Why Gas Prices For Industry Increase By 45% And Who Profits From It

Since March 2024, the price of gas in the unregulated segment has increased by more than 45%, from 11.2 UAH per cubic meter to 16.25 UAH per cubic meter in December 2024 (excluding VAT). It is in the unregulated segment that Ukrainian companies buy this energy carrier, so such a significant increase in gas prices hit the Ukrainian industry hard and further boosted inflation in Ukraine.

Unfortunately, neither the Ministry of Energy nor the National Energy and Utilities Regulatory Commission has paid attention to the situation so far. Therefore, I will try to analyze it personally, based solely on publicly available data and my assumptions.

Currently, the price in the unregulated market segment is determined mainly by the results of gas trading on the exchange. Figure 1 shows the dynamics of the gas price on the exchange: there has been a steady increase in the price throughout the year. Even in dollar terms, the price increased from $283 per 1,000 cubic meters in March 2024 to about $385 in December. This is almost a 35% increase in dollar terms, taking into account the devaluation of the hryvnia from 38 to 42 UAH to the US dollar.

According to basic economic theory, the price of a commodity in a free market is formed by the interaction of supply and demand, and significant fluctuations are mostly associated with corresponding changes in either of them (or both).

However, there have been no significant fluctuations in gas supply and demand. According to official information, in 2024, gas production increased by 2.2% and reached 19.1 billion cubic meters (see Figure 2). There was no significant increase in gas consumption in 2024 (approximately 1.8%), and industrial consumption has fallen significantly since the beginning of the war. That is, there is a surplus of gas in the unregulated market, which should lead to lower prices for industry, but they are rising.

It makes no sense to attribute this to rising prices in European markets, as gas exports from Ukraine have been banned since March 2022 and are unlikely to be allowed until the war ends. Therefore, when there are no exports and imports, domestic gas prices do not depend on European prices.

Some may say that if we are building a free gas market, then the price formed by participants on the commodity exchange reflects real market prices. In theory, this is true, but in Ukrainian reality it is not.

Firstly, in Ukraine, participants prefer not to use exchange instruments associated with full-fledged exchange trading in gas, as it is understood in the developed world, with anonymous trading in standardized products, a single order book for all buyers and sellers, a clearing system and enforcement of transactions. Almost 99% of gas is traded on our exchange not on the standardized exchange segment, but at a one-sided auction, where non-anonymous gas sellers or buyers place their non-standardized bids. Therefore, the trading mechanism chosen by Ukrainian market participants is hardly comparable to the classic exchange trading in the EU. Rather, they use a kind of platform that simply allows customers to organize gas purchase or sale procedures.

Secondly, Naftogaz of Ukraine purchases very significant volumes of gas from private producers through the exchange, which greatly affects the price on the latter. According to Naftogaz statements, in 11 months of 2024, the company purchased almost 1 billion cubic meters of gas from private producers through the exchange, which accounted for 50% of the total trading volume on it. Obviously, a company with such a share of purchases can significantly influence the price on the gas market, both upward and downward. But in 2024, the price of gas at the auction mostly increased.

No one is aware how Naftogaz forms its procurement policy and how it determines the initial gas purchase price. However, I can assume that there must be some internal document according to which the company’s executives independently determine what offers the company makes to the exchange when purchasing gas.

I still don’t understand the economic sense for Naftogaz to buy such significant volumes of gas from private companies, considering that it sells gas to its customers mainly at regulated prices under the public service obligation (PSO). And the price there is much lower than the price of these purchases. Naftogaz sells gas to households at UAH 6.63 per cubic meter without PSO (UAH 7.96 with PSO), to сombined heat and power plants (CHPs) and thermal power plants (TPPs) at UAH 9.125, to regional gas companies for gas losses at UAH 6.183 per cubic meter, etc. Naftogaz usually does not sell gas to industrial consumers at unregulated prices because of the existing competition from the same private gas producers. So how Naftogaz of Ukraine makes a profit from purchasing 1 billion cubic meters of gas at 12–16.25 UAH per cubic meter is a big question for me. Although this question should be of interest primarily to the company’s independent supervisory board, which should be concerned with its profitability and operational efficiency.

I assume that with the ban on gas exports and the surplus of gas in the unregulated segment, the government decided to informally oblige Naftogaz to buy gas from private producers to enable private companies to sell the gas they produce with sufficient profit to allow these companies not only to continue their operations but also to invest in new production. And it is very important to increase domestic production because the country still consumes more gas than it produces, so there is still a minor need for imports (1–1.5 billion cubic meters per year), which will increase with economic recovery and growth in gas generation.

However, the state could have taken a different approach to solving the problem of gas surplus in the unregulated segment by reducing the share of the regulated gas price segment (supply to regional gas companies, power companies and district heating companies). Of course, these steps are considered unpopular. That is why they decided to do what they always do: to support private producers in a non-transparent way through gas purchases by Naftogaz.

However, the question is through what mechanism and at what price Naftogaz should buy this gas. Theoretically, there were two ways.

The first is to buy gas at the export parity price, but then it would be necessary to impose additional taxes on the excess profits of producers because the price in Europe in 2024 reached $550 per 1,000 cubic meters.

