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Naftogaz loses its monopoly (at last) – Ukraine

October 1, 2015

Legally, with effect from 1st October 2015, the opaque, budget burdening behemoth that is Naftogaz Ukrainy loses it monopoly within the Ukrainian gas market – and not before time.

So many are the entries within the blog going back many years calling for the butchering of this monopolistic monstrosity that there are simply too many to link to.  However an entry last year raised the question (again) over the restructuring of Naftogaz Ukrainy vis a vis bankrupting it, and starting again with an entirely new structure that falls squarely within Ukrainian obligations to the EU Third Energy Package.

“Unbundling the gas transport system from the gas production and the end user network is perhaps one way to restructure Naftogaz. In doing so, it may eventually come to light as to just how this massively opaque behemoth actually manages to lose so much money every year – and when Naftogaz deficits can run at anywhere between 3.3% – 7% of GDP per annum, questions really do need to be asked about firstly how they are actually accrued, and secondly why successive governments continue to finance a structure that is simply a lead weight upon any annual budget?

So big, cumbersome, opaque and costly is Naftogaz to the nation, it appears to have become too big not to fail if Ukraine is to survive economically in the current circumstances – and as the saying goes, “never waste a good crisis”.

Therefore, is restructuring Naftogaz a better option than making the most of the current crisis, and taking the opportunity to declare Naftogaz bankrupt – and then restructuring the hard assets into entities that would fall neatly within the EU 3rd Energy Package, whether those entities be entirely or partly State controlled, or indeed privitised entirely?

It could, of course, be incredibly messy. Does anybody actually know who owes what to Naftogaz, or who Naftogaz owes within its opaque internal structures? How many entities have contracts with Naftogaz? Dozens? Hundreds? Thousands? Who are they, What are they?

Naftogaz is now so big, opaque, unwieldy and economically unbearable, restructuring is an absolute requirement. The question presented to any new leadership is therefore whether partial dismantlement or complete obliteration of this behemoth will be the answer they arrive at.”

So where to go from here when 1st October marks a very significant legislative date regarding Ukrainian energy?

Theoretically and legislatively the liberalisation of the energy sector has now begun.  No longer will the State be able to control either prices or allocation.  The corruption that accompanied such practices will face difficulties going forward as long as new entrants step forward and regulators prevent cartels.  Certainly the corruption that occurred via arbitrage and the capping of domestic production via pricing look set to face challenges.

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Market based prices will lead to energy efficiency rather than the wanton waste that currently exists.  Market based prices rely upon ending subsidies, bad debt write offs and endless recapitilisation to Naftogaz Ukrainy in order to create an open and free market – and not before time.

Naftogaz Ukrainy is Ukraine’s largest vertically integrated state-owned oil and gas producer, whose companies provide for more than 97% of domestic production of oil and gas.  Naftogaz Ukrainy is engaged in mining, oil and gas extraction, transportation and sale of petroleum products through its own network of filling stations.  Some clear and obvious dismemberment presents itself that would serve to fulfill the Ukrainian obligations to the EU’s Third Energy Package.

Firstly there is no alternative to separating the transit companies within Naftogaz Ukrainy from the rest of its subsidiaries.  Thus Ukrtransnefta (oil pipelines) and Ukrtransgaz (gas transit) legislatively and corporately are required to stand alone, no longer subservient nor part of Naftogaz Ukrainy, and legislatively proscribed to allow guaranteed transparent and equal access to their transport systems for all market players.  If the government of Ukraine continues to believe that the transit systems are jewels in the State crown and not to be sold, then it will be necessary to create an independent operator per the Third Energy Package.

Alternatively, the government of Ukraine should privatise these entities (which seems unlikely given the deep-seated belief within the political elite that the transit systems are a matter of national security).

Clearly the petrol stations owned by Naftogaz Ukrainy can and should be sold of – as should the trading subsidiaries of Naftogaz Ukrainy.

Is there any need to have a State gas producer having opened the gas market?  Probably not, so the privatisation of subsidiaries such as Ukrgazvydobuvannia (which would undoubtedly sell for many $ billions in and of itself) would be entirely in line with butchering this State monster.  A similar line is desirable within the oil subsidiaries of the Naftogaz Ukrainy.

However, as yesterday’s entry made clear, selling minority shares in these entities is not enough – in fact it could well be a backward step – “Quite simply, aside from other sovereign governments, or those eilite large companies with close relationships and direct channels within their governments, who is going to buy a minority share in entities that will be at the directional whim of the Ukrainian government of the day?

The answer is only those that can directly influence the Ukrainian government of the day – and that remains the existing oligarchy!

As foreign governments and large foreign corporations are not likely to be excited about buying minority shares ranging from 5% to 46% in Ukrainian State owned companies with the major shareholder (Government of Ukraine) being historically either unpredictable or predatory or both (and there is nothing to suppose that cannot return with any election) it seems likely that only an oligarchy that already influences the government will have any serious interest in buying minority shares in State owned enterprises.

After all, holding minority shares in State owned enterprises is nothing new for the oligarchy – and neither is using their influence within the Verkhovna Rada to insure that their interests overrule the interests of the State majority shareholder.”

At the very least, if the State is intent on retaining shares in any of the severed and dismembered parts of Natfogaz Ukrainy, then the State should hold a (significantly) minority share.

Of course, if Ukraine does not provide the right tax stimuli for producers and effective recourse for suppliers when buyers will not/cannot pay, then a legislative end to the Naftogaz Ukrainy monopoly is not going to create an active and vibrant Ukrainian energy market – de facto the monopoly will continue due to lack of competition.

“On October 1, the Law of Ukraine on the gas market will come into force, and it will radically change the system of coordinates and the gas market itself. Naftogaz Ukrainy will lose its monopoly both for the supplies and the sale of natural gas. In fact, we are building a fully European non-monopolized system of the natural gas market, when the supplier may personally determine to whom and where to sell, and when the buyer may personally decide from whom he wishes to buy” – Prime Minister Yatseniuk.

Let’s hope he is proven to be correct, if it is to be so then there are many necessary privatisation and taxation issues to be addressed to support any new market – together with statute guaranteeing any market entrant use of State retained transport systems.

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