The drop in gas prices is forcing producers to slash their development plans, and the global crisis coupled by the outbreak of the Covid-19 epidemic has further exacerbated the state of hydrocarbon producers. In addition, the gas market is oversaturated, with record high gas reserves in both European and Ukrainian underground gas storage facilities. Under these conditions, only the most effective producers win. Victor Gladun, as appointed last year to serve as CEO of the British company JKX Oil & Gas, with the JV Poltava Petroleum Company (JV PPC) as its asset in Ukraine since 1994, shared with ExPro his strategies and practices for business survival and sustainability.
“Our 5-year plan is akin to a living organism making projects implemented, constantly updated and adjusted to the ambient conditions“.
- There were many surprises in the Ukrainian gas market last year, and one of them was the rapid growth of the production by JV PPC, despite its almost 80% depleted deposits. How did you manage that?
- As far as I know, the situation is similar in the Ukrgasvydobuvannya (UGV), where the depletion of deposits is over 70%. Gas exports by the UGV (gas entering the gas transmission system) are steadily declining, while gas exports by the JV PPC are increasing. The main cause for that is the private ownership, which allows to be flexible and more efficient. Although, not of less importance is the company’s team. Historically, JV PPC has grown a professional team, whose work efficiency and skill levels have been steadily thriving over the last 25 years. We have further strengthened our team by professionals in the geological and technical departments. For the last 2 years, both geologists, the workover and construction departments, the drillers, employees of general departments of the company worked intensively. At the end of 2017, because of significant depletion of deposits, we began to intensify our production. First, we updated the geological model of the fields. That resulted in the increased natural gas production by 5% in 2018, and by 55% in 2019. In addition, in 2018, in addition to our own wells, we began to commission wells of state-owned companies located in our licensed fields. The first contracts were signed with the NJSC Nadra Ukrayny. Subsequently, we concluded similar agreements with the UGV and the PJSC Ukrnafta. Currently, we operate on 18 wells of UGV. I would like to say that any company can go this way, if within its licensed areas there are previously drilled wells by other natural gas producers. Last year our main results were achieved due to the production from new wells and sidetracking in wells, such as the Well Ign -103 lateral with an initial flow rate of 250 mcm-260 mcm a day, and the Ign Well Ign -142 plus the Well NM-81 increasing our production of natural gas by 55% in 2019. I must admit the importance of sidetracks is that their drilling is usually less costly than to drill a new well. Cost-wise, a 3 km well can take $ 3 million - $4 million, while a sidetrack can be done for $ 1 million - $ 1,2 million, i.e. the latter option is 3 times less. Of course, it does matter at what depth the drilling occurs, its length and at what kick-off point from the vertical, but in any case the cost saving is considerable.
- In Ukraine, not that many companies have skills in sidetrack drilling, thus few producers dare do that works…
- I think sidetrack drilling will develop widely in the future, and especially on our licensed hydrocarbon areas. We had proven practices in 2018-2019 that such projects could be successful, and there are contractors in Ukraine who are able to do both sidetracking and positioning, drill-down deviated wellbores to the right point. The feasibility of using sidetracking operations depends on the number of wells available and the features of the geological structure of the deposits. For example, if the deviation is to be 2 km and the depth is small, then there is no point in sidetracking. However if the existing well is within 300 m – 500 m from the reservoir one plans to develop, then a sidetrack is a win-win the solution for that. Today, we mainly kick-off at depths not more than 500 m. Though, we have in our success portfolio of more sophisticated operations, say, in one well in 2013 we drilled 1 km horizontal leg to enter the productive reservoir and carried out 10 fractures on it with the help of Schlumberger. Noteworthy that now we are carrying out such technologically complex operations with the help of the Ukrainian contractor, the Spetsmehservis company. Since 2019, we have similar projects together with Crosco drilling contractor.
- Will you keep on sidetracking this year?
- Sure we will. In addition to drilling 2 new wells, this year we plan to drill 4 sidetracks. The Spetsmechservis is moving to well # 130 and will be sidetracking for 1 km. The outcome of this project and the exploration of the well will determine our plan of further operations. What is the key of our success in general? Because we respond very quickly to changes, we are updating our five-year plan as we review the geological model. If we see changes in the geological model and 3D seismic survey did not shown it before, we make adjustments to the field model and our program of operations. It is impossible to make a plan for 5 years ahead and stick to it for 100%. Therefore, our 5-year plan is akin to a living organism making projects implemented, constantly updated, and adjusted to the ambient conditions.
- What other technologies, other than sidetracking, do you use? What about nowadays trended snubbing installations allowing to carry workovers under pressure without killing of wells?
- Snubbing can be used under certain geological conditions, that is wells must be deep and with high pressures. And since all of our wells are shallow and with more than 80% sagged pressures in wells, it is irrelevant to use such technology. We’d rather be sidetracking to a new reservoir where pressure is intact, and we get an inflow from there easily. Moreover, we have many wells with gaslift outfits. In fact, all intensification technologies are not new to us, as most of them have been in use since the mid-20th century. If these or other technologies are suitable for the conditions, say, geological, technical, commercial, then of course, they should be applied.
