Gas projects be­gin with re­search, not ex­plo­ration

Kyiv Post - - Business Focus - BY MARK RACHKEVYCH [email protected]

To para­phrase poet Robert Frost, there are prom­ises to keep and miles to go be­fore one can sleep.

That’s cer­tainly the sit­u­a­tion in Ukraine’s much-touted shale gas pro­duc­tion agree­ments with Chevron and Shell. Last week, the Ukrainian gov­ern­ment chose the oil and gas ma­jors in sep­a­rate projects to ex­plore and po­ten­tially un­lock shale nat­u­ral gas re­serves in east­ern and western Ukraine.

In heav­ily en­ergy-de­pen­dent Ukraine, it’s not an over­state­ment to say that the hopes of the na­tion are count­ing on suc­cess.

“Now our fo­cus will be on [the] suc­cess­ful ne­go­ti­a­tion of the pro­duc­tion shar­ing agree­ment with the Ukrainian gov­ern­ment and the Joint Op­er­at­ing Agree­ment with our new part­ner… whom we look for­ward to work­ing with,” a Shell spokesper­son emailed the Kyiv Post.

The land­mark projects could even­tu­ally lure bil­lions of dol­lars of badly needed in­vest­ment and help break de­pen­dency on in­creas­ingly ex­pen­sive Rus­sian gas im­ports.

But much de­pends on what is found un­der­ground.

And even be­fore the ex­plo­ration phase kicks in, the en­ergy ma­jors of this size have mas­sive amounts of due dili­gence work ahead.

Lots of dig­ging will be nec­es­sary. Many ques­tions re­main unan­swered, es­pe­cially when look­ing at the coun­try’s shoddy 20-year track record of treat­ing for­eign in­vestors.

At stake is some 42 tril­lion cu­bic feet of shale gas re­serves. The mar­ket value of Ukraine’s shale is be­tween $10.3 bil­lion to $1.5 tril­lion, Gor­don Lit­tle wrote ear­lier this year for the In­ter­na­tional As­so­ci­a­tion for En­ergy Eco­nom­ics.

It will be wel­come news if Ukraine could change its opaque en­ergy mar­ket to im­prove its se­cu­rity out­look – Ukraine’s en­ergy in­ten­sity is 2.5 times that of Europe due to in­ef­fi­ciency and it gets two-thirds of its nat­u­ral gas from Rus­sia.

On their end, Chevron and Shell could to­gether put up to $500 mil­lion for ex­plo­ration in their re­spec­tive blocks: Shell could in­vest up to $300 mil­lion to ex­plore in east­ern Ukraine; Chevron up to $200 mil­lion in western Ukraine.

In­dus­trial ex­trac­tion of gas at the sites could be­gin in 2018-2019, of­fi­cials said.

The deal is fur­ther complicate­d be­cause the in­vestors are be­ing told they will need to part­ner up on 50/50 par­ity terms with two do­mes­tic part­ners whose con­tri­bu­tion is be­ing ques­tioned by diplo­mats and ex­perts.

The first is state min­eral re­sources com­pany Nadra Ukraine. It has limited fi­nan­cial re­sources or ex­pe­ri­ence in projects of this size. The same goes for Spk-geoserv­cie, a pri­vately-owned Ukrainian com­pany cho­sen by the gov­ern­ment as Nadra’s part­ner in a sep­a­rate ten­der held ear­lier this year.

Both com­pa­nies are form­ing a joint ven­ture that will con­trol half of a ven­ture along with Chevron and Shell. Nadra will hold a 90 per­cent stake in the Ukrainian side’s stake; the re­main­ing will go to Spk-geoser­vice.

Ed­uard Stavyt­sky, head of Ukraine’s ecol­ogy and nat­u­ral re­sources min­istry, said that Spk-geoser­vice will fi­nance the ac­tiv­i­ties of the two com­pa­nies that will part­ner with the for­eign oil and gas com­pa­nies.

Ac­cord­ing to En­ergo Biznes, SPKGeoser­vice was founded in 2008 by Ser­hiy Stovba, the com­pany’s di­rec­tor of re­search pro­grams; Ihor Popa­diuk, chief ge­ol­o­gist for the com­pany; and Ok­sana Khri­ashchevska, the com­pany’s deputy chief ge­ol­o­gist.

En­ergo Biznes stated that be­fore join­ing Spk-geoser­vice, the three founders worked for a re­search in­sti­tute at­tached to the state-owned oil and gas com­pany Naftogaz Ukrainy.

