Mozambique’s New Petroleum Regime
By Kevin Atkins, Julien Bocobza and Alex Neovius and written with the assistance and co-operation of AG Advogados (in association with F. Castelo Branco & Associados), in Mozambique
This year has seen the passing of the much awaited new petroleum legislation in Mozambique. The need for an overhaul of the prior regime, which dates back to 2001, arose following the discovery of vast commercial quantities of gas in the Rovuma Basin offshore Mozambique. The discovery has transformed the domestic upstream sector and given Mozambique some of the largest gas reserves in the world, potentially making it also the third largest exporter of LNG behind Qatar and Australia. The revised law (Law No. 21/2014) came into force on August 18, 2014.
This article looks at some of the key changes brought about by the new petroleum law and its related fiscal legislation and draws on an English translation of the new law kindly provided by AG Advogados (in association with F. Castelo Branco & Associados), who have co-authored this article and provided Mozambique law input.
While the new legislation will apply to all future projects, the existing Rovuma Basin projects are specifically exempted from the new regime.
During September 2014, the Mozambique parliament approved development of a new separate special legislative regime for LNG projects in the Rovuma Basin. While the exact scope of the Rovuma Basin regime has not been identified, it is expected to deal with, among other things, procurement rights for goods and services, terms and conditions of financing arrangements, labor rights, work permitting, customs rules and the design, construction and operation of facilities, and is intended to give the relevant oil and gas stakeholders (Anadarko and ENI) much needed clarity on how much tax they will be required to pay.
The parliamentary approval granted in September 2014 is understood to be on the basis that the Rovuma Basin regime is implemented by December 31, 2014. The status of the regime is unclear, although it is commonly acknowledged that a near final form has been in existence since early 2014. In any event, in addition to the December 2014 deadline, both Anadarko and ENI need the regime to be finalized before they can proceed to their final investment decision.
The new petroleum law applies to future LNG projects.
The law deals with petroleum and production operations and expressly includes liquefaction activities. “Petroleum” is defined to include “treatment, including liquefaction, storage and preparation for the loading and transport of petroleum,” and the phrase “production operations” is defined to include “loading as a commodity, in the form of liquefied natural gas.”
The law also allows the government to authorize projects for the design, construction, installation, ownership, financing, operation and maintenance of facilities and related equipment for the production, processing, liquefaction, delivery and sale of natural gas. However, the new form of oil and gas concessions to be issued under the new law may include specific authorization for LNG projects as part of the production phase of an oil and gas investment (in which case a further separate LNG authorization will not be required).
Interestingly, though, the new law does not apply to refining and refined products (such as LPG, naphtha, diesel and fuel oils) which are excluded from the scope of the law. It is unclear whether they will be covered by a separate legislative regime.
Any Mozambican or foreign company can carry out oil and gas operations in Mozambique.
However, the mere fact of incorporation in Mozambique does not mean that a company is treated as Mozambican, as a majority of its shareholders must also be Mozambican for this to be the case. A local branch office or Mozambican subsidiary of a foreign company will not be treated as a Mozambican entity for the purposes of the new petroleum law.
Foreign investors and their intermediate group holding companies must be incorporated in a “transparent jurisdiction” where the government of the jurisdiction can verify the ownership, management, control and fiscal situation of the investor. While this provision obviously has not yet been tested in the courts, it appears to prohibit the use of offshore holding companies in corporate groups, which may be a problem as a number of African investments are routed through offshore tax-efficient holding companies to mitigate against withholding taxes and other tax leakage.
A last-minute change that was included in the new law is that oil and gas investors must also be listed on the Mozambique Stock Exchange. It is unclear when the listing must take place and how much of a free public float is required, and obviously any international institutional investors appetite for such a listing would reduce the local share ownership for any Mozambican company. This requirement is likely to prove burdensome to investors, as the initial public offering timetable will need to be factored into the project timeline and public shareholders will need to be aware that where the company is project financed, as is likely to be the case where heavy capital expenditures are envisaged for LNG infrastructure, revenue streams will be locked down and fully secured which will prohibit distributions until there is enough free cash flow.
The participation of the Mozambican government in oil and gas projects is not subject to any cap or thresholds. The state “reserves the right to participate in any petroleum operations whatsoever,” and such participation may take place “during any phase of petroleum operations” and the Mozambican government shall “progressively promote an increased level of participation in the oil and gas enterprise.”
