Tymoshenko, Vanco offer wildly different stories on Black Sea project

(Note – 5/16/08: Updated with Vanco’s revelation of the involvement of Akhmetov’s DTEK and other investors below.)

Ukrainian Prime Minister Yulia Tymoshenko and American independent petroleum company Vanco Energy both held press conferences today outlying sharply contrasting images of Vanco’s Black Sea hydrocarbon development project and throwing the future of Ukraine’s deep-water oil and gas production into question.

Vanco signed a landmark production sharing agreement (PSA) with the Ukrainian government in October 2007 granting the company access to the 13,000 square kilometer Prykerchenska region off the Crimean coast. Tymoshenko and her government have been critical of the deal, however, asserting that the company lacks sufficient means to cover the necessary investment. That criticism culminated last Thursday when the Ministry of Environmental Protection revoked Vanco’s subsoil permit for Prykerchenska.

Vanco, in turn, has sent a formal letter of complaint to Ukraine’s Cabinet of Ministers, alleging that the government has been negligent in holding up its side of the PSA. If a mutually satisfactory resolution cannot be reached within 60 days, Vanco will be able to open arbitration proceedings against the government in Stockholm court.

In a press conference today, Tymoshenko stood by her previous assertion that Vanco’s representation in Ukraine, Vanco Prekerchensa Ltd. (VPL), is in fact an offshore structure registered to four female college students. She also asserted that VPL has only tens of thousands of dollars at its disposal, far from the billions eventually necessary for investment into a large-scale Black Sea project. Tymoshenko used the opportunity to lay blame at the feet of President Yushchenko, saying that the crooked deal happened under his watch and amounted to a “RosUkrEnergo-2.” She further justified her the revocation of the permit by suggesting Vanco was in current negotiations to sell off its activities to other companies, including Gazprom.

At a press conference earlier in the day, Vanco’s senior vice president Jeffrey Mitchell dismissed claims about the four students and expressed frustration at the government’s unwillingness to discuss the situation directly with the company. “Gene Van Dyke is absolutely the owner of Vanco,” he said. The practice of assigning a project to a country-specific subsidiary is “absolutely normal,” he added, pointing to the same practice in its African offshore projects. All such subsidiaries are connected by Vanco International Ltd. (VIL), itself a subsidiary of Vanco Energy.

Mitchell declined to expressly describe the ownership structure of VPL, but presumably its main shareholders are VIL and London-based JNR, the private investment vehicle for Nathaniel Rothschild. Vanco and JNR put forth a joint bid during the tender process in 2006 that resulted in the PSA after a year and a half of negotiations. JNR is likely playing the role of financier for the project. (Updated – see below.)

The only instance of four college-aged people associated with the deal, according to Mitchell, were the signatures of four accountants with Ernst & Young that helped with registration services–they are otherwise unconnected to any of Vanco’s activities.

As for questions about financial viability, Mitchell pointed out that the company was drilling two wells in Africa this year, one for about $65 million and the other for $40 million. The company is planning on investing $87 million in the Prekerchenska project this year, with about $60 million of that covering over 4,000 sq km of 3D seismic data collection. Following an open bid process, Vanco is currently negotiating with a seismic mapping firm with the aim of starting this fall. Collection and interpretation of the data is expected to take over a year and any delays could interfere with the company’s drilling plans.

Mitchell said Vanco was expecting to sign a contract for a drilling ship within the week, a process which includes a $30 million letter of guarantee. Drilling of the two wells is expected to cost about $140 million (about $1.2 million / day, 60 days per well), with the first one scheduled for the first quarter of 2010. Vanco is in the process of coordinating with Turkey and Petrobras, who will also be using the same ship for drilling in the Turkish section of the Black Sea. This cooperation is necessary to justify the expense in getting the ship, which will be the largest such drill rig in the world after it is completed in December 2009, through the Bosporus.

Should the government continue with its attempts to strip Vanco of its ability to work on the project, the company is prepared to use legal action to recoup sunk costs. This could potentially cost the Ukrainian government around $100 million. It would also delay any production in the Black Sea for years, as high demand for technically capable drill rigs complicates scheduling.

