Oil and gas in Kenya – regulatory framework

May 2013 | EXPERT BRIEFING | SECTOR ANALYSIS

financierworldwide.com

Oil and gas is a fast developing area of law in Kenya and this can be seen by the rate at which government has been aggressively putting in place laws and regulations that will govern companies which have been allocated, or intend to apply for, oil prospecting rights in Kenya.

The recent discovery of crude oil and natural gas in Kenya has brought international attention to the country on the possibility that Kenya could join the league of oil producing countries. It has also increased the appetite for investors in the oil sector.

Currently, the exploration and production of oil and gas is primarily regulated by the Petroleum (Exploration and Production) Act, and its regulations.

Any person intending to engage in ‘petroleum operations’ in Kenya is required to obtain the permission of the Minister for Energy before commencing such operations. Such permission, if granted, does not allow that person to prospect and mine any other minerals or other natural resources (other than petroleum) in that area.

Petroleum operations is defined in the PEPA to mean “All or any of the operations related to the exploration for, development, extraction, production, separation and treatment, storage, transportation and sale or disposal of, petroleum up to the point of export, or the agreed delivery point in Kenya or the point of entry into refinery, and includes natural gas processing operations but does not include petroleum refining operations”.

The Minister for Energy is granted wide ranging powers under the PEPA including, among others, the power to negotiate petroleum agreements, supervise petroleum operations, and make regulations to govern the exploration and production of petroleum.

Production sharing contract

A petroleum agreement (PSC) is defined in the PEPA as an agreement, contract, or other arrangement between the government and a contractor to conduct operations in accordance with the provisions of the PEPA.

The Ministry of Energy has published a model PSC to be entered between the government and prospective contractors.

The PSC contains the core terms that will govern the conduct of petroleum operations and must be entered into before commencing petroleum operations. It sets out the specific area within which a contractor has been granted exclusive rights to conduct petroleum operations and the modalities for conducting such operations.

The PSC provides for an initial exploration period of three years, and one is expected to commence exploration works within three months of its execution date. Extensions may be granted upon written application in the event a contractor has fulfilled its work and expenditure obligations as will be outlined in the PSC.

In the event a commercial discovery is made during the term of the PSC, the term continues for an additional 25 years from the time a development plan is adopted. The PSC clearly sets out the matters to be contained in the development plan.

Proposed amendments

A proposal has been made to move away from the current system where exploration rights are issued on a first come first serve basis and, instead, introduce a public auction system. Exploration blocks are to be awarded to the highest bidder, who offers the best terms to the government, and agrees to pay requisite fees.

A contractor is expected to surrender a portion of the contract area on or before expiry of the initial exploration period. The proposal is for contractors to cede 25 percent of the contract area.

In respect of a commercial discovery which is producing or has produced petroleum, one year’s notice of the surrender is to be given and one month’s notice in respect of any other part of the contract area.

A signing bonus is to be paid upon execution of the PSC. This is to increase this from approximately US$300,000 to around US$1m. This is an effort to exclude prospectors and increase revenues to the government.

Penalties are to be imposed for non-observance of exploration schedules, which involve revoking the mining and exploration licences of companies that do not keep to their exploration schedule.

Contractors are also to cede 35 percent of the issued shares to local investors and institutions. It is not clear how this is to be implemented.

Taxation

Recently, the government has announced that it will charge tax of between 10 and 20 percent on the actual gross proceeds of sale (and not the gain made on a sale) of any interest in oil exploration companies. There is some lack of clarity on the effect of this law, especially its effect on extra-territorial transactions and on a possible conflict with specific provisions of the Income Tax Act.

With nine new exploration blocs soon to be auctioned by the government, and announcements of significant discoveries in some of the 46 existing blocks, the oil exploration sector in Kenya will be a very interesting sector for international players to follow.

Paras V Shah is a partner and Alex M Njagi is a senior associate at Hamilton Harrison & Mathews. Mr Shah can be contacted on +254 20 325 8274 or by email: pshah@hhm.co.ke. Mr Njagi can be contacted on +254 20 325 8278 or by email: anjagi@hhm.co.ke.

Paras V Shah and Alex M Njagi

Hamilton Harrison & Mathews