainian petroleum products market 1.61 million tons, industrial 2015 2016 2017 oil refinery in Ukraine. The in 2016–2017, million tons operations of the other five plants are suspended and 11.5 unlikely to resume in the short Balance Structure of petroleum products output at Shebelynka gas condensate and oil refinery in 2015–2017, term; 11.0 thousand t 2) other ways of selling oil and gas condensate are legally 9.0 9.7 Imports Technological restricted; 8.5 9.7 losses 3) Ukrtatnafta’s shift to the higher 9.1 quality gasoline and diesel 2.9 Production 18.1 fuel production and increased 2.7 Other dark 9.5 volume of processing due to petroleum products 9.5 the purchase of Azeri Light oil. –0.41 Exports –0.23 34.0 At the same time, according to 51.1 the results of the auctions, the Oil residue 51.1 price of sales of oil and gas con- 2016 2017 densate was at the level of world 177.5 oil prices. Other light 139.1 petroleum products and components). After the new diesel fuel, which is 14% and 16% 104.0 Production of petroleum technological regulations that less than in 2016, respectively. products and LPG at oil refineries prohibit the sale of diesel fuel At the same time, production 14.9 and gas refineries increased by Euro-4 became effective in 2018, of benzole-containing fraction, LPG 11.2 about 6% to 2.9 million tons in the plant completely switched reformate and liquefied 4.0 2017. This increase in output was to the production of the Euro-5 hydrocarbon gas increased. due to an increase in imported diesel fuel, which resulted in The balance of light and dark 97.4 oil and gas to the Kremenchuk some changes in the structure petroleum products production Diesel fuel 116.8 oil refinery. At the same time, of production of petroleum has improved compared to past 108.7 the volume of processing products. periods. 133.8 at Shebelynka refinery (Ukrgazvydobuvannya) remained In 2017, Shebelynka gas refinery According to the State Fiscal Gasoline 156.3 unchanged in 2017 (510.000 produced 133.800 tons of Service, Ukraine imported 176.8 tons of oil and gas condensate gasoline and 97.400 tons of petroleum products worth 2015 2016 2017

40 41 OUR MARKET AND REFORMS ANNUAL REPORT 2017 wholesale prices on the Comparative developments in wholesale prices for gasoline in by about 18%. Since Unipetrol, Volumes of oil transit during 2015–2017 Ukrainian market: by the end Ukraine and Nothwest Europe (price as of 01.01.17 = 100%) which manages the refinery in of 2017, the price of gasoline the Czech Republic, extended and diesel fuel increased by 35 the term of long-term contracts about 25% compared with the 30 with Russia for oil supplies till 16 beginning of 2017. The wholesale 25 July 2019, Ukraine can expect 15.2 CAGR -2.7% 15 prices of petroleum products on 20 to have continuous stable oil the domestic market of Ukraine 15 supplies through its transit 13.8 13.9

% 14 are less volatile compared with 10 corridor to the Czech refineries. 5 13

the change in prices in the main million t hubs of Northwest Europe, 0 At the same time, as a result of and this is primarily due to the –5 diversifying the supply chain by 12 –10 particularities of the imported refineries, further decrease in 11 petroleum products purchasing –15 transit volumes to the refineries mechanism, namely purchases of Slovakia and Hungary are 10 July May June April 2016 2017 March observed in 2017 – by 4% and 2015 are based on average monthly August January October February December November quotations and the purchasing September 7% respectively. price of petroleum products includes supplier’s trade margin. Gasoline A-95 (Ukraine) In addition, one of the risk Gasoline 10 ppm quotations (Northwest Europe) factors that could adversely Volumes of domestic oil transmission during 2015–2017 affect the volume of oil transit through the Ukrainian oil Oil transmission transportation system is the Comparative developments in wholesale prices for diesel fuel in deterioration of the qualitative 25 2.5 Ukraine and Nothwest Europe (price as of 01.01.17 = 100%) characteristics of the Russian In view of the historical CAGR 9,27% 2.1 features and technological 40 oil blend delivered to Europe. 2.0 connectivity of oil In late 2017 and early 2018, the 30 1.6 transportation systems, the Russian Federation redirected 1.5 1.4 large volumes of low-sulfur oil

volume of oil transit largely 20 million t depends on Russia's policy as from west to east to strengthen 1.0 the main supplier of oil to the % 10 its leading position in the Chinese market. As a result, 0.5 Central European countries 0 and the main customer of the quality of Urals oil, the oil transportation services –10 main Russian export oil grade 0.0 on the territory of Ukraine, dropped sharply, causing 2015 2016 2017 –20 as well as from the policy, dissatisfaction with European processors26. At the end of 2017, * Including oil transmission volumes for the companies of the group July May June provision of resources and April March August

January the official representatives of October technical state of the refineries February projects, the following ways to satisfy the needs of their December November in the Czech Republic, September the Russian operator of the conclusion can be drawn: the refineries. Slovakia and Hungary. These main oil pipelines reported that redirection of light sweet oil dependencies are typical the content of sulfur in the oil to the eastern markets and The framework agreement for all oil transportation Diesel fuel (Ukraine) net of taxes and duties to be shipped from the port of the replacement of oil with between the Czech refinery Primorsk will increase to 1.63% in service companies in the ULSD 10 ppm quotations (Northwest Europe) petroleum products in Russian Unipetrol and Jadranski world, since the volume 2018, in the oil to be supplied via exports is a long-term trend, Naftovod, the Croatian operator of oil transportation and, Druzhba oil pipeline and through and in view of deterioration of of the main oil pipelines, respectively, the volume of by 8% in 2017 compared to accordingly, the restoration of Ust-Luga – to 1.8%, through the quality characteristics of the signed in late 2016, on the ordered services depend on 2016 while the volume of oil the route Odesa – Kremenchuk Novorossiysk – up to 1.55%. Russian oil mix, the increase of oil establishment of cooperation demand for raw materials. transportation for domestic 25 oil refinery. exports through the oil pipeline and oil transportation to the consumers increased by 49% Based on analysis of the system in the western direction is Czech Republic via the Adria 27 Today signifcant capacities of due to the increase in supply of The main reason for the prospective Russian oil unlikely. pipeline will also adversely the main Ukrainian oil pipelines imported raw materials to the increase in transit volumes was transportation development impact the volume of oil are not used (see infographic Kremenchuk oil refinery and, the restoration of the normal Deterioration of qualitative transit via the Ukrainian oil Ukraine’s refinery capacities operation of the Litvinov 26 https://ru.reuters.com/article/businessNews/ characteristics of oil can lead to transportation system. The said p.122). At the same time, the 25 Wholesale prices for petroleum products in Refinery in the Czech Republic idRUKBN1FP1FO-ORUBS lower demand for the mixture, pipeline is an alternative to the Ukraine, USD (according to the NBU’s average 27 Transneft Group’s main investment projects volume of oil transit through the monthly rate of Ukrainian hryvnias to USD/Euro) in 2017 and an increase in the (as of 30.09.17) http://www.transneft.ru/u/ and encourage European traditional supply through the territory of Ukraine increased excluding VAT, excise tax transit of oil in that direction section_file/28354/tn_mda_09m2017_rus.pdf consumers to seek alternative Druzhba oil pipeline.

42 43 OUR MARKET AND REFORMS ANNUAL REPORT 2017 HISTRORICAL VICTORY Key results of the Arbitration on gas supply contract FOR UKRAINE: STOCKHOLM Gazprom’s claims Award Contract gas price Gas price for Q2 2014 485 in Q2 2014 352 reduced ARBITRATION $ per tcm $ per tcm linked to oil products linked to market price on German hub

After four years of arbitration proceedings between Naftogaz and Gazprom, the Stockholm Arbitration Gazprom’s Take-or-pay provision 56 take-or-pay claims 0 fully rejected for 2009-2017 has delivered two fateful awards: the first one came on 22 December 2017 concerning a gas supply $ bn $ bn contract based on the "take or pay" principle, and the second one on 28 February 2018 with respect to a transit contract.

Annual contract Contractual volume Initiated in 2014, the arbitration The Stockholm arbitration also Following the results of the 52 volume obligations 5 reduced to actual needs proceedings have become the satisfied Naftogaz's claim for two proceedings, Gazprom bcm bcm largest commercial arbitration compensation of USD 4.63 shall pay Naftogaz USD 2.56 ever. Mutual claims amounted billion for Gazprom's failure to billion adjusted to a USD 2.1 to about USD 125 billion, which deliver the agreed volumes of billion set-off for gas delivered threatened to bankrupt both Gaz- gas for transit. in 2014. To pay for gas allegedly We will not pay for supplies prom and Naftogaz. CADLR* supplied to the occupied CADLR* to CADLR territories #NaftogazWins#NaftogazWins in SCC arbitrations against Gazprom * Certain Areas of Donetsk and Luhansk Regions

$ 44.3 Maximum possible value of claims, billion Naftogaz

On 22 December 2017, the Naftogaz has succeeded in reduced by 27% – from USD Arbitral Tribunal ruled in favor reducing the future mandatory 485 tcm to USD 352 tcm. Due of Naftogaz on all contentious annual volumes of gas purchases to revision of the contract In favor issues concerning contracts from Gazprom tenfold from price, Naftogaz saved USD for the supply of gas with 42-52 bcm to 4-5 bcm, which 1.8 billion on gas purchased in 3.1 of Naftogaz Gazprom: pricing, the "take or corresponds to actual needs for 2014-2015. $ billion pay" provision, and invalidat- gas imports. ing other provisions that are • Naftogaz has successfully The arbitrators also indicated compensation ungrounded and contrary to revised the contract that Naftogaz should not pay for 2.6 from Gazprom the principles of competition, towards the reduction the volumes of gas supplied to namely: of gas prices according the temporarily occupied terri- gas price reduction • The arbitration court to market conditions, as tories of Luhansk and Donetsk 0.5 in 2018-2019 completely dismissed well as compensation for regions, as the volume of these Gazprom’s retrospective claims overpayment in the periods supplies cannot be determined. for USD 56 billion in accordance after April 2014 when In addition, the arbitration has with the "take or pay" provision Naftogaz initiated a revision declared invalid some other pro- (which sets up the obligation of the price. In particular, visions of the contract, including $ 81.4 Maximum possible value of claims, to pay for undisbursed gas the price of gas received by the prohibition on re-export. So billion Gazprom volumes) for 2009-2017. Naftogaz in the Q2 2014 is Naftogaz may resell gas abroad.

44 45 OUR MARKET AND REFORMS ANNUAL REPORT 2017 Key results of arbitration process on gas transit Failure by Gazprom to abide by the arbitration decisions

On 1 March 2018, amidst Despite the awards and timely Swedish courts and initiated On 28 February 2018, the Stock- • The volume of transit remains reform in Ukraine is a matter abnormal frost, Gazprom violated pre-payment by Naftogaz, a new arbitration attempting holm Arbitration Tribunal ruled unchanged (in 2017, Gazprom for the Ukrainian authorities its contractual obligations Gazprom refused to resume to reverse the outcome of the in favor of Naftogaz on most of pumped 95 bcm of gas and is not within the having refused to supply gas deliveries to Naftogaz as agreed awards. the important issues in the dis- through Ukraine). competence of the tribunal in to Ukraine without warning. on 1 March 2018. Gazprom pute with Gazprom regarding • The Tribunal did not support this case. The Russian company returned has also not paid the USD In light of Gazprom's unwill- the existing gas transit contract. Naftogaz's request for the prepayment for March to 2.6 billion it owes Naftogaz. ingness to comply with its • The Tribunal confirmed the revision of the transit tariff, Naftogaz secured a financial Naftogaz, lowered pressure in its Instead, Gazprom has launched legal obligations under the violation by Gazprom of since the review application victory and is now entitled pipelines by 20% and reduced ill-founded proceedings final awards rendered in the its obligations for transit filed by Naftogaz in 2009 to purchase natural gas for a gas sales to other customers to against the awards in the sales and transit arbitrations in volumes, which according to did not meet the procedural better price that fully complies minimum. Swedish courts and initiated Stockholm, Naftogaz has initi- the contract amount to 110 requirements. The Tribunal with the European market, and a new arbitration attempting ated enforcement of the USD bcm per year, and awarded also rejected Naftogaz's Gazprom must fulfill its obliga- Naftogaz managed to substi- to reverse the outcome of the 2.6 billion award. The company compensation of USD 4.63 demand to review the transit tions under the transit contract, tute Gazprom’s deliveries with awards. has asked the Swiss courts to billion. The arbitration contract in accordance with however with the same transit gas acquired from European enforce the award, and under- award confirmed the legal European and Ukrainian tariff. Naftogaz also has to buy suppliers during one day and In addition to this, Gazprom has stands that Swiss authorities obligations of Gazprom energy and competition a certain amount of gas directly took measures to decrease gas launched ill-founded proceed- already have taken measures concerning deliveries under legislation, noting that the from Gazprom on a pre-paid consumption. ings against the awards in the against Gazprom's assets there. the transit contract. implementation of regulatory basis.

Response by Naftogaz and Ukraine

Ordered urgent Ensured switching Gazprom’s demarche deliveries from to other fuels the EU

50 Maintained #COOLITDOWN atm EU uninterrupted campaign widely Refused Notified Ukraine Gas prices transit supported by Ukrainian to supply gas of the intention in the EU to Europe citizens and enterprises to Ukraine to terminate supply skyrocketed helped cut consumption and transit contracts to over $1000/tcm by 14% in big cities Failure Move to cancel Transit put to supply Pressure drop Prices surge contracts at risk

Decreased Created crisis pressure conditions by for European breaching transit (50 atm both supply instead of 60-65 and transit stipulated in contracts the contract)

46 47 OUR MARKET AND REFORMS ANNUAL REPORT 2017

gas transmission assets would put at risk the fulfilment of UNBUNDLING OF obligations to transit gas to “The suggested internal restructuring is a very sensible and first real step European customers. towards TSO unbundling that we see from the Ukrainian side” The company continues to look Janez Kopač, Energy Community Secretariat Director GAS TRANSMISSION FUNCTION for a solution, but it is important to note that the Ukrainian energy regulator (NCREU), with the support of the EU, should play a key role and make Gazprom business operations in place. implementation of gas market bring the contract into line with According to advisors, the reform in Ukraine. To make the EU legal norms incorporated in branch concentrates all key TSO genuinely independent, Ukrainian law. business processes required the following conditions are for TSO certification according necessary: The Ukrainian government to the OU model stipulated continues to focus its efforts on by Ukrainian law. The natural • control over the independent identifying technical issues of gas transmission function is TSO should be removed from Naftogaz group restructuring therefore ready for unbundling. the Cabinet of Ministers of related to unbundling, though In the absence of Gazprom Ukraine and then it will not as mentioned above, the resistance, Naftogaz would be deemed as a vertically unbundling and independence transfer it to the new legal entity integrated organization According to the Law of Ukraine this, which served as the reason the proper operation of Ukraine’s requirements of the law primarily as required by law. according to the law of “On the Natural Gas Market”, for Naftogaz’s appeal to the GTS and ensures secure and concern the TSO, which is now Ukraine “On the natural gas the country’s natural gas Stockholm Arbitral Tribunal. uninterrupted transit, which part of the group. Naftogaz’s unbundling efforts market”. If this occurs, a) the transmission operations must means that the company has focus on maximizing Ukraine’s laws regulating the Energy be separated and independent The tribunal announced the relevant technical and financial The tribunal’s award does not benefit from using the transit Ministry and the Cabinet from supply and production. final award in Naftogaz vs capacity to provide gas transit prevent the company from infrastructure in terms of of Ministers of Ukraine The Law also stipulates that the Gazprom case regarding the services as well as the right to continuing active preparation both current contracts and need to be amended, and vertically integrated company transit contract on 28 February operate the gas transmission for unbundling after 2019. those concluded after 2019. b) the TSO must have a and the TSO are accountable 2018. The tribunal satisfied some system. Ukrtransgaz is in charge PricewaterhouseCoopers Polska Meanwhile, the book value of corporate governance for compliance with these claims in this case, including of the technical implementation Sp. z o.o. (PwC) is advising gas transmission assets as of system complying with requirements. This means the Gazprom’s obligation to pay of the contract under Naftogaz’s Naftogaz on the process of the end of 2017 was almost OECD principles and implementation of European Naftogaz USD 4.63 billion for obligations. gas transmission unbundling. UAH 190 billion. These assets recommendations in place, energy market principles under-delivery of contracted Experts from Naftogaz and should be unbundled in a way including a supervisory ensuring that all players are transit volumes. Following Ukraine consequently remains Ukrtransgaz, in cooperation that would neither decrease their board with a majority of on a level playing field and a the results of two Stockholm where it was in 2014: despite with PwC, held an inventory, value nor generate losses for independent members and vertically integrated company arbitrations (regarding gas Naftogaz’s efforts, progress in identified categories of both Naftogaz group. ample powers to ensure cannot abuse its access to the transit and supply contracts), the gas transmission unbundling fixed and intangible assets to be maximum autonomy gas transmission system. The Gazprom now owes Naftogaz process is highly unlikely until transferred to the new TSO, and An independent TSO was (including the approval Ukrainian side is not currently USD 2.56 billion. the termination of the current developed a detailed roadmap established to facilitate an of strategy, development able to satisfy the unbundling for the implementation of effective gas market. As a link plans, financial plans and requirements because of Resolution #496 of the Cabinet between those who inject gas appointments); Gazprom’s unwillingness to of Ministers of Ukraine “On into the system and those who stick to Ukrainian and European Unfortunately, the tribunal rejected Naftogaz’s request to review the the unbundling of natural withdraw, the TSO cannot bear • a legal framework that would legislation in its relations with contract with regard to the transfer of rights and obligations to the gas transmission and storage the risks of either party. The bring the TSO’s rights to the Naftogaz. designated TSO, noting that the implementation of regulatory reform (injection and withdrawal)”. competent and independent gas transmission infrastructure in Ukraine lies in the domain of the Ukrainian authorities and is beyond energy regulator controls the as close as possible to In 2014, Naftogaz urged the tribunal’s competence in this case. The Operator of the Gas TSO’s independence along with ownership rights (including Gazprom to apply the relevant Transmission System of Ukraine observation of competition the right to pledge property); legislation to the contract for (OGTSU) branch was established rules and proper operation of Russian gas transit through and started operation as part the gas market. It is obvious that • secondary legislation, Ukraine in 2009-2019, including The current gas transit contract transit contract. Naftogaz of Ukrtransgaz. This new unbundling the transmission including network codes the right to transfer Naftogaz’s between Naftogaz and Gazprom can only fulfill its unbundling branch has tens of thousands function without accomplishing (primarily GTS Code of Ukraine, rights and obligations under is valid until 1 January 2020. requirements with Gazprom’s of assets needed for gas clear prerequisites will ensure which sets the rules for the the contract to the designated According to the contract, written consent. Otherwise, transmission along with neither desirable independence market), must comply with EU TSO. Gazprom refused to do Naftogaz alone is responsible for Naftogaz’s loss of control over the relevant personnel and of the TSO nor successful standard network codes and

48 49 OUR MARKET AND REFORMS ANNUAL REPORT 2017

hence with the Third Energy things, it is necessary to solve customers reflects this. However, Package; the problem of purchasing unbundling the transmission and funding of nearly 4.7 function without the LIBERALIZATION OF GAS SUPPLY • solving the issue of the bcm of gas that belongs to abovementioned conditions in unviable business model of Naftogaz and is currently place may lead to discrimination heat suppliers and DSOs, used by Ukrtransgaz to against some natural gas market TO HOUSEHOLD CONSUMERS, which use legal loopholes to maintain the required amount participants, including Naftogaz. shift their risks and losses to of cushion gas; There is ample evidence of the TSO, a responsible entity this discrimination, including a PSO AND SUBSIDIES SYSTEM for maintaining balance in the • reformed composition of the guaranteed supplier function system; energy regulator should win imposed on Naftogaz until the trust of market participants 2015 and the actual role of an • following the results of and international partners in entity assuming the offtakes the EC-funded technical terms of independence and of the most defaulted market assistance project, an competence. participants since 2016. This optimization program discriminative policy resulted for underground gas Currently the TSO, as part of in about UAH 28 billion in storage facilities should be Naftogaz group, is ensuring free debts owed to Naftogaz by implemented, including access to the gas transmission heat suppliers, CHPs and direct finding the most efficient way infrastructure. The absence of industrial consumers as of the to use them. Among other complaints from transmission end of 2017.

A liberalized and competitive more than 60 independent efficiency and energy saving, European-type retail gas natural gas importers. also creating conditions for market has been the main the replacement of natural gas objective of gas market reform The transformation of with other fuels or energy. for Naftogaz group. Achieving pricing policy in gas supply this will bring tangible results to household consumers, At the same time, the segment from the reform process for launched in 2014, is an obvious of gas supply to household every consumer. reason for the decline in consumers remains non- natural gas consumption by liberalized and uncompetitive. According to the market households by almost a third This is hampered by two major participants, the segment over the period from 2014 to systemic issues: imperfect of gas supply to industrial 2017. The rise in prices has and ineffective public service consumers has become contributed to a change in obligations (PSO) in the gas completely liberalized and consumer behavior, which led market and the housing highly competitive. There are to a reduction in wasteful use subsidies. now more than 400 suppliers of gas, and has become an in the Ukrainian market, and incentive to increase energy

Public service obligations in the gas market

PSO means special duties, the The current special duties for previously supplied gas. essence of which is that the model obliges Naftogaz to These companies are de facto government sets the price sell its domestically produced monopolists and operate on for gas at a level below the gas and imported gas to preferential terms in gas supply market and obliges individual designated regional gas retail to households and do not incur companies to sell gas at a companies (oblgazzbuts), any financial risks because they regulated price. The companies which are exclusive suppliers are not obliged to pay for gas on which public service to households in their in advance or to pay financial obligations are imposed are region. The company has no sanctions in case of untimely entitled to compensation for right to refuse to sell gas to post-payment. Oblgazzbut is a costs related to their execution. oblgazzbut regardless of debts de facto intermediary.

50 51 OUR MARKET AND REFORMS ANNUAL REPORT 2017 Main disadvantages of the existing PSO CURRENCY RISK NAFTOGAZ PRICE RISK VOLUME RISK FINANCE AND GAS STORAGE COST 1. The sale of gas at below not allow Naftogaz to restrict gas accrued to the group for the market prices and the supply to gas retail companies fulfillment of the duties in the Taxes and dividends absence of cost-recovery in response to non-payment. period from 1 October 2015 to mechanisms As a result, regional gas retail 31 December 2017, is more than companies have accumulated UAH 111 billion, and the company Prices set by the government more than UAH 34 billion in debts is forced to defend its legitimate are lower than market prices, in the approximately 2.5 years of interests in court in order to OBLGAZZBUTS so independent suppliers have their existence. receive compensation. The no commercial interest for the court ordered the government segment. The existing PSO In addition, the government has to determine the sources of includes no effective mechanisms not established compensation funding, and the procedure for enforcement of financial mechanisms and funding sources. for compensation for PSO. settlements between market According to Naftogaz group΄s However, the decision is still to be players. Current procedures do assessment, the compensation implemented. HOUSEHOLDS 2015–2017 PSO-RELATED LOSSES PAYABLE BY CASH PAYABLE BY SUBSIDIES COMPENSATION STATUS Consumed, Not consumed, UGV Naftogaz Naftogaz Consumed Consumed Not consumed, covered by gov't below norms 111 Foregone Related bad Related and paid and not paid fake addresses UAH bn revenue debt reserve losses PROBLEM 1 PROBLEM 2 PROBLEM 3 PROBLEM 4 PROBLEM 5 Naftogaz doesn't Inefficient debt Gas sold to ineligible Risk of Naftogaz not Gas sold to ineligible get due share of collection consumers, Naftogaz getting due share of consumers, 74.8 24.1 12.1 paid amounts will never be paid paid amounts government overpays incl. UAH bn UAH bn UAH bn Gas supply and retail to households in PSO

Problem # 1. Problem # 2. Problem # 3. • UGV and Naftogaz are entitled to a compensation of losses Lack of transparency and access Collecting debts Consumption data related to PSO according to the law On Natural Gas Market Compensation for losses to the consumer data base manipulation • CMU failed to determine the compensation policy when related to PSO claimed by imposing the PSO in 2015 and 2017 Naftogaz, as a natural gas Naftogaz has no data on An internal audit of UGV and Naftogaz • Naftogaz was successful in court and court of appeal in proving supplier to households, debtors and so cannot Kirovohradgaz, after the CMU has to determine the policy and funding sources is exposed to many risks: collect debts from them. restoration of operational fluctuations in prices, volumes This is a function of the control and change of 2. The sale of gas through income to pay for gas and heat at a reduced price is supplied to and exchange rates, as well as regional retail companies and management in June 2017, intermediaries significantly from their own pocket, which households. Naftogaz is interested gas storage costs. Oblgazzbuts as subject to inefficiency. Since revealed more than 9.8 mcm of complicates monitoring the leads to inefficient use of the state in identifying evidence of the intermediaries only bill end users. oblgazzbuts do not bear the gas allocated to non-existing use of gas as intended and budget funds. actual volumes of gas supplies At the same time, they do not financial costs of servicing the consumers or so-called "dead ensuring payments provided to households because provide Naftogaz with data on gas debt to Naftogaz, they souls". Kirovohradgaz reported To date, there is no effective it is the basis for calculating actual volumes of gas usage. The have no effective incentive to law enforcement authorities The lack of effective mechanisms, mechanism for confirmation by Naftogaz group΄s expenses for consumers do not pay directly to work efficiently with about the detected facts, which enable monitoring the use regional gas retail companies of fulfilling its special duties. In to Naftogaz, but to the accounts debtors, which leads to the but similar cases may exist in of gas as intended, creates a basis supply of certain volumes of gas the absence of compensation of oblgazzbuts. As of 1 June accumulation of gas debts. other gas distribution system for abuse. Not only vulnerable to specific consumers under the for the performance of special 2017, Naftogaz has lost access to operators (“oblgazes”) and consumers benefit from PSO, special duties framework. There duties, these costs become data on actual gas payments by oblgazzbuts, which causes but also people with a sufficient is no evidence that all the gas Naftogaz group΄s losses. customers. losses to Naftogaz.

52 53 OUR MARKET AND REFORMS ANNUAL REPORT 2017

Problem # 4. over and priority of payments subsidies helped to mitigate Lower than market prices and price revision and bringing it to and uncertainties from a legal Partial monetization of for gas, there are risks that Order the impact of rising prices on the lack of effective control over import parity level should have point of view. In the absence of subsidies No. 1 dated 4 January 2018 people, especially low-income gas use and settlements for gas been launched. However, it is adequate government action "On the procedure for treasury groups. On the other hand, the induce no interest from potential still not in effect, despite the to address these deficiencies, The settlement system for bodies to settle and finance disadvantages of the subsidy independent suppliers to this government΄s commitments to the Energy Community gas used by the recipients of local budget expenditures for system have led to excessive market segment. Household the IMF. The Energy Community Secretariat has started a process housing subsidies is imperfect. implementation of measures to spending of state budget funds consumers cannot choose a Secretariat has repeatedly drawn of resolution disputes in case From 1 January 2018, the implement state social welfare to pay subsidies and excessive supplier, and therefore this the government's attention to ECS‑2/17.28 so-called "monetization" of programs using subventions uncompensated financial losses market remains uncompetitive. the flaws in the current special housing subsidies began, from the state budget" can be for Naftogaz. These deficiencies duties model in the gas market although in fact, as before, end challenged in court. originated from inadequate On 1 October 2017, the in terms of its discriminatory, 28 https://www.energy-community.org/legal/ consumers neither receive cash targeting of subsidies, excessive mechanism of automatic gas disproportionate character cases/2017/case0217UE.html nor use the subsidy funds at Problem # 5. social standards for subsidies, their own discretion. After the Excessive consumption rates and low motivation for saving introduction of "monetization", gas consumption by the the state does transfer funds Along with price liberalization, recipients of subsidies. How to solve the problem onto the treasury accounts the government has expanded of regional retail companies. the system of targeted subsidies Analysis has shown that In view of the above-mentioned with regional gas distribution segment, which would However, no effective and for households. As of the end recipients of subsidies consume problems, in order to develop companies and deliver natural enable the consumer to efficient mechanism for of 2017, about 6.9 million twice as much gas as consumers a liberalized and competitive gas to households without realize his right to choose monitoring their target use households, which was about who live in similar buildings in retail market for gas supply intermediaries. gas supplier; exists. Although the Ministry of 45% of the total, benefited the same area but pay from their to household consumers, the – avoid excessive costs Finance tries to ensure control from it. On the one hand, pocket. following steps are necessary: 3. Improve the housing paid by the company's subsidies accrual and customers and losses 1. To regulate the compensation funding mechanism, incurred by the company; to market entities on which including implementation – increase the efficiency Subsidy recipients use twice as much gas as consumers who pay PSO are imposed or abolish of subsidy monetization of natural gas use, which the state regulation of prices at the level of the end would increase the energy their bills themselves for natural gas and switch to consumer. security of the country, market pricing. improve its trade balance Gas use for heating by consumer category* These steps would produce a and bring the country closer 2. To eliminate intermediaries number of desirable results: to self-sufficiency in natural in the retail gas segment. – attract independent gas. Naftogaz is ready to compete suppliers to the retail 73%

2.1 times more 2016/2017 KIROVOHRAD region

1.6 times 7% 1.6 times more 20% more 1.3 times more

apartment house THAN THOSE WHO PAY apartment house THEIR BILLS THEMSELVES Subsidy recipient Recipient of social benefits

* based on the analysis of Tsentrgaz client database (Kirovohrad region)

54 55 OUR MARKET AND REFORMS ANNUAL REPORT 2017 2017 IMPORTANT REGULATORY Regulatory changes Impact of the changes on the market

State companies have started A positive event for the market. implementing the new corporate CHANGES The government has begun implementation of a new model of governance model. corporate governance for state companies for enhancing the Resolution № 142 of the Cabinet of Ministers of Ukraine efficiency of the activities of public sector economic entities. It is "On Certain Issues of Governing the State Unitary expected that the new model will provide a financial benefit for Enterprises and Economic Entities, 50 Per Cent or More the state budget while having a positive impact on the national The process of harmonization of Ukrainian legislation with the European rules of the natural gas market of the Shares (Stakes) in the Authorized Capital of economy and business environment, which would enhance and the Law of Ukraine "On the Natural Gas Market" significantly slowed down in 2017. which Belong to the State" of 10.03.17 has approved: Ukraine's attractiveness for foreign investors and ensure the depolitization of the work of state companies. The procedure for the creation, organization of activities, and liquidation of the supervisory boards of state unitary enterprises and their committees; The procedure for performing the competitive selection of candidates for the position of independent Regulatory changes Impact of the changes on the market members of the supervisory boards; The requirements for independent members of supervisory boards of state unitary enterprises and their Rent payments for natural gas extraction A positive event for the market that appointment, as well as to performing the competitive were reduced. selection of candidates to positions of independent would facilitate the development of the extraction industry and members of supervisory boards of economic entities, The Law of Ukraine № 2245-VIII "On the Introduction of fulfillment of the 20/20 Extraction Program for the purpose of 50 percent or more of shares (stakes) in the authorized Amendments to the Tax Code of Ukraine and Certain Legal ensuring the country's power independence. capital of which belong to the state. Acts of Ukraine On Ensuring the Balancing of the Budget Revenue in 2018” of 07.12.17 was adopted. Thus, rent payments for natural gas extraction for new wells were reduced to 12% (for the wells up to 5 000 m deep) and Measures aimed at the harmonization A neutral event for the market, to 6% (for the wells deeper than 5 000 m). The Law also of natural gas consumption metering to provided for the reduction of the rent payment for gas since currently the natural gas consumption metering in Ukraine condensate from 21-45% to 14-29% from 1 January 2019. European standards have been taken. is carried out in m3 under standard conditions in accordance The Law fixed adopted rent payments until 2023. The NCREU Resolution № 84 of 26.01.17 "On the Approval with "GOST 2939-63 Gases. The terms for determining the of Amendments to Certain NCREU Resolutions on the volume" (temperature 20°С and absolute pressure 101.325 kPa). Introduction of Use of the Units of Energy in the Natural Natural gas consumption metering in EU countries is carried Gas Market" obliges gas distribution system operators to out in units of energy. Ukraine and EU countries use different provide natural gas consumers information in payment measurement units for natural gas volumes, which creates documents on consumed gas volumes in units of energy obstacles for doing business with European partners and slows along with the volumes of natural gas in m3. At this stage down the process of integration of the Ukrainian gas market into The licensing terms for performing A positive event for the market, the transfer of the natural gas market to settlements in the EU gas market. the economic activities in the natural units of energy has not taken place. which concerns the fulfillment of provisions of the Law of gas market were approved. Ukraine "On the Natural Gas Market" and is aimed at the The NCREU Resolution № 201 of 16.02.17 "On Approval of formation of the natural gas market through establishing a the Licensing Terms of Performing the Economic Activities comprehensive list of requirements for the economic activities in the Natural Gas Market" was adopted. on transportation/storage/distribution/supply of the natural gas, and gas (methane) of coal fields, which are mandatory for The period of installation of individual meters A positive event for the market. fulfillment by the licensee and which the license receiver should for natural gas consumers has been extended. meet in order to receive their license. The extension of the period of installation of gas meters for The Law of Ukraine № 2260-VIII "On the Introduction household consumers was conditioned by the inefficiency of Amendments to the Law of Ukraine "On Ensuring of state regulatory policy over the period of validity of the Commercial Metering of the Natural Gas Consumption" previous wording of the Law, specifically, concerning the tariff Concerning the Procedure for the Installation of the regulation, which did not ensure the adequate financing of Meters for the natural Gas Consumers" of 21.12.17 measures for the installation of meters in order to meet the The Law of Ukraine "On Fighting Corruption" A negative event for the market. extends the period of installation of gas meters for the requirements of the Law within the established deadlines, has been extended to the members of the The amendments to the Law of Ukraine "On Fighting Corruption" population until 1 January 2021. It is envisaged that and the inefficiency of measures of regulatory control supervisory boards of the legal entities of pose risks for the attraction of qualified persons to the supervisory meters will be installed at the expense of the state over the efficiency of use of the tariff revenue by the GDN public law, specifically, state enterprises and boards of the economic entities of the state sector. budget. The consumers who install the gas meters operators for financing the measures on the installation of state organizations whose aim is to receive themselves during 2018 will receive compensation over meters. profit. a 12-month period. However, there are difficulties in the practical implementation The Law of Ukraine № 1975-VIII "On the Introduction of of the Law concerning the compensation of expenses to Amendments to Certain Laws of Ukraine on the Peculiarities household consumers who install individual gas meters of Financial Control Over Certain Categories of Officials" of themselves. 23.03.17 has been adopted.

56 57 OUR MARKET AND REFORMS ANNUAL REPORT 2017

Regulatory changes Impact of the changes on the market Regulatory changes Impact of the changes on the market

Amendments to the GTS Code concerning A negative event for the market. Public service obligations have been A negative event for the market. balancing in the natural gas market have been The said Resolution was adopted in violation of Article 33 imposed on the company and the gas The effective PSO regime is excessive and goes beyond the introduced. of the Law of Ukraine "On the Natural Gas Market", which extraction companies of the Naftogaz group minimum sufficient for achieving the real goal of ensuring the fixed the GTS operator's right to develop the GTS Code. (Ukrgazvydobuvannya, Chornomornaftogaz). On 27.12.17 the NCREU approved Resolution № 1437 "On general public interest in the functioning of the natural gas the Approval of Amendments to Certain NCREU Thus the GTS operator PJSC Ukrtransgaz developed a By virtue of the CMU Resolution № 187 "On the Approval market. Instead, it has damaged competition in the retail natural Resolutions on the Introduction of the Daily Balancing new draft GTS Code for the purpose of implementation of the Provisions for Imposing Special Obligations on gas market, having created preferences for certain regional in the Natural Gas Market and the Procedure for the of balancing in Ukraine in accordance with the the Natural Gas Market Entities for Ensuring the General suppliers (oblgazzbut). The adoption of the Resolution has raised Development, Submission and Approval of the Gas Regulation (EU) 312/2014 and submitted it to the Public Interests in the Process of Functioning of the doubts over the proper fulfillment by Ukraine of its obligations Transportation System Development Plan for the Next working group at the NCREU on 30.06.17. Natural Gas Market" of 22.03.17 (hereinafter – the "PSO") under the Treaty Establishing the Energy Community, which 10 years ". In the course of work of the working group on this the gas extraction companies of the Naftogaz group have forced the Secretariat of the Energy Community to initiate the project, the necessity to finalize the draft GTS Code arose. had imposed special obligations to sell gas of their own respective proceedings against Ukraine (Case ECS-2/17). Without having waited for the updated draft from the extraction to the company for the purpose of formation of GTS operator, the NCREU developed amendments to a natural gas resource for household consumers, religious the GTS Code concerning the daily balancing itself and organizations and heat energy producers (subject to Besides, the price at which natural gas is sold and supplied on 21.09.17 published them on its website for public fulfillment of the established conditions thereby). under the PSO does not correspond to the market price, which discussion. The draft GTS Code finalized by the GTS contradicts the memorandum on economic and financial policy operator and sent to the NCREU on 28.09.17 was left approved by the International Monetary Fund on 01.09.16. without consideration by the regulator. The CMU Resolution № 166 of 28.02.18 also included the International children's center Artek in the PSO consumers category. The company and PJSC Ukrtransgaz participated in all the meetings held by the NCREU on daily balancing and repeatedly voiced their comments on the inconsistency The CMU Resolution № 228 of 28.03.18 extended the of the amendments developed by the NCREU with period of validity of the PSO until 01.06.18. the Regulation (EU) 312/2014, as per both form and The implemented PSO mechanism in general causes significant substance. losses for the company and the Naftogaz group companies, due to the high level of debt to the company for natural gas sold Irrespective of these critical comments, the NCREU The CMU Resolution № 415 of 30.05.18 extended the under the PSO (as of 08.05.18 the debt of the regional suppliers approved amendments that compromise the existence period of validity of the PSO until 01.08.18. to the company comprised about UAH 25.4 bn, the debt of of the balancing system as such and risk causing heat energy producers comprised about UAH 27.3 bn), and the significant financial losses for the GTS operator and other lack of a mechanism of compensation to the entities where the participants of the market. This immediately concerns PSO has been imposed (which is required by the Law and is an the incorrectly determined neutrality mechanism as integral part of the PSO mechanism). the basis for the daily balancing and the inclusion of unauthorized off take volumes into the balancing process in contradiction to the requirement of the Resolution (EU) 312/2014. Besides, the amendments approved by the regulator are discriminatory in relation to the suppliers with special obligations, since the approved new wording of the GTS Code envisages that the GTS operator will determine A nontransparent mechanism for the A negative event for the company. the consumers which shall be entitled to receive natural allocation of funds from the special accounts The loss of validity by Part 6 of Article 11 of the Law of Ukraine gas under PSO through completing the information of regional natural gas suppliers has been "On the Natural Gas Market" on 01.04.17 and the simultaneous platform, whereas the rest of the suppliers will carry approved. extension of validity of the special obligations regime has out the registration of their consumers themselves. resulted in the extension of validity of the special accounts Such automatic registration contradicts the provisions On 01.10.17 the CMU Resolution №667 "On the Introduction of Amendments to the Resolution of the regime through adopting the CMU Resolution №296 of of the Law of Ukraine "On the Natural Gas Market", in 26.04.17 according to which funds from the special accounts accordance with which it is the Cabinet of Ministers Cabinet of Ministers of Ukraine №296 "Certain Issues of Settlements for the Consumed Natural Gas" of 26.04.17" of oblgazzbuts were transferred by authorized banks at rates of Ukraine that determines the terms for the supply of which were previously approved by the NCREU. However, the natural gas under the PSO. of 23.08.17 came into force. The provisions of Resolution № 667 have approved a nontransparent mechanism for CMU Resolution № 667 of 23.08.17 has significantly changed Neither does the new wording of the GTS Code, as the allocation of funds from special accounts, which in the mechanism of special accounts and envisaged that from adopted by the NCREU, take into consideration the practice allowed unfair suppliers to receive more funds 05.09.17 natural gas suppliers (oblgagzzbut) would unilaterally GTS operator proposals, which would significantly than the maximum trade markup established by the determine rates and amounts of fund transfers without improve the work of the natural gas market government. agreement with the other participants of the settlements and (specifically, concerning the elimination of limitations provide to authorized bank institutions payment orders for the for the allocation of capacity of interstate points, transfer of funds. implementation of the mechanism for exercising of right The change of the procedure has resulted in further to have several suppliers during one gas day by large accumulation of debt of oblgazzbuts to the company which as industrial consumers, etc.). of 08.05.18 constituted UAH 25.4 bn.

58 59 OUR MARKET AND REFORMS

Regulatory changes Impact of the changes on the market

The procedure for financing benefits and A negative event for the company. OUR PERFORMANCE housing subsidies for the population has been The positive idea of facilitating the procedure for the financing changed. of subsidies and their monetization at the level of providers of The CMU Resolution № 951 "On the Introduction of housing and utility services as a result of implementation of the Amendments and Recognizing Void Certain Resolutions of non-finalized mechanism which contains a number of gaps and the Cabinet of Ministers Ukraine" of 08.11.17 has changed weaknesses may result in the accumulation of debt for natural the procedure for the payment of subvention funds for gas to the company as the wholesale seller and supplier with financing benefits and housing subsidies from 01.01.18. special obligations in 2018. Besides, the adoption of the Resolution would also result in a decrease in the transfer of funds to the company's accounts from special accounts of heat supplying enterprises in accordance with the CMU Resolution №217 of 18.06.14.

The introduction of changes to the procedure A negative event for the company. of allocation of funds from DHC special The CMU Resolution №70 has reduced the adjusting factor for purpose accounts. natural gas settlements with the company and, respectively, the During 2017, the CMU Resolution № 217 of 18.06.14 has rate of transfer of funds. CMU Resolution №492 has increased the been amended three times (by the CMU Resolutions maximum rate of transfer of funds by the DHC and, respectively, №70, 492, and 951) and the amendments were aimed reduced the maximum rate of transfer of funds to the company. exclusively at the reduction of the volume of settlements The total negative economic effect of the adoption of these two of DHCs with the company and an increase of the share of resolutions for the company constituted UAH 0.4 bln in 2017. funds at DHC disposal. The CMU Resolution №951 granted DHCs the right to reduce the amount of settlements using ready cash by 25-30% of any amount of settlements with the company when using benefits and subsidies.

60 OUR PERFORMANCE ANNUAL REPORT 2017 BUSINESSES GEOGRAPHICAL DISTRIBUTION OF NATURAL GAS RESOURCES IN UKRAINE Naftogaz group has the largest company, according to the amounted to 308 bcm, oil and reserves of oil and gas in Ukraine. PRSM30, classification, natural gas gas condensate reserves (proven OF NAFTOGAZ GROUP According to the estimates by reserves (proven and probable) and probable) amounted to Miller and Lents company and 51 million tons. DeGolyer and MacNaughton 30 Petroleum Resources Management System

Oil and gas Oil and gas Natural gas, condensate, Natural gas (million condensate bcm million t barrels of oil equivalent)* (million barrels)* Naftogaz** proven developed – – – – proven undeveloped – – – – probable – – – – production of hydrocarbons – – – – increase in hydrocarbons reserves – – – – Reserves as of 31.12.2017 – – – – Resources as of 01.01.2017 104.85 15.21 620.43 110.71 resources located in the ATO zone and theannexed territory 104.85 15.21 620.43 110.71 Resources as of 01.01.2016 (excluding the ATO area and the annexed – – – – territory) Ukrgazvydobuvannya CHANGE IN PRESENTATION OF BUSINESSES proven developed 205.80 4.18 1 218 37.60 proven undeveloped 19.76 1.18 117 10.90 probable 40.92 2.01 242 16.70 In 2018, Naftogaz changed its Among other key changes, business and Oil Transit production of hydrocarbons in the second half of 2017 7.77 0.23 46 1.67 approach to the composition of Naftogaz has started to: business separately from increase in hydrocarbons reserves in 2017 15.40 0.24 91 1.75 businesses (see details in Note Oil Domestic Transmission Reserves as of 31.12.2017 274.10 7.38 1 622 53.71 4 to Consolidated Financial identify four main groups of business (because of high Resources as of 30.06.2017 186.20 6.40 1 102 48.40 Statements for 2017). customers in respect to gas concentration risks in gas Ukrnafta production, imports, sales and transit business from its only proven developed 14.52 14.48 85.89 105.39 The change in the composition supply: client, PJSC “Gazprom”, and proven undeveloped 7.50 9.66 44.38 70.31 of businesses is explained by: • sales to regional gas supply in oil transit business from its probable 10.72 16.28 63.46 118.50 1) respective changes to companies (RSC) for the needs only client, JSC "Transneft"); production from 01.07.2016 till 31.12.2017 1.75 2.10 10.37 15.27 assessment and monitoring of of households increase in hydrocarbons reserves from 01.07.2016 till 31.12.2017 – – – – operational efficiency of key • sales to municipal heat disclose operating cash Reserves as of 31.12.2017 30.99 38.32 183.36 278.94 businesses by management; generating entities (MHE) for flows for each business Resources as of 01.01.2017 18.16 84.73 – – 2) necessity of providing an the needs of households segment of the group, Egypt accurate picture of the • sales to other customers under because it helps to proven developed 0.76 1.20 4.50 8.76 company's performance by PSO demonstrate segment- proven undeveloped 0.30 0.91 1.78 6.61 breaking its activities down • supply to other customers specific problems related to probable 0.47 0.80 2.80 5.82 into different client-based outside PSO non-payments (in particular, production of hydrocarbons 0.51 0.92 3.02 6.71 segments (that capture all gas sales to RSCs, gas Reserves as of 31.12.2017 1.04 2.05 6.12 14.95 Resources as of 01.01.2017 0.96 2.43 5.67 17.66 the relevant costs along the Each group of customers has supplies to municipal heat Group value chain incurred providing its own selling price setting generating entities and gas proven developed 221.08 19.86 1308 151.75 specific services and/or goods procedure and its own transmission pipelines); proven undeveloped 27.73 11.63 164 87.03 29 to client or clients ). economic characteristics, such probable 52.15 19.21 309 141.92 as product delivery to end disclose net working production of hydrocarbons 9.53 2.39 56 17.42 customers, their credit risks etc. capital and value of increase in hydrocarbons reserves 16.44 2.29 97 16.69 Therefore, these four groups fixed assets of each Reserves as of 31.12.2017 307.86 50.61 1822 379.97 29 In particular, segment result of Gas production, import and sales to RSC's for constitute different businesses segment, because it helps Resources as of 01.01.2017*** 205.32 93.56 1215 681.09 resale to households includes not only the according to management; to calculate return on Sources: The report on assessment of proven, probable and possible hydrocarbon reserves of PJSC Ukrgazvydobuvannya, prepared by Miller and Lents as of June 30, 2017. The report on assessment of cost of production, purchased and sold gas, invested capital of group’s stocks and revenue and conditional resources in some deposits of Ukrnafta prepared by DeGolyer and MacNaughton as of July 1, 2016. The values specified are calculated by subtracting the but also relevant allocated storage- and volumes of hydrocarbons produced in the second half of 2017 from and adding the reserves increments for the same period to the value of reserves estimation for the same period. transmission-related costs, while results of demonstrate results of key businesses (with * To convert the volumes of oil and gas condensate into barrels, a coefficient of 7.28 per 1 metric ton of oil is used. For the conversion of natural gas into the oil equivalent, a Gas Storage Business refect value chain of the Gas Transit business appropriate adjustments coefficient of 169 cubic meters per barrel is used. gas storage services provided to third-parties separately from Gas to demonstrate correct ** In 2017, DerzhGeonadra annulled the special permits for the use of the subsoil and the Naftogaz's right to develop the Budyschansko-Chutivsky, Obolonsky and Pysarivsky gas only (i.e. external users of underground gas fields, therefore the Naftogaz's reserves of hydrocarbons as of December 31,2017 are zero. storages) Domestic Transmission value of invested capital). *** The resources do not include the resources located in the temporarily annexed territory.

62 63 UGV FIELDS 2.2 that produced more than 2/3 of total production EASTERN OIL AND 90.9 85% GAS REGION Production in 2017, bcm 1.0 1.0 2 Remaining reserves as of 30 June 2017 , bcm 17.2 50% % extracted from reserves 7.4 67% Licensed fields Fissure (Dnipro-Donets Rift)

0.3 WITHOUT RECEIVING NEW LICENSES, UGV 0.9 63%

WILL NOT BE ABLE TO INCREASE GAS SUMY REGION PRODUCTION IN 2020 AND BEYOND Kulychyha oil, gas and condensate field 0.3 223 464 500-600 20.5 licensed licensed million t in oil bcm 2.4 18% 0.9 equivalent 0.4 fields fields Tymofiivka oil,gas and ** 22.2 85% 0.9 3% 3% condensate field 5.3 62% 0.3 13.8 17%** 73% 32% 0.4 31% Yablunivka oil, gas and 3.8 74% 1 5.2 64% 5% WESTERN OIL AND condensate field Yuliivka 13% GAS REGION Komyshnia gas and gas and condensate field1 condensate 21% Kotelva gas and 0.6 field 1 KHARKIV 59% 18% condensate field 2.5 42% 0.5 0.4 REGION 0.07 Berezivske gas and 67% 22% condensate field1 4.1 67% 1.5 54% 0.3 16.0 3% 0.08 3.1 91% 16% 38% 45% 75% 2.2 85% 0.4 Svydnytsia gas field Khidnovychi gas field POLTAVA Western 73% Licenses Acting Recoverable Production LVIV Khrestyshche REGION gas and issued over licenses* oil and gas in 2017, 0.05 REGION condensate 4.9 the past 10 reserves bcm 36% field years* Mashivka gas and Medvedivka Melyhivka 1.2 condensate field gas and gas and 0.08 condensate condensate field Yefremivka gas and Other private production companies 1.2 38% field condensate field Shebelynka gas and Letnia gas and condensate field condensate field Kehychivka TOP-7 private companies gas and Bilche-Volytsia gas field condensate Ukrnafta Kobzivka field gas and UGV condensate field *as of 2016 **estimate 0.1 2.9 90% Despite accounting for ≈ 45% IVANOFRANKIVSK REGION of licenses, UGB represents 75% ZAKARPATTIA of production Bytkiv-Babche oil, gas and REGION condensate field Only 15% of all license applications DONETSK (36 out of 223) were granted to UGV CHERNIVTSI REGION over the past 10 years REGION DNIPROPETROVSK A third of all new licenses are issued to companies accounting for only 3% REGION of production 1 Gas deposits deeper than 5000 m 2 Report on estimation of hydrocarbon reserves and resources calculated by Miller and Lents Ltd (USA) OUR PERFORMANCE ANNUAL REPORT 2017

at UAH 4942/ tcm to cover Gas production by Ukrgazvydobuvannya, bcm residential demand (from SALES TO REGIONAL GAS SUPPLY households and municipal 2016 2017 heating enterprises). Prices, conditions and supply procedures Total: 14.6 15.3 COMPANIES FOR THE NEEDS are set out in the regulations marketable gas (for households and other 13.0 13.9 of the Cabinet of Ministers of PSO consumers) Ukraine. In particular, because of joint ventures 0.9 0.5 the existing regulatory regime, OF HOUSEHOLDS operating needs 0.7 0.9 Naftogaz does not supply gas to households directly but to designated private intermediaries beneficiary being Dmytro Operating cash flow margin32 KEY RESULTS OF THIS BUSINESS SEGMENT: who further resell it to Firtash). of the “Gas production, import households. and sales to RSC's for resale Second largest business of Naftogaz group by revenues (23.9% of total). According to RSCs, this debt was to households” segment for As a result, gas supplying formed because of household 2017 considerably improved Domestic production by Ukrgazvydobuvannya (which increased by 4% to a 24-year maximum in companies, the so called consumer debts to them. But compared to 2016, which was 2017) is the main source of gas for this segment. “oblgazzbuts” which supply gas Naftogaz cannot check if the gas mainly explained by an increase sold by RSCs to other parties in subsidies financing. As long Sales volumes to retail supply companies in 2017 were 11 bcm (-5% y-o-y). Naftogaz is still not to households and are controlled mainly by the group of one of had not been written off as as operating cash flows for allowed to supply gas directly to households under the existing PSO regime. the notorious oligarchs remain household consumer debt. Due 2017 comprises repayments of Nontransparent and unfair intermediaries between Naftogaz and households are the main a monopolistic intermediary to non-transparency, there is the debts for gas sold in prior roadblock for this segment. Due to accumulation of debt owed by retail supply companies between Naftogaz and a substantiated suspicion that financial years (mainly in 2016), consumers in the retail market RSCs write off the unconsumed average operating cash flow (equivalent to more than USD 1 bn for the last two years), average cash flow margin31 in 2016-2017 due to preferences granted by the gas to the household consumers margin for 2016-2017 better was nearly 3%. government. In practice, all these whose consumption is covered represents the financial results Return on Invested Capital (ROIC) of this business in 2017 was four times lower than cost of intermediaries do is generating by subsidies (which in its turn of this segment if compared capital rate (4.5% vs 18.7%). This gap suggests that the current model of this business does not invoices and collecting increases the amount of subsidies money from households. and expenditures of the State unlock the potential for creating additional value for the company's shareholder. Trade accounts receivable The intermediaries receive a Budget). for gas supplied to RSC for commission envisaged by the household needs, UAH bn 31 Operating Cash Flow Margin is calculated as operating cash flows from sales of gas to retail supply companies government, which increases There are grounds to believe (net of respective operating costs) divided by revenues. the gas price for the households. that the RSCs and related DSO They do not create any additional use their market position in the value (since there are separate retail gas supply segment and 30.1 companies – "oblgazes", and not the possibilities based on the In 2018, Naftogaz has changed (100% of which is owned by hampered higher growth of gas oblgazzbuts, which are involved difference in prices for the PSO 21.8 its approach to the presentation Naftogaz). UGV produced 15.3 output. in the servicing and repairs of the and industrial consumers to sell of businesses. The segment bcm of gas (74.3% of Ukraine’s pipelines and meters), and do not it illegally to industrial consumers result is calculated based on total) in 2017, which is 0.64 bcm In 2018, UGV plans to increase bear any risks related to ordering which is recorded as used under revenues from selling gas or 4.2% higher if compared to gross output to 15.9 bcm of gas natural gas and price fluctuations the PSO and used to cover to customers and all costs 2016. Over the past two years, (+650 mcm by 2017). The initial when supplying natural gas to technological needs of DSO. While household consumers. there remains a possibility to take incurred along the value chain. the company managed to production plan was 16.5 bcm 3.2 These include costs related increase gas production thanks in 2018, but it was adjusted due gas from Naftogaz on beneficial to exploration, production, to optimized field development, to problems with issuing of new There is an issue, that the RSC conditions, this issue is unlikely purchasing and selling gas, increased production drilling licenses by regional councils business is nontransparent. to be resolved. There should 31.12.2015 31.12.2016 31.12.2017 including allocated costs and production enhancement and slow deregulation of the These intermediaries, on the one also be a centralized consumer related to the business without operations including hydraulic industry. In order to increase gas hand, accumulate large debts for base, but it would never work with operating cash flow margin applying transfer prices fractures, coil tubing, etc. production, UGV plans to increase gas they take from Naftogaz. In in practice until there are separately for 2016 and 2017. between value chains. Meanwhile, delays in extending its drilling volume by almost two- 2017, the total debt of regional significant economic incentives The average operating cash and granting licenses by the State fold to 460 thousand meters. suppliers for the natural gas sold not to provide data on certain flow margin was just 3.1%. Such The main gas source for this Geology and Mineral Resources to them by the company under consumers. In this situation, it is a modest result reflects the the effective PSO mechanism logical that Naftogaz demands segment, primarily for sale Service of Ukraine, blocking of All marketable gas produced 32 Operating cash flow margin is calculated as Net to the regional gas retail licensing processes by regional by UGV in 2017 was purchased increased by UAH 8.3 bn (or bringing prices to the market segment cash flows from operating activities companies, is gas produced by councils, and overregulated land by Naftogaz at a price of by 38%), of which 65% are the level and having direct relations divided by revenues of the segment according RSC companies (the ultimate to Consolidated Financial Statements as at and Ukrgazvydobuvannya (UGV) allocation procedure have all UAH 4849/ tcm and sold with the consumers. for the year ended 31.12.2017.

66 67 OUR PERFORMANCE ANNUAL REPORT 2017

SURPLUS CMU AVERAGE OPERATING CASH FLOW MARGIN OF profit from OBLIGED "Gas production, import and sales to RSCs for resale difference NAFTOGAZ to households" for 2016-2017 in prices TO SUPPLY GAS WITH DISCOUNT 3.1% Main scheme TO RSCs AVERAGE ROIC OF "Gas production, import and sales to RSCs for resale of RSC ATTRIBUTE GAS TO CAN BE SOLD TO THE 4.7% to households" for 2016-2017

problems with poor payment HOUSEHOLDS* INDUSTRIAL SECTOR NONE ROIC vs cost of capital, UAH-denominated, % FOR CASH PAYS NAFTOGAZ discipline of regional supply GOR GAS companies. As mentioned above, during 2016-2017 trade 20 18.7 18.7 accounts receivable for gas sold The debt remains with RSCs to regional supply companies for 14.5 RSC is a dummy without assets resale to households increased 15 Gas is attributed to non-existing users as by USD 1 billion. their debt to RSC * high level of payments for actual consumption 10.1 Low ROIC33 of the “Gas production, % 10 import and sales to RSC's for resale to households” segment 5.0 5 4.5 PRICE LIMITATION ISSUES – PRICES ESTABLISHED UNDER THE PSO ARE LOWER was also low on average 4.7% THAN IN THE UKRAINIAN WHOLESALE MARKET for 2016-2017 – both because of lower than market gas 0 1. Losses for the state. The under-receipt of income in comparison with the alternative to sell gas at selling prices (imposed by PSO 2016 2017 market prices. In turn, lower company income means lower state budget income. Even the increase Regulation) and accumulation of in expenses for subsidies does not change this simple rule, since by no means all consumers receive debts. ROIC Hypothetical ROIC Cost of capital rate subsidies. In 2018, Naftogaz group asked economically justified expenses production assets evaluated 2. Social injustice. The underpricing of gas sales to household consumers below the market level which the Cabinet of Ministers of reduced by the income received according to the market value) actually means hidden subsidies for gas consumers received even by those who are able to pay the Ukraine to compensate the loss in the course of PSO performance, and net working capital. market price. Moreover, the higher the consumption – the more hidden the subsidy. Those who do not of UAH 111 billion for supply and taking into account the consume gas, do not receive such subsidies at all. Such allocations of public wealth is unjust. of gas under public service acceptable rate or return. The consideration underlying 3. Distortion of economic incentives for energy efficiency and energy saving obligations (PSO). The right Naftogaz group's corporate of companies to demand the If PSO compensation claimed by strategy implies that an efficient 4. It is impossible to create a real retail gas market. There are no substitutes to free pricing as the key determination of sources of the company for gas sales to RSC alternative to the current system factor of market development. There is no competition without market pricing. World practice proves financing and the procedure for for resale to households was paid of gas supply to households is that competitive pricing is better than state regulation of prices for consumers in the medium and long- compensation for PSO by the for 2016 and 2017, hypothetical the creation of a transparent term perspective. government is confirmed in court. ROIC of this business would be gas market for the population According to the Gas Market 10.1% and 14.5% respectively. with the possibility of selection 5. Drop in the investment attractiveness of gas production in Ukraine. Even now, private production Law, the group has the right to This hypothetical ROIC would be of the supplier. This would allow in Ukraine covers all consumers with an acceptable credit risk level. Therefore, investors understand that receive compensation for its significantly higher if compared Naftogaz group to receive the additional volumes of produced gas would have to be sold to household consumers and heat producing with unadjusted value, but it is money for the produced gas and companies. Investors cannot forecast the prices to be established by the state for this category of still lower than cost of capital of monetize the profit of the gas 33 ROIC is calculated as NOPLAT divided by market consumers. The impossibility of forecasting prices reduces the industry's investment attractiveness. 34 value of invested capital, which was determined 18.7% due to high invested business. So far, the gas business 6. Incentives for arbitration (resale) and corruption, due to different prices for one and the same as a sum of invested capital in fixed assets capital in fixed assets (mostly is funded at the expense of based on estimation of its market value and product. net working capital as of the end of the year. transit. Market value of invested capital in fixed assets, 34 Cost of capital is estimated by independent 7. Difficulties in relations with international creditors,receiving respective financing and attracting mostly represented by upstream assets, appraisers to determine the fair value of In order to do that, it is necessary cheap loans. was estimated as monetary value of 2P gas property, plant and equipment of PJSC “National reserves audited and appraised by independent Joint Stock Company ’Naftogaz of Ukraine’” as of to get rid of the monopoly O&G consulting firm. 31.12.2017. intermediaries represented by

68 69 OUR PERFORMANCE ANNUAL REPORT 2017 the regional supply companies or gas supply to the population and untimely financing or failure to force them to make settlements infringement of interests of other finance the accrued subsidies with Naftogaz. Instead, the market participants, which would by the state), the opening of the GAS PRODUCTION, IMPORTS AND intermediaries attempt to divert be impossible under significant household consumers market attention from the fact that their competition. Under certain would result in significant position in the market results in conditions (if non-payment competition and the emergence SUPPLY TO MHE'S FOR THE NEEDS non-admission of competition in risks are eliminated, including of private suppliers. OF HOUSEHOLDS WHAT NAFTOGAZ WAS AND IS PROPOSING?

1. To review the obligation may supply gas directly to They should also have an imposed by the CMU on the consumers which do opportunity to retain a Naftogaz to sell gas to not want to select another portion of the saved money the regional supplying supplier for any reason. for themselves. This would companies at a beneficial be the best incentive to price and without any 2. To monetize subsidies. reduce gas consumption. guarantee of payment Money for subsidies In its turn, it would help to KEY RESULTS OF THIS BUSINESS SEGMENT: by the monopoly should be received not by get rid of the necessity of Fourth largest business of Naftogaz group in terms of revenues (10% of total). intermediaries. intermediaries, but by the importing gas at all, and Consumers should select gas consumers directly. The result in export parity in Sales volumes to municipal heating enterprises supplying heat to households in 2017 were 4.6 bcm suppliers themselves and the consumers must have the prices instead of import (-20% change y-o-y). This segment sources gas both from imports and domestic production by the suppliers should produce right to spend this money parity. group. gas themselves or buy it in both for payment for gas the free market. Naftogaz and energy efficiency. Financially unsustainable model of residential municipal heating “business” translates into low payment discipline among this segment’s customers. That is the key problem for the segment. Average operating cash flow margin of this business in 2016-2017 was negative, with average ROIC 6x KEY PROBLEM: lower than cost of capital (3.0% vs 18.7%). · Ineffective gas downstream market (due to market regulation and poor payment discipline of downstream market players) MITIGATION INITIATIVES: • gas market liberalization (incl. PSO revision, subsidies monetization, retail players transparency) Trade accounts receivable • presence in retail household segment Current regulation defines “Gas domestic transmission” for gas supplied the right of municipal heating for details). • strategic partnership with existing retail players or provider of retail services (e.g. UkrPoshta, Privat Bank, to MHE (supplying gas Osсhadbank) enterprises producing heat for households to purchase The abovementioned to households), VALUE FOR OVERALL MARKET: natural gas from Naftogaz accumulation of debts is UAH bn • Increase in efficiency of gas consumption under PSO, and the obligation explained by unsustainable of Naftogaz to supply gas to model of residential municipal • Lower sustainable market prices and better service quality for end-consumers (stronger competition, reducing this category of consumers heating “business” that system cost via eliminating inefficiency, stimulation of energy efficiency) at subsidised prices. Over translates into low payment 16 14.15 14.13 • Lower government expenditures on subsidies the last two years, gross debt discipline of segment 14 for gas supplied for these customers. In addition, 12 purposes has increased Naftogaz was obliged by law35 twofold, by approximately to restructure MHE debts for 10

UAH 7 bn. Almost zero gas supplies before July 2016 UAH bn 8 6.76 increase in debt over 2017 is for five years without any 6 explained by accumulation indexation. of debts for unauthorized 4 withdrawal of gas by MHE's, 35 The Law of Ukraine “On measures aimed at 2 which is allocated to another settlement of the debts of municipal heating business segment (see companies and enterprises of centralized wa- 0 ter supply and drainage for consumed energy” 31.12.2015 31.12.2016 31.12.2017 section with description of # 1730-VIII as of 03.11.2016.

