Neighborly Corporate Raid

May 7, 2010

At the end of a meeting on April 30 in Sochi, Russia, Russian prime minister Vladimir Putin shocked Ukrainian prime minister Mykola Azarov with the offer to merge Gazprom with Ukrainian state energy company Naftogaz. On the surface, the offer makes no sense at all.

Gazprom is the largest gas producer in the world and a publicly traded company with a market capitalization of over $130 billion. Naftogaz is practically bankrupt, wholly owned by the Ukrainian state, which regularly props it up financially because of the social and political, in addition to economic, functions it performs. Naftogaz has long been the poster child of inefficient and nontransparent state monopolies bearing high credit risks, whereas Gazprom prides itself as an effective business with favorable access to capital markets. The scale and nature of the two proposed merger partners are as different as night and day. It is as if ExxonMobil offered to merge with the Bolivian state gas monopoly. How would this even work?

It is much easier to explain Russia’s offer as a corporate raid on Ukraine. Mr. Putin, his energy minister Sergei Shmatko and Gazprom’s chief executive Alexei Miller variously described their offer as a corporate merger, a share swap, or an asset swap, which only confuses matters because they are such different financial transactions in the rest of the world. What Russian and Ukrainian decisionmakers know well is the logic of corporate raids all too prevalent in both countries the past 20 years.

Just because a company is poorly run and technically bankrupt does not mean it has no hidden value or good assets. A successful corporate raider in Russia or Ukraine strips the valuable assets and leaves the original owners with all the liabilities. In the case of Naftogaz, its valuable assets are the international gas transportation system, which transits 80 percent of the gas Gazprom sells to Europe; its large gas storage facilities, which provide the surge capacity to meet Europe’s winter demand; oil transportation systems capable of moving more than a million barrels per day to European markets; and underperforming oil and gas producing fields and exploration potential, widely recognized by Ukrainian and international geologists. If these assets are spun off by Naftogaz, they would each be worth tens of billions dollars.

Russia has the whip hand in any negotiation with Ukraine. In almost 20 years of independence, Ukrainian leaders regularly make short-term accommodations with Russia on gas, in order to avoid difficult reforms of their energy-intensive economy, which each time leave them further in debt to Russia. This was true of President Viktor Yushchenko in January 2006, Prime Minister Yulia Tymoshenko in January 2009, and again on April 21 when newly elected President Viktor Yanukovych met with President Dmitry Medvedev in Kharkiv, Ukraine. These deals were always based on false premises and deliberately misleading to the outside world, so concerned about its own energy security given the prominent role Ukraine plays in oil and gas transit.

It is always useful in a corporate raid to have insider’s help. The raider also takes advantage of moments when other stakeholders are preoccupied elsewhere. This fits the current situation perfectly.
This last deal of gas for 25-year extension of Russia’s Black Sea Fleet Crimean base lease is based on the misnomer that Ukraine is getting a “discount” on Russian gas, which unfortunately has been unquestioningly reported by the media. Ukraine is getting no such thing. It is getting a similar price as European buyers after Gazprom was forced at the beginning of this year to adjust prices because of lower demand and market pricing due to ample global gas supply. Nevertheless, Russian and Ukrainian leaders claim that this new bargain will give the Ukrainian economy a $40-billion boost between now and 2019—virtual benefit from virtual discount.

Just as the promise of previous gas agreements between Russia and Ukraine turned illusory, so will this one as long as it is based on a fundamental falsehood. What remains unresolved are past and future financial obligations Ukraine has for failing to buy the gas it is contractually committed to pay for and the 11 billion cubic meters of gas in storage that Ukraine took for its own use in the winter of 2009, which belonged to a Gazprom joint venture and gas middleman, RosUkrEnergo.

What is almost certain is that it will be discovered in a year or two that Ukraine once again owes Russia billions of dollars in past gas debt. This perfectly fits the debt-for-equity dirty privatization model of Russia in the 1990s and of Ukraine even today. Ukrainian debt can then be converted into Russian assets.

Edward C. Chow is a senior fellow in the Energy and National Security Program of the Center for Strategic and International Studies in Washington, D.C.

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