Tymoshenko’s government begins work in Ukraine as Yanokovich leads rival “shadow cabinet”

Last Tuesday saw Yulia Tymoshenko elected as new Prime Minister of Ukraine after several failed Rada (parliament) votes. Eventually resorting to an individual hand-raising / oral -confirmation voting procedure, however, ensured that she passed with the required majority — barely. Only one vote carried her into the new post, which paved the way for the new Bloc of Yulia Tymoshenko (BYuT) and Our Ukraine – People’s Self Defense (NUNS) coalition government. However, her slim majority has left her with less political capital than her impressive parliamentary election results (gaining over 8 percentage points between elections) would have otherwise suggested.

Recognizing this, the Party of Regions has resolved to occupy its new role as opposition with relish, and has already formed its own “shadow cabinet” in response to the government just formed by Tymoshenko and her allies.

The opposition Minister of Economics Irina Akimova told Ekonomicheskie Izvestia that the Party of Regions sees the oppositional cabinet of ministers as a springboard for criticizing the actions of Yulia Tymoshenko’s government in parliament: “Also, participants in the oppositional cabinet will acquire certain skills, if they don’t already have them, in order to follow the work of this or that ministry. When the power changes, they will come with prepared presentations about what their ministries need to contribute into the strategy of the country.”

Ousted PM Viktor Yanukovich has taken on the role of “shadow” Prime Minister, while former Fuel and Energy Minister Yuri Boyko has reclaimed that role in this Party of Regions-organized endeavor.

His counterpart in the real government — the one that occupies the ministry buildings and official government offices rather than the Zoyarny movie theater — is Yuri Prodan, a NUNS representative with a history in the Fuel and Energy Ministry and a former deputy in the President-controlled National Security and Defense Council (NSDC).

Oleg Dubina, a veteran of the Dnipropetrovsk industrial sector, has been named as the new chairman of Naftogaz. He has already been holding talks with Uzbek representatives about the possibility of arranging direct sales of natural gas from the Central Asian country to Ukraine, which currently relies on RosUkrEnergo (RUE) for its gas import needs. Dubina is connected to the powerful Industrial Union of Donbas (IUD), which has a history of direct sales of Uzbek gas, so this relationship may help establish something on a larger scale. However, Uzbekistan is reportedly seeking a price of $180 per thousand cubic meters from Gazprom, and any counter offer from Naftogaz would have to be higher. Adding in transport costs would put the Ukraine border price closer to $220, higher than the $179.50 agreed upon with RUE.

Naftogaz is facing an increased tax burden for next year — up from 26% to 30% — along with a government regulation freezing the residential consumer price of gas at current levels. The sale price of domestically produced gas, another opportunity for Naftogaz to potentially turn a profit, is expected to remain at the same depressed level as well. While industrial prices are expected to rise 30%, much of the sales to this sector are controlled by UkrGaz-Energo, a joint venture between Naftogaz and RUE, which dilutes any profits coming to the embattled state energy firm.

In another move by the new government within Ukraine’s energy sector, the Ministry of Finance has called for a 25% increase in the rental rates (up to about $400 per ton) applied to domestic oil production next year. This largely affects Ukrnafta (not to be confused the Ukrtatnafta), the majority state-owned oil production company that accounted for about 95% of Ukrainian oil production last year. However, while 50%+1 of the shares are controlled by the government, the Privat Group owns over 40% of the shares, and therefore effectively guides the actions of the company. This ownership structure made the announcement of the tariff increase more surprising, given that Privat is seen to be connected to the current government and supported NUNS in the last election (Igor Palitsa, a former Ukrnafta chairman, is on the NUNS list).

According to NUNS deputy Viktor Topolov, the current price for oil is about $580 per ton, and the cost of extraction is about $175. Adding the $396 proposed tariff negates all but a few dollars in profits, hardly enough for any re-investment or development — and well below the $300 average world profits on a ton of oil. Typical oil production rental prices (in Europe and Russia, for example) are determined as a percentage of world oil prices (usually around 12-15%), which would come out to closer to $100 per ton.

Viktor Pinzenik, a BYuT deputy, is Ukraine’s new finance minister, and this surprising tariff increase (the previous government had assured Ukrnafta it would keep the charge the same) may be an early fissure between the BYuT and NUNS coalition. However, Privat has also spearheaded a court procedure relating to a recent Dniproenergo deal in what appears to be an attempt to gain more control over the regional energy firm. (A key decision was made by the same court that was central in the move that brought about the “management dispute” at the Kremenchuk refinery.) Analysts for this article cite alleged closeness between Privat and Tymoshenko as a possible reason behind this latest move, contradicting the assertions that Privat is now moving closer to the NUNS sphere.

According to the director of the International Institute of Privatization, Property and Investment, Alexander Rybchenko, Privat holds an edge in the unfolding case due to the current political situation:

“The Privat Group once again, as with NZF [nickel and ironworks factory], benefited from the coming to power of Yulia Tymoshenko. Therefore, now the political protection is on the side of the group, but if president Viktor Yushchenko or the new secretary of the NSDC Raisa Bogatyryova [see below] does not change the situation, Privat will have an advantage in the form of government support.”

It is unclear at this point just which factions will emerge more powerful withing the new government, and how exactly major business players will utilize the new structure.

