The Ukrainian government has repeatedly claimed it is doing its best to improve
the oil and gas investment climate, but official statements are the opposite
of the reality, as Prime Minister Arseniy Yatsenyuk is leading the great
deception.
According to Prime Minister Yatseniuk, Ukraine has taken a number of important
steps to reform the energy sector, and has even achieved success in the formidable
fight against rampant corruption, as well as signed open and transparent
contracts for purchase of the natural gas from EU member states. Now he claims
Ukraine is looking forward to Western companies' investment in Ukraine's
gas transportation system.
"I would like to point out where we have succeeded: we have succeeded in overcoming
corruption in the energy sector. Billions of dollars, which previously used
to flow into the pockets of Ukrainian oligarchs, are now being brought out
of the shadows. At present, Ukraine purchases gas under transparent and open
contracts with European companies," Yatseniuk recently told a joint press
conference with German Chancellor Angela Merkel in Berlin.
Even the President has made misguided and naïve statements this past
week in Davos, declaring that "...Ukraine will build new ways for receiving
Norwegian gas and gas from Europe, and Ukraine will also produce shale gas."
The stark reality is that these official statements are in no way reflected
by government action, and the gas market players in Ukraine recognize the
deception as does the energy industry as a whole.
The real story is that while gas has been received from Norway in reverse
flows, Ukraine's current energy strategy, taxation and fiscal regime has
forced Ukraine's current producers of oil and gas to stop drilling new wells
and curtail production.
The development of Ukraine's potential shale gas is even further afield with
Chevron announcing its departure from Ukraine and only Cub Energy remaining
in the country as an operator with both technical and local expertise in
developing the shale. Even if shale can be developed in Ukraine it will be
extremely challenging given the highly service-oriented logistical train,
which does not presently exist in Ukraine.
In the course of the last year the Ukraine's private gas producers were doing
their best to overcome, if not merely survive, the consequences of the government's
move to significantly increase fiscal and administrative pressure on the
industry without any consultations with the latter. The government failed
to deliver on its promises, and the only thing it managed to achieve was
an undermining of any trust the industry may have had in it.
Ukraine's current regulatory and fiscal systems governing the energy sector
are overly complicated and non-transparent, even without the major political
and military conflict with Russia and annexation of the Crimea. The implications
have been significant. Since last year, all major oil and gas projects in
Ukraine have significantly slowed down at best, and been suspended entirely
at worst.
Issue by issue, the lies continue to mount.
Rising Taxation
The government recently raised the tax burden on private natural gas producers
twofold (55% of the sales price - for the natural gas extracted from deposits
up to 5km, and 20% - for the natural gas extracted from deposits deeper than
5km), instead of implementing long-awaited market reforms. Notwithstanding
its own promises for this to be a temporary measure by 1 January 2015, at
the initiative of the Ministry of Finance, just a few days before the New
Year, Parliament rendered the tax increase permanent--in violation of the
Parliament majority's Coalition Agreement.
It is interesting to note that the practicability of these high rates was
based on the calculations and official data of the Ministry of Finance for
the old huge fields that had been explored and developed in Soviet times
by state-owned oil and gas companies, while the gas producers were deprived
of the opportunity to present their own figures and assessments for the new
wells drilled on their smaller fields. The government simply brushed the
matter aside, stating that the costs and expenses claimed by the investors
were inflated.
Most poignantly here, the figures suggested by the Ministry are so wildly
out of line with the facts that even state-owned oil and gas companies refuse
to acknowledge them. Recently state-owned Naftogaz calculated the economical
production cost of natural gas extracted by its subsidiary, Urgazvydobuvannya,
up to UAH 5,430 [USD 344] for 1,000 cubic meters (excluding VAT), which is
much higher that the data submitted by the Ministry of Finance (according
to which the gas production expenses do not exceed UAH 230-240 [USD 14.6-15.2]
per 1,000 cubic meters).
