The CEO of Smart Energy Sergei Glazunov told NV Business about the development and risks for the company, about sales of gas to the population and the influence on the business from its shareholder, MP Vadym Novynskyi.
People's Deputy of Ukraine (MP) Vadym Novynskyi is one of the country's few dollar billionaires. Dragon Capital investment company together with NV magazine estimated his fortune at USD 1.224 billion. The lion's share is a partnership with the richest citizen of Ukraine Rinat Akhmetov in Metinvest Group where Novynskyi owns 25%. However, he has a fairly diversified business of his own ranging from food production to real estate and extraction of natural gas.
Smart Energy, a group of gas producing companies, consists of two parts. One of them is 100% owned by Vadym Novynskyi. This is Ukrgazvydobutok company. The other one is the public company Enwell Energy, which is listed on the AIM (London stock exchange). Previously, it was called Regal Petroleum, but after Vadym Novynskyi bought out Victor Pinchuk's share, the shareholders decided to rename it. The company explains this by an intent to move away from the old stories associated with the company's founder Frank Timis.
At year-end 2020, Smart Energy increased its gas production by 8.6% – to 400.6 million cubic meters. However, the decline in demand and the slump of prices for natural gas seen last year affected its development. NV Business talked to Sergei Glazunov, the CEO of Smart Energy, about the company's development strategy for natural gas production, its operations in the retail segment, its cooperation with DTEK of Rinat Akhmetov, as well as the influence on the business from the shareholder Vadym Novynskyi.
Shareholder and Masked Raids
— How does the name of the beneficiary, his political past and present influence the activities of the company?
— This question is often asked. The answer is rather template: the influence is the same as on any other Ukrainian business that is associated with this or that famous politician or businessman. In fact, there is an interesting phenomenon at the level of public opinion in Ukraine: to link the activities of shareholders and businesses, to trace their influence on such businesses. For an appropriate, sound coordinate system, this is a fundamentally false concept. If you take a look at the United States, there is, for example, Bloomberg, Hyatt or Target chains. The owners of these businesses take the most active part in politics. However, it never comes to anyone's mind there to look for their influence on companies.
We are going the same way. We are engaged in gas production business; we are trying to increase the volume of produced gas, to replenish all the necessary budgets at all levels and operate openly and transparently.
Therefore, the problems or difficulties that we encounter are essentially the same as those of all other gas producers.
— But we remember the cases that were filed against your companies during the presidency of Petro Poroshenko. There were searches, “mask shows” (masked raids) in offices, and one of the company's senior executives was arrested. Was it somehow connected with the activities of the shareholder?
— Here the role of the media is important in particular in order to shape up the right accents. One should not look at it so superficially: if the shareholder is engaged in something or is in some political stream at a given time, then this should automatically spill over to his business. We need to look deeper: how such business behaves, how it structured its corporate governance procedures. Then it will more firmly crystallize in the minds of people who consume this information.
Speaking about the cases that you mentioned, the charges against our former CEO of Ukrgazvydobutok were dismissed. The prosecutor's office itself revoked its claim then as it was impossible to prove his guilt. To what extent can this case be deemed to be connected with the political activity of the shareholder? I don't know this. De facto, this case was closed. It did not affect the development of our company in any way. It's just a pity for the time that was wasted.
— Have you found out for yourself what it was? Political pressure or competitive rivalry?
— To be honest, we did not try to figure it out to the end. There was no particular need to be getting to any root of the matter. Absolutely unfounded accusations.
— How often does the shareholder intervene in the company's activities?
— He in no way makes any decisions and is not entitled to make them. He is not involved in the management of the business. There is the Supervisory Board for that.
— Vadym Novynskyi is Rinat Akhmetov's business partner in metals and agricultural businesses. Akhmetov owns DTEK that has a large oil and gas business line. Do you collaborate in any way? Do you have any plans for a partnership?
— We are in quite a close contact on the platform of the Association of Gas Producers of Ukraine. There are regular discussions of draft documents on the development of the sector. We are also cooperating with DTEK on gas sales. Basically, that's it.
— What is your gas sales structure in general?
— We have a long-term contract with DTEK's trading company. We sell more than half to them and we sell the rest through electronic auctions. We work with a number of foreign traders.
— Who is the end consumer of your gas?
— As for DTEK, it supplies gas to Metinvest. Speaking about other traders, these are mainly industrial enterprises.
— You almost do not work directly with end consumers, do you?
— No, we don't. Except testing retail sales to individuals.
Dual Structure
— All your production results are split into two verticals: Enwell Energy and Ukrgazvydobutok. Are there any plans to consolidate all this?
— On the one hand, Smart Energy group owns 82.7% of the shares in Enwell Energy. This is a UK listed company. It has its own governing bodies, an independent Board of Directors. Ukrgazvydobutok goes separately. It is a private company that is 100% owned by one beneficiary.
