EU sanctions against Russia: what does it mean for the energy industry?
November 2014 | SPECIAL REPORT: ENERGY & NATURAL RESOURCES SECTOR
Financier Worldwide Magazine
The EU has again strengthened sanctions against Russia, including further restrictions directly impacting the energy industry. We are already seeing in the press the effect sanctions are having on the Russian energy sector, and the oil majors’ interests there. Developments over the next few months may well dictate what the long-term future of the industry looks like in this region. It is therefore vital that those involved in the Russian energy industry are aware of the current restrictions on trade and finance, and keep up to date with developments.
On 12 September 2014, the EU expanded its ‘Stage III’ sanctions against Russia by issuing Council Regulation (EU) No 960/2014. Russia’s capital markets, energy and defence sectors, as well as identified individuals and entities, have all been targeted by these sanctions, which are currently due to expire on 31 July 2015.
How do these sanctions affect the energy industry?
The Stage III sanctions take direct aim at certain parts of the Russian energy industry in two ways. Firstly, by prohibiting the supply into Russia of certain oil related equipment, technologies and services for use in specified future Russian oil projects. Secondly, by restricting state-owned Russian energy companies’ access to EU capital markets.
Specified equipment, technology and services
EU entities now require prior authorisation for the ‘sale, supply, transfer or export’ of listed equipment and technologies to a Russian entity, or to any entity which intends to use the equipment or technology in Russia.
Each EU Member State will administer such authorisation, which will not be granted if there are reasonable grounds to determine that the ‘sale, supply, transfer or export’ is for deep water oil exploration and production (E&P), Arctic oil E&P, or shale oil projects in Russia. The applicable equipment and technologies mainly include pipes and casings used for drilling and constructing pipelines, drilling and pumping equipment, floating or submersible production platforms and associated items. Their origin is irrelevant; it is the import into Russia that is restricted.
The sanctions also prohibit (except in emergency situations) the provision of certain services necessary for deep water oil E&P, Arctic oil E&P, or shale oil projects in Russia. The services are well testing, logging and completion services, and supply of specialised floating vessels.
Capital market access
The sanctions also expand the list of entities subject to EU capital market restrictions relating to transferable securities and money-market instruments to include Rosneft, Transneft and Gazprom Neft. The Stage III sanctions list had previously been limited to Russian financial institutions.
From September 2014 onwards, it is prohibited to buy or sell (directly or indirectly), or generally provide investment services or deal with transferable securities and money-marketing instruments, with a maturity exceeding 30 days, with these entities. The definition of ‘transferable securities’ limits the classes of securities to company shares (and other securities equivalent to shares in companies, partnerships or other entities), bonds and other forms of securitised debt (including depositary receipts in respect of such securities), and any other securities giving the right to acquire or sell any such transferable securities. ‘Money-market instruments’ include treasury bills, commercial papers and certificates of deposit. Instruments of payment are excluded. The sanctions also prohibit any arrangement to make new loans or credit with a maturity exceeding 30 days to the listed entities, unless it is a loan for a specified and permitted purpose (excluding oil industry purposes as discussed above), or to maintain the liquidity/prevent insolvency of subsidiaries based in the EU.
It should be noted that the US (and other countries) have imposed their own sanctions against Russia. The US sanctions prohibit the provision, exportation or re-exportation of goods, services (not including financial services) or technology in support of E&P for deepwater, Arctic offshore or shale projects that have the potential to produce oil in Russia (or its claimed territory), however the restrictions only apply when the dealing involves Gazprom, Gazprom Neft, Lukoil, Surgutneftegas and Rosneft, whereas the EU has imposed a blanket ban. The US sanctions also impose capital market restrictions on Gazprom Neft, Transneft, Rosneft and Novatek.
Limitations of the sanctions
The Stage III EU measures are not designed to curtail current oil production projects, but to restrict future access by Russia to EU technology, hardware, services and expertise when developing new oil sources. The EU appears to be seeking to strike a balance between, on the one hand, taking effective action against Russia, and, on the other, recognising Europe’s dependence on Russian gas and the need to minimise costs to EU energy companies.
There are two aspects of the sanctions which limit their impact. First, the relevant competent authority may grant the authorisation if the transaction concerns the execution of an obligation from a ‘contract or agreement’ concluded before 1 August 2014. Similarly, the prohibition on specified services does not apply to the execution of obligations arising from a ‘contract or framework agreement’ that was concluded prior to 12 September 2014, or ancillary contracts necessary for the execution of these contracts.
