UEEX Exchange Committee Chairman: "The requirements for the commodity exchange market in Ukraine were as stringent as those for the capital market"

Natural gas, discovered thousands of years ago, is an essential energy source in most countries worldwide, including Ukraine. It is clear that for the successful functioning of the industry, it requires not only technology and equipment but also an efficient market. However, in our country, the process of its development is complicated partly due to incompetent state policies, bureaucracy, and corruption scandals, and since February 24, 2022, also by the challenging conditions of the ongoing war waged by russia against Ukraine, which has fundamentally changed the situation in the economy.

In regard to the latest trends shaping the situation in the gas and energy resource trading on the domestic market, Mind had a conversation with Oleksiy Dubovsky, the Chairman of the Exchange Committee of the Ukrainian Energy Exchange, where he is also the ultimate majority owner.

– One of the reasons for this interview was the comments that I have recently heard from my colleagues in the gas market. They have been drawing attention to the low quality of compliance at UEEX, which means that offers from suppliers who fail to fulfil their obligations after the trading results may appear. How do you comment on such accusations?

– Thank you for the opportunity to address this issue. Speculating on definitions becomes at least more difficult for those who do so.

First, let's clarify what UEEX compliance is. The duty and the form of its implementation are established by law. UEEX is also a subject of primary financial monitoring under the legislation on combating money laundering and financing of terrorism. This means that it is obligated to conduct the same monitoring as banks, insurers, credit unions, pawnshops, and other financial institutions. The task of financial monitoring is to ensure national security by detecting and preventing the laundering of criminally obtained income, terrorism financing, and the proliferation of weapons of mass destruction. Our UEEX compliance service carries out this task regarding each client or financial transaction.

However, when you enter an organised exchange market, you agree to operate within it under the same rules as everyone else. Even in this case, UEEX gives each participant the right to form their own blacklists of counterparties with whom they cannot enter into agreements, or a 'white' list where all companies that have undergone compliance procedures with that counterparty or security checks are listed, and agreements can be made with such participants.

A for non-performance of supply. There is a trading direction on a UEEX, where settlements are ensured through the exchange with payment blocking in escrow and the exchange of trading notifications. There is also a direction of unilateral auction where the exchange unblocks guarantee deposits when both parties have concluded a purchase and sale agreement based on the exchange certificate, and all settlements between the parties are made independently according to the terms of the contract.

The text of this contract is always part of the initiator's buy or sell order. The counterparty knows in advance what conditions and responsibilities are stated in the contract and what they agree to. If it is a buyer, they can attach their contract with payment upon delivery and strict liability for non-delivery.

What claims can be made against the exchange if a participant chooses a section for trading with off-exchange settlements, agrees to a contract that does not guarantee delivery, and even does not provide exclusion lists to the exchange?

An exchange is a trading venue. We cannot prevent a participant from trading, who theoretically may or may not refuse to deliver goods. This participant may be entirely trustworthy and a major player.

UEEX is currently working on expanding its trading directions where we provide clearing. We will see the interest of participants in using these products.

– The most significant recent event is the appearance of Naftogaz at UEEX auctions, where they purchase gas from Ukrainian production. What conditions have emerged in the market to attract such a major player?

– Private companies have accumulated a significant stock of natural gas that, due to reduced demand during the war, was not needed by domestic consumers and could not be delivered externally. On the other hand, Naftogaz has accumulated a portfolio of customers primarily through special obligations, for which the production volumes of UkrGasVydobuvannya are insufficient. A transparent and competitive procurement procedure was needed to ensure purchases within the legal framework regulating the organised commodity market.

Moreover, when comparing Naftogaz's purchases with imports, it is undoubtedly better for the state-owned company to keep funds within the country. This generates revenue and other contributions to the budget.

– Conversations with industry insiders in extraction companies revealed that Oleksiy Chernyshov, head of Naftogaz, held personal meetings with market participants before entering the UEEX auctions. Did you take part in these negotiations?

– I personally am not acquainted with him. We did not engage in such negotiations or discussions from our side. As you can see, the new management of certain state-owned companies has recently made clear decisions regarding the transparency of their trading activities.

Markets are not built at the whim of one person; it requires coordinated efforts from all process participants. UEEX has long demonstrated a sustained interest and willingness to take a leadership role in building communities and coalitions advocating for economic efficiency and the unshadowing of trading activities.

