Gas talks on hold

In the US, John McCain is suspending his campaign to address the country’s distressful economic situation.  In Ukraine, Yulia Tymoshenko has suspended key natural gas price negotiations due to the country’s distressful political situation.

From Monday’s Kommersant:

On Friday Prime Minister Yulia Tymoshenko communicated that negotiations with Russia on the price of gas in 2009 have been halted because of the political crises.  Naftogaz intends to use this pause to wait out for the December lowering of world hydrocarbon prices, which theoretically allows it to get gas at a more advantageous price.  Analysts figure that this expectation is not unfounded — if oil quotes, to which gas prices are connected, will continue to drop, than the cost of gas could end up being lower by 25%.  But if the pricing market isn’t favourable, it threatens to be a significant loss.

The head of the government, Tymoshenko, announced to journalists that because of the political instability in Ukraine, negotiations with Russia on the supply of natural gas have stopped for the time being.  “Without question, when there is an uncertain situation in Parliament, an uncertain situation with the coalition, holding negotiations doesn’t work out [не получается],” noted Tymoshenko.  A highly-placed source in Gazprom confirmed to Kommersant that the Ukrainian side has for the time being halted consultation on the price of gas.  “Next week representatives of Naftogaz were supposed to arrive to reach agreement on the pricing fromula and concrete points in the agreement.  But the visit was put off for an unspecified amount of time without explanation,” said the source.

Oleg Dubina, the head of Naftogaz, explained the delaying of negotiations not as political, but with completely comercial justifications.  According to him, the later that a contract is reached, the less the price of gas for Ukraine could be.  Based on the price-setting formula that Gazprom uses, the price of gas is connected to the price o oil, which gets lower as we approach December, asserted Dubina on Friday.  Correspondingly, gas for Ukraine also would become cheaper.  Therefore, Naftogaz figures that “it’s not worth it to rush into signing [an agreement].”

Should give Naftogaz a bit more time to try to secure another loan to buy the fuel it needs for the upcoming heating season.

There’s more to it than just relying on this “December price drop”…


More seeps out on Vanco’s partners

Update (9/21/08): A bit more on Khmelnitsky, the alleged figure behind Integrum, is appended below.

A very intriguing article in today’s Eurasia Daily Monitor by Myroslav Demydenko digs into possible organized crime connections to one of the investors in the Vanco-led Black Sea oil and gas project.

Through an offshore subsidiary, the US-based Vanco makes up about 1/4 of the joint venture established to run the development of the 13,000 square km offshore tract.  The other partners were revealed to be the Rinat Akhmetov-owned DTEK, the anonymous Austrian investment firm Integrum Technologies (more on them later), and Shadow Light Investments, owned by Evgeny Novitsky–who, according to Demydenko’s article, has connections to a Russian mafia outfit:

According to a number of reports in the press and the book Darkness at Dawn-The Rise of the Russian Criminal State by David Satter (Yale University Press, September 2004), Evgeny Novitsky is alleged to be a member of, or very close to, Russia’s Solntsevo organized crime gang.

Satter wrote that Solntsevo had close ties to a Russian company called Sistema [I would classify being “director” as having “close ties”], which is linked to Moscow Mayor Yuriy Luzhkov and to the IVK, the information technology company, of which Novitsky was director. Solntsevo, working through the company SV-Holdings, eventually came to own a large share of IVK.

… Kommersant wrote on July 22, 1997, that an unnamed official of the FBI had revealed the names of three individuals suspected of being “shadow bankers” for the Solntsevo mob, one of whom was Evgeny Novitsky.

There are more connections and citations listed by Demydenko to reiterate Novitsky’s supposed connections to the mob, including tantalizing references to infamous gangster Semyon Mogilevich, who some claim is in deep with RosUkrEnergo.

As for Integrum:

Integrum Technologies has refused to disclose its main investors, and Vanco executives have admitted on a number of occasions that they do not know the identities of the owners of Integrum…Evidence suggests, however, that Kyiv Investment Group, a company owned by Ukrainian oligarch Vasyl Khmelnytsky, is one of the hidden partners of Integrum.

Update (9/21/08): Khmelnitsky is a former Tymoshenko supporter who has since switched over to the Party of Regions.  However, their separation was reportedly relatively amicable and without scandal.  Khmelnitsky’s main investments are within the Kyiv property sector.

