Firtash Arrested in Austria

Dmitro (Dmitry) Firtash was arrested in Vienna today on an FBI warrant for organized crime stemming from a 2006 investigation.

Readers of this blog (from five years ago, at least) are well aware of his role in Ukraine’s energy sphere.

He is most well-known perhaps for being the central Ukrainian behind RosUkrEnergo, a gas middleman from back in the day.  Before being outed as the Ukrainian businessman behind the venture, he was notoriously camera shy.  Since then, he has worked to burnish his image (though the creepy corporate shot above is a bit weird) and expand his Group DF assets.

Some reports link Firtash with infamous gangster Semion Mogilevich, though he has disputed this connection.  When Mogilevich was surprisingly arrested in Moscow in 2008, some thought that it might resonate down to Firtash and others.  However, Mogilevich was released on bail, despite being listed as one of the FBI’s top 10 most wanted, and Firtash continued to grow his business.

He and Tymoshenko have a long-standing feud. As she emerges more powerful in the latest round of Ukrainian leadership, it could be expected that he may suffer as a result, especially given Ukrainian politicians’ propensity for retribution. His arrest is also being viewed as a means of putting pressure on Russia, sending a message to oligarchs with ties to the country that they could be targeted as part of the Washington’s frustration with Putin’s moves in Crimea.

I haven’t written here in a long time (clearly), but upon seeing the big news, I decided to take a break from finals studying and post something.  Maybe I’ll follow up with more later.  Follow me on twitter if you want: @hansstege

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Gas war reignites in a big way

A couple friends have mentioned my lack of blogging, and its absence is particularly notable now during the latest iteration of the Ukraine-Russia gas spat.

I’ve been working on the conflict at work (which has kept me busy, and away from this blog) and following it quite closely.  However, at this point I don’t feel I can put the time and effort into a post that the current situation would deserve.  Hopefully I’ll be able to do a “postmortem” roundup, though that of course has to wait until it’s actually more-or-less resolved.

I say more-or-less because there’s no way that any agreement reached in the next weeks (and it could stretch that long to get something relatively concrete) will solve the underlying issues, just as none of the past contracts since the breakup of the Soviet Union have.

Here’s the deal though.

Gazprom has announced that they will be buying Central Asian gas at essentially netback European prices, as opposed to the rock-bottom prices that they’ve gotten historically.  (Whether or not they actually are paying what they say they are is another matter though.)  Europe obviously pays European prices.  The only cogs in the system that don’t pay “European” prices then, are Ukraine and Russia (internally) itself.

Russia was apparently willing to continue “subsidizing” Ukraine by passing along a set price for the year of $250 per mcm, so long as Ukraine froze transit fees, ceded more of the internal industrial market to its local marketing arm Gazprom Sales Ukraine (GSU), and opened up some strategic infrastructure within the country to ownership by Gazprom. Late in 2009 would bring more negotiations for the price in 2010, before moving to a formula indexed off of gasoil and heavy fuel oil prices in 2011.

Ukraine balked, and Yushchenko ordered Dubina home from negotiations in Moscow right before the deadline.  The two sides made good on their posturing, and have ground the gas flow westward to a halt.

Putin has grown angry, suggesting Ukraine move to the “market” rate of about $450 / mcm immediately.  Yushchenko came back with his own $201 figure.  Based on the lag time in gathering the average oil product prices incorporated in Gazprom’s sales contracts, gas prices would be pretty much reaching their peak around now (corresponding to the all-time oil price highs in July and August 2008).

So if Ukraine were using a formula to determine their prices, they’d be stuck with a figure roughly corresponding to Putin’s threats.  But that price is adjusted quarterly, and because of the rapid fall in oil prices at the end of 2008, it is guaranteed to go down by about $50 by the time it’s recalculated in April 2009 — that is, if Ukraine moved fully into this “European”-style arrangement, which doesn’t appear to be likely.  If they did however, and if oil product prices stayed at about the same levels they are at now partway into this year, by 3Q2009 the gas price would drop nearly $100 and by 4Q2009 it would even be below the $250 / mcm originally offered.

Gas pricing is a tough job because it lacks the market drivers and signals of other commodity exchanges.  It’s particularly obtuse when two monopolies are the buyer and seller.  Add in the political back-story behind each country and their historical relationship, and you have a rather complicated situation.

P.S.  Check out the coverage by LEvko, Taras, and Adrian for more regular news updates.  The Oil Drum also has been posting about it, as has the local press (once they came back from their New Year’s breaks).

Gas and Politics

So it seems that I have left Kyiv just as things are getting interesting.

My Fulbright scholarship ended this summer and I have moved to Washington DC to begin working in the energy consulting field. Events in Ukraine’s energy and political fields continue to draw my attention, though, and I hope to keep this blog updated—certainly more frequently than I have for the past month.

Perhaps the key issue in the energy sphere now is how the deepening political crisis will affect the ongoing talks between Naftogaz and Gazprom concerning the price of imported natural gas for Ukraine. Last year’s negotiations happened between the transition of the Party of Regions-led Rada and the tenuous Democratic Coalition (headlined by Tymoshenko at PM). PoR deputy Yuri Boyko negotiated the deal in October 2007, but Tymoshenko immediately voiced objections and began pulling strings to put her own stamp on the agreement. That led to rounds of protracted and contentious negotiations that lasted well into 2008 before a key deal was signed in mid-March. Until then, in an unstable and imperfect arrangement, gas was being supplied to Ukraine without a contract.

Negotiations for next year’s contract began months ago, tied in with Tymoshenko’s goal for a long-term deal with Gazprom. While a multi-year contract is unlikely at this point, progress is continuing on next year’s deal. This big question is the price charged to Ukraine, guaranteed to rise from the current $179.50 per thousand cubic meters (mcm). Predictions run from $250-450, and they tend to be connected to various “concessions” granted to Russia, running from the status of the Russian Black Sea Fleet in Crimea to maneuvers for Ukraine’s 2009/10 presidential elections.

The fracturing political landscape affects the mandates of the various actors involved. As I mentioned, last year’s deal was principally negotiated by Boyko, who was then the Minister of Fuel and Energy. This year’s negotiations have mainly been conducted by Oleg Dubina, the head of Naftogaz, a position beneath the ministerial level. Both positions, though, ultimately report to the Prime Minister, Tymoshenko.

