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EXECUTIVE SUMMARY Advance Energy Ltd (‘AVD’ or the ‘Company’) has announced the proposed acquisition of an operating
interest in the Ortynytska Prospect, which is prospective for gas.
The Ortynytska license area is located near the centre of the productive Foreland Belt of the Carpathian Basin, which is the oldest-producing Basin either in or surrounding Ukraine, and is located immediately south of the producing
Zaluzhany gas and condensate field and in proximity to well developed gas and oil infrastructure. Attractiveness of the Ukraine Gas Market
An assessment of the Foreland of the Carpathian Basin by the US Geological Survey (USGS) in 1999 concluded that between 20 to 175 gas fields remain undiscovered (mean value of ~76 fields), with field sizes ranging from six to 400 BCF of recoverable gas (median size 20 BCF).
In addition, the USGS report stated that approximately
37% of the undiscovered gas fields will be in the Ukraine.
A ready market exists for any gas produced in Ukraine, as Ukraine’s production is currently less than one-third of domestic gas requirements.
The Ukraine Government is aiming to increase energy independence through more natural gas production. Notably, according to the US Energy Information Administration estimates, the country has around 42 TCF of shale gas reserves, placing it 3rd among European countries. Chevron and Royal Dutch Shell announced plans earlier this year to
invest at least US$370 million in the development of the Yuzivske and Oleske shale fields in Ukraine.
Ukraine has a favourable oil and gas licensing regime,
especially for gas.
Continued over page
ADVANCE ENERGY LTD (AVD)
PPllaannss eennttrryy iinnttoo lluuccrraattiivvee UUkkrraaiinnee ggaass mmaarrkkeett
SPECULATIVE
27 June 2012
Important Disclosure Investors should be aware that Advance Energy Ltd is a corporate client of Alpha and that Alpha will receive a consultancy fee from Advance Energy Ltd for compiling this research report
Share Trading Info
ASX Code AVD
Current Share Price (Aust. cps) 0.4
Trading Low /High (Rolling Year) (cps) - $3.980.3 - 1.2
Mkt Captalisation (undiluted) ($m) 1.4
Est Cash (Pro-Forma - Post Raising) ($m) 3.0
Capital Structure (m)
Current Shares on Issue* 340.4
Listed Options (ASX: AVDOA) 202.9
Convertible Notes 6.7
Total Securities on Issue 550.0
* Not including proposed capital raising (up to 600m
shares) and the issue of 500m shares to vendors
as consideration for the Ortynytska acquisition
Pro-Forma Balance Sheet ($m)
Cash 2.4
Total Assets 5.0
Total Liabilities 7.2
Net Assets -1.1
* Following completion of both the capital raising and
Ortynytska acquisition
Board of Directors
Gordon Sklenka Non Executive Chairman
Anthony Short Managing Director
** Further details on Page 23
Major Shareholders
CQS Asset Management 9.4%
Fay Holdings P/L 5.5%
Goldbond Super P/L 4.2%
Palace Resources Ltd 3.6%
Odin Energy Ltd 3.5%
Kip Plankinton Non Executive Director
Advance Energy (AVD)
Page 2 of 24
Planned Work Program – Ortynytska Prospect
Subject to completion of a proposed capital raising and the acquisition of the Ortynytska
Prospect, AVD’s planned work program involves a re-entry of the Ortynytska-3 well, which was drilled to 3,577 metres in 1993-4 and discovered gas in the LD-15 sand.
The focus on the LD-15 Horizon is further validated by seismic data analysis undertaken by Perth-based ISIS Petroleum Consultants, which identified three horizons:
1. Base of Stebnyk Thrust Sheet, the shallowest horizon, which also appears to be an excellent closure for the LD-15 sand.
2. LD-15 Horizon, located at approximately 3,500 metres depth.
3. GA Horizon, comprising two deeper secondary sands at approximately 4,500 metres and 4,700 metres depth.
The Company will fund the construction of a drill pad to enable preparations for the re-entry
to be undertaken and expects to undertake a minimal amount of confirmatory 2D seismic prior to a re-entry of the Ortynytska-3 well.
The vendor (Celiastad) has already invested in excess of US$0.9 million securing the license and JAA, commissioning an independent report and constructing a road to the Ortynytska-3 well.
AVD anticipate that the re-entry will commence in the 4th quarter of 2012. All relevant
approvals are already in place.
