Update on new Ukraine/Russia US sanctions impacting the energy sector

In our previous posts (which can be accessed here and here) we tracked the legislative process of the Countering America’s Adversaries Through Sanctions Act (“CAATSA”), and identified the key issues arising for the energy sector from the Ukrainian/Russian parts of the legislation. However, as we identified, the position for many energy projects remained unclear, as the US Treasury Department’s Office of Foreign Assets Control (“OFAC”) and the US State Department was yet to implement and/or provide guidance on some of the key new aspects of CAATSA.

The energy sector now has a degree of certainty over the implementation of the CAATSA amendments, as the main provisions with respect to Ukraine/Russia that impact the energy sector have been implemented, and helpful guidance has now been issued. Our summary of these key aspects, and the accompanying guidance, is set out below.

Unconventional Oil Projects

CAATSA amended Directive 4 under Executive Order 13662, which now imposes two prohibitions on the provision, exportation, or re-exportation, directly or indirectly, of goods, services (except for financial services), or technology in support of exploration or production for deepwater, Arctic offshore, or shale projects with the potential to produce oil (referred to below as unconventional oil projects), that involve certain Russian energy companies (or any entity 50 percent or more owned by one or more of such entities) – referred to below as a Directive 4 Target.

First, the amended Directive 4 still imposes restrictions in relation to unconventional oil projects that are (i) within Russia (or in a maritime area claimed by Russia), and (ii) in which a Directive 4 Target is involved (“Existing Prohibition”). However, the amended Directive 4 now imposes an additional prohibition on unconventional oil projects where: (i) the project was initiated on or after 29 January 2018; (ii) the project has the potential to produce oil in any location; and (iii) a Directive 4 Target either (a) owns a 33 percent or more interest in the project, or (b) owns a majority of the voting interests in the project (“Additional Prohibition”).

This Additional Prohibition is notable for a couple of reasons. First, the Existing Prohibition focuses on projects within Russia or Russian waters, whilst the Additional Prohibition now potentially applies to unconventional oil projects anywhere in the world. Second, the Existing Prohibition targets unconventional oil projects in Russia “involving” Directive 4 Targets. However, the Additional Prohibition requires a Directive 4 Target to have either an ownership interest of 33 percent or greater, or a majority of the voting interests, in the particular project. As discussed in our previous post, we expect this to result in less non-Russian projects being affected by the new sanctions than originally envisaged by earlier versions of the new sanctions wording, however the implications for non-Russian projects is still significant.

Guidance issued by OFAC provides that ownership stakes of all Directive 4 Targets (including entities caught by the 50 percent rule) will be aggregated when determining whether a project is 33 percent or more owned by a Directive 4 Target, or whether a Directive 4 Target owns a majority of the voting interests in a project. Therefore, if two Directive 4 Targets have a combined ownership interest of 33 percent or more in a non-Russian unconventional oil project, those that need to comply with US sanctions must carefully consider the prohibition in Directive 4.

We identified in our previous post that one of the key issues for the energy sector was the definition of the word “new” (referred to in CAATSA) in relation to the Additional Prohibition. OFAC has clarified that the Additional Prohibition will only apply to projects “initiated” on or after 29 January 2018, and that a project is “initiated” when a government or any of its political subdivisions, agencies, or instrumentalities (including any entity owned or controlled directly or indirectly by any of the foregoing) formally grants exploration, development, or production rights to any party. This clarification will greatly assist parties with determining whether Directive 4 will impact on their project.

Debt of SSI entities

As set out in our previous post, CAATSA also provided for the tightening of restrictions on the financing of, or transactions in, debt issued by particular entities in the Russian financial services and energy sectors. Such amendments have now been implemented, and OFAC has issued guidance in relation to those amendments. In summary, Directive 1 under Executive Order 13662 (which targets specific Russian financial institutions) has been modified to impose a 14-day maturity limit (previously 30 days) on such debt, and Directive 2 under Executive Order 13662 (which targets specific Russian energy companies), has been modified to impose a 60-day maturity limit (previously 90 days) in relation to such debt. As expected, such amendments will not apply retrospectively. The list of entities determined to be subject to one or more of the directives under EO 13662 can be found here.

