In August 2021, it will be one year since the government “cut loose” the natural gas prices for household consumers, thus laying the foundation for a free retail gas market. As a result, Ukrainians received an opportunity to select a gas supplier themselves, based, first of all, on the price offer. However, the hopes of many consumers that the amounts due in their gas bills will become lower were dashed. Prices went up, and in response, the government partially reverted to price regulation. Experts believe that the major reason for this situation is that suppliers operate in unequal competitive conditions.

Ukrainian Energy analyzed the most important results of the last year and the problems and prospects of this market segment.

Achievements of the gas market

The process of opening the gas market in Ukraine was gradual. In 2015, it began to operate on new terms for non-household consumers (with the exception of communal heat supply enterprises). The government regulated the price for households by placing special obligations on regional suppliers and Naftogaz of Ukraine NJSC. They were required to supply gas to households at the price calculated using the government-designated formula. And in August 2020, the market was finally opened for household consumers as well. However, that does not mean that the market’s liberalization has been completed.

“Almost six years have passed since the enactment of the Natural Gas Market Law in October 2015,” DiXi Group Research Director Roman Nitsovych says. “However, the liberalization process has begun even earlier, when this document was still in the development phase and when the plan of reforming the gas sector was approved (it was the spring of 2015). In other words, we have already been through six years of reform, and it still continues.”

This is not a fast process, the analyst points out. The advance depends in many regards on development of both legislative framework and a certain infrastructure of this market (operators, commodity exchanges). Nevertheless, the progress is visible, he believes.

When the gas market for households was launched, many experts expected the inevitable collapse.

“A collapse, a catastrophe, which many expected as a result of certain liberalization of the gas market for households after 1 August 2020, just did not happen,” Roman Nitsovych stresses. “The market has indeed become operational, in particular, thanks to a certain simplification of the procedure of changing supplier, which was adopted before that. Many new companies entered the market, in addition to those that were historically present there.”

As a result, household consumers received, for the first time, the opportunity to select a gas supplier themselves. But at the same time, competition turned out to be limited, because the market was basically dominated by the same players as before.

“There was an attempt to open a competitive market, and that’s a good thing,” Naftogazbudinformatyka LLC CEO Leonid Unigovskyi says. “The educated part of the population (the ones using the Internet and having certain experience in working with these systems) received an opportunity to have access to information and choose a supplier. I think that it’s very important, as Ukrainians are gradually learning how to behave in the conditions of competitive markets. I believe that it’s the most positive achievement of this year.”

Major players received a somewhat different positive experience of operating in the gas market.

“Let’s take a look at the wholesale segment,” Director for Integrated Communications at Naftogaz of Ukraine NJSC, Maksym Biliavskyi, says. “Naftogaz Trading LLC has tripled the number of counterparties from various sectors of economy, particularly the chemical, steelmaking, processing, energy and other industries. It became possible thanks to the implementation of 11 products, including the sale of gas for the current and next months, for the current and next day, and for two months ahead.”

Maksym Biliavskyi, Director for Integrated Communications at Naftogaz of Ukraine NJSC

Speaking about the retail segment, the customer base of Naftogaz of Ukraine GC LLC, for example, is growing, the Naftogaz representative says. As of today, it contains over one million customers.

“The launch of the gas market a year ago became a victory for Ukraine,” DiXi Group expert Viktoria Tkachuk believes. “We became one step closer to a competitive economy, strong consumer and transparent rules.”

However, that does not mean that the things are moving and all problems that hitherto existed in the gas market have disappeared all at once.

Problems of the gas market and prices

According to the NEURC’s forecasts voiced a year ago, the changes that took place in the market had to not only increase the number of suppliers and produce competition but also reduce the gas prices for consumers. However, the gas price started to climb as soon as in October of last year, and in December, certain gazzbut companies charged the price as high as 11 hryvnias per cubic meter. At the same time, the average cost of gas delivery (distribution) increased, beginning from January 2021, from 1.2 to 2 hryvnias per cubic meter, or 1.6 times. In some regions, people took to the streets in “tariff protests”.

This situation forced the government to intervene in the market’s operation: in February, the Cabinet of Ministers imposed a two-month cap on the gas price for households at 6.99 hryvnias per cubic meter, and soon, obliged suppliers to offer a base annual tariff. Therefore, the free market turned out to be not so free.