She herself has gotten involved in the negotiations, and one of the issues raised is how she accepts directives passed on to her from the president. Yushchenko has traditionally given the Ukrainian negotiators instructions for their meetings with the Russian side, but as he and Tymoshenko continue their drift apart, it seems more and more unlikely that the two will be able to cooperate. They had already bickered about this issue last winter, with Tymoshenko proudly proclaiming that she had talked with the Russian delegation “without directives,” only to be confronted with the list of instructions passed to her from the President after it was posted on the Presidential Secretariat’s website.

Yushchenko himself is not a good negotiator for natural gas deals. His former nickname within Gazprom upper management was reportedly “The Artist” because of his finicky and aloof manner. During meetings following the Orange Revolution he gave no indication of understanding the complexities of the gas business, and did not appear to be too invested in the outcome.

Since then, Yushchenko has taken the task more seriously for a variety of reasons.

• He witnessed the effect of unpopular deals after outrage at the 2005 agreement helped contribute to the split of the Orange Coalition.
• He recognizes the boost in popularity gas deals can bring to the figures involved, and seeks to capitalize it—or at least prevent Tymoshenko from solely benefiting from it.
• He resists ceding any more authority to the Prime Minister, using his directives to emphasize the political pecking order he is trying to maintain.
• He respects the economic impact of gas deals and, drawing on his background as a successful economist, positions himself as more in touch with the realities of the financial ramifications. (This economic experience is generally contrasted with Tymoshenko’s aggressive social spending plans.)

The two sides have both asserted that they will be able to present a unified front in the ongoing negotiations, and keeping the talks at company-level (i.e., between Dubina of Naftogaz and Alexei Miller of Gazprom, rather than Tymoshenko and Putin or even Yushchenko and Medvedev) should theoretically help keep the political fallout at arms length.

In reality, there is no way to completely divorce the maneuvering of Ukraine’s politicians with the natural gas negotiations, and every twist and turn will be used as “proof” of Tymoshenko’s alleged deal with Putin or Yushchenko’s rumored affinity to RosUkrEnergo. Politics has been deeply intermingled in Ukraine’s natural gas relations with Russia and Central Asia since the breakup of the Soviet Union, and it is unlikely to cease being so at this point.

As a footnote, I expect the price to be between $300 and $350 per mcm, though this is of course speculation at this point. A lot depends on how the costs are derived, as I explained in an earlier post.

—

Also worth mentioning is that Ukraine’s main stock market, the PFTS, has declined over 60% since January 1st, 2008, making it the worst performing stock market in the world. The PFTS performed extremely well last year, perhaps leading traders to feel that it was over valued at the start of 2008. Unhealthily high inflation, poor regional financial performance, geopolitical worries exacerbated by the Georgian conflict, and the upswing in domestic political instability have all contributed to the decline.

Gazprom enters Ukraine’s gas market, but overall picture remains unclear

Late last month, Gazprom Sales Ukraine (Газпром сбыт Украина, or GSU) was granted a license by the National Energy Regulatory Commission (NKRE) to sell up to 7.5 billion cubic meters (bcm) of natural gas per year to Ukraine’s industrial consumers. The five-year license was a key part to the March agreement between Russia and Ukraine on the “development of relations within the gas sphere.”

The entry of Gazprom’s fully-owned subsidiary into Ukraine’s gas market was also meant to compensate for the exit of Ukrgazenergo, which previously dominated sales to the industrial sector with a yearly quota of 32 bcm. The removal of this gas trader–50% owned by the state-owned Naftogaz, 50% by RosUkrEnergo, which is itself 50/50 split between Gazprom and two Ukrainian businessmen–is supported by the Ukrainian government. Prime Minister Yulia Tymoshenko has been especially vocal in her opposition to such “middlemen,” seeking to completely liquidate Ukrgazenergo’s (and eventually RosUkrEnergo’s) presence in the Central Asia-Russia-Ukraine gas scheme.

Earlier this year, the NKRE slashed Ukrgazenergo’s quota to just over 5 bcm per year in an effort to drive the trader from the market and open room for Naftogaz’s on gas sales division, Gaz Ukrainy. An additional point in the bilateral gas sphere agreement saw Ukrgazenergo lose another of its key tasks, buying gas on the Russian-Ukrainian border from RosUkrEnergo. This transaction is also being taken over by Naftogaz.

However, the shift towards a greater Naftogaz presence has been far from graceful.

First there was confusion among consumers over whom to pay stemming from overlapping assertions and a muddled legal situation. A cement factory complained that “we in fact have two actual agreements with both companies [Gaz Ukrainy and Ukrgazenergo]. But the ODU [United (gas) Distribution Administration, controlled by Naftogaz] can shut the valve off at any moment.” Citing this reason, the factory decided to pay Gaz Ukrainy despite a fax from Ukrgazenergo asserting ownership over the gas that the plant was receiving.

Indeed, Naftogaz’s control over the gas distribution pipes allowed them to limit supplies to factories hesitating to sign on with Gaz Ukrainy. Such tactics prompted protests in front of Naftogaz’s office and warnings of catastrophic accidents resulting from the decreased gas pressure.

The majority of the protesting factories are set to sign on for supplies from GSU, and interest in working with Gazprom subsidiary–as versus Naftogaz–is reportedly high. About twenty companies sought contracts with GSU, according to a company source, more than the quota would allow for. The attraction apparently stems from a continuation of Ukrgazenergo’s policy of giving the consumers a 10-day payment window as opposed to Gaz Ukrainy’s 100% prepayment terms. Gaz Ukrainy is also reportedly charging a higher price than what the companies paid Ukrgazenergo.

Despite this reorganization, Ukrgazenergo cannot be counted out yet.

An April 18th ruling from the Kyiv district administrative court struck down the NKRE’s limitation of Ukrgazenergo’s sales quota. This decision re-opens the door for Ukrgazenergo, at least partially. “Essentially,” an industry participant told Kommersant, “three major players have emerged on the internal market instead of two.” While it has lost its direct purchases from RosUkrEnergo (essentially, its ability to import the gas), Ukrgazenergo allegedly has about 7 bcm of gas in underground storage that they can sell on the market.

