Considering the uncertainties surrounding energy supplies around the
world, there is a need for the region to establish its position by
developing strategies that will ensure adequate future supplies. TEA
GRAPHIC
By JOSEPH THOGO Special Correspondent
In Summary
- Forecasts indicate that East Africa will emerge as the world’s most exciting new gas exporting region in the next decade.
- Retrogressive and uninformed legislative changes, refusal to honour agreements and adopting policies that paint the region as unstable and unpredictable only delay such projects, and could make capital-intensive oil and gas related projects economically unviable for the region.
The spotlight is currently on Africa for all the
right reasons — its resources. In recent times, there have been
frequent and substantial new finds of oil and gas in particular.
These rich oil fields and prospects for further
discoveries have transformed the continent into an important player and a
key “target” in global oil production and resource extraction.
A joint study by the African Development Bank and
the African Union on oil and gas in Africa shows that over the past 20
years, oil reserves have grown by over 25 per cent, and gas reserves by
over 100 per cent. Oil production on the continent is expected to
continue to rise at an average rate of six per cent per year in the
foreseeable future.
More than 90 per cent of Africa’s oil production
comes from Libya, Nigeria, Algeria, Angola and Sudan. Proven natural gas
reserves are concentrated in four countries — Algeria, Egypt, Libya and
Nigeria — which represent 91.5 per cent of Africa’s reserves.
Large deposits of natural gas have been identified
in Mozambique and Tanzania; significant oil deposits have been found
onshore in Uganda and Kenya, and offshore in the western part of Ghana.
In East Africa, gas finds take the lead, and with
hopes high for more oil discoveries along the shores of the Indian
Ocean, the prospects for the region seem promising. Forecasts indicate
that will emerge as the world’s most exciting new gas exporting region
in the next decade.
Advances in technology have encouraged exploration
in previously unexplored acreage on different parts of the continent
culminating in the emergence of the so called “new kids on the block”
such as Uganda, Ghana, Kenya, Mozambique, Tanzania and South Sudan.
The discoveries made to date have been from
relatively few wells, so there could be a lot more oil and gas that is
yet to be discovered. It is envisaged that Mozambique could develop a
liquefied natural gas (LNG) sector on the same scale as Algeria, which
would involve capital investment of tens of billions of dollars.
Considering the current uncertainties about global
energy supply, the policies of consumer countries (especially with
respect to nuclear and other alternatives to oil and gas), and expected
future global economic growth and advances in development, there is a
need for the “new kids on the block” to establish their position by
putting in place an enabling framework and developing strategies for
future supply adequacy.
UGANDA: A case of throwing out the baby with the bath water
In East Africa, exploration activities have been
stimulated by the enabling environment created through the existing
legal framework on petroleum exploration, the taxation regimes and the
production sharing agreements (PSAs) signed between the international
oil companies (IOCs) and governments.
However, in recent times, there have been a number
of policy and legislative changes that have brought into question
governments’ commitment to the industry, and negatively impacted on
exploration activities resulting in some cases in cancellation of
drilling activities.
In Uganda, for example, IOCs have recently been
dealt two blows. The first is their de-registration from tax exemptions.
This meant that drilling a well in Uganda became 18 per cent more
expensive, and most IOCs had to reschedule their plans.
The second is a ruling by the Tax Appeals Tribunal
— in which the legitimacy of PSAs signed with the Ugandan government
was questioned — on farm-in transactions. In its ruling, the tribunal
concluded that a government ministry exceeded its powers by giving
exemptions in the PSA.
READ: How URA-Tullow tax row could affect oil, gas production in Africa
Where one IOC invites another to participate in its exploration
activities, it is said to have farmed-out, while the IOC acquiring the
interest is said to have farmed-in. An IOC can enter into a farm-out
agreement with another IOC if it wants to maintain its interest in a
block but needs to reduce its exposure to risk associated with the
exploration activities, or if it doesn’t have the resources to undertake
exploration activities. Typically, the IOC farming out would be
reimbursed its past costs by the IOC that is farming in.
The additional 18 per cent on the cost of drilling
in Uganda, the relatively low ratio of drilled wells to viable
discoveries and the dark cloud of uncertainty hanging over PSAs explain
the reduced activity in the oil sector in Uganda . In short, Uganda is
headed in the wrong direction.
KENYA finally getting its ducks in a row
With potential discoveries of commercial oil reserves onshore and offshore, Kenya appeared to be headed in the wrong direction.
However, after listening to the IOCs,
understanding the unique aspects of the industry and perhaps realising
the negative consequences that policy and legislative changes would
have, the country now appears to have found its bearings.
Kenya had introduced a 10 per cent tax on farm-out
transactions. This meant that in addition to reimbursing the
person/company farming out a proportionate amount of his past costs
based on the interest acquired, the person/company acquiring the
interest was required to factor in the additional cost.
Exploration activities are risky and expensive,
which is one of the reasons governments invite IOCs to undertake them.
IOCs in turn enter into farm-out agreements to mitigate risks and
acquire funds necessary for exploration activities.
In farm-out agreements, the IOC invites the person
farming-in to participate in the impending risk by assigning him an
interest in the block in return for the conduct of, or payment for
drilling or testing operations on that acreage. Imposing the 10 per
cent tax made farm-out agreements more expensive, and Kenya
unattractive.
Kenya has proposed to overhaul its legislation
relating to the taxation of upstream, midstream and downstream
operations. The proposed changes, which are supposed to take effect from
January 1, 2015, seek to harmonise the provisions in Kenya’s Income Tax
Act with those in the PSAs that the government has signed with IOCs.
