EXPLORING UKRAINE'S VANCO DISPUTE

ANALYSIS & COMMENTARY: By Tammy Lynch
The ISCIP Analyst An Analytical Review
Volume XIV, Number 14, 25 July 2008
Institute for the Study of Conflict, Ideology, and Policy
Boston University, Boston, MA, USA

The Western business community in Ukraine still is reeling over the
government’s decision to annul a major deep-water oil and gas exploration
contract involving a US-based company.  “How will companies sign contracts
if they are canceled at a press conference, without negotiations to find out
whether the company is willing to make changes before all this is aired as
part of campaign speeches?” asked Morgan Williams, president of the
US-Ukraine Business Council.  (1)

To be sure, it is understandable why the unilateral canceling of a contract
without benefit of court or mediation decision would send shockwaves through potential investors, and the government must begin to understand that this type of remedy is not supported in Western circles. Nevertheless, while the government handled the situation badly, it does appear to have had grounds for concern.  The issue appears far more complex than originally thought. The question is whether Ukraine originally approved one deal following a public bidding process, but now has another (thanks to the curious approval of the previous government).

The contract with an affiliate of Vanco International Ltd. - a subsidiary of
Houston’s Vanco Energy Company – was “revoked and terminated” on 21 May.

The Production Sharing Agreement had a 30-year span and reportedly could
have involved up to 15 billion dollars in investment to complete the
surveying, prospecting and possibly extracting of oil and gas on Ukraine’s
Black Sea shelf.  Most experts suggest that the area at issue – the
Prykerchenska region of the shelf – contains enough gas to provide the
country with 25 percent of its domestic needs per year.

The depth of the gas, however, is extremely problematic, and the size of the
area is unusually large at 13,000 square kilometers.  Therefore, the
government issued a highly specialized request for proposals in late 2005 to
conduct the exploration work.

On 19 April 2006, Vanco International Ltd won the tender to develop the
Prykerchenska area.  The bid, submitted jointly with UK-based JNR Eastern
Investments, beat out, among others, a joint bid by Shell and Exxon Mobil.

Jim Bown, Vanco’s representative in Ukraine, told journalists at the time
that the Vanco-JNR bid was a 50/50 partnership, with Vanco providing the
technical expertise and JNR “the financial dimension.”  Vanco International,
registered in Bermuda, but reportedly based in Switzerland, suggested it
would spend around $330 million over eight years to explore the field.   Any
financial guarantees associated with the winning bid presumably would be the
responsibility of JNR, based on Bown’s comments at the time. (2)

The details of the Production Sharing Agreement were negotiated for 18
months, with much of the time reportedly spent waiting for the government’s
responses to Vanco’s proposals.

Finally, the contract was signed in fall 2007.  But while the Production
Sharing Agreement (PSA) reportedly was signed between Ukraine and Vanco
International Ltd., all licenses for subsoil exploration were awarded to an
entity known as Vanco Prykerchenska.  This company, according to the
government, was said to have been registered on 18 October 2007, just one
day prior to the signing of the PSA.  (3)

(As we go to press, the government suggested that the contract actually was
not signed by Vanco International, but by Vanco Prykerchenska Ltd.  This
claim is unconfirmed, as the document is unavailable, and a source
associated with Vanco Energy denies this statement.  However, Vanco
Prykerchenska is the entity requesting arbitration for failure to fulfill a
contract, suggesting that it may be the actual party to the contract at this
point.)

President Viktor Yushchenko signed the PSA in a public ceremony on 19
October 2007, announcing on his website that he would hold an event “to sign
a production sharing agreement to explore the Prykerchenska area of the
Black Sea shelf between Ukraine and Vanco Energy Company.” (4)  The deal,
he said, “is a strategic project for Ukraine and this is a unique precedent
for, on the one hand, formulating a national energy strategy and, on the
other hand, for cooperating with the world’s leading international
investors.” (5)

The agreement was signed, perhaps not coincidentally, almost directly
following a snap parliamentary election that led to a change in government
from then-Prime Minister Viktor Yanukovych to current-Prime Minister Yulia
Tymoshenko.  The ceremony occurred as the new parliamentary majority
coalition was being formed.

In explaining his ministry’s decision to revoke licenses for subsoil use,
Environmental Protection Minister Heorhiy Filipchuk suggested that Vanco
International was not granted the right in the PSA to transfer rights of
subsoil use to its affiliate.  (6)

Moreover, both Filipchuk and Tymoshenko complained that Vanco International
did not provide the required information about its affiliate.  On 21 May,
Filipchuk said, “We still have not received confirmation of financial,
technological or technical documentation from this company [Vanco
Prykerchenska].”  (7)

Gene Van Dyke, the President of Vanco Energy Company and Board Chair of
VPL, vigorously denies the government’s charges.  “According to the Production
Sharing Agreement,” he said, “Vanco International Ltd., winner of the
tender, has the right to pass further execution of the agreement to a
company founded with this purpose – for example, Vanco Prykerchenska Ltd.”
(8)  Van Dyke also suggested that the government had all necessary
information on the Prykerchenska affiliate.  Moreover, in an interview this
week, a Vanco representative, who asked that his name be withheld, noted
that the company often works through consortiums and profit-sharing
agreements.

