NAFTOGAZ GROUP STRUCTURE BY OPERATING REVENUES AND ASSETS 2015
FINANCIAL PERFORMANCE REVIEW
Revenue and gross loss
The group's revenue increased by 63% in 2015 compared to the prior year and amounted to UAH 131.2 billion including:
• Revenue from regulated businesses (trading and supply of natural gas, natural gas production storage) increased by 30% and amounted to UAH 62.5 billion, due to increase in natural gas selling prices, gas storage services, and consolidation of Ukrnafta (on 22 July 2015 the group regained its control over Ukrnafta and consolidated its financial statements). Until 22 July 2015 the group included Ukrnafta investments in associates and joint ventures.
• Income from non-regulated businesses (production of crude oil and gas condensate, transmission and supply of natural gas, transmission of crude oil, refinery of crude oil and gas condensate and petroleum products trading, etc.) increased by 112% and amounted to UAH 68.7 billion. The increase in revenues from non-regulated businesses is mainly explained by the growth of gas transit volumes and consolidation of Ukrnafta.
The share of revenue from regulated businesses decreased by 12.2% in 2015 compared to 2014 and comprised 47.6% of the group"s total revenue.
Based on the results for 2015, for the first time in 4 years (since 2011), the group received gross profits amounting to UAH 8.5 billion (in 2014 gross losses amounted to UAH 7.3 billion). Formation of the gross profit was possible due to the doubling of revenue in unregulated segments from UAH 13.6 billion to UAH 27.6 billion. Regulated segments in 2015 provided 47.6% of the group's revenues, despite the fact that on 1 April 2015 the process of bringing natural gas prices to economic levels was initiated, and in general they remained unprofitable and led to a decrease in gross profit of UAH 19.7 billion.
FINANCIAL RESULTS BY SEGMENT
REGULATED BUSINESS SEGMENTS
The volume of natural gas produced by the group in 2015 amounted to 15.3 bcm, which is 0.2 bcm more than produced in 2014. The increase in production is explained by the consolidation of Ukrnafta starting from 22 July 2015 (+0.7 bcm) and sales of natural gas produced under the product sharing agreement in Egypt (+0.1 bcm) started in 2015. Gas production by Ukrgazvydobuvannya decreased by 0.6 bcm in 2015 compared to 2014.
Revenue from sales of domestic gas and gas production services has almost tripled in 2015 compared to 2014 and totalled UAH 21.2 billion (2014: UAH 7.1 billion) considering the following:
• Revenue from the sale of natural gas for the needs of households (sales to Naftogaz) increased by 3.5 times and amounted to UAH 16.4 billion. This increase, along with a decrease in sales volume by 0.6 bcm, was driven by the selling price increase for Ukrgazvydobuvannya from 1 April 2015 from UAH 349/tcm to UAH 1590/tcm net of VAT. The average gas selling price for Ukrgazvydobuvannya in 2015 was UAH 1276/tcm net of VAT.
The increased gas selling price for Ukrgazvydobuvannya enabled the group to reach gross profit from gas sales to Naftogaz for household needs in 2015. In 2014, Ukrgazvydobuvannya made a loss of UAH 28 per tcm of gas sold to Naftogaz. In 2015, the margin earned by Ukrgazvydobuvannya was UAH 94/tcm. Losses on gas sold to Naftogaz were caused by revaluation of fixed assets in 2014 to their fair value which was significantly higher than their carrying value, and the corresponding increase in depreciation and depletion expenses, that also affected the cost of gas produced. In 2015 the group has also involved independent appraisers in fixed assets revaluation, which contributed to the increase in depreciation and depletion expenses included in the cost of gas produced. Additionally, the level of subsoil royalties for gas output increased from 20% to 70% starting from 1 April 2015. If there had been no increase in gas selling price for Ukrgazvydobuvannya, and taking the increased subsoil royalty level into account, the negative margin when selling gas to Naftogaz in 2015 would have been UAH 344/tcm, leading to significant losses in this segment.
Additional profits from the increase in gas selling prices for Ukrgazvydobuvannya to Naftogaz in 2015 was partially offset by the hryvnia devaluation: gas price in hryvnia increased almost 4 times, however the price increase in USD terms was only 2 times compared to 2014, and 1.3 times compared to 2013.
