• Forecast performance of Naftogaz group for 2016

    Forecast performance of Naftogaz group for 2016

    *On 1 January 2016, the NEURC set new RAB tariffs for gas transportation through trunk pipelines to entry and exit points located on Ukraine's border. Naftogaz asked Gazprom to apply these tariffs to the transit of gas to Europe for the contract between the parties from 2009. However, due to the fact that Gazprom refused to negotiate to bring the conditions of the transit contract into line with changes in Ukrainian legislation, Naftogaz included a call for transition to the new tariffs for transit from 1 January 2016 into the company's arbitration claim. Until the contractual relations between Naftogaz and Gazprom are brought in line with the provisions of Ukrainian legislation (in particular, as regards the use of the new RAB tariffs), the NEURC decided that Naftogaz will temporarily provide gas transit services to Gazprom on the terms in force in 2015 (that is, using the "old" unregulated tariff for transit), demanding at the same time that Gazprom retroactively pay under the new tariffs. As the management expects that the new tariffs will be applied retroactively (i.e. after 1 January 2016, following repeal of the abovementioned NEURC decision) either (a) as a part of compliance with this requirement and adoption of the relevant decisions by the Arbitration Institute of the Stockholm Chamber of Commerce, or (b) with the voluntary consent of Gazprom to apply these tariffs and introducing changes into the contract. Upon either of these two eventualities, both the company's revenues and depreciation of fixed assets will be reviewed/adjusted retrospectively (from 1 January 2016) for the purposes of Naftogaz's consolidated financial statements. In particular, 2016 will reflect the part of the accelerated depreciation of the assets relating to the assets before the transit, and the revenues from gas transportation — according to the new RAB tariffs. Hearings on the case on the contract for gas transit will begin in 4Q 2016 and the decision is expected to be delivered in 2Q 2017. Povisionally (pending the decision), the revenues from transit are to be stated at the "old" tariff under the existing contract with Gazprom (not to the RAB tariffs), and accelerated depreciation is not charged.


    Planned gas sources and use

    According to the forecasted balance of gas sources and planned consumption for 2016 approved by the executive board of the company, which takes into account actual data for the first half of 2016, gas sales are expected to fall to 18.9 bcm or by 14% compared to 2015. The projected decrease in gas consumption is explained by the downturn in the economy, decline in production, and the military conflict in eastern Ukraine, as well as use of energy efficiency technologies and a decrease in gas consumption by households.

    In accordance with legislative requirements, Naftogaz is obliged to accumulate the necessary volumes of gas which Naftogaz buys from its subsidiary Ukrgazvydobuvannya, for households, district heating companies and religious organisations. The volume of domestically produced gas will reach 12.4 bcm in 2016. The gas produced by Ukrnafta will be used, as in previous years, for processing the production of ammonia. The volume of gas in underground storage facilities in Ukraine at the beginning of 2016 amounted to 13.99 bcm, including 12.8 bcm of gas owned by Naftogaz. It is expected that by the end of 2016, the volume of gas accumulated in underground gas storages will go down to 13.2 bcm. In order to ensure the necessary volumes of gas in storage facilities, Naftogaz plans to purchase 7.8 bcm of imported gas. The sources for financing this imported gas purchase will be cash from operations and credit, primarily the USD 300 million credit line from the EBRD, and a USD 500 million World Bank loan scheduled for the fourth quarter of 2016.

    Factors behind the reduction in gas consumption

    Major changes in legislation and their expected impact on the group

    In February 2015, an agreement was reached between Ukraine and the International Monetary Fund regarding the Extended Finance Facility (EFF) which resulted in the signing of a Memorandum on Economic and Financial Policies stating the following obligations of the Ukraininan government:

    • Gradually bring natural gas prices for all customers and heating tariffs for households to full parity with the price of imported gas by 2017;

    • Adopt the law on the natural gas market and reforming the gas sector;

    • Adopt appropriate laws and regulations that will lead to an improvement on the return of receivables;

    • Implement other measures to restore the financial viability of Naftogaz.

