Chukwuka Eze March 3 2014 Divesting interests in upstream petroleum assets Udo Udoma & Belo-Osagie | Energy & Natural Resources - Nigeria Chukwuka Eze Energy & Natural Resources IntroductionLegal issuesCommentIntroductionIn the past few years a number of international oil companies have divested interests in upstream petroleum assets – namely, oil prospecting licences and oil mining leases – in Nigeria, particularly in the onshore and shallow water areas. Among the most notable are:Total Exploration & Production Nigeria Limited's sale of its 20% participating interest in Oil Mining Lease 138;Conoco Phillips' indirect sale of its interests in Oil Prospecting Lease 214 and Oil Mining Leases 60, 61, 62, 63 and 131 to Oando Energy Resources Limited by way of share sale (reported to be the largest-ever sale of onshore oil and gas assets in the Niger Delta region);Shell Petroleum Development Company of Nigeria Limited's sale of Oil Mining Leases 4, 38 and 41 to Seplat Petroleum Development Company Limited;Shell Petroleum Development Company of Nigeria Limited's sale of Oil Mining Lease 26 to First Hydrocarbon Nigeria Limited; andShell Petroleum Development Company of Nigeria Limited's sale of Oil Mining Lease 30 to Shoreline Energy Resources Limited.This spate of divestments has been attributed to various factors, including:the low production rate in onshore and shallow water assets;the high cost of operations;oil theft;the lack of security for personnel, installations and facilities such as pipelines;unresolved problems with host communities leading to the disruption of production for protracted periods;the commercial and operational challenges of complying with recent Nigerian laws, policies and regulations;issues in relations with the Nigerian national oil company; anduncertainty surrounding the timing and impact of the Petroleum Industry Bill.What is increasingly clear is that these divestments appear to be creating opportunities for greater participation by indigenous companies and other participants in the Nigerian oil and gas industry: there has been a notable increase in the involvement of local Nigerian banks in the financing of oil and gas projects. There are also apparently greater opportunities for the acquisition of technical and commercial experience by operators domiciled in Nigeria and for local employment, all of which portend benefits for the Nigerian economy.However, a number of legal issues have arisen, which should be taken into account before definitive decisions are taken either to divest or acquire oil and gas assets in Nigeria.Legal issuesTitle and assignability of interestsOne of the first legal issues that a prospective acquirer of interest in an upstream petroleum asset should consider is the title of the owner of the asset or interest to be acquired. There may be defects in the owner's title or encumbrances to the interest. It is not uncommon to discover that the interest proposed to be acquired has been the subject of a prior, unconcluded acquisition process, or a court case is pending in respect of the asset. In order to ascertain the nature of the owner's interest in the asset and whether there is any encumbrance on the asset, the acquirer should conduct legal due diligence on the asset, which will typically involves reviewing the title documents and agreements that the owner had entered into with other interest holders and third parties in respect of the asset, and carrying out searches at the courts and company and state land registries.In addition, the due diligence exercise should confirm whether there are any restrictions on the owner's ability to transfer the assets. Some standard agreements in respect of upstream petroleum assets in Nigeria require that the prior consent of the other interest holders in the asset be obtained before any interest in the asset can be transferred to a third party. In such circumstances, the prospective acquirer should confirm that such other interest-holders in the target asset are willing to consent to the assignment – and obtain evidence of such consent – before proceeding with the acquisition.Regulatory consent and approvalTwo main regulatory consents and approvals may be required for an acquisition of interests in an upstream petroleum asset in Nigeria:the consent of the Nigerian minister of petroleum resources, required under the Petroleum Act; andthe approval of the Nigerian Securities and Exchange Commission (SEC), required under the Investment and Securities Act 2007 and the SEC Rules and Regulations.While the minister's consent is required for both direct and indirect acquisitions through the acquisition of controlling shares, SEC consent is required only for indirect acquisition of a licence or lease through the acquisition of controlling shares in the company to which the minister had granted such licence or lease. Although the Nigerian National Petroleum Commission (NNPC) is not a regulator, its consent is usually required where the interest to be divested is held by a production sharing contract counterparty under a production sharing contract with the NNPC.Pursuant to Paragraph 14 of Schedule 1 to the Petroleum Act (Chapter P10, Laws of the Federation of Nigeria), the prior written consent of the minister is required for the assignment of a participating interest in an oil prospecting licence or an oil mining lease.In relation to marginal fields, Paragraph 17 of Schedule 1 to the Petroleum Act authorises the holder of an oil mining lease to farm out to a third party any marginal field which lies within the oil mining lease area, but only with the consent of and on such terms and conditions as may be approved by the president of Nigeria. In practice, however, the minister exercises this power on behalf of the president. The obligation to apply for ministerial consent is imposed on the assignor. The process can be protracted and cumbersome, and in some cases may take up to 12 months.By virtue of the Federal High Court of Nigeria's judgment in Moni Pulo Limited v Brass