Andrew Favorov: Now is not the time to catch the falling knife

Former head of gas division of Naftogaz of Ukraine, Andrew Favorov told about reasons for leaving Naftogaz, the fate of Tryzub gas production development program, awards at Kirovohradgaz, prospects for global gas production and Ukrainian energy sector in an interview for Kosatka.Media.

- Mr. Favorov, how do you spend time during quarantine?

 - I have a great time. I master the technique of piloting a helicopter. Today I have flown, even though with an instructor.

 - Are you going to replenish the vehicle fleet with a personal helicopter?

It’s more convenient for me to rent a prepared and refueled one. For example, if you do not check the oil level in the bearing, you will demolish the tail rotor and then pay a fortune to fix it. Let professionals check everything better and I will just rent it.

- What are you going to do after quarantine?

- On Facebook I post phrases about trading which I like. The principle of "do not try to catch the falling knife" is a perfect match for 2020. Making decisions now is foolish and premature. There are three huge unknown variables that will largely determine the vector of global development for the next 4-5 years.

First one is that we must understand the depth and danger of this coronavirus: what is the real level of mortality, when normal tests appear, when quarantine ends, will there be a second wave.

Next important unknown variable is the economic impact of the pandemic. If we talk about oil and gas markets, I think that large investment projects can be written off there.

The third key factor is the election of the President of the United States in November. It is clear that the vector of international politics will change, depending on who wins – Republicans or Democrats, which is 20% of the global economy.

Therefore, I see the year of 2020 as an opportunity to hit the reset button and bethink of who I am and what I like. I have been working constantly for the past 30 years, always in a hurry somewhere. And all my wishes, for example, to learn to fly, run a half marathon, were put on a waiting. And it seems to me that it is a great time for later, will we have such an opportunity again? It is unknown.

- Your unexpected resignation from the post of director of the gas division was actively discussed in social networks. How did everything really happen?

- NJSC Naftogaz decided to change the direction and management strategy of the company. It was not interesting for me and I quit.

- So simple?

- Reality is simpler than conspiracy theories. At the beginning of this year, we developed a strategy for the greatest work efficiency – to make decisions as close to the bore well as possible. I do not believe that being in Kyiv you can effectively manage a company whose assets are scattered throughout the country. There is not a single bore well in the capital, they are all located in the regions, and decisions must be made there.  

The new management model recreates the matrix structure, I do not believe in its effectiveness. It takes away managerial resources from the head, turning him into pure functionality. In 15 years I have been working in the energy sector, I have never seen an effective work of a matrix. And I am an ambitious person, I have never hidden this, I like to achieve my goals. When I see that I do not have tools for this, as a responsible leader, I file for voluntary leave. That’s exactly what I did.

I have never been interested in a high position itself, I am interested in the scale of problems and tasks that can be solved by being in the position. But it is foolish to take responsibility without having the authority to achieve a result. And when the situation got to this point, I quit. People who worked with me continue to work. This is not an issue of an individual, it is an issue of the company’s success. And the company belongs to shareholders – citizens of Ukraine.

On the other hand, this shows which development path NJSC Naftogaz has passed. No one could even think about how to voluntarily leave such a powerful state-owned company five years ago. People left Naftogaz only for the final journey. Today, the corporation has reached the level when professionals may disagree with the direction of the company’s development and leave it in order to realize themselves in another project.

- Was it difficult to make this decision?

- We discussed a lot about the new development strategy of the company with Naftogaz CEO Andriy Kobolyev and the new Chief Transformation officer Otto Waterlander. But we were not able to find a compromise solution.

Naftogaz still has a strong team of professionals and it will continue to develop. I may not agree with the new strategy, but this does not mean that they will not succeed. I see that Naftogaz is one of the few energy companies that sincerely supports the business and is trying to find ultimate solution to the accumulated problems.

- Have you been offered a position in a new structure?

- Yes, I was offered to head the commercial line. But I have been doing it for the last 15 years, this is a passed stage in my career. I started from this line at AES, created it in DTEK, stood at the origins of the ERU Group, and moved to Naftogaz precisely because I was interested in the scale of the task, the level of challenge. I believe that today Naftogaz has such people as Maksym Rabinovich or Iryna Mykhailenko, who will do better.

