A comparative review and technical analysis of the Petroleum Revenue Bill (2015), a detailed appraisal & top facts you should know!
BEHOLD! LET US TALLY OUR OILY BARRELS WHILST STILL UNDERGROUND, ELSE WHY BOTHER?!
Let us dare to be optimists! Let us assume that Somaliland succeeds with the politics and fiscal governance for the natural resources and specifically how to make the economic decision chain right. Let us hope Somaliland puts the correct processes for discovering natural resources; proper taxation system that captures the economic rent of those resources for the nation; and finally brought the local communities where the discovery is made onboard with greater buy-in and commitment. The only boom or bust left for Somaliland is the highest authorities in the country to devise proper and transparent revenue management that includes significant savings for future generations.
Most of the lands on earth are rich with one or more natural resources or others. After discovering natural resources, nations could take one of the two different routes: either the boom and bonanza superhighway or the less desired doom and bumpy busted road; the choice is ours! To prove that the success of a country squarely depends on the country’s top leadership and its development plan, we could briefly look into the economic development journey of the African nation of Botswana. Scores of countries envy Botswana, not only for the abundance of the king of minerals, the Diamond but more on their first leader President Sir Seretse Khama (1966 – 1980). Pres. Khama steered Botswana from the 3rd poorest nation in Africa, with only 12kms of tarmac road, only 22 university graduates, and 100 secondary graduates; to these days as one of the most thriving nations in the continent.
Pres. Khama succeeded in developing the nation by realising that natural resources are non-sustainable and ever depleting, thus converting revenues from the natural resources into domestic investments and social development programs. Before any resources discovery, he also secured the consent and support of all those feuding tribal societies to agree on one thing: regardless of whose region the natural resources discovered, the government will use them for the nation’s common good.
Revenue leakages and losses for the extractive resources industry occur not only due to corruption but sometimes also due to lack of experience and knowledgeable workforce at the host nation’s side. Nigeria is reported to have missed over $21 billion in revenues from their petroleum production due to oversight and lack of understanding of old Production Sharing Contracts that could have given them more government-take when oil prices got higher.
Introduction – Looking from a bird’s eye view!
This article will technically review and analyse the Petroleum Revenue Bill (2015) of Somaliland in detail by dissecting it into two focus areas. Firstly, the critical components of a successful fiscal regime will allow the highest government-take revenue possible from the Petroleum contracts (Revenue Acquisition). Secondly, sound petroleum revenue management practices guarantee a proper revenue expenditure in Somaliland (Revenue Management) by looking into the Revenue Bill (2015).
The Key Components of a Successful Fiscal Regime
To carefully dissect a successful fiscal regime, we must first grasp the very definition of it. A Fiscal Regime is a combination of inter-related contractual instruments through which the state generates revenue through its extractive projects by using tools such as royalties, taxes, government participation etc. It is a proven fact that there are more petroleum fiscal frameworks in the world than there are countries, but they all share four key objectives they share:
- Ease of Compliance and Administration
- To maximise the economic returns to the state from its resource endowments
- Consistency with development context
- To balance the sharing of risks of expected returns.’
The onus remains on Somaliland to design a fiscal system where exploration and production rights are awarded only to capable companies, place the highest value, and attempt to capture as much economic rent as possible through various means such as levies, taxes, bonuses, and royalties.
Somaliland has adopted a Production Sharing Contract (PSC) model to govern the fiscal side of its petroleum extraction. The international oil companies will have the exploration and production rights for a fixed period on an agreed block while bearing all the exploration risks and costs in exchange for a share of the produced petroleum. The advantage for Somaliland remains that in this particular system, we will receive a large percentage of the rent from our oil production activities without bearing any risks and have control of the oil. Another plus is that a cash signature bonus is usually given upfront upon finalising the contracts with the IOC.
