Update on problems at Kremenchug

Last Wednesday, ousted head of Ukrtatnafta Sergei Glushko attempted to regain his former position in the Kremenchug refinery through force, but was apparently rebuffed by the forces of in-place director Pavel Ovcharenko. This is on the heals of Ovcharenko’s own assault on the offices a week earlier that, according to information from general prosecutor Alexander Medvedko quoted in yesterday’s Ukrainian daily Economicheskie Izvestia, resulted in two minor injuries to company security guards.

According to the article, the auto-factory regional court of Kremenchug (within Ukraine’s central Poltava oblast) overturned an October 25th decision by Medvedko calling the seizure of the refinery an “agitated criminal act.” The higher court apparently annulled the ruling following fallout from the attempted retaking on the 24th by Glushko. The article states that Glushko had returned to the offices, but that report is contradicted by a Reuters article saying that Interior Ministry forces rebuffed Glushko, leaving Ovcharenko in charge of the refinery:

“There was an attempt to capture (the headquarters) but it failed,” Ovcharenko’s lawyer, Yuri Pocheptsov, told Reuters on Thursday.

“The plant is under the protection of interior ministry troops and Glushko abandoned the plant. Some people were with him (too).”

Interfax Ukraine news agency reported on Wednesday that “unknown people in camouflage” had blocked Ukrtatnafta headquarters in Kremenchug.

Economicheskie Izvestia ran a longer article by Mariya Pomazai as well, detailing the effects of the disruption on the already turbulent oil market in Ukraine. Noting that the pump price of gasoline had already risen over 3% in October to about $0.94 / liter ($3.55 / gallon), the article raised concerns about further price rises stemming from Kremenchug’s decline in production.

Tatarstan-controlled Tatneft ceased the flow of crude to the refinery following the “management dispute” and “does not intend to renew the deliveries of oil until Sergei Glushko has been returned to the seat of head of the factory,” according to Tatneft first deputy general director Nail Maganov. He also asserted that by running at reduced capacity, the refinery stands to lose up to $4-5 million a day.

Ovchenko bought an additional 170,000 tons of oil for the factory, which gives it another 17-20 days of production at a reduced rate. There are worries that this decrease will create cost increases in the Ukrainian domestic petroleum market, as about a third of the country’s refined oil products come from the plant.

This whole episode reeks of criminal and underhanded behavior, and much more resembles a corporate raid than a management dispute. Details still seem a bit sketchy, emphasizing the opaque conditions many of these actions and motivations stem from. In all, it appears to be a fight to control ownership of the lucrative refinery, either legitimately (through a court decision on unresolved shareholdings that would grant a majority to one side over the other), forcibly (storming the offices with armed police), or bribery (ceding 3% of company shares to the firm entrusted with keeping Ukrtatnafta’s shareholder register).

The dispute is hurting both sides — the refinery is connected via pipeline to the Tatneft oil supplies, making any substitute for Tatarstan oil much more expensive, while depriving the oil producer of a convenient and established market for its crude. It is also an appalling example of a severe lack of respect for the rule of law by either side, instead resorting to thuggery and economic blackmail. The problem is, Ukraine’s oil and gasoline consumers, already reeling from high global oil prices, end up as one of the main losers.

Check out Interfax’s article for more details on the affair.

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Gazeks responds to Yulia’s accusations over Dnepropetrovsk explosion

In what looks like a repudiation of the guilt laid at its feet by Tymoschenko, Viktor Vekselberg-owned Gazeks — the gas transportation company that owns Dneprogaz — claimed that the degradation of Ukraine’s gas distribution network has been the result of a concerted effort by the government to consolidate bankrupted firms. As a result, the country’s gas infrastructure is now at a “critical” level. From Zerkalo Nedely, quoting the report submitted by the head of IES (Gazeks’ parent company), Mikhail Slobodin:

“Such a de facto consolidation has been implemented by UkrGazEnergo with close collaboration from government agencies, experts note. Various forms of coercion were used for this consolidation, including through financial instruments, contractual terms for the supply of gas and possession of the [distribution] networks, the recall of [a company’s distribution] license, and other methods.”

The report goes on to list statistics supporting its claim about the poor state of the network’s infrastructure, stating that the average age of the network is 40 years, and half of it needs to be replaced in the next 10 years.

Following the tragic gas explosion in Dnepropetrovsk that claimed 23 lives, expected future PM Tymoschenko blamed the owners of local gas distributor Dneprogaz for shirking their responsibility for infrastructure refurbishment and a general disregard for the public’s safety.

In the face of the accusations, the firm has stressed that it is awaiting the results of forensic reports before taking any responsibility — “We do not acknowledge our fault until our involvement is proved.” While Gazeks has agreed to provide about $100,000 for each victim, the company asserts that it is not compensation, but “material aid.”

Zerkalo Nedely has a longer piece about Yushchenko’s efforts to reassert control over so-called “natural monopolies.” The report by IES mentioned above was in fact submitted by the firm’s head at a roundtable sponsored by Yushchenko’s compatriots on the level of government control in these “natural monopolies.” These seem to include “strategic” industries such as transport, telecommunications, gas, electricity, heat and water.

The Ukrainian government is far from blameless in the sorry state of much of the country’s public utilities, and likely needs to take a more active role in their regulation. However, the difficult task will be in finding a balance between state and market oversight, as I still believe that increased liberalization of gas, heating and electricity markets will in the long run be necessary — and beneficial — to the upgrading of key utility infrastructure.

Shtokman, Gazprom, and Ukraine gas prices

With a decision on Russneft’s future likely a couple months away and part II of my post on RosUkrEnergo still in the works, lets catch up on a bit of news concerning Gazprom. First off, Norwegian oil major StatoilHydro will join the French firm Total in cooperation with Gazprom in developing the giant Shtokman gas field. Sort of. While StatoilHydro has agreed to participate in the currently ongoing planning and exploration phases, it is reserving judgment on a rumored $800 million investment until a more detailed prospectus is released in 2009. From Forbes.com:

Market rumours have suggested StatoilHydro could have agreed to pay Gazprom 800 mln usd in return for its 24 pct stake in Shtokman, however the firm this afternoon said no payments have yet been made.

