“We believe, as we go into the next decade, Mozambique will emerge as the third-largest exporter of LNG in the world,” Al Walker, Anadarko Chairman, President and CEO1

In February’s edition of “Notes From the Field,” we looked at realising the potential in East Africa and highlighted that new entrants to, and existing participants in, the rapidly evolving East African gas market will want to identify and mitigate the risks of doing transactions against this changing legal and political backdrop.

The development of the oil and gas industry in East Africa, to the extent that East Africa is now regarded as containing some of the most significant gas provinces in the world, has catapulted the region into becoming a core geographical focus for many international oil companies ("IOCs") looking to expand their oil and gas portfolios.

The underlying oil and gas legislation in these jurisdictions which will regulate IOCs investments in oil and gas projects reflect the fact that the oil and gas industry in these jurisdictions are in their relative infancy compared to other jurisdictions with a “mature” oil and gas industry like the UK North Sea. These lead to the inevitable issues which arise from inadequate legislation which fails to address the complexities of oil and gas production from such large discoveries.

A prime example of this has been Mozambique. Though oil and gas exploration in Mozambique dates back to as early as 1904, it has been the 2012 offshore discoveries of Eni, Anadarko and their partners that has transformed Mozambique into a major new gas province with realistic ambitions at become a key player in the LNG market.

The Government along with IOCs recognised that the 2001 Petroleum Law (Law No.3/2001) failed to provide a suitably robust legal framework which was needed to regulate IOC investment in these discoveries which may hold significant reserves of gas and to allow IOCs to monetise these discoveries by developing the necessary LNG facilities. Allied to this was the need for the Government to ensure from a local content perspective that Mozambique secured the economic benefits of these large gas provinces.

To achieve this, the Government passed a new petroleum law (Law No. 21/2014) which came into force on 18 August 2014 and is still subject to further regulation by Mozambique’s Government (“2014 Petroleum Law”).

This article looks at certain key aspects of the 2014 Petroleum Law which may be of interest to IOCs. The article is not intended to cover every aspect of the 2014 Petroleum Law and is not intended to be a substitute for reading the 2014 Petroleum Law itself. IOCs should also refer to the primary legislation.

Dissecting the 2014 Petroleum Law

1. Concession contracts

IOCs looking to participate in petroleum operations (which is the term used in the 2014 Petroleum Law) in Mozambique need to be aware that the conduct of petroleum operations in Mozambique is subject to the prior execution of a concession contract or other form of contract in accordance with the 2014 Petroleum Law. 

These contracts are set out below.

  1. (Contrato de concessãor de reconhecimento) – reconnaissance concession contract (valid for a maximum period of two years) – grants the non-exclusive right to conduct preliminary exploration work and assessment operations in the concession contract area;
  2. (Contrato de concessãoprospecção e pesquisa) – research and production concession contract – grants the exclusive right to carry out petroleum exploration and production as well as a non-exclusive right to construct and operate oil pipelines or gas pipelines systems for the transportation of crude oil or natural gas or infrastructure for liquefaction of gas produced from the concession contract area, except where access to an existing oil pipeline or gas pipeline system or existing infrastructure is available on reasonable commercial terms;
  3. (Contrato de concessão de sistemas de oleoduto ou gasaduto) – oil pipeline or gas pipeline system concession contract – grants the right to construct and operate oil pipeline or gas pipeline systems for the purpose of transporting crude oil or natural gas “in those cases that such operations are not covered by an exploration and production concession contract.” The contract will need to be accompanied by the relevant development plan; and
  4. (Contrato de infra-estruturas) – concession and infrastructure contract – grants the right to construct and operate infrastructure for petroleum operations, such as processing and conversion, which are not covered by an approved exploration and development plan.

2. The State

The 2014 Petroleum Law clarifies the specific role of the State, with the State being responsible for controlling the prospection, exploration, production, transportation, commercialisation, refining and transformation of liquid and gas hydrocarbons and their derivatives including petrochemicals, LNG and Gas for Liquids Activities.

For IOC, this clarification is important because it emphasizes the philosophy of the State with respect to having an active role in the Mozambican oil and gas sector. Under the previous petroleum law, the role of the State was expressed in a very broad manner with the state having a “definitive role in promoting the exploitation of the existing potential in such a way as to provide access to the benefits of petroleum production and contribute to the social and economic development of the country.”  

Under the 2014 Petroleum Law, the State reserves the right to participate in petroleum operations in which any legal entity is involved through the national oil company, Empresa Nacional de Hidrocarbonetos (“ENH”). The participation of the State via ENH may occur during any phase of petroleum operations in accordance with the terms and conditions which will need to be agreed by a contract between the IOC and the State.