• Revenue from gas sales to other customers and sales of gas extraction supporting services increased 2 times and amounted to UAH 4.8 billion. Consolidation of Ukrnafta and gas sales under the consession agreement in Egypt contributed to this increase. Sale of gas in Egypt started in 2015.
Gross profit from the Gas Upstream segment in 2015 increased by almost 4 times compared to 2014 and reached UAH 2.8 billion, mainly as a result of introducing positive mark ups on costs of gas produced which were reflected in gas selling price increases for Naftogaz.
Such a significant increase in gross profits led to overall profitability in the Gas Upstream segment of UAH 0.6 billion (in 2013 and 2014, segment results were negative and amounted to UAH 1.2 billion and UAH 4.7 billion losses respectively).
While revenues grew 3.5 times, payments to the budget (subsoil royalties and income tax) increased by almost 9 times, and sources of financing capital expenditures (depreciation and depletion and profit after tax) by less than 2 times. Thus, segment profit in 2015 remained insufficient to finance gas production at the current level (according to Ukrgazvydobuvannya, requirements for capital expenditure to maintain production levels stand at UAH 5.2 billion). An increase in gas output is also required. Starting from 1 May 2016, the gas selling price for Ukrgazvydobuvannya was increased to UAH 4,849/tcm which should ensure profit levels sufficient to extend gas production.
Gas trading and supply
Natural gas consumption in Ukraine (excluding technological use) decreased by 22% in 2015 compared to 2014 due to the economic crisis and the decline in production, military conflict in the eastern regions of Ukraine, as well as energy saving technologies and economical gas use by households. The group's natural gas sales volumes decreased by 25% comparing to 2014 and amounted to 21.8 bcm. As a result, the share of the group in total sales in 2015 decreased by 3% from 76% to 73% at the expense of sales to industrial customers.
Revenue from gas trading to external customers increased by 26% or UAH 11.8 billion compared to the previous year and amounted to UAH 57.3 billion (2014: UAH 45.5 billion). The increase in revenue in monetary terms against decline in sales in volumes was caused by the increase in gas selling prices for household needs and entities generating heat for household needs by 259% and 67% during the year respectively, and by 42% for industrial customers. Reduction in sales volumes led to revenue decrease by UAH 11.5 billion, while the selling price increase contributed to revenue growth of UAH 23.3 billion.
Despite an increase in revenues of UAH 11.8 billion mainly as a result of the gas selling price increase, increases in purchase cost for imported gas in hryvnia equivalent and hryvnia devaluation meant that the segment "Gas trading and supply" posted a gross loss of UAH 21.3 billion, or only UAH 0.8 billion less compared to 2014 .
The root cause of this loss is the regulated selling price of imported gas set by the NEURC, that is much lower than the purchase price of imported gas (in 2015, the price of imported gas was higher than the price of gas for the needs of households by 3.8 times. In 2014: by 6.1 times). Households annually consume nearly 20 bcm of gas for cooking and heating (in 2015, consumption decreased by 5 bcm due to the warm winter and economical use of gas compared to 2014). Only 50-60% of household needs are covered by domestically produced gas produced by Ukrgazvydobuvannya.The remaining needs are met by imported gas. Thus, the profit that the group receives from sales of domestically produced gas for households is significantly lower than the losses from the sale of imported gas.
Gas sales to other groups of customers (entities generating heat for other customers, regional gas distribution entities for resale to other customers, industrial and other customers) is profitable. Prior to 1 October 2015, the maximum gas price for other customer groups was set by the NEURC. Starting from October 2015, the gas price for other customer groups has been set by Naftogaz according to the Law of Ukraine "On Natural Gas Market". This price is reviewed monthly and adjusted in line with imported gas prices and hryvnia valuations, which resulted in small gross margins of 16% and 3% for 2014 and 2015 respectively. Gross profit from gas trading to other customer groups in 2015 amounted to
UAH 0.8 billion (2014: UAH 5.2 billion). However, this profit was not sufficient to cover the loss from the sale of gas for the needs of households. As a result, this segment recorded a loss.
With a slight decrease in gross losses compared to 2014, the segment result increased by UAH 25.5 billion and amounted to UAH 55.7 billion, which was the result of reduced currency exchange differences and decreased losses incurred in the occupied territories of eastern Ukraine and in Crimea.
Gas storage business segment
In 2014, gas storage tariffs increased by 3.4 times. As a result of the increase in tariffs, segment revenues increased by 9% and amounted to UAH 1.5 billion. The majority of gas underground storage services are provided by the group (in 2015 — 74%,
in 2014 — 76% of segment revenue).
