OIL AND GAS LAW AND POLICY - by THE LEGAL AND FISCAL REGIMES OF GHANA’S UPSTRE[1].pdf

7/30/2019 OIL AND GAS LAW AND POLICY - by THE LEGAL AND FISCAL REGIMES OF GHANAS UPSTRE[1].pdf

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ICAG CONFERENCE ON OIL AND

GAS LAW AND POLICY, OCTOBER2010

THE LEGAL AND FISCAL REGIMES OFGHANAS UPSTREAM OIL AND GAS

INDUSTRY:

BY JUSTICE SAMUEL MARFUL- SAU


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WHY THE NEED FOR LEGAL

FRAMEWORK The Upstream industry brings with it issues of conflicting

interest among the major stakeholders namely:-

1. The government of the host country with a commercial

interest and at the same time has the responsibility ofprotecting its citizen from the hazards of the petroleumproduction.

2. The International Oil Company (IOC) which has invested

huge capital at a risk and is expecting early returns oninvestment.

3. The communities hosting the project whose health andvocation may be at risk.

4. The environment at large including the future generationwhich must be protected.


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NEED FOR LEGAL FRAMEWORK

CONTD. To balance the conflicting interest of the major

players, host countries need to devise a requisite

legal framework for efficient and soundmanagement of the petroleum production

activities.

The prime purpose of designing a legalframework is to control the exploration,

development and production of the oil and gas

and also guarantee the investments of the IOC.


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WHAT DOES THE LEGAL REGIME

ADDRESS? Most legal regimes seek to address the following issues:-

a) the procedure for licensing, exploration periods, efficient development andproduction of the resource in accordance with good oilfield practice.

b) setting the financial benefits between the government and the IOC and

ensuring the utilization of national goods and services, subject to theiravailability. See section 19, 20 and 21 of PNDC Law 84 on payment of royalty,income tax and transfer of assets.

c) set the financial obligations of the IOC and their audit and monitoring.(Seesection 26 of PNDC Law 84)

d) the acquisition and transfer of appropriate technology and the training of

nationals within the industry. NOTE- By a Policy Framework Ghana hopes toachieve 90% Local Content in the oil and gas value chain by 2020. COMPARE TONIGERIAS 40% LOCAL CONTANT SINCE IT S OIL FIND.

e) set standards for environmental protection, health and safety of thecommunities hosting the petroleum project.


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THE CURRENT LEGAL REGIME

The upstream petroleum industry in Ghana iscurrently regulated by three basic laws,

namely:- 1. Petroleum(Exploration and Production)Act,

1984 (PNDC Law 84)

2. Ghana National Petroleum CorporationAct,1983( PNDC Law 64)

3. Petroleum Income Tax Act, 1987(PNDC

Law188)


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THE PETROLEUM(EXPLORATION AND

PRODUCTION) ACT, PNDC LAW 84- Section 1(1) of the law creates ownership for all petroleum resources inthe Republic of Ghana and same is vested in the President on behalf ofthe people in accordance with article 257(6) of the 1992 constitution

- It establishes the contractual relationship between the state, the

national oil company and prospective IOCs.(Section 2(1) and Section5(4)

- Under section 2 of the law no person other than the GNPC shall engagedin petroleum exploration development and production without anagreement with the GNPC and the Republic.

- The law provide a contractual period of 30 years subject to renewal forall petroleum agreements between the state and IOCs.( Section 12)

- The law provides in Section 14 a Relinquishment period to be specifiedin the agreement where no commercial discovery is made by the IOC.

- Section 8 of the law prohibits the assignment of petroleum agreement

without the prior consent in writing of the Minister of Energy.( This isthe basis of the conflict with Kosmos Oil)


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PNDC LAW 84 CONTD.

The law makes it obligatory for the IOC to promotenational economic linkages in the operations by usinggoods and services available in Ghana and also employ

nationals when appropriate. This ensures sustainedeconomic development. Section 23(10)(11)(12) and(13) It makes the IOC responsible to decommission the

project site making it safe for marine activities after the

operations. See section 28 (1) (b) of PNDC Law 84. The law provides that the IOC shall maintain at the

work place a system capable of adequately dealingwith fire, oil spills, blow outs and accidents. Section 3

and section 23(17)(18) and (19)


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PNDC LAW 84 CONTD.

The law also provides that the production of petroleum shall be carriedout in accordance with best international practice.( Section 3)

Under section 27 the Minister may authorize any person to inspectany petroleum operations and ensure that the operations arecarried out in accordance with the law.

