• The system of oil trunk lines of Ukraine includes 19 oil pipelines with a diameter of up to 1 220 mm, with a total length of 3 506.6 km, oil pumping stations and the Pivdennyi oil terminal, tank farms, systems of power supply, corrosion protection, remote control, engineering communications, firefighting facilities and erosion control structures.

    The entry capacity of the system is 114.5 million t per year, while the exit capacity is 56.3 million t per year. The combined nominal capacity of the tank farms of the system of oil trunk lines amounts to 1.083 tcm.

    The Pivdennyi oil terminal is designed for receiving, shipping, and transporting oil through the oil trunk lines of Ukraine. The capacity of the terminal is 14.5 million t per year, with the possibility of expanding it to 45 million t per year. Tanker deadweight is up to 150 000 tons with a maximal draft of 13.8 meters. Tank farm capacity is 200 tcm.

    The volume of crude transportationMain results

    Ukraine's considerable oil-trunk pipeline system is not currently used to capacity.
    The volume of oil transit through Ukraine in 2016 compared to 2015 decreased by 8.8%. Given the historical features and technological connectivity of the systems, the volume of oil transit largely depends on the policy of the Russian Federation as a major supplier of oil to Central Europe and the main customer of oil transportation services through Ukraine. The strategic priorities of Russia in favor of developing its own pipeline and port facilities have led to a significant reduction of oil transit through the territory of transit countries including Ukraine.

    Russia is persistently doing away with intermediary transit countries, and therefore oil transit through Ukraine has decreased dramatically in recent years. In 2002, Russia built Sukhodilna-Rodionivska oil pipeline (28 million tons/year), which directly linked two Russian oil pipelines, bypassing Ukraine: Samara-Lysychansk and Lysychansk–Tykhoretsk. In 2008, Russia finally decided to channel all its oil flows bypassing transit countries, and in 2012 completed construction of the Baltic Pipeline System (BPS-1 and BPS-2) with a total capacity of 80 million tons per year. In addition, since 2004 the Caspian Pipeline Consortium has connected oil fields of Kazakhstan and Russia with terminal operations in Novorossiysk, bypassing Ukraine.

    These Russian efforts mean that in 2015 oil transit through Ukraine to three countries (Czech Republic, Hungary and Slovakia) totaled only 15 million tons. Compared to 2015, transportation volumes in 2016 decreased by 9.1%. This is primarily due to reduced oil transit volumes to Slovakia and the Czech Republic, where the overhaul of local oil refineries (OR) was performed in the first half of 2016.

    Revenues from the saleAnother factor influencing oil transit volumes through Ukraine was increased competition and redistribution of the oil market between the major oil-producing countries in response to low crude oil prices. In such circumstances, Russian Urals oil was partially ousted by Middle East oil due to both competitive pressure from the Middle Eastern suppliers and the raw material diversification policy of oil refineries.

    In 2016, foreign partners voiced both positive and negative signals that can affect Ukraine's pipeline system capacity utilization volumes. On 1 July 2016, the Czech company Unipetrol operating refineries in the Czech Republic extended long-term contracts with the Russian party to supply oil. However, the most negative news was the signing of a framework agreement between UNIPETROL and the Croatian operator of the Jadranski Naftovod oil-trunk pipelines on cooperation and transportation of oil to the Czech Republic via the Adria oil pipeline, which is an alternative to traditional supplies via the Druzhba and TAL-IKL pipelines.

    The forced shutdown of most domestic refineries and underutilized capacity of Kremenchuck Refinery — the only one currently operating- prevent any significant increases in pipeline capacity to supply oil to Ukraine's refineries.

    Change in segment revenuesOil supplies via pipelines to refineries in Ukraine decreased from 22.9 million tons in 2003 to 1.4 million tons in 2016. In 2016, oil transportation volumes to refineries in Ukraine declined by 12.5% or 200.8 thousand tons.