Despite this revenue growth, the gas storage segment showed a gross loss of UAH 1.2 billion (2014: gross profit amounted to UAH 0.2 billion). The main reason for this was the revaluation of fixed assets to their fair value, which was significantly higher than their estimated value, and the corresponding increase in depreciation and depletion. Segment loss was UAH 2.2 billion, or UAH 0.8 billion less than in 2014, which included impairment of fixed assets of UAH 2.7 billion (in 2015 there were no impairment losses).
Negative segment results indicate insufficient levels of gas storage tarrifs. In 2017, the group expects the transition to RAB methodology in gas storage tariff calculation that should ensure fair returns on the regulatory asset base and improved segment results.
Gas transmission and distribution
The volume of natural gas transmission under the contract with Gazprom in 2015 increased by 8% compared to 2014 despite the implementation of the policy of the Russian Federation to minimize the use of the Ukrainian gas transmission system.
The volume of gas transmission to Ukrainian customers declined by 20% compared to 2014 as a result of a general reduction in gas consumption due to the economic crisis, military actions in eastern regions of Ukraine, and energy saving technologies and gas saving by households.
Despite the reduction of domestic gas transmission, revenue from the gas transmission and distributon business increased by more than 2 times compared to 2014 and amounted to UAH 50.0 billion.
The increase in revenue was influenced by the following:
• International gas transit services: devaluation of the national currency (+ UAH 22.3 billion) and 5% was contributed by an increase of transit volumes (UAH 1.6 billion); at the same time reduction in the transit rate resulted in revenue decrease of UAH 0.5 billion;
• Domestic gas transmission: increase in transportation tariffs contributed to revenue growth of UAH 3.8 billion; at the same time reduction in transportation volumes resulted in revenue decrease of UAH 1.5 billion.
The cost of services increased by UAH 12.7 billion, mainly due to depreciation charge increases.
Thus, gross profit of the segment has increased by 2.4 times compared to last year and amounted to UAH 22.6 billion (2014: UAH 9.5 billion).
A significant decrease in the return on assets (ROA or relation of segment result to segment assets) after revaluation of fixed assets in 2014 may indicate both the lack economic justification of gas transmission tariffs and high segment costs compared to peer companies. The increase in gross profit in 2015 was caused by hryvnia devaluation (since Gazprom pays the transit rate in US dollars) and not by bringing tariffs to market levels.
NEURC approved the policy of defining and calculating tariffs for gas transmission to entry and exit points in September 2015, pursuant to the Law "On the Natural Gas Market" No. 329-VIII dated 9 April 2015, and in order to introduce European tariffs on gas transmission to the entry and exit points based on incentive RAB regulation (this ensures that the GTS operator receives a fair income for its regulatory asset base). Starting from 1 January 2016, NEURC set tariffs for gas transmission with transmission pipelines to entry and exit points located on the state border of Ukraine, applying RAB methodology based on this policy. Naftogaz requested Gazprom to apply these tariffs to Gazprom's gas transit to Europe under the current contract. As the matter remains unresolved, the company has included the requirements for the transition to the new tariffs for transit from 1 January 2016 to the claim under the contract for gas transit through Ukraine which Naftogaz submitted to the Stockholm Arbitration Tribunal in October 2014. Until the contractual relationship is aligned in accordance with the NEURC regulations, gas transit services are provided by the company under the terms and conditions effective in 2015.
In addition, the NEURC plans to complete transition to RAB methodology for gas transmission tariffs from entry to exit point for Ukrainian customers by the end of 2016, as was specificly mentioned by NEURC in August 2016. In particular, dueing a meeting on 18 August 2016, NEURC approved establishing gas transmission tariffs for Ukrtransgaz at the entry/exit points located on the territory of Ukraine after NEURC Resolution "On approval of the policy on calculating gas distribution tariffs" No. 236 dated 25 February 2016 becomes effective, and after the amendments to legislation needed for the new Law of Ukraine "On the Natural Gas Market" in terms of splitting gas transmission and distribution tariffs and the cost of gas as a commodity in the gas prices for households. These measures should ensure that the company receives fair returns on its regulatory asset base, and should result in better segment results in future.
