The ratings agency said the Outlooks for the IDRs remained Negative and the senior unsecured rating on the company's $500 million Eurobond maturing in 2007 had also been downgraded to 'B+' from 'BB-'.
"The downgrade reflects expectations that Naftogaz could be facing a serious liquidity constraint as the company seeks to cope with rising natural gas costs in a regulated domestic price environment," Fitch said.
The ratings agency said the Ukrainian government had begun looking into Naftogaz's accounting practices amid claims that first quarter losses in 2006 were between $500 million, according to Naftogaz Board Chairman Oleksiy Ivchenko, and $660 million, according to the Fuel and Energy Ministry.
Fitch said company expectations were that losses could be as high as $1.5 billion in fiscal year 2006. Naftogaz's EBITDA totaled $1.24 billion in 2004.
The agency also said the government had refused to sign off on Naftogaz's financial plan for 2006. The government had demanded instead that Naftogaz scale back spending on a number of foreign projects, rather than allow price increases on gas supplied to domestic households, in order for the company to conserve cash. At the same time, Fitch said the Finance Ministry was claiming that Naftogaz had tax arrears of $118 million.
Naftogaz's tax burden increased by 90% in 2005, while income grew by 11.7% over the same period, as measured under Ukrainian GAAP.
Fitch cited press reports as a form of additional concerns that Naftogaz had accumulated debts of around $700 million for natural gas supplied by Rosukrenergo, a gas transportation company 50% of which is owned by a subsidiary of Russian energy giant Gazprom with the other 50% held by Austria's Raiffeisen Bank, in February and March, after Naftogaz was forced to sell gas in the domestic market at prices lower than the acquisition price.
As a result, out of the reported 11 billion cubic meters of gas supplied in Q1 2006 to Naftogaz, only 4 billion cm was paid for, which in turn caused Rosukrenergo to cut its supplies to 50% of the previously agreed volumes.
Fitch said the Outlook remained Negative, reflecting concerns over potential price increases for Ukraine to import gas. Under the current agreement with Gazprom (BB+/Stable), transportation tariffs through Ukraine are fixed for five years, whereas gas prices for Ukraine could be reviewed every six months.
The Fitch report said the next review would come on July 1, 2006, which effectively put a cap on Naftogaz's ability to recover any additional gas cost increases from Gazprom and could place additional downward pressure on Naftogaz's ratings. An additional rating downgrade would likely result from an inability to adequately offset rising costs, resulting in a further deterioration of the company's key cash flow and leverage ratios.
Fitch said it was starting to question the degree of state support for Naftogaz, despite its 100% state-ownership, as relations between Naftogaz and the Finance Ministry have become contentious with Naftogaz laying the blame for any potential disruptions to gas imports on the government.
The ratings agency said the Outlook could return to Stable if Naftogaz were able to demonstrate an ability to offset rising natural gas costs either through a renegotiation in prices, an increase in transportation tariffs or an ability to pass on these costs to domestic end-users.
