Liability for irrational subsoil use

Export of crude oil and other natural resources is the basic income of our country. Active development of oil and gas industry is related to increased risk for the environment. Alongside with this industry development special legislation is actively developing, new tendencies of the recent years include resolving actual issues of preservation and rational use of subsoil resources. In pursuance of preservation, rational and multiple use of subsoil resources the legislator pays close attention to responsibility issues as the major “tool” and legal remedy to support rule of law in the subsoil use area.

Responsibility in the subsoil use area just as any other responsibility in the environment preservation area and responsibility in general may arise in the cases and according to the procedure established by the legislation.

Law on Subsoil and Subsoil use dated 24 June 2010 (further – “Subsoil Use Law”) foresees that any infringement of the legislation of the Republic of Kazakhstan on mineral resources and subsoil use involves liability prescribed by the laws of the Republic of Kazakhstan (Article 126). Further the Article 127 provides that persons causing damage through violating provisions of ecological legislation of the Republic of Kazakhstan shall reimburse the caused damage unless proven that the damage arose due to insuperable force circumstances or willful intent of the aggrieved to the extent and in the manner established by the legislation of the Republic of Kazakhstan. Herewith, the extent of damage caused through breaching requirements in the area of rational use of subsoil resources shall be defined by the authorized agency for studying and using subsoil resources.

Thus Subsoil Use Law contains reference rule to special legislation. Moreover the last developments implemented by the Laws “On introducing changes and additions to certain statutory acts of the Republic of Kazakhstan regarding issues of cardinal improvement of favorable conditions for entrepreneurial activity in the Republic of Kazakhstan” of 29 December 2014, Criminal Code of the Republic of Kazakhstan of 3 July 2014, Administrative Violations Code of the Republic of Kazakhstan of 5 July 2014 are specification and division of responsibility for certain breaches of law, introduction of new elements of legal offence, specification of elements of legal offence and breaches of law as well as authorities ensuring control over particular issues.

Within limits of this article we would like briefly touch upon issues of corporate, administrative, criminal and civil responsibility for breaching rules in the area of rational use of subsoil resources, consider few practical examples of compensation for damage due to irrational use of subsoil resources and certain other violations in the area of use of subsoil resources.

Corporate responsibility

Talking about corporate responsibility we’d like to group such responsibility types among companies-subsoil users as financial (material) and disciplinary responsibility of the employees and responsible managers. This responsibility by its legal nature is based on employment and labor regulations. As a rule responsibility extent is regulated by internal corporative documents, acts of the employer (policies, procedures) and financial liability contracts. At present principles of Corporate Social Responsibility are increasing, internal control services are enforced and company standards for ensuring safety, environment preservation and health care are increasing on a voluntary basis. These principles become the ground for honest business and increasing trust to subsoil users on the part of community and the state authorities. Within the framework of analyzing voluntary responsibility for damage it’s also required to use insurance institution to a wider range.

Administrative liability

Administrative liability plays important role in ensuring rational use of subsoil resources.

Administrative Violations Code of 05 July 2014 (Administrative Code) regulates 13 elements of administrative offenses in the area of rational use of subsoil resources. New legal developments provide for inclusion of administrative liability for “non-compliance with the rules for rational and multiple use of subsoil resources”, “performing production without State appraisal of reserves of commercial minerals” as well as correction of the Article “Infringement of rules for petroleum operations and works for subsoil resources management”. 12(!) parts detailing description of legal offence such as flaring associated and (or) natural gas, divergence from design documentation, operations of wells in violation of requirements established by the legislation and etc are additionally included in the Article 365 “Infringement of rules for petroleum operations and works for subsoil resources management”. Also sizes of administrative charges are specified and reduced in a majority of cases.

Criminal liability

In pursuance of ensuring rational management of subsoil resources the Criminal Code of the Republic of Kazakhstan of 16 July 1997 provided for one element of crime with regard to issues of rational management of subsoil resources – Article 286 (infringement of rules for protection and use of subsoil resources).

