Russian Federation: Changes in the Russian Production Sharing Regime

Last Updated: 12 June 2003

A package of federal laws introducing substantial changes to the regime of production sharing agreements (the "PSAs") in Russia has been adopted on 6th June 2003, coming into effect on 10th June 2003. For lenders wishing to participate in projects connected with PSAs these changes are important and we have set out below those areas where the main changes have been implemented:

New Procedures for Concluding PSAs

This has been the most controversial section of the amendments, as the new rules make the conclusion of PSAs extremely problematic.

In particular, a field may become available for PSA development only after: (a) an auction for the development of such field on the standard licence and tax terms has been held and has been declared void due to the lack of bidders, (b) this field complies with certain additional conditions introduced in the PSA Law (e.g., the fields are located in hard-to-reach areas lacking transportation and other infrastructure) and (c) this field has been included in the list of fields eligible for PSA development.

A separate auction will be held in order to select an investor with whom a PSA will be concluded in relation to any field from the list of eligible fields. The tender route for conclusion of PSAs was excluded.

The new rules are stated also to apply to the following fields:

  • those that have already been included in the list of fields eligible for PSA development by previous laws but in relation to which no PSAs have been concluded; and
  • those in relation to which PSAs have been signed after the adoption of the PSA Law, but where the taxation provisions of such PSAs have not become effective.

The only fields which have escaped the new regime for concluding PSAs are the following:

  • the fields (i) which were already contained in the list of fields eligible for PSA development, (ii) for which investors have already obtained mineral licences and (iii) which are located on the continental shelf of Russia, within the exclusive economic zone of Russia or on that part of the seabed of the Caspian sea which is within the jurisdiction of Russia;
  • the fields which are subject to PSA development on the basis of an international treaty; and
  • the fields operated on the basis of PSAs which have been signed prior to the adoption of the original 1995 PSA Law (e.g., Sakhalin I, Sakhalin II and Kharyaga), since these projects are protected by the "grandfather clause" in the PSA Law.

Protection of Russian Participation in the Operation of PSAs

The changes are also aimed to reinforce the preferential right of Russian companies to participate in the operation of PSA projects (in particular, the rule that 70% of all technological equipment and materials utilised for production, transportation and processing of the minerals should be produced in Russia).

The amended PSA Law now provides detailed criteria which should be met by such equipment and materials in order for such equipment and materials to be considered to be produced in Russia.

However, it should be noted that these amendments contain a special WTO clause, which provides that any privileges of Russian companies involved in the operation of PSAs, which are not consistent with the WTO principles, will be brought into compliance with the WTO rules once Russia becomes a member of this organisation.

Restrictions on the Production Sharing

The changes introduce more detailed rules regarding the principles for sharing of the production. The distinction between the two alternative methods of sharing (i.e. sharing of the "profit production" only or of the total production) is retained, but it is now stated that only one method of sharing may be utilised in a specific PSA.

In addition, the following restrictions were introduced in respect of the sharing of production:

  • if the first sharing method is used, the level of investor's compensatory production share may not exceed 75% of the total output (90% for offshore fields); and
  • if the second sharing method is used, the investor's production share may not exceed 68% of the total output.

Abolishment of the Exemption from Mandatory Conversion of Export Proceeds

The changes abolish the previously existing exemption for Russian companies involved in the operation of PSA projects from mandatory conversion of their foreign currency export proceeds on the Russian domestic currency market.

Introduction of the Tax Regime of PSAs

Some of the major changes concern the long-awaited special tax regime of PSAs, which is now incorporated in the Tax Code. In due course we will be providing you with a short analysis of the tax changes.

Failed Changes in Relation to Special Treatment of Private Pipelines

Originally, the draft package of laws contained changes to the Law "On Natural Monopolies", which were designed to grant owners of private pipelines some flexibility with respect to the establishment of tariffs and access to pipelines by other producers. However, ultimately these proposed changes have not been adopted.

Article by John Balsdon, Liza Ivanova and Luke Wells

© Herbert Smith 2003

The content of this article does not constitute legal advice and should not be relied on as such. Specific advice should be sought about your specific circumstances.

For more information on this or other Herbert Smith publications, please email us.

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