Ukrgazenergo could also purchase gas from Naftogaz for resale to consumers, like GSU is doing now. The margin for sales by Naftogaz to GSU is set at $0.01 per thousand cubic meters (mcm) by the gas sphere agreement, making the price $179.51. It is unclear what the internal Naftogaz-Gaz Ukrainy margin is or how much Naftogaz will sell gas to other market participants such as Ukrgazenergo and smaller gas trading firms (typically with quotas of 1-2 bcm or less). Ukrgazenergo had apparently been charging about $185 before being removed as a middleman.

While the internal market has yet to be completely sorted out, a major obstacle in negotiations with Gazprom has apparently been passed–Tymoshenko announced in late April that Ukraine had (finally) fully paid off its debt for imported gas. This had been a tripping point for nailing down a longer-term agreement between Naftogaz and Gazprom, and hopefully signals the resolution of some of the company’s financial difficulties.

The announcement coincided with the visit to Kyiv by Russia’s PM Viktor Zubkov, his last such trip before he’s expected to be replaced by outgoing President Vladimir Putin. Energy topics were high on the list for discussion between the two Prime Ministers. Ten bilateral priorities were drawn up from the meeting, with the gas issue the second one mentioned (right below WTO cooperation):

The second priority concerns the fact that after regulating tactical gas problems we should turn to the establishment of strategic cooperation. And this second priority – signing strategic long-term agreements on natural gas supplies to Ukraine and transit of the Russian natural gas through the territory of Ukraine to the European countries. It would be better to sign this agreement for 10 and more years in order to see how much prospective and progressive our move toward each other is.

Oil issues also came up (abridged English version):

Ukraine in its turn agreed to work through the conflict surrounding the Kremenchug oil refinery and by the end of April form a working group with representatives from Ukraine’s Ministry of Fuel and Energy, the State Property Fund, Ministry of Justice and Russia’s Ministry of Industry and Energy and the Federal Property Agency “for the preparation of suggestions for the normalization of work at Ukrtatnafta.”

And by the first of July, Russia’s Ministry of Industry and Energy and Ukraine’s Ministry of Fuel and Energy will hold consultations in order to “better the competitive terms of transporting oil” for both transport to Europe as well as supply to Ukrainian refineries without levying VAT.

The two governments will also work on another long-term nuclear fuel deal, despite Ukraine’s plans to buy fuel for its nuclear plants from Westinghouse beginning in 2010 and the country’s aspirations to eventually develop its own supply.

Activity in Kyiv has picked up some since the Easter and May Day holidays, but Friday’s Victory Day celebration is just around the corner.  The extended vacation time has made getting responses and clarifications particularly different.  As people begin returning to work, I’ll keep trying to find out more, particularly in regards to the relatively productive visit of Zubkov and the next step for Ukrgazenergo.

Firtash and Privat resist Naftogaz’s encroachment on Ukrgazenergo as Gazprom prepares to enter Ukraine’s gas market

Protesters linked to Firtash and Privat rallied against Naftogaz’s attempts to replace Ukrgazenergo in Ukraine’s gas supply scheme.

Protesters connected to major factories in Ukraine that have been sparring with Naftogaz over gas deliveries rallied on Tuesday in front of the national energy company’s office. The picketers were protesting against reductions in gas supply to the industrial enterprises.

The gas cuts are a result of the factories’ unwillingness to sign new supply contracts after political pressure forced the gas trader Ukrgazenergo from Ukraine’s internal market.

Negotiations in Moscow between Naftogaz and Gazprom appear to have found a solution to placate the protesters, as the newly established Gazprom Sales Ukraine (GSU) will provide most of the factories in question with gas beginning in May.

Naftogaz dismissed the rally as a “political show,” and part of “unprecedented pressure from the side of interested business groups with the aim of complicating and delaying the negotiations currently underway in Moscow [between Naftogaz and Gazprom over a middle- to long-term gas supply agreement].”

Naftogaz’s statement further defined those “business groups” as Dimitry Firtash-controlled enterprises and the financial-industrial conglomerate Privat Group.

Firtash is a co-owner of Ukrgazenergo and the key Ukrainian figure in the country’s shady gas supply scheme. Ukraine’s Prime Minister Yulia Tymoshenko has long rallied against the role Firtash has played as a gas middleman between Central Asia, Russia, Ukraine and Europe. Her government has led a push to replace his presence with that of the state-owned Naftogaz.

Earlier this month, factories that are controlled by Firtash and that had been receiving gas from Ukrgazenergo–namely Rivneazot, Crimean Titan and Krimsky Soda–complained that Naftogaz was limiting their gas supplies. Naftogaz has asserted that Presidential and Cabinet of Ministers decrees have stripped Ukrgazenergo of its right to provide gas on Ukraine’s internal market. It has aggressively sought to transfer sales previously with Ukrgazenergo to its own gas marketing subsidiary, Gaz Ukrainy.

“Tymoshenko, give the criminals in Naftogaz a slap on the wrist!” The factories have refused to sign new contracts with Naftogaz once Ukrgazenergo was removed from the scheme.

These companies, however, refused to sign new contracts and instead have asserted that their agreements with Ukrgazenergo are still valid. They have warned that dropping gas pressure could lead to technical problems and even catastrophic accidents, particularly since many of the factories are chemical producers.

Naftogaz, via its spokesman Valentin Zemlyansky, asserted that gas supplies to these enterprises have remained above the technical minimum required to avert a disaster.

While it may be expected that Firtash would protest actions that limit the revenue to his companies, Privat’s inclusion in the dispute is slightly more surprising.

The Privat-controlled Galychna and Neftekhemik Prekarpatia oil refineries both suffered reduced gas supplies due to a failure to sign on with Naftogaz. Representatives of these companies were also allegedly present at the protests in front of Naftogaz’s offices, in addition to workers from Firtash-connected enterprises.

Privat and Naftogaz have a recent history of conflict within Ukraine’s energy sphere, as they are sparring over the fate of Ukrtatnafta and its Kremenchug oil refinery.

The two companies have also had a longer-running feud over Ukraine’s largest oil firm, Ukrnafta. Privat is a 42% shareholder, enough for a blocking stake despite Naftogaz’s 50% holding. The two sides have been unable to agree on the distribution of dividends, leading to a round of unsuccessful shareholders meetings and criticism from Tymoshenko.

