Reforming the Ukrainian Gas Sector

by Roman Kupchinsky

Can the Ukrainian natural gas sector be reformed? For the last two decades the Ukrainian gas business has been one of the least transparent and reportedly most corrupt and mismanaged sectors of the economy. Will this begin changing in 2009-2010?

Ukrainian policy makers and politician’s have resisted reforms tooth and nail because if they were implemented they would not only abolish a system which was so profitable for the political and economic elites, but would further impoverish an already poor population.

However, once the price charged for Russian gas reached European market levels in 2009; hastened by a debilitating shutdown of gas supplies to Europe in January 2009, the European Commission had had enough and began demanding immediate demonstrable reforms.

By June/July 2009 the European Commission finally had the leverage it needed to force Kyiv into taking action. Ukraine lacked the $4 billion needed to pay Russia’s Gazprom for gas to insure uninterrupted supplies to the EU during the fall/winter heating season. Prime Minister Yulia Tymoshenko had asked Russia for a loan - which was rejected - so she turned to the Commission with her request.

At the heart of the problem is the domestic pricing structure for Ukrainian produced gas which is sold to regional communal heating companies which supply heat and hot water to domestic consumers. The price currently charged communal heating companies is $154 per 1,000 cubic meters while the price of Russian gas is $228/1,000 cubic meters – a difference of $74 which is subsidized by the state budget.

On July 17, European banks demanded that these state subsidies end. According to the Commission spokesman Mark Grey, a decision on extending credits to Ukraine will be announced only after the Ukrainian government provides a definitive date when the subsidies will end.

Meanwhile the head of the Ukrainian National Regulating Commission for Power, Valeriy Kalchenko, stated the price of gas for consumers “does not make any economical sense”.

Yet Prime Minister Yulia Tymoshenko, immersed in an upcoming bitter presidential campaign, expressed doubts that the price of gas for Ukrainian consumers will rise in 2009. “Do not believe in rumors. I ask you to wait for the signing of a memorandum and then it will become clear if there will be a price increase or not”.

Earlier, Tymoshenko had promised to increase consumer prices in 2009 by 20 percent, a bare minimal which will not solve the problem according to experts. What is needed is a far greater increase, a proposition few in the Ukrainian government are willing to endorse at this time.

Are reforms likely? Many observers believe they will be postponed until 2010 or later. If so, Europe could well expect another gas delivery crisis this fall.

EU and Ukraine Discuss Gas Loan

by Roman Kupchinsky

Consultations between Ukraine and the EU Commission about Ukraine’s urgent need for a loan to buy Russian gas ended Monday night in Brussels. Ukraine needs the loan to insure a steady flow of gas to Europe in the rapidly approaching heating season.

The EU was optimistic that terms could be worked out; however the size of the loan would be $2 billion, half of the $4 billion Ukraine was seeking. Moreover the Commission attached a number of conditions to the loan, foremost of which is a restructuring of Naftohaz Ukraine, the state-owned Ukrainian gas monopoly in order to improve its transparency. The Commission wants to see Naftohaz split into separate entities which would each be responsible for different functions such as transport, sales, production and storage.

Kommersant Daily reported that the EU was demanding that Ukraine insure the implementation of the March 2009 agreement on renovating the Ukrainian gas pipeline system, an agreement which has come under heavy criticism from Russia.

Ukraine needs to store 19.5 billion cubic meters (bcm) of Russian gas in its underground storage facilities in order to insure an uninterrupted flow of gas to Europe. This gas is used to power compression stations along the route of the Ukrainian pipeline.

The talks included representatives of Gazprom and Naftogaz, the World Bank, the IMF, the EBRD and the EU.

"The participants made good progress in identifying the key issues of concern and elements for possible solutions including possible financing arrangements," the representatives said in a joint statement.

Despite the optimistic prognosis, Russian energy experts and officials were not convinced that the problem could be solved in time for the heating season. One "Gazprom official was quoted as saying “We heard that it would be impossible to finalize the loan before September. This is already too late and we hope that it be agreed upon earlier.”

Russian Gas Update

by Roman Kupchinsky

The European Commission will send a delegation of officials to Moscow and Kyiv in order to ascertain the facts surrounding the latest gas-related tensions between the two neighboring countries the website Ukrayinska Pravda reported on June 4, 2009. The delegation comes on the heels of a statement by Russian Prime Minister Vladimir Putin who warned that if Ukraine is unable to pay its gas bills, the transit of Russian gas to Europe could be stopped by the end of June. The delegation’s report will be crucial for the upcoming EU summit to be held in Brussels on June 17-18.

At issue is Ukraine’s May 2009 gas bill which is due on June 7th and Naftohaz’s ability to pay for gas to be placed in underground storage which is shipped to Europe during the fall-winter heating season. These topics were discussed in Moscow on June 2, 2009 during a meeting between Alexei Miller, the CEO of Gazprom and Oleh Dubyna, the head of Naftohaz Ukrayina, but no results of the talks were reported in the media.

The mysterious case of the sale of the Hungarian gas company Emfesz KFT to an unknown company named RosGas based in Zug, Switzerland resurfaced today. The Russian daily Vedomosti reported that Emfesz was sold to RosGas for $1 by its manager, Istvan Goczi who apparently had a power of attorney to do so. Emfesz is owned by Mabofi Holdings which in turn is controlled by Dmytro Firtash, a Ukrainian businessman who owns 45 percent of RosUkrEnergo (RUE). Russia’s Gazprom owns 50 percent of RUE and 5 percent is owned by Firtash’s partner Ivan Fursin. Emfesz supplied about 20 percent of the Hungarian gas market with gas it purchased from RUE. However, in January 2009 RUE was eliminated from the gas supply chain and could no longer supply Emfesz.

When news of the sale was made public, the British-based organization Global Witness conducted an investigation into RosGas in order to determine who stood behind it. According to their report:

We have been unable to find the company’s office, but have learned that its correspondence address is that of a mobile phone company in the Swiss tax haven of Zug. There is no evidence to suggest that RosGas AG is currently anything more than a shell company. Curiously, the Hungarian Energy Office (HEO) does not seem to know who owns RosGas AG either, despite having rapidly approved its takeover of Emfesz. The HEO said in an emailed response to questions from Global Witness that: “in the resolution we asked for further information in [the] Hungarian language on the new owner’s owner as the full ownership structure was not transparent enough.” A spokesman added that the HEO was seeking information on the “structure of ‘owners’ tree’”, presumably the chain of ownership of the company. RosGas AG is supposed to provide this information within 45 days of the deal being approved. But even if it does not, there is no suggestion from the HEO that its takeover of Emfesz will be cancelled. Instead, the company will merely face a fine.