Ambassador John Herbst
Energy's Role in Euro-Atlantic Integration
International Oil and Gas Conference
Kyiv, Ukraine
October 28, 2003

Energy is crucial to economic development and national security. Oil and gas are two key energy sources for every economy. Because of energy's central role, energy independence and energy diversification are essential for country's security. Ukraine understands that. Although Ukraine is dependent on Russia for a majority of its energy needs, Ukraine is also a key transit country using its large network of pipelines to transport a majority of Europe's natural gas supply, and could also provide Europe an alternative source of oil. Ukraine is also rich in natural resources, possessing a large cache of virtually unexploited energy resources. The Odesa-Brody pipeline can offer Ukraine energy diversification opportunities, long-term revenue and an important step toward integration. Development of a more transparent business environment that provides energy efficiency incentives will further contribute to Ukraine's energy independence and economic growth. Clearly, with the right policy choices, Ukraine can solidify a prosperous European future.

Although Odesa-Brody's future as a Eurasian Transport Corridor did not look bright upon its completion in August 2001, market realities have changed. Perhaps the most important occurrence was the sinking of the Prestige off the coast of Spain, and the international outcry that followed. This tragic accident made clear the need for tighter environmental norms, and Europe looked to potential land-based routes to source crude to avoid other environmental disasters. International oil businesses began looking for even more ways to minimize the risks associated with getting oil from the ground to the markets. In addition, the Bosphorus Straits are severely crowded, an accident waiting to happen. Since October of last year Turkish authorities have strengthened requirements on traffic through the Bosphorus Straits in hopes of avoiding such a tragedy. Oil shippers are looking for ways to avoid expected delays at the Straits during the winter months.

Since before the completion of the Odesa-Brody pipeline the United States has been stressing the need for Ukraine to engage international oil companies working in the Caspian Basin to gain long-term commitments to keep the pipeline fully utilized. Despite delays in this process, it is clear that these companies are interested.

Ukraine cannot afford to waver in its European choice. Ukraine must show that it is a reliable partner ready to live up to western international standards of contract negotiations. It will be rewarded with a steady flow of Caspian crude, as well as rising transit, transhipment and port service income. Odesa-Brody's reversal would represent a sharp blow to energy independence - and could solidify Odesa-Brody's future as a doomed liability for the GOU.

The United States Government strongly supports Ukraine's development as a stable, independent, democratic European country with a strong market economy. Commercialization of the Odesa-Brody pipeline represents one step along the road toward economic reform and European integration. It offers a way to strengthen European ties where energy demand is rising, open up new export opportunities and increase cooperation with Slovakia, the Czech Republic, Germany, Hungary, Poland and beyond. Through economic cooperation with countries of the Caspian Sea, Ukraine can also pursue its strategic goal of diversifying its oil and gas supply.

Reversal is not only at odds with Ukraine's professed Euro-Atlantic intentions, it is at odds with Ukraine's desire for energy diversification.

Ukraine imports 89 % of its oil demand largely from Russia and imports 75% of its natural gas needs from or through Russia. Thus, it is dependent on one single source for most of its energy needs.

Serious commercial negotiations are underway to move Caspian oil to Central Europe using the Odesa-Brody pipeline. Why?

1. The supply is available from the Caspian region. Germany and the Czech Republic are already importing light sweet crude using a circuitous sea-based route through the Bosporus Straits and Trieste and environmental concerns with this route are rife.
2. The Bosphorus Straits are reaching their historical limits. Since last October, Turkey has taken action to deter further increases of large tanker traffic while flows to the Black Sea are only projected to increase. A Bosphorus Bypass is needed now, and Odesa-Brody is available.
3. Demand has been established. Germany and the Czech Republic have the capacity and have expressed an interest in importing about 7 mt of light sweet Caspian crude now and Odesa-Brody could deliver it without additional investment. Mr. Todiychuk has also pointed out that western Ukrainian and southern Polish refineries are prepared to take another 3 mt. Odesa-Brody could deliver an additional 4 mt of Caspian crude to German and Austrian refineries with minimal investment.

Western companies are still at the table despite the mixed signals of the Government of Ukraine. That, in itself, proves that Odesa-Brody is commercially viable.

But, in order to close the deal, Ukraine must focus on its long-term economic, energy security and European integration goals. Ukraine must show it is committed and prepared to enter into western standard international contracts and it must show that it is prepared to offer western stakeholders competitive tariffs.

Coal Bed Methane Finally, Ukraine is sitting on top of a huge energy resource. Some Ukrainian and Western experts estimate that Ukraine has as much as 117 trillion cubic meters of coal bed methane reserves, still largely left untapped.

Ukraine enacted the Law on Production Sharing Agreements in October 1999. Unfortunately, enactment was not followed by applications to develop deposits. The absence of proper guidelines for permits and licenses, incomplete passage of regulations, and apparent lack of political will to attract investment severely limit the incentive to develop this area.

Despite the flawed legislative environment, American, Japanese and German firms have still shown interest, indicating Ukraine's huge potential. A renewed effort to fully implement the production sharing agreements law could open the door to a whole series of investments and make a major contribution toward Ukraine's energy independence.

Ukraine is a country with both severe energy challenges and some clear advantages. By energetically using Odessa-Brody to bring Caspian oil to Europe and by pursuing policies that would take advantage of its coal bed methane Ukraine can both establish energy independence and facilitate its integration into the Euro-Atlantic community. These are goals we share with our Ukrainian partners.

Commercial negotiations are underway with all the relevant oil transportation companies, key producers and key oil buyers at the target refineries. As outlined by PWC, Kralupy, Ingolstadt, Vohburg and stage 2

Timetable - deliveries beginning of 2004 - on track

Consistent with growing Caspian oil producers problems this winter Bosphorus constraints. There are specific requests for the route to be available for this winter and terms and conditions being worked out to use the route - provisional arrangements in place to provide access to storage facilities at Pivdenniy, but is expected that superceded by a real transportation.

Ukraine now has the choice of equating intentions with action. Ukraine has a historic opportunity to move boldly towards its Euro-Atlantic future