OIL AND GAS SERVICES IN UKRAINE

31 JANUARY 2000

SOURCE: US EMBASSY KIEV

INTERNATIONAL COPYRIGHT

U.S. & FOREIGN COMMERCIAL SERVICE AND U.S. DEPARTMENT OF STATE 2000

Note:1.Subject ISA concerns the products of the following Harmonized System codes: HS 2705, 2706, 2707, 2709, 2710, and 2711.

2. Facts and figures are accurate as of January 1, 2000.

A. SUMMARY

There are three petroliferous areas in Ukraine. They are located in the west (the Carpathian region), in the east (the Dnipro-Donetsk region), and in

the south (the Black Sea and the Crimea region). Ukraine’s carbon resources are estimated at 7-8 billion tons of fuel equivalent. There are 8,000 potentially profitable oil and gas fields in Ukraine. More than 300 oil and gas fields have been developed with significant outputs. The number of operational extraction wells exceeds 4,400 units.

Oil and gas make up 63 percent of the primary fuel consumption in Ukraine. According to Naftogaz of Ukraine national company, the country ranks sixth in the world in natural gas consumption, and third in natural gas imports after the USA and Germany. According to Naftogaz of Ukraine, Ukraine spends nearly US$ 5 billion on imported natural gas annually. Crude oil and natural gas are imported primarily from Russia, or through Russia from Turkmenistan (natural gas) and Kazakhstan (crude oil.)

Domestic extraction covers 21 to 24 percent of the demand for natural gas and 10 to 12 percent of the demand for crude oil in Ukraine. Average annual oil and gas production amounts to 18 billion cubic meters of natural gas and 4 million tons of crude oil, figures that have remained unchanged since 1997. This is a sharp decrease from the 65 billion cubic meters of gas and 14 million tons of oil produced in 1975. Primary fuel consumption decreased between 1991-1998. In 1991 gas consumption was 119 billion cubic meters; annual natural gas consumption fell to 75 billion cubic meters in 1998. The primary reason for the decrease was not an increase in energy efficiency, but a decline in industrial consumption due to numerous shutdowns of Ukrainian enterprises.

The Ukrainian oil and gas industry is sub-divided into specialized firms: crude oil and natural gas producers, natural gas and crude oil/petroleum transport companies, and refineries and retail traders. The first two categories are under state control and completely monopolized. Oil refineries have been actively undergoing privatization in 1999. Some of them, like Odessa or Naftokhimik Prykarpattia, are currently controlled by private shareholders. Only petroleum trading, both wholesale and retail, is a free self-regulating market. There are over 250 state and private companies working in the oil and gas market of Ukraine.

Naftogaz of Ukraine (Naftogaz), a national holding company, and its subsidiaries control oil and gas transportation through the pipelines. Naftogaz controls the domestic natural gas and crude oil extraction industry, and over 60% of the gas trading market. Naftogaz and its subsidiary, Ukrgazvydobuvannya, and subordinate companies Ukrnafta and Chornomornaftogaz, produce 97% of domestic natural gas. Ukrnafta, a 50% state-owned company managed by Naftogaz, is the largest oil producer in Ukraine (94% of domestic oil production.) Naftogaz owns all oil and gas transportation and distribution systems, and most of the oil and gas storage facilities in Ukraine. It owns the main oil and gas pipelines and facilities, the main oil and gas storage facilities, and means of transport. According to current Ukrainian legislation, these facilities are not available for privatization; however, in the future portions of Naftogaz are intended to be privatized.

Ukraine has approximately 35,000 kilometers of gas pipelines. Some 290 billion cubic meters of gas are transported annually through Ukraine. Naftogaz owns all Ukrainian gas transportation system, and is reported to be the largest gas transporter in the world. Capacity for the system is 290 billion cubic meters; output capacity (to South Russia, Belarus, Moldova, Romania, Hungary, Slovakia, and Poland) is approximately 170 billion cubic meters annually. Naftogaz moves Russian gas through its pipelines to numerous countries of Western, Central and Eastern Europe. Naftogaz also operates underground gas storage tanks with a total capacity of 32 billion cubic meters.

Ukraine has two main oil pipelines, Druzhba and Prydniprovsky Main Pipelines, which transport about 68 million tons of crude oil annually. Six major Ukrainian oil refineries (Ukrtatnafta/Kremenchuk, Galychyna/Drohobych, Lysychansk, Odessa, Kherson, and Naftokhimik Prykarpattia/Nadvirna) have the capacity to process about 53 million tons of oil per year. Oil refineries experienced shortages of crude oil in the last few years. In 1998-1999 they were operating at only about 20-24% of their capacity.

Unlike oil refineries, Ukrainian gas processing plants (GPPs) are not independent entities. They are part of larger oil/gas producers (or their regional branches.) GPPs are not significant in the motor fuel market due to a low output capacity. Altogether Ukrainian GPPs and privately owned small gas processing units produce only about 1.2 million tons per year. GPPs are involved in the purification of light crude oil, processing of petroleum gas, and the production of LPG and some motor fuel.

The overall level of privatization in the oil and gas sector remains low. Privatization was more active in the oil extraction, oil refining and the retail trade industry during 1999:

a. 11% of the state-owned portion of Ukrnafta was sold through the exchange in December of 1999.

b. A 52% portion of the state-owned share in the Odessa oil refinery was sold in an investment tender the summer of 1999.

c. 44% of Ukrnaftoprodukt, a state holding company, was sold in an investment tender of December 1999:

d. 26-50% of the state-owned shares in some oil refineries were transferred to private companies for management during 1999.

Despite the level of state control, there are a number of successfully operating companies with foreign investments in oil and gas extraction. They are small foreign companies working in joint ventures or under joint agreements with Ukrnafta or with the enterprises subordinate to the Geology Committee of Ukraine. It is hoped that the recently adopted Law on Production Sharing Agreements would increase investments in oil and gas extraction.

The following large foreign companies are successfully working in oil refining and in the retail trade of petroleum products:

Russian Lukoil (Odessa oil refinery),

BP-Amoco (gas filling stations in Kiev),

Russian Tatarstan Tatneft (Ukrtatnafta: Kremenchuk oil refinery, gas filling stations in Poltava and Kiev regions),

Kazakhoil (Kherson refinery),

Mobil and Shell (motor oils and lubricants.)

Ukraine is having a more difficult time than its neighbors in attracting petroleum investments. It has never been a large oil and gas producer, and is perceived to have small to medium sized fields, which are expensive to locate and develop. Ukraine has not been attractive to major international petroleum companies. The country does warrant consideration in the oil and gas market for small and medium sized companies who develop smaller projects.

To implement market oriented oil and gas policies and attract foreign investments, during 1998-1999 new legislation was enacted (the Law on Concessions and the Law on Production Sharing Agreements). Government administrative institutions were reformed, licensing and tax policies were liberalized, and a series of oil and gas field development projects were offered for implementation.

There are opportunities for investment in the development of older oil/gas fields; in crude oil, natural gas and coal bed methane exploration; in the manufacturing and distribution of petroleum products; and in the exploration, processing and distribution chains. The cornerstone of successful oil enterprises – integrated up- and downstream operations - are not present in Ukraine. This would provide an opportunity for international oil corporations to establish control over a share of the national market. State Property Fund prices for shares in the oil refining plants are untenable, as are prices for regional gas distributors (regional "naftoproducts").

The best prospects are:

1. Fuels and lubricants

2. Pipeline construction equipment

3. Oil and gas drilling machinery and technologies

4. Equipment for atmospheric-vacuum oil refining

5. Cracking units, distillation units

6. Industrial automation, control and monitoring systems for refineries, gas processing and petrochemical plants

7. Desulfurization and quality control facilities

8. Safety systems

9. Fuel storage and dispenser systems

10. Fuel level monitoring and accounting systems.

B. MARKET HIGHLIGHTS:

Naftogaz of Ukraine state monopoly

Since 1998 the oil and gas sector of Ukraine has undergone restructuring. The new company Naftogaz of Ukraine (Naftogaz) was created in early 1998 to control and manage all government-owned shares of oil and gas companies. It is the largest company in the Ukrainian oil and gas sector. Although Naftogaz was declared a state joint-stock company, it is in fact a state holding firm. This company has secured state-owned shares in such giants of the oil and gas industry as Ukrgazprom (gas exploration), Ukrgaz (distribution of gas to end-users), Ukrnafta (crude oil exploration), and other companies. Naftogaz was created to increase the effectiveness of oil and gas management, and to control the privatization of oil and gas industry. A declared goal was also to concentrate financial resources to carry out investment projects and to establish links between company holdings. According to Cabinet of Ministers Decree #1173, “On the Separation of Functions of Production, Transportation and Sale of Gas,” dated July 24, 1998, Ukrgaz and Ukrgazprom were liquidated, and three subsidiaries of Naftogaz were created to separately handle the three subsections in the gas industry:

Ukrgazvydobuvannya - gas extraction and production,

Ukrtransgaz - gas transportation and storage,

Trading House Gaz Ukrainy - gas trading.

Naftogaz is a vertically integrated company that performs the following functions: oil and gas exploration and production (Ukrgazvydobuvannya, Ukrnafta, Chornomornaftogaz), gas transportation and storage (Ukrtransgaz), gas trading (Trade House Gaz of Ukraine), oil transportation (Druzhba Pipeline Company, Prydniprovsky Main Pipeline Company), oil refining (Azmol), and liquefied petroleum gas (LPG) transportation (Ukrspetstransgaz.)

Oil and gas exploration and production

Ukrgazvydobuvannya (a subsidiary of Naftogaz) is a significant natural gas extraction and production company. It is responsible for the annual natural gas production of 74.4% of the Ukrainian total. It includes five regional branches (Ukrburgaz, Poltava-, Shebelinka-, Kharkiv- and L’viv-gazvydobuvannia). Within Shebelinkagazvydobuvannia there is the Shebelinka gas processing plant, producing high-octane gasoline (A-95, A-98) and LPG; within Poltavagazvydobuvannia – the Yablunivsky GPP, mostly producing LPG.

