More from Tim Ash of Standard Bank: From: Timothy Ash (STANDARD BANK PLC) Date: Wed, Apr 2, 2014 at 5:34 PM Subject: Ukraine - You just cannot make this stuff up! Ukraine continues to be something of a moving target as far as the analyst is concerned – no pun intended there. As expected, President Putin signed a decree which in effect pulls the various (2007 and 2010) treaties between Ukraine and Russia covering the Black Sea – this follows Russia’s annexation of Crimea. In effect this will remove any discount secured by Ukraine for the supply of energy – and the assumption now is that the price of imported gas from Russia will rise by a further USD100/kcm to around USD490/kcm. All else being equal this could add USD2bn to the annual energy import bill, equivalent to around 1.3% of GDP. This will make the current account and fiscal positions even more difficult. And, inevitably, it will force further energy price hikes, and energy conservation and diversification, which will be positives over the longer term, and might actually reduce the annual 28-30bn cu metres of gas imports from Russia – it could hence reduce the USD2bn annual cost as above. The above reflects the on-going “stealth war” for Ukraine now being played out between Russia and the West. Russia has made it crystal clear that it is determined to stop Ukraine’s European integration, by any means. Moscow tried a border incursion through Crimea, but this failed to provoke a wider opportunity to intervene in east and southern Ukraine to protect ethnic Russians, so the strategy now appears to be to heap pressure on the new Turchynov/Yatseniuk administration through the security channel (a huge troop build up across the border in Western Russia), meddling over the ethnic issue in Eastern Ukraine, higher gas prices, and disruptions to trade relations more generally. The assumption is that this will either bring the Maidan administration down – either through elections, or through street protests - and/or to provide an opportunity for further ‘direct’ intervention. Against the above backdrop, the Maidan administration faces a huge and difficult task in ensuring macro stabilisation and forcing through structural reforms, even with the support of bilateral and multilateral creditors. The plus perhaps is though that the shear extent of the threat – of invasion – and to the very independence of the country, is such that it means the administration has no choice but to reform. Alternatively it could be argued that this creates a wonderful opportunity for much needed transformational change – it might just work, assuming Russia is held in check; the latter appears to be the logic behind Western (mostly US) sanctions being rolled out now against Russia (not the FATCA non-cooperation), i.e. to keep Russia at bay for long enough to let reforms secure traction. Returning to the energy sector issues, there is actually a huge opportunity herein for Ukraine to make some huge short term wins. Energy price liberalisation should force much needed conservation, and this could very significantly reduce energy use – gas consumption could conceivably fall by around one third over the medium term. Likewise the pressure will be to accelerate the diversification of energy supplies away from Russia, both geographically and in terms of type of energy. But, through these combined means, it is possible for Ukraine to be energy self-sufficient over the medium – long term, i.e. erasing almost the entire USD15bn annual energy import bill, which so happens to come close to equalling the current account deficit at present. On the issue of the energy sector, Finance Minister Shlapak, indicated today that the deficit of the state owned gas transit company, Naftogas, is likely to be UAH56bn this year – this is somewhat at odds with comments from the CEO of Naftogas last week who implausibly suggested that the deficit could be UAH80bn. Assuming Shlapak’s number is correct then this would suggest a combined quasi-fiscal deficit of UAH124bn (or USD11.8bn at the MOF’s somewhat optimistic 10.5 exchange rate forecast, or 8.3% of GDP). Press reports today suggested a 73% hike was in the offing for households this year. This is not entirely true, as a 50% average hike is being planned across households, but with a 73% hike for that used in cooking – it tends to be very small amounts, and a small part of the monthly bill. Staying with Shlapak he came out with the line that the government would come back to market as early as H2 2014, with a 5Y issue, and wanted to issue with a yield of 6-7%. If I was the IMF I would be terrified, as Ukraine’s past track record is that when market access opens up, it closes the door with the IMF – not sure if the IMF officials