TIME TO REVIEW OUR OIL & GAS ACT AND THE MINING ACT

By CHARLES KERUA

Background
I am prompted to write this after reading an article on the Australia’s Financial Review on a court battle between Oil Search Ltd & Inter Oil Ltd over the development rights (or pre-emptive rights) of the Elk-Antelope oil fields in the Gulf Province; a ruling which is expected to be handed down this March 2015 in London, UK. Many intelligent people will agree that our State & its people have “thrown away” so much of our natural resources so cheaply in the name of foreign investment and foreign capital injection. (Let us keep our discussion within the mineral & petroleum sector, and leave for a while other equally important sectors like forestry and fisheries). Proponents of foreign direct investments (FDIs) in our extractive industry have meticulously “seasoned” the spin offs, or so called “economic benefits”, of FDIs such as job creation, substantial foreign reserve base/cover, and tax revenue as a rosy cover to lure the State & its people into committing so much of our natural resources. However, looking at the other side of the coin, the picture is different. The State, on behalf of the people of PNG, may have unwittingly given up so much in exchange for an exceedingly lesser returns on our natural resources. We have become losers in most of these resource development deals since the 1980s beginning with the Bougainville Copper mine (BCM). Have we been exploited by foreign investors? We wonder. And the answer is “Yes” - we have been exploited to the core and our natural resources been “raped” with much consequences to our society and the environment. (As it is not the focus of this topic, let us self for a while the important discussion on social ills & environmental damage and degradation caused to our society and environment by the activities in the extractive industry).

Evidence of Loss Revenue in the Mining Sector (1982-2002)

Evidence from recorded data reveals the bleak reality of how Papua New Guineans have lost considerable amount of revenue in the extraction and sale of our natural resources. Between 1982 to 2002, PNG's extractive industry has reported to have extracted and sold K24 billion (2002 kina value) worth of minerals. And what portion of this remained onshore, including tax revenue, for the people of PNG? A mere 14.5%- which means 85.5% of the total proceeds from the extraction of our resources gone off shore to foreigners, either remitted out as capital expenditures, wages of foreign workers or dividends to foreign shareholders.

Leakages in the System


We need to close this massive leakage if we are to fully participate and benefit from our natural resources. Since the days of BCM we have been so generous to foreign multi-national corporations. We have given, and surprisingly continue to give, tax holidays, our “rights of ownership” over land and resources through prospecting & development licenses, exemption of import duties on capital equipment, and so generously giving without free-carry interest conditions to multi-national corporations. Ironically, most of these billion-dollar corporations’ total budgets and profits dwarf PNG's National Budget, or even the GDP. There are fears that imposing new rules or instituting aggressive regulatory regimes might act as a deterrent for these so called “most crucial economic players” to invest in our economy. Whether or not investors may react to these regime changes in the 21st century is something for the academicians and researchers to tell us. However, one truth that still remains is: so long has the global population maintains its growth, the demand for natural resources and the “hunt” for the natural resources to feed this demand will continue to co-exist. Hence, the notion that regime change will scare corporate conglomerates to invest in PNG is still a mare bluffing.

Options To Close the Leakages

The thrust of this article is to promote the idea of how we can close these unwarranted leakages of “our” revenue to foreign hands so that we can divert them internally to develop our economy. This is not to say we forget the interest of our foreign investors. Off course we need a win-win situation so that our foreign friends who come in to develop our natural resources make a “reasonable” return on their investment. The problem, however, lies in the State’s understanding of the term “reasonable return”. Most often, I suppose, we have given little consideration to understand the balance between how reasonable is a “reasonable return on investments” and how reasonable is the State’s willingness to give away our wealth. Have the State given away too much of our resources to foreign investors in guise of FDIs? I would likely think so. Contract negotiations by our governments with resource developers are held behind closed doors, while the general populace and resource owners are kept uninformed and suspicious. Most often we have seen resource owners being “dragged in” and “forced” to accept certain terms of the agreements relating to royalty payments that may or may not be in their favor in the long term. Have the “powerful” multi-national corporations thrown down our throat and dictated how much we should take? Since everything happens behind closed doors, we would not be able to understand the aggressions of corporate muscle and the State’s bargaining positions to counter these effects on the deals to our advantage. Only those representatives who are in the inner circle of negotiations would have a better knowledge. To stop such leakages, three approaches are recommended or proposed: (1) Increase Royalty Payments, & (2) Impose Free-carry Interest, and (3) Apply Corresponding Corporate Tax Reductions. A “proper combination” of the above three approaches can be used together to maximize the States returns on the sale of our natural resources. I’ll elaborate these three approaches further below.

