Natural gas supplies from Russia to Europe could be endangered if Naftogaz, Ukraine's state-run energy company, fails to strike a restructuring deal with its Eurobond holders by the end of September.
Naftogaz, an ailing behemoth from the Soviet era, is the key link in shipments of Russian gas to the European Union.
The government-run company has a $500 million Eurobond that matures Sept. 30 and is strapped for cash.
Ukraine's government said early August it wants to restructure Naftogaz's bonds. However, no proposal has appeared since, and some bondholders suggest that, given a massive external financial help from the E.U., Naftogaz is able to pay.
Bondholders and analysts are worried that time may be running out to restructure the deal in a manner that's acceptable to creditors.
The consequences, analysts say, could be dire, complicating Naftogaz's international transactions and, as a result, payments to Russian gas monopoly OAO Gazprom (GAZP.RS), which, as recently as January, showed its willingness to turn off the gas to its neighbor.
Should the bondholders find the restructuring unattractive, "likely Naftogaz's international accounts would be blocked by international courts", Maria Maiboroda, an analyst at Kiev-based Phoenix Capital said.
Naftogaz supplies its local market with Russian gas and also manages a pipeline through which the lion's share of Russian gas is shipped to the E.U.
Naftogaz's finances are under constant pressure, both from subsidizing the price of the Russian gas it sells domestic consumers and from nonpayment by those consumers.
Both Russian government officials and Gazprom have repeatedly questioned Naftogaz's ability to pay on time for gas deliveries. But Ukraine's Prime Minister Yulia Tymoshenko has repeatedly said that Naftogaz will pay Gazprom for gas in full and on time, and Ukrainian presidential energy advisor Bohdan Sokolovsky says dialog between the two companies remains "constructive."
Such a description can hardly be applied to the relationship between Naftogaz and some of its bondholders.
Corlblow Trade International Ltd, a Belize-registered holding company which owns roughly $11 million worth of the bonds, has set up a Naftogaz noteholders' action group and said it plans to block attempts by the Ukrainian company to restructure the debt.
Alexey Olshansky, Corlblow's director, said holders, representing $112 million worth of Naftogaz bonds supported the move.
The group will need to attract creditors representing over 25% of the debt in order to veto any restructuring offer. Olshansky said that although the creditors don't want to bankrupt Naftogaz, they would take legal action against both the Ukrainian government and the company if the restructuring failed and the bond went into default.
Olshansky says that Naftogaz has the money to repay the bond and has accused the company of being unwilling, rather than unable to pay.
He also said that, despite Naftogaz's claims that it has been in consultations with bondholders, he has only recently been contacted by Squire Capital, an adviser on the debt restructuring, and no substantive talks have yet been held.
Timur Khromaev, a partner at Squire Capital, said that only the largest bondholders had been met, for "non-public" discussions.
He declined to name those bondholders, and said Aug. 28 that proposals on restructuring will be announced within a week.
Naftogaz said it wanted to find an "investor-friendly" solution to restructuring the debt and is "analyzing ways to settle this issue."
But analysts and traders say they are puzzled by what those ways may be, and how far Naftogaz and the Ukrainian Finance Ministry, which is also involved in the issue, have proceeded with restructuring plans.
"We haven't heard of any restructuring terms", said Maria Maiboroda, an analyst from Phoenix Capital.
Neither has Luis Eduardo Costa, a debt strategist at Commerzbank, who said that it's "almost impossible to know who holds what part of the debt". He assumes that some Russian and Ukrainian investors could be the "substantial holders" Naftogaz is in talks with.
Nevertheless, he said that the whole restructuring process is "rather time-consuming" and time is running out.
He also said he believed that Naftogaz could pay back the bond. He assigned a 30% probability to a failure of the talks and subsequent repayment of the bonds, which are currently trading at between 80% to 85% of their face value.
However, Costa sees as equally possible a "doom scenario," when Naftogaz pushes bondholders towards unattractive restructuring terms with minimal levels of cash buyback, low coupon rates on the new bonds, and most importantly no explicit government support attached to the bond issue.
The degree of government commitment to Naftogaz's bonds is important for their salability. The government has supported Naftogaz through budget allocations, state bank bonds and non-direct guarantees. However, there are no explicit state guarantees on the company's bond.
"We've seen the government's statements and letters of comfort, but no guarantees," Alexey Olshansky, Corlblow's director said.
"The government has a right, but no obligation to pay-out Naftogaz's debt", Phoenix Capital's Maiboroda said.
A default, or an unfriendly restructuring, by Naftogaz would make it more difficult for Ukraine's government to tap international capital markets on its own account, since many investors regard Naftogaz debt as quasi-sovereign and held the paper as a proxy for state debt.
However, Fitch Ratings said early August, it would not view a forced debt restructuring of Naftogaz as a case of sovereign default, although the agency acknowledges there could be negative implications for investor sentiment towards the country.
Costa said that an investor-unfriendly forced restructuring would lead to litigation and a possible freeze of Naftogaz's assets overseas.
Naftogaz doesn't, in fact, have substantial assets outside Ukraine. But such a scenario, by complicating Naftogaz's international transactions, could affect payments to Gazprom. This problem, "could be resolved by involving local banks and other entities, although this would be a complicated solution", Maiboroda said.
However, the freeze would also complicate financial assistance from international financial institutions, and such assistance is crucial for cash-strapped Naftogaz. "We don't have internal financial resources to pay for gas, and need external help to pay for it and to repay the bonds", a person at Naftogaz said on condition of anonymity.
The European Commission and international financial institutions reached a deal with Ukraine at the end of July that offered the country some $1.7 billion in loans to pay its gas bills in return for a reform of Ukraine's gas sector. The rebel bondholders say that this money could be used to pay them, but the government has said it's needed to secure gas supplies.
Commertzbank's Costa reckons Naftogaz is more likely to restructure, "at not-so-glaring new coupon levels, but attaching an explicit government guarantee."
Rebel bondholder Olshansky said he would agree to restructuring were the new conditions "super-attractive" and had a state guarantee.
"It would be logical for the government, which wants to maintain a cordial relationship with the E.U., to offer attractive restructuring terms or even to pay back the principal on time," said Phoenix Capital's Maiboroda. However, "it's not clear that the government will follow the rational and logical way," to resolve the bonds issue, he said.