There are some notable recent developments and pending initiatives in Russia’s subsoil use sphere as 2020 unfolds.
Split licenses for hard-to-recover resource blocks. Russia’s subsoil use legislation was amended in December 2019 to allow the splitting of licenses for hard-to-recover resources. These amendments aim to stimulate technologies for extraction of hard-to-recover resources (primarily hydrocarbons). There is also an early-stage initiative to introduce further amendments that would allow the splitting of licenses for different subsoil horizons within what is now considered as a single license area. This broader initiative is not limited to hard-to-recover resources and might conceivably be of interest for certain mining as well as hydrocarbon development projects. See Section 1 below for further discussion of this.
Geological study licenses for internal waters/territorial sea blocks. Another set of amendments enacted in November 2019 now allow companies to apply for geological study licenses in respect of subsoil blocks located within Russia’s internal waters and territorial sea. These blocks had been traditionally available only for advanced exploration and production licenses granted upon auction to state or private companies (with possible restrictions on foreign-company participation). The amendments open up these blocks for geological study—including by private companies. (Subsoil operations on the continental shelf do not fall within the scope of the amendments—these operations are still reserved only for production, or advanced exploration and production by Russian state-controlled companies having at least five years of continental shelf experience, and they receive such licenses without auction.) See Section 2 below for further discussion of this.
“Universal” licenses for Far East blocks. In September 2019 President Putin requested that the government develop the possibility of issuing universal geological study, exploration, and production licenses for subsoil use (in Russian “сквозные лицензии”). This new type of license is intended to stimulate geological study in undeveloped territories, especially in the Russian Far East. See Section 3 below for further discussion of this.
Fiscal initiatives. We also provide in Section 4 below a brief overview of current fiscal initiatives aimed at incentivizing certain Eastern Siberian/Far East projects.
As the discussed legal amendments have been adopted only recently, there remain various issues as to how they will be implemented in practice. And of course, there is no certainty as to what shape the various still-unfolding initiatives will finally take. For this reason and generally, this LawFlash is for general briefing/orientation purposes only. It is not intended to be and should not be taken as legal advice applicable to any particular project or set of facts. Qualified legal advice should be obtained for any such particular project or set of facts.
1. Split Licenses for Hard-to-Recover Resources
While there is no universally accepted definition of hard-to-recover resources, these generally are considered to be hydrocarbon resources that require application of special technologies for their development to be economical due to low porosity, high viscosity, and other natural factors. For purposes of these amendments discussed below, the hard-to-recover resources will be defined by a government decree.
Such resources are often located within subsoil blocks that also contain conventional resources. Until a month ago, the Subsoil Law did not allow for the separate application for a license to explore/produce hard-to-recover resources in a block that is already under license.
Because “spinning off” a portion of a license has not been possible to date, subsoil users seeking partners to develop hard-to-recover resources only (which are usually more capital and technology intensive than development of conventional resources) had to implement complex, less than ideal contractual structures (often featuring a side joint venture as risk-based service provider) in order to develop the hard-to-recover deposit. These structures have been employed when engaging certain foreign oil and gas companies, and are contemplated even for some recently announced northern fields projects between affiliated Russian majors.
The recent amendments now allow the following:
- Application for split subsoil use licenses on blocks where both conventional and hard-to-recover resources of the same type (e.g., hydrocarbons) are located
- Obtaining a license with respect to hard-to-recover resources for a block where no conventional resources of the same type are under license (i.e., for hard-to-recover hydrocarbons only)
A license for (1) development of hard-to-recover resources on a block split off from one containing conventional resources is to be issued for up to 7 years, and (2) development of a block having only hard-to-recover resources is to be issued for up to 15 years (in each case with right for extension).
Such licenses are to be granted either upon decision of a Rosnedra commission (with participation of a representative from the executive authority of the relevant regional government) or pursuant to a tender. The main criteria for determining the winner of a tender should include the scientific and technological characteristics of the proposed work program for development of technologies for geological study, exploration, and production of hard-to-recover resources, as well as the qualifications and experience of the applicant’s employees.
