EDITOR’S NOTE: Michael McWalter, former Director, Petroleum Division and Adviser to the Government of Papua New Guinea, and erstwhile petroleum adviser to the Governments of Ghana, Liberia, Cambodia, Sao Tome, and South Sudan, comments on PNG’s oil and gas industry and changes to the petroleum regime made, muted, abandoned and planned.
Optimising Benefits for PNG - It is alleged that Papua New Guinea is not getting enough benefit from its petroleum resources and that the solution to such a problem might be for the Government to exact more demanding fiscal and commercial terms on sector investors. However, the same could be said about almost any source of Papua New Guinea’s revenue that we are not getting enough impact and outcome from the revenues that find their way into the Consolidated Revenue Fund of the Government.
One might deduce that either the quality of Government expenditure is poor and unfocused, or there is gross misuse and misspending of Government funds, but in reality it is likely to be a mixture of both. Efforts to address this problem have include the creation of a National Procurement Commission and support for transparency by the Prime Minister of what has often been called a systemic problem.
But when it comes to petroleum resources, we must remember that it is after all the Government that sets the terms of investment when seeking to develop the Nation’s petroleum resources, and it is the Government that needs to police the regime thoroughly that it has established.
Aside from the poor quality of Government expenditure, the oil and gas companies that invest in Papua New Guinea do indeed need more scrutiny. Transparency of the terms of business and audit by the Government of the corporate taxation returns of petroleum licensees are the normal means by which to ensure appropriate performance and compliance of the oil and gas companies.
Need for Commerciality
In the petroleum sector, oil and gas production leads to substantial income streams from sales of produced oil and gas, but getting to the development stage is not automatic. Those revenue streams need to be large enough to recompense the investors, primarily for their exploration, appraisal, development and production costs, and yet be able to pay the various fiscal and commercial demands and requirements of the Government and other local stakeholders. And more than that, they hope that there will be a return on their investment for their shareholders, whilst they have to reserve enough funds for abandonment of fields, pipelines and facilities at the end of production.
The Government needs to understand that its does not share directly in the sales revenues, but rather that it shares mainly in the profit when a particular production project is commercially viable through the taxation of profits and by taking a share of the profits when it holds equity. Fiscal devices like royalty and levies may be charged at rates proportionate to production and its value, but they are not the main devices in the current regime.
If the Government exacts too much and a project thus becomes marginally economic and lacks commerciality, then it is unlikely that the project will proceed, especially if its economic viability is too diluted. This viability requirement extends to all manner of petroleum regimes and likely success has to be weighed carefully against the general and specific risks.
Investment of Revenues
When petroleum sector development takes place in the context of poor governance and poor financial management with a very leaky financial system which allows the results of petroleum development -- its revenues to be capriciously handled, misspent, or misappropriated -- the result of that enterprise will obviously be unrecognised, obscured, and unfortunately, all too often diminished.
In this image from Santos, a container ship docks at the PNG LNG terminal
In almost all cases of oil and gas production around the world, the share of the net value stream accruing to the Government from the development of an oil and/or gas field is greater than the share of the net value that the companies get. Generally, a Government should be realising significant revenue windfalls from petroleum development activity, once all costs are paid for.
Such revenues should be most carefully invested on public expenditure that is capital in nature for the good of the people, and not squandered on self-gratifying recurrent expenses. These resources are the treasures of the people, and their value should only be mobilised to enhance the capital-based welfare of the people.
Need for Better Sector Management
If a Government has a general and systematic disregard for monitoring the actual returns and benefits to the State versus the system benefits as designed and devised by prior and current petroleum policy determination, and their corresponding laws, regulations, and agreements, how can the State reliably know what it should have earned as its share in the enterprise of petroleum resource development versus what it does actually earn and receive?
