Ukraine discovers its own worst enemy on energy: Itself

DISCLAIMER: All opinions in this column reflect the views of the author(s), not of EURACTIV Media network.

This article is part of our special report EU-Ukraine Relations.

With oil majors waving billions of dollars around, President Viktor Yanukovych’s party is eager to tap Ukraine’s shale gas deposits. Political foes are no less eager to make hay of the controversial technology, writes Ivan Lozowy.

Ivan Lozowy is director of the Institute of Statehood and Democracy in Kyiv. This commentary was first published by Transitions in Prague and is republished with permission.

With its economy struggling, Ukraine’s government is desperate for budget revenues.

In its March report on Ukraine’s macroeconomic situation, the Bleyzer Foundation, an offshoot of Texas-based private equity investor SigmaBleyzer, noted, “Economic weakness continued to take a toll on state budget revenues, while expenditures continued to grow at a fast pace.”

Those findings were echoed by the World Bank in its latest global economy report, issued in June, which forecasts continued weak economic growth this year of 1%, up from 0.2% in 2012.

But instead of tackling corruption, simplifying regulations, and taming bureaucracy, the government launched a show-and-tell expedition to try and sell the idea that Ukraine is a good place to invest in, led by a new Agency for Investment and National Projects, which has been pitching the country to potential investors in the United States, Europe, and Asia. In November, however, the road show crashed spectacularly when it turned out that the representative of a Spanish gas company who signed a $1 billion deal to build a liquefied natural gas terminal, in the presence of Prime Minister Mykola Azarov, was an impostor and merely a former ski instructor.

Despite the odds and its persistently inhospitable investment climate, Ukraine has managed to attract the attention of major international companies in one area: shale gas.

Kyiv is doubly anxious to move ahead with its plans to extract natural gas from shale deposits, not only in order to boost the budget, but also as a means of lessening the country’s energy dependence on Russia. Gazprom, the Kremlin-controlled gas distributor, has set such a high price for its natural gas that Ukraine has begun importing natural gas from Germany, at $100 less per thousand cubic metres. Although in 2012 Ukraine imported just 53 million cubic metres of gas from Germany, a tiny fraction of the 33 billion cubic metres imported from Russia, the state gas company, Naftogaz, has dropped hints that the figure will increase substantially this year.

Estimates of the size of Ukraine's shale gas fields – thought to be among Europe's largest – help explain why the government is keen to develop this resource. The Yuzivska field in eastern Ukraine may contain 4 trillion cubic metres of gas, according to government estimates, with annual production between 10 and 20 billion cubic metres annually. The country consumes about 45 billion cubic metres of natural gas each year.

Production of those volumes of gas would channel billions of dollars annually into the state budget and help Ukraine diversify its energy supply, now dominated by nuclear power and expensive Russian-sourced hydrocarbon fuels.

As in other parts of Europe, though, the “fracking” technology for recovering natural gas locked within shale deposits is highly controversial, and opponents of the ruling Party of Regions are making political hay of it.

On 24 January the government and Royal Dutch Shell signed a 50-year production-sharing agreement that foresees a five-year exploration phase at the Yuzivska field, followed by joint production of gas split 50-50 between Shell and Nadra Yuzivska, a state-run company created specifically for this joint venture.

Shell will invest at least $10 billion – potentially as much as $50 billion, Environment Minister Oleh Proskuryakov has said – to develop the field.

Plans to conclude a similar deal with Chevron for the Olesska field, in the west of the country, ran into a hitch, however. In February Ukraine’s Environment and Natural Resources Ministry said a production-sharing agreement with Chevron would be concluded within two months. By mid-June, nothing was on paper, and the deadline to sign a deal was extended to 24 August.

The principal problem facing the Chevron deal is local politics. By law, local councils must approve such production-sharing arrangements in advance. That presented no difficulties for Shell at the Yuzivska site, which spans the Kharkiv and Donetsk regions, each dominated by the ruling Party of Regions of President Viktor Yanukovych. The needed approvals were obtained quickly and painlessly.

That has not been the case in the western regions of Lviv, Ivano-Frankivsk, and Ternopil, where the Olesska field is located. Here, the far-right Svoboda party is the dominant political force. Svoboda did well in local elections in 2010 and came in fifth place with just over 10% of the vote in the elections to the national parliament last year. The party has the largest factions in all three regions, with 33% of the seats in Lviv, 46% in Ternopil, and 16% in Ivano-Frankivsk.

