The government of President Viktor Yanukovych has set the strategic goal of doubling domestic natural gas production over the next decade. Their plan is to attract foreign companies to produce gas from the Black Sea shelf, estimated to hold 330 trillion cubic meters of gas, and the Lublin Basin, estimated to hold 1.4 trillion cubic meters of shale gas.
This is a laudable goal. But, in order to achieve it, Ukraine will need to attract companies such as Chevron, Exxon Mobil, Total or Texaco, who have the expertise and capital to develop these resources. This is unlikely to happen unless major political and legal reforms are adopted that would lessen the risk to foreign investors.
Ukraine has lagged behind other Eastern European nations and its Black Sea neighbors in attracting foreign investment because of the high political and financial risk associated with the country. According to the latest World Economic Forum Competitiveness Index, the biggest problems are unpredictable government policies and the lack of a legal framework to settle disputes and challenge government decisions.
Drill men at a Regal Petroleum gas well in Poltava Oblast. (Ukrainian photo)
International petroleum companies assume substantial political and financial risk when investing in foreign jurisdictions that are far from their main base of operations. Ukraine has succeeded in attracting junior exploration companies that have high risk thresholds. These companies are focused on exploration and small scale production, have small market capitalization, are privately owned or traded on venture stock exchanges. In the long term, these companies are beneficial in discovering hydrocarbons but do not have the capital or technological knowhow to produce in any appreciable quantity.
In order to attract large integrated petroleum companies that have the technology and capital to develop Ukraine’s offshore and shale gas resources, the government will need to lower the risk to invest in Ukraine. Specifically foreign companies need to have greater rights over assets, legal institutions need to be present to protect contracts and the political interference on existing projects needs to be stopped.
The recent decision by the Kyiv court in favor of Regal Petroleum and the decision by the government to reengage Vanco Prykerchenska in negotiations on their offshore license are of particular interest to foreign investors. The perception to outside investors is that these moves are steps in the direction of a more business friendly environment, but outside of this perception, there are still major issues that need resolving.
Regal Petroleum is a junior exploration company that operates a small number of gas and condensate wells in the Mekhedivsko- Holotovshinske and Svyrydivske fields. In May, they received a signed letter from the Minister of Environmental Protection identifying certain matters that required rectification in relation to Regal’s compliance with certain legislation relating to its operations, and requiring an immediate suspension of operations. According to Regal, the issues were procedural rather than operational and the matter should not result in a costly production stop.
Subsequent legal action was brought by Ukrzakordongeologia, a Ukrainian company that has the contract to buy all the off-take from Regal’s wells, against the Ministry of Environmental Protection challenging the Ministry Order on the basis that it adversely affected Ukrzakordongeologia. The result of the legal challenge was that an injunction was granted from the District Administrative Court of Kyiv and Regal’s operations were allowed to continue without any interruption of gas supplies to its off-take partner Ukrzakordongeologia.
It is beyond the scope of this article to comment on the background of Regal and their business practices, but the salient point is that the issue, at least from the perspective of the foreign investor, was settled in a legal court and Regal’s Ukraine operations continue.
The case of Vanco Prykerchenska is more important to potential foreign investors because it is a case of perceived political involvement in a foreign company’s commercial operations. Vanco International and The Cabinet of Ministers signed a product sharing agreement for the Prykerchenska section of the Black Sea shelf on Oct. 19, 2007.
Subsequently Vanco International delegated all its rights and commitments under the agreement to Vanco Prykerchenska (Virgin Islands) and the Cabinet of Ministers cancelled the agreement and annulled the license claiming Ukraine did not sufficiently profit from the partnership. Vanco subsequently launched an international lawsuit that has yet to be settled.
After the change of the Ukrainian government in March 2010, the Cabinet of Ministers offered Vanco Prykerchenska the opportunity to conclude an amicable agreement. Vanco and the Cabinet are currently negotiating this agreement. Justice Minister Oleksandr Lavrynovych said “the proposal to Vanco was just one of the proposals that they hope to settle amicably.”
Vanco is cautiously optimistic that this is a chance to settle the conflict and sign an agreement that will allow them to restart operations. Jim Brown, Vanco’s president, believes that the resolution of the conflict would be a positive sign for international oil producing companies and foreign investors.
Right or wrong, the Yanukovych government has changed the outside perception of the foreign investment climate of Ukraine through the Regal and the Vanco cases. I believe this will increase the number of junior companies willing to explore in Ukraine, but exploration is not production.
The Yanukovych government’s goal to increase gas production from 20 billion cubic meters to 40 billion cubic meters a year over the next 10 years is laudable but unrealistic unless institutional changes are made. The cases of Vanco and Regal may show a trend towards a more business friendly government and nascent legal protection of foreign companies, at least to the outside world, but Ukraine will need to do more. In order to attract companies with the capital and technological knowledge to develop the gas reservers from both the Black Sea shelf and the Lublin Basin, Ukraine needs to take giant steps forward in the legal protection of foreign companies and end the direct and indirect political influence in the gas industry.
Ryan Lijdsman is an international business consultant. He has worked with several international governments and businesses and has degrees in political science and energy economics from the University of Calgary and a MBA from Queen’s University. He can be contacted at [email protected]