Ukrnafta, an open joint-stock company (Naftogaz holds 50% plus one share), is the largest and the most profitable Ukrainian oil extraction company, with annual profits in 1998 reported at UAH 64 million (about US$ 18.3 million.) In 1998 Ukrnafta produced an estimated 94% of Ukraine's crude oil and 18% of its natural gas. The company extracts oil in two areas: western, which covers three regions (Lviv, Ivano-Frankivsk, and Chernivtsi), and eastern, covering five regions (Sumy, Chernihiv, Poltava, Kharkiv, and Dnipropetrovsk). The exploitation stock of the company includes 100 hydrocarbon deposits, 2,180 oil wells and 237 gas wells. It supplies crude oil to four of Ukraine's six refineries: Ukrtatnafta in Kremenchuk, Kherson oil refinery, Halychyna in Drohobych, and Naftokhimik Prykarpattia in Nadvirna. Ukrnafta includes six oil and gas extraction regional departments, six exploration and drilling departments, and three gas processing plants (Kachanivsky, Dolynsky and Gnidyntsivsky) producing LPG and gasoline. Ukrnafta participates in the joint ventures Ukrkarpatoil (with Carpatsky Petroleum, U.S.); Ukrainian-Canadian joint ventures Kashtan Petroleum Ltd. and Boryslavska Naftova Company; and Ukrainian-Ireland JV Romgas. Ukrnafta has joint activity agreements with other western companies. Joint venture agreements are in the oil and gas exploration and the construction of gas processing facilities. According to Ukrnafta, total foreign investments in existing joint ventures and under joint activity agreements as of January 1, 1999 amounted to $12 million. As of January 1, 2000, company shares were distributed in the following manner: 50% plus one share state-owned (managed by Naftogaz), 10.96% owned by Privatbank (Ukrainian private bank); about 8.6% employee owned, and about 30.44% owned by private investors.

Chornomornaftogaz joint stock Company (Naftogaz holds 100% of its shares) deals with oil and gas exploration and production in the Black and Azov Sea shelves. The company has its own gas pipeline over 1,000 kilometers long, 38 gas distribution stations and two compressor stations. In 1998, Chornomornaftogaz produced 800 million cubic meters of gas (4.4% of the total produced in Ukraine) and 80,000 tons of oil and petroleum gas (2.5% of total.)

Transportation, distribution and storage of natural gas

Naftogaz of Ukraine, through its subsidiary Ukrtransgaz and subordinate companies Chornomornaftogaz and Ukrnafta, owns and operates the gas transport system in Ukraine, which is still a state possession by current Ukrainian legislation. In 1998, Shell International Gas Ltd. (US - UK) evaluated the Ukrainian gas transport system. Foreign companies have concession agreements with Naftogaz of Ukraine to manage parts of the gas transport system. However, detailed information has not been disclosed, as this is considered commercially sensitive. After the Law on Concessions was enacted in the summer of 1999, the entire Ukrainian gas transport system might be offered for management under a concession agreement to an experienced foreign pipeline operator. Shell, Enron (US-UK) and other foreign companies were interested in managing the gas transport system.

Ukrtransgaz, a Naftogaz' subsidiary company, is the major transporter of natural gas throughout Ukraine, and the sole transporter of Russian gas through Ukraine to European markets through the gas pipeline system. Ukrtransgaz operates a high pressure gas pipelines with a total length of 34,000 kilometers and an annual capacity of 170 billion cubic meters of gas. Ukrtransgaz has:

1. 122 compressor stations with 786 gas pumping units;

2. 12 underground gas storage tanks with a combined capacity of 30 billion cubic meters;

3. 1,329 gas distribution and 60 gas measuring stations;

4. Low pressure gas distribution lines with a total length of 215,000 kilometers and 22,000 gas distribution points.

The company has six regional branches: in Kharkiv, Lviv, Prykarpattia, Donbas, Cherkasy, and Kiev regions. Of the 786 gas pumping units currently in operation at the Ukrtransgaz's compressor stations, 30% have been in operation for 11-15 years, 20% for 16-20 years, and 5% for over 20 years. The efficiency of the operating gas pumping units is below 28%; the 27 domestically produced units installed in the last five years do not exceed 36%.

Currently, there are 53 regional gas distribution companies operating in Ukraine; the state (through Naftogaz) retains controlling interest in 19 of them (source - Energobusiness.)

Natural gas: sources of supply. Trading of natural gas

Ukraine's total annual demand for natural gas in 1996-99 was 86-74 billion cubic meters. Domestic extraction accounts for about 21-24% of the total demand, and stands at about 18 billion cu m of gas per year. For the year 2000, total demand for natural gas is expected to be 73-74 billion cu m. To cover the difference, Ukraine will have to import at least 55-56 billion cu m of gas.

Supply and distribution of natural gas in Ukraine in 1997-99, billion cu m:

Indices	1997	1998	1999
Supply for Ukraine, including:	89.1	79.5	*86.3*
Domestically extracted	18.1	18.0	18.2
Imported into Ukraine,	62.4	53.5	67.5
From Turkmenistan	13.0	-	12.5
From Itera International Energy	-	21.5	-
From Gasprom	49.4	32.0	55.0
Pumped from underground storage facilities	8.6	8.0	0.6

Distribution, including:	89.1	79.5	86.3
Pumped into underground storage facilities	5.5	3.9	8.0
Ukraine's total demand, including:	81.3	75.5	73.6
Industrial consumers	45.3	34.9	33.2
Municipal services	28.6	33.0	32.9
Technical needs	7.4	7.6	7.5
Exported	2.3	0.1	4.7

(Source: Fuel + Power Magazine, December 6-12, 1999)

Diversification of the fuel supply has been under discussion in Ukraine since the country became independent in 1991, but little has changed. Ukraine is 90% dependent on Russian and Kazakh oil, and 80% dependent on Russian and Turkmen gas supplies. Both Kazakh oil and Turkmen gas are transported through Russia, which reflects on the final price for Ukraine. The price for natural gas for Ukraine was high also due to necessity for Ukraine to engage barter trade in payment for gas. In 1998-99, Ukraine was buying Russian gas at $80 per 1,000 cu m, Turkmen gas at $72 per 1,000 cu m, while Russian Gasprom was selling it at $30 to Belorus and at no more than $56 to European countries. Ukraine lacked political will, nor did expression of commercial interest motivate Ukrainian financial groups who control fuel distribution to let multiple sources of fuel supply into the market of Ukraine. Lack of internal financing, due to low cash collections from final consumers was given as the reason why nothing was done. Another obstacle in solving the problem is that Ukraine owes huge debts to Russia and Turkmenistan for gas supplied in the last few years.

The present Ukrainian natural gas supply consists of gas imported from Russia and Turkmenistan (Russian Gasprom, Itera International Energy Company with US-Russian investment) and domestically extracted gas. Gasprom supplies roughly 30 billion cu m of gas per year to the Trading House Gas Ukrainy/Naftogas of Ukraine as Russian payment/toll for transporting its gas through Ukraine. About 19-25 billion cu. ms are supplied annually on a commercial basis to Naftogaz of Ukraine and to private Ukrainian companies. Itera transports Russian and Turkmen gas to the Ukrainian border; for its transportation services, Itera is paid in gas, some of which the company sells to Trading House Gas Ukrainy/Naftogas of Ukraine or to private companies (consumers or independent gas traders.) Domestic producers of natural gas are either selling to consumers directly, or selling at gas auctions for cash. The Trading House Gas Ukrainy also sells gas at the gas auctions. According to the Cabinet of Minister's resolution #2184 "On the terms of natural gas supply to the economy and populace in 2000", the needs of the state budget-financed organizations and the populace of Ukraine is to be covered entirely by gas purchased directly from Trading House Gas Ukrainy/Naftogas of Ukraine -- the gas that Naftogaz receives in payment for transiting Russian gas through Ukraine. All other groups of consumers, including municipal heat supply companies and boilers for industrial enterprises, who supply heat to the above-mentioned consumers, should purchase gas either at gas auctions or from gas suppliers (domestic producers or independent gas traders) under direct contracts.

Gas auctions were introduced to Ukraine in 1998 to improve cash payments for gas. In recent years barter operations in the Ukrainian commodity markets were high - in 1998 they averaged 40%; in the fuel trade in 1999 barter accounted for 37.2% of the sales (source - Ministry of Statistics.) The purpose of gas auctions was to decrease barter trade by selling for cash, and to improve cash payments for gas. Domestically extracted gas or gas purchased from abroad (except received as payment for the transit of Russian gas) is sold through gas auctions. The amount actually sold at auction for cash was usually much less than the total offered -- about 2% in 1998, and 18% in 1999 of the total gas offered on auctions. In 1999, the auction price (not including VAT and transportation cost) for gas was $30-32 per 1,000 cu m. Industrial enterprises were able to buy gas from gas traders for $20-22 per 1,000 cu m; Naftogaz of Ukraine was selling gas to heat supply firms for about 230 UAH (about $42) per 1,000 cu m (source - Business Newspaper, #50, 12/13/99.)

Independent gas traders are divided into two categories: domestic producers, and wholesale gas traders who buy gas either at gas auctions, or under direct contracts with Itera or Naftogas of Ukraine for resale directly to consumers. In 1998 fifty gas traders were registered in Ukraine (source - Ukrainian News Agency, Business Week'22, May 31-June 6, 99.) In 1999 there were over 200 gas traders operating in the Ukrainian gas market (source - Business Newpaper #50, 12/13/99.)

Independent gas traders account for 73% of the total gas consumption (see the chart below.) Gas traders sign agreements with gas transportation companies (with Naftogaz of Ukraine, including Ukrnafta and Chornomornaftogaz and with Kievgaz) on using their gas transportation system. Gas traders are to pay Naftogaz of Ukraine a security deposit in cash or in natural gas equivalent to 10% of its quarterly supply.

