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No cheap gas in 2021: Why Ukraine cannot increase blue fuel production?

Author : Olena Holubeva

Source : 112 Ukraine

Ukraine has finally failed the task of abandoning imported gas by the end of 2020, which would have contributed to lower prices for natural gas
21:40, 29 December 2020

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By the end of this year, about 20.3 billion cubic meters of gas will be produced, which is no more than even in 2014, when 20.5 billion cubic meters were produced. Despite all the statements and declarations of the authorities, it was not possible to increase gas production either in the state or in the private sector. The outgoing year has drawn the final line under the many years of "dancing with a tambourine" in attracting foreign investors to the gas industry: it is already clear that in the coming years, domestic companies will remain the main players in it.

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 Why are gas prices growing in Ukraine?

With the slogan "Get off the Russian gas needle" at the end of 2015, Ukraine broke off relations with its partner, the Russian Gazprom.

At the time of the termination of Russian gas supplies, Ukraine produced 19.9 billion cubic meters of gas from its own subsoil, and consumed 33.8 billion cubic meters. Missing 13.9 billion cubic meters needed to be replaced. There was little choice: either it was expensive to buy in Europe, which did not break off relations with Gazprom, or to increase gas production from the Ukrainian subsoil. The latter would be logical - the cost of a cube of gas produced in Ukraine fluctuates around 100 euros at already developed fields (brownfield), and some companies may have even lower price.

However, due to the fact that Ukraine covers a third of its needs by expensive gas, which it buys in Europe, even cheap Ukrainian gas is sold at the import price - not less than 200-300 euros.

The state-owned Naftogaz, which (through its subsidiary Ukrgazvydobuvannya), accounts for about 70% of all domestic production, did the same. Until August 1, 2020, the NJSC was selling gas extracted from the Ukrainian subsoil for the needs of the population at a price that was calculated using a formula tied to import parity. Remarkably, one of its components was transportation from a hub located near the German town of Dusseldorf (NCG). The transport component was also introduced into the "Amsterdam +" formula.

"I always conventionally give an example that gas is produced in the Poltava region and is conventionally supplied to a sugar factory located five kilometers from the field. The price for it is determined in such a way as if this gas was produced in the USA, brought in liquefied form by tanker to Europe, regasified and only after that they were delivered to Ukraine", the director of ExPro Consulting, Gennady Kobal, illustrated the situation.

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In recent years, the population has been buying gas at a price not lower than 200-300 euros per 1,000 cubic meters with delivery, despite the fact that the decree of the Cabinet of Ministers secured the obligation to sell exactly the gas produced by Ukrgazvydobuvannya in Ukraine.

Officials from the blue screen were broadcasting with might and main that if the dependence on gas imports could be reduced to zero, the market would be reoriented to export parity, which would help lower gas prices. How this could work, we can see now, when the Ukrainian facilities are filled to capacity with gas. This, of course, is not domestic gas, production of which has not been increased despite the slogans, but imported. Nevertheless, the volume in the underground storage facilities is large.

The gas used to fill the Ukrainian underground storage facilities was mostly imported during the price collapse. It was bought in the equivalent of 100-200 euros per 1,000 cubic meters. "Ukraine has not been importing gas for two months now, since the underground gas storage facilities are full. As a result, our prices are now on average 10% lower than in Europe," Kobal said to 112.ua.

If Ukraine produced gas in the amount of its annual demand or even more, a similar principle would work, which would help reduce gas prices and their sensitivity to fluctuations in external markets.

"A country that has gas resources should extract them. Due to gas from domestic subsoil, it will be less dependent on price jumps in foreign markets," the vice president of the American Sigma Bleyzer fund in Ukraine (together with Aspect Energy won competition for the development of the Varvinsya gas-bearing area) Vadym Bodaev said.

How the authorities promised to increase production and who failed it

The result is disappointing: the promises of officials to refuse gas imports remained empty words. By the end of this year, Ukraine will produce about 20.3 billion cubic meters of gas, said Artem Petrenko, executive director of the Association of Gas Producing Companies of Ukraine. For a second, this is even less than in 2014, when 20.5 billion cubic meters were produced. For 9 months Ukraine produced 15.2 billion cubic meters of gas, which is 1.85% less than in the same period last year.