VPL has called on the Ukrainian government to allow the publication of the
PSA (also known as the Hydrocarbons Sharing Agreement), which it says has
been misrepresented and quoted out of context for the purpose of misleading
the public.  (9)

Tymoshenko is standing her ground, however, suggesting that the deal with
Vanco International and VPL was “a corrupt agreement concluded by the
previous government.”  The government “has put a stake in the ground on this
issue,” she said, and expressed confidence in “a very strong case.”  (10)

Her primary contention appears to be that the VPL ownership includes a
company closely linked both to former Prime Minister Yanukovych, who
suddenly approved the deal before leaving office, and the current Secretary
of the National Security and Defense Council, who has taken the lead in
defending the agreement.

Vanco Prykerchenska confirmed in May that it is not owned wholly by Vanco
International, as assumed by many.  Instead, its ownership is split “in
parity” among four entities:  Vanco International, the Donbass Fuel and
Energy Company (DTEK), Integrum Technologies of Austria, and Shadowlight
Investments Ltd., linked to Russian businessman Yevgeny Novitsky.  (11)

It is the inclusion of DTEK that reportedly got the government’s attention.
DTEK is the corporation linked to System Capital Management, which is owned
by Ukraine’s richest billionaire Rinat Akhmetov.  In addition to his
business interests, Akhmetov serves as a parliamentary deputy and is
allegedly the chief financier of former Prime Minister Yanukovych’s Party of
Regions.  Akhmetov is also a close ally of Raisa Bohateryova, now the head
of President Yushchenko’s National Security and Defense Council.
Bohateryova serves on the Party of Regions Political Council and was one of
the leaders of the Party’s parliamentary faction during Yanukovych’s
premiership.

Neither DTEK nor any of Vanco International’s current partners in Ukraine
were involved in the original bid proposal.  At the same time, JNR Eastern
Investments, Vanco’s original financial partner, is no longer involved with
the project.

While DTEK’s connections are clear, Integrum Technologies is unknown.  Its
ownership has not been disclosed by anyone involved in the project, and the
government claims to be unable to find its backers.

An email request from this author to Vanco Prykerchenska asking for contact
information for Integrum Technologies received no response.  The Austrian
company appears to have no website, or at least none that appears on any
general search engine.

Hans Stege of the Kremlin, Inc. Blog, has been one of the most aggressive
pursuers of information about Integrum.  Since May, he has spent
considerable time calling and emailing Austrian, Ukrainian and Russian
companies attempting to locate contact information for Integrum
Technologies, but to no avail.  (12)

The shadowy nature of the company has allowed Ukraine’s government to
speculate about its ownership – suggesting everything from Gazprom to
companies related to the presidential secretariat.  None of this speculation
is based on any available information and certainly cannot be proven.

The Vanco Energy Company website is no help; the site makes no mention
of Vanco Prykerchenska's connection to the contract.  In fact, the site has
little information about its Ukraine work.  The company is respected for its
deep water exploration in several African countries, and openly lists its
partners in these countries on its website.   It makes no mention of any
partners in its description of its work in Ukraine.  (13)

An archived page located through a Google search (and not available when
entering the site through its main page), however, shows what appears to be
a graphic of a power point presentation slide.  The slide – titled “Legal
Structure” -- provides an overview of the Vanco Energy Company through the
use of a flow chart.

“Vanco Energy Company is an integrated independent oil and gas company
which operates its exploration and production activities through its wholly owned
overseas subsidiary, Vanco International Ltd. and through the wholly owned
subsidiaries of Vanco International Ltd.,” the slide explains.  “Vanco's
integrated corporate structure is consistent with generally accepted
practices of the international petroleum industry.” (14)

The graphic flow chart appears to show a company called “Vanco Ukraine Ltd.
(Bermuda)” as a subsidiary of “Vanco International Ltd. (Bermuda).”  The
slide is dated April 2006.  (15)

Vanco International’s bid proposal to Ukraine was submitted in April 2006.

