Africa Oil Week: Regulations, fiscal policy and good governance
5 November 2019
Provide a brief overview of the current regulatory environment applicable to the oil sector in South Africa.
On 7 February 2019, Total announced a major discovery of gas condensate offshore South Africa in the Outeniqua Basin (Brulpadda prospect, Block 11B/12B), reported to contain around 1 billion barrels of oil equivalent. The discovery has put the spotlight on the regulatory regime governing the upstream petroleum sector in South Africa.
Currently, the principal legislation governing the exploration and production of oil and natural gas (in other words, the upstream sector) is the Mineral and Petroleum Resources Development Act, 2002 (MPRDA).
Other legislation governs the midstream and downstream sectors, including:
the Gas Act, 2001, governing the construction and operation of gas transmission, storage, distribution, liquefaction and re-gasification facilities, and trading in gas (including liquefied petroleum gas);
the Petroleum Pipelines Act, 2003, governing the construction and operation of petroleum pipelines, loading and storage facilities;
the Petroleum Products Act, 1997, governing the manufacture, wholesale and retail of petroleum products;
the International Trade Administration Act, 2002, governing the import and export of oil (among other commodities) into and out of South Africa.
The MPRDA empowers the Minister of Mineral and Energy Resources (Minister) to grant, refuse, renew, suspend, cancel and allow transfer of reconnaissance permits, technical cooperation permits, exploration rights and production rights.
The Petroleum Agency of South Africa (PASA) is responsible for receiving and evaluating applications for these permits and rights, as well as monitoring compliance and reporting on it to the Minister.
Petroleum companies (upstream, midstream and downstream) are also subject to a black economic empowerment (BEE) code – the Liquid Fuels Charter, 2000 – which sets targets for greater involvement and advancement of Historically Disadvantaged South Africans (HDSA) in the petroleum industry. Among other things, it requires upstream petroleum companies to be at least nine per cent HDSA-owned.
Originally a non-binding pact between government and industry, the Liquid Fuels Charter was officially promulgated by the Minister in 2003, and is in the process of being “aligned” with other sector codes under the Broad-Based Black Economic Empowerment Act, 2003 (as amended in 2013). It is hoped that, once this “alignment” is complete, which should be imminent, it will be much easier for petroleum companies to have their empowerment credentials verified independently and accepted by government.
The regulation of the upstream petroleum sector is currently undergoing a long-overdue reconfiguration.
When the MPRDA was enacted in 2002, there was a single Department of Minerals and Energy responsible for both mineral and petroleum resources. However, when former President Jacob Zuma assumed office in May 2009, and vastly increased the size of the Cabinet, he separated the energy portfolio from mineral resources, each with its own minister and department.
Apart from significant cost implications, this created serious practical problems, chief of which was that the matters governed by the MPRDA all fell under the authority of the Minister of Mineral Resources. These included the permits and rights applicable to the upstream petroleum sector. PASA, however (which remained the designated agency responsible for assessing applications for, and compliance with, such permits and rights) as a wholly owned subsidiary of the Central Energy Fund (established in terms of the Central Energy Fund Act, 1977), fell under the authority of the Minister of Energy (who was responsible for regulating the midstream and downstream petroleum industries).
Further confusion was caused by the fact that the Liquid Fuels Charter (whose targets were meant to be built into the permits and rights granted to upstream petroleum companies) was administered by the Minister of Energy, and was not adopted under the MPRDA, meaning that the Minister of Mineral Resources had no proper authority to enforce compliance with the Liquid Fuels Charter.
These issues stood only to be exacerbated by the Mineral and Petroleum Resources Development Amendment Bill, 2013 (Bill) – more on that later – which stultified the development of South Africa’s upstream petroleum industry for about five years.
The administration of President Cyril Ramaphosa has seen the withdrawal of the Bill late last year, and the reunification of mineral resources and energy portfolios in one Ministry from May this year. There is now one Minister (currently Gwede Mantashe) with authority over the MPRDA, PASA and the Liquid Fuels Charter. After ten years of separation, however, it will take some time for the still divided Departments of Mineral Resources and Energy to coordinate their functions coherently.
What were the principal issues with the clauses which were proposed under the MPRDA Amendment Bill (which has since lapsed)?
The Bill was hastily passed by Parliament in early 2014, but was referred back by President Zuma in early 2015, to address certain doubts about its constitutionality. The substantive concerns were specific to the mining sector, but a major reservation was that the rushed legislative process had not allowed meaningful public participation at the provincial level.
Beyond the President’s reservations, both the mining and upstream petroleum industries had significant problems with the Bill. Of concern for both industries were provisions that would:
replace the predictable “first in, first assessed” application system with bidding system (more susceptible to administrative caprice and corruption);
upgrading the Minister’s policymaking powers to binding legislative powers;
requiring Ministerial approval to transfer shares in any right-holding company, as well as a controlling stake in any listed company with an interest in a right under the MPRDA.