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The situation in recent years has been pulled out mainly by private traders represented by companies of Ukrainian oligarchs. "Private companies were able to increase production by 7% thanks to the drilling of new wells over the past two years. State-owned companies remain at the level of production last year. In general, the volume of drilling in the country has dropped by 4 times over 11 months. We forecast that the state-owned companies (Ukrgasvydobuvannya, Ukrnafta) will remain at last year's figures or, perhaps, they will slightly decrease. Private companies may grow within 5%," Petrenko said to 112.ua.

The financial capabilities of domestic private companies are limited, including by the economic situation within the country, and the high cost of debt capital for Ukrainian issuers. As 112.ua has repeatedly written, in the gas production industry in Ukraine, it is mainly companies of Ukrainian oligarchs who operate in this way: their recruitment has not changed, in recent years no one has managed to get rich to the level of moneybags known throughout the country and far beyond its borders.

And they don't have much free money either. Eight electronic auctions for the sale of gas-bearing areas did not take place this year. There were no interested investors in the exposed areas. "This year, two auctions were held for oil and gas plots, one of which became a record one. We are talking about the Budishchansko-Chutovska area, which was bought by DTEK Naftogaz at transparent electronic auctions", said Artem Petrenko to 112.ua.

To reduce dependence on imported gas, the authorities relied heavily on Ukrgazvydobuvannya (as we remember, it belongs to Naftogaz and produces about 70% of gas in Ukraine).

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In 2016, the 20/20 Strategy was approved, according to which Ukrgasvydobuvannya was to increase gas production to 20 billion cubic meters per year in 2020. In accordance with the concept for the development of the gas industry adopted at the same time, it was assumed that in general (together with private companies) Ukraine would produce 27 billion cubic meters. And with the condition of reducing the volume of gas consumption by the country to the same 27 billion cubic meters the country will come to a complete rejection of imported gas. Note that the decrease in consumption was expected due to the implementation of energy efficiency programs, which also failed miserably. Falling gas consumption to the current 30 billion cubic meters occurred only due to a reduction in industrial production, due, again, to an unfavorable economic situation.

The state-owned company has not yet announced the results of its activities in 2020, but experts are confident that the results will not be higher than last year's and may even decrease.

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And all would be fine if billions from the budget had not been allocated to Ukrgazvydobuvannya under the fairytale of increasing production and achieving independence from gas imports. During 2016-2018 the company invested about UAH 40 billion, of which about 60% was spent on drilling and 30% on modernizing obsolete facilities and developing competencies.

Why there are no prospects to increase gas production

The authorities tried to attract foreign investors. They have their own considerable finances and would not ask for money from the budget by announcing a tender for the transfer of oil and gas fields on the basis of production sharing agreements. Investors received immunity from changes in the regulatory environment (rent, taxes, benefits) for 50 years. In addition to domestic companies and the ubiquitous Ukrgazvydobuvannya, six foreign investors announced their participation in the tender. It was rumored that the competition was closely watched by the "father" of the shale revolution in Texas, ex-US Energy Secretary Rick Perry. It should be noted that after leaving in 2014-2015 of the world giants Shell and Chevron, foreigners in the field of gas production were represented rather modestly. The company Cub Energy operates in Ukraine, the largest shareholder of which is Mikhail Afendikov, a native of Eastern Ukraine, who has become a US citizen. The company is implementing, in particular, a joint (50-50%) project with the Slovakian Nafta at the Uzhgorod gas field.

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"Very promising areas were put up for the tender. In fact, this was the largest sale of oil and gas production assets that we have seen over the past 8 years," Kobal said to 112.ua.

If agreements with the winners of the tenders were concluded quickly and they would start work this year, Ukraine could reach an output of 30 billion cubic meters (equal to the current consumption) already in 2025. In other words, without allocating billions from the budget, but on the contrary, replenishing it, the country could increase production by almost 10 billion cubic meters of gas, against the background of the fact that Ukrgasvydobuvannya was unable to increase its production.

The agreement on land has not been signed so far.