Refinering of crude oil and gas condensate
In 2015, the revenue of the segment amounted to UAH 6.6 billion demonstrating a 27% increase compared to 2014. The growth of revenue was driven by revenue from Ukrnafta LPG sales from 22 July 2015 (UAH 1.4 billion). In 2015, Naftogaz and Ukrtransnafta did not perform operations on sales of petroleum products, which were processed under tolling schemes, as was the case in 2013 and early 2014. These activities are not core to Naftogaz and Ukrtransnafta and and they earned low margins, while freezing significant levels of working capital and inventory stock. Consequently, the group has decided to cease this line of activity. As a result, in 2015 the revenue from this segment is formed largely by the sale of petroleum products and LPG produced from raw materials by UGV and the sale of compressed natural gas via the filling stations of Ukravtogaz.
Despite the increase in revenues and gross profit in 2015, the segment result amounted to UAH 1.1 billion which constitutes a decrease of 44% compared to the previous year. Ukrnafta indicators contributed to the decline of the segment result: unprofitability of LPG sales and provision for trade receivables.
Crude oil transmission
Over the past few years volumes of crude oil transmission have continuously declined. This is explained by both a decrease in volumes of oil transmission to domestic refineries, and a decrease in oil transit volumes. In 2015, the total volume of crude oil transmission decreased
by 0.1 million tons compared to 2014 (including a decline in crude oil transit by 0.2 million tons and a 3 million ton decline in crude oil transmission to domestic refineries) and amounted to 16.8 million tons.
Despite the slight increase in oil transit in 2015, the political instability in relations between Ukraine and the Russian Federation, as well as a significant drop in world oil prices with rising risk of reallocation of traditional markets between the main oil-exporting countries, has created a threat of further decline in oil transit through Ukraine to Central Europe.
The decrease of volumes of oil transmission to Ukrainian oil refineries to 13% in 2015 is related to the negative trends in the oil industry of Ukraine. Out of 6 refineries in Ukraine, only the Kremenchuk refinery is operating today, which uses up to 2 million tons per year of locally produced crude oil and light oil from the Caspian region delivered by railway transport.
The main reason for other Ukrainian refineries to stop their activities was the competition from Belarusian, Russian and Baltic refineries, which take advantage of duty-free imports of oil products, close location to natural resources in the Russian Federation, the absence of Russian export duty, and a high level of technological development, allowing them to produce higher output of light oil products from Russian Urals crude oil.
In 2015, despite the decline in transmitted volumes, segment revenue rose to UAH 3.3 billion showing a 67% increase compared to 2014. The main reason for this growth was the UAH devaluation, as oil transit charges are set in euros. In addition, from 1 July 2015, the tariff for transmission of oil to domestic refineries was increased by 6 times on average, which also secured revenue growth.
Crude oil and gas condensate refinering and petroleum products trading
Before 2015, revenue from this segment was formed by sales made by the division in Egypt since all oil and gas condensate produced by Ukrgazvydobuvannya was refined and sold within the segment of refining crude oil and gas condensate. Since 22 July 2015, the group resumed control over Ukrnafta and included results of the company to the overall performance of the group, which led to revenue increases from oil sales by almost 20 times compared to 2014.
Oil sales in Egypt
The company entered into a concession agreement for oil exploration and development with the Arab Republic of Egypt (ARE) and the Egyptian General Petroleum Corporation (EGPC) covering the area of the Alam El Shawish East in the Western Desert (concession agreement) on 13 December 2006. The development period under the concession agreement is limited to a maximum of 25 years from the date of commercial oil discovery or from the date of the first natural gas deliveries, which started in 2011.The concession agreement includes the following conditions:
• The company shall recover on a quarterly basis all exploration and development costs to the extent and out of 25% of all petroleum produced and saved from production areas and not used in petroleum operations (cost recovery portion);
• The remaining 75% of the petroleum produced is shared by the company and EGPC depending on the volume of production. The company's share varies from 15% to 19% (profit sharing portion);
• EGPC shall become the owner of all the company's assets acquired and owned within the concession agreement.
Revenue from the sale of oil produced in Egypt increased by UAH 0.03 billion in 2015 compared to 2014, and reached UAH 0.3 billion. This increase in revenue is caused by an increase in crude oil production volumes (+ UAH 0.02 billion) and the change in the UAH/ USD exchange rate (+ UAH 0.1 billion). Thus, after the decline in oil prices is taken into account, revenue decreased by UAH 0.17 billion.