The second option is to voluntarily buy back surplus gas at a price that would guarantee the necessary profit for producers. But what should this price be? At one time, the business plans of the main gas producers in Ukraine were calculated at a selling price of $220–240 per 1,000 cubic meters, which reflects the real long-term range of gas prices. Naftogaz could have offered even $280–290, which would have included an additional margin of 15–20% for “risk” to the profit margin already included in the business plans.

However, a third way was chosen. Naftogaz started buying gas from private companies, but the state did not set the price for such purchases. They also introduced additional benefits for producers, allowing them not to pay rent in the month of gas production, but only during its sale. This began to encourage producers to simply pump gas into UGS facilities without paying rent and wait for better prices or the opening of exports. This is the best asset in which to keep money and which does not lose value. At the end of the year, private companies had almost 1.6 billion cubic meters of gas in the UGS facilities. And at the same time, Naftogaz was buying back gas that producers wanted to sell if they needed cash. At the same time, the price on the exchange where Naftogaz bought gas was constantly rising and in December reached $385 per 1,000 cubic meters. According to my calculations, the state-owned Naftogaz spent almost UAH 13.5 billion (excluding the VAT) to purchase almost 1 billion cubic meters of gas from extractive companies, which went to the accounts of private companies.

If the state had chosen to set a clear purchase price for gas, say, at $280 per 1,000 cubic meters, then, according to my calculations, Naftogaz could have saved about $51 million (UAH 2.04 billion) on the purchase of this billion cubic meters of gas in 2024. And these savings could be used either to invest in increasing its own production, pay dividends to the state or to import additional 150 million cubic meters of gas into the UGS facilities to get through the winter.

I would like to think that the situation with these gas purchases is only the result of Naftogaz’s ill-conceived and inefficient commercial strategy. However, I also see major corruption risks because such generous purchases are difficult to explain. We are talking about at least $50 million in additional costs for the state-owned Naftogaz and, accordingly, a similar amount of additional profit for private producers.

What to do?

If the government does not want to reduce the share of the regulated gas price segment now, then the first step is to formally determine the maximum price for gas purchases by Naftogaz, which would provide a sufficient profit market for extractive companies, but definitely not at $385 per 1,000 cubic meters, as it is now.

However, then we should not reinvent our Ukrainian wheel and implement standard Western approaches instead. For example, we should finally start switching to real exchange trading in gas and clearly define how Naftogaz participates in such trading.

About five years ago, MPs discussed a proposal to amend the Law on the Natural Gas Market and oblige all production companies to sell 10% of their daily production on the short-term market a day in advance in the form of standardized products (1,000 cubic meters). These trades would take place daily in an anonymous trading mode with a single order book, where all buyers and sellers of gas admitted to trading by the exchange would be eligible to participate, which would guarantee settlements between all participants. The presence of large volumes of gas and a large number of participants would make it possible to determine the real market price for gas.

To ensure that there is demand so that the price does not fall too low, Naftogaz would have to act as a market maker for some time. That is, to guarantee the purchase of all offered volumes that would not be bought by other buyers. In fact, Naftogaz is already doing this, buying 1 billion cubic meters of gas annually. At the same time, Naftogaz’s purchase price should be determined on the basis of a government decision, which could be, say, $280. This would be a guaranteed price at which any producer could voluntarily sell its gas and which would ensure an adequate level of profit. Given the level of production by private companies in the amount of 3.4 billion cubic meters, the mentioned 10% is 340 million cubic meters, or one third of the volumes that Naftogaz purchases annually.

In addition, it is necessary to oblige private producers once again to pay rent to the state budget in the month of gas production, rather than in the month of gas sales, as was done after the war. This approach encourages producers not to sell gas, but to keep it in storage and wait for more interesting price offers. Currently, private companies have about 1.6 billion cubic meters of gas in storage. Apparently, they hope to export it to the EU when the opportunity presents itself. This deprives the budget of billions of hryvnias in rent payments, VAT and income taxes.

Summarizing the above, we can say that the 45% increase in gas prices for industry was caused by ill-conceived government regulation and Naftogaz’s dubious and inefficient commercial strategy. As a result, the industry overpaid billions of hryvnias for gas, which affected the profitability of companies and the prices of their products. Naftogaz could also have overpaid up to $50 million, or UAH 2 billion, for the billion cubic meters of gas it bought from private producers.

Therefore, in fact, the only beneficiaries of the current situation were private extractive companies. You can find the names of their owners yourself on the Internet. I hope that the additional billions of hryvnias they received were used to develop gas production in Ukraine since, unfortunately, for the third year in a row, there has been a steady decline in private production (from 5 billion cubic meters in 2021 to 3.4 billion in 2024; a 33% decrease). At the same time, production at the state-owned Ukrgasvydobuvannya (UGV JSC), which operates in similarly challenging war conditions, increased by 6% in 2024. Moreover, UGV sells all of its gas at much lower regulated prices under PSO, rather than at UAH 16 per cubic meter, as private extractive companies currently do.

 

Read this article in Ukrainian and russian.