Fuel consumption in 1998, by industry/category:

	Consumed Total	Consumed by industries/consumer categories, %
	Consumed Total	Industry	Agriculture	Construction	Transport	Municipal services	Other, incl. populace and SBF entities *
Natural gas	71.1 billion cu m	53.9	0.7	0.3	6.4	11.6	27.1
Oil and petrol. Gas	13.7 mln t	99.0	0	0.1	0	0	0.9
Gasoline	3.2 mln t	14.7	27.8	5.1	11.1	2.6	38.7
Diesel fuel	5.8 mln t	27.6	42.3	5.0	15.6	1.2	8.3
Fuel oil	3.4 mln t	88.4	0.6	1.2	4.1	4.2	1.5
LPG	0.3 mln t	2.9	0.7	0.4	3.5	14.3	78.2

* SBF - state budget-funded

(Source - Ministry of Statistics)

Crude oil: Sources of supply. Transportation and storage of crude oil

Druzhba and Prydniprovsky pipelines are the major transporters of crude oil coming from Russia and Kazakhstan. They currently transport 68 thousand tons of crude oil per year, operating at about 60% capacity. Druzhba Pipeline State joint-stock company (Naftogaz is 100% owner) operates the pipeline, which extends from Mozyr in Western Ukraine to the Slovak and Hungarian borders, and is over 1,500 kilometers long. The company is a transshipper for Russian oil to Central Europe, and transports crude oil to the Halychyna (in Drohobych) and Naftokhimik Prykarpattia (in Nadvirna) oil refineries. The company has 8 oil pumping stations and 16 storage tanks, with a total storage capacity of 140,000 cubic meters. Prydniprovsky Main Pipeline state joint-stock company (Naftogaz owns 100% of the shares) operates the following facilities: 9 connected pipelines running through 11 regions of the south, central and eastern Ukraine, with a total length of 2,400 kilometers and an annual capacity of 104.4 million tons. Their facilities include 18 oil-pumping stations, 36 storage tanks of 580,000 cubic meters total capacity and 8 gas distribution stations. The company delivers crude oil to four of the six Ukrainian refineries (in Kremenchuk, Odessa, Lysychansk and Kherson), and transships a significant part of Russian crude through the Odessa seaport.

The situation with oil supplies diversification might be considered somewhat better than with gas supplies. Construction of an Odessa-Brody pipeline and Yuzhny oil terminal (near Odessa) that would enable Ukraine to receive Caspian crude oil, bypassing Russia, is currently underway. Reportedly, as of December 28, 1999, the pipeline was 72% complete, and the terminal was 20% complete. Pipeline construction is continuing, although construction of the terminal has been suspended since February 1999 due to lack of state budget financing. The pipeline will connect Odessa terminal and Yuzhny (near Odessa) terminal capacities in southern Ukraine, with the Druzhba pipeline system in the northwest. Four of the six Ukrainian refineries would be connected en-route to the pipeline. As of today, Druzhba Pipeline State Company is the general contractor and the major investor for both projects.

Ukrainian oil supply currently comprises oil imported into Ukraine from Russia (Yukos, Lukoil, Tatneft), and Kazakhstan (Kazakhoil), as well as some crude oil produced domestically (Ukrnafta.) There are two major groups of companies working in oil supply: importers and traders. Importers purchase crude oil from producers (Yukos, Lukoil, Tatneft, Kazakhoil, and Ukrnafta) and transport it to local refineries through Transneft’s Russian oil pipeline network, and then through the Prydniprovsky or Druzhba pipelines in Ukraine. Major importers are Espro, Interlink, ACS SA, Victoria-A, Atlantic, Vimet, Landesco, Seagroup, Carbico, and Shelton. Traders purchase crude oil at the refinery gate from the importing companies. The major traders are Ukrtatnafta, Slavutych, Sodruzhestvo, Dobrobut, Olgroup/Ukreximnaftoproduct, and Alpha-Nafta.

Crude oil and natural gas transportation through Ukrainian pipelines:

1996

1997

1998

1999

Natural gas: total, billion cu m

174

165

169

No data

-Incl. for export

No data

108

114

124

Crude oil: total, million t

No data

(Source: Ministry of Statistics, Business Newspaper #50 of 12/13/99)

The Odessa oil terminal, which has an annual capacity of 20 million tons of crude oil, accounts for most of the crude oil and petroleum products transshipped in Ukraine. Currently the Odessa oil terminal is operating at about 20% of its capacity (source - Ukrainian News Agency, Business Week'20, 5/17-23, 99.)

Oil refining and gas processing

Ukraine’s refining sector is one of the largest in Europe. Six Ukrainian refineries have total processing capacity of 53 million tons per year. It was created to serve the most industrialised and populated Republic of the former Soviet Union, Ukraine, mainly with low-quality fuel oil that was used for power generation. Light products were traditionally imported into Ukraine from other countries of the former Soviet Union. Quality of products had never been the subject of Soviet management’s concern. It was really poor at all refineries except Lysychansk, the largest and most modern plant at that time. Even now, none of Ukraine’s oil refineries manufactures A-98. At the same time, slow modernization progress and large debts are not failures of the refineries themselves. Governmental macroeconomic policies in 1992-1994 led to hyperinflation, which ate circulation capital. Full state control over refineries at that time prevented plants from waiting through inflation with stocks of fuel: refineries were forced to sell or rather "provide" oil products on credit by administrative directives. When such credits were returned they usually made up 10-20% of initial product value in hard currency equivalent.

Having lost their own money, refineries had to switch to processing deals with private crude providers. Simultaneous decline of crude production in Russia and widening export opportunities in the Western markets limited the quantity of oil that was available for processing in Ukraine. As a result, processing fees collected by refiners proved insufficient for modernization and even return of old debts. For example the LINOS refinery still can not settle a $100 million German loan used for construction of polypropylene plant because the output of this plant is about 10,000 per annum instead of the planned 100,000.

Moreover, external suppliers to refineries are discouraged by the taxation regime, which treats direct products imported from foreign manufacturers and processing deals with Ukraine’s refineries similarly. As a result, oil refineries (except Ukrtatnafta/Kremenchuk and Naftokhimik Prykarpattia/Nadvirna) have no financing to purchase crude themselves, while the volume of private supplies falls every year. The only realistic solution for the rehabilitation of Ukrainian refining sector is rapid privatization. Some successful sales of state-owned shares were made in 1999.

Kremenchuk Oil Refinery/Ukrtatnafta

Facilities/Process

Capacity, million tons per year

Exploitation since

Total capacity

18.6

1966

Atmospheric vacuum towers

9.3

1966-76

Catalytic reforming of gasoline

1.9

1967

Synthetic acid production

0.3

1974

Catalytic cracking

1.48

1970

Diesel and kerosene hydrofiner

1971

Gas-fractionating

0.8

1969

Oil bitumen production

0.3

1967

Paraffin production

0.02

1978

Lube oil plants complex

0.36

1973

Sulfur production

0.06

1977

Ukrtatnafta is a joint venture between Ukraine’s Kremenchuk refinery (43%) and several Russia’s entities including Tatneft producer, Tatnefteprom and others who own another 57% of the joint venture. Ukrtatnafta refinery enjoyed cash and crude injections on part of Russian partner Tatneft that helped to pay off debts. Ukrtatnafta purchases itself about 80% of all crude it processes, while associated companies (Dobrobut/Sigma and other) supply the rest through processing deals. As the largest of Ukraine’s refineries (35% of national refining capacity), Ukrtatnafta accounted for about 45% of national crude throughput in 1998, and its capacity usage is above average – about 33%. The technology of refinery is comparatively progressive – no leaded gasoline and mostly low-sulfur diesel, despite a significant share of high-sulfur crude from Tatarstan. Having reliable financial backing, Ukrtatnafta is expanding its wholesale presence by aggressive (sometimes, by dumping) marketing policy. Low-octane gasoline (unleaded A-76) and diesel fuel are successfully competing against imported (mostly Russian) fuel in all segments of the solvent market, including retail trading. Ukrtatnafta is developing its own retail network. It has a number of modern gas filling stations in Kremenchuk, Poltava and Kiev.

Producers and other crude owners do not play a significant role in crude supply to Ukrtatnafta. Purchase policy is directed by the refinery’s management and implemented through two dozen affiliated traders, which act as the importers of record. Crude processing fees at Ukrtatnafta vary from 19-21% of the product.

Lysychansk Oil Refinery (LINOS)

Facilities/Process

Capacity, million tons per year

Exploitation since

Total capacity

16.0

1976

Atmospheric vacuum towers

7.5

1979-83

Catalytic reforming of gasoline

2.0

1980-86

Catalytic cracking

2.0

1994

Diesel and kerosene hydrofiner

4.0

1981-87

Ethylene production

0.32

1976

Polyethylene production

0.1

1994

Sulfur production

0.06

1983-84

Hydrogen production

0.02

1994

Linos refinery was Ukraine’s largest (23.5 million tons) till 1994 when one of the three atmospheric vacuum towers badly damaged by corrosion stopped, and refinery's production fell to 16 million tons.

Just before the break up of the USSR, Linos received an ECU 70 million ($100 million) loan from West LB for construction of the polyethylene plant. When the plant construction was completed in 1995, the refinery’s production collapsed to 2.2 million tones -- insufficient for operating a new plant at full capacity. The loan for construction was to be repaid from the polypropylene exports but output became insufficient. Returning West LB’s loan has become a permanent headache for the refinery. In addition, the government’s decision to confiscate a quantity of product in 1992-1993 created refinery’s debts to owners that are now estimated at another $60 million. A June 1998 court ruling declared Linos bankrupt and since then, supplies to the refinery have virtually stopped. Crude owners fear that the refinery can be "sealed" by court officials at any time and their crude and products may be left in the arrested equipment.

At the same time, the government taking into consideration several unsuccessful privatization attempts, is considering retaining the refinery under state control -- at least till the debts are paid off. Although, it would definitely benefit the refinery if a private entity buys it, and its massive (in Ukrainian terms) debts are eliminated. Fuel produced by the Linos refinery is considered quality, though sulfur remains high. After renovation Linos could emerge as serious competitor to Ukrtatnafta in the low-octane gasoline and gas oil markets. Traditional crude suppliers are Runo, Rosukrnaftoproduct, Ukreximnaftoproduct and Lukoil. Unlike other refineries, Linos operates exclusively on the give-and-take/tolling basis. It was built to supply agricultural regions of southern Ukraine and Russia, and could remain a most cost-efficient option until the construction of a new refinery in southern Russia. In this context is has market potential after privatization.

Kherson Refinery

Facilities/Process

Capacity, million tons per year

Exploitation since

Total capacity

8.6

Atmospheric vacuum towers

6.9

1951

Catalytic reforming of gasoline

0.7

1973

Coke production

0.6

1947

(reconstruction 1980)

Bitumen production

0.4

1956-81

The Kherson refinery is Ukraine’s least developed – it can only manufacture A-76 unleaded gasoline and gas oil. Construction of a 2 million-ton hydro-treating unit worth $70 million, is planned to improve the quality of the gas oil, but financing is lacking. In 1997 the refinery achieved relatively good results – its production was one of Ukraine’s highest – thanks to Kazakh crude. In 1998 Kazakh supplies were limited and production was low. Sodruzhestvo concern, partially owned by Lukoil, retains 12.4% of the refinery. Lukoil traditionally had strong presence at the refinery, which was reinforced by the creation of the Lukoil-Kherson affiliate: in the second half of 1998 LUKoil emerged as sole supplier to the Kherson refinery. The Kherson refinery is located in the heart of the Ukraine agricultural south and constitutes an ideal location for goods-for-food barter. Kherson has a direct pipeline link to the neighboring Mykolayiv oil depot. It is believed that this terminal may be used for exporting gas oil – Kherson refinery’s production in 1998 – was a source for European refineries. In 1999 one of the major crude oil suppliers to the refinery was Kazakhoil. 50% plus one share of the state-owned stake in Kherson refinery was transferred to Kazakhoil for management in October of 1999 (taken back 1/24/2000 by the Cabinet of Ministers' resolution.)