As referenced above, Yushchenko unexpectedly named Raisa Bogatyryova, the second deputy on the rival Party of Regions (POR) parliament list, as secretary of the powerful NSDC on Monday. POR-head Yanukovich has stated that no party member will serve high-level positions in the BYuT -NUNS government and meetings between POR members in the past two days have apparently been contentious regarding whether or not she should accept the offer. As of the evening of the 25th, however, it appears that she accepted the invitation and will become the new NSDC secretary. It remains to be seen whether she will be cut from the POR list now, as she apparently made the decision against the wishes of most high-ranking members.

The announcement also caught off-guard members of the new coalition government, who apparently only learned of the offer through the press. According to Taras Stetskiv, a NUNS deputy:

“At a minimum, we are surprised. Never in the civilized world has the opposition — a political opponent — been given such a key post like the position of secretary of the NSDC.”

Apparently, such a move had been in the works since immediately after Tymoshenko was elected PM, with Boris Kolesnikov being the first POR name suggested. The choice of Bogatyryova, a professor from Donetsk with a background in medicine, apparently only happened on the 24th. This appears to be an attempt by Yushchenko to balance Tymoshenko’s ascent into the top of Ukraine’s government by promoting a key figure in her (and his, not to be forgotten) opposition party. Some POR deputies — before Yanukovich’s statements on remaining strictly in the opposition surfaced — praised the choice as an example of pragmatic bipartisanship. Tymoshenko has diplomatically stated that she will agree to work with all high-level presidential appointees in the government. Bogatyryova’s potential impact will likely affect coordination efforts between the president and parliament, but losing her POR position would alter the relationship.

Meanwhile, Yushchenko is planning a visit to Moscow to meet with Putin in the near future, and the topic of gas negotiations is likely to come up — regardless of what actions Tymoshenko may take in the meantime. The “specter” of Dimitry Medvedev — current Gazprom chairman and favorite to win Russia’s March presidential elections — will likely temper such talks. While Medvedev has been open to the idea of restructuring the gas supply scheme, outspoken Russian political analyst Stanislav Belkovsky suggests that Medvedev will champion for RosUkrEnergo, pointing out that he attended law school with Konstantin Chuychenko, one of RUE’s current executive directors.

Tymoshenko’s government has finished a re-worked 2008 budget that incorporates increases in social spending as well as the newly-finalized $179.50 price for natural gas. The budget must still pass POR approval, and the window for enacting it before Jan. 1st is rapidly closing. Nevertheless, it appears that Tymoshenko is willing to live with the current gas price — or at least, fully prepare for its likely existence — rather than attempt a last-minute negotiating blitz. Not only would this move have cost her political capital even as she is working on getting the budget passed, but it also would have worried gas consumers in Europe who remember the drop in downstream gas pressure caused by the contentious negotiations around January 1st of 2006.

All in all, it has been a busy and interesting start for Ukraine’s new government. Passing the budget will be a key first step, as will establishing the new centers of power and important relationships. With any luck, this government will be productive for Ukraine in general, and not resort to the bickering and deadlocks that have marked some of the country’s recent political incarnations.

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FAS mum on Deripaska’s bid for Russneft as the oil firm prepares for leadership shakeups

Russia’s Federal Anti-Monopoly Service (FAS) was expected to rule on Oleg Deripaska’s bid to buy the oil company Russneft by the end of November, but there is yet to be a word on their decision. The FAS had previously taken a one-week extension, allegedly due to changes in case examination procedure, but that deadline has also passed. They are now choosing to remain mum.

Rulings on two tax evasion suits filed against the oil company by Russia’s tax service, following the predominant trend, were also delayed.

Meanwhile, snap elections have been called for the boards of directors of five main Russneft subsidiaries. They are scheduled for late January through early February at the Varyerganneft, Saratovneftegaz, Orsknefteorrgsintez, Neftermaslozavod and Orenburgnefteprodukt subsidiaries. None of the five are those cited last month as having breached the terms of their resource licenses; investigations into those violations are currently underway.

A source within the company told Kommersant that two vice-presidents had also been recently replaced with Oleg Schegolev and Igor Marchenko, both former members of management at the natural gas firm Itera. Rumored to have been axed are Dimitry Romanov (vice president for corporate relations) and Olga Prozorovskaya (senior vice president for finances), both of whom shared seats on a majority of subsidiaries’ boards with embattled former Russneft head Mikhail Gutseriev. Another vice president, Sergei Bakhir, left for vacation and has not returned, theoretically opening his position for a management shift. He is facing a criminal charge along with Gutseriev, who is currently on the run from Russian authorities.

These leadership changes are seen as the first steps in preparing the company for inclusion under Oleg Deripaska’s holding company, Basic Element. The expectation seems to be that the FAS will have ruled before the scheduled votes for the boards of director, allowing Deripaska to insert his own management team into the boards’ makeup once his firm takes control.

Speaking of Gutseriev, according to the British ambassador to Russia, he has not applied to England for asylum, nor are his whereabouts known by Interpol. He apparently used his connections in Belarus — stemming from a $90 million investment in the RussNeft-Bryansk oil firm there, 25% of which he then gifted to Lukashenko’s government — to escape from Russia. His final destination has been suggested as Switzerland (cited because of his close ties to Glencore, though I would imagine he would have had more dealings with the commodity trader’s London offices) or somewhere in the Middle East (referring to his Muslim faith and connections to the oil sphere). For now, though, it remains a mystery.

