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ULF, August 2019

Authors: Myroslava Savchuk, counsel; Taras Shmyh, associate

 

In recent months, there has been meaningful progress in ensuring transparency in the domestic extraction industry. In particular, at the end of 2018 the Government approved the Provisional Procedure for Implementation of a Pilot Project on the Introduction of Auctions for Special Permits for Subsoil Use through Online Tenders. The document introduces, from 24 October 2018 till 1 December 2019, on a trial basis, online auctions for the licenses (special permits) for subsoil use. Such innovation is intended to simplify the process of obtaining a special permit, ensure transparency and publicity of the procedure, as well as minimize the time commitment on the part of bidders. The holding of open tenders on a competitive basis can increase revenues to the state budget (by way of increase of the initial price of special permits) and heighten investor interest in the domestic extraction industry.

1. How Does it Work?

Online auctions for special permits for subsoil use are held in real-time on the basis of the ProZorro.Sales system and consist of three consecutive rounds. The person who offered the highest bid for a specific subsoil area following on from the results of a tender becomes the winning bidder.

The list of subsoil areas, the permits for which are offered for sale, is compiled by the State Geology and Subsoil Service of Ukraine. However, any interested party can submit its own proposal regarding any subsoil area to be put up for auction. The announcement of the auction is posted on the official websites of the State Geology and Subsoil Service of Ukraine and the ProZorro. Sales system. The online auction is held 90 days (for oil, natural gas, and condensate), and 50 days (for other minerals) after the date on which the announcement of such auction is posted. The announcement, inter alia, contains general information on the auction procedure and information on the area that is put up for auction. 

The announcement of the first online auction for 10 gas and oil areas was posted at the beginning of December 2018. In aggregate, the State Geology and Subsoil Service of Ukraine plans to put up for online auction 30 new oil and gas areas in 10 regions of Ukraine, with a total area of approximately 5,000 square kilometres.

The first three licenses were sold through online auctions on 6 March 2019. By way of example, the final price of one of the oil and gas areas offered through the online auction exceeded the initial price by 479%.

2. What are the Advantages of the New Procedure?

The introduction of online auctions for the sale of special permits for subsoil use is an innovation that has become possible due to recent reforms in the extraction industry, including the opening of access to geological information and simplification of certain approval procedures. The issue of a special permit following on from the results of an open online auction significantly cuts down opportunities for abuse when a special permit is obtained and minimizes related corruption risks. The special permit is obtained by the person who, at an open tender in real-time mode, has offered the highest price for the subsoil area in question, having assessed its investment potential beforehand based on available geological information. To obtain a special permit, the winning bidder or its representative needs to visit the State Geology and Subsoil Service of Ukraine only once — to take the issued special permit and related documents.

Instead, regular procedure of holding auctions, which is not applicable during the trial period of online auctions (Resolution No. 594 of the Cabinet of Ministers of Ukraine On Approval of the Procedure for Holding Auctions for Sale of Special Permits for Subsoil Use of 30 May 2011) provides for personal participation of the purchaser (or its representatives) in the meeting of the auction committee as well as disallowed sending an auction participation application by electronic means. Currently, the possibility exists for filing an application and participating in an auction in real-time mode from anywhere.

According to the assessment of industry participants most of the areas that are put up for auction are within the boundaries of well-explored promising oil and gas-bearing basins. Because of the introduction in 2018 of open access to geological information, each bidder may review a certain amount of geological information free of charge. The amount of such information is equal for all potential bidders and available for public review within the package of auction documentation.

The current auction-related documentation also includes a detailed description in English of oil and gas areas put up for the auction, together with geological maps and information on geological investigations conducted. The publication in English of key information on such areas is intended to expand the number of bidders on account of foreign investors and help them in making an informed investment decision based on exhaustive information.

Finally, the auction-related documentation includes a special exploration programme for each oil and gas area. This program, inter alia, provides for the interpretation of available seismic data, conducting a seismological study and preliminary drilling within strict periods. The said mechanism aims to prevent the appearance of so-called “sleeping” licenses and should induce the subsoil users to actively develop the areas obtained.

3. What Next?

As stated above, the introduction of online auctions to sell special permits is a pilot project. Thus, following on from its results, the State Geology and Subsoil Service of Ukraine should, by 1 September 2019, submit proposals to the Government, on the basis of which the future of that procedure will be determined. 

Undoubtedly, the introduction of online auctions is a progressive decision simplifying the issue of special permits, increasing public confidence in that process, and raising relations between the state and subsoil users to a completely different level. At the same time, to ensure ground support of online auctions on the part of domestic and foreign companies, the final mechanism of online auctions, if adopted on a permanent basis, shall be investor-friendly to the maximum extent.

The period during which an application on participation in an auction is required to be filed (90 or 50 days, depending on the type of mineral) may be insufficient for an investor (specifically a foreign investor) to study relevant offers, prepare an indicative budget, and make a balanced investment decision. This problem is even more relevant for investments in the oil and gas sector being, as is known, highly capital intensive and complex in terms of technology.

The issue of determining the initial auction price of a special permit is no less important. The current methodology (as approved by Resolution No. 1374 of the Cabinet of Ministers of Ukraine of 15 October 2004) provides for the application of conditional rates and complex formulas, thereby disallowing a potential subsoil user to independently calculate (or at least make a forecast) of the initial price of a special permit. At the end of 2018, the Ministry of Ecology and Natural Resources of Ukraine published,
for public discussion, a draft resolution on the introduction of a new approach to determining the initial price of a special permit. According to the published draft resolution, the initial price of a special permit will be determined using clear rates and subject to market prices for the mineral in question. The application of such an approach will allow a potential investor to independently calculate the price of a special permit and, most importantly, it will make the calculation procedure more open and transparent.

Hopefully, the initial experience of online auctions will meet the high expectations of investors and will be taken into consideration by the Government when a decision is made regarding the implementation of that mechanism on a permanent basis. Only implementation of transparent licensing procedures for attractive and promising areas has the potential to significantly increase investments in the industry.