The difference lies in these two perimeters, let's put it this way, within the group. This is the public perimeter and the private company. If the question is about the convergence, the merger, conditionally speaking, of all licenses under one legal entity, then this is inexpedient.
— I rather meant the prospects of making Ukrgazvydobutok part of Enwell structure in order to increase the capitalization and transparency of the business, for example...
— At the moment, this is not a question on the agenda. We did not consider it.
— You bought Arkona Gas-Energy company last year. Why did you bring it under Enwell’s structure and not under Ukrgazvydobutok?
— That was a business decision. Their license [site] is located 15 kilometres from our current licenses. In order to have the operational management synergy, it made sense to place it in that cluster.
— Let's assume that your majority shareholder decides to take over some large gas production business. How would you decide as to what structure to bring it under: Ukrgazvydobutok or Enwell?
— Those would be some ad hoc, situational decisions. We would need to see what would be a more rational option, whether there are territorial or areal synergies there. In any case, even if at the level of Smart Energy’s Supervisory Board, a decision is made that some target is promising and interesting to us, before acquiring it for Enwell, the approval of this company's Board of Directors would be required.
— When Enwell was still Regal Petroleum, the company had several large groups of shareholders: you, Victor Pinchuk's group. At what level were the negotiations on the buyout of Pinchuk's share held: the management, the Supervisory Board or the shareholder was also involved?
— We report to the shareholder, but decisions are made at the level of the Supervisory Board.
How to Grow
— What are your further expansion plans?
— We have the development strategy that was devised at several horizons. There is a long-term strategy that provides for full development of the fields that we currently have. There is also a more concentrated five-year strategy that focuses primarily on organic growth. In addition, we very closely look at the market. During 10 years, we studied about 150 objects in detail, but only on two of them we came to some particular agreements.
This is Ukrnaftainvest in Odesa. We signed a memorandum, but we did not move forward to the purchase and sale agreement. Last year we acquired Arkona Gas-Energy.
— Until 2014, the license that now belongs to Arkona Gas-Energy was held by state-owned Ukrnafta. It was merged with other field and sold for UAH 3.8 million to a legal entity associated with Petro Poroshenko's orbit. And then you bought it for USD 8.6 million. In this chain, one can see losses for the state. Do you see any risks for the activities of Arkona Gas-Energy as part of Smart Energy? After all, there have been attempts from Ukrnafta to challenge these decisions in court.
— Firstly, it is incorrect to compare the two mentioned figures: the first one is the cost of the license, the normative evaluation calculated in accordance with the regulatory methodology approved at that time, while the second one is the subject of commercial agreements and the value of a legal entity, and not the cost of a special permit. Secondly, before acquiring this asset, we made a detailed legal due diligence and audit review, which showed compliance of Arkona's previous transactions, including the acquisition of a license for Svystunkivsko-Chervonolutske field. To date, there are two decisions of the Supreme Court regarding this special permit, which also confirm its legality, so we do not see any risks.
— What production build-up do you expect annually?
— Over the past five years, we had an average growth of about 17.7%. During this period, we doubled our production output, but our trends were downward trends. While in 2018 we had a gain of about 38%, then last year it was about 9%. This is mainly due to the situation around external economy and gas prices. For the future, we are determined to increase production, but the industry is inert. If you launch a project to drill a new well, then the production will start only in one year's time.
We Cut Our Investment Program by 40%
— Last year, when oil and gas prices collapsed, many gas producing companies stopped drilling of new wells. How did that situation affect your activities?
— We also had to respond. We cut our investment program by about 40%, since the economy did not make it possible for such projects to be feasible. We finalized drilling of what we started to drill earlier. We made some workovers that were less capital-intensive, but could give us a gain in production.
— Will this be seen in your performance results in 2021?
— In 2021, in the best-case scenario, we will be able to maintain what we had. Yet, it is not certain. As for the economy, prices fell to almost USD 70 in the summer months. For some companies, this was at the margin of their operating revenue. However, we try our best to control the production costs in order to be a low-cost producer. And we managed to be quite successful last year.
— And this year, where do things stand in terms of the investment program?
— While last year the average gas price was around USD 139, this year it will be about USD 200. This makes it possible to resume the program. Drilling of one well has begun at Svyrydivske field, and I think that we will start two more this year.
— Speaking about some potential mergers and acquisitions, do you look only at the Ukrainian market?
— Yes, this is our focus. We understand that we have a certain set of geological and technical competencies here. However, if something is offered abroad, we do pay attention to it too. Primarily in Eastern Europe.
— Several years ago, Vadym Novynskyi's companies received a permit for production of gas offshore in the Azov Sea...
— It was a separate project. We are probably the first private company in Ukraine that drilled an offshore well. Unfortunately, we did not receive the expected commercial inflow, but then... Let's put it this way that the annexation of Crimea and the activity of the Russian Federation in the region make further development of this site impossible.
— Can we say that this project has been frozen or wound up?
