Market Thinking

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Ukraine’s Energy Reserves

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At 1.03trillion cubic metres (tcm), Ukraine has the second largest gas reserves in Europe after Norway, and yet it is a net importer of gas, since it only produces 20bcm a year while consuming nearer 27bcm, leaving it with an import bill of tens of billions a year. In the Soviet Era it produced over 70bcm a year and could do so again relatively easily, should it get the capital investment. Moreover, Ukraine has the same again in recoverable unconventional gas reserves (coal bed methane, tight gas etc), reserves that are now much more accessible with new technologies. Ukraine also has 30bcm of gas storage (equivalent to 30% of the EU total) and, of course the pipeline infrastructure that currently carries Russian gas to Europe. In short, while Norway has GDP per Capita 5x the world average, Ukraine has 1/5th the world average. A little capital would go a long way. Except of course, no prizes for guessing which part of Ukraine most of the gas reserves are in…..

Poor Capital Allocation – accident or design?

A report from the Ukrainian Institute of the future back in 2016 highlighted the absurdity of Ukraine, with the second largest gas reserves in Europe (ex Russia) being a net importer of gas at a then price ($400 per 1000 cubic metres) approximately 10-13x the cost of extracting its own gas. For context, today’s price is almost 4x that level. The Institute calculated that an investment in the order of $20bn would rapidly pay for itself and satisfy not only domestic energy needs but also allow Ukraine to become a net exporter. This is in contrast to the solution ‘preferred’ by many in the west, a focus on ‘alternative energy’ investments which would cost more than 3x as much yet yield much less (not even cover domestic consumption) and take 10-20 years. Polite as the authors were trying to be back in 2016, it’s not difficult to see their frustration with the ESG crowd and their approach to capital investment in basic needs.

The Forgotten Potential of Ukraine’s Energy Reserves
Source Harvard International Review

The traditional Oil and Gas companies have long been interested in Ukraine though, and in particular in the uncoventional assets, especially in the wake of the huge turnaround in the fortunes of the US, which went from a similar position as an importer of gas to an exporter in the wake of the Shale Gas revolution of the early to mid 2000s and the developments in fracking.

In an article in October 2020 titled ‘The forgotten Potential of Ukraine’s Energy Reserves‘, the Harvard International Review discussed the opportunities for Ukraine’s oil and gas development with a relatively modest (c$20bn) investment offering the potential solution to Europe’s gas import problems. Indeed, we should not forget that Europe had become overly dependent on Russian gas years before the Ukraine invasion in February (although this is being used as an excuse for extremely poor energy policy planning right now).

Here is how the IHS saw the potential back in 2013 – the politics may have changed, but the reserves, particularly in unconventional gas have not.

Source IHS Cera, Shell 2013

At current elevated prices, Ukraine producing 70bcm would allow for a 40+bcm surplus and turn a multi billion deficit to a multi billion surplus, but even at something nearer ‘normal’, the margins (and profits) would still be enormous.

The opportunity was indeed picked up by Shell in 2013, but immediately ran into (likely Russian sponsored) opposition on dubious environmental grounds. Indeed, there is growing evidence to suggest that the seemingly contradictive eco campaigns that were simultaneously for Green Energy but against fracking and nuclear power were heavily sponsored by major conventional gas producers like Russia. Renewables are unreliable (especially in Europe) and need back up from conventional generators. Nuclear is ideal for base load, but can’t be ‘spun up’ quickly and so does not work alongside renewables. With coal sufficiently traduced by the big Oil and Gas companies and their ‘carbon footprint’ campaigns, gas has become the only option, but the last thing someone like Russia wants is a major new gas supplier emerging, especially one that is already connected to western Europe.

No prizes for guessing where all the potential gas fields in Ukraine are concentrated

After a failed attempt by OPEC to collapse the Oil and Gas prices in 2014 and thus bankrupt US shale producers, the coup in Ukraine and the demand for autonomy by Russian speaking Donbas regions gave Russia the excuse it needed to encourage disruption in Ukraine and thus effectively block any more energy development, because no prizes for guessing where all the Ukraine gas is located. Indeed, Shell effectively abandoned its plans to develop the Yuzivska field 2015 due to the conflict in the Donbas, while the offshore gas potential in the Black Sea lies off Crimea.

Follow the Money…it nearly always works

The more we look at it, the more it seems like gas has a bigger role to play in the current conflict than we first thought, or indeed is being acknowledged. If (and of course it’s a big if) the plan to ‘retake’ the Donbas and Crimea as declared by Zelensky in March last year was actually tied in with plans to rapidly develop Ukraine as a major competitor to Russia for gas exports to Europe, then the moves by Putin take on a very different perspective. Having been happy to not recognise the breakaway republics for 7 years and thus simply prevent any developments, the prospect of Ukraine, backed by NATO taking control of the region again presented a major economic threat. Indeed by taking the pipelines that transport most of the Russian gas to Europe and by utilising the gas storage facilities, a revitalised Ukraine energy industry could effectively control a lot of the European energy market – particularly if Germany did not allow Nordstream 2 to operate. As such a rapid move to encircle the Donbas and secure it for Russia makes a lot of strategic and economic sense. It also suggests that both sides have to admit their real motives (money, not sovereignty) and come to some sort of mutually beneficial agreement on gas production and distribution to resolve this conflict.

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