The law provide the IOC the right to export its share of the petroleumunder the petroleum agreement. (Section 24)

It provides for governments participatory interest in all petroleumprojects and sets the basis of fiscal measures like royalty and income tax inpetroleum agreements. (Section 17)

Under section 32 the Minister is empowered to make Regulations byLegislative Instruments to give effect to prescriptions in the Act. TheMinister may regulate 25 core areas of the oil production including thesafe construction, maintenance and operation of installations and

facilities, the safety, health and welfare of persons employed, theprevention of pollution etc.


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THE GHANA NATIONAL PETROLEUM

CORPORATION ACT, PNDC LAW 64 The law establishes the GNPC and makes it responsible for

managing the petroleum resources of Ghana. It is to undertakethe exploration, development, production and disposal ofpetroleum.(See Section 2)

The law mandates the GNPC to promote the exploration andorderly development of the petroleum resources. For eg.undertake geological data acquisition, evaluating IOCs who applyfor license to engage in petroleum operations etc. See Section 2(3)

The law further mandates the GNPC to ensure effective transfer of

appropriate technology relating to the petroleum industry toGhana. See Section 2(2)(c).

Under the law GNPC is to ensure that Ghana benefits greatly fromthe development of the resources. See Section 2(2)(b)

GNPC is to ensure that the production is conducted in a manner as

to prevent adverse effects on the environment. See Section2(2)(e)


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GNPC ACT CONTD.

Under the law GNPC is empowered to enter intocontracts both within and outside Ghana to

purchase and own shares in companies engagedin petroleum production.( Section 3)

GNPC manages the participatory share of thegovernment in the project.

Under the law GNPC doubles as a Regulator andalso a commercial interest holder in thepetroleum production.

Note the conflict position of the GNPC.


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OTHER STATUTORY ROLE OF THE GNPC

It negotiates the petroleum agreement with

IOCs; approving field development plans;

monitoring production cost and the activitiesof the IOCs.

As the Regulator, the GNPC has the power to

apply appropriate sanctions against IOCsthrough the Minister of Energy.


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THE PETROLEUM INCOME TAX ACT,

PNDC LAW 188 The law establishes the tax system for petroleum

production in Ghana.

It provides that income tax shall be assessed on gross

income after the deduction of outgoings and expenseswholly incurred in the petroleum operations, includingthe payment of royalties and rentals.( Section 3)

It provides a progressive income tax based on profit

rather than revenue. The law provides for income tax of 50%, unless

otherwise agreed or negotiated in the petroleumagreement. That is why the income tax for the jubilee

field is 35%. (Section 6)


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THE LICENSING AUTHORITY AND

PROCEDURE

Section 2(2) of the Petroleum(Exploration andProduction) Act, PNDC Law 84 provides that anyperson intending to engage in petroleumexploration and development shall submit anapplication to the Minister for Energy. This formsthe basis of licensing application in the industry.

Besides this provision there has been noregulation or any known competitive biddingprocedure in existence to regulate the issue of

license to prospective investors.


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LICENSING CONTD.

In practice the licensing procedure is coordinated bythe GNPC, which has packaged Ghanas upstream oilpotential into blocks.

Interested investors apply to the Minister, who thenrefers the application to the GNPC, for evaluation anddue diligence.

The GNPC then issues a report which leads to

negotiations and a draft petroleum agreement is thensent for the approval of Cabinet and Parliament.

The license is only granted only after Parliament ratifiesthe Petroleum Agreement. (Article 268 of the 1992

Constitution).


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PETROLEUM AGREEMENTS

The production of oil and gas is traditionally a

risky business, involving huge foreign capital.

The industry is exposed to three major risks,namely:- Geological or Prospecting risk;

Financial(commercial or contract) risk and

Political risk. Petroleum Agreements are thus fashioned taking

into account the risks inherent in the industry,

which also dictate the nature of fiscal regime.


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PETROLEUM AGREEMENTS CONTD.

There are two major types of petroleumagreement in use in the upstream industry. Theseare the Concession system and Contract system.

a. The Concession System:- This is also known asthe Royalty/Tax System. The fiscal arrangementinvolves the payment of Royalty and Tax.

Under this system the state grants an IOC theright to explore, develop and produce oil and gas,in exchange for the payment of royalty and

income tax to the state.


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CONCESSION AGREEMENTS CONTD.

In modern times concessions have thesupplementary entitlements of additional oil,signature or production bonuses.

