BALANCING CONTENDING INTERESTS IN THE 2020 PETROLEUM INDUSTRY BILL
The 2020 Petroleum Industry Bill (PIB) offers Nigeria perhaps the last opportunity to restructure and reform the petroleum industry in order to get as much benefits as possible from oil and gas. It should also be a platform for the country to prepare for a future without oil. The current industry forecast is that oil and gas may not be as relevant beyond the next thirty years. In the long term life of the nation, that is like three minutes.
The truth of the matter is that Nigeria has not maximized the potentials of the industry in terms of revenue generation and multiplier effects in the last six decades or so of crude oil exploration and production in the country. The fact that a little shock in the prices of crude oil sends Nigeria into economic coma underscores this fact. Depending on who you ask, the reason for this ranges from corruption, lack of political will, badly run Nigeria National Petroleum Company (NNPC) and the influence of multi-national oil companies to lack of requisite infrastructure to unleash the potentials of the industry. Also, there are the issues of vandalism, crude oil theft, minimal local content, unrealistic pricing and regulatory uncertainty.
The journey towards the passage of the PIB started around 2000, about 20 years ago. The bill was first put before the National Assembly in 2008. Thirteen years after and after series of changes and restructuring, it remains a bill. This has created uncertainty in the industry with serious consequences for investment. It has been reported that of the $70 billion invested in the industry in Africa in the last few years, Nigeria got only $3 billion. That is a meager 4% despite the fact that Nigeria is the highest producer of the commodity in Africa.
Given this background, the drive by the National Assembly to hasten the passage of PIB must be saluted. However, in doing so, informed decision must be made on balancing interests in the sector.
Major contending issues
The PIB seeks to restructure the way the oil and gas industry is taxed. The bill introduces Hydrocarbon Tax at the rate of between 42.5 percent-5 percent depending on the area of operation and also provides that the upstream, midstream and downstream industries will be subject to Companies Income Tax at the rate of 30%. The existing fiscal framework taxes the upstream industry under the Petroleum Profit Tax Act and the downstream industry pay taxes under the Companies Income Tax. This is in addition to 10% withholding tax on dividends paid to shareholders from their profits from petroleum operations and 2% Education Tax.
We need to seriously consider this dual approach to taxation of the upstream industry. Though the introduction of double taxation mechanism may increase government take, it has the potential of introducing complexities in oil and gas taxation. There are also fears that it may not provide the needed incentive for offshore oil and gas development.
Nigeria first enacted the Deep Offshore and Inland Basin Production Sharing Contract, Act (PSC Act) in 1999 to incentivise deep offshore crude oil production and development. The Act was designed to give security to International Oil Companies (IOCs) with the requisite funding, expertise and technical know-how to invest in offshore crude oil production at the time. The incentives under the Act included Petroleum Profit Tax of 50% as against 85% (65.75% for the first five years) for joint venture contracts; Investment Tax Allowance (ITA) of 50% on qualifying capital expenditure; reduced royalty rates of between 12% and 0 % depending on the water depth; and the use of realizable price in the determination of royalty. There was however a provision that the incentives would be reviewed when crude oil price exceeds $20. The review was not done despite the fact that oil consistently sold beyond $20 since at least 2000.
In 2019, following the Supreme Court’s decision in the case of Attorney-General of Akwa Ibom State & ors v. FGN, Suit No.SC.964/2016, the PSC Act was amended to review the incentives. For example, a fixed royalty rate of 10% was imposed on deepwater irrespective of the water depth and 7.5% for inland basin. This means that 1000 water depth and above that was hitherto 0% royalty will now be 10%. Investment Tax Credit and Investment Tax allowances were discontinued but replaced with production allowance.
The PIB repealed the 2019 PSC Act but retained most of the provisions of the Act. The general consensus of industry players was that the royalty regime introduced in 2019 and now being sustained in the PIB will discourage investment. While the review of royalty for deepwater is understandable, it must be balanced with the need to increase investment in deepwater development and production.
