4.6 Contractual Provisions for Natural Gas

Box 4.6 Contractual Provisions for Natural Gas

Petroleum exploration and production contracts signed with governments will typically include some or all of the following specific gas-related provisions:

1. Definitional provisions. Natural gas operations typically are highly integrated but contain distinct segments: upstream, midstream, and downstream, each subject to a specific fiscal regime. Definitions are required to clarify the phase of operations to which the contract applies, the point of delivery, and the point of valuation, distinguishing upstream facilities from transportation pipelines and downstream facilities. Definitions will cover associated and nonassociated gas, condensate, and natural gas liquids. 2. Appraisal of discovery provisions. Relative to oil, a longer period is generally allowed for appraisal of a natural gas discovery. Assessment of commercial potential generally takes more time given limited domestic markets, the absence of competitive international markets, and the need to establish longterm sales agreements (based on a sufficient aggregation of gas reserves, before final commitments to development are made). A retention period mechanism may be included in the contract. 3. Joint development provisions. Contracts may include obligations for joint development of gas discoveries and for the use of common infrastructure where stand-alone development would be noncommercial. It is similar to schemes designed to develop a project as a single unit where the resource crosses a boundary. 4. Associated gas provisions. Natural gas is often found together with oil. The priority use of associated gas is generally in support of oil operations to increase oil recovery through reinjection into the oil reservoir.

Disposal of associated gas provisions may (1) prohibit or heavily fine gas flaring on environmental grounds, (2) allow the investor the right to commercialize associated gas if possible, or (3) set terms for the sale or delivery of associated gas to the state if so requested by government. 5. Gas market provisions. Contract provisions may require priority allocation of gas to the domestic market and/or set conditions for the authorization of export sales. 6. Gas pricing provisions. The typical absence of a competitive upstream market for price reference purposes and the integrated character of gas operations necessitate that contracts contain a detailed gas valuation clause (in addition to the oil valuation clause) setting out how wellhead prices are to be determined for sale of the gas. Often government approval of gas sales contracts, including pricing, is required; there can be tensions as a result between the imposition of a low price for domestic consumption and a price based on fair market value, with damaging effects on long-term investment. 7. Fiscal provisions. Gas operations are typically less profitable than oil operations. Fiscal terms in contracts are typically adjusted to reflect this distinction unless the fiscal regime is based on achieved profitability (in which case no adjustments are required).

The past practice of leaving the negotiation of fiscal terms until discovery or setting fiscal terms for gas equivalent to those for oil has largely been abandoned (see chapter 6).

evident in Nigeria’s case. A large proportion of its associated gas is still flared, with significant environmental and social costs. The reasons are rooted in the absence of appropriate infrastructure for processing, transporting, or distributing gas or for generating electricity.

Mining

Types of licenses and application procedures. The vehicle used to transfer a right to a company or other legal entity to explore for and extract minerals is usually called a license. The name can vary, however, with convention being common in civil law countries and development agreement sometime used in others. The idea is the same: it is a legal instrument that sets out rights and obligations of the investor and host state that are additional to the legislation relevant to mining activities. Sometimes the content is in a standard form, sometimes it is individually negotiated, and sometimes it is partly standardized and partly negotiated.

More often than not there are between two and three kinds of licenses covering prospecting, exploration, and exploitation (the mining regimes of Ghana, Côte d’Ivoire, Tunisia, Turkey, and the Republic of Yemen are examples).

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Some countries offer a special license to artisanal or smallscale miners. Algeria, Madagascar, Mali, Mozambique, and Nigeria, for example, have such a license, the Democratic Republic of Congo and Zambia have a license for each). Some such licenses for local citizens only (Namibia, Tanzania, and Zambia, for example). In some cases, the words permit, lease, or concession are used. There may also be significant legal implications following from the terms used between civil and common law countries.

According to the vehicle chosen, the mineral right is transferred by the government authority in exchange for a commitment to carry out mineral exploration, development, or production. The manner of transfer and the rights and obligations of the licensee are usually set out in laws and regulations (see 4.7, “The Award of Contracts and Licenses”). Most countries with mining operations offer two main types of license for commercial-scale activities: a license to explore and a license to mine. A small number of states, especially in Latin America, where Chile is the most important example, grant a simple mining concession— which is a right to produce—through an application to a judicial proceeding. The application must show technical and financial capacity. In addition, these states will probably also offer some type of artisanal and small-scale mining license or registration.

A prerequisite of the law and regulations is to stipulate clearly the procedures for submitting license applications and the process by which mining rights will be issued and approved. Any qualifications, such as technical and financial capacity requirements, also need to be set out in relation to the kind of license, the obligations imposed, work commitments, and the size of land being licensed. Normally, the time will be stipulated within which a license will either be issued to an applicant or in which the applicant will be informed of the reasons as to why it has been denied. The manner of award of rights is discussed in section 4.7.

