In Re (#11 November 2010)

Developing the Legal Framework for Unconventional Gas Development in Ukraine

Vitaliy V. Radchenko, Inna A. Saakova

In recent years shale gas has boosted natural gas production in the USA to record levels and at the same time reduced the gas price. Similarly, shale gas has been seen as a way towards European energy independence from Russian gas supply and has easily become one of the most discussed and hottest topics for Europe in 2010.

The shale gas rush has now reached Europe: JP Morgan recently published analysis, which forecasts European shale gas production growing to nearly 30 billion cubic meters per year by 2015. Several companies have announced the start of shale gas exploration campaigns in such regions as the North Sea Coast, Sweden and Romania. In neighbouring Poland a number of leading international oil and gas giants, including ExxonMobil, have already shown interest in conducting exploration works for shale gas and some of them have even managed to drill their first wells.

Given that Poland and Ukraine share some common geological structures, it was only a question of time when the unconventional gas fever would come to Ukraine. According to the local media, several international oil and gas companies have already declared their intention to explore for unconventional gas reserves in Ukraine. Nevertheless, the debates on the prospects of the shale gas production in Ukraine are still ongoing and energy experts believe that the State will have to solve a number of serious regulatory problems in order to facilitate exploration for unconventional gas. Analysis of the American experience proves that several major obstacles stand in the way to making shale gas production profitable in Ukraine.

Peculiarities of shale gas production

In order to understand the peculiarities of shale gas production, it is necessary to understand what shale gas is and how it can be explored and produced. Shale gas is often referred to as so-called unconventional gas. Conventional gas reserves are comparatively easy to develop as the natural gas usually lies in deposits under pressure and will naturally flow out when a well is drilled. In turn, unconventional gas occurs in formations where the permeability is so low that the gas cannot flow out easily or is adsorbed by the rock. Generally shale gas includes both hydrocarbons in rocks with low permeability and hydrocorbons ones which are attached to clay particles. That is why shale gas is extracted by the special techniques of horizontal drilling and hydraulic fracturing.

Horizontal (or directional) drilling is the process of drilling a curved well (up to a 90 degree turn), in order to reach a deposit that is not located directly beneath the drill site. This technology increases contact with the gas-bearing formation in comparison to vertical drilling, as it is not limited to the thickness of the layer and can move along the formation. After drilling the horizontal section of the well, operators hydraulically fracture the shale. During hydraulic fracturing, operators pump fracturing fluid (a mixture of water, sand and chemicals) at high pressure into the well. Due to the high pressure and chemical impact the fractures open the shale, thereby releasing the natural gas trapped or contained there. After hydraulic fracturing is complete, gas begins to flow out of the well onto the surface. A single fracture treatment may need more than 19,000 cubic meters of water, for reference, an Olympic-size swimming pool holds over 25,000 cubic meters.

Commercial aspects of shale gas production

The above-mentioned technologies may differ slightly from one deposit to another, but generally the production process is quite time-consuming and expensive. Exploration and estimation of shale gas deposit reserves may continue for up to 10 years. Futhermore drilling and fracturing of a typical horizontal well takes about three weeks to complete and costs about USD 3.5 4.5 million (US, Marcellus shale). The profitability of each separate well is not very high, as its production rate declines rapidly after the first few months of production. While the great majority of natural gas is produced during the first few years of production, a well could continue to produce for a maximum of 5-10 years before losing its commercial value (in comparison to a conventional gas well which average lifetime is about 50 years). These circumstances prompt gas companies to drill as many horizontal wells on the licensed subsoil plot as possible through a period of up to 30-40 years. As a result, they would try to get a hold of land plots with much larger acreage compared to a conventional gas field, in order to extract commercially viable volumes of natural gas while trying to recuperate their massive capital investment in the development of a single shale gas deposit site and its infrastructure.

Going back to Ukrainian realities, we should note that our legislation does not correspond to the best practice for shale gas production. For example, the special permits for exploration of natural gas are issued for only 5 years, while permits for exploration and production combined are limited by a 20-year term. In terms of adjusting Ukrainian subsoil legislation to the needs of unconventional gas development, it would make sense to introduce a specific type of special permit for combined exploration and production activities for a period of at least 30 years and preferably up to 40 years.

In terms of boundaries, the Ukrainian Oil and Gas Act limits the acreage for the special permits to 500 km2 onshore and 1,000 km2 offshore, which is not enough to develop an the unconventional gas field. Oil and gas investors would definitely seek an extension of these limits. The only other way to date of obtaining a larger acreage is to sign a Production Sharing Agreement (PSA) with the Ukrainian Government.

