Energy expert Edward Chow once said that if one were to design an energy system optimized for corruption, it would look like Ukraine’s. The state oil and gas monopoly Naftogaz Ukraine is a crucial part of it.
It is set to end this year with a whopping $8.9 billion deficit, according to the International Monetary Fund, which granted Ukraine’s ailing economy a $17 billion loan package hoping that it could change how the nation is managed.
Once again, it will be bailed out by the taxpayers, who also picked up the payment of a $1.6 billion eurobond on behalf of the company on Oct. 1.
But even if one were to multiply Ukraine’s banking system by two and shift its profits to finance Naftogaz’s loss-making business model, it still might not be enough, says Andriy Kyrylenko, professor of finance at Massachusetts Institute of Technology.
“Naftogaz is ruining the balance of various sectors – finance, public budget, currency market, etcetera. The problem is so huge that while it remains unsolved, it’ll be extremely difficult to resolve something in other sectors,” he told Liga, a news and analysis website.
Naftogaz produces one-eighth of the national gross domestic product. It owns and operates, through subsidiarycompanies, Ukraine’s gas transit network and gas storage facilities, develops 235 oil and gas wells, and sits on 50 years worth of known gas reserves, according to Mathew Sagers, managing director for IHS, an international gas and oil consultancy.
And yet this mammoth is a major burden for the economy. There are many reasons why.
Until May, the company was forced to sell gas to households at half the production cost – below $50 per 1,000 cubic meters. Mounting debts and the IMF pushed the government into raising the price by 40 percent to $93 per 1,000 cubic meters.
But to maintain the current production rate of around 15 billion cubic meters per year, and have enough left over to continuously upgrade and reinvest into efficiency, Ukrgazvydobuvanya, the subsidiary that produces gas, would need to sell it at $250.
But so far, the company’s half-year losses stood at $4.4 billion, exceeding 2013 mid-year losses by more than three times. Private and industrial consumers combined currently owe Naftogaz about $1.5 billion for gas, according to its own estimates.
“Cheap Ukrainian gas is a myth, populism,” said Naftogaz chief Andriy Kobolev at a Sept. 23 talk show. “Gas should have one and only price (for everyone). If we’re going to charge a market price for domestically extracted gas… the public budget will get $2.3 billion of additional net profits that could be spent on energy savings.”
Corruption is another one of Naftogaz ailments, and it takes many forms. Dubious procurements have cost the company hundreds of millions of dollars. In one such well-documented case the state overpaid $150 million for the purchase of two oil rigs.
There have been various schemes in the works to sell cheap, subsidized gas meant for consumption by households, to industrial enterprises at a premium price. Regional private distribution monopolies inflated records of gas consumption by households to receive cheap, domestically-produced gas from Naftogaz. The government lost income from industry as a result, and handled the bill.
The scheme worked for years ecause many compressor stations and households still have no meters, which makes it difficult to track consumption. In late September, the Cabinet of Ministers cut the gas available for the scheme by 40 percent.
Other challenges for Naftogaz are more complex. Ukraine lacks enough gas to supply the needs of the country for the winter season. The nation needs 26 billion cubic meters in storage, but only 16.7 billion was in storage on Oct. 4, according to Ukrtransgaz, the gas transit subsidiary of Naftogaz.
Russia’s Gazprom, Ukraine’s near-monopolist foreign supplier, stopped shipping gas to Ukraine on June 16 over a price dispute. The company used to supply 60 percent of Ukraine’s needs.
Europe’s energy commissioner Gunther Oettinger on Sept. 26 said he brokered a temporary pricing formula to resume supplies of Russian gas, but only after Naftogaz pays $2 billion in what Gazprom claims to be arrears, and prepays another $1.1 billion for future supplies. But the price implied by the deal is $385 per 1,000 cubic meters – higher than the market price in Europe.
In the meantime, Russia is making sure that Ukraine cannot re-export its gas through the so-called reverse flow from Europe by limiting supplies to a number of countries.
Moreover, Russia took over Chornomornaftogaz, Naftogaz’s Crimea-based unit, which produced 1.6 billion cubic meters last year. It had plans to extract hydrocarbons with foreign energy giants like ENI and Shell off the Black Sea shelf.
There is an estimated deposit of 2 trillion cubic meters of gas in that field, according to the Institute of Energy and Finance in Moscow.
Ukraine’s Energy Minister Yuriy Prodan says a fair price for Russian gas is $285. To get that price, Ukraine filed a lawsuit to Stockholm Arbitration Court in June.
Gazprom has been trying to make many of its EU clients pay around $485 per 1,000 cubic meters of gas, but most of them successfully sued in Stockholm for a better price. “Gazprom’s average gas price for neighboring countries stands at $270,” says Mikhail Korchemkin, executive director of East European Gas Analysis, a Pennsylvania-based energy consultancy.
Korchemkin faults ex-Prime Minister Yulia Tymoshenko for signing a deal with Rusia’s Gazprom in 2009 that allowed for a price of up to $485 per 1,000 cubic meters.
Ukraine signed a contract with Norway’s Statoil, Western Europe’s biggest oil and gas producer, on Oct. 1 to diversify gas supplies. But each side isn’t divulging the details, including volume.
Weekly newspaper Dzerkalo Tyzhnya, citing anonymous sources at the Energy Ministry, reported that Ukraine secured the price of $340 and 11 million cubic meters a day in volume.
That’s half of what Poland and Slovakia supply Ukraine daily through a reverse flow, and could provide as much as 1 billion cubic meters by year’s end.
Hungary, Poland and Slovakia sold Ukraine 2.3 billion cubic meters of natural gas of Russian origin since the beginning of the year. On Sept. 25, Hungary stopped supplying gas because Russia had refused to supply above the contracted volumes to make sure nothing gets resold to Ukraine.
The current government and management of Naftogaz say they want to sell large minority stakes in the energy behemoth’s gas storage and transportation units, preferably to a foreign investor. Deloitte and EY have been hired to conduct an evaluation and financial audit. The cost of the contract is $2.5 million.
Kyiv Post associate business editor Ivan Verstyuk can be reached at [email protected].
