UEF 2014: 7 Key Messages On The Development Of Gas Sector In Ukraine

We’ve tried to put together key messages from the speakers and participants of 5th Adam Smith Ukrainian Energy Forum on the development of Ukrainian natural gas sector. The forum was held in Kyiv on 24-26 of June, 2014 and gathered both international and Ukrainian oil and gas industry companies, traders, experts, diplomats and representatives of governmental authorities. One of the main topic of the forum discussions was the nearest future of Ukrainian energy and gas sector in light of illegal annexation of Crimea, armed clashes on the east of Ukraine, ongoing gas disputes with Gazprom and recent stoppage of gas supply from Russian Federation to Ukraine.

Here are seven recommendations to overcome the current emergency situation and reform Ukrainian gas production sector.

1. Boost energy efficiency

Energy efficiency measures and technologies were not the main focus areas of 5th Adam Smith Ukrainian Energy Forum. Nevertheless, we’ve put this recommendation first, because the best way to reduce energy and gas dependence of the country is to reduce the consumption of energy resources per unit of economic output. Ukraine has enormous potential for the improvement of energy efficiency in different areas, which will result in lower natural gas consumption for industrial processes and heat energy generation. Boosting energy efficiency will demand time and investment, but has exceptional potential for reducing natural gas demand by billions cubic meters per year.

2. Raise domestic gas production

During recent years Ukraine’s annual natural gas extraction equals to around 20 billion cubic meters. This figure includes gas production from Black Sea and Azov Sea reserves (1.65 billion cubic meters of natural gas in 2013) developed by the state company Chornomornaftogas, over which Ukraine recently lost control due to annexation of Crimea.

Increase in domestic natural gas production is an important step to guaranty energy security. However, the existing natural gas fields are exhausted and the reservoirs’ pressure is continuously decreasing. Thus, to achieve natural gas production growth Ukraine needs investment in geological exploration of new natural gas deposits, modernization of drilling and pumping equipment, as well as gas production intensification technologies, including hydraulic fracturing.

According to Chief engineer of Ukrgasproduction (Ukraine’s largest gas producer with annual output of 15 billion cubic meters of natural gas) Oleksiy Nesterenko, drilling of new wells (70-80 wells per year) does not compensate the natural drop of reservoir pressure of depleted gas fields as 90% of all natural gas produced is extracted from the wells put in production before 2005. Resource base is depleting and to keep production rates at current level or ensure their growth it is important to obtain licenses for new fields, perform geological exploration works, 2D and 3D seismic studies, modernize existing drilling equipment and purchase new modern drilling rigs as well as to construct additional boosting compressor stations to allow gas production from depleted gas fields.

Maksym Tymchenko, Director General and Head of the Board of DTEK (leading Ukrainian company in electricity generation and coal mining also active in oil and gas industry) was optimistic on the future of national gas production sector and declared that the use of comparatively low cost methods of natural gas production intensification on existing gas fields and construction of new wells could afford to cover the whole national natural gas demand by domestic supply just in 5-7 years.

Unconventional gas is another promising option for domestic natural gas production growth. Yet it is necessary to perform geological exploration works on major prospective areas for shale gas and tight sand gas production to prove the availability of technically recoverable gas reserves and commercial feasibility of unconventional gas production in Ukraine. Commercializing unconventional gas production even under optimistic scenario will take at least 5 years, therefore this option should be considered only in the mid-term and long-term perspective.

3. Diversify natural gas import

In covering its natural gas demand Ukraine largely relies on natural gas import from Russian Federation. In 2013 Ukraine imported almost 28 billion cubic meters of natural gas, 92% (25.84 billion cubic meters) out of which came from Russia. The remaining part was supplied from Europe via so called reverse supply scheme.

Reverse flow of natural gas from Europe to Ukraine is possible from three countries: Poland, Slovakia and Hungary. As for now, gas is supplied from European traders via Poland (potential supply of 1.5 billion cubic meters per year) and Hungary (potential supply of 3 billion cubic meters per year), while the negotiations with Slovakia, which is the largest potential supplier, are still ongoing. There are two options for organizing the reverse gas supply from Slovakia: the so called big reverse option with the potential supply of 30 billion cubic meters of natural gas per year and the small reverse option with the potential supply of 8 billion cubic meters per year. The big supply option looks unrealistic in the short term as it demands changes in contracts with Gasprom, which is naturally not interested in Ukraine’s natural gas supply diversification efforts. The second option foresees construction of new pipeline on the Slovakian territory and is expected to be available starting from September.

