George Comyn and Hamish McArdle of Baker Botts take a closer look at the petroleum industry in Nigeria.
"The importance to Nigeria of creating a transparent and efficient upstream oil and gas sector is clear."
Nigeria is Africa’s biggest producer of oil and the world’s fourth biggest exporter, producing around 2.3 million barrels of oil per day (BOPD). Despite predictions of production reaching 4 million BOPD by 2010 it has stagnated, and today lies at levels similar to those of the 1970s. This failure to increase and maintain production levels can be attributed to a combination of factors including insecurity, political and legal uncertainty, and competition from emerging continental rivals offering more attractive business and fiscal markets.
With estimated proven reserves of 37.2 billion barrels, and a number of new offshore projects scheduled to come online there is scope for oil production in Nigeria to increase in the medium term. Much depends on market confidence and sustained investment, which in turn depend on the long-awaited and much-debated Petroleum Industry Bill (PIB). This article reviews key fiscal, commercial and regulatory changes proposed by the PIB, and discusses how the PIB may address the challenges facing Nigeria’s oil and gas industry.
The Nigerian economy is heavily dependent on its hydrocarbon sector, which accounts for more than 95 per cent of export earnings and more than 75 per cent of federal government revenue. Accordingly the failure to maintain and increase oil production has had a significant impact on the Nigerian economy, notwithstanding the consistently high price for crude in recent years. The aim of the PIB is to address this decline in production, investment and competitiveness by establishing a transparent and attractive environment in Nigeria within which domestic and foreign oil companies can operate.
The Petroleum Industry Bill
In 2000, to bring about comprehensive industry reform, the Nigerian government established the Oil and Gas Sector Reform Implementation Committee (OGIC). Subsequently OGIC was charged to make recommendations for establishing a new regulatory and institutional framework within the Nigerian oil and gas industry, and in a 2008 report OGIC published their recommendations. The first draft of the PIB followed the 2008 report and set out a framework for the restructuring of Nigeria’s hydrocarbon sector, clarifying the regulatory and operational roles of the various Nigerian energy institutions, increasing the government’s share of revenues, and increasing and mandating local content requirements. Several iterations of the PIB followed, none of which passed into law, mainly due to opposition to the projected economic effect of some of the PIB’s provisions. Lack of support from key stakeholder groups (notably IOCs), presidential elections in 2011, ongoing parliamentary debate and the promotion therein of diverging versions of the PIB have all contributed to the slow progress of the PIB through the legislature.
In July 2012 the latest version of the PIB (PIB 2012) was presented by President Goodluck Jonathan to the country’s National Assembly. Unlike previous drafts of the PIB, which were debated in a less commercially sensitive environment, there appears to be a relatively unified and renewed commitment within the Nigerian government to ensure that PIB 2012 passes swiftly into law.
PIB 2012 aims to make the Nigerian oil and gas industry more transparent, productive and attractive to foreign investment, and to this end 11 specific objectives are set out in Part I, Section 1 of the bill. Achieving these objectives requires significant regulatory changes the most material and sensitive of which are arguably: the establishment of a new tax and fiscal regime; and the restructuring of the institutional and the regulatory framework within the Nigerian oil and gas industry.
Importantly, PIB 2012 also provides for the deregulation of the downstream sector and the introduction of a domestic gas supply obligation. These matters are not addressed in this article.
New Tax and Fiscal Regime
Nigerian Hydrocarbon Tax
The Petroleum Profits Tax Act (PPTA) will be repealed and petroleum profits tax with be replaced by the Nigerian Hydrocarbon Tax (NHT). NHT will be “levied upon the profits of each accounting period of any company engaged in upstream operations during that period” at: (1) “50 per cent for onshore and shallow water areas”; and (2) “25 per cent for bitumen, frontier acreages and deep water areas”.
The profits on which the NHT will be levied are calculated as per section 304 of PIB 2012 and as well as the proceeds of sale and value of oil and gas, any income “incidental to and arising from” that companies “upstream petroleum operations” is included in the chargeable profits. In accordance with Section 313(2) of PIB 2012, if a company has assets in different geographical areas (for example both deepwater and onshore assets) the appropriate NHT rate will be levied on the “proportionate parts of the chargeable profits arising” from each area.
Stricter limits on permitted deductibles in the calculation of profits for NHT purposes are introduced with a view to increasing Nigeria’s taxation revenues. Prohibited deductions include (i) income tax, profit tax or similar taxes whether charged within Nigeria or elsewhere (except in accordance with the Education Tax Act); (ii) penalty payments relating to gas flaring or domestic gas supply obligations; and (iii) interest expenses incurred in upstream operations under a Production Sharing Contract (PSC).
Corporate Income Tax
Whilst the proposed NHT rates are lower than the to-be-repealed petroleum profits tax rates – currently 50 per cent for deepwater operations and 85 per cent for onshore and shallow water areas – as a result of PIB 2012 upstream companies will incur an additional income tax charge that under the existing tax regime is only applied to downstream companies. This will be achieved through an amendment of the Companies Income Tax Act (CITA), so that companies operating in the upstream and the downstream are required to determine their CITA liability separately, and that any NHT payable by an upstream company is not deductible for CITA purposes.