Naftogaz facing default if 2006 report isn’t published by end of the year

Naftogaz Ukrainy, the indebted national energy company of Ukraine, is facing a December 31st deadline for submitting its 2006 financial report as stipulated by its international creditors, and risks being pushed into a technical default should it fail to adhere to this regulation. The UK-based investment funds Ashmore and BlueBay together hold 40% of Naftogaz’s debt, and on Friday representatives from the firms held meetings with both Tymoshenko’s and Yushchenko’s people on the issue. Jules Green from Ashmore stated during a press conference:

“We are the creditors of NAK Naftogaz and we came to the Verkhovna Rada [Ukraine’s parliament building] in order to communicate that there exists a serious risk of the declaration of a technical default of Naftogaz. If before the 31st of December an audited financial report is not produced and presented, then a technical default will be declared.”

He went on to say that in the event of a default, “the owners of the obligations can demand a return of [their] money.”

Naftogaz has about $2.2 billion in debts and budgeted around $800 million for debt repayment and interest fees for 2007. It recently secured a $52 million loan from Ukraine’s state-owned Oshchadbank for debt restructuring and asserted that it plans to repay $67 million in loans this December. However, besides regular repayment of its debts — which account for about 15% of Ukraine’s total national debt — terms of the international lenders also included regular financial reports, something Naftogaz has apparently been struggling with.

Ashmore and BlueBay are also both nervous over the company’s prospects in 2008, especially in light of the significant price increase in natural gas recently negotiated with Gazprom. However, after meeting with representatives from the presidential secretariat and with Yulia Tymoshenko herself, the creditors were slightly more optimistic:

“For the first time in its history, the Ukrainian government will find a solution to these [financial] problems,” in the form of the making available on the side of Ukraine “sovereign” government guarantees relating to the debts of Naftogaz.
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Earlier, right after the two failing votes for Tymoshenko [for the post of Prime Minister], in the cupolas of the Verkhovna Rada crept a rumor, in the form of Tymoshenko being forced to refuse, in particular, from the claim on the position of head of Naftogaz, which would divert BYuT from the coalition agreement.

Naftogaz responded by calling the news of impending financial trouble “speculation” generated by various “political forces” and urged its partners and investors not to worry. According to the company, the problems with finances arose from an earlier management team, and changes have been implemented for the better:

“Naftogaz Ukrainy is continually removing the consequences of the financial crisis [that lasted from] 2005 through the first half of 2006, and during this year [the company] is gradually reaching a financial balance, strengthening the position of the company in both internal and external markets,” says Naftogaz’s announcement.

The document noted that “the increased health of Naftogaz’s finances began with the arrival in August 2006 of a new management team to the leadership of the company.”

On Thursday — the day before the announcement by the British creditors — Naftogaz submitted its deficit-free financial plan for 2008 to its auditing firm, Ernst & Young. This was apparently one hurdle in the publication of the company’s 2006 IFRS report, suggesting that with some effort the financial information will get published within the necessary time frame. One thing that is not clear, however, is if the 2008 plan has to be approved by the cabinet before the 2006 report can be published. If so, this could create significant problems due to the political instability currently permeating Ukraine’s government.

It sounds like Tuesday has been pegged for not only another PM vote for Tymoshenko, but also for votes on ministry heads and cabinet makeup. Should problems arise then, when a new government gets formed is up in the air — Yushchenko may be away from the country, and then we are pushed into the New Years / Christmas holidays, where no work gets done.

A delay in cabinet approval of the financial plan would be bad news for Naftogaz, especially if, indeed, as asserted (and as is generally accepted), the company is starting to become more financially viable. A default after the new year would be a rough start for the new Fuel and Energy Minister (rumored to be Yuri Prodan) and the Naftogaz leadership.

Ukraine not settled on gas deal with Gazprom as more provisions of the agreement filter out

Following Yulia Tymoshenko’s immediate disapproval of the deal struck between Ukraine and Gazprom over supplies of natural gas for 2008, President Yushchenko appears to also be casting a critical eye over the agreement. During a a television interview on Sunday night, the deputy head of Ukraine’s presidential secretariat Alexander Shlapak said Ukraine is now looking into ways to scrap the current gas scheme and instead buy supplies directly from Central Asian producers. Unlike Tymoshenko, however, the President is willing to live with the recently agreed upon deal for 2008, and is instead looking to negotiate throughout the next year and have a new system in place for 2009.

Kommersant cites a source in Gazprom asserting that the gas giant would be willing to do away with the services of RosUkrEnergo so long as Ukraine would pay the “market” price of $270-300 per thousand cubic meters (mcm) of gas. This is significantly higher than the $179.50 price recently agreed on, and higher than the $230 Gazprom was charging Ukraine for Russian gas (versus cheaper Central Asian) last year.

However, the President’s plan would have Ukraine bypassing Russian gas, and instead looking to re-establish direct negotiations with Central Asia. A source within Ukraine’s Cabinet of Ministers outlined the early stages of the secretariat’s plan for Kommersant:

According to the source, it plans on re-opening negotiations with Turkmenistan, Kazakhstan and Uzbekistan on the purchase by Naftogaz Ukrainy in 2009 of 60 billion cubic meters (bcm) of gas. “From that, 50 bcm would be left for the internal market [the average of imported gas for the past two years] and 10 bcm would be re-exported. Even if we buy the gas for $250 per mcm, the total from re-exporting would give us more than $1 billion in profits.”

