Forecast: Naftogaz Struggles with Gas Debts

On October 1, Ukraine's energy monopoly, Naftogaz, announced a technical default on its $500 million five-year Eurobond. The company reached an agreement with international creditors to restructure this debt on October 19. The bond's maturity date has been extended to September 2014, interest payments have increased from 8.125% to 9.5%, and servicing this debt is now guaranteed by Ukraine's government. Naftogaz restructured another $1.15 billion of external debt on exactly the same terms.

Non-payment risks by Naftogaz are still considerable, however. In the run-up to January 2010 presidential elections, Timoshenko's government is using Naftogaz's revenues to support the state budget. In January-September 2009, Naftogaz paid 30% of its revenues, some $4.5 billion, into the state budget. The firm is currently facing an internal budget deficit of $4 billion. To improve Naftogaz's balance sheet the government 'restructured' the firm's $1.3 billion of domestic debt by transferring it between two-state controlled banks, Oshchadbank and Ukrgazbank. Overall, Naftogaz still owes $4.4 billion to domestic banks and another $2 billion to international lenders. The IMF has demanded an increase in gas prices for domestic consumers, but the government has blocked this prior to elections.

Given the government's failure to shore up Naftogaz's financials, the EBRD suspended its $300 million loan to the company. The fate of a further $1.7 billion loan from international financial institutions is now in question. Furthermore, we assess that payment to Ukraine of the next tranche of the IMF loan, amounting to $3.8 billion and due in November 2009, is likely to be delayed. The country's budget deficit will probably exceed 8% of GDP this year, and yet the parliamentary opposition insists on increasing salaries and pension payments.

More positively, Ukraine's economy is showing its first signs of recovery. Importantly, the metallurgy industry, prime generator of foreign currency revenues, returned to pre-crisis levels of production in September. Although Ukraine's economy is likely to contract about 14% this year, the World Bank estimates it will grow by 2.5% in 2010.

Overall therefore, we forecast that Naftogaz will struggle to meet its external and domestic financial obligations, including payments for gas deliveries to Gazprom. State-controlled banks, like Oschadbank and Ukrgazbank, will also be affected by Naftogaz's insolvency.