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Ukraine's State Gas Company, Struggling To Reform, Is Pulled Into U.S. Impeachment Politics


Naftogaz headquarters in downtown Kyiv

KYIV -- Not long ago, Ukraine’s state-run natural-gas company was considered a monopolistic cesspool of corruption, “the poster child of inefficient and nontransparent state monopolies bearing high credit risks,” as one think-tank report put it in 2010.

That has partly changed in recent years, as Western lenders have pushed new management to streamline Naftogaz -- steps on the path to the larger goals of weaning Ukraine off Russian gas and increasing the company’s contributions to the state budget.

Now the effort to reinvent Naftogaz is being roiled as the company is pulled into the undercurrents of impeachment proceedings in Washington, D.C., and a so far unrelated U.S. criminal case.

The complications come at a critical moment for the company. Executives are trying to cement a new deal with Russia to replace a 10-year agreement that expires on New Year’s Eve. In the past, tussles over transit terms have resulted in wintertime gas shutoffs to swaths of Europe.

And Kyiv continues to try and persuade European governments that a Baltic Sea pipeline to carry Russian gas directly into Germany, bypassing Ukraine’s pipeline network and depriving Kyiv of revenues, is a bad deal.

“Naftogaz management has had a mixed record, based on what they’ve done and what they haven’t done. This may not be entirely their fault,” said Edward Chow, an analyst at the Center for Strategic and International Studies in Washington and an expert on energy issues in the former Soviet Union.

“The fact is there was no unity of purpose on energy reform among Ukrainian authorities since 2014. Control over energy assets continued to be contested by different political interests inside the government,” he said.

Naftogaz, which says it currently contributes about 15 percent of the state budget, has been at the center of the battles between Ukraine and Russia over natural-gas shipments since at least the mid-2000s.

The company produces some gas within Ukraine. But its real clout comes from its monopoly over the country’s pipeline network, which has long been the primary route for Russian gas shipments to Europe -- and the source of billions of dollars in revenues for Kyiv.

It has also been a magnet for organized crime groups, according to analysts and former diplomats.

One man who profited handsomely from murky gas deals was Dmytro Firtash, a Ukrainian tycoon who in 2004 set up a joint venture with state-controlled Russian giant Gazprom to import Central Asian gas to Ukraine and resell it after shipping it through the Naftogaz network.

The joint venture, RosUkrEnergo, netted billions for Firtash before it was sidelined in 2009, in a deal negotiated by then-Prime Minister Yulia Tymoshenko.

In a series of lawsuits filed in U.S. federal court beginning in 2011, Tymoshenko accused Firtash of essentially laundering gas revenues and using some of the proceeds to fund a political party headed by Viktor Yanukovych. She also alleged that Naftogaz executives received kickbacks from Firtash.

Through his lawyers, Firtash denied the allegations, as did other RosUkrEnergo officials. A U.S. judge dismissed the lawsuits in September 2015.

Yanukovych, meanwhile, went on to be elected president of Ukraine in 2010 but was ousted four years later amid the Maidan protests -- mass demonstrations fueled mainly by public concerns about high-level corruption and Yanukovych’s decision to scrap plans for closer EU ties and turn toward Russia instead.

Weeks after Yanukovych abandoned power and fled to Russia, Firtash was arrested in Austria on a warrant issued by the United States for alleged bribery and corruption. He continues to fight the U.S. extradition request.

In a 2017 filing as part of the bribery case against Firtash, U.S. prosecutors accused him of having ties to an "upper-echelon [associate] of Russian organized crime."

That assessment echoed one contained in a State Department cable published in 2010 by WikiLeaks. The cable details a 2008 meeting between Firtash and the U.S. ambassador to Ukraine at the time, William Taylor. In it, Taylor cites Firtash as confirming his ties to organized crime, including a notorious reputed Russian mafia boss named Semyon Mogilevich.

In an interview with RFE/RL in September 2018, Taylor confirmed the substance of the cable, but declined to comment further.

Representatives from Firtash’s company, Group DF, did not respond to e-mails seeking comment.

Reforming Naftogaz

As a pro-Western government came to power following Yanukovych’s flight, the United States, European backers of Ukraine, and major Western lenders pushed Naftogaz to reform, arguing that it would shore up Ukraine’s finances and quash a major source for debilitating corruption.

“The most rampant corruption existed in the energy sector of Ukraine. Mainly it was so-called 'gas corruption,’” then-Prime Minister Arseniy Yatsenyuk said in a July 2015 speech. “We succeeded in eliminating gas corruption and eliminating middlemen in the Ukrainian energy sector.”

He said that Naftogaz “had very shadowy and nontransparent deals with middlemen and with the Russian Federation.”

The reform effort included a push for Naftogaz to end government subsidies as well as to sell Ukrainian gas to European markets, in compliance with EU regulations. That led to a plan to make its gas transmission affiliate into an entirely new entity that experts estimate could generate more than $2 billion annually.

That company is expected to formally begin operations in January.

A worker at a gas-compressor station in the village of Mryn, about 130 kilometers outside Kyiv.
A worker at a gas-compressor station in the village of Mryn, about 130 kilometers outside Kyiv.

Western officials also successfully pushed the Ukrainian government to create an international supervisory board, in 2016, as a way to monitor the company’s efforts to root out corruption and inefficient operations.

Within Naftogaz, which began turning a profit in 2016, the reform effort has been spearheaded by its chief executive officer, Andriy Kobolyev, who has been praised by U.S. and European officials for his efforts.

In a speech in March, Marie Yovanovitch, then the U.S. ambassador to Ukraine, publicly called for “independent corporate governance teams” at Naftogaz and other state companies to “be able to continue their reform work with full autonomy and integrity.”