This amendment law was enacted on 2 December 2019, and will come into force on 31 May 2020. Various further regulations will need to be adopted by the government for its effective implementation—such as the specific types of hard-to-recover resources eligible for licensing or license splitting under the amended Subsoil Law, and the rules for spinning off a portion of a license, etc. In addition, certain important issues as to application of the new law await actual practice.
Further Potential Developments
We understand from various public sources that there is a current legislative initiative to allow for the split of subsoil use licenses with respect to different horizons of any natural resources (i.e., not limited to hard-to-recover hydrocarbons) within what is now considered as a single license area. This initiative is still at a very early stage and no draft (even just conceptual) has yet been developed. To date, only an interdepartmental working group, comprising business and government agency representatives, has been established. As this initiative is aimed at a broad range of natural resources, it might well also be of interest for mining industry projects where a single license covers a significant area or several types of minerals.
2. Geological Study in Internal Waters and Territorial Sea
The Subsoil Law was also amended on 4 November 2019, with effect as of 3 February 2020, to allow companies to apply for geological study licenses for subsoil blocks situated within Russia’s internal waters and territorial sea.
Subsoil blocks located within Russia’s internal waters and territorial sea (or on the continental shelf) qualify as deposits “of federal significance,” per Subsoil Law art. 2.1. To date, only advanced exploration and production or combined licenses may be issued for such deposits. These licenses were being issued upon government directive pursuant to an auction (except for continental shelf licenses, which have been and will continue to be issued by the government without auction). Geological study licenses are issued for subsoil blocks that do not qualify as deposits of federal significance. Since this new amendment does not cover blocks located on Russia’s continental shelf, still no geological study licenses will be issuable for such blocks.
The right to use the subsoil on Russia’s continental shelf remains reserved to Russian state-controlled companies (i.e., where the Russian state controls more than 50% of votes) having five-plus years of Russian shelf experience—which in practice for now means only Gazprom, Rosneft, and a few select affiliates of these two state companies. (While there have been discussions of possible easing of this continental shelf state monopoly for some years, the only real dent in this strict regime to date is limited to allowing Lukoil in 2015 to convert its pre-2008 geological study licenses into a full exploration and production license for its discovered fields in the Baltic Sea.)
This amendment envisages that companies (either state-owned or private) will be entitled to apply for a geological study license without a tender or auction. The licenses will be granted per government decision, subject to approval by the Ministry of Defense and the Federal Security Service confirming the absence of threat to state security. The government is entitled to introduce additional requirements for applicants having any foreign participation.
A list of eligible internal waters/territorial sea blocks has yet to be issued by the government.
Such a geological study license will entitle its holder to conduct a geological study, and to apply for an advanced exploration and production license in the event of a discovery. If a discovery is made, the government has the right (but not the obligation) to issue a production license (again, without additional auction or tender). As is the case with discoveries on all deposits of federal significance, per Subsoil Law art. 2.1, the government has wide discretion and can deny issuing an advanced exploration and production license if the subsoil user that made the discovery has “foreign participation.” The subsoil user in such case is entitled to compensation of its costs incurred for obtaining the relevant geological study license and operations thereunder—plus some premium amount, which varies depending on the location of the subsoil block, but is generally perceived as inadequate to the geological risk having been assumed by the subsoil user to achieve such discovery. In the absence of any carve-out in the Subsoil Law (as now amended) this discretion would apparently extend to cases where the holder of an internal waters/territorial sea geological study license would attempt to convert to production following a commercial discovery.
3. Universal Licenses for Geological Study in the Russian Far East
This initiative followed a September 2019 meeting of the Presidium of the State Council devoted to the Russian Far East. At the meeting, Mr. Trutnev, the presidential envoy for Russia’s Far East, asked President Putin to improve state support for geological study in that region, which has vast untapped resources.
Most of these resources are located in territories that have not been subject to past geological study and exploration and thus do not appear on the state balance of reserves. Mr. Trutnev proposed that exploration of such territories would therefore require the introduction of a different type of license and corresponding amendments into the Subsoil Law.
