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Legal Nature of the Papua New Guinea Petroleum Arrangement [2003] MLJ 6; [2003-04] 29 MLJ 117 (1 January 2003)

Legal Nature of the Papua New Guinea Petroleum Arrangement

Melvin Yalapan[*]

Introduction

Petroleum exploration and development in Papua New Guinea (PNG) are carried out under a policy regime that fixes in advance, conditions under which rights to explore for and produce petroleum are granted. The legal regime is set out primarily in the legislation[1] and complemented by petroleum agreements that are entered into in respect of each exploration licence.[2]

Some countries do not use the legislation to set out the terms and conditions of petroleum development. If there is such a law, it is of a general nature. The government grants exploration and production titles on the basis of individually negotiated agreements.[3]

Other countries take the middle ground by using a hybrid system of fixing the terms of petroleum exploration and production, partly by legislation and partly by agreements. In such cases, certain fundamental terms of petroleum exploration and production are set out in the legislation while the specific terms and conditions are negotiated and settled by agreements.[4]

Petroleum agreements are used in many countries as the main policy instruments, to set the scope of, and govern petroleum exploration and production. These agreements are used exclusively or in association with petroleum legislation.

The public and private arrangements under which petroleum exploration and production are authorised and undertaken have gone through a variety of phases since the emergence of petroleum as an internationally traded commodity, from the earliest grants of concessions by various sovereigns in the Middle East to the modern concessions, joint venture agreements, service contracts, production sharing contracts or combination of one or more of these traditional forms of petroleum arrangements.

Petroleum arrangements of some countries have the characteristics of more than one formally recognised legal arrangements. This paper will endeavour to identify and consider the salient features of these legal arrangements and apply them to the Papua New Guinea’s (PNG) petroleum arrangement. The object of this exercise will be, firstly, to highlight the fundamental features of PNG’s petroleum arrangement and, secondly, to classify the PNG’s petroleum arrangement under one or more of the recognised forms of petroleum arrangements that are in use in the petroleum industry, globally.

A. Different Petroleum Arrangements

Whilst various legal arrangements are used by different countries to secure and regulate petroleum exploration and production, they deal with common considerations that are essential for petroleum exploration and production. It is the treatment of these features that distinguish the different legal arrangements under which petroleum development is conducted.

(a) Concessions

The history of petroleum agreements begins with the granting of an oil concession by the Persian Government to William D’Arcy in 1901.[5] The original 1901 D’Arcy concession was granted over the whole of the Persian Empire with the exception of 5 provinces, covering 480,000 square miles. Concessions granted by the rulers of Abu Dhabi and Kuwait covered their entire countries.[6] The concessions were granted for very long periods[3] and on modest fiscal terms.[7] Professor Charles Lipton summarised the traditional concession arrangement as follows:

"It was a long term agreement. 99 years was not untypical. It created enclave and give rise to exception to the general law application. Management ‘prerogative’ were left to the operating company. There was no government participation in the basic decisions such as the rate of operation or marketing. The investor provided all capital typically, and was entitled to all profits, originally paying the government a per ton royalty."[8]

Thus under the traditional concession, the concessionaire was granted, and had, the exclusive right to explore for, produce and deal with petroleum within the concession area. The oil companies therefore made decisions affecting all aspects of the petroleum operation. In terms of petroleum exploration, it meant that the oil companies decided exclusively how much or how little exploration they wished to undertake. Upon discovery, the oil companies decided the rate, extent and level of production.[9]

The companies also had, in a traditional concession, by the grant of the concession, title to the petroleum in situ. The host government, or ruler, normally received an initial consideration, roughly amounting to the modern day signature bonus and only the right to receive financial return from the petroleum operation. Originally, this was in the form of royalty payment, and later royalty and taxes.[10]

The scope of the traditional concession is startling when other aspects of a concession are considered. The 1901 Mexican petroleum law, for example, authorised, granting of liberal tax exemption, the right to import machinery, equipment and materials duty free and other special privileges, which included the right to expropriate land necessary to conduct petroleum operations.[11]

The situation existed until the late 1950’s when governments with the aid of progress in technology, considerable discovery of new oil fields and worldwide dependence on oil, broke the shackle that underpinned the traditional concession arrangement. These enabled governments to demand and secure improved terms under which the petroleum resources located within their territories could be developed.

The post 1950’s concessions provided significant new terms. The financial return to the host country increased significantly with provisions for equitable profit sharing. The petroleum acreages were reduced, and provisions for relinquishment of the concession areas or part of the concession areas, driven by work program and budget were introduced. It was during this period that governments began to take direct equity participation in petroleum projects. In addition, host governments also enacted legislation that dealt specifically with petroleum exploration and production, thus establishing uniformity the basic terms under which petroleum exploration and production were undertaken within the country.[12]

The increased concerns of governments with regard to ownership and control of the natural resources led to the assertion of permanent sovereignty over the natural resources within the states’ territories. The 1962 UN Resolution on the Permanent Sovereignty over Natural Resources[13] is the reflection of the assertion of sovereignty, particularly by the newly independent third world governments, to natural resources within their territories.

The UN Resolution on the Permanent Sovereignty over Natural Resources also provided further impetus for the creation of alternative legal arrangements for petroleum development. These were structured not only to enable host states to retain ownership of the resources in situ in their national boundaries but at the same time, to allow oil companies to conduct petroleum operation in the country. Old concession arrangements were revised and new concession arrangements were established.[14]

The modern concessions differ in important respect from the traditional form of concession. Under the new concession arrangements:

"...ownership of petroleum in the ground remains with the State, and at best provision is made for ‘sharing’ of petroleum at the well-head between governments and companies. Power of management and control over operations are vested in the government. Duration is shorter and the size of the area covered by the agreement considerably smaller than under the traditional concession".[15]

Provisions for relinquishment of, and reduction in, the concession areas were introduced. Minimum work and expenditure commitments were established. Requirements for training of national work force and procurement of local goods and services were also introduced. In some instances, provisions were made for crude oil to be made available for local consumption and host states also participated in the petroleum development either directly or through a state enterprise. Generally, greater powers of management and control of petroleum development shifted from the oil companies to the host states. One can say that the entire bundle of rights that governed petroleum development changed hands, from the oil companies to the host governments.

New legal arrangements for petroleum development were also developed and introduced. Such arrangements included joint venture agreements, service contracts and production sharing contracts.

(b) Joint Ventures

The oil companies traditionally prefer partnership with the host government in the petroleum exploration and production to be limited to profit sharing.[16] As host governments become conscious of the need to actively participate in petroleum development, they began pressing for greater control over the resources in their territories.

Under the traditional concessions, the near total control exercised by the companies was based on its ownership of the petroleum resources. However, the exclusive ownership of the petroleum resources by the concessionaire naturally militated against the desire by governments to own the petroleum resources located in their territory and to develop these resources to pursue national development objectives. The joint venture arrangement was therefore developed to realise these national goals and aspirations.

