On 2 October the Ukrainian parliament passed a law (No. 5406-VI) which introduced a number of important and welcome amendments to the production-sharing regime for oil, gas and mineral exploration and production activities in Ukraine (the “Amendment”). The changes are effective from 7 November 2012.

The Amendment affects the legislation governing production sharing agreements (“PSAs”): contracts under which the state (as owner of the subsoil) allows an investor to conduct mineral and/or hydrocarbon exploration and production. In return, the investor shares any production with the state on the terms of the PSA. The principal law governing PSAs is the Law of Ukraine “On Production Sharing Agreements” (“PSA Law”).

The Amendment was drafted through the joint efforts of the Ministry of Ecology, foreign investors (in particular international oil and gas companies interested in PSA projects in Ukraine) and a number of law firms, including the Kyiv office of CMS. Its primary goal is to align the effective Ukrainian PSA legislation with the standards of international best practice and to adjust it to the realities of modern PSA projects. These often have complex multilateral structures, involving national oil and gas companies and international investors, and display the increasing regional focus on unconventional resources, such as shale gas.

The Amendment has brought about the following changes.

Unconventional hydrocarbons

  • The PSA Law now specifically recognises “unconventional hydrocarbons”, which are defined as shale gas, coalbed methane, basin-centred gas, and oil, condensate or other hydrocarbon resources trapped in unconventional reservoirs.
  • Ukrainian legislation remains untailored to the peculiarities of developing unconventional oil and gas resources. As a result, the Amendment now allows the parties to agree in the PSA upon the stages, rules and procedure for developing unconventional oil and gas where these are different from those prescribed by Ukrainian law governing conventional oil and gas projects.

PSA performance

  • The state is now obliged to procure consents, licences and permits not only for the investors which are parties to the PSA, but also for their contractors and subcontractors.
  • The Amendment adds clarity to the existing provision in the PSA Law allowing a subsoil user which has been awarded a “special permit” (i.e. licence) to develop subsoil resources to apply to convert this into a PSA. This had been envisaged by the PSA Law in a general manner as allowing the investor and the government to sign a PSA without following the usually mandatory tender procedure. The Amendment adds detail to this mechanism by (i) introducing a clear procedure for applying to enter into a PSA in these circumstances and (ii) clarifying that not only one, but several special permits held by one or more subsoil users can now be converted into and covered by a single PSA.
  • The concept of “production sharing”, i.e. an in-kind distribution of produced resources between the investor(s) and the state, has been extended expressly to allow an operator to sell all or part of the produced resources due to investor(s) and/or to the state, and replace the in-kind sharing in such circumstances with monetary compensation of the equivalent value, provided that the other parties to the PSA have agreed to this.
  • The state’s right to terminate the PSA for a substantial violation of its terms can now be exercised only on the basis of a court or arbitral tribunal decision. However in order to balance rights of the state and investor(s), the state has been granted the right optionally to suspend operations under the PSA until any dispute regarding its termination has been resolved by a court or by arbitration.
  • The PSA Law now allows investors to recover from cost production not only the costs incurred after the PSA has become effective, but also any costs incurred by investors after the results of the PSA tender award are published (e.g. the cost of geological-data acquisition).
  • The state can now effectively waive its sovereign immunity in a PSA at the request of a foreign investor. The scope of such a waiver will include international commercial arbitration proceedings/awards.

Exemption from numerous requirements and restrictions

  • The National Bank of Ukraine’s licensing requirements and limitations on foreign currency operations will no longer apply to financial settlements performed by investors under the PSA. This includes exemption from the mandatory sale of foreign currency receipts and the so-called “90-day rule” (according to which exported or imported goods or services must be paid for within 90 days of their receipt).
  • The ongoing moratorium on changing the designated purpose of agricultural land is no longer applicable to PSA projects. PSA investors may apply for change of the designated purpose of such land plots to an industrial purpose.
  • PSA investors will now be entitled to construct and operate main (high-pressure) pipelines in Ukraine.
  • PSA investors wishing to supply natural gas produced under a PSA to consumers in Ukraine will not be subject to the price-cap restrictions affecting domestic supplies of gas set by the National Commission for the State Regulation of the Energy Sector (NERC).
  • It has been expressly stated that public procurement procedures will not apply to PSA projects – an important consideration for PSA projects involving partnerships with companies wholly or partly owned by the state.
  • The PSA Law used to prohibit changes to the geographic coordinates of the subsoil block granted under the PSA. That approach did not correspond to accepted international oil and gas practice which would allow investors to relinquish parts of their PSA block upon completion of certain phases of the PSA project. Following the Amendment, the geographic coordinates of the PSA subsoil block can be altered in accordance with the terms of the PSA without further need to amend the PSA – just by introducing changes into the corresponding special permit (licence).
  • PSA projects are now exempt from the requirements of the Law of Ukraine “On Public Private Partnerships”, which in practice had never been focused on PSA projects and was likely to create conflicts between its requirements and those of PSA regulations and procedures.
  • The Amendment now provides for the automatic grant of work permits and related documents to the foreign employees of PSA investors and their contractors.

Administration of the PSA project.

  • The Cabinet of Ministers of Ukraine is now allowed to delegate its powers to administer a PSA project to the specially designated central governmental agency. This change is expected to improve the efficiency of a PSA operator’s interaction with the state.
  • The Amendment greatly simplifies the day-to-day operations of foreign investors’ representative offices in Ukraine, in particular with respect to those operations which are related to the financing of PSA-related activities. The representative offices are now exempted from certain currency control restrictions for PSA-project purposes.
  • The PSA Law has been adapted to accommodate multilateral PSAs. Special permits for PSA subsoil blocks in multilateral PSAs will be issued in the names of all involved investors.
  • Parties to the PSA will now be able to modify the scope of their rights and obligations under the PSA, including their participating shares, with regard to operations in different parts of the PSA block, individual phases of the project, or different types of works. These amendments should allow investors to include more detailed provisions in the PSAs for:
  1. sole risk operations;
  2. carrying a party through the exploration phase;
  3. re-distribution of cost / profit production between the parties based on e.g. the inability of one party to fund operations; and
  4. the forfeiture of a party’s entitlement to production e.g. in the case where it is unable to meet its obligation to fund operations.
  • The PSA Law now clearly provides for the role of the operator and outlines its rights and obligations in a PSA project. Importantly, the operator now has the right to pay taxes and charges on behalf of all of the investors. Also, the operator is no longer required to have its representative office in Ukraine registered within one month of entering into the PSA, but now has three months to do so.

LAW: Law of Ukraine No. 5406-VI “On Amendments to Certain Legislative Acts of Ukraine with Respect to the Performance of Production Sharing Agreements”, dated 2 October 2012.