Despite this history of conflict, Privat has generally been seen as an ally of Tymoshenko (though typically only when it serves the interests of the financial group). Privat has had its own problems with Ukrgazenergo, with the gas trader allegedly refusing to supply Privat-connected industries for a period of time last year.

Siding with Firtash in this latest dispute may be an attempt by Igor Kolomoisky, a key owner of Privat and the group’s most public face, to earn points with Firtash for future collaboration.

“Send the bandits in Naftogaz to jail!” Most protesters appeared to be from the Firtash-owned factory Rivneazot.

Kolomoisky suggested in a recent interview that he would be interested in buying out Firtash’s stake in RosUkrEnergo (RUE), a 50% owner of Ukrgazenergo and the key coordinator of Ukraine’s gas imports. Privat’s hold-out in signing contracts with Naftogaz may be an indication that it is expecting to do business in the future with Ukrgazenergo, despite the government’s intention to remove it completely.

Indeed, no word was given about the Privat-owned enterprises when Zemlyansky announced that negotiations on Tuesday in Moscow arranged to have GSU provide gas to the Firtash-connected companies.

While this arrangement may be a way for Firtash’s factories to avoid buying gas from Naftogaz, the situation hasn’t yet fully solidified. Neither Ostchem (Firtash’s holding company for chemical factories that includes the affected plants in Ukraine) nor Gazprom said they had any knowledge of the deal. A source in Gazprom told Kommersant that “the question of Dimitry Firtash was not raised during the negotiations.” Talk of Firtash is just “small change in negotiations between countries,” the source added.

Naftogaz’s spokesman asserted that the protestors had no legal justification and were instead looking only to make a scene.

The agreement (if it exists) may not even satisfy the protesters. “They haven’t given any concrete demands,” Zemlyansky told me. They are instead more interested in creating the image of dissent in an attempt to influence the continued restructuring of Ukraine’s gas sphere.

Those rallying in front of the office appeared to be actual factory workers (and essentially asserted as much, when I asked them) as opposed to the pensioners and students protesting the Dniproenergo conflict (which are typically hired for $10-20 day).

However, Wednesday’s steady rain and cool weather dispersed all but a few people sitting in tents pitched in front of the office. Zemlyansky said that he expects them to be completely cleared away by the end of the week at the latest.

A court case is currently in the works that aims to resolve any legal claims by the enterprises, as well as an anti-monopoly case lodged against Naftogaz’s increased presence within the gas market.

Meanwhile, the negotiations in Moscow have been pushed back to Wednesday as the two sides are struggling over additional (unknown) amendments to last month’s broad agreement and guarantees from Ukraine on the repayment of about $2 billion in debts for gas already delivered.

“Yulia, don’t let Rivne be destroyed!” Rain pushed out most of the protesters, though the tents still remain.

An early draft of the the amended agreement currently being negotiated allegedly included language that allowed Gazprom to unilaterally annul the new arrangement in the event of Ukraine’s failure to repay its obligations. The previous setup, featuring Ukrgazenergo, would then be put back into place.

I talked with Ukrgazenergo’s press secretary on Monday, but he didn’t want to comment on the situation yet, saying only that “things are still being figured out.” He did agree to talk after the “May holidays,” a two-week block of time between Orthodox Easter (April 27th) and (WWII) Victory Day (May 9th) when basically nothing gets done.

One development is likely during that time, however. If an agreement is reached in Moscow on Wednesday, the holidays’ centerpiece–International Day of Labor on May 1st–will see GSU enter Ukraine’s market officially.

Note: Zemlyansky confirmed that Ukrgazenergo’s April 1st shareholders’ meeting, which was held in Naftogaz’s office, didn’t reach a quorum due to the absence of RUE’s representatives. (RUE and Naftogaz are 50/50 shareholders in the gas trader.) He suggested that the spate of failures among energy company shareholders’ meetings (Ukrgazenergo, Dniproenergo, Kievenergo, Ukrnafta, Ukrtatnafta, etc.) is representative of today’s turbulent nature of Ukraine’s energy sphere. I would add that political turmoil is also playing a part.

Zemlyansky went on to call the situation surrounding Ukrtatnafta a “political issue,” saying that Naftogaz needed to wait for the politicians to sort out things before they could attend to the business side of things.

Waiting for politics to resolve itself, though, seems at times to be a never-ending endeavor here.

RosUkrEnergo to remain Ukraine’s gas supplier

RosUkrEnergo’s tagline belies its reliance on personal connections to function in the lucrative Central Asia-Russia-Ukraine-Europe gas scheme – From rosukrenergo.com

On Friday an official from Ukraine’s presidential secretariat announced that RosUkrEnergo (RUE) would be supplying Ukraine with gas for the remainder of the year.

The continuation of this arrangement comes as a blow to Prime Minister Yulia Tymoshenko’s hopes to completely remove the maligned middleman.

While she has praised the expulsion of RUE’s 50%-owned subsidiary UkrGazEnergo from Ukraine’s domestic gas market, its place will partly be filled by a new Gazprom subsidiary authorized to directly market gas to Ukrainian consumers.

In the meantime, Naftogaz (Ukraine’s state-owned oil and gas company) is aggressively seeking to make deals with Ukraine’s major industrial consumers, likely in an effort to stymie Gazprom’s commercial ambitions.

Naftogaz confirmed that it signed a contract with RosUkrEnergo to purchase 49.8 billion cubic meters (bcm) of gas at a price of $179.50 per thousand cubic meters (mcm) through to the end of 2008.

Meanwhile, “Gazprom Sales [Marketing] Ukraine,” (“Газпром сбыт Украина,” or GSU — I haven’t seen that acronym used yet, so remember, you saw it here first) a fully-owned subsidiary of Gazprom, has registered in Ukraine and is in the process of gaining clearance to sell 7.5 bcm per year on the country’s “unregulated” industrial market. GSU will buy the gas from Naftogaz (who itself purchases it from RUE, which purchases it from Gazprom Export, which allegedly purchases it from Central Asia), though according to early drafts of the new gas scheme agreement, Naftogaz is limited to an extremely minimal price increase (pennies per mcm) on the sale to GSU.

The industrial sector of gas sales had been dominated by Ukrgazenergo, but intense regulatory and administrative pressure has essentially forced the gas trader to shut down operations. (Nonetheless, I am still in talks with Ukrgazenergo to arrange an interview, and will update accordingly.)