This is very similar to the current scheme that is operated by RusUkrEnergo. In 2006, RUE reported exporting nearly 9 billion cubic meters (bcm) of gas while selling just over 50 bcm in Ukraine. (Gazprom reported sales of 59 bcm to Ukraine for 2006, so these figures mesh.) RUE reported over $700 million in profits for 2006.

In 2007, however, RUE apparently only bought about 50 bcm, nearly all of which was sold to Ukrainian customers. (RUE has not published any reports for this year, so this number is based on quarterly reports from Gazprom as well as estimations.) Instead, RUE was making $2 per mcm on the trade between Central Asia and Ukraine. Profits for RUE dropped to about $140 million for the first half of 2007, according to Gazprom reports.

RUE’s 2006 profits were based on a much larger re-export margin than the secretariat’s plan — RUE was buying gas for about $100 per mcm and reselling it for over $200. The figures suggested by the source would drop that margin closer to $30 per mcm, based on average Eastern European gas prices. This leaves a profit of $300 million from the re-export, not taking into account earmarking this income for the defrayment of increased domestic prices.

Ukraine is slated to buy 62 bcm of gas from RUE next year, according to Interfax. As consumption has dropped to around 65 bcm and domestic production is expected to remain around 20 bcm, this leaves a significant volume for re-export. Who exactly gets a piece of that pie, however, is unclear and depends on how much will be handled by RUE, by its 50/50 joint venture with Naftogaz “UkrGaz-Energo,” or by Naftogaz itself. The president’s plan looks to ensure that Naftogaz will dominate the re-export position in the future.

The same Vedomosti article cited above also sheds light on the price breakdown for this year’s gas deal:

The Ukrainian Ministry of Fuel and Energy yesterday explained how the price of imported gas for the country for 2008 was formed ($179.50 per mcm). About $140 of that is the average purchase price, $2.80 is the commission for Gazprom Export on the resale to gas trader RosUkrEnergo, and the remaining $36.70 is the cost to RUE for transporting gas through the territory of Russia, Kazakhstan and Uzbekistan to the Ukrainian border (with an average length of the route is 2,360 km), according to Interfax.

This breakdown is similar to the preliminary one I gave in my earlier post, through the disclosure of the previously unknown $2.80 commission is worth noting. While it was assumed that Gazprom Export was getting something at the resale point, it was unclear exactly how much. I had expected the export division, led by the ambitious (one description of him that I feel comfortable repeating) Alexander Medvedev (no relation to chairman and expected future Russian President Dimitry Medvedev), was one of the main actors pushing for the reformatting of the gas scheme in late 2005. Even a quick look at the few statistics they have available shows that its involvement in the supply chain has added a massive income stream for the division.

Apparently, in 2007 transport costs for RUE were around $27-28 per mcm, so the increased allotment of the price share for 2008 will be where RUE can make its profit (besides any reselling). However, this increase also takes into account the $0.10 rise in transit tariffs, which apply not only to Russian gas being export across Ukraine, but also Central Asian gas traversing Russian territory to get to the Ukrainian market.

Given Ukraine’s current heavy reliance on Turkmen gas (about 2/3 of imported supplies), the main obstacle to Ukraine re-inserting itself into direct negotiations with Central Asia is Turkmenistan’s agreement with Gazprom that essentially locks up all Turkmen gas for sales to Gazprom. The recent agreement between Russia and Turkmenistan on building the Precaspian pipeline also puts a damper on Ukraine re-claiming direct Turkmen gas sales. However, should Ukraine be willing to provide a significant price boost from what Gazprom is currently paying (slated for an average of $140 per mcm next year), potentially along with other side benefits, you never know what could happen…

Gazprom chairman Dimitry Medvedev chosen to lead United Russia’s presidential ticket

Long-rumored to be a leading possibilty to succeed Vladimir Putin as Russia’s President, Gazprom chairman and first deputy prime minister Dimitry Medvedev was tapped to be the candidate from Putin-led “United Russia” for the March 2008 elections. I will get into more of the potential effect this could have on Gazprom later, but for now, here is a section of my senior thesis on Gazprom and the Russian government that deals with Medvedev (I have excluded the footnotes only because they do not translate into blog format. If anyone has interest in the sources, feel free to contact me.):

In 2000, Swiss officials claimed that tens of millions of dollars had been transferred into accounts controlled by [former Gazprom head Viktor] Chernomyrdin. Following that assertion, the government managed to have Dimitry Medvedev, a close ally of Putin, elected as Gazprom’s chairman of the board of directors in July 2000, replacing Chernomyrdin. Putin then appointed Chernomyrdin as ambassador to Ukraine, thus removing him from the Moscow political scene. Medvedev had served under Putin at the External Relations Committee of the St. Petersburg Mayor’s Office from 1990-1995, establishing a close relationship with Putin. Medvedev then served in the Office of the President from 1999-2000 before leaving to run Putin’s presidential campaign. From there, he was chosen as the first step in the restructuring of Gazprom’s leadership.
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After being chosen to chair Gazprom’s board of directors, Medvedev remained involved within the Kremlin. In October 2003, Putin chose Medvedev to head his Presidential Administration, the high-level office that works closely with the President on all important issues. In November 2005, Medvedev was appointed as one of the two First Deputy Prime Ministers.

