Naftogas Ukrainiy: Its Future Prospects and Dilemmas

by Anna Bartkiv

On the 3rd of March 2014 Arseniy Yatsenyuk announced that Naftogas Ukrainy shall be privatized. In his eyes it is a burden for the Ukrainian economy and by privatizing it Ukraine will no longer accumulate astonishing debts to Gazprom, amounting to almost $3.3 billion as it was in the beginning of this year. He called Naftogas a “burden for the budget and nontransparent monster”. He proposed to sell Naftogas and its “daughter” companies, such as Chernomorneftegaz, through clear auctions, as it will help fight corruption in Ukraine.

Experts have been questioning the reasons behind such a statement; does Yatsenyuk really care for the future of his motherland or is this a repetition of old scenarios played out in Ukraine, such as the notorious privatization of Kryvorizhstal, in which Rinat Akhmetov, the richest man in Ukraine, and Viktor Pinchuk, the son-in-law of ex-president Kuchma? (According to a 2004 article in the Telegraph, the two Ukrainian businessmen paid $800 million for the state-owned property despite the submission of bids almost twice that sum) Whenever anything is changed in the political realm one has to ask himself: in whose interests is this change? This especially concerns Former Soviet Union countries where political cliques are the true determinant of political paths and almost no deal can be finalized without a bribe.

If Naftogas were privately owned right now, it would have no real competitors and therefore the government would need to understand how to prevent it from taking advantage of its dominant position.

But let us first examine the very nature of Naftogas, its prospects and the future dilemmas that makes it such a hot topic. The National Joint Stock Company Naftogas of Ukraine is the leading enterprise in Ukraine’s fuel and energy complex. According to the Kyiv Post, Naftogas comprises Ukraine’s largest oil and gas extraction activity and it holds a monopoly on the transit and storage of natural gas in underground storage facilities. It produces one eighth of the country’s gross domestic product and provides one tenth of the state budget revenues. Consequently, these characteristics make it an extremely valuable asset for the state and its people.

Pros and Cons of Naftogas Privatization

From a purely economical point of view there are number of advantages and disadvantages of privatization presented in this paper. The advantages include improved efficiency, which would highly benefit Ukraine’s economy, considering that energy inefficiency is the main reason behind its dependence on Russia. Also, the lack of political interference that would come from privatization would be great in theory since the political situation is so unstable and depending on who is in power, state-owned companies serve only those who are in charge. Additionally, increased competition would raise its efficiency, especially if new companies were to form. Finally, from the sale of Naftogas the government could raise revenue, which Ukraine needs in light of the current economic situation and multiple debts.

There are, however, certain limitations to the benefits of privatization. The problem with natural monopolies, like Naftogas, is that if they are left unregulated, they will produce much less and charge a price much higher than what is socially optimal (where marginal benefit equals marginal cost). For instance, if Naftogas were privately owned right now, it would have no real competitors and therefore the government would need to understand how to prevent it from taking advantage of its dominant position. Importantly, the prices, which are heavily subsidized (87 cents from each dollar) for the households, are rising anyway as the import price goes up, some predict up to $500 per mcm – twofold after Gazprom’s discount is lifted. If the subsidy is not eliminated, then the government would continue paying, draining the budget. Another disadvantage is that the government would lose potential dividends.

The current government is trying to demonstrate that it lives according to European laws and operates within the Third Energy Package, hence the explanation why now it is now considering the privatization of Naftogas – it might please the European authorities.

Now, if we turn to the political side of the debate, the picture differs. It is no secret that in Ukraine’s case, politics will be heavily involved in the decision making, therefore one needs to consider local dynamics carefully.

Pandering to the EU and Other Political Factors

There is a reason behind Yatsenyuk’s statement about the privatization of Naftogas. First of all, Yatsenyuk claims subsidies are bad in the long run because they make the economy weak and crippled by constant financial support. European states, especially the Baltics, the logic goes, suffered in the beginning from the transition away from cheap gas prices but are now some of the strongest states and since Ukraine wants to be a European state it should act like one. Plus, the IMF advised the current government to raise the price for customers by 50% in exchange for a loan. However, experts claim that the reason why Europe has such high prices is very different. High prices are conscious policy in Europe designed to stimulate the development of renewables. Ukraine with its current economy is incapable of focusing on developing renewables.

The second part of the question of the whole privatization matter is who would buy Naftogas? Konstantin Simlonov, the general director of national energy security in Russia, claimed Gazprom doesn’t need Naftogas and of course now nobody would sell it to Russia taking the current situation into account. The current government is trying to demonstrate that it lives according to European laws and operates within the Third Energy Package, hence the explanation why now it is now considering the privatization of Naftogas – it might please the European authorities. Another reason is that it is in the finest Ukrainian traditions to reject whatever has been done before by the previous government; this may simply be a PR move before the upcoming presidential elections in May 2014. Yatsenyuk is trying to portray himself as a forward looking young leader who will revitalize Ukraine’s economy and carry out lustration, that is, getting rid of previous corrupt politicians.

Time to Settle Old Scores?