We strive for as many stakeholders as possible to rally around the issue of Ukraine's need to establish its own market. And we must act as a united team: ministries, regulators, parliamentarians, market participants, industry associations, experts, and international and financial organisations.

Еhe previous management of Naftogaz, unfortunately, chose a different course, which, in my opinion, deviated from the idea of building a Ukrainian gas hub and was even further removed from European models and market structure concepts.

That is why the decisions of the new head of Naftogaz and his statements supporting competition and market development inspire optimism that we will indeed be able to realise our plans. And in the eyes of Europe and the rest of the world, we will once again be seen as part of their civilised market and a team player.

– What are the results of Naftogaz's participation in trading on the UEEX?

– Naftogaz has been participating in UEEX procurements for over a month now. During this time (data as of June 7), the company has purchased 579 mln cbm of domestically produced gas, with a total of 15 companies selling gas to Naftogaz.

Speaking about the overall price trend, there has been a downward trend in the market during this period, and it was also reflected in Naftogaz's trades. The procurement price exclusively for Naftogaz between the first auction (April 26) and the time of preparing this interview (June 7) decreased by 200 UAH and amounted to 10,580 UAH per 1000 cbm (excluding VAT). Although there has been both an upward and downward trend since the first auctions, reflecting the current market situation.

European prices have significantly decreased compared to last year but remain higher than Ukrainian prices established on the UEEX. It's important to consider the geographical distance between these markets when making comparisons. Taking into account transportation costs, the UEEX price was, on average, 36% lower than the price at the Austrian hub in April-May.

– What allows the exchange to remain the primary trading platform for energy resources in Ukraine?

– You will not see a bunch of exchange platforms operating in one price zone In no developed country. There is always one operator, or several if it concerns different market segments. But each of these operators, let's say, crystallises from a range of others who want to work in the segment. Such a concept and the main idea are at the core of the construction of European markets – that they should gradually integrate for free cross-border trading. Similar processes are underway for the countries of the Energy Community Treaty.

We were not the first and we were not the only ones, no laws were written for the UEEX, and we were not included in the laws as an operator of a separate market. In fact, we gained all our positions through competitive struggle, no matter what accusations are made now. I can recall many attempts and ideas to create a state commodity exchange, including a monopoly, but all of that ended badly or with nothing.

Leading global exchanges are private, hence more flexible. Their employees strive not to sit at work until 6 p.m., simulating activity but are interested in working for results and their own expertise and efficiency, usefulness for the company, which needs to be developed to grow itself. We still have many experts working at the UEEX from the first day of its founding. There were times when they were motivated solely by the idea, but now we have created a truly powerful structure known in international markets and approaching gradual integration with international exchange markets.

Imagine that today some regulatory document changes the trading order or market participants demand a specific configuration. Moreover, only a few days may be allocated for this complete transformation. You invest significant investments, the team works 24/7, and you make decisions, but after a month, the task changes drastically. Thanks to the fact that we have, let's say, such basic constructors with a memory of transformation history, the UEEX can solve such tasks. In this case, newcomers would simply lose investments and would have to take risks for new tasks. Therefore, it is important to build a strong muscle mass on the basic skeleton. Overall, to your question, I could have answered with a single word, experience, but here we took on the task of debunking myths and deciphering sensational headlines.

– How did UEEX's financial results change in 2022 compared to 2021, prior to the full-scale invasion?

– We experienced a 6.8% decline in profitability in terms of net income from sales. Overall, I consider it a decent result given the conditions of war and considering the additional expenses we incurred, including assistance to the Armed Forces. The main achievement this year was that Ukraine did not resort to a complete closure of markets and a departure from the reforms made. The enemy failed to plunge our markets into chaos. No employees were laid off at the UEEX; on the contrary, we significantly strengthened and expanded our team.  

– How did the war affect trading volumes on UEEX?

– In terms of the natural gas market, it experienced a significant decline during February 2022, with the start of the full-scale invasion. The wholesale natural gas market saw a substantial drop overall and on the UEEX in February-March 2022 due to reduced consumption and new wartime restrictions. While 1.85 bn cbm of gas were sold on UEEX in 2021, the volume dropped by about ten times in 2022.

The electricity market was not affected as significantly. In 2022, 59.2 mln MWh of electricity were traded, compared to 108.5 mln MWh in 2021. Trading volumes were largely reduced because the Public Service Obligations (PSO), to safeguard the interests of the state during the invasion, were traded outside of UEEX..

