About 24 hours after announcing a preliminary deal worth $410 million with UK-based oil firm Regal Petroleum, Shell pulled out of the agreement citing Regal’s surprise management shift. David Greer, the former head of Shell’s Sakhalin-II project, was tapped to replace Regal’s chief executive and chairman, both of whom resigned after news of the deal with Shell was announced — despite a general consensus that the agreement was a sound move for the firm. After Greer took over at Regal, he gave an interview to the Financial Times that seemed to call into question Shell’s involvement:
Mr. Greer said he planned a “dramatic” increase in drilling in Ukraine, with the aim of “markedly” increasing proved reserves.
“We have to evaluate this Shell offer and compare it against other funding mechanisms,” he said.
An article in the Nov. 26th edition of the Ukrainian daily Kommersant cites a source within Regal suggesting that Greer was seeking a price for a 51% stake in the fields that was 10-15% higher than what was agreed upon with Shell.
Shell, in announcing its withdrawal, cited the uncertainty caused by Greer’s comments.
“The management change … at Regal was not expected by Shell, and we see from the new management’s comments that they may have changed their thinking on this transaction,” Shell said.
Greer, while generally acknowledged as a competent and experienced manager, faced criticism over a stirring motivational email he sent out to his Sakhalin team earlier this year (that was later leaked), especially after it became obvious that some of the most bombastic statements (“lead me, follow me, or get out of my way,” etc.) were copied from speeches made by US WWII general George Patton. His removal — and the cancellation of this recent agreement — has been linked to a conflict with Shell’s chief executive of exploration and production, Malcolm Brinded. However, the above-mentioned Kommersant article cites a source within Gazprom as saying that Greer left Shell over a “personal conflict between the leadership of Shell and Gazprom,” likely stemming from the confrontational relationship between the two major energy firms over the Sakhalin-II project.
Frank Timis, who founded Regal but was forced out as head of the firm following a much-hyped oil field in Greece turning up dry in 2005, is cited by The Times as orchestrating the negation of the deal by bringing in Greer with the expectation that Shell would then back out:
One source close to the company claimed that Frank Timis, who was convicted in the 1990s for possession of heroin and who controls 20 per cent of the company’s [Regal’s] shares, may have orchestrated the termination of the Shell deal.
“Frank didn’t like the deal with Shell – he thought they were getting assets on the cheap,” the source said. “He thought the best way of breaking it was to get rid of the executives who had negotiated it and replace them with two that Shell had got rid of.” [Hendrikus (Harry) Alardus Verkuil, another former Shell employee, was also appointed as executive director of Regal’s board, effective January 15th, 2008.]
Regal has had problems in Ukraine for a while now, and has yet to produce any significant amount of gas there (see below for recent production figures). In 2004, it was granted a license to the Mekhediviska-Golotvschinska and Svyrydivske gas and condensate fields, but has been mired in legal trouble for much of the past few years. Timis — without the knowledge of the board or shareholders — apparently granted an option for buying the gas rights to the two Ukrainian fields to an unknown Hong Kong firm in June of 2005, which the Chinese company attempted to invoke following Timis’ dismissal from Regal. While Regal was eventually able to cancel the option in 2006, the firm was facing a court battle in Ukraine over the original grant of the license. According to the suit, the fields were to be given to Chernihivaftogasgeologia (CNGG), a subsidiary of the Ministry of Environmental Protection, which had originally awarded Regal the license.
However, on one last appeal to Ukraine’s supreme court, Regal enlisted the help (possibly through the influence of Timis, who was still a significant shareholder in the firm) of the Ukrainian consultant Dmytro Gelfendbeyn by offering him, through his firm Alberry Ltd., a 15% stake in Regal for about $200,000 that could then be repurchased for $51 million in the event of a favorable court decision.
In December of 2006, the supreme court granted the rights to Regal, and in June of 2007 Alberry Ltd received nearly 14 million of the firm’s shares, which were then worth about $60 million. (The transaction is described as a “non-cash charge” of $48.9 million in Regal’s 2006 annual report.) Later, it became known that CNGG and Nadra (a Ukrainian state-owned hydrocarbon exploration firm) were themselves major shareholders in Alberry. As of August 31st, 2007, Alberry — with Dmitro Gelfendbeyn acting as the controller — still held those shares (.doc), representing about 10% of Regal.