Medvedev is a member of Putin’s “tea-drinking group,” the moniker attached to a number of high-level officials who meet together with Putin frequently, yet discreetly. These advisors typically have a shared background in either the security services (siloviki) or the St. Petersburg mayor’s office (Petersburgers, sometime referred to as piteri)—or both—and represent those who have the highest level of presidential access and influence. Medvedev, like [Gazprom president Alexei] Miller, is considered more of a technocrat. His promotion to head of the PA (i.e. Putin’s chief of staff) in 2003 was seen as a balancing choice to prevent too much power to accumulate with the typically hard-line siloviki. By placing both Medvedev and Miller as the top two figures in Gazprom’s leadership structure, Putin has both strengthened the presence of the technocrat bloc while ensuring comprehensive connections between the Kremlin and Gazprom’s operations. The connections go both ways, however, giving the group an influence on policy decisions beyond everyday business dealings.

Through Medvedev’s dual role as chairman and deputy prime minister, he has a wide range of powers. When it is suggested that such influence might create various conflicts of interests or facilitate overt control of Gazprom by Putin’s government, Medvedev has disregarded the worries, saying that he was just “a lucky man” to hold both jobs. However, some conflict of interest may be expected, given that Medvedev heads the company that pays the most taxes to the government he helps run. The upcoming 2008 presidential election will be a chance to see exactly how Medvedev will balance the two positions.

Ukrtatnafta supply issues reverberate across Ukraine’s oil sphere

Despite expectations of boosted production in December, the Ukrtatnafta-owned Kremenchuk oil refinery is still facing problems in securing oil supplies, even as its efforts to buy domestic crude have forced two smaller Ukrainian refineries to shut down.

Both the Drogobych (Galichina) and Nadvornyansk (Neftekhimik Prikarpatiya) refineries in western Ukraine have ceased production for the month, apparently unable to buy any Ukrainian crude on the market. Ukrtatnafta, facing halted supplies from previous partner Tatneft stemming from a “management dispute,” bought what was available in Ukraine and routed it to its Kremenchuk refinery.

Both of these smaller refineries are linked to the powerful Ukrainian conglomerate Privat, which is believed to have engineered the move that installed Ukraine-friendly Pavel Ovcharenko atop Ukrtatnafta in October. This move, which forcibly removed the Tatneft-aligned Sergei Glushko, angered Tatarstan shareholders. In response, Tatneft shut off direct supplies to Kremenchuk and pressured other Russian oil firms from providing shipments. Ukrtatnafta dropped production well below capacity and turned to Ukraine’s relatively-small domestic crude market to make up the difference while searching for new sources of Russian crude.

According to Argus FSUE, quoting local traders, Ukrtatnafta was able to purchase nearly 170,000 tons of Ukrainian crude for December at about $103 per barrel. This is similar to volumes that were domestically purchased for November. Drogobych and Nadvonyansk together had been averaging about 140,000 tons a month (see chart), so the increased presence of Ukrtatnafta in the domestic market–buying more than their combined delivery–has forced them out of production. Western Ukraine is facing an increase of 10-20 kopeks (2-4 cents) per liter of gasoline due to the halting of the two refineries, at least in the short term until boosted exports from Belarus enter the market.

Tatneft has also been relatively successful in pressuring other Russian suppliers from making a deal with Ukrtatnafta. According to industry sources, last month Privat-controlled companies approached Lukoil and TNK-BP about supplying the Drogobych refinery, but both Russian companies refused over worries that the deliveries would be re-routed to Kremenchuk. Ukrtatnafta was able to purchase two deliveries from Rosneft through the trader Gunvor, to be sent via tanker through Odessa. However, stormy Black Sea weather delayed the first (82,000 ton) shipment, which pushed back the loading of the second (80,000 ton) shipment, leading to the delivery of only 132,000 tons of Russian crude for the month of November.

The refinery had been hoping to process 300,000 tons a month (and is predicting 360,000 tons for December), and this extra 30,000 tons of Russian crude to that was delayed from the November shipment may be incorporated in the prediction for boosted production. A source with Tatneft said the supplemental Russian crude deliveries were purchased at around $105 per barrel, pricing Ukrtatnafta’s supplies higher than the average for Urals-blend, which closed at $90.55 / barrel at the end of November.

Privat also moved to increase its control over the trading division of Ukrtatnafta that supplies the Ukrainian regions of Poltava, Cherkasy and Sumy with the firm’s refined oil products. The Privat-controlled company Vato bought an additional 25% of the trading firm’s shares, mainly from the insurance company Oniks (of which Vato owns a quarter), boosting its holding to 89%.

This appears to be a solidification of Privat within the supply chain, from the oil port services firm Sintez at Odessa to the Kremenchuk factory to the sales division. Upon re-taking control over the refinery, one of Ovcharenko’s main complaints centered on the use of Tatneft-aligned intermediaries on either side of Kremenchuk’s operations unnecessarily bumping up prices and decreasing margins for the refinery while simultaneously lining the pockets of management figures. It looks like Privat is either looking to end this relationship — or reinforce it with entities of its own choosing.