‘When it comes to potential bonus payments, we haven’t paid any bonuses yet, but if there is a positive investment decision in 2009 there will be a cash bonus paid, but I can’t comment on amounts at this stage’, said chief financial officer Eldar Saetre.

Similar to the deal Gazprom made with Total, this agreement offers shares to StatoilHydro in the “special-purpose company to manage engineering, financing, construction and exploitation of installations at Phase 1 of Shtokman field development.“ Gazprom owns a 51% stake in that firm, Total a 25% share, and now StatoilHydro has the remaining 24%. Meanwhile, the license for the reserves as well as “all the rights for marketing of the commodities will be retained by Gazprom.”

Shotkman is still years for development, beyond just the 2009 date for further preliminary research. StatoilHydro, a majority government-owned oil and gas company formed following the recent merger between Norwegian firms Statoil and Hydro, has the experience to work in harsh conditions. But no project of this magnitude and difficulty has ever been attempted — the risk and expense levels will be huge.

In other Gazprom news, CEO Alexei Miller was recently elected chairman of Gazprom Media, which controls the television channels NTV and TNT, as well as press outlets Izvestia and Itogi (among others). Some analysts, citing Miller’s deteriorating health, speculate that this is a type of “golden parachute” for the well-connected chief executive. However, heading Gazprombank (where he is the chairman) seems to be a more fitting position for the technocrat with an economics background. The move also contradicts previous assertions by Gazprom that it is working on spinning off its media arm as a more independent part of the Gazprom Group.

Gazprom Media reported over $100 million in profits last year, which is a stark increase from the losses the division had been suffering from for much of the past. The previous chairman, Alexander Dybal, got bumped up to head of the newly empowered Gazprom Neft, possibly a reward for turning around the debt-ridden media holding company. By inserting Miller, perhaps Gazprom may be attempting to put a further legitimate face on the media group as it seeks to take advantage of this additional revenue stream — particularly as Russia heads into its parliamentary and presidential election seasons.

In another bit of news, Ukraine’s President Yushchenko weighed in on expectations for price negotiations with Russia over next year’s cost of natural gas:

“Given the trends on energy markets, the optimal, rational price for gas at the Russia-Ukraine border, the price which would be viewed with some understanding by most of the market, is about 150-160 dollars per 1,000 cubic metres.”

My own hunch is something closer to $170, but some analysts are going as high as $190. Everyone seems resigned, however, that the price will rise from the current $130. Of course, that’s just one half of the equation — Ukraine will likely attempt to renegotiate its price for transiting Russian gas through its territory. These tariffs are a major source of income for state energy company Naftogaz Ukrainy, and it relies on them for offsetting the market price of gas against the capped residential end-user price. Hopefully the upcoming negotiations will not be as contentious or controversial as those in late 2005 / early 2006, although the recent government shake-up in Ukraine following snap parliamentary elections, as well as renewed calls for completely changing the structure of the Central Asian-Russian-Ukrainian gas trade by removing middleman RosUkrEnergo, will add plenty of uncertainty to the bargaining table.

Russneft Update — Glencore joins Deripaska in the fray

After it was leaked earlier this week that a mysterious second bidder had submitted paperwork to acquire parts of Mikhail Gutseriev’s beleaguered Russneft, speculation on the challenge to Oleg Deripaska’s earlier bid centered on Roman Abramovich and Lakshimi Mittal, or state firms like Rosneft and Gazprom. It turns out that the papers were instead filed by Glencore, the Swiss commodities trader that originally cooperated with Gutseriev in the founding of Russneft (and had since continued the relationship). From MSNBC (via FT):

Alexander Temerko, the former Yukos vice-president and a business associate of Mr Gutseriyev, said Glencore’s filing, first made in September, was an attempt by the trader to protect its interests in the company after the bid by Mr Deripaska failed…Glencore helped Mr Gutseriyev found the company in 2000, lending more than $3bn and taking shares and oil as collateral. Mr Temerko said Glencore already held a considerable stake in RussNeft itself, while a banker familiar with the situation said Glencore owns stakes in Russneft’s production units.

The bid Glencore submitted to Russia’s Federal Anti-Monopoly Service was for three of those production units, and appears to be an attempt to keep itself involved in the successful oil venture.

Glencore had previously cooperated with Deripaska in the creation of the world’s largest aluminum firm in 2006, made from a combination of the Deripaska’s Rusal, the Russian company Sual, and Glencore’s aluminum assets. This history together was seen as a potential plus in the efforts of Deripaska to take over the reigns from Gutseriev, after the former chief stepped down under pressure. However, with Deripaska’s bid sidelined by apparently competing factions within the Russian government, Glencore stepped in (supported by its weight in the mining and metals industries) to attempt to regain control of the production units.

However, Glencore is not trying to take over the entire company — these 3 production units only account for about 15% of Russneft’s entire output. Instead, the bid for the firms, which are valued at around $800 million, could be a deal for Glencore to ensure it will recoup some of its outstanding loans. Glencore already controls significant stakes in three other production units stemming from a 2003 deal with Russneft. The Swiss firm also has an exclusive 10 year exporting contract (beginning Jan 1, 2004) for those three subsidiaries.

Deripaska’s bid for the company had stalled, allegedly over incomplete paperwork. Apparently, the additional documents arrived “a few days ago” and are in the process of being investigated. The overall fate of Russneft — including the three units pursued by Glencore — may still be a ways in coming, however.

RosUkrEnergo background, and thoughts on its future – Part 1, creation and key figures

Given recent statements from Russian and Ukrainian officials on the possibility of removing Swiss-registered gas trader RosUkrEnergo as middleman from the Central Asian-Russian-Ukrainian gas scheme, I thought it would be useful to recap the known history surrounding this mysterious firm. I had originally planned on including this information in one post, but will instead split it into several to aid in the breakdown.