Tymoshenko also allegedly criticized the terms of the PSA, which she claimed gave Vanco a 90/10 revenue split. Vanco asserted that the ratio for the first phase of the project (until the company recoups its investments) is only 70/30 in favor of the company. Following that point, revenues will be split 50/50, though taxes and royalties are likely to shift that the figure closer to 35/65 in favor of the government. Mitchell claimed the terms of the PSA are more “pro-government” than about 70-80% of comparable deals worldwide and suggested that Ukraine’s inexperience with such agreements is leading to unfounded accusations.

Vanco is also frustrated that the government, by not seating its half of the inter-agency PSA coordinating committee, is interfering with progress on the project. The company is still awaiting approval from the government for its 2008 work program, submitted in February. Vanco has yet to receive even an acknowledgment of its receipt.

The company expressed further frustration that the battle against its activities is being waged through the press–Vanco only learned that its permit had been revoked through mass media reports. It is hoping that the formal complaint and threat of a lawsuit will finally force the government to confront the company with its issues and begin a discussion.

To me, four things suggest Tymoshenko’s crusade against Vanco is much more about publicity and popularity than on sound business sense:

1. Her reliance on the press for communication as opposed to direct talks with the company.
2. The current government’s obvious intention from the beginning to not cooperate with Vanco on the project, as suggested by the lack of an attempt at fulfilling any parts of the PSA.
3. Tymoshenko drawing Yushchenko into the conflict, blaming him for much of the trouble despite the fact that he had absolutely nothing to do with the deal other than to be present when it was signed. The PSA was completely the result of Yanukovich’s cabinet.
4. Her attempts to connect the issue to corruption in the gas sphere (another of her pet issues) by mentioning Gazprom, RosUkrEnergo and shadowy foreign-registered companies.

The sad part is, if they cannot reconcile, both Vanco and Ukraine will end up the eventual losers in this episode.

Update (5/16/08) – From today’s Kommersant (my translation):

Mr. Mitchel said [at a press conference yesterday] that JNR Eastern Investment Ltd. had intended to participate in Vanco Prykerchenska Ltd., but because the granting of the license and the signing of the PSA lasted 18 months, the company [JNR EIL] lost interest in the project.

[Instead] Mr. Mitchel explained that the composition of Vanco Prykerchenska Ltd is made up of his company [Vanco], Rinat Akhmetov’s Donbass Fuel and Energy Company [DTEK], Russian entrepreneur Evgeny Novitsky’s Shadowlight Investments Ltd, and the Austrian investment company Integrum Technologies Ltd [represented at the press conference by Gerhard Eckert], all on a parity basis.

While Integrum wouldn’t divulge whose interests it served, a UralSib analyst Kirill Chuiko told Kommersant that Integrum had in its time acted in the role of an investment intermediary for the Austrian oil [and gas] company OMV. [Edit: An OMV spokesperson responded to my inquiries regarding a possible connection by saying that “There is no connection between OMV and Integrum Technologies Ltd. at all.”]

And from UkrRudProm (my translation):

“Deutsche Bank (fulfilling the role of an intermediary) approached us, suggesting we participate in the project in the role of a financial investor,” explained Maxim Timchenko, general director of DTEK.

The government denied that the annulling of the license was aimed strictly against DTEK [a long-standing rival of Tymoshenko, including in the Dniproenergo affair]. The Minister of Environmental Protection Gregory Phylypchuk responded that, “Independent of which groups will be the investors, a beneficial investment climate will only appear when all the main players legalize their relations with the Ukrainian power [government].”

The government is still refusing the return the license to Vanco. The revelation of investors is seen as a way for Vanco to strengthen its position should the dispute go to court, depriving Ukraine of a “gotcha” moment.

The composition of investors is certainly interesting and it’s too bad that I missed this press conference…

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Government revokes Vanco’s Black Sea hydrocarbon license

Vanco faces the revocation of its Black Sea shelf hydrocarbon project – From vancoenergy.com

On May 8th, Ukraine’s Ministry of Environmental Protection announced it was revoking Vanco Energy’s offshore exploration and production license for the Prykerchenska region of the Black Sea.

Vanco had signed Ukraine’s first ever hydrocarbon production sharing agreement (PSA) last October after a year and a half of intense negotiations, but growing criticism from Prime Minister Yulia Tymoshenko and her government had led to speculation that the deal may be canceled.

Ukraine is apparently willing to allow Vanco to reclaim its license should the terms of the deal be restructured. The company is refusing to reexamine the agreement, however, and is likely to take the issue to international courts.