The joint venture agreement was pioneered as a new form of petroleum arrangement by Italian State Oil Company – ENI. The first of such agreement was entered into between ENI through its subsidiary Agip Mineraria and the National Iranian Oil Company (NIOC). The Agip-NIOC Joint Venture was established under a joint stock company, and a joint Board of Directors managed the company.[17]

Under the joint venture arrangement, the entire petroleum operation is a joint activity. A joint operation company is formed between the host country (more usually the host country’s national oil company), and the company to develop the petroleum reserves. The acreage is jointly licensed and the petroleum operation is jointly conducted, consistent with the joint ownership of the venture. However, the entire exploration expenditure is financed solely by the oil company. In the event of a commercial discovery, the oil company is fully reimbursed either in kind or out of revenue earned either directly by the state or through the allocation of part of the state’s share of the petroleum produced. [18] The joint venture arrangement is therefore a partnership arrangement between the state through its national oil company and the non-state oil company, under an arrangement of share equity, ownership rights and interest in the project. Martin Olisa summarised the arrangement as follows:

"The structure and content of various joint ventures vary considerably...(On) the national side you have private, or government controlled enterprises. The foreign enterprise supplies the risk capital for, and carries out, exploration. Explorations expenses in whole or in part are recoverable from production, if obtained. If commercial production is obtained, an equity joint venture company is established as an operating company. Participation may be on 50:50 basis or one ‘partner’ may be in a minority position, in which case, a management contract is entered into."[19]

The joint venture arrangement was therefore seen as a realisation of host governments’ aspirations, not only to take greater management and control over the natural resources within their territories, but also as a realisation of joint ownership of the exploration and production titles.

(c) Production sharing Contract

The "Production Sharing Contract" was pioneered in Indonesia in 1967 and is still used there. Libya, Egypt, India, Ghana, Malaysia and Trinidad and Tobago are some of the countries that also use this contractual arrangement.[20] A. Zen Umar Purba summarised the main features of the Indonesian Production Sharing Contract as follows:

- management of the oil operations rest with PERTAMINA.[21]
- at the time the contract is signed, the contractor pays a bonus to PERTAMINA, which can be treated as a tax credit.
- exploration expenses are recoverable if oil is discovered by contractor.
- after the exploration cost and expenses are deducted from the oil extracted, the balance (after tax) is divided under a certain formula, mainly 85%:15% in favour of PERTAMINA.
- the contractor is required to spare 8.5% of its portion (based on the above formula) to supply the domestic market in Indonesia.
- after a certain period of time, the contractor has to relinquish areas of its operations, the area must be re-surrendered if oil is not discovered, or if at the end of the exploration stage, the areas are considered not commercially viable.
- title to equipment used in the exploration rest with PERTAMINA as soon as the goods enter Indonesian customs."[22]

Under the production sharing contract arrangement, the exploration and production of petroleum can be undertaken only by the State, and is exclusively carried out by the State enterprises. The oil company has no proprietary interest in the petroleum exploration and production titles. The company is engaged as a contractor for the state enterprise to undertake services that cannot or yet to be undertaken by the state enterprise.[23]

Although, the oil companies are engaged as contractors to undertake petroleum operations, they however bear all the exploration risk so that if no commercial discovery of petroleum is made, the loss is borne by the contractor. In the event of a commercial discovery, the contractor is entitled to be reimbursed by a percentage of the oil produced. This is achieved by applying portions of petroleum produced as "cost oil," to defray the pre-development expenditure. Once all the authorised expenses have been deducted up to the maximum percentage of "cost oil" set out in the agreement, the remaining oil, usually called the "profit oil," (less "cost oil,") is shared between the contractor and the national oil company in accordance with an agreed formula.[24]

Ownership of the petroleum, either in the ground or as produced, rest with the state until it reaches the point of export. This differs from the traditional concession arrangement where title in petroleum rest in the oil company, and under the new concession arrangement where the petroleum companies acquire title to the petroleum at the wellhead.

The legal rational for using the production sharing contract is that from the host government’s standpoint, it does not involve surrender of the host country’s sovereignty in the title to the resource. In entering into a production sharing contract, the company receives less than title or interest to the oil.[25]

(d) Service Contracts

The final form of petroleum exploration and production arrangement that require specific consideration for the purpose of this paper is the service contract. Under this contractual arrangement, the foreign oil company is engaged by the national oil company to conduct petroleum exploration for a fee or a share of production. The oil company also provides the host country and its national oil company with technical services and information relating to the development of the petroleum resources.

Upon discovery of petroleum in the area, the national oil company engages the foreign oil company as its agent to produce the oil, and if it so agrees, also to market the oil produced on behalf of the national oil company. The feature of a service contract is summarised as follows:

"The national oil company is by law the sole titular holder of the area under the agreement. All petroleum deposit and oil and/or gas produced are the property of the national oil company at the wellhead. The foreign company either directly or through a subsidiary, acts as general contractor for the national oil company and as such carries out, in the name and on behalf the latter, all operations necessary for exploration and development of oil deposits. Thus the contractor is not a concession holder or partner, but merely a hired agent."[26]

In a pure service contract, the host country’s national oil company would contract the oil company to perform a specified service for a flat fee. However, in view of the difficulties that countries face in obtaining capital to finance the payment of service fees, some agreements provide that the contractor may be paid in kind with a certain specified amount of production from the acreage, the subject of the service contract. Thus service contracts can be arranged as Risk-Service Contract or Service Contract (Non-Risk). Under a Risk-Service Contract arrangement, the host government pays for the services of the oil companies in cash and not in kind. On the other hand, under the Service Contract (Non-Risk) arrangement, the oil company is paid a flat rate for its services usually by applying a percentage of the oil produced.[27]

Generally, the oil company provides all the risk capital. If oil is found, the amount spent in exploration is "deemed" as loan to the national oil company to be debited from the national oil company’s accounts. The oil company may also sell for the national oil company, if agreed, the oil produced. From the revenue earned by the national oil company, a percentage is applied towards the repayment of the "deemed loan" until the loan is reduced to zero.[28]

The title in the petroleum in situ rests in the state and upon production is transferred at the wellhead to the national oil company. The oil company does not acquire exploration or production title nor does it acquire ownership to the petroleum produced at any stage of the production chain. It is engaged simply as an agent to the national oil company and is paid a fee either in cash or in kind from the oil produced, in consideration for the services rendered.

Service contracts are used in countries like Venezuela, Brazil and Iran as a form of legal arrangement for the development of petroleum located within the territories of these countries.[29]

(e) Petroleum Arrangements

Petroleum arrangements developed post 1950’s also included contracts under names such as Operations Agreement[30] and Works and Technical Services Agreement.[31]

The post 1950’s contractual arrangements have different "labels" but they have common objectives and hence share common features. For instance, the production sharing contract petroleum arrangement is similar in terms to the service contract arrangement. The arrangements differ from each other on the consideration as to who bears the exploration risk. In a service contract, the title to petroleum in situ rests with the host state through its national oil company and the oil company is engaged by the national oil company as a contractor to conduct petroleum operations for consideration either in cash or in kind from petroleum produced from the petroleum operations. The exploration and production risk rest with the national oil company or the host government. However, under the production sharing contract, the oil company undertakes the petroleum exploration and production at its risk. It then takes the share of production as "cost oil." The balance of the production, which is normally termed "profit oil," is shared between the host government or its national oil company and the oil company. On the other hand, under the joint venture structure, title to the licence and the means of production are jointly held between the state and the oil companies, and petroleum is jointly produced and sold. The following features are common in the post-1950 petroleum arrangements.[32]

(i) The risk of exploration is borne by the oil company and the cost of exploration is not recoverable unless a commercial discovery is made.

(ii) The exploration phase is distinguished from the production phase. Accordingly, if no significant discovery of petroleum is made within the stipulated period, the company must surrender the acreage.

(iii) The oil company is subjected to minimum work and expenditure program.

(iv) The oil company is subject to obligations to provide information and data to the host government.

