TURKMENISTANTURKMENISTAN

www.haynesboone.comwww.haynesboone.com

INTERNATIONAL PETROLEUM TRANSACTIONS INTERNATIONAL PETROLEUM TRANSACTIONS IN TURKMENISTANIN TURKMENISTAN

20082008

Sergei A. LomakoSergei A. LomakoPartnerPartner

Haynes and Boone, LLPHaynes and Boone, LLP

Sergei.Lomako@haynesboone.comSergei.Lomako@haynesboone.com

TURKMENISTANTURKMENISTAN

- Permanent NeutralityPermanent Neutrality- International CooperationInternational Cooperation- Regional StabilityRegional Stability- Transition Towards Market Economy Transition Towards Market Economy

TURKMENISTANTURKMENISTAN

““Strategy of Socio-Economic Strategy of Socio-Economic Transformations in Turkmenistan for the Transformations in Turkmenistan for the Period until 2030”Period until 2030”

APPLICABLE LAWAPPLICABLE LAW

- International TreatiesInternational Treaties- Laws of TurkmenistanLaws of Turkmenistan- ContractsContracts- Laws of Foreign StatesLaws of Foreign States

INTERNATIONAL TREATIESINTERNATIONAL TREATIES

Multilateral treaties [for example:Multilateral treaties [for example:

- Membership in International Organizations- Membership in International Organizations

- Energy Charter Treaty- Energy Charter Treaty

- Washington Convention (ICSID)]- Washington Convention (ICSID)]

Bilateral treatiesBilateral treaties

ENERGY CHARTER TREATYENERGY CHARTER TREATY

- National Treatment or Most Favored Nation TreatmentNational Treatment or Most Favored Nation Treatment- Compensation in case of ExpropriationCompensation in case of Expropriation- Repatriation of Capital and Profits in Hard CurrencyRepatriation of Capital and Profits in Hard Currency- Observance by Local AuthoritiesObservance by Local Authorities- International Dispute ResolutionInternational Dispute Resolution

[Bilateral] Treaty Between Turkmenistan and [Bilateral] Treaty Between Turkmenistan and Great Britain “On Protection of Investment” Great Britain “On Protection of Investment” of 9 February 1995of 9 February 1995

- ““Investment” definedInvestment” defined- Fair and equitable treatment; National Treatment; Fair and equitable treatment; National Treatment;

Most Favoured Nation TreatmentMost Favoured Nation Treatment- Expropriation and Nationalization is forbiddenExpropriation and Nationalization is forbidden- Restitution or adequate compensationRestitution or adequate compensation- Unrestricted Repatriation of Investment and Unrestricted Repatriation of Investment and

ReturnsReturns- International dispute resolutionInternational dispute resolution

SYSTEM OF TURKMENISTAN LAWSSYSTEM OF TURKMENISTAN LAWS- ConstitutionConstitution- Laws adopted by ReferendumLaws adopted by Referendum- LawsLaws- Presidential Decrees, Decrees by Medjlis (Parliament)Presidential Decrees, Decrees by Medjlis (Parliament)- Decrees of the Cabinet of MinistersDecrees of the Cabinet of Ministers- Acts by the Ministries and other Central Bodies of State Acts by the Ministries and other Central Bodies of State

GovernanceGovernance- Resolutions by Khyakims (Governons and Mayors)Resolutions by Khyakims (Governons and Mayors)- Decisions by Gengesh’sDecisions by Gengesh’s

LAW OF TURKMENISTANLAW OF TURKMENISTAN

ConstitutionConstitution

Turkmenbashi Civil CodeTurkmenbashi Civil Code

Investment LawsInvestment Laws

Law on SubsoilLaw on Subsoil

Law on ConcessionsLaw on Concessions

Petroleum Law (The Law on Hydrocarbons)Petroleum Law (The Law on Hydrocarbons)

Petroleum Operations Rules (Rules for the Petroleum Operations Rules (Rules for the Development of Hydrocarbon Fields)Development of Hydrocarbon Fields)

