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.

Late 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.

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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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.

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.

Update on Privat’s role in the Ukrtatnafta affair as Glushko dismissal hearings begin

Hearings on the dismissal of former Ukrtatnafta head Sergei Glushko began yesterday in Kyiv, but I am still working on trying to gain access to them. In the meantime, the Ukrainian news magazine Kommentarii (Comments) ran an article in this week’s edition attempting to shed some light on the recent supplementary oil shipments routed to the refinery. The article alleges that Gennadiy Timchenko, a former KGB colleague of Russian President Vladimir Putin, is connected to the crude shipments, and is doing so in collusion with the Ukrainian firm Privat. From Kommentarii (my translation):

According to Kommentarii’s source, the supply chain of oil to Ukrtatnafta appears as follows: Rosneft — Gunvor — Rixo (a Turkish company, trading in mazut [low quality fuel oil] for thermal power plants). The key element in the chain is the transfer at the Odessa oil harbor of oil into railroad tankers to Kremenchuk for Ukrtatnafta. [see below]

According to Russian experts, the conductor of this operation is none other than the former colleague and friend of President Putin, Gennadiy Timchenko — 50% owner of the Swiss firm Gunvor. Through the firm are sent the majority of exports for Rosneft and Gazprom (its oil exports). As a result of the bankruptcy of Yukos, the assets of this company [Yukos] were obtained by Rosneft, and its exports–by Guvnor.

The article details the connection between Putin and Timchenko as beginning during a shared stint in the KGB’s foreign intelligence division, and reinforced through belonging to the same judo gym in St. Petersburg. Timchenko entered the oil trade in 1988 with the firm Kineks which grew to reach turnover of around $2 billion a couple years later. He later moved on to form Gunvor in 1997 with a Swedish partner Torborn Tornquist. In 2001, the firm moved its headquarters to a swanky banking district in Geneva, and business began to take off.

By 2006, Gunvor was exporting 60 million tons of oil and petroleum products, worth about $30 billion. That figure is expected to jump to $43 billion for 2007. According to Russian press, the growth of Gunvor’s oil trading activities corresponds to Putin’s ascension to power, as the firm was able draw upon its political connections to win beneficial contracts with state energy giants.

The Kommentarii article goes on to identify three possible reasons why the Russian government (via Putin’s links to Timchenko’s Gunvor) would help out Ukratatnafta — or at least, not prevent this assistance — despite harsh condemnations of the corporate raid:

• This is an attempt by the federal government to lower the influence of Tatarstan President Mintimer Shaymievym.
• This represents a desire by Putin to further entrench his agents within Ukraine’s energy sphere; similar to the introduction of Yurii Boyko and Igor Voronin in the RosUkrEnergo scheme, this would allegedly put a key Ukrainian energy asset at the whims of a close Kremlin ally.
• This is the result of cooperation between the Kremlin and the powerful Privat Group (led by Igor Kolomoisky), which has been lobbying for increased control in Ukraine’s oil market.

Here is a translation of the deeper explanation given for the involvement of Privat, which apparently stems from its efforts to entrench its recently-acquired holding Sintez Oil into the transferring and services sector at the Odessa oil port. (I am including the entire section — again, my translation — to try to give a fuller explanation of this theory.)

Implementing deliveries by tanker is practically impossible without interested partners who possess the necessary infrastructure and are interested in the conflict at the Kremenchuk refinery. Privat, whose representatives openly declared the firm’s participation in the conflict, is such a partner for the Kremlin. It shouldn’t be forgotten that this group controls the above-mentioned Odessa oil port.

The possibility of the collection of barter tariff payments (rather than monetary) for the services of port trans-shipment and loading of oil is one of the most attractive sides of the operation of the oil terminal at the port. Sintez Oil, the Cypriot International Petroleum Company [unclear…] and [Sintez’s partner] OAO Eximnefteproduct sell the whole spectrum of transit services: trans-shipment of cisterns [tankers] and their steam cleaning, use of the reservoir park for the loading of tankers, direct transfer of oil, along with services for the cleaning ballast water from the tankers.

The cost of this port service is high, since the market for the supply of large quantities of oil by pipeline and railway to Ukraine is extremely monopolized. It is dominated by two or three players. Control of the port would allow favored investors to enter into this market, escaping the risk of investing into refineries.

