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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