Of specific concern for upstream oil and gas were provisions that would:
require right holders to give the state a minimum 20 per cent free carried interest;
subject right holders to the Mining Charter, which (among other things) required HDSA shareholding of at least 26 per cent (dwarfing the Liquid Fuels Charter’s 9 per cent);
remove PASA and give its functions to Regional Managers of the Department of Mineral Resources.
What type of provisions should form part of any forthcoming Petroleum Resources Bill?
Since Total's announcement in February 2019, the Government has stated that it intends to develop stand-alone legislation for the oil and gas sector and in September, the Minister announced that “The department has begun with the process of developing a Petroleum Resources Development Bill.” To date however, no such Petroleum Resources Development Bill has been published. It is hoped that developing a separate oil and gas policy will correct some of the uncertainties that have plagued the sector as a consequence of its regulation together with minerals under the MPRDA.
The most important role of the legal framework governing the resources sector is to ensure that the sector contributes to the wider economy and avoiding the pitfalls of resource-rich countries. First and foremost, this means putting transparency and accountability at the centre of the legal framework. Africa is in many respects at the forefront in this area, with initiatives such as the Extractive Industries Transparency Initiative (EITI) making significant progress in promoting transparency in the sector. This includes publication of contracts, disclosure of sector data and beneficial ownership. However, these requirements are only effective if they are implemented in a wider environment of effective national governance, notably with respect to political stability, the rule of law and effective institutions. Unfortunately, where these elements are missing, the governance deficit will have a greater impact in resource-rich countries.
The Natural Resource Governance Institute’s Resource Governance Index (RGI), which assesses governance in 81 resource-rich countries, provides an interesting look into where South Africa is performing well and where improvement is needed. South Africa is ranked second in Africa (behind Botswana) for its ‘enabling environment’, broadly covering voice and accountability, government effectiveness, regulatory quality, rule of law, control of corruption, political stability and absence of violence and open data. Compared to many other jurisdictions in the region, South Africa’s overall governance environment gives it a natural head start, particularly as a jurisdiction with a long history of managing natural resources.
However, at the same time, the RGI ranks South Africa 23rd out of 31 Sub-Saharan African jurisdictions on licensing, identifying a number of shortcomings in South Africa’s licensing regime. Although the current legislation (under the MPRDA) provides for a degree of visibility as to bid qualification and disclosure of bidder information, that transparency diminishes significantly post-award. For instance, the MPRDA does not require the disclosure of winning bidders or blocks allocated. Most strikingly, although exploration and production rights must be registered with the Mineral and Petroleum Titles Registration Office, the registry is not accessible to the public. By contrast, Ghana has established a comprehensive and accessible online Petroleum Register6, managed by the Petroleum Commission pursuant to the Petroleum (Exploration and Production) Act, 2016. A publicly accessible cadastre or title registry in South Africa would contribute substantially to transparency public accountability in the sector. An accessible registry would also significantly improve title security for prospective investors.
The last decade has seen an increase in legislative reform in the resources sector in Africa, with a mixture of objectives and results. A resurgence in resource nationalism across the continent has in some cases led to a blunt rebalancing of economic terms between the State and the investor, with little confidence that a better-governed industry will emerge. Elsewhere, reforms have contributed to greater accountability and more robust regime, to the benefit of both host States and investors.
With the momentum of Total’s discovery earlier in the year and the promise of an emerging player in the oil and gas sector, 2019 may be South Africa’s best opportunity to set the legal framework for a successful and productive domestic oil and gas industry.
While it is impossible to say what the new proposed Petroleum Resources Development Bill will include, if correctly considered, this will encourage investment and investor confidence in the sector. In order to encourage such investment, the Petroleum Resources Development Bill will need to create an environment of certainty and predictability in relation to licensing and enforcement. In addition, provisions encouraging exploration should be included to "jump-start" the activity in the country together with clearly defined parameters for the involvement of the State and historically disadvantaged persons at commensurate / proportionate levels in such activities.
Provisions relating to licensing of exploration and production activities must, among other things, (i) be easy to comply with, potentially including the ability to make full applications through online portals; (ii) provide precise time frames within which applications must be decided and (iii) should also limit the exercise of discretion by the relevant authorities as far as possible to increase the sense of certainty and predictability in the licensing process.
The World Bank recently published the "Doing Business 2020" Report which compares business regulation in 190 economies in which South Africa's ranking dropped from 82 to 84. The report’s ease of doing business score compared South Africa’s business environment between 2017/18 and 2018/19, whereas the doing business ranking assessed South Africa’s performance in relation to the other 189 economies analysed in the study. Despite a marginal increase of 0.3 in the ease of doing business score, South Africa is viewed as lagging in the areas of trade facilitation and business incorporation.
Certainty and predictability in legislation applicable to the oil and gas sector could help improve South Africa's ranking in such studies encouraging investment, both internationally and locally, in the sector and the country as a whole.
What are some examples of best practice from other companies / countries in relation to the oil and gas sector?
South Africa has the potential to be one of the next big frontiers in oil and gas, particularly in Africa, provided discipline and foresight is shown in relation to the policy environment within which the sector operates.  When Parliament prepares the draft Petroleum Resources Bill, it should consider the approach adopted by jurisdictions where the oil and gas sectors are thriving.