A new element – unauthorized subsoil use (Article 334) is introduced along with liability for infringing rules for protection and use of subsoil resources (Article 333) in the existing Criminal Code of 3 July 2014 and also additional and alternative sanctions are established. Also the Criminal Code contains articles, which may likewise be related to the issues under question, e.g. Article 330 (offshore pollution) and Article 329 (atmosphere contamination).

In addition in the existing Criminal Code definitions for damage types are reviewed: a definition of considerable damage was used before and used to be punished with a fine, disqualification to hold certain positions or to practice certain professions or corrective labor for a period up to two years; the new Code provides only liability for large scale and very heavy damage. Also punishment for committing acts is reviewed in the form of changing the size of penalties and terms of deprivation of freedom.

As to the criminal liability for crimes in the area of rational management of subsoil resources we’d like to highlight major issues arisen in law enforcement practice:

• complications in qualifying a legal offence and identifying the dividing line between administrative and criminal liability;

• considering specificity and demand for highly qualified specialists nowadays who could have done criminal – legal evaluation of infringements in the area of rational management of subsoil resources;

• bringing a certain party to criminal liability is problematic since it’s often impossible to identify the subject and the subjective aspect due to continuous nature of business processes and team involvement in all processes by stages of activity in companies – users of subsoil resources leading to a unified result;

At present there are various speculations in respect of bringing to criminal liability for irrational use of subsoil resources. Some people think the number of elements shall be increased in view of importance of the subsoil resources as an object of the environment, its specificity, others believe in the need for humanization of penalties for committing this type of legal offences “in exchange” for increasing size of compensation for damage.

We believe that in Kazakhstan the issue for introduction institution of corporate criminal liability following pattern of Western countries is already escalated. Of course this proposal requires long time for studying and involvement of academicians and practitioners, local and foreign because it’s going to fundamentally change the concept of criminal law. However this initiative will correspond to specificity of this crime since in most cases it’s practically not possible to identify the subject of offence as well as evaluate extent of involvement of particular parties into the process. Moreover introduction of this institution will enable to considerably raise corporative legal consciousness and legal consciousness.

Recovery of damages as a remedy of civil and legal liability

The most effective remedy of responsibility for violating requirements of ecological legislation and legislation on subsoil use throughout the world is civil and legal liability. The most common forms of claims of civil and legal liability in the area of subsoil use and environment protection are claims for compensating damages filed by ecology authorities and / or agencies for studying and using subsoil mineral resources. Also such claims are often put forward by prosecutors on behalf of the state for violations in the area of rational use of subsoil recourses.

There are some issues related to regulating these affairs in civil and legal space due to specifics of subsoil resources as an object of civil law relations, impossibility to compensate the damages in the form of bringing the subsoil resources into the initial condition, condition approach in estimating the damage extent and difficulties (in some cases impossibility) in estimating lost profit.

Considering that in most cases it’s not possible to identify the scales of caused damage and consequently estimate damage to the fullest extent, the state authorities shall use fair approach to assessment and estimation of the damage based on economic efficiency, specificity of subsoil operator’s activity and compensating nature in recovering damages.

Thus actual damage to the subsoil resources from the state viewpoint as the owner of subsoil resources may be caused in reducing the quantity of natural resources lying in subsoil which in itself serves the purpose of subsoil use as lawful use of subsoil resources.

Ground for imposing remedies of civil liability may be a breach of requirements for rational use of subsoil resources.

Earlier Subsoil Use Law expressly divided responsibility for violating requirements for rational use of subsoil resources and requirements for protection of subsoil resources, attributing the first type of responsibility to the scope of Subsoil Use Law whereas issues of protection of subsoil resources – to environmental legislation. Introducing recent changes in Subsoil Use Law the legislator highlighted definition of damage caused through breaching the requirements for rational use of subsoil resources falling in competence of the authority for studying and using subsoil resources. Specification of any other damage as a result of breaching environmental legislation requirements was attributed to agencies of corresponding competence depending on a particular environmental object which has been damaged.

Estimating extent of the damage caused due to non-compliance with the requirements for rational use of subsoil resources.

