Mozambique’s Rovuma Basin LNG Regime
By Kevin Atkins, Julien Bocobza and Alex Neovius with the assistance and co-operation of AG Advogados (in association with F. Castelo Branco & Associados) in Mozambique
After much waiting, the government of Mozambique has taken a huge step toward monetizing its much-publicized gas reserves by publishing the eagerly-anticipated legal framework for the development of an LNG project in the deepwater Rovuma Basin offshore Mozambique.
The discovery of gas reserves in the Rovuma Basin has transformed the domestic Mozambican upstream sector and given Mozambique some of the largest gas reserves in the world, potentially making it the third largest exporter of LNG behind Qatar and Australia. (For earlier coverage, see Mozambique’s New Petroleum Regime.)
This article looks at some of the key changes brought about by the new Rovuma Basin law 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.
The new law applies to all the existing concessionaires in Areas 1 and 4 offshore Mozambique, as well as any special-purpose vehicles (SPVs) they may establish and any contractors engaged by them in relation to the “design, construction, installation, ownership, financing, operation, maintenance and use” of project infrastructure necessary for the “extraction, processing, liquefaction, storage, transportation, delivery and sale” of gas discovered in Areas 1 or 4. However, the new law also includes a catch-all provision that extends its application to any other person directly involved in any of the foregoing.
All SPVs established by concessionaires must be incorporated in Mozambique, although SPVs for the purposes of raising finance or undertaking sales and shipping activities may be incorporated in any “transparent” jurisdiction where the government of the jurisdiction can verify the ownership, management, control and fiscal situation of the investor (subject to Mozambique government consent). While this “transparent” jurisdiction standard is equivalent to the standard imposed on new concessionaires under the new general petroleum law of August 2014 (Law No. 21/2014), unlike the requirements of the new petroleum law, neither the existing concessionaires of Areas 1 and 4 nor their SPVs are required to be listed on a stock exchange.
The consent of the Mozambique government will be required prior to any transfer of shareholdings or change of control of any SPV (although any such transfer or changes effected by way of enforcement over a security interest granted as part of a financing does not require prior consent, as financing structures are subject to the prior approval of the government at the outset). However, the new law does not set a minimum threshold and, accordingly, any changes in shareholding (even minority interests) will require prior consent from the government. Given the scope of what constitutes an SPV, this restriction will likely apply to indirect changes, too, where shares in intermediate holding companies are transferred. The prior consent of the Mozambique government will also be required upon any amendment to the constitutional documents of any SPV, which could prove to be a burdensome ongoing corporate obligation in light of a 30-year project lifespan, particularly as and when equity participants look to take stakes in the project and seek to include operational and governance controls within the terms of constitutional documents.
In either case, the consent of the government must be granted within 10 days of application, although there is no explicit concept of deemed consent if such consent is not granted within the 10-day time period, nor is there any reference to what happens if neither a consent nor a refusal is communicated to the applicant.
A key principle in the new law is the legal and fiscal stabilization available to concessionaires to preserve the legal regime for the project. However, concessionaires are not protected from changes in law that result in an annual change not exceeding US$5 million in the aggregate, nor are they protected from other changes to health, safety and environmental legislation, provided such changes are non-discriminatory and consistent with international standards (although that is itself a fairly ambiguous and frequently-challenged standard).
Where any of the non-excluded changes are brought about, the government must restore the concessionaires to the position they would otherwise have been in if the changes had not occurred. If the concessionaires and the government cannot agree within 90 days on those required restoration steps, then an independent expert will determine the steps for them.
Additionally, the concessionaires are entitled to a 10-year fixed rate of petroleum production tax payable in relation to the project. The rate is currently 2%. The rate will be examined and adjusted by mutual agreement with the government within 90 days of the 10th anniversary and again on the 20th anniversary of the first shipment of LNG from the project, provided that where no such agreement is reached, the rate of petroleum production tax will increase to 4% on the 10th anniversary and to 6% on the 20th anniversary.
This system, the so-called “meet-to-disagree” system, was included in the new law as a compromise to ensure the new law complies with the legislative authorization that enabled the government to pass the new law in the first place. The legislative authorization provides that the fiscal stabilization provisions should be renegotiated every 10 years, without affecting the profitability and feasibility of the project. At the same time, these fixed figures should enable concessionaires to factor the tax take into their project economics and maximize the cost recovery for the financing and capital expenditures.
Finally, the new law stipulates that the contracts or agreements to which the government is a party and the rights relating to the Rovuma Basin project may only be modified or terminated by mutual agreement in accordance with the respective contractual terms and conditions, thereby constituting an exception to the general regime of the Public Administration Law of August 10, 2011 (Law No. 14/2011), which provides that the government is entitled unilaterally to modify or terminate contracts under certain conditions.
