As 2017 comes to a close, Ukraine faces a long road to energy independence.
Many blame oligarchs for preventing private investment to develop the estimated 1.1 trillion cubic meters in natural gas reserves.
Others argue that state-owned gas company Ukrgazvydobuvannya, known as UGV, is hoarding licenses to tap the reserves themselves.
In either case, the government looks to be a tool for serving vested interests, making the market unfair and uncompetitive.
Since 2014, Ukraine’s gas extraction has remained stagnant. It was 20.2 billion cubic meters in 2016, while the nation consumed 33.2 billion cubic meters in 2016.
Its 11.1 billion cubic meters of imports came from Slovakia (9.1 billion cubic meters), Hungary (1 billion cubic meters) and Poland (1 billion cubic meters).
‘Dog on hay’
One phrase that comes up is the old proverb “like a dog on hay,” or selfishness, referring to a dog who barks at those who come up to a haystack, even though it is of no use to the dog.
Oleksandr Chaly, head of Grant Thornton’s Kyiv office, has used the phrase many times to accuse UGV of hoarding gas extraction permits.
Ecology Minister Ostap Semerak described the State Service for Geology and Minerals with the same aphorism, accusing the agency of failing to conduct auctions for gas extraction licenses.
But there could be something else going on other than UGV simply holding on to licenses.
UGV, as a state company, had a built-in preference for receiving licenses until April, when legislation limiting such a benefit came into effect.
“If I were the head of a monopolist company, I would conduct the same policy in their place,” said Yulia Borzhemskaya, manager of regulatory policy at DTEK, Ukraine’s largest energy group, which has assets in gas production, coal mining, electricity generation and alternative energy. “The issue is what the government will do further with the monopolies.”
But UGV chief Oleg Prokhorenko disputes that the advantage had any effect, describing allegations that his company took all the licenses as misleading.
“This company almost never got licenses,” he said. in October. “We’re now mostly working on the brownfield, and we have very few greenfields to go with.”
Prokhorenko added that a license does not guarantee that massive gas reserves will be found.
Ideology
Opposition to UGV’s market dominance is rooted in the ideology that government-run solutions are inefficient.
“A private business is always better than a state one,” said Viktor Gladun, general director of Poltava Petroleum Company. “It’s always ahead. That’s why I think the growth potential for private producers in Ukraine is much better.”
Gladun said that since “UGV has licenses that they want to dispose of… they can release them into the free, open market.”
But it’s not clear whether private always beats public. Private companies have aided and abetted corruption in Ukraine’s public sector gas drilling.
Former Ecology Minister Mykola Zlochevsky, for example, allegedly abused his position to give his company — Burisma Holdings — state gas extraction licenses. Zlochevsky and Burisma deny the allegations, although data shows that dozens of licenses given out under his tenure have yet to produce significant volumes of gas.
Prokhorenko said that most of these licenses were given during the rule of ex-President Viktor Yanukovych from 2010 to 2014. “They were pocketed and supposed to be sold on the market,” he said. “That’s the way corrupt politicians in this country think. I will appropriate and some foolish Westerners will come, and I will sell it to them for a billion dollars.”
Under Prokhorenko, UGV has committed itself to a plan that will see the company extract 20 billion cubic meters of the country’s gas by 2020, with private producers adding another 6 billion cubic meters.
In fact, UGV’s gas production increased by 4 percent in 2017, outpacing the private sector.
Ministerial outreach
Private gas extractors says they cannot obtain drilling concessions in a straightforward way.
Much of this has to do with the State Geological Service, which, according to Roman Opimakh, the head of the Association of Gas-Producing Companies of Ukraine, has not given out a single license over the past year.
“They said they would probably hold an auction at the beginning of next year, but nobody believes them,” Opimakh added.
Opimakh said that companies can get around the obstruction by getting a geologist to certify a conclusion that the resources are available in a given land plot.
The State Geological Service is a part of the Ecology and Natural Resources Ministry, which Semerak, the former People’s Front lawmaker and now ecology minister, has headed since 2016.
Semerak told the Kyiv Post that he has been pressing the Geological Service to issue more licenses and open up its geological data for public auction, but that he has been frequently thwarted by his inability to appoint personnel at the agency, which is the responsibility of the Cabinet of Ministers.
“The only tool for influencing them is political pressure, and I am using this,” Semerak said. “And for the management of the geology and subsoil service, I have criticized them, and I have been continually sending reform initiatives, which died there.”
Semerak’s initiative to open up access to geological data has been much heralded. On Dec. 7, the Rada lowered the tariff on gas extraction to the 6 to 12 percent range from 14 to 29 percent on non-production sharing agreements, a big win for the gas business lobby.
“The state wants these deposits to be worked in an effective and transparent manner, in a way that the state minimizes its part of the labor,” Semerak said.
Borzhemskaya, the DTEK regulatory policy manager, said that the ecology ministry holds weekly meetings with the gas industry on licensing issues and opening up geological information.
“Of course it’s not going as quickly as we would like, but the process is moving forward,” Borzhemskaya said.
The government is responsible for other delays in the gas market.
In her interview with Naftogaz CEO Andriy Kobolyev, Melinda Haring, an Atlantic Council editor, said that there hasn’t been much progress since May 2016 as Ukraine’s government stalled gas reforms. Prime Minister Volodymr Groysman did not liberalize gas prices of state-owned monopoly Naftogaz, despite the government agreeing to adjust the prices as part of one of the International Monetary Fund conditions to receive the $17.5 billion bailout package.
Kobolyev said that market prices will give consumers a choice and as well as stop oligarch Dmytro Firtash’s gas monopoly over households. Ukraine’s regulations force Naftogaz to provide gas to households through private intermediaries which are mostly controlled by Firtash, who also controls the regional distribution networks called oblenergoes.
International institutions such as the IMF and European Bank for reconstruction and Development expressed their concern regarding the stalled reforms. On Nov. 22 the government approved the new Naftogaz board of directors citing government obstruction of efforts to reform the company. The new board has been received with mixed reviews.
Who’s got what?
The story of Yuzgaz, a foreign attempt to enter Ukraine’s gas market, provides a window into the problems holding Ukraine back.
Yuzgaz, headed by former European Bank for Reconstruction and Development country director Jaroslaw Kinach, won a tender for the Yuzivska gas field in June 2016 on a $200 million proposal to drill 15 wells after Shell left the market.
The field has enormous potential and could hold up to 10 trillion cubic meters of shale gas.
But the 67-year-old businessman has been embroiled in a scandal. Kinach came under fire for allegedly stealing the rights to access the field via a rigged tender, with deputies and companies across the gas industry accusing him of corruption.
Kinach plans to develop the field with Schlumberger, the Paris-based global oilfield services firm.
“We can outsource what we need,” Kinach said. “We don’t need to be a vertically integrated manager.”
He and his company first began to encounter problems in July 2016, weeks after being awarded the contract for the field. Nadra Yuzivska, the company’s state-owned partner in the venture, “inherited the information from Shell because they were the minority partner,” Kinach said.
The Cabinet of Ministers revoked the production sharing agreement that Yuzgas had entered into upon winning the tender. Kinach then sued the government, igniting a year-long court battle that ended in a victory for the Canadian businessman in July.
“I can mobilize and form a company that can do what Shell wanted to do at a fraction of the cost,” he said.