Meanwhile, the Cabinet of Ministers passed a resolution to divide up another large Black Sea shelf plot into 33 smaller sections, rather than license it off as one large structure.  OMV had reportedly early expressed interest in the project, but it’s unclear how this–and the ongoing scandal surrounding Vanco–could affect their viewpoint…

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.

Georgia, Crimea…

I’m leaving for Crimea later today, and have been busy packing up (leaving Ukraine soon too…), so excuse the lack of posting.

Like many others,  I’m following the events in Georgia with great interest.

From the energy side of things, it looks like the BTC pipeline is relatively unaffected.  And anyway, it was already shut down because of the blast in Turkey last week.

Azerbaijan stopped sending oil through Georgia, but the amount is relatively small anyway.  However, this was going to be one of the routes for getting oil to Odessa-Brody, so it will be interesting to see if prolonged conflice emerges and if it will hamper that route further…

Back next week, hopefully will update again with more interesting things…

A pattern…

Update (8/8/08): I’ve appended a quote from today’s Ekonomicheskie Izvestia article on Marathon’s quiet exit from Ukraine.  The article also includes a funny caricature featuring Tymoshenko

Gas production from independents is flat

The Vanco situation is pretty well documented.  Other stories are less so.

Following its London IPO in June, Cadogan Petroleum saw its share price plummet when two of its licenses were called into question last month by the Ukrainian courts.  (In 2007, the EBRD had purchased a 5.2% stake in Cadogan as a way to help promote independent oil and gas production in Ukraine.)

In July, the Naftogaz subsidiary Chornomornaftogaz announced the annulment of offshore agreements with CBM Oil and Shelton Canada Corp, two other small-scale oil and gas producers.

A similar announcement was made in June regarding cooperation between the US-based major Marathon Oil and Chornomornaftogaz.  Now Marathon is packing up its Kyiv office and leaving Ukraine.

In all, 73 subsoil licenses have been revoked by the Ministry of Environmental Protection, with another 83 still under threat.  The majority of these were granted in 2006-7, under former PM Viktor Yanukovich’s government.  Back in December, the new Yulia Tymoshenko-led government announced plans for a major check of all licenses, in an alleged attempt to root out “speculators” who were sitting on valuable reserves but not investing into their development.

When Tymoshenko came to power in 2005, she made a similar push.  By February 2006, 504 licenses granted between June 23rd and December 31st, 2004 (again, under Yanukovich), had been revoked.

Rooting out corruption is one thing; shooting yourself in the foot is another, a point that President Yushchenko seems to be trying to make as he cites problems with foreign investor relations at Kryvorizhstal and the new terminal at Boryspil airport.

Ukraine seems to be struggling at reaching a balance between making the country attractive for foreign investment, preventing corruption from spreading, and engaging in revenge by attacking past moves made by political opponents.

Meanwhile the oil major Shell continues to have a presence in Ukraine, both with downstream retail and a exploration and production joint venture.  The company has committed $100 million for developing a project in the Dnieper-Donets basin, but it remains in the early stages (seismic surveys are expected to be completed by next summer, last I heard).

Successfully implementing this project, with potentially a couple hundred million tons of oil equivalent at stake, would be a huge boon to Ukraine’s foreign investment climate, and might make up for some of the pummeling it’s been getting lately.

Update (8/8/08): From today’s Ekonomicheskie Izvestia article “Marathon left on the sly“:

An industry specialist within the Ministry of Fuel and Energy structure told Ekonomicheskie Izvestia that, “Marathon decided to close their Kyiv office and leave the market without any extra noise in order to not attract any extra attention to the event. They got tired of waiting for progress in negotiations with the Ukrainian government for further cooperation and decided to end the study of their posible perspectives within the country. Marathon’s mood was also negatively affected by the problems with the license of the American company Vanco for work on the Prykerchenskaya section of the Black Sea.”

Ukraine suggests talks with Vanco even as government prepares its case

Ukraine’s government has expressed willingness to hold talks with Vanco, so long as the oil exploration company drops its international arbitration suit. At the same time, an analysis by Kommersant of the government’s case against Vanco suggests that Ukraine’s argument, which includes accusations of corruption, may hold up in court.

According to Deputy Justice Minister Yevgeniy Korniychuk speaking on July 30th:

“Our position is that we will immediately hold consultations with Vanco Prykerchenska Ltd., as soon as they suspend their suit.  We have turned to Vanco with a request – if they want to continue talks, at first it is necessary to suspend the suit for 60 days, and than we will talk.”