Advance Energy (AVD)
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11.. CCOOMMPPAANNYY OOVVEERRVVIIEEWW
1.1 Background AVD was incorporated on 16 November 2004 and was admitted to the official list of ASX on 2 June 2006. The Company’s business strategy is to acquire and develop early stage oil and gas properties and, since listing, the Company has drilled a number of successful production wells and undertaken a significant number of work-overs of existing wells. At one stage, the Company and its partner had interests in over
30 wells in the Permian Basin of the US. Much of the Company’s acquisitions have, to date, been funded by convertible note debt with development activities being funded by a
loan facility with the Sterling Bank of Texas. In December 2009, the Company retired over $6 million in short-term
unlisted convertible notes and issued 6.675 million listed convertible notes which mature in December 2014. As a result of disappointing workover results (which failed to deliver increases in oil and gas production) and a downturn in US energy prices, AVD sold its producing assets in December 2010 retiring all remaining unlisted convertible notes and senior debt.
The Company currently retains a 50% working interest in the Mother Lode III project; an oil and gas exploration project located in the Permian Basin of the US. The operator of the Mother Lode III Project, Endeavour Energy Partners
Inc, drilled a successful well on the project in September 2010 and this
well continues to produce. The Company elected not to participate in the drilling of this well. Consequently, Endeavour Energy Partners Inc and other funding contributors are entitled to recover the dry hole and completion costs of the well plus an amount equivalent to 300% of those costs before the Company resumes its interest in the well.
The Company retains its 50% interest in the rest of the lease comprising the Mother Lode III Project and is entitled to participate in all future wells. The proposed acquisition of the Ortynytska Prospect is the result of AVD’s active pursuit, since December 2010, of additional projects that have the potential to deliver growth for
the Company.
Advance Energy (AVD)
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1.2 Funding and Balance Sheet
AVD is planning to raise up to $3 million, the majority of which will be used to fund the cost of re-entry at the Ortynytska-3 well (estimated to be ~$2.5 million). Following completion of the transaction, AVD will have a potential contingent liability up to a maximum of US$0.9 million (i.e. off balance
sheet entry), representing reimbursement of the vendors for costs incurred by them to date in developing the Ortynytska Prospect. This amount may be paid out of any future profit derived from the Ortynytska Prospect once AVD has successfully re-entered the Ortynytska-3 well and recovered its initial investment.
Table 1: Pro Forma AVD Balance Sheet – Post Completion of Placement and Issue of Shares to Vendor
1.3 Capital Structure
AVD has a tightly-held share register, with the top 20 shareholders holding ~53% of the total shares on issue. The share register is comprised of institutional shareholders, ASX-listed companies, sophisticated and retail investors, with AVD directors combined holding ~11% of the total shares on issue.
There are currently a total of 340.4 million ordinary shares on issue, with a further ~202.9 million listed options on issue (ASX: AVDOA) exercisable at 3 cents per share with an expiry date of 31 August 2012, all of which are presently out-of-the-money. In addition, there are 6.675 million listed convertible notes on issue paying 9.5% p.a. interest and maturing in December 2014. The Company has shareholder
`
Pre Acq'n Pro Forma
& Placement Post Acq'n
31 Dec 2011 & Placement
Adjusted ($) ($)
Current Assets
Cash & Cash Equivalents 154,238 2,355,151 Assuming $2.4m (at 0.4c) is raised in placement,
Trade & Other Receivables 42,600 42,600 less costs
Total Current Assets 196,838 2,397,751
Non Current Assets
Property Plant & Equipment 5,844 5,844
Oil & Gas Exploration 609,981 609,981
Other Financial Assets - 2,000,000 Value of Ortynytska Asset, (based on issue of
Total Non Current Assets 615,825 2,615,825 500m shares to Vendor at an assumed price of
0.4c)
TOTAL ASSETS 812,663 5,013,576
Current Liabilities
Trade and Other Receivables 360,440 360,440
Interest Bearing Liabilities 183,785 183,785
Total Current Liabilities 544,225 544,225
Non Current Liabilities
Interest Bearing Liabilities 6,675,500 6,675,500
Total Non Current Liabilities 6,675,500 6,675,500
TOTAL LIABILITIES 7,219,725 7,219,725
NET ASSETS (6,407,062) (2,206,149)
Comments
Advance Energy (AVD)
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approval to issue shares in lieu of interest at 80% of the volume weighted average price of shares.
