Interview with Naftogaz supervisory board chairperson Clare Spottiswoode

Naftogaz supervisory board chairperson Clare Spottiswoode shares her vision of the TSO unbundling in Ukraine and partnership opportunities for international companies in the gas transmission sector

Naftogaz supervisory board chairperson Clare Spottiswoode shares her vision of the TSO unbundling in Ukraine and partnership opportunities for international companies in the gas transmission sector.

Prepared by Mariia Tsaturian, RBC Ukraine deputy editor in chief

- Let's talk about current relations between supervisory boards of Naftogaz and MGU. MGU board chairman Walter Boltz stated that despite the signed Memorandum, there was neither cooperation between the two companies nor progress in the unbundling process; and the Memorandum was not observed. You publicly responded that MGU’s position was surprising. Could you explain what is going on between the two companies?

- First of all, we agreed on our cooperation with Walter Boltz back in the summer. He sent me a Memorandum. I agreed it and sent him back. I was expecting him to sign it, but it took him several months. Besides that, we had to sign a non-disclosure agreement with MGU. Because otherwise, we cannot share confidential items with MGU. It also took a while to sign this document. I think now that besides signing legal documents by Naftogaz, there are other reasons too.

I’d like to emphasize that we have signed all documents with MGU relatively recently. So Mr Boltz is quite right – our cooperation could and should be more active. But it does not mean that we do not want it. The only reason is that MGU is a relatively new company and some organizational issues still need to be addressed.

All this time, we have been doing our work. Both Andriy Kobolev and I have promised that we are going to deliver unbundling, and we are ready to unbundle the company. Anyway, it is up to the parliament and the parliament of Ukraine to decide on unbundling.
We could give them substantiation of what part of the company needs to be unbundled, argue the way and the purpose of unbundling and facilitate organizational issues. But politicians have to make decisions regarding the unbundling process and solve regulatory issues. For our part, we are ready to unbundle, but other institutions should be ready to move forward too, which is still not quite clear.
One of the urgent things we should do as soon as possible is to draft contracts between Naftogaz and MGU and between Naftogaz and the government. We have started this work.

In September, we promised to report on our common progress to the public on a quarterly basis. We will be open for everyone to ask us on how far we have got in the unbundling process and make sure that we will deliver it by the end of the next year. We have scheduled the report for the next month.

- As far as I know, directors of MGU supervisory board have some problems with their salary payments. Naftogaz and MGU are discussing the possibility to incorporate them into Naftogaz supervisory board as salaried advisers. MGU board should remain independent. It is not quite clear how Naftogaz can pay salaries to its members.

- At some point, it became clear that the government was not ready to continue funding MGU board due to lack of funds. It is indeed a difficult situation, because MGU board needs to remain independent. They addressed us for a solution. We suggested engaging MGU board as advisers to our unbundling committee. This would make MGU supervisory board part of the unbundling process.

- But as advisers, would they be paid by Naftogaz?

- Yes, they would then receive salary from Naftogaz. We had two options to do that. In Ukraine, we would be eligible to pay them as Naftogaz employees. But MGU is concerned that in this case they would not be independent. I have always said that I want them to be our “eyes and ears”, so that they could tell us what they think about how we procced with the unbundling process.

We started to discuss it with MGU, being very careful about who they would work for and what documents they would to sign as employees. For instance, all employees of Naftogaz should sign a non-disclosure agreement (NDA). We also had to make sure that MGU supervisory board could retain and use its independent voice regardless of employment contracts signed by its members with Naftogaz.

The second option was engage MGU as unbundling adviser through a tender. In this case, Naftogaz would have to go through a very strict tender procedure. And what would be if MGU failed the tender? Furthermore, this would add several months to the process. That is why we proposed the employment scenario.

Some of directors on MGU board refused to sign employment contracts, being concerned that it could compromise their independence. Others were ready to sign employment contracts with us. Later, MGU had a meeting with the government, and I think, they probably got some funding (ed. - from the government) for the next year. So they decided not to take up employment contracts and signed only NDAs.

We have held several meetings between the members of the unbundling committee of Naftogaz supervisory board and the Consortium of potential partners for GTS operation.* NOTE MGU representatives attended that meeting too.

