Ukraine gets 1/3 natural gas price discount based on Gazprom option

Макроэкономика 18.12.2013 Naftogaz of Ukraine (NAFTO) and Gazprom (GAZP RX) signed an amendment to their 2009 natural gas deal that will “offer the possibility” for Gazprom to supply gas to Ukraine at USD 268.5/tcm (33% below the current average price, USD 406/tcm), Russian President Vladimir Putin announced at the Dec. 17 meeting of the Russian-Ukrainian Interstate Commission. Gazprom “intends to use” this possibility, he said. He stated that this is “a temporary decision”, meaning that “long-term agreements should be, and will be reached”. Gazprom is ready to reach further agreements with Naftogaz “but before us is the task of developing a truly and effective long-term scheme of cooperation” on both the supply of gas (to Ukraine) and its transit (through Ukraine), the Russian president said. The temporary conditions were reached part of a “contract for buying and selling the delivery, volumes and transit conditions for natural gas for 2009-2019.” The Interfax-Ukrayina news agency reported on Dec. 18 on clauses not officially announced as a result of reading from the document that Ukrainian Deputy Prime Minister Yuriy Boyko flashed before TV channels the prior day. The amendment stipulates that Gazprom and Naftogaz will sign quarterly contracts “to confirm the price of USD 268.5/tcm.” If the quarterly deal is not signed by the tenth day of a quarter “for whatever reason”, the previous pricing formula (based on the “Tymoshenko deal”) will apply for the quarter. Alexander Paraschiy: The most important aspect of the deal is the gas discount isn’t fixed, which gives Gazprom the ability to renege on a quarterly basis, whether for commercial or geopolitical reasons, such as periodically being able to “reward” or “punish” Ukrainian officials for their political maneuvers. So far, it’s not clear what the Ukrainian side has offered for such a concession from Gazprom, which is a very disturbing aspect of these Russian-Ukrainian deals. Recall that in 2010, Ukraine extended the lease of the Russian Black Sea Fleet by a quarter century from 2017 to 2042, just for a USD 100/tcm gas discount. The most obvious concession that Ukraine might have offered to Gazprom is to increase gas purchase volumes by 20-30%. That would nearly entirely offset the positive effect of the gas discount on Ukraine’s trade balance. As there is little clarity on the sustainability of the gas discount for Ukraine, we only can foresee preliminary effects on Ukraine’s economy from the deal. First, if the discount will be valid through the next year, Ukraine may save about USD 3.5-3.7 bln in foreign currency from the deal (providing gas import volumes remain unchanged yoy). The discount will also enable Ukraine to get closer to an IMF deal as one of its core requirements – boosting household gas prices - is losing its importance. Theoretically, the amended gas deal can be beneficial for Naftogaz (NAFTO), whose cash deficit (the difference between low gas tariffs for utility firms and the high price of imported gas) will decrease. But to state this with certainty, we still have to see the amendment. On the equity side, the discount of USD 132 per tcm would boost iron ore miner Ferrexpo’s (FXPO LN) 2014 EBITDA by 6% to USD 468 mln, and add almost USD 200 mln to the EBITDA of Metinvest (METINV, whose EBITDA was USD 1,985 mln in 2012). The third winner will be Astarta (AST PW), which also may improve its EBITDA margin by some 1pp. And we also can point out those who will definitely suffer from cheaper imported gas: they are independent Ukrainian gas producers Serinus Energy (SEN PW), JKX Oil & Gas (JKX LN), Regal Petroleum (RPT LN), Cadogan Petroleum (CAD LN) and Cub-Energy (KUB CN). The price for imported (Russian) gas serves currently as a benchmark to price all the gas that is supplied for industrial consumers in Ukraine, including the gas offered by local producers. A 33% decline in their achieved gas price will nearly halve their netback and operating margin.