Identifier
Created
Classification
Origin
09KYIV955
2009-06-03 15:51:00
UNCLASSIFIED
Embassy Kyiv
Cable title:  

UKRAINE: NAFTOHAZ'S FINANCIAL HOUSE OF CARDS

Tags:  ENRG EPET ECON PINR PREL RU UP 
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VZCZCXRO9603
RR RUEHDBU RUEHIK RUEHLN RUEHPOD RUEHSK RUEHVK RUEHYG
DE RUEHKV #0955/01 1541551
ZNR UUUUU ZZH
R 031551Z JUN 09
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC 7904
INFO RUCNCIS/CIS COLLECTIVE
RUEHZG/NATO EU COLLECTIVE
UNCLAS SECTION 01 OF 03 KYIV 000955 

SIPDIS

DEPT FOR EUR/UMB, EB/ESC/IEC - GALLOGLY/WRIGHT
DOE PLEASE PASS TO LEKIMOFF, CCALIENDO

E.O. 12958: N/A
TAGS: ENRG EPET ECON PINR PREL RU UP
SUBJECT: UKRAINE: NAFTOHAZ'S FINANCIAL HOUSE OF CARDS

REF: A. KYIV 421

B. KYIV 750

UNCLAS SECTION 01 OF 03 KYIV 000955

SIPDIS

DEPT FOR EUR/UMB, EB/ESC/IEC - GALLOGLY/WRIGHT
DOE PLEASE PASS TO LEKIMOFF, CCALIENDO

E.O. 12958: N/A
TAGS: ENRG EPET ECON PINR PREL RU UP
SUBJECT: UKRAINE: NAFTOHAZ'S FINANCIAL HOUSE OF CARDS

REF: A. KYIV 421

B. KYIV 750


1. (SBU) Naftohaz's ability to pay its gas bill has become a
monthly guessing game since the January 2009 gas crisis.
While Ukraine has managed to pay its gas bill for the first
four months of the year, it will face increasing difficulties
to do so through the summer as it pumps gas into underground
storage facilities for use during the winter heating season.
In the past Ukraine paid for gas put into storage as it was
consumed. Under the January 2009 contract, however, Ukraine
must now pay for all gas it takes on a monthly basis.
Ukraine will likely find someway to pay for its May gas bill,
but the need for short-term financing of approximately $5
billion to pay for some 20 billion cubic meters (bcm) of gas
this summer will remain.

Summer Financing Crunch
--------------


2. (SBU) Ukraine is forecasted to purchase less gas from
Gazprom in 2009 than in 2008, due largely to reduced demand
from industrial consumers and increased reliance on gas
Ukraine already had in storage. With a forecasted average
price of less than $250 per thousand cubic meters (tcm) in
2009, Ukraine will pay some $7.6 billion USD if it purchases
33 bcm total during 2009. (Note. In the January 2009 supply
contract, Ukraine agreed to take 40 bcm in 2009. Following
the conclusion of the contract, however, Naftohaz officials
asked for a revision to 33 bcm which is allowed under the
contract's 80 percent take or pay provision. End note.) In
2008, Ukraine purchased 52.5 bcm at $179.5/tcm for a total
payment of $9.4 billion.


3. (SBU) Despite an expected lower total gas payment in 2009,
Ukraine again faces difficulty in making its payments to
Russia. The January 2009 gas supply contract stipulates that
Ukraine must pay in full each month's delivery of gas by the
seventh of the following month. Prior to the January 2009
contract, Ukraine paid for its gas as it was consumed, not as
it was delivered. This allowed Naftohaz to use the revenues
it collected as it sold the gas to offset the gas bill from
Gazprom. Any shortfall was made up through state budget

subsidies and loans. This year, however, Naftohaz is
required to pay Gazprom as it takes gas. In winter months,
when gas usage is high because of heating needs, Naftohaz
receives more revenues and is able to make the gas payment
with some financial wrangling (Ref A). In the summer,
however, when Ukraine needs to pump approximately 20 bcm of
gas into underground storage facilities for use during the
winter heating season, it will be difficult for Ukraine to
pay its monthly gas bill as its revenues drop due to lower
consumer demand for gas in the summer.


4. (SBU) When Naftohaz's financial plan was accepted by the
Cabinet of Ministers in March, the government and Naftohaz
boasted that Naftohaz would have a budget surplus in 2009,
which is only possible because of tax breaks and subsidies it
receives (see para 7 below). However, the financial plan did
not address how Naftohaz would pay for the 20 bcm of gas it
needs to pump into storage during the summer months. In
April Naftohaz paid $621 million for 2.3 bcm of gas from
Russia and pumped 800 million cubic meters of that total into
storage. In May Naftohaz purchased some $650 million or 2.4
bcm of gas. Kyiv-based Center for Energy Research estimates
that Naftohaz in May collected approximately $350 million
from the domestic sale of gas, leaving a $300 million
shortfall for the May payment to Gazprom due June 7.

