April 12, 2013

Shale gas perspectives for Ukraine: where does illusion end and reality begin?

AFP/Scanpix
Pump jacks are seen at dawn in an oil field over the Monterey Shale formation where gas and oil extraction using hydraulic fracturing, or fracking, is on the verge of a boom on March 24, 2014 near Lost Hills, California.
Pump jacks are seen at dawn in an oil field over the Monterey Shale formation where gas and oil extraction using hydraulic fracturing, or fracking, is on the verge of a boom on March 24, 2014 near Lost Hills, California.

The effects of the recent revolution in North American shale gas are now being felt in Europe, as both states and energy companies rush to be the first to reap the promised benefits of the region’s reserves. The Ukrainian government—making positive headlines for a change—has seized the momentum, calling for a new European energy future that will break the chains of Russia’s energy monopoly in the region.

Figure 1. Shale Gas Basins of Eastern Europe. U.S. Energy Information Administration.
Yet, headline-driven momentum is no substitute for policy reform; not only do official statements do not always get translated into practice, but they cannot change reality: Ukraine remains bound by the restrictive “take or pay” clauses of its gas agreement with Russia. Therefore, the question remains: is Ukraine’s shale-gas future just an illusory pipe dream designed to improve the government’s image, or a realistic option for improving energy security for Europe in general as well as Ukraine in particular?
To bring its shale-gas dreams to life, Ukraine first needs to tackle the harshness of its existing situation: after years of attempted reforms, the country’s energy picture remains poor. The condition of its distribution, production, storage, and transport facilities ranges from poor to appalling; moreover, many of these problems will not be solved even if shale fulfills all of its gleaming promise. With total natural gas consumption at about 52 billion cubic meters (bcm) per year, Ukraine is among the world’s most energy-intensive economies; for a given input of energy (defined by the World Bank in terms of kg of oil equivalent), for example, Germany produces 8.4 units of PPP-adjusted GDP, while Ukraine manages just 2.1.
As stated above, the government is aware of the problems; it continues to make ambitious plans to decrease national energy consumption, switch its power stations from natural gas to coal, build an LNG terminal, and open reverse flows of gas from Europe. Undoubtedly, these things would bring the energy revolution to Ukraine going beyond pipeline politics and ambitious statements.
The shale-gas deal signed with Royal Dutch Shell on January 24 signaled Ukraine’s aspiration to become a self-sustaining gas producer and, simultaneously, an energy resource exporter. We should distinguish between simply holding large energy resources and being able to extract them efficiently, of course; accordingly, a quick look at the facts would be helpful.
Under its recently-signed $10 billion (€7.7 billion) contract (the largest shale gas agreement in Europe to date) to explore the nearly 8,000 square kilometer Yuzivska shale gas field in eastern Ukraine, Shell could in time extract up to 1.2 trillion cubic meters of gas. If this volume is confirmed by further explorartion (geologists have identified potential limitations in the field’s depth, thermal maturity, and so on that could reduce its size), Ukraine could ideally become self-sufficient in gas within ten years, at least according to the production schedule announced by Shell (with the first gas flows coming in 2020.) By demonstrating the economic viability of shale for import-dependent energy markets, success for Shell here would have wide-ranging impact, further stimulating outside investment. Already, we have seen ExxonMobil and especially Chevron are also elbowing their way into the region, with the latter gaining positions in Bulgaria, Lithuania, Poland, and Romania as well as Ukraine.
For Ukraine, the long-term impact would be even more profound, as by improving perceptions it would help to attract desperately-needed inward investment in the energy sector. In the end, revamping mature exploration, production, storage and transportation facilities is the key towards energy self-sufficiency—and moreover represents a valuable card for Ukraine to play at the negotiating table with Russia. At the moment, state-owned companies like Naftohaz simply do not possess the expertise or technology in horizontal drilling and hydraulic fracturing to explore and extract deeply-buried shale gas. Moreover, already burdened with high levels of debt, these firms cannot acquire such technology from outside. However, revenue-sharing agreements such as the Shell venture, as well as planned Chevron projects, all represent “win-win” scenarios, in which outside partners enjoy a steady stream of profits from their initial investment while Ukraine is able finally to envision a future in which its heavy dependence on Russian gas imports is a thing of the past.
Another look at the numbers shows that this vision is by no means necessarily an illusion. First, the estimated volume of shale gas production is 20 bcm per year, approaching the 24 bcm level of Russian natural gas deliveries to Ukraine expected this year. Second, in 2012 Ukrainian gas imports from its north-eastern neighbor have already shrank by 26.5% accompanied with a decrease in gas consumption by 7.8%
There is still one major potential Achilles’ heel in Ukraine’s shale gas revolution, however: rising opposition among environmental activists to the controversial method of hydraulic fracturing. Chevron’s draft agreement to explore the western Ukrainian field of Oleska—over 6,000 sq. km, and tentatively scheduled to come online in 2017—is being blocked by local authorities for this reason. Certainly, anti-shale campaigners have reason to worry; done poorly or haphazardly, shale exploration can indeed cause damage to groundwater supplies. Nonetheless, as the Economist concluded last year, “[t]the risks from shale gas can be managed” at relatively little additional cost by the taken of appropriate precautions, making it “a small price to pay for environmental protection and the health of a promising industry.”
As always, the primary source of uncertainty in Ukraine is the far-reaching domestic political stalemate that has obstructed genuine reform virtually since the beginng of independent statehood. Even the environmental stalemate on Oleska can be perceived in these terms; the Lviv and Ivano-Frankivsk oblast governments are arguably blocking the Chevron project in part due to broader disagreements with the central government.
Yet, while any near-term prospect for resolving this stalemate may be quite illusory, the gap has been at least temporarily bridged for tactical reasons before. With the heated Russo-Ukrainian gas wars again reaching fever pitch, and with Russia making credible threats to bypass Ukraine further (e.g., by finally constructing Yamal-2), Ukrainian elites of all inclinations know that their interest lies in cooperation. The prospect remains realistic, then—but it remains up to the oft-feuding members of the nation’s political class to make it a reality.

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