Only those that invest money into factories earn money on the import of oil in Ukraine. The circle of such investors is primarily narrow. At the same time, control of the port gives a peculiar free pass into the entrance of this club: who would argue about the importance of transit?

By receiving oil in payment for transit services, the managers of the oil port were able to avoid threats from major players in the market and enter into reprocessing at the Odessa refinery and into Ukrtatnafta, which are connected to the port by pipelines. From recent times, thanks to the new Zhulin-Nadrovnaya bridge, among these clients has appeared the Nadrovnyanskiy refinery of the group Privat.

Thanks to the inclusion of Nadrovornaya into the pipeline network, the firm received the opportunity to take from the Russian exports “natural payment” for the transit not in Odessa itself but, for example, in Brody or Mozyr. In fact, the scheme “transit in place of delivery” allows Privat to economize on the purchase of expensive imported oil.

Earlier, this economy allowed the former co-owners of Sintez Oil, Alexander Zhukov and Andrei Derkach to play a noticeable role in the Ukrainian oil products market. Their attempts to create an oil empire on the basis of control over the deliveries to the Kherson refinery and over the system of sales by Ukrnaftoprodukt came to an end in complete failure. Experts called the causes of the failure the weak connection with the owners of the Kherson and Odessa refineries.

Neither Lukoil nor the Bazhaev brothers from Alians [who controlled the refineries] trusted Zhukov or Derkach. It is unlikely that Privat will repeat the mistakes of its predecessors. After all, in the group [Privat] are two of its own smaller refineries, and not long ago Ukrtatnafta entered the orbit of the firm.

In sum, control over the last [presumably meaning Ukrtatnafta], along with control over the port, would allow Sintez to create a fully vertically integrated oil complex, which includes all technical chains “from the tanker and well to the filling station.” Over such a business stake in the large oil game that is now flaring up between Moscow and Kyiv, the Dnepropetrovsk-based Privat is fully capable of becoming the victor.

Apparently Privat is lobbying the Kremlin to allow these supplemental deliveries in order to cement both the role of Sinitez in the oil services sphere, as well as its newly-acquired influence over Ukrtatnafta. This combination would apparently bump up Privat’s stake in the regional oil market significantly. Where Moscow benefits — besides gaining a business partner (trustworthy or not) — is unclear.

Kommentarii’s source (backed up here) also says that 80,000 tons of crude from Rosneft was scheduled to be shipped from Novorossisk to Odessa aboard the SeaBravery tanker, but the shipment was delayed by last weekend’s storm. At the press time of the magazine (November 15th, or so), the ship had yet to leave port. By this point, it is still unclear if it has left yet. The prevention of further shipments from Novorossisk due to the storm’s aftermath may throw a wrench into Privat’s plans (if, indeed, this is all part of its grand plan), as it would presumably be forced to look beyond its sphere of influence for additional shipments to feed the Kremenchuk refinery. Undoubtedly, however, the group will develop a new scheme…

I’m still working on wrapping my head around these ideas, and am looking into some of the players. If anyone has further insight, feel free to add your own comments or send me an email.

“Oil and Gas 2007″ roundup and Kremenchuk update

Last week Ukraine’s Ministry of Fuel and Energy sponsored its annual “Oil and Gas” conference in Kyiv, a part of its larger “Energy and Power” exhibition. While mainly serving as a product exposition for companies within the oil and gas industry (think valves, pipes, compressors, gauges, drills, etc.), there were also a few majors there such as Shell, E.ON Ruhrgas and TNK. I took the opportunity to talk with various company representatives about their work in Ukraine, and what they saw for the future.

The conference was opened with a speech by Fuel and Energy minister Yurii Boyko, before he left for natural gas negotiations with Russia (which I will be writing on shortly). At the exhibition, he touched on the upcoming negotiations, saying transit tariffs for gas through Ukraine would reach “market” levels in 3-5 years. This seemed to be a reminder of the leverage Ukraine holds over Russia on the eve of their price negotiations, but still falls in line with previous statements regarding the gradual rise in both transit costs and delivery price. Sure enough, later that week Gazprom announced that the two sides would be paying “market” prices for gas deliveries and transit by 2011. The headline from that statement, however, tended only to emphasize Gazprom’s commitment to charging Ukraine higher gas prices, and ignored the obligation for Gazprom to pay higher transit costs. (No word on bumping up storage costs to market levels, either.)

