Annual Report 2019
Annual report 2019
ON TO NEW HEIGHTS Financial results of Naftogaz Group in 2019, UAH bn
Oil midstream Gas domestic Total Integrated gas and downstream Gas transit* transmission* Gas storage Ukrnafta Other MARKET AND REFORMS
Revenues**
2018 289.6 137.8 13.0 72.3 27.2 1.8 36.1 1.4 2019 251.6 114.5 12.0 70.2 22.7 3.3 28.2 0.7 -13% -17% -8% -3% -17% 83% -22% -50% STRATEGY AND OPERATIONS STRATEGY
Assets
2018 578.3 210.5 14.9 96.4 18.3 199.8 30.0 8.6 2019 484.5 224.9 16.6 111.4 14.2 76.7 32.9 7.7 -16% 7% 11% 16% -22% -62% 10% -11% CORPORATE GOVERNANCE CORPORATE
Adjusted EBITDA
2018 90.9 43.3 2.2 36.6 -1.8 0.0 13.1 -2.5 2019 65.0 37.0 1.1 34.3 -9.8 2.0 2.3 -1.9 -28% -15% -50% -6 -444% 6 494% -82% 24% RESPONSIBILITY ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL
* discontinued operations ** elimination for operations within the group was not included Net cash generated by Net profit Dividend payments Tax payments Capital investments operating activities
2018 11.6 29.5 109.1 24.9 71.6 2019 63.3 20.8 100.6 27.7 110.0 446% -30% -8% 11% 54% FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 2 Naftogaz Group Annual Report 2019 3 Naftogaz Group CONTENTS Address of supervisory board 7 CEO's address 9 MARKET AND REFORMS MARKET AND REFORMS Macroeconomic overview 13 Natural gas market 17 Global oil market 33 Unbundling of GTS Operator 41 Natural gas transit 45 Legislative changes 49 STRATEGY AND OPERATIONS Address of COO 55 Integrated Gas Business Delivery Unit 61 Oil Midstream and Downstream Business Delivery Unit 77 Natural gas transmission 83 STRATEGY AND OPERATIONS STRATEGY Gas Storage Business Delivery Unit 91 Technical Business Enabling Unit 95 Ukrnafta PJSC results 101 New Energy Business Unit 105 New Businesses 109 CORPORATE GOVERNANCE Address of the supervisory board member 115 Corporate governance 117 Report of Naftogaz supervisory board 121 Executive board members and their remuneration 131
Risk management 133 GOVERNANCE CORPORATE ENVIRONMENTAL AND SOCIAL RESPONSIBILITY Address of first deputy CEO 137 Human resources management 139 Occupational safety 149 Cooperation with local communities 157 Investments in energy efficiency 159 Environmental protection 163 Procurement management 173 FINANCIAL OVERVIEW AND STATEMENTS CFO's address 179 RESPONSIBILITY Summary of 2019 results 181 ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL Consolidated financial statements 185 Independent auditor’s report 187 Consolidated statement of financial position 191 Consolidated statement of profit or loss 192 Consolidated statement of comprehensive income 192 Consolidated statement of changes in equity 193 Consolidated statement of cash flows 193 ADDITIONAL INFORMATION Determination of the content and the material topics of the report 237 Material topics under GRI Standard 239 Contacts 245 Terms and abbreviations 246 FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 4 Naftogaz Group Annual Report 2019 5 Naftogaz Group MARKET AND REFORMS
It is my great pleasure, on behalf of my colleagues on the private discussions with the President of Russia. We are also supervisory board and all employees of Naftogaz of Ukraine, grateful to Ukraine's international partners in EU and USA to invite you to read this 2019 Annual Report. whose support helped us achieve the result. ADDRESS OF The past year has been an extraordinary time for the Finally, the third challenge was to steer the Naftogaz Group company and achievements have been commensurate. Our through turbulent global times, including a rapidly melting challenges have been numerous and extremely difficult. I am energy market and falling oil and gas prices. This context has very proud that the company, under the leadership of Andriy made our third challenge equally vital: the transformation Kobolyev and the executive board, has managed to meet all of Naftogaz into a modern energy company that Ukraine can SUPERVISORY of our challenges successfully, to the benefit of the people of be proud of and that is a major actor on the energy front Ukraine. contributing in a substantial way to the transformation of the In these thanks, I naturally wish to associate the country towards a vibrant, healthy and sustainable future that
government of Ukraine. Without their support, our serves the people of Ukraine well. AND OPERATIONS STRATEGY achievements would not have been possible either. Now that the unbundling has been completed, the BOARD CHAIR Allow me some brief words on each of these challenges. Stockholm arbitration is behind us – fortunately with The first challenge has been the successful unbundling substantial revenues in our bank accounts – the third and delivery of our UTG business to form an independent challenge, the Naftogaz transformation into a vibrant and transmission business. On January 1, 2020 the unbundling exemplary energy player in the midst of a collapse of the project was completed. OGTSU LLC was transferred from energy markets will become the main focus of the group for Ukrtransgaz JSC (Naftogaz Group) to the ownership and the coming years. This challenge has also seen progress during management of the state company MGU JSC, 100% of which the last year, particularly with the planned strengthening of is owned by the Ministry of Finance of Ukraine. Many doubted our executive board and the further progress on the internal that this unbundling would be achieved, in time and in quality. organization of the "new" Naftogaz. This was for me never in doubt. I wish to thank the Naftogaz We already know that 2020 does not offer in its early Unbundling team for ensuring this outcome, as well as the months much to rejoice about: gas prices have continued to
supervisory board of MGU, who have become partners in this fall, but in addition the entire globe has been attacked by the GOVERNANCE CORPORATE major development. COVID-19 virus, which in the short run has halted most of the In creating the successful unbundled business, we greatly world's economies, further depressing energy markets, but benefited from the support of major European international foremost putting the government and the people of Ukraine transmission partners who formed a consortium to advise in front of tremendous challenges, of a type not experienced us on the operation, and also the Energy Community so far. Secretariat who atively participated and certified the new Times were already expected, towards the end of 2019, unbundled entity as complying with the European Energy to become even more difficult in 2020. The current health Directives. Other international partners, such as the World and economic crisis are making the year 2020 even more Bank, the EBRD, and also some major countries committed critical. Fortunately, the government of Ukraine has agreed to Ukraine's transformation, watched and supported us. Let with our recommendation to reappoint our CEO for another them receive our thanks here and we remain indebted to 4 years, allowing continuity and competence in leadership them. This means that a major step has been made to fulfill at a time when stress and disruption appear all around us. RESPONSIBILITY Ukraine's promise as an integrated player in European and Andriy Kobolyev, together with the new executive board and international gas markets. This has been achieved and we the entire Naftogaz community, has our greatest thanks and AND SOCIAL ENVIRONMENTAL should all take pride in it. admiration for accepting the challenge in what are most Clare Spottiswoode The second challenge facing Naftogaz was our litigation difficult times, and agreeing to put their best efforts that the Supervisory board chair with Gazprom at the Stockholm Court of Arbitration. All have group can continue its journey towards showing that Ukraine witnessed the successful conclusion of these negotiations has one more great company to be proud of. with an agreement by Gazprom to not only pay USD 2.9 billion Ukraine is a resilient country, not unfamiliar with suffering to Naftogaz as part of the settlement of the arbitration case, in major ways. Naftogaz has inherited this resilience in its but also to agree a 5-year transmission contract which allows blood, and it will serve the group well in the months and years Naftogaz to absorb the loss of its transmission business (and to come, and Naftogaz will come out of the current global With my and my board’s sincere thanks. its associated revenues) in a more gradual way. Of course, this crisis stronger. This we all are committed to in Naftogaz Group, agreement was made possible by the excellent negotiating and we will spare no efforts to also navigate 2020 in the best efforts of Naftogaz team, which very early on believed in the way possible notwithstanding a very adverse environment. possibility of this outcome and then spared no effort to make In this environment, we look forward to the support of it happen. The outcome vitally benefited from the full support our shareholder, the government of Ukraine, and all the and engagement of the President of Ukraine, who spared stakeholders of Naftogaz Group who share its ambition and no effort either in ensuring this most favorable outcome in purpose. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 6 Naftogaz Group Annual Report 2019 7 Naftogaz Group a drop in their cost. In particular, we anticipated that gas Ukrainians. Therefore, steps aimed at creating a transparent, would cost much less due to the LNG market glut and the competitive gas market in Ukraine will develop the country emergence of new suppliers. However, the economic crisis as a whole and strengthen opportunities for greater social CEO’S ADDRESS turned out to be much stronger than we expected. Sharp justice. fluctuations in the price of oil and gas, together with the As a result of reforms in recent years, today’s Ukraine is
obvious dependence of this volatility on political decisions, no longer dependent on gas supplies from Russia, and no MARKET AND REFORMS the development of pandemic conditions in different regions one can use the gas lever for political purposes. To further of the world, and the growing global trend of abandoning strengthen the country's energy independence, we will work hydrocarbons as an energy source, all serve to create a in two key areas – increasing natural gas production and fundamentally new environment in which we have to work. reducing consumption by implementing energy efficiency The dramatic change in the economic landscape measures. Given the unprecedented reduction in gas prices definitely impacts our development strategy, budgets and in the world this year, and the fact that prices in some periods investment priorities. The plunge in prices for fossil fuels were lower than the cost of production, we are introducing and uncertainty about the timing of the global economic internal competition between upstream and energy efficiency recovery are forcing us to revisit previously approved businesses for capital investment. The company's money will development programs. Naftogaz must always respond work exactly where it currently generates the greatest return. to external changes and adapt in order to achieve its own Economic feasibility is the main criterion when determining strategic objectives. the directions of internal investment. We realize that Naftogaz remains one of the major Despite the fluctuations in oil and gas price, expansion
Andriy Kobolyev contributors to the state budget and an important stability of proven hydrocarbon reserves remains a strategic priority. AND OPERATIONS STRATEGY Chief Executive Officer factor for Ukraine’s financial system. We also understand that We see this work as an investment in the future energy raising funds in international financial markets under current independence of our country and aim to increase the intensity market conditions will be more difficult than before and and efficiency of our exploration activities. GETTING STRONGER AND SHOWING RESULTS In 2019, Naftogaz generated a net profit of will require a clearer business model, rigorous selection of The preparation of the company for a future IPO – place- UAH 50.6 billion, of which 95% was paid to the state as investment projects, and reliable repayment sources. ment of part of its shares on a stock exchange – is closely 2019 was a year of great challenges for Naftogaz, but dividends. This is a new record for our company or any other Cooperation with international financial organizations linked to the transformation processes taking place within the also a year of significant achievements. The hard work of the state-owned company in Ukraine. remains a priority to both Ukraine and Naftogaz. The group. These processes are implemented in order to increase previous periods has begun to yield results – the company has Ongoing transformation processes within the group now company successfully secured loan facilities from the the efficiency of business processes, eliminate duplication of demonstrated its ability to resolve the most difficult problems allow Naftogaz to rapidly resolve complex problems in related EBRD and the World Bank on several occasions in order to functions, simplify decision-making procedures, and strength- rapidly and efficiently. areas. In particular, a serious challenge for us was the prompt ensure uninterrupted gas supplies to Ukrainian consumers. en the personal responsibility of managers. To perform these 2019 saw an effective reset in relations between Ukraine’s take over of operational management of Novoyavorivska and This fruitful cooperation was possible thanks to reforms tasks, we have significantly updated the composition of the biggest company and the country’s authorities. For perhaps Novorozdilska combined heat and power plants (CHPs) in implemented by the Ukrainian government in the gas market board and management of the company, attracting experi- the first time, we saw clear synergy in the teamwork of the Lviv region. The ability of the Naftogaz team to quickly adapt and SOE corporate governance. enced professionals. The company will further strengthen its GOVERNANCE CORPORATE government, parliament and Naftogaz. This synergy resulted to risks and learn new skills we gained during past years of While continuing reforms aimed at improving the management capabilities. in the flawless unbundling of the gas transmission system reforms prevented a man-made catastrophe. We launched efficiency of the group, we will focus on specific tasks It is during the current crisis that we have to prove that operator (GTS) and successful negotiations with Russia on both CHPs and promptly provided 60,000 residents with heat set by our shareholder – the government. These include we are an effective company capable of transforming and continued gas transit through Ukraine. We would like to thank and hot water. I greatly appreciate this local achievement, ensuring revenues to the state budget, strengthening energy changing the business landscape around us. the president, the governmental team, and members of as it supports our course to build a sustainable and highly independence, increasing proven oil and gas reserves, and Naftogaz is pursuing a digitization strategy, which helps parliament for their commitment to coordinated and fruitful efficient business capable of responding quickly to changing preparing the company for an IPO. These strategic tasks remove paper document flow, make business processes more cooperation with Naftogaz to the benefit of the Ukrainian circumstances while creating value in new industries. require us to work even harder in the current environment. In transparent, and improve accuracy and speed of data with people. I hope this effective cooperation will continue in 2020. Last year, in view of the size of the company and its impact the process of their implementation, new growth points will controlled access to information. We began this process with We performed a very complicated unbundling of the GTS on the economy of Ukraine, one of our key focuses was the inevitably be created, both for Naftogaz Group and for the the comprehensive introduction of SAP. operator in as little as six months. I would like to emphasize development of the national gas market. whole country. It is especially important for me that the tasks Implemented projects include a consolidated reporting that the unbundling process was implemented according An oversupplied market and full storage facilities induced set by the owner are organically combined with our vision of and financial planning system based on SAP BPC, Energy to the comprehensive plan proposed by the Naftogaz team price decoupling in the Ukrainian market: competitive offers the group’s overall development strategy. Trading Risk Management, Business Process Management and RESPONSIBILITY several years ago. This plan enabled Ukraine to achieve two have been priced below import parity over the past several Talent Management System. Our IT strategy road map until goals: create the independent GTS operator in line with to months. Naftogaz shifted from regulated pricing cap set out in 2023 contains nearly 70 IT projects. AND SOCIAL ENVIRONMENTAL European rules and protect the country's interests in the a resolution of the Cabinet of Ministers to market pricing. LEADERS OF FUTURE CHANGE In addition to improving business processes, we plan to arbitration proceedings against Gazprom. I am grateful to all The new opportunities, competencies and safety buffer continue opening up new areas of activity, including entry to involved decision makers for trusting our judgement. gained in 2019 make us confident that the group will address In addition to close cooperation with international the gas retail market and development of renewables. We The successful unbundling of the GTS operator made it new challenges effectively and set even more ambitious goals. financial organizations, the task of generating increased believe that only an effective and diversified business will be possible to sign a new transit deal with Gazprom on beneficial It is already clear that further challenges await in what is an economic value requires the completion of the Ukrainian able to ensure sustainable value creation for shareholders terms for Ukraine. This new contract guarantees at least extremely unfavorable business environment. gas market reform, an increase in its resilience to external amid the economic storm. USD 7.2 billion in stable revenues until 2024. influences, and the elimination of opportunities for abuse To ensure sustainable development, the group will con- Moreover, the Russian monopolist paid compensation by individual players. This is possible under conditions of tinue to increase investment in occupational safety, environ- awarded under the early Stockholm arbitration ruling. ON THE THRESHOLD OF GREAT full market liberalization, transition from mass to personal mental protection, and interaction with the local communities In 2019, Naftogaz was once again the largest source of state TRANSFORMATIONS subsidies, and the creation of a favorable environment for the where we operate. budget revenues. During the year, we paid UAH 121.4 billion development of competition. The state and society are just as I am grateful to the Naftogaz team. I remain convinced in taxes and dividends to the state and local budgets. Almost The world, including Ukraine, has entered a period of interested in these transformations as Naftogaz, because the that by constantly improving, we will be able to respond to every sixth hryvnia of the state budget revenue was generated economic crisis due to the COVID-19 pandemic. Last year, we billions of dollars owed by individual market participants are the many challenges facing the company. We take our share by Naftogaz Group. Flexibility and financial reliability of Naftogaz projected certain indications of crisis in the global economy, direct budget losses. These funds would greatly strengthen of responsiblity for Ukraine, we care for our country, and we provide support to the state as our only shareholder. including a reduction in consumption of fossil fuels and the government's ability to provide social support for all drive its development through our work. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 8 Naftogaz Group Annual Report 2019 9 Naftogaz Group IN THIS SECTION: WORLD GAS PRODUCTION GAS PRICES AT EUROPEAN HUBS 13 | Macroeconomic overview 17 | Natural gas market 33 | Global oil market +6.1 % -40 % 41 | Unbundling of GTS Operator Increase in world gas Change in gas prices at
45 | Natural gas transit production European hubs MARKET AND REFORMS 49 | Legislative changes STRATEGY AND OPERATIONS STRATEGY CORPORATE GOVERNANCE CORPORATE RESPONSIBILITY ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL
THE ERA OF LOW PRICES
While natural gas has often been described as the "fuel of the future," recent trends indicate that the future is already here. In 2019 the global natural gas market showed the second fastest annual growth rate in global gas production, gradually growing over the last decade. Due to low gas prices and high prices for carbon emission permits, gas consumption MARKET AND REFORMS MARKET has increased in the electricity sector, displacing coal in many European countries. FINANCIAL OVERVIEW AND STATEMENTS
Річний звіт 2019 10 Група Нафтогаз Річний звіт 2019 11 Група Нафтогаз MACROECONOMIC GDP IN 2019 REAL WAGES In 2019, real GDP In 2019, real wages growth remained at the of regular employees level of 2018 increased by 9.8% OVERVIEW +3.2 % +9.8 % MARKET AND REFORMS
STRENGTHENING THE POSITION 2020, real wage growth began to decline at the end of Q1 2020. Consumer Price Index and Real Wages Index in 2014-2020 2019 was the year of restoring relative financial stability Despite the recovery of domestic demand, the National in Ukraine, which was achieved against the backdrop of sig- Bank of Ukraine managed to keep consumer inflation to the 50 nificant political changes. Major factors include decrease in level of 4.1%. Lower inflationary pressure on the national -cur 43.3% inflation pace, successful efforts of the Ministry of Finance of rency, primarily due to lower energy prices and stabilization Ukraine on the capital markets, which resulted in reduction of of hryvnia after weakening in March 2020, provides grounds 40 the costs of borrowings as well as in reduction of refinancing for 2020 inflation expectation in the target range of 5% + -1% rate. Other factors included strengthening of the national according to the Inflation Report released by National Bank of 30 currency, decrease in the unemployment rate, increase in Ukraine on January, 2020. AND OPERATIONS STRATEGY average wages and salaries. Increase in goods and services export revenues, growing 24.9% 19.1% At the same time, in 2019 Ukraine faced slight reduction agricultural productivity coupled with a decrease in energy 20 12.4% 12.5% in real GDP growth rate relative to 2018, which amounted to prices had a positive impact on the balance of payments. In 9.8% 9.3% 3.2%. This slowdown could be explained, primarily by the addition, a significant factor in decrease of the current-ac- % 10 13.7% unfavorable external markets environment which affected count deficit (from USD 4.2 billion to USD 1.3 billion) was re- 9.0% 8.9% 4.1% 6.0% industrial production and outlook, including falling prices ceipt of compensation by Naftogaz of Ukraine from Gazprom 0 on the metal market resulting from trade wars between the pursuant to the Stockholm arbitration award. largest producers and consumers, as well as weakening of Stabilization of macroeconomic indicators led to decrease price competitiveness of the industry due to strengthening of the capital costs to the lowest, over the years, borrowing -10 -6.5% of the national currency. In turn, high crop yields and rising rates on public offering in foreign markets. domestic consumption supported by higher incomes of the Nafogaz managed to get the attractive interest rate during -20 population and improving consumer sentiment partially Eurobonds placement in 2019. The interest rate at the date of is- -20.2% offset the negative effect of the industrial slowdown. suance was only 127 basis points higher than the quotaton of the GOVERNANCE CORPORATE -30 In 2019, incomes of the population continued to grow, Ukraine’s sovereign debt with a similar maturity. Peak demand for 2014 2015 2016 2017 2018 2019 2020 forecast largely as the result of the increase in the average wage. Nafogaz Eurobonds exceeded supply by 2.9 tmes, which indicates Thus, in 2019 real wages of full-time employees increased a high level of confdence in the сompany’s creditworthiness. Consumer Price Index Real Wages Index by 9.8%, however, primarily due to the quarantine restric- The economic growth in 2019 contributed to an increase tions imposed to contain the COVID-19 outbreak in March in demand for labor, which led to a reduction in unemploy- Source: State Statistics Service of Ukraine
GDP growth rates and Industrial Production Index Ukraine's balance of payments in 2019, USD billion
6 4.0% RESPONSIBILITY 4 3.4% 3.2%
2.4% AND SOCIAL ENVIRONMENTAL 2.5% -4.2 2 3.0% 2.9 0 1.1% 7.3
% -2 -0.5% 6.0
-4 3.1 -6 -6.6% -5.0% 0.0 -8 -9.8% Capital Financial Current Balance of Compensation Balance of -10 GDP change rate Industrial Production Index account account operations payments not from Gazprom payments -12 -12,3% including including compensation compensation 2014 2015 2016 2017 2018 2019 2020 from Gazprom from Gazprom forecast FINANCIAL OVERVIEW AND STATEMENTS Source: State Statistics Service of Ukraine Source: NBU's Inflation Report
Annual Report 2019 12 Naftogaz Group Annual Report 2019 13 Naftogaz Group ment rate. The labor migration continues to play an import- IMF forecasts a 7.7% drop in Ukraine's GDP in 2020 and an ant role in the Ukrainian economy. According to preliminary increase of 3.6% in 2021. Labor market in Ukraine estimates by the National Bank of Ukraine, in 2019 private Along with global challenges, a number of internal problems 12 25 transfers to Ukraine (through official and informal channels) remain relevant: Ukraine continues to lag behind the European amounted to nearly USD 12 billion. Still, a significant reduc- countries in growth rates and is more vulnerable to the effects 9.3% 9.5% tion in transfers from abroad should be expected in 2020 of the financial crisis without international support. 9.1% 9.3% 8.8% 20 since thousands of migrant workers were forced to return to The stability of the Ukrainian economy continues to be 9 8.2%
Ukraine due to the quarantine restrictions. significantly influenced by the program of Cooperation with MARKET AND REFORMS 15 IMF, the main condition of which is the continuation of reforms in Ukraine. The adoption of a law prohibiting the return of % 6 1.4 EXPECTING THE CRISES bankrupt banks to ex-owners and opening the land market are 18.1 10 million among the key steps to the new program. 16.4 16.3 16.2 16.4 16.6 3 In 2019, new external challenges appear, in particular, As of the date of this report, Ukraine has fulfilled all the 5 worsening conditions through the transition of the global conditions for continuing cooperation with the IMF, agreed on a economy into a recession phase as well as increased world stand-by program in the amount of UAH 5 billion for a period of commodity prices volatility. A real shock to the global econ- 18 months instead of an extended financing program (EFF) for 0 0 omy was the COVID-19 pandemic, which broke out in China a period of 3 years and received the first tranche from IMF. The 2014 2015 2016 2017 2018 2019 in December 2019. This event forced major review of the cooperation with IMF is expected to enhance financial stability by Unemployment rate. % Employed population aged 15-70, million expectations of the global economy growth. maintaining a balance of payments and supporting the budget. Source: State Statistics Service of Ukraine At the time of the release of this Annual Report, a high In recent years the international analytical agencies have level of uncertainty concerning the virus influence on the perceived Ukraine's cooperation with the IMF as an indicator of economy and the time needed for restoring the world stability. Continuation and protection of initiated reforms from AND OPERATIONS STRATEGY economy growth remained both in Ukraine and globally. political influence such as anti-corruption, corporate gover- Revised global growth forecast According to the World Economic Outlook Report (here- nance reforms, etc. directly affect the macroeconomic situation 10 9.2 inafter WEO Report) released by the International Monetary in the country. 8 Fund (hereinafter IMF) as of April 2020, and based on the 2020 is expected to be the year of high levels of required 6.1 6.0 6 5.8 5.8 assumption that the pandemic will fade in the second half public debt repayment. Macroeconomic dangers may be com- 4.7 4.7 4 2.9 3.3 3.4 3.0 2.9 of 2020, the world economy is expected to decline by 3%, pounded by other risks, such as global economic recession 2.3 2.0 2.2 2 1.2 1.3 1.4 1.7 1.2 1.1 which is 6.3 percentage points below January 2020 expecta- due to the coronavirus, war escalation in the eastern Ukraine, 0.7 0.7 0.5 2.3 tions. The major impact is assumed in Q2 2020 for almost all reduction in agricultural yields due to worsening of weather % 0 countries except China (where it was in Q1 2020). In turn, it conditions, increased volatility in world prices, and decline in -2 is estimated that countries experiencing the large-scale virus foreign investments. -4 -3.0 outbreak will lose up to 8% of working days in 2020 during One of the Ukraine’s tangible risks, namely the loss of the -6 -5.2 -5.3 the quarantine regime and gradual abolition of the quaran- contract for the gas transit through the territory of Ukraine to -5.9 -8 -7.5 tine measures. The current Great Lockdown is considered to the European clients starting from 2020, which has created sig- World Eurozone USA China Japan Brazil GOVERNANCE CORPORATE be the worst recession since the Great Depression, never- nificant tensions in Europe as well, has been resolved satisfac- theless, the IMF anticipates recovery to begin in 2021, the torily for Ukraine, reduced uncertainty and will have a positive 2019 2020 (forecast as of Jan‘20) 2020 (forecast as of Jan‘20) global economy is projected to grow by 5.8%. In turn, the impact on the country's economy in the coming periods. 2021 (forecast as of Apr‘20) 2021 (forecast as of Jan‘20) Source: IMF
Capital flows in Ukraine in 2019 Scheduled sovereign debt repayments as of 01.06.2020
Net borrowings FDI 600
8 RESPONSIBILITY 7.2 7.3 2012 8.4 500 486.7
7 AND SOCIAL ENVIRONMENTAL Rest of 2013 4.5 400 6 real sector 171.8 363.5 2.5 2014 0.4 5 4.3 2015 3.0 300 0.5 Naftogaz 264.0 billion UAH 162.7 232.9 232.3 4 Group 215.6 USD billion USD 2016 3.3 200 190.2 176.7 157.3 3 314.9 134.1 131.8 115.0 153.9 140.8 2017 2.6 117.8 Public 137.2 94.0 96.3 78.6 2 4.2 100 200.8 66.0 sector 2.4 2.9 2018 98.8 100.5 87.3 100.6 1 53.0 59.9 61.0 51.8 62.2 2019 3.1 0 0 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 0 1 2 3 4 5 6 7 8 9 2018 2019 Foreign debt Domestic debt USD billion FINANCIAL OVERVIEW AND STATEMENTS Source: NBU Source: Ministry of Finance of Ukraine
Annual Report 2019 14 Naftogaz Group Annual Report 2019 15 Naftogaz Group EUROPEAN NATURAL GAS MARKET 1 EUROPEAN GAS MARKET KEY INDICATORS 2019: Sustainability-focused policies in selected markets NATURAL — For the 2019, the spot prices at the European hubs drop by 43.7% (or 10.2 EUR / MWh) on TTF and 38.9% (or 8.6 China Mandated coal to gas switch to improve local air EUR / MWh) on NCG. quality — Gas consumption in European countries increased by 3.6% South Korea Reduction in coal and nuclear power generation
(or 18.5 bcm) compared to the previous year. MARKET AND REFORMS GAS MARKET — Natural gas production in Europe was 6.3% (or 16.8 bcm) Saudi Arabia Phase out of oil products used in power generation lower than the 2018 volumes. — Natural gas imports to Europe increased by 10.2% (or 38.3 bcm) compared to 2018, while European LNG imports Great Britain Carbon price floor driving coal out of power generation GLOBAL NATURAL GAS MARKET rose by a record 41.6% from 54 million tons in 2018 to 76 million tons in 2019. According to the European Com- India Expansion of city gas distribution to improve air 2019 can safely be called the year of beginning "low prices" mission, LNG became the second largest source of natural quality trend in both the natural gas and overall commodity gas imports to Europe in Q2 and Q3 2019. 36% Source: Snam Global Gas Report 2019 Change in price of gas markets: A clear downward trend in prices in Europe can be traced at world hubs** — Over the year, natural gas prices have significantly fallen as far back as January 2019. or even halved at 3 key world gas hubs, i.e., the prices in The main contributors to the declining trend were, first Europe (TTF hub) decreased by more than 40%, in the USA and foremost, an increase in supply in the market owing to + (Henry Hub) – by 19%, in Asia (NE Asia spot hub) – by 40% the increasing LNG imports and the convergence of world 143 compared to the 2018 average. regional prices. The decline in gas consumption in Asia and -41 % AND OPERATIONS STRATEGY BCM — At the beginning of 2020, the prices kept dropping and the increase in production in the US led to excess LNG flows Change in gas prices at over Q1 2020 the TTF prices fell by another 21% compared diverted to Europe that surged gas supply in an already satu- Change in capacity for gas European hubs** export-import*** to Q4 2019. rated market. — According to forecasts by leading think tanks, gas prices The factor that contributed to supporting gas prices in the - % will remain depressed in the short term due to slowdown European market, especially the front-month curve in Octo- 6.3 in global economic growth and foreign trade volumes, ber-November 2019, was a concern about the expiry of the Change in natural gas +12.5 % weak demand for liquefied natural gas (hereinafter transit agreement between Ukraine and Russia on January 1, production volumes* referred to as “LNG”) in China, large volumes of natural gas 2020 and uncertainty at that time about the likelihood of the Growth of LNG production in the world**** in European storage facilities, and commissioning of new parties entering into a new agreement. Due to the uncertainty LNG capacities. about the terms of the potential new agreement, the vol- umes of transit, and the overall risk of not entering into a new +41.6% However, such a price drop is not surprising, given the agreement, market participants ensured record volumes of Increase in LNG imports to
+ % GOVERNANCE CORPORATE 11.1 number of factors that were affecting the natural gas natural gas injected into the UGS (i.e., 97% of UGS maximum Europe*** Increase in biogas market during the year such as: capacity was filled up) during the gas injection season. capacity *** — Natural gas production and trade growth rates, amounting Owing to the fact that the risks of not signing the transit to 6.1% and 2.8% respectively, exceeded the consumption agreement between Ukraine and Russia did not material- +33.9 % +6.1 % growth rate of 2.5%, which resulted in an imbalance ize, and because of the temperatures keeping higher than The level of reserves in storage between supply and demand building energy resource the historical averages (the average annual temperature facilities in Europe at the end of Increase in world gas surplus. in Europe in 2019 was 1.2 °C higher than the 1981-2010 the year compared to production* — Development of trade infrastructure, namely increase in average), Europe ended the heating season with record 2014-2018 average**** LNG production capacity by 40 million tons / year (up to high gas reserves (i.e., 60% of total capacity was filled up, +2.5 % 442 million tons / year) in North America, Asia, Africa and which is the highest level ever recorded in Europe at the + % the Middle East; regional pipelines capacity expansion and end of the heating season). The lockdown measures taken 3.6 Increase in world gas commissioning of the Turkish Stream, the Trans-Anatolian to curb the spread of the COVID-19 pandemic as well as Increase in natural gas consumption* Natural Gas Pipeline (TANAP) and the EUGAL pipeline. anticipation of a financial crisis are not favorable conditions consumption* RESPONSIBILITY — The world average temperature in 2019 keeping 0.6 °C to boost gas demand. The prices keep falling in 2020 (by +2.8% above the 1981-2010 average and only 0.04 °C below the 21% in Q1 2020 compared to Q4 2019), and it is difficult to AND SOCIAL ENVIRONMENTAL average temperature in 2016, which is the warmest year in predict the potential floor the gas prices could touch owing Increase in LNG trade and the history of meteorological observations. to such bearish sentiments. +10.2 % gas transportation through — At the same time, along with the factors favorable for the Increase in natural gas pipelines* gas prices downward dynamics, 2019 saw a noticeable Overall, 2019 proved to be a year of "surplus" for the imports to Europe* intensification of the implementation of sustainable devel- global natural gas market due to both endogenous factors opment policy and government support for environmental (i.e., supply), and exogenous factors including weather and + °С protection measures. These practices, in turn, are becom- infrastructure developments. Whether the natural gas price + °С Note: Unless otherwise stated, the 2018 and 0.6 1.2 ing increasingly important drivers inflating demand for curve can change its trend upward will depend on possible 2019 indicators are compared. The average annual Average annual natural gas. In particular, in 2019, global biomethane ca- changes in the natural gas supply and demand balance. Note: Unless otherwise stated, the 2018 and temperature in the world temperature in Europe pacity increased by 11.1% (or 0.5 bcm), low-carbon hydro- Factors that can have a significant impact on this balance and 2019 indicators are compared. (compared to the period (compared to Source: 1981-2010)***** gen capacity – by 37.8% (or 1.7 bcm), and CCUS (carbon determine price dynamics are discussed below. 1981-2010) ***** Source: *OECD Monthly gas statistics December 2019 capture, utilization and storage) capacity – by 16.2% (or 6 *Eurostat **Average change in prices at the Henry Hub, NBP, and NE Asia spot hub **Average change in prices at TTF and NCG hubs; data taken from Bloomberg ***Snam Global Gas Report 2019 Mt СО2) comparing to the previous year. ***According to ICIS ****According to McKinsey ****According to AGSI+platform *****https://www.climatechangenews.com/-2019/08/01/2020second- *****https://www.euronews.com/13/01/2020/climate-now-2019-was- FINANCIAL OVERVIEW AND STATEMENTS warmest-year-record-ends-hottest-decade-yet-says-eu-observatory/ warmest-year-on-record-in-europe
Annual Report 2019 16 Naftogaz Group Annual Report 2019 17 Naftogaz Group THE ERA OF LOW PRICES Dynamics of gas production in the United States While natural gas has often been described as the "fuel of — Average annual spot prices at TTF hub fell by 41% (from +10.3% the future," recent trends indicate that the future is already EUR 23.59 / MWh in 2018 to EUR 13.83 / MWh in 1 050 here. In 2019 the global natural gas market showed the sec- 2019). In December 2019, the price decreased by 43.7% 1 000 +12.4% ond fastest annual growth rate in global gas production, grad- compared to the beginning of the year. ually growing over the last decade. — Average annual spot prices at NCG hub fell by 39% 950
Due to low gas prices and high prices for carbon emission (from EUR 23.16 / MWh in 2018 to EUR 14.17 / MWh in 900 +26.9% MARKET AND REFORMS permits, gas consumption has increased in the electricity 2019). In December 2019, the price decreased by 38.9% sector, displacing coal in many European countries. In Q3 compared to the beginning of the year. 850 bcm 2019, coal imports to Europe have fallen to a minimum since — Brent crude oil prices fell 10% year-on-year (from 800 1 025 2000, according to KPMG. As a result, coal-fired electricity USD 71.06 / barrel in 2018 to USD 64.24 / barrel in 929 generation in Europe is down 24% in 2019 compared to the 2019). In December 2019, the price increased by 10.8% 750 previous year. compared to the beginning of the year. 815 804 827 700 779 Supply indicators analysis shows the main increase in — Coal API2 average annual prices fell by 33% (from 724 gas production in the U.S. (+87 bcm, or +10%) and Australia USD 91.87 / t in 2018 to USD 61.67 / t in 2019). In 650 634 681 716 (+21.4 bcm, or +16.4%), which is related to the global LNG December 2019, the price decreased by 32.2% compared 0 infrastructure development and the shale gas production to the beginning of the year. 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 technology prices reduction. According to EIA (U.S. Energy — At the same time, the price of CO2 emission permits Information Administration), natural gas consumption in the has increased by 56% (from USD 15.92 / t in 2018 to Source: U.S. Energy Information Administration, in-house estimates United States increased by only 3% in 2019, though it reached USD 24.78 / t in 2019). In December 2019, the price in- a record 2.4 bcm / day. At the same time, gas production creased by 5.8% compared to the beginning of the year. AND OPERATIONS STRATEGY increased by as much as 10.3%. The difference between gas consumption and production growth rates, as well as the Significant LNG supply in the European market, and, as Dynamics of spot prices for natural gas at the American Henry Hub trend towards redirection of LNG flows from Asia to Europe, a consequence, highly filled gas storages, have also had a led to a surplus of natural gas in world markets. significant impact on gas pricing. Thus, in 2019, LNG imports 7 In 2019, the U.S. natural gas market has also seen a down- to Europe increased to nearly 76 million tons (+ 41.6% to 6 ward trend in prices due to rapidly growing production rate 2018). and completion of construction of Permian Basin infrastruc- In view of the above factors, there was a 50-60% decrease 5 ture pipelines. in spot prices at European gas hubs in Q3 2019 year on year. u t 4 Spot prices at most European gas hubs have also gone By September 2019, the spot gas price at TTF, continuing the B down, and as early as September 2019, the price at the TTF downward trend started in Q4 2018, had fallen to EUR 9.6 / M 3 gas hub had fallen to a ten-year low. Gas prices in Europe fell MWh, which was the lowest since September 2009. In the first USD/ in parallel with prices in other commodity markets, amid rising days of September 2019, the average daily price dropped to 2 CORPORATE GOVERNANCE CORPORATE СО2 emission permits: EUR 7.5 / MWh, which was the lowest since October 2006. 1
0 Jul 17 Jul Jul 14 Jul Jul 15 Jul Jul 16 Jul Jul 19 Jul Jul 18 Jul Jan 17 Jan Jan 14 Jan Jan 15 Jan Jan 16 Jan Jan 19 Jan Jan 18 Jan Apr 17 Oct 17 Apr 14 Oct 14 Apr 15 Oct 15 Apr 16 Oct 16 Oct 19 Apr 18 Oct 18 Jan 20 Jan Apr 19
Source: U.S. Energy Information Administration
World gas production growth rate Dynamics of spot prices for natural gas at TTF RESPONSIBILITY 8 24 Drop in gas flows Start of heating season in the EU
to the European market and no signed gas transit agreement AND SOCIAL ENVIRONMENTAL 7 20 from Russia and Norway between Ukraine and Russia
6 16
5 12 Increase by 26% %
4 EUR/MWh 8 in price of coal 3 4 2 0 1
0
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 01.01.2019 01.02.2019 01.03.2019 01.04.2019 01.05.2019 01.06.2019 01.07.2019 01.08.2019 01.09.2019 01.10.2019 01.11.2019 01.12.2019 01.01.2020 FINANCIAL OVERVIEW AND STATEMENTS Source: Statista, in-house estimates Source: U.S. Bloomberg
Annual Report 2019 18 Naftogaz Group Annual Report 2019 19 Naftogaz Group NATURAL GAS Dynamics of spot prices for oil, coal, СО2 emission permits, and IN STORAGES AT RECORD LEVELS natural gas at European hubs The EU countries with the largest gas storages are Germa- Filling levels of major European ny, Italy, the Netherlands, and France covering 62.6% of the 30 total European active storage capacity. According to AGSI data, gas storages as of 1 October 2019 the EU gas storage operating capacity at the end of 2019 was 35
Ukraine MARKET AND REFORMS 20 104 bcm, excluding 16 bcm of capacity to be constructed or already under construction. Ukraine's gas storage is the largest 30 in Europe with 30 bcm total capacity, which is 28.8% of all EU 25 Germany 10.8% gas storages volume. 10 Italy In 2019, European gas storages were filled with gas at their 20 5.8% highest levels. The average gas reserves were above the 2014- bcm 15 France Netherlands
% 0 2018 average by 33.9% against the backdrop of rising LNG 66.5% 10 imports, declining spot prices, and abnormally warm weather. 98.2% 97.0% On average, net storage balances accumulated during Q3 5 98.1% 100% -10 2019 accounted for 23.9% of the total gas storage capacity, compared to 33% for the same period in 2018: the average 0 filling rate increased from 73% as of 30 June 2019 to 97% as Used capacity Free capacity -20 of 1 October 2019. As a result, at the end of September 2019, Source: AGSI, in-house estimates STRATEGY AND OPERATIONS STRATEGY -30 -32.2% The level of gas reserves in EU gas storages in 2019
-40 -38.9% compared to the 5-year range of 2014-2018 gas years -43.7% 110
-50 100 90 80 +33.9% -60 70
bcm 60 50 2019 Jul 19 Jul Jan 19 Jan Jun 19 Jun Apr 19 Oct 19 CORPORATE GOVERNANCE CORPORATE Feb 19 Feb Sep 19 Sep Nov 19 Nov Aug 19 Aug Dec 19 Mar 19 Mar May 19 May storage capacity 40 2014-2018 average 30 Brent, EUR/barrel Spot at NCG, EUR/MWh maximum – minimum range in 2014-2018 20 Coal AP12, EUR/ton Emission allowances, EUR/ton Spot at TTF, EUR/MWh 10 Source: Bloomberg Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Source: AGSI, in-house estimates
GLOBAL LNG MARKET Structure of global LNG imports in 2019 Gas stocks in Ukraine’s UGS facilities as of the 1st day of each month In 2019, global LNG demand increased to 359 million tons1. 21.8 22 LNG imports to Europe increased to almost 76 million tons in 20.5 20.7 2019, the highest ever recorded. Europe absorbed most of the 2015-2018 average RESPONSIBILITY Europe 21.4% 6.7% India 20 additional production, namely more than 21% of LNG produced 2018 18.3 worldwide in 2019, compared to 13.5% in 2018. Thus, the growth 2019 AND SOCIAL ENVIRONMENTAL 18 of Europe's share in total LNG imports globally was the most America maximum – minimum range in 2015-2018 significant compared to other regions (+7.9% year over year). 4.1% 15.9 and Mexico 16 Increase in the diversification of LNG contract terms among producers and buyers has led to increase in the num- 13.8 13.6 9.1% Others 14 ber of liquefaction and regasification plants by almost 10%, as bcm well as increase in LNG market liquidity. Reduced LNG prices 12 11.5 have fueled its use and, as a consequence, accelerated the 11.1 shift from other energy sources to natural gas in remote re- 9.7 10 9.5 gions with no developed gas transportation infrastructure. The 8.8 Pakistan, European market ended the 2019-20 heating season with high JSТC* 55.4% 3.3% Bangladesh 8 levels of UGS reserves, which in turn does not allow the Euro- * Japan, South Korea, Taiwan, China pean market to absorb oversupply, as it did in 2019. 6 Source: Independent Commodity Intelligence Services (ICIS) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec FINANCIAL OVERVIEW AND STATEMENTS 1 https://www.shell.com/promos/download-the-full-lng-2020/_jcr_content.stream/1582140325378/ddcfff9e5f778ee9e8876b3b564e7337599b0d61/lng-outlook-twentytwenty-factsheet-final.pdf Source: AGSI, in-house estimates
Annual Report 2019 20 Naftogaz Group Annual Report 2019 21 Naftogaz Group the average filling rate of EU gas storages was 14% higher than to the EU countries. Because of this uncertainty, there was the year before; by late September, it has been at the last a trend to inject more in gas storage facilities before the World temperature anomalies dynamics (deviation from the 20th century average temperature), оС eight years' highest. heating season in order to mitigate the risks to gas supply in 8.0 As a result, the average filling rate of EU gas storage winter. 1.6 facilities at the end of September 2019 was 14% higher than a Ukraine, being the direct participant in these process- 1.4 year before. es, has also accumulated gas in storage facilities as a backup 1.2 The excess over the average gas volume is due to not source in case of any transit halts. In the course of this prepara- 1 only climatic conditions and lower prices, but also the un- tion, Ukraine has managed to accumulate the largest gas stocks MARKET AND REFORMS certainty regarding gas transit from Russia. In early 2019, in its UGS facilities for the heating season for the past seven 0.8 the gas transit agreement with Gazprom was to expire from years: on 22 October 2019, UGS reserves reached 21.5 bcm, 0.6 1 January 2020. Historically, this is the main gas supply route which is 4.8 bcm more than in 2018 (16.7 bcm). 0.4 0.2 0 NEW TEMPERATURE RECORDS -0.2
According to the National Oceanic and Atmospheric Jan 1992 Jan Jan 2013 Jan Jan 1995 Jan Jan 1983 Jan 2016 Jan 2019 Jan Jan 2010 Jan Jan 2001 Jan Jan 1986 Jan 1989 Jan 1998 Jan Jan 1980 Jan Jan 2007 Jan -7.7 % Administration, 2019 was the second warmest year since 2004 Jan Change in records began. The average global surface temperature Source: NOAA natural gas consumption** of the Earth in 2019 was 1.42 °C higher than the average temperature in the 20th century (anomalies are calculated compared to the average for each period of the 20th century). о + % In addition, 9 of the 10 warmest years have been recorded Europe temperature anomalies dynamics (deviation from the 20th century average temperature), С AND OPERATIONS STRATEGY 3.2 since 2005. 5.0 Changes in volumes of In Europe, in December, according to the Copernicus transit of natural gas Climate Change Service, the average air temperature in De- 2.0 through Ukraine* cember was 3.2 °C higher than the standard benchmark for 1.5 December in 1981-2010. In Ukraine, 2019 was a record year. According to the Boris 1.0 Sreznevsky Central Geophysical Observatory, 2019 was the 0.5 warmest in the entire observation period since 1881. The + % highest deviation from the average occurred in the heating 0 43.3 season, which had a significant impact on gas consumption. It -0.5 Stocks in storage in Ukraine at is worth noting that the air temperature in December 2019 in the end of the year compared Kyiv exceeded 15 °C for the first time in the history of obser- -1.0 to the average for 2014-2018* vations. GOVERNANCE CORPORATE Jan 1992 Jan Jan 2013 Jan Jan 1995 Jan Jan 2016 Jan 2019 Jan Jan 1983 Jan Jan 2010 Jan Jan 2001 Jan Jan 1986 Jan 1989 Jan 1998 Jan Jan 1980 Jan Jan 2007 Jan Jan 2004 Jan - % NATURAL GAS MARKET IN UKRAINE Source: NOAA 1.3 In 2019, the Ukrainian natural gas market, as a part of the Change in natural gas European and global gas markets, was influenced by the same production volumes* fundamental factors that were exacerbated by a number of Temperature deviation in 2019 from the average in the last 30 years in Ukraine, оС local factors and expectations, namely: — Reduction in gas consumption that took place due to high Jan 2019 temperatures and regulatory changes in gas prices for PSO consumers: natural gas consumption decreased by 7.7% Feb 2019 (or 2.5 bcm) compared to 2018. RESPONSIBILITY + % Mar 2019 34.5 — Natural gas surplus in the market that occurred owing to a 34.5% (or 3.7 bcm) y-o-y increase in natural gas imports Apr 2019 AND SOCIAL ENVIRONMENTAL Increase in natural gas amid reduced consumption. May 2019 imports to Ukraine* — Decrease in gas production by 1.3% (or 0.3 bcm) compared to the previous year. Jun 2019 — Uncertainty by the end of 2019 regarding the prospects for Jul 2019 an extension of the transit contract with Russia. +2.6°С — A record high volume of natural gas in Ukrainian UGS at Aug 2019 the end of 2019, that was 43% (or 5.7 bcm) higher than Average annual temperature Sep 2019 in Ukraine (compared to the the 2014-2018 heating season average, amid preparations climatic norm)*** for a “zero transit” scenario and a possible shortage of gas Oct 2019 in the heating period. Nov 2019 Note: Unless otherwise stated, the 2018 and 2019 indicators are compared. Dec 2019 Source: *Ukrtransgaz **According to the company's data -2 -1 0 1 2 3 4 5 *** https://apostrophe.ua/ua/article/society/01-02-2020/pyilevyie-buri- FINANCIAL OVERVIEW AND STATEMENTS zasuha-i-ad-letom-kak-izmeneniya-klimata-povliyayut-na-ukrainu/30693 Source: Bloomberg
Annual Report 2019 22 Naftogaz Group Annual Report 2019 23 Naftogaz Group GAS TRANSIT THROUGH UKRAINE GAS PRODUCTION IN UKRAINE Volumes of natural gas transit In 2019, the transit volume was 89.6 bcm, which is through Ukraine in 2015-2019 Along with the increase in liquefied natural gas imports on-year to 14.9 bcm. At the same time, the reduction in the 2.8 bcm (or 3.2%) more than in 2018. in 2019, Europe also demonstrates a tendency to reduce volume of commercial gas produced by Ukrgasvydobuvannya Russia supplies about 40% of its gas to the European mar- 100 +22.5% +13.7% -7.2% +3.2% its natural gas production. For example, in 2019, the Dutch in 2019 was not so significant comparing to the previous year, kets through Ukraine. However, there is a risk of significant government approved an updated plan to halt production in i.e., the company produced 13.6 bcm of natural gas in 2019, decrease in transit through Ukraine after the Nord Stream 2 80 Groningen – Europe's largest gas field – by 2022. which is 1.4% less than in 2018. pipeline is put into operation. Under the terms of the con- Overall, in 2019, the European countries produced Ukrnafta produced 1.16 bcm of natural gas in 2019, MARKET AND REFORMS tract, Gazprom will reduce the amount of gas transmitted 60 250.1 bcm of natural gas, which is 6.3% less than in 2018 which is 7.0% (or 0.08 bcm) higher than the 2018 through Ukraine in 2020 from 90 bcm to 65 bcm. Reductions (266.9 bcm). volumes. bcm 93.5 82.2 86.8 89.6 in gas transit volumes will continue in the coming years, with 40 In 2019, gross gas production in Ukraine amounted to 20.7 Private companies operating in Ukraine increased their an average annual gas transit volume in accordance with the 67.1 bcm, which is 1.3% less than 20.9 bcm produced in 2018. natural gas production in 2019 by about 230 mcm (or 5.3%) – contract of about 40 bcm in 2021-2024. 20 Gross gas production by Ukrgasvydobuvannya, the key up to 4.6 bcm. production company in the Naftogaz group, fell by 3.8% year- 0 2015 2016 2017 2018 2019 Source: Ukrtransgaz
Distribution of transit flows by exit points in 2018-2019, bcm Natural gas production in European countries and Ukraine in 2018-2019, bcm STRATEGY AND OPERATIONS STRATEGY 0 5 10 15 20 25 30 35 40 45 50 55 60 126.4 Uzhhorod 49.2 2018 2019 (Slovakia) 57.2 119.1 Orlivka 40.7 18.1 39.9 38.9 (Romania) 10.2 Berehove 11.8 33.7 20.9 (Hungary) 15.1 20.7 10.3 10.0 Drozdovychi 4.0 6.0 5.7 5.6 5.7 5.5 (Poland) 4.9 4.0 4.1 3.1 3.4 2.6 1.9 1.7 1.3 1.1 1.1 1.0 0.5 0.5 GOVERNANCE CORPORATE 2.9 0.4 0.2 0.2 0.4 Moldova 2.9 Italy Serbia Poland Ireland Austria Croatia Norway Tekove Ukraine Hungary
0.7 Romania Germany Denmark (Romania) countries
0.2 Netherlands 2018 2019 Britain Great Czech Republic Czech Other European Source: Ukrtransgaz Source: Eurostat, Ukrtransgaz
Changes in the volume of gas transit through the Ukrainian GTS in 2018-2019 Gross natural gas production GAS PRODUCTION IN UKRAINE IN 2019 in Ukraine in 2016-2019 350 Among the European RESPONSIBILITY +2.0% +2.1% -1.3% countries, Ukraine takes 25 the fourth place as one of AND SOCIAL ENVIRONMENTAL the leading gas producers 300 20.1 20.5 20.9 20.7 20.7 20 4.2 4.1 4.4 4.6 BCM 250 15 1.3 1.1 1.1 1.2 bcm mcm/day
10 200 15.5 14.9 GAS TRANSIT THROUGH UKRAINE 14.6 15.3 5 In 2019, the transit volume was 89.6 bcm, which is 150 2.8 bcm (or 3.2%) more 0 than in 2018. Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2016 2017 2018 2019 89.6 2018 2019 Private companies Ukrnafta Ukrgasvydobuvannya BCM FINANCIAL OVERVIEW AND STATEMENTS Source: Ukrtransgaz Source: Ukrgasvydobuvannya
Annual Report 2019 24 Naftogaz Group Annual Report 2019 25 Naftogaz Group Gas balance in Ukraine in 2019, bcm MARKET AND REFORMS 9.5 Households GAS BALANCE (direct use) 14.1 Households 4.6 Heat producers for households*** Private AND OPERATIONS STRATEGY 7.0 importers 14.2 25.4 8.1 Imports Gas consumed Industrial consumers by users
7.2 Naftogaz Public sector 0.4 and religious organizations CORPORATE GOVERNANCE CORPORATE Heat producers for public sector, 2.8 religious organizations, industrial sector** 29.9 29.9 Gas sources Gas consumption
14.9 1.9 Ukrtransgaz Ukrgasvydobuvannya RESPONSIBILITY 0.9 Gas distribution operators* 4.5 AND SOCIAL ENVIRONMENTAL 20.7 Operating needs and Production technical loss 4.6 Other 1.3 Ukrgasvydobuvannya
1.2 Ukrnafta 0.4 Ukrnafta
* including the estimated volume of gas used as unauthorized offtakes (~0.7 bcm) UGS – underground gas storage -5.0 UGS ** including the estimated volume of gas used as unauthorized offtakes (~0.5 bcm) *** according to Operational Activity Department, Naftogaz 0.0 Other FINANCIAL OVERVIEW AND STATEMENTS Source: Naftogaz
Annual Report 2019 26 Naftogaz Group Annual Report 2019 27 Naftogaz Group GAS IMPORTS GAS CONSUMPTION amounted to 4.6 bcm, which is 0.2 bcm or 4.3% less than in 2018 due to milder weather in 2019 compared to 2018. Amid the global growth in export and import capacity togaz's share of total gas imports to Ukraine in 2019 consti- In 2019, Europe consumed about 529 bcm of natural gas, Basically, households are unable to regulate the use of heat in 2019, the European countries increased their natural gas tuted 50.2%. which is 3.6% more than in 2018. Ukraine ranked 7th among in their homes (or such regulation in individual apartments has imports by 10.2% – from 376.0 bcm in 2018 to 414.4 bcm in In 2019, about 50 private Ukrainian companies imported European countries in terms of gas consumption. little effect on the apartment block due to the redistribution of 2019. In 2019, Ukraine ranked 8th among the largest natural gas from Europe, totaling 7.0 bcm (49.8% of the total Natural gas consumption in Ukraine fell by 7.7% in 2019 (i.e., heat among other apartments). Therefore, gas saving factors for gas importers in Europe ranking. volume). from 32.3 bcm to 29.9 bcm) compared to 2018. household heating are insignificant.
In 2019, Ukraine imported gas exclusively from the Euro- In 2019, the Slovak route remained the main gas supply In 2019, households used 9.5 bcm of gas, which is 1.1 bcm Heat production for public institutions and the industrial MARKET AND REFORMS pean market. Compared to 2018, total gas imports increased route to Ukraine. Deliveries through Slovakia increased from or 10.4% less than in 2018. Such a decline can be explained by a sector reached 2.8 bcm, which is 0.5 bcm more than in 2018. by 34.5% – from 10.6 bcm to 14.2 bcm. Naftogaz imported 61% in 2018 to 64% in 2019, while flows from Hungary de- decrease in temperature-sensitive natural gas demand. In 2019, gas consumption by the industrial sector has 7.2 bcm, which is 2.4% or 0.2 bcm more than in 2018. Naf- creased from 32% in 2018 to 26% in 2019. Gas consumption by district heating companies in 2019 dropped significantly – from 9.4 bcm to 8.1 bcm (or 13.8%).
Natural gas imports to the European countries and Ukraine in 2018-2019, bcm Natural gas consumption in the European countries and Ukraine in 2018-2019, bcm
91 92 2018 2019 85 2018 2019 81 84 79 73 74 71 43 44
42 AND OPERATIONS STRATEGY 67 41 43 44 36 32 41 40 31 30 36 32 21 21 19 18 16 18 18 16 15 14 14 15 16 11 12 11 11 12 11 10 10 8 8 8 10 9 9 9 9 8 6 6 6 6 5 5 6 6 5 5 5 4 5 3 5 5 5 3 2 3 1 3 3 3 3 3 CORPORATE GOVERNANCE CORPORATE Italy Italy Spain Spain Poland Poland France France Ireland Ireland Austria Austria Greece Greece Croatia Norway Ukraine Ukraine Slovakia Slovakia Belgium Belgium Bulgaria Bulgaria Hungary Hungary Portugal Portugal Romania Romania Germany Germany countries countries Netherlands Netherlands Great Britain Great Great Britain Great Czech Republic Czech Czech Republic Czech Other European Other European Source: Eurostat, Ukrtransgaz Source: Eurostat, Ukrtransgaz
Natural gas imports to Ukraine in 2016-2019 Natural gas imports to Ukraine by entry Ukraine's gas consumption 2018-2019, bcm points in 2016-2019 10.6 Households (direct use) 9.5
15 15 14.1 14.2 RESPONSIBILITY 14.1 14.2 9% 10% Heat producers for households* 4.8 4.6 7.8 – Naftogaz to private gas supply ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL 11.1 10.6 companies for resale to households 11.1 20% 26% Heat producers for public sector, religious 2.3 5.4 10.6 9% 0.2 – Naftogaz direct supplies to households 10 7.0 10 7% organizations and industrial sector** 2.8 9.5 2.9 9% 0.5 Total 1.5 – supplies to households by other 3.6 bcm Public sector and religious organizations consumption companies 32% 0.4 bcm 9.4 5 5 82% Industry 8.2 8.7 7.2 71% 8.1 (61.7%) 7.0 61% 64% (73.9%) (66.0%) (50.2%) Operating needs (gas production, transmission 4.7 and distribution), LPG production*** 4.5
0 0 0 2 4 6 8 10 12 2016 2017 2018 2019 2016 2017 2018 2019 Naftogaz of Ukraine JSC From Poland (Hermanowice) From Slovakia (Budince) * including the estimated volume of gas used as unauthorized offtakes (~ 0.7 bcm) ** including the estimated volume of gas used as unauthorized offtakes (~ 0.5 bcm) 2018 2019 Other importers From Hungary (Beregdaroc) *** according to the company’s data FINANCIAL OVERVIEW AND STATEMENTS Source: Ukrtransgaz Source: Ukrtransgaz Source: Eurostat, Ukrtransgaz
Annual Report 2019 28 Naftogaz Group Annual Report 2019 29 Naftogaz Group In 2019, changes were made to the PSO regime governing adopted Resolution No485 of 5 June 2019 according to which Naftogaz's activities. Naftogaz purchased natural gas produced by prices for June-December 2019 were set as the lowest of the four Ukrgasvydobuvannya and Chornomornaftogaz in 2017-2019 at a options: import parity price, average UEEX price, selling price for regulated price: by 31 October 2018 at the price of UAH 4 849 / industrial users paying in advance, PSO price (according to Reso- tcm (w/o VAT); from 1 November 2018 to 30 April 2019 – at the lution No867 of 19 October 2018). price of UAH 6 116 / tcm (w/o VAT). At the beginning of 2020, realizing that gas transit through As a result of the decrease in the price in the European mar- Ukraine will continue and the risk of interrupted supply was ket, the gas price for industrial consumers in Ukraine has become avoided, the government adopted a new pricing methodology MARKET AND REFORMS lower than the one for households and heat producers. To linked to import parity. In January, the Cabinet of Ministers issued eliminate such an imbalance, on 5 June 2019, the CMU adopted Resolution No17 of 24 January 2020 according to which the price Resolution No. 485, which amends Resolution No. 293 and, con- should not exceed the level based on the TTF average actual sequently, the mechanism for calculating the price of natural gas gas price for the period from 1 to 22 day of the delivery month, sold for the needs of households and heat producers. In accor- difference (spread) between the TTF price and the price at the dance with Resolution No. 485, Naftogaz sets the price of gas at a Ukrainian border, gas transmission tariff for the entry point to level equal to the lowest of the following: Ukraine at the cross border interconnection. — average customs value of imported gas for the previous However, the pricing based on the new resolution applied month, published by the Ministry of Economy; only in January and February. The objective conditions in the — average natural gas price for commercial customers of Ukrainian market drove a decrease in domestic gas prices lower Naftogaz for the last month, which is delivered on a prepaid than the import parity level (record high stocks in UGS facilities, basis; warm winter, lower gas demand). The oversupplied market and — average price on the Ukrainian Energy Exchange; or filled UGS facilities conditioned a decoupling in the Ukrainian
— the price of gas under the PSO regime set in the PSO market, which means that price fluctuations in the Ukrainian AND OPERATIONS STRATEGY Regulation No. 867 as of 19.10.2018. market were not reflecting European trends. Supporting the The foundations for the liberalization of gas prices for PSO market-based gas pricing mechanism, the company shifted from consumers were laid gradually in 2019, including coupling with the pricing methodology recommended by the CMU resolution market indicators. Unlike January-April 2019, when the price was to market-based pricing. Upon Naftogaz’s initiative, starting from set according to the CMU Resolution No867 of 19 October 2018 March, the PSO price is calculated as weighted average price (paragraph 13 of the PSO Regulation), in May 2019, the price was offered by winners of Prozorro biddings for balancing and fuel gas calculated as Naftogaz’s average selling price to industrial users purchased by the GTS Operator and adjusted according to gas according to the CMU Resolution No293 of 3 April 2019. Later, to sale and purchase agreements. Thanks to this initiative, house- minimize the influence of one source on pricing, the government holds saved on their gas bills and real market price was offered.
