Toward Securing Ukraine’s Energy Independence

US-Ukraine Energy Dialogue III:
Securing Ukraine”s Energy Independence

Toward Securing Ukraine’s Energy Independence

Volodymyr Makukha

Keynote address by Deputy Minister of Fuel and Energy of Ukraine V. Makukha, delivered at “US-Ukraine Energy Dialogue III”, Capitol Hill/Hart SOB Ninth Floor Forum Room, Washington, D.C., April 15, 2008.

Dear Ladies and Gentlemen,

First of all, I would like to thank Senator Richard Lugar, President of the Orange Circle Adrian Karatnycky, President of the American Foreign Policy Council Herman Pirchner and President of the Center for US-Ukrainian Relations Walter Zaryckyj for organizing such an important event in our bilateral dialogue in the energy sphere.

It is especially very important today when the issues of energy security in our region has became again, like it already happened in January 2006, a matter of concern not only for Ukraine itself but for all our friends and strategic partners in the world.

And again Ukraine has proved itself as a responsible and reliable country which honors all its obligations in providing stable and uninterrupted supplies of natural gas to Europe. But unlike 2006, this time we showed much more resolve in securing high standards of transparency in our domestic gas market as well as in transit arrangements with our major partners. Believe me, it was not and is not an easy issue.

The visits of President Yushchenko and Prime-Minister Tymoshenko to Moscow in February 2008 facilitated development of the new approaches in cooperation between Ukraine and Russia in this area. As a result the new Agreement on the Development of the Relations in Gas Sphere” was signed on March 12, 2008. This Agreement stipulated the amounts and price of gas supplies to Ukraine in 2008 (49.8 bln cubic meters at 179.5 US dollars for 1000 cubic meters). It also identified the amounts of direct supplies of gas from Gazprom to Ukraine (nor less than 7.5 bln cubic meters) which is equal to 10% of total Ukrainian gas market or 25% of gas supplies to industrial enterprises. Therefore Gazprom will entirely substitute Ukrhazenergo (the subsidiary of Ukrainian gas monopoly Naftohaz of Ukraine” and well known RosUkrEnergo) with its own subsidiary (by the way, this company was established last week in Ukraine). The Agreement also facilitated payment arrangements between Naftohaz and gas suppliers to Ukraine.

We believe that this is a very important agreement which laid grounds for signing direct contracts with gas suppliers without participation of non-transparent middlemen.

Today negotiations with Gazprom officials are continued. Both sides are trying to clarify certain issues such as who will be the major gas supplier to Ukraine (Gazprom, its subsidiary or RosUkrEnergo), time frame and the scope of Gazprom operations on Ukraine”s internal market, etc. And I believe that we are quite close to strike the deal.

Of course the question is what we could expect in coming years? Frankly speaking, our life will not be easier especially taking in account recent statements of Central Asian leaders that from the next year they are intended to sell their gas at international market prices. And Central Asian gas is almost the only source of supplies to Ukraine. Therefore we could expect that in this situation the prices for imported gas could come close to 300 US dollars for 1000 cubic meters

How we are planning to respond to these very serious challenges? First of all we are taking steps to decrease the amounts of gas consumed by Ukrainian economy. Despite some progress especially in industry – last year we consumed 68 bln cubic meters of gas which is much less than 76 bln cubic meters consumed just few years ago – Ukraine is still one of the most energy consuming contries on the planet.

Among the most important measures in this direction – creation an effective stimulus for energy saving. The financial plan of Naftohaz adopted last Wednsday made a first, probably too modest, step in moving the prices for gas for households and utilities to cost recovery levels. During 2008 the prices will be raised by 25% but they still will be respectively only 40% (512 UAH or 100 USD) and 60% (757 UAH or 150 USD) of the price for gas paid by the industry (1340 UAH or 265 USD) (1). In 2009 we could expect much more drastic rise in prices for households and utilities.

Another big challenge is to decrease the amounts of gas used for technical needs and prevent leaks in our transit systems. Now we are using more than 6 bln cubic meters for pumping gas via our major transit system to European countries and to our domestic consumers. Our GTS was built in early 80-s and requires a serious modernization. Introduction new energy efficient compressor stations and new pipes where it is needed will increase the reliability of transit system and definitely decrease the amounts of gas consumed for technical needs. Such modernization program will cost 2.5 bln US dollars by estimates made by EU experts. To find funds for this program we are planning with EU officials to organize a special donor conference this autumn. We hope that most of the European countries as well as the United States, Russia and some other countries will participate in this event.

Another important measure is to increase the amount of domestic production of gas in Ukraine. Now Ukraine is producing more than 18 bln cubic meters or around 25% of national gas balance. We have a potential to produce close to 30 bln cubic meters annually which will strengthen our energy security and have a positive effect on price situation in our country. I believe that this issue will be discussed later today in greater detail. I would like just to mention that despite certain organizational problems we have some progress with projects in exploration and production of hydrocarbons offshore and onshore. The examples – Vanco, Shell, Marathon Oil.