Of course, this won’t do the firm any good if it can’t secure the delivery of Russian crude. Privat seems to be willing to let its other two refinery assets — which are less technically advanced than Kremenchuk — dwindle while flexing its presence within Ukraine’s domestic oil market (it controls Ukrnafta, as well) in order to support its plans for Ukrtatnafta.

Tatneft crude, meanwhile, has been rerouted through alternative export channels to compensate for the cessation of deliveries to Kremenchuk. However, given the heavier nature of the crude produced in Tatarstan versus other Russian sources, this has affected the makeup of some Russian crude oil exports. As a result, a denser mix of crude has been flowing through the southern leg of the major Druzhba oil pipeline and at Black Sea ports that serve as destinations for Russian crude (i.e. Novorossiysk and Pivdenne). This denser mix could potentially lessen the attractiveness for traders of Urals-blend from these sources, and is likely producing pressure from other Russian oil exporters for Tatneft to resume its standard export regime to Kremenchuk. The refinery is more suited to dealing with the heavy blend, and Ural export density would then return to its previous, more attractive, level.

While a shareholders meeting for Ukrtatnafta is scheduled for Dec. 17th, it is unlikely to be held due to the continued boycott of Tatarstan-allied owners (accounting for about 40%). Not only is this protracted dispute affecting the performance of both sides — as well as the oil market around Ukraine and Russian in general — it also is a continued example of a lack of respect for the rule of law and the “raiders” culture of strong-armed business tactics. While the incoming Ukrainian government has questioned the previous privatization of of Ukrtatnafta (lending credence to the Ovcharenko’s placement atop the firm), the circumstances upon which the current management rose to power and the inability between the sides to reach any form of civil agreement or business cooperation cry for the involvement of an impartial and lawful intervention by Ukrainian state forces for the development of a mutually acceptable settlement.

Gazprom and Ukraine reach deal on gas prices, while Tymoshenko objects

Ukraine and Gazprom have finally reached an agreement on the price of natural gas deliveries for next year, pegging $179.50 per thousand cubic meters (mcm) as the Ukraine / Russia border price, while bumping up transit rates 10 cents to $1.70 per mcm per 100 km. This rate not only covers the cost of transporting Gazprom’s gas through Ukraine for export in Europe, but also the cost of gas transiting through Russia for delivery to the Ukrainian market.

Volumes of the deal, however, were not enumerated — either the sides refused to disclose them, or the exact amount of gas had not been agreed upon (almost certainly the latter). As a result, there is currently no way of knowing how much Russia is actually charging for its gas, as the final number is only a representation of the price of the gas “cocktail” consisting of cheaper Central Asian supplies and more expensive Russian gas.

After meeting with President Yushchenko to receive last-minute instructions on Monday, Ukraine’s Fuel and Energy Minister Yuri Boiko flew to Moscow on Tuesday for the latest round of negotiations with Gazprom head Alexei Miller. The agreement apparently took over 5 hours to pound out. From Kommersant:

A Ukrainian source says that negotiations between Gazprom head Alexey Miller and Ukrainian Minister of Fuel and Energy Yury Boiko [began] yesterday morning with Gazprom proposing $180 per 1000 cu. m. and without changing the price of transit. The Ukrainian side countered with a proposal to raise the price of transit from $1.60 to $1.70 per 1000 cu. m. per 100 km. and lower [the mcm] price [by] $1-3. Negotiations lasted five hours. The minister was ready to leave when Gazprom offered a raise of $0.10 in the transit price. That concession led to a concession of $0.50 on the price of gas and an agreement.

According to an analyst from Brokercreditsevice, the raise in price is expected to cost Ukraine an additional $2.71 billion, with the boost in transit fees bringing in another $2.65 billion

While the deal is set to be concluded by UkrGaz-Energo today, the necessary documents were signed yesterday by RosUkrEnergo (RUE), the entity left in charge (as expected) of coordinating the trade. There had been rumblings of finally cutting out the maligned middleman, particularly due to the expected rise of Yulia Tymoshenko to Ukraine’s premiership. Indeed, she has panned the deal saying the price is too high, and is already calling for new negotiations with Russia.

BYuT representative Sergei Terekhin explained that the soon-to-be-formed government is looking at invoking provisions of the Energy Charter as leverage in forcing negotiations and a lower price. Specifically, he says conditions within the charter provide for Ukraine buying Gazprom’s gas set to be exported to Europe at the Ukraine / Russia border and re-exporting it via Naftogaz, cutting out Gazprom from its European customers. From the profit made on this export, “we can subsidize our own industry, and the population will have a cheaper price of gas.”

He also suggested a compromise could be reached where Naftogaz takes over for RUE in the role of coordinating gas shipments from Central Asia through Russia. A source in Gazprom told Kommersant that this was unrealistic, especially since Russia hasn’t signed the Energy Charter, and it’s conditions apply to inter-European gas trade. He also said that the only way for Ukraine to get a cheaper price on gas would be to cede control of part of its high-pressure gas transportation network, through which about 3/4 of Russia’s gas exports to Europe pass.

Tymoshenko complained about Gazprom backing away from a previously “agreed” upon price of $160 per mcm, but this was discussed before the exact price of Turkmen gas was settled. Turkmenistan and Gazprom recently reached an agreement bumping up the price of Turkmen gas from $100 per mcm to $130 for the first half of 2008 and $150 for the second half. Uzbek and Kazakh prices will likely follow similar increases as those countries renegotiate their deals. Assuming an average price of $140 per mcm for Central Asian gas, plus about a $30 transit fee for transport to Ukraine, this leaves only a $9.50 margin for the middleman, even before factoring in the cost of more-expensive Russian gas.