Revoking the deal will likely push back any Black Sea production for years, while worsening an already jittery mood among international investors.

There is a press conference scheduled for Monday afternoon featuring Tymoshenko and her Ministers of Economics and Environmental Protection, with the revocation of the license as the likely topic. (I have requested permission to attend and will update accordingly. Update: I’m not enough of a journalist for their tastes, so cannot attend. However, I will be going to Vanco’s press conference earlier in the day. Updates from that to follow.)

The Houston-based Vanco was the surprise winner of a 2006 tender giving them exclusive rights to negotiate for the license on the 13,000 square kilometer Prykerchenska region off the Crimean coast. Ukraine’s Black Sea offshore zone is believed to contain massive amounts of hydrocarbons, with Vanco estimating its region alone potentially holding 2-4 billion barrels of oil equivalent. Development of these reserves would help Ukraine wean itself from reliance on Russian oil and gas.

However, production in this deep-water region is complicated by Ukraine’s offshore inexperience and technical limitations. Chornomornaftogaz, the Crimean subsidiary of Naftogaz, lacks the means to drill beyond depths of around 100 meters, while the Prykerchenska zone ranges from about 500 to over 2,000 meters deep. Full-scale production (should the region be fruitful) would likely take tens of billions of dollars.

The combination of these technical and financial hurdles led Ukraine to call for outside investment and employ a PSA to coordinate the project. The process of reaching the agreement was a drawn-out and affair complicated by the government’s inexperience. The final agreement (discussed below) was signed as the Viktor Yanukovich-led government was on its way out of office, to be replaced by Tymoshenko’s cabinet.

In March of this year, the Minister of Environmental Protection criticized the PSA, saying that the tract was too large to give away, especially to such a relatively-unknown company. His calls to reexamine the license were picked up by various Verkhovna Rada Deputies and were later echoed by Tymoshenko herself.

On April 11th, Tymoshenko publicly criticized the PSA, intimating that foul play was involved in the deal and announcing the government’s intention to look into the situation with the aim of restructuring the license.

“Ukraine gave all this wealth away to one company,” she reportedly said. “Meanwhile, the State Finance Monitoring Agency has figured out that this company, it has become clear, is registered in an offshore zone by four female students between 20 and 22 years old.” This off-shore structure, along with the grand size of the area, led her to equate the awarding of the license to a “global crime.”

On April 15th, Vanco’s 80-year old founder and chairman, Gene Van Dyke, gave a press conference in Kyiv to give his company’s side of the story.

Vanco’s founder Gene Van Dyke emphasized his company’s experience in deepwater drilling.

One of his central messages was iterating a desire for openness and clarity throughout the process, and he backed up that goal by clarifying terms of the company’s bid, the PSA, and its work schedule. He also expressed frustration at the government’s comments and lack of support as the company has attempted to move forward in its development plan.

Indeed, Vanco asserted that the Ukrainian government had not contacted them privately regarding its criticisms, instead relying on accusations through the press. This comes even as the government has failed to fill its half of the inter-agency PSA coordinating committee that is supposed to be overseeing the work of Vanco on the offshore project.

Just before the mid-April press conference, the government announced that first deputy PM Alexander Turchynov (Tymoshenko’s right-hand man and candidate in Kyiv’s pre-term mayoral elections) would lead the committee. This position was supposed to be filled by the second of two first deputy PMs, whose duties cover the fuel and energy complex, but Tymoshenko has not filled this role (though at one point Vitaly Gaiduk from the Industrial Union of Donbass was rumored to be tapped for the position). The other spots on the government side of the committee, however, were not filled.

The absence of this committee forced Vanco to essentially proceed with its business plan without explicit approval. This has led to delays and trepidation from the company that they may come under additional pressure.

Van Dyke also emphasized his experience in the oil industry and background as a “wildcatter.” He spoke of the significant potential of the region due to its geological characteristics, while at the same time stressing that there remains critical risk–all of which is being borne by the company, as versus the Ukrainian government.

Van Dyke, an 80-year old “living legend,” is a sharp contrast to the co-eds described by Tymoshenko.

