Unconventional Prospects

31 March 2013, 13:38

Despite Ukraine’s acute energy dependence on Russia, the recent production sharing agreement (PSA) for Yuzivska area in Kharkiv and Donetsk Oblasts between the Ukrainian government and Shell stirred negative feedback from a number of environmental organizations and opposition parties. Their concerns include potential pollution of water through hydraulic fracturing and unprecedented tax cuts for Shell, plus suspicions of corruption involved in the deal.

Shell will extract tight gas at Yuzivska area in partnership with Nadra Yuzivska LLC (Yuzivska Deposits) founded by Nadra Ukrayiny NJSC (Ukraine’s Deposits), a company with a 90% government stake, and the little known private firm SPK GeoService as the holder of the other 10%. When asked whether he knows who owns SPK GeoService earlier, Energy Minister Eduard Stavytsky did not answer the question directly, just stating obscurely that “it is owned by geologists”. Many experts thus believe that the purpose of the company was to legitimize a kickback for access to Ukrainian tight gas. Given the few disclosed details of the PSA, this private Ukrainian company may end up with a relatively large share of gas extracted at Yuzivska area. Experts have already connected “geologists” to the Family.

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Meanwhile, Shell as an investor of at least USD 200mn at the stage of exploration, has yet expressed no complains about it. The Ukrainian Week talks to Shell’s VP-Ukraine Graham Tiley about controversies in the local unconventional gas production.

UW: How do you see the impact of the production of unconventional gas in Ukraine by Shell on the country’s energy security? Could this gradually squeeze Gazprom as the monopolist out of the market?

We are in Ukraine to help it develop its domestic resources. The unconventional gas revolution has had an impressive impact on the US energy sector in terms of lowering gas prices, creating jobs and bringing back industries developing of that gas. Petrochemical industry is just one example. Only a few years ago, the US had to import significant amounts of gas while now it exports it. As to other countries, Canada and China have also developed successful unconventional gas industries. And we have seen the same thing increasingly happening around the world.

Our ambition is to be a preferred partner for Ukraine in developing these resources. How Ukraine itself manages its energy balance is an issue for the government. Currently, we are only at the exploration stage. And the reason we’ll be drilling our first wells is to find what the potential is. We think it is good. But it is too early now to talk about the amounts of final production. The exact figures will depend on each well. In Yuzivska, for example, we are going to acquire seismic data and drill some 15 wells during the initial exploration period. In a few years, we hope to have a good understanding of the actual potential.

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UW: How much does Shell plan to invest at the exploration phase? Who will control the expenditures?

We now have two projects in Ukraine – one is the joint activity with UkrGazVydobuvannia, and the other one is the PSA on the Yuzivska area. Under the Yuzivska PSA tender, the minimum commitment of the investor at the exploration phase was USD 200mln. The minimum amount of investment into the joint project with UkrGazVydobuvannia is similar. We are the operator in both projects, so all invoices come through my financial department. Shell applies consistent spending control standards around the world. We are subject to quite stringent regulations, including the UK Foreign Corrupt Practices Act. So, our global operations are conducted under very strict accounting standards.

UW: Could you shed any light on your Ukrainian partner SPK GeoService? The public is concerned about its goodwill…

We do not have direct control over other companies. However, this very project will be operated under Shell’s corporate international standards. Our partner in the PSA is Nadra Yuzivska LLC. This was a mandatory partner under tender requirements. It’s not unusual for governments around the world to have a state partner in PSAs. The involvement of SPK GeoService in Nadra Yuzivska was part of the public tender process held by the State Geology and Deposits Service of Ukraine. We have worked with SPK GeoService specialists in the past; we’ve known them as a geological service company ever since Shell came to Ukraine.

UW: How do you assess political risks? Opposition parties in Ukraine have already suggested investigating details of the PSA.

A production sharing agreement is a confidential document. It is common international practice to make these documents confidential. Meanwhile, political risks exist in any country. Interestingly, when people talk about changes in taxation, the one country that seems to change its system more than others is the United Kingdom. But the PSA in Ukraine was signed for 50 years and it needs to be sustainable. Can you tell me how many Ukrainian governments and presidents will change over 50 years? We need to have guidelines for decades. We have signed the agreement with the government of Ukraine, not a particular party or individual. I will not comment on the democratic process in Ukraine. But I can say that I have heard very positive assessments of the agreement from various opposition parties.

UW: How did Shell manage to persuade the Ukrainian government to give it significant tax discounts?

When a government gets a share in the production under a PSA, it is normal that it can cut some taxes for the investor. Unfortunately, I cannot go into details of the commercial agreement, , but I can assure you that all terms and provisions of the document we signed fully comply with the Ukrainian legislation.

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UW: There are concerns about environmental risks the technology involved in unconventional gas extraction carries. How do you evaluate the risks in Ukraine?

Hydraulic fracturing was applied in more than a million wells in the US. This technology has been used for 60 years already. Consistent reports by the US Environmental Protection Agency and the relevant regulators state that they do not find evidence linking hydraulic fracturing to any fresh water contamination. Moreover, hydraulic fracturing is not new to Ukraine. It has been applied here for several decades now.

I think it’s useful to talk briefly about the process of production. The critical point here is that the rocks where gas is held are very tight. Gas is in small pores inside the rocks. To get it out and produce it in commercial quantities, you need techniques like hydraulic fracturing. The latter is the process of using fluid – water in this case, with sand and some additives – to transmit pressure down the well. That pressure creates tiny fractures in the gas bearing rock. The sand is used to hold these little fractures open. The chemical additives I mentioned are added, for example, to prevent bacteria from growing in the water or to improve the reaction of the water in the ground. As to the chemicals, Shell is committed to disclosing what it uses as far as the law allows it. Many of these chemicals are normally used in food industry or household.

One of the concerns people have about these chemicals is possible contamination of drinking water. I’d like to explain why this is unlikely using the Biliaivska 400 well we are already drilling jointly with UkrGazVydobuvannia. The well will go down to 5,000 metres. The fresh water people use for drinking is probably a few hundred metres down. The gas bearing sandstones we currently explore go down from 3,000 to 5,000 metres. The fractures will typically stretch for up to a few tens of metres. So, there is a lot of solid rock between induced fractures and drinking water. Furthermore, when we drill through the shallow water, we use either air or fresh water to avoid any contamination. Once we drill through this layer, we put down a steel shield, known as casing, cemented in place. By the time we drill the whole well, there will be several layers of steel and cement protecting the water layers

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