Features of Signing Long-term Oil and Gas Contracts with Ukraine

Rostyslav Nykitenko

Today, the external economic relations between the states are formed primarily through the oil and gas sector. Ukraine, given its territorial position, is an important transit hub through which oil and gas trade between Europe and Asia is conducted.

State-owned National Joint Stock Company Naftogaz of Ukraine is the leading enterprise of the fuel and energy complex, one of the largest Ukrainian companies, and is actively involved in the formation of commercial relations between Ukraine and other countries.

Ukraine’s main gas partner today is Russia, namely Gazprom. The current gas contract between Gazprom and Naftogaz has been in place since 2009, and will expire on 1 January 2020. This document for the first time formed a long-term stable gas relationship between Ukraine and Russia, but its terms quickly became unprofitable for Ukraine. Under the current contract, Ukraine has to pay for 41.6 billion cubic meters of annual use of gas, regardless of the volume of actual consumption. This take-or-pay principle was an economic disaster for Naftogaz, as Ukraine’s actual gas usage was three times smaller.

This unfavorable economic situation led to the accumulation of debt and in 2014 Naftogaz Ukraine filed a lawsuit with the Arbitration Institute of the Stockholm Chamber of Commerce. According to official data, the amount of mutual claims came to approximately USD 125 billion. In 2018, the arbitration panel made a decision that:

— the principle of «take or pay» is maintained, but the minimum volume of gas supply is significantly reduced, from 41.6 billion cubic meters up to 4-5 billion cubic meters per year;

— lifting the ban on gas re-export, thus allowing Ukraine to resell unused gas volumes;

— Ukraine has to pay a USD 2 billion debt for deliveries in 2013-2014;

— Gazprom owes Naftogaz USD 4.56 billion for failing to comply with the minimum volumes of transit on the principle of «download or pay», which under the contract amount to 110 billion cubic meters per year;

— The volume of transit on the principle of «pump or pay» is maintained until the contract expires on 31 December 2019 (in 2017 Gazprom pumped about 95 billion cubic meters of gas through Ukraine);

— Gazprom cannot bill Naftogaz for gas deliveries to the war-torn and temporarily un-controlled territories of Donbas, as the volumes of these supplies cannot be determined.

This arbitration award has significantly improved Ukraine’s economic situation, but today there is a considerable threat to Ukraine’s energy and economic stability. Gazprom has launched a new transit gas stream to Europe, bypassing Ukraine, along the bed of the Baltic Sea — Nord Stream 1 and another pipeline — Nord Stream 2, is already under construction. Four countries — Finland, Sweden, Germany and the Russian Federation — have approved the pipeline. Denmark has now rejected Gazprom and is requesting the company building the Nord Stream 2 to evaluate the environmental impact of the third gas pipeline route, which will take place in Denmark’s exclusive economic zone.

The purpose of such heightened activity on the part of Gazprom is to minimize dependence on gas transit through the territory of Ukraine, because in 2017, despite the ongoing conflict in Donbas, 50% of Gazprom’s export volumes to Europe went through Ukraine.

As of 2019, the second gas stream has not yet been put into operation (its opening is postponed to the second half of 2020) and, therefore, Russia still needs stable economic relations with Ukraine. Experts say Naftogaz should take advantage of the favorable position and conclude the most profitable long-term gas contract with Gazprom. Ukraine’s next steps should be to develop alternative sources of income and to pay dividends into the state budget, particularly through domestic production.

Reform of Ukraine’s oil and gas industry

Russia will sign a gas transit agreement with Ukraine if the Ukrainian government implements European legislation by the end of 2019, Russian President Vladimir Putin said during Russia’s Energy Week on 2 October  Interfax-Ukraine reports. So, a number of steps have recently been taken to bring Ukraine’s oil and gas legislation into line with European standards.

Features of concluding international treaties with the participation of Ukraine

Oil and gas contracts are very specific types of contracts, which play a big role in formation of state policy and the country’s economy. The conclusion of long-term international oil and gas contracts is a long-term process that includes elements of diplomacy and foreign economic activity of the state. Therefore, the procedure for signing a contract is preceded by the conclusion of an international agreement with the country-party of oil and gas relations.

At the legislative level, the process and features of concluding international treaties are enshrined in the Law of Ukraine On International Treaties of Ukraine. According to this law, all international treaties with the participation of Ukraine are concluded by the following persons:

— By the President of Ukraine or via his behalf on behalf of Ukraine;

— The Cabinet of Ministers of Ukraine or on its behalf — on behalf of the Government of Ukraine;

— Ministries and other central bodies of executive power, state bodies — on behalf of ministries, other central bodies of executive power, state bodies.

The procedure for concluding an international treaty involves several steps:

Submission of proposal for conclusion of international agreement;

Deciding on negotiations;

Formation of a delegation;

Signing of international agreement;

Entry into force of the contract.