Here’s a rundown of the situation, as described by Van Dyke at the press conference last month:

• Vanco’s bid in the initial tender outlined a three-year initial stage, with the committee committing to investing around $200 million during that time frame. This expenditure comes in the form of at least 3,000 square km of seismic data (budgeted at $60 million) and the drilling of two wells, regardless of the results of this data (at $70 million per well). Van Dyke believes this pledge to sink two wells within the first three years pushed Vanco’s bid above others, which apparently included more conditional language. “We had the most aggressive work program,” he said.
• The plan for the next three years included an additional 1,000 sq km and drilling another two wells.
• Three years after the start of the deal, Vanco is required to release a quarter of the land back to the government. At the end of the nine-year exploration period, the company has to give back everything except for the land surrounding any fields they discover. The government can then give out the returned acreage to other companies through new license agreements.
• The PSA calls for a 70-30 revenue split in favor of Vanco until the point when the company recoups is losses. From that point on, it will be a 50-50 division. However, adding in the 2% royalty and the 25% corporate income tax results in about a 65-35 split in favor of the government, according to Vanco.
• This year’s work program calls for $87 million in investment from Vanco. They aim to complete 4,200 sq km of 3D seismic mapping (above the 3,000 sq km required). After receiving seven bids, they expect the task to cost about $50 million. They hoped to begin in September, expect the mapping to take about seven months, and then plan eight months for reviewing the data.
• Vanco expects to begin drilling in 2010. Turkey’s national oil company and Brazil’s Petrobras are also coordinating in potential Black Sea development. Vanco has agreed to jointly contract a drilling rig with them. The rig, MPF01 (multi-purpose floater) is currently being constructed in China. The topside will be built in Spain, and it is expected to leave the docks in December 2009. Passing through the Bosporus will require a partial de-construction of the large rig. Once in the Black Sea, Petrobras gets to drill the first well, followed by Vanco, followed by Turkey’s oil company, with the pattern then repeating itself.
• The ship costs about $1.2 million per day. With wells expecting to take 60 days, that results in about $70 million per well. If Vanco can get cooperation from the government, by 2010 “we should have some major discoveries off the shore of Ukraine,” Van Dyke said.
• All resources extracted are to be sold in Ukraine (unless the government refuses, and decides to export them). All oil extracted will be sold at world market prices. The price of gas will be pegged to the current import price for Russian / Central Asian gas. (No one knows exactly what will be down there–the geological formations are very suggestive that something is there, though.)
• Vanco has no intention to sell off its license. While Van Dyke admitted that they have been approached, he said they are firmly committed to their work program and developing the area. He also strongly denied the rumor that they would sell off to Gazprom, saying he had never hear anything from the Russian company and wouldn’t sell to them anyway. (Gazprom has no offshore experience anyway, so that idea is rather impractical).

I’m off to Vanco’s press conference, more later.

Gazprom enters Ukraine’s gas market, but overall picture remains unclear

Late last month, Gazprom Sales Ukraine (Газпром сбыт Украина, or GSU) was granted a license by the National Energy Regulatory Commission (NKRE) to sell up to 7.5 billion cubic meters (bcm) of natural gas per year to Ukraine’s industrial consumers. The five-year license was a key part to the March agreement between Russia and Ukraine on the “development of relations within the gas sphere.”

The entry of Gazprom’s fully-owned subsidiary into Ukraine’s gas market was also meant to compensate for the exit of Ukrgazenergo, which previously dominated sales to the industrial sector with a yearly quota of 32 bcm. The removal of this gas trader–50% owned by the state-owned Naftogaz, 50% by RosUkrEnergo, which is itself 50/50 split between Gazprom and two Ukrainian businessmen–is supported by the Ukrainian government. Prime Minister Yulia Tymoshenko has been especially vocal in her opposition to such “middlemen,” seeking to completely liquidate Ukrgazenergo’s (and eventually RosUkrEnergo’s) presence in the Central Asia-Russia-Ukraine gas scheme.

Earlier this year, the NKRE slashed Ukrgazenergo’s quota to just over 5 bcm per year in an effort to drive the trader from the market and open room for Naftogaz’s on gas sales division, Gaz Ukrainy. An additional point in the bilateral gas sphere agreement saw Ukrgazenergo lose another of its key tasks, buying gas on the Russian-Ukrainian border from RosUkrEnergo. This transaction is also being taken over by Naftogaz.

However, the shift towards a greater Naftogaz presence has been far from graceful.