Two of the most prominent elements of the PSC are the “Royalties” and the “Sliding Scale”. Royalty is a form of payment taken straight off the revenue. Somaliland will receive a royalty fee to indicate that it owns the resources. After carefully analysing various oil and gas Production Sharing Contracts, we found the standard royalty percentage varies from a minimum of 7 to 15% at the maximum. Anything above that will be considered excessive by the oil and gas companies and will discourage investments.
The government may also apply a ‘Sliding Scale” bonus and royalty that varies with production and oil price increases. The most common is the incremental sliding scale based on average daily productions and taxing each production threshold separately. The aim of this is Somaliland can use this same example to create a very flexible system alongside the sliding scale so that as production or oil prices increase, so does the government take.
Another form of government taken through petroleum activities comes in the form of corporate income taxes. Many countries adopted the ROR (Rate of Return) Contracts, whereby it is a system used to ensure that as oil or gas production increases, the government-take also increases. ROR is more progressive and can capture more since it is measured on profitability. In which Somaliland could do the same and employ it.
Many countries miss valuable revenues due to the Contractors setting a high “Cost Recovery Limit”. Most Production Sharing Contracts typically impose a Cost Revery Limit between 30% to 60%. The above ensures that the government can share the profit as soon as the production flows instead of the contractor using it all to offset their exploration, development, and operation costs.
Many International Companies use two indicators to measure how attractive is the fiscal regime of a country. Namely, the Payback Period’ and the ‘IRR (Internal Rate of Return)’ is used to gauge how compelling the fiscal regime is. Somaliland should adopt a method offering attractive returns to investors whilst employing different tools to acquire their shares for the nation.
After a brief review of the Production Sharing Contract details, let us dissect the Somaliland Petroleum Revenue Bill and see whether it has all the features necessary to govern the Petroleum Activities’ revenue successfully.
Revenue Management of Somaliland:
One of the critical principles of Somaliland’s management of its petroleum resources is that all the production must result in maximum value creation for society. All revenues that we accrue will benefit the community of today and the future as a whole. The Petroleum Revenue Bill of Somaliland (2015) proposes that the Minister establish a National Petroleum Account at the Bank of Somaliland where any petroleum revenue due to the government from petroleum activities that companies carry out shall be paid in the National Petroleum Account. No other revenue sources shall ever be paid into this account. The Bank of Somaliland shall then hold all the Petroleum Revenue received in foreign currencies at interest-accumulating current accounts abroad with financial institutions with the highest security. The Minister and the Bank of Somaliland should then enter into a management agreement to govern the National Petroleum Account.
The Bill also proposes that the Bank of Somaliland shall only make transfers from the National Petroleum Account to:
- The Ministry of Finance under the condition that government will submit a proposal to the parliament to transfer the amount to the Ministry of Finance to help finance the National Budget of Somaliland. The amount shall not exceed the annual benchmark based on an estimate of the Petroleum Reserves. It will require the request of the Minister of Energy and Minerals alongside the signature of two authorised officials. The transfer shall be made public to discourage any illegal practices and establish transparency.
- The Petroleum Fund
- Petroleum Producing Regions & Districts will receive a share of the agreed-upon petroleum revenue between the communities and the ministry.
Note: No other transfers shall take place other than the three above mentioned. No loopholes shall be allowed, and all must respect what the Revenue Bill proposes.
How will our petroleum fund be managed?
The petroleum bill states the Minister of Energy and Minerals will be responsible for the overall management of the Petroleum Fund. This fund aims to ensure long-term responsible management of revenue from Somaliland’s oil and gas resources to benefit current and future generations. Investing domestically and nourishing the local economy is far more yielding than putting funds into foreign hedge accounts. A good investment policy is to be undertaken by the Minister using qualified expertise to formulate better fund management.
Somaliland should use a considerable portion of the petroleum fund for the current generation to develop the necessary infrastructure to link economic sectors from the whole nation successfully. It cannot afford to copy Norway’s model, which has the world’s largest wealth fund estimated to be $1.3 trillion. Somaliland needs the funds now as it is still a developing nation needing to catch up with the rest of the world. Assets of the Petroleum Fund shall not be used as collateral for Somaliland to borrow or repay its debts. We must avoid the Ghana case that received $200 million deposited into their Petroleum fund account and used to borrow $2 billion from syndicate banks, hence incurring $1.8 billion in debt.
