Gas production in 2014: from general to particular

January 26, 2015

2014 was a real trial for the Ukrainian oil and gas industry. There were some significant events that radically changed the market, especially gas one. After the occupation of the Crimea Ukraine has lost control over the state company Chornomornaftogaz and the Black Sea shelf, where two new floating installations operated. Ukraine lost almost 2 billion cubic meters of gas annually, or 10% of production. The rest of the production facilities were located on the occupied Donbass territory, there were minor losses – 50 million cubic meters. Overall production totaled 19.8 billion cubic meters in 2014, which was 460 million cubic meters or 2.4% more than in 2013 (excluding Chornomornaftogaz).

Balance Has Swung

Taking into consideration the complexity of the economic situation and increase in gas prices for all consumers, its consumption decreased sharply in Ukraine – to 42.6 billion cubic meters. This was 16% less compared to 2013. However, 2014 was a turning period for the domestic gas market. The growth of own production and consumption led to the decrease of Ukrainian gas share in balance close to 50%. If the trend continued, the volume of domestic production would exceed import amount for the first time in the history of Independence of Ukraine.

State Pantry

16,850 million cubic meters or 85% of production were accounted for public companies in 2014. It was the most difficult year for Naftogaz of Ukraine, which lost control over Chornomornaftogaz. Significant funds were invested in the development of the Crimean company. Two self-elevating drilling rigs were purchased, which began operation in Odessa and Bezimenne fields. Due to the commissioning of these fields in the years of 2013-2014 the company increased production by 40%. In the moment of occupation, in March 2014, Chornomornaftogaz had the largest increase in production, and overcame Ukrnafta according to volume of gas production in 2014. Executive Management was changed several times for less than a year in Chornomornaftogaz. Sergey Beym was CEO in the company, owner of a small network of filling stations TES in the Crimea. It emerged that he lacks experience in the mining industry (Head of the “nationalized” asset has declared intention to feed the Crimea from non-existing South Stream). The company was working only for the Crimean consumers and it managed to avoid serious problems associated with capture of property of Ukraine at the moment. However, Naftogaz repeatedly stated its intention to return the seized property via the court. The development of the Crimean Company was out of the question in that current situation, not to mention the investment in the development of offshore fields. Chornomornaftogaz and its Executive Management was able to only wait for the court decision whose result was easy to predict.

Difficult year was for Ukrgasvydobuvannya Public Company. Chairman of the Board Yuriy Borisov left the company in 2013, a close loyalist of disgraced businessman Dmitry Firtash, who was then under house arrest in Austria. At the beginning of 2014, when power shift in the country been in the air at the Independence Square already, the People’s Deputy Alexander Onishchenko tried to “enter” the state company, whose enterprises are working under a contract of joint activity with the Ukrgasvydobuvannya (Nadra Geocenter, Firm KhAS and Karpatnadrainvest). But replacement of Borisov did not got a chance at that time. After nearly four years of work under management of Manager Firtash Ukrgasvydobuvannya was in a difficult situation: debt increased up to 3 billion USD for gas supply, corrupt system of liquefied gas and, as a result, huge loans in Russian banks. the company entered into 2014 with those problems.

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Ukrgasvydobuvannya was headed by Sergey Kostyuk in March, who worked for many years in the realization department of the company. In addition, the new deputies were appointed for all key directions. The new management planned to improve the financial condition of the company, as well as to invest in drilling and processing. It should be noted, that he really managed to improve the situation with the sale of petroleum products and liquefied gas, which brought the company the main income and profits.

However, it became clear before the summer that Ukrgasvydobuvannya lost any government support, Ministry of Energy and Coal-Mining Industry and Naftogaz. The main task – to increase the purchase price of gas – was not fulfilled. Ukrgasvydobuvannya requested to increase the price up to 800 UAH per thousand cubic meters, but the government decided that 349 UAH without VAT was enough for the development of production. However, gas price for population increased significantly starting from May 1 – from UAH 1,089 to UAH 4,011, depending on consumption. Development was out of the question at all if no change in the purchase price of gas for Ukrgasvydobuvannya.

The production of state company amounted 15.1 billion cubic meters in 2014 – exactly the same as in 2013. Its part, 800 million cubic meters, came to joint ventures – JV – with dozens of private companies. 80% of JV production was on the largest of them – Karpatygaz with subsidiary of Swedish Misen Energy. Ukrgasvydobuvannya major production losses occurred in the Lugansk region, where the company had several industries. In April and May armed bandits robbed drilling. Employees had to be evacuated, and all work stopped. The company estimated production losses amounted 50 million cubic meters or 0.3% of total production. There were also problems last year in the segment of joint activities. The change in Ukrgasvydobuvannya management led to the reconsideration of work conditions. For example, there were demands to transfer all produced gas to Ukrgasvydobuvannya. There were difficulties also with taking into balance. The problems were solved till summer, and several major projects in June and July were able to implement with Karpatygaz. Two previously started projects on construction of booster compressor stations on Rozpashnivske and Skhidnopoltavske fields (both in Poltava region) were completed. Thus, joint activities could significantly increase gas production.