“In my opinion, price capping is an example of the government’s clumsy meddling with market mechanisms,” Leonid Unigovskyi strongly believes.

In the opinion of Roman Nitsovych, the introduction of a price cap in February 2021 became a big step backwards.

“It seriously obstructed the flow of switches from one supplier to another, and in general, cooled down the interest of players in this market,” the expert explains.

On the other hand, such measures of government regulation as price cap introduced for two months and the regulator’s requirement to market operators to have a base annual offer (annual contracts) prevented the market from slumping. These measures have somewhat cemented the situation, Roman Nitsovych says.

Moreover, certain regulation of energy (in particular, gas) markets takes place in other developed countries as well.

“There is no such thing as a fully liberalized market. In the whole world (to a lesser degree in the United States and Great Britain, to a larger degree in France and Poland, for example), these markets are being regulated. Say, in Poland, regulated prices are in effect for a certain part of the population, and will be abolished only in 2023. The same is true about France, where almost 4 million households receive regulated prices for natural gas,” Leonid Unigovskyi says.

But why the puzzle pieces didn’t come together in the Ukrainian market and the competition turned out to be insufficient to restrain serious price hikes? Experts believe that the reason for a difficult situation in the gas market is the fact that the cheapest resource – gas produced by Ukrgazvydobuvannia – is accessible, in principle, only by historical players: gazzbut companies and Naftogaz, to which Ukrgazvydobuvannia is subordinated.

Because of that, commercial offers from these players are more attractive than those from other market participants.

“So, the market has opened, and there were attempts to create competition,” Leonid Unigovskyi says. “To some extent, it was accomplished, and Naftogaz gas supply company already has more than a million household consumers. But from my point of view, instead of one dominant player (oblgazzbut companies), we currently have two dominant players: oblgazzbut companies and Naftogaz. And if this trend continues, in the future we again will have only one dominant player, Naftogaz. Fact is, for as long as the prevailing access to gas produced by Ukrgazvydobuvannia remains in the hands of Naftogaz Group itself, there will be a danger that by offering the lowest price, they will gradually take over the major part of the market.”

Therefore, experts believe, the question is how to create an equal opportunity for all to buy domestically-produced gas in the wholesale market.

“The access to this resource must be made independent from Naftogaz’s commercial policy and from the bilateral contracts that aren’t transparent,” Roman Nitsovych says.

Commodity exchange as the foundation of healthy competition

The interviewed experts believe that the sales of gas via a commodity exchange on certain standard transparent terms could be an optimal solution of the problem with access to Ukrgazvydobuvannia’s resource. Suggestions like that have already been voiced for a while, but for some reason, the government is not in a hurry to solve this problem.

“The working group for functioning of the natural gas market at the Energy Ministry’s Expert Council, whose member I am, has proposed back in 2020 to oblige Ukrgazvydobuvannia to sell the bulk of gas, but not the entire volume (because back then, there were teplokomunenergo companies with special obligations and own needs, which also should’ve been taken into account), at a commodity exchange. On which one? Let the Cabinet of Ministers decide, but today, I could see only one that’s reasonably sophisticated: Ukrainian Energy Exchange,” Leonid Unigovskyi says.

According to Mr. Unigovskyi, there was also a not bad suggestion from the-then Acting Energy Minister, Yuri Vitrenko, to sell a substantial portion of “Naftogaz’s” gas via Naftogaz Trading, but directly for the subsequent resale to end consumers. But despite these options, the government chose a different approach, capping the retail price at 6.99 hryvnias per cubic meter.

Effective 9 July 2021, the July gas price (for the volume of 50 thousand cubic meters) at the Ukrainian Energy Exchange starts from 15,037 hryvnias per thousand cubic meters. To some extent, it’s a consequence of the rising gas price in Europe, but it also could be a result of another series of manipulations by market participants, experts believe.

“It’s the consequence of a European, not domestic factor,” Leonid Unigovskyi says.

“Record high gas prices observed in July began to grow back at the beginning of this year, following the dynamics of European markets,” DiXi Group Junior Analyst Andrii Ursta says. “It was predictable, because contracts for wholesale deliveries of natural gas in Ukraine are often being pegged to quotes at European hubs. The “unpegging” would hardly be possible in a short term, because for the time being, Ukraine is not a net exporter of gas and does not have its own transparent price indicator, using which, market participants could calculate the gas price.”

