Ukraine War Day #155: Naftogaz Defaults

Dear Readers:

Today we must talk about some important news, namely the default of the Ukrainian state-owned Oil & Gas Company, called Naftogaz. This past Tuesday (July 26), the company was forced to admit that it could not pay the interest (and portion of the principal) that was due on their Euro obligations. That is to say, it technically could pay the bill that was due, it technically had the cash on hand and was ready to pay the invoice; however the government would not allow it to pay. What the..?

In this piece, our duet of girl-Friday reporters Alyona Zadorozhnaya and Darya Volkova cover the beat by quoting various analysts who know what they are talking about. We also have this newer piece, just from this morning, the reporter is Olga Samofalova, who adds some interesting touches to the overall pircture.

Shmygal: “My precious Lend Lease!”

But first a quick sidebar: Also on Tuesday we knew something foul was in the air. Oh, excuse me that was just Denis Shmygal (Ukrainian Prime Minister) opening his mouth to schnorr for liquified gas. From the United States. Calling it “Lend Lease”. Wait a minute, Denis, Lend Lease was supposed to be for tanks and fighter jets, not gas.

“But we are trying to prepare ourselves,” Shmygal whined, “for a very tough winter. The toughest one in our history. And we are seeking every possible instrument, so that we are prepared for every possible scenario.” More specifically, the Ukrainian government is asking America to supply Ukraine with 6 billion cubic meters of liquified natural gas. With a promise to pay them back in two years. [America: If Ukraine is starting to sound like your mooching brother-in-law, you’re not wrong!]

And then the news of the Naftogaz default. Now that they have declared bankruptcy, they will never have to pay another penny to their creditors, and it’s all Russia’s fault.

A Feud Of Oligarchs

For those not in the know, Naftogaz is run by people from Petro Poroshenko’s circle, and those guys don’t get along at all with Zelensky’s people, which includes Shmygal. (Two different, competing sets of oligarchs.) Shmygal is trying to maneuver this situation so that he can remove the top management of Naftogaz and he doesn’t care if he has to drive the company to bankruptcy to accomplish that. (Scorched earth policy.) Secondly, Naftogaz management are not too cut up about it themselves, they don’t care if they can continue to acquire loans and never have to pay them back (after declaring bankruptcy). There is always Russia to blame.

All of the various lady reporters turn to an analyst named Igor Yushkov, who is an expert in the energy sphere and who can explain the complicated situation. Judging by his photo, this is a young guy and actually kind of cute. According to his Forbes profile he graduated from Moscow State University with a degree in Politics and works as an analyst for the Russian Fund For Energy Security. He also works as an Instructor at the Financial University which prepares cadres for the Russian government. Igor specializes in oil and gas issues.

Igor Yushkov

Yushkov: “It is obvious that here we have an issue of competition within the Ukrainian elites… [Poroshenko vs Zelensky] … Naftogaz is trying to show that it is holding to the norms of corporate accountability, whereas the government is intent on proving the incompetence of the company’s management.” But none of this worries the Ukrainians one whit: “All of the difficulties can be blamed on Russia. This will permit Kiev and and Naftogaz to accuse any [creditor] of being a Kremlin agent, who has the gall to demand the repayment of the debt. Not only that, but the company can continue to demand even more money as loans. They have no incentive to try to repay anything, because they can convert the issue from a purely economic one onto the ethical and political plane.

“In an ideal world, one would sell Naftogaz assets and put a hold on all its accounts. To do this, a creditor must sue in court. But, given the current political realities, none of that is going to happen. And the bankruptcy process presupposes that all the debts will be written off.

“After which, Naftogaz can go out onto the loans market and beg for more money, threatening everybody [who doesn’t want to donate $$$] that Ukrainians will freeze to death this coming winter. [And then it’s all their fault.] However, one thing we don’t know, is how much gas the country needs. Ordinarily [in the past] it would consume 30 billion cubic meters. […] However, Kiev has lost control over a large swathe or territory, and industrial activity has come to a halt. This means they could actually be self-sufficient, although it’s certainly nothing to be proud of, given the circumstances.”

