Can’t pay, won’t pay!

Bulgargaz on the ropes

Bulgarian state-owned gas trader Bulgargaz has recently missed a payment under its controversial LNG-focused 2022 contract with Turkey’s BOTAŞ and says it won’t be able to make future payments. A showdown is impending and the stakes are high. BOTAŞ seems to be standing firm on the question of USD 2 billion in future revenues implied by the contract – and the very existence of Bulgargaz is potentially in doubt. But the stakes may be even higher. The repercussions for powerful sections of Bulgaria’s political class could be serious, while the travails of Bulgargaz could prove to be part of an end-game that will see the final touches put to the ambitious “Turkish Gas Hub” scheme.

To hardly anybody’s surprise, it seems that Bulgaria’s state-owned national gas trader Bulgargaz is in a lot of trouble.

On July 4, it has since emerged, its management sent a letter, referred to in the reply by Turkish oil and gas giant BOTAŞ – also state-owned – announcing that it would be unable to pay that month’s invoice for USD 15 million. This was due under a controversial agreement between the two companies dating from December 2022, primarily covering deliveries to Turkish regasification terminals of liquefied natural gas (LNG) destined for Bulgargaz and its subsequent transit to the Bulgarian border.

This inability to pay was due to “market changes”, said Bulgargaz, and these also precluded payments in future. The situation was urgent, the gas trader implied, calling for flexibility and adjustment on BOTAŞ’ part.

Malinov to the rescue?

BOTAŞ’ reply – which followed in mid-July and whose text, unlike the Bulgargaz letter, is publicly available – indicated precious little flexibility on the Turkish side. Vladimir Malinov, the hitherto “Teflon” technocrat currently serving as Bulgaria’s caretaker energy minister, seems to have moved into crisis mode, assuring parliament that he could negotiate his way out of the situation and making an urgent call on August 7 to his counterpart, Alparslan Bayraktar, Turkey’s Minister of Energy and Natural Resources. A new meeting is scheduled on August 15, when a BOTAŞ delegation will visit Bulgaria for contract negotiations.

There’s a lot at stake. In effect, Bulgargaz is facing insolvency and bankruptcy, unless there is a substantial cash injection from the state, accompanied by a review of the agreement responsible for the situation. Its balance sheet is a mess, especially if normal accounting standards are applied to payments under that agreement. Whether Mr Malinov’s energy diplomacy will succeed in such a dire situation remains to be seen.

If it doesn’t, his reputation and career could be on the line. Though his job title until recently had been CEO of Bulgartransgaz, Bulgaria’s gas transmission system operator (TSO), he has in practice functioned as the gas sector’s ultimate and indispensable strategist, policy architect, and technical insider, shaping its direction in the service of top politicians. He’s also been the sectoral diplomat and deal-maker. In this capacity he masterminded the Turk Stream project, for instance, and has recently been a key figure in helping Russia and Turkey craft the EU extension of the Turkish Gas Hub as a device to smuggle Russian gas into Europe as part of a “Turkish mix”.

Broad policies – policies, it must be said, that have generally made poor Bulgargaz the “fall guy” – have been his, and their failure will be seen as his failure. Likewise, failure to deliver diplomatically will call his place in the scheme of things into question: energy diplomacy, after all, is his forte.

But he’s not the only one under threat. Look back to December 2022 and you’ll see that there was intervention and diplomacy at the highest political level involved in the process. Bulgarian state president Rumen Radev – the country’s effective ruler in a situation of political deadlock where there was no regular government – hob-nobbed with his Turkish counterpart Recep Tayyip Erdogan in the process of putting the agreement together. And whoever was calling the shots in determining the content of that agreement it assuredly wasn’t the hapless management of Bulgargaz.

Home to roost?

Recent developments may mean the chickens are coming home to roost for Mr Radev. But said chickens have been clucking discontentedly for some time.

For a start, there’s a somewhat surprising rooster in the shape of Magnitsky-sanctioned businessman-cum-politician Delyan Peevski. After long years during which he, Mr Radev and former prime minister Boyko Borissov observed a tacit non-aggression pact in matters of business and sleaze, Mr Peevski has taken to denouncing the energy business dealings of the president – or “Mr Cash”, as he likes to call him.

