Retrospective Review of Production Sharing Contract Terms in Nigeria

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Retrospective Review of Production Sharing Contract Terms in Nigeria

By Efe Etomi and Elvis E. Asia*

 

Introduction

 

The fiscal terms of Production Sharing Contracts (PSCs)[1] in Nigeria have been very stable and acceptable to both parties until the recent decision of the Nigerian Supreme Court (NSC), which has greatly upended the fiscal balance in the industry. This article looks at the implications of the NSC decision on the existing framework for PSCs in Nigeria and concludes that there are practical and legal challenges to the enforcement of the decision of the court.

 

Incentives for PSCs in Nigeria

 

To encourage offshore exploration and production, Nigeria enacted the Deep Offshore and Inland Basin Production Sharing Contract Act (PSC Act) in 1999[2]. The PSC Act provides various incentives for International Oil Companies (IOCs), as well as other companies operating in the deep offshore and inland basin under PSCs. These incentives includes Petroleum Profit Tax of 50% as against 85% (65.75% for the first five years) for joint venture contracts[3]; Investment Tax Allowance (ITA) of 50%[4] on qualifying capital expenditure[5]; reduced royalty rates of between 12% and 0 % depending on the water depth[6]; and the use of realizable price in the determination of royalty[7].

 

More significantly, section 15 of the PSC Act provides for the adaptation and invalidation of other legislative enactments to the extent of their inconsistency[8] with the PSC Act. This in effect removed the flexibility associated with PSCs and confirmed the Act as a stabilization enactment[9].  The Act supersedes all other legislative enactments including the Petroleum Act and the Petroleum Profit Tax Act.

 

The Act provides for cost oil[10], royalty oil[11], tax oil[12] and profit oil at the rate of 60% and 40% for the Federal Government and contractors respectively[13]. Cost oil is allocated to the contractor to cover all operating costs associated with exploration and production[14], royalty and tax oil to the Nigerian National Petroleum Corporation (NNPC)[15] and profit oil to the parties in agreed percentage[16].

 

Review Provision in the PSC Act

The  PSC Act contemplated the need for review to increase government take. Section 16 of the Act provides that:

“(1)      The provisions of this Act shall be subject to review to ensure that if the price of crude oil at any time exceeds $20 per barrel, real terms, the share of the government of the Federation in the additional revenue shall be adjusted under the production sharing contracts to such extent that the production sharing contracts shall be economically beneficial to the government of the Federation.

 

(2)       Notwithstanding the provisions of subsection (1) of this section, the provisions of this Act shall be liable to review after a period of fifteen years from the date of commencement and every five years thereafter.”

 

As can be seen from the above provision, the contractual terms envisaged for PSCs were not cast in stone but were subject to review in the event that crude oil prices exceeds $20 per barrel and in any case, 15 years from commencement of the Act, and thereafter every five years. However, since the enactment of the PSC Act in 1999, a period of about 18 years, no review has been made to the fiscal terms of PSCs to increase government share.

 

From all available statistics, it is apparent that the only time the price of  per barrel of crude oil sold for $20 and below was in 1999. Average crude oil prices have consistently exceeded $20 per barrel since the year 2000.[17]   In light of the crude oil price and by virtue of the enabling law, the fiscal terms and incentives guaranteed for PSCs ought to have been reviewed since 2000, a year after the amendment of the Act.


Recent Decision of the Supreme Court

 

The Federal Government of Nigeria has, for whatever reason, never seriously considered the need for a review of the PSC terms despite huge revenue loss[18]. There were, however, discussions around amending the fiscal terms between 2017 and early 2018 but no concrete framework for review was put in place.

This was the state of things until the Supreme Court was invited to wade into the matter in Suit No. SC.964/2016.

 

The plaintiffs in the suit, the Attorneys-General of Akwa Ibom State, Bayelsa State, and the Rivers State[19], approached the court in 2016 for an interpretation of Section 16(1) of the PSC Act. They asked the court to determine whether there is a statutory obligation imposed on the Federal Government pursuant to the section to adjust the share of the Federal Government in the additional revenue accruing under the various PSCs at any time the price of crude oil exceeds $20 per barrel.  They consequently prayed the court to decide that they were underpaid and short-changed in estimated earnings of $1,149,750,000,000 under the PSCs for the period between 2003 and 2015 because of the failure of the Federal Government to adjust the sharing formula. They further argued that in view of the fact that crude oil consistently sold beyond $20 per barrel during the period 2003- 2015, the 60% to 40% sharing formula between the Federal Government and oil companies (contractors) no longer applied and that the Federal Government had a duty to recover the lost revenues.