Much of this information relies on the in-depth report put together by Global Witness on corruption within Turkmenistan-Russia-Ukraine gas trade.

Creation of the firm

RosUkrEnergo (RUE) was created in July of 2004, four days before a summit in Yalta between Russian President Putin, Ukrainian then-President Kuchma, and businessmen from both countries with the aim of updating the gas trading scheme. As a result of the meeting, RUE was designated as the official replacement for the in-place gas intermediary, Eural-Trans-Gas. While many of the same figures from this troubled firm remained involved in the new middleman, the main difference was the direct involvement of Gazprom — the Russian gas giant owns a 50% stake in RUE through the Gazprombank-owned firm ArosGas Holding AG. The remaining 50% stake is owned by CentraGas Holding AG, which is controlled by Raiffeisen Investment on behalf of individuals who did not wish to be named.

When asked about whom its firm represents, a Raiffeisen official would only say,

“A consortium of Ukrainian businessmen and companies, very knowledgeable in the gas trading business, very well-connected in the Ukraine…[who] know about the local background [and] local politics.”

There was apparently some hope that after the problems of dealing with the privately-owned Eural-Trans-Gas, the new subsidiary could function better with more direct state involvement — that is, split ownership between Russia’s Gazprom and Ukraine’s Naftogaz. However, this was not the case, as the Ukrainian side of the firm was once again placed into the hands of private individuals.

When asked why this was the case, Putin asserted that it was a Ukrainian decision to include Centragas rather than Naftogaz:

“Ask Viktor Yushchenko [why Naftogaz is not directly involved]. Gazprom has a 50% stake and the Ukrainian side has 50%. I said to Viktor Yushchenko, ‘we would welcome it if your 50% stake is held directly by Naftohaz Ukrainy. But this is not our decision. It was the Ukrainian side’s decision. Who the names are behind the 50% stake held by Raiffeisen Bank, I don’t know any more than you do and Gazprom does not know either, believe me…It was they [the Ukrainian side] who proposed that RosUkrEnergo supply gas to Ukraine instead of Gazprom. We agreed.”

Putin made these comments in January of 2006, following the disruptive gas dispute in which RUE took a major role within the settlement. He seems, however, a bit misleading in asserting that it was Yushchenko himself who was dictating the terms of the makeup of RUE — after all, the decision on the creation of the firm was made at a meeting between Putin and Kuchma, Yushchenko’s predecessor. Yushchenko arrived on the scene after the structure had already been put into place, and lacked the options to easily adjust the lines of ownership.

Key Personnel

However, that isn’t to say that Naftogaz was not in some way represented in the RUE. According to the minutes of the inaugural company meeting in July 2004, Yurii Boyko and Igor Voronin — Naftogaz’s chairman and deputy chairman — were nominated by Centragas to be on RUE’s coordinating committee. Voronin left the coordinating committee in June 2005, coinciding with announcement by Ukrainian officials of a criminal investigation into RUE. Boyko apparently left the committee at around the same time. Boyko and Voronin were both sacked from Naftogaz’s leadership following Yushchenko’s ascent to presidency in 2005, but both later returned to prominent positions within the industry. Voronin was rehired as deputy chairman of Naftogaz around September of 2005 following the dismissal of Yulia Tymoshenko from Ukraine’s premiership, and is still working there. Boyko ascended to Minister of Fuel and Energy once Yanukovich’s government entered office, and currently still serves in that position (at least until the new Tymoshenko-Our Ukraine government is installed).

The identity of the Ukrainian figures behind Raiffaisen’s side of RUE was eventually established (under shady proceedings) following threats of investigation by the US Justice Department. Dmitry Firtash, a reclusive and camera-shy billionaire, owns 90% of Centragas (giving him 45% of RUE) while the remaining 10% is held by Ivan Fursin.

Firtash is listed in Wprost’s recent listing of Eastern Europe’s richest people as the 5th richest Ukrainian, with $3.4 billion in assets primarily in “petroleum, [and] gas.” Firtash also controls a series of chemical and titanium factories, a Kyiv basketball team, and owned the modestly-sized television stations K1 and K2 before apparently recently selling them.

Fursin, not appearing on the list, is a more minor figure in the Ukrainian business world. He owns a bank and movie studio in Odessa and some other local assets. He is also involved in various other Firtash-connected investments, like the Cyprus based companies Highrock Holdings and Arcadea Investment Fund Ltd.

Taking a look beyond ownership and into the RosUkrEnergo’s management structure, we can notice some trends:

• The two-person Board of Directors consists of a Swiss economist, Lars Haussman, and a lawyer, Hans Baumgartner. Baumgartner was recently outed by Stern magazine as being involved in Gazprom’s complicated international monetary schemes (principally involving Switzerland and Cyprus, it seems).
• The Executive Directors are two Russians — one a St. Petersburg native with experience in “various office positions in security services” before joining Gazprom where he serves on the board as well as head of the company’s legal division. The other is a hold over from Eural-Trans-Gas management.

RUE’s Coordination Committee is split into two halves, one representing Gazprom and the other Centragas.

Gazprom:

• Valery Golubev
  Golubev replaced Alexander Ryazanov, the former head of Gazprom Neft who clashed with Gazprom leadership over the role of its oil division and left the company (under unclear circumstances) early this year. Golubev is also a St. Petersburg native (serving in the Mayor’s office at the same time as Putin) with experience in the security services (KGB), and had previously overseen the procurement and investment division of Gazprom. Under his watch, this division’s expenses ballooned by about 80% as it began purchasing materials from intermediaries rather than directly from manufacturers. Golubev is also a deputy chairman of Gazprom’s powerful Management Committee and coordinates sales to former Soviet countries (but not RUE specifically).
• Alexander Medvedev
  Medvedev (no relation to Gazprom chairman and Russian first deputy PM Dmitry Medvedev) is in charge of Gazprom’s export division, Gazpromexport and, like Golubev, is also a deputy chairman of Gazprom’s management committee. He is one of the most powerful figures within Gazprom’s management, mainly due to his control over the lucrative export business. When RUE replaced Eural-Trans-Gas as the gas intermediary for Ukraine, Gazpromexport was able to regain control over providing gas to Ukraine. This increased its export totals by over 30 billion cubic meters per year (more than a quarter of its total export volumes), adding considerably to the division’s bottom line.
• Sergey Khomyakov
  Khomyakov, another deputy chairman of Gazprom’s Management Committee, was also recently appointed as head of Gazprom’s private Security Service. Gazprom apparently employs tens of thousands of private security guards (many former KGB-types), who were just recently given expanded rights on carrying arms to protect company property — at home, or abroad.
• Stanislav Tsygankov
  Tsygankov is the head of Gazprom’s foreign economic relations department, but is a figure I know nothing about.
  