This past year’s contract called for 55 bcm for Ukraine from Central Asia at $130 per mcm . That gas is bought at the Central Asian border with Russia by Gazpromexport, who then resells it to the intermediary RosUkrEnergo, who pays transit fees through Gazprom’s pipeline system to the Russia / Ukraine border, where the gas is then sold to Naftogaz. The previous pricing system, however, already left a very small margin for the middleman. From the in-depth Oxford Institute for Energy Studies report “Ukraine’s Gas Sector:”

Assuming that Turkmen gas costs $100/mcm at the Turkmen border [the publicized price], that Uzbek and Kazakh gas may cost more than that, and transit costs from central Asia are about $30 / mcm , industry analysts had some difficulty seeing where RosUkrEnergo would earn its margin.

RUE likely received some sort of external benefit for the deal, possibly its partnership with Naftogaz in the recently-created joint venture UkrGazEnergo, which is tasked to supply gas to most industrial customers in Ukraine. These consumers have a much higher payment rate and tariff level, making it a more lucrative sector than public utilities and residences, which are left to Naftogaz itself.

Of course, there is also a very real possibility that $130 is simply the publicly acknowledged price, and that in reality, Ukraine has been paying RUE more, possibly even as high as around $180 already. Due to the complexity of the market and opacity of the negotiations, however, this figure is hard to peg down concretely.

This small margin may also be the reason RUE only reported profits of under $70 million for the first quarter of 2007 (the latest results available), whereas the company had made around $800 million the year before. However, this may be a bit misleading given the cyclical and variable nature of finances within the industry, given the extreme seasonal shifts in demand.

According to Gazprom’s 2007 quarterly reports (RUE hasn’t published anything for the current year while Naftogaz still hasn’t published its 2006 report), Gazprom sold RUE 16 bcm of gas in the first quarter, 11.93 bcm in the second quarter and 10.95 bcm for the third quarter, totalling 38.88 bcm. In the fourth quarter of 2006, Gazprom sold RUE 11.34 bcm and due to similar weather patterns, it could probably be assumed that this year’s fourth quarter sales will be a near-equivalent volume. Sources in Gazprom and Naftogaz confirmed that Ukraine had bought less than 50 bcm of gas for the past year, despite the contract signed at the end of 2006 calling for volumes of 55 bcm from Central Asia. RUE may attempt to buy out the rest remaining 5 bcm provided buy the contract at the current cheap price, and store it for use next year. At $650 million, however, this may be too much for capital for the firm to muster, as it has already allegedly been facing credit problems.

Ukraine reported consuming about 65 bcm of gas for the year. Adding the 50 bcm of imported gas to the around 18 bcm of domestic production that Ukraine has lately been averaging, that leaves 3 bcm for re-export into Europe (or storage for later). Since gas sold in Europe is on average 6 times more expensive than gas sold in Ukraine (and 11 times more expensive than average Ukrainian residential gas prices), this re-export is a key profit producer for Ukraine.

Turkmenistan outlined ambitious production figures for the future, pledging to somehow quadruple its gas output by 2030 to 250 bcm. Last year, the country produced about 62 bcm, the vast majority of which was sent to Ukraine via Gazprom and RUE. Gazprom has essentially secured Turkmenistan’s entire gas output via contract, but look for Ukraine to attempt to elbow itself back into direct negotiations for Turkmen gas, especially with Tymoshenko now poised to come to power.

Much more later…

Ukraine’s new government outlines hydrocarbon license examination plans

In one of the earliest ministerial-level strategies to be unveiled, Ukraine’s newly-formed coalition between the Bloc of Yulia Tymoshenko (BYuT) and the Our Ukraine – People’s Self-Defense (NU-NS) parties outlined its plans for the country’s oil and gas sphere.

Besides preparing to take oil transport monopoly Ukrtransnafta public, the government hopes to sign a long-term contract for gas purchase from Central Asia. Currently, Ukraine’s national energy firm Naftogaz no longer buys gas directly from Central Asian countries, instead relying on the gas intermediary RosUkrEnergo. This maligned trader coordinates the purchase of the gas and its transport through Russia, as well as its resale to Ukraine. Breaking back into direct negotiations with Central Asia (despite relying on the region for about 3/4 of its gas imports, Ukraine lost this position a few years ago) may help Naftogaz in its own talks with Gazprom on Russian gas supplies.

Also discussed in the strategy (which I’m attempting to obtain a complete copy of) are plans to re-examine the results of oil and gas producers to determine if they are adhering to their license agreements, specifically in regards to their upstream investment plans. Those firms that are not pumping in an adequate amount of investment or producing the necessary volumes will be stripped of their license, which will be then be given to other companies who promise closer adherence with the government regulations.

BYuT deputy Mikhail Volynets, who previously suggested a re-examination of Regal’s licenses, is quoted as suggesting that these moves are expected to boost production 5-7% by 2009. From Korrespondent (my translation):

“We can’t increase the volume of production of oil and gas in the country when companies holding the production licenses don’t invest enough in deposits [fields]. The majority of them received licenses for further resale. We plan to return to the government the licenses and transfer them to companies which will fulfill the investment conditions and conduct the extraction of oil and gas.”

