Roman STOROZHEV: private investments to boost gas production

Many experts call the impending price increase for Russian and Turkmen gas the main threat to Ukraine’s economic stability. Considering that gas accounts for 40 percent of all energy consumed in our country, one may conclude that even a relatively small increase in the price of this resource will immediately raise the cost of Ukrainian products. In the light of Ukraine’s new relationship with Russia, we should not only be seeking alternative sources of energy resources, but also increasing the production of our own gas. That is the only way we will be able to reduce our national economy’s dependence on foreign supplies. How this can be done is the subject of an interview with Roman STOROZHEV, president of the Gas Traders of Ukraine Association.

“Mr. Storozhev, what additional sources of gas do you think can be used most adequately?”

“There are many gas provision concepts being framed in Ukraine today, including the construction of gas pipelines, as an alternative to Russian ones, and sea terminals for liquefied gas. But these purely theoretical projects are extremely expensive. We believe that the most promising way is to increase the extraction of Ukrainian gas. Ukraine has enough to supply the entire country for many years.”

“Why has this not been done before?”

“There are several reasons. First of all, our reserves were in fact exhausted by the end of the Soviet era. These are mainly surveyed reserves that were actively utilized in past years but were not replenished because of extremely inadequate geological explorations. In reality, our deposits are definitely larger than is commonly believed. Prospecting and extraction are directly related. The more deposits are prospected, the more resources are extracted. But given our meager funding of geological surveys, there is practically no increment in reserves and, therefore, there is no significant rise in extraction.

“The best specialists go abroad, where they are needed, so this country is gradually losing its highly-skilled personnel. Therefore, we think that geological survey must be put at the top of the list of national priorities. If the state is too cash-strapped to do this, we must attract private capital. Naturally, an investor will only invest in an enterprise that promises revenues. Therefore, the state and business should cooperate on a mutually beneficial basis.

“An investor should be able to benefit from the survey and exploitation of new deposits because when reserves are being surveyed and evaluated, gas may well be extracted and sold. An investor who explores the bowels of the earth and bores holes, each of which costs him tens of millions of hryvnias, runs the risk of losing the money in the event of a possible failure — so he should receive adequate compensation in this case.

“Conversely, this is the real situation today: the businessman is a 100-percent investor who shoulders all the losses, but in the event of success, he has to hand over 50 percent of the profits to the state. Naturally, very few people want to run a risk, so prospecting for new deposits remains on an extremely low level.”

“By all accounts, there will be no breakthrough in this field in the foreseeable future. Is it possible to increase domestic production through already explored reserves?”

“Intensifying the survey is not as time-consuming a job as it may seem. As soon as the rules of the game change, the market will work twice as fast. As for further exploitation of the available deposits, Ukraine has about five trillion cubic meters of forecasted gas reserves. With today’s consumption rate of 75 billion cu m, this resource would be totally sufficient for 70 years. Out of this 5 billion, 1.2 billion are confirmed reserves that would suffice for 20 years.

“The problem is that many deposits are exhausted, while others are considered small, so it is unprofitable for large state-run companies to exploit them. On the other hand, private and hence more mobile companies could extract this gas at a profit for themselves and the state. Right now these companies are making a negligible contribution to national gas production: about 20 private firms extract a mere 1.5 billion cu. m. a year, i.e., 2 percent of this country’s gas balance. This figure convincingly illustrates how inadequately private capital is involved in gas production and what impetus would be given to this sector if the state changed its attitude to this problem.”

“Why does the state so ‘dislike’ private gas producers?”

“I would say it is indifference. No government official is really concerned about the growth of domestic gas production, whereas they should encourage it by, among other things, granting such companies major financial and tax privileges. In reality, everything is the other way round. The license auction price is often so high that no bids are submitted. Private business knows how to count its money and will never invest it in an obviously risky project. Besides, they have to lay out money to ‘persuade’ local councils to give them permission to exploit the deposit — extractors sometimes have to repair house roofs in cities and villages.

“In my opinion, the state should regard gas production as a strategic sector and apply conditions to it than to other business activities. After all these tribulations, the extractor has to comply with the contract and give the state half of his profit, pay taxes on a residual basis, and pay off his short-term loans issued by banks at a very high interest rate. The system itself is so structured that it tends to discourage private capital from producing gas.”

“What does your association propose?”

“First of all, the license starting price must be reduced — the real market price will be named during the auction. The paperwork on land use must be simplified as much as possible, cheap credits and tax exemptions should be provided. It is also important to differentiate deposits on the basis of exploitation difficulty because today the state takes a uniform approach to all of them. As a result, an extractor who is boring a hole in the difficult-to- access Carpathians obviously loses out to his rival who is exploiting a deposit on a plain.

“If our country is to make domestic gas production its top priority, it should take a differential approach. Ukraine has a lot of deposits located very far from gas pipelines, and their reserves are quite limited on the national scale. It will be unprofitable to lay a special pipeline to them. But there is a different way: the businessman supplies gas to a nearby city or village at his own expense, while the state provides him with pipeline gas by way of compensation. But this kind of compensation will only be reasonable until prices for household and industrial gas are aligned: in the latter case it will make no difference to an entrepreneur to which category of consumer he will be supplying gas.”

“The measures you are proposing are quite expensive.”

“I don’t agree. Every additional billion cubic meters of gas produced in Ukraine means $95 million that we take out of this country and pay to Russia. However, this is just a direct loss, while indirect losses — stemming from the outflow of money from the economy — exceed this figure several times over. If we manage to raise domestic production by 10 billion cu. m., we will save a billion dollars a year; we can then channel this money into the economy and give it a shot in the arm.”

“How much gas do you think Ukraine should produce to be able to influence its gas market situation by market-related methods?”

“Domestic production should account for more than half the national gas balance, i.e., about 40 billion cu. m. If we attract private capital to this and encourage prospecting for new deposits, this level will not seem like sheer fantasy. In that case we will finally be able to thwart any attempts to undermine our country’s energy security.”