Under the 2014 Petroleum Law, the State shall progressively promote the increase of its participation in the oil and gas concession over time. The 2014 Petroleum Law does not explain the ultimate extent of the State’s participation over time. Ultimately, for oil and gas project development in Mozambique to succeed, a combination of both State and IOC support will be needed and IOCs need to be mindful that the State does envisage seeking a greater role in the oil and gas concessions.

Specific legislative provisions regarding the role of ENH as the vehicle for State participation in petroleum operations in Mozambique are included in the 2014 Petroleum Law.

The 2014 Petroleum Law states that ENH is the national entity responsible for the prospecting, exploration, production and commercialisation of petroleum products and for representing the State in petroleum operations. The Government reinforces this principle under the 2014 Petroleum Law by guaranteeing the financing of ENH. 

For IOCs looking to acquire acreage in Mozambique, under the 2014 Petroleum Law, any investor is required to enter into a partnership with ENH as the exclusive state representative.

Interestingly, the 2014 Petroleum Law envisages that ENH will take the lead with respect to the marketing of oil and gas. This will be a significant issue which IOCs will need to investigate further because it is unclear how ENH would market oil and gas and upon what terms would ENH enter into marketing arrangements with offtakers. 

3. The ability for an IOC to participate in petroleum operations in Mozambique

Foreign legal entities” and “Mozambican legal entities” that are registered in Mozambique and who demonstrate that they have the technical capability and adequate financial resources for the effective conduct of petroleum operations may have the right to conduct petroleum operations.

IOCs need to be aware that the 2014 Petroleum Law grants pre-emption rights with respect to the granting of concession contracts to foreign legal entities and Mozambican legal entities which “associate” with Mozambican legal entities. Mozambican legal entities must be incorporated and registered in Mozambique and have at least 51% of its share capital held by “national citizens or controlled by Mozambican citizens or Mozambican public or private companies or institutions.” 

As part of the drive for the promotion of “national entrepreneurship,” the 2014 Petroleum Law also states that oil and gas companies must be listed on the Mozambican stock exchange in accordance with applicable Mozambican legislation.

The 2014 Petroleum Law does not provide any further clarification about this listing requirement and IOCs will need to fully understand the implications of the listing requirement in conjunction with its tax and accounting advisors. IOCs will also need to factor in this requirement when assessing the optimal commercial and legal structure for their participation in the Mozambican oil and gas sector, including the cost and timing implications for listing a company on the Mozambican stock exchange and any ongoing reporting requirements which may stem from listing on the Mozambican stock exchange.

4. Investment structures for participating in concession contracts

Under the 2014 Petroleum Law, foreign legal entities which directly or indirectly own rights under a concession contract, are required to be established, registered and administered under a “transparent jurisdiction.” The concept of a “transparent jurisdiction” is defined in the 2014 Petroleum Law as being jurisdictions where the Government in an independent manner may verify the ownership, management, control and financial position of a company wishing to participate in petroleum operations in Mozambique.

Although the 2014 Petroleum Law does not expand upon how the Government will verify the ownership, management, control and financial position of a company wishing to participate in petroleum operations in Mozambique, IOCs looking to structure their investment through the use of offshore incorporated holding companies need to be mindful that the incorporation of offshore holding companies (whether to derive tax benefits or not) will be scrutinised by the Government. 

5. Transfer of rights in concession contracts

Under the 2014 Petroleum Law, any direct or indirect transfer of rights and obligations granted under the concession contract to an affiliate or to a third party needs to be in accordance with Mozambican law and is subject to the approval of the Government. 

The requirement for compliance with Mozambican law and the approval of the Government will also apply to other direct or indirect transfers of interests including the transfer of shares or other forms of participation of the rights holders under the concession contract.

This is particularly relevant in particular for IOCs. When IOCs are looking to acquire or divest upstream interests, one of the key issues which IOCs consider is whether the upstream interest will be transferred by a share sale or an asset sale. In a share sale, an indirect transfer of the upstream interests will occur by the divestment of the share capital of the company that holds the upstream interests. IOCs commonly use share sales as method of reducing third-party consents given that the relationship between the company being sold and its contractual counterparties does not change. 

Given that perfecting transfers is a time consuming process, it is important that both the incoming party and transferring entity seek to confirm as early as possible that the relevant governmental authority will not hinder or reject the proposed transfer or impose additional conditions on the parties as a prerequisite for the granting of its consent to the transfer.

6. Guarantees

Under the 2014 Petroleum Law, IOCs are required to provide financial performance guarantees to ensure compliance with the terms and conditions of the “petroleum exploration authorisations.” The 2014 Petroleum Law does not elaborate on the terms or the financial amount to be guaranteed, though the 2014 Petroleum Law does state the terms of the guarantees are “to be regulated.” 

