On the financial results of NJSC Naftogaz of Ukraine for the 1st half of 2021

08.11.2021

Naftogaz of Ukraine, the largest group of companies in the Ukrainian fuel and energy sector, plays a critical role in the country’s energy security and state budget. According to the Company itself, it “stands in defense of the country’s energy independence and serves as a support for the state budget.”

Therefore, Ukraine’s energy security largely depends on the financial condition of NJSC Naftogaz of Ukraine.

It should be noted that based on the results of financial activities, on April 28, 2021, the Cabinet of Ministers of Ukraine recognized the work of the supervisory board and the board of NJSC Naftogaz of Ukraine as unsatisfactory.

The main reason for recognizing the work of the board and supervisory board of NJSC Naftogaz of Ukraine as unsatisfactory was that “the net consolidated loss of the Naftogaz group of companies in 2020 amounted to UAH 19 billion. At the same time, the financial plan of the company approved by the Cabinet of Ministers envisaged a profit of UAH 11.5 billion.”

Accordingly, from April 28, 2021, the Cabinet of Ministers of Ukraine, as a shareholder of the Company, terminated the powers of independent members of the Supervisory Board of NJSC Naftogaz of Ukraine, representatives of the state on the supervisory board of NJSC Naftogaz of Ukraine, as well as the chairman of the board Andriy Kobolyev.

Since April 29, 2021, Yuriy Vitrenko has headed the National Joint-Stock Company Naftogaz of Ukraine.

Since the previous management was dismissed due to unprofitable activities and failure to meet the indicators of the financial plan, for the new management of NJSC Naftogaz of Ukraine headed by Yuriy Vitrenko, it was an extremely important task to show real indicators of the Company’s profitable activity in 2021.

On October 28, 2021, Naftogaz of Ukraine published its consolidated report for the first half of 2021.

Along with the report on the financial results for the first half of 2021, the report on the financial results for the second quarter of 2021 is also presented.

It is probably worth citing a few quotes from the message of NJSC Naftogaz of Ukraine, which clearly characterize the new management’s attempts to present their work in the best possible light:

“in the second quarter of 2021, at the beginning of which Yuriy Vitrenko replaced Andriy Kobolyev as the chairman of the board, Naftogaz received a net profit of UAH 8.5 billion.”

“net profit in the second quarter of 2021 was less than the net loss in the first quarter of 2021, and therefore the net loss for the entire first half of 2021 amounted to UAH 1.7 billion.”

“if we subtract the result of the second quarter from the results of the half-year, we can see that the net loss for the first quarter of 2021 amounted to UAH 10.2 billion.”

Thus, the new management of Naftogaz tried to distance itself from the financial results for the first quarter of 2021, for which the previous management headed by Andriy Kobolyev should be responsible.

For a more objective approach, it should be noted that the consolidated interim financial statements of NJSC Naftogaz of Ukraine as of June 30, 2021, indicate that according to the results of the first half of 2021, the Company received a loss of UAH 1.65 billion.

At the same time, according to the presented results for the second quarter of 2021, the Company received UAH 8.50 billion of consolidated net profit.

Thus, the consolidated financial result of NJSC Naftogaz of Ukraine’s activities based on the results of the first quarter of 2021 is UAH 10.15 billion in losses.

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The publication of the results regarding the received consolidated UAH 10.15 billion in losses in the first quarter of 2021 contrasts sharply with the statement of the new management headed by Yu. Vitrenko, published on the Naftogaz website dated May 5, 2021, which stated that “according to the results of the first quarter of 2021, NJSC Naftogaz of Ukraine received UAH 12.6 billion in net profit. This is evidenced by the data of the unaudited and unconsolidated reporting of the Company.”

Further in the text, it is even stated that “the main reason for the improvement of Naftogaz’s financial result was the significant increase in natural gas prices on the European and Ukrainian markets in the first quarter of 2021 compared to prices both in the previous quarter and in the same period last year.”

