In Re (#12 December 2016)

Developments in Ukraines Legal Framework for Oil and Gas Transit via Pipelines

Tars V. Dumych

This article is a continuation of the study and article on a related topic first published in the August 2005 issue of the Ukrainian Journal of Business Law. A decade later, both the Ukrainian legal framework for oil and gas transit via pipelines as well as business practices and international relations in this sector have undergone considerable developments.

National legislation

It would be no exaggeration to say that the developments and changes in Ukraines national legislative framework were largely driven by the countrys activities at international level and by its integration into the European legal landscape. The main statutory act which was passed so as to start implementing the countrys international commitments was the Natural Gas Market Act of Ukraine of 9 April 2015 (the Natural Gas Market Act). The Natural Gas Market Act was adopted in order to implement the Treaty establishing the Energy Community concluded in Athens on 25 October 2005 (the EC Treaty), which became effective for Ukraine in 2011, as well as some the European Union (the EU) regulations applicable to transportation (both domestic and cross-border) of natural gas. The Natural Gas Market Act has not only introduced some (for Ukrainian law and for the natural gas transit business practice) completely new regulations, but has also implemented unprecedented principles for the application and interpretation of the law. When it comes to the application of the EU regulations which the Natural Gas Market Act aims to implement in Ukraine, the Act obliges Ukrainian state authorities and courts to take into account the law application practice of the Energy Community and of the EU, in particular the decisions of the EU Court. For a country which is not an EU member or candidate, this is a significant commitment. To a certain extent the Natural Gas Market Act may be considered a codified piece of legislation due to the fact that it comprehensively governs the relationships arising in the sale and purchase, supply, transportation (including cross-border transit), distribution, and storage of natural gas as well as business transactions with respect to liquefied natural gas (LNG). When it comes to transportation of natural gas, the Act establishes fundamental rights and obligations for gas suppliers and for operators of gas transportation systems (the GTS Operator) responsible for the transportation of gas. While a GTS Operator must be a specially licensed and certified entity, such a requirement is not applicable to the supplier of gas i.e. the entity which employs the GTS Operator to transport gas. Unless a supplier of gas is engaged in other activities which are subject to licensing (for example, gas distribution, gas storing, LNG plant operation or gas supply to end customers), no license will be required for it to contract a GTS Operator to transport gas. Furthermore, there are no limitations provided in the Act for the gas supplier to be a Ukrainian person or entity regardless of whether the gas is transported within or to Ukraine, or relates to cross-border gas transportation. The Natural Gas Market Act has introduced and implemented into Ukrainian law those requirements concerning GTS Operators which were earlier introduced into EU law. In particular, a GTS Operator must be independent of and not involved in activities related to the production, distribution, supply and sale of natural gas. Additionally, even stricter criteria and requirements are established for companies controlled by entities or persons from countries which are not members of the Energy Community. The Ukrainian Government has started its actions to fulfill the commitment on ensuring the independence of the GTS Operator. For this purpose, the Cabinet of Ministers of Ukraine has decided to incorporate the PJSC Trunk Pipelines of Ukraine (the TPU), which is supposed to become Ukraines principal GTS Operator. The establishing of TPU is expected to be implemented by unbundling the gas transit infrastructure from the national oil and gas monopoly Naftogaz of Ukraine. This step by the Government of Ukraine will also be in the EU Third Energy Package, which implements the EC Treaty provisions on the level of EUs legislation. Importantly, the licensing terms for the transportation of natural gas (as well as for other licensed activities under the Natural Gas Market Act) may only be approved by the regulator upon consultation with the Secretariat of the Energy Community. As of the date of this article, no licensing terms have been approved. However, as it is expected that the President of Ukraine will sign into law the draft on the National Commission for State Regulation of Energy and Utility Services (the National Commission) which has already been passed by Parliament, it is quite likely that such licensing terms will be approved in the near future. The National Commission shall be the regulator for all natural gas related business activities (including gas transportation) as well as for the transportation of oil and oil products (derivatives) via trunk pipelines. As to the transit of oil, the Natural Gas Market Act is not applicable. Statutory acts which have already been in existence for quite some time, including the Oil and Gas Act of 12 July 2001 and the Pipeline Transport Act of 15 May 1996, are the main statutes regulating the transportation, including cross-border transit, of oil via oil pipelines. The transportation of oil and oil products via trunk pipelines is subject to licensing. Although there is no clear prohibition on a foreign company applying for and being granted a license for oil transportation, as a matter of operation of the law, only Ukrainian registered companies may be granted such licenses. Despite the fact that this area of activity has historically been monopolized by state-owned companies, privately-owned companies, including those owned or controlled by foreign shareholders, hold licenses for the transportation of oil and carry out cross-border transit of oil derivatives.