Odessa Oil Refinery

Facilities/Process

Capacity, million tons per year

Exploitation since

Total capacity

3.8

1949

Atmospheric vacuum tower

1.2

1949-57

(reconstruction 1964-78)

Catalytic reforming of gasoline

0.4

1977

Secondary treatment of gasoline

0.5

1975

Diesel and kerosene hydrofiner

1.5

1994

Bitumen production

0.2

1985

Odessa refinery was upgraded and retooled by the Italian engineering company Ctip. After construction of the hydro-treating unit in the same upgrade, output of low-sulfur diesel dominated gas oil production. Gasoline production was well developed (in Ukrainian terms) as well. In 1998 output was over 50% – a significant achievement. The refinery’s location was ideal for the export of fuel oil to the Mediterranean market, and crude suppliers Yukos and Lukoil intensively used it -- over half of refinery’s production in 1998 was fuel oil. The refinery is clearly dependent on Yukos/Lukoil supplies. It charges $10-15 per ton processing fee. Refinery is 52% owned by Lukoil mutually with Syntez Oil, both Russian companies. It allows importing of crude, delivered by sea and exporting to the Mediterranean markets. It’s future in the short term is connected to gas oil and fuel oil exports to the European markets – and clearly under the control of Russian Lukoil. In the long run it may be re-oriented to meet Ukraine’s domestic market demand. Odessa refinery's shareholder Luk-Syntez Oil (Lukoil and Syntez Oil JV) has its own distribution network (gas filling stations) in the Odessa region.

Galychyna/Drohobych oil refinery

Facilities/Process

Capacity, million tons per year

Exploitation since

Total capacity

3.5

Atmospheric vacuum tower

2.6

1952-69

(reconstruction 1972-79)

Catalytic reforming of gasoline

0.3

1969

Thermal cracking

0.4

1951

Bitumen production

0.15

1955-61

Coke production

0.01

Paraffin Production

0.04

1955

(reconstruction 1965)

Galychina/Drohobych refinery is pursuing a $278 million modernization project financed by a loan from the Japanese Eximbank. The loan will be used for the purchase of technology and equipment from Nissho Iwai and JGK Corp., for modernization of the Galychyna refinery and for reconstruction of the catalytic reforming unit, enhancing refining to 75-80% and allowing production of A-95 gas. The Galychyna refinery claims after completion of the project (scheduled for 2002) its profits will increase four folds to $107 million per year. Experts note that calculations have been made for the full load of 3.5 million tons the refinery can maximize, but output has never exceeded 35% of capacity since 1993. The refinery has its own distribution network in Ukraine. 16% of the refinery’s output is exported to neighbouring countries including Moldova, Romania, Slovakia and Hungary. In 1998 Galychina processed crude oil mostly on tolling/give-and-take conditions. Give-and -take processing partners included Slavutych, Rosukrnaftoproduct and others. The processing fee was $17-18 per ton.

Naftokhimik Prykarpattia/Nadvirna oil refinery

Facilities/Process

Capacity, million tons per year

Exploitation since

Total capacity

2.5

Thermal cracking

0.5

1964

Raw material preparation facility

0.81

1994

Catalytic reforming of gasoline

0.6

1974-94

Paraffin production

0.2

1978

Coke production

0.37

1967

Synthetic acid production

0.02

1968

Naftokhimyk Prykarpattia's crude suppliers include Galnaftogaz, which extracts domestically. A new 650,000 tons catalytic reforming complex was finished and put into operation in 1994. Naftokhimyk faces competition from Slovakia’s Slovnaft,Hungary’s MOL and Mazheiku dealer Galnaftogaz. Its customers are regional agriculture and power generating utilities. Naftokhimik is Ukraine’s only refinery not connected to a crude oil pipeline, but it has petroleum pipelines running to neighboring depots. 44% ownership in the refinery is currently in private hands, including British company Wattford Petroleum that owns 16%; Wattford Petroleum manages another 30% that is owned by the State Investment Fund; 26% of the state-owned share has recently been transferred for management to the private Ukrainian company Alfa-Nafta.

(Source of information for this chapter - UPECO)

Status of Privatization of Ukrainian Refineries

Share Allocation Plan and the Privatization Status of Ukrainian Oil Refineries (as of 01.01.99)

Oil Refinery Name

Statutory Fund (UAH)

Share Face Value, UAH

Share Allocation (planed/sold), %

Total Privatized, %

State Owner ship

Privileged stock (mostly owned by employees)

For sale on auctions

for

cash

For sale on non-commercial tenders

for cash

For sale on stock exchange

Lysychansknaftoorgsyntez (LINOS), in Lysychansk ****

9,887,421

0.01

26 /

****

10 /

19 /

41.409 /

****

3.6 /

3.6

32.6

Khersonnaftopererobka, in Kherson

6,582,600

0.05

10 /

24 /

5 /

56 /

5 /

Odessa Oil Refinery, in Odessa

2,201,960

0.01

25 /

8 /

15 /

51.9 /

51.9 *

0.1 /

0.1

75 *

Naftokhimik Prykarpattia, in Nadvirna

3,280,252

0.25

30 /

+++

11 /

30 /

26 /

+++

3 /

Halychyna Oil Refinery, in Drohobych

8,706,750

0.01

35 /

*****

10.5/

10.5

23.5/

23.5

30 /

30 **

1 /

Kremenchuk Oil Refinery, in Kremenchuk ***

18,274,821

0.10

43.05

56.95

(The official exchange rate as of January 1 was UAH 3.427 to USD 1)

* Sold to the Russian oil company, Lukoil on March 31, 1999 through an investment tender.

** Sold to Halychyna Economic Union, Ukrainian company consisting of refinery management and employees, through an investment tender.

*** 43.05 % in Kremenchuk Oil Refinery/Ukrtatnafta (upstream) is owned by State Property Fund; 28.78 % is owned by Tatarstan Committee on State Property Management; the rest 28.17 % is owned by private companies both Russian and Ukrainian.

**** Non-commercial privatization tenders for LINOS were held twice during 1998, both failed due to the company’s outstanding debts (about $200 million to crude suppliers and loan repayments to Westdeutsche Landesbank), and huge investment requirements. According to the Cabinet of Ministers resolution dated June 11, the state will retain 51% share in LINOS for five years. The stake of 16.4% would be offered as a non-commercial tender along with the right to manage the state-owned share and acquire a significant portion in the future.

***** Shelton JV (Canada-Ukraine) is managing a 25 % state-owned share in Halychyna Oil Refinery (it won the tender 10/99.) Prior to that, according to the Cabinet of Ministers resolution dated 7/13/99, "Naftogas of Ukraine" managed the state-owned share.

++ 50 % plus one share in Kherson Oil Refinery was transferred to Kazakhoil (Alliance Group/Russia-Kazakhstan) for management (CabMin resolution #1050 of 10/7/99.) The Cabinet of Ministers cancelled this decision later in January 2000 (CabMin resolution #48 of 01/24/2000.)

+++ 30 % state-owned (by State Investment Fund) share in Naftokhimik Prykarpattia is managed by Wattford Petroleum Ukraine Holding (Ukraine-UK); Wattford Petroleum owns 16 % share in the refinery, and currently controls over 59% of the refinery's stock (through management of 30 % state-owned share and through Wattford-Sentoza alliance with other private shareholders.) 26 % (still state-owned but planned for privatization) in Naftokhimik Prykarpattia was transferred for five-year management to Alpha-Nafta, Ukrainian oil operator company (CabMin resolution #1204 of 11/4/99.)

Gas Processing Plants

The five major Ukrainian gas-processing plants (GPP) can not really affect the Ukrainian gas market, due to low processing capacity. At the same time, GPPs are important players in their local markets. GPPs are specializing on crude preparation/purification (extraction of water and salt, and stabilization) and processing of petroleum gas. They producemostly LPG, stable gasoline, gasoline-free gas; Shebelinsky GPP and the low-capacity gas processing units also produce some fuel oil and diesel fuel. GPPs are smaller in terms of capacity and profits than oil refineries, and their policies are more flexible and client-oriented. Initial processing fees for a new client could amount to between $11 and $20 (similar to processing fees charged by oil refineries) but long-term partners receive more favourable terms – discounted processing fees for partners may be as low as $8-10 per ton. Suppliers of crude to oil refineries and GPPs are also different, and rarely shift from one processing facility to another. Only Slavutych, Rosukrenergo and Ukrnaftoproduct sometime divert their oil reserves for processing at GPPs. At some point supplies to GPPs may become subject to competition between suppliers, due to savings in transportation costs. Three of the five operating GPPs in Ukraine are a part of Ukrnafta producer (Gnidyntsivsky, Kachanivsky and Dolynsky plants.) Their operations are inseparable from the parent company – they enhance profitability of the company’s oil and gas trading. Okhtyrkanaftogaz (a subsidiary of Ukrnafta that is seeking independence of the central authority) controls two of these GPPs in Gnidyntsi and Kachanivka. Two other GPPs, Shebelinsky and Yablunivsky (both owned by Naftogaz of Ukraine), have recently been constructed and have installed modern gas processing equipment, supplied by the U.S. companies, Basic Systems International Inc. and Chemdesign Inc. Also operating in the Ukrainian market is Seleschensky petroleum gas stabilizing unit (belonging to Poltavagazvydobuvannia / Naftogaz), and low-capacity processing units owned by the private companies (MTN closed joint-stock company, Grant-Oil Ltd.) and by petrochemical plants (Snezhanskhimmash plant, Zaporozhkoks plant.)

There is a number of lubricant manufacturing plants, including ventures with foreign investments. Ukrainian company Azmol (Naftogaz holds 100% of shares) is one of the largest. It produces more than 100 varieties of lubricants, and is exporting to Russia, Belarus, Germany, and Poland.

