Insight Conversation: Sergiy Makogon, Gas TSO of Ukraine

Interwiew with S&P Global Platts

As part of its transformation into a liberalized natural gas market, forged in the image of its liquid European neighbors, Ukraine’s natural gas transmission network GTSOU was made legally, financially and operationally independent from state-owned company Naftogaz at the beginning of this year, as a requirement of European benefactors who have helped fund the development of the country’s natural gas industry.

As the first anniversary of its independence approaches, so does the next phase of the Russia-Ukraine transit accord, which was signed with the new TSO under European regulations. This next phase will stretch over the next four years, and is likely to see an even greater reduction in Russian utilization of Ukrainian transport, as Russia itself seeks to complete and introduce the Nord Stream 2 pipeline to Northern Europe, circumventing Ukrainian transit in the process.

With these prospects looming, GTSOU’s CEO Sergiy Makogon spoke to S&P Global Platts on September 17 to discuss the network’s future direction in a post-Russian transit environment, how natural gas source diversification for Ukraine is progressing, the benefits of liberal market structures, and the growing pains of introducing them.

In the event that US sanctions are successful in preventing Nord Stream 2 from being completed, how welcoming would you be if tomorrow, Gazprom asked you for a Ukrainian shipping license in addition to the long-term agreement in place?

It was actually part of our initial proposal to Gazprom during the previous negotiations, but Gazprom insisted at the time on some intermediary to minimize the risk related to this. They don’t need a shipper license or something like that, they just need to sign a transportation contract with us, and I believe that after five years of cooperation with us, it will prove that we are a reliable partner even for Gazprom.

From the point of view of a TSO, we don’t have any kind of possibilities which do not involve Gazprom transporting gas through Ukraine. I really think this is more of a political decision than a commercial decision. Gazprom has all the necessary tools to trade on the Eastern border: they have the electronic trading platform which they use to sell gas in several locations. Technically they could add additional delivery points to this platform, and this is the key way in which I see for the Ukrainian traders to get this gas, without Gazprom having to sign a transportation contract with us, and instead just sell gas on the border between Ukraine and Russia. I believe these auctions would be quite successful, but this is solely the decision of Gazprom.

I would like to mention that now we have contracts will all major traders in Europe, all big names, everybody is working with us. These international companies have sent 8 Bcm to Ukrainian storages, so it means that there is trust with Ukraine in general, but also with the operators. I don’t know why there is no trust with Gazprom, but I hope in five years this situation will change, and we will sign the direct contract with Gazprom, but we are also ok working in this current set up as well.

When the Russian agreement expires, how does GTSOU seek to position itself in the future? What can it achieve strategically without large scale, long-term transportation contracts?

We are still the biggest gas market in Eastern Europe, maybe in all of Europe. Our annual consumption is around 30 Bcm, our local production is about 20 Bcm and is growing a little bit, but we expect this to grow fast in the future. So we will focus on growing transportation sales when that applies.

Definitely we will optimize the transmission system and the compression power, because now our maximum capability is 145 Bcm/year, which is around 80% of all European exports from Gazprom. But if Gazprom will not sign a contract to occupy the system, it would be too costly to keep it waiting until when the Nord Stream 2 is on maintenance, and they need just one week of transport.

In the future without the long-term contract, Europe will lose flexibility, and Europe will fully depend on the Nord Stream 1 and 2 pipelines. That’s why we will definitely not keep the system just to wait on somebody ordering transportation for a week or so. I think that Europe in general is neglecting the risk, so when something happens, we can easily add 50-100 mcm/d of gas because our system is flexible and very powerful.

We would insist that the Russian Federation should open the transit possibility for Central Asian countries, which would provide alternative gas sources to Europe. I believe that Europe would be interested in these sources of gas, and we will be focusing on that.

This is why we will also be considering other opportunities to use our system to transport any kind of synthetic methane, biomethane, or hydrogen. We are looking for these opportunities, and I believe Ukraine, together with our gas transportation system, could significantly contribute to this carbon reduction plan of Europe.

What more could your partners in Europe or Central Asia be doing to encourage greater integration?

We will continue fighting with Gazprom, and we will seek the support of the European Union to open the free transit of Central Asian gas to Europe. Ten years ago, Turkmenistan and Kazakstan was able to sell gas to Europe by transiting through Russia. We believe that Europe should be very persistent on this, in order to move the delivery point for all European consumers from the points inside Europe to the point at the border between Ukraine and Russia, minimizing any kind of price discrimination that Gazprom could impose on their clients and countries.

