How do you secure the future of a national oil and gas company in a country like Ukraine?
To Otto Waterlander, 55, a top manager from the Netherlands hired earlier this year by Ukraine’s state-owned energy company Naftogaz, there are a couple of clear solutions: make sure people are only doing what they’re good at, cut costs as much as possible and discover proven new reserves that will bring in investors.
“I want to go forward with a lantern, have people who can point the lantern down and say, ‘I can show you the data why this is an exciting new deposit,’” Waterlander told the Kyiv Post.
Ukraine saw a major gas boom in the 1970s, but production has been stagnant for the past 30 years. Close to 99% of existing fields are already being exploited and a majority of gas reserves have been depleted. One of Naftogaz’s biggest priorities, after ensuring profitability, is to increase gas production.
Waterlander, who was previously a senior partner at McKinsey & Company’s oil & gas practice, was brought in as a chief transformation officer to restructure Naftogaz in January. In April, he also gained the title of chief operating officer.
“We think the gas is somehow in the ground,” said Waterlander, who has worked in the gas and chemicals sectors for over 30 years, primarily at McKinsey and Booz Allen Hamilton. “We can go a long way in that direction again. Not exactly to that level, but we can really change and grow” to secure the country’s energy independence.
“If you look at the international industry estimates for Ukraine, they think there’s at least as much as we produced over the last 50 years to be gained again, if not two times that.”
Boosting production
Ukraine’s gas transit is declining. The country will transmit 65 billion cubic meters of Russian gas in 2020 followed by 40 billion during the next years, according to a bilateral agreement reached in December 2019.
Shrinking revenues are another reason why it will be important to invest more in the oil and gas sector.
“Gas should remain one of the fundamental pillars of growth for Ukraine,” said Waterlander. He estimates that if the company and the government do everything right, investment could guarantee a 3% growth of the nation’s economy in the next 10 years.
That’s easier said than done. Required investment runs up to $5 billion per year, which Naftogaz doesn’t have. The company is investing just over $1 billion per year and two thirds of that are going toward maintaining production. Ukraine needs foreign investment.
But Waterlander sees current enthusiasm from foreign investors to be limited. And there are obstacles like licensing monopolization and Russia’s domination of the Black Sea, where potential offshore reserves are located.
That’s not even mentioning the major crash in gas prices that resulted from the global COVID-19 pandemic as a result of plummeting demand.
European natural gas prices have fallen to multi-decade lows, and are down almost 40% since the start of 2020. The oversupply is even worse because of a simultaneous collapse in demand in the liquefied market.
“I do think that the price crash will be with us longer than we hoped for,” said Waterlander.
The company is compensating by reducing short-term and maintenance investment by 20%, but Waterlander said that this should not affect Naftogaz’s long-term plans to increase investment and open new reserves. He hopes that prices will recover by then.
Over the past few years, Naftogaz greatly increased investment in seismic exploration. But Waterlander says it needs to do more. The company is now working on exploring tight gas, deep fields and offshore.
Beyond extraction, he thinks Naftogaz should become an orchestrator: The company would find reserves, determine their size and point them out to foreign players that can drop a billion dollars on a project with guaranteed production. This is a much more effective way to attract foreign investors than saying “I have a promise,” he said.
In the meantime, Ukraine remains a gas importer, along with the rest of Europe. Waterlander said that Europe has and always will be a gas importer, with two major sources – Gazprom and liquefied natural gas, which comes from the Americas and the Atlantic.
Ukrgasvydobuvannya (Ukrainian gas extraction) remains the top gas producer in the country, with the share of private players having not grown very significantly over the past five years. Otto Waterlander says that Naftogaz will try to draw in international investors by discovering proven gas fields.
Restructuring
One of Waterlander’s visions is to reorganize the company to improve specialization.
“We want to become faster with decision-making,” he said. “A lot of good people in the company are complaining about bureaucracy and how long it takes to make decisions. That is what we want to take away.”
Under Waterlander, who has been at Naftogaz for six months, the company has split its integrated gas division into one exploration and production branch and one commercial branch. The former will focus on exploring and extracting hydrocarbons, while the other will develop the retail segment, trade and focus on imports.
“Exploration and production divisions are doing everything in their field of focus, they should not be worrying about how to sell gas,” said Waterlander. “If we have a bunch of engineers excited about how to build infrastructure for a target reservoir three kilometers deep and you ask them to build a customer business, then you’ve got trouble.”
Cost efficiency is also a priority in several areas, including procurement – Naftogaz needs to be more strategic about where, what and how it buys. The other is investments – drilling a well has to be done faster and cost less than in the past.
“What we will see today is that the speed with which we drill wells is massively increased,” said Waterlander. “Drilling is more than twice as fast as in the past.”
Retail gas market
Starting on July 1, Ukraine was supposed to do away with a public service obligation or PSO that kept gas prices artificially low for the population. This would also mean that people would be able to choose their own gas supplier. The change was mandated by a 2018 law that set July 1 as the final deadline.
On July 1, the Cabinet of Ministers agreed to extend the PSO by one month. Some experts worry that the deadline will keep being extended.
If the change takes place, consumers will be able to buy gas directly from Naftogaz or any other supplier, bypassing regional gas companies that previously had local monopolies. These companies have been widely criticized for stealing gas, falsifying consumer records and other illegal activity.
Waterlander said that the PSO is currently the “biggest issue” for the company, which is enthusiastic about its cancellation. Today, Naftogaz serves 250,000 consumers and wants to serve millions more.
Naftogaz is participating in a tender to become a gas supplier of last resort. Once the tender is concluded, there will be no more obstacles to the new market model.
According to the executive, today’s low gas prices created the best opportunity to do away with the PSO. Stripping away public subsidies is always a very politically unpopular move. Nevertheless, he said, competition is good for consumers.
“For example, customers may choose to have flexible market prices that will fluctuate up and down with European market prices,” he said.
“Alternatively, customers may opt for a fixed price arrangement. And customers may choose to come directly to us or via one of our partners.
Naftogaz is still owed billions of dollars by fugitive oligarch Dmytro Firtash’s regional gas companies, which have been able to avoid paying the state company via manipulative business practices and loopholes in the gas transit code. Despite being stuck in Vienna, fighting extradition to the U.S. on bribery charges, Firtash controls three quarters of these enterprises.
“We want to deal with the debt issues, we want to deal with the nonpayment issues,” Waterlander said but did not comment with any additional details.
Branching out
Besides growing its business to the customer segment, the company is also looking to grow its gas trading business and generate money from opportunities Waterlander sees between Europe and Ukraine.
But the company should also look beyond oil and gas to become an energy player, according to the executive.
Waterlander said they’re starting the process to look into entering hydroelectric, geothermal or renewable energy. The company will also look into creating a business that would focus on energy efficiency and alternative heating solutions — Ukraine uses up a third more gas than Europe in similar situations.
The plan is in the early phase, but is intended to diversify Naftogaz and improve its growth not just in hydrocarbon production but in the commercial arena as well.
“We’re now starting to look at our new strategy to make sure that our vision gets us ready to find new sources of value,” he said.