Naftogaz, via its subsidiary Gaz Ukrainy, is looking to fill as much of the void left by Ukrgazenergo as possible, lining up contracts from 90 of Ukraine’s top industrial gas users. It is unclear whether the holdouts of companies connected to RUE co-owner Dimitry Firtash have been resolved.

Late in March, Ukraine attempted to pressure RosUkrEnergo by halting the transit of gas owned by RUE through Ukraine destined for sale in Eastern and Central Europe. The Polish and Slovak consumers the gas was meant for lodged complaints, citing violations of the Energy Charter. It isn’t known if the new agreement with RUE protects the trader’s ability to transit gas through to Europe, a lucrative aspect of the scheme.

The early draft of the agreement reached between Gazprom and Naftogaz last month left the exact seller of gas at the Russia-Ukraine border–either Gazprom or RUE–ambiguous. While Tymoshenko was apparently able to erase the words “not less than” before the 7.5 bcm quota to be granted to Gazprom, removing RUE–with its rumored connections to the Yushchenko camp, organized crime, Gazprom management, former politicians, etc.–proved to be not so easy.

Note: No word on the potential technical default of Naftogaz, but the debt issue with Gazprom for gas sales during the first four months of this year–a couple billion dollars, apparently– remains a pressing issue. Meanwhile, the government is suggesting that domestic prices for gas raise by 3% and 5% (depending on volume consumed) per month, beginning in May (i.e. 21-35% by the end of the year). This, in combination with an increased presence in the industrial sales sector mentioned above, should help Naftogaz’s financial situation. Of course, 20% inflation rates and woeful bill collecting problems won’t help.

Also, Naftogaz has scheduled (another) attempt at a shareholders’ meeting for Ukrtatnafta, again with the aim of changing leadership and making sweeping administrative changes. The meeting is scheduled for May 29th (coincidentally, the day before my birthday). Meanwhile, the company announced the April 23rd auction of its 4.4 thousand sq. meter office building in Kremenchug, with a starting price of UAH 9.9 million (just under $2 million). Clearing out the shelves before the store gets taken over?

Naftogaz’s financials are creating worry as Ukraine and Russia struggle to finalize their gas deal

Naftogaz’s debts continue to rise while deadlines come and go – from eizvestia.com

Despite signing a key agreement on the development of gas sphere relations over three weeks ago, Ukraine’s Naftogaz and Russia’s Gazprom have yet to draw up and agree upon the technical and commercial contracts needed to make the deal final.

April 1st had been the anticipated deadline for reaching a solid agreement, but negotiations have now spilled over into the second week of April.

Meanwhile, March 31st was also the extended deadline for Naftogaz to fulfill its creditors’ requirements on a portion of its outstanding debt. Representatives of two of Naftogaz’s main creditors visited Kyiv in late December to push for progress in reaching the requirements on a $500 million Eurobond. Negotiations with government officials convinced the lenders to push back the January 1st deadline. However, the regulation–publishing Naftogaz’s 2006 IFRS report–has yet to be completed (though financial information on the company is available and has been analyzed by Ekonomichesky Izvestia), threatening the financial viability of the company.

Naftogaz is looking to get another two-month extension on publishing the financial report, which should be ready in a couple weeks according to information a source gave Reuters. Ernst and Young, Naftogaz’s auditors, have apparently been hesitant to certify the 2006 results without first knowing the company’s future tax burden and other prospective information. This uncertainty was exacerbated when a Cabinet of Ministers meeting last week failed to approve Naftogaz’s financial plan. The issue is set to be reexamined at another meeting on April 9th.

Ukrainian President Viktor Yushchenko warned of Naftogaz’s dire financial situation, saying the company “has never been closer to bankruptcy.” This elicited a quick response from PM Yulia Tymoshenko, who has asserted that her government will not allow a financial tragedy to befall the national energy company. Indeed, this year’s budget contains a $2.4 billion bailout in the form of sovereign guarantees, should it come to that. The Cabinet is also promising to lower Naftogaz’s tax burden.

Naftogaz’s profits have also dramatically increased, suggesting viability could be an option should it get its outstanding debts in order – From eizvestia.com

If the government can escape from this latest debt issue–which is compounded by outstanding debts to Russia for recent gas deliveries–then Naftogaz has a solid chance of turning its economic situation around.

In 2007 Naftogaz reportedly made about $620 million, and the new version of the gas scheme should increase the revenues to the energy company and its subsidiaries. That’s assuming, of course, that a deal that replaces the current structure can ever get signed.

Amidst gas negotiations with Russia last month, Ukraine’s Cabinet of Ministers amended the draft agreement on the future of the gas scheme, capping the amount of gas Gazprom will be allowed to sell on the internal market at 7.5 billion cubic meters (bcm) per year. The original deal stipulated only no less than 7.5 bcm, but gave no maximum. Other amendments, however, remain unknown as the current version of the agreement has not been publicized.

The shifting terms of the deal make predicting Gazprom’s response difficult. Nonetheless, Naftogaz is continuing to work at expelling Ukrgazenergo from Ukraine’s gas market–a key term in the prospective deal.

One of Ukrgazenergo’s main jobs–buying gas at the border of Russia and Ukraine from RosUkrEnerg–is set to be transfered officially to the hands of Naftogaz, according to the draft agreement. (Indeed, this is likely already happening, due to an anxious Ukrainian government backed by the services of customs officials.)

Naftogaz refuted claims it was resorting to gas cutoffs in order to pressure holdout industrial customers.

Ukrgazenergo’s other central job is selling some of that gas to industrial consumers within Ukraine. Tymoshenko employed the National Energy Regulation Commission to severely limit the amount of gas Ukrgazenergo is regulated to sell to the industrial sector. While the gas trader is fighting that decision in court, Naftogaz’s subsidiary Gaz Ukrainy has stepped into the void created by the commission’s decision.

Last week, the chemical factory Rivneazot complained that its gas pressure had dropped by about 20%, creating a potentially dangerous situation within the plant. The factory blamed Naftogaz for the drop in pressure, telling the company–which is in the process of replacing Ukrgazenergo in supplying Rivneazot–to “stop experimenting in the country’s gas sphere.”