A PSA should be more preferable to oil and gas companies as it allows them to lease a larger subsoil plot for up to 50 years. As of today, the Government has only signed one PSA and no PSA tenders have ever been held since that time. There have been no auctions for oil and gas special permits either. In the USA and Europe, competitive auctions/tenders are held on a regular basis. In light of the above, the successful development of shale gas reserves in Ukraine seems to be impossible without a transparent and stable mechanism for awarding special permits and PSAs for oil and gas deposits.

Another issue will be the gas field infrastructure and access to pipelines. Americans say that any shale gas well is at most 10-15 km away from the nearest McDonalds. The US experience proves that local legislation must be in good shape to make unconvenctional gas development happen: it has to entitle gas companies to sign right-of-way agreements that will allow natural gas pipelines and gathering systems to be built across the land of property owners with compensation to be paid to the latter. Ukrainian legislation is yet to see these changes.

Land for shale gas development

According to Ukrainian legislation currently in effect, the rights to land for the purposes of exploration or production of minerals must be obtained separately from subsoil use rights as per the general procedure established by the Land Code. As a result, the operator cannot start subsoil activities unless the land use rights were obtained from the local authorities prior to this, but the process is quite time-consuming. Clearly, shale gas development would require a simplified procedure to be introduced to the Land Code for getting access to the land necessary for carrying out exploration activities and leasing out the land at the production stage. Ideally, a special permit for the combined exploration and production of shale gas should have a land lease attached to it.

Below the surface, oil and gas have the ability to move through the rock. Such mobility allows a well to drain oil or gas from the adjacent land (subsoil) plots. Thus, a well drilled on a separate land plot could drain gas from a neighbouring land plot if the well was drilled close enough to its boundaries. Likewise, a horizontal well started at one land plot may easily cross the boundary of an adjacent land plot. Stories about oil and gas companies blackmailing land owners with statements such as Lease us your land now or we will drill on your neighbours land and drain your gas without paying you a cent! were quite popular in the USA and the American experience proves that the absence of respective state regulations does allow this to happen. Moreover, there are no legal tools in Ukraine which would provide for sharing (unitization) of the jointly owned oil and gas reserves both internal and cross-border reserves.

Protection of water quality

Development of the shale gas industry in Ukraine may also be hindered by somewhat negative lessons from US environmental experience. In addition to the risks which are similar to those associated with conventional gas extraction (i.e. groundwater contamination, blowouts, seismic risks, etc.), shale gas development involves large volumes of water being pumped in and out of the drilled well. The disposal of water in the process of hydraulic fracturing may pose a significant challenge to water quality as most of the injected water (containing chemical residue and even radioactive elements) returns to the surface as flow back and requires adequate treatment.

Companies exploring for or producing the shale gas must ensure there is sufficient water treatment and processing capacity, in addition to the appropriate infrastructure around the field.

The regulatory authorities in the US have already faced a number of environmental problems. For years a loophole in federal laws allowed gas companies to conduct subsoil use activities without any adequate quality management in relation to the water used in hydraulic fracturing. Ukrainian legislation is, in its current state, silent on this aspect as well. Ukraine may need to employ US experience and adopt special laws and regulations aimed at protecting water resources during oil and gas production activities. For example, each company may be required to report on the chemicals used during hydraulic fracturing and the volumes of such fluids that flow back to the surface and also be responsible for their impact. Taking into account that each fracturing fluid contains a different subset and concentrations of hazardous chemicals, public disclosure of the chemicals used in hydraulic fracturing on a site-by-site basis seems to be a necessary measure. The introduction of such novelties would enable Ukrainian regulatory authorities to conduct water testing and respond accordingly, should any contamination of or risk to health, safety or environment occur.

Shale gas boom or bubble?

Development of unconventional gas in Ukraine is definitely a long shot and will not make the Ukrainian energy sector completely independent from Russian supplies in the near future but it can be an opportunity to reduce that dependence. At the same time, the Ukrainian Government has to understand that in order to even take the chance of playing the unconventional gas card against Russia, it has to introduce significant changes to the Subsoil Code, the Land Code, the Oil and Gas Act of Ukraine and subordinate legislation with the aim of motivating international oil and gas majors to give it a try.

The Ukrainian Journal of Business Law

Subscribe to The Ukrainian Journal of Business Law right now and enjoy the most relevant issues on doing business in Ukraine on your device or in print.

All this for just USD 9.99 a month.


Subscribe now