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21.01.2008 Feature Article

FRAMEWORK FOR MANAGING UPSTREAMPETROLEUM INDUSTRY IN GHANA

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The framework for managing the upstream petroleum industry in Ghana is established and given legal backing by two main statutes, PNDC Law 64 and the Petroleum Exploration and Production Law, PNDC Law 84, supplemented by the Petroleum Income Tax Law, PNDC Law 188 of 1987.

PNDC Law 64 established the Ghana National Petroleum Corporation and made it responsible for managing the petroleum resources of Ghana. The Law, in the main, spells out the organizational structure, the objects and modus operandi of GNPC. The supervising Ministry of the activities of GNPC is the Ministry of Energy.

The Petroleum Exploration and Production Law (PNDC Law 84) provides the framework for the management of oil and gas exploration, development and production in Ghana. PNDC Law 84 establishes the contractual relationship between the State, GNPC and the prospective investor in the upstream operations.

It provides the basic terms and conditions of every Petroleum Agreement negotiated and executed in Ghana and spells out the rights and obligations of each party to the Agreement, as well as sanctions that may be applied for any breach of obligations assumed under the Petroleum Agreement.

Flowing from the Petroleum Exploration and Production Law is the Model Petroleum Agreement (MPA). As the name suggests, the MPA guides the process of negotiating the terms and conditions of a Petroleum Agreement among the parties thereto, namely, GNPC, Government of Ghana and the oil company. The Petroleum Agreement embodies the final terms and conditions to regulate the intended petroleum operations.

Also, the Petroleum Agreement defines the under-mentioned parameters:

* The Contract Area (Block), that is to say, the delineated area where petroleum operations may be carried out by the oil company (Investor);

* the Exploration Period, that is to say, the limit in terms of duration for the exploration operations;

* the Work Programme, that is, the defined amount of work that the investor is expected to achieve in the Contract Area during the exploration period;

* the cost of work, that is, the agreed amount to be expended by the investor to carry out the Work Programme, during the exploration period;

* sanctions, in case of failure by the investor to achieve his work programme at the stipulated time;

* benefits, that is the level and nature of returns on investment to be enjoyed by the Parties under the Petroleum Agreement.

Monitoring of Operations

The Petroleum Agreement empowers GNPC to effectively monitor the operations of the oil company and apply sanctions through the Minister for Energy.

The monitoring is done through a Joint Management Committee (JMC) which is established by the Petroleum Agreement, comprising an equal number of representatives of GNPC and the Investor and chaired by GNPC. The JMC oversees, evaluates and enforces the implementation of the work programme of the Investor.

Relinquishment

The Law also provides that Investor relinquish periodically, areas of the awarded block that it is not working on. This provision of the Law is incorporated into the Petroleum Agreement to ensure its legal enforceability. The purpose of this provision is to ensure that the Investor does not unduly encumber the areas of the licensed Block under the guise of carrying on petroleum operations. Areas of the Block that are relinquished could be repackaged and allocated to interested investors.

Decommissioning

The Law makes it the Investor's obligation to reclaim the area of operations after the oil company has finished operations. This is to guarantee environmental safety and sanctity and to ensure that all unused installations by the Investor are removed to guarantee free and safe passage for sailing vessels and the re-use of the land.

PROCEDURES FOR OBTAINING AN EXPLORATION
BLOCK IN GHANA

GNPC has conducted a preliminary evaluation of the oil and gas potential of all our sedimentary basins and has packaged the potential into Blocks which are promoted to the international oil and gas industry.

This is done through presentations at various international oil and gas conferences, industry exhibitions and other forums. Interested investors visit GNPC for further data review and discussions. An application form is then completed and submitted to the Minister for Energy who then refers it to GNPC for evaluation and due diligence on the Company that has applied for a block.

GNPC then conducts the evaluation using the following criteria, that is, GNPC assesses and evaluates the Financial Capability, Technical Track Record, Proposed Work Programme and Budget, and the Fiscal Package proposed by the Investor. The work programme and the fiscal package are the two critical items for negotiations.

