• One of the strategic priorities for Naftogaz is to improve the operational efficiency of the group. Naftogaz seeks to carry out its functions as a supplier and corporate centre in the interests of the Ukrainian people.

    As a supplier, Naftogaz currently purchases gas at the best available price without intermediaries, involving the cheapest funding sources to minimize the cost of gas for consumers.

    As a corporate centre, Naftogaz sets business goals for each of the areas of its activity that can increase the value of assets, monitor the payment of taxes to the state budget, transfer dividends to shareholders, and make informed investment decisions.


    MARKET REFORM HELPED TURN NAFTOGAZ INTO A NET CONTRIBUTOR TO STATE BUDGET

    Naftogaz group is the largest taxpayer in Ukraine. Based on figures for 2015, three companies within the group are among the ten largest Ukrainian taxpayers: Ukrgazvydobuvannya (No.1), Naftogaz (No. 2) and Ukrnafta (No. 8). In 2014, payments from Naftogaz enterprises accounted for 25% of contributions from the country's 20 largest taxpayers. In 2015, this figure increased to 38%. Two additional companies from the group, Ukrtransgaz and Ukrtransnafta, were included on the list of the 30 largest taxpayers by volume of taxes paid.

    Ukrgazvydobuvannya

    In 2015, Naftogaz group has not only significantly increased its tax contributions. In addition to that, state budget transfers to Naftogaz and spending on direct gas subsidies for households have sharply decreased.

    It is expected that in 2016 Naftogaz will become a net contributor to the state budget. For the first time since 2006, Naftogaz does not expect to receive compensation from the state.

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    Naftogaz has evolved from a black hole into a source of income for the state budget

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    Back in 2014, the Naftogaz deficit covered by the state budget was higher than the rest of the state budget deficit combined and amounted to 6% of GDP. It is expected that in 2016, the net contribution from the Naftogaz group will account for 10% of the state budget revenues.

    It is expected that in 2016, the group will pay more taxes than the state will spend on total gas subsidies for the households. Even after providing direct subsidies to all citizens who face difficulties paying for gas at the import parity price, the state is expected to have nearly UAH 25 billion remaining to be spent on defence, health care, education and other needs. This is a significant resource for the state that can be spent on improving the standards of living of a wide range of Ukrainian citizens.

    After two years of reform, Naftogaz has been transformed from a black hole into a source of income for the state budget.

    Reform of the procurement system in UGV

     

     

    THE IMPORTANCE OF CONTINUING MARKET REFORM CANNOT BE OVEREMPHASIZED

    Naftogaz took on the role of gas market reform leader because the changes taking place within Naftogaz will not be sustainable without the creation of a genuinely competitive domestic market.

    The further transformation of both the company and the industry is necessary to gain public confidence in Naftogaz becoming an efficient, transparent and accountable commercial organization, comparable to major European public companies.

     

    IMPLEMENTING DEBT COLLECTION MEASURES

    According to a ranking published by Deloitte, Naftogaz ranked 15th by revenues among the 500 largest companies in Central and Eastern Europe in 2015. The group ranked 7th among energy sector companies in the region and second among Ukrainian companies.

    One of the most significant challenges to improve the efficiency of Naftogaz is related to receivables. In line with the 2015 memorandum of cooperation signed between the Ukrainian government and the IMF, PricewaterhouseCoopers conducted a diagnostic analysis of Naftogaz receivables. This analysis allowed Naftogaz management to increase transparency in this area and improve the process of debt collection.

    During 2015, the company invested much effort in resolving the long-standing debt of the Ostchem group enterprises. On 16 September 2015, Naftogaz concluded settlement agreements — later approved by court decisions — which saw JSC "Azot" (Cherkasy) and the JSC "Rivneazot" repay debts to Naftogaz and "Gas of Ukraine" (a subsidiary that carried out the sale of gas purchased by Naftogaz until 2011) worth almost UAH 2.96 billion. At the beginning of 2015, Ostchem group, which includes these enterprises, had been Naftogaz's largest single debtor.

    However, at the beginning of the reporting period, industrial enterprises accounted for only 18% of the company's outstanding debtors. The biggest share of debts to Naftogaz was generated by heat producers (51% of total unpaid debts) and regional gas companies (21%).