(v) Provisions are made for division of revenue generated by the projects which feature increased financial take by governments in the form of income tax and revenue from equity in the projects.

(vi) Provisions are made for procurement of local goods and services and for the training and employment of nationals.

There are variances in the treatment of different considerations under different petroleum arrangements. Notable among these is the treatment of title in the oil produced, whether title in the oil is acquired by the oil company either at the point of export or at the wellhead. The second consideration relates to exploration and production risk – whether the exploration and production risk is borne by the oil company or the host government. The third consideration relates to the fiscal arrangement under which governments take active participation in the management and control over the project; in essence, equity participation in the project.

The key features of the petroleum titular system, the arrangement for State equity participation under the petroleum arrangements and the fiscal regime applicable to petroleum exploration and development will be considered in some details with particular reference to the PNG’s petroleum arrangement.

B. PNG’s Petroleum Exploration and Production Licencing Regime

The PNG legal and fiscal regime that governs petroleum development could be described as that which is governed primarily by legislation. The terms for the granting of petroleum exploration and production licences are set out in the legislation[33] and these are supplemented by details set out in the petroleum licence.

The basic considerations in dealing with natural resources development is firstly, the question of who has the title to the resources and secondly, who has right to exclusive use, control or management of the resources. Generally, the owner of the resources would have the right to use, control and manage the exploitation of these resources. Ownership therefore underpins property rights and provides the basis to manage the exploitation of the resources.[34]

The English Common Law presumes that the owner of the land is entitled to all that is located above and below the land; cujus est solum ejus est usque ad colum et usque ad inferos. Under common law, minerals naturally occurring form part of the land on which they are situated unless these minerals are specifically severed from the crown land grant. The only exceptions are the royal metals; gold and silver, which remain subject to crown ownership, notwithstanding the crown grant of the land on which minerals are naturally occurring.[35]

PNG’s natural resources laws adopted the practice of reserving title to mineral and petroleum in situ exclusively to the State.[36] Ownership in resources in situ therefore rests with the State. The vesting of ownership of mineral and petroleum resources in situ together with the vesting of the prerogative to licence the exploration and production of these resources, and the prerogative to manage the exploration and development of same, provides the foundation of resources law. It underpins the legal arrangement under which the resources are developed. The prerogative to manage the exploitation of these resources is a significant factor that one would need to examine in the quest to identify the contractual arrangement of the PNG’s petroleum regime. This is underlined by the fact that despite State ownership of the petroleum naturally occurring, the resources will be developed by private enterprise and hence the petroleum policy regime is geared towards encouraging private sector investment in petroleum development.

The licensing system governing petroleum exploration and production is therefore the ultimate exercise of the host state’s ownership of these resources and the exercise of the management prerogative is the ultimate exercise of sovereignty over the exploration and production of the resources that lay within its national boundaries.

(a) Exploration Licence

The PNG’s petroleum exploration and development licensing system is primarily a two-tier system. A Petroleum Prospecting Licence (PPL) is an exploration licence issued to an oil company pursuant to which the oil company undertakes petroleum exploration.[37] The Petroleum Development Licence (PDL) is a production licence[38] issued to the holder of a PPL upon commercial discovery of petroleum, to produce and deal with the petroleum produced within the acreage.

The process of granting a PPL commences on application for or upon invitation by the Minister, for a PPL.[39] For the purpose of granting an exploration or a production licence, the earth’s surface is divided up into gratucular sections called-blocks, comprising five minutes longitudes and five minutes latitude.[40] An application for a PPL would be made in respect of not more than 60 blocks[41]and in special circumstances the minimum acreage could be increased to 200 blocks.[42]

The conditions under which petroleum exploration and production will be undertaken are prescribed by legislation.[43] A PPL is granted for a term not exceeding 6 years[44]and renewable for a further term of 5 years but for a reduced area,[45] and is also subject to work and expenditure requirements.[46]

A licence sets out the basic terms and conditions under which petroleum exploration will be undertaken.[47]

Where petroleum discovery is made in a exploration acreage, a declaration would be made of a location, within the exploration acreage, of a petroleum discovery. [48] Subsequent to the declaration of a location, the oil company may apply for and be granted a further extension of the exploration licence for a further period of not more than 3 years.[49]

A PPL confers on the licensee the exclusive right to explore for petroleum, to carry out appraisal work in respect of the petroleum discovery, and to undertake such task as are necessary to otherwise explore for, produce and sell or otherwise disposed of petroleum produced. The legislation provides the scope of a PPL as follows:

"A petroleum prospecting licence, while it remains in force, confers on the licensee, subject to this Act, and to the conditions specified in the licence, the exclusive right to explore for petroleum, and to carry out appraisal of a petroleum discovery, and to carry on such operations and execute such works as are necessary for those purposes, in the licence area, including the construction and operations of water lines, tests for appraisal of a petroleum pool (including the construction in accordance with the authorization and disposal), and the recovery and sale or other disposal of all petroleum so produced."[50]

As noted, the legislation gives sufficient scope and rights, in exclusivity, to the holder of an exploration licence to explore for, produce and sell or dispose of petroleum produced within the exploration acreage. The scope of a PPL is therefore as wide as a PDL. The case on point is the Moran Petroleum Project.[51] In September 1996, oil was discovered in Moran IX sidetrack well in PDL 2.[52] In early 1997, the State approved the PDL 2 (Kutubu Joint Venture) to carry out an Extended Well Test Program (EWT)[53] within PDL 2 pursuant to which the PDL 2 licensee produced oil within the block under the EWT program.[54]

Moreover, the State proceeded to approve the licence holders of PPL 138[55] to conduct EWT program using Moran 4 well and the PPL 138 licensees produced oil within the exploration licence area from Moran 4 exploration well under a EWT program. Hence, oil was produced at PPL 138 under the EWT program prior to carving out the area and grant of PDL.[56] The production of petroleum at Moran 4 well within Moran PPL 138 is a case on point to demonstrate that the scope of a PPL - an exploration licence, includes exclusive rights not only to explore for, but also to produce and sell or dispose of, petroleum produced within the exploration acreage. A PPL could also contain incidental features as are necessary to undertake and facilitate production of oil within the PPL, including construction of flow-lines and gathering lines, roads and bridges, and other infrastructure.

Technical justifications can be advanced to justify oil production within the exploration acreage under an EWT program but consideration of the same is not within the scope of this paper. The fact that petroleum production is undertaken within the exploration acreage is, for the purposes of this paper, sufficient endorsement of the view that petroleum production can be undertaken under an exploration licence in the PNG’s petroleum arrangement.