A good example of a well-constructed policy framework in the oil and gas sector is Norway – the third largest exporter of natural gas and 13th largest exporter of oil in the world. The petroleum sector is the country's single largest sector. Norway has been considered leading example of successfully implementing policies to develop the oil and gas sector.
The main reasons attributed to Norway's success in regulating the oil and gas sector, as well as its broader economy as a result of this sector, include:
the successful separation of the main players representing the Government. In other words, Norway established the Ministry of Petroleum and Energy, a separate regulatory agency, the State oil company, and another separate entity responsible for the financial interests;
through the regulation of concession rounds, the Norwegian government has both controlled pace of production in order to maintain a steady investment in the economy avoiding the so-called "Dutch disease" (also guarded against through the establishment of the creation of a petroleum fund) and strengthened local engagement in the oil industry by stimulating oil companies to buy more local goods and services;
ensuring the transfer of technologies and know-how from the International Oil Companies to the local industry, including by ensuring foreign contractors transfer knowledge to local suppliers through establishment of joint ventures; and
by analysing, at strategic points, the performance of local suppliers in order to adjust policies to better stimulate such entities.
A second more local example is Mozambique which has recently been spotlighted for its discoveries of an estimated 190 trillion cubic feet of natural gas reserves. These reserves have attracted investment of over US$ 50 billion to its economy (the largest investments of their kind in Africa), and a further US$ 30 billion anticipated investment in commitments. Although the oil sector in Mozambique is in a state of relative infancy, the gas sector is thriving as a consequence of the pragmatic framework within which the gas and finance sectors are regulated. Five concession rounds culminating in the granting of rights to explore and produce petroleum have been concluded.
In 2001, Mozambique undertook a review of its Petroleum Laws in order to ensure transparency, accountability and competition in the sector. The revised legislation also reinforced the role of the State and the protection of national interests.
Presently, the sector is regulated through a number of laws and decrees, including the Petroleum Law, 2014. The legal framework is also supplemented by concession contracts which stipulate the rights and obligations of the concessionaries and Government.
For over thirty years, Norway has provided petroleum-related support to Mozambique and since 2005, both countries have cooperated within the Oil for Development Programme (OfD Programme). Through the OfD Programme, Norway shares its four decades of experience in petroleum management with developing countries. The partners involved in the programme include multilateral actors such as the IMF and the World Bank.
In 2014, a new four-year programme was signed between Norway and Mozambique which encompasses four elements of holistic programming, namely, resources, revenue, environment and safety. Through the OfD Programme:
the Petroleum Safety Authority Norway (PSA) has assisted the National Petroleum Institute (INP) in allocating licences;
contractual issues between the new fifth round concessionaires and the Mozambique Government were addressed and aligned and five Exploration and Production Concession Contracts (EPCCs) were concluded. In addition, legal advisors financed through the OfD programme assisted INP in revising the old EPCC.  The new EPCC will provide a model for future licensing; and
standard contracts for multi-client seismic data collections were completed by the INP (with support from the Norwegian Petroleum Directorate’s consultants).
The exclusive rights to explore and produce petroleum within a certain geographical area are awarded through EPCCs (referred to above) which have progressively been amended in a gradual fashion towards the practice of awarding concessions to groups of companies within a designated operator. A number of other standardised model documents have also been developed by the Mozambican government following the international best practice example of Norway.
The main clauses in EPCCs are subject to publication in the official gazette in order to promote transparency and accountability. This, however, is considered a unique feature as in other jurisdictions such contracts are treated as private and confidential.
Investor confidence has steadily increased in Mozambique. An important indicator of this is the Board of Executive Directors of the World Bank Group's decision (on 20 June 2019) to approve US$ 420 million of International Development Association grants and guarantees to strengthen Mozambique's transmission capacity for domestic and regional markets and increase electricity generation through private sector investment. The project was also co-financed by US$24 million in grants from the Norwegian Trust Fund. The project will support the construction of a 563 km high-voltage transmission line between Maputo and Vilanculos/Temane and the private sector financing of a 400-MW combined cycle gas-to-power generation plant.
From a financial regulatory perspective, authorities in Mozambique approved several statutes in order to attract and maximise foreign direct investment in the country and reduce the red tape faced by investors. For example, in 2017 Mozambique's Parliament amended laws to provide that foreign direct investment be registered with a commercial bank within 90 days after such investment is made. Previously, prior authorisation from the Central Bank was required for such investment. Further, entities entering EPCCs are permitted to maintain bank accounts in both national and foreign currency, open bank accounts abroad for purposes of receiving revenues from export and disbursements of credits and investments, and (subject to applicable tax and other obligations) repatriate profits and dividends.
Opportunities in the oil and gas sector in South Africa are viewed as an extremely positive economic lever to catalyse economic growth in the country. To ensure that this occurs, a clear, concise, economically viable and socially acceptable regulatory framework must be created. Only this will promote, rather than discourage, investment in the sector.
By Peter Leon, Partner and Africa Co-Chair, Herbert Smith Freehills LLP, 5 November 2019