    The unresolved situation with the replacement of Urals oil in Odesa/Pivdennyi-Kremenchuk Refinery pipeline section directly affected the use of the pipeline capacity towards Kremenchuk Refinery in 2016. Under these circumstances, Kremenchuck Refinery management opted for using more expensive railroad to transport the imported oil from Odesa.

    Financial resultIn March 2017, Urals oil was removed from the pipeline section and transported by railroad to Brody in order to refill the second branch of Druzhba oil pipeline. This enabled transportation of Azeri oil to Kremenchuk refinery.

    Total net income from crude oil transportation services increased in 2016 compared to 2015 by UAH 159 million or 4.9%, mainly due to the devaluation of the hryvnia against the euro, which resulted in growth of revenue from sales of transport services by UAH 458 million, since the tariff for transit of oil is set in the euro. However, due to the decrease in sales, revenues decreased by UAH 299 million.

    Impact on segment resultsThe financial result of the segment decreased in 2016 compared to 2015 by 0.5%. Devaluation of the hryvnia against the euro fully offset the negative impact of the decline in oil transportation volumes and increased depreciation costs due to increased value of fixed assets as a result of revaluation as of 31 December 2015.

     
     

    Assets

    The total value of the crude oil transportation segment increased slightly in 2016 compared to 2015 (+ 3%). The main change was due to the change in the value of inventories and fixed assets. 

    The segment's ROA decreased insignificantly (- 0.3%) in 2016 compared with 2015. The change was mostly caused by the growth in inventories and fixed assets value as a part of total assets.

    Assets

    Ukrtransnafta

    Transportation of oil via trunk pipelines is carried out by Ukrtransnafta — a part of the Naftogaz Group. Ukrtransnafta includes affiliates, such as the Druzhba oil-trunk pipelines, Prydniprovski oil-trunk pipelines, and PIVDENNYI oil-trunk pipelines.

    In 2016, Ukrtransnafta transited Russian Urals oil through Ukraine and transported domestically produced oil from production sites to refineries. At the beginning of 2017, Ukrtransnafta started transporting Azeri Light oil to Kremenchuk refinery.

    Contract for reviving Odesa‑Kremenchuk Refinery route in 2017 

    In late 2016, Ukrtatnafta and Ukrtransnafta signed a contract for transportation beginning in 2017 to Kremenchuk Refinery of at least 1.3 million tons of Azeri Light grade oil per year, with  further increases up to 1.9 million tons per year.

    To obtain approval for the transfer of Urals grade oil, which previously occupied the Odesa‑Kremenchuk pipeline section, from "fixed assets" to "reserves", and its replacement with Azeri Light oil to fill the specified pipeline section, Ukrtransnafta developed a new standard (Standard of Ukrainian Companies) in 2016. This allowed the company to distinguish between the existing oil in the oil pipeline system and the "oil for industrial and technological needs", and "oil inventory".

    Increasing tax and compulsory payments by 64%

    Ukrtransnafta paid taxes and all compulsory payments totaling UAH 2.2 billion in 2016, which is 64.3% more than in 2015 and represents the largest total since the establishment of the company.

    This significant increase in payments to the state budget is associated with a surcharge on income tax based on performance in 2015 (UAH 242.7 million), a significant increase in this tax payment in 2016 (UAH 419.5 million) based on performance in Q1‑Q3, and payment of dividends based on performance in 2015 to the amount of UAH 1.02 billion.

    Net profit of the company for 2016 amounted to UAH 1.5 billion, which is 18.5% or UAH 237.7 million more than the planned target.

    The efficiency of the company in the reporting period is demonstrated by the 44.5% profitability of operations and EBITDA margin of 57.2%. Return on assets was 6.8% and return on equity ‑ 8.4%.

    Procurement system reform

    In April 2016, the company joined the ProZorro public procurement system.
    Ukrtransnafta introduced unified internal regulations that were developed using Naftogaz standards, namely the procedure for procurement of goods, works and services, tender committee regulation, procurement monitoring procedure, local conflict commission regulation, and the procedure for interaction of structural units in the purchase of goods, works and services.

