Ukraine gas contract revision looms after PM calls for end of Naftogaz

Ukraine gas contract revision in the offing
Ukrainian Prime Minister Mykola Azarov, has announced on Friday that the Ukrainian government is planning to liquidate Naftogaz Ukraine, the national oil and gas company, and revise all current contracts.

The move brings to a head the possibility that the gas disputes, which arose over contracts with Gazprom, for supply to Ukraine and transshipment across the country to European markets from Russia, which arose in 2006 and 2007 could again arise.

Naftogaz was the key Ukraine counterpart of Gazprom in resolving the gas disputes in 2009. Ukraine currently pays up to US$400 per thousand cubic meters of Russian gas, but in straightened budgetary circumstances has long pushed to revise the contracts and for further discounts from Russia and Gazprom.

Azarov said that Naftogaz will cease to exist, and that its role and place in the market will be replaced with new companies, which will lead to the revision of all existing gas supply and transshipment agreements.He said, speaking to students at the T. Shevchenko National University in Kiev, the government will restructure Naftogaz, and spin off its gas production division, through public listing, potentially raising $5- 10 billion in investment funding.

"We have decided to restructure Naftogaz, to separate its gas production company, to prepare it and to allocate its shares on a public exchange," and adding, "Our estimate is that we should receive a very serious investment resource of around $5 billion-$10 billion."

Azarov added the existing agreements with Gazprom, dating from 2009, will need revision.

"It is completely evident that there will be an impendent gas production company. An independent company, which will be engaged in gas transit andtherefore,itwillbenecessarytorevisewell-known agreements [signed with Gazpromin January 2009]since a neweconomic entity will come into being."

Azarov also called into question the legality of those agreements under Ukrainian legislation, noting that previous agreements had required renegotiation of volumes each year.

“This agreement,that has interstate power and is placed above the inland laws, has never been effected. That’s why we think that the contracts concluded in 2009 contradict at least the part that concerns the annual gas supply volumes.”

Naftogaz has brought McKinsey&Co to advise on selecting a lead manager for a possible IPO.The news comes just days after Ukraine signed an $800 million contract with European energy major Royal Dutch Shell to explore and develop Ukraine’s shale gas reserves, which are widely believed to be Europe’s largest.But experts say that developing the shale gas reserves could take more than a decade. Konstantin Simonov, the Head of the National Energy Security Fund, adds that developing shale gas could lead to environmental and health issues.

“Shale gas is extracted by hydrofracking. That means special chemicals are added to the water to break up the rock formations. The components of these chemicals are kept secret by the companies in the United States, who claim it's a commercial secret. But that water, laced with chemicals, ends up in drinking water. So shale gas development poses a serious threat to the environment and health.”

Ukraine has indicated it is seeking to reduce gas purchases from Russia by a third from next year, which would break the 2009 gas agreement signed between Naftogaz Ukraine and Gazprom. But the Russian energy minister has given assurances that the events of 2009 will not be repeated and that there is enough time to find a compromise.

Speaking on Friday, Gazprom CEO, Alexei Miller, said that he agrees with the possibility of restructuring Naftogaz Ukraine, as well as the possibility of revising contracts, but only if Naftogaz Ukraine was to be merged with Gazprom.

"Of course, following a merger with Gazprom, Naftogaz Ukrainy will cease to exist as an economic subject. There will be a liquidation period and, over a certain period of time after all necessary formalities have been carried out, a completely new company will operate on the market. Therefore, all agreements that are currently in place will be revised."