(b) Petroleum Retention Licence

An exploration licensee may also exclusively apply for a Petroleum Retention Licence (retention licence) in respect of blocks within the exploration acreage in which petroleum is located.[57] This may be done within 2 years from the date on which the blocks were declared as a location.[58]

A retention licence can be issued over "... a gas field or, a part of the gas field or, for better administration of petroleum activities." [59] The provision is designed primarily to allow holders of an exploration licence to retain and hold natural gas discoveries within the acreage pending commercial extraction of the same. However, provisions are also made for retention licence to be issued in respect of oil discoveries within the acreage "... for better administration of petroleum activities." The proviso creates scope for retention licences to be issued in respect of marginal oil fields where the reserves cannot be commercially produced.[60] That is, where a discovery is over a marginal field and it is not commercially viable to produce the petroleum discovered within the location, a retention licence may be issued over the respective blocks in the exploration acreage, which would allow the exploration licensee to retain the discovery pending further appraisal, further and additional discovery and commercial production of the petroleum discovered within the acreage.[61]

A retention licence may be granted for 5 years[62]and may be extended for further terms of 5 years at each extension.[63] Accordingly, a retention licence can be further extended over number of 5 years extension periods before commercial production can be realised. It therefore allows a holder of an exploration licence to hold onto the acreage pending commercial production of the discovery.[64]

(c) Petroleum Development Licence

If significant petroleum discovery is made that can sustain commercial production, a PDL, which is the production licence, will be issued to the holder of the PPL.[65] The basic requirement of a PDL is fixed by legislation.[66] A PDL is issued to the holder of an exploration or retention licence for a period not exceeding 25 years, renewable for a term not exceeding 20 years.[67]

A PDL confers on the licensee the exclusive rights to explore for petroleum within the licence area, to produce petroleum within the licence area, to sell or otherwise disposed of petroleum so produced and to carry out such other works in the licence area as are necessary to conduct petroleum operations in accordance with the terms of the licence.[68] The works necessary to carry out petroleum operations include construction of flow lines and gathering lines, roads, bridges and other civil works, airports, seaports and related facilities.[69]

In the case of the Kutubu project, the PDL 2 licensees also own and operate the only oil pipeline in PNG that transport oil from the oil fields to the offshore loading terminal.

The development licensee is therefore licensed not only to produce and sell or disposed of petroleum produced, but also the added right to "...carry on such operations and execute such work as are necessary for or in connection..." with carrying out petroleum operations.[70]

C. Charecteristics of Petroleum Agreements

The PNG petroleum agreements deal with matters, which include State equity participation, foreign currency management, local business development and procurement of local goods and services. For the purpose of this paper, particular consideration is given to those provisions dealing with State equity participation.

The State takes its share of the revenue from production and sale of petroleum, primarily from petroleum taxation computed and collected under the Income Tax Act,[71] petroleum royalty and from direct equity participation in the project. In computing the State’s share of the petroleum produced or the revenue derived from sale of petroleum produced within the acreage, and the oil companies’ share of the petroleum produced, the amount taken up by the State pursuant to the exercise of its rights to take equity participation in the petroleum project within a license area is regarded and treated by oil companies as the State’s share of the oil or revenue. Accordingly, the State equity participation policy regime is an important element of the State’s petroleum policy regime, and that which forms the core of the petroleum agreement.

The terms under which the State may take equity participation in the petroleum project are set out in the petroleum agreements entered into in respect of each PPL. The petroleum agreements are entered into pursuant to the petroleum legislation.[72] The respective petroleum agreements, as a matter of policy, are entered into prior to discovery of petroleum. Therefore the subsequent PDL incorporates provisions of both the negotiated agreement and legislation, which form the conditions of the PDL.[73] Both instruments are therefore needed to undertake petroleum development.

The detailed features of State equity participation in a petroleum project are not covered by the legislation[74] but are set out in the respective petroleum agreements. This is a major feature of the PNG’s petroleum arrangement that can be termed as the heart of the petroleum agreement. It is therefore the fiscal arrangement and the arrangement for the State’s equity participation in the projects that distinguish the PNG’s petroleum agreement from other recognised forms of petroleum agreements.

The basis of the State’s equity participation in petroleum projects is legislatively framed[75] and forms part and parcel of the State’s petroleum policy regime. The genesis of the State equity participation policy can be traced backed to the 1976 petroleum policy white paper which provides that the government’s "total financial take" from oil produced in any production licence area follows:

"(I) 11/4 percent royalty on well-head value of production;
(II) a percentage income tax at a rate of 50 per cent of taxable income;
(III) an additional profits tax at rate 50 per cent of after tax cash flow after total investment has been recouped with a money returned of 25 per cent;
(IV) State participation in development of commercial fields on ‘carried interest’ principles"[76] (My emphasis).

The State’s equity participation in petroleum projects is, therefore, on the basis of "carried interest principles."

As a matter of practice, the holder of a PPL is advised to enter into a petroleum agreement with the State before any well is drilled in the exploration acreage. The agreement defines, inter alia, the State’s equity participation in the subsequent petroleum discovery. [77] The agreements state that the State has an option to take equity participation in the project, up to the nominated percentage.[78] It can also elect not to take equity participation in a particular project. For instance, the PPL 100 (Kutubu) Petroleum Agreement, provides that:

"...the State may acquire for a Nominee of the State from the Oil Companies constituting the Development Licensee in the Development License Area, an unencumbered ... interest in the venture interest attributable to the Development Licence Area... up to nominated percentage not exceeding twenty – two and one-half percent (22 ½%) and where the State has acquired such a Joint Venture Interest for a Nominee of the State, the Nominee of the State shall have the right to share... production from that Development Licence Area equal to the nominated percentage,..."[79]

The provisions of the petroleum agreement[80] set out the terms under which the State will take equity participation in the project.[81] The State upon electing to take equity participation in the project acquires equity through its Nominee,[82] to the value of the nominated percentage.[83] It also enters into joint venture arrangement with the oil companies that are holders of the PDL. In entering into a joint venture agreement with the oil companies, the State’s Nominee becomes a joint participant under the joint venture arrangement,[84] effectively a tenant in common of the PDL under the joint venture structure with the other joint participants. In this respect it also subscribes to all licences, permits and authorisations necessary for the conduct of project development as a joint venturer and holds the petroleum titles jointly and severally with the oil companies in the joint venture as a tenant in common.

The State in taking up equity in the project, through its Nominee, also becomes a joint venturer and a joint licensee of the PDL. The non-State joint venturers finance the Nominee’s pro rata percentage of exploration, development and other cost and expenditures under the "carried interest" arrangement. Under the arrangement, the amount owed to the oil companies by the Nominee is "deemed" as a loan from the oil companies to the Nominee at a commercial interest rate, to be debited from the Nominee’s revenue from its proportionate share of the petroleum produced within that PDL.[85]

The production titleholders acquire title to the petroleum, upon production, at the wellhead. Similarly, the State, through the Nominee, as joint licensee and tenant in common, acquires title to petroleum produced at the wellhead. However, the Nominee does not lift the petroleum produced and deal with oil produced during the period it has outstanding liability to the oil companies under the carried interest arrangement. Instead, the oil companies lift the State’s proportionate share of the petroleum produced, sell same and apply the revenue derived to defray the liability of the State under the carried interest arrangement. When the aggregate of the exploration, development and operation expenditures, proportionately owed to the respective oil companies, is reduced to zero, the carried interest arrangement is discharged and the State, through the Nominee, is able to take petroleum, unencumbered, at the well-head and sell or dispose of same as a joint licensee and a member of the joint venture.

The liability to the oil companies is computed, applying a pre-agreed formula.[86] This is ascertained, at any given time, by deducting from the State’s proportionate share of the revenue earned, the pro rata share of exploration and capital expenditures, and amount spent by the oil companies attributable to the oil production. The arrangement remains in place for the duration of the period when income from the share of oil produced, attributable to the State’s equity participation, is insufficient to discharge its liability to the oil companies.

