Laying down the law: New hydrocarbons legislation is expected to provide a much-needed tax break

After three rather disappointing bidding rounds and increasingly lacklustre interest from international oil and gas companies, Algeria’s minister of energy and mines, Youcef Yousfi, declared towards the end of 2011 that the country needed to review its hydrocarbons legislation. Algeria’s Council of Ministers approved changes to its 2005 Hydrocarbons Law on September 17, 2012. The amendments introduce further tax incentives to attract international oil and gas companies to invest in the hydrocarbons sector, particularly unconventional oil and gas reserves.

CLEAR SIGNAL: A statement by the Algerian Council of Ministers said that the new law aims to “maintain Algeria’s appeal for foreign energy investment”. The bill is said to contain 250 articles that regulate the reduction of taxes, including benefits accumulated by foreign companies. The changes have long been awaited and will bring more flexible tax regulations to match the increasing costs faced by international companies as they seek to invest in long-term exploration and drilling work in Algeria.

Three rather disappointing bidding rounds for oil and gas concessions in 2008, 2009 and 2011 sent a clear signal to the government. As a result of the limited interest by international oil companies (IOCs), the number of projects in the downstream sector had slowed noticeably, with some even being shelved. In December 2011 at the 20th World Petroleum Congress in Doha, Yousfi had already indicated that the government intended to make legislative changes as Algeria was looking to work with experienced partner to efficiently exploit the county’s massive hydrocarbon reserves. He had also said Algeria wanted to ensure security in the long term and maintain its position as a leader in the global energy sector.

NEW BIDDING ROUND: A new hydrocarbons bill is now in the offing, but even before the new bill was approved by the Algerian Council of Ministers in September 2012, Yousfi had already announced that the country is preparing for a new bidding round within the next two years that will include offshore blocks.

Once the details of the new petroleum law are made public, the specifics of the offshore licensing round will also be announced. “We are opening new regions in the south-western and northern parts of the country to exploration [in line with] our policy to intensify exploration in new and mature basins. Algeria is looking at opening up its offshore areas to exploration for the first time and expects the first offshore wells to be drilled within the next two years,” Yousfi told the media at the World Gas Conference in Kuala Lumpur in June 2012.

NEW REGULATION 2012: The minister of energy and mines shared only a few details with the public regarding the planned amendments to Algeria’s hydrocarbons regime towards the end of September 2012. The new law will tax a project’s rate of return rather than its turnover, according to the minister. “What is new is that we have clarified the criteria for passing from one tax level to another. In the previous 2005 law, it was based on turnover and this was criticised by companies,” Yousfi said during an interview on Algerian national radio.

However, the changes will not be retroactive and will not concern projects already in operation, making them applicable to future concessions only.

Sonatrach will maintain its majority interest in all partnerships with companies and will keep exclusivity over transmission via pipelines. In other words, the 51:49 rule will not be changed. “The 51:49 rule is not unusual for the industry. Most international oil and gas companies have no objections to it. But high taxation has been a concern,” Yacine Amrouche, former manager of Tenaris, a supplier of tubes and related services for energy firms, told OBG. Yousfi further said the tax incentives mentioned in the bill do not concern the windfall-profit tax, but rather adjust oil taxation depending on difficulty and the investments made for field development. Yousfi had stated that the government intended to boost exploitation of medium-sized oilfields in underdeveloped areas, with an emphasis on offshore drilling.

Local industry analysts are optimistic that the new law will bring at least some of the needed changes. As economist Abdelmalik Serrai pointed out, the amendments are “a hand extended to foreign companies to invest in Algeria”. Several firms have said they are cautiously waiting for more details before they can fully understand what impact it will have on their activities.

FROM MONOPOLY TO PARTNERSHIPS: To gain a sense of the importance of these new amendments, it helps to have some historical context given the influence the country’s regulations have had on the overall appeal of investing in the sector. In 2005 the revised hydrocarbons law in Algeria was widely considered groundbreaking for the country’s oil and gas sector. It replaced the old 1986 law, which had established a state monopoly over hydrocarbons exploration, exploitation and transport activities. In 1986 only the state was allowed to allocate these activities to state-owned companies such as Sonatrach. Under this arrangement, foreign oil and gas companies were required to form a partnership with Sonatrach before beginning operations in the country. Such partnerships were in fact only possible with regard to exploration and exploitation activities, and Sonatrach also maintained a monopoly on hydrocarbons transportation through pipelines. In the case that the firm lacked the capacity for pipeline transportation, it could request that foreign companies assist in the financing, building and operation of the pipelines; in such a situation Sonatrach would still own the transportation facilities. The firm also held all mining licences and titles exclusively.

Regarding natural gas production, foreign companies were required to form a joint venture with Sonatrach, with the latter holding the majority rights. As for oil and gas revenue, the IOC was given a share of the profits from the sale of hydrocarbons. This profit share (net of tax) could not exceed 49% of the project’s entire production per year. Sonatrach also received shares from royalties, taxes and transportation costs.

