Practice Areas Review: Energy

Legislative Developments in Ukrainian Energy Law in 2015

Bate C TOMS

Bate C TOMS

Managing Partner, B.C.Toms & Co. Legal education: Yale Law School (J.D., 1975); Magdalene College, Cambridge University (Law Tripos I; 1972-1973). Mr. Toms is admitted to legal practice in the District of Columbia and Virginia, USA, and in France.Chairman, British Ukrainian Chamber of Commerce

Natalia VIETOSHKINA

Natalia VIETOSHKINA

Associate, B.C.Toms & Co. Legal education: Kyiv National Economic University (Commercial and International Law, Master’s Degree, 2008), Ukrainian Bar Association (Certificate of advocate, 2010)

PROfile

B. C. Toms & Co

Address:
18/1 Prorizna Street,
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B.C. Toms & Co is a multinational law firm of Ukrainian and Western lawyers specializing in Ukrainian law. It was the first Western law firm to open a Kiev office, having focused its practice on Ukraine at its independence in 1991. The firm has handled, for example, the land leasing for many of Ukraine’s largest agricultural and oil and gas projects, as well as acquisitions of land for commercial property developments. We also handled the legal work for the first, and the most, IPOs to raise funding for Ukrainian companies, as well as the first true project financing in Ukraine. Based on our over 25 years of experience in Ukraine, we can provide, with our legal advice, practical commercial advice on how to establish and develop a business in Ukraine.

The firm has recruited and trained its Ukrainian lawyers from students at Ukraine’s leading law schools, most of whom have also studied at UK and US law schools as Chevening, Pinchuk, Fulbright and Muskie fellowships. Based on the firm’s practical experience, it has written numerous articles on Ukrainian law, including the legal section of the book Doing Business in Ukraine.

The principal practice areas of B. C. Toms & Co include real estate and land development, energy, natural resources, agriculture, banking and finance, M&A, environmental, labor, bankruptcy and administrative law. The firm also has a successful litigation and arbitration practice, having successfully handled many of Ukraine’s most important cases, including in all Ukrainian courts and before the Permanent Court of Arbitration in The Hague. The firm regularly advises on Ukrainian tax law, including from a multinational tax planning perspective.

B. C. Toms & Co has prepared a wide variety of documentation for clients, including Ukrainian law share purchase agreements, asset purchase agreements, joint venture agreements, construction contracts, project financing documentation, production sharing and oil and gas license agreements, airport investment and management agreements, hotel management agreements, private placement agreements, real estate acquisition agreements, loan agreements, leases and agency, distribution, franchise and licensing contracts.

 

The New Law Reducing Gas Royalty Rates

On 1 January 2016, Act No. 909-VIII of 24 December 2015, On Introducing Changes to the Tax Code of Ukraine and Some Other Legislative Acts of Ukraine to Ensure the Balance of Budgetary Contributions in the Year 2016 (hereinafter — the Budgetary Contributions Act) came into force, which, among the other things, greatly reduced the applicable natural gas production rental fee (“royalty”) rates from the uneconomically high levels that they had been raised to during the previous year.

In particular, for the extraction from deposits that lie entirely or partly at depth of up to 5,000 meters, the royalty rate has been decreased from 55 to 29%1 and for deposits that lie entirely at a depth of more than 5,000 meters the rate was lowered 28 to 14%. The Budgetary Contributions Act has also cancelled the requirement to make rental fee payments in advance and has changed the basic tax reporting period for subsoil use fees from quarterly to monthly. There is also a two-year royalty tax relief period for new wells.

Reducing the royalty rates for natural gas production in the Budgetary Contributions Act has reversed the increase in fees made in August 2014 that previously caused a fall in domestic gas production and made investors rethink investing in Ukraine. This increase also effectively obliged an important oil and gas company to initiate a major arbitration in the Permanent Court of Arbitration in The Hague under the Energy Charter Treaty to contest the higher rates. Presumably, the world decrease in oil prices, a desire to reduce Ukraine’s dependence on Russian gas and closer ties with the EU, as shown by Ukrainian legislation adopted to reflect the EU’s Third Energy Package, influenced Ukraine’s decision to reduce the royalty to make it more commercially acceptable.

In order to attract investment, Ukrainian policy needs to consistently reflect international standards and be better implemented in practice.

