LNG: The fiscal alignment and stability conundrum

Thursday August 04 2022
NG pic
By David Tarimo

Achieving appropriate balance between the interests of the state and of the investor is a key concern in the context of a project such as the proposed $30bn liquefied natural gas (“LNG”) project. Both parties want “fairness”, but alignment on such a subjective concept can be quite challenging given the complexities and uncertainties of petroleum projects.

Complexity arises due to the fact that significant costs are incurred upfront, with a significant time lag before production starts enabling payback of capital costs and ultimately a return to the investor. At the same time there can be uncertainties with regard to the petroleum geology particularly at the exploration stage, as well as the future market trends - as evidenced by the see-sawing of the oil price in recent years.

In this context, consider the LNG project where $2bn had already been spent on exploration by 2015. If all goes to plan, the hope is that 2025 will see a final investment decision (“FID”) which will enable the project to move forward to development, which it is contemplated would cost $30bn and take five years - so first income by 2030.

At the same time, consideration is required of anticipated future market dynamics.

Natural gas is often described as a bridging fuel to renewable energy due to its being a cleaner fossil fuel alternative.

Against this background the opportunity for gas is there but is time bound. Indeed, PwC’s Africa Energy Review 2021 highlighted the risk that Africa’s gas reserves could remain untapped if African nations do not expedite the development of the necessary infrastructure to capitalise on their natural gas reserves.

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BP’s Energy Outlook 2022 reaffirms that prospects for natural gas demand depend on the speed of the energy transition, for which it paints three scenarios for future gas demand (“Accelerated”, “Net Zero” and “New Momentum”). Initially, it projects growth in global gas demand in all three scenarios, driven by increasing demand in emerging economies.

However, from the early 2030s onwards, natural gas demand declines in both “Accelerated” and “Net Zero” as the increasing switch to low-carbon energy sources leads to declining use in the world’s major demand centres.

In contrast, gas demand in “New Momentum” continues to grow in the 2030s and 2040s, driven by increasing demand in emerging Asia (outside of China) and Africa.

Given these complexities and uncertainties and consequent project risks it is likely that investors looking at the LNG project will wish to ensure that the fiscal framework is appropriately balanced and that there is some commitment to fiscal stability.

In common with many other jurisdictions (especially developing countries), Tanzania’s fiscal arrangements for the upstream petroleum sector are governed by production sharing agreements (PSAs).

In broad terms this provides for production to be allocated firstly to a royalty payment to Government, then to “cost recovery” (enabling the investor to recover costs incurred, subject to certain annual limits as proportion of production), and with the remainder of production (so called “profit oil” or “profit gas”) shared between Government (represented by TPDC, as the national oil company) and the investor. The investor will then also account for income tax, and potentially additional profits tax.

Tanzania’s PSAs are based on a model agreement (MPSA) which has gone through various iterations including a 2004 model, 2008 model and 2013 model - with each iteration providing for an increased take for the Government.

The concern is as to whether the latest iteration pushed the envelope too far - in particular one regional comparison modelled in 2014 for a deep water oil discovery showed an overall take under Tanzania’s MPSA 2013 (at 96 percent) much higher than Kenya and Mozambique (61 percent and 65 percent respectively).

In addition, once fiscal terms are agreed the investor will want some kind of reasonable assurance that these will not be overturned in the future. Fiscal stability clauses are a common tool to help reduce investor risk - but to make such a clause tenable for the long term it is important that the fiscal regime at the time of stabilisation is appropriately designed.

Whilst there may be agreement as to the idea of fiscal stability, the challenge can come with the form it will take.

Firstly, there is the question of the period for which stability is granted, which may require some express time limitation.

Secondly, there is the question of administrative practicality; in particular, tax laws will continue to change and so it may be that the stabilisation focuses on certain key aspects of the tax rules relating to the sector but does not seek to stabilise tax laws of general application that affect all businesses.

Much as a fiscal stability clause is important in an agreement, it is as important that the Government more generally in its actions gives commitment to fiscal predictability - not in the sense of no change, but rather “no surprises” (or “no unpleasant surprises”) such that any change is part of a collaborative and well thought through process. As they say “actions speak louder than words”!

David Tarimo is a Country Senior Partner with PwC Tanzania