“Irresponsible actions of Ukraine’s Cabinet of Ministers and Naftogaz in settling the situation in the gas industry are destabilizing the work of Rivneazot which could potentially lead to severe environmental and humanitarian consequences in the Rivne region [of Ukraine].
…
“Rivneazot also calls on the judicial organs of Ukraine to give a proper assessment of the actions of Naftogaz and its responsible figures, who by virtue of professional incompetence, negligence or design [intention], provoke a technological catastrophe in one of the largest chemical producers in Ukraine.”

These complaints of decreased pressure were echoed by the Krimsky Titan and Krimstky Soda factories. Not coincidentally, all three enterprises are owned by Dimitry Firtash, the major Ukrainian shareholder of the maligned gas intermediary RosUkrEnergo (RUE). Tymoshenko has long tried to remove RUE from the gas scheme, but for now is targeting RUE’s 50% owned subsidiary, Ukrgazenergo.

The three factories are trying to hold out for the fulfillment of their contracts with Ukrgazenergo, and conflicts over signing new agreements with Naftogaz likely led to this latest row.

Naftogaz responded by calling the accusations of decreased gas pressure “provocation and indirect pressure from the owners of RosUkrEnergo against representatives of Naftogaz on the eve of the next round of talks with Gazprom.”

“The company figures the statement by the press service of Rivneazot concerning the reduction of the volume of gas to the company from April 3rd of this year to be unreasonable, merely political in character and a form of sabotage against the process of transition to direct negotiations with Naftogaz.”

Besides facing resistance from such industrial consumers, Naftogaz will likely encounter other problems as it attempts to insert itself further into the gas supply scheme. Not the least of these is actually signing the new agreement with Russia, something that hopefully will be completed within the next week.

But also key will be resolving the debt situation, as becoming a major gas supplier requires significant credit–a characteristic not likely for a company flirting with default.

Note: There were rumors that Naftogaz (50% shareholders of Ukrgazenergo) would press Gazprom (25% ownership) into voting to liquidate Ukrgazenergo completely and legally at the company’s April 1st shareholders’ meeting. However, the meeting was not recognized due to a lack of a quorum. The next meeting apparently isn’t likely until October.

I’m still waiting for word on the results of the latest attempted Ukrtatnafta shareholders’ meeting. (Though here’s an amusing rundown of the attempted meeting in mid-March on the Kremenchug premises, replete with unmarked private security guards, buses full of thugs and a fire drill.)

The latest Dneproenergo and Kievenergo shareholders’ meetings also faced problems, apparently due to the absence of the companies’ registers, which are under the control of Privat-affiliated Ukrneftegaz. I hope to post on these issues–as well as more on the spy allegations at TNK-BP–as more info comes out.

Dip in Ukrainian exchange rate blamed on Ukrgazenergo, gas sphere shakeups

The exchange rate of Ukraine’s gryvna unexpectedly dipped last week, allegedly due to financial moves arising from instability in the gas sphere – Graph from finance.yahoo.com

Over the past week and a half, the exchange rate of the Ukrainian gryvna (UAH) versus the US dollar has fallen by about 5% at exchange stations across Kyiv. While the official central bank rate has remained at UAH 5.05 to $1, most of the exchange booths littered across the city have dropped their selling rate to around UAH 4.80.. The buying rate has remained closer to UAH 5.00.

Besides frustrating those of us who get paid in dollars, the dip in the rate has a significant effect on the large number of Ukrainians who keep their savings in dollar form. Indeed, much of the economy is based off the dollar benchmark, with distrust in the local currency stemming from wide rate fluctuations and high inflation in the 1990s. The continued heavy reliance on the dollar in Ukraine has remained despite a relatively long period of stability. (Inflation levels are excessively high now, however.)

When exchanging some dollars last week, I asked the woman working at the booth if she knew of the reason for the decline. “No one knows,” she said, shrugging her shoulders. Now it appears the adjusted exchange rate can be traced back to–what else–problems in Ukraine’s natural gas sphere.

The lowered exchange booth rate is a reflection of the decline interbank exchange rate (represented in the graph above), punctuated by a sharp drop on March 24th to nearly UAH 4.90. The fall began last week, as a source in the National Bank of Ukraine (NBU) told Kommersant:

The market was expecting on the 20th or 21st of March the traditional output (offering) of Ukrgazenergo for the purchase of currency on the bank exchange, but the expected offer of grynas didn’t happen.

From what I understand, Ukrgazenergo usually will convert the gryvnas it receives for its gas sales within Ukraine to dollars, which it pays to RosUkrEnergo for gas imports (which are calculated on dollars, i.e. $179.50). Because Ukrgazenergo appears to be on its way out of the gas supply scheme, this influx of grynas didn’t occur and pushed the exchange rate down.

In response, the NBU allowed the state oil and gas company Naftogaz to exchange currency on the market in the place of Ukrgazenergo. It now appears that Naftogaz is continuing its gradual takeover of Ukrgazenergo’s duties, key to PM Yulia Tymoshenko’s goal of ridding Ukrgazenergo and gas intermediaries from the supply scheme.

Recall that the latest gas contract between Naftogaz and Gazprom explicitly gave the duties of purchasing gas at the Ukrainian border to Naftogaz, a job previously held by Ukrgazenergo. (Who they buy it from–Gazprom or RosUkrEnergo–is not specified.) This transition, which appears to be happening even though we are still waiting for all the technical and commercial contracts to be signed which would make the agreement official, seems to be the reason for the currency’s tumult.

Ukrgazenergo asserts that the reason it didn’t follow its traditional pattern is that it lacked the currency to due so, and should no longer be expected to fill this role. Its press secretary Vitaly Kisel asserted that the company hadn’t been receiving payment from Naftogaz since January:

“In accordance with the external economic contract, since the new year Ukrgazenergo buys natural gas solely for the needs of the industrial sector,” he said. “Naftogaz Ukrainy in its turn uses gas from the external supplier RosUkrEnergo for the consumption of the gas transport system, budget consumers, and the communal heating plants. It’s clear that in the absence of a contract for these categories of consumers, Naftogaz has not settled accounts with RosUkrEnergo for the gas nor has it purchased currency for this goal,” asserted Mr. Kisel.

