Russia: Expanding Opportunities For Foreign Investment In Major Oil And Gas Deposits

Tuesday, December 13, 2011 - 17:41

In the context of forthcoming Russian presidential elections, discussions have resumed concerning possible steps that Russia might take to encourage greater foreign investment and generally simplify transactions in strategic sectors of the Russian economy, including oil and natural gas projects.

On November 16, 2011, President Medvedev signed into law significant amendments to the law “On Foreign Investment into the Strategic Sectors of the Russian Economy” (the Strategic Investment Law). The amendments will enter into force in mid-December 2011 and should ease some of the current legislative restrictions on foreign investment in strategic sectors of the Russian economy.

Background Of The Strategic Investment Law

In the final days of Vladimir Putin’s presidency in 2008, President Putin signed into law the Strategic Investment Law and related amendments to the Subsoil Law, which imposed formal restrictions on foreign investment in certain sectors of the economy, including major Russian upstream oil and natural gas projects. The new legislation introduced the concept of “deposits of federal significance” and considerably complicated investment in companies that operate such deposits, both for foreign investors and domestic investors operating through offshore entities. 

Although there is an official list of deposits of federal significance approved by the State, a subsoil deposit is automatically deemed to be a “deposit of federal significance,” subject to the provisions of the Strategic Investment Law if (i) it meets certain quantitative requirements (e.g., it has proven oil reserves of over 70 million tons or natural gas reserves of over 50 billion cubic meters); (ii) it is located in internal waters, territorial waters, or on the continental shelf; or (iii) its development requires the use of land plots designated for defense or security purposes. 

Pursuant to the Strategic Investment Law, any transaction that would result in a foreign company or person acquiring “control” over a Russian company having rights to a deposit of federal significance is subject to prior approval by a special governmental commission chaired by the Russian prime minister. The approval procedure is time consuming and the paperwork intensive; at the same time, in practice, rejections of applications have been rare. According to the Russian Federal Antimonopoly Service, which is charged with administering the approval process, only 2 applications out of 174 were denied between 2008 and 2010. 

Recent Amendments To The Strategic Investment Law

The amendments to the Strategic Investment Law introduce important changes that include (i) increasing the thresholds for “control” that trigger State approval requirements, and (ii) permitting acquisitions by foreign investors that are ultimately owned or controlled by Russian entities or persons (e.g., offshore holding vehicles). 

Acquisition of Control: The amendments liberalize the thresholds that signify “control” over a Russian strategic company. Prior to the amendments, the thresholds for “control” in a company developing a deposit of federal significance were 10 percent. Henceforth, foreign “control” of a company associated with a deposit of federal significance will be defined as:

(i) direct or indirect control over 25 percent or more of voting shares in the company’s charter capital, or 

(ii) the right to determine the decisions taken by the company, including its business activities (whether acquired pursuant to an agreement or otherwise), or 

(iii) the right to appoint the sole executive body or 25 percent or more of the members of a collegiate executive body or the board of the company, or 

(iv) acting in a management capacity in such a company. 

Foreign states and international organizations or entities controlled by states (e.g., national oil companies) must receive approval prior to acquiring an interest amounting to 5 percent or more of a company developing a deposit of federal significance. While this approval threshold remains the same, the Strategic Investment Law raises a ceiling on the extent of “control” that a foreign state or international organization can acquire. Prior to the amendments, these entities were prohibited from acquiring an interest of 10 percent or more; however, with the recent amendments, the thresholds for “control” (and therefore the ceiling on foreign state or international organization investment) will be raised to 25 percent.

Subsoil License Tender/Auction Requirements: Based on the increased “control” thresholds, a company under foreign “control” may be prohibited in tender or auction rules from taking part in a specific tender or auction of a subsoil deposit at the discretion of the Russian government. 

Holding Structures: Prior to the amendments, the notion of a “foreign investor” captured not only non-Russian investment in Russian companies and assets, but also investments by Russian companies and individuals through the use of offshore investment vehicles. The amendments expressly provide that the requirements for prior approval do not apply to investments by foreign companies that are controlled ultimately by Russian entities or persons (and not by foreign elements). The concept of control in this respect is determined in the same way as set out in the Strategic Investment Law (as described above). (This exemption is inapplicable if the controlling person is also a citizen of another country and/or is not a tax resident of the Russian Federation.)

Exemptions From The Strategic Investment Law

The Strategic Investment Law provides a general exemption from its approval requirements if an investment is governed either by (i) a separate federal law (e.g., the production sharing law) or (ii) a duly ratified international treaty. 

In addition, the Strategic Investment Law provides that its provisions, including approval requirements, do not apply to entities in which the Russian Federation directly or indirectly owns or controls greater than 50 percent of the total votes represented by the share capital of such entity (i.e., Rosneft, Gazprom, and Zarubezhneft). Accordingly, joint ventures between majority-controlled Russian State companies and foreign investors (other than investors controlled by foreign states or international organizations) are entitled to an exemption from the approval requirements. However, if the State were to privatize its interests in a joint venture partner, such as Rosneft, then the joint venture would no longer qualify for an exemption. 

The prior regulatory approval required pursuant to the Strategic Investment Law does not apply to transactions with international financial institutions in which Russia holds a membership, or with whom Russia shares treaty obligations. The application of this exception is dependent on government approval of a list of exempted international financial institutions.

Regulation Of Exploration On The Continental Shelf 

Special regulations apply to the development of offshore fields that, regardless of size, are deemed to be deposits of federal significance. Rights to offshore oil and natural gas deposits are granted only to Russian legal entities (i) with no less than five years’ experience developing continental shelf deposits in Russia and (ii) in which the Russian State holds more than 50 percent of votes in the share capital. These limitations mean that only the State-owned companies Rosneft and Gazprom may develop offshore fields. (Zarubezhneft, also a State company, is not eligible to hold an offshore subsoil license as it does not possess five years of Russian offshore experience, although it does have non-Russian offshore experience (e.g., in Vietnam).) 

In addition to these amendments to the Strategic Investment Law, there are a number of draft amendments in various stages of development that are anticipated to apply to the regulatory and tax aspects of offshore operations. 

Jennifer A. Josefson, Partner, is a member of King & Spalding’s Global Transactions Practice Group in its Moscow office. She specializes in Russian and international transactions in the energy and natural resources sector, regularly advising clients on M&A and joint venture arrangements, joint operating agreements, concessions, PSAs, farm-ins, supply and service agreements and international arbitration in the subsoil and energy sectors. Ms. Josefson is a vice president of the Association of International Petroleum Negotiators and was the founding regional director of AIPN’s CIS Chapter from 2005 to 2008. Alexandra A. Kotlyachkova is an Associate in King & Spalding’s Moscow office and a member of the firm’s Global Transactions Group. She focuses on legal aspects of business operations in the Russian energy and natural resources sectors, focusing on regulatory and corporate matters relating to the power sector.

Please email the authors at jjosefson@kslaw.com or akotlyachkova@kslaw.com with questions about this article.