Change in the difference between import parity and regulated (PSO) gas prices, GOVERNANCE CORPORATE UAH/tcm (excluding VAT)
9 500 9 000 8 500 Decoupling period 8 000 (market price 7 500 below import parity) 7 000 6 500 RESPONSIBILITY 6 000 UAH/tcm
5 500 AND SOCIAL ENVIRONMENTAL 5 000 4 500 4 000 3 500 3 000 2 500 2 000 Jul 2017 Jul 2016 Jul 2019 Jul 2018 Jul 2020 Jan 2017 Jan 2016 Jan 2019 Apr 2017 Jan 2018 Oct 2016 Oct 2019 Apr 2016 Apr 2019 Oct 2018 Apr 2018 Jan 2020 Oct 2 017 Apr 2020
actual PSO price MEDT price (import parity) CMU PSO price, 2020
Source: Naftogaz, in-house estimates FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 30 Naftogaz Group Annual Report 2019 31 Naftogaz Group Brent oil prices, 2018-2019
95 Exacerbation of the GLOBAL problem of the US 86.07 90 government shutdown 85 80.42 in Q4 2018
80 MARKET AND REFORMS 74.69 OIL MARKET 75 70 USD/barrel 65 OPEC and International Energy OIL MARKET: KEY EVENTS 60 Growth against the resolution 62.11 of the US government Attacks on oil Agency pessimistic forecasts for decline in oil demand and slowdown 1 Brent oil price fluctuation range, USD per barrel 55 shutdown in Q1 2019 tankers in — The oil market in 2019 was more stable than in 2018: 53.24 Gulf waters 55.25 of global economy 50.57 Brent prices ranged within USD 53.2-74.7 per barrel, 50 compared with USD 50.6-86.1 per barrel in 2018. Com- The price of Brent crude oil, USD per barrel Min Max Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec modity prices were declining impacted by a slowdown in 2018 50.57$ 86.07$ global trade and limited demand. This was due to reduced 2019 53.24$ 74.69$ 2018 2019 consumption because of macroeconomic factors, on the Джерело: EIA one hand, and geopolitical conflicts, on the other hand. Source: Platts STRATEGY AND OPERATIONS STRATEGY — Shale oil has enabled the United States to become the world's largest oil producer. According to EIA, annual crude Oil exports, million bpd oil production in the United States in 2019 reached a re- 2 Global oil demand and supply cord high of 12.23 million barrels per day (b/d), which is 12,00 11% more than in 2018. 2018 2019 2020 F 2021 F Total oil production, million bpd 100.81 100.60 102.09 102.44 10,00 9.00 9.54 9.36 — Global demand for oil increased by 0.78% in 2019, while Total consumption, million bpd 99.97 100.75 101.12 102.85 Supply and demand situation 0.84% -0.15% 0.96% -0.40% 8,00 GDP increased by 2.9%. 8.26 8.38 8.61
Source: EIA 6,00 million bpd 5.93 4,00 4.50 CORPORATE GOVERNANCE CORPORATE 2,00 3.13 THE GLOBAL OIL MARKET However, as the coronavirus epidemic that began in late 2019 in China continues to spread and more and more 0 Compared to 2018, which was a year of contrasts for the countries suffer significant losses, a slowdown in oil and gas 2012 2013 2014 2015 2016 2017 2018 2019 2020 F 2021 F 2022 F 2023 F 2024 F oil market, oil prices in 2019 were much more stable and demand in the next period will have a negative impact on Saudi Arabia The Russian Federation USA were determined by a trade corridor of USD 53.2-74.7 per world oil prices. barrel. This was mainly the case in the second half of the Source:IEA year, when as a result of OPEC + efforts to reduce the supply, on the one hand, and increased production in the US, on US OIL PRODUCTION GROWTH the other hand, the market almost reached equilibrium (USD 55-69 per barrel). The world oil market is undergoing significant changes. Shale oil production in the United States At the beginning of the year, oil prices showed a significant The shale revolution in the United States, which has made RESPONSIBILITY rise amid an improving global situation. The US government the country the leading oil-producing nation in the world, 12,00 shutdown in Q4 2018 - Q1 2019 was resolved, the US Federal is ongoing. Total annual crude oil production, according to AND SOCIAL ENVIRONMENTAL 9.6 9.6 Reserve eased its rhetoric on monetary policy, and the US and EIA, in 2019 was a record 12.23 million bpd (11% more than 10,00 9.1 9.4 China settled into a trade war ceasefire regime and sought in 2018), of which 7.4 million bpd is shale oil. Since 2010, 8.4 compromise in negotiations. After nearly four months of shale oil production has increased by almost 40%. The rapid 8,00 7.4 “optimism”, Brent prices came close to USD 74.7 per barrel. growth of the industry is due to the fact that it takes only 3 In early May, negotiations between the US and China to 18 months for a new field to start producing oil. By com- 6.3 million bpd 6,00 failed and markets faced another wave of protectionism. parison, it takes five to seven years to get oil from a new off- 4.7 5.0 Signs of global economic slowdown began to emerge, which shore field. Consequently, there is strong growth in exports, 4.0 4.4 contributed to the deterioration of forecasts for oil demand and which strengthens the US position in international markets. 4,00 3.0 reflected in a drop in quotes. A partial rise in quotes in June- In December 2018, for the first time in 50 years, the US 2.0 August was due to tension in the Middle East. Amid the US-Iran acted as a net exporter of liquid fuels. In 2020, the IEA fore- 2,00 1.1 confrontation, there were several attacks on oil tankers in Gulf casts an average net export of 740 000 bpd. Over the past 0.6 waters, which have increased the risk of supply disruption. ten years, the USA has more than doubled its oil production 0 Significant pressure on oil prices in 2019 was caused by trade thanks to the rapid development of the shale oil industry, 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 F 2021 F 2022 F 2023 F 2024 F wars. A decline in global trade tension was felt since October and which has enabled the United States to become one of the had a positive impact on global commodity and stock markets. world's largest oil producers. Source: IEA FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 32 Naftogaz Group Annual Report 2019 33 Naftogaz Group According to EIA, global oil demand grew by a mere 0.78% in 2019. In OECD countries, which account for almost half of Oil demand and supply in 2018-2019 Refinery utilization rate in Europe and Brent oil prices world consumption, demand decreased by 0.52%. In other countries, consumption of "black gold" rose by 1.99%, which is + 0.78% 90 90 101,00 the lowest rate since the 2008-2009 crisis. At the same time, 100.81 100.75 the IMF estimates show that global GDP grew by 2.9%, includ- 100.60 80 85 ing in developing countries by 3.7%. Global oil demand growth 100,60 is projected to decline as soon as in 2020 and 2021, since MARKET AND REFORMS 70 80 % global trends including for transport fuel demand, demon- 99.97 strate negative dynamics. 100,20 / barrel USD 60 75 million bpd
99,80 GLOBAL GDP GROWTH OIL DEMAND 50 70
99,40 01.11.2019 01.11.2018 01.12.2019 01.12.2018 01.10.2019 01.10.2018 01.07.2019 01.01.2019 01.07.2018 01.01.2018 01.02.2019 01.04.2019 01.03.2019 01.05.2019 01.02.2018 01.04.2018 01.03.2018 01.01.2020 01.05.2018 01.06.2019 01.09.2019 01.06.2018 01.09.2018 01.08.2019 01.08.2018 2018 2019 01.02.2020 +2.9% +0.78% Global oil production Global oil consumption Brent oil prices, USD / barrel (left axis) Refinery utilization rate in Europe, % (right axis) Source: EIA Source: OPEC, Thomson Reuters STRATEGY AND OPERATIONS STRATEGY
Forecasted global oil supply and demand Refinery utilization rate and oil refining margins in Europe
104,00 9 90 88 103,00 8 86 7 102,00 84 101,00 6 82 % 100,00 5 80 USD / barrel / barrel USD million bpd 78 99,00 4 76 98,00 3 74 97,00 2 72 GOVERNANCE CORPORATE 96,00 01.11.2019 01.11.2018 01.12.2019 01.12.2018 01.10.2019 01.10.2018 01.07.2019 01.01.2019 01.07.2018 01.01.2018 01.02.2019 01.04.2019 01.03.2019 01.05.2019 01.02.2018 01.04.2018 01.03.2018 01.01.2020 01.05.2018 01.06.2019 01.09.2019 01.06.2018 01.09.2018 01.08.2019 01.08.2018 01.02.2020 Q1 2017 Q1 2019 Q1 2018 Q2 2017 Q4 2017 Q3 2017 Q2 2019 Q4 2019 Q3 2019 Q2 2018 Q4 2018 Q3 2018 Q1 2021* Q2 2021* Q4 2021* Q3 2021* Q1 2020* Q2 2020* Q4 2020* Q3 2020* Global oil production Global oil consumption Brent oil refining margin, North-Western Europe, USD / barrel (left axis) Refinery utilization rate in Europe, % (right axis) *forecast Source: EIA Source: OPEC
Production of petroleum products Structure of petroleum products production EUROPEAN OIL REFINING MARKET December last year, the margin reached its minimum at least in Europe in 2018-2019, million tons in Europe in 2019 RESPONSIBILITY for the past two years – USD 2.54 per barrel – under pressure Despite the fall in oil prices, the European oil refining market from the accumulated petroleum products in the region due 260.9 Other 30% 3% Liquefied gas AND SOCIAL ENVIRONMENTAL has remained relatively stable over the last two years. For to reduced consumption amid a slowdown in industrial pro- Diesel fuel 262.3 example, 2019 was at the level of 2018 in terms of profitability duction in Europe. Gasoline 123.3 7% and demand for petroleum products in Europe. The average Overall, production of petroleum products decreased by 120.0 refinery utilization rate in Europe in 2019 was at the same level only 1% over the previous year to 655.5 million tons in com- 79.6 Oil Other as in the previous year – about 84%. Throughout the year, parison with 2018. Within the petroleum products range, 83.9 Mazut 10% refining margins showed volatility, ranging from about USD 2.50 mazut production decreased the most – by 12% to 68.5 mil- Mazut 77.7 18% to 7.50 per barrel. The highest average margin – almost USD 7 lion tons due to reduced demand for the product during warm 68.6 per barrel – dropped during the summer season, when demand winter and as a result of improved efficiency of mazut refining, 56.8 Gasoline for petroleum products is traditionally higher due to seasonal which has led to increase in light petroleum production at Кerosene 57.8 9% factors. some refineries. Last year, as in 2018, the total share of gas- 45.6 40% In September, the seasonal drop in demand for gasoline oline and diesel in the production structure of the European Oil 44.7 and the decline in petroleum product exports marked the refineries accounted for 58% of total refining. 18.3 Diesel fuel Kerosene beginning of a margin decline that continued until the end Trends for the coming years Liquefied gas 18.3 2018 2019 of 2019. In October, the refining margin increased slightly The profitability of oil refining on the continent will decline amid the planned closure of individual refineries. However, by this year due to the drop in demand in Europe and other Source: IEA Source: EIA FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 34 Naftogaz Group Annual Report 2019 35 Naftogaz Group markets adjacent to European refineries where transport The policies of Western European countries to reduce restrictions are in place due to the measures designed to curb harmful emissions will gradually promote the replacement of Ukrnafta oil and gas condensate selling price in 2019 the spread of the COVID-19 virus. Partly, these negative trends petroleum products with renewable energy, which will be curbed by the planned closure of a number of refining will have a negative impact on refinery utilization 75,00 71.83 1 70.10 plants in Europe this year . and profitability. In addition, most of the European 68.47 The launch of new refineries in Europe, Africa, the Middle refining industry will remain vulnerable to imported 70,00 66.87 72.50 67.09 East and the United States can adversely impact the refinery oil supplies. 63.51 65,00 67.32 utilization rate in Europe. If the number of European refineries All these factors are already driving the European refin- 59.93 60.64 59.45 MARKET AND REFORMS are not reduced, their average utilization rate may drop to eries to close or optimize their capacity. Total refinery ca- 60,00 62.42 62.68 62.93 70% by 2023 due to reduced consumption and dependence of pacities in the European Union decreased from 15.8 million 61.82 60.83 USD per barrel USD the European capacities on demand in the neighboring mar- bpd in 2008 to 14 million bpd in 20183. Under the current 55,00 57.90 2 54.83 kets in Africa, Asia and the Middle East . circumstances, the trend will continue. 50,00
45,00
UKRAINIAN OIL AND PETROLEUM PRODUCTS nya, which produces and processes gas condensate and oil at 40,00 January February April May July August October November December MARKET its own production facilities, increased its raw material pro- duction by 6.6% – from 446.7 thousand tons to 478.2 thou- The needs of the Ukrainian market for oil are satisfied sand tons. Estimated average auction sale price normalized to USD/barrel Brent oil by domestic production and imported supplies. The most Naftogaz Group’s share in total oil and gas condensate Source: OPEC, Thomson Reuters important oil and gas condensate companies in Ukraine are production in Ukraine in 2019 was over 90%. At the same
Ukrnafta and Ukrgasvydobuvannya, which are included to time, the share of petroleum products produced by Ukrainian AND OPERATIONS STRATEGY Naftogaz Group. Overall, these companies increased oil and companies of Naftogaz Group is significantly lower than the condensate production by 5.7% in 2019 – from 1.89 million share of petroleum products imported to Ukraine from abroad Total volumes processed by Structure of petroleum products tons to 1.99 million tons. Ukrnafta, in particular, increased its or produced from imported oil. Shebelynka GPP in 2016-2019 produced by Shebelynka GPP in 2018-2019 oil and condensate production by 4.8% – from 1.45 million According to Enkorr, in 2019, Ukrtatnafta (Kremenchuk tons to 1.52 million tons. The company managed to achieve Oil Refinery) increased its crude oil imports by 37% to +3.5% 1% positive production results under the conditions of limited 918 thousand tons compared to 669 thousand tons in 550,0 515.4 515.7 Losses investment resources thanks to a number of operations 2018. The plant reduced its purchases of Azerbaijani oil 497.8 2% 500,0 481.1 on the active wells, transition to new productive horizons, by 7.7% to 617 thousand tons, but began importing raw optimization of major and current repairs of potentially materials from the US and Libya in the amount of 240 and 450,0 LPG 2% productive wells, and replacement of critically worn-out 56 thousand tons, respectively. In addition, according to 3% 400,0 equipment. However, the overall trend in oil production in the Ukrainian Interbank Exchange and the Ukrainian Energy 8% Ukraine in recent years remains negative. Exchange, 1.325 million tons of Ukrnafta oil was purchased 350,0 Heavy petroleum products 9% In accordance with Article 4 of the Law of Ukraine "On Oil for processing at the Kremenchuk Refinery, which is 9.3% GOVERNANCE CORPORATE thousand tons and Gas", Ukrnafta shall sell its produced oil and gas conden- less than in 2018. The total volume of crude oil used for 300,0 sate at exchange auctions. Change in selling prices at auctions processing at the Kremenchuk Refinery amounted to Light petroleum 89% 250,0 products followed global oil price trends. approximately 2.32 million tons / year, while the Shebe- 86% Another company of Naftogaz Group, Ukrgasvydobuvan- lynka Refinery processed about 0.5 million tons / year. The 200,0 2016 2017 2018 2019 0% 20% 40% 60% 80% 100%
2018 2019 Source: Ukrgasvydobuvannya Source: Ukrgasvydobuvannya Oil and gas condensate production Sales of oil and gas condensate by Naftogaz group companies in 2013 - 2019 by Ukrnafta in 2018-2019 Kremenchuk Oil Refinery and the Shebelynka Oil Refinery petroleum products shipped by rail was optimized: 5 3,00 2 000,0 -9.3% produce Euro 5 fuel. new weighing complexes have been installed with an CAGR - 4.7% In 2019, the Shebelynka Oil Refinery (Shebelynka VPGKN, automated analytical and control system. RESPONSIBILITY 2,50 1 600,0 1 461.9 Ukrgasvydobuvannya JSC) increased its raw material process- — The geography of retail sales was expanded – fuel under 1 325.4 ing to 473 thousand tons (by 18.7 thousand tons or 4.1% the Shebel brand became available in Kyiv, Zhytomyr, AND SOCIAL ENVIRONMENTAL 2,00 more than in 2018). The production of motor fuels increased Chernihiv, Kharkiv, Dnipro, Zaporizhzhia, Poltava regions 1 200,0 as follows: gasoline up to 149 thousand tons (by 18.5 thou- and the territories of Donetsk and Luhansk regions 1,50 sand tons or 14.2%), diesel up to 88.3 thousand tons (by 3.2 controlled by the Ukrainian government. thousand tons million tons 800,0 thousand tons or 3.8%). In 2019, the estimated balance (total consumption) of the 1,00 The overall production of liquefied hydrocarbon gas at Ukrainian motor fuel market, according to the sector publi- 0,50 400,0 the production capacities of Ukrgasvydobuvannya decreased cations, has increased by 7%. The highest growth rates were to 152.7 thousand tons (by 12.2 thousand tons or 7.4% com- demonstrated by diesel and LPG. In 2019, the diesel market 0,00 0,0 pared to 2018) due to the reduction of the raw material pro- increased by 7% (by 471 thousand tons), while the LPG market 2013 2014 2015 2016 2017 2018 2019 2018 2019 duction (reduction in gas condensate factor). (excluding raw materials for petrochemical processes) grew by In 2019, at the Shebelynka Refinery: 11% (by 195 thousand tons). Industrial consumption was the Ukrnafta Ukrgasvydobuvannya — A new hydro-purification reactor was put into operation driver for increase of diesel supply. The gasoline market ended Source: Naftogaz Source: Ukrnafta, Ukrainian Energy Exchange and diesel dewaxing was launched, which enabled the a three-year volume downturn and also posted an increase of plant to start a new product – arctic diesel fuel. 1.3% or 25 thousand tons. 1 https://www.spglobal.com/platts/en/market-insights/latest-news/oil/111119-refinery-news-roundup-works-continue-in-europe 2 https://www.clingendaelenergy.com/inc/upload/files/CIEP_paper_2017-02_web.pdf — The technological losses during processing and production The Ukrainian petroleum product market is heavily depen- FINANCIAL OVERVIEW AND STATEMENTS 3 https://www.bp.com/content/dam/bp/business-sites/en/global/corporate/pdfs/energy-economics/statistical-review/bp-stats-review-2019-full-report.pdf fell by more than half – down to 1%. Accounting for dent on imports of finished petroleum products – in 2019,
Annual Report 2019 36 Naftogaz Group Annual Report 2019 37 Naftogaz Group imports accounted for almost 75% of domestic demand. eries increased by 10% to 908 thousand tons. The production OIL TRANSIT AND TRANSMISSION In 2019, among other things, Ukrtransnafta signed an According to the State Statistics Service of Ukraine, in 2019, of gasoline by the Kremenchuk Refinery (Ukrtatnafta PJSC) for additional agreement with Transneft PJSC on the provision Ukraine imported 8.4 million tons of petroleum products worth the first time exceeded the volume of imports from Belarus, Oil transmission through the Ukrainian trunk oil pipe- of services for the transmission of Russian oil through the USD 5.36 billion, which is 2.75% less than in 2018 in monetary which until 2019 was the main source of supply for this type lines is carried out exclusively by Ukrtransnafta, which is an territory of Ukraine, which continues the terms of the main terms. Since the Ukrainian petroleum product market is import of motor fuel. In 2019, the Belarusian refineries reduced their enterprise of Naftogaz group. In 2019, the total volume of agreement until 2030. The extension of the agreement guar- dependent, the price of petroleum products in the domestic gasoline deliveries to Ukraine by 17%, reducing their share in transmitted oil amounted to approximately 15.51 million tons, antees the safe and sustainable operation of the Ukrainian oil market is determined in line with the exchange rate and quo- this segment of the Ukrainian market from 43.5% to 35.5%. which is 0.5% more than in 2018, of which: to the Ukrainian transmission system on a long-term basis, serves as a basis for tations for oil products on international exchanges. This formu- Analysis of the geographical structure of diesel fuel im- refineries – 2.38 million tons (13.4% more than in 2018); tran- loading the trunk oil pipelines system with transit volumes of MARKET AND REFORMS la-based pricing practice based on quotations from internation- ports shows that the Russian Federation is still the largest sit through the territory of Ukraine – 13.13 million tons (1.6% oil towards European countries, and ensures a stable source al independent price agencies is common in many commodity source of supply, although the volume of deliveries decreased less than in 2018), which was caused, among other reasons, of revenue for the company. markets around the world. by 7.8% (by 211 thousand tons), which is explained by the by forced oil transit interruptions from 25 April to 11 May Following the results of a number of consultations, at both Eastern European petroleum product importing countries introduction of an additional special duty in accordance with 2019 and from 17 May to 21 May 2019 because of a sharp de- the interstate level with the participation of the presidents play an important role in the fuel supply to the Ukrainian mar- the CMU Resolution No. 624 dated 17 July 2019, for heavy terioration in the quality of raw materials coming from Russia of Ukraine and Belarus and the level of state companies, a ket, including Belarus and Lithuania, Ukraine’s major gasoline distillates (gas oils) of 3.75% from 1 August 2019 and 4% from through the Druzhba pipeline. The content of organochlorine contractual, technical, technological and commercial framework suppliers. In 2019, according to Enkorr, the production of 1 October 2019. At the same time, imports of diesel fuel from compounds exceeded the norm tenfold. Because of the or- was developed for arrangement of oil transportation from the petroleum products, including gasoline, by the Ukrainian refin- Belarus increased by 14.8% to 2.47 million tons. ganochlorine compounds identified in the Druzhba pipeline, Black Sea basin to the refineries of the Republic of Belarus using Slovakia and Hungary refused to accept Russian oil transmit- Ukrainian trunk oil pipelines that would enable the conclusion ted by Ukrtransnafta. of the relevant contracts and the start of oil transportation in During the entire period when low-quality Russian oil was the shortest possible time. Indicative balance of petroleum products Changes in the structure of the Ukrainian displaced from the Ukrainian section of the Druzhba pipeline, Also during 2019, Ukrtransnafta actively worked on other market of Ukraine in 2017-2019, mln tons gasoline market in 2018-2019 Transneft PJSC was booking the Ukrtransnafta capacity and paid promising projects aimed at diversifying the sources and EUR 4.3 million to the company for this service from May 2019 to routes of oil supply to Ukraine and its transit through the AND OPERATIONS STRATEGY 50 January 2020. territory of Ukraine, including a project designed to enable the Balance 44% 2018 2019 In cooperation with Ukrtatnafta, the number of oil grades transmission of various oil grades through the southern branch 40 39% transmitted through the Ukrainian oil transportation system of the Druzhba oil pipeline to oil refineries in Slovakia, the Czech 35% 36% expanded in 2019. In particular, this was the first time that the Republic, and Hungary, and a project for the construction of the Imports Kremenchuk Oil Refinery received Libyan El Sharara oil and Brody-Adamovo oil pipeline in order to connect Ukrainian and 30 American Bakken oil. Polish oil transmission systems, etc. % Production 20 17% 12% 10 7% 8% Alternative routes of oil export to Europe have enough free capacity to substitute Ukrainian route Exports ШВЕЦИЯ 1% 1% 0 CORPORATE GOVERNANCE CORPORATE -2,00 0,00 2,00 4,00 6,00 8,00 10,00 Belarus Lithuania Kremenchuk Shebelynka Others FINLAND oil refinery oil refinery Transneft oil transit routes 1 Prymorsk 2017 2018 2019 other oil transit routs 2 Source: Naftogaz, Enkorr, State Statistics Service of Ukraine Source: Enkorr potential risk of alternative route Ust-Luga ESTONIA RUSSIA exit points Comparative dynamics of changes in the wholesale prices for gasoline in Ukraine and LATVIA 1 Prymorsk North-Western Europe in 2019 (price as of 03.01.2019 = 100%) 22 38 LITHUANIA Moscow 70% 2 Ust-Luga 10 28 RUSSIA Adamovo 60% 3 RESPONSIBILITY 12 28 50% BELARUS Adamovo 4 Budkovice AND SOCIAL ENVIRONMENTAL 3 40% 5 Fenyeslitke 12 13 POLAND Novorossiysk 30% GERMANY 6 5 37 20% Kyiv CZECH Budkovice UKRAINE free capacity, million t 10% REPUBLIC SLOVAKIA 4 oil transit in 2019, million t
0% AUSTRIA 5 MOLDOVA Fenyeslitke -10% HUNGARY Jan 19 Feb 19 Mar 19 Apr 19 May 19 Jun 19 Jul 19 Aug 19 Sep 19 Oct 19 Nov 19 Dec 19 SLOVENIA ROMANIA
CROATIA A-95 gasoline (Ukraine) net of taxes and duties Eurobob quotations (North-Western Europe) ITALY BOSNIA AND Novorossiysk HERZEGOVINA 6 Source: Platts, Ukrgasvydobuvannya SERBIA GEORGIA FINANCIAL OVERVIEW AND STATEMENTS Source: Ukrtransnafta
Annual Report 2019 38 Naftogaz Group Annual Report 2019 39 Naftogaz Group gas transportation system of Ukraine to GTS Operator LLC, In addition, the separation of the GTS operator should by the right of economic management. not have jeopardized the legal position of Naftogaz in the — The Act of transfer of a 100% stake in GTS Operator LLC, arbitration proceedings against Gazprom in Stockholm, which completed the acquisition by JSC "Mahistralni which began in 2018. In the arbitration on transit tariffs, UNBUNDLING Gazoprovody Ukrainy" of full control over GTS Operator Naftogaz required Gazprom to revise the transit tariff in LLC. 2018-2019 in accordance with the EU tariff regulation By signing these documents, Naftogaz Group completed transposed into Ukrainian legislation. If an unbundling
the separation of the gas transportation system operator. model was implemented that would not allow Naftogaz MARKET AND REFORMS OF GTS OPERATOR to claim compensation under this proceeding, Naftogaz MAIN OBJECTIVES would be exposed to losing the opportunity to receive up to USD 12 billion from Gazprom. In addition, it would weaken ACHIEVED THROUGH UNBUNDLING: Ukraine’s position in the negotiations to continue transit. On January 1, 2020, the unbundling process, i.e. the of Energy and Environmental Protection of Ukraine to the 1Ukraine has made the most progress in implementing restructuring that resulted in the full separation of natural Ministry of Finance of Ukraine. European legislation among the countries that have acceded 3Separation of the GTS operator gave impetus to the gas transportation activities from Naftogaz, was completed. to the Energy Community Treaty. continuation of Ukrainian gas market reform. Before 2020, gas storage and transportation through trunk 2Authorization of the Ministry of Finance of Ukraine to manage This conclusion can be drawn from the latest report of The achievement of GTS Operator LLC as an independent gas pipelines was provided by Ukrtransgaz (a company 100% state property used in Ukrainian natural gas transportation the Energy Community Secretariat1 and the progress made in operator, in its relations with the adjacent GTS operators, is owned by Naftogaz). From January 1, 2020 the company operations. the last months of 2019. The report, published in November the implementation of European operating rules at almost was divided into two separate legal entities: the gas storage 2019, stated that the key steps not yet implemented by all western points. This allowed not only for the launch of facilities operator (Ukrtransgaz), which remained a part of 3 Transfer, by right of economic management, the authority to Ukraine as of then on its path towards further integration virtual reverse natural gas, but also created, in the long run, Naftogaz Group, and the gas transportation system operator use state-owned assets engaged in the process of natural gas into the European gas market were the separation of natural the opportunity for European gas companies to reserve
(Gas Transmission System Operator of Ukraine LLC (GTS transmission through trunk pipelines, from the Ministry of gas transportation operations and the termination of special GTS capacities on the eastern border of Ukraine. So far, this AND OPERATIONS STRATEGY Operator LLC), which operates independently and is only Finance of Ukraine to GTS Operator LLC. obligations assigned to natural gas market entities. Therefore, possibility was blocked by Gazprom. Moreover, the next engaged in natural gas transmission. the unbundling process has brought the country even closer transit agreement may be concluded directly with the GTS The unbundling process has taken almost five years. The 4Transfer, by concluding a share purchase agreement, 100% of to its declared goal. operator, but for this end, Ukraine has to fully implement separation has gained considerable resonance in Ukraine the share in the authorized capital of GTS Operator LLC, from European legislation including EU network codes and and abroad. It was the first large-scale restructuring case for Ukrtransgaz JSC to JSC "Mahistralni Gazoprovody Ukrainy". 2The timing and the manner in which the separation was demonstrate their successful operations. Naftogaz. implemented helped Ukraine strengthen its position in gas 22 NOVEMBER 2019 GTS Operator LLC received the transit negotiations, and Naftogaz in its arbitration against 4The unbundling was carried out and completed without 18 SEPTEMBER 2019 The Cabinet of Ministers of Ukraine preliminary decision of the Regulator regarding its Gazprom. any threat to the operations of both strategically important adopted Resolution No. 840 “On Separation of Natural certification as a gas transmission system operator. In February 2018, Naftogaz received a tribunal decision on operators. Gas Transportation and Ensuring Operations of the Gas ON DECEMBER 24, 2019, taking into account the positive its transit agreement with Gazprom, according to which the The GTS operator started its independent operations in Transportation System Operator” (hereinafter Resolution No. conclusion of the Energy Community Secretariat, the NEURC company, as a party to the transit agreement, had no right the middle of the heating season, so any mistake that would 840), which provided for the following unbundling arrangement: adopted its final decision on the certification of the gas without Gazprom's consent to transfer this agreement to the lead to its failure was a threat to the energy security of the
transmission system operator of Ukraine. new GTS Operator. In fact, Naftogaz remained the operator in country. GOVERNANCE CORPORATE 1Transfer the function of managing the corporate rights of 1 JANUARY 2020 the parties signed: the gas transit relationship, which made unbundling impossible Since the decision to separate the two operators, JSC "Mahistralni Gazoprovody Ukrainy" from the Ministry — The Act of transfer of property (assets) of the state-owned until the agreement expires, i.e. until January 1, 2020. there were risks of operating the gas transmission system
Legal structure of unbundling State of implementation of European gas legislation, November 20192
60% Cabinet of Ministers Ministry 48 of Ukraine of Finance 50% 46 Economic RESPONSIBILITY Management 40% 36 Rights 32 30 31
30 AND SOCIAL ENVIRONMENTAL 30%
Naftogaz GTS 20% 13 15 10% SPA for 100% 0 MGU Ukrtransgaz (Independent Supervisory Board) Ukraine Albania Georgia Kosovo Northern Macedonia Moldova Montenegro Serbia Bosnia and Bosnia Herzegovina
Source: the Energy Community Secretariat
1 Annual Implementation Report 2018/2019 of 01.11.19, published on the official website of the European Energy Community https://energy-community.org/implementation/IR2019.html GTS Operator LLC 100% GTS Operator LLC 2 As of the date of publication of the Report, the Cabinet of Ministers of Ukraine approved its Resolution No. 840 “On Separation of Natural Gas Transportation and Ensuring Operations of the Gas Transportation FINANCIAL OVERVIEW AND STATEMENTS System Operator”; However, the separation was completed on 1 January 2020, and it was not taken into account in the overall assessment of Ukraine's progress in the implementation of European gas legislation
Annual Report 2019 40 Naftogaz Group Annual Report 2019 41 Naftogaz Group separately from gas storage facilities, since they are closely GTS and UGS connection points. These agreements, when linked technologically. At the same time, European practice needed, allow the GTS operator to meet the needs of the shows that the vast majority of GTS operators are, with some day-to-day balancing process and provide for an effective and exceptions, disconnected from UGS. The problem was solved transparent mechanism for monitoring the flow of natural gas using a standard European operator interaction arrangement. between the GTS and the UGS. Commercial and technical agreements were concluded at the MARKET AND REFORMS HOW UKRTRANSGAZ WAS RESTRUCTURED Key unbundling stages By the time of adoption of the updated unbundling plan, Naftogaz Group was already preparing for restructuring. The teams of Naftogaz and Ukrtransgaz started their work in 2018. 18 NOVEMBER 2018 In a little more than one year, all the necessary steps were The Unbundling Project Statute is approved taken to complete the separation under the new unbundling plan. The separation of gas transportation operations was, in fact, a complex and sophisticated project and it was for 1 JANUARY 2019 the first time Naftogaz Group dealt with such a complicated The branch UGS Operator is functionally separated, project. The company involved consultants from PwC including the related processes, assets, personnel. Polska and EY Ukraine to develop the internal restructuring Preparation for independent operations from model and implementation plan. The teams were assigned July 1, 2019 arranged AND OPERATIONS STRATEGY responsible for different areas, deadlines for implementation were set up, regular reporting and monitoring mechanisms were put in place. 5 FEBRUARY 2019 The key team included over thirty Naftogaz and Ukrtransgaz employees, with dozens of professionals working GTS Operator LLC is established, the transfer of assets, in each area. business processes, and personnel launched The project implementation schedule consisted of more than 400 tasks in many areas, such as the separation of assets, business processes, personnel, IT infrastructure, contracts, 1 JUNE 2019 analysis and compliance with certification requirements and support for the specified process. Functional separation of the branch GTS Operator of During the preparation period, about 900 contracts, Ukraine completed, the branch performs natural gas transportation independently more than 300,000 asset positions, more than 150 internal GOVERNANCE CORPORATE regulations and normative documents were analyzed and separated. Plans for the gradual transfer of more than 11,000 employees to the new GTS operator were developed and 1 JULY 2019 implemented. However, it is important to understand that the work was carried out in a rather difficult environment, when Full separation of business processes related to gas transportation and gas storage. Transfer to GTS Operator Ukrtransgaz's financial resources were limited due to tariff of Ukraine LLC reductions and an impressive amount of losses related to the unauthorized withdrawal of gas. At each stage of implementation, the process included consultations and checks to verify whether the resulting 24 DECEMBER 2019 decisions would meet the requirements of EU legislation, Certification of GTS Operator of Ukraine LLC for compliance RESPONSIBILITY whether the smooth operations of the operator would be with the requirements for independence issued by NEURC ensured at the time and after separation, to analyze and advise on the technical aspects of unbundling, to consider the AND SOCIAL ENVIRONMENTAL progress of the developed plan. Naftogaz, Ukrtransgaz, and the GTS Operator LLC 1 JANUARY 2020 continue their operations after the unbundling. In particular, Ukrainian GTS is transferred to the new GTS Operator. GTS and UGS operators are working to strengthen their 100% share in the Operator transferred to Trunk Gas competencies and further optimize their business processes Pipelines of Ukraine JSC and organizational structures. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 42 Naftogaz Group Annual Report 2019 43 Naftogaz Group REVERSE FLOW FROM EUROPE TRANSIT VOLUMES The increase in reverse supplies In 2019, Russian gas transit of imported gas from Europe to through the territory of Ukraine NATURAL Ukraine by 3.7 bcm compared amounted to 89.6 bcm, which is + to 2018 in anticipation of the 2.8 bcm more than the transit 3.7 transit termination scenario 89.6 volume in 2018 GAS TRANSIT BCM from 2020 BCM MARKET AND REFORMS
KEY BUSINESS RESULTS FOR 2019: the zero gas transit scenario from 2020. Considering uncer- tainty in gas transit negotiations in 2019 and the last-minute Change in gas stocks in European UGS facilities in 2016 – 2019 — Net revenues from the gas transit business in 2019 was agreement on the new transit deal, European market players UAH 70.2 billion. assessed the threat of transit interruption in 2020 as high. 1200 — Transit volumes amounted to 89.6 bcm (+3% compared to Both European customers and Gazprom were preparing to 2018). This is more than 45% of the total gas supplied by this scenario, accumulating gas stocks in European UGS fa- Gazprom to European countries in 2019. cilities: 1000 — In line with the final award of the Arbitration Institute (а) as of April 2019, the remaining volumes of gas inventories of the Stockholm Chamber of Commerce in the transit in European UGS facilities was above the average for the last 800 case, Gazprom paid UAH 68.5 billion (USD 2.92 billion) to three years due to the warm heating season of 2018/2019; AND OPERATIONS STRATEGY Naftogaz. (b) 2019 saw an increase in imports of liquefied natural gas — Primarily in exchange for Naftogaz's waiver of new claims (LNG) to Europe by almost 70%; 600 in 2018 arbitration against Gazprom, a transit contract for (c) the onset of the 2019/2020 heating season was TWh 2020-2024 (with guaranteed income based on ship-or-pay significantly warmer than normal, leading to a decrease in 400 principle and European rules) has been signed. Estimated natural gas consumption by households. revenues under the contract will amount to more than USD 7 billion over the next five years. 2The increase in reverse supplies of imported gas from Europe 200 In 2019, Russian gas transit through the territory of to Ukraine by 3.7 bcm compared to 2018 as part of preparation Ukraine amounted to 89.6 bcm, which is 2.8 bcm more for the transit termination scenario from 2020. Imports of gas than the transit volume in 2018. In addition, in December from the EU, not Russia, increase the overall level of demand 0 2019, Naftogaz received compensation from Gazprom in Europe. Like European countries, UKraine was preparing for Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec following the arbitration award in the transit case of 2018 of possible Russian gas transit termination from 2020, and the
USD 2.92 billion. relevant action plan was developed in time through accumula- Gas volumes in European UGS facilities in 2016-2018 2019 GOVERNANCE CORPORATE The aforementioned change in transit volumes in 2019 tion of sufficient gas volume in UGS facilities. As evidenced by was due to a number of factors including: the actual transit volumes in January-February 2020, Russia was Source: Gas Infrastructure Europe indeed preparing to terminate its transit through the territory 1 Preparation of other European countries and Gazprom for of Ukraine after the expiry of the 2009 transit contract. Gas transit through Ukraine in 2014-2019
Breakdown of consolidated revenues from the gas transit business in 2019 100 93.5 89.6 86.8 82.2 THE HIGHEST REVENUE IN THE HISTORY OF UKRAINE 80 RESPONSIBILITY Compensation under 67.1 the transit arbitration 62.2 AND SOCIAL ENVIRONMENTAL 2.92 award of 2018 60 USD billion bcm 5.64 40 evenue from USD billion transit services 20 2.72 rendered in 2019 USD billion 0 2014 2015 2016 2017 2018 2019 Total revenue from gas transit business in 2019 Gas transit volume FINANCIAL OVERVIEW AND STATEMENTS Source: Naftogaz Source: Naftogaz
Annual Report 2019 44 Naftogaz Group Annual Report 2019 45 Naftogaz Group EXCHANGE OF NEW CLAIMS BY NAFTOGAZ FOR A pay for the booked capacity, Gazprom would have had no USD 11.8 billion. The claim was based, among other things, 10) According to our estimates, such a development amid NEW TRANSIT CONTRACT economic motivation to use this capacity – so the revenue on compensation by Gazprom for the loss in value of the increasing competition from LNG in the European market would have been even smaller. In addition, the transmission Ukrainian GTS due to the expectation of termination of could have made Gazprom reassess the importance of The second half of 2019 was marked by negotiations -be cost is formed based on tariffs for entry and exit points set by transit by Russia from 2020. This requirement was in fact a maintaining its reputation as a reliable counterpart that is tween Ukraine and Russia in various formats regarding the the Ukrainian regulator calculated according to the standard continuation of the work on the revision of the transit tariff committed to the rule of law (in particular by fulfillment of conclusion of a new gas transit agreement. Until December European methodology. under the 2009 contract, which has been actively pursued the decisions of international courts). 2019, the negotiations were held in a trilateral format (in- Unlike the 2009 contract, the new deal provides for ad- by Naftogaz since 2014. Naftogas successful efforts in the volving representatives of the European Commission), and in vance payment. arbitration proceedings was one of key factors in achieving MARKET AND REFORMS December, mainly in a bilateral format at the company level. successful transit arrangements by the Ukrainian side. IMPORTANT FACTORS THAT ENSURED Since Gazprom has long been reluctant to sign a new contract The signing of the new Transit Agreement and the Settle- 6) On 27 November 2019, the Swedish Court of Appeal SUCCESSFUL CONCLUSION OF THE TRANSIT for the period after 2019, the zero-transit scenario after 2019 ment Agreement should be considered in the context of the rejected Gazprom's appeal against the separate award was a baseline. Under this scenario, Naftogaz had to continue circumstances and events that preceded the agreements on of the Stockholm Arbitration Tribunal in the gas sale case AGREEMENT a new arbitration, which provided for the possibility of receiv- 30 December 2019: between Naftogaz and Gazprom. The judgment could have ing multi-billion dollar compensation for Gazprom's termina- 1) The Ukrainian side was well prepared to defend its position not been appealed on the merits and minimized Gazprom’s 1Unbundling of gas transmission system operator (TSO): tion of gas transit through the territory of Ukraine. to prevent accusations of disruption of the negotiation chances to win an appeal against the final award of the The Russian side reiterated the need to bring Ukrainian gas In the result of negotiations process, completed at the end of process during Ukraine-Russia-EU trilateral negotiations. Stockholm Arbitration Tribunal in the gas sale case. legislation in line with EU market rules. Unbundling was a pre- December 2019, on the conclusion of the Agreement for the set- 2) During 2019, a stakeholder awareness campaign was 7) On 22 October 2019, the District Court of Amsterdam requisite for this compliance. Naftogaz’s active participation tlement of existing gas disputes and the basic terms of the future successfully launched to counteract the possibility that in satisfied Naftogaz’s request for the attachment of 100% in the development and implementation of the unbundling relationship in respect of transportation of natural gas (hereinafter return for extension of the old transit contract, Naftogaz would of the shares of Gazprom's South Stream Transport B.V. model was an additional leverage in successful negotiations Settlement Agreement) and the Contract on rendering services have to agree to Gazprom’s “zero option” (that is, without subsidiary. This was done in connection with the legal on continued gas transit. of organisation of natural gas transmission through the territory fulfilling the 2018 arbitration award), and the terms and condi- proceedings against Gazprom for the fraudulent transfer of Ukraine (hereinafter Transit Agreement), an arrangement be- tions of such a prolongation of the transit would be disadvan- of these shares to Transgaz Krasnodar LLC a day before 2US sanctions against Nord Stream 2: AND OPERATIONS STRATEGY tween Naftogaz and Gazprom was reached on booking capacities tageous for Naftogaz (much smaller volumes, no ship-or-pay the bailiffs started to freeze Gazprom's assets in the Neth- More than three years of Naftogaz’s targeted efforts facil- for transit in 2020-2024. Under the Transit Agreement, the mini- principle and no responsibility for the failure to deliver the erlands upon Naftogaz’s claim. In addition, on 4 December itated the adoption of US sanctions against companies pro- mum guaranteed amount of revenues from it comprises almost transit volumes, non-compliance with European rules, etc.). 2019, a court hearing on the recognition and enforcement viding vessels and technology for the construction of Russian USD 7.2 billion. 3) Ukraine and the European Commission took a common of the Stockholm Arbitration Award in the case initiated export-oriented offshore energy projects. The sanctions were The Settlement Agreement provided that Gazprom should stand regarding the benefits and future use of the Ukrainian by Naftogaz against Gazprom as been successfully com- adopted in December 2019 and led to immediate withdrawal pay USD 2.92 billion as compensation under the 2018 arbi- GTS during the negotiation process. pleted in Amsterdam. We had been expecting a favorable of two companies providing pipelaying vessels from the Nord tration award and both parties should waive their claims and 4) The Ukrainian side started to prepare for the scenario of judgment in this case to be rendered in February 2020. Stream 2 project and suspended its construction. This urged relevant court proceedings. Gazprom demanded the revision interruption of gas transit by Russia from 2020 in advance, This would have enabled us to enforce Gazprom’s debt Gazprom to agree and sign a new transit contract with Naftogaz of arbitration awards on the invalidation of the “take or pay” including accumulation of sufficient gas volumes in UGS under the arbitration award of 2018 through selling the as soon as possible. It should be noted that until the final adop- clause and compensation for the underdeliveries under the facilities for flawless heating season. attached assets, making Gazprom far less optimistic about tion of the sanction bill in the US Congress, Gazprom had been transit contract. 5) The company was actively supporting its claims in a new its chances to win other cases against Naftogaz. refusing to constructively negotiate a new transit deal, hoping Gazprom has also factually waived the claims for payment arbitration proceeding against Gazprom for a total of 8) The Ukrainian side was prepared to defend its position when to complete Nord Stream 2 within a short period of time and be for gas deliveries to the occupied territories, which was esti- USD 12.2 billion, which were submitted to the tribunal the format of the negotiations changed from trilateral to able to refuse from the Ukrainian transit route in 2020. GOVERNANCE CORPORATE mated at USD 2.6 billion. on 1 November 2019. The substantive component of the bilateral negotiations with the involvement of representatives The new transit agreement is based on the ship-or-pay claim was the compensation for Gazproms non-compliance of the Ukrainian government. 3High-level political arrangements principle – that is, Gazprom pays not for physically transmitted with a clause from 2009 transit contract that allowed Naf- 9) On 9 December 2019, the gas issue was discussed between The signing of the new transit contract took place based volumes, but for booked capacity. Without the obligation to togaz to claim tariff revision in 2018-2019 with a value of Ukraine and Russia during the Normandy summit in Paris. on the political arrangements reached, which were formalized in the minutes of the meeting of the representatives of the European Union, Ukraine and the Russian Federation of 19-20 December 2019.1 Value components of the new transit contract for Naftogaz Gas transit in Q1 2020
6 5.5 5.5 WHAT IS NEXT Naftogaz’s GUARANTEED 5.0 contractual margin The most pressing issues in relations with Gazprom include RESPONSIBILITY MINIMUM 5 4.6 REVENUES unlocking the following opportunities: 3.9 — gas delivery to European companies on the Russia-Ukraine AND SOCIAL ENVIRONMENTAL 7.15 4 border; USD billion — gas exports from the Russian Federation by gas producers 3 2.5 bcm independent from Gazprom; Gas transit — gas transit from Central Asia through the Russian Federation contract Decrease in entry tariffs for 2 by gas producers independent from Gazprom. 2020-2024 gas production companies 1 Solving these issues is related to Ukraine’s integration in the Euro- pean gas market, including harmonization of legislation regulating 0 market relations; advocation and strengthening Ukraine’s position January February March in the European energy and political landscape; and building trust among European institutions and businesses. Actual transit volumes In a long-term perspective, this will help Ukraine become DECREASE IN GAS TRANSMISSION a rightful participant of the European gas market and retain its indirect taxation of transit Capacity booked by Gazprom TARIFFS FOR END USERS position in gas transit and relevant revenue. revenues (VAT) FINANCIAL OVERVIEW AND STATEMENTS Source: operational data from OGTSU LLC 1 See https://www.kmu.gov.ua/news/protokol
Annual Report 2019 46 Naftogaz Group Annual Report 2019 47 Naftogaz Group AMENDMENTS TO THE LAW EFFECT OF THE AMENDMENTS
Conditions have been created to increase the efficiency of use of the gas A positive development for both the LEGISLATIVE transmission system of Ukraine and to improve the procedure for obtaining natural gas market of Ukraine and access to capacity by customers of transportation services. Naftogaz Group. Thanks to these novelties, the GTS
The NEURC Resolution of 12.04.2019 No 580 “On Approval of Amendments Operator is able to offer a new service – MARKET AND REFORMS CHANGES to Certain NEURC Resolutions” amended the Gas Transmission System Code, the "short-haul services". The availability of Standard Natural Gas Transportation Agreement, the Gas Storage Facility Code, such a service will further unleash the the Standard Natural Gas Storage (Injection, Withdrawal), and the methodology potential of the Ukrainian GTS, as Europe- for determining and calculating tariffs for natural gas transportation services for an suppliers will be able to transport gas The natural gas market has switched to a daily balancing re- transportation services into balancing groups, and the provision entry and exit points based on long-term incentive regulation. Amendments were at competitive prices in transit through gime, which brings the Ukrainian gas market closer to integration of capacity with restrictions. In addition, the methodology for also made to the reporting form No 4-NKREKP-natural gas transportation (quarter- Ukraine, as well as pump natural gas into with the EU gas market. The independent GTS operator has been determining and calculating tariffs for natural gas transportation ly), in particular in terms of capacity allocation and introduction of procedures for Ukrainian underground storage facilities. separated and certificated. In terms of EU legislation transposi- services for entry and exit points based on multi-year incentive providing access to capacity with certain restrictions. tion, it is worth noting the amendments to the GTS Code aimed regulation was amended to ensure compliance with Regulation The amendments provide that entry / exit point capacity will be ordered and at harmonization with the relevant EU network codes, in partic- (EC) No 2017/460 of 16 March 2017 establishing a network code paid for by the customers of transportation services rather than consumers. In ular, regarding allocation agreements, clustering customers of of harmonized gas transportation tariff structures. turn, this allows the operator to achieve greater predictability of long-term loading of the GTS and optimizes its operation. In addition, these amendments make it possible for the customers of transportation services to have more flexible mecha-
AMENDMENTS TO THE LAW EFFECT OF THE AMENDMENTS nisms for accessing the capacity of domestic entry / exit points for various periods AND OPERATIONS STRATEGY (a year, quarter, month and day ahead), which allows them to effectively plan their orders and capacity use. The NEURC Resolution of 30.11.2018 No 1573 once and for all rescheduled the date A positive development for both the The procedure for providing access to capacity with certain restrictions is in- of introduction of daily balancing on the natural gas market of Ukraine on March 1, natural gas market of Ukraine and the troduced. The positive effects of the implementation of this procedure include the 2019. Naftogaz Group. The introduction of daily following: Accordingly, on March 1, 2019, the system switched to daily balancing, which balancing contributes to the development — ensuring regional transit flows through the gas transmission system of Ukraine imposes on the customers of natural gas transportation services the obligation to of the liquidity of the short-term whole- and efficient use of the existing infrastructure; settle their imbalances within one gas day. sale market (purchase and sale of natural — loading of Ukrainian gas storage facilities at the expense of European suppliers; gas within one day) and liberalization of — diversification of GTS operator's sources of income; the natural gas market as a whole, which — increased cross-border trade and improvement of liquidity in gas markets. significantly brought the operations of the Ukrainian natural gas market closer to
European standards, including in terms of The legal acts of the Regulator have been improved to ensure fulfillment by the Positive effect for market players. GOVERNANCE CORPORATE determining the fee for imbalances NEURC of its responsibilities in the oil and gas sector and interaction with licensees
The NEURC Resolution of 05.02.2019 No 156 "On Approval of the Procedure Daily balancing mechanisms and conditions have been standardized. A positive development for both the for Settlement of Disputes Arising between Business Entities Carrying Out Activi- natural gas market of Ukraine and Naftogaz ties in Energy and Utilities" regulated the settlement of pre-trial disputes arising The NEURC Resolution of 12.04.2019 No 558 “On Approval of Amendments Group as it strengthens competition in the between market participants with regard to access / connection to gas networks, to Certain NEURC Resolutions” amended the provisions of the Gas Transmission market of gas supplied for non-domestic observance of license conditions by business entities. System Code, the Standard Natural Gas Transportation Agreement and the Natural consumers and improves the work of the Gas Supply Rules, which determine the procedure for entering into an allocation GTS Operator. The NEURC Resolution of 22.04.2015 No 615 "On Approval of the Instruction agreement (allowing non-household consumers to simultaneously receive natural on Monitoring of Oil and Gas Markets by the National Energy and Utilities Regula- gas from several suppliers in one commercial accounting point) and introduced tory Commission" approved the instructions for monitoring of oil and gas markets the procedure for balancing group establishment and operation in the natural gas by NEURC. According to these instructions, the procedure and the rules for mon- RESPONSIBILITY market (the rights and responsibilities of the party that can be accountable to the itoring, the system of indicators for each object of monitoring (in particular, sepa- GTS operator for paying for daily imbalance of a group of customers it services). rately for the gas market), as well as the rules for publishing the results obtained in AND SOCIAL ENVIRONMENTAL Also, the date when the fees for neutral balance will start to accrue (1 January the process of market dynamics monitoring, are established. 2020) was established. The NEURC Resolution of 17.05.2019 No 750 “On Amendments to the NEURC Resolution dated 30 September, 2015 No 2494” amended the GDN Code, which The NEURC Resolution of 07.10.2019 No 2081 "On Amendments to the Rules A positive development for the natural gas exempted the owners of commercial natural gas metering units with meters of siz- of Natural Gas Supply" has regulated the issue of non-application of penalties market player. es G-1,6, G-2,5, G-4, G-6, accounting for an annual volume of gas less than 10,000 to heat-producing enterprises, as well as condominiums with their own boilers cubic meters, from the obligation to install remote data transmission devices on (which receive gas under the PSO Regulation) for actual consumption of gas that their own commercial metering units. The idea of this decision is to avoid burden- does not match the ordered amount. After the introduction of daily balancing in some technical requirements and additional financial burden for this category of the natural gas market, the company was required by law to impose fines on these consumers. consumers in case of deviation of their actual gas withdrawal by more than 5% The NEURC Resolution of 02.07.2019 No 1333 “On Approval of the Rules for from pre-ordered volumes, and spent significant resources on administration of Consideration of Consumer Appeals on Actions of Business Entities Operating in fines. The purpose of this decision was to protect the rights of these consumers Energy and Utilities and Settlement of Disputes” determined the procedure for and reduce any financial burden. consideration by NEURC of the appeals of consumers or persons intending to be- FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 48 Naftogaz Group Annual Report 2019 49 Naftogaz Group AMENDMENTS TO THE LAW EFFECT OF THE AMENDMENTS AMENDMENTS TO THE LAW EFFECT OF THE AMENDMENTS come consumers, as regards the violation of their rights and interests by economic entities operating in the energy and utilities sectors, the state regulation of which The NEURC Resolution of 07.10.2019 №2080 “On Approval of Amendments to is performed by NEURC, and the settlement of disputes. Certain NEURC Resolutions” amended the Gas Distribution Systems Code and the Standard Natural Gas Distribution Agreement, as well as the methodology for
The NEURC Resolution of 01.08.2019 No 1623 "On Approval of Amendments Determining and Calculating Tariffs for Natural Gas Distribution Services. MARKET AND REFORMS to the Resolution of the National Energy and Utilities Regulatory Commission- dat ed 07 July 2016 No 1234" approved the changes to the reporting forms and in- The amendments also changed the principles of determining the amount of The approved amendments enabled structions for their completion, which relate to monitoring the natural gas market. capacity for natural gas consumers through transition from the connected capacity calculating and setting tariffs for GDN Op- The decision to modify these forms is due, on one hand, to the need to bring them to ordered capacity which will best meet the needs of consumers. In addition, erators to satisfy the requirements of the into line with current legislation (in particular, the PSO Regulation), and the need capacity ordering procedures have been simplified based on statistics on natural provisions of the Law of Ukraine “On the to automate information collecting and processing for the purposes of monitoring. gas consumed by each consumer in previous periods, and provided additional Natural Gas Market” regarding providing protection for household consumers. access to gas infrastructure on the princi- The NEURC Resolution of 13.09.2019 521952 "On Approval of Amendments to ple of granting the right to use capacity. the Procedure for Monitoring Compliance by Licensees Operating in Energy and Utilities, Legislation in the Relevant Areas and Licensing Conditions" supplemented the procedure for control with new chapters on the organization of two types of Tariffs for natural gas, oil and oil product transportation services, as well as for A positive development for both the unscheduled inspections: off-site inspections (i.e. those held on the premises of natural gas storage (injection, withdrawal) services in underground gas storage oil and gas market and Naftogaz Group the regulator) and inspections carried out before the decision on the merits of the facilities have been set companies, as it allows market players to dispute. The approved amendments regulate the terms, grounds, and list of issues The NEURC Resolution of 18.07.2019 No 1480 “On Amendments to the NEURC plan their business activities, as well as to AND OPERATIONS STRATEGY subject to such inspections. Resolution of June 19, 2018 No 480” from August 1, 2019 established tariffs for receive income from licensed activities. natural gas storage (injection, withdrawal) in the underground gas storage facilities With its Resolution of 29.11.2019 No 2586 "On Transposition of the Provisions of Ukrtransgaz JSC. of the European Union and the Energy Community Acts on the Natural Gas Market of Ukraine", the regulator approved the decision to transpose the provisions of The NEURC Resolution of 11.10.2019 No 2108 "On the Establishment of Tariffs the European Union and the Energy Community Acts on network codes in the gas for Transportation of Oil by Trunk Pipelines of Ukrtransnafta JSC for Consumers of sector, namely: Ukraine for a Transitional Period" from November 1, 2019, established tariffs for — Commission Regulation (EU) No 2015/703 of 30 April 2015 establishing a the transportation of oil by trunk pipelines with their gradual increase over three network code of interoperability and data exchange rules; years. — Commission Regulation (EU) No 2017/459 of 16 March 2017 establishing a network code on capacity allocation mechanisms in gas transmission systems The NEURC Resolution of 24.12.2019 No 3013 "On Setting Tariffs for GTS and repealing Regulation (EU) No 984/2013; Operator of Ukraine LLC for Natural Gas Transportation Services for Entry Points
— Commission Regulation (EU) No 2017/460 of 16 March 2017 establishing a and Exit Points for the Regulatory Period 2020 - 2024" from January 1, 2020, es- GOVERNANCE CORPORATE network code of harmonized transmission tariff structures for gas; tablished tariffs for natural gas transportation services for entry and exit points — Commission Regulation (EU) No 312/2014 of 26 March 2014 on the Network to / from the gas transmission system on cross-border connections, tariffs for Code on Gas Balancing of Transmission Networks; natural gas transportation services for domestic entry and exit points to / from the — Commission Decision (EU) No 2012/490 of 24 August 2012 on amending gas transmission system, and also approved both the coefficients that take into Annex I to Regulation (EC) No 715/2009 of the European Parliament and of the account the period and the season for which the capacity is ordered, as well as Council on conditions for access to gas transmission systems. reducing factors for capacity with restrictions. Transposition is done by translating the provisions of EU Regulations and trans- posing them into national law without making changes to the structure or text. Certification of the gas transmission system operator and issuance of a license A positive development for players of the have been provided. natural gas market of Ukraine. Tariff methodologies for natural gas transportation and natural gas distribution A positive development for natural gas services have been improved market players . With NEURC Resolution of 24.12.2019 No 3010, the regulator made a final RESPONSIBILITY The approved amendments enabled decision on the certification of the gas transmission system operator. The NEURC The NEURC Resolutions of 11.10.2019 No 2107 and of 20.12.2019 No 2899 calculating and setting tariffs for the -certi Resolution of 24.12.2019 No 3011 approved the decision to issue a license for the AND SOCIAL ENVIRONMENTAL approved the amendments to the methodology for determining and calculating fied operator of the GTS of Ukraine accord- transportation of natural gas to GTS Operator of Ukraine LLC tariffs for natural gas transportation services for entry and exit points based on ing to European standards. long-term incentive regulation. The amendments are aimed at ensuring com- pliance with the regulations of the European Commission (EU) No 2017/460 of March 16, 2017 on the establishment of a network code of harmonized transmis- sion tariff structures for gas. In addition, the approach to the distribution of the required revenue between entry / exit points, the calculation of the adjustment of required revenue from natural gas transportation activities on the basis of capacity charges was modified, and a mechanism for determining the auction price using the newly introduced concepts of "regulatory account", "homogeneous group of points", and "cluster of points". Among other things, for the GTS entry / exit points on a cross-border pipe joint, a tariff may be set below the GTS operator’s econom- ic costs, however only in order to bring tariffs to a competitive level, taking into account the level of alternative gas transportation routes, alternative costs, and economic feasibility for customers of gas transportation services and other factors. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 50 Naftogaz Group Annual Report 2019 51 Naftogaz Group IN THIS SECTION: NEW WELLS COMMISSIONED IN 2019 55 | Address of COO 61 | Integrated Gas Business Delivery Unit 77 | Oil Midstream and Downstream Business Delivery Unit In 2019, 60 new wells Incremental 83 | Natural gas transmission were commissioned production 91 | Gas Storage Business Delivery Unit 60 into production and 504 from new wells contributed 504 commissioned in MARKET AND REFORMS 95 | Technical Business Enabling Unit NEW WELLS mcm of production MCM 2019 was 504 mcm 101 | Ukrnafta PJSC results 105 | New Energy Business Unit 109 | New Businesses STRATEGY AND OPERATIONS STRATEGY CORPORATE GOVERNANCE CORPORATE RESPONSIBILITY OPERATIONS
HYDROCARBON EXPLORATION AND PRODUCTION ACTIVITIES AND SOCIAL ENVIRONMENTAL
Key challenges for Naftogaz Group in its objective to grow its resource base and STRATEGY AND STRATEGY production for several years have been field depletion, limited portfolio of special permits for development of new fields, and significant time and other costs required for their development. Naftogaz Group focuses on optimizing production from existing fields with simultaneous capability enhancement, attracting partners, and investing in new opportunities. Sustaining baseline production, enhancing capabilities, and pursuing partnerships and investments into new opportunities in combination will create a solid foundation for a steady increase in production and resource base and strengthen the nation’s energy security. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 52 Naftogaz Group Annual Report 2019 53 Naftogaz Group MARKET AND REFORMS INTERVIEW WITH CHIEF OPERATIONAL AND OPERATIONS STRATEGY OFFICER Otto Waterlander Сhief operational officer
A completely new position has appeared in the compa- CTO is a temporary position. What will follow the com- of our investments to make sure we protect the financial base have become a different company when you see that our per- ny’s top management. What is your role as the Chief Trans- pletion of the transformation? of the company. The challenge is phenomenal. On the one formance metrics are comparable to those that are common formation Officer? What are your priorities? What is the I think we can consider the transformation complete when hand, we need investments to target new businesses and new in the international oil and gas industry. That’s how you will GOVERNANCE CORPORATE difference between CTO and COO? How will you combine we have achieved the planned shift to business divisions and resources. On the other hand, we have to have a very reduced know that we have transformed the company. these two positions? implemented the right accountabilities for decisions. Today investment level because we need to protect the financial I think what is important is that the executive board has we have a mix. Some are legal entities, some are business base of the company. This requires a very fine balance. We How will Naftogaz change for the outside world? chosen an operating model where executive board members divisions. We want to move all the decision rights from legal need our team to deliver production growth, to deliver re- The outside world will recognize a different Naftogaz. It are closer to the operational side of the business. We don’t entities to businesses. That’s one way to recognize that the source growth, to be ready to enter the retail business, to de- will be easier to work with Naftogaz. There will be less bureau- only want to be a shareholder, we want to be very active to transformation is complete. The second sign is increased effi- liver financial improvements in the storage business, in the oil cracy. We will be open and transparent to the external world, guide our business leaders. For that reason we created the ciency. With the amount of people we have, we can do more business, and also in the gas business. At the same time, we comparing ourselves to international industry standards. You role of the COO. This is a fundamental change for the compa- and we must become more efficient. There are some activities need to reduce the number of people that we involve in each will look at Nafogaz and you will see that this is a normal oil ny and therefore we also created the CTO position. It’s very we could do with less people and less capital. That’s also true. of our activities and we need to become more efficient. Those and gas company improving the way it is operating and push- important for the success of the Group to achieve its transfor- We can grow faster. We want to develop to the level that we are the challenges that we need to continuously balance. ing its way into becoming an energy company. mation in a short timeframe. When we think about transfor- say, “yes, we can achieve more ambitious plans”, and we need mation, we are not just thinking about organizational change. to move towards creating more value. Especially today. The What is the essence of the transformation you oversee What are the key risks for the transformation? RESPONSIBILITY We are thinking about changing the way we work and about efficiency theme is everywhere from oil to storage to gas to in Naftogaz? Which are the key workflows of the transfor- I think that financial instability is the first and the most results we hope to achieve with that. What does that mean in trading. We need to make all the parts of our business profit- mation? important risk today. If we don’t transform, particularly in AND SOCIAL ENVIRONMENTAL practice? It means we need to improve processes to reduce able and attack the elements that are not profitable. We need The essence is set up a new organizational structure where view of the current crisis, we have a very significant risk that red-tape and speed up decision making. It means we need to to make our work efficient, make sure that we have the right people will find it easier to work together where we establish we lose financial strength and stability of the group. We have allow decision making in the organization where people know people in the right places. When we see all those things hap- clear and transparent individual accountability to achieve to change, we have to transform. In meetings with the top best. We then need to make sure we have the best talent pen and we see growth in value, then I’ll consider the trans- results. Our teams then can focus on identifying opportunities leaders of the company, I compared this with the coronavirus for the tasks ahead of us. This is true for operational matters formation complete. for creating value and growth that we could not see before. crisis: it came suddenly, but almost overnight we found that such as how to bring together our best people to drill new An important element is to create better capabilities and we can work very differently. The way we communicate to- wells. But also to make a decision about investments in a new What key challenges for Naftogaz do you see in the cur- competences, at par with international standards. How do we gether today, I think in early 2020 we thought was impossible. LPG plant where we need the best people evaluating the LPG rent environment? How will the group respond to them? achieve that? We have one big work stream that is focused Within six weeks, we all changed how we work. We all created market, about investment technologies and about project and Most of us have never seen anything like the current crisis on organization and work culture. Another is focused on a new method of interacting together. It’s the same with the risk management. My role as a chief transformation officer is before. We must be clear about that. The entire oil and gas achieving breakthrough performance. For example, our supply rest of the transformation: if we do not transform, we will no to make sure that I bring all of the elements together. As we sector is responding to it quite aggressively and our response chain management project is a new concept in how we want longer be able to deliver on our objectives because we will evolve the Group, it makes a lot of sense to combine the CTO is in line with the Industry response. We are reducing our op- to reduce the cost of the supply chain and manage things like lose the financial health of the company. And we will lose the and COO roles for now. To be closer to the business, working erating costs and we are reducing our investments. Basically, our warehousing and logistics in the company to make sure credibility of the public because if we are not able to grow the with the businesses, to change how we work, to help create we now need to accelerate the transformation we are already that all the things we buy are brought at the lowest cost. This reserve base, than our right to exist as a national oil and gas better results. undertaking. On top of that, we are reducing or delaying some will improve how we execute our work. You will recognize that company will be questioned. So, what we need to do is to lead FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 54 Naftogaz Group Annual Report 2019 55 Naftogaz Group development of new reserves, reduce the risks of developing grow but needs to demonstrate the viability of the refining dependent on oblgazes or other parties who resell our own international partners. I also believe Ukraine needs to tell its oil and gas activities in Ukraine. Naftogaz needs to lead and be activities under reduced demand for petroleum products. gas to end users and then don’t pay Naftogaz. We are building story better and within our report we do a good job of this, a platform to bring international companies to Ukraine to help For Shebelynka this will be an important year to demonstrate our own direct channel to customers to be more efficient. but we need to have an extra hundred thousand copies of our MARKET AND REFORMS us grow. This is another issue we need to look at. Without how to maintain the refinery. We are also continuing to That’s what our response is going to be. In parallel, we will Annual Report because we need to tell the story of Ukraine’s international partners we achieve less. We’ll reach our goals look at extracting a high value product like LPG form our gas continue collection efforts from those companies who are not oil and gas industry much more outside the country. We need much quicker if we are able to attract international partners production. The opportunity to sell LPG in Ukraine is strong paying Naftogaz. to take our Annual Report everywhere. Today, very few people who will invest alongside with us. and we want to continue playing in this segment. We must talk about Ukraine. And when they talk about Ukraine, very also look at the storage business. Our storage business is a Naftogaz is planning an IPO within the next 3 or 4 years, few people talk about opportunities in Ukraine. And even The shareholder decided to extract 95% of profits from new since we separated the TSO. This business works very depending on financial markets. What is the company doing fewer people talk about opportunities in the oil and gas sector Naftogaz as dividend. How critical is this decision to the hard to increase its efficiency. Unfortunately, this means that to prepare? in Ukraine. I find this a great pity. As a consequence, many group's ability to produce gas and remain profitable? we will reduce our indirect staff activities. We need to have It is, of course, up to the owner to decide on the IPO. For people don’t know where Ukraine is and have no idea what’s That decision in itself is not relevant to the near-term abil- fewer people working in storage. And we need to market Naftogaz it is the state of Ukraine, which owns 100% of our going on here. ity to produce gas. We will continue to be able to produce gas our storage capacity in the European market. We will work shares. And it is up to the owner to decide if this is a full IPO and will probably be able to grow our volume base to some commercially to attract foreign partners who want to store in or partial IPO and whether this is to replace existing share- We know that the European Union is now working on degree. In the longer term, if this becomes a norm, it means Ukraine. Turning that around and creating that commercial holder money or to attract new money. A lot of things still a new green deal agenda. Do you see a role for Naftogaz in that Naftogaz will no longer be able to invest to grow the opportunities at more affordable cost levels is important for need to be decided. NAftogaz want to become ready so it this green deal, for instance reducing methane emissions or reserve base and we will not be able to increase gas produc- the storage business. We then will need to look at the tech- creates the opportunity for the IPO. What we need to do is producing and storing hydrogen, which is a very important AND OPERATIONS STRATEGY tion. The only way for Naftogaz to grow the long-term produc- nical business. We must become more efficient, lower cost to improve the valuation of the company. This is step number buzzword now in Brussels? tion volume is by investing more in finding new reserves. We and clarify where and how the technical business can add one and this is what a lot of our activity this year is focused on I am very committed to the Green agenda and reducing cannot grow sustainably from existing reserves. In short, we most value. As I said, this is crucial to afford our investments. with the transformation. The second thing we need to do is greenhouse gases. Natural gas will have a role to play, among must invest and find new reserves. This is the only way we can For the Commerce business, today we have opportunities to to establish the right governance and transparency. From this others to reduce coal in power generation, for a long time to increase the volume and create energy independence for the trade in the market that we never had before. We can grow year onward, we become more transparent in reporting our -fi come. And, we will face more opportunities from investing in country. We must invest significant money into finding and this business and create more value for the company. We nancial performance. This also helps us internally, because we green electricity, to reducing our own emissions in operations. developing new reserves. One year of taking out 95% will not also want to go into the retail market and build a new busi- need to report externally and create transparency internally About hydrogen am less excited about the near term poten- inhibit our long-term opportunities. If this becomes a norm, ness. Our ambition is to grow to serve two and half million and be open about what our financial performance is to iden- tial. It will likely remain a research and development effort it will slow down the pace at which we can develop and delay customers after the abolishment of the PSO. And finally, the tify what we can improve. The other topics we’ve just talked for most of the coming 10 years, with costs and investments. the achievement of energy independence for the country. upstream part of the business which is generating most of about in terms of changing and improving each and every of Hydrogen as a technological challenge needs to be subsidized. the cash today for its own development. Upstream needs the five businesses are, I think, the critical pillars in order to If the European Union is ready to consider financing such One of the tasks that the shareholder set for Naftogaz to move from generating cash from production to investing demonstrate improvement. Then what you need to do for an projects in Ukraine, we are happy to be part of the process. I is to increase 2P oil and gas reserves. The current market cash into the growth of future production. We have strength- IPO is demonstrate stability. Can we sustain improvements in think the crash in oil and gas prices is fantastic for the green GOVERNANCE CORPORATE conditions are far from favorable. What are Naftogaz’s plans ened our leadership to lead that change. I would say that the company? Can we show that the company is able to at- deal as it may accelerate the phase out of coal from electric- in terms of investments in the development of domestic gas our upstream business is the largest business today in terms tract, develop, and promote talent? Can we show that we are ity generation. Ukraine should adjust its policy accordingly. production? of cash generation and in terms of investment levels, but all building a pipeline of talent internally in the company? Exter- Otherwise, the electricity price will increase as a consequence The oil and gas market always experiences periods of five businesses must change in order to generate the cash nal investors love to see that we have the right people coming which hurts the industrial development and creating new jobs. higher prices and lower prices. Today’s market in that context that we need to have as a group. Naftogaz cannot afford through the ranks and stability at the top of the organization. Gas will benefit from this process of replacing coal for gas in is not different. But the crisis seems bigger because many divisions that are not carrying their weight in value creation. These are all steps that we are undertaking in 2020. Europe. As a consequence, the opportunity to use Ukraine's more factors are involved, and it may take longer to recover. storage and transit will grow. I believe that being a gas player What we need to do in response is two things. First, Naf- What are the key growth and investment areas for the What else do you think should be addressed in the An- is still a very important thing. Let’s focus on doing it well. togaz has the need to become more efficient. Improving and group in the next three years? nual Report? What important messages with regard to the demonstrating greater efficiency, allows us to improve the I would say that all of them are important because if you transformation of Naftogaz need to be communicated to We know that we face a very challenging time. We need affordability of our investments. We need to make sure that can imagine that I got four small businesses and they are los- stakeholders in the Annual Report? to work on efficiency and spending less. How will this affect all the investments we do are really economic under tougher ing money or costing money, then it reduces the opportunity Given the fact that we are building the annual report on the group’s focus on HSE, on job security, and our responsi- RESPONSIBILITY market conditions. We must ensure that investments remain for upstream to find new gas because I don’t have enough what we achieved during the last year, I would not mind if we bility to the environment? economic when prices are USD 100/tcm to extract, so we are investment money. I think that in the coming three years put more emphasis on discussing or highlighting the external So, first, HSE. The only journey is to strengthen our HSE AND SOCIAL ENVIRONMENTAL still economic also in the long term. Second, we must ensure finding enough investment funds will be a challenge for us. market crisis. We are not transforming just because we want performance. We will not attempt to save even a single that we also prioritize enough investments that give us good We need to demonstarte affordability and more efficiency in to but because we need to. We must demonstrate to be on hryvnia in that direction. In fact, we plan to spend more this opportunities to be economical for the country in the longer investments and make sure that every business, even small a par with the international industry under the new market year in order to strengthen HSE performance. We can never term. Investments in new reserves is not done for tomorrow businesses, generates cash. They cannot lose cash. condition. On the oil side, we no longer have the demand we let the economic situation reduce the importance of HSE per- but will bring production volumes in five years from now. We used to have, while on the gas side, prices are below import formance. This will remain the most important challenge for think there are enough opportunities for us to invest. How will the major problems be solved, such as out- parity of LNG from the US. These are situations we have never us. We cannot sacrifice lives for the sake of efficiency. But we standing receivables and increases in production? experienced before. It is crucial for the company to transform do recognize that we are not efficient today and we need to You oversee the work of different divisions. Which ones There are many challenging topics. We are actively dis- if we want to have investment capital in the future and to become more efficient. We can train or retrain people and we do you believe have the biggest potential? cussing on our PSO debts trying to find a way to resolve this demonstratewe are a responsible state-owned company. We will be responsible where we need to say goodbye to people. First of all, you know that this year we have split Inte- and this is also very much linked to finding final agreements must make sure that we are more affordable in everything we We don’t have a specific reduction target. It has to be a con- grated Gas into two divisions. We created a Exploration & with Ukrnafta. Hopefully, we can solve these problems do. That’s the only way we can have sufficient cash to invest tinuous effort. We cannot offer job security. I think we need to Production Division and a Commercial Division. In 2020, all by striking the right deals with between the government, in new reserves in the long-term production potential of the be honest about it. Reducing bureaucracy is important for us. the divisions are critically important to us because they all Ukrnafta and Naftogaz. Regarding the other outstanding debts company. Without transformation, we will not be able to We will continue to consolidate our activities to increase qual- need to demonstrate their economic viability in new market of oblgazes, as soon as the PSO regime cease to exist, we will achieve the targets that the government has set for us. In or- ity, increase automation so that we become a more stable and conditions. The Midstream Oil and Gas Division wants to step further into the retail market. We will try to become less der to realize these ambitions, we need to do more to attract more investment-friendly company. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 56 Naftogaz Group Annual Report 2019 57 Naftogaz Group Transformation
BETTER NAFTOGAZ - RESULTS 2035 Improvement performance of Naftogaz Group with respect to safety, reducing injuries, implementation of HSE industry standards 2034 Ensure stable transfers to the state budget and reducing negative impact of low prices to Naftogaz Group performance 2033 2023 MARKET AND REFORMS Successful transformation of Naftogaz Group and build highly efficient operational model 2032 Ensure sustainability of development and value creation of Naftogaz Group “Reshape our Future” Better organizational efficiency – quick decision making and execution 2031 Naftogaz Group positioning as attractive employer of “choice №1” in Ukraine or national center of competencies and best practices based on professional growth 2030 and development 2029 Fit for 25 by 2023 Culture of personal responsibility, results-oriented and collaboration 2028 Ensure financial stability and profitability of business in an KEY PRINCIPLES OF NAFTOGAZ GROUP OPERATING MODEL 2027 environment of low stable prices and crisis 2026 The Company's readiness to IPO Compliance with Naftogaz Group values, Code of Corporate Ethics, anticorruption policy, Compliance & Risk Core values Sustained gas supply independence, reducing import gas Management policies, Delegation of Authority 2025 2024 dependency: optimizing gas production and consumption, Promoting internal Awareness of responsibility for Naftogaz Group common results invest to built new gas reserves and gas production as control framework 2023 well as in gas demand reduction through renewables and Ensuring proper functioning of the internal control system AND OPERATIONS STRATEGY Regular monitoring (self-assessment) of internal controls 2022 energy efficiency 2021 Gain recognition as key player and market maker in the Business divisions are responsible for financial results and implementation of key initiatives aimed at creation of Accountability energy market of Ukraine (highly efficient operating added value for Naftogaz Group 2020 and responsibility model and philosophy) Corporate functions ensure operational excellence of corporate functions, increased service quality and trust by the 2019 stakeholders 2018 Accountability, avoidance of multiple reporting 2017 Speed of Segregation and delegation of powers with regard to decision-making 2016 Reduction in number of decision-making levels across Naftogaz Group decision making 2015 Level of complexity and priority of issues corresponds to the decision-making level 2014 Efficiency and Activities, goals and priorities of corporate functions are based on needs of the business divisions 2013 GOVERNANCE CORPORATE Horizontal and vertical synergies across Naftogaz Group scale of activity 2012 2019/2020 Result orientation and value creation for Naftogaz Group 2011 Operating shared service centers & corporate function at the lowest cost at required service level Monetizing Results Implementation of process-based approach to Naftogaz Group management, standardization and continuous 2010 improvement of business processes by it's owners 2009 2008 Big achievements ДОРОЖНЯROADMAP OFКАРТА TRANSFORMATION ТРАНСФОРМАЦІЇ 2020 НА 2020 2007 Eliminate corruption 2006 Executing of market reforms Transformation components 2020 Plan 2005 Gas independence
2004 RESPONSIBILITY Implement effective operational Develop cooperation principles and rules according to the matrix operating model Independent and modern governance model model Decrease decision-making levels and distribute powers in a clear way 2003 Develop and implement mechanism for escalation controversial issues Win in Stockholm arbitration AND SOCIAL ENVIRONMENTAL 2002 Develop and implement corporate functions TSO unbundling 2001 Implement unified group standards Ensure standardized taxonomy and centralized methodology Gazprom payment and methodologies Regulate and standardize business processes 2000 Develop and implement project management standards / procedures 1999 Transit contract 2020-2024 Transform processes and Supply Chain Management (SCM) Transformation 1998 corporate functions Optimize investment process Evaluate and prioritize risks on an annual basis 1997 Automate business process 1996 Building "new Naftogaz": Ensure effective communication and cooperation based on corporate values 1995 leadership and culture Mobilize and develop the team of leaders (TOP-100) Hold regular communication and feedback session 1994 Build HSE oriented corporate culture pre-2014 1993 Create unified open internal data bases: regulatory, methodical, technical Launch unified internal portal of Naftogaz Group 1992
Constrained Company FINANCIAL OVERVIEW AND STATEMENTS Create center of knowledge and experience exchange 1991
Annual Report 2019 58 Naftogaz Group Annual Report 2019 59 Naftogaz Group INTEGRATED GAS BUSINESS DELIVERY UNIT
THE KEY RESULTS OF THE INTEGRATED GAS and production increase and (2) in the commercial segment – MARKET AND REFORMS BUSINESS DELIVERY UNIT continuing the reform of the gas market and preparation for Estimated depletion level and remaining 2P reserves of Ukrgasvydobuvannya fields as of 01.01.2020 effective entry and operation of supply activities in key- cus — Integrated Gas revenue in 2019 was UAH 114.5 bn, tomer segments after PSO regime abolition and building the 90 UAH 90.2 bn of which was obtained from the supply and commercial organization of Naftogaz Group. sale of natural gas to external consumers. 75 Shebelynske — 2019 EBITDA1 of the business unit amounted to UAH 37.0 bn, with respective EBITDA margin of 32%. HYDROCARBON EXPLORATION AND PRODUCTION 60 — Overall natural gas sales and supply volume by Naftogaz ACTIVITIES Group was 15.7 bcm, 8.0 bcm of which was supplied 45 Zakhidno-Khrestyshchenske to households, 4.5 bcm – to district heating companies (hereinafter DHCs) for household needs, and a further KEY CHALLENGES FOR NAFTOGAZ GROUP IN ITS 30 2.5 bcm was supplied to DHCs for needs of other customer Yablunivske OBJECTIVE TO GROW ITS RESOURCE BASE AND Tymofiyivske Melykhivske segments. PRODUCTION FOR SEVERAL YEARS HAVE BEEN FIELD 15 Yefremivske — Gas imports amounted to 7.2 bcm (including the purchase Berezivske AND OPERATIONS STRATEGY DEPLETION, LIMITED PORTFOLIO OF SPECIAL PERMITS bcm 2P reserves, remaining Estimated of imported gas in underground gas storage facilities), the 0 largest imported volume for the past 5 years. FOR DEVELOPMENT OF NEW FIELDS, AND SIGNIFICANT 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% — Preparations of Naftogaz and other traders for potential TIME AND OTHER COSTS REQUIRED FOR THEIR Depletion level, % termination of gas transit starting from 1 January 2020 DEVELOPMENT. Large (2P reserves > 15 bcm) Medium (2P reserves of 5-15 bcm) Small (2P reserves < 5 bcm) resulted in a reaching record natural gas stock level in 4 large fields (Shebelynske, 4 medium fields (Melykhivske, Tymofiyivske, underground storage facilities of 14.7 bcm as of the In its pursuit to optimize and ensure long-term growth Zakhidno-Khrestyshchenske, Yefremivske, Medvedivske, Berezivske) contain 14% of Small fields contain 30% of beginning of the year. of its resource base and production, Naftogaz Group faces Yablunivske) contain most of Ukrgasvydobuvannya 2P Ukrgasvydobuvannya 2P reserves. Average Ukrgasvydobuvannya reserves. — Trade volume of produced natural gas by serious challenges – those of the current low market price reserves – 56%. Average depletion level is 88% depletion level is 79% Average depletion level is 86% Ukrgasvydobuvannya was 13.6 bcm and production of liquid environment as well as historically accumulated production hydrocarbons reached 481 thousand tons. challenges due to neglect or deliberate impediments for both 69% of Ukrgasvydobuvannya 2P reserves
— In 2019, the business unit kicked off the process of production activities of Naftogaz Group and domestic hydro- Note: For calculation of field depletion levels for 31 December 2019, remaining 2P reserves as of end of 2019 calculated as 2P reserves based on PRMS methodology from the report of DeGolyer and structuring a full-scale Production Enhancement carbons and gas industry: MacNaughton from 1 January 2019 less 2019 gross production volume; initial reserves in place estimated as estimated remaining 2P reserves as of end of 2019 and cumulative production level since the start of production from the field until end of 2019. Picture includes fields that had 2P reserves as of 01.01.2019 according to report by “DeGolyer and MacNaughton” Contract (PEC), the first ever in the oil and gas industry GOVERNANCE CORPORATE of Ukraine, which resulted in signing of the agreement 1High field depletion level, where most of Ukrgasvydobuvan- Source: Report by DeGolyer and MacNaughton as of 1 January 2019 on Reserves and Revenue of Certain Properties with Interests Attributable to Ukrgazvydobuvannya in Ukraine. Data: Ukrgazvydobuvannya with international company Expert Petroleum in April nya’s fields are over 75% depleted and have depressed 2020 aimed at increasing hydrocarbon production on remaining pressure levels , which makes increasing or even Ukrgasvydobuvannya's fields in Western Ukraine, with the sustaining production at these fields challenging. partner committing to invest about UAH 1 bn (or about 2 Formation pressure levels of Ukrgasvydobuvannya USD 30 million) during the first 5 years of partnership. 2Limited portfolio of new fields due to obstacles obtaining Formation pressure — In 2019, Naftogaz Group obtained 14 special permits new special permits . Since 2001, Ukrgasvydobuvannya has Year production for field development via auctions and won the right to received only 160 special permits for new field development Field started Initial Mpa Current Mpa Depletion, % conclude 4 production sharing agreements, 2 of them – in compared to 544 special permits obtained by other companies. Shebelynske 1956 24 2 91% partnership with the Canadian company Vermilion Energy. In the period from 2007 to 2013, Ukrgasvydobuvannya ob- Solokhivske 1961 33 6 81% — Among the most important activities of the team in tained only 4 special permits, while other companies received Mashivske 1962 41 5 88% exploring new sources of resource base increase were 154 special permits. Although since 2014 the situation has Bytkiv-Babchynske 1962 19 4 79% RESPONSIBILITY spudding of Shebelynske 888 well, completion of 3D seismic somewhat improved and Ukrgasvydobuvannya has obtained 45 Kegychivske 1965 30 7 77% interpretation for Svyatohirske field, and ramp-up of efforts new special permits, the timeline required for new field devel- Yefremivske 1967 35 7 80% AND SOCIAL ENVIRONMENTAL to prepare for development of tight gas reservoirs. opment does not allow them to be immediately converted into Opishnyanske 1969 38 6 85% production, even if development is accelerated . Zakhidno-Sosnivske 1969 42 13 68% Integrated Gas Business Unit was established in January Zakhidno-Khrestyschenske 1970 36 5 86% 2019 and linked the entire vertical of activities from hydro- 3The overall depletion of the Dnieper-Donetsk Basin with a de- Lannivske 1971 41 12 71% carbon exploration and production to import, sale, supply, crease in the probability of opening new large traditional fields Melykhivske 1973 40 9 77% and distribution of natural gas. The purpose of creation of the forces Naftogaz Group to consider other possibilities for large- Rozpashnivske 1976 46 4 91% business unit was to establish end-to-end P&L accountability scale expansion of the resource base and production . Tymofiyivske 1978 42 17 59% throughout of the entire gas business value chain. Key objec- Medvedivske 1978 41 7 83% tives set for 2019 included (1) in the hydrocarbon exploration 4Sharp fall in natural gas prices during 2019 and its respective Kotelevske 1978 57 12 78% and production segment - optimizing production in the current impact on the commercial attractiveness of development of Berezivske 1982 64 16 76% 1983 41 9 78% brownfield portfolio and finding new sources of resource base greenfields, in particular sub-scale or inconventional ones. Yablunivske Bilche-Volytske 1991 7 3 57% Skhidno-Poltavske 1995 49 22 56% Komyshnyanske 1995 78 50 35% FINANCIAL OVERVIEW AND STATEMENTS 1 Adjusted EBITDA as defined in Note 3 to the Consolidated Financial Statements Source: Report by DeGolyer and MacNaughton as of 1 January 2019 on Reserves and Revenue of Certain Properties with Interests Attributable to Ukrgazvydobuvannya in Ukraine. Ukrgazvydobuvannya
Annual Report 2019 60 Naftogaz Group Annual Report 2019 61 Naftogaz Group NAFTOGAZ GROUP FOCUSES ON OPTIMIZING PRODUCTION Time-to-gas and field life cycle FROM EXISTING FIELDS WITH SIMULTANEOUS CAPABILITY 114.5 ENHANCEMENT, ATTRACTING PARTNERS, AND INVESTING Obtaining and processing of Field opening and Industrial UAH bn IN NEW OPPORTUNITIES geological information start of operation development Integrated Gas revenue 3 years 5-7 years 38-50 years in 2019 Naftogaz Group's new hydrocarbons exploration and pro- MARKET AND REFORMS 1–2 months 6 months 10–15 years duction strategy is based on the following pillars: Obtaining special permit Environmental impact assessment Initial development 1 year 1 year 20–25 years 90.2 1Focus on managing base production, surface infrastructure Analysis and interpretation of prior Exploration drilling Partial depletion + intensification modernization, and working to improve existing well bank years data. 3–5 years 5 years UAH bn operation Field life cycle Environmental impact assessment Research and industrial development Full depletion obtained from the 1–2 years 1 year Seismic studies Geological evaluation of reserves supply and sale of 2Rigorous selection of new well candidates for drilling from natural gas to external current field portfolio, taking into account geological and tech- Time to first gas production on greenfields is 3–5 years consumers nical risks and potential for production growth Source: Ukrgasvydobuvannya 3Development and implementation of exploration and produc- tion digitization program
15.7 Assessment of potential and development and implementa- History of field discovery in Ukraine Over the past 15–20 years AND OPERATIONS STRATEGY 4 there were no large-scale tion of liquid hydrocarbons production increase program bcm 1000 bcm geological discoveries in overall natural gas Dnipro-Donetsk Basin. sales and supply 5Investments into new opportunities to build resource base Historical data suggest that the probability of large field volume and partnership with industry leaders. 100 bcm discovery is quite low. In 2019, gross natural gas production was 14,892 mcm and trade gas production volume was 13,621 mcm, which was 10 bcm All discovered fields of lower than 2018 levels . To ensure this level of production, Dnipro-Donetsk Basin 7.2 the business unit team had to overcome over 2 bcm of natural All fields of Dnipro-Donetsk decline and losses from well flooding, well downtime, surface Basin discovered over the past 1 bcm bcm infrastructure and other issues. To compensate for natural 20 years natural gas imports decline and losses, teams from Integrated Gas and Technical All fields of Dnipro-Donetsk 100 mcm business units completed 161 well workovers, 736 coiled Basin discovered over the past GOVERNANCE CORPORATE tubing operations, 76 reperforations, and 117 hydro fracking 15 years by private companies Natural gas reserves estimate gas reserves Natural operations. A sidetrack drilling project in partnership with All fields of Dnipro-Donetsk Basin discovered over 10 mcm Halliburton was launched in 2019. the past 15 years by
14.7 year level) at current production + 7 years of (historical production Ukrgasvydobuvannya bcm 1 mcm natural gas stock level in undeground storage as of 0,05 0,2 0,5 1,0 2,0 5,0 10 20 30 40 50 60 70 80 90 95 98 99 99,8 99.99 Probability of respective reserve volume discovery the beginning of 2020 Source: Ukrgasvydobuvannya
Dynamics of new special permit issuance to Ukrgasvydobuvannya and other companies* Dynamics of gross and trade natural gas production volume by Ukrgasvydobuvannya in 2015-2019 RESPONSIBILITY
Area of issued special 18 000 AND SOCIAL ENVIRONMENTAL Number of issued special permits, 83 80 15 251 15 497 permits in 2001-2019 thousands sq. km 16 000 14 528 14 605 14 892 72 13 889 13 785 13 621 14 000 12 819 13 002 Ukrgasvydobuvannya 160 20.5 12 000 55 Other companies 544 66.3 10 000 45 42 43 mcm 8 000 39 6 000 21 22 24 4 000 18 17 18 14 11 13 13 2 000 9 9 8 8 9 8 6 4 4 1 1 3 3 1 0 2015 2016 2017 2018 2019 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Gross production Trade production *As of the date of issue, including research and industrial development with further production of oil and gas FINANCIAL OVERVIEW AND STATEMENTS Source: State Service of Geology and Subsoil of Ukraine, Ukrgasvydobuvannya Source: Ukrgasvydobuvannya
Annual Report 2019 62 Naftogaz Group Annual Report 2019 63 Naftogaz Group In parallel with efforts to sustain production, preventative workover program was developed in 2019, with its implemen- NEW WELLS COMMISSIONED IN 2019 14.9 tation already started in 2020. To develop depleted field management and cost optimi- bcm zation capabilities and to increase production, in 2019 -Naf In 2019, 60 Incremental Gross natural gas togaz Group kicked off the process of attracting a partner for 60 new wells were 504 production from new commissioned into wells commissioned production in 2019 managing a selection of fields in Western Ukraine on terms of MARKET AND REFORMS production enhancement contract (hereinafter PEC). The pro- NEW WELLS production MCM in 2019 was 504 mcm cess of partner attraction, selection, and contracting finished 13.6 in April 2020 with signing of a respective contract with inter- national company Expert Petroleum. bcm This contract became the first ever full-scale Production (PECs). Expert Petroleum’s technical capabilities and expertise production-to-reserve ratio of Ukrgasvydobuvannya at a level Marketable gas Enhancement Contract (PEC) in the history of Ukraine's oil and are focused on fitness-for-purpose, new technologies and above the comparable benchmarks . production in 2019 gas industry, under which Expert Petroleum committed to in- enhanced processes to rehabilitate old wells and reservoirs vest about UAH 1 bn (USD 30 m at the forecast exchange rate) in decline. At present, the company effectively manages During 2019, detailed analysis of geological and technical into intensification measures, drilling, and infrastructure de- production at 25 depleted fields, operates 1,200 wells, and drilling risks was performed to develop the methodology to velopment in the first 5 years of cooperation and, potentially, produces 8.5 thousand barrels of oil equivalent per day. It has consider these risks when selecting and evaluating new well make additional investments in further periods. The contract about 1,000 employees. candidates and allow Naftogaz Group to better select well 161 between Expert Petroleum and Ukrgasvydobuvannya was con- candidates and increase investment returns. With delivery Well workovers cluded for 15 years with the possibility to extend for additional In addition, in 2019 surface infrastructure modernization and commissioning of new drill rigs, the generation of a suffi-
10 years. To fulfill this contract and provide respective ser- program was developed and includes the following components: cient number of economically attractive well candidates to be AND OPERATIONS STRATEGY vices, Expert Petroleum had registered a specialized Ukrainian — Operating pressure optimization measures, including included into the drilling schedule and thus ensure full utiliza- company that was the party to the contract. Naftogaz Group installation of mini-compressors at complex gas treatment tion of the new drill rig fleet became one of the strategic tasks will approve the development plans, annual work program units and construction of pipelines of the business unit . 736 and budget proposed by the operator (Expert Petroleum) for — Modernization of booster compressor stations, in Coiled tubing operations these fields. The operator will receive a fee for supporting particular Chervonodonetsk booster compressor station, Seismic and 3D model development is one of the key areas baseline production (at the level of current operating costs of which pumps ~13% of production volume of in the capability development and upstream digitization effort: Ukrgasvydobuvannya, adjusted for inflation) and for achieving Ukrgasvydobuvannya — Performed 3D seismic works cover overall territory of incremental production increases. Full ownership of the pro- — De-bottlenecking of surface infrastructure 801 sq.km, including Khidnovitske, Zakhidno-Medvedivske, duced hydrocarbons, special permits and respective assets will — New field infrastructure construction and commissioning Kolontaivske, Zakhidno-Volokhivske, Rospashnivske, Bez- 76 remain with Ukrgasvydobuvannya. — Measures to ensure natural gas quality. palivske, and Pivdenno-Bezpalivske areas; Reperforations Expert Petroleum is a French-owned company that is part — 18 3D models built through the joint efforts of the of the GMS holding group, a large investment group with In 2019, 60 new wells were commissioned into production Ukrgasvydobuvannya and Schlumberger teams, with
assets around the world. Expert Petroleum maximizes mature and contributed 504 mcm of production. Among them, eight following reserve revaluation and well parameter update. GOVERNANCE CORPORATE oil & gas field potential by investing in these assets, assuming wells received an initial industrial production rate of gas above 117 responsibility and additional risks to increase production 100 tcm per day. In 2019, the business unit team managed to substantially Hydro fracking operations through long term Production Enhancement Contracts As a result, Integrated Gas team was able to keep the increase production of liquid hydrocarbons. This was the re-
Production enhancement partnership in the Western Ukrainian fields of Ukrgasvydobuvannya Recovery factor* for fields depleted by 70% or more, Ukrgasvydobuvannya and its peers Field locations Key field parameters 9.8% Poland 25 km 8.2% Lviv Number of fields 13 RESPONSIBILITY Natural gas 2P reserves as of 01.01.2019, bcm 15 Skh.-Dovhivske Hrudivske 5.9% AND SOCIAL ENVIRONMENTAL Natural gas production in 2019, mcm 319 Bilche-Volytske Letnianske Number of wells (incl. abandoned wells) 269 4.1% Lugivske Number of active fields 140 3.0% 3.3% Oparske Stryh.-Teisarivske Area, sq. km 386 Average depth, m 880 Dashavske Haivske Depletion, % 81% Komarivske Large fields Medium fields Small fields Kavske (>15 bcm) (5-15 bcm) (<5 bcm) Lubeshivske Note: For calculation of field depletion levels for 31 December 2019, remaining 2P reserves as of end of Other companies Ukrgasvydobuvannya Berezhnytske 2019 calculated as 2P reserves based on PRMS methodology from the report of DeGolyer and MacNaughton from 1 January 2019 less 2019 gross production volume; initial reserves in place Slovakia estimated as estimated remaining 2P reserves as of end of 2019 and cumulative production level *Recovery factor equals to gross annual since the start of production from the field until end of 2019 production volume divided by 2P reserves at the beginning of the year. FINANCIAL OVERVIEW AND STATEMENTS PEC fields Other Ukrgasvydobuvannya fields Other companies’ fields Source: Ukrgasvydobuvannya Source: Ukrgasvydobuvannya, McKinsey & Company
Annual Report 2019 64 Naftogaz Group Annual Report 2019 65 Naftogaz Group Ukrgasvydobuvannya fields, that produce more than 2/3 of total volume
Production in 2019, bcm EASTERN OIL AND GAS REGION
Remaining reserves as of 31.12.20192, bcm Scale 1:400 000 % produced to date out of original reserves 1:550 000 MARKET AND REFORMS
Ukrgasvydobuvannya’s largest fields
New exploration permits in 2014-2019
Borders of Dnieper-Donets basin SUMY WESTERN OIL AND GAS REGION 0.6 REGION 10.5 63% Scale 1:500 000 CHERNIHIV
1.1 Kulychyhynske OGCF 15.4 80% Tymofiyivske OGCF AND OPERATIONS STRATEGY 0.2 0.4 3.4 45% 4.6 81% 0.06 2.3 78% Yablunivske OGCF1 0.3 0.3 91% 0.08 0.2 1.4 2.7 78% 5.2 75% 2.2 89% 1 Komyshnyanske GCF 1 Kotelevske GCF KHARKIV LVIV 0.1 2.1 Solokhivske 1 REGION Svydnytske GCF REGION 2.1 78% Berezivske GCF 74.7 89% 0.1 Yuliyivske OGCF 2.9 47% Opishnyanske OGCF 0.3 0.4 0.2 Hidnovytske GCF 2.9 94% 1.4 91% 1.7 69% GOVERNANCE CORPORATE 4.2 84% 1.0 0.9 32.7 90% 12.5 83% 0.3 0.4 0.5 Sementsivske OGCF Skhidno-Poltavske GCF 6.5 84% 15.9 83% Rozpashnivske GCF Bilche-Volytske GCF POLTAVA Mashivske GCF Melyhivske GCF Vyshnevske GCF REGION Zahidno-Khrestyshchenske GCF 0.1 Lanivske GCF Medvedivske GCF 2.3 95% 4.6 53% Zakhidno ЛУГАНСЬКА 0.8 Sosnivske GCF Yefremivske GCF Kegychivske GCF Shebelynske GCF ОБЛАСТЬ 3.5 91% 0.4 Kobzivske GCF RESPONSIBILITY IVANOFRANKIVSK 62%
4.5 AND SOCIAL ENVIRONMENTAL REGION 0.3 2.9 87% ZAKARPATTIA Bytkiv-Babchynske OGCF 0.4 REGION 2.6 71% 0.4 CHERNIVTSI REGIO DNIPROPETROVSK Note: For calculation of field depletion levels for 31 December 2019, remaining 2P reserves as of end of 2019 calculated as 2P reserves based on PRMS methodology from the report of DeGolyer REGION and MacNaughton from 1 January 2019 less 2019 gross production volume; initial reserves in DONETSK 1 place estimated as estimated remaining 2P reserves as of end of 2019 and cumulative Gas deposits deeper than 5000 m production level since the start of production from the field until end of 2019. Picture includes 2 Estimation based on Ukrainian classification REGION fields that had 2P reserves as of 01.01.2019 according to report by “DeGolyer and MacNaughton” of hydrocarbon reserves and resources FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 66 Naftogaz Group Annual Report 2019 67 Naftogaz Group sult of an increased focus on oil well recovery activities and Preparation for development of tight gas fields improved condensate production management practices. As a In 2019, the team completed interpretation of 3D seismic result, the decline trend in liquid hydrocarbons was reversed for Sviatohirske tight gas field. These works were performed Spudding of Shebelynske 888 well 481 and their volume increased to 481 thousand tons in 2019 vs. by Schlumberger and resulted in identified sweet spots with 449 thousand tons in 2018. In particular, oil production -in highest probability to obtain positive result from drilling and, thousand tons creased by 16%, from 73 to 85 thousand tons. consequently, open the field and its reserve base. Based on In December 2019, Ukrgasvydobuvannya together with Production of liquid this data, Ukrgasvydobuvannya plans to spud two wells in Schlumberger through integrated service provision contract hydrocarbons in 2019 spudded Shebelynske 888 well with project depth of 5,750 meters 2020, one of them spudded in the end of May 2020. MARKET AND REFORMS 85 10 Dynamics of liquid hydrocarbons production by Production sharing agreements and partnership with Shebelynske field: estimated ultimate recovery (EUR) reserves thousand tons Ukrgasvydobuvannya, thousand tons Canada's Vermilion Energy Oil production In 2019, Naftogaz Group participated in and won the right in 2019 Product type 2015 2016 2017 2018 2019 to enter into four production sharing agreements, two of Area: 22 sq. km Area: 51 sq. km Condensat 394 381 389 373 393 them in partnership with Vermillion Energy. I EUR: 22 bcm II EUR: 26 bcm Oil 118 101 80 73 85 Additionally, Naftogaz Group plans to participate in a com- Petroleum bitumen 3 3 2 3 3 petition for the development of offshore fields in the Black Sea.