Following the proposed issue of:
i. 600 million shares under the placement (assuming that this amount of shares are issued at the current AVD share price of 0.4 cents in order to raise $2.4 million & the issue of fully subscribed) and
ii. 500 million shares to the vendors of Celiastad as consideration for acquiring an interest in the Ortynytska Prospect,
AVD is likely to have up to a total of 1,440.4 million ordinary shares on issue. Based on this figure, the vendors of Celiastad are expected to have a combined shareholding representing ~35% of the Company;
however, each vendor’s shareholding is considered separate (i.e. not as
one voting block), as the shares will be distributed to the vendors on a pro-rata basis. Table 2: AVD Current Capital Structure
`
Expiry
Date
Listed Ordinary Shares 340.4
Listed Options
- Exercise Price 3c 202.9 31-Aug-12
Convertible Notes 6.7
Total Securities Currently on Issue 550.0
Current Shares/Options on Issue Million
Advance Energy (AVD)
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22.. OORRTTYYNNYYTTSSKKAA PPRROOSSPPEECCTT,, UUKKRRAAIINNEE
2.1 Overview
The Ortynytska Subsoil License covers an area of 19km2 and is located approximately 50 kilometres SW of the city of L’viv in western Ukraine. The Ortynytska Prospect is located in the North Carpathian Basin, which stretches in an arc from Ukraine through southern Poland and Slovakia through to the Czech Republic and Austria.
The license area is close to a well-developed gas and oil infrastructure network and is located immediately south of the producing Zaluzhany gas and condensate field. The Zaluzhany field was discovered in 1969 and was estimated to have total recoverable reserves of 1TCF. First
production commenced in 1975 from three wells, with a peak production of 26.7 MCF/day (1979 to 1984) from 27 wells from 13 producing horizons. By 1993, the field had produced approximately 135
BCF.
Figure 1: Location of Ortynytska Prospect in Context to Zaluzhany Field
Source: ISIS Petroleum Consultants Report, March 2012
Advance Energy (AVD)
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2.2 Geological Characteristics
The Ortynytska Prospect is prospective for gas in the lower part of the Mid-Late Miocene Dashava Formation. The Dashava Formation is the principal gas reservoir in the area, including the adjacent Zaluzhany Field. The gas is typically dry, predominantly methane and low in inerts.
Two wells, Ortynytska-1 and Ortynytska-3, were drilled on the Ortynytska structure between 1990 and 1996, based on a loose grid of 10 poor-to-fair quality 2D seismic data available over the Ortynytska structure (from 24 wells). Both wells were prematurely abandoned without reaching their objectives. At Ortynytska-1, there were no oil or gas shows and the well was abandoned in June 1992.
The Ortynytska-3 well was drilled to 3,577 metres in 1993-4 and discovered gas in the LD-15 sand. The well had a gas kick at 3,533 metres and was discontinued well short of its proposed TD of 5,400 metres because of drilling problems. Consequently, the operator did not bring the well into production or drill to the lower horizons. Ortynytska-3 was suspended in May 1996 for a possible re-entry.
Ortynytska-3 is believed to have penetrated the section beneath the Stebnyk Thrust, possibly intersecting the LD-15 Horizon. As part of an evaluation of the Ortynytska area (within and outside of the license area), Perth-based ISIS Petroleum Consultants P/L mapped three horizons from 10 seismic lines:
1. Base of Stebnyk Thrust Sheet
The Ortynytska Prospect is located in the relatively
undeformed Foreland sediments beneath frontal thrust of the
Flysch Belt. The frontal thrust is known locally as the Stebnyk Thrust, which is the shallowest horizon, and dips strongly to the South and very shallow to the North. The Stebnyk Thrust does appear to provide an excellent closure for the LD-15 sand.
2. LD-15 Horizon
This horizon is cut out to the South by the Stebnyk Thrust and could only be mapped within the northern third of the license area. The LD-15 Horizon is located at approximately 3,500 metres and is the largest of the several leads identified in and
around the Ortynytska license area.
3. GA Horizon
This horizon was mapped over the entire area and picked as a
trough in the leading part of a strong band of reflectors. The GA Horizon comprises of two deeper secondary sands at approximately 4,500 metres and 4,700 metres.
Figure 2 outlines the location of the two leads at the GA Horizon in relation to the Ortynytska license area. The closures for the two leads
are about 0.69km2 and 0.38Km2, respectively.
