Kyiv September 19, 2016

ANALYSIS OF SITUATION OCCURRED WITH REGARD TO THE MINISTRY OF ECONOMY’S

DECISION TO AMEND THE CHARTER OF NJSC “NAFTOGAZ OF UKRAINE”

RELATING TO THE CONTROL OVER PJSC “UKRTRANSGAZ”

What happened.

On September 07, 2016 the Ministry of Economic Development and Trade of Ukraine through its order, which in this case has the force of a general meeting of shareholders, has approved amendments to the charter of NAK "Naftogaz of Ukraine". From the excerpts of the document published in medias it is evident that the Ministry complemented the charter with some new items, which in particular expanded the powers of the Ministry itself. Now the exclusive rights of the general meeting include:

"to resolve the issues of management of the Gas Transportation System Operator, to elect the chairmen and members of the Supervisory Board and the Board of Directors of the gas transportation system operator and to terminate their powers, to release them from duties and to elect individuals who temporarily carry out these powers;

to approve and to amend the charter of the Gas Transportation System Operator;

to approve the financial plan (budget), business plan, investment program of the Gas Transportation System Operator"1 (emphasis by DiXi Group).

As of mid-day of September 19, 2016, the Vice Prime Minister - Minister of Economy Stepan Kubiv said that this decision was suspended by himself in anticipation of the dedicated session of the Cabinet of Ministers.2

Feedback.

Information on this decision was first publicly circulated on September 16, 2016. According to Director of Business Development of Naftogaz Mr. Yuri Vitrenko, the company heard no more than rumors about the planned changes, indicating that the decision of the Ministry was taken without prior consultations with the company.3

On the same day and repeatedly thereafter representatives of Naftogaz expressed surprise and dissatisfaction with the decision describing it as sudden and threatening. In particular, the official press release on the website reads that the decision is contrary to the requirements of the Third Energy Package, the Law "On the Natural Gas Market" and the Resolution "On the Separation of Transportation and Storage (Injection, Withdrawal) of Gas" No. 496 dated 01.07.2016 (hereinafter - "Resolution 496"). In addition, Naftogaz asserts that this decision threatens implementation of corporate governance reform of Naftogaz adopted in 2015 and preconditioning a EBRD loan of USD 300 million purposed for the purchase of gas. As a result of misconduct of the Ministry’s management, as Naftogaz calls it, the loan agreement with the World Bank in the amount of USD 500 million is jeopardized too, which may turn to the risk for stable passage of the heating season of 2016-2017.4

1 https://www.rbc.ua/rus/news/mert-budet-samostoyatelno-upravlyat-ukrtransgazom-1473967038.html 2 http://www.epravda.com.ua/news/2016/09/19/605974/ 3 https://www.youtube.com/watch?v=E5ch4Z9J5Js 4 http://www.naftogaz.com/www/3/nakweb.nsf/0/B947718D26D4FE7EC2258030005B00C8?OpenDocument&year=2016&month=09&nt=%D0%9D%D0%BE%D0%B2%D0%B8%D0%BD%D0%B8&

NGO “DiXi Group”

Instytutska Str. 18a,

office 3

01021 Kyiv

Ukraine

EDRPOU 36159679

Bank account No:

26004257852200

PJSC «Ukrsibbank»,

MFO 351005

+38 044 253 66 94

author@dixigroup.org

olepav@dixigroup.org

www.dixigroup.org

On the same day the Ministry of Economic Development commented on the case. In particular, on the website of the Ministry information was posted with details of the amendment version of Naftogaz’s charter. The purpose of amendments was described as fulfillment of Ukraine's commitments towards the Third Energy Package on Gas Transmission System Operator’s (which function is currently carried out by Ukrtransgaz) independence from the vertically integrated Naftogaz. In addition, the press service of the Ministry said that Naftogaz remains a sole shareholder of "Ukrtransgaz", however, it is the MEDT which would continue the corporate governance reform of the Gas Transportation System Operator through establishment of the Supervisory Board of Ukrtransgaz, involving independent directors.5 On the same day, this position was confirmed by Stepan Kubiv, Vice Prime Minister and the Minister of Economy.6

On 17 September 2016, the Energy Community Secretariat, being the body charged with assessment of compliance of decisions and laws against the European law included in the Third Energy Package, spoke on its position. Its statement titled “Secretariat concerned unbundling of Naftogaz is at risk” indicates that the unilateral decision of the Ministry of Economy is not in line with the Resolution 496 and was not consulted with the Energy Community. In addition, it is highlighted that despite the fact that the Resolution 496 envisages that a new transmission system operator is being established under the control of the Ministry of Energy and Coal Industry, the changes deal with the existing company, and the Ministry assumed the control over production and supply contrary to the liberalized market rules. In the end, the experts of the Secretariat call upon the Government to follow the process approved by the Resolution 496, as any other way may cause enforcement action by the Secretariat, jeopardize ongoing arbitration cases and endanger the role of Ukraine as a gas transit country.