This suggestion is similar to one delivered by mail to Vanco right before the company became eligible to file arbitration proceedings.  At the time, the letter had been sent to Vanco International Ltd (VIL).  Korniychuk’s direct address to Vanco Prykerchenska Ltd. at his press conference on Wednesday may be a concession aimed at pulling both sides to the negotiating table.

However, it is clear that the government is against any involvement for VPL–which includes in its ranks VIL, Rinat Akhmetov’s DTEK, and two investment firms–in the future of the Black Sea shelf development.  According to Korniychuk, in the event of a amicable resolution, they would be willing to allow VIL to take part in some sort of project:

“We are not arguing the right of Vanco International, which won the competition [to sign the PSA], to develop the shelf.  They can return to it, though maybe with some other commecial terms.  But the shelf certainly won’t be developed by Vanco Prickerchensaka.”

In the past Vanco has stated its openness to hold negotiations, both during the 60 day period necessary before filing for arbitration, as well as during the beginnings of the proceedings themselves.

While Vanco may acquiesce to this pause for talks, they will likely grumble about it as well.  After all, the government was rather quiet during previous 60 day period, which was initiated by an official letter of complaint sent by Vanco to the government and meant to begin a dialog.

Should no settlement be reached and the case proceeds to the Stockholm arbitration court, it appears that Ukraine has a fairly solid argument on its side, according to Kommersant.

The government’s case, which was prepared in March by the law firms Astapov Lawyers and Barlow Lyde & Gilbert, has two prongs: the first concerns violations of Ukrainian law; the second alleges corrupt elements within the deal.

The first prong concentrates on the relationship between Vanco International and Vanco Prykerchenska, alleging that the transfer of the PSA from the former to the latter was against the law.  Indeed, this point has been one of the more questionable acts in the saga — how could VIL win the tender, negotiate and sign the PSA, and then pass off the deal to a separate entity that contains three new players?

Vanco has asserted it was within its rights to do so.  Ukraine’s case argues that this is against the law, saying that a separate agreement had to be reached first.

Other issues within this branch of the argument:

  • While Vanco International of Houston registered to particpate in the PSA tender, Vanco International of Deleware won it.  This allegedly violates article 7 of Ukraine’s law on production sharing agreements. Delaware has a listing for Vanco International Ltd in its corporations databse. Texas has a Vanco International Inc.  From what I’ve heard, Vanco has admitted that VIL is registered in Delaware, despite press reports placing it in Bermuda (the location of VPL) or the Virgin Islands.
  • Vanco International’s application was not submitted in full, violating a regulation concerning the tender.  This apparently includes “providing contradictory information regarding its whereabouts, ownership, jurisdiction and financial status.”  Besides the confusion over locations mentioned above, VPL was created with only $12,000 in initial capital, while pledging to invest about $330 million.  Vanco secured a letter from Citigroup saying the company would attract necessary funds by holding an IPO, but it turns out that this move was planned for VIL, not VPL.  Therefore, “in reaching the decision on determining the winner of the tender, the inter-agency commission was relying on misleading information, a violation of part 1, article 230 of the civil code.”
  • According to the PSA regulations, the company was apparently not allowed to have a stake higher in the production than 50%; the PSA signed by Vanco has it receiving 70% during one phase of production.
  • Part of the area granted to Vanco overlaps with the military training ground Chauda.  As such, Ukraine’s Defense Department should have been involved in the deal.  While the agreement apparently stipulated that Vanco would pay $37 million for the relocation of the training ground, the situation is still “inconsistant with the law on ensuring security of the state.”
  • According to point 34.13.1 of the PSA, which concerns double taxation, Vanco could avoid paying any taxes to Ukraine, thus dropping the government’s share of production.

The government appears to be slightly worried over how these violations will be accepted by the Stockholm court.  There is also the possibility that the joint investment protection agreement reached between Ukraine and Britain may be enacted, due to Bermuda’s status as a British protectorate.  This agreement is investor-friendly, shifting additional burden onto the government’s case.

In response to these worries, there is a second line of argument based on corruption within the deal.

After it emerged that DTEK is involved in the project, observers immediately began questioning if illegal influence could have affected the outcome.  (Actually, ever since the relatively little-known company Vanco won the tender, beating out some other heavy hitters, there have been suggestions that something has been going on behind the scenes.) DTEK is owned by Akhmetov, who is a member of the Party of Regions in parliament — the same party as Viktor Yanukovich, Prime Minister at the time the PSA was signed with the government.