Exploration Unlimited (Suit FHC/L/CS/835/2011, unreported), ministerial consent will also be required in respect of an indirect acquisition of interest in an upstream asset by way of an acquisition of the controlling shares in the company that holds such interests (for further details please see "Ministerial consent required for change of corporate control under oil and gas law"). However, there is still some uncertainty as to whether ministerial consent would also be required where less than a controlling share is to be acquired in a company that holds an oil prospecting licence, an oil mining lease or a marginal field. Although there is no legislation or judicial pronouncement on this issue, the Department of Petroleum Resources has taken the view that such acquisitions will also require prior ministerial consent.In addition to the minister's consent, an acquirer of an interest by way of the acquisition of controlling shares in the company that holds the asset may be required to obtain prior approval of the SEC. Section 118 of the Investment and Securities Act and Regulation 423(1) of the SEC Rules require that every merger, acquisition or external restructuring between or among companies shall be subject to the prior review and approval of the SEC. An 'acquisition' is defined in Regulation 421(1) of the SEC Rules as "the takeover by one company of sufficient shares in another company to give the acquiring company control over that other company". Therefore, it would appear that the acquisition of more than 50% of the shares of a company that holds an interest in an oil prospecting licence, an oil mining lease or a marginal field requires the SEC's prior approval. If an acquisition is completed without the prior review and approval of the SEC, the SEC may, on becoming aware of this and determining that the failure to obtain its approval is in breach of the Investment Securities Act or the SEC Rules, impose various penalties.Indigenous status requirement for oil fieldsIn a bid to increase Nigerian participation in the ownership of oil and gas assets in the country, the government has initiated policies which set a limit on foreign participation in or ownership of upstream assets. In this respect, the department requires that any upstream asset in Nigeria (operated under an oil prospecting licence or an oil mining lease), the Nigerian interests in such fields should be a minimum of 60%, and the Nigerian interests in a marginal field should not be less than 51%. These prescribed foreign ownership thresholds can restrict the choice of third parties to which the owner of the relevant asset can transfer its interest. The parties must bear this in mind in undertaking the transaction, as it may be grounds for the minister to refuse to grant consent to the acquisition, rendering the entire asset transfer ineffective.Financing acquisitions and the issue of collateralA constant challenge for most acquiring companies, particularly indigenous companies, is how to raise the funds required for the acquisition, development and operation of the acquired fields. Oando Energy Resources Limited has reportedly been trying to raise funds to pay for its acquisition of the Conoco Phillips assets for more than 12 months after the acquisition. Of the 24 marginal fields awarded by the Nigerian government to 31 indigenous companies in 2003, statistics show that only eight have gone into production. Most of the marginal field owners have been unable to raise the funds they require to develop their fields.Loan financing is a common source of funding for the acquisition of upstream petroleum assets, but a key issue with such loan facilities is the collateral that the acquirer or borrower can provide to secure the loan. Given the nature of upstream petroleum assets and the requirement for ministerial consent to the assignment of such assets, their use as collateral has proved to be not a viable option. This is primarily because of the ministerial consent requirement and the fact that the minister is unlikely to grant consent to an entity that does not have the necessary technical capacity to develop and operate the asset (eg, a bank).As an alternative to using the asset as collateral, acquirers appear to be seeking reserve-based lending, which involves a non-recourse loan, whose amount is based on the expected present value of future production from the fields in question, taking account factors such as:the level of reserves;the expected oil price;a discount rate;assumptions for operational expenditure;capital expenditure;tax; andany price hedging employed.Reserved-based lenders will usually require that the shareholders of the acquirer or borrower charge or mortgage their shares as security for the financing. Under the Moni Pulo decision, such share mortgage or charge could raise the issue of whether ministerial consent will be required.CommentA prospective acquirer of interest in an upstream petroleum asset in Nigeria will have to deal with a number of legal, fiscal, environmental and community issues to ensure that the transaction is viable. The legal issues identified above are increasingly topical in Nigeria. While some of the issues are simple and straightforward and can be resolved easily, others appear to be more controversial or to have no clear definitive precedent to guide putative investors. It is hoped that in time, these issues will be decided or at least clarified by the courts, or settled by legislation such as the Petroleum Industry Bill that is still under consideration before before Parliament, if it passes into law. However, until then these issues will have to be dealt with on a case-by-case basis.For further information on this topic please contact Sally Udoma, Folake Elias Adebowale, Chukwuka Eze or Aniekan George Ikott at Udo-Udoma & Belo-Osagie by telephone (+234 1 263 4831), fax (+234 1 263 4541) or email ([email protected], [email protected], [email protected] or [email protected]). The Udo-Udoma & Belo-Osagie website can be accessed at www.uubo.org.