- Could you give more details on how Naftogaz supervisory board is working with the Consortium and your cooperation with MGU in this context?

- Cooperation with the Consortium is another complex issue. As you may know, the Ministry of Energy and Coal Industry, willing to create competition and engage international companies to operate the GTS, formed a pool of potential partners. (In December 2017, the Ministry of Energy invited international gas companies to take part in a special tender. The winner – one or several companies – would become the unbundled pipeline business operator, - ed.) Hopefully, they will be interested to invest in gas transmission assets after unbundling. It is very clear now that those companies are not ready to come to Ukraine with their investments. Partly because the political situation is unclear, partly because they did not do quite a lot of due diligence.

We have never done unbundling in Ukraine before. We do not have people within Naftogaz, who know how to do that. We will need therefore many advisers to help us find the best option for the unbundling process.

In August, different organizations and companies (ed. - mostly EU gas market operators) established the Consortium and agreed to work as one entity. Supported by the European Commission, we asked them to provide us with qualified people to help us do our job better. We have specified requirements for five vacant positions and we want those people to be embedded in our organization. I want them to use their expertise to provide an adequate assessment of our steps in the unbundling process. If they see something is not going fast enough or quite right, we need their advice. Those people should speak not only to Naftogaz supervisory board, but first of all to their employers – the Consortium members.
Their major task is to make sure that the Consortium makes proper due diligence. They should analyze the pipeline situation and provide an adequate assessment of how much investment is needed. They have a very clear vision of the investment plan for the next year and beyond.

We had a meeting in Brussels with MGU and Consortium members. As I have mentioned, it is quite difficult for us to do our work because of organizational issues, we still do not know who we are supposed to work with. Is it MGU? Is it the Consortium? Or both? So we have asked the Consortium to help us with people who would provide expertise and tell us how to do our job right. We also asked the Consortium to decide if they work together with MGU or not. We need to know who we are working with and how.

- Do you have an answer?

- No, they are thinking and discussing. They have some concerns about having people embedded in the organization as employees of Naftogaz or MGU. They want to keep those people as employees of the Consortium and our advisers as well. They are accountable to the Consortium members now. Naftogaz is therefore discussing all these issues with the Consortium. And I am going to check if that is happening.

- Ukrainian media published a letter addressed to the Ukrainian government by the World Bank, Energy Community Secretariat, US Ambassador, and Vice-President of the European Commission. They are all concerned about the situation with the unbundling process that could be stopped or had already stopped. We can't ignore the position of our donors. Is there any ground for their concern?

- It is not true that unbundling has stopped. As Naftogaz, we are doing the stuff behind the scenes as well. I think this letter was written because the donors were not properly informed. That is why we are doing these quarterly meetings to show all stakeholders what we've done. Now, we are trying really hard to get the Consortium and MGU involved in that process.

The unbundling process depends not only on Naftogaz. The government, the regulator and other participants need to be involved. It is important that all of them and us as well contribute to the successful unbundling.

- I had information that according to the offering memorandum, the issue of Eurobonds by Naftogaz would make unbundling impossible. Could you deny or confirm that information? (The interview had been prepared before Naftogaz postponed the Eurobond issue, - ed.)

- We have made very clear for the MGU board and the shareholder that the Eurobond emission would not prevent us from unbundling. But there is a question mark in a longer term. When you are unbundling a company you cannot ignore the economic reality. And for the moment, Naftogaz has got lots of cross-subsidies all over the place*. NOTE The lion’s share of these cross-subsidies is between the pipeline business and the rest.

When we unbundle the company, the cross-subsidizing would no longer be possible.

If you take a pipeline business and you have an account of transit revenues, that will be a very profitable company. If you take a pipeline business and there is zero transit revenue, then it is lossmaking. Now, it is critical that the regulator established some rules that would allow the company to survive even with zero transit revenues.
But the rest of Naftogaz also has to be profitable. The energy company should generate significant profit for its shareholder, not loss. That also forces some decisions that need to be made by the government on gas price, on the public service obligation (PSO). You can't continue to use the transit business of Naftogaz as a sink for public and social policy. As I said, you cannot ignore the economic reality. And if to speak about bonds emission, the bonds should support the company that should be self-sufficient without the pipeline business and should be making profit. But it is the government's choice whether it decides to have self-sufficient and effective business or it decides to keep cross-subsidizing.

