Vikoil searches for shale gas deposits in the Lugansk region
Vikoil searches for shale gas deposits in the Lugansk region © Bloomberg News

The public, and policymakers, often don’t really understand the motives of economic actors such as, for example, oligarchs and energy companies. The common view is that it’s all about the cash. No, it’s all about the cash and the discount rate on that cash. How fast do you want, or need, your money back and your minimum acceptable profit on that money?

If prospective partners’ discount rates, or, to look at it another way, time horizons, are compatible with each other then there’s a good chance they can make a deal, assuming they both agree the cash is there to be had. Right at the moment, investors and US domestic gas directed exploration and production companies don’t seem to be matching up in this way. Not with gas at $3.50-$4.00 a mmbtu in the American market. Nor can money and onshore gas drilling get together in the EU, even with natural gas selling at $9.50 to $11.00. The time horizon on getting any public support or regulatory approvals for drilling is too far away, in truth not even visible.

In Ukraine, though, gas-directed independent North American exploration and production companies, the Ukrainian government, and even the previously obstructionist local oligarchs finally seem to have converging interests and compatible discount rates. Since there are already gas prospects that can be better developed than they have been, an extensive domestic pipeline network, and a gas price on offer at about $12 per mmbtu – that’s around three times the US price – the material pre-conditions are also present.

Contrary to the common perception outside North America, the major international hydrocarbon companies have not been the principal developers of new gas resources. The majors have, historically, waited for small and midsize independents to find new fields, do the initial development, make all the mistakes and take any early losses, then acquired the reserves by buying out the independents.

The North American independents would like to be able to stay within an afternoon’s flight of home and just develop new domestic fields of high priced oil. Unfortunately for them, there are very few North American oil prospects on offer.

So for all the talk about the “ shale gas boom” in the US, the gas-directed onshore rig count has dropped by over 52 per cent in the past year; the comparable Canadian rig count is down by over 40 per cent. Backlogged completions and connections of already drilled wells have kept gas production high and prices low, even with the fast decline rates of shale wells.

In the previous couple of decades, there were North American independents who attempted to make a go of it in Ukraine. There were a lot of disappointments. What US officials call “local private interests”, ie the oligarchs, were not interested in having anyone else making money in their manors. So, customs problems, permitting problems and so on would emerge.

Two forces have worked to change this environment. First, Ukraine’s key strategic assets in negotiating for Russian-supplied gas, the pipelines connecting Russia to European markets, are being increasingly bypassed by expensive, Russian-sponsored pipelines, first under the Baltic, and soon under the Black Sea.

Second, the Ukrainian oligarchs have now been around long enough that they have developed time horizons, and, therefore, discount rates, beyond the month to month, or year over year threshold that led to all those barriers to foreign companies’ entry. Even an utterly ruthless ethnic Russian Donbass industrial oligarch needs reliable, cheaper gas for his factories and smelters. Russia’s recent strategic success with alternative pipelining has reinforced this point.

Yuriy Boyko, Ukraine’s energy and coal minister, has been quite effective in applying the new discount rate dynamics in working out unconventional gas (shale and coal bed methane) development deals with Chevron and Shell. Both companies are applying their American experience to delineating the Ukrainian resources for long-term development. That takes a lot of drilling and geology, since the existing data are inadequate. But the companies don’t seem too worried now about the risks from politicians or oligarchs.

The Ukrainian gas prices are high enough to pay for the costs of shale and coal-bed gas, which are much higher than conventional gas. Unconventional gas will have a local market, by replacing Russian imports. The lead times for unconventional development though, are too long to provide immediate support for Ukraine’s chess game with Gazprom/Russia.

So Mr Boyko is moving on to encourage mid-size North American exploration and production companies to work with local partners such as Naftogaz, the state company, to redevelop existing conventional fields. Such deals have the prospect of producing rapid paybacks of gas (for Ukrainian industry), cash (for the drillers), and strategic advantage (for Ukrainian government negotiators).

As he says, “It would be a very good time for mid-size exploration and production companies to get started here. Now that gas is cheap in America, they should go somewhere where they can get a better price. We need dynamic mid-size onshore drilling companies, and we will explain to them how secure they would be here now.

“We’re ready to make joint venture with them …We can organise these very quickly.”

There are alternative onshore gas plays in the world, of course. But most of the possible reserves don’t have a nearby market with a developed pipeline and road system. So Ukraine’s outreach to the gas independents has a good chance of working. Consider that $3.50 to $12.00 price gap. Eventually it has to close from both directions.

john.dizard@ft.com

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