Advance Energy (AVD)
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Figure 2: Location of the Two Leads at the GA Horizon within the Ortynytska License Area
Source: ISIS Petroleum Consultants Report, March 2012
Figure 3: Principal Gas-Bearing Horizons at Ortynytska Prospect
Source: AVD
Advance Energy (AVD)
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Figure 4: 3D View at Depth of Three Horizons at Ortynytska Prospect (Looking West)
Source: ISIS Petroleum Consultants Report, March 2012
2.3 Deal Structure and Acquisition Terms
AVD’s proposed acquisition of an operating interest in the Ortynytska License will be effected by the acquisition of a 100% interest in Celiastad P/L (Celiastad), by issuing the shareholders of Celiastad
with 500 million ordinary shares in AVD1. Celiastad has the rights to acquire 100% of Epic Energy Ukraine Ltd (Epic). Epic has executed a Joint Activity Agreement (JAA) with ZakhidUkrGeologiya (ZUG), the holder of the license over the Ortynytska License. ZUG is a subsidiary of National Joint Stock
Company (NJSC) Nadra Ukrainy, which was established by Presidential decree in 2001. Under the terms of the JAA:
i. AVD funds all capital and operational commitments and expenses relating to the Ortynytksa Prospect;
ii. AVD receives 70% of net profits from production under the Ortynytksa Prospect until such time as it has recovered 100% of its invested funds; and
iii. AVD receives 50% of net profits thereafter.
1 The shares will be distributed on a pro rata basis amongst the vendors. None of the vendors are related parties to AVD.
Advance Energy (AVD)
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Figure 5: Proposed Deal Structure - Ortynytska Prospect
Source: AVD, Alpha Securities
2.4 Ukraine Management Team
Gennady Varytsky
Mr Varytsky began his career in 1983 as a line officer in the USSR Armed Forces before undertaking legal roles in the Military Counsel of the Ukrainian Naval Forces and as Head of the International Agreements Department at the Ukrainian Ministry of Defence.
On leaving the Armed Forces, he became a legal advisor and International Practice Partner in Tax and Legal Advice with Grant Thornton Ukraine Ltd. He has also held management roles with Premdor Ukraine Ltd and Amsel & Co Law Firm. Mr Varytsky has tertiary qualifications in law and social studies and is fluent in English, Ukrainian and Russian. He is a member of the Joint
Activity Agreement (JAA) Committee and will play a key role in managing AVD’s relationship with ZUG.
Steve Fast
Steve, who is currently AVD’s US in-country Manager, will oversee the Company’s operations in Ukraine. He has around 13 years
experience, mainly in oil and gas and has extensive managerial and supervisory experience and broad experience in finance. Steve has near-native proficiency at reading, writing and speaking Russian, with around 11 of his 13 years of experience in Russian speaking work environments, primarily in Kazakhstan. He holds a Certificate in Petroleum Asset Management and Economics from the
Department of Petroleum Engineering at Texas A & M University. Steve is a member of the Joint Activity Agreement (JAA) Committee.
Advance Energy (AVD)
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Douglas Jendry BA App Geol MAIMM
Mr Jendry is an oil and gas geologist with over 40 years experience across the world. He was a Director of Carpathian Resources Ltd which
successfully explored for hydrocarbons in the Czech Republic and consequently has extensive knowledge of the Carpathian Basin. Mr Jendry was a Director of Impress Energy from 2000 (until it was acquired by Beach Petroleum in 2010) and was also Managing Director of Omega Oil NL from listing in 1995 until it was acquired by AWE in
1999. Under his leadership, the market capitalisation of Omega increased twenty-fold.
Advance Energy (AVD)
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33.. OOVVEERRVVIIEEWW OOFF OOIILL AANNDD GGAASS IINNDDUUSSTTRRYY IINN UUKKRRAAIINNEE
3.1 Ukraine’s Strategic Significance
As at January 2011, Ukraine was estimated to have 395 million barrels of proven oil reserves, the majority of which are located in the eastern Dnieper-Donetsk Basin. Although Ukraine has made efforts at exploration, particularly in its sector of the Sea of Azov, oil production has remained relatively flat since independence from Russia. Ukraine's geographic location makes it an important corridor for oil and natural gas to transit from Russia and the Caspian Sea region to Europe.
In addition, Ukraine is situated right in the intersection of oil and gas transportation routes of the Eurasian continent. Member states of the
European Union, which are economically and socially developed countries, are consumers of substantial volumes of natural hydrocarbons, but they have insufficient volumes for their own power requirements.
As is the case with oil, Ukraine plays a significant role as an intermediary connecting Russia, the world's largest natural gas producer, with growing European markets. Ukraine has sufficient generating capacity to supply more than twice its electricity needs, but the country’s ageing infrastructure is in need of investment and
maintenance. The US Energy Information Administration believes that investment in the Ukrainian transport network, more international cooperation and a more transparent energy sector are needed to provide reliable supplies domestically and in Europe. While oil consumption dropped precipitously immediately after its declaration of independence from Russia, the country continues to
import a material amount of crude. As highlighted in Figure 6, Ukrainian oil production over the last 20 years has remained relatively stagnant. Since 2000, domestic production has declined to 50%, with oil consumption requirements met by imports from Russia and Kazakhstan.
