Ukrainian Energy Law
A. Recent Developments in Oil and Gas Regulation
The principal Ukrainian statute governing activities in the upstream oil and gas industry and, in particular, the licensing of oil and gas exploration and production, is the Oil and Gas Act of 12 July 2001 (Oil and Gas Act). However, in the last five years, the Oil and Gas Act has been significantly undermined by the annual State Budget Acts of Ukraine (each a Budget Act), including the most recent Budget Act of 2009. This is because every year these acts have established the requirement that all special permits to explore or produce must be sold exclusively by auction, a special permit for production by negotiation without an auction.
Fortunately, in May 2008, some of the provisions of the Oil and Gas Act, which were suspended by the State Budget Acts for over five years, were finally reinstated, due to the Decision of the Constitutional Court of Ukraine ruling that these provisions in the Budget Act of 2008 regulating the oil and gas licensing regime were unconstitutional and, therefore, void.
The Oil and Gas Act, although stating that subsoil use special permits must be granted on a competitive basis by auction, also establishes the basic principle that licensees performing exploration works in an area based on an exploration license shall have a priority right to be granted a special permit for production in that area (the term special permits is used in Ukraine for oil and gas licenses). Assuming that exploration works were performed at the licensee’s expense, if the licensee can obtain a special permit for production by negotiation without an auction, then wishes to conduct commercial production. Such a rule is obviously necessary for investment to be made in exploration, since nobody will spend money on exploration just to allow others to save their cash in order to later bid higher at an auction for production rights.
However, in 2009, according to Article 5 of the Budget Act 2009, the sale of special permits for the use of the subsoil, including those for oil and gas exploration and production, licenses, was again required to be by auction, except for specially exempted cases, as determined by the Cabinet of Ministers. The Cabinet of Ministers then adopted the following resolutions to govern the process for licensing exploration and production of oil and gas and other minerals:
(1) Approval of the Procedure for the Issuance of Special Permits for the Use of the Subsoil in 2009, No. 608 (Resolution No. 608), and (2) Approval of the Procedure for the Carrying Out in 2009 of Auctions for the Sale of Special Permits for the Use of the Subsoil, No. 609 (Resolution No. 609).
Resolution No. 608 provides the general rule that exploration and production special permits are only issued to the winners of auctions, and for special permits, subject to a number of limited exceptions where the state has a majority interest, for which a special permit may be issued without an auction.
The 2009 Budget Act provides for a special regime, and pricing, for the sale of oil and natural gas that is produced. In particular, according to Article 3 of the Budget Act 2009, (i) enterprises where the percentage of state-owned shares in the charter capital is more than 50%, (ii) companies of which more than 50% of shares are held by majority state-owned companies, (iii) subsidiary enterprises of such enterprises and companies, and (iv) participants of joint activity agreements and/or persons authorized by joint activity agreements concluded with the participation of such “state-controlled” enterprises are required to perform monthly sales of:
(1) all produced crude oil and gas condensate, except that which is used for its own technological needs, as well as liquid gas, exclusively by auctions; and
(2) all produced natural gas (including accompanying petroleum gas) for the needs of the population, to the entity as directly authorized by the Cabinet of Ministers and at the price determined by the National Electricity Regulatory Commission of Ukraine,
Resolution No. 608 also cancelled certain previously existing special rights re-issue special permits where (1) the special permit holder is reorganized; (2) there is a change in the special conditions of the special permit or of the use of granted subsoil area; or (3) there are merely changes in the legal name or legal address only of the special permit holder. Furthermore, Resolution No. 608 expressly cancelled the previously existing rights of the Ministry to agree on amendments to the terms of a special permit or license agreement after it is signed.
Since 2004, the priority right of investors exploring for oil and gas under an exploration special permit to receive a production special permit, which, as explained, has been limited by the Budget Acts, has been restored every year by resolutions of the Cabinet of Ministers. This instability in the licensing regime certainly discourages both foreign and Ukrainian investment in oil and gas. However, this instability makes long-term planning difficult. Such planning is vital for a capital intense activity like oil and gas exploration and production. This problem appeared to have been resolved by the Decision of the Constitutional Court of Ukraine, but the new restriction on priority licensing for in the Budget Act of 2009 raises doubts as to whether the issue will be definitely rescued.
One positive regulatory development in this sector is the provision of the Oil and Gas Act, which establishes that a subsoil user that has properly performing personal obligations under a special permit and a license agreement has the right to extend the validity of its special permit when it expires, as is further provided by Resolution No. 608.
Until the priority right to receive a production special permit is explicitly recognized and guaranteed on a long-term basis for investors exploring for oil and gas under an exploration special permit, private investors, especially multinational energy companies that are able to bring much needed modern technology to Ukraine, will find it difficult to justify making any investments in exploration for oil and gas in Ukraine. (This same problem applies for the exploration and production of all other natural resources in Ukraine.)
B. Legal Framework for the Electricity Power Sector
The development of the laws governing the Ukrainian electric power sector is guided, in particular, by the Energy Strategy of Ukraine through 2030 of 15 March 2006 (Energy Strategy) approved by the Cabinet of Ministers of Ukraine. The most important recent developments concern regulatory steps for the future restructuring of the electric power market in Ukraine and further amendments to electricity legislation on the procedures for recovering debts, on activities subject to licensing and on the introduction of a “green tariff”.
1) Liberalization of the Ukrainian Power Energy Market
The Energy Strategy contains the main plans for the development of all sectors of the Ukrainian energy market, including the electricity power industry. In particular, the Energy Strategy, with reference to the Conception for the Operation and Development of the Wholesale Electricity Market of Ukraine of 16 November 2002 (Conception Study), provides for a gradual shift from the current wholesale market model to a full-scale competitive market model. This will include a combination of the following: (a) a balanced market; (b) a direct contracts market; © an additional services market; and (d) a financial contracts market. (The current centralized system was originally adopted by following the rather unique UK and Argentinean systems, which are now generally considered as inappropriate for Ukraine.)
The model proposed by the Energy Strategy and the Conception Study is expected to eventually enable Ukraine’s integration in the European Union’s electricity power system, where most countries employ a similar market model. Liberalization of the electricity power energy market is also recommended in the Nationwide Program for the Adaptation of Ukrainian Legislation to the European Union Act (adopted by the Ukrainian Parliament on 18 March 2004), according to which the energy industry belongs to the priority areas for the adaptation of Ukrainian legislation to that of the legislation of the European Union Community.
2) Debt Recovery Procedures
The period for application of the special debt recovery procedures for enterprises in the energy industry, including those provided for by the Measures Aimed at Ensuring the Stable Operation of Enterprises in the Energy Industry Act of Ukraine (Debt Recovery Act) introduced in 2005, have been extended until 1 January 2011. These regulations govern, in particular, the procedure for the participation of energy industry enterprises in debt recovery procedures, and the applicable reporting requirements.
3) Other Developments
The Electrical Energy Act of 16 October 1997 (Energy Act) was recently amended to encourage the production of electrical and thermal power from alternative sources of energy (e.g. wind and solar energy, energy produced by small hydroelectric power stations, etc.). These amendments provide for the introduction of a special “green tariff” for the purchase of electric power generated from such alternative sources.
The National Electricity Regulatory Commission (NERC) of Ukraine has also introduced changes so that its electric power production licensing rules cover not only wind energy producers, but also enterprises producing electricity from other alternative energy sources.