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'Why so expensive?' How much does Ukrainian gas really cost?

Author : Olena Holubeva

Along with the increase in gas prices for the population, experts began to argue about its fair price. They talk about different numbers, up to $ 50 per thousand cubic meters. We tried to calculate the real cost of Ukrainian gas production
21:47, 31 October 2018

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How the gas price is formed?

As you know, the Cabinet announced the growth of gas prices for Ukrainian population. According to the text of the decree number 867 of October 19, 2018 - from November 1, 2018 to April 20, 2019 the price of gas for the needs of the population with VAT and transportation costs will be 8550 UAH (303 USD) per 1 thousand cubic meters. From May 1, 2019 year to December 31, 2019 - 9851.66 UAH (350 USD) per 1 thousand cubic meters, from January 1, 2020 - 12,313.85 UAH (437 USD) per 1 thousand cubic meters, the press service of the Gas Market Association reports. For now the document is published only on the government website. It will come into force after the publication in the "Uriadovy Courier" newspaper. Thus, in three stages, gas for the population will rise in price by 71%.

It should be noted that according to the decision of the Cabinet of Ministers, 100% of the gas produced in Ukraine by the state-owned Ukrgasvydobuvannia is supplied to meet the population’s demand for natural gas - last year the company transferred 15.2 billion cubic meters to the needs of the population, while the total demand is estimated at about 20-22 billion cubic meters. We note that for several years the monopoly right to buy the gas from Ukrgasvydobuvannia has been assigned to Naftogaz Ukraine. Until recently, the state-owned company bought it at a fixed price of 4849 UAH (172 USD) for 1 thousand cubic meters without VAT.

Now, the price of gas purchase for the state-owned company will increase in proportion to the increase in the supply price of the PSD (Provisions for imposing special duties). The price at which Naftogaz will buy Ukrvydobuvannia gas will be determined by paragraph 12 of Resolution No. 867, taking into account the Naftogaz trade allowance - 1.917% of the specified price, the company’s press service reported. Note, paragraph 12 of the resolution contains the formula according to which the price of gas in PSD is calculated as the arithmetic average price of the sale / supply of gas by Naftogaz Ukraine for industrial consumers. But the condition is advance payment of the price for the period of gas supply, which was valid from July 1, 2018 to September 30 2018 (8991 UAH / 319 USD per 1 thousand cubic meters according to Naftogaz price list) multiplied by the discount rate.

From November 1, a coefficient of 0.6943 will be applied, from May 1, 2019 - 0.8, and from January 1, 2020, the sale will be carried out at a price not higher than the arithmetic average price of gas at which Naftogaz offers gas to industrial consumers under condition of prior payment by the period of gas supply.

As specified by the Gas Market Association press service, earlier the State Regulatory Service approved the new PSD edition, which provided for equal access of all market players to domestic gas. The right to purchase the resource of Ukrgasvydobuvannia was granted to all suppliers who were willing to supply gas to household consumers," explained the press service of the Gas Market Association.

In the case of liberalization of access to domestic gas, commercial companies would be interested in trading it, says Director of ExPro Ukraine Gennady Kobal. According to him, traders could earn what Naftogaz is currently earning (93 UAH / 3.3 USD per thousand cubic meters). But it would be especially profitable for companies to work if the PSD price would be higher than the market one. In addition, domestic gas, unlike imports, is always available, Kobal adds: "The price of gas from Europe varies depending on the market situation, on the hryvnia exchange rate."

"ERU Trading" (one of the largest traders on the gas market in Ukraine) is positive about opening access to the resource of Ukrgasvydobuvannia for suppliers who want to sell it to household consumers, confirmed the director Yaroslav Mudryi. "We believe that the implementation of the initiative will not change the price of gas (for end consumers, - ed.), but the level of the trade allowance will be set by each supplier separately (within the limits provided for in the draft resolution of the Cabinet of Ministers), which can create an additional advantage in terms of competition of the market gas supplies to domestic consumers, "he says.

What is the cost of Ukrainian gas?