 

In a landmark decision on 17 October 2018, The Supreme Court ordered the Federal Government adjust its share of proceeds from the sale of crude oil whenever the price exceeds $20 per barrel and adopted the terms of settlement entered by the parties. The agreement provides that the government shall immediately set up a body and mechanism for recovery of lost revenue and calculate the backlog of unpaid contractual obligations to the federal government and the benefitting states.

 

Review of the Decision of the Supreme Court

 

This decision has settled one of the challenges with the review provision of the PSC Act. Prior to this decision, it was unclear whether the review contemplated was to be made by amendments to the PSC Act, by enacting regulations or by an order of Court. This created ambiguity and a lacuna in the PSC Act.[20] By this decision, the review is to be carried out by an executive action and negotiation between the parties, and not through legislation.

 

However, the decision merely mandates government to set up a mechanism for the review and recovery; it is not clear from the judgment what the mechanism will be. In practical terms, this will mean that the government will negotiate with all stakeholders and come up with workable commercial terms going forward.

 

The problematic part of this decision is the requirement that government carry out a retrospective review of PSCs in order to account for and recover lost revenue. This will be unfair for IOCs who had invested based on what was represented to be acceptable to the government at the relevant time. The judgment wrongly suggests that there was an established liability, which was not recovered under the PSCs. The truth is that there was no established liability but a legal basis for adjustment of the PSCs to increase government share which the government waived by conduct. The consequence of the failure of government to comply with its own law cannot be imposed on IOCs.[21] The IOCs can rightly claim that Nigeria is estopped from carrying out a retrospective review of the terms and activate necessary investment disputes settlement mechanism.

 

A literal interpretation of the decision will be disastrous for the industry because it means the fiscal terms of PSCs between 2003- 2015 were illegal and unenforceable to the extent of non- compliance with section 16 of PSC Act. This position is impossible for the simple reason that the IOCs were not party to the terms of settlement between the parties in the action and are therefore not bound by the decision. Despite the fact that the NSC is the highest court in Nigeria, they can still explore the dispute resolution mechanism under the PSCs if the issue cannot be amicably resolved.

 

On the other hand, the decision exposes one of the basis of criticism of the incentives regime in Nigeria, which is that they are maintained even when they no longer serve any useful purpose. The PSC Act was designed to encourage offshore exploration because of the difficulties that existed at the time. With modern technology, these difficulties are either non-existent or have reduced substantially necessitating review of the incentives. 

 

The decision also underscores the urgent need for a comprehensive review and harmonization of the regulatory framework for oil and gas exploration and production in Nigeria. There are more than 33 legislative enactments and countless regulations and directives in the oil and gas sector. It is very difficult to keep track of all the legislative enactments, regulations and directives, hence problems like the one under consideration. Since 2008, attempts have been made for a comprehensive review of the petroleum industry through the Petroleum Industry Bill (PIB) but has been largely unsuccessful.[22]

 

The effect of the decision is that the fiscal stability in PSCs since 1999 has ended. Government must now mandatorily review the terms to increase its take in PSCs. This would effect future offshore petroleum exploration and production in Nigeria. From investment dynamics in the industry in the last couple of years[23], government would be circumspect in carrying out the review of the terms. Government must consider other factors in response to the judgment.

 

Conclusion

 

The recent decision of the Supreme Court in Nigeria has dramatically put an end to the existing framework for PSCs and offshore investments in the oil and gas industry. Even though the decision is based on the PSC Act, it has the potential of increasing the uncertainty in Nigeria’s Petroleum Industry. In the last few years, international oil companies have deliberately delayed further investments due largely to the difficulties in the passage of a comprehensive regulatory framework (PIB). Nigeria must be diplomatic and adopt political solutions with the oil producing states to reduce the boomeranging effect of the decision.

 

Overall, Nigeria needs to expeditiously streamline the regulation of the oil and gas industry to avoid uncertainty with its attendant freeze in investment.

 


 

 

[1] A Production Sharing Contract (PSC) is a contractual arrangement in the Petroleum Industry under which International Oil Companies (IOCs) finance and bear the risks of exploration and production. The Deep Offshore and Inland Basin Production Sharing Contract Act (PSC Act) defines PSC's as any agreement or arrangement made between the Nigerian National Petroleum Corporation, or the holder, and any other petroleum exploration and production company or companies for the purpose of exploration and production of oil in the Deep Offshore and Inland Basins. PSCs have become very attractive in Nigeria for many reasons, one of which is that Nigeria serially defaulted on cash call obligations under joint venture arrangements. This problem led to an arrangement which allows the IOCs to finance and recoup investment upon production. Furthermore, the Government assumes little or no risk at all in the production of its petroleum resources. Another advantage is that it gives the government a sense of ownership and control as the crude oil produced is deemed to belong to the government but only shared with the IOCs

[2] The commencement date of the Act was backdated to 1st January 1993 to make it applicable to PSCs executed in 1993. This may suggest that the legislation is retroactive. Generally, retroactive legislation are offensive and against the fundamental principles of the rule of law. However, the law was proposed by the military and is only applicable to assessments performed after the date it enacted and was not intended to apply retrospectively in the sense that it would change assessments completed between 1993 and 1999. In any event, the retrospectivity of the PSC Act it is in the interest of the oil and gas industry as it did not deprive players of anything they were entitled to under existing PSC contracts.  Under Nigerian law, except in criminal cases where retroactive legislations are unconstitutional, the legislature can enact retroactive legislations but such legislations will be subject to the supremacy of the constitutionally guaranteed rights.

