Naftogaz’s Profit Not Equal to Ukraine’s

Or What is Evidenced by the 2021 Consolidated Report of National Joint Stock Company Naftogaz of Ukraine

It was at the time when the head of the board of NJSC Naftogaz of Ukraine was telling reporters about the achievements of the “new” management and profits of UAH 12 billion in 2021 that lobbyists and opponents of Draft Law No 7427 and several related initiatives were breaking lances in the Verkhovna Rada. The lobbyists won mostly with the support of the Servant of the People. A Draft Law on an unprecedented UAH 264.3 billion (USD 8 billion) subsidy mainly to Naftogaz was adopted by a majority of votes in the first reading. It is highly probable that this bill will be adopted in general as a law one of these days. However, not everything that benefits Naftogaz benefits Ukraine.

Even more relevant is the question: how did we get here? And also what do the results of the activities of NJSC Naftogaz of Ukraine and its 2021 report indicate compared to 2020? A thorough analysis of the financial report of Naftogaz as a parent company explains a lot, in particular, what is behind the company’s UAH 12 billion profit and why this does not at all indicate a stable financial position of NJSC and its subsidiaries.

Let me remind you that on April 28, 2021, the Cabinet of Ministers, as the founder and owner of NJSC Naftogaz of Ukraine, following the consideration of its annual report as of 2020, dismissed head of the company Andriy Kobolyev recognizing his work as unsatisfactory, and subsequently the Supervisory Board as a whole was dismissed. Yuriy Vitrenko, “technically”  fired almost a year before by Andrey Kobolyev, was appointed new CEO.

See also: 2022 Forecast. What Will Happen to the Gas?

“The new CEO of the company has been tasked with systematically increasing Ukrainian gas production, as well as assisting in the formation of a full-fledged and fair gas market in Ukraine,” the official government portal noted. 

At the time of the re-election and appointment of Y. Vitrenko (04/26/2022) as the head of the board of NJSC Naftogaz of Ukraine, the Cabinet of Ministers did not consider, approve or evaluate the activities of the head of the board in fulfilling his tasks related to the systemic increase in production, and the main areas of the company’s activities, specified by the government additionally for 2021, and also did not approve the company’s annual report, including separate financial statements of Naftogaz.

At the same time, according to the analytical study On the Results of the Work of NJSC Naftogaz of Ukraine in 2021, published by Energy Club energy community, none of the main directions approved by the government for 2021 have been implemented, neither in terms of the sufficiency of volumes to cover the withdrawals of residential consumers on non-discriminatory conditions, nor by changing the terms of payment.

Gas Production: Systemic Decline

The first and most important task is a systematic increase in gas production in Ukraine, which is the main activity of Ukrgasvydobuvannya (literally – Ukrainian Gas Production) JSC. At the end of 2021, the volume of commercial natural gas production amounted to only 12.93 billion cubic meters, or four per cent less compared to 2020.

A similar situation is observed in private mining companies in Ukraine, but the rate of decline here is much lower. According to ExPro consulting company, in 2021 gas production in Ukraine amounted to 19.79 billion cubic meters, which is 2.2 per cent less than in 2020.

The consolidated financial report of Naftogaz, as the parent company controlling all commodity and cash flows, for 2021, according to International Financial Reporting Standards, contains a confirmation hereof. This is the volume of investments, i.e., Naftogaz was able to finance only UAH 15.6 billion of capital investments, which corresponds to the level of 2020. Investing at the level of the year before last, even a stop in the decline in production should not be expected. One should not legitimize everything by the war without investing in production.

However, during a press conference on June 21, the head of the NJSC tried to do exactly the said. He stated that “we expect this year, under the current circumstances, to see decrease in production in Ukraine by 5–10 per cent. This is a non-critical decrease in production ... the company has conducted an analysis and is able to predict a drop at the level indicated above.”