Increase Royalty Payments

The first step is to increase the State’s share in “royalty payments”. Current royalty payments paid to our landowners and the State are calculated based on the “well-head value” (or “mine-head value”) of natural resources. Usually, wellhead (mine-head) value is derived by calculating the “gross value” of the total value of minerals (gold, copper, oil or gas) recovered from the project and deducting all the costs incurred for the project to the point of sales. These deductible costs are costs associated with the extraction, processing, storage and transportation of extracted (and/or refined) minerals to the point of sale. (Note that the details and methodologies of how such calculations done for our natural resources should be provided as a separate schedule by our respective regulatory authorities such as the Mineral Resources Authority or the Department of Petroleum & Energy). Under the existing legislations of Oil & Gas, the State is allowed a royalty of 2%, while the host provincial and local government is allowed another 2%, which is termed as the “development levy”. For the mining activities the royalty payable to the State is only 2%. All these royalty benefits are calculated as the proportion of the wellhead value and “not” based on the gross value. When comparing with other natural resource host countries, the royalty rates offered to us is significantly small. Our neighbor Australia, by law, have allowed for greater benefits under the royalty payment terms. In Western Australia, for example, the royalty rates for oil & gas development projects is around 10% based on the wellhead value. For coal in New South Wales in up to 8.2% also based on wellhead value. For Australian mining companies mining iron ore, the federal and state royalty rates are 6.5% and 22.5% respectively. In the USA, royalty payments to the State for producing oil & gas is around 12.5%, while some States in the USA are negotiating for still better terms. Russia also allows for better royalty terms which are around 6% and 8% for copper and gold productions respectively. These are few examples of other countries that have instituted favorable terms in royalty payments in their various legislative instruments.

For PNG, we must also improve our royalty rates. It is recommended that the State should look at increasing the royalty rates up from the current 2% to something better, for example between the range of 10-15%. In addition, we should look at calculating the royalty payments based on the “gross value” and not the well-head (mine-head) values. In the USA, for example in the States such as Kansas and Oklahoma are negotiating and bringing before the courts to change the old method of calculating royalties on well-head instead to base their calculations on the gross value oil & gas productions. If we take similar approach, we can maximize our value of our natural resources under this benefit sharing arrangement.

Impose Free-Carry Interest

A second approach, which can be used in conjunction with the first one, is to impose a “free-carry interest” condition in the development and extraction of our natural resources. Obviously, this has to be done by way of changing our existing laws governing our oil, gas and mining sectors. We need to learn from countries such as Ghana, Sierra Leone, Guinea and Ethiopia which respectively has a free carry interest of 10%,10%, 15%, and 5% in all mineral development projects. The South African government has made the headlines in 2013 for implementing free-carry interest policies on its oil and gas industry. It planned to have a 20% free-carry interest in all new oil and gas ventures and to acquire a further 30% at market- related rates. Also, while not going into the details, Saudi Arabia, a major member player in the OPEC, in the early 1930s developed a model through concessions that protected the interest of the State & its people from exploitation by foreign investors on its oil fields. Although the Arab state at that time had a weak bargaining power to negotiate favorable terms with the US giant Standard Oil Company of California, the wise king Rahman Al Saud cleverly inserted provisions in the agreement for reviews that later allowed them to negotiate favorable terms in ownership, profit sharing and share purchase options. From a 0 percentage (%) shareholding in 1933 in this oil producing company - Saudi Arabian Oil Company, the Saudi Arabia government increased its shareholding to 25% in 1973, 60% in 1974 and 100% in 1980. The Kingdom of Saudi Arabia now has full (100%) shareholding in Saudi Arabian Oil Company and is boasting as one of the largest oil producing companies in the world. These are few examples of what other States as custodians of their people’s resources have done. For PNG, we need to look out abroad, think ahead and learn from these countries to design policies and legislations that can give us the possible maximum returns on our natural resources.