This instruction is very unclear, and investors will need certainty as to what proportion of a project is reserved for the Mozambican government before deciding whether to invest.
As currently drafted, the cap on government ownership is to be agreed as part of the negotiations in a concession award, meaning that investors in new award rounds will probably be in competition with each other to offer up attractive state participation terms to give themselves the best chance of a concession award. Obviously, the extent to which the Mozambican government can fund its own share of costs and expenses for the duration of a project will also be another key concern for investors. The new law says that the government’s share will be funded by “revenue from existing resources and other forms to be defined by the Government.”
The new law also includes an obligation to commit 25% of production to the domestic market, with pricing for such sales to be determined by the Mozambican government. This will affect revenue streams as sales to the domestic market may not attract the same price as sales in the international market, where Asian buyers are actively pursuing gas purchases in the LNG sector, and there is a lack of visibility as to what pricing will be adopted by the Mozambican government.
Consistent with trends across the African continent, the new law also stresses the importance of local content and the use of local contractors and service providers throughout oil and gas projects, even if this comes with extra costs. In particular, investors are required to “give preference to local products and services when analogous in terms of quality to international materials and services that are available within the timeframe and quantities required, and when the price, including taxes, is not in excess of ten percent of the price of imported goods.” In addition, where foreign contractors and service providers are used, they must work in partnership with Mozambican persons.
This implies that where an international oilfield services provider is selected instead of a Mozambican equivalent (for example, because it was more than 10% more cost effective), the international service provider must provide the services in a joint venture or a partnership with a Mozambican person anyway. This could severely delay project timelines, as any international service provider would arguably need to establish a local joint venture relationship in order to provide services in-country, and agreements as to intellectual property ownership and know-how development will need to be agreed among the joint venture parties.
Sales and Marketing
Another important change is that the national oil company (Empresa Nacional de Hidrocarbonetos, E.P., or “ENH”), which is a partner in all oil and gas projects and the vehicle through which the Mozambican government participates in projects, is required to lead the marketing and sales of all production.
The precise scope of this obligation is unclear and whether or not this will work in practice is also unknown, as it is unlikely that ENH will have as thorough a knowledge of the buyers in the international market as international oil and gas investors that routinely participate in that market.
It may be that while ENH takes the lead in sales and marketing, the back-room technical work and responsibility for such sales and marketing efforts is carried out by the investors under some sort of technical co-operation arrangement, as is frequently the case where national oil companies take operatorship roles in oil and gas projects.
In any event, project finance lenders will want to ensure that the most economic and effective revenue streams possible are used. Leaving sales and marketing solely in the hands of ENH is unlikely to be viewed favorably.
The new law also includes a requirement to obtain government consent upon an indirect transfer of concession rights through a sale of shares.
This is to prevent exit transactions that are structured so as to avoid the need for prior Mozambican government consent and to avoid Mozambican tax being payable on the capital gains. However, the provision is so broadly drafted that it could conceivably apply to trading in shares in Anadarko on the New York Stock Exchange. Notwithstanding the deliberately broad drafting of the new law, in practice the scope of share transactions that require prior government consent may be narrowed by the subordinate legislation to be issued in support of the new law or may also be narrowed by the specific terms and conditions of concession awards that are negotiated between the government and oil and gas investors, as concessions are customarily interpreted as clarifying those areas of legislation that are ambiguous.
Under the previous legislative regime, consent was only required upon a sale at the asset level by the oil and gas investor, but prior concession awards often extended this requirement to sales of shares where a change in control of the concessionaire occurred.
The new law will obviously affect exit strategies. All sale transactions, however structured and irrespective of the stake being sold, will require government consent as a condition precedent and, as with any sale and purchase agreement, responsibilities for obtaining this and the consequences of not obtaining it on any deposits paid will be hotly negotiated. As with the prior regime, the new law does not provide for a specific timeframe to achieve government consent nor is there a deemed or implied consent right. In any case, where technical and financial capabilities are satisfied and capital gains tax liabilities are agreed, consent is likely to be swift.
Like the prior regime, the new law is silent as to whether government consent is required for the creation of security interests over oil and gas assets. However, prior concession awards have been drafted and interpreted such that the granting of security is subject to prior government consent and, unless the new subordinate legislation provides otherwise when published, this is likely to remain a requirement under the new regime.