Of course, it is necessary to distinguish between the consolidated reporting of the Naftogaz Group of Companies and the separate reporting of Naftogaz itself, but taking into account the specifics of accounting for the separate reporting of Naftogaz, such an indicator as the net profit (loss) of Naftogaz itself does not differ much from the consolidated profit (loss), since the total results of profits (losses) of all Naftogaz Group enterprises are reflected in the financial statements of Naftogaz itself, as income from participation in capital (within the ownership of shares of enterprises that are part of the Naftogaz Group).

For example, in 2020, according to the consolidated reporting, the Company’s loss amounted to UAH 19 billion, and the loss according to Naftogaz’s separate reporting amounted to UAH 18 billion. Not too much of a difference.

It remains unclear how, against the background of statements at the beginning of May 2021 (already by the new management) about receiving UAH 12.6 billion of net profit in the separate reporting of Naftogaz, UAH 10.2 billion of losses were suddenly formed in the consolidated reporting of the first quarter of 2021.

With a high degree of probability, it can be argued that during the formation of the consolidated report for the first half of 2021, the new management made significant adjustments to the period of the first quarter of 2021, which led to the formation of losses instead of the announced profits.

If this is the case, then the statements of the new management regarding the improvement of their results in the second quarter of 2021 compared to the first quarter of 2021, with the arrival of the new management, are nothing more than manipulation, which is unacceptable from the point of view of managing both a state-owned and a private company. The only question is that in a private company such manipulations would end very quickly with corresponding consequences for management.

Unfortunately, the new management does not provide explanations regarding the existence and reasons for discrepancies in the separate reporting of Naftogaz for the first quarter of 2021 as of the beginning and end of the second quarter of 2021. At the same time, the consolidated financial report for the first quarter of 2021 has not been published yet.

After analyzing the operating income and expenses of the published consolidated reporting of NJSC Naftogaz of Ukraine, it can be concluded that the main element of expenses, due to which losses were formed in the first half of 2021, is the accrual of “provision for impairment of receivables” in the total amount of UAH 20.18 billion. Moreover, the amount of these “provisions” attributable to the first quarter of 2021 is UAH 26.53 billion. Accordingly, in the second quarter of 2021, instead of expenses, UAH 6.35 billion of income appeared from the reversal (decrease) of the “provision for impairment” (UAH 26.53 billion – UAH 20.18 billion).

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Such changes in the accrual of “provisions for impairment of receivables” in the first and second quarters of 2021 look quite strange, because the reflection of the allegedly “improved” result of Naftogaz’s financial activities in the second quarter of 2021 depends on the distribution (adjustment) of these expenses between quarters.

If the Cabinet of Ministers of Ukraine wants to objectively evaluate the activities of the new management of Naftogaz, then it is precisely such dubious transformations in the financial statements that should attract its attention as a shareholder, because manipulation of the accrual of “provisions for impairment” is a direct consequence of tax evasion from paying dividends to the state budget.

It was precisely such violations in the formation of the doubtful debt reserve that were indicated in the act of the State Audit Service dated September 2, 2020, No. 05-21/2 regarding the inspection of Naftogaz, and it was due to such illegal formation of reserves that the state budget losses, according to the State Audit Service, amounted to about UAH 75 billion.

And, strangely enough, it was Yuriy Vitrenko who in 2020, after his dismissal from the Company, fully supported the conclusion of the state auditors, emphasizing that “after reading the conclusions of the auditors, I did not find sufficient grounds to deny that this audit was objective, unbiased, and that the conclusions about violations were justified.”

A completely logical question arises, why, after the government appointed Yuriy Vitrenko as the head of Naftogaz, does the main reason for Naftogaz’s unprofitable activity remain the accrual of “provision for impairment of receivables”?

What has changed in Yuriy Vitrenko’s positions regarding the use of the “provision for impairment of receivables” in 2020 and 2021?

It should be noted separately that according to the financial plan of NJSC Naftogaz of Ukraine for 2021 approved by the Cabinet of Ministers of Ukraine, the amount of the “provision for impairment of receivables” based on the results of the first half of 2021 could not exceed UAH 3.54 billion. Despite this, in the published consolidated reporting of Naftogaz for the first half of 2021, the actual amount of accrued “provisions” exceeds the planned indicator by almost six times and amounts to UAH 20.18 billion, the main part of which is the accrual of provisions for impairment of receivables for natural gas, which is reflected in the separate reporting of Naftogaz.