At the same time, Naftogaz emphasizes that the main area of ​​​​activity, and therefore the source of income in 2021, was the sale of gas, which the NJSC imports, stores, and solely purchases from its “daughter” Ukrgasvydobuvannya JSC and resells through other subsidiaries to population and heating utilities, etc. Meanwhile, they explain that a slight increase in income from the import, storage and sale of gas, or even the unprofitability of some areas of the company’s activities, are due to the actions of the government and the National Commission for State Regulation of Energy and Public Utilities.

Gas release program

“The formation of a full-fledged and fair gas market in Ukraine” was determined by the Cabinet of Ministers as the second task in appointing Yuriy Vitrenko head of the NJSC. This is a rather general wording, however Vitrenko himself specified it, while holding office of acting minister of energy.

Two months before his appointment as head of Naftogaz, Vitrenko stated that the main volumes of gas were produced by the state-owned Ukrgasvydobuvannya JSC, specifically from wells transferred to it free of charge by the state. He noted, “Ukrgasvydobuvannya does not sell such volumes on the market though. They are taken by Naftogaz of Ukraine. Thus, Naftogaz has a special position in the natural gas market, which differs significantly from the position of other companies. And the status quo allows Naftogaz to manipulate prices on the gas market.”

According to Vitrenko, in order to “develop the natural gas market in Ukraine and ensure the security of gas supplies to household consumers,” it was necessary to provide that Ukrgasvydobuvannya should start selling gas to natural gas suppliers and heat producers. Moreover, it was also important to oblige Ukrgasvydobuvannya to sell 100 per cent of its own gas starting from April 2021 to all consumers of natural gas on terms no worse than for Naftogaz.

In early March 2021, Y. Vitrenko assured everyone it is these steps that will make it possible to implement the program for opening access to volumes of natural gas produced by state-owned companies (Gas release program).

Since April 29, 2021, Yuriy Vitrenko has had every opportunity to put his initiatives into practice. But for some reason he has not managed to do so. Even despite the order of the Cabinet of Ministers.

Real Financial Result is in the Cash Flow Statement

No matter what you say, in the end of 2021, there was no financial breakthrough at Naftogaz. And the practice of forming the NJSC net profit, given the numerous scandals, cannot be a criterion for evaluating the activities of the “new”management. However, the financial statements of Naftogaz themselves contain one report, according to which one can put things together, that is to properly assess the activities of the Naftogaz management. This is about “Consolidated Statement of Cash Flows” (using the indirect method), compiled solely on the basis of the Naftogaz financial report.

It is in this document that all profit adjustments are reflected and the real financial result is shown ­– and such results are comparable. This report also reflects the main indicators of changes in working capital (increase / decrease in liabilities), the main indicators of the investment and financial activities of the enterprise.

Thus, the data of the Consolidated Statement of Cash Flows indicate a deterioration in the activities of NJSC Naftogaz of Ukraine in 2021. The profit before taxation, excluding adjustments, amounted to UAH 58.4 billion, which is UAH 2.5 billion less compared to 2020 (60.95 billion). This is the data of Naftogaz itself.

If the financial results of Naftogaz before changes in working capital are comparable, then following the results of operating activities in 2021, Naftogaz had a significant deficit of funds in the amount of UAH 24.4 billion. There was no deficit in 2020, on the contrary, Naftogaz had a net cash flow from operating activities of UAH 19.5 billion.

The main reason for the formation of a deficit of funds from operating activities in 2021 was an increase in trade receivables by UAH 34.7 billion, which is almost five times more than in 2020 (UAH 7.1 billion).

It was precisely due to the formation of an increase in such receivables that Naftogaz did not have enough funds to purchase natural gas to increase its reserves in underground gas storage facilities (UAH 28.7 billion). The specified deficit of funds was covered by “compensation for lost income from gas transportation” in the amount of UAH 30 billion.

