Category Archives: Exploration

More seeps out on Vanco’s partners

Update (9/21/08): A bit more on Khmelnitsky, the alleged figure behind Integrum, is appended below.

A very intriguing article in today’s Eurasia Daily Monitor by Myroslav Demydenko digs into possible organized crime connections to one of the investors in the Vanco-led Black Sea oil and gas project.

Through an offshore subsidiary, the US-based Vanco makes up about 1/4 of the joint venture established to run the development of the 13,000 square km offshore tract.  The other partners were revealed to be the Rinat Akhmetov-owned DTEK, the anonymous Austrian investment firm Integrum Technologies (more on them later), and Shadow Light Investments, owned by Evgeny Novitsky–who, according to Demydenko’s article, has connections to a Russian mafia outfit:

According to a number of reports in the press and the book Darkness at Dawn-The Rise of the Russian Criminal State by David Satter (Yale University Press, September 2004), Evgeny Novitsky is alleged to be a member of, or very close to, Russia’s Solntsevo organized crime gang.

Satter wrote that Solntsevo had close ties to a Russian company called Sistema [I would classify being “director” as having “close ties”], which is linked to Moscow Mayor Yuriy Luzhkov and to the IVK, the information technology company, of which Novitsky was director. Solntsevo, working through the company SV-Holdings, eventually came to own a large share of IVK.

… Kommersant wrote on July 22, 1997, that an unnamed official of the FBI had revealed the names of three individuals suspected of being “shadow bankers” for the Solntsevo mob, one of whom was Evgeny Novitsky.

There are more connections and citations listed by Demydenko to reiterate Novitsky’s supposed connections to the mob, including tantalizing references to infamous gangster Semyon Mogilevich, who some claim is in deep with RosUkrEnergo.

As for Integrum:

Integrum Technologies has refused to disclose its main investors, and Vanco executives have admitted on a number of occasions that they do not know the identities of the owners of Integrum…Evidence suggests, however, that Kyiv Investment Group, a company owned by Ukrainian oligarch Vasyl Khmelnytsky, is one of the hidden partners of Integrum.

Update (9/21/08): Khmelnitsky is a former Tymoshenko supporter who has since switched over to the Party of Regions.  However, their separation was reportedly relatively amicable and without scandal.  Khmelnitsky’s main investments are within the Kyiv property sector.

Meanwhile, the Cabinet of Ministers passed a resolution to divide up another large Black Sea shelf plot into 33 smaller sections, rather than license it off as one large structure.  OMV had reportedly early expressed interest in the project, but it’s unclear how this–and the ongoing scandal surrounding Vanco–could affect their viewpoint…

A pattern…

Update (8/8/08): I’ve appended a quote from today’s Ekonomicheskie Izvestia article on Marathon’s quiet exit from Ukraine.  The article also includes a funny caricature featuring Tymoshenko

Gas production from independents is flat

The Vanco situation is pretty well documented.  Other stories are less so.

Following its London IPO in June, Cadogan Petroleum saw its share price plummet when two of its licenses were called into question last month by the Ukrainian courts.  (In 2007, the EBRD had purchased a 5.2% stake in Cadogan as a way to help promote independent oil and gas production in Ukraine.)

In July, the Naftogaz subsidiary Chornomornaftogaz announced the annulment of offshore agreements with CBM Oil and Shelton Canada Corp, two other small-scale oil and gas producers.

A similar announcement was made in June regarding cooperation between the US-based major Marathon Oil and Chornomornaftogaz.  Now Marathon is packing up its Kyiv office and leaving Ukraine.

In all, 73 subsoil licenses have been revoked by the Ministry of Environmental Protection, with another 83 still under threat.  The majority of these were granted in 2006-7, under former PM Viktor Yanukovich’s government.  Back in December, the new Yulia Tymoshenko-led government announced plans for a major check of all licenses, in an alleged attempt to root out “speculators” who were sitting on valuable reserves but not investing into their development.

When Tymoshenko came to power in 2005, she made a similar push.  By February 2006, 504 licenses granted between June 23rd and December 31st, 2004 (again, under Yanukovich), had been revoked.

Rooting out corruption is one thing; shooting yourself in the foot is another, a point that President Yushchenko seems to be trying to make as he cites problems with foreign investor relations at Kryvorizhstal and the new terminal at Boryspil airport.

Ukraine seems to be struggling at reaching a balance between making the country attractive for foreign investment, preventing corruption from spreading, and engaging in revenge by attacking past moves made by political opponents.

Meanwhile the oil major Shell continues to have a presence in Ukraine, both with downstream retail and a exploration and production joint venture.  The company has committed $100 million for developing a project in the Dnieper-Donets basin, but it remains in the early stages (seismic surveys are expected to be completed by next summer, last I heard).

Successfully implementing this project, with potentially a couple hundred million tons of oil equivalent at stake, would be a huge boon to Ukraine’s foreign investment climate, and might make up for some of the pummeling it’s been getting lately.