Source: Ukrgasvydobuvannya
14 New field permits 709 6000
obtained by SUSTAINING BASELINE PRODUCTION, ENHANCING 708 6000 888 5750
Ukrgasvydobuvannya field portfolio Ukrgasvydobuvannya
CAPABILITIES, AND PURSUING PARTNERSHIPS As of 1 January 2020, the field portfolio of Ukrgasvydobu-
via auctions in 2019 н.р AND OPERATIONS STRATEGY
vannya included 201 special permits, 65 of which are special AND INVESTMENTS INTO NEW OPPORTUNITIES IN 707 6000
permits for new fields (greenfields), most of which are at the COMBINATION WILL CREATE A SOLID FOUNDATION 706 6000 710 6000 exploration stage, field infrastructure setup, or have already н.р FOR A STEADY INCREASE IN PRODUCTION AND н.р 801 been put into operation. 14 out of these 65 new field permits RESOURCE BASE AND STRENGTHEN THE NATION’S 712 6000 were obtained by Ukrgasvydobuvannya via auctions in 2019, 711 6000 sq. km ENERGY SECURITY. and by May 2020, it has already started processing and reinter- Area covered by 3D seismic works in 2019 pretation of seismic and drilling data of the prior periods.
Spudding of Shebelynskе 888 well Area: 11 sq. km Spudding of Shebelynske 888 well with depth of 5,750 me- III EUR: 16 bcm 18 ters in December 2019 became a landmark event. If success- 3D field models ful, the well should unlock the potential of the deep horizons developed in 2019 of Shebelynske field. Source: Ukrgasvydobuvannya CORPORATE GOVERNANCE CORPORATE
Composition and status of special permits of Ukrgasvydobuvannya as of 1 January 2020 Sviatohirske field development project
Sviatohirske field Current project status: Brownfields Greenfields Acquired knowledge on permeability, porosity and formation Area – 126 sq. km pressures, performed PLT studies of wells after hydro fracking Area 4,814 sq.km Area 11,393 sq.km gion re kiv Recoverable resources – ar >50 bcm Performed wide-angle 3D seismic works in processing and Kh Depth – 4-5 km interpretation in partnership with Schlumberger 136 65 New well spudded in May 2020 RESPONSIBILITY
9 Production performed, research Knowledge on unconventional hydro fracking AND SOCIAL ENVIRONMENTAL 127 production stage and industrial development technologies: 68% 32% Field / seams discovered, 4 fully depleted 8 field infrastructure setup A range of well completion technologies for multi-stage 201 preparation, intensification and hydro fracking tested additional exploration 15 stages of hydro fracking performed according to the P o new technology and design Geological research works l n 43 ta io g v e a r Scientific polygons, hydrocarbon re k Other fields of gi ns Next steps: 2 on ga Ukrgasvydobuvannya production not allowed Lu
Two exploration wells planned to be spudded in 2020 to Fields of other companies 5 located on temporarily uncontrolled territories 3 unlock the potential of Sviatohirske field
Source: Ukrgazvydobuvannya Source: Ukrgasvydobuvannya FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 68 Naftogaz Group Annual Report 2019 69 Naftogaz Group NATURAL GAS IMPORTS, SALES, SUPPLY, In addition, in 2019, a guaranteed supply of about bcm respectively. The use of natural gas by DHCs for other con- AND DISTRIBUTION ACTIVITIES 0.9 bcm of natural gas through Q1 2020 was contracted sumer categories increased, in particular due to increase in gas to cover potential peaks in consumption and avoid usage as a resource for electricity generation. Meanwhile, market exceeding technical limits for gas withdrawal from under- inefficiencies and structural problems of the sector lead to lack 21.9 THE KEY CHALLENGE IN THE AREA OF NATURAL GAS ground storage. of progress in resolving the issue of indebtedness of RSCs and bcm IMPORT ACTIVITIES HAS BEEN TO PREPARE FOR A DHCs to Naftogaz Group. As of the end of 2019, the total debt to accumulated in Ukrainian POSSIBLE CRISIS AND SHORTAGE IN THE GAS MARKET Naftogaz of Ukraine of RSCs for gas supplied for household needs underground storage FROM JANUARY 1, 2020, IN CASE OF TERMINATION THE KEY CHALLENGES TO EFFICIENT SUPPLY, SALE amounted to UAH 28.1 bn, while debt of DHCs was UAH 30.4 bn. MARKET AND REFORMS facilities as of 1 Nov. 2019 OF NATURAL GAS TRANSIT FROM THE RUSSIAN AND DISTRIBUTION OF NATURAL GAS TO REGULATED The issue of household indebtedness remains relevant. 28.1 FEDERATION TO EUROPE THROUGH UKRAINE. CONSUMER SEGMENTS ARE CONTINUATION OF PSO REGIME, LIMITED COMPETITION IN THE NATURAL GAS UAH billion In the beginning of 2019, Naftogaz Group assessed the SUPPLY SEGMENT, FORMAL SEPARATION OF SUPPLY RETAIL NATURAL GAS SUPPLY BUSINESS debt of regional scenario of discontinuation of gas transit through Ukraine AND DISTRIBUTION ACTIVITIES IN MOST REGIONS OF DEVELOPMENT supply companies starting from January 1, 2020 and the country's gas demand THE COUNTRY, AND STRUCTURAL PROBLEMS IN HEAT for passing the heating season in case of inability to import Currently, the Gas Supply Company Naftogaz of Ukraine LLC SUPPLY SEGMENT. gas in the first quarter of 2020 at the level of previous peri- (hereinafter GSC Naftogaz of Ukraine) is the only subsidiary of ods. The most conservative scenario assuming a temperature Naftogaz Group operating in the retail gas supply business. Now drop to the minimum level of the previous five years was In its commercial activities, Integrated Gas Business Delivery most of its customers are located in Kirovograd region. Naftogaz 30.4 also evaluated. To mitigate potential crisis, nearly 22 bcm Unit focused on systemic work to overcome challenges associat- Group sees further development in rolling out retail supply busi- of natural gas were accumulated in Ukrainian underground ed with the fulfillment of PSO obligations of Naftogaz Group to ness to all other regions of Ukraine. Retail gas supply business de- UAH billion storage facilities as of November 1, 2019, of which 16.8 bcm supply natural gas to households (through regional supply com- velopment is defined as direct natural gas supply to households debt of district heating was natural gas of Naftogaz Group – the highest level of gas panies (hereinafter RSCs)), DHCs and some other categories. as well as to small and medium business customers. Entry into AND OPERATIONS STRATEGY companies stocks in the last 5 years. The volume of natural gas imported While in pre-2019 periods, the PSO price had always been retail supply business will give Naftogaz Group the opportunity by Naftogaz Group reached a record 7.2 bcm, including 0.5 substantially below the market price of natural gas, in 2019 due to provide quality service, better understand household needs, 388 bcm purchased in underground storage, which allowed for a to the steep decline in price levels, this gap disappeared. Due to and develop a product portfolio that will ensure the most optimal mcm in delay payment for supplied gas. As a result, the accumu- mild climatic conditions, the total volume of natural gas supply to satisfaction of those needs in an economically sustainable way for gas trade volume on lated natural gas in underground storage exceeded the 2018 households and DHCs for household needs, by Naftogaz Group both parties, as well as payment discipline and operating stability UEEX in 2019 level by 4.7 bcm . decreased from 10.6 bcm to 8.0 bcm and from 4.8 bcm to 4.5 of the segment.
Production sharing agreements and partnership with Vermilion Energy A supply crisis was avoided but Naftogaz Group was ready for it
13 bcm of natural gas was injected in UGS… …that allowed to accumulate the highest storages stocks for the last 5 years
bcm bcm GOVERNANCE CORPORATE 21.9 1.0 22.0 20.8 2.0 2.0 Production sharing agreement (PSA) Partnership of Naftogaz Group and Vermilion Energy: 2.0 17.2 competition results: 2.0 16.1 3.0 Number of field plots with obtained right to go into PSA: Vermilion Energy is an international oil & gas company, 9.0 1.0 4 (Balakliyska, Ivanivska, Berestyanska, Buzivska), headquartered in Calgary, Canada, with its shares listed on including 2 (Balakliyska and Ivanivska) jointly with Canadian New York and Toronto Stock Exchanges. The company has company Vermilion Energy significant experience in developing unconventional reserves. 7.7
Ukrgasvydobuvannya and Vermilion Energy signed an agreement to RESPONSIBILITY Total area of plots: 2 917 sq. km jointly apply for PSA competition on the following terms: Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Regions: AND SOCIAL ENVIRONMENTAL Poltava, Kharkiv, Lviv, Ivano-Frankivsk Investment and profit split - 50/50%
Total guaranteed investment amount: UAH 3.6 bn Vermilion Energy will be the operator at work program preparation average 2014-2018 2018 2019 and exploration stage Minimum number of wells: 12 wells Ukrgasvydobuvannya has preferential right to offer its products and Purchase of import gas Purchase of import Purchase of natural Purchase of import Start of production: in 2-3 years after singing services for the tenders conducted by Vermillion Energy of PSA agreement in delivery month gas in storages gas on internal market gas in Q1 2020 Objectives of Naftogaz Group in partnership with Vermilion Energy: Potential production: up to 2 bcm/year in 2025 was bought was bought was bought Sharing investments and risks 6.8 bcm purchased 0.5 bcm in UGS 27 mcm on UEEX 0.9 bcm with supply in Q1 Expected singing of PSA agreement: summer 2020 2020 Leveraging experience of Vermillion Energy in development and Individual December delivery cheaper UA Border delivery point
management of unconventional reservoir fields transfer of 300+ contracts 2019 – Q1 2020 period 10+ USD/tcm than import was changed to know-how) guarantee supply The most impressive import New mechanism of purchase Naftogaz added a new source Additional source to cover Obtaining capacity and resources (financial, technical etc.) for for last 5 years of gas (local production) peak demand in Q1 2020
developing of several plots simultaneously FINANCIAL OVERVIEW AND STATEMENTS Source: Ukrgasvydobuvannya Source: Naftogaz Group
Annual Report 2019 70 Naftogaz Group Annual Report 2019 71 Naftogaz Group Meanwhile, Naftogaz Group will work on eliminating legisla- the heating season have to be covered from the budget with a tive and regulatory barriers preventing from entering and operat- respective decrease in subventions to local budgets where the LLC (hereinafter Naftogaz Trading) grew its share in the total Pricing. Traditionally, natural gas prices were set at UEEX by ing in the retail gas supply segment. This includes simplification indebted DHCs operate. In case the required contract is not con- trading volume from 0% to 38% over the period of July-Decem- private gas producers, domestic and international traders, of the household supplier switching procedure through reduction cluded, NJSC Naftogaz of Ukraine will not have any grounds to ber 2019. In annual terms, the share constituted 32%, which is a and the key factor influencing Ukrainian market gas price of the administrative burden, allowing new suppliers to act on continue supply, hence the supply should be discontinued by the record increase for UEEX. From the beginning of participation in was European market quotations. In a situation when do- behalf of the consumer in the process of supplier switching, distribution system operators. Thus, the responsibility for natural trade auctions (October 23, 2019) to the end of 2019, GSC Naf- mestic market prices fell below import parity level, supply for removing any obstacles regarding unresolved issues between the gas supply payment level by the DHCs will be with the local au- togaz of Ukraine increased its share in UEEX trade volumes from UEEX auctions was limited and its volume decreased. How- consumer and the previous supplier to allow the new supplier thorities, which will have all the necessary instruments and levers 0 to 20% (8% in annual terms). In the context of trading activities ever, the start of daily auctions by Naftogaz Trading became MARKET AND REFORMS to successfully start service provision. For effective operation in to exercise the appropriate control. at UEEX, the overall 2019 share of Naftogaz Group companies another important price factor. Daily auctioned supply by the segment, it is also important to ensure that regional gas dis- reached 40%. Naftogaz Trading offering products with different delivery tribution companies provide information on historical gas con- THE KEY OBJECTIVE OF NAFTOGAZ GROUP IN THE In the future, Naftogaz Group aims to create a stable market periods created additional liquidity in the market and be- sumption by the consumer on a free basis with the creation of a UNREGULATED SEGMENT IS ACTIVE PARTICIPATION IN position by concluding long-term contracts with local producers came an indicator for private participants. At the same time, database of such information for consumers. DEVELOPMENT OF LIQUID NATURAL GAS MARKET. and optimizing the volume of imports, and the supply (sell) side, the entry of GSC Naftogaz of Ukraine as a buyer in auctions using flexible payment terms and market competence to attract enabled UEEX to increase transparency to the process of customers. setting market prices. RESOLVING SYSTEMIC CHALLENGES IN THE HEATING Natural gas trade and supply in the unregulated segment of Currently, Naftogaz Trading is performing the role of mar- SUPPLY SEGMENT the Ukrainian market are characterized by low liquidity and trans- ket maker in the natural gas segment, i.e. natural gas selling parency. The dominant part of gas sales to industrial consumers CASE STUDY: NAFTOGAZ GROUP IMPACT ON UEEX price of the company is a significant reference point for other In 2019, heating producers remained the most problema- tic is done under bilateral agreements, and 2018 trade volume on ACTIVITY TRADING VOLUMES participants. group of customers of Naftogaz Group. A substantial part of the the most active trading platform, the Ukrainian Energy Exchange In 2019, Ukraine's position in the European gas hubs maturity negative inbalances indebtedness of gas distribution system (hereinafter UEEX), was mere 155 mcm, or Trading volumes. Start of operation by Naftogaz Trading and assessment chart increased by 3 positions, with Ukraine ranked operators (DSOs) was caused by low payment discipline of this 2% of consumption by industrial enterprises of Ukraine. Because GSC Naftogaz of Ukraine on UEEX resulted in increase in natural higher than Bulgaria, Portugal and Slovenia . AND OPERATIONS STRATEGY category of consumers, and the problem of accumulation of such of the insignificant trade volumes at UEEX, participants of the gas trade volume in 2019 by 2.5 times – from 155 mcm debts has remained unresolved since 2015. trading platform could influence the daily price index, which to 386 mcm . At the same time, Naftogaz Group continues to work on made using the UEEX price as a proper fully-fledged market indi- BUILDING HIGH PERFORMANCE COMMERCIAL mechanisms to ensure the reliable supply of gas to Ukrainian cator not possible. Competition. Participation of Naftogaz Trading and GSC Naftogaz ORGANIZATION AND CAPABILITIES IN NATURAL DHCs. In October 2019, Naftogaz Group came out with a propos- In order to create the required level of liquidity at UEEX, en- of Ukraine was of great importance for the increase of participant al to resolve the issue in question. hance competition, increase transparency in the setting of natu- activity and reviving competition on UEEX. Naftogaz Trading came GAS TRADING AND SUPPLY The proposed mechanism envisages obliging NJSC Naftogaz ral gas market prices, and mitigate possible price manipulations out 229 times with starting positions. 48% of 252 mcm of natural In 2019, Integrated Gas Business commercial team developed of Ukraine to cover full offtake volume for heating producers, in the gas market of Ukraine, in 2019, Naftogaz Group started gas put up for auction was sold. This is the highest rate of effec- and started using new instruments to model market dynamics even for those not able to meet minimum settlement level re- trading activities at UEEX. tiveness of starting positions among participating companies. In and build price forecast . quirement, under the PSO obligation. However, debts of those Having started operations of buying and selling gas through UEEX’s buying segment, GSC Naftogaz of Ukraine took a leading Strategic initiatives to develop commercial competency for heating producers that have not paid for supplied gas by end of the UEEX on July 5, 2019, Gas Supply Company Naftogaz Trading position in competition with other sales and supply companies. 2020 are the following: CORPORATE GOVERNANCE CORPORATE
UEEX liquidity increase and role of Naftogaz Group 17 Maturity assessment for selected European hubs in 2019
UEEX trade volume in 2018-2019 Monthly UEEX trade volume National Liquidity regulatory Total Change mcm mcm Market Hub index* party index TSO index authority index score** comparing to 2018
86 UK-NBP 10.0 10.0 10.0 10.0 10.0 - +149% NL-TTF 10.0 10.0 9.1 9.2 9.6 - 386 DE-NCG 7.5 10.0 8.2 8.3 8.5 - RESPONSIBILITY 55
54 AND SOCIAL ENVIRONMENTAL HU-MGP 0.0 6.9 9.1 5.0 5.3 +0.5 47 235 37 38 SK-VTP 0.0 6.2 8.2 2.5 4.2 +0.2
155 29 PL-VTP 0.0 4.6 7.3 4.2 4.0 - 79% 16% 32% Україна 0.0 0.0 4.5 5.0 2.4 +0.9 14 14 54% 155 (122) 8 51% 33% RO-VTP 0.0 0.0 4.5 3.3 2.0 +0.7 4 24% 2% 8% (29) 1 4% 2018 2019 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec *10 – if annual spot trade volumes >150TWh and annual forward trade volumes >2000TWh, 7,5 – if the indices in question constitute respectively 150-50 TWh and >2000 TWh OR >150 TWh and 2000-1000 TWh, 5 – if the indices in question constitute respectively >150 TWh and <1000 TWh OR 150-50 TWh and 2000-1000 TWh OR <50 TWh and >2000 TWh, 2,5 – if the indices in question constitute respectively 150-50 TWh and <1000 TWh OR <50 TWh and 2000-1000 TWh. **Indices were evaluated within the 10-0 range, where 0 – a poor development, 10 – an advanced development; the total score is calculated as the arithmetic average of all indices: the score is ≥ 7 points – blue field, the score is > 3, Other participants Naftogaz Trading GSC Naftogaz of Ukraine but < 7 points – grey field, the score is ≤ 3points – white field.
Source: UEEX, own calculations Source: European traded gas hubs: a decade of change. July 2019. The Oxford Institute for the energy studies (OIES), EFET 2019 Gas Hub Benchmarking Study, own calculations FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 72 Naftogaz Group Annual Report 2019 73 Naftogaz Group 1Launch of a fundamental model for forecasting and market By 2019, Integrated Gas Business Unit team completed the analysis tasks assigned to it in building an integrated approach to managing Hydrocarbon reserves and resources of Naftogaz Group Competence of modeling key factors (demand, supply, gas the efficiency and profitability of Naftogaz Group’s gas business. transportation system limits, etc.) in the short- and long-term, However, the range of strategic priorities in front of the business affecting business of Naftogaz Group, and generation of commer- unit and level of complexity continued to increase. On the one Hydrocarbon Hydrocarbon Source: cial insights. hand, Naftogaz Group has to focus on further building a strong Natural gas, liquids, Natural gas liquids For Ukrgasvydobuvannya: Report as of January 1, 2020 on Reserves and Revenue of Certain Properties with Interests commercial organization, rolling out of the retail supply business, bcm million t (MMboe) (MMbbl) Attributable to JSC Ukrgasvydobuvannya in Ukraine PRMS 2Launch of an energy trading and risk management system and solving the structural and regulatory issues of the natural gas Case (for proved and probable reserves) and Report as of MARKET AND REFORMS (ETRM) market. On the other hand, Naftogaz Group should also actively Naftogaz July 1, 2019 on the Prospective Resources and Potential Present Worth Associated with Various Prospects with Competence of quickly identifying and highlighting daily pricing build geotechnical capabilities, improve field management efficien- proven developed - - - - Interests Attributable to JSC Ukrgasvydobuvannya in risks, organizing trade and supply chains, as well as displaying eco- cy, and expand the reserve base. proven undeveloped - - - - Various License Blocks Ukraine (for prospective resources, nomic results of market activities. ETRM will allow for creation of a Taking into account the above-mentioned factors, in April reported under 2U (P50) estimate basis) by DeGolyer and probable - - - - MacNaughton. single database for all natural gas transactions, facilitate real-time 2020, the executive board of Naftogaz decided to divide the Inte- produced - - - - For Ukrnafta: Report as of April 1, 2019 on Reserves and portfolio management, and support re-engineering and automa- grated Gas Business Delivery Unit into two – the Exploration and Revenue and Contingent Resources of Certain Properties reserves increase - - - - tion of gas trading processes. Production business unit and the Commerce business unit. with Interests Attributable to PJSC Ukrnafta in Ukraine Reserves as of 31.12.2019 - - - - PRMS Case by DeGolyer and MacNaughton. Production data are provided for period from April 1, 2019 to Prospective resources December 31, 2019 and and hydrocarbon reserves increase as of 31.12.2019 34.96 1.31 205.75 9.52 data are for year of 2019 and both are based on non-PRMS management data. Prospective resources as of 31.12.2019 Launching new instruments for regular modeling & market forecast including prospective resources have been provided by Ukrnafta management, are based in United Forces Operation zone on Ukrainian classification standards and have not been Description Model configuration Future steps and temporarily occupied areas audited under PRMS. For Naftogaz Group assets in AR of Egypt: NJSC Naftogaz of Donetsk and Luhansk regions 34.96 1.31 205.75 9.52 of Ukraine Branch in Arab Republic of Egypt Estimated AND OPERATIONS STRATEGY New approach for forecasting Inputs Outputs Solver improvement Future Reserves and Income Attributable to Certain was introduced mid of 2019 (neuro-network, Ukrgasvydobuvannya Interests Escalated Parameters as of March 31, 2018 and KNIME solver) proven developed 180.95 3.44 1 065.05 30.32 NJSC Naftogaz of Ukraine Branch in Arab Republic of Egypt Starting/current level of USG Scenario analysis based on Estimated Contingent Resources and Income and different weather, import, Consumption / Withdrawal Technological gas consumption Testing different data proven undeveloped 26.37 0.61 155.25 5.13 Prospective Resources Attributable to Certain Leasehold production cases Interests in the Territory of Alam El-Shawish East Area, in Forecast based on 5Y average (daily rate based on historical data sources (temperature, probable 47.06 0.85 276.98 7.35 +expectations) Western Desert in Arab Republic of Egypt Escalated Forecasted level of USG consumption produced - - - - Parameters as of March 31, 2018 by Ryder Scott Company, Internal production (historical daily forecast) L.P. Production and reserves increase are provided for the Consumption / Withdrawal SOLVER reserves increase - - - - Forecast based on Monte Carlo rate + updated production profile) Withdrawals forecasts (with period of April 1, 2018 to December 31, 2019 and are based Creating model for IG Reserves as of 31.12.2019 254.39 4.91 1 497.28 42.81 on non-PRMS management data. Prospective resources Model Monte- Carlo the points of possible Consumption (insensitive breaking technical limits) buy-sell side forecast and reserves increase is estimated based on share of consumption for Industrial and simulation Prospective resources Naftogaz Group in assets. Import is based on Technical as of 31.12.2019 96.12 3.11 565.77 22.69 sensitive heating consumption) Regression Mid and Long-term forecast For Naftogaz: NJSC Naftogaz of Ukraine, PJSC Limit / Withdrawal ratio Ukrgazvydobuvannya NJSC Naftogaz of Ukraine Branch in Temperature (historical 5Y analysis Ukrnafta Arab Republic of Egypt Estimated Future Reserves, avr. + °C forecast for nearest Resources and Income Attributable to Certain Interests
Model is a universal instrument 14 days) proven developed 9.30 12.34 67.88 90.08. and Derived Through a Concession Agreement Escalated GOVERNANCE CORPORATE for Ukrainian balance forecast proven undeveloped 5.04 4.90 36.78 35.77 Parameters as of December 31, 2014 by Ryder Scott Company, L.P. In 2017, the State Geologicals and Subsurface probable 11.37 10.30 83.02 75.17 Service of Ukraine annulled the special permits for the produced 0.87 1.13 6.36 8.28 use of the subsoil and the right of Naftogaz to develop Mid-term model example Long-term model example Budyschansko-Chutivska, Obolonska and Pysarivska areas, reserves increase 0.05 0.19 0.39 4.30 hence reserves of Naftogaz equal zero as of year-end Reserves as of 31.12.2019 24.89 26.99 181.71 197.04 2019. Numbers for Naftogaz do not include data for special 250,0 Gas balance for the 2019-2020 250,0 Gas balance for the 2020-2021 permits in the Black Sea and the Sea of Azov, control of heating season as of 06.12.2019 heating season as of 06.12.2019 Prospective resources which was lost due to annexation of the Autonomous 200,0 200,0 as of 31.12.2019 48.10 67.42 351.10 492.19 Republic of Crimea. For PRMS audited reserves and resources, ratios to 150,0 150,0 convert volumes of liquid hydrocarbons from metric tons Naftogaz Group assets into barrels, as wells as ratios to convert natural gas 100,0 100,0 in Arab Republic of Egypt volumes from cubic meters into barrels of oil equvivalent proven developed 0.15 0.25 0.88 1.86 were identified by auditors according physical properties mcm mcm
50,0 50,0 of hydrocarbon fluids. For Ukrgasvydobuvannya, ratio of RESPONSIBILITY proven undeveloped 0.00 0.02 0.01 0.15 6,000 cubic feet of gas per barrel of oil equivalent is used 0,0 0,0 probable 0.06 0.16 0.38 1.17 for conversion purposes. For Ukrnafta, 7.30 ratio is used to convert 1 thousan cubic meters of natural gas or 1 ton of AND SOCIAL ENVIRONMENTAL -50,0 -50,0 produced 0.11 0.16 0.65 1.17 condensate or oil into barrels (of oil equivalent). For reserves increase 0.14 0.08 0.83 0.62 Naftogaz Group assets in AR of Egypt, 7.33 ratio is used to do conversion between tons and barrels for oil and 23.11.19 21.12.19 Reserves as of 31.12.2019 0.25 0.36 1.44 2.62 condensate. For Naftogaz, 7.28 ratio is used to do 09.11.19 18.01.20 07.12.19 01.11.20 14.03.20 15.02.20 26.10.19 01.01.21 01.02.20 04.01.20 01.12.20 29.02.20 01.10.20 01.03.21 28.03.20 01.04.21 01.02.21 01.07.20 01.05.20 01.03.20 01.04.20 01.04.20 01.09.20 01.08.20 Prospective resources conversion between tons and barrels for oil and condensate. Technical limit Withdrawals Monte-Carlo model withdrawal Technical limit Monte-Carlo model withdrawal as of 31.12.2019 0.38 1.18 2.22 8.64
Source: Ukrgasvydobuvannya, open sources Naftogaz Group proven developed 190.40 16.29 1 133.81 122.26 proven undeveloped 31.41 5.53 192.04 41.06 probable 58.50 11.31 360.38 83.69 produced 0.98 1.29 7.01 9.45 reserves increase 0.19 0.67 1.22 4.92 Reserves as of 31.12.2019 279.52 32.26 1 680.43 242.47 Prospective resources FINANCIAL OVERVIEW AND STATEMENTS as of 31.12.2019 144.60 71.71 919.08 523.52
Annual Report 2019 74 Naftogaz Group Annual Report 2019 75 Naftogaz Group processing, liquid hydrocarbons extraction, and LPG production assets of JSC Ukrgazvydobuvanya into its SOLVING THE PROBLEM OF LOW-QUALITY OIL perimeter. A network of condensate pipelines with total length of more than 700 km was also transferred to the OIL MIDSTREAM Ukrtransnafta and perimeter of the OMD Business Delivery Unit. ◦ As a trading capability development effort, in October Transneft reached agreement on 2019, OMD team established a specialized company, compensation for the entry of high organochlorine content oil Naftogaz Oil Trading LLC, for the purpose of purchasing 104 MARKET AND REFORMS AND DOWNSTREAM into the Ukrainian section of the and selling hydrocarbons and fuel products in the interests UAH MILLION Druzhba pipeline of all companies of Naftogaz Group as well as perform- ing independent trading activities. At the start of 2020, BUSINESS DELIVERY UNIT Naftogaz Oil Trading LLC entered into an agreement with BNK-Ukraine to supply 120,000 tons of diesel fuel pro- duced by Belarus refineries in February-November 2020. of forcing out Russia’s high organochlorine content oil from the Ukrainian section of the Druzhba pipeline. Moreover, JSC KEY RESULTS OF OIL MIDSTREAM AND The OMD Business Delivery Unit was created in January Ukrtransnafta and PJSC Transneft reached agreement on DOWNSTREAM BUSINESS DELIVERY UNIT: 2019 and combined the following activities: transit and trans- compensation for the entry of high organochlorine content oil portation of oil and LPG; processing of natural gas and liquid into the Ukrainian section of the Druzhba pipeline. This covered 12.0 — In 2019 the revenue of Oil Midstream and Downstream hydrocarbons; sale and trade of liquid hydrocarbons, fuel the shortfall in income caused by the temporary suspension of Business Delivery Unit (hereinafter OMD or OMD Business products, LPG and compressed natural gas. OMD includes transit in April – May 2019. JSC Ukrtransnafta received more UAH bn Delivery Unit) was UAH 12.0 bn. activities of JSC Ukrtransnafta, JSC Ukrspetstransgaz, a branch than UAH 103 million worth of compensation over the
The revenue of the OMD — EBITDA value was UAH 1.1 bn with a margin of 10%. of the Gas and Gas Condensate Processing Department of timeframe from May 2019 till January 2020. AND OPERATIONS STRATEGY Business Delivery Unit — Key results of the transit and transportation of oil and JSC Ukrgazvydobuvannia, SE Ukravtogaz, and Naftogaz Oil in 2019 LPG (Oil Midstream segment) in 2019 were the following: Trading LLC. Conclusion of new transit agreement with PJSC Transneft ◦ Oil transit in 2019 was 13.1 million tons, which is 1.6% The key objective of the business delivery unit is to achieve In addition to the contract on natural gas transit through less than 2018; synergies through optimization and development of oil related Ukraine between NJSC Naftogaz of Ukraine and PJSC Gazprom, 1.1 ◦ JSC Ukrtransnafta concluded a new 10-year agreement assets of Naftogaz Group. In 2019, the OMD Business Delivery another contract covering crude oil transit which had been in with Russia’s PJSC Transneft for oil transit through Unit focused (1) on maintaining existing positions, in particular place between JSC Ukrtransnafta and Russia’s PJSC Transneft UAH bn Ukraine. This allowed to ensure the utilization of trunk in the oil transit business, and identifying new opportunities since 2005, was due to expire at the end of 2019. Performing EBITDA oil pipelines and sustain the company’s stable earnings in to increase pipeline utilization and transportation volumes operations under this contract ensured the financial stability foreign currency; in the Oil Midstream segment, and (2) on development and in the Oil Midstream segment due to the significant stable ◦ Successful resolution of issues related to low-quality and operational use of the target processing and refining volumes for utilization of the oil pipeline system and the oil from the Russian Federation entering the oil asset perimeter, diagnostics of processing and refining assets, euro-denominated tariff for transit services. In 2019, revenue 13.1 transportation system of JSC Ukrtransnafta was an and strategic initiatives for the development of refining and from oil transit services accounted for 90% of the total million tons important result of 2019. commercial capabilities in Oil Downstream segment. revenue of the Oil Midstream segment. GOVERNANCE CORPORATE — Key results of liquid hydrocarbons and natural gas During autumn 2019, JSC Ukrtransnafta and PJSC Trans- Oil transit in 2019 processing and sale of fuel products, LPG and compressed neft conducted negotiations, including within the framework + natural gas (Oil Downstream segment) in 2019 were the TRANSIT AND TRANSPORTATION OF OIL AND LPG of events organized by the International Association of Oil 13% following: Transporters, during which the current state of cooperation The volume of domestic ◦ In 2019, OMD completed the transfer of all processing In 2019, the last year of the previous 15-year contract between JSC Ukrtransnafta and PJSC Transneft and further oil transportation in 2019 assets, oil and condensate stabilization and gas between JSC Ukrtransnafta and Russian JSC Transneft, oil plans were discussed. As a result, an additional agreement transit through Ukraine amounted to 13.1 million tons, was concluded, which ensured the extension of oil transit for which was 1.6% less than in 2018. The decrease of transit the following 10 years. volumes occured due to problems caused by the entry of low- Volume of oil transit and domestic transportation quality oil into the oil pipeline system of JSC Ukrtransnafta, Diversification of sources and routes of oil transit and which triggered interruptions of transit in April-May 2019. The transportation 16 volume of domestic oil transportation increased by 9,5% from Ukraine’s oil transportation infrastructure (in particular, RESPONSIBILITY 13.8 13.9 2.2 million tons in 2018 to 2.4 million tons in 2019. the Odesa-Brody pipeline) was recognized as the most eco- 14 13.3 13.1 nomically feasible, fastest, and reliable delivery route for AND SOCIAL ENVIRONMENTAL 12 Solving the problem of low-quality oil entering the oil Caspian oil to customers in Belarus. In 2019, Belarus began to pipeline system of JSC “Ukrtransnafta” implement initiatives aimed at diversification of sources and 10 In spring 2019, there were several interruptions of routes of importing raw materials for processing at its own oil transit through the oil transportation system of Ukraine. facilities. In October 2019, the Ukrainian and Belarusian par- 8 On April 19, 2019, OJSC Gomeltransneft Druzhba (Belarus) ties, at the highest official level, started a dialogue regarding 6 informed JSC Ukrtransnafta of the entry of oil with degraded transporation of Azeri Light oil to the Mozyr refinery in Belar- million tons quality indicators from the technological section of the trunk oil us via Ukraine. On March 2, 2020, JSC Ukrtransnafta signed a 4 pipeline of JSC Transneft-Druzhba (Russian Federation). framework agreement with BNK (UK) Limited, a subsidiary of 2.1 2.0 2.4 2 1.4 A similar situation occurred in May 2019. To fix this issue, tran- CJSC Belarusian Oil Company. At the same time, the parties sit of oil from the Russian Federation through the territory of agreed that the actual volumes of oil for transportation and 0 Ukraine was suspended during April 25 to May 11, 2019 and the cost of services will be further agreed by signing relevant 2016 2017 2018 2019 May 17 to May 21, 2019. At the same time, operation of certain additional agreements to the framework agreement. In March storage reservoirs of JSC Ukrtransnafta and one of the sections 2020, JSC Ukrtransnafta received three oil tankers at Pivdenny Oil transit Oil domestic transportation of Druzhba oil pipeline was blocked due to low quality oil. On sea oil terminal for transportation of oil with a total volume of FINANCIAL OVERVIEW AND STATEMENTS Source: Ukrtransnafta January 18, 2020, JSC Ukrtransnafta completed the process more than 260 thousand tons.
Annual Report 2019 76 Naftogaz Group Annual Report 2019 77 Naftogaz Group In 2019, the volume of liquid hydrocarbon processing Increasing of LPG and other gas product at Shebelynske plant (Shebelynske Unit for Gas Condensate SALE 0F CNG BY SE UKRAVTOGAZ transportation volume and Oil Preparation of JSC Ukrgasvydobuvannya) increased In 2019, JSC Ukrspetstransgaz, which is part of the to 473 thousand tons, compared to 454 thousand tons in 473 In 2019, for the first time OMD Business Delivery Unit, increased the volume of 2018. The total volume of processing, including additives and thousand tons transportation of liquefied hydrocarbon gases and other components, amounted to 498 thousand tons, which is in many years CNG sale through SE Ukravyogaz products by more than 60%, reaching 475 thousand tons 16.7 thousand tons or 3.5% higher than in 2018. the volume of liquid CNG station network compared to 295 thousand tons in 2018. The key factor The extraction rate of light petroleum products was MARKET AND REFORMS hydrocarbon processing at + grew year-on-year Shebelynske plant behind this increase was the growth in volume of trans- 89% compared to 86% achieved in 2018. The production 4% portation of light hydrocarbons from Belarus and the Baltic of motor fuels increased: gasoline volume increased States. In particular, delivery of isopentane fraction from to 149 thousand tons (18.5 thousand tons or 14.1% higher Belarus for the needs of JSC Ukrgazvydobuvannya was per- than in 2018); diesel fuel volume increased to 498 formed via agreements concluded in 2018. LLC Karpatnafto- 88.3 thousand tons ( 3.2 thousand tons or 3.8% higher than thousand tons him, the key client of JSC Ukrspetstransgaz in the domestic in 2018). A decrease by 12 thousand tons or 7.4 % was trend of declining sales of compressed natural gas (hereinafter market, maintained stable production volumes, engaging the observed in LPG production at the production facilities of JSC CNG) and achieved a 4% increase in sales, as well as of total processing volume tank railcar fleet of JSC Ukrspetstransgaz to meet domestic Ukrgasvydobuvannya to equal 153 thousand tons, is explained implementing a number of measures to improve operational needs. by the reduction of the gas condensate factor. and commercial efficiency. In 2019, the OMD Business Delivery Unit sold 528 thousand tons of fuel products and LPG to external customers + HYDROCARBON REFINING AND SALE OF FUEL (518 thousand tons in 2018). At the same time, a total volume Transformation of Ukravtogaz and prospects for the use of 14.1% PRODUCTS, LPG AND COMPRESSED NATURAL GAS of 57 thousand tons of oil products (mainly diesel fuel) was methane transport in Ukraine increase in gasoline shipped to internal consumers, primarily to the Technical SE Ukravtogaz performs the production and sale of CNG AND OPERATIONS STRATEGY volume 2019 was a year of operational integration of fuel Business Enabling Unit to supply the operations of its drill and through a network of its own automobile gas-filling compres- products and LPG production activities. Throughout the year, workover rig fleet. sor stations (hereinafter CNG stations). The CNG network the perimeter of the OMD Business Delivery Unit, which The vast majority of diesel, gasoline and LPG was sold at has 90 CNG stations (including 9 CNG stations located in + at the time of creation of the business unit included three the Ukrainian Energy Exchange, while in 2019 the total volume temporarily uncontrolled territory). 3.8% key assets – Shebelynske Gas Processing Plant (hereinafter of just 13,000 tons of fuel products and LPG was sold through For many years, sales of CNG in the country and SE increase in diesel fuel Shebelynske plant), Technological Condensate Stabilization the own gas station network. The reformate, benzene-contain- Ukravtogaz have been declining. This trend was caused volume Shop Bazylivshchyna, and Yablunivske Gas Treatment Unit – ing fraction and fuel oil were mainly exported. by a number of external factors, primarily aging and was extended through the transfer of four additional Gas decommissioning of the vehicle fleet with methane gas Treatment Units – Tymofiyivske, Yuliyivske, Solokhivske and Improving operational and commercial efficiency of refining cylinder equipment, replacement of methane transport with Khrestyshchenske. In addition, a network of condensate and sale of fuel products and LPG diesel and LPG vehicles, lack of state support for use of meth- pipelines with a total length of more than 700 km was Key initiatives to improve operational efficiency of refining ane transport, etc. This was also caused by lack of operational also transferred to the perimeter of the business unit. This activities were the following: efficiency, service quality, and focus on business development 89% separation was performed to better delineate hydrocarbon — commissioning of a new hydro cleaning reactor and launch and customer engagement. GOVERNANCE CORPORATE light petroleum production activities from processing, with accountability of diesel fuel dewaxing process that allowed for the start In 2019, when SE Ukravtogaz became a part of extraction ratio assigned to two business units. of production of a new type of product at Shebelynske OMD Business Delivery Unit, the new team of the enterprise plan - Arctic diesel fuel; implemented a number of transformation measures that led — optimization of accounting for fuel products transported to improved performance of the company and, as the result, by rail through the installation of 5 new weighing systems increase in CNG sales for the first time since 2007. Total processing volume at Shebelynske Gas Processing Plant with automated analytics and control; The company implemented a two-tier management Shebelynske Gas Processing Plant production structure — geographic expansion of retail sales of fuel products under structure and eliminated regional production units. the Shebel brand, with current coverage including Kyiv, Remuneration grading system was introduced and the +3.5% 2% 2% 2% 1% Zhytomyr, Chernihiv, Kharkiv, Dnipropetrovsk, Zaporizhia, average monthly salary of employees was increased by 600 100% 2% 3% 3% 2% and Poltava regions together with the government- 32%. The number of staff was optimized by 160 full- 8% 510 498 12% 11% 9% controlled districts of Donetsk and Luhansk regions. time employees (FTEs), or more than 10% of the total 500 481 headcount. At the same time, the company implemented RESPONSIBILITY 80% Development of trading business a number of measures aiming to improve operational 400 In October 2019, a specialized company, efficiency, including the introduction of an accounting AND SOCIAL ENVIRONMENTAL 60% Naftogaz Oil Trading LLC, was established within OMD Business system, upgrade of software for gas supply, and 89% Delivery Unit. Its key activities are purchasing and selling liquid implementation of a control system through installation of 300 84% 84% 86% hydrocarbons and fuel products for the needs of the companies modern hardware and software systems at CNG stations. In million tons 215 40% of Naftogaz Group as well as performing independent trad- 2019, SE Ukravtogaz implemented a new strategy of natural 200 ing activities. In early 2020, Naftogaz Oil Trading LLC entered gas purchasing via the Ukrainian Energy Exchange and o into an agreement with BNK-Ukraine to supply diesel fuel from ther trading platforms, which enabled the establishment 20% Belarusian refineries totaling 120,000 tons during the period of an attractive price level whilst lowering the input ma- 100 February-November 2020 to supply the private Ukrainian terial cost. Due to increasing efficiency of the procure- market and take part in public procurement tenders. ment system, enterprise costs decreased by 26%. Elec- 0 0% tricity costs for the production of CNG decreased by 11% VS. 2017-2018 levels. The company resumed operation 2016 2017 2018 2019 2016 2017 2018 2019 Transformation of compressed natural gas sales activity through the network of SE Ukravtogaz compressed natural of four mothballed CNG stations. In 2019, for first time in the Losses Heavy petroleum products gas filling stations history of the company, SE Ukravtogaz introduced a loyalty Note: includes additives and components Liquefied gas Light petroleum products In 2019, for the first time in many years, the team of OMD system for its customers, started systematic work with them, FINANCIAL OVERVIEW AND STATEMENTS Source: Ukrtransnafta Source: Ukrtransnafta Business Delivery Unit managed to overcome the historical and created a sales department.
Annual Report 2019 78 Naftogaz Group Annual Report 2019 79 Naftogaz Group Key areas of work for 2020 primarily include the following — Re-equipment of CNG stations and optimization of the initiatives: number of units of equipment in operation. — Attracting new customers and further increasing sale; In addition, OMD Business Delivery Unit is planning to — Construction of automated gas stations on the premises of raise a number of legislative initiatives aiming to create customer enterprises for their own needs; mechanisms to increase demand for the use of CNG as — Introduction of gas delivery service to customer motor fuel, as well as to conduct an active marketing enterprises for refueling vehicles with the help of mobile campaign to promote the use of natural gas as a
car refuelers; motor fuel. MARKET AND REFORMS
Strategic initiatives to increase the value of Oil Midstream to optimize its operational and commercial efficiency; and Downstream Business Delivery Unit in the segment of — Implementation of measures to digitize oil and condensate hydrocarbon refining and sale of fuel products, LPG and refining activities to increase operational efficiency; CNG — Optimization of raw material flow control systems to redu- The key strategic initiatives of the division in the segment сe losses of condensate and oil; of hydrocarbon processing and sale of fuel products, LPG and — Construction of Khrestysche LPG plant with capacity CNG are the following: of 100 thousand tons of LPG per year; — In-depth diagnostics of the current level of profitability of — Development of the trading business of the Oil Midstream Shebelynske Gas Processing Plant and assessment of options and Downstream Business Delivery Unit. STRATEGY AND OPERATIONS STRATEGY Dynamics of CNG sales through the network of Ukravtogaz
250 226
197 200
159 150 130 mcm
97 GOVERNANCE CORPORATE 100 -19.8% -6.0% +4.0% 65 49 50 39 37 38
0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Source: Ukravtogaz RESPONSIBILITY ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 80 Naftogaz Group Annual Report 2019 81 Naftogaz Group NATURAL GAS GAS TRANSMISSION AND TRANSIT IN 2019 Decrease in domestic gas Increase in gas transmission to transmission compared to the European customers compared to - % previous year + % the previous year TRANSMISSION 7 3 MARKET AND REFORMS
THE KEY RESULTS OF THE GAS TRANSMISSION SEGMENT IN 2019 Gas transmission and transit in 2015-2019 — The revenue of the Natural Gas Transmission segment 100 94 01.01.2020 89.6 in 2019 amounted to UAH 22.7 billion, of which 90 86.8 Natural Gas Transmission segment separated from UAH 18 billion was received from the provision of 82 Naftogaz Group 80 transmission services to external consumers. 67 — The EBITDA of the segment for 2019 was negative and 70 amounted to UAH 9.8 billion.
bcm 60
— The total volume of gas transmission to domestic AND OPERATIONS STRATEGY 50 consumers amounted to 26.4 bcm, which is 7% less than the previous year (28.5 bcm). 40 22.7 30 30 28.5 — Natural gas transmission to European consumers was 30 27 26.4 89.6 bcm of natural gas, which is 3% more than in 2018 UAH BILLION 20 Revenue of the Natural (86.7 bcm). Gas Transmission — 14.2 bcm of natural gas was imported to Ukraine, which 10 segment in 2019 is 35% more than in the previous year (10.6 bcm). 0 — Negative imbalances in 2019 amounted to more than 2015 2016 2017 2018 2019 2 bcm, which is 36% more than in the previous year, the debt for imbalances at the end of 2019 reached a record Domestic gas transmission Gas transit of UAH 44.1 billion. Source: Ukrtransgaz 26.4 With the completion of unbundling and the establishment of an independent gas transmission system GOVERNANCE CORPORATE BCM operator, Naftogaz Group lost control over natural gas Domestic transmission transmission activities. As part of this organizational Gas imports to Ukraine by country in 2018-2019, bcm transformation, in December 2019, the operational division "Natural Gas Storage" was created, where the Naftogaz Всього: 10.6 Naftogaz Total: 14.3 Group assets involved in the natural gas storage are currently concentrated. Other suppliers During 2019, the objective of Ukrtransgaz as the 3.6 operator of the gas transmission system of Ukraine was 7.2 7.1 89.6 7.0 to ensure efficient and uninterrupted operation of gas BCM transmission infrastructure and, accordingly, the security Transit to European of natural gas supply to Ukrainian and European 0.8 customers consumers amid unprecedented internal and external 2.1 RESPONSIBILITY challenges. 7.1 2018 5.7 2019 AND SOCIAL ENVIRONMENTAL 1.1 ESTABLISHMENT OF A NEW GAS TRANSMISSION 0.1 3.6 +35 % SYSTEM OPERATOR 2.3 0.2 Increase in gas The large-scale restructuring of operations and the 1.4 imports compared to separation of the new operator from Naftogaz Group was 0.5 the previous year definitely the main internal challenge for the natural gas transmission segment. This process was accompanied by a dramatic change in the organizational structure of from Poland (Hermanowice GMS) from Poland (Hermanowice GMS) Ukrtransgaz, the final separation of the two activities, changing from Hungary (Beregdaroc GMS) from Hungary (Beregdaroc GMS) + % the levels and algorithms of decision-making, increasing the 36 powers of regional units, and a reorganization of business from Slovakia (Budnice GMS) from Slovakia (Budnice GMS) Increase in negative processes. Starting from the second half of 2019, the service of imbalances compared to the the gas transmission system was transferred to the Operator Total Total FINANCIAL OVERVIEW AND STATEMENTS previous year of the Gas Transmission System of Ukraine LLC (OGTSU LLC) Source: Ukrtransgaz
Annual Report 2019 82 Naftogaz Group Annual Report 2019 83 Naftogaz Group Performance of Ukraine’s gas transmission infrustructure in 2015-2019, bcm
Capacity entry: 28.9 2010 3.1 Capacity Capacity 2011 3.5 entry: 48.5 entry: 6.0 2012 3.1 2010 24 MARKET AND REFORMS 2013 3.4 2010 4.3 2011 24 2014 2.6 2011 4 Capacity 2012 21.1 2015 2.1 BELARUS 2012 3.3 entry: 107.5 RUSSIA 2013 15.2 Capacity 2016 0.0 2013 2.8 2010 83.8 2014 13.1 2017 0.0 2014 0.5 exit: 5.0 entry: 1.5 2011 83 2015 12.8 2018 0.0 2015 2.4 2010 3.4 0 2012 72.1 2016 16.5 2019 0.0 0.0 POLAND 2011 4 0 2016 2013 71 2017 19.2 2012 3.8 0.1 2017 0.0 2014 47.3 2018 16.4 2013 3.9 1 Kobryn 2018 0.0 Capacity 2015 45.4 Capacity 2019 16.2 2014 3.5 0.9 2019 0.0 2016 57.0 entry: 25.5 entry: 13.0 Capacity 2015 3.7 0.1 Mozyr 2017 66.2 2010 11.1 2010 0.1 entry: 46.0 2011 9.5 2016 4.5 1.0 2018 62.4 2011 5.1 2010 3.7 2012 9.4 2017 4.7 1.3 2019 65.8 2012 1 2011 4.4 10.5 2018 4.0 0.7 2013 Sudzha 2013 1.3 2012 4.4 2019 4.0 1.4 2014 7.4 2014 0.9 2013 5.7 Capacity 2015 7.5 AND OPERATIONS STRATEGY 2015 0.0 2014 4 exit: 92.6 entry: 14.3 2016 7.1 2016 0.0 2015 3 2017 6.6 2010 67.9 0 2017 0.0 2016 1.6 2018 5.7 2011 70.6 0 2018 0.0 2017 1.6 2019 5.5 2012 51.8 0 2019 0.0 2018 2.3
2013 53.5 0 2019 2.0 2014 31.4 3.6
2015 37.8 9.7 Drozdovychi Valuiky 2016 48.8 9.1 Serebrianka 2017 53.5 9.9 Pysarivka 2018 49.3 6.5 Sokhranivka 2019 57.2 9.2
SLOVAKIA GOVERNANCE CORPORATE Uzhhorod
Berehove HUNGARY Oleksiivka Capacity Capacity Tekove exit: 32.5 entry: 3.3 exit: 3.5 Capacity Capacity 3.2 2010 2010 3.3 exit: 4.5 exit: 13.2 entry: 5.4 3.1 2011 Prokhorivka 2011 2.8 0.3 2010 3.1 2012 1.9 2010 7.1 0 2012 0.7 2011 2.4 2013 2013 0.9 2011 5.9 0 0.3 2012 2.8 2014 Platove 2014 1.1 2012 5.7 0 ROMANIA 0.2 2013 2.9 2015 2015 0.0 RESPONSIBILITY 2013 6.4 1.1 Capacity 0.0 2014 2016 0.0 2014 6.5 0.6 3.0 2016 entry: 5.3 0.0 2015 2017 0.9 0.0 2.7 2017 2010 AND SOCIAL ENVIRONMENTAL 2015 5.9 0.5 0.8 2016 2018 0.0 2.9 2018 2011 1 2016 6.7 1.0 0.7 2017 2019 0.0 2.9 2019 2012 0.7 2017 11.7 2.8 0.7 2018 2013 0.7 2018 11.8 3.4 0.2 2019 MOLDOVA 2014 0.6 2019 15.1 3.7 Capacity exit: 26.8 2015 0.0 2016 0.0 19.9 Desig ned GT S exit capacity Designed GTS entry capacity 2010 2017 0.0 19.6 2011 2018 0.0 Capacity 19.6 2012 2019 0.0 exit: 32.5 entry: 3.3 18 2013
16.7 2014 Gas transmission Gas transmission 2015 Orlivka volume at GTS exit volume at GTS entry 18.5 2016 20.2 2017 Transborder temporarily occupied gas metering 89.6 14.3 18.1 2018 and uncontrolled territories stations bcm bcm 10.2 2019 FINANCIAL OVERVIEW AND STATEMENTS Gas transit to Europe in 2019 Gas imports to Ukraine in 2019 Source: Ukrtransgaz. 2019
Annual Report 2019 84 Naftogaz Group Annual Report 2019 85 Naftogaz Group based on the relevant service agreements. THE NEW RULES OF THE GAS MARKET – DAILY UNREASONABLE TARIFF POLICY – A THREAT TO 5 The OGTSU LLC management transformation is focused BALANCING THE SECURITY OF GAS SUPPLY TO UKRAINIAN Performance indicators of the daily balancing on transferring from a three-tier to a two-tier management platform system. Before June 1, 2019, there were three GTS From March 1, 2019, daily balancing is introduced in CONSUMERS management levels: "head office – branches – line production Ukraine, which implies the calculation of positive or negative In December 2018, NEURC Resolution No 2001 established departments (LPDs)." In preparation for the separation of the imbalances for customers of natural gas transportation temporary tariffs for natural gas transmission services for GTS Operator of Ukraine, the decision was taken to "merge" services by the GTS Operator on a daily basis. It is expected entry and exit points for the first year of the second regulatory the head office and branches. In this way, the management that the changes will enable Ukraine to take a significant step period (hereinafter Temporary Tariffs), effective since January MARKET AND REFORMS structure was transformed into a two-tier management towards completing the reform of the gas market and the 1, 2019. On average, the tariffs were halved to a level that is 1 512 system: "head office – LPDs". Previously, in December 2018, introduction of the standard rules of operation of European economically unreasonable in terms of covering the operating Users a number of LPDs were consolidated, which resulted in a operators. The Government of Ukraine set this goal back in costs of the GTS operator. decrease of their number from 32 to 20. 2014 within the framework of the EU – Ukraine Association In connection with the above, Ukrtransgaz faced The administrative apparatus has been significant Agreement. challenges financing repair works and purchasing the amount changed as well. In particular, compared to the Ukrtransgaz To prepare for the transition to daily balancing, Ukrtransgaz has of gas required for production and technological purposes. organizational structure, the number of reporting levels developed and implemented an Information Platform. During 2019, At the same time, while preparing for the heating season and was significantly reduced from seven to three. The new the Platform was supported by Ukrtransgaz in accordance with potential transit suspension, Ukrtransgaz managed to ensure 11 827 331 organizational structure was initially introduced from June 1, the GTS of Ukraine Code. After unbundling was completed, the preparation of the system, development of reverse modes in Registered EICs 2019 with the Operator of GTS of Ukraine branch, and from Platform was transferred to OGTSU LLC . The Platform automates case of no transit, and to ensure the smooth heating season. July 1, it was introduced in the newly established GTS Operator electronic interaction and document flow between the key natural of Ukraine LLC. Also in advance – a few months before the gas market players – the GTS Operator, gas distribution network launch of the full-fledged operation of the OGTSU – business operators (GDNs), and gas transmission service customers. NEW RULES VS. OLD PROBLEMS – ACCUMULATION processes were developed, and the relevant policies and The key advantages of using this information platform OF DEBTS FOR BALANCING SERVICES AND OPERATIONS STRATEGY internal regulations of the company were created, which made include the shift from paper to electronic document 259 323 it possible to maintain the continuity of the gas transmission management. It allows for minimization of time for processing The Resolution of the National Energy and Utilities Processed trade notifications in process and reduce the risk of emergencies in the GTS. nominations for natural gas transmission up to one day, the Regulatory Commission of 30.09.2015 No 2493 approved the March-December 2019 Restructuring revealed the key tasks that both the GTS ability to record the volume of gas input and output in/from Gas Transmission System Code (hereinafter the GTS Code). The operator and the UGS operator need to work on in the near the GTS during the day, and form a portfolio for each gas GTS Code established the mechanism for monthly balancing future: transmission service customer with the details of end users. With of the gas transmission system and obliged Ukrtransgaz — further optimization of the operating model and business all these instruments, the Platform allows the GTS Operator to to provide balancing services to gas distribution system processes; monitor the status of imbalances of gas transmission service operators on a monthly basis. — establishing interaction between the two operators; customers, to control the sufficient level of financial security During the period from 2015 until the end of 2019, the 114 096 — strengthening competencies and introducing new for each nomination, and to assess its own operating costs and total amount of negative natural gas imbalances in the Submitted nominations/renominations functions. forecast possible losses. Ukrtransgaz system, based on the results of market participant Source: Ukrtransgaz CORPORATE GOVERNANCE CORPORATE
Gas transmission through Ukraine to European countries and gas imports to Ukraine in 2010-2019 6 Functionalities of the Information Platform
160 Register/Database Nomination Allocation Balancing General opportunities
137.7 Data collection for Nominations / Development of lists of Daily balancing Productivity optimization. 140 134.4 the initial input to the renominations flows, subconsumers, Introduction of imbalance Register and tentative list users of gas production Monthly balancing payment 118.0 for disconnection Data input for compliance enterprise networks 120 35.8 33.5 114.2 checks ("matching") for Adjusting data at the Integration with the existing 107.6 103.8 Development of lists interstate connections Input of actual data on end of the month, shift ERP to obtain financial support 97.4 of the gas distribution points and underground flows, subconsumers, between consumer data 100 93.3 14.1 RESPONSIBILITY 33.7 28.1 14.3 system consumers, gas storage facilities users of gas production volume calculation modes 81.8 83.5 10.6 suppliers, operators enterprise networks Integration with the existing
11.1 AND SOCIAL ENVIRONMENTAL bcm 80 Trade notifications (with ERP to obtain imbalance 19.6 16.4 Generation of messages compliance check) Obtaining forecast and payment status and 104.2 in accordance with the actual values for supply / accounting documents 60 GTS Code withdrawal volumes Integration with Gazolina 98.6 86.1 84.3 93.5 89.6 Maintenance of the Downloading physical information system 40 82.2 86.8 67.1 Registry data on gas transmission 62.2 Communication instruments Consumer list Forecasts, tentative and built in the Information 20 administration final allocation Platform
0 Supplier change Short reports procedure 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Creating the Platform user profiles Gas transit to Europe Gas imports to Ukraine FINANCIAL OVERVIEW AND STATEMENTS Source: Ukrtransgaz Source: Ukrtransgaz
Annual Report 2019 86 Naftogaz Group Annual Report 2019 87 Naftogaz Group operations, amounted to 6.3 bcm. In 2019, the level of significant threats to the continued uninterrupted operation of include availability of imports, no imports, different withdrawal negative imbalances amounted to more than 2 bcm, which is Ukrtransgaz. volumes from different underground storage facilities, criteria UAH13.6 billion – the highest since approval of the GTS Code. In the process of separation of natural gas transmission for optimal use of capacity of the trunk gas pipelines and 6.3 As of the end of the year, the debt of transmission service activities, the accumulated debt for balancing services was compressor stations, etc. customers to Ukrtransgaz for balancing was about UAH 44.1 not transferred to the new gas transmission system operator. The gas transmission system had operated in similar BCM billion, including the debt of gas distribution system operators At the same time, available public data on unauthorized conditions in January 2009, during the gas crisis due to the Negative imbalances in of more than UAH 35.2 billion. Despite the introduction of a withdrawals in 2020 shows that this problem remains the main cessation of gas transit through Ukraine by Russia. At that
2015-2019 daily balancing system in March 2019, debt for transmission threat to the financial condition of the new independent gas time, all consumers were supplied with gas and the availability MARKET AND REFORMS services increased by UAH 7.2 billion by the end of 2019. This transmission system operator. of natural gas reserves in underground storage facilities and means that replacing monthly balancing with daily balancing capacity for its extraction ensured a balanced system (there is insufficient without eliminating the main cause of debt was no crisis situation with gas supply to consumers in 4 4.1 accumulation for negative imbalances, which is unauthorized TRANSIT INTERRUPTION RISK Ukraine). In addition, since the end of the gas crisis in 2009, gas withdrawals of gas by gas distribution system operators. a large number of gas transmission infrastructure facilities UAH BILLION Unauthorized withdrawal is a major violation in the natural During 2019, Ukraine was preparing for an end to transit have been reconstructed and rehabilitated, which has greatly Outstanding debt for gas gas market. The continuous increase in debt results in the of Russian gas after the expiration of the contract between facilitated the organization of reverse operation modes and transmission services outflow of GTS operator working capital. In turn, the situation Naftogaz of Ukraine and Gazprom on January 1, 2020. expanded the capabilities of the gas transmission system. in 2015-2019 makes settlements with suppliers and the implementation Naftogaz Group therefore successfully implemented plans of modernization and development of the gas transmission to import sufficient natural gas from Europe, its transmission, system more complicated and difficult. and pumping into underground gas storage facilities. 2.0+ Due to the increase in natural gas costs as a result of Meanwhile, Ukrtransgaz ensured its readiness to take the increased transit volumes in 2019, the growth of debts of gas necessary technical steps to redistribute gas routes to meet
BCM distribution system operators and the accumulated effects of the needs of Ukrainian consumers. AND OPERATIONS STRATEGY Negative imbalances totalling temporary tariffs set by the NEURC, Ukrtransgaz was not able The GTS of Ukraine operator has developed different UAH 13.6 billion in 2019 to pay for gas purchased for its own needs in 2019. GTS operation modes in different gas resource distribution Several suppliers refused to supply contracted volumes scenarios, depending on the changes in ambient temperatures of gas. The lack of natural gas for in-house needs created in different regions of Ukraine, as well as other factors. These
Negative imbalances in 2015-2019 Tariffs for transportation services in 2019 bcm Negative imbalances in 2019 36.40
2015 0.01 2 000 13.6 GOVERNANCE CORPORATE 2016 mcm UAH billion
2017 0.9 1.8 1.5 2.0 260 Jan 3.2 26.68 615.1 2018 179 Feb 1.9 2019 333 Mar 1.6 16.52
12.47 167 Apr 1.0 296.8 248.7 10.41 230.0 248.7 105 May 0.8 219.0 RESPONSIBILITY Debt, UAH billion* 157.19 157.2 6.22
49 Jun 0.4 91.87 AND SOCIAL ENVIRONMENTAL 2015 0.3 2016 71 Jul 0.4 For consumers Cross-border entry Cross-border exit Domestic entry points Domestic exit points 2017 6.7 20.1 34.4 44.1 Aug directly connected to points points (average 49 0.3 (GDS operators) the trunk gas weighted) 2018 195 Sep 0.6 pipelines 2019 202 Oct 1.0 UAH/tcm USD/tcm
Nov 186 0.9 Tariff effective in 2018 Estimated tariff for 2019 Temporary tariff
Source: Ukrtransgaz * Including accrued % and fines according to court decisions 245 Dec 1.6 1 The NEURC Resolution of 21.12.2018 No 2001 "On Setting Temporary Tariffs for Ukrtransgaz for Natural Gas Transmission Services For Entry And Exit Points For The First Year of the Second Regulatory Period and FINANCIAL OVERVIEW AND STATEMENTS Source: Ukrtransgaz Repealing Some Resolutions.”
Annual Report 2019 88 Naftogaz Group Annual Report 2019 89 Naftogaz Group GAS STORAGE VOLUMES OF GAS INJECTED TO THE UGS IN 2019 VOLUMES OF GAS WITHDRAWN FROM THE UGS IN 2019 +34 % 13.1 -25 % 8.0 more than compared BUSINESS DELIVERY UNIT in 2018 BCM to 2018 BCM MARKET AND REFORMS
KEY RESULTS IN 2019 storage facilities in Ukraine. One storage facility, Verhunske, is located in the temporarily occupied territory of Luhansk Gas stocks in the UGS facilities as of the end of the heating season 2019/2020 — Net revenue of Gas Storage Business Delivery Unit in 2019 region. amounted to 3.3 bln UAH which is 82% more as compared to the previous period, mostly due to higher volumes of Solokhivske injection and storage, as well as tariffs revision in August UNBUNDLING OF THE TWO SYSTEMS – Olyshivske 2019. ONE OF MAJOR CHALLENGES IN 2019 1 300 41% — EBITDA of Gas Storage Business Delivery Unit in 2019 310 31% amounted to almost 2 bln UAH as compared to almost null Creation of the “Storage System Operator of Ukraine” Oparske Uherske (XIV-XV) EBITDA in 2018. branch in November 2018 was the first and one of the key AND OPERATIONS STRATEGY Chervonopartyzanske — Injection to storages by all parties comprised 13.1 bcm stages in the unbundling process. Upon its creation, the 1 900 33% 1 920 39% (34% more than previous year). Withdrawal volumes by all restructuring of business processes and reporting lines 1 500 78% Krasnopopivske parties totaled 8.0 bcm (25% less compared to previous began both at SSO and TSO. This process covered complete Bilche-Volytsko- Dashavske year). In 2018 withdrawal volumes comprised 10.6 bcm. segregation of assets, teams and responsibilities. Uherske 420 29% — 21.8 bcm of gas was accumulated in Ukraine's gas storage By June 2019, SSO had developed its own IT environment, 2 150 100% Proletarske facilities at the end of 2019 injection season, which is 27% a single database of technological parameters, and set up 17 050 73% 1 000 69% more than a year ago. its own dispatching system. Operational dispatching of Verhunske In 2019, the objective of Naftogaz Group developed in underground gas storage (hereinafter also UGS) facilities is Bohorodchanske Kehychivske 400 n/a 2014 has been finally reached by timely implementation of currently carried out from Lviv. In August 2019, Ukrtransgaz 2 300 98% 700 96% unbundling of natural gas transmission and storage activities. specialists launched the SSO Information Platform which As part of the organisational transformation of Naftogaz significantly increased the effectiveness of SSO interfaces with Group in December 2019, the Supervisory Board of Naftogaz customers. Work continues on expanding its functionality.
Group adopted a decision to create Gas Storage Business Metering equipment installed at connection points is used GOVERNANCE CORPORATE Delivery Unit. The Unit is responsible for providing reliable to account for transmitted gas between the two operators. and economically justified natural gas storage services for However, to increase the accuracy of calculations, it is planned Total – UGS both Ukrainian and European customers, as well as for inte- to equip new measuring units in the next 3-4 years. grating Ukrainian gas storage infrastructure and services into On December 27, 2019, JSC Ukrtransgaz and “Gas 30 950 – active capacity of UGS facilities, mcm the European system. The Gas Storage Business Delivery Unit Transmission system operator” LLC (TSO LLC) signed 70% – used capacity, % includes Ukrtransgaz’s structural divisions, and, in particular, an interconnection agreement (“Technical Agreement” the "Storage System Operator of Ukraine" (hereinafter also between operators). The agreement introduced common SSO) branch of Ukrtransgaz, which operates 12 underground market practices for interaction between the two operators. Source: Naftogaz
1 IT-platform of SSO RESPONSIBILITY ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL REGISTRY / DATABASE NOMINATION ALLOCATION CUSTOMS WAREHOUSE GAS STORAGE SYSTEM OPERATOR ACCOUNT CLIENT’S ACCOUNT GENERAL
Gas storage services customers and Nomination/Renomination Allocation management: Nomination/Renomination/ Verification and confirmation Submission of an applica- Submission of nominations/ contracts management management obtaining data from TSO trade notifications manage- of nominations/renominations/trade notifications tion for changing customs renominations/trade notifications and managing informa- ment regime by the customer Management of information re- Physical flow scheduling Capacity allocation management Submission of application for changing tion on actual volumes of garding gas balances on customers’ (data management for Customs warehouse clear- customs regime gas injection / with- Natural gas volumes seizure analytics Capacity booking accounts verification (“matching”) ance drawal Accounting of gas volumes stored in customers’ Change of volumes of security gas for GTS Points) Change of gas reserve Notifications and information Information exchange with accounts stock Change in allocation exchange according to Gas Storage Trade notifications man- TSO, analytics regarding Capacity change with based on the results Administration of change in customs regime Change in capacity with restrictions Network Code agement (with compliance «Short-haul» capacities in restrictions of nominations / trade Planned in 2020: Execution of court decisions on verification) customs warehouse mode Planned in 2020: Periodic customs notifications changing gas volumes in the account of the storage Planned in 2020: Capacity booking
declarations management. Synchro- Planned in 2020: Customs services customer nization with customs database Declarations management Planned in 2020: Technical capacity of UGS facilities FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 90 Naftogaz Group Annual Report 2019 91 Naftogaz Group According to this agreement, the new TSO, under standard from the territory of Ukraine or their placement in different transmission services, meaning capacities with limited access 3 Key features of gas transmission and storage conditions, stores a certain volume of natural gas in customs regime. to the Ukrainian VTP and domestic market. business in Ukraine underground gas storage (hereinafter UGS) facilities to meet In 2019, customers placed over 8.1 bcm of natural gas the needs of GTS balancing. The agreement also regulates (more than 30% of the total volume of gas storage), of which Improve tariffs approaches for SSO services rules and procedures for the use of operational balancing residents (10 customers) accounted for 6.1 bcm, and non- The Gas Storage Business Delivery Unit intends cooperates account to facilitate interaction. residents (19 customers) accounted for 2.0 bcm, representing with NEURC to improve tariff setting methodology for 65% and 35% respectively. natural gas storage services, taking into account the common
practices of European operators as well as current and MARKET AND REFORMS 30 950 IN ANTICIPATION OF A NEW GAS WAR expected market conditions for natural gas. The key task is to mcm UNBALANCED TARIFF REGULATION OF set a tariff approach which will allow the operator to cover By December 28, 2019, it was difficult to predict whether MONOPOLIES – A CHALLENGE FOR SSO IN 2019 operating and investment costs and provide the necessary Maximum volume of transit through Ukraine would be continued, and if so, what level of profitability while keeping commercial attractiveness active gas in storage the conditions and volumes would be. In such circumstances, Starting from 2014 and until the final separation of TSO, of SSO products. the critical task of SSO was to ensure technical capability to one of the key problems that the faced by Ukrtransgaz was inject and store sufficient stock of natural gas in UGS, and to cross-subsidisation between the two operating segments Improve operational performance develop technological regimes of UGS operation together –transmission and storage of natural gas. This problem During the implementation of unbundling, Naftogaz with part of the main gas pipelines. It was also necessary became critical in 2019 after the introduction of temporary Group pursued the goal of creating an effective GTS operator, 597 to implement technical measures aimed at improving the tariffs for natural gas transmission services, which were taking into account the existing technical and administrative reliability of the main UGS technological equipment and nearly half lower than the justified tariffs initially calculated restrictions. This, in turn, means that certain services, assets MW proper preparation of natural gas for transportation during by Ukrtansgaz. At the same time, Ukrtransgaz faced sharp and business processes were not transferred to TSO LLC. Capacity of compressor the heating season in the absence of transit. increase in network users’ debts for balancing services. As a Therefore, in the short term, the activities of Ukrtransgaz and
stations By the end of October, 2019, the injection season was result, in mid-2019, the company was on the verge of default the Gas Storage Business Delivery Unit will encompass the AND OPERATIONS STRATEGY completed and the volume of natural gas in UGS facilities on its obligations: financing of capital investment and repair optimisation of organisational structure, business processes, amounted to more than 21.8 bcm of natural gas, which was plans was threatened, including the modernisation of natural and personnel. the highest indicator since 2011. gas storage assets. The crisis was prevented thanks to the support provided by the parent company – NJSC Naftogaz of 1 232 Ukraine – to Ukrtransgaz. Production wells VALUE CREATION FOR CUSTOMERS – During 2019 a number of important maintenance activities CUSTOMS WAREHOUSE SERVICE were carried out by Ukrtransgaz, which significantly improved the condition of the main technological equipment and 260 During 2019, SSO provided Customs Warehouse services increased the reliability of UGS facilities. to a record number of customers. The service itself was the The company carried out 67 well work-overs and ongoing mcm result of the joint efforts of Ukrtransgaz, Naftogaz and the repairs of 120 wells at UGS facilities, together with 89 repairs Maximum daily Ukrainian authorities, and was introduced in 2017. and maintenance of UGS gas pumping units.
withdrawal at the Based on 10 UGS facilities, the Customs Warehouse Ser- In addition, during neutral periods (after the withdrawal GOVERNANCE CORPORATE beginning of the vice allows customers to store natural gas in Ukrainian UGS season 2018-2019 and after the injection season 2019), withdrawal season facilities for up to 1095 days without paying taxes and customs planned repair and maintenance work of technological Source: designed parameters (UTG's specifications) duties, subject to further transportation of these volumes equipment was fully implemented.
KEY STRATEGIC DIRECTIONS OF THE GAS Gas stock volumes at the end of the injection season 2011-2019 STORAGE BUSINESS DELIVERY UNIT Dynamics for customs warehouse 21.8 services in 2017-2019 22 20.6 20.3 Realize synergies with the Naftogaz Group Gas Business Naftogaz Group anticipates further realizing synergy of the 20 8.2 Gas Storage Business Delivery Unit with the gas commercial
17.2 RESPONSIBILITY 18 16.8 17.1 17.0 17.2 units, leveraging the potential of underground natural gas storages to: 16 29 14.7 AND SOCIAL ENVIRONMENTAL — ensure security of natural gas supply to inside Ukraine; 14 — implement attractive commercial projects of Naftogaz group gas business. 12 bcm 10 Increase the level of gas storage utilization by external customers 8 + SSO is taking steps to increase revenues and utilization 0.1 6 21.8 of infrastructure, Ukrtransgaz anticipates to increase the 5 4 BCM share of revenue from services in accordance with trends in 4 the European gas market, given benefits of the location of As of 1 November 2019 0.0 2 Ukrainian gas storages and infrastructure in the western part of the Ukraine. Effective cooperation with the gas transmission 2017 2018 2019 0 system operator of Ukraine will contribute to this process. 2011 2012 2013 2014 2015 2016 2017 2018 2019 Starting from January 2020, a significant step in this direction Volume of natural gas, bcm Number of customers was made by the introduction of the new TSO “Short-haul” FINANCIAL OVERVIEW AND STATEMENTS Source: Naftogaz service, which provides special reduced tariffs for transit Source: Naftogaz
Annual Report 2019 92 Naftogaz Group Annual Report 2019 93 Naftogaz Group What is Technical: Full stack technical competence portfolio of Naftogaz Group
TECHNICAL BUSINESS SOLUTIONS AND VALUE DESIGN OIL & GAS FIELD SERVICES R&D Drilling & Completions Logging and other services Subsurface well work services MARKET AND REFORMS ENABLING UNIT Technology development Well drilling & completion Well logging Workovers projects Innovative project Perforation Coiled tubing operations implementation Own drill fleet management Hydro fracking operations Patent and license Contractor drill fleet Side-tracking operations management management THE KEY RESULTS OF THE TECHNICAL BUSINESS Other well stimulation Integrated procurement of operations ENABLING UNIT (HEREINAFTER TECHNICAL drilling solutions (incl. internal OR TECHNICAL BUSINESS ENABLING UNIT) & external inputs) 20 ARE THE FOLLOWING: New drill rigs Engineering Capital construction Diagnostics, maintenance Procurement — Performing organizational transformation and development and overhaul of technical competence at Naftogaz Group level; — Drill rig fleet renewal and modernization: commissioning Preparation of design/project Capital construction and Technical monitoring and Procurement planning and
15 AND OPERATIONS STRATEGY Fully or partially of new drill rigs, ensuring achievement of expected levels documentation commissioning diagnostics of equipment execution modernized drill rigs of efficiency and commercial drilling speed for new drill rig Project cost estimation and Capital repair, reconstruction Prevention of breakdowns and Category management fleet; budget preparation and modernization emergencies Development of strategic — Modernization of own hydro fracking fleet and its active Coordination of state expert Decommissioning of oil and Maintenance and overhaul framework agreements utilization; review process gas infrastructure facilities Emergency recovery work Stock management — Development of strategic relationship with the Big Four Transportation & logistics global oil and gas field services companies, including start management + % of strategic partnership with Halliburton through signing of 14 a major sidetracking program execution contract; Surface infrastructure and other capital projects Supply chain & purchasing Increase in commercial — Active implementation of new technologies and methods drilling speed of own of production intensification, in particular usage of Source: Ukrgasvydobuvannya drilling fleet oil-based drilling mud and application of Artificial Lift technology.
management competence. The business unit includes ser- Technical Business Delivery Unit responded to this reduc- GOVERNANCE CORPORATE The Technical Business Enabling Unit was created in vice branches and procurement units of JSC Ukrgazvydobu- tion in drilling volume with optimization of drilling capacity, 212 April 2019 with the objective of developing a centralized vannya, JSC Ukrtransgaz, JSC Ukrtransnafta and other Naf- taking into account new drill rig delivery and launch schedule, thousand m technical and procurement capability within Naftogaz togaz Group companies. While other business units within most of which had been planned for 2019. Both business 2019 drilling volume Group, with a particular focus on developing capital project Naftogaz Group are business delivery units, Technical is a units’ teams worked intensely to update the drilling schedule business enabling unit, which means that its operations are focused on maximization of new and modernized drill rig utili- aimed at enabling the achievement of financial and busi- zation. In parallel, the Technical Business Enabling Unit had to ness development goals of business delivery units which substantially reduce the number of third-party drill rigs (from Ukrgasvydobuvannya drilling volume dynamics in 2015-2019 create value for external customers and primarily focus on 13 rigs in 2018 to 4 rigs by the end of 2019) as well as imple- external markets. The key objective of Technical Business ment a conservation program for older rigs. As a result, by the 350 Enabling Unit is quality and timely performance of tasks end of 2019, the drill rig fleet of the business unit centered 313 or execution of capital projects that are delegated to it by around 20 new, 15 fully or partially modernized own drill rigs, 300 other business units. The split of accountability in this case and 4 third-party drill rigs. RESPONSIBILITY 67 is done based on the rule that while business delivery units As a result, the average commercial drilling speed of
248 AND SOCIAL ENVIRONMENTAL 250 8 answer the questions “What” and “When”, Technical Busi- own drill rig fleet increased by 14% in 2019 – from 428 to 198 212 ness Enabling Unit answers the question “How”. 488 meters per month. At the same time, new drill rigs have 200 173 demonstrated performance which allow to expect closure of 65 the gap to third-party rig speed level of 1,000-1,100 meters 150 245 TRANSFORMATION AND CAPABILITY per month in 2020-2021. In 2019, several wells were drilled at 240 DEVELOPMENT IN OIL AND GAS FIELD the level of third-party contractor commercial drilling speed. 100 The Zakhidne-Sosnivske 150 well (depth of 5.7 thousand thousand meters 147 SERVICE ACTIVITIES meters) was drilled at 1,120 meters per month commercial 50 2019 was the year of rollout of new drilling fleet of drilling speed and Bezpalivske 52 well (depth of 4.7 thousand JSC Ukrgazvydobuvannya, together with a reduction of meters) was drilled with 1,049 meters per month commercial 0 reliance on external drilling capacity and the transformation drilling speed. 2015 2016 2017 2018 2019 of drilling competence within Naftogaz Group. The start of drilling at the Shebelynske 888 well with new Following a decline in natural gas prices, Integrated Gas Honghua rig in partnership with Schlumberger, which provides Third-party drill rig fleet Own drill rig fleet Business Delivery Unit had to review its investment plans integrated well drilling and construction project management related to drilling and greenfield development, which resulted services, was an important landmark for Technical Business FINANCIAL OVERVIEW AND STATEMENTS Source: Ukrgasvydobuvannya in a reduction of 2019 drilling program volume. Enabling Unit.