This seeming lack of care is often based on a lack of accountability, and a lack of an appropriate sector yardstick (based on good statistical data of the oil and gas industry) against which to measure the sector performance. Pilfering and lassitude, of one kind or another, compound the problem. So a potent cocktail is created which prompts a demand for sector reform and change, when such is perhaps not fundamentally justified or needed.
Perhaps, more ardent and diligent work might rather be required along with firmer enforcement of the current petroleum regime, but this requires heightened professionalism prompted by better terms and conditions for all that are involved in Government administration of such National assets as the petroleum resources of the country.
These two problems: the lack of monitoring and accounting of the sector performance and disdain for proper sector management merge in the minds of political leaders to convince them that sector matters are not as good as they could be and therefore need intercession by way of reform. That reform may be beyond the proportions required, or even possible.
Making the current regime work effectively using the current provisions of laws, regulation and terms of agreement is paramount to achieving optimum resource sector outcomes. However, if full application of these provisions is neglected for more immediate needs, perhaps inevitably disorder with be propagated and sector performance will suffer in the eyes of the State.
Reform should only be embraced if it rationalises and simplifies the petroleum regime and makes it more transparent and accountable to all stakeholders. Any petroleum regime poorly applied and poorly managed will equally give suboptimal and questionable results.
The Current Petroleum Regime
Indeed, it would seem that no-one in Government today can articulate with much clarity the current Papua New Guinea petroleum policy that defines the applicable petroleum regime.
Over the last eight years, there have been many changes to the petroleum regime through amendments to legislation such as the introduction of dividend and interest withholding taxes, an increase in the rate of foreign contractor taxes, change to deductibility of royalty, a consolidation of oil and gas operations tax rates to a single uniform rate, and the changes to the Oil and Gas Act concerning the treatment of applications for petroleum development licences and the removal of the right to arbitration.
Oddly, within the negotiations of recent Gas Agreements, basic application of many of these new provisions has been waived and new devices introduced such as a production levy and a domestic market obligation. If the changes devised in 2015 had been dutifully applied, perhaps these inventions might not have been necessary.
Certainly, it is time to rewrite the Petroleum Policy Handbook published by the Department of Petroleum and Energy in 2005, and to state the current petroleum regime unequivocally. It is difficult to invest in a country if the rules of the game are not clearly articulated.
Incidentally, if contract-based Production Sharing Arrangements are to be used in the future as has been suggested, all the terms of exploration, appraisal, development, production, and abandonment will have to be most carefully spelt out and agreed to. Companies will not contract their services to Government unless they can clearly see a pathway to profitability if they successfully find hydrocarbon accumulations.
Some New Policy Initiatives
A few years ago, the PNG Government, led by its Gas Project Coordination Office, devised a new Natural Gas Policy of which there were several editions during the period of 2016 to 2017, none of which were duly and properly issued, and which sought to introduce changes to the fiscal and commercial terms of gas development.
Some people in Government (and a few in the industry) have taken these to be official policy, despite there being no public record of their presentation to Parliament, formal Government approval, or public dissemination.
These variously included an increase in State equity from 22.5% to 30%; a production levy of 10%; royalty and development levy based on 2% of export value (instead of wellhead value); a 5% import duty on all goods and services; a 2% social levy; and 10% domestic market obligation to sell production into local markets at a discounted price; and a withdrawal of foreign exchange exemptions.
Such a clamour for more benefits, whilst admirable, was sadly not quantified in any of the gas policy drafts, and the manner in which the draft documents was handled smacked of stealth and the policy clearly lacked transparency in its formulation and enunciation.
It has to be emphasised that petroleum resource development is big business, and its success or failure is enumerated in very large amounts of money underlying it, for all stakeholders.
It is the numbers arising from the interaction of a variety of fiscal and commercial devices at different times in the petroleum development cycle that give rise to the overall effective split of the net value between the Host Government and the investing companies. This cannot be guess work and requires sensitive well-informed economic modelling.