In addition to the development of gas deposits located exclusively within either Area 1 or Area 4, the new law also expressly authorizes the development of 24 trillion cubic feet (or 680 billion cubic meters) of gas located in fields that straddle the boundaries of Areas 1 and 4.
For these straddled reservoirs, the concessionaires are required to submit a proposed unitization agreement and a development plan to the government within six months after the date the new law was published. Where this is not satisfied, an independent expert will be appointed to determine the terms of the unitization agreement within 12 months after the date the new law was published. A heads of agreement was signed in December 2012 proposing separate but co-ordinated development of these straddled reservoirs, with the operator of each area being responsible for development of the straddled reservoirs lying within the boundaries of its Area, although a formal unitization agreement and joint development strategy have not been agreed.
Given the scale of deposits that straddle Areas 1 and 4, a co-ordinated development effort is fundamental to achieving a successful LNG project and maximizing recovery of available reserves; hence the emphasis in the new law on unitization and joint development.
The concessionaires must also deliver to the government, within six months after the date the new law was published, a joint plan for construction, development and operation of an LNG terminal and related infrastructure on the Afungi peninsula in the Cabo Delgado province of northern Mozambique, and the offshore infrastructure connecting to the LNG terminal.
The concessionaires are authorized to design, construct, install, own, finance, encumber and use the LNG terminal and, in tandem with port authorities, will have responsibility for controlling and directing maritime traffic inbound to, and outbound from, the LNG terminal pursuant to a new separate concession to be awarded to the Area 1 and Area 4 concessionaries.
However, the materials offloading facility that is needed to allow for offloading of materials required to construct LNG facilities will be managed and operated by a new special-purpose joint venture owned 30% each by the operators of Area 1 and Area 4 and 40% by Portos de Cabo Delgado, S.A. (a state-owned entity established as a 50-50 joint venture between ENH, the Mozambican national oil company, and CFM, the Mozambican regulatory body for ports and railways). Additionally, upon release of the construction completion guarantees for the first four LNG trains (out of a possible 10-train project), a new separate concession for the materials offloading facility will be awarded to the joint venture, with the principle being to ensure that the concessionaires have control over the construction phase of the materials offloading facility as this will inevitably affect progress of the entire Rovuma Basin project.
The new law also requires the concessionaires to involve personnel from Portos de Cabo Delgado, S.A. in operations for the loading of LNG vessels and to permit such personnel to have access to the LNG terminal from time to time to monitor the volumes loaded. While the effectiveness of the required joint venture structure remains to be seen, the intention clearly seems to be to enhance local content participation, train Mozambican citizens and increase local industrial know-how. However, the involvement of a separate independent 40% shareholder in the holder of the concession for the materials offloading facility, at a time when a substantial number of LNG trains are yet to be constructed and the material offtake facility will remain in considerable use, may lead to issues when negotiating O&M service fees payable to the joint venture, as the interests of the 40% shareholder may not always be aligned with the interests of the concessionaries.
The new law also requires that ENH be involved in operations under the new separate concessions awarded for the materials offloading facility and the LNG terminal. Although the extent and scope of this involvement is unclear, local sources have interpreted the obligation as being satisfied through ENH’s participating interest in Portos de Cabo Delgado, S.A. and not as an additional obligation that could give ENH a potential right to delay project development and extract fees along the value chain of the project.
Third Party Access
Similarly to the provisions of the new general petroleum law of August 2014, concessionaires are required to grant third parties access to their LNG infrastructure where there is available capacity and the access would not be adverse to concessionaires. However, unlike the new general petroleum law of August 2014 (and, in fact, the prior Mozambican petroleum law of 2001), there is obviously no obligation on the concessionaires to expand their facilities at the cost of the third party if there is insufficient available capacity to accommodate their volume demands.
Development and Production
The government has nine months from receipt of a development plan to approve the plan or notify the concessionaires of deficiencies that require amendments to the plan. Upon receipt of a notification of deficiencies, the concessionaire will have 45 days to make the required amendments to the plan and resubmit the amended plan to the government after which the government will have another month to approve or reject the amended plan. This nine-month approval period may delay the ability of concessionaires to achieve their final investment decisions during 2015 if development plans were not submitted by the end of March 2015.
Once a development plan has been approved by the government, concessionaires have a 30-year development and production period for their LNG projects. Gas sales contracts require the prior approval of the government, although the government can delegate to ENH the authority to approve gas sales contracts with a term of 12 months or less to ENH. This may give ENH visibility into pricing formulations and the strategic decision making of the concessionaires, which may consequently affect any negotiations between ENH and the concessionaires for domestic supply obligations.
Such approval rights could fetter the rights of concessionaires to sell their gas to whichever buyers and on whatever terms they see fit, as the government may be primarily concerned with maximizing the revenue stream generated by such gas sales while the concessionaire will have broader issues and commercial relationship matters to consider with each offtaker. Additionally, despite the lack of a formal domestic supply obligation under the new law, it is possible that the government approval right for gas sales contracts could be manipulated to ensure that all gas sales are to a local offtaker. Thus, the government could refuse to approve any sales contracts that are not with local offtakers.
