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CB - Converting licences into PSAs in Ukraine
1. Converting subsoil licences into production sharing agreements in Ukraine 1
Converting subsoil licences into
production sharing agreements in
Ukraine
Offering a number of significant benefits to investors, production sharing
agreements ("PSAs") represent potentially attractive tool for doing upstream
business in Ukraine. Investors may convert their existing subsoil licences into
PSAs to take advantage of a direct contract with the State of Ukraine, cost
compensation mechanism and legislative stabilisation protections.
What PSA is and how it
works
Key features of PSAs
PSA is one of the tools for investors to carry out the
upstream business in Ukraine, along with getting a subsoil
licence and entering into a joint activity agreement with a
holder of a subsoil licence. Under PSAs, investors contract
directly with the State of Ukraine.
PSAs are used to attract significant investments in
exploration and production of mineral resources by granting
especially advantageous terms and guarantees. To date,
PSAs in Ukraine have been concluded in respect of large
subsoil blocks which potentially contain strategic volumes
of hydrocarbons. However, the law allows PSA to be
concluded in respect of any blocks regardless of their size.
While the State of Ukraine does not usually invest in
exploration, under the PSA regime it has the right to receive
certain share of the produced minerals. The State also
receives cash flows from a limited number of taxes payable
by the PSA investors.
The investor invests a pre-agreed amount of funds in
exploration. If the project is successful, the investor may
use part of the extracted minerals (up to 70%) to recover its
costs (knows as "cost production") until they are fully
recovered.
The remaining minerals are the "profit production" and are
shared between the state and investor in proportions set
out in the PSA.
Why convert licence into PSA
Key benefits of PSAs
Legislative stabilisation
With limited exceptions, PSA investors obtain the benefit of
a legislative stabilisation which allows investors to apply
those laws which exist as at the date of conclusion of the
PSA. This gives investors a higher degree of certainty as
to the rules that apply to the conduct of business in Ukraine
which is not otherwise available in Ukraine. The laws in
Ukraine are fast changing. Such changes are often very
July 2015Briefing note
Key issues
PSA is an investor's opportunity to switch its
existing licences to a preferential regime.
Conversion procedure is relatively simple but its
successful completion is subject to discretion of the
State of Ukraine.
Taxation of PSAs requires improvement to make it
an efficient tool for investments in upstream
business.
2. 2 Converting subsoil licences into production sharing agreements in Ukraine
controversial and unfavourable which makes an efficient
business a challenging exercise in Ukraine.
Long-term projects
PSA projects may be concluded for up to 50 years. While
such long-term contracts are mostly relevant for very large
investment projects, this provides investors with additional
stability assurance and long-term business planning and
budgeting. Unlike PSAs, licences are usually issued for the
period of five (5) years with no prolongation guarantees.
Ability to negotiate the terms
Investors operating under general licensing regime must
comply with the terms of a license and general
requirements of Ukrainian legislation. There is no ability to
negotiate the terms of the license with the State or alter
legislative rules.
In contrast with this regime, the PSA investors and the
Ukrainian government may directly negotiate and
customise a number of terms of the business which would
otherwise be regulated. These include, for example, the
ability to negotiate the VAT refund procedure or project
phases for unconventional PSAs.
Ability to attract co-investors
Where the holders of subsoil licences lack funds,
technologies or knowledge, they are allowed to invite other
partners to co-invest as they may think fit. Unlike general
licensing regime, such additional partners become PSA co-
investors and obtain the stake in the upstream project and
may subsequently cash out by selling it.
Simplified tax and currency control regime
There approximately are a dozen of various national and
local taxes and mandatory payments payable in Ukraine.
Ukrainian law exempts PSA investors from most of them.
The PSA investors will only be subject to VAT (currently –
20%), corporate profits tax (currently – 18%) and royalties
(currently from 0.75% to 70%, depending on the type of
mineral). No other taxes will apply to PSA investors.
