Ukraine’s Naftogaz outgoing chair, new CEO debate board dismissal, financial performance, company outlook

LONDON (ICIS)–On 28 April, the Ukrainian government shocked local and foreign stakeholders by dismissing the supervisory board of energy incumbent Naftogaz, along with CEO Andriy Kobolyev – only to reappoint the board immediately afterwards.

The move sparked a wave of international criticism from the EU and global financial institutions, which had tied the disbursement of financial aid to Ukraine improving corporate standards at state-owned institutions such as Naftogaz. At the same time, the US Department of State described the decision as a “calculated move” showing “complete disregard for fair and transparent corporate governance practices”.

Ukraine’s western backers had expected the country to fulfil its commitments to clamp down on corruption and consolidate its institutions to withstand political pressure from Russia.

Naftogaz, which had been a major source of corruption and particularly vulnerable to Russian influence was at the forefront of the government’s corporate governance reform. Kobolyev, himself, is credited with overseeing the transformation of the company from a financial basket case accounting for 27% of state budget spending in 2014, to a net contributor of Ukraine hryvnia (UAH) 121 billion (€3.6bn) to government coffers in 2019.

Against the backdrop of international protests and with the dust yet to settle on the government’s move, the supervisory board, chaired by Clare Spottiswoode, a highly-respected international gas specialist and one of the architects of British gas market liberalisation, resigned. The board said it would stay on until 14 May to oversee an orderly leadership transition.

‘UNPRECEDENTED’

Three independent members of the six-strong board signed a letter to the government, seen by ICIS, labelling the decision an “unprecedented move” as well as “a violation of corporate governance”, and saying it raised concerns about a potential conflict of interest surrounding the appointment of new CEO Yuriy Vitrenko, a key figure in Ukraine’s negotiations of a five-year gas transit deal with Russia’s Gazprom. Vitrenko worked at Naftogaz until last year when he was dismissed following a company restructuring.

On Wednesday 5 May, the executive board members of Naftogaz issued a statement, calling on the government to uphold the principles of corporate governance and ensure a supervisory board is in place. Failure to guarantee one after 14 May would make it “impossible” for executive board members to continue their duties, they said.

As US State Secretary Antony Blinken arrived in Kyiv to meet the president and prime minister on 6 May, he was expected to raise the issue of the dismissals at Naftogaz, a company that in the past had been at the centre of some of the biggest corruption scandals in Ukraine.

ICIS interviewed exclusively both Clare Spottiswoode and Yuriy Vitrenko about the shock events, the causes of the dismissals and the outlook for the company under new leadership.

ICIS also invited the office of the Ukrainian prime minister to comment on allegations made during the interview but had not received answers by publication time.

CORPORATE GOVERNANCE

Clare Spottiswoode said last weeks’ chain of events raised questions on multiple fronts.

Firstly, she said the government had extended the terms of some of the now former board members by six months in December 2020, which meant their mandates would be expiring in upcoming weeks. She also noted the government had renewed the term of outgoing CEO Andriy Kobolyev by four years in March 2020.

“The logic you would expect is that if they wanted to get rid of us, they would have waited for our [supervisory board’s] term to expire rather than make a big fuss now. The timing was very weird,” she said.

Secondly, Spottiswoode said the entire process of sacking the supervisory board and the CEO only to reappoint the board a few days later “made a mockery of corporate governance”.

Under its wider reform commitments, Ukraine pledged to introduce corporate governance principles at state-owned enterprises (SOEs), which would reflect the principles of the OECD, a club of rich countries.

Naftogaz was at the forefront of the country’s corporate governance reform and its charter was recently updated to ensure the supervisory board was given the powers to appoint or dismiss CEOs. The charter amendment was one of nine structural benchmarks established last year by the International Monetary Fund as part of a $5.5bn stand-by agreement to aid with financial recovery.

Under the updated terms of the charter, therefore, the supervisory board would have had the responsibility to dismiss and appoint a CEO in line with a competitive procedure. The process should have involved consultations with the government, as the sole shareholder of Naftogaz, Spottiswoode said.

The supervisory board members’ letter to the government said: “We have no issue with the authority of the shareholder to terminate our powers, even early.

“However, to do so in order to replace the CEO, which is clearly in the competence of the supervisory board is a violation of corporate governance. […] Should the government have felt that the outgoing CEO was a major issue, this too should have been discussed with the supervisory board.”

PERFORMANCE CONCERNS

In response, Vitrenko denied the decisions taken by the government were violating principles of corporate governance. He pointed out that some members of the supervisory board had their terms extended only provisionally and that the outgoing CEO of Naftogaz had not been appointed and reappointed in line with OECD guidelines.

“The government has now launched an open tender for [four] supervisory board members,” he said.

“I would not agree that [what happened] was a mockery of corporate governance. I would say that the reason why the supervisory board and the CEO were fired is obvious and stated transparently in the decision of the government [in a statement at the time] and that is because their performance was deemed unsatisfactory.”