Title to the oil and gas pass to the IOC at thewellhead, which means if royalty and otherobligations are to be paid in cash, the IOC can liftall the crude oil produced.

The host state becomes the owner of theequipment used in the operations and the IOC isresponsible for decommissioning at the end of

the project.


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b. THE CONTRACT SYSTEM

(i) Production Sharing Contract (PSC): Under

this system the IOC is engaged as a contractor

to conduct exploration and upon commercialdiscovery the IOC is rewarded with an agreed

part of oil referred to as PROFIT OIL.

The IOC is allowed to take agreed volumes ofthe oil produced as part of recovering the cost

of production. This is referred to as COST OIL.


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PRODUCTION SHARING CONTRACT

CONTD.

The IOC is also obliged to pay petroleumincome tax to the state.

The title in the oil produced passes to the IOCat the export point.

The title in the equipment used for the

operations passes to the state immediatelythe operation starts and unless otherwiseagreed, the state is responsible for

decommissioning the fields.


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PSC CONTD.

. Inherent in the PSC arrangement are fiscalpolicies like royalties, bonus payments and

state participation.. PSC is popular in the industry because it allows

the IOCs control of their share of the crude oil

and generally a stake in the state share of thecrude oil produced.

. The PSC system has been made popular by

Indonesia.


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ii THE SERVICE AGREEMENT

There are two types, the pure and risk serviceagreements.

With a pure service agreements, the contractor isengaged for a specific service and paid a flat fee for theservice rendered.

The contractor in a risk service agreement is engaged

to conduct exploratory and development services,however it is only upon commercial discovery that thecontractor is entitled to recover the cost, together withinterest and a risk fee. The State then takes over the

project from the development stage.


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SERVICE AGREEMENT CONTD.

This system of legal arrangement is the least

used in the upstream oil industry.

As at 2001, the world regional distribution oflegal regimes showed that 12 countries are

using the Service Agreement, as against 55 for

the Royalty/Tax and 64 for Production SharingContract.


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NEEDED REFORMS IN LEGAL

FRAMEWORK

The current legal framework though workableneeds reforms to promote efficient

management of the upstream oil industry. Thereforms should include the following:-

1. To decouple the regulatory regime from the

GNPC, so that it will concentrate on itscommercial role.

2. The need for a new regulatory body or

authority for the industry.


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REFORMS CONTD.

3. The establishment of a modern regulatory regime thatwill address specific issues such as; a transparent licensingsystem that will publicly advertise available petroleumblocks; define a fiscal regime for the industry; set rules onachieving environmental standards and enforcementprocedures; set rules that will ensure proper coordinationbetween revenue collection agencies involved in theindustry; and address rights of communities hosting the

petroleum production. SEE SECTION 32 OF PNDC LAW 84 4. The need for rules that will regulate the different stages

in the upstream that is exploration, development andproduction.

These reforms will ensure efficient and sustainedoperations in the upstream industry.


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FISCAL REGIMES IN THE UPSTREAM

INDUSTRY

Fiscal regimes represent the legislated taxationstructure of a country, including the payment ofroyalty.

The term includes all aspect of contractual andfiscal elements that constitute the relationshipbetween a government and a foreign company inthe upstream industry.

It defines what the host governments take will bein the production venture. It also shows theentitlements of the oil company, which has

invested scarce capital into the project.


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FISCAL REGIMES CONTD.

In view of international concerns on the

environment and the huge cost of

decommissioning, modern fiscalarrangements are required to address the

funding of decommissioning. For example in

1989 the cost of removing the 218 offshoreinstallations in the UK area of the North Sea

was estimated then as high as 8billion.


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There are various structures of fiscal regimesin use in the industry depending on the

petroleum contract that is adopted by acountry. For example a petroleum contractbased on the Royalty/Tax, will simply haveroyalty and income tax as its fiscal regime.

A typical Production Sharing Contract will haveprofit oil, cost oil and income tax as its fiscalregime.


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With the emergence of National Oil Companies,

leading the negotiations of oil contracts on behalf

of host governments, various hybrid forms offiscal regimes are now in use.

Most fiscal regimes are structured with the

following elements:- Royalty- a traditional reward to a landlord or

resource owner, payable on gross revenue or as a

flat rate.


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FISCAL REGIME CONTD.

Carried Interest- this is negotiated interestacquired by the state, making it a participant

in the project. Additional or Paying Interest- a form of

interest that increases the shares of the state

in the project. Petroleum Income Tax- this is normally

imposed on the income or profit earned by

the IOC.