In 2015, the segment demonstrated a negative result — UAH 2.1 billion, whereas in 2014 the group's revenue amounted to UAH 0.3 billion. Deterioration of the segment result was caused by Ukrnafta results. Unprofitability of sales of Ukrnafta oil was primarily driven by decline in world oil prices and the current procedure for accrual of royalties at fixed rates regardless of the actual level of oil prices. Since August 2014, the royalty rate for deposits that in whole or in part lie at a depth of 5,000 meters was set at 45%. Meanwhile, the price for Urals oil was USD 107 a barrel. In 2015, when the average oil price during a year was USD 1 per barrel, the stability of the royalty rates led to a loss in production of crude oil and condensate and formed Ukrnafta's operating cash flow in the amount insufficient to stop the decline in oil production. The decrease of cash flow from operating activities and actions of the previous Ukrnafta management resulted in late payment by the company of its tax liabilities primarily on royalties, and, as a result, led to additional penalty charges imposed by the tax authorities and corresponding increase in the segment's expenses in the amount of the penalties assessed.
Setting the differentiation royalty rates for the subsoil use for the production of oil and/or condensate with regard to the actual level of world prices for Urals oil will improve the segment result and ensure availability of sources for financing the measures to stop the decline and increase oil and condensate production in Ukraine.
NET LOSS FACTORS
In 2015, the group significantly (by 2.44 times) reduced the net loss compared to the previous year and for the first time in 4 years (since 2011) received a gross profit amounting to UAH 8.5 billion.
The main reasons for these improved financial results compared to 2014 are:
• Increasing operational efficiency of the group and consequently, increasing gross profit in non-regulated segments by UAH 15.2 billion, including: in the non-regulated segments — for UAH 14 billion (gas transmission and distribution and crude oil and gas condensate refinery) and in regulated segments — by UAH 1.2 billion (gas upstream and gas supply);
• Reducing the hryvnia devaluation and reducing the debt of the group in foreign currency, which led to a decrease in losses from exchange rate fluctuations of UAH 19.3 billion. At the beginning of 2015, debt in foreign currency amounted to about UAH 3 billion, and at the beginning of 2014, it was about UAH 7 billion;
• Reducing the losses in the occupied territories in eastern Ukraine and Crimea by UAH 24.6 billion, including UAH 13.7 billion of losses from discontinued operations (Chernomornaftogaz) and UAH 10.9 billion of losses of other companies of the group, other than Chornomornaftogaz, located in the occupied territories in eastern Ukraine and Crimea.
On the other hand, in 2015 the provision within legal proceedings and other amounts increased and amounted to UAH 7.5 billion compared to 2014 due to accrued reserves to cover possible fines, penalties and interests for Ukrnafta related to the late payment of royalties, income tax, VAT and the dividends.
The total negative result of the group in 2015 of -UAH 36.3 billion with a gross profit amounting to UAH 8.5 billion was caused by:
1. The loss on foreign exchange fluctuations -UAH 19.9 billion, incurred by the group due to the hryvnia devaluation: at the beginning of 2015, the debt of the group in foreign currency amounted to nearly UAH 3.0 billion. In this case, the US dollar rose from UAH 15.77/USD at the beginning of the year to UAH 24.00/USD in December 2015, which led to accrual of losses of the group related to the revaluation and payment of debts in foreign currencies;
2. Financial expenses of UAH 10.9 billion, the principal amount of which is formed by interest on loans;
3. Accrual of provision amounts for legal proceedings and other provision amounts of UAH 7.9 billion (see the explanation above);
4. Other expenses decreased other profits by UAH 6.0 billion, including losses incurred in the occupied territories of UAH 2.1 billion, fines and penalties accrued of UAH 1.5 billion, an increase in provisions, accrued receivables and other current assets of UAH 1.4 billion, and others.
BALANCE SHEET ANALYSIS (STATEMENT OF FINANCIAL POSITION)
As of 31 December 2015, the total assets of the group amounted to UAH 669.7 billion (including UAH 651.9 billion allocated between segments). This amount is UAH 153.60 billion or 30% higher than total assets at 31 December 2014.