Since the net cash flow from operating activities was formed with a deficit of UAH 24.4 billion, capital investments were financed, in fact, only thanks to the sale of government bonds in the amount of UAH 11.4 billion and receipts from Mahistralni Gazoprovody Ukrainy (The Main Gas Pipelines of Ukraine) JSC on account of the purchase of the Gas Transmission System Operator LLC in the amount of UAH 3.2 billion.

As for the financial activities of Naftogaz, its 2021 performance is also not in favor of the new management. And the point is not that in 2020 UAH 39.6 billion of dividends were paid to the budget for the state share, but in comparing the total indicators of attracting and repaying loans. In 2020, the total value of attracting and repaying loans indicates a reduction in borrowing by UAH 4.7 billion, while in 2021 this reduction was only 1.1 billion, or four times less.

Taking into account the results of operating, investment and financial activities of Naftogaz, the balance of funds and their equivalents decreased by UAH 6.6 billion at the end of 2021 compared to the balances at the beginning of the year and amounted to UAH 30.5 billion.

It is strange when the CEO of Naftogaz reports an increase in net profit by UAH 31 billion in 2021, while the balance of funds at the end of the year is significantly reduced.

These conclusions of the analytical study, in fact, are confirmed by the independent auditor’s report.

According to key findings of the auditing company LLC AF “PricewaterhouseCoopers,” which audited the consolidated financial statements of NJSC Naftogaz of Ukraine for 2021, Naftogaz Group’s liquidity expectations are based on the following factors:

• the possibility of collecting receivables for natural gas;
• the possibility of increasing the price of gas sold to heating utilities since June 2022;
• continued receipt of funds for gas and oil transit services;
• continued receipt of funds from compensation for lost income from gas transportation.

Therefore, without the ability of the Naftogaz Group to collect receivables for natural gas and without compensation for lost income from gas transportation, a gap in the company’s liquidity arises.

According to the auditor’s opinion, future events or conditions may cause the company to cease to be able to continue as a going concern.

Based on the results of the audit of financial statements in 2020, there were no such conclusions of the auditor. But even in the absence hereof, the Cabinet of Ministers recognized the work of the board of NJSC Naftogaz of Ukraine as unsatisfactory.

In 2021, the auditor already had warnings about the liquidity and ability of the Naftogaz Group to continue its operations on an ongoing basis, which, in turn, indicates a deterioration in the financial position of NJSC Naftogaz of Ukraine.

Thus, at the end of 2021, Naftogaz significantly worsened its performance indicators, found itself on the verge of a liquidity gap and, according to the auditor’s conclusions, may lose the ability to continue its operations on an ongoing basis. Meanwhile, we are told about UAH 12 billion in income ...

Deputies of several parliamentary factions and groups addressed Prime Minister Denys Shmygal with parliamentary inquiries, namely how the Cabinet of Ministers reacts to the warning of an independent auditor about the potential liquidity gap and the loss of the ability of the Naftogaz Group to continue its activities on an ongoing basis and how such warnings are taken into account when assessing the activities of the board NJSC Naftogaz of Ukraine at the end of 2021?

We expect an answer!

Why the NJSC Continues to Receive Funds for Transit

Only thanks to the “compensation for lost income from gas transportation” received in 2021 from Gas Transmission System Operator LLC in the amount of UAH 30 billion and UAH 4.7 billion in 2022, Naftogaz managed to stay afloat until the end of the heating season.

At the same time, the right to receive such compensation by Naftogaz, according to many experts, is very doubtful. Without going into details, Naftogaz continues to receive income from transit, which is provided by Gas Transmission System Operator LLC, in accordance with an agreement with Ukrtransgaz. However, the auditor notes that the NJSC considers this not as income, but as a “contribution” from the government as a shareholder of both the NJSC and Gas Transmission System Operator LLC. This is probably why, having received UAH 30 billion of “compensation”, the management of Naftogaz decided not to reflect them as income, respectively, proper tax charges and their payment to the budget were not carried out.