IOCs will need to monitor any impending regulations which will regulate guarantees, particularly given that IOCs will have internal governance requirements with respect to the authorisation of parent company guarantees.

7. Overlapping rights

The 2014 Petroleum Law acknowledges that concession rights for the conduct of petroleum operations may be granted over a concession area which may already be subject to pre-existing rights for the exploitation of other natural resources in that concession area. 

If this occurs, the 2014 Petroleum Law allows the Government to decide which rights shall prevail, without prejudice to the compensation due to the concession holder.

IOCs need to make that sure that when undertaking due diligence of the concession area, any pre-existing rights over the concession area for the exploitation of other natural resources are identified accordingly and factored into their transactional risk assessment given that any concession rights for the conduct of petroleum operations may be subject to review by the Government.  

8. Local content

  • Oil and Gas for internal consumption

The 2014 Petroleum Law states that the Government shall guarantee that a quota of at least 25% of the oil and gas produced in national territory is dedicated to the national market. IOCs may have differing views about these requirements, however some may form the view that this is indirect expropriation.

IOCs will need to consider how will the Government compensate them for the 25% of oil and gas produced which is being reserved for the domestic market. The 2014 Petroleum Law states that the Government shall approve the methodology for pricing. 

Given that the 2014 Petroleum Law is silent about the methodology which would be employed, this raises uncertainty regarding the pricing mechanism which the Government would employ to price the oil and gas reserved.

Under the 25% quota, IOCs will want a pricing formula which follows international practice and which reflects its own pricing expectations. This is important because IOCs looking to participate in Mozambique’s oil and gas industry will require certainty that the price received for oil and gas produced and reserved under the 25% quota is economically competitive for IOCs and ensure sufficient shareholder value for its shareholders.

Equally, the Government will look to employ a pricing mechanism that is economically competitive and avoids any domestic concern that the Government is “overpaying” for the oil and gas reserved under the 25% quota.

Secondly, it is uncertain how the 25% is actually calculated. Is the 25% figure based on oil and gas extracted after refining or processing?

If the intention is for the 25% quota to apply to the oil and gas extracted after it has been refined or processed, then will IOCs be reimbursed for the capital expenditure incurred with respect to constructing the necessary midstream and downstream facilities or is the intention that the Government will responsible for constructing these facilities?

  • Government acquisition of petroleum produced in a concession contact 

As a separate provision, the 2014 Petroleum Law states that where the national interest so requires, the holder of a reconnaissance exploration and production, infrastructure, construction and operation and oil pipeline or gas pipeline system right” is required to give preference to the Government regarding the acquisition of petroleum produced in the concession contract area, “in accordance with specific legislation.

IOCs need to be aware that the concept of “national interest” is not defined in the 2014 Petroleum Law, and is therefore open to the discretion of the Government. Equally it is unclear how this provision will interact with the requirement to reserve 25% of oil and gas produced for the national market.

  • Development of industry activity 

The State may request the “petroleum product” at “negotiable prices” for use in local industry whenever Mozambique’s “commercial interests” demand it.

Again, IOCs need to be aware that the concept of “commercial interest” is not defined in the 2014 Petroleum Law and is therefore open to the discretion of the Government. IOCs will also need to be mindful that negotiations with the Government may be protracted as both parties seek to achieve a common position with respect to the price of the “petroleum product” requested by the Government.

  • Acquisition of goods and services 

The 2014 Petroleum Law requires that petroleum operation right holders are required to acquire goods or services above a “set amount” through a public tender. This “set amount” is not defined in the 2014 Petroleum Law, so IOCs will be in an uncertain position regarding compliance with this requirement.

Foreign entities that provide services to the petroleum operations must “associate to single or collective Mozambican entities.” One scenario which could occur because of this requirement is that Mozambican companies will be incorporated by IOCs with the sole purpose of satisfying this legislative requirement. 

  • Training of the local work force involved in petroleum operations

The 2014 Petroleum Law requires IOCs to ensure the employment and training of Mozambican nationals, as well as their participation in the management of petroleum operations. The 2014 Petroleum Law does not provide a specific quota regarding how many Mozambican nationals must be employed and trained by IOCs in Mozambique or the level of training that is required to achieved compliance with the 2014 Petroleum Law. 

9. Rights acquired under contracts and concession contracts entered under the 2001 Petroleum Law

One of the key concerns for IOCs with any revision of laws in jurisdictions in which they operate in, is the status of rights relating to petroleum operations which they acquired under contractual arrangements which are governed by the previous laws before they were revised.

The 2014 Petroleum Law acknowledges the concerns of IOCs regarding this issue by stating that rights acquired under the contracts and concession contracts entered into under the 2001 Petroleum Law relating to petroleum operations remain valid.