Developments in Renewable Energy

Another issue, which should be of interest to many investors, is the recently conducted reform of the “green” tariffs, which encourages investment in renewable energy projects in Ukraine.

On 16 July 2015, Act No. 514-VIII, of 4 June 2015, On Introducing Changes to Certain Laws of Ukraine on Ensuring Competitive Conditions for the Production of Electric Energy from Alternative Energy Sources, came into force. This Act’s changes included the following:

(1) cancellation of the local content requirement and replacing this with the introduction of the following premiums to increase the “green” tariff where the equipment used is of Ukrainian origin: (i) If 30% of the equipment is of Ukrainian origin, the tariff is increased 5%., and (ii) if 50% is Ukrainian, then the increase is 10%.

(2) The green tariff will be protected against further devaluation of the Ukrainian currency by fixing the minimal amount of the “green” tariff in euro, with quarterly indexation until 2030.

(3) The calculation of the “green” tariff has been adjusted and unified so that it will be the same for all types of alternative energy sources, and the “green” tariff has also been extended to include power generated from geothermal energy sources, finally officially recognizing geothermal as an alternative energy.

(4) On the other hand, 100%. of the costs of the connection to the grid for power sources producing energy from such alternative energy will now have to be financed by the investor.

These generally favorable changes in Ukrainian legislation for alternative energy can be attributable primarily to the desire to decrease Ukraine’s dependency on foreign gas and become energy self-sufficient. In addition, Ukraine is following the European trend to develop “green” and clean energy. Finally, many are looking for alternatives not based on nuclear power in view of the Chornobyl nuclear disaster in 1986 in Ukraine.

Increase in Tariffs for the General Population

In 2015, the National Commission on State Regulation in the Sphere of Energy and Communal Services (hereinafter — the National Commission), the state regulatory body setting tariffs for energy and communal services, adopted Resolution No. 220 of 26 February 2015, On Establishing Tariffs for Electricity for the Population, which resulted in an average 45.2%. increase in tariffs for residential individuals.

This measure has been explained by the National Commission as being necessary in order to balance the energy market, because it has been functioning on the basis of “cross-subsidies”, whereby commercial electricity customers (both entities and private entrepreneurs) were paying up to 26% more in order to cover the short fall between the low fixed energy prices for the general population and the higher real market cost that had to be paid by the state.2 At the same time, Section 2 of Chapter XII of the Parliamentary Parties’ Coalition Agreement foresaw the creation of market prices for electricity, and the gradual elimination of cross-subsidies by making prices more even for all, while introducing narrowly-tailored subsidies to the most vulnerable groups in the population to enable them to be able to afford the higher prices.3  

The National Commission also increased the tariffs for gas for the general population, justifying this as being required by Ukraine’s agreement with the IMF.

Adjustments for the Ukrainian Energy Sector Due to the Conflict in Eastern Ukraine

There have been two sets of measures adopted by the Ukrainian government to address the complicated internal situation in Ukraine connected with antiterrorist operations in the east of the country and the occupation of Crimea, as follows:

(a) Special Electricity Regime for the Territory on which Antiter- rorist Operations are Conducted

 

Act No. 284-VIII of 7 April 2015, On Amendments to the Electricity Law on the Regulation of Relations in the Electricity Sector on the Territory of an Antiterrorist Operation empowered the Cabinet of Ministers of Ukraine to establish details for the regulation of the legal, economic and organizational relations connected with the sale of electricity on the Wholesale Electricity Market of Ukraine in territories where the Ukrainian public authorities temporarily do not provide full electric power. This Actspecially regulates relations connected with the production, transmission, distribution, supply, purchase, sale and usage of electricity in these areas. The Government of Ukraine is also authorized to define the list of those areas where the Ukrainian public authorities temporarily do not provide full electric power.

 

(b) Temporary Extraordinary Measures Related to the Situation in Crimea

On 21 December 2015, the Ministry of Energy and the Coal Industry of Ukraine issued Order 828, On Adoption of Temporary Extraordinary Measures in the Electricity Market”, on the plan for the implementation of measures to reduce power consumption in order to normalize the energy supply, which has been interrupted due to the energy blockade of occupied Crimea.

 

1 Percentage of value of extracted minerals per 1,000 m3.

2 See Letter of the National Commission on State Regulation in the Sphere of Energy and Communal Services No. 2726/17.2/61-15 of 24 March 2015, paragraphs 22-25.

3 3 Supra note, paragraph 29.