THE 2005 LAW: The changes pertaining to the 2005 law were significant for downstream, midstream and upstream activities in Algeria. It also relieved Sonatrach of its responsibilities as regulator of the hydrocarbons sector by establishing two new agencies: the Hydrocarbon Regulatory Authority (Autorité de Ré gulation des Hydrocarbures, ARH) and the Algerian National Agency for the Development of Hydrocarbons Resources (Agence Nationale pour la Valorisation des Ressources en Hydrocarbures, ALNAFT).

ARH was tasked with the implementation and enforcement of exploration and production activities in Algeria. Such activities include technical regulations; standards pertaining to health, safety and the environment; transportation tariffs; access to transportation infrastructure; and decisions on applications for pipeline transportation contracts. ARH also became responsible for reviewing pipeline concessions and considering applications from IOCs to build their own pipelines; in the past pipelines were constructed exclusively by Sonatrach.

ALNAFT, on the other hand, oversees the promotion of the hydrocarbons industry, which includes the evaluation of competitive bids and the awarding of exploration and exploitation rights.

These changes transformed Sonatrach into a commercial company that no longer had a monopoly in the sector, with a widespread impact on IOCs. Under the new law, IOCs were no longer required to enter into a partnership with Sonatrach, and their profits were no longer limited to 49%. The same applied to the marketing of natural gas, which no longer had to be through a joint venture in which Sonatrach held the majority. IOCs were also allowed to own all production and extraction facilities. Sonatrach, however, was given the right to acquire a stake of 20-30% while at the same time paying costs related to development, exploration and exploitation.

Under the 2005 law, Sonatrach’s transport monopoly was abolished, giving IOCs the right to operate their own transport facilities, thus liberalising the hydrocarbons transport sector. On the downstream side, the law stipulated that IOCs were free to invest in refining, storage and distribution activities. Finally, the tax regime was simplified and liberalised, subjecting IOCs to taxes including a royalty, surface tax and hydrocarbons income tax. The new regulation moved from previously production-sharing agreements to royalty- and tax-based agreements.

The 2005 Hydrocarbons Law was ratified at a time when oil prices stood at $20-30 per barrel. At this price, companies would have to produce oil or gas for a period of several years in order to reach a high turnover before entering a different tax bracket and being taxed accordingly. Since recently oil prices have consistently been over $100 per barrel, despite higher production costs, it only takes a few months for companies to reach a high turnover. Yet international oil and gas companies operating in Algeria have expressed dissatisfaction with the tax burden, pointing out that a tax regime based on turnover makes operations in Algeria less profitable.

Despite the apparent progress in sector legislation, however, a 2006 presidential order reversed many of the market liberalisation measures pushed through by the 2005 law, complicating matters for companies involved in the energy business. In addition, a windfall tax was levied on profits, with this perceived to be highly unpopular among foreign companies. Sonatrach was also restored the right to own at least a 51% share in projects pertaining to exploration, production, transport and refining. This was extended to all contracts in 2008, further complicating the situation. However, with the most recent changes to the hydrocarbons law, IOCs are slowly regaining optimism. According to a statement from the president’s office, “The purpose of this new text is to help maintain the attractiveness of investment in our country by adopting legislation that corresponds to the evolution of the energy industry.”

TESTING NEW WATERS: The 2008 bidding round was greatly anticipated since it was the first one after the ratification of the 2005 Hydrocarbons Law and the amendments that followed in 2006. A total of 16 blocks were on offer, raising the interest of some 50 foreign firms and pre-approved operators. A statement from the Ministry of Energy and Mines said, “Projects that shall be tendered concern areas located in the fields with the most potential in the Algerian mining sector. Such projects include zones with a high potential for oil and gas.” The then-minister of energy and mines, Chakib Khelil, was quoted as saying the decision would be based not only on “technical competitiveness, but on the reputation of the partner and what the firm could bring in terms of technology and know-how, including environmental protection”. Bids had to be submitted to the newly created ALNAFT. However, to much surprise, only four firms submitted bids, and all of them were awarded. The global economic downturn contributed to low participation and prompted companies to consider carefully before submitting a bid, since they had experienced difficulties accessing capital for exploration. The four licences awarded went to Russian, European and UK firms, including Gazprom, Eni, BG Group and E.ON Ruhrgas. The Al Assel licence went to Russian gas giant Gazprom; Italy’s Eni won the Kerza exploration; Guern El Guessa went to the BG Group; and E.ON was awarded the Rhourde Yacoun permit.

AHNET AWARDED: The second round was launched in July 2009, which included 10 blocks. This round was widely regarded as a test of whether Algeria would still be able to attract interest from foreign energy companies. On December 10, 2009 the results were announced. In total, six bids were submitted with three permits, Ahnet, Sud Illizi and Hassi Bir Rekaiz, awarded. The licensing of Ahnet came as something of a surprise as it was seen as the block with the greatest potential for natural gas. It had been on offer during the previous round in 2008, but was later withdrawn. It is located next to the In Salah gas field operated by BP, Statoil and Sonatrach. Bidding for the block was restricted to companies that had won and implemented contracts of a similar scale before. The successful bidder was a consortium of Total (47%), Partex Oil and Gas (2%), and Sonatrach (51%).

