Fiscal reform could support Myanmar's upcoming energy tenders

The previous administration, led by U Thein Sein, awarded oil and gas blocks that offered companies the chance to earn handsome margins. However, since the fall of oil prices in 2014, production-sharing contracts (PSCs) have become less attractive. As such, private investors have called for fiscal reform to spur exploration activity. According to the state-owned Myanma Oil and Gas Enterprise (MOGE), fresh bidding rounds for unoccupied offshore and onshore oil and gas blocks will be held in the first half of 2019. This will be the first bidding round held under the current government, led by the National League for Democracy (NLD), which has been in place since 2015.

Setbacks

Myanmar’s gas reserves possess the potential to help meet rising domestic demand and generate significant export earnings. Nonetheless, though some progress has been made in attracting international operators, there have also been setbacks in exploration activity. Given current oil and gas market dynamics, many stakeholders believe the success of the next bidding rounds will depend on whether the existing fiscal regime, which currently leaves little room for profit, is amended. In addition, internal conflict has drawn international condemnation and heightened the risk of investing in Myanmar.

As it stands, there are a total of 53 onshore oil and gas blocks in the country: of these, 23 remain unoccupied (five relinquished); 20 are under production by Myanmar state-owned enterprises and foreign partners; and the remaining 11 are still being managed by MOGE. Myanmar is also home to 51 designated offshore blocks. Of these, 24 remain unoccupied after 11 offshore assets were dropped by investors. Under previous governments, 38 offshore blocks were awarded to foreign companies such as Thailand’s PTT Exploration and Production, France’s Total and South Korea’s Daewoo.

The relinquishment of assets by upstream players was partly due to sustained low oil prices and was exacerbated by an unattractive fiscal regime. Companies that have terminated their agreements include India’s Reliance Industries, which exited blocks M-17 and M-18, and Australia’s Tap Oil, which relinquished block M-7. In addition, Shell and its partner Mitsui Oil Exploration have dropped some deepwater assets and extended the study periods for others. Subsequently, the Ministry of Electricity and Energy requested that interested local firms register in the first week of July 2018, with the aim of encouraging them to work with foreign oil and gas companies. In the first half of 2018, 20 local firms had registered their interest in bidding in upcoming tender rounds.

Contract Stages

A PSC is signed between MOGE and the relevant foreign investor to regulate the rights and obligations of the investor. For onshore PSCs, these correspond to three phases: preparation, exploration, and development and production. Offshore PSCs have one additional phase, known as the study period. Alternatively, improved petroleum recovery contracts are signed for onshore blocks that have previously been explored.

The list of government organisations required to review and approve a PSC is extensive and includes: MOGE; the Ministry of National Planning and Economic Development, superseded by the Ministry of Planning and Finance (MOPF); the Ministry of Finance, now part of the MOPF; the Contract Department of the Attorney General’s office; the Myanmar Investment Commission (MIC); and the Ministry of Environmental Conservation and Forestry, now replaced by the Ministry of Natural Resources and Environmental Conservation.

The initial preparation period is six months, extendible at the discretion of MOGE. During this period the contractor is required to commission an environmental impact assessment (EIA), a social impact assessment (SIA), and an environmental management strategy. The total costs of the three reports count towards the minimum exploration expenditure requirement, which is negotiated for each PSC. Once the reports have been prepared they must be approved by the MIC before exploration operations can commence. The study period provides an offshore contractor with two years to conduct technical evaluations and assessments prior to the exploration period. While the PSC anticipates that there will be a minimum work commitment during this period, it does not specify what this will be.

Following the study period, the contractor must disclose all of their findings to MOGE, at which point the contractor may terminate the PSC and relinquish its rights to a specific block. The duration of the exploration period is a maximum of six years: three years for the initial exploration period, followed by a two-year first extension period at the contractor’s discretion, followed by a one-year second extension period, again at the discretion of the contractor. The development and production period commences once a contractor gives notice of a commercial discovery to MOGE and continues for 20 years from the date that development is completed or is stated in the sales contract, depending on which is later.

Government Take

While many other petroleum-producing countries around the world employ similar production-sharing mechanisms, fiscal rates are generally more favourable than in Myanmar. Under the country’s existing exploration and production commitments, investors shoulder all of the risk, while the government, as resource owner, invests nothing. According to a report by Wood Mackenzie, the share of government revenues from oil and gas projects can be as high as 94% under existing PSCs.

After the submission of EIA and SIA reports, a signature bonus is required before exploration can commence. The cost of this is determined by the contractor during the bidding process and must be paid within 30 days of the MIC approval. Official data suggests that investors paid a total of $226.1m for the first 20 offshore blocks – 10 deepwater and 10 shallow-water – awarded during the Union Solidarity and Development Party government between 2011 and 2015. In addition to the signature bonus, the contractor must pay 12.5% of all available petroleum as a royalty. Both local and foreign companies who are engaged in PSCs are subject to a 25% tax on profits, according to income tax law.

Standard PSC terms also grant MOGE a share of any capital gains from share transfers: for a profit of less than $100m, MOGE is entitled to 40%; for earnings of $100m to $150m, MOGE’s share is 45%; and for profits over $150m, MOGE receives 50%. All three of the standard PSCs – onshore, shallow-water and deepwater – include state buy-in provisions. For onshore blocks, the standard PSC dictates that MOGE receives an undivided interest rate of 15%, with an optional increase to 25%. MOGE also has the right to a buy-in of 20% for offshore projects upon commercial discovery, which can increase to 25% for reserves greater than 5trn standard cubic feet.

Changing Framework

PSCs were created before the 2014 drop in oil prices and are now viewed as counterproductive to Myanmar’s industrial development. In the long run, Myanmar may benefit more from domestic gas as a source of power than as a source of tax revenue. Although state revenues are necessary to support the economic aspirations of the NLD-led government, revising PSCs could help enhance Myanmar as an attractive international investment destination, as well as encourage the production of energy for domestic use. Without revisions, the lack of investment could see the country’s considerable energy potential remain unfulfilled.

“The government should revise the legal framework related to energy as it constrains the sector’s growth,” U Thein Win Zaw, chairman of Shwe Byain Phyu Group, a trading company dealing in petroleum, told OBG. “A positive move would be to adapt it to international standards and make the sector more appealing to FDI by granting bigger chunks of exploration and production blocks to private investors.”

With existing reserves depleting and eight expwloration wells in the pipeline for 2018, Myanmar needs to exploit more sources of natural gas in order to meet domestic power needs in a cost-effective manner. Failure to appropriately address investors’ concerns could compromise the country’s industrialisation efforts. However, suitable amendments to existing PSCs should encourage a new wave of exploration activity and major investments, which would be able to support the country’s economic growth for many generations to come.

“From a resource perspective Myanmar has a lot to offer, but under current price conditions attracting inventors is a challenge due to unfair taxes,” U Kyaw Kyaw Hlaing, chairman of SMART Group of Companies, a local oil and gas services provider, told OBG. “The rise and fall of Myanmar’s energy sector is ultimately dependent on the priorities of policymakers.”