Svoboda is understandably reluctant to support an initiative that is so important to its political opponents in the Party of Regions. Citing procedural irregularities and environmental concerns, all three regional councils concerned in the Olesska site have refused to approve the draft agreement that is being negotiated with Chevron. Vasyl Popovych, the head of Svoboda’s faction on the Ivano-Frankivsk regional council, was quite open in admitting that local councils felt passed over: “Politically, we are for Ukraine’s energy independence. But we have questions as to the technology used for shale gas. Because we were shoved aside, did not participate in choosing who will do the extraction, we will be on the side of the local community, we will study the agreement very closely.”

One of Svoboda’s national parliamentarians, Iryna Sekh, chairs parliament’s environmental committee. Sekh is vocal about the dangers Ukraine may face if it goes ahead with fracking: “The risks of shale mining are being concealed from Ukrainians. Experience in America, where the lion’s share of shale gas operations is done using millions of tonnes of water, chemicals, and sand, shows that the process is not without negative consequences. Some European countries have refused to allow shale gas operations because of these considerations, including France in July 2011 and Bulgaria in January 2012, which cancelled Chevron’s licence for shale gas exploration.”

Plans to exploit shale gas reserves have also run into opposition in Poland, Romania, and elsewhere.

Sekh’s concerns are echoed by a slew of environmental activists and assessments. At a press conference held in October by three environmental groups, Olena Kravchenko, director of the Ecology-Law-People organisation, said, “Countries around the world, one after another, are imposing moratoriums on the development of shale gas, calling it an ecological catastrophe.”

The chorus of voices warning about environmental consequences of shale gas development has been joined by that of Ukrainian Choice, a political project initiated by Viktor Medvedchuk, the one-time chief of staff to former President Leonid Kuchma. Medvedchuk’s daughter was christened by Russia’s president, Vladimir Putin, and Ukrainian Choice has taken a decidedly pro-Russian stance, espousing, for example, Ukraine’s entry into the Russia-led Customs Union at the expense of integration into the European Union.

“Developing shale gas with the use of current environmentally dangerous technologies in Ukraine should be categorically prohibited,” Medvedchuk said in May at a discussion in Lviv.

Political manoeuvrings may also explain Svoboda’s stance on shale gas. According to Serhiy Kozheliuk, an independent deputy on the Lviv City Council, “Svoboda has adopted a decidedly negative position [on the government’s shale-gas exploration plans]. They could have softened it by saying, ‘we’ll see,’ but they are completely against it.”

As matters stand, not only Svoboda, but the local councils are cut out of practically any benefits from the joint extraction deals with Western oil majors, since Ukraine’s centralised tax system means that tax revenues from shale gas development will go to the national government.

One party that has been “cut in” on the potentially very lucrative deals with Shell and Chevron is a little-known company, SPK-GeoService. In 2012, GeoService won a government tender granting it 10% in the two companies, Nadra-Yuzivska and Nadra-Oleskaya, that are authorized to negotiate production-sharing agreements for their respective gas fields. A state-owned corporation, Nadra Ukrainy, owns the remaining 90%.

GeoService’s tender win over three well-financed bidders prompted questions about how a small, obscure private company muscled its way into multibillion dollar energy projects. Some have tied in GeoService to “The Family,” the shadowy circle around Yanukovych and his two sons, Oleksandr and Viktor.

GeoService was registered recently, in 2008, and declared a modest net profit in 2011 of $80,000. The company’s principal owner and chief executive, Serhiy Stovba, is a geologist who previously worked for the state oil and gas company, Ukrnaftohaz.

Questions about GeoService's bona fides emerged even from among Yanukovych's own team. In an apparent clash of wills with Energy Minister Eduard Stavitsky, who had been pushing both GeoService and the shale gas agreements with Shell and Chevron, in April 2012 a top presidential aide, Iryna Akimova, penned an internal memorandum to her boss saying, “We believe that SPK-GeoService was artificially introduced” into the shale gas deals “with the goal of private persons receiving significant sums from the extraction of shale gas.”

Though Akimova later retracted this statement, the damage had been done.

In its fumbling to emerge from dependence on Russian oil and gas and attract foreign investment, Ukraine continues to be its own worst enemy.

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