Distribution/trading of petroleum products

In December of 1999 the Concern Naftoproduct of Ukraine, the company with foreign investment (possibly Russian, and including the Alliance Group) acquired a 44.19% share in the JSHC Ukrnaftoproduct, one of the largest petroleum product distributors, with a 25% market share. 5.8% of the company shares will be offered to employees on preferential terms; a 50% plus one share of the company stock would remain with the GOU (JSHC Ukrnaftoprodukt is expected to be included on the list of "strategic companies" to remain state-controlled for the next several years.) Before 1991, Ukrnaftoprodukt was the exclusive supplier of petroleum products for Ukraine. By 1999 the company was no longer a monopoly on the Ukrainian petroleum market. It owned a substantial distribution network for oil products and lubricants in the east, south and center of Ukraine: 612 gas filling stations (one-third of all in Ukraine), 116 petroleum storage facilities (one-forth of the total in Ukraine.) JSHC Ukrnaftoprodukt owned 26-51% shares in 14 distribution companies (including 51% in seven of them) in 11 regions of Ukraine. Ukrnaftoproduct distributed in Kiev, Crimea, Vinnytsia, Kirovohrad, Luhansk, Mykolaiv, Kharkiv, Kherson, Khmelnytsk, Cherkassy, and Odessa regions, as well as in Lysychansk and Svitlovodsk. It had 51% in Eximnaftoprodukt of Odessa who handled 80% of all petroleum products shipped through Ukraine.

To overcome a fuel crisis in the summer of 1999, favorable legislation was passed to attract petroleum products into the market; this also encouraged traders' activity. By October of 1999 Russian Lukoil signed an agreement with Kiev City administration for construction of 10 gas filling stations (GFS) in Kiev; it owns a GFS network in Odessa and in Crimea. Ukrtatnafta (Ukrainian - Russian/Tatarstan investments) is expanding its gas filling stations network; new GFS opened in Kiev in 1999. BP-Amoco opened its first Kiev gas filling stations in 1999. Major petroleum traders are Slavutych, Sodruzhestvo, Shelton (Ukraine-Canada), Ukrtatnafta, Interagro, Ukrintertsukor, Ukrros, and Ukragrotekhservice. These companies are politically dependent, belonging to political-financial groups/clans (source - Transformation of Society Institute, EE 8/2/99.)

LPG Production and Trading

A promising market is LPG production and trading. About 26 million, or 50% of the country's population, utilize LPG. The populace in rural areas, uses as fuel in the households about 65% of total LPG consumed; another 30% is used as motor fuel for vehicles; and a low percentage is used for industrial needs. The rural households consumption is forecast to drop in a few years, as rural areas are supplied by natural gas through the gas pipeline distribution network. The motor fuel group is the most promising due to the low cost and ecological promise of LPG compared to gasoline or diesel fuel. There are now 86 LPG filling stations in Ukraine, and their number is forecast to grow to 430 by 2010 (source - Energobusiness.) Total demand for LPG in 1998-99 was about 260 thousand tons, of which 30% was imported, from Russia and the Baltic countries. Six Ukrainian refineries, five gas processing plants, and Seleschensky petroleum gas stabilizing unit produce LPG. Major producers are Gnidyntsevsky gas processing plant, Ukrtatnafta/Kremenchuk oil refinery, and Yablunivsky gas processing plant.

Ukrspetstransgaz JSC (Naftogaz owns 100% of shares) specializes in LPG railway transportation; the company operates over 2,000 railway tank cars. To transport LPG by railway, the companies sign contracts with Ukrzaliznytsia, the state railway transport company.

Tariff Policy

The state regulates tariffs for the transport of gas; wholesale and retail gas prices for the populace. Gas prices for industrial consumers are not regulated. For the populace, budget entities and municipal enterprises, the ceiling price for gas is established by the state. Until the end of 1998 the Ministry of Economy was regulating gas wholesale ceiling prices and transportation tariffs. Current wholesale ceiling price for gas (set by the Ministry of Economy effective January 1, 1999) is UAH 148 (approximately US$ 43.40) per 1,000 cubic meters for the populace, and UAH 231 (approximately US$ 67.50) per 1,000 cubic meters, including VAT, for state budget-financed organizations and municipal enterprises.

A President’s Decree of April 21, 1998 extended the functions of the National Electricity Regulatory Commission (NERC), giving it some additional authority. NERC has the authority to participate in regulating payment relations on the wholesale markets of oil, gas and oil products, and to determine the rules by which these markets operate. It can participate in the formation of the pricing policy for oil and gas sale, and tariffs on transportation and storage. A resolution of the Cabinet of Ministers dated November 30, 1998 authorized NERC to regulate prices and tariffs in the oil and gas sector in agreement with the Ministry of Economy. By this resolution, effective January 1, 1999, prices and tariffs regulated by NERC are the following:

a. Wholesale price ceilings for enterprises that sell their own domestically extracted gas;

b. Wholesale price ceilings for gas sold to the populace;

c. Municipal and domestic-service enterprises, and state

budget-financed organizations;

d. Tariffs for transportation of natural gas, crude oil, petroleum products, ammonia, and ethylene substances;

e. Gas storage tariffs;

f. Retail gas prices for the populace.

The current tariffs for transporting oil through the lines of the Prydniprovsky Pipeline system, for non-resident companies operating in Ukraine vary from $ 0.7 to $ 4.90 per ton, depending on the line: for Ukrainian resident companies' oil transportation tariffs vary between UAH 2.9 - 20.5 depending on the line (NERC resolution # 1044 of 8/12/99.) Tariffs for gas transportation depend on the gas transport company (Ukrtransgaz, Chornomornaftogaz, Ukrnafta, and Kyivgaz) and vary between UAH 9 - 42 (about $ 1.7 - $ 7.8) per 1,000 cu m (including VAT.)

Current oil transit tariff for transiting Russian oil through Druzhba Pipeline system is $5.2 per ton for the length of the route. Through the Velikotsk-Kremenchuk-Odessa section of the Prydniprovsky Pipeline (to Odessa seaport) - $ 4.9 per ton. Through the Velikotsk-Lysychansk-Luhansk section (to Novorossiysk seaport) - $2.35 per ton.

Gas storage license holders set their own tariffs for gas storage and pumping, within the rules set by NERC. Tariffs are to be approved by the NERC; license holder may apply to NERC to revise the tariff, but it has to give grounds for such a revision.

C. BEST PROSPECTS

Direct Export Opportunities

In the pre-break-up of the USSR times, Ukraine had an abundance of subsidized oil and gas from Russia. Today, Ukraine’s petroleum industry is underdeveloped, and it's equipment is outdated. There is almost no domestic manufacturing of oil and gas field machinery. Technology and equipment is years behind that of the United States. Ukraine does not have pumping equipment capable of producing below 6,000 feet, even though many of the fields are at depths of 10,000 to 15,000 feet. Stimulation technologies such as hydraulic fracturing and acid stimulation are not available. Three-D seismic has not been used on-shore, and drilling equipment is antiquated and limited to 15,000 feet. It takes three to five years to drill a well to 15,000 feet, and there is no domestic manufacturing of equipment for drilling deeper than this. Major reserves, developed and underdeveloped, are below 15,000 feet and impossible to exploit without outside financing and modern equipment. Drilling machinery has been imported mostly from Russia and Romania.

Ukraine has the second largest refinery capacity in the Newly Independent States (NIS), with a potential of about 60 million tons per year at six refineries. However, utilization is very low. About 60% of petroleum products consumed in Ukraine are imported. Most of the refineries date from before World War II, and are unsophisticated, with little modern technology to process crude oil into valuable light products such as gasoline, diesel fuel, aviation fuel, kerosene, and liquefied petroleum gas. Refined products yield (the ratio of light products to the total refined) in Ukrainian refineries constitutes only 57% on average, versus a desired 75%.

The Ukrainian government has made the development of the oil and gas sectors a top priorities. There are several planned projects that may offer potential sale of U.S. equipment and services:

1. Ukrainian refineries modernization;

2. Exploration of the Azov-Black Sea shelves;

3. Construction of the $150 million Yuzhny oil terminal (near Odessa);

4. Yuzhny-Brody pipeline (a transit route for Caspian oil through Ukraine to reach Eastern and Central Europe);

5. Rehabilitation of the 35,000 kilometers gas pipeline that delivers nearly 35% of Western Europe's natural gas.

The best prospects for U.S. companies include:

a. Crude oil and natural gas;

b. Petroleum products, particularly gasoline, diesel fuel, motor oils and lubricants;

c. Pipeline construction equipment; compressors and pumps for pipeline applications; gas transmission systems; gas pipeline leaks control systems;

d. Gas pipe fittings and applications; welding machines, cranes, pipe-cleaning equipment, and line tending machines;

e. Advanced and highly efficient oil and gas exploration and drilling equipment and technologies (pontoons supported on columns, hoisting cranes, drilling rigs, bits, electric motors, winch rollers, rotary tables, sheds, hoisting blocks, monkey boards, crown blocks, gin holes, shackles, cutting, roller and diamond bits, casing sleeves, chemicals, stimulation technologies, modern 3-D seismic, particularly for offshore projects where Ukrainian technology is very limited);

f. Equipment for atmospheric-vacuum oil refining; hydro- cracking and catalytic cracking units, distillation units; industrial automation, control and monitoring systems for refineries, gas processing and petrochemical plants; de- sulfurization and quality control facilities;

g. Safety systems;

h. Fuel dispensers, fuel storage tanks, fuel level monitoring and accounting systems.

Market Size Data for OGM (in $ Millions)

1997 1998 1999

A. Total Market Size 110.0 111.0 112.0

B. Total Local Production N/A N/A N/A

C. Total Exports N/A N/A N/A

D. Total Imports 47.0 44.0 46.0

E. Imports from the U.S. 8.0 11.0 10.0

(The above statistics are unofficial estimates.)

Investment Opportunities

There are numerous areas for investment in the oil and gas sector. Estimates indicate that Ukraine has 5 percent of the world’s mineral wealth. A study by the Geology Committee of Ukraine indicates that 94 kinds of mineral resources are available. The state budget lacks funding for the exploitation of these deposits. GOU is hoping that the recently adopted PSA law will attract strategic investors for the extraction of mineral resources in Ukraine.