Quotes at the Ukrainian Energy Exchange (UEE) cannot serve as such indicator yet, because trading operations at UEE account for only 8% of the entire wholesale market, the analyst says. Therefore, Ukraine will remain dependent on the volatile pricing situation at European hubs.

However, Leonid Unigovskyi believes, Ukraine could depart from import parity formulas if it makes sure that UEE is sufficiently liquid, i.e., that the price indicator is set on the basis of trading operations at our commodity exchange.

“But to make that happen, a resource is needed. And in order to have this resource, we need a program of freeing gas volumes,” the expert adds.

This program should envisage the sales of gas at a commodity exchange on certain terms. For example, selling gas in small lots to make sure that even small traders could buy it and then resell to households. For if a resource is sold in large volumes, one would need to pay large sums for it. Therefore, small companies won’t be able to buy this gas. Another condition is to ensure that any company could participate in the trading for not more than, say, 10 times. Still another condition is to bar from trading the companies affiliated to dominant players.

“These conditions were used in the United Kingdom, Germany, Spain and other countries before,” Leonid Unigovskyi says. “These mechanisms helped create competitive markets relatively fast. Although let me repeat again: every market like that is regulated in a certain way. Moreover, manipulations in these markets are being tracked down. There is a regulation on market transparency in Europe, REMIT, designed to control abuses in wholesale natural gas markets. I hope that a law on REMIT will be adopted in our country as well. Even if it would be a light version of REMIT, it is still extremely important for us to have it.”

According to Roman Nitsovych, speculations occur everywhere, but they in the European Union really watch it, and watch closely. In Ukraine, there are also talks today about implementation of the Regulation on wholesale energy market integrity and transparency (REMIT), which envisages enhanced control over market transactions to make manipulations and abuses of any kind impossible. The only thing, our interlocutor says, is that these measures should not stop or weaken competition, but on the contrary, they must encourage it.

“We’re talking about development of competition in the wholesale segment with access to the gas resource at commodity exchanges. Presently, it was partially liberalized for budget-funded institutions and for operators by adopting a law stating that gas for balancing needs could be bought not just on Prozorro but also on a commodity exchange,” Roman Nitsovych says.

The expert believes that this decision isn’t bad for operators and for companies ordering transmission services. They can sell surplus gas if their customers consume less of this commodity, or buy additional volumes if the demand for this gas is larger than expected.

“In principle, this segment must be developed using both short and long products,” the DiXi Group analyst adds. “In particular, it would be good if the market for futures and forwards in Ukraine grows, thus allowing suppliers to insure themselves against price fluctuations. This risk insurance instrument would bring trading operations in our country closer to realities of the European market. But presently, annual products for households help, in a certain way, smooth out market fluctuations. Therefore, these products are justifiable.”

Prospects of the gas market, or what will happen to prices

Despite the introduction of limitations and the existing problems, the retail gas market did become a reality, experts say. However, the most important questions for household consumers are what gas prices will be in this market and what suppliers will be the best to buy gas from.

“As before, Ukrainian consumers are worried about the gas price and correct gas bills,” Viktoria Tkachuk says. “Price is the most important factor when choosing a supplier. Also, the largest number of complaints received by gas market participants and the NEURC via Energy Online mobile app concerns billing-related abuses.

“In the present situation, when the gas price for the majority of consumers will remain fixed until May 2022 and market instruments frozen, the government must themselves solve the problem of billing monopoly held by gas distribution system operators in order to prevent repetition of the story with “temperature coefficients”.”

In today’s conditions, it is better for consumers to stick to base annual offers from suppliers, Roman Nitsovych believes. However, what will the annual price be the next year?

