INTERVIEW: A future Ukrainian oil champion made in Belgium

By bne IntelliNews March 28, 2011

Graham Stack in Kyiv -

In a move unique to the former Soviet Union, Ukraine's government has appointed a Westerner to run the ailing national oil and gas producer Ukrnafta with a brief to reverse the decline in production and transform the company into a national champion.

Belgian investment banker and ex-head of Renaissance Capital Ukraine, Peter Vanhecke, was a surprise choice to head Ukrnafta - a company debilitated in recent years by a shareholder struggle between the state with 50% plus one share and minority shareholders linked to the owners of PrivatBank, the country's largest lender, holding upwards of 42%. In fact, he was doubly a surprise, as not only is he not a Ukrainian national, but he's also an investment banker new to the oil and gas industry.

Only four days into the job and Vanhecke was already talking to journalists, even though he still has no PA. His Ukrainian predecessor was invisible to the press. Ukrnafta's headquarters also lacks a reception, and the $5bn market-cap, 29,000-employee strong company doesn't have an English-language website either. It's a job many would have balked at, but Vanhecke regards it as a challenge. "I didn't take the job for the company that Ukrnafta is, but the company it could be," he says.

Vanhecke says he was initially surprised when contacted mid-January on whether he would throw his hat into the ring for the position, and it was only at the annual general meeting (AGM) on March 25 that voted him in that he knew he had the job. In itself, the selection process was a minor revolution for Ukraine, where insiders usually rule the roost. "There was an objective search to find a CEO," he tells bne in an exclusive interview. "People find that hard to believe, but it was done, and along two routes - one to find an industry expert, and the other to find to find someone with management skills and also financial savvy. I was interviewed separately by the two main shareholder groups to see whether they had my support. It was open and transparent. In both cases, they wanted to understand the strategy and logic of what I wanted to do."

"If you analyse this as a business, there are clearly strategic challenges, but do they require oil and gas experts? They probably require strategic and financial knowledge more. My skill set is oriented towards transforming this business. The shareholders share the same vision going forward - this is a business that needs capital investment, and needs it rapidly, needs harmony between shareholders and needs a level of efficiency that is not in the business right now. If they didn't want change, they would not have appointed me."

"I am here with a mandate, I am not here to be a patsy for anyone. The shareholders said: 'get to know the company, formulate a strategy and implement it'. They have given me very high, broad and specific goals to achieve: to make this a viable long-term company that is funded sufficiently to achieve this... That gives me a level of freedom to do what I can."

National champ

Vanhecke's aim is to turn the company into a national champion equivalent to regional peers like Austria's OMV, Hungary's Mol and Poland's PKN Orlen. A tall order, but not the first for Vanhecke. "I compare it to what I did in the Russian vodka sector, 2004-05. At the time, there were 400 distilleries, and everyone said" 'you're nuts, don't spend time on this, it's dodgy, you can never do a deal, no foreigners will go there'. Three years later, we did all these deals and consolidated the sector."

During his time in Russia working for investment bank Renaissance Capital, which he then headed in Ukraine, Vanhecke also witnessed how oil companies abandoned Soviet ways and introduced modern western technologies to work depleted fields and squeeze more oil out of them. For a company like Ukrnafta faced with falling extraction levels - the figure for January-February was 7.5% down on the previous year - reversing this decline is an overriding task. "There are no 20 options left for this company," he says. "If you look at the production levels, it's not like they have the freedom left to wait another five years."

The question is: how to stop the rot? This is where Vanhecke, only days into the job, is looking for answers. Besides introducing new technologies to squeeze more out of existing assets, he says foreign operations are possible. "Why limit ourselves to Ukraine? If you look at other regional peers, you see that typically, when faced with a situation when domestic assets were reaching their limits, they started looking further afield. But you need to do this in a very clever way."

At home, Vanhecke says that as the national producer Ukrnafta "should be all over" the Black Sea shelf where oil companies of the littoral countries and international oil companies are investing heavily, although he acknowledges the company lacks offshore drilling experience.