— Yes, it is now in a frozen state.
Other Business Lines and Contractors
— You have mentioned the start of gas supplies to the population (individual consumers). Tell us more about that, please.
— We began to probe this market. It is very different from the segment where we historically operated and are operating now, that is the segment of industrial consumers.
This is a pilot project in partnership with Energy Trade Group in Kharkiv region where we supply gas directly to the villages near which we produce it. And even with such a small number of clients, we understand the difference in approaches, we see some “underwater reefs”, and we have to take some specific technological steps.
We have not yet made a decision to make a full-fledged entry into this segment.
— There are a number of signs that behind your partner, Energy Trade Group, there may be people who help to develop either financially or in terms of lobbying. It is not you, is it?
— No, it is not. We have a certain history of cooperation with them as a trader that was selling gas to the industrial sector. In 2016, when the first talks about the emergence of the retail market started, they began to test it. They developed their own software and worked out the document flow. As far as I understand, for many years they worked for minus, but they were among the first ones to develop and test the platform. Thus, they began to enter this market as an independent private supplier.
— Rumours are circulating that they may be backed by some businessmen who have a controversial reputation...
— Before submitting a decision on cooperation with them to our Supervisory Board, we also scrutinized this question. It seems that there are none.
— You said that you are trying to be a low-cost producer. Recently, Alexey Tymofeyev, the former CEO of Smart Energy, in one of his interviews talked about the costs of drilling dry wells. How does it affect your economy?
— Hydrocarbon production is a very risky business, generally speaking. That is why dry wells are absolutely normal. Surely, any unsuccessful drilling project is worth USD 5, 10, 15 million. This is quite painful, but it provides additional information. Therefore, we need to look at it philosophically, on the one hand, but also practically, on the other hand.
At the beginning of our activity, there were projects with dry wells, unfortunately. However, this provided additional geological information, an understanding of our fields' structure. For the past five years, we have not had such [wells].
— Do you drill using your own resources?
— No, we hire external contractors. We have a customer service that monitors their work.
— Is there competition among contractors?
— They are competing, but the development of this market was going in waves in Ukraine. When the 2020 Strategy was declared [by the Cabinet of Ministers — NV Business], a large number of overseas contractors came here. After all, the stake was made on the growth in production then. Later on, the approach was changed: the priority was not the production, but the economy. And thus, most of the contractors left the country, but these circumstances gave an impetus to the development of local companies. Many of them upgraded their equipment pool, bought better equipment, moved from the Soviet legacy (Uralmash) to more modern rigs. The service has changed in a positive direction.
— You also have a production of propane-butane mixture. Do you see the prospects for the development of this business?
— This market is growing quite well. In the previous seven years, it more than doubled. Ukraine now produces about 15% of demand.
This is an interesting market for us. This year we plan to make retrofitting on our hydrocarbon mixture processing unit. The equipment's upgrade will make it possible to increase the output of propane-butane by 60%.
— What growth potential do you have?
— The hydrocarbon mixture that we produce at two fields in Poltava region is rich in propane-butane fraction. The potential is associated with drilling on these fields. Now we process everything that we extract. New technologies are also emerging that make it possible to more efficiently extract this fraction from the mixture. It is them that we introduce as part of the retrofitting program.
Macro-environment
— Your assessment of conditions for doing gas production business in Ukraine. What are you satisfied with and what could be changed?
— Over the past five years, the sector changed significantly in a positive direction. Liberalization has taken place in a number of ways starting with a simple cutting of rent in 2016. Then the so-called incentive rent for new wells was adopted, which was guaranteed for 5 years. Decentralization took place and some of the companies' rent payments are now going to local budgets. This helps to improve relations between hydrocarbon producers and local communities. Open tenders for licenses have appeared.
However, we would like to see more sustainability in initiatives. Every fiscal year, the question “where to get the money” is raised? And then suggestions arise: let's cancel the incentive rent or alter it... This is a very bad signal to investors.
— But you have the shareholder who is People's Deputy (MP) and who can resist this.
— There is always a civilized toolkit in lobbying available. We do this through a specialized Association that represents 90% of all gas production in Ukraine. Yet, even attempts to raise this question do not look very appropriate from the point of view of potential foreign investments in Ukraine. If the state promises something, it must do it. This business is a very capital-intensive one, very inert. It is not just about buying and selling. You enter a project the results of which may be achieved in five to ten years. That is why stability and predictability are very important.
— Are you developing using your own funds or are you bringing in external funding?
— Until now, we have been developing at our own expense. We are considering the possibility of intensifying our development program, our drilling program in particular. And in this context, we are looking at the possibilities of raising capital.
We compete for investor capital just like any other country. Therefore, we need to look at what is happening in other European countries, how they are trying to raise resources for their hydrocarbon production.
In addition to declarations that Ukraine wants to become an energy-independent state, it is necessary to take some concrete actions that will be consistent, sustainable and will take into account the competition for capital.