Of late, loan debts of NJSC NAFTOGAS UKRAINY have been growing rapidly. Last week the company announced that they had received a USD 220 million loan. Since Olexiy Ivchenko was appointed NAFTOGAS CEO, the company borrowed over a billion dollars from foreign lenders. Moreover, as Mr Ivchenko stated last Monday, the company intends to get a series of new billion-dollar loans to modernize the Ukrainian gas transportation system.
The Ukrainian public and UKRNAFTOGAS creditors have been told the same story for over a year now, but no large-scale investment projects have been launched so far. Each and every loan received last year went “to optimize debt”, “to cover general corporate costs” and “to increase the company’s working capital”. The meaning of those vague definitions evades everyone except the NAFTOGAS management and, presumably, state trustees who do not seem in a hurry to scrutinize the company’s financial and operational performance.
Meanwhile, a speculative version, whereby NAFOTAS debts are being accumulated deliberately in order to bankrupt it, does not appear totally absurd, once you give it a second thought. The key state-owned oil-and-gas monopolist, having surrendered a large share of the domestic power supplies market to the UKRGAS-ENERGO Joint Venture, is running a risk of falling prey to being “the receiver in bankruptcy of Ukraine’s national economy”.
Many a little makes a mickle
On Monday, 13 January, Ukrainian news agencies reported that a Cyprus bank, DEPFA Investment Bank Limited, a 100% subsidiary of the Irish DEPFA Bank, gave a USD220 million loan to NJSC NAFTOGAS UKRAINY for five years. Whereas UNIAN Information Agency stated that the parties signed a preliminary loan agreement in December 2005, Interfax-Ukraine Agency argued the loan was, actually, made in December 2005.
On the surface of it, the new loan received by NAFTOGAS looks fairly respectable. As reported by the media, it is an unsecured bank loan, which means that no specific state-owned property was pledged as collateral. The interest rate does not exceed monthly LIBOR + 1.75% per annum; the principal debt is to be repaid in one payment, while the interest is to be repaid in monthly payments; the stated purpose of the loan is to cover general corporate costs.
Coincidentally, the bank-lender has been cooperating, closely and fruitfully, with GASPROMBANK and GASPROM of Russia for a few years now, being a co-initiator of a series of big contracts and a major creditor to the Russian gas monopolist.
It raises concerns, particularly in light of the recent report by Inetrfax-Ukraine that in 2005 Deutsche Bank assigned to DEPFA Investment Bank è GASPROMBANK (Russian Federation) the right to service the EUR2 billion-worth multicurrency credit line opened to NJSC NAFTOGAS UKRAINY.
Luxurious wedding
Last year, NAFTOGAS received USD600 million through a credit line opened by Deutsche Bank. The credit line was opened during President Yushchenko’s visit to Germany. On 9 March 2005, Chair of the Board of NJSC NAFTOGAS UKRAINY Olexiy Ivchenko (who at that time was also Deputy Minister for Fuel and Energy) and Deutsche Bank Member of the Board Tessen von Heidebreck signed a framework financial agreement in the presence of the Ukrainian head of state. It was announced that the credit would be repaid within the next five to seven years at an interest rate of around 8% per annum.
The imprecise description of the purposes of the credit (“to modernize the oil-and-gas transportation system, to intensify geological prospecting and implement other projects”) suggested the Ukrainian leadership had no clear understanding of how to spend the money. The President confirmed it, albeit indirectly, by saying: “This joint project by NAFTOGAS UKRAINY and Deutsche Bank is open for any kind of innovation. The range of relations with the creditor is unusually wide”.
In an interview with the BBC World Service, Viktor Yushchenko tried to be more specific: “the fist task that I set to our company is to form a list of priorities, in various branches of the gas industry, for allocating the loan money. I think it should take two to three weeks… Then they will get a more precise task: to get the first installment in June and launch a specific project amounting, I assume, to 10-15% of the credit line funds. The money will be spent either to reconstruct wells and gas pipelines or to establish a recording system for oil and gas. Alternatively, it could be used to enhance security of gas transit to Europe or to construct a new transit pipeline in Ukraine”.
Likewise, O. Ivchenko, who had been appointed NAFTOGAS CEO a week before these events (on 3 March 2005) could hardly have a clear idea of how to spend the credit money. Commenting on the signed agreement, he suggested the money could fund the extension of the Odessa-Brody oil pipeline to Plotsk in Poland, and Ukraine’s participation in gas transportation consortium with Germany and Russia. The loan could be instrumental in modernizing oil and gas production in Ukraine and raising its annual output by two billion cubic meters, on average.
