Ukraine heralds "game-changing" shale gas deal with Shell

By bne IntelliNews January 25, 2013

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Shell and Ukraine's Nadra Yuzovska signed a $10bn production sharing agreement in Davos on January 24 to develop the Yuzovska shale gas deposit. The deal could potentially almost double Ukrainian gas production, offering Kyiv huge leverage in its fight with Moscow over gas prices, but much uncertainty remains.

Should the field's reserves be confirmed, Ukraine would fully resolve its gas production-supply deficit. Shell has already invested $400m in exploration on the project, which is forecast to require at least $10bn in investment. Preliminary unproven reserves at the field, spanning the Kharkiv and Donetsk regions, are estimated at 4 trillion cubic metres (cm) of various types of gas and coal-bed methane.

At the signing ceremony, Ukrainian President Victor Yanukovych presented the deal as a game-changer for Ukraine's rapidly sliding investment climate, and promised it would lead to greater funding for social needs, as well as boosting the economy in general. However, much uncertainty reigns over the actual level of reserves, while accurate production costs are yet to be estimated. Alfa Bank says Shell expects to produce as much as 20bn cm a year, though notes that the "pessimistic scenario assumes production of only 7-8bn cm."

Leverage

The main thrust for Kyiv is the leverage that the deal could provide in its standoff with Moscow over the price of Russian gas imports. Ukraine remains caught between paying the highest price of any former-Soviet state ($415 per 1,000 cm in 2012) to Gazprom and insistence from the IMF that it raise domestic gas tariffs in order to get the bailout it so desperately needs to help secure its precarious economy.

It's a fight that boils down to whether Ukraine will look east or west going forwards. Yanukovych and his big business backers would rather plot a middle course to try to leverage both sides and protect their own assets, but the economic crisis has seen that strategy drop the country in a hole.

Ukraine consumed 54bn cm of gas last year, with Gazprom delivering around 27bn cm. Kyiv has made big noises through the last couple of years that it aims to reduce that import volume, but with recent political developments provoking severe criticism from the EU and US, has been struggling to attract the investment needed to boost its domestic production. Ukraine currently produces around 21bn cm per year itself.

"Ukraine's potential for increasing domestic gas production, and hence lessening its dependence on Russian gas, is very vague and remote," the Alfa Bank analysts suggest. "Nevertheless, [this news] once again signals that Ukraine is doing its best to force Gazprom to lower the price, consequently reducing the chance that these high export prices will be sustained in the long run."

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