[3] Section 3

[4] The maximum for joint venture is 20% depending on the water depths of between 0 and 200.

[5] Section 4

[6] 12% in areas from 201- 500 metres water depth, 8% from 501- 800 metres water depth, 4% from 801- 1000 metres water depth, 0% in areas in excess of 1000 and 10% in Inland Basin. See section 5 of the PSC Act.

[7] Section 13

[8] See also section 1 of the Act

[9] Stabilization clauses are a contractual drafting technique used to mitigate political risks in a host country. There are many stabilization provisions and agreements in Nigeria. A major example of the use of legislation is its use to provide stability to Oil and Gas investments is the Nigeria LNG (Fiscal Incentives, Guarantees and Assurances Act). This has been subject to decisions of the court. Nigerian courts upheld the provisions of the act to the effect that the NLNG operations cannot be affected by any other law except as amended in terms of the Act. See  Niger Delta Development Commission v Nigeria Liquefied National Gas Limited (NDDC v NLNG) (2010) LPELR-CA/PH/520/2007

[10] This is the amount of crude oil the proceeds of which is sufficient for the contractor to recover all operating costs of exploration and production.

[11] Crude oil equal to actual royalty payable and annual concession rentals.

[12] Allocated for payment of Petroleum Profit Tax

[13] Profit oil, being the balance of available crude oil after deducting royalty oil, tax oil and cost oil, shall be allocated to each party in accordance with the terms of the production sharing contract.

[14] Section 8

[15] Sections 7 and 9

[16] Section 10

[17] See the Central Bank of Nigeria crude oil price statistics at https://www.cbn.gov.ng/Rates/crudeoil.asp?year=2018&month=3, https://www.macrotrends.net/1369/crude-oil-price-history-chart and https://www.statista.com/statistics/262858/change-in-opec-crude-oil-prices-since-1960/

[18] See “Nigeria fails to review oil contract despite $21b loss” by the Guardian Newspapers of 8 June, 2018. Available online at https://guardian.ng/news/nigeria-fails-to-review-oil-contract-despite-21b-loss/

[19] The three states are part of the oil producing states in Nigeria. Under section 162 of Nigeria’s constitution, oil-producing states are entitled to 13% derivation from proceeds of crude oil to the Federal Government. The contention of the states was that their share of 13% derivation is part of what will be due to the government of the Federation upon review of PSCs terms.

[20] See Dr. Taiwo Adebola Ogunleye, “A Legal Analysis of Production Sharing Contract Arrangements in the Nigerian Petroleum Industry”, (2015) Journal of Energy Technologies and Policy Vol.5, No.8. available online at https://www.iiste.org/Journals/index.php/JETP/article/download/24714/25317

[21] It must however be mentioned that in a country like Nigeria, regulatory decisions in the industry are subject to influence from these companies and the home countries of their parent companies. This may have accounted for the inability of government to carry out the review over the years. Notwithstanding, the government would have to be diplomatic in upending the commercial balance in the industry.

[22] The present National Assembly slip the Petroleum Industry Bill (PIB), (which had been in the works since 2000) into four segments for ease of passage. The Petroleum Industry Governance Bill (PIGB) was passed but the president has refused to assent to it because it substantially reduced the power of the presidency. The other components of the PIB are the Petroleum Industry Administration Bill (PIAB), the Petroleum Industry Fiscal Bill (PIFB) and the Petroleum Host Community Bill (PHCB).

[23] There has been delays in further investment by oil majors in the last few years. This has threatened the target of 40 billion barrels of crude oil reserves by 2020. The delay has been attributed to uncertainty in the regulatory environment due to difficulties in passing the Petroleum Industry Bill, security challenges, the proposed review by the Federal Government of the existing Production Sharing Contracts and the steep fall in global oil prices.



[*] Efe Etomi is a partner andElvis. E. Asia is a Senior Counsel in the Lagos office of Chief Rotimi Williams’ Chambers. Mrs Etomi can be contacted on eoe@frawilliams.com. Mr. Elvis can be contacted at eea@frawilliams.com

Friday, January 18, 2019