Looking ahead, we note that the Swedish shareholders reconsider the previously approved development program in February due to changes in the fiscal laws of Ukraine (see. News on p. 21). It is easy to assume that Misen Energy intends to reduce investment.

Ukrgasvydobuvannya believed that the construction of booster compressor stations was the fastest way to increase production. Payback period for individual projects was less than a year. About 80 fields in Ukrgasvydobuvannya are at the final stages of development, where BCS can be successfully implemented. However state company did not have money for the BCS construction, those projects were mostly implemented within the frames of JV together with private company Karpatygaz. The situation in Ukrgasvydobuvannya was worse with oil and condensate production. Production was decreased to 533 thousand tons last year, i.e. by 110 thousand tons, or more than 17% (it is the loss of approximately two-month scope of plant work at the current load of Shebelinka GPP). That was the worst result in 15 years. The production decrease was explained by the company as the depletion of major gas condensate fields. The result of liquid hydrocarbons production decrease was a rapid decrease of oil production on Shebelinka Gas Processing Plant. The situation was worsened by supply stop of Chornomornaftogaz resource that was processed on Shebelinka. Nowadays the factory was loaded with almost half of its capacity and upgrading perspectives were less. Despite the difficulties in 2014 there were good news in Ukrgasvydobuvannya. The company opened two small fields.

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Malokrynkivske gas and condensate field in the Kharkiv region was located in Shevchenkiv district territory. According to assessments result of the Ukrainian Institute of Natural Gas Resources experts total reserves were 500 million cubic meters of gas. Olshychne oil field was opened in the same with reserves of 500 million cubic meters. Besides, it was also drilled 45 new wells; three of them were high rate.

Another state monopoly Ukrnafta showed stable poor results. Oil production was 1.9 million tons, decrease 7%, gas – 1.7 billion cubic meters, decrease almost 9%. Main events around Ukrnafta in 2014 were related to the government’s attempt to return control over the company. There were several attempts to hold a meeting of shareholders, but the Government did not achieve the expected result. Adoption of the law on joint stock companies was failed too, which should help the country to put Ukrnatfa under control. The law was voted in, but there were serious mistakes made in the wording of the document.

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Successful projects were implemented in the framework of joint activities in 2014. Drilling of seven wells with the company Gals-K was completed in Hnidentsivske field. There were 7 wells drilled in total, two of them had an initial production rate of 40 tons per day, the rest ones – 10-20 tons. Although the field was operated more than 50 years, oil production was not reduced. Four wells more are planned to drill in 2015. However, that was perhaps one of the few successful projects, which Ukrnafta was involved in. Overall, the volume of Ukrnafta drilling was minor. Hence there were disappointing results in the production.

Swan Song of Private Companies

According to the results in 2014 private companies produced 2,950 million cubic meters of gas, which was 622 million cubic meters of gas (27%) more than in 2013. Oil and condensate production was increased by 1.8% to 308 thousand tons. At the same time production of condensate was increased and oil production was decreased. For the first time ever the volume of condensate production from private owners exceeded oil production – 168 thousand tons against 140 thousand tons. However, huge problems of the sector were hidden in good results. Since August, the taxes for private companies were increased significantly. Rent payments were increased from 28% to 55% of the gas in the production of 5 000 meters and from 15% to 28% in the production of more than 5 000 meters. It was predicted that the rent increase would be temporary, but the government extended the rules for the year of 2015 that buried the last hopes of private investors.

Rapid increase in taxes resulted in that gas production turned from profitable business into risky. Companies faced with decrease of income, which served as a source of investment. Many projects were left without funding, some of them were closed. The rates of production growth were decreased by the end of the year.

The market leadership among independent gas producers was captured by two companies, which had half of all private gas. That was Naftogazvydobuvannya PrJSC, which was part of DTEK of businessman Rinat Akhmetov, and Burisma Holdings of former head of the Ministry of Natural Resources and Environment Nikolay Zlochevskyi. First place was taken by Naftogazvydobuvannya. It increased production in one and half: gas – up to 750 million cubic meters, condensate – 30 thousand tons. The key to success was eightfold increase of drilling (eight times more!), which was 34 thousand meters against 4 thousand meters in 2013, and workover operations of wells, which the company had 12. Olefirivska gas processing plant was commissioned, which allowed to connect the new well and ensure stable operations of the company.

According to Naftogazvydobuvannya information it was invested in the development in 2014 UAH 1.4 billion of its own funds, while the company paid UAH 1.8 billion taxes – almost twice more than a year before. It should be noted that almost all gas was extracted from the depth of more than 5 000m and the rent was 29%.

