23.11.2012

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.