Putting the PSC Act Amendment in Perspective
On Tuesday, 29th October 2019, the House of Representatives concurred with the Senate in amending the law governing the Production Sharing Contracts (PSCs) in Nigeria’s oil sector. The amendment, which was initiated by the executive arm of government and was signed by President Muhammadu Buhari yesterday, has been hailed as a historic milestone. And indeed it is, for many reasons. But the amendment has also been dismissed by some, even if in muffled tones, as desperate, unrealistic, badly-timed, and short-sighted. Such reservations and pushbacks should also be expected.
But given that the original PSC law categorically included unambiguous conditions that should have necessitated review(s) of the terms of the PSCs first in 2004, then in 2008, and in 2013 and 2018 if the 2008 review had taken place, it is clearly unrealistic to expect that the incentives frontloaded to oil companies for taking major risks at a period of uncertainties would be in perpetuity. A March 2019 report done by the Nigeria Extractive Industries Transparency Initiative (NEITI) and Open Oil stated that failure to review the PSCs terms, as demanded by the law, cost the country between $16.03bn and $28.61bn within 10 years (2008 and 2017).
That is a loss of between $1.6bn and $2.86bn on the average per year within that period. Observers can postulate about how much difference that additional revenue would have made for Nigerians, if judiciously spent; and they can even speculate about why a country in dire need had left such a princely sum on the table for so long. While one exercise may be mostly academic, the other may be quite speculative, except there is clear evidence of collusion, a possibility that should not be ruled out. However, and no matter how those opposed to the review spin it, there should be little doubt about its necessity and the inevitability.
A quick background on the PSCs, its defining nature, and its governing law will help put things in perspective. In the late 1980s and early 1990s, oil prices were very low and Nigeria was struggling to meet its
cash-call obligations for the Joint Ventures (JVs), which for a long time accounted for more than 90% of oil produced in Nigeria. The country was also keen on expanding its oil reserves. To achieve these multiple goals, the country turned to an oil production/contractual arrangement called the PSC, pioneered by Indonesia in 1967.
Under the PSC arrangement, the country as the sole owner of the oil engages contractors to provide technical and financial services for exploration and production. The PSCs are a form of PPP, if you will. When successful, the contractor pays rent on the right to extract (royalty), recoups its costs, takes a major chunk of the profits over the life of the project, and pays taxes due on its profits. Fruits (oil) of PSCs are usually shared this way and in this order: royalty first (which goes to government), then the cost (which goes to the contractors), then profit (shared by the government and the contractors, but more to the contractors, as high as 80% in the early days), then tax on profit (paid to the government).
Based on its tight financial situation and its reserve aspiration, Nigeria did not have much leverage when the first PSCs were rolled out in January1993. Besides, the technology for offshore exploration was expensive and uncertain. So the country gave and frontloaded a lot of incentives. While the royalty rate for JVs was 20%, the one for PSCs was graduated from 16.67% for oil production within 200 metres water depth to 0% for production from 1000 metres. This is the crux of the matter, which will be addressed shortly. Also, the tax rate for PSCs was 50% of chargeable profit, instead of the 85% for JVs. It is important to note that companies are allowed to recover their capital and operational costs before profit oil is shared and that companies get 50% investment tax credit or investment tax allowance on qualifying expenditure before tax is paid.
Given the economic and political uncertainties of the period and the fact that this was, literally, uncharted waters, the generous incentives made sense. However, it was reasoned that these liberal incentives would be superfluous at a price point and after some years because the costs would have been recouped and the risks taken would have been substantially rewarded. The first set of PSCs started in 1993 as contracts. To give additional comfort to the contractors and reinforce government’s commitment, the terms were set out in cold and clear letters of a law.
Thus the Deep Offshore and Inland Basin Production Sharing Contracts Decree (No 9, 1999) was promulgated on 23 March 1999, with 1st January 1993 as commencement date. On 10th May 1999, less than two months after, the decree was amended as Decree 29 of 1999 to extend the years of review of the terms from 10 years to 15 years and after oil price exceeds $20 per barrel. The decree later became the Deep Offshore and Inland Basic Production Sharing Contracts Act, Cap D3, Laws of the Federation of Nigeria (LFN), 2004.
In Section 16, the law had two trigger clauses or conditions for the review of terms “to such an extent as the PSCs shall be economically beneficial to the Government of the Federation”: when oil exceeds $20 per barrel, in real terms, and (irrespective of if this happens), fifteen years after and every five years thereafter. As stated earlier, the $20/barrel (adjusted for inflation) threshold was reached in 2004, but no review happened. On 26 July 2007, a letter from the Department of Petroleum Resources gave notice to the contractors that the 15-year mark would be attained on 1st January 2008 and the review would commence. But nothing of such happened on that date. If the 2008 review had taken place, two other reviews would have been necessary in 2013 and 2018. Needless to say that nothing of such happened.
Beyond the need to abide by the spirit and the letters of the law, two developments make the review inevitable: one, oil production from PSCs started to surpass the oil from JVs from 2012, with PSCs now accounting for over 40% and JVs now about 30%); and two, roughly 80% of PSC production attracts no royalty at all, because they come from water depth of 1000 meters and beyond. Agbami, Akpo, Bonga, and Erha—Nigeria’s most prolific fields— are beyond 1000 meters.
This means that in 2016 for example (when PSCs accounted for 49.2% of total oil produced in Nigeria), 39.3% of Nigeria’s total oil production attracted no royalty at all. Put differently, this means that no rent whatsoever was paid on four out of every 10 barrels of oil extracted from Nigeria that year. It is clear that at some point someone would summon the will to activate the review that the law not only foresaw but mandated.
Apart from assigning responsibilities and sanctions for subsequent reviews, the major highlight of the amendment is that all PSC productions will now attract royalty based on a combination of water depth and oil price. For productions from 200 meters, royalty rate now ranges from 10% when oil price is below $20 per barrel to 20% when oil sells above $150 per barrel. A review of the royalty rates for PSCs in different countries does not support the claim that the new rate is not competitive.
It is also important to state that other elements of the suite of incentives for PSCs in Nigeria remain intact. The tax rate is still 50% of chargeable profits, instead of 85% for JVs. The investment allowances (ITC/ITA) still remains at 50% of qualifying expenditure, and this will be before arriving at taxable profits. Cost recovery, cost determination, and cost consolidation issues have not been addressed.
The point is that as there are those protesting the amendment there are those who do not think it is far-reaching enough. For sustainability, a fair balance must be struck between the interests of the resource owner and of the contractors. Also, it is in the interest of both parties that the reviews mandated in the law are abided by, otherwise they open themselves up to charges of collusion. It is possible that nothing untoward happened in the periods when the triggers of the PSC law were observed in the breach. But given that resource-rich environments are low-trust spaces it is imperative to stay above suspicion by always keeping to the terms of the law in a transparent, responsible, and accountable manner.