Annual Report 2019 94 Naftogaz Group Annual Report 2019 95 Naftogaz Group 3 Technical Business Enabling Unit drill rig capacity renewal – Before and After 161 Workover operations performed 736 MARKET AND REFORMS Coiled tubing operations performed 117 Hydro fracking operations +2 AND OPERATIONS STRATEGY bcm over 10 years Estimated volume of gas expected to be reached through a 26 well sidetrack program delivery in partnership Source: Ukrgasvydobuvannya with Halliburton
Technical team also pursues other activities to increase Workover program was equipped with the newest coiled tubing operations tools tion and allow increases in gas produced from depleted GOVERNANCE CORPORATE drilling efficiency, including the following : In 2019, Technical Business Enabling Unit completed produced by NOV with respective employee training done in reservoirs. — Development of regulations and operating standards for 161 workover operations, of which 41 were performed by advance, which made it possible to further strengthen the well drilling and construction activities; third-party contractors. 63 workovers involved fishing opera- capabilities of the coiled tubing operations team in performing Hydro fracking operations program — Transition to API (American Petroleum Institute or API) tions, which are often very complex and carry significant risks. operations of different levels of complexity. In 2019, Technical Business Enabling Unit performed 117 standards; These works were performed in partnership with Weather- hydro fracking operations, of which 92 operations were per- — Usage of oil-based mud that will allow reductions in ford. Partnership with Schlumberger formed by third-party contractors Тacrom Services S.R.L. and accident and complication time when drilling through To deliver this program, business units deployed on aver- Partnership with Schlumberger allowed the business unit Belorusneft. 60 hydro fracking operations were performed on intervals which are prone to mud absorption; age 35 own workover rigs and 15 workover rigs of third-party to apply the latest technologies: existing wells, with others performed on new wells. During — Reduction of rig-up / rig-down time (pilot projects have contractors. To increase workover capacity, a contract for de- — Organoseal technology, which makes it possible to the year, the business unit team successfully completed mod- confirmed a time reduction potential of up to 50%); livery of 5 new workover rigs ZJ-20 was signed with Zhongman temporarily block producing zones in order to minimize ernization and launch into operation of its own hydro fracking — Drilling branch personnel optimization reflecting Petroleum in 2019. These rigs were delivered in December fluid absorption by formation and allows to perform other fleet, which managed to perform 25 operations, including optimization of drill rig fleet; 2019 and have alreadybeen commissioned in May-June 2020. operations in the well without causing damage to forma- 4- and 8-stage hydro fracking series with application of spe- RESPONSIBILITY — Conducting qualification improvement and training In parallel, negotiations with the European Bank for Recon- tion, was used for the first time in Eastern Europe. Based cial multi-stage layouts. To enable operation of its own hydro programs, including training abroad in partnership with struction and Development are being conducted to finance on this application, engineer teams of Naftogaz Group and fracking fleet, a special mobile laboratory was purchased and AND SOCIAL ENVIRONMENTAL global leading drilling companies. purchasing of 10 additional workover rigs. Schlumberger are currently working on a joint paper for put into operation in the UGV-Service branch as part of the the Society of Petroleum Engineers (SPE). existing hydro fracking auxiliary equipment set. TO WORK WITH THE OLD WELL BANK, ESPECIALLY IN A Coiled tubing operations program — CoilFlate technology, which makes it possible to run LOW PRICE ENVIRONMENT, THE TEAM OF TECHNICAL In 2019, Technical Business Enabling Unit performed 736 an inflatable packer through a pump compressor pipe, Sidetrack drilling BUSINESS ENABLING UNIT MAKES EVERY EFFORT TO coiled tubing operations, of which 257 were done as support precisely isolating the required zone for further treatment In May 2019, the two-year cooperation between Naf- operations and were part of new well construction, workover, with a coiled tubing unit. Naftogaz Group was the first togaz Group and US company Halliburton moved to a new UTILIZE CURRENT CAPABILITIES TO THE MAXIMUM, or hydro fracking projects. All these operations were per- company in Eastern Europe to apply this technology. level as a result of signing of a Memorandum of Under- WHILE SIMULTANEOUSLY INCREASING BUSINESS UNIT'S formed by 7 own coiled tubing units and 12 third-party coiled — Production Logging Tool, which is a technology allowing standing regarding deepening of cooperation in the sphere WELL WORK CAPACITY AND CAPABILITY tubing units, of which 4 units were deployed through the for logging with the help of a coiled tubing unit in wells of provision of oil and gas field services for development of contract with Schlumberger. where standard methods of well studies cannot be ap- hydrocarbon reservoirs in Ukraine. Within this cooperation Decline in natural gas prices and reduction in drilling vol- Owing to partnerships and experience exchange, the busi- plied. Rapid interpretation of data allows for quick and framework, Halliburton was contracted to provide integrat- umes strengthened the focus of Integrated Gas and Technical ness unit managed to improve its capabilities and started per- correct decisions regarding further works on the well. ed sidetrack drilling services on 26 wells. Naftogaz Group business units on delivery of well work operations program, forming complex coiled tubing operations, including abrasive — Deep acid stimulation with coiled tubing unit forecasts that successful delivery of this sidetrack drilling which in particular include workovers, coiled tubing and hydro jetting and cementing operations. Additionally, oil and gas technologies, that encompasses unique acid recipes, program will make it possible to obtain 2 billion cubic meters fracking operations as well as sidetrack drilling. field service branch of JSC Ukrgasvydobuvannya UGV-Service which are developed individually for each type of forma- of natural gas over 10 years. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 96 Naftogaz Group Annual Report 2019 97 Naftogaz Group TECHNICAL BUSINESS ENABLING 3Overhead optimization and development of high performance Dynamics in quantity of performed wellwork operations and commissioned wells UNIT STRATEGIC INITIATIVES organizational structure. Leveraging of best practices and implementation of optimized organizational structure and 800 Technical Business Enabling Unit is setting itself the follow- processes comprise the core of Technical Business Enabling 729 736 ing ambitious goals as to increasing efficiency of oil and gas Unit optimization. This work will reflect the need to ensure 700 field service fleet management,and other equipment, provi- cost efficiency for services provided to other business units, siion of oil and gas field services: centralize technical capability and transform service branches 600 578 of JSC Ukrtransgaz. MARKET AND REFORMS 500 1Achieving the commercial drilling speed level of other drilling companies. The business unit plans to achieve this 4Special vehicle fleet management optimization. It will allow 400 through application of new instruments, materials and tech- substantial savings on fixed costs linked to car and other vehi- nologies (in particular, high performance drill bits, directional cle maintenance. 300 drilling management system, oil-based drilling mud) contract- ing cementing services, transition to API standards for key One of the key strategic initiatives to increase the efficien- 200 173 161 157 components. Additionally, rig-up / rig-down time will also be cy of the Technical Business Enabling Unit is transformation 123 133 110 117 101 reduced. of the supply chain management system. Key streams in this 100 65 63 51 64 60 42 direction include development of professional capability in 0 0 16 0 2Reduction of non-productive time (hereinafter NPT) of drilling purchasing, stock, transport and logistics management based 2015 2016 2017 2018 2019 and other service equipment. Achievements of 2019 show on the data management system. that reduction of NPT is an important factor in optimization of The implementation of strategic initiatives will allow the Workovers Coiled tubing operations Hydro fracking operations Wells commissioned operational processes. Redesign and implementation of new Technical Business Enabling Unit to achieve the required level of
Source: Ukrgasvydobuvannya standardized processes, improvement of logistics and stock competence in technical and operational activities to effectively AND OPERATIONS STRATEGY management and wide-scale application of IT are key work support the implementation of Naftogaz Group’s strategic streams to achieve implementation of this initiative. objectives. Artificial Lift — Modernization of Grebinka compressor station, with its In 2019, 9 artificial lift systems were installed on wells of stable operation is of strategic importance for the opera- the Shebelynka and Poltava gas production units (1 plunger lift tion of Ukraine’s gas transportation system and is one of and 8 capillary injection systems) in partnership with Weath- the obligatory components that ensure the reliability of Key streams for supply chain management transformation erford (Weatherford Ukraine LLC). The pilot project resulted in Ukraine as a transit nation and as a transporter of natural an increase of average well production by 26 thousand cubic gas within its borders. Modernization of the station will Centralized Category Master Data Professional Transport & Logistic meters per day with all 9 wells continuing to operate without make it possible to increase economic and environmental warehouse & stock management Management tender management the need for blowdowns, positively impacting the volume of operating indicators to the latest European standards. management System committee trade gas while reducing emissions and HSE risks incurred Thus, new gas turbines consume up to 4,900 cubic during fracking. meters of fuel gas per hour to support their operation, Optimization of not Creation of new Create integrated Create one Transport utility 50 more capillary injections systems are planned for installation which is 15% more efficient compared to the old ones. At GOVERNANCE CORPORATE efficient structure and products permanently active rate and routes in 2020 to obtain additional production of 15 million cubic the same time, based on actual testing results, the level warehouse and process nomenclature as a tender committee improvement via meters in 2020 and 53 million cubic meters in 2021. of nitrogen and carbon dioxide emissions is within the structure basis of SCM data / responsible centralization of norms of the Directive 2010/75/EU, which covers indus- Launch of category management Supply Chain logistic and trial emissions. Optimization of management Manager transport function costs and improved processes by TECHNICAL ENABLEMENT OF GAS — Reconstruction of Beregovo gas measurement station, control selecting pilot Optimization local TRANSPORTATOIN SYSTEM AND STORAGE which is an important component of Ukraine’s gas transpor- categories and tender committees tation system, since it is at this station that natural gas trans- Optimization of preparing FACILITIES OPERATION ported from Ukraine to Hungary is measured. Approximately stock level regulation on category In the year of active preparation for unbundling of natural gas 12-13% of natural gas that Ukraine transports to Western management transmission activities, the service branches of JSС Ukrtransgaz, European and Balkan nations comes through the station. In which are part of Technical Business Enabling Unit, performed a 2019, the pumped volume of natural gas exceeded 15 billion range of major projects. cubic meters. Main and back-up gas measurement systems RESPONSIBILITY Key streams of activities of Technical Business Enabling using high precision ultrasonic gas meters manufactured by Source: Ukrgasvydobuvannya Unit for the natural gas transmission system and storage fa- Sick AG and RMG Messtechnik, as well as new automatic AND SOCIAL ENVIRONMENTAL cilities operations in 2019 were capital repairs (53%), capital flow chromatographs to measure natural gas composition construction (21%) and investments in equipment (8%). and hygrometers to measure moisture level, were installed Among 2019 projects, it is worth highlighting the following: at the station as part of reconstruction efforts. — Bar compressor station reconstruction, which is part of Upon completion of unbundling of gas transmission activ- Ukraine’s gas transportation system modernization, began ities, service branches of JSC Ukrtransgaz, which are part of in February 2018. German engineering company Ferrostaal Technical Business Enabling Unit, perform supply of services Industrieanlagen GmbH is the general contractor for the for repair, maintenance, technical diagnostics of gas trans- project. Reconstruction will improve energy efficiency portation system objects and big capital project execution of the station. Efficiency ratio of gas-pumping units will support to the Operator of GTS of Ukraine LLC from 1 January increase from 25% to 36% and annual savings of fuel gas 2020. In parallel, JSC Ukrtransgaz service branches are to be are estimated to be around 76 million cubic meters. Aside transformed through 2020 as part of the effort to build a sin- from that, the station upgrade will significantly increase gle integrated technical competence within Naftogaz Group the inter-repair period and emission volumes will corre- taking into account internal needs, the needs of the Operator spond to the latest European norms. Station commission- of GTS of Ukraine LLC, and other sources of market demand ing is planned for 2020. for such services. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 98 Naftogaz Group Annual Report 2019 99 Naftogaz Group AVERAGE DAILY GAS, OIL AND CONDENSATE PRODUCTION IN 2019 Growth factors: switching to new productive horizons UKRNAFTA PJSC repairing prospective wells OIL AND hydrofracturing GAS +7% CONDENSATE +5% optimizing well production RESULTS replacing heavily worn-out equipment MARKET AND REFORMS
— For the second year in a row, the company increased of operations at active wells including a shift to new government to the shortcomings of state auctions and has to sell oil and gas condensate at nearly 50% of the auctions production despite limited financial resources and productive horizons, carrying out capital and ongoing proposed ways to avoid this problem, given the instability because of high (as the buyer believes) starting prices. In restricted ability to invest resulting from a tax debt. repairs of prospective wells, conducting hydrofracturing and of the cash flow and the inability of the company to freely 2019, out of 20 oil and condensate auctions, 11 auctions were — With its increased production, the company faced the enhancement, well production optimization, and replacement dispose of the extracted oil and condensate. However, no declared as failed. As a result, in 2019, 242.8 thousand tons of impossibility of selling oil and condensate, caused by of critically worn out equipment. changes have been made to the oil sales mechanism. oil remained unsold, which is equal to two-month production imperfect mechanism of regulated sales through auctions In particular, last year, the company completed well Under the current conditions of Ukrainian oil sales, volumes. and a lack of vertical integration with the refining segment. workovers (hereinafter WOs) at 160 wells and conducted Ukrnafta is not sufficiently integrated with the refining In 2019, the company failed to sell oil equivalent to two 42 production enhancement operations (including 7 segment and is the only company that sells crude oil and gas months of production volume. hydrofracturing operations). WOs helped increase production condensate of its own production exclusively at exchange
— Due to the collapse of government oil and condensate of oil and condensate by 60.1 thousand tons and of gas by auctions. Throughout 2017-2019, the company was unable AND OPERATIONS STRATEGY auctions and a forced shift to tolling refining, as well as 98.2 mcm as of 31 December 2019. Enhancement operations a significant fall in gas and oil prices, the company was added 8.8 thousand tons of oil and 4.4 mcm of gas while unable to convert its production growth into a positive production optimization operations – 75 thousand tons of oil financial result for 2019. and condensate and 15 mcm of gas. Oil and condensate production in 2014-2019 — Despite the debt repayment mechanism agreed in 2019 The average daily production of oil and condensate for a total of nearly UAH 30 billion, its implementation was increased by 5%, up to 4.15 thousand tons / day compared to 2 500 blocked by the government. Plans to appoint a new CEO last year's indicator of 3.97 thousand tons / day. -11.5% +5.0% and define a new strategy for company development were Average daily gas production increased from 2.96 mcm / 1 888 -9.1% +4.7% 2000 -9.2% also postponed. day to 3.18 mcm / day. 1 671 — Along with agreeing the mechanism for repaying the tax 1 518 1 448 1 516 1 379 debt in 2019, the shareholders reached a decision on 1 500 changes in corporate governance, taking into account LIMITATIONS ON OIL SALES
OECD recommendations and Ukrainian legal and GOVERNANCE CORPORATE
regulatory provisions. In particular, the company's charter, In 2019, Ukrnafta sold 1275.75 thousand tons of oil and thousand tons 1000 the composition of the supervisory board, and regulations condensate (84% of its production volume) in accordance with covering supervisory board operations were amended. the Law of Ukraine "On Oil and Gas" and the CMU Resolution 500 No. 570 "On the Organization and Conduct of Exchange Auctions for the Sale of Crude Oil, Gas Condensate Produced 0 PRODUCTION by the Company and Liquefied Gas." Starting from March 2019, potential buyers refused to 2014 2015 2016 2017 2018 2019 In 2019, oil and condensate production increased by 4.7% buy oil and condensate at state auctions because the pricing Source: Ukrnafta and gas rose by 7.4% compared to 2018. mechanism set by the state produced starting prices for the The company managed to achieve positive production most part higher than the cost of imported crude oil of similar results with limited investment resources due to a number quality. Ukrnafta has repeatedly drawn the attention of the Average daily oil and condensate production RESPONSIBILITY
4.4 AND SOCIAL ENVIRONMENTAL 1 Ukrnafta's key production indicators 4.2 Production indicators Unit 2019 2018 Change % 4.0 Oil and condensate production thous tons 1 516 1 448 5% Gas production mcm 1 162 1 082 7% 3.8 LPG production thous tons 112 110 2% 3.6 Production losses because of special permits blocked Operating wells pcs 1 997 2 093 -4% thousand tons / day thousand tons / day 3.4 Additional oil and condensate production from operational & technical activities thous tons 175 154 13% Additional gas production from operational & technical measures mcm 138 112 23% 3.2 Commissioning of new wells from drilling pcs 3 2 50% 3.0 Number of production enhancement operations well-oper. 42 87 -52% Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec 2017 2018 2019 FINANCIAL OVERVIEW AND STATEMENTS Source: Ukrnafta Source: Ukrnafta
Annual Report 2019 100 Naftogaz Group Annual Report 2019 101 Naftogaz Group The restrictions on oil sales imposed by the government by up to 20%. For a certain period of time, prices for Urals Average daily gas production have led to a reduction in oil sales and an increase in (the main indicator for the sale of Ukrainian oil) fell below operating costs. In 2019, the company’s sales of oil and USD 20/barrel, well below its full cost including subsoil royalty 3.8 petroleum products in the wholesale segment decreased and other tax payments. The situation is exacerbated by the 3.6 by 335 thousand toe against the previous year. As a result, fact that before the fall of prices, Ukrnafta has accumulated according to Ukrnafta's estimates, the company under-received about 420 thousand tons of oil and condensate (extracted 3.4 UAH 4.7 billion in net sales revenue. In addition, Ukrnafta has in December – March), which the company could not sell 3.2 under-received about UAH 3.0 billion, mainly due to a 29% at the regulated auctions. The royalty for this unsold oil and MARKET AND REFORMS 3.0 decline in sales in the retail segment, as well as a decrease in condensate, calculated based on the December – March the average selling prices for petroleum products: by 2% for prices much higher than current rates, has already been
mcm/day mcm/day 2.8 gasoline and by 13% for liquefied gas. At the same time, the accrued and paid. 2.6 adverse impact of falling natural gas prices was balanced by an In such circumstances, Ukrnafta's production operations 2.4 Production losses because increase in sales volume of 226 mcm. Due to all these factors, become unprofitable and the company faces a risk of a 2.2 of special permits blocked net sales revenue decreased by UAH 7.9 billion (-22%) to shutdown. UAH 28.2 billion compared to 2018. 2.0 Due to the collapse of the state auction system, Ukrnafta Jan Feb Mar Apr May June July Aug Sep Oct Nov Dec was forced to change its oil monetization model. Since April ARBITRATION AGAINST THE RUSSIAN FEDERATION 2017 2018 2019 2019, the company started buying its own oil at state auctions Source: Ukrnafta with subsequent refining on the terms of tolling at the facilities On 12 April 2019, the international arbitration tribunal of the Kremenchuk Oil Refinery. Given the refusal of the ordered the recovery of over USD 44 million from the Russian Ukrainian oil refineries and regulatory limitations to buy oil Federation in favor of Ukrnafta PJSC as compensation for AGREEMENT WITH NAFTOGAZ CORPORATE GOVERNANCE REFORM and condensate, the switch to tolling operations allowed to expropriation of investments in the Autonomous Republic of AND OPERATIONS STRATEGY avoid a complete shutdown of production in Q2 2019 due to Crimea. In May 2019, the Russian Federation appealed to the The problem of tax debt remains a major obstacle for Along with agreeing the mechanism for the settlement overloaded reservoir parks. Supreme Court of Switzerland, requesting that the decision of the continued effective operations of the company. Last year of the tax debt in 2019, Ukrnafta's shareholders decided to As a result of tolling operations, the company received a the international arbitration court be overturned. On 12 De- (and as of the date of this report), Ukrnafta was not able amend the company's charter based on the requirements of full basket of petroleum products with different profitability. cember 2019, the Supreme Court of Switzerland dismissed to implement the tax settlement mechanism approved by the Law of Ukraine "On Joint Stock Companies", and approved According to Ukrnafta's data, the profitability of tolling the request of the Russian Federation. This decision is final the shareholder meeting in March 2019. The mechanism regulations on the supervisory board, taking into account OECD operations is positive, however its level was lower than and is not subject to appeal. In addition, the Supreme Court envisaged the purchase by Naftogaz of natural gas totaling corporate governance guidelines. As a result, the supervisory profitability in oil sales. As a result, the cost has increased of Switzerland ordered the Russian Federation to pay 155 000 2.062 bcm already injected by Ukrnafta to UGS in 20061, and board is currently composed of 6 independent members (3 by UAH 1.2 billion compared to 2018. In addition, other Swiss francs to Ukrnafta PJSC as costs for the proceedings. prepayment for 2 bcm of of future production. This would of which are Naftogaz nominees, however they meet criteria operating expenses increased by UAH 4.2 billion compared enable Ukrnafta to completely repay tax debt, along with fines of independence, like all other independent members) and 5 to the previous year. The main factors behind the increase and penalties. members representing shareholders (3 of which are Naftogaz in expenses are the accrual of provisions for trade and other At the time of arranging the agreement, the nominees), with the supervisory board being delegated the receivables of UAH 3.3 billion, as well as the effect from the independent appraiser concluded that the terms of the power to appoint and dismiss the chairman of the board. revaluation of fixed assets and reserves of UAH 0.9 billion. GOVERNANCE CORPORATE agreement were in line with normal market conditions. At In March 2019, the shareholders elected a new supervisory All together, these factors – a decrease in sales revenue, an the same time, this mechanism would allow Naftogaz to board of Ukrnafta and decided to terminate Mark Rollins' term increase in costs, and an increase in other operating expenses – make some payments to Ukrnafta while the state would of office as chairman of the board. led to a net loss of UAH 4.1 billion. be able to compensate Naftogaz for fulfilling public service By decision of the shareholders, from 1 May 2019, Oleg Despite these adverse factors, Ukrnafta paid obligations imposed on the company. The implementation Gez became acting chairman of the board until the election UAH 13.45 billion to budgets of all levels in 2019. The of this agreement was to be the first step in resolving both of a new chairman in accordance with the procedure set up company fully paid its current tax obligations and repaid over the issue of settlements with Naftogaz for gas produced in by the new Charter. The appointment of a new chairman of UAH 60 million in overdue tax debt. At the same time, Ukrnafta 2006-2011 and the problem of receivables from 2012-2015 the board and his tasks depend on the tax debt settlement, became the eighth largest taxpayer in Ukraine. together with minority shareholders. Such comprehensive which is necessary to unlock the company's operations. Status In 2020, the company faced the problem of falling demand changes would allow the company to unlock its activities, of the tax debt issue determines the range of tasks to be for petroleum products and record low oil prices. Due to however in April 2019, the CMU blocked signing of the dealt by the chairman of the board, as well as the possibility restrictions on movement due to quarantine measures, the aforementioned gas purchase agreements. The companies of implementing an active company development strategy. consumption of petroleum products is expected to decline RESPONSIBILITY returned to the implementation of this mechanism only in Currently, the price crisis in the oil market exacerbates the 2020. process, which requires shareholders to review plans in these AND SOCIAL ENVIRONMENTAL The company is currently working with Naftogaz to resolve areas. the tax debt problem. As the first step, on 31 January 2020, 5 Ukrnafta's key financial indicators Ukrnafta received 2.062 bcm of natural gas that had not been paid since 2006. At the same time, Naftogaz and Ukrnafta UKRNAFTA'S KEY FINANCIAL INDICATORS signed purchase and sale agreements for this volume of gas and Financial indicators Unit 2019 2018 Change gas of future production. Ukrnafta transferred gas to Naftogaz On the one hand, Ukrnafta managed to increase oil and gas Net sales revenue UAH mn 28 210 36 113 -22% and the parties signed an acceptance certificate. Further production, on the other hand, the company failed to convert Gross profit UAH mn 12 257 21 330 -43% implementation of the agreements was highly dependent on this increase into a positive financial result due to the collapse Operating profit (loss) UAH mn (4 505) 7 979 -156% the government's further steps. In particular, measures that of the state auction system for oil and condensate, forced would enable compensation for the fulfillment of public service switchover to tolling operations, as well as a significant fall in Net profit (loss) UAH mn (4 058) 6 438 -163% obligations by Naftogaz Group need to be adopted. natural gas and petroleum product prices. Capital investments UAH mn 1 473 1 210 22% Taxes and duties paid UAH mn 13 450 16 286 -17%
1 If these volumes were not included in the scope of the agreement, it was likely that Naftogaz would have pay to Ukrnafta the market value of the natural gas as of May 2014, including the penalty accrued from the date of the Supreme Economic Court ruling in favor of Ukrnafta in May 2014. The estimated amount of compensation is USD 1.2 billion, which is more than twice the cost of the gas based on the agreed terms FINANCIAL OVERVIEW AND STATEMENTS (USD 0.5 billion). Source: Ukrnafta
Annual Report 2019 102 Naftogaz Group Annual Report 2019 103 Naftogaz Group NEW ENERGY THE PROJECTS CURRENTLY IMPLEMENTED BY THE NEW ENERGY BUSINESS UNIT
20 Construction of 33 Construction of 995Construction of MW Mariivka WPP MW Chudniv SPP kW MARKET AND REFORMS BUSINESS UNIT Andriivka SPP
THE KEY RESULTS OF THE NEW ENERGY BUSINESS By introducing stimulating tariffs, so-called "green tariffs", UNIT for the generation of electricity from renewable sources in Energy supply strategy Ukraine, the RES segment is now integrated into the energy 1Consolidated expert opinion on and construction of a compe- market and the installed capacity of plants generating electric- World* USA* EU* Ukraine tence center for the development, implementation and man- ity from sunlight and wind energy has significantly increased. 4% 5% 9% 1% 3% agement of renewable energy projects within Naftogaz Group. At present, local and foreign companies have implement- 14% 3% 7% 15% 24% 25% ed a number of RES projects in the Ukrainian energy market, 9% 5% 5% 7% 3% 2Elaboration of a development concept and organizational including with the support of international financial organi- 4% 6% 26% structure, and establishment, in December 2019, of the New zations. In 2019, more than 3.5 bn euros was invested in the 16% 12% 5% 28% 8% 1% Energy Business Unit for the implementation of renewable renewable energy segment in Ukraine. Despite the loss of a 8% AND OPERATIONS STRATEGY 21% 16% 25% energy sources (RES) generation projects. large share of assets in Crimea, Ukraine remains a leader in 7% RES development in the post-Soviet zone, but still lags far be- 35% 30% Launch of construction works pursuing implementation of the hind developed European countries and is currently failing to 29% 3 21% project "Chudniv SPP Construction" with a capacity of 33 MW. achieve the goals set out in the Energy Strategy of Ukraine. 23% 26% 13% Over the past 10 years, the cost of electricity production 26% 4Completion of construction of a meteorological mast 120 m from RES has decreased significantly and reached the level of high, installation of wind measuring equipment for the imple- the cost of electricity from conventional sources, which has 29% 30% mentation of the pilot project "Mariivka WPP Construction" allowed many countries to change the principles of stimulat- 38% 37% with a capacity of 20 MW. ing the use of RES. From 2020, Ukraine will move to a sys- 33% 33% 30% tem of auctions designed to introduce a competitive market 28% 5Establishment of relations with regard to the construction for renewable energy and ensure sustainable development 12% 7% of highly shunting capacities with one of the world’s lead- without creating additional burdens on the energy system of 2015 2035 2015 2035 2015 2035 2015 2035 ing manufacturers of products for dynamic stabilization of Ukraine. forecast forecast forecast forecast GOVERNANCE CORPORATE network load, peak load management with unstable energy Naftogaz Group, aiming to reduce the environmental generation. burden of Ukraine by cutting greenhouse gas emissions, RES Hydro Nuclear Coal Natural gas Oil A growing international consensus on the decarbonization also implements "green technologies" on the group's assets * Primary energy supply structure forecasted based on projected primary energy consumption pattern of the global economy has encouraged more than 150 coun- throughout Ukraine. The implementation of projects using its Source: BP Energy outlook 2019, Ukrainian Energy Strategy till 2035 tries to develop plans and set goals to generate an increasing own resources and with the involvement of experts with ex- share of energy from renewable sources. The Energy Strategy perience in implementing large-scale RES projects in Ukraine of Ukraine also includes the goal of increasing the share of allowed for the creation of its own competence center with Capacity of renewable sources in Ukraine renewable energy generation from 3% to 25% in the primary a team that has significant expertise in implementing RES energy supply structure by 2035. projects in Ukraine, information on wind and sun potential of 8 areas and regions of the country, network infrastructure, and 6.7 access to international investors and partners. 7 The next step was developing a vision and strategy for 6.1 RESPONSIBILITY 6 1.2 the transition of Naftogaz Group from an oil and gas com- 1.2 pany into an energy company with a portfolio of businesses 5 AND SOCIAL ENVIRONMENTAL in renewable energy and energy efficiency. This trend is -ob 3.5 GW served with almost all international (Shell, BP, Total, Eni and 4 EUR billion others) and many national oil and gas companies in response 3 5.5 Invested in the renewable to the changes in global energy trends and capital market 4.9 1.9 energy segment in Ukraine conditions. 2 in 2019 In order to develop a new profitable segment of "clean" 1.2 0.5 0.9 energy, increase the revenues and capitalization of Naftogaz 1 0.8 0.8 0.5 0.4 0.4 0.4 1.4 Group through "green investments", and strengthen the coun- 0.5 0.7 0 0.4 0.4 try's energy independence, the Supervisory Board decided to +25% create the New Energy Business Unit within the structure of 2014 2015 2016 2017 2018 2019* March 2020 Ukraine’s energy strategy Naftogaz Group. One of the key objectives of this new Business Solar power plants Wind power plants includes the goal of increasing Unit is fulfillment of Ukraine's international obligations and the provisions of the Energy Strategy of Ukraine till 2035 by addi- *According to the “Report on Conformity (Sufficiency) Assessment of Generating Capacities” of Ukrenergo SE NEC, as of 31 December 2019, the installed the share of renewable energy capacity of RES facilities in UES of Ukraine which are directly connected to the networks and supply electricity is: WES – 1 GW , SES – 3.6 GW generation in the primary tional production of alternative energy, both for internal needs
Source: NEURC data for 2019: NEURC data, Information on alternative energy FINANCIAL OVERVIEW AND STATEMENTS energy supply structure by 2035 and for other consumers in an economically feasible way. facilities which enjoy a "green" tariff (as of 01.01.2020), the data also includes installed capacity that did not produce electricity
Annual Report 2019 104 Naftogaz Group Annual Report 2019 105 Naftogaz Group The New Energy Business Unit was established on the basis 2Construction of Chudniv SPP with a capacity of 33 MW (Naf- of the Vuhlesyntezgaz of Ukraine SE and the Chudniv SPP togaz-Energoservice SE); Construction Project Implementation Office of the Naftogaz- Energoservice SE. The main activities of the Business Unit 3Construction of Andriivka SPP with a capacity of 995 kW (Naf- are: togaz-Energoservice SE). — creation and operation of renewable energy facilities; The New Energy Business Unit continues implementing — creation and operation of highly shunting power plants; a solar generation pilot project, explores promising areas,
— creation and operation of electricity facilities for electricity develops potential partnerships with international energy and MARKET AND REFORMS storage. service companies, and looks forward to the future develop- At the same time, because of uncertainty about the chan ment of the segment. ges in current Ukrainian legislation on renewable energy and the future of "green tariffs", projects for implementation are Strategic initiatives considered by the New Energy Business selected using a conservative approach. Unit: — acquisition of corporate rights for promising SPP and WPP The Projects currently implemented by the New Energy projects in Ukraine with international partners; Business Unit: — development of marine wind farms in the Black Sea aquatorium; 1Construction of Mariivka WPP with a capacity of 20 MW, name- — entering the shunting generation segment by building ly the component that includes wind potential research and high-shunting capacity, including near compressor stations design and estimate works (Vuhlesyntezgaz of Ukraine SE); of the Ukrainian gas transmission system. STRATEGY AND OPERATIONS STRATEGY
The main activities of the New Energy Business Unit
1 Concept 2 R&D 3 Pilot 4 Capacity addition
Chudniv (33 MW)
Solar power plants M&A 4 plots ready CORPORATE GOVERNANCE CORPORATE for construction (>150 MW)
M&A Onshore wind Mariivka (20 MW) power plants 1 plot ready for construction (>100 MW)
First wind farm Location: Mykolaiv and Offshore wind Odesa regions RESPONSIBILITY power plant Рlot area: 73 sq. km Distance to the shore: 25 km AND SOCIAL ENVIRONMENTAL Sea depth: 19-20 m
Analysis of the construction plan to build high-shunting capacity, including near the Balancing compressor stations of the gas transmission system
Source: Naftogaz FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 106 Naftogaz Group Annual Report 2019 107 Naftogaz Group COLLECTION RATE FOR HEAT
During the heating season, Naftogaz NEW Teplo LLC complied with the minimum level of 90% of settlements under PSO 70% 86% terms BUSINESSES Novyi Rozdil Novoyavorivsk MARKET AND REFORMS
NOVOYAVORIVSK AND NOVYI ROZDIL CHPs As of the moment of transfer to the property complexes of Novoyavorivsk and Novyi Rozdil CHPs, the technical condition The heating season of 2019-2020 in Novoyavorivsk and of the combined thermal power plants required urgent repairs Novyi Rozdil, with a total population of almost 60,000 people, of core and auxiliary production equipment, heating networks, did not start on time due to reasons related to the activities purchase of chemical reagents for complex chemical water of Garant Energo M, a private property manager of No- treatment, etc. voyavorivsk and Novyi Rozdil CHPs. Problems were also identified in the field of sales: the Based on the results of a tender arranged by the National subscriber base of Novoyavorivsk CHP was not transferred to
Agency of Ukraine for Detection, Investigation and Manage- Naftogaz Teplo LLC. In Novyi Rozdil; the previous manager (Ga- AND OPERATIONS STRATEGY ment of Assets Obtained from Corruption and Other Crimes rant Energo M ) did not maintain a subscriber base; and town (hereinafter ARMA), in 2018 (and again in 2019) Garant Ener- residents were not invoiced for heating and hot water during go M was selected as the property manager of both CHPs. the heating season of 2018-2019. During just one heating season of 2018-2019, both As a result, Naftogaz Group had to incur costs for the CHPs increased their debts to Naftogaz of Ukraine NJSC start-up of the CHPs and the launch of the heating season in and Ukrtransgaz JSC for gas consumed and transportation both towns, realizing the need to eliminate emergencies and services worth UAH 0.4 billion. The total debt of the CHPs provide the necessary maintenance of equipment not carried to Naftogaz Group enterprises at the beginning of the heat- out for years. ing period 2019-2020 amounted to UAH 0.8 billion. This Managed by Naftogaz Group, both CHPs successfully management approach led to an increase in debt by an passed the heating season, and emergencies were resolved additional UAH 0.7-1.0 billion. The total debt at the end quickly and with no social tensions. A thermal energy consum- of the heating season of 2019-2020 is set to amount to er base was established in Novyi Rozdil. In both towns, the about UAH 1.4-1.7 billion. subscriber bases were audited in cooperation with local au- GOVERNANCE CORPORATE In addition, from a technical point of view, the stations thorities, housing and communal services (ZhEK), the Bureau and the heating networks were not prepared for the heating of Technical Inventory (BTI), and regional gas companies. Work season. Due to a failure to perform scheduled maintenance is currently underway to improve the quality of customer and repair works in order to prepare for the heating season service. Payment discipline was gradually established in both during the previous three years, equipment at the stations towns. 70% of thermal energy bills are paid in Novyi Rozdil, and the heating networks were in poor condition. The station and 86% – in Novoyavorivsk. During the heating season, Naf- and power plant workers went on strike because of six-month togaz Teplo LLC complied with the minimum level of 90% of wage arrears. The residents of Novoyavorivsk and Novyi Rozdil settlements under PSO terms. blocked roads to draw attention to their cold homes. At the same time, the transfer of single property complex- The risk of disruption to the heating season in these towns es of Novoyavorivsk and Novyi Rozdil CHPs under the manage- was recognized as a potential manmade emergency. ment of Naftogaz Group enterprise made it possible to avoid In order to prevent emergencies in the towns of No- the illegal withdrawal of natural gas and prevent the increase RESPONSIBILITY voyavorivsk and Novyi Rozdil, Lviv region and ensure smooth in debt for natural gas and transportation services by at least heating season of 2019-2020 in the towns in accordance UAH 0.7-1.0 billion. AND SOCIAL ENVIRONMENTAL with Article 16 of the Civil Protection Code of Ukraine and Novoyavorivsk and Novyi Rozdil CHPs are unique objects as Article 10 of the Law of Ukraine "On Heat Supply", ARMA they have high-shunting generating capacities. The gas -tur was instructed to take urgent steps to change the manager bines, if prepared properly, due to their speed, can help bal- of the property complexes of Novoyavorivsk and Novyi Rozdil ance the unified energy system of Ukraine, and in the future combined thermal power plants, to ensure their proper oper- become a potential additional source of income. ations. Intensive integration of RES in Ukraine requires much more Accordingly, in pursuance of the Resolution of the Cabinet flexibility from the power system. This is possible through of Ministers of Ukraine of November 6, 2019 No 1040-r “The high-shunting generation. There is already a shortage of such issues of ensuring smooth heating season of 2019/20 in the capacity in the country. International experience of participa- towns of Novoyavorivsk and Novyi Rozdil, Lviv region, Naftogaz tion in the regulation of electricity producers proves that the Group (represented by Naftogaz Teplo LLC) was appointed the use of gas turbines is one of the most efficient ways to do this, manager of the two combined heat and power plants in No- which meets the requirements for equipment in terms of load voyavorivsk and Novyi Rozdil, that ensured the restoration and acceptance speed. It is this type of energy generation that stable operation of Novyi Rozdil CHP and Novoyavorivsk CHPs. Naftogaz Teplo LLC manages and develops. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 108 Naftogaz Group Annual Report 2019 109 Naftogaz Group MODERNIZATION OF INDIVIDUAL AND DISTRICT residents had the chance to benefit from the EBRD IQ Energy ENHANCING HOUSEHOLD ENERGY EFFICIENCY HEATING program and receive an additional 35% grant compensation for special turnkey consumer products developed by Naf- Households consume about a third of the total final ener- togaz-Energoservice SE, which include not only equipment Within the framework of the Affordable Heat Additional compensation gy consumption in Ukraine, with the largest share of this ener- and components, but also a range of design and engineering program, Naftogaz-Energoservice SE and city of 35% of costs from the gy used to heat homes. services and registration of permits. For the convenience of council provided compensation to the low- EBRD IQ Energy program Improving the efficiency of energy use by households is consumers, a Center for Energy Services was opened in Kro- 50% income families in Kropyvnytskyi and Kirovohrad 35% the key to overcoming energy poverty, strengthening energy pyvnytskyi, where people can get both professional advice and region MARKET AND REFORMS security, and mitigating negative impact on the environment. order all the above-mentioned services of the EBRD IQ Energy Naftogaz-Energoservice SE of Naftogaz Group implements program. measures to improve the energy efficiency of households, -in The objective of the Affordable Heat for Employees project cluding the Affordable Heat program and the Affordable Heat is to increase the efficiency of gas use for heating the homes reduced and Naftogaz Group managed to avoid losses of at is mostly inhabited by the employees of Shebelinkagazvydobu- for Employees project. of employees of Naftogaz Group, as well as in the cities and least UAH 500,000 annually. vannia GPU, Ukrgazvydobuvannia JSC. Since 2018, the Affordable Heat program has provided towns where the group is present. The residents of the village of Mryn with the help of Naf- As a part of the project, individual gas heating systems energy services to the residents of Kropyvnytskyi and Since 2018, in the village of Mryn, Chernihiv region, togaz-Energoservice SE replaced heating equipment and are installed at 527 sites in the village of Donets and design Kirovohrad regions. It has also installed individual heating apartments of employees of Chervonopartyzanske VUPZG, installed individual heating systems with savings of up to 40% documentation is developed for another 290 sub-projects systems for residents of Kropyvnytskyi in order to optimize Ukrtransgaz JSC in 2-3-storey apartment buildings have been due to direct Naftogaz cooperation with the equipment man- to be implemented in 2020. The project implementation the district heating system. Optimization measures are transferred to individual heating. The need to transfer arose ufacturers. In addition, consumers who chose the most highly helped consumers save 40-60% on heating. A total saving for implemented under a city program initiated and developed by due to an imbalance in the district heating system of the efficient equipment, with support of Naftogaz-Energoservice a standard two-room apartment during the heating season Naftogaz-Energoservice SE jointly with the city council. Low- village. This led not only to an increase in heat tariffs for con- SE, enjoyed additional compensation of 35% of costs from the makes up nearly UAH 10 thousand. income families benefited from the city program and received sumers, but also losses for the heat producer, because costs EBRD IQ Energy program. Naftogaz-Energoservice SE plans to expand its energy service guaranteed compensation from the local authorities equal were not covered even with by high tariffs. With the introduc- Since 2019, Naftogaz-Energoservice SE has expanded the and energy efficiency program to include the household seg- AND OPERATIONS STRATEGY to 50% of their modernization expenses. In addition, city tion of individual heating, heating costs of the villagers are project to include the village of Donets, Kharkiv region, which ment. CORPORATE GOVERNANCE CORPORATE RESPONSIBILITY ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 110 Naftogaz Group Annual Report 2019 111 Naftogaz Group IN THIS SECTION: SUPERVISORY BOARD MEETINGS IN 2019 115 | Address of the supervisory board member 117 | Corporate governance 121 | Report of Naftogaz supervisory board 25 140+ 131 | Executive board members and their remuneration MEETINGS RESOLUTIONS MARKET AND REFORMS 133 | Risk management HELD PASSED STRATEGY AND OPERATIONS STRATEGY CORPORATE GOVERNANCE CORPORATE RESPONSIBILITY ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL
PROCEEDINGS OF THE SUPERVISORY BOARD AND ITS COMMITTEES
In 2019, the company’s supervisory board held 25 meetings (including 13 extraordinary meetings) during which it passed resolutions on more than 140 items of agenda and considered numerous matters submitted for discussion. During the reporting period, the supervisory board continued supervising and regulating the operations of the executive board, all within the supervisory board’s powers as determined in applicable laws, the company’s Charter and the Rules of Procedure of the supervisory board. At each regular meeting, the supervisory board was presented with business update by the chief executive officer, internal audit and risk management reports. FINANCIAL OVERVIEW AND STATEMENTS CORPORATE GOVERNANCE CORPORATE
Річний звіт 2019 112 Група Нафтогаз Річний звіт 2019 113 Група Нафтогаз and guide the company’s transition to the global level, new internationally recognized managers joined us in this tough period for both the company and the country. The CEO, his team, and the company all deserve great credit for this. If Ukraine’s economic development is to continue, it is very important that this internationalization of the board remains.
Naftogaz is intimately related to global and regional fac- MARKET AND REFORMS tors. Transit revenues are one such feature. The remarkable result of the Stockholm arbitration is another example (un- imaginable in an isolated Ukraine). Finally, the ability to raise monies globally to further development is a third feature. I will also mention the active role played by international institu- tions (EBRD, IMF, European Commission) whose investments in Ukraine have contributed to the country’s stability and development. There can be no doubt that Naftogaz should serve Ukraine. ADDRESS OF The best way to do that is to trade with international custom- ers and gain access to international technology and experts. Naftogaz aims to become a global player in global energy markets. This will be an outstanding achievement that will
THE SUPERVISORY help Ukraine strengthen its international profile significantly. AND OPERATIONS STRATEGY BOARD MEMBER But this goal requires much effort. Ludo Van der Heyden OUR CHALLENGES Member of the supervisory board The challenges facing the Naftogaz supervisory board are the challenges facing Naftogaz: the transition to a post-un- Allow me to state at the outset that I feel privileged to be A qualified supervisory board is a team of experienced security, etc. This approach was chosen by developed OECD bundling world, recognizing that transmission was the core associated with Naftogaz, the company, my colleagues on the people with a wide range of professional knowledge to meet countries, which arrived at this point via trial and error many of Naftogaz’s profitability, the transformation of the company supervisory board, the management, and all Naftogaz employ- shareholder expectations of the company’s performance. years ago. into a viable energy company with a global reputation, and, in ees. All of us share a deep commitment to contribute, in our Supervisory board members have sufficient hands-on experi- the short-term, the crisis in the energy market together with respective roles and to the best of our abilities, to Ukraine’s ence and time to find the best way to achieve the company’s the impact of the coronavirus pandemic. There is no shortage development and to the country’s journey, where Naftogaz performance sought by shareholders. ON THE IMPORTANCE FOR UKRAINE AND of challenges. Naftogaz is going to go through a major trans- GOVERNANCE CORPORATE figures prominently. To meet those expectations, the supervisory board is NAFTOGAZ REMAINING CONNECTED WITH THE formation over the next 3 to 5 years in order to become an empowered to make important decisions on strategy, people energy company that operates at global levels. This requires (CEO and senior executives), financing of the business and its WORLD management competence of the highest level along with THE CRITICAL ROLE OF AN EFFECTIVE BOARD OF future through investment, and rewarding those that contrib- I hear that there are discussions in the Ukrainian parlia- governance capabilities. This is what Naftogaz is building. It is DIRECTORS ute to the enterprise. ment to become more “nationalistic” or “isolationist.” I would a fascinating and extremely motivating program. When making decisions, the supervisory board must con- strongly advise against this path, which is not in Ukraine’s For these efforts to be successful, it is crucial to build Corporate governance is a tricky topic. It is therefore al- sider the company’s responsibility for environment, health interests. Countries that isolate are not doing well in today’s good relations with the Ukrainian government as the sole ways good, at the beginning of any discussion of the topic, to and safety, and relations with local communities. It monitors global world. Countries that are doing well are countries that shareholder of Naftogaz. Recent years also demonstrate that remind all stakeholders that the primary role of the supervi- the system of internal controls and prevents corruption. The interact with the world (think of China, whose development Naftogaz delivered the best results for Ukraine when the sory board is to be responsible for the organization’s perfor- decisions of the supervisory board are made after consultation was only made possible by a global economy, of Portugal and company enjoyed the trust and cooperation of the Cabinet of mance. In this reform process, Ukraine uses the experience with stakeholders - government, employees, clients, suppliers. Poland that both did so well thanks to investments made after Ministers, Verkhovna Rada, and President. Of course, this trust of OECD countries which have achieved high quality of life Consultation implies listening, but does not mean agreement they joined the EU). should be deserved. We are happy that in 2020 the govern- RESPONSIBILITY for their citizens. OECD Guidelines on Corporate Governance with what has been said. The supervisory board is professional In today’s world, one has to be both local and global. ment confirmed Andriy Kobolyev in his role as CEO, which we of State-Owned Enterprises provide that supervisory boards and independent in its judgment and is driven by what is good The most competitive countries are smaller countries like regarded as vital for Naftogaz’s ability to implement an ambi- AND SOCIAL ENVIRONMENTAL should carry out their functions of strategic guidance and for the organization and facilitates the implementation of the Singapore, Switzerland and Denmark. These are all very open tious transformation program. monitoring of management based on the goals set by the ownership policy. countries. The level of scientific and industrial collaboration For Naftogaz, as for any other company, contextual sta- government. The boards of SOEs should have the necessary One of the most complicated issues causing the strongest has never been so intense. Exchanges of people, knowledge, bility and predictable working conditions are very important. authority, competencies and objectivity; they should act with tension is the need to balance between long-term sustain- and finance have never been greater. I am a strong believer in Having a clear ownership policy and charter, which complies integrity and be held accountable for their actions. able development of the company aimed at creating value mixing local specifics and strengths with global opportunities with OECD guidelines, would help. These are the main ele- Usually, people are willing to assume responsibility if they and short-term interests such as dividends for shareholders and contributions. It is this mix that will allow Ukraine and ments that are needed to complete the corporate governance have autonomy in decision-making: it would be too easy for (limiting investments and development) or remuneration for Naftogaz to flourish. reform of SOEs in Ukraine, and we hope this will happen some to call the shots, while others are held responsible for managers and employees. The mix of international and Ukrainian board members soon. Naftogaz used to be considered the biggest problem of outcomes. The autonomy of boards can create tensions with Governance means a proper balance of various inter- has molded into an effective group, with rich and diverse Ukraine’s state budget while gas supply to the country was a shareholders and executives, as the latter like autonomy, too. ests. Seeking the right balance between various interests or viewpoints. The energy market is international, with many chronic headache for the Ukrainian authorities. Naftogaz is Governance amounts to the proper exercise of this autonomy choosing among various options, supervisory board members players. The fact that Naftogaz has international board now consistently the biggest revenue source to the state bud- within a given (legal, owners, regulatory) framework. To facili- should always pursue the company’s interests. members brings outside views and a level of expertise that get and key to the country’s energy independence. tate and clarify their expectations, shareholders typically write Introducing these principles, a properly governed company is not that easily available in the country. With a world that Naftogaz is a prominent example of how SOE corporate an ownership policy, which specifies what owners expect from creates value for its shareholders. SOEs also perform addition- is globalizing, boards have become more international. The governance reform has truly benefited the company, the the board and the company they own. al functions such as facilitating market reforms, R&D, energy company’s supervisory board is no exception. To support shareholder, and the country. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 114 Naftogaz Group Annual Report 2019 115 Naftogaz Group CORPORATE
GOVERNANCE MARKET AND REFORMS
In March 2015, the Gas Sector Reforming Implementation order to bring it into line with the requirements of current Plan was agreed with the World Bank and the Secretariat of legislation and OECD principles and governance; the Energy Community and then approved by the Cabinet of — elimination of political interference in the management of Ministers of Ukraine. This Plan, among other things, provided the company and creation of market conditions that are for the reform of the corporate governance system of the equal to those for commercial companies; Naftogaz Group in accordance with the principles of the Orga- — replacement of existing ineffective controls by the state nization for Economic Cooperation and Development (OECD). with appropriate mechanisms of internal controls; The Gas Sector Reforming Implementation Plan, including — determining the status of the company's property, the corporate governance reform of Naftogaz Group, is part including the stocks of companies in which the company is AND OPERATIONS STRATEGY of Ukraine's obligations under the terms of loan agreements a shareholder. with the European Bank for Reconstruction and Development Partial resolution of these issues in the part that requires (EBRD). It is a necessary step for Ukraine's integration into the amendments to the laws of Ukraine was expected in 2019 European Union. The success of the reform is important for with the adoption by the Verkhovna Rada (parliament) of the security of gas supply to Ukraine and Europe. Ukraine of the Draft Law "On Amendments to Certain Legis- The reform aims to implement rules and procedures that lative Acts of Ukraine to Improve Corporate Governance of are in line with global best practices, primarily the OECD Legal Entities in which the State is a Shareholder (Founder, Guidelines on Corporate Governance of State-Owned Enter- Participant)" (Draft law No 6428-d). However, this draft was prises and G20/OECD Principles of Corporate Governance. withdrawn. The company's specialists were actively engaged Naftogaz of Ukraine became the first state-owned com- in discussions with the Ministry of Economic Development, pany to launch best corporate governance practices in accor- Trade and Agriculture over a new draft law aimed at regulating dance with OECD principles. In particular, in 2016, a super- the issue of improving the corporate governance of legal enti- visory board with a majority of independent directors was ties in which the state is a shareholder (founder, participant). GOVERNANCE CORPORATE established, supervisory board committees were formed, a This draft law aims to amend current legislation in a way that corporate secretary was appointed, and regulations on super- it will allow effective implementation of corporate governance visory board committees and the corporate secretary service reform. were approved. In addition, during 2016-2018, the company Other steps on further implementation of the company's developed and implemented internal controls based on three corporate governance reform are expected from the Cabinet lines of defence. Launch of internal controls in 2018 was con- of Ministers of Ukraine. To this end, the company maintains firmed by an independent consultant. The internal controls an ongoing dialogue with the Cabinet of Ministers of Ukraine, of the company and Naftogaz Group are constantly subject to the Ministry of Economic Development, Trade and Agriculture, improvement. Uniform standards are being introduced, and as well as with other ministries, including with the participa- explanatory seminars are being held. tion of OECD representatives. In particular, in October 2019, At the same time, it should be noted that as of the end of corporate governance reform of the company was discussed 2019, the company's corporate governance reform has not during an OECD working session in a special panel on corpo- RESPONSIBILITY been completed, although a significant amount of work has rate governance reform of state-owned companies in Ukraine. been done. The event was attended by representatives of the government AND SOCIAL ENVIRONMENTAL In particular, the following important issues remain unre- delegation of Ukraine, as well as the head and members of the solved which are critical for the implementation of effective Supervisory Board of the company. corporate governance at Naftogaz Group: In 2019, Naftogaz Group continued to implement the -se — empowering the supervisory board with the necessary lected operating model, namely the introduction of divisions powers including approval of strategy, financial, business and corporate functions. These processes directly impacted and investment plans; elimination of inconsistency be- the corporate governance of Naftogaz Group legal entities. In tween the Charter of the company and current legislation, particular, in order to increase the personal responsibility of in particular the Law of Ukraine "On Joint Stock Compa- managers and improve decision-making processes, the colle- nies" regarding the exclusive powers of the Supervisory gial executive bodies of companies in which the company is Board to elect and terminate the powers of the Chairman the sole shareholder (participant), were replaced by sole exec- and members of the executive board, etc. utive bodies. Meanwhile, a requirement to agree transactions — establishment of a clear and transparent procedure for with the heads of the relevant divisions along with the binding payment of dividends based on the results of the company nature of the decisions of the heads of divisions/heads of and its subsidiaries; corporate functions were introduced. The procedure for man- — approval of a new version of the Charter of the company in aging divisions/corporate functions has been approved. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 116 Naftogaz Group Annual Report 2019 117 Naftogaz Group Levels of decision-making within Naftogaz Group
SHAREHOLDER (THE STATE REPRESENTED BY THE CABINET OF MINISTERS) MARKET AND REFORMS Identifies key operation areas and goals via ownership policy
SUPERVISORY BOARD (MAJORITY INDEPENDENT DIRECTORS) Approves strategy, appoints, controls and regulates the executive board STRATEGY AND OPERATIONS STRATEGY
EXECUTIVE BOARD HEADED BY CEO Appointment and specification of powers of All opeartions of the company (including performance as a shareholder (participant, founder) of legal business unit directors and authorized entities), except for issues of exclusive competence of the shareholder and the supervisory board heads of corporate functions* – within the powers of the board
Governance through decisions of authorized BUSINESS UNITS AND CORPORATE FUNCTIONS*
body GOVERNANCE CORPORATE Exploration and Production Business Unit Commerce Business Unit Oil Midstream and Downstream Business Delivery Unit Gas Storage Business Delivery Unit Decisions of executive board Decisions of executive board Governance in accordance with New Energy Business Unit are the decisions of the are the basis for the decision the constituent documents and highest governing body of the shareholder depending on the size of Technical Business Enabling Unit corporate rights of the company RESPONSIBILITY ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL
Decisions of business unit director /authorized head of the corporate function* are mandatory for relevant legal entity or its department within the powers specified in the charter of the relevant legal entity
Business entities fully Legal entities not fully owned by the company, Subsidiaries estab- owned by the company other legal entities of lished by the company Naftogaz Group
* Corporate unction is being developed FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 118 Naftogaz Group Annual Report 2019 119 Naftogaz Group REPORT SUPERVISORY BOARD COMPOSITION AS AT THE END OF 2019
OF NAFTOGAZ MARKET AND REFORMS Chair of the Deputy chair of Independent Independent Independent Supervisory supervisory board the supervisory director director director board member Clare board Bruno Lescoeur Amos Hochstein Ludo Van der Nataliya Boyko SUPERVISORY BOARD Spottiswoode Yuliia Kovaliv Heyden
STRUCTURE OF THE SUPERVISORY terminated on 11 September 2019, at the meeting held on PROCEEDINGS OF THE SUPERVISORY tangible assets used in the process of carrying out natural gas BOARD AND ITS COMMITTEES 22 October 2019, members of the supervisory board elected BOARD AND ITS COMMITTEES transmission activity by main pipelines and other transactions Yuliia Kovaliv as deputy chair of the supervisory board. entered into pursuant to the Action Plan for Fulfilment of During 2019, the composition of the supervisory board Pursuant to the relevant ordinances of the Cabinet of Changes in the personal composition of the supervisory Unbundling and Independence Requirements for the Gas was subject to a number of changes related to termination Ministers of Ukraine, service agreements were entered into board resulted in the renewed composition of its committees Transmission System Operator, as approved by Resolution of of authorities of individual supervisory board members and with all supervisory board members. over 2019. the Cabinet of Ministers of Ukraine dated 18 September 2019 AND OPERATIONS STRATEGY election of new ones based on a series of ordinances of the In 2019, independent directors submitted statements The current composition of supervisory board’s No. 840 “On Unbundling of Natural Gas Transmission Activity Cabinet of Ministers of Ukraine. (available on the company’s website) confirming that they meet committees is as follows: and Ensuring Operation of the Gas Transmission System In particular, Ordinance of the Cabinet of Ministers of the criteria of independence envisaged by applicable laws of — audit and risks committee: Bruno Lescoeur – chair of Operator”. Furthermore, in December 2019, the supervisory Ukraine dated 20 March 2019 No. 160-р provided for early Ukraine for independent directors of business entities in which the committee, Clare Spottiswoode and Yuliia Kovaliv – board reviewed and addressed the general meeting of the termination of authorities of independent director Steven the state owns more than 50 per cent of shares. members of the сommittee; company with a proposal for granting approval for the company Haysom who did not participate in meetings of the supervisory According to provisions of the service agreements — ethics and unbundling committee: Clare to enter into material transactions for ensuring natural gas board and its committees and did not discharge his other duties entered into with members of the supervisory board, Spottiswoode – chair of the committee, Amos transit through the territory of Ukraine going forward. as supervisory board member. He did not enter into a service remuneration for the performance of supervisory work is Hochstein, Ludo Van der Heyden and Nataliya Boyko – During 2019, the supervisory board adopted numerous agreement with National Joint Stock Company “Naftogaz of established at the level of gross UAH 6.3 million annually members of the сommittee; resolutions on organizational changes in the сompany aimed Ukraine”, was not remunerated and did not make a statement for independent directors and 75% of that amount for — nomination and remuneration committee: Amos at ensuring functioning of business delivery/enabling units and of his independence in line with the Rules of Procedure of the government appointees. Under terms and conditions of Hochstein – chair of the committee, Bruno Lescoeur and implementing the Naftogaz Group Transformation Project. With a Supervisory Board. service agreements, supervisory board members are also Ludo Van der Heyden – members of the сommittee; view to replacing collegial executive bodies of business entities in
This was followed by early termination of authorities of entitled to additional remuneration amounting to 20% of — committee on health, safety, environment and which the сompany is the sole shareholder (founder, participant) GOVERNANCE CORPORATE government appointee Volodymyr Kudrytskyi by Ordinance of the total remuneration for performance of the function of chair reserves: Bruno Lescoeur – chair of the committee, with sole executive bodies and implementing the matrix manage- Cabinet of Ministers of Ukraine dated 22 May 2019 No. 324-р, of the supervisory board and 10% of the remuneration for Amos Hochstein and Nataliya Boyko – members of the ment structure, the supervisory board granted prior approval to as well as by election of Ludo Van der Heyden (independent participation as member of a committee of the supervisory committee. resolution of the company’s executive board regarding amend- director) and Kostiantyn Marievych (government appointee) as board, as well as to compensation for their expenses ments to the charters of the relevant entities in late 2019. supervisory board members by Ordinances of the Cabinet of incurred during performance of supervisory work. Supervisory board members devoted sufficient time to As part of ensuring proper functioning of the system of Ministers of Ukraine dated 22 May 2019 No. 325-р (effective During 2019, the company incurred UAH 34.9 million in performing their duties as required by the Rules of Procedure of internal control, the supervisory board approved the Risk from 27 May 2019) and dated 26 June 2019 No. 448-р. expenses for the operations of the supervisory board. This the supervisory board. Assessment Plan of Joint Stock Company “National Joint The current composition of the supervisory board was amount includes UAH 29.4 million in service fees accrued and In 2019, the company’s supervisory board held 25 meetings Stock Company “Naftogaz of Ukraine” and the Procedure for formed by Ordinance of the Cabinet of Ministers of Ukraine UAH 5.5 million in compensation for expenses incurred by (including 13 extraordinary meetings) during which it passed acquainting internal audit department staff with conflict of dated 11 September 2019 No. 793-р which provided for early supervisory board members during performance of supervisory resolutions on more than 140 items of agenda and considered interest declarations at the meetings held on 21-22 January termination of authorities of government appointees in the work, including directors and officers liability insurance numerous matters submitted for discussion. During the 2019 and 19-21 February 2019 respectively. In order to align supervisory board Volodymyr Demchyshyn, Sergii Popyk, procured by the company to cover liability of these officers after reporting period, the supervisory board continued supervising the company’s operations with the requirements of the Law RESPONSIBILITY Kostiantyn Marievych, and election of Yuliia Kovaliv and Nataliya their election, as set by their service agreements. and regulating the operations of the executive board, all within of Ukraine “On Audit of Financial Statements and Auditing Boyko to the supervisory board as government appointees During 2019, no remuneration was paid to Yuliia Kovaliv the supervisory board’s powers as determined in applicable Activities”, the Procedure for selection of auditor for conducting AND SOCIAL ENVIRONMENTAL starting from 12 September 2019. for performance of supervisory board duties because of laws, the company’s Charter and the Rules of Procedure of the statutory audit of financial statements of National Joint In addition to the above changes in the composition of her appointment to an office subject to the provisions of supervisory board. At each regular meeting, the supervisory Stock Company “Naftogaz of Ukraine” was approved by the committees, given that the authorities of deputy chair of article 3 (1) clause 1 of the Law of Ukraine “On Prevention of board was presented with business update by the chief supervisory board on 25-26 March 2019. the supervisory board Volodymyr Demchyshyn had been Corruption”. executive officer, internal audit and risk management reports. In the reporting year, the supervisory board supported The most frequent matters submitted by the executive audits of the procurement and independent financial board for consideration at meetings of the supervisory board investigation (forensic) in individual Naftogaz Group and its committees were those pertaining to endorsement subsidiaries, as well as actions aimed at improving corporate SUPERVISORY BOARD MEETINGS IN 2019 (approval) of financial plans of the company and business governance in PJSC “Ukrnafta”, repayment of its tax arrears and entities in which the company is the sole shareholder (founder, addressing the situation with disputable stock of natural gas. participant), approval of investment projects, business plans A substantial number of items considered during meetings of individual business delivery units and business segments in 2019 concerned personnel matters, including: extension + for 2020-2024, approval of entering into interested party of the tenure of the chief executive officer of the company, 25 140 transactions and transactions exceeding the thresholds set election and termination of authorities of members of the out in clause 70 (32) of the сompany’s Charter, including executive board of the company and chief executives of
MEETINGS HELD RESOLUTIONS PASSED FINANCIAL OVERVIEW AND STATEMENTS transactions for alienation of own current and non-current business entities in which the company is the sole shareholder
Annual Report 2019 120 Naftogaz Group Annual Report 2019 121 Naftogaz Group (founder, participant), setting of goals and key performance company and director general of JSC Ukrtransnafta, because he documentation with state-owned banks, as well as approval of of unbundling of the natural gas transmission business, indicators and assessment of their achievements, appointment had been direct subordinate of Mykola Havrylenko in one of his the Annual Internal Audit Plan for 2019 and follow-up on inter- future operation of the unbundled gas transmission system and dismissal of officers directly subordinate to the supervisory previous positions. nal audit objectives. operator and regulation of the natural gas market. board and assessment of their performance, revision of the Members of the supervisory board raised the issue of approach to calculating the variable part of remuneration. the existence and management of the conflict of interest In preparation for the annual general meeting for 2018, of supervisory board member Kostiantyn Marievych who SHAREHOLDER AND EXTERNAL COMMUNICATION the supervisory board endorsed proposals for amendments simultaneously served on supervisory boards of the company to the company’s Charter and the Rules of Procedure of the and Joint Stock Company “Mahistralni Gazoprovody Ukrainy”. In 2019, the supervisory board maintained regular liaison MARKET AND REFORMS supervisory board, the separate and consolidated financial with the Cabinet of Ministers of Ukraine and the relevant statements as at and for the year ended 31 December 2018, ministries. and the company’s annual report for 2018. SUPERVISORY BOARD PRIORITIES Additionally, the supervisory board held working Under the Technical Assistance on Naftogaz Corporate sessions with representatives of the World Bank, European Reform 2018-2019 Project funded by the U.S. Department of The priorities of the supervisory board in 2019 were Commission, Energy Community Secretariat and other key State, members of the supervisory board undertook the training to prepare Naftogaz Group for unbundling of the natural stakeholders involved in the unbundling process. Moreover, on best corporate governance practices, which was delivered in gas transmission business by 1 January 2020, to ensure the the supervisory board held quarterly public events on June 2019 by professionals from Deloitte Corporate Governance continuity of the management of the company, to ensure unbundling with the engagement of representatives of Academy. proper functioning of the system of internal control of the governmental authorities, EU institutions, IFOs, G7 embassies, company and to work with the shareholder on revising the consortium of European gas transmission system operators company’s state ownership policy. and other external stakeholders to update on the status CONFLICT OF INTEREST Other issues extensively reviewed by the supervisory board included matters of compensation for the discharge of public During several supervisory board meetings, Volodymyr service obligations in the natural gas market and ensuring suf- COMPETENCE AND PROCEEDINGS OF SUPERVISORY BOARD COMMITTEES AND OPERATIONS STRATEGY Kudrytskyi informed of a potential conflict of interest in relation ficient financing to purchase additional stock of natural gas for to agenda items on the achievement assessment and resolving the 2019/2020 winter season, including external financing in other matters reserved to the supervisory board as regards foreign currency through the issue and placement of eurobonds AUDIT AND RISKS COMMITTEE statements, as well as justification and acceptability Mykola Havrylenko, member of the executive board of the on international capital markets, amending the existing loan of applied principles of financial statements, and any Key functions of the committee material correction of the statements; 3) to review the compliance and consistency of and any In line with the current Regulations on the audit and risks changes to accounting methods and the accounting pol- Attendance of supervisory board meetings in 2019 committee of the supervisory board, the key tasks of this icy along with how these changes affect the content of committee are as follows: the statements, across the company and its subsidiaries; Attendance of Assisting the supervisory board in protection of the 4) to consider any significant differences between the supervisory board Committee on 1сompany’s interests by preparing drafts and providing external auditor and management regarding the meetings in 2019 Ethics and Nomination health, safety, recommendations and proposals regarding: company’s financial statements.
(regular and Audit and risks unbundling and remuneration environment and 1) the completeness, accuracy and timeliness of the 2.4. To organize and perform the following functions related GOVERNANCE CORPORATE extraordinary)1 Supervisory board committee committee committee reserves preparation of the сompany’s financial statements; to internal controls and risk management: Clare Spottiswoode 24/25 16/17 12/12 15/17 4/4 2) the effectiveness of the internal accounting and 1) to review at least annually the overall state and Volodymyr Demchyshyn 16/17 12/13 8/8 12/12 3/3 financial controls of the сompany; efficiency of the company’s internal control and risk Bruno Lescoeur 25/25 17/17 11/12 17/17 4/4 3) the effectiveness of the сompany’s risk management management systems, including review of reports of Amos Hochstein 21/25; with partial presence during 7/17 3/12 14/17 2/4 activities; the external and internal auditors; meetings on 2-3 October 2019, 4) the selection, appointment, performance and 2) to review the effectiveness of corrective actions taken 9-10 October 2019 and ongoing work of the external (independent) auditor; by the management with respect to improvement of 16-19 December 2019 5) the selection, appointment, reappointment and the system of internal control and risk management; Steven Haysom2 0/6 0/4 0/2 0/4 0/1 dismissal of the chief audit executive, performance 3) to meet regularly with the executive board of the Sergii Popyk 15/17; with partial presence during 9/13 7/8 10/12 3/3 and ongoing work of the internal audit department; company to review significant risks and issues of the meeting on 13 May 2019 6) the treasury arrangements in place for the company. control and planning. RESPONSIBILITY Volodymyr Kudrytskyi 11/12 8/8 5/5 7/9 2/2 In accordance with the above tasks, the committee shall 2.5. To organize and perform the following functions related Ludo Van der Heyden 11/12; with partial presence during 8/9 5/7 6/7 2/2 perform the following functions: to external audit of the company:
2 AND SOCIAL ENVIRONMENTAL the meeting on 9-10 October 2019 2.1. To organize and perform preliminary review of the matters 1) to make recommendations to the supervisory board Kostiantyn Marievych3 1/4; with partial presence during 0/5 0/3 0/2 0/1 included into the agendas of the committee and the super- and where appropriate to the general meeting on the the meeting on 23 July 2019 visory board meetings, and related to finance, audit and appointment, reappointment or removal of the external Yuliia Kovaliv 8/8; with partial presence during 3/4; with partial 4/4 5/5 1/1 risk management. auditor, the audit fee and the terms of engagement meetings on 2-3 October 2019, presence during the 2.2. To organize and elaborate on drafting of conclusions, of the external auditor, to study issues that may be proposals, recommendations, other documents, draft deemed as the reason for dismissal of the external 18-19 November 2019 and meeting on policies, strategies, rules of procedure, procedures, auditor and to answer any questions of resignation or 16-19 December 2019 16-19 December 2019 decisions related to finance, audit and risk management, dismissal relating to the external auditor; Nataliya Boyko 8/8; with partial presence during 3/4 4/4 4/5 1/1 and submit them for supervisory board’s review. 2) to control compliance with the Law of Ukraine meetings on 18-19 November 2019 2.3. To organize and perform the following functions related “On Public Procurement” as of 25 December 2015 and 16-19 December 2019 to financial statements: No. 922-VIII and other applicable legislation in the Source: Naftogaz 1) to monitor and review the integrity, completeness, selection of the external auditor; accuracy and timeliness of the preparation of 3) to control independence and objectivity of the exter- 1 During meetings of the supervisory board and the audit and risks committee on 17 September 2019, changes in the composition of the supervisory board, as approved by Ordinance of the CMU dated 11 September financial information of the company; nal auditor in line with the Handbook of International 2019 No. 793-р, were not taken into account, given that as of the date of the said meetings, the relevant ordinance was not made public, was not communicated to the company or persons to whom it relates 2 Officially remained a supervisory board member until termination of his authorities on 20 March 2019 2) to review with the management of the company Quality Control, Auditing, Review, Other Assurance, and FINANCIAL OVERVIEW AND STATEMENTS 3 Was present only at the supervisory board meeting on 23 July 2019 during discussion of the matter regarding existence and management of the conflict of interest and the external auditor the summary financial Related Services;
Annual Report 2019 122 Naftogaz Group Annual Report 2019 123 Naftogaz Group 4) to establish and apply an official definition of a policy, 4) providing recommendations on the selection, amendments thereto, heard regular reports of the director of est and unbundling; types of services that are not subject to audit, and which appointment, reappointment and dismissal of the head the internal audit of Naftogaz Group – chief audit executive on 2) review of allegations of ethics-related breaches are excluded or permitted after the committee’s review of the budgeting unit; the execution of the plan and other internal audit matters. by officers and employees of the company, and or permissible without the recommendation of the 5) to provide the supervisory board with the report on In 2019, the committee cooperated with the external submission of relevant recommendations to the super- committee; the committee’s activity at least once every six months, auditor of the company – LLC “Deloitte & Touche USC” on the visory board; 5) to develop and implement policy on the engagement as also, upon supervisory board’s demand, regular results of audit of the consolidated financial statements of the 3) permanent review and monitoring of the conflict of of the external auditor to supply non-audit services, reports or information on certain matters of the com- company as at and for the year ended 31 December 2018 and interest among officers, executives and employees of
taking into account relevant ethical guidance regarding mittee’s activity; planning of the external audit for 2019. the company; MARKET AND REFORMS the provision of non-audit services by the external audit 6) to submit for review by the supervisory board of draft Through an open bidding for the procurement of audit 4) upon requests of officers, executives and employees firm; new versions of the Regulations on the сommittee or services, conducted in line with the Law of Ukraine “On Public of the company conducting, on a confidentiality basis, 6) to review efficiency of processes of the external audit, necessary amendments and additions thereto with the Procurement” and on the basis of a submission of the super- of preliminary evaluation of compliance of particular the nature and scope of the audit, to monitor the audit respective substantiation; visory board, the Cabinet of Ministers of Ukraine appointed instances of conduct with ethics rules of the company; and review any problems or reservations arising from 7) to perform other duties related to the committee’s LLC “Deloitte and Touche USC” as auditor for rendering the 5) analysis and review of the company’s rules, procedures the audit, the responsiveness of the management to competence when requested by the supervisory board. services of statutory audit of the financial statements of the and practice on ethics-related issues with a view to written recommendations and to review the findings The Regulations governing the committee’s activity pro- company for 2019-2020. The company performed internal identify possible breaches and assess their effectiveness of the audit with the external auditor, including but not vide for reporting to the supervisory board no less than once compliance procedures and verified independence of the au- to meet the company’s interests and needs; limited to the discussion of any major issues which arose per six months. ditor, namely its compliance with the specific requirements of 6) monitoring of the operating environment of the during the audit, including: the Law of Ukraine “On Audit of Financial Statements and Au- company and best international practices (general — any accounting and audit judgments; Key results in 2019 diting Activities” in the wording effective as of the date of such and sector-specific) in terms of corporate ethics and — levels of errors identified during the audit. verification. In its letter dated 30 March 2020, LLC “Deloitte unbundling, engagement with various stakeholders to 2.6. To organize and perform the following functions related to In 2019, the audit and risks committee held 17 meetings and Touche USC” informed the company and the audit and assess the adequacy of current company’s policies in
internal audit of the company: at which it passed more than 60 resolutions. During 2019, the risks committee that the key audit partner, officers and- em these areas; AND OPERATIONS STRATEGY 1) to submit for approval by the supervisory board the committee reviewed financial and investment plans of the ployees who participated in rendering the services of statuto- 7) ensuring the appropriate level of accountability and Regulations on the internal audit department; company and key business entities of Naftogaz Group. The ry audit of the consolidated and separate financial statements transparency of the company where this can eliminate 2) to make recommendations to the supervisory board on committee made recommendations to the supervisory board of National Joint Stock Company “Naftogaz of Ukraine” were or mitigate ethical risks for the company with due the appointment, reappointment or removal of the chief concerning significant investment projects of business entities independent of the company. account of the data protection requirements; audit executive; of Naftogaz Group and transactions that require prior ap- 8) ensuring awareness of ethics-related issues with the 3) to make recommendations to the supervisory board proval of the supervisory board. Furthermore, the committee company’s officers and employees, and the efficiency of on the terms of labour agreements which are being made recommendations to the supervisory board with regard ETHICS AND UNBUNDLING COMMITTEE available means to raise and handle their complaints; concluded with the internal audit department staff to matters of managing treasury arrangements of the compa- 9) promotion of effective communication between the (including with the chief audit executive); ny and Naftogaz Group, in particular, transactions for amend- Key functions of the committee company’s management and its staff with a view to 4) to prepare the draft budget of the supervisory board, ing terms of financial obligations of the company towards reinforce understanding of the company’s ethical val- including the budget of the internal audit department, banks and raising financial resources on international capital In line with the current Regulations on the ethics and un- ues and encourage their implementation, as well as to and submit it for approval by the supervisory board; markets through placement of corporate eurobonds. bundling committee of the supervisory board, the key task of deter unacceptable practices;
5) to submit the annual plan of risk-oriented internal audits To ensure the efficiency of the internal control and risk this committee is to assist the supervisory board in protection 10) advice to the company’s executive board on corporate GOVERNANCE CORPORATE for approval by the supervisory board; management systems, the committee considered the results of the company’s interests by evaluating and providing recom- ethics issues upon request of the latter; 6) to review reports on the activities of the internal audit of internal audits and reviews of the company and business mendations and proposals regarding: 11) reporting to the supervisory board on the tasks and department; entities of Naftogaz Group, as well as gave initiated reviews on 1) application of the Code of corporate ethics; functions of the committee performed within the 7) to review at least annually the performance and issues that require special attention, in particular, forensic- in 2) conflict of interest at the level of the officers and framework of preparing the annual report; effectiveness of the internal audit department; vestigations. The committee also held meetings with the- man employees of the company; 12) issuing recommendations to the supervisory board 8) to consider issues that prevent the internal audit agement of the company and key business entities of Naftogaz 3) amendments to the Code of corporate ethics as regarding the matters of the gas transmission system department from effective performance of set tasks, Group to consider matters of improving the effectiveness of mandated by the company’s mission and strategy in operator unbundling. and help eliminate such restrictions; corrective actions based on the results of audits performed. the changing operating environment; The Regulations governing the committee’s activity pro- 9) to ensure sufficient and adequate resources for The committee reviewed and made recommendations 4) effective implementation of the Code of corporate vide for reporting to the supervisory board no less than once the effective performance of the internal audit concerning risk management matters, approval of the Risk ethics in the company, monitoring and elimination of a year. department. Assessment Plan and quarterly risk dashboards of the compa- one-off and recurring violations of the Code of corpo- 2.7. To organize and perform the following functions related ny. In addition, the committee held regular meetings with the rate ethics by the company’s officers and employees; Key results in 2019 RESPONSIBILITY to treasury arrangements of the company to review and chief risk officer and management of the company to discuss 5) specific rules and procedures for handling of third-party report to the supervisory board on the overall manage- risk management reports and matters of improving the risk complaints related to ethics breaches committed by the In 2019, the ethics and unbundling committee held AND SOCIAL ENVIRONMENTAL ment of treasury activities in the company, including: management system. company’s officers and employees; 12 meetings at which it passed three resolutions and discussed — banking arrangements and relationships; Regarding the organization of internal audit, the com- 6) appropriate means to mitigate negative consequences more than 15 matters submitted for consideration of this — liquidity management and forecasting; mittee reviewed and made recommendations concerning caused by ethics breaches committed by the company’s committee. During 2019, the committee devoted considerable — debt management; the approval of the Annual Internal Audit Plan for 2019 and officers and employees; attention to the matters of control and cooperation with — interest rate risk management; 7) processes pertaining to or associated with unbundling of key external and internal stakeholders in the process of — treasury internal control. the gas transmission system operator, which are taking unbundling of natural gas transmission activity. In particular, 2.8. To organize and perform other responsibilities in the place both inside and outside Naftogaz Group as to members of the committee took an active role in meetings company, including: AUDIT AND RISKS COMMITTEE ensure their compliance with the Law of Ukraine “On with representatives of the European Commission Directorate- 1) to initiate and conduct special investigations as Natural Gas Market”, the Third Energy Package, and taking General for Energy, the Government of Ukraine, supervisory needed, including involving independent consultants into account legitimate interests of Naftogaz Group. board members of Joint Stock Company “Mahistralni (experts); The ethics and unbundling committee shall organize and Gazoprovody Ukrainy”, as well as representatives of the 2) to consider cases of fraud and assess the adequacy of + perform the functions related to: consortium of European gas transmission system operators measures taken by the management to prevent fraud; 17 60 1) review of the matters included into the agendas of the to discuss the matters of preparation for certification and 3) to consider the need for amendments to the committee and the supervisory board meetings, and operation of the independent gas transmission system
MEETINGS RESOLUTIONS FINANCIAL OVERVIEW AND STATEMENTS Regulations on the сommittee; related to corporate ethics, including conflict of inter- operator of Ukraine. Furthermore, members of the committee
Annual Report 2019 124 Naftogaz Group Annual Report 2019 125 Naftogaz Group ETHICS AND UNBUNDLING COMMITTEE assessment of the supervisory board members’ work; 11) periodic assessment of the structure, size, composition into with the chief executive officer, and setting the amount of 4) candidates for the positions of supervisory board and performance of the executive board and provision his remuneration. members. of recommendations for any changes; With a view to exercising supervisory board’s powers In accordance with the tasks, the committee shall perform 12) periodic assessment of the chief executive officer and specified by law, the committee conducted a preliminary 3the following functions: members of the executive board for conformity with review for making recommendations concerning matters of + 1) development and periodic review of the company’s qualification requirements and relevant reporting to the election and termination of authorities of executive board 12 3 15 policies (internal regulations) on nomination and supervisory board; members, as well as granting prior approval to resolutions of MEETINGS RESOLUTIONS MATTERS remuneration; 13) development of the succession plans for the chair and the executive board on election and termination of authorities MARKET AND REFORMS 2) preliminary review of the matters related to the members of the supervisory board; of chief executives of business entities in which National Joint nomination and remuneration of the chief executive 14) development of the succession plans for the executive Stock Company “Naftogaz of Ukraine” is the sole shareholder officer and members of the executive board, as well as board, ensuring that the executive board has an (founder, participant), and reviewed terms and conditions of participated in regular public events to raise awareness among other officials (if applicable pursuant to the Charter or appropriate succession plan for the company’s contracts with the aforementioned executives. At the same the public and a wide range of stakeholders about the status internal regulations of the company); executives; time, the committee placed considerable emphasis on perfor- of preparing for the unbundling and ensuring independence 3) organization of drafting and processing of draft 15) advising the supervisory board on the composition of mance-based incentives for executives of Naftogaz Group, in of the gas transmission system operator. policies, strategies, rules of procedure, resolutions its committees and periodic rotation of committees’ particular, by reviewing for setting objectives and key results The committee considered matters related to resolving and other documents that regulate the activity in the members; for 2019 and goals in mid-term projects (until 2021) of heads conflicts of interest, adherence to ethical standards by the area of nominations and remunerations of the chief 16) ensuring training programs for members of the of business delivery/enabling units, directors by business company’s management in covering information on Naftogaz executive officer and members of the executive board, supervisory board and the executive board required for areas of National Joint Stock Company “Naftogaz of Ukraine”, Group activity, as well as the whistleblowing process and re- preparing conclusions, recommendations, proposals their efficient performance in the corporate govern- key management personnel of Naftogaz Group companies. sponse to compliance violations. for the supervisory board; ance framework implemented by the company; Pursuant to terms and conditions of contracts and provisions 4) analysis of current and expected needs of the company 17) preliminary analysis of performance results of the chief of the company’s internal regulations, the committee conduct-
in professional qualification of the chief executive officer executive officer and members of the executive board, ed periodic assessment of achievements of executive board AND OPERATIONS STRATEGY NOMINATION AND REMUNERATION COMMITTEE and members of the executive board, other officers including in view of possible remuneration increase, members and performance of executives who are directly of the company nominated and dismissed by the application of other incentives; subordinate to the supervisory board. Key functions of the committee supervisory board, based on the company’s interests 18) monitoring of the supervisory board resolutions’ In addition, the committee made recommendations for the and development strategy, defining the eligibility criteria implementation within the committee’s authority; election of supervisory board members to its committees and In line with the current Regulations on the nomination and for nomination of candidates; 19) approving nomination of the company’s executives at assessment of supervisory board members’ work for 2018. remuneration committee of the supervisory board, the key 5) determination and ensuring selection procedures, their appointment; tasks of this committee are as follows: nomination of candidates and recommendation for 20) controlling the level and structure of remuneration How remuneration for supervisory board Assist the supervisory board approval by the general meeting or the supervisory of the company’s executives, provision of general members is calculated 1in preparing draft: board (as defined by the Charter) of candidates for recommendations to the executive board on these 1) succession strategy of the company’s supervisory vacancies in the supervisory board, the executive issues; Remuneration for members of supervisory boards is set board, executive board and other officials (if applicable board or other officers of the company nominated and 21) making an annual report to the supervisory board on according to Resolution No. 668 of the Cabinet of Ministers pursuant to the Charter or internal regulations of the dismissed by the supervisory board; the activity of the committee including information of Ukraine dated 4 July 2017 (amended) “On the approval of
company) that includes, in particular, search of poten- 6) preparation and submission for review by the general on the composition, number of meetings and main the Procedure for setting remuneration and compensation GOVERNANCE CORPORATE tial nominees for the position of the chief executive meeting or the supervisory board (as established by the activities of the committee, and also, upon supervisory conditions for members of supervisory boards at SOEs and officer in case of termination of authorities of the- cur Charter) of proposals regarding election or termination board’s demand, regular reports or information on business entities that are more than 50% owned by the state”, rent chief executive officer, in order to ensure continu- of authorities of the chief executive officer and mem- certain matters of the committee’s activity. except for the members of supervisory boards who are public ous work of the executive board; bers of the executive board, other officers of the compa- The Regulations governing the committee’s activity provide officers or are empowered to execute central or local govern- 2) policies and standards of the company on selection ny nominated and dismissed by the supervisory board; for reporting to the supervisory board no less than once a year. ment functions specified in article 3 (1) clause 1 of the Law of of nominees for the positions of the chief executive 7) making comparative analysis and informing the Ukraine “On Prevention of Corruption”. officer and members of the executive board, other- of supervisory board of the policies, programs, Key results in 2019 In 2017, remuneration for members of supervisory boards ficers of the company nominated and dismissed by the international practice, situation in the labour market at SOEs and business entities that are more than 50% owned supervisory board, aimed at engagement of qualified regarding levels and systems of remuneration for In 2019, the nomination and remuneration committee by the state was calculated based on the thorough analysis specialists in the management of the company; members of executive bodies of business entities, held 17 meetings at which it passed more than 45 resolutions. of average remuneration for supervisory board members at 3) principles for defining of remuneration for the chief proposals for remuneration of the chief executive officer During 2019, the committee focused on succession planning leading European companies of various industries. executive officer and members of the executive board and members of the executive board; for senior management of Naftogaz Group. The committee In addition, Resolution No. 668 of the Cabinet of Ministers RESPONSIBILITY in order to create necessary incentives for the efficient 8) submitting proposals to the supervisory board concerning played a central role in the process of renegotiating terms of Ukraine dated 4 July 2017 was amended with Resolution work in implementation of the company’s development individual remuneration for members of the executive and conditions of the contract with the chief executive No. 141 adopted by the Cabinet of Ministers of Ukraine on AND SOCIAL ENVIRONMENTAL strategy; board, ensuring their compatibility with the remuneration officer and extending his tenure by reviewing and making 5 February 2020 in fulfilment of the tasks set by the President 4) terms of employment agreements (contracts) to be policy adopted by the company and compliance with the recommendations to the supervisory board concerning of Ukraine for the Government with regard to the revision of concluded with the chief executive officer and members assessment of the performance of the member of the rationale for extending the tenure of the chief executive officer, remuneration for SOE top managers. Pursuant to the amend- of the executive board, other officers of the company executive board who is individually remunerated; determining terms and conditions of the contract to be entered ments, basic monthly remuneration for supervisory board nominated and dismissed by the supervisory board. 9) organization of development, processing, making members at enterprises whose net annual income from sales Submission to the general meeting or the supervisory board recommendations regarding forms and essential terms of products, works or services is UAH 20,000,001 thousand or 2(as established by the Charter) of recommendations and of labour agreements (contracts) to be concluded higher according the latest annual financial statements was proposals on: with the chief executive officer and members of the NOMINATION AND REMUNERATION COMMITTEE limited to 22 average monthly wages in relevant industries 1) candidates for the positions of the chief executive officer executive board; across the economy in the quarter preceding the quarter and members of the executive board, other officers of the 10) forming proposals regarding key performance indicators when remuneration for supervisory board members is calcu- company nominated and dismissed by the supervisory and organization of procedures of their periodic lated based on the statistics published by the State Statistics board; assessment for the chief executive officer and members + Service of Ukraine. 2) termination of authorities of the chief executive officer of the executive board, corporate secretary, chief risk 17 45 According to Resolution No. 334 of the Cabinet of Min- and members of the executive board; officer, chief audit executive, chief compliance officer, isters of Ukraine dated 29 April 2020 “On remuneration for
MEETINGS RESOLUTIONS FINANCIAL OVERVIEW AND STATEMENTS 3) engagement of independent external adviser for anticorruption officer; managers, members of executive bodies and supervisory
Annual Report 2019 126 Naftogaz Group Annual Report 2019 127 Naftogaz Group boards of business entities operating in the public sector”, 8) the quality of HSE and Reserves management, and monthly salaries of managers, members of executive bodies appropriateness of methods and measures for achieving and remuneration of members of supervisory boards at busi- the main goal and making the appropriate management ness entities operating in the public sector, except for state- decisions; owned banks, should not exceed UAH 47,230 (excluding sick 9) creating favourable conditions for attracting investments pays and annual leave allowance) for the period from April to increase the production of hydrocarbons. and to the end of the month when the quarantine introduced Review the rating and position of the company with respect by Resolution No. 211 of the Cabinet of Ministers of Ukraine 2to international best practice for HSE and Reserves, and legal MARKET AND REFORMS dated 11 March 2020 “On prevention of COVID-19 acute res- requirements on these issues, including relevant corporate piratory disease caused by SARS-CoV-2 coronavirus in Ukraine” governance developments. is canceled. The Regulations governing the committee’s activity pro- vide for reporting to the supervisory board no less than once a year. COMMITTEE ON HEALTH, SAFETY, ENVIRONMENT AND RESERVES Key results in 2019 Key functions of the committee In 2019, the committee on health, safety, environment and reserves held four meetings at which it passed one In line with the current Regulations on the committee on resolution and discussed more than five matters submitted health, safety, environment and reserves of the supervisory for consideration of this committee. During 2019, the com- board, the key tasks and functions of this committee are as mittee focused on the results of Naftogaz Group in the area
follows: of occupational health, industrial safety and environmental AND OPERATIONS STRATEGY Examine and prepare for consideration by the supervisory protection, taking into account a significant increase in the 1board of the items with regard to exercise of the control scope of upstream operations, and on the key challenges over: faced by Naftogaz Group, in particular, ensuring compliance 1) strategy for health, safety and environment (the “HSE”), with the policy of zero tolerance to non-reporting of acci- and evaluation and management of hydrocarbon dents. Members of the committee also discussed with the resources and reserves (the “Reserves”), HSE plans and company’s management the goals, objectives and actions related risk assessment in the context of the overall pursued across Naftogaz Group with the aim to ensure fulfil- business strategy of the company; ment of requirements for and improvement of occupational 2) scope and focus of policies and action plans prepared to health and safety, environmental protection, road traffic support delivery of HSE and Reserves strategy, including safety, industrial safety and prevention of man-made emer- mitigation of related risks; gencies. 3) implementation of plans and controls in relation to HSE The key matters considered and supported by the com-
and Reserves strategy, implementation of plans and mittee in 2019 included the health, safety and environment GOVERNANCE CORPORATE measures, including emergency and accident (accident vision for Naftogaz Group providing for a comprehensive set situation) response plan; of actions to ensure sustainability and safe working environ- 4) scope and outcomes of social investment programs and ment, and the new structure of a centralized health, safety social development partnerships; and environment function in Naftogaz Group, as proposed 5) evaluation of major and recurring failures within the by the company’s management within the implementation company in terms of HSE and Reserves governance and of the said vision. Furthermore, the committee discussed the performance and its influence on general economic operation of the unified monitoring system for occupational activities, including those that lead to significant legal health, environmental and industrial safety across Naftogaz consequences; Group. 6) integration of HSE and Reserves into major business During meetings, the committee highlighted the feasibility processes, including capital programs, exploration of applying the best practices in the oil and gas industry, inter programs, mergers and acquisitions, and expanding alia, in addressing the safety-oriented mindset and culture RESPONSIBILITY into new markets; issues among employees of Naftogaz Group, measuring the 7) external disclosures of information relating to HSE and severity of incidents in production and organizing work of AND SOCIAL ENVIRONMENTAL Reserves; contractors at Naftogaz group facilities.