Then there’s the Special Investigation Commission on the Bulgargaz-BOTAŞ contract set up in December last year by the National Assembly (Bulgaria’s parliament). This reported in April this year and the report was pretty scathing about the contract. Furthermore, it recommended that the information and data in the report should be sent to the General Prosecutor’s Office and the State Agency for National Security for further investigation.

And accountants as well as politicians have been having their say. The international firm Grant Thornton’s audit report on the financial statements of Bulgargaz for 2023 – available online since end-June this year – doesn’t make pleasant reading.

Specifically, and not to get too technical, that report states unequivocally that Bulgargaz management’s attempt to categorise the Bulgargaz-BOTAŞ agreement as a “non-encumbering contract” is untenable. That’s a categorisation under International Accounting Standard (IAS) 37, which deals with “Provisions, Contingent Liabilities, and Contingent Assets”. No, says the audit report: this contract exhibits the characteristics of a “burdensome contract” because the unavoidable costs of fulfilling the contract’s obligations exceed the expected economic benefits. That makes a big difference to the company’s books, since it affects how current obligations are measured for provisioning purposes.

In more concrete terms, this is mostly concerned with the accounting treatment of an advance payment of BGN 307 million to BOTAŞ specified in the agreement and actually made in April 2023. Grant Thornton’s point is, effectively, that classifying the contract as “non-encumbering” is an accounting manoeuvre to obscure the extent of the losses made by Bulgargaz in 2023. That extent becomes visible if accounting standards are followed properly: specifically, this payment then increases the loss by BGN 189 million to BGN 247 million. Which is important because it means the loss exceeds the company’s registered share capital by a substantial margin. And that would mean Bulgargaz is, in legal terms, insolvent.

Nor is that July non-payment to BOTAŞ a one-off event. The contract obliges Bulgargaz to make payments for its whole duration whose minimum amount is not dependent on the amount of LNG it actually imports or the money it makes from doing so. True, they are monthly payments rather than annual advance sums, but they add up to over $2.3 billion of revenue for Botas over the contract’s 13 years. And it’s these payments that Bulgargaz is already finding it impossible to pay.

The lamentations of BOTAŞ

Meanwhile, as noted above, BOTAŞ’ letter of reply to Bulgargaz suggests the Turkish company isn’t in a very forgiving mood. Its complaints are numerous. And, though the Bulgargaz letter has not been published and its content must be inferred from what BOTAŞ says, it looks very much as if Bulgargaz is in an extremely weak position.

The primary message from the Turkish side is clear from the letter: we will not agree to any changes that could jeopardise the security of the $2.3 billion projected revenues from this 13-year contract. To put it bluntly, Bulgargaz is being told, if you want us to alter the terms, you must offer something of equivalent benefit in return. One potential explanation for this stance is that these anticipated future revenues are linked to already past or pending future off-market “wheel oiling” expenditures by BOTAŞ, which logically explains why the signed contract is so one-sided and impossible to amend. That is, the relevant costs have already been incurred by BOTAŞ, which is loth to put itself at a disadvantage by allowing the future revenues that will recoup these costs to be imperilled.

Besides this, BOTAŞ’s letter indicates considerable vexation at the fact that no full contract has yet been signed. A little explanation is in order. We have have been talking loosely so far of a “contract”, but the document actually signed in December 2022 was a “Term Sheet” – that is, a bullet-point document outlining the material terms and conditions of a potential business agreement, which establishes the basis for future negotiations between a seller and buyer. It was meant to be finalised into a full contract, said BOTAŞ in its letter, which claimed that it had already provided a draft in February 2023, but that Bulgargaz had never responded.

If this is true, it’s a matter of guesswork why – perhaps management’s understandable reluctance to make such a cash-draining agreement more final than it already was. But it makes little difference, beyond annoying BOTAŞ. The Term Sheet was signed; the advance payment was made with reference to the signed Term Sheet as the basis for payment; and a Council of Ministers (government) decision was taken effectively approving the contract’s signing. So Bulgargaz’s case in an arbitration court doesn’t seem strong.