Oil and Gas Amendment Act 2020
In 2020, the Government introduced an amendment to the Oil and Gas Act that fundamentally changed the offering of the National petroleum prospectivity for exploration development and production to investors from that which was firmly established in the 1975 White Paper: Government Statement on Petroleum Policy and Legislation, an extract of which follows:
“But, before we can gain the benefits of oil and gas production, we must first find oil and gas in commercial quantities. At present, the best way to do this is by relying on foreign oil companies, who have both the technical expertise and the financial capability to mount a major exploration programme. And in order to attract these companies for exploration, while at the same time increasing our own knowledge of our resources and our ultimate ability to control the petroleum industry, we need to offer terms and conditions that are fair and reasonable.
“This does not mean that we need to be evenly generous to foreign oil companies. There is enough potential profit in most oil discoveries so that a company can earn a generous return on its investment, while at the same time the government, as trustee for the people of the country as a whole, can secure significant revenue. The terms proposed in this policy statement are fair and just. They allow foreign companies to make reasonable and adequate profit, yet they ensure that the nation will benefit substantially from any oil or gas production, and that as the profitability of any oil venture increases Papua New Guinea will take an increasing share of these profits.”
The above is from the Forward of the White Paper on Petroleum Policy and Legislation 1975 laid before the National Parliament by M. T. Somare, M.P., Minister for Natural Resources and Julius Chan, M.P., Minister for Finance – two of PNG’s most esteemed leaders. It was a strong foundation.
Essentially, the 1975 policy sought experienced companies to invest in exploration at their own risk and to develop at their own risk any discovery to the extent that they were happy with the commerciality of the outcome of development and production, to which the regime would then be judiciously applied. If the commerciality was fragile, the State was not so concerned.
This has changed substantially with the Oil and Gas (Amendment) Act 2020 which has introduced new criteria in a new section - Section 56A. An application under Section 56 (1) of the Oil and Gas Act for a Petroleum Development Licence has to now pass a test as to “the benefit or otherwise to be derived by the State”, notwithstanding matters of project commerciality. This is reproduced below in full.
Oil and Gas Act Section 56A. Minister’s Instrument of Notification to Applicant.
Where subject to Section 56(1), this section applies, the Minister must:
(a) by instrument served on the applicant, notify the applicant that this section applies; and
(b) seek the advice of the Board on whether the applicant’s proposals should reflect a minimum expected return to the State over the life of any recovery of petroleum from the blocks the subject of the application and, if so:
(i) what that minimum expected return should be (specifically or according to a conditional or sliding scale or calculation); and
(ii) the appropriate methodology for its assessment or calculation; and
(iii) the appropriate milestones for its achievement (and any compensation regime that should apply if those milestones are breached); and
(c) based on, but without being limited by that advice, the materials already furnished by the applicant in support of the application and any other information otherwise available to the Minister relevant to the application, form the Minister’s own view on the matters referred to in Paragraph (b) and, by further instrument served on the applicant, notify the applicant of that view; and
(d) where proposals already provided by the applicant:
(i) meet or exceed the minimum requirements contained in that farther instrument; and
(ii) contain binding undertakings to that effect enforceable on acceptance by the State as. an agreement pursuant to, or as an amendment to an existing agreement under, either of Sections 183 and 184, serve an instrument on the applicant under Section 56(l)(a), (b), or (c) as the Minister determines; and
(e) otherwise proceed under Section 56(l)(b) save that the Minister must as a minimum require proposals under Section 56(1 ){b) at least satisfying the minimum requirements referred to in Paragraph {d},
and the Minister may in any event, and notwithstanding any other provision of this Act to the contrary, impose conditions on the grant of any application to which this section applies that implement the Minister’s view referred to in Paragraph (c).
This is a paradigm shift in the petroleum regime, as investors who have risked their money in exploration, appraisal and development planning can now only pursue a recoupment of their investment by seeking a licence to develop the discovery, if it is not only necessarily commercially viable, but also meets “the minimum expected return to the State over the life of any recovery of petroleum” which criteria is only examined and assessed by the Petroleum Advisory Board and is subject to the Minister’s own view at the time of application. This is certainly putting the State in the lead and advancing control of the sector, hopefully for the better.
