Questions abound over secret oil deals and legislation in Lebanon

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The Ministry of Energy is one of the few entities overseeing the oil extraction process in Lebanon with little oversight. (Photo: Marwan Tahtah)

By: Nicolas Sarkis

Published Friday, October 24, 2014

There is no oil and gas-friendly climate in Lebanon. This is clear from the way the country is dealing with what may well be the most important socio-economic issue in the country for decades to come. To be sure, the much-hyped oil and gas wealth is the public property of current and future generations, requiring broad public participation in drafting Lebanon’s hydrocarbon policy.

Instead, the format of contracts to be signed with foreign energy companies is being treated almost like a state secret. So is it possible that this is meant to conceal favoritism being afforded to foreign mega corporations at the expense of the public interest? Who are the local stakeholders who would benefit from this alleged collusion?

If any event should occur in Lebanon, in a way that would for decades to come represent a historical turning point in its economic and political landscape, this event would most likely be the confirmation of the presence of significant oil and gas reserves in its territories or waters. But the conditions proposed for adoption in the framework of the agreements with foreign companies, to exploit the promised oil and gas wealth, are being treated as a top-secret matter, along with the legal framework, the taxation regime, the role of the government, and various other parameters related to financial resources and economic benefits that the Lebanese hope to reap from the sector. This is unjustified in the context of exploiting a national resource that belongs to all citizens, the investment of which requires drafting a highly transparent policy by the competent authorities led by the legislature, which is then published in the official gazette, and the press and media, on par with what is usually done in other countries.

It is odd that none of this has happened in Lebanon so far. The most important legal texts in this regard, that is, the so-called executive decrees of the Petroleum Law numbered 132 issued in 2010, have for long been hidden in locked drawers, so to speak. No one has had the chance to examine their contents except foreign companies and a handful of employees at the Ministry of Energy and Water, and some members of the cabinet.

One does not need a lot of experience to realize the dangers of what is being plotted in secret, and the possible consequent irregularities and heavy losses resulting from the mismanagement and misappropriation of this resource, which the Lebanese have the right to pin a lot of hopes on. The most important irregularities involve the unprecedented discounts on royalties, with the government’s share of the profits left to the mercy of the companies, the favoritism shown to the latter in the draft tax law, and the exemption of these companies from any real oversight.

The lowest royalties in the world

Specifying royalties in the draft executive decrees at 5 to 12 percent for petroleum and only 4 percent for natural gas, compared to an average of 12.5 percent worldwide, means at best that Lebanon would lose no less than $14 billion in 25-year agreements, and more in 30-year agreements, or if prices increase and exceed the minimum production levels used as a baseline.

Some officials justify the low level of royalties by saying that the authors of the decrees were inspired by the laws in Norway, where no royalties are collected whatsoever. However, these officials seem to have forgotten that Norway had replaced the royalties system years ago with a special tax on petroleum companies, which currently stands at 51 percent, in addition to the 27 percent corporate tax, meaning that petroleum companies pay up to 78 percent in tax. The current draft decrees in Lebanon would not even levy a third of that figure.

Companies’ share of profits is bigger than the state’s

Oil and gas profits are the second most important issue after royalties, in the context of the state’s revenues from the exploitation of its resources, even ahead of income tax. What is meant here are profits from extracted oil or gas, which are shared between the state and a given company, after the latter pays royalties to the state minus its costs. The irregularity involved here is that no one yet knows how profits are going to be shared between the government and the operating company, because the authors of the relevant pieces of legislation have opted to let each company propose the share it wants to keep, and the share that is given to the state, as part of a bidding process. The only thing that the draft decrees seem to confirm is that the companies’ share must be larger than the state’s.

Needless to say, resorting to an auction in this manner opens the floodgates of enticements, side dealings, and irregularities in general. If we accept the argument that auctions are the best way to secure the largest possible share for the state, it is still obvious that the Lebanese legislator should specify the minimum acceptable and reasonable level for the state’s share, and then let foreign companies bid, or in other words, they must ensure the best conditions for Lebanon. The draft decrees also indicate that companies would be able to determine themselves certain specifications related the share of each side from oil and gas profits.

Exempting companies from certain taxes

It is not normal for oil companies to be given the contract format for exploration and production agreements before a tax system is put in place, especially the income tax to which the companies would be subjected. Yet this is exactly what is happening in Lebanon.

On the one hand, Law 132/2010 stipulates that the companies concerned must pay the taxes in force. But on the other hand, a new tax system has been developed to bring taxes to be more in line with tax regimes applied in other countries to the profits of petroleum companies. These tax regimes impose a much higher income tax than the 15-percent rate Lebanon collects on the profits of commercial and industrial companies. There is an ongoing debate about how to amend the current tax system, and whether it is better to draft a new law for the petroleum industry, or amend the income tax in the current law to make it progressive in proportion to profits.