Mr. Ivchenko seized the opportunity to commend his company for its role in securing the agreement. He bragged that the company received the loan directly, rather than against governmental guarantees, and got priority rights to decide how to use it. Without false modesty, the NAFTOGAS CEO accounted for the creditors’ exceptional generosity and confidence: “It testifies that such a respected institution as Deutsche Bank trusts the management of NJSC NAFTOGAS UKRAINY, regarding it as a company integrated in Europe”. He placed special emphasis on his personal trustworthiness and contacts: “In fact, they were waiting for my appointment”. According to Mr. Ivchenko, he was directly involved in the agreement’s preparation and negotiation, with which the former NAFTOGAS managers had nothing to do.
With all respect to Mr. Ivchenko, we will disagree with him here. It was the former management that started preparatory work: the Deutsche Bank plans to open the EUR2-billion credit line to NAFTOGAS UKRAINY were officially announced a month before his appointment. On 10 February 2005, Olexander Kyseliov, member of the Board on NJSC NAFTOGAS UKRAINY and Director of the Foreign Markets Department, disclosed those plans at a press conference: “Two days ago we signed a memorandum”.
Anyway, NAFTOGAS received the first actual installment worth USD300 million earlier than expected, in late April 2005. On 21 April, the parties entered into a contract on extending, within the frameworks of the credit line, the first USD300-million loan for seven years, with interest rate computed as monthly LIBOR denominated in USD + 5% per annum (that is why the interest rate is often cited as being around 85 per annum).
We should explain some things about the loan terms to those readers who are not financial experts: in the simplest terms, LIBOR (the London Interbank Offered Rate) is an average credit rate as registered on the London interbank market, at which loans are granted on the European currency market. The loan agreement in question mentions monthly LIBOR denominated in USD, i.e. the cost of dollar resources lent for a month. This rate is revised on a daily basis and depends on the cost of dollar resources on the world market. Since the loan was extended to NAFTOGAS, monthly LIBOR has grown by more than 1.5% (from 3.02% per annum as of 21.04.05 to 4.57% per annum as of 15.02.06). In other words, the nominal interest rate today is not “around 8% per annum” but around 10%. The real interest rate is even higher, but we will come to that later.
What matters at this stage of our discussion is that even upon receiving the first loan installment, the NAFTOGAS management did not have in mind any specific investment projects to be funded from it. “The first installment will be used to optimize technological processes and modernize oil and gas industries. Thus we will work towards increasing domestic production of carbohydrates. This is one project. Another is modernization of the gas transportation system,” - the company managers declared in March, shortly before signing the agreement.
However, once the agreement was signed, Mr. Ivchenko claimed the loan will be channeled to lower the cost of other credit resources available to NAFTOGAS UKRAINY. According to him, the company planned to use this money to reduce interest rates on outstanding credits from 13-16% to 8% per annum. The company CEO promised to use other installments of the Deutsche Bank loan to finance projects increasing gas and oil production in Ukraine and abroad, and for modernizing the country’s gas transportation system. At the same time, he did not rule out the possibility of using the loan money for other projects as well. On hearing those mutually contradictory statements, a thoughtful observer would have doubts about the proper use of the Deutsche Bank’s loan money.
In August, the parties announced the granting of the second installment of the Deutsche Bank loan for the same amount of USD300 million. In September, O.Ivchenko admitted that NAFTOGAS negotiated receiving another credit line for EUR2.5billion from the French Soñiete Generale Bank. Later still, information was leaked about Credit Suisse’s intention to grant the company a loan totaling EUR3 billion. However, neither of the above agreements was implemented. What NAFTOGAS did get was a loan of USD200 million from London-based Standard Bank, made known to the public only month ago, on 10 January 2006.
It is still unclear how the Deutsche Bank loan has been spent, as NAFTOGAS UKRAINY has not presented any large-scale investment projects. In mid-January, Serhiy Lukyanchuk, the Head of the NAFTOGAS press service, declined to comment on the allocation of USD600 million received from Deutsche Bank, claiming it was a commercial secret. He said part of the loan money went to increase the company’s working capital and to cover production costs.
Divorce and change of name
In late January, some Ukrainian media, acting on a tip from an authoritative Russian business magazine, reported that Deutsche Bank had closed its EUR2-billion credit line to NJSC NAFTOGAS UKRAINY, having extended two installments worth USD600 million. The company CEO, O.Ivchenko, dismissed this information as false; no official confirmation of the credit line closure came from the German party. However, according to our sources in contact with Deutsche Âank, the credit line has been closed, albeit unofficially. Two reasons have been quoted. First, NAFTOGAS failed to use the loan money for the designated purpose of modernizing Ukraine’s gas transportation system. Purportedly, the funds were used to pay the company’s taxes. Last year, the company increased its tax allocations to the state budget twofold, as compared with 2004, which amounted to USD2.2 billion (equivalent to UAH11.25 billion).