As brave as it attempts to be, such provisions dealing with the benefit arising from the development and production of oil and gas from a field, will likely be swamped by the key exogenous variable of the oil and gas industry, which is the crude oil price itself.
However, the fact that a planned petroleum development might be the subject of such scrutiny would in itself be a leap forward in sector management, and the minimum expected return to the State will need to be defined most careful and should consider the extremely volatile nature of the industry.
Moreover, such analysis will need to be professionally undertaken emphasising once again the need for better sector management institutions manned by skilled and experienced persons with appropriate technical and financial support.
Refusal of Development
Also, in the 2000 amendment, the hitherto unlikely outcome of a refusal of a willing application for a petroleum development licence has now become a defined option for the Minister who is now required to assess whether the proposals for development attached to an application will pass an approved threshold level of benefits for the State, and if they do not: to refuse the application.
On top of that, the right to take the Minister’s decision to refuse an application may no longer be referred to international arbitration by virtue of the Oil and Gas Act. That option is now closed.
An Avalanche of Change
Our dilemma is to see through this avalanche of sought-after-changes and see what the PNG Government really wants. As the Governors of three Provinces (Gulf, Hela, and Western) said in a joint letter dated 30th August 2020 to the Prime Minister: “What is the end game for the Government with these changes?" Do we want State control on (sic) Licences or increased State take?” One wonders whether, or not it is both, but one ponders how will such desires be fulfilled?
How Industry Can Help
If the oil and gas industry is to remain in business in PNG with credibility, it has an implicit, if not necessary, duty of care to guide the Government out of the problems into which it has fallen, by enlightening them as to the commercial limitations of seeking more and more benefits without due regard to good revenue management, good governance and high fiduciary standards, whilst understanding and allowing for the Government aspirations of heightened benefit and control of the sector.
The PNG LNG Project is an integrated development that includes gas production and processing facilities in the Southern Highlands, Hela, Western, Gulf, and Central Provinces of Papua New Guinea. It will provide a longterm supply of liquefied natural gas (LNG) to four major customers in the Asia region.
Clearly, the concessional terms which highly incentivised the PNG LNG Project should not be allowed to persist, and one might regard it as indecent for the large corporate to try to cling to such incentives.
PNG has shown that it can host world class LNG development and can be home to world class companies such as ExxonMobil. The green-field fear factor is diminished, and future projects will encounter fewer hurdles in seeking the support of shareholders and financial institutions. If the oil and gas industry of PNG wishes to be part of that future, it might be wise of it to provide the Government the benefit of its global knowledge, so it may share in that future.
PSCs Can and Do Work
The Government has expressed its intention to move to a Production Sharing Contract (PSC) system in 2025 and has already introduced enabling Constitutional and Organic Law legislation. Whether such a move gives the Government what is wants, we shall see. There is nothing intrinsically wrong with a PSC system.
The author has worked in many countries with such petroleum regimes: putting some together, pulling others apart, whilst repairing some. The one thing that a PSC gives the Government, if the industry is well-managed, is much better control of that industry for planning purposes and an ability to resolve intra-company wrangles, which often delay project development.
One could say that some of the most infamous despots of the world and their oligarch associates in countries with substantial oil and gas reserves know that to milk the system handsomely, one needs to have a well-run petroleum industry, else there might be nothing to plunder!
But it goes without question that that if we wish PNG to gain optimal benefits from our petroleum industry for the people at large for their development or indeed even for personal enrichment of a political elite, one needs to have efficiency in the business of conducting petroleum exploration, development, and production, and that means good governance and proper understanding and accountability.
Competent Petroleum Management Agency Required
Normally, good governance is achieved through the Nation having a strong and competent petroleum sector management entity: call it a Department of Petroleum, Ministry of Petroleum, National Petroleum Agency, Commission or Authority, or whatever. It should have very well-educated staff, who are knowledgeable and experienced.
