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In this chapter of Doing business in Russia, we outline the key aspects of the regulation of the oil & gas sector with a specific focus on a foreign investor’s perspective.
Alongside other natural resources, oil and gas remains the “flagship” and one of the most highly regulated sectors of the Russian economy. Its legal framework is centred around the regime of the Russian subsoil, its use and licensing.
The key legislation framing up the legal regime of the Russian oil & gas industry is:
Federal Law No. 2395-1 “On Subsoil” dated 21 February 1992 (the “Subsoil Law”); and
Federal Law No. 225-FZ “On Production Sharing Agreements” dated 30 December 1995 (the “PSA Law”).
The Subsoil Law serves as the cornerstone of the legislation on the use of subsoil in Russia and essentially regulates all key issues relating to geological surveying, exploration and production of natural resources, including oil and gas.
The PSA Law specifically deals with the collaboration of Russian and foreign investors with the Russian state in geological surveying, exploration and production of natural resources under production sharing agreements (“PSAs”). The PSA Law is essentially dormant: all three PSAs currently implemented in Russia were signed before its enactment.
Ownership and licensing
In Russia, all subsoil resources belong to the state until such time as they are extracted by a private investor pursuant to a duly granted licence. Following such extraction, the resources become the property of the licence holder.
The Federal Agency for Subsoil Use (“Rosnedra”) is responsible for awarding, amending, transferring and extending the licences in respect of any onshore blocks, except for so-called “strategic” blocks (as defined below). Licences to strategic blocks (including offshore) may only be awarded to investors pursuant to a decision of the Russian Government.
Restrictions on foreign investors
Under the Subsoil Law, companies incorporated in foreign jurisdictions are prohibited from obtaining licences to use strategic blocks (blocks of federal significance), which include:
those containing deposits with the following reserves, as evidenced by the state register of reserves:
recoverable oil reserves of 70m tons or more; or
gas reserves of 50bn cubic meters or more;
subsoil plots located in the inland sea waters, territorial sea waters or on the continental shelf of the Russian Federation (the so-called “offshore” blocks); and
subsoil plots that can only be developed using land used for defence or security purposes.
Only a company established in Russia may hold a licence for a strategic block. Special requirements apply to the acquisition by a foreign investor of “control” over such company. Additional limitations are also established in relation to companies holding licences for the areas extending to the Russian continental shelf (see below).
The Russian Government may restrict the ability of Russian companies with direct or indirect foreign ownership to participate in an auction or tender for the right of subsoil use of a strategic block.
Unless otherwise provided by federal law, if a subsoil plot is included in the published list of subsoil blocks of federal significance, such subsoil block will retain this status indefinitely, notwithstanding any subsequent change to the criteria listed above.
Acquisitions of Russian companies operating a strategic block
Under the Strategic Industries Law
Federal Law No. 57-FZ “On Procedures for Foreign Investment in Companies of Strategic Significance for National Defence and Security of the Russian Federation” dated 29 April 2008.
when a foreign investor, wishes to acquire “control” over a Russian company holding a licence for a strategic block, it must seek the approval of a special commission headed by the Chairman of the Russian Government (please see the Strategic industries section of the Common forms of business structures for foreign investors chapter). The requirement is triggered if a foreign investor acquires at least a 25% interest in the licence holder. It also applies in certain other cases, including, for example, if under a shareholders’ agreement the acquirer is given at least 25% of the seats on the board of directors.
Special restrictions are established for foreign investors controlled by any foreign state. Such investors may not acquire “control” over a strategic licence holder (and so their aggregate interest must be less than 25%). Approval is also required for the acquisition by such investors of an interest in a strategic licence exceeding 5%.
Exceptions to these requirements may be set out in relevant international agreements which Russia is a party to. In addition, most of the rules do not apply if, following the acquisition, the strategic licence holder would remain more than 50% owned by state-controlled companies such as Gazprom or Rosneft.
Subsoil blocks that are fully or partially located on the Russian continental shelf may only be licensed to a Russian company (i) that is more than 50% owned or controlled by the Russian state; and (ii) that has at least five years of development experience within the Russian continental shelf.