In the context of increasing gas prices, the most important question is “How much does Ukrainian gas actually cost?” Note that in an interview with Ukrainska Pravda on October 4, Oleg Prokhorenko, the head of Ukrgasvydobuvannia, said that the cost of a state company’s full gas production cycle - from the start of drilling and production to the well shutdown - can vary from 180 to 250 dollars per thousand cubic meters. Taking into account the current rate, this is 5000–7000 UAH for 1 thousand cubic meters. If so, then it turns out that Naftogaz until recently bought the gas from its daughter at a price below the cost price (by 4849 UAH / 172 USD for 1 thousand cubic meters)?

A source, well acquainted with the pricing of Ukrainian gas, told 112.ua that the cost of gas production at Ukrgazvydobuvannia without investments made in the development of fields, rent and other financial expenses does not exceed UAH 1079 ($ 38) for 1 thousand cubic meters. Judging by the financial report of the Ukrgazvydobuvannia for the first half of 2018, the rent, the cost of production, operating expenses and income amount about 3040 UAH (108 dollars) in every thousand cubic meters of gas produced. According to our calculations, approximately this amount one thousand cubic meters of gas cost in the first half of 2018, excluding the necessary investments. Of course, the figure is very conditional, but it’s just for a common understanding.

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“Considering that Ukrgazvydobuvannia is investing huge amounts of money in drilling, exploration, and intensification in depleted wells, they can actually have a high cost, more than $ 150 (UAH 4,200) per 1,000 cubic meters. The minimum cost of already developed fields (brownfield) taking into account taxes (for other mining companies, - Ed.), usually starts from $ 100 (UAH 2800) per 1 thousand cubic meters," says Gennady Kobal.

There may be several methods for calculating the cost of gas, but, for example, in private production companies in Ukraine when developing new fields in the Dnipro-Donetsk Basin (the main gas production area in Ukraine), taking into account the cost of geological exploration, the duration of the license, including drilling for a depth of 2-5 km, the cost can be $ 185-225 (5,200–6300 UAH) per 1 thousand cubic meters. The calculations are correct in accordance with the figures relevant in the first quarter of 2018, says the head of the gas and energy market research department of the Ministry of Economic Development and Trade of Ukraine Lubomyr Vasyunik.

Vasyunik specified that if Ukrgazvydobuvannia was selling the produced gas on the open market to industrial consumers, then as of October 2018 it could cost about 12 000 UAH / 426 USD for 1 thousand cubic meters, depending on the volume of delivery, payment terms and other terms of contracts, excluding the cost of transportation by main pipelines and fees for the use of distribution networks.

Why do we need investment in the gas industry?

So why gas for the population costs not $ 100-150, as at the cost of production, but much more? If not to mention the government’s habit of patching the state budget holes at the expense of Naftogaz and the wallets of Ukrainians, then there are purely economic reasons for this.

Ukrgazvydobuvannia management does not deny that they take into account capital investment while forming the cost of gas. “Taking into account the processes in state-owned companies, the cost of gas cannot be reduced. The reason is that the company is investing huge funds in re-equipment,” said Mykhailo Paduchak, Head of Drilling Department.

From 2016 to 2020, according to the 20/20 program (an increase in production to the consumption volume of 20 billion cubic meters per year, - ed.), it was planned about 4 billion dollars of investment, ¾ of which is intended for implementation of projects to increase gas production from drilling, re-equipment of drilling machines and improvement of infrastructure for drilling operations.

By the end of the year, Ukrgazvydobuvannia plans to commission 87 wells (of which 13 are to be received from external contractors). Next year it is planned to drill another 131 wells. During the period from 2007 to 2014, Ukrgazvydobuvannia commissioned an average of 55 wells per year.

Drilling wells is the main and one of the most effective methods for increasing gas production. In particular, this year it was possible to increase production by almost 25 million cubic meters, another 25 million cubic meters we received due to the overhaul of wells at the second largest field - Yablunivske. Over the past year, about 1 billion cubic meters of gas was produced at the field.

Another area requiring significant costs is the technical re-equipment of its own facilities.

