Ariel Cohen
If you ask Stepan Kubiv, Ukraine’s Energy Minister, what the long-term economic losses will be as a result of Crimea’s annexation in 2014, he’ll tell you to look towards the sea. The Ukrainian Energy Ministry reports that “Ukraine has lost 80% of oil and gas deposits in the Black Sea and a significant part of the port infrastructure due to the annexation of Crimea.” The announcement comes on the heels of a continuing standoff in the adjacent Sea of Azov, where 24 Ukrainian sailors and three navy ships were seized last November by the Russian coast guard.
Moscow’s brazenness in Ukraine’s territorial waters since 2014 serves as a reminder that the Kremlin views these areas and their associated hydrocarbon resources as its exclusive war booty. While Ukraine has made an effort to resist Russia’s irredentist aspirations – at the cost of more than 10,000 soldiers and civilians since 2014 – her strategic position continues to deteriorate. Western military support has been muted and economic sanctions against the aggressor are proving an inadequate means of deterrence.
Meanwhile, the little leverage Ukraine does enjoy as a transit hub for Russian natural gas is fading fast. The controversial Nord Stream 2 pipeline, Russia’s latest attempt to strengthen its grip over Europe’s energy supplies, has received approval from Paris and Berlin and may be launched as early as December 2019. The subsea pipeline entirely bypasses Ukraine and would deprive the country of $3 billion in annual transit revenues – almost 3% of the country’s GDP.
To make matters worse, Ukraine’s oil and gas sector is plagued by corruption, red tape, and dominance by state monopolies. Kiev has subsequently struggled to attract outside investment in its energy resources, leaving the country in an increasingly perilous economic position. The loss of its Black Sea hydrocarbon deposits is a major setback. Any legal actions to gain reparations for the oil and gas assets lost after the capture of Crimea will take many years – if it happens at all – as collecting compensation from a belligerent a nuclear power can be complicated.
Russia’s Resource Grab
The Black Sea contains a wealth of hydrocarbon resources. The northwestern portion holds estimated reserves of 495.7 bcm of natural gas and 50.4 million tons of oil and condensate. The Prykerchenska zone holds about 321.2 bcm of gas and 126.8 million tons of oil and condensate, and the continental slope has an estimated 766.6 bcm of gas and 232.6 million tons of oil and condensate.
The real story here, however, is the gas.
There are nine so-called “blocks” of natural gas available for licensing in Ukraine’s Black Sea, the potential of which ranges from 92 billion cubic meters (bcm) to over 500 bcm, according to an April 2018 survey conducted by Deloitte. While this is a paltry amount compared to 635 bcm Russia produces annually, grabbing new supply and denying gas to Ukraine is an enticing ‘two birds’ opportunity for Moscow.
Russia’s energy ambitions in the Black Sea region are further helped by circumstance and geographical luck. Some 70% of potential natural gas deposits of the Black Sea are concentrated in just two blocks: Neptune Deep and Trident – well within Russia’s newly claimed Exclusive Economic Zone (EEZ) around the Crimea (see map).
Moscow’s intent to exploit Ukraine’s natural gas deposits is not just idle speculation; it is currently underway. When Russian forces annexed Crimea in 2014, they seized subsidiaries of Ukraine’s state energy conglomerate Naftogaz operating in the Black Sea. The Kremlin appropriated these companies — and billions of dollars of equipment — and delivered them to Gazprom, Russia’s state-owned energy giant. In one fell swoop, Russia ended Ukraine’s offshore oil and gas operations and bolstered its own.
Unlike the Donbass, where Moscow exercises indirect control, in the Black Sea and the Sea of Azov Russia has sought to gain de-facto control over Ukraine’s territorial waters. This was seen with its occupation of the strategic port of Sevastopol, the seizure of Ukraine’s offshore oil and gas assets, the claim of exclusive jurisdiction of the Kerch Strait, and the capture of Ukrainian sailors in November.
Ukraine’s Domestic Energy Mess
Major international energy conglomerates have noticed Ukraine’s energy potential before. U.S Energy Secretary Rick Perry called the country the “Texas of Europe.” According to Kyiv Post, some of the world’s largest oil and gas companies, Shell (NYSE:RDS), Chevron (NYSE:CVX), Eni (NYSE:E) and ExxonMobil (NYSE:XOM), have entered the Ukrainian market before and committed to invest millions of dollars. Yet these deals have repeatedly failed: Shell and Chevron notably backed off a $10 billion agreement in 2015.
Despite measurable progress with internal reforms, Ukraine is still unable to meaningfully expand its domestic hydrocarbon production due to over-regulation, corruption and the dominance of state monopolies. UkrGasVydobuvannya (UGV) for example, a 100% subsidiary of Naftogaz, controls 75% of all domestic natural gas production. The dominance of UGV and Naftogaz has led to valuable private leasing contracts being consistently given to those connected to the highest echelons of government. The best example of this is Mykola Zlochevsky, who served as Ukraine’s natural resource minister under Yanukovych. During his time in office he would issue extraction licenses to his own company, and despite numerous criminal investigations has successfully escaped all charges levied against him.
This past January, key oil and gas players met in London at Ukraine’s E&P forum to discuss the auctioning of licenses for rights to 30 onshore hydrocarbon deposits. The licenses – to be awarded March 6th – would allow investors to take part in production sharing agreements with up to 70% private ownership. Still, questions about Naftogaz dominance, the fiscal regime, and regulation left most attendees skeptical. Participation in next week’s auction will be an important indicator of market sentiment.
Today, only small operators with high tolerance to risk, like Ilya Ponomarev’s Trident Acquisitions and international financial institutions such as the EBRD, are willing to invest in exploration and production in the embattled country – not Western majors. Don’t expect this to change anytime soon.
To Extract or Not to Extract: That is Not the Question
Ultimately the energy resources in the Black Sea will be extracted and produced– the question is by whom. The rightful beneficiaries of Crimea’s offshore oil and gas should be the Ukranian people. The Kremlin has different ideas. Beyond the Black Sea, Ukraine cannot hope to develop its domestic energy sector without getting its regulatory and legal house in order. At the same time, it will need to find an effective strategy to fend off Russia’s creeping annexation. A war-torn country dominated by corrupt state monopolies is not an attractive destination for private investment.
Courtesy: (forbes.com)