70 71 OUR PERFORMANCE ANNUAL REPORT 2017

municipal heating business or invest in rehabilitation for timely settlements, and issues should be secured not at and modernization of the a decrease in Naftogaz’s AVERAGE OPERATING CASH FLOW MARGIN the expense of destabilization system. The deterioration of contingent assets due to writing of “Gas production, imports and supply to MHE's for the of the financial position of district heating infrastructure, off of accrued fines. Naftogaz by writing off this debt in turn, leads to a decline in –1.1% needs of households” business for 2016-2017 (which is also, in its substance, a quality of service. As a result, In 2017, Law 1730 also had a hidden subsidy). willingness to pay drops, and negative impact on Naftogaz's some customers39 completely current operations, enabling Therefore, a number of issues disconnect from the district debtors not to maintain the AVERAGE ROIC must be addressed in order heating system, leading to level of payments for consumed of “Gas production, imports and supply to MHE's for the to achieve “turnaround” and decreased revenues that do not gas at an appropriate level. As the long-term viability of the even cover current regulated stated above, in accordance 3.0% needs of households” business for 2016-2017 municipal heating sector. In revenues of district heating with PSO regulations, Naftogaz particular, addressing these companies. In order to break is obliged to supply natural gas issues may involve changing this vicious cycle, tariffs need to to MHEs (even if there are debts) heating tariffs to: reflect the full cost of providing under certain conditions. Such service40. Quality of service conditions include the presence Average operating cash Gas production, import and sales to MHE for the needs of i) eliminate hidden subsidies should improve, leading to of a contractual agreement on 36 flow margin of the “gas households business: UAH-denominated ROIC vs cost of capital rate, % that take needed funds increased willingness to pay, the restructuring of the debt for production, import and away from other things while customer retention would consumed natural gas within sales to MHE for the needs including gas, operation and improve leading to higher the framework of the Law 1730, of households” segment for maintenance, and return on revenues for MHEs. in connection with which a 2016-2017 was negative 20 18.7 18.7 invested capital of municipal significant number of municipal (-1.1%), though it improved heating companies; Bad faith behaviour among heat producers hoped to pass last year compared to 2016 management of some MHEs the heating season of 2017-2018 mostly due to an increase 15 13.3 12.1 ii) cover the return on new supplying gas to households by fulfilling only this particular in the amount of subsidy invested capital needed to is another problem of this condition. financing by the state. As long % 10 maintain and refurbish the business segment. Providing as operating cash flows for system. financial guarantees by MHEs to The Law 1730 extends to MHEs 2017 comprises repayments Naftogaz (eg. the requirement included by the Ministry of of the debts for gas sold in 5 However, there is no easy way to provide guarantees from the Regional Development in the prior financial years (mainly in 3.1 3.0 to reach this goal based on tariff owner of the district heating Register of Enterprises that 2016) and due to a substantial change alone, because raising network) may partially solve this participate in the mechanisms reduction in gas supply to 0 tariffs has social constraints as problem. provided for by this Law. At the MHE segment for residential 2016 2017 many people in Ukraine are end of 2017, there were 198 consumers by 20% in 2017 vs. ROIC, % not willing to pay a full-cost The Law of Ukraine No. MHEs in this list, 182 of which 2016, average operating cash recovery heating tariff given the 1730-VІІІ "On Measures for had debts to Naftogaz. During Hypothetical ROIC, % flow margins for 2016-2017 current costs and consumption Settlement of Debts of District 2017, the company considered are more representative of the Cost of capital, % levels of heat energy in Ukraine. Heating Companies and Heat- the cases of 144 enterprises that situation in this segment. Generating Organizations and applied for the implementation Measures like energy efficiency Water Supply and Drainage of the law and informed 37 Average ROIC of the “gas sales to MHE for the needs ROIC would still be lower than improvements, optimization of Enterprises for the Consumption participants of the decision to production, import and of households” segment in the cost of capital of 18.7%38. the municipal heating system, of Energy Resources" (Law write off fines or restructure 2016-2017 was 3% primarily public awareness campaigns, 1730) came into force on debts for natural gas. 36 Average operating cash flow margin is due to the subsidized (lower Continuation of this practice and an enhanced role of the 30 November 2016. It had a calculated as net segment cash flows from than market) gas selling is impossible for this business national regulator can help negative impact on Naftogaz operating activities divided by revenues of the segment to third parties according to Consol- price imposed by PSO segment of Naftogaz in a to realize a ‘turnaround’ in due to further growth and the idated Financial Statements as of and for the regulation on Naftogaz. If financially sustainable way. a sustainable manner while accumulation of customer debts year end 31.12.2017. PSO compensation claimed Mechanisms for settlement ensuring the affordability of heat because of a lower motivation 37 ROIC is calculated as NOPLAT divided by by Naftogaz for gas supplied of gas market players’ debts energy for end-customers. market value of invested capital, which was 39 determined as a sum of invested capital in to MHE for the needs of that will allow resolution of Particularly non-residential customers, though fixed assets based on estimation of its market households was paid in full, The current business model of earlier residential customers were also allowed to disconnect. value and net working capital as of the end of municipal heating enterprises the year. Market value of invested capital in hypothetical ROIC would 38 Cost of capital rate is estimated by independ- 40 Specifically, increasing tariffs will make possi- fixed assets, mostly represented by upstream comprise 12.1% and 13.3% for ent appraiser to determine the fair value of creates a vicious cycle in which ble to eliminate gas subsidies and allow MHEs assets, was estimated as monetary value of 2016 and 2017 respectively. property, plant and equipment of PJSC “Nation- companies do not have enough to allocate sufficient funding to maintenance 2P gas reserves audited and appraised by al Joint Stock Company “Naftogaz of Ukraine”” money to maintain their assets and investment in the district heating network independent O&G consulting firm. However, this hypothetical as of 31.12.2017 as well as pay their bills.

72 73 OUR PERFORMANCE ANNUAL REPORT 2017

Customers structure of "Gas production, imports and supply to other customers under GAS PRODUCTION, IMPORTS PSO" business for 2017-2016 by revenues, UAH billion

2 255 AND SUPPLY TO OTHER CUSTOMERS 1 156 2016 1 146 UNDER PSO 44

6 439 1 269 2017

In 2017, the business segment MHE to consumers other than households (including CHP) Odessa Port Plant of supplies to other consumers under PSO was mainly repre- KEY RESULTS OF THIS BUSINESS: Retail supplies to households Other customers sented by municipal heating companies producing heat for Sales volumes to customers of this business in 2017 were non-residential consumers (83% 1.2 bcm (+43% change y-o-y) of revenues) and retail supplies Average operating cash flow margin of this business ditional approval41 of draft – Market distortions in favour business increased by 69% in to households by Naftogaz’s sub- in 2016-2017 comprised only 1.2%, with ROIC 6x lower than PSO Regulation for 2017- of the private commercial 2017 vs. 2016, mainly due to sidiary (17% of revenues). Since сost of сapital (3.2% vs 18.7%) 2018 dated March 2017, the interests of selected market growth of the share of MHE PSO Regulation was introduced Energy Community Secretariat participants rather than in a for non-residential consumers in October 2015, its scope of expressed its opinion on the clearly defined public interest (including CHP) from 49% of regulated supplies to municipal abovementioned PSO exten- should not be considered business revenue in 2016 to heating enterprises has under- sions as the following: proportionate to achieve the 83% in 2017. gone significant changes. goal of security of gas supply. – Extension of public service the scope of PSO regulation Hence, natural gas supply to Cash flow margin of this Evolution of PSO scope supplies of natural gas to Gradual extension of PSO Reg- went beyond what is neces- district heating companies segment in 2016 was negative for municipal heating compa- district heating companies ulation with the inclusion of sary to ensure the stability within the framework of pub- (-48%), and was caused by gas beyond the scope of serving additional supplies (see timeline nies (MHE) and affordability of district lic service obligations may supply to PJSC "Odessa Port household customers and below) has led to 100% coverage heating services to vulnerable be justified in the general Plant" under PSO Regulation religious organisations, given of MHE’s use of natural gas for As was publicly commu- final customers or other final economic interest only for (25% of total revenues of their clearly commercial nature all categories of heat consumers nicated by international customers subject to special providing district heating ser- this segment in 2016). This in the interest of individual since April 2017. organizations, extension of protection. In its public con- vices to household customers company has not yet paid district heating companies and religious organisations off this debt as of the date of and not in the public interest, and, as the case may be, for this report. Since April 2017, is excessive and thus not combined production of heat natural gas was supplied to necessary in view of the and electricity (CHP). Natural this segment at a regulated objective pursued. It would Evolution of PSO scope for municipal heating companies (MHE) gas for any other operations, price with a 1.6 multiple to the also constitute an unjustified in the opinion of the ECS of wholesale price for the needs of advantage for industrial district heating companies, households, which is lower than customers of district heating should be purchased on the the market price. The increase +MHE for any other consumers services and cogenerated +MHE for religious market. in the volume of gas supply organisations (including CHP) electricity, and distort the to MHE’s for other consumers market for electricity. These changes to PSO (including CHP) within the Nov 2015 Arp 2017 100% regulations affected the scope extension of PSO and Oct 2015 Oct 2016 of MHE's use 41 Conditional approval of imposition of public operational results of «Gas repayment of prior years debts of natural gas service obligations in the natural gas sector of Ukraine for the period of 2017-2018 as of 7 production, import and sales led to an improvement in the is covered by PSO MHE for +MHE for budget March 2017, Energy Community Secretariat. for other consumers under operating cash flow margin Regulation since households organisations See details: https://www.energy-commu- PSO» business for 2016- of this business in 2017 (30%), April 2017 nity.org/dam/jcr:dc82686d-91a9-4aa1-a65f- b5e550b6609e/APP_2017_PSO_UE.pdf 2017. Total revenues of this however, the average operating

74 75 OUR PERFORMANCE ANNUAL REPORT 2017 cash flow margin of this Port Plant" (as stated above, UAH-denominated ROIC business in 2016-2017 was only this company has not paid its vs cost of capital, % 1.2%. This modest result reflects debt for supplied gas). Due to GAS IMPORTS AND SUPPLY TO the problem of low payment the non-market terms of gas discipline of MHE’s. supplies to other consumers 25 under PSO in regard to gas OTHER CUSTOMERS OUTSIDE PSO Negative ROIC42 for 2016 is price and payment terms, ROIC 20 18.70% 18.70% mainly explained by accrual of for this business for 2017 was provisions for impairment for 8.7%, which is lower than cost 15 43 gas supplied to PJSC "Odessa of capital of 18.7%. % 8.70% 10

42 ROIC is calculated as NOPLAT divided by market 5 value of invested capital, which was determined Customer structure and as a sum of invested capital in fixed assets sales volumes of “Gas based on estimation of its market value and 0 net working capital as of the end of the year. imports and supply to other KEY RESULTS OF THIS BUSINESS: 43 Market value of invested capital in fixed assets, Cost of capital is estimated by independent –2.23% customers outside PSO” have mostly represented by upstream assets, appraisers to determine the fair value of prop- –5 significantly changed in 2017 Supply volumes to this segment’s customers in 2017 were was estimated as monetary value of 2P gas erty, plant and equipment of PJSC “National 2016 2017 reserves audited and appraised by independent Joint Stock Company “Naftogaz of Ukraine”” as due to the following key 0.6 bcm (-72% change y-o-y). O&G consulting firm. of 31.12.2017. ROIC Cost of capital factors: Naftogaz’s share of supplies to industrial consumers · expansion of the scope of PSO Regulation related to decreased twofold, from 9% in 2016 to 5% in 2017. supplies to MHEs (100% USD-denominated ROIC of this business in 2017 (11.2%) was lower of supplies to MHEs are than USD-denominated cost of capital (13.4%). subject to PSO regime since April 2017); · decrease in supply volumes to industrial consumers Negative ROIC44 of «Gas import outside PSO» for 2016 was (to 5% of total gas uses by and sales for other consumers driven by accrual of provision industrial consumers excl. of accounts receivable in 44 ROIC is calculated as NOPLAT divided by market consumption by CHP). value of invested capital, which was determined amount of UAH 4 billion, mainly as a sum of invested capital in fixed assets based attributable to gas supplies to As a result, gas supplies on estimation of its market value and net working regional distribution companies capital as of the end of the year. Market value of outside PSO became a very invested capital in fixed assets, was determined for their technical needs. There small business of Naftogaz, based on proprietary estimate of opportunity cost were no such non-recurring with a mere 2% share in of hydrocarbon resources and other assets of items in 2017, and as a result, this segment. NOPLAT and invested capital were total revenues of the group converted from Ukraine hryvnia to US dollar using ROIC of «Gas imports and in 2017. annual average exchange rates of the NBU and supply to other customers at the end of the relevant year, respectively (in outside PSO» of 11.2% for 2017 order to compare USD-denominated ROIC with USD-denominated cost of capital).

Customers structure of "Gas imports and supply to other customers outside PSO" business in 2016-2017 by revenues, UAH million

6 713 2016 4 761 1 406

2 591 2017 487 1 035

Industrial consumers MHE for other consumers Other consumers

76 77 OUR PERFORMANCE ANNUAL REPORT 2017 was lower than cost of capital45 Production and net imports of gas, bcm Physical gas trading Paper trading and risk management of 13.4%, indicating that issues with generation of value are not fully addressed in this segment 2013 2014 2015 2016 (business only generates value EXPECTATION Financial in a financially sustainable way Ukraine 48.1 38.1 36.9 32.1 FOR 2020 engineering when ROIC exceeds cost of capital). Slovakia 5.6 4.2 4.5 4.4 RISK Prop trading Trade Poland 17.7 17.0 17.1 18.8 derivatives Wholesale gas market Assset-backed for making liberalization brought a Hungary 8.6 10.1 8.0 9.4 trading Paper profits and number of challenges and trading hedging risk positive developments for Czech Republic 8.6 7.5 7.7 8.3 NAFTOGAZ Portfolio unrelated the market outside PSO as a TODAY Paper Austria 7.7 9.0 7.2 8.7 hedging to physical whole. With the opening of trading positions imports for private traders Transaction related to Germany 85.9 78.2 81.3 87.6 and integration of Ukrainian hedging Hedge physical overall positions portfolio Sourcing Gas imports and supply to Match in paper sales and other customers outside PSO: markets 73% 84% 14% 13% purchase 200 USD-denominated ROIC Physical gas commitments 180 169 vs cost of capital, % 163 trading 160 RETURN 140 120 % 25 100

20 bcm 80 15 13.4% 13.4% 11.2% 60 48 10 38 40 35 32 5 23 23 20 0 0 –5 2013 2014 2015 2016 –10 –15 Relevant market volume Naftogaz on the relevant –20 market, % –20.2% Naftogaz sales volume –25 2016 2017

ROIC to alternative sellers are 10x and developing its trading higher than Naftogaz gas sales capabilities. Key benefits for Cost of capital in 2016, thus private importers Naftogaz from developing may totally replace Naftogaz trading capabilities include: and EU markets, Naftogaz volumes if the latter raises · effective price discovery no longer enjoys dominance prices above market prices. mechanism; on the relevant gas market. Moreover, as a result of market Free entry capacities available liberalization, the Naftogaz · lower price of sourcing (spread share in supply to industrial vs European hub prices); 45 Cost of capital estimated in UAH by inde- consumers decreased twofold, pendent appraisers to determine the fair · better portfolio management, value of property, plant and equipment of from 9% in 2016 to 5% in 2017. lower risk. PJSC “National Joint Stock Company “Naftogaz of Ukraine”” as of 31.12.2017, was converted Naftogaz is going to face into US dollars with subsequent adjustment of the elements of that rate for the better a decrease of its share displaying the risks associated with the spe- in supplies to industrial cifics of this business, and the corresponding consumers by strengthening comparison with ROIC of the business.

78 79 ANNUAL REPORT 2017 GAS BUSINESS: PERFORMANCE SUMMARY*

In 2017, Naftogaz group Gross production of natural gas, bcm produced almost 80% of the total natural gas produced in Ukraine. The leading companies 15.9 Total: 2,8% among the Ukrainian enterprises 16.4 are Ukrgazvydobuvannya with a share of 74% in the total Ukrainian gas production, and Ukrnafta 14.6 Ukrgazvydobuvannya 4,4% with a share of 5% in the total 15.3 Ukrainian oil production.

The bulk of natural gas 1.3 Ukrnafta –14,7% production in Ukraine is in the 1.1 Kharkiv and Poltava regions, which together provide about 90% of the group's production. 2016 2017 2016/2017 Exploration works are carried out mainly in the Carpathian group companies increased level over the past 24 years, and Dnipro-Donetsk oil and gas by 2.8% compared to 2016. thanks to the successful regions. The increase was basically implementation of the 20/20 due Ukrgazvydobuvannya strategy. Despite the natural In 2017, the volume of natural which increased its output drop in production of about gas production by Naftogaz by 4.4% in 2017 - a record 1.4 bcm/ year cumulatively by

The geographical breakdown of natural gas production by Ukrgazvydobuvannya in Ukraine in 2017, mcm

29 SUMY VOLYN 23 7 917 528 6 116 LVIV POLTAVA KHARKIV 53 137 IVANO-FRANKIVSK 0,3 DNIPROPETROVSK LUHANSK ZAKARPATTYA 1 2 445 CHERNIVTSI DONETSK 14

KHERSON Total 15 253 mcm

* Includes four main groups of gas sales and supply customers *Naftogaz does not operate in this market segment

81 OUR PERFORMANCE ANNUAL REPORT 2017 all fields, Ukrgazvydobuvannya (DerzhGeonadra) blocked the Thus, from October 1, 2015, suppliers of natural gas for - milder weather conditions Gas sales and managed to offset the decline extension of the company's the company was vested the state enterprise of Ukraine during the heating season supply outside and increase production by special permits in April 2017. with special responsibilities "International Children's compared to the previous the group, bcm 646 mcm of gas compared According to Ukrnafta, about for the formation of a natural Center "Artek". year, which led to a decrease with 2016. Thus, in 2017, a 76 mcm of gas were lost due gas resource for the needs of in the need for heat and 5% large-scale program was to the forced suspension of households and heat energy Currently, the company's special - reduction of social standards implemented to intensify production. Production was producers for the production of responsibilities have been for natural gas consumption the gas production process renewed in late October and thermal energy for the provision extended until August 1, 2018 - the in which subsidies for which included 120 fracturing November after the licenses of heating and hot water by the Resolution of the Cabinet individual heating were operations, which resulted were extended and mining services to the households, of Ministers of Ukraine dated provided since 16.10.2017, in additional production areas allocated. its sale at determined prices May 30, 1848, No. 415. which created additional of more than 875 mcm of to natural gas suppliers to incentives for the recipients 20.1 –14% 17.4 gas. In addition, an effective In 2014, with the active the households and supply In addition, the current of subsidies to savings in gas 2017/2016 work-over campaign was involvement of Naftogaz, the at determined prices to the version of the PSO Regulation consumption. implemented, which included reform of the gas market was producers of heat energy for the states that if the price of gas the restoration of wells, coiled launched in Ukraine, which households. calculated at import parity The use of natural gas by tubing operations, various resulted in the adoption of the level as of July 1, 2017 exceeds municipal heat generating reservoir treatments resulted Law of Ukraine "On the Natural Subsequently, the scope of the current price more that by entities (MHE) for the needs of in additional 550 mcm of gas. Gas Market" and the gas sector special responsibilities imposed 10%, then in the period from households decreased by 20% reform plan. The reform of the on the company was gradually October 1, 2017 to August 1, in 2017 compared to 2016. In The further successful gas market provided for the expanded by the government: 2018, the selling (supply) price addition to the weather factor, 2016 2017 implementation of the 20/20 gradual liberalization of the gas - from November 4, 2015 – of gas to households, religious which affected the households strategy will require extended market and the introduction resource formation, sale at organizations and heat energy category as well, the key factors consumers, by 89%. This exploration areas, improved of targeted subsidies. Starting determined prices to the producers will be equal to the for this category were: significant decrease is due to legislation on land issues, from November, 2015, gas natural gas suppliers and calculated gas price at import • withdrawal of gas by the extension of the scope transparent procedures for prices for consumers beyond supply at determined prices parity level. At the same time, MHEs without obtaining of the PSO Regulation and granting and extending the scope of the Regulation to the producers of heat the Ministry of Energy and the nominations, which led to inclusion in it in 2017 of the licenses, and a foreseeable on the imposition of special energy for the needs of Coal Industry had to ensure attributing such volumes of new categories of consumers46. taxation regime for mineral duties (hereinafter referred religious organizations; taking steps by July 1, 2017 to gas to the imbalance of the production operations. to as the PSO Regulation) - from September 29, 2016 – calculate the price of natural respective gas distribution The sales of gas for industrial ceased to be regulated and supply to PJSC "Odessa Port gas at import parity and to pipelines operators and and other consumers and gas Increase in the volume are to determined by Naftogaz Plant"; place the information on that ignoring them in sales distribution companies for of gas production by independently on the basis of - from October 19, 2016 – price on its own official website. volumes for this category their technological needs also Ukrgazvydobuvannya are a the market conditions. supply to thermal energy • replacement of natural gas decreased by 63% and 13% positive factor for the stable producers for the production Despite the fact that in the with other fuels (primarily respectively due to the general gas supply to consumers and At the same time, since of thermal energy for the 2016-2017 the preconditions coal) and reduction of gas consumption an effective tool for reducing October 1, 2015, and till now institutions financed from the for revision of the current price • shift from district heating to in Ukraine and, partly, due to Ukraine's dependence on the Resolutions of the Cabinet state and local budgets, and emerged, the decision on the autonomous and individual the change of supplier for such imports of energy resources of Ministers of Ukraine No. 758 from December 23, 2016 – at question was not made. heating systems in some enterprises. and ensuring the country's dated 01.10.15 (as amended) a specified price; cities, with or without energy security. and No. 187 (as amended) - from April 1, 2017 – supply of Total sales of gas to Ukrainian substitution of natural gas for dated 22.03.17, the Company natural gas at a determined consumers decreased in 2017 other fuels or energy. In 2017, Ukrnafta continued has been vested with special price to the producers of compared to 2016 by 14%. to show a decline in natural responsibilities (PSO) for the heat energy for all categories Sales volumes to other gas production and finished formation of the natural gas of consumers, as well as for Consumption of natural gas by consumers outside PSO the year with a decline resource for households, the production of electricity households in 2017 decreased decreased by 70% in 2017 in production by almost religious organizations and by such producers, while by 5% compared to 2016. The compared to 2016. The 15%. Like in the previous heat energy producers and the obligation to supply change in consumption was major reduction occurred in year, Ukrnafta's decline in some other natural gas PJSC "Odessa Port Plant" is significantly affected by the the category of enterprises 46 See timeline Evolution of PSO scope for Munici- production was affected by consumers. The categories excluded; following factors: that produce heat for other pal heating companies the high level of depletion of consumers covered by - March 16, 2018 – formation of most deposits that are at the PSO are continuously of a resource for the the final stage of their use, expanded by the government, producers of heat energy for as well as the fact that the and the term of the all categories of consumers, State Service for Geology special responsibilities was resource formation and sale and Subsoil of Ukraine continuously extended. at a determined price to the

82 83 OUR PERFORMANCE ANNUAL REPORT 2017

Gas sales and supply outside the group, bcm UAH billion Trade accounts receivable Provision for impairment

11.6 31.12.2016 31.12.2017 2017/2016 31.12.2016 31.12.2017 2017/2016 Gas production, imports and sales to RSC's for –5% the needs of households 11.0 Total 57.1 65.5 15% (21.5) (23.0) 7%

5.7 Gas production, imports and supply to MHE's for –20% the needs of households 4.6 Trade accounts receivable for natural gas

Gas production, imports and supply to other 0.9 43% RSC's for resale to households MHEs to households customers under PSO 1.2 –1.2 0.1 1.9 Gas imports and supply to other customers –70% outside PSO 0.6 –0.2 0.2 –3.1 -4.2 9.7 2016 2017 2016/2017

30.1 3.2 3.5 UAH bn Weighted average gas prices by category, UAH/tcm147 21.8 UAH bn 0.8 14.1 14.1 UAH bn UAH bn 2.4 20.2 4 118 21.6 10.1 8.2 Gas production, imports and sales to RSC's for 20% resale to households 4 942 2016 2017 2016 2017

3 288 Trade accounts receivable less Trade accounts receivable Trade accounts receivable Trade accounts receivable Gas production, imports and supply to MHE's for 50% than 90 days more than 365 days less than 90 days more than 365 days the needs of households 4 942 Trade accounts receivable Provision for impairment Trade accounts receivable Provision for impairment within 90-365 days within 90-365 days 5 342 Gas production, imports and supply to other 18% customers under PSO 6 288 Other customers under PSO Other customers outside PSO Gas imports and supply to other customers 6 484–7 148 outside PSO 7 516–8 265 –16.9

–16.2 0.4 0.03 2016 2017 2016/2017 –1.4 –1.4 3.5 47 Price for gas, net of VAT and tariffs for natural gas transportation and distribution services 0.3 1.4 19.6 0.9 1.6 4.8 UAH bn 16.5 UAH bn UAH bn UAH bn The trade accounts receivable The growth in receivables is the same time, consumers 0.4 for natural gas increased observed due to the regional outside PSO showed 1.4 3.0 15.1 16.0 in 2017 compared to 2016 gas supply companies for decreased arrears by 16% in by UAH 8.4 billion or 15%. the needs of households. At 2017 compared to 2016. 2016 2017 2016 2017

Trade accounts receivable less Trade accounts receivable Trade accounts receivable Trade accounts receivable than 90 days more than 365 days less than 90 days more than 365 days Trade accounts receivable Provision for impairment Trade accounts receivable Provision for impairment within 90-365 days within 90-365 days

84 85 OUR PERFORMANCE ANNUAL REPORT 2017

The level of settlements for natural gas Gas sales to RSC's for the needs of households results*, UAH billion

RSC's for resale to households MHEs to households

19.9 20.4

The results of this business was achieved thanks to the improved by 2% or UAH 0.4 reduced royalty (royalty for % billion in 2017 compared with deposits deeper than 5 thousand 48.9 57% 88 54.3 59% UAH bn 2016. Although gas sales to meters was cut down to 29% in UAH bn 22.8 44% % 18.9 37 UAH bn Ukrainian consumers shrank January 2017, while it was 70% in 69% UAH bn due to lower gas consumption, January-March 2016 and 50% in decreasing the result by UAH April-September 2016). 70% 100% 2016 2017 2.7 billion, the positive result

2016 2017 2016 2017

% of settlements, % of settlements by % of settlements, % of settlements by including subsidies including subsidies The results of the business48 The results of the business48 The results of the business48 gas supply to the municipal gas supply to the other gas supply to the other heat generating entities for customers under PSO, custome rs outside the needs of households, UAH billion PSO, UAH billion The state budget for 2017 During 2017, Naftogaz the end of 2017, the issue UAH billion provided for funding of benefits group was actively working of budget funding of the and subsidies to households to to match the allocations granted subsidies remained pay bills for electricity, natural gas, for housing subsidies in problematic. For example, 1.6 heating, water and wastewater the state budget with the out of the total amount of 4.9 services, maintenance of amount of funds that were protocols subscribed of UAH buildings and structures and objectively necessary for 64 billion only UAH 51 billion 3.9 0.5 adjoining territories, the removal their funding in view of the or 80% has been financed, of household garbage and liquid changes in the regulatory which is 4% less than in 2016. sewage for a total amount of environment throughout UAH 68 billion. the year. Nevertheless, by

–0.4 –1.7

2016 2017 2016 2017 2016 2017

The results of this business The results of gas supply to other The results of the business decreased by UAH 1 billion in consumers under PSO in 2017 improved by UAH 2.2 billion in 2017. The slump in sales reduced improved compared to 2016, from 2017 compared to 2016. The the result by UAH 3.7 billion, a loss of UAH 0.4 billion to a profit decrease in sales adversely which was partly compensated of UAH 1.6 billion. The key factor impacted the result. The decrease for by lowered royalties. 48 here was the increase in sales in in the provision for doubtful this category, which is due to the debts by UAH 4.2 billion in 2017 extension of PSO categories to as compared to the previous year heat and power consumers49. positively affected the result of the business at the same time. 49 CMU Resolution No. 187 of 22.03.17 "On Approval of the Regulation on the Imposition of Special Responsibilities on the Subjects of the Natural Gas Market for protection of General Public 48 operating profit/(loss) before income tax Interests in the Natural Gas Market Operations"

86 87 HOW GAS IS PRODUCED EXPLORATION, PRODUCTION AND PROCESSING OF GAS

1. GEOLOGICAL EXPLORATION Geological studies are conducted to identify areas where there may be new deposits. Seismic studies account for as much as 90% of the geological exploration budget. 2. EXPLORATORY DRILLING On average, only one in three exploratory wells finds a new deposit. The cost of an 8. GAS TRANSMISSION exploratory well is between USD 2-3 million but sometimes it may cost more than USD Gas is transmitted from the 10 million. production site to consumers through gas trunk pipelines.

NONPURIFIED GAS PURIFIED GAS

MARKETABLE GAS COMPENSATOR

CONDENSATE LOW TEMPERATURE SEISMIC SEPARATOR VIBRATORS

EXPLORATORY COMPLEX GAS WELL TREATMENT GAS CONDENSATE DRYER PLANT (CGTP) STABILIZER

3. PRODUCTION DRILLING GAS SEPARATION WELL Production wells are drilled to develop WORKOVER an explored field. The cost of a well depends on its depth and ranges from USD 2-3 million to USD 10 million. DRILLING The number of wells can range from a SITE dozen to hundreds. Thus, this stage is COILED considered the most capital-intensive. TUBING UNIT

4. DEVELOPMENT OF THE FIELD 5. PRODUCTION ENHANCEMENT PRODUCTION A mixture of gases (methane, ethane, WELL propane, etc.), gas condensate, Booster compressor stations (BCS) 6. WELL REPAIR 7. GAS TREATMENT stratum water and other mineral maintain the pressure necessary for BOOSTER The final products of the mixture impurities comes to the surface production at the final stage of field COMPRESSOR Wells are regularly checked and processed by a complex gas through a well. Subsequently, this development. Most of the fields in STATIONS repaired to ensure uninterrupted and treatment plant (CGTP) are dry mixture is purified and separated. Ukraine are significantly depleted. accident-free production. natural gas and gas condensate. OUR PERFORMANCE ANNUAL REPORT 2017 OIL AND Oil and gas condensate production by Ukrnafta in 2002-2017, mnt 3.5 70 3.2 3.0 3.1 3.2 3.1 2.8 2.9 GAS CONDENSATE 3.0 2.8 60 2.5 2.5 2.3 50 2.1 2.0 1.9 40 2.0 1.7 1.5 1.4 1.5 30

1.0 20

0.5 10

0 0 Gross production of oil and gas condensate by the enterprises of the group, mnt 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Wells commissioned (right axis) Liquid HCs production, mnt (left axis) 2.0 Total –7.6% 1.8 KEY ISSUES OF THE SEGMENT'S PRODUCTION ACTIVITIES IN 2017:

1.5 · Liquid hydrocarbon production dropped rapidly due to the forced stop of production as a result of suspension of Ukrnafta –9.2% 1.4 the special permits by Derzhgeonadra. • Ukrnafta decreased production despite the growth potential - reserves of liquid hydrocarbons made up 0.5 38.3 mnt according to the assessment as of 31.12. 2017 (based on the audit by DeGolyer & MacNaughton). Ukrgazvydobuvannya –2.7% 0.5 · The capital investments volume is lower than the minimum required for the fulfillment of stabilization and production volume build-up programs. · Only four wells were drilled and put into operation (three of them under JV agreements), which is 90% lower 2016 2017 2016/2017 compared to the 2010s. · In September 2017, Derzhgeonadra extended 9 special permits, which expired in 2017 and which provided the reason for the production halt at these fields.

The production of liquid Ukrnafta's tax liabilities and provisions for fines · In 2018, 27 more special permits expire, 11 of which are to be extended in accordance with the resolution of the Kyiv administrative court of appeal. However, there is a concern regarding the approval of another 16 special hydrocarbons of Naftogaz group and penalties, UAH bn in Ukraine is performed by permits. Ukrnafta (75% of the group's total · At the beginning of 2018, further to the State Fiscal Service submission, Derzhgeonadra obliged Ukrnafta to liquid hydrocarbons production) repay debts on rent payments by 1 July 2018, threatening to suspend 77 special permits for the production of and Ukrgazvydobuvannya hydrocarbons in case of failure to do so. 13.3 (25% of the group's total liquid Tax liabilities hydrocarbons production). 12.8 Ukrnafta sells liquid During 2017, tax regime for oil used 52% of its cash flow for tax 2016 was -13%, was the accrual hydrocarbons through auctions Provision 11.2 and condensate production payments. of Ukrnafta's receivables and these volumes form the for related fines remained unchanged, and the impairment reserve of UAH segment's financial result. and penalties 14.1 pricing situation improved: the The reason for the negative 6 bn. Without this one-time average selling price of a barrel ROIC50 of the oil and gas accrual, ROIC would have been Based on 2017 results, Naftogaz of oil was USD 51.8 compared to condensate segment, which in 9.4% in 2016. In 2017, ROIC group's liquid hydrocarbons 31 December 2016 31 December 2017 USD 40.5 in 2016. These factors increased almost twice (to 50 production dropped by 7.6% (by allowed Ukrnafta to pay off ROIC is calculated as NOPLAT divided by invest- 16.6%) due to the growth of the 152 thousand t), and Ukrnafta's ed capital, which was determined as a sum of UAH 10.2 bn of taxes in 2017, invested capital in fixed assets and net working market prices for oil and gas production dropped by 9.2% to which is higher compared to capital. The capital invested in fixed assets was condensate and the decrease 1.379 mnt and reached the new calculated based on proprietary estimate of 2016 when the company paid opportunity cost of hydrocarbon resources of in rent payments (specifically, historical minimum. UAH 8.1 bn. In total, the company this segment. from 45% to 29% for the

90 91 OUR PERFORMANCE ANNUAL REPORT 2017 production of oil from the wells several options of financial Investments hydrocarbons production. with the depth of up to 5000m). rehabilitation. Besides, Those are licenses which THE PROBLEM WITH ISSUING SPECIAL The operating result for 2017 Ukrnafta's management has Due to the critical limitation of expire during the first six would have been even better repeatedly addressed the financial resources, Ukrnafta's months of 2018 and which PERMITS IS THE BIGGEST SHORT-TERM RISK if Ukrnafta's special permits executive authorities with drilling volumes decreased by grant the company the right had not been blocked, and the the proposal to restructure 90% against the early 2010s, to produce hydrocarbons in FOR THE BUSINESS special auctions for the sale the tax debt. The company which immediately impacts oil the Rosilnyanske, Turutynske, of oil and gas condensate had will continue to pay off the production volumes. Mykolaivske, Lukvynske, not been suspended. Besides, outstanding tax debt, service Dovbushansko-Bystrytske, , Ukraine №2665-III On the Oil • a number of norms concerning the assets for the production current tax liabilities and make Oriv-Ulychnyanske, Dolynske, Capital investments in 2017 were and Gas of 12.07.01. the oil and gas condensate of oil and gas condensate critical investment to ensure Strutynske, Spaske, and UAH 710 mn against a planned pricing mechanism have been have been chronically basic production needs for the Andriyashivske fields. The ruling 2.4 bn, which was lower than Over the period of its existence, revised; underfinanced, which resulted purpose of stabilization and of the court of appeal came the minimum required for the the said sales mechanism has • the reduced coefficients have in the descending trend the increase in production. into force on 3 April 2018. stabilization and production undergone a number of changes, been cancelled; in the production of liquid volumes build-up. which often resulted in the • the starting price of crude hydrocarbons. A very important government According to the company's non-transparency of the oil sale at auctions in view of the initiative for this segment calculations, during the year, the In 2018, the company planned process and the reduction of insignificant volumes of import With the ROIC of 16.6% in 2017, is the reduction of the state and local budgets would its investment program at the profit under the transactions on in Ukraine of the Urals and Azeri this segment was the second nominal rate payment for the receive income from production level of UAH 3.2 bn. It believes sale of domestically produced oil grades is mainly determined among Naftogaz businesses. But condensate production to of hydrocarbons at the above 27 that these investments are oil and gas condensate. It taking into account world oil it is still lower than the estimated 29% for wells with the depth fields of nearly UAH 3 bn from critical for ensuring basic specifically provided for reduced quotes. cost of capital which comprises of up to 5000 m, and to 14% rental payments only. production needs, labor safety coefficients from the customs 22%51, and shows that even this for deeper wells (against 45% and failure-free operation value, a price calculation which Due to the absence of a almost unregulated business and 21% respectively, which At the beginning of 2018, of equipment. However, the did not include the VAT, etc. competitive environment does not create value in a were effective in 2015-2016) Derzhgeonadra, further to the fulfillment of the investment This resulted in under received between oil buyers - refineries - financially sustainable manner. scheduled for the beginning submission of the State Fiscal program would depend on the profit and the reduction of the the demand for crude oil and gas of 2019. It is expected to Service, set for Ukrnafta the agreements on the mechanism profitability of this segment. In condensate in Ukraine is limited. As of 31 December 2017, have a positive impact on the term for the elimination of of the tax debt repayment. 2007-2014, Ukrnafta's oil sale They are processed in Ukraine Ukrnafta's tax debt constituted acceleration of the Ukrnafta's violations of special conditions price did not fully correspond to by the Kremenchuk refinery about UAH 13 bn. This indicator debt repayment and to release of special permits for the use During 2017, Derzhgeonadra the world prices in the specified (PJSC Transnational Financial includes the company's additional funds, which could of the subsurface resources in suspended special permits for period. Beginning from the and Industrial Oil Company outstanding liability and debt be used for the stabilization of terms of rent payments to the the development of 9 fields. In end of 2014, certain changes Ukrtatnafta), which in 2017 on JV operations. hydrocarbons production. State Budget and threatening 2018, 27 special permits expire, to the oil and gas condensate partially switched to Azerbaijan to suspend 77 special which account for 53% of the sales mechanism have been oil. The combined result of the The risks for the repayment of tax permits for the production of company's annual oil and gas introduced: existing rigid regulatory pricing debt include attempts to block Oil and gas condensate: condensate production and 30% hydrocarbons. Ukrnafta has 82 special permits by regulatory ROIC vs capital cost rate of the annual gas production. special permits for production bodies and the obstruction of UAH-denominated, % In 2017, Ukrnafta submitted to of hydrocarbons in total. Evolution of sales price for domestically produced oil government auctions for the Dergeonadra in advance the sale of oil through which the applications for their extension. 120 company sells the oil and gas The extension of the special per- 11 auctions failed concentrate at regulated prices*. % 25 22.0% 22.0% Oil sale regulation mits is critical for the company 100 20 16.6% and would have a significant mechanism Appearance of an alternative oil source In order to turn around 15 80 impact on its production and for refineries Ukrnafta without applying The state regulation mechanism 10 financial indicators, fulfillment 60 bankruptcy or financial of the investment program, for the sale of domestically rehabitation procedures, 5 employment and state and local produced oil and gas 40 specifically for the reduction of 0 budget revenue contributions. condensate for the companies Estimated auction social tension and preservation 20 starting price brought –5 where the state share in the to the market level of the company’s personnel authorized capital is 50 percent At the beginning of April 2018, 0 potential, the company's 10 or more was introduced starting the Kyiv administrative court 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 management is developing –15 –13.0% of appeal ruled for Ukrnafta from the 2000s. The group 2016 2017 sells domestically produced * See section The world oil market and obliged Derzhgeonadra to consider the company's crude oil and gas condensate EU price of oil import (on CIF terms $/bbl)) 51 Cost of capital is calculated based on an ROIC at exchange auctions in independent assessment of the alternative cost applications for the extension Estimated average sales price at auctions $ per 1 bbl of capital for this segment. Capital cost rate of 11 special permits for accordance with the Law of Platts Urals price $/bbl

92 93 OUR PERFORMANCE ANNUAL REPORT 2017

OIL AND GAS A verage daily oil and condensate production by Ukrnafta, UKRNAFTA thousand t/day The state share in the Oil, gas condensate CONDENSATE SALE 5.5 company's authorized capital 50% and more AUCTION Naftogaz group extracted about 5.0 90% of the total oil and gas • Absence of competitive market condensate produced in Ukraine 4.5 • Overstocking of storage facilities in 2017. Ukrnafta is the group’s during unfavorable price period leading company in oil and gas 4.0 Only one buying refinery Production loss due to the for the refinery condensate production, with 3.5 suspension of special • Oil is sold at starting price a 66% share of Ukraine's total permits • Only best quality oil is sold Regulated price production. Ukrgazvydobuvannya 3.0

Market deregulation Market is the second placed oil and gas July May June April

extractive company in Ukraine March August January October February December with a share of more than 22%. November September • Ensuring free logistical access to the resource • Formation of fair price for different oil grades of domestic production In the territory of Ukraine, oil and 2014 2015 2016 2017 gas condensate are produced by • Integrated Eastern European market the Group's companies in fields in • Enhancing the integration of production and processing enterprises Poltava, Chernihiv, Sumy, Kharkiv, Free market price • Appearance of clear market and investment indicators for oil production Dnipropetrovsk, Lviv, Ivano- Geology and Subsoil of Ukraine The results of this business Frankivsk and Chernivtsi regions. to extend the validity of licenses improved in 2017 compared which resulted in suspension to 2016 by UAH 9 billion. The The results of oil and gas of mining at 6 deposits from result was positively affected by condensate extraction for 2017 April to June 2017. The industrial the growth of oil sales prices in reflect the general trend to losses during this downtime are Ukraine in line with world market mechanism and the absence the oil sale chain and enhance from Russia does not include the reduce production volumes. estimated by Ukrnafta experts at trends. The average Brent crude of an efficient and competitive Naftogaz group's position in export duty (as of April 2018 – Overall, oil and condensate about 92 thousand tons of oil and oil prices in 2016 amounted to oil purchasing market was the the oil and petroleum products 111.4 $/t, or about 15 $/bbl) and, production fell by 7.6%. The gas condensate. USD 43.7 per barrel and in 2017 failure of 11 energy auctions in market. respectively the cost of produced biggest production reduction (by they increased to USD 54.2 per 2017 and an unsold oil volume petroleum products is lower. 9.2%) was made by Ukrnafta. This Nevertheless, in H1 2017, the barrel and exceeded the 2015 of about 200 thousand t. Taking was due both to internal causes – company managed to stabilize average prices. into account that the revenue If Russia fully replaces oil natural depletion of deposits and production at the level higher from the sold volumes of oil Market deregulation export duties by mineral insufficient level of investment in than natural production decrease and the gas condensate is the perspectives resources extraction tax servicing, equipment upgrading despite limited investments. Oil and gas condensate source for financing investment within the 'tax maneuver', and drilling, and external – the This was due to a number sale results*, UAH bn programs for the intensification the oil price for Belarus The initiatives on further liberal- refusal of the State Service of of budgetary and technical of production and payment of would reach the market ization and deregulation of the measures for production rent payments, unpredictable one to the maximum. In wholesale segment of the oil and Sales of crude oil and gas enhancement at the existing volumes and irregular sell this situation, when the oil gas condensate market is a logi- condensate by the group, wells. timelines mean big risks. purchase price from Russia 6 5.6 cal step, taking into account the and the price of potential thousand t tendencies of the Eastern Euro- The volume of oil and One of the possible options oil supplies from alternative 4 pean oil processing market. This condensate produced by to overcome the dependency sources are at world levels, the concerns mainly the expected Ukrgazvydobuvannya also on one buyer is enhancing Belarusian refineries would 2 tax changes concerning oil 1 270 dropped by 2.7% compared integration of the companies be interested in purchasing supplies from Russia to Belarus52. to 2016, due to the natural within Naftogaz group. Specif- oil with minimum logistic Belarus buys oil at Russian pro- depletion of deposits. 0 ically, this could mean further costs, including in Ukraine. ducers' prices, since it is a mem- The extracted oil and gas development and moderniza- The development of the ber of the Customs Union with condensate are used by –2 tion of Ukrgazvydobuvannya's situation under this scenario –14% Russia, i.e. the export price of oil Ukrgazvydobuvannya for production facilities and the may have a positive impact 2017/2016 the production of petroleum –4 –3.5 52 attraction of Ukrnafta's produc- From 2015 Russia initiated tax reform in the on oil market development, products at their own tion resources for the purpose oil sector. The essence of the reform which is since a competitive domestic called the 'tax maneuver' is the reduction of the production capacity. The result 2016 2017 of processing and production of export duties for oil, their gradual equation with oil and gas condensate buyers' 1 479 of petroleum products sales petroleum products. This would the export duties for light and dark petroleum market may subsequently be is discussed in the section allow partial diversification of products, and the increase of the mineral formed. resource extraction tax rates (MRET). 2016 2017 Petroleum products sales. * operating profit/(loss) before tax

94 95 OUR PERFORMANCE ANNUAL REPORT 2017

B alance between gas transit and Russian gas import costs for GAS TRANSIT Naftogaz, USD billion

4 KEY RESULTS OF THIS BUSINESS SEGMENT: 2.33 2.77 2 • The largest (32.5% of revenues) and the most capital-intensive (35% of PP&E carrying value) business of 0.38 Naftogaz group 0 • Transit volumes – 93.5 bcm (+14% y-o-y), a 6-year maximum –2 • Almost 50% of natural gas supplies from Russia to Europe were delivered through Ukraine in 2017 –2.13 USD bn USD • Historical win in Stockholm arbitration on under-deliveries totaling USD 4.63 billion including interest –4 –2.95 (for the period from 2009 to 2017) –4.36 –6 • ROIC in 2017 (3.0%) was lower than cost of capital (11.9%) –6.33 • Uninterrupted transit flows during March 2018 artificial crisis, created by Gazprom –8 –7.60

–10 –9.31 Gas transit by direction for the period from 2014, bcm 2009 2010 2011 2012 2013 2014 2015 2016 2017

31.4 In 2017, transit of Russian gas of Nord Stream and Yamal As a result: 56 37.8 through Ukraine increased by pipelines. Approximately 35% – ROIC of gas transit business Slovakia 14% to 93.5 bcm. This growth is of exit capacities of Ukrainian in 2017 was significantly lower 48.8 explained by the increase in gas gas transmission system on the than cost of capital for this 53.5 consumption on the European border with the EU were not capital-intensive business. market due to weather-related utilized. 18.0 factors (see “The European – Due to negative expectations 16.8 natural gas market” section), In addition to the above about gas transit flows starting Romania 19.3 and, quite possibly, by economic mentioned under-deliveries, 56 ROIC is calculated as NOPLAT for the respective 20.9 incentives to pump more gas Gazprom refused to implement year divided by invested capital, which was deter- through Ukraine due to probable the final award in transit mined as a sum of invested capital in fixed assets Gazprom estimates of the arbitration53. The currently and net working capital as of the end of the year. 6.5 NOPLAT and invested capital were converted outcome in transit arbitration (i.e. applicable transit tariff is both from UAH into USD using NBU’s average annual 5.9 Hungary because of high probability that not cost-reflective and not exchange rate for NOPLAT and exchange rate 6.7 Naftogaz would be successful compliant with regulated as of the end of the respective year for invested capital (in order to compare USD-denominated 54 11.7 with its under-deliveries claim). tariffs and as of the date of ROIC with USD-denominated cost of capital, used this report, the management by independent appraisers). Invested capital in fixed assets was estimated in two steps: 3.5 Due to such flows via Ukraine, believes that zero transit flows 55 (a) Net replacement costs less physical 3.7 in 2017 Naftogaz cemented from 1 January 2020 are depreciation of GTS (UAH 419 bn as of Poland the positive balance between highly likely. 4.5 31/12/2017) was adjusted for the effect from values of gas transit services and expectation of zero or immaterial transit 4.7 flows beyond 2019 (cf. pages 25-26 of 2017 Russian gas imports for Naftogaz 53 Taking into account that Gazprom has appealed Consolidated Financial Statements). Should (USD 2.77 bn, +19% y-o-y). the final award in the transit arbitration, and expectation of material transit beyond 2.9 the fact that the amount was not settled by 2019 have been used for revaluation, net Gazprom, management follows a prudent replacement costs less physical depreciation 2.9 In spite of record supplies of Moldova approach and does not recognise the amount of the gas transmission system cash 2.9 gas to Europe by Gazprom owed by Gazprom (USD 2.6 bn) as receivable as generating unit would be 10% higher, i.e. UAH at 31 December 2017 460 bn. 2.7 in 2017 and the resulting 6-year maximum transit 54 As a result of transit arbitration, the Tribunal (b) UAH 460 bn was apportioned among key has rejected the Naftogaz claim to review the businesses of the group according to flows through Ukraine, such 62.2 transit contract in accordance with European management approach to measuring group volumes were significantly and Ukrainian law (incl. application of regu- performance. In particular, capacity and 67.1 lated tariff), noting that the implementation distance were used as factors for allocation Total lower than minimal contractual 82.2 of regulatory reform in Ukraine is a matter of assets between gas transit and other volumes according to the for the competent Ukrainian authorities, businesses. 93.5 transit contract with Gazprom e.g. NCREU UAH-denominated value of invested capital in (110 bcm p.a.) or historical 55 Due to alternative route developments fixed assets as of 31/12/17 was used as a proxy (e.g. status of Opal case, construction of NS2, for UAH-denominated value of invested capital 2014 2015 2016 2017 volumes transported through Turkish Stream, evidence of higher capacity in fixed assets as of 31/12/16 for the purposes of Ukraine before construction of NS1) ROIC calculation.

96 97 OUR PERFORMANCE ANNUAL REPORT 2017

from 1 January 2020, economic Effect from expectations about transit beyond 2019 on value of Level of transit tariff: comparison with Slovakia obsolescence was recognized the gas transmission system as of 31.12.2017, UAH bn in a report of independent appraisers of 16 March 2018, who determined the fair value Net replacement cost (without effect from zero Booked Booked Tenor of long-term What Gazprom Availability of VRFs transit assumption beyond 2019) 460 of Naftogaz gas transmission entry capacity? exit capacity? bookings? pays for? on exit points? assets as of 31 December 2017. Net replacement cost (with effect from zero transit 419 assumption beyond 2019) Generally, the uncompetitive and highly politicized behavior VValue based on income approach (based on zero 189 –64.7 bcm of entry ~62.5 bcm of exit Entry capacities For capacities Available at of Gazprom is the key problem transit axpactation beyond 2019) capacity is booked capacity is booked for at Velke Kapusany Baumgarten point of this business segment. For by Gazprom for 2018 2018 at Baumgarten and exit capacities example, Gazprom has not at Velke Kapusany, and Lanzhot, western at Baumgarten are transit services related to the tariff corresponds to the level eastern border of border of Slovakia booked until the end recognized new RAB-tariffs investment in and operation of Slovakian transit tariff. But Slovakia of 2028 for cross-border entry and of the infrastructure (which in order to compare ‘apples to (91% of technical) (90% of technical) exit points approved by the is a part of Naftogaz's asset apples’, the following should be Ukrainian energy markets base); taken into account: (a) current 110 bcm/year of De facto 161 bcm/ Capacities are For volume Blocked by Gazprom regulator in December 2015. – is exclusive to Gazprom, and expected reservations entry capacity is year of exit capacity booked by Gazprom transported It has continued to pay old booked by Gazprom is booked by until the end of 2019. (thus booked specific for transit as opposed of capacity by Gazprom and on the Ukrainian Gazprom on the Gazprom and top capacities are not contractual tariffs and rejected to other use of the Ukrainian their utilization; (b) if Gazprom border with Russia Ukrainian border Russian politicians paid) since 2016 negotiations gas transmission system pays for booked capacity or and Belarus with EU and Moldova said they intended about implementation of (approximately 70 importers for volumes; (c) the level of to halt gas transit regulated tariffs with respective pay regulated entry tariff); complexity of the Ukrainian (39% of technical) (100% of technical) after 2019 amendments of the transit – implies significant flexibility transit system, and the volume contract. As a result, currently to choose direction of transit and destination flexibility Note: Data about long-term capacity booking is taken from EUSTREAM web-site (https://tis.eustream.sk/TIS/#/?nav=bd.ltc) applicable transit tariffs in the flows. provided to Gazprom; (d) contract between Gazprom and effective distance of gas transit Naftogaz (determined during At the same time, European in Slovakia; (e) possibility the negotiations between two principles of tariff formation of VRFs on interconnection As mentioned above, one of transit contract that prevent used to enable EU member companies in January 2009): determine that tariffs should points. For example, with key results of this business is the free trade of gas between states such as Poland, Slovakia, – is volume- and be capacity-based. They should adjustment for average the historic win in Stockholm EU member states bordering Hungary and Bulgaria to distance‑based; be set taking into account distance and load factor, the arbitration over transit. Ukraine. For example, the trade surplus gas with each – does not reflect Naftogaz's the actual costs incurred applicable contractual tariff Naftogaz did win USD 4.6 billion role given to Gazprom Export other, using the Ukrainian actual costs of providing for provision of services specified in contract between in damages for Gazprom's at the metering stations at infrastructure as a "bridge". In considering the level of Naftogaz and Gazprom is under-deliveries of transit gas, Ukraine's border with the EU particular, virtual reverse flows complexity of the network, and significantly lower than the to some extent mitigating prevents virtual reverse flows through Ukraine could allow Gas transit business: USD- that the actual costs are related tariff Gazprom pays for transit Gazprom's capacity hoarding through Ukraine and the use European importers to divert denominated ROIC vs to the investment in and through Slovakia. in the Ukrainian transmission of the system by third parties surplus gas to the currently cost of capital operation of the infrastructure system, and resulting in a more generally. To cement its isolated South East European which is part of the regulated As the tribunal in its final net payment obligation for position, Gazprom still refuses market. % 14 asset base for the provision award on transit case from Gazprom of USD 2.6 billion to provide shipper codes to 11.9% 11.9% of the services. Based on 28 February 2018 found that after settlement of Naftogaz's Ukrtransgaz. These codes are Naftogaz follows a rigid 12 these principles, Naftogaz has communication between underpayments for gas necessary in order to enable approach to capital 10 estimated as of the date of this Naftogaz and Gazprom on deliveries in 2013 and 2014. trade in natural gas across investments allocation when report that the transit tariff in revising the transit tariff However, so far Gazprom has borders, and the refusals to reviewing and approving 8 2018-2019 should be increased fall short of some formal refused to comply with this supply could be considered long-term development by between 40% and 300% requirements, Naftogaz has 6 5.2% payment obligation. an abuse of dominance by plans and financial plans (depending on whether transit filed a new tariff revision Gazprom in its own right. related to gas transit. As 4 3.0% capacities of Ukrainian GTS request in March 2018 In this arbitration, the tribunal stated above, management will be utilized beyond 2019 or and held a first round of 2 refrained from applying the Without the restrictions decisions are currently based not). negotiations with Gazprom relevant competition rules, implemented by the existing on the expectation of zero (or 0 on this issue in April 2018. leaving the responsibility to transit contract and Gazprom's immaterial) transit after the 2016 2017 If one looks at the nominal Renegotiating transit tariffs the regulatory authorities in conduct, the Ukrainian gas expiration of the contract with unadjusted cost of gas with Gazprom is currently one Ukraine. The tribunal's award transmission system (including Gazprom (in December 2019), ROIC, % transmission in Slovakia, they of key strategic initiatives for in applying competition law the largest underground gas but at the same time, Naftogaz Cost of capital, % may say that Ukrainian transit Naftogaz group. left intact the provisions in the storage in Europe) could be secures reasonable funding

98 99 OUR PERFORMANCE ANNUAL REPORT 2017 for maintenance projects GTS. Capital investments 1.7 UAH billion/year, enough to prevent any breach of in this segment for the last for securing uninterrupted GAS TRANSIT operational ability of Ukrainian 2 years were approximately transit flows. Ukraine's gas transportation is 178.5 bcm/year, including which comprise the integral system is one of the most 146 bcm/year towards the technological complex that powerful in Europe. The EU and Turkey. The main operates in continuous mode. capacity at the entrance is component of the Ukrainian The total length of the gas about 300 bcm, of which gas transmission system is a pipelines operated by the KEY PROBLEM: 23 bcm/year from the EU, network of trunk gas pipelines Naftogaz group is more than 38 UNCOMPETITIVE AND HIGHLY POLITICIZED BEHAVIOR OF GAZPROM: and its capacity at the exit and gas pipelines-branches, thousand km. high risk of Gazprom’s non-compliance with Stockholm arbitration award potential litigations incl. appeals and tariff revision risk of loss of gas transit post-2019 due to non-market-driven behavior of Gazprom Gas transit results*, Gas transit volumes, UAH billion bcm INITIATIVES TO ADDRESS THE PROBLEM: Gain scale to counterbalance Gazprom’s bargaining power (by leveraging on existing transit contract and final decisions in Stockholm transit case) The result of this business segment in 2017 decreased Attract strong international partners to TSO 24.6 by 40% or by UAH 10 billion compared to 2016. The reduction VALUE FOR OVERALL MARKET: of the result is basically caused 14.5 82.2 93.5 by a significant increase in Positive effect for GDP, trade balance and sustainability of public finances 14% 2017/2016 depreciation charges in 2017 Ensuring development of infrastructure and related services - by UAH 16.5 billion. This increase is due to events that Full integration with the European gas market took place in early 2017 and led to a significant increase in the probability of zero gas transit through the territory of Ukraine. 2016 2017 2016 2017 As a result, Ukrtransgaz revised the remaining useful life of some * operating profit/(loss) before income tax assets used in gas transit and which will be decommissioned after 31 December 2019 in such conditions. The total volume of natural gas over the last six years. This transit in 2017 amounted to increase is due to the increased At the same time, an increase in 93.5 bcm, which is more than demand for natural gas in the volume of gas transit in 2017 the actual figure for 2016 by Europe mainly because of improved the result by UAH 8.2 14% and is the highest volume weather factors. billion.

100 101 Capacity entry: 28.9 UKRAINE’S GTS 2017 2009 2 2010 3.1 Capacity bcm 2011 3.5 entry: 6.0 2012 3.1 2009 5.4 Capacity 2013 3.4 2010 4.3 entry: 48.5 BELARUS Capacity 2014 2.6 2011 4 2009 19.4 entry: 107.5 2015 2.1 2012 3.3 2010 24 2009 77.6 2016 0.0 2013 2.8 2011 24 2010 83.8 Capacity 2017 0.0 2014 0.5 RUSSIA 2012 21.1 2011 83 exit: 5.0 entry: 1.5 2015 2.4 2013 15.2 2012 72.1 2016 0.0 Capacity 2014 13.1 2.8 0 Kobryn 2009 2013 71 2017 0.0 entry: 25.5 2015 12.8 2010 3.4 0 2014 47.3 2009 8.6 2016 16.5 2011 4 0 Mozyr 2015 46.4 11.1 Capacity 2017 19.2 2012 3.8 0.1 2010 2016 57.0 entry: 13.0 2011 9.5 2013 3.9 1 2017 66.2 2009 0.0 Capacity 2012 9.4 POLAND 2014 3.5 0.9 Sudzha 2010 0.1 entry: 46.0 2013 10.5 2015 3.7 0.1 2011 5.1 2009 8.1 2014 7.4 2016 4.5 1.0 2012 1 2010 3.7 2015 7.5 2017 4.7 1.3 2013 1.3 2011 4.4 7.1 Capacity 2016 2014 0.9 2012 4.4 2017 6.6 exit: 98.4 entry: 15.5 2015 0.0 2013 5.7 2009 65.2 0 2016 0.0 2014 4

2010 67.9 0 2017 0.0 2015 3 2011 70.6 0 2016 1.6

2012 51.8 0 2017 1.6 2013 53.5 0 Valuiky Drozdovychi Serebrianka 2014 31.4 3.6

2015 37.8 9.7 Pysarivka

2016 48.8 9.1 Sokhranivk 2017 53.5 9.9 SLOVAKIA Uzhhorod

Berehove Oleksiivka HUNGARY АТО Capacity Tekove ZONE exit: 32.5 entry: 3.3 Capacity Capacity Capacity 2009 0.8 entry: 3.5 exit: 13.2 entry: 6.1 exit: 4.5 Prokhorivka 2010 3.3 2009 7.9 0 3 2009 0.3 2009 2011 2.8 2010 7.1 0 3.2 2010 2012 0.3 2010 1.9 5.9 0 3.1 2011 2011 2013 0.7 2011 Platove 0.9 3.1 2012 2012 5.7 0 ROMANIA 2014 0.3 2012 1.1 2013 6.4 1.1 2.4 2013 Capacity 2015 0.2 2013 0.0 2014 6.5 0.6 2.8 2014 entry: 6.0 0.0 2014 2016 0.0 2009 0.7 2015 5.9 0.5 2.9 2015 0.0 2015 2017 0.0 2010 0.9 1.0 3.0 2016 2016 6.7 0.7 2016 2011 1 2.8 2017 2017 11.7 2.8 0.7 2017 MOLDOVA 2012 0.7 2013 0.7 Capacity 2014 0.6 exit: 26.8 2015 0.0 16.6 2009 2016 0.0 16.7 2010 2017 0.0 19.9 2011 19.6 137.7 2012 134.4 19.6 2013 122.8 118.0 Desig ned GT S e xit capacity Desig ned GT S en try capacity 114.2 107.6 18 2014 Orlivka 93.3 81.8 83.5 16.7 2015 18.5 2016 Gas ﬂow 20.2 2017 Capacity to Ukraine

exit: 32.5 entry: 3.3 2009 2010 2011 2012 2013 2014 2015 2016 2017 Transit Gas volume transmitted Gas volume transmitted through Ukraine on GTS exit on GTS entry 62.2 67.1 In 2017, the volume Gas metering 84.3 86.1 82.2 95.8 98.6 93.5 of natural gas transit stations located 104.2 close to the border to Europe reached Source: Ukrtransgaz, 2017 93.5 bcm temporarily occupied and uncontrolled territories OUR PERFORMANCE ANNUAL REPORT 2017

GAS DOMESTIC TRANSMISSION NATURE OF DEBT FOR UNAUTHORIZED GAS WITHDRAWAL

40% 19% Kharkivmiskgaz KEY RESULTS OF THIS BUSINESS SEGMENT: 24.7 Donetskoblgaz UAH bn Kryvorizhgaz • ROIC in 2017 (0.01%) was significantly lower than cost of capital (11.9%) 15% • Rapid accumulation of debt for unauthorized gas withdrawal (UAH 20.0 bn as of 31/12/17, +38% y-o-y) Dnipropetrovskgaz • Uninterrupted gas supplies to vulnerable local consumers during March 2018 artificial crisis created Debts for unauthorized gas Kyivoblgaz withdrawal by Ukrtransgaz’s 12% Other 57 companies by Gazprom 6% 8% • Total domestic transmission volumes – 27.4 bcm (-7% y-o-y) counterparts as of 31.03.2018 • Maximal gas imports from European direction – 14.1 bcm (+27% y-o-y), including 5.4 bcm for third parties (+84% y-o-y) In March 2018, the total counterparties debts to Ukrtransgaz for unauthorized withdrawal of gas had increased by UAH 3.3 bn

The circumstances that led to the emergence of significant volumes of negative gas imbalance Gas domestic transmission US D-denominated ROIC vs Key reasons behind such results are related to the entry into force on 27 November 2015 of the Resolution of the NCREU No. 2493 is the third largest business cost of capital, % in 2017 were: of 30 September 2015 "On Approval of the Code of the Gas Transportation System". According of Naftogaz group (11% of • the accumulation of bad to this resolution, the operators of the gas distribution system were obliged to perform the revenues), but it remained debts for unauthorized allocation, i.e. the confirmation of the distribution of natural gas submitted for transportation one of key underperforming % 14 gas withdrawal caused by to and actually withdrawn from gas distribution systems. Therefore, operators of the gas 57 segments in 2017. ROIC 11.89% 11.89% regulatory flaws in secondary distribution system actually got the opportunity to include unauthorized withdrawal of natural remained almost nil in 2017 12 legislation and the unfair gas in their networks in the allocation to other customers, in particular, to Naftogaz. 10 behavior of some network 57 ROIC is calculated as NOPLAT for the respective users (see Nature of debt for The consumed volumes of natural gas for which no nomination has been submitted and the year divided by invested capital, which was 8 determined as the sum of invested capital in 6.79% unauthorized gas withdrawals); supply of which has not been documented by Naftogaz are considered unauthorized and should fixed assets and net working capital as of the 6 • the shift to domestic cost- be reimbursed by the respective gas distribution system operator in favor of PJSC Ukrtransgaz. end of the year. NOPLAT and invested capital reflective tariffs is not finalized However, gas distribution systems operators failed to comply with the requirements of the current were converted from UAH into USD using NBU’s 4 59 average annual exchange rate for NOPLAT and yet (e.g. implementation legislation of Ukraine and continued to perform allocation and report on the actual volumes of exchange rate as of the end of the respective 60 2 of domestic entry tariffs is natural gas distribution by suppliers in which not themselves but Naftogaz was indicated as the year for invested capital (in order to compare supplier of natural gas. USD-denominated ROIC with USD-denominated 0.01% blocked by court decision). cost of capital used by independent 0 appraisers). Invested capital in fixed assets was 2016 2017 As of January 2018, almost 70 cases initiated by Ukrtransgaz against its debtors on collection estimated in two steps: D ebt for unauthorized gas for transportation services, including for unauthorized gas withdrawal, are pending before (a) Net replacement costs less physical ROIC, % depreciation of the gas transmission withdrawal, UAH bn the commercial courts. The enforcement services are in process of enforcement of more than system (UAH 419 bn as of 31/12/2017) was Cost of capital, % 50 orders for the collection for natural gas transmission services, including for balancing services adjusted for the effect from expectation and penalties. of zero or immaterial transit flows beyond 20.0 2019 (cf. pages 25-26 of 2017 Consolidated Financial Statements). Should expectation (compared to 11.9% as cost of material transit beyond 2019 have been 58 of capital ), with NOPLAT 14.5 59 used for revaluation, net replacement The illegitimacy of such actions by gas distribution system operators is confirmed by the decision of the Kyiv Commercial Court of Appeal dated costs less physical depreciation of the gas equal just to UAH 3 million 15.02.107 and the Supreme Commercial Court dated 06.07.2017 on case No. 910/10225/16. This established that the consumed volumes of natural transmission system cash generating unit (compared to UAH 2.5 billion gas for which no nomination has been submitted and the supply of which have not been documented by Naftogaz constitute unauthorized with- would be 10% higher, i.e. UAH 460 bn.. drawal and should be reimbursed by the respective gas distribution system operators in favor of PJSC Ukrtransgaz. in 2016). 60 (b) UAH 460 bn was apportioned among key Following the introduction of Resolution No.615 dated of 28 April 2017, Ukrtransgaz performed allocation of actual volumes of natural gas by customers of businesses of the group according to 6.6 transmission services with the goal to determine imbalance volumes of such customers for the certain period. management approach to measuring 4.1 group performance. In particular, capacity and distance were used as factors for the allocation of assets between gas transit As of today, Ukrtransgaz as in accordance with the signed transmission service customers and other businesses. UAH-denominated value of invested capital in 58 Cost of capital is estimated by independent 01.01.2016 01.01. 2017 a GTS operator balances the monthly acceptance-transfer according to the results of fixed assets as of 31/12/17 was used as a proxy appraisals in USD to determine the fair value of system for transmission service acts). This creates high risks for the month. For this reason, for UAH-denominated value of Invested capital gas transmission assets of PJSC “National Joint Gross amount customers on a monthly basis the business for the settlement the requirements for financial in fixed assets as of 31/12/16 for the purposes Stock Company “Naftogaz of Ukraine”” as of of ROIC calculation. 31/12/2017. Provision for impairment (i.e. based on the actual data of imbalances between the security, which is linked to the

104 105 OUR PERFORMANCE ANNUAL REPORT 2017 monthly transmission volumes, are rather high. Key achievements of the segment in 2017:

The introduction of daily balancing61 will reduce the 1.2 UAH billion per year 1) Establishment of the branch "Operator of the Gas Transportation System of Ukraine" risks for all natural gas market participants and, as a result, will REVENUE TO BE LOST BY THE GROUP AS A RESULT In pursuance of the company's Restructuring Plan designed to separate gas transmission and reduce the financial burden on storage activities (unbundling) approved by the Cabinet of Ministers of Ukraine Resolution transmission service customers. OF NON PAYMENTS AT DOMESTIC ENTRY POINTS No. 496, in October 2017, a branch of OJSC Ukrtransgas named "Operator of the Gas In addition, daily balancing Transportation System of Ukraine" (OGTSU) with GTS operator functions was established. will allow for the launch of a At present, OGTSU provides operational management of the Ukrainian GTS and is a functionally full-fledged market of short- self-sufficient structural unit with an approved organizational structure and staff schedule for 290 positions. As of 31 December 2017, the OGTSUU is staffed with 189 employees. The branch term products (one day ahead, operator, rather than create its incomplete shift to the RAB serves more than 1000 gas transmission contracts in Ukraine. during the day) and stock own code or modify separate tariffs at the internal entry and trading, where international articles of the code developed exit points is the critical issue: traders and domestic by the GTS operator. • as of the date of this report, 2) Shift to transparent procedure for purchasing gas for own needs producing companies will be the tariffs for the points of exit able to trade, and will allow full Naftogaz's interest in bringing from the gas transportation In 2017, Ukrtransgaz conducted tenders for the purchase of natural gas for its own production usage of the underground gas the rules into line with European system to Ukrainian and technical needs through the electronic public procurement system ProZorro, which storage facilities. standards, in particular in the consumers are not approved resulted in improved transparency and made it possible to save UAH 3.8 billion. In total, gas transmission segment, is as by the NCREU; 13 auctions (23 lots) with a total volume of 4.7 bcm of natural gas were conducted. Ukrtransgaz as a GTS operator follows: • the establishment of tariffs for 15 companies participated in the tender, including subsidiaries of the international gas traders is currently in the process the natural gas transmission The Trafigura group and MET group. of launching an information 1. European rules will allow for services for internal points platform62 and administering a more efficient balancing of entry was suspended by the market of bilateral exchange of supply and demand that a decision of the District trade agreements using a means more efficient gas Administrative Court of Kyiv model that will fully meet the consumption and supply. dated 27 April 201763 Group’s plans for the business in 2018: requirements of the EU’s Third Greater efficiency means less Energy Package. At the same import that brings the market • continue work on daily balancing introduction time, Naftogaz is guided in closer to energy independence. this process by the following Moreover, greater efficiency • carry out legal collection of the accumulated debts for unauthorized gas withdrawal (which reached principles: would lead to better consumer almost USD 1 billion) • introduction of European solvency. network codes in Ukraine • facilitate the finalization of introduction of entry/exit tariffs for internal points (including on balancing) 2. Opportunities for abuse by • takes the position that the unfair market participants, • optimize operating costs and processes to bring them into line with European counterparts, to Market Regulator’s role is to who use Naftogaz's gas free develop additional functions that are common for standard European GTS operators. As part of this approve or not approve the of charge, will diminish. process, the group considers the option of involving a technology partner for the GTS operator code developed by the GTS

61 On 27 December 2017, the NCREU approved 3. Transparency, clear and fair • start the procedure for selling future capacity in the framework of the Poland-Ukraine interconnector Resolution No. 1437, which provides for the European rules, elimination construction project (this will allow better understanding of the demand for these capacities and to introduction of daily balancing from 1 August of opportunities for manual 2018. According to the resolution, the operator attract part of the investments required for project implementation) of the gas transmission system will be control at the GTS operator's responsible for ensuring daily balancing of all level for corruption purposes users of the system, informing the customers is a guarantee for Naftogaz about the expected imbalances during the day of transmission, receiving and processing that the GTS operator will of daily allocation, and calculating customer not be a tool for pumping imbalances per day, which requires the appropriate software and business process money from state-owned optimization. companies. 62 As of the date of this report, an independent technical audit by an international company In the implementation of found that the information system that 63 Claimer in this case was a People's Deputy is in place in Ukrtransgaz does not meet European norms, another major (whose name is not indicated) who mentioned the requirements for systems of this level problem for the GTS operator is that the National Commission illegally and and is exposed to unreasonable risks. The to generate revenue that covers incorrectly replaced the resolution of 28.03.2017 management of Ukrtransgaz is currently with a new resolution of 10.04.2017 instead of working out ways to address this situation. all its costs. In this regard, the abolishing this document.

