Funds and Firm Actions to Reanimate Ukraine’s Gas Distribution System

Ukraine’s gas distribution networks are in bad shape and if nothing is done, the situation will get even worse in the next 5 years

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Ukraine’s gas distribution networks are in bad shape and if nothing is done, the situation will get even worse in the next 5 years. In this column, the author overviews the current state of affairs and explores causes and solutions.  He concludes  that the Ukrainian gas distribution system needs around UAH 7 billion of investments per year to reach a European level of safety and efficiency.

Decayed

The original purpose of the study was to find out the real condition of the gas distribution networks and understand the limits of their safe and continuous operation. Surprisingly, but Ukraine has turned to be the only country among those where I worked and where the gas distribution network operators seem to be the solely responsible for monitoring of the condition of gas transmission facilities with no involvement at the state level, for example, of the industry regulator. Contrary to Europe, the operation of the morally and physically worn pipelines in Ukraine reminds a sort of a sports competition with relevant elements of luck and adrenalin rather than a systematic and serious work aimed at satisfying customer needs.

The study has taken me almost two years and I have collected the data about the major part of Ukraine’s gas distribution market, and my brief summary is as follows:

  • Gas pipeline

Currently Ukraine has about 3200 km of gas distribution pipelines being in a very poor condition. Compared to the total 350 thousand kilometers of the entire network the figure is not that impressive, but in fact it means that in average every 100 meters of the existing gas pipe in a city or village has a weak section and that is always a potential danger.

The study of the dynamics of aging of Ukraine’s gas pipes has brought my colleagues and me to the conclusion that within 5 years the number of the worn-out sections will double, which is terrible. The European standards allow for no pipelines of this kind at all. Deficient Ukraine’s gas pipes seem to become a sort of a technical standard. In the Czech Republic, should any unsafe section be detected in any inhabited area the local authorities immediately take safety measures because of a high risk arising therefrom. In Ukraine no one cares about the gas pipes condition and very few know the true state of things.

  • Structures and equipment

The situation with the equipment is far worse. Gas control facilities (gas control points and cabinet distribution units), which reduce the gas pressure and ensure its necessary downstream level (for example, from high to average or from average to low), are the vital elements in the safe and continuous gas delivery chain. Currently over 5,5 thousand of Ukraine’s gas control points and cabinet distribution units (which is 8% of all units being in operation) are critically worn-out. Moreover, within 5 years this figure will reach up to 10 thousand objects.

Aging costs dear

Another thing that should be discussed in connection with the troublesome gas pipelines is the network elements and equipment which service life is over. Parts and elements that are still in use despite their “declining years” cannot be operated efficiently. These pipe sections create losses which makes the entire business unprofitable with no interest among foreign investors.

Let us take, for example, the domestic pipelines. Currently the number of the aging gas pipes in Ukraine is something around 7% and in 5 years the figure is about to increase and exceed 10%. Despite this the national rules and regulations provide for no special control. Ukraine allows for a 3% limit while in Europe the figure cannot be higher than 1.5%.

The things are as bad with the national gas control points and cabinet distribution units. Today almost 15% of them have reached their zero depreciation reserve and within 5 years the number will go beyond 20% contrary to Europe with their 3% limit.

In other words the old pipelines need extra funds and resources to ensure their necessary operating condition leaving no option for the new technologies implementation, its modernization and safety improvement.

The operation of the weak and worn-out pipelines is very expensive and entails high technical losses of gas (what is called production and technical losses in Ukraine). Deficient gas transportation networks let the expensive gas escape into the air and the consumer pays for it. The principle is very simple and can be observed in any country – the less the investments are the worse the gas pipeline network condition is and the bigger the losses are. In Eastern Europe the generally accepted loss limit does not exceed 2.5% while in Ukraine the figure has reached 4.5% and is expected to grow to around 6% in 2020. One thing to bear in mind is that the burden of losses falls on the consumer.

Who is to blame?

How is it that the condition of the Ukraine’s gas distribution networks has become so deplorable? For this we need to get to the root of the problem. To my mind there are two underlying causes and both are connected with the lack of state regulation.

  • Historical retrospective

I hear constantly from the Ukrainian gas experts that the deplorable condition of the gas distribution networks covers the period of the last 3–5 years and, also, that it is due to the privatization. But the pipelines and equipment service records show that the problem dates back 20 years ago and is connected with insufficient state strategic planning. The 1990s were to witness the mass replacement of the pipelines and gas control points/cabinet distribution units built during the Soviet times. Yet, the replacement was hardly to occur then so a temporary solution was found to do the equipment repairs and extend its service life for which purpose the relevant legal norms and regulations were adopted.

20 years have passed and the additional technical resource is gone. Now the equipment is technically ineligible and unsafe and every pipeline section, every gas control point/cabinet distribution unit being in this condition is not just dangerous and unstable in terms of the gas network operation and continuous supply, it also poses a danger to people’s lives.