    In early 2015, Ukrainian legislation contained a number of obstacles to collecting debts from certain categories of consumers. In order to eliminate these barriers and expedite the work on debt collection, the Verkhovna Rada of Ukraine introduced important legislative changes in May 2015. These amendments were aimed at remedying the situation and stabilizing the financial state of Naftogaz. These changes were part of Ukraine's commitments within the framework of the IMF program.

    As a result of these changes, two moratoriums protecting energy and other companies from the application of enforcement procedures were cancelled, while the process for enforcement of court decisions was improved. The government cancelled the moratorium on the enforcement of court rulings on debt collection for companies included in the fuel and energy complex register, as well as the moratorium on the forced sale of property of state enterprises and commercial companies where state share capital is not less than 25 percent.

    As a result of these actions, Naftogaz was able to regularly receive funds from the state executive service written off from the accounts of debtors during the enforcement procedure.

    Overall in 2015, over a thousand court proceedings were opened to recover debts for natural gas supplied. Of these, more than half have already been considered by the courts with final decisions delivered.

     

    The list of largest taxpayers in Ukraine

     

    IMPROVING THE PAYMENT SYSTEM OF THERMAL ENERGY PRODUCERS


    The most problematic category of Naftogaz debtors are the companies that produce thermal energy for the population, budget organizations and other institutions (district heating companies, DHCs). In 2011, the Verkhovna Rada of Ukraine adopted a decision to write off more than UAH 20 billion in debt owed by these companies to Naftogaz. By the beginning of 2014, they had accumulated a further UAH 23.5 billion in debt. As of 1 January 2014, the total accumulated volume of unpaid gas used by thermal energy producers totalled 9.1 bcm.

    The sharpest deterioration in payment discipline was observed in 2013. During the course of this year, thermal energy producers failed to pay for 6.7 bcm of delivered gas. After the new team took up their positions at Naftogaz in 2014, payment discipline significantly improved and debt levels have been reduced. This was in part due to the adoption of the necessary legislation by the Verkhovna Rada and other state bodies.

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    ProZorro is an electronic public procurement system which replaced paper state tender procedures

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    As of 1 January 2016, the total unpaid debt formed in 2011-2015 (excluding non-payment penalties) amounted to UAH 14.9 billion. Including UAH 2.9 billion in penalties accrued and upheld by court, the debt of this category of consumers totalled UAH 17.8 billion. 

    The problems surrounding the thermal energy industry are complex and require a comprehensive solution. Ukrainian citizens should be given an opportunity to receive high-quality and reliable heating services. Naftogaz hopes the Verkhovna Rada will soon consider a draft law that would offer an comprehensive solution to the thermal energy sector issues.

    Debts of thermal energy producers

    RAISING FINANCING FROM INTERNATIONAL INSTITUTIONS

    In 2015, Naftogaz received a loan of USD 300 million from the EBRD for the purchase of natural gas from Europe.

    This revolving credit facility was provided based on the government commitment to reform corporate governance system within Naftogaz in accordance with OECD principles for state-owned enterprises. The bank set strict conditions on procurement under this loan. These conditions included the application of EBRD procurement rules, preliminary selection of suppliers under the agreed criteria, and procurement under a mandatory non-discriminatory procedure.

    In 2015 Naftogaz used about USD 48.7 million of the EBRD loan to purchase 241 mcm of gas for the 2015-2016 winter heating season.

    The remaining funds were used in January 2016. Naftogaz partially funded gas purchase contracts concluded within the framework of this EBRD facility at its own expense.

    This EBRD loan is renewable during three years. Within this period, Naftogaz can repay and draw down up to the same amount to finance advance purchases of gas before winter periods.

    Naftogaz is also negotiating with the World Bank over funding in the form of a letter of credit/credit lines for commercial banks against IBRD guarantees of up to USD 500 million. Naftogaz is also discussing a credit of up to USD 200 million with the International Finance Corporation (IFC). Naftogaz is engaged in fundraising discussions with other financial institutions.

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    In 2016, Naftogaz group overcame the Ministry of Defense by total savings achieved via ProZorro

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    In 2015, within the framework of cooperation between Naftogaz and European suppliers of natural gas, Naftogaz continued to transition toward operating under the EFET contract for gas purchase, a common practice in the European gas market.

