Author: Peter Leon

Regulatory scheme remains modelled on mining principles 

Much anticipation awaited the release of the draft Upstream Petroleum Resources Development Bill on Christmas Eve after a one-year gestation by the department of mineral resources & energy. The long-awaited bill is intended to create a new regulatory framework for the exploration and extraction of both onshore and offshore oil and gas.

This underdeveloped sector has long been viewed by the government as a potential economic destiny-changer. In 2014, during the Zuma administration’s Operation Phakisa (Sotho for “hurry up”), it was estimated that SA’s territorial waters sit atop 9-billion barrels of oil (40 years’ worth of national consumption) and 11-billion barrels of natural gas (375 years’ worth of consumption).

Drilling 30 exploration wells in 10 years could see SA producing 370,000 barrels of oil and gas a day in the subsequent 10 years — reducing the country’s reliance on oil imports (by up to 80%), as well as the energy grid’s dependence on coal; creating 130,000 jobs; and adding $2.2bn (R32.5bn) to GDP annually.

Operation Phakisa found six years ago that one of the major obstacles to “unlocking” this economic potential was a “lack of legislative clarity”, inhibiting investment in exploration projects.

Since 2004, the upstream petroleum sector has been regulated by the Mineral and Petroleum Resources Development Act (MPRDA), in almost identical terms to the mining sector. It was always an awkward fit, as the two industries operate in vastly different ways and different global markets.

Moreover, even for the mining sector, the MPRDA is considered an unattractive regulatory framework, leaving too many matters open to interpretation and administrative discretion.

The awkwardness worsened after 2009, when the new Zuma administration split the department of minerals & energy in two, leaving upstream petroleum regulation in the hands of the department of mineral resources, while the Petroleum Agency of SA, residing in the department of energy, would continue to receive and process applications for permits and rights.

Operation Phakisa concluded that resolving this conundrum was the “highest priority” for “unlocking” the economic potential of SA’s oceans: “To affirm investor confidence, clarity and stability must be provided on the full legislative, regulatory and contractual package.” This was to involve petroleum-specific legislation separate from the MPRDA.

The government regrettably did not “hurry up”. For the next five years, the oil and gas sector was held hostage to the constitutional quagmire surrounding the MPRDA Amendment Bill, 2013, which was rushed through parliament in the run-up to the 2014 election. It was then referred back to parliament by president Zuma in 2015 with reservations as to its constitutionality, and subjected to an error-riddled reconsideration process until it was sensibly withdrawn in 2019 by the new minister of mineral resources & energy, Gwede Mantashe (now responsible for a combined ministry).

In that lost half-decade, SA saw no significant investment in petroleum exploration and production.

The bill is thus a long-overdue step towards changing that — at a time when SA desperately needs to attract foreign investment. Total’s major discovery last year of roughly 1-billion barrels of oil equivalent in the Brulpadda prospect offshore Mossel Bay has generated much-needed international interest in exploring the country’s seabed.

To turn that interest into tangible investment, it is critical that parliament gets this legislation right. The current draft bill, however, is far removed from that objective.

While the regulatory scheme set out in the bill is not unworkable, it inappositely remains modelled on mining principles, rather than on modern petroleum laws reflective of international best practice, such as that enacted in 2014 by Mozambique.

As such, several features of the bill are illsuited to offshore oil and gas projects, such as requiring an exploration right holder to commence work within 90 days of the right being granted, and thereafter conduct exploration activities “continuously”, which is not feasible for major deep-water drilling, which depends on seasonal conditions and the availability of rigs, for example.

The bill does get some of the basics right. For one, it entitles an exploration rightholder exclusively to apply for the production right over that block once a discovery is made. This is vital to the security of tenure that all investors require. This security is undermined, however, by the bill’s failure to entrench the terms of the eventual production right in the initial exploration right. This means that, once a discovery is made, the government may impose less favourable terms for the production phase than anticipated. This insecurity is exacerbated by the bill’s provision that a production right is only renewable after renegotiation of the terms with the minister.

Investors will likewise be discouraged by the lack of clarity for “participation in exploration and production rights” by the state (in the form of PetroSA) and black South Africans. Giving the state a 20% carried interest in a right is not uncommon in other jurisdictions, but the bill contains contradictory provisions about how that interest is to be exercised. The same applies to the 10% interest reserved for black South Africans, with the additional uncertainty about how that stake is to be funded.

It is also unclear whether further black ownership requirements may be imposed in the minister’s regulations, envisaged by the bill, on “transformation of the upstream petroleum industry”, or indeed in the Petroleum and Liquid Fuels Sector Transformation Charter expected to be promulgated and administered by the minister of trade & industry under the Broad-Based Black Economic Empowerment Act. All this requires clarification.

Further, the bill’s requirement of prior ministerial consent for the transfer of any interest in an unlisted company or a controlling interest in a listed company that holds an exploration or production right — copied and pasted from the mining chapter of the MPRDA — will stultify investment in the petroleum sector.

The most important issue for foreign investors — on which the bill offers more questions than answers — is the fiscal regime. Investment decisions depend on calculations of what profit will remain after the total “take” by the state — the sum of the carried interest, royalties, income tax and any other taxes.

By contrast, the bill assumes a uniform regime for all investors and projects, which is not objectionable in principle, but it does not spell out the particulars, or even the broad parameters, of the fiscal terms. The bill charges the minister of finance to determine and levy: royalties (but fails to state the kind of royalty, volume- or valuebased); a “resource rent tax” (which it does not define clearly); and a “production bonus” (which it does not define at all). It also does not indicate how soon the minister must determine these charges, how regularly he may change them, and within what limits.

Without clarity on these issues the bill is meaningless for prospective investors.

It is disappointing that the bill does not seem to serve the purpose of creating a new sector-specific regulatory regime for the oil and gas industry. Rather, it moves the same old inappropriate provisions of the MPRDA into a new container, repeating the mistake made in the MPRDA — shoehorning the petroleum sector into a mining regime.

Much work will need to be done to turn the bill into an attractive and competitive regulatory framework. In doing so, the industry will need to educate the department and parliament about the requirements of their business as well as how these are catered for in comparative African jurisdictions such as Mozambique. Meanwhile, one is left with the feeling that the department has laboured mightily but brought forth a mouse.

This article first appeared on the Sunday Times news paper published on 09 February 2020.

 

For more information, please contact Peter Leon or your usual Herbert Smith Freehills contact:

Peter Leon
Peter Leon
Co-Chair of Africa Practice Group, Johannesburg
+27 10 500 2620