Naftogaz, Ukraine’s Biggest Taxpayer, Faces Uncertain Future

On September 19, two members of the independent supervisory board of the state-owned Ukrainian energy giant Naftogaz made a statement in which they announced their intent to resign. Two weeks earlier another member had announced his wish to resign by the end of the month. That was remarkable news, especially if one considers that Naftogaz is one of the biggest companies in Ukraine, certainly the country’s biggest energy operator, and in recent months the biggest taxpayer into state coffers. Furthermore, in that statement the board members cited as one of the main reasons for resigning the government’s obstruction of reforms. Prime Minister Volodymyr Groysman responded that Naftogaz was a monopoly and, in keeping with the EU guidelines along which Ukraine’s new gas market law was drawn up, had to be broken up despite any attempts to resist this move. After the statement appeared, I received a few emails from my colleagues abroad, including the United States, who were concerned about the hidden reasons for that decision and the possible ramifications of such a step. This short article explains the main issues and what is at stake for the company and the government.

Conflicts between the management of Naftogaz and Prime Minister Groysman are nothing new but equally are far from over, and are connected to political battles.

The statements of Naftogaz leaders and Ukrainian prime minister Groysman made clear the growing tension between the monopoly and government. But that was predictable, and the conflict had been in the air for a long time. A few days before the statements mentioned above appeared, the Kyiv Circuit Administrative Court had canceled three permits for gas extraction that had been issued to Naftogaz. The suit was filed at the request of an MP, a member of President Petro Poroshenko’s bloc in the Verkhovna Rada. The Antimonopoly Committee of Ukraine for the first time in its dealings with Naftogaz canceled the gas trading tender announced by Ukrtransgaz (a subsidiary of Naftogaz) that Naftogaz had won (the court claimed) under conditions of noncompetitive behavior. The next day, after the board members issued their statement, the Security Service of Ukraine blocked the appointment of a new CEO of Ukrtransgaz who had been approved by Naftogaz.

The creation of the five-member board  was undertaken as a way to justify the activity of the company’s management, especially decisions concerning any reform of the company. The board members were all reformers who wanted the Ukrainian government to advance corporate reform and permit greater independence of state-owned companies. Three board members were considered to be independent (all came from Europe and all announced their intention to resign in September), one represented the cabinet, and one represented the president of Ukraine. The issuing of statements by board members who intended to resign became a kind of mechanism to push the government into meeting Naftogaz’s requirements. By April 2017 four board members had already mentioned possible retirement should the government not take the steps necessary for the company to continue normal operations. One week later one of the four, the board chair and former Ukrainian deputy minister of economic development and trade Yulia Kovaliv, resigned. She was the board member who had most often supported the decisions of Naftogaz management and the independent members of the board. On both occasions the board members were supported with a statement from the European Bank of Reconstruction and Development (EBRD) saying that board resignations would hinder reform of the company. In addition, the current management of Naftogaz is unofficially supported by U.S. authorities.

Conflicts between the management of Naftogaz and Prime Minister Groysman are nothing new but equally are far from over, and are connected to political battles. For instance, in March 2017 Naftogaz fired the head of Ukrtransgaz, Ihor Prokopiv, who was later appointed to the government to assist in the reform of the energy giant. On a few occasions the government made decisions regarding Naftogaz’s activity that disagreed with those of the company, which did not make the company’s management happy. So it is interesting to note briefly the reasons for the clash. One might imagine that if different state structures, acting independently, file suit against a company, the company has probably done something wrong. But then one is faced with the matter of Western support for Naftogaz’s management, along with the niggling question of whether the agencies were not in fact acting wholly independently but in response to prompts by the executive branch of government.

For decades, Naftogaz was an object of interest for the economic elites because of the rent-seeking possibilities it offered. Gas trading agreements helped earn billions of dollars for oligarchs and top officials. Today, however, the situation is a bit different. After the adoption of a new law on the gas market in Ukraine in 2015, the rules of the game for gas companies changed: Naftogaz had to be “unbundled” to split the functions of extracting, trading, storing, and transporting gas, in line with the requirements of the European Third Energy Package, and final gas prices were increased to be closer to break-even level (rather than substantially below). And in 2016, for the first time in five years, Naftogaz became profitable: its total profit amounted to 26.5 billion UAH (about U.S. $1 billion), and for the first time in ten years the company did not have to be subsidized by the state. Naftogaz became the biggest taxpayer in the country, contributing 16 percent of the state’s income in the first half of 2017. For comparison, in 2014 state financial support for Naftogaz amounted to 110 billion UAH and in 2015 it amounted to 32 billion UAH. On the other hand, the profitability of Naftogaz (without any subsidizing of its losses) led to rapid increases in the cost to the state of subsidizing households’ utilities. (The higher prices were in part pushed by Western partners and financial donors as part of the reform of Ukraine’s gas market.) Moreover, increasing the price that consumers paid for gas noticeably dented the authorities’ popularity, including that of the current prime minister, Groysman.

Naftogaz’s current management is interested in turning the company into a more influential and powerful company or group of companies that would be able to function independently of government policy: extracting and trading gas, supplying it to final consumers instead of to existing intermediary companies, and transiting gas from Russia to the EU. And, reasonably, the prime minister is interested in controlling the asset. Another threat for Groysman is that people from Naftogaz’s management might see rising popularity during an election period and aspire to run the government. For instance, the increase in the gas price paid by consumers is associated with the actions of the current government, but success in diversifying gas supplies to Ukraine from the EU and a refusal to accept direct supplies from Russia, as well as some success in claims against Russia’s Gazprom that were heard at the Arbitration Institute of the Stockholm Chamber of Commerce, are associated with Naftogaz’s management, not with the political establishment.

To summarize, tension between the current management of Naftogaz and Prime Minister Groysman shows no signs of resolving. And Groysman probably will not pay too much attention to the “soft” statements of the boards of even international institutions such as the EBRD before the presidential and parliamentary elections of 2019 and will try to present all claims of Naftogaz as an attempt by the company to retain its monopoly status.