Natural Gas Market: European Requirements in Ukrainian Realities

On 9 April 2015 the Verkhovna Rada (Parliament) approved the On the Market of Natural Gas Act of Ukraine (further — the Act) in its second reading. To a large extent, the Act met requirements of the Secretariat of the European Energy Community. It will come into effect in October. Its objective is to streamline the operation of market participants according to market rules and to ensure that the market is open to all providers. Therefore, we propose discussion of some provisions of the Act.

The Act provides separation of the functions of gas supply, transportation and distribution. Thus, NJSC Naftogaz will cease to be a monopoly in the market. What should be expected from its reorganization?

Oleh Malskyy, partner, head of corporate and M&A, AstapovLawyers

National JSC Naftogaz is about to be in for a big change — this is at least declared and stands out from the new Act. The Act was passed to implement the Third Energy Package initiated by the EU. The basic principle of this package is to demonopolize the market and make it more competitive. All the principles are clearly stated in the Act, which would allow free trade with natural gas, equality between all the market players and the state, free choice of the supplier, freedom to import and export natural gas, etc. The Act also foresees segregation of different subject of gas trading, segregation of extraction, transportation, distribution sale, etc. It all sounds very good on paper. The biggest question is whether and how it will be implemented and exactly how it will influence the destiny of NJSC Naftogaz.

Several provisions of the Act try to define the line between the dominant monopoly and other market players. It is not known where that line will be drawn in practice. According to the Act, the natural gas market should function freely and be competitive. But later it says: “with the exception of activities of natural monopolies”. Later it also clarifies that it is prohibited to limit competition of natural gas market players, including by subject of natural monopolies and state companies. However, it is still unclear on where the lines of this abuse are, so who exactly will define this? Theoretically, NJSC Naftogaz should be divided and its subsidiaries should be separate, should not be cross-subsidized and should function as separate legal entities and not one big entity. How that will happen and when, most likely will be clarified by additional legal acts, decisions of the Cabinet of Ministers, regulations, etc. It is not clear when those will be accepted, adopted and implemented.

The trend generally is very, very positive. However, implementation still remains to be carried out. Another more interesting thing is Article 51 of the Act, which sets special rules for those who have “take or pay” provisions in their contracts. It is no secret that NJSC Naftogaz has such provisions in its contract with Gazprom, which is valid until 2019, and it may be presumed that since those provisions are in place, no major restructuring of NJSC Naftogaz, which includes the state monopolist of the gas extraction — PJSC Ukrgasdobycha — and transportation — PJSC Ukrtransgas — may be in place because of those contractual limitations and a loophole in the Act.

Furthermore, the restructuring of NJSC Naftogaz may just be the first step before the privatization of different parts of the gas market and gas players in Ukraine. Time will show how fast and how effective the Act will come into effect. As Machiavelli said: “I never asked how good the Acts are, I ask how they are implemented”. This will also be the case for NJSC Naftogaz. 

 

 

The Act is essentially a framework document. Efficiency of further reforms depends on approval of a large number of regulations. Which of these documents should be a priority for ensuring uninterrupted movement towards the sector’s reform?

Yaroslav Petrov,  counsel, Asters

The Act, envisages that almost all sections will come into effect from 1 October 2015, and several articles — after 1 January 2016. However, Paragraph 1 of Part 2 of Article 22, Article 33 comes into effect from the day the Act is officially published. These articles state that the gas transportation system operator should draft a Gas Transportation System Code and the National Commission for State Regulation of Energy and Public Utilities (the Regulator) is to adopt the Gas Transportation System Code within 60 days after the gas transportation system operator submits such draft to the Regulator. Consequently, it may be concluded that the Gas Transportation System Code is among the first regulatory acts that must be adopted.

From 1 October 2015 the On the Principles of Natural Gas Market Operation Act of Ukraine comes into effect. Under such circumstances and subject to the requirements of the Act relevant subordinate legislation needs to be amended.

The Act stipulates that the Cabinet of Ministers of Ukraine (the CMU) must introduce amendments to relevant regulatory acts to reflect adoption of the Act. Such amendments should be introduced within two months after the Act comes into effect. 