Other Normative ActsOther Normative Acts

TURKMENBASHI CIVIL CODETURKMENBASHI CIVIL CODE

- - Service ContractService Contract

- - Contract securityContract security

CONTRACT SECURITYCONTRACT SECURITY

Immovable propertyImmovable propertyMovable property (including goods in circulation, Movable property (including goods in circulation,

such as hydrocarbons)such as hydrocarbons)SharesSharesSubsoil and land use rightsSubsoil and land use rightsLicensesLicensesAgreementsAgreementsOffshore bank accountsOffshore bank accounts

INVESTMENT LAWSINVESTMENT LAWS

- Law on Foreign Economic Activities Law on Foreign Economic Activities - Law on Investment ActivitiesLaw on Investment Activities- Law on Foreign InvestmentLaw on Foreign Investment- Law on ConcessionsLaw on Concessions- Law on EnterprisesLaw on Enterprises

INTERNATIONAL PRIVATE LAWINTERNATIONAL PRIVATE LAW

International Standards and RulesInternational Standards and Rules

- A direct reference in the contract is advisable - A direct reference in the contract is advisable

- Accounting: GAAP; International Accounting Standards;- Accounting: GAAP; International Accounting Standards;

- UCP 500 (ICC Uniform Customs and Practice for Documentary - UCP 500 (ICC Uniform Customs and Practice for Documentary Credits);Credits);

- International petroleum industry standards (not defined in - International petroleum industry standards (not defined in Turkmenistan laws)Turkmenistan laws)

- Applicability criteria: should not contradict local rules.Applicability criteria: should not contradict local rules.

COMPLIANCE WITH TURKMENISTAN LAWCOMPLIANCE WITH TURKMENISTAN LAW

- Activity in Turkmenistan should not contradict - Activity in Turkmenistan should not contradict Turkmenistan LawTurkmenistan Law

- Provisions of International Treaties prevail (or “may - Provisions of International Treaties prevail (or “may prevail”)prevail”)

- Government agencies monitor compliance- Government agencies monitor compliance

PETROLEUM LAWPETROLEUM LAW

Petroleum Law (Law on Hydrocarbon Resources)Petroleum Law (Law on Hydrocarbon Resources)

Presidential Decree 3189 (Competent Body on Hydrocarbons, Model Presidential Decree 3189 (Competent Body on Hydrocarbons, Model JVA, Model PSA.JVA, Model PSA.

The Statute No. 8421 of March 10, 2007 “Oon the State Agency for the The Statute No. 8421 of March 10, 2007 “Oon the State Agency for the Management and Use of Hydrocarbons Resources at the President of Management and Use of Hydrocarbons Resources at the President of Turkmenistan”. (Petroleum Agency)Turkmenistan”. (Petroleum Agency)

Turkmenbashi Civil Code (Service Contract)Turkmenbashi Civil Code (Service Contract)

Law on Subsoil, Law on Concessions, Petroleum operations rules, Law on Subsoil, Law on Concessions, Petroleum operations rules, Licensing Rules, other regulationLicensing Rules, other regulation

PETROLEUM DEFINED in the Petroleum LawPETROLEUM DEFINED in the Petroleum LawPetroleum - “Crude oil and Natural Gas as well Petroleum - “Crude oil and Natural Gas as well

as all components derived therefrom or as all components derived therefrom or produced therewith.”produced therewith.”

““Crude Oil – “any hydrocarbons, including distillates Crude Oil – “any hydrocarbons, including distillates and condensates extracted from Natural Gas, and condensates extracted from Natural Gas, which at Normal Atmospheric Pressure and which at Normal Atmospheric Pressure and Temperature, are in liquid state at the well head or Temperature, are in liquid state at the well head or oil/gas separator”. oil/gas separator”.

““Natural Gas – “hydrocarbons, which are in the Natural Gas – “hydrocarbons, which are in the gaseous state at Normal Atmospheric gaseous state at Normal Atmospheric Temperature and Pressure associated or non-Temperature and Pressure associated or non-associated with Crude Oil”.associated with Crude Oil”.

