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Rotterdam Plus: Where has the investigation gone?

Almost a year ago the National Anticorruption Bureau of Ukraine (NABU) opened an investigation into the Rotterdam Plus formula – a method used to calculate the prices of coal. It seems quite likely that the escalation of the Rotterdam Plus topic in the media was made in the interests of politicians and big industrial electricity consumers.

April 9, 2018 - Valerii Vorotin - Analysis

Power plant Burshtyn TES, Ivano-Frankivsk Oblast, Ukraine/ Image by Raimond Spekking

International experts and Western partners have long argued in favour of liberalising Ukraine’s energy market and deregulation of gas and coal prices. As a result in 2016 the market pricing method for energy resources was introduced in accordance with Article 269 of the EU-Ukraine Association Agreement. The new gas pricing formula has been referred to as Dusseldorf Plus, and coal pricing formula as Rotterdam Plus.

Rotterdam Plus is set as an average market price for 12 months according to ARA Amsterdam–Rotterdam–Antwerp index, plus its freight rate to Ukraine. The price forms the basis of the wholesale market price, which is used as a forecast price for tariff setting for industrial consumers.

Almost a year ago the National Anticorruption Bureau of Ukraine (NABU) opened an investigation into the Rotterdam Plus formula. This is the first time that the agency’s management has commented on the investigation since last summer. Artem Sytnyk, the Bureau’s director, outlined the complexities of the case and refused to give any prognosis as to when the investigation might be completed. He also noted that there are a lot of speculations about the Rotterdam Plus formula.

Contrary to the restraint demonstrated by law enforcement agencies, members of parliament and activists have been actively discussing the subject of coal energy tariffs and kept sending new requests and materials to NABU. However, the increasing evidence has not been spurring the investigation of the agency, which merely issues formal replies that new documents have been included in the case files.

Why have electricity tariffs been rising?

On March 24th 2017 NABU opened a pre-trial investigation into a suspected abuse of powers by the chief officers of the National Energy and Utility Regulation Commission (NEURC) during the design and implementation of a procedure for calculating an estimated wholesale market price of electricity (WMP).

The investigation was opened at the request of Viktor Chumak, a member of the Ukrainian parliament, despite the previous court decision which found NEURC’s activities as legitimate. The Rotterdam Plus formula was also strongly opposed by members of parliament Serhii Leshchenko (Petro Poroshenko Bloc) and Vitalii Kuprii (an associate of Igor Kolomoyskiy, according to Ukrainian media), and Andrii Herus, an expert and a former member of the NEURC, dismissed in 2015.

According to critics of market pricing for energy resources, Donbasskaya Toplivno-Energeticheskaya Kompaniya (DTEK, owned by Rinat Akhmetov), the largest coal and mining company in Ukraine, is the formula’s main beneficiary. At the beginning of 2016 DTEK was on a brink of default caused by steep devaluation of the national currency and a military conflict in eastern Ukraine. The company’s Eurobonds were traded with a huge discount as investors doubted DTEK’s ability to pay off its creditors. Taking advantage of low prices the Investment Capital Ukraine (ICU), whose former employee Dmytro Vovk is now the chief of NEURC, started buying DTEK’s bonds. Later on, NEURC introduced the Rotterdam Plus formula, as a result of which DTEK’s position strengthened and the price of their Eurobonds gradually restored.

People who initiated the investigation into the Rotterdam Plus suspect that ICU had internal knowledge about the introduction of the formula. However, the accusers ignore the fact that everyone had known that electricity prices would increase one year prior to the introduction of Rotterdam Plus. In February 2015 the national commission approved a five-stage schedule for raising electricity prices. According to this document, within two years electricity prices were to increase 3.5 times on average. The gradual increase of electricity prices was agreed with the IMF. The relevant document was signed, among others, by NEURC’s member, Andrii Herus, who now suspects collusion between the investment company and the commission.