Before 1 October 2015, the CMU, central executive bodies, and the Regulator must ensure the adoption of subordinate regulatory acts as provided in the Act (except the gas transportation system operator certification procedure) and revision or repeal of its own regulatory acts which contradict the Act. For instance, one such act is the Procedure for the Access and Connection to the Unified Gas Transportation System of Ukraine ratified by the Resolution of the National Commission for State Regulation of Energy of 7 May 2012, because there are a considerable number of conflicts between the regulations of the Resolution and the Act, which must be revised in line with the Act.

Finally, before 1 January 2016, the Regulator is to ensure adoption of the gas transportation system operator certification procedure.

At present, more and more experts are sharing the opinion that despite the progressive nature of the Act in general, further regulations that need to be approved may retain the privileged situation of financial-industrial groups. What should be considered when developing the relevant legislation? Which existing legislative provisions imply potential risks?

Vyacheslav Krahlevych,  partner, FCLEX Law Firm

The provisions of the Act are intended to bring existing legislation into compliance with EU legislation. As for the novelty of this Act, it is worth noting the following. Thus, the Act expressly provides that in the application of this Act the government authorities and courts take into consideration the enforcement practice of the Energy Community and of the European Union, in particular, the decisions of the Court of European Union (the European Court of Justice and the General Court), and the practice of the European Commission and of the Energy Community Secretariat. That is, in Ukraine, the law of the European Union has taken effect at the legislative level. In addition, Ukraine has permanently fixed provisions as to the application of case law. In addition, the Act obliges the subject of government authority, whilst making decisions (actions) on the basis of this Act, to take them so that they can be in line with the principles of proportionality, transparency and non-discrimination. The Act discloses the aforesaid principles. That is, in this area of relations, the legislator clearly determined for the subjects of governmental authority the appropriate decision-making procedure aiming to prevent any abuse and  illegal decisions. Also, the Act requires that businesses in this area share their activities and that each of them depend on their own other activities. Consequently, legislators decided to clearly distinguish between market participants according to the area of activity. The positivity or negativity of the decision can be assessed  in the future. Moreover, the Act allowed the gas distribution system’s operators to have the right of unrestricted and free access to all land of any form of ownership where a gas distribution system is located, in order to perform their duties prescribed by law. That is, in order to ensure safety in gas distribution systems and ensure sustainability of its functioning, the legislator conferred the necessary competence upon operators to make it possible for them to perform those functions. The Act also contains other progressive provisions and novelties. In conclusion, consideration must be given to the fact that the provisions of the Act are quite progressive and necessary to current social relations in the area. In addition, by adopting the Act Ukraine once again confirms its persistent intention to became part of the European Community.

 

One of the key issues in efficient implementation of the Act is the antimonopoly regulation. What changes are needed to the relevant legislation? How would it affect the competitive environment in the sector?

Alexey Kot,  managing partner, Antika Law Firm

Adoption of the Act was one of the key conditions of the EU for signing the Association Agreement. The need for diversification of the gas market brewed a long time ago, and strong monopolization of the market did not contribute to its development.

The adopted Act was developed with the assistance of European experts and was discussed with entering amendments for a long time by professional communities. Despite the fact that the most critical issues have been resolved by the Act and the Act is far from being ideal. Practical implementation of the Act requires adoption of more than 150 (!) regulatory acts by different ministries and departments. Another problem is the implementation of the provisions as to the division of market participants in practice. In any case, unfortunately, a significant effect from the adoption of the Act in the near future is unlikely.

From the standpoint of antitrust regulation the Act is progressive enough and focuses on the latest trends of regulation and practices of the energy market in the EU. However, the Act does not provide an answer to the key question − how will the provisions aimed at defeating monopolistic tendencies work in practice. Unfortunately, the gas market is highly politicized. As of today the Antimonopoly Committee of Ukraine feels pressured, especially when questions relate to  politically sensitive issues. More than a year has already passed and there are still no appointments  of the new head of the AMCU and state commissioners. We can recall the situation as regards the imposition of heavy fines on regional power distributions companies for monopoly abuse. As is known, the fines were eventually reduced significantly.

In any case, before making any final conclusions we should wait until the moment when the Act is  in force.

What role will the regulator play — the National Commission for the State Regulation in Energy and Utilities? What tools will be given to the regulator to control transparency and equal competition among market participants? Does the Commission have sufficient powers to perform its functions?