TITLE TO PETROLEUMTITLE TO PETROLEUM

Petroleum in its natural state in or upon the land Petroleum in its natural state in or upon the land in the territory of Turkmenistan is the exclusive in the territory of Turkmenistan is the exclusive property of Turkmenistan.property of Turkmenistan.

Title and quantity of entitlement share, including Title and quantity of entitlement share, including the place and time when title passes to Foreign the place and time when title passes to Foreign Investor, are to be stipulated in the contract.Investor, are to be stipulated in the contract.

GRANTING OF PETROLEUM RIGHTSGRANTING OF PETROLEUM RIGHTS

Petroleum rights are granted by the Petroleum rights are granted by the Petroleum AgencyPetroleum Agency (before March (before March 10, 2007 – by Competent Body on Hydrocarbons), on the basis of a 10, 2007 – by Competent Body on Hydrocarbons), on the basis of a Production Sharing Agreement or a Joint Venture Agreement, and a Production Sharing Agreement or a Joint Venture Agreement, and a License.License.

The grantee may be a local juridical person or a foreign juridical or The grantee may be a local juridical person or a foreign juridical or physical person.physical person.

Foreign juridical persons must register with the State Agency for Foreign juridical persons must register with the State Agency for Foreign Investments of the Ministry and Economy and Finance (SAFI) Foreign Investments of the Ministry and Economy and Finance (SAFI) before entering into JVA or PSA. before entering into JVA or PSA.

ACQUISITION OF PETROLEUM RIGHTSACQUISITION OF PETROLEUM RIGHTSA typical course of action:A typical course of action:

Preliminary application by a foreign company;Preliminary application by a foreign company;Preliminary negotiations;Preliminary negotiations;Registration of the Foreign Investor with the State Registration of the Foreign Investor with the State

Agency for Foreign Investments (SAFI) Agency for Foreign Investments (SAFI) Negotiations and execution of PSA or JVA; Negotiations and execution of PSA or JVA;

simultaneously, issuance of a License based on the simultaneously, issuance of a License based on the executed PSA or JVAexecuted PSA or JVA

Registration of the PSA or JVA with the State Registration of the PSA or JVA with the State Agency for Foreign Investments (SAFI)Agency for Foreign Investments (SAFI)

Commencement of Petroleum Operations.Commencement of Petroleum Operations.

PETROLEUM RIGHTSPETROLEUM RIGHTS

LICENSELICENSE Revocable Revocable administrative actadministrative act Contingent upon execution of a JVA or PSAContingent upon execution of a JVA or PSA Not available to contractors under the Service Contract Not available to contractors under the Service Contract Limited term, can be suspended or revoked Limited term, can be suspended or revoked Revocation of License automatically terminates the ContractRevocation of License automatically terminates the Contract Licensing Authority is the Petroleum AgencyLicensing Authority is the Petroleum Agency One License Holder only.One License Holder only.

PETROLEUM OPERATIONS defined in Petroleum Law:PETROLEUM OPERATIONS defined in Petroleum Law:

““All Exploration and Production Operations and All Exploration and Production Operations and related operations for treating, metering, saving, related operations for treating, metering, saving, storing, marketing, delivery and transportation of storing, marketing, delivery and transportation of Petroleum and its derivatives as well as other Petroleum and its derivatives as well as other operations connected to the implementation of a operations connected to the implementation of a Contract.” Contract.”

PETROLEUM RIGHTSPETROLEUM RIGHTS

TYPES OF LICENSESTYPES OF LICENSES

Exploration Exploration LicenseLicense

ProductionProduction License License

CombinedCombined Exploration and Production License Exploration and Production License

EXPLORATION OPERATIONS defined in Petroleum Law:EXPLORATION OPERATIONS defined in Petroleum Law:

““Geological, geophysical, aerial and other surveys, the Geological, geophysical, aerial and other surveys, the drilling of such shotholes, core holes, stratigraphic drilling of such shotholes, core holes, stratigraphic tests and other wells for the discovery of Petroleum tests and other wells for the discovery of Petroleum and the purchase as well as the leasing of materials and the purchase as well as the leasing of materials and equipment thereof.” and equipment thereof.”