    In April 2015, Ukraine adopted a new Law "On the Natural Gas Market" which is fully compliant with the provisions of the Third Energy Package and with the IMF Memorandum. The law provides for:

    • Ensuring non-discriminatory access to Ukraine's gas transmission infrastructure;

    • Integration with the European gas market;

    • Restructuring of the group in acoordance to the requirements of the Third Energy Package with respect to the separation of natural gas transmission pipelines from other activities, including the production and supply of natural gas;

    • Approval of tarrif-setting principles for services of natural monopolies (transportation and storage of natural gas) in line with European standards.

    Implementation of the Law led to the introduction of a new system regulating tariffs for gas transmission at the beginning of 2016. The NEURC has set tariffs for all entry points to the gas transmission system of Ukraine at the same level of USD 12.47/tcm and different tariffs for exit points from USD 16.74/tcm to USD 32.80 tcm. Since the bulk of gas is imported to Ukraine by the group, the introduction of tariffs for entry to Ukraine will slightly increase the group's income.

    Pending the decision of the Arbitration Institute of the Stockholm Chamber of Commerce, the group applies gas transmission taffifs to Gazprom as set in the current contract on gas transit. As a result, the group plans to increase revenues from gas transit only by increasing the volume of transit and projected growth of the US dollar.

    Starting from 1 January 2016, amendments to the Tax Code of Ukraine came into effect regarding transactions for the provision of services to Gazprom. Gas transit through the territory of Ukraine is subject to VAT at 20 percent under the generally established procedure. The amount of VAT is included in other operating expenses as it is not reimbursed by the buyer. The expected VAT costs for 2016 amount to UAH 10.3 billion.

    Assumptions regarding gas prices and tariffs for gas transmission and storage

    Average projected purchase price of imported gas by the group in 2016 is USD 185/tcm including the transmission cost to the border of Ukraine (taking an entry cost to the gas transmission system of Ukraine of USD 12.47/tcm, the total average price of imported gas to Ukraine in 2016 is projected at USD 197/tcm), comparing to USD 277/tcm in 2015 (there were was no charge on entry to the GTS).

    Starting from 1 May 2016, a two-level system of gas selling prices for the needs of households was cancelled (for consumption within social norms during the heating season (1200 cubic meters) and on general grounds) and a single marginal retail price was introduced for this group of customers at 100% of the gas import parity — UAH 6879/tcm.

    Starting from 1 May 2016, gas selling prices for heat generating entities for the needs of households increased to UAH 4942/tcm net of VAT and transmission costs, which corresponds to 100% gas import parity.

    The selling price for gas supplied to industrial customers is adjusted on a monthly basis, according to the purchase price of imported natural gas and exchange rates. The average selling price in 2016 is forecasted at USD 5722/tcm net of VAT and transmission costs.

    The selling price for gas produced by Ukrgazvydobuvannya is changed from UAH 1590/tcm to UAH 4849/tcm net of VAT as of 1 May 2016.

    It is further expected that in 2016 compared to 2015:

    • The average tariff for gas transmission will increase by 13%.

    • The average tariff for gas storage will not change.

    Assumptions regarding currency devaluation

    The projected devaluation of the national currency expected to result in UAH 5.8 billion loss.

    At the beginning of 2016, the group's debts in foreign currency amounted to nearly
    USD 2 billion, and the exchange rate was UAH 24.00 per USD. At the same time, the average exchange rate is forecasted at UAH 26.2 per USD (at the year end — UAH 27.5 per USD), which will lead to an increase in the group's payables in hryvnia terms and will result in foreign exchange losses amounting to approximately UAH 5.8 billion.


    Net income of the group

    Outcomes of the gas market reform and insignificant consumer price inflation will allow the group to significantly reduce losses in the regulated segments and earn a net profit.

    For the first time for the last five years, the group projects a net profit of UAH 17.6 billion in 2016 (net loss for 2015 was UAH 36.3 billion).