DTEK bonds’ growth

The years 2014-2015 were a difficult period for Ukraine marked by the change of the government, fall of hryvnia, and the onset of a military conflict.

Against this background, Moody’s reduced the rating of Ukraine’s Eurobonds in 2014, which resulted in a plunge of Eurobonds issued by Ukrainian companies. In March 2015 many Eurobonds recorded their historic minimum: Oshchadbank’s securities traded at 40.1 per cent of their nominal value, and Ukreximbank’s – at 51.5 per cent. During the same period DTEK’s bonds hit their minimum of 35 per cent of the nominal value. The downward dynamic continued until the end of the first quarter of 2016.

Despite opponents’ statements that ICU had internal knowledge about the introduction of the formula Makar Paseniuk, the managing partner at ICU, indicates other reasons for buying the company’s bonds: “We started investing in DTEK’s bonds far back in 2011-2013, when the prices were at the level of the nominal value. In 2015 and 2016 we were purchasing more of these securities due to the two reasons that are apparent to any investor: the cheap price of the securities and the negotiations the company had started with the creditors to restructure its debts”.

Moreover, the fact that ICU had purchased a portion of the Eurobonds issued by DTEК became known from an interview with the company’s CEO Maksim Timchenko. Would Rinat Akhmetov’s top manager have disclosed this information if the agreement had resulted from some secret arrangement between the owner of DTEK and the government?

On August 17th 2017 NABU detectives conducted a search at NEURC, which, judging by the absence of any further comments from law enforcement, failed to produce any results.

Growth factors

The first changes to the methodology used for calculating the WMP were submitted by NEURC for discussion on November 17th 2015. The new methodology was adopted on March 3rd 2016. Over this period, the price of DTEK’s bonds dropped by 18.6 per cent, and the decline continued in March 2016, when the methodology entered into force. The securities issued by other Ukrainian companies demonstrated more significant growth as compared to DTEK’s bonds over the same period: the price of Metinvest securities grew by 39.6 per cent, and Ferrexpo bonds rose by 37 per cent.

DTEK’s management points out that there is no conclusive evidence of a connection between the growing prices of the company’s Eurobonds and the adoption of the Rotterdam Plus formula.

“DTEK’s securities had been restoring their position on the background of negotiations that were opened by the company to restructure its own debts”, Yulia Shylina, Corporate Communications Director at DTEK, said. “ In 2016, the company succeeded in negotiating the consolidation of the entire portfolio of securities issued in 2010 and 2013 as a single issue with a maturity date of 31 December 2024. Thus, the company deferred the repayments under the Eurobonds from 2018 until the end of 2024”, she informed.

Market members who participated in a survey believe that the rise of Eurobonds price owed to debt restructuring carried out by DTEK.

“There were several factors behind the growth of DTEK’s bonds. One of them, to be sure, is the completion of the restructuring negotiations. Growth is a usual thing in such situations”, commented Nick Piazza, the founder and CEO of SP Advisors, an investment company.

In the opinion of analysts, other factors that contributed to the rise of DTEK’s securities include a gradual growth of electricity tariffs that began on April 1st 2015 and was recorded in a coalition agreement and in a memorandum signed with the IMF. The development of gas extraction and renewable sources of energy by DTEK has also played a role.

“I can say with confidence that the growth had nothing to do with Rotterdam Plus. There were several drivers: bond restructuring, the rise of electricity tariffs, and changes in electricity export regulations”, noted Tanteli Ratovoheri, an analyst with Empire State Capital Partners.

“The other factor explaining DTEK’s growth was an increase of electricity exports to the EU and also to Moldova where the company won a contract and pushed out the Russians. It became evident that DTEK recovered from the loss of its assets in Donbas and started making profits”, he added.

DTEK’s bonds quotes were tumbling during the entire process of the Rotterdam Plus formula’s adoption. At the same time, the quotes of Eurobonds of all major Ukrainian issuers at the end of the first quarter of 2016 have been on the rise.