The concept of such universal licenses would be in line with a previously launched state initiative to promote “junior companies” (in Russian “юниорные компании”) for geological study: in 2017, the Ministry of Economic Development (together with the Ministry of Energy and some others) produced a strategy for the development of junior companies for geological study, which aims to encourage geological study in undeveloped regions of Russia.
A universal license would entitle its holder to conduct geological study, and proceed with exploration and production in the event of a discovery. Similarly to a geological study license, a universal license would be issued upon request of an interested subsoil user (i.e., without auction or tender—although it is unclear how this would proceed in the case of two or more applicants vying for one offered block). However, in contrast to a geological study license, moving into production under a universal license would not require issuance of a new license subject to the government’s discretional approval. Nevertheless, if the deposit under such universal license is or becomes through the geological work of “federal significance,” then presumably the government will still retain the discretion to revoke such license if the licensee has foreign participation at the time of moving to the production stage, per Subsoil Law art. 2.1 (as noted above), unless a specific carve-out for such type of licenses or for Far Eastern fields generally is included in the future amendment.
This type of universal license seems to differ from a combined exploration and production license: the latter is currently issued only upon auction or tender for deposits that already have proven reserves for production but require further substantial exploration (although greenfield blocks could also be auctioned in case of two or more applicants).
This initiative is at a very early stage, and no draft legislation has yet been published.
4. Evolving Fiscal Incentives for Hydrocarbons E&P
We provide here a brief snapshot of the ever-changing landscape of fiscal incentives for hydrocarbon E&P projects in remote areas or having other challenging circumstances.
A recent round of debate between the Finance Ministry (charged with filling the state treasury) and the natural resource use regulators (charged with stimulating the development of new remote areas, which may not be commercial under the standard tax regime) seems to have resulted in an in-principle agreement to grant tax benefits to the newly proposed “Vostok-Oil” project of Rosneft and Neftegazholding (an independent company owned by Eduard Khudainatov, Rosneft former CEO) to develop new fields in the northeast of Siberia. While no official draft legislation has yet been published, per press reports these benefits could feature a zero mineral extraction tax (MET) and a special reduced rate for the excess income tax (a new tax for natural resource companies aimed at gradual replacement of the MET), all totaling an estimated 60–70 billion rubles of tax savings per year for the first 12 years. Other remote area projects of Rosneft in the northern parts of the Khanty-Mansi Autonomous Region and the vast Krasnoyarsk Kray may gain similar benefits. But again, so far this is reflected only in press reports; no draft legal act has appeared yet (and such MET and/or excess income tax reductions will require amendments to the Tax Code).
It is worth briefly highlighting the origins and aims of the newly introduced excess income tax framework. The MET-based tax regime for hydrocarbon E&P projects was introduced in 2002, replacing the prior fiscal regime (essentially comprising the subsoil use payment, mineral rehabilitation charge, and excise tax), which had been considered prone to arbitrary inequality and corruption.
But the “level playing field” MET system failed to recognize and respond to the vast differences in the economics of E&P projects across Russia—ranging from the well-developed fields in established oil provinces with readily available infrastructure, to remote areas with little or no infrastructure (including offshore and/or Arctic), to hard-to-recover deposits and other economically challenging parameters. This varied economic reality has led to many special-case carve-outs from the initially conceived “one size fits all” MET system, which grew to be considered overly complicated and unstable (the situation has been further complicated by the addition of export customs duties, as well as excise tax for various petroleum products).
In an attempt to rationalize this complex fiscal regime, the new excess income tax was introduced in 2018 (Tax Code arts. 333.43–333.56) with a view to gradually replacing the MET (and perhaps other hydrocarbon E&P project fiscal system elements). In essence, the base for this new tax is to be computed as the difference between the hydrocarbon sales revenues and the costs expended for the project development (subject to various limitations). This profit-based system is similar to fiscal regimes in various other petroleum exporting countries. It is now being applied in Russia on an experimental basis to certain remote area deposits that have a low reserve depletion level (i.e., the Yakut Republic, Krasnoyarsk Kray, the Caspian). As this new tax system is only now taking shape, its anticipated effectiveness remains to be seen.