106 107 OUR PERFORMANCE ANNUAL REPORT 2017

GAS DOMESTIC The volume of natural gas transportation and distribution to Ukraine in 2017 decreased by Gas domestic The level of settlements customers outside the group, bcm 7% compared to the previous transmission results*, for unauthorized gas TRANSMISSION year due to the reduction in UAH billion withdrawal, UAH billion the total volume of natural gas The Ukrainian gas transmission consumption because of factors -7% +84% described in the Gas production, system also provides domestic 94% 2017/2016 2017/2016 14% gas transportation services for imports and sales to various 4 Ukrainian consumers. Since consumer categories section. 6.2 the end of 2015, Ukrtransgaz 29.5 2016 27.4 The volume of capacity 3.1 has been offering two new 3 types of services: balancing distribution at the points of service (physical balancing and entry/exit in 2017 increased by commercial balancing), and since 84% due to a decrease in the 2 the beginning of 2016 - capacity total natural gas imports to Ukraine by companies outside distribution service for cross- 81% border entry points (import) due the group. to the transition to RAB tariffs. 1 The result of this business 16.1 5.4 decreased by UAH 3 billion 2017 Pursuant to the Code of the 0.004 33% gas transmission system, 2.9 in 2017 compared with 2016. 0 The major negative factor was Ukrtransgaz provides the 2016 2017 customer with one or several the increase in doubtful debt components of natural gas 2016 2017 2016 2017 allowance caused mostly by transportation services (capacity unauthorized gas withdrawal % of settlements, distribution order, natural gas Natural gas volumes transmitted to Natural gas volumes transmitted and relevant reserves generated * operating profit/(loss) including before income tax transportation order, balancing consumers in Ukraine through cross-border points because of the failure by gas % of settlements service). Customers who ordered (transmission capacity distribution operators to comply by subsidies transportation services pay the at the entry points) with Ukrainian law (see “Nature operator of the gas transmission of debts for unauthorized gas system the cost of the services withdrawal” section). received. system, namely the necessary the NCREU's Regulation64, The system balancing service ratio between natural gas №348 of 28.03.2017 “On includes: volumes that have physically UTG's transmission tariffs for • commercial balancing - entered through entry points Ukrainian consumers at entry activity of the gas transmission and natural gas volumes and exit points”. Naftogaz group system operator which that have physically been continues to emphasize that consists of identifying and removed through exit points. gas transmission tariffs for both adjusting the imbalance that transit and domestic supply arises from the difference In March 2017, the NCREU must be non-discriminatory as between the volumes of approved UTG's transmission required in Directive 2009/73/EU natural gas entering through tariffs for Ukrainian consumers on common rules for domestic the entry points and the at entry and exit points as well gas market and Regulation volumes of natural gas exiting as gas distribution tariffs for (EU) 715/2009 on access to through the exit points in distribution system operators gas transmission systems. This the context of the customers calculated based on connected requires an urgent transition who ordered transportation capacity according to new to tariffs based on long-term services, whereas such activity methodology. However, in incentive-based regulation is carried out on the basis of April 2017 the NCREU adopted according to the methodology data received through the another resolution which approved in the resolution65. allocation procedure; and cancelled its previous decisions • physical balancing - on transmission and distribution The volume of natural gas measures taken by the tariffs set as payment for utilized transportation for consumers in operator of the gas capacity. The award by the 64 NCREU Resolution “On denouncing some NCREU transmission system to Kyiv District Administrative Resolutions” dated 10.04.17 No.494 ensure the integrity of the Court of 27 April 2017 stopped 65 NCREU Resolution dated 30.09.15 N0 2517

108 109 OUR PERFORMANCE ANNUAL REPORT 2017

purpose of other UGS was to the same decree, security without customs clearance69. to ensure the supply of gas stock in 2016-2017 security With the new option, all gas UNDERGROUND to regional consumers at stock was equal to zero. As a traders are able to store their the location of the UGS and result, there was no demand gas on Ukrainian territory to compensate for seasonal for storage services related for up to 1095 days without GAS STORAGE and daily fluctuations in to security of supply (from paying taxes and customs demand. Due to significant private suppliers). duties if the gas is going to be decrease in gas transit transported away from Ukraine. KEY RESULTS OF THIS BUSINESS: volumes through Ukraine Due to the large total capacity All legal barriers have been • Injection volumes by third parties – 1.5 bcm (15% of total injection volumes, incl. by the group). (which was ~140 bcm of UGS, Ukraine has 10-15 bcm thus removed in Ukrainian in the late 1990s) and of spare capacity that could regulations for providing non- • Withdrawal volumes by third parties – 1.0 bcm (13% of total withdrawal volumes, incl. by the group). domestic consumption be offered to European residents with the services of • Negative ROIC in 2017 (-0.35%). (up to 120 bcm in early consumers. As mentioned gas storage in UGS facilities. 1990s) demand for seasonal above, the largest storage On 13 June 2017, Ukrtransgaz and peak storage has capacities are located at the pumped the first 3 million significantly decreased. western border of Ukraine, cubic meters into gas storage 31% of carrying PP&E value as of Revenues of gas storage Gas storage business: – High cost of capital in at the crossroads of key in the "customs warehouse" Ukraine and narrower gas pipelines that link GTS mode, commissioned by 31.12.17 allocated to gas storage business (from third USD-denominated ROIC vs summer-winter spread on of Ukraine, Belarus, Poland, leading international traders business. It makes this segment parties), UAH million сost of capital, % the second largest business European markets makes Slovakia, Hungary and TrafiguraSarl (Switzerland), maximum import in summer Romania. The major share of Trafigura Ukraine and MND after Gas Transit in terms of 2016 2017 invested capital. However, with commercially unattractive. gas transit from Russia also (Czech Rep.). Actual processing – Problems with international passes through these gas of natural gas in this "customs low demand for gas storage 401 11.89% 11.89% services in Ukraine from the traders’ perception of credit transmission routes. warehouse" regime began third parties (gas storage system 338 risks related to Ukrainian in late August 2017, and is used mainly for security of counterparties. Perception Based on the initiative to within the next four months, gas sales and supply by the of legal risks, associated with increase utilization of Ukrainian Ukrtransgaz concluded 23 group), revenues of this business storage of gas in Ukrainian UGS by private traders, on 1 contracts with international and gas storages. June 2017, following a year Ukrainian traders for the total constituted less than 0.1% of 184 2017 group’s revenues. – Specifics of national of joint efforts of Ukrtransgaz, volume of 52.7 mcm. emergency plan on the Naftogaz, the Ministry of In terms of NOPLAT, the results gas market. In accordance Finance, and the Power At the same time, based on of gas storage business are 61 with the government’s Customs Office of the State analysis of the gas storage even worse – this indicator was -0.37% -0.35% decree #860 of 16 November Fiscal Service of Ukraine, market in Europe, management negative (-329 UAH million) 2016, in case of emergency, Ukrtransgaz was granted 69 in 2017. As a result, ROIC66 of suppliers of natural gas are permission to open and Previously, it was possible to clear natural gas 2014 2015 2016 2017 ROIC, % transported to the customs territory of Ukraine this business is also below obliged to create a security operate a customs warehouse only in ‘customs transit’ mode. In this case, the zero: on average it was -0.36% Cost of capital, % stock of 10% of expected using Ukraine’s UGS. This Customs Code of Ukraine allows for 31 days monthly supply volumes to enables gas traders to store to secure customs clearance for gas. These in 2016-2017. Therefore, the is that it faces a substantial conditions were not economically attractive for key problem of this business gap between ROIC and its Low utilization of gas storage by their consumers. According natural gas for over 1000 days most foreign gas traders. сost of сapital67 (estimated as third parties and resulting poor 66 ROIC is calculated as NOPLAT for the respective 11.89%) due to significantly financial results of this segment year divided by invested capital, which was underutilized UGSF capacities. are explained by: determined as a sum of invested capital in fixed Historical summer/winter price spread on TTF hub assets and net working capital as of the end Comparison of ROIC with сost – Highly excessive gas of the year. NOPLAT and invested capital were of сapital reveals that invested storage capacities due to 6 Overview of EUgas storage capacity Ukraine converted from UAH into USD using the NBU capital is used ineffectively and ‘historical heritage’. Among average annual exchange rate for NOPLAT and 5 exchange rate as of the end of respective year additional economic value is European countries, Ukraine 68. 2.5 0.3 for invested capital (in order to compare USD- 1.4 not created has the largest capacity 1.5 17.0 denominated ROIC with USD-denominated сost 4 0.7 14.3 1.9 0.4 of UGSFs, and most of 1.3 of сapital, used by independent appraisers). The 4.8 3.5 3.3 1.9 2.1 1.3 0.8 24.6 2.3 capital invested in fixed assets was estimated them are concentrated in 3 30.9 0.4 67 9.0

Cost of capital is estimated by independent EUR/MWh 6.4 based on net replacement costs less physical Western Ukraine. During 12.8 3.1 appraisals in USD to determine the fair value of 0.5 0.5 depreciation of Underground Gas Storages 2 their development, their 0.6 (see page 25 of 2017 Consolidated Financial gas storage assets of PJSC “National Joint Stock 17.8 0.3 Total capacity Statements). UAH-denominated value of Company “Naftogaz of Ukraine”” as of 31/12/2017. main purpose was to ensure 2.9 2.6 1 30.9 bcm invested capital in fixed assets as of 31.12.17 was 68 At the same time, the value for group’s customers uninterrupted supplies of Total capacity 145.8 bcm used as a proxy for UAH-denominated value of from the use of gas storage capacities utilized gas from the Soviet Union invested capital in fixed assets as of 31.12.16 for by the group itself (mostly related to security of 0 the purposes of ROIC calculation. supply initiatives) is significant. to European countries. The 2010 2011 2012 2013 2014 2015 2016 2017 Acquifer Salt cavity Depleted O&G field Other

110 111 OUR PERFORMANCE ANNUAL REPORT 2017 realizes that there is limited opportunity to increase KEY PROBLEM: GAS STORAGE utilization of Ukrainian storages Excessive UGS capacities, value-destroying business by leveraging international Movement of gas in storage facilities in 2017 demand. Over the last 7 INITIATIVES TO ADDRESS THE PROBLEM: years we observed significant Maximization of value by: decrease of gas consumption 2 423 in most European countries, Identification and possible decommissioning/mothballing of combined with increases of identified excessive UGS 10 376 17 050 6 674 214 310 96 domestic gas storage facilities, OPEX savings on labor intensity creating oversupply and OLYSHIVSKE 430 738 0.00% 643 1 500 857 pressure on gas storage tariffs VALUE FOR OVERALL MARKET: 3 987 559 (this has led to concerns of BILCHE-VOLYTSKO-UHORSKE 899 2 150 1 251 CHERVONOPARTYZANSKE Increase of gas production from excessive storages – faster 41.10% 6.30% 244 lower use of gas storage and 939 242 DASHAVSKE 205 236 700 464 has even to closure of some transition to energy independence 1 446 1 900 455 10.80% 1 078 364 1 300 936 460 KEHYCHIVSKE gas storage facilities in Europe). Financially sustainable security of supply 312 207 147 UHERSKE 4.50% 1 259 2 300 1 041 SOLOHIVSKE 273 420 147 Market participants can choose 3.60% 407 2.60% 160 KRASNOPOPIVSKE alternatives to gas storage 526 1 633 1 920 287 1 364 BOHORODCHANSKE 2.00% such as flexible gas production, encompasses a trustworthy – even with such an adjustment 15.70% 532 1 000 468 import contracts, line pack, and up-to-date analysis of and non-zero international 583 OPARSKE 577 PROLETARSKE 224 400 176 swaps, interruptible contracts, the technical, commercial demand, there is an excessive 6.30% 7.10% VERHUNSKE scale down contracts, LNG etc. and legal viability of each capacity. 0.00% underground gas storage 310 Due to such expectations, facility, with recommendations On top of low utilization of UGS, Design capacity (mcm) a large study of UGSFs in in terms of their optimal the segment’s negative financial Free capacity (annual average) Ukraine was launched in 2017. usage and strategic fit while result may be partly attributed Volume stored (annual average) Storengy, one of the leading considering opportunity to the currently economically [%] Activity (movement) operators of underground cost of invested capital (in unfeasible tariffs for natural gas Pumped in gas storages in the world, in particular, value of cushion storage. As of the date of this Withdrawn consortium with a top global gas). Several scenarios are to report, the Regulator still has not management consulting be generated and adequate approved new higher regulated firm and the international strategic options developed tariffs70 calculated based on the law firm CMS Cameron with a roadmap to ensure methodology agreed in 2016. McKenna Nabarro Olswang, efficient implementation of In future, the group expects Ukrtransgaz manages one of The volume of UGS injection/withdrawal to customers outside are contributing to this preferred option. to transition to RAB tariffs for the largest gas storage networks the group, bcm comprehensive study. This gas storage, with a cap based in Europe. It is an important strategic, technical and legal Although the project is still on a competitive level of tariffs integral technological part of assistance project, funded by underway and the estimations in neighboring European the Ukrainian gas transmission the European Union bilateral are preliminary, it is apparent countries. That will ensure fair system. Today 12 storage facilities program with Ukraine, is that: returns from the regulatory asset are in operation, two of which Gas injected into Gas withdrawal designed to build up a – current active capacity should base and improve the segment’s are based on water-bearing UGS from UGS sustainable business case for be significantly adjusted; result. structures. The rest are based Ukraine’s underground gas – under the most probable on depleted gas fields. The total storage facilities in the context scenario, international capacity of the gas storage of the European and Ukrainian demand is very modest or 70 Though all supporting calculations were filed with the Regulator by the designated operator facilities is about 31 bcm. energy markets. The project insignificant; of UGS, Ukrtransgaz The storage facilities are multi- purpose objects. They are used 1.5 2017 1.0 to ensure the smooth and efficient delivery of natural gas to consumers, reliable gas transit through Ukraine to the EU, and to serve as long-term 0.9 2016 1.8 gas emergency reserves and balancing peaks periods in gas consumption.

112 113 OUR PERFORMANCE ANNUAL REPORT 2017

The group provides gas storage 2017. The group's stocks at Gas storage results* services in its storage facilities the beginning of the heating UAH billion to both gas suppliers and season (that is, as of 15 October OIL TRANSIT AND DOMESTIC consumers. 2017) 2017/2018 amounted to 16.8 bcm, which is 14% more The volume of natural gas than in the same period of 0.5 TRANSMISSION withdrawn from underground 2016. gas storage facilities in 2017 is less than in 2016 by 46%, The results of natural gas which is the result of a later storage business in 2017 did not 0 start of the heating season: change much compared to 2016 active withdrawal of gas from and it remained a loss making the UGS in 2017 started on 1 segment. The negative trend KEY ACHIEVEMENTS IN 2017:

November 2017, two weeks of the business indicates that –0.5 –0.3 –0.3 later than during the heating tariffs on natural gas storage 13.9 million tons – 0.8% increase in oil transit volumes through oil transmission pipelines season in 2016/2017. At the are economically unreasonable. same time, the total volume The group expects in 2018 to Volumes of oil transmission to Ukrainian refineries increased by 64.1% to 1.7 million tons. of natural gas injected into switch to the RAB methodology Operation of the oil pipeline Odesa-Kremenchuk section and the first phase of Mozyr-Brody oil underground gas storage for calculating gas storage –1.0 pipeline were renewed facilities in 2017 compared to tariffs, which will ensure that 2016 2017 2016 increased by 75% due to fair returns are accrued on the In January 2018, Ukrtransnafta and Ukrtatnafta concluded an amicable settlement to a three-year more active pumping of natural regulatory asset base and lead dispute on the value of storage and the terms for returning the crude oil linefill in the amount of gas into UGS in May-September to improved business outcomes. * operating profit/(loss) before income tax 239 thousand t, which had been stored in the Kremenchuk refinery reservoirs since 2014

ROIC for the oil transit and transmission was 6% in 2017, which is less than the appraiser’s cost of capital (17.4%). ROIC for oil transmission business (-6.3%) was the lowest among Naftogaz’s businesses in 2017

Oil transmission through Nevertheless, ROIC71 of oil the the last ten years and low Ukrainian oil pipelines is domestic transmission business level of demand for oil from performed by Ukrtransnafta, was still negative, the lowest local Ukrainian refineries which is a part of Naftogaz among other businesses in 2017 (see section “Oil and gas group. The oil transmission (-6.3%), and lower than the cost of condensate”); system includes 19 oil capital for this business72 (17.4%). • approximately 20% of oil pipelines with a one-line total This situation was caused by the transmission pipelines are length of 4767 km, the entry following key factors: mothballed, but maintenance capacity of 114 million tons • low utilization of the system and repair costs associated and exit capacity of 56.3 owing to domestic crude with these assets remain; million tons. Ukrtransnafta oil production decline for • oil transmission tariffs are comprises the Druzhba Oil regulated and do not even Pipelines, Prydniprovski Oil 71 ROIC is calculated as NOPLAT divided by the sum cover the operating costs of pipelines and Southern Oil of invested capital in fixed assets (associated Ukrtransnafta. and allocated to domestic oil transmission Pipelines. system) and net working capital. Value of invested capital in fixed assets is equal to ROIC of oil transit business In 2017, decline in domestic the amount of depreciated replacement cost (app.20% for 2016-2017) before the test for economic obsolescence, production of oil was partly estimated by independent appraisers during exceeded the cost of capital compensated by higher determination of fair value of oil transmission (17.4%), mostly due to imports, resulting in marginal assets of Naftogaz as of 31.12.2017. unregulated tariffs for oil transit improvement of ROIC. and low amount of invested 72 Cost of capital is estimated by independent capital allocated to this business. appraisers to determine the fair value of oil transmission assets of Naftogaz as of 31.12.2017. The value of the oil transmission

114 115 OUR PERFORMANCE ANNUAL REPORT 2017

Oil domestic transmission: Oil transit: UAH-denominated system allocated to the transit Key problems: UAH-denominated ROIC vs ROIC vs cost of capital, % business is almost equal to cost of capital, % the value of pipelines used for existing transit routes (currently only Druzhba oil pipeline), which 1. Russia and Kazakhstan Russia and Kazakhstan redirected oil export routes to Russian redirected oil export routes comprises about half of total ports’ terminals since 2001 value of oil transmission system as to Russian port terminals 20.5% of 31.12.2017. 17.4% 17.4% 19.9% Russia is working to remove 17.4% 17.4% transit intermediaries as part If historical transit routes were 35 60 preserved (such as Samara – of the Kremlin’s geo-economic strategy. This is precisely why Lysychansk – Tykhoretsk and 30 50 Brody–Yuzhny in reverse mode), Ukraine has been facing dramatic reductions in oil transit during 25 ROIC of oil transit would be much 40 the past few years. lower. 20 CAGR 3.4% 30 If ROIC for the whole business With the aim of bypassing % 15 % transit countries, Russia group of oil transit and 20 –6.8% –6.3% 10 transmission is calculated for completed construction of the Baltic Pipeline System 2016 2017 2016 2017 2017, it would be 6%, which is less 5 CAGR –7.1% 10 than the appraiser’s cost of capital (BTS-1 and BTS-2) with a total transfer capacity of 80 ROIC ROIC (17.4%). 0 0 million tons of oil per year. 2011 2017 2012 2013 2015 2014 2016 2001 2010 2007 2002 2003 2005 2004 2006 2009 Cost of capital Cost of capital As a result, in 2016 and 2017, 2008 about 80% of Russia’s crude oil and condensate exports were seaborne. However, Share of Russia oil in EU import (left scale) regardless of the ultimate mode Share of Ukrainian route in Russia export (right scale) of transport, most of Russia’s crude oil exports must traverse Transneft’s pipeline system (RF oil pipeline operator), either The volume of crude oil transportation as a direct route to reach bordering country or to reach Diversification of Hungarian import Russian ports. Despite the 90.0 growing share of oil supplies The Baltic pipeline route-1 2004-42 2015-55 from the Russian Federation started 12 MT/y MT/y MT/y estimated losses of Ukrainian route 2.8 million t 80.0 78.0 to the European market, the transit flow via the Ukrainian 66.9 Bypassing pipeline to 45.1 36.9 68.5 The Baltic pipeline route-2 string of Druzhba oil pipeline is 120 43.7 43.8 43.8 50 70.0 65.3 Novorossiysk started 64.6 64.1 65.4 65.2 64.0 started 25 MT/y 17.9 63.6 28 MT/y dropping. 45 19.2 100 60.0 15.2 11.2 11.2 12.0 11.3 7.6 40 15.0 56.7 54.9 89% 48.0 50.9 As a result of the low 79% 79% 35 56.4 46.7 80 50.0 44.9 diversification of transit flows, 53.4 52.9 53.4 53.9 60% 30 50.6 50.1 40.9 the aggressive policies of 47.7 48.6 20.6 23.5 22.4 15.3 11.7 11.1 38.5 40.0 60 25

neighboring countries and the % 8.1 41.1 39.8 29.8 20 million t/year 9.4 slow response to changes in the 40 30.0 33.2 25.2 15 33.2 32.5 31.4 32.8 market situation, Ukraine has lost 29.1 9.7 27.4 more than 30 million tons of oil 10 7.4 17.2 17.6 16.9 20 20.0 16.8 15.2 16.0 transit flow per year since 2001. 20.1 2.7 2.0 5 17.8 1.8 1.6 1.4 2.1 15.6 10.0 14.5 15.0 15.2 13.8 13.9 0 0 2. Lack of diversification 2014 2015 2016 2017 0.0 Ukrainian transit oil flow 2011 1997 2017 1992 1993 2012 2013 1995 2015 1994 2014 1996 1999 2016 1998 2001 2010 2007 2002 2003 2005 2004 2006 2009 2008 2000 comprises only oil from Russian % Russian Federation oil % other oil (left scale) Transit Domestic transportation Total producers. Transit volume Total imported volume million barrels/year (right scale)

116 117 OUR PERFORMANCE ANNUAL REPORT 2017

Key opportunities and plans for 2018:

1. Positive preconditions for active cooperation of Ukraine with the countries of Central and Eastern Europe in light oil grades delivery from the Black Sea Basin to the markets of Central and Eastern Europe through the Ukrainian territory. The key objectives in this regard are “deblocking" of the Slovak section of Druzhba pipeline for supply of various oil grades and construction of Brody – Adamova Zastava oil pipeline. 2. To promote the project “Bratislava-Schwechat connection” with a capacity of 3.25 - 5 million t/year. The implementation of the project will allow the Austrian refinery to supply Russian oil or light oil when it is transported by the Odessa-Brody-Druzba route, increasing the transit of oil through the territory of Ukraine. 3. Capacity utilization could be increased through realization of synergies between oil transportation and untapped local oil upstream and refinery potential. 4. Currently Ukrtransnafta sets OPEX optimization as the main improvement lever: • increasing labor intensity; • decreasing maintenance costs while ensuring reliable and safe operation of transmission facilities; • improving energy efficiency. Present tariffs for domestic oil transportation do not cover the operating costs of this business. Further adoption of cost-reflective tariffs will increase profitability of this segment. 5. Creation of minimum stocks of crude oil and/or petroleum products pursuant to Council Directive 2009/119/EU is one of the contemporary national security objectives. Using unique storage and through Ukraine in 2017 creation of an alternative route transportation of Azeri crude oil transportation infrastructure for diversification of the business model through participating in the project amounted to 14 million tons of for the transportation of oil in through the Odesa-Kremenchuk to establish a system of minimum crude oil stocks and petroleum product is one of the key prospects in oil, which actually supplies three sufficient quantity to Slovakia oil pipeline. As a result, during the domestic market. After a minimum stocks model (minimum crude oil and petroleum product stocks) countries – Czech Republic, bypassing Ukraine. the year, 850 thousand tons of has been determined, Ukrtransnafta is ready to start creating new additional production infrastructure. Hungary and Slovakia. Azeri Light oil was transported 6. Expanding the range of services utilizing capacities of the Pivdennyi oil terminal for transshipment of oil to the Kremenchuk oil refinery. and petroleum products using rail transport. The oil terminal may accept and load crude carriers up to 3. Low utilization Ukrainian transit oil flow Most domestic refineries are 14.5 million t/year and may accommodate crude carriers with a deadweight of 35 000-150 000 tons. comprises only oil from Russian of pipeline system currently not functioning and producers. Transit volume at present the domestic market 7. Further solution of issues related to Illegal tie-in in oil trunk pipelines. During 2017, the company's through Ukraine in 2017 From 4 767 km of total pipeline is insufficiently saturated with security service recorded 27 attempts at so-called tie-ins causing losses to the company. amounted to 14 million tons of length, more than 20% are on home-processed oil products, 8. Implementation of new services: oil, which actually supplies three “safe hold” (pipelines filled with which in turn caused an • oil blending for European consumers at the sea oil terminal Pivdenny and LVDS Brody - currently countries – Czech Republic, special liquid), and a 680 km increased import share of oil consumers in the Central and Eastern Europe are showing interest; Hungary and Slovakia. section of the Odessa-Brody oil products and a corresponding • provision of services for oil and petroleum products quality assessment: pipeline is filled with Azeri Light decrease in oil processing - accreditation of Naftogaz group laboratories; The possible extension of oil but does not pump oil. and transportation of oil by - purchase of equipment for calibrating tank battery. pipelines. diversification in sources of oil 9. In order to streamline the company’s management, accounting, tax and real time accounting and make Thus we see a low level of by Czech Republic, Hungary and it more transparent, the company plans to shift to the unified SAP-based management system in Q4 capacity utilization caused by Slovakia carries a high risk for There are significant risks last of 2018. The key modules of this system will be repairs management and investment activities and the presence of a large number future activities. Over the past that the utilization gap of construction management, including thorough overhaul, and a financial module. five years, Hungary, of the three of unused pipelines in the this business (if compared countries mentioned above, eastern region of the country, with its peers) is unlikely 10. A new MES/SCADA technology management system is also expected to be launched on the basis of has diversified its oil supply to which previously transported oil to be covered. The risk of the Oil Pipelines Druzhba. The new platform would allow timely decisions regarding the technological the greatest extent. Slovakia to the seaports of Ukraine from further reduction of oil transit processes of oil pipelines, reduce the human risk factor, and ensure maximum automation of production was in the worst position with Russia and Kazakhstan and to through Ukraine may also be processes. respect to the diversification of Ukrainian refineries. realized because of active EU transmission routes over the last operator policies to diversify decade, but in 2015 Hungary Domestic transportation after and substitute Russian oil and Slovakia completed the years of lingering decline began for oil from the Middle East reconstruction of the Adria oil to recover in 2017. In March within both all-European and pipeline and this means the 2017, Ukrtransnafta renewed the business strategies.

118 119 OUR PERFORMANCE ANNUAL REPORT 2017

The results of the Oil domestic the increase in transportation to the Kremenchuk refinery and, OIL TRANSIT transmission business improved volumes for domestic consumers accordingly, the rehabilitation by 10% in 2017 compared to by 49% due to the increase in the of the Odessa-Kremenchuk oil The volume of oil transit refineries was stopped for improved the result of the 2016. The key positive factor was supply of imported raw materials refinery route. through the territory of repairs). business by UAH 0.02 billion Ukraine in 2017 compared to (since the tariff is formed in 2016 increased by 0.8% due The results of this business euro), in addition, an increase in to an increase in the transit remained in 2017 about at the transit volumes had a positive The volume of crude oil transportation outside Oil domestic transmission volume to the Czech Republic level of 2016. The devaluation impact on the result of UAH 0.03 the group, million t results*, UAH billion (in 2016 one of the local of the hryvnia to the euro billion.

The volume of oil transit by the group enterprises, million t Oil transit results*, 1.7 UAH billion 64.1% 2017/2016 –0.64 –0.58 1.2 15.2 0.8% 1.1 2017/2016 2.0 2.0

13.9 13.8 2015 2016 2017 2016 2017

2015 2016 2017 2016 2017

* operating profit/(loss) before tax

OIL DOMESTIC TRANSMISSION

The capacity of the Ukrainian suspension of their operations from Odesa to Kremenchuk trunk oil pipelines system is and the reduction of oil refinery in March 2017. At currently largely unused. This processing at the Kremenchuk the end of 2016, Ukrtransnafta mainly concerns oil pipelines oil refinery, the loading of the and Kremenchuk oil refinery designed to supply oil for the trunk oil pipelines system has reached an agreement and needs of domestic refineries. decreased dramatically. concluded a contract for The operations of domestic the rehabilitation of Odesa oil refineries is a key factor in The volume of oil - Kremenchuk oil refinery ensuring the proper level of transportation to Ukrainian route in 2017 with an annual loading of a large part of the refineries showed positive oil transportation volume of group's trunk oil pipelines dynamics in 2017 and 1.3 million tons. In Q1 2017, which was built during in the exceeded the indicator for the necessary technical Soviet era with the purpose to 2016 by 64.1%. The increase in preparatory works were provide oil supplies to Odesa, oil transportation to Ukrainian completed and 850 thousand Kremenchuk, Lysychansk and refineries is caused by the tons of oil was transported * operating profit/(loss) before tax Kherson oil refineries. Due to renewal of oil transportation during the 12 months of 2017.

120 121 Ukraine has design refining capacity of 63 million t/year, of which UKRAINE’S REFINERY CAPACITIES 3.0 million t/year the estimated available technical refining capacity as of 2018* million t/year

Kremenchuk reﬁnery Design capacity: 18.0 million t/year Production 2017: 2.1 million t Gasoline: Euro 5 Diesel: Euro 5

Shebelynka reﬁnery Holovashivka Pleshchivka Design capacity: 1.0 million t/year Drohobych reﬁnery Hlynsko- Production 2017: 0.5 million t Design capacity: 3.9 million t/year Rozbyshivska Gasoline: Euro 5 Production 2017: 0 Diesel: Euro 5 Gasoline: Euro 1 Diesel: Euro 1 Chyzhivka Hnidyntsi Novyny 2012 Shebelynka Brody Velykotsk Drohobych Kurovychi Kremenchuk Lysychansk Pereshchepyne Boryslav Novoaidar Zhulyn Oriv Chykalivka Dolyna Kamianohirka Luhanska Proletarska Karpaty Солочин Shyroke

Stepova Andriivka Nadvirna reﬁnery Design capacity: 3.5 million t/year Oil refinery Production 2017: 0 Mykolaivska Snihurivka Lysychansk reﬁnery Gasoline: Euro 1 Design capacity: 24.0 million t/year operating refineries Diesel: Euro 1 Production 2017: 0 Gasoline: Euro 4 2011 Diesel: Euro 5 non-operating refineries Avhustivka 2012

maximum refinery quality Odesa reﬁnery ﬁ Design capacity: 3.9 million t/year Odesa Kherson re nery year when production stopped Production 2017: 0 Design capacity: 8.7 million t/year Gasoline: Euro 3 Production 2017: 0 Diesel: Euro 4 Gasoline: Euro 1 Temporarily frozen routes Diesel: Euro 1 (oil pipelines filled with service fluid) 2010 (2014) Oil pipelines filled with Urals 2005 Oil pipelines filled with Azeri Light Oil pipeline routes for Ukrainian oil planned oil pipelines existing oil pumping stations

* given the current Euro 5 standards for gasoline and diesel and the capacities of secondary petroleum refining processes OUR PERFORMANCE ANNUAL REPORT 2017

Ukrgazvydobuvannya's engine oil sales struct PETROLEUM PRODUCTS SALES Ukrgazvydobuvannya has only 19 petrol stations, located in 4% Kharkiv region. The world engine oils market is dominated by oil companies which try to build the maximum 396.8 efficient fuel supply chain. The Sale of petroleum products and LPG by Naftogaz Utilization ratio of Shebelynka refinery Total engine oil company development using the group (incl. Ukrnafta*) in 2014-2017, million t in 2014-2017, % production, thousand t renowned world oil companies' model may become one of the 1.6 88 priorities for enhancing the 1.4 96% Wholesales share, % 1.4 1.3 efficiency of Naftogaz group 1.2 86 1.1 1.2 Retail sales share, % operations in general. 84 1.0 0.8 82 Total sales volume Retail sales 0.6 million t % Own (including own volume Share of retail sales in total sales 80 Company Retail profile 0.4 production production) million million t/ volume % 78 0.2 t/year year 0 76 ORLEN GROUP is the leader of the retail fuel market in Poland, where 2014 2015 2016 2017 74 it owns a network of 1.8 thousand Light and heavy petroleum products LPG 2014 2015 2016 2017 franchise and petrol stations (35% ORLEN of the market). The company is + 23 8 26% GROUP also a large operator in the Czech market (338 petrol stations, 15% The segment's results are formed at the expense of: Shebelynka refinery capacities in % of total of the market) and the German • Production of liquid hydrocarbons, their Ukrainian consumption of petroleum products market (567 petrol stations, 5% of processing and sale of petroleum products the market) received. Specifically, Ukrgazvydobuvannya OMV manages about 3.8 supplies almost all its own production volumes thousand. Petrol stations (OMV, 6.2 Avanti, Petrom, Petrol Ofisi), nearly to the Shebelynka refinery for further processing OMV + 24 8 25% and sale of the petroleum products. 6.0 350 of which are located in Austria • Purchase and sale of purchased petroleum 5.8 and 3.4 thousand petrol stations in 10 other European countries products through Ukrnafta's petrol stations 5.6 MOL Group owns more than 1.7 network. 5.4

% thousand petrol stations under 8 5.2 different brands in 11 Central and 5.0 Eastern European countries 20% 4.8 MOLGROUP + 18 4 (MOL, Slovnaft, INA, Tifon, Low share of retail sales in the Energopetrol, Papoil, Roth, IES ). total sales of Ukrgazvydobuvannya 4.6 The MOL network is the leader in 2014 2015 2016 2017 the retail fuel market in Croatia, Historically Ukrgazvydobuvannya has been viewed Hungary and Slovakia by the market as a producer of low quality petroleum Rompetrol manages retail petrol products, and, respectively, the development of its stations in Romania, Moldova, own network of petrol stations for the purpose of Euro 5 ecological class and utilized the previously idle Bulgaria, Georgia and France. ensuring the sale of its own products was considered refinery's potential. ROMPETROL + 5 1 11% Specifically, Rompetrol manages as a low perspective project by market participants. At more than 700 petrol stations and 210 LPG modules the Romanian the same time, the modernization of the Shebelynka In view of undeveloped retail sales through the petrol market refinery allowed for the start of production of more stations network, Ukrgazvydobuvannya is forced to Ukrgazvydobuvannya has only profitable and high quality petrol and diesel fuel in the build and focus its strategy and sales policy almost Ukrgaz- + 0.5 0.01 4% 19 petrol stations located in the exclusively on the wholesale market segment. The vydobuvannya Kharkiv region * Naftogaz group regained control over Ukrnafta as of 22.07. 2015 and from that volume of retail sales in Ukrgazvydobuvannya's engine date accounts the company’s performance in its financial statements oils production structure is nearly 4%.

124 125 OUR PERFORMANCE ANNUAL REPORT 2017

The extension of activities at Estimated retail margin of petrol station petroleum products Ukrnafta's petrol stations sales points and restaurants sells its petroleum products in different stages of the fuel as of the end of 2017, UAH/t network is part of a cheap within the petrol stations. the wholesale market, losing supply chain ensuring not only segment. This was caused, the retail margin. As a result, the production and processing, but first of all, by the absence of a Taking into account the above, ROIC comprised 12.7%, which is 26 500 also the logistics/storage and 1 570 26 020 clear petrol stations network there seems to be a significant lower than the cost of capital74, retail sale of finished products 26 000 development plan over a long potential for the development which comprises 19.7% would increase the profitability 25 500 period of time and the absence of Ukrnafta's petrol stations of this segment of the company 25 000 of the marketing policy. network, should it opt for and its market value. 24 500 500 the development and design

UAH/t 24 000 During 2014-2015, due to the of a detailed plan for petrol General dependence 23 550 23 500 devaluation of the hryvnia station modernization and currency and drop in purchasing rebranding, which should take of the domestic Drop in the sales 23 000 capacity, petrol and diesel fuel into account the peculiarities of market on the import volumes and 22 500 consumption in Ukraine was placement of each item. In case 22 000 of petroleum products rebranding of the decreasing. Besides, during of successful implementation Wholesale price Logistics EBITDA margin Retail price 2016-2017 the tendency for of the strategy for petroleum existing Ukrnafta the reduction of consumption products retail sales, an increase Irrespective of the success of petrol and its replacement in the sales volumes of the main of the Ukrainian refineries petrol stations Dynamics of sales at Ukrnafta petrol stations, thousand t by liquid hydrocarbon gas product - fuel, should also be in terms of improvement of continued. At the same time, the expected. the quality characteristics of network their petroleum products, 800 low pace of installing additional LPG modules at petrol stations The reason for the negative and specifically, full transfer As opposed to 700 667 CAGR –7% should be mentioned. The total ROIC73 for the Sale of Petroleum to the production of Euro-5 Ukrgazvydobuvannya, Ukrnafta 594 600 class of petroleum products, has the largest petrol stations 541 annual coefficient of decrease in Products segment, which in 493 the domestic market remains network in Ukraine (537 petrol 500 the network's sales volumes is 2016 was -36.7%, was the accrual about 7%. of the accounts receivable dependent on imports of stations, of which 166 are t thousand 400 impairment reserve in the finished petroleum products. equipped with the liquid gas 300 Due to the protectionist policy filling For the purpose of business amount of UAH 8 billion and one 200 diversification and risks loss-making transaction on the of Customs Union countries regarding their refineries and At the same time, as opposed to 100 mitigation, the national petrol sale of Ukrnafta products. In the station networks are more actively absence of these one-time items the logistical closeness of the other large networks in Ukraine, 0 developing retail sales and open the ROIC in 2016 would have Belarusian refineries, the latter 2014 2015 2016 2017 been 5.4%. manage to preserve their large share in the Ukrainian market Petroleum products: Ukrnafta owns the largest petrol stations network in Ukraine In 2017, the ROIC increased (about 50% in the supplies of UAH-denominated ROIC vs almost twice (to 12.7%). This the motor car petrol, 70% - cost of capital, % improvement of the operating diesel fuel and liquid gas). Thus, 22 12 result was due to the increase the absence of investments 29 of the average sales prices. in the technical re-equipment 11 1 6 5 However, the operating result of Ukrainian refineries, % 30 insufficient transparency in 63 5 20% 20% of Ukrnafta's assets still remains 17 the management of such 22 23 20 much lower in comparison 12 19 17 13% enterprises and, respectively, 10 with Ukrainian competitors, 11 8 33 3 1 specifically productivity per one inadequate resources provision 12 16 10 0 for the Ukrainian refineries, 27 petrol station and profitability 4 resulting in the total transition 3 1 10 67 2 –10 of sales. At the same time, 18 9 Ukrgazvydobuvannya mainly of the Ukrainian petrol stations 20 –20 network to the import of 9 63 73 petroleum products and –30 ROIC is calculated as NOPLAT divided by 3 invested capital, which was determined as a promotion of petroleum 29 19 –40 sum of invested capital in fixed assets and products produced by foreign 23 net working capital as of the end of the year. –37% refineries. –50 Invested capital in gas upstream assets are 2016 2017 estimated on the basis of preliminary estimate of monetary value of 2P gas reserves audited 74 Cost of capital is estimated by independent Ukrnafta's petrol stations and appraised by independent O&G consulting appraiser to determine the fair value of ROIC firm, and processing assets and petrol stations property, plant and equipment associated Including petrol stations were estimated at replacement value which is with this business of PJSC “National Joint Stock equipped by the LPG modules Cost of capital lower than physical impairment. Company “Naftogaz of Ukraine”” as of 31.12.2017.

126 127 OUR PERFORMANCE ANNUAL REPORT 2017

This evidence of the fact that in production, their processing country may be expected, Petroleum products sales Hydrocarbon processing by Naftogaz group case of realization of synergies and sale, a significant decrease which would respectively results*, UAH billion between the development of in the share of imported positively impact the country's domestic liquid hydrocarbons petroleum products in the balance of trade. 498 6 Petroleum products, –0.8% thousand t 494 4 3.4

2 302 LPG, thousand t –9.0% The structure of motor car petrol supply The structure of diesel fuel supplies in 2017 0 274 in 2017 by country of origin by country of origin UAH billion –2

–4 49 Compressed gas, –20.0% 2% mcm –6 39

–8 –7.6 9% 2016 2017 2016/2017 11% –10 9% 2016 2017

39% 48% 12% 39% Volumes of petroleum products Sales of hydrocarbon by Naftogaz group and liquefied natural gas sales include the sales by Ukrgazvydobuvannya of its own 781 Petroleum products, –6.0% processed products, and the sales thousand t 738 31% of products through Ukrnafta's gas filling stations. 332 LPG, thousand t –5.0% A 6% decrease in Ukrnafta's sales 317 Belarus Lithuania Belarus Lithuania in 2017 compared with 2016 Ukraine Other Russia Other impaired total sales of petroleum products. The volume of liquefied Compressed gas, 49 Ukraine –20.0% gas sales decreased by 5% in mcm 39 2017 due to a decrease in the volume of oil gas production for the production of liquefied gas 2016 2017 2016/2017 as a result of natural depletion of wells and the forced suspension of production during the period persists in recent years against is a significant increase in when Ukrnafta's licenses were the overall shrinkage of the prices of natural gas in recent PETROLEUM PRODUCTS SALES renewed. compressed natural gas market. years, which in turn reduces the number of consumers of The volume of compressed gas The decisive factor in reducing compressed natural gas and the Shebelynka gas condensate 424 thousand tons of light 2016. Ukrnafta's Hnidyntsi, sales decreased in 2017 compared the volume of compressed number of compressed natural and oil refinery, a branch of petroleum products, including Kachanivka and Dolyna to 2016 by 20%. This tendency natural gas sales in Ukraine gas vehicles. Ukrgazvydobuvannya is the 134 thousand tons of gasoline refineries processed 116 only company of Naftogaz and 97 thousand tons of diesel thousand tons of petroleum gas group engaged in producing fuel. in 2017, which is 9% less against petroleum products. It is one 2016. of the two currently operating In 2017, Ukrgazvydobuvannya's oil refineries in Ukraine. The Bazylivshchyna, Yablunivka, The decrease in LPG output in total processing volume of the Tymofiivka and Yuliivka gas 2017 compared with 2016 was refinery, including from tolling and gas condensate refining caused by lower production of raw materials, in 2017 amounted departments manufactured petroleum gas by the group due to more than 510 thousand tons. 158 thousand t of LPG, which to the exhaustion of most oil * operating profit/(loss) before tax The refinery produced almost is 6% less compared with and gas fields.

128 129 OUR PERFORMANCE ANNUAL REPORT 2017 ANALYSIS ASSETS OF OTHER ACTIVITIES Gas production, Gas imports imports and and supply Oil and gas Gas Gas domestic supply to to other condensate transit transmission customers customers under PSO outside PSO

Assets 2017, UAH billion 197.4 2.3 10.8 189.4 21.9 Assets 2016, UAH billion 175.4 6.6 6.1 256.4 19.4 INVESTMENT PROJECTS IN ARAB REPUBLIC OF EGYPT Change 12.5% -65.3% 77.5% –26.1% 13.1%

Naftogaz group is implementing to almost 286 thousand Oil exploration in South two hydrocarbons mining tons of crude oil and gas Oil domestic Petroleum Gas storage Oil transit Other projects in Egypt. condensate and 145 mcm of Wadi El Mahareeth and transmission products sales natural and petroleum gas. Wadi El Mahareeth areas A pre-oil refinery plant was Assets 2017, UAH billion 152.4 8.0 8.9 22.2 13.0 also put into operation. These areas are developed Assets 2016, UAH billion 155.7 8.1 9.1 16.8 13.6 Development under the Concession of Alam The volume of natural Agreement between the Change –2.1% –1.7% –1.4% 32.2% –4.5% El Shawish gas extraction under the SE Zakordonnaftogaz, the Arab Concession Agreement in Republic of Egypt and the South East territory Egypt decreased by 17.7%, Valley Egyptian Petroleum and oil and gas condensate by Holding Company dated 2012. The group's core assets75 About 30% of the assets increase in prices, as well as The territory has been 8.1% in 2017, due to natural The project is at the stage of are related to Gas transit, of the group relate to gas the results of a fixed assets developing pursuant to depletion of gas condensate exploration works. In 2017, representing about 30% of production, imports and revaluation carried out in 2017. the Concession Agreement reserves and delays in Zakordonnaftogaz completed assets of all businesses of the supply to other customers between Naftogaz, the Arab gas compression plant the interpretation of a 2D seismic group (38% in 2016). According under PSO (26% in 2016). In A significant share in the assets Republic of Egypt (ARE) construction. survey data, the development to fixed assets revaluation, 2017, the amount of assets in of the Group is involved in and the Egyptian General of a geological and geophysical the amount of assets in this business increased by UAH gas storage - about 24% (23% Petroleum Corporation model of the concession areas, this business decreased by 22 billion compared to 2016. in 2016). The reduction in (EGPC) dated 2006. In and identified the location UAH 67 billion in 2017. The increase in the amount of the amount of assets in this 2017, extraction from the for drilling four wells to be assets is basically due to the business by UAH 3.3 billion in concession areas amounted constructed in 2018. 75 Notes 4 to the consolidated financial increase in the cost of natural 2017 is a result of revaluation statements gas reserves, caused by an of fixed assets.

GAS DISTRIBUTION SERVICES

These types of activities is licensed distributor of natural by 41 mcm or -9.3% compared represented by Kirovohradgaz, gas in the region. to 2016. The trend towards which operates gas distribution reducing the volume of natural pipelines in the territory The volume of natural gas gas transportation through of the Kirovograd region. transmission by distribution distribution pipelines is caused by Kirovohradgaz is the only gas pipelines has decreased a decrease in gas consumption.

130 131 OUR PERFORMANCE ANNUAL REPORT 2017 CAPITAL INVESTMENTS PAYMENT OF TAXES TO THE BUDGET The total amount of capital investments of Naftogaz group increased in 2017 compared to 2016 by 79%, or by UAH 7.5 billion. Total amount of taxes paid by group enterprises, UAH billion In 2017 Naftogaz remained Capital investments by business, UAH billion the largest taxpayer in Ukraine. For example, during this year Naftogaz group paid 9.5 Capital investments 79% UAH 109.9 billion of taxes to the 17.0 budget, which is 49% more than in 2016. Gas production and 5.4 130% 74.0 sales under PSO 12.5 49% 109.9 2017/2016 In addition, in 2017 Naftogaz, 0.1 being a separate legal entity, Sales of natural gas at –56% nonregulated prices 0.0 paid UAH 13.3 billion to the state budget as a dividend 0.6 2016 Oil and gas 15% calculated based on its condensate sales 0.7 2017 performance in 2016. 1.7 Gas 2% transit 1.7

0.1 Payment of taxes by type, UAH billion Gas domestic transmission 16% 0.1

0.6 30.4 116% VAT 35.9% Petroleum products sales 1.3 41.4

0.3 Subsoil royalty 23.3 Oil transit –58% 18.9% 0.1 charge for gas 27.7

0.04 7.7 –9% Income tax 82.2% Gas storage 0.04 14.1

0.1 1.0 –58% Dividends 1198.7% Oil domestic transmission 0.05 13.3

0.6 Subsoil royalty charge 4.4 Other –14% 30.7% 0.5 for oil 3.2

3.3 Social charges 36.4% 2016 2017 2017/2016 4.3

2.7 Subsoil royalty charge 102.0% The group's priority for capital with 2016 due to the continued sales, where investments for gas condensate 3.7 investment is still the extraction expansion of exploration and grew by 116% mainly 1.1 of natural gas, which is further operational drilling capacities of due to an increase in the Other –26.5% directed to the sale and supply Ukrgazvydobuvannya. The total Ukrgazvydobuvannya capital 2.3 of natural gas to consumers cost of these works in 2017 is investments program. The under PSO. 74% of the total more by UAH 2 billion, or 53% amount of capital investments 2016 2017 2017/2016 investment is allocated for this compared with 2016. in Gas transit, which represents business in 2017 (compared about 10% of the total to 57% in 2016). The amount In addition, significant investments, remained almost of investment has more than investments of the group unchanged in 2017 compared doubled in 2017 compared relate to petroleum product to 2016.

132 133 OUR PERFORMANCE ANNUAL REPORT 2017

Average interest rates in 2017 Average interest rates, % kept on decreasing compared LOANS to 2016 for all currencies. The average rate on loans in UAH 19.0% UAH -1.3% decreased by 1.3% compared to 17.7% The total amount of loans of the group during 2017 decreased by UAH 11.5 billion or by 16.3% and amounted 2016, due to the NBU base rate to UAH 59.3 billion by the end of 2017. Total change of loans in 2017 was as follows: decrease in 2016. Interest rates on loans in the US dollars and euros 7.8% USD -1.1% decreased in 2017 compared 6.7% Total amount of the group Total change of the group loans, UAH billion to 2016 by 1.1% and 4.9% loans, UAH billion respectively, due to a decrease in the interest rates on existing loans 7.2% EUR -4.9% 140 and an increase in the share of 2.3% 48.9 (63) cheaper international funding in 120 the group's portfolio. 2016 2017 2016/2017 100

70.8 59.3 80 70.8 –16.3% 2.6 59.3 2017/2016 60

0 31.12.2016 Proceeds Repayment FOREX profit/loss 31.12.2017 2016 2017

Loans by repayment terms, UAH billion

In terms of maturity, the 23.1 Long-term –36% amount of long-term loans loans 14.7 decreased in 2017 by UAH 8.4 billion or 36% compared to 2016. The amount of short- 47.7 Short-term –7% term loans at the same time loans 44.6 decreased in 2017 by UAH 3.2 billion or by 7% compared 2016 2017 2016/2017 to 2016.

The increase in euro Loans by currency, UAH billion denominated loans in 2017 compared to 2016 amounted to UAH 11.2 billion due to the 27.3 UAH –23% revolving credit line granted 21.2 by Citibank Europe for the purchase of natural gas. The share of the portfolio in US 43.3 USD –38% dollars decreased in 2017 by 26.7 38% or by UAH 16.6 billion due to the full repayment of the loan to Gazprombank. 0.2 EUR 5274% 11.4

2016 2017 2016/2017

134 135 OUR PERFORMANCE ANNUAL REPORT 2017

A 20% growth of reserves in billion increase in trade accounts Other non-current assets 2017 compared with 2016 was receivable of RSC's for resale decreased in 2017 compared WORKING CAPITAL mostly due to an UAH 11 billion to households. The reasons for to 2016 by 44% or by increase in value of gas arising this are described in the Gas UAH 0.6 billion due to a from UAH 6.5 billion growth production, import and sales to reduction in the amount The net working capital of the Naftogaz group's businesses in 2017 increased by 10% or UAH 7.6 billion in volume and UAH 4.6 billion RSC's for resale to households of restructured long-term compared to 2016 due to increase in the value of natural gas inventories as a result of the increase in gas effect on price. The reserve section. As a result, the turnover receivables from gas consumers stock volumes and the prices of its purchases, as well as a significant increase in receivables for sold and turnover did not change much of accounts receivables impaired as a result of reduction of supplied natural gas, as already mentioned in the previous sections. compared with 2016. by 20 days in 2017 against 2016. the principal amount of the restructured debt. Structure of working capital of businesses76, UAH billion The amount of trade accounts Prepayments and other current receivables increased by 20% assets decreased in 2017 due to Accounts payable increased by 50.2 in 2017 or by UAH 9.8 billion the reduction of the amount of 2.5 times due to an increase in 20% Inventories 60.2 compared to 2016. The major advances from imported natural debt for natural gas compared to factor was a 38% or UAH 8.3 gas. 2016. 49.2 Accounts 20% receivable 59.0

7.7 Prepayments and other –20% current assets 6.2

1.3 Other non- –44% current assets 0.8

(2.8) Accounts 154% payable (7.2)

(15.5) Advances received and other –25% short-term liabilities (11.7)

(7.2) 25% Provisions (9.0)

(2.3) Income tax 329% liabilities (9.9)

80.6 Working 10% capital 88.2

2016 2017 2017/2016 Turnover by type in days

Inventories77 126 128

111 Accounts receivable78 131

Accounts payable79 29 11

2016 2017

76 Except the obligations that can not be directly attributed to the segment result 77 Calculated as average inventories divided by the total cost of sales 78 Calculated as average receivables before deducting the reserve for doubtful debts, divided by revenue from sale 79 Calculated as average payables divided by the cost of purchases

136 137 OUR PERFORMANCE ANNUAL REPORT 2017

The main procurement items in 2017, UAH billion PROCUREMENTS BY NAFTOGAZ 2.1 ARCHITECTURAL, CONSTRUCTION AND ENGINEERING SERVICES 2.1 GROUP COMPANIES IN 2017 CHEMICAL PRODUCTS 2.8 MINING AND 1.5 CONSTRUCTION EQUIPMENT REPAIR AND MAINTENANCE SERVICES For two years now, state institutions pursuant to the Law Key results 2017 3.6 of Ukraine "On Public Procurement" are obliged to procure TRANSPORT EQUIPMENT AND goods and services using the ProZorro system. Procurements AUXILIARY EQUIPMENT by Naftogaz account for about 20% of the total purchases through ProZorro. UAH 6.9 billion 4.5 saved due to procurements using INDUSTRIAL MACHINERY In 2017, the companies of Naftogaz group used the ProZorro the ProZorro system 5.1 system for 9,944 purchases for a total of UAH 119.2 billion. CONSTRUCTION WORKS AND REPAIRS 4% Of these, 49% of purchases were by Ukrgazvydobuvannya, 9.944 10.7 81% 35% by Ukrtransgaz, 8% by Ukrtransnafta, 3% by Naftogaz, and procurements made using ProZorro AUXILIARY BUILDING PRODUCTS 15% another 5% by other companies of the group. 11.5 81% Improvements to internal Naftogas group procurement UAH 119.2 billion SERVICES RELATED (UAH 96.3 BN) – GOODS procedures with the aim to ensure transparency of business TO OIL AND GAS the total expected value INDUSTRY processes resulted in savings of about UAH 6.9 billion in 2017. 15% 69.8 (UAH 17.7 BN) – SERVICES Of these, UAH 3.8 billion was saved by Ukrtransgaz as a result PETROLEUM PRODUCTS, 4% of the procurement of natural gas for technological needs and 97% FUEL, ELECTRICITY (UAH 5.1 BN) – WORKS balancing. The savings achieved by Naftogaz group prove the of the contracts are concluded with Ukrainian success of the economy of scale effect. companies of the budget of 2017 was planned for the purchase of goods, which is explained by the purchase of natural gas by Ukrtransgaz to meet technological and balancing needs. The savings achieved by Naftogaz group since ProZorro has Naftogaz group, which includes 81% been in operation equal almost UAH 13 billion or 32% of the 18 individual legal entities or 44 customers, savings of all customers in the system. is one of the biggest users of the ProZorro public procurement system. Facilitating the development of the domestic supplier

Procurements by Naftogaz group using ProZorro in 2017 Reform of the procurement concluded with companies related industries – turbines, system is still underway and incorporated in Ukraine. pipes, construction. the management of Naftogaz Ukrgazvydobuvannya Ukrtransnafta Ukravtogaz Completed group is making the most Every year, Naftogaz group During 2017, the companies 4.902 procurements 797 procurements 263 procurements 9.944 procurements of its efforts to promote procures goods and services of the group concluded UAH 39.0 bn UAH 1.5 bn UAH 0.5 bn transparency and strengthen for a high total value, and in 7 314 contracts worth Total expected value controls in the procurement such a way actively supports UAH 73.409 billion mostly UAH 119.2 bn process. domestic producers and their with enterprises registered in dealers. These procurements by Ukraine. Foreign companies The role of Naftogaz in Naftogaz group help to boost are mainly involved where 49% 35% 8% 3% 3% 2% supporting local producers domestic enterprises and create procurement of equipment and the development of an and revitalize the domestic or technology is required that efficient domestic supplier is market. This relates primarily to is not available from local evidenced by 98% of contracts mechanical engineering and companies.

Ukrtransgaz Naftogaz Other companies of the group We are doing our best to enable our suppliers to compete 3.464 procurements 285 procurements 233 procurements UAH 76.9 bn UAH 1.2 bn UAH 0.1 bn with each other. Transparency in procurement is one of our priorities." Orest Logunov, chief procurement officer of Naftogaz group.

138 139 OUR PERFORMANCE ANNUAL REPORT 2017

Major suppliers by volume of procurements Interaction with suppliers and appealing procurements

Naftogaz group publicized Number of contracts with the counterparts registered: Naftogaz group of businesses to better prepare tier system of appeal has been set Company of the group companies are keen to for the procurement process, up within Naftogaz group. contracts on the territory of Ukraine beyond Ukraine make communication with collecting the necessary 7 314 businesses sound and effective. certificates and licenses so If necessary, a complaint can 3 938 through ProZorro Ukrgazvydobuvannya 93 They inform suppliers about that in the case of the best be filed to the local conflict (84% of the value) procurements through price offer, they cannot be commission at each group 2 099 ProZorro and arrange open disqualified due to lack of the enterprise, or contact the central Ukrtransgaz 5 (97% of the value) meetings to clarify needs. necessary documents. conflict commission which also Such communication with the considers complaints about 591 Ukrtransnafta 5 businesses helps get results In order to adhere to the local commission decisions. (74% of the value) that are more relevant to the principles of open and That is another step in the fight Ukravtogaz 153 0 tasks in hand, and also helps transparent procurement, a two- against corruption.

(7 194 contracts) Ukraine 217 98% Naftogaz of Ukraine 17 (21% of the value) 2% (120 contracts) beyond Ukraine Appeal of procurement other than appeals to Antimonopoly Committee of Ukraine

■ Is established in the Headquarters Upgrading procurement process ■ Is established at each ■ Considers appeals of procurement decisions enterprise Central ■ Reviews the grounds for rejecting bids and Local The companies of the group or as a security for contract In 2017, 3,055 procurements cancelling tender procedures ■ Considers appeals of procurement decisions continue the large-scale process enforcement. with an expected value of conflict ■ Review of complaints with regard to local conflict of reforming the procurement UAH 17,893 million initiated commission conflict commission decisions commission system, including the improvement In 2017, the following key through the ProZorro system ■ Makes resolutions and ■ Makes resolutions and provides provides recommendations of transparency standards, internal documents on were cancelled or declared void recommendations formalization of requirements to procurement of goods, works by Naftogaz group. About 70% participants, approval of standard and services were approved and of the tenders were canceled processes and procedures, put into effect: due to submission of less than TO SUBMIT A COMPLAINT: and updating of management • Regulation on Conflict two bids. ! і Detailed information on the submission Personally or by mail: 6 B. Khmelnytskoho Street 6, of an appeal is posted on the official structures. Committees; e-mail: [email protected] websites of the group enterprises • Procedure for the procurement The high rate of cancellation phone: +380 (44) 537 0560 During 2017, new directors of goods, works and services in is due to: for procurement at Naftogaz group; Ukrgazvydobuvannya Felix • Procedure for procurement • low interest of potential Cherni and at Ukrtransgaz Andriy monitoring; suppliers, contractors for Khomenko were appointed • Regulation of interaction works and service providers in Procurement plan for 2018 as well as the procurement between the company's participating in the tenders; director of Naftogaz group Orest structural units during the Logunov. procurement of goods, works • unclear or overly narrow The total procurement budget In 2018, Ukrgazvydobuvannya geophysical research and and services. requirements for the subject for the key enterprises of the plans to increase the cost of procurement of services The companies continue of procurement / excessive Naftogaz group (UTN, UTG, purchased works and services. including core recovery, use improving their procurement In 2017, the introduction of qualification requirements for UGV, Ukravtogaz, Naftogaz) in While in 2017 they accounted of coiled tubing technology business processes. For example, category management with the participants that are difficult to 2018 is about UAH 120 billion. for 46% of total expenditures, and contracting for hydraulic Naftogaz group procurements expansion of functions and powers meet; In 2018, Ukrgazvydobuvannya in 2018 the figure is 53% fracturing of formation (HFF). process has been reformed, of the procurement department plans to spend the most (UAH 46.8 billion). The cost of including the approval of unified continued, which would allow • wrongly estimated expected among all enterprises of procured materials as a portion For Ukrtransgaz, procurement requirements for banks whose for the optimization of costs value of procurement / terms the group for procurement of the total expenditures of the is a service function aimed banking products are used as a and increase the efficiency of and conditions of payment or of goods and services – company will grow from 16% to at ensuring the reliable and security for the proposal under procurement procedures in the supply that do not correspond UAH 88.9 billion. For comparison, 17%, and that of equipment will uninterrupted operations of the the procurement procedure near future. to the market. in 2017, Ukrgazvydobuvannya decrease from 38% to 30%. Ukrainian GTS. spent UAH 66.8 billion on purchases, and 4 years ago – Planned purchases will be UAH 300 million. related mainly to drilling,

140 141 OUR PERFORMANCE Tentative procurement plan for 2018, UAH billion CORPORATE

Ukrgazvydobuvannya Ukrtransgaz Ukrtransnafta Ukravtogaz Naftogaz • Compressor • Reconstruction • Auxiliary • Natural gas • Current and equipment of the construction • Purchase major repairs GOVERNANCE • Energy equipment compressor products of mobile • Financial shop • Mobile drilling rig • Fuel, electricity, NGV filling investigation for workover • Piping armature petroleum stationand services • Gas fuel products mobile gas • Software • Reconstruction filling station and overhauls • Reconstruction 0.3 Naftogaz and moderni 0.4 Ukravtogaz zation of gas 2.2 Ukrtransnafta accounting 29.9 Ukrtransgaz units 88.9 Ukrgazvydobuvannya

Plans for 2018

Next year, amendments are In addition, in terms of quality submitted for procurement planned to the Regulation management of procurement procedures; on interaction between the the following is planned: • consolidation of purchases structural units of Naftogaz • introduction of a unified and benefits from economies of Ukraine NJSC during approach in determining the of scale; the procurement of goods, expected value of the subject • introduction of a new works and services based of procurement of goods and procurement mechanism on the lessons learned from services at the enterprises of which would be based on its application in 2017 and the group in order to set up the framework agreements; analysis of the effectiveness of economic bases for increasing • development of a procurement of goods, works the efficiency of procurement; methodology for the and services. • development of standard preparation of annual plans requirements for for purchases and changes to documentation to be these plans.

