The Chronicle Of Oil And Fuel Market Of Ukraine

Over the last ten years, the country’s light oil market has been regularly hit twice a year: in the run up to (or even in the height of) the sowing and harvesting campaigns. Light oil manufacturers and traders have tried to raise prices, which is logical from a business perspective. Agrarians have lamented over the “unbearable pressure”, which is also understandable, albeit vexing. The government has traditionally poured oil on troubled waters, which has eased the agrarians’ situation and moderated the oil traders’ appetite.

Yet never since independence has the confrontation between the Cabinet of Ministers of Ukraine and the key light oil manufacturers (owned predominantly by Russian oil-producing companies) been as bitter as in April 2005. This article is an attempt to analyze the latest oil market developments and give both parties a chance to present their case.

The current “oil crisis” surfaced in the public discussion after Olexander Baranivsky, Minister for Agrarian Policy announced at a press conference that the top managers of Ukrainian oil refineries had, allegedly, colluded at a “secret meeting” to raise prices in the domestic fuel market. He also complained that the light oil manufacturers had refused to sell fuel on the terms laid down in the “Memorandum on Coordinated Actions by the Cabinet of Ministers of Ukraine and Ukrainian Oil Companies in Developing and Regulating the Oil Market” signed in Kyiv on 16 February 2005, and in the “Agreement on Coordinated Actions by Agricultural Manufacturers and Ukrainian Oil Refineries” dated 11 February 2005.

May I remind you that the latter agreement between oil refineries, on the one hand, and the Ukrainian Union of Agricultural Enterprises and Farmer and Landowner Association, on the other, envisions the fuel manufacturers’ commitment to supplying, in February-May 2005, up to 600,000 tons of diesel fuel at a maximum price of UAH 2,400 per ton? The agreement was signed by the CEOs of seven leading oil companies, namely: Private Joint Stock Company UKRTATNAFTA (Kremenchug Oil Refinery), Limited Liability Company TNK-BP UKRAINE, Industrial and Investment Concern LUKOIL UKRAINE (Odessa Oil Refinery), Private Joint Stock Company KAZAKHOIL UKRAINE (Kherson Oil Refinery), Public Joint Stock Company NPK-HALYCHYNA (Drohobych Oil Refinery), Public Joint Stock Company NAFTOKHIMIK (Nadvirne Oil Refinery) and National Joint Stock Company NAFTOGAS UKRAINY (Shebelinsk Gas Refinery).

While signing the memorandum with the oil companies, Yuliya Tymoshenko’s government undertook to set up an analytical expert group to study proposed measures conducive to a stable operation of the oil and fuel market in Ukraine. The group was established and approved by the Cabinet resolution of 28 February. All of the above companies were invited to delegate a representative to it.

Minister Baranivsky’s statement on possible collusion triggered a strong reaction. Felix Luniov, Commerce and Production Department Director of the TNK-UKRAINE LLC, stood up for the oil refining companies: “Unfortunately, the Agriculture Minister is not fully aware of the situation as it is. Nor does he communicate properly with his colleague - the Minister for Fuel and Energy. The meeting he refers to was not secret. It was not a “cartel gathering”, but an open conference attended by oil manufacturers and Minister Ivan Plachkov. The manufacturers informed the minister of their inability, for economic reasons, to sell diesel fuel to the agrarians at UAH 2,400 per ton and offered a new price - UAH 2,800 per ton. It is sad the government has not responded to our offer yet…”

The Antimonopoly Committee of Ukraine asserted that all of its territorial divisions were monitoring the situation on the oil and fuel markets. According to the AMCU representatives, there existed “several objective reasons for price dynamics in the market. At the same time, the Antimonopoly Committee has no verified information on any particular cases of collusion amongst oil product manufacturers to raise prices”.

“The Committee officially requested that the Ministry for Agrarian Policy forward to us all available materials that would corroborate the Minister’s statement. We also sent an inquiry to law enforcement. Should the oil traders’ anti-competitive practices be detected, the Antimonopoly Committee will conduct a proper investigation and put an end to them,” - said AMCU Chairman Olexiy Kostusev.

President Viktor Yushchenko declared that the situation in the domestic oil and fuel market looks like collusion. Prime Minister Yuliya Tymoshenko is resorting to tough measures (setting price ceilings and banning the exports of oil and oil products) to overcome “yet another unexpected” fuel crisis in the country and, probably, sometimes unconscious sabotage.

Back to the chronicle. On 7 April, the Cabinet dealt exclusively with the oil and fuel issue: it analyzed and discussed the current market situation in every minute detail, examined the prospects for its development and decided to design a strategy for the national fuel and energy sector. Olexiy Ivchenko, CEO of the National Joint Stock Company NAFTOGAS UKRAINY, who was present at the Cabinet session, claimed the government and the company he manages would never allow oil prices to be raised unjustifiably.