PETROLEUM RIGHTSPETROLEUM RIGHTS

Exploration LicenseExploration Licenseexclusive right to carry out Exploration Operations, valid for up exclusive right to carry out Exploration Operations, valid for up

to 10 years (six years initially, with the option to extend twice for to 10 years (six years initially, with the option to extend twice for two-year periods (“6+2+2” formula)).two-year periods (“6+2+2” formula)).

““6+2+2” formula: law does not provide for changing the 10-year 6+2+2” formula: law does not provide for changing the 10-year formula to other combination, e.g. “3+2+5” years formula to other combination, e.g. “3+2+5” years

a commercial discovery in a particular area gives raise to a commercial discovery in a particular area gives raise to priority right to obtain a Production License in that area.priority right to obtain a Production License in that area.

does not prohibit small-scale production and sale (contract may does not prohibit small-scale production and sale (contract may provide for such a pilot-scale production and sale).provide for such a pilot-scale production and sale).

PRODUCTION OPERATIONS defined in Petroleum Law:PRODUCTION OPERATIONS defined in Petroleum Law:

““All types of operations for recovery of Petroleum, its All types of operations for recovery of Petroleum, its saving, treating, handling, storing, transporting, saving, treating, handling, storing, transporting, metering, delivery and marketing as well as metering, delivery and marketing as well as operations connected with primary and secondary operations connected with primary and secondary production and other kinds of activities connected production and other kinds of activities connected with these operations.” with these operations.”

PETROLEUM RIGHTSPETROLEUM RIGHTS

Production LicenseProduction Licenseexclusive right to carry out Production Operations in a specified exclusive right to carry out Production Operations in a specified

area, sell or dispose of petroleum.area, sell or dispose of petroleum.valid for up to 25 years (20 years initially, with the option to valid for up to 25 years (20 years initially, with the option to

extend once for five years (“20+5” formula)).extend once for five years (“20+5” formula)).Does not prohibit “exploitational exploration” (= advanced Does not prohibit “exploitational exploration” (= advanced

exploration during the production operations, which can be exploration during the production operations, which can be granted under the contract);granted under the contract);

PETROLEUM RIGHTSPETROLEUM RIGHTSCombined Exploration and Production Combined Exploration and Production

LicenseLicense Exclusive right to carry our Exploration Operations and Production Exclusive right to carry our Exploration Operations and Production

Operations.Operations. Valid for up to 35 years (26 years initially, with the option to extend for Valid for up to 35 years (26 years initially, with the option to extend for

nine years, subject to certain requirements)nine years, subject to certain requirements) Normally, the Combined License term is considered as the succession Normally, the Combined License term is considered as the succession

of Exploration License and Production License; the granting authority of Exploration License and Production License; the granting authority would be reluctant to deviate from the term-extension formula, keeping would be reluctant to deviate from the term-extension formula, keeping it as follows: “6+2+2” (Exploration), then “20+5” (phase); the form of it as follows: “6+2+2” (Exploration), then “20+5” (phase); the form of the Combined License, and the form Instrument of Extension can be the Combined License, and the form Instrument of Extension can be suggested by the Foreign Party based on the model form licenses. suggested by the Foreign Party based on the model form licenses.

SUSPENSION OF LICENSESUSPENSION OF LICENSE

Suspension of License upon written notice from the Competent Suspension of License upon written notice from the Competent Body in the event that the License holder:Body in the event that the License holder:

conducts Petroleum Operations not provided for in the Licenseconducts Petroleum Operations not provided for in the License carries out activities within the framework of the License, but not carries out activities within the framework of the License, but not

under the program provided for in the Agreementunder the program provided for in the Agreement systematically violates Turkmen Law with respect to the systematically violates Turkmen Law with respect to the

protection of underground resources or environmental and protection of underground resources or environmental and safety regulationssafety regulations

Reinstatement of License upon rectificationReinstatement of License upon rectification AdjudicationAdjudication

