Fundamentals of the Legal Regulation of Production Sharing Agreements in the Russian Federation
Sergei Gudkov, Deputy Director for Legal Issues of the SRP-Nedra Centre
In addition to a conventional system of subsoil use based on a state licensing system, a regime of production sharing agreements (PSAs) based on civil relations is practised in the Russian Federation.
The basic law regulating relations in the sphere of the conclusion, fulfilment and termination of a PSA is the Federal Law On Production Sharing Agreements («the PSA Law») effective since 11th January 1996. Individual issues concerning PSAs are also governed by the Civil Code of the Russian Federation, the Law of the Russian Federation On Subsoil Use, the Federal Laws On the Continental Shelf of the Russian Federation, and On Precious Metals and Stones, plus other laws and regulations. Entities of the Russian Federation carry out the legal regulation of their participation in PSAs within the powers set forth by the Constitution and federal laws.
Compared with the subsoil use based on a conventional tax system applied in the Russian Federation, the PSA regime has a number of sound advantages which make it attractive to Russian investors, and especially to foreign ones.
First, the state acts as a party to the PSA and as a guarantor of its fulfilment, establishing its relations with the investor on principles of equal rights and mutual profit.
Second, it simplifies the taxation regime. In accordance with Article 13 of the PSA Law, the investor is granted exemptions for the entire duration of the agreement from taxes, duties, excises and other obligatory payments, except for profit tax, royalties and obligatory deductions for federal non-budget funds (the Pension Fund of the Russian Federation, the Social Security Fund, the Fund of Obligatory Medical Insurance, and the State Employment Fund of the Russian Federation).
Third, the law ensures the stability of the conditions of the agreement signed between the state and the investor. In particular, the PSA terms and conditions remain valid during the entire duration of the agreement. Amendments may be made only with the consent of the parties, or in cases of material changes in circumstances in accordance with the civil laws.
Should, during the period of the PSA validity, the laws of the Russian Federation, the laws of entities of the Russian Federation and the regulations of local authorities establish norms worsening the commercial benefits of the investor’s activity within a PSA, the agreement is amended to ensure to the investor such commercial results as the investor could have obtained under the laws in force as of the date of signing the agreement.
Fourth, an important issue is the opportunity to export out of the Russian Federation’s customs territory the mineral resources transferred to the investor’s ownership under the agreement on terms and in the manner set forth in the agreement without any export quotas. Exceptions are made for cases provided for in the Federal Law On State External Trade Regulation.
In accordance with Article 2 of the PSA Law, a production sharing agreement is a contract under which the Russian Federation grants to a business entity (an investor) the exclusive rights to prospect, explore and produce mineral resources in any subsoil block described in the agreement, and to carry out related operations, on a chargeable basis and for a certain period. The investor, for its part, is obliged to carry out the specified operations at its own risk and expense. The agreement sets forth all the required conditions relating to the use of subsoil, including conditions and procedures for sharing the production between the parties to the agreement.
PSAs may be signed for all types of mineral resources, except for diamonds (Article 25 of the Federal Law On Precious Metals and Stones). PSAs in effect are signed for hydrocarbons most of all.
So far, four PSAs on hydrocarbon fields – Sakhalin-1, Sakhalin-2, Kharyaginskoye field, and Samotlorskoye field – have been signed in the Russian Federation. The first three agreements were signed before the effective date of the Federal Law On Production Sharing Agreements, and they are being implemented based on the terms and conditions set forth therein.
The Sakhalin-1 (Chaivinskoye, Arkutun-Daginskoye and Odoptinskoye oil fields) and the Sakhalin-2 (Piltun-Astokhskoye and Lunskoye oil and gas fields) projects have been implemented on the shelf off Sakhalin Island. The Kharyaginskoye oil field project has been implemented in the Nenets Autonomous Region. The PSA on the Samotlorskoye oil and gas condensate field (the territory of the Khanty-Mansy Autonomous Region) signed in December has not yet entered into force, and is now at the stage of operation organisation.
In accordance with Article 3 of the PSA Law, the parties to the agreement are as follows:
• the Russian Federation (the state), on behalf of which the agreement is entered into by the Government of the Russian Federation and an executive body of an entity of the Russian Federation, in the territory of which the block of subsoil resources to be used is located; or their authorised bodies;
• investors – citizens of the Russian Federation, foreign citizens, legal entities and associations of legal entities which are created on the basis of a joint venture agreement and not having the status of a legal entity, investing their own, borrowed or outside funds (property and (or) proprietary rights) in mineral prospecting, exploration and production, and being subsoil users in the terms of the agreement.
In cases when the investor is represented by an association of legal entities which does not have the status of a legal entity, the members of such association have joint and several rights and obligations under the agreement.
