Graham Stack in Kyiv -

The appointment of a Belgium investment banker as the new head of Ukraine's largest oil and gas producer Ukrnafta has been billed as a breakthrough in terms of bringing management into line with ownership, modernising the company and moving it towards an international IPO. But suspicions remain that it will be a false dawn.

The appointment on February 25 of Peter Vanhecke as CEO raised hopes that the notoriously murky company would enjoy a period of greater value creation and transparency. Despite the state owning 50% plus one share in the company, Ukrnafta has for years been effectively controlled by the shareholders of the country's largest lender PrivatBank, oligarchs Gennady Bogolyubov and Ihor Kolomoisky, whose mutually interlinked financial-industrial interests are commonly referred to as the "Privat group."

Now the company is the first state company in the former Soviet Union to get a western CEO. An apparent sign of how much hope was being put in the new order was a nearly 220% rise in the share price from October 24, when buying seems to have started, through February 25, the date of the recent shareholders' meeting when Vanhecke was appointed. In addition, analysts point to a switch to market-priced sale of Ukrnafta's oil at auction. Previously, Ukrnafta regularly sold oil at prices well below the market price, and sometimes even significantly below production costs, to structures that analysts and media claim are linked to Privat group. Neither Kolomoisky nor Bogolyubov could be reached for comment on this piece.

Until October, Privat group had owned around 42% of Ukrnafta stock, with the state-owned energy company Naftogaz Ukrainy holding 50% plus one share, with the rest free float. Because Ukraine's laws require a 60% quorum for any annual general meeting (AGM), Privat group has historically been able to control Ukrnafta through the company's management, while blocking any attempt to change the management by failing to show up at shareholder meetings and preventing the quorum from being met. But with Ukraine's new government enjoying a large majority in parliament, it could now plausibly change the law and reduce quorums to 50% and so Privat group has been forced into a rethink, say sources. An unusually PR-savvy choice of poaching Vanhecke from investment bank Renaissance Capital Ukraine to serve as CEO seemed to personify a new start.

Not everyone is convinced. Dissecting the results of the AGM, some analysts conclude that the soaring share price was not the result of new investor interest in the stock, but of Privat group structures buying up the free float: the AGM recorded its highest ever quorum of 95.2%, up from 92% at the last AGM. In the apparent absence of any new investors, analysts conclude that Privat group had bought out around 3% of the free float, boosting their stake in the company to above 45%.

New Ukrnafta CEO Peter Vanhecke, however, disputes this was the case: the total volume of trading in the stock in the run-up to the AGM significantly exceeded the free float, he points out to bne in an exclusive interview, indicating the stock was indeed being traded up by investors.

Vertically challenged

A 25% share issue is now on the agenda for an EGM set for March 22 and could net the company up to $1.3bn. Vanhecke is adamant that the first priority for spending any new cash is investing in hydrocarbon production, which was down 11.7% in January-February compared with the same period last year. But he acknowledges that another crucial issue for the company is "fixing the business model." This refers to the fact that Ukrnafta is the country's largest oil and gas producer and owns one of the largest chains of petrol stations, but there is no refining capacity in between. The companies Vanhecke is seeking to emulate at Ukrnafta - national champions such as Austria's OMV, Hungary's Mol and Poland's PKN Orlen - are all vertically integrated including refining capacity.

"Fixing the business model", however, could be more controversial than it sounds, and potentially casts a shadow over the much-hailed fresh start. The reason is that Ukrnafta shareholders - the state and Privat group - also co-own the country's largest refinery at Kremenchug, with the state holding 43% and Privat group 19%. A merger between the two companies has been a hot topic for years.

It is widely held by analysts and the local media that the Kremenchug refinery has been a beneficiary of transfer pricing at Ukrnafta in the past. This did not stop it making over $150m losses in 2010, working at only 30% of its capacity. Now Ukrnafta's critics fear that instead of cash coming in after the new Ukrnafta share issue and being invested in production, the shareholders will instead offer their assets in the Kremenchug refinery and its petrol station chain, and finally merge the two companies.

This sheds new light on the share price surge, say critics. If the merger went ahead, the boosted Ukrnafta market capitalisation combined with the bigger Privat group stake in Ukrnafta would allow Privat group to retain its over 40% stake in the merged company. At the same time, the government's 50% stake would be diluted below a controlling stake. The Privat group would thus be strengthened in the company vis-à-vis the state, retaining its ability to prevent a quorum for shareholder meetings when desired.

At the same time, the merged company would lose the pricing transparency only recently regained at Ukrnafta. The merger might thus see the loss-making refinery fully loaded with oil, but at the cost of the cash needed to stem the production decline, according to oil market analyst Serhiy Kuyun.

Vanhecke acknowledges that part of this story is for the shareholders to decide and outside his remit as CEO. But Vanhecke says he will evaluate any proposed merger only according to shareholder value, and acknowledges that the Kremenchug refinery is financially in a bad situation. He also hints at one other key factor in the equation - whether Ukrnafta's controlling shareholder, the state, will introduce import duties on oil products to support Ukraine's loss-making refineries, which would make any merger more attractive. Currently, with zero duty paid, motor fuel imports hold 40-50% of the market, and many refineries are facing closure.

The government has indicated it wants more protectionism, but is currently terrified of arousing the massed ire of Ukraine's car drivers, already reeling from surging petrol pump prices due to higher oil prices. Ukraine's energy ministry even announced an "informal" price cap on March 14. So with no import duties making an opaque refinery merger less likely at Ukrnafta, Vanhecke's plans to kick-start production at his new company might still get the honeymoon start they need.