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Naftogaz 2017 Annual Report Summary

Core Content

The 2017 Annual Report of Naftogaz outlines the company's transformation from a state-controlled entity to a more transparent and competitive European energy corporation. It highlights significant achievements in financial performance, market reforms, and corporate governance, as well as the ongoing challenges in the Ukrainian economy and energy sector.

Main Views and Key Information

Financial Performance

• Net Profit: UAH 39.4 billion, adjusted for income from the Stockholm Arbitration with Gazprom (UAH 57.1 billion), and related income tax expenses (UAH 10.3 billion).
• Current Income Tax: Taxed at 18%, based on taxable income less allowed deductible expenses from both operating and non-operating activities.
• Revenue Sources:
  • Gas production, import and sales to regional supply companies: 54.3/48.9
  • Gas production, imports and supply to MHE's for households: 22.8/18.9
  • Gas production, imports and supply to other customers under PSO: 7.8/4.6
  • Gas imports and supply to other customers outside PSO: 4.1/12.9
  • Oil and gas condensate: 12.9/11.1
  • Oil transit: 3.6/3.3
  • Oil domestic transmission: 0.2/0.1
  • Petroleum products sales: 18.1/13.5

Market and Reforms

• Historical Victory: Naftogaz won a significant arbitration case against Gazprom, eliminating a USD 56 billion claim and receiving USD 4.7 billion in compensation.
• Unbundling of Transmission Function: A major focus was on separating the transmission system operator (TSO) function to ensure non-discriminatory access and efficient use of infrastructure.
• Liberalization of Gas Supply: The gas supply to households was liberalized, with the segment now open to competition. Previously, Naftogaz was a guaranteed supplier to all customers.
• Procurement Reforms: Implemented zero-tolerance policies against corruption, adopted the ProZorro e-procurement system, and increased transparency in procurement processes.
• Corporate Governance: Naftogaz became the first Ukrainian state-owned enterprise with a professional independent supervisory board, though it was not yet fully empowered.
• IPO Preparation: Naftogaz aims to prepare for an initial public offering (IPO) in the coming years, which would allow Ukrainians to become shareholders and benefit from the company's growth.

Economic and Institutional Context

• Ukraine's Economic Growth: Real GDP growth in 2017 was 2.5%, which is slower than global and developing country averages.
• Corruption and Reforms: Corruption remains a significant barrier to economic growth, and the lack of progress in corporate governance reforms has hindered Naftogaz's transformation.
• Sovereign Debt: Ukraine faces a significant sovereign debt repayment schedule in 2018–2021, increasing its dependence on international donors.
• Inflation and Labor Market: Inflation in 2017 reached 13.7%, exceeding the NBU's target. The labor market remains imbalanced, with rising migration and wage growth despite high unemployment.
• Geopolitical Risks: Continued Russian aggression and occupation in Eastern Ukraine pose risks to economic stability and investor confidence.
• Energy Sector Role: Naftogaz plays a crucial role in the Ukrainian energy sector, contributing 6–7% to GDP and 14% to the state budget in 2017.

Structure of the Report

Introduction

• Chairperson Statement: Highlights the progress made by the new supervisory board in corporate strategy, liquidity, and unbundling.
• CEO Statement: Emphasizes the transformation of Naftogaz into a European energy corporation and the importance of transparency, openness, and corporate governance.

Market and Reforms

• Macroeconomic Environment: Discusses the slow growth of Ukraine's economy and the impact of corruption on reforms.
• European Gas Market: Notes the increase in pipeline gas imports and the integration of the Ukrainian market with EU markets.
• Global Oil Market: Reviews the role of Naftogaz in the oil and gas sector and the importance of international collaboration.
• Stockholm Arbitration: Details the legal victory against Gazprom, resulting in a significant financial gain and the removal of a major debt risk.
• Key Reforms:
  • Diversification of gas routes and suppliers
  • Transparent procurement and anti-corruption measures
  • Corporate governance reforms aligned with OECD standards
  • Unbundling of gas transmission function

Performance Overview

• Gas Business: Shows improved efficiency and profitability, with a focus on domestic transmission, storage, and sales.
• Oil and Gas: Highlights the modernization of refineries and the shift from non-transparent procurement to competitive bidding.
• Procurement: Notes the significant cost savings achieved through the ProZorro system and legal challenges to joint venture agreements.

Corporate Governance

• The supervisory board focuses on long-term planning, liquidity, and the separation of TSO functions.
• The board emphasizes the importance of independence and transparency in governance.

Responsibility and Sustainability

• Human Resources: Emphasizes the importance of a motivated and ethical workforce.
• Safety and Environment: Highlights the company's commitment to safety and environmental protection.
• Social Contribution: Notes Naftogaz's efforts to support local communities and promote energy efficiency.

Financial Statements

• Includes consolidated financial statements, auditor reports, and detailed profit and loss accounts.
• Provides insights into the company's financial position and performance.

Additional Information

• Covers legal disclosures, terms and abbreviations, and material topics under GRI standards.
• Includes contact details and further reading sources.

Conclusion

Naftogaz 2017 Annual Report underscores the company's transformation into a transparent and competitive European energy corporation. It highlights the legal victory against Gazprom, the implementation of anti-corruption measures, and the progress in market reforms. However, the report also acknowledges the ongoing challenges in corporate governance and the broader economic context, emphasizing the need for continued reform to ensure Ukraine's economic growth and energy security.