Extent of the damage in the area of rational use of subsoil resources shall be estimated in accordance with the Rules for assessing damage caused due to non-compliance with the requirements in the area of rational use of subsoil resources approved by the Regulation No. 139 of the Government of the Republic of Kazakhstan of 15 February 2011 (Rules No. 139) substituting previously existing Rules for calculating damage caused due to non-compliance with the requirements in the area of rational use of subsoil resources approved by the Regulation No. 796 of the Government of the Republic of Kazakhstan of 22 August 2006.

Major change was cancelling probable “doubling” responsibility for one and the same offence simultaneously for irrational use of subsoil resources and breaching requirements for protection of subsoil resources by corresponding requests from agencies for studying and using subsoil resources and environment preservation authorities. In other words damage caused in violation of requirements for rational use of subsoil resources shall be estimated by authority for studying and using subsoil resources whereas damage arisen through non-compliance with requirements of environmental legislation and requirements for protection of subsoil resources shall be estimated by agencies in accordance with their competence foreseen under Environmental Code.

Rules specifies list of requirements for estimating and calculating extent of excessive losses to raise claims for compensating damage caused due to breach of requirements in the area of rational use of subsoil resources. However we’d like to draw your attention to the following aspects and probable problems in interpretation of these Rules:

• Rules No. 139 introduce new important definitions without explaining their meaning and content for example the Paragraph 9 says “excessive losses of oil in situ”. There is no such definition also in other statutory provisions;

• In addition Rules No. 139 establish estimation of damage in the form of paying difference between actual and normative losses in value terms herewith these Rules also establish excessive losses as index to estimate the damage extent though this index is not counted at direct estimation as indicated in the example;

• Rules No. 139 give references to uncertain data for example the Paragraph 11 describes estimation of design data for gas content in the extracted useful mineral resources. Thus so called “gas factor” – this is a changeable value and may not be fixed;

• Also it is important to note that Rules No. 139 go beyond the limits of its purpose. Thus Rules No. 139 shall contain methods for estimate damage extent, but not the damage itself. In other words the fact of incurred damage shall be proven by competent authorities and presence of proven damage fact may serve as the basis for calculating the damage extent. Estimation of damage in this case (in the absence of its direct estimation) is regulated by Environmental Code where it’s established that damage caused to the environment – pollution of the environment or extraction of natural resources in excess of the prescribed norms resulted or resulting in degradation or exhaustion of natural resources or death of live organisms. Thereby the following conditions shall be in place for proving damage: 1) pollution or extraction in excess of prescribed norms; 2) causing degradation, depletion of resources or demise. Thereby authority for studying and using subsoil resources shall identify availability of the mentioned conditions to estimate the damage as it is.

Calculation of damage caused through breaching requirements in the area of rational use of subsoil.

Procedure for calculating damage caused through breaching requirements in the area of rational use of subsoil also foreseen in Rules N. 139 via references to examples of calculation set forth in the Appendix to Rules No. 139. Absence of explanations to calculations and ambiguity in applied terminology result in arising few points at issue. Let’s consider example in Rules No. 139:

Example 2:

Subsoil user produced 2658000 tons of oil for the accounting period.

During this period actual oil losses were 4442 tons including approved normative losses 1081 tons of oil.

Average price at realizing oil by the subsoil user (London Metal and Oil Exchange) in the accounting period was 50,49 US dollars,

(4442 – 1081) х 50,49 = 169696,89 US dollars.

169696,89 х official exchange rate of national currency of the Republic of Kazakhstan against a foreign currency fixed by the National Bank of the Republic of Kazakhstan as of the moment of revealing the damage = amount of damage.

As you can see a formula of multiplying difference of actual losses over normative losses by average price at realizing oil by the subsoil user (London Metal and Oil Exchange) in the accounting period is used to estimate the damage.

Firstly the question that has to be answered is about the accounting period and namely what period is the accounting period: last calendar (fiscal) year? or period within which difference between actual losses and normative losses has been fixed? or period of carrying out state control (inspection)?

Secondly using the term “average price for sales” is uncertain. What sale price is used: average weighted sale price of the subsoil user for the last year? or for six months? or other definite period?

Thirdly to what extent the applied prices are grounded, fair and objective? As it’s known a number of subsoil users sell oil at the domestic market where the price is significantly less than sale prices for oil for export. Obviously the subsoil user selling oil at the local market with the same extent of damage caused to the subsoil resources in comparison with the subsoil user – exporter will bear less financial burden than that selling oil for export.

