By KENNEDY SENELWA
In Summary
How PSA will work
- If the draft model production sharing agreement (PSA) is adopted in its current form exploration firms will be required to give bank guarantees on minimum work to be done, expenditure, community projects, employment and training of local sector personnel.
- They would also pay annual surface fees to the government as rent for operations in the block per exploration period.
- The national government is expected to keep 80 per cent of the state’s share of hydrocarbons revenue, country governments 15 per cent and local communities five per cent.
- The draft Sovereign Wealth Fund Bill of 2014 proposes revenues from oil and gas due to the national government be put in a national sovereign wealth fund to diversify medium- to long-term local and foreign investment.
- Civil society has proposed the money be allocated to projects, direct cash transfers to households in the host community and savings for future generations.
Kenya is reviewing how revenues from oil and
natural gas sales will be shared in a bid to maximise the benefits to
the government, communities and counties while safeguarding the
interests of investors.
A production contract now under discussion by
government officials proposes a model of sharing that is not based on
volumes of oil brought to the surface but is calculated on
profitability, known as “R-factor” in industry-speak.
“With a progressive R-factor, if a discovery is
not made, the investor’s loss is limited to costs incurred during
exploration phase,” said Hunton & William’s lead consultant John
Beardworth.
Hunton & Williams of the US and Challenge
Energy Ltd of Britain were contracted by the Kenyan government and the
World Bank to advise on how the revenues should be shared.
The R-factor is the ratio of revenue earned from
oil divided by the costs of bringing the oil to the market. The smaller
the ratio, the less the profit realised, with a ratio of less than one
indicating a loss-making operation.
In the proposed formula, the government would earn
more from production as the profitability rises, starting with sharing
of the losses equally with the operator when the R is less than one.
The government’s share will increase to 65 per
cent of the profit where R is between one and 2.5 and 75 per cent when
it is 2.5 per cent or above. The three bands were proposed by the
International Monetary Fund (IMF) in the draft Extractive Industries
Fiscal Regimes report.
However, a consultant report seen by The EastAfrican
recommends that the middle band be split into three so that, for R of
between one and 1.5, the government’s share would be 55 per cent, 60 per
cent for between 1.5 and 2.0 and 65 per cent for2.0-2.5.
“This would maintain the higher flexibility
afforded by a five-band R-factor framework while providing returns for
contractors that are still competitive with Mozambique,” the report
said.
As an alternative, the consultant recommended a
sliding rate such as that used in Cyprus and Kurdistan, where the tax
rate is calculated for a given R factor.
“This provides much more granularity when fewer bands are used,” the report said.
Energy Principal Secretary Joseph Njoroge said the
model production sharing agreement (PSA) would be used to negotiate
agreements with contractors — including those involved in natural gas
exploration, who were not covered in previous documents.
Currently, the profit will be shared based on
daily output in four bands — the first 20,000 barrels, the next 30,000
barrels; the next 50,000 barrels and above 100,000 barrels. The accruing
percentages were kept strictly under wraps in line with confidentiality
clauses that make the extraction industry one of the most opaque in the
world.
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Legislators in Uganda have tried to push the
government to make full disclosure of provisions of PSA signed with
exploration companies operating in the country but the efforts have
borne little fruit.
Hunton & Williams and Challenge Energy said
existing contracts can be published to a level agreed on by the
government and each individual firm without giving access to
confidential documentation.
“Future PSAs are subject to parliamentary approval, and thus will likely need to be made public,” said the firms.
Kenya’s new Constitution requires all new oil and
gas rights negotiated by the government to be ratified by parliament.
The tax consultancy firm KPMG said the government would ensure a firm
owning various PSAs does not combine costs of one block area with
revenues of other acreages to depress the share of revenue due to the
state.
“This will be ring-fenced by only using costs with
revenues from same block to compute the state’s earning so the
government’s share rises as the profitability of a project increases,”
said KPMG tax services manager Robert Waruiru.
The model PSA, when complete, is expected to
enable investors to quickly make decisions about exploring blocks with
potential for natural gas.
Sources in the Ministry of Energy cited BG Group
as among firms that could not proceed with drilling of wells in
gas-prone offshore exploration blocks due to absence of fiscal and
contractual terms for natural gas.
Substantive investments
“Changes contained in the new draft model PSA will
to lead to substantive investments being made in gas-prone blocks in
Kenya’s Lamu basin as a result of greater certainty of gas terms and
markets,” said the officials.
Lamu basin, which spans Kenya’s coastline both
onshore and offshore, shares geological features with the coastal areas
of Tanzania and Mozambique, where vast quantities of natural gas have
been discovered.
The R-factor will ensure the government’s revenue
reflects the licensed firm’s production costs and total revenues. It
also balances taxation with project profitability, protecting investors
from margin dips caused by additional taxation. The R-factor also
ensures that Kenya remains competitive and attracts investment.
Qatar, Malaysia, India, Kurdistan, Algeria,
Tunisia, Mozambique, Nigeria, Libya, Madagascar, Cameroon, Colombia,
Suriname, Afghanistan, Azerbaijan and Turkmenistan are among countries
that use the R-factor to compute what accrues to the state. Hunton &
Williams said any changes to existing PSA can only be made by consensus
between the government and the contractor.
Last year, Tanzania issued a new model PSA
entailing payment of higher fees by companies following the discovery of
massive quantities of natural gas in offshore blocks. The Tanzania
model outlines capital gains tax obligations and requires firms to make a
one-off payment (signature bonus) of $2.5 million on signing of the
agreement and at least $5 million when production starts.
In addition, firms are to pay the government a
royalty of 12.5 per cent of total oil and gas production for onshore or
shallow water operations and 7.5 per cent for deep water offshore. The
previous deep water gas rate was five per cent.
The Kenyan draft PSA sets the terms for
negotiation with the government on the exploration period, field
evaluation once a discovery is made and duration of development and
production.
Revise spending upwards
In February last year, the Ministry of Energy
completed a term sheet proposing that Kenya revises upwards the minimum
amount of money firms have to spend on exploration for onshore and
offshore blocks. The signature bonus was to rise to $1 million from
$300,000 to keep off speculators.
Were the term sheet to be incorporated in the
PSAs, firms applying for new blocks will be required to spend $28.2
million in the initial two-year period for onshore blocks and $31.2
million in three years on offshore blocks.
Firms can get a renewal of two years only two
times after the initial phase, bringing to six years and seven years the
period a contractor can hold on to an onshore or offshore block,
respectively.
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