REVOCATION OF LICENSEREVOCATION OF LICENSE

Revocation of License by the Competent Body in the event Revocation of License by the Competent Body in the event that the License holder:that the License holder: fails to remedy the causes of any suspension within the fails to remedy the causes of any suspension within the

fixed deadlinefixed deadline is found to have deliberately submitted false information is found to have deliberately submitted false information

to the Competent Body which materially affected the to the Competent Body which materially affected the Competent Body’s decision to issue the LicenseCompetent Body’s decision to issue the License

deliberately delays signing and registering the Agreement deliberately delays signing and registering the Agreement or commencing Petroleum Operationsor commencing Petroleum Operations

Revocation of license renders the Contract (PSA, JVA)null Revocation of license renders the Contract (PSA, JVA)null and voidand void

- No reinstatement of LicenseNo reinstatement of License- AdjudicationAdjudication

CONTRACTCONTRACT

Production Sharing AgreementProduction Sharing Agreement

(Joint Venture Agreement is practically not used)(Joint Venture Agreement is practically not used)

Combination of PSA, JVA, and other types of contractCombination of PSA, JVA, and other types of contract

Service ContractService Contract

CONTRACTCONTRACT

Service ContractService Contract

- No model form under Turkmenistan law, although No model form under Turkmenistan law, although quite a lot of precedent forms existquite a lot of precedent forms exist

- Turkmenbashi Civil CodeTurkmenbashi Civil Code- Industry regulationsIndustry regulations- Local and international business practicesLocal and international business practices

CONTRACT: PSA and JVACONTRACT: PSA and JVA

- Petroleum Law, Model PSA and Model JVA were Petroleum Law, Model PSA and Model JVA were designed mainly for onshore oilfieldsdesigned mainly for onshore oilfields

- Specificity of onshore gas, offshore gas and Specificity of onshore gas, offshore gas and offshore oil might justify substantial variations of offshore oil might justify substantial variations of the Model Form, which can be suggested by the the Model Form, which can be suggested by the Foreign PartyForeign Party

- Gas clause is practically absent in the Model Gas clause is practically absent in the Model Form; requires substantial draftingForm; requires substantial drafting

- Pipeline clause requires draftingPipeline clause requires drafting

TAXTAXContractor is subject only to:Contractor is subject only to:a profits taxa profits tax

at the rate established by Turkmen Law (20%)at the rate established by Turkmen Law (20%)

Agreement will establish procedure for determining taxable profitsAgreement will establish procedure for determining taxable profits- using international accounting standards- using international accounting standards- using hard currency as the monetary unit for the contract- using hard currency as the monetary unit for the contract

TAXATION: PSA Contractors and SubcontractorsTAXATION: PSA Contractors and Subcontractors

Taxes applicable to the Contractor are limited to Taxes applicable to the Contractor are limited to those set forth in the Petroleum Lawthose set forth in the Petroleum Law

No tax, duty, fee or other impost on profit derived No tax, duty, fee or other impost on profit derived from Petroleum Operations shall be levied on the from Petroleum Operations shall be levied on the Contractor or its shareholders beyond those Contractor or its shareholders beyond those anticipated in the Agreementanticipated in the Agreement

Subcontractors under a PSA may enjoy the Subcontractors under a PSA may enjoy the same tax regime as the PSA parties. same tax regime as the PSA parties.

ROYALTY AND BONUSESROYALTY AND BONUSES

production royaltyproduction royaltyAgreement will determine rate (sliding scale, based on Agreement will determine rate (sliding scale, based on production, quarterly reports)production, quarterly reports)

bonusbonusSigning bonusSigning bonusProduction bonusProduction bonus

CONTRACT: CONTRACT: PARTIES’ SHARESPARTIES’ SHARES

Shares of the parties to PSA (and JVA) are determined by Shares of the parties to PSA (and JVA) are determined by the contract, with due regard to existing practices.the contract, with due regard to existing practices.

Model PSA provides an option to use “R-Factor” to Model PSA provides an option to use “R-Factor” to determine percentage shares of the parties.determine percentage shares of the parties.