Once the proposals are enacted, tax will be
imposed on any gain that is realised from farm-out transactions. In
addition, where there is a direct or indirect disposal of shares in an
IOC having an interest in Kenya, the net gain in such transactions will
be subject to tax in a manner similar to a farm-out transaction. The
proposed law also clarifies how future work obligations will be treated
for tax purposes.
Not surprising, the additional 10 per cent cost
has contributed to a decline in drilling activities in Kenya, and since
2010, there have been no farm-out transactions. However, it is
anticipated that the revamped Ninth Schedule under the Income Tax Act
will help spur activity in Kenya’s oil and gas sector.
It is also commendable that though Kenya enacted a
new VAT Act, favourable provisions that had been enacted to encourage
growth in the sector were retained.
TANZANIA, a case of shooting itself in the foot
IOCs operating in Tanzania have had their fair
share of hiccups ranging from enforceability of their PSA provisions to
interpretation of the law.
One such example is the confusion created by the Tanzania
Revenue Authority on the application of withholding tax on payments
relating to persons living outside Tanzania for services that they
performed while in the country.
This provision is aimed at bringing Tanzanian
non-residents — who provide services (and consequently earn income from
Tanzania) and then leave without paying taxes — into the tax net.
Unfortunately, Tanzanian tax authorities have
interpreted withholding tax on service fees from a payment perspective
as opposed to source perspective as required by the wording used in the
legislation.
TRA contends that service payments have a source
in Tanzania (and are, therefore, subject to the 15 per cent withholding
tax). They have disregarded the source rules, which require the services
to be rendered in Tanzania by a non-resident for withholding tax to
apply.
This erroneous interpretation by the TRA, which
the tax adjudication bodies have acquiesced, has generated confusion as
far as services are concerned, and left the IOCs between a rock and a
hard place with regard to paying their sub-contractors for services
rendered. The IOCs services contracts with their non-resident service
providers are now 15 per cent more expensive.
IOCs have also expressed their concerns about the
proposed VAT Act 2014, which is to be tabled before Parliament later
this year. The Act proposes to repeal the current VAT legislation and
introduce a new law that seeks to restrict tax exemptions.
While goods and services procured by IOCs in
relation to exploration activities currently enjoy VAT exemptions, one
of the changes proposed in the VAT Act 2014 is restricting the exemption
to only goods imported for exploration activities. The oil and gas
sector will certainly be affected negatively by this and other changes
in the proposed VAT Act 2014.
In addition, the removal of VAT relief on capital
items with the IOCs planning an onshore LNG processing facility has
meant that IOCs are currently re-evaluating the economic dynamics of
their future investment decisions.
While ideally the VAT should not be a business
cost, the uncertainty in the turn around time between lodging VAT refund
claims and receiving the money from the government means that the IOCs
have to factor in unnecessary cash-flow costs in their financial
modelling for exploration activities and the LNG processing facility.
The misunderstanding about farm-out transactions
and whether they constitute a sale of shares or assets has manifested
itself in Tanzania with the TRA adopting the position that a farm-out
transaction constitutes a disposal of an investment (shares) and have
gone ahead to demand 30 per cent tax on a couple of farm-out
transactions.
The motivating factors for a farm-out agreement
include drilling so as to fulfil PSA continuous development clauses,
sharing risk, sharing of geological information etc.
Seeking to tax farm-out transaction discourages
IOCs from farming-in, which means that exploration campaigns are
rescheduled or cancelled altogether. Tanzania should borrow a leaf from
Kenya regarding the treatment of farm-out transactions.
The Tanzanian oil and gas industry has been
relatively calm and stable, and the fruits of this can be seen from the
planned joint LNG facility, which is currently in the planning stage.
However, the waters seem to be getting rough as
evidenced from the policy and legislative changes and also from the
feedback from the fourth licensing round.
The fourth licensing round was based on the 2013
Model PSA, and there were seven deep-sea offshore blocks and one in Lake
Tanganyika on offer. While the results of the licensing round are yet
to be released, the feedback is that the 2013 Model PSA is unfavourable,
which would explain why there were no bids submitted for four offshore
blocks, and the blocks where bids were submitted only received
conditional offers.
Even though there has been a lot of buzz about offshore gas
discoveries, Tanzania cannot afford to be overly bullish about them.
Unfavourable PSA terms will deter prospective interest from IOCs,
particularly with regard to offshore exploration, which is more
expensive and risky.
Lesson from Papua New Guinea
East African countries could borrow from Papua New
Guinea the kind of policies to create an enabling environment that have
helped the country export its first LNG cargo ahead of schedule.
To be fair, discoveries in Papua New Guinea were
made almost 30 years ago and the process of putting up an LNG facility
has been plagued by challenges, most of which were outside the country’s
control. However, once everything was in place, it took seven years
between initiation of an LNG feasibility report (in 2007) and the first
shipment of LNG (this year).
It is disappointing and perhaps difficult to
comprehend that the oil discoveries in Ghana and in Uganda were made at
around the same time. Ghana is now an exporter of oil while the dynamics
in Uganda have taken a turn for the worse, and it is still uncertain
whether international oil companies will want to bring their projects to
fruition.
No business person seeks out the most expensive,
unpredictable and unstable place to set up shop. Retrogressive and
uninformed legislative changes, refusal to honour agreements and
adopting policies that paint the region as unstable and unpredictable
only delay such projects, and could make capital-intensive oil and gas
related projects economically unviable for the region.
Joseph Thogo is a senior tax manager with
Deloitte East Africa based in Tanzania. The views expressed here do not
necessarily represent those of Deloitte.
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