Keep The Presses Rolling

Next we meet another economist, goes by the name of Ivan Lizan. He is also young, but not as cute as Yushkov. Lizan: “Naftogaz will continue to operate, since it is a monopoly which controls the gas-transport system. Not to mention that an unbelievable amount of money has passed through it, due to the fantastically high prices for gas. But we have the heating season coming up, and they are actively discussing where they can buy the gas.

Ivan Lizan

“Still, in any scenario one thing is clear: The Ukraine is completely bankrupt. The presses keep printing money without pause. Just in the beginning of June they have already printed 235 billion hryvnas. While the army consumes in the course of a single month, an entire year’s budget. And there is nothing left to pay salaries to government workers.”

Lizan believes that the Naftogaz default might set off a chain-reaction throughout the whole of the Ukraine. “Next on the block could be Ukr-Avto-dor [roads], and other state corporations which will also not be able to pay the interest due on their Eurobonds. On the other hand, they might be able to buy a little time on the payments if Zelensky is not averse to seeing some capital outflow from the country.

“Here is one scenario: We could potentially see the handover of Naftogaz, under default, to external management. However, I don’t see any logic or benefit to doing that. It’s one thing to control a company during peace time, but a completely different ball game in the current circumstances. Another variant would be to force the creditors to restructure the debts. This has already been done with the state debts.”

“I got nutt’in.”

The Naftogaz default will make the company a pariah on the international capital market. But it wasn’t their fault: The Ukrainian government and Cabinet of Ministers forced them into this situation by not giving them the measley $335 million dollars which should have been the government’s portion of the overall $1.4 billion that Naftagaz needed to keep its debt swimming along. By the same token, said Cabinet is now responsible for keeping Ukrainian citizens warm over the winter. They will have to find a way to import enough liquified gas, according to Lizan. Which returns us to Shmygal’s unbounded hope that Uncle Sam will gallop to the rescue again. With the vaunted Lend Lease, showering free liquified gas upon the population, like manna from heaven.

Another sad fact, is that Naftagaz is one of the Ukrainian government’s main cash cows for tax revenues. Hence, its default will harm the government mainly even more than the government harmed it. Not to mention that the creditors will be quite wary of issuing more loans. Fitch Ratings has lowered the Ukrainian government’s rating, to the point where the country as a whole might have to declare default.

A Silver Lining?

In her piece, Olga Samofalova sees a possible silver lining: The Ukraine has an actual opportunity here to emerge as completely self-sufficient when it comes to gas. Much of this analysis also comes from Yushkov. Who points out that Ukraine is smaller now and doesn’t have to worry about keeping the “lost territories” warm over the winter. Ukraine doesn’t get all its gas from Russia either, it actually has its own gas, believe it or not, at a level of 20 billion cubic meters per year. This gas is drilled in the center and Western part of the country, which is still under Kiev. In earlier years consumption would exceed production by around 10 billion cubic meters annually, and Ukraine would have to somehow make up the deficit. But this year, the 20 bil might be just enough. Keeping into account, however, that you can’t wildly consume all the gas, a certain level needs to remain in the underground reservoirs, to keep the pressure up, that’s called “technical gas”. Nonetheless, self-sufficiency in a truncated Ukraine is still a possibility, except for one fly in the ointment: The greed of the suppliers. Who may decide it is more profitable for them to sell their gas to a freezing Europe, than to keep their own citizens warm and cozy.