Thus, the total potential reverse gas supply could reach 12.5 billion cubic meters per year, however practically the volume likely to be lower due to market availability issues, technical or administrative barriers.

4. Ensure reliable gas supply

The reliability of gas supply both to internal consumers and transit supply to European countries is the issue of great concern. The armed clashes on the east of Ukraine, the risk of emergency situations on the gas pipelines network (such as the recent blast on the Urengoy-Uzhgorod pipeline near Lohvytsia in Poltavа region), the ongoing negotiations on the gas contracts with Gazprom and parallel Stockholm arbitration process are all add uncertainty to the reliability of gas supply.

Taking into account the high importance of gas supply via Ukraine to Europe European Commission facilitates trilateral negotiations between Ukraine, Russia and EU. However, the agreement was not reached, which resulted in stoppage of gas supply to Ukraine. According to Walter Tretton, Head of the Energy, Environment and Transport Section of the EU Delegation to Ukraine, this does not effected so far the reliability of gas transit to Europe, however put at risk the accumulation of sufficient gas volume in Ukrainian gas storage system, which could negatively impact the gas supply during winter period. European commission hopes that the negotiations will be continued and the political will of both parties – Russia and Ukraine – will make the compromise possible.

Stabilization of the situation on the east of Ukraine and completion of anti-terror operation along with the resolving the dispute between Ukraine and Russia over natural gas price either via negotiations or Stockholm court decision will play vital role on ensuring reliable natural gas supply.

5. Integrate to European gas market

The integration of Ukrainian gas market with European gas market will strengthen energy security of both parties and ensure stability of gas supplies.

Such integration should be achieved at infrastructural level (pipelines allowing bidirectional gas flows, interconnection points, gas metering equipment etc.), regulatory level (implementation of the requirements of 3 Energy Package, eliminating regulatory barriers and establishing equal rules for all participants) and business level (contracts between European and Ukrainian companies, trading platforms etc.).

6. Develop regulatory framework

Development of the regulatory framework with clear and transparent rules as well as eliminating excessive bureaucratic procedures are critical steps for attraction of investment into Ukrainian oil and gas sector.

Some positive regulatory developments mentioned during the Forum include the ongoing work on new Subsoil Code of Ukraine, which is going to introduce new scheme of agreements for subsoil assets use instead of existing permit system, and updated Rules on Oil and Gas Fields Development. Both industry and regulatory authorities expect these documents to be approved in the near future. Besides, industry is looking forward for the liberalization of geologic information export procedures to streamline the analysis of geologic data and foster the projects development. Additional expected regulatory changes include lowering the number of permission documentation, number of inspections and regulatory documents, distinction among exploration and production licences, clarification or amendment of some regulatory provisions regarding taxation and governing law etc.

On the other side, one of the most controversial regulatory proposal is the recently published draft law on the emergency state in energy industry, which can oblige private extraction companies to sell the gas on a regulated price instead of selling it on a free market.

For Ukraine it is important to develop regulatory framework, which will attract investment in extraction industry, promote use of best available technologies and protect the interest of society and nature. Despite positive signals there is still a lot to be done to streamline the natural gas extraction projects and receive practical results in terms of increased natural gas output.

7. Increase transparency and eliminate corruption

Lack of transparency and corruption are the widely reported problems, which limit investment and the interest of international companies in all Ukrainian industries. Gas extraction and trading is not an exemption here. Transparency should be achieved in terms of regulatory procedures, financial data, technical and operational data.

There are some positive hopes and expectations, that after ousting the previous president and approval of the new government the level of corruption at all levels will be significantly reduced. However, the depth of the problem is so high that elimination of corruption will demand political will from the power authorities, strong support and control from the society and firm position of the business on the common goal to live by the new rules.

Increased transparency and eliminated corruption will attract investment and foster the achievement of all above mentioned goals.

The way ahead on reforming Ukraine’s natural gas sector will not be easy, but the achieved energy security gains will payback many times over.

Mykola Shlapak for Unconventional Gas in Ukraine

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