Oil and gas extraction has the potential for expansion using up-to-date Western technologies (deep drilling, 3-D seismic, well-logging, reservoir characterization, directional drilling, etc.) to locate new traps or untapped zones, or to rejuvenate older fields. Already discovered, highly pressurized gas fields are beyond the capability of Ukrainians to develop. Naftogaz of Ukraine has come up with investment projects to recover old fields (Gutzulin gas field, Pylypiv and Dobleslav fields), and developing new oil and gas fields (Odessa shelf, Lokachiv gas field, Glino-Rozbyshiv and Kokaniv oil fields). Investments needed for these projects are estimated at $ 250 million. The Azov-Black Sea shelf represents an interesting investment possibility in capacity expansion and hydrocarbon extraction. There is a state program on the Black Sea shelf development, which has been declared a priority by the President of Ukraine. It is anticipated the oil and gas deposits on the Black Sea shelf would take precedence on the list of PSA deposits. The Geology Committee of Ukraine conducted the international tender in 1996 for oil and gas extraction on the shelf. The geological survey was conducted by Western Geophysical (U.S.) and sponsored by the Geology Committee. Shell International Petroleum (Netherlands) and Pecten International (U.S.) won the first tender in July 1996 to prospect for and extract oil in the Black Sea shelf, but the joint activity agreement was not signed because the PSA law was not yet adopted at the time. Some American companies were interested in participating in the second round upon implementation of the PSA Law. Western companies have expressed their interest in the exploitation of gas deposits in Dnipro-Donetsk area. Gas deposits in the area are estimated at 500 billion cubic meters, and unexplored gas resources are estimated at another 600 billion cubic meters.

Naftogaz of Ukraine has investment projects in oil and gas transportation, including reconstruction of compressor stations in Dolyna and Lubny, and construction of the Kherson-Crimea and Dolyna-Uzhhorod gas pipelines. Total $ 300 million in investments is required for these projects.

The Ukrainian government has also included the rehabilitation of the natural gas transit network, and developed a program of support and promotional measures to implement this project. Total project cost is estimated at about $500 million. The project will include the upgrade and construction of new compressor stations and pipeline branches, to improve network reliability and provide for the expanding of four major export routes.

Investments relating to the modernization of existing refineries are expected to be commercially viable. According to the GOU program on the suspension of leaded gasoline use in Ukraine by 2005, all existing refineries need to be modernized in order to produce unleaded gas. Today, 10% of domestically produced gasoline is leaded. And, demand for high-octane gasoline far exceeds domestic production. Of the six refineries, all except Kremenchuk refinery, have been partially privatized. If domestic and foreign trade in crude oil and petroleum products are completely liberalized and prices decontrolled, refineries should be able to attract both commercial loans and equity investors to finance the required projects. The cost of modernizing the six major refineries (Lysychansk, Kremenchuk, Odessa, Kherson, Naftokhimik Prykarpattia/Nadvirna and Halychyna/Drohobych) is estimated at over $4 billion.

The GOU has reaffirmed the "strategic importance" of the completion of the Odessa-Brody oil pipeline and its related Yuzhny oil terminal (near Odessa) to increase internal oil supplies and decrease Ukraine's dependence on Russia (90% of Ukrainian oil demand was supplied from Russia or through Russian territory in recent years.) The pipeline starts near Odessa at the Black Sea port of Yuzhny and goes to the Brody pumping station located on the Druzhba Oil Pipeline's southwestern branch near Lviv. The oil terminal and pipeline project would enable Caspian oil to be delivered directly to Ukrainian refineries and allow Ukraine to export crude oil to Central and Eastern Europe. The current estimated cost of the pipeline and terminal construction project is roughly $500 million. The initial phase of the pipeline construction (with annual capacity of 14.5 million tons) is around $250 million, and the Yuzhny oil terminal (with 9 million tons of annual capacity) construction is estimated at $150 million. Another $100 million would be required to complete the second stage of the pipeline and to purchase technical crude oil to fill the pipeline. The extension of the Pivdenny-Brody oil pipeline to the Polish city of Plock would connect the system to the western branch of the Druzhba oil pipeline and allow delivery of Black Sea oil to new markets in Poland, Germany, and the Baltic Sea (through the port of Gdansk in Poland). According to the feasibility study conducted by U.S. company Gulf Interstate Engineering in 1998-99, upon completion of all phases, the Odessa (Yuzhny) – Brody – Plock pipeline, in conjunction with the Bratislava – Schwechat extension and the Druzhba upgrades, would be capable of delivering high quality Caspian crude oil to Eastern and central Europe as designed. The Ministry of Energy and Fuel of Ukraine is coordinating the projects; Druzhba Pipeline State Company is the general contractor and the major investor of both projects, as of today. It is anticipated that the first phase of the project will by completed by mid 2001; outside private/foreign investments are needed to complete the second phase.

D. COMPETITIVE ANALYSIS

Although the oil and gas exploration market remains highly monopolized and state-controlled, a number of private, including foreign, companies (mostly small and medium size) work in this market. Today, they are exploiting hydrocarbon resources in joint venture or under agreements on joint cooperation with State Property Fund of Ukraine, or one of state-controlled companies, such as:

a. Naftogaz of Ukraine;

b. Ukrnafta (50% state-owned);

c. Vnipitransgaz (state institute of gas transport, design and research),

d. State-owned oil/gas exploration companies subordinate to the Geology Committee (Crimeanaftogazgeologia on the south, Poltavanaftogazgeologia on the east, and Zakhidukrgeologia on the west of Ukraine.)

Total market share of the foreign companies operating in Ukrainian oil/gas exploration is about 4%. Major foreign investors in crude oil and natural gas production are:

Company	Market Share, %	Activity
JV Poltava Petroleum Company, JV Crimea Petroleum Company (both of JKX, UK)	2.9	Oil/gas extraction in Crimea and Poltava regions
JV Eurogas (Eurogas, USA; RWE-DEA, Germany)	N/A	Coal bed methane extraction in Lviv-Volyn and Donetsk regions
USENCO (USA)	N/A	Oil and gas extraction in Lviv and Ivano-Frankivsk regions
JV UkrCarpatOil (Pease Oil & Gas/Carpatsky Petroleum Corp., USA)	0.1	Oil/gas extraction in Ivano-Frankivsk and Poltava regions
JV Crimea-Texas Oil (HiTech, USA)	0.5	Oil extraction in Crimea
JV Kashtan Petroleum (Canargo, Canada)	0.2	Oil/gas extraction in Lviv and Chernihiv regions
JV Delta (Momentum Enterprise, Canada)	0.02	Oil/gas extraction in Ivano-Frankivsk region
JV Plast (Maru Consulting, Greece; Exploinvest Ltd., Cyprus)	0.1	Oil/gas extraction in Poltava region

(Sources - Ukrainian Petroleum Consultants, Energobusiness)

These companies sell natural gas, either on gas auctions (UkrCarpatOil, Plast, and Delta) or directly to consumers (mostly to private companies.)

Some foreign companies have concession agreements with Naftogaz of Ukraine for managing parts of the gas transport system; detailed information is not disclosed as a commercial secret. Itera International Energy Company (US, Russia) delivers Russian and Turkmen gas to the Ukrainian border and sells it in Ukraine through dealers.

Of the total petroleum products imported into Ukraine (gasoline, diesel fuel, motor oils and lubricants), so-called "privileged" companies with foreign investments that were registered before March 1996, supply about 90%. Under the Law on Foreign Investments dated March 13, 1992, a company with $50,000 in registered foreign investment was guaranteed tax breaks and was ensured it would not change for 10 years. On March 19, 1996 the Parliament adopted a new law on the foreign investments, which voided previous investment laws and put an end to the previous automatic five-year tax exemption -tax privileges were cancelled for the companies registered later. The companies with foreign investments that were registered in Ukraine before March 19, 1996 enjoy five-year tax holidays till March 13, 2002. But they do pay excise duty on domestically sold petroleum products. In November 1999, the Law on Excise Duty was changed to force "privileged" companies to pay excise duty indirectly, charging it from the consumer. Now "privileged" companies with foreign investments form a special category of tax agents: they should include excise duty in the product price, collect it from consumers who purchase the product, and transfer it to the state budget.

International companies invest in the Ukrainian refining industry, domestic manufacturing and sale of petroleum products.

International competitors represented on Ukrainian petroleum product market are:

Company	Activity
Lukoil, Syntez Oil (Russia-UK)	Crude oil supply, refining (own 52% of Odessa oil refinery), storage and re-export; petroleum products manufacturing, storage, distribution and sales
Watford Petroleum	Crude oil supply, refining (own 16% and control through partners total 59% of Galychyna/Drohobych oil refinery)
Tebodin (Netherlands)	Pipeline and storage facilities construction and upgrade
BP-Amoco, US-UK	Retail sales of gasoline and diesel fuel (own gas filling stations in Kiev)
Chemdesign, Inc./ Oil & Gas Services LLC (US)	Gas processing equipment supply; Exporting LPG to Eastern Europe
Mobil Oil (US)	Sales of motor oils and lubricants
Omni Sphere Trade/Omnilub (US)	Local manufacturing, distribution and sales of motor oils and lubricants
Chemlube International Inc./Petra Ltd. (US)	Local manufacturing and sales of motor oils and lubricants
Shell International Gas (US-UK)	Sales of motor oils and lubricants

Many international companies sell their products in Ukrainian market through their local distributors:

ú motor and industrial oils and lubricants -- Chevron (US),

ESSO (US), Addinol (Germany);

ú fuel pumps -- Marley Pump (US), Fe Petro (Italy);

ú fuel distribution units -- Tokheim (US), Adast Systems (Czech Republic), Zaklad Yautomatyki Przemyslowey (Poland);

ú equipment for gas filling stations -- Dresser Wayne AB (Sweden);

ú gas pipeline equipment and controls -- Kanex Krohne Anlagen Export Gmbh (Germany), Officina Meccanika Tartarini S.P.A (Italy), Metran Industrial Group (Russia); etc.

