Authors: Peter Leon, Paul Morton, Amanda Hattingh and Ernst Muller

INTRODUCTION

A year ago, on 27 February 2019, Total S.A. announced a major discovery of gas condensate in the Outeniqua Basin (Brulpadda prospect, Block 11B/12B) offshore South Africa. This deposit reportedly contains around one billion barrels of oil equivalent. 

This discovery had two significant consequences. First, it identified South Africa as one of the world’s new frontiers for oil and gas exploration. Second, it placed a spotlight on the inadequacy of South Africa’s existing regulatory regime and the urgent need to develop upstream petroleum legislation.

Following an undertaking by the Department of Mineral Resources and Energy (the DME) to develop discrete oil and gas legislation, the Minister of Mineral Resources and Energy (the Minister) published the Draft Upstream Petroleum Resources Development Bill (the Bill) on Christmas Eve 2019. The public were invited to submit comments on the Bill to the DME by 21 February 2020.2

The Bill seeks to ensure that the upstream petroleum sector is regulated not under the Mineral and Petroleum Resources Development Act, 2002 (MPRDA) but under standalone legislation. The desire to separate the legislation dealing with two different sectors is obvious and not uncommon in jurisdictions with successful oil and gas sectors.

For example, in 2013, following the discovery of significant natural gas reserves in Mozambique, the petroleum regulatory regime was overhauled, establishing tailored oil and gas legislation in order to encourage investment into the sector (in addition to project-specific legislation for the related LNG developments).

While the prospect of dedicated oil and gas legislation presented an opportunity to create a bespoke regulatory regime, the Bill in many cases simply reproduces existing provisions from the MPRDA. As a result, it retains many of the shortcomings of the existing legislative framework, which was drafted for the mining industry. While many of the Bill’s provisions may work for onshore oil and gas purposes, the Bill unfortunately fails to capitalise on the opportunity to create a genuinely tailored regime for the oil and gas sector. This will be particularly felt in relation to offshore exploration and production, where there is currently the most interest, as these operations differ materially from mining activities.

This Brief highlights some of the key issues emanating from the Bill and suggests opportunities for clarification.

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KEY POINTS ARISING FROM THE BILL

Principal rights and permits

  1. a reconnaissance permit (clauses 41 and 42);
  2. a technical cooperation permit (clauses 43 to 45);
  3. exploration rights (clauses 46 to 49);
  4. production rights (clauses 51 to 54); and
  5. retention rights (clauses 55 to 59).

State’s carried interest

The Bill provides that the State has, through PetroSA,3 a 20 percent carried interest in any exploration and production rights (which must include the corresponding percentage voting rights).

It is not unusual for exploration or production rights to include a substantial carried interest for the state (examples in Africa include Mozambique, Gabon, the Republic of Congo, Senegal and Chad). However, in its current form, the operation of the carried interest is difficult to decipher.

Further, in terms of structure and governance, the Bill4 refers interchangeably to PetroSA being a party to a shareholders agreement and to a joint operating agreement, leaving it unclear whether PetroSA’s interest is to be held directly at the asset level or in the shareholding of the right holder (as is common in the mining sector).

Finally, the financial consequences of the carried interest are ambiguous. Although the recovery of development and production costs is mentioned, the Bill does not make specific provision for the recovery of exploration costs. This suggests that the other participants will be able to recover carried development and production costs but potentially not exploration costs. Ultimately, investors will need to consider the economic impact of PetroSA’s carried interest together with the tax and royalty provisions which will be set out in subsequent fiscal legislation.

Unless these important fiscal issues are addressed, they are unlikely to encourage investment in what is, at this stage in South Africa, an embryonic industry.

Participation of black persons

Under the Bill,5 every exploration right and production right must have a minimum of ten percent participating interest held by black persons which must include economic interest and the corresponding percentage of voting rights per right.

While this requirement is not unexpected, the financing of such interests will need to be considered in the context of the unique expenditure and revenue cycle of upstream oil and gas operations. Unlike many other sectors, oil and gas exploration involves a high level of upfront investment with a significant time lag before revenues are generated (if at all). This is particularly the case in South Africa, where offshore drilling costs are among the highest in the world.

