The international oil and gas industry is continuously tasked with adapting to an ever evolving sanction-regulated environment. The level of sanction activity and implementation in recent years has been unprecedented, partly as a result of the political events which gave rise to the Arab Spring and the opposition to Iran’s nuclear programme. The recent crisis in the Ukraine, and associated sanctions against Russia, have sparked further debate around the need for effective, targeted punitive measures and the consequences they may have for Europe.
This article considers the EU’s sanction regime, explores the effect it has on international oil and gas companies and addresses the short-comings of the EU’s decentralised system.
What are sanctions?
Sanctions are political policy instruments used to encourage jurisdictions acting in contravention of international law to adopt standards supported by the wider global community. They impose measures designed to cause damage to the targeted government, non-state entity or individual ("Target") in order to force it to undertake, or prevent it from undertaking, certain behaviour. They may inhibit the Target from accessing foreign markets for trade or deny it from pursuing financial and other forms of commerce. The professed ultimate objective of a sanction is to preserve or restore global peace and security.
What is the source of EU sanctions?
The UN Security Council imposes sanctions through Security Council resolutions which are binding on the EU. The EU implements all sanctions imposed by the UN Security Council through legislation enacted by the European Council. The process typically results in a European Council regulation which has direct effect in EU member states’ separate legal systems, creating rights and obligations for those subject to them, and overrides national law. Additionally, the EU may decide to impose self-directed sanctions or restrictive measures which go further than a UN Security Council resolution in circumstances in which the EU deems such action to be necessary.
Why do EU sanctions affect international oil and gas companies?
Over the past two decades, the EU has engaged in an active use of restrictive measures in the form of economic and financial sanctions, embargoes and restrictions on admission to a country. Economic and financial sanctions typically take the form of asset-freeze measures which involve the use of funds and economic resources by Targets or persons acting for and on behalf of Targets, and the provision of funds and economic resources to designated Targets. Embargoes may prohibit trade in certain goods, and activities relating to such trade, with Targets (including the flow of arms and military equipment). Visa or travel bans can be imposed preventing certain persons from entering the EU or transit through the territory of EU member states. These sanction measures are part of the EU’s strategy to support the specific objectives of the Common Foreign and Security Policy.
At the time of writing, the EU has announced asset freezes and travel bans against around twenty individuals in Russia and the Ukraine. Companies conducting their business in the oil and gas sector should be particularly vigilant to ensure they act in compliance with EU sanctions, as Ukrainian and Russian entities and individuals who operate in this industry may increasingly become sanction targets.
US sanctions are questionable under international law because they apply extra-territorially to third state parties involved in business activities with the Target. Unlike the US, the EU has refrained from adopting legislation with extra-territorial effect. However, the EU’s recent sanctions against Iran displayed a greater resemblance to those levied by the US than had previously been the case. For example, sanctions were imposed prohibiting the provision of key resources to various parts of the Iranian oil and gas industry, as well as the provision of financial services to that sector. As a result of EU financial sanctions most, if not all, banks and other financial institutions have declined from conducting any business relations with the Iranian regime.
It is clear that EU sanctions are wide reaching and their scope has a significant impact on business activities. They will apply to international oil and gas companies in the following situations:
- within EU territory, including its airspace;
- on board of aircrafts or vessels under the jurisdiction of an EU member state;
- to EU nationals, whether or not they are in the EU;
- to companies and organisations incorporated under the law of a member state, whether or not they are in the EU (this captures branches of EU companies in non-EU countries); and
- to any business done in whole or in part within the EU.
The corporate behaviour, performance and conduct of international companies are powerful channels through which the objectives of sanctions against Targets are achieved. Since an international oil and gas company has little option but to observe EU sanctions to the extent such company falls within the EU’s jurisdiction, these restrictive measures are likely to play a big part in a company’s commercial decision making processes.
Why are EU sanctions difficult to manage?
A principal reason why EU sanctions are difficult for international oil and gas companies based in various EU member states to manage largely stems from the fact that the European Union lacks a centralised licensing body. Instead, the responsibility for implementing and enforcing EU sanctions is delegated to the relevant competent authorities of the EU member states. The potential for variance and discrepancy is rife in a system where there are twenty-eight EU member states, each with their individual national resource constraints and self-centred policy objectives.
Typically, the competent authorities of EU member states are responsible for:
- granting exemptions and licences;
- establishing penalties for sanction violations;
- coordinating with financial institutions; and
- reporting upon the implementation of sanctions to the European Commission.
There have been calls for a central EU licensing body which would produce a single licensing and exemption policy for EU member states. Although EU guidelines on sanctions and best practices for the effective implementation of restrictive measures go some way to plug the gap, arguably a more comprehensive regime for implementing sanctions is required to provide a better level of certainty to international businesses operating in the realms of the EU.
Managing the risks
International oil and gas companies have always had to function in politically active climates. As sanctions initiated by multilateral organisations such as the UN and EU become more fashionable, so too does the exposure to political risk that these companies will face. Given the considerable levels of investment that can only be recouped over extended periods of time, and in accordance with pre-determined contractual apportionments, international oil and gas companies need to be able to recognise, assess and manage these political risks effectively.
Oil and gas companies can relieve the risks imposed on them by sanctions through political lobbying, taking pre-emptive measures and by reacting quickly to sanctions once they are implemented. Commercial negotiations will need to focus on the allocation of risk as a result of one party’s failure to perform or withdrawal from the contract on the grounds of applicable sanctions.
International oil and gas companies need to be proactive and consider both the legal solutions and pre-cure safeguards. Time and effort should be spent focusing on drafting and negotiating the relevant contractual documentation, following a careful risk assessment, instead of deferring to dispute resolution provisions. For instance, careful construction of force majeure provisions can allocate each party’s obligations in the circumstance where an event outside of a party’s control causes contractual performance to become impossible. Thus, whilst conventional force majeure clauses relating to physical events afford relief to an affected party from its liabilities under the contract, oil and gas companies should consider expanding such contractual provisions to cover sanctions and other restrictive measures imposed on them by the UN and EU.
To avoid falling foul of existing EU sanctions, oil and gas companies should also consider putting in place comprehensive compliance procedures and systems to implement applicable sanction regimes. Penalties for breach of sanctions can be severe; a person guilty of a sanction-related offence may be liable on conviction to imprisonment and/or a fine. Falling foul of sanctions also means that a transaction can immediately become unlawful.
In view of the economic significance of the EU, the application of economic financial sanctions can be a powerful tool. But like a chain is no stronger than its weakest link, the effectiveness and success of the EU’s sanction regime depends on all EU member states applying, implementing and enforcing EU sanctions in a consistent manner.
The current EU sanction regime warrants a fully integrated approach which would undoubtedly benefit its policy objectives and move some way to reducing the unduly high economic cost that international oil and gas companies face when operating their businesses in the EU.
In voicing the sentiments of Henry Kissinger: “No foreign policy – no matter how ingenious – has any chance of success if it is born in the minds of a few and carried in the hearts of none”, perhaps now, in the dawn of the recent events which have taken place in the EU’s backyard in the Ukraine and Russia, the EU should further global security measures by tightening its ranks and implementing a more centralised, and better monitored, sanction regime.