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“Ukraine is an ‘eyes-wide-open’ country, it is definitely open for business”

Interview - May 29, 2013
Opportunities in tapping Ukraine’s rich resources run deep, from the petroleum and gas-rich bedrock of the Black Sea to the professionalism of its people, who have been lauded as “very well educated, very hard working and conscientious” by Dr Jim Bown, President of Ukraine’s Vanco Prykerchenska Ltd. In an interview with Globus Vision, Dr Bown highlights the potential in Ukraine’s oil and gas industry and Vanco’s planned exploration and development activities over the coming years.
As you know Germany is the first international stable partner with Ukraine. 15% of bank investment in Ukraine comes from Germany. We are talking about $7.6 billion. With the signing of the EU Association Agreement a new phase and a new way of doing business can start to develop. We want to tell German businessmen that Ukraine is getting stronger. Where are the opportunities for German investors to come here?
Look at the asset side of the equation. Agricultural potential, natural resources – potentially Ukraine has large amounts of minerals and natural gas. There is no reason that in 10 years’ time the country cannot be self-sufficient in energy. The government is improving the energy sector by improving the legislative base, which will encourage investors to come in. However, the greatest resource is the people. They are very well educated and very hard working and conscientious. Clearly Ukraine has world leaders in subjects such as computer science, mathematics and programming. The country and the people simply need the chance that investment would give. Given the right opportunity, investment, and guidance they will produce things very easily, efficiently and cost-effectively.
I am looking to understand the energy sector. The energy sector at the moment is import gas dependent; you have fracking looking to come online here by 2018 and the Russians looking to manoeuvre advantage. How does it all work? 
Ukraine does not produce enough gas to satisfy its market, but it can supply around 25% of its needs. This means that the country still has to import gas from Russia, but less and less every year. Ukraine is progressively reducing its gas consumption and slowly increasing its domestic production. However, oil is short, and the downstream in Ukraine is very complicated because there are a number of refineries most of which have some level of private ownership. Although there is private participation in each of them, some of them are not working at all. Unfortunately the refineries are not yet geared up to produce European standard fuels. Lukoil are just about to sell their refinery to a private group here. Kremenchuk is a joint venture between Ukraine and Tatneft. That has had problems although it is Ukraine’s biggest refinery. Ukraine’s refining sector clearly needs a lot of attention and a lot of investment especially in upgrading refinery technology. 
And the majors are not looking at doing that? 
Apart from TNB-BP there are no Western majors involved in Ukraine’s refining industry. The main interest at the moment is not the downstream but the upstream. Ukraine needs to be energy independent from the upstream point of view and to do that they need two things. They need a lot of foreign investment and a lot of technology and that is where the great investment opportunities lie. 
In the past the legislative base was rather difficult and complicated, but that is being improved consistently by the government since 2010. A key step of that improvement is the development of a mechanism called production sharing. The first production sharing agreement in the oil and gas sector was signed by Vanco on October 2007 and refers to a deepwater area of Ukraine’s Black Sea. More recently in Davos in February 201, Shell signed a production sharing agreement for the development of unconventional gas onshore in eastern Ukraine. Chevron is also negotiating a production sharing agreement for shale gas in western Ukraine, and Exxon Mobil is leading a consortium with Shell and others to develop another deepwater area in the Black Sea. 
The production sharing mechanism is very good because it is designed to protect investors and give stability and predictability for as long as it takes. Most of the productions sharing contracts are for 30 years duration with the possibility of a 20-year extension option. In the Vanco case, in terms of the total value of the project when you consider everything over the 30 year period of the agreement, the State will get a little more than 70% of the total value of the project and Vanco will get a little under 30% from the project. Due to confidentiality reasons I cannot go into the details. But it is a good deal for Ukraine considering Ukraine does not take any financial risk at all.  All the risks are carried on the investor side. 
RWE is Germany’s biggest energy player in Ukraine and is interested in Ukraine’s oil and gas sector.
Are they also involved in LNG? 
Currently I am not aware that RWE is doing anything in LNG here in Ukraine. One of Ukraine’s current National Projects is the building of an LNG terminal on the Black Sea coast. I hope they get it done. It is a very ambitious project.
LNG is liquid natural gas. The Ukrainians are hoping to get LNG supplies for the new terminal from Azerbaijan or perhaps from Qatar. The problem with supplies from Qatar is that this will require LNG carriers to sail thorough the Bosphorus, which is already overcrowded with shipping and where the Turks may be reluctant to give permission for major shipments of a rather hazardous natural gas cargo. 
The alternative LNG supplier could be Azerbaijan. Gas would go by pipeline from Azerbaijan into an LNG production facility on the Black Sea coast of Georgia and then by LNG tanker to Ukraine’s LNG terminal. This is a longer-term project and it may never happen because Ukraine’s own resources of natural gas could prove to be extensive. Not only have they got the base for conventional gas, but also the potential for substantial amounts of unconventional gas. That is why Shell will spend around US$400 million on exploration in eastern Ukraine. Chevron will probably spend a similar amount in western Ukraine. There are potentially huge natural gas resources, not to mention what might be offshore, where there also could be large reserves of gas. 
So if all these moving parts come together Ukraine may not only be energy sufficient, but also become a net exporter to Europe. Ukraine will be a stable and reliable exporter, particularly if they sign the European Association Agreement, and eventually become a member of European Union. 
The Russians stand to lose out from the energy independence of Ukraine. How does that interfere with what is happening now?
There is no evidence of Russian interference in terms of Ukrainian ambition for energy independence. However, if Ukraine becomes energy independent that will dramatically change the geopolitics of the region. That is all I can say. 