Figure 6: Oil Production and Consumption in Ukraine (1992 – 2010)
Source: US Energy Information Administration
Advance Energy (AVD)
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Similarly, natural gas production has also remained relatively stagnant over the same timeframe in the country, as highlighted in Figure 7. While gas consumption has trended downward, Ukraine still imports
approximately ~72% of its natural gas needs (mainly from Russia and Turkmenistan), with domestic gas production meeting ~28% of consumption requirements.
Figure 7: Natural Gas Production and Consumption in Ukraine (1992 – 2010)
Source: US Energy Information Administration
3.2 The Carpathian Basin The Carpathian Basin (or Pannonian Basin) is one of three oil and gas-
producing Basins in Ukraine and stretches ~600 kilometres from east
to west across several Eastern and Central European countries (including Ukraine, Poland and Slovakia) and ~500 kilometres from north to south. The Carpathian Basin is the oldest-producing Basin either in or surrounding Ukraine (see Figure 8), and has a well-developed oil and gas infrastructure. Oil field discoveries commenced in the mid 19th century in the thrust belt to the SW of the Basin, with large gas discoveries made in the NE of the Basin in the mid 20th
century. A wide variety of structural, stratigraphic and combination trap types are present. Producing traps in the basin range in depth from 80 metres to 5,000 metres, with most oil found at 800 to 3,000 metres - and most natural gas found in deeper reservoirs. About 500 fields have been
identified, with more than 2.1 billion barrels of oil and 11.2 TCF of natural gas discovered.
The North Carpathian Province within Poland, Austria, and the Czech Republic is part of the western Carpathian Mountains, whereas the Ukraine part of the province lies within the eastern Carpathian Mountains.
Advance Energy (AVD)
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Figure 8: 3D Location of the Three Oil & Gas Producing Basins in and around Ukraine
Source: ISIS Petroleum Consultants Report, March 2012
3.2.1 Undiscovered Potential of the Carpathian Basin
The Ortynytska Prospect is located near the centre of the productive foreland belt of the Carpathian Basin. An assessment of the Foreland Basin by the US Geological Survey (USGS) in 1999 concluded that between 20 to 175 gas fields remain undiscovered (mean value of ~76 fields), with field sizes ranging from six to 400 BCF of recoverable gas (median size 20 BCF).
In addition, the USGS report stated that approximately 37% of the undiscovered gas fields will be in the Ukraine.
Advance Energy (AVD)
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Figure 9: 3D Location of the North Carpathian Province and Total Petroleum Systems in Eastern Europe
Source: US Geological Survey Report (1999)
Advance Energy (AVD)
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Figure 10: Distribution of Undiscovered Fields in the Foreland Basin
Source: ISIS Petroleum Consultants Report, March 2012
3.3 Major Oil and Gas Players in Ukraine
The oil and gas industry in Ukraine is dominated by state-owned NJSC Naftogaz (‘Naftogaz’), which is a vertically-integrated oil and gas company engaged in the full cycle of operations in gas and oil field
exploration and development, production and exploratory drilling, gas and oil transport and storage, supply of natural gas and LPG to
consumers. Over 90% of the oil and gas in Ukraine is produced by Naftogaz, providing 1/8th of Ukraine’s GDP and 1/10th of the State budget revenues. Naftogaz processes gas, oil and condensate at five gas
processing plants, which produce LPG, motor fuels and other types of petroleum products. Naftogaz also has its own-brand filling station network. Aside from Naftogaz, a number of other state or quasi-state companies also have principal roles in the exploration for, production and transport of oil and gas.
Independent gas producers (such as Regal Petroleum) sell their gas to industrial consumers via Joint Ventures and Joint Activity Agreements. There are also a number of other western companies that have
successfully undertaken oil and gas exploration in Ukraine, including
two ASX-listed companies: Hawkley Oil and Gas Ltd (ASX: HOG) and Golden State Resources (ASX: GDN). Large global players such as Total, ExxonMobil, Chevron, Marathon, Wintershall and OMV previously had operations in Ukraine, but left, largely due to the political environment in the country at the time.
Advance Energy (AVD)
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Table 3: Major Listed Worldwide Companies Operating in Ukraine
Source: Company Reports, Alpha Securities
3.4 Oil and Gas Infrastructure in Ukraine
3.4.1 Natural Gas Transmission
Ukraine has an extensive gas transmission system, which consists of 39,800 kilometres of pipelines, including 14,000 kilometres with a diameter ranging from 1,020 to 1,420 mm, 74 compressor stations (112 compressor shops) providing a total capacity of 5,450 MW, and 13 underground gas storage facilities. The input capacity of the system is 288 BCM, and the output stands at 178.5 BCM a year.
