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 
 
¶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