Centragas:

• Dmitry Firtash
  After being “outed” as the major owner of Centragas, Firtash took a visible role on the coordinating committee. Previously, Firtash was behind the registering of Eural-Trans-Gas (whose interesting history will have to wait until a later post) in December 2002. Firtash is director of the Cyprus-registered Highrock Holdings, which cooperated with the predecessor of Eural-Trans-Gas, Itera, in supplying barter goods to Turkmenistan for gas deliveries. He also controls the Estonian fertilizer plant Nitrofert (that proudly claims to account for about 25% of the country’s total natural gas usage), and the Hungarian gas company EMFESZ (which apparently buys gas from RUE for reselling on the Polish and Hungarian markets).
• David Brown
  Brown, an Englishman involved with Eural-Trans-Gas management along with Robert Shetler-Jones (see below) and Howard Wilson, seems to have originally become involved through shared Moscow property deals with all three men. His connections to Shetler-Jones led to his involvement in Eural-Trans-Gas and then RUE.
• Robert Shetler-Jones
  Shetler-Jones entered the Ukrainian business world at the age of 22, when he founded a consulting firm in 1991. He apparently met Firtash through the other partial owner of Centrgaz, Ivan Fursin (see above), and facilitated the cooperation between Firtash, the British-registered JKX Oil and Gas, and Eural-Trans-Gas. He is the managing director of RSJ Erste, which controls various Ukrainian, German and Italian chemical factories. (RSJ Erste is a subsidiary of Firtash’s GDF company, and was in the running in the recent re-privatization of the Krivorozhstal steel works.) In general, Shetler-Jones is seen as Firtash’s “Western” partner. He was removed from the direct management of RUE around June of 2005, following the “transition period” during which he was ostensibly installed to help guide the firm. Since then, however, he has apparently been reinstated and now continues to serve in a leadership position. (He also has been staying involved in Ukraine-Europe energy relations, particularly through his consulting firm Scythian Ltd.)
• Hanno Schatzmann
  Schatzmann is another Austrian lawyer, specializing in mergers, acquisitions and corporate law. He apparently replaced the German Wolfgang Putschek as the “local” representation of Centragas.

There is some speculation that Firtash himself is acting on behalf of another figure, but this has been vehemently denied by him and Shetler-Jones. The Englishman has also suggested that the company is misconstrued, and is less mysterious than it would seem:

I would argue that Rosukrenergo is not a murky company, in fact it is very open and transparent. It is a Swiss registered company. The owners of the company are known, and Ukraine is benefiting today from some of the cheaper gas in Europe as a result of RosUkrenergo’s business.

RUE began under very shady circumstances, and operated for much of its early life outside of the public sphere. With the January 2006 gas deal, the firm was forced into the spotlight — Firtash was finally photographed and admitted to being they key owner, and efforts were made to legitimize the business. RUE now posts some of its financial data (which I will talk about more in another post), as well as its management positions and basic company history.

Firtash has also — with the help of Shetler-Jones — recently consolidated his holdings, admitting ownership of them and incorporating them under the umbrella of Group DF. This move seems to be aimed at boosting the public perception of Firtash and legitimizing the investment efforts being undertaken in his firms, while modernizing a previously much more opaque structure.

RosUkrEnergo has a long way before it becomes transparent, however, and this problem has led to many of the issues that have dogged the intermediary since its inception — a topic for the next post on RUE.

Standoff at the Kremenchug oil refinery

Taking a break from natural gas issues and a post I’ve been working on detailing some of the history of RosUkrEnergo… There is trouble now in Ukraine’s oil sector as a disagreement over leadership of Ukrtatnafta threatens to decrease the output of the country’s largest oil refinery. From the October 22nd issue of Kommersant (my translation):

The head of Ukraine’s largest producer of refined oil products, ZAO Ukrtatnafta, was replaced on Friday. With the help of a legal bailiff [executer of the law], the post of chairman of the board of the company was taken by Pavel Ocvharenko, who had been dismissed in 2004 [from that same position]. The Tatar shareholders [the “tat” of Ukrtatnafa] believe his appointment is a continuation of a conflict with NAK Naftogaz Ukrainy for the control of the Kremenchug oil refinery and are threatening to halt oil deliveries to the factory. Ovcharenko assured that he would take into account the interests of all sides and announced the necessity of an examination of the financial and production activities of the company.

In September of this year, following accusations of corruption, an investigation into Ukrtatnafta was launched by the state with the aim changing the firm’s leadership. The Ukrainian government has a 43% holding in Ukrtatnafta (through Naftogaz), the government of Tatarstan (a semi-autonomous region witin Russia) owns another 28.8%, and Russian-registered Tatneft has 8.6%. The ownership of the remaining shares — 18.3% — is currently being contested between Ukrainian and Tatar representatives. Ukrtatnafta owns the Kremenchug refinery — Ukraine’s largest, accounting for around a third of the country’s oil production — located in the central Poltava region.

The court-ordered ousting of former (Tartar-appointed) chairman Sergei Glushko was only accomplished after an armed confrontation on October 19th at the company’s offices between police and guards from Ukrtatnafta’s private security firm Buka.