- What about hydraulic fracturing?
- The JV PPC was one of the first in Ukraine to start using this technology in its fields. We had both achievements and mistakes that we learned a lot from. We are currently considering one project, there is a prospective contractor for the works. But under current low prices for natural gas, fracks won’t pay off. As soon as the price for natural gas goes up and bring more revenues to us, we will revert to this option for sure.
- As to the new appointments within JKX recently, how would you comment on them?
- We are grateful for our Chief Financial Officer Ben Fraser from our London office. A month ago, he made a statement that he had decided to expand his career beyond the oil and gas sector, and we wished him every success in that endeavor. Effective April 1, 2020, I suggested Dmitriy Piddubniy, effective April 1, 2020, fill in the CFO position, and his candidacy was 100% supported by the JKX’s Board of Independent Directors. Dmytro has 18 years of experience as a First Deputy CFO, then as CFO of the JV PPC, and in 2017 he used to serve as CFO of JKX. The company has consistent and professional management.
"Under low prices for natural gas, we focus on products with higher margins"
- The Technical Director of JV PPC Mykola Orynchak has previously stated that at the backdrop of low prices for natural gas, the company suggested that the UGV revise the formula for offsetting the joint well operations …
- The contractual relationship with the UGV envisages the provision of hydrocarbon extraction services from reservoirs licensed to the JV PPC , from the UGV wells drilled during Soviet times and located in the hydrocarbon area now licensed to the JV PPC. The key condition of contractual relations is the distribution of production profit from those wells on 50% / 50% equal terms. In this case, the JV PPC bears all the costs and risks associated with the well recoveries, workovers, maintenance, intervention and enhancement of hydrocarbon production. Following the sharp sag in prices for natural gas, those contracts became economically loss-making for the JV PPC because of the following two factors. First, with a fall in gas prices below a certain level, the share of the UGV should remain fixed and not dependent on market conditions. Second, the price for natural gas sales used to calculate profit before its distribution between the parties is set as the price at which Naftogaz of Ukraine sell its natural gas resource. Starting in the second half of 2019, this price became irrelevant and did not reflect the market price for natural gas in Ukraine, as far-exceeding and inflated. For example, in November and December 2019 the price of Naftogaz of Ukraine was set at 7033 UAH/tcm (including 29 % VAT), while the average market price in November 2019 was 5300 UAH/tcm (including 29 % VAT) and 5,200 UAH/tcm (including 29 % VAT) in December 2019. In this regard, the distribution parity shifted towards the UGV, with the latter not investing in any of the projects and not bearing of any risks, however, in fact receiving far more than the PPP. We have not yet reached a consensus with the UGV, although we have been in dialogue with its management for more than 4 months. The management of the UGV is still developing its own position, and we hope that they will eventually favor our point.
We are seeking fair market pricing and fair profit sharing, as well as formula changes that will not limit the minimum payment. With this situation, we have already stopped production at 4 wells the UGV, and consider to do the same at other 5 well of the UGV. It seems that the management of the UGV and NJSC Naftogaz are in no hurry to reconsider their position and reluctant to change the terms of the contract, that can halt the production at all the UGV’s wells. The non-market and inflexible position of the management of the UGV and NJSC Naftogaz can result in the loss of dozens of millions of hryvnias, and by the end of the year, perhaps, hundreds of millions of hryvnias, as a lost profit and potential losses for the UGV and Naftogaz JSC, apart from lower revenues to the national budget. In such a case, the UGV will be left at a loss instead of reaping a profit without any investment done.
Therefore, I am looking forward to the common sense of the management of a state-owned company. It is better to continue to work with us as a reliable partner with proven professionalism and experience, rather than receive no income at all. I would also like to point out that in most civilized countries of the world, when a license is issued, all wells available in the licensed area are transferred to the subsoil user. And in Ukraine, unfortunately, it is not the case. As a result, companies are left with wells that they cannot use as their primary asset, since the minerals in this area are the property of a new subsoil user for the duration of the license granted. Therefore, our market offer is definitely profitable for the UGV. We are all for equitable distribution and strategic relations with this company. For 2 years we paid UAH 187 million to the UGV.
- What about cooperation with the other two companies, whose wells are also located in your licensed area, the NJSC Nadra Ukrayny and the PJSC Ukrnafta?
- The agreements with the NJSC Nadra Ukrayny and the PJSC Ukrnafta stipulate other conditions, the distribution works fairly, depending on actual market prices. So we will develop and continue our work with them. - You said that it is not profitable to carry out hydraulic fracturing at the current level of prices for natural gas. In general, how is the market situation reflected in your production plans, what are the forecasts for the future? - Of course, the price situation affects the return on investment in production. If 1.5 years ago the price of natural gas was 300 $/mcm, then right now it is 140 $/mcm - 130 $/mcm, with the later making the production economy drop significantly. We hope that in a year and a half prices will go up, if not this, then next fall. Although, before that time the price for natural gas may fall a little more. Our five-year plan contains 12 areas we work on, and as product prices change, the cost effectiveness of projects is revised, and we focus on those projects where margins are higher.If the field is more gas-yielding, but there is an opportunity to switch to the production of liquid hydrocarbons (light oil and natural gas condensate), then we do that accordingly.
