Investor Energy Potential in Ukraine's Troubles

By: Money_Morning

Dr. Kent Moors writes: [LONDON] As you read this, Marina and I will be in London for the annual energy consultations at Windsor Castle.

Now, if it seems like I'm spending far too much time traveling these days, you're right. But the truth is our trip to England is just the beginning... more is yet to come.

You see, most of the major new developments are no longer taking place in North America. The global energy sector is intensifying, and its importance has never been more striking than it is right now.

The American unconventional oil and gas revolution has gone global. In fact, that is the prime topic of our discussions at Windsor.

However, there is another place in the world that has my attention on this flight. It's Ukraine.
Needless to say, the situation there hasn't exactly been encouraging.

But here's what you might not be aware of. In addition to all of its other problems, Ukraine is also at the center of an increasingly messy energy situation.

Here's what's behind it all...

Six Facets of a Very Sticky Situation

There are at least six components here, and they complicate any easy receipt of the short-term, international financial support that is critical.

First, the country still remains dependent on natural gas from Russia. The chill in cross-border relations as a result of the ongoing political turmoil hardly improves this situation.

In fact, the Kremlin had advanced the prospect of offering discounted gas. But that was before the pro-Russian President Viktor Yanukovych was ousted and pro-Ukrainian nationalists took over the reins of government in Kiev.

Now, that gas will certainly revert to its earlier "cash on the barrel head," or COB arrangement.

There will be no Russian credit forthcoming, and Ukraine cannot pay. They had been playing their earlier contracts by accumulating volume in storage during the high summer at low prices to be used in the higher-priced winter months, but all of that reserve is now gone.

Second, the European Union (E.U.) had offered assistance pending reforms of the gas transit system in tandem with the E.U.'s Energy Charter Treaty (ECT).

The ECT requires that signatories separate production and distribution assets as well as provide third parties with access to domestic pipeline and other transit systems. Russia has rejected this all-too-obvious frontal attack on Gazprom's natural gas monopoly over the market pricing and home pipeline system. Ukraine has been (at least in theory) more flexible.

After the recent events, however, Kiev will now probably have to give up some administrative control over the pipeline system for significant energy assistance.

Yet it is unclear where outside interests such as the E.U. or the U.S. would be able to source gas for use inside Ukraine. Some financial assistance will be forthcoming, but when it comes to the large price tag demanded by the domestic pipeline upgrades, immediate help will require that whatever government emerges be amenable to relinquishing some control.

The Kremlin, and therefore Gazprom, had been pushing for the same concession.

Third, there is an element I happen to be working on currently.

It's the need to bring additional foreign interests to bear on shale gas development in Western Ukraine and the building of a liquefied natural gas (LNG) terminal outside Odessa. Progress so far on the first has been slow and uneven, while on the second there is interest in Azerbaijan and Iraq to provide gas, but nothing substantive, and it would require several years of engineering and construction.

With genuine onshore conventional oil and gas prospects more limited, the country needs the domestic "new gas" and imports by a non-pipeline (and not-across-Russia) transit venue to avoid experiencing a genuine contraction on the demand side. That would wreak havoc with an already hard-pressed economic picture.

Fourth, Ukraine still controls the majority of Russian gas moving on to Western Europe, but that will end with the completion of the Russian bypass pipelines. Nord Stream, across the Baltic Sea bed, is already operating to Germany, while South Stream is about to move Russian gas into Southeastern Europe by way of the Black Sea and Turkey.

In addition, the alternative Yamal-Europe gas pipeline crossing Belarus to Poland is already owned by Gazprom. The Russian giant now owns 100% of the Belarusian national gas pipeline company, a fate several in Kiev believed was on the planning block for its own system once Russia laid out its full assistance schedule.

The end result here is less gas for Ukraine since much of the throughput fee is paid in kind by Gazprom for crossing Ukrainian territory, and even less prospects for using that transport avenue as a pawn in the negotiation process with its larger neighbor.

Fifth, the prospects for development of offshore Black Sea deposits are now up in the air. It is likely that a short-term response to the political instability now gripping Kiev will create more movement to fast track projects in Russian Black Sea waters.

Finally, given the increasing difficulties of meeting gas prices even before the current crisis, Ukraine had been moving more toward replacing gas with coal. But in addition to the environmental consequences, there is now a genuine political problem developing.

The primary domestic coal supplies are in the eastern, ethnic-Russian, Donetsk basin, where what has happened in displacing a local politician from the presidency has gone over hard.

Many in Donetsk, Crimea, and other parts of the eastern and southeastern portions of Ukraine are livid about the rise of a pro-Ukrainian nationalist - and anti-Russian - revolution in the capital.

So there is a rising concern that Russophone Ukraine may withhold coal supplies from Ukrainian-speaking Ukraine. And then there is the Russian Black Sea fleet which just happens to be based in the Crimean (and Ukrainian) port of Sevastopol.

It's an example of how geopolitical events sometimes have a major energy component. In the case of what is transpiring in Ukraine, energy may be the main chess board in which political change is worked out.

But that is hardly reassuring.

Source : http://moneymorning.com/2014/03/01/energy-potential-ukraines-troubles/

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