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October 2, 2006 8:48 pm

John Dizard: Ukraine’s offshore prospects

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The prospects for western investors in Ukraine, particularly the energy sector, appear to be getting worse under the coalition government led by Vitor Yanukovich that took office in early August. The development of the Black Sea offshore oil and gas prospects seemks threatened by a “resource nationalism” that could be a cover for transfers to new oligarchs.

Governments should push for the best deals possible for nationally owned resources. Norwegian and Dutch negotiators are known for their pitilessness (and honesty) in dealing with oil companies; not a bad model for Ukraine. However, Yuri Boyko, the Ukrainian minister for fuel and energy, has insisted Ukrainian state-connected companies take the lead in developing the Black Sea.

If we were talking about companies with the technology and integrity of, say, Norway’s Statoil, that would be realistic. As one oilman operating in Ukraine’s onshore patch (who has no offshore capability himself) says: “There are only five companies in the world that could develop a deep offshore prospect such as the Black Sea. For the energy minister to say he wants Ukrainian companies to develop this is absurd. They can’t even maintain their production for onshore wells. If they wanted to hand over control of the country’s hydrocarbons to Gazprom, this would be the way to do it.”

Under a controversial tendering process concluded by the Ukrainian government in April, a consortium of Vanco International, run by Gene Van Dyke of Houston, and Nathaniel Rothschild’s JNR Eastern Investment received the right to negotiate a production sharing agreement (PSA) covering 12,900 sq kms of the Black Sea. Neither Vanco nor JNR EIL have the internal operating capability to conduct seismic exploration and drilling; assuming the PSA negotiations are concluded, those functions would be subcontracted. “That should have been divided into much smaller blocks,” says our Ukrainian oilman, “and the process should have been made entirely transparent, which it was not.”

Mr Van Dyke says: “I met with Boyko [after he took office] and his concern was ‘why don’t we do this ourselves’. Well, they have drilled on their shelf down to 40 metres. Our block is from 400 metres deep to 2,200 metres deep.” It is only in the past five years or so that even the largest and most technically capable companies have implemented the technology for such deep drilling.

One US energy expert specialising in Ukraine says while major western energy companies could develop the Black Sea, their participation has disadvantages for some Ukrainian politicians. “If major western companies get involved in Ukraine, they will have to open up the black box of their policies and all sorts of cockroaches will come out. Who gets access to local customers? Who gets what prices for your production? Who gets access to pipelines and how do they get it?”

Yulia Tymoshenko, former Ukraine prime minister, and opposition leader, could benefit from internal opposition to the government’s energy dealings.

The expert says: “By now there is no one other than Tymoshenko to lead on the transparency issue. She is speaking on behalf of good government, of asking why Ukraine needs middlemen and shadowy deals.”

The Ukrainian oil operator says: “Her (Tymoshenko) attitude is that Ukraine should have half of any production from a deal with western companies. That is perfectly acceptable, and what the industry is accustomed to working with in the rest of the world. At least she wanted to bring in western investment to the energy industry, and believe me they can’t do it themselves.

“Look at the operating capability of the Ukrainian companies Boyko is talking about. It takes them about five times as long to drill onshore wells as it does in the west. Their equipment is terrible. There is no effective service industry here yet. Ms Tymoshenko seems to understand that . . . ”

Mr Van Dyke, who is optimistic he will be able to work out a PSA with Ukraine by his December 1 deadline, admits it will be difficult and expensive to fulfill the contract. “There aren’t any drillships operating in the Black Sea now. The drilling situation in deepwater is now horribly tough.”

Steve Pifer, senior adviser on Russia and Ukraine with the Center for Strategic and International Studies in Washington, and the former US ambassador to Ukraine, says: “I don’t think the government is really interested in negotiating a deal with Vanco. The issue for energy minister Boyko is not what gets done but who does it. If it’s going to be done by people he doesn’t control, he doesn’t want to do it at all.”

There is good news here for one group: Gazprom investors. Ukrainian energy policy could almost be designed for their benefit. It is not that Gazprom will likely take over the three dimensional seismic shoots, the exploratory drilling and production at thousand-meter depths. Who knows, though? It could come in as a financial partner. More to the point, delays in exploiting Ukrainian national resources would mean the country would remain dependent on Russia, or Russian transported imports, for decades longer.

■After I mentioned the Iridium LLC defaulted bond play in this space a couple of weeks ago, the judge delayed the next court date for the creditors and Motorola, along with his summary judgment decision. In the meantime, the bonds are up about 5 percentage points. I think they are an interesting play, and that the creditors have a fighting chance, but do not allow your children to try this trick at home. It is for professionals prepared to write off the position.

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