International legal framework

Ukraine has been a longstanding contracting party to the Energy Charter Treaty (the ECT). The ECT broadly applies to various types of energy and energy related activities; however, it has also set up key principles concerning the transit of oil and gas. Under the ECT each contracting party (i.e. state) shall, among others, take the necessary measures to facilitate transit, shall encourage relevant entities to cooperate in modernizing transit facilities and secure established flows of energy to, from or between the areas of other contacting parties. It will be interesting to see how the above obligation will be performed with respect to Ukraine-Russia oil and gas transit. Even though Russia has pulled out and is no longer a contracting party or signatory to the ECT, it is Ukraines obligation to ensure that the operation of the established flows, i.e. the oil and gas pipelines that connect Russia with EU via the territory of Ukraine, are secure. On the other hand, considering the possible effect of alternative routes which aim to circumvent Ukraine, Ukraine should have the same right towards the EU countries (although unlikely towards Russia too) with respect to existing Ukrainian pipeline system. In addition to various rights and obligations at the level of inter-state relations, the ECT has provided a number of rights for private investors in the energy sector. These rights concern the protection of foreign investors, as well as trade, transit and dispute resolution between foreign investors and states. The latter is often used as a basis for investment treaty arbitrations. Another important step for Ukraine at international level was the countrys joining the World Trade Organization (the WTO), thereby becoming a party to the WTO Agreement and the General Agreement on Tariffs and Trade (the GATT). Unlike the ECT, which allows not only states but also private investors from contracting states to rely upon it, GATT is a treaty under which only states can exercise their sovereign rights. According to GATT, there shall be freedom of transit [of goods] through the territory of each contracting party, via routes most convenient for international transit. Both Ukraine and Russia in the course of joining the WTO made statements that the transit of oil and gas falls within the scope of GATT. However, due to the fact that it is Ukraine and not Russia that is the transit state (Russia is mainly an exporter state), as a matter of practice, Ukrainian commitments under GATT are of a higher value for third countries and, therefore, Ukraines burden under GATT is arguably heavier. Nonetheless, when it comes to Ukraines interests in its relations with Russia, GATT may play an important role in pursuing the countrys interests with respect to the possible transit of gas from Central Asia countries via Russias gas pipelines, as was the case a decade ago. Turning to the EC Treaty, many of the principles of the ECT, especially those related to the facilitation of energy (not just oil and gas) transit, were subsequently also implemented in the EC Treaty. The same goes for GATT, it is the contracting state, rather than a private investor, who may exercise its rights under the EC Treaty. The main purpose of the EC Treaty is to implement unified rules and principles, largely based on EU regulations, applicable to the energy sector in most European countries. As mentioned above, Ukraines progress in the implementation of those principles into Ukrainian law has already been significant. As a result, not only Ukrainian law, but the Ukrainian oil and gas transit business sector have developed further. Furthermore, the EC Treaty may also be viewed as an instrument for Ukraine to protect its interests as a transit country in its relations with EU Member States.

Prospects

Ukraines position as a transit country is both an advantage and a huge responsibility for the country. It is a responsibility, as the neighboring EU countries, especially those in Central Europe depend on the Ukrainian oil and gas transit infrastructure and its safe operation. Considering the attempts of the only gas supplier that is presently using Ukraines gas transit infrastructure (i.e. Gazprom) to develop the alternative transit routes, holding the role of a transit only country arguably represents a risk for Ukraine. Notwithstanding the above, the current transit role of Ukraine is also an advantage, as it may be instrumental in transformation Ukraine from a transit only country into a transit, storage and sale hub. Taking into account Ukraines gas transportation and storage infrastructure, such transformation should be a key priority for both the state and for businesses operating in the energy sector. Becoming more than just a transit country can be considered an advantage for Ukraine. The pressure from alternative routes for natural gas transit and the interest in such alternatives from both suppliers and consumers of natural gas is tremendous, and will continue to be so. Although there is definitely a significant interest by suppliers and consumers of natural gas in Russia and EU that Ukraines infrastructure continues to function over the next couple of years, it is unclear whether the same interest will still be effective when, and if, additional alternative routes from Russia to the EU are constructed. The Ukrainian legal framework applicable to oil and gas transit is well advanced and the trend for its further development is definitely positive. This trend will hopefully continue and will help to make the sector attractive for investors and consumers as well as competitive when it comes to other transit countries and routes, both current and future. A lot depends on Ukraine to make the success of this business a long-term one.

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