“Branch of the company Ukrgazvydobuvannia company – Ukrburgaz until 2017 worked with outdated, non-upgraded equipment, which did not allow drilling high-quality wells in a short time, which therefore made it impossible to increase the volume of produced gas. In this regard, the drilling rate was very low - drilling of one well with a depth of 5,000 meters took up to three years. The commercial drilling rate of its own mashinery was 270 meters / machine-month (now, thanks to the modernization and improvement this indicator increased to 450 m / machine-month). For comparison: for external contractors the commercial speed is 1100 m / machine-month, which significantly approximates the start of gas production, "said Paduchak, noting that the time spent on drilling is one of the key factors affecting the total cost of gas.

Now, Ukrgazvydobuvannia claims that they buy the most high-tech equipment. The cost of acquired new machines for drilling with large carrying capacity is 12-22 million dollars per unit. In total, it is planned to purchase 20 machines, contracts have already been signed, and by the end of the year 8 machines will be delivered to Ukraine. And the next 12 machines will come before the end of July next year, Paduchak specified.

“Processes of cardinal changes in the life on drilling sites have been launched. At each site, a position of labor protection engineer, a medical worker with equipped cabinet and first medical aid equipment is introduced. Previously, there was nothing of the kind. For the resettlement of people, the company buys modern trailers with proper conditions. The employees will have a toilet in the room and a shower with hot water. Of the required 800 wagons, about 77 wagons have already been purchased", said Paduchak.

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At tenders, Ukrgazvydobuvannia is planning to purchase better and more expensive clothes for Ukrburgaz employees. Each driller will have two sets of changeable clothes (and not one, as it is now).

In order not to lose the pace of drilling, at the time while re-equipping its own machinery, Ukrgazvydobuvannia attracts external contractors whose work is more expensive ($ 18-24 thousand per day for one machine). “If we analyze the cost of a meter of drilling, then external contractors are somewhere twice as expensive comparing to our own. At the same time, they drill three times faster,” said Paduchak.

The company is currently working with three external contractors: the Croatian Crosco, the Chinese Beiken and the Ukrainian Spetsmehservis.

The Ukrgazvydobuvannia notes that they now have to work in the fields, many of which are already depleted. In the reservoirs of many fields, pressure has already been reduced, and it is not so easy to produce gas. The largest fields of the state company - Shebelinske and Yablunivske are depleted by 90% and 70% respectively. The first well at the Shebelinske field was drilled in 1950, at the Yablunivske - in 1977.

In order to increment reserves, Ukrgazvydobuvannia requires greenfield projects (exploration and discovery of new deposits). This also requires larger investment comparing to existing fields. Greenfield means much more money and time, as in this case we are talking about geological exploration, geophysical surveys (2D and 3D seismic), exploratory drilling. And we can’t be sure that the gas will be found. When 1 or 2 of the drilled wells can be dry and only a third can produce gas, oil or condensate, experts say.

“Today, due to the lack of a license offer and the blocking of special permission approvals by the regional councils, Ukrgazvydobuvannia is experiencing the greatest difficulties with the development of greenfield direction. The greatest resistance is felt from the Poltava Regional Council. In particular, over 2016-2018, Poltavagazvydobuvannia (a division of Ukrgazvydobuvannia) received 63 refusals from the Poltava Regional Council regarding permits for new areas of gas production or expansion of existing ones, ”said 112.ua Mykhailo Paduchak.

Ukrgazvydobuvannia also invests in intensification projects (hydraulic fracturing, gas lifting) to increase production at already obsolete fields.

* * *

Every Ukrainian who pays for gas and heat generated from it participates in the program for the development of Ukrainian mineral resources and the increase in gas production in the country. Of course, we could refuse, but in this case, gas production volumes would not only stop to grow, but would also decline rapidly - we would have to buy imported gas, which is more expensive than domestic one.

I don’t know whether the idea that we all invest in domestic gas production can warm someone in the winter, when we have to pay for gas at new prices. However, no one asked the Ukrainians’ opinions on this topic, and the choice has already been made for us.

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