The legal arrangement under which the State equity participation is accommodated and facilitated by the oil companies constituting the relevant licence is similar to the arrangement under the joint venture agreement.[87]

D. Income Tax Treatment of the "Carried Interest Arrangement"

The treatment of the petroleum exploration and production titles in the petroleum legislation and the petroleum agreements is followed through in the taxation regime.[88] Under the taxation regime, a petroleum project is "re-fenced" for taxation purposes and taxed on project basis.[89] That is, each oil company as a taxpayer (taxpayer) is assessed in relation to each project as if the assessable income of the taxpayer from petroleum operations attributable to the petroleum project was the only assessable income derived by that taxpayer, and conversely, all allowable deductions are deducted against future income from the petroleum project.[90]

For petroleum tax purposes, the pre-PDL exploration expenditures incurred by the taxpayer within the relevant exploration licence area in relation to a petroleum project are carried forward and accumulated for 20 years.[91] Upon commencement of petroleum production, the exploration expenditure is deducted from the income derived by the taxpayer from sale of petroleum produced from petroleum operations conducted within the PDL area. The exploration expenditure incurred in relation to the PDL is reduced; firstly in paying for the exploration expenditure incurred by the taxpayer in relation to the PDL in the relevant year of income; and secondly, any excess amount is applied to reduce the exploration expenditure incurred by the taxpayer in relation the PDL against the expenses earliest incurred within the 20 years period to the year of income, until the amount is fully recovered. [92] This has the effect of accelerating the recovery of exploration expenditures by applying all the available income derived from sale of petroleum produced from the petroleum project.

The Income Tax Act’s treatment of allowable capital expenditures is similar to treatment of allowable exploration expenditure under income tax principles.[93] In substance, the capital expenditures are carried forward and depreciated against future income derived by the taxpayer from sale of petroleum produced from petroleum operations conducted within the PDL area until the amount is fully depreciated by applying the relevant rate of depreciation.[94]

As to the nature of the petroleum titles, the Income Tax Act recognises that interest in the petroleum title is proprietary in nature, which can be sold or transferred for valuable consideration by the titleholders. In such transaction, the vendor and the purchaser can agree to treat the exploration expenditures as exploration expenditure per se, or capital expenditures, or partly capital and partly exploration expenditures, at their discretion, with minimum requirement to inform the Commissioner General of the Internal Revenue Commission of the arrangement as between the parties.[95] The holder of a petroleum title can therefore deal with the petroleum titles as a property right.[96]

The State, through its Nominee, is also treated as a purchaser of petroleum title, from the oil companies constituting the relevant petroleum title, as a tenant in common. The interest in the petroleum title, acquired by the State through its Nominee, is treated by the Income Tax Act as a sale of petroleum interest between oil companies. The tax treatment of the State’s equity in the petroleum projects also endorses the proprietary nature of the PDL. The Income Tax Act treatment of the petroleum title held by the State, through its Nominee, is also consistent with the treatment of the same under the petroleum legislation and the petroleum agreements.

Upon becoming a joint licensee and a member of the relevant joint venture, the Nominee, as a joint licensee, produces petroleum and acquires title to same at the well-head[97] together with other joint licensees, as tenant in common,[98] and pay royalty, for the petroleum produced, which is also computed and paid using the well head value. The Nominee, for the purpose of petroleum operations, is treated as a joint licensee of the PDL. This is the arrangement under which states or their nominee take an active participation in petroleum operations conducted within the country under the new concession arrangement.

In addition to the concession based tax regime, the petroleum agreements guarantee the holder of a production licence, the right to export petroleum free of export tax.[99] The oil company is also given a degree of comfort in relation to import duties in that the petroleum agreement guarantees non-discriminatory rates, taxes, duties, levies and other impost.[100] The concessions accorded in export duty exemptions for the petroleum exported and the degree of comfort given in relation to rate, taxes, import duties, levies and other impost are incidence of a concession based contract.

The PNG petroleum taxation regime is, without doubt, a concession based taxation regime.

E. Conclusion, The Nature of Petroleum Arrangement

The question to be considered at this juncture is; what is the legal nature of the PNG’s petroleum arrangement if one has to classify the arrangement under one or more of the internationally recognised petroleum arrangements.

(a) The Legal Nature of the Licensing Regime

As observed in this paper, there is little doubt that the PNG’s petroleum licensing regime is concession based. It can also be noted that the general emphasis in the petroleum licensing or titular system has always been to create and give certainty as to petroleum title. The petroleum titular regime therefore guarantees the holder of an exploration licence the exclusive right to be given a retention licence[101]where an application for such a licence can be sustained. An exploration licence also gives the holder of the licence exclusive right to explore for, produce petroleum and sell or dispose of the petroleum produced within the exploration acreage and to undertake works that are necessary to explore for and produce petroleum within the exploration acreage.[102] The exploration licence is also issued over a relatively large area. These are incidents of a concession-based licensing system.

The introduction of retention licence to the licensing regime underlines the concession nature of the licensing regime.[103] Upon petroleum discovery, the holder of the exploration licence is guaranteed a production licence. In addition, the exploration licensee is guaranteed the right to produce marginal fields in future by utilising the provisions for retention licences, which can be issued exclusively to the holder of a PPL, where the discovery is not sufficient to undertake commercial production of the discovery. Further, the scope of the production licence is such that it guarantees exclusive rights to produce and sell or disposed of petroleum.[104] Upon production of the petroleum, title to the petroleum produced transfers from the State to the holder of the production licence at the wellhead.[105] The holder of a production licence may also undertake such work as are necessary to produce petroleum.[106] These are features of the new concession arrangement.

The terms of the petroleum exploration, retention and production licences are relatively longer compared to petroleum titular regimes where petroleum exploration and production is conducted under the joint venture, service contract and the production sharing contract petroleum arrangements. The comparatively longer terms of the petroleum exploration licences, retention licences and production licences give the PNG petroleum titular regime the nature of a petroleum concession arrangement. Further, the tenants of the PNG’s petroleum regime are closely related to the concession arrangement where the concessionaire has the exclusive right to explore for, produce and deal with petroleum produced within the concession for relative long title period.[107]

Title to petroleum in situ is vested in the State and passes to the production licensee at the wellhead.[108] This is an incident of the modern concession arrangement as opposed to the traditional oil concession arrangement where title to petroleum in situ is granted to and held by the concessionaire. The treatment of title to petroleum in situ is consistent with the new concession arrangement, where title to petroleum is owned by the State, but upon production, the title in the petroleum produced shifts from the State to production licensees.

The petroleum titular regime is without doubt a concession-based licensing regime.

(b) Legal Nature of the Petroleum Agreements

Several matters can be considered as distinguishing features of the PNG’s petroleum agreements.

Firstly, petroleum title is acquired and exclusively held by the oil companies and not by the State enterprise. In this respect, the oil companies own the petroleum titles and operate the projects as opposed to the production sharing contract, and service contract arrangements where the host state holds the petroleum title, either directly or through its national oil company, and the oil company is engaged as a service provider. Further, under the PNG’s petroleum arrangement, title to the petroleum produced passes from the State to the oil company at the wellhead. This is opposed to the production sharing contract and service contract arrangements where title to petroleum always rest with the host state.

Secondly, the State’s share of revenue from the project is appropriated, primarily through petroleum taxation and by modest royalty rate of 2%, applied at the wellhead. [109] This can be contrasted with the production sharing contract arrangements where the petroleum produced is apportioned as cost oil and profit oil, and under the service contract arrangement where the oil company is engaged as a contractor and hence the issue of royalty payment for the oil produced is not a relevant consideration. These place the PNG’s petroleum arrangement away from the production sharing contract and service contract petroleum arrangements and align the arrangement with the new concession arrangement and joint venture arrangement.

