Privat making moves in Ukraine’s oil sphere

Note: I started writing this on Monday but my computer crashed on Tuesday and I have been struggling to get it working again since then. I’ll follow up this post with one covering the further developments (including the reappearance of some figures from the past — Igor Makarov and Itera along with scandal-ridden Igor Bakai) in the on-going gas negotiations.

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Much attention is still focused on Ukraine’s evolving “gas war” with Gazprom (Igor Didenko walked out of negotiations over Naftogaz’s debt to UkrGazEnergo, though follow-up meetings showed progress; Yulia Tymoshenko reiterated her pledge to remove middlemen even as her counter-point Raisa Bohatyryovna is in Moscow to pass along Yushchenko’s promise of stability; gangster Semyon Mogilevich’s arrest fueled speculation on imminent shakeups, while Dimitry Firtash once again denied any connection between the two within the gas sphere), despite calls by Naftogaz to de-politicize the ongoing and oft-contentious negotiations.

Honoring Naftogaz’s request (kind of), I’ll turn to some recent developments in Ukraine’s oil sphere.

Privat in Ukraine's oil sphereLate December 2007, Igor Kolomoisky, one of the major owners of the Privat Group, bought a 12.6% stake in British firm JKX Oil & Gas. The deal, valued at over $150 million based on stock price, makes Kolomoisky the second largest shareholder in the company behind only Alexander Zhukov. JKX’s presence in Ukraine is an 80% holding in the country’s largest private oil producer Poltava Petroleum Company (PPC). With production levels of about 800 tons of oil and 1 million cubic meters of natural gas per day, PPC trails only Ukrnafta (50%+1 owned by Naftogaz, 42% owned by Privat) in output for Ukraine.

Following the sale, Kolomoisky’s Privat partner Gennadiy Bogolyubov announced the possibility that the powerful financial group would divest from its 42% holding in Ukrnafta. Besides facing a 25% increase in oil extraction rental rates that severely limits profitability, firms with significant state ownership are also obliged to sell natural gas production to Naftogaz at the fixed rate of $53 per thousand cubic meters–well below market value. This provision, Decree 31 from the previous Yanukovich-led government, already forced out independent producer Cardinal Resources and appears to be pushing Privat into the private sector.

However, some analysts consider Privat’s statements on selling out of Ukrnafta as only a threat, as the group attempts to wrangle a better tax situation within the hydrocarbon sector from a government seen to be sympathetic to Kolomoisky. Indeed, Naftogaz today announced the possibility of raising the price for domestic (non-industrial) consumers at the end of the current heating season, recognizing the detrimental effect the depressed rate has on Ukrainian gas production sphere (which is tasked to supply the regulated market). It is unclear if these moves are related, but reform of the tax and fee structure surrounding Ukrainian hydrocarbon extraction is a key step in boosting domestic production figures, insuring adequate upkeep and attracting foreign investment.

Naftogaz and Privat are also apparently sparring over Ukrnafta’s profit allocations for 2006, with the government calling for 50% of the $480 million net profit to be distributed as dividends. The minority shareholders (including Privat), on the other hand, felt that number was too high and that more should be re-invested into production capabilities. The shareholders were set to vote on the issue in May 2007, but it was tabled until a shareholders meeting last week. However, neither Privat nor state representatives attended the meeting, leading to the absence of a quorum. The new leadership of Naftogaz apparently has to reach an agreement (.doc) on the fate of the profits, and the issue has been pushed back to a later (undetermined) meeting.

Meanwhile, Privat is making moves concerning its refineries, as well. Given Kremenchuk’s supply issues, the two smaller Privat-controlled refineries in Western Ukraine (Galichina and Neftekhimik Prikarpatia) have been forced to shut down production and undergo modernization repairs. Recently, however, the management of the refineries sent a letter to the government asking about the possibility of reversing the Odessa-Brody pipeline and sending Caspian crude north. Some would then be exported into Europe while the two refineries committed to processing 5 million tons per year. Responding to the letter, Fuel and Energy Minister Yuri Prodan instructed Ukrtransnafta to study the possibility of reversing the flow and including the two refineries in planned shipments.

Refining Caspian crude, which is a higher quality than Ukrainian or Russian varieties, would prevent Privat from having to invest in long-delayed upgrades to the Galichina and Neftekhimik Prikarpatia refineries. Newly-enacted government regulations on the quality of diesel fuel for Ukraine would have likely forced the refineries to close for repairs anyway, regardless of the availability of supply. Tapping into Caspian crude, however, would allow them to reopen without the costly improvements.