E. MARKET ACCESS

According to the Law on Concessions adopted July 1999, transporting and distribution of natural gas are among activities that may be done under a concession agreement in Ukraine. Under this Law, existing facilities may be offered in concession to private companies, including foreign investors; private companies may also construct new facilities for the transporting and distribution of natural gas under concession agreements. The GOU provides state guarantees for private investments made under concession agreements. The list of state-owned facilities that may be offered for concession tenders is approved by the Cabinet of Ministers (CabMin); corresponding state authorities (for transporting gas - Ministry of Energy and Fuel, Naftogaz of Ukraine) may suggest to CabMin to include certain facilities in the list. List of municipal facilities that might be offered for concession tenders is approved exclusively by plenary sessions of local municipal authorities/councils. Concession agreements are signed with the winners of concession tenders for activities or facilities offered in concession, upon payment of concession fee by a concessionaire. CabMin approves winners of concession tenders for state-owned facilities; local municipal authorities/councils approve winners of concession tenders for municipal facilities. CabMin approves concession fees for various types of activity. The tender is conducted by the entity - owner of a concession facility (concession offering entity.) Concession agreements may be signed for a period not less than 10 years but not to exceed 50 years. If under concession agreement a concessionaire will perform an activity subject to licensing (incl. transporting and distribution of natural gas), he should obtain appropriate license. Concession offering entity is obliged to respect and not disclose concessionaire's commercial secret; it should not interfere into commercial activities of the concessionaire. Concessionaire has to use locally developed technologies, materials and equipment, if concession agreement does not specify otherwise. Upon completion of concession agreement, concessionaire should return concession facility back in appropriate technical condition. Concessionaire retains ownership for product and profit received under concession agreement. Concession offering entity carries the risk of accidental crash or damage of concession facility, if concession agreement does not specify otherwise. Import duty, VAT and excise duty for goods imported into Ukraine for activities under concession agreements are paid as required by Ukrainian legislation.

The Law on Production Sharing Agreements (PSA) regulates investments into exploration and extraction of oil and gas. This Law was implemented in September 1999; the enabling legislation -- the legislation containing PSA enabling amendments (up to twenty laws, including tax laws), necessary to make these laws consistent with the PSA law -- is being updated/implemented respectively. Under the PSA Law, a production sharing agreement regulates the relationship between parties on mineral resource exploration and extraction. The law prescribes the sharing of extracted product, its transportation, processing, storage, utilization, and selling. The state parties to a PSA are the Cabinet of Ministers (CabMin) and relevant local authorities of the region where the PSA is being performed. The investor could be one or more Ukrainian or foreign citizens, or legal entities or corporations carrying mutual responsibility for the assigned PSA. The investor is commissioned by the State of Ukraine to perform all work at his own expense and risk, and is to be compensated with the product after it has been extracted and shared. According to the PSA Law, the investor may pay certain taxes in “sharing production” rather than in cash payment, and is exempt from paying certain mandatory local and state taxes. The investor pays VAT (on the product sold in Ukraine); excise duty; corporate profit tax; exploration duty (if the geological survey was paid from the state budget); social and pension fund deductions for the employees hired to work in Ukraine under a PSA; license fees for mineral wealth utilization as assigned in a PSA. The investor is exempt from paying profit repatriation tax for the profit received under a PSA. The investor and subcontractors involved in PSA activities do not pay VAT and custom duties (except custom fees) on goods and equipment shipped into Ukraine and used for implementing a PSA, and shipped out after a PSA is complete; this equipment is not subject to export/import licensing and quota limitation. The product obtained by an investor under a PSA is subject to VAT payment when sold locally, and is not subject to any tax and custom duty payment (except custom fee) when exported from Ukraine. The law is believed to correspond to international standards for PSA’s. Other major provisions of the PSA Law are the following:

ú The CabMin approves the list of mineral deposits allowed for exploitation in accordance with a PSA, and their size. The investor can apply to the CabMin or to the State Interagency Commission (SIC) to add any new mineral deposits to the list. PSA is signed on a tender basis; the SIC works out the tender documents and announces the tender for deposits that might be developed under a PSA. The time frame for submitting bids should be no less than three months. The SIC then evaluates the submitted bids, and sends its recommendations to the CabMin, who selects the winner;

ú A part of the extracted product that is intended to compensate the investor’s expenses ("compensation product") should not exceed 70 % of the total extracted during the calculation period (usually one quarter), until the investor’s expenses are reimbursed in full;

ú The ownership rights for property that was acquired or produced by an investor to conduct the work under the PSA, can be transferred to the state of Ukraine only after paying its cost to the investor in full, in product;

ú The Ukraine State retains ownership of the product before it is distributed among the PSA parties. At the time of production sharing, the ownership rights for compensation portion of the product and the profit portion of the product (determined according to a PSA) are vested in the investor;

ú During the time that a PSA is in effect, and within the actions determined by a PSA, the investor may pay certain taxes in “shares of production”, rather than making cash payments. The investor is exempt from paying profit repatriation tax for the profit received under a PSA;

ú The CabMin can terminate, suspend, or restrict the investor’s right to utilize mineral resources under a PSA “in case of a direct hazard to human life and health or to the environment”. These rights are to be restored as soon as the investor removes the factors that caused the rights restriction;

ú It is prohibited to unilaterally withdraw funds from the investor’s bank accounts that were opened in Ukraine to service the activities under a PSA.

The relevant ministries and committees advise to the CabMin on the list of deposits that can be used for PSA's. The GOU is supposed to clearly delineate the investment tendering procedures. It is anticipated that adoption of the PSA law would attract investors and boost joint activities in oil and gas exploration and extraction in Ukraine.

Before PSA Law was adopted, there were two ways for foreign companies to obtain the right to exploit hydrocarbon resources in Ukraine: to form a joint venture (JV) with a Ukrainian company which had an exploration/extraction license (in this case the Ukrainian license holder should have re-licensed to the JV); or to enter in an agreement with a Ukrainian company-license holder to jointly exploit the resources (agreement on joint activities.) The joint venture option was the most common. Ukrainian legislation protected foreign investors in that if the Ukrainian Company decided to stop working with its foreign partner in a JV, it could not hold the JV’s license. In case of agreement on joint activities between Ukrainian and foreign company, all the equipment purchased for the project was going toward the joint activities, unless it was leased equipment; the parties to the agreement paid taxes separately. Production taxes were paid of the joint activity balance; profit taxes were paid separately by the parties. The license was either Ukrainian company’s, or it was re-registered to be made conditional upon the parties’ working together. There were no existing laws/legislative documents that supported joint licenses or licenses that were conditional upon the two parties’ working together. For each joint license application a separate instruction regulating the concept of joint or conditional licenses would have to be initiated by the Geology Committee, approved by the License Chamber, and registered by the Ministry of Justice. (Source of the last paragraph information - PriceWaterhouse Coopers.)

Licensing

Licensing of products, technology, technical data, and services is being widely introduced in Ukraine. License for sub-surface mineral rights is required for using certain piece of land and its sub-surface area for whatever purposes (mineral resources exploration and extraction, construction of underground facilities etc.) Besides, the activities on exploration and extraction of mineral resources, rehabilitation and exploitation of oil/gas pipeline utilities, storage of natural gas above certain volumes, natural gas supply, crude oil and petroleum product transportation by main pipelines, and transportation of natural and petroleum gas through the pipelines are subject to licensing in Ukraine.

Basic laws that regulate the sub-surface mineral rights, and activities on exploration/extraction of mineral resources are the Law on Natural Deposits (#133-94, adopted 7/27/94), and the Mining Law (adopted June 1999). According to the laws, the documents that justify the companies' right to extract mineral resources or to construct underground oil/gas storage facilities are:

ú License for sub-surface mineral rights (issued by Geology Committee in agreement with the Ministry of Ecology and Natural Deposits; separate licenses are granted for each type of using certain piece of land and its sub-surface -- for geological exploration; for extraction of mineral deposits; for construction and exploitation of underground facilities including for oil/gas storage; for PSA implementation (see CabMin resolution #709-95);

ú License for performing activities on mineral deposit exploration/extraction (issued by the Geology Committee) or for construction of underground oil/gas storage facilities (issued by National Energy Regulatory Commission);

ú Mining allotment;

ú Work plan approved and agreed to as set forth by the law;

ú Geological-markshader documents, passports and plans.

According to the Law on Natural Deposits, the company is granted the license for sub-surface mineral rights after it presents preliminary rental agreement with local council/municipal authority for a piece of land that would be in use. To obtain the license for sub-surface mineral rights for certain purposes (oil/gas exploration/extraction, construction and exploitation of oil/gas underground storage facilities, etc.) the company should apply to the Geology Committee that issues licenses in agreement with the Ministry of Ecology and Natural Deposits. Local Department of labor safety (currently subordinate to the Ministry of Labor and Social Policy) is granting mining allotments (gorny vidvod) for development of oil/gas deposits "of state significance", for construction of underground oil/gas storage facilities, and other purposes not related to extraction of mineral resources. Mining allotments for development of other mineral deposits ("of local significance") are issued by local councils/municipal authorities, and should be registered in the state mining supervision authority (local department of labor safety, subordinate to the Ministry of Labor and Social Policy.) The Cabinet of Ministers determines the terms of issuing licenses and mining allotments. According to the CabMin resolution "On granting special permission (licenses) for using bowels of earth for exploration and extraction of strategically important mineral resources" (#742-97 dated 7/15/97), mineral deposits that have minimum 15 million tons of oil reserve or 15 billion cu m of gas are considered strategically important for Ukrainian economy ("of state significance".)

According to the CabMin resolution "On approval of terms of issuing special permissions (licenses) for sub-surface mineral rights" (#709-95, dated 8/31/95), such licenses are issued for the period not to exceed five years for geological survey activities, 20 years - for other activities; in case if special geological territory/object is created, license period is unlimited. License application is submitted along with other necessary papers (list of papers is set by the Geology Committee) to the Head of the Committee. Licenses are issued by the Geology Committee (currently is subordinate to the Ministry of Ecology and Natural Deposits) within 30 days after submission of all necessary papers and paying the license fee by the applicant. License holder has to start activities within two years of the license issuing date.

According to the CabMin resolution "On approval of terms of issuing mining allotments" (#59-95 dated 1/27/95), to obtain mining allotment the company should present the license for sub-surface mineral rights; the workplan for mineral deposit development (rozrobka rodovyscha) or for construction of underground storage facility must be presented to complete this lengthy procedure. The work plans are designed by special design or extraction enterprises that are involved in markshader activity (marksheiderska sprava.)

