Ukraine Economy Hangs on Investments From Exxon to Shell

Photographer: Bulent Kilic/AFP via Getty Images

People visit and mourn on Kiev's Independence Square on Feb. 25, 2014. Close

People visit and mourn on Kiev's Independence Square on Feb. 25, 2014.

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Photographer: Bulent Kilic/AFP via Getty Images

People visit and mourn on Kiev's Independence Square on Feb. 25, 2014.

(Corrects 14th paragraph of story published yesterday to show Shell’s drilling will take place over five years.)

The world’s largest oil companies from Royal Dutch Shell Plc (RDSA) to Exxon Mobil Corp. (XOM) are likely to reassess deals to drill in Ukraine where political crisis is threatening a promising source of new profits as well as the country’s drive for energy independence.

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Shell and Chevron Corp. (CVX) signed agreements last year to drill unexplored shale formations in Ukraine, offering the chance to upgrade the country’s energy infrastructure and boost domestic production, thus reducing the amount of gas imported from Russia. Before the crisis erupted last year, Exxon, the largest U.S. oil company, was also close to signing a pact to explore the Black Sea.

While the oil companies can spend their money in other countries, the investment, which could eventually be worth more than $10 billion, is vital to Ukraine’s quest to pull away from Russian control and revive an economy on the verge of collapse after three months of violent protest.

“Ukraine is a no-go area for any investment from any foreign investor right now,” said Chris Weafer, senior partner at Macro Advisory in Moscow. “Investors need two critical conditions to invest in any emerging economy: political stability and economic predictability.”

At the moment Ukraine has neither. Parliament delayed a vote today on appointing a government of national unity to fill the void left by President Viktor Yanukovych’s exit. Its first priority will be to negotiate an economic aid package to fend off default, replacing cash Russia had promised the old regime.

Steel Mills

Even if it gets the money, Ukraine remains reliant on Russia for energy. The steel mills and arms factories that once made Ukraine an industrial heartland of the Soviet Union mean it burns more gas than France, an economy six times as big, yet still relies on Russia for more than 50 percent of that supply.

What Caused Ukraine's Crisis?

Ukraine also hosts a network of Soviet-era pipelines that carry about half of Russia’s shipments to the European Union, making Kiev’s energy relations with the Kremlin a vital concern in western Europe.

Russian President Vladimir Putin has used natural gas to pressure Ukraine, cutting off supplies twice since 2006, and in the latest crisis Russia offered cheaper gas to bolster Yanukovych.

Historically, Russia’s gas export monopoly OAO Gazprom (GAZP) has charged Ukraine more than customers in the rest of Europe, according to Mikhail Korchemkin, chief executive officer of East European Gas Analysis in Malvern, Pennsylvania.

Discounted Rate

So far, the unrest hasn’t affected the flow of gas into Ukraine, and prices in Europe -- where a milder-than-average winter has kept stockpiles higher than usual -- haven’t risen.

Russian Prime Minister Dmitry Medvedev said yesterday the country will keep supplying gas to Ukraine at the discounted rate negotiated in December until the agreement lapses at the end of March, according to a report from Interfax.

If Ukraine achieves a measure of political stability, a new government will want to pursue gas drilling given Russia’s negative reaction to Yanukovych’s overthrow, said Andrew Neff, an analyst at IHS Energy in Moscow.

“Ukraine will have to engage productively with foreign energy companies going forward if it has any hope of reducing that dependence on Russian gas,” he said.

The Hague-based Shell plans to drill as many as 15 wells over the next five years to appraise the potential of the Yuzivska field, spread over 8,000 square kilometers (3,100 square miles) of eastern Ukraine. Spending on the project could rise to $10 billion if it reaches production, the government said last year.

The company said in a statement that operations haven’t been affected by the unrest.

Oleska Shale

Chevron, the second-largest U.S. oil company, has a similar agreement for the Oleska shale formation, where it pledged to spend $400 million on drilling. The San Ramon, California-based company said in a statement that it’s closely monitoring the situation in Kiev and has taken appropriate precautions to ensure the safety of staff and their families.

Exxon was close to signing an agreement to drill exploration wells in the Skifska area of Ukraine’s part of the Black Sea before the current crisis erupted. The deal, which would have seen Exxon commit $735 million to drill just two offshore wells, remains in limbo.

The Irving, Texas-based company didn’t immediately respond to a request for comment.

“Civil unrest in the Ukraine will have a dampening effect on future shale exploration,” said Gianna Bern, founder of risk-management adviser Brookshire Advisory and Research Inc. In Chicago. “I would expect many projects to get sidelined until the investment climate improves and we see what the next government really looks like.”

Even if drilling continues, production on a significant scale will take several years and the threat remains that Russia will use energy to maintain its influence over Ukraine -- its goal since protests first started in Kiev last year, when Yanukovych ditched a deal to strengthen ties with the EU.

“Ukraine is still very reliant on energy from Russia,” said Leslie Holmes, professor of political science at the University of Melbourne. “So Russia still has a trump card up its sleeve.”

To contact the reporter on this story: Will Kennedy in London at wkennedy3@bloomberg.net

To contact the editor responsible for this story: Will Kennedy at wkennedy3@bloomberg.net

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