    A company order of 2016 approved guidelines for operation under standard contracts. As a result, 98% of transactions are now concluded through standard contracts. Performance‑based payment as the basic form of contract payment within 10 calendar days was introduced. This can significantly reduce risks and losses from delays or the poor performance of contractual obligations by unscrupulous contractors, while also preventing corruption risks in payment settlement.

    Ukrainian oil pipelines map

    Joining the International Association of Oil Transporters (IAOT)

    In December 2016, Ukrtransnafta became a member of the International Association of Oil Transporters (IAOT)20. Membership in this organization will promote the priorities of the Ukrainian oil transportation system in Central and Eastern Before joining the association in May and November 2016, Ukrtransnafta participated in IAOT meetings as a guest.

    20IAOT currently unites eight members: MERO ČR, Transneft, Transpetrol, MOL, Gomeltransneft Druzhba, KazTransOil, CNPC, CPC

    Storing process oil in the tank farms of other enterprises

    The previous management of Ukrtransnafta signed a series of economically unfavorable tank lease agreements with JSC SPC‑Galicia, JSC Neftekhimik Carpathians, and JSC Ukrtatnafta. In the period 2013‑2014, the company used these agreements to store 388.5 thousand tons of process oil The cost of services provided under these contracts to Ukrtransnafta was estimated as many times greater than the market value of oil storage in Ukraine.

    Court rulings confirmed the Ukrtransnafta position, recognizing agreements with JSC SPC‑Galicia, JSC Neftekhimik Carpathians, and JSC Ukrtatnafta as illegal and denying claims for the recovery of Ukrtransnafta debts amounting to UAH 144.9 million.

    In response to PJSC Ukrtatnafta, JSC SPC‑Galicia, and JSC Neftekhimik Carpathians claims for the recovery of Ukrtransnafta debts amounting to and the collection of fines for overdue obligations amounting to UAH 872.9 million.

    As of the date of the report, the litigation regarding the storage of process oil has not finished.

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    "Regardless of the overall crisis in the oil refining industry and lower demand for oil transportation services, Ukrtransnafta can boast its performance. In 2016, we managed to resume transportation through Odesa-Kremenchuk pipeline section, which had been out of service for five years. We also filled the first branch of Mozyr-Brody oil trunk pipeline, which had been mothballed for three years. Ukrtransnafta's last year performance looks encouraging in terms of oil transportation revival in Ukraine."
    Ukrtransnafta CEO
    Mykola Havrylenko

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    Key objectives for 2017

    1. Increased transportation volumes to Ukrainian refineries

    In 2017, Ukrtransnafta is planning to increase oil transportation to Ukrainian refineries to 2.7 million tons (compared to 1.4 million tons in 2016).

    2. Modernization of oil‑trunk pipelines

    2017 targets provide for overhaul works, construction, reconstruction, technical inspection and maintenance to increase efficiency and ensure reliability of Ukrtransnafta oil pipelines.

    3. Approval of economically grounded tariffs

    The company has developed and forwarded to NEURC a new draft tariff methodology for oil transportation via Ukraine's main pipeline networks.

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    Regulatory issues affecting Ukrtransnafta's operation and possible solutions
    1. Abolition of rent payment for oil transportation via oil-trunk pipelines

    The Tax Code of Ukraine fixed rental rates for oil transportation via trunk pipelines at the amount of USD 0.56 per one ton. Additionally, this rent is not actually associated with the utilization of underground of other natural resources, and does not depend on the value of the property used in transportation. Therefore, it is problematic to determine an economically grounded rent payment.

    Lack of correlation between rent size and the taxpayer's performance is a key drawback. The current procedure requires rent payment even when the entity is operating at a loss.
    In its present form, rent for oil transportation is a tax that is included in the cost of oil transportation services. As such, it influences Ukrtransnafta financial and business operations. As a result, the cost of oil transportation services is excessively high relative to the economic realities of the current technological process and production features of the oil-trunk pipeline system.

