Ukraine considers hiking natural gas royalty on progressive scale

The Ukrainian parliament is considering hiking the
royalty for the extraction of natural gas, according to a draft of law #7038
dated Feb. 9.

 

The main change is that, under the proposed mechanism
for royalty calculation, the rate for the royalty payments will increase
progressively with natural gas prices. Under the current mechanism, the rate
does not depend on the price.

 

The base for royalty calculation will remain
essentially the natural gas price.

 

In detail, for old (construction started before 2018)
wells with depths of less than 5 km, the royalty rate will be 29% for natural
gas prices (the monthly average) below USD 200/tcm, 39% for USD 200-400/tcm,
49% for USD 400-600/tcm, 59% for USD 600-800/tcm, and 69% for more than USD
800/tcm. The rate under the current mechanism for such wells is 29%.

 

For old wells with depths of more than 5 km, the rate
will increase progressively by 10pp from 14% (the current rate) to 54%.

 

For new (construction started in 2018 or later) wells
with depths of less than 5 km, the rate will vary from 12% (the current rate)
to 52%. For new wells deeper than 5km, the rate will vary from 6% (the current
rate) to 46%.

 

The law aims to make fairer the distribution of excess
profits earned due to the high natural gas prices, according to an explanatory
note filed with the draft of the law. Ukrainian minerals belong to the
country’s people, who thus must be the primary beneficiary of the high prices,
the note said.

 

The law was initiated by Danylo Hetmantsev, the head
of the parliamentary finances, tax and customs policy committee. It is
currently planned that the changes proposed in the law will enter force from
Apr. 1.

 

Ukraine’s largest private producer is DTEK Oil &
Gas (DTEKOG), which in 2021 extracted 2.06 bcm (36.9 kboepd) of natural gas, or
12% more yoy. In 2021, DTEK Oil & Gas paid about UAH 2.7 bln (USD 99 mln)
in royalty for the extraction of natural gas and condensate, according to a
Feb. 3 press release by the company. Its royalty payments (the total for
condensate and natural gas) amounted to UAH 0.88 bln (USD 33 mln) in 2020 and
UAH 1.319 bln (USD 51 mln) in 2019.

 

Dmytro Khoroshun: In the
short term, the proposed mechanism will not impact greatly upon DTEK Oil &
Gas’ credit profile, because the payments will be similar when natural gas
prices are low.

 

However, the proposed change in the mechanism for the
natural gas royalty in Ukraine would decrease returns on equity much more than
the analogous recent change for iron ore royalty.
Therefore, investments into natural gas extraction might suffer at DTEK Oil
& Gas, which will be detrimental for the company’s credit.

 

Ukraine’s investment attractiveness more broadly will
also suffer.

 

Nevertheless, negotiations (between Ukrainian natural
gas producers and the government) that would alter the proposal might be in
order, we think. In particular, we do not exclude that the royalty rates in the
final version of the law will be lower than in the Feb. 9 draft.

 

Regarding the impact of the proposed mechanism, the
royalty for extraction of natural gas alone (without condensate royalty
payments) by DTEK Oil & Gas in 2021 would have been USD 310 mln, 3.5x
higher than the USD 89 mln we estimate it actually paid under the current
mechanism.

 

For 2020, its natural gas royalty payments under
the proposed mechanism would have been USD 31 mln, 11% more than our estimate
for the current mechanism payment, USD 28 mln. For 2019, the proposed mechanism
payments would have been USD 61 mln (43% than USD 42 mln under the current
mechanism).