"We hope that by the end of this year PSA agreements (onshore) will be signed, because the final deadline is January 12, 2021. The legislation provides for the possibility of a one-time extension of the deadline for signing by six months, but the Cabinet of Ministers has already used this option when it extended the deadline this summer. That is, the PSA must be signed by January 12, 2021. If this is not done by that time, it is difficult to say what will happen to the plots. The last word will remain with the authorities: will a new tender be announced or the plots will be transferred for sale at an auction in the Prozorro system, it is up to them to decide," Artem Petrenko said to 112.ua, noting that to transfer the plots to auctions, they will have to be split up, since the areas are huge.

All this bureaucracy will take time again!

“The process of negotiating PSA agreements really intensified two months ago, when the Prime Minister gathered all the ministers and said that it is important that he controls the process. And then it all started. Before that, the process was sluggish: either the ministers changed, or the commission did not could have been approved after the change of government, Vadym Bodaev told 112.ua.

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The Cabinet of Ministers gave the shelf to Naftogaz without any competition. The tender for the development of the huge area of ​​the Black Sea shelf "Dolphin" was attended by the Azerbaijani Socar, which has vast experience in the production of hydrocarbons on the shelf of the Caspian Sea, and the Trident company of the Russian politician Ilya Ponomarev, who managed to gather a pool of interested investors for the project. However, its results were canceled.

“Who prevented from giving the shelf to Naftogaz right away - by a separate resolution by the government or by law? Why did they need to hold a tender? Nobody says that Naftogaz should have been discriminated against. But it has promising areas on which it could develop. Authorities could attract non-budgetary money, reducing risks to the budget: no one is insured against dry wells (for the drilling of which funds were spent, but they were without gas, - ed.)", says Vadym Bodaev.

Note that drilling one well to a depth of 4,000 meters onshore costs about $ 5-7 million. On the deep-water shelf, these costs are much higher. Again, where will Naftogaz get the money?

This year, the Canadian Vermilion Energy, which had planned to participate in gas production at the sites put up for the competition with Ukrgasvydobuvannya, left. Whether this is due to the fact that in a year and a half the PSA process has not moved off the ground, it is difficult to say. The press service of Naftogaz explained the reasons for Vermilion's decision by falling gas and oil prices, the coronavirus pandemic and the global economic downturn. The company itself did not comment on its activities in Ukraine at any stage.

The year 2020 has drawn the final line under the many years of "dancing with a tambourine" in attracting foreign investors to the gas industry: it is already clear that in the coming years, domestic companies will remain the main players in it, Kobal said.

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And it seems that Ukraine lost the chance to attract foreign money, due to which it could increase gas production and reach a stable export parity price. "The difficult situation in the field of gas production, which we are witnessing now, was provoked by the pandemic and the crisis. Due to Covid-19 and the record drop in hydrocarbon prices, investors, including foreign ones, began to look very carefully at new projects. And this problem is not only in Ukraine. You can see that the leading oil and gas companies, the largest majors Shell, ExxonMobil, Total, Eni, receive billions of dollars in losses, "cut" their investments, optimize. This also affects large service companies, which in the absence of orders, are forced to cut staff," said Artem Petrenko.

“The outgoing year has shown that investments in the oil and gas industry are determined by the level of prices for the resource. If prices for gas and oil are high, Ukraine is interesting to investors, and if prices fall, then investor interest in any country (and ours is no exception) decreases. In addition, the main income of companies is the sale of gas, and if prices for it fall, the ability of companies to generate cash falls. In addition, Ukraine is not so attractive for investors in terms of both the availability of hydrocarbon reserves and in terms of their availability for retrieval, " agrees Kobal.

Against this background, Naftogaz's assurances that they are better than the Cabinet of Ministers will be able to come to an agreement with foreigners do not inspire much confidence. “We do not have to invest ourselves or act one hundred percent ourselves. In today's environment of low gas prices, it is likely that it will not be possible to take many partners on board in the short term. The country runs the risk of being late with investments. Naftogaz is your agent to speed it up," said Kobal.

In an amicable way, the state approach should be different. The largest consumers of gas are the agricultural, chemical and metallurgical industries - the backbone of the Ukrainian economy.

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