Sales of renewable energy generation also decreased due to limitations imposed on producers. Additionally, on September 11, 2022, the occupiers shut down the Zaporizhzhia Nuclear Power Plant, causing a loss of 6 GW of capacity in the Ukrainian grid, which had a negative impact on UEEX's sales volumes.

Under an optimistic scenario for the development of nuclear energy, the return of the occupied Zaporizhzhia Plant to Ukraine will contribute to increased liquidity in the market, especially for medium- and long-term contracts. The projected volume of freely priced nuclear generation sold on the exchange will increase to 20%.

Regarding expectations for the natural gas market in 2023, we are already seeing a recovery, facilitated by the entry of state-owned companies into the medium-term market. First, it was Ukrnafta, followed by Naftogaz Ukraine and the Gas Transmission System Operator of Ukraine. It is predicted that the achieved sales indicators for the first five months of 2023 will be maintained.

As for fuel trading volumes, sales of domestically produced liquefied gas continue as before, while sales of petroleum products have significantly decreased. We do not anticipate a revival in this direction until the end of the war.

– UEEX only facilitates physical contracts, and there is no 'paper market' for energy carriers with futures and options contracts that allow hedging price risks. In other words, the exchange market is not sufficiently developed. How does this impact trading?

– The exchange market in Ukraine is sufficiently developed to meet the needs of the Ukrainian organised market. There will be opportunities for the market to progress further, and we will implement requests accordingly. Currently, we are constantly monitoring the situation, but the litmus papers have not changed colour yet.

For example, almost a year ago, the Auction Committee approved the launch of auctions for bilateral contracts using the continuous bilateral auction technology, which involves trading of standardised products in line with European practices. However, in a year, no participants have shown interest in working in this section. Currently, we have set up standardised products for gas: four weeks ahead and four months ahead. Execution will be ensured through the exchange. While there is currently no influx of eager traders, the project is just beginning.

– Among market participants, there is much debate about what constitutes the Ukrainian gas price – domestic benchmark. How can it be determined?

– Currently, the price of natural gas on the open wholesale market is based on quotations from the UEEX. We have been organising natural gas auctions for the past 8 years and are the sole exchange that has consolidated liquidity in this area. Our indicative prices from the trading results are completely transparent and published on the website. They are recognized by the market and government authorities, and UEEX prices are included in the recommendations for specifying the price of natural gas in public procurement.

However, it is not yet a benchmark in our understanding, meaning it is not the price of a product that everyone trades and is the sole correct indicator for the Ukrainian wholesale market for all domestic and external users. Of course, market participants may use prices from international information agencies and Ukrainian consulting companies. It is up to the market participant to choose which data they have the opportunity to use and which data best align with the parameters of their agreements.

We still need to create our own clear benchmark. At UEEX, we are in the process of launching new standardised products: weekly and monthly. This is a step towards creating an internal benchmark in the Ukrainian gas market.

– How can the design of the Ukrainian gas market be improved to enhance its flexibility and liquidity?

– It requires concerted efforts to achieve that. If the market lacks self-awareness, there is a practice in the world when the government implements temporary regulatory measures aimed at opening wholesale markets to initiate competition or combat monopolies. This involves the implementation of government programmes that impose obligations to sell natural gas through exchanges (Gas Release Programmes, GRPs).

In 2020, the Secretariat of the Energy Community and later USAIDproposed introducing such a programme in Ukraine. Prior to the war, an updated memorandum with the IMF also included provisions for annual sales of no less than 40-50% of the gas produced by UkrGasVydobuvannya on the domestic exchange. There was also a decision by the AMCU (Anti-Monopoly Committee of Ukraine) that the Naftogaz of Ukraine should sell at least 15% of its own natural gas, unencumbered by PSO, on the exchange.

GRPs have been implemented in many countries at various stages of market development, and they continue to work in many of them. This would automatically address the issue we raised in the previous question about a domestic benchmark. If there was a fixed requirement in Ukraine to conduct trading operations through the exchange at a certain minimum level, for example, 5%, it would allow the formation of a price indicator for gas in Ukraine. Therefore, in my opinion, in conditions when market concentration is increasing, it would be appropriate to support its formation if we declare ambitions to be part of civilised European market relations in the future.