The government’s case calls for two past employees of Vanco International, former vice president John Gorman and former head of production Gabor Tari, to give evidence in favor of Ukraine.  It’s fairly easy to guess the gist what that evidence may be, but for now, it’s just conjecture…

Privat seizes Dniproblenergo

Figures connected to Ukraine’s powerful financial-industrial group Privat seized the offices of electricity distributor Dniproblenergo on Friday, in a move reminiscent of previous Privat-led corporate raids against the downstream oil company Ukrtatnafta and the power generator Dniproenergo.

The Dnipropetrovsk-based Dniproblenergo (the “obl” in the middle comes from oblast, meaning “regional”) is Ukraine’s largest power distributor, providing electricity to about 24 thousand enterprises — around 27% of Ukraine’s consumers.  The state-owned Electricity Company of Ukraine (EKU) controls 75% of the firm, with the Cyprus-based Larva Investments Ltd (a part of the Energy Standard group) owning 15.9% and the remaining 9.1% in the hands of minority shareholders.  This last category includes 3 shares owned by the Privat-connected company Business Invest.

Andrey Martinyuk, the director of Dniproblenergo from 2005-2006, was elected to return as head of the company after board changes made at an April 30th shareholders’ meeting attended by EKU and Privat and held at Dnepropetrovsk’s Palace of Culture. The government’s securities and exchange commission declared the meeting invalid, but Martinyuk continued to assert his legitimacy to the post.

At 8:00 AM on Friday, a few dozen guards from the Privat-controlled private security firm B.O.G. (an acronym for “Security. Protection. Guaranteed.” spelling the Russian word for God) broke into Dniproblenergo’s offices.  According to Kommersant’s account:

Plowing through the gates [to the office], they neutralized [Dniproblenergo’s on-site] security, broke through doors and forcefully ejected the company’s general director Edward Sokolovskiy from the building. Upon arriving on the scene of the altercation, the police were presented with a July 25th ruling from the Zhovtneviy district court of Dnipropetrovsk [declaring] the naming of Andey Martinyuk to the post of general director as legal.

Dniproblenergo’s chief accountant apparently escaped from the raid, managing to take away with her the firm’s official seal.  (Stamps are a big deal for organizations in Ukraine.)  Despite this, Martinyuk is proceeding as if under complete control of the company.

EKU, whose president is the former financial director of the Privat-controlled oil company Ukrnafta, supports the move, citing poor financial performance as the impetus for the change in management.  Martinyuk, the state electricity company’s choice for a replacement, had been the director of EKU’s distribution department.  The Fuel and Energy Ministry is also on-board with the seizure.

The ousted Sokolovskiy, who is connected to Rinat Akhmetov’s DTEK, accuses Privat and EKU of collaborating in an unlawful attempt to replace him.  He denies financial problems, saying that the raid “could be connected to the fact that in 2007, the company increased its profits by 7.5 times — to UAH 86.8 million [$18 million].”  This figure does not match other reports claiming that the profits for 2007 stood at UAH 28.3 ($5.9 million).

The press office of Alexander Turchinov, Yulia Tymoshenko’s first deputy prime minister, announced that the seizure would be examined by a government commission this week.  A statement circulated by his office said that “We will make efforts to prevent raiders attacks by the side of the Privat group.”

The same security firm was used in the October 2007 seizure of the Kremenchug offices of Ukrtatnafta, where once again a former head of the company was reappointed under the guise of saving the firm from financial ruin.

In March 2008, B.O.G. led an attack at Dniproenergo but the raid was expected and rebuffed under the presence of the press.  The fate of the electricity generator remains in limbo, as Privat, Rinat Akhmetov, Tymoshenko and President Yushchenko all have interests in the matter.

Kommersant ends its article by listing a couple of other sites that may fall victim to Privat-led seizures, including the Crimean Generator Systems, Luganskteplovozu and the Dnipropetrovsk (sunflower seed) oil extraction factory TM Oleina.

As the Ekonomicheskie Izvestia article sums up,

Dneproblenergo, together with Dneproenergo and a range of other energy-providing companies, is one of the objects of conflict in the protracted battle [conflict] between the current leadership of the Fuel and Energy Ministry on the one hand and, on the other, the management of the energy companies that was appointed during the period of [former PM] Viktor Yanukovich’s government.

The tactics in this battle include moves such as these dramatic corporate raids, gerrymandered shareholders’ meetings, control over the physical shareholder register, competing judicial decisions and proxy confrontations in the political spectrum.

Of course, while they may make for interesting reading, such events are not very helpful for Ukraine’s business world…