Gazprom-Ukraine gas deal fallout leads to renewed pessimism from Ukrainian critics

While Naftogaz pushed back negotiations to this week amidst growing controversy over the dealDespite the transfer of $105 million on Thursday as the first step in paying off Ukraine’s $1 billion (at least) debt, talks between Gazprom and Naftogaz stalled and have been pushed back to this week over disagreements on the exact terms of the new deal. A draft agreement between the two firms obtained by Kommersant created a stir among Ukrainian observers over worries that little is being done to change the underlying problems and too much is being sacrificed to the Russian side.

Meanwhile, sensing discontent and potential stalling, Gazprom has set two new deadlines for the fulfillment of the major terms enumerated by last Tuesday’s Putin-Yushchenko agreementMarch 14th to pay off Ukraine’s entire debt and April 1st to sign an agreement on the new structure for the gas scheme set to replace RosUkrEnergo and Ukrgazenergo.

Gazprom is pushing for quick action on the Putin-Yushchenko gas agreement - From gazprom.comWhile the original Ukrainian response to Yushchenko’s deal with Putin that removed RosUkrEnergo and its cousin Ukrgazenergo from the gas supply scheme was enthusiastic–this had been a goal of PM Yulia Tymoshenko for years–emerging details of the plan have led to growing discontent and further questions about Yushchenko’s motivations in the gas sphere and the cost to Ukraine this new deal will create.

The arguments of the critics have varying levels of importance, but in general show that Ukraine has certainly failed to solve this enduringly thorny issue:

  • The new agreement does not remove the intermediaries, but only replaces them. Indeed, the working name for the new Gazprom-Naftogaz entity to replace RosUkrEnergo is RosUkrGaz AG, another Swiss-registered company. Hopefully, its new address won’t be 12 Loewelstrasse, Vienna — the same building as Centragas, Dimitry Firtash’s firm that controls half of RUE. (As documented by Global Witness, major ownership figures for EuralTransGas and its “successor” RUE shared this same building, leading to undeniable connection claims.)
  • The new joint venture will give Gazprom 50% access to Ukraine’s internal market, including sales of domestically produced gas. The 50/50 Gazprom-Naftogaz company set to replace Ukrgazenergo (if it is even replaced–the current proposal has Gazprom buying out RUE’s 50% share and keeping the structure in place) will be broadened to include sales of gas produced in Ukraine. Previously, these sales–relatively unprofitable as they were, due to government-imposed price caps–had been controlled solely by Naftogaz. A bigger deal, however, is the increased direct access to Ukrainian consumers for Gazprom, from under 25% (based on 25% control of Ukrgazenergo, which supplied most–but not all–of the market) to 50%.
  • Naftogaz’s share in this internal market remains the same–50%–while Ukraine only succeeded in replacing RUE’s share in the importing scheme. According to sources within RUE quoted by Kommersant, the intermediary was facing increasingly small margins in its Central Asia-Ukraine gas scheme, and was expecting to actually lose $20 million from this part of operations in 2008 due to increased costs for Kazakh gas.
  • RosUkrEnergo will continue to exist and exclusively hold the right to re-export volumes of Central Asian gas to Eastern Europe. The re-export of gas to the Eastern European market allowed RUE to make its profits–last year’s margins were about $170 per thousand cubic meter (mcm) in Europe versus $2 per mcm in Ukraine. RUE is apparently going to be allowed to export between 3-8 billion cubic meters of gas per year for at least the next two years, with profits expected to be between $500 million and $1.3 billion according to a Renaissance Capital analyst. Naftogaz, on the other hand, will only be able to sell the imported gas internally in the same ratios and ownership percentages (and limitations) as before. As with the Ukrgazenergo deal, once again Naftogaz will be stuck with the unprofitable side of the gas scheme.

Indeed, it appears that RosUkrEnergo is itself indebted to Gazprom by about $2.4 billion, and Gazprom is counting on RUE being able to re-export 7 bcm this year to cover that debt, which consists of the following:

  • About $1 billion in debts to Gazprom Export (the entity that sells the Central Asian gas to RUE) in the form of $350 million in overdue arrears and $600 million from the reclassification of Central Asian gas within Ukrainian storage facilities presumably stemming from last October’s gas debt deal.
  • Over $550 million from restructured debts for gas delivered to Ukraine between August and November 2006.
  • Nearly $380 million for 1.2 bcm of Russian gas delivered in January of this year at the cost of $314.60 per mcm.
  • $450 million in credit granted to RUE by Gazprom.
  • $53 million to ZMB GmbH, Gazprom’s German subsidiary.

Ukrainian Vice PM Alexander Turchinov on Friday pushed to award Naftogaz re-export rights in the place of RUE, and this appears to be one of the major sticking points in reaching the new gas scheme agreement. In addition to the re-export clause, he suggests that the deal should be in the form of an inter-governmental agreement (which could be signed during Yulia Tymoshenko’s visit to Moscow on Feb. 21st, assuming she recovers from her current illness) as opposed to a contract signed between Gazprom and Naftogaz.

Negotiations are set to continue this week between Valery Golubev and Igor Didenko, deputy heads for Gazprom and Naftogaz, respectively. As the draft agreement stands now, Naftogaz and the Ukrainian government stand little chance of resolving many of the issues that face the country’s gas scheme. Pushing for gas re-export rights would be a key step in boosting Naftogaz’s financial durability, but this promises to be a difficult proposition due to Gazprom’s interest in seeing RUE repay its own significant debts.

Addendum: Yushchenko, fresh off his deal with Putin in Moscow, is apparently frustrated with Tymoshenko’s attempts at involving herself within the gas scheme and is now looking into transferring control of Naftogaz from the Cabinet of Ministers (controlled by the Prime Minister) to the Presidential Secretariat. Some have suggested that his reticence to push for a substantial shakeup of the gas sphere stems from alleged involvement of his brother or other family members in highly-placed companies connected to the gas industry.  Yushchenko has himself suggests that Tymoshenko’s agitation has fueled discontent between Gazprom and Ukraine leading to renewed conflicts, whereas his only goal is to reach the lowest possible price and continued supplies for Ukrainian consumers.  However, in his desire to reach these ends, Yushchenko may very well be contributing to a system that deserves a more thorough overhaul–despite potential shock to the related markets.

Note: I bought a new computer, hopefully ending my string of technical difficulties that limited my posting schedule. I’m hoping to write something soon on Gazprom’s recently-released financial report for the first 9 months of 2007.

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