The concern today is for the current tax system to be amended in a way that does not improve the state’s revenues from its resources, but rather increases the profits of operating companies at the expense of the treasury. The reason is that the new draft law not only keeps the income tax unchanged, but also exempts companies from some taxes and duties in place. This was confirmed during a workshop organized by the Petroleum Administration of the Ministry of Energy back in May, which was attended by a number of Lebanese experts. The gist that came out of some of the most prominent discussions, according to the Lebanese press, was that the various clauses of draft agreements and the new draft tax law “favor the interests of petroleum companies at the expense of the host country.”

It is no exaggeration to say that this situation threatens to inflict huge losses on Lebanon. If the income tax on the profits of petroleum companies remain at the 15-percent level, this would mean that Lebanon would have record low revenues from such taxes compared to other countries with similar circumstances. For example, the same tax in Israel starts at 20 percent and rises gradually to 50 percent, with the figures being 35 percent in Gabon and Argentina, 38 percent in Algeria, 50-60 percent in Angola, and 78 percent in Norway as we mentioned.

These large differences will be translated in Lebanon – as a result of current draft laws – to losses much higher than the $14 billion resulting from the discounts in royalties. The new draft tax law also includes a long list of exemptions and discounts to be granted to petroleum companies, including, for example, exemption from customs duties on imports and re-exportation, some value added taxes, and stamp duties. This is not to mention tax exemptions on any bonuses that these companies may pay out, whether after signing agreements, discovering fields, or starting production. For example, these bonuses sometimes account for 40 percent of the total revenues of the US government from exploiting its oil and gas in the continental shelf.

Guaranteed low taxes

The draft agreements not only grant the companies the lowest taxes anywhere in the world in the oil and gas sector, in addition to many tax breaks and discounts, but also grants many other concessions in the near and long-term future. For instance, the draft agreements ensure the continuity of this situation no matter what happens in the petroleum industry or in Lebanese legislation.

Article 28 stipulates, “If the income tax applicable to companies in Lebanon increases, the increase in income taxes on petroleum companies are then deemed to be reimbursable costs.” It is well known in all oil or gas producing countries that companies have to pay special taxes when their profits rise to exceptional levels for whatever reason, especially when prices rise sharply. The authors of the decrees in question ignored this, and also forgot to include measures for when unexpected developments harm the interests of the host country.

Even if we accept that the national interest requires some sort of stable taxation that would be enticing for companies, the question is: what is the rate at which tax should remain stable? Is it the current rate or the rate set by the new law? Also, which Lebanese authority has the mandate to grant foreign companies such guarantees; the Ministry of Energy and the Petroleum Authority, or is the legislative authority, which some seem to consider a symbolic body with no real power?

Flimsy oversight

No matter what shape the financial and tax-related terms and conditions end up taking in the final exploration and production agreements, these remain hypothetical without a clear mechanism for oversight over the operating companies’ operations and accounts. Indeed, even if the best possible royalties, profit-sharing formulas, or tax rates are agreed, all this remains moot if the government does not have the necessary means to verify the real level of production and exports, and the prices, costs, and revenues declared – or not declared – by the companies in question.

Obviously, the best if not the only way to achieve this would be for the state or any body that represents it inside the operating companies to be a full partner in managing petroleum-related activities. This is not only the most appropriate way to monitor operations, but is also the best way to train national cadres and steer the companies’ activities in a direction that guarantees the development of various economic sector such as industry, services, and so forth. This is what all producing countries have done, including the Arab ones.

In Lebanon, however, despite what is stipulated in Law 132/2010, the authors of the decrees ignored everything related to the state’s participation in petroleum-related activities and the establishment of a national corporation for this purpose. The decree might thus create a de facto situation that is extremely negative and dangerous, as it would deprive Lebanon of an opportunity that will not be repeated to be in a decision-making position in relation to its resources, and would take us more than 50 years back in time when developing countries could do nothing about what was happening in their territories and waters.

The only reference the authors included in the decrees in question in this regard was stressing the right of the Lebanese authorities to “scrutinize and audit the records of the operators and stakeholders.” Clearly, this right to monitor and audit is overoptimistic and even delusional, especially since the long and bitter experiences of all oil-producing developing nations indicate that it is impossible to monitor the operations and accounts of multinationals that control all aspects of petroleum operations inside and outside the host country.

In most cases, the companies concerned make additional profits by manipulating their books rather than rigidly observing the texts of agreements that do not include a role for a national partner. Article 20 of the draft agreement stipulates that companies should train Lebanese nationals working in the oil sector, but then add explicitly, “Unless this represents a possible or actual conflict with the interests of the companies, for example by training auditors expected to audit the records and balance sheets of the rights holders.” In other words, companies can train Lebanese nations to do everything except understand their accounts.

