UKRAINE NEEDS HELP TO BOOST DOMESTIC NATURAL GAS PRODUCTION
Obstacles to international investment must be removed to increase domestic gas production.
Interview with Patrick Van Daele, General Manager Ukraine, Shell
John Marone, Kyiv Post, Kyiv, Ukraine, Fri, Oct 1, 2010
KYIV - Energy independence is consistently flagged as key to the country's development. But with natural gas production declining, Ukraine remains addicted to increasingly expensive Russian imports.
In a Sept. 23 interview with the Kyiv Post, Patrick Van Daele, general manager in Ukraine for global energy major Royal Dutch Shell, said major foreign investment is needed simply to maintain current output. He called on the government to eliminate the barriers to bringing in badly needed Western money and technology.
Shell is the only multinational energy company with a presence in Ukraine, including a controlling share in a growing chain of gas stations and, since 2006, an exploration agreement with Ukrgazvydobuvannya, a subsidiary of state-owned Naftogaz.
Van Daele, a Belgian national with 27 years of experience at Shell, attributed the recent drop in gas production to the dominance of energy giant Naftogaz on the market. Ninety percent of Ukrainian gas is produced by cash-strapped Naftogaz, with the rest coming from tiny and often embattled independents.
Van Daele said independents' production levels were flat or inching up, while that by Naftogaz is declining. "They know [the reason] themselves and they've said it many, many times: We have no money to reinvest in our oil and gas fields," he said.
The price of gas imported by Russia has risen from $50 per 1,000 cubic meters in 2005 to the $230 agreed earlier this year, a 30 percent discount on a higher price in return for an extension on the Russian navy's stay in Crimea until at least 2042.
But Ukrainian households and industry continue to be heavily subsidized at the expense of Naftogaz, which houses the state's exploration and production together with importing and sales under one roof.
As a result, Naftogaz cannot raise the hundreds of millions of dollars needed to maintain current production levels.
BRING IN MORE MULTINATIONALS
The solution to this problem, according to Van Daele, is to bring in more multinationals under production sharing agreements or joint ventures with Naftogaz to give Ukraine the financing and technology it so badly needs to get at Ukraine's hard-to-reach gas reserves, much of which is deeply embedded in rock or the Black Sea.
But despite a widely acclaimed law overwhelmingly passed by Ukrainian lawmakers in July that envisions the liberalization of Ukraine's gas sector in line with European legislation, the country is still a long way from facilitating foreign investment.
The law foresees the unbundling of Naftogaz into its separate entities of gas transportation (which is profitable), sales (which is not) and production (which could be).
Van Daele, like many others, is cautiously optimistic, but raises certain concerns.
"The gas law is a big umbrella law. Underneath there are many secondary bits of legislation, the small rules that determine what really goes on. A lot of this still has to be changed, and one of the concerns that we've expressed is: Ok, the agreement on this umbrella is fine, great, necessary and timely. So now all this secondary legislation needs to be brought in line with the big umbrella," he said.
And although Shell is aware of a government plan to fill the umbrella law with more detailed legislation, the umbrella law itself contains serious flaws – namely, in its defining of the role of a sector regulator.
"The regulator should see how the market is developing, respond to that, making sure that everyone gets their gas on a monthly basis, balancing all the needs of the various customers. … He should not have an open telephone line to the cabinet of ministers that influences what goes on at the regulator."
OBSTACLES TO SHELL'S EXPANSION INTO GREATER PRODUCTION
Meanwhile, Shell is itself feeling penned in by Ukrainian legislation.
Obstacles to Shell's expansion into greater production include yearly changes to the country's budget law, which affects licensing. "There is the oil and gas law, there is the subsoil code – those are the pieces of legislation that determine by 90 percent what you can and cannot do and how you should do it. But there is 10 percent of legislation that is stipulated in the budget law, and this changes from year to year."
Another obstacle for Shell and other foreign companies interested in seeking a production sharing agreement with the Ukrainian government is a new amendment, passed on Sept. 23, which removes the "stabilization clause."
"Stabilization means that if you entered into a production sharing agreement, then you will execute this agreement for its duration under the rules – and typically its 30 to 50 years – under the rules that were agreed at the time of signing. So any subsequent changes to the tax code or whatever legislation will not affect you.
"A production sharing agreement is typically for investments that will require billions of dollars. Nobody is going to put that money on the table unless you have some guarantees that the rules of the game are not changed mid way. Someone has decided that the stabilization clause should not be in there anymore, and has removed it. And I can tell you if that stabilization clause doesn't go back again, then nobody in his right mind will be willing to come and invest here."
NOTE: Kyiv Post staff writer John Marone can be reached at firstname.lastname@example.org.
NOTE: Shell is a member of the U.S.-Ukraine Business Council (USUBC), www.usubc.org, Washington, D.C.