Anyway, back to the conference.

Nearly everyone there was optimistic, with most citing expected growth within Ukraine, particularly within the natural gas industry. This was true for firms like Shell, as well as the smaller service providers like Smith Ukraine and Weatherford who would look to capitalize on greater involvement by the majors. Ukraine still holds fairly significant hydrocarbon reserves (principally natural gas), especially within the Donbas, pre-Carpathian and Black Sea shelf regions. Developing these reserves is a key part of the Ukrainian government’s lofty Energy Strategy to 2030, though problems with financing at Naftogaz Ukrainy and unclear licensing and exploration laws have hindered much progress.

I swung by the Ukrtatnafta booth to see what they had going on there, but things were quiet. (For those of you not following the dispute between Tatneft and Ukraine over the Kremenchuk oil refinery, check out the rundown in the EDM.) The women upfront were mum, addressing any questions I had (specifically about the recent “management dispute”) to contact information on the back of the brochure they were handing out. Eventually, however, I was able to figure a few things out. In general, things at the company are proceeding as normal, despite the interruption by corporate raiders. While things were a bit up in the air, they are now continuing to receive oil shipments and are essentially going about their work. The new oil shipments will be more expensive from what they had been getting before, but they are continuing to pump out their products from the Kremenchuk refinery. Indeed, news reports have the the plant receiving oil via Odessa, despite the threats of an international lawsuit by the Tatar shareholders.

Meanwhile, the November 15th shareholders meeting that I had thought perhaps might facilitate a resolution to the conflict appears unlikely to do so now, as the Tatar shareholders stated that they will not be attending. This will prevent a quorum at the meeting, blocking any legitimizing motions from being passed. At this point, it’s appearing unlikely that Ovcharenko will be ousted from his current position atop the leadership, at least not without direct intervention from the top of Ukraine’s political ladder. The sense also seems that Tatneft will likely resume shipments of oil to the refinery due to the convenience of the natural conditions and in-place infrastructure, but at “less profitable terms for Ukrtatnafta.“

An Oil Special — Kremenchuk, Ukrtatneft, Naftogaz, Gazprom Neft…(and Privat?)

Sergei Ivanov, Russia’s powerful first deputy prime minister, weighed in on Friday about the ongoing conflict surrounding the Kremenchuk oil refinery, escalating the issue by further publicizing the opinions of the Russian government besides the previous condemnations from Tatarstan. From RIA Novosti:

“I consider the incident unacceptable, and we cannot ignore it, because the protection of Russian business interests has long been and is likely to remain a national priority,” Sergei Ivanov told a session of the government commission for industry, technology and transport development.
…
Ivanov said the incident, already denounced by authorities in Tatarstan and the Russian government, had also dealt “an obvious and considerable blow to relations between Russian investors and their Ukrainian counterparts.”

Ivanov does not believe the Ukrainian government is doing enough to resolve the issue, and while acknowledging the current transition period due to recent parliamentary elections, he says it’s no excuse for “anarchy.” Ukraine’s Ministry of Fuel and Energy had attempted to call a meeting of Ukrtatnafta’s supervisory board, but this was rejected by Tatarstan, which said it wouldn’t be sufficient to end the dispute. There is a shareholders meeting for Ukrtatnafta scheduled for November 15th, and a resolution may not come before then.

In the past, Yurii Lutsenko (former Interior Minister and current People’s Self-Defense headliner) has stated that he agrees that the refinery should be in state (i.e. Naftogaz) control, citing the shady privatization deals that led to the dispute over an 18% stake in the firm that precipitated the current conflict. Naftogaz recently appointed a new head, a representative from the Bloc of Yulia Tymoschenko. Lutsenko and Tymoschenko’s parties are expected to form the ruling coalition for Ukraine’s new government, propelling Tymoschenko to premiership.

A report by Tatarstan’s trade representative in Kyiv has cited major Ukrainian financial firm Privat as a driving force behind the current conflict:

“I am not saying that the raid was performed by Kolomoisky [a Privat co-owner], an entire conglomerate of interests is involved there. Others, quite powerful in Ukraine, who have certain influence in Russia, are also behind it,” [trade rep. Rostislav] Vakhitov said without specifying their names.