In cases when a subsoil block is located within a continental shelf or an exclusive economic zone of the Russian Federation, the state is represented by the Government of the Russian Federation, which, however, should co-ordinate its position in signing agreements with executive bodies of those entities of the Russian Federation, in the territory of which the operations under the agreement will be carried out.
Production sharing agreements can only be signed for those subsoil blocks which are on the list and can be used under production sharing terms. The lists are approved in federal laws or, in a simplified manner, in accordance with the resolutions of the Government of the Russian Federation or of government authorities of an entity of the Russian Federation.
To date, twelve laws approving lists of subsoil blocks have been passed. In total, 24 blocks are on the list (20 oil blocks, 1 gas block, 2 gold blocks and 1 iron ore block).
Lists may be approved based on resolutions of the Government of the Russian Federation or government authorities of an entity of the Russian Federation in cases, when the specified subsoil blocks include the following mineral fields:
• oil fields with recoverable reserves of under 25 million tonnes;
• gas fields with reserves of under 250 billion cubic meters;
• native gold fields with reserves of under 50 tonnes;
• placer gold fields with reserves of under 1 tonne;
• other mineral fields not classified as strategic minerals and currency values.
So far, the Government of the Russian Federation has not passed any resolutions on the inclusion of the mineral fields classified above in the lists.
The PSA Law allows for the use of not more than 30% of explored reserves and reserves registered by the state under the production sharing terms.
In the Russian Federation, the explored reserves of all minerals are subject to be registered by the state, with information on the quantity, quality and degree of exploration of minerals by commercially valuable fields provided. The registration of mineral reserves and their writing off are carried out in the manner established by a federal body of the state subsoil fund management, the functions of which are performed by the Ministry of Natural Resources of the Russian Federation (the MNR of Russia).
At present, the degree of the use of quotas on blocks included in the lists established in federal laws or prepared for being included in such lists is as follows:
• oil – 26.5%;
• natural gas – 11.2%;
• gold – 13.4%;
• iron ores – 9.5%.
It should be mentioned that the 30% limitation is not imposed on subsoil blocks which do not contain mineral fields, but are prospective for them.
As generally accepted, the state signs PSAs with the winners of tenders (auctions). Tenders or auctions for the use of subsoil blocks under production sharing terms are aimed at selecting a winner with whom the state will negotiate and sign an agreement.
Tenders and auctions are organised by the MNR of Russia and its territorial bodies which carry out its work in co-operation with the executive bodies of concerned entities of the Russian Federation.
Winners of tenders and auctions are granted an exclusive right to negotiate with the state and, if an agreement is reached, to sign a contract. The winners obtain the right to use a relevant subsoil block after signing the agreement, which is certified by a license issued within 30 days from the date of signing the agreement.
PSAs may be signed without tenders by a joint resolution of the Government of the Russian Federation and an executive body of a relevant entity of the Russian Federation in the following cases:
• when state defence and security interests require an agreement to be signed with a concrete investor, if a corresponding provision is made in federal law establishing a list of subsoil blocks;
• when an announced tender or an auction is considered invalid due to the participation of only one investor. In this case, an agreement may be signed with the investor who has participated in the tender or the auction on the terms of such tender or auction;
• when the investor is a subsoil user prospecting and producing on terms provided in the laws of the Russian Federation, other than production sharing terms, as of the effective date of the Federal Law On Production Sharing Agreements. In this case, an agreement may be signed with this subsoil user or any other legal entity or an association of legal entities created with the participation of this subsoil user;
• when negotiations with an investor for the preparation of draft agreements were commenced before the effective date of the Federal Law On Production Sharing Agreements as agreed with the Government of the Russian Federation and an executive body of a relevant entity of the Russian Federation.
When fulfilling agreements, the lawful rights and interests of the Russian Federation are observed by the Commission of the Russian Federation on the co-ordination of the work of federal executive bodies and government bodies of entities of the Russian Federation, established by the Decree of the President of the Russian Federation No.695 On Measures for the Fulfilment of the Federal Law On Production Sharing Agreements dated 8th July 1997.
The terms of subsoil use are established and draft agreements on each subsoil block are prepared by commissions which are appointed by the Government of the Russian Federation as agreed upon by the executive body of a relevant entity of the Russian Federation and proposed by the Commission of the Government of the Russian Federation on the co-ordination of the work of federal executive bodies and government bodies of entities of the Russian Federation.
Commissions consist of representatives of federal executive bodies, including representatives of the federal body of the state subsoil fund management and (or) its territorial subdivision, and representatives of an executive body of a relevant entity of the Russian Federation.
In accordance with the aforementioned Decree of the President of the Russian Federation No.694 dated 8th July 1997 and Resolution of the Government of the Russian Federation No.1132 dated 2nd September 1997, the rights and obligations of the Russian Federation under production sharing agreements for hydrocarbon fields are exercised and performed by the Ministry of Energy of the Russian Federation. Similar functions under agreements on other minerals are performed by the MNR of the Russian Federation.