Update (8/8/08): From today’s Ekonomicheskie Izvestia article “Marathon left on the sly“:

An industry specialist within the Ministry of Fuel and Energy structure told Ekonomicheskie Izvestia that, “Marathon decided to close their Kyiv office and leave the market without any extra noise in order to not attract any extra attention to the event. They got tired of waiting for progress in negotiations with the Ukrainian government for further cooperation and decided to end the study of their posible perspectives within the country. Marathon’s mood was also negatively affected by the problems with the license of the American company Vanco for work on the Prykerchenskaya section of the Black Sea.”

Ukraine suggests talks with Vanco even as government prepares its case

Ukraine’s government has expressed willingness to hold talks with Vanco, so long as the oil exploration company drops its international arbitration suit. At the same time, an analysis by Kommersant of the government’s case against Vanco suggests that Ukraine’s argument, which includes accusations of corruption, may hold up in court.

According to Deputy Justice Minister Yevgeniy Korniychuk speaking on July 30th:

“Our position is that we will immediately hold consultations with Vanco Prykerchenska Ltd., as soon as they suspend their suit.  We have turned to Vanco with a request – if they want to continue talks, at first it is necessary to suspend the suit for 60 days, and than we will talk.”

This suggestion is similar to one delivered by mail to Vanco right before the company became eligible to file arbitration proceedings.  At the time, the letter had been sent to Vanco International Ltd (VIL).  Korniychuk’s direct address to Vanco Prykerchenska Ltd. at his press conference on Wednesday may be a concession aimed at pulling both sides to the negotiating table.

However, it is clear that the government is against any involvement for VPL–which includes in its ranks VIL, Rinat Akhmetov’s DTEK, and two investment firms–in the future of the Black Sea shelf development.  According to Korniychuk, in the event of a amicable resolution, they would be willing to allow VIL to take part in some sort of project:

“We are not arguing the right of Vanco International, which won the competition [to sign the PSA], to develop the shelf.  They can return to it, though maybe with some other commecial terms.  But the shelf certainly won’t be developed by Vanco Prickerchensaka.”

In the past Vanco has stated its openness to hold negotiations, both during the 60 day period necessary before filing for arbitration, as well as during the beginnings of the proceedings themselves.

While Vanco may acquiesce to this pause for talks, they will likely grumble about it as well.  After all, the government was rather quiet during previous 60 day period, which was initiated by an official letter of complaint sent by Vanco to the government and meant to begin a dialog.

Should no settlement be reached and the case proceeds to the Stockholm arbitration court, it appears that Ukraine has a fairly solid argument on its side, according to Kommersant.

The government’s case, which was prepared in March by the law firms Astapov Lawyers and Barlow Lyde & Gilbert, has two prongs: the first concerns violations of Ukrainian law; the second alleges corrupt elements within the deal.

The first prong concentrates on the relationship between Vanco International and Vanco Prykerchenska, alleging that the transfer of the PSA from the former to the latter was against the law.  Indeed, this point has been one of the more questionable acts in the saga — how could VIL win the tender, negotiate and sign the PSA, and then pass off the deal to a separate entity that contains three new players?

Vanco has asserted it was within its rights to do so.  Ukraine’s case argues that this is against the law, saying that a separate agreement had to be reached first.

Other issues within this branch of the argument:

  • While Vanco International of Houston registered to particpate in the PSA tender, Vanco International of Deleware won it.  This allegedly violates article 7 of Ukraine’s law on production sharing agreements. Delaware has a listing for Vanco International Ltd in its corporations databse. Texas has a Vanco International Inc.  From what I’ve heard, Vanco has admitted that VIL is registered in Delaware, despite press reports placing it in Bermuda (the location of VPL) or the Virgin Islands.
  • Vanco International’s application was not submitted in full, violating a regulation concerning the tender.  This apparently includes “providing contradictory information regarding its whereabouts, ownership, jurisdiction and financial status.”  Besides the confusion over locations mentioned above, VPL was created with only $12,000 in initial capital, while pledging to invest about $330 million.  Vanco secured a letter from Citigroup saying the company would attract necessary funds by holding an IPO, but it turns out that this move was planned for VIL, not VPL.  Therefore, “in reaching the decision on determining the winner of the tender, the inter-agency commission was relying on misleading information, a violation of part 1, article 230 of the civil code.”
  • According to the PSA regulations, the company was apparently not allowed to have a stake higher in the production than 50%; the PSA signed by Vanco has it receiving 70% during one phase of production.
  • Part of the area granted to Vanco overlaps with the military training ground Chauda.  As such, Ukraine’s Defense Department should have been involved in the deal.  While the agreement apparently stipulated that Vanco would pay $37 million for the relocation of the training ground, the situation is still “inconsistant with the law on ensuring security of the state.”
  • According to point 34.13.1 of the PSA, which concerns double taxation, Vanco could avoid paying any taxes to Ukraine, thus dropping the government’s share of production.