One analyst suggests that this will bring about a similar situation to Russia in 2004, when a crackdown via stricter government enforcement resulted in a consolidation (and contraction) of operating oil and gas producers in Russia from about 300 to around 40. Large firms were able to scoop up the licenses for the fields operated by under-resourced smaller companies unable to follow the clauses of the licenses — or unable to pay the necessary bribes.

Ukrainian license holders, however, have apparently threatened to protest any such action with law suits, with one directer of a smaller producer warning that this plan will result in the survival of companies only with “political influence and financial resources.” While ideally, the producers would be financially successful enough to have the necessary financial means, the director may also be referring to money for extra-legal protection from a loss of license. There are also questions of the legality of this plan, which is based on how explicit the investment conditions were stipulated and how confidently their fulfillment can be estimated.

The outgoing government has already made it difficult for many oil and gas producers, forcing them to sell their output to a pre-ordained buyer for a capped price. While these are attempts to keep domestic energy prices low, it has also resulted in decreased capital available for investment, leading to this current attempt at essentially government-mandated investment. However, the plan doesn’t seem nearly as viable as commercially regulated investment, i.e. firms injecting money into their projects because they expect it to earn them more in the future. A combination of tightened finances and an unclear political / economic horizon has instead led many firms to concentrate on the short term.

BYuT representative Volynets (second from bottom) has an extensive background in the coal industry and is an accomplished labor rights organizer — a feat, considering some of the conditions present in Eastern Ukraine. Given his high level on the party list and these recent comments, it would seem that he may be a favorite to succeed Yuri Boyko as Minister of Fuel and Energy when the new Cabinet of Ministers is sworn in. However, he may also be a candidate for the Ministry of Labor and Social Policy, leaving the door open for someone else from the ruling coalition — so long, of course, as the two parties can cooperate enough to actually form a functioning government…

Russneft FAS ruling delayed a week, while decision by tax courts will come in “early 2008″

Despite the expectation that by November 30th, Russia’s Federal Anti-monopoly Service (FAS) would rule on the applications of Oleg Deripaska’s Basic Element and Swiss-based trading firm Glencore to buy the assets of Russneft, the agency decided to postpone the decision until the next week. Citing a change in methodology which adjusted the time-frame alloted for such applications, this delay also gave the FAS a chance to observe the results of this weekend’s parliamentary election in Russia before making a ruling.

It also would have given the FAS a chance to see how a Moscow arbitration court ruled claims from the Federal Tax Service (FNS) on the seizure of Russneft stock due to tax arrears, but the court also decided to delay a decision. One case is postponed to February 6th with another pushed back to January 23rd. The muddled affair involves numerous defendants associated with various Russneft subsidiaries.

The State Property Management Agency is also involved in order to ensure that the agency will be properly represented in the resolution. However, the property agency’s representative failed to show up for a meeting on December 2nd, leading to the court’s decision to postpone a ruling. Instead, the court is pushing the parties involved to come to a peaceful settlement in these interim two months, though this was presumably already tried in early stages of the case.

The court may be hoping that the FAS’ decision on the sale of the shares along with the country’s “new” political situation following the elections will facilitate a settlement. Typically, the absence of a 3rd party representative has not been enough of a reason for such a delay, suggesting that this is the desire of influential forces.

Ukrtatnafta apparently secures future crude deliveries, predicting upped production at Kremenchuk

According to an Ukrtatnafta press release, the oil products company is predicting a 20% increase in production at the Kremenchuk refinery for December, bringing the monthly total to 360,000 tons. However, this is still below the plant’s typical monthly average of between 500,000 and 600,000 tons, before the current “management dispute” led to a cessation of crude supplies from Tatneft.

The company’s plan has several refining assets that had been shut-down brought back on-line to account for the increased production figures.

Given the company’s confidence in its ability to boost the production rate, it would suggest that Ukrtatnafta has succeeded in securing future crude supplies, at least for this next month. It had been surviving at a limited production rate through deliveries of Russian crude via Odessa and supplies purchased on Ukraine’s domestic oil market.

These crude supplies are more expensive than what it had been getting from Tatneft via pipeline originating at the oil fields in Tatarstan. One Tatneft executive was quoted as saying that Ukrtatnafta was now paying about $105 per barrel but this may not be a reliable source, as Tatneft has an interest in making the affairs of Ukrtatnafta look as badly out of order as possible.

However, the plant’s output of refined products does reflect a higher base price. From Reuters:

Analysts said also on Thursday that prices for Kremenchug’s refined products had also risen — $1,095 for a tonne of diesel from $1,059, 92 octane petrol rose to $1,139 per tonne from $1,109 and “super” 95 octane rose to $1,168 from $1,129.

Kremenchuk (Kremenchug is the transliteration in Russian) produces around a third of Ukraine’s refined oil products and represents a vital economic asset as well. Bringing the production figures back up to pre-disruption numbers may also help slow rising gasoline prices in Ukraine, which have now hit the psychological mark of $1 / liter. However, the driving factor for gasoline’s price increase has been spiking prices in the world oil market, rather than problems at Kremenchuk–Ukraine still has one of the cheapest rates for gasoline in Europe.