By John Dizard
Published: October 2, 2006

The prospects for western investors in Ukraine, particularly the energy sector, appear to be getting worse under the coalition government led by Victor Yanukovych that took office in early August. The development of the Black Sea offshore oil and gas prospects, one of the more promising deep offshore areas in the world, now seems threatened by a "resource nationalism" that could just be a cover for transfers to new oligarchs.

Governments should push for the best deals possible for nationally owned resources. Norwegian and Dutch negotiators are known for their pitilessness (and honesty) in dealing with oil companies; not a bad model for Ukraine to have followed. However, Yuri Boyko, Ukraine's minister for fuel and energy, has been insisting that Ukrainian state-connected companies should take the lead in developing the Black Sea. If we were talking about companies with the technology and integrity of, say, Norway's Statoil, that would be realistic. But given the technological backwardness and shadowy control and ownership structures of the Ukrainian concerns, the new government leaders seem to have something else in mind.

As one oilman operating in Ukraine's onshore patch, (who has no offshore capability himself) says: "There are only five companies in the world who could develop a deep offshore prospect such as the Black Sea. For the energy minister to say he wants Ukrainian companies to develop this is absurd. They can't even maintain their production for onshore wells. If they wanted to hand over control of the country's hydrocarbons to Gazprom, this would be the way to do it."

Under a controversial tendering process concluded by the Ukrainian government in April, a consortium of Vanco International Ltd, run by Gene Van Dyke of Houston, and Nathaniel Rothschild's JNR Eastern Investment Ltd, received the right to negotiate a production sharing agreement (PSA) covering 12,900 sq km of the Black Sea. Neither Vanco nor JNR EIL have the internal operating capability to conduct seismic exploration and drilling; assuming the PSA negotiations are concluded, those functions would be subcontracted. "That should have been divided into smaller blocks," says our Ukrainian oilman, "and the process should have been made entirely transparent, which it was not."

Mr Van Dyke says: "I met with Boyko [after he took office] and his concern was 'why don't we do this ourselves'. Well, they have drilled on their shelf down to 40m. Our block is from 400m deep to 2,200m deep." It is only in the last five years or so that even the largest and most technically capable companies have implemented the technology for such deep drilling.

Edward Chow, an energy consultant who worked with Chevron on Caspian and Chinese projects, and who has done extensive analyses of Russian and Ukrainian energy policy, says that while big western energy companies could develop the Black Sea, their participation has certain disadvantages from the point of view of some Ukrainian politicians. "If major western companies get involved in Ukraine, they will have to open up the black box of their policies, and all sorts of cockroaches will come out. Who gets access to local customers? Who gets what prices for your production? Who gets access to pipelines and how do they get it? Who gets to export?"

Yulia Tymoshenko, the former prime minister of Ukraine, and now leader of the opposition, could benefit from internal opposition to the energy dealings. According to Mr Chow: "There is no one other than Tymoshenko to lead on the transparency issue. She is speaking on behalf of good government, of asking why Ukraine needs middlemen and shadowy deals."

"Her attitude," says the Ukrainian oil operator, "is that Ukraine should have half of any production from a deal with western companies. That is perfectly acceptable, and what the industry is accustomed to working with in the rest of the world. At least she wanted to bring in western investment to the energy industry, and believe me, they can't do it themselves.

"Look at the operating capability of the Ukrainian companies Boyko is talking about. It takes them about five times as long to drill onshore wells as it does in the west. To drill a 3,000m well takes them 300 days. Their equipment is terrible. There is no effective service industry here yet. Tymoshenko seems to understand that, while this government doesn't seem to care about the facts."

Mr Van Dyke, who is still optimistic he'll be able to work out a PSA with Ukraine by his December 1 deadline, admits that it will be difficult and expensive to fulfil the contract. "When I drilled two wells off west Africa, the day rate was $195,000. Now it's over $500,000 a day, and you can't get them. There aren't any drillships operating in the Black Sea now. Drilling in deep water is now horribly tough."

Steve Pifer, a senior adviser on Russia and Ukraine with the Center for Strategic and International Studies in Washington, says: "I don't think the government is really interested in negotiating a deal with Vanco. I think sabotaging the deal may be the objective. The issue for energy minister Boyko is not what gets done but who does it. If it's going to be done by people he doesn't control, he doesn't want to do it at all."

There is good news here for one group: Gazprom investors. At this rate, the Russian gas company will be able to hold on to a nation of customers for decades longer.