He also noted that the charter stated that the supervisory board could hire or fire CEOs “under normal circumstances, when the government agrees with the supervisory board”.

“When the government disagrees with the supervisory board, it is logical that they should dismiss [it],” he said.

He acknowledged that although the government did not agree with the board, it decided to reappoint it. He added that in some areas, where the government disagreed with the approach of the board, it would opt to take decisions instead of the board. Vitrenko did not clarify what these areas would relate to.

CONFLICT OF INTEREST

Spottiswoode said the appointment of Yuriy Vitrenko himself raised concerns about potential conflict of interest, noting that prior to becoming Naftogaz CEO, Vitrenko was acting energy minister.

She explained that Ukraine’s anti-corruption law explicitly prohibits such appointments, mandating public servants to observe a one-year cooling off period regarding companies over which they had influence.

A note posted by lawyer Alan Riley echoed the view, pointing out that article 26(1) of Ukraine’s law on the prevention of corruption mandates that persons who regulate an entity cannot be appointed to its board for one year.

Spottiswoode added that any appointments of CEOs should be made in line with a competitive process that often takes close to a year to complete.

In response, Vitrenko confirmed he was appointed CEO of Naftogaz and that his term was for one year.

He denied there was a conflict of interest however, adding that as an acting energy minister he had no voting rights within the government, and therefore effectively no influence over Naftogaz or the government’s handling of the company’s management.

This meant not only that he did not have a say when the government decided to dismiss the supervisory board and the CEO but also that there was no conflict of interest as far as his Naftogaz appointment was concerned.

FINANCIAL PERFORMANCE

Spottiswoode said that although Naftogaz had a financial loss of UAH19bn (€570m) in 2020 because of low gas prices, suppressed demand linked to Covid restrictions and the inability of some companies to pay for delivered volumes, its overall financial situation was solid, praising the Naftogaz executive team as being “world-class”.

She said that Naftogaz had been in regular contact with the government to inform it of the company’s financial performance. She also insisted that Naftogaz paid UAH141bn in taxes and dividends which amounted to 13% of the total state budget.

The supervisory board letter to the government also points out that in 2020, its cash flow was UAH19.5bn, nearly three times the UAH6.9bn level the year before.

However, Spottiswoode said there was disagreement between Naftogaz and the government over the accounting methods that had been used. She said Naftogaz had insisted on using international IFRS accounting standards, which would have meant including the bad debt incurred as a result of non-payments. In contrast, the government insisted on Ukrainian accounting standards, which Spottiswoode said would not have shown the bad debt.

The upshot of including the bad debt into accounts in line with IFRS accounting standards was that the company was likely to pay fewer dividends to the government.

“The company did extremely well, considering the circumstances last year,” Spottiswoode said, noting that the results were already seen in the first quarter of 2021 when Naftogaz reported a profit of UAH12.6bn.

Vitrenko said in response that, while he had been heading the department of transit at Naftogaz in 2019, he warned Naftogaz of potential losses in 2020. These were linked to a certain extent on the inability of some consumers to pay for deliveries.

He said that he had always spoken the truth, even if this may not have been comfortable to some stakeholders and this may have led to his dismissal as executive director in 2020.

Naftogaz said his position was no longer required following the restructuring of the company in 2020.

Vitrenko said that in 2019, Naftogaz registered a profit of UAH63bn, with his department overseeing the transmission operations and the transit of Russian gas making UAH70bn that year. The profit was partially offset by some losses in other departments.

The transmission operations were moved to the newly established gas grid operator GTSO in January 2020 and the money that had been cashed in 2019 represented the cash paid by Gazprom for transit to Ukraine under an older agreement.

COMPANY PROSPECTS

Looking forward, Spottiswoode said the latest developments plunged into doubt the future of Naftogaz and its reputation.

She also noted the executive board of Naftogaz had been working hard to raise cash on foreign markets in order to expand local production and pay dividends to the state. However, she said this prospect may not be on the table any longer as investors may now need additional reassurance and stability.

She added that the supervisory board had invited Vitrenko to come up with a leadership plan or at least to reassure the executive board that the changes that had been put in place – including the establishment of a strong anti-corruption department – would be upheld.

“He did neither,” Spottiswoode said.

Vitrenko responded that it was agreed with the executive board that he would not provide a plan since he did not have the time to draft it but insisted that he had held meetings with the executive board both collectively and with individual members.

He said there was no guarantee that no changes would be made going forward, insisting that members of Naftogaz would be appointed based on merit.

Spottiswoode said supervisory and executive board members, most of whom are based in European countries, would move on irrespective of what has happened in Ukraine.

However, she said the latest development was detrimental to Ukraine.

“If you were Russia [what happened] would be fantastic.” She said the prospects of Ukraine raising cash may diminish, denting its ability to compete.