Thirdly, oil companies are granted exploration title, exclusively of the State, with the State retaining the right to participate in petroleum production. Upon successful petroleum exploration and discovery, the State may elect to take up an equity position in the ensuing petroleum project. In such case, the State, through its Nominee, is assigned a portion of the petroleum production licence and other titles, leases, licences, permits and authorisations proportionate to its participating interest. It also enters into a joint operating agreement with the oil companies, and hold the petroleum title and the project assets and liabilities, jointly and severally with the oil companies as a tenant in common. These are features of joint venture contractual arrangements.

Fourthly, the State’s equity participation, as set out under the relevant petroleum agreements, is paid for under a carried interest arrangement. Under this arrangement, the pro rata amount on account of exploration, capital and operation expenditure is represented as a debt from the State to the oil companies. The debt is classified as a loan to the State from the oil companies, from the issuance of the production licence. The amount owed to the oil companies accrues interest at a commercial rate and the debt or the "deemed loan" is defrayed by the revenue earned from sale of "oil foregone" in favour of the oil companies during the period the liability remains outstanding. The financial arrangement under which the State pays for its participation in the project reflects features of a service contract and joint venture arrangement. However, the treatment of the title to petroleum produced under the PNG’s petroleum arrangement is not analogous to the arrangements under the service contract arrangements[110] but is more aligned with the treatment of title to oil produced and owned under a joint venture agreement, where title to the petroleum passes at the wellhead upon production. The petroleum titles, under the PNG’s petroleum arrangement rest with the oil companies, which are granted the same under the petroleum legislation. This is unlike the service contract arrangement or the production sharing contract where the petroleum title rest[5] with the state enterprise, and the oil company is engaged as a contractor and its services are paid for either in cash or from portion of the oil produced. Further, the State equity participation is carried by the oil companies and defrayed through the allocation of the State’s share of petroleum produced. This incident is consistent with that of a joint venture petroleum arrangement.

Fifthly, title in the petroleum in situ rests with the State and is acquired upon production at the wellhead. Accordingly, it can be argued that the petroleum title is of proprietary nature.[111] This is confirmed by the taxation treatment of the titles, which gives the petroleum titles proprietary nature. The acquisition of title to petroleum by the companies from the State at the wellhead, upon production, is a feature of the concession arrangement.

In summation, the PNG’s petroleum arrangement cannot be exclusively classified under one of the established petroleum arrangements. However, it contains basic features, primarily of the joint venture and the new concession arrangements. The bundle of legal incidences governing petroleum exploration and production and the fiscal regime is a concession-based regime. However, the State equity participation arrangement, established under the petroleum agreement, is primarily a joint venture agreement.

Generally, the PNG’s petroleum arrangement is a unique hybrid with features of different established petroleum arrangements, fixed partly by legislation and partly by agreement. The salient features of the arrangement that distinguish it from other petroleum arrangement are the legal incidences of the petroleum titles set out under the legislation,[112] the arrangement for the State’s equity participation in the projects as set out under the petroleum agreements[113] and the tax treatment of title to petroleum produced as set out under the Income Tax Act.[114]

The titular regime established by legislation and the income tax regime are concession based, and the petroleum agreement shows elements of arrangements under joint venture agreement. Consistently therefore, the PNG petroleum agreements can be labeled as a Concession Based Joint Venture Agreement.

[*] LLB (PNG), LLM (Melb.), Law School, University of Papua New Guinea.

[1] Oil and Gas Act 1998. Prior to the enactment of the Oil and Gas Act 1998, petroleum exploration and production was undertaken under the Petroleum Act, Chapter 198 (repealed). The fiscal provisions are contained in the Income Tax Act 1959.

[2] Countries with such regime include Australia, United States, Canada and most of the EEC countries. Kamal Hassain, Law and Policy in Petroleum Development, (1979) France Printer (Publishers) Ltd, London, 100.

[3] Ibid, 101. Indonesia and Bangladesh are examples of such countries.

[4] Ibid, 101 & 102. Norway, New Zealand, Britain, Trinidad and Tobago are examples of countries that have a hybrid petroleum regime.

[5] H.Cattan, “The Evolution of Oil Concessions in the Middle East and North Africa” (1967) Oceania Publication Inc., New York, 1. The D’Arcy Concession was subsequently taken over by the Anglo – Persian Oil Company (renamed Anglo – Iranian Oil Company, which developed into the present day British Petroleum - BP). The D’Arcy Concession was replaced by a new concession in 1933.

[6] Suleiman, The Oil Experience of the Middle East, (1988) 6 Journal of Energy and Natural Resources Law, 1, 3.

[7] Ibid. The host governments collected revenue based on per tone production. By today’s standard, the fiscal terms under which the payments to the host governments were based, that is on per tone production was extremely modest.

[8] “Mining the Resources of the Third World: From Concession Agreements to Service Contracts” 67 American Society of International Law 227, 230.

[9] Ibid.

[10] Ibid.

[11] Ernest E. Smith, Typical World Petroleum Arrangements, (1991) International Resources Law, Volume 9-4.

[12] Cattan. op. cit. 6 and Hassain, op.cit. 110-120.

[13] UN Resolution No. 1083 of 1962.

[14] The term “concession” with its implication that rights have been conceded and the historical connotation of multinational corporations trampling on the rights of host countries is the cause of its unpopularity. Hence, the concession arrangement is given other labels in some jurisdictions.

[15] Hassain, op. cit. 120.

[16] This was originally by royalty per tonne. Post 1950’s, the financial arrangements under which governments take their share of revenue from petroleum changed from royalty per tone to some form of taxation or a combination of royalty and tax, from which governments could take up to 50% of the profit from the projects.

[17] Hassain, op. cit. 120-122. Joint ventures are also established under contractual un-incorporated joint ventures.

[18] Article 2 (6) of Joint Venture Contract for Petroleum between Esso Exploration Production Angola Inc and State Oil Company dated 6 March 1994 in World Petroleum Arrangements, Borrows, New York, 574

[19] Martin Olisa, “Comparison of Legislation Affecting Foreign Exploitation of Oil and Gas Resources in Oil Producing Countries” (1972) 10 Alberta Law Review 487, 489. The arrangement is described as “carry arrangement.” Under the arrangement, the companies pay for the state’s participation in the exploration and production of natural resources and the state reimburse the company either in kind through barrels of oil produced from the acreage or by using the proceeds of the state’s share of oil that is produced from the acreage to reimburse the oil company.

[20] World Petroleum Arrangements, Borrows, New York, 564-573.

[21] PERTAMINA is the National Oil Company of Indonesia.

[22] A. Zen Umar Purba, “Legal Aspect of Foreign Participation in Development of Oil Reserves in Indonesia”, (a paper presented at the International Law Conference on “Exploitation of Resources in the Pacific”, Port Moresby, Papua New Guinea, 6-8 November 1989), 4.

[23] See also Rudioro Rochmat, “Contractual Arrangement in Oil and Gas Mining Enterprises in Indonesia” (1981) Sijthoff & Noordhoff, 16.

[24] Ibid. For samples of Indonesian production sharing contract, see World Petroleum Arrangements, Borrows, New York, 544-555.

[25] The Production Sharing Contract is the most popular form of petroleum arrangement, particularly amongst the third world developing countries for the reason that under the arrangement, the host government does not surrender title to the petroleum within its boundaries.

[26] H. Zakariya, “New Direction in Search for and Development of Petroleum Resources in Developing Countries” (1976) Vanderbilt Journal of Transnational Law 547, 564.