The increase in the group's total assets is explained by the following:
• An increase in non-current assets from UAH 471.9 billion up to UAH 581.8 billion (+ 24%) following a revaluation of property, plants and equipment. Compared to the previous revaluation performed in 2014, key factors of this asset value increase were as follows:
• Increase in prices of steel products, including pipes and steel structures;
• Increase in fuel prices;
• Increase in salaries of construction and installation staff;
• Increase in prices for both domestic and imported equipment (e.g. gas pumping units, mining equipment, construction equipment);
• Changes in the macroeconomic situation (devaluation which led to higher prices for products in UAH terms);
• Change in oil and gas market forecasts (including the approval of tariffs for transit according to the NEURC incentive tariffs and the use of accelerated depreciation in tariffs, increased prices for hydrocarbons for households and DHCs, lower royalty rates for natural gas);
• The value of current assets almost doubled during 2015 from UAH 44.1 billion to UAH 87.9 billion, mainly following the increase in inventories (increase of gas volumes in the underground storage facilities), increased receivables and balances in the accounts of the group (see details in Working Capital).
In 2015, the share of assets of regulated businesses increased from 44% as at 31 December 2014 to 46% as at 31 December 2015. The main factor contributing to the increased share of non-regulated businesses in total assets was the revaluation of property, plants and equipment in the natural gas production segment. The share of assets in this segment increased from 9% to 12%.
In 2015 Naftogaz group's capital expenditure increased by 76% compared to 2014 and amounted to UAH 6.5 billion. The priority for the capital expenditures of the group was the natural gas production segment. In 2015 capital expenditure in this segment amounted to UAH 4.2 billion or 64% of total capital expenditures. Compared to 2014, the volume of capital expenditures in the segment grew by UAH 1.6 billion or by 1.6 times. The main focus of capital expenditures within this sector was exploration and development drilling. In 2015, higher prices for natural gas for Ukrgazvydobuvannya produced almost double the volume of resources to finance capital expenditures compared to 2014, but did not secure even the minimum amount of funds to finance production which would ensure the stabilization of gas output at the 2014 level (for details, see Financial Results by Segment. Regulated business segments. Gas Upstream). Increased capital expenditures into gas production in comparison with peer companies in 2015 was the result of a decrease of expenditures, primarily for the Russian gas producing companies (in 2014, the volume of capital expenditures in production amounted to USD 2.3 million/BOD, and was the lowest among peer companies).
The Gas Transmission and Distribution segment is the second largest area of the group's capital expenditures. In 2015 the volume of capital expenditures in this sector amounted to UAH 1.1 billion or 17% of total capital expenditures (in 2014, capital expenditures amounted to UAH 0.3 billion, or 8% of total expenditures). Despite the substantial increase in expenditures in the gas transmission and distribution segment, in 2015 the results of the group, as in 2014, was the lowest among gas transmission companies in the world.
With the transition to incentive tariffs under the RAB based methodology, the group will have to annually invest into Ukraine's gas transmission system in accordance with the approved 10-year plan for the development of the gas transmission system, investing amounts not less than the annual depreciation. In March 2016, the NEURC in its Resolution No. 389 approved a development plan for Ukrtransgaz gas transmission system for 2016-2025 and identified sources of financing of over UAH 69 billion per year. Expenditures to that extent will be available for Ukrtransgaz only after contractual relations with Gazprom are brought in line with the NEURC regulations and the new tariffs are applied, as well as upon introduction of the RAB methodology for calculation of tariffs for gas transmission to consumers in Ukraine.
As of 31 December 2015, Naftogaz group's liabilities amounted to UAH 219.2 billion. This amount increased by UAH 60.1 billion or by 38% compared to 31 December 2014.
The increase in liabilities of the group was the result of the following:
• An increase in long-term liabilities from UAH 97.1 billion to UAH 125.0 billion (+29%), mainly following the increase in deferred tax liabilities after revaluation of assets and increase of debt for long-term loans denominated in foreign currency due to the foreign currency appreciation.
• An increase in current liabilities by 52% in 2015 from UAH 62.0 billion to UAH 94.3 billion mainly due to accrued provisions and increase in accounts payable after accounting for Ukrnafta results.
As of 31 December 2015, Naftogaz group's loans amounted to UAH 71.8 billion (31 December 2014: UAH 61.3 billion).
In 2015 the group:
• Repaid loans amounting to UAH 11.5 billion
• Refinanced loans from Ukrainian banks amounting to UAH 17.8 billion
• Refinanced the liabilities under loans from the state-owned banks of Ukraine to the amount of UAH 21.4 billion
• secured loans from international financial institutions at much lower interest rates than in the domestic market. In 2015 the company signed a loan agreement with the EBRD for the amount of USD 300 million. These funds are intended for the purchase of gas at the western border of Ukraine of about 1.5 bcm. In 2015 about USD 48.7 million of these funds was used. In addition, the company and the World Bank reached an agreement in the form of letter of credit/credit lines from commercial banks against the IBRD guarantees of up to USD 500 million.
