How to restore market confidence in subsoil resource allocation


Source: Economichna Pravda

Officials should not allocate subsoil resources. There is an easier and more efficient tool – an auction.

In early March, the Derzhgeonadra (State Service of Geology and Subsoil) held first electronic oil and gas field auctions in the ProZorro.Sale system.

We could call this a milestone event.

In 2013-2017, auctions were legally defined as the main tool to sell subsoil use rights, but 84% of land plots were allocated without auctions.

In 2018, the first auctions were held in the fall. The government set a number of limitations in subordinate acts. This led to the fact that most of permits were sold through tenders and production sharing agreements in a non-transparent way.

The greatest advantage of auctions is that the market received a signal about the launch of a procedure that provides fait subsoil access for all participants in the process.

It was a signal for investors that the rules would likely continue to be respected. The Derzhgeonadra has already announced the following electronic auctions: it will sell another 16 oil and gas zones in May and June.

In addition to the transparency of the process, auctions also demonstrated their economic benefits. The aggregate price of subsoil areas sold is three times higher than the starting price. 140 million hryvnias is a small amount at the national level, but such an increase is a very significant fact.

In addition, auctions are applied in economic practice not only to obtain the maximum amount of money, but also to find out the real asset value.

If we continue this practice, we will have the market in the future and understand the real value of mineral rights in Ukraine. Investors will have guidelines for making decisions on how to engage in mineral production.

When the assets are sold at a price determined by some official, it is absolutely senseless to plan something. The starting lot price is now determined by some kind of monstrous formula. Its main problem is the unjustified complexity.

It implies not only the need to assess mineral reserves in the depth of the area being evaluated. It is still possible to make this resource assessment, although there are high manipulation risks both in terms of price increase and lowering.

The need to calculate how much profit a company will get during its licensing period is the cherry on top. The economic analysis geniuses from the Derzhgeonadra try to calculate the profitability of this business for 20 years ahead and include 2% of that profit into the lot price. It is science fiction in the Ukrainian reality.

Having analyzed the effectiveness of this tool, the experts of the Better Regulation Delivery Office concluded that it would be more reasonable to set the token starting price of lots of 1 UAH for further auctioning.

Of course, it is subject to a certain warranty payment, for example, 1 million hryvnias, which a winner will lose if they do not want to pay for the purchased asset.

If an auction is properly organized (informing potential participants in advance, open and easy auction registration), market participants will raise the lot price from this 1 hryvnia to the market price anyway.

The second option is to choose another objective criterion for lot assessment, for example, the plot area. A land plot is easier to estimate, and the received value can be adjusted for the multiplying coefficient, for example, by being multiplied by ten.

This will significantly reduce the time and cost to determine the starting price. If the auctioned starting lot price is less, the percentage of successful sales and interest will be higher.

Of course, this is not the only problem. The fact that buyers participated only in three of ten land plot auctions is a negative signal. It also points to the quality of the assets offered to the market. There is a suspicion that they will try to allocate the most desirable land plots by using old schemes through some tenders with specific criteria.

Selling subsoil use rights through tenders is a normal world practice, but only countries with a developed market and strong public institutions can afford it. When the market is only being developed, applying any criteria other than the price is associated with additional corruption risks.

Currently, the government is planning to sell another 12 land plots under a production sharing agreement (PSA). This is a non-transparent procedure that was discredited.

The experience of selling land plots under the PSA scheme to Shell and Chevron companies showed that both agreements contained a corrupt component at the level of 10% of the transaction amount (the SPK-Heoservis company, which was associated with Eduard Stavytsky, was involved in both projects). In fact, these tenders are a threat to return to the old regime.

In order to eliminate the possibility of a corrupt component, the BRDO Office proposes to define clear criteria when land plots are put up for a tender instead of an auction on an exceptional basis. This does not require legislative intervention. Only the political will of the Cabinet of Ministers will be enough to make the market more transparent.

The BRDO Office sees two criteria, by which an asset can be sold through a tender. The first one is if a land plot was not sold at electronic auctions for three times. The second criterion is as an exception when it comes to extraction of mineral resources in inaccessible areas by using unique technologies or as offers for strategic investors.

There are another two aspects that should be resolved.

The first one is the unpredictability of auctions frequency. The Derzhgeonadra should develop a schedule of auctions. Its lack complicates the monitoring of the market of subsoil use rights for potential participants and reduces their interest in the process.

The second aspect is the need to remove the barriers to foreign investors’ participation. Today, gas companies should have a registered company in Ukraine to participate in auctions. We propose to replace this rule with the auction winner right to create a legal entity in Ukraine in two months after the auction is over.

When the market is only emerging, it is necessary to use simple and effective subsoil allocation tools. We should achieve the ideal model when the Derzhgeonadra concentrates on the geological component being removed from the allocation process, and the assets are allocated externally through auctions.

The state receives an economic effect in the form of increased mineral production and budget revenues, and businesses will have transparent and clear production license terms.