Another BOTAŞ gripe is that, in the July 4 letter, Bulgargaz referred to changes in the natural gas market that could lead to its inability to continue making the monthly fixed obligatory payments without clearly defining what those changes were. If that is true – and it’s hard to imagine BOTAŞ saying so unless it were mostly true – it probably reflects an interesting degree of disarray and haste at Bulgargaz HQ as the payment was missed. We might of course engage is some educated guessing as to what those market changes could consist of. My guess would be gas price dumping by Russia’s Gazprom, which has made LNG supplies, the core of the contract, uncompetitive.

One final complaint from BOTAŞ is interesting: that Bulgargaz has allowed the contract and the surrounding issues to become topics of public debate – most notably, discussion by a parliamentary committee – thus breaching the confidentiality clause. Most importantly, alleges BOTAŞ’ letter, Bulgargaz has made key parts of the contract public. Even revealing that it had sent that July 4 letter seems to have been an offence on the part of Bulgargaz, in BOTAŞ’ eyes. The Turkish company clearly prefers secrecy. As well it might, as the deal is being investigated by the European Commission (EC) and, some would say, since the Term Sheet – itself officially unpublished and, indeed, a commercial secret, though in fact circulating unofficially but widely since February 2023 – contains questionable clauses that raise suspicions of hidden agreements and could damage the company’s reputation.

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So where does all that leave Bulgargaz and the dispute generally? That’s a little equivocal.

Bulgargaz: an absurd situation

On the one hand, as far as the agreement embodied in the Term Sheet is concerned, Bulgargaz is in a ludicrously difficult position and has nothing obvious to hope for.

The Term Sheet grants BOTAŞ unilateral and nearly indisputable advantages, while giving Bulgargaz almost no opportunities to address imbalances, that are detrimental to its interests. The gas trader’s capacity to protect its interests in the event of adverse market developments is so restricted as to be effectively non-existent. In fact, there are no conceivable scenarios in which this contract could be favourable for Bulgargaz. And that is especially true given a development noted by A&A in July, namely a sizeable drop, in the last few months, in the prices of Russian (or “Turkish mix”) natural gas delivered by pipeline, which has made importing LNG unprofitable. LNG imports are, after all, the primary subject of the contract with BOTAŞ. And if little or no LNG is being imported, it’s not much of a revenue source for Bulgargaz.

This situation, of course, is no accident. It has arisen with the complicity of the top Bulgarian state politicians who consented to this absurd contract.

And let’s just dwell on the absurdity for a bit. The agreement was ill-conceived, ill-executed and, worst of all, devoid of any ideas of risk identification and risk management. It involved a lethal combination of certain costs and uncertain benefits. The general rule, in such contracts, is that the terms of a capacity engagement contract should be related to identical terms in a supply contact, with supply taking the primary role and the LNG discharge and transmission contract naturally being secondary. Not in this case: supply was simply ignored. Absurd, as I say.

The politicians need to answer for this. But so, perhaps, does Mr Malinov. He was the “adult in the room” who couldn’t have failed to see the absurdity. As “chief engineer” of the gas sector, with clout far beyond Bulgartransgaz, he could have come up with something more sensible. But he lured the politicians into a trap and let the absurdity happen anyway.

The bigger picture

On the other hand, Bulgaria as a country – as opposed to Bulgargaz as a company – is in a strong position as the main transit country for natural gas flowing from Turkey. BOTAŞ has significant ambitions to export increasing volumes of natural gas, a goal that cannot be achieved without Bulgaria’s involvement in entry, transmission, storage, and exit capacities. It’s not fanciful to speculate that the current exchange of “pleasantries” between BOTAŞ and Bulgargaz may serve as prelude to a new phase of transactional diplomacy. This could allow Turkey to realise greater revenues from increased natural gas exports, thereby offsetting the “losses” that would arise from a partial or full revision of the BOTAŞ contract – a revision which is essential if Bulgargaz is to survive.

And it’s even possible that this was the plan from the start, that LNG was seen as a side-show, and that the Term Sheet – drafted after significant interventions by presidents, prime ministers, and energy ministers – was designed to put Bulgargaz in a disadvantageous position that would force future Bulgarian governments to be helpful in the area that really mattered to Ankara, namely Turkey’s development as a pipeline gas hub. This notion involves a certain amount of speculation, of course. But stranger and more devious things have happened.

