At the end of April a ray of hope was cast by the Verkhovna Rada on the future of Ukraine's oil refining and petrochemicals industry. The draft law "On changes to the laws of Ukraine related to reconstruction, modernisation and construction of existing and new refining and petrochemical facilities" is now headed for its final reading and if approved, the operators of six major Ukrainian refineries will finally be able to launch large scale modernisation progr-ammes aimed at bringing their facilities into line with EU standards.
The new legislation, which will give petrochemicals firms a raft of tax breaks and relaxed import regulations designed to ease the financial burden of modernisation, may have come along just the nick of time for Ukraine's petrochemicals industry which has the potential to generate billions of dollars for the state budget annually.
According to Dr. Vladimir Kapustin, a professor at the Moscow Gubkin University of Oil and Gas and general director of the Moscow-based VNIPIneft Research and Development Centre, Ukraine is in danger of increasingly lagging behind its neighbours in terms of refining industry technology and efficiency. "Further delays in the modernisation of Ukraine's refining sector not only puts the country in danger of losing billions of dollars in potential export revenue from its nicely positioned refineries, but could also threaten Ukraine's long-sought goals of energy stability and independence," he says.
Ageing assets, but high potential
Since their privatisation in the late 1990s and at the beginning of this decade, Lukoil's 80,000 b/d (barrels per day) refinery in Odessa, TNK-BP's 320,000 b/d LINIK refinery in Lisichansk, and Alyans' 150,000 b/d Kherson refinery have not seen much in the way of investment. Meanwhile, amid worries over political stability following the Orange Revolution and having completed in 2004 the installation of a USD 20 million isomerisation unit, Lukoil shut down its Odessa unit in July 2005 for prolonged modernisation. Company sources recently said the facility is likely to reopen towards the end of 2007. Both Lukoil and other industry sources indicate that a number of improvements have been made at the refinery including the development of an independent power source (the facility was previously hit twice by major power cuts from the main grid). In another development in February this year, the Swedish firm Alfa-Laval supplied the refinery with a new state of the art heat exchanger.
The Alyans-owned refinery at Kherson in southern Ukraine has been idle since August 2005 and the company's management makes no secret of the fact that the unit is simply too unprofitable to operate at current crude prices and refining margins.
TNK-BP's LINIK, often seen as a flagship of Ukraine's refining industry, is arguably the most dynamically developing unit in the country. In March this year the company started exports of Euro-4-compliant diesel fuel. However, in a recent public statement TNK-BP President Sergey Lizunov conceded that refining in Ukraine remains unprofitable under the pressure of oil product imports from more advanced refineries in Russia and Belarus, where the necessary legislative changes to allow modernisation were made several years ago.
Nevertheless, according to Kapustin, Ukraine's refineries have high export potential, especially the units in Nadvirna and Droghobych which sit close to the EU border and are also well-placed for exports via the Ventspils terminal in Lativia. Both refineries however need to first undergo extensive modernisation in order to produce EU-compliant diesel.
Failed government policies
Progress towards meaningful reform has been slow and the oil industry in Ukraine has suffered serious setbacks, none worse that in the spring of 2005, when then-prime minister Yulia Tymoshenko introduced a floating excise tax on motor fuel sales. With world crude prices climbing at the time, refiners and retailers had to raise retail prices in order to cover higher production costs and taxes. Soon after, Tymoshenko's government issued another regulation limiting the maximum retail price at UAH 2.9 per litre, which forced many oil companies and petrol station operators to shut down their outlets rather than face outright losses. Only the direct intervention of President Viktor Yuschenko following a meeting with industry representatives on May 18, 2005 enabled suppliers to resume retail sales when the President ordered the lifting of the government's price limitations and floating excise tax rate.
Surprise progress in 2007
With last year's return of Viktor Yanukovych as Prime Minister and the appointment of experienced refiner Yuriy Boyko as Minister of Fuel and Energy, the oil industry had high expectations of early changes in government policy and their expectations were partially met in August when a meeting with Yanukovych and Boyko resulted in the signing of a memorandum on co-operation between the state and the oil industry.
Another step towards reform was made towards the end of last year when the Verkhovna Rada approved differential excise rates for diesel based on sulphur content and since January 1 this year producers of lower-sulphur diesel have been benefiting from the new lower rates. However, the tax breaks promised by the new government in August 2006 on the import of foreign equipment for refinery modernisation failed to materialise in the 2007 state budget.
When Ukraine was hit by yet more political turmoil in April, many industry insiders began writing of the prospect of being able to go ahead with any modernisation programmes this year, instead looking to 2008. However, the Ministry of Fuel and Energy insisted on parliamentary hearings on new legislation and much to the surprise of the oil companies, the draft document passed its first reading. Ministry sources now say there is a more than reasonable chance for the document to pass its final reading before the beginning of June and it even being applied retroactively from January 1, 2007.
All this could mean a major investment windfall for Ukraine. Lukoil alone has earmarked USD 500 million for investment in its downstream business in Ukraine, primarily at the company's Odessa refinery. For the Russian companies, their Ukrainian outlets in Odessa, Kherson, Lisichansk and Kremenchug represent not only solid footholds in a large and developing market (Ukraine's annual motor fuel consumption is estimated at more than 15 million tonnes or more than USD 9 billion), but a strategically important location with direct access to both the eastern borders of the EU and the Black Sea.
