Monthly Archives: October 2007

Gas explosions in Ukraine

Gas explosion in Dnipropetrovsk - From 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 2nd, 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 1st, 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 1st, 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.