1. Purpose of regulating the petroleum industry

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1 Petroleum Legislation and Regulations Overview Petroleum sector projects are complex, high-risk investments which require a carefully drafted regulatory framework that combines sustainable economic development for the host states as owners of the resource with guarantees and incentives to investors asked to risk their capital in these projects. Petroleum sector legislation operates with fiscal legislation and foreign investment law. This topic overview explains the hierarchy of petroleum law in exploration and production stages, and how the national and sub-national levels interface with international law instruments. It is split according to the following chapters: 1. The purpose of regulating the petroleum industry 2. Key forms of upstream legislation 3. Commonly regulated activities 4. International law 5. Industry view 6. Considerations for new producers 1. Purpose of regulating the petroleum industry Upstream sector activities require significant investments. Typically, governments invite international oil and gas companies to take the risk to invest and (if successful) to profit from petroleum operations on the basis of a long-term contract, setting out detailed terms and conditions. Ownership of petroleum almost always lies with the host country rather than foreign investors. 1

2 Where an established petroleum industry exists, as in Mexico or Nigeria, a public or mixed-owned entity may play a leading role in developing the resources. The host state normally regulates petroleum activities through a body of law based on a series of policy choices, contract forms and fiscal instruments in a distinct structure or framework. Petroleum legislation aims to regulate sector operations and determine the sharing of the petroleum revenues and income between the State and the entity authorised to undertake these operations. It also aims to maximise and preserve monetary benefits in the long term and foster exploration. In practical terms, knowledge of what the ground rules allows a prospective investor to model business operations in advance of making an investment. 2. Key forms of upstream legislation There are two key forms of petroleum legislation: The key actors of the petroleum industry The key petroleum industry players include: Government authorities, such as a ministry or a petroleum directorate; National oil companies (NOCs) (for example the State Oil Company of the Azerbaijan Republic); International oil companies (IOCs) (for example Chevron, Shell, or BP), as well as Independent companies and service companies. 2

3 3. Petroleum legislation A host state needs to regulate petroleum activities in its jurisdiction and develop strategic policies to develop its resources. This often involves specialist legislation, i.e. a petroleum, natural gas or hydrocarbons law, which operates with other relevant legislation such as fiscal laws and investment laws. Any specialist legislation needs to also comply with the state s constitution, which may contain provisions relevant for hydrocarbon operations. For instance, a resource-rich state s constitution may contain principles on expropriation in the public interest and compensation (i.e. Norwegian constitution), or provide rules on ownership. Other examples are the constitutions of both Ghana and Bolivia, which vest ownership of their respective states natural resources with their people. Typical approaches to designing a petroleum legal framework Three approaches are typically used in to design a legal framework to regulate the upstream sector: In the first category, a host state s petroleum law or act regulates key stakeholders responsibilities and license terms in comprehensive detail and they are non-negotiable. This is the preferred route for most European Union member states, the US and Australia, as well as most Latin American states. The second approach is usually used by developing states where petroleum legislation is very general or does not exist at all, and this gives the host states utmost flexibility in negotiations. 3

4 The hybrid approach uses the country s petroleum law as guidance in drafting detailed international instruments such as pipeline agreements, and for preparing bids and licenses. 4. Commonly regulated activities Some of the key areas of consideration when drafting an upstream petroleum law typically include: Which of these commonly regulated activities will be governed under given legislation varies according to the socio-economic characteristics and political context of each country and whether the legislative model chosen is the detailed approach, the flexible one or a hybrid as mentioned above. In any event, licenses are generally awarded via competitive bids or auctions. There will also be interactions with investment law and foreign control laws. 5. International law International law recognises the State s sovereignty over its natural resources under the 1958 Convention of the Continental Shelf, which was later carried over to the UN General Assembly (GA) Resolution 1803 on 4

5 Permanent Sovereignty over Natural Resources in 1962.To further emphasise that a host country fully owns and controls petroleum resources under its jurisdiction, a further UN Resolution 3281 (XXIX), Charter of Economic Rights and Duties of States is adopted by the UN GA in Acknowledgement of permanent sovereignty meant that the host states could nationalise or expropriate foreign company assets. However, they could only do so for reasons of public utility, security or national interests and if compensated in accordance with the host state s laws and international law. A more elaborate and modern version of this rule is contained in the Energy Charter Treaty (ECT), signed in 1994 between the then newly emerging former Soviet Union states of resource rich Central Asia and Europe, as well as Japan, Russia and Turkey. Article 18 of the ECT also recognises permanent sovereignty over natural resources but reiterates the standard tests for expropriation: it is only allowed when it is undertaken for the purpose of the public interest; it is not discriminatory; it adheres to due process of law and it is accompanied by prompt, adequate and effective compensation. The ECT also has a comprehensive investment protection chapter (Part III of the Treaty) which has become the standard of investment treatment in many successive Bilateral Investment Treaties (BITs). The ECT s executive body, the Energy Charter Secretariat, produced a model intergovernmental and host-government cross-border pipeline agreement for natural gas which has been the basis of a few pipeline agreements in Central Asia, such as Baku-Aktau pipeline agreement. With regards to offshore exploration and laying of subsea pipelines, the UN Convention on the Law of the Sea Treaty provides fundamental rules and international rules, including rules on obligations for the removal and disposal of offshore installations and structures. 6. Industry view One of the major consideration for the petroleum sector in the making and implementation of oil and gas law is the potential for conflicts between national interests and the interests of the international petroleum industry. It is important to ensure there is sufficient competition amongst oil companies and within the supply industry to serve for the interest of national and international industry participants, by opening up the sector and building dialogue within the authorities and the industry on the direction of legislative developments. 5

6 This interaction should aim for capacity and trust building within the industry stakeholders and between them and policy makers, and to enhance transparency when deciding on approvals for each important activity such as drilling, development, pipeline transportation, and disposal. For the foreign investor, it is often preferable that the general framework for exploration and production is legislated under a generic petroleum law, so there is room for negotiations of the details under the contract. Nevertheless, a well-defined and detailed tax law within the petroleum code or as a separate legislation would give more predictability and increase investor appetite. 7. Considerations for new producers New producer countries such as Mozambique, Ghana, South Africa, Tanzania, Uganda and Kenya can experience particular problems with an evolving petroleum legal framework. Their legislation needs to take the resource curse into consideration and carefully plan to avoid it, via linkages to other critical economic sectors. For instance, Nigeria and Ghana have given high priority to this aspect. In principle, this ought to be easier for new and emerging producers as they can learn from the experience of established producers such as Nigeria and Angola, which are considered to have made mistakes in this respect. Resource nationalism is another element that shapes the making of petroleum legislation in most producing countries. However, the local communities are increasingly aware of their rights to benefit from their resources and tend to push some governments to adopt more strict regulations on local content in particular. Another challenge is to understand and act on the importance of environmental legislation especially the environmental impact assessment requirements (EIAs). A draft EIA should be made available to the public before a project can go ahead. Regulations should make this obligatory. Harmonisation of regional standards, policies, legal framework and regulations, the promotion of cross-border public-private partnerships and collaborative sustainability efforts are thus important components of petroleum law and policy. As the discovery and commercial development of new sources becomes increasingly challenging, the right balance of biodiversity, environment, 6

7 health and safety also needs to be made: for instance, exploration in lakes puts biodiversity at risk and requires vigorous social-economic and environmental planning. Finally, investors entering a new market have a strong interest in assisting governments in designing the best policy and regulatory framework for the country concerned. A long-term, sustainable legal framework will provide investor security but also increase the likelihood that benefits will accrue to the country s citizens. 7