ABOUT 20/20 PROGRAM, TRYZUB, EXPERT PETROLEUM AND COMPETITION

 - Mr. Favorov, after leaving Naftogaz, did you have a new answer to the question about the reasons for the failure of the 20/20 program?

- The 20/20 program had been written and approved several years before I joined the company. And Mr. Vitrenko began to implement it, he oversaw the development of Ukrgasvydobuvannya. But Andrew Favorov, who came and said that this program was completely absurd and had to be thrown into the trash 3-4 years ago, was to blame for the failure.

Bad input data gives poor results. The introductory assumptions which were the basis of 20/20 program were completely inaccurate. In addition, the government completely ignored its obligations to issue licenses; there were others who wanted to. And if you do not have a license, you will have no reserves, and no production. I did not complete the 20/20 program as well as I destroyed it. It was populism and wishful thinking. And I am proud that I was the first who was not afraid to stand up and say that this was nonsense, in no way connected with reality.

- The new Tryzub production expansion program was introduced just a couple of months ago. Will its implementation continue after your resignation?

- Yes, according to public statements, Naftogaz intends to continue the development of this direction.

The main fundamental problem of Ukrainian production – all the best were collected before us. Our key fields, which are located in the Dnieper-Donetsk Depression, have been exploited since the late 50s of the last century. According to various estimates, about 500 billion cubic meters are commercially rationally recoverable there. We extract about 5-6% of this volume per year, give or take 20 billion cubic meters. Squeezing more is difficult and expensive.

It is necessary to increase not production, but the amount of reserves on the balance, from which it will be possible to gain additionally over the time. There is a need to find a new Shebelinka to know where to extract when prices begin to rise again. And sooner or later they will go back.

Now there is no future in Ukraine. No one knows where to develop further beyond the Dnieper-Donets Basin. We can continue to drill there, but we reduce what we have, and not increase our reserves. Therefore, the Tryzub program must be continued today. It is better to invest in prospecting for reserves, not in increasing production today. Successful exploration of superdeeps at three eights is 200-300 billion cubic meters of additional reserves, which can be obtained in 5-10 years, when prices recover. Investments in Dolphin will result in up to a trillion cubic meters, in Svyatohorka – up to 100 billion. And this must be done now. Not because they will give production, but because they will give the future of our industry.

These are difficult decisions. It is much easier to solve the tasks of fulfilling the plan and receiving bonuses. If you think in the range of one year, then people make decisions on the implementation of only short-term tasks. But it can’t go on like this for a long time, we are avoiding problems, but not solving them. It must be honestly acknowledged that the Dnieper-Donetsk history, which has continued for the past 70 years, is over. At best, it will give Ukraine about 20 billion a year. But there will be no breakthrough. It is necessary to look for another 700-800 billion of reserves, in order to increase production later.

And I am proud of the team that, last summer, foreseeing the development of events, made a lot of difficult decisions to limit drilling. This helped to save hundreds of millions of dollars that were not spent on the production of gas unnecessary today.

- But the drillers did not agree with you...

- Yes, I took a rather tough stand on investments in new drilling. My leadership set me the task of maximizing repayments for shareholders. We carefully analyzed and calculated everything: taking into account unsuccessful, emergency bore wells, full costs, many investments became economically inexpedient. They did not pay off in 7-10 years at a price of $250-300, and at the current price of $100-120 they will never pay off. No such bore wells are needed.

And yes, the drilling program was comprehensively reviewed last summer, and will still be reviewed. Now private traders will stop drilling also. No one will drill new bore wells at such prices. Now it’s more profitable to have money than gas.

At the same time, together with Andriy Khomenko and colleagues from the technical division, we reduced drilling for external contractors by 80%. New machines were delivered – equipment that will allow Ukrburgaz to compete in speed and quality of drilling with external contractors.

In addition, I actively promoted the idea to put up for a tender all our orders, and to give an opportunity for Ukrburgaz to take part in it on a par with private companies. You can you get the best and objective measurements of the quality of your work only in competition. When everything is dumped into one boiler, and this is the problem of UGV, when geologists and drillers, the owner of the license, and the contractor are all there, this is an old Soviet legacy.