142 CORPORATE GOVERNANCE ANNUAL REPORT 2017

PROBLEMS OF CORPORATE – introduction of generally approved by the Supervisory GOVERNMENT REFORM recognized internal controls Board, and submitted for CORPORATE GOVERNANCE procedures to enable Naftogaz approval to the Cabinet of The government has taken a to operate on the same level Ministers of Ukraine). number of decisions that do not as commercial companies; take into account the interests – investing the supervisory Corporate governance reform in A GOOD CORPORATE GOVERNANCE SYSTEM IS AN EFFICIENT TOOL THAT ENSURES: of the Company. Below is a list of board with full authority Ukraine is at a crucial stage, since important CGAP measures that including: appointment/ without legislative changes all ■ management and control; have not been implemented in termination of powers of the proposed solutions will remain full or partly: head of the executive body, incomplete. In addition to the ■ procedures for establishing and achieving company goals and monitoring their implementation; – drafting of laws envisaging approval of strategy, financial appointment of professional ■ a clear definition and allocation of powers, rights, and responsibilities between all participants in the elimination of political and investment plans, etc.; members of the supervisory corporate relations including the board (an executive body), the supervisory board (a supervisor), interference and submitting – determination of the status board, it is of paramount the general meeting (a shareholder), company body officials, management, employees and other them to parliament; of Naftogaz corporate rights importance to create the right stakeholders; – approval of the Corporate in the authorized capital of environment for their activities Strategy of Naftogaz group; controlled entities; and to find solutions to the issues ■ understandable rules and procedures for decision-making; – replacement of inefficient – approval of new version of electronic declarations and ■ efficiency, transparency and accountability; statutory controls with of the Company's Articles assets owned by independent effective corporate of Association (a draft was directors of the state companies ■ conflict prevention and resolution; governance; developed by the Board, who are foreign citizens.

■ availability of checks and balances, as well as internal controls functions.

The implementation of an control, higher profitability and the energy market of Ukraine Two-level board of directors (mandatory in Ukraine) effective corporate governance better opportunities to attract and play an important role in system results in better external financing, better its respective segments. This COLLEGIAL strategic and day-to-day relationships between internal means that the implementation (independent directors (the board headed by the management, increased and external participants of a good corporate + other members of chairperson of the board) operational efficiency of in corporate relations, and governance system in the the supervisory board OR SOLE companies (as a result of improved reputation. Naftogaz group is an important SUPERVISORY (state representatives) EXECUTIVE (general director) setting goals and monitoring contribution to ensuring BOARD BODY their implementation), higher The companies of Naftogaz economic efficiency and market levels of transparency and Group are significant players in competitiveness. CURRENTLY: OBJECTIVE: CURRENTLY: it manages the joint stock company and management of day-to-day limited range of powers, supervises and regulates the activities of the company activity, development the prior approval of the executive body (which results in the duplication and implementation of strategy supervisory board or Corporate governance reform of functions and conflict of powers of the and budget. Representation of shareholder for operational supervisory board and executive body). the company. issues is required. Naftogaz's corporate the availability of fully-fledged – formation of a supervisory governance reform was and effective management board with a majority of launched in 2015. The Corporate bodies, a clear division of independent directors; Governance Action Plan (CGAP) powers, functioning internal – investing the supervisory developed by experts and controls, the elimination of board with the required Іnternal control system legal advisers has become the political influence and the scope of authority including roadmap for this reform. It is creation of a level playing field the right to approve The company now has its internal controls in place as implemented in the Naftogaz group in the worth mentioning that Naftogaz with commercial companies strategy, financial plans, and following areas: reform is part of the broader on the market that meets appointment of the executive corporate governance reform OECD Principles of Corporate body; process for all state-owned Governance. – introducing effective internal Governance and Internal Risk Management Financial enterprises in Ukraine. controls to replace existing Control System (ICS) control THE BASIC PREREQUISITES inefficient statutory controls; (consolidated) The reform aims to implement NECESSARY FOR ACHIEVING – determination of status of rules and procedures that are THIS GOAL ARE: the company's property, in line with best international – elimination of political including shares in the practices. It should ensure the interference in company companies where the Internal Compliance Investment protection of the owner rights, management; Company is a shareholder. audit management

144 145 CORPORATE GOVERNANCE ANNUAL REPORT 2017

Company ’National Joint-Stock 13 December 2017 No. 892-p they are fully compliant with Company ’Naftogaz of Ukraine’”, “On certain matters of the the independence criteria REPORT OF NAFTOGAZ the board’s composition was supervisory board of Public as established by Article 2 of expanded from five to seven Joint Stock Company ’National the Law of Ukraine “On Joint members, four of whom shall Joint-Stock Company ’Naftogaz Stock Companies” and Article SUPERVISORY BOARD 2017 be subject to independence of Ukraine’” which came into 11 of the Law of Ukraine criteria envisaged by legislation, force on 15 December 2017. “On Management of State and the government initiated Property”. Identical statements the selection process for new Spottiswoode Clare Mary Joan, are available on the company’s board members. Lescoeur Bruno, Jean, Gaston, official website. Hochstein Amos and Haysom Beginning in April 2017, several Steven John were elected During January and February supervisory board members as independent directors. 2018, the company concluded resigned: They were joined by Popyk service agreements with the • Kovaliv Yulia Ihorivna; Sergii Dmytrovych, Kudrytskyi majority of board members Volodymyr Dmytrovych and pursuant to Order of the • Proctor Charles Richard Demchyshyn Volodymyr Cabinet of Ministers of Ukraine Faraday; Vasylyovych as government dated 17 January 2018 No. 21-p • Warwick Paul Cyril; appointees. “On certain matters pertaining • Richards Marcus Trevor. to conclusion of service During 2017, all of the agreements with members of Before the termination of supervisory board members the supervisory board of Public the authority of the three elected were compliant with Joint Stock Company ’National independent directors in the necessary criteria including Joint-Stock Company ’Naftogaz BUSINESS OVERVIEW OF THE COMPANY: OPERATIONAL AND FINANCIAL PERFORMANCE October 2017, the board regarding competences and of Ukraine’”. operated with a composition dedication of time to the work Key results of the company’s 2016) was purchased from gas suppliers. As of the end of four members, which of the board. According to the provisions operational and financial 13 European suppliers none of 2017, the company had constituted the majority of the of the existing agreements, performance in 2017: of which accounted for more 30 effective EFET master total number of the supervisory The independent directors remuneration for performance than 25% in total imports by agreements; board members as set by the made statements of their of the board member • Naftogaz generated a Naftogaz; general meeting. independence to the functions (including • loans from the EBRD, City and UAH 39.3 billion net profit nomination committee for compensation for expenses) • new payment mechanisms Deutsche Bank guaranteed which is almost twice as The new composition of the appointment of officers is payable for the period for natural gas imports by the IBRD utilized, much as the budgeted net supervisory board had been of strategically important starting from 15 December (payment upon delivery Gazprombank loan repaid profit and 1.5 times more formed by Order of the Cabinet enterprises at their 2017. Compensation for the and letters of credit) and early, the company’s bonds compared to net profit in of Ministers of Ukraine dated appointment confirming that performance of board duties is more flexible procurement 2016; repaid in a timely fashion strategies with short-term allowing for a decrease in • for the first time since contracts were introduced weighted average effective 2012, the company paid in order to optimize the interest rates on financial company’s portfolio costs; UAH 13.3 billion in dividends liabilities from 18.9% to 17.6% SUPERVISORY BOARD to the state budget for 2016; in UAH and from 7.7% to 5.1% • natural gas totaling more in foreign currency. • for the second consecutive than EUR 645 million year, the company received procured via credit no aid from the state facility guaranteed by STRUCTURE OF THE BOARD the International Bank through recapitalization with AND ITS COMMITTEES government bonds; for Reconstruction and Development (IBRD): the Changes in the board Chairperson of Deputy chairman Independent Independent Independent Board member Board member • in 2017, the company IBRD confirmed that the the supervisory of the supervisory director director director satisfied its demand in natural company’s natural gas In line with Resolution of board board gas imports with supplies procurement business Spottiswoode Demchyshyn Lescoeur Bruno, Hochstein Amos Haysom Steven Popyk Sergii Kudrytskyi from the European market processes complied with the Cabinet of Ministers of Clare Mary Joan Volodymyr Jean, Gaston John Dmytrovych Volodymyr only; international practices; Ukraine dated 29 March 2017 No. 232 “Matters pertaining to Vasylyovych Dmytrovych • 8.7 bcm of imported natural • EFET master agreements formation of the supervisory gas (0.4 bcm more than in concluded with 8 European board of Public Joint Stock

146 147 CORPORATE GOVERNANCE ANNUAL REPORT 2017 established at the level of gross In February 2017, the Hochstein Amos as with matters pertaining to Following extension of the committees in their new UAH 6 328 000 annually for committee on health, the chairperson of the versions in February 2018. completion of corporate responsibilities of certain independent directors and 75% environmental and industrial committee, Lescoeur Bruno, committees and their renaming, of that amount for government safety was established and Jean, Gaston and Popyk Sergii governance reform and the There have been no instances of the new composition of the appointees. Supervisory board chaired by Warwick Paul Cyril. Dmytrovych as the members systematic absence at board or unbundling of the natural gas supervisory board approved members are also entitled All of the board members were of the committee; committee meetings during the to additional remuneration appointed to the composition · Committee on health, transmission business. regulations on all of the board’s reporting year. amounting to 20% of total of this committee. safety, environment and 82 remuneration for performance reserves : Haysom Steven Attendance of the Nomination Committee on Following the formation John as the chairperson of supervisory board Ethics and of the function of the Supervisory Audit and risks and health, safety, of the new board, at the the committee, Hochstein meetings in 2017 unbundling chairperson of the supervisory board4 committee remuneration environment and first meeting which was Amos, Demchyshyn (regular, extraordinary committee board and 10% of the committee reserves5 held on 22 December 2017 Volodymyr Vasylyovych and and by absentee voting) remuneration for participation Spottiswoode Clare Mary Joan Popyk Sergii Dmytrovych as the member of a committee Kovaliv Yulia Ihorivna 8/11 4/5 2/3 2/3 1/1 was elected as the chairperson as the members of the of the supervisory board, as of the supervisory board. All committee. Warwick Paul Cyril 21/21 9/9 7/7 8/8 2/2 well as to compensation of members of the supervisory their expenses incurred during Richards Marcus Trevor 19/21 7/9 7/7 8/8 2/2 board supported the motion PROCEEDINGS OF THE BOARD (with partial presence performance of board member that Demchyshyn Volodymyr AND ITS COMMITTEES during meetings on functions. Vasylyovych should continue to 13–16 March 2017 hold the position of the deputy In 2017, the supervisory board and 3–6 April 2017) In total, during 2017 the chairman of the supervisory held 22 meetings, including 14 Proctor Charles Richard 21/21 9/9 7/7 8/8 2/2 company incurred approx. board. extraordinary meetings at the Faraday UAH 25.5 million in expenses request of the executive board, for the operations of the The new composition of including 1 meeting held via Demchyshyn Volodymyr 21/22 9/9 7/7 7/8 2/2 Vasylyovych supervisory board. This the board’s committees was absentee voting. amount includes UAH 20.3 elected at the meeting held on Spottiswoode Clare Mary 1/1 – – – – million in service fees accrued, 23 January 2018. The current The majority of the board Joan and UAH 5.3 million in composition of the committees members accumulated twice Lescoeur Bruno, Jean, 1/1 – – – – compensation of expenses is as follows: as much time dedicated to the Gaston incurred by board members · Audit and risks work of the board compared Hochstein Amos 1/1 – – – – during performance of their committee80: Lescoeur to time commitment required duties, as well as D&O insurance Bruno, Jean, Gaston as by the Rules of Procedure Haysom Steven John 1/1 – – – – of the supervisory board. which covers liability of these the chairperson of the Popyk Sergii Dmytrovych 1/1 – – – – officers after their appointment. committee, Spottiswoode In addition, supervisory Clare Mary Joan and board members contributed Kudrytskyi Volodymyr 1/1 – – – – Kudrytskyi Volodymyr additional time to individual Dmytrovych APPOINTMENTS WITHIN THE committee obligations outside SUPERVISORY BOARD Dmytrovych as the members of the committee; the formal meeting periods as well as ongoing work for the Conflict of interest status of selection process for and implementation of the Following the termination of · Ethics and unbundling development of the company’s positions of the chief operating system of internal control of 81 authorities of the chairperson committee : Spottiswoode revised strategy, planning and During the meeting of the officer (COO) and chief the company, ensure progress Clare Mary Joan as transformation officer (CTO) of the supervisory board Kovaliv performance management nomination and remuneration in the corporate governance the chairperson of the of the company was notified reform of the company, and Yulia Ihorivna, during the framework on an individual or committee of the supervisory as conflicted by the chairman extraordinary supervisory board committee, Hochstein collective basis. monitor the internal audit Amos, Kudrytskyi board held on 5–6 September of the committee, Warwick procedures across Naftogaz meeting held on 18 April 2017 Volodymyr Dmytrovych and 2017, the agenda item on Paul Cyril, due to his personal group, as well as to collaborate the board members elected: In addition to this, during the Demchyshyn Volodymyr reporting year, the members the update of the current acquaintance with one of the with the executive board Vasylyovych as the members 83 proposed candidates. and key subsidiaries of the • Warwick Paul Cyril as the of the supervisory board Total number of meetings includes 1 supervisory of the committee; participated in a number of board meeting as of 29 September 2017 that group in drafting financial and chairman of the supervisory was not valid due to absence of quorum as well working groups established Board priorities investment plans for 2017. board; · Nomination and as 1 supervisory board meeting convened on remuneration committee: under the auspices of the 29 September 2017 and held via absentee voting • Demchyshyn Volodymyr 84 Total number of meetings excludes the first The priorities of the supervisory The board focused on: 80 government that deal Vasylyovych as the deputy Previously the audit committee, renamed at the supervisory board meeting held on 13-16 Febru- board in 2017 were to continue (i) agreement of the mission meeting held on 23 January 2018 82 Previously the committee on health, ary 2017 that resolved to establish the committee chairman of the supervisory 81 Previously the ethics committee, renamed at environmental and industrial safety, renamed on occupational health, environmental and working on the projects related and corporate objectives for the board. the meeting, held on 23 January 2018 at the meeting held on 23 January 2018 industrial safety to setting up the strategy company; (ii) implementation

148 149 CORPORATE GOVERNANCE ANNUAL REPORT 2017 of the Corporate Governance company within the compliance will continue in 2018 aiming Competence and proceedings of supervisory board committees Action Plan (the CGAP) to office. at aligning the charters of key bring corporate governance subsidiaries of the group and and the relationship with As part of the CGAP the Charter of the company which are being concluded financial statements and the shareholder in line with implementation process as with new legal requirements. AUDIT AND RISKS COMMITTEE with the internal audit staff; qualifications expressed in the accepted OECD guidelines for regards the system of internal independent auditor’s report, state-owned enterprises; and control of the company and In 2017, the supervisory board Key functions of the 8) preparing the draft budget of as well as on the financial (iii) approval and monitoring of passed 106 resolutions on committee the supervisory board; Naftogaz group, in 2017 the management of Naftogaz implementation of the internal matters within its competence 9) submitting the annual plan supervisory board adopted a group. In particular, the treasury audit plan for 2017. including 21 resolutions related The restated version of the of risk-oriented internal number of policies, regulations arrangements and debt portfolio Regulations on the Audit audits for approval by the and programs developed in to transfer of issues to agendas of Naftogaz group were reviewed, and Risks Committee of the supervisory board; Other issues reviewed by the cooperation with external of next meetings, and 85 including matters pertaining supervisory board was approved supervisory board included professional advisors: resolutions on substance. 10) ensuring sufficient and to non-compliance of business adequate resources for the liquidity of the companies • Naftogaz group Investment by resolution of the supervisory companies in which the company effective performance of the across Naftogaz group and TSO Policy; board in February 2018. In is the sole shareholder (founder, unbundling. SHAREHOLDER AND EXTERNAL particular, it was supplemented internal audit; • Naftogaz group Policy on the participant) with Naftogaz COMMUNICATION with the following key tasks and 11) providing recommendations System of Internal Control; group treasury policies, cash and In June 2017, the board functions of the committee: on the selection, liquidity management in Naftogaz • Naftogaz group Compliance In 2017, the supervisory granted prior approval for 1) monitoring of the integrity of appointment, reappointment group. The members of the Program; board maintained regular the draft corporate strategy financial information of the and dismissal of the head of committee stressed the necessity liaison with the government of Naftogaz group for its • Naftogaz group Risk company; the budgeting unit. of the centralized management of submission to approval by the Management Program; by holding joint meetings the Naftogaz group loan portfolio with the Prime Minister 2) reviewing at least annually the company’s general meeting. • Risk Management The Regulations governing the and of further work to reduce the of Ukraine, the Vice Prime efficiency of the company’s The supervisory board currently Methodology of Naftogaz committee’s activity also provide overall cost of debt to Naftogaz considers the strategy in very Minister of Ukraine and internal control and risk for reporting to the supervisory group; management systems; group given its financial position detail in order to update and other representatives of board not less than once per six and general market conditions. revise as necessary following • Rules on Risk Management the shareholder. The board 3) studying issues that may months. Interaction within Naftogaz some significant events that was actively engaged in be deemed as the reason Another important aspect of the group; took place at the end of 2017 the operation of working for dismissal of the external committee’s activities covered the Key results in 2017 and in the first quarter of 2018. • Quality Assurance and groups established under auditor; review of the key risks identified Improvement Program of the the government with the 4) controlling the independence by the risk management office In 2017, much of the work of The supervisory board and Internal Audit Department of purpose of finalizing the work and objectivity of the external in the course of an initial risk this committee focused on the executive board focused Naftogaz group; on CGAP implementation and auditor in line with the assessment of Naftogaz group. the results of internal audits, on the development of the addressing issues pertaining Handbook of International In the view of the committee, • Internal Audit Department in particular of Ukrtransgaz, optimal operational model of to TSO unbundling. further risk assessment should Regulation; Quality Control, Auditing, Ukrgazvydobuvannya and the company and Naftogaz take into account financial, • Code of Ethics of Internal Review, Other Assurance, and Ukrtransnafta, as well as on group, and on implementation Additionally, the board operational, HSE, reputational and Audit Department of Related Services; the search for opportunities to of the CGAP adopted by the regularly met with other non-financial risks. 5) establishing and applying an ensure the internal auditing of government in 2015. By the Naftogaz group, and; representatives of official definition of a policy, Ukrnafta. The members of the end of 2017, the actions that • Health, Safety, Security and international financial types of services that are not committee reviewed the current were required by the CGAP on Environment Policy. organizations as the ETHICS AND UNBUNDLING subject to audit, and which status of audits held by internal the part of the company and company’s lenders, and took COMMITTEE are excluded or permitted audit with a focus on the audits the board in particular were Moreover, the board approved an active part in cooperation after the committee’s review of procurement activities in the completed. initiating the procurement of a with professional external companies of Naftogaz group, Key functions of the whistleblowing line outsourcing advisors engaged by the or permissible without the including “red flag” purchases committee During the reporting year, service and forensic services. company to develop a recommendation of the committee; identified by the external the board approved the Code strategy for Naftogaz group, auditor during audit of financial The restated version of the 6) reviewing the efficiency of of Corporate Ethics and the During 2017, the board granted implement a system of statements for 2016, on a regular Regulations on the Ethics and external audit processes Anti-Corruption Program of prior approval to resolutions internal controls, and prepare basis. Unbundling Committee of the the company. In addition to of the executive board on the group for the unbundling and responsiveness of the supervisory board was approved this, the board appointed an amendments to the charters of of the gas transmission system management to written During 2017, members of the by resolution of the supervisory anticorruption officer for the key subsidiaries, and this work operator. recommendations; committee held discussions board in February 2018. In 7) making recommendations to with representatives of the particular, it was supplemented the supervisory board on the independent auditor on the with the following key tasks and terms of labour agreements key figures of the consolidated functions of the committee:

150 151 CORPORATE GOVERNANCE ANNUAL REPORT 2017

1) providing recommendations meeting or the supervisory for their efficient performance In addition, committee Key functions of the Key results in 2017 and proposals regarding board (as defined by the in the corporate governance members endorsed an increase committee processes pertaining to or Charter) of candidates for framework implemented by of staffing for internal audit, risk In 2017, this committee focused associated with unbundling vacancies in the supervisory the company; management and compliance The Regulations on the on the review and subsequent of the gas transmission board, the executive board or 10) approving the nomination of functions that commenced work Committee on Health, Safety, endorsement of the draft Code system operator, which are other officers of the company the company’s executives at in early 2017. Environment and Reserves of of Corporate Ethics developed taking place both inside and nominated and dismissed by their appointment; the supervisory board define the by the compliance office in outside of Naftogaz group the supervisory board; following key functions of this cooperation with external 11) controlling the level and to ensure their compliance 4) submitting proposals to structure of remuneration COMMITTEE ON HEALTH, committee: with the Law of Ukraine “On consultants. the supervisory board of the company’s executives SAFETY, ENVIRONMENT 1) controlling HSE and Reserves the Natural Gas Market”, concerning individual along with provision of AND RESERVES strategy, plans and related the Third Energy Package, The committee also commented remuneration for members on and recommended approval recommendations to the risk assessment in the context and taking into account of the executive board, The committee on health, of the draft Anti-Corruption executive board on these of the overall business the legitimate interests of ensuring their compatibility issues. environmental and industrial Program, as well as the plan for strategy of the company, and Naftogaz group; with the remuneration safety has been established by its rollout, including introduction the integration of HSE and 2) consideration of issues policy adopted by the The Regulations governing the the decision adopted at the of the whistleblowing line, Reserves into a major business pertaining to or associated company and compliance committee also provide for assessment of corruption risks, and supervisory board meeting processes; with unbundling of the with the assessment of the reporting to the supervisory held in February 2017. At the implementation of mechanisms performance of the member 2) controlling the evaluation of gas transmission system board not less than once a year. meeting held in January 2018, for control of identified risks. of the executive board who is major and recurring failures operator, in particular, it was renamed the committee individually remunerated; within the company in internal restructuring and on health, safety, environment The committee reviewed, among Key results in 2017 terms of HSE and Reserves intended transactions 5) forming proposals regarding and reserves. The committee is other things, conflicts of interests key performance indicator governance and performance, involving assets, systems, In 2017, this committee focused the permanent consulting and and leakage of information. criteria and the organization and its influence on general contracts, licenses and staff its work on developing the advisory body of the supervisory of procedures for their economic activities; within Naftogaz group, good Remuneration and Succession board accountable to it with periodical assessment for the corporate governance and NOMINATION AND Planning Policy, in particular, the key task to examine, 3) creating favourable conflict of interest issues chief executive officer and current remuneration principles prepare for consideration and conditions for investments REMUNERATION COMMITTEE members of the executive of the newly established in Naftogaz group and potential to increase the production of board, the corporate secretary, advise the supervisory board gas transmission system improvements or replacement hydrocarbons; Key functions of the the risk management officer, on issues pertaining to health, operator, GTS partner with more effective mechanisms, 4) reviewing the rating and committee the chief audit executive, the safety, environment (HSE), engagement; as well as completion of actions position of the company with chief compliance officer, and evaluation and management 3) monitoring of the operating envisaged by CGAP concerning respect to international best The restated version of the the anticorruption officer; of hydrocarbon resources environment and best the adoption of new policies and Regulations on the Nomination and reserves (Reserves). The practice for HSE and Reserves, international practices 6) periodic assessment of the procedures on related matters. and Remuneration Committee supervisory board resolved and legal requirements on (general and sector-specific) structure, size, composition of the supervisory board was on the establishment of this these issues. in terms of unbundling, and performance of the During 2017, the committee approved by resolution of the committee to ensure addressing engagement with various executive board and provision provided recommendations to supervisory board in February matters pertaining to health and The Regulations on the stakeholders to assess of recommendations for any the supervisory board regarding 2018. In particular, it was industrial safety at the highest Committee also provide for the adequacy of current changes; the nomination of candidates supplemented with the following level which is normal practice for reporting to the supervisory company’s policies in this 7) periodic assessment of the to be appointed as members of key tasks and functions of the leading international oil and gas board not less than once a year. area; chief executive officer and the company’s executive board committee: companies. 4) elaborating and drafting members of the executive by the shareholder, including 1) development of succession Key results in 2017 decisions and conclusions, board for conformity with recommendations regarding plans for the company’s The Regulations on the proposals, recommendations, qualification requirements CEOs of business companies in supervisory board, executive Committee on Health, Following commencement policies, strategies, rules and relevant reporting to the which the company is the sole board and other executives; Safety, Environment and of its operations in 2017, this of procedure, procedures, supervisory board; shareholder (founder, participant). Reserves of the supervisory committee paid specific attention other documents related to 2) development and periodic 8) advising the supervisory Committee members supported board were adopted at the to the circumstances and reasons unbundling, and submitting review of the company’s board on the composition of the executive board in the supervisory board meeting them for supervisory board’s policy on nomination and its committees and periodic selection process for positions of of accidents, and health and approval. remuneration; rotation of committee the chief operation officer and the held in September 2017, and industrial safety system across 3) determining and ensuring members; chief transformation officer of the restated by resolution of the Naftogaz group, as well as The Regulations on committee selection procedures, 9) ensuring training programs company, as well as the president supervisory board in February considering possible ways to activity provide for reporting to nomination of candidates for members of the of Ukrtransgaz. 2018. improve safety at workplace. the supervisory board not less and recommendation for supervisory board and the than once a year. approval by the general executive board as required

152 153 CORPORATE GOVERNANCE ANNUAL REPORT 2017

Oleg Prokhorenko EXECUTIVE BOARD STRUCTURE Member of the executive board since 24 May 2017 Chairman of executive board at Ukrgazvydobuvannya PJSC since June 2015

Prior to his appointment to UGV, Prokhorenko worked for 8 years at a AND REMUNERATION worldwide consulting firm McKinsey in Ukraine and in other countries where he advised clients on strategic management issues.

He has experience of cooperation with the largest private companies and Andriy Kobolyev governmental institutions in oil and gas production, power generation, Chief executive officer (chairman of the executive board) since 25 March 2014 extraction of metals and mineral resources, as well as with the public sector in strategic planning, operational improvements, and reorganization Andriy began his career at the international audit and consulting group of companies. Oleg holds an MA degree in Public Administration and PriceWaterhouseCoopers (PwC), where he specialized in strategic Public Policy from John F. Kennedy School of Government in the USA and management and corporate transformation. From 2002 to 2010 he worked at a BA degree (with honours) in Economics and Public Administration from Naftogaz, rising from a chief specialist to adviser to the chairman. Some time Dartmouth College. later, Andriy co-founded AYA Capital investment banking group where he focused on debt and equity capital raising, debt restructuring and corporate reorganizations of large enterprises and holdings. Andriy holds a master’s Mykola Havrylenko degree in international economic relations with honors from the Institute of Member of the executive board since 24 May 2017 International Relations at Taras Shevchenko National University of Kyiv. Chief executive officer at Ukrtransnafta PJSC since November 2015

Sergiy Pereloma Prior to his appointment to Ukrtransnafta, Previously, Mykola Havrylenko First deputy chairman since August 2014 headed private oil and gas companies VIK OIL LTD and GAZNGO LTD.

Sergiy has more than 15 years experience in the oil and gas industry Havrylenko holds a degree from Tugan-Baranovsky Donetsk State University and manages divisions responsible for transit and supply of natural of Economics and Trade. He also completed a master’s degree in oil and gas, customs clearance, gas sales and gas balancing. He has extensive gas pipelines and storage facilities at Ivano-Frankivsk National Technical experience in finance, banking and insurance sectors. Sergiy graduated University. from the Institute of International Relations at Taras Shevchenko National University of Kyiv.

Sergiy Konovets Chief financial officer (deputy chairman) since April 2014 Remuneration of the management Sergiy is responsible for financial and economic management in Naftogaz. Sergiy has more than 20 years of professional experience in strategy During 2017, the management consisted of 6 executive board members and 9 directors (4 executive development, business development, finance and audit with international board members and 6 directors in 2016). Compensation to the management, which is part of other companies. He worked as audit partner for leading audit companies Deloitte operating expense, included salary and additional current bonuses and made up UAH 214 million and EY. Before his appointment to Naftogaz, Sergiy worked at international (UAH 87 million in 2016). consultancy Boston Consulting Group. He also worked in a business development and strategic planning function at international agriculture holding Bunge located in Switzerland. Sergiy holds an MBA degree from the Remuneration paid to Naftogaz board members in 2017 International Institute for Management Development (IMD) in Lausanne, Switzerland. Members 01.01.2017–31.12.2017 Remuneration including unified social tax as board member, UAH million Andriy Kobolyev 47.1 Yuriy Kolbushkin Oleg Prokhorenko* 24.0 Member of the executive board since February 1999 Sergiy Pereloma 17.0 Sergiy Konovets 15.2 Yuriy has worked at Naftogaz since the company was founded. He is Yuriy Kolbushkin 14.0 responsible for taxation, pricing policy, budgeting and economic relations. Before moving to oil and gas industry, he worked for 15 years in the Ministry Mykola Havrylenko* 10.4 of Finance of Ukraine. Yuriy graduated from the Kyiv Institute of National Total 127.7 Economy, holds a doctoral degree in economics and is a member (academic) * Oleg Prokhorenko and Mykola Havrylenko took up their appointments as Naftogaz board members in May 2017. of the Ukrainian Academy for Oil and Gas. No remuneration for performance of their duties in this board was paid by the company.

154 155 CORPORATE GOVERNANCE ANNUAL REPORT 2017 Other Top Executives RISK MANAGEMENT AT NAFTOGAZ GROUP

Yuriy Vitrenko Margarita Korotkova Сhief commercial officer of Personnel management Within the framework of of risk management regulatory of the first Naftogaz group Naftogaz Group and social policy director corporate governance reform documents and tools, as risks register which is a single and the introduction of internal well as the initial group risk document containing detailed controls at Naftogaz group, an assessment. For this purpose, risk information on identified risks, independent risk management management best practices were their correlation and levels of office of Naftogaz group was applied, including the provisions impact, control mechanisms and established. It began work in of the international standards processing measures. The data of November 2016. (ISO/IEC 31010:2009 Risk the register ranks risks in order to management – Risk assessment address the most significant. The Yaroslav Teklyuk Orest Logunov The main goals of the service are methods, ISO 31000:2009 Risk register is continuously revised Director for legal Сhief procurement the development of an efficient, management – Principles and updated in order to contain affairs officer comprehensive risk management and guidelines). International up-to-date information on the system and the coordination of consultants and experts risks. the risk management process participated in the process. at Naftogaz group to secure the The risks register which group's operations and help to In 2017, Naftogaz group was created based on the achieve its strategic goals. carried out a comprehensive results of the initial risks risk assessment based on assessment in 2017 includes Oleg Didenko Bruce Owen The priority tasks of the office developed tools. The outcome 276 risks and has the Director for corporate Dingeman in 2017 were the development of this work was the creation following structure: debt workout, Director exploration gas distribution systems and production Naftogaz group risk structure and their assessment and retail gas supply 4 REPUTATIONAL 127 8 OPERATIONAL ENVIRONMENTAL, HEALTH AND SAFETY Vitaliy Shcherbenko Aliona Director for administrative 12 Osmolovska LEGAL activity and energy Head of corporate efficiency communications 13 REGULATORY

5 10 15 20 25 35 FINANCIAL

RISK ASSESSMENT FOR THE GROUP: 1-4 LOW 77 5-14 MEDIUM STRATEGIC 15-25 SIGNIFICANT

156 157 CORPORATE GOVERNANCE ANNUAL REPORT 2017 Environmental, health and safety risks GTS and enhance the level of Procurement" do not prevent mechanism of prompt reliability of the Ukrainian GTS in dishonest suppliers from and timely acceptance of the eyes of the European energy participating. As a result, there proposals for consideration, Within its operational activities outdated production equipment own personnel training and community. are high risks of collusion determination of the winner for the extraction, transmission in the group’s drilling fleet. adhering to the requirements among tender participants based on the results of the and storage of gas and oil, of national and international PROCUREMENT DELAY/FAILURE and dangers of refusal to tender, and conclusion of the Naftogaz group companies face In order to mitigate this risk, regulatory documents and RISKS sign contracts or their non- contract. The subdivisions that the risk of serious accidents that Naftogaz group companies are standards. These measures are fulfillment or supply of goods initiate the procurement also may result in harm to people's actively introducing modern also among the elements for The relevant Ukrainian of inappropriate quality. This carry out a detailed analysis health and the environment, methods of exploitation, managing the risk of low quality legislation provides for may result in re-tendering of the market and potential loss of production facilities, diagnostics, and modernization of geological data as described carrying out procedures for or delays in the supply and participants. and suspension of operating of existing production facilities, below. the procurement of goods production process and may activities. The situation is using the world's best practices and services through the have material consequences The group holds regular complicated by the presence of in this area together with their electronic public procurement for Naftogaz group operations. open meetings with potential system ProZorro. At the same suppliers to inform them about time, the said system and the To minimize this risk, the its needs and details of the Operational risks Law of Ukraine "On Public company implements the procurement process.

LOW QUALITY OF GEOLOGICAL Geology and Mineral Resources transmission system operator DATA (Derzhgeonadra) which hinder or GTS) from its extraction Regulation the issuance or extension of and supply was initiated in The low quality of geological permits for field development 2014 in accordance with LENGTHY PROCESS OF APPROVAL provisions on imposing PSO This situation also creates data used by Naftogaz group and subsequent gas and oil the requirements of the EU OF THE FINANCIAL PLAN regulations on the company difficulties in negotiations companies for gas and oil extraction. Specifically, in 2017, Third Energy Package. This is until June 2018. The company with the IMF, EBRD, European extraction results in the growth Poltava Oblast Council blocked one of the most important The relevant Ukrainian is obliged to supply gas at Commission, World Bank, etc., for of uncertainty regarding the level the issuance of new licenses preconditions of Ukrainian legislation provides that the regulated prices directly to financing and attracting cheap of hydrocarbons at development for the development of fields natural gas market liberalization company agrees its financial heat producers and regional loans. and extraction plots. This in turn to Ukrgazvydobuvannya, while and its further integration into plan with executive authorities, suppliers to satisfy needs results in increases in drilling Derzhgeonadra, based on the EU natural gas market. which results in significant of households. Failure to In order to minimize the expenses and decreases in the court resolutions, annulled the delays in its adoption and implement the subsidy impact of this risk and enhance volumes of oil and gas extraction, company's 3 special permits Ineffective unbundling may result increases the risk of its non- monetization system, opaque the efficiency of Ukraine’s which directly impacts the for the development of the oil in a number of problems in the fulfillment. The absence of an regional intermediaries and gas market, the company achievement of one of the key and gas bearing areas in Poltava transit and internal transmission approved financial plan makes the lack of a compensation communicates the negative Naftogaz group strategic goals – oblast. systems including the operation it impossible to implement mechanism for the company consequences of the current maintaining and expanding of the underground gas and investment programs in full, results in the accumulation of PSO system and discusses survey and extraction possibilities. Such obstacles pose a threat buffer gas storage facilities. This which may challenge both bad debts for supplied natural possible amendments to the to the group's fulfillment of could cause the company΄s the successful performance of gas. effective legislation with the Improvement of geological the Ukrgazvydobuvannya financial losses, threaten the current technical servicing work government and IFOs on a survey quality is achieved through 20/20 strategy. natural gas market reform and and the planned growth of As of 31 December 2017, regular basis. continuous cooperation between may harm Ukraine's efforts to Naftogaz group. the total debt of DHCs to Naftogaz group companies and Additional information on maintain its transit status after Naftogaz was UAH 30.6 billion, Additional information on the Ukrainian scientific and technical Naftogaz group company 2019. EXTENSION OF VALIDITY OF and that of the regional PSO impact on the group's institutes, and engagement of activities regarding this risk PROVISIONS ON IMPOSING SPECIAL suppliers was UAH 14.2 billion. operations is provided in the international experts in service of is provided in sections "Local Along with regulatory and OBLIGATIONS ON UNFAVORABLE This level of debt significantly section "Liberalization of the oil and gas fields. Communities Development" legal initiatives in order to TERMS FOR THE COMPANY affects the company's segment of gas supply to and "The European Natural Gas minimize the risk, the company liquidity, especially during household consumers, PSO FAILURE TO OBTAIN THE Market" of this report. engages international experts On 22 March 2017, the the summer period, when the and the subsidies system". REQUIRED PERMITS FOR FIELD to help in ensuring an efficient Ukrainian Government gas is purchased for the next DEVELOPMENT INEFFECTIVE UNBUNDLING OF unbundling process. This extended the validity of heating season. NATURAL GAS TRANSMISSION would also allow engaging Naftogaz group companies ACTIVITIES a reliable and professional (specifically Ukrgazvydobuvannya Western partner to the GTS and Ukrnafta) must deal with The process of separation of management, which would also the actions of local councils the natural gas transmission grant the market participants and the State Service for activities (activities of the gas indiscriminate access to the

158 159 CORPORATE GOVERNANCE Strategic

LAUNCH OF TURKISH STREAM signed on 10 October 2016 significant portion of income of OUR RESPONSIBILITY AND NORD STREAM 2 between the governments of Naftogaz group starting from Russia and Turkey, the expected 2019. The main strategic risk for capacity is 31.5 bcm/year. Naftogaz group today is Exposure to risk also relates to the implementation of 2. Under Nord Stream 2 gas correct unbundling (described in bypass gas pipeline projects pipeline construction contract detail in Risk No. 4 above). outside the territory of signed in 2015, the expected Ukraine that are expected to capacity is 55 bcm/year. Additional information on the be launched in 2019: company's actions regarding The implementation of these this risk is provided in the 1. Under Turkish Stream gas bypass gas pipelines projects section "The European Natural pipeline construction contract, would result in the loss of a Gas Market".

Legal

VAT GAZPROM'S CLAIM UNDER contract for the purchase Naftogaz engaged qualified THE GAS PURCHASE CONTRACT of gas (take-or-pay) in the and experienced legal (TAKE-OR-PAY) IN THE ARBITRATION Arbitration Institute of the advisors. INSTITUTE OF THE STOCKHOLM Stockholm Chamber of CHAMBER OF COMMERCE Commerce for the total The Arbitration Court fully amount of USD 56 billion. rejected Gazprom's claim for During 2017, one of the USD 56 billion in accordance key risks for Naftogaz was For the purpose of defense of with the take-or-pay rule for Gazprom's claim under the its position in this litigation, 2009–2017.

Financial

LIQUIDITY RISK natural gas injection into Taking into account the the underground storage strategic importance of timely Naftogaz group operating facilities for the next heating preparation for the heating activities are of a seasonal season. season, the company attracts nature that provides for loans on national and foreign receiving the main revenue The increase of debts by financial markets. At the same from the natural gas sale the DHCs and regional time, an important factor for and transmission during gas suppliers to Naftogaz the conclusion of agreements the heating season. Over and the necessity to pay with Naftogaz international the summer period, sales dividends to the state budget financial partners is the volumes are significantly during the summer period fulfillment of the corporate less and the group incurs pose significant threats to governance plan, correct significant expenses related Naftogaz group liquidity for unbundling and the to the financing of the the summer period. settlement of the PSO issue.

160 OUR RESPONSIBILITY ANNUAL REPORT 2017

218 persons hold a PhD, By activity including 53 women. In HUMAN RESOURCES addition, 23 persons have a degree (13 associate professors, 74 765 7 senior scientists, 3 professors). Total 71 881 Key results and achievements in HR management in The average age of the 2017: employees is 42.2 years. 21% 15 542 Ukrgazvydobuvannya 8 142 persons (11%) of Production Ukrnafta 21% 15 383 Zakordonnaftogaz • since 1 July 2017, a Grade Basic Payment System has been employees are under the age introduced in Naftogaz; of 30; 42 590 persons (59%) Ukrnafta are from 30 to 50 years old; 19 34% 25 788 Transportation Ukrtransnafta • increase in average monthly wage to UAH 13 374 (+ 24.5% 237 people (27%) are more than Ukrtransgaz 34% 24 794 Ukrspetstransgaz compared to 2016); 50 years old; and 1 912 persons (3%) are pension age. In difficult conditions, only a team • since February 2017 a system of voluntary health insurance 45% 33 435 of professionals can guarantee Almost 90% of the staff Other has been introduced; 44% 31 704 the security of energy supply and works in three companies: create a high-quality new market. • the company’s internal communications system and Ukrnafta (22 952 persons), We managed to rally specialists reforming of the pay system of Naftogaz of Ukraine NJSC Ukrgazvydobuvannya (20 876 2016 2017 who seek constant growth and projects were awarded a prize in a special nomination persons) and Ukrtransgaz share our corporate values. With Reforming the State as an Employer at the All-Ukrainian (19 583 persons), including 61% such human potential, we are Competition Prize HR Brand Ukraine 2017. of employees employed in gas confidently building a great and oil production, and 27.5% in The average monthly wage at Naftogaz group companies European company. gas transportation. compared to the average wage in Ukrainian industry, 2014-2017, UAH The personnel of Naftogaz group – quantitative and qualitative profile Personnel turnover in 2017 was as low as 3.2% 6 597 2014 As of 31 December 2017, the Naftogaz group personnel structure, 2017 3 988 enterprises that belong to In 2017, 10 252 employees left Naftogaz group employed the companies of the group, 7 388 71 881 employees (-3.9% of which 2 303 employees 2015 GENDER STRUCTURE PERSONNEL CATEGORIES 4 789 compared to 2016), including quitted voluntarily, 22 8 103 managers (11%), 50 693 employees were dismissed for 12 626 professionals and specialists 78% violating labor discipline, 797 10 091 (18%), 459 technical staff (0.5%); employees were dismissed 2016 5 902 50 693 qualified and other workers due to reorganization (70.5%). and redundancy, and EMPLOYEES 12 626 7 130 employees quitted 13 374 The gender structure of group TOTAL 2017 because of other reasons. The 7 631 enterprises is dominated by men, 71 881 main reasons for termination which is related to the specifics of employment contracts were: of operations: 55 939 men (78%) 22% 8 103 the desire of the employee, and 15 942 women (22%), which the termination of the contract Naftogaz group companies complies with international term, the agreement of the Ukrainian industry practices according to BCG. 459 parties including according to voluntary separation program, Of the total number of managers, Men Qualified and other workers relocation and outflow of professionals and specialists skilled personnel abroad, companies, measures of working conditions, (20 729 persons), 20 447 persons Women Professionals and specialists retirement by age, and transfer are taken to ensure development of new forms or 99% have complete higher Managers to another enterprise. productive employment of labor organization, and the education, incomplete higher and rational and efficient formation and maintenance Technical staff education or basic higher To reduce the personnel use of work time, staff of a favorable moral and education. turnover at Naftogaz group optimization, improvement psychological environment.

162 163 OUR RESPONSIBILITY ANNUAL REPORT 2017 Social security for the employees of Naftogaz group Employee remuneration scheme

In 2017, total expenditure In 2017, the average monthly to 2016 and amounted to In 2017, in order to create This grade system is based on – create opportunities to earn on personnel social security wage across Naftogaz group UAH 13 374 per month. a fair remuneration system hierarchical groups of positions – honestly and thus prevent amounted to UAH 1.9 billion, increased by 24.5% compared linking the strategic grades – depending on the tasks corruption; which is 7.6% more than in 2016. objectives of the enterprises and functions of each position – make the wage structure with the performance of and the value created for the transparent; employees and aimed at company. – link the remuneration system to The expenses of the Naftogaz group companies for social security of employees in 2017, UAH million increasing the motivation of business goals. employees, Naftogaz group The introduction of a new companies successfully remuneration system allowed the The introduction of grades and introduced a grade group to: of a goal-oriented management 445.2 163.2 remuneration scheme – introduce a flexible system at Naftogaz group created OTHER SOCIAL SECURITY ONE-OFF (Naftogaz, Ukrtransnafta, remuneration management conditions for the development of PAYMENTS RETIREMENT Ukrgazvydobuvannya) and system; a consistent remuneration policy PAYMENT goal-oriented management – offer competitive wages to and benefit system according to system (Ukrtransnafta, engage and retain qualified international practices and best 132.1 Ukrgazvydobuvannya). employees; standards in HR management. REHABILITATION Total in OF EMPLOYEES AND 416.2 THEIR FAMILIES HOLIDAY AND ANNIVERSARY BONUSES 2017 Staff assessment and career management

34.9 In order to create a highly is paid to the young specialists Creating a personnel reserve and 1 947.9 HEALTHCARE 371.2 professional personnel reserve who demonstrate rationalization career management system is the MAINTENANCE OF SOCIAL at the enterprises of the group, skills and are keen to improve main task for 2018. FACILITIE 25.7 personnel evaluation is in the forms and methods of the PAYMENT place, while the managerial and production process, contributing (REMUNERATION) FOR WINNING workforce personnel reserve are to their development and UKRNAFTA INDUSTRIAL subject to selection and staff continuous training. 359.4 AWARDS FINANCIAL ASSISTANCE, IN- undergo training. Ukrnafta has begun the CLUDING EMPLOYEES’ HEALTH transformation of its training and IMPROVEMENT UKRGAZVYDOBUVANNYA course centers together with the UKRTRANSGAZ unification of activities in order In 2017, corporate, managerial to provide high-quality modern In view of the specifics of the and professional competencies knowledge among its working By Naftogaz group companies, UAH million core operations of the company, were developed to evaluate professions. More than 180 597.2 a professional certification of employees of different levels and employees of Ukrnafta received UKRGAZVYDOBUVANNYA employees is carried out – its a wide-scale personnel training opportunities for career growth in 648.7 scope and frequency is regulated system based on the defined 2017. This included both vertical UKRNAFTA and supervised by the supervisory competencies was introduced. opportunities to become head authorities. of a unit, shop or service, and Personnel evaluation is carried out horizontal opportunities to join Total in 441.1 Employees are tested by via performance development projects and become experts in 2017 UKRTRANSGAZ wage rate and qualification review. The collective agreement their field. commissions for professional of the enterprise establishes 1 947.9 development and included in the the frequency of employee In 2017, a group was created that 119.7 personnel reserve. assessment as once every five includes 34 promising young UKRTRANSNAFTA years, and determines the specialists from different structural In order to promote the categories of employees to units of the company that will form 110.3 professional development and be assessed. Young specialists the basis of the personnel reserve. NAFTOGAZ professional careers of young who have been working for less In order to reveal the managerial 30.9 specialists, young specialist than three years enjoy certain potential of young employees, a OTHER ENTERPRISES conferences are regularly held privileges regarding assessment training and development MIST at Ukrtransgaz. Special attention obligations. (abbreviation for Youth, Initiative,

164 165 OUR RESPONSIBILITY ANNUAL REPORT 2017

Conscious and Talented) program to specialists. Scheduled Prospective young specialists the employment of young of the Ivano-Frankivsk National Within the framework of has been developed. assessments are held for the are appointed to positions of specialists who graduated in Technical University of Oil and cooperation with the Ivano- recruitment and promotion of masters and senior positions 2017 from the Ivano-Frankivsk Gas, 313 students of the Poltava Frankivsk National Technical employees to senior positions. in production departments or National Technical University Petroleum Exploration Technical University of Oil and Gas, Ukrnafta UKRTRANSNAFTA transferred to work in branch of Oil and Gas, the National School, and 149 students of the granted scholarships to the five In order to prepare and update management. Aviation University, and others. Drohobych College of Oil and best students. At the company and its affiliates, management and technical Gas. three evaluation committees personnel, strengthen personnel Plans for 2018 include upgrading have been set up that carry potential and ensure the career the HR reserve for management UKRTRANSGAZ In addition, 88 graduates UKRTRANSNAFTA out preparatory work on the development of young specialists positions with a view to shifting of specialized educational evaluation of employees before at the enterprise, staff undergo towards a target functional In total, 373 students undertook institutions of Ukraine were With a view to establishing assigning five-six grades to rotation and a personnel reserve structure. an internship at the company in offered employment at the qualified selection and further workers and higher categories is in place. 2017. company's affiliates in 2017. employment in 2017, 16 students of the Ivano-Frankivsk National As of January 2018, Ukrtransgaz Technical University of Oil and Gas employs 108 young UKRNAFTA and 30 students of the Drohobych professionals that graduated College of Oil and Gas undertook Code of Ethics from higher educational 1 090 students undertook their their internship at Ukrtransnafta institutions in the last three internship in structural units of branches. Naftogaz has its Code of Ethics in place, i.e. a set of rules and values that underpin the corporate ethics and years. In 2017, 33 young Ukrnafta, including 848 from business conduct of the company's employees. The Code provides a clear understanding of the principles of specialists were employed. the Ivano-Frankivsk National As of 31 December 2017, doing business and the requirements that must be observed by all company employees, as well as members of Technical University of Oil and Ukrtransnafta branches employed the board and supervisory board of the company while performing their functions and tasks, regardless of their Gas; 211 – from Drohobych 11 young specialists that functional responsibilities, location or level of office. The Code is based on generally accepted principles and UKRGAZVYDOBUVANNYA College of Oil and Gas; 24 – graduated in the last three years. norms of Ukrainian and international law. It implements the best European practice. from the Ukrainian Chemical In 2017, based on the selection In 2017, the affiliates of the Technology University; 6 from procedure, two students were company hosted 885 students Kyiv Taras Shevchenko National employed at a branch of trunk for internships (232 students University, and 1 from the oil pipeline Druzhba from the IMPLEMENTATION OF SOCIAL POLICY were provided with paid work Middle East Technical University Ivano-Frankivsk National Technical places), including: 313 students (Turkey). University of Oil and Gas. Naftogaz's social policy aims to achieve the following goals: – increasing the attractiveness of the company as an employer; – attraction and adaptation of young and highly professional specialists; – increasing employee loyalty; Training of employees – material encouragement and social protection of employees; – increasing the effectiveness of social spending. The company creates the – English language courses; – personnel reserve formation necessary conditions for the – sharing knowledge and and development; improvement of professional experience with leading – individual employee training On 15 June 2017, a conference agreement enshrines the while also stipulating a knowledge and managerial foreign companies. and development programs. of the labor collective of the priority of preserving the lives specific mechanism for their skills of its employees. The workers of Naftogaz was and health of employees, implementation. current corporate training An educational project for The companies of the group held, at which a collective decent wages and the system provides a wide range training top management also implement the following agreement for 2017-2020 prevention of arrears and the This collective agreement covers of opportunities for employee under the MBA program was personnel training and was adopted. The collective expansion of social guarantees, 99% of Naftogaz employees. development: implemented at Naftogaz and development activities: – education, training and Ukrgazvydobuvannya in 2017. retraining in the training The project will be scaled up at centers of enterprises, the Naftogaz group level in 2018. UKRTRANSGAZ Work with universities and attracting young professionals specialized training centers and postgraduate education The plan envisages the 3 387 persons were educated, centers; development of a competencies trained and retrained in 2017, The group's companies pay qualified staff for the company. and promote their further – obtaining a second higher model (a set of knowledge and including 2 922 persons who great attention to attracting The enterprises systematically employment. education at relevant skills necessary for the quality improved their qualifications, talented young people to the oil collaborate with Ukrainian specialized universities; performance of work) for the 350 persons were re-trained, and gas industry and working specialized educational The specialists of Naftogaz – participation in training, enterprises of Naftogaz group and 115 persons were trained with young specialists, which institutions to train specialists, group enterprises participate training seminars and which will be the basis for: in new professions. are one of the main sources of provide student internships in the commissions for conferences; – personnel assessment,

166 167 OUR RESPONSIBILITY ANNUAL REPORT 2017

Professional certification and number of corporate training and Research and Design Number of Naftogaz group employees who improved their skills in 2017, persons certification of workers, training sessions were held for engineers Institute of PJSC "Ukrnafta" (RDI); on occupational safety and fire and technicians on leadership, – engineers have listened to more safety, quality and ecological safety behavior audit and risk than 10 highly specialized voca- 13 560 21 741 management, safe operation assessment as well as for workers tional training courses (project of the linear part of main gas on risk assessment, safety in management, data interpreta- pipelines, IT and other aspects operation and safe workspace. tion, statistical analysis, etc.); were conducted. These training sessions are – external experts delivered delivered by in-house coaches monthly master classes on time BY THE GROUP 950 BY STAFF 947 Accountants and financiers management and communica- who were trained and certified. ENTERPRISES CATEGORIES underwent retraining in tions for all employees The training covered about 700 of accordance with the requirements – company workers are now employees since November 2017; for their certification in line with provided with access to One – completed the pilot phase of 8 921 3 387 4 130 international standards. Petro – the largest oil and gas the distance learning project library in the world. (3 courses); Plans for 2018 include: Ukrnafta Ukrgazvydobuvannya Managers W orkers – training of specialists in internal – trained 8 921 employees, During the reporting period, Ukrtransgaz Ukrtransnafta Middle managers and specialists audit programs, HR-systems, including 60 specialists instructed 710 persons were trained in standardization, software; on drilling fluids at the Ivano- new professions at the training – advanced training of the Frankivsk National Technical centers. 4 885 employees, management of the Company; University of Oil and Gas. including 631 engineers and – short-term workshops for technicians would upgraded their Plans for 2018 managers and specialists Plans for 2018 include training qualification. in the fields of accounting, in management accounting and – Introduction of HR management system comparable to those at leading international companies – economic security, finance, labor fundamentals of management, Plans for 2018 include manager protection, technical supervision external trainings with the development programs and highly the Talent Management system (including a unified personnel training and development system for and fire safety, organization involvement of world-class specialized training events. of labor and pay, ecology and specialists, the development of Naftogaz group) to attract, hold, effectively manage, motivate and develop employees who contribute capital construction; a distance learning system (the significantly to Naftogaz group’s development. – training, retraining and advanced development of an in-house UKRTRANSNAFTA training of engineering and platform and courses), and the – Development of performance management system. technical workers and workers establishment of a training center. With a view to creating and (about 4 500 persons) to ensure updating the personnel reserve – Unification of the current remuneration systems across Naftogaz group’s enterprises. smooth GTS operation. in 2017, individual employees – Establishment of Naftogaz training center. UKRNAFTA underwent mandatory periodical training and qualifcation UKRGAZBYDOBUVANNYA In pursuing the personnel improvements as required development and training by legislation. The following In 2017, the company strategy, a number of measures programs also were implemented implemented a comprehensive and funded: ACCA training and were implemented in 2017: training system: second university degree in – unified management standards – established training for trainers; "Gas Pipelines and Gas Storage were introduced, according – introduced a bottom-to-top Facility" at the Ivano-Frankivsk to which 300 leaders of the approach to identify training National Technical University of company were trained in needs, plan programs and Oil and Gas. The second program budget; effective management; encompassed 21 managers and – designed and introduced – special training in finance for operators from Ukrtransnafta, standard programs for training non-financiers for 60 managers; with their graduate projects corporate, managerial and – professional training in project scheduled for defense in 2018. professional competencies management, geology, (in drilling, geology, ground geophysics, drilling and Plans for 2018 also include training infrastructure and procurement); metrology was organized for of employees (accountants, – to improve health and safety almost 100 employees of the economists, HR) in SAP standards at UGV production facilities, a management of the company and ACCA.

168 169 OUR RESPONSIBILITY ANNUAL REPORT 2017 COMPANY OCCUPATIONAL Number of accidents 3 8 2015 AND SAFETY POLICY 5 5

Labor safety is one of the basic In 2017, the company Naftogaz of Ukraine NJSC principles of Naftogaz group and made important steps to which are in line with the 3 one of the group’s core corporate implement labor safety requirements of 18001 11 values: we continuously seek management at the group's standard (ISO 45001), and 2016 5 to increase our occupational enterprises. This included the the Regulations on the health and safety standards while company’s new occupational committee on occupational 5 reducing the risk of accidents health and safety policy, safety, environmental and and possible environmental objectives and targets industrial safety approved by consequences. approved by the board of the supervisory board. 1 4 2017 11 9 4 The company’s occupational health and safety policy is designed to reduce the risk of accidents and other incidents along with occupational diseases among Ukrtransnafta Ukrgazvydobuvannya Kirovohradgaz employees during the production processes. It is based on the following principles: Ukrnafta Ukrtransgaz

■ employee life and health are the priority. The employer is fully responsible for creating an adequate, safe and healthy work environment;

■ monitoring of compliance with occupational health and safety requirements; management and examined 29 accidents, including group in 2017 amounted to 0.486 thoroughly. Mitigation measures 4 group accidents, occurred (in 2016 – 0.37485), the severity ■ achieving occupational health and safety targets based on comprehensive measures and programs, are then developed to improve at the enterprises of Naftogaz rate – 71.00 (in 2016 – 49.85)86. implementation of innovations; occupational safety and to bring group (Ukrgazvydobuvannya, guilty officials or employees Ukrtransgaz, Ukrnafta, Loss of time due to the accidents ■ application of economic methods for occupational health and safety management; to justice. If any violations are Ukrtransnafta, related to production amounted ■ providing training and improving employees’ skills to ensure workplace safety; identified that pose a threat to Chornomornaftogaz, to 2272 man-days in 2017 the health and life of people, Ukravtogaz, Ukrspetstransgaz, (1296 in 2016), of which 1,063 ■ ensuring coordination between the company’s enterprises in occupational health and safety; work is immediately stopped. Naukanaftogaz, man-days at Ukrnafta, 675 man- Naftogaz-Energoservis, days at Ukrgazvydobuvannya, ■ use of best European and global practices in work environment and labor safety. In compliance with the Zakordonnaftogaz, 473 man-days at Ukrtransnafta, requirements of industrial Vuhlesyntezgaz Ukrainy, and 61 man-days at in Ukrtrans- labor protection management Gas of Ukraine, Likvo, gaz87. All employees at the protection. Controls include officials, availability of labor standards and the relevant Naftogazobslugovuvannya, enterprises of the group that inspections of production protection service, harmful and regulatory documents, Center for Metrology and hold a contract are insured units and workplaces. Labor arduous work environment, and accidents occurring in the Gas Distribution Systems, 85 The accident frequency rate and the loss of against accidents at work and protection services inspect the many other factors. For example, workplace and occupational Kirovohradgaz) in 2017. Due time due to accidents for 2016 differs from occupational diseases; they structural units on a regular four-stage operational controls safety and health preventive to these accidents, 35 people those mentioned in the Annual Report 2016 are provided with sanitary basis. Following the findings of are applied at Ukrtransgaz and measures are monitored and suffered injuries, including since in February 2017 an employee of the Company submitted documentation of injury facilities, means of personal the inspections, occupational three-stage controls at the main analyzed by the enterprises of three deaths. 40% of the victims in an accident that occurred in November and collective protection in injury preventive measures are gas pipeline Kyivtransgaz branch the group on a quarterly basis. were injured in road accidents, 2016. Following review of the documents, the accordance with established developed and implemented. office. An official internal investigation mostly on public highways. accident frequency rate and the loss of time for 2016 were updated accordingly. standards. takes place for each accident The number of accidents and 86 Accident severity rate is calculated using the The number of the stages is The findings of the multistage with grave consequences and injuries increased compared to formula: D/N, where D = the number of work Five-stage operational determined individually by controls are documented in for each road accident. Officials 2016. days lost due to injury for the reporting period; controls are in place at the each enterprise, depending a special act and recorded N = the number of the reported workplace or other employees guilty of accidents enterprises of the group to on the number of employees, in the control log. Identified accidents or road accidents face The accident frequency rate at 87 Loss of time is calculated based on working monitor the state of labor structural units, duties of violations are reported to liability. the enterprises of the Naftogaz days only.

170 171 OUR RESPONSIBILITY ANNUAL REPORT 2017

Analysis of accidents by types of causes, 2015-2017 1/1"С" 3 5/1"С" 1 1 10/2"С" 3 14/1"С" 2 1 1 2 1 1"С" 1 2 4 2015 3 2016 2017 2 4/1"С" 3 5 3 3/2"С" 5 6/1"С"

24 accidents including 5 fatalities 27 accidents including 2 fatalities 35 accidents including 3 fatalities

Fall of an injured person Traffic accident Traffic accident Traffic accident Fall of an injured person Injuries caused by moving objects Injuries caused by moving objects Injuries caused by moving objects Fall of an injured person Intentional injury inflicted by other person Intentional injury inflicted by other person Intentional injury inflicted by other person Fall of equipment Contact with animals (dog bite) Fall of equipment Toxic substance Poor health Electrocution Landslide Gas dynamic phenomena Other Transfer of technology or vehicles Injuries caused by objects reacting under Other pressure Fall of equipment "F" – fatal accidents

THE MAIN CAUSES OF ACCIDENTS: ■ 19 accidents (66% of total accidents), of which 4 were group accidents, occurred due to organizational reasons, resulting in injuries to 25 employees (71% of the total number of victims), including 3 deaths;

■ 9 accidents (31%) – due to psycho-physiological causes, resulting in 9 employees injured (26%);

■ 1 accident (3%) – due to technical causes, resulting in 1 injured employee (3%).