In addition to these, GNPC conducts due diligence on the Company to satisfy itself that it is duly incorporated as a corporate legal entity and it is free to conduct petroleum operations. GNPC further examines the competences of the investor's management and key technical personnel.

A comprehensive report, including the Board's recommendation, is then submitted to the Minister for Energy.

If the Company is found qualified in accordance with the set criteria, the Minister constitutes a Petroleum Agreement negotiation team to negotiate with the Investor.

The team includes senior officials from:

1. Ministry of Energy;

2. Ghana National Petroleum Corporation;

3. Attorney-General's Department; and

4. Internal Revenue Service.

The negotiated draft Petroleum Agreement is submitted to the Minister for Energy for review and thereafter it is presented by the Minister to Cabinet for consideration.

If Cabinet approval is obtained, the Agreement is then forwarded to Parliament for consideration, modification, where necessary, and ratification.

GNPC appears before the Parliamentary Select Committee for Mines and Energy to defend the Agreement and to clarify provisions or terms that might be questioned. It is only when parliamentary ratification is secured that the Petroleum Agreement becomes effective, and barring any other conditions precedent, the Investor is granted the licence to commence operations. Investors without strong financial capabilities are required to post performance bonds or provide bank guarantees to cover the risk of their inability to discharge agreed work programmes.

All Investors carrying on petroleum operations in Ghana are doing so within the framework of negotiated Petroleum Agreements that have gone through the above-described processes.

BENEFITS TO THE STATE FROM EXPLOITATION OF ITS
PETROLEUM RESOURCES

The benefits accruing to the State from any petroleum exploration and production venture is predetermined in the Petroleum Agreement approved by Cabinet and ratified by parliament before the commencement of the exploration activity.

Because of the risky nature of exploration and the fact that a venture could fail to result in a discovery, the parties always, and in line with international practice, negotiate how cost will be recovered and profits shared in case of a discovery and have the terms incorporated in the Petroleum Agreement. If there is no discovery, Investor bears his cost without recourse to the State.

Again, because of the risky nature of the exploration and production business and the State's desire to avoid high exposure in petroleum exploration and production activity, it has adopted the Royalty Tax System instead of the Joint Venture System which requires Parties and therefore the State to fund its portion of the project cost.

The main advantage of the Royalty Tax System, is that the resource owner, that is, the State, can get its resources exploited and receive benefits without making any financial contribution.

Under the system, the State derives its benefits from levies on production. The levies are:

1. Royalty;

2. Carried Interest;

3. Paying Interest;

4. Additional Oil Entitlement;

5. Petroleum Income Tax; and

6. Annual Surface Rental

Royalty
The Petroleum Law provides that the oil company (the Investor) pays royalty on production, but no figure has been fixed. However, the Model Petroleum Agreement, which is in use at GNPC and which was prepared by GNPC and the Commonwealth Secretariat and approved by Government, has stipulated the rate negotiable between 4% and 12.5%, which is the range most countries adopt.

Payment of royalty affects the profits of the operation, hence the industry practice has been to levy lower royalty rates on the more costly, riskier and deep sea operations, and then levy higher rate commensurate with the lower level of risk associated with the onshore and offshore shallow water operations.

Royalty is levied on gross production of oil and gas by the State irrespective of the profitability of operations. It can be taken in the form of oil or cash.

Carried Interest

Carried Interest is another source of revenue to the State. It is a participating interest in the oil exploration and production venture. Carried Interest is normally levied at a rate between 7½ and 15% in most oil producing countries. The same rate range is adopted in the Model Petroleum Agreement by the Ghana Government.

Carried Interest entitles the State to a share of the oil produced without making financial contribution towards exploration and development costs. Thus Carried Interest is levied after deduction of royalty and operating costs, but before the deduction of exploration and development costs from the total value of oil produced. It can be taken in the form of oil or cash.