We can already see the impact American shale gas has had on global gas dynamics. You can analyse the effects of this on prices. Gas prices globally are starting to come down. LNG is becoming much more available to Europe. In the US they built a number of plants on the eastern seaboard, which are similar to the proposed Ukrainian re-gas plant. Probably these are not needed now because the US is not importing LNG anymore. Consequently they are starting to convert some of the re-gas plants to LNG production units so they can export LNG produced from shale gas rather than import it. 
Qatar also has developed extensive LNG exporting facilities, so has Australia. Australia will sell towards Japan and China. There is a lot more availability of gas than there used to be. Some of it is coming into Europe. Maybe six months ago two things became clear. The spot price for gas in Europe was less than pipeline prices, which led to some renegotiation of gas supply contracts. There were some arbitration court cases concerned with gas supply contract disputes that were resolved outside the courts. But the consumers have managed to reduce their prices, or renegotiated the prices. 
In terms of the interest for our readers on how to make an impact here, you have talked about the need for FDI and the need for technology. Germany would not be a traditional powerhouse in E&P, but technology has always been its forte. What areas do you see of being of opportunity for the Germans, especially relating to technology in oil and gas? 
RWE is Germany’s biggest energy player in Ukraine so the best people to answer that would RWE themselves. Business has been rather slow so far for RWE. They are still negotiating projects. But because they are a major company here they will have an important role in Ukraine’s energy sector. They are a very good company. 
These days in the West, everybody has access to the same technology. Even Vanco has the same access. If we were to drill a deepwater well, we would use the same technology and facilities that Shell and Exxon Mobil would use. There is only one way to do it, which is to contract a deepwater drilling vessel in the Black Sea and do your drilling. Some companies use their own vessels and technology to do that and others outsource. All of this technology is available in the West, but not all of it is available in Ukraine. For example, Ukraine cannot operate very easily in water depths much more than 100 metres, which is within 20 kilometres of the coast. After that the, Black Sea deepens dramatically – too deep for current Ukrainian technology.
I have this picture of the Black Sea. It is a satellite picture and it provides a picture of how the Black Sea would look if empty of water. You can see in a model sense how dramatic the change is from rather shallow waters within a few miles of the coast down to more than 2000m in the middle. 
In our contract area the water is two kilometres deep. One well in such deep water will cost us more than $150 million. In the first three years of our project we are committed to drilling two deepwater drills. For the first three years we will acquire 3D seismic data and analyse it to select two well locations. We have to get it right. If there are no hydrocarbons at the bottom of the well there will be no asset value, so it will all be financial losses. Based on global statistics, the chances of success with a deepwater well are no better than about 20%, which means the chances of failure in your $150 million well is 80%. So why do it? Well, because if you do find oil or gas it is likely to be substantial and will be very valuable indeed – perhaps tens of billion of dollars. 
It is said that the Ukrainian Black Sea is one of the world’s last great untapped offshore hydrocarbon provinces.
These are the words of Gene Van Dyke, the founder and former owner of Vanco Energy Company, and one of the more famous figures in the global oil and gas exploration scene.
We did our research. You described it as having as much potential as what the North Sea has. 
That was an earlier statement to illustrate the hydrocarbon potential of Ukraine’s Black Sea. It could be less but it will probably be much greater than the North Sea.
The size of the blocks is interesting. 
Some opponents have stated that the blocks are too big. But to justify the expense and the risks of deepwater exploration, large blocks are needed to maximise the chance of investors making discoveries. 
It is an expensive game of battleship you are playing. 
Yes. People say why do you do it? It is a matter of the old maxim “high risk - high reward”. Providing the rewards will be great enough, the risks will be worth taking. This is what makes the exploration business so exciting and challenging. An old American friend of mine from the industry said to me once: ‘Hell Jim, you don’t drill wells on your own money, boy!’ He was right. Accordingly we use a range of financial instruments to finance our exploration projects. But it will be difficult to raise the finance if the prospectivity case is weak or inadequate. 
You made a point about drilling on somebody else’s money. All of this is capital intensive. Vanco’s project hopefully will resume activities this year. I think you have said you will not need financing during the first three years. 
That is up to the shareholders and investors to decide. The commitment for the first three-year exploration period is for us to shoot a minimum of 3,000 square kilometres of 3D seismic data, which will probably cost around $45 million, then the second year will be spent analyzing the seismic data and selecting two well locations. The third year will be drilling the two wells. The budget will be around $40-60 million in the first year, $30 million in the second year, and then $350+ million for the third year. Most wise companies would already be analysing how much do we want to do ourselves and how much do we want to use external financing. How much of the project do we want to share? Everybody will constantly evaluate these options. That is normal. 
Are you are open to foreign investors?
I cannot say that. It is up to the shareholders and investors what they want to do and how they want to do it. It is true that Vanco is currently evaluating its strategic options going forward. But having resolved the dispute with the government we can now move on. Once the legal formalities involved in the settlement with the government have been completed, we can contemplate starting the exploration work. We have waited for four years for this and we are now going to work with the government to get this thing done.
What would be the financing institutions that would roll in behind these projects?
Investment funds, private funds and funds specifically available to the petroleum industry. The oil industry knows where to get the money. It is very specialised. There are many means to do it. Both debt and equity transactions can be considered. 
Can you give us your message for German investors? You have come to the country and flourished here. What advice would you give for someone coming in to invest?
This is an “eyes-wide-open country”. Nobody is saying that it is easy to do business here, but Ukraine is definitely open for business and in spite of difficulties, business can be done successfully here. Because Ukraine is an “eyes-wide-open country” foreign investors need to have a presence here, or engage someone here to represent them who know what they are doing. Over the years I have learned how to do business in Ukraine. I will be happy to help German investors get established in Ukraine and to find potentially attractive investment projects in which to become involved.