Artem Petrenko, the Executive Director of the Association of Gas Producers of Ukraine, explained ExPro the situation in the E&P sector and what is actually needs to be done for the further growth of the industry.
- Due to the economic crisis that affected world industry markets, production companies have faced serious troubles. How’s the Ukrainian Oil&Gas industry undergoes through such difficulties?
- Bearing in mind that Ukraine is the part of the global oil and gas market, it affects us with no exception. Accordingly, each global movement affects domestic gas production. The record fall in oil and gas prices combined with the deepening economic crisis caused by the spread of COVID-19, poses a major threat to the industry. There is a high risk of partial or even complete cut of investment activities. Consequently, it means a decline in gas production in the nearest future.
- And what will be the aftermath for the companies and the whole economic situation?
- Oil and gas industry is the main breadwinner of the state budget. The lower prices for gas, the smaller the production in the country, the less taxes will be received by the state and local budgets, respectively. This is a combined problem, which consists not only of investment or financial stuff. At the moment, no incentives or measures are not provided, so If nothing will change in future, the crisis will only be compounded by time.
- How do you think, how long it will cause influence on the industry?
- The situation with falling prices has begun last year. There were several vital reasons that instigated threefold prices reduction. Among them are the oversaturation of global market with LNG, overfilled gas storages in Europe and unexpected warm winter. Additionally, sharp reduction in consumption and demand for hydrocarbons is the result of pandemic and further quarantine. Currently, the market is oversaturated that makes pressure on the prices.
We admit, that the end of quarantine won`t mean the immediate recovery and stable functioning of the market, as well as it won`t solve all of the problems. Well, it is possible to make predictions regards further fall in prices, although it is still blur to foresee the market situation even in a few moths’ term.
- How does this affect the companies?
- Producers are forced to reconsider their investment plans and, unfortunately, cut them. The gas production industry is very risky and involves regular investment in geological surveys, drilling of wells, workovers and other non-drilling activities, purchase of necessary equipment etc. We expect the significant optimization to become a main priority and investors to be more careful about new projects. After all, the risks remain high, especially if we are talking about new large-scale blocks.
If the state introduces incentive conditions for the evolution of the sector, it definitively will transform into a fruitful benefits. We have a good example of incentive fiscal policy for new gas wells from January 1, 2018. For two years of those new taxes, domestic producers have drilled more than 200 wells and consequently, gas production began to grow. As a result, it speaks for itself, the state should and definitively can effectively interfere the enhancement of the sector.
- A lot of countries have already announced different measures provided to support the oil and gas producers. The question is, is it possible for Ukraine to adopt something from them?
- The main priority in Ukraine and the rest of the world was to support SME’s during the quarantine. Reduction of taxes, corresponding simplifying regulation legislation was adopted, and so on. However, we can`t ignore the fact, that the main breadwinners of the budget have not received any incentives or other type of support from the state.
We analyzed the variations of policy changes in different countries regards key industries, including oil and gas sector. Among them the Norway case, where the Government has announced tax cuts to allow the continuation of the companies’ investment activities. The UK case, where is offered to develop the supportive strategy to assist operators and contractors working with exploration projects on the continental shelf.
During the survey, one of the interesting cases is Alberta, Canada, that cuts and simplifies unnecessary bureaucracy in terms of running business, extends licenses for exploration and production.
– What are the first steps need to be done?
- The Association appealed to the President, to the Verkhovna Rada and to the Government to pay attention on current problems in the oil and gas industry and to work on a package of incentives for its further development. Companies must continue to invest, even in such difficult and hard conditions, the only way they can do it – through governmental incentives. Lack of investment will lead to stagnation, further reduction in gas production, cut in budget revenues and, consequently, job losses. It`ll affect gas producing companies as well as contractors. And for sure, it will influence the energy security of Ukraine.
We come up with four supportive and necessary steps for the oil and gas sector.
Firstly, is to immediately apply an incentive rent for the recovered wells that were not used for production of hydrocarbons last two years and were reintegrated through workover assistance. These are wells that are on the balance of state-owned companies, most of which were drilled in Soviet times. Due to various accidents or other reasons, production is not active out there. Recently, several private companies have successfully implemented joint projects with state-owned enterprises - JSC Ukrgasvydobuvannya, Ukrnafta and NJSC Nadra Ukraine. There are examples when it was possible to increase the total production by 50% after workovers. At the moment, there are thousands of such non-functioning wells, hence, there is either no production or paid to budgets rent. Ukraine will have a great lever that will allow to increase production, but only in case of introduction of the tax incentives we discussed earlier.