Why was the idea of ​​divisions, in fact, correct? There is a technical division – a contractor, and there is an integrated division – a customer. The customer determines where to drill, how to drill, and transfers this order for execution to the technical division. But if the customer does not have the right to say that something does not suit him, that he wants to enter the market and place an order for the tender, then the integrated division will not receive the quality of service that will make it competitive on a par with private companies, but the contractor will lose motivation to provide quality services – the customer will not disappear anywhere.

- A week ago it became known that the leadership of Ukrburgaz had changed in. But director Serhiy Skyba did not announce the reasons of his quit.

- I believe that it is a big loss for the company. Mr. Skyba was a high-level leader. He delved deeply into the problems, looking for not guilty, but solutions. Regarding the reasons, I think that in the process of transformation of management, many people who do not agree with the matrix structure will seek themselves in the labor market. And it is okay.

- Let's go back to the Tryzub program. The intensification of production at old fields was not mentioned in it as a priority. Now Naftogaz is talking about a partnership with Expert Petroleum.

- UGV has a large number of depleted fields in Lviv, Poltava, and Shebelinka. And Expert Petroleum has a real success story in Romania, where they increased production in old depleted fields. As part of the tender, it won three other options. Now a couple of divisions of Lvivgazdobycha will be controlled by them. Production remains on the UGV’s balance sheet so our economic interests are respected. And I will be very happy if UGV can learn something from Expert Petroleum, apply their experience in its fields.

- What is the commercial interest for Expert Petroleum?

- They see an opportunity for successful investment, they see an opportunity to earn. And there’s nothing wrong with that. Expert Petroleum does not take away a piece of the pie from UGМ, it increases the pie itself. In this case, the win-win strategy works.

ABOUT RELATIONS WITH MR. VITRENKO, MR. FIRTASH AND GAS DISTRIBUTION COMPANIES

- The conflict between Naftogaz management is not a secret. At first, these were the disagreements between Yurii Vitrenko and Andriy Kobolyev, but recently Mr. Vitrenko does not miss the opportunity to address the grievances to you in social networks. Don’t you have a desire to make any statement?

- Mr. Vitrenko’s defiant behavior was shocking from the very beginning of my work at Naftogaz. You do not agree with the decisions of the Supervisory Board, with the decisions of the Director General, so quit and then say whatever you want.

And to respond to the attacks of this person in social networks is to discredit himself. I do not want to get into an argument with this Oedipus complex. However, now I do not have to restrain myself and I can express everything that I think about him and his approach.

He reproaches me for the lack of professional expertise. But I’ve been in the energy sector for more than 15 years, I have worked in various countries. When my company, ERU, traded in technology to enhance gas production, I traveled all over our gas producing regions. And that was long before I thought about moving to Naftogaz.

Again, I’ve never said that I am an expert in production, I am an expert in process management in the energy sector. I entrusted the technological part to the specialist – executive director of UGV Steve Baldwin, who has 35 years of experience as the general and executive director of oil and gas companies. Steve worked in Kazakhstan, in Argentina, in Mexico, USA. I relied on him as a key technical expert, and never regretted it.

Mr. Vitrenko accuses me of some flaws while he protected lies about the growth of production volumes. Let me remind you that in 2016 we had 0.5 billion cubic meters of technical loss, and 1.4 billion in 2018. So, production was not increased, production was finished painting! People in the company were sitting and thinking how much we needed in order to fulfill the plan and get bonuses, and draw as much. By the way, I fired many of them. But nothing has been done to really solve the problem.

I removed his lie on gross gas production, kept the production of marketable gas at the same level as last year, and increased the production of liquefied gas by 20-25%. And this is commercial gas!

- Recently Mr. Vitrenko accused you of easing pressure on gas distribution companies; you allegedly had “comfortable” relations with Dmytro Firtash’s group. What is your relationship to the oligarch?

- I have never met Mr. Firtash. Representatives of the RGC discussed real problems with me. It doesn’t matter whether we like this company or not, but it is the largest gas consumer in the country. And the largest producer needed to build a dialogue in order to sell its gas.