In­ter­fax-ukraine re­ported that SPKGeoser­vice’s 2010 in­come was $56,500, and net in­come was $33,750.

An­ders As­lund, an ex­pert on East­ern Euro­pean economies at the Peter­son In­sti­tute for In­ter­na­tional Eco­nom­ics, said that there are also con­cerns that Chevron and Shell’s nat­u­ral gas projects could per­ilously get em­broiled in murky deal­ings in­volv­ing lo­cal oli­garchs or, pos­si­bly, in­ter­ests close to Ukraine’s lead­er­ship.

“You can­not have a deal like this go through with­out one of three big ma­jors be­ing in­volved who have a spe­cial re­la­tion­ship with gov­ern­ment," As­lund said.

Oil and gas in­dus­try ex­perts have sug­gested that con­ser­va­tive com­pa­nies like Chevron and Shell may have to con­duct for­eign cor­rup­tions act re­port­ing on the deal if gov­ern­ment of­fi­cials are some­how in­volved in com­pa­nies that are part of the deal.

Shell has more in-coun­try ex­pe­ri­ence of the two li­cense win­ners so it should know where the land mines are and will en­ter the part­ner­ship with their eyes wide open, ex­perts said.

But en­ergy con­sul­tant Ed­ward Chow, a se­nior fel­low of the En­ergy and Na­tional Se­cu­rity Pro­gram at the Cen­ter for Strate­gic & In­ter­na­tional Stud­ies in Washington, D.C., said both oil and gas ma­jors “will be de­lib­er­ate and cau­tious in their ap­proach. They’re at the be­gin­ning of a process, not at the end. There are still a lot of bridges to cross.”

That ju­di­cious ap­proach is at­trib­uted, ac­cord­ing to Chow, to the Ukrainian gov­ern­ment’s poor 20-year track record in deal­ing with for­eign in­vestors.

“If the Ukrainian gov­ern­ment does this prop­erly, and these are the kind of com­pa­nies you want to do busi­ness with, then it’s a very good thing. But if they fool around like they did the last 20 years, and like they did with Vanco, then it’s an­other missed op­por­tu­nity,” Chow, a for­mer Chevron ex­ec­u­tive, told the Kyiv Post.

In 2008, one of Hous­ton-based Vanco En­ergy Com­pany’s sub­sidiaries had its li­cense to ex­plore the Black Sea shelf re­voked in 2008 amid rev­e­la­tions that the four par­ity share­hold­ers of the Vanco sub­sidiary were: DTEK, owned by Ukrainian ty­coon Ri­nat Akhme­tov; Shad­ow­light In­vest­ments, Ltd., owned by Rus­sian businessma­n Evgeny Novit­sky; Vanco In­ter­na­tional of Ber­muda, a sub­sidiary of Vanco En­ergy Com­pany; and In­te­grum Tech­nolo­gies of Aus­tria.

The Vanco project re­mains frozen to this day. The Hous­ton par­ent com­pany has been sold by its orig­i­nal Amer­i­can founders to Rus­sian in­ter­ests. Vanco’s project in Ukraine, which ad­mits to hav­ing Akhme­tov as a part­ner but has strug­gled to re­veal who its other ben­e­fi­cial own­ers are, is in talks with Ukrainian of­fi­cials on re­sum­ing the project.

Diplo­mats, rep­re­sen­ta­tives of en­ergy com­pa­nies in­volved in the shale gas bid­ding and Ukrainian of­fi­cials ad­mit that there are con­cerns that SPKGeoser­vice might be in a front for a rent-seek­ing ar­range­ment by Ukrainian of­fi­cials.

How­ever, ex­perts also noted that be­cause of their high pro­file and level of public scru­tiny Shell and Chevron re­ceive, they can­not bend cor­ners as Vanco, a rel­a­tively small Us-based en­ergy com­pany, did.

En­ergy ex­perts did ad­mit though that the Vanco pro­duc­tion shar­ing agree­ment was con­cluded when Yanukovych was prime min­is­ter in 2007, and when many cur­rent top of­fi­cials served in his gov­ern­ment.

Due dili­gence in Chevron and Shell’s case could take up to four months and carry a $100,000 price tag, said Svi­atoslav Belei, an as­so­ci­ate with the Gide Loyrette Nouel law firm.

And the depth of qual­ity of due dili­gence, Belei said, de­pends on

An­ders As­lund, an ex­pert on East­ern Euro­pean economies at the Peter­son In­sti­tute for In­ter­na­tional Eco­nom­ics.

Ed Chow, a U.s.-based en­ergy con­sul­tant

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