General Production Allowance
Currently contractor parties to PSCs are entitled to investment tax credits (if a pre-1 July 1998 PSC) and investment tax allowances (if a post-1 July 1998 PSC) that act to reduce, respectively, the tax or taxable profits paid by those companies. PIB 2012 will replace investment tax credits and allowances with a General Production Allowance (GPA) which will act to reduce taxable profits and will be calculated dependent on: (i) location of asset (for example whether the asset is onshore, in shallow/deep water, or is frontier acreage); (ii) production volume; and (iii) price per barrel received versus an “official selling price”. As the GPA will not act as a direct reduction of tax payable, it is likely to have more of a negative impact on the total economic value of a pre-1 July 1998 PSC to its contractor parties. Specific provisions regarding the GPA for gas-producing companies are set out in PIB 2012.
PIB 2012 does not address specifically the fiscal position under PSCs creating some uncertainty as to the overall economic effect of the new law on existing PSCs and future PSCs.
Failure to Pay Tax
PIB 2012 will reduce the penalty levied against the amount of unpaid tax from 200 per cent of the unpaid tax to 10 per cent of the unpaid tax plus interest. Arguably this may reduce the incentive of companies to make timely payment of their tax liability.
Upstream Institutions and Regulations
The regulatory and institutional framework of the Nigerian oil and gas industry will be significantly reformed by PIB 2012. The role of the Minister of Petroleum Resources will remain largely as it is at present, so that the Minister is “responsible for the co-ordination of the activities of the petroleum industry” and is to “exercise general supervision over all operations and all institutions in the industry” (Section 5, PIB 2012). The Petroleum Technical Bureau will be established to provide technical and professional assistance to the Minister and support in developing and implementing government policy.
Changes to Upstream and Downstream Regulatory Bodies
Two new regulatory bodies will be created: the Upstream Petroleum Inspectorate (UPI) and the Downstream Petroleum Regulatory Agency (DPRA), both organised as state-owned corporate entities. One reason for their establishment as corporate entities is to enable them to attract personnel with the requisite qualifications and skills, so that they function more efficiently than a pure government run entity.
Covering the upstream, the UPI will have both technical and commercial functions. It will be responsible for the administration and enforcement of policies, laws and regulations in the upstream industry as well as having responsibility of conducting bid rounds and issuing and administering licences and leases. As would be expected, one of the primary functions of the UPI is to ensure the payment of royalties and fees, and in doing so it will support the Nigerian Federal Inland Revenue Service.
Covering the downstream, the DPRA’s technical, commercial and regulatory functions include the administration of all downstream licences and authorisations and the facilitation of gas supply to strategic sectors of the Nigeria economy in accordance with an approved national gas pricing framework. One important aspect of the DPRA’s remit, concerning the regulation of refining in Nigeria, is not addressed in detail in PIB 2012. Whilst PIB 2012 provides that further regulations in relation to refining may be made, they are not elaborated on. As refining capacity in Nigeria is a critical issue at present, this omission is surprising.
Significantly, in terms of overall regulatory competence and ownership of upstream oil and gas assets, PIB 2012 proposes that the functions and assets of the Nigerian National Petroleum Company (NNPC) be divided into three new entities: the National Oil Company, the National Gas Company and the National Petroleum Assets Management Corporation, which will have a subsidiary management company. Apart from the fact that the National Petroleum Assets Management Corporation will acquire and manage all of NNPC’s unincorporated joint venture assets, the process of allocating NNPC’s remaining assets between the three new entities is not finally determined.
Many commentators have questioned the splitting of the NNPC and the subsequent division of NNPC assets between three separate entities. It was widely predicted that PIB 2012 would mandate the incorporation of NNPC as a single entity under the Companies and Allied Matters Act, which, following incorporation, would be partially privatised as a means of raising financing (in a manner similar to Brazil’s Petrobras and Statoil of Norway). The thinking was that if NNPC was incorporated in this manner it would become a stronger national company holding all of its existing oil and gas assets, but permitting their management and financing (possibly through part privatisation) in the same way as a private entity. In the current form of PIB 2012 the model of a more flexible and commercially focused national champion is unlikely to be achieved and some of the more obvious restrictions which result from direct state control are likely to continue.
Transparency in Granting Upstream Licences and Leases
Openness and transparency in the granting and administration of upstream concessions in Nigeria is acknowledged as a critical component to ensure a favourable investment climate which, in turn, should facilitate the desired increase in oil and gas production. It is a positive signal to the industry that PIB 2012 provides that licences and leases shall be granted by the Minister to a successful bidder only after an “open, transparent and competitive bidding process conducted by the Inspectorate” (Section 190 of PIB 2012). However, such transparency and clarity is arguably undermined by a provision of PIB 2012 that enables the president, at his discretion, to directly grant licences and leases without reference to an open and competitive bidding process. The failure of PIB 2012 to remove the discretion of the President to award upstream interests outside of a transparent bid process is arguably a significant failure and contrary to a key objective of PIB 2012, to promote openness and transparency in the Nigerian oil and gas industry.
The importance to Nigeria of creating a transparent and efficient upstream oil and gas sector is clear. The new resolve to adopt PIB 2012 into law is a positive sign. As illustrated in this article, there are some important issues for the industry that are not resolved by PIB 2012 in its present form. If these issues are not addressed in the protracted legislative process currently taking place, it is possible that the wider objectives of the legislation may not be fully achieved.