Kobolyev was opposed by Volodymyr Hroysman, who was prime minister from 2016 until August 2019, following the inauguration of President Volodymyr Zelenskiy in May, and who sought to push Kobolyov out.

But demands from Western leaders also included reforming how gas is distributed within Ukraine, an effort that has collided with Firtash, who owns the bulk of the local transmission companies that bring gas directly to homes and factories.

That fact was highlighted in a letter released in 2018 by Republican U.S. Senator Roger Wicker.

"Firtash still controls intermediaries in the Ukrainian gas industry…. Firtash accepts the gas and sells to end users, but he refuses to pay Naftogaz and pockets the revenue,” Wicker wrote. “This scheme is estimated to have cost Ukraine $2 billion thus far."

For its part, meanwhile, Naftogaz hired lobbyists in Washington, D.C., as part of its outreach to bolster its standing among U.S. officials, and resist efforts to reorganize its board.

In a statement filed with the U.S. congressional lobbying database in March, the company said that the campaign would result in the “reestablishment of corrupt schemes in the natural-gas sector, redirecting funds out of the company, away from the state budget, and into the pockets of individuals like Dmytro Firtash."

Criminal Indictment

On October 10, U.S. prosecutors unsealed a criminal indictment charging two Soviet-born U.S. businessmen, Lev Parnas and Igor Fruman, with illegal campaign finance contributions. The two have pleaded not guilty.

As part of the scheme detailed by prosecutors, Parnas and Fruman allegedly worked on behalf of an unnamed Ukrainian government official who was seeking the ouster of Yovanovitch. The official is not named in the indictment, but one of the most outspoken Ukrainian officials in opposition to Yovanovitch was Prosecutor-General Yuriy Lutsenko.

According to the indictment and Ukrainian officials familiar with the effort, Parnas and Fruman were also trying to build support for a deal to sell U.S. liquefied natural gas (LNG) to Naftogaz -- something that the company did not support.

Hopes of ousting the company’s management were part of that effort, a goal that was shared by Firtash, who employed Parnas for a time as a translator.

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In March, Parnas and Fruman met with a Naftogaz executive named Andriy Favorov in Texas, and proposed a plan that would elevate Favorov to the position of chief executive, according to people familiar with the plan.

Parnas and Fruman said they would utilize their contacts in Washington to push for the ouster of Kobolyov and the reorganization of the Naftogaz board. Those contacts included Rudy Giuliani, President Donald Trump’s personal lawyer.

In exchange for lobbying for Favorov’s elevation to CEO, Favorov would agree to back Parnas and Fruman’s plan to import LNG, according to sources with knowledge of the deal, who spoke on condition of anonymity because of the sensitivity of the subject. Favorov would also support paying more than $200 million in debts that Firtash has claimed he is owed.

That effort was first reported by the Associated Press.

In the end, Favorov rejected the proposal.

Naftogaz declined to comment.

“The real question is: ‘Were these two people connected to Firtash trying to replace part of the board in order to advance Firtash’s business interests?’” said one veteran energy analyst who asked to remain anonymous in order to not jeopardize longstanding Ukrainian business relationships.

“Who are these guys really doing this for and who are they doing it for? Replacing Naftogaz management, with whom [Firtash] has been fighting with for the past five years, sounds more credible to me, rather than this LNG import nonsense,” the expert said.

Impeachment Probe

Naftogaz has played a small role in the impeachment drama engulfing the U.S. Congress and the Trump White House.

On October 10, the chairmen of three committees spearheading the impeachment inquiry in the House of Representatives issued a subpoena to Energy Secretary Rick Perry, demanding he turn over documents and asking whether he tried to get the Ukrainian government to add Americans to Naftogaz’s supervisory board.

The subpoena stemmed largely from Perry’s role as the senior U.S. cabinet official attending Zelenskiy’s inauguration in May.

“During your extensive interactions with Ukrainian officials,” the congressional letter to Perry said, “you also reportedly ‘pressed the Ukrainian president to fire members of the Naftogaz advisory board’ and ‘made clear’ to Ukrainian officials and energy sector officials ‘that the Trump administration wanted to see the entire Naftogaz supervisory board replaced.”

The subpoena also asks for records regarding “proposed or actual transactions, investments, or projects relating to liquified natural gas in Ukraine.”

Russia, Russia, Russia

U.S. politics aside, next year will be a challenging year for Naftogaz, said Olena Pavlenko, an energy analyst at DiXi Group, a Kyiv think tank. Spinning off the transmission business will dent the company’s overall profitability. And the company has failed to meet earlier promises to increase production.

And then there’s Russia.

Naftogaz is also grappling with more urgent issues. On December 31, a 10-year agreement governing the conditions under which Russian gas transits Ukraine will expire.

The potential lack of a deal worries policymakers in Europe, who fear a repeat of the disputes in the 2000s that saw a sharp reduction in gas supplies during the winter months.

This week, negotiators from both sides failed again to reach a deal, prompting a warning from the European Union’s energy chief, who said that “there must be a clear sense of urgency.”

A ruling by the Stockholm Arbitration Court in March 2018, ordering Gazprom to pay $2.5 billion to Naftogaz over a contractual dispute, has added further complication.

Russia, meanwhile, expects the Nord Stream 2 pipeline, which is to bring Russian gas under the Baltic Sea to Germany, will increase its leverage in negotiations with Naftogaz.

On October 30, the project passed a significant hurdle when Denmark gave final approval for the pipeline to pass through its territorial waters.

"This is not only a matter of energy security, it is also a geopolitical question,” Zelenskiy said on October 31, “so I’ll tell you frankly that it strengthens Russia and weakens Europe.”

With reporting by Liubomyra Remazhevska, a correspondent for RFE/RL's Ukrainian Service in Kyiv
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