Having taken back control of the company, Ovcharenko asserts the refinery’s net 2007 losses could reach about $80 million as a result of paying high prices for oil deliveries while selling the products at lower prices than their market worth. This corresponds to his message that the company’s management has failed since he left in 2004, and has instead dealt serious financial harm to the company.

In a further financial analysis of the company released by his office, Ovcharenko cites the nontransparent means that the refinery pursues to buy its oil supplies as the key factor in driving up the firm’s costs.

In May 2007 Ukrtatnafta reneged on its deal to buy oil directly from Tatneft, and instead there appeared numerous intermediary firms within the supply chain. In particular, according to information from the state customs agency, in the importing of Russian oil there is the firm OOO Taiz (Ukrtatnaft’s debt to this firm is greater than UAH 1.5 billion [$300 million]), a “receiver-giver” of MKChP Avto [unclear what that acronym stands for]. In July, this small firm was replaced with OOO Technoprogress (the debt to this company exceeds UAH 750 million [$15 million]). The purchase of oil through these intermediaries was done at prices $20-30 above the market value. In the past three years, Kremenchug’s entire market [of refined products] has been controlled by companies affiliated with Tatneft — Novoil, Tatnafta-Service and Ukrtatnafta-Center. Products [from Kremenchug] were sold to these firms at 25-30% below market prices.

Given these figures, it’s easy to see why the company would be hurting financially, and how possible inside connections between the intermediary firms and company management could account for the price differences.

Disputing the action, Tatneft has halted its supplies to the refinery, forcing the factory to scale back production and seek other options for crude delivery. If no other sources are found for a supply of oil, the refinery may have to cease production in about ten days.

Tatneft has asserted political motivations behind the move, and there are certainly geopolitical issues in play that complicate the economic rational. The continued question over the remaining ownership of the firm — enough to give either side (Ukrainian or Tartar) a majority and clear authority on appointing board leadership — adds a further element to this confrontation. For instance, Ukraine could have found out that an inopportune resolution on the issue may have been soon in coming, forcing the government to act now while ambiguity exists to insert its own loyal management. A shake up of the Ukrainian state leadership following the recent parliamentary elections also would have created a possible disruption in the political chain of command, leading to an action not fully coordinated within the government.

Ukraine obviously feels a sense of ownership towards the refinery since it is located on Ukrainian territory. At the same time, it relies on the cooperation of Tatarstan for its oil supplies and, therefore, livelihood. While a change in ownership may have been in order — along with a clean sweep of tainted intermediary firms (as in the gas trading scheme) — the intense alienation of the Tatar partners will only make future operations more difficult. Energy relations with Russia remain a sore spot for Ukraine; so long as it is economically feasible, it would do well to try to keep itself aligned with those relatively independent options that exist — including Tatarstan.

Postscript: As someone I was talking with tonight commented, this has much of the feel of “crooks versus crooks.” Indeed, the involvement of armed security forces tends to be a sign of competing power bases who are able to leverage support within local “strength” agencies, rather than those who have gone through more widely accepted channels. Regardless, it is an indication that clearly established procedures based upon rule-of-law ideals are not being followed in this issue…

Update on gas deal between Gazprom and Ukraine

I have a more in depth and technical post in the works, but I wanted to write a few comments on the recent gas deal between Gazprom and Ukraine now that a few more details have trickled out.

It appears now that the announcement of Gazprom of the (originally) $1.3 billion owed by Ukraine was indeed tied to the political transition surrounding Ukraine’s parliamentary elections. However, it was not meant as a “punishment” for the rising Yulia Tymoshenko, as has often been interpreted. Instead, the announcement of the debt — which Gazprom was considerate enough to wait until after the election to give — was in response to numerous comments made by Tymoshenko threatening the removal of the well-connected RosUkrEnergo (RUE) intermediary.

Ukraine has about $5 billion worth of gas in storage, according to Fuel and Energy Minister Yurii Boyko, and of that, $1.3 million had not been paid for yet. RUE is in charge of importing the gas from Gazprom and Central Asian states, so in theory, that debt is RUE’s, although in reality, it is passed down through it’s subsidiary UkrGazEnergo and into Naftogaz Ukrainy through those companies’ chains of ownership.

Hearing threats of the removal of RUE, Gazprom worried that the Tymoshenko-led government would take control over the unpaid-for gas currently in storage in Ukraine. By making the loud public announcement of the debt, Gazprom captured the government’s attention and was able to negotiate for the return of control of that gas.

Debts by gas intermediaries and distributors at this time of year are common, as they stockpile gas supplies ahead of the heating season. Typically, Gazprom has been consent to live with these floating IOUs, knowing it will get paid back as customers pay their gas bills over the course of the winter. A global credit squeeze may have inflated that typical debt, but the uncertainty over a shakeup within the gas market tipped the scales in the mind of Gazprom, forcing a response by their part.

The monetary portion of the debt — originally stated as over $900 million — now appears to be only $400 million, which is being covered by an interest-free advance payment by Gazprom to cover gas transportation costs through Ukraine for the fourth quarter. This money, given to Naftogaz, will work its way up the chain (Naftogaz to UGE to RUE to Gazprom) and end up essentially where it started.

The gas portion of the debt — that is, the volumes in storage being “returned” to Gazprom — is made up of two parts. One part, the original 8 billion cubic meters (bcm) announced at the time of the deal, is to be sold essentially “at cost” by Gazprom on the Ukrainian market. This alleviates fears (including those by me) that this gas transfer would leave Ukrainian customers short come the winter season.

The second part of the gas volumes consists of 4 bcm to be bought back by Gazprom at $150 per thousand cubic meters (mcm), and then re-exported to the European market where it is likely to be sold at around $250 per mcm, or more. This should net Gazprom at least $400 million, which is well below the over $2 billion mark bantered about by Russian PM Viktor Zubkov even when including the roughly $400 million repayment coming from Naftogaz via the advanced payment. The $2.2 billion figure given by Zubkov, then, likely stems from the overall “cost” of the total 12 bcm based on a price of $150 per mcm ($1.8 billion) plus the $400 million coming back to Gazprom. However, Gazprom isn’t receiving that money — it’s getting control over the gas instead of money.

