Ukraine’s Energy War with Russia, Canadian Gas Magazine

by Diane Francis

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INTERNATIONAL
The Demand for Energy Security in Ukraine – Interview with Andriy Kobolev, Chairman and CEO of Naftogaz
by Diane Francis
Issue 4, 2015
Diane Francis visited Ukraine in June as a journalist, the latest of her many visits there dating back to 1992. She wrote this about the country’s natural gas monopoly Naftogaz, Ukraine’s largest corporation, and the 12th largest corporation in Eastern Europe. Naftogaz’s history has been controversial, due to corruption. She, and others, sat down with Naftogaz Chairman and CEO Andriy Kobolev and his team who provided an overview of the state of their business during their country’s and company’s most turbulent years.

Natural gas is a preferred fuel around the world because of its low cost and low emissions compared with other fuels. So you would think that being CEO of one of the world’s largest oil and natural gas utilities, with significant supplies and a huge export market, is a plum assignment.

Flag of Ukraine.
Flag of Ukraine.
But you would be wrong.

In March 2014, Andriy Kobolev, 37, took over the reins of Naftogaz after the former CEO was investigated concerning a massive fraud. His ascension came just one month after the country’s then-President fled to Russia following Ukraine’s second revolution in a decade against political corruption and pro-Russian policies. Since that President’s departure, nine per cent of the country has been occupied with Russian help, prompting regional fighting that has led to an estimated 8,000 deaths and the displacement of 1.4 million from their cities and towns. Russia denies direct involvement, but most of Europe (including the Ukrainian government) disputes that and has imposed tough sanctions on Russia in protest.

“Naftogaz is a state-owned monopoly that controls exploration, production and distribution of oil and natural gas.”
“Now 60 per cent, of gas destined for Central and Western Europe flows through the Naftogaz system.”

Now a reform-minded government and international pressure on its President in Kiev expects a restructuring of the country and Naftogaz is central to the effort. The company is a state-owned monopoly that controls exploration, production and distribution of oil and natural gas throughout this country of 45 million.

Ukraine is the largest country in Europe, twice the size of Germany.

The shooting war in 2014 between Russia and Ukraine may be new, but natural gas wars between the two have been constant. Russia provides Europe with roughly 30 per cent of its gas and as much as 80 per cent, now 60 per cent, of gas destined for Central and Western Europe flows through the Naftogaz system.

Kobolev, a management consultant, is stern in his delivery and speaks flawless English as he outlines his mandate and strategy of eliminating losses and dependence on Russia for supplies. He is flanked on either side by operations, communications and legal executives.

“We need Russian gas for balancing purposes only and have signed, long-term contracts that will prevent them [the Russians] from playing their usual winter game,” he said bluntly.

The “game” he refers to has been Russia’s tactic of cutting off Ukraine from supplies over late payments, price disputes or, as happened last month, in protest against the fact that a debt payment deadline to Moscow, involving $120 million, was missed due to debt restructuring talks with the IMF and others. Since 1993-94, Ukraine and, the various European countries served by its pipelines, have had major supply disruptions so a priority is to wean Ukraine’s dependency on Russian.

Naftogaz has nearly eliminated dependency on Russian gas in the last year, he said, by virtue of increased home production, lower consumption and “reverse flow” arrangements. These allow Ukraine to buy surplus gas more cheaply from European countries. But, because that gas was from Russia’s Gazprom, Moscow claims such arrangements are illegal so that’s another wrangle between the two sides.

The government in Kiev also decided to dramatically increase the cost of natural gas because subsidizing household gas is unaffordable. “We are increasing tariffs and will subsidize those who need it,” said Ukraine’s Minister of Economics Aivaras Abromavicius in a separate interview in Kiev. Government support will remain only for low-income residents.

In some years, Ukraine used seven times’ more gas than neighboring Poland, the latter with an economy seven times’ larger. “This was not fraud,” suggested Kobolev “but wasted gas because it was virtually free.” The result will be that losses, or deficits, should drop from US$3.9 billion this year (2015) to US$1 billion next year. Total revenues are roughly US$9 billion.

View of the Lavra and Dnipro in Kiev, Ukraine.

“Naftogaz intends to recoup damages from Russia for the confiscation of its assets in Crimea and elsewhere.”
The company intends to recoup damages from Russia for the confiscation of its assets in Crimea and elsewhere “where our companies were kidnapped by the Russians,” he said. Claims will be in the billions. Then there’s the crossfire litigation between Gazprom’s $24-billion claim against Naftogaz over unused, but contracted gas, and Ukraine’s $16-billion claim for losses incurred because of an unfair contract.

Government prosecutors are also investigating some suppliers, customers and former executives for various types of fraud such as government subsidy or kickback schemes. In 2014, financier and philanthropist George Soros described Naftogaz as “a black hole in the budget and major source of corruption” that should be reformed to eliminate dependence on Russian gas. In 2014, a Radio Free Europe documentary featured the expensive mansions of Naftogaz executives who were paid small salaries.

“There was a great deal of fraud and the prosecutors are supposed to be looking at this,” he said in an interview in Kiev. “We believe that they are not doing enough. [These people and companies] are not even hiding somewhere.”

Preventing this in the future, the government is corporatizing Naftogaz by creating an independent board of directors, western corporate governance requirements and a requirement for transparent operations, financial statements and procurement practices. So far, so good.

What’s admirable is Kobolev has built a tough and determined team under extraordinarily difficult conditions. Hopefully, they will continue to keep the heat and lights on for the embattled Ukrainian people.

Diane Francis, editor at large, National Post and author of “Merger of the Century: Why Canada and America Should Become One Country. Published in Energy Magazine, Canadian Gas Association .

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