First there was confusion among consumers over whom to pay stemming from overlapping assertions and a muddled legal situation. A cement factory complained that “we in fact have two actual agreements with both companies [Gaz Ukrainy and Ukrgazenergo]. But the ODU [United (gas) Distribution Administration, controlled by Naftogaz] can shut the valve off at any moment.” Citing this reason, the factory decided to pay Gaz Ukrainy despite a fax from Ukrgazenergo asserting ownership over the gas that the plant was receiving.

Indeed, Naftogaz’s control over the gas distribution pipes allowed them to limit supplies to factories hesitating to sign on with Gaz Ukrainy. Such tactics prompted protests in front of Naftogaz’s office and warnings of catastrophic accidents resulting from the decreased gas pressure.

The majority of the protesting factories are set to sign on for supplies from GSU, and interest in working with Gazprom subsidiary–as versus Naftogaz–is reportedly high. About twenty companies sought contracts with GSU, according to a company source, more than the quota would allow for. The attraction apparently stems from a continuation of Ukrgazenergo’s policy of giving the consumers a 10-day payment window as opposed to Gaz Ukrainy’s 100% prepayment terms. Gaz Ukrainy is also reportedly charging a higher price than what the companies paid Ukrgazenergo.

Despite this reorganization, Ukrgazenergo cannot be counted out yet.

An April 18th ruling from the Kyiv district administrative court struck down the NKRE’s limitation of Ukrgazenergo’s sales quota. This decision re-opens the door for Ukrgazenergo, at least partially. “Essentially,” an industry participant told Kommersant, “three major players have emerged on the internal market instead of two.” While it has lost its direct purchases from RosUkrEnergo (essentially, its ability to import the gas), Ukrgazenergo allegedly has about 7 bcm of gas in underground storage that they can sell on the market.

Ukrgazenergo could also purchase gas from Naftogaz for resale to consumers, like GSU is doing now. The margin for sales by Naftogaz to GSU is set at $0.01 per thousand cubic meters (mcm) by the gas sphere agreement, making the price $179.51. It is unclear what the internal Naftogaz-Gaz Ukrainy margin is or how much Naftogaz will sell gas to other market participants such as Ukrgazenergo and smaller gas trading firms (typically with quotas of 1-2 bcm or less). Ukrgazenergo had apparently been charging about $185 before being removed as a middleman.

While the internal market has yet to be completely sorted out, a major obstacle in negotiations with Gazprom has apparently been passed–Tymoshenko announced in late April that Ukraine had (finally) fully paid off its debt for imported gas. This had been a tripping point for nailing down a longer-term agreement between Naftogaz and Gazprom, and hopefully signals the resolution of some of the company’s financial difficulties.

The announcement coincided with the visit to Kyiv by Russia’s PM Viktor Zubkov, his last such trip before he’s expected to be replaced by outgoing President Vladimir Putin. Energy topics were high on the list for discussion between the two Prime Ministers. Ten bilateral priorities were drawn up from the meeting, with the gas issue the second one mentioned (right below WTO cooperation):

The second priority concerns the fact that after regulating tactical gas problems we should turn to the establishment of strategic cooperation. And this second priority – signing strategic long-term agreements on natural gas supplies to Ukraine and transit of the Russian natural gas through the territory of Ukraine to the European countries. It would be better to sign this agreement for 10 and more years in order to see how much prospective and progressive our move toward each other is.

Oil issues also came up (abridged English version):

Ukraine in its turn agreed to work through the conflict surrounding the Kremenchug oil refinery and by the end of April form a working group with representatives from Ukraine’s Ministry of Fuel and Energy, the State Property Fund, Ministry of Justice and Russia’s Ministry of Industry and Energy and the Federal Property Agency “for the preparation of suggestions for the normalization of work at Ukrtatnafta.”

And by the first of July, Russia’s Ministry of Industry and Energy and Ukraine’s Ministry of Fuel and Energy will hold consultations in order to “better the competitive terms of transporting oil” for both transport to Europe as well as supply to Ukrainian refineries without levying VAT.

The two governments will also work on another long-term nuclear fuel deal, despite Ukraine’s plans to buy fuel for its nuclear plants from Westinghouse beginning in 2010 and the country’s aspirations to eventually develop its own supply.

Activity in Kyiv has picked up some since the Easter and May Day holidays, but Friday’s Victory Day celebration is just around the corner.  The extended vacation time has made getting responses and clarifications particularly different.  As people begin returning to work, I’ll keep trying to find out more, particularly in regards to the relatively productive visit of Zubkov and the next step for Ukrgazenergo.