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13 Responses to Ukraine War Day #155: Naftogaz Defaults

  1. lou strong says:

    A quick look to Ukraine’s big economical data shows a chronical deficit in the balance of trade, that became surplus on March 2022, to get back again to deficit in May, a current account mainly positive after 2020 and a rising external debt, so I imagine the foreign sector is financing both the current account surplus and the trade deficit.
    This reminds me that Russia, mainly, and China a little bit too, financed Ukraine’s debt at advantageous conditions in the last Yanukovich period, to be sustituted after 2014 Maidan by IMF or , if you prefer, by the US who gave order to Lagarde to finance Ukraine despite the prohibition clauses of the IMF statute itself.
    To get more in detail to the Naftogaz issues, normally apart the dust of small savers these kind of bonds, like the rest of so-called free financial markets,are concentrated in the hands of some big players,for instance hedge-funds, pension funds and blah blah blah .If I got this right, it would be interesting to know who are the double loser investor, because both bonds were denominated in Euro, which took a long way down since the moment of their issuance, and by the way because Naftogaz defaulted.
    Incidentally, it was too long and boring to read, but I saw the titles of an establishment economist explaining how “Ukraine’s reconstruction” will be under the rule of external administration in order to safeguard the interests of the creditors and backers….

    Liked by 1 person

    • yalensis says:

      These very same “big players” like the Hedge funds and so on…
      any chance that they placed bets to short the Ukraine?
      It’s just a diabolical thought that popped into my head, based on nothing, but I wonder if there is a way to check.


      • lou strong says:

        Yep, for sure somebody in that nice club is frantically trading Credit Default Swaps over Ukraine, but nobody will know it.


  2. Greg says:

    I’m curious how the US would even supply gas to Ukraine – US exports LNG by tanker (which they don’t have enough of) and Ukraine at this point doesn’t have a functional port let alone an LNG terminal port.
    Seems like a fantasy in all regards.


    • yalensis says:

      Does Poland have an LNG terminal on the Baltic Sea? Maybe American LNG is plugged into that, and then the Poles convert liquid gas to gaseous gas and ship to Ukraine over a physical pipe?
      I realize I am ignorant of the technology and chemistry involved, I should do more research…
      But I think the main point is, that Ukraine gets free gas from the U.S. (in some fashion) and promises to pay back later, yeah right…


  3. To expand on the comments by Lou and you, I wonder who is holding the the now-empty bag? Will it cause financial contagion?

    Loans — which are made up out of thin air based on the fractional reserve system of lending, if you understand how the debt-based monetary system works — still have a creditor on the originating end. Now, it’s not like some bank or hedge fund or the IMF delivered truckloads of euro or U.S. dollar banknotes to Naftogaz. The loan was magicked up on a keyboard. But according to the rules of the financial game, banks that create “money” still have to have a certain percentage of “real” money in their vaults. Not actual pieces of paper or the plastic polymer notes that are used in much of the world aside from the archaic U.S., but “Tier 1 capital” like government bonds. The “reserve ratio” was traditionally 10%, but it gets arcane when you get into the details, so enough about that. Anyway, is this default going to mean that some bank has had a big % of its assets vanish, so it will be technically bankrupt? And that bank will have financing that it shared with other banks, which has gone crap, and so fall the dominoes. That was at the heart of the 2008 global financial panic.

    Chances are that Naftogaz itself isn’t going to pull the crucial piece out of the world’s financial Jenga tower. Look at Argentina — it defaults on its foreign debt at least once a decade, and it’s a bigger entity than a Ukrainian gas company. Money, ultimately, is imaginary. It has value only because we as a society believe in it. Central banks, which are the creators of “money,” have ways of making bad debts disappear. (See “quantitative easing” in the U.S., for example.) Will that happen here, with friendly central banks assuming the debt of whatever entity advanced money to Naftogaz and sending it into some accounting black hole, never to be worried about again? As far as shorting, somebody has to pay off the other end of the short deal, but will that happen? Should be interesting to see who gets paid, who gets screwed, and who gets let off the hook.


  4. raccoonburbleca says:

    Do not feel bad about not understanding it. I do not understand most of it. I don’t think most of the people writing about it understand it. Probably the people trying to pull off this nonsense do not really understand it. They are just looking for some way to shift blame. They don’t end up making much out of it.