    Applying rent payment reduces the competitiveness of the Ukrtransnafta pipeline system compared with companies offering alternative routes and ways of oil transportation (e.g. by railway transport) that do not have taxation mechanisms similar to rent.

    It should be noted that in international practice, especially in European countries, rent payments for pipeline services are not applied.

    In 2016, Ukrtransnafta prepared draft amendments to the Tax Code of Ukraine on abolishing rent for oil transportation via oil-trunk pipelines and agreed it with Naftogaz. This draft is under consideration by the Ministry of Economic Development and Trade of Ukraine.

    2. Prohibition of alienation and lease of Ukrtransnafta fixed assets

    Current legislation deprives Ukrtransnafta of the possibility of effectively using fixed assets that are not involved in the oil transportation process. Article 7 of the Law of Ukraine "On Pipeline Transport" prohibits the alienation of assets of enterprises engaged in trunk pipeline transportation operations, the transfer of assets between balance sheet accounts, concession, rent, lease, mortgage, etc. Alienation of fixed assets that are not involved in oil transportation is permitted only with the approval of the Cabinet of Ministers. However, this authorization is a complex and lengthy procedure.

    These legal constraints make it practically impossible to improve the operation of non-core assets, including hotels, catering, meat products, leather goods, and tailoring enterprises. The company bears the cost of maintaining these facilities while having no alternative ways of using these properties.

    Free non-core asset management would help attract investors, develop additional business, and consequently have a positive impact on the cost-effectiveness of Ukrtransnafta operations.

    3. Failure to implement capital investment plan

    The prohibition of all types of capital investments as per the Cabinet of Ministers of Ukraine Regulation of 3 December 2012 (No.899) is currently blocking some of the key activities of public sector enterprises, namely ensuring the reliable, safe and efficient use of state assets placed at their disposal.

    Over the last seven years, the final version of the company's financial plan was approved only twice, and each time approval took place in the second half of the year.

    This lead to poor performance on investment plans. In 2016, the total volume of Ukrtransnafta capital investments amounted to UAH 385.4 million, which is 28% of the target sum. The main investment target in the reporting period was the overhaul repair of line sections of the Brody-State Border pipeline, which is a part of the main oil transit route across Ukraine to the EU, with investments amounting to UAH 169.5 million.

    According to the Corporate Governance Action Plan, the company's financial plan shall be approved by the supervisory board.

    4. Strengthening penalties for damage to oil pipelines

    Abusers illegally interfering in the operation of oil-trunk pipelines for the purpose of stealing oil cause damage to state property and significant losses to Ukrtransnafta. Organized crime groups have years of experience in this criminal field, including well-functioning sales and agent networks, excellent technical equipment, and their own vehicles specially reequipped for oil transportation.

    On 17 September 2015 at the initiative of Ukrtransnafta, a group of MPs registered draft law No. 3129 "On amendments to the Criminal Code of Ukraine regarding strengthening responsibilities for damage to facilities of trunk or industrial oil, gas, condensate and oil product pipelines."

    This draft law proposes punishment with imprisonment for a term of three to eight years for damage to or destruction of pipelines and bypassing pipelines and their technologically related facilities, if these actions have led to the disruption of pipelines or created a danger to life. Earlier punishment for this offense was a fine of one hundred to a thousand times the untaxed minimum income.

    The same actions committed repeatedly or by a group of persons by prior collusion are punishable by imprisonment of five to ten years. The harshest punishment of ten to twelve years in prison applies if the actions envisaged by parts one or two of this article have caused deaths or led to accidents, fires, significant pollution or other serious consequences.

    On 26 November 2015, draft law No. 3129 was adopted as a basis (Regulation No.3129/P) and submitted to the Law Enforcement Legislative Support Committee. Adoption of the draft law has currently been postponed for an indefinite term.

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