Boosting Domestic Gas Production, a Solution for Ukraine

August 19, 2015 | 00:00
Boosting Domestic Gas Production, a Solution for Ukraine
Boosting Domestic Gas Production, a Solution for Ukraine
Ukraine significantly decreased its gas import from Russia last year due to diversification from European countries. “It is very good news that Ukraine is able to diversify its gas supply. The worrying news is that this diversification again comes from imports instead of increased domestic production” says Nicholas Tymoshchuk, Director of the Representative Office of the Ukrainian League of Industrialists and Entrepreneurs in the EU and formerly working for Chevron and TNK-BP in Ukraine, in an exclusive interview with Slovak energy analyst Jozef Badida.

JB: Ukraine has been trying to reduce its domestic gas consumption since the beginning of the price dispute over Russian gas. Consumption decreased in 2014 by 16% from 50.4 to 42.6 bcm. Moreover Ukraine has been successfully replacing Russian with European gas. Is this good news?

NT: Yes, it is good news. Ukraine has been one of the most inefficient gas users in the world for the last two decades. Its usage of gas in relation to its GDP has been the highest in Europe and among the highest in the world. We consumed up to 60 bcm per year generating far less GDP than, for instance, neighbouring Poland, which is of comparable size, or other big European countries like Germany, France or the UK.

In general, the reduction of gas consumption in Ukraine is a positive fact, but the underlying reason is not that the government has implemented a successful energy efficiency policy or found replacement for gas. This difference is the result of our plummeting economy. We have a contracting GDP and a war in Eastern Ukraine. This region was a huge, huge gas consumer because of the high number of industrial enterprises situated there.

JB: I see your point, not energy efficiency measures but lower productivity led to the decline of gas consumption. But what about the replacement of Russian with European gas? Is that a positive change?

Nicholas Tymoshchuk
Nicholas Tymoshchuk

NT: I think that competition and diversification are, in general, good things. Any sane person and especially any businessman would like to have several sources of supply. So it is definitely very good news that Ukraine is able to diversify its gas supply. The worrying news is that this diversification comes again from imports instead of increased domestic production. Our European partners made a lot of efforts and faced difficulties with Gazprom in their attempt to provide Ukraine with alternative sources of gas supply. And they did with some success. We should be grateful to the EU and we are. At the same time we must realize that it is just a temporary solution. A long-term sustainable solution should be boosting domestic production.

JB: Actually that is my next question. You've said elsewhere that oil and gas fields are a key factor to ensure Ukrainian energy security but we haven't seen growth of production volumes. Why? What are the challenges?

NT: It is because the hydrocarbon sector in Ukraine is not market driven. It is not a market as such. It is dominated by state controlled monopolies that have proved, over 20 years of Ukraine’s independence, to be disastrous. They are not able to take the Ukrainian oil and gas industry forward. I am not criticising any individual politicians, managers or companies, but the system in which these monopolies, like Naftogaz and its subsidiaries, operate. The biggest cancer of this system is cross-subsidies. They have been subsidised for subsidising their consumers. It is a vicious circle that must be undone. Though it is very painful for the population it is what the government is now forced to do under pressure from the international financial institutions.

JB: I will return to this question later on but first I would like to go into the oil and gas drilling industry which is capital intensive. In order to reduce fiscal deficit, Ukraine has increased gas royalty – a tax paid by companies producing natural gas. Is it sustainable? How can the business environment be improved with regard to production of hydrocarbons?

NT: We have to acknowledge and live with simple facts. To start with, Ukraine does not have tremendous hydrocarbon resources like Saudi Arabia, Russia, Iran, Iraq, UAE or the USA. Moreover, hydrocarbon production in Ukraine is plagued by inefficiency, lack of new technologies, high taxes and a very difficult entry to market for private investors. Ukraine has potentially enough hydrocarbons to be self-sustainable, but they are not easy to access. They are either small, scattered, shallow fields like those in Western Ukraine or they are deep, difficult to access, high pressured fields like in the Poltava region, or they are hydrocarbons trapped in special formations like tight sands, shale or coalbed horizons in some regions of both Eastern and Western Ukraine. Basically, all those reserves are expensive to explore and develop. This means that the only reason why an investor would come and take the risk of a 3 to 7-year exploration period to assess whether these reserves are recoverable or not and then be ready to spend 10 to 50 years for a production period, is because you incentivise them. You provide financial conditions under which investors would be ready to take the risk and bring in (or bring up in Ukraine) skilled workforce, experience, know-how, advance technologies, etc. For instance, subsoil fee increase in Ukraine in 2014 was meant to be a temporary measure to cover the budget deficit of a country being in a state of war. But in the end private producers in Ukraine were fooled, since this temporary solution turned out to be a permanent one. I am not sure whether a reduction or even reinstatement of previous rates would encourage new investors to come because they have been faced with outrageous instability and unpredictability.

JB: Have you observed any companies leaving the country due to this situation of instability and unpredictability?

NT: Yes, I have seen companies leaving the market or at least putting their production or exploration projects on hold. Both local producers and international companies have done that. But I do not want to name any of them due to sensitivity of the issue. It might cause them some legal and reputational problems.

Nicholas Tymoshchuk serves as Director of the Representative Office to the EU for the Ukrainian League of Industrialist and Entrepreneurs (ULIE) – the biggest association of the Ukrainian business – based in Kyiv and Brussels. Prior to ULIE, Nicholas managed Government Affairs activity for the world's second biggest public energy company Chevron in Ukraine. Before Chevron, he spent five years in Russian-British oil and gas giant TNK-BP on a position of Director for International Affairs, and before that five years in American-based political and charitable NGOs.

JB: In the second part of the interview we will speak, among other things, about a potential privatisation of Naftogaz, the Ukrainian oil and gas Champion and Mr. Tymoshchuk´s sceptical view on Russia's intentions to route gas flows intended for Europe via Turkey to bypass Ukraine. In this respect he believes the Ukrainian corridor “remains the cheapest, shortest and most convenient route for Russia to transport its hydrocarbons to the EU”. Regarding a progressive phasing out of gas subsidies, a hotly debated topic in Ukraine, he admits that “Ukraine has no other way than increasing its tariffs” incentivising citizens to become more energy efficient.
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