Interviewed by Maria Danyuk

Lyudmyla Kuchmenko says “It is necessary to fight for each investor”

CEO of GEO ALLIANCE GROUP told The Rating about last year’s results, adaptation to PSA and why there is currently a need for a system that would incentivize investors   

How did you finish 2019? Did you manage to implement new projects?

I think that 2019 was quite successful for us. We achieved all the performance targets – last year GEO ALLIANCE GROUP produced 210 million cubic meters of natural gas, 39,000 tonnes of gas condensate and oil. By increasing our LPG production (20,000 t) we continue to be a leader among the private companies of Ukraine in this segment. At the end of the year, a company of our Group – LLC EASTERN GEOLOGICAL UNION – started producing natural gas in the Koshevoyske field (Myrhorod district, Poltava region).

How favourable are the current market conditions for producers?

Currently we have the lowest natural gas price over the past 10 years. Unfortunately, further forecasts are discouraging (I am saying this, of course, as a representative of the industry). This being said, neither Ukrainian, nor leading international service companies have reduced cost of drilling and exploration because they are guided by the global oil prices. Under such circumstances, in particular deep drilling (especially when we speak about exploration wells) is uneconomic. However, when a field has already been developed and subsurface risks are not so high, then chances of positive economics are higher. Currently, in order to improve investment performance, companies target shallower deposits or workovers of the existing well fund, side tracks.

What global trends should Ukraine pay attention to?

Today everybody’s attention focuses on gas price decline and factors influencing gas pricing. As Ukraine imports gas, its domestic price depends on the gas price in the European market which is currently oversaturated with natural gas. As a result of the warm winter all underground gas storages both in Europe and Ukraine are full, and demand is falling. And given that Europe’s market is actively being conquered by American LNG, supply remains persistently high consequently pushing the price down. Another trend (that is relevant not only for our industry) is global requirements to environmental measures. Unfortunately, the Ukrainian business culture is rather low as regards compliance with environmental standards. And it is a very important matter because it has direct impact on the quality of our life, life of our future generations. Ukraine needs to carefully monitor these trends while building its energy strategy.

The gas producers’ business model envisages long planning horizons. Currently we have 2 models, the so-called tools for development of oil and gas areas – granting of permits (licenses) and based on PSA. What are their pros and cons?

It is not easy to implement non-discriminatory, equal conditions for operation of all the market players when two different systems are introduced at the same time. Yet, if you compare them, there are pros and cons either way. On the one hand, the special permit model is worked-out and clear to all the market players. But license holders have to operate under the statutory conditions that are frequently modified. For instance, the state gave guarantees for 5 years of stable taxation for the industry. However, there have already been numerous attempts to change or even cancel them (I mean initiatives regarding cancellation of incentivizing royalty rates for new wells). The government should pay attention to the fact that investors – both those already operating, and potential ones – are already tired of the instability. I emphasize again that the oil and gas industry is a capital intensive activity with rather significant (geological and engineering) risks requiring long-term planning. Therefore, it is important to fix the rules of the game at least for some time.

Operating under production sharing agreements is attractive due to the possibility to get a predictable rate of return on investments thanks to fixed tax and regulatory conditions. However, at the moment my concern is that PSA may turn into rather overregulated, complicated mechanism. This refers both to getting approvals for certain procedures under PSA, and lack of detailed information on this tool at the level of statutory instruments. It is absolutely clear that neither private market players, nor governmental institutions understand how to work with PSA. This nuance should not be underestimated. Colleagues who already dealt with production sharing agreements in the past said that it had taken them 6 months just to open a bank account. I think that such difficulties may arise, for instance, when sharing production in kind; in particular it is needful to refine a procedure for work with the Operator of Ukraine’s Gas Transmission System. So, we will have to go through the adaptation of the tool to the Ukrainian legislation for a while, and this will require close interaction between the state and an investor.

And what are the global practices? For instance, will proposals from companies willing to work under PSA be released to the public?

As far as I know, the use of the two models simultaneously is not typical of the other countries. I know from my colleagues that either one or another tool prevails.

Answering the second question I will point out two things. On the one hand, stakeholders of this process demand that information be open. On the other hand, the legislator protects an investor’s confidentiality. However, the demand for openness of such agreements remains quite high. One should understand that a competitive tender is not an auction where subsoil user’s rights are obtained in a simple and fast manner – the one who pays the highest bid wins. After a tender for PSA, there are long negotiations with the state about the terms and conditions of the agreement. I believe that the state will definitely win if most of such conditions were clear-cut and worked-out in detail.  

Currently the Tax Code contains a provision on a special royalty rate for production of additional gas volumes from hard-to-recover reservoirs but this rate does not work in reality (there is a limited circle of entities able to use it and the procedure is very difficult and non-transparent). In your opinion, what solution could be optimum for the companies and beneficial for the state?

Honestly, I am not a supporter of this norm because really one can hardly call the criteria it sets objective. As a market player I want the rules to be clear and transparent. There is a need for an investor incentivizing system but certainly not through setting a separate norm for some programs and agreements. In my opinion, it would be fair to replace the existing taxes with a special taxation system – the so-called “profit based taxation”.  In fact, it is a progressive tax on profit or an income tax surcharge. You accepted the risk, made investments, got high flow rates – you pay tax on high profit. A well is a low rate one – you pay less; the well is dry – you do not pay at all. This system is not new; it works in the world and has proven to be efficient and fair. In 2015, a respective draft law was developed in Ukraine too but unfortunately it was not adopted. I do not insist that this should be done immediately but in the long run we need to think about introduction of fair market conditions.

What approaches to unconventional gas production can be used to attract big international companies to Ukraine?

Almost all big foreign companies such as Shell, Chevron and Exxon stayed in Ukraine long enough to evaluate its geology and potential for unconventional gas production. The fact that none of them stayed is eloquent. In my opinion, first we should master technologies of work with tight reservoirs and hydrocarbon pools bedded at significant depths. And then proceed with extraction of shale gas which is a more technically challenging process. I believe that stakes should be on small and medium investors who are ready to work with small pools. And given our complicated geology and ongoing changes in taxation, it is necessary to fight for each investor.

For the third year in a row, there has been a norm about keeping 5% of royalty in local budgets. What changes in communities do you see and how has this decision facilitated your dialog with communities and local governments?

It has certainly made it easier. With the previous tax regime, it was hard to explain benefits from gas production to communities. Now local governments clearly understand that we bring real money to local budgets. The 5% royalty has allowed local governments to become to some extent participants of the gas production process and to benefit from our activities. These funds are used to finance community infrastructure development – to build water supply facilities, maintain schools and reconstruct community centers, roads and other facilities making life significantly better for local communities.

What are the current barriers impeding the industry’s development in Ukraine?

Let us be frank, an investor’s appetite is formed by gas price, taxes and geology. As already mentioned, currently economics of most projects, especially of exploration ones, fail to hold up to unfavourable conditions existing in the market. The Dnieper-Donets Depression is a mature province, i.e. the area that has been developed for more than 70 years. Large fields confined to big anticlinal traps have already been discovered. In the present circumstances, when it comes to prospecting for and exploration of new hydrocarbon pools (fields), we are dealing with small pools (in terms of reserves) that mostly lie at significant depths and are confined to thin hydrocarbon-saturated beds, which are often structurally complex reservoirs. Thus, we need to focus more on bringing new technologies to unlock the potential that was possibly missed earlier.  

But I do not want it all to seem so pessimistic. Yes, the industry is operating under difficult conditions now but this is not the first time it happens. We will manage it. There is potential. There will be some re-orientation and adaptation process where pragmatism and professionalism will be key success factors.

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