Alistair McBain, CEO of Arawak Energy, a small independent hydrocarbon company in Ukraine, still hopes for better times soon.
He’s one of only a handful of energy sector investors who do. A
combination of ongoing corruption, stifled innovation, ambiguous tax rates and
non-transparent bureaucratic processes in Ukraine has caused most international
players to shut down their operations in the country, or pare them back to a
minimum.
“All of this is creating the wrong kind of atmosphere to encourage more
people to come in,” McBain told the Kyiv Post during an interview on March 2.
Contrary to what many might assume, McBain wants more small-scale
competitors for his business in Ukraine, not fewer.
“The U.S. shale revolution was basically down to the incredibly
innovative practices of a very large number of small independent companies”
creating a highly competitive and efficient market, McBain said. “The problem
in Ukraine is that there aren’t very many small independent companies – there
aren’t many independent companies at all.”
In Ukraine there are just five Western gas enterprises still operating,
accounting for no more than 15 percent of total domestic production. These are:
Cub Energy, Kub Gas, Arawak Energy, Eni and Cadogan.
Royalty tax pain
One of the main reasons Ukraine’s oil and gas market is unattractive is
the unpredictable royalties system. For a year, starting in December 2014,
parliament passed a bill which increased royalties on gas production to 55
percent, up from 28 percent.
For private companies like Arawak Energy, the rates were effectively
65-75 percent of sales prices, the company’s CEO says.
“It really was very painful,” McBain said.
Energy giants such as ExxonMobil and Chevron left the Ukrainian market when the rates went up.
A year later, in December 2015, Ukraine’s parliament approved a tax bill
that returned royalty rates to their original levels.
“It’s a step in the right direction,” but this “is certainly not the
recipe for attracting new inward investment,” McBain said.
The Oxford University graduate said he wants to see stability,
simplicity and competitiveness as the fundamental building blocks of the
system.
Ukraine’s current unpredictable royalties tax is based on a two-level
system: companies extracting gas at depths less than 5,000 meters pay 28
percent, while companies extracting deeper pay 15 percent.
“Having these kinds of jump points is not normal – there are, to my knowledge,
no other countries in the world with this type of jump in taxation,” McBain
said.
A better way to encourage extractors to take the risk of drilling deeper
wells would be to have a profits tax, McBain said.
Alternatives
In fact, McBain said his company is fine with paying high taxes – but
only under the appropriate conditions, when the risks aren’t so high and when
the company starts making a profit instead of having to pay upfront.
One positive change McBain has seen is that the gas prices are now set
in a more transparent way – pegged to average gas import prices. Before, the
prices were established by state-owned monopoly Naftogaz Ukrainy.
“I don’t think this is a perfect mechanism,” McBain says. “I think on
the gas side it would be better to (peg to) one of the European hub prices,
which are absolutely transparent.”
Arawak Energy, which employs 230 people in Ukraine, is a subsidiary of
energy commodities company Vitol Group headquartered in Geneva, Switzerland. It
has a 50 percent stake in Ukraine’s Geo Alliance, which is majority owned by
oligarch Victor Pinchuk.
McBain said in a previous Kyiv Post interview that his company lost “millions” of dollars during the past two years. Right now the situation
doesn’t look any better.
Ukraine – gas exporter?
But that could easily change if lawmakers created a business-friendly environment.
Many experts, including McBain, believe Ukraine could not just become
self-sufficient in gas, but even be a net gas exporter, rather than having to
import gas from Russia.
Such experts argue that back in the 1970s the Soviet Union extracted in
Ukraine 70 billion cubic meters of gas a year, which is more than 3.5 times the
volume extracted today. If Ukraine brought in modern extraction technology,
diversified its energy sources, and reduced wasteful consumption, the country
could end up being a hydrocarbon exporter.
“There is a lot of pent-up potential in Ukraine,” McBain says.
Storage space for gas
Ukraine also loses an opportunity to rent out its unused gas storages –
the third largest of such facilities in Europe, McBain says. In addition to
local traders, there are neighboring countries that have a storage deficit and that
could easily benefit from Ukraine’s services.
“Traders would want to put gas in storage in the summer months when it
is cheap, and sell it in winter,” McBain says. So a lot of that seasonality in
the market would be paid for by commercial activity rather than have the state
do it itself… And my belief is that the requirement for gas storage in Europe
is going to increase over time.”
Corruption
But the government is barely putting any energy in attracting investors
to Ukraine.
“A lot of the fundamental subsurface data of Ukraine is treated by the
old (geology) institutes almost like it is a state secret,” McBain says. “So
Ukraine has not made a big effort to go out there and attract people to come in
and use modern technologies, and people in general haven’t come to use a lot of
modern technology.”
Meanwhile, Ukraine’s overstaffed energy bureaucracy is another
disincentive to investors.
“We have many more inspections than we think would be normal, and we
have many more people trying to make decisions for us that we ought to be
making for ourselves,” McBain says.
For example, Arawak Energy can’t even make an independent decision on where
to drill. As in other former Soviet countries, Ukraine has a state institute that
grants approval for drilling sites. In the United States, the process is
entirely different: There, companies can rent a piece of land, obtain drilling
approval, and then drill wherever they want.
“It’s your risk, and it should be your decision,” McBain says.