The operator of Ukraine's gas transmission system is a subsidiary company of Naftogaz, SC Ukratransgas, SC Ukratransgas provides both gas supply to domestic consumers and a major volume of Russian gas export deliveries to other European countries.
SC Ukratransgas annually transmits 50-60 BCM to Ukrainian
consumers with natural gas transit through the Ukrainian gas transmission system, ranging from 110 to 120 BCM to Central and Western European countries. At present, the technical capability exists to increase gas transit to Central and Western European countries up to 142 BCM without expanding the gas transmission system. About 70% of Russian natural gas is transited to European countries through the territory of Ukraine.
In recent years, SC Ukratransgas has transported 50-60 billion m3 of natural gas to Ukrainian consumers and 95-117 billion m3 of natural gas to West and Central European countries.
TNK-BP TNBP Moscow 33746
Ow ns and operates f ive refineries (four in Russia and one in
Ukraine) and has a retail netw ork of approximately 1,500 sites
spread across Central Russia and Ukraine, w ith a particularly
strong position in the Moscow market.
Cadogan Petroleum CADP LSE 108
Working interests in 11 license areas covering 14 f ields in Ukraine
w ith a combined area of approximately 1150 km². Assets are
located in the Dnieper-Donets Basin and the Carpathian Basin
Misen Energy MISE Sw eden 105
Previously Svenska Capital. Activities in Ukraine are via a JAA
focusing on gas extraction from earlier oil exploration.
Regal Petroleum RPT AIM 90
Holds a 75% interest in the Mekhediviska, Golotovschinska and
Svyrdivske (MEX, GOL and SV) gas f ield areas in Eastern
Ukraine.
Hawkley Oil & Gas HOG ASX 37Ow ns tw o licenses in Ukraine (Chernetska & Sorochynska) w ith
appraisal opportunities on successful discoveries
TransEuro Energy TSU TSX-V 34Has a 72% interest in tw o gas condensate f ields and is
developing the Povorotnoye gas f ield.
Golden State
Resources GDN ASX 16
Recently acquired an initial 62.1% interest in the Povorotnoye Gas
Field, located on the Kerch Peninsula in the Crimea region. JAA
entered into w ith Crymgeologica. Scheduled to commence
spudding of the f irst w ell.
w
Company Name
JKX Oil & Gas Plc JKX
Projects in Ukraine
LSE 240
Wholly-ow ned subsidiary PPC is the largest non-state producer
of oil and gas in Ukraine. PPC holds 100% interest in four
production licenses in the Poltava region
Code Listing Mkt Cap (A$m)
Advance Energy (AVD)
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The 13 underground gas storage facilities with a working capacity of 32 BCM represent an important technological element of Ukraine's gas
transmission system. The underground gas storage network includes four systems: the West-Ukrainian, Kiev, Donetsk and South-Ukrainian complexes. At maximum storage and output rates, Ukraine's storage facilities can withdraw 250 million cubic meters of natural gas a day. Connected by a network of pipelines, the underground gas storage
facilities guarantee reliable operation of the entire gas transmission system, and provide a stable gas supply to domestic consumers and transit of Russian gas to Europe. Due to intensive development of the European gas market, the underground gas storage facilities located in the Western region of
Ukraine could play a much more important role in providing safe and
secure gas supplies to neighbouring countries.
Figure 11: Gas Transmission & Infrastructure Network in Ukraine
Source: ISIS Petroleum Consultants Report, March 2012
3.4.2 Oil Transportation
In addition to gas transmission, Ukraine has a developed oil transport system. With a total length of 4,700 kilometres, the system is activated by 51 main pumping stations. The annual input capacity of the system is 114Mt, and the output capacity is about 56Mt. Via Ukraine's trunk line system, crude oil is delivered from Russia and
Kazakhstan to Ukrainian refineries and is also exported to Central and Western European countries.
Advance Energy (AVD)
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In Ukraine, crude oil is transported by the Ukrtransnafta Open Joint-Stock Company, which is a subsidiary of NJSC Naftogaz of Ukraine. The Ukrtransnafta has two three enterprises operating within its
structure - Prydniprovski Magistralni Naftoprovody (South-Eastern region of Ukraine), Magistralni Naftoprovody Druzhba (operating in the North-Western region of Ukraine), and Pivdenni Magistralni Naftoprovody (operating in the South region of Ukraine). Crude oil transportation via Ukraine’s oil pipeline system sustained
65Mtpa prior to 2000, including exports of 53Mt of crude oil transit. 25.2Mt of crude oil were transported in 2011, including 17.8Mt of transit and 7.4Mt supplied to oil refineries based in Ukraine. Prospects of development of the Ukrainian oil pipeline network and its further integration with the all-European network of oil pipelines are
connected, first of all, with implementation of the project of
construction of the Europe - Asia Oil Transport Corridor.
