Galnaftogaz Expansion Phase II

Summary of Proposed Investment

This Summary of Proposed Investment is prepared and distributed to the public in advance of the IFC Board of Directors’ consideration of the proposed transaction. Its purpose is to enhance the transparency of IFC’s activities, and this document should not be construed as presuming the outcome of the Board decision. Board dates are estimates only.

Project number	25694
Company name	PJSC "Concern Galnaftogaz"
Country	Ukraine
Sector	Chemicals
Environmental category	B
Department	Oil, Gas, Mining And Chemicals
Status	Active

Date SPI disclosed	July 13, 2007
Projected board date	August 23, 2007
Previous Events	Invested: March 7, 2008 Signed: December 18, 2007 Approved: December 11, 2007

View Environmental & Social Review Summary (ESRS), click here

Overview

Sponsor/Cost/Location

Development Impact

Contacts

Attachments

Project description

Open Joint Stock Company Concern Galnaftogaz (GNG or the company), an existing IFC client, is the largest independent (not tied to a refinery) operator of gas filling stations in Ukraine. Galnaftogaz’s main business is distribution of petroleum products mainly gasoline and diesel through its network of filling stations and direct sale in the wholesale market. GNG currently operates 15 storage terminals and about 206 stations, including 163 OKKO branded stations. OKKO stations are high throughput and modern format gas stations which offer high quality fuel and a variety of related products and services (convenience store, car wash, auto repair, and fast food services). GNG had sales of $515.9 million and EBITDA of $24.7 million in 2006 and was ranked fourth in Ukraine by number of stations and third by sales volume.

GNG requested IFC for financing package of $100 million ($50 million on IFC’s own account and $50 million on account of participant banks) to fund the second phase of its expansion with estimated capital expenditures of $642 million over the next 4 years. The expansion aims to increase the company’s petroleum distribution network to about 358 OKKO stations through acquisitions of 170 stations and construction/upgrading of 188 stations (currently GNG operates 43 unbranded stations most of which will be converted, while the remainder will be sold or closed). Besides the stations, the project involves investments in supporting infrastructure (storage terminals, petroleum trucks, acquisition of land under existing stations, etc.).

Project sponsor and major shareholders of project company

In 2001 Financial and Investment Energy Holding (FIEH) Establishment, a Liechtenstein based holding company, founded the company through the merger of three regional companies (Ivano-Frankivsknaftoproduct, Zakarpatnaftoproduct-Uzghhorod, and Zakarpatnaftoproduct-Khust). Since 2001, the company was able to establish 200 service stations in Western and Central Ukraine with sales of over $515.9 million equivalent in 2006. The company has developed a premium brand named OKKO which was applied to its modern stations known for high-quality petroleum products, convenience stores, and auto services; 176 of GNG’s 219 stations operate under OKKO brand. To support the operation of station by ensuring uninterrupted inventory supply, GNG owns 15 tank storage facilities (9 facilities are used and 6 are not utilized) and a tanker-car fleet with total capacity of 1,232 tons (1,541 thousand liters).

As GNG’s business increased, the company’s shareholders strived to transform GNG into a transparent and professionally managed business. IFC’s involvement with Galnaftogaz originated from the work performed by PEP Ukraine Corporate Development Project (UCDP). As the result of Galnaftogaz’s work with UCDP to establish better governance and increase transparency and disclosure, GNG was among first companies in Ukraine to develop and adopt a corporate governance code. According to a study performed by Concorde Capital, one of the leading Ukrainian investment banks, GNG was ranked first among Ukrainian businesses in terms of corporate governance (February 6, 2007).

The members of the Supervisory Board, executive directors, and related family members directly control 80% of the voting shares of the Company, institutional investors, and fund hold circa 18%, and the balance by individuals. The ultimate controlling party of the group is Mr. Vitaliy Antonov (the sponsor), a reputable Ukrainian businessperson.

Mr. Antonov also owns other businesses in Ukraine of which the most notable are Universalna Insurance Company (non-life and life insurance), Khlibprom (vertically integrated bread/pastry/confectionary producer), and Vash Dim (construction company). However, his largest business, by assets and sales, is Galnaftogaz.

Total project cost and amount and nature of IFC's investment

The total project cost is estimated at $642 million over four years. The proposed IFC investment consists of an A loan of up to $50 million and a C Loan of up to $20 million for IFC’s own account (in aggregate investment for IFC’s own account is capped at $50 million) and a B Loan of up to $50 on the account of participant banks.

Location of project and description of site

The company is headquartered in Lviv, Ukraine. Its network of service stations is concentrated around Western/Central Ukraine; however, as a part of the project, GNG has plans to spread its network throughout Ukraine.

Anticipated development impact of the project

- Development Impact

Access to high-quality petroleum products and services:

The core of GNG’s business strategy is providing high-quality petroleum products and ancillary products/services to its customers. By expanding further in western Ukraine and entering in the eastern regions, Galnaftogaz will provide access to such services to its new customers and at the same time will lift the standards for other market players.

