Maplecroft Sees Continuing Investment Risk in Ukraine
Maplecroft: Country Risk Report Ukraine Q1 2013
Political continuity deem Ukraine precarious for oil and gas investors
Exploration of Ukraine’s vast shale gas reserves has come to the fore following this week’s deal between the country’s government and Shell. The government also looks set to approve production-sharing agreements (PSAs) with other energy majors in a bid to jump-start domestic natural gas production and reduce dependence on Russian gas supplies. However, oil and gas companies should be aware of the potential pitfalls of investing in a country where political authority is increasingly concentrated in the hands of powerful and competing groupings of oligarchs and where endemic corruption continues to impact upon all aspects of the business environment. As with the wider business landscape in Ukraine, the operational challenges associated with investment in the shale gas sector also remain challenging and characterised by a high degree of uncertainty.
Pro-market reforms unlikely as limited political change following parliamentary election
Prospects for pro-market reforms to boost investor confidence in Ukraine have diminished following the October 2012 parliamentary election. Despite a loss of majority for the ruling Party of Regions (PRU), President Yanukovych managed to consolidate his influence over politics via a subsequent reshuffle of the Cabinet of Ministers in December. The new government has also strengthened the ‘family’, a grouping of oligarchs believed to be close to Oleksandr Yanukovych, the president’s elder son. Any new developments to energy policy are likely to now emanate from the appointment of Serhiy Arbuzov - a member of the ‘family’ - as first deputy prime minister.
The continuation of politics under the authority of President Yanukovych following parliamentary election signals the diminishing likelihood of any significant improvements to the business environment for oil and gas companies investing in Ukraine. Investors were left disappointed at the news that Mykola Azarov would return to the post of prime minister, as they had hoped that a more pro-market candidate would take over the post, one which would be more willing to make the reforms needed to tackle the country’s economic challenges. However, the selection of Arbuzov is significant, as it is widely believed that he will effectively control parliament, while Azarov’s influence gradually diminishes.
Energy policy will continue to remain on the backburner while the government grapples with a deepening economic recession, which risks inciting social discontent and public protests. Ukraine is also seeking to sign an Association Agreement with the European Union – a treaty which will create a framework for co-operation between the two. This will be in conjunction with negotiations to reduce the price Ukraine pays for Russian natural gas – the success of which will, in part, determine the pace Kiev develops its domestic energy sector. With the PRU unable to gain a majority in the parliamentary elections, cohabitation with the Communist Party will also deem the introduction of pro-market reforms even more unlikely.
Regulatory framework for the extractives industry remains concern for investors
The effectiveness of the regulatory framework in relation to the extractive sector is also of particular concern for foreign investors. Legislation relating to Subsoil Licensing (special permits) remains confusing, conflicting and unstable for foreign investors. The status of the Product Sharing Law for foreign investors will also remain a key concern. Further clarity of regulation pertaining to the extractive sector and improvements to the potentially inconsistent manner in which it is applied in conjunction with the Product Sharing Agreement Law are needed to foster an internationally competitive extractives industry to vie alongside other energy producing countries over the next decade.
The potential benefits of amendments to the regulatory framework for the extractives industry is, however, stymied by a lack of implementation by the relevant authorities and a raft of risks await foreign companies investing in the country. High levels of corruption and political interference under Yanukovych’s leadership exist in the awarding contracts and in the judiciary – a situation that can inhibit fair and unbiased resolution of disputes. Furthermore, long-standing problems with land-ownership rights also complicate the operating environment
Energy majors secure investment prospects despite regulatory uncertainty
With record energy investments confirmed, Ukraine will be eager to jumpstart its much anticipated move towards energy independence, particularly in the face of emboldened moves by Russia in late January - Moscow has handed Kiev a US$7bn bill for failing to import the agreed volumes of gas last year. Against a backdrop of political uncertainty and a precarious economic landscape during the latter half of 2012, effective reform of the investment climate is unlikely considering that energy majors are already entering the country. However, opening up the market further to international investors through improvements to the business environment is essential if domestic production of unconventional gas is to commence at the required pace.
Jamie Scudder – Senior Analysts at Maplecroft
The article is provided by Maplecroft, a Natural Gas Europe Industry Partner. Maplecroft had published its Country Risk Report Ukraine Q1 2013. For more information, please email at info@maplecroft.com or call +44 (0)1225 420000.