    Basically, Ukraine does not have revenues to run its war. So it is issuing new currency, greatly increasing the amount in circulation. This will eventually lead to inflation and the currency becoming worthless.

    I just wrote something new about Ukraine war and I am using my usual tactic to get around the algorithms; posting it on everybody else’s comments box.


    • yalensis says:

      Thanks, racoon. That’s a fine post, nice job!


    • The way I see it, finance is like quantum physics. The deeper you look into it, the more unreal it becomes. We experience the material world around us as solid objects — pieces of wood, the ground under our feet, etc. But when physicists drill down to the quarky nature of subatomic particles, they say that atoms are mostly empty space, and are basically energy fields that kinda blip in and out of existence in the dimensions we can perceive. The diagram of an atom that we learned in elementary school, with electrons spinning around a nucleus like planets around a star, is not how it actually is. Instead, the electrons are charged particles that appear and disappear in their potential “energy spaces.” I enjoy reading about that sort of thing, but it does my head after a while, because I can only perceive what’s comprehensible to a 3-dimensional being such as myself. The more we learn, the more we discover how much we don’t know. Same thing with money — our coins and banknotes seem one way to us, but in the higher realms of derivatives and arcane financial instruments, it gets extremely weird. All the better for the Master Manipulators of Money to keep us work-donkeys striving to catch the carrot on a stick that’s dangling in front of our noses, while we pull the masters to where they want to go!


      • yalensis says:

        That’s philosophically very deep, Bukko. When I start reading about quantum physics, it freaks me out, because of the entire “un-reality” and randomness of reality.
        I never could quite accept that whole Schrödinger cat thing.

        On the other hand, I recently watched a youtube video about this new branch of physics, it’s called “Superdeterminism”, which is equally freaky but from the other side of things. Basically physicists who hold to this, posit that every moment in our universe, from start to finish (on the timestream) is predetermined. Going back to the very first “particles” or whatever they are (they use the term “light cone”), and given the initial spin and coupling and all that jazz, then every future development is fully deterministic.

        Not sure which idea freaks me out more: that everything is by chance; or that we have no free will?


  5. Bukko Boomeranger says:

    The way I deal with that sort of Deep Thought conception is to realise that there’s nothing I can do about it, so I might as well go on about my Shallow Thought existence with the things I can control. Such as “do I want toast with my coffee this morning or a pastry?” Maybe it’s all pre-determined — Calvinists and some Muslim schools of thought are big on that idea — but my brain hurts less if I operate under the illusion of choice. Which might, after all, not be an illusion. My brain hurts less that way.

    I have the same mindset about politics, the environment, the future of the world, etc. I stopped imagining that I could have any impact about the way things are going, which was part of the reason I exited the United States. TPTB didn’t care that millions of people marched against the War on Iraq 2.0, even though we were right. The world is screwed; we’re going to keep burning carbon and destroying as many plants and animals as we can, like two-legged malignant cancer cells. Richmaggots are making money on that, and they will keep doing so until it all hits the wall and billions of people die.

    I still do political stuff with the Green Party down here, still go and pick up trash along a creekside bicycle path where I ride so that at least that small amount won’t go into the Oceanic Garbage Patch. Not that I think it’s going to make a damn bit of difference in the overall scheme of things. I accept my powerlessness. No point getting frustrated about banging my head against a wall for zero results. But I can sleep better at night knowing that I didn’t succumb to utter nihilism. Better to light a single candle…


    • yalensis says:

      That’s a good philosophy. I follow it too. I don’t want to sound pretentious, but I try to be polite and help other people whenever I can, just in the small things in life. Like holding a door open for somebody carrying stuff, helping a newbie figure out how to use her card at the laundrette, not being a jerk on the highway, that sort of thing. That makes me feel like I have some tiny bit of control, at least in the world of people.


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