Subject to scrutiny: Popular debate continues over contracts and revenues

One of the most important and often heated debates in the energy sector centres on the revenue agreements between the government and operators. While the contracts for the partners at the Jubilee Field were drawn up as far back as 2005, there is an increasing belief in the media and among local think tanks that Ghana should be getting more from its hydrocarbons reserves. These arguments, which have been reprised in the mining sector for some time, leading to cries of “resource nationalism” from private investors, will shape the future of the energy sector and the broader investment environment.

RENEWED INTEREST: Oil exploration has been ongoing in Ghana for more than a century. However, prior to the arrival of Kosmos Energy in 2004, the country had a reputation as an expensive place for investors to seek new finds. Several companies drilled for oil in the late 1990s and early 2000s, including Nuevo Energy, Dana Petroleum, Hunt Oil, and Fusion Oil and Gas, but none of them made significant commercial discoveries. Several key factors have brought renewed interest in the oil and gas sector, including a rapidly increasing oil price, which brought expensive deep-water exploration into play, and the Deepwater Horizon spill in the Gulf of Mexico, which has prompted deepwater exploration teams to shift their attention elsewhere, including West Africa. However, perhaps the biggest change for the sector was the introduction of new contracts – with Kosmos Energy in 2004 and Tullow Oil in 2006 – for exploring the West Cape Three Points and Deepwater Tano blocks.

CONTRACT DETAILS: The details of the contract agreements between the government and the Jubilee partners are now well known. Under these contracts with Tullow and Kosmos, the government receives a 5% royalty and an additional oil entitlement of 5-25% if returns to operators reach 19-40%. The Petroleum Income Tax Law from 1987 sets a default rate of 50%, but in the Jubilee Field it has been set at 35%. There are also surface rental fees and a 5% withholding tax on sub-contractors. On top of this, the government, through the Ghana National Petroleum Company receives a 10% initial carried interest and an option of an additional 2.5% (West Cape Three Points) to 5% (Deepwater Tano) interest in the blocks upon discovery of commercial quantities.

For operators, there is no limit to carrying forward losses under the Petroleum Income Tax Law, while cost recovery allows for a five-year straight-line depreciation of exploration, development and other capital expenditure costs. Furthermore, the law does not contain provisions against abusive transfer pricing, in which a company can write off tax against expenses for purchases from a subsidiary company, or any limitation on the deductibility of interest expense in financing petroleum operations (known as thin capitalisation provisions). Finally, there are limited ring-fencing provisions, thus allowing a company to deduct cost recovery expenses from one licence area against production from another licence area.

While little was made of these agreements at the time of negotiation, there has been significant ink spilled in providing information and misinformation about these agreements since oil production commenced in late 2010. Much of the focus has been on the returns to government and whether Ghana is benefitting enough from its hydrocarbons resources. This scrutiny has been possible because of the government’s decision to make petroleum revenues and management as transparent as possible to avoid charges of mismanagement and corruption that have plagued other regional producers, such as Nigeria.

CRITICISM: Critics have relished the government’s invitation to scrutiny. While the 2012 budget forecast oil and gas revenues to the government of GHS1.24bn ($735.2m), representing 8.6% of total budget revenues in 2012 (70% of which will be funnelled into budget spending under the terms of the Petroleum Revenue Management Act), there has been criticism of the amount of state oil revenue generated so far. Two prominent criticisms are that the cost recovery and deduction provisions are too generous, allowing operators to avoid their tax obligations, and also that the government should have adopted a pure production-sharing agreement (PSA) rather than a predominantly royalty tax system (RTS).

REVENUE MODEL: Indeed, many developing countries, including near neighbour Nigeria, have moved from an RTS system, based on concessions and taxation, to a PSA, where the host country usually takes a majority of the oil produced. A March 2010 analysis by the Ministry of Finance and Economic Planning said under the terms of their hybrid contract agreements, Ghana would effectively receive a 42.2% share of the country’s oil revenue. Given the carry forward losses and cost recovery provisions, Ghana’s share in 2011 amounted to 16.08%, according to the local publication, Modern Ghana.

A 2010 study, “An Evaluation of Ghana’s Petroleum Fiscal Regime” by Joe Amoako-Tuffour, a tax policy advisor at the Ministry of Finance and Economic Planning, and Joyce Owusu-Ayim, an economist with the GTZ Good Financial Governance Programme in Accra, found that the government take from the Jubilee Phase I under the current fiscal regime is between 38% and 50%, compared to a government take of 64-70% in Nigeria, 64% in Angola and 74-78% in Cameroon.

The media pressure on the government to revise the terms of these contracts may weigh on future agreements, although the MoE is remaining tight-lipped on the issue. Edem Wordi, an advisor with the Petroleum Directorate of the MoE, told OBG, “We’re going with a hybrid model at the moment but the decision will be made at the ministerial level and we’re not settled on one system yet.”

Future agreements are likely to be more favourable to the government, not only because of the public backlash and criticism of the current revenue models from the Jubilee Field, but also because these finds have decreased the risks associated with any future exploration. A July 2012 workshop hosted by the Institute of Economic Affairs (IEA) on the topic, “Making Ghana’s Oil and Gas Resource Count”, recommended that future contract agreements should include thin capitalisation rules for the petroleum industry, stricter relinquishment rights, a review of the corporate tax regime as well as local content requirements.

According to John Asafu-Adjaye, a senior fellow at the IEA, “There should be an equivalent increase in favourable arrangements to mirror the lower level of exploration risk, now that oil has been discovered.”

NEW CONTRACTS: Since the establishment of the contracts with Kosmos and Tullow, this has already been happening and Amoako-Tuffour and OwusuAyim believe the system will become increasingly progressive over time. According to their paper, “As a newcomer with challenges to access to markets, Ghana’s fiscal regime appears reasonably competitive and less onerous for investors. It is expected that Ghana’s take should increase over time with greater prospects, clarity on the regulatory environment and predictability of the political environment.”

Indeed, since the discovery of Jubilee oil in 2007, new contracts have already become more favourable to the government. In contracts signed in 2008 with Vitol Upstream, Oranto Petroleum International, Afren, Mitsui, Aker ASA and Chemu Power, the royalty increased to a level between 10% and 12.5% (as opposed to 5% for the Jubilee partners), and the additional oil entitlements owed to the government on company profits were brought in at a lower rate of return and a higher percentage. In the case of the Vitol and Oranto agreements, the entitlements were 17.5% at a rate of return of 17.5%, compared to only 5% at a 19% rate of return for Tullow.

This suggests that the fiscal system is becoming more progressive and that as Ghana establishes itself as a credible, low-risk environment for oil and gas investment, the government can generate greater revenue from production. This will, of course, mean less favourable terms for future investors, although Ghana is unlikely to become a prohibitively expensive place to invest compared to the region.

Nonetheless, while the general progressive trend does not pose a direct risk to the current operators of the Jubilee Field, as there are stability agreements written into their contracts, the possibility of the government attempting to renegotiate these contracts has certainly made operators slightly uneasy and is duly noted as an investment risk in their annual reports.

MOVING FORWARD: However, the sector is still in its infancy and experiencing growing pains as the government tries to find the correct balance between investment incentives, returns for the Treasury and the demands of the people of Ghana. There have already been significant strides made in establishing a sound regulatory environment for the growth of the industry. Indeed, the future appears very positive as more investors eye the Ghanaian market and the government plans how to maximise the benefits from the country’s new offshore hydrocarbons reserves.