However, due to hryvnia devaluation, the amount of loans denominated in foreign currencies increased to UAH 18.8 billion.
Consequently, despite the fact that loans in USD terms decreased by 23% in 2015, given the devaluation of the national currency, loans in UAH equivalent increased by 17%.
Securing funding for working capital in 2015 was one of the most important tasks of the group's management. The previous Naftogaz business model (payment for imported gas upon delivery, financing operations with advances received, accumulation of debts by customers, reducing the residual gas in underground storage facilities, etc.) has changed significantly in 2014 following the switch to 100% prepayment for imported gas. In addition, the critically low reserves of the natural gas in underground storage facilities at the beginning of 2015 put the safety of the gas transmission system at risk during peak loads and required additional investments in working capital. As a result of effective performance, as of 31 December 2015 working capital amounted to UAH 30.7 billion.
Working capital increased by more than 2 times compared to 2014 while the structure of working capital compared to the previous year changed as follows:
• Advanced payments issued and other current assets (including income tax prepayments) decreased by 28% and amounted to UAH 9.8 billion: advanced payments for imported natural gas decreased. At the end of 2014, Naftogaz paid advances for imported gas supplied in January, a total of about USD 703 million, while in December 2015, due to an agreement with the EBRD, the group made advance payment only to the amount of USD 55 million; the remaining gas was purchased through a loan in early 2016.
• As of 31 December 2015, inventories more than doubled and amounted to UAH 32.1 billion compared to 31 December 2014. The main component for the inventories as of 31 December 2015 was natural gas (84%) owned by the group, stored in underground storage facilities and available for sale to consumers (so-called "active gas"), as well as gas in the gas transmission system (nearly 1 mcm). The cost of natural gas increased by 3.4 times following an increase in the amount of gas in the underground storage facilities by 4 bcm and increase in weighted average price of imported gas for which the gas is accounted, for more than 10% due to the increase in foreign currency exchange rate (during 2015 the
purchase price for imported gas decreased from USD 333/tcm to USD 209/tcm, producing an average price of USD 277/tcm for the year), and increase of the cost of domestically produced gas. Additionally, the cost of inventories increased due to accounting Ukrnafta results after regaining control over the company.
• In 2015 trade accounts receivables increased by more than 3 times and as of 31 December 2015 amounted to UAH 33.6 billion. The increase resulted from including Ukrnafta results, which led to an increase in accounts receivable by UAH 10.5 billion. Additionally, Gazprom receivables for gas transit services increased by UAH 3.0 billion (the debt for transit services for December 2015 was paid in January 2016). Also, accounts receivable for natural gas increased by UAH 3.1 billion. The amount of trade receivables for gas before deducting the provision for trade and other receivables increased as of 31 December 2015 compared to the beginning of the year by UAH 8.4 billion and amounted to UAH 32.7 billion. This increase in accounts receivable was the result of an increase in the current debt of customers who pay bills in the month following the month of delivery (households, DHCs, budget organizations), due to increased sales prices. The overall level of payments from natural gas customers in 2015 was 97%, while in 2014 the figure was 94%. On the other hand, the provision for trade and other receivables increased by UAH 5.3 billion from UAH 12.1 billion to UAH 17.4 billion, which generally led to an increase in trade receivables for gas only for UAH 3.1 billion.
• As of 31 December 2015, trade accounts payable amounted to UAH 19.9 billion, which is UAH 5.7 billion more than 31 December 2014. The increase in accounts payable was primarily due to accounting for Ukrnafta results and the exchange rate fluctuations for accounts payable denominated in foreign currencies.
• As of 31 December 2015, advances received and other current liabilities (including income tax liabilities) increased by UAH 13.1 billion and amounted to UAH 24.9 billion. The increase was mainly the result of accounting for the Ukrnafta debt for royalty payments to the amount of UAH 8.4 billion (including penalties). The impact of the Ukrnafta debt upon the dividend payments amounted to UAH 2.8 billion.