“It was a market trend. DTEK’s bonds were not the only ones that demonstrated the growth”, Dmytro Churin, director of the analytics departments at Eavex Capital, stated. “In fact, the outlook of investors on Ukraine today is very different from the outlook back in 2014, and almost all Eurobond quotes have risen”.

Dragon Capital, which is one of the major competitors of ICU, agrees that the introduction of the Rotterdam Plus formula had nothing to do with the rise of DTEK’s securities. The company’s specialists noted that during the period in question, ICU was not the only buyer of DTEK’s Eurobonds, as other major international investment funds were also purchasing these securities.

“If we analyse the dynamics of Eurobonds issued by big Ukrainian industrial holdings, Metinvest, Ferrexpo, DTEK, and also by agrarian majors, we can see that all these securities started growing almost simultaneously. The end of the first quarter of 2016 became a turning point for entire Ukraine. So, tying it with Rotterdam or anything else is far-fetched”, Denis Sakva, a senior analyst with Dragon Capital, explains.

DTEK commented that the company’s bonds are held mainly by international investors.

“We know that international funds were increasing their portfolios. During the restructuring process, the creditors’ committee was chaired, among others, by Ashmore Investment Management and VR Global Partners. The company does not have reliable information how many Eurobonds are held by each of the investors”, Shylina said.

Corruption in the coal sector

According to the government, the Rotterdam Plus formula was introduced as a solution to the problems caused by the blockade of coal deliveries from certain districts of Donetsk and Luhansk regions, and the loss of control over mines located in the occupied territories. Although complete diversification of coal has not been achieved, import accounted for almost a quarter of the coal consumption (5.88 million tons) in the past year.

These numbers can be compared against the statistics of the gas market, where, although domestically-extracted natural gas makes up to two thirds of the consumption, a special pricing formula is also used (NCG Plus based on the gas price in Düsseldorf hub plus the cost of transportation to Ukraine). Market-based pricing is one of the requests made by the West, and all attempts to annul or adjust it have been strongly criticised by the European Energy Community and the IMF.

Instead, representatives of mining trade unions insist that the coal market had a bluntly corrupted structure before, rather than after the introduction of the formula. Tying the coal price to an understandable reference price ensured the survival of the industry which is on a brink of collapse. First of all, this applies to state‑operated mines.

“The most important thing is that (before the introduction of the Rotterdam Plus formula) Ukrainian coal was purchased from mines at 40 US dollars, and the price of imported coal exceeded 100 US dollars. As a result, state-operated mines experienced a shortage of funds required to pay salaries, which ultimately made people go to the street protests”, commented Mykhailo Volynets, president of the Independent Trade Union of Miners of Ukraine and the Confederation of Free Trade Unions of Ukraine. “An increase in coal prices brought up to 3.5 billion hryvnias to the industry annually, and state-operated mines were given an opportunity to survive”.

At the same time, one of the key accusations made by Rotterdam Plus opponents is that Ukrainian consumers have to pay for Ukrainian coal the price of coal from Rotterdam. A detailed analysis into the WMP pricing methodology and coal prices that exist on global markets clearly demonstrates that the formula does not cover the real market price of coal paid by Termal Power Plant (TPP), as this price is predicted and is based on the average values of the API2 index in the past 12 months. For example, NEURC  based its calculations of the WMP in 2018 on the average API2 index of 83 US dollars per ton. The current market prices are considerably higher: in December 2017 the API2 index was 93 US dollars per ton while the price of coal imported from South Africa and the US reached 100 US dollars and 110 US dollars per ton respectively, based on the Ministry of Energy data.

“Rotterdam Plus does not affect the price charged to household consumers. It is clear that the scandal in connection with this issue was orchestrated. Concerning a formula-based approach, it should be noted such an approach is used throughout the entire power industry”, commented Valentyn Zemlyanskyi, an energy expert.

