The Association of Gas Producers of Ukraine warns about possible failure of the Government’s natural gas production increase program

The Association of Gas Producers of Ukraine (AGPU) forecasts a significant slowdown of the natural gas production growth in 2017 in case the fiscal regime for the industry remains unchanged. Moreover, AGPU sees a high probability of stagnating natural gas production in the independent sector due to lack of necessary investments in development of new and running projects.
The Association’s members are confident that growth of natural gas production to 28 bcm in 2020 – a level outlined in the project of the Government’s Conception of Ukrainian gas production industry development – is possible only if investment attractiveness of the the industry is increased by reducing the tax burden on new investments. Thus, we address the public with our concern that the Government’s goals of energy independence and self-sufficiency by 2020 may be at risk of not being achieved.
Domestic and international investors have stressed out numerously in their public messages that too high fiscal burden is the main problem, which makes it impossible to attract new investments into the natural gas production. We point out that under current tax regime and world prices on energy sources, exploration and development of new fields, as well as development of large-scale projects in Ukraine, has already been halted by the independent operators, and will not be resumed due to uneconomical nature of such projects’ realization. As forecasted by the AGPU, if the current situation remains, the country will not receive 8.3 bcm of domestic natural gas during 2017-2020, which is ₴14 billion of not received taxes, 5% of underperformed GDP, and 15 thousand less workplaces in various sectors of the economy.
According to the independent expert research of the Deloitte company, tax load on natural gas production in Ukraine exceeds the average European level more than twice. This means that by keeping the current tax regime in place, Ukraine ultimately loses the battle for the international investments. At the same time, it is the increase of both internal and external investments in new projects and drilling on old and new fields, and involvement of new technologies, which should be the main driving force of increased natural gas production.
Natural gas producing companies unanimously support the Government in its efforts to make Ukraine energy independent and to get rid of the imported gas burden, which Ukraine had to carry for decades. With respect to the Government’s budgeting for 2017 and adjustments to the Tax Code, we have prepared for the Ministry of Finance of Ukraine a proposal of priority changes to the industry’s tax regime, which should start next year. Our position is based on the analysis of the tax policies in European countries, Deloitte’s detailed research, and complex assessment of Ukraine’s natural gas production industry development potential, which has been prepared last year by the international consulting company IHS.
We think it is necessary to implement a single 12% royalty on natural gas produced on the wells, which were drilled on or after January 1, 2017. Thus, the industry suggests the Government implements a stimulating royalty solely on new investments, maintaining the current tax regime on the existing projects. In our opinion, implementation of a 12% royalty, in line with the average European level, will allow to attract the investments, necessary for the dynamic growth of production. At the same time, this will allow to guarantee consistent revenue streams in 2017 and their notable growth in the years to follow.
In particular, the stimulating sole royalty on new wells will allow to attract $1 billion of new investments in the independent sector, which will increase natural gas production by almost 60% by 2020. Natural gas production growth will in turn allow to increase the annual tax payments by 22% in the industry overall, which will result in cumulative tax revenues of ₴195.5 billion in 2017-2020.
Keeping the current fiscal system unchanged will make all the efforts of the Government and the industry towards energy independence useless. Moreover, lack of any changes in the fiscal system for the gas production industry contradicts the Government’s international obligations of tax reform for the industry. In the last couple of years, the independent gas production sector was the main source of natural gas production growth in Ukraine. According to the recommendations of the IHS consultants, independent gas producers can significantly increase their production from current 4 bcm to 8 bcm as soon as in 2020. However, such scenario is only plausible if the competitive and stable tax regime is implemented not later than in 2017.
The Association again notes that the government should choose the path: either it continues the policy of short-term budget filling by the means of increasing royalty, or it creates competitive conditions for new investments into the industry, restores the trust and establishes collaboration with the domestic and international companies. This can be done by having a complex reform of the tax system, and, thus, implementing a stable basis for absolute growth of fiscal payments from the gas producers in the long-run. Ukraine can use the examples of Great Britain, Italy, or Canada, which in the last year have eased the taxation of their oil and gas industries with the purpose of maintaining the workplaces, further development of the industry, and expanding the tax base. Examples of Slovakia, Poland, or Czech Republic, in all of which royalty is not higher than 5%, could also be considered.
We again point out, that gas producers advocate for a consistent and the most transparent process of update and edit of the tax system in the industry. It is important to understand, that taxes are on of the most important components of an attractive investment climate, which is necessary to increase domestic natural gas production. We systematically argue for expanding the horizons of the government planning to more strategic ones. We recommend that a complex effect of the changes to the tax system of the gas production industry should be considered in the forecasts. We opine that stimulating new investments can ultimately guarantee a win-win scenario for both the Government and the business community. It should also provide strong grounds for further implementation in the oil and gas industry of a progressive fiscal system reform, which should be based on revenue taxes after 2020.