A populist government decree has raised concerns about further FDI into the country’s oil and gas sector, as one Western company already sold its assets
A government decree has forced a small, Western energy company to sell off its assets in Ukraine, raising concerns about further foreign investment into the country’s oil and gas sector.
Cardinal Resources, an independent oil and gas exploration and production company, is selling off its Ukrainian interests in the wake of a decree by the government of Prime Minister Viktor Yanukovych that introduces price caps on gas sold by companies in joint activity agreements (JAA) with the state. Cardinal is being sold for $71 million to a company called Kuwait Energy, a private oil and gas company based in Kuwait, whose majority shareholders are unknown.
“Cardinal has signed a framework agreement and made the subsequent announcement on Oct. 30. The sale and purchase agreement is being finalized now and is expected to be signed in the near future,” Cardinal CEO Robert Bensh told the Post.
“Populist actions taken by the Ukrainian Government – Decree 31, increased taxes and royalties – made all of Cardinal’s JAA gas sales subject to a disputed but mandatory price cap and, since January 2007, all JAA gas produced has been stored, resulting in a significant reduction in both the earnings of the company and its liquidity,” Bensh added.
The decree, which was passed in late 2006 and came into force early this year, obligates companies in JAAs with the state, or majority owned by the state, to sell gas to the state-owned oil and gas company Naftogaz Ukrainy at a fixed government rate of around $1.50 per 1,000 cubic feet – a fraction of the current market rate of $4.80 per 1,000 cubic feet. According to Bensh, the rate is even below the company’s production costs.
Cardinal, whose operations are limited to Ukraine, holds interests in four gas fields and three license areas. One of the licenses is 100 percent owned by Cardinal, but the remaining licenses and all the fields are held through agreements with two Ukrainian state-controlled entities: Ukrnafta and Ukrgazvydobuvannya, both Naftogaz Ukrainy subsidiaries.
“Under present circumstances, the sale of the company’s interests in Ukraine is the only viable option available other than an administration-insolvency procedure,” said Bensh, a US citizen.
Cardinal is not the only foreign investor trying to develop Ukraine’s oil and gas deposits feeling uneasy over the government’s decree.
Anglo-Dutch energy giant Royal Dutch Shell, which has made an initial commitment of $100 million in a joint agreement with Ukrgazvydobuvannya to explore for oil and gas in central-eastern Ukraine, could also be affected down the road.
“Decree 31 does not currently affect Shell’s exploration activities, which are just entering the seismic study phase. However, should these studies prove successful, and Shell and its partner begin producing gas, it will have an adverse effect on the project’s ability to remain profitable and sustainable,” Shell’s spokesman in Ukraine, Antonius Papaspiropoulos, told the Post.
Following a cooperation agreement signed with Ukraine in 2005, Shell has obtained development licenses and recently landed an interest in a Ukrainian filling station network through a joint venture with Moscow-based Alliance Group.
“Any market participant needs to be able to sell gas, on an unimpeded basis, at market levels in order to be ‘incentivized’ to make any upstream investment. Shell is concerned about the negative effect Decree 31 has and is lobbying to have it revoked… Decree 31 is not in Ukraine’s foreign investment interests and it does nothing to help the country become more energy independent,” Papaspiropoulos said.
UK-registered Cardinal, which boasts offices in Kyiv and Houston, has appealed to the US and Ukrainian governments, arguing that Decree 31 increases Ukraine’s dependence on Russian imports by forcing foreign investors to sell their gas at below-market prices.
Ukraine currently relies on imports from Russia and Central Asia to fulfill the majority of its gas needs. Most domestic production is controlled by state-owned companies. While privately-owned companies produce only a small amount of Ukraine’s gas, their operations are potentially very lucrative and are viewed as a way of raising investment to boost domestic production and, in turn, reduce dependence on imports.
Formerly known as Carpatsky Petroleum Corporation, Cardinal has interests in Ukraine dating back to 1995. In 2005, it raised about $20 million through an IPO on the Alternative Investment Market of the London Stock Exchange, one of the first listings on a major foreign market by a company with Ukraine-based operations. But the company’s stock has suffered due to production rights difficulties in Ukraine.
Cardinal is mostly owned by hedge funds, according to Bensh, with a 19 percent interest held by Syrian-born Ukrainian businessman Youssef Hares. Cardinal’s estimated oil and gas reserves at the end of last year were 32.5 million barrels of oil equivalent. Net daily production at the end of last year was 800 barrels of oil equivalent.
According to Bensh, Decree 31 and accompanying tax hikes were not directly aimed against foreign investment into Ukraine’s oil and gas sector, but rather short-sighted, populist measures intended to boost the economy in the short run by increasing budget revenues.
“The government achieved two goals by adopting Decree 31 and increasing taxes: It subsidized state-owned energy consumers and attracted additional funding into the state budget,” he said.
Volodymyr Nesterenko, an analyst at Kyiv-based investment bank Concorde Capital, said the government decree was meant to ease the effect of increases in domestic gas and heat prices.
“It [the government] needed a sufficient volume of gas, about 30 billion cubic meters (bcm) a year, at a low price. Only 21 bcm is produced by all domestic companies, so the more gas the state can get at a discount, the more ability it has to restrict growth in prices,” he said.
Nevertheless, the net effect will be a drop in gas production volumes and thus more reliance on imports, Nesterenko said.
“It was really crude to cap prices for private companies. It has already hurt investors’ attitude toward join agreements with the state and will result in a lack of investments in the exploration and development of the licenses in which the state has some working interest.”
In addition to Shell, a subsidiary of US-based Marathon Oil Corporation inked a cooperation agreement in June with Naftogaz Ukrainy to explore hydrocarbon deposits in central-eastern Ukraine, but has yet to obtain licenses.
Brazil’s state-owned Petrobras is reportedly holding talks with Naftogaz Ukrainy and Ukrnafta to partner up in developing the resource-rich Black Sea shelf.