According to our sources close to Deutsche Bank, the German partners were not happy with the use of loan money to replenish Ukraine’s state budget. The creditors had expected that these funds would be better used for purchasing new gas compressors that would allow to burn less technological gas (the estimated savings being 3 billion cubic meters, half the amount burned today). Yet the agreement did not spell out this requirement explicitly, and the money went elsewhere. Mr.Ivchenko does not sound discouraged, though. He said, the other day, that the USD3 billion needed for the modernization of our gas transportation system could be raised through new credits - “banks are queuing up to offer us loans”. Modernization will allow gas losses in the transportation system to be halved, currently reaching 7.8 billion cubic meters per year. Therefore, the company CEO believes that these new loans could require no collateral, since prospective creditors should be interested in “projects with such high liquidity”. He also believes the project could earn up to USD1 billion per year.
The second reason for the clogging-up of the Deutsche Bank credit line is that the fuss around the new Russian-Ukrainian gas agreement and newly created joint venture raised creditors’ doubts about the NAFTOGAS future solvency, especially given the loss of a large market share by its former monopolist.
To make matters worse, in mid-January the international credit agency Fitch downgraded the company’s credit rating form “stable” to “negative”. Fitch put its decision down to the gas price increase from USD50 to USD95 per 1,000 cubic meters, which will increase the company’s net expenses by USD1.8-2 billion. In their opinion, additional risk is connected with the fixed transit dues set, according to the Russian-Ukrainian gas agreement, for five years (in fact, under the contact with GASPROM, transit dues are fixed for seven years, and under contact with RosUkrEnergo, for 25 years), whereas gas prices are subject to change in the second half of 2006.
The non-transparency of NAFTOGAS’s financial activities and cash flows has long been notorious. The need to restructure the company and ensure its transparent financial accounting has been repeatedly discussed at various national and international forums. The World Bank experts insist, time after time, on improving NAFTOGAS’s corporate governance and commercialization, referring to the success stories of STATOIL and PETROBRAZ. According to the World Bank reports, today these corporations are “characterized by clear structures in their subsidiaries and joint ventures, independent boards of directors, transparent performance indicators, good audit reports, and compliance with accounting and disclosure requirements to private businesses with publicly traded stock”.
The last time NAFTOGAS made public its consolidated report was in 2003. When asked if the company published any subsequent reports, its press service answered in the negative, although last November Mr. Ivchenko promised to inform the public of the company’s financial and economic performance indicators for the previous nine months of 2005, in response to an inquiry from several MPs. “This is a political move”, said Ivchenko then. “We could have disregarded it but it was the last straw. As of late, a lot of rumours have been circulating about NJSC NAFTOGAS UKRAINY, ungrounded claims have been made. All of it has a purely political motivation. Those people do not care about the country. No matter what, we will do what is best for Ukraine and ensure its energy security. Therefore I will give a detailed account of the company’s financial, business and production indicators to the Ukrainian people”.
“The report will be broadly covered in the media. We will present it to the public, the press, and all the MPs that initiated the inquiry,” - added Mr. Ivchenko saying he was confident the report would “put an end to all speculations about NJSC NAFTOGAS UKRAINY”. This was five months ago, but the company’s CEO has not, yet again, kept his promise.
Thus, for want of more official and reliable data, we have to cite the statement made in an interview to the “Delo” newspaper by Anatoliy Rudnik, former General Manager of UKRTRANSGAS (subsidiary of NJSC NAFTOGAS UKRAINY) that the company’s accounts payable exceed accounts receivable by UAH15-16 billion (most probable, he did not include recently received loans in this amount). One should also bear in mind that the accounts payable are looming, whereas the accounts receivable are 50% “dead” and will never be recovered.
Previously, problems of this kind were addressed thanks to the company’s monopolist position on the market. Tariffs calculated under the tried and tested “cost-recovery method” and low gas prices enabled it to offset all costs at the expense of industrial consumers. Yet now the situation has changed dramatically. As the result of the gas joint venture incorporation, NAFTOGAS has lost its role of a monopolist gas supplier to Ukrainian market, and its capacity to re-export gas. The company will not get substantial profits from its joint venture with RosUkrEnergo. For one thing, I.Voronin, acting joint venture CEO, represents the interests of both RosUkrEnergo and NAFTOGAS, which means, in effect, that the shares will be divided between NAFTOGAS and RosUkrEnergo at a proportion of 2:4, at the best. Appointing I.Voronin to manage the Russian-Ukrainian joint venture is like commissioning Bin Laden to represent US interests…
For another thing, the joint venture will try to minimize its future profits (via intermediaries or through informal agreements). For example, they could agree with holders of some industrial assets in Ukraine to supply them with gas at USD60-80 per 1000 cubic meters, thus decreasing their profit to the lowest possible level. In the meantime, NAFTOGAS UKRAINY and its subsidiaries will have to provide gas for the population, budget-funded institutions and municipalities without much profit, either. Thus the company’s future solvency is questionable.