    In 2016 revenue from non-regulated segments is expected to grow by 24% as a result of higher gas transmission revenues and transit volume increase, hryvnia devaluation, and increase in petroleum product sales.
    It is expected that regulated segment losses will be fully offset by non-regulated segment profits in 2016, and the group will earn a net profit. Decrease in regulated segment losses should result from bringing gas selling prices to an economically justified level and smaller hryvnia devaluation comparing to the previous year.

    Working capital

    In 2016 the group plans to invest 1.5 times more in working capital as opposed to 2015.

    Working capital is projected to grow by UAH 24.1 billion and reach UAH 54.8 billion by the end of 2016 (31 December 2015: UAH 33.4 billion). This increase is attribulable to:

    • UAH 12 billion increase in accounts receivable from gas customers as a result of the projected deterioration in payment discipline and unsettled invoices for December 2016 by households. Management makes a conservative estimate of growth in receivables due to adjusting gas selling prices for the household needs up to the market level, and switching to direct subsidies for low income households from the state of cross-subsidies for Naftogaz;

    • Increase in prepayment for imported gas by more than UAH 4 billion that corresponds to the total cost of gas supplies for January 2017 (as of the end of 2015, the amount of prepayments for imported gas was insignificant as gas supplies in January 2016 were mainly paid in January 2016);

    • Increase in the cost of gas in underground storage facilities by UAH 4 billion as a result of increased costs of domestic gas and increase in the average price of imported gas due to hryvnia devaluation.


    In 2016 the Naftogaz group plans to diversify and optimize the loan portfolio by attracting loans from international financial institutions.

    By the end of 2016 the group expects a decrease in outstanding loans of UAH 2.0 billion, while in dollar equivalent the outstanding amount on loans will decrease by UAH 452 million. During 2016 the group plans to settle loans totalling UAH 35.1 billion. With the purpose of financing the purchase of imported gas, in 2015 the group signed a loan agreement with the EBRD worth USD 300 million which secured the purchase of about 1.5 bcm of imported natural gas at the western border of Ukraine in December 2015 — 1Q 2016. The loan was settled on time in May 2016 and will be used again to purchase imported natural gas in 3Q — 4Q. To finance the purchase of imported gas in 4Q 2016, it is planned to sign an agreement with the World Bank for funding in the form of opening of letter of credit/credit lines for commercial banks under IBRD guarantees of up to USD 500 million. Credit funds from international financial institutions are attracted at much lower interest rates than on the domestic market.

    Naftogaz group contributions

    Capital expenditure

    In 2016 Naftogaz group plans to make capital investments necessary to ensure smooth GTS operation and an increase in natural gas extraction.

    Over the years, due to loss-making activities, the capital investment of the group been below the required extent. This resulted in a drop in natural gas output by 0.7 bcm. In 2016, through the profitable operations, the group plans to almost double the amount of capital investments compared to 2015. This growth will primarily be ensured by investing in natural gas output, which will be the first step towards ensuring the independence of Ukraine from imported gas.

    Financial assistance from the state

    In 2016 Naftogaz group will transform from a state budget recipient to a donor.

    Economically unjustified prices for households and DHU as well as lack of necessary funding from the budget to cover the losses from the sale of gas to these categories of customers led to the accumulation of debts by Naftogaz, created in connection with the need for financing purchases of the Russian gas in 2009 — 2013 (the debt for gas to Gazprom advances received for transit from Gazprom, Gazprombank loan and Eurobonds). In early 2014, the debt amounted to nearly USD 8 billion.

    The need to repay debts and finance losses from the sale of natural gas to households and DHU caused a significant need for funding from the state budget in 2014-2015.

    The gas market reform and the gradual reduction of sales prices for natural gas will allow the group to score a net profit in 2016 and become the country's largest taxpayer instead of being financed from the state budget.

    In 2016, for the first time since 2006, the group did not receive direct support from the state budget as compensation for price differences in the form of state treasury bonds contributed to the share capital.

    Setlements of Naftogaz group with the state budget in 2009-2016


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