The amendments imposed by CAATSA also relate to US secondary sanctions with respect to “special Russian crude oil projects” and “energy export pipelines”.

Special Russian Crude Oil Projects

CAATSA amended section 4(b)(1) of the Ukraine Freedom Support Act of 2014 by requiring (rather than authorising) the Secretary of State, in consultation with the Secretary of Treasury, to impose (unless s/he determines that it is contrary to the US national interest), specified sanctions on non-US persons determined to have knowingly made a significant investment in a special Russian crude oil project. To determine whether an investment – which could include arrangements where goods or services are provided in exchange for equity, or rights to a share of the revenue or profits of an enterprise – is “significant”, the State Department will consider the totality of the facts and circumstances surrounding the investment, and weigh various factors on a case-by-case basis. The guidance sets out various factors which may be considered in the determination, however it confirms that an investment is not significant if US persons would not require specific licenses from OFAC to make or participate in it.

Energy export pipelines

CAATSA also authorized the Secretary of State, in consultation with the Secretary of the Treasury, to impose sanctions with respect to a person the Secretary of State determines (1) knowingly makes an “investment” that directly and significantly enhances Russia’s ability to construct energy export pipeline projects initiated on or after 2 August 2017, or (2) sells, leases, or provides to Russia, for the construction of Russian energy export pipelines, goods or services – any of which has a fair market value of $1 million or more, or that, during a 12-month period, have an aggregate fair market value of $5 million or more – that directly and significantly facilitates the expansion, construction or modernization of energy export pipelines by Russia.

Seemingly in response to concerns from certain European Union Member States, most notably Germany and Austria, the guidance specifically confirms that any decision to impose sanctions will be made in coordination with US allies and will be consistent with US policy to “work with European Union Member States and European institutions to promote energy security”. It remains to be seen how the Secretary of State will elect to wield this authority, and the impact that coordination with US allies will have on the Secretary of State’s decision.

The State Department’s guidance clarifies that the focus of implementation will be on energy export pipelines that (1) originate in Russia, and (2) transport hydrocarbons across an international land or maritime border for delivery to another country; as opposed to pipelines which originate outside of Russia and transit through Russian territory. Of specific interest to the energy sector is that, for the purposes of these sanctions, a project is considered to have been “initiated” when a contract for the project is signed. Further, sanctions will not target investments or other activities related to the standard repair and maintenance of pipelines which were capable of transporting commercial quantities of hydrocarbons on or before 2 August 2017.

Sanctions related to foreign financial institutions (FFIs)

FFIs engaged in energy transactions involving Russia and/or Russian persons should take note that the amendments under CAATSA also make mandatory certain previously discretionary sanctions related to FFIs who knowingly engage in significant transactions involving certain energy-related activities, or knowingly facilitate significant financial transactions involving Russian Specially Designated Nationals (“SDNs”). As set out above, OFAC will consider the totality of the facts and circumstances to determine whether a transaction is “significant”, while “financial transaction" will encompass any transfer of value involving a financial institution.

Any FFI engaged in sanctionable activity under this section will be prohibited from opening, and prohibited or have strict conditions imposed on the maintaining, of correspondent accounts in the United States. This amendment could impact energy transactions involving Russia and/or Russian persons, and FFIs would be advised to conduct careful screening to establish Russian SDN involvement – followed by a risk-based assessment – before providing finance or otherwise engaging with such a transaction.

Following the provision of guidance from OFAC and the State Department on the implementation of CAATSA, it is arguable that the scope and impact on energy projects of CAATSA will be less than originally thought. However, the above sanctions will still have significant consequences for many energy projects globally, and therefore if you are involved in one of the projects referred to above, or your business or project involves one of the entities targeted by Directives 1, 2 or 4 under Executive Order 13362, you should seek advice to ensure you comply with US sanctions obligations.