The currency control regime in Ukraine is one of the
strictest in the world. However, the PSA investors are
exempt from the following currency control restrictions:
obligation to reclaim, within ninety (90) days, foreign
currency for supplied products or services (or products
or services after making advance payments) under
cross-border contracts;
mandatory sale of foreign currency funds;
registration of loan agreements with foreign lenders
and maximum NBU interest rate cap;
requirement to obtain price evaluation act to pay to
foreign service providers; and
requirement to obtain license to buy and transfer
foreign currency or to place foreign currency at the
overseas bank accounts.
Ability to include several separate blocks under one
PSA
PSAs may cover subsoil block(s) of any size. It is also
possible to combine several subsoil blocks (even non-
adjacent) in one PSA. Consequently, the holders of several
licences may consolidate them under one PSA on the
agreed terms.
Foreign dispute resolution forum
Disputes under the PSAs may be subject to international
arbitration. The State, acting through the Ukrainian
government, has a right to waive its sovereign immunity.
Such option is not available under licensing regime and
dispute resolution remains subject to the implications and
uncertainties inherent in the Ukrainian judicial system.
Conversion procedure
The conversion procedure is generally straightforward.
Most importantly, the investor does not have to follow an
auction or tender process which would usually apply in
case of issuance of a new licence or conclusion of a PSA
for the "green fields". However, the decision on whether or
not to conclude the PSA remains at the discretion of the
Ukrainian government. The procedure involves the
following key steps:
the investor alone or jointly with other co-investors
request ad hoc conversion of the licence(s) into PSA;
the Interagency Commission on PSAs may (but is not
obliged to) recommend conversion to the Cabinet of
Ministers of Ukraine (the "CMU");
the CMU, within three (3) months following the request
of investor(s), makes a decision on whether or not to
convert the licence(s);
the parties carry out PSA negotiations and obtain the
relevant state and municipal approvals; and
the parties conclude the PSA (no later than twelve (12)
months following the decision of the CMU to kick off
the PSA negotiations).
3. Converting subsoil licences into production sharing agreements in Ukraine 3
Key challenges of the PSA
regime
While the PSAs have significant benefits, there are
currently serious challenges that restrain wide application of
this business model in Ukraine. Below are the challenges
that we consider most material.
High tax rates
In summer 2014, the special reduced rates of subsoil use
royalty of 2% for oil and condensate and 1.25% for gas
were abolished and since then any new PSAs would have
been subject to general royalty rates.
Unfamiliarity of local authorities with the
PSA regime
Although the first PSA in Ukraine was concluded back in
2007, since then little progress have been achieved in
implementing any of them. Accordingly, the local authorities
are not well informed of the concept of PSA and its key
distinctive features allowing the investors to customize the
terms of business in the PSA and, in some way, override
certain legislative provision that the local authorities
otherwise commonly apply in the upstream projects.
From the practical perspective, it is advisable for investors
to proactively work together with the local authorities to
clarify the specifics of the PSA regime and the agreed
business terms so that to ensure maximum cooperation at
the local level.
Political implications
As PSAs are concluded directly with the Ukrainian
government, these projects imply essential political context.
They require cooperation and full support on part of the
government. In this turbulent time, Ukraine has seen rapid
political transformations and changes in the vector of
nation-wide development. These changes make it hard for
investors to predict the future business climate and the
rules for upstream operations in Ukraine.
No successful precedents in Ukraine
The Ukrainian government has signed several PSAs with
foreign investors, including major multinational companies,
such as Shell, Chevron, and Eni, however, for a number of
reasons none of them has become fully operational so far.
Lack of practice and real life examples makes PSAs only a
potentially attractive but 'yet-to-be-tested' tool for the
investors in the upstream business in Ukraine.
investor (alone or
jointly with co-
investors) develop the
commercial terms for
the project
investors submit
application to convert
licence(s) into PSA
Interagency
Commission on PSAs
submits its views as to
conversion to CMU
CMU makes a decision
as to conversion
parties negotiate PSA
and procure relevant
approvals
parties conclude PSA