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If Naftogaz had adhered to the financial plan for accruing “impairment reserves,” then according to the results of the first half of 2020, instead of UAH 1.65 billion in losses, NJSC Naftogaz of Ukraine would have generated about UAH 15 billion in net profit, and the state could continue to count on receiving appropriate dividends from such profit.

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If instead of reflecting reasonable profits, Naftogaz again “shows” losses, then how does Yuriy Vitrenko, under whose leadership the indicators of the financial plan are violated, which led to Naftogaz’s unprofitability in the first half of 2021, differ from Andriy Kobolyev, who was dismissed precisely for allowing the Company’s actual losses at the end of 2020, if necessary, to maintain profitability at the level of the financial plan approved by the Cabinet of Ministers of Ukraine?

At the same time, the data of the consolidated financial statements for the first half of 2021, compared with the indicators of the first half of 2020, indicate an improvement in financial results, both in individual business segments and in the Naftogaz Group as a whole.

The main profits of the Naftogaz Group are generated in the “Exploration and Production” segment (natural gas production). The adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) for this segment in the first half of 2021 amounted to UAH 26.64 billion, which is UAH 15.78 billion or 2.5 times more than in the first half of 2020 and close to the annual figure for 2020 (UAH 27.99 billion).

The increase in profit in this segment contrasts sharply with the decline in natural gas production. Following the results of the first half of 2021, JSC Ukrgasvydobuvannya, which is part of the Naftogaz Group, reduced gas production by 5%, having produced 6,788 million cubic meters of natural gas (gas production in the first half of 2020 amounted to 7,127.9 million cubic meters).

Thus, the main factor in the increase in profit in this segment is a significant increase in the selling price of own gas production. If in the first half of 2020 the average estimated selling price of own gas production was about UAH 3.4 per thousand cubic meters (excluding VAT), then in the first half of 2021 it was already about UAH 7 per thousand cubic meters (excluding VAT).

Regarding the volume of natural gas production, it is worth noting that in the 2nd quarter of 2021, compared to the 1st quarter of 2021, against the backdrop of a decrease in gross production volumes, the indicator of commercial gas production improved. In turn, the increase in commercial gas volumes is explained by a significant reduction in the use of gas for technological needs (by 14%).

The reduction in technological gas costs in the 2nd quarter of 2021 (including by 7% compared to the 2nd quarter of 2020) indicates the intensification of work in the field of gas production and gives hope that the story with last year’s inflated technological costs will not be repeated.

If the segment of the Naftogaz Group’s natural gas production activity brings profits for the Company, then the segments from “Trailing” (wholesale gas trade) and the segment “Retail Business” (retail gas trade) neutralize these profits by forming significant losses. Thus, according to the results of the first half of 2021, the “Trading” segment received UAH 15.85 billion in losses, despite a twofold increase in revenue. Compared to the first half of 2020, the result worsened by UAH 7.27 billion.

The main reason for the formation of losses in the wholesale gas trade segment is the formation of a “reserve for impairment of receivables”, which, according to the results of the first half of 2021, amounted to UAH 20.48 billion for this segment, which is 13.53 billion more than in the first half of 2020. The formation of receivables is one of the main problems of the Naftogaz Group’s activity and the filling of the state budget at the expense of the Company’s dividends. As of the end of the first half of 2021, the total value of trade receivables amounted to UAH 168.8 billion. During the 6 months of the current year, it increased by UAH 13.2 billion. For comparison, in the previous two years (2019-2020), the total increase in receivables amounted to UAH 15.9 billion. Thus, only in the first 6 months of 2021, the Company increased its receivables to the level of its growth over the past two years. Such rates of debt accumulation should have alerted the Company’s shareholder in the person of the Ukrainian government.

Since 2014, the amount of total receivables has increased by almost 5 times (from UAH 34.1 billion in 2014 to UAH 168.8 billion in the first half of 2021).

In the structure of the total value of trade receivables (UAH 168.8 billion), 88% are doubtful receivables, for which UAH 147 billion of impairment reserve was accrued.