Despite wide-ranging assertions, this whole deal has not been an attempt to strengthen Yanukovich’s hand in coalition negotiations (by many accounts, he did little to promote the Ukrainian side of the negotiating table), nor to bankrupt Naftogaz to force it to sell off its export pipeline network (Gazprom could have charged interest on the advance on transit payments if it desired further financial hardships for the Ukrainian company), nor to further entrench RUE in the gas scheme.

Indeed, plenty of people in the negotiating picture seem willing to do without RUE. Yurii Boyko suggested that his ministry would consider any profitable method of gas delivery; Tymoshenko has been very vocal of her desire to be rid of the company; just this Monday, Gazprom chairman Dmitry Medvedev said changes in the structure could be forthcoming and that the Russian company would be willing to do without the maligned intermediary.

Many commentators assume that because Gazprom is a 50% owner in RUE, its existence is at the behest of the Russian gas giant. However, reportedly RUE was established in the manner it was and then entrusted with its current responsibilites at the behest of influential Ukrainian interests — Gazprom apparently would have rather created a 50/50 joint venture with Naftogaz, rather than through a shadowy private Ukrainian businessman.

Historically, the use of middlemen in the Ukrainian gas market has been tied to the leverage Naftogaz holds over Gazprom’s export capabilities, as well as corruption within the industry. With the gradual opening of Ukraine’s economy and business practices –and with a big push by the incoming government — the creation of a transparent joint venture between Russia’s government-controlled Gazprom and Ukraine’s national energy company, Naftogaz, would serve the interests of both countries. That is, provided that neither side resorts to forms of blackmail while they both adhere to the general guidance provided by a fair market.

Gas explosions in Ukraine

Ukrainian officials have now raised the death toll to 16 (including five children) in the large gas explosion that decimated a 10-story apartment block in Dnipropetrovsk. The explosion was apparently caused by a pressure surge, and blame has been laid on local gas supplier Dneprogaz for failure to prevent the tragedy by both President Yushchenko and expected future PM Yulia Tymoshenko.

Suspicions of terrorism were roused earlier when reports surfaced of two men in black jackets fiddling with the gas valves. However, these were apparently two Dneprogaz officials who had become aware of “hissing and vibrating” coming from the pipes, and rushed over to tighten the valves. Presumably, this could have led to a subsequent build up of pressure and the resulting explosion, though obviously there were multiple problems with the gas system. These two officials are now being detained in connection with the criminal investigation currently underway that is focusing on negligence on the part of Dneprogaz. Allegedly, residents had called in complaining about the smell of gas before the explosion and were told only to open a window.

Recovery is expected to cost nearly $2 million, to be covered with a mixture of local and national-level fund. However, $19 million has been allocated in national emergency funds for victim compensation, continued gas supply, and the construction of new homes for those displaced. Rinat Akhmetov, Ukraine’s richest man, has pledged through his charitable foundation “The Development of Ukraine” an additional $2 million in aid money to go to local families affected by the tragedy. President Yushchenko, who has pledged a day’s earnings of him and his secretariat to the relief effort, has declared today as a day of mourning in response to the incident and has called for repercussions:

I demand that the prosecutor general’s office and the prosecutor general investigate the criminal cases initiated after the blast thoroughly and immediately find out the causes of the accident and find those guilty.

The bank account of Dniprogaz has been arrested. Its leaders, among them chief engineer and his first deputy, [the two officials who had been fiddling with the valves] have been arrested on the grounds of professional negligence. I firmly demand that all the circumstances of this tragedy be studied.

Meanwhile, two more people died in a gas explosion in the Zhytomyr region yesterday, one engineer died in a gas explosion in the Poltava region, while in the Ivano-Frankivsk region another gas explosion injured three people. This run of gas incidents corresponds to the beginning of the heating season, as gas systems across Ukraine are turned on en masse to collectively provide heat for local residents. (October 15th was the day here in Kyiv, though I’m still waiting for the heat to kick in at my apartment for some reason.) As the infrastructure continues to age and a bankrupt system prevents refurbishment, these types of problems are only likely to continue.

President Yushchenko is now mulling over the fate of Ukraine’s aging gas distribution network, which is made up of over 300,000 km of pipelines and corresponding pumping stations and is valued at nearly $2 billion. While 39 out of the 45 city and regional gas distribution networks are profitable, they are reporting only slim earnings and are clouded by an opaque structure that has failed to reinvest those profits into infrastructure improvements. Technically state owned, the overall network has been administered since 2001 through Ukrgazmerezhi, which is a subsidiary of Gaz of Ukraine, itself a subsidiary of the state oil and gas firm Naftogaz Ukrainy. Yushchenko now is calling for the reinforcement of leasing terms used by private companies to secure access to the network. Contraty to the “chaotic” situation now, the terms of the contracts need be clearly stated, along with liabilities for failure to comply to them.

Dneprogaz, the city gas distribution company at the center of the the gas blast in Dnipropetrovsk, is one of the private entities with access to the pipeline system. It was privatized in the 1990s to Complex Energy Systems Company, a Russian-based firm owned by billionaire Viktor Vekselberg who also controls the TNK side of the oil joint venture TNK-BP. Tymoshenko, while accusing Dneprogaz of recently cutting back on equipment and personnel, suggested that all such regional distribution firms should be returned to state management or at least regulated from shirking on providing necessary infrastructure improvements. It is unclear if the strict terms of the contracts mentioned in Yushchenko’s plan would qualify as these types of guarantees.