These special limitations do not apply to other offshore blocks – the inland sea/territorial sea waters. They remain within the category of “strategic” and are subject only to the general requirements applying to strategic licence holders.
Foreign companies are not disqualified by law from obtaining a licence in respect of a non-strategic block. However, in practice, foreign licence holders of a non-strategic block in Russia are rarely encountered. Therefore, foreign companies usually hold mineral rights to such blocks indirectly through their Russian subsidiaries.
Issue and term of licences
Mineral rights are documented by a licence which is essentially a permit issued by the Russian state to conduct a particular type of activity in respect of a given subsoil block. Subsoil licences do not give any surface rights to the territory on which the activity is to be carried out. Therefore subsoil users must obtain land use rights (usually under a lease (please see the Real estate and constructionchapter)) separately.
Geological surveying licences
A licence for geological surveying is issued without a tender or auction:
generally for up to five years;
for up to seven years in respect of subsoil blocks located at least partially within certain Russian regions; and
for up to ten years for offshore blocks.
The validity term of a geological surveying licence can be extended to enable the licence holder to complete the works under the licence.
Exploration and production (“E&P”) licences
E&P licences can be issued for the project life span. Their term can be extended provided that the licence holder has not breached any terms of the licence and proved the need to extend the licence term in order to complete the production cycle within the licensed area.
E&P licences may only be issued through a tender or auction, except (i) where a holder of a geological surveying licence has made a commercial discovery; and (ii) in respect of some of the strategic blocks exempted by the Russian Government from the standard tender/auction procedure.
Combined licences cover geological surveying, E&P. They can be granted in respect of blocks with proven reserves that require substantial additional exploration.
The issue conditions and term of this type of licence are the same as for an E&P licence.
Special licences for hard-to-recover resources
Since May 2020, a company holding an E&P licence or a “combined” licence may be given a separate licence for developing new technologies for E&P of hard-to-recover resources within the previously granted territory. Such “licence split” has been long awaited by Russian companies wanting to attract foreign investment into the development of unconventional resources within their blocks. The “unconventional” licence can be granted for up to 15 years (if combined with the E&P rights), with five-year prolongations.
Transfer of licences
Since subsoil licences are acts of government, neither the licences themselves, nor any mineral rights thereunder, are transferable (including by way of sale, pledge or other disposal or encumbrance), except pursuant to special rules set out in the Subsoil Law.
These rules specifically permit the transfer in certain instances (except for the transfer of licences to strategic blocks to companies with foreign participation), including a transfer:
within a group of companies (from a parent to a subsidiary, from a subsidiary to a parent and between subsidiaries as directed by the parent);
following a merger or consolidation of the licence holder with another company;
following a spin-off or split-off of a new company (from the licence holder);
from a shareholder to a joint venture where the shareholder holds at least 50% of the equity interest (subject to certain conditions). Foreign investors often enter into joint ventures with Russian companies on this basis in order to obtain access to their subsoil licences.
Any such transfer requires a special decision of Rosnedra. Licences to strategic blocks may not be transferred to entities with foreign participation other than with the permission of the Russian Government.
For the above reasons, an “acquisition” of a Russian subsoil licence is mainly possible through the purchase of an interest in the company holding the licence, or by forming a joint venture with the current licence holder and subsequently transferring the licence to the joint venture. In certain cases where obtaining an equity interest in the licence is not possible for regulatory or other reasons, contractual arrangements are put in place to give the foreign investor benefit of the licence.
In Russia, PSAs have been aimed at providing investors with greater stability in the tax (please see the Tax system chapter) and regulatory aspects of subsoil development in the long run.
Since 2003, the PSA regime has been significantly curtailed. PSAs are only available if the block was put out to auction and the auction failed. This means that a PSA is a second choice of the state, used where the relevant blocks are not of interest to subsoil users on standard licence terms. Hence, the most lucrative blocks are awarded on the basis of the general subsoil licensing regime. As noted above, to date not a single PSA has been awarded under the PSA Law.