Gas hub in Ukraine: fantasy or reality?

Ukraine declares the concept of a gas hub based on the domestic HTS and PSG system as a strategic project in the energy sector. What has been done in the last ten years, writes the general director of the Ukrainian Energy Exchange Oleksandr Kovalenko for epravda.com.ua.

Illustrative photo

The gas hub consists of three mandatory elements: infrastructure, competitive market and own gas production. Of course, a powerful gas infrastructure has been our indisputable competitive advantage for many years.

However, the current assessments of the world's leading analysts regarding the prospects for the development of gas markets rely on the assumption that the current transit agreement between Gazprom and Naftogaz, which will be valid until the end of 2024, will not be extended.

Flows of Russian gas to the EU through Ukraine will stop and will be carried out only through the Turkish Stream. Thus, if the right steps are not taken in time, Ukraine may find itself not in the center of gas flows, but on their sidelines.

In this direction, Ukraine began to deepen cooperation with neighboring countries of Europe and the Energy Community in order to expand the possibilities of gas entry and exit at cross-border connection points. This is especially relevant in the context of the expansion of prospects for the transportation of regasified LNG.

Gas entering Ukraine can be stored in the largest gas storage facilities in Europe. However, due to the risk of infrastructure damage and the instability of our legislation, Europeans are wary of pumping gas into Ukraine.

Despite this, many foreign traders have ventured to transport gas for storage in Ukrainian gas storage facilities due to the rapid filling of storage facilities in the EU.

The trend is good, but, unfortunately, from the point of view of the prospects of creating a hub, it is not enough. Non-residents pump gas in the "customs warehouse" and short-haul modes. This means that this gas will return to the EU by re-export after temporary storage. We are not talking about trading, formation of price indicators and the hub here.

Thus, we smoothly approached the second factor — the competitive market, the basis of which is stock trading. While there are numerous restraining factors for the development of the domestic market due to the war (ban on exports, partial monopolization of the market, moratorium on increasing gas prices for the population and tariffs for the supply of heat for the population during martial law), the only segment where it is possible to develop a commercial gas hub is Ukrainian PSGs in the part of trade in "customs warehouse".

On the eve of the Great War, the gas storage operator Ukrtransgaz and the Ukrainian Energy Exchange (UEB) announced the launch of an exchange tool that would allow non-residents and residents to trade gas in a "customs warehouse" on the exchange. By the way, non-residents can trade in Ukraine only with gas stored in the "customs warehouse" mode due to the requirements of tax legislation.

However, exchange trading in the "customs warehouse" did not work due to restrictions on currency transactions introduced by the NBU at the beginning of the war. These restrictions do not allow the exchange to apply classic mechanisms for guaranteeing the fulfillment of obligations.

Although on August 10, the National Bank allowed stock exchanges to return to non-residents their guarantee fees in foreign currency, this did not solve the problem in any way, because the main point of the guarantee fee is the possibility of paying fines from it.

For example, the contribution of a non-resident who has defaulted on his contractual obligations to another non-resident should be passed on to the injured party, but this is currently not permitted. UEB states that they continue to work on other mechanisms and structures that would allow the market to work.

One of the main indicators of the efficiency of the hub is its liquidity. The map of the European gas market is an extensive network of hubs on which an unlimited number of exchanges operate, increasing their liquidity.

Ukraine should be interested in supporting exchange platforms that attract leading technologies to our market. The main thing here is that the traditional Ukrainian love of creating monopolies does not become a serious obstacle.

The main product of the gas hub is price indicators. For a long time, Ukraine did not have its own price index and was guided by the prices of European hubs. When this became impossible and due to war restrictions on exports, we lost our connection to external indicators, battles broke out in the country regarding the gas price index.

The stock market of Ukraine is not yet highly liquid and needs the help of the state to support the establishment of liquidity for the formation of price benchmarks. In the world, for this, special temporary measures were introduced with the aim of building competitive markets and fighting monopolies Gas Release Programs.

That is, when obligations for certain categories of market participants regarding trading on the stock exchange are established for a certain period of time. Let's take the Romanian market as an example. It is most similar to Ukraine, because this country is 85% self-sufficient in its own gas (from 2027 it can become a net exporter thanks to Neptun Deep).

The quota for the mandatory sale of gas through the exchange in Romania was introduced in order to increase the dynamics of the centralized wholesale gas exchange market. According to the Romanian offshore law, producers must trade at least 40% of the produced gas in the form of standardized products (monthly, quarterly, semi-annually, seasonally and annually) on the Romanian commodity exchanges.

However, stable supply of the resource to the market can only be ensured by own production, which is our third factor. Of course, maintaining stable production remains a non-trivial task during a war, but in the long term, attracting foreign investment to increase gas production is a top priority for the industry, the ability to solve which largely depends on the stability of the taxation system.

The producer's gas must enter the wholesale market (we are not currently considering PSO, but with the prospect of its cancellation after the war). If we look at the gas market in Ukraine, we will not find a trader there in the classical sense. The gas movement chain from the producer to the consumer is one-way, without resale.

However, it is resale that is a feature of the developed market. If we look at European countries, where there are many participants who sell many different products in large quantities, then the churn (resale rate) will definitely be high there. Churn is used by traders as a "snapshot" of market liquidity. Some traders do not participate in markets with churn less than 10.

In the future, the exchange should be the center of trade operations of traders, not producers, consumers or suppliers. However, attracting a trader, especially a foreign one, to the exchange requires a favorable environment for his existence on the wholesale market. This can be characterized by two components: free circulation of gas and free circulation of currency both within the country and across borders.

While the Ukrainian market has a long way to go in the development of trade. The gas market needs a reboot after the war. It is not only about returning to the basics of marketity, but also about fulfilling tasks as a candidate for EU membership.

For the access of non-residents to the market, tax issues should also be resolved. The prospects for the implementation of Directive 2006/112/EC in terms of the introduction of the reverse charge mechanism are still very remote for the natural gas market, although some moves for the electricity market to ensure market coupling are still being initiated.

We can be inspired by the example of the Polish market. There, since April 1, 2023, a domestic reverse charge mechanism (DRCM) has been introduced in the field of electricity, gas and emissions trading. It is interesting that this applies precisely to stock transactions carried out through exchanges, and to the exchange itself, which allows for full clearing without financial tax losses.

The capacity market has not been created in Ukraine either. Our regulatory framework assumes that unused capacity is redistributed into short products, it can be transferred or returned, but mechanisms for centralized power trading have not been created, and standardized products of combined capacity (so-called power between hubs) have not been introduced.

After the victory, other challenges may await us in terms of transit restrictions. Then the question of access to capacity may look different due to the limitations of the backhaul service and other replacement options will have to be developed. Perhaps there will be a request for new exchange products or spreads.

Also, until the victory, the issues of consistency of gas quality and Ukraine's transition to energy units were postponed. The creation of a gas hub is a long-term process that requires not only political will, but also systematic reforms and investments. Measured planning, development of effective mechanisms and cooperation with key stakeholders are important success factors.

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