COMMITTEE ON HEALTH, SAFETY, ENVIRONMENT AND RESERVES 4 1 5+ MEETINGS RESOLUTION MATTERS FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 128 Naftogaz Group Annual Report 2019 129 Naftogaz Group KEY MANAGERS AND
THEIR REMUNERATION MARKET AND REFORMS
Аndriy Kobolyev Chief executive officer STRATEGY AND OPERATIONS STRATEGY
Sergiy Pereloma First deputy chief executive officer CORPORATE GOVERNANCE CORPORATE
Sergiy Konovets Deputy chief executive officer (stepped down as Naftogaz Deputy CEO as of 7 November 2019)
In 2019, the management team included five executive board members and eleven directors (2018: six executive board members and nine directors). The compensation for the management team, which is part of other operating costs, RESPONSIBILITY included salaries and additional current bonuses, making up UAH 343 million (UAH 717 million in 2018). AND SOCIAL ENVIRONMENTAL
Yuriy Kolbushkin Аndriy Kobolyev* 21.2 Executive board member Sergiy Pereloma 25.7 (until 21 January 2020) Sergiy Konovets 29.9 Yuriy Kolbushkin 22.1 Mykola Havrylenko** 18.7 Total 117.6
Remuneration of executive board members (including unified social tax), UAH million.
* Includes UAH 4.6 million in taxes, duties and other levies. Since mid February till the end of 2019, Mykola Havrylenko Andriy Kobolyev donated all his remuneration from Naftogaz to charity. During this period he transferred UAH 11.4 miilion to Come Back Alive, Tabletochki, Narodnyi Tyl Reabilitaciya and Blagomay. Executive board member The charity funds used the donations to organize management training programs for the Ukrainian (until 21 January 2020), Armed Forces, support rehabilitation of families of the fallen soldiers, finance medications for Head of Oil Midstream and children fighting cancer as well as hold carreer orientation events for kids raised without parents. FINANCIAL OVERVIEW AND STATEMENTS Downstream Division ** Including UAH 2.5 million reward as executive board member.
Annual Report 2019 130 Naftogaz Group Annual Report 2019 131 Naftogaz Group NAFTOGAZ ISSUED EUROBONDS IN 2019
This ensured the purchase of sufficient RISK volumes of natural gas for a flawless heating season and the timely repayment 835 600 of obligations to the shareholder and banks MANAGEMENT USD MILLION EUR MILLION MARKET AND REFORMS
During 2019, the group continued enhancing its risk culture of the unbundling of the Gas Transmission System Operator of The key risks identified in 2019 by Naftogaz Group include for the Sale of Special Permits for the Use of Subsoil Through and risk management efficiency. It should be noted that Naftogaz Ukraine LLC and the signing of a new gas transit contract and the following: Electronic Auctions” enabled Ukrgazvydobuvannia JSC to Group’s material risk structure has been significantly affected by settlement agreement with Gazprom PJSC. As of 1 January 2020, obtain 14 licenses in 2019, a record number in recent years. events that took place at the end of 2019, such as the completion the group’s risk structure was as following: However, it takes 3 to 5 years from the moment of obtaining STRATEGIC RISKS the license to extracting gas at new sites, which does not allow for an instant increase in natural gas production. The extension of the terms of validity of the regulation Naftogaz group risk structure by level rating Naftogaz group material risk on imposing public service obligations (PSO) on terms structure by classes unfavorable for the company, and continued gas sales HSE RISKS through the regional gas suppliers (“oblgazzbut”) and AND OPERATIONS STRATEGY 2% 4% municipal heat generating entities (MHE) The risks of violating occupational safety and harming the 5% The regulation on imposing public service obligations health and life of employees are inherent in oil and gas 4% (PSO) with regard to Naftogaz NJSC continued to be effective industry. Accidents at enterprises may not only lead to a 7% till August 2020 (as amended), which has led to an increase in loss of production capacity and suspended operations, but 60% bad debts for supplied natural gas. also adversely affect the environment and cause injuries As of 31 December 2019, the MHE`s debt to Naftogaz to employees or fatal accidents. One of the factors that 17% 43% was about UAH 41.3 billion, and the debt of the regional cause these situations is human factor. To mitigate this risk, 17% gas supply companies (RSC) was about UAH 23.2 billion. The Naftogaz Group employees are regularly trained to comply significant level of this debt significantly affects the company’s with national and international labor safety standards. liquidity. In addition to contingent emergencies, outdated equipment is a significant threat to occupational safety. This is why Naftogaz Group invests in diagnostics and the
modernization of existing production facilities. GOVERNANCE CORPORATE 19% 22% FINANCIAL RISKS Liquidity risk High Medium Low Operational Strategic Legal HSE The company is exposed to liquidity risk as a result of the OPERATIONAL RISKS Risks with low probability and high impact Regulatory Reputational Financial following factors: — seasonal nature of income and expenses; Risk of losses due to accidents, unauthorized withdrawal of Source: Naftogaz — payment of dividends as scheduled by the resolutions of resources, and forced break in production facilities the Cabinet of Ministers of Ukraine; Naftogaz Group companies have an extensive system of — fixed due dates of bank loans; offshore production facilities and oil and gas transmission — accumulation of bad debts by MHEs and RSCs for natural facilities. These facilities may be vulnerable to natural disasters In addition to the risks identified in 2019, particular gas supplied. including fires, floods, droughts, frosts, hail, and earthquakes. attention should be paid to risks associated with the To mitigate this risk, during 2019 Naftogaz issued At the same time, Naftogaz faces the problem of spread of the Covid-19 pandemic. Eurobonds worth USD 835 million and EUR 600 million, which unauthorized withdrawal of Naftogaz Group oil and RESPONSIBILITY In January 2020, the Covid-19 pandemic ensured the purchase of sufficient volumes of natural gas condensate by third parties, resulting in damaged equipment was declared a global emergency by the World for a flawless heating season and the timely repayment of and extra costs for repair. AND SOCIAL ENVIRONMENTAL Health Organization (WHO), forcing countries and obligations to the shareholder and banks. Naftogaz Group companies take all measures necessary to organizations, including Naftogaz Group, to take mitigate the likelihood and consequences of these risks. measures to mitigate risks to workers and businesses. As of today, it is difficult to assess the full impact REGULATORY RISK of the pandemic on Naftogaz Group's operational and financial performance. Risk of failure to obtain new licenses for exploration and However, it is quite clear that the restrictive industrial development of fields measures applied by enterprises and countries have Despite the fact that Ukrgazvydobuvannia JSC accounts for a significant impact on demand and supply of oil and three-quarters of natural gas production in Ukraine, every year gas, which in turn contributes to the fall in prices for the company faces the challenge of getting new hydrocarbon these resources and can have a significant impact on production licenses and extending existing licenses. At the on the achievement of the operational and strategic same time, three-quarters of all licenses for the past 18 years goals of Naftogaz Group. have been issued to private companies. The approval of the CMU Resolution “On the Implementation of a Pilot Project on the Launch of Auctions FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 132 Naftogaz Group Annual Report 2019 133 Naftogaz Group IN THIS SECTION: EXPENDITURES ON ENVIRONMENTAL CURRENT EXPENSES ON PROTECTION IN 2019 ENVIRONMENTAL PROTECTION 137 | Address of first deputy CEO 139 | Human resources management 149 | Occupational safety 157 | Cooperation with local communities 178.9 171.7 159 | Investments in energy efficiency UAH MILLION UAH MILLION MARKET AND REFORMS 163 | Environmental protection Total expenditure of Naftogaz Group 96% or UAH 171.7 million was Naftogaz 173 | Procurement management enterprises on environmental Group current expenses protection in 2019 on environmental protection STRATEGY AND OPERATIONS STRATEGY CORPORATE GOVERNANCE CORPORATE RESPONSIBILITY ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL ENVIRONMENTAL PROTECTION
Reducing the adverse impact of Naftogaz Group on the environment and environmental protection are extremely important components of the company's development strategy. In its operations, Naftogaz adheres to sustainable development principles in order to preserve a clean and safe environment for future generations. Every year, the company increases its investment in environmental protection and focuses its efforts on responsible water management and soil protection, reduction of air emissions, responsible waste management and implementation of energy efficiency programs. The companies of Naftogaz Group ENVIRONMENTAL AND ENVIRONMENTAL strive to ensure that their activities comply with European rules and at the same time implement best practices and best available technologies to minimize their SOCIAL RESPONSIBILITY adverse impact on the environment. FINANCIAL OVERVIEW AND STATEMENTS
Річний звіт 2019 134 Група Нафтогаз Річний звіт 2019 135 Група Нафтогаз MARKET AND REFORMS
ADDRESS OF FIRST DEPUTY CEO AND OPERATIONS STRATEGY Sergiy Pereloma First deputy chief executive officer
Naftogaz Group continued energetic efforts in the area of home. Those who have to perform their functions in the work- velopment strategy of the group covers all business processes Naftogaz continues increasing its renewable energy produc- corporate, social and environmental responsibility in 2019. place, undergo body temperature screening. The process of and is aimed at implementing and improving the environmental tion capacity. This year, additional generating capacity of a solar In 2019, Naftogaz identified its occupational safety and providing all workers working at production facilities with per- management system in accordance with the requirements of power plant in Zhytomyr region will be put into operation, pro- environmental objectives as one of its key priorities. These are sonal protective equipment – masks and rubber gloves – has the international standard ISO 14001:2015. Naftogaz focuses on ducing about 30 MW. In 2019, Ukrtransgaz's solar power plant included in top manager individual performances, and their now been completed. All employees who were outside Ukraine responsible management of natural resources, in particular on generated 152 MWh. achievement is monthly monitored by the group’s supervisory for any purpose before the borders closed were subjected to control over water use and soil reclamation, overall reduction of On April 16, 2020, the first Naftogaz charging station entered board. two-week mandatory self-isolation. Similar measures are taken harmful emissions into the atmosphere, and support for ener- operation. If the pilot project is successful, the company intends GOVERNANCE CORPORATE in relation to people with any signs of possible infection. Much gy efficiency programs. Naftogaz Group also implements joint to invest significant resources in charging infrastructure to build attention is paid to the communication of WHO preventive rec- projects with local communities and improves the occupational an extensive network of charging stations across the country. NAFTOGAZ'S RESPONSE TO THE NEW CHALLENGE – ommendations and the guidelines of the Ministry of Health of safety standards for employees. Last year, the company successfully implemented a pilot COVID 2019 Ukraine on coronavirus infection prevention. A series of printed Significant efforts are focused on the organization of con- project aimed at the production of electricity from the heat of materials with a consolidated list of preventive rules has been tinuous HSE training for staff members with a focus on raising combustion products generated during the operation of gas In early 2020, the country and the company faced a new, distributed at all enterprises of the group. employee awareness. There is continuous communication on turbine engines. Due to the new high-tech equipment installed hitherto unseen challenge – the rapid spread of COVID-2019. However, we did not limit ourselves to protecting our occupational safety at the enterprises of the group. at the Ukrgasvydobuvannya facility, the company was able to The coronavirus epidemic has forced significant adjustments employees. Naftogaz, being a socially responsible company, generate electricity on an industrial scale without burning ad- to the company's current activities and plans. The situation is purchased modern medical equipment and personal protec- ditional volumes of fuel. Naftogaz is ready to become a flagship complicated by the lack of a clear forecast regarding the end of tive equipment worth almost UAH 500 million from China ECOLOGY AND ENERGY EFFICIENCY for the inevitable transition of the Ukrainian economy to envi- the epidemic. There is no doubt that the spread of the infection and transferred it free of charge to hospitals across Ukraine in ronmentally friendly energy sources. will adversely affect the company's performance, although the record time. This humanitarian consignment included 500,000 In 2019, total environmental costs of Naftogaz Group RESPONSIBILITY extent of the impact at the time of the Annual Report is still protective suits, 700 patient monitors, 50 mobile digital X-ray amounted to UAH 179 million. The company also paid profile hard to predictable. machines, and 50 portable ultrasound devices. The cargo was taxes and fees totaling UAH 94 million. In 2020, the group plans PARTNERSHIPS WITH LOCAL COMMUNITIES AND SOCIAL ENVIRONMENTAL In this difficult situation, the priority for the company is to transported by 4 planes – three An-22 "Antey" and the An-225 to spend about UAH 400 million on environmental protection, save the lives and safeguard the health of employees. From the "Mriya", which is the largest cargo aircraft in the world. doubling last year's figure. Naftogaz Group companies are key partners of the local first days of disease detection in Ukraine, Naftogaz launched Additional initiatives by the company aimed at supporting One of the priority areas is increasing the environmental authorities and communities where hydrocarbons are mined. In preventive measures. A single coordination headquarters, the the fight against the COVID-19 pandemic are estimated at over safety level when drilling oil and gas wells, particularly in the addition to statutory rent payments, we implement a number Coronary Staff, was established, which analyzes the current UAH 20 million. field of waste management. Ukrgasvydobuvannya JSC sys- of our own initiatives to solve social problems and improve situation on a daily basis and issues orders and directives cen- The lives and health of people remain the greatest value for tematically implements measures aimed at reducing damage the quality of life in communities. These are mostly capital trally to safeguard employees. We have developed the relevant Naftogaz Group, so virus preventive steps are a priority and will to the environment. Currently the company is negotiating infrastructure projects including road repairs, construction and policies and regulations aimed at maximizing the security of the continue to be so until the epidemic is completely over. cooperation with the world leader in this field – the Finnish renovation of educational institutions, houses of culture, sports company's employees. To do this, the headquarters has ana- company Lamor. grounds, construction of heating, gas and water supply systems, lyzed the valuable experience of companies in other countries In August 2019, the sludge processing plant in the village landscaping, street lighting in settlements, projects to provide that encountered coronavirus before Ukraine. Among other HSE IS A PRIORITY FOR THE COMPANY of Sencha, Poltava region, resumed operations. Its capacity access to the Internet and installation of video surveillance sys- things, we gained access to the internal documents of Chinese is 10 m3/h, which allows to process drilling waste from three tems. The group's total investment in community development and Swiss companies, got acquainted with their response to the The issues of ecology and occupational safety at the en- simultaneously operating wells. The project is also being im- in 2019 amounted to UAH 5.3 million while local communities challenge, and studied the measures they have implemented. terprises of the group remain a priority for Naftogaz despite plemented jointly with a large international partner – Schlum- where the group performs its production operations received In particular, most of our office staff started working from unfavorable market conditions. The corporate sustainable de- berger. UAH 1.1 billion in direct royalty payments. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 136 Naftogaz Group Annual Report 2019 137 Naftogaz Group HUMAN RESOURCES THE TOTAL NUMBER OF THE FULL-TIME EMPLOYEES OF NAFTOGAZ GROUP IN 2019 55 078 12 827 42 251 MANAGEMENT EMPLOYEES WOMEN MEN MARKET AND REFORMS
The employees of Naftogaz Group companies are their practices was finalized. A fully transparent and effective Compared to the previous year, the number of full-time em- Accordingly, the proportion of women in Naftogaz Group most precious assets. The success of the group's activities grading remuneration system is in place across Naftogaz ployees decreased by 19.5% (13 308 persons). This is due to the is 23.3% (12 827 persons). This comparison shows that the depends on the level of professionalism and skills of the Group. successful implementation of the unbundling program, which group has been consistently implementing a forward-looking staff. Therefore, the group's companies are focused on The main areas of activities in the field of personnel included transferring from July 1, 2019 the function of technical and up-to-date gender policy and undertakes a systematic the continuous development of staff competencies, the management in 2019 are: operation of the gas transportation system and 10 386 employ- effort to involve women. improvement of approaches to attracting and retaining — continuous improvement of professional and technical and ees from Ukrtransgaz JSC to Operator of GTS of Ukraine LLC. The largest share in the age structure of Naftogaz Group talents, their remuneration and social security, and improving managerial competences of the staff; In the gender structure, 76.7% are men (42 251 persons), employees is in the age group from 30 to 50 years – 60.0% productivity. — increase productivity in all spheres of activity; which is explained by the specificity of production activities (33 052 persons), 26.4% are employees over 50 years (14 523 In 2019, Naftogaz Group Human Resources Policy — maintaining high standards of corporate behavior; and is typical for the global oil and gas industry, which is persons), 10.1% – below 30 years (5 563 persons), persons was finalized and approved, and a functional personnel — implementation of a comprehensive system of staff proved by the official statistics of World Petroleum Council of retirement age account for 3.5% of employees of group management structure was set up. The key objectives of this training and development; showing that women account for 22% in the industry. companies (1 940 persons). AND OPERATIONS STRATEGY HR Policy are: — introduction of best practices of staff remuneration and — developing partnerships between management and motivation; employees based on respect for human rights; — implementation of social policies aimed at improving the — formation of a corporate environment favorable to quality of life and health of employees and their families; 2 Naftogaz Group personnel structure 3 Personnel breakdown by group continuous development of Naftogaz Group; — completion of the preparatory phase of implementation by age and gender, 2019 enterprises in 2019 — ensuring respect for the principle of decent work, fair and of advanced IT solutions in the HR management sphere Age structure, % non-discriminatory treatment of employees, creation of at Naftogaz Group companies. The charter of the Talent equal opportunities; Management System project was approved. In 2020, below persons of 30 years 10.1% 3.5% — protecting and promoting the health and safety of the a tender will be held to contract one of the best and retirement age staff; most powerful suppliers of digitalization solutions for HR — preventing all forms of discrimination and all forms of processes. Ukrnafta forced and child labor. 21 400
Naftogaz Group's approach to personnel management is GOVERNANCE CORPORATE based on compliance with all requirements of labor, social QUANTITATIVE AND QUALITATIVE FEATURES OF security, health and safety legislation, as well as the principles NAFTOGAZ GROUP and norms set out in conventions of the International Labor Ukrgasvydobuvannya Organization and other international treaties binding on The total number of the full-time employees of Naftogaz 18 563 26.4% Ukraine. Group as of December 31, 2019 was 55 078 persons. Of 60.0% The main aspects of labor relations at the enterprises of these, 12% are management staff (6 631 persons), 20.2% – over the Naftogaz Group are governed by collective agreements. professionals and specialists (11 155 persons), 0.5% – 50 years from 30 The shift from obsolete remuneration management systems technical staff (252 persons), 67.3% – qualified and other to 50 years Ukrtransgaz inherited from the Soviet times to up-to-date and effective workers (37 040 persons). 7 296
Gender structure, % RESPONSIBILITY 1 Structure of full-time employees at Naftogaz Group companies in 2019, persons Ukrtransnafta Women 3 213 AND SOCIAL ENVIRONMENTAL 23.3%
37 040 6 631 Ukrspetstransgaz 156 qualified and other workers management staff
11 155 252 Zakordonnaftogaz professionals and specialists technical staff 58
76.7% Men Chornomornaftogaz FINANCIAL OVERVIEW AND STATEMENTS Source: Naftogaz 47
Annual Report 2019 138 Naftogaz Group Annual Report 2019 139 Naftogaz Group In 2019, staff turnover was 3.9%. Compared to 2018, the — UAH 443.2 million – bonuses; SOCIAL BENEFITS figure has not changed much. — UAH 321.6 million – maintenance of social AVERAGE MONTHLY WAGE infrastructure; — UAH 40.0 million – providing housing and loans. Average monthly wage STAFF REMUNERATION across Naftogaz Group increased by 34% in 2019 UAH MILLION Operating the high-tech equipment that Naftogaz STAFF ASSESSMENT AND CAREER + % against 2018 2 358.9 Group has been investing in requires highly qualified 34 MARKET AND REFORMS MANAGEMENT staff. Replacement of obsolete equipment, technical modernization and automation of production processes leads In 2019, Naftogaz Group, introduced an advanced and to optimization of staff. Considering lack of experienced and effective tool for managing staff performance – setting qualified candidates in the labor market, in part due to the Objectives and Key Results (OKR). This tool enabled each drain of highly qualified staff away from Ukraine, Naftogaz employee to understand and evaluate his/her own role in 4 The expenses of the Naftogaz Group companies for Group companies invest significant funds in professional achieving the Group's strategic goals. 5 Expenses on social security for the employees in social security of employees in 2019 development of staff and use higher remuneration as a means In 2019, a corporate competency model was developed 2019 by group enterprises, UAH million to retain employees with necessary expertise. based on the values of Naftogaz Group. The model and the As a result of technical modernization and optimization of staff evaluation guidelines are to be introduced in 2020. staff, average monthly wage across Naftogaz Group increased Performance and career development of 8.8% employees by 34% in 2019 against 2018, which is much higher than in of Ukrgasvydobuvannya were regularly assessed in 2019. Ukraine (18%) and in the industrial sector (22%). With the support of NexT (part of Schlumberger group) 45.1 685.5 and using its web-platform within the Drilling Training Program 823.3 UAH MILLION UAH MILLION for engineers, 80 key drilling experts were evaluated. UAH MILLION AND OPERATIONS STRATEGY medical services for financial assistance SOCIAL SECURITY Plans for 2020 include assessment of the competencies Ukrgasvydobuvannya employees stipulated by collective of geologists and geophysicists of Ukrgasvydobuvannya JSC, agreements, including: The social policy of Naftogaz Group as a part of the considering the position profiles that are used by world-class 657.7 • health improvement personnel management system is an important mechanism production companies. UAH MILLION for employees and for attracting, retaining, increasing the motivation and loyalty Ukrnafta their children as well as of qualified specialists, and forming a professional high- treatment for children performance team capable of achieving the highest results STAFF TRAINING AND DEVELOPMENT with disabilities of the group's enterprises. It aims to make sense not only • treatment for of work but also of life: the creation of overall emotional, Continuous introduction of new technology and employees with spiritual, and psychological comfort. modernization of production facilities in the oil and gas 504.6 164.9 disabilities In 2019, long-term initiatives were launched: industry require uninterrupted professional improvement, UAH MILLION • compensation for — A Corporate Donor Day was held in conjunction with the training and development for staff-members working in UAH MILLION
medicines and medical Kyiv City Blood Center. Employees of Naftogaz Group all domains and at all management levels. Investing in Ukrtransgaz GOVERNANCE CORPORATE rehabilitation and treatment to the retired attended the event. professional training and development helps mitigate recreation of employees • to single parents — In April – June 2019, the Theatrical Spring at Naftogaz risks in activities of Naftogaz Group and ensure proper and their family • to the Commemoration project was implemented for the employees of the group use of modern equipment. members, including Day of the Chornobyl 180.9 companies residing in small towns with the group’s The corporate training system offers a wide range of children Disaster presence with no access to a wide range of cultural events. opportunities for development: UAH MILLION The Kyiv Theater in Podil, supported by trade unions of — professional education and training of staff, Ukrtransnafta group companies, has toured around towns with a group including in the training centers of enterprises, presence. 2 190 employees attended a performance of the specialized educational institutions, and centers Kyiv Academic Drama Theater in Podil named "One Hundred of postgraduate education; 192.3 Thousand" by Ivan Karpenko-Kary. — participation in seminars, training, online courses and This art project is a good example of a positive social workshops, corporate training programs; UAH MILLION RESPONSIBILITY partnership by the company and support provided by trade — participation in conferences, forums for the purpose of Other enterprises unions. professional development, exchange of knowledge and
658.6 40.0 AND SOCIAL ENVIRONMENTAL UAH MILLION UAH MILLION During 2019, Naftogaz Group companies, within their experience with leading foreign companies; financial capabilities, ensured the implementation of — participation in long-term educational programs, Ukrgasvydobuvannya other social benefits and providing housing and agreements enshrined in the Sectorial Agreement and including MBAs. payments, including: loans the collective agreements on providing social guarantees, Of the total number of employees in such categories as Ukrnafta • one-time retirement benefits, compensation to employees, as well as the exercise managers, professionals and specialists of Naftogaz Group payment of the rights of labor collectives. (17 786 persons), 17 652 persons have complete higher, • bonus to employees Ukrtransgaz Naftogaz Group companies spent UAH 2 358.9 million on incomplete higher and basic higher education, or 99% of distinguished with social development and social events in 2019, including: employees in these categories. industry awards Ukrtransnafta • monthly allowance — UAH 45.1 million – medical services for employees; Of the total number of full-time employees of Naftogaz to families with many — UAH 685.5 million – financial assistance stipulated by Group, 17 persons are Doctorate-level (including 3 women), children collective agreements; and 205 persons are PhD (including 46 women). In addition, Other enterprises • monthly allowance to — UAH 164.9 million – rehabilitation and recreation of 46 persons hold academic titles (27 persons are associate 321.6 0 100 200 300 400 500 600 700 800 900 the retired employees and their family members, including professors, 9 persons are senior researchers and 10 are UAH MILLION children; professors). UAH million maintenance of social — UAH 658.6 million – other social benefits and Employees of Naftogaz Group companies regularly FINANCIAL OVERVIEW AND STATEMENTS infrastructure payments; participate in training and education programs that include Source: Naftogaz
Annual Report 2019 140 Naftogaz Group Annual Report 2019 141 Naftogaz Group in-house training, distance learning courses, adopting global GROUP STAFF BY EDUCATIONAL LEVEL IN 2019 company experience, joint training programs, advanced Training hours by group enterprise in 2019 EMPLOYEES WHO IMPROVED THEIR SKILLS IN 2019 training, and retraining programs. Total number of managers, Number of Naftogaz Overall, 29 200 employees of Naftogaz Group enterprises professionals and specialists Group employees at Naftogaz Group with were trained and retrained in 2019. who were trained and complete higher, incomplete Ukrtransgaz retrained in 2019 17 652 In 2019, Ukrtransgaz implemented the following training Ukrgasvydobuvannya 288 757 29 200 higher and basic higher EMPLOYEES education activities: EMPLOYEES MARKET AND REFORMS — internal developmental training based on six training programs developed for different categories of personnel Ukrnafta 39 075 (change management, time management, recruiting, performance management, importance and principles of 6 Naftogaz Group managerial staff breakdown by feedback, and training for trainers). Ukrtransnafta 33 934 TRAINING HOURS BY GROUP EMPLOYEES IN 2019 education level in 2019 Based on the findings of the audit, recommendations were Total number of developed on how to improve the employee training process. 0 training hours All centers remained in the structure of Ukrtransgaz. Their provided to 75 000 25 000 50 000 175 000 125 000 150 000
activities will be further scaled up to Naftogaz Group. 275 000 100 000 225 000 250 000 200 000 300 000 361 766 employees of group hours enterprises in 2019 The plans for 2020 include the following: HOURS 17 652 — conducting “Effective Job Search” training as a transition Source: Naftogaz period support program and conducting “Management. Employees with complete Module 1” training for the branch Operator of Ukrainian AND OPERATIONS STRATEGY higher education, incomplete higher education and basic Gas Storage Facilities. higher education Number of Naftogaz Group employees who improved their skills in 2019, persons Ukrgasvydobuvannya Within the framework of the personnel training and 350 development program, the following activities were carried Ukrnafta 3 750 11 400 out in 2019: — training in first premedical aid, management accounting, 6 17 HSE, work at height (during 2019 there was no case of Ukrtransnafta 185 Doctors of Sciences falling from height), training within the “internal trainers” 528 program; — testing and evaluation of the level of knowledge of Ukrtransgaz 1 248 734 employees after training, conducting internal training as
needed; GOVERNANCE CORPORATE Ukrgasvydobuvannya 1 836 3199 5905 205 — field-specific training with global companies (Shlumberger, PhDs Nabors, Deloitte and others) in order to encourage the use of world best practices; 0 2 000 4 000 6 000 8 000 10 000 12 000 14 000 16 000 18 000 persons — training in new specialties for the employees of Shebelynkagazvydobuvannya company. managers middle managers and specialists workers The Advisor program concept was developed at Source: Naftogaz 27 Ukrgasvydobuvannya . The Advisor program is a community Associate professors of unique industry professionals, most of them retirees, who collaborate with company departments to provide advice on complex and extraordinary production issues and situations. Average training hours per employee by category in 2019 1 The objective of the program is to transfer professional and 9 scientific expertise gained over the years to other specialists in 30 RESPONSIBILITY Senior scientists order to develop their skills in dealing with difficult situations.
24.2 AND SOCIAL ENVIRONMENTAL In addition, the program aims to support experienced retired 25 professionals to help them adapt to life after their professional 20.8 21.0 20 career is over. 10 15 13.0 13.5 Plans for 2020 include the following: Professors 10.6 10.3 — scaling-up the internal trainers project that improves 10 9.3
professional and management competencies, which will be hours/per person carried out by specialists who have been specially trained 5 2.5 2.9 GROUP ENTERPRISES INVOLVED IN TRAINING and received verification, i.e. permission to deliver training 1.0 1.5 ACTIVITIES IN 2019 of this kind. The company-based internal trainers project 0 Ukrtransgaz has been operating successfully since 2017. It is driven by Ukrgasvydobuvannya Ukrtransnafta Ukrnafta Ukrgasvydobuvannya experienced professionals with specific knowledge and average by enterprise managers middle managers and specialists workers Ukrnafta expertise who are motivated to share with colleagues; 5 Ukrtransnafta — training of coil tubing instructors; Source: Naftogaz — development of HSE (Occupational Health, Industrial ENTERPRISES Naftogaz of Ukraine FINANCIAL OVERVIEW AND STATEMENTS Safety and Environment Protection) programs; 1 The information on the average number of hours of training per employee by gender for 2019 is only available for Ukrgasvydobuvannya (men – 18.9 hours / person, women – 10.3 hours / person)
Annual Report 2019 142 Naftogaz Group Annual Report 2019 143 Naftogaz Group — arranging NEBOSH (National Examination Board on Safety Frankivsk National Technical University in "Oil and Gas and Health at Work) international certification; Engineering and Technologies". During 2019, activities were implemented under the and update educational standards in their specialties. — training on international IWCF (International Well Control Throughout 2019, the company has actively implemented educational project "Ukrainian Modern Engineering Studios" Forum) certification; programs designed to get employees ready for potential aimed at transforming engineering education in order to — driver training, first premedical aid training. redundancy – they have days off for job search, they would provide oil and gas industry enterprises with up-to-date highly 4Upgraded laboratories and state-of-the-art equipment will be Ukrnafta get retirement compensation, and are offered retraining qualified technical specialists. The project was initiated by used in the course of training - SAIT has provided requirements In 2019, the following measures were implemented by opportunities. Naftogaz of Ukraine jointly with the Southern Alberta Institute for laboratories based on the audit results.
Ukrnafta in accordance with its training and staff development The plan for 2020 includes further training for the heads of Technology, Canada, and the Federation of Oil and Gas MARKET AND REFORMS strategy: of production units on effective team management and Industry Employers, the Kyiv City Organization of Oil and Gas 5Graduates will gain sound knowledge of workplace safety – — a distance learning system was introduced, which is mastering advanced management skills, creation of personnel Industry Employers, and implemented at Yuri Kondratyuk they will be ready for work from day one, which is crucial for accessible to all employees in all structural units of the reserve, work with young specialists, conducting internal National University Poltavska Politechnika and Kharkiv Beketov long-term use and maintenance of equipment. company. At the moment, the system includes courses and external training, support and modernization of existing National University of Urban Economics. in occupational safety, information security, goal-setting, training, and personnel development practices. The "Ukrainian Modern Engineering Studios" project is 6Project partners seek to develop gender equality principles specialized tests, training videos, etc.; the most up-to-date and innovative training program for and declare their intention to support them – at least 40% of — more than 11 000 employees have undergone advanced Naftogaz of Ukraine engineering professionals. Implementation of the project will female students will be admitted to study and form student training and retraining on the basis of three regional According to the Naftogaz of Ukraine employees Training contribute to the sustainable development of the country's oil groups. training courses (employee development is done through and Development Plan for 2019, about 350 employees and gas sector and other sectors of the economy. specialized training facilities (training and retraining); participated in various training activities (overall 754 man/ Next steps: — the company's engineering staff has participated in more events) including in the corporate format in the following The project approach: — involvement of new partners and sponsors (the first phase than 10 highly specialized professional training courses areas: of the project has already been financed by a member of and conferences; — Finance for non-financial managers. 1The new educational program will enable transition from the Federation of Oil and Gas Industry Employers); — the company produced weekly newsletters with — Project management and organizational change almost 90% theoretical education to 60% practical and 40% — purchase of modern equipment and its installment in AND OPERATIONS STRATEGY educational articles and videos; management. theoretical education, thus ensuring proper preparation of training laboratories; — company employees now have access to One Petro – the — Innovation in public procurement and control: risk graduates to work with the latest technology. — selection of Ukrainian teachers and students to participate world's largest oil and gas library; management. in the program; — internal exchange of experience between the employees of — Financial analysis: evaluation of the company's 2The foreign partner institute will provide the content of the — development and launch of SAIT bachelor program for the company through the Microsoft Teams system is in place; performance. program, audit the material base, select and train students – third- and fourth-year students based on adapted technical — considerable attention is paid to financial expert — Training on Naftogaz Group strategic planning and the Southern Alberta Institute of Technology (SAIT, Canada) universities programs and training of Ukrainian teachers certification and training: ACCA, DipIFR, and SIA. transformation. has a successful track record in implementing such projects. using SAIT methodology; In order to retain the employees of the company, a — Corporate communications. — licensing of a curriculum developed by SAIT for teaching number of retraining programs are offered by Ukrnafta’s — Financial reporting as taxpayers see it. 3For two years, Ukrainian teachers will be trained under the by Ukrainian teachers and approval of modern Ukrainian training facilities and internal recruiting is widely used. — Compliance conference. SAIT program in order to further improve the teaching process educational standards by specialty. — Personal efficiency, and also strategic planning, Ukrtransnafta transformation of Naftogaz Group and compliance.
Modernization, retrofitting, and new technologies GOVERNANCE CORPORATE require continuous updating of professional knowledge and In cooperation with universities, Naftogaz seeks to attract 1 252 persons underwent undergraduate training at Naftogaz skills. Throughout 2019, training and continuous education INTERACTION WITH EDUCATIONAL INSTITUTIONS talented young people to work in the company. During 2019, Group companies. of managers, specialists and workers was underway. Work was carried out on education, training and retraining of Naftogaz Group companies actively cooperate with a employees in all categories of positions.In addition, in 2019 number of educational institutions. the company: In 2019, implementation continued of a long-term Total number of students who conducted undergraduate training at Naftogaz Group enterprises, persons — organized specialized training sessions aimed at developing educational project for training high-potential employees of skills in effective teamwork and communication (soft skills) Naftogaz Group companies under the SOE MBA program of involving 250 employees; the Kyiv School of Economics. The project was launched by Ukrtransnafta 29 — held training on mastering advanced management skills for the business school for public sector enterprises, initiated by the heads of production units, workshops on developing the Ministry of Economic Development and Trade of Ukraine, skills in providing first premedical aid; and supported by the Western NIS Enterprise Fund. The RESPONSIBILITY Ukrnafta 405 — supported by the company, employees participated in mission of the program is to help public sector companies external profile training and workshops; become competitive through the implementation of modern AND SOCIAL ENVIRONMENTAL — provided in-service training sessions organized for standards of management and changing corporate culture. production facilities in order to provide employees with Four training groups consisting of the employees of Ukrtransgaz 182 in-depth knowledge of the equipment they use and Naftogaz of Ukraine and the Group's enterprises, defended production processes they are part of. their diplomas. A fifth group is still undergoing training. 20 employees of a joint group of office and the production Overall, 115 people have been trained within the framework 636 units are receiving their second higher education at Ivano- of the program. Ukrgasvydobuvannya
0 100 200 300 400 500 600 700 800 persons
Source: Naftogaz FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 144 Naftogaz Group Annual Report 2019 145 Naftogaz Group Ukrgasvydobuvannya — National Aviation University Ukrgasvydobuvannya selected the students of Ivano- — Kharkiv National University of Radio Electronics Frankivsk National Technical University of Oil and Gas, Poltava — Drohobych College of Oil and Gas National Technical University named after Kondratyuk. In 2019, 182 students had their undergraduate training According to the results of interviews, candidates were at Company facilities. During the year, 12 graduates of employed in such areas as "Drilling of wells" and "Geology". higher educational institutions were hired to work at During 2019, 54 university graduates were hired by the Ukrtransgaz, including 2 persons who had previously had their company as young specialists. undergraduate training at the enterprise. Young specialists MARKET AND REFORMS An educational project was launched to cover the activities were accepted mainly for working positions. of the Ukrainian Gas Research Institute (UkrNDIGaz) and the company in secondary and higher educational institutions Ukrtransnafta in Kharkiv and the prospect of pregraduate training at Ukrtransnafta actively cooperates with the following UkrNDIGaz. The company takes part in job fairs at the Kharkiv educational institutions: Ivano-Frankivsk National Technical Employment Center and contributes to the Olympiad of Young University of Oil and Gas, Drohobych College of Oil and Geologists in Kharkiv. Gas, Ivan Franko National University of Lviv, Lviv Polytechnic National University, National University of Water Management Ukrtransgaz and Natural Resources of Rivne, Lviv College of the State In order to attract new specialists, Ukrtransgaz works closely University of Telecommunications, Kiev National University of with Ukrainian educational institutions. As of December 31, Technology and Design, Lviv State University of Internal Affairs, 2019, the company has signed cooperation agreements with: Odesa National Maritime University, Odesa National — Ivano-Frankivsk National Technical University of Oil and Maritime Academy, Odesa National Academy of Food
Gas Technologies. AND OPERATIONS STRATEGY
PLANS FOR 2020
— Implementation of a Talent Management — Establishment of an Internal Trainers Unit within IT-System. Naftogaz Group. — Centralization of training at Naftogaz Group. — Implementation of a mentoring system enabling more — Establishment of a Naftogaz Group Training effective training of new employees (interns) through Center. the involvement of experienced employees as — Implementation of distance learning system. mentors. CORPORATE GOVERNANCE CORPORATE RESPONSIBILITY ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 146 Naftogaz Group Annual Report 2019 147 Naftogaz Group The management of the company is fully aware of its responsibility for the life and health of employees at the enterprises of the Naftogaz Group. Therefore, the policies of the company are aimed at the creation of healthy and safe working conditions, along with the prevention of accidents and occupational diseases at work. Every year, the company invests in occupational safety OCCUPATIONAL measures and strives to implement international standards and best world practices in occupational safety management at group enterprises to achieve these goals.
SAFETY MARKET AND REFORMS
HEALTH AND SAFETY MANAGEMENT environmental protection of Naftogaz Group and Action measures to minimize the risk of accidents; analysis of of Naftogaz Group, as well as the Health and Safety, Envi- Plan for its implementation; occupational safety and health; elimination of the causes ronmental and Industrial Safety Department of the compa- The activities of the company in the field of health and — Regulations for the conduct of internal investigations, of accidents; training of employees on occupational safety; ny are responsible for the implementation of plans. safety management meet the requirements of the Law of analysis and accounting of incidents and events in providing employees with means of protection; conducting Ukraine "On health and safety". Since 2017, a dedicated oc- Naftogaz Group; medical examinations of employees and health and safety cupational health and safety policy has been in place, which — Regulations for reporting on the state of labor and days; inspection of the technical condition of equipment HEALTH AND SAFETY, INDUSTRIAL meets the requirements of the OHSAS 18001 standard (ISO environmental protection, civil protection, fire and and appliances, facilities and buildings, arranging repairs, SAFETY AND ENVIRONMENTAL 45001). At the level of the supervisory board, health and safe- industrial safety, road safety of Naftogaz Group. The etc. ty management is within the scope of the health and safety, decision was made to organize the implementation of a — The Action plan to improve road safety at Naftogaz of PROTECTION VISION OF NAFTOGAZ GROUP ecological and industrial safety committee. Unified Automated Health and Safety, Environmental and Ukraine and the enterprises of Naftogaz Group for 2019- In 2019, the board of the company approved the Health AND OPERATIONS STRATEGY The companies of Naftogaz Group have implemented five- Industrial Safety Monitoring System of Naftogaz Group and 2020; and Safety, Industrial Safety and Environmental Protection vi- stage operational control over the state of health and safety, an Implementation Plan approved; The Action plan to improve road safety includes the follow- sion of Naftogaz Group (hereinafter the Vision) with the main which includes inspections of production units and work- — Instructions on actions during evacuation of employees ing tasks: development and annual review of the register focus on the development of a mature culture in the areas of places. Issues related to health and safety are considered at from premises and buildings, civil protection training, and of risks of road accidents; monitoring and implementation health and safety, industrial safety, and environmental pro- meetings of group enterprises and general meetings of labor exercises; of road safety world experience and best practices, instal- tection. One of the key features of the Vision is a clear focus collectives; following these meetings, additional measures are — The Order "On medical authorization of employees of lation of GPS-navigators (trackers with an accelerometer on changing the daily habits of employees, their attitudes and determined to improve working conditions and safety. Training Naftogaz of Ukraine to physical education and sports." which enables analysis of driving style of drivers) on vehi- perception of safety, in contrast to the previous practices of and briefings on health and safety as well as professional de- In addition, amendments to the Company's Code of Cor- cles; conducting training on road safety and special medi- formal indicators and monitoring the implementation of poli- velopment of employees are held regularly. porate Ethics were drafted to cover sections dealing with the cal training for drivers; improving the medical examination cies and procedures. All employees of Naftogaz Group companies working un- Health and Safety, Environmental and Industrial Safety Depart- of employees of the motor transport service; implementa- An integrated approach or the so-called "Naftogaz HSE1 der employment contracts are insured against accidents at ment. tion of measures to bring practices into line with the re- Pyramid" has been created, which covers all areas of security work and occupational diseases. They are provided with sani- The following measures were approved to improve occu- quirements of the international standard ISO 39001: 2012 and combines the goals, tools and areas of implementation of tary facilities in accordance with regulations. pational safety and avoid injury: "Road traffic safety management system. Requirements the Vision. It aims to achieve: GOVERNANCE CORPORATE In 2019, the Board of Naftogaz of Ukraine developed and — The Action plan to improve occupational safety and health with guidance for use"; compulsory insurance of civil — zero mortality rate; approved a list of documents that determine the company's of Naftogaz of Ukraine and the enterprises of Naftogaz liability of drivers, vehicles, cargo; development and imple- — zero loss of time as a result of accidents; general approach in the field of health and safety manage- Group for 2019-2020; mentation of a system of material incentives for drivers for — zero injuries; ment, namely: The action plan to improve occupational safety and health accident-free work, etc. — zero damage to the environment. — Vision of health and safety, industrial safety, and includes a number of tasks, in particular: monitoring and The heads of the company's branches and enterprises
An integrated approach or the so-called +20% "Naftogaz HSE Pyramid" Zero mortality rate Implementation areas RESPONSIBILITY Increase of investments nta nme l pro ro te in health and safety vi c Zero loss of time as a result of accidents n ti Sustainable activities 1 2 3 AND SOCIAL ENVIRONMENTAL E o n and safe conditions % Zero injuries 48.3 Innovative technology Zero damage to the environment of total investments Discipline in health and safety Sustainable activities was spent on personal and safe conditions
protection equipment Implementation
I n d
Innovative technology Systems u
s
t Communication
r
i Discipline a
Working environment environment Working l
People and organization People s
a Implementation Identification and
f e prevention of problems
t buildings and equipment security of y and competencies culture corporate
y Communication and procedures management systems 2 216 t a n fe on-site fire workshops were d a a s Identification and prevention of problems Accountability conducted in 2019, including ss rk et i Wo 132 training sessions together ntegrity Accountability FINANCIAL OVERVIEW AND STATEMENTS with units of the SES of Ukraine 1 Health, Safety and Environment
Annual Report 2019 148 Naftogaz Group Annual Report 2019 149 Naftogaz Group The Vision specifies the following tools designed to pre- RESULTS OF HEALTH AND SAFETY MEASURES INVESTMENTS IN LABOR vent injuries and accidents at work: accountability, identifica- IN 2019 PROTECTION Dynamics of investments in labor protection tion and prevention of problems, communication, implemen- in 2017-2019 tation, discipline, innovative technology, sustainable activities 19 inspections of structural and production units were In 2019, the enterprises of Naftogaz Group spent +20% and safe conditions. The Vision will be implemented in three carried out in 2019 to check their readiness for operation UAH 318.4 million on the implementation of measures to 350 318.4 areas: working environment (security of buildings and equip- in the upcoming autumn-winter period, their organizational create safe and healthy working conditions along with the 300 ment); systems (management systems and procedures); peo- approaches to health and safety, and technical surveillance, prevention of accidents and occupational diseases at work. 264.3 ple and organization (corporate culture and competencies). fire safety and road traffic safety measures. Following the This sum was 20% more than in 2018. MARKET AND REFORMS 250 To implement the Vision of Naftogaz Group, a dedicated inspections, the company conducted the necessary internal As a proportion of the payroll budget, Ukrtransgaz invests 205.3 vertical system is to be created that determines the direction investigations. Mitigation measures were taken and the rele- the most in health and safety measures – 5.6%, followed by 200 and provides comprehensive support in all HSE and sustain- vant officials were disciplined. Ukrnafta – 4.4% and Ukrgazvydobuvannia – 2.6%. At the same able development areas. The new role of HSE Chairman has Training was held for employees when they were evacuat- time, the regulatory share of health and safety expenditures UAH million 150 been determined, and its key goals are the implementation ed from buildings where their workplaces are located. Training in accordance with the legislation of Ukraine is much lower – of best practices and approaches of leading companies in the courses "Auditor of the health and safety management system 0.5% of the company’s payroll budget. 100 field of health and safety, industrial safety and environmental in accordance with the requirements and provisions of the Significant attention is paid to providing employees with protection, integrity and risk management and sustainable international standard ISO 45001:2018" and "Auditor of the personal protective equipment (overalls, footwear, seat belts, 50 development, maintenance of safe and healthy working condi- road traffic safety management system in accordance with safety helmets, goggles, respirators, noise-canceling head- 0 tions, and sustainable development culture in Naftogaz Group. the requirements and provisions of the international standard phones, protective gloves, etc.). In 2019, UAH 153.9 million 2017 2018 2019 The Vision serve as the basis for developing an appropriate ISO 39001:2012" were also organized and conducted. was spent on PPE, which is 48.3% of total investments in strategy for the divisions of Naftogaz Group. The goals and key Following the certification of the working conditions of health and safety. Source: Naftogaz results of each manager will include indicators on health and 2,283 working places at the Group's enterprises in 2019, mea- safety, industrial safety, and environmental protection within sures were developed and implemented to mitigate harm and AND OPERATIONS STRATEGY their responsibilities. improve the situation. Financing of labor protection measures by Naftogaz Group companies, % of payroll budget
2 Health and safety through children's eyes Ukrtransgaz 5.6% Ukrnafta 4.4%
Jointly with the Trade Union Committee of the company, Ukrgasvydobuvannya 2.6% a competition of children's drawings, posters, photographs and literary works "Health and safety through the eyes of Chornomornaftogaz 1.6% children" was held among the children of the company's Ukrtransnafta employees; with the winners and participants joining cele- 1.6% GOVERNANCE CORPORATE brations. Ukravtogaz 1.5%
Ukrspetstransgaz 1.5%
Kirovogradgaz 1.0%
0 0.5 1 2 3 4 5 6
Source: Naftogaz RESPONSIBILITY
HSE THROUGH CHILDREN'S ART Expenses to provide employees with personal protective equipment by Naftogaz Group AND SOCIAL ENVIRONMENTAL enterprises in 2019, UAH million
Ukrnafta 65.9
Ukrgasvydobuvannya 57.5
Ukrtransgaz 28.0
Ukrtransnafta 1.7
In 2019, representatives of Naftogaz Group took part in Ukrspetstransgaz 0.8 meetings, conferences and forums, including those organized by the International Labor Organization Ukraine and the Min- 0 10 20 30 40 50 60 70 FINANCIAL OVERVIEW AND STATEMENTS istry of Social Policy of Ukraine. Source: Naftogaz
Annual Report 2019 150 Naftogaz Group Annual Report 2019 151 Naftogaz Group OCCUPATIONAL INJURIES Most accidents at Naftogaz Group enterprises are caused by organizational issues. In 2019, 75% of injured workers suffered Number of injured employees by cause of injury, 2017–2019 In 2019, there were 34 accidents at Naftogaz Group en- as a result of accidents due to organizational causes, 14% due terprises, including 2 group accidents (in 2018 – 34 accidents, to technical causes, and 11% due to psycho-physical causes. 1/1"F" 1/1"F" 1/1"F" including 2 group accidents), as a result of which 36 employ- 1 1 3 1 2 3 1 6 ees were injured, including 1 death (in 2018 year – 36 injured Organizational causes: 1 persons, including 3 deaths), namely: — failure to comply with the requirements of health and 2
— Ukrgazvydobuvannia – 18 accidents, including 1 group safety instructions – 16 employees were injured, including 4 14/1"F" 1 13/1"F" 3 MARKET AND REFORMS accident, 19 employees were injured, including 1 death (in 1 death; 1 2018 – 20 accidents, 20 employees were injured); — violation of traffic safety rules and violation of safety 2 2017 3 2018 2019 — Ukrnafta – 9 accidents, including 1 group accident, 10 requirements during the operation of public transport 11 employees were injured (in 2018 – 8 accidents, including (road) – 6 employees were injured; 11 1 group accident, 9 employees were injured, including 1 — failure to perform official duties – 3 employees were 6/1"F" 9 resulting in death); injured; 5 — Ukrtransgaz – 5 accidents, 5 employees were injured — violation of safety requirements during operation of (in 2018 – 3 accidents, including 1 group accident, 4 equipment, machinery, machinery, etc. – 2 employees employees were injured); were injured. 35 accidents including 3 fatalities 36 accidents including 3 fatalities 36 accidents including 1 fatality — Ukrtransnafta – 1 accident, 1 employee was injured (in 2018 – 2 accidents, 2 employees were injured, including 1 death); Technical causes: Traffic accident Traffic accident Traffic accident — Naftogaz of Ukraine – 1 accident, 1 employee was injured — design flaws, imperfections, insufficient reliability of means Fall of an injured person Fall of an injured person Fall of an injured person (in 2018 – 1 accident, 1 employee was injured and died). of production – 2 workers were injured; Injuries caused by moving objects Injuries caused by moving objects Injuries caused by moving objects — low-quality construction works – 1 employee was injured; Fall of equipment Fall of equipment Fall of equipment AND OPERATIONS STRATEGY In 2019, the accident frequency rate at the enterprises of — unsatisfactory technical condition of production facilities, Intentional injury inflicted by other person Intentional injury inflicted by other person Injuries caused by high temperature Naftogaz Group was 0.615 (in 2018 – 0.532), and the severity buildings, structures, utilities, territory – 1 employee was Electrocution Poor health Sinkholes of injuries rate – 75.83 (in 2018 – 76.64). The loss of time due injured; Other Injuries caused by toxic substances Transfer of technological vehicles to accidents at work amounted to 2,654 man-days (in 2018 – — others (dirty steps of tank truck ladder) – 1 worker was Electrocution Collapse of building structures 2,529). injured. Injuries caused by high temperature Other
"F" – fatal accidents Other
Source: Naftogaz Number of accidents and injured employees at Naftogaz Group enterprises in 2017-2019 nia – 4, Ukrtransgaz – 4, Ukravtogaz – 1, Naftogaz Teplo – 1. The reason for such situations is the inconsistency of medical Number of injured employees by cause reports regarding the health of employees.
9 9 of injury, 2017–2019 The primary strategic goal of Naftogaz Group companies is GOVERNANCE CORPORATE Ukrgasvydobuvannya 20 20 achieving a zero death rate due to occupational injuries, and 18 19 the next step is a zero number of injuries overall. The number 40 11 13 of injuries resulting in death decreased from 3 in 2018 to 1 in 2019. The safety and life of employees is the main asset of the Ukrnafta 8 9 35 1 3 9 10 5 company, so the company continues to focus efforts on pre- 30 5 venting death and occupational injuries. 4 6 9 4 Ukrtransgaz 3 4 25 5 5 SAFETY OF GAS AND OIL TRANSPORTATION 20 4 5 The uninterrupted functioning of the gas transmission Ukrtransnafta 2 2 15 28 27 system and the trunk oil pipelines system is the key to the RESPONSIBILITY 1 1 25 10 effective operations of Naftogaz Group enterprises and the
Total AND SOCIAL ENVIRONMENTAL Number of injured employees injured Number of realization of the economic interests of the state. 0 2017 29 35 Naftogaz 1 1 5 In 2019, a number of organizational and technical mea- 1 1 2018 34 36 sures was designed and implemented to prepare for trou- 2019 34 36 0 ble-free operation during the autumn-winter period of 2019- 1 2 Number of injuries Number of injured persons 2017 2018 2019 2020. For example, in order to ensure the trouble-free state of Kirovogradgaz 0 the gas transmission system of Ukraine and reliable transpor- Organizational Psycho-physiological Technical 0 tation of gas to European countries and Ukrainian consumers, Source: Naftogaz the following works were performed by Ukrtransgaz during 0 5 10 15 20 25 2019: Psycho-physiological causes: — overhaul and emergency repair of 117.1 km of the linear Source: Naftogaz — personal negligence of injured persons – 4 employees part of the trunk gas pipelines; were injured. — corrosion due diligence of 2,541.7 km of the linear part of 2 1 The accident frequency rate (accidents resulted in death) is determined using the formula: AFR = N * 1000 / Av where N - the number of reported accidents at work in the reporting period In 2019, there were 14 sudden (natural) deaths of employ- the trunk gas pipelines; with loss of ability to work for one or more days (resulting in death); Av - average number of employees for the reporting period. The rate is calculated per 1000 registered employees 3 The accident frequency rate for 2018 is adjusted in comparison with what was disclosed in the previous report ees (mainly as a result of cardiovascular diseases) at Naftogaz — overhaul of 880 means of electrochemical protection; 4 2 The severity rate is calculated using the formula: SR = D / N, where D - the number of working days of disability in all accidents, N - the total number of accidents 5 3 To calculate time losses, only work days are taken into account Group enterprises, which were not related to industrial acci- — repair of 43 gas pumping units of compressor stations; dents (in 2018 – 17 cases): Ukrnafta – 4, Ukrgazvydobuvan- — overhaul of 65 wells of underground gas storage facilities; FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 152 Naftogaz Group Annual Report 2019 153 Naftogaz Group and paraffin deposits using the technique of repeated SECURITY OF OIL AND GAS COMPLEX FACILITIES tia region – 2, Ivano-Frankivsk region – 1; Kirovohrad region 9 Expenses on fire safety measures in 2019 passage of pistons; – 1, Luhansk region – 1, Lviv region – 10, Mykolaiv region – 1, — works on a comprehensive instrumental survey of Despite the measures taken by Naftogaz Group to pre- Odesa region – 1, Poltava region – 20, Rivne region – 1, Sumy 767.1 km of the linear part of the trunk oil pipelines; vent, detect and stop offenses against the property of the region – 5, Kharkiv region – 9, Khmelnytsky region – 1. — in-pipe diagnostics of 917.9 km of the linear part of the company's enterprises, the number of offenses remains — 72 acts of damage (destruction) of technological main oil pipelines; significant. equipment of transportation and mining enterprises. — repair of 8 sets of anode groundings of cathodic protection During 2019, the company's security and protection units The most damage (destruction) of technological equip-
18.1 stations and repair of 34 cathodic protection stations and detected and law enforcement agencies recorded 213 illegal ment of mining facilities, trunk and industrial pipelines was MARKET AND REFORMS UAH MILLION drainage installations; encroachments on the company's facilities, namely: recorded in Poltava (13), Kharkiv (10) and Kyiv (8) regions. — scheduled preventive repairs of 23 pumps and 55 electric — 60 illegal cuts into the trunk and industrial oil, gas and — 66 acts of theft of valuable assets (hydrocarbons, fuels and maintenance for existing fire motors of pump units. condensate pipelines (in 2018 – 77), of which 28 were lubricants, etc.); detection and extinguishing In addition, employee training sessions were conducted equipped with taps with a total length of 27 km 312 m. — 15 other offenses (thefts, equipment damage, etc.). systems in proper condition, where the participants practiced various possible scenarios of Illegal cuts into pipelines were detected and documented All illegal encroachments were reported to the law en- purchase of fire extinguishers gas transmission system operations during the heating season in 16 regions of Ukraine: Volyn region – 1, Dnipropetrovsk forcement agencies and 172 criminal proceedings were initi- 2019-2020. This was done by simulating the mode of opera- region – 2, Donetsk region – 2, Zhytomyr region – 2, Zakarpat- ated. tions of the gas transmission system under different scenarios of natural gas resource distribution, air temperature, technical capabilities of the gas transmission system etc. TASKS FOR 2020 11.8 — Implementation of the Health and Safety, Industrial Safety knowledge, topics, and content of training programs in FIRE SAFETY and Environmental Protection Vision of Naftogaz Group, order to bring them into line with the regulations and real UAH MILLION approved by the Board of Naftogaz of Ukraine NJSC (Min- needs of production processes, introduction of new forms AND OPERATIONS STRATEGY other fire-fighting measures The fire regime at the enterprises of the Group is regu- utes of September 3, 2019 No 423). and methods of training. lated by object instructions, orders and instructions in accor- — Development (review), implementation and analysis of — Installation of GPS-navigators (trackers with mandatory dance with the requirements of NAPB A.01.001-2015 "Fire policies, goals and programs in the field of occupational availability of an accelerometer to analyze the driving style safety rules in Ukraine" and SOU 75.2-20077720-017:2013 health and safety in accordance with the requirements of of drivers) on vehicles including buses and other vehicles "Naftogaz of Ukraine NJSC Fire safety management system. ISO 45001. transporting dangerous goods and employees of Naftogaz Key provisions". — Implementation of actions to introduce modern Group. 1.3 In 2019, the company employed a total of 215 fire safety requirements in the field of road traffic safety, including — Improving the procedure for mandatory general (when specialists, including 108 full-time employees and 107 persons the international standard ISO 39001:2012 "Road traffic entering employment) and periodic medical examinations UAH MILLION who perform some additional functions. The company also safety management system. Requirements with guidance of employees, including through cooperation with health- elimination of identified had 193 fire technical commissions and 329 fire brigades with for use". care facilities, the inclusion of a relevant clause in collec- violations a total staff of 2,778 persons. The objects of the company's — Review of the organization of training for personnel of tive agreements and non-admission of employees with enterprises are guarded on a contractual basis by 24 fire and enterprises in the field of health and safety, testing of certain medical conditions.
rescue units from the State Emergency Service of Ukraine; GOVERNANCE CORPORATE they are equipped with 83 fire trucks. The number of staff in these units is 847 people. The company conducts fire inspections of the group's fa- 435.1 cilities on a regular basis. 5,701 such inspections were carried out in 2019, with 23,769 violations identified, of which 21,811 UAH THOUSAND violations were eliminated, and 64 disciplinary sanctions were modernization of fire-fighting imposed. During the reporting period, the State Emergency technical equipment Service of Ukraine (SES) conducted 54 inspections at Group enterprises and identified 441 violations, of which 334 viola- tions were eliminated.
In order to ensure the readiness of the employees of RESPONSIBILITY Naftogaz Group to act in case of fire, 2,216 on-site fire work- 20.4 shops were conducted in 2019, including 132 training sessions AND SOCIAL ENVIRONMENTAL together with units of the SES of Ukraine. UAH THOUSAND During 2019, the enterprises of the group spent a total of research and development work UAH 164.0 million on fire-fighting measures including: — UAH 132.4 million contracting the fire brigades of the State Emergency Service for the protection of the company's — geophysical surveys at 121 wells. facilities; In order to maintain trunk oil transport facilities in proper — UAH 18.1 million on maintenance for existing fire technical condition, Ukrtransnafta, in turn, carried out the detection and extinguishing systems in proper condition, following works: purchase of fire extinguishers; — overhaul of 8.25 km of the linear part of the trunk oil — UAH 11.8 million for other fire-fighting measures; pipelines, including repair of the insulating coating of — UAH 1.3 million to eliminate identified violations; 5.87 km; — UAH 435.1 thousand on the modernization of fire-fighting — elimination of 29 examples of malicious damage on the technical equipment; linear part of oil pipelines; — UAH 20.4 thousand for research and development — cleaning of 24,386 km of oil pipeline sections from water work. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 154 Naftogaz Group Annual Report 2019 155 Naftogaz Group RENT PAYMENTS DEVELOPMENT OF LOCAL COMMUNITIES
The total amount of In 2019, Ukrnafta spent COOPERATION WITH rent payments from UAH 11.1 million for the social Ukrgasvydobuvannya to the + development of local communities 23.3 consolidated budget in 2019 11 LOCAL COMMUNITIES UAH BILLION UAH MILLION MARKET AND REFORMS
The companies of Naftogaz Group pay considerable RENT PAYMENTS FOR THE DEVELOPMENT rent payments is the right decision that stimulates the Naftogaz Group pays considerable attention to social attention to the social development of local communities OF LOCAL COMMUNITIES development of small villages and towns. assistance and support for the development of children with where hydrocarbon mining takes place. disabilities. In 2019, Ukrgasvydobuvannya spent more than The total amount of rent payments to the consolidated During 2019, the company's employees made UAH 5.3 million on social projects and charitable assistance budget in 2019 from Ukrgasvydobuvannya amounted to UAH CHARITABLE EXPENSES charitable transfers to the following children's in the areas of its activity. The main areas of funding include 23.3 billion, of which UAH 1.16 billion in rent payments was institutions in Kyiv: healthcare, education development, and infrastructure received by local budgets in accordance with oil, natural gas, Since 2014, Naftogaz employees have been transferring — UAH 94 000 for the purchase of computer equipment for development of small settlements close to mining activities and gas condensate production rent distribution mechanisms part of their monthly salaries to charitable assistance the Kyiv Boarding School No. 5 where children with visual and where Ukrgasvydobuvannya employees reside. enshrined in the law that came into force in 2018. to the Ukrainian Allied Forces operations (ATO/OOS). impairment study;
Key social development projects funded by The funds received were used by local communities for During this period, a total of over UAH 50 million — UAH 167 700 for the Kyiv City House "Berizka", where AND OPERATIONS STRATEGY Ukrgasvydobuvannya in 2019 include the following: needs related to infrastructure development, support of was allocated for the purchase of medical equipment orphans with physical and mental health issues receive healthcare facilities, and other projects providing jobs and for hospitals, protective equipment, and clothing treatment. Lviv region: settlement development. for servicemen. Moreover, medical facilities for the 1 — village of Bilche – UAH 250 000 rehabilitation of servicemen receive active assistance from In addition to direct financial support, Naftogaz annually for the construction of a bridge Distribution of Ukrgasvydobuvannya rent receipts by group employees. During 2019, a total of UAH 11.3 million organizes and participates in charitable events. In 2019, the — village of Pasichne – region: was collected for the purchase of medical equipment and company's employees organized a New Year Party for students UAH 200 000 for the repair of — Kharkiv region – UAH 578.5 million; supplies for the military, of which 71% (UAH 7.9 million) was of the only special boarding school in Kyiv No 18 for children a local road — Poltava region – UAH 493.1 million; spent on medical needs, 26% (UAH 2.9 million) went for with hearing impairments. They also took part in the most — Lviv region – UAH 42.7 million; the purchase of clothing and military equipment, and 3% popular sports and charity event in the country, the "Chestnut Kharkiv region: — Dnipropetrovsk region – UAH 26.9 million; (UAH 335.0 thousand) for gifts to children of border guards Run", with all funds raised transferred to the Center for 2 — village of Donets – UAH 250 000 — Others – UAH 21.9 million. and servicemen. Pediatric Cardiology and Cardiac Surgery. to support the activities of
the robotics class of the NGO The bulk of these funds went to the budgets of two gas- GOVERNANCE CORPORATE "Brobots" in the secondary producing regions – Kharkiv and Poltava, namely to satisfy the school No. 2 needs of the following communities: 1 The amount of rent payments to local budgets from Ukrnafta in 2019, UAH million — village of Chkalovske – — Starovirivska community, Kharkiv region – Total Chernihiv region UAH 3 million for road repairs UAH 62.5 million; — Senchanska community, Poltava region – UAH 55.7 million; 34.4 Poltava region: — Kolomatska community, Poltava region – UAH 37.5 million. 352.5 Sumy region 3 — Novosanzharska Rayon State During 2019, Ukrnafta paid UAH 7.05 billion in rent to the 149.8 Administration – UAH 210 000 state. UAH 352.5 million, or 5%, went to local budgets. Poltava region for the purchase of medical In 2019, the communities of Sumy (UAH 149.8 million), Lviv region 56.2 equipment Ivano-Frankivsk (UAH 78 million) and Poltava (UAH 56.2 28.3 million) regions received the largest amounts of revenue from Kharkiv region In 2019, Ukrnafta spent UAH 11.061 Ukrnafta's rent payments. The portion of the rent paid to local Ivano-Frankivsk region 4.7 RESPONSIBILITY million for the social development budgets depends on the volume of hydrocarbon production 78.06 Dnipropetrovsk region of local communities. Key projects in specific regions. According to information provided by the AND SOCIAL ENVIRONMENTAL were as follows: communities that benefit from the rent, the vast majority Chernivtsi region 0.8 went towards financing social and infrastructure projects. 0.2 Cherkasy region Sumy region: Visiting communities near to Naftogaz Group production, 4.4 1 — village of Okhtyrka – UAH 1.796 you can once again see that the decentralization of Source: Naftogaz million for road repairs
Ivano-Frankivsk region: 2 — village of Dolyna – UAH 5.2 SOCIAL PROJECTS AND CHARITY ARMY SUPPORT CHILDREN SUPPORT million for the repair of a During 2019, a total of UAH dormitory and a kindergarten In 2019, Ukrgasvydobuvannya Naftogaz employees made spent more than UAH 5.3 million 11.3 million was collected charitable transfers for the on social projects and charitable for the purchase of medical Chernihiv region: development of children 3 assistance in the areas of its equipment and supplies for with disabilities — village of Borshna (Valkivska 5.3 11.3 the military 261.7 activity village council) – UAH 0.381
UAH MILLION UAH MILLION UAH THOUSAND FINANCIAL OVERVIEW AND STATEMENTS million for water well repair
Annual Report 2019 156 Naftogaz Group Annual Report 2019 157 Naftogaz Group Use and savings of FER by Naftogaz Group in 2014-2019 INVESTING IN FER consumption Actual savings of FER, % (compared to the targets) 4 8 7.6 6.9 3.3 3.3 7 3.2 3.2 3.1 MARKET AND REFORMS 3 6 5.8 ENERGY EFFICIENCY 2.6 5.3 5 4.4 4.1 %
Mtoe 2 4 COMPANY ENERGY MANAGEMENT POLICY 3 ENERGY RESOURCES USED BY THE GROUP IN 2019 The company is taking consistent steps to improve the 1 2 energy efficiency of its production processes and to save In 2019, the group used 3.1 million 1 fuel and energy resources. These issues are central to the tons of fuel and energy resources 0 0 Naftogaz Group development strategy and important for (FER) in oil equivalent for 2014 2015 2016 2017 2018 2019 2014 2015 2016 2017 2018 2019 the realization of national energy independence interests. technological needs, including: The company, in its operations, is guided by the 3.1 Source: Naftogaz Energy Management Policy of Naftogaz of Ukraine million tons o.e.
NJSC approved in 2017; the adopted Energy Management AND OPERATIONS STRATEGY Goals and Objectives and the action plan to achieve them In 2019, the “per unit” energy intensity indicator for individual by 2020. Operational and technological activities was as follows: consumption of FER by types in 2019, % — Gas transmission – 0.019 mcm/mcm * km; Energy management system — Oil transportation – 0.0013 tons o.e./thous t * km; In 2019, the executive board of the company electricity — Oil production (Okhtyrkanaftogaz NGVU) – approved the Regulation on Operations of the Integrated 3.2 3.0 0.042 tons o.e./t; Management System (IMS), which includes an energy bcm — Gas processing (Dolinsky Gas Refinery, Kachanivsky Gas management system in accordance with the requirements Refinery) – 63.18 tons o. e./mcm. natural gas of the international ISO 50001 standard. In August 2.5 oil (gas 2019, the existing management system was assessed condensate) by an external reviewer in terms of its compliance with 1.1 the requirements of international standards, including
billion kWh GOVERNANCE CORPORATE ISO 50001. As a result, the conformity of the existing 2.3 heat 0.019 management system of the company with international electricity standards was confirmed and extension of certificates of mcm/mcm * km conformity was recommended; a list of recommended 85.6 Gas transportation steps for potential improvements was provided. 6.7 other types of FER One of the potential improvements of the energy 597.3 natural gas management system is transition to the new version of the international standard ISO 50001:2018 and implementation thousand Gcal Source: Naftogaz of energy management systems in all Naftogaz Group heat 0.0013 enterprises. Company management is aware of its responsibility for tons o.e./thous t * km creating a supportive environment for the implementation Operational and technological consumption Oil transportation and continuous improvement of the company's energy 76.5 RESPONSIBILITY of FER by the group’s companies in 2019, % management policy, as well as the importance of its role
thousand tons AND SOCIAL ENVIRONMENTAL as a leader in the operations of an integrated management oil (gas condensate) system. 50.7 Ukrtransgaz 0.01 Chornomornaftogaz 0.042 tons o.e./t USE OF ENERGY RESOURCES BY GROUP 203.7 0.01 Ukrspetstransgaz Oil production COMPANIES IN 2019 ktoe (Okhtyrkanaftogaz NGVU) During 2019, Naftogaz Group companies used fuel other FER 0.08 Ukravtogaz and energy resources (FER) for their technological needs (boiler and furnace fuels) amounting to 3.1 million tons o.e., including: — 3.2 bcm of natural gas; 0.38 Ukrtransnafta — 1.1 billion kWh of electricity; The decrease in FER consumption in 2019 was due, among 63.18 — 597.3 thousand Gcal of heat; other factors, to the implementation of energy-efficient — 76.5 thousand tons of oil (gas condensate); measures under the Energy Efficiency Improvement Program 19.8 Ukrnafta 29.0 Ukrgasvydobuvannya tons o. e./mcm — 203.7 ktoe other types of FER of National Joint Stock Company Naftogaz of Ukraine for 2015- Gas processing (Dolinsky Gas Refinery, FINANCIAL OVERVIEW AND STATEMENTS (boiler and furnace fuel) 2020. Source: Naftogaz Kachanivsky Gas Refinery)
Annual Report 2019 158 Naftogaz Group Annual Report 2019 159 Naftogaz Group Ukrtransgaz JSC: saving: 13.07 mcm. ACTUAL ENERGY SAVINGS AND THE TOTAL COST OF FUEL AND ENERGY RESOURCES SAVED IN 2019 — Purification of the flow part of axial compressors of gas — Utilization of secondary energy resources through the turbine units with effective solutions and cleaning liquids – utilization of excess gas pressure for electricity production – Saved fuel and energy The total cost of fuel natural gas saving: 18.163 mcm. electricity generation: 8.86 million kWh. resources and energy resources — Consumption of gas by consumers at minimum possible — Introduction of frequency control of actuators of induction (FER) in 2019 saved in 2019 pressure from pipeline section before start of repair motors – electric energy saving: 5.48 million kWh. works – natural gas saving: 16.059 mcm.