- But the rent for oil production is higher the one for natural gas production …
- Yes, taxes are higher, but the price is also higher. Of course, the latest events in the world have changed everything: $ 30 a barrel and below is the reason to reconsider your plans, if that price must last long. In general, in Ukraine, both natural gas and oil markets are scarce, that is, Ukraine’s own production is not enough to cover the country's needs in natural gas and oil. Therefore, we expect the Ukrainian hydrocarbon market to be on par with European prices. Ukraine's oil and gas production has good prospects in terms of investment attractiveness. If the license area has reservoirs, then you can go to the market and work. Important in this matter is the stability and predictability of political and fiscal situation in the country, so that investments could come.
"Reducing rents and setting a flat rate for all fields will allow producers to accumulate investment into development"
- In your opinion, what changes are needed in Ukraine to boost the production of natural gas and oil and the development of oil and gas industry? - First and foremost, they should relate to fiscal policy. The first step, by reducing the rental rate to 12% and 6% for new wells, is certainly good (and we have done a lot to bring incentive rents to life). But now it is not enough. It is advisable to set uniform rates for all fields, either oil or natural gas, either old or new wells, and such rates should, of course, be lower the current rates.
We offer a flat rate of rent at 12 % for all wells up to 5 thousand meters. This will allow producers to save money of their investment into production. This will add investment attractiveness to the oil and gas sector. Deregulation and decentralization should be continued, including on land issues in the oil and gas sector. The owner of the land on which the production is carried out must understand that his agreement to cooperate will be paid off. And for the country as a whole, this is a strategically important issue. We have been in this market for over 25 years, the company has been operating effectively, and in 2019 paid more than UAH 1 billion in taxes. We actively participate in the development of regions where our assets are present, without providing much publicity to it. We are approached by local communities, we help with road repairs, play and sports grounds, have recently purchased a fire truck and a bus, and are also helping hospitals with quarantine amid the spread of coronavirus.
- The tax rates for natural gas and condensate in Ukraine vary, although both gas and condensate come from the same well, shouldn’t one also unify that tax rates as well?
- I think that all that needs to be leveled, as well as to lower tax rates.
- On the other hand, neither fair taxes nor the high cost of gas sales guarantee good results in production result…
- Of course, this is not enough to grow in production, but it is a good precondition for development. When fiscal policy is steady, administration occurs in a duly systematic manner, when tax and law enforcement agencies operate under the law rather than come with unscheduled sudden checks, then there is an opportunity to be fully engaged into business and its development. We, as a British company whose shares are listed on the international stock exchanges, are frequented from time to time by international companies seeking advice, while asking us how we manage to work so successfully, wondering about our problems here. Even international counterparties are contacting us to learn about possible cooperation with us, or subsequently get recommendations whether or not to enter the Ukrainian market. Many Western companies ask one question, “ Are investments protected in Ukraine?” And we answer that JKX won the Hague tribunal in 2017 and has been waiting for 3 years for the Ukrainian state to pay $ 14 million ($ 12 million in compensation for illegal rent raise, and $ 2 million in penalties for that time). At the same time, in Ukraine the law stipulated that the decision of the international arbitration has to be legalized (i.e. to pass all instances of the Ukrainian judicial system), and this process took more than 2 years. If and when we receive these funds, it will be a real proof that the laws in Ukraine work and the investments are protected in practice, not in words!
- What do you think about taxing "sleeping" licenses? What is your opinion about the draft Law on dormant licenses? Does your company have dormant licenses?
- There are no "sleeping" licenses in the JV PPC, and they cannot be there. We have only one license for geological exploration, and we have already spent about $ 25 million in its exploration. On the rest of the licenses we are actively producing. In our view, combating the dormant phenomenon of "sleeping licenses" is an extremely important step, though such steps should be carefully considered and weighted. If we include penalties in the license terms, or impose a tax on such licenses (as provisioned in the draft Law), we will reduce the investment attractiveness of the sites whose development permits are auctioned.
Only a geological survey can take 3 years, sometimes much more, the risks of not producing in such a period are very high. As for licenses that have confirmed reserved, but production is not conducted, in this case, you can impose penalties or taxes, but carefully, taking into account the circumstances in each particular case. I believe that the State Geologic and Subsoil Survey of Ukraine (SSGSU) should clearly distinguish when and what due works should be performed, and then monitor their implementation throughout the license period, rather than when the expiration date is approaching. And if the licensee does not fullfill the obligations set, then the SSGSU should suspend the license because of violation of the license conditions. In addition, worldwide experience has proven effectiveness of developing licenses in case of existing of a bank guarantee. In case of violation of a clearly defined list and terms of due works under the bank guarantee, the funds are written off and subsequently the license is canceled. Thus, such practice excludes dormant licenses a priori. Shouldn’t we study international experience and introduce its mechanisms in Ukraine?!Author: ExPro