This is just a further indication of the depths of the problems facing Ukraine’s natural gas industry, and the hard decisions facing industry and political leadership regarding its future. These regional distribution networks are the same entities that are at the bottom of the debt chain that led to last week’s gas payment settlement. They are tasked with supplying cheap gas to domestic customers while racking up debts to their providers (UkrGazEnergo, Naftogaz Ukrainy), who are then left with debts to their provider (RosUkrEnergo), who is then indebted to its provider (Gazprom). (Opaque connections along this chain are a further money sink, as any profits that are made are often skimmed away by connected officials.) With higher gas rates from Gazprom expected following upcoming contractual negotiations, those lower down the chain will only be faced with tougher financial decisions that will likely result in further operational cuts. The safety of the gas distribution network will only continue to suffer.

Tymoshenko can’t have it both ways — she can’t pledge to keep gas prices low while at the same time refusing to allow local gas companies to make cuts to offset the price discrepancies. Something will have to give, and hopefully it won’t be another tragic apartment explosion.

Update: The death toll has risen to 17 now, and other regions are beginning to question whether such a tragedy could strike their susceptible gas systems, including the debt-ridden Kherson oblast.

Gazprom – Ukraine “settlement” raises more questions

Following a meeting between current Ukraine PM Viktor Yanukovich and Russian PM Viktor Zubkov, Gazprom announced that a settlement had been reached in Ukraine’s debt for gas deliveries. While the announcement was meant to assure European customers that the disagreement is resolved and there is no future threat of reduced supplies stemming from the dispute, the terms of the settlement bring up plenty of new issues.

From Bloomberg:

Gazprom will take ownership of $1.2 billion of gas stored underground in Ukraine, selling it to consumers in that country and Europe… A $929 million debt owed by retailer UkrGazEnergo to Gazprom’s half-owned Ukrainian gas import venture, RosUkrEnergo AG, will be paid in cash by the end of this month, Zubkov said.

For those doing the math at home, that’s over $2 billion in debt owed, much larger than the $1.3 billion figure quoted at the beginning of this issue. It’s unclear exactly where the extra $700 million came from, but it seems to be indicative of the general problems in weeding out exactly where the debts are accumulating and who is responsible for repaying them.

An article by the Washington Post highlights the confusion over who owes what, and where the money is going. According to the agreement, “the first payment of $200 million (142 million euros) is to be made by Oct. 22 to RosUkrEnergo, a statement from RosUkrEnergo said.” The paper doesn’t say who the first payment is being made BY, however, or what that money covers. Likely, it will by coming from Ukrgazenergo, itself 50% owned by RosUkrEnergo.  Regardless, since RosUkrEnergo was apparently one of the firms that owes significant amounts of money, it’s unsure why it’s getting paid. The firm is 50% owned by Gazprom, so in a way, it seems to be paying itself for its own debts. The article goes on to say that, “the underground storage facilities from which the gas is to be transferred to Gazprom also are owned by RosUkrEnergo.”

According the more comprehensive article in the FT, RosUkrEnergo (RUE) owns about 10 billion cubic meters (bcm) of gas that it has been stockpiling in Ukraine’s storage facilities, likely in preparation for the winter. Unfortunately, facing problems on the global credit market, it hasn’t been able to pay for all that gas which it presumably acquired from Gazprom. Now, Gazprom regains control of the gas, which is strategically located near the western Ukrainian border, priming it for easy export and a high return.

Where exactly that leaves domestic Ukrainian customers come winter, however, is unclear. Or, why RUE can’t just export the gas that it already owns itself, collecting the profits, and then using them the pay back Gazprom while making its own structure more soluble. Now a significant role in the Ukrainian market has been ceded to Gazprom — how to divvy up the gas supply it has gained control of within Ukraine (8 bcm, reportedly). This is beyond the 25% stake Gazprom already has in Ukrgazenergo (UGE), a further middleman which has itself been struggling with debt repayments.

Gazprom has been storing gas in Ukraine since before there was even a Gazprom, so part of this scenario is not new. However, the companies entrusted to supply gas to Ukrainian customers — UGE, and Naftogaz Ukrainy — are left with an ultimatum to pay in cash hundreds of millions of dollars in debts by next month, and this winter cannot rely on gas previously stored up by their partner, RUE.

If Ukraine faces a gas shortage this winter, you had better believe that domestic entities under pressure would siphon off gas traversing the country rather than plunge swaths of customers into the cold. Of course, I don’t think it will ever come to that, but for Europe to believe that this “settlement” will prevent any future problems is absurd.

Tymoshenko has vowed to rid Ukraine of its shadowy gas middlemen — ironically, a task she is perhaps best suited to given her own beginnings in such a firm — as a way to ensure Ukrainian energy security and downplay the contentious links between regional natural gas machinations and domestic politics. Clarifying the relationship between the actors — and cutting out the “dead weight” — would certainly help bolster the transparency of a historically opaque system. Perhaps even better would be a full market liberalization, allowing market forces and competition to dictate those firms that establish themselves in the industry, while divorcing the battered state-owned Naftogaz from further bungling. Unfortunately, that isn’t possible now, at least not so long as a majority of end-user gas prices are effectively subsidized. Clearly, the embracing of market prices and forces must be continuous throughout the entire chain of supply, a problem that is all to evident in Ukraine’s current natural gas issues.

Gazprom warns of problems with Ukraine

On October 2^nd, just two days following Ukraine’s early parliamentary elections, Gazprom sent a message to its European partners warning of possible problems with future downstream gas flow due to Ukraine’s $1.3 billion debt accumulated for gas deliveries since January 1^st, 2007. The Russian gas company said that the country may face a reduction in gas supplies if the issue is not resolved soon, an action that could potentially affect a large portion of Gazprom’s export clients since over three quarters of Russian gas sent to Europe flows through Ukraine’s pipelines. The last time Gazprom reduced supplies to Ukraine in response to a price dispute—January 1^st, 2006—European customers became alarmed as they noticed a reduction in their own gas deliveries, due to Ukraine continuing to withdraw its normal volume of gas.