Other federal executive bodies of the Russian Federation take part in the preparation, signing and fulfilment of agreements in accordance with the regulations of such bodies and the instructions of the Government of the Russian Federation.
The preparation of an agreement for signing, and negotiations with the winners of tenders and auctions, as well as persons entitled to negotiate and sign agreements without tenders and auctions, are the responsibility of the relevant commission.
A prepared draft agreement should be co-ordinated by the aforementioned commission and the federal executive bodies and the executive bodies of the relevant entity of the Russian Federation.
A resolution on signing the agreement on behalf of the state is made by the Government of the Russian Federation and an executive body of a relevant entity of the Russian Federation or, in cases stipulated in the PSA Law, by the Government of the Russian Federation with the approval of an executive body of the relevant entity of the Russian Federation.
PSAs should contain provisions required in laws of the Russian Federation. An agreement may also include other provisions agreed by the parties but not contradicting the laws of the Russian Federation. The requirements for PSAs are set forth in many normative and legislative acts regulating relations in this sphere, which creates additional problems in the preparation and signing of PSAs.
It should be noted that PSAs are concluded individually on each block. There is no model (standard) production sharing agreement authorised by government authorities in the Russian Federation.
Operations under agreements are carried out in accordance with programmes, plans and estimates developed and approved in the manner established in agreements and in accordance with the provisions of the PSA Law.
Operations under agreements are organised by the investor or by an operator of the agreement on the investor’s instructions. The operator’s activity is limited to the organisation of such operations. The operator may be represented by branches and legal entities specially established by the investor in the territory of Russia for such purposes, or legal entities attracted by the investor, or foreign legal entities operating in the territory of the Russian Federation. The investor bears material responsibility to the state for the actions of the operator of the agreement, as for its own actions.
Operations under agreements are co-ordinated by a steering committee created by the parties in accordance with the PSA Law.
Production under PSAs is divided between the state and the investor in accordance with the agreements, which should establish terms of and procedures for:
• definition of the overall production and its value;
• definition of a share of production (including its limit) to be transferred to the investor for reimbursement of its costs and expenses for operations under the agreement (compensatory production). The list of costs to be reimbursed to the investor from compensatory production is established in the agreement in accordance with Resolution No.740 of the Government of the Russian Federation dated 3rd July 1999;
• sharing of profitable production between the state and the investor; such profitable production should mean production less the share of production used for payment of royalties in accordance with the PSA Law, and compensatory production.
The investor owns compensatory production together with a share of profitable production which is the investor’s share under the agreement.
The state’s share of profitable production and its value equivalent is divided between the Russian Federation and the subject of the Russian Federation based on the agreements signed by the relevant executive bodies of the Russian Federation and the executive bodies of the subject of the Russian Federation.
When the agreement is expired or terminated earlier, the investor should dismount, liquidate and (or) conserve the equipment, boreholes and other facilities in the field, as well as reclaim lands within the territory on which operations under the agreement were carried out, unless otherwise stipulated in the agreement.
Liquidation operations under a PSA are financed from a liquidation fund created by the investor. The amount of the fund as well as terms of its formation and use are set forth in the agreement in accordance with Resolution No.741 of the Government of the Russian Federation dated 8th July 1999.
State supervision over the fulfilment of the agreement is carried out by the federal government authorities together with the government authorities of the relevant subject of the Russian Federation. A document regulating the procedures and terms of state supervision is currently under development.
Disputes between the state and the government arising from the fulfilment, termination and invalidity of agreements are settled in the courts or in arbitration, including international arbitration, in accordance with the agreements.
When signing an agreement with a foreign investor, such an agreement may provide for the state’s waiver of legal immunity, immunity from preliminary claim security and the enforcement of a court and (or) arbitration award.
PSAs application in Russia have been complicated by numerous organisational, legal, financial and economic problems. In particular, a package of regulations ensuring the fulfilment of the PSA Law has not been developed, and the competencies of the federal executive bodies in this sphere is still to be clearly defined, etc.
These issues were discussed at a meeting of the Government on 31st August 2000. Special attention was placed on the necessity for further improvements in the PSA laws in order to create favourable conditions for attracting Russian and foreign investment in the fuel, energy, and mineral sectors of Russia. The Government also approved a schedule for the preparation of legislative and normative acts on PSAs, which provides for amendments to the basic Federal Law On Production Sharing Agreements, the Federal Law On the Continental Shelf of the Russian Federation, the Water Code of the Russian Federation, and other acts.
When passed, these acts will allow the process of PSA signing and fulfilment to be regulated in order to establish a reasonable balance of interests between the state and the investors.
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