The initial stage of the procedure is submission of a proposal for an international treaty, This step is taken by the parties most interested in concluding a treaty and involves the submission of a written proposal together with a package of supporting documents, namely:

a) submission accordingly to the President of Ukraine or the Cabinet of Ministers of Ukraine of;

b) an explanatory note, which substantiates the expediency of concluding an international treaty, identifies the likely political, legal, socio-economic, financial, humanitarian and other consequences of its conclusion, as well as the subjects of implementation of the international treaty;

c) draft of the international treaty in Ukrainian language;

d) the text of the international treaty in Ukrainian in its official translation and in the language of the original in case of submitting a proposal for its ratification, approval, acceptance or accession;

e) a certificate of approval of the draft of the international agreement by the interested ministries, other central executive bodies and state collegial bodies;

f) a draft decision on the establishment of a delegation or an assignment to the representative of Ukraine to prepare the text of the international treaty, to adopt it, to establish its authenticity, as well as the draft directives of the delegation or representative of Ukraine;

g) electronic versions of the abovementioned documents. Proposals for the conclusion of international treaties of Ukraine shall be submitted after the Ministry of Justice of Ukraine has carried out a legal examination regarding the conformity of the draft of the international treaty with the Constitution and laws of Ukraine.

Decisions on holding negotiations and signing international treaties of Ukraine shall be made:

a) concerning international treaties concluded on behalf of Ukraine by the President of Ukraine;

b) in respect of international treaties concluded on behalf of the Government of Ukraine, by the Cabinet of Ministers of Ukraine;

c) in respect of interagency agreements — in accordance with the procedure established by the Cabinet of Ministers of Ukraine. After the official announcement of the terms of the negotiations, the composition of the delegation is formed.

Authorized persons, depending on the type of treaty, approve the personal composition of the delegation or the representative of Ukraine, who is charged with negotiating the drafting of the international treaty, its adoption, establishing its authenticity or signature, as well as the relevant directives of the delegation or representative of Ukraine. At this stage, ministries, other central executive bodies and state collegial bodies are selected, which must be involved in the conclusion of an international treaty of Ukraine and may be charged with ensuring the fulfillment of contractual obligations.

The delegation or representative of Ukraine shall submit a report on the implementation of the directives, respectively, to the President of Ukraine or the Cabinet of Ministers of Ukraine. The report shall contain the conclusions and proposals agreed upon with the Ministry of Foreign Affairs of Ukraine on the follow-up to the conclusion of the international agreement.

The powers to negotiate and sign international treaties of Ukraine are vested in:

a) related international treaties concluded on behalf of Ukraine by the President of Ukraine;

b) in respect of international treaties concluded on behalf of the Government of Ukraine, by the Cabinet of Ministers of Ukraine;

c) in respect of interagency agreements — in accordance with the procedure established by the Cabinet of Ministers of Ukraine.

In addition to the above-mentioned persons, the Head of the Diplomatic Mission of Ukraine in a foreign country or the Head of the Mission of Ukraine by an international organization has the right to negotiate the conclusion of an international treaty, prepare the text of the international treaty and adopt it with the accreditation country or within the relevant international organization without special authority.

After negotiations are conducted and the text of the treaty is brought into line with the interests of both parties and the norms of the legislation of the participating countries, the text of the treaty is signed by authorized persons from both parties. From that time on, the contract comes into force, unless otherwise stated in the text of the contract. The concluded treaty is not the driving force for economic relations between the states, on the background of which more specific contracts are concluded, which spell out in detail all the conditions of cooperation.

An example of a transparent procedure for concluding international treaties is the Agreement between the Cabinet of Ministers of Ukraine and the Government of the Republic of Kazakhstan on cooperation in the supply of Kazakh oil to Ukraine and its transit through the territory of Ukraine from 2007. This document contains not only general provisions on mutual loyalty, but also specific volumes of transportation and a list of used transit pipelines of Ukraine.

The main elements of a long-term oil and gas contract with the participation of Ukraine

The procedure for concluding oil and gas contracts is an important element of a country’s foreign policy, which requires the use of diplomatic ties. Typically, Ukraine’s gas and oil contracts with the participation of other states, are covered extensively in the media. However, despite the publicity of this procedure, the text of the contract itself may be prohibited from being accessible to the general public for reasons of business secrecy. A striking example of such a policy is the history of gas contracts between Gazprom (Russia) and Naftogaz (Ukraine). Some provisions of these contracts are known to the general public solely through the results of the analysis of the texts of the contracts by expert groups.

Both oil and gas contracts come under the general category of International Commercial Contract, which is characterized by the following mandatory elements:

— Preamble. This is the introductory part of the contract, which spells out the name and number of the contract, the place of signing, its parties with a detailed indication of the persons authorized to sign.

— The subject matter of the contract and its full description, including title, quality, compliance with common criteria and international standards, etc.

— Rights and duties. This part includes the following conditions: the obligations and rights of the first and second parties to the contract; term of fulfillment of obligations by the parties; place of fulfillment of obligations of each partner; the method of fulfillment of obligations (procedure and timing).