According to NEURC, while the issue of price has been intentionally escalated in the scandal surrounding Rotterdam Plus, the accusers hide the fact that the absence of ties to market indicators burdens state‑operated companies with multi-billion debts that have to be shouldered by taxpayers. Also, the commission was surprised that NABU did not express any interest in the natural gas market where a similar pricing methodology is used.

“Speaking about the claims from law enforcement that arose following the complaints made by activists, I am quite surprised that NABU has not opened an investigation into the gas price (which is calculated using a similar methodology) that has risen alongside the electricity tariffs as a part of a program for cooperation with the IMF”, Dmytro Vovk, NEURC’s chief, said.

Those criticising the Rotterdam Plus formula fail to take into account, or intentionally ignore, yet another important factor, that is, the entry into force of the Law of Ukraine on Electricity Market in June 2017. According to this act, a new model of an electricity market used by EU countries will be introduced in Ukraine on June 1st 2019. In this model the majority of electricity will be supplied under direct bilateral contracts, and the very notion of the WMP will cease to exist. Electricity producers will get an opportunity to sell electricity on the market terms.  NEURC’s  decision to peg the WMP formula to market indexes is a necessary and logical step in global practice.

Who are the judges?

The coal issues are not related to the public’s energy needs, but there is a strong connection with major financial and industrial corporations that control big industrial facilities dependent on the price of electricity. The households’ tariff is set administratively by NEURC. The latest resolution revising the households’ tariff was adopted in 2015 while the method for calculating WMP and Rotterdam plus formula were introduced in 2016. The resolution introducing the formula states that the Rotterdam plus pricing is used only to set the electricity tariff for industrial consumers. Ihor Kolomoyskyi’s group is one of them. But he is not the only “victim” of the electricity prices: Viktor Pinchuk’s ferroalloy plants have lost a significant portion of their profits following the rise of electricity price.

Therefore, it seems quite likely that the escalation of the Rotterdam Plus topic in the media was made in the interests of politicians and big industrial electricity consumers.

Valentyn Zemlyanskyi noted that the same applies to gas. “The Düsseldorf-based gas prices vary around 100 US dollars during a season for industrial consumers. It should be noted that all major Ukrainian financial and industrial groups have in their portfolios gas-extracting assets”, he said. “Probably, this is a reason why the media owned by the same financial and industrial groups are focusing on coal Rotterdam Plus but not on gas Düsseldorf Plus.”

It appears that this case is not as straightforward for NABU as for those who made accusations: the members of parliament and activists. The agency’s chief Artem Sytnyk is reluctant to give any comments on the progress of the investigation, citing the complexity of the case and excessive attention of the media. “The case is extremely complex; it involves an analysis of an enormous number of documents. First of all, the investigation is underway, there is investigatory privilege, and I am not entitled to disclose any information”, Sytnik explained. “Secondly, from the outset, the case has been attracting a lot of attention from the public, and any comments on certain final and interim decisions will be undue as they can be used for certain manipulations and speculations”, he added.

The NABU director noted that the efficiency of the investigation depends on the ability of detectives to access the international mechanisms for discovering financial information. “So far, there are no indications as to when this case will go to court”, Sytnik said. “99 per cent of this investigation is made of requests for international legal assistance. They depend on other states and international legal documents. The investigatory actions have not been completed so far”.

Experts do not believe in legal prospects of the case and underline the absence of evidence, a political nature of the case, and failed attempts to challenge the Rotterdam Plus in courts.

“The practice shows that it is virtually impossible to prove such accusations. The NABU is forced to deal with political issues that have no standing in court”, Rostyslav Kravets, a senior partner with Kravets and Partners Law Firm, stated.

However, it would be unreasonable to expect that the case of the Rotterdam Plus has been closed. The subject is way too sensational to be dropped in the forthcoming election run.

Valerii Vorotin is an expert at the Institute of Law of the Verkhovna Rada.

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