  • Present-day situation

Here the things are complicated, too, since the tariff does not incorporate the real need for gas distribution networks, following are the two examples to illustrate this:

  • At least since 2012 the actual gas transportation quantity was smaller compared to the quantity proposed by the state regulator during the approval of tariffs for natural gas distribution companies. Recent years show the difference of 2-3 billion cubic meters per year. Because of these “blunders” the gas distribution companies earn scant revenues (based on the analysis of the data of 17 gas companies). The year 2014 unveiled the revenue of UAH 1,8 billion which was less than the tariffs provided. And a year earlier, in 2013, the difference was about UAH 0,8 billion. Plus we should not disregard that the length of gas distribution networks to be maintained does not decrease, on the contrary, the pipeline network grows.
  • A similar situation can be observed with the gas transmission and distribution losses. We believe that natural gas production and technical losses as incorporated into the tariff do not correspond to the approved methodology and actual figures. Here’s an example: according to the data we have, in 2014 the tariff included UAH 4,2 billion as a loss amount while the study has revealed the actual amount of around UAH 5,6 billion.

The conclusion is simple: the gas companies lack the funds necessary for the investments and networks repairs and modernization.

What to do?

It should be noted that many of Central and Eastern European countries used to face something alike. Their experience has helped us develop a ready-made solution for Ukraine to solve the problem.

Investments are to be considered first. Based on the results of the study we suggest three options with respect to the investments to be applied.

Option 1. Renovation of technically ineligible and unsafe sections

Our estimate shows that the reconstruction of the technically ineligible and unsafe sections throughout Ukraine will take at least 5 years of additional investments in the amount of UAH 2,5 – 3 billion per annum. What will be the outcome? The pipeline wearing-out will discontinue and no extra troubled sections will emerge. Nevertheless the technical gas losses will remain the same. The reduced gas consumption will also result into the increase of the share of these loses and the remaining end-users will have to pay for their “loyalty” (and the amount will be only growing). Moreover, the natural gas supplies are likely to be interrupted, especially during the winter time. We might also guess that some of the consumers will be disconnected from the service because of the absolutely poor operational condition of gas pipeline sections which will have to be put out of service only.

Option 2. Reconstruction of sections which service life is almost over

This option will help eliminate the technically ineligible and unsafe pipeline sections problem and set the gas transportation technical losses limits at the level of 3.5 – 4.5% even in case of the reduction of volumes of natural gas consumed. For that an investment of UAH 5 billion per annum is required and shall coverthe 5 – 7 year period. The consumer’s financial burden to cover these losses shall be set at a fixed level.

Option 3. Complete modernization of pipeline and facilities

With this option the Ukrainian gas distribution network condition can reach the European level. Figuratively speaking, the Ukrainian ‘Zaporozhets’ car (a national automobile industry product) can be transformed into the Czech ‘Skoda’. The process will need annual investments of around UAH 7 billion and will entail not only the replacement of the old and worn-out pipes but the introduction of the new technologies as well. The gas transmission and distribution losses will drop to 2-2.5% to meet the European standards, the number of the technically ineligible and unsafe pipeline sections will be almost reduced and the service life will have optimal limits.

But the “pipeline” investments are not suffice to succeed. Skilled and qualified personnel with the relevant remuneration represent another force necessary to perform the transformation as the East European experience unveils. Yet, this factor has not been included into the estimation of the amount of investments since it is obvious that any state-of-the-art technology will not serve long without the due technical support and correct operation which entails the engagement of skilled personnel whose work does need to be paid decently.

Ukraine cannot afford this so far – the amount of salaries, especially within the gas distribution sector, is dramatically small. So in 2014 the average salary of an industrial worker in Ukraine was around UAH 5,000, and the worker employed by a gas company earned about UAH 3,000 per month. We have discovered another interesting fact: the employees of UKRTRANSGAZ, the Ukrainian state-controlled company, are paid on average UAH 7,000 while the same employee of a private company is offered twice as less money. For me, as for a person who lives in Europe, this situation represents something unreal.

Due to the gap in the amount of salaries the gas distribution companies have their best personnel leaving their jobs, plus, in general, the industry suffers from the staff shortage – the actual number of employees is 35% less than required. The Czech Republic had similar problem 10 years ago which was solved in quite a simple way. The state defined the gas supply as a strategic objective whereupon the state regulator incorporated the salaries into the gas tariffs at the level being average across the industry. Besides, the salary was regularly reviewed and updated based on the indicators of economic development.

Another aspect to be considered is the optimization of the entire gas distribution network in Ukraine mainly the public and communal pipelines. Currently their operation is effected under the standards which differ from those applied during the stage of their designing. For example, the natural gas from the transmission to distribution lines was originally transported under the pressure of 12 kgs/sm2. At present, due to the reduced gas consumption, the suffice level of pressure varies between 6 and 1.5 kgs/sm2 which makes idle many of the existing equipment items. Some of the companies have up to 20% of the idle items. Yet the Ukrainian laws do not allow the operators to put this equipment out of service (especially if it is a part of the state-owned pipeline) and install a bypass pipe instead. The safety norms also require that this idle equipment is to undergo the necessary maintenance procedures which results into unreasonable costs while the money could be directed into the pipeline modernization.

