Introduction
The President of the Federal Republic of Nigeria, Muhammadu Buhari, on 4th November 2019, signed the Deep Offshore and Inland Basin Production Sharing Contracts (PSC) (Amendment) Bill into law (the “Amendment Act”). The Federal Government of Nigeria (FGN) anticipates that the Amendment Act will significantly increase Nigeria’s earnings from oil wells located deep offshore and give it a fair and equitable share of income derived from its natural resources.
Purpose of the Deep Offshore and Inland Basin Production Sharing Contracts Act CAP. D3 LFN 2004 (the “Principal Act”)
The Principal Act, was promulgated as a Military decree in 1999 but given retroactive effect from 1st January 1993. It was designed to enshrine into law certain fiscal incentives given to exploration companies operating in the Deep Offshore and Inland Basin areas (mainly international oil companies [IOCs]) (the “Operators”) under PSCs with the Nigerian National Petroleum Corporation (NNPC).
To give further assurance to the Operators, Section 15 of the Principal Act required that the relevant provisions of all existing enactments or laws, including but not limited to the Petroleum Act, and the Petroleum Profit Tax Act, be read with such modifications as to bring them into conformity with the provisions of the Principal Act.
Section 5 of the Principal Act provided for the payment of royalties by the Operators on a sliding scale referenced to the water depths at which oil was produced.
Furthermore, Section 16 of the Principal Act, provided for periodic reviews to ensure that if the price of crude oil at any time exceeds US$20 (Twenty United States Dollars) per barrel, the share of the FGN in the additional revenue shall be adjusted under the PSCs to such extent that the PSCs shall be economically beneficial to the FGN. In effect Section 16: (1) allows the FGN to review and adjust its shares of revenues above $20% per barrel; and (2) permits parties to renegotiate the PSCs after the expiration of fifteen (15) years from commencement and every five (5) years thereafter.
Why was the Principal Act Amended?
From Mr President’s speech during the presentation of the 2020 budget to the National Assembly on 8th October 2019, it seems that the focus of the FGN is on the first item mentioned above, which is increasing the revenue of the nation. The incentives given to the Operators when the PSCs were negotiated seem to have taken a back-seat in the FGN’s considerations.
It is interesting that despite the provisions of the Act permitting the periodic review of the revenue sharing formula to reflect economic realities the FGN failed to review the Act until now.
Significant Changes Contained in the Amendment Act
The Amendment Act introduced the new concepts of “Royalty by Price” and “Royalty on a Field Basis”. Section 5 (2) of the Principal Act, provides that the payment of royalty shall be graduated based on the water depth of the oil field. However, the Amendment Act has introduced a fixed royalty rate of ten percent (10%) on all oil fields in Deep Offshore, greater than 200 meters water depth and seven and a half percent (7.5%) rate on all oil production from fields in the Frontier/Inland Basin (Royalty on a Field Basis). In addition, Section 5(2) of the Amendment Act, introduced a rate based on the price of crude oil, condensates and natural gas (Royalty by Price). The Amendment Act also deletes Section 16 of the Principal Act.
Royalty by Price is expected to be identical for various water depths in Deep Offshore (beyond 200 meters water depth) and frontier acreages for crude oil and condensates.
The Amendment Act further provides for the applicable royalty rates based on additional revenues above US$20 (Twenty United States Dollars) per barrel, and shall be determined separately for crude oil and condensate as follows:
|
S/N |
Calculation |
Percent |
|
(a) |
from US$ 0 and up to US$ 20 per barrel |
0 % |
|
(b) |
above US$ 20 and up to US$ 60 per barrel |
2.5% |
|
(c) |
above US$ 60 and up to US$ 100 per barrel |
4% |
|
(d) |
above US$ 100 and up to US$ 150 per barrel |
8% |
|
(e) |
above US$ 150 |
10% |
It is instructive to mention that the Minister of Petroleum is now saddled with the ultimate responsibility to cause the NNPC to request for a review of the PSCs every eight years.
These adjustments to the way royalty is calculated will increase the FGN’s revenue share but also impose an additional burden on the Operators.
Effect of the Amendment Act
It is understandable that the FGN intends to increase its revenue by taking what it believes is its fair and equitable share of the income derived from the exploitation of its natural resources.
It is customary for PSCs to contain Stabilization Clauses that protect their capital investment in host countries (HCs) from the risks associated with a change in the fiscal laws of a HC. The degree of stability is important to foreign Operators as the less stable an investor perceives a project to be the less interested it is to enter into a long-term contract. The appropriate law that governs the validity of Stabilization Clauses is international law since it involves the national law of the HC and the lex mercatoria.
Essentially, Stabilization Clauses strike a balance between the sovereign right of HCs to impose taxes and modify legislation on the one hand and the legitimate expectation of Operators that the HC will not do anything in the exercise of these sovereign powers to make their contracts with the HC less profitable. By agreeing to have a Stabilization Clause in a PSC, the HC accepts that the existing and future laws would affect the contractual terms agreed upon with the Operator and that there is therefore a need to maintain the initial contractual economic equilibrium agreed by both parties.
Stabilization Clauses further ensure that the operators are compensated for the effect of any changes in the law or fiscal regime and that they are not adversely affected by such change.
Conclusion
We expect most Operators to invoke the Stabilization Clauses contained in their various PSCs by requesting that the NNPC should meet with them to agree on amendments to the PSCs that will restore them to the economic positions they were in before the enactment of the Amendment Act. In the event that there is no agreement to review the PSCs, the Operators are likely to commence arbitration proceedings against the NNPC.
Recent news reports indicate that Shell Nigeria Exploration and Production Company Limited is opposing the FGN’s demand for a total of US$13.65Billion, and it intends to commence arbitration proceedings in respect of the issue. The crux of the dispute is that the FGN is unilaterally making adjustments in the PSC in respect of the Oil Mining Lease 118.
The jury is out on whether the FGN’s decision to amend the Principal Act would ultimately provide the much sought-after revenues that it needs.
ABOUT THE AUTHOR
Lekan Dairo
Lekan is a Senior Associate with TNP and member of the firm’s Regulatory and Compliance Team. His areas of expertise are energy, taxation, real estate, construction and infrastructure transactions.
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