Some 37 years after the first major oil discovery, there are plenty of experienced Papua New Guinean people within the petroleum industry either working in PNG or in the diaspora, whom if properly remunerated can become the core of the proposed new National Petroleum Authority.
Back in the 1970s and 1980s, there was little understanding about petroleum matters within PNG; that is not the case today, and many of PNG’s petroleum technocrats and businessmen are first class. Indeed, some of the very best have and are leading lives as highly competent international oil and gas men and women around the globe. They need to be seduced to come home and build PNG’s petroleum industry to greater heights.
Good Record Keeping Required
One of the basic tasks of managing the sector is understanding the range of fiscal and commercial outcomes that may stem from the business. And like all business, whether a simple trade store or a multi-billion-dollar oil and gas company, we can only determine the condition and health of the enterprise if we maintain accurate records.
The same too applies to the Government’s management of the petroleum sector. It is not sufficient just to cry and shout without a basis, especially when the main determinant of the sector’s outcomes is the price of crude oil, and consequently due to referencing against crude oil prices, the price of natural gas and LNG. Volumes and prices need to be carefully monitored with respect to all of PNG’s petroleum operations both upstream and downstream, as well as global industry statistics and prices.
Economic Modelling Required
If one has good sector statistics, one can monitor actual performance against anticipated performance. That anticipated performance will normally be presented by the licensee as an open-book economic model at the time of submission of their proposals for development accompanying the application for a petroleum development licence.
The model should be agreed between the State and the licensees to be as accurate as possible model encompassing all of the costs and benefits to the State and to the licensees. The model should show all scenarios and reflect the implications of crude oil prices and modes of project financing.
Even better, the State should have a model of its own, developed in-house using its own petroleum economists, so that they are totally familiar with the contained algorithms and able to vary and adjust the fiscal and commercial terms as needed to assess different policy scenarios and options for the Government.
The results of the modelling combined with different projections of the crude oil price should guide decision making about all and any petroleum project. The ongoing use of the model to reflect real costs and calculated real benefits based on produced actual volumes should be a tool for ensuring that the system benefits are being realised. No number of National Oil Companies, Government Petroleum Authorities or other entities will be adequate unless this fundamental work is done.
We do not navigate the oceans or skies without charts and careful guidance; the same too, applies for a Government wrestling with the development of its petroleum resources: it should not expose such valuable patrimony to reckless unaccountable development, and it must take all necessary actions to ensure measurable account of petroleum operations. The time for the industry dictating development terms for their corporate satisfaction and to their own agenda and timetables has gone.
Reform therefore should encompass excellence in all aspects of the business whether it is overhaul and more ardent application of the current petroleum regime, or indeed a move to the use of PSCs. No single regime brings about greater fiscal or commercial benefit than the other, and any regime has to recognise the fundamental requirement that the development of discoveries of petroleum accumulations, either oil and/or gas needs to be made commercially viable in order for them to be developed.
PSCs do indeed bring about more control by Government, but only marginally more than the current regime, were it to be fully enforced and complimented with more comprehensive regulations to give effect to some of the provision of the Oil and Gas Act. PSCs require considerable responsibility on the part of the Government petroleum management agency to lead the sector well for the benefit of the country and its people.
One has no doubt that there is enough adequate qualified and experienced PNG people in the sector to accomplish this, but they will need absolute rectitude, dedication, and professionalism to achieve it and gain the desired outcomes. Essential to success will be the support appropriate support from the Government to give it the necessary financial and human resources to take on a more advance role in managing and regulating the petroleum industry of PNG.
Michael McWalter is a technical specialist in petroleum industry regulation, administration, and institutional development with over 42 years’ experience of the oil and gas industry, predominantly in the Ministries and Agencies of newly emerging oil and gas producing nations, particularly in PNG.
