Kyiv 'undoes seven years of work'

Kyiv may have done long-term damage to its fortunes by its April 28 sacking of Andriy Kobolev, the CEO of Naftogaz Ukrainy and the dismissal of the supervisory board. From an investment and financial perspective, the country's position is now weaker than before, and gas supply security could also be at risk, sources told NGW May 13. This jeopardises the seven years of trying to reform Ukraine's economy on Western lines.

Kobolev's replacement with Yuri Vitrenko, until that point the acting energy minister, was ostensibly a consequence of a loss-making year, which the company had attributed to market distortions that allowed consumer debt to grow. There had also been government dissatisfaction with the company's failure to produce more gas each year. 

However, the dismissals broke a number of agreements between Kyiv and the European Union (EU) and the US about how to reconstruct the country as a market economy that followed OECD rules on corporate governance. Ever since the annexation of Crimea, European and US advisors had worked with Ukraine on fighting corruption, developing corporate governance in state enterprises, gas market unbundling and introducing a market economy. This had cost them money and expertise.

In justification Vitrenko told journalists at a press conference April 30 that companies analogous to Naftogaz – such as PGNiG – were profitable last year despite the challenges and had paid dividends to the government. "We should be able to do the same ourselves," he said.

However, investors might be apprehensive if they perceive a risk of Vitrenko continuing to act as if he were an energy minister without following western conventions on corporate governance.

At time of press, there had been no other board changes. Vitrenko said he had had discussions with unnamed executives and that these talks had gone constructively. Kobolev appointed former McKinsey management consultant Otto Waterlander as COO a year ago and, earlier this year, a former Shell executive Petrus Van Driel became Naftogaz’ CFO.

 Financial backlash

A number of major financial supporters – including the European Bank for Reconstruction and Development, the EU’s European Investment Bank and the World Bank – deplored the violation of corporate governance of state-run enterprises that led to the resignation of the supervisory board.

They called on the leadership of Ukraine “to ensure that crucial management decisions at state-owned enterprises are taken in full accordance with the basic tenets of recognised corporate governance standards.”

They will be unlikely to advance more money at their own disposal, or recommend that foreign investors do the same, while the government acts in this arbitrary way. “Ukraine has shot itself in the foot,” one banking source told NGW. There are still some $2.5bn to come under an IMF loan awarded last year. "There is no way they will sign off on that now," he said.

Following its suspension, the supervisory board issued a condemnatory statement of its own April 29, saying it had evaluated the company's performance as "very good if not excellent, given the context in which it was operating." Removing the CEO directly was not only against Ukrainian law but also jeopardised the company's business continuity, it said.

And given that Naftogaz supplies more than 13% of state revenues and raises financing in international capital markets, the management of the company has to meet best corporate standards, the board said. 

Security risk

As well as finance and consultancy, the EU had also brought Moscow and Kyiv together at a series of trilateral meetings to negotiate winter deliveries and transit for several years, culminating in the five-year transit agreement of December 2019. The deal was helped on its way late in the year by US sanctions on Russia’s Nord Stream 2 project, bringing construction to a standstill. Until the still incomplete pipeline is running at full capacity, Russia will have to keep using Ukraine as a transit route for its gas supplies to Europe.

International lawyer Alan Riley told NGW: "The act of the government to suspend the supervisory board, and the suggestion by the new CEO Yuri Vitrenko, that Naftogaz could open new legal proceedings against Gazprom could give Gazprom cause to pull the five-year transit deal which was agreed in December 2019. The entire deal was based upon full Ukrainian compliance with EU energy liberalisation law, including full ownership unbundling, which includes the observance of EU corporate governance standards. Furthermore, the deal settled a host of litigation matters between Naftogaz and Gazprom, so seeking to open further litigation could again threaten the transit deal.

“The real danger here is that Gazprom is close to completing Nord Stream 2. The pipes will be physically in place probably by the end of the summer. At that point before winter sets in Gazprom can pull the transit agreement citing Ukrainian malfeasance, and put the EU under pressure to immediately certify Nord Stream 2 so they can be brought into operation for the winter heating season.”

In a paper published a week ago, Riley, who is also a senior fellow at Washington think-tank Atlantic Council, said “reforms have reassured beneficiaries of the Ukrainian transit regime that gas can be safely transited and stored in Ukraine. It has permitted Kyiv to effectively respond to Russian claims of Ukrainian “unreliability” by pointing to the gas sector’s compliance with EU liberalisation and corporate governance norms, something almost entirely absent from the Russian gas sector.

"Meanwhile, utilisation by foreign firms of Ukrainian storage facilities (one of Naftogaz’s recent successes) is likely to drop off a cliff. There is a real danger that by so needlessly wrecking the corporate governance regime, the Ukrainian authorities have also seriously damaged Naftogaz’s ability to generate revenues for the state budget," he said.

Riley also cited Article 26 of Ukraine’s law on the prevention of corruption: it prohibits – for a one-year cooling-off period  – any move by someone in a regulatory capacity into executive control of a formerly regulated entity.