Figure 12: Oil Infrastructure Network in Ukraine
Source: ISIS Petroleum Consultants Report, March 2012
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3.5 Gas Pricing Considerations
As a large percentage of Ukraine’s natural gas volumes come from Russia, natural gas pricing in Ukraine is benchmarked against agreements with Russian gas monopoly Gazprom. Ukraine has been involved in numerous disputes with Russia over pricing, which have led to disruptions of Gazprom's supplies to Europe through Ukraine's territory, prompting Russia to create alternative export routes that
bypass Ukraine. The Russia–Ukraine gas dispute of 2009 occurred when Gazprom refused to conclude a supply contract for 2009 unless Ukrainian gas company Naftogaz paid its accumulating debts for previous gas supplies.
The dispute began in 2008 with a series of failed negotiations, and on 1 January 2009, Russia cut off gas supplies to Ukraine. On 7 January 2009, the dispute turned to crisis when all Russian gas flows through Ukraine were halted for 13 days, completely cutting off supplies to South Eastern Europe, most of which depends on Russian gas, and partially to other European countries. On 19 January 2009, the
dispute was resolved when Russian Prime Minister Vladimir Putin and the then Ukrainian Prime Minister Yulia Tymoshenko negotiated a new contract that covered the next ten years. The Ukrainian Government is currently paying US$416 per 1,000m3, but sees a fairer price at US$250 per 1,000m3. Ukraine media have reported that Naftogaz predicts a reduction in the price of Russian gas
from US$416 to US$413 per 1,000m3 in the 4th quarter of 2012. The Ukrainian Government has sought for more than a year to negotiate a lower price on Russian gas but talks have produced no results so far.
Russia has long insisted it would review the price only if Gazprom was allowed to take over Ukrainian gas transit pipelines or if Ukraine joined a Russia-led Customs Union. The Ukraine has so far dismissed
both options. Another aspect of the current impasse with Russia is that Ukraine is seeking to almost halve current gas imports from Gazprom. Naftogaz has notified Gazprom that it would be reducing its gas imports to 27 BCM (Billion cubic metres) of gas for 2012, as opposed to a contracted 52 BCM. However, the Russian Government has pointed
out that Naftogaz's contract only allowed for a maximum reduction of 20%. To reduce its reliance on Russia, as well as the potential for further disputes, the Ukraine Government is aiming to increase energy independence through more natural gas production. Notably, according to the US Energy Information Administration estimates, the
country has around 42 TCF of shale gas reserves, placing it 3rd among European countries. Chevron and Royal Dutch Shell announced earlier this year plans to invest at least US$370 million in the development of the Yuzivske and Oleske shale fields in Ukraine.
Advance Energy (AVD)
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3.6 Oil and Gas Licensing Regime in Ukraine
Ukraine has a favourable oil and gas regime, particularly for gas production. Subsoil hydrocarbons are regulated by the ‘Oil and Gas’ Law, with permits either auctioned in a public process or granted to state companies. Royalties are set in Hryvnas and are determined according on its use
(either domestic or export) and the depth from which the oil and gas is produced (shallow depths are defined as below 5,000 metres, while deep depths are defined as deeper than 5,000 metres). There is also an adjustment factor to the royalties that accounts for increased realised pricing.
Table 4: Ukraine Subsoil Rents - (Amounts in Hryvnia - UAH)
Source: Ukraine Ministry of Energy and Coal
Rates Applicable to Domestic Households
Gas - Cont. Shelf or Maritime Zone UAH 11.85/1,000m 3 $0.04/MCF
Gas - Shallow Domestic UAH 59.25/1,000m 3 $0.21/MCF
Gas - Deep Domestic UAH 47.40 / 1,000m 3 $0.17/MCF
Natural Gas Basic Royalty
Gas - Shallow Export UAH 237.00 / 1,000m 3 $0.83/MCF
Gas - Deep Export UAH 118.50 / 1,000m 3 $0.42/MCF
Crude Oil and Natural Gas Condensates
Oil - Deep UAH 792.54/t $42.10/bbl
Oil - Shallow UAH 2,141.86/t $15.60/bbl
Category Tariff Equivalent
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Underlying inflation for the first five months of 2012 equated to 0.3%;
in annual terms slowing to 4.2% from 4.7% in April 2012. In February 2012, the inflation rate fell to its lowest level since 2003, driven by declining food prices. The Ukraine Government is targeting 2012 inflation of less than 7.9%, as economic growth has slowed in comparison to 2011. Factors that have contributed to the slowing of inflation include lower consumer demand (and a simultaneous increase in individual bank deposits) and, according to the National Bank of
Ukraine, a strengthening in the Hryvnia. The European Bank for Reconstruction and Development (EBRD) forecasts GDP growth in Ukraine over 2013 to reach 4% compared to
2.5% in 2012. This growth is the second highest in Central and Eastern Europe, with only a prognosis for Moldova being higher (at 4.5%).