- When Ukrtransgaz transfers its assets to MGU and loses the transit business, what will be the financial situation in the two companies?

- The unbundled business requires a lot of modernization and investment. But it is not going to be profitable if there is no transit. We do not know for sure if gas transit through Ukraine continues after 2020. If the new company – MGU – is not profitable, the Energy Community Secretariat will not certify it as a new TSO. Then, no one will want to invest in it. That is why I like the idea of involving the Consortium and Western companies because they are consumers of transit gas and so we are more likely to get transit revenues.

- Let's talk about the global task of the whole unbundling process. Now we are trying to create a new TSO, to attract a partner to operate the unbundled business. And if we find investors and demonstrate a fair work the need for Nord Stream 2 in the EU could vanish. Speaking about the worst-case scenario – there is no partner, no transit and no investments in the pipeline business. Do we really need unbundling then?

- When I began to work at Naftogaz, I did not actually understand, why there is such a big focus on unbundling. In economic terms, it does not make huge sense of it. Much more sense is to get upstream in non-corrupt and appropriate way and make Ukraine self-sufficient with energy resources. So I thought unbundling is a little bit distraction, but the shareholder insisted they want it, so we will deliver it. My concern about the Consortium is that if they do not see a transit contract beyond 2020, they will not invest in the pipeline.

- It brings us to another problem. If there is no transit, Ukraine will have to find funding for the reduction of the pipeline capacity…

- It does cost money really. But it is not as big as a lot of people think. If you have a pipeline business, it has to make some profit even with zero transit. Then you can get some funding in restructuring the capacity.

- You know about the discussions between Naftogaz and the shareholder regarding the separation of storages from the pipeline. According to the unbundling plan, you are going to establish a new storage operator in future. Naftogaz says that now it is an unprofitable business with a lot of debts and disputes about whose gas is inside. How do you plan to achieve this goal and why storages should stay within Naftogaz?

- Storages definitely should not be a part of the pipeline business. Because it does not need a storage business in order to run the transit. And the storages have nothing to do with gas transmission. And you have pointed out a lot of issues about the difficulties of the storage business. There is a big issue about metering and a lot about whose gas is in the storages, potential corruption and etc. So now we are tending to separate the storage and pipeline businesses and keep the storages within Naftogaz for the time we are trying to resolve all problems, mentioned above. But absolutely sure that after that, the storage business has to be separate business. And hopefully time to come it will be a hub-work and it'll be providing all the services the storage can. We are creating separate TSO in storage business, but it will take us a while. This is a task for future.

- What is your personal vision of the upstream business? How will it develop in future?

- I find the situation is really upsetting. Because Naftogaz is one of many. And we should be treated as a potential buyer of license like any other company. And there should be a competitive tender – open and transparent and not corrupt. If it is corrupt, we are not going to attract capital, and we all know that Ukraine needs capital. We also know that Ukraine is not producing all gas it could. Ukraine has a potentially huge wealth and upstream oil and gas is a part of what that wealth could be. Many people are saying that you have enough of oil and gas not only to be self-sufficient, but also for export. So upstream could be a huge wealth driver. You need good regulations in that sector, responsibility for giving licenses, anticorruption policy. This all will encourage investment.

- What do you think about the privatization of the upstream business? Is it possible that Naftogaz could sell UGV?

- I personally believe that privatization is really good for the economy, for the country, and for the citizens. But it is difficult for governments to do and for some people to believe it is the right thing to do. Because they feel like losing the country tools. And when you privatize the company you have to do it in a way that stops the oligarchs, you have to do it in a way that creates good businesses, not bad ones. I think Naftogaz is being a really good example, because what we are trying to do and all our anticorruption policy is addressed on how to stop oligarchs in the energy sector.

Corporate Communications Department
NJSC Naftogaz of Ukraine

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