Black Sea Gambit

Ukraine is about to open its Black Sea shelf to large-scale exploration and drilling by international oil companies, following a tender won by an independent United States-based energy company that says it's ready to funnel hundreds of millions of dollars into finding and extracting oil and natural gas under a production-sharing agreement.

If hydrocarbon reserves in the almost 13,000-square-kilometer field located just a few miles south of the Crimean peninsula pan out, Ukraine could eventually loosen its dependence on Russia, which supplies Ukraine with 80 percent of its oil needs, and together with Central Asia, 75 percent of its gas.

Although the full details of the production-sharing conditions will only be available after an agreement is signed later this year, the tender demonstrates an effort by the government to hold more transparent tenders for mineral rights with equal opportunities for international investors.

Vanco International Ltd., a subsidiary of Houston-based Vanco Energy Company, beat out multinational oil companies like Shell and ExxonMobile in an April 19 decision taken by a commission headed by First Deputy Prime Minister Stanislav Stashevsky. However, according to Vanco President and CEO Gene Van Dyke, "somewhere down the road we could bring in partners."

Current Vanco partners include international energy giants like China's Sinopec, Italy's Eni and ExxonMobile, among others.

Environment Minister Pavlo Ihnatenko told a briefing after the announcement of the April 19 decision that an agreement between Vanco and the Ukrainian government could be signed within a couple of months.

"I think that this will be taken care of with maximum (speed) and without any catches," he said.

The tender was announced in December 2005, with five proposals being accepted for consideration on March 25 this year: Shell and ExxonMobile competed jointly, as did Turkey's state-owned Turkiye Petrolleri with a little-known British firm called Alphex One Limited. Other tender participants included Ukraine's majority state-owned Ukrnafta, the largest oil producer in the country, and Hunt Oil Company of Ukraine, a subsidiary of another U.S.-based independent.

Hunt Oil and Shell are so far the only major Western energy groups with exploration and production rights in Ukraine. Hunt struck a Black Sea exploration agreement in 2004, while Shell inked an agreement last year to explore along the so-called Dnipro-Donetsk Basin, promising $100 million in investments.

Vanco was joined in its bid by UK-based JNR Eastern Investments Limited, part of the JNR group of companies, which represent the interests of Nathaniel Rothschild and his family in the former Soviet Union and Eastern Europe.

The partnership between Vanco and JNR is 50/50, with Vanco providing the technical expertise and JNR providing "the financial dimension," said Jim Bown, a consultant to Vanco who represents the company's interests in Ukraine.

Together, the companies plan to come up with around $330 million to explore the deepwater field over an eight-year period. Bown said that Vanco has already spent $3 million on seismic research conducted by another company last year.

"We believe that the Black Sea is one of the world's last great hydrocarbon frontiers," he said, adding that in one part of the 13,000-square-kilometer field alone, there could be as much as 1 billion barrels of oil.

It's still not clear exactly what production sharing between Ukraine and Vanco/JNR will entail for each side, as the agreement has yet to be signed.

Insiders predict anywhere from a 40 to 60 percent share for the government, with the two Western companies taking on all the risk.

"Vanco doesn't receive anything in the way of grants or subsidies from the Ukrainian government and doesn't expect to. We will carry all of the risk and it won't cost Ukraine anything," said Bown.

Bown declined to give Vanco International's 2005 financial figures, explaining that the Bermuda-registered company is private, having issued no public stocks.

According to him, the company won the tender because "small, independent oil companies can handle deepwater exploration projects faster than larger companies."

Van Dyke, known for spearheading bold deepwater hydrocarbon exploration projects in Africa, is the founder and majority owner of Vanco.

Deepwater exploration and drilling is, in fact, Vanco's specialty.

According to a Nov. 28, 2005 article by U.S. Time magazine, Vanco CEO Van Dyke is the largest deepwater exploration license holder in Africa.

Called one of the last wildcatters, Van Dyke, now 80, started off in the U.S. over half a century ago, and then moved on to the North Sea and, about 10 years ago, to Africa, where he has cut leasing deals with the leaders of half a dozen countries.

Vanco's project in Ukraine represents Van Dyke's first deal in the former Soviet Union.

"While deepwater exploration is very risky, I believe that the Ukrainian Black Sea represents an extremely attractive opportunity for Vanco. And Vanco in association with JNR has the requisite deepwater expertise and financing needed to successfully explore and develop the tender areas," said Van Dyke.

One of the reasons the Ukrainian government has given for inviting foreign companies to explore the shelf is that domestic companies don't have the experience to work in deep water.

The shelf area set to be licensed to Vanco goes as deep as 2,000 meters.

"The business now is very, very sophisticated. The days of the wildcat that would go out and drill under a tree or a graveyard are gone," said Van Dyke.

But as in Africa, Vanco will hire contractors to do all the exploration and drilling.

Bown said all oil companies, big and small, contract drilling ships with crews, or seismic teams, rather than using their own staff.

"We want to get Ukrainian companies involved as much as we can, but we don't know whether they can do the seismic work or deepwater drilling," said Van Dyke.

Konstantin Borodin, director of Kyiv's Energy Research Center, disagrees, arguing that Ukrainian companies could handle the exploration projects themselves if Ukrainian taxes were liberalized.

However, said Borodin, there is nothing strange about an independent company like Vanco coming in ahead of a larger 'partner' that may have initially lost out in a tender bid.

"It's normal. They simply let relatively smaller companies in first, and either the smaller company confirms the estimated reserves and gets a bonus, or it fails, and the larger company has lost northing," said Borodin.

Digging down under

Ukrainian geologists suspect that the Black Sea shelf promises at least as much gas as oil, according to Borodin. Deputy Prime Minister Stashevsky has said that, according to preliminary estimates, the Black Sea shelf could yield enough gas to increase the country's production by 4 billion cubic meters, or 20 percent.

Whatever lies beneath the sea floor, Vanco stands to get a 30-year license to extract it.

"There is definitely a risk but the shelf is promising," said Borodin. Moreover, production costs are several time higher than on land.

According to Borodin, a single oil well in deep waters can cost up to $20 million to set up, while many wells come up dry.

Even if Ukraine and Vanco do strike it rich, "it would be at least years" before the country would feel the difference in the amount it has to import from Russia, said Serhiy Sapegin, an analyst for Psikheya, a Kyiv-based energy consultant.

The administration of Ukrainian President Viktor Yushchenko has made it a priority to decrease Ukraine's energy dependence on Russia. Timing is key, as Russian gas giant Gazprom nearly doubled the price of its gas exports overnight earlier this year.

Unlike his predecessor Leonid Kuchma, Yushchenko favors closer ties to the West, including more administrative transparency, and thus, a greater likelihood of attracting Western investment.

In February, during a trip to Poltava region, where much of the country's oil is currently produced, Ukrainian Prime Minister Yuriy Yekhanurov criticized past corruption in the issuance of hydrocarbon production licenses to little-known companies.

"There was such a problem, where licenses were being given out on the basis of personal ties," said Sapegin.

Although Stashevsky's office declined to release information on the proposals put forward by other oil companies, citing commercial confidentiality, Borodin said the tender was held "in accordance with international practice."

John Marone, Kyiv Post Staff Writer
Apr 27 2006