Planned hike in gas royalties to hurt private oil & gas producers

Ukraine’s Cabinet of Ministers has drafted a law that increases royalties on the extraction of natural gas by 4x, according to Kommersant. The base royalty rate will rise from the current USD 30/tcm to USD 119/tcm for gas extracted from depths of less than 5 km and from the current USD 15/tcm to USD 59/tcm for gas from depths of more than 5 km. Accounting for an additional tariff coefficient, this implies a hike in effective royalty rates to USD 137-275/tcm or 31-63% of the current price cap on gas sold to industrial producers (USD 439/tcm). At the same time, the government plans to keep unchanged the royalty for gas sold for consumption by households at a regulated (and heavily discounted) tariff of USD 94/tcm. According to Kommersant, the sole aim of the law is to increase budget revenues so as to enable delivery on the president’s new social initiatives.

Royalties on natural gas extraction in Ukraine, USD/tcm       

———————————————————-
                                 Depth of gas deposit
                             5 km or less   More than 5 km
———————————————————-
Base royalty                              30               15
Coefficient applied*                   2.3x             2.3x
Effective royalty, current             69               34
Effective royalty, expected          276              138
Cap on gas sale price                 439              439
———————————————————-

* Effective in March                      

Source: Tax code, Ministry of Economy, Concorde Capital 

Vitaliy Vavryshchuk: The document, if passed into law, would squeeze the gross margins for gas extraction operations by about 47 pp (24 pp for companies with gas deposits below 5 km). That would decrease EBITDA margins by 2x-4x for local oil & gas producers. Ukraine-based listed companies that would be affected by the document are JKX Oil & Gas (JKX LN), Cadogan Petroleum (CAD LN) and Kulczyk Oil Ventures (KOV PW) and to a lesser extent Regal Petroleum (RPT LN). On the other hand, state-owned Ukrnafta (UNAF UK) is unlikely to be heavily affected as it sells the bulk of its produced gas for use by households. We think the chances for adoption of the bill are high and expect the draft to be passed into law within a couple of weeks. We nevertheless believe the government and parliament are likely to go ahead with a less substantial hike in royalties so as to keep an incentive for private oil & gas producers to develop operations.