The recent announcement by Gazprom appears to be an attempt to improve on its communication surrounding potential disputes, an issue that has plagued Russia for years. Following a row over oil deliveries through Belarus this past winter, President Putin promised to German Chancellor Merkel that more direct communication surrounding pricing negotiations would be a key part of Russia’s pledge to contribute to European energy security. However, Ukrainian officials felt miffed that the warning over potential problems was given first to European customers (and the press), before a similar announcement was issued to relevant Ukrainian parties.

Ukrainian Prime Minister Viktor Yanukovich immediately dispatched the Fuel and Energy minister Yuri Boiko to Moscow to hold talks with Gazprom leadership. It was soon announced that the issue would be resolved (somehow) by November, reducing a bit of the sudden urgency the original announcement had created. However, the Ukrainian government is in the process of rearranging and the current officials have an unclear mandate, complicating the legitimacy (and efficacy) of the negotiations.

The expectation remains that the two major “orange” forces—Yulia Tymoshenko’s bloc and the pro-Yushchenko Our Ukraine—will attempt to team up, hopefully with better results than last time immediately following the Orange Revolution. Yushchenko was forced to dismiss Tymoshenko from the premiership last time due to conflicts over the direction of economic policies, as well as mutual accusations of corruption. However, the two forces pledged to team up before the election, with Yushchenko agreeing to back Tymoshenko for prime minister again. The conflict over gas supplies will likely be the coalition’s first major test, similar to the situation the government faced in the 2005-6 winter. That pricing dispute—which left Ukraine paying about 50% more for its gas, though still well below Western European prices—struck a blow to Yushchenko’s administration, and there is some speculation that this round of talks could in effect cut the legs out of the new government before it even has a chance to get going.

Indeed, the timing of the announcement seems a bit suspect, given its proximity to the Ukrainian elections. Gazprom has stressed that they deliberately waited until after the poll to make the announcement, recognizing the effect of gas problems (har-har) on the Ukrainian government. However, there is really no time when such an announcement would not affect the political situation of Ukraine. Yanukovich is often accused of closer relations to Moscow, and the gas conflict could be seen as a ploy to enable him to keep a measure of power—he may claim to have the best chance as striking a beneficial deal with Gazprom / the Kremlin, particularly when compared to the fiery Tymoshenko. The pending negotiations may even allow Boiko, the energy minister, to remain in his powerful post while the conflict remains unresolved—or longer, depending on how it plays out. Tymoshenko’s potential choice for Fuel and Energy Minister is not known (by me, at least), but it is doubtful she would keep the scandal-ridden Boiko, who is a member of Yanukovich’s Party of Regions, if she can help it. She has expressed anger over the debt, calling on a criminal investigation into how such a large figure could have been accumulated under Yanukovich’s watch.

Part of the issue to be resolved is in determining exactly who owes the $1.3 billion. As a result of the January 2006 negotiations, the importing of Russian and Central Asian gas to Ukraine is to be solely coordinated by one company, the Swiss-registered RosUkrEnergo (RUE). RUE is 50% owned by Gazprom, with the remaining 50% originally anonymously held by Ukrainian interests. It was later revealed that those interests were two businessman, principally one Dmytro Firtash. RUE later entered into a joint partnership with Naftogaz Ukraina, the Ukrainian national oil and gas company, creating a vehicle (UkrGasEnergo, UGE) for delivering the imported gas to customers within Ukraine. In general, this company would be in charge of supplying gas to Ukraine’s industrial customers, leaving Naftogaz to supply the much more problematic residential users.

So then, whose debt is it? RUE, which is in charge of the imports from Gazprom? UGE, which delivers much of that gas to customers throughout Ukraine? Or Naftogaz, with its own delivery responsibilities? Or the people of Ukraine collectively? In the past, the problems have come from the middlemen—they were generally collecting gas bills from the customers, but were often not passing them along to Gazprom. It was expected that Gazprom’s 50% involvement in RUE would help alleviate this problem, along with the exclusion of the historically reticent Naftogaz. That does not appear to be the case now, however. Instead, the problem likely stems from massive under charging of Ukrainian customers, often a social necessity (at least, at the moment). The government had agreed to keep end user prices depressed, despite the previous rise in import prices, agreeing to take on the difference itself while slowly readjusting domestic prices. However, the political climate has made passing on those price increases difficult, especially to the more vulnerable residential population. (Russia is facing a similar problem, but can rely on its gas exports to generate profit.)

The current debt negotiations also reopen the question of contractual gas prices for Ukraine. Dmitry Medvedev, Gazprom’s chairman, announced on Sunday that Ukraine’s price for gas would be “fair and market-based.” Determining that, however, is a bit difficult. Should Ukraine be charged as much as Germany? As Poland? As Britain? As Kazakhstan? Unlike oil, there is no global natural gas market, particularly for pipeline-delivered gas. There is much more of a mutual dependency between the buyer and seller—the destination of the pipeline cannot be simply changed, should a disagreement arise. This has led to the prevalence of long-term gas contracts, guaranteeing a minimum volume of delivery and a minimum amount to be paid for (whether it is used or not). The price to be paid for the volumes is typically renegotiated annually or biannually. Oil remains the de facto standard that gas prices are typically pegged against, and as global oil prices have risen lately, so too have the prices associated with typical gas contracts.

Complicating the matter is the involvement of Turkmen gas in the supply delivered to Ukraine. There is a long historical precedence for this relationship, and by relying on the cheaper Turkmen gas, Ukraine has been able to keep the price it pays down. Turkmenistan is in a bit of difficult situation—it must rely on Russia to help coordinate the export of its own gas, given the layout of the Soviet-era pipelines. Indeed, Ukraine is essentially Turkmenistan’s only export partner, besides Russia (and Kazakhstan), though Gazprom will sometimes re-export Turkmen gas that it ostensibly buys for domestic use. (Ukraine does the same thing with some of its gas imports.)

The winter has been Gazprom’s favorite negotiating period lately, with the threat of cold temperatures a reminder of the necessity of providing gas at a social level. The further coincidental timing with the election may or may not be an accident, but there is no doubt that the outcome of the negotiations will have a significant impact on the early health and success of the soon-to-be formed Ukrainian government.