Mineral development is a high-risk, long-term and large-capital investment endeavor; as such, it should form part of an overall legal and economic strategy.
Regulation of petroleum development in all its aspects before starting exploration and exploitation activities is crucial for the protection of the national interests and natural resources in a country.
Experiences of oil producing countries show that there is always a challenge for the host government to strike a balance between attracting the international oil companies and efficiently regulating their activities.
The Lebanese government worked thoroughly to build a strong legal regime to govern and regulate offshore hydrocarbon activities. With the Offshore Petroleum Resources Law, the Petroleum Activities Regulations and the Lebanese Exploration and Production Agreement, Lebanon has taken major steps toward developing a reliable oil and gas sector in accordance with international standards. Whether Lebanon will be able to control its mineral resources and protect its national interests through these legal instruments and how the government will maximize its revenues through the EPA are the real challenge.
The magnitude of the economic benefits for the Lebanese government depends on the design of the best and proper profit-sharing mechanism, especially since there is no universal or standard profit sharing formula; each country has to develop its own fiscal mechanism according to its specific geological, economic and political circumstances. Even within a country, the host government may negotiate different fiscal terms for different geographical areas.
The cornerstone of the EPA’s fiscal system is how it is structured to allow for division of profits and recovery of costs. As long as it is flexible, it should provide a more stable investment environment for both the international oil company and the host government. In designing a petroleum fiscal mechanism, the main objective of any government should be to efficiently capture economic rent from their natural resources without undermining foreign investments.
The cost recovery parameter: Usually, before sharing the profit oil between the government and the companies, the firm is entitled to a prespecified share of production for recovering the exploration and production (EP) costs. Therefore, defining a limit for EP costs is a must, otherwise a host government cannot generate a high level of profits. In other words if cost recovery percentage is too high, the government will end up with only a small share of the gross production. Moreover, governments will be concerned that companies would waste the natural resources through EP costs and/or overbill such costs. The saving index is a measure that may be used by governments to keep costs down. Regular approval and control of the budget through auditing is another way. Penalties for noncompliance with laws or for fraud may also be applied.
Exploration and development costs in Lebanon are expected to be high as petroleum reserves in Lebanon are found in deep waters. Accordingly, companies will tend to offer a high level of cost recovery, arguing that high exploration and development costs will increase their economic risks, but they are also willing to spend more as long as they expect to find huge fields. Areas previously regarded as too expensive or complex to explore, or too politically unstable to justify operations, have become more economically viable given the expectations of high energy demand and advances in technologies. Even ultra-deep water drilling has become profitable; new innovative technologies, products and services have been developed and used to make substantial advancements in the most complex deep water fields.
Consequently, countries with huge reserves remain very attractive despite the high EP costs. Defining recoverable costs is also fundamental in the EPA. Environmental costs shall be properly addressed in the EPA and should not be considered recoverable costs as they may lead to major negative economic impacts on the government.
The Profit oil parameter:This parameter plays the most important role in generating high or low level of revenues for the government. After recovering the EP costs, the remaining oil produced (called profit oil), is then shared between the government and the companies at a stipulated share. Production sliding scales are usually used for creating a flexible fiscal system; however, they are unresponsive to fluctuation in oil prices. Therefore, a profit-sharing mechanism should be based on sliding scale tied to R-factor or ROR systems, which usually increase the government’s portion under higher oil prices as they contain a progressive profits-based fiscal element tied to profitability of the project, not only on production sliding scale. As for the portion of the government’s share of profit, it is mainly determined by the characteristics of the field and the size of the recoverable reserves. The investment decision by companies is influenced by the geological features of a field as water depth, proven or unproven reserves. Part of a well-balanced EPA involves matching the split of profits to the prospects of an area. Some of them are geologically rich to justify the high rate of government share. This should be the case in Lebanon, which has huge reserves of gas: Preliminary surveys of the Lebanese offshore fields show that reserves in the surveyed 45 percent of Lebanese waters have reached 95.9 trillion cubic feet of natural gas. Lebanon’s oil reserves of its southern coast are of the richest and best in the region, as the British Spectrum Company unveiled in 2012.
Would Lebanon be one of the richest producing countries in the region? Many political, economic, legal and technical factors will determine the future of the sector.
Lana Fayad is a partner with Kouatly & Associates-Attorneys LLM with merit in Oil and Gas Law from Aberdeen, Scotland.