Based on the average annual value of realized gas of own production at the level of UAH 70 billion, as of the end of the first half of 2021, doubtful receivables reached the size of the two-year value of all extracted own gas.

In the “Retail Business” segment, in the first half of 2021, a loss of UAH 240 million was generated, but unlike “Trading”, the amount of such losses is less than the losses for the first half of 2020 (UAH 406 million). The presence of losses in this segment indicates a direct subsidy of this segment at the expense of other segments of the Naftogaz Group’s activities. The presence of losses in the retail trade of natural gas continues for the second year in a row, and the possibility of their subsidization at the expense of other activities of the Company may provide the Naftogaz Group with competitive advantages in the gas supply market, which in turn leads to distortion of competition in the market.

It should be noted that in the first half of 2021, the profit (EBITDA) of PJSC Ukrnafta, which is part of the consolidated financial statements, amounted to UAH 2.46 billion against a loss of UAH 2.32 billion in the first half of 2020. Thus, Ukrnafta improved its financial result by UAH 4.79 billion.

A characteristic feature of the consolidated report for the first half of 2021 is that it presents the structure of total selling expenses, general and administrative expenses, both for the first half of the year and for the second quarter of 2021. Based on the specified data, it is easy to compare such expenses incurred in the second quarter compared to the first quarter of 2021.

In the second quarter of 2021, the total selling, general and administrative expenses amounted to UAH 5.14 billion, which is 2.34 billion, or 84%, more compared to the first quarter of 2021.

It is indicative that in the second quarter, after the change of the head of Naftogaz, personnel costs amounted to UAH 2.29 billion, which is 432 million more than in the first quarter of 2021. If we compare the indicated UAH 2.29 billion of personnel costs with the corresponding expenses of the second quarter of 2020, then they are also more by more than UAH 685.

Considering the above, and taking into account the fact that the change of the management of Naftogaz took place in the second quarter of 2021, it is possible to assert with a high degree of probability that a significant part of the personnel costs increased by UAH 432 million in the second quarter of 2021 was payments for the company’s management team.

The question remains open – how could additional bonuses be paid to the management team after the Cabinet of Ministers of Ukraine recognized the work of the Company’s board as unsatisfactory. And most importantly, who and on what basis signed payment orders for the payment of such bonuses in the second quarter of 2021, after the change of the head of Naftogaz.

The total volume of investments of the Naftogaz Group in the first half of 2021 amounted to UAH 7.4 billion, which is 0.4 billion less than in the corresponding period last year.

It is also worth noting that with the increase in the first half of 2021 compared to the first half of 2020, revenues from the sale of gas of own production by 2 times and the growth of profit (EBITDA) in this segment by 2.5 times, the Naftogaz Group was not only unable to increase investments in its own production, but also reduced such investments by almost half.

At the same time, it should be noted that the Company’s investments in the “Other segment” of its activity for the corresponding period increased by 3.5 times and amounted to UAH 2.93 billion. As noted in the report, “93% of capital expenditures and 68% of assets of the “Other” segment belong to projects that are being implemented by the technical division for the “Exploration and Production” segment.

According to the data of the consolidated financial statements for the first half of 2021, as of the end of the reporting period, there were UAH 47.8 billion of cash on the Company’s bank accounts.

If we compare with the information published by RBC-Ukraine that “As of 01.05.21, cash in the amount equivalent to UAH 57.7 billion was accumulated on the Company’s current accounts, then only in two months of the second quarter of 2021, UAH 10 billion was used. At the same time, NJSC Naftogaz of Ukraine did not purchase imported gas for injection into UGS during the second quarter of 2021 and did not make large investments, so the nature of the decrease in cash on the company’s accounts is not clear.

Summarizing the above, – with such parameters of the financial report, it is difficult to share the statement that “The Naftogaz Group stands for the energy independence of the country and serves as a support for the state budget.”

And if Ukraine’s energy security depends on the financial condition of NJSC Naftogaz of Ukraine, then there are all reasons to assert about obvious threats to such energy security.

Authors of the analytical report:
Iaroslav Dykovytskyi, Valerii Bezus