Ahnet has a number of existing structures, an important fact as Algeria attempts to boost gas exploration in the country. It therefore attracted a lot of interest. Sud Illizi was awarded to a consortium of Spanish company Repsol, French multinational GDF Suez and Italian electric utility firm Enel. The last permit, for Hassi Bir Rekaiz, went to Thailand’s PTT Exploration and Production and the Chinese National Offshore Oil Corporation. Each of the three had seen various levels of exploration resulting in some proven oil and gas reserves, and they were all part of the previous bidding round, the first national and international round of 2008.

LIMITED INTEREST: The ALNAFT announced the third national and international round in September 2010. It was the first round since Khelil, who had held the post for a decade, was replaced as minister of energy and mines in a government reshuffle by industry veteran Yousfi. Likewise, the CEO of state firm Sonatrach and a number of senior managers were also replaced. Although it was the ninth round in Algeria, it was only the third for ALNAFT. Of the 10 blocks across the country open for bidding to pre-qualified companies, eight had not been offered previously. Originally, the round was supposed to close on March 3, 2011, but was then extended to March 17, 2011, after poor responses to bidding invitations. A total of 40 companies, including BP and Total, had shown interest in the blocks, but only four bids were made by March 17, 2011. Within a day the results were announced to the public: only two blocks were awarded. State firm Sonatrach won the Rhourde Fares licence, and Spanish firm Compañía Española de Petróleos (Cepsa) won the Rhourde Rouni II block. The block awarded to Cepsa is located in the Berkine basin, about 100 km north-east of Cepsa’s RKP field. Rhourde Rouni covers an area of 3034 sq km and contains a total of 14 drilled wells. Granted for 32 years, the concession will grant Cepsa a maximum of seven years to undertake exploration. This will include high-resolution, 3D-seismic surveys and drilling of six wells for exploration. The Rhourde Fares licence covers blocks 406b and 209. Cepsa has already drilled seven wells.

RESPONSE TIME: The lack of interest in the 2011 round was widely seen as an indication by foreign oil and gas firms that doing business in Algeria was no longer viable given the tough financial terms. Foreign investment in Algeria was dwindling, and there was speculation as to whether the country had enough projects on-stream to be able to keep output stable. As the world’s eighth-largest exporter of natural gas and the fourth-biggest exporter of crude oil on the African continent, Algeria gets most output from mature fields and requires foreign investment and expertise to find and develop new fields.

The muted responses to the last three bidding rounds indicate hesitation on the part of the IOCs to invest in Algeria. While in 2005 the dismantling of Sonatrach’s overarching monopoly spurred new interest in the sector, the 2006 amendments reversed some of the aspects that were particularly attractive to foreign investors. International firms regained optimism that the government was showing it was committed to making changes that would benefit the sector.

CAUTIOUS APPROACH: However, irregularities within the Ministry of Energy and Mines and Sonatrach in 2010 prompted IOCs to adopt a more cautious approach. Sonatrach’s upper management was replaced, judicial proceedings were initiated and the company issued a new code of conduct for staff and commercial partners. As a result, Algeria had difficulty financing and managing enough projects to balance the shortfall of foreign investment.

The development of new discoveries fell behind, putting a strain on the country’s energy supply, and there was little advancement upstream either. This was partly due to the corruption scandal, which caused a number of delays and cancellations, among them: an ethane cracker at the Arzew refinery with Total, though negotiations did resume in 2012; a methanol plant with Almet, an international consortium led by Kuwait’s Qurain Petrochemical Industries Company; a refinery in Tiaret; an integrated purified terephthalic acid and polyethylene terephthalic complex; and a linear alkyl benzene facility.

Furthermore, current production levels of oil have decreased during the last five years, according to the International Energy Agency, and the same trend can be observed in the natural gas sector. In 2011 Algeria pipeline-LNG exportation and domestic market gas sales amounted to 78bn cu metres, while in 2005 this figure stood at 88bn cu metres, according to BP statistics. If this trend continues, Algeria may have trouble filling its export capacity. However, in June 2012 Yousfi announced that he is hoping to raise the export capacity of liquefied natural gas from the current 60bn cu metres per year to 90bn cu metres, of which 40bn will be exported.

In a bid to support the necessary expansion of production, the government introduced the proposed amendments to the hydrocarbons law. By September 2012 the new bill was approved by the Council of Ministers. The preparation of a new bidding round, expected within two years, sends a promising signal that the state is serious about preventing irregularities and doing what is best for the industry. In spite of the meandering road to improved and more liberal sector regulations, the door seems to be open for investment in Algeria’s hydrocarbons sector again.