Our Sound Judgement and Recommendation
A successful petroleum fiscal regime balances the government’s interests and the oil companies in a fair and balanced way. Having carried out a comparative review of the revenue bill with several other bills enacted by neighbouring countries, we find that an excellent fiscal regime usually exhibits two key components – royalty or additional production-based bonuses. Those two tools will provide a maximum flow of revenue to Somaliland whenever production occurs and a mechanism for capturing a share of the profit and remaining rent. As such, we would like to recommend several options for Somaliland to boost the attractiveness of its fiscal regimes.
- Due to the high demand for petroleum and the revenue that follows from Somaliland’s untapped potential, the Petroleum Revenue Bill (2015) must be re-reviewed and passed by the legislative branch of the government. The above step will set the stage for significant transformative growth and capture a higher economic rent from this sector.
- The Revenue Bill (2015) gives a lot of powers to the Minister. Instead, Somaliland could use the current practice of forming the Petroleum Revenue Management Committee to manage the fund for better utilisation.
- The Revenue Bill will set a precedent for years to come; however, there seem to be gaps that require addressing, and we recommend a second cross-ministries and legislative branch review.
- Somaliland has to realise that taxation is one of the most successful tools to capture the high economic rent employed by nearly every country. It should incorporate different forms of taxes, such as an additional special tax rate on International Oil Companies in addition to a company tax rate. Also, try to introduce a windfall tax on companies that gain excess profits.
- Introduce a Somaliland Stabilization fund, whose primary purpose will be to serve in times of an emergency where it is to be available during financial recessions.
- The Petroleum Bill (95/2021) says International Oil Companies shall get the approval of the Minister of Energy of Somaliland for their expenditure budgets when it exceeds $50 Million; we find that very high and should be revised.
- Laws should be set in the Somaliland Petroleum Revenue Bill to prohibit using assets to extend credit to the government and restrict borrowing from the National Petroleum Account for personal gain.
- A proper cost estimation analysis shall be done by Somaliland either internally or externally by hiring competent foreign skilled labour using the best available data at the time. Somaliland can avoid losing revenues by the practices of international oil companies altering their expenditure records to recover bigger contractor-take through the cost recovery mechanism.
- A mandate must be set for the Minister of finance to publish all records of petroleum payments or receipts online on their websites or any form of media to increase transparency. A Recommendation would be for Somaliland to join the EITI (Extractive Industries Transparency Initiative) to set the global standards of transparency.
- Employ Absorptive Capacity measures and policies to transform the additional money (revenues, taxes, etc.) into tangible goods and services (roads, hospitals, etc.) without causing inflation.
- Transparency should be mandatory when dealing with the extractive sector to manage the public expectations associated with the attractive petroleum revenues.
- Inform, Educate and continuously update the general public openly and transparently to avoid negative speculations and obstructions.
Alongside the Petroleum Revenue bill of Somaliland, all these recommendations shall lead to a well-designed fiscal system in which there will be investor confidence, low levels of inflation, low debt levels, and higher economic growth. The above will steer away Somaliland from the likely Resource Curse that affects many African countries due to their weak fiscal governances.
Jointly co-authored by Mohd Faisal Hawar and Mohamoud Faisal Hawar, both Oil and Gas Management Graduates, specialising in Oil and Gas Fiscal Regimes, Oil and Gas Economists, Trainers & Consultants on all the Extractive Fiscal Regimes.
|Mohamed Feysal Hawar
Extractive Resources Economist (Upstream Petroleum & Mining Economist )
BBA (Hons) Oil and Gas Management.
|Mohamoud Feysal Hawar
Extractive Resources Economist (Upstream Petroleum & Mining Economist )
BBA (Hons) Oil and Gas Management.