Strategy and Reality: What Ukraine Must Do to Maximize its Gas Production Potential

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Victor Gladun, General Director of JV PPC & Acting CEO of JKX Oil&Gas

Energy independence remains a priority for Ukraine. The recently published Energy Strategy of Ukraine to 2035 reiterates our government’s aim of eliminating gas imports by, amongst other things, increasing domestic production to meet the needs of Ukrainian consumers. Gas exports to Europe will be the next logical step. Acting CEO of JKX Oil&Gas and General Director of Poltava Petroleum Company (PPC) – our Ukrainian subsidiary – I fully support these important goals, and believe that a lot can be achieved. But I am also well aware of the day-to-day realities in our sector. Much still needs to be done to finally create an investment environment that will bring the capital and technology we need to achieve our common aim. The reality is that after three years of gas sector reform, some minor improvements aside, Ukraine’s gas production sector remains mired in antiquated bureaucratic procedures, access to data is highly restricted, and fiscal conditions are not competitive internationally. A number of important proposals have been made to improve the regulatory environment in Ukraine’s upstream (oil and gas production) by supporters of energy reform in our parliament, the Association of Gas Producers of Ukraine (AGPU), the American Chamber of Commerce, and other NGOs. But the government now needs to begin implementing those proposals, and the Rada needs to start passing important legislation that has been languishing in committees for too long. I would like to share my own view on what Ukraine needs to develop a dynamic, competitive and transparent gas production industry, so as to transform lofty goals on paper into reality, for the benefit of Ukraine and those who invest in its future. Like the rest of Ukraine’s economy, our sector is in desperate need of investment, deregulation, stability and transparency. As a law school graduate, I, more than most, appreciate the importance of a strong legal system and its impact on the economy. Deregulation: Today it takes around four years to receive the 44 permits from 16 different government agencies that are needed to begin oil and gas production. This is far too difficult, particularly for new potential investors. Several important draft laws to streamline permitting and simplify land use rules are ready and awaiting approval by parliament. There has been some progress in adjusting rules on license auctions, and modern guidelines for oil and gas field development have been introduced. However, we need a new Subsoil Code, which will stabilize regulation and put an end to the management of the sector by government decree. Finally, investors need transparency of information. Ukraine has a wealth of geological data after over a hundred years of hydrocarbon production, but it needs to be systematized, and open access to all legacy data (wells, seismic, etc.) must be guaranteed. We, together with private oil and gas producers and the Association of Gas Producers of Ukraine (AGPU), support free access to data for all investors. Fiscal regime: Taxation in the oil and gas sector remains a major deterrent to investors. Other countries in Europe and the rest of the world that are actively competing for international capital more often than not offer more favorable tax terms than Ukraine. I am encouraged by the recent announcement of the Ministry of Finance that it will introduce a proposal for a reduced royalty on new wells into the draft budget for 2018, and I hope that the Rada will finally pass this proposal after failing to do so last year. But this is only the beginning. The current fiscal system is far too complex, with eight different royalty rates on hydrocarbon production. This needs to be simplified, while Ukraine needs to move towards a system of profit-based taxation – the common practice in the West. Such a system would be far more suitable to our mature geology, with many projects vastly differing in their risk profile and thus in need of more flexible taxation. However, this would also mean Ukraine would need to modernize its accounting and tax collection systems, and this is something that has not yet been started. But in the near future, a simple 10-12 percent royalty rate, applicable over a broad tax base for all fields and wells, and guaranteed in law for five years would be an answer to a market desperate for investment. Private sector development: Throughout my career I have been fortunate to hold senior management positions in both highly successful private and state-owned energy companies and have thought about the relationship between the state and the private sector in the oil and gas business a great deal. While the role of the state in our strategic industry will always be important, I believe Ukraine needs to expand the role of legitimate private business in the sector. Although the role of private companies has grown significantly over the past ten years, state companies continue to dominate with around 80 percent of production and 90 percent of proved reserves. Much progress has been made in reforming our state gas producer, UGV, and we are already seeing positive results in terms of investment and production growth. But the private sector will be the main driver for innovation and investment in the future. The experience of the United States and the role of over fifteen thousand small private companies in the hydrocarbon production revolution it has gone through over the past ten years is an example Ukraine must keep in mind. How can Ukraine expand the role of the private sector? By offering more opportunities to investors. The government needs to focus on offering new licensing rounds. Those licenses where investor commitments are not being met – both state and private – need to be put up for auction. Ukraine needs to overcome the negative legacy of Joint Activity Agreements (JAAs) and offer new, transparent mechanisms for cooperation between the private sector and the state including services contracts and production sharing agreements. A place to start could be work on giving investors systematic access to hundreds of state-owned wells outside licenses owned by state companies. As General Director of PPC, over the past year, finding ways to work on state-owned wells located within our license boundaries has been a top priority. While we have achieved some success in signing services contracts, the peculiarities of our legislation on the one hand, and public scrutiny of senior management at state-owned companies on the other, make this a difficult and lengthy process. Amending the famous Article 7 of the Law on Pipeline Transport to allow leasing of such wells by UGV would be a good start. Longer-term we need a transparent mechanism for the purchase of such wells by private license operators. After all, the practice of separating ownership of wells from production licenses is almost completely unique to Ukraine and is suboptimal for oil and gas field management. More broadly, privatization of state assets in the oil and gas sector through a transparent process via auction to qualified investors is something that will be key to Ukraine’s long-term success. If Ukraine is to compete for foreign capital with countries like Mexico and India, which have made tangible progress in offering foreign investors a stake in their oil and gas sector over the past few years, privatization needs to stop being a dirty word. This is one aspect of reform still completely missing from Ukraine’s Energy Strategy to 2035.

JV PPC Poltava office 153 Evropeys’ka str., 5th floor 36002, Poltava, Ukraine telephone: +38 (0532) 501317 fax: +38 (0532) 501314 е-mail: info@ppc.net.ua www.ppc.net.ua

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