Additional Interest

Additional Interest, which is a paying interest, is an option for which, if the State opts to exercise, will require the State to pay the proportionate share of only the development and production cost. No exploration and appraisal cost is paid by the State/GNPC. It is an option incorporated into the Petroleum Agreement to enhance the State's benefits.

This option is exercisable by the State within sixty (60) days after the Investor has determined that petroleum operations would be financially and commercially viable and profitable. There are various ways for paying this additional interest provided under the Petroleum Agreement:

i) One method is where all the partners in the venture including the State represented by GNPC agree to go for project financing from financial institutions, using the proven reserves of the block as security.

ii) A second method will be for the parties in the venture to pay for the State's proportionate share in the development and production operations. The State will reimburse the amount involved and interest thereon from its share of the oil produced over a negotiated period.

iii) The third method is where the parties agree to finance the venture from their own resources. This would require the State to find the resources to make payment upfront when cash calls are made.

Petroleum Income Tax

Petroleum Income Tax is a profit related revenue accruing to the State. For example, the marginal tax rate to be applied in the recent discoveries made by both Kosmos Energy and Tullow Oil is 35%. The tax can be levied in the form of oil or cash.

Additional Oil Entitlement

Additional Oil Entitlement which is also called “super normal” profit tax is additional profit tax that the Government is entitled to levy on operations in case of windfall profit, that is, where the Investor's actual internal rate of return exceeds the targeted rate of return used to evaluate the profitability of the venture during the negotiations.

MANAGEMENT AND CONTROL OF PETROLEUM OPERATIONS

There are several provisions in the Petroleum Agreement which enable GNPC to participate in the petroleum operations and at the same time to exercise control of management of petroleum operations.

Fiscal provisions allow the Investor to recover his cost in case of commercial discovery. Cost incurred by Investor directly affects the revenues to GNPC and Government. It is therefore important that GNPC and the Government closely monitor and control operations and cost. This is even more paramount since the resource belongs to the State and therefore the State/GNPC should have a say in its exploration and exploitation. How is this achieved under the Petroleum Agreement?

Article 6 of the Petroleum Agreement provides for a Joint Management Committee which enables GNPC to actively take part in the management of petroleum operations. The Joint Management Committee is made up of a minimum of two representatives each from GNPC and Investor and it is chaired by GNPC.

The key functions of the JMC are:

1. Discussions and approvals of Work Programmes and Budget;

Having approved the detailed work programmes and budgets, the Investor needs to submit its expenditure at the end of the budget period for approval. GNPC vets the expenditure and has the power to reject any expenditure not properly incurred in the calculation of the Petroleum Cost.

The Accounting Guide incorporated in the Petroleum Agreement which describes the way the accounts should be organized and presented, also provides another avenue for the control of cost through the financial reporting and GNPC's right at any point during the operations to audit the accounts of Investor.

2. The bidding process, evaluating and award of contracts to subcontractors, are all subject to the approval of the JMC and GNPC; and

3. The JMC has to approve all cost before they are accepted as Petroleum Cost and thereby, eligible for deduction for Additional Oil Entitlement and Petroleum Income Tax purposes.

The JMC is given power to approve all appraisal and development plans before submission to the Minister for Energy for final approval.

The JMC meets minimum of twice in a year.

In the interim, there are various periodic reporting requirements that Investor has to submit to GNPC. These include, quarterly operational and financial reports, yearly statement of expenditure, and any other reports that GNPC and the government would request from the oil company.

MONITORING OF PRODUCTION OPERATIONS BY GNPC

GNPC personnel are stationed on board the production platform or Floating Production Storage Offshore (FPSO) and other facilities where the oil and gas produced are metered. The GNPC personnel on board would submit daily, weekly, monthly, quarterly and annual production reports to GNPC. There would also be Customs representatives onboard all production facilities at all times. In addition, GNPC would arrange with the Navy for regular patrols in areas where production is taking place to protect installations and facilities and the product.