have figured out the connection yet – it’s like 101 Ukraine, and not particularly encouraging in my view. Ukrainian officials evidently just love road-shows, with Eurobond issuance seen as a badge of honour, where perhaps actual reform implementation should be a bigger priority. Stepan Kupiv, the NBU governor argued that the NBU will no longer support the UAH – good news, as in line with IMF recommendations and there is no sense wasting scant NBU FX reserves, and limited IFI cash defending the undefendable. It is currently trading at UAH11.35:USD1, and is still vulnerable in my mind to downside risk, more likely weaker from here than towards the government’s UAH10.5 average forecast. I am struggling a bit with the consistency of the government, and presumably IMF’s broader macro forecasts though. They have 3% real GDP growth decline, a 12-17% inflation rate (so a high GDP deflator) and then nominal GDP of around UAH1480bn. For an exchange rate of UAH10.5, their inflation and growth projections appear too optimistic (inflation is close to zero at present and recession will weigh on prices still, accepting some administered price hikes), and both, alongside nominal GDP should probably be lower in my mind. But the strangest development by far today were media reports that presidential candidate, Petro Poroshenko, and Udar leader, Klitchko, visited Austria for a meeting with Dmitri Firtash, the high profile energy oligarch. Firtash is currently in Austria fighting an extradition request from the US. Firtash has as a result come out strongly in favour of Poroshenko’s presidential bid. Firtash has historically had closer ties to Moscow, and his Ostechem energy company benefitted from cheaper energy import prices. It seems a strange move from Poroshenko now to pander to the energy lobby, unless this has somehow been given the nod by the US, or is an attempt by Poroshenko to appeal across the political spectrum, to ethnic Russians and traditional supporters of Regions. There have been persistent rumours that Firtash and Klitchko had prior associations, albeit Klitchko has denied this. Still, this is “manna from heaven” for Yulia Tymoshenko who can perhaps now argue that she is the only candidate defending Ukrainian national interests, and she will presumably market herself as the Ukrainian nationalist, pro-Western candidate, against the more centrist Poroshenko. What the US administration really thinks of all this is beyond me, but given the close ties between various US officials and the former “gang of three” opposition leaders seen during the Maidan protests, presumably they have a view/angle on the Poroshenko-Firtash hook up. Poroshenko is surely still the leading contender for the presidential election, with a core support of 25%, perhaps bolstered with 8-10% for Klitchko, and rising high so far ahead of Tymoshenko with 10% or so. Tymoshenko’s campaigning prowess could probably double her core vote, and the Firtash-Poroshenko tie up could perhaps give a bit more momentum to Tymoshenko. A future Poroshenko-Tymoshenko presidential election debate will be like a raw knuckle fight with two very experienced, and very heavy weight debaters. Net-net the presidential election is now likely to be very bitterly fought, and a contest in my mind between the two front-runners, albeit some are even suggesting that Poroshenko could yet win a 50% plus one victory in the first round. I am not sure about that – but Poroshenko might be positioning himself to cut deals, even perhaps with Moscow. I am not really sure how this will sit with the likes of Turchynov and Yatseniuk, who are both members of Tymoshenko’s party, but Poroshenko has said that if he wins the presidency, Yatseniuk will remain as prime minister. This looks set to be a messy presidential election campaign, with potential for very messy domestic politics, irrespective of what Russia gets up to. Meanwhile, back at the ranch (or Sovkhoz), but on the border, Russian tanks still seem to be keeping their engines warm, if NATO officials are anything to go by. NATO’s top US commander, Gen Breedlove (what a name for a military man, ‘breed love, not war man’ – you cannot make this stuff up, with ‘Chuck’ Hagel, also set to take on Steven Segal in the next Hollywood Blockbuster) noted that Russian troops could achieve their objectives in 3-5 days. Presumably their objectives would be to take South and East of Ukraine, cutting off rump-Maidan’s access to the Black Sea, and making Russian congruent with the enclave of Trans-Dniestr. Given these comments why would any foreign investor even consider buying Ukraine 5Y Eurobonds at 6-7% yield?
Posted on: Wed, 02 Apr 2014 21:04:56 +0000
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