Experience of our foreign colleagues

Following is a brief outlook of the technical efficiency of Ukraine’s gas distribution system as opposed to the European one based on the key indicators of the Ukrainian and Czech gas companies:

THE CZECH REPUBLIC
7 gas distribution companies
UKRAINE
17 gas distribution companies
Key indicators
approx. No. of end-users 2.2 million
approx. No. of pipelines 70 000 km
approx. No. of gas control points /
cabinet distribution units 3 500 units
approx. scope of
investments in 2014 UAH 2,5 billion
Total investments
per end-user UAH 1 250
per km of pipeline UAH 39 300
per gas control point /
cabinet distribution unit UAH 786 000
Total production and technical losses
Actual 2014 approx. 1.5%
Budget 2015 approx. 1.5%
Key indicators
approx. No. of end-users 7 million
approx. No. of pipelines 156 000 km
approx. No. of gas control points /
cabinet distribution units 34 000 units
approx. scope of
investments in 2014 UAH 172 million
Total investments
per end-user UAH 25
per km of pipeline UAH 1 100
per gas control point /
cabinet distribution unit UAH 5 000
Total production and technical losses
Actual 2014 approx. 3.5%
Budget 2015 approx. 4.5%

The figures in the table show why the Ukraine’s gas distribution system is in need of investments. With the present scope of the problem if we increase the current tariff rate applied in Ukraine to the transportation of gas through the pipeline network by 10 kopecks per m3 we will have additional UAH 2,5 billion per year with reference to the total annual consumption of the natural gas in the amount of 25 billion m3, and the funds are to be directed to fix the technically ineligible and unsafe pipes. The increase of the tariff by 30 – 40 kopecks per m3 (which represents about 5% tariff rate raise) would allow Ukraine solve all the issues related to the pipelines condition and operation, and these funds would be used to support the Ukraine’s gas distribution system, make it challenging and keep it from being a financial burden for any of the consumers.

As an observer I would like to highlight that the Ukraine’s gas distribution system has almost reached its top crisis point. The problem does exist and those who are responsible for its settlement have to be brave enough to admit this (and not act as if nothing happens) and get to firm and resolute actions. To start with they may look into the problem and see how the situation will look like within a 5-year period.

Table 1. Condition of pipelines

Pipeline to be replaced on average during 10 years, per year
IN NEED OF REPLACEMENT
Pipeline to be replaced on average during 10 years, per year
ACTUALLY REPLACED
Underinvested in km of pipeline
replacement,
per year
2014 year-end ACTUAL worn-out pipeline length 2020 year-end EXPECTED worn-out pipeline length
475 km 315 km 160 km 1% (1,6 thous. km) 2% (3 thous. km)

Table 2. Condition of gas control points and cabinet distribution units

Units to be replaced on average during 10 years, per year
IN NEED OF REPLACEMENT
Units to be replaced on average during 10 years, per year
ACTUALLY REPLACED
Underinvested
in replacement per year, on average
2014 year-end ACTUALLY worn-out gas control points and cabinet distribution units 2020 year-end EXPECTED worn-out gas control points and cabinet distribution units
1 580 1 300 280 8% (2 800) 15% (5 000)

Table 3. Depreciation rates

Infrastructure Optimal figure with reference to current service life 2014 year-end
actual figure
2020 year-end expected figure
Pipelines 2.5% (3,9 thous. km) 7.2% (11 thous. km) 10% (16 thous. km)
Gas control points and cabinet distribution units 4% (1,4 thous.) 14,5% (5 thous.) 21% (6,8 thous.)

*In Ukraine the suggested life for depreciation of pipelines covers 40 years, of gas control points – 40 years, and of cabinet distribution units – 20 years

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Additional information

Structure and components of the production and technical losses

The production and technical losses are divided into three elements with two of them having direct dependence on the volumes of natural gas transported:

  1. Pipeline condition. This element embodies technical losses that arise out of insufficient pipe tightness, technological properties of gas pressure reducing equipment (relief valves operation, etc.), maintenance service, new connections and any emergency situations. It should be understood that the pipeline is not fully sealed. The gas losses are inevitable irrespective of the pipe age and condition.
  2. Demand for natural gas among gas distribution companies. This element covers technical losses connected with heating of manufacturing facilities during the cold season, pipe network purging, adjusting the protection equipment actuation and filling the flasks.

Due to the fact that natural gas travels constantly under the pressure the scope of the above elements remain unchangeable regardless of the volume of the natural gas transportation. Therefore the reduced volume of the gas transportation raises the rate of technical gas losses.

  1. Commercial losses. This element includes poor gas consumption accounting management, failure to bring to the standards the volumes of gas consumed by households, incorrect data taken from the gas meters along with their aged service live. Besides it includes the natural gas theft, losses caused by unauthorized hot tapping, etc.

Disclaimer

The author doesn`t work for, consult to, own shares in or receive funding from any company or organization that would benefit from this article, and have no relevant affiliations