R-Factor (R= All revenues / all recoverable costs)R-Factor (R= All revenues / all recoverable costs)

(R=1; 1-1.5; 1.5-2; 2-2.5; parties’ shares sliding scale)(R=1; 1-1.5; 1.5-2; 2-2.5; parties’ shares sliding scale)

CONTRACT MAY PROVIDE FORCONTRACT MAY PROVIDE FOR INTERNATIONAL DISPUTE INTERNATIONAL DISPUTE RESOLUTIONRESOLUTION

Petroleum Law (Art.56 – Resolution of Disputes) provides Petroleum Law (Art.56 – Resolution of Disputes) provides for international dispute resolution (international for international dispute resolution (international arbitration) based on an agreement between the partiesarbitration) based on an agreement between the parties

Model PSA provides that either party to the Agreement Model PSA provides that either party to the Agreement may refer a dispute to an international arbitration bodymay refer a dispute to an international arbitration body

Institution and Place of Arbitration; nationality of Institution and Place of Arbitration; nationality of Arbitrators; material and procedural law.Arbitrators; material and procedural law.

PIPELINEPIPELINE

PIPELINE defined in the Petroleum LawPIPELINE defined in the Petroleum Law

““Main Pipeline” is defined as an engineering facility Main Pipeline” is defined as an engineering facility consisting of the main (linear) part of the pipeline systems consisting of the main (linear) part of the pipeline systems and associated on-land facilities, communications and and associated on-land facilities, communications and equipment designated for transportation of Petroleum equipment designated for transportation of Petroleum from the place of production (treatment) to the place of from the place of production (treatment) to the place of transfer to other transportation, refining or consumption transfer to other transportation, refining or consumption facilitiesfacilities

PIPELINE OWNERSHIPPIPELINE OWNERSHIP The “Main Pipeline” may be constructed, financed, The “Main Pipeline” may be constructed, financed,

operated, and maintained by a specially established operated, and maintained by a specially established company, the owners of which may be the Government, company, the owners of which may be the Government, Contractors, private investors or a combination thereof.Contractors, private investors or a combination thereof.

Pipelines other than the “Main Pipeline” (e.g. gathering Pipelines other than the “Main Pipeline” (e.g. gathering systems) are part of immovable assets of the project.systems) are part of immovable assets of the project.

Pipeline TariffsPipeline Tariffs

“ “The company which constructs the The company which constructs the pipeline may set and charge a pipeline may set and charge a transportation tariff for its use”transportation tariff for its use”

FOREIGN CURRENCYFOREIGN CURRENCY

- Foreign Party is entitled to maintain offshore bank - Foreign Party is entitled to maintain offshore bank accounts to hold only the proceeds of sale of accounts to hold only the proceeds of sale of Foreign Party’s entitlement share Foreign Party’s entitlement share

- No restriction on borrowing of hard currency by - No restriction on borrowing of hard currency by Foreign PartyForeign Party

- Revenue from sale of Foreign Party’s entitlement - Revenue from sale of Foreign Party’s entitlement share in petroleum is exempt from any future share in petroleum is exempt from any future conversion requirement conversion requirement

TRANSFERABILITYTRANSFERABILITY

“ “Contractor may assign to a third party all Contractor may assign to a third party all or part of its rights and obligations under or part of its rights and obligations under the License and the Agreement upon the the License and the Agreement upon the prior written consent of the Petroleum prior written consent of the Petroleum Agency Agency [formerly, by the Competent Body[formerly, by the Competent Body] ] which shall not be unreasonably withheld”which shall not be unreasonably withheld”

CONTRACT STABILITYCONTRACT STABILITY

In the event of a change in law affecting the balance of In the event of a change in law affecting the balance of interests of the parties, the foreign investor may interests of the parties, the foreign investor may require that it be governed by the law that was in force require that it be governed by the law that was in force at the time of its registration in Turkmenistan, for the at the time of its registration in Turkmenistan, for the period of 10 years.period of 10 years.

The contract may contain such a provision, and the The contract may contain such a provision, and the investor must declare its choice each time it wishes to investor must declare its choice each time it wishes to invoke this right.invoke this right.