140.7 1 273.7 — Introduction of gas pipeline repair technology under MARKET AND REFORMS Naftogaz – Energoservice SE – Affordable Heat Project ktoe UAH million (including VAT) pressure (using composite bandages, etc.) – natural gas In 2019, Naftogaz – Energoservice SE implemented the saving: 69.424 mcm. Affordable Heat project in the city of Kropyvnytskyi and the — Utilization of heat of exhaust gases of gas turbine town of Donets (Kharkiv region). installations instead of boiler house operation – natural gas Individual gas heating systems were installed at more than ENERGY SAVING POLICY RESULTS saving: 3,526 mcm. 500 sites in the town of Donetsk and about 300 similar projects FER saved in 2019, ktoe — Decommissioning of unloaded power transformers, have been developed. Thanks to implementation of energy saving measures replacement with less powerful models – electricity saving: In the city of Kropyvnytskyi, through the Center for in line with the objectives of the Energy Efficiency Program by companies 2.07 million kWh. Energy Efficiency Solutions, 15 electric heating installation of Naftogaz of Ukraine for 2015-2020 and energy saving — Reconstruction of outdoor lighting systems and lighting projects were implemented, including 14 projects under the programs of the group's enterprises for 2019, energy savings Ukrtransnafta 0.6 Ukrgasvydobuvannya networks – electricity saving: 2.151 million kWh. District Heating Optimization Program in cooperation with of 140.7 thousand tons o.e. were achieved, including: the Kropyvnytskyi City Council. In addition, 36 contracts were — 148.2 mcm of natural gas; Ukrgasvydobuvannya JSC: concluded and installation works were carried out to install — 30.8 million kWh of electricity; 26.9 — Utilization of gas from condensate degassing – natural gas individual gas heating systems and 98 units of boiler equipment. — 100.9 thousand Gcal of heat; AND OPERATIONS STRATEGY — 0.8 ktoe other types of fuel. KEY ENERGY EFFICIENCY TARGETS FOR 2020
— Implementation of activities under the Energy Efficiency — Improving the Energy Management System by moving 106.7 6.5 Program by Group companies and the further FER savings to a new version of the international ISO 50001:2018 in 2020: natural gas – not less than 64.986 mcm; electricity standard. 148.2 – not less than 14.416 million kWh; thermal energy – not — Development of an Energy Efficiency Improvement less than 28.445 thousand Gcal. Program for Naftogaz group Companies for 2021-2025. mcm Ukrtransgaz Ukrnafta natural gas FER saved by Naftogaz companies, 2016-2019 CORPORATE GOVERNANCE CORPORATE by programs 30.8 2016 Naftogaz Energy Efficiency Program for 0.9 2017 million kWh 2015-2020 Other types of FER (ktoe) 1.2 2018 electricity 0.8 0.8 2019 98.3 25.6 54.6 100.9 Electricity (million kWh) 32.6 thousand Gcal 30.8 heat
42.4 RESPONSIBILITY 106.0 98.8 Heat (thousand Gcal) 99.9 AND SOCIAL ENVIRONMENTAL Sectoral energy-saving 100.9 0.8 programs of subsidiaries and joint stock companies of Naftogaz 240.1 ktoe 253.7 other types of fuel Source: Naftogaz Natural gas (mcm) 227.4 148.2
In 2019, energy savings exceeded the target by 28.6 IMPLEMENTATION OF ENERGY EFFICIENT 214.8 thousand tons o. e., including: PROJECTS 232.3 — 18.7 mcm of natural gas; Total (ktoe) 205.3 — 16.1 million kWh of electricity; Naftogaz Group companies implement energy efficiency 140.7 — 73.1 thousand Gcal of heat. measures under the Energy Efficiency Program of Naftogaz of Ukraine for 2015-2020 and their own energy saving 0 50 100 150 200 250 300 The total cost of saved fuel and energy resources in 2019 programs. FINANCIAL OVERVIEW AND STATEMENTS amounted to UAH 1 273.7 million (including VAT). The most effective measures in 2019 to save energy were: Source: Naftogaz
Annual Report 2019 160 Naftogaz Group Annual Report 2019 161 Naftogaz Group EXPENDITURES ON ENVIRONMENTAL PROTECTION
Capital ENVIRONMENTAL Naftogaz investments aimed Waste management 7.2 Group capital 7.1 at preserving and 0.13 (Ukrgasvydobuvannya) investments restoring soils PROTECTION UAH MLN UAH MLN (Ukrtransnafta) UAH MLN MARKET AND REFORMS
Reducing the adverse impact of Naftogaz Group on the and discipline of the staff, the use of an electronic document hazardous waste, as well as water resources protection and 6The regulation on the contracting procedure was amended environment and environmental protection are extremely management system, and the successful implementation of rational management. To achieve these goals, the company's to include suppliers’ HSE commitments and monitoring important components of the company's development the Green Office program. specialists brief the employees and draft amendments to mechanisms. strategy. In its operations, Naftogaz adheres to sustainable In addition, to ensure the effective operation of the governmental regulations in the field of environmental development principles in order to preserve a clean and environmental management system, internal environmental protection, radiation safety, and rational use of natural safe environment for future generations. Every year, the audits are conducted at the enterprises of Naftogaz resources. EXPENDITURES ON ENVIRONMENTAL company increases its investment in environmental protection Group. Audits of environmental aspects are performed PROTECTION and focuses its efforts on responsible water management in accordance the requirements of the SOU (Standard of and soil protection, reduction of air emissions, responsible Ukrainian Company) "Environmental Protection. Audit of KEY RESULTS IN THE FIELD OF ECOLOGY AND Total expenditure of Naftogaz Group enterprises on AND OPERATIONS STRATEGY waste management and implementation of energy efficiency environmental aspects of activity at the national joint-stock ENVIRONMENTAL PROTECTION IN 2019 environmental protection in 2019 amounted to UAH 178.9 programs. The companies of Naftogaz Group strive to ensure company "Naftogaz of Ukraine" (approved by the order million, of which 96% or UAH 171.7 million was current that their activities comply with European rules and at the of the company of 31.01.18 #30). Based on audit results, 1Compliance of the company's standards in the field of expenses and 4% or UAH 7.2 million was capital investments. same time implement best practices and best available plans are formed to eliminate any discrepancies. In 2019, environmental protection, occupational health, and safety Capital investments were aimed at preserving and technologies to minimize their adverse impact on the four internal environmental audits were conducted at with the requirements of the EBRD's Environmental and restoring soils totaling UAH 7.1 million (Ukrnafta costs) and environment. Naftogaz Group enterprises (the Underground Gas Storage Social Policy was confirmed, which made it possible to attract waste management – UAH 0.1 million (Ukrgasvydobuvannya Operator Branch; Gas Transmission System Operator financial resources of EUR 120 million by issuing Eurobonds costs). LLC; the Shebelynka Drilling Department of Ukrburgaz and confirm the status of reliable partner. The largest share of current expenses was spent on ENVIRONMENTAL POLICY Branch, Ukrgasvydobuvannya JSC; Gas and Gas Condensate soil protection and remediation (36.3% of total current Processing Department, a Branch of Ukrgasvydobuvannia 2Amendments to the “Procedure for decommissioning of trunk expenditures), return water treatment (28.7%), waste All decisions and activities in the field of environmental JSC). Following these audits, among other things, an pipelines designed to transmit oil, gas and refined products” management (18.4%). The allocation of current costs was the safety and environmental protection at Naftogaz Group are environmental service was established at the Underground approved by the CMU Resolution of 28.03. 2018 No 209 following: 3.2% – for air protection, 0.9% – for R&D, 0.2% –
implemented based on the Environmental Policy of NJSC Gas Storage Operator Branch. were drafted and submitted to the Ministry of Energy and for radiation safety and 12.3% – for other areas (including GOVERNANCE CORPORATE Naftogaz of Ukraine approved by the decision of the Board The decision of the Board No 167 of 21.03.2019 provided Environmental Protection of Ukraine to initiate the changes. No 348 dated 21.08.2017. The environmental goals and for the introduction of integrated HSE monitoring, which objectives of the company are established by the decision of would enable automatic urgent incident notification at 3In order to optimize the procedure for issuing air emission the Board No 552 of 18 October 2018 (for more details see Naftogaz Group. permits for stationary sources of drilling companies, the Change in expenditure on the Report 2018). The company has established an environmental company drafted the laws of Ukraine "On Amendments environmental protection Since 2018, all Naftogaz Group companies have working group, which includes representatives of Naftogaz to Article 11 of the Law of Ukraine "On Air Protection" to +26.5% implemented environmental management systems in of Ukraine NJSC and environmental services of Naftogaz simplify the procedure for issuing emission permits" and accordance with the requirements of the international Group companies. Meetings of the working group consider "On Amendments to the Tax Code of Ukraine to simplify the 200 standard ISO 14001:2015. In 2019, the certifying agency environmental safety issues and provide recommendations on procedure for issuing emission permits". 178.9 180 4.0% TÜV SÜD Management Service GmbH conducted the first how to improve the activities of the enterprises. 160 supervisory assessment of the existing management system Naftogaz Group has a hotline for complaints or suggestions Completion of a pilot project designed to introduce a 141.4
4 RESPONSIBILITY for compliance with the requirements of international on environmental protection, occupational safety, and social greenhouse gas emission monitoring, reporting and 140 2.3% standards ISO 14001, OHSAS 18001 and ISO 50001. The protection. No official complaints about environmental verification (MRV) system at the enterprises of the group, 120 ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL
assessment found that the existing integrated management pollution as a result of the company's activities during 2019 supported by the World Bank. UAH million system of the company which combines a wide range of were received. 100 91.3 83.7 0.7% aspects – quality, environment, labor protection and energy The company organizes independently and also 5As part of the implementation of the Methane Emission 80 6.7% 96.0% management – meets the requirements of international participates in seminars and trainings on education and Reduction Program across the gas supply chain, which 97.7% standards. The assessment also praised the high qualification promotion of safe management of solid household and is currently implemented based on the Memorandum 60 99.3% of Understanding between the EBRD, the Ministry of 40 93.3% Environment1 and Naftogaz of Ukraine NJSC, in June and July 2019, natural gas (methane) leaks from the equipment of 20 EXPENDITURES ON ENVIRONMENTAL PROTECTION IN 2019 CURRENT EXPENSES ON ENVIRONMENTAL PROTECTION Ukrgasvydobuvannya JSC, Ukrtransgaz JSC and Kirovogradgaz 0 OJSC were monitored and their volume identified. For 2016 2017 2018 2019 the first time, an unmanned aerial vehicle (drone) with Total expenditure of 96% or UAH 171.7 million specialized equipment and an infrared camera was used for Capital investments Current expenses Naftogaz Group enterprises was Naftogaz Group measurements at oil and gas facilities. Source: Naftogaz 178.9 on environmental protection 171.7 current expenses on in 2019 environmental protection UAH MLN UAH MLN 1 As of the end of 2019, the current name of the ministry is the Ministry of Energy and Environmental Protection of Ukraine (Ministry of Ecology and Energy). According to the CMU Resolution of 02.09.2019 No 829 the FINANCIAL OVERVIEW AND STATEMENTS Ministry of Ecology and Natural Resources was renamed the Ministry of Energy and Environmental Protection of Ukraine and merged with the Ministry of Energy and Coal Industry
Annual Report 2019 162 Naftogaz Group Annual Report 2019 163 Naftogaz Group noise and vibration reduction , training, IT for environmental environmental monitoring of Boryslav, a commercial offer protection monitoring, etc.). from Lamor Ukraine LLC was developed. The objective of the The structure of current expenditures In 2019, Naftogaz Group companies paid UAH 94.0 million project is to conduct a reliable environmental in Boryslav and on environmental protection measures 94.0 of environmental tax, of which 98.1% accounted for air to develop recommendations to eliminate the adverse effects emissions. of long-term oil and gas production on the environment. in 2019 by Group enterprises UAH million In 2019, Naftogaz Group companies were fined Environmental tax UAH 2.169 million for violating the requirements of 0.3% 0.3% payment environmental legislation (petroleum product spills and on- MARKET AND REFORMS POLLUTION INCIDENTS IN 2019 Ukrtransnafta site pollution). Others In 2019, UAH 161.9 million was spent on environmental During 2019, 68 environmental pollution incidents services. Revenues from the provision of environmental were recorded at the production facilities of Naftogaz 2.169 services amounted to UAH 6.3 million, from the sale of Group enterprises, most of which had a minor impact on 3.0% UAH million waste – UAH 74.2 million. the environment. The main causes of such incidents were Ukrtransgaz corrosion of pipelines, mechanical damage to equipment, Fines paid on Naftogaz Group and illegal taps (criminal intervention). The largest number of companies for violating the requirements of AIR PROTECTION incidents occurred at the production facilities of Ukrnafta – environmental legislation 53 cases, followed by Ukrgasvydobuvannya with 11 and 55.8% 40.5% In 2019, air emissions by stationary sources at the Ukrtransnafta with 4. Nine of all environmental incidents enterprises of Naftogaz Group decreased down to 50.8 occurred because of illegal taps. Ukrnafta Ukrgasvydobuvannya thousand tons, which is 26.0% less than in 2018 (68.7 The most high profile incident occurred at Ukrnafta’s Source: Naftogaz thousand tons2). well #121 in the Anastasivka field of TsVNG #4. Unauthorized
161.9 interference to steal petroleum products resulted in a release AND OPERATIONS STRATEGY UAH million of gas mixture and ignition of hydrocarbons on the discharge line of the well. As a result, the car of the wrongdoers The structure of environmental tax paid by Spent on environmental BORYSLAV AREA GAS POLLUTION ELIMINATION (with unidentified registration) caught fire. The fire was services PROGRAM (UKRNAFTA PJSC) enterprises of Naftogaz Group, % extinguished and no one was injured. Ukrnafta continues the development and implementation 0.1% 0.3% of measures to eliminate the consequences of long- 6.3 term oil and gas production and reduce environmental Others Ukrtransnafta WASTE MANAGEMENT UAH million pollution in the town of Boryslav. As of 1 January 2020, Ukrnafta spent UAH 37.5 million on the implementation of In 2019, Naftogaz Group generated 259.6 thousand tons of Revenues from the provision these measures including UAH 1.3 million on control and waste, of which 68.8% was drilling waste (drilled rock, waste of environmental services 36.1% prevention, UAH 17.7 million on repair and insulation works, drilling fluids and drilling wastewater), 18.8% – ferrous scrap, UAH 18.4 million on the operation and reconstruction of and 6.9 % – household mixed waste. The main share of waste Ukrgasvydobuvannya
facilities related to the elimination of gas pollution of the was generated by Ukrgasvydobuvannya (73.9%) and Ukrnafta GOVERNANCE CORPORATE 74.2 town, and UAH 0.1 million on R&D. (23.0%). Ukrnafta initiated independent environmental monitoring The bulk of waste generated at Naftogaz Group 45.9% 17.6% UAH million of the territory of the town of Boryslav. In 2019, within the enterprises was low-hazard (hazard class IV according to Ukrtransgaz Ukrnafta Revenues from the framework of cooperation between Boryslav Town Council, DSanPiN 2.2.7.029-99, which expired in 20143) – 94.2%, sale of waste Ukrnafta PJSC, and Lamor Ukraine LLC for comprehensive and moderately hazardous (hazard class III) – 5.5%. Highly Source: Naftogaz
The structure of current expenditures on environmental protection in 2019 by activity, UAH million 5 Air emissions by Naftogaz Group enterprises in 2019 including, thousand tons:
Protection and remediation of soil 62.3 Sulfur RESPONSIBILITY
dioxide (SO2) Suspended
Waste water treatment 49.2 and other Nitrogen Non-methane solids AND SOCIAL ENVIRONMENTAL Carbon sulfur compounds (NOX), light organic (small particles Group enterprises Air emissions monoxide (СО) compounds excluding N O compounds and fibers) Waste management 31.6 2 Ukrgasvydobuvannya 19.0 11.9 0.17 4.6 1.5 0.8 Air protection 5.5 Ukrnafta 13.5 5.8 0.02 2.5 4.7 0.5 Environmental protection research 1.5 Ukrtransgaz 16.5 6.1 0.03 9.9 0.4 0.03 Ukrtransnafta 1.8 0.01 0.001 0.006 1.7 0.004 Radiological safety 0.3 Others 0.023 0.003 0.0 0.002 0.02 0.001 21.2 Other environmental protection activities Total 50.8 23.8 0.2 17.0 8.4 1.4 0 10 20 30 40 50 60 70 Source: Naftogaz Source: Naftogaz 3 The decision of the State Service of Ukraine for Regulatory Policy and Entrepreneurship Development dated 15.07.2014 #33 suspended the State Sanitary Rules and Norms (DsanPiN) 2.2.7.029-99 "Hygienic requirements for industrial waste management and determination of their public health hazard class" in part of determination of the waste hazard classes. As of the end of 2019, no new regulatory document is FINANCIAL OVERVIEW AND STATEMENTS 2 Emission of suspended solid particles (small particles and fibers) was not included in total emissions given in Annual Report 2018 available as a basis for determination of the waste hazard class
Annual Report 2019 164 Naftogaz Group Annual Report 2019 165 Naftogaz Group hazardous and extremely hazardous waste account for a small and amounted to 7.4 million tons in СО2 equivalent. The Greenhouse Gas Emissions” was adopted, which provides for share – 0.2% and 0.04%, respectively. largest share of greenhouse gas emissions was generated by the establishment of a transparent and unified procedure for The structure of waste generated in 2019 by A 23.5% increase in waste generated in 2019 compared to Ukrtransgaz (60.7%) and Ukrgasvydobuvannya (30.1%). calculation and monitoring of greenhouse gas emissions from Naftogaz Group enterprises 2018 was due to the growth in drilling and drilling waste, as well According to the Naftogaz comprehensive Environmental energy and industrial enterprises. The adoption of this law as the improvement of the scrap metal accounting system. Action Plan for 2015-2020, in order to reduce greenhouse gas was aimed at fulfilling Ukraine’s obligations under the EU – 0.3% 0.5% Waste management approaches are determined in emissions, the enterprises of Naftogaz Group implement the Ukraine Association Agreement, as well as the requirements accordance with the requirements of the Law of Ukraine "On following steps: of the UN Framework Convention on Climate Change and the Others Ukrtransnafta
Waste". The main criterion for selecting organizations engaged — inventory of stationary emission sources; Paris Agreement. The law comes into force on 1 January 2021. MARKET AND REFORMS in waste disposal is a valid license for the relevant activities. — optimization of technological modes of existing equipment Therefore, Naftogaz Group and the Gas Transmission System 23% In addition, Ukrnafta has all the necessary permits and running on hydrocarbon fuel and its modernization; Operator of Ukraine are ready to work within the MRV system equipment for the disposal of hazardous waste. In 2019, the — detection of leaks from shut-off valves by mobile and the greenhouse gas emission allowance trading system Ukrnafta company disposed of about 4 thousand tons of waste. laboratories and their elimination using modern after their introduction in Ukraine. Experience in developing As part of the Green Office project in 2019, 15 additional equipment and highly efficient sealing materials; a monitoring plan and compiling a report on greenhouse gas containers for the collection and storage of office waste were — repair and adjustment of technological equipment; emissions is shared with other enterprises. installed in the head office premises of Naftogaz of Ukraine. — replacement of tanks with a stationary roof with Currently, the company is engaged in research entitled During 2019, paper (0.436 tons of waste paper) and plastic technically modern tanks with a floating roof; "Development of a regulatory document on the procedure for 73.9% 2.3% (0.01 tons of plastic bottles) were collected and transferred for — systematic maintenance of breathing valves of tanks and energy analysis, determination of energy efficiency, and the Ukrgasvydobuvannya Ukrtransgaz disposal to the specialized enterprises. devices, sealing of pontoons and tank roofs; carbon footprint of Naftogaz Group." This research is included — overhaul of engines and replacement of radiators; in the Comprehensive R&D Plan of Naftogaz Group for 2020. — use of tank pumping and operation modes which minimize The document will determine the approaches to identifying CONTRIBUTION TO COMBATING CLIMATE CHANGE emissions; energy-consuming processes of Naftogaz Group enterprises — construction of control and regulation points and and their energy consumption, assessing the process Volumes of greenhouse gas emissions by AND OPERATIONS STRATEGY The total amount of direct greenhouse gas emissions installation of equipment to inspect and reduce the toxicity efficiency, and calculating greenhouse gas (carbon footprint) Naftogaz Group enterprises in 2016-2019, in 2019 increased by 1% compared to the previous year of exhaust gases of vehicles; emissions. — conversion of vehicles to environmentally friendly fuels. thousand tons of СО2-equivalent In 2019, Naftogaz Group companies completed the +1.0% implementation of a pilot project supported by the World WATER RESOURCES 6 Waste management at Naftogaz Group Bank aimed at the implementation of a greenhouse gas 8000 7 332.5 7 402.6 6 765.2 enterprises emission monitoring, reporting and verification (MRV) The volume of water intake by Naftogaz Group enterprises 7000 system. The project involved Naftogaz, VERICO (Germany), in 2019 amounted to 4 524.3 thousand cubic meters (in 6000 5 646.6 Waste, thousand tons 2017 2018 2019 Ukrtransgaz, the World Bank PMR project, Carbon Limits 2018 – 5 139.2 thousand cubic meters), 61.7% of which 5000 Waste generated 210.1 210.2 259.6 (Norway), and TMS (Ukraine). The project reviewed the (2 790.3 thousand cubic meters) was surface water. Naftogaz 4000 Burned 0.01 0.06 0.04 technological processes, activities, and sources of greenhouse Group companies generate no significant impact on water 3000 Disposed 1.85 21.88 4.02 gas emissions and material flows, then prepared a package intake sources.
Junked 152.73 151.39 101.66 of necessary documents including a monitoring plan and The objective of water resources management is their 2000 GOVERNANCE CORPORATE Transferred to third parties 52.96 47.71 90.09 Greenhouse Gas Emissions Report verified by independent rational use, large-scale introduction of water reuse, reduction 1000 Exported - - 0.0008 verifier VERICO (Germany). of water consumption, especially drinking water, which should 0 At the same time, in December 2019, the Law of Ukraine result in annual reduction of water consumption by Naftogaz 2016 2017 2018 2019 Source: Naftogaz “On Principles of Monitoring, Reporting and Verification of Group companies by 4% during 2018-2020. Source: Naftogaz
The structure of waste generated in 2019 by type 10 Greenhouse gas emissions by Naftogaz Group enterprises in 2019, thousand tons
Drilling waste 68.8% including: Greenhouse RESPONSIBILITY
gas emissions, Carbon dioxide Methane (CH4) Nitrous oxide
Group enterprises СО -equivalent (СО ) emissions emissions (N O) emissions AND SOCIAL ENVIRONMENTAL Ferrous scrap 18.8% 2 2 2
Ukrgasvydobuvannya 2 231.4 1 676.6 19.5 0.04 Household mixed waste 6.9% Ukrnafta 655.4 522.5 4.5 0.03 Oil waste and oil sludge 2.1% Ukrtransgaz 4 492.3 3 753.9 24.8 0.16
Worn out and damaged tires 0.2% Ukrtransnafta 4.7 2.5 0.08 0.0003
18.8 1.6 0.6 0.0 Others 3.2% Others
0 10 20 30 40 50 60 70 80 Total 7 402.6 5 957.1 49.5 0.2 FINANCIAL OVERVIEW AND STATEMENTS Source: Naftogaz Source: Naftogaz
Annual Report 2019 166 Naftogaz Group Annual Report 2019 167 Naftogaz Group The use of water is accounted for by primary measuring (without purification); water compliantly purified at the Ukrgasvydobuvannya's activities. and recording of water supply and waste water based on treatment facilities included: biological treatment – 230.8 Ukrnafta currently uses the lands adjacent to the territory Volume of water used by Naftogaz Group the indicators of measuring equipment and the results of thousand cubic meters, physical and chemical treatment – of the nationally important Andriyashivsko-Hudymivsky enterprises in 2019 measurements of water quality indicators. In some cases, 5.9 thousand cubic meters, mechanical purification – 105.9 hydrological reserve. Every year, an independent organization in the absence of such means, the accounting is carried out thousand cubic meters. conducts environmental biological and hydro-biological according to the technological data (using ancillary accounting In 2019, in the process of well operations, the enterprises monitoring of the forest, meadow and aquatic ecosystems By Naftogaz Group enterprises, thousand cubic meters methods). The correctness of such accounting is regularly of Naftogaz Group extracted 9 186.0 thousand cubic meters on the territory of the Andriyashivsky gas condensate field 2 832.6 monitored. of associated waters. Combined formation waters, which of Ukrnafta, which borders the reserve. According to the Ukrnafta MARKET AND REFORMS In 2019, 4 388.4 thousand cubic meters of water were are extracted together with hydrocarbons, were returned to results of 2019 monitoring, no adverse impact of oil and gas 2 714.1 actually used, which is 5.9% less than the previous year. Of the underground horizons through absorption wells in accordance infrastructure on flora and fauna in the field was identified. 1 050.5 Ukrgasvydobuvannya total, the largest share (69.7%) was used for production and with the requirements of current legislation, which reduces the In 2019, Ukrtransgaz continued the reconstruction of 1 036.8 technological needs. negative impact on surface and groundwater and soil condition. the Urengoy ‑Pomary ‑Uzhgorod trunk pipeline accompanied A 5.9% decrease in water use in 2019 compared to 2018 In 2019, Ukrgasvydobuvannya jointly with MI Swaco with consulting services on bio-resource management and Ukrtransgaz 611.2 proves the successful work of Naftogaz Group enterprises in (Schlumberger) took measures to introduce new technologies collection of information on crossing water barriers. The state 457.3 achieving water resource management objectives. In order to for the purification of return aqueous solutions when drilling of bio-resources and anthropogenic impact on water bodies protect water resources and rational use of water in 2019, the wells in order to increase their reuse and save water resources. was assessed based on a set of normative environmental Ukrtransnafta 150.8 159.7 following activities were implemented: Environmental and radiation safety specialists documents of regional, national, and international levels. 2018 — repair and replacement of dilapidated sections of oil electronically monitor on a regular basis (usually quarterly) Subject to compliance with all recommended requirements Others 19.5 2019 pipelines, gas pipelines and water pipelines; the content of pollutants in domestic effluents, associated and measures, the repair of the main gas pipeline 20.5 — inspection of pipeline crossings over water obstacles and and sewage water, and quarterly control the quality of Urengoy ‑Pomary ‑Uzhgorod will have no adverse impact on the highways; water collected from groundwater sources. They perform state of local biodiversity. 0 500 1000 1500 2000 2500 3000
— restoration of embankment of reservoirs, wells and other compliance control of these indicators. The laboratory control AND OPERATIONS STRATEGY objects; of physio-chemical parameters of waste water is carried out By purpose of use — assessment of the technical condition of production by accredited laboratories. In addition, the content of natural SOIL PROTECTION columns of oil and injection wells using geophysical radionuclides in the waters of artesian wells is monitored method; annually. The basic civil protection action plan of Naftogaz of 69.7% 21.8% — examination and replacement of production and injection Ukraine for 2019, approved by the company's order in January Production and Drinking and wells; 2019, provides for the introduction of modern technologies technological needs sanitation needs — examination and replacement of valves on water mains, BIODIVERSITY for the restoration and purification of technologically water meters. damaged ecosystems (including soils). While eliminating the The total volume of water reuse and circulating use During 2019, Ukrgasvydobuvannya audited the territories pollution of soils and water bodies with oil and oil products, by Naftogaz Group enterprises in 2019 amounted to: of its operations in order to identify the areas with potentially the enterprises of the group are guided by the provisions of 161.8 million cubic meters in the circulating water supply high biodiversity in terms of species. Such areas include the SOU 74.2-20077720-34: 2018 “Environmental protection. 4 388.4 systems and 6.4 million cubic meters in water re-use systems. meadows and wetlands, unplowed steppe areas (grasslands) Elimination of pollution of soils and water bodies with oil thousand cubic In 2019, the total amount of wastewater discharged and forests of various compositions. Materials developed and oil products. Rules,” approved in December 2018 by the GOVERNANCE CORPORATE (excluding associated waters) amounted to 1 295.5 thousand as part of the international research program Copernicus company. meters cubic meters (in 2018 – 1 547.6 thousand cubic meters). (European Space Agency) were used to audit the territories. In 2019, as a result of the activities of Naftogaz Group 8.5% In the total wastewater discharged into natural bodies of Within the licensed areas of Ukrgasvydobuvannya, enterprises, a significant negative impact on the environment water: 17.6 thousand cubic meters was discharged without areas with potentially high biodiversity of species occupy was caused in 23 cases impacting land plots with a total area Others purification; 40.4 thousand cubic meters was insufficiently 38.27% of the total area. Disturbed areas (arable land and of approximately 17 715 sq. m. The consequences of this treated; 7.4 thousand cubic meters was compliantly clean built-up area) make up a total of 61.42% of the total area of environmental pollution have been eliminated. Source: Naftogaz
The structure of water intake by Dynamics of water used by Group enterprises The volume of waste water by the place of discharge in 2018-2019, thousand cubic meters Naftogaz Group enterprises in 2019 in 2016–2019, thousand cubic meters RESPONSIBILITY by source 7000 Total 1 547.6 6 369.9 1 295.5 ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL 13.2% 0.1% 6000 Sewage 416.3 584.4 Public water Others 5000 4 664.6 Water bodies 726.2 supply 4 418.5 4 388.4 314.1 4000 Filtration fields 271.4 240.8 3000 32.4 4 524.3 Waste pits 34.6 thousand cubic 2000 Treatment facilities 101.3 meters 31.3 2018 1000 Others 2019 25.0% 61.7% (evaporation pond, 90.3 accumulating ponds) Underground Surface 0 0 200 400 600 800 1 000 1 200 1 400 1 600 1 800 water water 2016 2017 2018 2019 FINANCIAL OVERVIEW AND STATEMENTS Source: Naftogaz Source: Naftogaz Source: Naftogaz
Annual Report 2019 168 Naftogaz Group Annual Report 2019 169 Naftogaz Group ENVIRONMENTAL PROBLEMS AND RISKS 1.2) Development of temporary technological standards for medium power plants in accordance with 1A number of issues unresolved as of the end of 2019 are still the requirements of the MCP (Medium Combustion Plant) relevant: Directive, which is mandatory for implementation in 1.1) Slowdown in reforms, low level of implementation accordance with the EU – Ukraine Association Agreement. of international agreements in the field of environmental 1.3) The problem of staffing the environmental safety protection and inconsistencies in Ukrainian legislation. services with the required number of qualified employees for
In particular, the following issues are important for some production facilities of Naftogaz Group. MARKET AND REFORMS Naftogaz that require legislative regulation at the 1.4) Pollution of the environment with hydrocarbons and national level: associated reservoir waters due to obsolete and outdated — Development and implementation of a procedure equipment, especially pipelines, and illegal intervention by for obtaining permits by entities to carry out waste third parties. Diagnosing and replacing obsolete equipment management operations if their activities lead to can solve the problem. the generation of waste for which the total waste generation indicator exceeds 1000. 2Imperfection in the procedure for decommissioning of main — Development of a new by-law to replace DSanPiN pipelines of oil, gas and processing products. 2.2.7. 029-99 (expired in 2014), to be used as a basis for determination of the hazard class of waste in 3The problem of handling compressor pipes and other accordance with international requirements. equipment contaminated with natural radionuclides (NORM). — Solving the issue of the absence of utility companies responsible for the implementation from 01.01.2018 of Compressor pipes and other equipment where mineral
the requirements of the Law of Ukraine "On Waste" of salts containing natural radionuclides are built up during AND OPERATIONS STRATEGY separate collection and disposal of solid waste. the development of oil fields pose a threat to the health of — Simplification of complicated and lengthy procedure employees and the environment. All equipment and sludge for obtaining permits for pollutant emissions for drilling at the enterprises of Naftogaz Group which are contaminated rigs, especially for drilling shallow wells using mobile with natural radionuclides are transferred for storage to installations with a drilling period of up to one year. specialized enterprises under the established procedure. At — Improving the procedure for submitting water user the same time, as of the end of 2019, in Ukraine there is no electronic reports or information on the volume regulatory framework, technologies, or specialized enterprises of extracted groundwater (order of the Ministry of for decontamination of such equipment. Environment of 23.03.2016 #110) and the procedure for calculation of water use and waste water (Article 4The existence of natural and industrial zones and systems 49 of the Water Code and order of the Ministry of with unauthorized uncontrolled release of oil and gas on the Environment of 23.06.2017 #234). surface and oil pollution of groundwater and rocks. CORPORATE GOVERNANCE CORPORATE
PLANS FOR 2020
1Implementation of the Methane Emission Reduction Project 5Creation of a unified system for monitoring the activities Agreement with the EBRD at the facilities of Naftogaz Group. of Naftogaz Group enterprises related to environmental Specifically, the second stage of the Methane Emission protection on the basis of the MS Consulting software Reduction Program involves plans to continue works on product. locating natural gas (methane) leaks along the entire gas supply chain and develop a systematic approach to reducing 6In the field of waste management: emissions. — Further implementation of activities under the Green Office program, in particular the installation of containers RESPONSIBILITY Carrying out of 5 audits of ecological aspects at the for batteries and plastics in the head office premises of
2 AND SOCIAL ENVIRONMENTAL enterprises of Naftogaz Group according to the provisions of Naftogaz, the introduction of separate collection of solid SOU “Environmental protection. Audit of ecological aspects waste at the enterprises of Naftogaz Group; of the activities of the Group of the National Joint-Stock — Ensuring the transfer of valuable waste (used batteries, Company "Naftogaz of Ukraine". Substantive provisions". tires, lubricants, etc.) for disposal to specialized enterprises on a paid basis. 3Resolving issues related to the continuation of the development of technological standards for existing and new 7Monitoring the state of the environment of Andriyivka gas turbines and engines with a nominal heat output of 1 to industrial pollution zone and Mashiv groundwater pollution 50 MW. The plan envisages a measurement campaign and halo, Ukrgasvydobuvannya JSC, identified earlier (1980-2000) tenders for the purchase of standard development services. and implementation of programs to study and eliminate pollution. 4Further implementation of an environmental management system in accordance with the requirements of ISO 14001, in particular the implementation of measures to achieve the objectives of the environmental management system related to conducting internal audits within the company. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 170 Naftogaz Group Annual Report 2019 171 Naftogaz Group TOTAL QUANTITY AND VALUE OF ANNOUNCED PROCUREMENTS
Of these, 5 611 contracts were PROCUREMENT announced by Naftogaz group via the ProZorro system, worth UAH 33 bn, 7 400 70 662 94% of which were concluded with MANAGEMENT PROCUREMENTS UAH MILLION residents MARKET AND REFORMS
Naftogaz group is focused on improving public procurement process without ProZorro have been of the agreement, meaning that the company may The priority objectives achieved by Naftogaz group in procurement professionalization as one of the most effective expanded; independently or with the involvement of the third parties, 2019 include the following: ways to use company resources. Considerable attention is — the procedure (the rules) for evaluating vendors to be check the activities of the contractor on environmental — Based on the results of the study of best world practices paid to ensuring transparency and openness of information included in the vendor list was developed; protection, social responsibility and occupational safety. In and analysis of the Ukrainian legal framework, Naftogaz and the prevention of bidder misconduct. In addition, — technical specifications preparation methodology was the event of any counterparty's non-compliance with the group implemented potential counterparty pre- public tenders serve as a catalyst for the development of developed; current legislation of Ukraine or if any inaccurate information qualification and audit mechanisms and reached the the Ukrainian economy, as they provide for an independent — the method for calculating the expected cost of routine is identified during the verification, the contractor shall highest possible number of procurements from qualified choice of the most cost-effective trade offer, thereby overhaul works and services was developed. agree with the company on measures to correct these participants. stimulating competition. Internal standards (regulations) provide for the possibility inconsistencies, the timing of their implementation, and — The tender documentation preparation process and As part of its focus on public procurement development, to include in procurement terms the environmental criteria provide guarantees of their fulfilment in due time and in full. tender document forms development process were
Naftogaz group has approved internal procurement that are part of the requirements for bidders (for example, Along with these changes and improvements, the improved, which made it possible to attract more bidders AND OPERATIONS STRATEGY standards. As a result, the following changes occurred during the availability of the necessary certificate or providing Naftogaz group has been actively using the existing due to the clear process of preparation of information 2019: additional information in the form of an environmental electronic purchasing system for 5 years. During this time, a required for participation in tenders. — requirements for the procurement documentation were questionnaire). The specific criteria are set directly by the total saving of UAH 22 023 million was achieved1. — The Naftogaz group adjudication of grievances unified; sponsor of the procurement before the application submission In 2019, the procurement activities of the company was changed by liquidation of the Central Conflict — qualification criteria and requirements for the bidders stage. In addition, a working group was set up and operates resulted in 7 408 purchases totalling UAH 70 662 million. Commission and introduction of the Naftogaz and evaluation of bidder compliance with the established internally dealing with implementation and supporting the Of these, 5 611 contracts were announced by the Procurement Ethics Office as arbitration between the criteria and requirements were unified; environmental management system at the group level. Naftogaz group via the ProZorro system, worth UAH 33 Bidder – Customer – the Local Conflict Commission of the — measures to address identified irregularities during In addition, in special cases, the company may apply billion, 94% of which were concluded with residents. Customer. procurement were approved and implemented; environmental control measures to verify the information With the ProZorro system, the actual achieved savings Their implementation allows us to state the fact that the — the powers of divisional directors during the provided by the contractor at the stage of the conclusion amounted to UAH 1 379 million. average number of bidders increased and amounted to 3.1. CORPORATE GOVERNANCE CORPORATE Total quantity and value of announced procurements in 2019 TOP-7 external suppliers in 2019, UAH million
Services related to gas production 27% Ukravtogaz Halliburton Ukraine 228 procurements Ukrgasvydobuvannya Naftogaz of Ukraine 223 UAH million 2 621 UAH million NAFTOGAZ GROUP PROCUREMENTS 2 868 procurements 399 procurements 20% Naftogaz Digital Technologies VIA PROZORRO IN 2019 Natural gas 21 349 UAH million 30% 1 525 UAH million 37 procurements Axpo Ukraine 170 UAH million 3% 1 347 UAH million 18% Chornomornaftogaz 54 procurements Electrical energy, natural gas 5 611 33 173 151.5 UAH million ERU TRADING contracts UAH million 10% Ukrspetstransgaz 1 322 UAH million 119 procurements RESPONSIBILITY 7 408 80 UAH million Schlumberger Services related to gas production ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL procurements 1% 9% Naftogaz-Enerhoservis Services Ukraine 40 procurements 1 163 UAH million 94% 73.1 UAH million 70 662 Other Steel, casing and tubing pipes Residents UAH million 846 procurements 8% Kirovogradgaz Interpipe Ukraine 131 procurements 828 UAH million 990 UAH million 67.3 UAH million 4% Gaz Ukrainy Oil and distillates (fuel) 68 procurements BOC-Ukraine 6% 2% 31 UAH million 750 UAH million Non-residents 2% Naftogaz of Ukraine Natural gas Gas Supply Company Euroenergotrade 98 procurements Ukrtransgaz 64% Ukrtransnafta 19 UAH million 746 UAH million 2 584 procurements 711 procurements 44 909 UAH million 2 051 UAH million 1% Vuhlesyntezgaz Source: ProZorro database 4 procurements 7,6 UAH million 1 The ProZorro system calculates savings as the difference between the expected cost of the purchase and the price of the most economically advantageous bid using the following bidder FINANCIAL OVERVIEW AND STATEMENTS Source: ProZorro database status indicators: qualification of the winner; offers considered/completed. Savings calculated in this way are not final because after the auction the winner's bid may be rejected by the customer.
Annual Report 2019 172 Naftogaz Group Annual Report 2019 173 Naftogaz Group Actual saving on procurements in 2019
Ukrtransgaz Naftogaz of Ukraine 409 UAH million 70 UAH million PROCUREMENT SAVINGS 30% 5% 1 379 MARKET AND REFORMS UAH million
1% Ukravtogaz Gaz Ukrainy Other Kirovogradgaz UAH million 18 Naukanaftogaz Ukrspetstransgaz 2% Chornomornaftogaz Naftogaz-Enerhoservis Vuhlesyntezgaz Ukrainy STRATEGY AND OPERATIONS STRATEGY Ukrgasvydobuvannya 62% Ukrtransnafta Naftogaz Digital Technologies 848 UAH million 34 UAH million Naftogaz of Ukraine Gas Supply Company
Source: ProZorro database
Average proposals vs average purchases in 2019
3500 6 2 868 3000 4.80 5
2 584 GOVERNANCE CORPORATE 2500 3.85 4 2000 3.47 3.25 3.17 3.20 2.69 3.00 2.92 2.83 3 1500 2.33 2.29 3.00 1.63
2 received Proposals 1000 711
Number of bids actually analyzed Number of 399 1 500 228 131 119 98 68 66 54 40 37 4 0 0 RESPONSIBILITY ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL Ukrgasvydobuvannya and branches) (office Ukrtransgaz and branches) (office Ukrtransnafta Ukraine Naftogaz of and branches) (office Ukravtogaz Kirovogradgaz Ukrspetstransgaz Ukraine Naftogaz of Gas Supply Company Gaz Ukrainy Naukanaftogaz Chornomornaftogaz Naftogaz- Enerhoservis Naftogaz Digital Technologies Vuhlesyntezgaz Ukrainy
Source: ProZorro database
PLANS FOR 2020
— Establishment of tender committees with dedicated — Development of supply chain management. members who would not have their operational — Continued digital transformation of the procurement responsibilities and establishment of an institute of process to improve its efficiency through targeted authorized persons. implementation of the software systems that increase — Increasing the effectiveness of procurement of goods, works the speed and accuracy of business processes while and services, reducing the operating costs of the customer minimizing errors and incorrect decisions as a result of during the procurement procedures by using the vendor list. human factors. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 174 Naftogaz Group Annual Report 2019 175 Naftogaz Group IN THIS SECTION: KEY RESULTS 179 | CFO's address 181 | Summary of 2019 results 185 | Consolidated financial statements 187 | Independent auditor’s report 63.3 65.0 110.0
191 | Consolidated statement of financial position UAH billion UAH billion UAH billion MARKET AND REFORMS Net profit Segment result – Cash flows generated by 192 | Consolidated statement of profit or loss Adjusted EBITDA operating activities 192 | Consolidated statement of comprehensive income 193 | Consolidated statement of changes in equity 193 | Consolidated statement of cash flows STRATEGY AND OPERATIONS STRATEGY CORPORATE GOVERNANCE CORPORATE RESPONSIBILITY ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL
AND STATEMENTS CONTRIBUTIONS TO THE STATE BUDGET
In 2019, the group transferred to the state budget UAH 100.6 billion of taxes, including UAH 22.3 billion of corporate income tax.
FINANCIAL OVERVIEW Additionally, the group paid dividends of UAH 12.3 billion, or 90% of the 2018 net profit, and UAH 8.5 billion of interim dividends for 2019. The group remains the largest net contributors to the state budget of Ukraine. FINANCIAL OVERVIEW AND STATEMENTS
Річний звіт 2019 176 Група Нафтогаз Річний звіт 2019 177 Група Нафтогаз MARKET AND REFORMS
DEAR READERS, net cash position of nearly UAH 78 billion and a gearing ratio of 10.8% provide support. We may increase our gearing and use I am writing to you for the first time as Naftogaz Chief the balance sheet during the downturn. We see a gearing ratio of CFO'S Financial Officer and I am pleased to inform you that the 30% as the maximum in combination with a sound debt structure performance of the group was strong in 2019. and repayment schedule. In a challenging year with declining oil and gas prices, we At the same time, we must reduce our costs and show delivered some major achievements. Naftogaz built the largest financial discipline by limiting our investments. ADDRESS gas inventory in recent years to ensure a flawless heating season We see a multi-billion opportunity for cost reductions in our and uninterrupted operation of the transmission system operator supply chain. We identified UAH 7.5 billion in potential opex AND OPERATIONS STRATEGY in case of a zero-transit scenario. Our legal and negotiation efforts savings, mainly from the centralization of our warehouses and resulted in a new gas transit agreement with Gazprom that optimization of logistic operations. incorporates European rules and ensures viable transit volumes. We expect that our capital expenditure in 2020 will be some Moreover, Gazprom paid USD 2.9 billion worth of compensation 20% lower than in 2019. We want to maintain a balance between under the terms of the transit award rendered by the Stockholm medium-term growth and maximizing our returns. Some of our arbitration tribunal in 2018. investment projects will be postponed to ensure the group’s Due to effective cooperation with the Ukrainian government, financial flexibility. I expect our supply chain partners to play their the regulator, and the Energy Community Secretariat, we attained role in reducing our unit costs. certification of the independent transmission system operator Capital efficiency is key in our industry. Affordability of according to European standards, and retained our economic investments will be an important consideration when making interest in its gas transit operations. In addition, the successful investment decisions. Priority will be given to maintaining unbundling of the Gas Transmission infrastructure accelerated production at existing fields with the help of our international
the implementation of European energy regulations in Ukraine partners, who bring new technologies and cost-effective GOVERNANCE CORPORATE and gave a powerful impetus to reforms in the energy market. solutions to Ukraine. To ensure our medium-term growth, we Further liberalization of the household segment offers will continue to increase our 2P oil and gas reserves and de-risk Naftogaz growth potential in the short- to mid-term future. greenfield opportunities. Integration with the European market provides Ukrainian In April, Fitch affirmed Naftogaz’s B rating with a neutral consumers the same opportunities that consumers in EU outlook. countries experienced for the previous 15 years, leading to lower The key risks to our liquidity are traditionally doubtful natural gas prices. receivables, low collection rates, and forex risks. I expect that the Naftogaz generated UAH 63.3 billion in net profits planned cancellation of our public service obligations and the compared to UAH 11.6 billion in 2018. With net transfers of liberalization of the retail gas market will help to mitigate these UAH 121.4 billion to the state budget in taxes and dividends, risks. Naftogaz continued to be the biggest contributor to the state I look to the future with confidence and believe that budget. Naftogaz will manage through the downturn successfully, RESPONSIBILITY We continue to face economic headwinds with low prices becoming an efficient national oil and gas company. To achieve and reduced demand, but the group is well prepared for the this, we are transforming Naftogaz with a focus on building AND SOCIAL ENVIRONMENTAL downturn and our financial position is strong. In 2019, we a new performance-oriented culture, promotion of personal increased our operating cash flow to UAH 110 billion from accountability, and efficiency across the group. Naftogaz will then UAH 71.6 billion in 2018. We also paid an attractive dividend be able to ensure energy independence for the country, generate of UAH 48.1 billion for our shareholder, the State of Ukraine. more value for the people of Ukraine, and get ready for an IPO in UAH 8.5 billion was paid in 2019 as an interim dividend. Our the medium term. Petrus Stephanus van Driel Naftogaz Group CFO FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 178 Naftogaz Group Annual Report 2019 179 Naftogaz Group Key performance indicators in 2019, UAH billion
SUMMARY 11.6 Net profit +447% 63.3
Segment result – 90.9
-28% MARKET AND REFORMS 0F 2019 RESULTS Adjusted EBITDA 65.0 71.6 Cash flows generated +54% by operating activities 110.0
Naftogaz Group reports consolidated net profit of 45.7 Free cash flows +86% 85.0 UAH 63.3 billion for the year ended 31 December 2019. The 2019 was characterised by: 24.9 Capital expenditures +11% — 16.1 bcm gas production, 78% share of Ukraine’s total, and 27.7 63.3 89.6 bcm of gas transit. — Cash flows generated by operating activities amount to UAH billion Net debt -2% 43.2 Net profit UAH 110 billion; of which UAH 55.7 billion post-tax relates 42.6 to the Gas Transit Award. 2018 10.45% — Unbundling of gas transmission infrastructure completed. Gearing, % +4% 2019 — New 5-year gas transit deal signed with guaranteed 10.84% AND OPERATIONS STRATEGY revenues and foreign currency inflows. 65.0 0 20 40 60 80 100 120 — Naftogaz issued Eurobonds for an amount of UAH billion USD 835 million and EUR 600 million. Source: Naftogaz Segment result – — Total dividends paid to the State Budget in 2019 exceeded Adjusted EBITDA UAH 20 billion, including 90% of net profit for 2018 and interim dividends for 2019. PERFORMANCE BY SEGMENT purchased for balancing services, and an increase in provisions for doubtful debts for such services due to lower collection Integrated gas result reflected lower volumes of gas sales rates. 110.0 SUMMARY OF RESULTS to the different groups of customers due to a warmer winter Gas storage benefited from higher gas storage tariffs season and lower gas prices as compared to 2018. effective from 01 August 2018 and switching to booking UAH billion Net profit of UAH 63.3 billion included income Oil midstream and downstream results were negatively capacity instead of paying for exact volume of gas stored. Cash flows generated by from positive outcome of Gas Transit Arbitration, lower impacted by lower average selling prices for petroleum Ukrnafta’s result were negatively impacted by lower operating activities contributions from gas sales and gas domestic transmission as products and hryvnia appreciation affecting oil transit volumes of crude oil and petroleum products sold as GOVERNANCE CORPORATE well as higher income tax. revenues. compared to 2018. Segment result – Adjusted EBITDA of UAH 65.0 reflected Higher transit volumes in the gas transit segment Other activities relate to impairment losses recognised lower contributions from integrated gas, gas domestic partly offset the hryvnia appreciation affecting gas transit in respect of accounts receivable in the product sharing transmission and Ukrnafta. revenues. agreement with the Arab Republic of Egypt and Egyptian 85.0 Cash flows generated by operating activities excluding cash Gas transmission segment reflected higher cost of gas General Petroleum Corporation. UAH billion received from Gas Transit Arbitration, decreased due to lower Free cash flows cash contributions from gas sales and the gas transmission businesses. Free cash flows of UAH 85.0 billion benefited from higher Performance by segment, UAH billion cash flows generated by operating activities and lower net cash used in investing activities. +34.3 -9.8 27.7 Capital expenditures of UAH 27.7 billion reflected +2.0 +2.3 -1.9 RESPONSIBILITY higher investments in gas upstream, and oil midstream and UAH billion downstream businesses. AND SOCIAL ENVIRONMENTAL Capital expenditures Net debt of UAH 42.6 billion generated after issuance of +1.1 Eurobonds and repayment of loans with Ukrainian banks. +37.0 Gearing of 10.84% at the end of 2019 compares with 65.0 42.6 10.45% last year. UAH billion Net debt Integrated Oil Gas Gas Gas Ukrnafta Other Segment gas midstream transit domestic storage result – and downstream transmission Adjusted EBITDA
% The above excludes income related to the Gas Transit Award received in 2019. 10.84 FINANCIAL OVERVIEW AND STATEMENTS Gearing, % Source: Naftogaz
Annual Report 2019 180 Naftogaz Group Annual Report 2019 181 Naftogaz Group Segment result, UAH billion Receivables for natural gas supply, UAH billion -2.1 43.3 Integrated gas -6.3 37.0 30.2 28.1 +2.4 Oil midstream and downstream 2.2
-1.1 MARKET AND REFORMS 1.1 22.8 -2.7 36.6 20.4 Gas transit -2.3 34.3 16.9 14.2 Gas domestic transmission -1.8 +1.2 -8.0 -9.8 8.3 0.0 7.1 Gas storage +2.0 2.0 13.1 Ukrnafta -10.8 2018 2.3 2019 Regional gas distribution Heat producers to Other customers Resale to companies households under PSO non-PSO -2.5 Other +0.6 for resale consumers
-1.9 to households AND OPERATIONS STRATEGY
-10 0 10 20 30 40 50
Source: Naftogaz Source: Naftogaz
CONTRIBUTIONS TO THE STATE BUDGET Taxes and compulsory payments Receivables for natural gas supply, UAH billion In 2019, the group transferred to the state budget paid by the group companies, UAH billion UAH 100.6 billion of taxes, including UAH 22.3 billion of Regional gas distribution companies Heat producers to households 2018 corporate income tax. for resale to households Additionally, the group paid dividends of UAH 12.3 billion, 23.9 2018 2019 2018 2019 29.5 or 90% of the 2018 net profit, and UAH 8.5 billion of interim -1.1 -0.3 -8.7 -12.1 dividends for 2019. GOVERNANCE CORPORATE 0.1 0.3 The group remains the largest net contributor to the state 3.7 20.2 4.5 budget of Ukraine. 5.8 3.8 7.1 6.0 7.0 2.6 138.6 6.5 20.4 22.8 UAH billion 12.0 28.1 UAH billion 3.5 30.2 14.3 UAH billion UAH billion UAH billion 5.5 2.2 7.7 49.7 4.1 8.8 100.6 0.3 11.0 UAH billion 2019 Taxes transferred to the RESPONSIBILITY state budget of Ukraine 22.3 Other customers under PSO Resale to non-PSO consumers 20.8 22.3 AND SOCIAL ENVIRONMENTAL 2018 2019 2018 2019 UAH billion 4.1 25.3 -3.6 -4.9 -15.6 0.8 -13.5 0.0 Corporate 121.4 0.3 0.0 income tax 2.4 0.8 UAH billion 5.4 0.8 1.5 1.9 1.8 2.8 39.0 7.1 3.0 16.9 14.2 8.3 UAH billion UAH billion 12.3 UAH billion UAH billion 1.2 0.3 1.8 UAH billion 13.4 0.8 15.0 Dividend payments Corporate income tax VAT 2.4 for 2018 Gas production royalty Excise tax 8.5 Oil production royalty Other taxes UAH billion Gas condensate production royalty Dividends Not past due <90 days >90 days <365 days >365 days Provision for impairment Interim dividends Other royalty FINANCIAL OVERVIEW AND STATEMENTS for 2019 Source: Naftogaz Source: Naftogaz
Annual Report 2019 182 Naftogaz Group Annual Report 2019 183 Naftogaz Group CONTENTS
JOINT STOCK COMPANY INDEPENDENT AUDITOR’S REPORT ��������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������187 CONSOLIDATED FINANCIAL STATEMENTS �������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������191
“NATIONAL JOINT Consolidated Statement of Financial Position 191 MARKET AND REFORMS Consolidated Statement of Profit or Loss 192 Consolidated Statement of Comprehensive Income 192 Consolidated Statement of Changes in Equity 193 STOCK COMPANY Consolidated Statement of Cash Flow 193
Notes to the Consolidated Financial Statements “NAFTOGAZ OF UKRAINE" 1. THE ORGANISATION AND ITS OPERATIONS 195 2. OPERATING ENVIRONMENT 195 3. SEGMENT INFORMATION 197 4. BALANCES AND TRANSACTIONS WITH RELATED PARTIES 202 STRATEGY AND OPERATIONS STRATEGY 5. PROPERTY, PLANT AND EQUIPMENT 203 CONSOLIDATED FINANCIAL STATEMENTS 6. INVESTMENTS IN ASSOCIATES AND JOINT VENTURES 204 AS AT AND FOR THE YEAR ENDED 7. OTHER NON-CURRENT ASSETS 205 31 DECEMBER 2019 8. INVENTORIES 206 9. TRADE ACCOUNTS RECEIVABLE 207 10. PREPAYMENTS MADE AND OTHER CURRENT ASSETS 208 11. SHARE CAPITAL 208 12. BORROWINGS 209 13. PROVISIONS 209 14. ADVANCES RECEIVED AND OTHER CURRENT LIABILITIES 212 15. COST OF SALES 212 CORPORATE GOVERNANCE CORPORATE 16. OTHER OPERATING INCOME 212 17. OTHER OPERATING EXPENSES 213 18. FINANCE COSTS 213 19. FINANCE INCOME 213 20. INCOME TAX 213 21. DISCONTINUED OPERATIONS 215 22. CONTINGENCIES, COMMITMENTS AND OPERATING RISKS 216 23. FINANCIAL RISK MANAGEMENT 220 24. FAIR VALUE 223 25. SUBSEQUENT EVENTS 226 RESPONSIBILITY 26. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES 226
27. CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS 234 AND SOCIAL ENVIRONMENTAL 28. ADOPTION OF NEW OR REVISED STANDARDS AND INTERPRETATIONS 236 FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 184 Naftogaz Group Annual Report 2019 185 Naftogaz Group INDEPENDENT AUDITOR’S REPORT Why the matter was determined to be a key audit matter How the matter was addressed in the audit To the Shareholder of Joint Stock Company “National Joint the ethical requirements that are relevant to our audit of Stock Company “Naftogaz of Ukraine”: the consolidated financial statements in Ukraine, and we have fulfilled our other ethical responsibilities in accordance Report on the Audit of the Consolidated Financial with these requirements and the IESBA Code. We believe With the involvement of our valuation experts we performed the — Assessing the accuracy of inputs used in the valuation model Statements that the audit evidence we have obtained is sufficient and following procedures: by tracing them on a sample basis to supporting documents;
appropriate to provide a basis for our opinion. — Evaluating whether the methodology applied and the model — Checking the mathematical accuracy of the model and MARKET AND REFORMS used are in line with the international valuation standards; correctness of the amounts recorded and presented in the Opinion — Based on our experience with the Group, our knowledge consolidated financial statements; Emphases of Matters of its business activities and the industry in which the — Assessing completeness and accuracy of the information We have audited the consolidated financial statements of Group operates, challenging management’s judgments and disclosed in the consolidated financial statements. Joint Stock Company “National Joint Stock Company “Naftogaz Operating environment analyzing validity of the key assumptions used in determining of Ukraine” and its subsidiaries (the “Group”), which comprise the fair values; the consolidated statement of financial position as at 31 We draw your attention to Note 2 to the consolidated December 2019, the consolidated statement of profit or financial statements, which describes that the impact of loss, consolidated statement of comprehensive income, the ongoing political and economic situation in Ukraine is Expected credit losses on trade accounts receivable expected credit losses on trade accounts receivable. consolidated statement of changes in equity and consolidated unpredictable and may have significant effect on the Ukrainian We assessed the Group’s methodology on the expected statement of cash flows for the year then ended, and notes to economy and the operations of the Group. Our opinion is not Estimate of allowance for expected credit losses on credit losses calculation on a collective basis in accordance the consolidated financial statements, including a summary of modified in respect of this matter. trade accounts receivable involves application of complex with the requirements of IFRS 9 “Financial Instruments”. significant accounting policies. methodology, use of management’s judgement and various We tested the Group’s historical data on credit losses
In our opinion, the accompanying consolidated Resolution of disputes with JSC “Gazprom” subjective assumptions. incurred based on a sample of trade accounts receivable and AND OPERATIONS STRATEGY financial statements present fairly, in all material respects, Taking into account the significance of the trade accounts performed alternative recalculation of the expected credit the consolidated financial position of the Group as at 31 We also draw your attention to Note 22 to the receivable balance, complexity of calculations and high level losses that are determined on a collective basis. December 2019, and its consolidated financial performance consolidated financial statements, which describes final of subjectivity of judgements and assumptions we considered We also assessed the appropriateness of management’s and its consolidated cash flows for the year then ended in resolution of the Arbitration process between the Group and measurement of expected credit losses on trade accounts judgment regarding assessment of expected loss rates and the accordance with International Financial Reporting Standards JSC “Gazprom”, including income recognised under the Gas receivable to be a key audit matter. historical period for which statistics can be used for calculating (“IFRSs”) and the preparation of the consolidated financial Transit Arbitration in the amount of USD 2.9 billion (equivalent Refer to the Note 9 “Trade accounts receivable” as well as expected credit losses that are assessed on a collective basis. statements requirements of the Law of Ukraine “On to UAH 67,958 million). Our opinion is not modified in respect Note 26 “Summary of significant accounting policies” of the We checked completeness and accuracy of the relevant accounting and financial reporting in Ukraine” (“Law on of this matter. accompanying consolidated financial statements for further disclosures in the consolidated financial statements. accounting and financial reporting”). details. We obtained understanding of the Group’s policy, Key Audit Matters processes and control procedures for measurement of Basis for Opinion
Key audit matters are those matters that, in our GOVERNANCE CORPORATE We conducted our audit in accordance with International professional judgment, were of most significance in our Accounting of the unbundling of gas transportation business We evaluated management’s assessment on Standards on Auditing (“ISAs”). Our responsibilities under audit of the consolidated financial statements of the current the classification of the disposal group as held for sale and those standards are further described in the Auditor’s period. These matters were addressed in the context of our As discussed in Note 2 “Operating environment” in 2019 held for distribution and presentation of the results of the Responsibilities for the Audit of the Consolidated Financial audit of the consolidated financial statements as a whole, the Cabinet of Ministers of Ukraine issued the Resolution Gas Transportation Business as discontinued operations in Statements section of our report. We are independent and in forming our opinion thereon, and we do not provide prescribing Ukrainian Gas Transportation System Operator accordance with the requirements of IFRS 5. of the Group in accordance with the International Ethics a separate opinion on these matters. to be singled out from the Group into a separate structure This included evaluating whether the Gas Transportation Standards Board for Accountants’ Code of Ethics for (the “unbundling”). This resolution stipulated the plan for the Business was classified as a disposal group, assessing the Professional Accountants (the “IESBA Code”) together with unbundling that was completed on 1 January 2020. valuation of the assets of the disposal group as the lower Management concluded that the Gas Transportation of the carrying amount and fair value less cost to sell, Business should be reported as a disposal group held the presentation of the assets in the consolidated financial for sale and distribution and discontinued operation statements and the date from which the Gas Transportation Why the matter was determined to be a key audit matter How the matter was addressed in the audit in accordance with IFRS 5 “Non-Current Assets Held Business is classified as held for sale and distribution. RESPONSIBILITY for Sale and discontinued operations” (the “IFRS 5”) in In addition, we evaluated the accuracy of presentation of the consolidated financial statements for the year ended the results of the Gas Transportation Business as discontinued AND SOCIAL ENVIRONMENTAL 31 December 2019. The application of IFRS 5 is a key audit operations, the allocated income and expenses including Determining the fair values of property, plant, and Determining the fair values of property, plant and equipment matter as the assessment of the classification is complex, assumptions and estimates made with regard to the equipment is a key audit matter since it requires applying subjective the transaction and its accounting is non-routine and involves allocation. unobservable inputs and assumptions. In addition, fair value significant management judgements. We obtained approved by the government list of assets The Group applies revaluation model for its property, model is highly sensitive to the assumptions used to determine These judgements include, amongst others, the date related to Gas Transportation Business that should be plant and equipment. As discussed in Note 5 “Property, economic impairment, such as the annual volumes of gas transit of classification of the non-current assets as held for sale transferred to a new operator on 1 January 2020 and checked Plant, and Equipment” to the consolidated financial and transportation, annual volume of oil transit, volume of or distribution, the identification of the disposal group and that these assets were appropriately classified as assets held statements, the latest revaluation of property, plant and hydrocarbons extraction, future gas sales price, future Euro and the presentation of its results as discontinued operations. for distribution. equipment was made as of 1 October 2019 and as of 31 USD exchange rates and the discount rate. Classification as a disposal group held for sale and distribution We evaluated the completeness and accuracy of December 2019 for Gas Transportation System group For more details, please refer to Note 5 “Property, Plant, and also affects valuation of the assets of the disposal group and the relevant disclosures included in the consolidated financial based on the valuation report of independent professional Equipment”, as well as Note 24 “Fair Values” and Note 27 “Critical presentation in the consolidated financial statements. statements. appraiser. As a result of revaluation the Group recognized Accounting Estimates and Judgments”. We obtained Refer to Note 21 “Discontinued operations” of the the revaluation decrease in the amount of UAH 77,486 understanding of and evaluated the Group’s policies, processes, accompanying consolidated financial statements for further million, less the effect of deferred taxes in the amount of methods, and assumptions used to assess the fair values of details. UAH 13,947 million. property, plant, and equipment. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 186 Naftogaz Group Annual Report 2019 187 Naftogaz Group Other Information As part of an audit in accordance with ISAs, we exercise regulation prohibits a public disclosure of a specific matter or, Basic Information About Audit Firm professional judgment and maintain professional skepticism in extremely adverse circumstances, we determine that such Management is responsible for the other information. throughout the audit. We also: an matter should not be addressed in our report, as negative Name: LIMITED LIABILITY COMPANY “DELOITTE & TOUCHE The other information comprises the information included — Identify and assess the risks of material misstatement consequences from such a disclosure may predictably UKRAINIAN SERVICES COMPANY”. in the management report prepared in accordance with the of the consolidated financial statements, whether due outweigh its usefulness for interests of the public. Address of registration and location of audit firm: 48, 50a article 11 of the Law on accounting and financials reporting and to fraud or error, design and perform audit procedures Zhylianska Str., Kyiv, 01033, Ukraine. the article 40 of the Law of Ukraine “On Securities and Stock responsive to those risks, and obtain audit evidence that Report on Other Legal Requirements “Limited Liability Company “Deloitte & Touche Ukrainian
Exchange Market”, which also includes corporate governance is sufficient and appropriate to provide a basis for our Services Company” was enrolled to Sections of “Audit Entities”, MARKET AND REFORMS report, but does not include the consolidated financial opinion. The risk of not detecting a material misstatement We have been appointed as auditor of the Group by the “Audit Entities and Auditors That Have the Right to Conduct statements and our auditor’s report thereon, which we obtained resulting from fraud is higher than for one resulting from Supervisory Board on 17 September 2019. In view of the previous Statutory Audits of Financial Statements”, and “Audit Entities prior to the date of this auditor’s report, and the annual report, error, as fraud may involve collusion, forgery, intentional renewals and reappointments, we conducted audit from 12 and Auditors That Have the Right to Conduct Statutory Audits of which is expected to be made available to us after that date. omissions, misrepresentations, or the override of internal September 2014 to the date of this report. Financial Statements of Public Interest Entities” of the Register of Our opinion on the consolidated financial statements does control. We confirm that the audit opinion is consistent with the Auditors and Auditing Entities of the Audit Chamber of Ukraine not cover the other information and we do not and will not — Obtain an understanding of internal control relevant to additional report to the audit committee. under #1973.” express any form of assurance conclusion thereon. the audit in order to design audit procedures that are We confirm that the prohibited non-audited services referred In connection with our audit of the consolidated financial appropriate in the circumstances, but not for the pur- to ISA or requirements of Article 6, paragraph 4 of Law of Ukraine statements, our responsibility is to read the other information pose of expressing an opinion on the effectiveness of «On Audit of Consolidated financial statements and Audit identified above and, in doing so, consider whether the other the Group’s internal control. Activities» were not provided and that the audit engagement information is materially inconsistent with the consolidated — Evaluate the appropriateness of accounting policies used partner and audit firm remain independent of the Group in financial statements or our knowledge obtained in the audit, and the reasonableness of accounting estimates and conducting the audit. or otherwise appears to be materially misstated. If, based on related disclosures made by management. the work we have performed on the other information that we — Conclude on the appropriateness of management’s use AND OPERATIONS STRATEGY obtained prior to the date of this auditor’s report, we conclude of the going concern basis of accounting and, based on that there is a material misstatement of this other information, the audit evidence obtained, whether a material uncer- we are required to report that fact. We have nothing to report in tainty exists related to events or conditions that may cast this regard. significant doubt on the Group’s ability to continue as a go- When we read the annual report, if we conclude that ing concern. If we conclude that a material uncertainty there is a material misstatement therein, we are required to exists, we are required to draw attention in our auditor’s communicate the matter to those charged with governance. report to the related disclosures in the consolidated fi- nancial statements or, if such disclosures are inadequate, Responsibilities of Management and Those Charged with to modify our opinion. Our conclusions are based on Governance for the Consolidated Financial Statements the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause Management is responsible for the preparation and fair the Group to cease to continue as a going concern. presentation of the consolidated financial statements in — Evaluate the overall presentation, structure and content GOVERNANCE CORPORATE accordance with IFRSs and Law on accounting and financial of the consolidated financial statements, including reporting, and for such internal control as management the disclosures, and whether the consolidated financial determines is necessary to enable the preparation of statements represent the underlying transactions and consolidated financial statements that are free from material events in a manner that achieves fair presentation. misstatement, whether due to fraud or error. — Obtain sufficient appropriate audit evidence regarding In preparing the consolidated financial statements, the financial information of the entities or business management is responsible for assessing the Group’s ability to activities within the Group to express an opinion on continue as a going concern, disclosing, as applicable, matters the consolidated financial statements. We are respon- related to going concern and using the going concern basis sible for the direction, supervision and performance of of accounting unless management either intends to liquidate the group audit. We remain solely responsible for our the Group or to cease operations, or has no realistic alternative audit opinion. but to do so. We communicate with those charged with governance RESPONSIBILITY Those charged with governance are responsible for regarding, among other matters, the planned scope and overseeing the Group’s financial reporting process. timing of the audit and significant audit findings, including AND SOCIAL ENVIRONMENTAL any significant deficiencies in internal control that we identify Auditor’s Responsibilities for the Audit of the Consolidated during our audit. Financial Statements We also provide those charged with governance with a statement that we have complied with relevant ethical Our objectives are to obtain reasonable assurance about requirements regarding independence, and to communicate whether the consolidated financial statements as a whole with them all relationships and other matters that may Certified Auditor Sergiy Kulyk are free from material misstatement, whether due to fraud reasonably be thought to bear on our independence, and or error, and to issue an auditor’s report that includes our where applicable, related safeguards. Auditor’s Certificate # 007492 opinion. Reasonable assurance is a high level of assurance, but Issued by the Audit Chamber of Ukraine on 21 December 2017 on the basis of Resolution of the Audit Chamber of Ukraine # 353/2 is not a guarantee that an audit conducted in accordance with From the matters communicated with those charged Registration Number in the Register of Auditors and Auditing Entities 102254 ISAs will always detect a material misstatement when it exists. with governance, we determine those matters that were of Misstatements can arise from fraud or error and are considered most significance in the audit of the consolidated financial LLC “Deloitte & Touche Ukrainian Services Company” material if, individually or in the aggregate, they could reasonably statements of the current period, which constitute the key 48, 50a Zhylianska Str., Kyiv, 01033, Ukraine be expected to influence the economic decisions of users taken audit matters included herein. We describe these matters on the basis of these consolidated financial statements. in our auditor’s report, except for the cases when a law or 13 April 2020 FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 188 Naftogaz Group Annual Report 2019 189 Naftogaz Group CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 2019 CONSOLIDATED STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 2019
31 December 31 December In millions of Ukrainian hryvnias Note 2019 2018 In millions of Ukrainian hryvnias Note 2019 2018
ASSETS Continuing operations: Revenue 3 149,781 184,862
Non-current assets Cost of sales 15 (106,688) (123,408) MARKET AND REFORMS Property, plant and equipment 5 240,506 434,370 Investments in associates and joint ventures 6 835 1,255 Gross profit 43,093 61,454 Deferred tax assets 20 10,439 5,119 Other operating income 16 2,482 3,072 Other non-current assets 7 8,505 8,988 Other operating expenses 17 (37,308) (36,280)
Total non-current assets 260,285 449,732 Operating profit 8,267 28,246 Finance costs 18 (7,082) (5,758) Current assets Finance income 19 1,890 2,105 Inventories 8 57,705 65,571 Trade accounts receivable 9 59,056 65,942 Share of after-tax results of associates and joint-ventures 6 (121) (1,316) Prepayments made and other current assets 10 9,887 6,888 Net foreign exchange income/(loss) 1,937 (446) Prepaid corporate income tax 263 17 Cash and bank balances 77,593 14,224 Profit before income tax 4,891 22,831 Restricted cash 436 1,338 Income tax expense 20 (2,310) (6,959) Assets of discontinued operations classified as held for sale and distribution 21 115,355 - Net profit for the year from continuing operations 2,581 15,872 AND OPERATIONS STRATEGY
Total current assets 320,295 153,980 Discontinued operations: Profit/(loss) for the year from discontinued operations 21 60,713 (4,305) TOTAL ASSETS 580,580 603,712 Net profit for the year 63,294 11,567 EQUITY Net profit/(loss) is attributable to: Share capital 11 194,307 194,307 Owners of the Company 65,043 8,696 Revaluation reserve 316,264 379,022 Non-controlling interest (1,749) 2,871 Foreign currency translation reserve 3,340 4,027 Accumulated deficit (123,234) (165,342) Net profit for the year 63,294 11,567
Equity attributable to owners of the Parent 390,677 412,014 CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 2019 Non-controlling interest in equity 1,897 1,844 GOVERNANCE CORPORATE
TOTAL EQUITY 392,574 413,858 In millions of Ukrainian hryvnias Note 2019 2018
LIABILITIES Net profit for the year 63,294 11,567
Non-current liabilities Other comprehensive (loss)/income Borrowings 12 47,148 11,299 Provisions 13 10,588 6,943 Items that will not be reclassified subsequently to profit or loss, Deferred tax liabilities 20 18,858 50,544 net of income tax: Other long-term liabilities 2,691 221 Loss on revaluation of property, plant and equipment (net of income tax effect of UAH 12,722 million Total non-current liabilities 79,285 69,007 (2018: UAH 7,110 million) (57,929) (32,390) Share of other comprehensive income of associates RESPONSIBILITY Current liabilities (net of income tax effect of UAH nil (2018: nil) 6 133 1,399 Borrowings 12 13,514 44,700 ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL Provisions 13 43,873 41,072 Remeasurement of defined benefit obligation (net of income tax effect of Trade accounts payable 5,061 5,500 UAH 113 million (2018: UAH 2 million) 13 (1,020) (7) Advances received and other current liabilities 14 18,462 23,269 Corporate income tax payable 10,471 6,306 Remeasurement of decommissioning liability (net of income tax effect of Liabilities of discontinued operations classified as held for UAH 375 million (2018: UAH 2 million) 13 (1,710) 11 sale and distribution 21 17,340 - Items that may be reclassified subsequently to profit or loss, Total current liabilities 108,721 120,847 net of income tax: Foreign currency translation reserve (687) 565 TOTAL LIABILITIES 188,006 189,854 Other comprehensive loss for the year (61,213) (30,422)
TOTAL LIABILITIES AND EQUITY 580,580 603,712 Total comprehensive income/(loss) for the year 2,081 (18,855) Total comprehensive income/(loss) is attributable to: These consolidated financial statements were authorised for issue on 6 April 2020. Owners of the Company 2,028 (21,181) Non-controlling interests 53 2,326 Andriy Kobolyev, Petrus Stephanus Van Driel, Chairman of the Executive Board Chief Financial Officer Total comprehensive income/(loss) for the year 2,081 (18,855) FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 190 Naftogaz Group Annual Report 2019 191 Naftogaz Group CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 2019
Equity attributable to owners of the Parent
Foreign currency Accumulated Non-controlling Total In millions of Ukrainian hryvnias Share capital Revaluation reserve translation reserve deficit Total interest equity
Balance at 31 December 2017 194,307 411,261 3,462 (168,057) 440,973 (454) 440,519
MARKET AND REFORMS Effect of implemantion of new standard - - - (3,666) (3,666) - (3,666)
Balance at 1 January 2018 194,307 411,261 3,462 (171,723) 437,307 (454) 436,853
Profit for the year - - - 8,696 8,696 2,871 11,567 Other comprehensive (loss)/income for the year - (31,988) 565 1,546 (29,877) (545) (30,422)
Total comprehensive (loss)/income for the year - (31,988) 565 10,242 (21,181) 2,326 (18,855)
Transfer of revaluation reserve - (251) - 251 - - - Change in investments in joint operations - - - (9) (9) (9) (18) Provision for dividends payable to the State Budget (Notes 11 and 13) - - - (4,084) (4,084) - (4,084) Profit share paid to the State Budget (Note 11) - - - (19) (19) (19) (38)
Balance at 31 December 2018 194,307 379,022 4,027 (165,342) 412,014 1,844 413,858 AND OPERATIONS STRATEGY
Profit/(loss) for the year - - - 65,043 65,043 (1,749) 63,294 Other comprehensive (loss)/income for the year - (61,540) (687) (788) (63,015) 1,802 (61,213)
Total comprehensive (loss)/income for the year - (61,540) (687) 64,255 2,028 53 2,081
Transfer of revaluation reserve - (1,218) - 1,218 - - - Provision for dividends payable to the State Budget (Note 11) - - - (15,197) (15,197) - (15,197) Profit share paid to the State Budget (Note 11) - - - (8,168) (8,168) - (8,168)
Balance at 31 December 2019 194,307 316,264 3,340 (123,234) 390,677 1,897 392,574
CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 2019 CORPORATE GOVERNANCE CORPORATE In millions of Ukrainian hryvnias Note 2019 2018 In millions of Ukrainian hryvnias Note 2019 2018
CASH FLOWS FROM OPERATING ACTIVITIES CASH FLOWS FROM INVESTING ACTIVITIES Profit before income tax from continuing operations 4,891 22,831 Purchase of property, plant and equipment and intangible assets (27,683) (24,904) Profit/(loss) before income tax from discontinued operations 21 77,360 (2,294) Proceeds from sale of property, plant and equipment 137 13 Adjustments for: Withdrawal/(placement) of bank deposits 1,500 (1,448) Depreciation of property, plant and equipment and amortisation of intangible assets 34,432 44,160 Withdrawal of restricted cash 903 253 Loss on disposal of property, plant and equipment 851 325 Proceeds from sale of the State treasury bonds and other financial Impairment of property, plant and equipment and intangible investments 148 145 assets 17 10,061 1,466 Dividends received 19 - Write down of inventories 8 2,457 5,781 Net movement in provision for trade accounts receivable, Net cash used in investing activities (24,976) (25,941) 21,857 19,361 prepayments made and other assets RESPONSIBILITY Change in provisions 13 4,751 18,188 CASH FLOWS FROM FINANCING ACTIVITIES Write off of accounts payable and other current liabilities (192) (46) Proceeds from borrowings 43,865 14,304 ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL Share of after-tax results of associates and joint-ventures 6 121 1,316 Repayment of borrowings (34,844) (35,192) Net foreign exchange (loss)/gain (1,414) 471 Interest paid (5,419) (5,163) Finance costs, net 5,419 4,073 Profit share and dividends paid 11, 13 (20,754) (29,536)
160,594 115,632 Net cash used in financing activities (17,152) (55,587) Operating cash flows before working capital changes 51 281 Decrease in other non-current assets (1,089) (12,408) Net increase /(decrease) in cash and cash equivalents 67,873 (9,885) Increase in inventories (16,305) (27,162) Increase in trade accounts receivable (4,493) 7,217 12,759 23,093 (Increase)/decrease in prepayments made and other current assets CASH AND CASH EQUIVALENTS AT THE BEGINNING OF THE YEAR (Decrease) /increase in (265) 15 other long-term liabilities 13 (5,167) (4,134) (3,039) (449) Provisions paid or used Effect of exchange rates change on cash and cash equivalents (155) 14,993 (Decrease)/increase in trade accounts payable (2,283) (563) 77,593 12,759 Decrease in advances received and other current liabilities CASH AND CASH EQUIVALENTS AT THE END OF THE YEAR 130,888 93,871 Cash generated from operations Significant Non-Cash Transactions Income taxes paid (22,296) (23,901) 1,409 1,673 - 17,699 Interest received Payment for the natural gas purchase by a lending bank FINANCIAL OVERVIEW AND STATEMENTS Net cash generated by operating activities 110,001 71,643
Annual Report 2019 192 Naftogaz Group Annual Report 2019 193 Naftogaz Group NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2019
1. THE ORGANISATION AND ITS OPERATIONS gas group of companies allowing optimisations across our In December 2018, the IMF Board of Directors approved taking that actions by the State are carried at a minimum suf- portfolio. We are engaged in exploring for natural gas, the the stand-by assistance (SBA) 14-month programme ficient level. Prices for a natural gas supply should be defined Joint Stock Company “National Joint Stock Company development of new natural gas supplies, the transportation for Ukraine, totalling USD 3.9 billion. In December between the supplier and the customer on an arm’s length, “Naftogaz of Ukraine” (“Naftogaz”, the “Parent” or the and storage of oil and gas and the sale of natural gas and 2018, Ukraine has already received USD 2 billion from except for the certain cases when the Cabinet of Ministers of “Company”) was founded in 1998 in accordance with the liquefied petroleum gas to our customers. the IMF and the EU, as well as USD 750 million credit Ukraine (“CMU”) imposes public service obligations (“public
Resolution of the Cabinet of Ministers of Ukraine #747 dated The Company holds stakes in various entities that form guarantees from the World Bank. IMF programme’s service obligations” or “PSO”) on the Company in respect of MARKET AND REFORMS 25 May 1998. According to the Resolution of the Cabinet of the national system of production, refinery, distribution, approval significantly increases the chance of Ukraine to certain groups of customers, mainly households. The currently Ministers of Ukraine dated 6 March 2019 the Company was transportation, and storage of natural gas, gas condensate and meet foreign currency obligations in 2020, and thus has effective rules of the PSO are described in the Resolution #867 changed from Public to Private Joint Stock Company. oil. supported the financial and macroeconomic stability of the dated 19 October 2018 “On Approval of the Provisions for Im- Naftogaz is owned by the State of Ukraine. The Cabinet The Company is registered at 6 B. Khmelnytskoho Street, country. However, the IMF will decide on further tranches posing Special Obligations on the Natural Gas Market Partici- of Ministers of Ukraine executes the State corporate rights Kyiv, Ukraine. depending on Ukraine`s success in fulfilling the terms of pants for Ensuring Public Interests in the Natural Gas Market and the shareholders’ meetings and appoints the Supervisory These consolidated financial statements were authorised the Memorandum on Economic and Financial Policies, Functioning”, covering the period from 1 November 2018 to 1 Board that controls and regulates the Executive Board for issue on 6 April 2020. which Ukraine plans to follow during the SBA programme`s May 2020 (“Resolution #867”). activities. The Group conducts its business and holds its production implementation. Further in April-May 2019, with the Resolutions #293 and Naftogaz and its subsidiaries (hereinafter collectively facilities mainly in Ukraine. The principal subsidiaries and joint In 2020, Ukraine faces major public debt repayments, #380, the Cabinet of Ministers of Ukraine changed a mecha- referred to as the “Group”) is a vertically integrated oil and operations are: which will require mobilising substantial domestic and nism of the gas price setting within the PSO, switching to the external financing in an increasingly challenging financing lower of: environment for emerging markets. Furthermore, negative — the average price of natural gas for industrial consumers % Interest held Subsidiary/ Country of trends in industrial production in Ukraine in the second half of for the previous month supplied on a prepaid basis;
Name/Type of activity as at 31 December Joint operations registration 2019 may continue in 2020. — the average customs value of imported natural gas for the AND OPERATIONS STRATEGY 2019 2018 Ukraine faced presidential elections in March-April 2019, previous month, published by the Ministry of Economic Production of gas, oil and refinery products and then early parliamentary elections in July 2019. The de- Development and Trade; Ukrgasvydobuvannya, JSC 100.00 100.00 Subsidiary Ukraine gree of uncertainty in respect of the future direction of the — the average month-ahead selling price of natural gas Ukrnafta, PJSC 50.00 + 1 share 50.00 + 1 share Subsidiary Ukraine reforms in 2020 remains very high. according to the results of electronic stock exchange, or Petrosannan Company, Joint operations In addition, on 16 January 2020, the Parliament of Ukraine — the price of natural gas set in the Resolution #867. with the Arab Republic of Egypt adopted the law #465-IX “On changes to other laws of Ukraine On 24 January 2020, the Cabinet of Ministers of Ukraine and Egyptian General Petroleum in respect of improving tax administration, eliminating techni- changed a mechanism of the gas price setting within the Corporation (“EGPC”) 50.00 50.00 Joint operations Egypt cal and logical inconsistencies in tax legislation” and #466-IX PSO from 1 January 2020 by Resolution #17. Under the new Zakordonnaftogaz, SE 100.00 100.00 Subsidiary Ukraine “On changes to the Tax Code of Ukraine in respect of improv- formula, the wholesale price of natural gas for the current Karpatygaz, LLC, Joint ing tax administration, eliminating technical and logical incon- month will include the weighted average price for natural sistencies in tax legislation”. These laws introduce numerous gas for the next gas delivery day on a Dutch gas hub (TTF) for operations with Misen changes to the local tax and financial reporting regulations. the period 1-22 day of the gas supply month, the difference Enterprises AB (Note 22) 49.99 49.99 Joint operations Ukraine The Law #465 IX was signed by the President and came into (spread) between the price on TTF hub and Ukrainian border, GOVERNANCE CORPORATE force on 27 February 2020. The Law #466-IX was submitted tariff for natural gas transportation services at interstate Oil and gas transportation for signature of the President. The Group is analysing their connections and trade margin. Ukrtransgaz, JSC 100.00 100.00 Subsidiary Ukraine impact on its tax and financial reporting process for the future For customers outside the PSO, imported natural gas Gas Transmission System periods. is sold under the prices set by the gas market participants. Operator of Ukraine,LLC 100.00 100.00 Subsidiary Ukraine Despite certain improvements in 2019, the the outcome The prices for natural gas set by the Group are differentiated Ukrtransnafta, JSC 100.00 100.00 Subsidiary Ukraine of the political reforms and the ongoing effects of the political based on the monthly consumption volumes and payment Ukrspectransgaz, JSC 100.00 100.00 Subsidiary Ukraine and economic situation are difficult to predict but they may method by the customer. have further severe effects on the Ukrainian economy and the In November 2016 the Law of Ukraine “On measures to Wholesale and retail distribution of oil, gas and refinery products Group’s business. settle the debts for the natural gas consumed by municipal Gaz Ukraiiny, SE 100.00 100.00 Subsidiary Ukraine In late 2019, news first emerged from China about the heat generating entities and distribution and water supplying Gas supply company COVID-19 (Coronavirus). At 31 December 2019, there was companies” #1730 was adopted. The settling principles Naftogaz of Ukraine, LLC 100.00 100.00 Subsidiary Ukraine a limited number of cases of an unknown virus reported for municipal heat generating entities and distribution and RESPONSIBILITY Gas supply company Naftogaz Trading, LLC to the World Health Organisation. The situation changed water supply companies’payables for gas are set in this Law. Naftogaz Trading, LLC 100.00 100.00 Subsidiary Ukraine dramatically in early 2020, when the virus spread globally As at 31 December 2019 outstanding amount per gas debt AND SOCIAL ENVIRONMENTAL Naftogaz Trading Europe AG 100.00 100.00 Subsidiary Switzerland and its negative impact gained momentum. Management restructuring agreements according to this Law included in Kirovogradgaz, OJSC 51.00 51.00 Subsidiary Ukraine considers the impact of this outbreak to be a non-adjusting other non-current assets was UAH 1,693 million (31 December Ukravtogaz, SE 100.00 100.00 Subsidiary Ukraine post balance sheet event. The Group assesses that the 2018: UAH 1,655 million). Fulfilment of gas debt restructuring situation might potentially result in inability or unfavourable agreements is guaranteed by municipal executive government pricing conditions in respect of raising financing on global bodies representing particular territorial community as set by 2. OPERATING ENVIRONMENT hryvnia were successful unlocking of the IMF programme at markets. While this is still an evolving situation, the impact the separate guarantee agreement. the end of 2018, strong revenues of agricultural exporters, cannot be predicted. Management will continue to monitor According to the terms of gas debt restructuring During 2019 the Ukrainian economy was showing signs tight UAH liquidity, and steady inflow of foreign currency the potential impact and will take all steps possible to agreements, the Company has a right to terminate them in of stabilisation after years of political and economic tensions. through government debt instruments. mitigate any negative effects. case of late payments by counterparty. There were no such Inflation rate in Ukraine has decreased to 4.1% during 2019 Starting from April 2019, the National Bank of Ukraine agreements terminated up to the date of these consolidated as compared to 9.8% in 2018, while GDP continued to grow at (“NBU”) launched the cycle of easing its monetary policy and Gas market in Ukraine financial statements. estimated 3.5% (after 3.3% growth in 2018). a gradual decreasing its interest rate for the first time in the The natural gas market of Ukraine is based on the princi- Starting from 1 March 2019, the Ukrainian gas market After several years of devaluation, Ukrainian hryvnia has last two years from 18.0% in April 2019 to 10.0% in March ples of free and fair competition. The State does not interfere switched to daily balancing, fulfilling the commitments strengthened by 17% against EUR and by 14% against USD 2020, which is justified by a sustainable trend of inflation to the operations on the market, except when it is necessary undertaken by the Ukrainian Government under the (Note 26). Among the key mitigating factors for the Ukrainian deceleration. to eliminate market constraints or to insure public interest, Association Agreement with the European Union. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 194 Naftogaz Group Annual Report 2019 195 Naftogaz Group NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2019