Reduce Corporate Tax on the Extractive Industry

The third proposition is to reduce the corporate income tax for companies extracting our oil, gas and mineral ores. This is considered as a balancing approach. The principle idea behind this approach is in two facets: (1).To at least recognize the foreign investors for the loss they may have incurred as the result of the State imposing the above two approaches, i.e. increasing the royalty rates and for the free-carry interest, (2). The State’s “trade-off” of imposing increased royalties and free share interests. State’s revenue based on income tax is variable and can sometimes be as low as zero kina. We have seen such cases recently with Newcrest Mining Ltd in Lihir where the State never collected any revenue because the company reportedly made a loss. Revenue on income tax is unpredictable and unreliable which can have significant impact on the government’s fiscal forecast and needs. This is the same for dividend payments. If the companies make loss, the State cannot receive a dividend from these companies. To avoid such uncertainty corporate income taxes and dividend payments on all mining and oil & gas companies will never be considered as the main source of revenue generation for State on its natural resources. Instead, by imposing the above two approaches, the State is now in good footing not to panic when companies announcing losses. We just cannot rely on 30% tax revenue on declared profit as the reliable source of State’s income. There also risks of companies not reporting accurately or may even falsify balance sheets and profit and loss statements. We have seen cases like this in the USA where the accounting firm Arthur Andersen erroneously wrote the financial reports in what was then termed as the “Enron Scandal”. We have also seen cases with Newcrest Lihir which has been declaring loss after loss yet continues to produce gold bars. In such cases, tax revenue is always unpredictable. Reducing corporate tax rates while at the same time increasing royalties would place our State in better and predictable environment to meet its fiscal needs and develop our economy.

Setback of Our Mining Act 1992 and Oil & Gas Act 1998

Looking at our own governing laws for the extractive industry, the Mining Act 1992 & Oil & Gas Act 1998, there is no provision for a free-carry interest, compulsory future share transfer to the State, share options for State participation, or a provision to increase royalty payments. The Oil & Gas Act 1998 gives the State only the right (but not the obligation) to acquire up to 22.5% of interest in any oil & gas development projects, while Mining Act 1992 gives the State the right (but not the obligation) to acquire up to 30% of interest in any mineral development projects in the country. This right to participation is only allowed at the development stages, and not during the production periods. Using these provisions, we have seen the State through the former Somare government acquired 22.5% of the PNG LNG project through borrowed money from IPIC. Looking at it quite literally, I would consider this arrangement as a “national tragedy” when we had to borrow funds to buy our stake in our own natural resources. The current arrangement between the developers and the State is like this: The capitalists are coming in with their money into the country, buying out “full rights” for the use of our land through prospecting licenses and start looking for minerals. Once they have discovered some minerals, they give notice to the State to participate. But to do that, the State must bring in its required contribution as a proportion of the total project cost. (Whether or not the projects costing are properly done by the project proponents and not miss-leading is another important issue of discussion). Failure to provide these funds would be seen as the State not willing to participate and which gives the developers the automatic right to take full ownership over the project. The most logical question to ask against this type of arrangement is: Is the State being fairly compensated for offering its natural resources? This question becomes clear when we separate the State into two parts, one part as being an investor and the other as a resource owner. Under the current regulatory regime, the State is being compensated as an investor for participating in the purchase of share equity, either 22.5% oil and gas projects or 30% mining projects. The State, however, is never recognized or compensated as the owner of the natural resources. Therefore, it can be clearly noticed that we as resource owners have been unfairly treated and grossly underpaid under the current regulatory framework.

Conclusion & Recommendation

There are few recommendations I wish to provide after this lengthy discussion.

  1. Review the Oil & Gas Act 1998 and Mining Act 1992, especially those that are governing the royalty payments. Increase the 2% rate to some rate higher, between 10-15%.
  2. The royalty payments calculated must be based on the “gross value” and NOT “well-head or mine-head value”
  3. Reduce the corporate income tax of all mining, oil & gas producing companies from 30% down to a reasonable rate.
  4. A scenario analysis of the three approaches should be conducted to ensure the State gets the possible maximum benefit. It can also be used to find the appropriate corporate tax rate for the firms in the extractive industry.

Appeal and Advise To Our Politicians and Bureaucrats


As a general appeal to our government, let us reconsider and review some of the existing regulations that do not allow us to fully participate in benefit sharing. The rate at which we are giving in too easily to industrial lobbyists and multinational conglomerates is alarming and worrying. We need to take complete charge and control of our resources NOW! We should balance our current fiscal needs with the needs of the future generation. Our national leaders & bureaucrat should never be so quick and fuss about signing documents. They need, especially at this time, to critically analysis development prospects before putting the ink on any contract paper or issuance of prospect and development licenses. Let us think and do things better for the good of our country and its future.

Our politicians, law makers, and bureaucrats should be brave and think straight. Let us throw out of the window greed, ignorance and lack of understanding. Only strong man like Ghandi or Mandela “think” for their people, so lots hope to be such.