Oil and gas exploration in South Africa: in search of stability

By Peter Leon, partner, and Kevin Williams, senior associate, Webber Wentzel Bowens.

SA drilling programme on the back burner

In November 2005, BHP Billiton (and its US partner Occidental Petroleum) postponed drilling a deep water well in Block 3B and 4B off South Africa’s west coast, despite having secured a drill rig. Media comment at the time suggested that it would take at least two years to secure a new rig, owing to an international shortage. This is a major setback for the industry, as the BHP Billiton/Occidental drilling programme represents the first deepwater play off South Africa’s extensive coastline. The 130,000m² Orange Basin off the west coast is largely unexplored. Only 44 wells have been drilled, with six wells producing gas and condensate and four with positive gas results. In addition, a geological survey by Norwegian group PGS Geophysical noted that basin modelling indicated a high potential for oil. (Financial Mail, ‘South Coast tapped out: Hope turns to West Coast’, 9 September 2005).

Royalty uncertainty

The project was suspended owing to uncertainty regarding the level of royalties that will be payable to the South African government (the SAG), from 2009, under South Africa’s proposed Mineral and Petroleum Royalty Bill (the Royalty Bill).

The Royalty Bill is part of a comprehensive legislative process aimed at transforming the South African minerals and petroleum industries, the legislative anchor of which is the Mineral and Petroleum Resources Development Act 2002 (MPRDA). The Royalty Bill was initially published for public comment in March 2003. The Royalty Bill proposes a revenue rather than a profit-based royalty and provides for the following royalty rates:

“1% for natural gas and natural gas condensate petroleum crude offshore production where the water depths are deeper than 500 metres” and
“3% for natural gas and natural gas condensate petroleum crude onshore and offshore production where the water depths are shallower than 500 metres”.

The current figures are based primarily on rates in international mining royalty legislation. It seems that no empirical research in South Africa was conducted into the level of royalties that would ensure an appropriate balance between collecting part of the receipts of mineral, gas and petroleum sales, and exploiting South Africa’s diminishing natural resources as effectively as possible (or in the case of oil and gas, promoting exploration). While the royalty rates are in line with royalty rates elsewhere in the world, they do not take sufficient account of the circumstances of natural resource producers in SA, including the costs of implementing socio-economic reforms and black economic empowerment initiatives and managing the HIV/AIDS pandemic.

Over 130 submissions were received on the Royalty Bill, including well-researched and argued papers by the Chamber of Mines[1], Marius van Blerk, a director of Standard Bank and tax expert and Dr Fred Cawood, a geologist and academic at Wits University’s Mining Engineering Department. The Bill’s drafting team consulted widely with South African mining companies, banks, academics and other government departments, particularly the Department of Minerals and Energy. In September 2003, finance minister Trevor Manuel announced that the Royalty Bill would be reviewed before being introduced into parliament, but indicated that the revised Bill was likely to retain a revenue based royalty model, rather than adopting the profit based approach favoured by industry. No new draft of the Bill has, however, been published for comment.

Oil and gas rights in flux

Prior to the MPRDA’s entry into force on May 1, 2004, oil and gas exploration in South Africa was governed by contracts between the SAG and private companies known as “OP26 subleases” and oil and gas production by “OP26 mining leases”. The MPRDA’s transitional provisions (the much-debated Schedule II) give holders of OP26 subleases a limited opportunity to ‘convert’ to ‘exploration rights’ and holders of OP26 mining leases to convert to ‘production rights’. Once converted, the holder of these rights will be required to pay the state royalties under the Royalty Bill.[2] As the royalty rates for oil and gas have not yet been finalised (nor the basis for calculating the royalty liability), however, companies like BHP Billiton remain uncertain of their fiscal obligations. As a result, some very useful information about South Africa’s oil reserves remains unknown.

Tax incentives to be renewed in the MPRDA

Another issue is the status of certain tax incentives granted in the OP26 leases. In the SA National Treasury’s 2006 budget review, it noted that these incentives would be renewed in the legislation and also, encouragingly, stated that the proposed amendments would do away with the possibility of a 40 per cent discretionary surcharge on oil and gas profits provided for in the OP26 leases. The review also stated that amendments to tax legislation would provide for the accelerated depreciation of drilling equipment.

References

1. The Chamber of Mines’ calculations, based on 2003 resource price and exchange rate figures, indicated that the proposed 3% royalty on gold could lead to the sterilisation of over 600 tons of gold.

2. Although the MPRDA provides for the payment of royalties to the state, it does not specify the rate of such royalties. Instead, the MPRDA defines “state royalties” as “any royalty payable to the state in terms of an Act of Parliament”. In addition, sections 86(2)(c) and 86(2)(e) of the MPRDA place an obligation on the holder of a production right (for oil and gas) to pay the state royalties.

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