     

    IMPROVING NAFTOGAZ COMPETITIVENESS IN THE MARKET

    The implementation of the Law of Ukraine "On Natural Gas Market" resulted in liberalization of gas prices for all consumers except for the households and DHCs producing thermal energy for the household of natural monopolies (transportation, distribution, storage, LNG installation services) and free price competition in the gas supply to industrial consumers.

    Starting from 1 October 2015, Naftogaz has been supplying gas to industrial consumers and other business entities on market conditions, independently determining the prices and conditions of natural gas sales. These prices are published monthly on the Naftogaz corporate website.

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    On 1 July 2015 Naftogaz filed its first application for the purchase of "plastic office or school supplies" through the ProZorro. The expected purchase price was UAH 118 thousand including VAT. Five companies participated in the electronic tender. Following three rounds of bidding the winning offer amounted to UAH 80 thousand, 1.5 times lower than the purchase price expected initially.

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    In order to maintain competitive pricing, the company has developed the appropriate internal regulations and procedures that are expected to improve the position of Naftogaz in the domestic gas market.

    Naftogaz group contributions

    STRENGTHENING TRANSPARENCY AND ACCOUNTABILITY

    For the second year, Naftogaz has conducted a comprehensive audit of financial results according to international financial reporting standards. An independent evaluation of fixed assets has been carried out by EY, and the valuation of hydrocarbons reserves has been conducted by Ryder Scott Company.

    Ukrtransgaz, the gas transmission system operator, by decision of the national regulator NEURC, switched to the RAB-methodology of setting transmission tariffs which is commonly applied by the Energy Community countries.

    Naftogaz is disclosing information in line with the requirements of relevant Ukrainian legislation on access to public information and transparency in the activities of the Naftogaz companies, including the Law of Ukraine "On Natural Gas Market", the Law of Ukraine "On Access to Public Information", the Law of Ukraine "On Amendments to Certain Legislative Acts of Ukraine on Transparency in the Extractive Industries", and the Law of Ukraine "On Special Aspects of Access to Information in Supply of Electricity, Natural Gas, Heating, Central Hot Water, Centralized Drinking Water Supply and Sanitation", and the Law Ukraine "On Open Use of Public Funds".

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    Introduction of the ProZorro system at UGV
    UGV was one of the first of Naftogaz companies to run a pilot tender through the ProZorro open electronic public procurement system. In August 2015, the company filed its first application for the procurement of 200 tons of hydrochloric inhibited acid through the system. The expected purchase price was UAH 970 000 which was reduced by 22% following the tender.

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    This improved level of transparency and accountability allows the company to secure the support of a wide range of stakeholders both in Ukraine and abroad, and continue to pursue its strategic agenda.

    In December 2015, the government has initiated in Naftogaz the reform of corporate governance according to OECD principles for state-owned enterprises. In May 2016, the first meeting of the independent supervisory board of Naftogaz took place. The implemented changes are intended to ensure the group's ability to operate as a commercial company and be effectively protected from undue political interference (see Strategy and reform — Сorporate governance).

    REDESIGNING PROCUREMENT PROCEDURES

    As part of the Naftogaz reform, in 2015 the group started re-engineering its procurement system, including a review of tendering processes, operating procedures and control mechanisms. This process aims to build in the group a procurement management system based on transparent business processes and in strict accordance with the laws of Ukraine. It also seeks to secure the long-term availability of materials and equipment at minimal prices with consistent quality, and to increase the level of customer satisfaction based on performance management and independent control.

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    Naftogaz in ProZorro in 2015:
    • 578 procurement procedures
    • Expected purchase price — UAH 710 million
    • Savings — UAH 92.1 million

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    In 2015, Naftogaz group became one of the first state-owned entities to start using the ProZorro e-procurement system.

    The main objective of the system is to ensure transparent and effective public spending and prevent corruption through public scrutiny while expanding the circle of suppliers. NGO Transparency International Ukraine is a guarantor for the transparency of the development and operation of the system. The organization agreed to maintain the system during the pilot project and before its transfer to the state.

    Naftogaz uses ProZorro in order to engage more tenders participants, increase the confidence of businesses in procurement procedures, and significantly reduce costs.

    Naftogaz group seeks to prevent corruption during the tender procurement and acts as a leader in the transition to the ProZorro electronic procurement platform among state-owned companies and state institutions.

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