Privat, through it’s affiliated company Korsan, owns a 1.2% stake in Ukrtatnafta. Igor Kolomisky is sometimes accused of close ties the Orange camp and to Tymoschenko (which she denies), and he may have seen the turnover in government as a opportunity to push for the move against Ukrtatnafta. The last time Tymoschenko was Prime Minister, she spearheaded a re-privatization campaign for the large Krivorozhstal steel works, and she has not ruled out further re-privatization moves. The incoming administration, then, may be sympathetic to the refinery’s new ownership given the economic rationale being stressed by the current head.

Pavel Ovcharenko took over the factory claiming he was doing so in the best interests of the company, asserting that it had been driven into near ruin by the previous head. Indeed, the firm struggled financially in the past year, apparently losing about $25 million over the past 9 months after profits of nearly $30 million for the same period in 2006. Ovcharenko stuck by that economic message in a letter he sent to the Poltava SBU outlining signs of apparent financial ruin nearly brought upon the company, along with large amounts of unpaid back taxes owed to the Ukrainian government. This echoes a similar letter from Ovcharenko sent to President Yushchenko and other government representatives.

At the heart of the company’s financial problems, asserts Ovcharenko, is the use of middlemen in buying the crude and selling the products at unreasonable prices, rather than a system in line with market principals. President Yushchenko recently wrote an open letter to PM Yanukovich that called for government intervention into the oil trading sector, citing schemes that are taking advantage of tax loopholes and costing Ukraine’s government significant amounts of money while negatively affecting market conditions:

“Это, в свою очередь, предопределяет нарушение конкурентных условий во время осуществления субъектами ведения хозяйства предпринимательской деятельности, в том числе на рынке нефти и нефтепродукто.”

“This, in turn, predetermines the violation of the competitive environment during firms’ implementation of business conduct by management, including in the market for oil and oil products.”

This viewpoint was reinforced by the deputy director of Ukrnaftokhimpererabotka (Ukraine’s state oil and chemical refinery division) Vitaliy Daviy, who cited a shift in May of this year from direct shipments of Russian crude to the Kremenchuk refinery to the use of middlemen within the trading system. Previous to a March 2005 law that changed the tax regime imposed on oil importers, the use of intermediaries to skirt tax laws was widespread. However, that law:

“created a level playing field for all refineries, though this became the main reason for the halting of several refineries, exposing their uncompetitiveness in regard to their technical backwardness.”

Recent lax enforcement of the law has apparently led to a ressurgence in the previously employed schemes and an uneven market, which Daviy believes is costing the government around $100 million per month.

Another letter by Ovcharenko implicates some of Ukrtatnafta’s leadership in these schemes, including deposed head Glushko and deputy director Nail Maganov, who has been vocally critical of the actions and is forecasting economic ruin for the company stemming from current slashed production levels.

Tatarstan-controled Tatneft halted the flow of oil to the refinery following Ovcharenko’s takeover, drastically cutting the plant’s production. Tatarstan is now attempting to lead a protest against any Russian oil being sent in as a replacement, hoping to “starve” out the entrenched head.

“Today, I think not a single Russian company in this complicated situation will provide oil when even the recipient is unclear,” the Ukraine-based [Tatarstan trade] representative, Rostislav Vakhitov, told a news conference [on Thursday].

However, one major Russian oil company is preparing to step up its ties to Ukraine — Gazprom Neft recently announced that it is planning on exporting about 3 million tons of oil to Ukraine in 2008. According to an article by Svetlana Dolinchuk in Oct. 31st’s Ekonomicheskie Izvestiya, the Russian company is prepared to supply Naftogaz with 200,000-250,000 tons of crude per month starting at the beginning of the year. That is about half of Kremenchug’s monthly capacity, but represents about 17% of Gazprom Neft’s total exports for 2006.

According to the article, this announcement led to rumors on the possibility of Fuel and Energy minister Yurii Boyko (expected to be replaced by the incoming Ukrainian government) being invited to become Gazprom Neft’s vice president in charge of foreign activities and oil export. However, according to the article, a source close to the former leadership of Gazprom Neft called these rumors unsound, saying that “foreign top managers can engage in the leadership of companies only in extreme circumstances. Such circumstances are not foreseen for the future.” The press service for the ministry also denied the rumored move, saying that Boyko “is not planning to transfer to a job with a private firm neither in Ukraine nor beyond its borders.”

