Legal Aspects of Development of Shale Gas in Ukraine

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Shale Gas in Ukraine – a great potential for investment opportunities

The Main Parties Involved in Exploration and Extraction of Shale Gas

Ways to Start Development of Shale Gas in Ukraine

General Approach – State Auctions for Purchasing Special Permits on Exploration/Extraction of Mineral Resources

Production Sharing Agreements: How It Works in Ukraine

Other Possible Approaches

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CONTENT

SHALE GAS IN UKRAINE – A GREAT POTENTIAL FOR INVESTMENT OPPORTUNITIES

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Shale Gas Reserves

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The reserves of shale gas in the world are estimated at the level of 200 trillion cubic meters

Shale Gas in Ukraine

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Reg

ions

Carpathian Mountains (over 500 billion tones) – with average thickness of industrial layers – about 400 m

Central part of Ukraine – Kirovogradska and Cherkaska oblasts

Dnieper-Donetsk Basin

Crimean mountains

The reserves of shale gas in Ukraine are estimated at the level of 7 trillion cubic meters by the Ukrainian government

According to the US Energy Information Administration this figure is lower and constitutes 1,2 trillion cubic meters which, however, makes

Ukraine 3rd in Europe

THE MAIN PARTIES INVOLVED IN EXPLORATION AND EXTRACTION OF SHALE GAS TODAY

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State Authorities

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• Cabinet of Ministers of Ukraine – the main player on behalf of the state in the sphere of Production Sharing Agreements

• State Service on Geology and Mines of Ukraine – specifically authorized state authority responsible for issuing permits for extraction of mineral resources, coordinating the conclusion of PSAs

• Local authorities – Oblast councils, Kyiv and Sevastopol city councils, Verkhovna Rada of Crimea – approval of applications for transfer of subsoil into use (approval of PSAs)

• Ministry of Ecology and Natural Resources – approval of applications for transfer into use of subsoil (approval of PSAs)

• State Service of Mining Supervision and Industrial Safety of Ukraine – approval of provision of subsoil into use, establishing mining allotment

• State Commission of Ukraine on Deposits of Mineral Resources

Investors

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The two Companies have won the contests for signing the PSAs on development of Olesskyi region (Carpathian Region) – 2,98 trillion cubic meters of shale gas; and Jusovskyi region (4,054 trillion cubic meters of

different types of non-traditional gases). The PSA with Shell was already signed in January 2013.

In 2012 ENI has purchased a share in the subsidiary of NAC “Nadra Ukraine” which conducts geological exploration of different types of unconventional

gases in Western Ukraine.

Future possibilities

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Ukraine plans to initiate PSA on the Sloboghanskyi region

(rich in shale gas)

Other interested companies

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Ways to start development of shale gas in Ukraine

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Possible approaches:

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1. Going through the general procedure for getting the right to explore/extract mineral resources in Ukraine

2. Entering into Production Sharing Agreements with the Ukrainian Government

3. Purchase of a share in a company conducting shale gas exploration/extraction and having all the necessary permits

4. Public-private partnerships

5. Entering into agreements on joint activity with authorized entities conducting shale gas exploration/extraction and having all the necessary permits

General procedure – part 1

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1. Purchasing special permits (licenses) via auctions:1) notice about the tender2) provision of tender information and guarantee payments;3) sale and purchase agreement 4) payment for permit

TERM - approximately 2-3 months

The cost of the auction documentation is 3,12 % of the starting price of the lot, up to EUR 7255. The guarantee fee - 20% of the starting price of the lot should be contributed by every candidate (subject to return if the candidate doesn’t win).

General procedure – part 2

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2. Obtaining the mining allotment – within 21 days after the documents are submitted.

3. Obtaining the right to use the land plot (land lease agreement or permanent use).

4. Obtaining necessary licenses for construction works connected with usage of subsoil etc and elaboration of project documentation.

Production Sharing Agreement

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Production Sharing Agreement (PSA) – an agreement between • the state of Ukraine and an investor which is assigned to conduct

• search, • exploration and • extraction of mineral resources at the specified area of subsoil • and conduct other works related to the performance of the agreement,

and• the investor undertakes to conduct the mentioned works

• at its own expense and risk• with the subsequent compensation of such expenses and remuneration

(payment) in the form of part of profit from the extracted resources.

Production Sharing Agreement

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Compensation – up to 70% of the resources. Around 15-20% of the rest is provided to the state while the other part remains with the investor.

The state may put an obligation on the investor to sell the resources only in the territory of Ukraine.

Several investors may sign the PSA with Ukraine (accepting joint obligations).

The state ensures and facilitates obtaining by the investors of all necessary permits, authorizations and documents.

The term of the PSA may be stipulated in the agreement but not more than 50 years.

PSA Procedure – part 1

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1. Cabinet of Ministers issues the decision on competition on conclusion of PSA with detailed description of site and investments expected and the deadline for submitting the applications is at least 1 month after the competition is announced.

2. The interested parties participate in competition. The payment for participation in the competition is set in the competition documentation (e.g. EUR 50 000). The competition documentation may include the requirement of bonus payment (the recent one had the requirement of bonus payment of EUR 240 000 000). It also contains the information on the minimum investments.

