SOUTH AFRICA: UPSTREAM PETROLEUM RESOURCES DEVELOPMENT BILL – POTENTIAL IMPACTS ON UPSTREAM OIL AND GAS COMPANIES
In anticipation of the Department of Mineral Resources and Energy's (DMRE) publication of its long-awaited Upstream Petroleum Resources Development Bill (UPRDB), we contemplate some of the issues that may arise for upstream oil and gas companies.
Under this proposed new legislation, which is expected to be tabled to Parliament soon, the Government has to perform a balancing act to achieve its own socio-economic goals along with a fair share of oil revenues but, at the same time, stimulating investment in the sector in what is an emerging oil jurisdiction.
The UPRDB (the first draft of which was Gazetted in late 2019) has been designed to replace the ‘serviceable’ Chapter 6 of the Mineral and Petroleum Resources Development Act (MPRDA) with a new dedicated upstream statutory and regulatory framework.
While the MPRDA has worked reasonably well for the oil and gas industry since its promulgation in 2004, it is a statute principally designed for the mining industry and has been perceived as cumbersome for exploration and production (E&P) companies.
In drafting the new upstream legal and regulatory regime, the DMRE has consulted widely and examined oil and gas regimes in a number of African and other jurisdictions.
However, it remains the fact that South Africa is an emerging hydrocarbons jurisdiction with few discoveries and little or no history of complex harsh-environment, deep-water exploration and production.
Attracting capital to a jurisdiction with a largely unproven geology and considerable above-ground risk, is a difficult goal to achieve. In the global E&P environment there is significant competition for capital across a wide range of competing projects.
In light of these conditions, fiscal terms in South Africa will need to remain competitive. The fiscal regime, as applied to the upstream oil industry, is the domain of the National Treasury and is contained in the Tenth Schedule to the Income Tax Act.
The current fiscal package is generous in global comparative terms. In 2016, the Davis Tax Committee, as part of a wider examination of aspects of South Africa’s tax regime, published a report for the Minister of Finance on oil and gas taxation in conjunction with input from the IMF.
That report was largely supportive of the continuing value of the Tenth Schedule. However, in the face of a major discovery, it was suggested that revision to the tax regime would be desirable.
A changed landscape: major discoveries
The offshore oil sector has been given a considerable boost recently following a major discovery of gas/gas condensate in the CNR/Total block 11b (Brulpadda and Luiperd). If these discoveries prove to be commercially exploitable then production could commence in the late 2020s.
Further regional interest has been generated by the upcoming Venus Well in southern Namibia, projected to be spudded by Total in Q3 this year. Venus is highly relevant for the geological understanding of South Africa’s north western Orange basin. Total’s recent decision to call force majeure on its Mozambique LNG project has delayed this potential gas supply until such time as the security situation is stabilised.
Gas as an energy generation source for South Africa is looking decidedly more domestic and will need to be carefully integrated with coal-use to reach a tipping point leading to a less-polluting energy generation source.
The controversial shale gas question will again become an important issue which must be resolved following several years of exploration moratorium.
Looking ahead to possible aspects of the UPRDB
The areas of key interest for E&P companies (other than the concerns in respect of the fiscal framework as referred to below), will be:
- security of existing agreed terms;
- a clear and deliverable timetable for progress of the Bill;
- a suite of detailed regulations; and
- issues around the level of State participation and BEE involvement in the industry.
There is also mention of a new domestic market obligation (DMO) which will need careful limitations. It is not clear whether the existing State entity (PetroSA) will take up the proposed 20% participating interest in each new petroleum right (exploration and production phases) or whether a new national oil company will be formed. Investors will consider closely the viability of any State participant entity as their obligatory JV partner.
PASA, the State oil and gas regulator, will be at the sharp end of rolling out and administering the new Act. The management of the transition to the new law will be critical to the success of generating exploration and investment momentum for the industry.
There are currently around 25 E&P companies holding rights in the offshore environment. It is anticipated that these holders will be invited to progress through a transition provision in the new law in order to ensure continued tenure and compliance. Security of tenure of existing rights is a clearly articulated objective of the UPRDB.
The Government also wants to see a rapid increase in exploration drilling after years of inactivity. The UPRDB may articulate a greater ‘use it or lose it’ tone in order to achieve more drilling.
It is likely that rights holders who have spent years not drilling (in some cases for perfectly understandable reasons) will be required to speed things up or risk being required to relinquish acreage.