Neither the new law nor the existing exploration and production concession contracts set out domestic supply obligations. However, as development plans are required to allocate some gas to the domestic market, the allocated volume is expected to be negotiated during approval of the development plan.
Tendering and Procurement
Concessionaires are required to file a local content plan in conjunction with development plans to be approved by the government. The local content plans must be updated every three years. As part of each local content plan, preference shall be given to Mozambican personnel or entities where the services offered by them are comparable to those available in the international marketplace and their prices do not exceed those of the international marketplace by more than 10% (except for specialized services relating to technology and intellectual property).
Except in very limited circumstances, such as emergency or failure to meet tender requirements or in the case of highly-specialized equipment, contracts with a value in excess of US$3 million must be tendered, with contracts having a value exceeding US$3 million but less than US$25 million requiring notification to, but not prior approval from, the National Petroleum Institute, and contracts having a value of US$25 million or more requiring prior approval from the National Petroleum Institute.
Concessionaires are also required to provide the Bank of Mozambique with a detailed list each quarter of contracts with international suppliers.
The selection of lenders and financing parties is not subject to any tendering obligation.
The new law grants concessionaires full rights to mortgage and secure LNG infrastructure and project assets for the purpose of raising finance for projects.
Financing structures require prior approval of the government, although once such approval is obtained, there are no requirements or restrictions on the concessionaires as to the identities of lender institutions. Concessionaires have full flexibility to adopt whatever arrangements they find most suitable and may obtain financing from lenders within or without Mozambique and may adopt whatever debt-to-equity or capital adequacy ratios they see fit. This flexibility is likely to be a necessity given the scale of development and capital expenditure required for each project.
The requirement that the government approve financing arrangements for each project undertaking may obviously affect project timing, although it will be in the government’s best interests to approve financing arrangements as quickly as possible in order to accelerate project development. However, an upfront government consent requirement at the outset of each such undertaking should facilitate smoother processes for security arrangements, as the initial government consent will constitute the consent required to implement the grant of any security interests, with no further consent required either to perfect or even to enforce security interests upon a default.
The new law also includes a commitment by the government to support such financing arrangements, once approved, by executing direct agreements required by lenders and even refers to the customary step-in and remedy rights available to lenders.
Perhaps most importantly from a financing perspective, concessionaires are permitted to open up offshore collection accounts for receivables and project revenues to be paid and out of which loans may be amortized.
However, capital operations, such as entry into loans and the provision of related guarantees or security, are subject to prior approval from the Bank of Mozambique which, if not granted within five business days after the request, will be deemed granted. Any disbursements and cash funding out of the proceeds of any such loans will need to be registered with the Bank of Mozambique, but will not require any prior authorization.
Monthly bank statements for offshore collection accounts must be provided to the Bank of Mozambique and the National Petroleum Institute who are entitled to audit the accounts annually.
However, sums required to satisfy domestic Mozambican obligations, such as taxes and domestic goods and services and personnel, must be transferred from the offshore collection account into an onshore Mozambique account, and 50% of such sums must be converted into metical, the Mozambican currency. Foreign direct investments must be registered with the authorities within 10 days of the investment being made in order to extract cash and remit profits resulting from such investments.
Given the importance of the Rovuma Basin project and the impact it is expected to have on the local economy, the new law provides that it is in the national interest that antitrust restrictions not apply to project operations. Accordingly, the Rovuma Basin project is excluded from any applicable Mozambican antitrust legislation.
As with the procurement obligation, concessionaires are required to give priority to the employment of Mozambican nationals in the project work force. In particular, foreign individuals must not be preferred for roles with less technical complexity.
Additionally, as part of their development plans the concessionaires must propose a quota of aggregate foreign individuals in the project work force at any one time that will be updated annually and approved by the government. Hiring more foreign workers than this agreed figure will be difficult unless the individuals are hired on a short-term basis for 180 days or less (although visas will typically only allow stays of up to 90 days) or the prior approval of the government is obtained specifically authorizing the employment of the identified workers.
Normal daily working hours are also increased from eight to 12 hours and concessionaires are given flexibility to implement different working periods, provided a suitable rest period is offered to the workers after the work period. This gives concessionaires more opportunity to advance development operations and offer competitive working schedules to incentivize workers and accelerate project timelines.
The new law provides that ENH and other state-owned companies may submit to international arbitration any disputes arising from the existing exploration and production concession contracts or from any other agreements related to the Rovuma Basin project. This is expected to be extremely advantageous as the Law on State Enterprises that applied previously prohibited state-owned companies from entering into arbitration agreements and, thus, restricted the rights of investors to seek independent and neutral arbitral recourse.