Despite the obligations of the Cabinet of Ministers to the IMF to suspend the further implementation of the agreement between Gas Transmission System Operator LLC and Ukrtransgaz JSC on reimbursement of the adjustment of the required income, they failed to do this. According to the auditor, after undertaking to suspend the agreement, Naftogaz continues to receive such compensation. In particular, in four months of 2022, it amounted to UAH 4.7 billion.

We wonder whether while saving Naftogaz at the expense of Gas Transmission System Operator LLC income the latter will soon be on the verge of bankruptcy.

On “Compensation to Key Management Personnel”

As noted in the above-mentioned analysis of the results of the NJSC for 2021, against the background of the funds deficit from operating activities in the amount of UAH 24.4 billion that year, an increase in wage payments to key management personnel seems too arrogant and cynical. In the submitted report, the following is discussed. “During 2021, the leading management personnel consisted of an average of five members of the board and 15 directors (in 2020 – five members of the board and 12 directors). Compensation to key management personnel included wages and additional current bonuses and amounted to UAH 911 million (UAH 672 million in 2020).”

Of the indicated UAH 911 million, UAH 338 million were paid to the former head of Naftogaz, Andriy Kobolyev, who was fired in April 2021.

“Thus, in 2021, UAH 573 million was paid for four members of the board (excluding the head of the board) and 15 directors. If we assume a certain gradation of wages between members of the board and directors, then the average salary of a member of the Naftogaz board will exceed UAH 4 million per month, and of a director – about UAH 2 million per month.”

According to the Naftogaz website data, the salary of the current head of the board is about UAH 50,000 per month, in particular, in April 2022, he received UAH 50,727.92. (The rest of the “temporary” ones seem to have no contracts, so the amounts of payments and rewards are not disclosed.)

The case is how, with a UAH 50,000 salary of the head of the board, a member of the board can receive 80 times more, and a “simple” director manages to get 40 times more than the head of the enterprise? Is this why Naftogaz refuses to publish data on the amount of salaries of board members using a far-fetched pretext?

It is also logical to ask why, against the backdrop of falling natural gas production and a galloping increase in receivables, increase the number of directors of Naftogaz from 13 to 15 people? This is probably a trifle for the NJSC, given all of the above and on the eve of the decisive battles for the jackpot of USD 8 billion “for the purchase of imported gas.”

It is not for nothing that Yuriy Vitrenko is preparing the ground stating “we must now import gas, but the difficulty lies in the fact that this requires huge funds.” And he immediately adds “Ukraine needs to accumulate 19 billion cubic meters of gas by the heating season – this is the position of the Ukrainian government, it (the government – A.Ye.) wants to create such a gas reserve in order to play it safe given various options in winter. I asked the US government to join in helping Ukraine finance the purchase of these volumes of gas.”

Vitrenko asks for an astronomical sum of  USD 8 billion, noting that it is necessary to import about six billion cubic meters of gas. Preferably on account of lend-lease, and for some reason, preferably through money, and not through gasitself, which would be logical. In addition, for some reason, the purchase of almost six billion cubic meters is being discussed, although, according to various estimates, Ukraine will not need more than 2–2.5 billion cubic meters of imports even with a harsh winter. After all, gas consumption in Ukraine was gradually reduced even before a full-scale war with the Russian Federation, and now even more so. Therefore, with savings in general, there will be enough gas produced in Ukraine, and not only by Ukrgasvydobuvannya. Ukrnafta and private companies produced over 7.5 billion cubic meters of gas last year.

Two and a half billion cubic meters of imports is already playing safe. And those in Naftogaz  know where to send the “saved” funds for non-purchase of unnecessary gas – to bonuses for the administrative apparatus, namely “for savings” and personal contribution ... to ensuring the energy security not only of Ukraine, but of all of Europe. That’s it!

God, save Ukraine!