Premier Tymoshenko admitted that the Ukrainian fuel and energy sector is dependent on power supplies from the Russian Federation, which increased, as of 1 April 2005, its oil export duty from USD 83 to USD 102.6 per ton. The Ukrainian market is still reeling from the blow.

On 14 April, the Ministry of the Economy, in coordination with the Ministry of Fuel and Energy, issued Order #95 “On Establishing Ceiling Wholesale Prices for Diesel Fuel and Petrol”, registered with the Ministry of Justice on 15 April and stipulating the following maximum wholesale prices: diesel fuel - UAH 2,932 per ton, A-95 petrol - UAH 3,528 per ton, А-92 - UAH 3,481 per ton and А-76 - UAH 3,455 per ton. The regional state administrations are requested to limit the sales mark-up to 13%. Retail prices were set at the following rates: diesel fuel - UAH 2.75 per liter, А-95 petrol - UAH 2.99 per liter, А-92 - UAH 2.95 per liter and А-76(80) - UAH 2.85 per liter. By the time the order was published, retail petrol prices had exceeded UAH 3.0; many petrol stations were selling А-95 petrol at UAH 3.20-3.50 per liter. The agrarian workers and managers were complaining that the oil company-signatories of the memorandum would not supply them with diesel fuel at the agreed price.

On 16 April, inspectors were sent to petrol stations check if order #95 was fulfilled. As a result, several petrol stations suspended their operations.

On 19 April, representatives of the seven leading oil companies called a press conference to challenge the legitimacy of order #95. According to them, the order was to come into effect on 25 April, but the authorities started fining the petrol station managers for overpricing. They argued the recent price increase for oil products was economically driven and any collusion was out of the question. To substantiate their position, the oil company representatives presented their market analysis, pointing out the economic and political factors behind the oil price rise in Ukrainian and international markets.

Their arguments seem credible, particularly if one disregards the Ukrainian population’s real purchasing power, ignores the fact that in some oblasts agricultural enterprises and farmers refused to launch their sowing campaigns because of the lack (or rather, the high cost) of diesel fuel, and turns a blind eye to the profitability rates of oil and fuel business. The oil companies assured the press that Ukraine had sufficient stocks of fuel, yet the price established by the government would render their business loss-making. They blamed the government for showing no will to negotiate the issue and publicly called on Prime Minister Tymoshenko for a constructive dialogue.

After the conference it transpired that four oil companies with Russian capital also appealed for support to the Russian Prime Minister, Mikhail Fradkov. They asked him to discuss the Ukrainian oil market situation in his meeting with Yuliya Tymoshenko.

When asked by the ZN correspondent why oil companies did not so openly oppose similar restrictions in the times of the Yanukovych government, their representatives answered that “those measures were temporary; besides, assault units armed with automatic guns were most convincing”. At first the oil companies were asked to keep prices unchanged till the end of the last year’s sowing campaign (just like today), later - till the end of harvesting campaign, later still - until the first round of the presidential elections, the election run-off, Yushchenko’s inauguration and… till the end of the sowing campaign again. The oil companies’ representatives say this vicious circle should be broken: the new government should introduce a new approach to the oil and fuel sector in general and to oil companies, in particular. They say they are ready for a dialogue but the government would not listen to them.

In the meantime, the Prime Minister, Minister of Economy and Minister of Fuel and Energy are meeting on a daily basis to discuss the fuel market situation and to find solutions. On the day of the above press conference, Prime Minister Tymoshenko had a blunt talk with the heads of oil companies with whom the state still has a controlling share, such as UKRNAFTA, UKRTATNAFTA, HALYCHYNA Oil Refinery, NAFTOKHIMIK PRYRAPATTIA and National Joint Stock Company NAFTOGAS UKRAINY. Following this meeting, in the Cabinet of Ministers the Minister of Fuel and Energy announced that the government planned to buy 100 thousand tons of oil products and 300 thousand tons of oil in order to intervene into the light oil market and bring down the price. Ivan Plachkov acknowledged, however, that the fully-fledged strategic oil reserves would hardly be formed before 2006.

On 20 April, the Antimonopoly Committee permitted UKRNAFTA to expand its petrol station network by purchasing 73 additional ones, in order to have more points selling petrol at a cheaper government-set price. Lately petrol at the UKRNAFTA stations has, indeed, been cheaper than elsewhere, but the drivers had to queue and complained about the petrol quality.

