As described earlier this year in our e-communication entitled “Russia: More Restrictions on Investment in the Oil and Gas Sector,” a new law restricting foreign investments into strategic companies was adopted in Russia on 29 April 2008. Simultaneous amendments to the Federal Law “On Subsoil” (the Subsoil Law) introduced the term “deposit of federal significance” which, in turn, is a criterion for determining whether a company holding subsoil rights is a strategic company. Introduction of the concept of “a deposit of federal significance” led to other significant changes in subsoil legislation. Following the amendments of 29 April, further amendments were adopted on 18 July. We have already discussed the application of the new legislation to foreign investors wishing to acquire stakes in Russian “strategic” companies. In this note, we also focus in some detail on the implications of the new legislation for current subsoil users if they are fortunate (or unfortunate) enough to discover a deposit of federal significance.

New Subsoil Law Provisions

Amendments to the Subsoil Law of 29 April stipulate that only legal entities incorporated in the Russian Federation may be users of deposits of federal significance. For such deposits located on the Russian continental shelf, it is also required that the user be majority-owned by the Russian state and that it has at least five years experience in exploring the Russian shelf.

With respect to oil and gas deposits, the following are considered to be of federal significance: those containing over 70 million tons of recoverable oil or 50 billion cubic metres of gas; those located in an internal sea, territorial sea, or on the continental shelf; and those located in areas used in connection with the maintenance of state security and defense. The official list, required to be published by the subsoil authority, is expected by mid-October, and the deposits that will be included on the list will remain of federal significance even if the thresholds in the law change.

With regard to greenfield sites, subsoil users typically hold either a geological survey license (which gives them the right to explore the area in question) or a geological survey, exploration, and production license, a so-called “combined license.” Upon discovery of a commercial deposit, a holder of a geological survey license has the right to obtain a license for exploration and production at the discovered field, provided that the discovery is confirmed by the supervising government authority and the license holder is in compliance with its license. Subsoil users who hold a combined license are allowed to produce hydrocarbons at the field during geological survey or after its completion, with the exception for deposits of federal significance.

The amendments to the Subsoil Law allow the holder of a combined license for a deposit of federal significance to commence production only after completion of a geological survey and upon the decision of the Russian Government. Furthermore, if, in the course of a geological survey, a foreign subsoil user (meaning either a foreign investor or a Russian legal entity with foreign equity participation) makes a discovery which is “of federal significance,” the Government may refuse to grant the right to use the deposit for exploration and production or, if the license is a combined license, may terminate the right to use the deposit for exploration and production, on the grounds of a threat to national defense and security. The fact that the license holder’s expenses incurred in carrying out the survey and evaluation, as well as the lump-sum payment made by a license holder in accordance with the combined license terms, must be reimbursed, is likely to be of little comfort. (On 16 September 2008, the Russian Government approved by Resolution No. 697 certain regulations setting out the procedure for the making of any decision regarding termination of the right to produce hydrocarbons in these circumstances; however, the procedure for reimbursement of expenses is yet to be adopted.)

The above new regulations apply to users of deposits of federal significance which are foreign investors, as defined in the Law on Foreign Investment, or have foreign participation in their charter capital. This would appear to be the majority of Russian oil and gas companies where there is discovery of a deposit of federal significance.

The provisions do not, however, apply to deposits for which rights were granted under a combined license, where the license holder had finished the geological survey and started production in a due manner before 5 May 2008.

Conclusion

Whilst the Government has repeatedly raised the issue of the need to stimulate investment in the exploration of new fields and the development of difficult deposits (in an effort to improve the country’s declining oil production), there is a concern that the new legislation will actually discourage investment in the exploration of fields which may potentially be of federal significance, due to a lack of confidence that the right to produce hydrocarbons at such fields will be granted. Since the procedure for reimbursement of expenses has not yet been approved by the Russian Government, it is also not clear whether the reimbursement of expenses will provide any comfort to subsoil users who discovered a deposit of federal significance but were refused the right to develop it.

For more information on this topic, please contact V&E Russia/CIS lawyer Natalya Morozova.  Visit our website to learn more about V&E's Russia/CIS Practice.