It should be the general position of the EU and Energy Community to create one single European energy market. We are fully ready to be integrated into that market. We believe we can bring significant additional capabilities, such as flexibility and storage capacity. Our storage system is the biggest in Europe, bigger even than Germany, and we believe that the flexibility which we can offer would significantly improve the energy supply security for all of Europe, especially when the LNG deliveries in Europe are growing, we can provide the storage capacities for this LNG, and for suppliers to create strategic stocks to be delivered to Europe in case of an emergency or in the event of extreme weather conditions.

Previously, Ukraine was normally the flexibility provider. Gazprom always used Ukraine to deliver significant volumes of gas in case of such extreme weather conditions and peak demand in Europe. If Gazprom were to accomplish this Nord Stream 2, these pipelines cannot provide such flexibility, they can only provide baseline deliveries of gas, and Europe might not be prepared for such volatility in demand. They will need additional flexibility for that, and Ukraine can provide such flexibility.

We should focus more on the integration of the market, the implementation of single market rules based on European network codes, and Europe should insist on moving the delivery point for Russian gas to the border between Ukraine and Russia, and try to persuade the Russian Federation to open its gas transportation systems for gas deliveries from Central Asia.

How willing do you think Russia will be to do that?

(Laughs) I don’t know. Maybe not very willing to do this.

How effective is your membership of Europe’s Energy Community in promoting your interests as a TSO?

I would like to think that the Energy Community Secretariat played a crucial role in the gas market reform in Ukraine, and certification of unbundling. The team helped us a lot to implement the requirements of the third energy package, to develop the network codes, and we are in very deep co-operation. We have almost weekly calls, and we still have some areas for development for the gas market in Ukraine.

Together with the Energy Community, we have built the foundation for gas market development, and they are now helping us to develop it further. At the moment we are focused on establishing the gas exchange, abolishing the Public Service Obligation, making the market more competitive for transport. So we are building based on fundamental principles such as the third energy package, and also building more sophisticated layers of transport in a competitive gas market.

What investments will GTSOU be making in order to increase transport towards Ukraine and enrich its diversity of supply? How about infrastructure upgrades within Ukraine?

Our import capabilities significantly exceed the export possibilities of our neighboring countries. For example, we can import 6.6 Bcm/year from Poland if the volumes and pressure are available on the Polish side, right now it can deliver 1.2 Bcm/year, so they need to accomplish some system expenditure measures in order to deliver such a volume of gas to Ukraine.

With regard to Hungary, we are interested in access to the Croatian LNG terminal, but our shippers insist on having guaranteed capacities to be able to deliver gas from Croatia, through Hungary and into Ukraine, which for now would be on interruptible capacities. We are in discussion with FGSZ about what they can do to make these capacities guaranteed.

It is the same with Romania and Bulgaria, and the TransBalkan pipeline. We can exit up to 20 Bcm/year of gas on the Romanian border. We have a very strong pipeline system, which was historically used to transport gas to Greece and Turkey. Now it is empty because Gazprom switched to the Turkstream, but we have the pipelines and we can use them to make deliveries.

We are working very successfully with our colleagues to ensure that Ukraine will get additional sources of gas.

Regarding our own infrastructure, we have our own ten-year development plan, we plan to spend $1.5 billion on critical investments, mainly on the replacement of compressor stations. This would ensure that our system would be fully ready to operate without transit flows [on which it currently depends], and that each part of Ukraine will be covered with the needed compression power.

We also invest about $20 million every year on regular maintenance, repair works and diagnostics, and this is enough to keep our system in a well-maintained mode, but the critical investments are just to make our system more efficient. We don’t need such compression power that we have now, and we will have to phase out 60-70% of compression power, because it is simply not necessary.

Our system is capable of transporting 145 Bcm/year from Russia to Europe, but next year we will only have 40 Bcm, so our capability is almost four times higher than the needs of Gazprom. We will need to decrease our capacity just to decrease our costs, because we understand that in five years we will need to be able to provide socially acceptable tariffs in case we lose transit with Gazprom.

We have a very developed, detailed plan, and have already identified the compressor stations which will be liquidated. We are now in the process of preparation, so in five years our system will be fully optimized and operational under the new market conditions.

How has the market dynamic changed since the introduction of Turkstream?