Because the relevant contracts have not been drawn up, Naftogaz being allowed to convert currency on the exchange market is technically illegal, as participants must have documented proof of their economic transactions. In the interest of financial stability and continued gas flow, however, it appears that the NBU and the government nonetheless will allow Naftogaz to undertake this task.

The entry of Naftogaz into the exchange market, however, may have cost the energy company a few million dollars due to the purchase of dollars at the depressed rate. The company is also in the process of restructuring its financial operations to go through the state-owned Oshchadbank, with the goal of streamlining payment procedures.

Naftogaz’s currency bailout is also being connected to Tymoshenko’s program–administered via Oshchadbank–of returning portions of lost savings from the former USSR’s savings bank (Oshchadbank’s predecessor). This populist program is about to enter its second wave of repayments, and Tymoshenko was worried that the exchange rate dip would have resulted in uneven results. The original repayments of $200 were calibrated on a UAH 5.05 exchange, so Tymoshenko apparently demanded this next round also adhere to this same rate. Enter Naftogaz to drive the rate back up again, essentially killing two birds with one stone.

Tymoshenko and the current government have hinted at a gryva re-evaluation, strengthening its worth against the dollar in an effort to fight inflation. While they may eventually wish to drop the exchange rate to around UAH 4.80, now is apparently not the right time.

Meanwhile, the Ministry of Fuel and Energy put in price caps on gasoline, which has risen by about 20% in the past month or so. The price increases stem both from rising global oil prices as well as internal problems. Kremenchug’s output is still down, refineries are struggling to adapt to new quality control laws, and Ukrnafta–Ukraine’s largest oil producer–halted deliveries to its filling station network (the country’s largest) in late February.

Based on the oil sphere problems and the natural gas situation, it’s reasonable to suggest that stability in the energy sphere could help the country’s economy. Assuming, of course, that populist measures don’t tank it even further.

Note: Interesting commentary from current and former officials at the Kyiv International Energy Club Q-Club, a lobbying group concerned with promoting general increased energy sphere performance along with greater energy security for Ukraine.

Gazprom and Naftogaz sign gas supply deal excluding Ukrgazenergo and keeping prices at $179.50

Update (3/15/08): As noted by IIU in the comments below, the Zerkalo Nedely weekly has an article by Alla Yeremenko on the agreement and includes a low-quality scan of the document. While the gas storage fees charged Naftogaz are likely going to be reexamined (they are scandalously low), Tymoshenko said that the transit fees charged to Gazprom will remain the same for this year. (However, you can expect a large increase for next year’s contract, coinciding with Gazprom’s increase in gas price in turn stemming from Central Asian producers asking for a higher price.) Yeremenko also notes that this agreement still requires both commercial and technical contracts to be drawn up and signed — indeed, this document lacks many specifics.

The ambiguity in the supplier of gas at the Ukrainian border that I mention below is somewhat explained in the document: the 49.8 bcm of Central Asian gas will be supplied either by Gazprom or by RosUkrEnergo. Hence, proclamations hailing the removal of RosUkrEnergo are premature.

Other points from the document:

• Naftogaz has until today (Saturday, three days from the signing) to figure out a framework on the “repayment” (through barter) of expensive “Russian” gas from the first two months of this year. (This may actually be three days following the “acceptance” of the agreement — see below.)
• Transit fees for “Central Asian” gas to Ukraine are to be figured based on a few different distance options, all significantly less than the actual distance between the two regions. This reaffirms that Gazprom is merely using gas substitution rather than supplying Ukraine with the actual gas from Central Asia.
• The agreement has to be accepted by Ukraine’s Cabinet of Ministers, Naftogaz didn’t have the authority to fully authorize it itself. Tymoshenko says this will happen on Wednesday, after a series of consultations. Hopefully the extra time will prevent any surprises from popping up later on into the deal…

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All it took was assuring Gazprom access to Ukraine’s industrial gas market…

From Gazprom.ru (my translation and emphasis):

Gazpom and Naftogaz Ukrainy signed an Agreement on the development of relations within the gas sphere

Chairman of the [management] board of Gazprom Alexei Miller and chairman of the board of Naftogaz Ukrainy Oleg Dubina signed an Agreement on the development of relations within the gas sphere.

In accordance with the agreement, from March to December of 2008 Ukraine will be supplied gas from Central Asian sources in volumes not less than 49.8 billion cubic meters for the price of $179.50 per thousand cubic meters. The purchaser of this gas on the border of Ukraine will be Naftogaz [NOT Ukrgazenergo]. In doing so, the supplies of Central Asian gas in January-February in the volume of 5.2 bcm [out of 9.1 total] will be fully documented and paid for based on the contracts of RosUkrEnergo and UkrGazEnergo.

In addition to the volumes of Central Asian gas, Naftogaz will formulate a contract with RosUkrEnergo on the sale of Russian gas delivered to Ukraine in January and February of 2008 on the base price of $315 per thousand cubic meters, the calculations of which can be realized by the return of corresponding volumes of gas.

From April 1st, 2008, a subsidiary or affiliated company of Gazprom will yearly provide direct deliveries of gas to industrial consumers of Ukraine in volumes not less than 7.5 billion cubic meters.

Negotiations on the terms of gas delivery to Ukraine in 2009 and following years will continue, taking into consideration the evolving nature of the purchase price of Central Asian gas.

Based on this:

• RosUkrEnergo is still in the picture. Notice the statement says the remaining volumes of gas this year “will be supplied from Central Asian sources,” but without clarifying by whom. This suggests that this part of the structure will likely remain the same.
• Ukrgazenergo is out of the picture. Their main role–buying gas at the border of Ukraine and Russia from RUE–is explicitly handed over to Naftogaz.
• The debt scare that was used to push for this latest round of negotiations will be settled as it normally is, with discrepancies caused by seasonal variations accounted for over time through corresponding volumes of gas. This means $315 may be used as a calibrating price, with no expectation of actual money changing hands. It is unclear where this leaves the contract signed by Naftogaz and RosUkrEnergo.
• Gazprom will make up from losing its 25% stake in Ukrgazenergo (since it looks like the company is on its way out) by being granted a license to sell about 25% of the volumes of gas Ukrgazenergo was selling (around 35 bcm). However, (ominously) the maximum size of the license isn’t mentioned. Previously, the regulatory commission has stated that no singular company (perhaps excluding Naftogaz?) can hold a license covering more than 35% of Ukraine’s market. Based on 70 bcm of consumption, this would be 24.5 bcm. However, if it is based on the unregulated market only (i.e. excluding communal services and residential consumers), the maximum would be about half that number.