Domestic gas obligation
A major thrust of the PIB is the development of the domestic gas market. The bill mandates Industry players to supply gas to the domestic market under the threat of fines or loss of licence. While the supply of gas to the domestic market is very important to Nigeria particularly for power generation and the maximization of the gas value chain, the PIB must address the concerns of the oil and gas companies. The major concerns are lack of infrastructure and low gas pricing. Nigeria has not paid much attention to gas development in the past, hence, the near absence of infrastructural framework to support the market. There is also no free market because prices are regulated. These issues would have to be addressed for the domestic gas obligation provision of the PIB to achieve the intended outcome.
The government has always expressed the desire to put an end to gas flaring. This desire was first expressed in the Associated Gas Re-Injection Act of1979. Since then, many regulations have been made to reduce or stop gas flaring but none has succeeded because of the realities of crude production. Nigeria has never seriously invested in the infrastructure that would support the policy, hence, waivers were always granted. Recently, government introduced the Gas Flare Commercialization Programme under the Flare Gas (Prevention of Waste and Pollution) Regulation, 2018.The programme is a scheme where flare gas will be auctioned to interested third parties who would build connection assets to access and take the gas from operators. Many investors have indicated interest in commercializing gas flare. However, lack of sufficient incentive, delay in naming government representative in the relevant contracts, bankability issues and acceptable dispute resolution/arbitration provisions in the relevant agreements seems to delaying the move.
The PIB retains the commercialization approach but still provides a window for waivers and penalties for default. Like in the past, host communities justifiably believe that the waiver provisions will become the norm rather than the exception. Perhaps, the way to assuage the concerns of host communities is to say that penalty fees should be payable to the host communities trust provided for in the bill. On the part of the investors, concerns arising from the negotiation of the relevant contracts for commercialization have not been addressed in the PIB.
Host communities development
Since the discovery of oil in commercial quantities in Oloibiri in 1958, host communities have suffered from gas flaring and other pollution which has destroyed the livelihood of members of the communities. No sustainable mechanism has ever been designed to address the problems facing the host communities. The PIB provides that oil and gas companies must establish and incorporate a trust for the development of the communities with 2.5% of their operating cost.
The Host Communities Development provision of the PIB seems to have watered down the provisions in the previous versions of the bill. There is also the concern that the host communities have not been given a voice in the constitution of the board of the trust. Indeed, the PIB specifically provides that membership of the board need not come from the host communities. Another worrisome provision of the PIB is that the communities may lose the development funds if a third party damages oil facilities in the area. This provision purports to make the host community vicariously liable for the actions of third parties over whom they have no control. This vicarious liability provision is rather strange and should be expunged from the bill. The bill also failed to state the basis for determination of operating cost.
An acceptable framework for host community development is expedient because not only does it have a real potential of reducing the cost of production of crude oil in the communities, it is also fair and just. It therefore should be seriously considered by all interested parties.
The PIB separates, though cosmetically, policy from regulation. The Minster of Petroleum Resources is vested with the power to make policies for the industry. Two agencies were created to regulate the industry- the Nigeria Upstream Regulatory Commission (NURC) and the Nigeria Midstream and Downstream Regulatory Commission (NMDRA). NURC regulates all upstream activities while the NMDRA regulates the midstream and downstream sector.
Contrary to expectation, the role of the Minister of Petroleum goes beyond policy formulation as it retains its overriding power over the industry. From the way the power structure is set up, the NURC and NMDRA would still be directly controlled by the minister. This does not create independence envisaged in the creation of the agencies. Furthermore, there is no reason why one regulator is not sufficient for the industry.
One welcomed provision in the PIB is the incorporation of NNPC limited within six months of the coming into effect of the law. The current NNPC is to be wound up with its assets transferred to NNPC Limited. This is an important step in building a commercially viable national oil company. However, upon incorporation the entire shares will be owed by government and there is no mechanism for the sale of some of the shares to private investors. This suggests that what we may have is a mere change of name. So long as government continues to own the entire shares of the company and determine the members of the board of the company, the problem of lack of transparency with the NNPC will remain. We need to input a timeline for the sale of a percentage of the shares to private investors who should be able to nominate some of the board members. This may not be immediate but there should be transitional provisions in this regard. We need to urgently pull down the amorphous nature of NNPC to allow for a properly managed oil company like other countries have done with the National Oil companies.
