Wednesday, November 18, 2009

Regal looks to help Ukraine wean itself off Russian gas

Since the break-up of the Soviet Union, Ukraine has been hooked on cheap gas supplied more and more reluctantly by Russia. But it's often overlooked the country produces around 25-30% of the gas it consumes, placing it just behind the UK, Venezuela and Kazakhstan on the list of the world's gas-producing countries. Now independent producers like Regal Petroleum are looking to help make Ukraine gas independent.

For that to happen, though, Ukraine needs Russia to continue with its policy of clawing back the discount it gives to Ukraine on its gas. Since 2005, the price Ukraine pays for gas imports has increased about five-fold, from $50 per thousand cubic metres in 2005 to what will be nearing $300 in 2010. When at the end of 2009, a remaining 20% price rebate for 2009 ends, Ukraine will finally be off the cheap gas hook, a process most other Warsaw Pact countries successfully completed years ago.

"Ukraine will move to European prices for gas in 2010, we are sure of this," John Greer, CEO of Regal Petroleum, the London-listed gas producer operating mostly in Ukraine, tells bne. "Ukraine has enjoyed a fuel discount for a long time thanks to its northern neighbour, but now it's time to get off the hydrocarbon hook. If no one else does, then the [International Monetary Fund] will make sure of this, to ensure a level playing field. And this is good news for Ukraine and for us."

For the handful of independent producers such as Regal Petroleum, the price surge suddenly makes gas production in Ukraine a more economically viable business. And with the government keen to reduce dependency on Russian gas, there is increasing political support for having foreign investors operate in the country. "The shift to European prices in 2010 marks the beginning of a new beginning for Ukraine's gas production," says Harry Verkuil, Regal Petroleum's Chief Operating Officer. "We are confident the country has the potential to attain self-sufficiency in hydrocarbons."

Dig deep

The move to European pricing is crucial to unlocking the reserves in Ukraine's Dniepro-Donetsk basin, which accounts for 90% of the country's oil and gas production. After half a century of production has depleted fields there, Ukraine's remaining gas lies deep underground, and so is expensive and technically challenging to get at. "We have great respect for Ukraine's drillers," says Verkuil, "but they are working with outdated Soviet-era technology. They can drill down to 5,000 metres, but it takes them one to two years. It takes us six months, and then we go even deeper."

Some 90% of Ukraine's gas is extracted by state-owned companies lacking capital for investment and any market stimulus to improve efficiency. Regal, on the other hand, has imported two state-of-the-art rigs from the US, enabling them to drill faster than the Soviet-era rigs and also incorporate modern evaluation technologies unique in Ukraine. Regal also sees huge potential for working over older wells in partly depleted fields to tap residual gas. Using new drilling techniques such as horizontal drilling and fracturing will also be beneficial to increase production. "The Ukrainian companies are interested in what we are doing, and whether it's successful," says Verkuil. "They're watching us and consulting with us, and we hope to convince them of the benefits.

Developing the country's exploration and production industry will ultimately result in reductions of cost and an increased availability of material and equipment in Ukraine. Pioneering new technologies is a time-consuming and bureaucratic process in Ukraine, where it involves importing all new machinery and spare parts and diverging from standard approved practices. The lack of any servicing infrastructure in the country is another drawback.

However, Verkuil says these are problems that should diminish going forward. Among the advantages of Ukraine is the gas production infrastructure, with huge storage facilities and a developed pipeline network, and customers located in close proximity to the gasfields. Regal feeds its gas directly into the Kursk-Kiev trunk pipeline and has closed a field-life contract with London-listed iron ore producer Ferrexpo, which has agreed to buy all Regal's gas over roughly the next 20 years.

Regal invested $48m in the first half of 2009 to boost gas production 156% in the second half to approximately 3,000 barrels of oil equivalent per day (boe/d). Even when complete, this will only comprise two new generation wells online, with a third currently being drilled. This is small beer; the long-term plan is to spend $1.6bn and drill 95 wells over the next decade, raising output to a plateau of 40,000 boe/d by 2017. This would make Regal the country's third-largest gas producer.

Until now, though, the record of foreign investment in Ukraine's oil and gas industry has been chequered, with a number of scandals and false dawns. But with the investment conditions now more favourable, Regal sees itself in the vanguard of what will be a stream of transparent and professional private investors.

This is exemplified by Regal's ability to raise the finance it needs. "We need $400m, and have raised $300m in equity over the last two years," says CEO Greer. "We were originally planning $200m in equity financing and $200m in debt, but things weren't looking good for debt earlier this year when the world was stood on its head, so we went for a share issue instead, and raised $100m. But things have changed significantly since then, so that we now hope to raise the additional $100m we need in debt. And even this does not happen, we will carry on regardless, turning cash positive in 2011."

There was a swirl of takeover rumours early in the year, with Russia's TNK-BP and Lukoil named. "There were Russian and also further Eastern offers," confirms Greer, "but it was bottom-feeding after the market collapse, and our share price has recovered significantly since then. We are open only to reasonable proposals."

By Graham Stack. Published on 18 November 2009
Copyright (c) 2009. bne. Reprinted with the permission of Business New Europe
The views expressed in this article are the author's own and do not necessarily reflect those of S & D.

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