KOSMOS AND TULLOW DISCOVERIES

BENEFITS THAT WOULD ACCURE TO THE STATE

The benefits from any discovery are spelt out in the Petroleum Agreement before its execution. In the case of Kosmos/Tullow discoveries the State derives its benefits from Royalty of 5%, Carried Interest of 10%, Average Additional Interest of 3.75% and Income Tax of 35%.

Let us assume a production of 100,000 barrels per day, which is the minimum expected from the Mahogany/Hyedua Field in full field development. The computation of the State's benefits is shown in the Table below:

Fiscal Benefits to the State (Assuming 100,000 Barrels per day @ US $60 per Barrel Reserves of 500 million barrels and Production Period of Fifteen (15) Years

A. Gross Production 100,000 barrels per day
5% of A = 5,000 barrels a day


C. Net Production 95,000 barrels a day

D. Production Cost 10,000 barrels a day =
cash equivalent

E. Basis for Carried Interest C – D = 85,000 barrels a day
10% of E = 8,500 per day


G. Development Cost US $3 billion @ US $60 per barrel = 10,500 barrels a day

H. Basis for Additional Interest E – F – G = 66,000 barrels per day
3.75% of H = 2,475 barrels per day

J. Basis for Tax H – I = 63,525 barrels per day
35% of J = 22,234 barrels per day

L. Total State Share B + F + I + K = 38,209 barrels per day

From the above computation, oil accruing to the State would be calculated as 38,209 barrels per day out of 100,000 barrels per day production and this multiplied by an assumed long term price of US $60 a barrel amounts to US $2,292,540.00 per day which would translate to US $836,777,100.00 per annum.

A daily production of 200,000 barrels which could be achieved 5 years after commencement of production could give the State a total revenue of approximately US$1.6 billion per annum.

Other Economic Benefits

In addition to revenues due to the State from the fiscal arrangements in the Petroleum Agreement, petroleum operations, especially, development and production operations have the potential of transforming the economy through the participation of indigenous businesses.

The Petroleum Agreement provides for the use of Ghanaian goods and services in all phases of petroleum operations in so far as they are of quality and quantity comparable to industry standards and are priced competitively.

This is what is popularly known in the industry as “local content” defined as “the quantum of composite value added or created in the Ghanaian economy through the utilization of Ghanaian human and material resources for the provision of goods and services to the petroleum industry within acceptable quality, health, safety and environmental standards in order to stimulate the development of indigenous capabilities”.

Criteria for defining such local content include the following:

§ Percentage of Ghanaian Management in Service Companies set up in Ghana;

§ Infrastructural investments in Ghana;

§ Percentage of Ghanaian ownership in company;

§ Percentage of Ghanaian Employees (Skilled and Unskilled);

§ Percentage value of Services provided by Ghanaians;

§ Percentage Value of Ghanaian Raw Materials utilized;

§ Percentage Value of Ghanaian Finished Goods utilized;

§ Technology Transfer/Capacity Development Programmes;

§ New Employment Opportunities for Ghanaians; and

§ Ghanaian Participation in the procurement of imported goods.

GNPC is empowered to monitor the use of local personnel, goods and services. The Petroleum Agreement demands that the Investor submits his employment requirements, materials, goods and services requirements for operations to GNPC for approval.

Some of the ancillary business opportunities that might become available include the following:

§ Dedicated shorebase to where a dedicated mini harbour with large acreage of land for warehousing and services will be available to service the industry;

§ Onshore support and logistics;

§ Office accommodation for numerous oil service companies that will move to set up here;

§ Supply chain services to manage supplies to the Mahogany and Hyedua discoveries and to the entire West African sub-region;

§ Expansion and rehabilitation of the Takoradi airport;

§ Helicopter and fixed wing aircraft transportation;

§ Supply boats, anchor handling boats, diving vessels, etc;

§ Real Estate – housing of the numerous expatriate staff of oil companies and service companies;