Economies of Scale and Competition:

The project will enable GNG to gain greater economies of scale and improve its operating efficiencies. Ultimately, the economies of scale and GNG’s independence from any single refinery will lead to increased competition in the petroleum retail sector.

Employment:

For each station put into operation, GNG will employ and train on average 8-12 Ukrainians depending on the type of station. The jobs on full time and part time basis would become available to nearby population, including women, retirees, and students. 220 additional stations will result in creation/preservation of about 1,760-2,640 jobs.

Temporary and indirect employment:

The project will on temporary basis create construction jobs as 1 station requires an estimated of 5,600 man-hours to build. The project in total will create about 725 thousand man-hours of construction employment. It is also likely to generate further positive downstream impacts through development of small entrepreneurs through outsourcing of supplies and services.

The key development indicators that are proposed to be monitored during the life of the IFC investment are:

- Direct employment (including % of women)
- Aggregate indirect employment during construction (in man-hours)
- Number of stations per region (OKKO and non-branded)
- Taxes to Government

Fit With World Bank Group Strategy:

The World Bank Group’s 2004-07 CAS for Ukraine has seven objectives:
- sustainable economic growth;
- poverty reduction and the strengthening of the middle class;
- comprehensive and harmonized human development;
- environmental sustainability;
- gradual integration into the world economic and financial systems;
- reduction of regional imbalances; and
- improvement of state administration.

IFC’s role in this strategy is to strengthen private sector development to contribute to these objectives. IFC is responding to recent improvements in economic management and legislation by stepping up its business development efforts, with an increasing focus on local companies both in the financial and real sectors. In addition, IFC is continuing its large and very effective technical assistance program, which has been directed to improve the business environment, as well as to provide hands-on support to small and medium enterprises and farms. The proposed investment fits well with the World Bank Group strategy for Ukraine.

IFC's expected development contribution

- IFC has important roles to play in the proposed investment:

Funding & Mobilization:

In 2005, IFC provided $25 million to support the company’s 2005 and 2006 investment program. The company has been able to deliver the investment program and its operational and financial position support this argument. The support for the proposed 2007-2010 expansion plan will mark the second time IFC and other parallel lenders support the company in its expansion strategy including the mobilization of $50 million B Loan with funding tenors of up to 9 years including 2 years of grace that is critical to the viability of the proposed project. Participation in B-loan program will allow GNG to build credit history with the biggest international banks for its future financing needs. In addition, IFC’s participation and de facto political risk mitigation are considered key to the successful raising of the facility, not least by providing debt with a tenor that will be at least 2 years longer than that of the commercial lenders;

Environment and Social Management System:

IFC’s involvement in the proposed investment will play an important role in developing an integrated Environmental, Health and Safety (EH&S) department, implement EH&S policies/procedures thought the company, and implement effective EH&S training, monitoring, and reporting programs. As a requirement during previous investment, GNG has conducted an Environmental, Health and Safety Audit of its petroleum storage terminals and as part of the 2007 – 2010 expansion program, IFC will help GNG to prioritize and implement the Audit’s recommendations.

Long-term Sustainability:

Aside from providing longer maturities unavailable in the Ukraine (up to 9 years including 2 years of grace), IFC is expected to play a key role in supporting the company to fine tune its long-term strategy. As a result of GNG’s work with UCDP to establish better governance, in February 2007 the company was ranked first among Ukrainian businesses in terms of corporate governance; IFC’s involvement in the second expansion will further support the company to improve transparency, disclosure, and general corporate governance best practices. In addition, IFC’s corporate financing type terms and conditions of the second expansion would stimulate the required financial discipline, and promote long-term sustainability.

In general, IFC has played and continues to play a significant catalytical and validating role in the company’s development, including its environmental practices and corporate governance.

Environmental and social issues - Category B

This is a Category B project according to IFC’s Environmental and Social Review procedures because a limited number of specific environmental and social impacts may result which can be avoided or mitigated by adhering to generally recognized performance standards, guidelines or design criteria.

The project mainly comprises the gas station network expansion and working capital increase. There is no new purchase for the fuel storage terminals. GNG will mainly purchase existing gas stations and industrial land to construct its OKKO brand gas stations. The environmental and social risk related to gas station operation is limited, and GNG plans to renovate its fuel storage terminals. Mitigation measures for the potential environmental and social impacts are identified and incorporated in the attached Environmental and Social Action Plan (ESAP).

Identified Applicable Performance Standards:

PS1: Social and Environmental Assessment and Management Systems
PS2: Labor and Working Conditions
PS3: Pollution Prevention and Abatement
PS4: Community Health, Safety and Security
PS5: Land Acquisition and Involuntary Resettlement

There are no protected species or protected areas at or near the GNG sites. There are no indigenous people near GNG sites. The proposed project has no impacts on cultural heritage.

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