Boyko is now working on settling with Russia on next year’s gas deal, which he was tasked to finish within about a week. All in all, it’s proving to be a very busy end of his term as minister. It will be interesting to see if his future position in any way relates to these experiences…

 

Update on problems at Kremenchug

Last Wednesday, ousted head of Ukrtatnafta Sergei Glushko attempted to regain his former position in the Kremenchug refinery through force, but was apparently rebuffed by the forces of in-place director Pavel Ovcharenko. This is on the heals of Ovcharenko’s own assault on the offices a week earlier that, according to information from general prosecutor Alexander Medvedko quoted in yesterday’s Ukrainian daily Economicheskie Izvestia, resulted in two minor injuries to company security guards.

According to the article, the auto-factory regional court of Kremenchug (within Ukraine’s central Poltava oblast) overturned an October 25th decision by Medvedko calling the seizure of the refinery an “agitated criminal act.” The higher court apparently annulled the ruling following fallout from the attempted retaking on the 24th by Glushko. The article states that Glushko had returned to the offices, but that report is contradicted by a Reuters article saying that Interior Ministry forces rebuffed Glushko, leaving Ovcharenko in charge of the refinery:

“There was an attempt to capture (the headquarters) but it failed,” Ovcharenko’s lawyer, Yuri Pocheptsov, told Reuters on Thursday.

“The plant is under the protection of interior ministry troops and Glushko abandoned the plant. Some people were with him (too).”

Interfax Ukraine news agency reported on Wednesday that “unknown people in camouflage” had blocked Ukrtatnafta headquarters in Kremenchug.

Economicheskie Izvestia ran a longer article by Mariya Pomazai as well, detailing the effects of the disruption on the already turbulent oil market in Ukraine. Noting that the pump price of gasoline had already risen over 3% in October to about $0.94 / liter ($3.55 / gallon), the article raised concerns about further price rises stemming from Kremenchug’s decline in production.

Tatarstan-controlled Tatneft ceased the flow of crude to the refinery following the “management dispute” and “does not intend to renew the deliveries of oil until Sergei Glushko has been returned to the seat of head of the factory,” according to Tatneft first deputy general director Nail Maganov. He also asserted that by running at reduced capacity, the refinery stands to lose up to $4-5 million a day.

Ovchenko bought an additional 170,000 tons of oil for the factory, which gives it another 17-20 days of production at a reduced rate. There are worries that this decrease will create cost increases in the Ukrainian domestic petroleum market, as about a third of the country’s refined oil products come from the plant.

This whole episode reeks of criminal and underhanded behavior, and much more resembles a corporate raid than a management dispute. Details still seem a bit sketchy, emphasizing the opaque conditions many of these actions and motivations stem from. In all, it appears to be a fight to control ownership of the lucrative refinery, either legitimately (through a court decision on unresolved shareholdings that would grant a majority to one side over the other), forcibly (storming the offices with armed police), or bribery (ceding 3% of company shares to the firm entrusted with keeping Ukrtatnafta’s shareholder register).

The dispute is hurting both sides — the refinery is connected via pipeline to the Tatneft oil supplies, making any substitute for Tatarstan oil much more expensive, while depriving the oil producer of a convenient and established market for its crude. It is also an appalling example of a severe lack of respect for the rule of law by either side, instead resorting to thuggery and economic blackmail. The problem is, Ukraine’s oil and gasoline consumers, already reeling from high global oil prices, end up as one of the main losers.

Check out Interfax’s article for more details on the affair.

Standoff at the Kremenchug oil refinery

Taking a break from natural gas issues and a post I’ve been working on detailing some of the history of RosUkrEnergo… There is trouble now in Ukraine’s oil sector as a disagreement over leadership of Ukrtatnafta threatens to decrease the output of the country’s largest oil refinery. From the October 22nd issue of Kommersant (my translation):

The head of Ukraine’s largest producer of refined oil products, ZAO Ukrtatnafta, was replaced on Friday. With the help of a legal bailiff [executer of the law], the post of chairman of the board of the company was taken by Pavel Ocvharenko, who had been dismissed in 2004 [from that same position]. The Tatar shareholders [the “tat” of Ukrtatnafa] believe his appointment is a continuation of a conflict with NAK Naftogaz Ukrainy for the control of the Kremenchug oil refinery and are threatening to halt oil deliveries to the factory. Ovcharenko assured that he would take into account the interests of all sides and announced the necessity of an examination of the financial and production activities of the company.