Burisma Holdings was on second place for volumes, which increased the production in one and half, to almost 700 million cubic meters. The company was accounted for a quarter of total private production. Holding comprised four operating companies engaged in mining and hydrocarbon production, including Energy service company “Esko-Pivnich”, “Pari”, “First Ukrainian Petroleum Company” and “Aldea”. Holdings owns 20 licensed areas, average daily production in November-December was 2,1-2,3 million cubic meters per day. The company drilled a lot, most of all in the market and added about 20 wells for a year. Last year was a turning period for the company: Burisma approved a new development strategy, updated management structure. The board of directors included Western experts. The dynamic growth allowed Burisma Holdings to become market leader. Good perspectives for the development of production were provided by company reserves that were 768 thousand BOE. Audit of reserves was held by international company DeGolyer & MacNaughton.

Third place among independent companies took KUB-Gas, which surpassed Geo-Alliance in 2013. The company increased production by 20% to 336 million cubic meters. Major work was carried out on Olginske (well O-11) and Makiyivske fields (wells M-17, M-22) in Lugansk region. Other company from club Cub Energy Tysagas Company successfully mastered Ruthenian-Komarivskyi field in Transcarpathian region. Tysagas drilled two wells РК-21 and РК-23. The volume of production was small, just 20 million cubic meters per year, but daily production exceeded 100 thousand cubic meters per day by the end of 2014. This was three times more than in 2013.

Geo-Alliance came down to the fourth place owned by businessman Victor Pinchuk and controlled by Natural Resources. The company has reduced production by 15% to 250 million cubic meters. Let us remember, two years ago, 25% of Geo-Alliance was bought by Arawak Energy. There were plans on modernization and investments, but the company did not have special achievements there still. In addition, East Geological Union LLC was included in Pinchuk’s sphere of influence. The general condition of the oligarch companies could be described briefly: lack of investments, as a result – production decline. The top five leaders were closed by Poltava Petroleum Company, with gas production of 249 million cubic meters, growth – 12%. The situation was worse with oil and condensate production – decrease up to 43 thousand tons, or almost 30% – the company was unable to maintain production at the depleted fields. The drilling of deep wells in Yelyzavetivske field should be marked as important projects in 2014. 18.7 thousand meters were totally drilled on the company’s fields in 2014. Poltava Petroleum Company drilled 6 wells with depth up to 5 000m last year. The company has suffered from increasing rents. Board of Directors declared about the need to reduce capital expenditures in order to compensate the additional production costs and tax of 10 million dollars in 2014. In 2015, the company stopped all drilling works. Another major player in the market was Smart Holding owned by Russian businessman Vadim Novinsky. Holding was represented by three production companies: Regal Petroleum, Prom-Energo Product and Ukrhazvydobutok. The total production volume in 2014 was 190 million cubic meters of gas, equal to the level of the last year. Production of condensate slightly increased. The declared ambition of “Smart Holding” in the oil and gas market remained unfulfilled. And at the time of Holding’s problems in other areas (assets in the Crimea, the troubled bank “Forum”, a corporate scandal with supermarkets “Amstor”, a general negativity in the country to the Russian business, work of Novinsky in the “Party of Regions”) the success of a businessman in production was out of the question.

As for small market participants it should be noted Lviv company Goryzonty owned by businessman Zinovy ​​Kozitskiy. It was a conglomerate of companies and firms, which, in addition to mining assets, including geological and service enterprise. Lviv Regional Council approved to companies affiliated with Goryzonty six oil and gas areas in Lviv region. The volume of production was small, about 1 million cubic meters per month. However, the company finished drilling of two wells in late 2014, which should begin production after testing.

Hard Times

Large projects of foreign companies did not work last year. Military operations in Eastern regions caused stoppage of any work of Shell company at Yuzivska site. And in December 2014 American company Chevron decided to withdraw unilaterally from the draft production sharing agreement – PSA – from Oleska area development. Officially, neither Chevron, neither the government did mention the reason of rejection, but one could speak about a whole complex of problems that made the work of oil and gas companies in Ukraine be unattractive.

Despite some successes in 2014, the overall state of the industry is very sad. After a brief renaissance the mining industry has rolled down once again. Under the banner of fight against the oligarchs Yatsenyuk government has taken a number of decisions harmful for the industry. It is not just about taxes, but about attempts to force private companies to pump gas into underground storage or force consumers to buy gas from Naftogaz of Ukraine. Al of that has turned into great problems for all market participants, including foreign investors from USA, Canada, Poland and the UK.

Joint ventures that work with state companies have been unlucky too. Starting from January 2015 they will have to pay 60% rent from the cost of gas, 65% – starting from the 2nd quarter, 70% – from the third. There are no such rents and taxes on the extraction of gas anywhere in the world. It is obvious that this kind of activity as JV will in Ukraine in the near future. Is this maybe what the government is seeking?

If the situation does not change in the next few months, then a new year can be last one for many producing companies, and Ukraine will reduce its own production. Under these circumstances, energy independence is out of the question.