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11 May, 2011

If Not Merger, Then Acquisition

The Government is preparing to sell 25% of NAK Naftogaz Ukrayiny shares, but that is just part of a global game

It would be hard to find a less suitable time to sell even part of Naftogaz: the national joint stock company for the extraction, transit and processing of oil and natural gas is in a very difficult position. Needless to say, this is not just the fault of the current management. Even though, the company has been systematically killed for some time, it is still in the state of soft default. Finding an investor who would buy at least some of its shares for good money is probably impossible. The only plausible candidate is Gazprom, the politically motivated monopolist operating on the market of the neighboring Russian Federation. It is well known that the giant has been struggling to gain control over Ukraine’s gas transit system, and the sale of gas inside Ukraine, for quite a while. Naftogaz is one of the largest consumers of Russian gas, so it is understandable why the Russians wish they had the company under their control. Buying a block of Naftogaz shares will allow Gazprom access to the decision making process within the company.  

The stake which has been officially announced for sale is only 25%. Yet, everybody knows what this really means from the experiences of other state-owned enterprises where the state officially controls, or used to control 75%. For instance, some oblast gas suppliers are officially state-owned, but their administration is completely under the control of minority shareholders and they transfer zero dividends to the state budget. This kind of situation is typical for Ukraine, where corporate relations issues are solved through agreements made behind closed doors and the power of officials, rather than through the usual market mechanisms.

The European Union has recently passed a Directive banning entities that do not meet the principles of operation on the EU energy market to buy energy companies. Also, Europeans will not invest into companies failing to meet the key criterion, meaning that gas cannot be extracted, sold and transited by one entity. Rumors have it that Ukraine will one day be using the same practice, but talk does not mean action. The memorandum[1] signed by the previous government of Ukraine in Brussels contains an intention to reform Naftogaz’s structure and outline its relevant components. None of this has been done which leaves a firm impression that Europeans will stay out of the game. Moreover, there is a pile of questions to Naftogaz concerning administrative reform, reporting to shareholders, transparency of decisions, the background of financial performance, running of tenders and so on. The only general answer to all these questions is complete ambiguity. Western companies are used to working without manipulation, so they will hardly invest into a non-transparent entity. That is why the Government’s statements about an open sale of Naftogaz shares and serious preparations for tender sound so unbelievable. Of course, it can spend a fortune hiring a foreign company to prepare the tender, and it probably will. But what will we have in the end – the sale of shares in one of Ukraine’s key companies to Gazprom which is controlled by the Russian government? This will almost certainly happen even if there is a tender. We have seen these kinds of transactions many times before. The scheme of getting access to the right objects for the right people has been tested on Ukrtelecom and others. Terms could be arranged to sell the company to the right people without encumbering them with extra investment liabilities. The price will be moderate too, which will likely be explained by Naftogaz’s huge debts. In fact, the company has many debtors, but its liabilities are also huge. The result will be the same as what happened after Ukraine’s oil refineries were sold – the industry is now virtually in ruins. It never saw proper investment to upgrade production and make Ukrainian refineries competitive with foreign ones. Meanwhile, the owners of these oil refineries are tireless in demanding protection, subsidies and privileges. Recently, they have offered to invest into upgrading the refineries provided that the Government bans all imports of oil products.

In the case of Naftogaz, the key energy company of Ukraine, it will be sold for peanuts, or a fair amount which will later return to the hands from whence it came through well-known scams as settlement for gas or equipment.

After the sale Ukrainians will get an answer to a critical question: how will relations between Naftogaz and Gazprom change? These companies depend on each other. And here comes a quote from a movie: “Everything depends on me here!” meaning President Viktor Yanukovych, who is an integral part of any strategic decision making. However, I doubt that this process will reach the right conclusion. The declaration of the Government’s intentions could well just be an attempt to play another one of its scenarios. We have already heard of the merger, and this time it’s the sale. This just looks like a game of multiple scenarios and attempts to check how the public responds to the various developments. Yet, with time, everything will become clear: Naftogaz is just an object in a bigger game.



[1]Joint Declaration on the Modernization of Ukraine’s Gas Transit System done in Brussels on March 23, 2009. The parties include the Ukrainian Government, the European Commission, the European Investment Bank, the European Bank for Reconstruction and Development, and the World Bank.


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