ZN hesitated whether it should share with its readers an explanation of the latest developments offered by a fairly high-ranking and competent official. It seems most incredible: the closure (or suspension) of the Deutsche Bank loan is, supposedly, just a stage in an engineered plan for GASPROM and its captive companies to take over a share in the Ukrainian gas transportation system and to assume full control of our domestic gas market.
We had doubts about this version. Yet recently ZN has come into possession of photocopied documents, according to which on 22 April 2005, i.e. a day after Deutsche Bank and NJSC NAFTOGAS UKRAINY signed the agreement, the creditor, Deutsche Bank, assigned all its rights and obligations under the credit agreement to a company named Linton Capital Limited and registered to the address: 5th floor, 100 Wood Street, London EC2V 7 EX.
The option of the creditor’s rights assignment to Linton Capital Limited was envisioned in the agreement, of which the company notified NAFTOGAS on 28 April 2006, having claimed, concurrently, a tidy sum of USD 4.05 million as payment “for service o arranging the credit line”. Thus, NAFTOGAS received USD 295.95 million instead of USD300 million as the first installment. Nevertheless, since late May it has been paying interest at the rate established for the original amount of USD300 million.
Experts who have studied the agreement maintain that it provides for no specific property guarantees. If no state-owned property was pledged as collateral, then why did NJSC NAFTOGAS UKRAINY apply to the State Property Find for permission to enter into the credit agreement? The sought-after permission was given, as certified by SPF letter #10-17-5117 dated 21 April 2005 and signed by SPF Head Valentyna Semeniuk.
The amount of monthly interest payments also deserves special attention. Registration certificate #4144, issued by NBU Chief Division for the City of Kyiv and Kyiv Oblast, indicates the effective interest rate (inclusive of the margin, commission, penalty and other fees) as LIBOR+6.193% per annum.
In principle, the assignment by Deutsche Bank of such a substantial loan to a third party should not raise any concerns. Experts argue this is a standard practice in effecting such transactions. In their opinion, Deutsche Bank did so in order to avoid overloading its balance with an “extra” debt, having engaged a company that functions as a nominal creditor. One thing, however, is worrisome: the name of the company (Linton Capital Limited) fully coincides with that of an off-shore firm, which the Russian media has linked to the ex-Head of SYBUR, Dmitry Mazepin (OJSC SYBUR Holding, a GASPROM subsidiary, is one of Russia’s major petrochemical enterprises). Not only is Mr. Mazepin implicated in a series of high-profile corporate scandals in the Russian chemical industry, but he is also reported to have high-ranking patrons in the office of the Russian President. Moreover, the address of the Linton Company coincides with that of several GASPROM-related business structures - 100 Wood Street, London.
In November 2005, the Russian “Kommersant” magazine reported that two off-shore companies controlled by Mr. Mazepin (Bonesco Commerce LTD and Oakledge Investing LTD) bought large amounts of stock in Perm-based chemical plants (OJSC AZOT and OJSC Mineral Fertilizers, earlier - OJSC Halogen), supposedly, to resell it to GASPROM. The owner of Russian chemical enterprises has repeatedly displayed an interest in gaining access to the pipeline in Ukraine…
We want to believe that the Linton Company, acting as the Deutsche Bank assignee, has no relation to Mr. Mazepin’s company of the same name. Then what about Deutsche Bank’s assigning its right to servicing its credit line to DEPFA Investment Bank and GASPROMBANK? It could have resorted to the mediation of Linton Capital Limited again. The creditor entitled to claim in the event of NAFTOGAS default, God forbid, is located at an address different from the Deutsche Bank’s. It will be no use trying to negotiate with DEPFA Investment Bank and GASPROMBANK via diplomatic channels, as could be the case with Deutsche Bank.
According to ZN sources, so far the creditors have been very lenient, giving and promising new loans to Mr. Ivchenko. Yet what will happen if, one of these days, all of them reject the over-enthusiastic borrower and, taking advantage of late payments or any other non-fulfillment of obligations by NAFTOGAS UKRAINY, come up with their claims? Attachment of accounts, debt restructuring, bankruptcy? What will the creditors’ claim be like at the negotiations on debt settlement or restructuring? It will not be the claim to NAFTOGAS but, rather, to the state of Ukraine, which holds 100% of NAFTOGAS shares and which transferred its gas infrastructure to the company’s management. Will they want part of the gas transportation system (the most treasured asset from GASPROM’s perspective), full control of the UKRGAS-ENERGO Joint Venture or Ukrainian underground gas holders?
Who will shoulder personal responsibility for this, as well as for the bankruptcy of the main state monopolist, should it occur? The public has growing doubts about the competence of the officials placed in charge of Ukraine’s gas sector. Every day brings new questions to be asked of them. Unfortunately, they fail to give credible answers.