I am unfamiliar with this particular case, but it sounds like a fairly straight-forward bribery (or perhaps “settlement” is the right word?) situation — CNGG will agree to not aggressively pursue its case before the supreme court in exchange for a significant share in the firm. The shares to Nadra may have been included to help facilitate future cooperation with Ukrainian exploration projects. (I have contacted Nadra to ask for confirmation on their involvement, and am awaiting their response.)
Following the resolution of Regal’s litigation, production at the fields was once again ramped up, and ended up averaging 110,000 cubic meters of gas and about 450 bbls of condensate per day by the end of 2006, grossing the company $11 million for the year. The two fields, according to the firm’s 2006 annual report, have estimated proven and probable reserves of 23 billion cubic meters of gas and 25,000 Mbbls of gas condensate (totaling 169 MMboe), making the fields an attractive target for more thorough development. Regal’s “conceptual plan” has production reaching about 6.8 million cubic meters per day (about 2.5 billion cubic meters per year) and 8,800 bopd by 2016.
This potential led the company to actively seek additional partners for boosting production at the fields, the licenses to which it holds through 2024. The current set-up has the Ukrainian state firm Ukrnafta operating the six producing wells, while Regal — as the license holder — receives 7% of the total revenue. Despite the already lengthy legal proceedings, the Ukrainian government may yet try to re-examine Regal’s right to the fields — further complicating the picture for attracting outside investment. According to the Nov. 26th Kommersant article noted above, BYuT representative Mikhail Volynets said that following the establishment of a new government, “this question [of Regal’s ownership of the licenses] could be raised anew.”
Foreign investment in Ukraine’s energy exploration industry already took a hit when a decree took effect earlier this year, mandating that all natural gas produced through a shared venture with a state-owned entity be sold to Naftogaz at a capped price. The decree has already forced out independent firm Cardinal Resources:
“Populist actions taken by the Ukrainian Government – Decree 31, increased taxes and royalties – made all of Cardinal’s JAA gas sales subject to a disputed but mandatory price cap and, since January 2007, all JAA gas produced has been stored, resulting in a significant reduction in both the earnings of the company and its liquidity,” [Cardinal CEO Robert] Bensh added.
The decree, which was passed in late 2006 and came into force early this year, obligates companies in JAAs with the state, or majority owned by the state, to sell gas to the state-owned oil and gas company Naftogaz Ukrainy at a fixed government rate of around $1.50 per 1,000 cubic feet – a fraction of the current market rate of $4.80 per 1,000 cubic feet. According to Bensh, the rate is even below the company’s production costs.
Shell is also pursuing a $100 million venture with state-controlled Ukrgazvydobuvannya, and may face the constraints of this law when they begin extraction:
“Decree 31 does not currently affect Shell’s exploration activities, which are just entering the seismic study phase. However, should these studies prove successful, and Shell and its partner begin producing gas, it will have an adverse effect on the project’s ability to remain profitable and sustainable,” Shell’s spokesman in Ukraine, Antonius Papaspiropoulos, told the Post.
The aim of the decree was to boost cheap gas flowing into the state energy firm, boosting the troubled company’s budget as it continues to struggle financially due to low collection rates and subsidized prices to the public. However, it will also likely result in reduced production due to inadequate investment and increasing jitters among potential foreign investors (quoting again from the Kyiv Post article):
“The government achieved two goals by adopting Decree 31 and increasing taxes: It subsidized state-owned energy consumers and attracted additional funding into the state budget,” [Bensh] said.
Volodymyr Nesterenko, an analyst at Kyiv-based investment bank Concorde Capital, said the government decree was meant to ease the effect of increases in domestic gas and heat prices.
“It [the government] needed a sufficient volume of gas, about 30 billion cubic meters (bcm) a year, at a low price. Only 21 bcm is produced by all domestic companies, so the more gas the state can get at a discount, the more ability it has to restrict growth in prices,” he said.
Naftogaz is facing serious financial difficulties — a few weeks ago, Fuel and Energy Minister Yurii Boyko struggled to convince Eurobond holders that the company was not about to default. According to an Oct. 31st article in Economicheskie Investia, the state-owned company’s gross revenue for the first half of 2007 dropped 22.7% from the level for the same period of 2006. Combined with the recent debt scare to Gazprom and uncertain future price levels for natural gas via Russia (article still in the works — and a resolution still in waiting…), Naftogaz could use any help it can get in investing in Ukraine’s energy resources.
It’s too bad that a foreign firm, operating under a generally accepted joint venture agreement, scares off a potential major investor due largely to circumstances outside of Ukraine’s control. Of course, rumblings from the government about re-examining the convoluted issue are also damaging to the situation. We’ll see who else may step up to the plate…