Moreover, if the “bigger picture” and not just the Term Sheet is considered, even the position of Bulgargaz may not be quite hopeless. For the EU is a key and up until now a strangely missing element in that bigger picture. The dispute with BOTAŞ and Turkey needs to be addressed in a European context and with the involvement of the EC – which has yet to rule on the conformity of this Term Sheet with European law.

But the process may not be an edifying one. To enhance the prospects of an acceptable outcome for Bulgargaz, an uncomfortable amount of dirty laundry will need to be aired in public. All the factors that contributed to the signing of this contract would need to be swiftly identified and documented. That would mean looking closely at goings on within the executive branch, the legislature, and the presidency, with particular focus on the energy ministry – and on Bulgargaz itself.

Now, the difficulties of investigating and holding accountable those in Bulgaria responsible for the current parlous situation of Bulgargaz should not be underestimated. Investigations will face difficulties at every stage. This is guaranteed by the fact that Bulgaria’s general prosecutor’s office is severely compromised and that numerous high-ranking officials have so much to hide. But the process of investigation could in itself lead to substantial reputational damage to President Radev and his “dream caretaker government team” – which would be all to the good.

And, ironically, some hope may lie in Ankara: investigations that could lead to indictments, thus presenting this case as an example of grand corruption of EU-wide significance, may pose a considerable reputational risk for Turkey and President Erdogan, especially if the contract itself comes under that sort of scrutiny. And this might compel Ankara to seek a resolution.

The way out

So how will things turn out? Well, there seem to be a lot of ingredients for an Apocalypse here. These could be End Times for Bulgargaz, which might logically face bankruptcy. The fact that the contract was approved and guaranteed by Bulgaria’s Council of Ministers means that, even if Bulgargaz declared insolvency and BOTAŞ decided to terminate rather than salvage the contract, the Turkish company could probably count on receiving the planned revenues, either in whole or in substantial part – at the expense of Bulgaria’s treasury.

But somehow I’m not expecting Armageddon. This is a contract between top-level politicians, involving two state-owned companies. And the logic of such contracts is that, when they hit trouble, they are not cancelled or sent to arbitration, but built on. That is, the contract is modified, supplemented and morphed into a new deal.

In this case, Bulgargaz could sell its capacity access rights under the contract to third parties or, more likely, BOTAŞ could trade concessions on the contract for an increase in the capacity of the Strandzha gas entry point into Bulgaria, given Turkey’s growing ambitions to serve as a gateway to the EU for its Russian-based “Turkish gas mix”. And it doesn’t take much fancy arithmetic to figure out that this could be a lot more lucrative than the USD 2 billion-odd in revenues over more than a decade to which BOTAŞ would be waving goodbye if it consented to amend the 2022 contract.

For his part, Mr Malinov has no choice but to raise the stakes by moving the issue up the political value-chain. Eager, for many reasons, to save Bulgargaz from the abyss, he will try to do so by offering new, comparable and long-term benefits that BOTAŞ can convert into revenues. By thus saving Bulgargaz he can save himself – and, incidentally, the political masters he has been serving for the last few years.

An increase in “Turkish mix” gas transited through the Bulgartransgaz transit system means increased revenues for Bulgaria too, so the benefits would not all be on one side. However, there’s a problem. These benefits – and the survival of Bulgargaz under this scenario – would come at the expense of other interests and opportunities.

Specifically, Bulgaria would be committed, to an excessive degree, to the exclusive servicing of (directly and indirectly) Russian-linked gas flows at the expense of non-Russian ones. Since there would be no comparable increase in the capacity of the transit and transmission system of Bulgartransgaz, the increased input volumes from Turkey would inevitably lead to a reduction in the volumes of natural gas from LNG terminals in Greece, unable to compete with the Gazprom gas that is even now flooding the Turkish Gas Hub. And that would divert Bulgaria from its recent direction of travel – towards becoming a gateway to the EU gas market for non-Russian gas – turning it instead into a transit country for the Russian-Turkish gas mix.

So there’s energy geopolitics at stake here too. And Bulgaria would have to make tough choices.

Ilian Vassilev