To the extent that any gas fields cross concession areas and need to be unitized, entry into any unitization agreements will also require the prior consent of the Mozambican government and must be agreed within six months of a declaration of commerciality. To the extent that any such consents are not forthcoming, this may also cause delays. Risks in this regard may arise if fields in the Rovuma Basin (which, as noted earlier, will be governed by a new regime specific to the Rovuma Basin) are later found to cross boundaries into other concession areas that are governed by the new general petroleum regime, as the Mozambican government is likely to prefer as much as possible of the discovery to fall within the boundaries of the concession as the concession has more favorable fiscal terms for the Mozambican government.
As another interesting point to note, Mozambican anti-trust laws are also being developed at present (with the first-ever competition law having been published in April 2013), although the full suite of subordinate legislation and regulatory authority rules and codes has not been finalized. However, as and when the anti-trust regime is established, it is currently expected, on the basis of current draft documentation, that filings and clearance from the Competition Authority will be required for future corporate transactions where, as a result of the merger or acquisition concerned, a party holds a 20% market share in Mozambique and generates turnover in Mozambique of MTN 100 million (approximately US$3.3 million).
The tax regime implemented as part of the new legislative package changes the capital gains landscape by applying capital gains tax to indirect transfers of concession rights through a sale of shares and also imposing joint liability on the purchaser and the seller for payment of the tax.
This broadens the scope of capital gains tax to include share transactions as well as the customary asset level sale and ensures that new entrants purchasing oil and gas projects in Mozambique, whether directly at the asset level or indirectly at the share level, are also directly liable for the payment of such taxes.
It will affect the economics of any transaction, and share sellers will want to ensure that there are tax treaty protections in place to mitigate the adverse effects of a double tax hit.
As is typically the case, capital gains tax is normally for the seller to pay as it is obviously the seller that will generate any capital gain on a sale. However, the concept of the new regime is to prohibit sellers from exiting the country, defaulting on their tax liability and leaving no assets in-country that the Mozambican government can pursue, while in the meantime the purchaser is successfully pursuing the project and generating more corporate profits. In practice, though, purchasers will not take any risk of failure by the seller to pay the capital gains tax, and purchase and sale agreements should enable purchasers to direct a proportion of the payment, equivalent to the capital gains tax charge generated by the sale, directly to the Mozambican government. Otherwise, the Mozambican government may take action against the operating company in-country at that point owned by the purchaser.
Additionally, holders of multiple concessions will be subject to ring-fencing rules that prevent losses from one concession being applied to offset profits from another concession as each concession will be taxed separately from each other.
The new law includes guarantees and investment protections and provides that “expropriation may only occur on an exceptional basis and must be substantiated” and any expropriation must “serve the public interest and is subject to the payment of fair compensation,” which must be determined within 90 days and payable within 190 days (presumably from the date the expropriation takes place).
While it is better to have these protections in than not, there is no frame of reference as to what is meant by “fair compensation” or as to what would constitute a substantiated case of expropriation, and these are clearly the most fundamental concepts in the protection mechanism.
Any disputes with the Mozambican government arising out of concessions awarded under the new law will be settled pursuant to ICSID arbitration unless other institutions are agreed to in the terms of the concessions. From an enforcement perspective, this is favorable to investors, although, unlike most other arbitral rules, any challenges to an award cannot be brought in the courts of the host state, but must be brought internally to the ICSID annulment committee.
It is likely that a major rationale for some of the changes introduced in the new law is the exit from Mozambique by Cove Energy in 2012 where the shareholders of Cove, a publicly-listed oil and gas explorer, approved a public takeover of the company by PTTEP (the national oil company of Thailand).
Cove held an 8.5% interest in one of the offshore gas fields in the Rovuma Basin (and a 10% interest in an onshore non-producing field), but structured the deal so that no Mozambican tax was payable on the capital gains, as the assets in Mozambique were not being sold, but rather the corporate group was being taken over. Consequently, the Mozambican government held up the proposed takeover and threatened to impose taxes on the sale as part of its consent process. Initial rumors speculated that the tax hit could be as much as 40%, although the eventual figure was settled at 12.8% and was accepted by the parties to the transaction.
This transaction followed swiftly on the heels of the Tullow Oil purchase from Heritage Oil in Uganda where an exit tax was imposed on Heritage Oil (that the company failed to pay) and held up Tullow Oil’s future development of its upstream assets in Uganda. (See the September 2014 Newswire article). A general concern for all investors is the fiscal stability of high margin cash generating projects in Africa, as there is precedent for host governments to take action and increase their shares of the pie. Therefore, good host governmental relations are absolutely key with any project.