The government appears to be slightly worried over how these violations will be accepted by the Stockholm court.  There is also the possibility that the joint investment protection agreement reached between Ukraine and Britain may be enacted, due to Bermuda’s status as a British protectorate.  This agreement is investor-friendly, shifting additional burden onto the government’s case.

In response to these worries, there is a second line of argument based on corruption within the deal.

After it emerged that DTEK is involved in the project, observers immediately began questioning if illegal influence could have affected the outcome.  (Actually, ever since the relatively little-known company Vanco won the tender, beating out some other heavy hitters, there have been suggestions that something has been going on behind the scenes.) DTEK is owned by Akhmetov, who is a member of the Party of Regions in parliament — the same party as Viktor Yanukovich, Prime Minister at the time the PSA was signed with the government.

The government’s case calls for two past employees of Vanco International, former vice president John Gorman and former head of production Gabor Tari, to give evidence in favor of Ukraine.  It’s fairly easy to guess the gist what that evidence may be, but for now, it’s just conjecture…

Tymoshenko, Vanco offer wildly different stories on Black Sea project

Tymoshenko accused Vanco of shennanigans.(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…

Government revokes Vanco’s Black Sea hydrocarbon license

Vanco responded to Tymoshenko's criticism on its Black Sea shelf hydrocarbon project - From

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.

Ukraine’s new government outlines hydrocarbon license examination plans

Ukraine's new government looks to changes at the Fuel and Energy ministryIn one of the earliest ministerial-level strategies to be unveiled, Ukraine’s newly-formed coalition between the Bloc of Yulia Tymoshenko (BYuT) and the Our Ukraine – People’s Self-Defense (NU-NS) parties outlined its plans for the country’s oil and gas sphere.

Besides preparing to take oil transport monopoly Ukrtransnafta public, the government hopes to sign a long-term contract for gas purchase from Central Asia. Currently, Ukraine’s national energy firm Naftogaz no longer buys gas directly from Central Asian countries, instead relying on the gas intermediary RosUkrEnergo. This maligned trader coordinates the purchase of the gas and its transport through Russia, as well as its resale to Ukraine. Breaking back into direct negotiations with Central Asia (despite relying on the region for about 3/4 of its gas imports, Ukraine lost this position a few years ago) may help Naftogaz in its own talks with Gazprom on Russian gas supplies.

Also discussed in the strategy (which I’m attempting to obtain a complete copy of) are plans to re-examine the results of oil and gas producers to determine if they are adhering to their license agreements, specifically in regards to their upstream investment plans. Those firms that are not pumping in an adequate amount of investment or producing the necessary volumes will be stripped of their license, which will be then be given to other companies who promise closer adherence with the government regulations.

BYuT deputy Mikhail Volynets, who previously suggested a re-examination of Regal’s licenses, is quoted as suggesting that these moves are expected to boost production 5-7% by 2009. From Korrespondent (my translation):

“We can’t increase the volume of production of oil and gas in the country when companies holding the production licenses don’t invest enough in deposits [fields]. The majority of them received licenses for further resale. We plan to return to the government the licenses and transfer them to companies which will fulfill the investment conditions and conduct the extraction of oil and gas.”

One analyst suggests that this will bring about a similar situation to Russia in 2004, when a crackdown via stricter government enforcement resulted in a consolidation (and contraction) of operating oil and gas producers in Russia from about 300 to around 40. Large firms were able to scoop up the licenses for the fields operated by under-resourced smaller companies unable to follow the clauses of the licenses — or unable to pay the necessary bribes.

Ukrainian license holders, however, have apparently threatened to protest any such action with law suits, with one directer of a smaller producer warning that this plan will result in the survival of companies only with “political influence and financial resources.” While ideally, the producers would be financially successful enough to have the necessary financial means, the director may also be referring to money for extra-legal protection from a loss of license. There are also questions of the legality of this plan, which is based on how explicit the investment conditions were stipulated and how confidently their fulfillment can be estimated.

The outgoing government has already made it difficult for many oil and gas producers, forcing them to sell their output to a pre-ordained buyer for a capped price. While these are attempts to keep domestic energy prices low, it has also resulted in decreased capital available for investment, leading to this current attempt at essentially government-mandated investment. However, the plan doesn’t seem nearly as viable as commercially regulated investment, i.e. firms injecting money into their projects because they expect it to earn them more in the future. A combination of tightened finances and an unclear political / economic horizon has instead led many firms to concentrate on the short term.

BYuT representative Volynets (second from bottom) has an extensive background in the coal industry and is an accomplished labor rights organizer — a feat, considering some of the conditions present in Eastern Ukraine. Given his high level on the party list and these recent comments, it would seem that he may be a favorite to succeed Yuri Boyko as Minister of Fuel and Energy when the new Cabinet of Ministers is sworn in. However, he may also be a candidate for the Ministry of Labor and Social Policy, leaving the door open for someone else from the ruling coalition — so long, of course, as the two parties can cooperate enough to actually form a functioning government…

Shell backs out from investing in Ukraine via Regal

Location of Regal's gas field liscense in Ukraine - From 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…