On October 31, 2017, the US Treasury Department’s Office of Foreign Assets Control (“OFAC”) amended and reissued Directive 4 of the Ukraine/Russia-related sectoral sanctions (“Directive 4”), which targets the Russian energy sector, and updated its guidance regarding the implementation of Ukraine/Russia-related sanctions. OFAC’s amendment and reissuance of Directive 4 was expected pursuant to Section 223(d) of Title II of the Countering America’s Adversaries Through Sanctions Act (“CAATSA” see our previous blog post on CAATSA here). Also under CAATSA, Directive 1 and Directive 2 were amended and reissued on September 29, 2017 (see our previous blog post here). OFAC originally published Directive 4 in September of 2014, pursuant to Executive Order 13662. In conjunction with OFAC’s guidance, the US Department of State (“State Department”) also published guidance regarding CAATSA Sections 225 and 232.
- Amended and Reissued Directive 4
The scope of prohibitions under Directive 4 has been expanded. Previously, Directive 4 prohibited US Persons from providing, exporting, or reexporting, directly or indirectly, goods, non-financial services, or technology in support of exploration or production for deepwater, Arctic offshore, or shale projects that (1) have the potential to produce oil in Russia or in maritime area claimed by Russia and extending from its territory and (2) involve any person determined to be subject to Directive 4. Persons determined to be subject to Directive 4 are included in OFAC’s Sectoral Sanctions Identifications List (“SSIL”).
Under the amended and reissued Directive 4, US persons are prohibited from providing, exporting, or reexporting, directly or indirectly, goods, non-financial services, or technology in support of the exploration or production for deep water, Arctic offshore, or shale projects that (1) are initiated on or after January 29, 2018; (2) have the potential to produce oil in any location (changed from just in Russia); (3) in which any person determined to be subject to Directive 4 has (a) a 33 percent or greater ownership interest or (b) owns a majority of the voting interests.
OFAC clarified in its new FAQ 373 that the new Directive 4 does not change the applicability of OFAC’s so-called “50 percent rule” for Directive 4 as a general matter. The references to “33 percent or greater ownership” and “ownership of a majority of the voting interests” specifically refer to a Directive 4 SSIL person’s ownership interest in a deepwater, Arctic offshore, or shale project; the “50 percent rule” still applies as a general matter. For example, if Company A, which is subject to Directive 4, owns 55 percent of Company B, then Company B is also subject to Directive 4 due to the 50 percent rule. This means if, for example, Company B owns 40 percent of a deepwater oil project covered by Directive 4, US persons may not deal with that deepwater oil project.
OFAC aggregates ownership stakes of all entities subject to Directive 4 (including entities owned 50 percent or more by one or more persons determined to be subject to Directive 4) when determining whether a project is 33 percent or more owned by a person subject to Directive 4, or whether a person subject to Directive 4 owns a majority of the voting interests in a project. This means if two entities subject to Directive 4 each own 20 percent of an Arctic offshore project covered by Directive 4, US persons may not deal with that project.
Key additional guidance points from OFAC regarding Directive 4 are as follows:
- If an energy project has the potential to produce gas only, and not oil, then the Directive 4 prohibitions do not apply (OFAC FAQ 414).
- The term “shale projects” applies to projects that have the potential to produce oil from resources located in shale formations. The prohibitions in Directive 4 do not apply to exploration or production through shale to locate or extract crude oil or gas in reservoirs (OFAC FAQ 418).
- The term “Arctic offshore projects” applies to projects that have the potential to produce oil in areas that (1) involve drilling operations originating offshore, and (2) are located above the Arctic Circle. The prohibitions do not apply to horizontal drilling operations originating onshore where such drilling operations extend under the seabed to areas above the Arctic Circle (OFAC FAQ 421).
- In the context of the new prohibition on dealing with certain projects “initiated” on or after January 29 2018, 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 (OFAC FAQ 536).
2. Additional CAATSA Guidance from OFAC
OFAC also published FAQs related to CAATSA Sections 223(a), 226, 228, and 233. These CAATSA provisions relate to potential targets of US sectoral sanctions (Section 223(a)), the imposition of sanctions with respect to foreign financial institutions (Section 226), sanctions with respect to certain transactions with foreign sanctions evaders (Section 228), and sanctions with respect to investment in, or facilitation of, the privatization of state-owned assets by Russia (Section 233).
Key guidance points offered by OFAC in these FAQs are as follows:
- Section 223(a) does not require OFAC to impose sanctions on Russian state-owned entities operating in the railway or metals and mining sector; OFAC may or may not impose such sanctions in the future.
- Under Section 226, which made the sanctions in Section 5 of the Ukraine Freedom Support Act mandatory, foreign financial institutions will face sanctions if OFAC determines that they knowingly engaged in significant transactions involving certain defense- and energy-related activities, or knowingly facilitated significant financial transactions on behalf of any Russian person added to OFAC’s Specially Designated Nationals and Blocked Persons List for reasons related to the conflict in Ukraine. OFAC will interpret the term “financial transaction” broadly to encompass any transfer of value involving a financial institution. In addition, OFAC will prohibit the opening, and prohibit or impose strict conditions on the maintaining in the United States, of correspondent accounts for any foreign financial institution that has engaged in such sanctionable behavior.
- The FAQs for Sections 228 and 233 primarily provide definitions for key terms such as “knowingly” and “facilitation … for or on behalf of.”
3. CAATSA Sections 225 and 232 Guidance from the State Department
CAATSA Section 225 requires the State Department, in consultation with OFAC, to impose mandatory sanctions on non-US persons who knowingly make a significant investment in a special Russia crude oil project on or after September 1, 2017, absent a determination that the sanctions are not in the national interest of the United States. In its guidance, the State Department clarified:
- A “special Russian crude oil project” is a project intended to extract crude oil from:
- The exclusive economic zone of Russia in waters more than 500 feet deep;
- Russian Artic offshore locations; or
- Shale formations located in Russia.
- The term “knowingly,” with respect to conduct, a circumstance, or a result, means that a person has actual knowledge, or should have known, of the conduct, the circumstance, or the result.
- “Investment” could include arrangements where goods or services are provided in exchange for equity in an enterprise, or rights to a share of the revenue or profits of an enterprise.
- To determine whether an investment 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.
- An investment is not significant if US persons would not require specific licenses from OFAC to make or participate in it.
CAATSA Section 232 authorizes the State Department, in consultation with OFAC (and “in coordination with allies of the United States”), to impose discretionary sanctions on persons who knowingly, on or after August 2, 2017 (1) made an investment that directly and significantly enhances the ability of Russia to construct energy export pipeline projects initiated on or after August 2, 2017; or (2) sold, leased, or provided goods or services that directly and significantly facilitate the expansion, construction, or modernization of such energy export pipelines by Russia, and where the investment or transaction has a fair market value of $1,000,000 or more, or that, during a 12-month period, has an aggregate fair market value of $5,000,000 or more. In its guidance, the State Department clarified:
- The focus of such sanctions would 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.
- Pipelines that originate outside of Russia and transit through the territory of Russia “would not be the focus” of sanctions implementation.
- A project is considered to have been “initiated” when a contract for the project is signed.
- Investments and loan agreements made prior to August 2, 2017 would not be subject to Section 232 sanctions.
- Implementation of Section 232 sanctions would not target investments or other activities related to the standard repair and maintenance of pipelines in existence on, and capable of transporting commercial quantities of hydrocarbons, as of August 2, 2017.
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The authors are grateful for the assistance of Callie C. Lefevre in the preparation of this blog post.