There is just no flow from Ukraine to Bulgaria, Greece and Turkey. The flow was reduced by over 95%, so we just have some minor flows as per the contract with Gazprom in delivering 2.5 Bcm/year of gas to Moldova.

My impression is that Bulgaria has fully switched to the Turkstream, and I understand that Romania is also switching to supply from Turkstream through Bulgaria, and is looking for the possibilities to use this pipeline when it is commercially ready for shippers.

We have already tested delivery of a quite minor amount of gas from Greece to Ukraine, to see if we could physically do it so capacity can be bought along the route, but the price of this gas is not very attractive.

The situation could change. Turkey is increasing imports of gas, and its output is growing. Maybe in the future the dynamics will be different, and economically reasonable for shippers to deliver gas from Greece to Ukraine.

Our task as a TSO is to create these capabilities, then the market and shippers decide how to use these.

To what extent are Ukraine and Romania dependent on each other for gas? Why is Transgaz of Romania so reluctant to sign interconnection agreements with you at certain points?

We don’t rely on each other. Ukraine’s system was used to deliver additional necessary volumes of gas to Romania, because Romania is almost self-sufficient in terms of gas, but during a cold winter, they historically needed these additional volumes, and used our system to get Russian gas to the North of Romania.

This winter, they didn’t use our northern points. They have sourced from Isaccea, but not really significant volumes.

Unfortunately we still have not signed interconnection agreements at all of the points; we only have such an agreement at one. We sent Transgaz our standard interconnection agreements for these other points at the start of the year, but we have not yet received them back.

What do you believe is holding this up?

Maybe demand is not enough for this. We use the same draft interconnection agreements for all other points, the same as the Isaccea one. At least we have not received any comments on the text we have sent!

We believe that from the market development of Ukraine, there is reason to transit through Ukraine. For the market itself, it would make the market better from the consumer’s point of view, to get better gas prices.

With regard to the recently completed Budince maintenance, what reassurance can you give to European shippers that future purchases in Central markets earmarked for export to Ukraine will not be stranded again?

The Velke Kapusany pipeline still has free capacity, so it would not be correct to say that somehow maintenance on Budince was limiting the import to Ukraine. If shippers still need to import gas into Ukraine, they can buy capacity at Velke Kapusany.

Unfortunately, EU Stream is not offering capacity on Velke Kapusany for October. We have sent an official request several times to EU Stream and the Slovakian regulator asking the reason why capacity at Velke Kapusany is not being offered, seeing as we need to run the auction according to the capacity allocation mechanism network code (CAM NC). Shippers are hesitant to buy the capacity on our side if they do not know they can purchase capacity on the Slovakian side.

So that is why there is still a significant need to align the procedures on both sides of the border based on the standard network codes, and CAM NC. Such an approach would ensure that shippers would have a clear understanding and very transparent allocation rules on both sides.

What progress has been made in aligning these procedures?

I did not expect that this situation could happen, because even when we had the discussions with the European Commission, I said that we were able to agree on European rules on the border between Russia and Ukraine, but we can’t agree them on the border with Slovakia!

There are loopholes in the regulations saying that this is voluntary for a member state, but we in Ukraine spent a huge amount of time and resources in order to implement what was required from Europe, like all these network codes, the Third Energy Package, the unbundling, and moving thousands of people within the company just to satisfy these requirements. We have spent almost three years working on this.

And then, finally, we realize this is not enough, and that Europe is not ready to implement to European network codes at the border with Ukraine! I personally was very upset by this situation.

We are in discussions with ACER and the European Commission. We’ve also had a call with the Slovakian regulator, and I hope that this issue will be solved, because both sides will benefit.

I believe that we and the Slovakian TSO, and our route between the Ukraine, Slovakia and Baumgarten creates significant business opportunities. Just the fact we can deliver gas into our storages, and we can make a lot of business opportunities there. I also believe we will find a solution and continue to grow business opportunities together.

Is there a movement to try and persuade Slovakia to change their mind, or even for the European Commission to change the regulations?

There are several European bodies involved in this, including the Directorate for Energy, ACER and ENTSOG. We are in discussion, but as you know, there is COVID-19, and also the allocation periods, but I expect the speed of such negotiations to increase very soon.

The goal of the Energy Community is to create one European, single energy market, based on the European network codes, so that’s why within the Energy community we need to resolve any problems or misunderstanding between operators. But in general, we must find the solution by implementing new rules on the border between Ukraine and Slovakia.