Global Traditional Energy Resources

Ukraine has an estimated 127.9 trillion cubic feet of unproved technically recoverable shale gas resources, according to the U.S. Energy Information Administration (EIA).¹ The most promising shale reserves appear to be in the Carpathian Foreland Basin (also called the Lviv-Volyn Basin), which extends across Western Ukraine from Poland into Romania, and the Dnieper-Donets Basin in the East (which borders Russia). However, the full extent of these reserves is yet to be proved. The Ukrainian parliament appointed Volodymyr Demchyshyn as Minister of Energy and Coal Industry in 2014.² It remains to be seen to what extent the new government will prioritize shale gas development in the country.

There are strong reasons for Ukraine to develop its shale gas resources, the most important being to diversify its energy sources away from Russia, with which it has a long-running history of pricing disputes that have frequently spilled into the political domain. In 2011, Ukraine’s domestic gas production met only 33% of demand, and all of Ukraine’s imports—more than 40 billion cubic metres (bcm)—came from Russia.³ More recently, in 2015, Ukraine’s direct imports from Russia were only 6.1 bcm, dropping the Russian market share in Ukraine to only 18%.⁴ However, while 63% of Ukraine’s 2015 gas imports were from European nations, the top three European countries importing to the Ukraine each sourced 44% or more of their national gas supply from Russia.⁵ Indeed, Russia provides approximately 30% of Europe’s natural gas, and the majority of this supply is transported through Ukraine.⁶ Increasing domestic gas production remains a “high-priority issue” for the Ukrainian government.⁷

U.S. Energy Information Administration, Technically Recoverable Shale Oil and Shale Gas Resources:An Assessment of 137 Shale Formations in 41 Countries Outside the United States X-1 (Updated June 13, 2013), http://www.eia.gov/analysis/studies/worldshalegas/pdf/fullreport.pdf.

Shale gas is not yet commercially produced in Ukraine. Following a series of initial shale gas development steps in 2011 and 2012 that included a licensing round, tenders from large multinational companies, and the signing of various production sharing agreements, armed conflict broke out in eastern Ukraine in 2014.⁸ The conflict contributed to a scale-down in commercial shale development, in part because much of the heaviest fighting occurred in areas associated with significant shale deposits.⁹ For example, as a result of the regulatory environment and political instability between Ukraine and Russia, Shell announced in June 2014 that it would postpone its Yuzivska activities in eastern Ukraine for two years pursuant to the force majeure clause in the Production Sharing Agreement.¹⁰ Chevron terminated its contract with the Ukrainian government later that same year.¹¹

Nonetheless, the Ukrainian government hopes that commercial development will resume at the conclusion of the ongoing conflict.¹² Although Shell and Chevron remain present in Ukraine,¹³ Italian firm Eni, which owns 50.01% of shares in the Ukrainian company Zakhidhazinvest, appears to be the most active. Eni had stated that it intended to begin drilling its first exploration well in Ukraine by the end of 2015,¹⁴ but the company appears to still be in the “preparatory phase” with respect to these activities, and an exact timeframe is not available.¹⁵

Ukraine has recently taken steps to re-attract foreign investment in shale development. Much of development activity in the country was scaled back when the Ukrainian government raised the mineral exaction tax in response to the armed conflict and associated economic crisis.¹⁶ However, in December 2015, the Ukrainian Parliament adopted Law No. 3688, which rolled these taxes back to their pre-2014 levels.¹⁷ More recently, the Ukrainian government has established a high-level working group that aims to address, among other things, deregulation in the oil and gas industry to attract additional foreign investment.¹⁸

Unlike most European countries, there has been limited public opposition to shale gas projects, though some anti-fracking campaigns have been reported.¹⁹

Statutory and Regulatory Framework

There is no specific legislative framework for shale gas exploration and production in Ukraine,²⁰ which activities instead fall within the scope of laws for conventional hydrocarbons, principally the Oil and Gas Act. Thus, there are currently no specific legal requirements relating to environmental matters such as baseline testing and monitoring, fracking fluid disclosure, and wastewater treatment, though an initial environmental assessment describing the existing environmental conditions is required.²¹ In addition to the environmental impact assessment, key required authorizations include a permit to begin hazardous work and operate hazardous equipment, a permit for waste management activities, and an air permission permit.²² Efforts are currently underway to revise the Subsoil Code, the major regulatory act for oil and gas activities in Ukraine, which could result in more specific environmental requirements.²³ Similarly, some have called for amendments to the country’s Rules for Oil and Gas Fields Development, last updated in 1984, to incorporate current industry best practices.²⁴

To sidestep legal uncertainties in relation to shale gas exploration and production, the government uses production sharing agreements (“PSAs”), which have historically been used alongside licenses. Ukraine’s Interagency PSA Commission announced the winners of the first shale gas tenders, which included two of Ukraine’s major shale gas areas (the Oleska and Yuzivska fields), in May 2012.²⁵ Although the country’s PSA Commission was briefly abolished in December 2012, leaving no institution within the Cabinet of Ministers to coordinate the PSA issues, it was restored in July 2013, providing assurance that there will be one institution within the Government that handles all key PSA issues.²⁶ The PSA Commission Amendments Law grants broad discretion to the Cabinet of Ministers to create the Commission, establish its procedures and operational rules, and appoint the Commission’s Working Body (Ministry of Ecology). The head of the Commission is the Minister of Energy and Coal Industry.²⁷

There are several relevant provisions of the Ukrainian PSA legislation that relate to unconventional gas exploration and production. For example:

• Fiscal benefits: For unconventional gas exploration and production, recoverable costs are determined in accordance with the PSA (as opposed to strict legal requirements) and may be up to 70% of total production costs. For tax purposes, indexation of non-recovered costs is also permitted. No import duties, royalties or VAT are charged for the import of goods, operations, and services for the purposes of the PSA and no export duties are charged. Finally, there is also no tax levied on the repatriation of incomes.²⁸
• Legal guarantees of PSA stability: All rights and obligations will be governed by the Ukrainian legislation effective at the moment of execution, save for any changes in relation to matters of defense, national security, maintenance of civil order and environmental protection (Article 8, Foreign Investment Law).²⁹ All tax obligations will be governed by the Ukrainian legislation effective at the moment of execution unless the tax change in question involves a reduction in the tax rate or duty.³⁰
• Tender processes: The PSA regime includes a competitive tender process,³¹ although some have made calls for additional transparency measures.³²
• Miscellaneous: Other clauses that may be included in PSAs upon negotiation include an international arbitration clause³³ and a clause that prevents the Ukrainian state from shielding itself from its PSA obligations by way of jurisdictional immunity.³⁴

Operating under the PSA model does not obviate the need for the special permit necessary for oil and gas development.³⁵ Nonetheless, foreign investors operating under a PSA typically enjoy help from the Ukrainian government in obtaining the necessary permits and authorizations.³⁶ Anecdotally, obtaining all the necessary permit can take up to 24 months.³⁷