“We hope for a meaningful dialogue with the government”

On 21 April, all of a sudden, after long public squabbling and remonstrating on the part of Russian oil importers, the news was spread about Prime Minister’s meeting with the CEOs of TNK-BP and TNK-BP UKRAINE and, what is more, about the TNK-BP UKRAINE agreement to refrain temporarily from increasing fuel prices in Ukraine. Alexander Gorodetsky, President of the TNK-BP UKRAINE LLC, specified the contents of agreements reached with the Ukrainian government:

“The TNK-BP top management appreciates the difficulties faced by the Ukrainian government; therefore it decided to support the Cabinet of Ministers and to agree with the Prime Minister on the following.

First, Lysychanks Oil Refinery (Public Joint Stock Company LINOS) will continue to supply diesel fuel to the agricultural sector at the earlier approved price of UAH 2,400 per ton. The refinery will schedule those privileged supplies based on the available stock, plan the enterprise re-launch after repairs and the amount to be supplied under the memorandum with agrarians. Second, till the end of this month, i.e. till 1 May, ТNК-ВР will freeze prices at its petrol stations at the level established by the Ministry of Economy. Our trade partner TNK-UKRAINE LLC will to its best to normalize the situation in the jobber network.

We failed to reach a longer-term agreement with the government because of a considerable divergence in the vision of the future operation of the oil product market in Ukraine. Yet we plan to come to a compromise by 1 May and find a solution beneficial for Ukraine’s economy and the oil refining industry.”

On Thursday night, after his live interview on TV Cannel 5, Mr Gorodetsky answered the ZN correspondent’s questions:

- Mr Gorodetsky, could you tell us more about your meeting with Prime Minister Tymoshenko?

- We wanted to discuss the economic model (structuring and pricing) of the oil and oil products market at large. Yuliya Tymoshenko still believes that such companies as ТNК-ВР have a good “stability factor”, so to speak. She has her own idea of how fuel pricing should work along the whole chain, from oil well to petrol pump. In our opinion such a model is viable in a limited number of countries. Ukraine, where most of refined oil is imported, does not belong to them. Thus we insist that all incremental costs should also be taken in to account, including taxes in the Russian Federation and Ukraine, transport expenses, etc.

Difference in vision and approaches is not a problem. There is a vital desire to hear the opponent’s arguments. We made this step to meet the government halfway because we believe it will facilitate mutual understanding. Thus, till the end of the month we will be complying with the prices established by the Ministry of Economy and supplying diesel fuel to the agricultural enterprises at the fixed price of UAH 2,400 per ton.

- To an outsider, it looked like giving in to pressure… What made you accept the Cabinet’s terms, albeit for the short term? Was it a threat to re-privatize LINOS or the national currency revaluation?

- Unfortunately, many are inclined to see it as a matter of politics, rather than of economy and unprejudiced market analysis. We assured the government that this was a conciliatory step. It is neither our tactics nor strategy.

Everyone uses all the arguments available to them. I cannot say the threats you mentioned were never brought up in the course of our negotiations. Yet we did not consider either of them critical in our case. Such companies as ТNК-ВР and ТNK-ВР UKRAINE can hold their prices down for a week with no noticeable adverse effect. Yet smaller enterprises, like Nadvirne, Drogobych and, probably, Kherson oil refineries could suffer.

- What do you think of the Ministry of Economy initiative to keep petrol prices frozen till 1 June? Would you agree to that?

- I do not think we would. If this is what the government plans to do, we will have to make decisions concerning our tactics in Ukraine’s market of oil and oil products. We will do that in May, but even today we see no economic reasons for restraining prices.

- Do you hope for a meaningful dialogue with the Ukrainian government?

- We do, and we have already started it by meeting with the Prime Minister of Ukraine. We hope the Ukrainian President and Prime Minister will pay due attention to our economic arguments. There are differences in approaches. It is normal, we can understand that. One of the reasons for our accepting the government’s terms was the need to facilitate oil contracting for the next month. The market players still do not know what prices we can discuss. In spite of all its problems, Ukraine holds sufficient oil reserves at the moment, but in May and especially in the summer the situation can become dramatically worse because of the shortage in the oil product supply. We have to reach a compromise as soon as possible, to avert a real crisis.

“The state should assume a managerial responsibility”

Having decided to intervene in the oil product market, the government should have at its disposal a wide network of petrol stations under its control. So it opted for the UKRNAFTA and NAFTOGAS networks. Plans to establish a state-owned, vertically integrated company as a lever in stabilizing the domestic market of oil and oil products have been in place since 2000, but they are yet to be implemented. Thus the government can only use the levers accessible to it.

