On October 31, 2017, the US Treasury Department’s Office of Foreign Assets Control amended Directive 4 of the Ukraine/Russia-related sectoral sanctions, which targets the Russian energy sector, and updated its guidance regarding the implementation of Ukraine/Russia-related sanctions. OFAC amended Directive 4 in accordance with section 223(d) of Title II of the Countering America’s Adversaries Through Sanctions Act (“CAATSA” see our previous blog post on the CAATSA here), which requires the Secretary of the Treasury to make such modification to Directive 4 within 90 days of the statute’s enactment. The CAATSA-related prohibitions that OFAC added to Directive 4 will become effective on January 29, 2018. OFAC originally published Directive 4 in September of 2014, pursuant to Executive Order 13662.
OFAC’s Amendment of Directive 4
OFAC expanded the scope of the Directive 4 prohibitions. Previously, Directive 4 prohibited US Persons from providing, exporting, or re-exporting, directly or indirectly, goods, non-financial services, or technology in support of exploration or production for deepwater, Arctic offshore, or shale projects that have the potential to produce oil in Russia or in maritime area claimed by Russia and extending from its territory, and that would involve any person determined to be subject to Directive 4. The list of persons determined to be subject to one or more Executive Order 13662 directives can be found on OFAC’s Sectoral Sanctions Identifications List (the “SSIL”).
The amended Directive 4 contains an additional prohibition on US Persons. For deep water, Arctic offshore, or shale projects initiated on or after January 29, 2018 that have the potential to produce oil in any location—not just in Russia– the amended Directive 4 prohibits US Persons from providing, exporting, or re-exporting, directly or indirectly, goods, non-financial services, or technology in support of the exploration or production for those projects that a person subject to Directive 4 either (1) has a 33 percent or greater ownership interest or (2) owns a majority of the voting interests. Directive 4 does not apply to the prohibition of financial services, such as clearing transactions.
OFAC clarified in its new FAQ 537 that the amendments to Directive 4 do not change the applicability of OFAC’s so-called “50 percent rule” in the Directive 4 context. Instead, the references to “33 percent or greater ownership” and “ownership of a majority of the voting interests” refer to a Directive 4 SSIL person’s ownership interest in a deepwater, Arctic offshore, or shale project. The 50 percent rules still applies. In other words, the new Directive 4 prohibition applies to dealing with projects 33 percent (or majority voting interest) owned by persons determined to be subject to Directive 4, as well as to projects 33 percent (or majority voting interest) owned by entities that are themselves owned 50 percent or more by one or more persons determined to be subject to Directive 4. For example, if Company A, which is subject to Directive 4, owns 55 percent of Company B, then due to the 50 percent rule Company B is also subject to Directive 4. If Company B owns 40 percent of a deepwater oil project, US persons may not deal with that deepwater oil project.
OFAC aggregates ownership stakes of all entities subject to Directive 4 (including entities owned 50 percent or more by one or more persons determined to be subject to Directive 4) when determining whether a project is 33 percent or more owned by a person subject to Directive 4, or whether a person subject to Directive 4 owns a majority of the voting interests in a project. If two entities subject to Directive 4 each own 20 percent of an Arctic offshore project, US persons would be prohibited from dealing with that project.
Additional guidance from OFAC regarding Directive 4 clarifies the following:
- If an energy project has the potential to produce gas only, and not oil, then the Directive 4 prohibitions do not apply.
- The term “shale projects” applies to projects that have the potential to produce oil from resources located in shale formations. The prohibitions in Directive 4 do not apply to exploration or production through shale to locate or extract crude oil or gas in reservoirs.
- The term “Arctic offshore projects” applies to projects that have the potential to produce oil in areas that (1) involve drilling operations originating offshore, and (2) are located above the Arctic Circle. The prohibitions do not apply to horizontal drilling operations originating onshore where such drilling operations extend under the seabed to areas above the Arctic Circle.
- In the context of the new prohibition on dealing with certain projects “initiated” on or after January 29 2018, a project is “initiated” when a government or any of its political subdivisions, agencies, or instrumentalities (including any entity owned or controlled directly or indirectly by any of the foregoing) formally grants exploration, development, or production rights to any party.