[27] World Petroleum Arrangements, Borrows, New York 1985, 564-573.

[28] Hassain, op. cit. 159.

[29] The service contract is the popular petroleum arrangement used in countries with highly prospective acreages, coupled with large and developed petroleum industries.

[30] Operating Agreement between Petroperu and Shell Exploration del Peru BV dated 13 January 1984.

[31] S.B.K. Asante, “Restructuring Transnational Mineral Agreements” (1979) American Journal of International Law, 335, 367.

[32] Hassain op.cit. 174. The list was adopted from the author’s summary. See also M. Olisa op.cit. 498 (note 20); H. Zakaria op. cit, 16 (note 27) and Rochmat, op. cit, 16 (note 24) for general discussions on the salient features of each of the petroleum arrangements.

[33] Oil and Gas Act 1998.

[34] Kalinoe, “The Basis of Ownership Claim” in Leach and Kalinoe (Ed) Rational of Ownership, UBSPD Publishers’ Distributors Ltd, New Dehli, India, 2001, p 82.

[35] The Case of Mines (1865) 75 ER 473.

[36] S. 5 of the Mining Act 1992 and S. 6 of the Oil & Gas Act 1998.

[37] S. 23 of the Oil and Gas Act 1998.

[38] S. 57 of the Oil and Gas Act 1998.

[39] S. 21 of the Oil and Gas Act 1998.

[40] Equals to 9 kilometers x 9 kilometers, effectively 81 square kilometers.

[41] S. 22(1) (c) of the Oil and Gas Act 1998.

[42] Effectively, a PPL can be issued over 16,200 square kilometers, indeed a relatively wide area.

[43] Part III (Ss 17-36) of the Oil and Gas Act 1998.

[44] S. 26(a) of the Oil and Gas Act 1998.

[45] S. 26(b) of the Oil and Gas Act 1998 set out requirements for relinquishment of part of a PPL area.

[46] S. 22 of the Oil and Gas Act 1998. In practice, the applicant submits a work program to the Petroleum Advisory Board (PAB), which assesses the work and expenditure program and advises the Minister whether to grant or not to grant a PPL. The Minister upon advice from the PAB grants the PDL under S. 29 of the Act.

[47] S. 23 of the Oil and Gas Act 1998.

[48] S. 30(1) of the Oil and Gas Act 1998. Upon discovery of petroleum, a declaration is made by the Minister, which states that petroleum has been discovered within the particular location, and (effectively) instructing the exploration licensee to put in place, and execute, appropriate technical programs to appraise the well and to bring it to commercial production.

[49] S. 30(2) of the Oil and Gas Act 1998.

[50] S. 25 of the Oil and Gas Act 1998.

[51] The oil field stretches from PDL 2 (Kutubu Oil Project) to PPL 138. A new PDL (PDL5) is now issued in respect of the PPL 138 portion of Moran project.

[52] Petroleum Development Licence No 2 issued to the Kutubu Joint Venture for the development of the Kutubu Oil Project. The Moran Oil Fields is located partly in the PDL 2 and partly in the PPL 138. PPL 138 licensees were subsequently granted a petroleum production Licence (PDL 5). The project was “unitized and developed as a single project under the “Unit” arrangement.

[53] The Extended Well Test Program is conducted for the purpose of gaining technical data for the purpose of technically appraising an oil field. Upon invitation, Mr. Gerard Mangal, the Chairman of the Society of Petroleum Engineers – PNG Section, described EWT as follows:

“Extended well testing (EWT) is a methodology for conducting prolonged production test with the primary objective of estimating hydrocarbon volumes and assessing the nature and strength of the drive mechanism before committing to full-scale development. EWTs are normally conducted in offshore areas for weeks to months in remote offshore locations where well locations/pads are very expensive to build. Any productions from these tests are used to offset against sunk costs.

There are basically two types of well tests.
The first of these is the development well test and these are conducted to gain the following data.

(A) Pressure within a drainage area,

(B) Skin factor, and

(C) Formation properties.

The second is appraisal well testing, where the following data are gained in new fields.

(A) Oil production rate,

(B) Skin factor,

(C) Fluid samples,

(D) Formation characteristics,

(E) Boundary conditions, and

(F) Determination of initial reservoir pressure.

In PNG the EWT as a technique has been used with the added justifications of our fields being remotely located and therefore give rise to high drilling costs. Reservoir compartmentalization has also been an argument in favour of EWT being used.”

[54] Oil was produced in Moran 1X, Moran 2X and Moran 5 wells in PDL 2 under the EWT program.

[55] Petroleum Prospecting Licence No 138, an exploration licence as opposed to a production licence.

[56] PPL 138 is an exploration licence. The State allowed the petroleum companies constituting the PPL 138 to produce oil within its exploration acreage from 21 April 2000 to 17 February 2001 under the EWT program. Subsequently, PDL 5 was carved out of the PPL 138, and the production licence issued to the holders of PPL 138 on 17 February 2001. Moreover, from 21 April 2000 to 17 February 2001, the PPL 138 licensees produced and sold 2.2 million barrels of oil under the EWT program.

[57] S. 37 of the Oil and Gas Act 1998.

[58] S. 34 of the Oil and Gas Act 1998. See note 49, in respect of the legal effect of a declaration of a location.

[59] S. 37 of the Oil and Gas Act 1998.

[60] S. 39 of the Oil and Gas Act 1998.

[61] A petroleum retention licence that is issued over a marginal field can be technically substantiated as a retention licence issued for “for better administration of petroleum activities” as provisioned in S.37 of the Act.

[62] S. 43 of the Oil and Gas Act 1998. This provisions petroleum retention licence to be extended for rolling periods of 5 years each.

[63] Ss 43&45 of the Oil and Gas Act 1998.

[64] In petroleum policy terms, the provision for petroleum retention licence, if not properly managed, has the potential for licensing an exploration licensee to “sit on an acreage.”

[65] S. 23 of the Oil and Gas Act 1998. A PDL can be issued only to the holder of a PPL. This guarantees security of tenure on the part of the oil companies. Further from the policy perspective, the exploration licensees who had spent substantial sum of money exploration and had discovered the resources should have the exclusive right to apply for and be granted the production licence.

[66] S. 59 of the Oil and Gas Act 1998.

[67] S. 60 of the Oil and Gas Act 1998.

[68] S. 59 of the Oil and Gas Act 1998 sets out the terms of a PDL. It reads:

“A petroleum development licence, whilst it remain in force confers on the licensee, subject to this Act and to the conditions specified in the licence, exclusive rights-

(a) to explore for petroleum in the licence area; and
(b) to carry on operations for the recovery of petroleum in the licence area; and
(c) to sell or otherwise dispose of petroleum so recovered;
(d) to carry on such operations and execute such work in the licence area as are necessary for or in connection with the purposes specified in Paragraph (a), (b), and (c) including the construction and operation of flow lines or gathering lines and water lines.

[69] The PDL 2 licensee (Kutubu Oil Project) built, own and operate the Moro Air Port within the PDL2 area. The PDL 3& PDL 4 Unit operates a private airport at the Gobe project site. At both airports, particularly the Gobe project site, access to the project site is highly restricted. One would need to secure the PDL operators consent before landing at the airports.

[70] S. 59of the Oil and Gas Act 1998.

[71] Division 10 of the Income Tax Act 1959.