Investors expect any license conditions offered to provide successful applicants with strong security and continuity of tenure for the term of the license. As long as the licensee is fulfilling its obligations, it should be clear that this title will not be taken away arbitrarily and will be renewed if requested by the licensee. Moreover, it should be equally clear that if the holder of an exploration license wishes to be granted a mining license for a discovery it seeks to develop, there is a provision in the law for this to happen. Without these provisions on security of title, usually regarded as good practice, companies might not apply for licenses (Onorato et al. 1998, 31).

An illustration is found in chapter 4 of the Swedish Minerals Act Minerals Ordinance (2007, section 3):

If several persons have applied for a concession for the same area and more than one person can be considered, . . . the applicant holding an exploration permit within the area for any mineral covered by his application for a concession shall have precedence. If none of the applicants holds an exploration permit, the applicant who has undertaken appropriate exploration work within the area shall have precedence.

This security includes exclusivity and a prohibition on unlicensed activity in the area. However, some countries allow licenses to be awarded to different licensees for different minerals on the same areas. The 2006 Ghana Minerals Act, section 34(1), for example, states the following:

The Minister may, on an application duly made by a qualified person and on the recommendation of the Commission, grant a prospecting license in respect of all or any of the minerals specified in the application.

Linked to this provision on security of tenure is the provision of rights to assign license interests to other parties. Usually, any such transfers would be permitted subject to the consent of the relevant government body, with consent largely triggered when the application meets financial and technical capacity criteria. Such transferability tends to be particularly important to junior mining companies that are the driving force behind high-risk, grassroots exploration. The Ghana Minerals Act, section 14(5), addresses this in the following terms:

Subject to the other provisions of this section, an undivided proportionate part of a mineral right or application for a mineral right may be transferred, assigned, mortgaged or otherwise encumbered or dealt with.

The Minister must approve such a transaction and his approval shall not be “unreasonably withheld or given subject to unreasonable conditions” (section 14(1)).

To limit speculation, the authorities in Western Australia do not allow a transfer of an exploration license to take place during the first year in which the license has been held.

Other provisions typically included in licenses (or in the provisions of the mineral law or regulations relating to licenses) are ones that identify the competent government

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authorities and their responsibilities, a matter that limits the risk of duplication or overlapping jurisdiction. They set forth rules for relinquishment, whether voluntarily after disappointing exploration, a failure to perform work obligations, or as part of an agreed scheme to return acreage in stages to the public authorities. They also set forth considerations for dispute settlement by a third-party authority (see section 4.11, “Disputes: Anticipating and Managing Them”).

Licenses: Exploration. Most exploration licenses have a short term relative to a mining license: an initial period in the range of two to four years may well be followed by subsequent (“repeat”) extension periods of two to four years, giving the licensee a total period in the range of 10 to 12 years. This amount of time is generally considered necessary or reasonable to allow for the identification and subsequent proof of an economic deposit that is viable for development. Some states grant exclusive licenses that will cover any and all minerals discovered.48 Other states grant licenses only for prespecified minerals. In these cases, different companies may have licenses for different minerals on the same tract of land. However, the latter approach can result in conflicts of interest as different license holders may be permitted to explore on the same land area.

A fundamental goal of an exploration license is to ensure that exploration does in fact take place and, further, that a flow of information is delivered to the granting authority, the state. License holders are therefore given the right to search for, or exploit, minerals on the basis of use. Typically, a license holder will lose provisions and rights under the license if the area is not developed. This is to ensure that mineral rights holders do not simply obtain the rights and then hold them for speculative purposes. ‘A “use it or lose it” approach can be implemented through a variety of mechanisms such as work requirements and obligations, time-based mandatory relinquishment of a portion of the license area, or annual rental payments for holding a license area that progressively increase over time.

The need to promote exploration activity can enter into the way other provisions are drafted in the exploration license. It may be necessary to define the content of a work program in a flexible manner, because the licensees will seek to do more work in areas that have proven to be promising and less in areas that have been found to be less prospective. There are, however, limits to the flexibility a government will typically offer. Minimum expenditures should, for example, be nonnegotiable. Exploration expenditures should be primarily for substantive and verifiable exploration work, rather than for large overheads or indirect cost allocations. Alternatively, a government could impose progressively increasing land rental or holding fees, which raise the cost of holding the license area each year. Licensees will retain land they consider highly prospective but will relinquish less promising land.

Another key principle is that exploration license holders should contribute to a flow of data to the state on the progress of their geological activities. They may be required to provide an annual summary report of their findings for land that they continue to hold. They may also be required to provide full details of their exploration work and findings and their interpretation of the exploration data for land that is handed back from the license area. Such information received by the government is usually kept confidential until the license is surrendered. Then it can be made public. Termination provisions should apply in the event that companies fail to meet minimum expenditure requirements or to provide required exploration information.

