John Dizard: Orange Revolution loses its lustre

A few months ago the western investing community had some doubts about how much real progress was being made by the Ukrainian “Orange Revolution”. One of the most highly touted of the US-backed colour-coded pro-democracy, pro-market political movements, the new Ukrainian government was, we were told, going to rescue the country from the reactionary past.

Ukraine had earned such a reputation for corruption and inefficiency that very few investors were willing to take a chance on developing the country’s resources and employing its people.

Now, though, those doubts are almost entirely cleared up, and the situation in Ukraine is pretty clear. It’s as bad as it was before the Orange Revolution. Far from establishing Ukraine’s effective independence from Russia, the oligarch-dominated government has, in effect, allowed it to remain an economic colony.

Mind you, there’s still quite a lot of effective spin control over the developing mess. That’s the one American technology import that’s worked so far. This week, for example, the “Extraordinary Ukraine Roundtable” of the World Economic Forum is being hosted in Kiev. According to the organisers’ announcement, “The Forum will provide a platform for leading multinational businesses to support President Yushchenko and his government in their efforts . . . to push through the necessary economic reforms and the opening of markets in the country.”

Fortunately for the organisers, the meeting is taking place just after most of the country’s gas stations managed to reopen after a disastrous attempt at price controls had Ukrainians queuing fruitlessly for fuel. The only stations that had supplies while the controls were in effect were Russian-owned, which may tell you something.

The progress, or complete lack thereof, in the Ukrainian oil industry is a good illustration of how the country is continuing a slide into stagnation that could accelerate into absolute decline.

Ukraine imports most of its oil from Russia, which gives the eastern neighbour a level of influence the US government agencies can only dream of. Ukraine doesn’t have the enormous hydrocarbon potential of Russia, but its known resources could, with modest increases in efficiency, produce at least three quarters of its requirements. Under Soviet management, the Ukrainian industry was given short shrift on development, partly to move more capital and skilled labour to the bigger Siberian fields.

Whatever you can say about Russian oligarchs, such as “scary”, or “ruthless”, at least they’re ambitious. Over the past decade, Russian oil production has gone from 4m barrels per day to 10m, while Ukraine’s output is in decline. The country’s largest oil producer, Ukrnafta, is controlled by the Privatbank group, which, on the face of it, seems to have been intent on running down Ukrnafta’s value.

A number of western oil companies have done what is usually considered the smart move, and have partnered with Ukrnafta to develop new or existing fields. None of them have anything good to say about the experience.

As one North American oil man says, “You can’t even get a meeting with the management of Ukrnafta since it’s come under Privatbank’s control. When you do talk to them, you’re told that they intend to run any western companies out of the country.”

Ed Southern, the manager of Kroes Energy Inc. of Calgary’s Ukrainian operations, says “Ukrnafta only drilled 60 wells in the entire country last year, which is less than the bare minimum needed to maintain production. In fact, their production declined by 3 per cent. Privatbank’s plan has been to run down the value of Ukrnafta so they could buy it out cheap.”

For the moment, Privatbank is exerting effective control over the oil company with only 42 per cent of the shares. A Ukrainian state owned company, Naftogaz Ukraine, owns 50 per cent plus one share. That doesn’t mean the state can exercise any real control, since Privatbank can keep a shareholders’ meeting from having a quorum. Any change in management would require action by such a meeting. So, no change in management.

In the meantime, no non-insider knows what related-party transactions are taking place between Privatbank and Ukrnafta.

A suspicious mind might wonder if Privatbank has found some means to influence people at the top of the government structure.

One enigma here is the true attitude of Yulia Timoshenko, the Ukraine’s prime Minister of Ukraine, who became known as “The Gas Princess” thanks to her role in the hydrocarbon industry in the first years of the country’s independence. As one of the oil people says, “She is supposed to be a poacher turned gamekeeper. Personally, I think once a poacher, always a poacher.”

Others are more optimistic. Ed Southern says: “The government will win, no question, in the end. Then they’ll have Naftogaz take over control from Privatbank. At least some of them are energy people, and then we can be off to the races. The bankers don’t understand anything.”

One reason for Timoshenko to take effective control of Ukrnafta would be the potential for a special dividend, the state’s share of which could fund a vote-winning pension payment.

We can be pretty sure that greater transparency and better management will not happen thanks to the advice and encouragement offered by the US government. “Their official aid is chump change compared to what the politicians can steal,” observes an oilman.

I wonder if any of these interesting questions will be debated at that World Economic Forum. Somehow I doubt it.