EBRD warns Ukrainian leadership of looming collapse of energy sector reform

EBRD warns Ukrainian leadership of looming collapse of energy sector reform
A worker at the Kolodnytsya gas field in the Stryi district of Ukraine's Lviv region.
By Sergei Kuznetsov in Kyiv April 11, 2017

The European Bank for Reconstruction and Development (EBRD) has warned Ukraine’s leadership that the possible collapse of the country’s energy sector reform could “shatter international confidence” in the current government in Kyiv.

According to a confidential letter sent by Sir Suma Chakrabarti to Prime Minister Volodymyr Groysman and President Petro Poroshenko, the chief of the multilateral lender underlined that “the reform of Naftogaz, which is just recognised as one of the most meaningful reforms undertaken under your leadership, is at risk of collapsing within the next few days”. This letter, seen by a bne IntelliNews correspondent in Kyiv, was dated April 7.

The EBRD head said that the implementation of the corporate governance action plan for the state-owned gas utility signed earlier between the bank and the Ukrainian government is being “unduly delayed” by the lack of enactment of the required legislation. After months of consultations, the draft state ownership policy for Naftogaz still contains provisions that go against the spirit of the corporate governance reform, thus compromising the intended independence and insulation of the company from undue political interference, according to the letter.

“Naftogaz also need to become, as originally agreed, an entity of private law,” Chakrabarti added. “I am asking you to do all that is necessary to have Naftogaz’s new charter and necessary enabling legislation in place before the end of this month [April].”

Chakrabarti also warned of negative effects from the threatened resignation of the independent board members of Naftogaz. This move might not only “severely damage” the company at a time when its transformation is finally beginning to take hold, but could also “shatter the international confidence in your government’s commitment” to reform and restructure Naftogaz and other state-owned enterprises in Ukraine, according to the letter.

On April 6, four of the independent board members – Paul Warwick, Markus Richards, Charles Proctor and Yulia Kovaliv – sent a letter to the Ukrainan government indicating their conserns over the situation in the company. Without “material progress” it would be “inappropriate and untenable” for them to continue as supervisory members, they said in the letter.

Specifically, the independent board members demand the “resolution of issues” related to the electronic declarations system of Ukrainian officials. According to recent amendments to Ukrainian legislation, financial disclosure obligations are extended to existing and potential members of supervisory boards of state-owned companies. “It is impossible for foreigners to complete necessary actions with such inaction leading to potential criminal claims against us,” the independent board members wrote.

Chakrabarti also said that the amendments will “seriously discourage worthy candidates” with international experience from applying for such positions and hence deprive the country of much-needed expertise for the transformation and proper governance of state-owned companies.

Stalled transformation

He also urged the Ukrainian government to take “immediate steps” in three main areas: opening of the country’s gas market, reform of the housing and utilities subsidies schemes and reform of the public service obligation for the gas market.

According to the IMF, low tariffs for residential gas and district heating have encouraged excessive energy consumption and led to large quasi-fiscal losses, pushed up gas imports, and discouraged investment in domestic production in Ukraine until recently.

Gas and heating tariffs reached full cost recovery levels in July 2016. Naftogaz’s deficit has now almost been eliminated, the IMF wrote in comments published on April 4. “The large tariff increases to full cost recovery have provided incentives to conserve energy and supported an improvement in energy efficiency and a dramatic decline in household gas consumption and corresponding reduction in macro imbalances,” the IMF added.

On April 11, Naftogaz posted UAH26.53bn (€930.3mn) net profit for 2016 against a net loss of UAH27.75bn in 2015 (audited data).

According to another confidential letter sent by Chakrabarti to Groysman on April 10, also seen by bne IntelliNews, the country has made progress in public procurement, financial sector and monetary policy reforms. However, progress on oil and gas sector reform, the commercialisation and privatisation of state-owned enterprises, and the reform of the judiciary and public administration “has not been so visible”.

Chakrabarti urged the government “to persevere in maintaining the reform momentum and accelerating the delivery of concrete results” in order to unlock further donor support, according to the letter.

The letter followed a new $1bn tranche released by the International Monetary Fund (IMF) in April under its $17.5bn support programme for Ukraine, and a second €600mn tranche of macro-financial assistance from the EU. The IMF, Ukraine’s main creditor, also called upon the country to speed up the pace of reforms and step up the fight against corruption.