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Signature and Production Bonuses:- these are

sums paid upfront by the IOC well before

exploration and production even starts. Surface Rents- these are rents paid by the IOC

for the acreage of land allocated to it under

the licence.

Profit Oil and Cost Oil- these represents the

sharing of rewards under a typical PSC.


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Cost Recovery- this is the mechanism whereby

the contractor is entitled to recover the

exploration, development and production costfrom the revenue of the production.

Ring fencing- this limits the recovery of cost

and other tax deductions to a particular unitor block, without offsetting the cost incurred

against revenue earned from another block.

FISCAL REGIME FOR GHANAS JUBILEE


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FISCAL REGIME FOR GHANAS JUBILEE

FIELD

The fiscal regime for the Jubilee field is based on

the principle of cost recovery and the sharing of

profit, taking into account the risks in theindustry.

1.ROYALTY:- Under Section 20 (1) of the

Petroleum(Exploration and Development) Law,PNDC Law 84, royalty is payable for all petroleum

produced in Ghana, except as may be provided

under terms of a petroleum contract.


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ROYALTY CONTD.

The royalty for the Jubilee Field is 5% leviedon the gross production. It can be taken in

cash or oil. The royalty rate is one of the lowest in the

upstream industry making the Jubilee Field

project attractive and competitive. For example royalties in Nigeria ranges

between 4% to 12% and in Indonesia it is 10%even with a Production Sharing Contract(PSC)


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2.PETROLEUM INCOME TAX

This tax is imposed by Section 6 of the Petroleum IncomeTax Law, PNDC Law 188.

Under the Law the tax payable on petroleum operations inan assessment year is to be 50% of chargeable income,unless the petroleum contract provides otherwise.

For the Jubilee Field project the contract imposed a tax rateof 35%.

Under Section 3 of the Law188, the IOCs are entitled to

deduct all outgoings and expenses including rentals,royalties, sums paid as interest, fees or charges on anyborrowed money, cost of repairing premises, plant,machinery, capital allowance and losses incurred beforetax.


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3.CARRIED INTEREST

The concept of carried interest in the oil industry

takes the form of government participation in the

exploration and development of the field. With the concept the government exploration

cost is carried by the IOC and upon commercial

discovery the government then takes a specifiedproportion of the exploration cost.

Under the Jubilee Field contract the government

is exempt from paying any exploration cost.


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CARRIED INTEREST CONTD.

The carried interest therefore representsgovernments free equity in the project.

The contract grants the Ghana government acarried interest of 10%. This is taken after thededuction of royalty and operating cost, butbefore the deduction of exploration &

development cost from the total volume of oilproduced.

The Ghana government will be earning a dividend

of 10% from the project.


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4.ADDITIONAL OR PAYING INTEREST

Under the petroleum contract the government

has the right to opt for Additional interest which

is a paying interest, unlike the carried interest. This is aimed at enhancing the benefits to the

state but it goes with cost.

The contract grants the government the right topay a proportional share of the development and

production cost to be entitled to the Additional

interest.


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ADDITIONAL INTEREST CONTD.

Under the contract the Additional interest was

negotiated at 3.75%.

In the 2009 State of the Nation address,President Mills directed the GNPC to pay

governments share of the development and

production cost, estimated at US$161million,to acquire the 3.75% Additional interest in the

Jubilee Field project.


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5. ADDITIONAL OIL ENTITLEMENT

The oil and gas market is very volatile with

fluctuating prices. An example was the price

surge in 2008 where the market price went uptoUS$145 per barrel from average of US$60.

The petroleum contract address situations of

oil price surge leading to super normal profits. Under the contract the government is entitled

to levy additional tax on windfall profit.

ADDITIONALOILENTITLEMENT


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ADDITIONAL OIL ENTITLEMENT

CONTD. The windfall profit is defined as when the IOCs

actual internal rate of return exceeds the targetedrate of return used to evaluate the profitability of

the venture during the project negotiations. The targeted internal rate of return for Kosmos

Energy is assessed at 25% and that of Tullowis19%. Accordingly, based on agreed progressivehigher rate of return threshold, the net profits inexcess of the targeted rate of return will be taxedat 5% for Kosmosand 7.5% for Tullow, whenever

windfall profit is recorded.


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6. ANNUAL SURFACE RENTS

The Petroleum(Exploration and Development) Law,PNDC Law 84 provides for the payment of annualrental charges as follows:-

a. Initial exploration period:-US$30 per squarekilometre.

b.First extension period:-US$50 per square kilometre. c.Thesecond extension period:-US$ 75 per square

kilometre. d. Development and Production Area:-US$100 per

square kilometre. NOTE:-These are all tax deductible for income tax

assessment.


