Ben Aris in Moscow -

Ukraine is finally trying to break its addiction to Russian gas and Cadogan Petroleum is one of those companies well placed to make that happen.

A medium-sized independent oil and gas producer, Cadogan was responsible in 2011 for bringing Italian energy giant Eni into Ukraine to start a $55m exploration and production programme on two gasfields in Ukraine's Dnipro-Donets eastern basin, the traditional home of the limited domestic gas production the country already has. Subsequently in 2012, Cadogan and Eni signed Ukraine's first unconventional gasfield agreement concerning the western Lviv gas basin, which looks the most likely to be first to realise the country's shale gas potential next year. A pilot production project could be sanctioned within three years should the exploration activity be successful.

Obviously given the running battle that Ukraine has been fighting with Russia since 2006 over the price of gas imports, the government in Kyiv has become extraordinarily interested in increasing domestic production. "In the last three years the government has done very well on opening the door to the majors. It's a big step for the country. There is a change in policy since 2011 via PSA [production sharing agreements] which are giving significant support to the industry," Cadogan's chief operating officer, Adelmo Shenato, tells bne in an exclusive interview in Moscow, arguing that Ukraine's gas business has finally come of age.

The country badly needs to wean itself off Russian gas imports, which are draining the cash-strapped country of precious hard currency. It is easily the most energy inefficient country on the Continent, making it the 14th largest consumer of gas worldwide and fifth largest in Europe.

Currently, Ukrainian demand for gas is on the order of 55bn-60bn cubic metres a year (cm/y) of gas. However, the country has pretty significant gas reserves: 969bn cm of gas in addition to 395m barrels of oil, according to official estimates.

And it has been producing oil and gas since Soviet times: currently annual production of gas is 18.5bn cm along with 81,000 barrels of oil per day (b/d). That's enough to cover 37% of Ukraine's gas needs with Russia supplying the remaining 27-50bn cm/y at enormous expense due to a bad deal signed by former Ukrainian prime minister Yulia Tymoshenko in 2008.

The state-owned Naftogaz is responsible for 90% of the gas produced today. But with the government's new attitude to foreign investors that will probably change rapidly. Cadogan and Eni broke the ice, but a string of other deals have been done in the last year, the most recent a $10bn PSA with US majors Chevron and ExxonMobil that was signed on November 7, which should increase domestic production by half again to total nearly 30bn cm/y.

Energy Minister Eduard Stavytskyi said at the signing ceremony in Kyiv that Chevron will extract shale gas in the Oleske field, while an Exxon-led group will explore the Skifska field in the Black Sea. Chevron will initially invest $350m in geological surveys and then "billions of dollars" as it plans to drill at least 2,000 wells, the minister said. The production could yield 5bn-10bn cm/y, he estimated.

If these projects work out, "the cost of gas production will be at least three-times lower than what Ukraine is paying for [Russian] imports," Stavytskyi told journalists gleefully during the press briefing.

Ukrainian President Viktor Yanukovych followed up with the boast that not only will Ukraine be able to cover its entire domestic needs by 2020, but may even become a gas exporter.

Whatever the final outcome, clearly things have started to move in Ukraine's gas business.

Pioneer

Cadogan is at the forefront of the shift to raising commercial production of gas in Ukraine. The company was originally set up in the 1990s by some Ukrainian entrepreneurs and floated on the London Stock Exchange in June 2008 with a valuation of about $1bn. Under new management since early 2011, today 29.9% of the company is owned by the company SPQR Capital Holdings, with the remainder in the hands of smaller institutions, high net worth individuals and retail investors.

Operating in one of the wildest markets in the former Soviet Union, Cadogan has not had an easy time of it. There were "management issues" early on and some disappointing exploratory wells as well as technical problems. Cadogan's problems are all too visible in the company's share price, which has plummeted since the IPO: today, Cadogan's market capitalisation is a mere $33m, a 50% discount to the company's cash pile of $63m.

Still, Shenato, an Italian national who has worked on gas projects all over the world, says that Ukraine's gas sector is entering a new phase thanks to the changing attitude of both the government and international energy companies. The so-called "shale gas revolution" sweeping the world has fundamentally changed the terms of the gas business.

Schenato and his team were in Moscow as part of an international tour to reintroduce the company to investors and analysts, as they have a lot of good news to present that will, they hope, turn Cadogan's fortunes around. "We want to get all the institutional investors back into the shareholding structure that should be but are not," he says.

Back in business

Ukraine has two gas basins in the east and west of the country that were well explored in the Soviet-era, thanks to their proximity to Western Europe, which has always been the main consumer of gas from the region. However, there is a third basin in the Black Sea that was barely touched by the communist regime. And this is not to mention the unconventional gas deposits that were also ignored until recently, as the technology to develop them simply did not exist.

Cadogan has a total of nine licenses in Ukraine's two traditional gas basins, in which Eni holds 30% of the Pokrovskoe license and 60% of the Zagoryanska license. Exploratory wells have already been sunk in these two fields, but the initial results have been somewhat disappointing so far, according to analysts. Work-over is continuing nevertheless to try to put the wells into production.

However, it is the shale gas joint venture signed with Eni in 2012 that continues to attract the most interest. Eni took a 51% stake in the company Westgasinvest, which holds licenses to develop highly promising shale gas deposits in the Lviv basin. Of the remaining 49%, 34% is held by the state-owned company NAK Nadra and 15% by Cadogan. Drilling on the first exploratory wells is expected to commence in the middle of 2014, with Cadogan being carried for its 15% of the exploration costs.

Cadogan is doing the work on the ground at the two conventional joint ventures, while at Westgasinvest it is Eni taking the lead, bringing in modern technology and expertise from its US operations and elsewhere. "The Lviv Basin is considered to be one of the most attractive basins in Europe for the exploration of unconventional gas, being a continuation of the Lublin Basin in Poland which has already attracted substantial interest from the hydrocarbon industry," Eni CEO Paolo Scaroni said at the time of the deal.

The first exploratory wells are going to be drilled in middle of 2014. "The question is if US [shale gas] techniques can be transferred from the US to Ukraine - it's hard to say," says Schenato. "There will be a 2-3 year exploration period after which there will be a pilot production. Only then will we be able to answer the question. But we have a unique opportunity to develop a reference model in Ukraine - a model that all the other international companies can come in and copy."

With three projects already in hand, Cadogan is already starting to think about the future. It still has half a dozen other attractive licenses to exploit. "We are looking for partners for some of the other major licences," says Schenato, who is not just an operations man, but has built up a reputation for being good at the business-side too in his previous jobs. "The most expensive in terms of capex are also the most promising fields, especially the Monastyretskaya and Bitlyanska field, which have in the range 400m barrels of oil equivalent."

Both these fields are close to Polish border and benefit from all the existing transport links and infrastructure. The Borynya field, part of the larger Bitlyanska license, was drilled twice in the 1980s by Soviet engineers and although several interesting gas bearing intervals were assessed, severe technical problems with both wells hampered further progress. In 2009 under previous management, Cadogan drilled a new well and also ran into difficulties with a "gas kick" (influx caused by rapid pressure increase while drilling), however with a new technical and sub-surface team already in place, Schenato is confident that all these problems can be overcome.

ED: this piece has been amended on November 14 to correct some misquoted numbers and small typos.