Analysis of the Restructuring Options of NJSC Naftogaz Part 1: Public Disclosure Authorized Unbundling options for gas transmission Part 2: Unbundling options for gas storage Final report, 9 February 2016 This work is being done as part of Task 1 of the joint EC-WB Facility to support the Ministry of Energy and Coal Industry of Ukraine and NJSC Public Disclosure Authorized ‘Naftogaz of Ukraine’ on advisory services and technical assistance for the reform and modernization of the natural gas sector The views in this report constitute the consultant’s views and do not necessarily reflect those of the World Bank or the European Commission Public Disclosure Authorized This project is jointly funded by the European Union, This task is implemented the World Bank and the Energy Sector Management by Economic Consulting Assistance Program (ESMAP) Associates Ltd Public Disclosure Authorized Key recommendations Transitional and target structures for transmission and storage: two-step approach The overall unbundling process is suggested to be viewed as a two- step approach, with a transition to full unbundling being accomplished in two steps The first step, in the short term, would be a transitional structure that needs to achieve, as a minimum, the unbundling of the TSO. Given that the TSO is part of UTG, the proposed transitional structure is for the unbundling of both the TSO (transmission operation and assets) and SSO (storage operation and assets) The transitional structure is shown in the next page The longer term possible target structure indicates a fully unbundled system with the main functions of transmission, storage, production and supply/trading separated It could be achieved in say 3-5 years 2 Recommended transitional industry structure Current Ministry of Economic Development and Trade structure NAK Naftogaz UGV Ukrtransgaz Trading & (production) supply TSO SSO Recommended State owner 1 State owner 2 transitional structure NAK Naftogaz UGV Trading & UTG / NewCo (production) supply TSO SSO 3 Analysis of the Restructuring Options of NJSC Naftogaz Part 1: Unbundling options for gas transmission Introduction Description and theoretical assessment of unbundling options Stakeholder views and proposals EU experience Evaluation of options against agreed criteria Conclusions and recommendations Current arrangements for gas transmission and transit in Ukraine – how to unbundle? KEY MARKET & BUSINESS KEY LEGISLATIVE CHARACTERISTICS FEATURES Conformity with 3EP as transposed by Gas Market Law (GML) requires transmission unbundling – Naftogaz via its wholly owned question is which model should be adopted? subsidiary Ukrtransgaz operates: GML allows only OU and ISO models (not ITO) Extensive national gas transmission Naftogaz and its subsidiaries do not own the and transit pipelines transmission and storage assets The storage system They are owned by the State of Ukraine with some ambiguity as to whether they are vested in the State The transit and transmission Property Fund of Ukraine (SPFU) or other state entity infrastructure is not separated Ukrainian Law specifies that the State must remain Transit volumes fell to around 62 owner of gas transmission and storage assets bcm in 2014 while domestic Assets are currently managed by 100%-owned transmission (in 2012-2014) has Naftogaz subsidiary, Ukrtransgaz We understand that the state can grant usage been in the order of 40-50 bcm rights over the transmission system and storage However, transit tariffs represent the facilities (and that such assets would appear on the bulk (88%) of Ukrtransgaz revenue balance sheet of the operator) Transmission revenues are earned by 100% of shares of Naftogaz were transferred to the Ukrtransgaz directly but transit revenues Ministry of Economic Development and Trade ( are received via Naftogaz MEDT) on 18 December 2015 Naftogaz has a long term transit agreement with Gazprom, which expires in 2019 This agreement has not been assigned to Ukrtransgaz 5 The work is being undertaken under the auspices of the European Commission – World Bank Trust Fund 1 Initial assistance to MECI , in refining The Gas Sector Reform the restructuring concept of NAK2 Implementation Plan (forming Naftogaz (under EC-World Bank Trust Fund: Task 1), also contributed to part of IMF MoU) requires developing the Gas Sector Reform transmission unbundling to Implementation Plan (GSRIP) be implemented by June The GSRIP aims to support a stable 2016 framework for Naftogaz restructuring Decision by the Government and unbundling, covering production and price reform as well as transmission according to the GML should be and storage unbundling made by January 2016 The work undertaken by this task Working Group established initially focuses on restructuring