ORGANIZATIONAL CAUSES OF ACCIDENTS: ■ violation of driving regulations (classifier code 21) – 12 injured including 1 death; Causes of injuries and accidents (number of injured employees), 2015-2017 ■ failure to comply with the requirements of the labor safety instructions (classifier code 24.2) – 8 injured including 2 deaths; 7 ■ failure to perform the employment duties (classifier code 24.1) – 3 injured; 2015 3 ■ violation of safety requirements during the operation of vehicles (classifier code 20) – 2 injured. 13

PSYCHO-PHYSIOLOGICAL CAUSES: 1 ■ injuries due to unlawful actions of other persons (classifier code 31) – 4 injured; 2016 6 ■ carelessness of the victim (classifier code 32) – 4 injured; 18

■ alcohol intoxication (classifier code 27) – 1 employee injured. 9 TECHNICAL REASON: 2017 1 ■ construction deficiencies, imperfections, insufficient reliability of means of production 25 (classifier code 01) – 1 employee injured. Physiological Organizational Technical

172 173 OUR RESPONSIBILITY ANNUAL REPORT 2017 Safeguards of Ukraine with 84 firefighting fire alarm equipment and fire engines. Additionally, vehicles on a contractual basis. 996 units of automatic fire 1044 fire ponds are in The number of personnel in extinguishing equipment. place. In 2017, the labor protection the requirements of the labor the level of psychosocial risks)” these units amounts to 935 services and the standing protection regulations formed the were organized and conducted in persons. There are 79 fire depots 230 departmental fire During 2017, two minor fires committees of the group's basis for the State Labor Service February-March 2017. on the balance sheets of the vehicles are ready to occurred at the enterprises enterprises conducted to suspend the works and use group's enterprises. be used to extinguish of Naftogaz group; they were 12 430 inspections of health of equipment and facilities; 101 The statistics on accidents fires, including 118 fire promptly liquidated and caused protection (12 210 in 2016). employees hold administratively indicate that road traffic safety Enterprises have installed apparatuses (24/7), one no significant losses. There were In response to identified violations, liability. remains the most urgent issue 3826 units of automatic fire-fighting boat, and 98 no victims or injured. 1722 workers were deprived of in the field of occupational a bonus, 150 were reprimanded, During 2017, 2561 work places safety. To improve this situation, and four were dismissed from their were certified at the enterprises of 39 employees of the group’s positions. the group. Due to this certification, companies were trained on “Road Protection of industrial objects measures are being developed Safety Management Systems 181 inspections of occupational and implemented to improve in the enterprise in accordance Due to the strengthening of 357 incidents were recorded in (pipeline electrochemical safety and health were working conditions. with the requirements of industrial facilities protection 2017 (474 in 2016) including: protection systems, well conducted by the State Labor ISO 39001: 2012” and received and the use of modern technical • 130 illegal oil, gas X-mass trees, block valve Service of Ukraine at the Seven workshops entitled, “Stress certificates. means, the number of offences and condensate taps stations, etc.). enterprises of the company in Management in Occupational against the property of the (226 in 2016); 2017. Identified violations of Safety Management” (reducing group's enterprises significantly • 123 damages (destruction) decreased. of technological equipment

Fire safety Investments in labor protection Overall, Naftogaz group spent UAH 153.8 million on fire Overall, there are 228 fire safety protection measures in 2017, of which: The company’s actual investment UAH 205.3 million against Employees of the company’s specialists in the company. in the occupational health and UAH 155.9 million the previous enterprises are provided with Of these, 129 are full-time staff safety of workers increased year, which is 2.4% of the payroll in overalls, special footwear and and 99 are employees who by 24% and amounted to 2017 (the regulatory rate is 0.5%). personal protective equipment. perform other functions in UAH 3.8 mn parallel. 186 fire and technical upgrading the fire-fighting equipment commissions and 352 fire Investments in labor safety, UAH million brigades and teams have been 61.3 formed at the enterprises of the UAH 40.1 mn Ukrtransgaz 54.7 group, featuring 4536 persons. R&D 68.4 Fire wardens have been appointed at enterprises, regulations and instructions have 21 been developed, and training UAH 1.6 mn Ukrgazvydobuvannya 26.4 and fire safety drills are regularly fulfillment of orders 38.1 conducted. 46.8 7021 internal fire safety UAH 15.5 mn Ukrnafta 61.6 inspections were carried out at fire detection and extinguishing systems maintenance in the proper 82.5 the enterprises of the company condition, purchase of fire extinguishing equipment in 2017, which led to the 5.3 identification of 29 468 violations. 143 disciplinary penalties Ukrtransnafta 10.8 were imposed for violation of UAH 84 mn 13.7 fire safety rules, including on Emergency Service fire departments guarding the company's 21 officials. facilities on a contractual basis 2.1 Other 2.3 The objects of the group are 2.6 guarded by 25 fire and rescue UAH 8.8 mn units of the Emergency Service other fire-prevention measures 2015 2016 2017

174 175 OUR RESPONSIBILITY ANNUAL REPORT 2017

Investments in labor safety in 2017, UAH thousand % CONTRIBUTION TO THE SOCIAL TOTAL 205 311.36 100.00

Providing employees with personal DEVELOPMENT OF LOCAL protective equipment 113 824.17 55.44

Bringing the enterprises' fixed assets into compliance 28 221.34 13.75 with the requirements of labor protection regulations COMMUNITIES

Elimination and minimization of the impact of hazardous 10 781.97 5.25 and harmful production factors on employees The companies of Naftogaz a systematic way while carried out in close cooperation group operate on the principle recognizing the importance of and interaction with local Special food for employees working in dangerous 10 096.74 4.92 of social responsibility and developing an effective model communities on the basis of conditions invest in the development of interaction between business partnership and aims to satisfy of local communities in and society. This activity is their needs. Health screening of employees 6 613.50 3.22

Training in labor safety 5 010.34 2.44 POLITICAL PRIORITIES OF THE COMPANY IN TERMS OF SOCIAL RESPONSIBILITY AND SUPPORT FOR LOCAL COMMUNITIES Detergents and antiseptic agents 2 903.66 1.41

Naftogaz group companies are committed to the principles of When considering the support of Certification of workplaces 1 624.83 0.79 the UN Global Compact and are committed to the sustainable social projects and programs, the development of business, personnel and society. In its corporate company’s most preferable projects Operations of labor protection offices 734.31 0.36 social responsibility (CSR) activities the company seeks to achieve are those that: the following goals: ■ meet the priority areas of Provision of employees with normative documents ■ 626.38 0.31 development of a successful, competitive business which corporate social responsibility on occupational safety ensures the long-term growth of share value and promotes policy and corporate strategy; the economic welfare of the community as a whole; ■ are implemented on a systemic 315.93 Measures to prevent injuries among the population 0.15 ■ reducing the negative impact on the environment through basis, are long-term, and are modernization of equipment and introduction of modern aimed at solving significant social Personal protective equipment checks and testing 259.61 0.13 resource-saving and more environmentally friendly problems; technologies, application of best practices in the field of ■ are relevant and requested by environmental management; the stakeholders, are in line Other* 24 298.58 11.83 ■ promotion of socio-economic development and welfare with the strategic interests of the regions of Ukraine wherever the company's of the company's business Investments, UAH % of the total amount spent on labor protection production facilities are located, in partnership with public development; authorities and local communities, including through the ■ use the best practices and Targets for 2018 implementation of charitable programs and social projects; modern technologies in the ■ building sustainable partnerships with all stakeholders social sphere. – Certification of labor protection management systems in accordance with OHSAS 18001 standard based on compliance with applicable laws and regulations, (ISO 45001); industrial standards, contractual and other obligations. – Implementation of ISO 39001: 2012 “Road Traffic Safety Management Systems Requirements with guidance for use” at the enterprises of the company; – Implementation of an environmental protection and social measures plan within the framework of the Interaction with local communities IBRD loan agreement; In the area of support for local In addition, taking into account This committee is a permanent – Development of an Industrial Safety Management System at PJSC Naftogaz of Ukraine; communities, Naftogaz and its the important social role of consultative and advisory – Implementation of an automated system of accounting for accidents and incidents at the production subsidiaries are governed by the company, a committee body to the supervisory board facilities of Naftogaz group. provisions on charity, corporate on occupational safety, whose main task is to study, social responsibility policies and environment, safety and reserves prepare for consideration and corporate strategy. was created in February 2017. provide recommendations to

176 177 OUR RESPONSIBILITY ANNUAL REPORT 2017 the supervisory board in the UAH 90 million to Poltava extension of the term of special Consequently, the greater the from the rent payments of of previous debts, local fields of labor protection, the communities in 2015-2017. permits for the use of subsoil. production of hydrocarbons in Ukrgazvydobuvannya will communities may not receive environment and security. the territory of the community, amount to UAH 1.2 billion in 2018, revenues from rent payments. According to experts from The EIA procedure provides for the more revenue it receives. The while Ukrnafta will pay about The decision to establish the Ukrgazvydobuvannya, the the right to and opportunity law provides for 2% of the rent to UAH 270 million. In order to pay off the tax debt, committee was taken by the development of the gas fields for the public to participate in be directed to regional budgets, Ukrnafta offered 2 bcm of gas, supervisory board to ensure covered by the permits that are such a procedure. This includes 2% to district budgets and 1% However, the unsettled issue which at current prices costs that social and environmental currently blocked by Poltava at least 25 working days given to the budgets of the local of Ukrnafta's tax debt may almost UAH 15 billion and issues are addressed at the Regional Council would have to the public. They are also governments (where the relevant hinder these plans. During fully covers the debt. Another highest level as practiced by additionally provided the local invited to take part in open natural resources are located 2017, the State Fiscal Service option is debt restructuring and leading international oil and gas budget with the following hearings on the EIA reports and (produced). of Ukraine (SFS) at its own repayment over a three-year companies. amounts: in 2018 – about to submit their comments and discretion credited the current period. Ukrnafta sent the relevant UAH 100 million, in 2019 – about suggestions. According to preliminary rent payments from Ukrnafta proposals to the SFS back in May The extractive enterprises of the UAH 300 million, in 2020 – more estimates, the total revenues as repayment of the tax debt. 2017. However, no substantive group, Ukrgazvydobuvannya than UAH 600 million. On 3 March 2018, the first allocated to the budgets of If the rent payments in 2018 response from government and Ukrnafta, enter into social open public hearings of the regions, districts and communities are also directed to repayment officials has yet been received. agreements with the authorities The abovementioned reports on environmental of the regions in which they blocked sites are located impact assessment of the operate on a voluntarily basis, near discovered fields which planned extraction of minerals in the spirit of partnership are currently developed by from the Pasichnanske oil Planned rent payments from Ukrgazbydobuvannya to local budgets, UAH and goodwill, in accordance Ukrgazvydobuvannya. The and gas condensate field in 50 225 665 with best European practices. annual production from these Nadvirna (Ivano-Frankivsk Kharkiv region Specialists from Ukrtransnafta sites amounts to about 1 bcm. region) were held at the oil 602 707 982 provide professional assistance and gas production facilities 41 227 607 in solving the administrative In other words, if granted the Nadvirnanaftogaz and Poltava region and economic problems of the special permits, the company Boryslavnaftogaz owned 494 731 282 community. would start exploration as soon by Ukrnafta. The deposit is 3 438 891 Dnipropetrovsk region as possible and find natural gas located on the territory of five 41 266 696 Unfortunately, a recent deposits with the similar annual village and town councils. stumbling block was the refusal production rates in the next 2-3 Almost 100 representatives of 3 197 645 Lviv region of local authorities and Staty years. the communities of all these 38 371 742 Geology and Mineral Resources settlements were present at 889 641 Service to grant special permits Naftogaz group companies these hearings. In addition to Ivano-Frankivsk region ACTUAL TAX LIABLITIES for oil and gas production. are keen to enter into dialogue environmental issues, a great 10 675 687 FOR JANUARY 2018: Ukrgazvydobuvannya has to with local communities, number of socio-economic 451 749 100 Lugansk region million extend the validity of its 37 especially in view of the Law issues were discussed. The 5 420 985 special permits in 2018, and of Ukraine "On Environmental communities agreed with the Ukrnafta – 27 special permits. Impact Assessment" which is relevant Ukrnafta EIA reports 438 410 Sumy region Although the Poltava Regional effective since 18 December and expressed their full support 5 260 918 Council has failed to approve the 2017 and which introduces with regard to prolongation of 268 522 issuance of special permits for a new European model the special permits, as well as Volyn region Ukrgazvydobuvannya for three of environmental impact hope for further expansion of 3 222 266 years, the company continues assessment (EIA) procedure. activities as it directly affects the 10 541 FORECAST TAX to fund social development and According to the Law, the welfare of these communities Chernivtsi region 126 497 LIABLITIES infrastructure on a voluntarily EIA procedure is obligatory and their neighbors. FOR 2018: basis and has transferred almost before any decision is taken on 5 250 1.2 Zakarpattya region 62 997 billion

4 334 Donetsk region Revenues for local budgets from rent payments 52 008

On 20 December 2016, the for the needs of local communities and private companies to ensure * The existing Ukrgazvydobuvannya production facilities are located on the territory of 11 regions. Verkhovna Rada adopted Law from January 2018. This is one of that residents of the areas where ** Expected revenues from rent payments according to the planned performances in 2018 to: – regional budget – UAH 480.8 million No. 3038 on the decentralization of the key draft laws that Naftogaz oil and gas are being produced can – district budgets – UAH 409.0 million gas extraction rents, which enabled companies actively lobbied directly benefit from the presence – local budgets – UAH 312.1 million the transfer of 5% of rent payments together with deputies, experts of extractive enterprises.

178 179 OUR RESPONSIBILITY ANNUAL REPORT 2017 Social investments by Ukrgazvydobuvannya environmental projects in designed to provide remote areas kilometers from Poltava and has the Poltava region. In 2017, with high-quality drinking water. about three thousand residents, the company continued Even small towns such as Sencha received financial resources to Ukrgazvydobuvannya, the largest Ukrainian gas The company provided financial support implementation of a program village, which is located 150 solve urgent problems. producing company, increases its financial support to for the following works: local communities every year.

The Poltava, Kharkiv and Lviv regions where the Kharkiv region deposits are located are of particular importance for the UAH 16.5 million operations of Ukrgazvydobuvannya. road repair: 85 sections Kharkiv region is one of the Local community development leaders in natural gas reserves In 2017, within the framework of cooperation with social program supported and production in Ukraine. 81 local communities, Ukrgazvydobuvannya financed by Ukrgazvydobuvannya, UAH 9.7 million The largest enterprise in 208 projects worth UAH 100.485 million. UAH million refurbishment of educational institutions (schools, the sector in this region is Total funds transferred: kindergartens): 17 objects Shebelynkagazvydobuvannya, Zolochiv 34.2 The list of objects is formed in cooperation with local Bohodukhiv which is owned by 1.7 government bodies and the company’s production Krasnokutsk 1 Velykyi Burluk Ukrgazvydobuvannya. In 2017, 2.2 Kharkiv units. The objects that are financed under the social Valky 4.7 Shebelynkagazvydobuvannya agreements include roads, water pipelines, and a rural UAH 25 million Kolomatskyi1.1 extracted almost 35% of the total stadium. Most of the projects are already completed, refurbishment of other buildings (hospitals, 0.3 natural gas produced in Ukraine. while some are in the process of active implementation. community centers): 43 objects Nova Vodolaha 1 Balakliia The objective of the social Krasnohrad Pervomaiskyi Social agreements are concluded directly with village and investments made by 1.3 Kehychivka 4.2 15.5 town councils in places of extraction and are based on 1.5 UAH 39 million Ukrgazvydobuvannya in Kharkiv the principles of targeting, transparency and intended construction/repair of networks (electric, water, gas region is creating favorable use control. distribution): 35 objects conditions for the economic and social development of the region. More detailed information about specific objects In 2017, the company invested UAH’000 supported by the company and the state of UAH 34.2 million to support the financing can be found on an interactive map UAH 10 million social development of the region. Up to 200 200-400 400 –1 million > 1 million at the Ukrgazvydobuvannya website in the other projects (improvement, rehabilitation of Social Responsibility section. residential houses, etc.) Lviv region Poltava region Local community development In 2017, Ukrgazvydobuvannya Local community development transferred UAH 12 million to social program supported Sokal social program supported the budget of Lviv region under In 2017, funds allocated by by Ukrgazvydobuvannya, 0.33 Ukrgazvydobuvannya for by Ukrgazvydobuvannya, UAH million a tripartite memorandum of infrastructure and the social UAH million cooperation between Lviv sphere of the Poltava region Lokhvytsia Regional State Administration, Total funds transferred: amounted to UAH 48 million. 6 Hadiach Total funds Lviv Regional Council and transferred: 5.6 Zinkiv 12 In addition, Ukrgazvydobuvannya 48.0 Yavoriv Ukrgazvydobuvannya. The 3.6 provided UAH 1.1 million as 1.2 Lviv funds provided by the company a charitable donation to local Myrhorod Kotelva Mostyska 3.2 were used for the construction, 0.1 Horodok 3.8 3.6 Pustomyty Dykanka refurbishment and maintenance communities. In 2017, the volume 0.7 0.1 2.4 Chutove of funding to Poltava region Sambir of social and road infrastructure under the social agreements 0.6 0.9 Mykolaiv objects owned by the local Reshetylivka Poltava Staryi Sambir 0.8 Drohobych communities, on whose territory increased 2.5 times compared 0.7 8.8 2.8 to 2016. The geography of the Karlivka 1.4 Lvivgazvydobuvanya (which is Novi Sanzhary Mashivka 11.5 Stryi social agreements also expanded 0.2 1.2 0.4 part of Ukrgazvydobuvannya) to cover 49 settlements versus units are located. 44 in 2016. UAH 2.8 million was spent on the UAH’000 UAH’000 construction of treatment facilities Ukrgazvydobuvannya is in the village of Mizhenets, Up to 200 200-400 400 –1 million > 1 million implementing a number of Up to 200 200-400 400 –1 million > 1 million Starosambirsky district.

180 181 OUR RESPONSIBILITY ANNUAL REPORT 2017

In 2017, the employees of Naftogaz treatment and rehabilitation of of the meeting unanimously collected UAH 10.1 million of their soldiers. supported the proposal to continue Comfortable conditions for patients at a healthcare facility are a own funds, of which UAH 5 million collecting funds for ATO assistance treatment factor. This pleasant hospital courtyard will definitely was spent to support ATO soldiers, At the staff meeting of the labor during the first half of 2018. The energize our patients, which accelerates their recovery and UAH 5.1 million went to collective of the company on next regular meeting will be held Deputy сhief of the Military Medical Clinical Center Ivan Derzhylo support healthcare facilities for the 29 December 2017, the participants in June.

First of all, assistance was provided to military units located on the contact line, in the zone of active hostilities. Aid was also received by servicemen of the Genichesk border service unit of the Berdyansk border platoon, which guards the Strilkovo gas field. We have helped to impove their stationing conditions by purchasing construction materials and other goods Sergiy Pereloma, first deputy chairman of Naftogaz executive board

NAFTOGAZ EMPLOYEES SUPPORT TO ATO SOLDIERS IN 2017

UAH 10.1 million SUMMARY OF AID PROVIDED collected TO ATO SOLDIERS IN 2014–2017

Social partnership in action: improvements at the Western Region Military Medical Clinical Center in the city of Lviv Aid was provided for the treatment of 11 045 49% ATO participants, including over 200 injured by Ukrnafta, within its capabilities, self-governing bodies and local areas where the company purchasing implants for hospitals provides social investments to authorities), orphanages, schools, operates. Assistance is provided support local communities as boarding schools, healthcare in the form of free provision of well as charitable donations to facilities and other organizations. materials, works and services, Clothing and military gear were provided for third parties. The beneficiaries of In the vast majority of cases, etc. In 2017, Ukrnafta's social more than 2 300 fighters this charitable support include the beneficiaries of charitable investments amounted to territorial communities (local support are located in the UAH 29.3 million. Several thousand units of special equipment Targeted charitable aid to ATO soldiers* 51% and devices were sent to combat units: radio sets, thermal imagers, generators Since the end of 2014, Naftogaz transfer of goods, accessories, of equipment required for the has been actively implementing and other means for ATO treatment of wounded soldiers. The material assistance was collected in the its own targeted charitable aid participants in the area of UAH 5.0 million program to support the army hostilities. In March 2017, Naftogaz and Gaz aid to ATO soldiers, incl. UAH 78 000 for amount of UAH 22.7 million and volunteer battalions in Ukrainy transferred to the Ministry presents to ATO soldiers’ children the area of hostilities, as well In line with the decision of of Internal Affairs of Ukraine for as via healthcare institutions. the commission, the company free 50 apartments in the town Real estate, motor transport and other tangible The decision to participate provides targeted charitable of Gorishni Plavni (Poltava region) UAH 5.1 million assets worth more than UAH 75 million transferred aid to healthcare facilities for soldier in projects of targeted aid for the means of protection with a total market value of almost to the Armed Forces of Ukraine and the Ministry treatment and rehabilitation charitable aid was taken and equipment for Ukrainian UAH 35 million for accommodation of Internal Affairs by the commission for the combatants in the east of the of ATO participants and their organization of purchase and country, as well as the purchase families.

* Starting from 30 April 2018 the ATO format was replaced by the Joint forces operation (JFO)

182 183 OUR RESPONSIBILITY ANNUAL REPORT 2017 Sponsorship ENERGY EFFICIENCY The companies of the group During 2017, a large number of communications of are active in the social and employees of the subsidiaries Ukrtransnafta organizes a The corporate objectives of Naftogaz group are to promote energy efficiency through the provision of public sphere and are involved of the group participated in charitable fundraising event for modern energy services and the introduction of energy efficient technologies and processes. in a number of projects fundraising marathons like the certain target needs. In 2017 implemented by charitable 25th Chestnut Run, the Wizz Air a Lemonade Day was held foundations and sports Kyiv City Marathon 2017, and the which raised UAH 12 510 for the Types of energy used by the group enterprises associations. Nova Poshta Kyiv Half Marathon Charity Fund “Tabletochki”. Weekend. During these events, In 2017, the group utilized 3.2 million tons of oil The main reasons for the increase in energy Ukrgazvydobuvannya and more than UAH 1.5 million Charity Christmas and equivalent for technological needs, including: consumption (natural gas) in 2017 were: Naftogaz are sponsors of the was collected and used for the St. Nicholas Day events are – іncrease in natural gas consumed by Games of Heroes initiative – purchase of equipment for the organized at the enterprises Ukrtransgaz for the operational needs an international competition research and practical center of the group. The joint efforts of gas pumping units engaged in the among people with disabilities of children's cardiology and of the employees of the 3.2 bcm natural gas transit of natural gas through the territory and war veterans. The company cardiosurgery and in support subsidiaries of the group of Ukraine that significantly increased in spent UAH 1.2 million to support of the charitable foundations resulted in fundraising for over 2017; the project. The implementation projects. 30 000 sweet gifts for children in period is May-October 2018 boarding schools, orphanages, 1.4 billion kWh – increase in gas extraction by (66 stages in different cities with Every year, the department general education schools, and electricity Ukrgazvydobuvannya which required finals in Kyiv). of external and internal low-income families. additional energy. 647.0 thousand Gcal heat 161.2 thousand tons oil (gas condensate) 340.6 ktoe other fuel and energy resources (FER) (boiler and furnace fuel)

Use and savings of FER by Naftogaz group companies in 2010-2017, Mtoe

Mtoe 8 8 % 7.6% 7.1% 6.9% 7 6.1% 5.7% 5.3% 6 5.3% 6 5.0 4.9 5 4.1% 3.8 4 3.6 4 3.3 3.2 3.2 3 2.6 Actual savings of FER (compared 2 2 to the targets) (right axis) 1 FER consumption 0 0 (left axis) 2010 2011 2012 2013 2014 2015 2016 2017

184 185 OUR RESPONSIBILITY ANNUAL REPORT 2017

Technological consumption of FER by Naftogaz group companies in 2017 FER saved by Naftogaz companies, 2014-2017

140.1 0.4% 0.1% 176.5 By the companies UKRTRANSNAFTA UKRAVTOGAZ Total (ktoe) of the group 214.8 232.3 0.0% 19.7% UKRSPETSTRANSGAZ 151.7 UKRNAFTA Natural gas (mcm) 192.9 10.9% 240.1 3.6% 253.7 20.5% 2.5% UKRGAZVYDOBUVANNYA 86.8 Heat (thousand Gcal) 108.8 106.0 By type of FER 98.8 83.0% 83.0% NATURAL GAS 23.5 Electricity (million kWh) 59.4% 10.9% 24.9 UKRTRANSGAZ OTHER TYPES OF FER 25.6 3.6% 54.6 ELECTRICITY

2.5% Other types of FER (ktoe) 0.8 HEAT 0.9 0.9 1.2

2014 2015 2016 2017 Results of energy saving policy FER saved, ktoe Due to energy saving measures implemented Actual energy savings exceeded the target By company under the NJSC Naftogaz of Ukraine Energy figure of 67.6 ktoe, including Efficiency Program for 2015-2020 and the Energy 187.9 Saving Programs of its subsidiaries, the group was UKRTRANSGAZ able to save 232.3 ktoe in 2017. 68.9 mcm 25.6 Natural gas savings amounted to 253.7 mcm, natural gas UKRGAZVYDOBUVANNYA electricity – 54.6 million kWh, heat energy – 8.0 98.8 thousand Gcal. UKRNAFTA 40.6 million kWh 10.9 electricity UKRTRANSNAFTA 67.6

164.6 The total cost of the fuel and energy 4.9 thousand Gcal By program resources saved in 2017 amounted heat TOTAL 232.3 164.6 to UAH 1 981 million (including VAT). NAFTOGAZ ENERGY EFFICIENCY PROGRAM FOR 2015-2020 1.2 ktoe 67.6 ENERGY SAVING PROGRAMS OF other types of fuel THE SUBSIDIARIES OF THE GROUP

TOTAL 232.3

186 187 OUR RESPONSIBILITY ANNUAL REPORT 2017

consumption during transmission started the project aimed at until September 2020. The total will decline, and emissions into modernization of heating systems compensation for the installed air during the operation of the in residential buildings in the city heating equipment will be station will comply with the EU of Kropyvnytskyi in Kirovograd EUR 15 million. environmental standards. region. Of the 192 000 units of heating equipment in Kirovograd In addition, within the Affordable In October 2017, region, about 44 000 are obsolete, Heat project, OJSC Kirovohradgaz OJSC Kirovohradgaz (51% the actual efficiency of which is will launch an intelligent owned by Naftogaz of Ukraine) not more than 70%. A program gas accounting pilot project jointly with the Housing called Affordable Heat, within that would enable remote Energy Efficiency Program which residents can receive a (contactless) readings of domestic supported by the European 35% refund for the installation gas meters. Due to these Bank for Reconstruction and of an energy efficient gas boiler, intelligent meters, energy savings Development (EBRD) IQ Energy will set for implementation of 3% are expected.

Expansion of Naftogaz's service activities

In accordance with the goals of - organization of combustion - implementation of other the Naftogaz group’s corporate products heat utilization at the energy efficiency, renewable strategy, a decision was made to facilities of Naftogaz group; energy, secondary energy and expand activities in the field of - organization of utilization of alternative fuels projects. renewable energy and energy energy generated by natural service contracts. The subsidiary gas excessive pressure at the The objective is to create an Naftogaz-Energoservis was facilities of Naftogaz group; energy service that will allow created for this purpose. - organization of the extraction of consumers to reduce the use of deep geothermal energy using natural gas due to renewable It is anticipated that Naftogaz- exhausted oil and gas wells; energy and increased energy Energoservis will implement - increasing the efficiency of efficiency. projects at the facilities of natural gas use by district heat- Implementation of the energy management system Naftogaz group and other natural ing systems (replacement of at enterprises of the group gas consumers in the following inefficient equipment, optimi- areas: zation of heat supply routes by – improvement of natural gas effi- installation of additional boilers, In 2017, the group proceeded field of energy management indicators, risks, input and ciency when used for individual installation of individual heat with implementation of the for 2017-2020 are approved; output information flows are heating; points); Energy Management System • business processes for identified; (EMS) in accordance with the the energy efficiency • an independent external requirements of the International management of enterprises audit of the energy Standard ISO 50001 as part of the of the company are management system has The most important tasks in energy efficiency improvement for 2018 are to: integrated management system: formalized. For each process, been carried out by TUV- • the Energy Efficiency Policy, responsible persons are SUD firm. 1. Continue implementation of the Energy Efficiency Program. In 2018, it is planned to save about the goals and tasks in the assigned, key performance 108.1 ktoe, including 124.657 mcm of gas, 14.582 million kWh of electricity, 27.954 thousand Gcal of thermal energy. Implementation of energy efficient projects 2. Complete certification of the Energy Management System in accordance with the requirements of the International Standard ISO 50001 with the receipt of the corresponding certificate.

On 7 February 2017, one of the of Bar in Vinnytsia region (Soyuz Ferrostaal Industrieanlagen was 3. Ensure the formation of an investment portfolio of the State Enterprise Naftogaz-Energoservis for the largest investment projects pipeline). chosen as the general contractor. purpose of implementation of energy efficiency and renewable energy projects at the facilities of aimed at modernization of the The reconstruction will increase Naftogaz group, in the public sector and in the household sector. gas transmission infrastructure The project is supported by the energy efficiency of the GTS. of Ukraine was launched - Deutsche Bank with a total cost In particular, the efficiency of 4. Develop and approve the Policy and Objectives of the enterprises in energy management for 2018 the reconstruction of the of more than EUR 79 million. The gas pumping units will increase and beyond. compressor station in the town German engineering company from 25% to 36%, natural gas

188 189 OUR RESPONSIBILITY ANNUAL REPORT 2017 ECOLOGY AND ENVIRONMENT Key results 2017 • Naftogaz group’s capital in Ukraine to regulate the use and the automated investments in environmental environmental audit of the recording of groundwater PROTECTION protection measures and their company's enterprises, is in production have been current costs amounted to place. The updated standard drafted; some draft UAH 91.4 million. takes into account the amendments were taken following: into account by the relevant Naftogaz group companies are committed to minimizing negative impact on the environment, • The environmental measures – current state of Ukrainian state authorities. ensuring sustainable development of the group, harmonizing the economic interests of the group and envisaged by an EBRD legislation, first of all society, and the implementation of international and European standards. In its activities, the company loan agreement have legislation on public • A new edition of the is guided by current Ukrainian legislation, the principles of European environmental law, and the best been implemented and a procurement, Environmental Policy world practices in this area. comprehensive analysis of – requirements of EU and Objectives and the environmental impact legislation to be Targets in the field of In 2017, the board approved was reduced by 17% in 2017 weaknesses of environmental of the company's measures implemented in Ukraine; environmental protection an updated environmental and temporarily stored oil- protection activities; analysis to improve the efficiency of – EU regulatory and as well as measures for policy that meets the containing waste at industrial and evaluation of conformity waste management and use reference sources on best their achievement were requirements of ISO 14001 and facilities of the company’s of actual results with ISO 14001 of water resources has been available technologies; approved. determines the principles of enterprises decreased by 17.1%. requirements. conducted; – best practices of the company's activities and independent environmental • The environmental and its responsibilities with regard During 2017, a set of works According to the requirements • The standard "Environmental inspections. radiation safety training to environmental protection. was performed to diagnose of current legislation, the group Protection. Audit of program for employees The board also approved goals the existing management and implements an Integrated Environmental Aspects • Amendments to current of Naftogaz head office and targets in the field of production processes of the Environmental Protection Action of the Naftogaz group's legislation and regulations is implemented – for the environmental protection and company including: diagnostic Plan annually.88 Activities. Key Provisions", concerning the issuance of first time in the oil and gas plan for implementation by audit, description of types of which is the first standard permits for special water industry of Ukraine. 2019 (hereinafter – the Goals). activities, organizational structure 88 More information about the group's In pursuing these Goals, the and management functions; environmental policy and goals can be found at: consumption of water resources analysis of strengths and www.naftogaz.com

Cooperation with international financial institutions Responsible procurement: in consideration of environmental requirements During 2017, within the framework of cooperation between the company and international financial institutions (EBRD and IBRD), the EBRD monitored the implementation by Naftogaz of its new reporting, Naftogaz takes care of socio-environmental aspects of managing the procurements undertaken by the transparency, environmental and social responsibility standards as well as fulfillment of its obligation company. A representative of Occupational, Environmental and Industrial Safety Department is now a to harmonize its operational standards to the EBRD principles of environmental and social policy. member of the Tender Committee of the company to monitor the compliance of suppliers with labor and environmental requirements. In 2017, OPIC Corporation (USA) conducted a technical audit of underground gas storage facilities. Based on the results of the audit, a positive conclusion was issued on the level of safety and environmental In 2017, the board approved regulations governing interaction between Naftogaz structural units in the impact. This is a prerequisite for obtaining investment funds from Goldman Sachs International. process of purchasing goods, works and services, which sets out a mechanism for assessing compliance by the supplier with the environmental and social requirements of the company and the requirements of In 2017, Deloitte audited the environmental activities of Naftogaz, including gas transmission and Ukrainian environmental protection legislation. According to the regulations, by concluding a contract underground storage facilities. This work is part of the assistance provided by the US Government to with the company, the supplier undertakes to meet the company’s environmental requirements and reform the oil and gas industry in Ukraine. the company reserves the right to inspect its compliance with these obligations. Regulations include a questionnaire on environmental and social policy for procurement bidders. The questionnaire is Based on the results of these audits, international partners concluded that the company's activities posted on the company’s website (www.naftogaz.com). The enterprises of the group already use this are basically in line with the commitments undertaken in the field of environmental protection, the questionnaire during the procurement process. requirements of the current Ukrainian legislation, and international standards.

190 191 OUR RESPONSIBILITY ANNUAL REPORT 2017 Implementation of international standards was issued by the State Enterprise Uzhhorod" will not have any section (27.1 km) and to collect Center of Environmental and negative impact on the state of basic information for crossing Expert Analysis (Ministry of local biodiversity. water obstacles in the Romny- The company has committed itself to Environmental Protection of Grebinky section (26.7 km) implementing and certifying an integrated In 2017, the following stages of Ukraine). The conclusion states Environmental surveys are and Grebinky-Sofiyivka management system, including environmental implementation of the environmental that, should the recommended planned for 2018 to develop a section (31.51 km) under the management in accordance with ISO 14001. management system were completed: requirements and safeguards biodiversity management plan for "Reconstruction of the Urengoy- be followed, the repair of the the "Dacia Galileya" forest reserve Pomary-Uzhhorod gas pipeline" In 2017, an external audit of the quality of the • a set of works to diagnose the existing system main pipeline "Urengoy-Pomary- in the Gusyatyn-Bogorodchany project. company’s management system was carried out of the company’s management and production to confirm its compliance with the requirements processes has been carried out, which included: of the international standard ISO 9001:2015; diagnostic audit, description of types of activities, a TUV SUD certificate of compliance was received. organizational structure and management Interactions with stakeholders on environmental issues functions; analysis of strengths and weaknesses Additionally, the necessary documents have been of quality control, ecology, occupational safety, The company has developed interaction with them (for In implementation of the drafted to organize the procurement procedure energy saving and social responsibility; analysis and and implemented the more details, see the section environmental protection for the purchase of external independent audit evaluation of the compliance of actual results with Stakeholder Engagement "The scope of the report and measures, the company services for the management system in the field of the requirements of ISO 9001, ISO 14001, ISO 50001, Procedure, which requires essential aspects"). cooperates with NGOs. A environmental protection, occupational health and OHSAS 18001 and SA 8000; any projects with significant Memorandum of Understanding safety and energy efficiency and their compliance • during the reporting period, meetings and training impacts on the environment Most enterprises of the and Cooperation with with the international standards ISO 14001, of members of working groups for implementation and community life to company are actively involved All‑Ukrainian NGO "Living OHSAS 18001 and ISO 50001. of the integrated management system of the be communicated to all in the implementation of Planet" has been signed. In company were held. stakeholders in order to environmental and social 2017, a workshop entitled During 2017, the company continued its properly inform them about projects on community "Implementation of Sustainable cooperation with the National Scientific Center • internal audit of the integrated management possible environmental and issues that may be negatively Procurement" was held at the "Institute of Soil Science and Agrochemistry named system of the company in all its subdivisions social impacts. The Map of affected by the company's Aarhus Center of the Ministry after O. N. Sokolovsky" in revision and updating of has been carried out in compliance with the Stakeholders of Naftogaz of production processes (see Local for Environmental Protection of the existing standard SOU 74.2-20077720‑034:2009 requirements of international standards ISO 9001, Ukraine was created in 2017 Communities Development Ukraine as well as training on "Environmental Protection. Elimination of ISO 14001, OHSAS 18001, ISO 50001 and SA8000. as well as the main ways of section for more details). Green Office implementation. pollution of soils and water objects with oil and oil According to the results of the internal audit, ICM products. Rules" in order to set up more stringent concluded that the company’s activities broadly environmental requirements for enterprises meet the criteria and requirements of international operating in the oil and gas industry. standards. Financing environmental activities

Current expenses and capital Naftogaz group expenditures on environmental protection and investments of Naftogaz group ecological charges in 2017, UAH million Biodiversity companies for environmental protection amounted to Conservation of biodiversity in of the Andriyashevsky gas Vinnytsia and Ternopil regions on UAH 91.4 million in 2017. Ukraine is a hot and relevant condensate field, which borders sites where the Urengoy-Pomary- 77.2 90.7 topic that is vital for certain with the Andriyashevsko- Uzhhorod gas pipeline repair and UAH 91.4 million of the enterprises’ SALE OF WASTES CURRENT species that are on the brink Gudimovsky hydrological hydro-testing were planned. All own funds was spent in 2017 91.4 EXPENSES of extinction. Therefore, the reserve. According to the possible ordinary, extraordinary for environmental protection, 0.7 0.1 CAPITAL enterprises of the company, monitoring results from 2017, and unplanned activities were including capital investments FEES RECEIVED INVESTMENTS whenever they operate in no negative impact from oil and considered in terms of their of UAH 0.7 million (which is FOR ENVIRONMENT 155.1 environmentally sensitive gas extraction infrastructure on ability to exert direct or indirect about 1% of the total amount PROTECTION SERVICES areas, carry out environmental forest, meadow and wetland ecological impact. Interaction of environmental protection 50.8 ECOLOGICAL TAX monitoring and assess the ecosystems was detected. with the existing natural costs) and current expenses of 77.8 51.3 impact of their operations environment and socio-economic UAH 90.7 million (99%). FEES PAID FOR 0.5 on biota. For example, every In 2017, Ukrtransgaz carried out elements was analyzed, as ENVIRONMENT PENALTIES FOR PROTECTION SERVICES VIOLATION OF LAW year Ukrnafta, together with analysis of the bio-resources well as potential violation of Of the total amount of capital an independent research of the water objects used for the applicable environmental investments, UAH 0.5 million was organization, conducts collecting or discharging water in principles together with legal spent for wastewater treatment, environmental biological and the course of its operations. Such and administrative requirements. and UAH 0.1 million was spent Expenditure on environmental protection hydro-biological monitoring studies were carried out on water Based on the results of the for radiation safety measures. Ecological charges of ecosystems on the territory facilities in the Sumy, Poltava, analysis, a positive conclusion The cost of major repairs of Ecological services

192 193 OUR RESPONSIBILITY ANNUAL REPORT 2017 sewage systems and reverse air protection measures, and rehabilitation, and Emissions of greenhouse gases by Naftogaz group in 2017, ths. tons water treatment amounted to UAH 45.6 million (50%) on return UAH 8.5 million (9%) on other UAH 0.2 million. water treatment. UAH 6.3 million areas (for example, reduction Emissions of carbon Emissions of methane Emissions of nitrogen Emissions of greenhouse (7%) was spent on waste of noise and vibration impact, Enterprises of the group dioxide (СО2) (СН4) oxide (N2O) gases, СО2-eq. Of the total current expenditures, management, UAH 24.3 million radiation safety, biodiversity Ukrtransgaz 3818.5 30.4 0.2 4509.8 UAH 6.0 million (about 7%) (about 27%) on soil, underground conservation, environmental Ukrnafta 1022.8 4.4 0.1 1159.0 was spent on atmospheric and surface water protection research, etc.). Ukrgazvydobuvannya 862.7 10.0 0.016 1078.4 Ukrtransnafta 1.7 0.1 – 3.5 Protection of atmospheric air Other enterprises 1.5 0.6 – 14.5 TOTAL 5707.2 45.5 0.3 6765.2

The total amount of pollutants in 2017, an increase in To reduce emissions, a emitted into the air by the volumes of drilling by complex of organizational and stationary sources of pollution Ukrgazvydobuvannya by technical measures has been Contribution of the company to the fight against climate change of the company’s enterprises in 21.2%, and an increase in implemented including: 2017 amounted to about 92.18 natural gas extraction by 4.4% − gradual replacement/ thousand tons, which is 4% (645 mcm). modernization of obsolete In accordance with the Readiness (PMR) project of technical workshops with more than in 2016. However, gas-driven internal commitments undertaken by the World Bank, continued personnel in charge of the pollution with pollutants According to the Law of combustion compressors Ukraine under the Association implementation of a pilot development of the monitoring produced in production Ukraine "On Air Protection" and and gas-pumping Agreement with the EU and greenhouse gas emissions plan have been conducted, processes in 2017 do not exceed permits for pollutant emissions, equipment; the Paris Agreement on Climate monitoring, reporting and and the information required the volumes specified in permits the company ensures control − phased replacement of tanks Change, a national greenhouse verification project (Pilot Project) for the Monitoring, Reporting or maximum allowable emission of the permissible emission with a stationary roof with gas emission allowance trading in 2017. and Verification Plan has been norms. of pollutants into the air technologically modern scheme shall be developed and collected. from stationary sources of tanks with floating roofs; implemented in Ukraine. On 30-31 January 2017, as According to the results of 2017, emissions, including control − systematic maintenance of part of the project, working The next stage of the project, the emissions of greenhouse of gas-cleaning equipment respiratory fittings and seals In view of the importance of meetings were held with assessment by an independent the issue and a great number project participants at the verifier (VERICO, Germany) of gases in CO2 equivalent by the efficiency in the units, as well of pontoons and tank roofs; enterprises of the group increased as control of pollutant content − modernization together of processing units that are UMG Kyivtransgaz Branch the developed monitoring, by 20%. Ukrtransgaz was the main on the border of the sanitary with ecological and heat the objects of licensing in oil of Ukrtransgaz and at the reporting and verification plan, producer (66.7%) of greenhouse protection zone. The frequency testing of fuel-using boiler and gas companies in Ukraine, Yagotin compressor station. is scheduled by the end of 2018. gas emissions in 2017. of such surveys (control) is equipment; Naftogaz group jointly with The technological processes, established explicitly in the − application of the tank Carbon Limits AS (Kingdom of the sources of greenhouse gas To reduce volumes of The growth of atmospheric permits for the emission of pumping and operation Norway) and with the support emissions, and material flows greenhouse gas, Ukrtransgaz emissions is due to a pollutants from stationary modes that have the lowest of the Partnership for Market were observed. Individual constantly monitors the 9% extension of works sources of pollution for each emissions of pollutants. performed by Ukrtransgaz enterprise of the company. Greenhouse gases per work unit (carbon intensity) emitted Emissions into the atmospheric air of polluting substances by Naftogaz group in 2017, ths. tons by Ukrtransgaz in 2014–2017 INCLUDING: Enterprises of the Pollutant Emissions of Emissions of sulfur Emissions of nitrogen Emissions of non- group emissions 44 carbon oxide oxide (SO2) and other compounds (NОx) methane volatile (СО) sulfur compounds without N2O) organic compounds 42 Ukrtransgaz 17.4 7.3 0.001 9.6 0.5 40 Ukrnafta 13.9 6.0 0.1 2.8 5.0 Ukrgazvydobuvannya 11.8 6.4 0.2 3.3 1.9 38 /mcm -eq . /mcm Ukrtransnafta 2.01 0.008 0.001 0.005 2.0 2 36 t СО Ukrautogaz 0.003 0.002 – 0.001 – 34 Ukrspetstransgaz 0.016 – – 0.0002 0.016 32 Kirovohradgaz 0.004 0.002 – 0.001 0.0002 30 TOTAL 45.1 19.7 0.3 15.7 9.4 2014 2015 2016 2017 Operation of a mobile compressor station at the Ukrtransgaz facility

194 195 OUR RESPONSIBILITY ANNUAL REPORT 2017 tightness of shut-off valves, Ukrtransgaz began operating atmosphere and transfer it into wells (226 items altogether). It Long-Term Extraction of Oil and In 2017, Ukrtransgaz conducted pipelines and other GTS a mobile compressor station a leakproof system. During the replaced, revised, and repaired Gas and Reduce Environmental 1527 environmental and heat equipment using mobile which allows, during repairs on first application of the mobile 373 safety breathing valves of Pollution in Boryslav town". As engineering examinations, which laboratories able to detect the gas pipeline, to minimize compressor, 1.3 mcm of natural tanks and apparatus, audited of 1 January 2018, Ukrnafta allowed control of compliance and eliminate natural gas leaks the amount of natural gas gas was saved. and replaced 326 sliding had spent UAH 31.4 million of the effective indicators of in GTS equipment. In 2017, that is bleeded into the valves on waterways and 29 on implementation of fuel-using equipment with the water meters, and assessed measures in 2017. This specifications in the technical the state of 88 operational included UAH 1.3 million on passports and technological columns of oil and injection monitoring and preventive regulations. For the purposes of Rational use of water resources wells. In addition, the company measures, UAH 15.7 million obtaining permit documentation, liquidated and reclaimed 19 on repair and isolation works, an inventory of 1835 stationary The use of water by the In addition, 9.1 mcm of formation-pressure maintenance oil, earth and other barns and and UAH 14.2 million spent on sources of emissions was enterprises of the company associated water was produced systems at Ukrnafta amounted to reservoirs. exploitation and reconstruction conducted. Substantiating decreased by 30.4% in 2017 in the process of extraction of 5.04 mcm. of objects connected with the materials were prepared and compared to the previous year hydrocarbons. Every year Ukrnafta develops liquidation of gas pollution of an expert examination of 556 and amounted to 4.42 mcm, 9.2 mcm of associated and implements "Measures to the city, with UAH 0.3 million project materials was conducted. with a total water withdrawal During 2017, 325 621 tcm of water was returned to the Mitigate the Consequences of on research. of 5.3 mcm. During the year, wastewater was treated at underground horizons during 1.7 mcm of reverse (sewage) biological treatment plants, 2017: 0.2 mcm of associated Use of water resources by Naftogaz group in 2015-2017, tcm waters were treated. 10.7 tcm at physical and chemical water was pumped into wells treatment facilities, and 88.5 tcm at the Ukrhazvydobuvannya Total water resources used 2015 2016 2017 % 2017 compared to 2016 2.6 mcm have been withdrawn at mechanical sewage treatment production facilities and Total, including*: 7 017.2 6 369.9 4 418.5 -30.4 from the surface water sources, facilities. 8.96 mcm at Ukrnafta facilities. Ukrtransgaz 708.6 680.3 645.4 -5.1 which is about 59% of the total The use of this method used water; the underground The volume of water used by significantly mitigates the Ukrnafta 3 081.7 3 361.3 2 650.0 -21.2 water intake amounted to the enterprises of the group in negative impact on surface Ukrgazvydobuvannya 2 229.2 2 131.5 947.8 -55.5 1.2 mcm (27%); intake from recycling supply systems in 2017 water objects and groundwater. Ukrtransnafta 171.99 179.1 168.6 -5.9 communal water supply was amounted to 5.04 mcm: It partially restores the natural 0.6 mcm (13%), with drainage • Ukrtransgaz – 32.6 mcm conditions of the areas of *Including other enterprises of the group water of 0.005 mcm (less • Ukrnafta – 137.3 mcm subsoil that are provided for than 1%). • Ukrgazvydobuvannya – use for oil and gas production Waste management 24.5 mcm purposes and contributes to the Water intake was for production • Ukrspetstransgaz – 0.04 mcm conservation of land. The total amount of waste • waste of hazard class II – wastewater) – 147.2 thousand and technological needs, as well generated at the enterprises 0.4 thousand tons (less than tons; household mixed waste – as the drinking, sanitary and The volume of water used by the In 2017, Ukrnafta renewed the of Naftogaz group in 2017 1%). Among the waste of 24.1 thousand tons; scrap of hygienic needs of workers. enterprises of the group in the embanking of reservoirs and amounted to 210.1 thousand class II, the most common items ferrous metals – 6.1 thousand tons, including: are used oils and lubricants tons; automobile tires worked (284.1 tons accumulated), and out and damaged – 0.7 thousand • waste of hazard class I – accumulator batteries – 59 tons; tons; construction waste – 0.075 thousand tons, which 0.5 thousand tons; agricultural is less than 1% of the total • waste of hazard class III – waste (various) – 0.2 thousand generated waste. Among 12.4 thousand tons (about tons and other waste generated the class I waste, the most 6%). The most widespread mainly via construction, drilling, common items are spent waste of hazard class III at extraction, transportation, storage fluorescent lamps, lead the enterprises of Naftogaz and of oil and gas processing batteries and accumulators. group that emerged in 2017 is facilities. All class I waste is transported spent petroleum products and for further environmentally petroleum products totaling Ukrnafta has all the appropriate sound disposal to specialized 8098.8 tons. permits and equipment for enterprises on a contractual the disposal of hazardous oil- basis. In addition, most • waste of hazard class IV – containing waste at its own companies in the group and 197.3 tons (about 94%). Hazard facilities. Due to the use of special the company's head office class IV includes the following equipment for processing oil arranged collection of spent main types of waste: drilling slime plants, spent petroleum batteries and fluorescent lamps sludge (drilled solids, spent products, and stable oil from all interested persons; drilling mud and drilling emulsions, Ukrnafta utilized

196 197 OUR RESPONSIBILITY ANNUAL REPORT 2017

1.5 thousand tons of oil sludge in by 17.1% and several thousand containing waste was stored in 2017, and 20.3 thousand tons of tons of oil and oil products were the temporary waste storages previously accumulated oil sludge extracted additionally. of the enterprises of the group, in the period from 2012 to 2017. which is by 25.3 thousand tons As a result, in 2017 the volume of As of 1 January 2018, less compared with the previous Environmental protection challenges and risks oil-containing waste decreased 12.3 thousand tons of oil- period. 1. Implementation of EU Directives. The MCP (Medium Combustion Plant) Directive regulates pollutant emissions from combustion of fuels in installations with rated thermal input capacity equal to or greater Structure of waste generated by Naftogaz companies, by hazard class, 2015-2017, thousand tons than 1 MW and less than 50 MW ("medium combustion plants"). The gas-driven internal combustion compressors and gas-pumping units used at enterprises of the company are out of date and will not Total waste generated at the enterprises of Naftogaz group 2015 2016 2017 be able to comply with the norm established by the Ministry of Environmental Protection of Ukraine on 3 3 including: 102.5 85.4 210.1 emissions: 500 mg /m for NOx and 250 mg /m for CO. Replacement or upgrading programs are in the process of implementation but at a low rate due to the need for significant funding. However, it should hazard class І 0.1 0.1 0.1 be noted that EU requirements for such equipment are even tighter (100 mg/m3 for NOx and 50 mg/m3 hazard class ІІ 0.9 0.3 0.4 for CO). To solve the problem, the existing gas-driven internal combustion compressors and gas-pumping hazard class ІІІ 8.0 5.9 12.4 units shall be fully replaced and the interim technological standards for the permissible emission of hazard class ІV 93.5 79.1 197.3 pollutants shall be developed. 2. Gaps in Ukrainian legislation. There is a lack of bylaws to implement the requirements of the current The increase in waste generation increase in the generation of transportation of waste. It does legislation, namely: in 2017 was mainly due to waste of third and fourth hazard not import or export waste – there is a delay in the implementation of certain provisions of the EU agreement; an increase in production, classes (drilling waste and oil- categorized as dangerous in – since 2015, no bylaws have been adopted for the implementation of the provisions of the Law of Ukraine in particular an increase in containing waste) accordance with the Basel "On Waste", in terms of developing a procedure for obtaining permits for waste management operations; the volume of drilling at Convention. – there is no regulation in place that defines the hazard classes of waste, since the State Sanitary Norm Ukrgazvydobuvannya by 21.2%, The company is not engaged and Rule 2.2.7.029-99 "Hygienic requirements with regard to industrial waste management and defini- which resulted in a significant in any trans-boundary tion of class of hazard for public health" is suspended. Without determining the hazard classes of waste, companies cannot calculate the total waste generation rate, take waste inventories, or submit a Decla- Waste management at the enterprises of Naftogaz group, 2015-2017, thousand tons ration of Waste; – information in the list of licensors for conducting economic activities in dealing with hazardous waste 2015 2016 2017 that is posted on the website of the Ministry of Environmental Protection of Ukraine is not up to date; Volume of generated waste 102.5 85.4 210.1 – there is no state automated system, with the required software, technical and telecommunication Volume of waste removed from facilities 4.5 0.00005 152.7 infrastructure for the automated measuring of extracted underground water; Volume of waste utilized and disposed of 51.3 49.3 1.9* – the implementation of certain provisions of the Law of Ukraine "On Environmental Impact Assessment" is not sufficiently regulated in terms of obtaining permits for subsoil plots. Volume of waste transferred to specialized organizations 60.9 38.1 53.0 3. Insufficient staff resources (lack of personnel at environmental safety services) at some industrial facili- * Reducing the volume of waste utilization or disposal was due to the reduction in waste volumes temporarily placed on production facilities of the company ties of the company’s enterprises. 4. Pollution of the environment with hydrocarbons and associated water as a result of use of obsolete Emergencies prevention and mitigation measures equipment and unauthorized interference by unauthorized persons.

During 2017, 15 emergencies cases drew public attention, to the company's regulatory Plans for 2018 at the company's production the Naftogaz supervisory board documents regarding facilities resulted in excessive at a meeting in September environmental pollution pollution of the environment, 2018 (No.19/2017) decided to notification regulations. • Implementation of the Environmental Protection and Social Action Plan, which is an annex to the loan doc- especially land pollution. The take appropriate measures and umentation for attracting financing with IBRD guarantees (approved by the minutes of the board meeting total area of contaminated instruct the chairman of the In 2017, the enterprises of the dated 12 May 2017, No. 191), which will allow to bring the standards of Naftogaz group as close as possible land, according to information board to personally inform the group carried out a monitoring to the environmental and social requirements of international financial organizations; received from the enterprises committee on occupational survey of pollution in the • conducting an external third-party assessment of Naftogaz's environmental management system, con- of the group, amounted to safety, environmental and environment of Mashivsky firming compliance of the company’s operations with the requirements of the international standard ISO about 9 360 sq.m. The issue of industrial safety of the high- region in the vicinity of 14001:2015 and obtaining an appropriate international certificate; environmental pollution has profile events and significant Mashivsky LNG processing • implementation of the World Bank Pilot Project and the launch of a GHG emissions monitoring, reporting been repeatedly addressed by negative impact on the facility, Andriivska technogenic and verification system at individual facilities; the company’s commission for environment due to emergency pollution zone and wells No 81 • development of technological norms for permissible emission of pollutants for medium combustion plants emergency situations in 2017. situations. In addition, relevant in East-Poltava gas condensate for the oil and gas industry of Ukraine. Moreover, since individual changes have been introduced field (GCF).

198 199 ANNUAL REPORT 2017

2012 2013 2014 2015 2016 2017 BALANCE Disclaimer 6 qualifications 1 qualification 3 qualification 3 qualifications 1 qualification FINANCIAL SHEET of opinion (56% of total (2% of total (2% of total (2% of total (0.2% of total assets value) assets value) assets value) assets value) assets value) PROFIT AND Disclaimer Disclaimer 6 qualifications 3 qualifications 3 qualifications 1 qualifications LOSS of opinion of opinion (38% of net loss) (9% of net loss) (53% of net (0.3% of net STATEMENTS profit) profit) The independent auditor expressed a qualified opinion on Naftogaz financial position and financial performance for 2017. Major part of the modifications in the auditors’ report does not have significant impact on the financial statements 2017 and relate to comparability of the current year and the corresponding figures.

AUDITOR’S QUALIFICATIONS AND RELATED COMMENTS

Effect on: Auditor’s qualification Statement Statement (the qualification number in the auditor’s report of financial Management comments of profit or indicated in brackets) position as at 31 loss 2017 December 2017 Matters that affect 2017 or both years: Investment in joint operation: yes yes Management expects this Use of different accounting policies by the group and (less than 1% of (less than joint operation agreement to the group’s associates and joint operations; lack of assets) 1% of net be terminated by the Court audited financial information of joint operation (1) profit) in 2018. After the Final Court decision on termination of the agreement is received, the Group will deconsolidate this investee. Matters related to prior periods that affect comparability of the current year and the corresponding figures: Technical accounting issues: • Use of different accounting policies by the group and no no the group’s associates and joint operations (2) • Unconfirmed quantities and valuation of inventories owned by the joint operation of Ukrnafta as of 31 no no Auditor’s comments relate to December 2015 (3c) previous reporting periods and do not impact the financial Financial information of “Ukrnafta” PJSC: results and financial position Lack of sufficient audit evidence that supports no no of 2017. recognition and measurement of Ukrnafta’s transactions regarding: Management has taken • sales of petroleum products by the joint operation in measures to avoid the impact 2016, of these issues on the group’s • trade accounts receivables related to sales of crude oil results in 2017, in particular in 2015; – performed adjustment in • prepayments made for the purchases of oil products respect of accounts receivables in 2015 and their classification, and prepayments made by as well as impact of these transactions on other “Ukrnafta” PJSC in 2015; as operating expenses, finance income and deferred tax well as improved control assets as at 31 December 2016 (3а,b) over purchases at the group’s Presentation and accuracy of the consolidated subsidiaries. financial statements: no no Nature of certain expenses may not be reflected in their legal form. Exposure to this issue amounts to UAH 6.2 billion for 2016 (4)

201 FINANCIAL STATEMENTS ANNUAL REPORT 2017 PUBLIC JOINT STOCK COMPANY CONTENTS

“NATIONAL JOINT STOCK COMPANY Page INDEPENDENT AUDITOR’S REPORT ...... 204 “NAFTOGAZ OF UKRAINE” CONSOLIDATED FINANCIAL STATEMENTS Consolidated Statement of Financial Position ...... 208 Consolidated Statement of Profit or Loss ...... 209 Consolidated Statement of Comprehensive Income ...... 210 CONSOLIDATED FINANCIAL STATEMENTS Consolidated Statement of Changes in Equity ...... 211 AS AT AND FOR THE YEAR ENDED Consolidated Statement of Cash Flows ...... 212 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 31 DECEMBER 2017 1. The Organisation and its Operations ...... 214 2. Operating Environment ...... 214 3. Restatement of Comparative Information ...... 219 4. Segment Information ...... 220 5. Balances and Transactions with Related Parties ...... 227 6. Property, Plant and Equipment ...... 228 7. Investments in Associates and Joint Ventures ...... 230 8. Other Non-Current Assets ...... 231 9. Inventories ...... 232 10. Trade Accounts Receivable ...... 232 11. Prepayments Made and Other Current Assets ...... 233 12. Cash and Bank Balances ...... 234 13. Share Capital ...... 235 14. Borrowings ...... 236 15. Provisions ...... 237 16. Advances Received and other current liabilities ...... 239 17. Cost of Sales ...... 240 18. Other Operating income ...... 240 19. Other Operating Expenses ...... 240 20. Finance Costs ...... 241 21. Finance Income ...... 241 22. Income Tax ...... 241 23. Contingencies, Commitments and Operating Risks ...... 243 24. Financial Risk Management ...... 248 25. Fair Value ...... 251 26. Subsequent Events ...... 254 27. Summary of Significant Accounting Policies ...... 255 28. Critical Accounting Estimates and Judgements ...... 266 29. Adoption of New or Revised Standards and Interpretations ...... 269

202 203 FINANCIAL STATEMENTS ANNUAL REPORT 2017

INDEPENDENT AUDITOR’S REPORT a summary of significant 1) Investment in joint operation b. Determine the effect of the opinion on the current period’s a third party as at 31 December accounting policies. departure from the uniform consolidated financial statements 2015, as we could not observe the To the shareholder of Pub- As discussed in Notes 7 and 27 accounting policy of the Group is also modified because of the counting of physical inventories lic Joint Stock Company In our opinion, except for the to the consolidated financial to use the revaluation model for possible effects of these matters or satisfy ourselves by alternative “National Joint Stock Company possible effects of the matters statements, the Group’s measurement of property, plant on the comparability of the means concerning the inventory “Naftogaz of Ukraine”: described in the paragraphs 1a, subsidiary “Ukrgazvydobuvannya” and equipment by the joint oper- current period’s figures and the quantities as of that date. 3 and 4 of the Basis for Qualified PJSC has investment in joint ation as at 31 December 2017 and corresponding figures. Opinion section of our report, operation with Misen Enterprises 2016. As a result, we were unable to and except for the effects determine whether any adjust- Qualified Opinion AB and LLC “Carpatygaz”. of the matters described in This investment is accounted Matters related to prior periods 3) Financial information of ments to the following amounts the paragraphs 1b and 2 of the that affect comparability of the related to Ukrnafta were nec- We have audited the for using the method of “Ukrnafta” PJSC Basis for Qualified Opinion section current year and the correspond- essary for the year ended 31 consolidated financial proportional consolidation. We of our report, the accompanying ing figures December 2016: statements of Public Joint were unable to: We were unable to obtain suffi- consolidated financial statements Stock Company “National Joint cient and appropriate audit evi- present fairly, in all material Stock Company “Naftogaz of a. Obtain sufficient and 2) Investments in associates and dence regarding: Consolidated statement UAH respects, the consolidated Ukraine” and its subsidiaries appropriate audit evidence joint operations of profit or loss million financial position of the Group (the “Group”), which comprise regarding the Group’s share in a. In 2015 “Ukrnafta” PJSC Revenue 771 as at 31 December 2017, and the consolidated statement assets, liabilities, revenue and As discussed in Notes 7 and 27 to (“Ukrnafta”) made prepayments for its consolidated financial Cost of sales (1,662) of financial position as at expenses of joint operation, as the consolidated financial state- the purchases of oil products with performance and its consolidated Other operating (13,600) 31 December 2017, and the other party of the joint operation ments, the Group has investments a contractual delivery in December cash flows for the year then expenses consolidated statement of is responsible for maintaining in associates and joint arrange- 2018 and sold crude oil with the ended in accordance with profit or loss, consolidated accounting records and we were ments, which are accounted payment expected in December Finance income 1,570 International Financial Reporting statement of comprehensive unable to obtain access to their for using the equity method of 2016. As at 31 December 2016 the Income tax expense (2,131) Standards (“IFRSs”). income, consolidated statement audited financial statements and investment. We were unable to: Group recognised provision for impairment in full amount of the of changes in equity and financial information prepared Our audit opinion on the consoli- respective trade accounts receiv- consolidated statement of cash Basis for Qualified Opinion in accordance with IFRS as at a. Determine the effect of the dated financial statements for the able and prepayments which flows for the year then ended, 31 December 2017 and 2016 departure from IFRS 11 “Joint year ended 31 December 2016 remained unsettled as at that and notes to the consolidated Matters that affect the current and for the years then ended as Arrangements” as the Group’s was modified accordingly. Our date. As a result, we were unable financial statements, including year or both years presented below: investments in joint arrangements opinion on the current period’s to obtain sufficient and appro- stated at UAH 40 million as at 31 consolidated financial statements priate audit evidence regarding December 2016 were accounted is also modified because of the 31 December 2017, 31 December 2016, recognition and measurement of Line item in the consolidated financial statements for using the equity method. In possible effects of these matters UAH million UAH million our opinion, these investments respective trade accounts receiv- on the comparability of the Consolidated statement of financial position as at: should have been accounted for able and prepayments made as current period’s figures and the as joint operations that requires at 31 December 2015, as well as corresponding figures. Property, plant and equipment 1,456 1,540 recognition by the Group of its impact of these transactions on Other non-current assets 3 3 share in each category of assets other operating expenses, finance and liabilities of the joint opera- income, including any tax conse- 4) Purchases classification and Inventories 1 130 tions as at 31 December 2016 and quences and other related consol- presentation Trade accounts receivable 80 60 its share in the joint operations’ idated financial statements effects As discussed in Note 27, the revenues and expenses for the for the year ended 31 December Cash and bank balances 1 14 following expenditures were year then ended. 2016. Prepayments made and other current assets 57 58 incurred by “Ukrtransgaz” PJSC during the year ended 31 Decem- b. Determine the effect of the b. Recognition and measure- Borrowings 95 90 ber 2016: departure from the uniform ment of revenue, cost of sales, Provisions 122 111 accounting policy of the Group other operating expenses and • Capital expenditures included into property, plant and Trade accounts payable 47 50 to use the revaluation model for other related effects on the con- measurement of property, plant solidated financial statements equipment amounting to Advances received and other current liabilities 2 109 and equipment by PJSC “Ukrtat- with respect to sales of petroleum UAH 1,872 million; and Consolidated statement of profit or loss for the year ended: nafta” as at 31 December 2016 products by the joint operation of • Expenditures for purchases and for the year then ended. Ukrnafta in 2016. of services and inventories Revenue 5 1,712 amounting to UAH 4,279 mil- Cost of sales (116) (1,472) Our audit opinion on the consoli- c. Quantities and valuation of lion. dated financial statements for the inventories in the amount of UAH year ended 31 December 2016 1,191 million owned by the joint As further stated in Note was modified accordingly. Our operation of Ukrnafta and held by 27, the substance of these

204 205 FINANCIAL STATEMENTS ANNUAL REPORT 2017 expenditures may differ from Emphasis of Matters statements that are free from • Identify and assess the risks accounting estimates and financial statements, their legal form according material misstatement, whether of material misstatement of related disclosures made by including the disclosures, and to the primary documents. Operating environment due to fraud or error. the consolidated financial management. whether the consolidated We were unable to obtain statements, whether due to • Conclude on the appropri- financial statements sufficient and appropriate audit We draw your attention to Note In preparing the consolidated fraud or error, design and ateness of management’s use represent the underlying evidence to satisfy ourselves 2 to the consolidated financial financial statements, manage- perform audit procedures of the going concern basis transactions and events in as to the amounts and nature statements, which describes that ment is responsible for assessing responsive to those risks, and of accounting and, based on a manner that achieves fair of the above expenditures the impact of the continuing the Group’s ability to continue obtain audit evidence that is the audit evidence obtained, presentation. sufficient and appropriate to and their classification in economic crisis and political as a going concern, disclosing, whether a material uncertainty • Obtain sufficient appropriate provide a basis for our opin- the consolidated financial turmoil in Ukraine and their final as applicable, matters related to exists related to events or audit evidence regarding ion. The risk of not detecting statements for the year resolution are unpredictable and going concern and using the conditions that may cast sig- the financial information a material misstatement ended 31 December 2016. may adversely affect the Ukrainian going concern basis of account- nificant doubt on the Group’s of the entities or business resulting from fraud is higher Consequently, we were unable economy and the operations of ing unless management either ability to continue as a going activities within the Group than for one resulting from to determine whether any the Group. Our opinion is not intends to liquidate the Group concern. If we conclude that a to express an opinion on error, as fraud may involve adjustments to these amounts modified in respect of this matter. or to cease operations, or has no material uncertainty exists, we the consolidated financial collusion, forgery, intentional were necessary. Our audit realistic alternative but to do so. are required to draw attention statements. We are omissions, misrepresenta- opinion on the consolidated Ongoing litigations in our auditor’s report to the responsible for the direction, tions, or the override of inter- financial statements for the Those charged with governance related disclosures in the con- supervision and performance nal control. year ended 31 December 2016 We also draw your attention to are responsible for overseeing solidated financial statements of the group audit. We remain was modified accordingly. Note 23 to the consolidated finan- the Group’s financial reporting • Obtain an understanding of or, if such disclosures are inad- solely responsible for our Our opinion on the current cial statements, which describes process. internal control relevant to equate, to modify our opinion. audit opinion. period’s consolidated financial decisions of the Arbitration Insti- the audit in order to design Our conclusions are based on statements is also modified tute of the Stockholm Chamber audit procedures that are the audit evidence obtained We communicate with those because of the possible of Commerce with regard to the Auditor’s Responsibilities for appropriate in the circum- up to the date of our auditor’s charged with governance effect of this matter on the claims between the Company the Audit of the Consolidated stances, but not for the pur- report. However, future events regarding, among other matters, comparability of the current and JSC “Gazprom” and mate- Financial Statements pose of expressing an opin- or conditions may cause the the planned scope and timing period’s figures and the rial uncertainty regarding final ion on the effectiveness of Group to cease to continue as of the audit and significant corresponding figures. resolution of contentious issues Our objectives are to obtain the Group’s internal control. a going concern. audit findings, including any between the Company and JSC reasonable assurance about • Evaluate the appropriateness • Evaluate the overall significant deficiencies in We conducted our audit in “Gazprom”. Our opinion is not whether the consolidated of accounting policies used presentation, structure and internal control that we identify accordance with International modified in respect of this matter. financial statements as a and the reasonableness of content of the consolidated during our audit. Standards on Auditing (“ISAs”). whole are free from material Our responsibilities under those Retrospective restatement misstatement, whether due to 16 May 2018 standards are further described fraud or error, and to issue an in the Auditor’s Responsibilities We further draw attention to Note auditor’s report that includes our PJSC Deloitte and Touche for the Audit of the Consolidated 3 to the consolidated financial opinion. Reasonable assurance Financial Statements section of statements which describes the is a high level of assurance, but our report. We are independent restatement of corresponding is not a guarantee that an audit of the Group in accordance figures for the year ended 31 conducted in accordance with with the International December 2016. Our opinion is ISAs will always detect a material Ethics Standards Board for not modified in respect of this misstatement when it exists. Accountants’ Code of Ethics matter. Misstatements can arise from for Professional Accountants fraud or error and are considered (the “IESBA Code”) together Responsibilities of Manage- material if, individually or in the with the ethical requirements ment and Those Charged with aggregate, they could reasonably that are relevant to our audit Governance for the Consoli- be expected to influence of the consolidated financial dated Financial Statements the economic decisions of statements in Ukraine, and we users taken on the basis of have fulfilled our other ethical Management is responsible for these consolidated financial responsibilities in accordance the preparation and fair presenta- statements. with these requirements and tion of the consolidated financial the IESBA Code. We believe statements in accordance with As part of an audit in accordance that the audit evidence we IFRS, and for such internal control with ISAs, we exercise professional have obtained is sufficient and as management determines is judgment and maintain profes- appropriate to provide a basis necessary to enable the prepa- sional scepticism throughout the for our qualified opinion. ration of consolidated financial audit. We also:

206 207 FINANCIAL STATEMENTS ANNUAL REPORT 2017

PUBLIC JOINT STOCK COMPANY “NATIONAL JOINT STOCK COMPANY “NAFTOGAZ OF UKRAINE” PUBLIC JOINT STOCK COMPANY “NATIONAL JOINT STOCK COMPANY “NAFTOGAZ OF UKRAINE” CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 2017 CONSOLIDATED STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 2017 31 December 2016 In millions of Ukrainian hryvnias Note 31 December 2017 2016 (as restated, Note 3) In millions of Ukrainian hryvnias Note 2017 (as restated, Note 3) ASSETS Non-current assets Revenue 4 227,478 192,764 Property, plant and equipment 6 491,482 551,661 Cost of sales 17 (157,147) (121,804) Investments in associates and joint ventures 7 1,197 1,328 Gross profit 70,331 70,960 Prepaid corporate income tax – 1,317 Other operating income 18 5,092 2,627 Deferred tax assets 22 4,204 4,508 Other non-current assets 8 11,131 9,326 Income recognised per results of Gas Transit Arbitration 11, 23 57,125 – Total non-current assets 508,014 568,140 Other operating expenses 19 (27,475) (45,545) Current assets Expense recognised per results of Gas Sales Arbitration 16, 23 (44,528) – Inventories 9 60,175 50,244 Trade accounts receivable 10 58,988 49,209 Operating profit 60,545 28,042 Prepayments made and other current assets 11 71,247 9,499 Finance costs 20 (8,302) (9,581) Prepaid corporate income tax 16 22 Finance income 21 1,598 5,913 Cash and bank balances 12 23,093 22,336 Share of after-tax results of associates and joint-ventures 7 (47) (99) Restricted cash 1,591 680 Total current assets 215,110 131,990 Net foreign exchange loss (1,043) (5,790) TOTAL ASSETS 723,124 700,130 Profit before income tax 52,751 18,485 EQUITY Income tax expenses 22 (13,302) (636) Share capital 13 194,307 164,607 Revaluation reserve 411,261 437,510 Net profit for the year 39,449 17,849 Unregistered contributed capital 13 – 29,700 Net profit/(loss) is attributable to: Cumulative exchange difference 3,462 3,164 Equity holders of the Company 39,644 24,311 Accumulated deficit (168,057) (178,214) Non-controlling interest (195) (6,462) Equity attributable to owners of the Parent 440,973 456,767 Non-controlling interest in equity (454) (1,177) Net profit for the year 39,449 17,849 TOTAL EQUITY 440,519 455,590 LIABILITIES Non-current liabilities Borrowings 14 14,736 23,100 Provisions 15 6,007 12,416 Deferred tax liabilities 22 67,304 82,312 Other long-term liabilities 12 4 Total non-current liabilities 88,059 117,832 Current liabilities Borrowings 14 44,579 47,744 Provisions 15 52,551 31,116 Trade accounts payable 8,137 16,234 Advances received and other current liabilities 16 78,608 28,327 Corporate income tax payable 10,671 3,287 Total current liabilities 194,546 126,708 TOTAL LIABILITIES 282,605 244,540 TOTAL LIABIITIES AND EQUITY 723,124 700,130

