Since the EuroMaidan Revolution that ousted Viktor Yanukovych as president, Ukraine has been successfully weaning itself off Russian gas by importing more from Europe. The goal is energy independence.
Could Ukraine ever stop importing gas altogether and start producing enough to meet its own needs?
It is a tall order, but one that Andriy Kobolev, head of the state oil-and-gas company Naftogaz, thinks possible. “By 2020 Ukraine can become self-sufficient in terms of gas production,” he told Bloomberg news.
In order to achieve that, Ukraine would need to boost production by 35 percent from today’s production, all the while improving energy efficiency and contending with declining output from existing fields.
That is not going to be easy with oil trading below $50 per barrel.
“Ukraine has to compete for investment and we are simply not attractive at the moment, even against regional rivals let alone global ones” said Olga Bielkova, a member of the parliamentary energy committee from the Bloc of President Petro Poroshenko.
(Nataliya Katser-Buchkovska, member of the Verkhovna Rada)
Lack of interest
A recent gas tender underscored the lack of interest in Ukraine. It offered rights to a vast gas field, but only three bids were received. These all came from smaller companies that focus on Ukraine. None of the global oil majors is currently interested.
“Given the current situation with oil prices slump, there are no plans for new exploration projects in Ukraine in the foreseeable future,” Shell spokesperson Yuliya Pikhnovska told the Kyiv Post.
But according to Roman Opimakh, who heads up the Association of Gas Producers of Ukraine, gas self-sufficiency could be achieved without the majors. “These medium-sized gas companies already have a lot of investments in Ukraine and want to invest more. It is just a matter of the taxes being too high at the moment,” Opimakh said.
The tax rate on gas production is no longer at the dizzying heights it reached soon after the EuroMaidan Revolution. Back then it was increased to 55 percent of revenues, in part to help fund the war against pro-Russian separatists in the east.
“That really killed the industry. Investors have a choice and no one wants to go where the tax rate is that high,” said Robert Bensh, senior managing partner at Pelicourt LLC, which specializes in energy investments in Ukraine.
The rate was reduced in last year’s budget, but not enough to encourage more investment.
Reverse flow
Since the EuroMaidan Revolution, the government’s primary aim had been to wean Ukraine off Russian gas by finding other suppliers. It has met with remarkable success in reversing the flow of the pipelines and getting more gas from Europe.
Between 2014 and 2015, the share of Russian gas used to produce energy in Ukraine fell from 34 percent of the total in 2015 to just 18 percent. Over the same period, the volume of gas imported from Europe more than doubled, its share rising from 12 percent to 30 percent. Last year, Ukraine got almost twice as much gas from Europe as it did from Russia.
Under this reverse-flow approach, a lot of the gas being imported from Europe still comes from Russia indirectly. Gazprom, the Russian state gas company, sells it to European countries who then resell it to Ukraine. Gazprom tries to prevent reselling of its gas, but EU competition law is keeping the pipelines open.
(Alistair McBain, CEO of Arawak Energy.)
Energy efficiency
Having diversified suppliers, the government is turning its attention towards boosting domestic production. The tax rate was cut to 29 percent of revenue for gas mined below 5,000 meters and 14 percent for anything deeper. The state-owned gas company, Ukrgazvydobuvannya pays a higher rate of 50 percent.
At first glance, the statistics suggest an improvement. In 2014, Ukrainian gas accounted for around 50 percent of all gas consumed. By 2015 that figure had jumped to 60 percent.
But this is misleading. Natural gas output actually fell by 3 percent over the same period. The share of domestic gas increased because the country was using less.
Gas consumption across Ukraine fell by 21 percent in just one year between 2014 and 2015. Increased prices, a government-led energy efficiency drive and a warm winter all contributed, but the greatest savings were made because of a contracting industrial sector. Industrial demand fell by 27 percent as Ukraine lost territory and foreign investors.
Intensification
There is also more trouble in store as wells dry up. Output is forecast to almost half over the next five years.These losses could be offset with more intensive mining techniques. But this will cost money.
Publicly-owned UGV produces around three quarters of the Ukraine’s gas, but its fields tend to be the oldest.
UGV’s parent company, Naftogaz, is undergoing a complicated unbundling process and investments are not being made as quickly as needed.
“If we just focus on improving output from existing fields it will not be enough, we need to focus on encouraging new production if we want to become self-sufficient,” said Bielkova.
Tax changes
The industry says the new tax rate is still too high. UGV and six smaller companies clubbed together last year to form the Association of Gas Producers of Ukraine. The association is calling for a more competitive tax rate of 12 percent.
The proposed 12 percent rate would initially be on revenue, but the association wants this partially switched to a profit-based tax system.
“Most countries tax oil and gas operations on the profits they make. This is helpful because the state shares the risks with the investor,” said Alistair McBain, CEO of Arawak Energy, which has investments in Poltava with GeoAlliance.
Fuel subsidies
Any reduction in the tax rate could have implications for ordinary Ukrainians because the tax on UGV is used to pay subsidies to the poor. More than half the population is eligible for a subsidy and for 15 to 20 percent of people their fuel bill is greater than their income.
The government is increasing the price of gas under pressure from the International Monetary Fund.
Nataliya Katser-Buchkovska, who heads the parliamentary subcommittee overseeing energy, understands that the taxes are needed to pay for the subsidies. But she acknowledges that the tax base will quickly diminish unless there is additional investment. “It is necessary to balance immediate budget needs and long-term investment incentives for gas production growth,” she said.
Dividend payment
The gas association believes that all gas players should be managed by the same tax rates, whether they are private or state entities.
In the short term, it argues that the any shortfall in revenue could be made up by UGV paying a dividend instead of subsoil royalty to the government. This is standard practice in neighboring countries. It also points to other possible benefits.
“Ukraine could cut the import cumulatively by 45 billion cubic meters by 2020… which would have a dramatically positive effect on the foreign currency balance and in creating many jobs in gas industry and linked sectors,” Opimakh said.
He has calculated that by implementing its proposed tax changes, the industry could see as much as a 15 percent annual growth rate to 2020. This would not, however, deliver complete self-sufficiency.
Budget changes
Ukraine’s parliament is setting next year’s budget, but tax changes for gas production are not on the agenda. One of the reasons is that an interagency working group that brought together the main stakeholders with the Ministry of Finance no longer meets. This group was instrumental in getting the tax rate reduced last year from its post-Maidan high.
Katser-Buchkovska, who is a member of parliament for the Popular Front party founded by former Prime Minister Arseniy Yatsenyuk, blames the transition to the new government of Volodymyr Grosyman.
“Lack of progress, instability and lack of political will of the responsible authorities, has led to this situation,” she said.
Katser-Buchkovska has made an appeal to the Ministry of Finance to re-establish the working group. In the meantime, Ukraine languishes low on investors’ lists.
“No one is talking about Ukraine right now,” Bensh said. “There is zero interest. If you have money, it’s better to invest elsewhere.”
