16 March 2015

A new dawn for Mozambique oil & gas

This article was written by Cerys Williams (Special Projects Lawyer, King & Wood Mallesons).

Mozambique catapulted to global investor attention in 2011, with game-changing gas discoveries on a previously unimagined scale. In the years following, the trickle of interested petroleum companies visiting the country on fact-finding missions grew to a steady stream as the scale and potential of the gas fields became clear. All had one question: "when is the next licensing round?". And the answer, in true African style, was always "soon, soon".

In October last year, the Mozambican government finally launched the long-awaited 5th petroleum licensing round for 15, mostly off-shore, areas. Given the dazzling scale of the discoveries already made, competition in the round is expected to be steep. But so is the learning curve for potential bidders new to Mozambique.  The original timeline gave just three months from launch to submission, in which to grapple with a complex and changing sector regime and business environment.

Recent years have seen a period of intense legal reform in key areas affecting this sector with new petroleum and tax laws and the introduction of over-arching "mega-projects" legislation that was intended to ensure a minimum government "take" from large-scale investments. The reforms were necessary. A spring clean of the legal framework was overdue and as the nature and scale of the discoveries became clear, the need emerged to address the fact that the discoveries have been of natural gas not oil.

Unfortunately, much of this law is poorly-drafted and untested, leaving investors at the mercy of the regulators' interpretation. Although the deadline for bids has been extended by three months to 30 April 2015, at the time of writing, the supporting regulations to the new petroleum law were not complete or publicly available and nor were the model form of Exploration and Production Concession Contract ("EPCC") or Joint Operating Agreement.

Since these documents will contain much of the important detail for investors included the hotly-anticipated new rules on local content (not to mention the legal framework for the bid), timing is still going to be very tight for all bidders. However, on the positive side, since the changes legally codify some of the matters previously covered in individual negotiations, the reforms perhaps simplify the concession award process and seek to reduce the scope for corruption.

The New Legal and Fiscal Framework

While full details of the new petroleum regime are still awaited, there is plenty for investors to digest in what has already been published. Some key points to note are as follows:

  • Bidders need not be registered or incorporated in Mozambique but will be required to register a branch or subsidiary there subsequently to conduct petroleum operations (although see below).
  • Foreign companies that associated with Mozambican majority-owned and headquartered entities will be given preference in the granting of concessions.
  • An EPCC will be concluded with successful bidders, which will grant an exclusive right to carry out petroleum exploration and production for an initial period of not more than 8 years but subject to extension.
  • All parent companies of an entity which owns rights under an EPCC must  be established, incorporated and administered in a "transparent jurisdiction", meaning one in which the Government of Mozambique can independently verify the ownership, management and control and fiscal standing of a foreign legal person wishing to participate, or participating, in petroleum operations.
  • The Petroleum Law reserves the right of the Mozambican state to participate in the petroleum operations at any phase, pursuant to the terms and conditions established by the contract. The current bid documentation is seeking a 10% free carried interest in the petroleum operations.
  • Subject to any clarification in the pending petroleum regulations, it appears that under the so called "Mega-Projects Law", 5-20% of equity in the company holding the petroleum must be made available via the Bolsa de Valores de Moçambique (i.e. the Mozambican Stock Exchange) on commercial terms - an added layer of complexity for investors.  The Mega-Projects Law requires this to be done within five years but the petroleum regulations, when published, may provide for a different timeline.
  • Sale or transfer of rights under an EPCC is subject to consent of the Mozambican government which is not unusual in the sector.
  • Public tender process must be used to appoint services providers for contracts above a set amount (not yet specified). Priority must be given to local products and services in some cases and foreign service providers must associate themselves with Mozambican persons (which is consistent with a general move to local content provisions in African petroleum laws).
  • Construction or operation of petroleum infrastructure will now normally be subject to the grant of an additional EPCC and provision is made for mandatory third party access to facilities.
  • Bid participants may need in some cases to have entered into Mozambican law compliant joint venture agreements with co-bidders and to have engaged with local agencies in advance of submission.
  • Under new rules, capital gains tax at 32% will be due on any sale (including an off-shore sale of shares) where there is an underlying oil and gas asset in Mozambique – a ‘super tax’ which is becoming more common in some African states that believe they are not benefitting directly from new oil and gas discoveries.
  • Petroleum Production Tax will be due from the time the oil or gas is extracted from a field. The rate for oil is 10% and for natural gas is 6%.
  • The formula used to determine the profit split between the operator and the Mozambican State (the "R Factor"), which used to be a matter for a contractual negotiation, has been adopted by law. 
  • Tax stability, which may be negotiated, will in general be limited to 10 years. While some fiscal benefits/concessions apply to petroleum companies, these are legally framed and may not be enhanced through individual negotiation.

