Fitch sees Naftogaz cutting losses from subsidized clients by 1.8x in 2014

Fitch Ratings confirmed the B- rating for the state-guaranteed Eurobonds of state monopoly Naftogaz of Ukraine (NAFTO), the agency declared on Dec. 18. Fitch also estimated that, with a price discount from Gazprom, Naftogaz will decrease its losses from inefficient natural gas tariffs for heating utility companies to USD 1.4 bln in 2014 from USD 2.5 bln in 2013.

Alexander Paraschiy: We agree with the Fitch estimate of Naftogaz’s losses from gas sales at below-market price in 2013. We estimate the company will generate about USD 0.4 bln in losses from the 10 percent share that imports comprise in supplies to households (at USD 93/tcm rate) and about USD 2.1 bln in losses from supplying heating companies (at an average rate of USD 136/tcm), which exclusively buy the imported gas. At the same time, we see that Naftogaz losses may be higher next year than what Fitch has estimated.

In particular, we believe that the effective price for natural gas that Naftogaz will import can be much higher than Gazprom is declaring. The trick is that the price of USD 268.5/tcm of Russian gas does not account for its calorific value, as it is written in the amended contract (based on what the media reported). This means that the calorific value of Russian gas under the amended contract might be up to 16% less than for gas that should have been supplied under the 2013 contract.

The calorific value of gas exported to Europe is close to 10.6 kWh/cm, while Ukrainian standards require a minimum calorific value of gas of 8.83 kWh/cm. Assuming the worst case (that the quality of Gazprom’s gas will be close to minimum requirements), the effective price that Ukraine will pay for “standardized” Russian gas will be USD 322/tcm. The discount, therefore, will not be 33%, but closer to 20%. In this case, Naftogaz will generate USD 1.8-1.9 bln in losses from inefficient gas tariffs.

Moreover, given that the USD 268.5/tcm rate will have to be confirmed each quarter by both Naftogaz and Gazprom, the sustainability of this discounted price depends fully on the good will of Gazprom, or the ability of the Ukrainian side to report each quarter on what it did for what ultimately amounts to Gazprom’s or Russia’s well-being. That creates certain risks that the cheaper price will not work so long. To keep prices low, we think the Ukrainian government will have to continue negotiations with the EU (fruitless, at that) to keep Gazprom “in line” with being willing to prolong the discounts.