— Additional terms of the contract. These terms are optional to indicate in the text of the contract, but their existence establishes additional elements of protection of the parties, in particular: the term of the contract, confidentiality conditions, liability of the parties and methods of securing obligations (penalty, security, surety, deposit), dispute resolution. Oil and gas contracts typically contain arbitration provisions for disputes indicating highly-qualified international arbitration agencies.

— Other terms of the contract include the results of the pre-contractual work and the terms of the agreement between the parties.

— Legal addresses of the parties, including postal, bank and shipping details.

— Add-ons. Taking into account the specifics of contracts, quality certificates, plans, tables, economic indicators and more can be annexed.

Based on the above information and statistics, we can conclude that Ukraine is on the verge of big changes in the energy sector. World events are pushing Ukraine towards establishing energy independence and forming exceptional mutually-beneficial trade relations with reliable partners.

 

 

Changes in legislation	The impact of change
The conditions for transparency in the extractive industries have been created. The Law of Ukraine of 18 September 2018 On Ensuring Transparency in Extractive Industries defines the organizational and legal bases of disclosure of information in the extractive industries, establishes specific obligations and methods of disclosure of information, and also provides for responsibility of the subjects of disclosure of information.	A positive event for the market. The law establishes international standards and best practices for the disclosure of information in the extractive industries in Ukraine in accordance with the Extractive Industries Transparency Initiative (EITI).
Deregulation measures have been taken in the oil and gas industry. The Law of Ukraine dated 1 March 2018 On Amendments to Some Legislative Acts of Ukraine on Deregulation in the Oil and Gas Sector was adopted, which simplified the procedure for obtaining permits for oil and gas production. Subsoil users were allowed to independently dispose of geological information in their possession, taking into account the requirements of the Laws On State Secrets and on Sanctions.	A positive event for the market. It will promote the development of the mining industry.
The resolution of the Cabinet of Ministers of Ukraine dated 7 November 2018 On Issue of Geological Information Disposal was adopted, which simplified access to state-owned geological information and the procedure for transfer of rights to geological information owned by legal entities and individuals.	A positive event for the market. It should facilitate access to geological information for foreign investors and individuals interested in the implementation of mining projects in Ukraine.
Resolution of the Cabinet of Ministers of Ukraine dated 17 October 2018 On the Implementation of an Experimental Project for the Implementation of Auctions for the Sale of Special Permits for the Use of Subsoil by Electronic Auction.	A positive event for the market. Introduces electronic auctions within the framework of auctions for the sale of special permits for the use of subsoil, will help to increase transparency and attract new investors into the Ukrainian mining industry.
Tariffs for transportation of oil and petroleum products, as well as for storage (pumping, extraction) of natural gas in underground gas storage facilities have been set. The NERCEP Resolution of 19 June 2018 set tariffs for services of storage (injection, extraction) of natural gas in the underground gas storages of JSC Ukrtransgaz and settled the issue of calculation of tariffs for the transportation of oil via the main pipelines for consumers over three-year period. in a simplified manner using the annual tariff growth rate.	A positive event for both the oil and gas market and the companies of the Naftogaz Group. Creates conditions for the operation of the oil and gas market, enabling enterprises to plan their economic activities, finance operating and capital expenditures, to receive income from the provision of services for the transportation of oil, petroleum products and natural gas, as well as storage (injection, extraction) of natural gas in underground gas stores.
Ten-year plans for the development of the gas transportation system and underground gas storage facilities have been approved. The NERCEP Resolution of 04.09.2018 On Approval of the Gas Transport System Development Plan of the Gas Transmission System Operator of JSC Ukrtransgaz for 2018-2027 provides for planned sources of financing of this plan to the total amount of UAH  60.043 billion, and the planned sources of financing for this plan come to UAH 13.1 billion (excluding VAT).	A positive event for the Naftogaz Group. It provides an opportunity for the development of GTS and UGS of Ukraine, also promotes a better understanding of the future infrastructure, potential routes and facilities for the transportation and storage of natural gas, and, accordingly, enables the long-term planning of the Group’s activities.
The provisions of the Gas Transmission System Code and the Gas Storage Code have been improved. The NERCEP Resolution of 25 September 2018 On Adoption of the Resolution of the NERCEC On Approval of Amendments to the Gas Transmission System Code ”introduced amendments to the GTS Code regarding the establishment of a sufficient level of financial security, clarification of the definition and details of trade notification, introduction of a clear and transparent mechanism.	The provisions of the Gas Transmission System Code and the Gas Storage Code have been improved. The NERCEP Resolution of 25 September 2018 On Adoption of the Resolution of the NERCEC On Approval of Amendments to the Gas Transmission System Code ”introduced amendments to the GTS Code regarding the establishment of a sufficient level of financial security, clarification of the definition and details of trade notification, introduction of a clear and transparent mechanism.

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Rostyslav Nykitenko is an advocate / barrister