Yatsenyuk’s plan to privatize Naftogas has faced more criticism than support from the experts for several reasons. The current scenario resembles vendetta rather than lustration. Take, for example, the arrest of Evgeniy Bakulin, the former head of Naftogas. He was accused by the new minister of Internal Affairs, Arsen Avakov, on his Facebook page, of stealing up to $4 billion by way of corrupt schemes involving the transport of Russia’s gas. Ukrainian political expert, Aleksey Blyminov, claims Bakulin’s arrest is related to Firtash’s arrest in Vienna on the 13th of March. He believes the arrest is a direct consequence of Firtash’s arrest. This is due to the fact that Bakulin was an important player in the corruption scheme of Firtash Sergey Levochkin, a Ukrainian politician – and Yuri Boiko, the former Energy Minister. Additionally, as Yulia Timoshenko is out of prison, she is finishing her personal lustration of Rosukraenergo, that she started in 2009, through the hands of her people Aleksander Turchinov, who is the Rada’s current speaker. Probably, next in line is the former minister Yuri Boiko, says Blyminov. The real question is whether the current government with the new Energy minister Yuri Prodan is interested in total liquidation of old corruption schemes, or if this is really about remonopolizing old sources of shadow income, as we saw take place after the Orange Revolution ten years ago.

The real question is whether the current government with the new Energy minister Yuri Prodan is interested in total liquidation of old corruption schemes, or if this is really about re-monopolizing old sources of shadow income, as we saw take place after the Orange Revolution ten years ago.

It is worth reminding that Boiko, when he was a deputy prime minister, claimed that Naftogas needed to be privatized and that the main reason for this was its lack of transparency. Therefore, the logic was similar, but the governments are different. During Yanukovich’s presidency, the consultancy group Ernst & Young advised privatization as a means to fight corruption. When Boiko was Energy Minister, the opposition was against it, because there was a fear that Gazprom would have bought shares of Naftogas in a 50-50 joint venture, which would have given Russia easy access to the EU market. Control over the gas transportation system of Ukraine by Gazprom could have brought risks to the access to the system for future unconventional gas, particularly if Ukraine were to withdraw from the EU’s Energy Charter Treaty – and thus Third Energy Package. Such developments could have forced international companies such as Chevron to leave or led to the reformatting of PSAs with the inclusion of Gazprom – or its affiliated companies – in the PSAs, according to shalegas.in.ua.

Issues Involving Price Levels and Legal Procedures

Andrey Pinchuk, a member of the Party of Regions – Yanukovich’s old party, claims that privatization of Naftogas could harm Ukraine’s economy. His reason is that Naftogas is subsidizing the prices for gas and oil for end consumers, and if Naftogas were to become a purely commercial organization, a lot of Ukrainian citizens would find themselves in a difficult situation in which the prices would be even higher than before the discount that Russia’s Gazprom is about to lift. Or, the government would end up paying the difference as before and therefore continuing to drain its budget. Thus, according to him, Naftogas has to remain state-owned due to its social role. He also claimed that the eagerness of the current government to make changes now in such unstable time could bring a lot of unresolved questions later. Therefore, before selling Naftogas, the state needs to make sure it will be able to control its social agenda (low prices) and assure that the auction is really clean as a whistle as Yatsenyuk claims it will be.

Yatsenyuk is eager to proceed with privatization ASAP, but Pinchuk says there is a specific law that states that bids must be organized exactly in a month, no shorter. In general, the legality of such a procedure is questioned. “Structures like Naftogaz are not privatized in accordance with the regular procedures. They can be turned into joint-stock societies which can place a small portion of their shares on exchanges. However, it’s a totally different thing. I don’t think privatization in which a package of shares is sold at auction is possible,” said Ukraine’s State Property Fund Director Oleksandr Riabchenko in late 2012. The law hasn’t been changed yet and therefore his claim remains legitimate.

The true motives of Yatsenyuk are questionable and worth examining. We don’t know who will want to buy this inefficient “monster” and whether privatization will really happen, or if this is just an empty threat, among many.

Vitally, Naftogas has shares in a couple of “daughter” companies. For example, Ukrgasdobycha (a Ukrainian gas extraction company) formally was under Naftogas, but it was claimed that its previous head (who was replaced this month) was Firtash’s man. In Ukranfta, Naftogas has 50% shares (48% are owned by “Privat Bank”) and in this case, commercial interests are the priority for its management. Ukrnafta has already received the right to sell part of its extracted gas not by regulated, but by commercial prices. Logically this might happen to other companies such Ukrgasdobycha. Currently, Naftogas and its daughter companies operate under the conditions of low internal prices that are not profitable, but if this were to change to realization of commercial prices, the stakes would be much higher. Importantly, Ukraine’s situation is one of almost total cronyism and corruption and such machinations will be implemented without people’s interests.

And finally, regional gas distribution companies “облгазы” that were privatized mostly by Firtash a year and a half ago were of little interest – old infrastructure requiring billions of investment with low regulated prices. If the prices became commercial, then these “oblgasi” would be much more valuable. Subsidies covering extra profit for the future owners of Naftogas in the event of its privatization would most likely be needed from the state. If not, a lot of people would be unable to pay their gas bills without substantial sacrifices. Luckily for the people, Yatsenyuk claimed the Ukrainian government will continue paying the subsidies, with two thirds of the population receiving them despite the 50% increase in prices after May 1.

To conclude, if Naftogas is privatized it will serve foremost political interests of the current government rather than those of ordinary citizens. The true motives of Yatsenyuk are questionable and worth examining. We don’t know who will want to buy this inefficient “monster” and whether this will really happen, or if this is just an empty threat among many.

Anna Bartkiv is an MA student in the ENERPO program at European University at St. Petersburg.

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