Another example of the absence of the state and the neglect of its rights and duties in managing petroleum operations is the text included in the draft executive decree related to the work and jurisdictions of the Management Committee representing the companies concerned in executing and overseeing petroleum activities. The text states that the Minister of Energy and the Petroleum Administration have the right to appoint representatives in the committee, but as “observers” only. Article 16 even states, word for word, that neither the minister nor the administration has the right to appoint representatives to attend the meetings of the committees, which the companies appoint in coordination with one another for their own purposes.

Dubious confidentiality

It is not surprising then that the irregularities mentioned above are being surrounded with the utmost secrecy. This was not absent from the minds of the sponsors of the executive decrees, who allocated Article 35 of the draft exploration and production agreement to confidentiality. The article explains how “this agreement, and all information, data, analyses, interpretations, and results obtained and acquired related to petroleum activities or resulting from them in accordance to this agreement are confidential, and may not be disclosed or transferred from the rights holders to any third party.” The clause is binding to any contractor or consultant working with the petroleum companies.

While confidentiality is a normal clause in commercial contracts, it is not comprehensible in the context of laws and regulations related to the exploitation of a national resource, which must be discussed and approved by parliament. Whoever examines the texts being prepared for launching the oil and gas industry in Lebanon cannot help but ask about the reasons that call for such secrecy.

No matter what the reasons may be, the fact of the matter is that these texts are a blueprint for squandering a resource that the Lebanese have the right to pin a lot of hopes on. Pursuing secrecy in this manner is a time bomb that will surely detonate one day, giving rise to further political conflicts in Lebanon that we do not need.

If the current texts are adopted for agreements with petroleum companies, they will become a trap that will be difficult to escape from and from its economic and political repercussions, which will be immeasurably more calamitous than, say, the inaccurate demarcation of maritime boundaries with Cyprus and Israel. It is not yet too late to disable this time bomb and draft a transparent petroleum policy that can fulfill the interests and aspirations of the Lebanese, and ensure a reasonable equilibrium with the interests of foreign petroleum companies.

This article is an edited translation from the Arabic Edition.

Comments

This article is very inaccurate, and shows no understanding of how production sharing contracts work. Examining royalty rates in isolation is not helpful. The ultimate government take (overall taxation) depends on royalty rates, but also (among other items) the "profit oil" split between the government and the contractor, as well as the cost recovery ceiling, i.e. what percentage of company costs can be recovered before profit oil begins and the revenues are divided between the contractor and the government. The profit oil split is a biddable term. If and when Lebanon finally holds a bid round, this is a key area that it will use to distinguish between bids. The state will choose the contractor that offers it the best terms (alongside other considerations, such as the company's technical experience/expertise and its financial strength). Looking at the royalty rate alone provides no indication of the ultimate tax rate. You cannot compare these royalty rates in isolation to overall government take in other countries - especially those that, unlike Lebanon, have proven reserves and geology that is better understood. The author should have consulted someone more knowledgeable about oil and gas contract terms. Articles like this mislead the public.

Solar power will slowly squeeze the revenue out of petrol-regimes in Russia, Venezuela & Saudi Arabia. They will have to find a new business model, or fade into decline.
There are already 19 regional markets around the world that can match or undercut local electricity prices without subsidy. Photovoltic energy is already so cheap that it competes with oil,diesel, liquified natural gas in Asia without subsidies.

It would have been insightful & prudent had the ...
GREAT MEN OF FUEL SUPPLY TO THE WORLD
taken a long term view of energy supply to fulfill the needs of planet Earth. Had they made the world less dependent on oil, etc & gone for a more broad spectrum approach...
1) the world would have progressed immensely
"why we would be the Jetsons today"
2) there would be no concerns over shortages.
3) they would have cornered the market forever & a day.
Alas the game was played on a "here today, gone tomorrow, live while you can" high.

Too bad that they held the world captive in medieval times, as the squandered not only their profits / wealth, but also the planets resources of fossil fuels. Today they are ready to blow the worlds nations into particles of dust to regain - by any means their "assets/product"

The 2008 GFC was not a good idea for the old guard, it left money open to new ownerships. New banking formats were forged to supply the up & coming entrepreneurs. It is said - "never leave a gap/space between you & that which you love lest someone else steps in" - over confident & comfort in that precarious confidence by the powers that be & that is exactly what happened.
i.e., 'sorry, but while you were sleeping dear, things changed'

Today the OLD MEN are exactly that & with old age comes a slowness, enter the new kid on the block.

Here's to you, the young people of tomorrow, I personally have wished to old ones dead many times over so as to make room for you - & it happened. We are on our way at last.

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