Forced insurance

 

 

 

 

In anticipation of winter Ukrainian government runs the risk of stepping on the same rake like a year ago. Once again officials are trying to solve the liquidity problems of Naftogaz of Ukraine at expense of private business. Initially 1 October 2015 all suppliers of gas, including independent gas producers may be obliged to create insurance reserves of gas in underground storages in the equivalent of 30-day sales volume. This initiative of Ministry of Energy and Coal Industry of Ukraine was made with the filing of Naftogaz of Ukraine. According to the developers of the document such a step would meet European practice and not conflict with a new law "On Natural Gas Market", which comes into force on 1 October.

The position of Naftogaz of Ukraine as to insurance reserves was announced by Yuriy Vitrenko, its Director of Business Development. Now Naftogaz carries the burden of so called "Warranty supplier”, that in Vitrenko’s point of view means that all imbalances and problems of consumers of gas shall have to be met by the company. Any trader can promise whatever and then at the end of month the client will apply to Naftogaz which will be obliged to maintain supply of necessary volumes of gas. A new law will provide such a function as so called "last resort" supplier. Its function will be to maintain balance for higher price of gas than in the market so that no one could wish to rely on such free option.

 

 

But reference to European experience is nothing but plain manipulation by facts to put it mildly. Indeed European practice is ultimately different from what is now offered by Ukrainian officials. The idea of establishing insurance reserve is threadbare because in Ukraine operating responsibilities for the establishment of an insurance reserve of natural gas already exist. Traders are obliged to create a 10% reserve stock of quarterly deliveries that is roughly equivalent to 9 days of supply (10% of 90 days). To put the other way round it is about 30% of monthly supply volume. But this requirement does not apply to gas companies that, in fact, have a guaranteed share of gas in their fields. Now Ministry of Energy and Coal Industry of Ukraine is willing to reserve 100% of monthly gas supplies and also apply this norm to gas producers. In figures, this is more than 300 million cubic meters to be frozen in storages and simply disappeared from the market. As Roman Storozhev (a President of Association of Subsoil Users of Ukraine) said, gas suppliers will be forced to find additional 2 billion UAH and "freeze" them in underground storages. Reality is as follows. Entire load of creating insurance reserves of gas will fall on its independent producers. They will have to take gas extracted in October into storages to create these reserves. It is despite the fact that companies will not receive a penny from the sale of gas, but pay high royalty that the government still has not deigned to lower although it publicly pledged to do it initially October this year. Given unfulfilled promises as for reduction of royalty from October 1 gas companies will lose incentives to development.

In a new draft decree working out process representatives of Naftogaz of Ukraine also took hand. And the document’s goal was designed just to meet liquidity problem of Naftogaz at the expense of other market participants. Of course 300 million cubic meters of gas cannot solve the problem of preparation to winter but they seriously undermine financial position of independent members of gas market and further strengthen monopoly of Naftogaz.

Initially, Ministry of Energy and Coal Industry put up for discussion a draft decree on the establishment of insurance reserves with less demand as to volume of reserves. The figure was 30 days for the period from October to March and 15 days from April to September. But now demand increased even more up to 30 days for the whole period.

 

 

Analysis of European experience in the development of new decree on formation of insurance reserves requires practice. However, studying itself is to be taken into account also. Requirements of the Ministry both from standpoint of European practice and realities of Ukrainian gas market, which is in its infancy, appear as draconian. Thus, an initiative that was born under slogan of market reforms will fail again or at least face distortion.

With regard to European experience we can say that proposals for insurance reserves considered by Ministry have no direct analogies in the EU.

According to European Energy Community requirements of single countries differ greatly. For example, in Austria, Germany and the UK there is no requirement to establish insurance reserves of gas. In Czech Republic, Denmark, Poland, Spain and Bulgaria requirements to create a insurance reserves of gas exist. Thus the latter are assigned to suppliers and mount for 3-9% of annual consumption (note: current version of requirements for insurance reserves call for a volume of 1 month supply in winter equivalent to 14% of annual consumption that Is more than 2 times higher than in the most stringent practice established in Europe). In Italy requirements for creation of insurance reserves are 7% of annual consumption.

The highest requirements for insurance and strategic reserves exist in Hungary and France. They imply 25% of annual consumption but in these countries most of reserve are to be created via state mechanisms. One should note that only two countries, Italy and Hungary, have strategic reserves. At the same time only Hungary imposes obligation to create insurance reserves and strategic stocks on suppliers.

Also, in different countries different practices are widespread as for calculating base on which the requirements for insurance reserves are to be worked out. The criteria are the following: winter consumption by protected consumers, percentage of total consumption, binding to import (for example, in Poland insurance reserves are required to be created solely by importers of natural gas). Current volume of compulsory insurance reserves in each country, including both types of inventories, varies in the range from 3% in Czech Republic to 24% of annual domestic consumption in Hungary.

 

 

Country	Volume of total consumption, bcm	Volume of domestic production, bcm	Import	Compulsory insurance reserves, bcm	Strategic stocks, bcm	Share of insurance reserves in total consumption
France	45	0	98%	8,02	0,00	18%
Germany	81	11	84%	0,00	0,00	0%
Hungary	8,6	1,9	78%	2,25	1,19	24%
Italy	60	7	90%	4,56	4,56	7%
Poland	16,7	5,26	72%	0,88	0,00	5%
Spain	30	0,04	100%	1,56	0,00	5%
Austria	30,5	1,9	87%	0,00	0,00	0%
Bulgaria	10,11	0,40	91%	0,25	0,00	9%
Czech Republic	8,00	0,25	97%	0,22	0,00	3%
Denmark	2,90	4,70	-78%	0,22	0,00	5%
Great Britain	70,00	39,00	37%	0,00	0,00	0,0%
Ukraine	42,6	20,5	46%

 

New governmental initiatives for private gas producers are reminiscent for last year's Decree 647 which was eventually overturned by the court.

Of course the desire of Ministry of Energy and Coal Industry of Ukraine and Naftogaz to put the task of filling underground gas storages on private suppliers is quite clear. Just as it is also clear that Naftogaz is willing to strengthen its monopoly position in the market and win over key industrial customers in the most profitable winter season. But why is gas market to be destabilized and destroyed this way? Furthermore, it has been created with great efforts during last few years.

A proposal to decrease the scope of compulsory insurance reserves of gas to 10 days instead of proposed 30 would be more acceptable. 10-day volume would be sufficient to cut off unscrupulous market players and guarantee availability of gas in the system. Also, it would be logical to make an exception from the requirement to establish insurance reserves of natural gas for companies with guaranteed resources such as gas production companies. After all they, unlike traders, undoubtedly have gas resources in form of proven reserves in subsoil. Such requirements will meet practice accepted in Europe and be more adequate as to needs and realities of Ukrainian gas market.