These consolidated financial statements were authorised for issue on 8 May 2018. Andriy Kobolyev Sergiy Konovets Chairman of the Executive Board Deputy Chairman of the Executive Board

208 209 FINANCIAL STATEMENTS ANNUAL REPORT 2017

PUBLIC JOINT STOCK COMPANY “NATIONAL JOINT STOCK COMPANY “NAFTOGAZ OF UKRAINE” PUBLIC JOINT STOCK COMPANY “NATIONAL JOINT STOCK COMPANY “NAFTOGAZ OF UKRAINE” CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 2017 CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 2017

2016 Unreg- Cumu- In millions of Ukrainian hryvnias Note 2017 Reval- istered lative Accu- Non-con- (as restated, Note 3) Share Total In millions of Ukrainian hryvnias uation contrib- exchange mulated Total trolling capital equity Net profit for the year 39,449 17,849 reserve uted differ- deficit interest Other comprehensive (loss)/income capital ence Balance at 164,607 430,503 29,700 2,086 (188,421) 438,475 5,287 443,762 Items that will not be reclassified subsequently to profit or 31 December 2015 loss, net of income tax: Profit/(loss) for the year – – – – 24,311 24,311 (6,462) 17,849 (Loss)/gain on revaluation of property, plant and (24,907) 7,221 equipment (net of income tax of UAH 5,488 million (2016: Other comprehensive – 7,176 – 1,078 (88) 8,166 (102) 8,064 UAH 1,585 million) income/(loss) for the year Total comprehensive – 7,176 – 1,078 24,223 32,477 (6,564) 25,913 Share of other comprehensive income of associates (net of 7 – 2 income/(loss) for the year income tax of nil (2016: nil) Transfer of revaluation – (169) – – 169 – – – Remeasurement of defined benefit obligation (net of income 15 (312) (142) reserve tax of UAH 68 million (2016: UAH 31 million) Change in investments in – – – – 100 100 100 200 Remeasurement of decommissioning liability (net of income tax 15 (115) (95) joint operations of UAH 24 million (2016: UAH 21 million) Provision for dividends – – – – (13,264) (13,264) – (13,264) Items that may be reclassified subsequently to profit or loss, payable to the State Budget net of income tax: (Notes 13 and 15) Profit share payable to the – – – – (1,021) (1,021) – (1,021) Cumulative exchange difference 298 1,078 State Budget and dividends Other comprehensive (loss)/income for the year (25,036) 8,064 declared (Note 13) Total comprehensive income for the year 14,413 25,913 Balance at 164,607 437,510 29,700 3,164 (178,214) 456,767 (1,177) 455,590 31 December 2016 Total comprehensive income/(loss) is attributable to: (as restated, Note 3) Equity holder of the Company 13,697 32,477 Profit/(loss) for the year – – – – 39,644 39,644 (195) 39,449 Other comprehensive – (26,032) – 298 (213) (25,947) 911 (25,036) Non-controlling interests 716 (6,564) income/(loss) for the year Total comprehensive income for the year 14,413 25,913 Total comprehensive – (26,032) – 298 39,431 13,697 716 14,413 income/(loss) for the year Transfer of revaluation – (217) – – 217 – – – reserve Change in investments in – – – – 7 7 7 14 joint operations Provision for dividends – – – – (29,498) (29,498) – (29,498) payable to the State Budget (Notes 13 and 15) Registration of shares 29,700 – (29,700) – – – – – (Note 13) Balance at 194,307 411,261 – 3,462 (168,057) 440,973 (454) 440,519 31 December 2017

210 211 FINANCIAL STATEMENTS ANNUAL REPORT 2017

2016 2016 In millions of Ukrainian hryvnias Note 2017 In millions of Ukrainian hryvnias Note 2017 (as restated, Note 3) (as restated, Note 3) CASH FLOWS FROM OPERATING ACTIVITIES CASH FLOWS FROM FINANCING ACTIVITIES Profit before income tax 52,751 18,485 Proceeds from borrowings 12,941 4,806 Adjustments for: Repayment of borrowings (49,469) (25,641) Depreciation of property, plant and equipment and amortisation of 39,824 24,068 Interest paid (7,378) (8,711) intangible assets Profit share and dividends paid 13 (13,264) (1,021) Loss on disposal of property, plant and equipment 132 406 Net cash used in financing activities (57,170) (30,567) Impairment of property, plant and equipment 19 3,399 1,231 Net (decrease)/increase in cash and cash equivalents (426) 11,500 Write down of inventories 9 1,903 1,905 CASH AND CASH EQUIVALENTS AT THE BEGINNING OF THE YEAR 21,853 9,256 Net movement in provision for trade accounts receivable and 19 12,613 24,656 Effect of exchange rates change on cash and cash equivalents 1,666 1,097 prepayments made, other current assets, financial investments and VAT balances CASH AND CASH EQUIVALENTS AT THE END OF THE YEAR 12 23,093 21,853 Net result of Gas Sales and Gas Transit Arbitrations (12,597) – Change in provisions 15 (834) 12,067 Significant Non-Cash Transactions Write off of accounts payable and other current liabilities (48) (101) In millions of Ukrainian hryvnias 2017 2016 Share of after-tax results of associates and joint-ventures 7 47 99 Payment for the natural gas acquired by a lending bank 21,850 13,636 Foreign exchange loss 1,043 5,790 Dividends set off with accounts payable 3,242 – Finance costs, net 6,704 3,668 Operating cash flows before working capital changes 104,937 92,274 (Increase)/decrease in other non-current assets (338) 554 Increase in inventories (10,749) (18,616) Increase in trade accounts receivable (24,981) (31,249) Decrease in prepayments made and other current assets 2,277 8,623 Increase/(decrease) in other long-term liabilities 8 (106) Provisions paid or used 15 (1,581) (873) Increase/(decrease) in trade accounts payable 18,702 (4,042) (Decrease)/increase in advances received and other current liabilities (5,199) 7,080 Cash generated from operations 83,076 53,645 Income taxes paid (13,719) (7,522) Interest received 1,244 1,182 Net cash generated by operating activities 70,601 47,305 CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property, plant and equipment and intangible assets (14,438) (7,680) Proceeds from sale of property, plant and equipment 2 4 Withdrawal of bank deposits 495 2,315 Dividends received 84 123 Net cash used in investing activities (13,857) (5,238)

212 213 FINANCIAL STATEMENTS ANNUAL REPORT 2017

1. THE ORGANISATION AND ITS Ministers of Ukraine, executes and petroleum products to 2. OPERATING ENVIRONMENT As part of foreign currency trans- (“the Law on Gas Market”) that OPERATIONS government functions over the customers. action regulations, the National became effective on 1 October Company through participation In the recent years, Ukraine Bank of Ukraine (“NBU”) decreased 2015. Starting from this date, the Public Joint Stock Company in the shareholders’ meetings, as The Company holds stakes has been in a political and share of mandatory sale of foreign wholesale and retail natural gas “National Joint Stock Company well as through the appointment in various entities that form economic turmoil. Crimea, currency proceeds from 65% markets introduced the principle “Naftogaz of Ukraine” (“Naftogaz of the Supervisory Board the national system of an autonomous republic down to 50% with effect from of free pricing and freedom of of Ukraine”, the “Parent” or the members, the Chairman of production, refinery, distribution, of Ukraine, was effectively April 2017, increased foreign choice regarding sources of the “Company”) was founded in 1998 the Executive Board and the transportation, and storage of annexed by the Russian Federa- currency denominated export/ natural gas supplies, except for in accordance with the Resolution Executive Board members. natural gas, condensate and oil. tion. An armed conflict contin- import transactions settlement the cases when the Cabinet of of the Cabinet of Ministers of ues in certain parts of Luhanska period from 120 up to 180 days Ministers of Ukraine imposes Ukraine #747 dated 25 May 1998. Naftogaz of Ukraine is a The Company is registered at and Donetska regions. These with effect from May 2017, and specific obligations on the natural vertically integrated oil and 6 B. Khmelnytskoho Street, Kyiv, events resulted in higher infla- allowed companies to pay the gas market participants. Naftogaz of Ukraine and gas company engaged in full Ukraine. tion, devaluation of the national 2013 (and earlier) dividends in its subsidiaries (hereinafter cycle of operations in gas currency against major foreign amount of not more than USD The Government and the Group collectively referred to as the and oil field exploration and The Group conducts its business currencies, decrease of GDP, 2 million per month with effect are undertaking significant mea- “Group”) are beneficially owned development, exploratory and holds its production facilities illiquidity, and volatility of finan- from November 2017. sures in the open European natu- by the State of Ukraine. The drilling and production, gas and mainly in Ukraine. The principal cial markets. ral gas market development that Government of Ukraine, as oil transmission and storage, subsidiaries and joint operations In March 2015, Ukraine signed is required by the Memorandum represented by the Cabinet of sales and supply of natural gas are presented as follows: In 2017, annual inflation rate four-year Extended Fund Facility on Economic and Financial Policy amounted to 13.7% comparing (“EFF”) with the International agreed with the IMF, provisions % Interest held to 12.4% in 2016. The Ukrainian Monetary Fund (“IMF”) that of the Coalition Agreement, the Country of Name/Type of activity as at 31 December registration economy proceeded recovery will last until March 2019. The “Ukraine-2020” Sustainable Devel- 2017 2016 from the economic and political total program amounted to opment Strategy, the Corporate Production of gas, oil and refinery products crisis of previous years that USD 17.5 billion, while Ukraine Governance Action Plan, and has so far received only USD 8.7 the Plan for Implementation of Ukrgazvydobuvannya, PJSC 100.00 100.00 Ukraine resulted in real GDP smooth growth of around 2.5% (2016: billion out of the total amount. the Gas Sector Reform approved Ukrnafta, PJSC 50.00+1 share 50.00+1 share Ukraine 2.4%) and stabilisation of In September 2017, Ukraine by Resolution of the Cabinet of Petrosannan Company, Joint operations with the Arab Republic of 50.00 50.00 Egypt national currency. From trading successfully issued USD 3 billion Ministers of Ukraine #375-р. These Egypt and Egyptian General Petroleum Corporation perspective, the economy was of Eurobonds, of which USD 1.3 measures introduce conceptual Zakordonnaftogaz, Subsidiary Enterprise 100.00 100.00 Ukraine demonstrating refocusing on billion is new financing, with the changes to the legal framework Carpatygaz LLC, Joint operations with Misen Enterprises AB 49.99 49.99 Ukraine the European Union (“EU”) remaining amount aimed to refi- and functioning of the natural gas market, which was a result nance bonds due in 2019. The market, to certain aspects of oper- Oil and gas transportation of the signed Association NBU expects that Ukraine will ations of the Company and also Ukrtransgaz, PJSC 100.00 100.00 Ukraine Agreement with the EU in receive another USD 3.5 billion will have significant impact on the Ukrtransnafta, PJSC 100.00 100.00 Ukraine January 2016 that established from the IMF in 2018. To receive performance of the Company and Ukrspetstransgaz, PJSC 100.00 100.00 Ukraine the Deep and Comprehensive next tranches, the government the Group as a whole. Wholesale and retail distribution of oil, gas and refinery products Free Trade Area (“DCFTA”). of Ukraine has to implement Under this agreement, Ukraine certain key reforms, including in Gaz Ukraiiny, Subsidiary Enterprise 100.00 100.00 Ukraine State regulation of gas market has committed to harmonise such areas as pension system, in Ukraine Naftogaz Trading Europe S.A. 100.00 100.00 Switzerland its national trade-related rules, anti-corruption regulations, and Kirovohradgaz, Open JSC 51.00 51.00 Ukraine norms, and standards with those privatisation, as well as transi- Starting from 1 October 2015 Ukravtogaz, Subsidiary Enterprise 100.00 100.00 Ukraine of the EU, progressively reduce tion to market pricing for natural model of the gas market has import customs duties for the gas. switched to the principles of free, Other goods originating from the EU fair competition and ensuring Vuhlesyntezgaz Ukraiiny, Subsidiary Enterprise 100.00 100.00 Ukraine member states, and abolish Further stabilisation of the eco- a high level of protection of Naftogaz-Energoservice, Subsidiary Enterprise (former 100.00 100.00 Ukraine export customs duties during nomic and political situation customer rights and interests Ukrnaftogazkomplekt) a 10-year transitional period. depends to a large extent upon from the regulated tariffs market Implementation of DCFTA success of the Ukrainian govern- model. began on 1 January 2017. As a ment’s efforts, yet further eco- result, the Russian Federation nomic and political developments At the same time, the Cabinet of implemented a trade embargo are currently difficult to predict. Ministers of Ukraine has issued or import duties on key Resolution #758 dated 1 Octo- Ukrainian export products. In Gas market reform in Ukraine ber 2015, imposing public service response, Ukraine implemented started with adoption of the Law obligations (“PSO Resolution”) on similar measures against Russian of Ukraine “On Natural Gas Mar- the Company during the transi- products. ket” #329-VIII dated 9 April 2015 tional period from 1 October 2015

214 215 FINANCIAL STATEMENTS ANNUAL REPORT 2017 to 31 March 2017 in respect of gas generating entities for all more than 10% higher than Households settle their debts entities and distribution and fulfilling such obligations plus purchase of domestic production groups of customers, as well currently effective price, sell- on natural gas consumed water supply companies adequate margin. The level of from “Ukrgazvydobuvannya” PJSC as for producing electricity by ing price should be calculated via special purpose accounts payables for gas settling are margin should be calculated and gas supply for the needs these companies. at 100% import parity for the opened in banks that were set in this Law. Among other, following the relevant resolu- of households, municipal heat • Starting from 1 April 2017 period from 1 October 2017 authorised by the Cabinet of the Law assumes writing off tion by the Cabinet of Minis- generating entities and religious the Company sells gas for the up to 1 April 2018 for gas Ministers of Ukraine for such penalties and fines implied ters of Ukraine. organisations, and starting from needs of households, religious sales to households, religious purpose. According to the cur- for overdue debts for gas 23 December 2016 – for the organisations and municipal organisations and municipal rent procedure, gas suppliers supplied, and restructuring of In July 2017, Kyiv county needs of budget financed entities heat generating entities at the heat generating entities. with public service obligations payables to the Company on administrative court has sup- and PJSC “Odessa Port Plant”. price of UAH 4,942 for 1,000 Concurrently with resolution open special purpose bank gas consumed. ported the Company’s claim cubic meters. (excluding VAT, on Company’s gas sales price accounts to receive payments against the Cabinet of Minis- Public service obligations transportation and distribution change for specified catego- for natural gas consumed. The list of companies entitled ters of Ukraine, and has admit- imposed on the Company were tariffs and trade mark-up). In ries, gas purchase price from Amounts accumulated on the for debt settling procedures is ted the failure of the latter to prolonged up to 1 April 2018 setting wholesale price for PJSC “Ukrgazvydobuvannya” special purpose bank accounts approved by the central body identify formula and sources according to the Resolution of the religious organisations and and PJSC “Chornomor are then allocated to current of the government executive of financing the compensation Cabinet of Ministers of Ukraine municipal heat generating naftogaz” should be revised. accounts of the transmission authority responsible for pur- for performing public service #187 dated 22 March 2017. This entities for the needs of reli- system operator, distribution suing the State policy in hous- obligations when approving Resolution contains, amongst gious organisations a ratio Nevertheless, despite all precon- system operators and gas ing and utilities. the PSO Resolution. The court others, a series of differences from of 0.5 is applied to the price ditions for such price revision supplier with public service decision became effective in the previous one, in particular: defined above; in setting after recalculations performed by obligations according to ratios As at 31 December 2017 the October 2017. • Both “Ukrgazvydobuvannya” wholesale price for gas for the Ministry of Energy and Coal calculated by the gas suppliers Company has signed gas debts PJSC and “Chornomornaf- municipal heat generating of Ukraine, final decision was not with specific obligations and restructuring agreements As at the date of these con- togaz” PJSC are obliged to sell entities for all customers, approved. approved by the National according to this Law in the solidated financial statements gas to the Company for the except for the needs of Commission for Regulation of amount of UAH 432 mil- such resolution has not been needs of households, religious religious organisations and Other customers outside the Res- Energy and Utilities (“NCREU”). lion. Fulfilment of gas debt adopted. Accordingly, the organisations, municipal heat households, and for electricity olution buy imported natural gas Balances on the special pur- restructuring agreements Company did not receive any generating entities for heat production by municipal heat under the prices set discretionary pose accounts cannot be is guaranteed by municipal compensation as a gas market distribution and hot water generating entities a ratio of by the gas market participants, arrested or blocked. executive government bod- player with public service supply for households and 1.6 is applied. including the Company. ies representing particular obligations during 2016 and religious organisations. • In case gas wholesale price Municipal heat generating territorial community as set 2017. Expected amount of The following tariffs and prices • The Company is obliged to calculated at 100% import entities also open special by the separate guarantee compensation for performing were set: sell gas to municipal heat parity before 1 July 2017 is purpose banks accounts for agreement. According to the special obligations for the the settlement of debts for terms of gas debt restructuring whole period of PSO and up 31 December 31 December heat supplied. Cash received agreements, the Company has to 31 December 2017 approx- 2017 2016 by municipal heat generating a right to terminate them in imates to UAH 36.2 billion Natural gas prices for households, including VAT, tariffs for gas From 1 April 2017: From 1 May 2016 to entities on their special pur- case of late payments by coun- (unaudited) per the Compa- transmission and distribution and mark up on price. UAH 6.96 per cubic 31 March 2017: pose bank accounts is then terparty. There were no such ny’s calculations, excluding Starting from 1 April 2017, Resolution of the Cabinet of Ministers of meter UAH 6.88 per cubic allocated, among others, to agreements terminated up to compensation that other gas Ukraine #187 dated 22 March 2017 sets maximum level of mark up meter current bank accounts of the the date of these consolidated market players with public on price of 2.5% from the retails price for gas suppliers. gas supplier with public ser- financial statements. service obligation are eligible Natural gas prices for municipal heat generating entities UAH 4.94 per cubic From 1 May 2016: vice obligations according to to, namely – “Ukrgasvydoby- producing heat for household, excluding VAT and tariffs for gas meter UAH 4.94 per cubic ratios approved by the NCREU vannia” PJSC and “Chornomor- Compensation of price transmission and distribution. meter monthly. The special purpose naftogaz” PJSC. Total amount difference between sales bank accounts of municipal of compensation to all gas Gas selling prices for industrial customers and entities financed From UAH 7 516 From UAH 6 484 tariffs and price of imported from the State or municipal budgets, excluding VAT and tariffs to UAH 8 265 per to UAH 7 148 per heat generating entities also market players named above gas and other types of for gas transmission and distribution. These selling prices are set 1 000 cubic meters 1 000 cubic meters cannot be blocked or arrested. comprises UAH 111 billion financial support by the State discretionary by the Company depending on monthly consumption (unaudited) according to Naf- levels and terms of payments. In November 2016 the Law In accordance with Para 7, Arti- togaz’s calculations. General tariff for gas storage (storage, injection, and withdrawal), UAH 112.0 UAH 112.0 of Ukraine “On measures to cle 11 of the Law of Ukraine excluding VAT, UAH per thousand cubic meters for one season of settle the debts for the natural “On Natural Gas Market”, a gas Gas transmission unbundling storage. gas consumed by municipal market player with public ser- process Tariff for entry and exit points of Ukrainian gas transmission USD 12.47 USD 12.47 heat generating entities vice obligations is eligible for network, excluding VAT, USD per thousand cubic meters per day and distribution and water compensation of economically As at 31 December 2017 and supplying companies” #1730 justified expenditures incurred 2016, the Company executed was adopted. The principles by such player, less any income control over transmission sys- of municipal heat generating obtained in the course of tem operator “Ukrtransgaz” PJSC.

216 217 FINANCIAL STATEMENTS ANNUAL REPORT 2017

Unbundling plan was alternatively, setting aside of Assets located at temporarily 3. RESTATEMENT OF solidated statement of financial loss and consolidated cash flows approved by the Resolution the Gas Transit and Gas Sales occupied territories COMPARATIVE INFORMATION position as at and for the year for the year then ended is not of the Cabinet of Ministers Contracts (Note 26). ended 31 December 2016. These material, so the Group does not of Ukraine #496 dated 1 July In early 2014, Ukraine suffered The Group has issued the consol- matters were corrected retrospec- present comparative information 2016, which envisages transfer Therefore, management from the military aggression of idated financial statements as at tively in these consolidated finan- at that date and for respective of gas transmission activities believes that legal ownership the Russian Federation which and for the year ended 31 Decem- cial statements for the year ended periods. to “Mahistralny gasoprovody unbundling is not an option, resulted in the occupation of ber 2016 on 4 May 2017. Subse- 31 December 2016. Ukrainy” PJSC after Stockholm because it would deprive the Autonomous Republic of quently to that date, the Group The effect of the retrospective Arbitrations are completed Naftogaz of control of the Crimea (“Crimea”) and unlawful identified matters requiring Impact of such misstatements on corrections to the consolidated (Note 23). assets, which provides the military take-over of certain correction in information for the the consolidated financial posi- statement of financial position basis for Naftogaz’s legal areas in Luhanska and Donetska previous reporting periods that tion as at 31 December 2015, con- as at 31 December 2016 was as Under the Gas Transit interest in defending its rights regions by armed terrorist has significant effect on the consolidated statement of profit and follows: Contract Naftogaz is under the Gas Transit Contract groups that are controlled, directed, and financed by the 31 December 2016, responsible for reliable and according to the Swedish law. Effect of 31 December 2016, In millions of Ukrainian hryvnias Note as previously uninterrupted functioning Meanwhile, implementation Russian Federation, as well as а restatement as restated of the Ukrainian gas of the ISO (Independent result of the unconcealed intru- reported transmission system. System Operator) unbundling sion of regular armed forces of Deferred tax assets 3.1. 6,415 (1,907) 4,508 Technical realisation of such model, which would require the Russian Federation. Prepayments made and other current assets 3.1. 12,051 (2,552) 9,499 Naftogaz’s obligations is separation of transit and Accumulated deficit 3.1. (175,873) (2,341) (178,214) performed by “Ukrtransgaz” domestic transmission if As a result, by 1 January 2016, PJSC. The rights and aiming at unbundling to be the Company has recognised Non-controlling interest 3.1. 1,164 (2,341) (1,177) obligations in respect of the done before 2020, also cannot a provision for impairment for Deferred tax liabilities 3.1. 82,088 224 82,312 Gas Transit Contract cannot be physically finalised until the assets located on anti-terrorist be designated to a third party Gas Transit Contract expires. operation (“ATO”) as stipulated The effect of the retrospective corrections on the consolidated statement of profit or loss for the year ended (e.g. “Mahistralny gasoprovody ITO (Independent Transmission by the Law of Ukraine „On Pro- 31 December 2016 was as follows: Ukrainy” PJSC) without Operator) unbundling model visional Measures during ATO” “Gazprom” PJSC (“Gazprom”) is not envisaged in the Law on #1669 dated 2 September 2014. 2016, Effect of 2016, consent. Gazprom is reluctant Gas Market. In millions of Ukrainian hryvnias Note as previously restatement as restated to give such consent and has Management of the Group con- reported filed a Request for Arbitration Given the above, management tinues to undertake all possible Other operating expense 3.1. (41,752) (3,793) (45,545) to The Arbitration Institute of believes that the transfer of legal and diplomatic measures Finance income 3.1. 4,672 1,241 5,913 the Stockholm Chamber of gas transmission activity is to reimburse for losses and Commerce (“Arbitral Tribunal”) unlikely to be completed recover control of the Group’s Income tax benefit 3.1. 1,495 (2,131) (636) requesting revision or, before 2020. assets in Crimea (Note 23). The effect of the retrospective corrections on the consolidated statement of cash flow for the year ended 31 December 2016 was as follows:

2016, Effect of 2016, In millions of Ukrainian hryvnias Note as previously restatement as restated reported

Net movement in provision for trade accounts 3.1. 20,863 (3,793) 24,656 receivable and prepayments made, other current assets, financial investments and VAT balances Finance costs, net 3.1. 4,909 1,241 3,668 Proceeds from borrowings 3.2. 19,348 14,542 4,806 Repayment of borrowings 3.2. (40,183) (14,542) (25,641)

3.1. Impairment of prepayments uncertainty in the form and 31 December 2016, as it believes made for petroleum products expected dates of their settle- that such accounting properly ment, have had impairment reflects expectation of their set- As at 31 December 2016, indicators. Management of the tlement as at this date. “Ukrnafta” PJSC accounted for Group has decided to recog- prepayments made for petro- nise provision for impairment leum products that, taking in respect of such assets as at

218 219 FINANCIAL STATEMENTS ANNUAL REPORT 2017

3.2. Change in accounting • Gas production, imports and Group. Management considers of petroleum products. Whole- lines and 11 oil reservoirs oper- from operating activities as policy in presenting cash flows supply to the other customers gas transit and gas transmission sale activities are performed ated by the Group. Total length measures of both a segment under PSO, as separate business segments as through electronic auctions, of oil transmission pipelines in operational efficiency and its From 1 January 2017 the Group gas transit is manly represented while retail sales are done Ukraine is 4.7 thousand km. short-term financial health. has changed its accounting • Gas imports and supply to the by a contract with a single coun- through own network of fuel Management also uses adjusted policy in respect of cash receipts other customers outside PSO. terparty and is being assessed filling stations. Other. Revenues of this segment operating result net of income and payments for borrowings separately. include revenues from sales of taxes (NOPLAT) to measure and presenting cash flows for Each group of customers has its Oil and gas condensate. The materials, services and chemical segment operational efficiency. such operations in consolidated own selling price setting pro- Ukrainian gas transmission sys- Group sells oil and gas con- products. The segment also Income taxes at nominal tax statement of cash flow on a net cedure and its own economic tem is one of the largest in the densate at exchange auctions includes results of joint operations rate are deducted from adjusted basic. Management believes such characteristics, such as products world in terms of its transporta- in accordance with the Law of under the concession agreement operating profit to arrive to presentation is more accurate and delivered to the end customers, tion capacities. The total length Ukraine “On oil and Gas” #2665- for exploration and development NOPLAT. Adjusted operating provides more relevant informa- their credit risks etc. of gas transmission pipelines III dated 12 July 2001 and the with the Arab Republic of Egypt. loss is not corrected for income tion for the users of the financial in Ukraine is 38.5 thousand km. procedure for organising and taxes. statements, since amounts of Selling price setting for gas sales Over 45% of natural gas supplies holding exchange auctions for Management assesses perfor- receipts and payments for bor- to RSC, MHE for the needs of from the Russian Federation sale of domestically produced mance of operating segments The accounting policies of the rowings are large and maturities households and to the other to European countries were crude oil, gas condensate and based on adjusted operating reportable segments are the same for such borrowings are quick. customers under PSO is performed within the current PSO delivered through Ukrainian gas LNG, approved by the Cabinet of result. Adjusted operating result as the Group’s accounting policies Resolution (Note 2). Gas supply transmission system in 2017 and Ministers of Ukraine Regulation represents operating profit/(loss) described in Note 26 other 3.3. Other changes for other groups of customers is 2016. #570 dated 16 October 2014. with operating foreign exchange than presentation of payments There were other individually performed at prices established differences included. for natural gas made directly insignificant adjustments. independently by Naftogaz. This segment also includes Oil domestic transmission and by lending bank to suppliers result of market-based gas bal- transit. These segments are pre- Management uses net working within cash flows from operating As described in Note 2, “Ukrg- ancing operations introduced sented by oil transmission pipe- capital and net cash flows activities. 4. SEGMENT INFORMATION asvydobyvannia” PJSC and by the Code of the Gas Trans- “Chornomornaftogaz” PJSC are mission System. Market-based The Executive Board is the obliged to sell gas to Naftogaz gas balancing operations is an Group’s chief operating decision for the needs of households, activity to balance gas volumes maker. As at 31 December 2017, religious organisations, munici- entered the gas transmission the Group has changed presen- pal heat generating entities and system at entry point and vol- tation of segment information in distribution and water supply umes taken out at exit point. line with performance manage- companies for households and Gas balancing services are pro- ment approach to its subsidiaries. religious organisations. There- vided to consumers of gas trans- Comparative information as at fore, management views perfor- mission services. Currently this 31 December 2016 was restated mance of gas upstream business type of activities is performed to reflect the changes in presen- from gas production up to its by “Ukrtransgaz” PJSC. tation. sale to one of the groups of customers named above as a single Gas storage. Ukrainian gas Management vision of the Group reporting segment. Natural gas transportation system includes performance is viewed through production is mainly performed 11 underground gas storage the following business areas: in Poltava, Kharkiv, Sumy, Dnipro, facilities located in mainland Lviv and Zakarpattya regions. Ukraine. The total capacity of the Gas production, imports, sales Exploration works are mainly underground gas storage system and supply to different groups performed in Carpathian and located in Ukraine is 31 billion of customers. Management Dnipro-Donetsk regions. The cubic meters of gas. identified four main groups of Group controls about 80% of all customers in respect of gas sales natural gas produced in Ukraine. Petroleum products sales. The and supply: Group sells purchased and • Gas production, imports and Demand in gas for other custom- domestically refined petroleum sales to the regional gas sup- ers outside PSO is satisfied from products through filling stations ply companies (“RSC”) for the gas imports. network in the most of Ukraine. needs of households, Domestic refinery of petroleum • Gas production, imports and Gas domestic transmission and products is performed at oil and supply to the municipal heat gas transit. These segments are gas refineries controlled by the generating entities (“MHE”) for presented by the gas transmis- Group. This segment includes the needs of households, sion pipelines operated by the both wholesale and retail sales

220 221 FINANCIAL STATEMENTS ANNUAL REPORT 2017

Segment information for the reportable business segments of the Group for the year ended 31 December 2017 is as follows:

In millions of Ukrainian hryvnias Gas production, import and sales to to resale for RSC’s households Gas production, imports and supply the for MHE’s to needs of households Gas production, imports and supply other customers to under PSO Gas imports and other supply to outside customers PSO Gas transit Gas domestic transmis-sion Gas storage products Petroleum sales Oil and gas condensate Oil transit Oil domestic transmission Other Elimination Total Sales – external 54,257 22,766 7,755 4,113 73,937 24,829 184 18,095 12,895 3,574 160 4,913 – 227,478 Sales to other segments – – – 23,399 – 2,874 774 – – – 28 6 (27,081) – Total revenue 54,257 22,766 7,755 27,512 73,937 27,703 958 18,095 12,895 3,574 188 4,919 (27,081) 227,478 Segment result 20,369 3,942 1,626 513 14,512 4 (329) 3,407 5,556 1,996 (581) (138) – 50,877 Net result of Gas Sales and Gas Transit Arbitrations 12,597 Change in provisions for litigations and other provisions 2,787 Impairment of property, plant and equipment (3,399) Finance income/ (expense) (6,704) Share of after-tax results of associates (47) Net foreign exchange loss/gain (764) Unallocated income/ (expense), net (2,594) Profit before income tax 52,751 NOPLAT 16,703 3,232 1,333 421 11,900 3 (329) 2,794 4,556 1,637 (581) (138) – 41,531 Net segment cash flows from operating activities 11,173 1,240 2,331 2,790 38,322 (4,878) 407 1,557 5,983 1,354 (151) 932 – 61,060 Payments for natural gas made directly by lending bank to suppliers 21,850 Net result of Gas Sales and Gas Transit Arbitrations (12,597) Unallocated cash flows from operating activities 288 Net cash flows from operating activities 70,601 Material non-cash items included in segment results: Depreciation, depletion and amortisation 5,336 1,287 147 109 28,014 1,570 382 916 963 497 215 388 – 39,824 Net movement in provision for trade and other receivables and 1,059 692 8 (91) – 11,197 (345) 17 (82) – (60) (42) – 12,353 prepayments made and other current assets Change in provisions 212 51 6 (19) – – 128 – 88 – – – – 466 Net foreign exchange (loss)/gain (52) (12) (1) (9) (1) – – – – – – (204) – (279) Capital expenditure 8,428 3,978 103 49 1,695 72 37 1,287 710 109 50 477 – 16,996 Property, plant and equipment 77,805 25,432 4,196 1,456 174,092 11,908 152,385 17,101 9,610 7,092 7,784 2,621 – 491,482 Other segment assets 65,641 23,246 1,050 848 15,278 9,999 25 5,058 1,195 873 1,156 10,357 – 134,726 Investments in associates and joint ventures 1,197 Cash and bank balances 23,093 Indebtedness under the Gas Transit Arbitration 57,125 Unallocated assets 15,501 Total assets 723,124 Segment liabilities 10,106 3,583 823 1,891 8,661 1,451 1,680 2,934 6,054 107 394 1,819 – 39,503 Borrowings 59,315 Portion of net profit attributable to the State Budget of Ukraine 29,498 Deferred tax liabilities 67,304 Indebtedness under the Gas Transit Arbitration 57,125 Unallocated liabilities 29,860 Total liabilities 282,605 Net working capital 54,350 19,238 198 (503) 5,662 8,430 (1,656) 1,825 (2,580) 766 755 1,747 88,232

222 223 FINANCIAL STATEMENTS ANNUAL REPORT 2017

Segment information for the reportable business segments of the Group for the year ended 31 December 2016 is as follows:

In millions of Ukrainian hryvnias Gas production, import for RSC’s and sales to households to resale Gas production, imports for MHE’s and supply to the needs of households Gas production, imports other and supply to under PSO customers Gas imports and supply other customers to outside PSO Gas transit Gas domestic transmission Gas storage products sales Petroleum Oil and gas condensate Oil transit Oil domestic transmission Other Elimination Total Sales – external 48,920 18,871 4,600 12,880 59,986 14,710 61 13,482 11,149 3,336 91 4,678 – 192,764 Sales to other segments – – – 15,560 – 2,624 930 23 – – – 31 (19,168) – Total revenue 48,920 18,871 4,600 28,440 59,986 17,334 991 13,505 11,149 3,336 91 4,709 (19,168) 192,764 Segment result 19,936 4,954 (392) (1,678) 24,648 3,093 (315) (7,550) (3,521) 1,959 (643) 513 – 41,004 Change in provisions for litigations and other provisions (10,957) Finance income/ (expense) (3,668) Share of after-tax results of associates (99) Net foreign exchange loss/gain (6,052) Unallocated income/ (expense), net (1,743) Profit before income tax 18,485 NOPLAT 16,347 4,062 (392) (1,678) 20,211 2,537 (315) (7,550) (3,521) 1,607 (643) 419 – 31,084 Net segment cash flows from operating activities (7,928) (1,713) (2,188) 5,403 35,187 1,437 323 (4,608) 4,425 898 497 (1,084) – 30,648 Payments for natural gas made directly by lending bank to suppliers 13,636 Unallocated cash flows from operating activities 3,021 Net cash flows from operating activities 47,305 Material non-cash items included in segment results: Depreciation, depletion and amortisation 5,585 2,120 – 165 11,503 1,564 124 1,335 716 456 221 280 24,069 Net movement in provision for trade and other receivables and (156) 46 1,375 4,033 – 4,048 152 8,024 6,610 – (15) 266 24,383 prepayments made and other current assets Change in provisions (22) (8) (2) – – – 2 – (44) – – – (74) Net foreign exchange (loss)/gain 5 – – 5 (501) 229 (262) Capital expenditure 3,580 1,805 51 112 1,667 62 41 597 617 260 119 558 9,469 Property, plant and equipment 67,019 32,565 1,669 1,540 242,350 14,651 155,554 12,430 5,203 7,285 7,996 3,399 551,661 Other segment assets 53,622 20,497 41 5,108 14,019 4,713 129 4,337 885 819 1,067 10,198 115,435 Investments in associates and joint ventures 1,328 Cash and bank balances 22,336 Unallocated assets 9,370 Total assets 700,130 Segment liabilities 6,068 3,163 129 1,772 3,868 1,065 1,461 4,415 3,457 440 79 2,040 27,961 Borrowings 70,844 Provisions for litigations 11,844 Portion of net profit attributable to the State Budget of Ukraine 13,264 Deferred tax liabilities 82,312 Unallocated liabilities 38,315 Total liabilities 244,540 Net working capital 47,277 17,139 1,368 1,721 9,630 3,573 (1,332) 538 (3,024) 379 987 2,313 80,569

224 225 FINANCIAL STATEMENTS ANNUAL REPORT 2017

Geographical information Allocation of sales in the table revenue exceeding 10% of 5. BALANCES AND TRANSACTIONS of Ukraine. Outstanding trade one loan to a revolving credit above is made based on the total revenues was Gazprom. WITH RELATED PARTIES accounts receivable related line. In millions country of residence of the Amount of revenue from to these transactions as at of Ukrainian 2017 2016 Group’s customers. Gazprom related to gas Parties are generally considered 31 December 2017 and 2016 are Pledges. As at 31 December hryvnias transit in 2017 amounted to be related if one party has the about 45% and 44%, respectively, 2017 and 2016, borrowings from Ukraine 147,309 127,908 External customers to UAH 73,937 million ability to control the other party, of the total trade accounts related parties (State-owned Russian 77,511 63,322 concentration, exceeding 10% (2016: UAH 59,986 million). is under common control, or can receivable balance. banks) were secured by property, Federation of total revenues exercise significant influence or plant and equipment, inventories Revenues, operating profit/(loss) Outstanding accounts payable, and proceeds from future sales. Egypt 457 398 joint control over the other party During the years ended and receivables of the segments in making financial and opera- advances and other current Europe 2,201 1,136 31 December 2017 and 2016, “Gas transit” and “Gas transmis- tional decisions. In considering liabilities as at 31 December 2017 Guarantees. Amount of guaran- Total 227,478 192,764 the only external customer sion” by main types of services are each possible related party rela- and 2016 are about 18% and 60%, tees, provided by the Government revenue with concentration of as follows: tionship, attention is directed to respectively, of the total balance of Ukraine, as at 31 Decem- the substance of the relationship, of these liabilities. ber 2017 and 2016 equalled 31 December 2017 not merely the legal form. to UAH 22,023 million and Provisions in respect of the UAH 28,912 million, respectively Trade accounts receivable As discussed in the Note 1, the entities controlled by the Govern- (Note 14). In millions of Ukrainian Operating Revenue NOPLAT ment of Ukraine as at 31 Decem- hryvnias profit/(loss) gross provision for carrying Group is ultimately controlled amount impairment amount by the Government of Ukraine, ber 2017 and 2016 are about 80% Transactions with the State are International transit 73,937 14,512 11,900 6,589 - 6,589 and therefore, all state-controlled of the total provisions. further disclosed in Note 13. entities and institutions are con- Domestic transmission 24,829 4 3 22,804 (15,562) 7,242 sidered as related parties under As at 31 December 2017 and Key management remuneration. including gas balancing 16,085 (6,133) (6,133) 20,033 (14,483) 5,550 common control. 2016, about 98% and 95%, During 2017, key management operations respectively, of cash and bank personnel consisted on average Total 98,766 14,516 11,903 29,393 (15,562) 13,831 Transactions with related parties balances were placed in the banks of 6 Executive Board members are performed on terms that controlled, jointly controlled or and 9 directors (2016: 4 Executive 31 December 2016 would not necessarily be avail- influenced by the Government Board members and 6 directors). able to unrelated parties. of Ukraine and about 65% of Compensation to the key man- Trade accounts receivable borrowings were provided by agement personnel included In millions of Ukrainian Operating Revenue NOPLAT these banks (2016: 54%). About into other operating expense hryvnias profit/(loss) gross provision for carrying Transactions with state- amount impairment amount controlled entities and 55% of finance income in 2017 consists of salary and additional International transit 59,986 24,648 20,211 6,354 – 6,354 istitutions. The Group relate to balances in these banks current bonuses and comprises performs significant (2016: 23%) and about 70% of UAH 214 million in 2017 (2016: Domestic transmission 14,710 3,093 2,537 8,873 (4,843) 4,030 transactions with entities and finance costs for the year ended UAH 87 million). including gas balancing 6,242 (3,475) (3,475) 6,616 (4,051) 2,565 institutions controlled, jointly 31 December 2017 (2016: 68%) operations controlled or significantly relate to borrowings from these During 2017 the Company Total 74,696 27,741 22,748 15,227 (4,843) 10,385 influenced by the Government banks. also incurred UAH 25 million of Ukraine. These entities of expenses on operations of and institutions include State In December 2017 the Company the Supervisory board (2016: Savings Bank of Ukraine, has completed redemption UAH 20 million). This amount Ukreximbank, Ukrgazbank, tax of bonds amounting to includes UAH 20 million authorities, municipal heat UAH 4 800 million that were in service fees accrued generating entities, regional issued in 2013 guaranteed by the (2016: UAH 15 million), and gas distribution entities and State. UAH 5 million in compensation of other entities. expenses incurred by the Board In 2017 the Group has concluded members during performance of For the year ended 31 December additional agreements with two their duties (2016: UAH 5 million), 2017, about 30% of Group’s state-owned banks in respect as well as directors and officers revenue (2016: 32%) were earned of decreasing interest rates and liability insurance procured and from transactions with the entities changes to the borrowings paid by the Company to insure controlled, jointly controlled or repayment schedules prolonging the liability of these officers after influenced by the Government their maturities, and converting their appointment.

226 227 FINANCIAL STATEMENTS ANNUAL REPORT 2017

6. PROPERTY, PLANT AND EQUIPMENT depreciated replacement cost. that could be obtained from management that there would This method considers the cost the use of assets (with future not be any gas transit flows Movements in the carrying amount of property, plant and equipment were as follows: to reproduce or replace the economic benefits calculated starting from 1 January 2020 property, plant and equipment, based on current estimates after the expiration of existing adjusted for physical, functional of the Group’s management, Gas Transit Contract with and economic depreciation, and expectations of independent Gazprom, because currently obsolescence. The depreciated appraisers and consensus Gazprom has not booked any In millions of Ukrainian replacement cost was estimated forecasts). Therefore, the fair gas transit capacities beyond hryvnias based on internal sources and value of specialised assets 2019 and is actively investing in analysis of available market was determined using the construction of alternative gas information for similar property, depreciated replacement pipelines bypassing Ukraine. Pipelines and related and related Pipelines equipment Oil and gas producing properties Machinery and equipment Buildings gas Cushion Drilling and exploration equipment assets Other fixed in Construc-tion progress Total plant and equipment (published cost approach as adjusted Should the assumption of no Net book value at 210,782 53,405 75,920 62,392 142,140 582 3,900 10,675 559,796 information, catalogues, for economic obsolescence transit flows from 1 January 31 December 2015 statistical data etc), and industry amount. If the fair value is lower 2020 change, this could have Cost or valuation 212,066 53,826 76,593 63,439 142,140 861 5,122 11,617 565,664 experts and suppliers. than carrying value of property, resulted in lower economic plant and equipment, an obsolescence per results of Accumulated (1,283) (420) (673) (1,047) – (279) (1,224) (942) (5,868) The results obtained using impairment loss is recognised income approach in valuation depreciation and impairment different valuation approaches (Note 26). procedures. provided evidence of the Additions and transfers (12,549) 5,487 38,019 (22,236) – 790 (2,588) 1,851 8,774 existence of economic The major part of economic The following table summarises Revaluation – – – – 13,282 – – – 13,282 obsolescence and impairment obsolescence identified values of property, plant and costs. Economic obsolescence is attributed to the cash equipment by selected cash Disposals (3) (33) (16) (68) – (34) (1) (247) (402) is caused by the fact that generating unit “Gas generating units based on Depreciation charge (7,137) (5,719) (7,104) (3,521) – (295) (307) – (24,083) replacement cost of assets less Transmission System”. It is different valuation approaches as physical depreciation exceeded explained by the implied at 31 December 2017: Impairment (20) (799) (1) (2,156) (1,856) (91) – (783) (5,706) the future economic benefits expectation of the Group’s Net book value at 191,074 52,342 106,818 34,411 153,566 952 1,002 11,496 551,661 31 December 2016 Cash generating unit Cost Approach (net replacement Income Approach Cost or valuation 199,270 59,300 116,533 39,194 155,422 1,447 2,724 13,117 587,007 In millions of Ukrainian hryvnias costs less physical depreciation) Gas Transmission System 419,309 188,628 Accumulated (8,196) (6,958) (9,715) (4,783) (1,856) (495) (1,722) (1,621) (35,346) depreciation and Underground Gas Storages 160,533 126,579 impairment Gas upstream, refinery and fuel filing stations 120,479 91,094 Additions and transfers (522) 4,335 2,106 1,673 – 870 338 6,740 15,540 Oil transmission and transit 15,923 14,444 Revaluation (42,181) 27,140 (8,506) (6,383) (3 526) 548 (99) – (33,007) Group’s management transit beyond 2019 have UAH 1,065 million) in Disposals – (19) (20) (6) – (20) (4) (289) (358) expectations of gas transit been used for revaluation, other operating expense, Depreciation charge (16,882) (6,202) (14,919) (2,728) – (565) (292) – (41,588) flows after 1 January 2020 net replacement costs less UAH 775 million (2016: (Note 27) is the main physical depreciation of “Gas UAH 631 million) were Impairment – – (41) (119) – (74) (6) (526) (766) assumption that affected both Transmission System” cash capitalised in the cost of Net book value at 131,489 77,596 85,438 26,848 150,040 1,711 939 17,421 491,482 revaluation of property, plant generating unit would be property, plant and equipment, 31 December 2017 and equipment and remaining 10% higher. For other assets, and UAH 1,085 million were useful lives revision for gas expectation of no gas transit capitalised in cost of inventories. Cost or valuation 132,909 77,944 86,105 27,484 150,045 1,738 2,128 19,443 497,796 transit assets included to the flows after 1 January 2020 Accumulated (1,420) (348) (667) (636) (5) (27) (1,189) (2,022) (6,314) ”Gas Transmission System” cash has resulted in a lower value As at 31 December 2017 and depreciation and generating unit. Expectation of under income approach 2016, the Group has pledged impairment no gas transit flows after this with respective impairment its property, plant and equip- date has resulted in shortened loss, if any, according to the ment with carrying amount useful lives for gas transit assets accounting policy (Note 26). of UAH 2,682 million and The Group engaged with International Valuation replacement cost for specialised planned for decommissioning UAH 10,536 million, respec- independent appraisers to Standards. assets, and using market-based after 31 December 2019, their In 2017, the depreciation tively, to secure its borrowings determine the fair value of evidence for non-specialised higher depreciation in 2017, and depletion expenses of (Note 14). its major groups of property, Taking into account the nature assets. Consequently, the and lower net replacement UAH 39,144 million (2016: plant and equipment as at of the Group’s property, plant fair value of main producing costs less physical depreciation UAH 22,387 million) was Included in property, plant 31 December 2017. The fair value and equipment, fair value was properties and equipment was as at 31 December 2017. included in cost of sales, and equipment in 2016 was determined in accordance determined using depreciated primarily determined using Should expectation of material UAH 604 million (2016: are capital expenditures of

228 229 FINANCIAL STATEMENTS ANNUAL REPORT 2017

UAH 1,872 million, for which presented on the basis Had the Group’s property, plant 8. OTHER NON-CURRENT ASSETS nature of expenditures could of the relevant primary and equipment been measured be different from their legal documents in the consolidated on a historical cost basis, their In millions of Ukrainian hryvnias 31 December 2017 31 December 2016 form according to primary financial statements as at carrying amounts would have Accounts receivable on product sharing agreement 4,866 4,204 documents (Note 27). and for the years ended been as shown in the table Intangible assets 2,318 977 These expenditures were 31 December 2016. below: Restructured accounts receivable of gas consumers 753 1,340 In millions of Ukrainian hryvnias 31 December 2017 31 December 2016 Other 3,194 2,805 Pipelines and related equipment 6,662 7,237 Total 11,131 9,326 Oil and gas producing properties 14,081 11,751 Machinery and equipment 8,371 9,149 Accounts receivable on product assets and hydrocarbon explo- sumed” #3319-VI was approved. sharing agreement. The Com- ration and development assets According to this Law, accounts Buildings 5,905 4,693 pany entered into a concession in the Arab Republic of Egypt. receivable due from entities sup- Cushion gas 217 212 agreement for hydrocarbon The Company plans to make a plying natural gas under the reg- Drilling and exploration equipment 931 354 exploration and development decision in respect of viability ulated tariff that were originated Other fixed assets 721 482 with the Arab Republic of Egypt of its future activities within the in 2010, were restructured for the and Egyptian General Petro- Concession Agreement per results period from 1 to 20 years and are Total 36,888 33,878 leum Corporation (“EGPC”) on of such evaluation, including, but stated at amortised cost using 13 December 2006. Under the not limited to potential exit from effective interest rate which at the terms of the concession agree- this project. restructuring dates varied from 7. INVESTMENTS IN ASSOCIATES AND JOINT VENTURES ment the Company has the right 15% to 24% per annum. Details of each of the Group’s associates and joint ventures as at 31 December 2017 are as follows: to recover all exploration and Intangible assets. As at development costs incurred in 31 December 2017 and 2016, Other. As at 31 December 2017 Place of Dividends connection with the concession included in intangible assets and 2016, included in other Proportion Share of Carrying incorporation received agreement (Note 27). The amount are licenses for exploration non-current assets are research Name of associate Principal activity of ownership (loss)/ amount of and principal from the interest profit investment presented in the table above and extraction amounting and development expenditures place of business associate represents such costs claimed by to UAH 1,641 million and amounting to UAH 1,171 million “Gaztransit” PJSC Construction works Ukraine 40.2% (1) (84) 937 the Group for recovery, and which UAH 535 million, respectively. and UAH 1,443 million, respec- “Ukrtatnafta” PJSC Oil refinery Ukraine 43.05% – – – are expected to be refunded after tively, that were incurred within one year since the reporting date. Restructured accounts receiv- the concession agreement for oil Other miscellaneous Ukraine miscellaneous (46) – 260 able of gas consumers. In May exploration and development (47) (84) 1,197 In 2017 the Company engaged 2011, the Law of Ukraine “On with the EGPC on 13 Decem- independent consultants to eval- certain matters on indebtedness ber 2006, but not yet claimed for Details of each of the Group’s associates and joint ventures as at 31 December 2016 are as follows: uate exploration and evaluation for natural gas and electricity con- recovery (Note 27).

Place of Share Dividends incorporation Proportion Share of Carrying of other received Name of associate Principal activity and principal of ownership (loss)/ amount of comprehen- from the place of interest profit investment sive income associate business “Gaztransit” PJSC Construction works Ukraine 40.2% 93 – (123) 1,022 “Ukrtatnafta” PJSC Oil refinery Ukraine 43.05% (241) 2 – – Other miscellaneous Ukraine miscellaneous 49 – – 306 (99) 2 (123) 1,328

All of the above associates are accounted for using the equity method in these consolidated financial statements. The Group’s investments in associates and joint ventures were as follows:

In millions of Ukrainian hryvnias 31 December 2017 31 December 2016 Investments in associates 937 1,047 Investments in joint ventures 260 281 Total 1,197 1,328

230 231 FINANCIAL STATEMENTS ANNUAL REPORT 2017

9. INVENTORIES Analysis of credit quality of trade accounts receivable is as follows:

The Group’s inventories were as follows: In millions of Ukrainian hryvnias 31 December 2017 31 December 2016 Neither past due nor impaired 27,333 29,774 In millions of Ukrainian hryvnias 31 December 2017 31 December 2016 Past due but not impaired: Natural gas 48,472 38,792 Less than 30 days overdue 13,279 13,220 Crude oil and petroleum products 4,299 3,378 31 to 90 days overdue 6,854 3,221 Spare parts 2,829 2,843 91 to 180 days overdue 4,559 265 Oil for industrial and technological needs 1,954 1,976 181 to 365 days overdue 6,738 2,415 Raw materials 1,500 1,760 Over 365 days overdue 225 314 Other 1,121 1,495 Past due and individually impaired (gross): Total 60,175 50,244 Less than 30 days overdue 1,663 2,858 Management estimates the sales and UAH 451 million was subsequently sold for house- 31 to 90 days overdue 732 820 necessity of write-down of included in other operating hold needs at regulated prices. 91 to 180 days overdue 1,180 738 inventories to their net realis- expense (2016: UAH 1,867 mil- 181 to 365 days overdue 13,053 3,102 able value taking into consider- lion included in cost of sales As at 31 December 2017 and Over 365 days overdue 33,291 29,711 ation indicators of economical and UAH 38 million included 2016, inventories with carrying and physical obsolescence. In in other operating expense). amount of UAH 38,208 million Less: provision for impairment (49,919) (37,229) 2017 write-down adjustment Amount included in cost of and UAH 37,698 million, respec- Total 58,988 49,209 amounted to UAH 1,452 mil- sales represents write down tively, were pledged as collateral lion was included in cost of adjustment to imported gas for borrowings (Note 14). 11. PREPAYMENTS MADE AND OTHER CURRENT ASSETS The Group’s prepayments made and other current assets were as follows: 10. TRADE ACCOUNTS RECEIVABLE 31 December 2016 In millions of Ukrainian hryvnias 31 December 2017 In millions of Ukrainian hryvnias 31 December 2017 31 December 2016 (as restated, Note 3) Trade accounts receivable 108,907 86,438 Indebtedness under the Gas Transit Arbitration 57,125 – Less: provision for impairment (49,919) (37,229) Prepayments to suppliers for materials, works and services 10,834 11,224 Total 58,988 49,209 Taxes prepaid, other than income tax 8,935 529 VAT recoverable 2,175 2,242 Out of total carrying amount of trade accounts receivable as at 31 December 2017 there are UAH 42,517 million of accounts receivable for gas sales and supply (31 December 2016: UAH 35,652 million). Receivables under assignation agreements in respect of natural gas 1,637 1,690 sales Movements in provision for impairment of trade accounts receivable were as follows: Promissory notes receivable 1,468 1,471 In millions of Ukrainian hryvnias 2017 2016 Prepayments for pipelines construction 1,348 1,412 Balance at 1 January 37,229 20,553 Prepayments to suppliers for natural gas 649 5,731 Provision for impairment recognised during the year 15,053 18,497 Other 5,385 4,162 Reversal of provision for impairment (2,480) (1,757) Less: Provision for impairment (18,309) (18,962) Amounts written off during the year as uncollectible (11) (64) Total 71,247 9,499 Other movements 128 - Balance at 31 December 49,919 37,229 On 28 February 2018, the in favour of Company by 31 December 2017 amounts Arbitral Tribunal rendered the Gazprom as a compensation to UAH 57,125 million, and is Final Award in the Gas Transit of losses in this respect. As recognised in other current Other movements in provision between current and non- related to joint ventures of one Arbitration (Note 23), where, further described in Note 23, assets. for impairment of trade current accounts receivable and of the Group’s subsidiaries, amongst other, it supported the Company has received accounts receivable relate to to difference in proportion of recognised in equity Company’s claim in respect a legal right to set-off the Net amount receivable from reclassification of provision assets and profits consolidation movement. of Gazprom failure to deliver amounts owing between Gazprom after the set-off minimum contractual volume the parties pursuant to the amounts to UAH 71,861 million of gas transit (underdeliveries) Gas Sales Arbitration and Gas (equivalent to USD 2,560 mil- during 2009–2017. As a Transit Arbitration, supporting lion at the exchange rate as result, the Tribunal awarded a respective Company request. at 31 December 2017, Note USD 4,674 million to be paid Amount of such set-off as at 23). As at the date when these

232 233 FINANCIAL STATEMENTS ANNUAL REPORT 2017 separate financial statements As at 31 December 2017, included Movements in provision for 13. SHARE CAPITAL In April 2017 the National According to the Resolution were authorised for issue, in taxes prepaid, other than impairment of prepayments Commission on Securities and of the Cabinet of Ministers of this amount was not settled, income tax are prepayments for made and other current assets As at 31 December 2017 and Stock Market registered the Ukraine #282-p dated 26 April and the Company does not subsoil royalty amounting to were as follows: 2016, nominal amount of report of share placement of the 2017, portion of net profit of recognise it as an asset as at UAH 3,250 million (31 December registered, issued and fully paid Company and issued respective the Company amounting to 31 December 2017 (Note 23). 2016: UAH 15 million). share capital of the Company share issue certificate. As a result, UAH 13,264 million was paid as was UAH 190,150 million and registered share capital was dividends to the State Budget of 2016 In millions of Ukrainian hryvnias 2017 UAH 160,450 million, respectively, increased to UAH 190,151 million Ukraine in June 2017. (as restated, Note 3) comprising 190,150,481 and (net of effect of hyperinflation). Balance at 1 January 18,962 11,514 160,450,481 ordinary shares, At the date of these consolidated financial Provision for impairment recognised during the year 116 7,999 respectively, with a par value of Profit share payable to the State statements, basic allowance Reversal of provision for impairment (317) (355) UAH 1,000 per share. Budget of Ukraine for profit distribution per Amounts written off during the year as uncollectible (129) (16) Also, as at 31 December 2017 For the year ended 31 Decem- results of 2017 was set at Other movements (323) (180) and 2016, share capital of the ber 2016, the profit share paid 75% of net profit (2016: 50%). Balance at 31 December 18,309 18,962 Company has been adjusted to the State Budget of Ukraine The Company has accrued for the effect of hyperinflation amounted to UAH 1,021 million. respective provision in respect of the portion of net profit Other movements in provision vision between current and to joint ventures of one of the in accordance with IAS 29 attributable to the State for impairment of prepayments non-current assets and to dif- Group’s subsidiaries, recognised in “Financial Reporting in Distribution of profits Budget of Ukraine in current made and other current assets ference in proportion of assets equity movement. Hyperinflationary Economies” by provisions (Note 15). Currently, relate to reclassification of pro- and profits consolidation related UAH 4,156 million. Therefore total Profit available for distribution amount of share capital of the to the shareholders for each the Company is negotiating Company as at 2017 and 2016 reporting period is determined with its shareholder on the 12. CASH AND BANK BALANCES was UAH 194,307 million and by reference to the stand alone level of allowance for profit UAH 164,607 million, respectively. financial statements prepared in distribution per results of 2017. In millions of Ukrainian hryvnias 31 December 2017 31 December 2016 accordance with International The allowance can be revised as Cash in banks 22,895 20,024 Financial Reporting Standards. the result of the negotiations. Unregistered contributed Term deposits 3 2,163 Under Ukrainian legislation, the capital amount of dividends is limited to According to the Ukrainian Other 195 149 In 2015, according to the net profit of the reporting period legislation, the Company has to Total 23,093 22,336 Resolutions of the Cabinet or other distributable reserves make a decision in respect of of Ministers of Ukraine, not exceeding retained earnings profit distribution up to 30 April, As at 31 December 2016, included with original maturity of more cash and cash equivalents for the the Government issued as calculated in the financial and make payment to the State in term deposits are bank depos- than three months and less than purpose of cash flow statement. UAH 29,700 million of the State statements prepared in accor- Budget of Ukraine up to 30 June its amounting to UAH 483 million one year, which are excluded from treasury bonds in exchange to the dance with International Financial of the year following the report- new share issue of the Company. Reporting Standards. ing year.

234 235 FINANCIAL STATEMENTS ANNUAL REPORT 2017

14. BORROWINGS 15. PROVISIONS The Group’s borrowings were as follows: Movements in provisions for the years were as follows:

In millions of Ukrainian hryvnias 31 December 2017 31 December 2016 Non-current Bank borrowings 14,927 23,275 Unamortised discount (191) (175) In millions of Ukrainian hryvnias Total non-current portion 14,736 23,100 Current Bank borrowings 43,993 47,099 Interest accrued 586 645 litigations for Provisions benefit Employee obligations Decom-missio-ning provision fines and for Provision penalties of net profit Portion the State to attributable Budget of Ukraine (Note 13) Other provisions Total Balance at 5,180 3,616 1,423 7,078 – 973 18,270 Total current portion 44,579 47,744 31 December 2015 Total 59,315 70,844 Provision for dividends payable to – – – – 13,264 – 13,264 the State Budget (Note 13) In 2017 the Group has concluded Group analysed the impact of UAH 4,800 million that were Charge for the year 6,728 1,111 109 4,099 – 21 12,068 additional agreements with two such changes to the financial issued in 2013 guaranteed by the state-owned banks in respect obligations and concluded that State. The Company has fulfilled Unwinding of discount (Note 20) – 379 134 – – – 513 of decreasing interest rates and they lead to no material changes all its obligations during the Used or paid during the year (64) (770) (11) (23) – (5) (873) changes to the borrowings in their value. bonds circulation period. Remeasurements – 174 116 – – – 290 repayment schedules prolonging In December 2017 the Com- The effective interest rates and Balance at 11,844 4,510 1,771 11,154 13,264 989 43,532 their maturities to 2018–2020, 31 December 2016 and converting one loan to pany has completed redemp- currency denomination of bor- a revolving credit line. The tion of bonds amounting to rowings were as follows: Non-current 7,670 3,447 1,299 – – – 12,416 Current 4,174 1,063 472 11,154 13,264 989 31,116 31 December 2017 31 December 2016 In millions of Ukrainian hryvnias Provision for dividends payable to – – – – 29,498 – 29,498 Balance % per annum Balance % per annum the State Budget (Note 13) UAH 21,162 18% 27,315 19% (Reversed)/charged during the year (6,083) 1,809 235 2,997 – 221 (821) USD 26,706 7% 43,316 8% Unwinding of discount (Note 20) – 521 152 – – – 673 EUR 11,447 2% 213 7% Used or paid during the year – (1,553) (1) (18) (13,264) (9) (14,845) Total 59,315 70,844 Remeasurements – 381 140 – – – 521 Pledges. All the Group’s borrowings were secured as at 31 December 2017 and 2016. Balance at 5,761 5,668 2,297 14,133 29,498 1,201 58,558 31 December 2017 The Group’s borrowings were secured by the following pledges: Non-current – 3,907 2,100 – – – 6,007 31 December 2017 31 December 2016 Current 5,761 1,761 197 14,133 29,498 1,201 52,551 Proceeds from future sales 43,393 143,965 Property, plant and equipment (Note 6) 2,682 10,536 Provisions for Litigations In 2017 provision for Current provisions for employee litigations amounting to benefits include provision for per- The Group is involved into a Inventories (Note 9) 38,208 37,698 UAH 7,300 million was reversed formance bonuses and provision number of litigations both as Total 84,283 192,199 after the court decision was for employees’ unused vacations. a plaintiff and as a defendant. received in favour of the Provision for litigations Guarantees. As at 31 December 2017, the Group’s borrowings in the amount of UAH 22,023 million were guar- Company. Non-current provisions for represents management anteed by the State (31 December 2016: UAH 28,912 million). employee benefits include lump assessment of the probable Employee Benefit Obligations sum benefits payable upon retire- Reconciliation of financial liabilities from financing activities outflow of the Group’s ment and post-retirement benefit resources arising from a The Group companies have In thousands of Cash flows from Non-cash Interest expense programs. These benefits plans 1 January 2017 31 December 2017 negative (adverse) outcome certain obligations to its Ukrainian hryvnias financing activities transactions (Note 20) are not funded, and there are no of the court and arbitration employees according to the Bank borrowings 66,044 (38,627) 25,069 6,829 59,315 plan assets. procedures. collective agreements. Bonds 4,800 (5,279) - 479 - Total 70,844 (43,906) (25,069) 7,308 59,315

Non-cash transactions relate to payment for the natural gas acquired by a lending bank and foreign exchange differences.

236 237 FINANCIAL STATEMENTS ANNUAL REPORT 2017

The principal actuarial assump- The sensitivity analysis pre- The decommissioning provision 16. ADVANCES RECEIVED AND OTHER CURRENT LIABILITIES tions used were as follows: sented above may not be repre- represents present value of sentative of the actual change in decommissioning costs relating The Group’s advances received and other current liabilities were as follows: the non-current employee ben- to oil and gas properties. 2017 2016 In millions of Ukrainian hryvnias 31 December 2017 31 December 2016 efit obligations as it is unlikely Nominal 14.5–14.6 14.7–14.9 that the change in assumptions Provision for fines and penal- Advances from customers for natural gas 1,461 1,130 discount would occur in isolation of one ties Advances for natural gas transportation 448 316 rate, % another as some of the assump- As a result of non-payment and Advances for oil transportation 301 303 Long-term 6.7 7.7 tions may be correlated. inflation, % late payment by “Ukrnafta” PJSC Advances received for geophysical surveys 237 240 of subsoil royalty, income tax Nominal 10.0–16.0 10.0–36.0 Furthermore, in presenting the Advances for petroleum products 149 205 and VAT, the Group had accrued salary above sensitivity analysis, the Other advances received 85 132 increase rate, provision for possible fines, pen- present value of the employee Total advances received 2,681 2,326 % alties and late payment interest. benefit obligations has been cal- Indebtedness according to the Gas Sales Arbitration 57,125 – Staff 1.5–5.3 1.5–5.7 culated using the projected unit turnover credit method at the end of the Taxes payable other than income tax 10,347 13,768 ratio, % reporting period, which is the VAT payable 4,138 6,195 same as that applied in calculat- Liabilities for purchase of property, plant and equipment 2,002 1,050 The sensitivity of the non-current ing the obligation recognised in Dividends payable to non-controlling shareholders of “Ukrnafta” PJSC 475 2,781 employee benefit obligations to the consolidated statement of changes in the principal assump- financial position. Wages, salaries and related social charges payable 348 343 tions is as follows: Recognised liabilities for litigations 47 482 There were no changes in the Other current liabilities 1,445 1,382 2017 2016 methods and assumptions used Total other current liabilities 75,927 26,001 in preparing the sensitivity anal- Nominal (7.68) / (7.60) / Total 78,608 28,327 ysis from prior years. discount rate 8.84 8.75 increase/ As at 31 December 2017, taxes On 22 December 2017, the award in other current liabilities. decrease by Decommissioning Provision payable other than income Company received the Final In February 2018, the Company 1%, % In accordance with the legisla- tax include UAH 10,128 million Award of the Arbitral Tribunal in received a legal right to set-off Nominal salary 7.22 / 6.54 / tion requirements, the Group of subsoil royalty payable the Gas Sales Arbitration (Note the amounts owing between increase/ (6.46) (5.93) is obliged to restore the lands (31 December 2016: 23). As at 31 December 2017, the parties pursuant to the Gas decrease by that underwent changes in the UAH 13,450 million). the Company recognised its Sales Arbitration and Gas Transit 1%, % relief structure, environmental obligations in respect of this Arbitration (Note 23). Staff turnover (4.68) / (3.96) / state of soils and parent rocks, as increase/ 5.44 4.58 well as hydrological regime due decrease by to drilling, geological survey, 1%, % constructing and other works.