Possible Financing Methods
--------------


5. (SBU) As long as Ukraine has sufficient foreign currency
reserves, it can resort to the financing scheme it used
earlier this year and late last year to make its payments to
Gazprom (Ref A). Under this mechanism, the National Bank of
Ukraine (NBU) loans hryvnia funds to state-owned banks who in
turn loan money to Naftohaz. Naftohaz then uses the liquidity
from the state banks to purchase dollars from the NBU to pay
Gazprom. Most experts forecast that Ukraine will have a
balanced current account this year allowing it to generate
enough foreign reserves to cover all imports, including gas
purchases from Russia. The IMF Resident Representative in
Kyiv similarly told us that he is confident Ukraine will have
enough reserves to cover gas purchases. As long as foreign
currency reserves are not depleted too quickly, Naftohaz
should be able to use this method to pay its monthly gas
bill.


KYIV 00000955 002 OF 003



6. (SBU) The Ukrainian government has also provided Naftohaz
with tax breaks and an increase to its budget subsidy for

2009. The 2009 budget already contains a 1.6 billion hryvnia
(UAH) subsidy (approximately $210.5 million) to Naftohaz
which covers the difference between the price Naftohaz pays
Gazprom for gas and the price at which it sells that gas to
the population and local heating companies. Additionally,
the Cabinet of Ministers on April 2 passed a resolution that
gave an additional UAH 3.5 billion ($460.5 million) to
Naftohaz to cover Naftohaz's tax debt for the last quarter of

2008. Finally, the parliament has also considered, but has
yet to take action on, amendments to the budget which include
an increase of Naftohaz's budget subsidy to UAH 7.7 billion
(approximately $1 billion). On May 13 the Cabinet of
Ministers agreed to postpone for five years tax payments
Naftohaz owes on the 11 bcm of gas that it took from
RosUkrEnergo as part of the January 2009 transit contract
signed with Gazprom, some UAH 6.7 billion UAH.


7. (SBU) Ukraine has also raised the possibility of paying
for the winter heating gas being placed in storage by
forgoing future transit fees (Ref B). Russia has already
allowed Ukraine to pay for a portion of gas purchased in
April through an advance of transit fees. Recent statements
from Prime Minister Putin, however, indicate that Russia is
unwilling to advance more transit fees to Ukraine having
already advanced all expected transit fees for 2009 to
Naftohaz. There are conflicting statements as to how much
Russia advanced to Ukraine for future transit. Russian
Deputy Prime Minister Igor Sechin stated on May 29 that
Gazprom has already paid Ukraine $2.15 billion for transit
fees through February 2010. Party of Regions Deputy Yuriy
Boyko stated that Gazprom has advanced transit fees through
May 2010. President Yushchenko has also spoken forcefully
against advanced transit payments, saying it could endanger
Ukraine's gas transit system by yielding some control of it
to Russia.


9. (SBU) Local press reports have also speculated that
Ukraine would seek financing from the European Union or other
donors to cover the $5 billion gas payment it faces this
summer. The energy expert at the EC Mission in Kyiv, though,
told us that by the end of May the Ukrainians had not
requested any financing assistance from the EU. EU officials
in Brussels, meanwhile, have stood by their call for greater
transparency in Naftohaz before any financing agreements
could be reached. Russian officials have stated publically
that Ukraine's request for a $5 billion loan was denied. The
prospects for any foreign commercial financing seem
non-existent for Naftohaz at this time. Following Moody's
downgrade of Naftohaz from B1 to B2 on May 15, the credit
rating agency again downgraded Naftohaz at the end of May to
Caa1 with a negative outlook.

Possible Impacts of Missed Payment
--------------


10. (SBU) If Naftohaz fails to pay on time and in full,
Gazprom could force it to prepay each month's expected gas
bill. Russian officials, most recently Gazprom's CEO Alexei
Miller, have repeatedly stated that Gazprom will enforce the
prepayment clause of the January 2009 contract if Ukraine
misses the June 7 payment. Naftohaz will be under even
greater strain if it is forced to prepay, as it currently
struggles to make each month's gas payment after having
collected revenues for the gas it sells. Under a prepayment
scenario, Naftohaz would need to seek even more
financing--either from the state or from donors.


11. (SBU) While Russia could turn off gas supplies to Ukraine
if it fails to make a payment, the near term impact on the
rest of Europe would be negligible given the lower demand for
gas in the summer months. However, if Ukraine does not
manage to fill its underground storage facilities during the
summer months, Ukraine and Europe could face gas shortages
come winter when demand is higher. The aging infrastructure
of Ukraine's gas transit system limits the rate at which the
underground storage facilities can be filled and how much gas
can be transited.

Comment
--------------


12. (SBU) The coming summer months will be the first real
test of Ukraine's ability to meet the stringent payment
provisions of the January 2009 gas supply contract. With low
summer revenues, Naftohaz is forced to look for outside
financing to meet its obligations to Gazprom. However,
Ukraine should have sufficient foreign currency reserves to

KYIV 00000955 003 OF 003


cover Russian gas purchases. While Naftohaz has argued that
the EU and Russia should finance the gas in storage as it
benefits both European countries and Gazprom to have Ukraine
store the gas, so far both the EU and Russia have been
reluctant to commit to any financing. Russia's repeated
warnings about Ukraine's inability to pay, meanwhile, appear
to be an attempt to paint Ukraine as an unreliable transit
partner to the EU and strengthen Russia's calls for
alternative gas routes. End comment.
PETTIT