Overall, the EBRD predicts Ukraine’s economic growth to be higher than that of the European Union, based on the World Bank’s expectation that the Eurozone and other developed economies grow by 2.1% in 2012 (1.9% less than predicted for Ukraine). The EBRD has also noted that further development of the Ukrainian economy.
4.1 Credit Rating Implications In March 2012, Standard & Poors (S&P) lowered its outlook for Ukraine from stable to negative, but reaffirmed its sovereign ratings at B+. The lowered outlook reflects “ongoing uncertainty about the Ukraine
government's negotiations with the IMF and Gazprom is increasing refinancing risks”.
The negative outlook provided by S&P reflects its view that there are increased risks regarding Ukraine's significant fiscal and external refinancing needs; in particular the Ukraine Government’s reluctance to decide on austerity measures to reduce the budget deficit (to a
targeted 1.8% of GDP) and risks that talks with Gazprom might not result in lower energy prices. In addition, S&P pointed to Ukraine’s unwillingness to make further structural improvements to public finances. Prior to S&P downgrading the outlook, Ukraine asked the International Monetary Fund (IMF) to delay US$3 billion worth of bailout repayments by 10 years. However,
IMF have stated that there is no mechanism to restructure or reschedule payments and have instead suggested that the Ukraine Government take steps to unblock a US$15.6 billion loan that was frozen in 2011 due to the Ukraine Government’s refusal to implement unpopular austerity measures, such as raising residential gas and
heating prices.
The Ukraine President, Viktor Yanukovych, is aiming to secure a discount on supplies of Russian natural gas to avoid raising gas prices ahead of parliamentary elections due in October 2012. The Ukrainian economy as a whole has around US$50 billion in external debt due to be refinanced during 2012 and failure to restructure these
loans as well as the IMF loan, will put pressure on the Ukraine Hryvna, as the National Bank of Ukraine is likely to run out of reserves to support the Hryvna.
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DIRECTOR BACKGROUND
Gordon Sklenka Non Executive Chairman
Interest in AVD:
10.93m ordinary shares
Listed Options 10.2m @ 3.0c exp 31/8/2012
Mr Sklenka has over 15 years experience in corporate finance in the areas of capital raisings, IPOs, acquisitions and project finance in the resources and technology sectors. He has worked with a number of listed public companies in both Australia and Canada and developed extensive experience in company formation, capital raising and project acquisition. He is on the board of AXG Mining Ltd, Tribune Resources NL and Rand Mining NL.
Anthony Short Managing Director
Interest in AVD:
25.79m ordinary shares
Listed Options 24.1m @ 3.0c exp 31/8/2012
Mr Short has over 19 years experience in the administration and management of listed public companies, particularly in the oil and gas sector. He has extensive experience at board level in the management and formation of public companies in gold mining, drilling and oil and gas in the US. He has been Chairman, CFO and Managing Director in a number of listed public companies and corporate advisor on a number of public company listings. He is a director of Padang Resources Ltd and Odin Energy Ltd.
Kip Plankinton Non Executive Director Interest in AVD: NIL
Mr Plankinton, appointed a Director of Advance Energy Ltd in April 2009, is an oil and gas attorney with over 20 years experience in the oil and gas industry. He focuses on energy and natural resource matters with an emphasis on international and domestic oil and gas acquisitions and divestments, oil and gas operational and
regulatory issues, oil and gas royalty matters and administrative adjudication. Prior to establishing his own practice in 2006, he served as in-house legal counsel for ExxonMobil Colorado Interstate Gas Company, Texaco and Marathon Oil Company.
Advance Energy (AVD)
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DIRECTORY – ALPHA SECURITIES Corporate
George Karantzias
0401 670 620
Research Analyst
John Haddad
[email protected] 0407 219 222
Disclaimer This document has been prepared (in Australia) by Alpha Securities Pty Ltd ABN 94 073 633 664
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