The company has systemic problems that arose at a time when, for political reasons, before the election, distribution tariffs were lowered and did not reflect the total cost of gas distribution companies. RGС has debts to Naftogaz and this money have to be received. And this decision should begin with regulatory decisions, which were adopted by the new NEURC.

The level of payments was at the same level as before me. I could not give out any concessions to RGC, because the PSO regime introduced by the government is still operating on the gas market. The Cabinet of Ministers determines the methodology for setting the price of gas, and we are obliged to calculate the price using it and provide it to RGC. And if gas distrribution companies reach a certain level of payments established by the Cabinet, Naftogaz has no right to turn them off. Where they do not, Naftogaz tries to suspend supplies. But, for example, you can’t simply turn off Luhansk TPP, although it does not pay.

- Does Naftogaz have the prospect of getting debts from RGC?

- Yes, it may well be true. I think this discussion will end successfully. But one must understand that the essence of the problem is too low tariffs of previous periods, which did not cover the cost of gas used for the technological needs of the company. You can argue to what level, but there is one systemic problem. And potential solutions are being discussed.

ABOUT PSO CANCELLATION AND NAFTOGAZ EXCHANGE

- Currently, the issue of ending the PSO mode is being actively debated. In your opinion, is the market ready for this?

- A complex, complicated question. Many market participants want to compete for the end consumer. And that’s okay. Aggregation of many end-users is a big trading position around which you can optimize: offer good market prices for the consumer, and at the same time find additional ways to earn money for the company.

But there is a limitation. A consumer moving from one company to another must bring a certificate of absence of debt. Current supplier companies will drag out this process by any means, maintaining their quasi-monopoly. In Europe, it took up to 10 years, while private companies gained the opportunity to compete on equal terms with the former monopolies. We felt this in the experience of the new product – Gas reserve. Yes, a large number of customers came, but it was not easy. Especially when they later tried to completely switch to receiving gas supply services from Naftogaz.

The PSO mode will end sooner or later, prices will reach the market level. But now the price on the market is so good that potential suppliers will fight for the consumer. If the Regulator responds correctly, it seems to me that it is competent enough now, it hears both the consumer and the market, then the battle for the client in the spirit of the “gold rush” awaits us. The struggle between gas suppliers will be very aggressive, which means that all of us, as consumers, will benefit from this.

- How far has the idea of ​​creating your own Naftogaz exchange progressed?

- This strategic direction of development was approved by the Supervisory Board of the company, and it seems to me that the role of Naftogaz is not to be a market participant, but its facilitator. Figuratively speaking, you can go to the casino, or you can open a casino. Naftogaz should have the opportunity to open an exchange, bid for both purchase and sale, for any product at any time. This will allow the liquid market to start working. Now market participants are afraid that they will buy gas, but they will not find a buyer. And if Naftogaz comes out every day and announces the price at which it buys and the price at which it sells, this will be a big signal for the development of the market.

I hope it will happen, my colleagues will continue to develop this area. Naftogaz was successful on the exchange, the volume of trades that we did was quite large. Especially compared to the previous strategy, when Mr. Vitrenko appointed a person with zero experience in the energy sector the director of Naftogaz Trading. As a result, the company suffered damage of UAH 300 million.

ABOUT THE TRADER’S DARK MARK AND AWARDS IN KIROVOHRADGAZ

- As everyone knows, former head of Naftogaz Trading Vitalii Volynets accused you of corruption. Aren’t afraid that your statement will be deemed revenge?

- The main rule in trading is that before you earn, don’t lose, but UAH 300 million is a very big loss for any company on the market. And it’s not okay that the weakest trader worked for the largest company on the market. Such an employee in any trading company would get a dark mark forever, he would never found a job in the energy sector... But here we can say that this is a normal situation, and the dismissal was unfair.

I also want to talk about the situation with Kirovohradgaz. Mr. Vitrenko is proud that the head of Kirovohradgaz was selected through a competition. As soon as he took office, he immediately began to write a prize, without coordinating it with anyone. Auditors of Naftogaz were not allowed to enter the enterprise, the prepayment for the meters was made without a contract, and the "dead souls" were simply washed away by the consumption of other residents. According to the findings of the Audit Commission, at the end of 2018, the amount of net loss amounted to UAH 184 million, and for the 9 months of 2019 – UAH 213 million! Now a criminal investigation has been opened.

