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 UKRAINIAN CEO MUST FIX HIS COMPANY TO SAVE HIS COUNTRY

Andriy Kobolyev’s job running Naftogaz involves more than a corporate restructuring—he must remake an institution central to Ukraine and its economy.

koboliev naftohaz
Andriy Kobolyev, chief executive of Ukraine's NJSC Naftogaz, the national gas company, took over the troubled enterprise two years ago. He swapped a portrait of the president with one of Taras Shevchenko, a 19th-century poet exiled for ridiculing the Russian czars, and replaced a map of the Ukraine gas pipeline network with a map of Europe's gas-transit routes. Photo: Brendan Hoffman for The Wall Street Journal

Kyiv, Ukraine- Andriy Kobolyev moved into the executive suite of the national gas company around the time his new enterprise and his country were near collapse.

Russia had just annexed Crimea, and he inherited a business model that imported gas at high prices and sold it to households for next to nothing.

Mr. Kobolyev's job as chief executive of Ukraine's NJSC Naftogaz encompassed more than a corporate restructuring-it was the remaking of an institution central to his country and its economy. "One of the very likely scenarios was to simply dismantle the company through the bankruptcy procedure," he said of his initial prospects.

With the stakes high, Mr. Kobolyev made clear his vision, starting in his office: He swapped a portrait of the president with one of Taras Shevchenko, a 19th-century poet exiled for ridiculing the Russian czars. He replaced a map of the nation's gas pipeline network with a map of Europe's gas-transit routes.

In the two years since taking over Naftogaz, Mr. Kobolyev has sought to cut the company's dependence on gas from Russia's PAO Gazprom, a change crucial for Ukraine's security, as well for Europe's.

Mr. Kobolyev has worked to transform the creaking monopoly into a competitor in the regional energy market capable of generating needed cash.

To start, he has had to persuade residents to pay for gas, many for the first time. "You can either be in Turkmenistan, where you have free gas but low salaries and no freedom," he said, "or you can be in the European Union-style, but then the gas will be priced to market value. Sorry."

The 37-year-old chief executive also has sought to loosen the grip of business and political leaders on the company. "Naftogaz was mostly used as an instrument to do two things: firstly to bribe the electorate through the huge prepaid subsidies," he said, "and secondly for corrupt practices."

If Naftogaz and Ukraine's new pro-Western government can't fix the company's troubles, the nation risks losing its position as the main transport route for Russian gas to the European Union, which now brings some $2 billion a year in transit fees, say officials in Brussels and Washington.

"Naftogaz is a critical company not only for Ukraine's economic success, but also for European energy security," said Amos Hochstein, the U.S. special envoy for international energy affairs.

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The company's challenges are complicated by war. Weeks before Mr. Kobolyev took over as CEO in March 2014, protesters in Kiev had ousted the pro-Kremlin government. Ukraine was soon drawn into an armed conflict in the country's east with Russian-backed separatists. That summer, Gazprom cut off supplies, citing billions of dollars in unpaid bills.

During Mr. Kobolyev's first year, Naftogaz piled up a loss of 89.9 billion hryvnia, about $3.5 billion, or 5.9% of Ukraine's economic output.

Government bailouts of Naftogaz more than doubled the country's deficit and prompted emergency loans from the International Monetary Fund and the EU to keep the country running and the gas flowing.

So far, Naftogaz seems to be advancing: Last year, Russian imports accounted for 37% of domestic gas consumption in Ukraine, down from 74% in 2014 and 92% in 2013. Imports from Slovakia and elsewhere have made Kiev less vulnerable to Russian price increases or threats to cut off supplies.

Financially, Naftogaz expects to have cut its losses in 2015 to 25 billion hryvnia after accounts are settled. This year, the company looks to break even.

A push for change

Worry sometimes keeps Mr. Kobolyev awake at night.

"What I tell myself is that I always wanted to do something important and good for the country," said the son of a scientist and an English teacher. He studied international economic relations and began work at Naftogaz in 2002 as a consultant on corporate strategy, thinking he would stay at most a year. By the time he quit in 2010, he was advising the CEO.

Mr. Kobolyev said he left Naftogaz because the election of Viktor Yanukovych as president put an end to the pro-Western hopes of Ukraine's Orange Revolution-along with his hope of modernizing the company.

His return to the company has thrown Mr. Kobolyev in the middle of some messy politics-a challenge he has met with confidence, Western officials say.

Mr. Kobolyev faced off with Ihor Kolomoisky, a grizzled media and banking tycoon who had fallen out of favor with the government. In a shareholder meeting last year, Mr. Kolomoisky was fighting to keep control of Naftogaz's oil production arm, Ukrnafta, where he is a minority shareholder.

"You're going to sit in prison," Mr. Kolomoisky, a billionaire, told Mr. Kobolyev.

Mr. Kobolyev was calm as Mr. Kolomoisky aggressively questioned his credentials in a news video of the meeting. "The most important question is the management," Mr. Kobolyev said of Ukrnafta, "which is not satisfactory."

Change has triggered complaints outside the boardroom. In April 2015, the government quadrupled gas prices for households. Beginning this month, prices will be set by the cost of gas imports. Next year, they will become unregulated for the first time.

koboliev naftohaz
Irinia Skibinska, a 77-year-old widow in the Ukraine town of Rivne, has started paying for the gas she uses at home instead of a monthly flat fee. 'I'm worried,' she said. 'That's why I put in the gas meter.' Photo: Gabriele Steinhauser

The plan has called for the installation of residential gas meters. In the northern town of Rivne, a large banner warned citizens about failing to pay. "To have your flame not run out, pay your gas on time," it read, showing a woman holding a ladle at a stove.