Additional CAATSA Guidance from OFAC
In addition to the amended Directive 4 and related guidance, OFAC also published FAQs related to CAATSA sections 223(a), 226, 228, and 233. These CAATSA provisions relate to potential targets of sectoral sanctions, the imposition of sanctions with respect to non-US financial institutions, sanctions with respect to certain transactions with foreign sanctions evaders, and sanctions with respect to investment in or facilitation of the privatization of state-owned assets by Russia.
Key guidance offered by OFAC in these FAQ:
- Section 223(a) does not require the Secretary of Treasury to impose sanctions on Russian state-owned entities operating in the railway or metals and mining sector. The United States may or may not impose such sanctions in the future.
- Under Section 226, which amends the Ukraine Freedom Support Act, foreign financial institutions will face sanctions if the Secretary of Treasury determines that they knowingly engaged in “significant transactions” involving certain defense- and energy-related activities, or knowingly facilitated significant financial transactions on behalf of any Russian person added to OFAC’s Specially Designated Nationals and Blocked Persons List (“SDN List”) for reasons related to the conflict in Ukraine. OFAC will interpret the term “financial transaction” broadly to encompass any transfer of value involving a financial institution. In addition, the Secretary of the Treasury will prohibit the opening and prohibit or impose strict conditions on the maintaining in the United States of correspondent accounts for any foreign financial institution that has engaged in such sanctionable behavior.
Sections 225 and 232 Guidance from State DepartmentSection 225
In conjunction with OFAC’s guidance, the US Department of State published guidance regarding CAATSA Sections 225 and 232.
CAATSA Section 225 requires the Secretary of State, in consultation with the Secretary of Treasury, to impose sanctions on non-US persons who knowingly make a significant investment in a special Russia crude oil project on or after September 1, 2017, absent a determination that the sanctions are not in the national interest of the United States. Prior to the enactment of CAATSA, imposition of such sanctions had been discretionary. In its guidance, the State Department clarified:
- A “special Russian crude oil project” is a project intended to extract crude oil from:
- The exclusive economic zone of Russia in waters more than 500 feet deep;
- Russian Artic offshore locations; or
- Shale formations located in Russia.
- The term “knowingly,” with respect to conduct, a circumstance, or a result, means that a person has actual knowledge, or should have known, of the conduct, the circumstance, or the result.
- “Investment” could include arrangements where goods or services are provided in exchange for equity in an enterprise, or rights to a share of the revenue or profits of an enterprise.
- To determine whether an investment is “significant,” the State Department will consider the totality of the facts and circumstances surrounding the investment, and weigh various factors on a case-by-case basis. The factors considered in the determination may include, but are not limited to, the significance of the transactions to US national security and foreign policy interests, in particular where the transaction has a significant adverse impact on such interest; the nature and magnitude of the investment, including the size of the investment relative to the project’s overall capitalization; and the relation and significance of the investment to the Russian energy sector.
- An investment is not significant if US persons would not require specific licenses from the OFAC to make or participate in it.
CAATSA Section 232 authorizes the Secretary of State, in consultation with the Secretary of Treasury, to impose discretionary sanctions on persons who (1) make an investment directly and significantly enhances the ability of Russia to construct energy export pipeline projects initiated on or after August 2, 2017; or (2) sell, lease, or provide goods or services that directly and significantly facilitate the expansion, construction, or modernization of such energy export pipelines by Russia. In its guidance, the State Department clarified:
- The focus of such sanctions would be on energy export pipelines that (1) originate in Russia, and (2) transport hydrocarbons across an international land or maritime border for delivery to another country.
- Pipelines that originate outside of Russia and transit through the territory of Russia “would not be the focus” of sanctions implementation.
- A project is considered to have been “initiated” when a contract for the project is signed.
- Investments and loan agreements made prior to August 2, 2017 would not be subject to Section 232 sanctions.
- Implementation of Section 232 sanctions would not target investments or other activities related to the standard repair and maintenance of pipelines in existence on, and capable of transporting commercial quantities of hydrocarbons, as of August 2, 2017.