Compensation for performing public service obligations and other byproducts sales. Management identified four main At the end of 2019 the Company, “Gas Transmission Adjusted EBITDA is the earnings measure used by the In accordance with Paragraph 7, Article 11 of the Law groups of customers in respect of gas sales and supply: System Operator of Ukraine” LLC, and Gazprom signed Executive Board for the purposes of making decisions about of Ukraine “On Natural Gas Market”, a gas market player — Gas production, imports and sales to the regional agreements to prolonge the transport of Russian gas through allocating resources and assessing performance. The earnings with public service obligations is eligible for compensation gas supply companies (“RSC”) for the needs of the territory of Ukraine until 2024. In particular, the Company measure adjusted operating profit has been retired, and is no of economically justified expenditures incurred by such households, and Gazprom signed an agreement on servicing gas transit longer used to allocate resources and to assess performance, player, less any income obtained in the course of fulfilling — Gas production, imports and supply to the municipal heat through the territory of Ukraine, where gas transit volumes as the Executive Board believes that adjusted EBITDA better MARKET AND REFORMS such obligations plus adequate profit margin. The level of generating entities (“MHE”) for the needs of households, and general terms are set (Note 22). reflects segment results. profit margin should be calculated following the relevant — Gas production, imports and supply to the other As at 31 December 2019, gas domestic transmission Adjusted EBITDA represents net profit/(loss) for the resolution approved by the Cabinet of Ministers of Ukraine. customers under PSO, and gas transit segments are presented as discontinued year after excluding the following income statement items: In October 2018 the Company initiated a claim to — Gas imports and supply to the other customers outside operations. income tax expense, finance costs, finance income, share request compensation for damages incurred when PSO and byproducts sales. Gas storage. Ukrainian gas transportation system includes of after-tax results of associates, impairment of property, the company performed its public service obligation Each group of customers has its own selling price setting 12 underground gas storage facilities located in mainland plant and equipment, depreciation of property, plant and during the fourth quarter of 2015. The claim amounts to procedure and its own economic characteristics, such as products Ukraine. The total capacity of the underground gas storage equipment and amortisation of intangible assets and income UAH 6.6 billion. In March 2019 the Kyiv Commercial Court delivered to the end customers, their credit risks etc. system located in Ukraine is 31 billion cubic meters of gas. and expenses recognised per results of Gas Transit Arbitration. ejected the claim. The Company appealed to this decision Selling price setting for gas sales to RSC, MHE for the needs of “Ukrnafta” PJSC. “Ukrnafta” PJSC is the biggest oil Adjusted EBITDA is a measure of operating segments and the case is panding at the date of publication of these households and to the other customers under PSO is performed producing company in Ukraine. “Ukrnafta” PJSC is composed performance and liquidity that is not required by or presented consolidated financial statements. within the current PSO Resolution (Note 2). Gas supply for of several production and maintenance units, which are in accordance with IFRS. At the date of these consolidated financial statements, other groups of customers is performed at prices established currently in the process of corporate restructuring, including Management uses capital expenditures and segment the Group did not receive any compensation, and therefore independently by Naftogaz. six oil and gas production units, one well drilling division and operating cash flows from before working capital changes did not recognise any income, for performing its public The Group controls about 75% of all natural gas production three gas processing plants. as measures of both a segment operational efficiency and AND OPERATIONS STRATEGY service obligation during 2018 and 2019 in Ukraine. As described in Note 2, “Ukrgasvydobuvannya” JSC “Ukrnafta” PJSC also owns one of the largest filling stations its short-term financial health. Capital expenditures are The Group estimates the amount of compensation for and “Chornomornaftogaz” JSC are obliged to sell gas to Naftogaz network in Ukraine located in different regions of Ukraine. presented on a cash basis for these purposes. Respective performing public service obligations up to 31 December for the needs of households, religious organisations, municipal Other. Revenues of this segment include revenues from sales reconciliations to the closest IFRS measure are presented in 2019 at the level of UAH 39.2 billion (unaudited) (31 heat generating entities and distribution and water supply of materials and services. The segment also includes results of this note. December 2018: UAH 27.1 billion, unaudited). This amount companies for households and religious organisations. Therefore, joint operations under the concession agreement for exploration The accounting policies of the reportable segments are the does not include compensation attributable to other gas management views performance from gas production up to its and development with the Arab Republic of Egypt. same as the Group’s accounting policies described in Note 26. market players with public service obligations, inter alia sale to one of the groups of customers named above as a single “Ukrgasvydobuvannya” JSC. Total amount of compensation reporting segment. Demand in gas for other customers outside to all gas market players named above is UAH 146 PSO is satisfied from gas import. billion (unaudited) (31 December 2018: UAH 114 billion, Byproducts sales include production of oil and gas unaudited) according to the Group’s calculations. condensate by “Ukrgasvydobuvannya” JSC which is consumed by Oil midstream and downstream segment at intra-group
Assets located at temporarily occupied territories prices. GOVERNANCE CORPORATE In early 2014, Ukraine suffered from the military Oil midstream and downstream. This segment includes aggression of the Russian Federation which resulted in activities related to transportation, sale and supply of oil, gas the occupation of the Autonomous Republic of Crimea condensate, petroleum products, and related services. (“Crimea”) and unlawful military take-over of certain areas The Group sells purchased and domestically refined in Luhanska and Donetska regions by armed terrorist petroleum products through filling stations network groups, as well as the collapse of law enforcement in such throughout Ukraine. Domestic refinery of petroleum products areas. Management of the Group continues to undertake is performed at oil and gas refineries controlled by the Group. all possible legal and diplomatic measures to be reimbursed Oil transit and transmission operations are presented by oil for losses and to recover control of the Group’s assets in transmission pipelines and 11 oil reservoirs operated by the Crimea (Note 22). Group. Gas domestic transmission and gas transit. As at 31 December 2019 and 2018, management considered gas RESPONSIBILITY 3. SEGMENT INFORMATION transit and gas transmission as separate business segments as gas transit is mainly represented by a contract with a single AND SOCIAL ENVIRONMENTAL The Executive Board is the Group’s chief operating counterparty and was assessed separately. decision maker. In 2018 the Group started the organisational Gas domestic transmission segment also included the transformation into an efficient integrated national oil and result of market-based gas balancing operations introduced gas company. Under the new operating model operations by the Code of the Gas Transmission System. Market- of the Group are organised by Business Delivery Units, based gas balancing operations is an activity to balance gas Business Enabling Units and Functions. Business Delivery volumes entered into the gas transmission system at entry Units undertake the Group’s principal activities to achieve point and volumes taken out at exit point. Gas balancing its financial and operational goals. Business Enabling Units services were provided to consumers of gas transmission and Functions support Business Delivery Units in order to services. As described in Note 21, on 1 January 2020 maximize the value of the Group. current obligations of Naftogaz and “Ukrtransgaz” JSC to The Executive Board makes decisions about allocating operate state-owned gas transmission infrastructure were resources and assessing performance for the following terminated. The Ministry of Finance of Ukraine transferred business units: state-owned assets related to the gas transmission system to Integrated gas. Integrated gas includes gas production, the new transmission system operator under the long-term imports, sales and supply to different groups of customers economic management agreement. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 196 Naftogaz Group Annual Report 2019 197 Naftogaz Group NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2019
Segment information for the reportable business segments of the Group for the year ended 31 December 2019 is as follows:
Integrated Oil midstream and Gas Gas domestic Gas In millions of Ukrainian hryvnias gas downstream transit transmission storage Ukrnafta Other Elimination Total MARKET AND REFORMS Sales – external 90,178 11,905 70,207 18,070 727 28,074 691 - 219,852 Sales to other segments 24,306 57 - 4,663 2,535 138 5 (31,704) -
Total revenue 114,484 11,962 70,207 22,733 3,262 28,212 696 (31,704) 219,852
Segment result 36,982 1,149 34,322 (9,767) 1,970 2,308 (1,932) - 65,032
Segment assets 224,862 16,634 111,441 14,184 76,724 32,945 7,705 - 484,495 Capital expenditure 23,702 1,817 349 48 44 1,449 274 - 27,683 Segment operating cash flows before working capital changes 41,677 1,533 104,505 6,017 2,008 6,442 (150) - 162,032
Material non-cash items included in segment results: Write down of inventories 1,039 19 1,091 149 - 181 (22) - 2,457 AND OPERATIONS STRATEGY Net movement in provision for trade and other receivables and prepayments made and other current assets 1,805 1 - 15,358 (8) 3,260 866 - 21,282
Net foreign exchange loss/(gain) 4 (4) (631) 3 - - (629) - (1,257)
Material non-cash items excluded from segment result: Depreciation, depletion and amortisation 10,900 740 18,132 2,186 251 1,551 672 - 34,432 Impairment of property, plant and equipment 8,008 146 706 97 392 669 - - 10,018
Segment information for the reportable business segments of the Group for the year ended 31 December 2018 is as follows: GOVERNANCE CORPORATE
Integrated Oil midstream and Gas Gas domestic Gas In millions of Ukrainian hryvnias gas downstream transit transmission storage Ukrnafta Other Elimination Total
Sales – external 108,534 12,950 72,347 24,815 259 36,029 1,378 - 256,312 Sales to other segments 29,291 30 - 2,353 1,537 84 - (33,295) -
Total revenue 137,825 12,980 72,347 27,168 1,796 36,113 1,378 (33,295) 256,312
Segment result 43,317 2,218 36,594 (1,818) (30) 13,108 (2,488) - 90,901 RESPONSIBILITY
Segment assets 210,511 14,862 96,350 18,327 199,774 29,969 8,552 - 578,344 AND SOCIAL ENVIRONMENTAL Capital expenditure 21,224 802 961 131 93 1,478 215 - 24,904 Segment operating cash flows before working capital changes 53,410 2,920 33,623 11,579 164 14,137 932 - 116,765
Material non-cash items included in segment results: Write down of inventories 5,717 70 - - - (6) - - 5,781 Net movement in provision for trade and other receivables and prepayments made and other current assets 2,421 4 - 13,344 86 219 3,287 - 19,361
Net foreign exchange loss/(gain) 128 - 73 - - - 8 - 209
Material non-cash items excluded from segment results: Depreciation, depletion and amortisation 8,515 1,359 29,912 1,378 1,234 1,539 223 - 44,160 Impairment of property, plant and equipment 332 231 859 - - 13 30 - 1,466 FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 198 Naftogaz Group Annual Report 2019 199 Naftogaz Group NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2019
information to the aggregate numbers of the consolidated Reconciliations 4. BALANCES AND TRANSACTIONS WITH RELATED the portion of net profit attributable to the State Budget of The following tables include reconciliations of segment financial statements, taking into account items which are not directly attributable to a segment. PARTIES Ukraine (Notes 11, 13). As at 31 December 2019 and 2018, about 99% and 96%, In millions of Ukrainian hryvnias 2019 2018 Parties are generally considered to be related if one party respectively, of cash and bank balances were placed in the has the ability to control the other party, is under common banks controlled, jointly controlled or influenced by the Total revenue control, or can exercise significant influence or joint control Government of Ukraine and about 38% of borrowings were MARKET AND REFORMS Sales – external 219,852 256,312 over the other party in making financial and operational provided by these banks (31 December 2018: 76%). About Gas transit revenue reclassified to discontinued operations (70,207) (72,347) decisions. In considering each possible related party 66% of finance income for the year ended 31 December 2019 Gas transmission revenue reclassified to relationship, attention is directed to the substance of the related to balances in these banks (2018: 75%) and about 62% discontinued operations (22,733) (27,168) relationship, not merely the legal form. of finance costs for the year ended 31 December 2019 (2018: Gas transmission intersegment revenue eliminated 4,663 2,353 As described in the Note 1, the Group is ultimately 97%) related to borrowings from these banks. Intersegment sales to domestic gas transmission and controlled by the Government of Ukraine, and therefore, all As at 31 December 2019 and 2018, borrowings gas transit segments 18,206 25,712 Pledges. state-controlled entities and institutions are considered as from related parties (State-owned banks) were secured by Total revenue 149,781 184,862 related parties under common control. property, plant and equipment, inventories and proceeds from Transactions with related parties are performed on terms future sales (Note 12). As at 31 December 2019, about 71% that would not necessarily be available to unrelated parties. of pledges were related to the borrowings from State-owned Segment result Transactions with state-controlled entities and banks (31 December 2018: 76%). Segment result 65,032 90,901 institutions. The Group performs significant transactions Guarantees. Amount of guarantees, provided by the Depreciation, depletion and amortisation (34,432) (44,160) with entities and institutions controlled, jointly controlled or Government of Ukraine, as at 31 December 2019 and 2018
Impairment of property, plant and equipment and intangible assets (10,018) (1,466) significantly influenced by the Government of Ukraine. These equalled to UAH 2,694 million and UAH 15,443 million, AND OPERATIONS STRATEGY Income recognised per results of Gas Transit Arbitration 67,958 - entities and institutions include State Savings Bank of Ukraine, respectively (Note 12). Change in provisions for litigations and other provisions (121) (14,409) Ukreximbank, Ukrgazbank, tax authorities, municipal heat Transactions with the State are further disclosed in Non-refundable VAT recognised according to the Gas Transit Arbitration - (4,751) Finance expense, net (5,419) (4,073) generating entities, regional gas distribution entities and other Note 11. Share of after-tax results of associates (121) (1,316) entities. Key management remuneration. During 2019 key Reclassified to discontinued opeartions (77,360) 2,294 For the year ended 31 December 2019, about 31% of the management personnel consisted on average of 5 Executive Unallocated income/ (expense), net (628) (189) Group's revenue (2018: 32%) was earned from transactions Board members and 11 directors (2018: 6 Executive Board with the entities controlled, jointly controlled or influenced members and 9 directors). Compensation to the key Profit before tax from continuing operations 4,891 22,831 by the Government of Ukraine. Outstanding trade accounts management personnel included into other operating expenses receivable related to these transactions as at 31 December consists of salary and additional current bonuses and comprises Total assets 2019 and 2018 were about 45% and 43%, respectively, of the UAH 343 million in 2019 (2018: UAH 717 million). total trade accounts receivable balance. During 2019 the Company also incurred UAH 35 million of Segment assets 484,495 578,344 Deferred tax assets 10,439 5,119 Outstanding accounts payable, advances and other current expenses on operations of the Supervisory Board (2018: UAH Investments in associates and joint ventures 835 1,255 liabilities with related parties as at 31 December 2019 and 53 million). This amount includes UAH 29 million in service GOVERNANCE CORPORATE Cash and bank balances 77,593 14,224 2018 were about 44% and 58%, respectively, of the total fees accrued (2018: UAH 46 million), and UAH 6 million in Unallocated assets 7,218 4,770 balance of these liabilities. compensation of expenses incurred by the Board members Provisions in respect of the entities controlled by the during performance of their duties (2018: UAH 7 million), as Total assets 580,580 603,712 Government of Ukraine as at 31 December 2019 and 2018 well as directors and officers liability insurance procured and were about 43% and 38%, respectively, of the total provisions. paid by the Company to insure the liability of these officers Net cash generated by/(used in) operating activities Additionally, the Group recognised provision in respect of after their appointment. Segment operating cash flows before 162,032 116,765 working capital changes (29,707) (21,761) Working capital changes (22,296) (23,901) Income taxes paid 1,409 1,673 Interest received (1,437) (1,133) Unallocated cash flows from operating activities RESPONSIBILITY 110,001 71,643
Net cash generated by operating activities AND SOCIAL ENVIRONMENTAL
Geographical concentration of sales Ukraine 143,182 178,077 Russian Federation 3,377 3,701 Egypt 354 505 Europe 2,868 2,579
Total revenue 149,781 184,862
Allocation of sales in the table above is made based on revenue exceeding 10% of total revenues was Gazprom. the country of residence of the Group’s customers. Amount of revenue from Gazprom related to gas External customers concentration, exceeding 10% of transit in 2019 amounted to UAH 70,204 million (2018: total revenues. UAH 72,344 million). During the years ended 31 December 2019 and 2018, the only external customer with concentration of FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 200 Naftogaz Group Annual Report 2019 201 Naftogaz Group NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2019
5. PROPERTY, PLANT AND EQUIPMENT Movements in the carrying amount of property, plant and equipment were as follows:
Exploration, Gas Gas LNG Other
evaluation and Gas and oil transmission Underground Cushion Oil transmission Gas and oil Filling distribution transpor- fixed Construction MARKET AND REFORMS In millions of Ukrainian hryvnias drilling assets upstream system gas storages gas system refinery stations assets tation assets in progress Total
Net book value at 31 December 2017 3,329 94,487 188,534 12,056 150,040 14,479 2,889 4,593 159 168 3,327 17,421 491,482
Cost or valuation 3,329 94,487 188,534 12,056 150,040 14,479 2,889 4,593 183 189 7,574 19,443 497,796 Accumulated depreciation and impairment ------(24) (21) (4,247) (2,022) (6,314)
Additions and transfers 1,921 12,249 (391) 1,745 - 92 136 67 4 - 675 13,726 30,224 Revaluation - - - - 36,457 ------36,457 Disposals (101) (47) - - - - - (1) - - (35) (383) (567) Depreciation charge (908) (10,731) (31,242) (1,228) - (888) (266) (256) (11) (12) (274) - (45,816)
Impairment - (937) (70,988) - - (5,025) (62) (97) - (9) (54) (238) (77,410) AND OPERATIONS STRATEGY
Net book value at 31 December 2018 4,241 95,021 85,913 12,573 186,497 8,658 2,697 4,306 152 147 3,639 30,526 434,370
Cost or valuation 5,014 106,649 188,162 13,829 186,497 14,571 3,025 4,659 187 189 8,262 32,806 563,850 Accumulated depreciation and impairment (773) (11,628) (102,249) (1,256) - (5,913) (328) (353) (35) (42) (4,623) (2,280) (129,480)
Additions and transfers 7,646 14,378 761 (1,078) - 653 1,193 107 12 9 2,720 6,178 32,579 Revaluation (1,530) 6,571 38,062 (3,736) (117,257) (553) 861 (270) - 366 - - (77,486) Disposals (14) (134) 69 - - - (4) (1) - - (189) (978) (1,251) Depreciation charge (1,212) (12,293) (19,747) (990) - (577) (349) (230) (9) (17) (623) - (36,047)
Impairment (65) (57) - - - - (8) - - - 28 (3,136) (3,238) GOVERNANCE CORPORATE Reclassification to assets of discontinued operations classified as held for sale and distribution - - (105,058) ------(113) (3,250) (108,421)
Net book value at 31 December 2019 9,066 103,486 - 6,769 69,240 8,181 4,390 3,912 155 505 5,462 29,340 240,506
Cost or valuation 9,411 106,843 - 6,785 69,240 8,330 4,514 3,974 198 518 9,978 34,666 254,457 Accumulated depreciation and impairment (345) (3,357) - (16) - (149) (124) (62) (43) (13) (4,516) (5,326) (13,951) RESPONSIBILITY The Group engaged independent appraisers to determine for similar property, plant and equipment (published As at 31 December 2019 and 2018, the Group has 6. INVESTMENTS IN ASSOCIATES AND JOINT the fair value of its major groups of property, plant and information, catalogues, statistical data etc), and information pledged its property, plant and equipment with carrying VENTURES AND SOCIAL ENVIRONMENTAL equipment as at 1 October 2019, and as at 31 December from industry experts and suppliers. amount of UAH 84 million and UAH 1,239 million, 2019 for “Gas transmission system”. The fair value was Impairment loss of property, plant and equipment in respectively, to secure its borrowings (Note 12). The Group’s investments in associates and joint ventures determined in accordance with International Valuation amount to UAH 9,206 million (2018: UAH 582 milion) was were as follows: Standards. included in other operating expenses (Note 17), and UAH Taking into account the nature of the Group’s property, 812 million (2018: UAH 859 milion)charged by discontinued 31 December 31 December plant and equipment, fair value was determined using operations. In millions of Ukrainian hryvnias 2019 2018 depreciated replacement cost for specialised assets, and In 2019, the depreciation and depletion expenses of UAH Investments in associates 820 1,236 using market-based evidence for non-specialised assets. 12,945 million (2018: UAH 12,418 million) was included in Investments in joint ventures 15 19 The fair value of main producing properties and equipment cost of sales, UAH 945 million (2018: UAH 503 million) in was primarily determined using depreciated replacement other operating expense, UAH 1,831 million (2018: UAH Total 835 1,255 cost. This method considers the cost to reproduce or replace 955 million) were capitalised in the cost of property, plant the property, plant and equipment, adjusted for physical, and equipment, UAH 95 million were capitalised in cost of functional and economic depreciation, and obsolescence. inventories (2018: UAH 875 million), and UAH 20,231 million The depreciated replacement cost was estimated based on charged by discontinued operations (2018: UAH 31,065 internal sources and analysis of available market information million). FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 202 Naftogaz Group Annual Report 2019 203 Naftogaz Group NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2019
Details of each of the Group’s associates and joint ventures as at 31 December 2019 are as follows:
Place of incorporation and Proportion of Additional Share of other Dividends Name of associate/ Principal principal place of ownership interest Share comprehensive received from Net foreign Provision for Carrying
joint ventures activity business interest acquired of loss income/(loss) the associate exchange loss impairment amount MARKET AND REFORMS
“Gaztransit” PJSC Construction works Ukraine 40.2% - (74) 137 (4) (134) - 820 “Ukrtatnafta” PJSC Oil refinery Ukraine 43.05% - (42) (4) - - (295) - Other Other Ukraine miscеllaneous 2 (5) - - (1) - 15
2 (121) 133 (4) (135) (295) 835
Details of each of the Group’s associates and joint ventures as at 31 December 2018 are as follows:
Place of incorporation and Proportion of Additional Share of other Reclassification to
Name of associate/ Principal principal place of ownership interest Share comprehensive other non-current Carrying AND OPERATIONS STRATEGY joint ventures activity business interest acquired of loss (loss)/income assets amount
“Gaztransit” PJSC Construction works Ukraine 40.2% - (10) (32) - 895 “Ukrtatnafta” PJSC Oil refinery Ukraine 43.05% - (1,090) 1,431 - 341 Other Other Ukraine miscеllaneous 4 (216) - (29) 19
4 (1,316) 1,399 (29) 1,255
All of the above associates are accounted for using the As at 31 December 2019 the Company recognised an Movements in provision for impairment of non-current accounts Management estimates the necessity of write-down of equity method in these consolidated financial statements. impairment loss in respect of accounts receivable on product receivable were as follows: inventories to their net realisable value taking into consideration sharing agreement and other non-current assets in other indicators of economical and physical obsolescence. In 2019
operating expenses amounting to UAH 916 million (2018: In millions of Ukrainian hryvnias 2019 2018 write-down adjustment amounted to UAH 679 million was GOVERNANCE CORPORATE UAH 3,069 million) (Note 17). included in cost of sales, UAH 540 million in other operating 7. OTHER NON-CURRENT ASSETS Balance at 1 January 3,746 758 Intangible assets. As at 31 December 2019 and 2018, Provision for impairment expenses (Note 17), and UAH 1,239 million charged by included in intangible assets are licenses for exploration and recognised during the year 1,577 3,069 discontinued operations (2018: UAH 5,717 million included in 31 December 31 December extraction of oil and natural gas amounting to UAH 1,953 Reversal of provision (594) - cost of sales and UAH 63 million included in other operating In millions of Ukrainian hryvnias 2019 2018 million and UAH 1,826 million, respectively. for impairment (22) (81) expenses). Amount included in cost of sales represents write Restructured accounts receivable of gas consumers. down adjustment to imported gas subsequently sold to the Accounts receivable In May 2011, the Law of Ukraine “On certain matters on Balance at 31 December 4,707 3,746 different groups of customers. on product sharing agreement 4,504 4,793 indebtedness for natural gas and electricity consumed” As at 31 December 2019 and 2018, inventories with Intangible assets 2,999 2,751 Restructured accounts receivable #3319-VI was approved. According to this Law, accounts Other movements in provision for impairment of non-current carrying amount of UAH 30,984 million and UAH 43,287 million, of gas consumers 2,979 1,645 receivable due from entities supplying natural gas under accounts receivable relate to reclassification of provision between respectively, were pledged as collateral for borrowings (Note 12). Other 2,730 3,545 the regulated tariff that were originated in 2010, were current and non-current accounts receivable. Less: restructured for the period from 1 to 20 years and are stated RESPONSIBILITY provision for impairment (4,707) (3,746) at amortised cost using effective interest rate which at the restructuring dates varied from 15% to 24% per annum. 8. INVENTORIES AND SOCIAL ENVIRONMENTAL Total 8,505 8,988 In November 2016 the Law of Ukraine “On measures to settle the debts for the natural gas consumed by municipal The Group’s inventories were as follows: Accounts receivable on product sharing agreement. heat generating entities and distribution and water supplying The Company entered into a concession agreement for companies” #1730 was adopted (Note 2). According to this hydrocarbon exploration and development with the Law, accounts receivable due from municipal heat generating 31 December 31 December In millions of Ukrainian hryvnias 2019 2018 Arab Republic of Egypt and Egyptian General Petroleum entities and distribution were restructured for 5 years and are Corporation (“EGPC”) on 13 December 2006. Under the stated at amortised cost using effective interest rate which at the Natural gas 45,847 52,461 terms of the concession agreement the Company has the restructuring dates varied from 14% to 16% per annum. Petroleum products 3,516 5,475 right to recover all exploration and development costs Other. As at 31 December 2019 and 2018, included in Crude oil 3,492 2,393 incurred in connection with the concession agreement (Note other non-current assets are research and development Spare parts 2,303 1,976 26). The amount presented in the table above represents expenditures amounting to UAH 895 million and UAH 1,277 Raw materials 1,349 1,627 Other 1,198 1,639 such costs claimed by the Group for recovery, and which are million, respectively, that were incurred within the concession expected to be refunded after one year since the reporting agreement for oil exploration and development with the EGPC on Total 57,705 65,571 date. 13 December 2006, but not yet claimed for recovery (Note 26). FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 204 Naftogaz Group Annual Report 2019 205 Naftogaz Group NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2019
9. TRADE ACCOUNTS RECEIVABLE 10. PREPAYMENTS MADE AND OTHER 11. SHARE CAPITAL CURRENT ASSETS The Group’s trade accounts receivable were as follows: As at 31 December 2019 and 2018, nominal amount of The Group’s prepayments made and other current assets registered, issued and fully paid share capital of the Company were as follows: was UAH 190,150 million, comprising 190,150,481 ordinary 31 December 31 December shares, with a par value of UAH 1,000 per share. MARKET AND REFORMS In millions of Ukrainian hryvnias 2019 2018 31 December 31 December Also, as at 31 December 2019 and 2018, share capital In millions of Ukrainian hryvnias 2019 2018 of the Company has been adjusted for the effect of Accounts receivable for natural gas 73,436 74,683 hyperinflation in accordance with IAS 29 “Financial Reporting Accounts receivable for balancing services 44,059 34,009 Prepayments to suppliers for in Hyperinflationary Economies” by UAH 4,157 million. Accounts receivable for petroleum products 10,987 1,616 materials, works and services 7,242 10,549 Therefore the total amount of share capital of the Company as Accounts receivable for gas transportation services 8,504 9,036 VAT recover 3,419 1,950 at 31 December 2019 and 2018 was UAH 194,307 million. Accounts receivable for crude oil 7,740 13,693 Prepayments to suppliers Other accounts receivable 2,608 2,680 for natural gas 3,007 109 Distribution of profits Less: provision for impairment (88,278) (69,775) Receivables under assignation Profit available for distribution to the shareholders for agreements in recpect of each reporting period is determined by reference to the Total 59,056 65,942 natural gas sales 1,497 1,618 stand alone financial statements of the Company prepared in Promissory notes receivable 1,429 1,436 accordance with International Financial Reporting Standards Movements in provision for impairment of trade accounts Prepayments for pipelines (IFRS). Under Ukrainian legislation, the amount of dividends receivable were as follows: construction 1,346 1,346 is limited to net profit of the reporting period or other AND OPERATIONS STRATEGY Taxes prepaid, other than distributable reserves but not more than retained earnings 31 December 31 December income tax 858 876 as per the stand alone financial statements prepared in In millions of Ukrainian hryvnias 2019 2018 Other 9,723 7,289 accordance with IFRS. The Company has to make a decision Less: Provision for impairment (18,634) (18,285) in respect of dividend distribution by 30 April and to pay the Balance at 1 January 69,775 49 919 dividend to the State budget by 30 June of the year in the Effect of adoption of new standard - 3 666 Total 9,887 6,888 following reporting year. The Cabinet of Ministers of Ukraine Provision for impairment recognised during the period 22,965 24 593 approves a percentage of net profit to be distributed each Reversal of provision for impairment (17,574) (21 773) year with a separate resolution. If there is no such resolution Amounts written off as uncollectible (1,735) (138) available by 30 June, the Company is obliged to distribute Provision recognised from discontinued operations 15,199 13 462 30% of its net profit to the State budget of Ukraine, as set by Other movements (352) 46 Movements in the provision for impairment were as provisions of the Law of Ukraine “On Management of State follows: Property Objects” #185-V dated 21 September 2006.
Balance at 31 December 88,278 69 775 According to the Resolutions of the Cabinet of Ministers GOVERNANCE CORPORATE In millions of Ukrainian hryvnias 2019 2018 of Ukraine #461-r dated 24 April 2019, 90% of the net profit Other movements in provision for impairment of trade related to joint ventures of one of the Group's subsidiaries, of the Company for 2018 amounting to UAH 12,252 million accounts receivable relate to reclassification of provision recognised in equity movement. Balance at 1 January 18,285 18,309 was distributed as dividends. However, the abovementioned between current and non-current accounts receivable and to Analysis of credit quality of trade accounts receivable as resolution was not published by 30 June 2019, and, following difference in proportion of assets and profits consolidation follows: Provision for impairment recognised 318 179 the requirements of the Ukrainian legislation, the Company during the period paid 30% of its net profit amounting to UAH 4,084 million to 31 DECEMBER 2019 Reversal of provision for impairment (221) (176) the State bugdet. After the Cabinet of Ministers of Ukraine Amounts written off as uncollectible (127) (118) Trade accounts receivable – days past due published its Resolution #461-r, the Company has additionally Other movements 379 91 paid UAH 8,168 million to the State budget as dividends. In In millions of Ukrainian hryvnias Not-past due 1 - 90 91 - 180 181 - 270 271 - 365 >365 Total total, during 2019, the Company paid UAH 12,252 thousand, Balance at 31 December 18,634 18,285 or 90% of its net profit for 2018. Gross carrying amount 27,832 17,208 4,321 17,028 18,001 62,944 147,334 The Company’s policy is to accrue a provision in respect RESPONSIBILITY Provision for impairment (4,680) (3,207) (1,415) (5,231) (11,363) (62,382) (88,278) of minimum obligatory dividend distribution level of 30% of Expected credit loss rate, % 17% 19% 33% 31% 63% 99% Other movements in provision for impairment relate to its net profit. As at 31 December 2019, the Company accrued AND SOCIAL ENVIRONMENTAL reclassification of provision between current and non-current a provision of UAH 15,197 million in respect of the portion accounts receivable and to the difference in proportion of of net profit attributable to the State Budget of Ukraine in 31 DECEMBER 2018 assets and profits consolidation related to joint ventures current provisions (Note 13). Then, following the Resolution Trade accounts receivable – days past due of one of the Group's subsidiaries, recognised in equity of the Cabinet of Ministers of Ukraine #1339-r dated 26 movement. December 2019, the Company has paid UAH 8,500 million out In millions of Ukrainian hryvnias Not-past due 1 - 90 91 - 180 181 - 270 271 - 365 >365 Total of this amount in December 2019 as dividends per results of 2019. Gross carrying amount 38,830 20,443 3,998 15,828 10,107 46,511 135,717 Provision for impairment (3,226) (3,377) (1,226) (7,834) (7,800) (46,312) (69,775) Expected credit loss rate, % 8% 17% 31% 49% 77% 100% FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 206 Naftogaz Group Annual Report 2019 207 Naftogaz Group NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2019 The effective interest rates and currency denomination of Pledges. The Group’s borrowings were secured by the borrowings were as follows: following pledges: 12. BORROWINGS Eurobonds issued as at 31 December 2019 were as 31 December 31 December 31 December 2019 31 December 2018 follows: In millions In millions of Ukrainian hryvnias 2019 2018 The Group’s borrowings were as follows: of Ukrainian Balance % per Balance % per In millions hryvnias annum annum Inventories (Note 8) 30,984 43,287 In millions 31 December 31 December of Ukrainian Coupon Date of Nominal Carrying Proceeds from future sales 17,588 28,229 of Ukrainian hryvnias 2019 2018 hryvnias rate, % maturity value Currency amount US dollars 24,605 8.1 17,829 8.5 Cash and bank balances - 1,457 Non-current Issue of UAH 19,075 17.4 24,815 19.6 Property, plant and equipment MARKET AND REFORMS Eurobonds 35,631 - July 2019 Euro 16,982 7.6 13,355 2.1 (Note 5) 84 1,239 Bank borrowings 11,689 11,425 (Tranche A) 7.125 July 2024 600 Euro 15,800 Total 60,662 55,999 Total 48,656 74,212 Unamortised discount (172) (126) Issue of Guarantees. As at 31 December 2019, the Group’s borrowings in the amount of UAH 2,694 million were guaranteed by the Total non-current portion 47,148 11,299 July 2019 State (31 December 2018: UAH 15,443 million). Current (Tranche B) 7.375 July 2022 335 US dollars 7,910 Bank borrowings 12,178 44,153 Reconciliation of financial liabilities from financing activities Interest accrued 1,336 547 Issue of Cash flows Nov. 2019 7.625 Nov. 2026 500 US dollars 11,828 In millions of Ukrainian 31 December from financing Non-cash Interest expense 31 December Total current portion 13,514 44,700 hryvnias 2018 activities transactions (Note 18) 2019 35,538 Total 60,662 55,999 Bank borrowings 55,999 (34,893) (1,521) 4,584 24,169 Eurobonds - 38,495 (2,987) 985 36,493 In July 2019, the Company issued Eurobonds via In 2019 the Company has concluded several additional Total 55,999 3,602 (4,508) 5,569 60,662
Kondor Finance plc (a public company with limited agreements with state-owned banks in respect of changes AND OPERATIONS STRATEGY liability incorporated in England and Wales) using the loan to the borrowings repayment schedules prolonging their Reconciliation of financial liabilities from financing activities participation notes structure. The issue comprises of two maturities up to 2022 and 2024. The Company has analysed Cash flows In millions of Ukrainian 1 January from financing Non-cash Interest expense 31 December tranches: tranche A of EUR 600 million and tranche B of USD impact of these changes and concluded that they do not hryvnias 2018 activities transactions (Note 18) 2018 335 million. represent significant modification to the financial liabilities. In November 2019 the Company issued Eurobonds for an Additionally, the Company has fully repaid the loan under Bank borrowings 59 315 (26 051) 17 719 5 016 55 999 amount of USD 500 million, again with Kondor Finance plc and the guarantee of the International Bank for Reconstruction Total 59 315 (26 051) 17 719 5 016 55 999 the loan participation notes structure. and Development in May 2019. Non-cash transactions relate to payment for the natural gas acquired by a lending bank and foreign exchange differences.
13.PROVISIONS
Movements in provisions for the years ended 31 December 2019 and 2018 were as follows: GOVERNANCE CORPORATE
Portion of net profit attributable Provisions Employee Provision for to the State for benefit Decomissioning fines and Budget of Ukraine Other In millions Ukrainian hryvnias litigations obligations provision penaltis (Note 11) provisions Total
Balance at 31 December 2017 5,761 5,668 2,297 14,133 29 498 1,201 58,558
Provision for dividends payable to the State Budget - - - - 4 084 - 4,084 Сharged during the year 11,083 3,636 96 2,530 - 843 18,188 Unwinding of discount - 597 224 - - - 821 RESPONSIBILITY Used or paid during the year (1,590) (2,432) (1) (2) (29 498) (109) (33,632) Remeasurements - 9 (13) - - - (4) AND SOCIAL ENVIRONMENTAL Balance at 31 December 2018 15,254 7,478 2,603 16,661 4 084 1,935 48,015
Non-current - 4,403 2,540 - - - 6,943 Current 15,254 3,075 63 16,661 4 084 1,935 41,072
Provision for dividends payable to the State Budget (Note 11) - - - - 15 197 - 15,197 (Reversed)/сharged during the year (1,367) 3,886 534 2,592 - (450) 5,195 Unwinding of discount - 635 221 - - - 856 Used or paid during the year (1,283) (3,866) (4) - (12 584) (14) (17,751) Remeasurements - 1,133 2,086 - - - 3,219 Reclassification to liabilities of discontinued operations classified as held for sale and distribution - (270) - - - - (270)
Balance at 31 December 2019 12,604 8,996 5,440 19,253 6 697 1,471 54,461
Non-current - 5,205 5,383 - - - 10,588 Current 12,604 3,791 57 19,253 6,697 1,471 43,873 FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 208 Naftogaz Group Annual Report 2019 209 Naftogaz Group NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2019
Provisions for litigations been calculated using the projected unit credit method at the 14. ADVANCES RECEIVED AND OTHER CURRENT LIABILITIES The Group is involved into a number of litigations both as a end of the reporting period, which is the same as that applied plaintiff and as a defendant. Provision for litigations represents in calculating the obligation recognised in the consolidated The Group’s advances received and other current liabilities were as follows: management assessment of the probable outflow of the statement of financial position. Group’s resources arising from an adverse outcome of the There were no changes in the methods and assumptions 31 December 31 December In millions of Ukrainian hryvnias 2019 2018 court and arbitration procedures. used in preparing the sensitivity analysis from prior years. MARKET AND REFORMS Advances for natural gas 1,559 1,560 In 2013, “Ukrtransgaz” JSC filed a claim with the Decommissioning provision Advances for natural gas transportation 291 338 Commercial Court of the Kyiv City against Naftogaz stating In accordance with the legislation requirements, the Advances for oil transportation 278 302 that seeking the transfer of 4.75 bcm of natural gas to the Group is obliged to restore the lands that underwent changes Advances received for geophysical surveys 185 213 gas transmission system was acquired without sufficient legal in the relief structure, environmental state of soils and parent Advances for petroleum products 130 206 grounds. The claim was granted in 2013 and further upheld rocks, as well as hydrological regime due to drilling, geological Other advances received 162 136 by the court of appeal and court of cassation. Then, in 2015, survey, constructing and other works. The decommissioning Naftogaz filed an application for revision of the Commercial provision represents present value of decommissioning costs Total advances received 2,605 2,755 Court of the city of Kyiv judgement based on newly discovered relating to oil and gas properties. circumstances, and the latter suspended the proceedings in The principal assumptions used for determining the Taxes payable other than income tax 8,891 10,900 this case pending finalisation of the proceedings in a related amount of provision for decommissioning of non-current Liabilities for purchase of property, plant and equipment 2,246 4,178 VAT payable 2,111 2,350 case that also remain suspended. However, as the judgement assets were as follows: Wages, salaries and related social charges payable 429 726 of the Commercial Court of Kyiv City has entered into force in 2019 2018 Dividends payable to non-controlling shareholders of "Ukrnafta" PJSC 428 431 2018 in respect of transfer of 1.09 bcm out of 4.75 bcm, and Recognised liabilities for litigations 186 57 AND OPERATIONS STRATEGY enforcement proceedings are currently ongoing, Naftogaz Discount rate before tax, % 9.1-9.3 13.8-14.4 Other current liabilities 1,566 1,872 created a provision in respect of this case amounting to UAH Long-term inflation rate, % 10,723 millions other operating expense in 2018. Change 5.0-5.3 6.5-7.6 Total other current liabilities 15,857 20,514 in this provision attributable to 2019 comprises UAH 1,914 millions. As at 31 December 2019, the Group has revised Total 18,462 23,269 calculation of provisions for decommissioning of non-current Employee benefit obligations assets to reflect its current best estimate. As a result, there As at 31 December 2019, taxes payable other than income tax included UAH 8,596 million of subsoil royalty payable (31 De- The Group companies have certain obligations to its was an increase in the amount of provision, which is mainly cember 2018: UAH 10,629 million). employees according to the collective agreements. related to the decrease of discount rate, as well as an increase Current provisions for employee benefits include provision in the market prices of typical works for liquidation of for performance bonuses and provision for employees’ depleted wells. 15. COST OF SALES unused vacations.
Non-current provisions for employee benefits include Provision for fines and penalties In millions of Ukrainian hryvnias 2019 2018 GOVERNANCE CORPORATE lump sum benefits payable upon retirement and post- As a result of non-payment and late payment by retirement benefit programs. These benefits plans are not “Ukrnafta” PJSC of subsoil royalty, income tax and VAT, the Cost of gas supplied 38,401 58,361 funded, and there are no plan assets. Group accrued provision for fines, penalties and late payment Subsoil royalty and other taxes other than on income 32,870 32,245 The principal actuarial assumptions used were as follows: interest in respect of such tax liabilities. Depreciation, depletion and amortisation 13,057 11,902 Staff costs and related social charges 6,342 4,806 2019 2018 Cost of purchased oil and petroleum products 3,804 8,925 Repair and maintenance costs 2,285 178 Nominal discount rate, % 9.2-9.5 14.0-14.4 Electricity 1,113 1,169 Long-term inflation, % 5.0-6.5 6.5 Reagents 1,074 1,022 Nominal salary increase rate, % 5.0-16.0 10.0-26.0 Other 7,742 4,800 Staff turnover ratio, % 1.2-8.6 1.4-6.7 Total 106,688 123,408 The sensitivity of the non-current employee benefit RESPONSIBILITY obligations to changes in the principal assumptions is as Subsoil royalty and rent tax are calculated with reference to the volume of crude oil, gas condensate or natural gas produced, follows: and volume of crude oil transportation. AND SOCIAL ENVIRONMENTAL 2019 2018
Nominal discount rate increase/ decrease by 1%, % (8.37)/9.77 (7.56) / 8.15 16. OTHER OPERATING INCOME Nominal salary increase/decrease by 1%, % 7.24/(6.45) 5.50 / (5.52) In millions of Ukrainian hryvnias 2019 2018 Staff turnover increase/decrease by 1%, % (2.83)/2.90 (3.21) / 3.19 Fines and penalties received 923 1,422 Income from sale of inventories and other current assets 810 1,278 The sensitivity analysis presented above may not be Income from lease 287 269 representative of the actual change in the non-current Write off of accounts payable and other current liabilities 191 43 Other 271 60 employee benefit obligations as it is unlikely that the change in assumptions would occur in isolation of one another as Total 2,482 3,072 some of the assumptions may be correlated. Furthermore, in presenting the above sensitivity analysis, the present value of the employee benefit obligations has FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 210 Naftogaz Group Annual Report 2019 211 Naftogaz Group NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2019
17. OTHER OPERATING EXPENSES Reconciliation between the expected and the actual taxation charge is provided below:
In millions of Ukrainian hryvnias 2019 2018 In millions of Ukrainian hryvnias 2019 2018
Impairment of property, plant and equipment and intangible assets 9,206 582 Profit before income tax 4,891 20,537
Staff costs and related social charges 7,284 6,965 MARKET AND REFORMS Net movement in provision for trade accounts receivable, prepayments made Income tax at statutory rate of 18% 880 3,697 and other assets and direct write-offs 6,083 5,899 Effect of changes in tax legislation Change in provisions for litigations and other provisions 1,773 14,124 Tax effect of items not deductible or taxable for taxation purposes: 229 - Loss on settling liabilities associated with litigations 1,399 288 - Non-deductible expenses Professional fees 1,220 1,269 - Non-taxable income 2,378 5,375 Depreciation and amortisation 1,145 1,195 Change in unrecognised deferred tax asset (1,045) (188) Loss on disposal of property, plant and equipment 861 207 (132) 86 Research, development and exploration costs 646 948 Income tax expenses Write down of inventories to net realisable value 540 63 2,310 8,970 Transportation costs 356 334 Fines and penalties 69 1,015 Other 6,726 3,391 The Parent and its subsidiaries are separate tax payers and, reflected in the consolidated statement of financial position therefore, their deferred tax assets and liabilities are present- after appropriate set off are as follows: Total 37,308 36,280 ed on an individual basis. The deferred tax liabilities and assets STRATEGY AND OPERATIONS STRATEGY 31 December 31 December Additionally to the audit fees related to the compulsory audit as included to the professional fees, are other audit fees for 2019 In millions of Ukrainian hryvnias 2019 2018 amounting to UAH 15 million (2018: UAH 15 million). Deferred tax assets 10,439 5,119 Deferred tax liabilities (18,858) (50,544) 18. FINANCE COSTS Net deferred tax liability (8,419) (45,425) In millions of Ukrainian hryvnias 2019 2018
Interest expense 5,464 4,713 Net deferred tax liabilities as at 31 December 2019 related to the following: Loss on origination of long-term accounts receivable 662 99 Unwinding of discount on employee benefit obligations 536 464 Reclassified Unwinding of discount of decommissioning provision 221 224 to liabilities of Other 199 258 Recognised discontinued Recognised in in profit or Recognised in operations GOVERNANCE CORPORATE Total 7,082 5,758 profit or loss loss from other compre- classified as 31 December from contining discontinued hensive held for sale and 31 December In millions of Ukrainian hryvnias 2018 operations operations income distribution 2019
19. FINANCE INCOME Property, plant and equipment (55,520) 3,725 3,587 12,722 16,554 (18,932) Trade accounts receivable 386 530 - - - 916 In millions of Ukrainian hryvnias 2019 2018 Advances received and other current liabilities 85 (27) - - - 58 Interest income on bank deposits and bank balances 1,421 1,672 Provisions 7,200 (118) (167) 488 - 7,403 Unwinding of discount on long-term accounts receivable and other non-current Inventories 1,860 (408) - - - 1,452 assets 290 188 Prepayments made and other
Other 179 245 current asset 564 95 - - - 659 RESPONSIBILITY Other non-current assets - 18 - - - 18 Unused tax losses - 7 - - - 7
Total 1,890 2,105 AND SOCIAL ENVIRONMENTAL
Net deferred tax liability (45,425) 3,822 3,420 13,210 16,554 (8,419) 20. INCOME TAX
The components of income tax expense from continuing operations forthe years ended 31 December were as follows:
In millions of Ukrainian hryvnias 2019 2018
Current tax expense 6,132 11,353 Deferred tax benefit (3,822) (4,394)
Income tax expenses 2,310 6,959
The Group is subject to taxation in Ukraine. In 2019 and 2018, Ukrainian corporate income tax was levied on taxable income less allowable expenses at the rate of 18%. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 212 Naftogaz Group Annual Report 2019 213 Naftogaz Group NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2019
Net deferred tax liabilities as at 31 December 2018 related to the following: Accordingly, “Gas Transmission System Operator of The major group of assets and liabilities comprising the Ukraine” LLC became a fully-fledged independent TSO in operations classifed as held for sale and distribution are as Ukraine starting from 1 January 2020. follows: Recognised in Recognised in Recognised in profit or loss profit or loss from other In millions of Ukrainian hryvnias 31 December 2019 31 December from continuing discontinuing comprehensive 31 December MARKET AND REFORMS У мільйонах українських гривень 2017 operations operations income 2018 Property, plant and equipment (Note 5) 108,421 Other non-current assets 177 Property, plant and equipment (70,334) 2,172 5,532 7,110 (55,520) Inventories 5,392 Trade accounts receivable 364 22 - - 386 Trade accounts receivable 434 Advances received and other Prepayments made and other current assets 492 Prepaid corporate income tax 12 current liabilities 57 28 - - 85 Cash and bank balances 423 Provisions 4,613 1,949 638 - 7,200 Provisions (Note 13) (270) Inventories 1,675 185 - - 1,860 Deferred tax liabilities (Note 20) (16,554) Prepayments made and other current assets 526 38 - - 564 Trade accounts payable (54) Other non-current assets (1) 1 - - - Advances received and other current liabilities (458)
Net deferred tax liability (63,100) 4,395 6,170 7,110 (45,425) Net assets directly associated with disposal group 98,015
The results of the discontinued operations, which have been included in the profit for the year, were as follows:
As at 31 December 2019 and 2018, unrecognised deductible temporary differences and unused tax losses are as follows: AND OPERATIONS STRATEGY In millions of Ukrainian hryvnias 2019 2018
31 December 31 December Revenue 70,071 71,450 In millions of Ukrainian hryvnias 2019 2018 Income recognised per results of Gas Transit Arbitration 67,958 - Other income 1,876 1,879 Provisions 45,609 45,529 Trade accounts receivable, prepayments made Expenses (62,545) (75,623) and other current assets 15,294 14,387 Inventories 7,423 9,327 Profit/(loss) before income tax 77,360 (2,294) Property, plant and equipment 10 - Attributable income tax expense (16,647) (2,011) Tax losses carried forward 1,275 1,104 Profit/(loss) for the year from discontinued operations 60,713 (4,305) Total 69,611 70,347 Profit/(loss) for the year from discontinued operations (attributable to
owners of the Company) 60,713 (4,305) GOVERNANCE CORPORATE
21. DISCONTINUED OPERATIONS On 1 January 2020, 100% of the participatory rights of Cash flows from discontinued operations: “Gas Transmission System Operator of Ukraine” LLC were In millions of Ukrainian hryvnias In accordance with international commitments of Ukraine, transferred to “Mahistralny gasoprovody Ukrainy” JSC under 2019 2018 the gas transportation activities should be unbundled from a sale and purchase agreement (“SPA”) and on terms of initial Cash flows from discontinued operations 101,690 21,463 the activities of natural gas production and supply. A new op- payment and regular payments for a period of 15 years and Net cash inflows from operating activities (333) (1,092) erator should possess all possibilities for smooth continuation establishment of a dynamic price calculated in accordance Net cash outflows from investing activities (2,275) 1,473 of the natural gas transportation operations. On 5 February with the formula agreed by the parties. The Group can’t make Net cash (outflows)/inflows from financing activities 2019, a new entity was established, “Gas Transmission System precise estimate of variable consideration at this stage.Initial 99,082 21,844 Operator of Ukraine” LLC, 100% of ownership in which be- payment has been agreed with reference to the market value Net cash inflows longs to the “Ukrtransgaz” JSC. of assets contributed to the participatory rights of “Gas Trans- CMU Resolution “On Unbundling of Natural Gas Trans- mission System Operator of Ukraine” LLC in amount of UAH RESPONSIBILITY mission Activity and Enabling Activity of Transmission System 3,851 million payable by the end of January 2020. According 22. CONTINGENCIES, COMMITMENTS AND be probable and the amount is measured with sufficient Operator” #840 dated 18 September 2019 (the “Restructuring to the SPA, the Group retains economic benefits to the GTS OPERATING RISKS reliability, the Group provides for those liabilities. Where AND SOCIAL ENVIRONMENTAL Plan”) provides that unbundling will be in accordance with the for 15 years from the date of the transfer. In addition, on 1 management of the Group estimates the risk of financial independent system operator model. January 2020, “Ukrtransgaz” JSC sold its own gas required for Tax legislation. Ukraine’s tax environment is characterised resources outflow as possible, the Group makes a disclosure According to the Restructuring Plan, in the fourth quarter the system operation to “Gas Transmission System Operator of by complexity in tax administering, arbitrary interpretation of these contingent liabilities. of 2019 “Ukrtransgaz” JSC made a contribution of its own as- Ukraine” LLC. by tax authorities of tax laws and regulations that, inter As at 31 December 2019, management estimated possible sets related to gas transmission activities to the participatory The Group classified these assets as assets held for sale as alia, can increase fiscal pressure on tax payers. Inconsistent tax exposures in total amount of UAH 15,733 million rights of “Gas Transmission System Operator of Ukraine” LLC at 31 December 2019. application, interpretation, and enforcement of tax laws can (31 December 2018: UAH 13,516 million). that was its 100% subsidiary and was expected to be unbun- Under the Restructuring Plan, “Gas Transmission System lead to litigation which, as a consequence, may result in the Management believes that it is not likely that any dled on the 1 January 2020. Operator of Ukraine” LLC submitted an application for cer- imposition of additional taxes, penalties, and interest, and significant settlement will arise from the above cases and, On 1 January 2020 current obligations of Naftogaz and tification as the GTS operator in the fourth quarter of 2019, these amounts could be material. therefore, the Group’s consolidated financial statements do “Ukrtransgaz” JSC to operate state-owned gas transmission in- and obtained respective certification, approved, inter alia, by Management believes that the Group has been in not include any amount of provision in this respect. frastructure were terminated. The Ministry of finance of Ukraine the Energy Community Secretariate. “Ukrtransgaz” JSC has compliance with all requirements of the effective tax During 2015 “Ukrnafta” PJSC was engaged in transactions transferred state-owned assets related to the gas transmission sys- transferred approximately 10 thousand employees involved legislation. In the ordinary course of business the Group is for petroleum products and crude oil sales, and made tem to the new transmission system operator under the long-term in gas transmission to “Gas Transmission System Operator of engaged in transactions that may be interpreted differently prepayments in respect of future supply of petroleum economic management agreement. The Group classified these Ukraine” LLC and ensured that all necessary business process- by the Group and tax authorities. Where the risk of outflow products. In 2017 National Anti-corruption Bureau of assets as assets held for distribution as at 31 December 2019. es and IT-systems are in place. of financial resources associated with this is deemed to Ukraine initiated a claim in the court to declare such FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 214 Naftogaz Group Annual Report 2019 215 Naftogaz Group NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2019 transactions invalid. The Group’s management believes make gas supplies in March 2018. There were no gas supplies and Gazprom settled all outstanding matters inter alia in Hague. The final award on the quantum is expected by the that there is likelihood that certain transactions performed during 2018 and 2019 from Gazprom to the Company. Such relation to the Final Awards in both Gas Transit and Gas Sales middle of 2021. by “Ukrnafta” PJSC can be challenged or declared invalid actions from Gazprom prevented Naftogaz from fulfilling the Arbitration and the 2009 Gas Transit and Gas Sales Contracts, in future, leading to additional tax obligations. The Group’s Final Award requirements in respect of offtaking minimum leading to a scheduled termination of all legal proceedings Legal proceedings. In the normal course of business, the management cannot estimate impact of such potential annual quantities according to Gas Sales Contract in 2018 and between Naftogaz and Gazprom. As a result of those Group is subject to claims. Where the risk of outflow of obligations to the consolidated financial statements reliably, 2019. negotiations the following agreements were signed between financial resources associated with such claims is assumed as MARKET AND REFORMS and does not recognise any provision in this respect as at 31 As stated above, after both Final Awards were rendered, Naftogaz and Gazprom: probable, a respective liability is recognised as a component December 2019. Gazprom representatives officially declared a refusal to а) Agreement for the settlement of existing gas disputes of provision for litigations (Note 13). Where management The Group conducts transactions with its subsidiaries. It resume deliveries to Ukraine as ordered by the Tribunal in the and the basic terms of the future relationship in respect estimates the risk of outflow of financial resources associated is possible with evolution of the interpretation of tax law in Gas Sales Arbitration. Additionally, Gazprom was refusing to of transportation of Natural Gas between Naftogaz and with such claims as possible, or amount of outflow cannot be Ukraine and changes in the approach of tax authorities under confirm its intention to settle outstanding amount as decided Gazprom. In this settlement agreement, both Parties waived measured reliably, no provision is recognised, and respective the Tax Code, that such transactions could be challenged by the Tribunal in the Gas Transit Arbitration. Instead, on 20 any and all current and future claims related to the Gas amount is disclosed in the consolidated financial statements. in the future. The impact of any such challenge cannot be April 2018 Gazprom filed a Request for Arbitration to the Transit and Gas Sales Contracts for 2009-2019, Final Awards Management believes that it has provided for all material estimated, however, management believes that it should not Arbitration Institute of the Stockholm Chamber of Commerce in both Gas Transit and Gas Sales Arbitration, the Challenge losses in these consolidated financial statements. be significant. requesting revision or, alternatively, setting aside of the Proceedings, Naftogaz’s complaint against Gazprom's The Group exports refinery products and transportation specific provisions of the Gas Transit and Gas Sales Contracts abuses of dominance to the European Commission, the Joint operations with Misen Enterprises AB, and services, performs intercompany transactions and is involved for 2009-2019 because of alleged imbalance between the 2014 and 2018 arbitrations. Inter alia, Naftogaz has taken “Karpatygaz” LLC. As a part of determining the validity of in transactions with related parties, which may potentially parties’ obligations under the Contracts following Final all necessary measures to withdraw all pending proceedings the joint arrangement, in July 2016, the Group initiated legal be in the scope of the new Ukrainian transfer pricing (“TP”) Awards in both Gas Transit and Gas Sales Arbitration. Naftogaz related to the enforcement of the Transit Final Award. proceedings in the Stockholm Arbitration on termination or regulations. The Group’s companies have submitted the rejected Gazprom’s claims and presented its counterclaims, б) A Transportation Organisation Agreement between recognition as invalid of this agreement. In July 2018, the AND OPERATIONS STRATEGY controlled transaction report for the year ended 31 December reserving the right to specify their monetary value later. Naftogaz and Gazprom securing continued transit of natural Arbitration Institute of the Stockholm Chamber of Commerce 2018 within the required deadline. The report on controlled Gazprom had also brought a challenge against the Separate gas through Ukrainian territory in 2020-2024 (on “ship-or- has issued a Partial Final Award regarding termination of the transactions for the year ended 31 December 2019 shall be and Final Awards on Gas Sales Arbitration and the Final Award pay” terms) in exchange of Naftogaz’s waiver to relinquish joint arrangement agreement. The Arbitral Tribunal found prepared by the Group’s companies by 1 October 2020. in Gas Transit Arbitration (the “Challenge Proceedings”). its claims amounting to more then USD 12 billion. that the joint arrangement agreement had been violated Management believes that the Group is in compliance On November 27, 2019 Svea court of Appeal has rejected by both Misen Enterprises AB and “Karpatygaz” LLC and is with TP requirements. As the practice of implementation Gazprom`s challenge of Separate Award on Gas Sales Claim against the Russian Federation regarding assets therefore terminated due to the change in circumstances and of the new transfer pricing rules has not yet developed and Arbitration. in Crimea. In October 2016, Naftogaz and its subsidiaries impossibility to continue the joint operation arrangement. wording of some clauses of the rules may be subject to Based on the Transit Final Award and in view of the initiated arbitration proceedings against the Russian various interpretations, the impact of challenge of the Group’s Gazprom’s failure to comply with the award, in 2018 Naftogaz Federation seeking compensation for the losses caused by “Ukrtransgaz” JSC bank accounts attachment. Arbitral companies transfer pricing positions by the tax authorities has moved to attach Gazprom’s assets in several jurisdictions, unlawful expropriation of Group’s assets in Crimea by the court of Kyiv City according to a claim issued by one of cannot be reliably estimated. including attachment in England of 51% Nord Stream’s AG Russian Federation. These arbitration proceedings were the customers of “Ukrtransgaz” JSC ruled in favour of the shares that are owned by Gazprom, and attachment in initiated under the Agreement between the Cabinet of customer and recognised ownership on 305 million cubic
Arbitration with Gazprom. On 28 February 2018, the Tribunal Netherlands of 50%+1 share of Blue Stream Pipeline Company Ministers of Ukraine and the Government of the Russian metres of gas with the latter. Further, in January 2020 means GOVERNANCE CORPORATE rendered the Final Award in respect of the Gas Transit BV that are also in Gazprom’s ownership. Federation on mutual encouragement and protection of of court decision execution were changed, and court ruled to Arbitration, and supported Naftogaz’s position in respect of Additionally, on 6 July 2018, Naftogaz submitted a Request investments. collect UAH 2,305 million from “Ukrtransgaz” JSC, and then its Gazprom failure to deliver minimum contractual volume of for Arbitration to the Arbitration Institute of the Stockholm On 15 September 2017, Naftogaz and its subsidiaries have bank accounts were attached together with UAH 226 million gas transit (underdeliveries) during 2009-2017. As a result, Chamber of Commerce seeking for transit tariff revision in the submitted the Statement of Claim to the Tribunal under the of cash withdrawn from its bank accounts. “Ukrtransgaz” JSC the Tribunal awarded USD 4,674 million to be paid in favour Gas Transit Contract for the period 2009-2019. Gazprom has auspices of the Permanent Court of Arbitration in The Hague. filed a claim of appeal to the commercial court of appeal, and of Naftogaz by Gazprom as a compensation of losses in this submitted its answer on 14 August 2018, rejecting Naftogaz’s On 22 February 2019, the Tribunal issued Partial Final the court decided in favour of “Ukrtransgaz” JSC and bank respect. Further, the Tribunal performed a set-off in respect claim. Upon request from Gazprom, on 6 September 2018 Award on jurisdiction and responsibility in favour of the accounts attachment was removed. The Group believes that of amounts owing between the parties pursuant to the Gas the Stockholm Chamber of Commerce Board made a decision Group. The Tribunal acknowledged its jurisdiction over the likelihood of further resources outflow connected with this Sales Arbitration and Gas Transit Arbitration, supporting to consolidate both cases to the consolidated arbitration claims and ruled that the Russian Federation is responsible for claim is not significant. a respective Naftogaz request. Consequently, the Tribunal case. Naftogaz has submitted its Statement of Defence and violation of the particular articles of the Agreement between ordered a single amount of USD 2,560 million payable by Counterclaim on 1 November 2019, according to which the Cabinet of Ministers of Ukraine and the Government Dispute with the non-controlling shareholders of Gazprom in favour of Naftogaz (plus late payment interest). Company’s monetary claims were estimated at more than of the Russian Federation on mutual encouragement and “Ukrnafta” PJSC in respect of the validity and subsistence of RESPONSIBILITY Despite the fact that the Tribunal has rejected Naftogaz’s USD 12.2 billion. protection of investments, including article on prohibition of shareholders agreement. In January 2010 Naftogaz and the claim on reimbursement of VAT payable on compensation On 19 and 20 December 2019, representatives of expropriation. non-controlling shareholders of “Ukrnafta” PJSC (“Ukrnafta”) AND SOCIAL ENVIRONMENTAL of losses for underdeliveries after 1 January 2016 in the Gas Ukraine, the Russian Federation and the European Union On 27 June 2019, Naftogaz submitted its Memorial signed a shareholders agreement that included, among other, Transit Arbitration, Naftogaz treats the amount awarded met and agreed, in the presence of Naftogaz and Gazprom on Quantum to the Tribunal under the auspices of the setting the procedure of electing the Chairman of the Board, as a contractual service price adjustment that is subject to representatives, on a protocol outlining a possible settlement Permanent Court of Arbitration in The Hague regarding the appointment of the Executive Board and the Supervisory VAT under the Tax Code of Ukraine. As a result, Naftogaz of the disputes between Naftogaz and Gazprom as well as of amount of compensation for the assets that were unlawfully board members. Under the shareholders agreement (until has recognised respective VAT liabilities amounting to an unrelated dispute between Gazprom and the Ukrainian expropriated by the Russian Federation in Crimea. Russia the agreement was amended in April 2019) the Chairman UAH 4,751 million in March 2018, which were paid by State (the "Protocol"). submitted its Counter-Memorial on Quantum in December of the Board was to be elected from among the candidates 30 April 2018. After the conclusion of the Protocol, Naftogaz and 2019. nominated by the non-controlling shareholders, 6 of 11 Additionally, according to the Final Award of the Tribunal Gazprom immediately entered into negotiations on whether On 14 February 2020, Group submitted its Reply Memorial Ukrnafta Supervisory board members, including Chairman, in the Gas Sales Arbitration rendered on 22 December 2017, and how to implement the settlement outlined in the on Quantum, responding to Russia’s Counter-Memorial were to be nominated by Naftogaz, and remaining 5 members Gazprom was obliged to resume gas supplies to Naftogaz Protocol. In particular, Naftogaz and Gazprom met in Vienna on Quantum. In its Reply Memorial, Naftogaz further by the non-controlling shareholders. according to the Gas Sales Contract for 2009-2019 as for negotiations in person from 26 to 30 December 2019. substantiates its claim for compensation for its assets that Under the shareholders agreement, any dispute arising amended by the Final Award. Following the Final Award in On 27 December 2019, Gazprom paid the USD 2.9 billion the Russian Federation unlawfully expropriated in Crimea in connection with it is to be resolved exclusively by the this case, in February 2018 Naftogaz made a prepayment of (equivalent to UAH 68 billion) (including late payment interest) in March 2014 – valued at approximately USD 5 billion, plus London Court of International Arbitration and the shareholder USD 128 million for gas deliveries to be made in March 2018. it was ordered to pay Naftogaz in the Transit Final Award, as interest (for a total of more than USD 8 billion). agreement is governed by the English law. However, Gazprom returned this payment and refused to envisaged in the Protocol. On 30 December 2019, Naftogaz A hearing on quantum is scheduled for May 2020 in The In April 2018 Tribunal rendered the Partial Final Award by FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 216 Naftogaz Group Annual Report 2019 217 Naftogaz Group NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2019 which it (i) acknowledged its jurisdiction over the claims, and with the State Property Fund of Ukraine, and received oil and 23. FINANCIAL RISK MANAGEMENT risk management policy the Group identifies, assessed and declared that (ii) specific provisions of the shareholders agree- gas transportation system into the operational control. The develops actions to minimise the potential adverse effects on ment are unenforceable as a matter of English law by reason of Agreement was signed for one year, and its term is prolonged The Group is exposed to a variety of financial risks: market the Group’s financial performance for those risks. their conflict with mandatory provisions of Ukrainian corporate automatically for one year, unless terminated by notice risk (including currency risk and interest rate risk), concentra- law, but (iii) any such non-enforceability does not affect the from either party, and is binding on the legal successor of tion risk (Note 3), credit risk and liquidity risk. According to its Major categories of financial instruments: enforceability of the shareholders agreement as a whole. each party. Historically, the agreement has been prolonged MARKET AND REFORMS In order to bring the terms of the shareholders agreement automatically, as neither party initiated its termination. As in conformity with the Law of Ukraine “On Joint Stock the State property not subject to privatisation forms an 31 December 31 December In millions of Ukrainian hryvnias Companies” Naftogaz, non-controling shareholders of essential part of the Group’s business, the future operations Note 2019 2018 7 Ukrnafta and Ukrnafta concluded the additional agreement and financial performance of the Group depends on the Other non-current assets 9 4,317 4,594 to the shareholders agreement in April 2019, which amended prolongation of the Agreement. The Group’s management Trade accounts receivable 10 59,056 65,942 Article 9 of the shareholders agreement. In particular, the believes that the Group will continue to operate with this Prepayments made and other current assets 1,144 1,189 parties agreed that the Supervisory Board of “Ukrnafta” PJSC property in the foreseeable future. Сash and bank balances 77,593 14,224 consists of 11 members elected by cumulative voting at the Pursuant to the Agreement, the Company is required, Restricted cash 436 1,338 general meeting of shareholders; and includes at least 6 inter alia, to handle oil and gas transmission and distribution independent directors as requires by the Law of Ukraine “On pipelines owned by the State of Ukraine, keep the state Total financial assets 142,546 87,287 Joint Stock Companies”; the chairman of the Supervisory property in adequate operational condition, and transfer 50% Board is elected by the Supervisory Board from amongst its share of profits received from using those assets to the State. members; proposals for the Supervisory Board candidates The amount of such transfer could be reduced by the amount Major categories of financial instruments: are formed by the parties independently in accordance with of capital investments in those assets. The Agreement does AND OPERATIONS STRATEGY the Ukrnafta’s charter; the chairman of the executive board not provide a mechanism of such calculations, and historically 31 December 31 December In millions of Ukrainian hryvnias Note 2019 2018 and its members are elected by the Supervisory Board. Other there were no payments from the Company to the State provisions of the shareholders agreement remain unchanged. in respect of using such assets. The Company believes that Borrowings 12 (60,662) (55,999) had the mechanism for calculating the state share in profits Trade accounts payable (5,061) (5,500) Possible transfer of the Company’s equity interest in from using the assets been determined by the State, the Advances received and other current liabilities 14 (3,392) (5,441) the subsidiaries to the State. In 1998, upon creation of capital investments performed by the Company would be Other long-term liabilities (2,685) (216) the Company, the Government of Ukraine contributed greater, and no payment in favour of the State would occur. shares of joint stock companies to the share capital of the Accordingly, no liability for such payment was recognised in Total financial liabilities (71,800) (67,156) Company, including “Long-Distance Pipelines “Druzhba” these consolidated financial statements. JSC and “Prydniprovskyi Long-Distance Pipeline” JSC (that As described in Note 21, on 1 January 2020 current were subsequently contributed to “Ukrtransnafta” JSC share obligations of the Company to operate state-owned gas Market risk. The Group is exposed to market risks. Market purchases of natural gas from foreign suppliers, which are capital), “Ukrspetstransgaz” SE, “Chornomornaftogaz” SE, transmission infrastructure were terminated. On 1 January risks arise from open positions in (a) foreign currencies, denominated in USD and EUR. The Group also receives
“Ukrnafta” OJSC, and fifty four regional gas distribution 2020, the Ministry of Finance of Ukraine transferred state- (b) interest bearing assets and liabilities, and (с) assets and borrowings in foreign currencies. The Group does not hedge GOVERNANCE CORPORATE entities. The Government of Ukraine may decide to transfer owned assets related to the gas transmission system to the liabilities that are exposed to other price risk. its foreign currency positions. shares (stakes) or ownership or control over all or part of the new transmission system operator under the long-term The Group’s exposure to foreign currency risk is as follows, Company’s equity interest in those joint stock companies economic management agreement. Currency risk. The Group operates within Ukraine and its based on carrying amounts of respective currency assets and and/or companies, and those actions could have a material exposure to foreign currency risk is determined mainly by liabilities: adverse effect on the Company’s operations. Capital commitments. Capital commitments for purchase of property, plant and equipment, and exploration and State property not subject to privatisation. In 1998, the development of oil and gas fields comprise UAH 6,670 million 31 December 2019 31 December 2018 Company entered into an agreement “On use of the State as at 31 December 2019 (31 December 2018: In millions of Ukrainian USD EUR Others USD EUR Others owned property not subject to privatisation” (“Agreement”) UAH 15,915 million). hryvnias
Restricted cash 235 45 - 828 54 -
Cash and bank RESPONSIBILITY balances 58,152 4,042 44 4,084 3,960 45 Trade accounts ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL receivable 6,063 - - 6,454 - - Prepayments made and other current assets 456 316 - 2,191 - - Other non-current assets 1,412 1 - 3,000 308 - Borrowings (24,605) (16,982) - (17,829) (13,355) - Trade accounts payable (570) (338) (7) (173) (380) (9) Advances received and other current liabilities (897) (125) - (954) (378) (3) Other long-term liabilities (2,582) - - (193) - -
Net (short)/long currency position 37,664 (13,041) 37 (2,592) (9,791) 33 FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 218 Naftogaz Group Annual Report 2019 219 Naftogaz Group NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2019
The following table presents sensitivities of profit or loss The exposure was calculated only for monetary balances The Group does not hold any collateral as a security and the use of flexible credit terms provided by suppliers and and equity to reasonably possible changes in exchange rates denominated in currencies other than the functional currency for its credit risks related to financial assets, except for banks. Prepayments are commonly used to manage both applied at the reporting date, with all other variables held of the Group’s entities. guarantees received in respect of restructured accounts liquidity and credit risks. The Group analyses ageing of its assets constant. receivable of gas consumers within the scope of the Law of and maturity of its liabilities and plans liquidity depending on At 31 December 2019 At 31 December 2018 Ukraine “On measures to settle the debts for the natural their expected repayment. The Group has capital construction
Impact on profit or Impact on Impact on profit or Impact on gas consumed by municipal heat generating entities and programs which are funded both through existing business cash MARKET AND REFORMS In millions of loss before equity net loss before equity net distribution and water supplying companies” #1730 (Note flows and borrowed funds. Borrowed funds are also used to Ukrainian hryvnias income tax income tax income tax income tax 2). Amount of such collateral as at 31 December 2019 finance the Group’s working capital needs. amounted to UAH 1,693 million (31 December 2018: UAH The following table analyses the Group’s financial liabilities USD strengthening by 10% 3,767 3,089 (259) (212) 1,655 million). by relevant maturity groupings based on the remaining period USD weakening by 10% (3,767) (3,089) 259 212 at the reporting date to the contractual maturity date. The EUR strengthening by 10% (1,304) (1,069) (979) (803) Liquidity risk. Prudent liquidity management implies amounts disclosed in the table are undiscounted cash flows of EUR weakening by 10% 1,304 1,069 979 803 maintaining sufficient cash and the availability of funding to principal and interest payments. meet existing obligations as they fall due. The Group’s objective The maturity analysis of financial liabilities as at 31 Interest rate risk. The Group normally has no significant interest the Group to the price risk. To manage this risk and offset its is to maintain a balance between the continuity of funding December 2019 was as follows: bearing assets, and its income and operating cash flows are negative impact on the Group’s financial position, the Group, substantially independent of changes in market interest rate. amongst other measures, is actively taking part in gas market In millions of Ukrainian Up to 6 6-12 1-2 2-5 Over 5 The Group’s interest rate risk exposure arises from borrowings reform in Ukraine and introduce the principle of free pricing for hryvnias months months years years years Total at variable interest rates. Borrowings at fixed rate expose the all groups of customers. In gas supply for groups of customers Borrowings 9,501 8,265 7,015 42,608 13,808 81,197 Group to the risk of fair value change of the interest rate. at prices established independently by Naftogaz on a monthly Trade accounts payable 5,061 - - - - 5,061 AND OPERATIONS STRATEGY The Group attracts borrowings at both fixed and basis price risk is not considered to be significant. Advances received and other current 3,392 - - - - 3,392 floating interest rates. As at 31 December 2019 around 1% liabilities - - 1,060 2,194 - 3,254 of the Group’s borrowings were provided at floating rates Credit risk. The Group is exposed to credit risk, which is the risk Other long-term liabilities (31 December 2018: 24%). The risk of increase in market that one party to a financial instrument will cause a financial 17,954 8,265 8,075 44,802 13,808 92,904 interest rates is monitored by the Treasury department of the loss for the other party by failing to discharge an obligation. Total Company. The key objective of managing interest rate risk is to Exposure to credit risk arises as a result of the Group’s sales get financing at a minimum costs, and match the liquidity needs of products on credit terms and other transactions with with the proceeds from borrowings. counterparties giving rise to financial assets. The maturity analysis of financial liabilities as at 31 December 2018 was as follows: The borrowing activities are reviewed on an annual basis. The Group’s policy is that the customers that wish to pay Long-term investing activities and associated funding are on credit terms are subject to the solvency check. Significant In millions of Ukrainian Up to 6 6-12 1-2 2-5 Over 5 considered separately, and are subject to the Government of outstanding balances are also reviewed on an ongoing basis. hryvnias months months years years years Total Ukraine approval. The maturity dates of financial liabilities are At the same time, the Group must follow the state regulations Borrowings 31,432 19,792 8,627 230 - 60,081 further disclosed in this Note. within public service obligations in respect of gas sales to Trade accounts payable 5,498 - - - 2 5,500 GOVERNANCE CORPORATE If floating interest rates on USD and EUR denominated certain gas market participants irrespective of whether they are Advances received and other current 5,420 21 - - - 5,441 borrowings had been 100 basis points higher as at delinquent or not. The Group makes a provision for impairment liabilities 2 - 21 272 - 295 31 December 2019 with all other variables remaining constant, that represents its estimate of incurred losses in respect Other long-term liabilities net profit for 2019 would have been UAH 18 million lower of trade accounts receivable. The main component of this 42,352 19,813 8,648 502 2 71,317 (2018: UAH 118 million lower). provision relates to specific individually significant exposures. Total The maximum exposure to credit risk as at 31 December Other price risk. The Group determines other price risk as risk 2019 is UAH 142,546 million (31 December 2018: UAH 87,287 Gearing ratio. Consistent with others in the industry, the in the consolidated statement of financial position. As at 31 of possible future losses as a result of price volatility during million). Group monitors capital on the basis of gearing ratio. This December 2019 cash and cash equivalents for the gearing purchase and sale transactions. Both volatility in gas prices The following table presents credit quality analysis for cash ratio is calculated as net debt divided by total capital under calculation were adjusted for cash received from Gazprom to at the European gas hubs that impacts gas purchase prices, and cash equivalents and cash collateral for participation in the management. Net debt is calculated as total borrowings arrive to normalised gearing ratio. and gas sale and supply to customers at prices set by the State procurement procedures as at 31 December based on Fitch (current and non-current as shown in the consolidated The gearing ratio at the end of the reporting period was as NCREU within PSO imposed on the Company (Note 2) expose ratings: statement of financial position) less cash and cash equivalents. following: RESPONSIBILITY Total capital under management equals total equity as shown
31 December 2019 31 December 2018 AND SOCIAL ENVIRONMENTAL Cash and Cash and 31 December 31 December In millions of Ukrainian bank bank In millions of Ukrainian hryvnias 2019 2018 hryvnias balances Restricted cash balances Restricted cash Total borrowings (Note 12) 60,662 55,999 A rating 45 - 141 - Less: cash and cash equivalents (18,099) (12,759) В+ rating 37 - - - В rating 77,173 228 38 - Total Net Debt 42,563 43,240 В- rating- 3 - 7,849 131 No rating 335 208 6,196 1,207 Total Equity 392,574 413,858
Total 77,593 436 14,224 1,338 Gearing ratio 0.11 0.10 FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 220 Naftogaz Group Annual Report 2019 221 Naftogaz Group NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2019
24. FAIR VALUE indicative of the amounts the Group could realise in Details of the Group’s property, plant and equipment and information about the fair value hierarchy as at 31 December a market exchange from the sale of its full holdings of 2019 are as follows: International Financial Reporting Standards defines fair a particular instrument or pay in the transfer of liabilities. value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between Fair value of property, plant and equipment Interrelationship between key market participants at the measurement date. Property, plant and equipment are measured at fair Description Group of assets Valuation Unobservable Range of unobservable inputs unobservable inputs and MARKET AND REFORMS The estimated fair values have been determined by value at the end of each reporting period. The following technique inputs fair value measurement the Group using available market information, where it table provides information about how the fair values of exists, and appropriate valuation methodologies. However, these assets are determined (in particular, the valuation Gas Gas Depreciated Period when transit 2020-2034 The longer the period of judgement is necessarily required to interpret market techniques and inputs used): transmission transmission replacement cost revenues are income generation from system and gas system method using the received transit, the higher the fair data to determine the estimated fair value. Management storages income approach value used all available market information in estimating the fair Undeground for economic value. The estimates presented herein are not necessarily gas storages obsolescence Applicable transit 65 bcm p.a in 2020 and 40 bcm The higher the volumes, the equipment determination volumes p.a in the next years (based on a higher the fair value Fair Transportation Organisation Agreement value Cushion gas between Naftogaz and Gazprom) hierar- Assets chy Valuation techniques and key inputs Date of The RBA-based (Regulatory Asset The later the introduction of Property, 3 The Group engages professional independent appraisers to determine the fair value of its property, plant and
implementation Base) tariffs for transportation services incentive tariff / entry point AND OPERATIONS STRATEGY plant equipment by using a replacement cost method for the majority of groups. The fair value is determined as the of incentive tariff were used for the perdiod 2020-2024. fees, the lower the fair value and cost of construction of these items at current prices less the economic obsolescence and physical tear and wear regulation system From 2024 and onwards tariffs for equip- to date. The main parameter used in this valuation technique are current prices on construction. transportation services were calculated ment based on the long-term stimulating tariff For items for which there are market analogues (mainly buildings), the sales comparison method is used, regulation methodology. The RBA-based the prices of market-based sales of comparable properties in the immediate proximity are adjusted with tariffs for storage are expected from reference to differences in main parameters (such as floor space of the property). The main parameter used in 2030 this valuation technique is the price per square meter of a property. The rate of return 14.52% The higher the rate, the higher The fair value of cushion gas in case of no economic obsolescence (tested using the income approach) is equal on the regulatory the fair value to the replacement cost defined as market price of gas pumped in the underground gas storages adjusted for basis of assets for cost of transportation from the point of sale to the underground storages and costs of its pumping. If economic storage obsolescence is identified, the value of cushion gas adjusted for economic obsolescence will not be lower than its liquidation cost, determined based on the assumptions of the period of gas withdrawal, volume of gas that is
Nominal WACC for 12.57% The higher the weighted GOVERNANCE CORPORATE possible to pull up, market price of gas in the relevant periods, average profitability of gas withdrawal and costs USD-denominated average cost of capital, the of its transportation to the point of sale. cash flows lower the fair value 2 For the items for which there are market analogs (mainly buildings), the sales comparison method is used, the prices of market-based sales of comparable properties in the immediate proximity are adjusted with reference to differences in main parameters (such as floor space of the property). The main parameter used in this Estimated average 5 years The longer the period, the valuation technique is the price per square meter of a property. period of cushion lower the fair value gas withdrawal
The following table summarises property, plant and equipment recognised at fair value after initial recognition using a fair value hierarchy:
31 December 2019 RESPONSIBILITY
In millions of Ukrainian hryvnias Level 2 Level 3 Total ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL
Property, plant and equipment 4,283 201,264 205 547
Total 4,283 201,264 205 547
31 December 2018
In millions of Ukrainian hryvnias Level 2 Level 3 Total
Property, plant and equipment 186,497 217,347 403,844
Total 186,497 217,347 403,844
The Group has transferred cushion gas from Level 2 to Level 3 of the fair value hierarchy on 1 October 2019 due to a change in valuation methodology. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 222 Naftogaz Group Annual Report 2019 223 Naftogaz Group NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2019
The following table provides information about how the fair value of Eurobonds was determined (in particular, the valuation techniques and inputs used): Interrelationship between key Valuation Unobservable Range of unobservable inputs unobservable inputs and Description Group of assets technique inputs fair value measurement Financial Fair value
Gas Gas and oil Depreciated Natural gas selling Market price forecast is based on The higher the selling price, liabilities hierarchy Valuation techniques and key inputs MARKET AND REFORMS extraction upstream replacement price regression analysis of historical NBP and the higher the fair value Eurobonds 1 Fair value of Eurobonds is measured at quoted prices in active markets using interest rates 5.4- assets cost TTF hub gas prices. The results were 7.2% p.a. method using applied to the consensus forecast of the income the NBP hub price and applied to the approach for TTF hub price forecast. Forecast Hub + 25. SUBSEQUENT EVENTS Company’s functional and the Group’s presentation economic prices are calculated as follows: TTF gas currency. All amounts presented in the consolidated financial obsolescence hub forecast plus spread between TTF Loans repayment. During January-March 2020 the Group statements are presented in UAH, rounded to the nearest determination and VTP hub (Slovakia) gas prices plus repaid UAH 1,256 million of bank borrowings. million, if not otherwise stated. entry fee to the GTS of Ukraine. Transactions denominated in currencies other than the Long-term forecast Natural gas and crude oil deposits at The higher the rate, the lower Gas transmission system operator unbundling. In relevant functional currency are translated into the functional of royalty rates depths up to 5000 m – 29%, over the fair value accordance with international commitments of Ukraine, gas currency, using the exchange rate prevailing at the date of the (estimated for 5000 m – 14% transportation activities were unbundled from the Group’s transaction. Foreign exchange gains and losses, resulting from selling Oil and gas condensate deposits at activities of natural gas production and supply on 1 January settlement of such transactions and from the translation of
price) depths up to 5000 m – 31%, over 2020. For more details please refer to Note 21. foreign currency denominated monetary assets and liabilities AND OPERATIONS STRATEGY 5000 m – 16% at year end, are recognised in the consolidated statement of Purchase of natural gas from “Ukrnafta” PJSC. During profit or loss. Translation at year end does not apply to non- Nominal weighted 18.58%-20.05% The higher the weighted January 2020 the Company purchased 2.06 billion cubic monetary items including equity investments. average cost of average cost of capital, the metres of natural gas from “Ukrnafta” PJSC, which the As at 31 December, the exchange rates used for translating capital for UAH lower the fair value latter received from “Ukrtransgaz” JSC according to a court foreign currency balances were: denominated cash decision. Further develepments of this transaction incuding flows settlements among the parties are dependant on receiving PSO compensation from the Government by the Company. In Ukrainian hryvnias 2019 2018 Oil Oil Depreciated Cumulative 0.42-0.85 The higher the factor, the The Group can not estimate the impact of this transaction USD 1.00 23.69 27.69 transmission transmission replacement factor of physical lower the fair value on the consolidated financial statements in future periods EUR 1.00 26.42 31.71 system and system cost and functional because the decision in respect of PSO compensation have storages method using depreciations not been taken yet.
