Putin Visit Puts Naftogaz in Focus

This week, Ukraine will begin intergovernmental negotiations with Russia over economic and energy issues, the highlight of which will be the April 12 visit to Kyiv by Russian Prime Minister Vladimir Putin.

This follows negotiations between Ukraine with the European Union over free trade and associate membership agreements.

Russia’s desire to keep Kiev within is sphere of influence led to Moscow to launch an significant offer of economic enticement.

In a variation of an offer first floated in August 2010 (see below), Valery Golubev, deputy chief executive of gas monopoly Gazprom, offered a discount on natural gas prices that would provide Ukraine $8bn in annual savings.

The hitch?  Ukraine would have to join Russia, Belarus and Kazakhstan in a free-trade and customs union.

The Merger Amongst Unequals

But it is natural gas that is perhaps the most critical issue in relations between the two countries.

Russia covets Ukraine's Naftogaz Ukrainy distribution network through which 80% of Russia’s gas exports to Europe pass and is proposing a merger of Gazprom and Naftogaz.

Gazprom chief executive Alexei Miller has stated that merger is "a historically predetermined step."

As Gazprom dwarfs Naftogaz as a commercial venture, Ukraine has resisted, knowing that it would essentially be a Russian takeover.

In a bid to sweeten the deal, Russia had said it would drastically reduce its export gas price for Ukraine.

In the case of a merger, “the gas could be delivered to the population of Ukraine … at a price at which gas is delivered to the Russian households,” said Miller.

The difference in pricing is vast. Russian customers pay around $60 for 1,000 cubic meters of gas, while the present price to Ukraine is around $230 per 1,000 cubic meters.

In April 2010, Ukrainian President Viktor Yanukovych and Russian President Dmitry Medvedev agreed to a 30 percent discount of the gas price, which at that time was $330 per 1,000 cubic meters, over the next 10 years.  In return for the deal valued at $40 billion, Ukraine agreed to extend Russia’s lease on a naval base in the Black Sea.

Even with that discount, fuel costs are squeezing the Ukrainian economy and Ukraine is pressing Russia for relief.

Ukraine has been attempting to move forward a proposition that its natural gas transport system, and not the development of the South Stream pipeline project, is the most efficient route to deliver Russian and central Asian gas to Europe.

Ukranian officials have suggested that Russia upgrade the Ukrainian pipeline system, thus eliminating the need for South Stream (and for gas to bypass Ukraine and the loss of significant transit fees).

However, Ukraine is in an all-round poor situation when it comes to its relationship with Russia over gas supply.

The country’s gas transit infrastructure requires significant upgrading and investment.

With its economy is in shambles, Ukraine doesn't have the money to modernize its grid and requires outside investment.

The Public Floatation

In a step that would certainly complicate if not scuttle Russia’s merger ambitions, Ukraine is considering publicly floating Naftogaz shares on the market in 2013.

Ukraine’s Energy Minister Yuriy Boyko has been quoted as saying by the press that Ukrainian authorities have decided to sell up to 25% in Naftogaz.

Yanukovych said earlier that he supported the idea of selling a stake in Naftogaz at an IPO as part of a plan to make the company more transparent.  He said the plan would stabilize Naftogaz financially and allow the company to go ahead with investment projects in order to increase domestic oil and natural gas extraction.

“We have to raise funds from international and domestic markets for the financial stabilization of Naftogaz and realization of its investment projects, create a transparent and effective vertically integrated company,” Yanukovych said addressing a government economic meeting, according to his press service.

“If we have to give up part of the company and sell some shares of the company at international stock exchanges, we have to go for it.”

A public floatation could also be one of the initial steps to unbundle Naftogaz by 1 January 2012, a commitment made by Ukraine under the EU Energy Community Treaty.

However, as a Ukranian diplomat told New Europe, “Putin’s visit may ruin everything — all forecasts, predictions, everything. We don’t know what to expect.”

Source: New Europe