and unbundling analysis for the with representatives of key transmission and storage business Ukrainian stakeholders and areas of Naftogaz donors pursuant to the order This report focuses on transmission of the MECI to coordinate this A separate, accompanying report addresses storage work and facilitate decision In a next step it will also include the on preferred unbundling and assessment of options for the restructuring options production business area of Naftogaz 1 2 6 MECI: Ministry of Energy and Coal Industry, NAK: Naftogaz of Ukraine This builds on prior work examining ownership unbundling options for transmission Naftogaz unbundling proposals have What we have previously proposed gone through changes but have Preferred model ownership unbundling, emphasised clear separation of TSO primarily to ensure TSO is incentivised to An evolution of proposals from 2014 invest in the upgrade of the transmission and 2015 on the basis of NAK’s system coordinated with system operation evolving business plan and associated needs implementation plan Advised on legal issues for implementation A number of different unbundling to ensure compliance with 3EP proposals formulated on which we provided comments Highlighted key issues requiring clarification and resolution: Discussion on the implications for the adoption of the ISO model compared to Analysis of whether gas transit agreement the OU model in relation to: with Gazprom can/needs to be assigned to The requirements for meeting the the TSO, or use of the assets can be 3EP/GML unbundling provisions facilitated by direct agreement between NAK/other state entity and independent TSO The tension between options for a minority private shareholding with Clarification that concessions or other European experience, and the legal similar form of usage rights over the requirement to keep fixed assets as state transmission system can be given to UTG property or other entity whether under public or Proposal has since firmed towards a private (full or partial) ownership variant of ownership unbundling How to ensure that public legal persons (discussed later) exercising ownership and control over Supported by McKinsey report (June different gas activities are separate and 2015) for Naftogaz demonstrating not under common influence (eg by the significant adoption of OU model in EU Cabinet of Ministers) 7 The aim is to support Government to make an informed decision on the restructuring of Naftogaz Assessment framework 3 1 EU experience 2 Taxonomy of 4 Review and pros and cons Qualitative assessment against assessment and agreed criteria: of stakeholder theoretical • 3EP compliance unbundling • Ease of implementation assessment • Efficient operation and proposals of unbundling investment ` options • Facilitation of gas market restructuring and private sector participation Conclusions and recommendations 8 Focus is on the structural options; good corporate governance needed irrespective of the chosen model The report builds on The present report examines previous analysis (by us transmission in isolation – and others), discussions storage is assessed separately during the November 2015 in an accompanying report Kiev ‘mission’, subsequent The report does not propose stakeholder proposals, and the specific public body that further meetings and a should exercise ownership control of the TSO (or of other presentation to the gas sector commercial Working Group of our draft activities), but this should be : report in Kiev in January a body consistent with the 2016 principle of separating ownership of system operation We attempt to distil the and transmission from supply main features and issues and production requiring to be addressed addressed immediately in the and resolved to arrive at a next phase of the work decision on the preferred consistent with principles of unbundling option for gas good corporate governance transmission/transit 9 Analysis of the Restructuring Options of NJSC Naftogaz Part 1: Unbundling options for gas transmission Introduction Description and theoretical assessment of unbundling options Stakeholder views and proposals EU experience Evaluation of options against agreed criteria Conclusions and recommendations The unbundling options EU Third Energy Package: three unbundling options (OU, ISO, ITO) Ukraine Gas Market Law*: prescribes one of only two options (OU, ISO) Increasing regulatory requirements control and regulatory Increasing Separate Transmission Vertically Transmission system OU integrated system operation undertaking Owners ownership Separate Separate Vertically Transmission Transmission ISO integrated system system operation undertaking Subsidiary ownership Owners Available options under the Ukraine Gas Market Law Separate Vertically