Otherwise prohibited dealings will therefore seemingly be authorised or allowed, provided they can be firmly linked to an agreement which was entered into before the relevant cut-off dates, to enable companies to comply with contractual obligations. This includes the numerous agreements already in place between oil majors and Russian companies to develop new Russian oil sources. Further, there is little constraint on the meaning of ‘contract’, ‘agreement’ or ‘framework agreement’, and therefore a provisional agreement, entered into before sanctions were introduced, could potentially be relied upon to allow subsequent (otherwise prohibited) dealings to occur.
Secondly, the sanctions do not apply to gas. By way of example, much of the listed oil-related equipment, technology and services is also commonly used in gas E&P and therefore may be authorised or allowed on this basis.
Although these limitations exist, the EU has left open the possibility of tightening up or expanding the prohibitions at a later date. Accordingly, the energy sector should be prepared for further restrictions, depending on how the situation develops.
Precautions that should be taken
There are certain measures that EU energy entities should take to ensure they do not fall foul of the Regulations.
Firstly, determine whether the relevant equipment, technology, product or service is one which is intended to be captured by the sanctions. Entities involved should verify whether the items in question appear on the lists annexed to the relevant EU Regulation or in the Regulation itself.
More than ever, thorough due diligence of counterparties is key. A review of company structures, shareholdings and management, including of the end user (which often will not be the contracting party) should be carried out before entering into any new agreements. Importantly, an inquiry into the intended use of relevant equipment, technology or services is vital. In relation to the capital market restrictions, entities should re-screen all Russian counterparties, and counterparties with relevant business or investments in Russia.
Include appropriate sanctions wording in contractual documentation. Issues may arise through due diligence which could require further investigation, for instance a contracting party who is situated in a jurisdiction which is not subject to EU sanctions, but who refuses to sign up to sanctions provisions in the contract. Consider what procedures need to be in place to monitor any potential risk. Consider all jurisdictions that may be involved in the transaction, including in relation to the assets involved or the parties to the transaction. Such other jurisdictions may have their own sanctions regime that could have an impact on the transaction. Consider what may happen if sanctions are further strengthened and it makes the contract difficult or impossible to perform, including the contractual consequences and where the inevitable loss will lie.
The sanctions do provide for a limited defence if the EU person or entity did not know, and had no reasonable cause to suspect, that its actions would infringe sanctions. This defence is premised on the assumption that reasonable checks have been carried out and that nothing was revealed that would give rise to such a suspicion. There may be contractual (or other) steps an innocent entity can consider to maximise its ability to rely on this defence, however this will depend on all of the circumstances of the transaction. It is also important to note that any intentional attempt to circumvent the sanctions is strictly prohibited.
Where authorisation is required, the applicant must supply the competent authority with all relevant information required for that application. The form and content of such an application is likely to differ between Member States. Pertinently, records will be shared, and where authorisation has been denied by one Member State, a second Member State cannot grant authorisation of the same transaction without first consulting the original Member State.
EU entities may also be affected by the asset freeze and visa bans which have been placed on specified individuals and entities. There are also specific sanctions in relation to Crimea and Sevastopol which are likely to affect any energy entity doing business with a connection to that area.
Consequences of being in breach of sanctions
Although the EU Regulations are directly applicable in all Member States without further national legislation being required, the EU leaves it to each Member State to legislate what the penalties are for breach of sanctions. In the UK, it is a criminal offence to breach the above sanctions. The penalties include a possible jail term of up to two years for individuals and/or a fine.
In light of the ongoing expansion of EU sanctions in connection with events in Eastern Ukraine, energy companies should undertake ongoing risk assessments. This includes bearing in mind potential future risks and any broadening of sanctions already in place.
Philip Roche and Neil Q. Miller are partners, and Katie McDougall is an associate, at Norton Rose Fulbright LLP. Mr Roche can be contacted on +44 (0)20 7444 2609 or by email: email@example.com. Mr Miller can be contacted on +44 (0)20 7444 2625 or by email: firstname.lastname@example.org. Ms McDougall can be contacted on +44 (0)20 7444 3344 or by email: email@example.com.
© Financier Worldwide
Philip Roche, Neil Q. Miller and Katie McDougall
Norton Rose Fulbright LLP