The Broader Context

As ever, the new legal framework must be understood in the context of the broader business environment in Mozambique. Potential bidders should be aware that, although the stated intention of the legal reforms is to attract investment, the tougher investment environment that they create also reflects a change in political and popular mood in the country.

The earliest investment projects in Mozambique benefitted from generous legal and fiscal concessions and robust stabilisation promises, intended to attract participants into risky and uncharted waters, as the country emerged from the shadow of its long civil war and subsequent experiments in communism. However, that time is past: Mozambique’s enviable year-on-year increases in GDP and the transition of pioneer investments into established and productive undertakings has reduced the perceived risk in Mozambique as an investment destination.

Nevertheless, for most Mozambicans, these advances have not translated into a significant increase in standards of living and the country continues to languish near the bottom of the UNDP’s Human Development Index. The causes of this failure to translate growth into development are a moot point but conventional wisdom in the Mozambican press and on its streets is that that this is due, at least in part, to unwillingness of investors to pay a fair contribution to the countries coffers and/or the failure of politicians to compel them to do so.

This issue inevitably became something of a political football in the run-up to the general election in October 2014 but while the pre-election rhetoric fades, this underlying trend in opinion endures.

A notorious flash point was the US$3.7bn purchase of the vast Benga coal mine by Rio Tinto in 2011. Since the shares in the acquired company, Riversdale Mining Limited, were owned off-shore, capital gains tax on the transaction was not paid in Mozambique, despite the most persistent and creative arguments of the fiscal authorities there. The resultant popular outrage still echoes in the ears of foreign investors and informs public opinion, not to mention in the new tax legislation on off-shore sales mentioned above.

Alongside the tougher tax regime there has been a hardening of attitudes in respect of foreign worker quotas. It is hard to overstate the practical challenges posed by this in a country where competition for the small pool of educated and skilled domestic talent is extremely fierce. All businesses enjoy a quota of foreign workers, which varies according to the size of their business. But, historically, investors in the petroleum sector were able to enjoy more flexible arrangements including the potential to agree increased quotas and the ability to bring in workers on short-term assignments for up to 180 days in any calendar year.

The petroleum specific regulations are in the process of revision and the expectation is that the new regime will be tougher. However, in the meantime, the practicalities of bringing in foreign labour have already become significantly more difficult through a mixture of a harder line on the interpretation of special quotas and new procedures and documentary requirements.

There have been other challenges too. After many years of peace, in 2013 and 2014 there was a resumption of civil war in Mozambique, albeit on a localised and relatively limited basis. The ruling party, FRELIMO, was once more in conflict with its old adversary, RENAMO, and this resulted in some casualties and also some disruption to business, as coal shipments on the single railway line serving the port of Beira were targeted.

There was also an unsettling spike in kidnappings in the country. The situation was concerning enough for some expat businesses and organisations to remove staff and/or their families temporarily. And then, of course, there was the notorious crash landing of Rio Tinto’s foray into Mozambique in 2014, when it finally divested the Benga mine with losses in excess of USD$3bn. All of this, alongside the uncertainty and disruption of the general election, drew a firm line last year under the period of investor exuberance in the initial aftermath of the resource discoveries.

Notwithstanding these developments, the overall picture in Mozambique is still comparably appealing. The scale of the potential prize cannot be ignored. The Mozambican government and agencies are welcoming to inward investors and remain willing to engage co-operatively - if less open-handedly – with investors. Despite ongoing grumbles of RENAMO dissatisfaction with the result, the elections fundamentally passed without major incident and the legal uncertainties caused by the reforms will also be clarified and resolved, in the end.

It seems likely that this licence round and the myriad other business prospects that now exist in Mozambique will evolve in perhaps a more measured and sober environment than those that preceded. Nonetheless, investors are advised to do their homework, find good local partners and retain experienced advisers at each stage.

Cerys lived in Mozambique for three years until 2014, where she acted as international counsel on numerous projects with SAL & Caldeira Lda. She now routinely acts alongside King & Wood Mallesons' global M&A and Energy & Infrastructure teams to navigate the Mozambique legal and regulatory landscape.

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