Ukraine’s President Yushchenko met with his Azeri counterpart Ilham Aliyev in Davos last week to discuss energy issues. A couple days later in a meeting with Prodan, Azerbaijan’s ambassador to Ukraine said they are willing to provide 5 million tons of Azeri crude per year should the pipeline reverse direction. However, there was talk of sending the crude (via the Druzhba pipeline) to a Czech refinery, or even building a new Azeri-sponsored plant within Ukraine.

TNK-BP has been coordinating the shipment of Russian crude southward through the line and managed to increase volumes in 2007 by 160% to 9 million tons for the year. Much of this increase was due to an agreement between Russia’s pipeline operator Transneft and Ukraine’s Ukrtransnafta to lower tariffs on Russian crude so long as the total volume exceeded 9 million tons for the year. However, this provision expired on December 31st and Transneft promptly increased tariff levels by 38 percent. While TNK-BP is working on reaching a similar deal, in all likelihood this year’s volumes will be down significantly due to the less attractive economic situation.

This should open the door for Ukraine to push through its reversal plans, presuming it can get all the players on board. The 5 million tons requested by the Privat-controlled refineries is considered to be overly ambitious for their production capabilities, and was likely meant to try to dissuade the construction of a new refinery (leading to more domestic competition) to handle the crude. While Prodan asked Ukrtansnafta to examine the scenario, it is unclear how strongly he would lobby for Privat’s interests. Privat, while perhaps not playing a central role through its refineries, would be key due to its strong position at the Odessa oil port. Of course, this is even assuming that the government decides (and manages to) actually reverse the pipeline.

Privat and Ukrtatnafta In the meantime, despite the closing of its two Western Ukraine refineries, Privat maintains a strong position within Ukraine’s refined products sphere due to its alleged control over Ukrtatnafta and the Kremenchuk refinery. Indeed, the halting of production at Galichina and Neftekhimik Prikarpatia–predicted due to the change in fuel regulations–has been suggested as an impetus for Privat to take control of Kremenchug, thus ensuring a market for its domestically produced crude (via Ukrnafta) and a continued presence in the refined products sphere. While Pavel Ovcharenko ascended to the top of the company pledging to remove shadowy middlemen from Ukrtatnafta’s supply chain and resurrect the firm’s financial status, nearly all of the refinery’s products are apparently sold via Privat-controlled Optima Oil or even Ukrnafta itself.

Ukraine’s vice prime minister Alexander Turchinov has stated that the Cabinet of Ministers will work to resolve the issue for the benefit of all parties (though he is also quoted as saying “for the benefit of Tatneft”), which is at least a welcome change from the silence the conflict had been generating from the government before. There is no word on exactly how this will happen, and Tatneft and Naftogaz (the two major shareholders fighting for control, despite Privat apparently pulling the strings) didn’t respond to my requests for a comment. However, Ukrtatnafta is apparently on a list of firms drawn up by PM Yulia Tymoshenko’s office for privatization (working on confirming this), and the government may attempt to structure any future sale in a manner that would create some form of resolution.

Even as Turchinov stressed the possibility of ending the conflict, though, Yuri Prodan ensured that an underlying source of tension–also involving Privat–will continue. The Privat-controlled financial company Ukrneftegaz is in charge of managing the shareholder registers for energy firms that have significant Ukrainian state ownership–including Ukrtatnafta. Tatneft accused Ukrneftegaz of manipulating the list for Ukraine’s benefit, leading to the eventual management dispute. Ukrneftegaz has also been accused of lobbying for the interests of Privat in energy deals and using its powers to dictate shareholder meetings. Prodan recently defended Ukrneftegaz’s performance, and said the state plans on continuing to use the financial company’s services.

Given these examples, it is clear that Privat–that is, Kolomoisky and Bogolyubov–are major players in Ukraine’s energy sphere, particularly within the oil market. While the rise to power of Industrial Union of Donbass-connected officials within Yulia Tymoshenko’s government may somewhat temper this involvement (IUD is a rival business conglomerate from Donetsk), Privat is still seen to be close to various factions within the ruling coalition. While Privat recently failed at its attempt to block Rinat Akhmetov’s deal with Dneproenergo, most observers are expecting the business group to use its political connections to launch another attempt at halting the transaction and increasing its presence within Ukraine’s energy market.

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