Improving production, says Vanhecke, will require massive capital investment and thus fund raising. But how much exactly is very difficult to predict. Ukraine has a low-key history in terms of capital market transactions both on the debt side and on the equity side, and a lot will depend on market appetite. Vanhecke says he is still in the process of analysing how big the company's capital needs are, and developing an optimal capital structure. Crucial is for the company to be able to absorb the capital it raises. "The worst thing is for the company to get in a big amount of money, without having an immediate focus for its use. Raising money for the sake of raising money, and pumping it into old technology that is proved to be not optimal, is wrong," says Vanhecke.

An upcoming March 22 extraordinary general meeting is set to vote on an up to 25% share issue that could bring in as much as $1.3bn. If the share issue goes ahead, Vanhecke sees the key spending priority as fixing the production side of the business. "An oil and gas company's life blood is production," he says.

Fixing the model

Vanhecke identifies as a second priority "fixing" the business model. Ukrnafta is the largest oil and gas producer in Ukraine with one of the biggest retail networks, but has nothing in between, ie. no refining capacity.

Ukraine's largest refinery by installed capacity, the Kremenchug refinery, belongs to Ukrtatnafta, a company that has the same main shareholders as Ukrnafta - the state with 43% and Privat group with 19%. Privat group controls a couple of other smaller refineries in West Ukraine, Drogobych and Nadvirna, in which the state also holds a blocking stake. Discussion of a merger between Ukrnafta and Ukrtatnafta in particular has been a hot topic for years now. "This question has an economic component and a shareholder component, and it is not for the CEO to figure how the latter component might work. My task regarding any acquisition is to safeguard shareholder value, so anything we do has to fit into an economic and value logic," says Vanhecke. "Does anybody actually know the financials of this business Ukrtatanafta? If the occasion comes, let's just work through the financials and see what that means. But if you look at the business models that should be our peers - Mol, Orlen, OMV - these are business models that are fully or partly integrated."

Vanhecke notes, however, that the legislative framework in the EU is different from that in Ukraine. One noticeable difference currently in the focus of public debate is that Ukraine imports motor fuel with zero duties, and the share of imported gasoline on the market, according to recent statements by Prime Minister Mykola Azarov, has reached 60%, making domestic refineries loss-making and possibly facing closure. But introducing import duty at a time of sharply rising gasoline prices would be politically difficult. "The current legislation needs to make it such that something is economically viable," says Vanhecke. "Just to add something to the business that is loss-making, is not necessarily the right decision... Ukrtatnafta will need to present an economic logic in order to be considered."

Another legislative issue is the price paid for Ukraine's domestically produced gas. One of the previous bones of contention between Privat group and the state has been the state's requirement for the company to sell its gas to households and utilities at regulated prices several times less than the prices charged to industrial companies for imported Russian gas. "This is a topic for the government," says Vanhecke. "We will, of course, comply with existing legislation. On the other hand, the best way to serve the population is to make this a company which is as highly capitalised as possible. What is good for all shareholders is by definition good for the Ukrainian state."

Vanhecke also dismisses the criticism that the company is a book with seven seals, pointing out it's audited by Ernst & Young according to International Financial Reporting Standards. "It's a complex business of course, but I've seen businesses in this part of the world where the only thing you can get are some management accounts on a spreadsheet."

Vanhecke compares running the company to running marathons. Topics like unconventional gas and offshore drilling are like "thinking about how tired you might be at kilometre 30. You need to finish kilometre 1 and 2 first."

Vanhecke's first kilometre at Ukrnafta will be building a management team. He admits to being pleasantly surprised with the talent pool internally, but that fresh blood with an international mindset will also be necessary. Moreover, he intends to upgrade management's English qualifications for better international communication, while working on his own local language skills. "But should Peter be learning Ukrainian, or should it not really be Ukrnafta learning English?" he asks.

INTERVIEW: A future Ukrainian oil champion made in Belgium

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