Government revokes Vanco’s Black Sea hydrocarbon license

Vanco responded to Tymoshenko's criticism on 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 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.

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