Far from disaster: Ukraine's energy sector seeks investment and growth.

• Author: Hunt, Martin

1. INTRODUCTION II. RECENT DEVELOPMENTS A. Trade Law B. Corporate Law C. Finance D. Energy III. GENERAL POLITICO-ECONOMIC ENVIRONMENT IV. DOING BUSINESS IN UKRAINE A. Joint Stock Companies B. Limited Liability Companies C. New Law on Joint Stock Companies D. Investment through Offshore Structures V. ENERGY SECTOR DEVELOPMENT VI. CONCLUSION I. INTRODUCTION

   Twenty-two years ago, the explosion at the Chernobyl nuclear power plant in present-day Ukraine and the initial attempt by the Soviet Union to cover up the scale of the disaster exemplified the futility of the secretive Soviet regime and its flawed visions for a nuclear-energy dependent future. Since gaining independence some five years later, Ukraine has worked to shed the vestiges of its oppressive Soviet past by opening up to a market-based economy, creating entirely new business, cultural, and economic environments, and reformulating an energy future that includes a diversified portfolio of on and offshore petrochemical operations. Ukraine, like other countries in Eastern Europe and Central Asia, continues to welcome Western capital and business investment, and offers unprecedented access to its markets. Furthermore, Ukraine's strategic location between Europe and Russia allows it to control gas shipments from East to West. However, the ongoing challenges of privatization and the political and economic changes that resulted have been made far more difficult by the ongoing global financial crisis that emerged in 2008.

   Ukraine's problems from the financial upheaval to some extent reflect the success of its integration into the world economy. The country formally became a member of the World Trade Organization (WTO) in 2008, (1) which led to negotiations with the European Union (EU) (its largest trading partner) to replace the myriad of fragmented trade and tariff agreements in place with a more comprehensive free trade agreement--a move that should strengthen EU-Ukraine business relations at the expense of Russia. (2) Since 1999, Ukraine's average annual economic growth of 7.3% was exceeded only by that of Kazakhstan among Eastern European and Central Asian countries, (3) and growth was on track for another 7.0% increase before the financial crisis ravaged Ukraine's stock exchange, causing the government to close down the stock exchange temporarily and dropping the hryvna, Ukraine's currency, to a record low against the dollar, depleting the country's already diminished foreign currency reserves. (4)

   Added to this economic tension is the pro-Western government's political stalemate between President Viktor Yushchenko and Prime Minister Yulia Timoshenko, and the government's on-again, off-again relationship with neighboring Russia. It is important to note, however, that the political difficulties do not indicate opposition to Western economic ideas. On the contrary, all political factions united to help Ukraine secure a $16.5 billion loan from the International Monetary Fund (IMF) in late October 2008, (5) and the passage that same month of a long-awaited Joint Stock Company Law by Ukraine's national parliament (the Rada) presages an improved foreign investment climate once the immediate economic crisis passes. (6) Once the global economy emerges from crisis, Ukraine's emergent energy sector should form the basis of a renewed attractiveness to foreign investors.

   In recognition of Ukraine's strategic importance to Europe as the energy gateway to Russia and Central Asia, the West has a vested interest in developing Ukraine's energy sector. As a result, investors in the energy sector should be aware of recent developments that are affecting investments, as well as have some basic familiarity with Ukrainian legal entities through which to structure investments. Part II of this Article canvasses several recent developments in the trade, corporate, finance, and energy sectors of Ukraine. Part III explores the general politico economic environment in which Ukraine finds itself currently. Part IV discusses the major business entities utilized in Ukraine for conducting business. Part V discusses recent energy sector developments.

2. RECENT DEVELOPMENTS

   The four most significant and positive long-term developments for Ukraine focus on foreign trade, corporate law, finance, and energy.

   1. Trade Law

      Ukraine's economy is based on agriculture, heavy industry (particularly steel production), and energy.7 The country's main trading partners are the EU, Russia, Turkey, Belarus, and the United States, (8) and expanding its foreign trade access is vital. The WTO's acceptance of Ukraine's membership in 2008 was the culmination of a process that began in 1993 that stands to expand dramatically its economic integration with the EU. (9) Ukraine's total trade with the twenty-seven EU countries is valued at nearly 35 billion [euro], and has tripled since 2000. (10) A significant portion of Ukrainian goods entering the EU benefit from the General System of Preferences in force since 2006, (11) and one of the immediate benefits of the country's WTO membership is unrestricted exports of steel and textiles to the EU. (12) Another anticipated benefit is the implementation of a Ukraine-EU Free Trade Agreement (FTA) to replace the more general Partnership and Cooperation Agreement. Three rounds of FTA negotiations have already taken place, and ongoing domestic economic reforms in Ukraine should help the establishment of a free trade arena. (13)

   2. Corporate Law

      The majority of the basic concepts and principles of Ukrainian corporate law date back to 1991, when Ukraine gained its independence. (14) Application of these corporate provisions has shown numerous inadequacies over the years, including major inconsistencies with the Civil Code and the Commercial Code adopted in 2004. (15) In particular, Ukraine is unique as the only former Soviet country lacking special legislation on joint stock companies--a situation that too often allowed the breach of investors' rights. (16) This situation at last stands to be rectified with the September 2008 approval by the Rada of a long-awaited Law on Joint Stock Companies, which should become effective six months following its official publication. (17) Additional details on the new law, and the general corporate legal environment of Ukraine, will be examined later in this Article. The new Joint Stock Company law is in line with both EU directives on shareholder protection, as well as Organization for Economic Cooperation and Development (OECD) guidelines on corporate governance. (18)

   3. Finance

      The $16.5 billion, twenty-four month IMF emergency loan that Ukraine accepted in October 2008 could lead to additional corporate governance changes. The country had already suffered credit rating cuts by major rating agencies (Fitch, Moody's, and Standard & Poor's) (19) and faced default without the additional funds, which were tendered and approved based upon reforms in the country's banking system (including stronger capitalization requirements) and a balanced budget in 2009. (20) Earlier in 2008 inflation had risen to more than 30% but has since fallen, and IMF requirements will likely bring a further emphasis on lower inflation. (21) The state of the economy rides on the coattails of steel prices since the steel industry comprises some 40% of Ukrainian exports. (22)

   4. Energy

      Ukraine has not yet become as dynamic an energy market as other countries in the region such as Kazakhstan, but it still has significant potential for both production and transport of hydrocarbon resources. It is estimated that the country has nearly 400 million barrels of proven oil reserves, the majority of which is located in the eastern Dnieper-Donetsk basin of the Black Sea. (23) Equally important, Ukraine's geographic location makes it an ideal corridor for oil and natural gas to transit from Russia and the Caspian Sea region to European markets-including more than 20% of Russia's average daily crude oil and natural gas exports. (24) Ukraine's state-owned oil and gas company, Naftogaz Ukrayiny, operates the country's massive natural gas pipeline network and has cooperation agreements with Russia's Gazprom that make Naftogaz the key shipper of Russian gas to markets in the EU. Naftogaz moves up to 80% of Russia's Europe-bound gas supplies. (25) As Ukraine's fledgling democracy matures, so too will its energy sector in response to increased global demand, oil discoveries, and the perceived stability of Ukraine in the face of declining worldwide reliance on Russian exports.

3. GENERAL POLITICO-ECONOMIC ENVIRONMENT

   The aforementioned recent economic...