In addition, the Bill6 empowers the Minister to reserve a block or blocks in an open area for 100 percent black person owned companies. This provision includes potential penalties in the event of dilution of the black ownership below 51 percent, triggering a State carried interest of “up to a minimum” of ten percent.

The combined effect of this provision, together with the existing State carried interest provision, is not clear and should be addressed in order to create greater regulatory certainty.

Transitional provisions

The Bill’s transitional provisions7 create some uncertainty in relation to pending applications for and pending lodgements of rights and permits under the MPRDA.

While pending applications and lodgements “must be regarded as having been lodged after…” the date of the Bill’s commencement, it fails to clarify whether such pending applications and lodgements will need to be supplemented prior to a decision by the relevant authority. This may be necessary if applicants are required to comply with the obligations under the Bill which were not otherwise applicable under the MPRDA. An example of this are clauses in relation to the State’s carried interest.

More clarity should be provided in the next draft of the Bill in order for those with pending applications and lodgements to better understand what will be required of them.

Transfer restrictions

Clause 36 of the Bill repeats almost verbatim the wording of section 11 of the MPRDA. It stipulates that an exploration or production right or an interest in any such right in an unlisted company or a controlling interest8 in a listed company may not be transferred, ceded, encumbered, assigned or alienated without the prior written consent of the Minister.

The Minister’s decision to rely on the wording of section 11 of the MPRDA is unfortunate as the provision has previously been the source of some uncertainty.9 Among other things, it is unclear what the reference to an “interest in a right” encompasses.

This uncertainty could be addressed in a further draft of the Bill by addressing direct transfers of a right and changes in control (i.e., transactions at a corporate level) separately.

Criminal and administrative sanctions

The provisions related to criminal offence and penalties are included under Chapter 5 of the Bill.10 Different from the MPRDA, these provisions contain substantially more severe financial sanctions for breaches of the Bill. Among other things, persons convicted of committing offences under the Bill may be fined up to ten percent of their annual turnover.11 This is a significant departure from the provisions of the MPRDA which makes reference to predefined amounts.12

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Conclusion

The publication of the Bill is a positive step towards creating a bespoke legislative framework for the oil and gas sector. Hopefully the DME will make use of the comment period to further tailor the Bill to the specific characteristics and requirements of the oil and gas sector.

Herbert Smith Freehills LLP

 

1 B Felix (7 February 2019) “Total’s South Africa discovery could hold 1 billion barrels oil equivalent: CEO” Reuters available online at https://www.reuters.com/article/us-total-exploration-discovery/totals-south-africa-discovery-could-hold-1-billion-barrels-oil-equivalent-ceo-idUSKCN1PW0LF (accessed 29 January 2020)

2 See the Media Statement published by the DME accessible at https://www.dmr.gov.za/news-room/post/1832 (last accessed on 29 January 2020).

3 Defined under the Bill to mean “the Petroleum Oil and Gas Corporation of South Africa (SOC) Ltd” production operation”.

4 Clause 39 of the Bill.

5 Clause 38 of the Bill.

6 Ibid.

7 Clause 24 of the Bill.

8 Defined under the Bill to mean “in relation to—

a company, means the majority of the voting rights attaching to all classes of shares in the company;

any other business other than a company referred to in paragraph (a), means any interest which enables the holder thereof to exercise directly or indirectly any control whatsoever over the activities or assets of the business.”

9 Mogale Alloys (Pty) Ltd v Nuco Chrome Bophuthatswana (Pty) Ltd and Others 2011 (6) SA 96 (GSJ)

10 Clause 89 and 90 of the Bill.

11 Annual turn-over in this regard is limited to that generated in the Republic and arising from exports from the Republic during that convicted person’s preceding financial year.

12 We do however note that both the MPRDA and the Bill provide for the imposition of a fine of up to ZAR 500 000 for each day that a person persists in case of certain contraventions (section 99(1)(f) of the MPRDA and section 90(1)(f) of the Bill).

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For more information, please contact Peter Leon, Paul Morton, Amanda Hattingh and Ernst Muller or your usual Herbert Smith Freehills contact:

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

Paul Morton
Paul Morton
Of Counsel, Johannesburg
+27 10 500 2645
Amanda Hattingh
Amanda Hattingh
Associate, Johannesburg
+27 10 500 2634
Ernst Muller
Ernst Muller
Associate, Johannesburg
+27 10 500 2628