238 239 FINANCIAL STATEMENTS ANNUAL REPORT 2017

17. COST OF SALES 20. FINANCE COSTS

In millions of Ukrainian hryvnias 2017 2016 In millions of Ukrainian hryvnias 2017 2016 Cost of gas supplied 52,527 27,267 Interest expense on bank borrowings 7,308 8,634 Depreciation, depletion and amortisation 39,191 23,003 Unwinding of discount on employee benefit obligations 521 379 Subsoil royalty and other taxes other than on income 24,999 37,508 Unwinding of discount of decommissioning provision 152 134 Non-reimbursable VAT on gas transit 14,788 11,998 Other 321 434 Cost of purchased oil and petroleum products 8,782 6,877 Total 8,302 9,581 Staff costs and related social charges 7,781 6,433 Repair and maintenance costs 861 834 21. FINANCE INCOME Oil and gas transportation costs 407 1,169 2016 Other 7,811 6,715 In millions of Ukrainian hryvnias 2017 (as restated, Note 3) Total 157,147 121,804 Interest income on bank deposits and bank balances 1,244 1,182 Subsoil royalty and rent tax are calculated with reference to the volume of crude oil, gas condensate or natural Unwinding of discount 213 4,328 gas produced, and volume of crude oil transportation. Other 141 403 Total 1,598 5,913 18. OTHER OPERATING INCOME

In millions of Ukrainian hryvnias 2017 2016 22. INCOME TAX Change in provisions for litigations and other provisions 2,787 – The components of income tax expense for the years ended 31 December were as follows: Income from sale of inventories and other current assets 1,594 76 2016 Fines and penalties received 259 1,112 In millions of Ukrainian hryvnias 2017 (as restated, Note 3) Reversal of inventories impairment – 749 Current tax expense 22,426 8,042 Other 452 690 Deferred tax benefit (9,124) (7,406) Total 5,092 2,627 Income tax expenses 13,302 636

19. OTHER OPERATING EXPENSES The Group is subject to taxation was levied on taxable income Reconciliation between the in Ukraine. In 2017 and 2016, less allowable expenses at the expected and the actual taxation 2016 In millions of Ukrainian hryvnias 2017 Ukrainian corporate income tax rate of 18%. charge is provided below: (as restated, Note 3) Net movement in provision for trade accounts receivable, prepayments 12,353 24,383 2016 In millions of Ukrainian hryvnias 2017 made and other assets and direct write-offs (as restated, Note 3) Staff costs and related social charges 5,227 3,861 Profit before income tax 52,751 18,485 Impairment of property, plant and equipment 3,399 1,231 Income tax at statutory rate of 18% 9,495 3,327 Fines and penalties 1,356 354 Effect of changes in tax legislation - (924) Professional fees 716 618 Tax effect of items not deductible or assessable for taxation purposes: Depreciation and amortisation 633 1,065 • Non-deductible expenses 2,964 1,876 Write down of inventories to net realisable value 451 – • Non-taxable income (1,895) (133) Transportation costs 449 326 Change in unrecognised deferred tax asset 2,738 (3,510) Research, development and exploration costs 387 250 Income tax expenses 13,302 636 VAT liabilities written off 260 279 Change in provisions for litigations and other provisions – 10,957 Other 2,244 2,221 Total 27,475 45,545

240 241 FINANCIAL STATEMENTS ANNUAL REPORT 2017

Parent and its subsidiaries are liabilities are presented on an the consolidated statement of As at 31 December 2017 and 2016, unrecognised deductible temporary differences and unused tax losses are as separate tax payers and, there- individual basis. The deferred tax financial position after appropri- follows: fore, the deferred tax assets and liabilities and assets reflected in ate set off are as follows: 31 December 2016 (as In millions of Ukrainian hryvnias 31 December 2017 31 December 2016 restated, Note 3) In millions of Ukrainian hryvnias 31 December 2017 (as restated, Note 3) Tax losses carried forward – 19,328 Deferred tax assets 4,204 4,508 Provisions 45,529 8,977 Deferred tax liabilities (67,304) (82,312) Inventories 9,327 11,145 Net deferred tax liability (63,100) (77,804) Trade accounts receivable, prepayments made and other current assets 14,387 14,387 Net deferred tax liabilities as at 31 December 2017 related to the following: Property, plant and equipment – 196 Total 69,243 54,033 Recognised in other 31 December 2016 Recognised in profit In millions of Ukrainian hryvnias compre-hensive 31 December 2017 (as restated, Note 3) or loss income 23. CONTINGENCIES, COMMITMENTS AND OPERATING RISKS Property, plant and equipment (84,890) 9,068 5,488 (70,334) Trade accounts receivable 300 64 - 364 Tax legislation. Ukraine’s tax Where management of the Group ment cannot estimate impact of Advances received and other - 57 - 57 environment is characterised by estimates the risk of financial such potential obligations to the current liabilities complexity in tax administer- resources outflow as possible, the consolidated financial statements ing, arbitrary interpretation by Group makes a disclosure of these reliably, and does not recognise Provisions 3,588 933 92 4,613 tax authorities of tax laws and contingent liabilities. any provision in this respect as at Inventories 125 1,550 - 1,675 regulations that, inter alia, can 31 December 2017. Prepayments made and other 418 108 - 526 increase fiscal pressure on tax As at 31 December 2017, man- current assets payers. Inconsistent application, agement estimated possible The Group conducts transactions Trade accounts payable 27 (27) - - interpretation, and enforcement tax exposures in total amount with its subsidiaries. It is possible Other non-current assets (2) 1 - (1) of tax laws can lead to litiga- of UAH 6,374 million, including with evolution of the interpre- tion which, as a consequence, different taxes exposure of tation of tax law in Ukraine and Unused tax losses 2,630 (2,630) - - may result in the imposition of UAH 5,842 million and related changes in the approach of tax Net deferred tax liability (77,804) 9,124 5,580 (63,100) additional taxes, penalties, and penalties of UAH 532 million authorities under the Tax Code, interest, and these amounts (2016: UAH 5,802 million and that such transactions could be Net deferred tax liabilities as at 31 December 2016 related to the following: could be material. Facing current UAH 498 million, respectively). challenged in the future. The economic and political issues, the impact of any such challenge can- Recognised Recognised in other 31 December 2016 Government has implemented Management believes that it is not be estimated, however, man- In millions of Ukrainian hryvnias 1 January 2016 in profit compre-hensive (as restated, Note 3) or loss income certain reforms in the tax system not likely that any significant set- agement believes that it should of Ukraine by adopting the Law tlement will arise from the above not be significant. Property, plant and equipment (86,534) 3,208 (1,564) (84,890) of Ukraine “On Amending the Tax cases and, therefore, the Group’s Trade accounts receivable 63 237 - 300 Code of Ukraine and Certain Laws consolidated financial statements The Group exports refinery prod- Provisions 2,402 1,155 31 3,588 of Ukraine” which is effective from do not include any amount of ucts and transportation services, Inventories 399 (274) - 125 1 January 2015, except for certain provision in this respect. performs intercompany transac- provisions which will take effect at tions and is involved in transac- Prepayments made and other (3) 421 - 418 a later date. During 2015 “Ukrnafta” PJSC tions with related parties, which current assets was engaged in transactions for may potentially be in the scope of Trade accounts payable 3 24 - 27 Management believes that the petroleum products and crude oil the new Ukrainian transfer pricing Other non-current assets (4) 2 - (2) Group has been in compliance sales, and made prepayments in (“TP”) regulations. The Group’s Unused tax losses (3) 2,633 - 2,630 with all requirements of the effec- respect of future supply of petro- companies have submitted the Net deferred tax liability (83,677) 7,406 (1,533) (77,804) tive tax legislation. In the ordinary leum products. In 2017 National controlled transaction report for course of business the Group is Anti-corruption Bureau of Ukraine the year ended 31 December engaged in transactions that may initiated a claim in the court 2016 within the required dead- be interpreted differently by the to declare such transactions line. The report on controlled Group and tax authorities. Where invalid. The Group’s management transactions for the year ended the risk of outflow of financial believes that there is likelihood 31 December 2017 shall be pre- resources associated with this that certain transactions per- pared by the Group’s companies is deemed to be probable and formed by “Ukrnafta” PJSC can be by 1 October 2018. the amount is measured with challenged or declared invalid in sufficient reliability, the Group future, leading to additional tax Management believes that the provides for those liabilities. obligations. The Group’s manage- Group is in compliance with TP

242 243 FINANCIAL STATEMENTS ANNUAL REPORT 2017 requirements. As the practice to the date of the Final Award; • The contractual annual vol- Gas Transit Arbitration. Naftogaz. As a result, the tration, supporting a respective of implementation of the new (b) decided that Naftogaz is ume of gas on “take or pay” Tribunal awarded approx. Naftogaz request. Consequently, Naftogaz initiated the Gas Transit transfer pricing rules has not terms (“MAQ”) was set as 80% USD 4,674 million to be paid a single amount of USD 2,560 mil- entitled to a market-reflective Arbitration on 13 October 2014 yet developed and wording of of ACQ. in favour of Naftogaz by Gaz- lion payable by Gazprom in favour reduction of the sales price and under the auspices of the Arbi- some clauses of the rules may be prom for its failure to deliver of Naftogaz was ordered by the to gas market indexation of the • It is not responsibility of tration Institute of the Stockholm subject to various interpretations, minimum gas transit con- Tribunal. This amount also bears price formula, with retrospective Naftogaz to pay for gas vol- Chamber of Commerce. In its the impact of challenge of the tract volumes. This amount a late payment interest. There effect from April 2014; (c) has umes delivered to occupied Statement of Claim, Naftogaz Group’s companies transfer pric- represents compensation of was no settlement of this amount declared invalid provisions territories of the Donetsk and claimed a revision of the transit ing positions by the tax authori- losses in this respect, plus performed by the date of these in the Gas Sales Contract in Luhansk regions to the parties tariff with retroactive effect, com- ties cannot be reliably estimated. interest up to 28 Febru- separate financial statements. Tak- respect of a destination clause, other than Naftogaz. pensation for underpayments ary 2018. ing that Gazprom has appealed illegally prohibiting sales of the as a result of tariff revision, com- Arbitral Tribunal requests. • As a result, as set in the the final award in the Gas Transit gas outside of Ukraine from pensation for underdeliveries, • Naftogaz also claimed com- Final Award, and taking the Arbitration, and the fact that the the date of the Contract. The amendments to the Gas Transit pensation of VAT that arises on obligation to pay for gas amount was not settled by the Gas Sales Arbitration. Tribunal has obliged the parties Contract authorising Naftogaz to damages awarded Naftogaz consumed but not paid for, date of these separate financial to determine the elements of gas assign its rights and obligations for underdeliveries, taking Naftogaz was ordered to pay statements, management follows The Gas Sales Arbitration was price formula to be used for gas under the Contract to “Ukrtrans- effect as at 1 January 2016. initiated by both Naftogaz and to Gazprom USD 2,019 million a prudent approach and does supplies starting from 27 April gaz” PJSC or any other entity However, the Tribunal has Gazprom on 16 June 2014 under and late payment interest in not recognise the amount owed 2014 through negotiations. Such designated as transmission sys- rejected such claim from Naf- the auspices of the Arbitration amount equal to 0.03% on by Gazprom after the set-off, as negotiations took place during tem operator, and certain other togaz. Institute of the Stockholm any amount overdue for each decided by the Tribunal, as receiv- June-August 2017, but the parties adjustments to the Contract. As • Naftogaz’s claim for underpay- Chamber of Commerce. In day of delay in payment after able as at 31 December 2017. failed to reach agreement on at 31 December 2017, Naftogaz’s ments were not supported, its Request for Arbitration, 22 December 2017 until the remaining issues, and thus, the maximum monetary claim stood as Naftogaz in its request for Gazprom claimed payment of payment has been made. As stated above, after both Final Tribunal had to decide on such at more than USD 12.5 billion transit tariff revision in 2009 unpaid invoices for gas delivered Later, on 17 January 2018, the Awards were rendered, Gazprom issues on its own. After additional including interest (up to USD did not follow the contractual under the Gas Sales Contract Arbitral Tribunal has amended representatives officially declared oral hearings in October 2017, 10.6 billion excluding interest). requirements. At the same from November 2013 to May this amount, and has set a a refusal to resume deliveries to all remaining issues and any Gazprom has submitted a coun- time, transit tariff was retro- 2014, while Naftogaz claimed a net payable from Naftogaz Ukraine as ordered by the Tribu- resulting monetary claims were terclaim in amount of approxi- spectively revised in relations retroactive revision of the price to Gazprom at the level of nal in the Gas Sales Arbitration. left for the final award. mately USD 7.0 million including to the adjustment to the tran- under the Gas Sales Contract, USD 2,030 million plus respec- Additionally, Gazprom refused interest (up to USD 5.3 million sit tariff as a result of the gas and compensation for previous tive late payment interest to confirm its intention to settle On 7 November 2017 Gazprom excluding interest), but has price made by the Tribunal in overpayments under the prices after 22 December 2017. outstanding amount as decided has challenged the separate the Gas Sales Arbitration. reserved the right to make addi- by the Tribunal in the Gas Transit applied before the revision. award on Gas Sales Arbitration During January-February tional counterclaims after receiv- • The Tribunal rejected Naf- Arbitration. Instead, Gazprom has in the Court of Appeal of Svea 2018 Naftogaz and Gazprom had ing the award in the Gas Sales togaz claim in respect of the officially suggested to amend In addition, Gazprom has later (Sweden). added a claim for payment of gas a number of negotiations to agree Arbitration. possibility to assign its rights both contracts or to terminate the gas supply process in 2018. and obligations under the them, and thus to reverse the which Gazprom did not deliver, On 22 December 2017 the Arbi- Following the Final Award in this Both the Gas Sales Arbitration Contract to “Ukrtransgaz” PJSC awards of the Tribunal. Gazprom but which Naftogaz allegedly tral Tribunal rendered the Final nevertheless was obliged to pay case, in February 2018 Naftogaz and the Gas Transit Arbitration or any other entity designated actions violate and neglect the Award in the Gas Sales Arbitration, for under the Contract (the “take has made a prepayment for were initiated by Naftogaz fol- as transmission system opera- awards rendered by the Tribunal stating the following: or pay” claim). gas deliveries to be made in lowing unsuccessful efforts to tor. that are final and binding for Gaz- • Contract price for natural gas March 2018. However, Gazprom reach agreement with Gazprom • The Tribunal has also rejected prom. Naftogaz finds this position On 31 May 2017 The Arbitral shall be calculated with 100% has returned this payment and in negotiations. The monetary Naftogaz claim in respect of unacceptable and has rejected Tribunal rendered a separate reference to the European refused to make gas supplies claims in both Arbitrations have adjustments to the Gas Transit Gazprom’s proposals to make award in the Gas Sales Arbitration. hub price under the revised in March 2018. Such actions been updated on a continuous Contract according to the EU amendments to the contracts. The separate award is final and price formula. from Gazprom currently prevent basis until the awards, inter alia in competition and energy law, Naftogaz from fulfilling the Final respect of interest calculations. stating that it is not the role Despite the fact that the Tribunal legally binding, and sets all • Gazprom “take or pay” claim legal and factual issues required Award requirements in respect of the Tribunal to implement has rejected Naftogaz claim on was fully rejected. to resolve the parties’ claims of offtaking MAQ volumes in On 28 February 2018 the Arbitral reforms in Ukraine but should VAT compensation of losses except for certain elements • Annual contract quantity 2018, and could result in a new Tribunal rendered the Final Award be decided by the Ukrainian for underdeliveries after 1 Jan- and/or values of a numeric or (“ACQ”) of gas that Naftogaz claim from Naftogaz in respect of in the Gas Transit Arbitration, stat- government. uary 2016, Naftogaz treats the quantifiable nature that had is obliged to purchase during compensation for losses against ing the following: amount awarded as a contractual to be defined before the Final 2018–2019 was set at the Gazprom. The Company considers • Naftogaz’s claim for mini- Further, the Tribunal has per- price of services adjustments, Award. The Tribunal in its award level of 5.0 billion cubic Gazprom’s refusal to supply gas as mum contractual volume formed a set-off in respect of that is subject to VAT under the of 31 May 2017: (a) declared metres. This Final Award also a contractual violation and non- of gas transit (underdeliv- amounts owing between the Tax Code of Ukraine. As a result, “take or pay” claim invalid from contains a quarterly distribu- compliance with the Tribunal’s eries) during 2009–2017 parties pursuant to the Gas Sales Naftogaz has recognised respec- the date of the Contract and up tion of gas deliveries in 2018. Final Award. was decided in favour of Arbitration and Gas Transit Arbi- tive VAT liabilities amounting to

244 245 FINANCIAL STATEMENTS ANNUAL REPORT 2017

UAH 4,751 million in March 2018, and other disputes. Management agreement. In January 2010 Naf- to satisfy its working capital joint-stock companies included handle oil and gas transmission payable by 30 April 2018. assesses its contingent liabilities togaz and the non-controlling needs and settle its tax payments JSC Long-Distance Pipeline and distribution pipelines owned under such disputes at the level shareholders of “Ukrnafta” PJSC as they fall due. Consequently, “Druzhba” and JSC “Prydniprovs- by the State of Ukraine, keep Claim to the Russian Federation of UAH 3,569 million (2016: (“Ukrnafta”) signed a shareholders as at 31 December 2017 and kiy” Long-Distance Pipeline that the state property in adequate regarding assets in Crimea. In UAH 3,928 million). Management agreement that included, among 2016 Ukrnafta had a negative were reorganised in 2001 into operational condition, and October 2016, Naftogaz and its cannot reliably estimate amount other, setting the procedure of working capital and incurred net JSC “Ukrtransnafta”, JSC “Ukrspet- transfer 50% share of profits subsidiaries initiated Arbitration of potential losses on these obli- electing the Chairman of the loss for the year ended 31 Decem- stransgaz”, “Chornomornaftogaz” received from using those assets proceeding against the Russian gations, if any. Board, appointment of the Exec- ber 2016. National JSC, JSC “Ukrnafta” and to the State. The amount of such Federation about reimbursement utive Board and the Supervisory fifty-four regional gas distribution transfer could be reduced by the of losses caused by unlawful Joint operations with Misen board members. Under the share- In 2017 Ukrnafta extended its entities. amount of capital investments occupation of Group’s assets in Enterprises AB, and “Kar- holders agreement the Chairman oil and gas producing licenses in those assets. The Agreement Crimea by the Russian Federa- patygaz” LLC. As a part of deter- of the Board is to be elected from that were suspended the State The Government of Ukraine may does not provide a mechanism of tion. This arbitration proceeding mining the validity of the joint among the candidates nominated Fiscal Authority of Ukraine in transfer ownership or control such calculations, and historically was initiated under Agreement arrangement, in July 2016, the by the non-controlling sharehold- 2015–2017. Ukrnafta also applied over all or part of the Company’s there were no payments from between the Cabinet of Ministers Group initiated legal proceedings ers, 6 of 11 Ukrnafta Supervisory to extend its producing licenses equity interest in those joint-stock the Group to the State in of Ukraine and the Government of in the Stockholm Arbitration on board members, including expiring in 2018. Management companies and/or other state- respect of using such assets. the Russian Federation on mutual termination or recognition as Chairman, are to be nominated believes that these licenses will be owned oil and gas transportation The Group believes that had the encouragement and protection of invalid of this agreement. Oral by Naftogaz, and remaining 5 successfully extended. and storage facilities to other mechanism for calculating the investments. hearings under the case were members by the non-controlling companies or Government agen- state share in profits from using held in November 2017 and Jan- shareholders. If Ukrnafta fails to restructure or cies, and those actions could have the assets been determined by On 15 September 2017, Naftogaz uary 2018. Management expects otherwise ensure settlement of a material adverse effect to the the State, the capital investments and its subsidiaries have submitted that, by late May 2018, the Arbi- Under the shareholders agree- overdue accounts receivable, pre- Company’s operations. performed by the Group would the Statement of Claim to the tration will pass a preliminary ment, any dispute arising in con- payments made, extend produc- be greater, and no payment in Tribunal under the auspices of decision on all conceptual issues nection with it is to be resolved tion licenses and perform other State property not subject favour of the State would occur. Permanent Court of Arbitration in within the said proceedings. Also, exclusively by the London Court measures to minimise amount of to privatisation. In 1998, the Accordingly, no liability for the Hague. The amount of claim in accordance with the Ukrainian of International Arbitration and net current liabilities, this could Company entered into an such payment was recognised will be estimated following the legislation, within the criminal the shareholder agreement is lead to insufficient funds to settle agreement “On use of the State in these consolidated financial Tribunals’ Partial Final Award, which proceedings, an issue on the governed by the English law. accumulated tax liabilities in the owned property not subject statements. is expected in the early 2019. validity of entering into this joint short run, and this will lead to to privatisation” (“Agreement”) arrangement is being investi- In April 2018 the London court additional measures to ensure with the State Property Fund of Capital commitments. Capital Legal proceedings. In the normal gated. of international arbitration came the going concern assumption, Ukraine, and received oil and commitments for purchase of course of business, the Group is to the conclusion that the key including negotiations in respect gas transportation system into property, plant and equipment, subject to claims. Where the risk Irrespectively of the decision provisions of the Joint agree- of export operations or partial sale the operational control. The and exploration and devel- of outflow of financial resources adopted by the Arbitration, it is ments between Naftogaz and the of assets. Agreement was signed for one opment of oil and gas fields associated with such claims is expected that the joint arrange- companies of non-controlling year, and its term is prolonged comprise UAH 11,573 million as assumed as probable, a respective ment between the Group, Misen shareholders on corporate man- Despite the material uncertainties automatically for one year, unless at 31 December 2017 (31 Decem- liability is recognised as a com- Enterprises AB, and LLC “Kar- agement of Ukrnafta are such that described above, and taking into terminated by notice from either ber 2016: UAH 1,260 million). ponent of provision for litigations patygaz” will be terminated, and cannot be enforced because they account Ukrnafta’s positive cash party, and is binding on the (Note 15). Where management the assets of the joint arrange- contradict the imperative norms flow for the year 2017 and man- legal successor of each party. estimates the risk of outflow of ment will be transferred into own- of the corporate legislation of agement actions in improving Historically, the agreement has financial resources associated ership of the Group. Consider- Ukraine. its liquidity, production and sales been prolonged automatically, with such claims as possible, or ation to Misen Enterprises AB and activities, management of the as neither party initiated its amount of outflow cannot be LLC “Karpatygaz” for the transfer of Uncertainty as to the ability of Group believes that application of termination. As the State property measured reliably, no provision their interests in the assets of the “Ukrnafta” PJSC to continue the going concern assumption in not subject to privatisation forms is recognised, and respective joint arrangement to the Group as a going concern. Following respect of Ukrnafta is appropriate an essential part of the Group’s amount is disclosed in the con- may reach up to USD 363 mil- accumulated debts to the State for the purpose of these consoli- business, the future operations solidated financial statements. lion, depending on the decision Budget of UAH 26,920 million as dated financial statements. and financial performance of Management believes that it has adopted by the Arbitration, but at 31 December 2017 (31 Decem- the Group depends on the provided for all material losses the Management believes that ber 2016: UAH 24,379 million), Possible transfer of the Com- prolongation of the Agreement. in these consolidated financial the consideration will not exceed limited ability to collect accounts pany’s equity interest in the The Group’s management statements. the carrying amount of the assets. receivable and settle prepayments subsidiaries to the State. In 1998, believes that the Group will made to suppliers with gross upon creation of the Company, continue to operate with this The Group and certain natural gas Dispute with the non-controlling amount of UAH 22,525 million as the Government of Ukraine con- property in the foreseeable future. suppliers have disputes in respect shareholders of “Ukrnafta” at 31 December 2017 (31 Decem- tributed certain shares of joint- of volumes and/or prices for PJSC in respect of the validity ber 2016: UAH 22,680 million), stock companies to the share Pursuant to the Agreement, the natural gas supplied to the Group and fulfilment of shareholders Ukrnafta had insufficient funds capital of the Company. These Company is required, inter alia, to

246 247 FINANCIAL STATEMENTS ANNUAL REPORT 2017

24. FINANCIAL RISK MANAGEMENT rate risk), concentration the potential adverse effects The exposure was calculated only for monetary balances denominated in currencies other than the functional risk (Note 4), credit risk and on the Group’s financial currency of the Group’s entities. The Group’s activities expose liquidity risk. According to its performance for those risks. it to a variety of financial risk management policy the At 31 December 2017 At 31 December 2016 Group identifies, assessed and Major categories of financial In millions of Ukrainian hryvnias Impact on Impact on risks: market risk (including Impact on equity Impact on equity currency risk and interest develops actions to minimise instruments: profit or loss profit or loss USD strengthening by 10% (123) (123) (3,400) (3,400) 31 December 31 December 2016 In millions of Ukrainian hryvnias Note USD weakening by 10% 123 123 3,400 3,400 2017 (as restated, Note 3) EUR strengthening by 10% (1,167) (1,167) 251 251 Other non-current assets 8 6,118 5,832 EUR weakening by 10% 1,167 1,167 (251) (251) Trade accounts receivable 10 58,988 49,209 Prepayments made and other current assets 11 1,531 1,598 Interest rate risk. The Group If floating interest rates on USD of products on credit terms and Сash and bank balances 12 23,093 22,336 normally has no significant and EUR denominated borrow- other transactions with coun- Restricted cash 1,591 680 interest bearing assets, and its ings had been 100 basis points terparties giving rise to financial Total financial assets 91,321 79,655 income and operating cash flows higher as at 31 December 2017 assets. The Group’s policy is that are substantially independent with all other variables remain- the customers that wish to pay 31 December 31 December of changes in market interest ing constant, net profit for 2017 on credit terms are subject to In millions of Ukrainian hryvnias Note 2017 2016 rate. The Group’s interest rate risk would have been UAH 149 mil- the solvency check. Significant exposure arises from borrowings lion lower (2016: UAH 40 million outstanding balances are also Borrowings 14 (59,315) (70,844) at variable interest rates. lower). reviewed on an ongoing basis. Trade accounts payable (8,137) (16,234) Borrowings at fixed rate expose At the same time, the Group Advances received and other current liabilities 16 (3,381) (2,777) the Group to fair value interest Other price risk. The Group must follow the state regulations Other long-term liabilities – (4) rate risk. determines other price risk as within public service obligations Total financial liabilities (70,833) (89,859) risk of possible future losses as in respect of gas sales to certain The Group attracts borrowings at a result of price volatility during gas market participants irrespec- both fixed and floating interest purchase and sale transactions. tive whether they are delinquent Market risk. The Group takes on Currency risk. The Group foreign currencies. The Group rates. As at 31 December 2017 Both volatility in gas prices at the or not. exposure to market risks. Market operates within Ukraine and its does not hedge its foreign almost 34% of the Group’s bor- European gas hubs that impacts risks arise from open positions exposure to foreign currency currency positions. rowings were provided at floating gas purchase prices, and gas The Group establishes a provision in (a) foreign currencies, (b) risk is determined mainly by rates (31 December 2016: 12%). sale and supply to customers at for impairment that represents interest bearing assets and purchases of natural gas from The Group’s exposure to foreign The risk of increase in market prices set by the NCREU within its estimate of incurred losses in liabilities, and (с) assets and foreign suppliers, which are currency risk is as follows, based interest rates is monitored by PSO imposed on the Company respect of trade accounts receiv- liabilities that are exposed to denominated in USD. The Group on carrying amounts of respective the Treasury department of the (Note 2) expose the Group to the able. The main component of this other price risk. also receives borrowings in currency assets and liabilities: Group. The key objective of man- price risk. To manage this risk and provision is a specific loss com- aging interest rate risk is to get offset its negative impact on the ponent that relates to individually 31 December 2017 31 December 2016 In millions of Ukrainian hryvnias financing at a minimum costs, Group’s financial position, the significant exposures. USD EUR Others USD EUR Others and match the liquidity needs Group, amongst other measures, Restricted cash 539 951 – 680 – – with the proceeds from borrow- is actively taking part in gas mar- The maximum exposure to credit Cash and bank balances 18,246 2,718 88 14,998 2,740 67 ings. ket reform in Ukraine and intro- risk as at 31 December 2017 is duce the principle of free pricing UAH 91,321 million (31 Decem- Trade accounts receivable 7,086 – – 6,642 – – The borrowing activities are for all groups of customers. In gas ber 2016: UAH 79,655 million). Prepayments made and other 3 – – 684 7 – reviewed on an annual basis. supply for groups of customers at current assets Long-term investing activities and prices established independently The Group does not hold any col- Other non-current assets – 307 – – 245 – associated funding are considered by Naftogaz on a monthly basis lateral as security. Borrowings (26,610) (11,447) – (43,316) (213) – separately, and are subject to the price risk is not considered to be Trade accounts payable (356) (4,133) (4) (13,602) (268) (10) Government of Ukraine approval. significant. Liquidity risk. Prudent liquidity The maturity dates of financial management implies maintain- Advances received and other (139) (67) – (85) – 1 liabilities are further disclosed in Credit risk. The Group takes on ing sufficient cash and the avail- current liabilities this Note. exposure to credit risk, which ability of funding to meet exist- Net (short)/long currency (1,231) (11,671) 84 (33,999) 2,511 58 is the risk that one party to a ing obligations as they fall due. position Re-pricing for fixed rate finan- financial instrument will cause a The Group’s objective is to main- cial instruments occurs at their financial loss for the other party tain a balance between the con- The following table to reasonably possible date, with all other maturity. Re-pricing for floating by failing to discharge an obliga- tinuity of funding and flexibility presents sensitivities of changes in exchange rates variables held constant. rate financial instruments occurs tion. Exposure to credit risk arises through the use of credit terms profit or loss and equity applied at the reporting continually. as a result of the Group’s sales provided by suppliers and banks.

248 249 FINANCIAL STATEMENTS ANNUAL REPORT 2017

Prepayments are commonly used business cash flows and bor- the reporting date to the contrac- 25. FAIR VALUE and appropriate valuation of a particular instrument or to manage both liquidity and rowed funds. Borrowed funds are tual maturity date. The amounts methodologies. However, pay in the transfer of liabilities. credit risks. The Group analyses also used to finance the Group’s disclosed in the table are undis- IFRS defines fair value as judgement is necessarily ageing of its assets and maturity working capital needs. counted cash flows of principal the price that would be required to interpret Fair value of property, plant and of its liabilities and plans liquidity and interest payments. received to sell an asset or market data to determine equipment depending on their expected The following table analyses the paid to transfer a liability in an the estimated fair value. repayment. The Group has capi- Group’s financial liabilities into The maturity analysis of financial orderly transaction between Management has used all Property, plant and equipment tal construction programs which relevant maturity groupings liabilities as at 31 December 2017 market participants at the available market information in are measured at fair value at the are funded both through existing based on the remaining period at was as follows: measurement date. estimating the fair value. The end of each reporting period. The estimates presented herein are following table provides infor- Up to 6 6–12 In millions of Ukrainian hryvnias 1–2 years 2–5 years Over 5 years Total The estimated fair values not necessarily indicative of mation about how the fair values months months have been determined by the the amounts the Group could of these assets are determined Borrowings 25,759 23,067 6,321 11,918 159 67,224 Group using available market realise in a market exchange (in particular, the valuation tech- Trade accounts payable 8,131 6 - - - 8,137 information, where it exists, from the sale of its full holdings niques and inputs used): Advances received and other 3,303 78 - - - 3,381 Fair value current liabilities Assets Valuation techniques and key inputs hierarchy Total 37,193 23,151 6,321 11,918 159 78,742 Property, plant and 3 The Group engages professional independent appraisers to determine the fair value The maturity analysis of financial liabilities as at 31 December 2016 was as follows: equipment of its property, plant and equipment by using a replacement cost method for the majority of groups. The fair value is determined as the cost of construction of these items at current prices less the economic obsolescence and physical tear and wear Up to 6 6–12 In millions of Ukrainian hryvnias 1–2 years 2–5 years Over 5 years Total to date. The main parameter used in this valuation technique are current prices on months months construction. Borrowings 33,684 19,706 16,349 12,123 - 81,862 For items for which there are market analogues (mainly buildings), the sales Other long-term liabilities 4 - - - - 4 comparison method is used, the prices of market-based sales of comparable properties in the immediate proximity are adjusted with reference to differences in Trade accounts payable 16,234 - - - - 16,234 main parameters (such as floor space of the property). The main parameter used in Advances received and other 2,775 1 1 - - 2,777 this valuation technique is the price per square meter of a property. current liabilities Property, plant and 2 The fair value of cushion gas is determined by application of the market price of gas Total 52,697 19,707 16,350 12,123 - 100,877 equipment at the end of the reporting date to the volume of cushion gas. The main parameters used in this valuation technique are market prices for gas at the end of the reporting Gearing ratio. Consistent with debt is calculated as total bor- equals total equity as shown in period. The market value of the cushion gas equals to the market price of gas others in the industry, the Group rowing (current and non-current the consolidated statement of less costs of its pumping and transportation to the point of sale. monitors capital on the basis of as shown in the consolidated financial position. The following table summarises property, plant and equipment recognised at fair value after initial recognition gearing ratio. This ratio is calcu- statement of financial position) using a fair value hierarchy: lated as net debt divided by total less cash and cash equivalents. The gearing ratio at the end of the capital under management. Net Total capital under management reporting period was as following: 31 December 2017 In millions of Ukrainian hryvnias 31 December 2017 31 December 2016 Total borrowings (Note 14) 59,315 70,844 In millions of Ukrainian hryvnias Level 2 Level 3 Total Less: cash and cash equivalents (Note 12) (23,093) (21,853) Property, plant and equipment 150,040 324,021 474,061 Total Net Debt 36,222 48,991 Total 150,040 324,021 474,061 Total Equity 440,519 455,589 Gearing ratio 0.08 0.11 31 December 2016

In millions of Ukrainian hryvnias Level 2 Level 3 Total Property, plant and equipment 153,566 386,599 540,165 Total 153,566 386,599 540,165

There were no transfers between Level 2 and Level 3 during the year.

250 251 FINANCIAL STATEMENTS ANNUAL REPORT 2017

Details of the Group’s property, plant and equipment and information about the fair value hierarchy as at Interrelationship 31 December 2017 are as follows: between key Group of Valuation Unobservable Description Range of unobservable inputs unobservable assets technique inputs Interrelationship inputs and fair between key Group of Valuation Unobservable value measurement Description Range of unobservable inputs unobservable assets technique inputs inputs and fair Gas ex- Pipelines Depreciated Remaining 0–50 The shorter the value measurement traction and related replacement period for natural period, the lower assets equipment cost meth- gas extraction, the fair value due Gas trans- Pipelines Depreciated Period when 2018–2019 The longer the Buildings od using the years (based to lower remaining mission and related replacement transit revenues period of income Machinery income ap- on proved periods of the use system and equipment cost meth- are received generation from and equip- proach for and probable of extraction assets gas stor- Buildings od using the transit, the higher ment economic reserves ages Machinery income ap- the fair value Other fixed obsolescence determined by and equip- proach for Applicable 110 bcm p.a. (based on minimal If Gazprom refuses assets determination an independent ment economic transit volumes contract volumes from transit to transit less expert) Other fixed obsolescence contract with Gazprom) then 110 bcm Natural gas Price for the period from 2018 to The higher the assets determination p.a. in 2018–2019, selling price 2020 is regulated for the volume selling price, the Naftogaz will of delivery under laying of special higher the fair have the right to duties. Market price for the volume value claim damages of delivery to the market is formed from Gazprom for on the basis of forecast prices for underdeliveries. natural gas in the German virtual The longer the gas trading point, plus cost of period of potential transportation to the Ukrainian arbitration western border and entrance fee. regarding such Market price for subsequent period claims, the is formed on the basis of forecast lower both the prices for natural gas in the German discounted virtual gas trading point, less cost value of such of transportation to the Ukrainian underdeliveries western border. and the fair value. Long-term Natural gas crude oil, deposits at The higher the rate, Date of The RBA-based tariffs are valid The later the forecast of depths up to 5000 m – 29%, over the lower the fair implementation for transportation services introduction of royalty rates 5000 m – 14% value of incentive from 2016 (cross-border gas incentive tariff / (estimated for Oil and gas condensate, deposits at tariff regulation pipelines), but they are not entry point fees, selling price) depths up to 5000 m – 45%, over system recognised by Gazprom. the lower the fair 5000 m – 21% Domestic entry tariffs (for value Nominal 18.70% The higher the local gas producers) are weighted weighted average currently put on hold by a average cost of cost of capital, the court decision, but begin to capital for UAH lower the fair value operate from 2019. The RBA- denominated based tariffs for storage begin cash flows to operate from 2021. Oil trans- Pipelines Depreciated Cumulative 0.38–0.79 The higher the The level of 11.89% The higher the bid, mission and related replacement factor of physical factor, the lower return on the the higher the fair system and equipment cost method and functional the fair value regulatory basis value storages Building using the depreciations of assets for Machinery income storage Nominal WACC 17.38% The higher the and approach for for UAH- weighted average Nominal 11.89% The higher the equipment economic denominated cost of capital, the WACC for USD- weighted average Other fixed obsolescence cash flow lower the fair value denominated cost of capital, the assets determination cash flow lower the fair value Fair value of financial assets The Group’s management statements approximate their fair and financial liabilities that are believes that, the carrying values as at 31 December 2017 not measured at fair value on amounts of financial assets and and 2016. a recurring basis (but fair value financial liabilities recognised disclosures are required). in the consolidated financial

252 253 FINANCIAL STATEMENTS ANNUAL REPORT 2017

26. SUBSEQUENT EVENTS result, the Company had to cover Dispute with the non-controlling 27. SUMMARY OF SIGNIFICANT as at and for the year ended converted at a rate close to the deficit in gas volumes from more shareholders of “Ukrnafta” ACCOUNTING POLICIES 31 December 2016. National Bank of Ukraine rate. At Refusal of “Gazprom” PJSC expensive sources of supply at PJSC in respect of the validity present, UAH is not freely convert- from fulfilling the Final Award the Western border of Ukraine. As and fulfilment of shareholders Statement of compliance. These Functional and presentation ible outside Ukraine. requirements rendered by the described in Note 23, such actions agreement. In April 2018 the consolidated financial statements currency. Items included in the Arbitration Institute of the Stock- from Gazprom currently prevent London court of international have been prepared in accor- financial statements of each of Basis for consolidation. Subsid- holm Chamber of Commerce. On Naftogaz from fulfilling the Final arbitration came to the dance with International Financial the Group’s entities are measured iaries are those companies over Award requirements in respect conclusion that the key provisions which the Group has control. 28 February 2018 the Tribunal ren- Reporting Standards (“IFRS”). using the currency of the pri- dered the Final Award in respect of offtaking minimum gas transit of the Joint agreements between mary economic environment in The Group controls an entity contract volumes in 2018. Naftogaz and the companies of when the Group has power over of the Gas Transit Arbitration, and Basis of preparation of consoli- which the Group operates (“the non-controlling shareholders the investee; is exposed to, or has supported Naftogaz’s position dated financial statements. This functional currency”). The con- On April 20, 2018 Gazprom has on corporate management of solidated financial statements are rights to, variable returns from its in respect of Gazprom failure to consolidated financial statements filed a Request for Arbitration Ukrnafta are such that cannot be presented in Ukrainian hryvnias involvement with the investee deliver minimum contractual have been prepared on the histor- to The Arbitration Institute of enforced because they contradict (“UAH”), which is the Company’s and has the ability use its power volume of gas transit (underde- ical cost basis except for property, the Stockholm Chamber of the imperative norms of the functional and the Group’s pre- to affect its returns. Subsidiaries liveries) during 2009–2017. As plant and equipment that are Commerce requesting revision corporate legislation of Ukraine sentation currency. All amounts are consolidated from the date a result, the Tribunal awarded. measured at revalued amounts at or, alternatively, setting aside (Note 23). presented in the consolidated on which control is transferred to USD 4,674 million to be paid in the end of each reporting period, favour of Naftogaz by Gazprom as of the Gas Transit and Gas Sales financial statements are pre- the Group (acquisition date) and as explained in the accounting a compensation of losses in this Contracts because of alleged Prolongation of the PSO Resolu- sented in UAH, rounded to the are deconsolidated from the date policies below. respect (Note 23). Additionally, imbalance between the parties’ tion. The Cabinet of Ministers of nearest million, if not otherwise that control ceases. according to the Final Award obligations under the Contracts Ukraine with its Resolution #228 stated. Historical cost is generally based of the Tribunal in the Gas Sales following Final Awards in both dated 28 March 2018 has pro- Intercompany transactions, bal- on the fair value of the consider- Arbitration, Naftogaz is obliged Transit and Sales Arbitration. longed the period of performing Transactions denominated in ances and unrealised gains or ation given in exchange for goods to resume purchases of gas from public service obligations by the currencies other than the relevant losses on transactions between and services. Gazprom according to the current Recognition of the Arbitral Tribu- Company (Note 2) up to 1 June functional currency are translated the Group companies are elim- Gas Sales Contract. Following nal Final Awards. The Company 2018. into the functional currency, using inated. Accounting policies of Fair value is the price that would the Final Award in this case, in has received a legal right to set- the exchange rate prevailing at subsidiaries have been changed February 2018 Naftogaz has made off the amounts owing between Loans repayment. During Janu- be received to sell an asset or paid the date of the transaction. For- where necessary to ensure con- a prepayment of USD 128 million the parties pursuant to the Gas ary-April 2018 the Group repaid to transfer a liability in an orderly eign exchange gains and losses, sistency with the policies adopted for gas deliveries to be made in Sales Arbitration and Gas Transit UAH 26,417 million of bank bor- transaction between market resulting from settlement of by the Group. March 2018. However, Gazprom Arbitration in February 2018, and rowings. This amount includes participants at the measurement such transactions and from the has returned this payment and further accounts for the amounts redemption of financing facility date, regardless of whether that translation of foreign currency The Company reassesses whether refused to make gas supplies in recognised as at 31 December from the European Bank for price is directly observable or denominated monetary assets or not it controls an investee if March 2018, and has decreased 2017 in current assets and current Reconstruction and Development estimated using another valuation and liabilities at year end, are facts and circumstances indicate pressure level in transmission liabilities on a net basis in its state- concluded in October 2015 that technique. recognised in the consolidated that there are changes to one or gas lines at their side of the gas ment of financial position (Notes was completed by the Company statement of profit or loss. Trans- more elements of control listed transmission system by 20%. As a 11, 16 and 23). in January 2018. These policies have been consis- lation at year end does not apply above. tently applied to all periods pre- to non-monetary items including sented, unless otherwise stated. equity investments. When the Group has a majority of the voting rights of an investee, it Purchases classification and As at 31 December, the exchange still considers whether the voting presentation. During 2016 rates used for translating foreign rights are sufficient to give it the “Ukrtransgaz” PJSC purchased currency balances were: practical ability to direct the rele- inventories and services in the vant activities of the investee uni- amount of UAH 4,279 million and laterally and, thus, has the power In Ukrainian 2017 2016 over the investee. performed capital expenditures hryvnias of UAH 1,872 million, included in property, plant and equipment. USD 1.00 28.07 27.19 The Group considers all relevant Nature of these expenses and EUR 1.00 33.50 28.42 facts and circumstances in assess- expenditures could be different ing whether or not the Group’s from their legal form according During 2017 and 2016 in Ukraine voting rights in an investee are to primary documents. These there were certain restriction sufficient to give it power, includ- expenses and expenditures were in respect of transactions with ing: presented on the basis of the rel- foreign currency, imposed by the • The size of the Group’s hold- evant primary documents in the National Bank of Ukraine (Note ing of voting rights relative consolidated financial statements 2). Foreign currency can be easily to the size and dispersion of

254 255 FINANCIAL STATEMENTS ANNUAL REPORT 2017

holdings of the other vote with IFRS 2 Share-based Pay- combination includes assets or sition date that have previously ognised directly in profit or loss. Investments in associates. Asso- holders; ments at the acquisition date; liabilities resulting from a contin- been recognised in other com- An impairment loss recognised ciates are entities over which the • Potential voting rights held by and gent consideration arrangement, prehensive income are reclassified for goodwill is not reversed in Group has significant influence the Group, other vote holders • Assets (or disposal groups) the contingent consideration is to profit or loss where such treat- subsequent periods. but not control. Investments in or other parties; that are classified as held for measured at its acquisition-date ment would be appropriate if that associates are accounted for using fair value and included as part of interest were disposed of. On disposal of the relevant the equity method of accounting. • Rights arising from other con- sale in accordance with IFRS the consideration transferred in a cash-generating unit, the attrib- The Group’s investment in asso- tractual arrangements; and 5 Non-current Assets Held for Sale and Discontinued Oper- business combination. Changes If the initial accounting for a utable amount of goodwill is ciate includes goodwill identified • Any additional facts and ations are measured in accor- in the fair value of the contingent business combination is incom- included in the determination of on acquisition, net of any accu- circumstances that indicate dance with that Standard. consideration that qualify as plete by the end of the reporting the profit or loss on disposal. mulated impairment loss. that the Group has, or does measurement period adjustments period in which the combination not have, the current ability to Goodwill is measured as the are adjusted retrospectively, occurs, the Group reports provi- Transactions with non-con- The Group’s share of its associates’ direct the relevant activities at excess of the sum of the consid- with corresponding adjustments sional amounts for the items for trolling interests. The Group post-acquisition profits or losses the time that decisions need eration transferred, the amount against goodwill. Measurement which the accounting is incom- treats transactions with non-con- is recognised in the consolidated to be made, including voting of any non-controlling interests period adjustments are adjust- plete. Those provisional amounts trolling interests as transactions statement of profit or loss, and patterns at previous share- in the acquiree, and the fair ments that arise from additional are adjusted during the mea- with equity owners of the Group. its share of post-acquisition holders’ meetings. value of the acquirer’s previ- information obtained during the surement period (see above), or For purchases from non-con- movements in other compre- ously held equity interest in the ‘measurement period’ (which additional assets or liabilities are trolling interests, the difference hensive income is recognised in Business combinations. Acquisi- acquiree (if any) over the net of cannot exceed one year from the recognised, to reflect new infor- between any consideration paid other comprehensive income. tions of businesses are accounted the acquisition-date amounts of acquisition date) about facts and mation obtained about facts and and the relevant share acquired of The cumulative post-acquisition for using the acquisition method. the identifiable assets acquired circumstances that existed at the circumstances that existed at the the carrying amount of net assets movements are adjusted against The consideration transferred in a and the liabilities assumed. If, acquisition date. acquisition date that, if known, of the subsidiary is recorded in the carrying amount of the business combination is measured after reassessment, the net of would have affected the amounts equity. Gains or losses on dispos- investment. When the Group’s at fair value, which is calculated as the acquisition-date amounts of The subsequent accounting for recognised at that date. als to non-controlling interests are share of losses in an associate the sum of the acquisition-date fair the identifiable assets acquired changes in the fair value of the also recorded in equity. equals or exceeds its interest in values of the assets transferred by and liabilities assumed exceeds contingent consideration that Goodwill. Goodwill arising on an the associate, including any other the Group, liabilities incurred by the sum of the consideration do not qualify as measurement acquisition of a business is carried When the Group ceases to have unsecured receivables, the Group the Group to the former owners transferred, the amount of any period adjustments depends at cost as established at the date control or significant influence, does not recognise further losses, of the acquiree and the equity non-controlling interests in the on how the contingent consid- of acquisition of the business less the retained interest in the entity unless it has incurred obligations interests issued by the Group acquiree and the fair value of eration is classified. Contingent accumulated impairment losses, is remeasured to its fair value, with or made payments on behalf of in exchange for control of the the acquirer’s previously held consideration that is classified if any. the change in carrying amount the associate. Unrealised gains on acquiree. Acquisition-related costs interest in the acquiree (if any), as equity is not remeasured at recognised in profit or loss. The transactions between the Group are generally recognised in profit the excess is recognised imme- subsequent reporting dates For the purposes of impairment fair value is the initial carrying and its associates are eliminated. or loss as incurred. diately in profit or loss as a bar- and its subsequent settlement testing, goodwill is allocated to amount for the purposes of gain purchase gain. is accounted for within equity. each of the Group’s cash-generat- subsequently accounting for the Accounting policies of associ- At the acquisition date, the iden- Contingent consideration that is ing units (or groups of cash-gen- retained interest as an associate, ates have been changed where tifiable assets acquired and the Non-controlling interests that are classified as an asset or a liability erating units) that is expected to joint venture or financial asset. In necessary to ensure consistency liabilities assumed are recognised present ownership interests and is remeasured at subsequent benefit from the synergies of the addition, any amounts previously with the policies adopted by the at their fair value, except that: entitle their holders to a propor- reporting dates in accordance combination. recognised in other comprehen- Group. • Deferred tax assets or liabil- tionate share of the entity’s net with IAS 39 Financial Instruments: sive income in respect of that ities, and assets or liabilities assets in the event of liquidation Recognition and Measurement, A cash-generating unit to which entity are accounted for as if the Dilution of gains and losses aris- related to employee benefit may be initially measured either at or IAS 37 Provisions, Contingent goodwill has been allocated is Group had directly disposed of ing on investments in associates arrangements are recognised fair value or at the non-controlling Liabilities and Contingent Assets, tested for impairment annually, the related assets or liabilities. This are recognised in the consoli- and measured in accordance interests’ proportionate share of as appropriate, with the cor- or more frequently when there is may mean that amounts previ- dated statement of profit or loss. with IAS 12 Income Taxes and the recognised amounts of the responding gain or loss being an indication that the unit may ously recognised in other com- IAS 19 Employee Benefits acquiree’s identifiable net assets. recognised in profit or loss. be impaired. If the recoverable prehensive income are reclassified Interest in joint ventures. A joint respectively; The choice of measurement basis amount of the cash-generating to profit or loss. venture is a joint arrangement • Liabilities or equity instru- is made on a transaction-by-trans- When a business combination is unit is less than its carrying whereby the parties that have ments related to share-based action basis. Other types of achieved in stages, the Group’s amount, the impairment loss is If the ownership interest in an joint control of the arrangement payment arrangements of non-controlling interests are previously held equity interest allocated first to reduce the carry- associate is reduced but signif- have rights to the net assets the acquiree or share-based measured at fair value or, when in the acquiree is remeasured ing amount of any goodwill allo- icant influence is retained, only of the joint arrangement. Joint payment arrangements of applicable, on the basis specified to its acquisition-date fair value cated to the unit and then to the a proportionate share of the control is the contractually the Group entered into to in another IFRS. and the resulting gain or loss, if other assets of the unit pro rata amounts previously recognised in agreed sharing of control of an replace share-based payment any, is recognised in profit or loss. based on the carrying amount of other comprehensive income are arrangement, which exists only arrangements of the acquiree When the consideration trans- Amounts arising from interests in each asset in the unit. Any impair- reclassified to profit or loss where when decisions about the rele- are measured in accordance ferred by the Group in a business the acquiree prior to the acqui- ment loss for goodwill is rec- appropriate. vant activities require unanimous

256 257 FINANCIAL STATEMENTS ANNUAL REPORT 2017 consent of the parties sharing assets), the Group is considered • EGPC shall become the owner attributable to acquisition of the proceeds with carrying amount with the focused search for new control. to be conducting the transaction of all the Company’s assets items. The cost of self-constructed of property, plant and equipment development techniques and with the other parties to the joint acquired and owned within assets includes the cost of mate- are recognised in the consolidated significant improvements in The Group recognises its inter- operation, and gains and losses the Concession Agreement, rials, direct labour and an appro- statement of profit or loss. When products, services and processes est in the joint venture using resulting from the transactions which assets were charged to priate proportion of production revalued assets are sold or dis- and in connection with research the equity method applied as are recognised in the Group’s Cost Recovery by the Com- overheads. Сost of acquired and posed, the amounts included in activities. Expenditures related to described above in the paragraph consolidated financial statements pany in connection with the self-constructed qualifying assets revaluation reserve are transferred research activities is shown as R&D Investment in associates. only to the extent of other parties’ operations carried out by the includes borrowing costs. to retained earnings. expenses in the period in which interests in the joint operation. Company: land shall become they are incurred. Development Interest in joint operations. A the property of EGPC as soon Any increase in the carrying Property, plant and equipment costs are capitalised if the recog- joint operation is a joint arrange- When a group entity transacts with as it is purchased; title to fixed amounts resulting from revalua- includes cushion gas which is nition criteria according to IAS ment whereby the parties that a joint operation in which a group and movable assets shall be tions are credited to revaluation required to be held in the stor- 38 Intangible Assets are fulfilled. have joint control of the arrange- entity is a joint operator (such as transferred automatically and reserve in equity through other age facilities for the operating ment have rights to the assets, a purchase of assets), the Group gradually from the Company comprehensive income. Decreases activities of the Group company Exploration and evaluation and obligations for the liabilities, does not recognise its share of to EGPC as they become sub- that offset previsouly recognised in transportation of gas and gas assets. Oil and gas exploration relating to the arrangement. Joint the gains and losses until it resells ject to the Cost Recovery. increases of the same asset are storage segments, respectively. and evaluation expenditures are charged against revaluation accounted for using the success- control is the contractually agreed those assets to a third party. sharing of control of an arrange- The development period under reserve in equity through other Cushion gas is gas intended for ful efforts method of accounting. ment, which exists only when the Concession Agreement is comprehensive income; all other maintaining pressure in under- Concession agreement (product decisions about the relevant limited to maximum 25 years decreases are charged to the ground storage facilities of the Expenditures at the pre-recon- sharing agreement). The Com- activities require unanimous con- from the date of commercial oil consolidated statement of profit or Group and protecting them from naissance stage of hydrocarbon pany entered into a concession sent of the parties sharing control. discovery or from the date of first loss. To the extent that an impair- flooding. Cushion gas is consid- reserves’ exploration and evalu- agreement for oil exploration and gas deliveries, started in 2011. ment loss on the same revalued ered to be fully recoverable based ation, including the economic development (“Concession Agree- When a group entity undertakes asset was previously recognised on an engineering analysis, and at and technical feasibility studies ment”) with the Arab Republic of its activities under joint opera- Segment reporting. Operating in the consolidated statement any time that the storage facility for exploratory field development tions, the Group as a joint oper- Egypt and the Egyptian General segments are reported in a man- of profit or loss, a reversal of that is closed will be available for sale and advisory services, are rec- ator recognises in relation to its Petroleum Corporation (“EGPC”) ner consistent with the internal impairment loss is also recognised or other use. Cushion gas is reval- ognised as expenses of the period interest in a joint operation: on 13 December 2006. reporting provided to the Group’s in the consolidated statement of ued when there is an indication when incurred. • Its assets, including its share chief operating decision maker. profit or loss. that its carrying amount as of the of any assets held jointly; The Concession Agreement Segments whose revenue, results reporting date is materially differ- Expenses directly related to obtain- includes the following conditions: • Its liabilities, including its or assets are ten percent or more Expenditure incurred to replace ent from its fair value. ing special rights to extraction share of any liabilities incurred • Subject to the auditing pro- of all the segments are reported a component of an item of prop- of mineral resources reserves are jointly; visions under the Concession separately. Segments falling erty, plant and equipment that is Construction in progress includes capitalised in cost of licenses for below this threshold can be accounted for separately, is capi- also prepayments for property, exploration and recognised as • Its revenue from the sale of Agreement, the Company reported separately at manage- talised with the carrying amount plant and equipment. intangible assets from the date of its share of the output arising shall recover on a quarterly ment decision. of the replaced component being special rights. Subsequently, the from the joint operation; basis all exploration and development costs to the derecognised. Subsequent costs Exploration expenses. Explo- relevant assets are accounted for • Its share of the revenue from Property, plant and equipment. are included in the asset’s carrying ration expenses comprise the using the requirements of IAS 38 the sale of the output by the extent and out of 25% of all petroleum produced and The Group uses the revaluation amount or recognised as a sep- costs associated with unproved “Intangible Assets”. joint operation; and model to measure property, arate asset, as appropriate, only reserves. These include geological saved from all production • Its expenses, including plant and equipment, except when it is probable that future and geophysical costs for the Expenses arising at the stage of areas and not used in petro- its share of any expenses construction in process which economic benefits associated with identification and investigation field development, including leum operations (“Cost Recov- incurred jointly. is carried at cost. Fair value was the item will flow to the Group of areas with possible oil and gas costs of drilling and trenching, ery”). Petroleum products based on valuations made by and the cost of the item can be reserves and administrative, legal leases and depreciation of under the Concession Agree- The Group accounts for the assets, external independent valuers. measured reliably. All other repairs and consulting costs in connec- property, plant, and equipment, ment include crude oil or gas liabilities, revenues and expenses The frequence of revaluation and maintenance are charged to tion with exploration. They also are capitalised in construction relating to its interest in a joint and liquefied petroleum gas depends on the movements in the consolidated statement of include all impairments on explo- in progress as exploration and operation in accordance with the (“LPG”). the fair values of the assets being profit or loss during the financial ration wells where no proved evaluation assets. The assets IFRSs applicable to the particular • Remaining 75% of the petro- revalued. The last independent period in which they are incurred. reserves could be demonstrated. created are reviewed for impair- assets, liabilities, revenues and leum produced is shared valuation of the fair value of Property, plant and equipment ment on an annual basis. In case expenses. by the Company and EGPC the Group’s property, plant and are derecognised upon disposal Research and development the exploratory drilling does not depending on the volume of equipment was performed as at or when no future economic ben- expenses. Research and devel- give a result or it is probable that When a group entity transacts production and the product 31 December 2017. Subsequent efits are expected to be received opment (R&D) expenses include the expenses incurred will not with a joint operation in which type (crude oil or gas and additions to property, plant and from the continued use of the all direct and indirect materials, generate revenue, the asset is a group entity is a joint operator LPG). The Company’s share equipment are recorded at cost. asset. Gains and losses on dis- personnel and external services partially or fully written off against (such as a sale or contribution of varies from 15% to 19%. Cost includes expenditure directly posal determined by comparing costs incurred in connection expenses of the period.