Update: Tymoshenko’s congratulatory announcement praised the removal of Ukrgazenergo and the $179.50 price, but any talk of the fate of RosUkrEnergo was conspicuously absent…

Ukraine capitulates on $321 for Russian gas but negotiations continue

Update (3/13/08): Scans of the “contract” can be found accompanying this article at Ekonomika.  Some critics are saying that since there is no Naftogaz stamp over Didenko’s signature, it is not valid and only represents a proposal by RosUkrEnergo.  It will be interesting to see how it fits into the new deal just signed in Moscow.  (Also, interestingly, the bank account numbers are not whited-out in the pictures accompanying the Kommersant paper edition.)

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Russia’s natural gas supply cuts to Ukraine last week were lifted after only two days following a vague agreement between Naftogaz and Gazprom that “solv[ed] the crisis situation in the gas area.” However, no solid terms were announced and negotiations are scheduled to continue this week to reach a more official agreement.

An article from today’s edition of Kommersant (shorter English version) has the details of a previously-unknown contract signed between Naftogaz and middleman RosUkrEnergo on March 6th, the day after supplies returned to normal. According to the article, Naftogaz has agreed to repay Gazprom for gas delivered to Ukraine since January 1st on two pay scales: for gas alleged to be of Russian origin, the company will pay $321 per thousand cubic meters (mcm); the remaining volumes, ostensibly from Central Asia, will be calculated from the $179.50 price agreed upon late last year.

While the exact volumes of Russian versus Central Asian gas are still being negotiated, Russian gas could account for roughly 4 billion cubic meters (bcm) out of the 9.1 so far delivered to Ukraine this year. This would put Naftogaz’s average price for gas at $240 per mcm for January and February of this year. Terms for the rest of the year are set to be negotiated starting tomorrow.

The print edition of the paper has partial scans of the faxed contract signed by vice chairman Igor Didenko of Naftogaz (interestingly, not the company’s head, Oleg Dubina) and RosUkrEnergo’s executive directors Dmitry Glebko and Konstantin Chuichenko (who is also on Gazprom’s board). I haven’t been able to find pictures of the contract online, however.

Gazprom is allegedly taking this as evidence of Naftogaz’s financial ability to pay for gas at European prices, and may press this issue during upcoming negotiations. (Ukraine may very well respond by demanding “European” prices for gas transit.)

Didenko apparently agreed to this price–which was higher even than the $315.50 price Gazprom was trying to charge–in order to pave the way for the removal of Ukrgazenergo (a 50/50 joint venture between RUE and Naftogaz) from Ukraine’s internal market. Paying for Russian gas at European prices has been an unofficial demand by Gazprom for acquiescence on the removal of middlemen within the gas supply scheme.

However, an analyst quoted in the Kommersant article suggested that this situation may create a two-tiered system, where Ukrgazenergo sells the gas it receives from RUE for $178.50 and Naftogaz sells “Russian” gas bought for $321. Given the price difference, it is hard to believe that Naftogaz would be able to compete commercially with Ukrgazenergo on the internal market.

Prime Minister Yuila Tymoshenko’s government has been actively working to “liquidate” Ukrgazenergo, to the benefit of Naftogaz. Ukraine’s National Energy Regulating Commission attempted to severely limit Ukrgazenergo’s allotted market share within Ukraine (from about 35 bcm per year to 5 bcm), and a suit on the issue between the commission and the gas trader is currently awaiting a hearing in Kyiv’s overworked administrative court. Tymoshenko’s vice premier asserted today that Ukrgazenergo’s license for the sale of gas at non-regulated prices had been revoked, but the company responded by calling him a liar.

Naftogaz responded to the article with a press release stating that Naftogaz isn’t going to be buying any “Russian” gas anyway, so the price isn’t a big deal (my translation):

Naftogaz notes that the publicized information relating to the purchase of Russian gas for Ukrainian consumers at the price of $321 per mcm is counter to the agreement reached between the Presidents of Ukraine and Russia and does not respond to reality. In the balance of the company [Naftogaz] for this year, there are no plans for selling volumes of Russian gas to Ukrainian consumers. According to the energy customs service, this year gas of Russian origin is not being cleared [растаможивался] into the Ukrainian customs territory

If indeed gas of Russian origin is not being sold within Ukraine, this would suggest it is instead either re-exported into Europe or being kept in storage. Though if Russian volumes of gas did make up 4 bcm out of the 9 bcm bought by Ukraine this year, it is hard to believe that domestic demand could have been satisfied by only the remaining 5 bcm of imports. (This underscores the difficulties in determining the origin of gas pumped through pipelines, particularly in the absence of clearly-delineated contracts and volumes.)

Assuming the price structure is expanded into the future, Naftogaz may be planning on simply re-exporting any gas it is forced to buy at “Russian” prices. It would then rely on the cheaper Central Asian blend (and domestic production) to supply internal consumers. In past years, the price of the gas “cocktail” supplied by RosUkrEnergo to Ukraine had included the cost of significantly higher-priced volumes of Russian gas. It is unclear why this year’s scheme has Russian gas being charged outside the system.

The negotiating delegation–which includes Didenko–plans to ensure that the price remains $179.50 during talks that resume in Moscow tomorrow. Bowing to the $315 Russian price for gas already delivered had been fodder in a public argument between Tymoshenko and President Yushchenko over the handling of gas issues.

Tymoshenko had claimed success at having escaped from the gas shut-off situation without agreeing to paying higher-than-contracted prices. She also intimated that Yushchenko was willing to accept the price Russia suggested. Yushchenko’s secretariat responded by posting the directives he had given her prior to her recent trip to Moscow, which included doing everything possible to secure the $179.50 price–steps that Yushchenko himself had taken during his own meeting with Putin earlier this year.

While Tymoshenko also wants a low price, she has stressed that any future deal should remove both RosUkrEnergo and Ukrgazenergo. She has been hesitant to endorse a plan to replace them with joint ventures between Naftogaz and Gazprom. It will be interesting to see what aspects of the President’s and Prime Minister’s visions for the gas scheme are stressed by the negotiating team–and eventually accepted by Gazprom.