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7.DECOMMISSIONING

The decommissioning of oil fields at the endof production has become a fiscal issue due tothe cost involved. For example in 1989 thecost of removing the 218 offshore installationsin the UK area of the North Sea was estimatedthen as high as 8 billion pounds sterling.

In modern times some governments insist thatinvestors post performance bonds as securityfor decommissioning obligations.

DECOMMISSIONING CONTD


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DECOMMISSIONING CONTD.

Under the Jubilee Field contract it is theresponsibility of the IOCs to decommission thefield.

However for better financial management of thedecommissioning, a fund is to established for thepurpose when production starts. The fund will be

treated as Project Revenue to finance thedecommissioning.

The fund will be insured to take care of future

rising cost.

8 RING FENCING


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8.RING FENCING

-This is a fiscal policy that limits the recovery ofcost and deductions to a particular unit orblock, without offsetting the cost incurredagainst revenue earned from another block.

- Under the Jubilee Field project there is no ringfence so cost incurred on a block can be offsetby revenue from another block. This reducesthe profit of the project, but encouragesreinvestment and attracts new investors.

9 OTHER INCENTIVES FOR THE IOC


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9. OTHER INCENTIVES FOR THE IOC.

Cost Recovery:- The Jubilee Field operation allowsfull cost recovery relating to the upstream chainof exploration, development and production, as

well as Service and general administrativeexpenses incurred in the course of the project.

No Export and Import Duties:-under the contract

for the Jubilee Field the IOCs are exempt frompaying export and import duties. This enhancesthe profit level of the IOCs, increasing theircapacity to re-invest in the industry.

OTHER INCENTIVES CONTD


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OTHER INCENTIVES CONTD.

No payment of bonus:- Under the Jubilee FieldContract bonuses such as signature orproduction bonus are not paid by the IOCs.

The payment of such bonuses which arefrontend in nature could delay the productionprogramme as it increases the initial cost ofthe project.

However such bonuses gives governmentearly revenue for its developmental projects.

BASIS OF FISCAL REGIMES


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BASIS OF FISCAL REGIMES

The upstream oil industry is full of risks. Eachphase of the entire project has an associated risk.Three types of risks generally affect the

exploration, development and production phasesof the project.

1.Geological Risk:- this relate to the prospectinguncertainties leading to a dry wildcat well. This

means after sinking much capital in theexploration activity no commercial discovery ismade. This risk is real notwithstandingtechnological advancement in the industry.

GEOLOGICAL RISK CONTD


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GEOLOGICAL RISK CONTD

For example before 2007 when Kosmos andTullowdiscovered oil in commercial quantities inthe west coast of Ghana, a lot of oil companies

had invested huge capital in exploration activitiesbut their investments did not yield commercialdiscoveries.

2. FINANCIAL RISK:- This is the contractual andcommercial uncertainties in the industry. In mostcountries except the USA petroleum resources isowned by the State on behalf of the people.

FINANCIAL RISK CONTD


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FINANCIAL RISK CONTD.

The IOC has to negotiate petroleum agreement withthe host State government. Part of the terms of thisagreement is how to share likely profits while the

resource is still hidden in the seabed or the ground. As production starts the bargaining power moves in

favour of the host States which begin to demand morebetter terms.

The IOC by this time has made huge investment andthus vulnerable. The answer to this risk is the insertionof stabilization clauses in the petroleum agreement.

FINANCIAL RISK CONTD


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FINANCIAL RISK CONTD.

The oil industry traditionally fluctuates. The upstreamindustry has a long lead period about ten years thusmaking the industry vulnerable to inflationary trends in

the world economy as well as unstable oil prices. 3. POLITICAL RISK:- This the situation where the IOC is

incapable of undertaking the petroleum operations andit is forced to suspend or even terminate the operation.

The major causes are political instability, civil unrest,civil war and the imposition of sanctions on the hostState making it impossible for the IOC to export the oilproduced.

RISKS CONTD


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RISKS CONTD.

Note that while the geological risk diminishes

after the exploration and development phases

of the project, the financial and political riskscontinue to hunt the industry throughout the

life cycle of the production phase which could

be up to thirty years.

THEEND


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THE END

THANK YOU

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OIL AND GAS LAW AND POLICY - by THE LEGAL AND FISCAL REGIMES OF GHANA’S UPSTRE[1].pdf