§ Telecommunications, weather forecasting, search and rescue facilities;

§ Banking Services – financing for GNPC's interest, transfers, letters of credit financing rigs and supply vessels, importing foreign flags rigs;

§ Insurance – all equipment and facilities will have to be insured including the personnel;

§ Construction Opportunities:

- LNG pressure vessels

- Petroleum separation facilities

- Construction, installation and commissioning of offshore structures

- Pipeline manufacturing from steel

- Electrical wiring of platforms and vessels

- Installation and maintenance of instrumentation for production plants

- Welding and Joinery

- Hookup of structures already built in other countries

- Assembling of knocked down structures in the yards

- Expansion of the Tema Dry Dock to accommodate increased activity.

The challenge is whether the Ghanaian business community will respond to the opportunities by setting up training institutions and companies to train the requisite personnel for the industry and to supply the required goods and services, some of which have been identified above.

To address the issues, the Government of Ghana, in conjunction with its development partners, will be organizing a National Consultative Forum and Workshop on Oil Sector Development at which the issue of “local content” in the development of the oil sector will be comprehensively considered.

ENVIRONMENTAL MANAGEMENT AND CONTROL

In Ghana, both the Petroleum Law and the Petroleum Agreement demand strict adherence to the environmental laws and regulations of the country, specifically, the Environmental Protection Agency Act, Act 490 of 1994 and the Environmental Assessment Regulation, LI 1652.

In addition, the Petroleum Agreement requires strict adherence to best international oil environmental practices. The Development Plan in the Petroleum Agreement requires the Investor to clearly spell out how he intends to develop the field so as to have the minimum negative impact on the environment. This has to be done to the satisfaction of GNPC, the Ministry of Energy and the Environmental Protection Agency before the Development Plan can be approved.

Monitoring and Implementation

The Law requires Environmental, Health and Safety Audits of Investor's operations by EPA and GNPC. GNPC requires that a comprehensive Health, Safety and Environmental (HSE) Manual, detailing out how the Company intends to handle the health, safety and environmental issues, policies and procedures, is submitted for review and approval before any operations are commenced.

Emergency plans for handling accidents are discussed thoroughly among GNPC, EPA and the Investor before the commencement of operations. All these are also contained in the Environmental Impact Assessment Report required to be submitted to the EPA for approval.

Decommissioning or Abandonment of Fields

When production comes to an end, what happens to facilities that have been put in place for oil and gas production and the wells that have been used for the production? Whose responsibility is it to decommission, more so, as at that time the ownership of these facilities is vested in GNPC? (The Petroleum Law and Petroleum Agreement vest GNPC with title to all equipment and facilities purchased and installed for petroleum operations once the cost has been recovered).

Unfortunately, this issue comes up at the end of production when Investor has no interest in the project anymore; and the cost of properly decommissioning these facilities could be very high. This phenomenon of abandoning project sites after extraction of the resources has been responsible for several environmental disasters globally.

1. In our Petroleum Agreements with all Investors, the obligation for decommissioning is clearly placed on the Investor.

2. At the time of seeking approval to develop the field, Investor must include decommissioning proposals as part of the Development Plan.

3. The approved decommissioning plan must be reviewed and modified periodically to ensure that it remains consistent with the obligation to decommission.

4. At specified time during production, a decommissioning fund is required to be established into which funds would be set aside for the project revenue to carry out the decommissioning in accordance with the approved decommissioning plan. The fund would be audited each year and would be under the control of GNPC and the oil company. This decommissioning fund could be put into escrow accounts or operated as a trust account.

In addition, insurance policy would be taken to cover the unfortunate situations where decommissioning costs would be higher than the funds available.

CONCLUSION

The oil discovery is a good thing for Ghana. We can make it a “blessing instead of a curse”.

Wednesday, January 16, 2008

Accra Mail
Accra Mail, © 2008

The author has 73 publications published on Modern Ghana. Column Page: AccraMail

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