Shareholders’ clash with Naftogaz Ukrainy is just the start

The Ukrainian state monopoly of upstream operations is under quiet but persistent challenge – most recently from private shareholders in the main oil producer, Ukrnafta, who are at daggers drawn with the state oil and gas monopoly that controls it, Naftogaz Ukrainy.

A scheduled shareholders’ meeting was cancelled for the second time on 15 November after private investors holding 41% of Ukrnafta boycotted it. The clash was sparked by the private shareholders’ demand to have more seats on the board, but industry sources say it may be fuelled by a quarrel about who refines Ukrnafta’s oil.

Ukrnafta’s oil, most of which is produced in Poltava in eastern Ukraine, goes to Kremenchuk refinery, which is owned 50% by the state and 50% by Tatneft of Russia. But one key private shareholder, Dnipropetrovsk-based Privatbank, would prefer Ukrnafta oil to go to the Naftokhimyprykarpattya and Halychyna refineries in western Ukrainian that it controls jointly with Watford Petroleum of the UK.

Privatbank’s campaign is supported by Ukrsibbank, a structure that is close to Millhouse Holdings, the holding company through which Roman Abramovich, owner of Sibneft, controls his industrial empire.

Valentin Sovetov, analyst at Alfa Capital Ukraine, said: “Ukraine has disproportionately high refining capacity, and the two western Ukrainian refineries are now short of crude oil supplies and sometimes idle for weeks on end. They would prefer to refine Ukrainian oil than imported Russian oil because it is cheaper and of higher quality.

“The dispute is pivotal in terms of the developing business environment too: for the market as a whole, because Ukrnafta is Ukraine’s most liquid stock, and for oil production in particular, in the sense that private investors are clashing with the state interests that dominate the sector.”

While Privatbank challenges Naftogaz Ukrainy on the equity side, small production and exploration companies are encroaching on upstream operations through joint ventures and joint activity agreements.

The state-controlled companies still dominate: Ukrnafta produces 94% of Ukraine’s crude oil and 18% of its natural gas; Ukrgazvydobuvannya (a wholly-owned subsidiary of Naftogaz Ukrainy) produces 74% of the gas; and Chornomornaftogaz (also wholly-owned) deals with oil and gas exploration and production in the Black Sea and Azov shelves. But private involvement is increasing slowly.

One hopeful signpost for the future is Ukraine’s only significant upstream service provider, Nadra Resources. Andrew Zagorodnyuk, business development officer, said the company is strong in the markets for seismic and geophysical services, logging equipment and well workover equipment. The company had a strong trading arm in the mid-1990s, but withdrew from that business, as did other companies, when gas trading was centralised by Naftogaz Ukrainy in 1998.

The largest private production company is JKX of the UK, which has a 66.2% interest in the Poltava Petroleum Company, a joint venture with the State Property Fund of Ukraine that last year produced 6,000 barrels of oil equivalent, about 73% of which was natural gas.

JKX also has a joint venture with Chornomorneftogas, the Crimean Petroleum Company. In July Chornomorneftogas reported commercial oil and gas reserves in a region of the Black Sea over which Ukraine and Romania are in territorial dispute but in which Crimean Petroleum Company has sole rights on resolution of the border.

Canadian-owned Carpatsky Petroleum is in the Ukrcarpatoil jv at the Bytkiv-Babchinsky field, which last year produced 3,280 tonnes of crude oil and 2413 tcms of natural gas. It is also developing the Rudovsko-Chervonozavodskoye field in the Dniepr-Donets basin.

Canargo Energy, a UK-Canadian production and exploration company also active in Georgia, is expanding its presence in Ukraine. It has a stake in the Boryslav Oil Company, a jv with Ukrnafta to develop the Stynavske field near L’viv in western Ukraine, and in April this year bought Lateral Vector Resources of Canada, one of whose main assets was an interest in development of the Bugruvativske field at Sumy, north-eastern Ukraine.

Substantial barriers to large-scale investment remain, however. The business climate is poor, the legal framework untested and, in the case of gas, the export market is to all intents and purposes closed to foreign companies.

The western majors, several of whom looked at projects in Ukraine in the mid-1990s but pulled back from commitment, are unlikely to return until there is movement on these issues. And for Russian companies, who now control 90% of Ukraine’s refining capacity, it makes business sense to buy downstream infrastructure but not to initiate upstream projects.

JKX chief executive Paul Davies said: “We export oil to Poland, selling at a discount to Brent, and sell gas at $1.25 per thousand cubic feet into the Ukrainian market. We have managed to find private customers who are reliable payers – but it is a notoriously difficult market.

“Ukraine has more gas than oil. If western companies are to come in and develop it, they will find it difficult to raise the project finance on the scale required unless it is guaranteed by export contracts.”

Jim Bown, who runs an energy industry consultancy in Kiev, says there will have to be improvements in the business environment as a whole for significant oil and gas projects to move forward. “Ukraine’s oil and gas industry has suffered from a serious lack of investment since the early 1970s when Soviet policymakers decided to concentrate on resource developments elsewhere, most notably in West Siberia.

“But to attract investment, whether foreign or local, on the scale necessary to develop Ukraine’s resources onshore and offshore, there has to be an acceptance in words and deeds that such investment is genuinely welcome.”

Ukraine’s production sharing agreement legislation, passed in 1999, is a good legal framework for projects, Bown believes. But other aspects of reform such as gas export market liberalisation, the privatisation programme and energy sector restructuring need to move forward too.

  • Ukraine’s own oil and gas reserves – estimated at 7-8 billion tonnes of fuel equivalent – are seriously undeveloped. Domestic production – unchanged since 1997, is about 18 million bcms of natural gas and 4 million tonnes of crude oil – covers only 21-24% of demand for gas and 10-12% of demand for oil.

A version of this article appeared in Energy Day, 29 November 2001
Posted 15.12.01; © 2001 Simon Pirani

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