In addition, license holders are normally required to restore any land that is disturbed during exploration. Penalties or sanctions typically apply to companies that fail to comply. In cases where the license is surrendered or terminated, an in-migration management plan and a resettlement and compensation plan is also mandated; these stipulations are particularly important in the mining sector. A full-fledged environmental impact assessment (EIA) is not generally required for exploration activities, but governments may require that a scoping study of an EIA be prepared.49 In most of these factors just described, there are strong parallels with the practices found in the petroleum sector.

Licenses: Exploitation. Before any mining license is issued to an applicant company, there needs to be a bankable feasibility study,50 along with the necessary environmental and social assessments and management and mitigation plans. There also needs to be a mine financing plan to demonstrate that the mine can be financed. In practice, there may be variations in approach. In small states where licenses for large-scale mines may be issued only once every few years, the government may require that a bankable feasibility study be completed and submitted with the license application. However, states with very large mining sectors and many mining license applications each year may issue the mining license on the basis of an application process that takes into account the technical and financial capacity of the applicant without formally requiring the submission of a bankable feasibility study.

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Exploration license holders usually expect an exclusive right to apply for a mining exploitation license for an area where they have discovered minerals, and to convert that exploration license to a mining license subject to fulfilment of specific criteria required by the relevant laws and regulations. Without this, they will probably not wish to take on the exploration risk: in the event of success, they may after all fail to be granted a right to develop the deposit. In any two-stage system, this is a source of risk, but many countries have taken steps to strengthen the linkage between exploration and mining rights in their laws. In Chile, Argentina, Mexico, Mongolia and Madagascar it comes close to being automatic access to a mining right for the licensee in its exploration area. Demonstration of the existence of a commercial deposit or of technical and financial capability to develop it become of little or no importance as criteria for granting a mining license.

The initial term for exploitation licenses is generally 10–30 years for large to very large deposits—shorter if the deposit will be mined out in a shorter period—with one or possibly two extensions depending on the size of the ore body (Martin and Park 2010). In the Centre for Sustainability in Mining and Industry study (CSMI 2010) for the Sourcebook, 51 the sample of countries using mining licenses found that periods varied between 25 and 40 years, with an option to renew. These periods could be negotiated depending on the estimated life of the mine. Licenses are generally exclusive and specify the main mineral products that will be or may be produced. The license will usually also give the license holder the exclusive right to exploit other minerals that may be found in the mining license area following approval and permits for such development.

Investors generally expect to be granted the right for the license holder to assign the license to another party with the consent of the government. Where given, this consent should be conditional on the new license holder meeting certain financial and technical capacity criteria. The government may also make the transfer conditional on payment of a tax on any capital gain made from the transfer. Policy on this subject has been rapidly evolving, particularly in Africa. Mozambique provides an example. In a takeover by Rio Tinto of a mining project no CGT was paid. This triggered significant popular unrest, and as a result the law was changed, but not retrospectively, and was enforced in relation to similar changes in the hydrocarbons sector.52

The mining license will typically contain reporting requirements on a variety of matters. Licensees have to report on and be in compliance with the prevailing health, safety, environmental, and social laws and regulations in the country. Similarly, license holders are expected to provide reports at regular intervals (monthly, quarterly, and annually) on production, employment, sales, stockpiles, earth moving, tailings, health, and safety performance. Reporting requirements will generally also include specifications on development and exploration activities as well as capital investment programs. If the license or contract contains provisions on reporting of payments made, it is important that such provisions are clear about when, where, and how such payments are to be made, as well as how much, and about the content and timing of the required reports. The government may also seek the power to require the data underlying the payment calculations or any operating reports the licensee is required to provide.

Termination provisions set out the circumstances under which the license can be terminated. Typically, this will include failure to construct and operate the mine as approved and/or frequent, repeated, uncorrected, and substantial HSE violations. There are normally provisions requiring the defaulting party to be notified of the breach and giving it an opportunity to rectify it. Termination of a license by a government is usually considered a last resort and is always open to legal challenge. For this reason, the termination must be material to the mining license or development agreement. If voluntary termination by the company is provided for, this provision needs to ensure that the circumstances are clear and that any required payments are set out. Closure of the mine is a stage that requires careful monitoring to ensure that obligations on rehabilitation and reclamation have been carried out (see chapter 9).

Operating permits. In addition to the mining license requirement, construction and operation of a mining project will be subject to environmental, water use, and land use permits (related to zoning and/or conversion from other uses such as forestry and agriculture) and approval for the commencement of production. It is likely that a bankable feasibility study will be required for environmental permitting.53 An approved preliminary mine closure plan, which includes financial assurance provisions, will usually be required.

Mining agreements. While there are many types of legal agreement used in the mining industry, a mining development agreement is commonly used to attract investment and develop mining projects. Usually, such agreements are provided for in a mining law and so are negotiated within the parameters set by such a law.54 An example is section 10 of the 2010 Tanzania Mining Act, which allows the minister of energy and minerals to enter into a development agreement

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