 ABOUT THE PAINFUL PRESENT AND OPTIMISTIC FUTURE

- Forecasts today are difficult to make. But nevertheless, in your opinion, what to expect both in Ukraine and in the industry as a whole in the next five years?

- Gas is considered a strategic type of fuel now. The world is moving from dirty fuels to clean renewable sources, and flexible fuels, relatively environmentally friendly to help solve the problem of balancing the energy system. Gas power is highly maneuverable, so they have a great future in the electric power industry. Therefore, strategically, I believe that gas will be one of the main types of fuel in the world for the next 20-30 years.

As for the medium term, there will be an excess of gas the next 3-5 years in the world market. Russian Gazprom continues to supply large volumes and is not going to stop. The technological revolution and the construction of LNG terminals brought American gas to the market. Plus, everyone was preparing for a cold winter in Europe if Ukraine had not signed a contract with Gazprom. Winter was canceled, the contract was signed – all European storages are filled with gas to the eyeballs. And this is a huge opportunity for Ukrainian gas storages, we see that many traders pump surplus gas to us, hoping to sell it in the winter.

But no one will drill anything new in Ukraine at such prices,. It is not economically feasible. I see no prerequisites for increasing demand, respectively, and price. Moreover, I think that Gazprom will try to regain the Ukrainian market, and will begin to sell large volumes on the eastern border, which will lower the price even more.

The maximum that I see for the next 2-3 years is $100-120, which will entail a very sharp reduction in investment, a series of bankruptcies in the United States, and equipment will become much cheaper. Then the market will “digest” the excess volumes and we will return to the range of $240-250.

- And how will private companies survive the crisis? Who can survive?

- The times are not easy. The world is changing and the industry must pass the moment of truth. I do not consider this a crisis, it seems to me - this is a process of purification that will help strong and efficient companies win.

At the same time, I am an optimist, and I am firmly convinced that Ukraine has enormous potential in gas production. You only need to learn how to make complex management decisions, think strategically, and not tactically, to achieve your goals. And do not explain to the next Minister of Energy or the Prime Minister why you did not reach them. It takes courage to make decisions.

- There is a shortage of complex management decisions and the courage to make them in the Ukrainian energy sector. What can it lead to?

- The problems of the Ukrainian energy sector have not been solved for the last 20 years, they were bashfully pushed under the carpet, until better times. Our economy is accustomed to being subsidized by two energy donors – Energoatom and Ukrgazvydobuvannya. But, if there is a huge step forward at Naftogaz –PSO is dying, and the owners of the company will receive a real market price, then nuclear engineers are doing badly. The things as bad with coal miners also – in a world flooded with cheap gas, it is expensive and dangerous to mine coal. Today, not a single coal mine can be profitable. It seems to me that the principle of medical sorting is appropriate for a large flow of patients – we treat those who have a chance to get out. Those mines that are still profitable, let them work, but close them within five to ten years. And those who are unprofitable today must be let go. And I pay tribute to the courage of Oleksiy Orzhel, who stood up and said unpopular things, advising the children of miners to learn new professions.

Today, the scarcest resource in the Ukrainian energy sector is a leader who has the courage to force the authorities to make difficult, unpleasant decisions. It is necessary to raise tariffs – it is politically painful, but in a different way it is impossible. It is necessary to give Energoatom the opportunity to sell its energy on market conditions so that it has funds for full repairs, to corporate it, perhaps to attract an investor. Energoatom is extremely important for our economy, and we cannot let it die.

- It is necessary to solve the problem with feed-in tariffs to support Energoatom...

- It will hurt someone. This is a political issue, but this situation cannot last forever. Our economy cannot afford such expensive electricity. Therefore, either we force the whole country to pay more for electricity than all our neighbors, and the entire energy-intensive business escapes to them, or investors will have to make some concessions. Yes, you may have to go to court. Southern Europe has already come this way. But it can’t go on like this; the situation will finally be resolved. The only question is how: through a social explosion, when the power engineers are left without salaries, or through unpleasant, but systemic solutions.

Tags: The Cabinet of Ministers, gas, Naftogaz, Ukrgazvydobuvannya, gas production

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