Down a narrow driveway in a Soviet-style housing block, workers had just installed the ten millionth gas meter in a small one-bedroom apartment owned by Irina Skibinska. Lighting the flame in her ancient water boiler, the 77-year-old widow watched anxiously as the numbered wheels ticked up.

"I'm worried, that's why I put in the gas meter," said Ms. Skibinska, who lives on a monthly pension of 2,200 hryvnia, or around $83.

Ms. Skibinska's gas bill used to be 17 hryvnia a month, about 65 cents, no matter how much she used. Now, she will be charged per cubic meter. "I want this gas meter to count less," she said, turning off the boiler after a minute.

Ukraine has expanded its social safety net, with some 5 million families, about one in three, now relying on subsidies to pay gas and heating bills.

The government-sponsored rollout of gas meters is one element of a broader plan to make Ukraine's energy-squandering economy more efficient.

Old pipes, outdated factories and other energy inefficiencies mean the country needs about three times as much energy as neighboring Poland to add a dollar to economic output, the World Bank said. Improvements will require investment, as well as new habits by residents accustomed to cooling overheated rooms by opening windows.

In fact, most residents of apartment buildings, the majority of urban housing, have no control over heating. Olena Pavlenko, the president of energy think tank Dixi Group, said many housing blocks were forming coop boards to tackle high-heating bills-by installing thermostats, for example.

Overall, gas consumption by households fell by a quarter in 2015 compared with a year earlier, the company said.

Price increases help the bottom line and are intended to boost domestic gas production, which has shriveled in recent years.

The next task, Mr. Kobolyev said, will be creating a Western-style gas market by separating gas and oil production from retail, transit and storage-and competing with private producers.

Ukraine has the fourth-largest proven gas reserves in Europe, after Russia, Norway and the Netherlands. With sufficient private investment, it could eliminate Russian gas imports, Naftogaz and government officials say.

But building a competitive market of private producers and traders has clashed with the government's aim to contain losses at Naftogaz.

Gene Palenka, finance director at private gas producer Poltava Petroleum Co., described why investors are wary. During a dinner with friends in the winter of 2014, he said, he received an alarming phone call: The government had ordered major Ukrainian corporations-including most of Poltava's customers-to buy gas only from Naftogaz.

The aim was to supply Naftogaz with cash in the crisis. The order forced PPC to shut down most gas production and lay off 200 people. "We lost our customers and we lost our markets," Mr. Palenka said.

The shutdown was voided by a court a year ago, but companies say other measures-high extraction taxes, for example, and a requirement to maintain large gas reserves-have weighed on traders and private producers.

Talk of opening the market, Mr. Palenka said, isn't persuasive so far.

Old guard

Ties between the government and Naftogaz run deep. Behind Mr. Kobolyev's desk sit six telephones, direct lines to the president, the prime minister's office and the military. "In the winter," he said, "they ring very, very often."

Sometimes, the close connection has its drawbacks. Aivaras Abromavicius, Ukraine's economy minister, resigned earlier this year, saying an ally of President Petro Poroshenko had tried to install "associates" in strategic political positions to gain control over changes at Naftogaz.

"Neither me, nor my team have any desire to serve as a coverup for the covert corruption, or become puppets for those who, very much like the 'old' government, are trying to exercise control over the flow of public funds," Mr. Abromavicius wrote in his resignation letter.

In a Facebook post in February, Mr. Poroshenko said that Mr. Abromavicius's allegations would be investigated and urged him to stay in his post. Mr. Poroshenko's office didn't respond to a request for comment.

Naftogaz and the Kiev government said former employees, officials and well-connected middlemen had for years funneled cheap gas earmarked for households to companies that paid higher prices, pocketing the difference.

"There is hardly a single industrial group in Ukraine which would not have a certain interest in preserving the old structures," the company said in its 2014 annual report.

Days before Mr. Kobolyev started as Naftogaz CEO, police said they seized 42 kilograms of gold, about 93 pounds, and $4.8 million in cash from the home of ousted Energy Minister Eduard Stavytsky, and arrested the former CEO of Naftogaz, Yevhen Bakulin.

Neither man has been charged with a crime. Mr. Bakulin now serves in parliament, which gives him immunity from prosecution. He didn't respond to a request for comment. Mr. Stavytsky said the investigation into his finances was baseless and politically motivated.

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Pipes carrying natural gas in Uzhgorod, Ukraine. Photo: Vincent Mundy/Bloomberg News

Mr. Kobolyev also faces a threat from abroad.

Russia's Gazprom teamed up last year with a consortium of European energy companies-including Royal Dutch Shell PLC and Germany's E. ON SE-to build a pipeline for Russian gas to the EU that bypasses Ukraine.

Around half of Russian gas exports to the EU flow through Ukraine's vast pipeline network. Payment disputes between Naftogaz and Gazprom-mostly triggered by battles between Kiev and Moscow-have hobbled deliveries and led to gas shortages in some European countries in the past decade.

European officials, sympathetic to Ukraine's struggles, say it is difficult to insist on Ukraine as a gateway for Russian gas if they can't rely on Naftogaz.

The project would kill the Ukrainian transit route, Mr. Kobolyev said: "With blows like that, the Russian Federation is trying to make sure that Ukraine as a state will fail."

Russian and Gazprom officials said Ukraine would remain a transit country for Russian gas to the EU even after the pipeline was built.

Mr. Hochstein, the U.S. special envoy, shares Mr. Kobolyev's worry. "I would be very concerned that this is an attempt to undermine the economic stability of the country in nonmilitary means," he said.

The two men confer often by phone over the problems confronting the company. "Every day for Naftogaz is like walking on the edge," Mr. Kobolyev said.

By Gabriele Steinhauser, with contribution by Laura Mills, The Wall Street Journal



 
 
 
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