Pavlo Byelousov,  counsel, AEQUO Law Firm

As a contracting party to the Treaty establishing Energy Community Ukraine (which acceded to the Treaty establishing Energy Community on 1 February 2011), is obliged to implement the acquis communautaire on energy and competition in accordance with the terms set out in the Protocol concerning the Accession of Ukraine to the Energy Treaty of 24 September 2010 in Annex I to the Treaty.

The acquis, inter alia, includes the EU rules and legislation on the gas market, the so-called Second (Council Directive 2003/55/EC, Regulation (EC) No.1775/2005 and Council Directive 2004/67/EC) and Third Energy (Directive 2009/73/EC and Regulation (EC) 715/2009) Packages. While the Second Energy Package has been implemented by Ukraine to a great extent, the Third Energy Package is pending transposition to Ukrainian legislation.

The new Act is to implement into Ukrainian legislation the mentioned EU Third Energy Package providing common rules for the internal market in natural gas, and terms and conditions for access to the natural gas transmission networks together with additional norms implementing rules of the Second Energy Package which were not fully covered before (e.g., unbundling requirement, measures to safeguard security of natural gas supply). The Act was drafted with the Energy Community Secretariat’s assistance and represents a fundamentally different approach towards regulating and developing an efficient and competitive environment in the natural gas market in Ukraine in line with EU rules and requirements. This Act is pending the signature of the President of Ukraine and official promulgation to come into force, but the majority of its provisions will not enter into force before 1 October 2015.

The government should determine the mechanism of transferring the low pressure gas distribution network that is currently used by regional gas companies to other operators. How can this be legally performed? 

Maryna Ilchuk,  associate, Arzinger

Returning to Ukrainian realities, it should be noted that under Resolution No.770 of 20 August 2012, state gas distribution networks were handed over into the economic control of regional gas companies (oblgas). At the same time, the new Act provides that the gas distribution system owned by the state may not be in the use of the operator of the gas distribution system under the right of economic control, except when such operator is a state company. The adopted amendment entitles the state to take payment from the gas distribution companies (oblgas) for usage of gas distribution network. When choosing the appropriate form under which oblgas will use the gas distribution network, it should be mentioned that the On Lease of State Property Act of Ukraine and the On State Property Privatization Act of Ukraine prohibit both lease and privatization of the gas distribution system. As regards concession of such network, Ukrainian legislation allows concession in the sphere of distribution and supply of natural gas. However, the unbundling requirement shall be complied with. Namely, one company cannot at the same time operate the network and supply the gas. In addition, when applying the concession scheme the question of investment return arises, as payment by the oblgas companies for usage of the distribution network will inevitably lead to a tariff increase for consumers.  Consequently, the Act provides for the unbundling requirement, but not the mechanism under which oblgas will use the gas distribution network.

How can European regulations on the Ukrainian gas market attract investment into the industry? How could this affect the competitiveness of the domestic GTS?

Yuriy Draganchuk, senior attorney, Sayenko Kharenko

The Act is definitely a significant step forward in the process of integrating the Ukrainian and EU gas markets. The Act transposes the basic principles and requirements of the EU’s Third Energy Package for gas. It establishes clear rules in Ukraine, which are common to EU investors and market players, in particular, unbundling requirements (de-monopolisation of Naftogaz), and equal access for market players to the gas transportation system, gas transmission system, gas storages and LNG terminals. In addition, the Act provides that the transportation tariffs shall be based on enter/exit points and secures the customers right to change the gas supplier. These new developments aimed at boosting transparency shall, as a consequence, increase the attractiveness of the Ukrainian gas market for foreign investors.

At the same time, the Act only establishes the legal framework for the gas market’s liberalisation and requires the adoption of numerous laws of primary and secondary legislation in order to fully implement its provisions. However, taking further necessary implementation steps (as required under the Act and outlined in the Action Plan on Gas Sector Reform approved by the CMU Resolution of 25 March 2015, No.375-p) shall result in raising the competitiveness of the Ukrainian gas market and attracting European gas players and investors needed to modernise the gas pipeline system. In addition, such measures shall ensure better protection of Ukrainian customers and improvement of Ukrainian energy security.