the income The average exchange rates for the year ended 31 GOVERNANCE CORPORATE approach for December were: economic Nominal WACC for 13.24% The higher the weighted 26. SUMMARY OF SIGNIFICANT ACCOUNTING obsolescence UAH-denominated average cost of capital, the determination cash flows lower the fair value POLICIES In Ukrainian hryvnias 2019 2018 Statement of compliance These consolidated financial . USD 1.00 25.85 27.20 statements have been prepared in accordance with IFRS. EUR 1.00 28.95 32.14 Basis of preparation of consolidated financial statements. This consolidated financial statements have been prepared During 2019 and 2018 in Ukraine there were certain on the historical cost basis except for property, plant and restriction in respect of transactions with foreign currency, equipment that are measured at revalued amounts at the imposed by the National Bank of Ukraine. Foreign currency end of each reporting period, as explained in the accounting can be easily converted at a rate close to the National Bank of RESPONSIBILITY policies below. Ukraine rate. At present, UAH is not freely convertible outside Fair value of financial assets and financial liabilities that are not measured at fair value on a recurring basis (but fair Historical cost is generally based on the fair value of the Ukraine. AND SOCIAL ENVIRONMENTAL value disclosures are required). consideration given in exchange for goods and services. Fair value is the price that would be received to sell an Basis for consolidation. Subsidiaries are those companies asset or paid to transfer a liability in an orderly transaction over which the Group has control. The Group controls Management believes that carrying amounts of financial assets and liabilities do not differ significantly from their fair values as between market participants at the measurement date, an entity when the Group has power over the investee; at 31 December 2019 and 2018, except as disclosed below: regardless of whether that price is directly observable or is exposed to, or has rights to, variable returns from its estimated using another valuation technique. involvement with the investee and has the ability to use its 31 December 2019 31 December 2019 These policies have been consistently applied to all periods power to affect its returns. Subsidiaries are consolidated In millions of Carrying value Fair value Carrying value Fair value presented, unless otherwise stated. from the date on which control is transferred to the Group Ukrainian hryvnias (acquisition date) and are deconsolidated from the date that 35,538 38,930 - - Functional and presentation currency. Items included in control ceases. Eurobonds (Note 12) the financial statements of each of the Group’s entities Intercompany transactions, balances and unrealised gains are measured using the currency of the primary economic or losses on transactions between the Group companies are environment in which the Group operates (“the functional eliminated. Accounting policies of subsidiaries have been currency”). The consolidated financial statements are changed where necessary to ensure consistency with the presented in Ukrainian hryvnias (“UAH”), which is the policies adopted by the Group. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 224 Naftogaz Group Annual Report 2019 225 Naftogaz Group NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2019
The Company reassesses whether or not it controls an Non-controlling interests that are present ownership A cash-generating unit to which goodwill has been Dilution of gains and losses arising on investments in investee if facts and circumstances indicate that there are interests and entitle their holders to a proportionate share allocated is tested for impairment annually, or more associates are recognised in the consolidated statement of changes to one or more elements of control listed above. of the entity's net assets in the event of liquidation may be frequently when there is an indication that the unit may be profit or loss. When the Group has a majority of the voting rights of initially measured either at fair value or at the non-controlling impaired. If the recoverable amount of the cash-generating an investee, it still considers whether the voting rights are interests' proportionate share of the recognised amounts unit is less than its carrying amount, the impairment loss is Interest in joint ventures. A joint venture is a joint sufficient to give it the practical ability to direct the relevant of the acquiree's identifiable net assets. The choice of allocated first to reduce the carrying amount of any goodwill arrangement whereby the parties that have joint control MARKET AND REFORMS activities of the investee unilaterally and, thus, has the power measurement basis is made on a transaction-by-transaction allocated to the unit and then to the other assets of the unit of the arrangement have rights to the net assets of the over the investee. basis. Other types of non-controlling interests are measured pro rata based on the carrying amount of each asset in the joint arrangement. Joint control is the contractually agreed The Group considers all relevant facts and circumstances at fair value or, when applicable, on the basis specified in unit. Any impairment loss for goodwill is recognised directly sharing of control of an arrangement, which exists only when in assessing whether or not the Group’s voting rights in an another IFRS. in profit or loss. An impairment loss recognised for goodwill is decisions about the relevant activities require unanimous investee are sufficient to give it power, including: When the consideration transferred by the Group in a not reversed in subsequent periods. consent of the parties sharing control. — The size of the Group’s holding of voting rights relative business combination includes assets or liabilities resulting On disposal of the relevant cash-generating unit, The Group recognises its interest in the joint venture to the size and dispersion of holdings of the other vote from a contingent consideration arrangement, the contingent the attributable amount of goodwill is included in the using the equity method applied as described above in the holders; consideration is measured at its acquisition-date fair value determination of the profit or loss on disposal. paragraph Investments in associates. — Potential voting rights held by the Group, other vote and included as part of the consideration transferred in holders or other parties; a business combination. Changes in the fair value of the Transactions with non-controlling interests. The Group Interests in joint operations. A joint operation is a joint — Rights arising from other contractual arrangements; and contingent consideration that qualify as measurement treats transactions with non-controlling interests as arrangement whereby the parties that have joint control of — Any additional facts and circumstances that indicate that period adjustments are adjusted retrospectively, with transactions with equity owners of the Group. For purchases the arrangement have rights to the assets, and obligations for the Group has, or does not have, the current ability to corresponding adjustments against goodwill. Measurement from non-controlling interests, the difference between any the liabilities, relating to the arrangement. Joint control is the
direct the relevant activities at the time that decisions period adjustments are adjustments that arise from additional consideration paid and the relevant share acquired of the contractually agreed sharing of control of an arrangement, AND OPERATIONS STRATEGY need to be made, including voting patterns at previous information obtained during the ‘measurement period’ (which carrying amount of net assets of the subsidiary is recorded which exists only when decisions about the relevant activities shareholders’ meetings. cannot exceed one year from the acquisition date) about facts in equity. Gains or losses on disposals to non-controlling require unanimous consent of the parties sharing control. and circumstances that existed at the acquisition date. interests are also recorded in equity. When a group entity undertakes its activities under Business combinations. Acquisitions of businesses are The subsequent accounting for changes in the fair When the Group ceases to have control or significant joint operations, the Group as a joint operator recognises in accounted for using the acquisition method. The consideration value of the contingent consideration that do not qualify influence, the retained interest in the entity is remeasured to relation to its interest in a joint operation: transferred in a business combination is measured at fair as measurement period adjustments depends on how its fair value, with the change in carrying amount recognised — Its assets, including its share of any assets held jointly; value, which is calculated as the sum of the acquisition-date the contingent consideration is classified. Contingent in profit or loss. The fair value is the initial carrying amount — Its liabilities, including its share of any liabilities incurred fair values of the assets transferred by the Group, liabilities consideration that is classified as equity is not remeasured at for the purposes of subsequent accounting for the retained jointly; incurred by the Group to the former owners of the acquiree subsequent reporting dates and its subsequent settlement is interest in an associate, joint venture or financial asset. — Its revenue from the sale of its share of the output arising and the equity interests issued by the Group in exchange for accounted for within equity. Contingent consideration that is In addition, any amounts previously recognised in other from the joint operation; control of the acquiree. Acquisition-related costs are generally classified as an asset or a liability is remeasured at subsequent comprehensive income in respect of that entity are accounted — Its share of the revenue from the sale of the output by the recognised in profit or loss as incurred. reporting dates in accordance with IFRS 9 “Financial for as if the Group had directly disposed of the related joint operation; and
At the acquisition date, the identifiable assets acquired Instruments”, or IAS 37 “Provisions, Contingent Liabilities and assets or liabilities. This may mean that amounts previously — Its expenses, including its share of any expenses incurred GOVERNANCE CORPORATE and the liabilities assumed are recognised at their fair value, Contingent Assets”, as appropriate, with the corresponding recognised in other comprehensive income are reclassified to jointly. except that: gain or loss being recognised in profit or loss. profit or loss. The Group accounts for the assets, liabilities, revenues — Deferred tax assets or liabilities, and assets or liabilities When a business combination is achieved in stages, If the ownership interest in an associate is reduced but and expenses relating to its interest in a joint operation in related to employee benefit arrangements are recognised the Group's previously held equity interest in the acquiree significant influence is retained, only a proportionate share of accordance with the IFRS applicable to the particular assets, and measured in accordance with IAS 12 “Income Taxes” is remeasured to its acquisition-date fair value and the the amounts previously recognised in other comprehensive liabilities, revenues and expenses. and IAS 19 “Employee Benefits” respectively; resulting gain or loss, if any, is recognised in profit or loss. income are reclassified to profit or loss where appropriate. When a group entity transacts with a joint operation — Liabilities or equity instruments related to share-based Amounts arising from interests in the acquiree prior to the in which a group entity is a joint operator (such as a sale payment arrangements of the acquiree or share-based acquisition date that have previously been recognised in other Investments in associates. Associates are entities over or contribution of assets), the Group is considered to be payment arrangements of the Group entered into to comprehensive income are reclassified to profit or loss where which the Group has significant influence but not control. conducting the transaction with the other parties to the replace share-based payment arrangements of the such treatment would be appropriate if that interest were Investments in associates are accounted for using the equity joint operation, and gains and losses resulting from the acquiree are measured in accordance with IFRS 2 “Share- disposed of. method of accounting. The Group’s investment in associate transactions are recognised in the Group’s consolidated based Payments” at the acquisition date; and If the initial accounting for a business combination is includes goodwill identified on acquisition, net of any financial statements only to the extent of other parties’ RESPONSIBILITY — Assets (or disposal groups) that are classified as held for incomplete by the end of the reporting period in which the accumulated impairment loss. interests in the joint operation. sale in accordance with IFRS 5 “Non-current Assets Held combination occurs, the Group reports provisional amounts The Group’s share of its associates’ post-acquisition When a group entity transacts with a joint operation in AND SOCIAL ENVIRONMENTAL for Sale and Discontinued Operations” are measured in for the items for which the accounting is incomplete. Those profits or losses is recognised in the consolidated statement which a group entity is a joint operator (such as a purchase of accordance with that Standard. provisional amounts are adjusted during the measurement of profit or loss, and its share of post-acquisition movements assets), the Group does not recognise its share of the gains Goodwill is measured as the excess of the sum of the period (see above), or additional assets or liabilities are in other comprehensive income is recognised in other and losses until it resells those assets to a third party. consideration transferred, the amount of any non-controlling recognised, to reflect new information obtained about facts comprehensive income. The cumulative post-acquisition interests in the acquiree, and the fair value of the acquirer's and circumstances that existed at the acquisition date that, if movements are adjusted against the carrying amount of the Concession agreement (product sharing agreement). The previously held equity interest in the acquiree (if any) over the known, would have affected the amounts recognised at that investment. When the Group’s share of losses in an associate Company entered into a concession agreement for oil explo- net of the acquisition-date amounts of the identifiable assets date. equals or exceeds its interest in the associate, including any ration and development (“Concession Agreement”) with the acquired and the liabilities assumed. If, after reassessment, other unsecured receivables, the Group does not recognise Arab Republic of Egypt and the Egyptian General Petroleum the net of the acquisition-date amounts of the identifiable Goodwill. Goodwill arising on an acquisition of a business is further losses, unless it has incurred obligations or made Corporation (“EGPC”) on 13 December 2006. assets acquired and liabilities assumed exceeds the sum of the carried at cost as established at the date of acquisition of the payments on behalf of the associate. Unrealised gains on The Concession Agreement includes the following condi- consideration transferred, the amount of any non-controlling business less accumulated impairment losses, if any. transactions between the Group and its associates are tions: interests in the acquiree and the fair value of the acquirer's For the purposes of impairment testing, goodwill is eliminated. — Subject to the auditing provisions under the Concession previously held interest in the acquiree (if any), the excess is allocated to each of the Group's cash-generating units (or Accounting policies of associates have been changed Agreement, the Company shall recover on a quarterly recognised immediately in profit or loss as a bargain purchase groups of cash-generating units) that is expected to benefit where necessary to ensure consistency with the policies basis all exploration and development costs to the extent gain. from the synergies of the combination. adopted by the Group. and out of 25% of all petroleum produced and saved from FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 226 Naftogaz Group Annual Report 2019 227 Naftogaz Group NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2019
all production areas and not used in petroleum operations that future economic benefits associated with the item will Expenses arising at the stage of field development, Leases. The Group has adopted IFRS 16 “Leases” (“IFRS 16”) (“Cost Recovery”). Petroleum products under the Con- flow to the Group and the cost of the item can be measured including costs of drilling and trenching, leases and from 1 January 2019. In accordance with the transitional cession Agreement include crude oil or gas and liquefied reliably. All other repairs and maintenance are charged depreciation of property, plant, and equipment, are provisions of IFRS 16, comparative figures were not restated. petroleum gas (“LPG”). to the consolidated statement of profit or loss during the capitalised in construction in progress as exploration and IFRS 16 introduced significant changes to the lessee — Remaining 75% of the petroleum produced is shared financial period in which they are incurred. Property, plant evaluation assets. The assets created are reviewed for accounting by removing the distinction between operating
by the Company and EGPC depending on the volume of and equipment are derecognised upon disposal or when no impairment on an annual basis. In case the exploratory drilling and finance lease requires and requiring the recognition of a MARKET AND REFORMS production and the product type (crude oil or gas and future economic benefits are expected to be received from does not give a result or it is probable that the expenses right-of-use asset and a lease liability at commencement for LPG). The Company’s share varies from 15% to 19%. the continued use of the asset. Gains and losses on disposal incurred will not generate revenue, the asset is partially or all leases. — EGPC shall become the owner of all the Company’s assets determined by comparing proceeds with carrying amount fully written off against expenses of the period. According to IFRS 16, the Group records assets in the acquired and owned within the Concession Agreement, of property, plant and equipment are recognised in the In the event a decision is taken on further development form of the right–of-use and lease liability in the consolidated which were charged to Cost Recovery by the Company consolidated statement of profit or loss. When revalued assets of the field and from the date of putting into operation of statement of financial position and measures at the present in connection with the operations carried out by the are sold or disposed, the amounts included in revaluation the first producing well, the Group classifies the capitalised value of future lease payments that are not paid at the Company: land shall become the property of EGPC as soon reserve are transferred to retained earnings. exploration and evaluation costs related to this well as oil and commencement date, discounted by using the rate implicit as it is purchased; title to fixed and movable assets shall be Property, plant and equipment includes cushion gas which gas extraction assets within property, plant, and equipment in in the lease. If this rate cannot be readily determined, the transferred automatically and gradually from the Company is required to be held in the storage facilities for the operating the statement of financial position. Group uses its incremental borrowing rate. The Group records to EGPC as they become subject to the Cost Recovery. activities of the Group’s subsidiary in transportation of gas and depreciation of assets in the form of the right-of-use and The development period under the Concession Agreement gas storage segments, respectively. Depreciation and depletion. Depreciation is charged to the interest on lease liability in the condensed consolidated is limited to maximum 25 years from the date of commercial Cushion gas is a gas intended for maintaining pressure in consolidated statement of profit or loss on a straight-line basis interim statement of profit or loss. Total amount of cash oil discovery or from the date of first gas deliveries, started in underground storage facilities of the Group and protecting to allocate costs of individual assets except their residual value paid to principal are presented within financial activities in
2010. them from flooding. Cushion gas is considered to be partially over their estimated useful lives. Depreciation commences on the consolidated statement of cash flows and interest are AND OPERATIONS STRATEGY recoverable based on an engineering analysis, and it will take the date of acquisition or, in respect of self-constructed assets, presented within operating activities. Segment reporting. Operating segments are reported in a several years and costs to pull up it from the storage. When from the time an asset is completed and ready for use. In respect of short-term leases (12 months or less) and manner consistent with the internal reporting provided to gas is sold, the Company will have to cover costs to liquidate Hydrocarbon extraction wells are depleted using a unit- lease of low value assets (such as personal laptops and office the Group’s chief operating decision maker. Segments whose wells and other infrastructure. Cushion gas is revalued when of-production method over the life of proved developed furniture), the Group records lease payments as an operating revenue, results or assets are ten percent or more of all the there is an indication that its carrying amount as of the hydrocarbons reserves. Specialised drilling tools and other expense on a straight line basis over the term of the lease in segments are reported separately. Segments falling below reporting date is materially different from its fair value. fixed assets used to perform any work on the well are accordance with the requirements of IFRS 16. this threshold can be reported separately at management Construction in progress includes also prepayments for depleted using a unit-of-production method based on relevant Leases in lessor accounting in which a significant portion decision. property, plant and equipment. output standard established by the Group. of the risks and rewards of ownership are retained by the Other property, plant and equipment are depreciated on lessor are classified as operating leases. Payments made Property, plant and equipment. The Group uses the Exploration expenses. Exploration expenses comprise the a straight line basis over its expected useful life. The useful under operating leases (net of any incentives received from revaluation model to measure property, plant and equipment, costs associated with unproved reserves. These include lives of the Group’s other property, plant and equipment are the lessor) are charged to the consolidated statement of profit except for other fixed assets and construction in progress geological and geophysical costs for the identification and as follows: or loss on a straight-line basis over the period of the lease. which is carried at cost. Fair value was based on valuations investigation of areas with possible oil and gas reserves and GOVERNANCE CORPORATE made by external independent appraisers. The frequence of administrative, legal and consulting costs in connection with Useful lives in years Decommissioning liabilities.The Group’s assessment of revaluation depends on the movements in the fair values of exploration. They also include all impairments on exploration the decommissioning liabilities is based on the estimated Exploration, evaluation and drilling assets 2-60 the assets being revalued. The last independent valuation of wells where no proved reserves could be demonstrated. Gas and oil upstream 2-60 future costs expected to be incurred in respect of the the fair value of the Group’s major groups of property, plant Gas transmission system 2-60 decommissioning and site restoration, adjusted for the effect and equipment was performed as at 1 October 2019 and for Research and development expenses. Research and Underground gas storages 2-60 of the projected inflation for the upcoming periods and the group “Gas transmision system” as at 31 December 2019. development (“R&D”) expenses include all direct and indirect Oil transmission system 2-60 discounted using interest rates applicable to the provision. Subsequent additions to property, plant and equipment are materials, personnel and external services costs incurred in Gas and oil refinery 2-60 Estimated costs of dismantling and removing an item of recorded at cost. Cost includes expenditure directly attributable connection with the focused search for new development Filling stations 2-60 property, plant and equipment are added to the cost of to acquisition of the items. The cost of self-constructed assets techniques and significant improvements in products, Gas distribution assets 2-60 an item of property, plant and equipment when the item includes the cost of materials, direct labour and an appropriate services and processes and in connection with research LNG transportation 2-60 is acquired, and corresponding obligation is recognised. proportion of production overheads. Сost of acquired and self- activities. Expenditures related to research activities is shown Other fixed assets 3-30 Changes in the measurement of an existing decommissioning constructed qualifying assets includes borrowing costs. as R&D expenses in the period in which they are incurred. liability, that result from changes in the estimated timing or RESPONSIBILITY Any increase in the carrying amounts resulting from Development costs are capitalised if the recognition criteria amount of the outflows, or from changes in the discount rate revaluations are credited to revaluation reserve in equity according to IAS 38 “Intangible Assets” are fulfilled. Construction in progress and cushion gas are not depreci- used for measurement, are recognised in the consolidated AND SOCIAL ENVIRONMENTAL through other comprehensive income. Decreases that ated. statement of profit or loss or, to the extent of any revaluation offset previously recognised increases of the same asset are Exploration and evaluation assets. Oil and gas exploration balance existence in respect of the related asset, in other charged against revaluation reserve in equity through other and evaluation expenditures are accounted for using the Intangible assets. Intangible assets have definite useful lives comprehensive income or loss. Provisions in respect of comprehensive income; all other decreases are charged to the successful efforts method of accounting. and primarily include licenses for exploration and extraction decommissioning activities are evaluated and re-estimated consolidated statement of profit or loss. To the extent that an Expenditures at the exploration stage of hydrocarbon and capitalised computer software. Acquired computer annually, and are included in the consolidated financial impairment loss on the same revalued asset was previously reserves’ exploration and evaluation, including the software is capitalised on the basis of the costs incurred to statements at each reporting date at their expected present recognised in the consolidated statement of profit or loss, economic and technical feasibility studies for exploratory acquire and bring it to use. Intangible assets are carried at cost value, using discount rates which reflect the economic a reversal of that impairment loss is also recognised in the field development and advisory services, are recognised as less accumulated amortisation and impairment losses, if any. environment in which the Group operates. consolidated statement of profit or loss. expenses of the period when incurred. If impaired, the carrying amount of intangible assets is written Interest expense related to the provision is included in Expenditure incurred to replace a component of an Expenses directly related to obtaining special rights to down to the higher of value in use and fair value less costs to finance costs in profit or loss. item of property, plant and equipment that is accounted for extraction of mineral resources reserves are capitalised in cost sell. Intangible assets are amortised on a straight-line basis to separately, is capitalised with the carrying amount of the of licenses for exploration and recognised as intangible assets allocate costs of individual assets over their estimated useful Impairment of non-financial assets. Assets are reviewed replaced component being derecognised. Subsequent costs from the date of special rights. Subsequently, the relevant lives. for impairment when events and changes in circumstances are included in the asset’s carrying amount or recognised assets are accounted for using the requirements of IAS 38 indicate that the carrying amount may not be recoverable. as a separate asset, as appropriate, only when it is probable “Intangible Assets”. An impairment loss is recognised for the amount by which FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 228 Naftogaz Group Annual Report 2019 229 Naftogaz Group NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2019 the assets carrying amount exceeds its recoverable amount. Equity instruments. An equity instrument is any contract that Derecognition of financial instruments. The Group petroleum products. Net realisable value is the estimated The recoverable amount is the higher of fair value less cost to evidences a residual interest in the assets of an entity after derecognises financial assets when (i) the assets are selling price in the ordinary course of business, less the cost of sell and value in use. For purposes of assessing impairment, deducting all of its liabilities. redeemed or the rights to cash flows from the assets completion and selling expenses. assets are grouped to the lowest levels for which there are Dividends on equity instruments are recognised in have otherwise expired or (ii) the Group has transferred separately identifiable cash flows (cash generating unit). Non- the consolidated statement of profit or loss when the substantially all the risks and rewards of ownership of the Trade accounts receivable. Trade and other receivables are financial assets that have incurred impairment are reviewed Group’s right to receive payment is established and the assets or (iii) the Group has neither transferred nor retained recognised initially at fair value and subsequently measured MARKET AND REFORMS for possible reversal of the impairment at each reporting date. inflow of economic benefits is probable. Impairment losses substantially all risks and rewards of ownership but has not at amortised cost using the effective interest method, less An impairment loss is recognised immediately in profit or are recognised in the consolidated statement of profit or retained control. Control is retained if the counterparty does provision for impairment. loss, unless the relevant asset is carried at a revalued amount, loss when incurred as a result of one or more events that not have the practical ability to sell the asset in its entirety to in which case the impairment loss is treated as a revaluation occurred after the initial recognition of equity investments. an unrelated third party without needing to impose additional Prepayments made and other current assets. Prepayments decrease. A significant or prolonged decline in the fair value of such restrictions on the sale. The Group derecognises financial are carried at cost excluding VAT less provision for impairment. When an impairment loss subsequently reverses, the instrument below its cost is an indicator that it is impaired. liabilities when, and only when, the Group’s obligations are A prepayment is classified as non-current when the goods carrying amount of the asset (or a cash-generating unit) is The cumulative impairment loss measured as the difference discharged, cancelled or they expire. The difference between or services relating to the prepayment are expected to be increased to the revised estimate of its recoverable amount, between the acquisition cost and the current fair value, less the carrying amount of the financial liability derecognised and obtained after one year, or when the prepayment relates to but so that the increased carrying amount does not exceed any impairment loss on that asset previously recognised in the consideration paid and payable is recognised in profit or an asset that will itself be classified as non-current upon initial the carrying amount that would have been determined had the consolidated statement of profit or loss, is removed from loss. recognition. no impairment loss been recognised for the asset (or cash- equity and recognised in the consolidated statement of profit If there is an indication that the assets, goods or services generating unit) in prior years. A reversal of an impairment or loss. Income taxes. Income taxes have been provided for in relating to a prepayment will not be received, the Group loss is recognised immediately in profit or loss, unless the Impairment losses on equity instruments are not reversed the consolidated financial statements in accordance with recognises provision for impairment in respect of such relevant asset is carried at a revalued amount, in which case through the consolidated statement of profit or loss. Ukrainian legislation enacted or substantively enacted by prepayment made and a corresponding impairment loss is AND OPERATIONS STRATEGY the reversal of the impairment loss is treated as a revaluation the end of reporting date. The income tax charge comprises recognised in the consolidated statement of profit or loss. increase. Impairment of financial assets. The Group applies the current tax and deferred tax and is recognised in the simplified approach to recognise lifetime expected credit consolidated statement of profit or loss unless it relates to Promissory notes. Some purchases may be settled by Financial instruments. The Group has adopted IFRS 9 from losses for its financial assets, as permitted by IFRS 9. The transactions that are recognised, in the same or a different promissory notes or bills of exchange, which are negotiable 1 January 2018. Financial assets and financial liabilities are Group accounts for expected credit losses and changes in period, in other comprehensive income or directly in equity. debt instruments. Purchases settled by promissory notes initially measured at fair value. those expected credit losses at each reporting date to reflect Current tax is the amount expected to be paid to or are recognised based on management’s estimate of the fair The Group’s principal financial instruments comprise changes in credit risk since initial recognition. recovered from the taxation authorities in respect of taxable value to be given up in such settlements. The fair value is borrowings, cash and bank balances, trade accounts The expected credit losses are estimated using a migration profits or losses for the current and prior periods. Taxes other determined with reference to observable market information. receivables and trade accounts payables. matrix by reference to past default experience of the than on income are recorded within operating expenses. All purchases and sales of financial instruments that debtor and an analysis of the debtor’s current position. In Deferred income tax is provided using the balance Cash and cash equivalents. Cash and cash equivalents require delivery within the time frame established by order to use this method, the Group's counterparties were sheet liability method for tax losses carried forwards and include cash on hand, deposits held at call with banks, and regulation or market convention (“regular way” purchases and grouped with uniform credit risk levels, for which expected temporary differences arising between the tax bases of other short-term highly liquid investments with original sales) are recorded at trade date basis, which is the date that credit losses were calculated by the Group. The Group assets and liabilities and their carrying amounts for financial maturities of three months or less. Cash and cash equivalents GOVERNANCE CORPORATE the Group commits to deliver a financial instrument. All other recognises 100% provision for impairment on trade accounts reporting purposes. In accordance with the initial recognition are carried at amortised cost using the effective interest rate purchases and sales are recognised on the settlement date. receivable overdue for more than 365 days, for counterparty exemption, deferred taxes are not recorded for temporary method. Restricted balances are excluded from cash and cash receivables that entered bankruptcy, liquidation or financial differences on initial recognition of an asset or a liability equivalents for the purposes of the statement of cash flows. Classification and subsequent measurement of financial assets. reorganisation, and counterparty receivables that are located in a transaction other than a business combination if the Balances restricted from being exchanged or used to settle a Financial assets are subsequently measured at amortised cost on temporarily occupied territories of Ukraine. According transaction, when initially recorded, affects neither accounting liability for the period from three to twelve months after the or fair value. Specifically, debt investments that are held within to historical experience, the probability of returning such nor taxable profit. Deferred tax liabilities are not recorded reporting date are included in other current assets. Balances a business model whose objective is to collect the contractual receivables is extremely low. for temporary differences on initial recognition of goodwill restricted from being exchanged or used to settle a liability for cash flows, and that have contractual cash flows that are solely The carrying amount of the asset is reduced through the and subsequently for goodwill which is not deductible for tax at least twelve months after the reporting date are included in payments of principal and interest on the principal outstanding provision, and the amount of respective loss is recognised in purposes. Deferred tax balances are measured at tax rates other non-current assets. are generally measured at amortised cost at the end of subse- the consolidated statement of profit or loss. When receivables enacted or substantively enacted at the reporting date which quent accounting periods. Debt instruments that are held within are uncollectible, they are written off against the provision are expected to apply to the period when the temporary Share capital. Ordinary shares are classified as equity. a business model whose objective is achieved both by collecting account for receivables. Subsequent recovery of amounts differences will reverse or the tax losses carried forwards will Incremental costs directly attributable to the issue of new RESPONSIBILITY contractual cash flows and selling financial assets, and that have previously written off are credited to the consolidated be utilised. Deferred tax assets and liabilities are netted only shares are shown in equity as a deduction, net of tax, from the contractual terms that give rise on specified dates to cash flows statement of profit or loss. within the individual companies of the Group. Deferred tax proceeds. AND SOCIAL ENVIRONMENTAL that are solely payments of principal and interest on the prin- assets for deductible temporary differences and tax losses cipal amount outstanding, are generally measured at fair value Classification and subsequent measurement of financial carried forwards are recorded only to the extent that it is Dividends and mandatory budget contribution of profit through other comprehensive income. All other debt investments liabilities. Financial liabilities are subsequently measured at probable that future taxable profit will be available against share. Dividends and mandatory budget contribution of profit and equity investments are measured at their fair value at the amortised cost or fair value through profit or loss (“FVTPL”). which the deductions can be utilised. share are recognised as a liability and deducted from equity end of subsequent accounting periods. Financial liabilities that are not (i) contingent consideration at the reporting date only if they are declared before or on Amortised cost is calculated using the effective interest of an acquirer in a business combination, (ii) held‑for‑trading, Inventories. Inventories are recorded at the lower of cost the reporting date. Dividends are disclosed when they are method and, for financial assets, it is determined net of any or (iii) designated as at FVTPL, are measured subsequently and net realisable value. The cost of inventories includes proposed before the reporting date or proposed or declared impairment losses. Premiums and discounts, including initial at amortised cost using the ffe ective interest method. The expenditures incurred in acquiring the inventories, production after the reporting date but before the consolidated financial transaction costs, are included in the carrying amount of the effective interest rate is the rate that exactly discounts or conversion costs and other costs incurred in bringing them statements are authorised for issue. related instrument and amortised based on the effective estimated future cash payments (including all fees and points to their existing location and condition. Cost of manufactured interest rate of the instrument. paid or received, transaction costs and other premiums or inventories includes an appropriate share of production Value added tax (“VAT”). In Ukraine VAT is levied at two rates: The Group uses practical expedient according to which the discounts) through the expected life of the financial liability, or overheads based on normal operating capacity. The cost of 20% on sales and imports of goods, works and services within amortised cost of financial assets with a maturity of less than (where appropriate) a shorter period, to the amortised cost of inventories is determined on the first in first out basis for all the country, and 0% on the export of goods and limited list one year, less any estimated credit losses, are assumed to be a financial liability. inventories except for natural gas, oil and petroleum products. of services (e.g. international transportation). A taxpayer’s their face values. Weighted average cost formula is used for natural gas, oil and VAT liability equals the total amount of VAT accrued within FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 230 Naftogaz Group Annual Report 2019 231 Naftogaz Group NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2019 a reporting period, and arises on the earlier of the date of Other liabilities. Other financial liabilities are recognised Employee benefits: Defined Contributions Plan. The Group following are the critical judgements, apart from those shipping goods or rendering services to a customer or the initially at fair value, net of transaction costs incurred, and makes statutory unified social contributions to the Pension involving estimations, that the Group management has made date of receiving payment from the customer. A VAT input are subsequently stated at amortised cost using the effective Fund of Ukraine in respect of its employees. The contributions in the process of applying the Group’s accounting policies is the amount that a taxpayer is entitled to offset against his interest method. Other non-financial liabilities are measured are calculated as a percentage of current gross salary and are and that have the most significant effect on the amounts VAT liability in a reporting period. Rights to VAT input arise at cost. expensed when incurred. Discretionary pensions and other recognised in the consolidated financial statements. when a VAT invoice is received, which is issued on the earlier post-employment benefits are included in labour costs in the Revenue recognition. In accordance with the Code of MARKET AND REFORMS of the date of payment to the supplier or the date goods are Contingent assets and liabilities. A contingent asset is not consolidated statement of profit or loss. the gas transmission system, starting from 1 October 2015 received or services are rendered. VAT related to sales and recognised in the consolidated financial statements but During the year ended 31 December 2019, the Group “Ukrtransgaz” JSC, as transmission system operator, is purchases is recognised in the consolidated statement of disclosed when an inflow of economic benefits is probable. recognised expenses from contributions paid to the Pension responsible for regulating an imbalance of the system which financial position on a gross basis and disclosed separately A contingent liability is not recognised in the consolidated Fund of Ukraine in amount of UAH 2,758 million (2018: UAH is calculated as the difference between the volumes of natural as an asset and liability. Where provision has been made for financial statements unless it is probable that an outflow of 2,360 million). gas entering through the entry points and the volumes of impairment of receivables, the impairment loss is recorded economic resources will be required to settle the obligation natural gas exiting through the exit points, on the basis of for the gross amount of the debtor, including VAT, except and it can be reasonably estimated. Contingent liabilities are Employee benefits: Defined Benefit Plan. The Group provides actual data received through the allocation procedure, in the provision for impairment of prepayments made. disclosed unless the possibility of an outflow of resources lump sum benefits, payments on reaching certain age, and context of transmission service customers. embodying economic benefits is remote. other benefits as prescribed by the collective agreement. The In accordance with the Code of the gas transmission Borrowings. Borrowings include bank borrowings and bonds. liability recognised in the consolidated statement of financial system, starting from 1 March 2019 Ukrainian gas market Revenue recognition. The Group has adopted IFRS 15 position in respect of the defined benefit pension plan is switched to daily balancing regime. Daily balancing is Borrowing costs. Borrowing costs directly attributable to the Revenue from contracts with customers from 1 January 2018. the present value of the defined benefit obligation at the an activity to match gas demand and supply in the gas acquisition, construction or production of qualifying assets, In accordance to IFRS 15, revenue is recognised to depict the reporting date. The defined benefit obligation is calculated transmission system on a daily basis. Daily gas balancing which are assets that necessarily take a substantial period of transfer of promised goods or services to customers in an annually using the projected unit credit method. envisions filing nominations by gas suppliers (importers and AND OPERATIONS STRATEGY time to get ready for their intended use or sale, are added amount that reflects the consideration to which the entity Present value of the defined benefit obligation is domestic producers) for day-ahead gas supplies and filling to the cost of those assets, until such time as the assets are expects to be entitled in exchange for those goods or services. determined by discounting the estimated future cash outflows nominations by customers for gas purchase. The interaction substantially ready for their intended use or sale. All other A 5- step approach to revenue recognition is used by the using interest rates of high-quality corporate bonds that are between suppliers, regional gas distribution entities and borrowing costs are recognised in consolidated profit or loss Group: denominated in the currency in which the benefits will be customers is secured through the Information Platform in the period in which they are incurred. — Identify the contract with the customer; paid, and that have terms to maturity approximating the developed by gas transmission system operator. Borrowings are initially recognised at fair value, net of — Identify the performance obligations in the contract; terms of the related pension liability. The Group provides balancing services and recognises transaction costs incurred. Borrowings are subsequently — Determine the transaction price; Actuarial gains and losses arising from experience revenue from these operations in accordance with the carried at amortised cost using the effective interest method. — Allocate the transaction price to the performance adjustments and changes in actuarial assumptions are Code of the gas transmission system and terms of individual Bank overdrafts are included into borrowings line item in the obligations in the contracts; charged or credited to other comprehensive income in the contracts with transmission services customers, considering consolidated statement of financial position. — Recognise revenue when (or as) the entity satisfies a period in which they arise. Past service costs are recognised that: performance obligation. immediately in the consolidated statement of profit or loss. — the Code of the gas transmission system provides that Trade accounts payable. Trade accounts payable are The Group recognises revenue when or as a performance balancing services are provided by the transmission system recognised and initially measured under the policy for obligation is satisfied, i.e. when ‘control’ of the goods or Changes in presentation of the other operating expenses operator based on the data on a monthly/daily imbalance GOVERNANCE CORPORATE financial instruments mentioned above. Subsequently, services underlying the particular performance obligation is in the statement of profit or loss. The Group has changed and do not require any confirmation from customers; instruments with a fixed maturity are re-measured at transferred to the customer. Revenue from the sale of gas presentation of costs on gas storage and gas withdrawal — the price of balancing services in 2018 and 2019 was amortised cost using the effective interest method. Amortised which is transported through gas transmission system is rec- from the underground gas storages as other operating determined by “Ukrtransgaz” JSC as transmission system cost is calculated by taking into account any transaction costs ognised when the gas has been delivered at delivery point to expenses. Previously such costs were part of cost of sales. The operator based on unadjusted negative balance of the and any discount or premium on settlement. the customer. Revenue from gas transmission services is rec- management of the Group believes that new presentation customer and basic gas price. The basic gas price includes ognised when services are rendered, and is confirmed by gas provides better transparency to its results. Consequently, gas purchase price, transmission and storage costs, and Advances received. Advances received are carried at amounts delivery to the customer according to the agreement. comparative information for the year ended 31 December other costs, related to balancing services that can be originally received excluding VAT. Amounts of advances 2018 was changed as follows: cost of sales decreased by measured reliably. received are expected to be realised through the revenue Revenue gross versus net presentation. When the Group acts UAH 1,422 million and other operating expenses increased by received from usual activities of the Group. as a principal, revenue and cost of sales are reported on a gross that amount. Key sources of estimation uncertainty. The following are the basis. If the Group sells goods or services as an agent, revenue key assumptions concerning the future, and other key sources Provisions. Provisions are recognised when the Group has is recorded on a net basis, representing the margin/commission of estimation uncertainty at the end of the reporting period, RESPONSIBILITY a present obligation (legal or constructive) as a result of a earned. Whether the Group is considered to be a principal or 27. CRITICAL ACCOUNTING ESTIMATES AND that have a significant risk of causing a material adjustment to past event and it is probable that an outflow of resources an agent in a transaction depends on the analysis of both legal JUDGEMENTS the carrying amounts of assets and liabilities within the next AND SOCIAL ENVIRONMENTAL embodying economic benefits will be required to settle the form and substance of the agreement the Group enters in. financial year. obligation and a reliable estimate can be made of the amount In the application of the Group’s accounting policies, Employee benefit obligations.The Group assesses of the obligation. Recognition of expenses. Expenses are recorded on an management is required to make judgements, estimates post-employment and other employee benefit obligations Where the Group expects some or all of a provision to be accrual basis. Cost of sales comprises the purchase price, and assumptions about the carrying amounts of assets and using the projected unit credit method based on actuarial reimbursed, for example under an insurance contract, the transportation costs, commissions relating to supply liabilities that are not readily apparent from other sources. assumptions which represent management’s best estimates reimbursement is recognised as a separate asset but only agreements and other related expenses. The estimates and associated assumptions are based on of the variables that will determine the ultimate cost of when the reimbursement is virtually certain. historical experience and other factors that are considered to providing post-employment and other employee benefits. The expense on any provision is presented in the Finance income and costs. Finance income and costs be relevant. Actual results may differ from these estimates. The present value of the pension obligations depends on a consolidated statement of profit or loss net of any comprise interest expense on borrowings, losses on early The estimates and underlying assumptions are reviewed number of factors that are determined on an actuarial basis reimbursement. If the effect of time value of money is repayment of loans, interest income on deposits and on an ongoing basis. Revisions to accounting estimates are using a number of assumptions. The major assumptions used material, provisions are discounted using a current pre-tax current accounts, income or loss on origination of financial recognised in the period in which the estimate is revised if in determining the net cost (income) for pensions include rate that reflects, where appropriate, the risks specific to the instruments, unwinding of interest of the pension obligation the revision affects only that period, or in the period of the the discount rate and expected salary increases. Any changes liability. Where discounting is used, the increase in provision and provisions. revision and future periods if the revision affects both current in these assumptions will impact the carrying amount of due to the passage of time is recognised as a finance cost. Interest income is recognised as it accrues, taking into and future periods. pension obligations. Since there are no long-term, high quality account the effective yield on the asset. Critical judgements in applying accounting policies. The corporate or government bonds issued in Ukrainian hryvnias, FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 232 Naftogaz Group Annual Report 2019 233 Naftogaz Group NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2019 significant judgement is needed in assessing an appropriate as at 1 October 2019, and as at 31 December 2019 for “Gas may impact the amount of the allowances for inventory that beginning on or after 1 January 2019: discount rate. Key assumptions are presented in Note 13. transmission system”. may be required. — IFRS 16 “Leases”; Decommissioning costs. The decommissioning provision Major assumptions used in estimating the recoverable Assets held for sale and distribution. As described in — IFRIC 23 “Uncertainty over Income Tax Treatments”; represents the present value of the decommissioning costs amount include judgments regarding discount rates, UAH/EUR Note 21, on 31 December 2019 the Group reclassified assets — Amendments to IFRS – Annual Improvements to IFRS 2015 relating to oil and gas properties, which are expected to exchange rates, and estimated changes in volumes of gas and related to gas transmission activities as assets of discontinued –2017 Cycle; be incurred in the future (Note 13). These provisions were oil transit and transportation. Management has determined operations classified as held for sale and distribution. — Amendments to IFRS 9 “Financial Instruments”: MARKET AND REFORMS recognised, based on Group’s internal estimates. the discount rate by using the after tax rate that reflects Managemet considered the assets to meet the criteria to Prepayment Features with Negative Compensation; Main estimates include future market prices for the current market investment rates with similar risk levels. To be classified as held for sale and distribution at that date — Amendments to IAS 28 “Investments in Associates”: Long- necessary decommissioning costs, and are based on market project UAH/EUR exchange rate, the Company has used following that sale and distribution of assets was highly term interests in Associates and Joint Ventures; conditions and factors. Additional uncertainties relate to consensus forecasts of analytical agencies. Movements in the probable and assets became available for sale and distribution — Amendments to IAS 19 “Employee Benefits”: Plan the timing of the decommissioning costs, which depends on volumes of gas and oil transit and transportation are based in their current condition for the following reasons: Amendment, Curtailment or Settlement. depletion of the fields, future oil and gas prices and as a result on the assumptions regarding industry developments and — all conditions, prescribed in the CMU Resolution “On Except the changes related to adoption of new standard – expected point of time, when there are no further economic expectations on further market changes. Cash flow forecasts Unbundling of Natural Gas Transmission Activity and IFRS 16 “Leases” (“IFRS 16”) described below, the adoption benefits in the production. are based on the assumptions outlined in the table below for Enabling Activity of Transmission System Operator” #840 of amendments to standards did not have any effect on the Changes in these estimates can lead to the material the next five years and the terminal value determined based dated 18 September 2019 to unbundle gas transmission financial position or performance reported in the consolidated changes in the provisions recognised in the consolidated on indicators for the last of five years. activities on the 1 January 2020 were met. financial statements and had not resulted in any changes to statement of financial position. Numerical values of key judgments of the Group’s — gas transit agreement between Naftogas and Gazprom, the Group’s accounting policies and the amounts reported for Depletion of the oil and gas assets.Oil and gas assets are management reflect their estimation of future business limiting the ability to unbundle unbundle gas transmission the current or prior years. depleted using a unit-of-production method. The cost of the trends; they are based on both internal and external sources activities and transfer the respective assets, was With the effect from 1 January 2019, the Group has wells is amortised based on the proved volumes of available of the Group. terminated on 1 January 2020; changed its accounting policy for recognition and accounting AND OPERATIONS STRATEGY reserves, estimated in accordance with the standards of the In making the assessment for general impairment, assets — on 24 December 2019 , “Gas Transmission System of lease according to IFRS 16 as described in Note 26. Petroleum Resource Management System (PRMS) prepared by that do not generate independent cash flows are allocated to Operator of Ukraine” LLC was granted the license for The Group has made use of the practical expedient the Oil and Gas Reserves Committee of Society of Petroleum an appropriate cash-generating unit. Indicators of a potential natural gas transportation activities effective from 1 available on transition to IFRS 16 not to reassess whether Engineers (SPE). The estimation of hydrocarbons reserves is impairment include analysis of market conditions, asset January 2020. a contract is or contains a lease. The application of IFRS 16 carried out in general on the field. Respectively, all wells of the utilisation and the ability to utilise the asset for alternative For more details on the discontinued operations, refer to did not have significant impact on the consolidated financial field are depreciated based on the total volume of extracted purposes. If an indication of impairment exists, the Group Note 21. position and/or consolidated financial performance of the from the field specific type of hydrocarbons for the period estimates the recoverable value (greater of fair value less cost Group. and the balances of reserves of such hydrocarbons at the to sell and value in use) and compares it to the carrying value, beginning of the period. Changes in estimates regarding the and records impairment to the extent the carrying value is 28. ADOPTION OF NEW OR REVISED STANDARDS Standards and Interpretations in issue, but not yet effective. volumes of total proved reserves either downward or upward, greater than the recoverable amount. AND INTERPRETATIONS At the date of authorisation of these consolidated financial can result in the change of depreciation and depletion Useful lives of other property, plant and equipment. The statements, the following Standards and Interpretations, as expenses. Group’s property, plant and equipment, except oil and gas Adoption of new and revised International Financial well as amendments to Standards were in issue but not yet
Estimation of oil and gas reserves. Reserves are the assets are depreciated using straight-line method over their Reporting Standards.The following standards have been effective: GOVERNANCE CORPORATE quantities of oil and gas which are anticipated to be estimated useful lives, which are based on management’s adopted by the Group for the first time for the financial year commercially recovered from known accumulations from business plans and operational estimates. a given date forward under defined conditions. Proved and The Group reviews the estimated useful lives of property, probable reserves used in depletion rate calculation are plant and equipment at the end of each annual reporting Effective for annual determined using estimates of known oil and gas reservoirs, period. The review is based on the current condition of recovery factors, operating conditions, future oil and gas the assets and the estimated period during which they will accounting period beginning prices and government regulations. Latest assessment of continue to bring economic benefit to the Group. Any change Standards/Interpretations on or after gas reserves was performed as at 1 July 2019, and latest in estimated useful life or residual value is recorded on a assessment of oil reserves was performed as at 1 April 2019. prospective basis from the date of the change. Amendments to References to the Conceptual Framework in IFRS Standards 1 January 2020 Reserves estimates involve some degree of uncertainty, Impairment of trade accounts receivable. Management and their estimates are revised as additional geologic and estimates the likelihood of the collection of trade accounts Amendments to IFRS 3 “Business Combinations”: Definition of a Business 1 January 2020 engineering data becomes available or as economic conditions receivable based on an analysis of individual accounts. Factors RESPONSIBILITY change. Accordingly, depletion rates and discounted cash taken into consideration include an ageing analysis of trade Amendments to IAS 1 “Presentation of Financial Statements” and IAS 8 “Accounting Policies, flows for revaluation and impairment of property, plant and accounts receivable in comparison with the payment history, Changes in Accounting Estimates and Errors”: Definition of Material 1 January 2020 AND SOCIAL ENVIRONMENTAL equipment may be also revised. credit terms allowed to customers and available market Revaluation and impairment of property, plant and information regarding the counterparty’s ability to pay. Should Amendments to IFRS 9 “Financial Instruments”, IAS 39 “Financial Instruments: Recognition equipment. Management performs assessment whether actual collections be less than management’s estimates, the and Measurement” and IFRS 7 “Financial Instruments: Disclosures”: Interest Rate Benchmark carrying amounts of property, plant and equipment accounted Group would be required to record an additional impairment Reform IFRS 17 “Insurance contracts” 1 January 2020 under the revaluation model, differ materially from their fair expenses. values. Such assessment is performed on an annual basis, Inventory valuation. Inventory are stated at lower of Amendments to IAS 1 “Presentation of Financial Statements”: Classification of Liabilities as and involves analysis of prices, price indices, changes in cost or net realisable value. In assessing the net realisable Current or Non-Current 1 January 2020 technology, foreign exchange rates and other relevant factors. value of its inventories, management bases its estimates on In case such assessment identifies that carrying amounts various assumptions including current market prices. At each Amendments to IFRS 10 “Consolidated Financial Statements” and IAS 28 “Investments in of items of property, plant and equipment differ materially reporting date, the Group evaluates its inventories for excess Associates”: Sale or Contribution of Assets between an Investor and its Associate or Joint from their fair values, management engages independent quantities and obsolescence and, if necessary, records an Venture To be determined appraisers to perform property, plant and equipment allowance to reduce inventories for obsolete and slow-moving revaluation. goods. This allowance requires assumptions related to future Latest revaluation of the major groups of property, plant inventories use. These assumptions are based on inventories Management anticipates that adoption of new Standards and Interpretations in future periods will not have a material and equipment was made by the independent appraisers ageing and forecasted demand. Any changes in the estimates effect on the consolidated financial statements of the Group in future periods. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 234 Naftogaz Group Annual Report 2019 235 Naftogaz Group DETERMINATION
OF THE CONTENT MARKET AND REFORMS
AND THE MATERIAL MATERIAL GRI TOPICS AND BOUNDARIES
TOPICS OF THE REPORT Category Topic Boundaries The Annual Report covers information on the main aspects company's activities on economic, social and environmental Economic Economic The information on the topic in the report is disclosed to all companies of the Naftogaz Group's activities in 2019. The company regularly issues and are important for stakeholders. The list of relevant performance of Naftogaz Group prepares and publishes annual reports, as it is important for it topics for inclusion in the report takes place in the process of Indirect economic The information on the topic in the report is disclosed for such companies as to transparently disclose information about the results of the interaction with stakeholders. This is followed by an assessment impacts Ukrgasvydobuvannya, Ukrnafta, Ukrtransgaz and Ukrtransnafta Naftogaz Group, its impact on society and the environment. The of the identified significant topics in terms of their impact on AND OPERATIONS STRATEGY Annual Report for 2019 is the fifth report prepared in accordance sustainable development and importance for the company, using Procurement The information on the topic in the report is disclosed to all companies with GRI Standards. the following tools: practices of Naftogaz Group The report was prepared in accordance with the principles — Analysis of the external information field of the company; Environment The information on the topic in the report is disclosed for such companies as of the GRI Standards for defining the report quality: accuracy, — Analysis of annual reports and reports in the field of Energy Ukrgasvydobuvannya, Ukrnafta, Ukrtransgaz and Ukrtransnafta balance, clarity, comparability, reliability, timeliness. sustainable development of similar companies in Ukraine and In identifying significant topics for disclosure in the report, the abroad; The information on the topic in the report is disclosed for such companies as company was guided by the principles of the GRI Standards for — Questionnaire of internal structural subdivisions and Water Ukrgasvydobuvannya, Ukrnafta, Ukrtransgaz and Ukrtransnafta determining the content of the report, namely: subsidiaries of Naftogaz Group; — Consultations with the top management representatives of The information on the topic in the report is disclosed to all companies the company; Biodiversity SUSTAINABILITY CONTEXT — Analysis of international standards, agreements, resolutions of Naftogaz Group in the field of sustainable development, for example, the UN The information on the topic in the report is disclosed to all companies
Emissions GOVERNANCE CORPORATE In its annual report, Naftogaz Group discloses information Sustainable Development Goals. of Naftogaz Group about its activities, covering, in addition to economic topics, In the process of defining the boundaries of coverage of each The information on the topic in the report is disclosed for such companies as social issues and environmental impact issues. The Company significant topic, a list of structural and organizational units of the Effluents and waste seeks to disclose the impacts of its activities in the broad context Naftogaz Group (subsidiaries, joint ventures) that have an impact Ukrgasvydobuvannya, Ukrnafta, Ukrtransgaz and Ukrtransnafta of sustainable development. The report covers information on each of the significant topics is compiled. The results of their Environmental The information on the topic in the report is disclosed to all companies on the direct and indirect impacts of the company on local activities are noted in the report when describing the significant compliance of Naftogaz Group communities, the country and the world in general. The report topics on which they have an impact. This provides a thorough describes both positive and negative aspects of sustainable coverage of the impact of the Naftogaz Group on significant Social The information on the topic in the report is disclosed to all companies Employment development, including possible ways and progress to address topics. of Naftogaz Group them. The number and list of relevant topics is reviewed annually Labor management The information on the topic in the report is disclosed to all companies and updated as necessary. Significant topics of Naftogaz Group's relations of Naftogaz Group activities in 2019 and their boundaries are listed in the table STAKEHOLDER INCLUSIVENESS below. Occupational The information on the topic in the report is disclosed to all companies RESPONSIBILITY health and safety of Naftogaz Group During the preparation of the annual report, considerable AND SOCIAL ENVIRONMENTAL attention is paid to the interests and priorities of stakeholders. COMPLETENESS Training and The information on the topic in the report is disclosed to all companies Interaction with them is based on the current "Stakeholder education of Naftogaz Group Interaction Procedure", which is published on the Naftogaz Naftogaz Group defines the list of significant topics and the Diversity and equal The information on the topic in the report is disclosed to all companies Group's website. The procedure regulates the main provisions, limits of their coverage so that the information presented in the opportunity of Naftogaz Group forms, principles of interaction with a specific list of stakeholder report covers all important aspects of the company's activities. The information on the topic in the report is disclosed to all companies groups, determines the ways of communication of a particular The content of the report reveals primarily information about Non discrimination information. A detailed list of stakeholder groups and methods of the company's activities in the reporting period (in this case – of Naftogaz Group interaction with them is provided in the Naftogaz Group's 2017 in 2019). However, one of the factors in the completeness of The information on the topic in the report is disclosed to all companies Child labor annual report. information disclosure is the report's coverage of short-term, of Naftogaz Group medium-term and long-term results, impacts and goals. Thus, the company ensures the appropriate level of Forced or The information on the topic in the report is disclosed to all companies MATERIALITY completeness of disclosures in the report so that all stakeholders compulsory labor of Naftogaz Group can review and analyze all significant impacts of the Naftogaz The information on the topic in the report is disclosed to all companies Significant topics of the Naftogaz Group's activities are, first Group on economic, social and environmental aspects, draw their Local communities
of Naftogaz Group FINANCIAL OVERVIEW AND STATEMENTS of all, those issues that reflect the significant impacts of the own conclusions based on structured transparent information.
Annual Report 2019 236 Naftogaz Group Annual Report 2019 237 Naftogaz Group Disclosure Page Material topic Disclosure name Report section and comments number number 102-13 Membership of associations - The company is a member of such organizations:
• International gas union;
MATERIAL • European energy forum; MARKET AND REFORMS • Eurogas TOPICS UNDER • EFET Strategy 102-14 Statement from the most senior 9 CEO's address decisionmaker Ethics and integrity 102-16 Values, principles, standards, and - Code of Ethics GRI STANDARD norms of behavior (http://www.naftogaz.com/files/ HR/Naftogaz-Kode-Ethics.pdf ) Disclosure Page Material topic Disclosure name Report section and comments number number Corporate 102-18 Governance structure 117 Report of Naftogaz supervisory governance board General Disclosures 115
Organizational profile 102-1 Name of the organization - NJSC “Naftogaz of Ukraine” Corporate governance AND OPERATIONS STRATEGY (Naftogaz Group) 102-35 Remuneration policies 127 Corporate governance 102-2 Activities, brands, products, and 55 Strategy and operations 131 Key managers and their services remuneration 102-3 Location of headquarters 245 Contacts Stakeholder 102-40 List of stakeholder groups 237 Determination of the content and 102-4 Location of operations 55 Strategy and operations engagement the material topics of the report 102-5 Ownership and legal form 179 Financial overview and statements 102-41 Collective bargaining agreements 139 Human resources management 102-6 Markets served 55 Strategy and operations All employees are covered by 179 Financial overview and statements collective bargaining agreement 102-7 Scale of the organization 55 Strategy and operations 102-42 Identifying and selecting 237 Determination of the content and
179 Financial overview and statements stakeholders the material topics of the report GOVERNANCE CORPORATE 139 Human resources management Code of Ethics (http://www. 102-8 Information on employees and 139 Human resources management naftogaz.com/files/HR/Naftogaz- other workers Kode-Ethics.pdf ) Indicator has been partially disclosed Procedure for Interacting with 102-9 Supply chain 173 Procurement management Stakeholders (http://www.naftogaz. com/files/official_documents/ 102-10 Significant changes to the - There were no significant changes Procedure_for_Interaction_with_ organization and its supply chain during the reporting period Stakeholders_UA.pdf ) 102-11 Precautionary Principle or 133 Risk management 102-43 Approach to stakeholder 237 Determination of the content and approach 163 engagement the material topics of the report RESPONSIBILITY 149 Environmental protection 159 Occupational safety Code of Ethics (http://www. AND SOCIAL ENVIRONMENTAL naftogaz.com/files/HR/Naftogaz- Investing in energy efficiency Kode-Ethics.pdf ) 102-12 External initiatives 139 Human resources management Procedure for Interacting with Stakeholders (http://www.naftogaz. com/files/official_documents/ Procedure_for_Interaction_with_ Stakeholders_UA.pdf ) FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 238 Naftogaz Group Annual Report 2019 239 Naftogaz Group Disclosure Page Disclosure Page Material topic Disclosure name Report section and comments Material topic Disclosure name Report section and comments number number number number 102-44 Key topics and concerns raised 237 Determination of the content and Indirect economic Disclosures on management 157 Cooperation with local the material topics of the report impacts approach communities
Code of Ethics (http://www. 203-1 Infrastructure investments and 157 Cooperation with local naftogaz.com/files/HR/Naftogaz- services supported communities Kode-Ethics.pdf) Indicator has been partially MARKET AND REFORMS Procedure for Interacting with disclosed Stakeholders (http://www.naftogaz. Procurement Disclosures on management 173 Procurement management com/files/official_documents/ practices approach Procedure_for_Interaction_with_ 204-1 Proportion of spending on local 173 Procurement management Stakeholders_UA.pdf ) suppliers Reporting practice 102-45 Entities included in the 179 Financial overview and statements Environment consolidated financial statements Energy Disclosures on management 159 Investing in energy efficiency 102-46 Defining report content and topic 237 Determination of the content and approach Boundaries the material topics of the report 302-1 Energy consumption within the 159 Investing in energy efficiency 102-47 List of material topics 237 Determination of the content and organization the material topics of the report Naftogaz uses standards, 102-48 Restatements of information - There were no restatements of methodologies and assumptions, AND OPERATIONS STRATEGY information provided in previous which are governed by regulations reports of Ukraine in energy saving and energy efficiency 102-49 Changes in reporting - There were no significant changes from previous reporting periods 302-3 Energy intensity 159 Investing in energy efficiency 102-50 Reporting period - 2019 calendar year 302-4 Reduction of energy consumption 159 Investing in energy efficiency 102-51 Date of most recent report - June 27, 2019 Fuel and energy savings were 102-52 Reporting cycle - Annual reporting calculated relative to planned targets 102-53 Contact point for questions - Aliona Osmolovska, Naftogaz Group regarding the report director of GR and stakeholder Water Disclosures on management 163 Environmental protection relations approach Tel.:+380 44 586 3579 303-1 Water withdrawal by source 163 Environmental protection GOVERNANCE CORPORATE Mob.:+380 73 335 80 53 303-3 Water recycled and reused 163 Environmental protection [email protected] 6 B. Khmelnytskoho st. Indicator has been partially Kyiv, 01601, Ukraine disclosed www.naftogaz.com Biodiversity Disclosures on management 163 Environmental protection www.naftogaz-europe.com approach 102-54 Claims of reporting in accordance - This report was prepared in 304-2 Significant impacts of activities, 163 Environmental protection with the GRI Standards accordance with GRI Standard, products, and services on “Core” level biodiversity Indicator has been partially 102-55 GRI content index 237 Determination of the content and disclosed the material topics of the report Emissions Disclosures on management 163 Environmental protection RESPONSIBILITY 102-56 External assurance - This report has not been approach ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL independently verified 305-1 Direct (Scope 1) GHG emissions 163 Environmental protection Specific disclosures GHG emission in CO2-equavalent Economic was calculated based on Global Economic Disclosures on management 55 Strategy and operations warming potential coefficients, performance approach IPCC Second Assessment Report 201-1 Direct economic value generated 55 Strategy and operations (100-years period) and 305-7 Nitrogen oxides (NOX), sulfur 163 Environmental protection 201-4 inancial assistance received from - Naftogaz did not receive financial oxides (SOX), and other significant government support from the government in air emissions the reporting period FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 240 Naftogaz Group Annual Report 2019 241 Naftogaz Group Disclosure Page Disclosure Page Material topic Disclosure name Report section and comments Material topic Disclosure name Report section and comments number number number number Effluents and waste Disclosures on management 163 Environmental protection Child labour Disclosures on management 139 Human resources management approach approach 306-1 Water discharge by quality and 163 Environmental protection 408-1 Operations and suppliers at - Not relevant. destination significant risk for incidents of child Child and forced labour are
labor MARKET AND REFORMS 306-2 Waste by type and disposal method 163 Environmental protection prohibited by any applicable laws Environmental Disclosures on management 163 Environmental protection or regulations of Ukraine. The compliance approach company does not operate in 307-1 Non-compliance with 163 Environmental protection countries where there is a high environmental laws and regulations risk of human rights violations, including use of child labour Social Forced or Disclosures on management 139 Human resources management Employment Disclosures on management 139 Human resources management compulsory labour approach approach 409-1 Forced or compulsory labour - Not relevant. 401-1 New employee hires and employee 139 Human resources management turnover Child and forced labour are Indicator has been partially prohibited by any applicable laws disclosed or regulations of Ukraine. The
401-2 Benefits provided to full-time 139 Human resources management company does not operate in AND OPERATIONS STRATEGY employees that are not provided to countries where there is a high temporary or part-time employees risk of human rights violations, Labor management Disclosures on management 139 Human resources management including use of child labour relations approach Local communities Disclosures on management 157 Cooperation with local 402-1 Minimum notice periods regarding - In accordance with the current approach communities operational changes legislation of Ukraine - 2 months; 413-1 Operations with local community 157 Cooperation with local enshrined in collective agreements engagement, impact assessments, communities Occupational health Disclosures on management 149 Occupational safety and development programs Indicator has been partially and safety approach disclosed 403-2 Types of injury and rates of injury, 149 Occupational safety occupational diseases, lost days, CORPORATE GOVERNANCE CORPORATE and absenteeism, and number of Indicator has been partially work-related fatalities disclosed 403-4 Health and safety topics covered - Health and safety topics covered in formal agreements with trade in separate section of collective unions bargaining agreement Training and Disclosures on management 139 Human resources management education approach 404-2 Programs for upgrading employee 139 Human resources management skills and transition assistance programs
Diversity and equal Disclosures on management 139 Human resources management RESPONSIBILITY opportunity approach ENVIRONMENTAL AND SOCIAL ENVIRONMENTAL 405-1 Diversity of governance bodies and 139 Human resources management employees 117 Report of Naftogaz Supervisory Board Non discrimination Disclosures on management 139 Human resources management approach 406-1 Incidents of discrimination and - During reporting period, the corrective actions taken company recorded no cases of discrimination FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 242 Naftogaz Group Annual Report 2019 243 Naftogaz Group CONTACTS TERMS AND ABBREVIATIONS
Naftogaz of Ukraine Ukravtogaz BCS – booster compressor stations, which maintain the OECD – Organization for Economic Co-operation 6 B. Khmelnytskoho St, Kyiv 01601 Ukraine 2 Hryhorovycha-Barskoho St, Kyiv 03134 Ukraine pressure necessary for production at the final stage of field and Development Т. +380 (44) 586-33-30; 39-63; 32-83 T.: +380 (44) 291-28-05/11 development OJSC KIROVOHRADGAZ, [email protected] , [email protected] [email protected] BP – British Petroleum, a transnational oil and gas, KIROVOHRADGAZ (KirGaz) – Open Joint Stock Company MARKET AND REFORMS www.naftogaz.com, www.naftogaz-europe.com www.ukravtogaz.com petrochemical and coal corporation Kirovohradgaz, a regional gas distribution and supply company https://www.facebook.com/NaftogazUA CABINET OF MINISTERS – The Cabinet of Ministers of Ukraine JSC CHORNOMORNAFTOGAZ, CHORNOMORNAFTOGAZ (CNG) – https://twitter.com/naftogazukraine Ukrspetstransgaz COMPANY – Naftogaz Public Joint Stock Company Chornomornaftogaz 3 Promyslova St, Dolyna 03477 Ukraine CRIMEA – The Autonomous Republic of Crimea, a region of JSC UKRAVTOGAZ, UKRAVTOGAZ (UAG) – Joint Stock Company Ukrgasvydobuvannya T.: +380 (3477) 2-53-10/11 Ukraine currently occupied by the Russian Federation Ukravtogaz 26/28 Kudryavska St, Kyiv 04053 Ukraine [email protected] DHC – district heating company (same as “teplokomunenergo”) JSC Ukrgasvydobuvannya, Ukrgasvydobuvannya (UGV) – Joint Т. +380 (44) 272-31-15, fax: +380 (44) 461-29-94 www.ustg.com.ua DSNS, SESU – State Emergency Service of Ukraine Stock Company Ukrgasvydobuvannya [email protected] EBRD – European Bank for Reconstruction and Development PJSC UKRNAFTA, UKRNAFTA (UN) – Public Joint Stock Company www.ugv.com.ua Naukanaftogaz EC – the European Commission Ukrnafta 8 Kyivska St, Kyiv Oblast, Vyshneve 08132 Ukraine EIB – European Investment Bank JSC UKRSPETSTRANSGAZ, Ukrnafta T.: +380 (44) 391-74-01, F: +380 (44) 496-64-18 EFET – European Federation of Energy Traders UKRSPETSTRANSGAZ – Joint Stock Company Ukrspetstransgaz 3-5 Nestorivskyy Provulok, Kyiv 04053 Ukraine [email protected] EGPC – Egyptian General Petroleum Corporation JSC UKRTRANSGAZ, UKRTRANSGAZ (UTG) – Joint Stock Company T.: 0 800 404 000 www.naukanaftogaz.com ENERGY MINISTRY – the Ministry of Energy and the Coal Industry Ukrtransgaz [email protected] of Ukraine JSC UKRTRANSNAFTA, UKRTRANSNAFTA (UTN) – Joint Stock www.ukrnafta.com EU – the European Union Company Ukrtransnafta
LLC Gas supply company “Naftogaz of Ukraine” AND OPERATIONS STRATEGY 1 Sholudenka St, Kyiv 04116 Ukraine EUSTREAM – Slovak gas transmission system operator PSO – public service obligations Chornomornaftogaz T: +380 (44) 537-05-54, 0 800 215 515 GAS – natural gas, unless stated otherwise PWC, PRICEWATERHOUSECOOPERS – international audit 1 Sholudenka St, Kyiv 04116 Ukraine [email protected] Gas trunk pipelines –a single-line system feeding into the consultancy Т. +380 (44) 537-05-56 www.naftogazpostach.com common system of gas pipelines, through which gas is ROIC – Return on Invested Capital. ROIC is calculated as [email protected] transmitted from the production site to consumers NOPLAT for the respective year divided by invested capital, LLC Gas supply company “Naftogaz Trading” GAZPROM – Public Joint Stock Company Gazprom, a Russian which was determined as a sum of invested capital in fixed Ukrtransgaz 1 Sholudenka St, Kyiv 04116 Ukraine energy company assets and net working capital as of the end of the year 9/1 Klovskyy Uzviz, Kyiv 01021 Ukraine T: +380 (44) 364-76-54; 79-14 GDS – gas distribution station RSC – regional gas supply companies T.: +380 (44) 461-20-95 [email protected] GMS – gas measuring station RUSSIA – the Russian Federation [email protected] www.naftogaztrading.com.ua GROUP – a group of companies that consists of SE VUHLESYNTEZGAZ, VUHLESYNTEZGAZ – Subsidiary enterprise www.utg.ua NJSC Naftogaz of Ukraine, JSC Ukrgasvydobuvannya, of National Joint Stock Company Naftogaz of Ukraine LLC Gas supply company “Naftogaz Teplo” JSC Ukrtransgaz, JSC Ukrtransnafta, SC Gas of Vuhlesyntezgaz Ukrtransnafta 1 Sholudenka St, Kyiv 04116 Ukraine Ukraine, SE Uktavtogaz, JSC Chornomornaftogaz, OJSC STATE COMPANY GAS OF UKRAINE, 32/2 Moskovska St, Kyiv 01010 Ukraine T: +380 (44) 537-00-43; 05-53 Kirovohradgaz, SE Zakordonnaftogaz, JSC Ukrspetstransgaz, GAS OF UKRAINE – a subsidiary of National Joint Stock
T.: +380 (44) 201-57-01/76, F: +380 (44) 201-57-78 [email protected] Naftogaz Overseas SA, SE Vuhlesyntez Ukraine, Company Naftogaz of Ukraine GOVERNANCE CORPORATE [email protected] [email protected] SE Ukrnaftogazkomplekt, SE Naukanaftogaz, STATE ENTERPRISE ZAKORDONNAFTOGAZ, www.ukrtransnafta.com www.naftogazteplo.com.ua SE Naftogazobsluhovuvannya, SE LIKVO, SE Naftogazbezpeka, ZAKORDONNAFTOGAZ – a subsidiary of NJSC Naftogaz of Ukraine SE Budivelnyk, PJSC Ukrnafta SUBSIDIARIES – subsidiary companies of National Joint Stock Gas of Ukraine Zakordonnaftogaz GTS – gas transportation system Company Naftogaz of Ukraine 1 Sholudenka St, Kyiv 04116 Ukraine 72 Velyka Vasylkivska St, Kyiv 03150 Ukraine HF – hydraulic fracturing TEPLOKOMUNENERGO – enterprises, producing heat and energy, T: +380 (44) 537-05-38, F: +380 (44) 537-05-74 T.: +380 (44) 237-64-65 IBRD – International Bank for Reconstruction and Development district heating companies [email protected] [email protected] IFRS – International Financial Reporting Standards UGS – underground gas storage www.gasukraine.com.ua IMF – International Monetary Fund, a special UNO agency UNBUNDLING – separation of gas transmission from gas supply LNG-TERMINAL – a liquefaction terminal, receiving and and production regasification of liquefied natural gas URENGOY-POMARY-UZHHOROD GAS LPG – liquefied petroleum gas PIPELINE (UPU) – the gas export route connecting the Urengoy Naftogaz offices abroad: MHE – municipal heat generating entities gas field and northern gas fields of Western Siberia to
NAFTOGAZ OVERSEAS S.A. – JSC Naftogaz Overseas (Switzerland) Uzhhorod at the western border of Ukraine RESPONSIBILITY Office in the Arab Republic of Egypt Office in Turkmenistan NEURC – National Commission for Regulation of Energy and USD – United States Dollar Utilities WO – workover operations
3 A ST. 259, New Maadi Cairo, 11311, Egypt ş.Aşgabat, Arçabil şaýoly, Biznes-Merkezi «ABC» AND SOCIAL ENVIRONMENTAL тел.: +202 27543365, +202 25202661 тел.: +99 312 48 01-86; 03-10 NOPLAT – adjusted operating result net of income taxes WORLD BANK – the organization that provides assistance for [email protected] [email protected] development. It comprises two institutions: the International Bank www.naftogaz.com, www.naftogaz-europe.com/en www.naftogaz.com, www.naftogaz-europe.com for Reconstruction and Development (IBRD), and the International Development Association (IDA) Office in the Kingdom of Belgium Naftogaz Trading Europe S.A. Rue Breydel, 40, Brussels, 1040, Belgium rue Dr-Alfred-Vincent 16, c/o SYNERGIX S.A., DISCLAIMER тел.: +32 2 235 8645/44 succursale de Geneva, 1201 Geneva, Switzerland Some statements in this document may be deemed to be “forward looking statements”. Forward looking statements include statements concerning Naftogaz’s plans, [email protected] тел.: +41 22 735 3805, +41 22 735 3807 objectives, goals, strategies, future operations and performance and the assumptions underlying these forward looking statements. Naftogaz uses the words “anticipates”, www.naftogaz.com, www.naftogaz.eu [email protected] “estimates”, “expects”, “believes”, “intends”, “plans”, “may”, “will”, “should” and any similar expressions to identify forward looking statements. Naftogaz has based these forward looking statements on the current views of its management with respect to future events and financial performance. These views reflect the best judgment of Naftogaz’s www.naftogaz.com management but involve uncertainties and are subject to certain risks the occurrence of which could cause actual results to differ materially from those predicted in Office in the Federal Republic of Germany Naftogaz’s forward looking statements and from past results, performance or achievements. Although Naftogaz believes that the expectations, estimates and projections Prinzregentenstraße, 54, 80538, München reflected in its forward looking statements are reasonable, if one or more of the risks or uncertainties materialise or occur, including those which Naftogaz has identified in T.: +49 (0) 89 5880 8466 2 this document, or if any of Naftogaz’s underlying assumptions prove to be incomplete or incorrect, Naftogaz’s actual results of operations may vary from those expected, +49 (0) 89 5880 8466 0 estimated or projected. [email protected] These forward looking statements speak only as of the date of this document. Except to the extent required by law, Naftogaz is not obliged to, and does not intend to, update or revise any forward looking statements made in this document whether as a result of new information, future events or otherwise. All subsequent written or oral forward looking statements attributable to Naftogaz, or persons acting on Naftogaz’s behalf, are expressly qualified in their entirety by the cautionary statements contained throughout this document. As a result of these risks, uncertainties and assumptions, a reader should not place undue reliance on these forward looking statements. FINANCIAL OVERVIEW AND STATEMENTS
Annual Report 2019 244 Naftogaz Group Annual Report 2019 245 Naftogaz Group