Fourthly the note in the brackets (London Metal and Oil Exchange) as well as the text in the Paragraph 6 of Rules No. 139 saying: “For useful mineral resources with official quotation prices their average cost for the accounting period shall be applied”. It’s uncertain whether use of quotations is mandatory or alternative.

Fifthly in case of applying the mentioned quotations should reduction in price (difference) be applied)? In other words quotations for oil are used subject to their price in a particular point of the world market whereas in order to supply oil a subsoil user or a buyer will incur significant expenses starting from the subsoil user’s well to the world market at which the mentioned quotations are fixed. Are the current prices in the region considered?

In pursuance of converting into the national currency what date will be the date of revealing the damage? The thing is that some breaches require occurrence of certain conditions in future to acknowledge the damage. In actual practice controlling authorities indicate various dates: inspection certificate date; year end during which losses are specified, etc.

In conclusion we’d like to point out that in the bottom line of the shown examples there is only difference between actual losses and normative losses. The examples lack a calculation procedure at diverging from excessive formation oil losses, excessive losses for gas burning, etc. Herewith the shown examples disregard the extent and scale of the damage caused to subsoil resources and its criticality for the environment on the whole.

Compensation of damage for excessive losses of oil in situ (practical example)

In 2013 Company А produced 100,000 tons of oil at Zhol field. The development program provided for extraction of 140000 tons of oil for the year.

Design level of ORF (Oil Recovery Factor) of Zhol field is 0,25. Approved extractable reserves– 1,500,000 tons.

According to inspection certificate issued by authority for studying and using subsoil resources ORF performance in 2013 is 0,17 (ORF was calculated as ratio between produced volumes and projected). Accordingly divergence from ORF is subject to compensation as damage in breach of rules in the area of rational use of subsoil (calculation: 0,25 – 0,17 = 0,08 divergence. Accordingly, ORF 1%=(1,500,000х1)/100=15,000 tons. Calculation: 15000 tons х 0,8 = 12,000 tons, average sale price 350 US dollars per ton. Accordingly the damage was 5,250,000 US dollars. Authority for studying and using subsoil resources registered court claim on damages reimbursement for irrational use of subsoil.

To check correctness of the calculations themselves you will need to clear the issue of having damage/harm as it is. To do so there are a few questions to be answered:

  1. What is ORF?
  2. What are “excessive losses of oil in situ”?
  3. Is it feasible to calculate and apply ORF to volumes of oil produced within a calendar year?
  4. Will ORF non-compliance within a calendar year result in excessive losses of oil in situ?

On first question, ORF definition is described in the Instruction for classifying natural resources deposited in the fields, perspective and prognostic resources of oil and natural hydrocarbon gas approved by Order No. 283 of Ministry of Energy and mineral resources of 27 October 2005 where it’s specified that oil recovery factors (gas and condensate) – values showing what part of reserves or resources may be extracted from subsoil with optimal regime of developing natural deposits up to economic efficiency limit applying approbated technologies and machinery to extract oil. In other words ORF means what part of oil of the initially approved geological reserves may be extracted up to economic efficiency limit i.e. up to completion of field commercial development.

Second: as mentioned above no definition for excessive losses of oil in situ is provided by the legislation, therefore we shall apply to definition for normative losses of useful mineral resources lying in subsoil which shall be understood to mean losses technologically related to methods and systems adopted for developing useful mineral resources at extraction the level of which is based on technical and economic assessments (Article 1, paragraph 13) of Subsoil Use Law. Considering that technical and economic assessments are the basis for calculating ORF and adopted development methods and systems are approved in pursuance of reaching ORF at the end of economic efficiency of the entire field, therefore excessive losses of oil in situ mean a part of unextracted reserves of the approved oil reserves as of the moment of the field development deadline.

Therefore, on third question, as described above and based on experience of developing oil and gas fields, ORF shall be calculated for the entire extraction period at the field therefore ORF may not be applied within the scope of a particular period (month, year, 2 years, etc.).