Cost of crude oil production
One major problem with crude oil production in Nigeria is the high cost of production. It is said that Nigeria’s production cost exceeds other countries by more than 40%. This is unacceptable. Though there is a mechanism for transparency in cost determination, oil and gas companies determine the cost and there are fears in some quarters that Nigeria does not have the capacity to verify these costs. The PIB therefore seeks to tackle the problem partly by restricting deductibility of certain expenses for tax purposes and limiting cost recovery by capping cost oil in production sharing contracts at 60%.
The attempt to check the high rate of production cost is necessary; however, the cost of producing anything in Nigeria is high mainly due to deficit in infrastructure, insecurity and corruption. While we need to include appropriate measures for transparency in cost determination in the PIB, Nigeria needs more than a law to reduce cost of production.
In order to design a fitting legislation, we must understand the dynamics and future of the Oil and Gas Industry. A lot has happened in the Oil and Gas industry since the PIB was first contemplated 20 years ago. Many countries, including in Africa, have discovered oil in large quantities. In the international market, the United States, fuelled by technological advancement in fracturing, had embarked on aggressive natural gas development with no further requirement for Nigeria’s crude oil. There is also a global shift towards electric cars and more environmentally friendly energy generation methods. Importantly, the failure of Nigeria to ensure legal certainty in the Oil and Gas Industry during the period drove oil majors to other more competitive environments and occasioned divestments in the last few years. A sentimental and ill-informed legislation may further slowdown investment.
Secondly, Nigeria has existing obligations, under various joint ventures and production sharing contracts. Thus there will be the need to preserve existing fiscal terms and to renegotiate to ensure contracting parties do not lose the substantial premise and benefits of the transactions in the event of PIB passage. The obligation is contained in stabilization clauses which typically provide that:
“If at any time or from time to time there should be a change in legislation or regulations which materially affects the commercial benefits afforded the contractor under this contract, the parties will consult each other and shall agree to such amendments to this contract as are necessary to restore as near as practicable such commercial benefits which existed under the contract as of the effective date”
The practical effect of the above is that Nigeria guaranteed the Contractors that their benefits under the contracts will not materially change even when the law changes. This means that the passage of PIB would call for a review of the contracts but without eroding the benefits accruable to the Contractors as at the time of the contract. This is a bitter pill for Nigeria who is entitled to a review to increase revenue generation. While there is a respite for Nigeria since most of the contracts are either due or will soon be due for renewal, Nigeria must consider the overall implication of PIB to existing contracts. Many provisions of the bill already contemplate this need for renegotiation.
The renewed push for the passage of the PIB by the National Assembly is a welcomed development but the exercise calls for circumspection, knowledge, information and skill in balancing the contending issues and interests in the overall interest of Nigeria. No doubt, Nigeria deserves a fairer share in oil and gas revenues but in doing so, we must ensure we formulate a legal framework that appreciate the dynamics of the industry and that can spur further development in the sector. Most importantly, we must use the PIB as a transitional platform for preparing for a future without ‘much’ oil.
Nigeria is a sovereign state with power to make whatever law she pleases but a bill such as the PIB is a negotiation that must consider the interest of all parties. The truth is that Nigeria is probably in a weaker bargaining position today than she was 20 years ago. While the country cannot afford to compromise on reforming the industry and on issues such as host communities development, domestic gas obligation and gas flaring, the law must usher in a competitive and investors’ friendly environment in order to attract investments that are currently flowing elsewhere. Nigeria must also take decisive steps towards bridging the infrastructural gap generally and in particular, in the oil and gas sector and redouble efforts at ensuring justice for host communities.
Elvis E. Asia is the Managing Partner of Law Future Partners, a full service law firm in Nigeria and author of the book ‘Oil and Gas Insurance and Nigeria’s Local Content Policy’. He may be contacted at email@example.com