Since 1998 the National Energy Regulatory Commission (NERC), an "independent" state authority, is responsible for issuing licenses for the activities on rehabilitation and exploitation of oil/gas pipeline utilities, storage of natural gas above certain volumes, natural gas supply, crude oil and petroleum product transportation by main pipelines, and transportation of natural and petroleum gas through the pipelines. All entities that own or lease over five million cubic meters of natural gas storage reservoirs are subject to licensing. According to the CabMin resolution "On terms of issuing licenses by the National Energy Regulatory Commission for performing certain activities" (#753-99, dated 4/29/99), license application should be submitted to NERC along with accompanying documents as set forth in the resolution. License is issued within 30 days upon submitting the application to the Chairman of NERC and paying the license fee, for the period set by NERC but not less than for three years.

There is no specific import/export license required for importing or exporting crude oil, natural gas and petroleum products. Import/export license is required for importing or exporting lubricating preparations HS 3403 (antirust etc. preparations based on lubricants) that contain ozone-damaging substances. The Ministry of Economy may grant the export/import license for this category of goods upon agreement with the Ministry of Ecology and Natural Deposits. Each year the Cabinet of Ministers approves (and may change) the list of products which export/import is subject to licensing.

License Fees:

According to the CabMin resolution "On approving the terms of issuing special permissions (licenses) for sub-surface mineral rights" (#709-95 dated 8/31/95), fees for this license vary from 20 to 100 non-taxable minimums ($64-320) for Ukrainian legal entities depending on the purpose of using the piece of land and its sub-surface, and 50% of this amount for Ukrainian private entrepreneurs (non-taxable minimum is currently UAH 17, or $3.2.) For foreign legal entities or private entrepreneurs the license fees are twice as much as for Ukrainian ones.

According to the CabMin resolution "On rates and terms of issuing and re-issuing licenses for performing certain activities" (#6-99 dated 1/4/99), activity license fees for Ukrainian legal entities or private entrepreneurs vary depending on the activity, and constitute: for legal entities 12-80 non-taxable minimums ($38-256), for entrepreneurs 2-40 ($6-128) non-taxable minimums.

Taxes and Duties

The number of taxes in Ukraine decreased during the GOU's tax reform conducted in 1997, and this trend was continuing through 1999. During summer of 1998, President Kuchma issued several tax reform decrees. The reform measures included the introduction of a single uniform tax for small businesses, and reduction of the payroll tax to 37.5% beginning January 1, 1999. The most significant taxes are: a 20% value-added tax (VAT); a 30% corporate profit tax; and a personal income tax based on an employee's income (ranging from 20-40% for most employees of foreign companies operating in Ukraine); and payroll taxes paid by the employers to the Social Insurance Fund, Pension Fund, and Employment Fund (total contributions to these funds amount to 37.5% of wages, borne by the employer).

The daunting menu of a VAT, import duties (ranging from 0 to 20% depending on the product), and excise duties (up to 300%) presents a major obstacle to trade with Ukraine. The VAT is levied at 20%, based on the customs value on the invoice, and is generally payable at the time of customs clearance by the importer. A promissory note can also be applied. VAT is not levied on the imported crude oil, natural gas, oil additives containing oil or petroleum products made of bituminous minerals, and on filter or cleaning equipment for gases/liquids (HS 27.09.00900, 27.11.21000, 38.11.21000, 84.21,21900.)

These three product categories are included in the list of critical import goods exempted from VAT payment, which is approved by the Cabinet of Ministers of Ukraine. All other petroleum products are subject to VAT. As the list of goods exempted from VAT changes frequently, businesses should contact CS Kiev for the most up-to-date list.

Excise duties are applied to a number of luxury goods, including automobiles and petroleum products, tires, jewelry, alcohol, and tobacco, that are imported into Ukraine or produced locally. According to the Law on Excise Duty, goods that are exported from Ukraine are not subject to excise duty. According to the Law on Excise and Import Duty Rates for Specific Categories of Goods, excise duty is levied on the following petroleum products sold domestically (either imported or domestically produced: special benzene, kerosene, motor fuels codes HS 2710 00 210, 2710 00 250, 2710 00 310, 2710 00 370, 2710 00 390, 2710 00 510, 2710 00 550, 2710 00 590, 2710 00 330, 2710 00 350, 2710 00 610, 2710 00 650, 2710 00 690. These duties are declared in ECU (European Currency Unit) per unit and paid in local currency at the exchange rate effective on the date of payment. Excise duties for above-listed petroleum products are calculated based on their weight, and vary from ECU 10 to 40 per kilogram. Crude oil and natural gas are not subject to excise duty payment.

Import duties differ and largely depend upon whether a similar item to that being imported is produced in Ukraine; if so, the rate may be higher. GOU policy to protect domestic manufacturers will probably result in gradually increasing import duties for items produced in Ukraine. Import duty rates (for goods imported into Ukraine), as well as export duty rates (for goods exported out of the country) are defined in the Common Customs Tariff Code of Ukraine in accordance with the Law on Common Customs Tariff Code, and international agreements. There are three types of duties: preferential, privileged and regular import duties. Preferential import duties are set for goods imported from countries that are members of the custom unions with Ukraine, or compile special custom zones with Ukraine. Preferential import duties are usually the lowest. Privileged import duties are set for goods that are imported from the "most favorable category" countries or economic unions that means exporters from these countries or unions enjoy certain custom duty privileges. For the rest of goods regular import duties apply. Depending on the product category, import duties are expressed as a percentage of the declared customs value of imported products, or are calculated by volume (engine volume, in the case of automobiles), units, or weight of products imported into Ukraine. These duties are declared in ECU per unit and paid in local currency at the exchange rate effective on the date of payment. According to the Common Customs Tariff Code, natural gas is not subject to import duty; crude oil, petroleum gas, coal gas, and petroleum products (HS 2705 00 000, 2706 00 000, 2707, 2709 00 000, 2710 00, 2711) are subject to import duty. Import duty is currently 2% (privileged) or 5% (regular) for the above-mentioned categories of goods, except for those specified in the Law on Excise and Import Duty Rates for Specific Categories of Goods. According to this law, import duties of ECU 1.5-40 are levied on the following petroleum products: special benzene, kerosene, and motor fuels (codes HS 2710 00 210, 2710 00 250, 2710 00 310, 2710 00 370, 2710 00 390, 2710 00 510, 2710 00 550, 2710 00 590, 2710 00 330, 2710 00 350, 2710 00 610, 2710 00 650, 2710 00 690.) For these petroleum products import duties are calculated based on their weight.

Customs fees are charged for processing any goods of declared customs value over US$ 100 through Ukrainian customs. The Cabinet of Ministers approves (and may change) the rates of customs fees. According to the Cabinet of Ministers' resolution #65 dated 1/27/97 "On the Rates of Customs Fees", for goods of customs value US$ 100-1,000, customs fees are fixed rates equivalent to US$ 5-30 per each customs declaration. For imported into Ukraine goods of customs value over US$ 1,000, customs fee is 0.2 % of their customs value. But, according to the Cabinet of Ministers' resolution #1836-99 dated 10/4/99 "On Some Issues on Customs Clearance of Natural Gas", customs fee in the amount of 2 % of customs value is imposed on natural gas imported into Ukraine.

Additional customs fee of 0.01 ECU per one kilogram is levied on imported into Ukraine petroleum products that are subject to excise duty. This additional customs fee is not imposed on domestically manufactured petroleum products that are made of crude oil supplied on give-and-take terms, if these products are sold in Ukraine.

It has been quite profitable to extract oil and gas in Ukraine. According to Naftogaz of Ukraine, in 1998 its exploration companies’ expenses (excluding tax) amounted to US$ 10 per 1,000 cubic meters of gas extracted domestically. But taxes were adding a lot to gas selling price. As Naftogaz stated, in 1997, out of the US$ 66 price for 1,000 cubic meters of gas for municipal and state budget-financed organizations US$ 56 (or 85%) was tax. According to the Ukrainian Petroleum Academy, direct tax payments now constitute at least 61% in the structure of Ukrainian gas price.

During 1998-99 the GOU made some efforts to lower the tax rates, and the overall number of taxes decreased. The investment attractiveness of oil/gas exploration increases as the tax rates are lowered further.

Besides general taxes that all businesses in Ukraine usually pay, oil and gas exploration companies also pay duty for using natural deposits, rent duties for domestically extracted oil and gas, geological survey duty (if survey was done for state budget expense), environment damage duty. To promote private investments into developing "hard-to-explore" deposits (with deep oil/gas layers), the GOU offers certain tax privileges to the exploration companies. Such as, the exploration companies do not pay the rent duty for oil/gas extracted on these deposits in excess of base volume (zero base volume apply for "hard-to-explore" deposits), and for 10 years do not pay the geological survey duty. The Cabinet of Ministers approves and adds to the list of "hard-to-explore" deposits in consultation with the Geology Committee. As of today, the list comprises some 18 local deposits.

Both Ukrainian and foreign entities pay their taxes on a quarterly basis. It is important to obtain the services of experienced international accountants for tax-reporting purposes, as many local accountants have not yet made the switch to the international accounting standards required for new tax reporting.

A new tax code, with significant changes to the tax regime, is expected to be introduced in the year 2000. The complete text of the current draft tax code in Ukrainian can be viewed at the following web site: http://www.tax.com.ua.

Country's Methods of Procurement

Under current Ukrainian legislation, all government procurements above US$ 100,000 are conducted through one of the following tender procedures: open tenders; open tenders with preliminary qualification required; competitive negotiations. Procurements from UAH 70,000 (about US$ 17,000) to US$ 100,000 are offered through the following competition procedures: competitive negotiations or limited competition, where invitations for bids are sent to at least three potential suppliers. Procurements under UAH 70,000 are done on a limited competition basis through invitations for bids. Open international tenders must be conducted when the procurement is financed by an entity that is not a resident of Ukraine.

Means of Financing Procurement

Financing is subject to contract negotiations. Among the forms of financing are company internally generated funds; domestic borrowing; foreign borrowing; domestic equity investments; domestic grants from the budget; grants from foreign aid agencies. Among foreign donors financing energy projects in Ukraine are the World Bank, the European Bank for Reconstruction and Development, the U.S. Agency for International Development (USAID) and the U.S. Trade Development Agency.

Natural gas: sources of supply. Trading of natural gas

* SBF - state budget-funded

Crude oil and natural gas transportation through Ukrainian pipelines:

Status of Privatization of Ukrainian Refineries

Distribution/trading of petroleum products

Direct Export Opportunities

A. Total Market Size 110.0 111.0 112.0

Taxes and Duties

Country's Methods of Procurement

Means of Financing Procurement

F. Major Annual Trade Events/Fairs