Private Ukrainian gas importer ready to take the Odesa Port Plant challenge

Private Ukrainian gas importer ready to take the Odesa Port Plant challenge
Odesa Port Plant (OPP) is the biggest enterprise in Ukraine's privatisation list.
By Mark Raczkiewycz in Kyiv June 7, 2017

Two weeks after the Ukrainian government failed for a second time to sell one of its most prized assets – Odesa Portside Plant (OPP) – the lossmaking enterprise sent out a veiled cry for help.

The country's largest fertiliser maker, which the State Property Fund (SPF) revalued at $200mn instead of the initial starting price of $530mn, offered its “whole property complex” on Ukraine’s Black Sea coast for rent in a statement on its website and in emailed messages to past bidders on December 27.

The plant was facing closure because in just four days the state-owned energy holding company Naftogaz would cut off natural gas supplies over an overdue gas bill worth more than $38mn. Given that gas accounts for 80% of production costs, the fate of 4,000 qualified employees was in peril and the plant risked standing idle, leading to irreversible damage to expensive equipment.

It was basically an “SOS call”, says Andrew Favorov, one of the three co-owners of Energy Resources Ukraine (ERU), the nation’s largest private gas importer. “They [OPP] sent out calls for proposals to anybody who knew how to spell ‘natural gas’ asking them to bring it back online.”

ERU in late February stepped in with a proposal to provide the plant with gas in return for fertilisers to sell on the market. Although the agreed terms are confidential, the deal was clearly risky for ERU as gas is purchased via forward contracts, whereas fertilisers are sold through spot transactions.

“I think there was no one else crazy to make such a proposal,” Favorov tells bne IntilliNews in a recent interview on the rooftop terrace of his office in Kyiv, referring to the contract that runs through this year. “As a trader, we’re trying to catch the positive spread where natural gas after conversion fee [to make it fertiliser] is cheaper than the market price for fertiliser.” 

In turn, the plant’s acting manager Serhiy Nazarenko says: “We welcome an opportunity to restart the operation of our plant … to ensure the economic viability … of this stalwart of [the] Ukrainian fertiliser industry.”

Ugly cloud

ERU is now seriously considering taking the next step to bid for OPP should the government attempt a third sale by the end of 2017, despite the plant's many problems. 

Situated 46km east of Odesa at the strategically located Yuzhniy port from which it exports over 90% of its output, the plant owes $38mn to the state for gas. 

And buyers have been afraid of inheriting almost $200mn of debt that the plant allegedly owes to exiled oligarch Dmytro Firtash’s Ostchem Holding in Austria for gas. Although the State Property Fund on May 13 appealed a lower court’s ruling in Odesa in favour of Ostchem, the Arbitration Institute of the Stockholm Chamber of Commerce has already sided with the Vienna-based company.

Investors have also become wary of ownership claims towards the plant by another Ukrainian oligarch, Ihor Kolomoisky, based on a 2006 auction in which his company took part, but which the government later scrapped.

Ongoing corruption and fraud scandals at the port have also cast an unfavourable light on the whole business.

The property fund’s continuing failure to sell the plant only illustrates the headaches tied to the Ukrainian state having some 3,500 companies on its balance sheet – excluding utility companies – with only a third being profitable last year, according to official statistics.

The OPP failure has cast an ugly cloud over the government’s hopes of selling off more than 330 companies by the end of 2017. “I would dismiss everyone who manages SPF if this were in my power, everyone would have been fired,” Prime Minister Volodymyr Groysman thundered at a cabinet meeting. Overall, the SPF raised only 1% of the $630mn privatisation revenue target for 2016.

Solid track record

But some in Ukraine’s investment banking community think ERU’s potential bid could increase the plant's valuation.  

Market insiders are already familiar with ERU’s three managing partners and owners. Favorov, a Moscow native turned US citizen, made history in Kazakhstan in 2008 with another partner, American Dale Perry. Employed by Virginia-based AES Corporation, the two helped clean up a 4,000-megawatt power plant, introduced transparency, and eventually sold the asset for $1.5bn to a mining company owned by Kazakh billionaire Vladimir Kim. 

Favorov then joined his other ERU managing partner Yaroslav Mudriy at DTEK, the biggest private energy company in Ukraine belonging to the country’s richest person Rinat Akhmetov. There they contributed to introducing “best international practices to trading”, Favorov says. Starting on the organisational level, to the front, main and back offices, the two helped get “Ukrainian-produced coal to the customer while minimising all sorts of leakage along the way”, he added.

“The ERU team has a long track record of cleaning up assets in the CIS and now that they have set their sights on Odesa Portside Plant, I think this bodes well,” says Nick Piazza, CEO and founder of SP Advisors in Kyiv, Ukraine. "They will show what can be done with traditionally poorly managed state assets when a Western management team comes in and operates the business transparently.” 

Industry players already know ERU for being the first company to start bringing reverse gas into Ukraine in 2013, a move that has eventually led Ukraine to cease gas imports from Russia, now seen by Kyiv as an aggressor state after the seizure and annexation of Crimea in 2014.

ERU has also taken advantage of the gas market opening up in the industrial sector, which accounts for about one third of total gas use in Ukraine.  In December, it competed successfully against Naftogaz and international giant Dutch-based Trafigura to supply the state-owned gas transport and storage company UkrTransGaz with 218mn cu m of technical gas, said Mudriy, the company’s commercial director.

Drilling for hydrocarbons is planned next, with ERU in the testing phase of using a gas gun to explore for hydrocarbons, which is considered by environmentalists to be much safer than hydrofracking. As of late spring, ERU will start to explore for energy sources in Ukraine’s eastern Poltava region.

 

Andrew Favorov is confident ERU can resurrect Odesa Port Plant

But ERU has already encountered speed bumps in its deal with OPP. An ammonia pipeline that OPP operates from Russia all the way to the Odesa region port became operational again when ERU’s contract came into force, following several interruptions because of the separatist conflict in East Ukraine through which the tubes run. Because Russia subsidises domestic producers gas inputs, making the key fertiliser input nearly one third the cost of Ukrainian producers, ERU has found itself at a severe disadvantage.

It’s an absurd situation,” Favorov said. “Ukraine managed to gain energy independence [from Russia] … What does Russia do with that extra gas? They shove it into the fertiliser and (trans)ship it to Ukraine for the agricultural sector or through Ukraine for exports.”

Relief came on May 18 when Ukraine’s legislature passed a bill that introduces customs tariffs of nearly 32% on Russian fertilisers, though President Petro Poroshenko has yet to sign the new measure into force.

Nevertheless, asked if they are willing to bid for OPP in a third auction round, Favorov says: “Once we find out the terms of the privatisation, we certainly believe we have the understanding and experience to put together a competitive proposal in an open and transparent privatisation.”

If not?

ERU still has the option to extend its contract with the ailing plant once December 31 rolls around.

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