258 259 FINANCIAL STATEMENTS ANNUAL REPORT 2017

In the event a decision is taken on Construction in progress and in the measurement of an existing When an impairment loss in the assets of an entity after Group’s financial liabilities, loans further development of the field cushion gas are not depreciated. decommissioning liability, that subsequently reverses, the car- deducting all of its liabilities. and receivables are measured at and from putting into operation result from changes in the rying amount of the asset (or a Equity instruments issued by a amortised cost. Amortised cost of the first producing well, the Intangible assets. Intangible estimated timing or amount of cash-generating unit) is increased Group entity are recognised at is calculated using the effective Group classifies the capitalised assets have definite useful lives the outflows, or from changes to the revised estimate of its the proceeds received, net of interest method and, for financial exploration and evaluation costs and primarily include licenses for in the discount rate used for recoverable amount, but so that direct issue costs. assets, it is determined net of any related to this well as oil and gas exploration and extraction and measurement, are recognised in the increased carrying amount impairment losses. Premiums and extraction assets within property, capitalised computer software. the consolidated statement of does not exceed the carrying Repurchase of the Group’s own discounts, including initial trans- plant, and equipment in the state- Acquired computer software is profit or loss or, to the extent of amount that would have been equity instruments is recognised action costs, are included in the ment of financial position. capitalised on the basis of the any revaluation balance existence determined had no impairment and deducted directly in equity. carrying amount of the related costs incurred to acquire and in respect of the related asset, loss been recognised for the asset No gain or loss is recognised in instrument and amortised based Depreciation and depletion. bring it to use. Intangible assets in other comprehensive income (or cash-generating unit) in prior profit or loss on the purchase, on the effective interest rate of Depreciation is charged to the are carried at cost less accumu- or loss. Provisions in respect of years. A reversal of an impairment sale, issue or cancellation of the the instrument. consolidated statement of profit lated amortisation and impair- decommissioning activities are loss is recognised immediately in Group’s own equity instruments. or loss on a straight-line basis ment losses, if any. If impaired, evaluated and re-estimated profit or loss, unless the relevant The face values of financial assets to allocate costs of individual the carrying amount of intangible annually, and are included in the asset is carried at a revalued Financial liabilities. Financial and liabilities with a maturity assets except their residual value assets is written down to the consolidated financial statements amount, in which case the liabilities are classified as either of less than one year, less any over their estimated useful lives. higher of value in use and fair at each reporting date at their reversal of the impairment loss is financial liabilities “at fair value estimated credit adjustments, are Depreciation commences on the value less costs to sell. expected present value, using treated as a revaluation increase. through profit or loss (FVTPL)” or assumed to be their fair values. date of acquisition or, in respect discount rates which reflect the “other financial liabilities”. The fair value of financial liabilities of self-constructed assets, from Leases. Leases in which a sig- economic environment in which Classification of financial assets. is estimated by discounting the the time an asset is completed nificant portion of the risks and the Group operates. The Group classifies its financial Initial recognition of financial future contractual cash flows at and ready for use. rewards of ownership are retained assets into the following measure- instruments. Financial assets the current market interest rate by the lessor are classified as Interest expense related to the ment categories: (a) loans and and financial liabilities are initially available to the Group for similar Hydrocarbon extraction wells operating leases. Payments made provision is included in finance receivables; (b) available-for-sale measured at fair value. financial instruments. are depleted using a unit-of-pro- under operating leases (net of costs in profit or loss. financial assets. duction method over a period of any incentives received from the The Group’s principal financial Gains and losses arising from a proved and probable hydrocar- lessor) are charged to the con- Impairment of non-financial Loans and receivables include instruments comprise borrow- change in the fair value of avail- bons reserves. Specialised drilling solidated statement of profit or assets. Assets are reviewed for financial receivables created ings, cash and bank balances. The able-for-sale assets are recognised tools and other fixed assets used loss on a straight-line basis over impairment whenevents and by providing money, goods or Group has various other financial directly in other comprehensive to perform any work on the well the period of the lease. Finance changes in circumstances indicate services directly to a debtor, other instruments, such as trade receiv- income. In assessing the fair are depleted using a unit-of-pro- leases are capitalised at the lease that the carrying amount may not than those receivables which ables and trade payables, which value of financial instruments, the duction method based on rele- commencement at the lower of be recoverable. An impairment are created with the intention arise directly from its operations. Group uses a variety of methods vant output standard established the fair value of the leased prop- loss is recognised for the amount to be sold immediately or in the and makes assumptions based on by the Group. erty and the present value of the by which the assets carrying short term, or which are quoted All purchases and sales of finan- market conditions existing at the minimum lease payments. amount exceeds its recoverable in an active market. Loans and cial instruments that require reporting date. Other property, plant and amount. The recoverable receivables comprise primarily delivery within the time frame equipment are depreciated Decommissioning liabilities. amount is the higher of fair loans, trade accounts receivable established by regulation or When available-for-sale assets on a straight line basis over its The Group’s assessment of the value less cost to sell and value including purchased loans and market convention (“regular way” are sold or otherwise disposed expected useful life. The useful decommissioning liabilities is in use. For purposes of assessing promissory notes. All other purchases and sales) are recorded of, the cumulative gain or loss lives of the Group’s other prop- based on the estimated future impairment, assets are grouped financial assets are included in the at trade date basis, which is the recognised in other compre- erty, plant and equipment are as costs expected to be incurred in to the lowest levels for which available-for-sale category. date that the Group commits to hensive income is included in follows: respect of the decommissioning there are separately identifiable deliver a financial instrument. All the determination of net profit. and site restoration, adjusted cash flows (cash generating Classification as debt or equity. other purchases and sales are rec- When a decline in fair value of Useful for the effect of the projected unit). Non-financial assets that Debt and equity instruments ognised on the settlement date available-for-sale assets has been lives in inflation for the upcoming have suffered impairment are issued by the Group are classi- with the change in value between recognised in equity and there is years periods and discounted using reviewed for possible reversal of fied as either financial liabilities the commitment date and set- objective evidence that the assets Pipelines and related 5–60 interest rates applicable to the the impairment at each reporting or as equity in accordance with tlement date not recognised for are impaired, the loss recognised equipment provision. Estimated costs of date. the substance of the contractual assets carried at cost or amortised in other comprehensive income Machinery and 3–60 dismantling and removing an arrangements and the defini- cost, and recognised in equity for is removed and included in the equipment item of property, plant and An impairment loss is recognised tions of a financial liability and assets classified as available-for- determination of net profit, even Buildings 3–60 equipment are added to the immediately in profit or loss, an equity instrument. sale. though the assets have not been cost of an item of property, plant unless the relevant asset is carried derecognised. Drilling and exploration 3–30 and equipment when the item at a revalued amount, in which Equity instruments. An equity Subsequent measurement of equipment is acquired, and corresponding case the impairment loss is instrument is any contract that financial instruments. Subse- Dividends on available-for-sale Other fixed assets 3–30 obligation is recognised. Changes treated as a revaluation decrease. evidences a residual interest quent to initial recognition, the equity instruments are recognised

260 261 FINANCIAL STATEMENTS ANNUAL REPORT 2017 in the consolidated statement of of the provision is the difference profit or loss unless it relates to Inventories. Inventories are Promissory notes. Some pur- posed before the reporting date profit or loss when the Group’s between the asset’s carrying transactions that are recognised, recorded at the lower of cost and chases may be settled by prom- or proposed or declared after right to receive payment is estab- amount and the present value of in the same or a different period, net realisable value. The cost of issory notes or bills of exchange, the reporting date but before lished and the inflow of economic estimated future cash flows. The in other comprehensive income inventories includes expenditures which are negotiable debt the consolidated financial state- benefits is probable. Impairment carrying amount of the asset is or directly in equity. incurred in acquiring the inven- instruments. Purchases settled by ments are authorised for issue. losses are recognised in the con- reduced through the use of a pro- tories, production or conversion promissory notes are recognised solidated statement of profit or vision account, and the amount Current tax is the amount costs and other costs incurred in based on management’s estimate Value added tax (“VAT”). In loss when incurred as a result of of the loss is recognised in the expected to be paid to or recov- bringing them to their existing of the fair value to be given up in Ukraine VAT is levied at two one or more events that occurred consolidated statement of profit ered from the taxation authorities location and condition. Cost such settlements. The fair value rates: 20% on sales and imports after the initial recognition of or loss. When receivables are in respect of taxable profits or of manufactured inventories is determined with reference to of goods, works and services available-for-sale investments. uncollectible, they are written off losses for the current and prior includes an appropriate share of observable market information. within the country, and 0% on A significant or prolonged decline against the provision account for periods. Taxes other than on production overheads based on the export of goods and limited in the fair value of an instrument receivables. Subsequent recover- income are recorded within oper- normal operating capacity. The Cash and cash equivalents. list of services (e.g. international below its cost is an indicator that ies of amounts previously written ating expenses. cost of inventories is determined Cash and cash equivalents transportation). A taxpayer’s VAT it is impaired. The cumulative off are credited in the consoli- on the first in first out basis for include cash on hand, deposits liability equals the total amount impairment loss measured as the dated statement of profit or loss. Deferred income tax is provided all inventories except for natural held at call with banks, and of VAT accrued within a report- difference between the acqui- using the balance sheet liability gas, oil and petroleum products. other short-term highly liquid ing period, and arises on the sition cost and the current fair Derecognition of financial method for tax losses carried Weighted average cost formula investments with original earlier of the date of shipping value, less any impairment loss on instruments. The Group derecog- forwards and temporary differ- is used for natural gas, oil and maturities of three months or goods or rendering services to a that asset previously recognised nises financial assets when (i) ences arising between the tax petroleum products. Net realis- less. Cash and cash equivalents customer or the date of receiv- in the consolidated statement the assets are redeemed or the bases of assets and liabilities able value is the estimated selling are carried at amortised cost ing payment from the customer. of profit or loss, is removed from rights to cash flows from the and their carrying amounts for price in the ordinary course of using the effective interest rate A VAT input is the amount that equity and recognised in the assets have otherwise expired financial reporting purposes. In business, less the cost of comple- method. Restricted balances a taxpayer is entitled to offset consolidated statement of profit or (ii) the Group has transferred accordance with the initial recog- tion and selling expenses. are excluded from cash and against his VAT liability in a or loss. substantially all the risks and nition exemption, deferred taxes cash equivalents for the pur- reporting period. Rights to VAT rewards of ownership of the are not recorded for temporary Trade accounts receivable. poses of the statement of cash input arise when a VAT invoice is Impairment losses on equity assets or (iii) the Group has differences on initial recogni- Trade and other receivables are flows. Balances restricted from received, which is issued on the instruments are not reversed neither transferred nor retained tion of an asset or a liability in a recognised initially at fair value being exchanged or used to earlier of the date of payment to through the consolidated state- substantially all risks and rewards transaction other than a business and subsequently measured at settle a liability for the period the supplier or the date goods ment of profit or loss. If, in a of ownership but has not retained combination if the transaction, amortised cost using the effective from three to twelve months are received or services are ren- subsequent period, the fair value control. Control is retained if the when initially recorded, affects interest method, less provision for after the reporting date are dered. VAT related to sales and of a debt instrument classified as counterparty does not have the neither accounting nor taxable impairment. included in other current assets. purchases is recognised in the available-for-sale increases and practical ability to sell the asset profit. Deferred tax liabilities Balances restricted from being consolidated statement of finan- the increase can be objectively in its entirety to an unrelated are not recorded for temporary Prepayments made and other exchanged or used to settle cial position on a gross basis and related to an event occurring third party without needing to differences on initial recognition current assets. Prepayments are a liability for at least twelve disclosed separately as an asset after the impairment loss was impose additional restrictions on of goodwill and subsequently for carried at cost less provision for months after the reporting date and liability. Where provision has recognised in the consolidated the sale. The Group derecognises goodwill which is not deductible impairment. A prepayment is are included in other non-cur- been made for impairment of statement of profit or loss, the financial liabilities when, and only for tax purposes. Deferred tax classified as non-current when rent assets. receivables, the impairment loss impairment loss is reversed when, the Group’s obligations balances are measured at tax the goods or services relating to is recorded for the gross amount through current period’s consoli- are discharged, cancelled or they rates enacted or substantively the prepayment are expected Share capital. Ordinary shares of the debtor, including VAT, dated statement of profit or loss. expire. The difference between enacted at the reporting date to be obtained after one year, or are classified as equity. Incre- except provision for impairment the carrying amount of the finan- which are expected to apply to when the prepayment relates to mental costs directly attributable of prepayments made. A provision for impairment of cial liability derecognised and the the period when the temporary an asset which will itself be clas- to the issue of new shares are loans and receivables is estab- consideration paid and payable is differences will reverse or the tax sified as non-current upon initial shown in equity as a deduction, Borrowings. Borrowings include lished when there is objective recognised in profit or loss. losses carried forwards will be recognition. net of tax, from the proceeds. bank borrowings and bonds. evidence that the Group will not utilised. Deferred tax assets and be able to collect all amounts due Income taxes. Income taxes liabilities are netted only within If there is an indication that the Dividends and mandatory Borrowing costs. Borrowing according to the original terms. have been provided for in the individual companies of the assets, goods or services relating budget contribution of profit costs directly attributable to Significant financial difficulties the consolidated financial Group. Deferred tax assets for to a prepayment will not be share. Dividends and manda- the acquisition, construction or of the debtor, probability that statements in accordance with deductible temporary differences received, the Group recognises tory budget contribution of production of qualifying assets, the debtor will enter bankruptcy Ukrainian legislation enacted or and tax losses carried forwards are provision for impairment in profit share are recognised as which are assets that necessarily or financial reorganisation, substantively enacted by the end recorded only to the extent that respect of such prepayment a liability and deducted from take a substantial period of time and default or delinquency in of reporting date. The income tax it is probable that future taxable made and a corresponding equity at the reporting date only to get ready for their intended payments are considered to be charge comprises current tax and profit will be available against impairment loss is recognised in if they are declared before or on use or sale, are added to the cost indicators that loans and receiv- deferred tax and is recognised in which the deductions can be the consolidated statement of the reporting date. Dividends of those assets, until such time ables are impaired. The amount the consolidated statement of utilised. profit or loss. are disclosed when they are pro- as the assets are substantially

262 263 FINANCIAL STATEMENTS ANNUAL REPORT 2017 ready for their intended use or The expense on any provision is • The Group retains neither Recognition of expenses. solidated statement of financial reaching certain age, and other sale. All other borrowing costs are presented in the consolidated continuing managerial Expenses are recorded on an position unless the transferee has benefits as prescribed by the recognised in consolidated profit statement of profit or loss net of involvement to the degree accrual basis. Cost of sales the right by contract or custom collective agreement. The liability or loss in the period in which they any reimbursement. If the effect usually associated with own- comprises the purchase price, to sell or repledge the securities, recognised in the consolidated are incurred. of time value of money is mate- ership nor effective control transportation costs, commissions in which case they are reclassified statement of financial position rial, provisions are discounted over the goods sold; relating to supply agreements as repurchased receivables. The in respect of the defined benefit Borrowings are initially recognised using a current pre-tax rate that • The amount of revenue can and other related expenses. corresponding liability is presented pension plan is the present value at fair value, net of transaction reflects, where appropriate, the be measured reliably; within amounts due to other of the defined benefit obligation costs incurred. Borrowings are risks specific to the liability. Where Finance income and costs. banks or other borrowed funds. at the reporting date. The defined • It is probable that the eco- subsequently carried at amortised discounting is used, the increase Finance income and costs com- benefit obligation is calculated nomic benefits associated cost using the effective interest in provision due to the passage prise interest expense on borrow- Employee benefits: Defined Con- annually using the projected unit with the transaction will flow method. Bank overdrafts are of time is recognised as a finance ings, losses on early repayment of tributions Plan. The Group makes credit method. to the Group; and included into borrowings line cost. loans, interest income on deposits statutory unified social contri- item in the consolidated state- • The costs incurred or to be and current accounts, income or butions to the Pension Fund of Present value of the defined ben- ment of financial position. Other liabilities. Other financial incurred in respect of the loss on origination of financial Ukraine in respect of its employ- efit obligation is determined by liabilities are recognised initially at transaction can be measured instruments, unwinding of inter- ees. The contributions are calcu- discounting the estimated future reliably. Trade accounts payable. Trade fair value, net of transaction costs est of the pension obligation and lated as a percentage of current cash outflows using interest rates accounts payable are recognised incurred, and are subsequently provisions. gross salary and are expensed of high-quality corporate bonds If the goods are transported to and initially measured under the stated at amortised cost using the when incurred. Discretionary pen- that are denominated in the cur- a specified location, revenue is policy for financial instruments effective interest method. Other Interest income is recognised as sions and other post-employment rency in which the benefits will recognised when the goods are mentioned above. Subsequently, non-financial liabilities are mea- it accrues, taking into account the benefits are included in labour be paid, and that have terms to passed to the customer at the instruments with a fixed maturity sured at cost. effective yield on the asset. costs in the consolidated state- maturity approximating the terms destination point. are re-measured at amortised ment of profit or loss. of the related pension liability. cost using the effective interest Contingent assets and liabil- Sale and repurchase agreements Revenue from sales of services is method. Amortised cost is calcu- ities. A contingent asset is not and lending of securities. Sale During the year ended 31 Decem- Actuarial gains and losses recognised when: lated by taking into account any recognised in the consolidated and repurchase agreements ber 2017, the Group recognised arising from experience adjust- transaction costs and any dis- financial statements but disclosed • The amount of revenue can (“repo agreements”) which effec- expenses from contributions paid ments and changes in actuarial count or premium on settlement. when an inflow of economic ben- be measured reliably; tively provide a lender’s return to to the Pension Fund of Ukraine assumptions are charged or efits is probable. • It is probable that the eco- the counterparty are treated as in amount of UAH 1,929 million credited to other comprehen- Advances received. Advances nomic benefits associated secured financing transactions. (2016: UAH 1,482 million). sive income in the period in received are carried at amounts A contingent liability is not with the transaction will flow Securities sold under such sale which they arise. Past service originally received excluding VAT. recognised in the consolidated to the Group; and repurchase agreements are Employee benefits: Defined costs are recognised immedi- Amounts of advances received financial statements unless it is • The stage of completion of not derecognised. The securities Benefit Plan.The Group provides ately in the consolidated state- are expected to be realised probable that an outflow of eco- the transaction at the report- are not reclassified in the con- lump sum benefits, payments on ment of profit or loss. through the revenue received nomic resources will be required ing date can be measured from usual activities of the Group. to settle the obligation and it can reliably; be reasonably estimated. Contin- gent liabilities are disclosed unless • The costs incurred on the Provisions. Provisions are rec- transaction and the costs to ognised when the Group has the possibility of an outflow of resources embodying economic complete the transaction can a present obligation (legal or be measured reliably. constructive) as a result of a past benefits is remote. event and it is probable that an Revenue gross versus net outflow of resources embody- Revenue recognition. Revenue presentation. When the Group ing economic benefits will be is measured at the fair value of acts as a principal, revenue and required to settle the obligation the consideration received or cost of sales are reported on a and a reliable estimate can be receivable, and are shown net of gross basis. If the Group sells made of the amount of the obli- value added tax and discounts. goods or services as an agent, gation. Revenue from the sale of goods is revenue is recorded on a net recognised when the goods are basis, representing the margin/ Where the Group expects some delivered and titles have passed, commission earned. Whether or all of a provision to be reim- at which time all the following the Group is considered bursed, for example under an conditions are satisfied: to be principal or agent in insurance contract, the reim- • The Group has transferred to a transaction depends on bursement is recognised as a the buyer the significant risks analysis of both legal form and separate asset but only when the and rewards of ownership of substance of the agreement the reimbursement is virtually certain. the goods; Group enters in.

264 265 FINANCIAL STATEMENTS ANNUAL REPORT 2017

28. CRITICAL ACCOUNTING over “Ukrnafta” PJSC starting from Key sources of estimation the future, management makes standards of the Hydrocarbons regulations. Latest assessment ESTIMATES AND JUDGEMENTS 22 July 2015. Accordingly, the uncertainty. The following are judgements and applies estima- Resource Management System of gas reserves was performed investment in “Ukrnafta” PJSC the key assumptions concerning tion based on historic taxable (PRMS) prepared by the Oil and as at 30 June 2017, and latest In the application of the Group’s is accounted for as investment the future, and other key sources profits and expectations of future Gas Reserves Committee of Soci- assessment of oil reserves was accounting policies, management in subsidiary starting from that of estimation uncertainty at the taxable income that are believed ety of Petroleum Engineers (SPE). performed as at 30 June 2016. is required to make judgements, date. The Company considers this end of the reporting period, that to be reasonable under the cir- The estimation of hydrocarbons Reserves estimates involve some estimates and assumptions about change as a business combination have a significant risk of causing cumstances. reserves is carried out in general degree of uncertainty, and their the carrying amounts of assets and applied acquisition method of a material adjustment to the on the field. Respectively, all wells estimates are revised as addi- and liabilities that are not readily accounting, respectively. carrying amounts of assets and Tax legislation. Ukrainian tax, of the field are depreciated based tional geologic and engineering apparent from other sources. The liabilities within the next financial currency and customs legislation on the total volume of extracted data becomes available or as estimates and associated assump- Revenue recognition. In year. continues to evolve. Conflicting from the field specific type of economic conditions change. tions are based on historical expe- accordance with the Code of the regulations are subject to varying hydrocarbons for the period and Accordingly, depletion rates and rience and other factors that are gas transmission system, starting Employee benefit obligations. interpretations. Management the balances of reserves of such discounted cash flows for revalua- considered to be relevant. Actual from 1 October 2015 the Group, The Group assesses post-em- believes its interpretations are hydrocarbons at the beginning tion and impairment of property, results may differ from these esti- as transmission system operator, ployment and other employee appropriate and sustainable, but of the period. Changes in esti- plant and equipment may be also mates. is responsible for regulating an benefit obligations using the no guarantee can be provided mates regarding the volumes revised. imbalance of the system which projected unit credit method against a challenge from the tax of total proved reserves either The estimates and underlying is calculated as the difference based on actuarial assumptions authorities (Note 23). downward or upward, can result Revaluation and impairment of assumptions are reviewed on between the volumes of natural which represent management’s in the change of depreciation and property, plant and equipment. an ongoing basis. Revisions to gas entering through the entry best estimates of the variables Decommissioning costs. The depletion expenses. Management performs assess- accounting estimates are rec- points and the volumes of natural that will determine the ultimate decommissioning provision rep- ment whether carrying amounts ognised in the period in which gas exiting through the exit cost of providing post-em- resents the present value of the The following events occurred of property, plant and equipment the estimate is revised if the points, on the basis of actual data ployment and other employee decommissioning costs relating during the first quarter of 2017 accounted under the revaluation revision affects only that period, received through the allocation benefits. The present value of to oil and gas properties, which that provide higher probability of model, differ materially from their or in the period of the revision procedure, in the context of the pension obligations depends are expected to be incurred in the assumption of no transit flows fair values. Such assessment is and future periods if the revision transmission service customers. on a number of factors that are the future (Note 15). These provi- from 1 January 2020, including performed on an annual basis, affects both current and future determined on an actuarial basis sions were recognised, based on but not limited to: ratifying the and involves analysis of prices, periods. The Group provides balancing using a number of assumptions. Group’s internal estimates. Intergovernmental agreement price indices, changes in tech- services and recognises revenue The major assumptions used in respect of “TurkStream” gas nology, foreign exchange rates Critical judgements in applying from these operations in accor- in determining the net cost Main estimates include future pipeline project by the State and other relevant factors. In case accounting policies. The follow- dance with the Code of the gas (income) for pensions include market prices for the necessary Duma of the Russian Federation; such assessment identifies that ing are the critical judgements, transmission system and terms the discount rate and expected decommissioning costs, and are obtaining permissions for partial carrying amounts of items of apart from those involving esti- of individual contracts with salary increases. Any changes in based on market conditions and commissioning of gas pipelines property, plant and equipment mations, that the Group manage- transmission services customers, these assumptions will impact factors. Additional uncertainties within “Nord Stream-2” project. differ materially from their fair val- ment has made in the process of considering that: the carrying amount of pension relate to the timing of the decom- As a result, the Group has revised ues, management engages inde- applying the Group’s accounting • the Code of the gas trans- obligations. Since there are no missioning costs, which depends useful lives of its transit assets pendent appraisers to perform policies and that have the most mission system provides that long-term, high quality corporate on depletion of the fields, future planned to for decommissioning property, plant and equipment significant effect on the amounts balancing service is provided or government bonds issued in oil and gas prices and as a result – after 31 December 2019. This revaluation. recognised in the consolidated by the transmission system Ukrainian hryvnias, significant expected point of time, when resulted in higher depreciation financial statements. operator based on the data judgement is needed in assess- there are no further economic expense by UAH 16,486 million Latest revaluation of property, on a monthly imbalance and ing an appropriate discount rate. benefits in the production. for the year ended 31 Decem- plant and equipment was made Investment in “Ukrnafta” PJSC. does not require transmission Key assumptions are presented ber 2017. by the independent apprais- The Group holds 50% + 1 share service customers to confirm in Note 15. Changes in these estimates can ers as at 31 December 2017. of voting rights in “Ukrnafta” PJSC. the provision of services ; lead to the material changes in Estimation of oil and gas reserves. Key assumptions for revaluation The rest is owned by limited • the price of balancing services Deferred tax asset recognition. the provisions recognised in the Reserves are the quantities of oil are presented in Note 25. number of investors. In March is determined by the Group The deferred tax asset, recognised consolidated statement of finan- and gas which are anticipated to 2015, according to changes in on the basis of data on in the consolidated statement cial position. be commercially recovered from Management also reviews the Law of Ukraine “On Joint- unadjusted negative balance of financial position, represents known accumulations from a carrying amounts of property, Stock Companies”, quorum of the of the customer and base income taxes recoverable through Depreciation of the gas transit given date forward under defined plant and equipment to General meetings of shareholders price of gas. The base price future deductions from taxable assets and depletion of the oil and conditions. Proved and proba- determine whether there was lowered from 60%+1 share for gas consists of price of profits. Deferred tax assets are gas assets. Oil and gas assets are ble reserves used in depletion are any indicators that these down to 50%+1 share. Following natural gas procurement, recorded to the extent that reali- depleted using a unit-of-produc- rate calculation are determined assets are impaired. In making those changes and changes transmission and storage sation of the related tax benefit is tion method. The cost of the wells using estimates of known oil and the assessment for general in the Supervisory Board of costs, and other costs, related probable. In determining future is amortised based on the proved gas reservoirs, recovery factors, impairment, assets that do not “Ukrnafta” PJSC in July 2015, the to balancing services that can taxable profits and the amount of volumes of available reserves, operating conditions, future oil generate independent cash flows Company has regained control be reliably measured. tax benefits that are probable in estimated in accordance with the and gas prices and government are allocated to an appropriate

266 267 FINANCIAL STATEMENTS ANNUAL REPORT 2017 cash-generating unit. Indicators The Group reviews the estimated ability to pay. Should actual 29. ADOPTION OF NEW OR • Amendments to IAS 1 The adoption of amendments of a potential impairment include useful lives of property, plant and collections be less than man- REVISED STANDARDS AND “Presentation of Financial to standards did not have any analysis of market conditions, equipment at the end of each agement’s estimates, the Group INTERPRETATIONS Statements”– Initiative as to effect on the financial position asset utilisation and the ability annual reporting period. The would be required to record an the disclosure of information; or performance reported in to utilise the asset for alternative review is based on the current additional impairment expense. the consolidated financial Adoption of new and revised • Amendments to IAS 16 purposes. If an indication of condition of the assets and the statements and had not International Financial Report- “Property, Plant and Equip- impairment exists, the Group estimated period during which Inventory valuation. Inventory resulted in any changes to the ing Standards ment” and IAS 38 “Intangible estimates the recoverable value they will continue to bring eco- are stated at lower of cost or Assets” – Clarification in Group’s accounting policies and (greater of fair value less cost nomic benefit to the Group. Any net realisable value. In assess- The following standards have been respect of applying depre- the amounts reported for the to sell and value in use) and change in estimated useful life ing the net realisable value of adopted by the Group for the first ciation and amortisation current or prior years. compares it to the carrying or residual value is recorded on a its inventories, management time for the financial year begin- formulas; value, and records impairment prospective basis from the date of bases its estimates on various Standards and Interpretations ning on or after 1 January 2016: • IFRS 14 “Regulatory Deferred to the extent the carrying value the change. assumptions including current in issue, but not yet effective. Accounts”; is greater than the recoverable market prices. At each reporting • Amendments to IFRS 12 “Dis- At the date of authorisation of amount. Management did not Impairment of trade accounts date, the Group evaluates its closure of Interests in Other • Amendments to IAS 27 “Sep- these consolidated financial identify any general indicators of receivable and prepayments inventories for excess quantities Entities”; arate Financial Statements”– statements, the following impairment as at 31 December made. Management estimates and obsolescence and, if nec- • Amendments to IFRS 11 “Joint applying equity method in Standards and Interpretations, 2017. the likelihood of the collection essary, records an allowance to Arrangements” – Accounting separate financial statements; as well as amendments to of trade accounts receivable reduce inventories for obsolete for acquisition of interest in • Annual Improvements to Standards were in issue but not Useful lives of other property, based on an analysis of individ- and slow-moving goods. This joint arrangements; IFRSs 2012–2014 Cycle. yet effective: plant and equipment. The Group’s ual accounts. Factors taken into allowance requires assumptions property, plant and equipment, consideration include an age- related to future inventories use. Effective for annual except oil and gas assets are ing analysis of trade accounts These assumptions are based Standards/Interpretations accounting period depreciated using straight-line receivable in comparison with on inventories ageing and fore- beginning on or after method over their estimated the payment history, credit casted demand. Any changes in Amendments to IAS 12 “Income Taxes” – Recognition of deferred tax assets for unrealised 1 January 2017 useful lives, which are based on terms allowed to customers and the estimates may impact the losses management’s business plans available market information amount of the allowances for Amendments to IAS 7 “Statement of Cash Flows” – Disclosure initiative 1 January 2017 and operational estimates. regarding the counterparty’s inventory that may be required. IFRS 15 “Revenue from Contracts with Customers” 1 January 2018 IFRS 9 “Financial Instruments” 1 January 2018 Amendments to IFRS 2 “Share-based Payment” – Classification and Measurement of Share- 1 January 2018 based Payment Transactions IFRS 16 “Leases” 1 January 2019 Amendment to IFRS 10 “Consolidated Financial Statements” and IAS 28 “Investments in Effective date to be Associates and Joint Ventures” – Sale or contribution of assets between an investor and its determined associate or joint venture IFRIC 22 “Foreign Currency Transactions and Advance Consideration” 1 January 2018 Amendments to IFRS 4 “Applying IFRS 9 “Financial Instruments” with IFRS 4 „Insurance 1 January 2018 Contracts“ Amendments to IAS 40: Transfers of Investment Property 1 January 2018 Annual Improvements to IFRSs 2014–2016 Cycle 1 January 2018

Management is currently Cycles, IFRS 15 Revenue from IFRS 9 Financial Instruments evaluating the impact of the contracts with customers and adoption of Amendments IFRS 9 Financial Instruments. IFRS 9 issued in November 2009 to IAS 1: Disclosure Initiative, For other Standards and introduced new requirements Amendments to IFRS 10 and Interpretations management for the classification and mea- IAS 28: Sale or Contribution of anticipates that their adoption surement of financial assets. IFRS Assets between an Investor in future periods will not 9 was subsequently amended and its Associate or Joint have a material effect on in October 2010 to include Venture, Amendments to IFRS the consolidated financial requirements for the classification 11, Amendments resulting statements of the Group in and measurement of financial from Annual Improvements future periods. liabilities and for derecogni-

268 269 FINANCIAL STATEMENTS ANNUAL REPORT 2017 tion, and in November 2013 to investment (that is not held requirements retain the three its trade and other receivables, as customers. IFRS 15 will supersede the particular performance include the new requirements for trading nor contingent types of hedge accounting permitted by IFRS 9. In relation to the current revenue recognition obligation is transferred to the for general hedge accounting. consideration recognised mechanisms currently avail- the cash and cash equivalents, the guidance including IAS customer. Far more prescriptive Another revised version of IFRS by an acquirer in a business able in IAS 39. Under IFRS 9, management of the Group con- 18 Revenue, IAS 11 Construction guidance has been added in 9 was issued in July 2014 mainly combination) in other com- greater flexibility has been siders that they have low credit Contracts and the related IFRS 15 to deal with specific to include a) impairment require- prehensive income, with only introduced to the types risk given their strong external Interpretations when it becomes scenarios. Furthermore, extensive ments for financial assets and dividend income generally of transactions eligible for credit rating and hence expect effective. disclosures are required by IFRS b) limited amendments to the recognised in profit or loss. hedge accounting, specifi- to recognise 12-month expected 15. classification and measurement The core principle of IFRS 15 is • Classification and mea- cally broadening the types of credit losses for these items. requirements by introducing a ‘fair that an entity should recognise In April 2016, the IASB issued Clar- surement of financial instruments that qualify for value through other comprehen- In general, the management revenue to depict the transfer ifications to IFRS 15 in relation to liabilities. With regard to hedging instruments and the sive income’ (FVTOCI) measure- anticipates that the application of of promised goods or services the identification of performance the measurement of finan- types of risk components of ment category for certain simple to customers in an amount that obligations, principal versus agent cial liabilities designated as non-financial items that are the expected credit loss model of debt instruments. reflects the consideration to considerations, as well as licens- at fair value through profit eligible for hedge accounting. IFRS 9 would not have significant which the entity expects to be ing application guidance. or loss, IFRS 9 requires that In addition, the effectiveness impact on the amount of loss The key requirements of IFRS 9 are: entitled in exchange for those the amount of change in test has been overhauled and allowance recognised for financial goods or services. Specifically, The standard permits either a • Classification and measure- the fair value of a financial replaced with the principle assets. the Standard introduces a full retrospective or a modified ment of financial assets. All liability that is attributable to of an ‘economic relationship’. 5-step approach to revenue retrospective approach for the recognised financial assets changes in the credit risk of Retrospective assessment of This assessment is based on recognition: adoption. that are within the scope that liability is presented in hedge effectiveness is also currently available information of IFRS 9 are required to be other comprehensive income, no longer required. Enhanced and may be subject to changes • Identify the contract with the Based on five-step model subsequently measured at unless the recognition of such disclosure requirements arising from further reasonable customer; defined by IFRS 15 the Group amortised cost or fair value. changes in other compre- about an entity’s risk manage- and supportable information • Identify the performance obli- performs a review to understand Specifically, debt investments hensive income would create ment activities have also been being made available to the gations in the contract; how IFRS 15 applies to the that are held within a business or enlarge an accounting introduced. Group in 2018 when the Group • Determine the transaction Group’s business. The Group’s model whose objective is to mismatch in profit or loss. will adopt IFRS 9. price; management is currently collect the contractual cash Changes in fair value attrib- Based on an analysis of the • Allocate the transaction price completing to estimate the effect flows, and that have contrac- utable to a financial liability’s Group’s financial assets and finan- The Group does not apply hedge to the performance obliga- of IFRS 15 on its accounting for tual cash flows that are solely credit risk are not subse- cial liabilities as at 31 December accounting under IAS 39 and tions in the contracts; balancing services. Except for payments of principal and quently reclassified to profit or 2017 based on the facts and does not intend to apply it under • Recognise revenue when (or this issue and providing more interest on the principal out- loss. Under IAS 39, the entire circumstances that exist at that IFRS 9. as) the entity satisfies a perfor- extensive disclosures on the standing are generally mea- amount of the change in date, the management of the Group considers that they have mance obligation. Group’s revenue transactions, the sured at amortised cost at the the fair value of the financial IFRS 15 Revenue from low credit risk given that 99% of management does not anticipate end of subsequent account- liability designated as fair Contracts with Customers Under IFRS 15, an entity that the application of IFRS 15 ing periods. Debt instruments value through profit or loss is the Company’s cash and cash IFRS 15 establishes a single recognises revenue when or will have a significant impact that are held within a business presented in profit or loss. equivalents are placed in the model whose objective is state-owned banks. comprehensive model for entities as a performance obligation is on the financial position and/ achieved both by collecting • Impairment. In relation to to use in accounting for revenue satisfied, i.e. when ‘control’ of the or financial performance of the contractual cash flows and the impairment of financial Classification and measurement arising from contracts with goods or services underlying Group. selling financial assets, and assets, IFRS 9 requires an that have contractual terms expected credit loss model, as All financial assets and financial that give rise on specified opposed to an incurred credit liabilities will continue to be dates to cash flows that are loss model under IAS 39. The measured on the same basis solely payments of principal expected credit loss model as is currently adopted under and interest on the principal requires an entity to account IAS 39. Based on its assessment, amount outstanding, are gen- for expected credit losses and the Group believe that the new erally measured at FVTOCI. All changes in those expected classification requirements will other debt investments and credit losses at each reporting not have a material impact on its equity investments are mea- date to reflect changes in accounting for financial assets sured at their fair value at the credit risk since initial recog- and financial liabilities. end of subsequent account- nition. In other words, it is no ing periods. In addition, under longer necessary for a credit Impairment IFRS 9, entities may make event to have occurred before an irrevocable election to credit losses are recognised. The Group expects to apply the present subsequent changes • Hedge accounting. The new simplified approach to recognise in the fair value of an equity general hedge accounting lifetime expected credit losses for

270 271 ADDITIONAL INFORMATION ANNUAL REPORT 2017

Stakeholders Area of interest/ stake in Forms of interaction Interaction tools DETERMINING REPORT CONTENT Trade unions fulfillment of the collective agreement; dialogue; collective agreement; protection of interests of the trade regular information trade union conferences; union members sharing; labor dispute commission; joint activities commission on labor issues; AND SIGNIFICANT ASPECTS campaigns Government Sustainable development of the regular information The Company's Supervisory Board; During the preparation of this annual report, Naftogaz uses the world's best practices in the area of non- authorities industry and the country; sharing; meetings; financial and corporate reporting. Naftogaz is guided by the following GRI Standard principles for deter- compliance with the law; dialogue; sessions; approval of projects joint activities; conferences; mining the content of the report: participation in events reports; • Interaction with stakeholders; • Significance organized by stakeholders correspondence • Sustainable development context; • Completeness. Regulatory compliance with the law; regular information reviews; bodies monitoring of operations; sharing reports; Detailed information on each principle is provided further. permits and approvals correspondence Local self- implementation of social programs; regular information correspondence; government provision of work places; sharing; projects; bodies provision of energy resources; dialogue; campaigns INTERACTION WITH STAKEHOLDERS tariffs for energy supplies; joint activities land allotment issues; cushioning the impact of the company's operations on the environment Continuous interaction with stakeholders is a necessary condition for the company's sustainable development and successful business operation. The company holds a continuous dialogue with 13 Mass media transparency of operations; regular information press releases; openness and accessibility of information; sharing; press conferences; main groups of stakeholders represented below: Interrelations with the government dialogue interview; • shareholders and investors; • financial and credit institutions; authorities, self-government bodies and newsletters; • company's employees; • partner organizations; the public reports • trade unions; • contractors, suppliers; Financial fulfillment of contractual obligations; dialogue; negotiations; and credit return of loans joint activities agreements; • government authorities; • consumers; institutions memoranda; • regulatory bodies; • local communities, public and charitable financial transactions • local self-government bodies; organizations; Partner mutually beneficial cooperation; dialogue; corporate site; • mass media; • scientific and educational establishments. organizations fulfillment of obligations; joint activities financial reports; the company's positive image business meetings; The company uses different methods and forms of interaction with stakeholders including: meetings, forums, negotiations; conferences, sessions, open doors days, correspondence, different inquiries, etc. consultations; projects; campaigns Contractors, fulfillment of obligations; dialogue; tender procedures; NAK Naftogaz of Ukraine stakeholders map and the main methods of interaction with them suppliers timely and reliable supplies; Identification of opinions agreements; quality of goods (services) and interests work and services acceptance acts; interrogation; Stakeholders Area of interest/ stake in Forms of interaction Interaction tools correspondence Shareholders the company's sustainable development; regular information annual report; Consumers quality and safety of goods and dialogue; corporate site; and investors profitable operations; sharing; financial reports; services; identification of opinions conferences; Improvement of performance dialogue reviews; provision of energy recourses; and interests; meetings; indicators; negotiations; sustainable heat supply; participation in interrogation/questioning; transparency of operations and reporting; consultations; tariffs for energy supplies events organized by forums; the company's positive image stakeholders exhibitions Company the company's positive image; dialogue; collective agreement; publications in the mass media; employees the company's sustainable regular information corporate ethics code; advertising campaigns; development; sharing; community liaison office; Local cushioning of the impact of goods and regular information consultations; improvement of labor conditions; identification of opinions corporate site; communities, services on the environment; sharing; public hearings; personal development; and interests electronic networks; public and partnership for the implementation of dialogue; sessions; social guarantees and benefits correspondence/responding to inquiries charitable joint projects participation in events round tables; interrogation/questioning; organizations organized by stakeholders campaigns; training social and charitable programs

272 273 ADDITIONAL INFORMATION ANNUAL REPORT 2017

Stakeholders Area of interest/ stake in Forms of interaction Interaction tools Information inquiries Scientific and sustainable scientific and technical dialogue; memoranda; educational development; joint activities; agreements; Main issues : % establishments enhancing the level of education participation in the projects; On provision of documents 10 12,35 events organized by the scientific and research work; stakeholders conferences; On PJSC Zaporizhgaz 10 12,35 round tables; workshops; On gas price 8 9,88 exhibitions; training courses; On consumption volumes 7 8,64 education On settlements 7 8.64 The company has a Procedure for Interaction with the Stakeholders in place, which applies to all types of the company's activities and is used for the identification of opinions and feedback from different stake- On energy utilities 6 7.41 holder groups. On amounts of debt 5 6.17 On conclusion of agreements, signing natural gas 5 6.17 Addresses and inquiries of the stakeholders in 2017 acceptance acts, allocation of limits

On the NAK supervisory board 4 4.94 Total number Addresses of the citizens of registered inquiries On write-off of debt 3 3.70 Main issues raised in addresses: % On NAK management income 3 81 3.70 On disconnection of gas supply 31 10.00 On installing meters 2 2.47 On provision of material aid 28 9.03 Other 11 13.58 On abuses by management 28 9.03

On installing meters 10 3.23 Addresses and inquiries from the People's Deputies Sustainable development of Ukraine (MPs) On employment 9 2.90 context On gasification 8 2.58 In 2017 the company received: The "sustainable development context" On provision of energy utilities 5 1.61 130 addresses from the People's Deputies of Ukraine principle provides for highlighting in the company's report its performance results and On settlements 5 1.61 35 Inquiries from the People's Deputies of Ukraine impact in a broad sustainable development context. On gas connection 4 1.29 Key inquirers For the purpose of compliance with this On payment for utilities 4 1.29 TOTAL 81 principle, the company discloses information NGOs 29 in its annual report on current and potential On rational proposals 3 0.97 Individuals 31 Naftogaz group operations impact on economic, Media 16 ecological and social sustainable development Other 5 On restructuring of liability 3 0.97 at the local, regional, national and international Total number of registered addresses levels. When presenting the performance results, On benefits 3 0.97 the company intends to present the scope of 310 impact and contribution to different aspects of On social protection 2 0.65 sustainable development. On fuel price 1 0.32 Compliance with this principle is very important for Naftogaz, particularly due to On liability on salary 1 0.32 the fact that the company is engaged in integration into the European energy market. Other 165 53.23

274 275 ADDITIONAL INFORMATION ANNUAL REPORT 2017

Significance Material GRI topics and boundaries

Significant aspects include • Analisis of annual reports (the report coverage areas) the Category Topic Boundaries important issues which concern and reports in the area of company determines limits of the company's economic, sustainable development of coverage – the list of structural Economic performance The information on the topic in the report is disclosed to ecological and social impact. peer companies in Ukraine and and organizational units all companies of Naftogaz group Naftogaz identifies and takes into abroad; (subsidiary companies, joint Indirect economic impacts The information on the topic in the report is disclosed account the internal and external ventures), the performance results Economic manifestations of significant • Questioning of the internal of which will be presented in the for such companies as Ukrgazvydobuvannya, Ukrnafta, aspects. structural subdivisions and report. Ukrtransgaz and Ukrtransnafta Naftogaz subsidiary companies; Procurement practices The information on the topic in the report is disclosed to Significant aspects are identified The company regularly (once a all companies of Naftogaz group primarily via a process of • Consultations with the year) revises the list of significant Energy The information on the topic in the report is disclosed continuous interaction with representatives of the aspects for inclusion in the for such companies as Ukrgazvydobuvannya, Ukrnafta, Naftogaz stakeholders, both company's top management; following annual report. Ukrtransgaz and Ukrtransnafta internal and external. Identified Water The information on the topic in the report is disclosed aspects are assessed for their • Analysis of international The table below shows the for such companies as Ukrgazvydobuvannya, Ukrnafta, significance for the company's standards, agreements, significant aspects identified in Ukrtransgaz and Ukrtransnafta operations and its impact. For resolutions in the area of the course of preparation of the Biodiversity The information on the topic in the report is disclosed to the assessment and prioritizing sustainable development e.g. report for 2017, and the limits of all companies of Naftogaz group of the aspects the following SDG (Sustainable Development their coverage. Environment mechanisms are used: Goals). Emissions The information on the topic in the report is disclosed to all companies of Naftogaz group • Analysis of the company's Along with the formation of Effluents and waste The information on the topic in the report is disclosed external information field; the list of significant aspects for such companies as Ukrgazvydobuvannya, Ukrnafta, Ukrtransgaz and Ukrtransnafta Environmental compliance The information on the topic in the report is disclosed to all companies of Naftogaz group Completeness Employment The information on the topic in the report is disclosed to all companies of Naftogaz group Finally, during the preparation performance for the reporting • Limits determined for each Labor management relations The information on the topic in the report is disclosed to of the annual Naftogaz report year. In order to comply with this significant aspect. all companies of Naftogaz group we adhere to the principle principle, the company takes Occupational health and safety The information on the topic in the report is disclosed to of completeness according into account three main criteria: • The time frame of the report. all companies of Naftogaz group to which information on This report represents the Training and education The information on the topic in the report is disclosed to significant aspects and • Coverage which provides for performance results for the all companies of Naftogaz group indicators should be adequate the inclusion in the report 2017 calendar year. However, Diversity and equal opportunity The information on the topic in the report is disclosed to Social to represent the company's of the topics and issues that where necessary, the report all companies of Naftogaz group impact on the economy, the adequately reflect significant also reflects events which took environment and society, and aspects of the company's place in prior periods, or after Non discrimination The information on the topic in the report is disclosed to provide stakeholders with the impact on the economy, the the expiry of the reporting all companies of Naftogaz group possibility to assess the group's environment and society. period. Child labor The information on the topic in the report is disclosed to all companies of Naftogaz group Forced or compulsory labor The information on the topic in the report is disclosed to all companies of Naftogaz group Local communities The information on the topic in the report is disclosed to all companies of Naftogaz group

276 277 ADDITIONAL INFORMATION ANNUAL REPORT 2017

The information to be disclosed by the company Regulatory basis for № Brief description Reference source COMPANY DISCLOSURES as required by law disclosure 3 Regarding the conditions for the natural Information on the Law of Ukraine «On http://www. gas supply: terms of natural gas the peculiarities naftogaz.com REQUIRED BY LAW • the current edition of the Rules for the supply, including: of access to natural gas supply and the Contract for • prices for natural gas, information in the the natural gas supply to consumers; payment terms; areas related to electricity, natural • prices for natural gas, payment terms • terms of supply, gas, heat supply, The information to be disclosed by the company Regulatory basis for and conditions for the used natural gas; responsibilities of the № Brief description Reference source centralized hot as required by law disclosure supplier; • general terms of supply, rights and water supply, 1 Regarding the use of a company’s funds Information about the Law of Ukraine «On https://spending. responsibilities of supplier and • forms of contract for centralized drinking from economic operations (to be published use of a company’s Openness of Use of gov.ua/edata consumer, regulations guiding natural gas supply water supply and annually, no later than January 31 of the year funds from economic Public Funds» dated relations between the supplier and which are offered to sewage» dated following the reporting year): operations, including 11.02.15, No. 183-VII. the consumer, available means of consumers; December 10, the amount of • the amount of payments under the settlement agreement with the • debt; 2015, No. 887-VIII; payments under the contracts in the reporting period – by goods, supplier, framework contracts for the licensing conditions current contracts; • gas payments. works and services; supply of natural gas to domestic for conducting information on the • information on the contracts concluded households (in case of intention to natural gas supply concluded contracts, during the reporting period, the total value supply natural gas to households) business; minimum whose total value of which exceeds UAH 1 million (the subject approved by NCREU; standards and exceeds UAH 1 million matter of the contract, the contractor, the • the procedure for resolving disputes by requirements for (including the price); value of the contract, the price per unit (if the supplier and contact information customer service information on the any), the term of the contract); of the licensee’s units responsible for quality and natural state of execution of resolving disputes (telephones, e-mail, gas supply. • information on the status of implementation the contracts, whose of the contracts concluded in the previous working hours, address, full name of total value exceeds the responsible employees, etc.); reporting periods and still in process of UAH 1 million (including implementation, the total cost of which the price). • information on the minimum standards exceeds UAH 1 million (subject matter of and requirements to the quality of the contract, the contractor, the value of natural gas supply services, the amount the contract, the price per unit (if any), of compensation and the procedure for the total amount of payments under the providing them (before March 1 of the contract in the reporting period, the claims year following the reporting year); and penalties that arose as a result of the • information on compliance with the implementation of the contract (if any), the minimum standards and requirements acts of execution of the contract (acts of to the quality of natural gas services provided, acceptance-transmission supply services and the amount of acts, acts of works performed), if available). compensation paid for non-compliance 2 Regarding the procurement: Information on the Law of Ukraine https://prozorro. with these standards (annually before • announcement of the procurement procurement, including «On Public gov.ua/; http:// March 1 of the year following the procedure and tender documentation; information on the Procurement». www.naftogaz. reporting year); announcement com • changes to tender documentation and • quality of natural gas supplied to and conduct of the clarifications to it (if any); consumers; procurement procedure, • the fee for gas; • announcements with the details of the determination of the • debts of debtor enterprises; concluded framework agreement (in case of winner or the rejection procurement under framework agreements); of the offer, the • payments for gas; • protocol of tender offers review; concluded procurement • volumes of gas use; • notification of intention to conclude a agreements, notification • subsidies and benefits; of changes to them purchase agreement; • energy saving measures. and the reports on their • information on the rejection of the tender implementation. 4 Regarding the remuneration of the Data on the Economic Code of Annual offer submitted by the purchase agreement supervisory board members and the board fees paid to the Ukraine. Report of the counterpart; members. supervisory board company, • purchase agreement; members and the which is • notice of amendments to the agreement; company’s board published on • report on the agreement performance; members. its official website. • report on concluded agreements.

278 279 ADDITIONAL INFORMATION ANNUAL REPORT 2017

The information to be disclosed by the company Regulatory basis for The information to be disclosed by the company Regulatory basis for № Brief description Reference source № Brief description Reference source as required by law disclosure as required by law disclosure 5 Regarding data sets that are subject to General information Law of Ukraine «On http://data.gov. • annual reports of the supervisory board • minutes of the http://www. public disclosure in the form of open data: on natural gas access to public ua/ and the executive body of the company;- general meeting. naftogaz.com • information on the volumes of gas consumption, natural information»; structure, principles of formation and the consumption in Ukraine; gas imports/exports, Regulation on data remuneration of the chairperson and the oil transportation, sets that are subject members of the executive body and the • volume of petroleum products imports/exports payments for natural to disclosure in the members of the supervisory board of the (by destination, volume and customs value); gas. form of open data. company, including compensation packages • volume of natural gas imports/exports (by and additional benefits they receive (or destination, volume and customs value); entitles to receive) during the execution of • volume of oil and petroleum products the official duties and when they resign; transshipment in ports (according to the • notice of the general meeting, minutes of Administration of seaports); the general meeting; • volume of exploration and operational • draft decisions on issues included in the drilling by oil and gas companies; general meeting agenda, prepared by the • payments for natural gas supplied by the supervisory board; National Joint-Stock Company Naftogaz • notice of the replacement of the supervisory of Ukraine (by categories of consumers, by board member; regions); • notice on the acquisition of shares of a • oil transmission via oil pipelines (according to public joint stock company as a result of the operational data of PJSC Ukrtransnafta, by acquiring a controlling stake or significant destination–transit, domestic consumption); controlling stake of shares. • oil transmission via oil pipelines (operational 7 Regarding securities: Certificates on stock Law of Ukraine «On https:// data, by destination–transit, domestic issues, prospectuses. Securities and the stockmarket.gov. consumption). • prospectus, certificate of registration of shares issue and other securities of the Stock Market»; Law ua/ 6 General information on the company’s General information Economic Code http://www. company, annual information about the of Ukraine «On Joint operations: about the company’s of Ukraine; Law of naftogaz.com issuer. Stock Companies»; • objectives of the company and their operations: Ukraine «On Joint Regulation on respective status; • current corporate Stock Companies»; Disclosure of Law of Ukraine «On Information by • quarterly and annual financial statements charter; Accounting and Securities Issuers. (including consolidated) of the company • financial statements; Financial Reporting for the last three years, including (if any) auditor’s conclusions 8 Regarding the company as a “last hope” The Last Hope Supplier Law of Ukraine «On http://www. in Ukraine»; expenditures for non-commercial purposes of on the annual supplier: Report. the Natural Gas naftogaz.com Procedure for the state policy and sources of their financing; statements; Market»; Rules for the disclosure of • the «last hope» supplier’s annual report on • auditor’s conclusions on the annual financial • ownership structure economic activities; supplying natural information on the gas. statements (including consolidated ones) of of the company; operations of state • information on the number of customers of the company for the last three years; • biographies of unitary enterprises the «last hope» supplier, the total amount • the corporate charter of the company in the board members and and companies, of the supplied natural gas and the average current edition, as well as earlier versions; supervisory board with more than duration of supplying; • ownership structure of the company; members; 50 percent of the • the cost of natural gas for consumers and shares (shares) in the • biographical information (including • reports of supervisory the version of the «last hope» natural gas authorized capital professional profile) of the head and the board and board of supplier’s contract, which should correspond of which is owned members of the company’s executive body the company; to the framework contract, and clarification by the state, and (in view of requirements of the legislation on • structure, principles on its conclusion. companies with 50 personal data protection); of formation and or more percent of remuneration of • biographical information (including shares (shares) of the chairperson and professional profile) of the supervisory board which belong to the In addition, the resolution of the company’s supervisory board of 19–22 September 2016 approved the Transparency and Disclosure Policy the members of the members (if established) of a company (in companies, 100% developed in accordance with the Principles of Corporate Governance for State Enterprises as defined by the Organization for Economic executive body and Cooperation and Development (OECD). Thus, the company shall voluntarily disclose: view of the requirements of the legislation owned by the state. on personal data protection), the principles the members of the • actions and events that have a significant impact on the operating income or assets of Naftogaz group; of their selection, their membership in supervisory board of • decisions or events that, according to management, have or may have a significant impact on the implementation of any of the the supervisory boards of other entities, the company; key areas of the strategy of the holding company or any of the group’s enterprises; indicating the independent members of the • notice of the general • changes in the composition of the board of the company or the enterprises of Naftogaz group; supervisory board; meeting; • other essential information about the operations of the company or the enterprises of Naftogaz group.

280 281 ADDITIONAL INFORMATION ANNUAL REPORT 2017

PJSC CHORNOMORNAFTOGAZ, UGS – underground gas storage CHORNOMORNAFTOGAZ (CNG) – Public Joint TERMS AND ABBREVIATIONS Stock Company Chornomornaftogaz UNBUNDLING – separation of gas transmission from gas supply and production PJSC UKRAVTOGAZ, UKRAVTOGAZ (UAG) – Public BCS – booster compressor stations, which GDS – gas distribution station Joint Stock Company Ukravtogaz URENGOY-POMARY-UZHHOROD GAS maintain the pressure necessary for production PIPELINE (UPU) – the gas export route connecting at the final stage of field development GMS – gas measuring station PJSC UKRGAZVYDOBUVANNYA, the Urengoy gas field and northern gas fields of Ukrgazvydobuvannya (UGV) – Public Joint Stock Western Siberia to Uzhhorod at the western border BP – British Petroleum, a transnational oil and GROUP – a group of companies that Company Ukrgazvydobuvannya of Ukraine gas, petrochemical and coal corporation consists of NJSC Naftogaz of Ukraine, PJSC Ukrgazvydobuvannya, PJSC Ukrtransgaz, PJSC UKRNAFTA, UKRNAFTA (UN) – Public Joint USD – United States Dollar CABINET OF MINISTERS – The Cabinet of JSC Ukrtransnafta, SC Gas of Ukraine, Stock Company Ukrnafta Ministers of Ukraine SE Uktavtogaz, PJSC Chornomornaftogaz, WO – workover operations OJSC Kirovohradgaz, SE Zakordonnaftogaz, PJSC UKRSPETSTRANSGAZ, COMPANY – Naftogaz PJSC Ukrspetstransgaz, Naftogaz Overseas SA, UKRSPETSTRANSGAZ – Public Joint Stock Company WORLD BANK – the organization that provides SE Vuhlesyntez Ukraine, SE Ukrnaftogazkomplekt, Ukrspetstransgaz assistance for development. It comprises two CRIMEA – The Autonomous Republic of Crimea, SE Naukanaftogaz, SE Naftogazobsluhovuvannya, institutions: the International Bank for Reconstruction a region of Ukraine currently occupied by the SE LIKVO, SE Naftogazbezpeka, SE Budivelnyk, PJSC UKRTRANSGAZ, UKRTRANSGAZ (UTG) – and Development (IBRD), and the International Russian Federation PJSC Ukrnafta Public Joint Stock Company Ukrtransgaz Development Association (IDA)

DHC – district heating company GTS – gas transportation system PJSC UKRTRANSNAFTA, UKRTRANSNAFTA (UTN) – (same as “teplokommunenergo”) Public Joint Stock Company Ukrtransnafta HF – hydraulic fracturing DSNS, SESU – State Emergency Service of PSO – public service obligations Ukraine IBRD – International Bank for Reconstruction Type and name of the joint-stock companies and Development PWC, PRICEWATERHOUSECOOPERS – international in which 100% shares are owned by National EBRD – European Bank for Reconstruction audit consultancy Joint Stock Company “Naftogaz of Ukraine” and Development IFRS – International Financial Reporting Standards were changed on 21.05.18 in accordance ROIC – Return on Invested Capital. ROIC is EC – the European Commission IMF – International Monetary Fund, a special calculated as NOPLAT for the respective year with their Charters: UNO agency divided by invested capital, which was determined EIB – European Investment Bank as a sum of invested capital in fixed assets and net Full name Abbreviated name LNG-TERMINAL – a liquefaction terminal, receiving working capital as of the end of the year Joint Stock Company JSC Ukrtransgaz EFET – European Federation of Energy Traders and regasification of liquefied natural gas Ukrtransgaz RSC – regional gas supply companies EGPC – Egyptian General Petroleum LPG – liquefied petroleum gas Joint Stock Company JSC Ukrgazvydobuvannya Corporation RUSSIA – the Russian Federation Ukrgazvydobuvannya MHE – municipal heat generating entities Joint Stock Company JSC Ukrtransnafta ENERGY MINISTRY – the Ministry of Energy SE VUHLESYNTEZGAZ, VUHLESYNTEZGAZ – Ukrtransnafta and the Coal Industry of Ukraine NAFTOGAZ OVERSEAS S.A. – акціонерна компанія Subsidiary enterprise of the National Joint Stock Naftogaz Overseas (Швейцарія) Company Naftogaz of Ukraine Vuhlesyntezgaz Joint Stock Company JSC Ukrspeсtransgaz EU – the European Union Ukrspeсtransgaz NCREU (NEURC) – National Commission for STATE COMPANY GAS OF UKRAINE, Joint Stock Company National Joint EUSTREAM – Slovak gas transmission system Regulation of Energy and Utilities GAS OF UKRAINE – a subsidiary of the National «National Joint Stock Company operator Joint Stock Company Naftogaz of Ukraine Stock Company «Chornomornaftogaz» NOPLAT – adjusted operating result net of income «Chornomornaftogaz» GAS – natural gas, unless stated otherwise taxes STATE ENTERPRISE ZAKORDONNAFTOGAZ, ZAKORDONNAFTOGAZ – a subsidiary of Gas trunk pipelines –a single-line system OECD – Organization for Economic Co-operation NJSC Naftogaz of Ukraine feeding into the common system of gas and Development pipelines, through which gas is transmitted from SUBSIDIARIES – subsidiary companies of the the production site to consumers OJSC KIROVOHRADGAZ, National Joint Stock Company Naftogaz of Ukraine KIROVOHRADGAZ (KirGaz) – Open Joint Stock GAZPROM – Public Joint Stock Company Company Kirovohradgaz, a regional gas distribution TEPLOKOMUNNENERGO – enterprises, producing Gazprom, a Russian energy company and supply company heat and energy, district heating comanies

282 283 ADDITIONAL INFORMATION ANNUAL REPORT 2017

Material Disclosure Disclosure Page Report section MATERIAL TOPICS UNDER topic number name number and comments

Governance 102-18 Governance structure 146 Supervisory board report GRI STANDARD 154 Executive board structure and 144 remuneration Corporate governance 102-40 List of stakeholder groups 284 Material topics under GRI Standard 102-41 Collective bargaining agreements 162 All employees are covered by collective bargaining agreement 102-42 Identifying and selecting stakeholders 284 Material topics under GRI Standard

Material Disclosure Disclosure Page Report section Naftogaz Annual report 2015, Stakeholder topic number name number and comments relations

General Disclosures Code of corporate ethics (http://www.naftogaz.com/files/HR/ 102-1 Name of the organization 214 NJSC “Naftogaz of Ukraine” (Naftogaz group) Naftogaz‑Kode‑Ethics.pdf) 102-2 Activities, brands, products, and services 62 Our performance 102-3 Location of headquarters 291 Additional information Procedure for Interacting with 102-4 Location of operations 62 Our performance Stakeholders (http://www.naftogaz. 102-5 Ownership and legal form 201 Financial statements com/files/official_documents/ Procedure_for_Interaction_with_ 102-6 Markets served 62 Our performance Stakeholders_UA.pdf) 202 Financial statements 102-7 Scale of the organization 62 Our performance 102-43 Approach to stakeholder engagement 284 Material topics under 202 Financial statements GRI Standard 162 Human resources Naftogaz Annual report 2015, Stakeholder 102-8 Information on employees and other workers 162 Human resources Indicator has been partially disclosed Stakeholder relations There were no significant variations in engagement employment numbers Code of corporate ethics (http://www. naftogaz.com/files/HR/Naftogaz‑Kode‑ 102-9 Supply chain 138 Procurements by Naftogaz group Ethics.pdf) Organizational companies in 2017 profile 102-10 Significant changes to the organization and its There were no significant changes during Procedure for Interacting with supply chain the reporting period Stakeholders (http://www.naftogaz. 102-11 Precautionary Principle or approach 157 Risk management at the Naftogaz group com/files/official_documents/ 190 Ecology and environment protection Procedure_for_Interaction_with_ 170 Company occupational and safety policy Stakeholders_UA.pdf) 185 Energy efficiency 102-44 Key topics and concerns raised 284 Material topics under 102-12 External initiatives 162 In the reporting period, the company GRI Standard did not subscribe to any economic, environmental and social charters, Naftogaz Annual report 2015, Stakeholder principles, or other initiatives relations 102-13 Membership of associations The company is a member of such organization: Code of corporate ethics (http://www. • International gas union naftogaz.com/files/HR/Naftogaz‑Kode‑ • European energy forum Ethics.pdf) • Eurogas • EFETnet Procedure for Interacting with Stakeholders Strategy 102-14 Statement from the most senior decision- 9 (http://www.naftogaz. Address of CEO Andriy Kobolyev maker com/files/official_documents/ Procedure_for_Interaction_with_ Ethics and 102-16 Values, principles, standards, and norms of 162 Code of Ethics Stakeholders_UA.pdf) integrity behavior (http://www.naftogaz.com/files/HR/ Naftogaz-Kode-Ethics.pdf)

284 285 ADDITIONAL INFORMATION ANNUAL REPORT 2017

Material Disclosure Disclosure Page Report section Material Disclosure Disclosure Page Report section topic number name number and comments topic number name number and comments

102-46 Entities included in the consolidated financial 202 Financial statements Environment statements Disclosures on management approach 185 Energy efficiency 102-47 Defining report content and topic Boundaries 284 Material topics under GRI Standard 302-1 Energy consumption within the organization Energy efficiency

102-48 List of material topics 284 Material topics under Naftogaz uses standards, methodologies GRI Standard and assumptions, which are governed by 102-49 Restatements of information There were no restatements of Energy regulations of Ukraine in energy saving information provided in previous reports and energy efficiency 102-50 Changes in reporting There were no significant changes from 302-4 Reduction of energy consumption 185 Energy efficiency previous reporting periods Reporting period 2017 calendar year Fuel and energy savings were calculated relative to planned targets 102-51 Date of most recent report June 6, 2017 Disclosures on management approach 190 Ecology and environment protection Reporting 102-52 Reporting cycle Annual reporting 303-1 Water withdrawal by source 190 Ecology and environment protection practice 102-53 Contact point for questions regarding the Aliona Osmolovska Water report Head of Corporate Communications 303-3 Water recycled and reused 190 Ecology and environment protection Tel:+380 44 586 3579 Indicator has been partially disclosed M:+380 63 555 5538 Disclosures on management approach 190 Ecology and environment protection [email protected] Biodiversity 6 B. Khmelnytskoho Str., 304-2 Significant impacts of activities, products, 190 Ecology and environment protection Kyiv 01601 Ukraine and services on biodiversity Indicator has been partially disclosed www.naftogaz.com Disclosures on management approach 190 Ecology and environment protection www.naftogaz-europe.com 305-1 Direct (Scope 1) GHG emissions 190 Ecology and environment protection 102-54 Claims of reporting in accordance with the This report was prepared in accordance GRI Standards with GRI Standard, “Core” level GHG emission in CO2-equavalent was 102-55 GRI content index GRI content index calculated based on Global warming potential coefficients, IPCC Second 102-56 External assurance This report has not been independently Emissions Assessment Report (100-years period) verified 305-4 GHG emissions intensity 190 Ecology and environment protection Specific disclosures Indicator has been partially disclosed Economic 305-7 Nitrogen oxides (NOX), sulfur oxides (SOX), 190 Ecology and environment protection and other significant air emissions Disclosures on management approach 62 Our performance Disclosures on management approach 190 Ecology and environment protection 201-1 Direct economic value generated and 62 Our performance Economic distributed Effluents and 306-1 Water discharge by quality and destination 190 Ecology and environment protection performance waste Indicator has been partially disclosed 201-4 Financial assistance received from government 306-2 Waste by type and disposal method 190 Ecology and environment protection Disclosures on management approach 177 Contribution to the social development of Disclosures on management approach 190 Ecology and environment protection Environmental Indirect local communities compliance Non-compliance with environmental laws and 190 Ecology and environment protection economic 203-1 Infrastructure investments and services 177 Contribution to the social development of regulations impacts supported local communities Social Indicator has been partially disclosed Disclosures on management approach 162 Human resources Disclosures on management approach 138 Procurements by Naftogaz group Procurement companies in 2017 401-1 New employee hires and employee turnover 162 Human resources Indicator has been partially disclosed practices Proportion of spending on local suppliers 138 Procurements by Naftogaz group Employment companies in 2017 401-2 Benefits provided to full-time employees that 162 Human resources are not provided to temporary or part-time employees

286 287 ADDITIONAL INFORMATION ANNUAL REPORT 2017

Material Disclosure Disclosure Page Report section topic number name number and comments CONTACTS

Labor Disclosures on management approach 162 Human resources management 402-1 Minimum notice periods regarding In accordance with the current relations Naftogaz of Ukraine Gas of Ukraine operational changes legislation of Ukraine - 2 months; 6 B. Khmelnytskoho St, Kyiv 01601 Ukraine 1 Sholudenka St, Kyiv 04116 Ukraine enshrined in collective agreements Т. +380 (44) 586-33-30; 39-63; 32-83 Т. +380 (44) 537-05-38, fax: +380 (44) 537-05-74 Disclosures on management approach 170 Company occupational and safety policy [email protected] , [email protected] [email protected] www.naftogaz.com, www.naftogaz-europe.com www.gasukraine.com.ua 403-2 Types of injury and rates of injury, 170 Company occupational and safety policy https://www.facebook.com/NaftogazUA occupational diseases, lost days, and Ukravtogaz Occupational https://twitter.com/naftogazukraine absenteeism, and number of work-related Indicator has been partially disclosed 2 Hryhorovycha-Barskoho St, Kyiv 03134 Ukraine health and fatalities Ukrgazvydobuvannya Т. +380 (44) 291-28-11/78 safety 26/28 Kudryavska St, Kyiv 04053 Ukraine [email protected] 403-4 Health and safety topics covered in formal Health and safety topics covered in Т. +380 (44) 272-31-15, fax: +380 (44) 461-29-94 www.ukravtogaz.com agreements with trade unions separate section of collective bargaining [email protected] agreement www.ugv.com.ua Ukrspetstransgaz Disclosures on management approach 162 Human resources 3 Promyslova St, Dolyna 03477 Ukraine Training and Ukrnafta Т. +380 (3477) 2-53-10/11 education 404-2 Programs for upgrading employee skills and 162 Human resources 3-5 Nestorivskyy Provulok, Kyiv 04053 Ukraine [email protected] transition assistance programs Indicator has been partially disclosed Т. +380 (44) 506 1199, fax: +380 (44) 503 0389 www.ustg.com.ua Diversity Disclosures on management approach 162 Human resources [email protected] and equal www.ukrnafta.com Naukanaftogaz 405-1 Diversity of governance bodies and 162 Human resources 8 Kyivska St, Kyiv Oblast, Vyshneve 08132 Ukraine opportunity employees Chornomornaftogaz Т. +380 (44) 391-74-01, факс: +380 (44) 496-64-18 Disclosures on management approach 162 Human resources 1 Sholudenka St, Kyiv 04116 Ukraine [email protected] Non Т. +380 (44) 537-05-56 www.naukanaftogaz.com discrimination 406-1 Incidents of discrimination and corrective During reporting period, the company [email protected] actions taken recorded no cases of discrimination LLC Gas supply company “Naftogaz of Ukraine” Ukrtransgaz 1 Sholudenka St, Kyiv 04116 Ukraine Disclosures on management approach 162 Human resources 9/1 Klovskyy Uzviz, Kyiv 01021 Ukraine Т. +380 (44) 537-05-63; 05-54 408-1 Operations and suppliers at significant risk Not relevant. Child and forced labour Т. +380 (44) 254-34-38 [email protected] for incidents of child labor are prohibited by any applicable laws [email protected] www.naftogazpostach.com Child labor or regulations of Ukraine. The company www.utg.ua does not operate in countries where Zakordonnaftogaz 72 Velyka Vasylkivska St, Kyiv 03150 Ukraine there is a high risk of human rights Ukrtransnafta 32/2 Moskovska St, Kyiv 01010 Ukraine Т. +380 (44) 237-64-65 violations, including use of child labour Т. +380 (44) 201-57-01/76, fax: +380 (44) 201-57-78 [email protected] Disclosures on management approach 162 Human resources [email protected] Operations and suppliers at significant risk Not relevant. Child and forced labour www.ukrtransnafta.com Forced or for incidents of forced or compulsory labor are prohibited by any applicable laws compulsory or regulations of Ukraine. The company labor does not operate in countries where Naftogaz offices abroad there is a high risk of human rights violations, including use of child labour Office in the Arab Republic of Egypt Office in Hungary Disclosures on management approach 177 Contribution to the social development of 3 A St 259, New Maadi Cairo 11311 Egypt Népfürdő u. 22/B. 12. em. Budapest 1138 Hungary local communities Т. +201 272 47 77 72, +201 220 88 57 76 Т. +36 1 791 02-56/57 Local [email protected] [email protected] communities 413-1 Operations with local community 177 Contribution to the social development of www.naftogaz.com, www.naftogaz.com, www.naftogaz.hu engagement, impact assessments, and local communities www.naftogaz-europe.com/en development programs Indicator has been partially disclosed Office in Turkmenistan Office in the Kingdom of Belgium ş.Aşgabat, Arçabil şaýoly, Biznes-Merkezi “ABC” 40 Rue Breydel, Brussels 1040 Belgium Т. +99 312 48 01-86; 03-10 Т. +32 2 235-86-45/44 [email protected] [email protected] www.naftogaz.com, www.naftogaz-europe.com www.naftogaz.com, www.naftogaz.eu Naftogaz Trading Europe SA Office in the Russian Federation rue Dr-Alfred-Vincent 16, c/o SYNERGIX S.A., 24 Academyka Pilyugina St, Moscow 117393 Russia Succursale de Geneva, 1201 Geneva, Switzerland Т. +7 495-747-59-14 Т. +41 22 735 38-05/07 [email protected] [email protected] www.naftogaz.com, www.naftogaz-europe.com/ru www.naftogaz.com

288 289 TRANSIT OF RUSSIAN GAS TO EUROPE Russia

Finland Gas imports 2017 (%) 55 Nord Stream 80+ Norway bcm Sweden 60 to 79 55 Nord Stream 2 bcm 40 to 59 Estonia

20 to 39 Latvia 146 Traditional route 0 to 19 bcm via Ukraine Denmark Lithuania

39 Yamal – Europe bcm Traditional route via Ukraine Belarus UK 36 OPAL bcm 55 EUGAL Poland Nord Stream NL bcm Ukraine Germany Belgium Czech Nord Stream 2 Republic Slovakia Moldova Yamal – Europe Austria

Hungary OPAL France Romania 32 Turkish Stream bcm EUGAL Serbia Bulgaria Italy 16 Blue Stream Turkish Stream bcm

Turkey Blue Stream Spain Greece NAFTOGAZ GROUP [email protected] +380 44 586 3605 @NaftogazUkraine www.naftogaz.com