Secondly, there should be incentives to develop hardly-recovered and unconventional hydrocarbon deposits. Present conditions make them simply unprofitable to explore and produce. We made a survey according to the international experience and highlighted Canada, Argentina, Brazil, Mexico, and Poland. These countries encourage producers to develop such deposits by lowering rents or providing other incentives. Hence, we have a conclusion about the need of additional incentives for the development of heavy and unconventional deposits, but with the mandatory development of a transparent methodology for determining such deposits, so that there are no accusations and misunderstandings with the Ministry of Finance in future. It is necessary to purely define which deposits are difficult to extract or which deposits are unconventional.
Thirdly, incentive rent for the new gas wells must be saved because it paid off nice. We believe that, by analogy, the incentive tax on condensate and oil production should be defined on the level of 6/12% for new and recovered wells.
Fourthly, state should extend its guarantees regards hydrocarbon production from new wells for up to 10 years. It shall be recalled, previous September, the Verkhovna Rada has taken to consideration law №1210 which proposed to remove the incentive rent for new gas wells. And it is crucial, that the deputies listened to the position of the industry and kept alive such extremely important norm. The stability of fiscal policy is one of the main components that attract domestic and international investment activities.
- Let’s get back to taxes. Obviously, the Government won`t appreciate cut in taxes for oil and gas producing companies…
- Currently, we are talking about important and high priority steps that consist of incentive fiscal policy implemented to new and recovered wells, hardly-recoverable deposits as well as unconventional reserves, that are not being extracted at the moment. They are not already in budget, those are additional, so rent from its production will transform into a supplementary revenue to the budget.
- When do you expect such decision?
- The sooner the innovations are adopted, the sooner we will stabilize the oil and gas industry and will be able to avoid further complications. Precious time needs to be used properly.
- What is your vision regards engagement of new investment into the Ukrainian oil and gas industry in the nearest time? Specifically, through the PSAs?
- Last year was a good example of a significant investors’ interest in the oil and gas industry of Ukraine. Several rounds of online e-auctions of obtaining new licenses were undertaken, and the winners of 9 PSA tenders were announced. It is important to note, that among the winners are different foreign companies: the Canadian Vermilion Energy (got two blocks together with UGV) and the American Aspect Energy. As for now, Interdepartmental Commission and investors are going through the negotiations phase on the texts of agreements. We hope that despite the current situation, the PSAs will be signed quickly and companies will be able to begin work on the blocks as fast as they can.
Emphasizing on 3 conducted PSA tenders, we have only international winners, among them the Slovakian Nafta, which included on the large European holding EPH and the company York Energy (UK). It proves investors encourage and preparedness to invest in the development of Ukrainian subsoil.
Additionally, despite the crisis, Ukrgasvydobuvannya quite recently has attracted an international investor – the Romanian company Expert Petroleum to develop depleted brownfields in Western Ukraine. This is a unique and progressive project for Ukraine, that involves workovers and drilling of new wells as well as intensification of production and infrastructure enhancement. So, it is a really positive signal in such grave situation.
Summing up, I would like to say, that at the moment, situation is literally unpredictable and this year will be a rough year. Such conditions make it really difficult to attract foreign investors to stand up for new projects. That is the reason of our vision, that countries which implement incentive mechanisms for production of hydrocarbons will win in prevailing situation.
Alongside, the state should work on the preparation of oil and gas lots as well as to promote them, including the global perspective. We, in turn, will support the initiatives of the State Service of Geology and Subsoil of Ukraine to announce and conduct a new tenders for both offshore and onshore.
- Returning to PSAs, training procedures and selection of winners. What needs to be finalized and paid attention at all?
- The Law that is the basis for the implementation of PSA agreements isn`t perfect. The Association is working on proposals for changes to make the procedure for preparing and selecting winners more transparent.
I must say that some of the progressive and important innovations have already been implemented. Last year, the obligatory environmental impact assessment inside the texts of the agreements was removed, as well as the approval of the regional councils of these texts. However, the experience of PSA tenders has shown that there are still a bunch of problems. In particular, the question of how the winner should be chosen remains vital. Transparent quantitative criteria needs to be put in place to define it so that the Commission has a clear selection tool and consequently its decisions are objective. Under such conditions, it will be much more difficult to challenge the victory. There is a problem with confirming the financial capacity of the applicants. In addition, the question of the deadline of tenders is very relevant. At the moment, according to the legal norm, there must be at least one month since the date of announcement of the tender to the deadline for submission of contracts. According to the world practices, this period is from 3 months and more depending on the country, location of the block and the complexity of the projects. Last year, we saw when the PSA tender for the Dolphin shelf section was reduced to 2 months.
Yes, from the point of view of the norm of the Law, everything was done correctly. However, in terms of logic, common sense and objective realities, attracting large investors to such competitions and such large-scale projects takes much more time to analyze the field. We have always supported the idea that for PSA blocks, the application period should be at least 3 months onshore and 6 months or more for the shelf.