We asked Oleh Salmin, member of the Supreme Rada Committee for Fuel and Energy Complex, to comment on the oil market situation and on the mechanisms available to the government for stabilizing it.

- Is a ban on exporting oil and oil products justifiable in this situation?

- It is, for the time being.

- In your opinion, what should be done to stabilize the Ukrainian oil and fuel market?

- The major thing we should do today is build up stocks. The government is doing it at the moment. The root cause of the problem is that previous governments did not care to do it. That is what we need a national oil company for. The regulatory mechanisms that the government can use should aim to form a balance between the import and export components. Then we will get rid of the problems and scandals that we have with re-export, export ban, etc. The government should not forbid an enterprise to export its product if it is economically profitable. The government can negotiate transparent export arrangement with refineries, build its relations with the business on trust and mutual recognition that some costs are variable and others are constant. World oil prices are going up and we do not know to what level they might rise to by the autumn.

- Do you see any signs of collusion in the oil refineries’ behaviour?

- People in this country are prone to seeing politics in everything. The Odessa-Brody pipeline is politics. In today’s situation we again proved unprepared for the oil price increase. The new government did not pay enough attention to the oil and fuel sector, and the oil refineries decided that supplying fuel to the agrarians at fixed prices could be detrimental to their business. Whether it is collusion or not is difficult to say. It might be a defensive reaction on their part. The Cabinet, on the other hand, has to protect people’s interests.

- Who is right, under the circumstances? Can both be right?

- I think both are right, each in its own way. That is why I promote this idea of a national oil company. There should be an entity, a focal point of technical and economic levers of power. It will allow the government to obtain control of 2,500 petrol stations, instead of today’s 400, resorting, which is important, to purely economic measures. The new structure could have monitoring functions as well. It cannot be UKRNAFTA or UKRTATNAFTA. Those companies have been devastated by the previous authorities. The state should assume managerial functions, both at UKRNAFTA and UKRTATNAFTA. It is good they have other shareholders, but the state, with its controlling block of shares, should have a greater role to play.

The reserve of oil and oil products should not be formed at the expense of the state budget. It should be done from the profit earned by UKRNAFTA and UKRTATNAFTA. The latter has UAH 1,300 million of active money on its balance sheet. This resource should be used to buy oil and form a reserve for the next autumn.

No pressure should be brought to bear on the oil companies. The government should tell them: let us look for solutions together; we are ready to stand by you, but you should play by the rules. Help us to form the reserve you have a pool of reservoirs. I am speaking about LUKOIL, ТNК-ВР. Let us negotiate the pricing policy for petrol stations. Oil price is a variable. We should base our calculations on it, but we also have constant costs (which we should agree on in advance). So even if oil prices go up, we will be ready for that. We will rise fuel prices smoothly, and mitigate the situation at the expense of our strategic reserve.

We should tell the traders: you are invited to participate in reserve formation; you could earmark, say, 5%-10% for critical situations like this. We will buy it from you at the price you paid for it. If the previous government had bought oil last autumn at those prices and established a reserve at oil enterprises, there would have been no problem today.

As for the national company incorporation, I would not recommend that it be based on UKRNAFTA. Unfortunately, its shares are so divided that some of the external shareholders are not strategically important ones. There is one major shareholder - a representative of the PRIVATE group. They are now developing a programme for a company to establish a petrol station network. Yet they are approaching this task from the company’s, rather than the state’s, perspective. Here is the main difference, in the approach.

When we were introducing the UKRNAFTA shares to the American stock market, we always acted transparently. We were the first Ukrainian company to offer its shares overseas. We placed 5% of UKRNAFTA shares then. We did it in order for the company to win trust amongst international investors. Our objective was to attract USD 100-200 million of investments, primarily, in petrol stations, which UKRNAFTA did successfully.

- Having bought petrol stations with its own money and at an exorbitant price?

- One should do it with loan money. Working capital should be channeled into production development. Presently, UKRNAFTA has serious problems with oil reserves. We are speaking about 30-40 years of the company’s operation. It needs new technologies, new economic mechanisms and new capital. You need all of that for better performance and for establishing partnerships. Yet if you have spent all your money to buy petrol stations, the investors are likely to tell you: wait, you have to achieve success in your domestic market; unless you have got enough money I will not be interested in signing any, say, lease contracts with you. Should a crisis occur in your country tomorrow, your petrol stations will be worthless. Why should I do business with you?

Loan capital is a different story.

- Does it mean there is no use establishing a vertically integrated company based on UKRNAFTA? Will it be unable to address the outstanding issues?

- In strategic terms, it will never be a uniting force. Our main task is to integrate the remaining market that the state still can control.

Alla Yeremenko