[72] S. 183 of the Oil and Gas Act 1998. The Petroleum Act, which was repealed and replaced by the Oil and Gas Act, did not make expressed provisions for the execution of petroleum agreements. Accordingly, prior to the enactment of the Oil and Gas Act 1998, petroleum agreements were entered into using the provisions of the Public Finances (Management) Act and the general laws.

[73] For instance, Paragraph 2(b) of the PDL 2 (Kutubu Project PDL) incorporates Clause 8 of the Kutubu Petroleum Agreement as condition of the PDL.

[74] Oil and Gas Act 1998.

[75] S. 165 of the Oil and Gas Act 1998. Prior to the enactment of the Oil and Gas Act 1998, the State equity policy was implemented as a matter of policy.

[76] Government of Papua New Guinea Petroleum Policy of March 1976.

[77] There are no legal requirements compelling the holder of a PPL to enter into a petroleum agreement. However, the policy driver is that before discovery, the negotiation strength of the parties is differently weighted and placed. Upon discovery, the negotiation position of the parties’ change and depending on the location, volume and other consideration, there is real potential for negotiation and documentation of an agreement that unduly weighted in favour of one party. In an effort to overcome this, parties, as a matter of policy negotiate, document and execute petroleum agreements prior to drilling in the exploration acreage. From the perspective of the oil companies, the agreements set the terms and conditions for petroleum exploration and production within the PDL. It also provides security of title and certainty of the terms and conditions for petroleum exploration and development.

[78] S.165 of the Oil and Gas Act 1998. The State has an option to take up to 22.5% equity interest in any petroleum project.

[79] Clause 8(2) of the PPL 100 (Kutubu) Petroleum Agreement.

[80] Clause 8 of the PPL 100 (Kutubu) Petroleum Agreement.

[81] Paragraph 2(b) of PDL 2 and Clause 8 of PPL 100 (Kutubu) Petroleum Agreement.

[82] The State Nominee is Mineral Resources Development Company Limited a company wholly owned by the State. The equity participation in respect of each projects are undertaken through special purpose subsidiaries. In the case of the Kutubu Project (PDL 2 and PL 2), the participation is through Petroleum Resources Kutubu Limited, which original held 22.5% interest in the project. In 1996, 15.75% was sold to Orogen Minerals Limited and PRK now holds 6.75% interest in PDL 2 and PL 2.

[83] S. 165 of the Oil and Gas Act 1998 provides that the nominated percentage would be up to 22.5% of the equity in the project.

[84] Clause 8(3) of the PPL 100 (Kutubu) Petroleum Agreement.

[85] Clause 8.1(a) of the PPL100 (Kutubu) Petroleum Agreement for instance, provide for the commercial rate of interest to be sets at the rate of interest offered in US domestic borrowings rate of “AAA plus a margin of 5%”.

[86] Clause 8 of the Petroleum Agreement sets out the actual formula. That is –

AL=SVI (E+D+OC)+S-F-W-Z-R. Where-

AL= total amount owing to the PDL licensee at any time by the State Nominee.
SVI= State Nominee’s interest expressed in percentage.
E= Pre-PDL exploration expenditures.
D= PDL Capital Expenditures
OC= Any amount spent by the oil companies in the PDL area attributable to the State’s equity participation, during the period in which income from pro rata share of the oil production is insufficient to finance project cost that is not specifically included under E&D.
S= Amount spent on behalf of the State Nominee during the shortfall period when its pro rata share of the revenue from the petroleum produced an sold is in-sufficient to meet project costs.

F= Aggregate revenue from sale of oil attributable to the State Nominee’s equity interest.

W= Amounts attributable to money spent by the State in funding any project facility or amount spent in connection with project development.
Z= Amount contributed by the Nominee of the State or the State in reduction of the AL.
R= Amounts foregone by the State Nominee (share of insurance proceeds, etc.) that is credited to the oil companies towards payment and discharge of the AL.

[87] The oil companies bear the exploration and development risk. Upon commercial production, the State Nominee (National Oil Company) is carried by the oil company until the pre-production cost and accumulated capital and operating costs are fully paid off.

[88] Income Tax Act 1959, Division 10 contains taxation provisions for petroleum, gas and mineral resources. Clauses 8 of the petroleum agreement deal with State’s equity participation in petroleum projects. It is drafted in a way that one cannot use the provisions of the petroleum agreement without the aid of the Income Tax Act. The Income Tax Act and the petroleum agreement therefore compliment each other and must be read together.

[89] S.137A (5) of the Income Tax Act 1959 provides that income tax is assessed on project basis. This is described as “ring fencing.” The provision also define “petroleum project” as petroleum operation conducted within a PDL or a pipeline licence, as the case may be, and the cost and expenses and revenue from the construction and operations of all the facilities used in the petroleum operations.

[90] The “assessable income from petroleum operations” is defined to include assessable income of a taxpayer from sale or other disposition of oil and gas obtained from carrying out petroleum operations. Petroleum operation is defined under S4 of the Act to include operations for the purpose of recovering petroleum.

[91] S.157B (5) of the Income Tax Act 1959.

[92] S.157B (7) of the Income Tax Act 1959.

[93] Ss 155E and 157C of the Income Tax Act 1959.

[94] Ss 155D and 155C of the Income Tax Act 1959.

[95] S. 155 of the Income Tax Act 1959.

[96] S. 155 of the Income Tax Act 1959 defines petroleum title as “petroleum right,” “petroleum prospecting licence or a petroleum development licence”

[97] S. 159 of the Oil and Gas Act 1998.

[98] The joint properties are held under an arrangement that is established as tenant in common pursuant to which, each of the joint venture partners hold their respective joint venture interest jointly and severally.

[99] Clause 12 of the PPL 100 (Kutubu) Petroleum Agreement.

[100] Ibid.

[101] S. 34 of the Oil and Gas Act 1998.

[102] S. 59 of the Oil and Gas Act 1998.

[103] See Professor Lipton, note 10 above.

[104] S. 59 of the Oil and Gas Act 1998.

[105] S. 159 of the Oil and Gas Act 1998.

[106] The licensee may, accordingly, build townships, roads, bridges and other civil works including airports and seaports. The scope of the production licence is indeed very wide.

[107] See Professor Lipton’s comments, note 10, above.

[108] S. 6 of the Oil and Gas Act 1998.

[109] S. 159 of the Oil and Gas Act 1998.

[110] Under the production sharing and service contract arrangements, title to petroleum in situ and petroleum produced always rest with the State, through its national oil company. Under PNG’s petroleum arrangement, title transfers to the oil companies and the Nominee but the Nominee does not access the oil until the costs of its participation is paid, by applying the proceeds from the sale of the portion of oil which is identified as the State’s share of oil.

[111] The title could be classified as a profit a’ prendre. See Professor Crommelin’s discussion of the legal nature of the petroleum title in Australia. M. Crommelin “The Legal Nature of Petroleum Licenses in Australia” in Dantith (Ed) A Legal Character of Petroleum Licenses, Comparative Studies (1981) 60.

[112] Oil and Gas Act 1998.

[113] The arrangement for the State equity participation is set out in the respective petroleum agreements. As regard the PPL 100 (Kutubu) Petroleum Agreement, the provisions are contained in Clause 8 of the Petroleum Agreement.

[114] Other features of PNG’s petroleum agreements have not been raised and considered for the purpose of this paper. There are also relevant for comparative consideration of the PNG’s petroleum arrangement against other formally recognised petroleum regime. The scope of this paper was structured as a time-little, consideration of the petroleum regime for the purpose of labeling PNG’s petroleum regime.