PowerPoint Presentation - UNCTAD XI

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   Investing with certainty: stability
    under South Africa’s new oil and
        gas regulatory regime
                Address by Peter Leon
    Partner, Webber Wentzel Bowens, Johannesburg,
      UNCTAD´s Africa Oil, Gas, Trade and Finance

                   Nairobi, Kenya

                     23 May 2007
International Best Practice for Oil and Gas
Exploration and Production
• This year, the South African oil and gas regulator, the Petroleum
  Agency, SA (“PASA”) actively sought investment in its 2007 licensing
  round for a number of blocks offshore the South African coast. This
  licensing round closes in September 2007

• Resource-rich countries must make themselves attractive to private

• For those countries which are geologically less prospective (such as
  South Africa), this is all the more so

• A successful oil and gas regulatory regime requires certainty and
  predictability in a high cost, high risk and capital intensive industry

• The success of PASA’s licensing round will rely in part on the extent to
  which the South African regulatory regime affords investors certainty,
  security of tenure and stability
Previous regulatory framework for oil and gas in
South Africa: the Mining Rights Act, 1967 and the
Minerals Act, 1991 (1)
•   The OP26 prospecting lease and OP26 prospecting sub-leases and mining
    leases (going back to 1967):
      PetroSA leased rights to explore and produce oil and gas to exploration and
       production companies (“lessees”)
      Terms and conditions were guaranteed for the duration of the prospecting sub-
       leases and the mining leases

•   Legislative stability
        The lessee was protected as it was subject to the laws of South Africa and such
         further laws passed, provided such further laws would not adversely affect the
         rights of the lessee

•   Guarantees in favour of the lessee by the Minister of Minerals and Energy:
        the contractual obligations of the lessee would not be altered without the
         lessee’s consent
        the form of the mining lease was attached to the prospecting sub-lease. A
         lessee thus knew what rights it would have in the event of a discovery
Previous regulatory framework (2)

• Fiscal stability – Tax, customs and exchange control
    Income tax payable frozen as at the 1977 amendments to the
      Income Tax Act
    Customs duties waived
    Exemption from exchange control
• Fiscal stability – Royalties
    Royalties calculated as a share of profits on an ad valorem formula
    Formula to calculate royalties remained the same for the duration
      of sublease
• Limited socio-economic obligations placed on lessees
    A multinational could employ non-South African citizens if required
      skills and qualifications not available in the local labour market
    Limited Black Economic Empowerment (“BEE”) equity divestiture
      requirements (9 percent under the Liquid Fuels Charter)
Current regulation: Mineral and Petroleum
Resources Development Act, 2002 (“the MPRDA”)

• State is now the “custodian” of all mineral and petroleum
  resources in South Africa, including oil and gas

• Oil and gas exploration and production administered by PASA,
  overseen by the Department of Minerals and Energy (“DME”)

• MPRDA attempts to secure tenure of rights holders through its
  transitional arrangements

• “old order” to “new order”: the “old order” OP26 sub-leases
  and mining leases must be converted into exploration rights
  and production rights by 30 June 2007

• The terms of the new order rights are still being negotiated,
  despite the fact that there is less than six weeks to go!
Current regulation: the MPRDA (cont)

Socio-economic objectives:
      ● The MPRDA seeks to promote “equitable access” to oil and gas
        resources, and expand opportunities for historically
        disadvantaged persons, to enter and benefit from the industry
      ● The 2000 Charter for the South African Petroleum and Liquid
        Fuels Industry (“the Liquid Fuels Charter”) is applicable to
        exploration and production of oil and gas
      ● The requirements of the Liquid Fuels Charter may seem
        somewhat benign in relation to the far more onerous Mining
             9% BEE equity divestiture
             Vague employment equity and BEE procurement requirements

      ● This is appropriate in a high risk, capital intensive industry in a
        geologically uncertain area
      ● Social objects of the MPRDA are linked to the grant and
        conversion of rights under the MPRDA
Issues arising from the MPRDA’s regulatory
framework and the draft Exploration Rights (“ER”)
and Production Rights (“PR”)
• Legislative stability

• Fiscal stability
      ● Royalties
      ● Tax

• Transitional Arrangements

• Onerous empowerment requirements
ER/PR: Legislative Stability

• Holder will be subject to the “applicable laws” of
  South Africa, as amended from time to time. This
  will include all new legislation and legislation to be
  passed in the future which may adversely affect
  the holder’s rights
• Holder is subject to all laws
• The ER/PR may now be affected by any legislative
  amendments which are enacted after the
  conclusion of the ER/PR, thus potentially affecting
  the rights granted to the holder
ER/PR: Fiscal stability - royalties

• Draft Mineral and Petroleum Royalty Bill, 2006 (“the
  Draft Bill”):
   if enacted in current form, a royalty rate of 1.5%
    (deeper than 500 metres) and 3% (shallower than
    500 metres) will be imposed on oil and gas production
   The issue is not so much that of the royalty rate
    payable under the draft Bill, but rather whether the
    rate will remain at the rate it is at in the draft Bill
   the industry has endeavored to include a “walk-away”
    provision in the ER, under which the holder may
    terminate the ER without liability or suspend the ER
    until the royalty legislation is enacted
ER/PR: Fiscal stability - taxation

• Holder will be liable for income tax in accordance with the “applicable
  laws”, as defined

• The Tenth Schedule to the Income Tax Act, 1962 came into force on 7
  February 2007. It empowers the Minister of Finance, after consulting
  the Minister of Minerals and Energy, to guarantee that the provisions
  of the Tenth Schedule will continue to apply for the duration of the
      tax rate applicable (29 percent for residents and 32 percent
       for non-residents) over the duration of right
      Secondary tax on companies (“STC”) limited to 5 percent
       and no STC payable if dividends arise from an OP26 right
      foreign entities can decide on the currency used in
       calculating tax payable
      A “windfall tax” has been mooted, but not finalised
ER/PR: Onerous empowerment

• PR: Holder must comply with 26% BEE equity divestiture
  requirements of the Mining Charter by 2014, or a new Liquid
  Fuels Charter to be adopted in terms of the MPDRA

• Narrower scope to employ non-South African citizens

• Holder must implement a programme for the recruitment,
  training and employment of historically disadvantaged South

• Holder is required to effect payments to the Upstream Training
Conclusion (1)

• Need to create investment certainty and an
  attractive investment environment
   A lack of clarity and regulatory certainty may deter
   South Africa is not the Gulf of Guinea. It has to
    compete with resource-rich oil and gas jurisdictions.
    This will only be successful if investors are given
    adequate incentives
   Look to other jurisdictions:
      ● Kenya’s regulation of oil exploration. Strong security of
        tenure and active investment schemes aimed at
        promoting foreign investment and terms of the licences
        are negotiable.
Conclusion (2)

• Need to create security of tenure for holders of
  existing old order rights
      ● The ER/PR could provide for financial guarantees by the
        South African government in the holders’ favour in the
        event of legislative or fiscal changes which are
        detrimental to the holder
      ● In a capital intensive, high risk industry, the ER/PRs
        should provide for more reasonable empowerment
        requirements to stimulate investment
      ● Kenya has shown how to incentivise investment in a
        geologically uncertain area
Conclusion (3)

• The National Treasury is alive to the need for
  certainty and stability in the oil and gas industry in
  South Africa, as is evident from the fiscal stability
  provisions contained in the Tenth Schedule to the
  Income Tax Act

• PASA and the DME need to reflect a similar
  intention in finalising the draft ER and PR in the next
  six weeks

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