Despite these questions, like many Western investors, the US Ambassador to
Ukraine originally expressed regret over Ukraine’s decision.  “I am very
disappointed that the Cabinet of Ministers today took unilateral action to
revoke the Production Sharing Agreement [that] the Government of Ukraine
negotiated with U.S. company Vanco,” Ambassador William Taylor said in a
statement.  “For the government of Ukraine to attract investors,” he
continued, “particularly in those sectors vital to its energy security, it
needs to make clear that it respects the sanctity of contracts and the rule
of law.”  (16)

This is, of course, very true.  The manner in which the Tymoshenko
government annulled its agreement with Vanco International is questionable.
The case not only demonstrates the continuing opaque nature of government
agreements, but also underscores the utter failure of the country’s judicial
system to mediate conflict.

The country long has been criticized for a culture of corruption – judges
routinely are accused of accepting bribes or backing down in the face of
severe intimidation, while prosecutors often are dependent on political
favors for their positions.  As a result, power plays and public relations
often are substituted for legal remedies, as even political leaders have
little trust in the judicial system.

Following the government’s announcement, President Yushchenko responded
by requesting that the country’s prosecutor-general intervene.  Without benefit
of investigation or court ruling, the prosecutor immediately issued an order
to the government to revoke its decision.  Because Tymoshenko apparently
views the prosecutor as a vessel of the president (with some reason), she
simply ignored the order.

On 4 June, Yushchenko issued a decree ordering the government to rescind its
decision.  Tymoshenko ignored that decree, too, noting that it had come
based on a recommendation of Bohateryova’s National Security and Defense
Council.  Yushchenko also created an interdepartmental commission to
investigate the situation, and placed Bohateryova—Rinat Akhmetov’s ally—in
charge of it.  (17)

The Vanco case highlights many of the most urgent problems facing Ukraine.
Continued reliance on administrative methods to remedy questionable
contracts—to say nothing of the fact that so many questionable contracts
exist—should cause serious concern for corporations looking to work in the
country.  Close relationships between political leaders and businesses
involved in major contracts also undoubtedly do not send the appropriate
signals.

Furthermore, the ease with which Western corporations may become (sometimes
unwittingly) enmeshed in the country’s muddy business environment is
unsettling.   Corporations attempting to conduct normal business often find
themselves held hostage to political turf battles and politically-oriented
business interests.

As the government works to clean up its business dealings, it must also
understand the need to reform the judicial and prosecutorial mechanisms that
should protect both private investors and the government.  If nothing else,
this should be the message of the Vanco dispute.
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Source Notes:

(1) Anna Poludenko, “Tymoshenko cancels Vanco contract in fight with
Yushchenko,” Kyiv Post, 22 May 08 via www.kyivpost.com.
(2) John Marone, “Vanco wins Black Sea deepwater tender,” Kyiv Post, 27 Apr
06 reprinted in Alexander’s Gas and Oil Connections, Vol 11, Issue 10, 18
May 06 via www.oilandgas.com.
(3)  Alexander Serafimovich, “Ukraine’s government says: Vanco go home!,”
Oil and Gas Eurasia, June 2008, No. 6 via www.oilandgaseurasia.com and
www.eurasiapress.com.
(4) “Ceremony to sign deal with Vanco,” Press office of President Viktor
Yushchenko, 19 Oct 07 via www.president.gov.ua/en/news/7901.html.
(5) “Ukraine strikes deal with Vanco,” Press office of President Viktor
Yushchenko, 19 Oct 07 via www.president.gov.ua/en/news/7905.html.
(6) Alla Yeremenko, “The Black Sea Shelf to the Bearer,” Zerkelo Tyzhnia, 17
May 08 via BBC Monitoring, Lexis-Nexis.
(7) Ibid.
(8) Press Release, Vanco Prykerchenska Ltd, 12 Jun 08 via PRNewswire.
(9) Press Release, Vanco Prykerchenska Ltd., 17 July 08 via email to author.
(10) BYuT Inform Newsletter, 22 Jul 08 via email to author.
(11) Alla Yeremenko, “The Black Sea Shelf to the Bearer,” Zerkelo Tyzhnia,
17 May 08 via BBC Monitoring, Lexis-Nexis.
(12) See “A Tale of Two Business Cultures:  The Integrum Technologies Case,”
3 Jul 08, Kremlin, Inc. Blog for an interesting (and sometimes humorous)
description of Hans Stege’s attempts to track down Integrum Technologies
(www.dartmouth.edu/~stege/blog/?p=112)
(13) Website located at www.vancoenergy.com.
(14) Vanco Energy Company website,
www.vancoenergy.com/aboutus/legalstructure.htm.
(15) Ibid.
(16) “Statement by U.S. Ambassador Taylor on Vanco Case,” Public Affairs
Section, U.S. Embassy, 21 May 08.
(17) “Bohateryova will study the agreement between Ukraine and Vanco,” Forex
and Finance, 21 May 08 via www.fin-forex.com.
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Tammy Lynch (tammymlynch@hotmail.com)
LINK: http://www.bu.edu/iscip/news.html#western