Status of Russian petroleum legislation.

I. INTRODUCTION II. THE JOINT VENTURE LAW III. THE LAW ON OIL AND GAS IV. THE LAW ON PRODUCTION SHARING AGREEMENTS

V. THE SUBSOIL LAW VI. CONCLUSION

I. INTRODUCTION

The Author's first exposure to the laws of the Soviet Union and Russia took the form of an international contract conference presentation in Moscow in October 1989. (1) The Ministry of Geology, the main point of contact in the Soviet Union for foreign investors, had invited the Author's employer to make a presentation about the three main types of international petroleum contracts (tax royalty/concession agreements, service contracts, and production sharing agreements), covering both the legal and economic aspects of each. (2) Three specialists and an interpreter were sent to conduct the conference. (3) There were many lawyers in attendance from various institutes around the country, as well as a few KGB agents and some Ministry personnel. Many insightful questions were asked, and it was apparent that there was a fairly high level of understanding of many issues. (4)

Although the Author was convinced that the audience would view the tax/royalty system, which is basically the modern concession agreement, as the most suited to their own administrative law system, they were indifferent to the suggestion. (5) Unfortunately, due to the bad experience with concession agreements during the 1920s, (6) the Russians viewed these agreements as giveaways. (7) So, concession agreements had a bad name, and the audience was not interested for that reason. The attendees said, in effect, it didn't work before, so what else can you tell us about? (8)

It was made clear to the audience that international oil companies prefer to acquire equity interests in available properties and would usually not be interested in entering into a service contract unless it was the only option. (9) As a consequence, not much time was devoted to discussing service contracts, which shifted the focus of the legal presentation to the production sharing agreement (PSA) form of investment. (10) It became a theoretical discussion, however, because the existing legislation would not support such a system.

II. THE JOINT VENTURE LAW

The only legislation that existed in the Soviet Union in connection with foreign investment from 1987 to early 1992 was the Joint Venture Law (JV Law). (11) The JV Law permitted a foreign investor to own an interest in a Soviet limited liability joint venture company (JVC) that was formed with an existing domestic license holder to obtain the rights to develop an oil field under a reissued license. (12) Due to the lack of alternatives and the desire to participate in the Russian oil industry, a few foreign investors entered into such joint venture agreements (JVAs). (13) Most of these joint ventures were established through the execution of a JVA between a U.S. or European international oil or service company and a Russian exploration or production association, followed by the registration and formation of a JVC. (14) All of these JVCs suffered through countless changes in the tax laws, increases in the rates of tariffs and taxes, battles for VAT refunds, and pipeline access complications throughout the 1990s. (15) It was, therefore, no wonder that the foreign investors became convinced that the PSA approach must be a better way to make investments in Russia. (16)

In general, JVCs were subject to the infamous current tax regime (CTR), there were no exemptions from any of the tax laws, and those that were granted on an ad hoc basis were short term in nature and subject to change without notice. (17) Investors came face to face with the fact that once a foreign investor was captured within a JVC in Russia it was subject to all new and amended laws, the JVA lacked tax and fiscal stability, and neither the JVC nor the foreign investor was in privity of contract with either the federal government or the local government, both of which were the ones that granted the JVC the ultimate rights through the license. (18) By contrast, upon entering into a PSA, the foreign investor would be in privity of contract with the host country government or its national oil company as the rights granting authority, meaning that there could be significant exemptions from various tax and customs laws, and there could be some predictability and stability under a separate legal and fiscal regime. (19)

III. THE LAW ON OIL AND GAS

In late August 1991, the first meeting of the University of Houston's Russian Petroleum Legislation Project (the UH Project) took place between the Western representatives of academia, government, and the oil industry, and their Russian counterparts from various ministries and legislative committees. (20) The purpose of the UH Project was to recommend a legislative framework for the new Law on Oil and Gas (O&G Law) based on then-current practices and laws in the international petroleum industry. (21) The Author's employer was one of the corporate sponsors of this daring endeavor, and the Author was named as one of the three reporters for the Exploration and Production (E&P) Licensing Working Group that was charged with the responsibility of drafting the proposed Licensing Code. (22)

In 1993, the proposed Licensing Code was published as part of the overall Petroleum Code that was prepared by the UH Project. (23) One of the recommendations for the Licensing Code was to establish a flexible licensing system that would permit the issuance of both production licenses and production sharing licenses. (24) This was an attempt to finesse the administrative law system by allowing an alternative form of investment to occur under the Russian civil law system. (25)

Unfortunately, by the end of July 1992, the UH Project was out of funds and was taken over by the World Bank. (26) Thereafter, competing drafts of the O&G Law began to be published by the Joint Parliamentary Commission (JPC) of the Supreme Soviet in October 1992 and by the Inter-Departmental Commission (appointed by then Deputy Prime Minister Chernomyrdin) in January 1993. (27) Although, or perhaps because, the JPC's draft followed the UH Project's proposed Licensing Code to a large extent, it fell out of favor. Eventually, the battle of the drafts ended in 1995, and the fatally flawed version of the O&G Law written by the JPC passed the third reading--only to be vetoed by President Yeltsin, never to be heard from again. (28) Thus, what had begun so favorably as a collaborative and creative legislative effort ended as an unceremonious, disappointing and anticlimactic failed attempt to produce useful legislation geared to work within the dual administrative and civil law systems.

IV. THE LAW ON PRODUCTION SHARING AGREEMENTS

The first time the words "production sharing" were ever published officially in Russia was on February 21, 1992, when the Law on Subsoil Resources (Subsoil Law) was enacted. (29) The next significant event occurred on Christmas Eve, 1993, when President Yeltsin signed the Presidential Decree on Production Sharing and its Implementation in the Russian Federation, which was quickly dubbed the "Christmas Present" because it paved the way for the executive branch to propose this new system of production sharing to the State Duma. (30)

By July 1995, a draft Law on Production Sharing Agreements (PSA Law) had been passed by the State Duma. (31) In the draft, there were a number of excellent provisions that would have provided the type of stability and predictability that foreign investors and financing institutions would need in a country that was in a volatile state of transition like Russia. (32) Unfortunately, between June 1995 and December 1995, the opposition legislators, who viewed the PSA Law as some sort of wholesale giveaway of Mother Russia's natural resources, had the influence to modify the draft to the point at which it became only marginally viable. (33)

Consequently, when the PSA Law came into effect on January 11, 1996, (34) it was apparent to the reformist legislators and outside observers that many other laws needed to be amended, more laws needed to be passed, and normative acts had to be enacted. (35) The conflicts that were created by this final version of the PSA Law were so striking that most foreign oil companies decided they were not going to invest under the PSA Law until these conflicts and contradictions were resolved. (36) Many of those conflicts were resolved by the amendments to the PSA Law and the enabling legislation. (37) Nevertheless, there were still a few significant shortcomings in the legislation that were never addressed by the Russian government or the State Duma. (38) As a result, the international oil companies refused to invest under the PSA Law until the remaining conflicts and contradictions were eliminated. (39)