ALACO DISPATCHES: Ukraine’s Naftogaz still stymied by gas market monopolies

ALACO DISPATCHES: Ukraine’s Naftogaz still stymied by gas market monopolies
Naftogaz is pressuring national authorities to root out “unnecessary intermediaries” which increase the cost of gas for end-users.
By Jonathan Melliss of Alaco July 7, 2017

Substantial reforms of Ukraine’s Naftogaz have markedly improved the finances of the formerly loss-making, state-owned oil and gas company, but its revenue-generating potential continues to be held back by a retail gas distribution market dominated by monopolies owned by prominent businessmen from the Yanukovych era.

Naftogaz recently renewed concerns over the ownership of the country’s retail gas distributors. Amid otherwise encouraging news about its finances, the company has pointed out that these operators are a hindrance to reducing consumer prices, amongst the highest in Europe. Naftogaz is obliged by the government to sell gas to households through these companies. The issue has been given added urgency ahead of the proposed full liberalisation of gas prices in April 2018.

Naftogaz’s concerns appear to be focused on one of the most controversial players in retail gas distribution, Dmytro Firtash. He remains a powerful figure in the sector despite being subject to arrest warrants from Spain and the US and the government’s declared commitment to curb the influence of his like.

In its recently published annual report, Naftogaz revealed a $1bn profit, the first for five years, enabling it to become a net contributor to the Ukrainian budget, not achieved since 2006. Prior to the appointment of a new management team post-Maidan, Naftogaz was considered a byword for elite corruption and used as a political cash cow by successive governments.

The reforms of Naftogaz, much heralded by the European energy community, have allowed it to dramatically decrease total gas imports and diversify its list of suppliers, bringing about substantial savings.  Key reforms included the introduction of a reverse gas supply from the EU – the process by which Ukraine now acquires its gas from European gas traders – and the use of the government’s e-procurement portal Prozorro, making company tenders, formerly fertile ground for backhanders and cronyism, more transparent. Naftogaz’s use of the new procurement portal reportedly saved the company over $50mn in 2016.

A possible threat to the company’s financial turnaround was averted at the end of May when the Stockholm Arbitral Tribunal rejected Gazprom’s $45bn claim to enforce the terms of a 2009 ‘take-or-pay’ gas sales contract with Naftogaz. The final hearing, at which the amount Naftogaz might demand from Gazprom will be decided, should be held before the end of the summer.

Naftogaz’s progress is one of the brightest spots of the post-Maidan reform programme in Ukraine, but its management appears to be increasingly frustrated at the lack of government commitment to fully support domestic gas market reform, seen as a brake on the company’s further commercial development.

The government requires Naftogaz to sell gas to consumers through a select group of formerly state-owned regional gas supply companies. The latter, sold to a small number of businessmen that had been favoured during the Yanukovych era, effectively act as mini-monopolies.

A wry line in its annual report, published in May, reflects the company’s frustration with the current state of affairs. “The situation is complicated by the fact that the majority of gas distribution networks and regional gas supply companies are jointly owned by a dominant business group,” it says.

The line refers to holding company Group DF, controlled by Firtash, who is widely acknowledged to have benefited hugely from the gas trade between Russia to Ukraine over the last ten years and was a key figure in cementing the close ties between the Yanukovych government and the Kremlin. Firtash is even alleged to have owned businesses alongside organised crime figure Semyon Mogilevich – claims Firtash has denied on numerous occasions.

One month prior to the publication of the annual report, Naftogaz released a press statement in which it called on the Ukrainian government and the country’s regulatory bodies to put an end to Firtash’s continued domination of the retail gas market. It described distributing companies as “unnecessary intermediaries” which increase the cost of gas for end-users.  In response to Naftogaz’s request, Prime Minister Volodymyr Groysman instructed First Deputy Prime Minister Stepan Kubiv to set up a working group made of Rada Deputies, ministry officials and civil servants from the Antimonopoly Committee to examine Firtash’s position in the market.

A spokesperson for Group DF has described Naftogaz’s claims as false, and blamed the state company for the high price of retail gas. Firtash has in the past argued that Naftogaz should buy gas directly from Russia rather than pay over the odds for supplies from EU countries.

Firtash’s continued role in the supply of gas to millions of Ukrainian households – and his resulting profits – is surprising to say the least. In February this year the Higher Regional Court of Vienna allowed his extradition from Austria to the US on charges that he bribed state and central government officials in India to allow him to mine titanium in the country.

The drama of the court’s decision was heightened moments later when Firtash was arrested by plainclothes Austrian policemen on charges of money laundering and organised crime affiliation brought by Spanish magistrates. Reports suggest Firtash will not be extradited to the US until the Spanish claim has been dealt with by the Austrian court system. He has been released on bail but not allowed to leave Austria.

Whatever the eventual outcome of the investigations, it is striking that a government which ceaselessly professes its commitment to ridding the country of oligarchs, permits regional gas distribution monopolies to be owned by such men.

Jonathan Melliss is a senior analyst at Alaco. Alaco Dispatches is the business intelligence consultancy’s take on events and developments shaping the CEE/CIS region.