Fourthly based on the foregoing it’s obvious that ORF non-compliance for one year may not be acknowledged as excessive losses of oil in situ since: 1) the definition excessive losses of oil in situ itself may be applied only to the period of finishing field operation; 2) failure to extract production output in the current year will not mean that such failure results in loss of these volumes because they may be and will be extracted in the future period in accordance with development rules and methods; 3) there is no option to calculate damage caused to the subsoil in the legislation and in practice at failing to perform liabilities for production approved by the work program.

In accordance with article 917 of the Civil Code harm caused by illegal actions shall be reimbursed by the person which caused the harm. The above mentioned review proves absence of harm as a legal fact and damage to the subsoil resources as such; therefore, damage estimation is not possible and the courts are obliged to dismiss the claims.

In view of the above said we come to a conclusion that Rules No. 137 need to be reviewed to a considerable extent to bring them in compliance with the legislation and specificity of activity for using subsoil resources, adopted standards of legal drafting methodology, principles of clearness and fairness of imposed responsibility to avoid “figuring out” formulas and “creating” methodologies which after all leads to punitive function of civil liability which may not be tolerable as such.

Compensation of damage caused by the previous subsoil user

Nowadays there are more and more cases when responsibility is imposed on a subsoil user for non-compliances committed by the previous subsoil user – so called “historic” or “past” environmental damage. In these proceedings one should differentiate the cases when the current subsoil user obtained the right to use subsoil resources based on a civil transaction as a result of transferring from the previous subsoil user from the cases when the current subsoil user obtained the right to use subsoil resources from the state authorities with liability to accept transfer of ownership of previously drilled wells and arrange monitoring over them. If in the first case everything is more or less clear and common principles of succession in title are applicable then in case when subsoil rights are acquired from the state authorities and within the contractual territory previously drilled wells suddenly started to cause damage (e.g. a suspension bridge broke inside the well, etc.) questions of liability for “historic” environmental damage will arise. We believe in that case it’s required to develop a mechanism for compensating the damage (procedure and conditions) and distribution of liability between the previous and the current subsoil user and the state. If it’s impossible to bring the previous subsoil user to responsibility due to various reasons (termination of business activity, etc.) in some countries they apply concept of joint and several liability of the state with the current subsoil user to repair “historic” environmental damage. This option of joint several liability seems to be more fair and serving the purposes of meaningful work held by the state authorities with subsoil users.

There is no regulation of this mechanism in Kazakhstani legislation and in most cases conservative and formal approach is being applied, to be more specific availability of previously drilled wells on the books of the current subsoil user and monitoring activity by the wells arranged by this subsoil user is recognized as ownership right of the subsoil user to such wells and accordingly claims for compensating damages caused by such wells will be put forward to the owner – current subsoil user nevertheless absence of fault in causing damages and bona fides of the current subsoil user.

Failure to achieve the expected production levels: damage for failing to perform contractual obligations or for breaching requirements in the area of rational use of subsoil resources

One of the recent developments in Subsoil Use Law as to the part of possible divergence from performance of design target values by solid commercial minerals is that they formalized in legislation that it’s now optional to introduce changes and (or) additions in conditions and scope of works specified under approved projects provided that production outputs specified by the approved projects change to an extent less than twenty percent expressed in physical terms from the design target values.

Unfortunately this innovation doesn’t cover subsoil users carrying out oil exploration and production. Oil companies are obliged to be governed by requirements of approved design documents during production. Insofar as it refers to compensation of damage due to non-performance of design target values for production we encountered practice of claims filed by authorities for studying and using subsoil resources concerning compensation of damage in the area of rational use of subsoil resources. In this case it’s required to divide liability for a particular non-compliance depending on the caused damage type.

Thus oil production levels are defined in the project documentation and work program being enclosure to the subsoil contract therefore any breach of its provisions may be acknowledged as a breach of conditions of the subsoil contract and therefore leading to possible claims filed by a competent authority concerning compensation of damage resulted from failure to perform the subsoil contract.