The analyst explains: “Since Naftogaz has the access to the resource, it decides whom to sell it to and on what terms. Because of that, we have a somewhat limited competition. In other words, there is a price from Naftogaz, and there is a price from gazzbut companies, which contracted this gas before other suppliers. And to be sure, this price range is the most competitive one. The next price “corridor” concerns companies importing gas, which contracted it at a certain price. They added their markup, and the price comes, say, not to 8 but to 9.5-10 hryvnias per cubic meter. However, we can see from the dynamics of, for instance, monthly prices in the wholesale market that they are growing, and therefore, the base annual offer for the next season will be higher than the present one (as we know, this year’s offer can no longer be revised by raising the price). It is hardly probable that it will be lower than 12-15 hryvnias per cubic meter. And that’s absolutely uncompetitive position comparing to the offers placed earlier.”

If someone wants to enter the market and sell gas to households, they will be required to publish their annual offer. This regulation, our interlocutor points out, makes the entry of new players to the market impossible in principle today.

“Obviously, it places certain constraints on further development of both commercial offers and ancillary services for consumers,” Roman Nitsovych stresses.

“And although we see that many electricity suppliers have received a gas supply license, their commercial offers are presently higher than those of companies traditionally operating in this market. Perhaps in the future we’ll see, for instance, postal or telecommunication operators interested in dealing with gas entering this market. The West knows examples of such sectoral integration, when you’re buying not only Internet access or electricity but also gas. The most commonly found package offers in developed countries feature the simultaneous sale of electricity and gas by the same supplier. In our country, we do not see active dynamics for the moment, because of soft regulation (all suppliers to households are required to have base annual offers).”

Because of this situation, the analyst says, the market went toward the growth and the majority of household consumers receive gas at a pseudo-regulated price which, unfortunately, falls behind the market dynamics.

“Therefore, some suppliers will probably operate at a loss, failing to calculate all risks related to price hikes in the wholesale market. Therefore, I’d like to stress one more time: the one who has access to a relatively cheap resource inside the country will win in this situation,” the DiXi Group analyst adds.

At the same time, flaws in the system of protecting vulnerable consumers are becoming more evident in the market, Viktoria Tkachuk points out.

“As we saw in April-May 2021, the government isn’t ready yet to combat energy poverty other than by price regulation,” the expert says. “That’s why the initial surge of the market after introduction of the annual price has, in the end, turned into a disappointing dive. According to data by Gasotheque, consumer activity in the gas market in 2021 declined more than tenfold. Also, small suppliers of gas to household consumers publicly complained on numerous occasions about unprofitability of the retail segment during recent months and their worrying expectations as regards the future of this market.”

Moreover, Viktoria Tkachuk adds, Naftogaz’s future financial result raises serious concerns, too. Every day, this group of companies loses money on the difference between the market price of gas and the too low sale price for households, instead of investing this money in gas production.

At the same time, speaking about prospects of the gas market, Naftogaz suggests that communities take advantage of the opportunities offered by the company through three-year contracts and focus their efforts on improving energy efficiency of teplokomunenergo companies by reducing losses and increasing the share of alternative energy sources. “These changes will boost business activity in regions and reduce utility bills in the upcoming heating season,” Maksym Biliavskyi says.

And in order to make the gas market efficient both for suppliers and for consumers, he believes that digitalization must be completed in every segment, from producer to consumer.

“We must see the entire flow of gas, and then, the environment will indeed become competitive and the quality of services high,” Maksym Biliavskyi adds.

In sum, it is worth noting that today’s retail gas market in Ukraine did not come of age yet, because it differs from its European counterparts by quite limited competition in the segment of supply to households. It remains highly concentrated, because the major players in this market are the same as before: the group of gazzbut companies (mostly affiliated to Dmytro Firtash’s oblgaz companies) and Naftogaz of Ukraine GC, thanks to having access to relatively cheap gas produced by Ukrgazvydobuvannia. To change this situation for the better, Ukrgazvydobuvannia’s gas must be sold at a commodity exchange to all potential suppliers. Moreover, it must be done on equal and transparent terms, which allow even small traders to participate in the trading. It would enhance competition and help avoid peak pricing situations. The ultimate winner will be the consumer, who will have a wider choice of suppliers, and therefore, price offers, a broader range of services and better quality of service.

P.S. What place in the market does a particular gas company occupy?

A presentation of the pilot version of the Rating of Gas Suppliers was held on 23 July. For the first time, independent experts analyzed the retail gas market in Ukraine. The sample covers almost 70% of the retail gas market. So now, learning about marketing and commercial activity of the competitors and analyzing the company’s positioning became much easier!

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