REVIEW OF CHANGES IN EQUITY
As of 31 December 2015, the group's total equity amounted to UAH 445.2 billion, which is UAH 88.2 billion or 25% higher than the total equity as of 31 December 2014. This increase was caused by the following factors:
• Contribution of state treasury bonds to the share capital of Naftogaz to the amount of UAH 29.7 billion;
• Revaluation of fixed assets resulting in an increase in revaluation reserves of UAH 94.5 billion.
On the other hand, the group incurred a net loss in 2014 that resulted in an increase of the accumulated deficit by UAH 36.1 billion.
The company receives financial support from the state in the form of state treasury bonds in exchange for new share issues. The purpose of these funds is to cover the cash deficit of Naftogaz although in fact they can also be viewed as a form of compensation for the losses incurred by Naftogaz from supplying gas for households at prices administratively capped by the state below the market level. However, this interpretation is currently not legally supported by current legislation. In addition, there is no reconciliation act or a similar document between the company and the government of Ukraine where such compensation would be confirmed.
Had Naftogaz received compensation for the price differences in cash and not in the form of state treasury bonds, this money would be recognized as income. This would also result in a reduction of the accumulated losses and in an increase of the group's taxable profit, increasing the amount of income tax payments to the state budget.
The reform of the gas market and gradual decrease in gas sales prices will significantly reduce the financial deficit of the company in 2016, which will be completely eliminated in 2017. In 2016, for the first time since 2006, the company has not received direct support from the state to compensate the difference in prices in the form of recapitalization at the expense of the treasury bonds received.
REVIEW OF CASH FLOWS
In 2015 the group had a positive cash flow from operating activities amounting to UAH 2.0 billion (in 2014, cash flow from operating activities was negative and amounted to — UAH 58.9 billion). The increase of cash flow from operating activities was due to the UAH 39.2 billion decrease of losses before tax (see details in the Chapter "Net Loss Factors") and changes in the working capital amounting to UAH 19.2 billion.
In 2015 net cash used in investment activities amounted to UAH 4.9 billion, which is UAH 0.6 billion more than in 2014.
Net cash flow from financing activities decreased by 87% and amounted to UAH 8.3 billion. The decrease in cash flow from financing activities was a result of a decrease in revenues from the sale of treasury bonds for UAH 66.9 billion (see details in the Chapter "Review of Changes in Equity") and a UAH 10.8 billion reduction of net debt (excluding the EBRD loan of UAH 1.1 billion, which is allocated for non-cash transactions in the statements).
STRUCTURE OF CASH EXPENDITURES OF THE GROUP
The structure of the group's expenses changed as follows:
• Reduction of costs for natural gas purchases for UAH 26.4 billion due to the fact that in 2014 the group was repaying the debt for gas purchased in 2013 amounting to UAH 24.2 billion. Thus, without repayment of the debt for gas, the cost of gas purchases have remained virtually unchanged in UAH terms: UAH 82.9 billion in 2015 and UAH 85.1 billion in 2014. In US dollar equivalent, the payments for gas (without the debt repayment) decreased from USD 6.5 billion to USD 4.0 billion, including USD 1.2 billion after reduction of the amount of imported gas from 19.3 bcm in 2014 to 15.4 bcm, for USD 0.3 billion by reducing the purchase price from USD 294/tcm to USD 277/tcm, as well as upon the decrease in advances from USD 703 million to USD 55 million;
• Decreased expenses for interest and credit repayment by UAH 3.7 billion, due to the payment for Eurobonds in 2014 (USD 1.6 billion);
• Taxes paid by the group in 2015 increased by UAH 22.1 billion and amounted to UAH 40.5 billion. This included an increase in the payment of royalties due to higher royalty rates for the gas and sales price for gas from Ukrgazvydobuvannya;
• Other expenses increased by UAH 2.0 billion and amounted to UAH 21.3 billion. The increase was mainly the result of increased spending on capital expenditures, transportation services, and the cost of other works and services.
In 2015 about 0.3% of group funds were actually used for the maintenance of Naftogaz administration. 46.0% constituted the costs for gas purchased for customers, 19.4% was used to pay creditors of loans from previous years. Another 22.5% of funds were spent on the payment of taxes. In 2015, the share of tax expenses increased by 12.6% compared to the previous year. In absolute values, in 2015 the amount of payments to the budget increased by UAH 22.1 billion or more than doubled compared to 2014 and amounted to UAH 40.5 billion. The remaining expenses include salaries of employees, gas transmission and reservation of transmission capacity, capital and financial investment, operational costs, etc.