In September of this year, following accusations of corruption, an investigation into Ukrtatnafta was launched by the state with the aim changing the firm’s leadership. The Ukrainian government has a 43% holding in Ukrtatnafta (through Naftogaz), the government of Tatarstan (a semi-autonomous region witin Russia) owns another 28.8%, and Russian-registered Tatneft has 8.6%. The ownership of the remaining shares — 18.3% — is currently being contested between Ukrainian and Tatar representatives. Ukrtatnafta owns the Kremenchug refinery — Ukraine’s largest, accounting for around a third of the country’s oil production — located in the central Poltava region.

The court-ordered ousting of former (Tartar-appointed) chairman Sergei Glushko was only accomplished after an armed confrontation on October 19th at the company’s offices between police and guards from Ukrtatnafta’s private security firm Buka.

Having taken back control of the company, Ovcharenko asserts the refinery’s net 2007 losses could reach about $80 million as a result of paying high prices for oil deliveries while selling the products at lower prices than their market worth. This corresponds to his message that the company’s management has failed since he left in 2004, and has instead dealt serious financial harm to the company.

In a further financial analysis of the company released by his office, Ovcharenko cites the nontransparent means that the refinery pursues to buy its oil supplies as the key factor in driving up the firm’s costs.

In May 2007 Ukrtatnafta reneged on its deal to buy oil directly from Tatneft, and instead there appeared numerous intermediary firms within the supply chain. In particular, according to information from the state customs agency, in the importing of Russian oil there is the firm OOO Taiz (Ukrtatnaft’s debt to this firm is greater than UAH 1.5 billion [$300 million]), a “receiver-giver” of MKChP Avto [unclear what that acronym stands for]. In July, this small firm was replaced with OOO Technoprogress (the debt to this company exceeds UAH 750 million [$15 million]). The purchase of oil through these intermediaries was done at prices $20-30 above the market value. In the past three years, Kremenchug’s entire market [of refined products] has been controlled by companies affiliated with Tatneft — Novoil, Tatnafta-Service and Ukrtatnafta-Center. Products [from Kremenchug] were sold to these firms at 25-30% below market prices.

Given these figures, it’s easy to see why the company would be hurting financially, and how possible inside connections between the intermediary firms and company management could account for the price differences.

Disputing the action, Tatneft has halted its supplies to the refinery, forcing the factory to scale back production and seek other options for crude delivery. If no other sources are found for a supply of oil, the refinery may have to cease production in about ten days.

Tatneft has asserted political motivations behind the move, and there are certainly geopolitical issues in play that complicate the economic rational. The continued question over the remaining ownership of the firm — enough to give either side (Ukrainian or Tartar) a majority and clear authority on appointing board leadership — adds a further element to this confrontation. For instance, Ukraine could have found out that an inopportune resolution on the issue may have been soon in coming, forcing the government to act now while ambiguity exists to insert its own loyal management. A shake up of the Ukrainian state leadership following the recent parliamentary elections also would have created a possible disruption in the political chain of command, leading to an action not fully coordinated within the government.

Ukraine obviously feels a sense of ownership towards the refinery since it is located on Ukrainian territory. At the same time, it relies on the cooperation of Tatarstan for its oil supplies and, therefore, livelihood. While a change in ownership may have been in order — along with a clean sweep of tainted intermediary firms (as in the gas trading scheme) — the intense alienation of the Tatar partners will only make future operations more difficult. Energy relations with Russia remain a sore spot for Ukraine; so long as it is economically feasible, it would do well to try to keep itself aligned with those relatively independent options that exist — including Tatarstan.

Postscript: As someone I was talking with tonight commented, this has much of the feel of “crooks versus crooks.” Indeed, the involvement of armed security forces tends to be a sign of competing power bases who are able to leverage support within local “strength” agencies, rather than those who have gone through more widely accepted channels. Regardless, it is an indication that clearly established procedures based upon rule-of-law ideals are not being followed in this issue…