Is failure to perform the work program an infringement in the area of rational use of subsoil resources? Rational and multiple use of subsoil resources is economically effective development of all types of mineral resources in the subsoil based on using advanced technologies and positive expertise for field development. Rational use of subsoil resources includes apart from anything else ensuring completeness of extracting commercial minerals from subsoil avoiding selective development of areas rich in minerals. Under these conditions in case if the subsoil user’s fault regarding selective development of areas rich in minerals resulting in loss of oil in subsoil is proven then it’s probable to bring to responsibility for causing damage to subsoil resources because it will take a lot of time and investments to extract oil form disturbed and complicated subsoil areas and in some cases no further oil extraction is possible. On the other part in practical experience certain cases are often encountered when non-compliance with contractual obligations due to failure to meet requirements for oil production outputs resulting in bringing to liability under the subsoil use contract does not coincide with damage for irrational use of subsoil resources since a confirmation is required to evidence the fact of the caused damage. And on the contrary there are probable cases of breaching requirements in the area of rational use of subsoil resources with full compliance to the targeted production rates, provisions of the subsoil use contract to the extent of oil production outputs. For instance one of wasteful methods of oil extraction is oil production through injecting a large volume of water into the oil formation under high pressure resulting in oil migration and large extraction output. Obviously production outputs foreseen under the work program may be reached however there will be a considerable damage caused to subsoil (in some cases catastrophic).

Dividing liability between the subsoil user and its contractor specifically pertaining to liability for causing damage to the environment

In practice it’s often complicated to identify fault and limits of liability between the subsoil user and its contracting (service) organization. Damage caused during the process of rendering services by such service company may be a reason of the damage caused to subsoil and the environment.

In accordance with the Paragraph 1 Article 917 Civil Code of RK damage caused due to unlawful acts (omission) to proprietary and non-property welfare of citizens and legal entities is subject to indemnification by the person causing the damage to the fullest extent.

In accordance with the Article 321 Environmental Code persons committed ecological offences shall reimburse the damage caused by them subject to Environmental Code and other statutory acts of the Republic of Kazakhstan.

Damage caused to the environment, people’s health, property of physical persons and legal entities, the state is subject to indemnification as a result of the following:

  1. Destruction or damaging natural resources;
  2. Illegal and irrational use of natural resources;
  3. Unauthorized environment pollution, including emergency uncoordinated breakaway releases and discharges, placement of production waste and consumption waste;
  4. Environment pollution in excess of industry norms.

In cases related to damage caused to the environment involving a service company first of all it is necessary to identify the harm-doer as well as prove cause effect relationship between acts of the subsoil user, the service company and the damage. In practice for the purposes of facilitating operations for finding the party at fault and identifying legal facts state authorities file claims directly to the subsoil user, whereas the acts of the subsoil user may contain no fault in causing damage and the service company may terminate its operations. Is such case it’s necessary to: directly identify the party at fault; 2) with confirmation of no fault of the subsoil user determine mechanisms for compensating damage caused to the environment on the basis of economic indicators and fair estimation of the damage extent compensation.

Despite the fact of active and timely development of our legislation, some aspects of subsoil user’s liability haven’t obtain proper legislative recognition or need to be reviewed to a considerable extent. Resuming the aforesaid we’d like to draw your attention to the fact that the analyzed problems in law application practice regarding issues of compensating damage caused through non-compliance with requirements in the area of rational use of subsoil and the environment preservation in many respects defy fair liability principle and convert liability which should have preventive and “compensating” nature to punitive measures absolutely not supporting creation of certain and understandable rules and interrelations between subsoil users and state authorities. As a result we come to a situation when in fact: 1) a subsoil user is may be brought to “multiple” responsibility for one the same non-compliance with the rules; 2) legislation on rational use of subsoil fundamentals of legal drafting methodology are not complied with: absence or inconsistency of definitions in various regulatory acts; 3) absence of understanding economic indicators in projects and establishing unfair system for calculating the damage and not necessarily with respect to the subsoil user; 4) absence of a system for recording specificity of subsoil user’s activity, project on the whole; 5) “buck passing” the state liability over to the subsoil user; 6) ignoring requirements for adversary nature of the judicial process, discrimination of natural resource user.

The information contained in this Table is of a general nature and cannot be used as legal advice or recommendations. Please note that Kazakhstan is an emerging economy and its legislation and legal system are in constant development. Should you have any questions or want to discuss the information provided in this Table, please contact us.