Drilling and investment activity have been muted for years (Brulpadda aside) as E&P companies have reacted to the lack of legislative certainty. As the new regime may soon be upon us, lack of certainty as a reason to hold off exploration work, will no longer cut it with the Regulator.
Bid-round invitations and BEE issues
A new ‘invitation only’ bid-round system of licensing awards has been mooted.
It has also emerged that at least some of these invitations may be reserved for 100% black-owned companies. The transformation imperative, embedded in all legislation in South Africa, may finally be given statutory effect in the upstream industry in the form of the UPRDB.
Under the MPRDA, the current expectation is that non-BEE rights holders are required to bring in a BEE partner for 10% participating interest on commercial terms in the exploration and production phases. This has been challenging and is not mandated.
It would seem that the new regime may completely change the status quo in relation to who is ‘calling the shots’ on BEE participation. For those petroleum rights under the new invitation system which are open only to BEE companies, then it will be those BEE companies who will select who their IOC JV partners will be, should any register interest. Currently it is the other way around, with IOCs required to find a BEE partner in order to remain compliant, at least in the production right application phase.
There are a number of BEE companies already in the offshore sector with control over large acreages around the coast. However, largely lacking the vast capital and technical armoury needed for exploration in challenging environments, these ‘minnow’ BEE companies will generate investor returns by farming down, as a few already have. The enhanced ‘use it or lose it’ concept may accelerate this process.
The issues around transformation and BEE investment and funding in the upstream industry are complex. BEE is a concept unique to South Africa and is not capable of regional comparison.
The Constitutional imperative of economic and social transformation is given effect in all areas of the statutory framework in South Africa. BEE participation in the economy should not be viewed by international investors as ‘local content’, a concept seen widely across the globe, but as an addition to local content.
A commitment to using local suppliers, providing training programmes and local employment is not the same as being statutorily mandated to have a BEE JV partner holding a participating interest in a block.
How this issue is resolved in principle for the upstream and its funding challenges addressed, remains to be seen. Mandatory participation for BEE companies at the exploration phase is challenging. Funding participation for BEE companies is really the key challenge and the notion of a ‘carry’ for BEE companies in addition to any State carry is likely to be unpalatable to IOCs.
There are also tricky issues to be addressed around BEE exit from projects and whether such an exit will render the project non-compliant. The now widely debated concept of ‘once empowered, always empowered’ will be brought to the fore again.
Whether the Minister will produce some form of upstream petroleum charter, in similar vein to the Mining Charter, will emerge in due course.
Possible new taxes?
In the 2019 iteration of the draft UPRDB, windfall tax, bonus structures and production-sharing mechanisms were all included.
The Minister of Finance referred to the gas finds near Mossel Bay in his Budget Speech of February 2021 and promised a review of the tax regime for the upstream petroleum industry, which will include the publication of a discussion paper by National Treasury and the DMRE on potential tax reforms. This has not yet been published.
As new taxes can only be introduced by way of a so-called ‘money bill’, we expect the consideration of these taxes and a possible variation to the current royalty regime to be left to National Treasury.
While the existing fiscal framework provides for oil and gas rights holders to enter into fiscal stability agreements with the Minister of Finance, no new fiscal stability agreements have been concluded in the last seven years.
The current uncertainty regarding what a new tax regime would entail and how it would impact on the rights of existing rights holders, is detrimental to the industry.
Increase in level of State participation
We expect there to be a mandated 20% State participation in both the exploration and production phases. How this participation will be structured is yet to be seen, but more important is the question of how any proposed carry of the State’s involvement will be accounted for and recovered by the carrying commercial parties.
It would seem a challenge for any national oil company to participate as a technical and financial JV partner across all of the new petroleum rights.
Progress of the UPRDA
The industry more widely, and current and future investors, will be looking closely at the timing of the legislative process leading to the Bill becoming law. This has been a vexed issue in the past and coupled with the need for developed regulations and a clear transition and grandfathering provisions along with timely delivery of the critical fiscal proposals, means that the Departments and Regulator will be very busy in the weeks and months to come.
With all elements of the industry and related stakeholders invited to make comment on the Bill, including merchant banks, environmental lobby groups, the accounting and legal communities and BEE interests, we are in for an interesting and hopefully fruitful journey towards a world-class hydrocarbons regime for South Africa.
Our oil and gas specialists will circulate a client update on the UPRDB promptly after its tabling to Parliament.