Talking about energy security in our region I should mention the active position of our country in development of a new format of cooperation between the countries of Caspian region and EU. And we are looking for support from the United States in broader inclusion of Ukraine in major energy diversification projects such as Nabucco, Trans Caspian and others.

We are also very interested in cooperation with US oil companies which could participate in implementation of Eurasian Oil Transit Corridor Project which envisaged the prolonging of Odessa-Brody pipeline to Polish city of Plock, construction of new oil refinery and providing a stable supplies of Caspian oil to consumers in Poland, Czech Republic, Germany and other countries.

The issues of energy diversification and energy security in our region will be discussed during Energy Security Summit which will take place in Ukraine on May 23, 2008. Several heads of states from East Europe as well as from Caspian region already confirmed their participation in this forum. We hope that American representatives will take an active part in discussions during this Summit. We also expect American energy companies to participate in business forum that will take place one day prior to the Summit on May 22 in Kyiv.

In my remarks I would like to say a few words about electricity sector and nuclear energy programs.

About the Electricity Sector: Here we are planning significant reforms in 2008 and coming years. First of all, privatization of the next group of distribution companies (Oblenergos) – this year we expect to sell blocking shares in 6 Oblenergos (the decision on privatization was approved by KMU and State Property Fund is now preparing tenders).

We are also planning to privatize 4 thermal generating companies which represent 44% of total installed generation capacity in Ukraine (2). I have a special presentation on this issue, prepared by Energy Company of Ukraine” which holds the state-own shares in generation and distribution companies and I will leave it to organizers of this Round Table. All needed steps were already made by the Government and we are waiting for approval from the President. The Government believes that privatization will help us to prolong the time of operation of our TPP, introduce modern energy saving technology and to bring our TPP into compliance with EU Directives on reduction noxious emissions

Second, Government is making significant efforts in liberalizing of electricity sector. With the support from the World Bank and Swedish and Dutch consultants, we are preparing deep changes in the model of functioning of our electricity market which will make it more attractive for investors. Today generating companies are selling all produced electricity to and distribution companies and other consumers are buying all electricity from single special entity – state own enterprise “Electricity Market”. During next 5 years we are planning to move from existing model to the system of direct contracts between suppliers and consumers supported by balancing market. We hope that first stage of this system will be introduced next year with direct contract representing 10% of total operations on electricity market.

The reforms process is supported by intensified dialog with European Union. We are actively implementing projects aimed to join European electricity grid – UCTE, improving our legal environment in energy sector within the framework of New Enhanced Agreement between Ukraine and EU which is currently under negotiations. Ukraine also became the observer of European Energy Community Treaty which stipulates the liberalization of electricity and gas markets between EU and its neighbors.

And the last but not least: the Nuclear Energy Sector. Ukraine and US already have a successful cooperation in this sphere. The day before the visit of US President G. W. Bush to Ukraine on April 1 2008 our nuclear energy company Enerhoatom” signed two very important agreements concerning the construction of Spent Nuclear Fuel Storage Facility with Holtec International and on implementation of Nuclear Fuel Qualification Project with Westinghouse Electric.

The first project will provide enough capacity for storage of the spent fuel from 3 Ukrainian NPP (South Ukrainian, Rivnenska and Khmelnitska) for next 100 years. It will help us to minimize political risks from monopoly position of Russian Federation in processing of spent nuclear fuel from Ukrainian NPP and to save money for transportation of this fuel to Russia (3).

The recent signing of the contract on supplies of 630 fuel rods during 2011-2015 will secure full loading of 3 nuclear power units at South Ukrainian NPP with the fuel produced by Westinghouse. We believe that it will be a very important step toward diversification of Ukrainian nuclear power sector.

Among the other issues, one of the most important ones is the development of so called full nuclear cycle”. Having significant deposits of uranium ore, and zirconium production facilities, Ukraine is considering the organization of domestic production of nuclear fuel rods with the exception of enrichment process of course. We already created a special holding company Ukratomprom which includes most of enterprises dealing with this issue.

And finally I would like to express our satisfaction with the pace of activities at Chornobyl NPP site where after a long delays the process of transformation of this area into ecologically safe place have been finally started.

At this point, I will conclude my remarks. I would like to thank you for your attention and I am ready to answer your questions.

(1) Financial plan envisaged 8 bln UA hryvnias in budget subsidies to cover the losess of Naftogas from these operations which constitute close to 11% of total revenues of the company
(2) Installed capacity is close to 53 000 MW, including 52% of ThermalPP, 27% of NuclearPP, 9% of HydroPP and the rest are Central Heating Plants and others; renewables and alternative sources are less then 1%). In production of electricity more then 47% is attributed to energy produced by NPP, 42% – by TPP, more then 4% – by HPP
(3) The total cost of storage of the spent fuel from 3 Ukrainian NPP is 2 bln US dollars, when construction of SNFSF costs are 600 mln US dollars.