EXPERTISE

Kinstellar Energy Digest: Ukraine January 2018 in Review

January 2018

RENEWABLES: Regulator further amends model PPA

In early January 2018 Ukraine’s National Commission for the Regulation of the Energy and Public Utilities Sectors (the “Regulator”) announced new set of amendments to model power purchase agreement ("PPA") for electricity from renewable energy sources ("RES"). By amending the model PPA, the Regulator seeks to address concerns of investors to make it bankable and thus, to attract new investments into the sector.

The key changes include:

• Energy for own needs: it is clarified that the producer shall use its own power generated from RES for its own purposes

• Force majeure: the list of force majeure events has been revised. It will become easier to qualify an event as force majeure (the event which influences the ability of the party to perform its obligations as compared to event which objectively makes it impossible for the party to perform its obligations in the previous version)

• International arbitration: only entities with foreign investments can opt for international arbitration. The arbitration clause is drafted more precisely to make it enforceable; it sets the number of arbitrators (3), the seat of the tribunal (Paris, France), language (English), applicable law (law of Ukraine), and also specifies that the arbitral award shall be final and binding for the parties

• Direct contract with lenders: for financing purposes, the off-taker can enter into a direct PPA with the lenders of a producer, and the off-taker shall be entitled to terminate the PPA not earlier than after 120 days following the notification of its intent to terminate the PPA due to a breach on the side of the producer

• Amendments due to changes in law: changes in law may trigger an obligation to amend the PPA if such changes result in an increase of the producer`s expenses by 5% or more

• Unilateral termination and compensation: the amended PPA includes grounds for unilateral termination by a producer, such as certain changes in law, failure to execute an arbitration award, material breach by the off-taker, etc. and establishes the structure of the compensation fee in case of such unilateral termination

The changes will become effective following their publication in the official newspaper.

OIL AND GAS: Royalty rates lowered and exemptions granted to boost production volumes

Two key sector initiatives – decreasing the royalty rates for new gas wells and decreasing royalties under production sharing agreements for gas, condensate and oil – have been included in the amended Tax Code of Ukraine.

The introduction of a more favourable taxation regime is envisaged by the Plan on implementation of the Concept for Development of Ukraine’s Gas Production Industry by 2020 (the "Plan"), which aims to increase gas production to 27.6 bcm in 2020, compared to 19.9 bcm in 2015. Lower royalty rates and stabilisation provision shall attract new investors to the sector.

The new rates for gas production – 12% and 6%, depending on the depth of the deposits – apply to wells where drilling from the ground level commences from 1 January 2018.

The new rates do not apply to gas production from new wells under joint activity agreements, which are taxed at a rate of 70%. Offshore drilling within the continental shelf and exclusive economic zone is taxed at 11%, while gas extraction under a production sharing agreement is taxed at 1.25%.

The new royalty rates are "frozen" until 1 January 2023

Unless a taxpayer voluntarily chooses otherwise, the royalties for new gas wells will not increase during the subsequent five years, including a de facto increase by any changes to the Tax Code or other laws, any corrective coefficients or other mechanisms that would result in a factual increase of royalty rates compared to the rates effective from 1 January 2018.

Royalty rates under PSAs do not exceed 2%

Effective on 1 January 2018, a new royalty rate for production of oil or condensate is 2% and for natural gas the royalty rate is 1.25%. The rates cover extraction of the mineral resources both on the territory of Ukraine and on the continental shelf and within exclusive economic zone, and apply for the extraction of oil, condensate and gas under the production sharing agreement only.

Royalty rates for gas condensate will become equal to the current rate for oil production within a year

From 1 January 2019, the royalty rate for the production of condensate from deposits less than 5,000 m in depth will be 29%; a reduced rate of 14% will apply if the deposits are located more than 5,000 m in depth.

The tax base for royalty rates is changed

In accordance with the amended Tax Code, the volume of gas (methane) from coal deposits degassing shall not be included into the tax assessment base for royalties, provided that the gas does not meet the quality requirements for natural gas intended for transportation, industrial or municipal consumption.

Clarification of the tax assessment base is important for companies in the coal mining sector that carry out periodic degassing, e.g. for preventing explosions.

Additional exemptions for the use of methane from coal deposits

By 1 January 2020, income derived from activities using gas (methane) from coal deposits and/or raw materials of gas (methane) from coal deposits is exempt from taxation provided that the income is used for the modernisation of equipment and introduction of new technologies.

The funds saved because of the exemption should be utilised by the end of the following tax year and, in case of misuse, the taxpayer would lose its right for exemptions.

Further developments to watch

One of the steps foreseen by the above-mentioned Plan is the relaxation of land use rules and regulations on permits. On 19 December 2017 the parliament passed, in its first reading, a draft law dedicated to the above-mentioned deregulation.

OIL AND GAS: Royalties for oil, gas condensate and natural gas "decentralised"

Starting from 1 January 2018, 5% of the royalties collected from oil, gas and condensate extracted onshore will be allocated to the respective local and regional budgets.

This change will make extraction projects more attractive for the local authorities, who previously occasionally used their discretionary powers to bloc new endeavours on their territory.

The regional budget will receive 2% of the royalties, while the remaining 3% of the royalties would be distributed among local communities, depending on the location of the natural resources.

REGULATOR: The Regulator resumed activity after a temporary inability to adopt decisions

On 23 December 2017, following amendments to law, the President of Ukraine appointed two temporary members of the Regulator. This appointment took place after a month-long absence of the quorum, which was caused by rotation of members, as a result of which, by end of May 2018 composition of the Regulator shall be completely renewed.

The temporary members will procure that the meetings of the Regulator can be quorate to take decisions, as absence of quorum caused significant risks for the business, in particular due to inability to issue licences and decide on tariffs.

The temporary members will serve for three months, while the Nomination Committee created in December 2017 will be selecting candidates for the vacant positions.

For further information please contact Olena Kuchynska, Partner, at , Viktoriia Pysmenna, Associate, at , and Mariana Antonovych, Associate, at ,