Why an open gas market is more beneficial to consumers than a regulated one

January 25, 2022

In 2015, the law “On the natural gas market” came into force in Ukraine. This law aimed to implement the main European rules of gas supply on the Ukrainian market. Such rules include market-based gas pricing and free supplier choice.

Ukraine had a long history of state regulation of energy prices for household consumers, including natural gas. The price of gas for the population did not change from 2010 to 2014, and was five times lower than the gas price for industry and 1.4 times lower than gas for district heating. Why did Ukraine abandon such state regulation?

How Ukraine controlled the supply of gas to the population

Gas supply to the population was carried out vertically – from state production (or import) through regional gas companies, to the consumer.

State-owned Naftogaz bought gas from its own production companies (Ukrgasvydobuvannya and Chornomornaftogaz) and resold it at a regulated price to regional monopolies. In addition, Naftogaz was to supply gas to heat and power authorities for heat production.

According to the National Commission for State Regulation of Energy and Utilities, gas consumption in this regulated segment was approximately 25.5 billion cubic meters. per year. Proprietary production of Naftogaz and its “subsidiaries” did not cover those needs. Therefore, Naftogaz imported gas from abroad at a rate of $233 (more than UAH 1,800) per thousand cubic meters in 2010 to $ 400 (UAH 3,200) per thousand cubic meters.

The difficulties caused by regulation of the gas market

Under the regime of the regulated gas market, Naftogaz had to provide the necessary amount of natural gas for the needs of the population, district heating, state, communal and religious organizations. To do this, Naftogaz had to extract “cheap” Ukrainian gas and purchase “expensive” imported gas. This allowed Ukrainians to buy gas at a constant price – from UAH 0.72 to UAH 2.95 per cubic meter, depending on consumption.

According to Naftogaz estimates, the company spent $25.5 billion on gas imports from 2005 to 2015 (mostly purchased from Russia’s Gazprom). The company ended up with a loss almost every year: in 2010 it amounted to UAH 24 billion, in 2012 – UAH 31.5 billion, in 2013 – UAH 17.9 billion.

The difference between the price of buying and selling gas grew so much that in 2014 the state financed Naftogaz by a sum of UAH 96.6 billion so that it could import the necessary volumes of gas. Naftogaz, as a state-owned company, regularly received additional funding from the state budget. Ukrainians paid the market price of gas, but not directly – they ultimately paid through their taxes.

The regulation deprived consumers of the right to choose a supplier: in each area there was a state-appointed supplier. This also discouraged suppliers to compete for customers by improving services.

War and reform in Ukraine’s gas market

In 2014, with strained relations with Russia, which at that time was the only exporter of gas to the Ukrainian market, Ukraine’s dependence on Russian gas became clearly dangerous.

Ukraine set out to join the European gas market, where many suppliers operate via market rules rather than political agreements. To do this, the country began to update its own energy legislation.

At the same time, the state budget could no longer subsidize low gas prices for the population and district heating companies. To make the gradual transition to market pricing, the government introduced a mechanism of protection for the population – the imposition of special responsibilities (ISR) to safeguard the public interest in the functioning of the natural gas market.

The price of gas and the list of suppliers remained under state control but tied to prices at European gas hubs. The price of gas for the population in different years and even months of the ISR regime ranged from UAH 2 to UAH 8 per cubic meter. The price for the population came closest to the market price of gas in the last year, in preparation for the abolition of the ISR regime. The reason for this was a record decline in market gas prices.

What does the open gas market change?

The transition from regulated gas price and supply conditions to free pricing is the next phase of reforming the energy market in Ukraine.

Gas suppliers offer different tariff plans (monthly, seasonal and annual), different prices, discounts (for example, for fast bill payment), convenient communication (via chatbots and messengers).

All suppliers must comply with the basic requirements of transparency: have a website, publish a standard contract, terms of gas supply and tariff plans. This gives consumers a basis for comparing suppliers and their services and choosing the best option.

But the opening of the market and the end of the ISR regime are also important for the state budget: market participants will no longer be able to demand compensation from the state for the performance of special duties. For example, in 2020 Naftogaz received UAH 32.2 billion in compensation for the sale of gas for the needs of the population in 2015-2020 at prices below market rates. This support to Naftogaz was eventually covered by all Ukrainians through higher taxes or less funding for state services such as healthcare and education.

In the future, state support for the population should be only targeted to truly deserving social groups through personalized benefits and subsidies.