Ukraine’s state-owned oil and gas company Naftogaz defaulted on a portion of its debt on July 26 after a government decision caused it to miss the deadline for Eurobond payments.
The company, which accounted for 17% of Ukraine’s public revenue in 2021, was due to repay a $335 million bond that matured on July 19 as well as a separate interest installment of 45 million euros in interest on another bond that matures in 2024. Naftogaz missed its deadline after the grace period expired on July 26 without payment.
Before the default, at the government’s request, Naftogaz tried to persuade its bondholders to agree to a payment moratorium. Bondholders rejected the proposal.
The Cabinet of Ministers has reportedly instructed Naftogaz to immediately begin another round of talks with investors. Naftogaz is currently preparing another debt plan, which will need to be approved by the government and investors before it becomes public.
The European Bank of Reconstruction and Development is one of the bondholders and the default may complicate Naftogaz’s future attempts to raise money from this institution.
A default on bonds "deprives Naftogaz of access to the international capital market," according to the company's statement. As a result, the government will have to take “full responsibility for raising the funds needed to import natural gas for the upcoming heating season.”
Why did Naftogaz miss its payments?
Russia’s war against Ukraine has hit the country hard. Ukraine’s economy is expected to shrink by 45% this year, Finance Minister Serhiy Marchenko said in May, making it hard to run the country, finance the war effort, and keep paying foreign debt.
Ukraine has been trying to restructure foreign-owned debt and get investors to agree to a two-year freeze on repayment so that it can free up its limited resources to fight Russia. According to Bloomberg, the Ukrainian government was looking to freeze payments on about $23 billion of its own foreign debt for two years as it deals with Russia’s invasion.
Prime Minister Denys Shmyhal also recently requested on July 26 that Eurobond holders of state road agency Ukravtodor and electricity grid operator Ukrenergo defer interest payments until the end of 2024. The total bond value of the two companies is $1.5 billion.
Despite being a state-owned company, Naftogaz communicated that it had the resources and the intention to pay its obligations on time. The government nonetheless ordered it to approach its investors with a restructuring plan.
But according to energy experts Denys Sakva of Dragon Capital and Oleksandr Kharchenko of the Energy Industry Research Center, Naftogaz was very late with its proposal and sent mixed messages. Bondholders expecting to be paid rejected the plan.
Naftogaz reportedly blamed the government, referring to the Cabinet’s June 7 order to have no less than 19 billion cubic meters of natural gas in storage for the upcoming winter heating season. Vitrenko has said that 15 billion cubic meters would be enough for Ukraine for winter and the difference, at current prices, would cost more than $8 billion.
The Cabinet of Ministers in turn slammed Naftogaz’s unsuccessful debt restructuring attempt and ordered it to get permission before it does anything with its Eurobonds.
What does this mean for Naftogaz?
Defaulting on payments will make it harder for Naftogaz to raise money on international financial markets in the future. It will complicate its relationship with the EBRD, which it’s relied on to raise money for natural gas imports. The EBRD last agreed to a 300 million euro loan to Naftogaz in June.
“The main trouble with the default of Naftogaz, apart from the joy in the Kremlin, is that it blocks cooperation with creditors,” wrote investment banker Serhiy Fursa. “For example, the EBRD. This, in turn, deprives Naftogaz of the opportunity to buy the gas necessary for pumping into storage facilities.”
Investors could theoretically go after Naftogaz in courts. The situation can also trigger a cross-default, when other creditors also demand to be paid. However, it’s more likely that investors will just wait for the next proposal, Sakva said.
Kharchenko believes the default’s fallout will be limited. After last year, when Naftogaz’s supervisory board was essentially disbanded by the state, investors weren’t exactly lining up to invest in the company, even before July.
“Ukraine is in a war and everything is done in crisis mode. Nevertheless, it is unusual to have differences between the government and an important state-owned enterprise to be aired in public,” said Edward Chow, an energy security expert at CSIS. “It does not help Ukraine in its relationship with its international creditors.”
Will the default prevent Ukraine from having enough gas this winter?
According to Ukrainian Prime Minister Denys Shmyhal, Ukraine currently has 11 billion cubic meters of gas in storage. Estimates of how much Ukraine needs for the winter vary.
While the Cabinet wants Naftogaz to have 19 billion cubic meters in reserve, EIR’s Kharchenko believes that 14 billion cubic meters would be enough to avoid any gas crisis come winter.
Kharchenko said that reduced consumption due to the war has led to monthly surpluses of close to 1 billion cubic meters and, with some purchases, Ukraine should have enough by October.
The ball is in the investors’ court, as far as Naftogaz’s options are concerned. Their reactions to the default and Naftogaz’s second debt plan offer will determine how much difficulty will be added to raising funds and importing gas for the state company.
Default aside, gas prices are astronomically high and Ukraine doesn’t have a lot of money. There are some possible solutions, such as a lend-lease agreement, which would see the US provide Ukraine with natural gas through Europe's LNG terminals, to be paid back in two years — Ukraine asked the U.S. this week. But it’s unknown what will end up happening.
Fortunately, the European Investment Bank will provide Ukraine with 1.6 billion euros for the purpose of buying gas for the winter, Shmyhal announced this week.