According to the medias, on September 17, 2016, EBRD’s Managing Director in the region Mr. Francis Malige emphasized it is necessary to suspend the decision and to start negotiations between the Ministry and Naftogaz, as well as other applicable partners in order to find a solution in line with the agreement signed between Ukraine and EBRD. He further said the lender is extremely troubled by the fact the decision was taken in violation of procedures of corporate governance.7 Mr. Anton Usov, EBRD’s senior advisor confirmed that in case the facts prove to be correct EBRD will be concerned and the case is very important.8

In addition, investigative journalist project NASHI HROSHI released details about the tender offers made by Ukrtransgaz for a total amount of more than UAH 4 billion, which coincided in time with the change in control over the company. Journalists also reported that the only domestic equipment manufacturer capable of performing these tenders is Sumy Scientific and Production Association, which is associated with the business of the scandalous Russian businessman Konstantin Hrigorishin.9

Prime Minister Volodymyr Groisman pledged to inquire personally into the conflict erupted and underlined that the Ministry has been acting within their powers. He promised however to "do what it takes to make any problem perish" if any threat stemming from such a decision will be confirmed.10

Opinion of DiXi Group.

The decision of the Ministry is currently criticized on the basis of three separate reasons - 1) Contradiction of such a step to the agreed plan of reforming of gas transportation business in Ukraine, 2) Collateral threat to the loan and funding agreements to which Naftogaz is a party, as well as additional burdens within arbitral process in the Stockholm arbitration between Naftogaz and

5 http://me.gov.ua/News/Detail?lang=uk-UA&id=ddf2d8b0-8fa2-4b18-a1b2-934739f6407c&title=ZatverdzhenoNovuRedaktsiiuStatutuNaknaftogazUkraini 6 http://www.epravda.com.ua/news/2016/09/16/605778/ 7 http://biz.liga.net/all/tek/novosti/3487275-ebrr-trebuet-otmeny-resheniya-po-ukrtransgazu.htm 8 http://www.ft.com/cms/s/0/89a349a4-7da2-11e6-8e50-8ec15fb462f4.html#ixzz4Kd1itOEI 9 http://nashigroshi.org/2016/09/17/kubiv-vyrishyv-peredahuvaty-ukrtranshaz-yakraz-koly-toj-oholoshuvav-try-tendery-na-4-milyardy/ 10 http://www.epravda.com.ua/news/2016/09/17/605857/

Gazprom and 3) The lack of transparency in decision-making and incomprehensibility of Ministry’s actual goals.

1. After a lengthy approval process, final unbundling model was finally approved by all related parties, including international donors and experts, and set forth in Resolution 496. Implementation of the relevant plan, though with a delay, has already begun, as the results of the meetings of the Working group at the Ministry of Energy witness.

Despite the official position of the Ministry of Economy, its decision can in no way be interpreted as performing of the Resolution 496. Similarly, re-subordination of Ukrtransgaz cannot be seen as an alternative way to achieve the objectives of the Third Energy Package on the terms of ownership unbundling as the vertical integration remains due to the simultaneous control by the Ministry of both Naftogaz and Ukrtransgaz. We can assume that the intention of the Ministry was effecting of unbundling on other acceptable terms, such as the model of «independent system operator - ISO», which may provide for new system of control distribution. In any event, the argument of the Ministry is quite general and one should wait for further explanation of its position.

2. At least one item of amendments provides for definitive influence of the Ministry of Economy towards financial decisions of Ukrtransgaz through the right to approve of financial plans and investment programs. At the same time, without reading of the actual texts of specific loan agreements of Naftogaz, namely the events of default items, it is impossible to fully confirm the position of the inevitable consequences for the country during the heating season. Given the importance of such agreements, as well as their political aspects, it is difficult to expect that, even given an early repayment claim right, EBRD and / or World Bank would indeed resort to use it. However, one can confidently assert that the fact of deep inconsistency of public policy in reforming the corporate governance model of one of the largest and most profitable public companies in the country has caused great damage to reputation and investment attractiveness of Ukraine.

As long as information on the positions of the parties in arbitration in Stockholm has rather limited access character, it is difficult to confirm or refute the statements of representatives of Naftogaz. Unclear enough wording in the new charter’s Naftogaz concerning "to resolve the issues of management of the gas transportation system operator " may, depending on the circumstances and the party resorting to it, be understood quite differently.

3. Decisions of the Ministry of Economy regarding changes to the charter of Naftogaz may be safely called unexpected, badly prepared and questionable. This is also confirmed by a joint comment given by the Deputy Ministers of Economy Ms. Yulia Kovaliv, Ms. Natalia Mykolska and Mr. Maxim Nefedov given on September 19, 2016 in social medias in where they confirmed they have not been involved in elaboration and taking this decision.11 Even assuming that the management of the Ministry of Economy will further explain the ultimate goal of such change, the fact of a violation of decision making procedure remains and is particularly important in view of the social significance of the company under review. This explanation of motives is especially significant in view of the huge tender offers made public, as it is clear that in the absence of a realistic justification of its actions, decision of the Ministry retains highly suspicious character and high corruption risks, especially given the non-transparent process of taking of this decision.

11 https://www.facebook.com/nataliya.mykolska/posts/10157546537880360