Investors Are Ready for Cooperation, Not the Government
Private gas producers have been open about their costs and expenses. Some
of them are actually publicly traded companies (JKX Oil & Gas, Serinus
Energy, Regal Petroleum and Cub Energy), and their financial data is open,
transparent and publicly available. Over and over again investors sent letters
to the Ministry of Finance, with a call for cooperation and open dialogue,
demonstrating the relevant figures and presenting underlying documents and
statistics. For some reasons the Ministry chose to ignore their efforts and
declined any suggestions to establish a joint working group on this matter.
Instead of working closely with the industry the Government has already pushed
independent businesses out of the gas market by introducing Naftogaz's monopoly
on gas supplies to large industrial consumers. This is because the government
has been trying desperately to ensure financial support for the eternally
cash-starved Naftogaz. Forcefully redirecting the financial flows from gas
consumers in favor of Naftogaz was a small-minded, short-sighted remedy.
Such administrative measures shocked the Energy Community, which demanded
explanations from Ukrainian officials as such measures completely contradict
European 3rd Energy package.
Corruption in the Energy Sector
No need to say that such a state of affairs only encourages corruption in
the country. In spite of the Prime Minister's promises and assurances to
the contrary, the energy sector is still the biggest source of corruption
in the Ukrainian economy.
Repeated reports by the IMF, the World Bank, and the International Energy
Agency (IEA) bring up the issue of corruption in the energy sector. They
strongly recommend abolishing price subsidies and cross-subsidization, as
well as raising gas prices to a level that will at least cover the production
costs of the state producers. Ukraine's system of gas subsidies for households
has long been abused by the gas distribution companies that are able to buy
gas intended for households at subsidized prices and sell it to businesses
at much higher market prices, with a 200-400% margin. The estimated budget
losses exceed hundreds of millions of dollars per year. No need to say that
the existing system only further destabilizes Ukraine's economy and puts
enormous pressure on Naftogaz and its subsidiaries, at whose cost these subsidies
are cross-directed by the Government.
No Reforms, No Success
It is obvious that the measures and steps taken by the Ukrainian Government
have nothing in common with successes and reforms claimed by Arseniy Yatseniuk,
as neither doubling tax rates and serving the oligarchs' interests nor corruption
and monopolization of the gas market correspond to the recommendations given
by the Energy Community and IMF to Ukraine. Despite repeated announcements,
implementation of the reform has been held back by fear of losing the electorate's
support and approval of the oligarchs' groups. Under the mask of nominal
fight with the oligarchs the Government takes populist decisions and the
Parliament adopts killing laws. One must admit that the Government seems
to be unwilling to undo the money-making mechanisms in the energy sector.
Given the desperate situation in which Ukraine finds itself today, it should
have become extremely committed to the proper development of its domestic
gas production, as that would introduce some extra volumes of the gas produced,
in addition to 20 bcm domestically, into the local market to satisfy Ukraine's
ever-hungry annual consumption of around 53 bcm. This would also allow Naftogaz
to save some foreign currency reserves on buying imported gas in lesser volumes,
including gas coming from Russia. As a result, financial pressure on the
state budget and government (which attempts to plug Naftogaz' deficit by
any means necessary - including loans from state-owned banks, international
financial institutions and currency reserves of the National Bank of Ukraine)
could have been significantly lowered.
Instead, the government has directed its actions against independent gas producers
and the continuing crackdown is severely affecting both the country's energy
independence and its currency reserves. The massive fiscal and administrative
burden and lack of investment in the national gas extraction industry will
only result in further decline of gas production, worsening of economic conditions
and a higher degree of Ukrainian dependence on Russia. Ukraine's short sighted
policy moves ensure that investment in the sector will cease and attracting
new capital will become nearly impossible as Ukraine will be viewed as hostile
based on it's treatment of businesses currently operating in the country.
The revenues that the government hoped to generate from taxation of the oil
and gas companies with the concomitant politically popular taxation of the
oligarchs is proving to be a failure, as its actions are not only killing
the independent gas production industry in the country, but are in fact depriving
Ukraine of the opportunity to become a strong, energy independent economy.
Without implementation of the necessary reforms, the Ukrainian energy sector
will continue to be the nursery of corruption and playground for blackmail,
which Russia enjoys greatly.