PSA Procedure – part 2

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3. Maximum 3 months after the deadline, based on the best offer Cabinet of Ministers issues the decree defining the winner – future signee of the PSA.

4. The draft PSA is to be developed by the investor and is subject to state financial, legal, environmental and other expertise.

5. The draft PSA is subject to approval by local authorities.

6. The PSA is to be registered with the Ukrainian state authorities.

7. The PSA must be signed within 12 months from the day when it was obtained all necessary approvals.

Next steps upon signing PSA

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1. Foreign investor must register permanent representative office within three months after signing the PSA

2. Obtaining special permits (licenses) for usage of subsoil, exploration, extraction

3. Obtaining the mining allotment (up to 21 days)

3. Obtaining the right to use the land plot (land lease agreement or permanent use)

4. Obtaining necessary licenses for construction works, usage of subsoil, project documentation etc.

PSA Guarantees

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The investor may import equipment, materials etc. without the licensing and quota requirements as well as re-export them back outside of Ukraine.

The state guarantees that the PSA shall be regulated by the legislation in force as of the moment when it was signed except when it lowers taxes, simplifies requirements and procedures concerning the activities of the investor.

Decisions of executive and local authorities do not apply to the investor if such decisions limit the rights of the investor provided by the PSA.

Monetary income may freely be converted in other currencies and transferred outside of Ukraine. Many limitations and restrictions concerning the currency are not applied to the investor.

Other possible approaches

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Purchasing a share in a Ukrainian company

Concluding Agreements on Joint Activity with authorized entities conducting shale gas exploration/extraction and having all the necessary permits

Public-private partnerships

- Investor has to make sure that the Ukrainian company has all the necessary permits and documents when taking the decision on purchasing

- It should be kept in mind that the scope of necessary documents and approvals is very complicated and elaborated therefore the risk of certain non-compliance is quite considerable

- As an example of ENI, a company established by a state enterprise may be more trustworthy, however, there is no guarantee. Thus, the respective due diligence should be conducted

Subcontracting Works and Services by Danish Companies within the PSA

Agreements in Ukraine

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Forms of business presencein Ukraine

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Subcontractors may choose on of the two options:

Limited Liability Company

Permanent Representative Office

Representative office is not an independent legal entity and therefore can conduct commercial activity only on behalf of the founding company

Subsidiary is an independent legal entity which conducts activity on its own behalf

RepOffice vs. LLC (1)

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1. Process of establishingRegistration authority: Ministry of Economy of Ukraine Registration fee: USD 2 500Timeframe: up to 4 months Legal services fees: USD 4 995, excluding any notarization and translation fees

Registration authority: state administrationRegistration fee: around USD 22Timeframe: up to 1 monthLegal services fees: up to USD 3 380, excluding any notarization and translation fees.

2. LiabilityDirect liability of the founding

companySubsidiary bears liability

independently

RepOffice vs. LLC (2)

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3. Banking issues

Bank account of type “P”:• No limitations as to transactions

in national currency• Restrictions on purchasing foreign

currency• Restrictions to conducts

investments in Ukraine

Standard rules for operating bank accounts in Ukraine

4. Obtaining permits and licensesNo direct restriction to obtain permits and licenses- Practical problems are highly possible

May obtain any permit/license upon compliance with the respective requirements

RepOffice vs. LLC (3)

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5. Reporting on income to tax authorities

• Separate accounting and balance sheet is recommended

• Often queries re possible additional incomes

• Alternative ways for assessing taxable profit (0,3)

Strictly separated accounting and balance sheetNo grounds for tax authorities to claim additional income

6. Working permits for foreign citizensNot required (as of today –

limited number)Required

RepOffice vs. LLC (4)

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7. Practical issuesPower of attorney issued by the Head of the RepOffice needs to be notarized

Simple delegation of powers by the director

8. TaxationTaxation regime is the same for both types of business presence

Taxation of contractors

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Supply of production produced under PSA is subject to VAT (20 %).

Corporate Profit Tax

Goods imported for usage within PSA are tax-free at customs (saving the excise duty).

The services connected with the performance of PSA rendered by non-resident to investor are exempted from VAT.

VAT

Tax rate of Corporate Profit Tax as for 2013 – 19 %.

DOING BUSINESS VIA SUBSIDIARY OR REPOFFICE

Taxation of contractors

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Corporate Profit Tax

• According to Double Taxation Treaty between Denmark and Ukraine doing business regarding shale gas for more than average 30 days (totally) per 12 months constitutes PE.

• If related to offshore drilling, PE arises after 6 month activities.• In this case the tax rate of Corporate Profit Tax (for 2013) 19 % shall be

applied. If presence in Ukraine is less than 30 days (for offshore drilling less than

6 month)

All profits gained by non-resident in Ukraine are not subject to taxation in Ukraine unless there is PE in Ukraine

The same rules as mentioned in previous slide shall apply.

VAT

DOING BUSINESS WITHOUT A SUBSIDIARY OR REPOFFICE

CONTACTS

t +38 044 596 46 36 f +38 044 596 46 35e maksym.sysoiev@danevychlaw.com a 10 B, Vozdvyzhenska Street, Office 8, Kyiv, 04071 Ukrainewww.danevychlaw.com

MAKSYM SYSOIEV, LL.M., Attorney-at-law, Counsel of DANEVYCH law firm