Investing with certainty: stability under South Africa’s new oil and gas regulatory regime Address by Peter Leon Partner, Webber Wentzel Bowens, Johannesburg, to UNCTAD´s Africa Oil, Gas, Trade and Finance Conference Nairobi, Kenya 23 May 2007 NOT AN OFFICIAL UNCTAD RECORD

International Best Practice for Oil and Gas Exploration and Production This year, the South African oil and gas regulator, the Petroleum Agency, SA (“PASA”) actively sought investment in its 2007 licensing round for a number of blocks offshore the South African coast. This licensing round closes in September 2007 Resource-rich countries must make themselves attractive to private investment For those countries which are geologically less prospective (such as South Africa), this is all the more so A successful oil and gas regulatory regime requires certainty and predictability in a high cost, high risk and capital intensive industry The success of PASA’s licensing round will rely in part on the extent to which the South African regulatory regime affords investors certainty, security of tenure and stability

Previous regulatory framework for oil and gas in South Africa: the Mining Rights Act, 1967 and the Minerals Act, 1991 (1) The OP26 prospecting lease and OP26 prospecting sub-leases and mining leases (going back to 1967):  PetroSA leased rights to explore and produce oil and gas to exploration and production companies (“lessees”)  Terms and conditions were guaranteed for the duration of the prospecting sub- leases and the mining leases Legislative stability  The lessee was protected as it was subject to the laws of South Africa and such further laws passed, provided such further laws would not adversely affect the rights of the lessee Guarantees in favour of the lessee by the Minister of Minerals and Energy:  the contractual obligations of the lessee would not be altered without the lessee’s consent  the form of the mining lease was attached to the prospecting sub-lease. A lessee thus knew what rights it would have in the event of a discovery

Previous regulatory framework (2) Fiscal stability – Tax, customs and exchange control  Income tax payable frozen as at the 1977 amendments to the Income Tax Act  Customs duties waived  Exemption from exchange control Fiscal stability – Royalties  Royalties calculated as a share of profits on an ad valorem formula  Formula to calculate royalties remained the same for the duration of sublease Limited socio-economic obligations placed on lessees  A multinational could employ non-South African citizens if required skills and qualifications not available in the local labour market  Limited Black Economic Empowerment (“BEE”) equity divestiture requirements (9 percent under the Liquid Fuels Charter)

Current regulation: Mineral and Petroleum Resources Development Act, 2002 (“the MPRDA”) State is now the “custodian” of all mineral and petroleum resources in South Africa, including oil and gas Oil and gas exploration and production administered by PASA, overseen by the Department of Minerals and Energy (“DME”) MPRDA attempts to secure tenure of rights holders through its transitional arrangements “old order” to “new order”: the “old order” OP26 sub-leases and mining leases must be converted into exploration rights and production rights by 30 June 2007 The terms of the new order rights are still being negotiated, despite the fact that there is less than six weeks to go!

Current regulation: the MPRDA (cont) Socio-economic objectives: ●The MPRDA seeks to promote “equitable access” to oil and gas resources, and expand opportunities for historically disadvantaged persons, to enter and benefit from the industry ●The 2000 Charter for the South African Petroleum and Liquid Fuels Industry (“the Liquid Fuels Charter”) is applicable to exploration and production of oil and gas ●The requirements of the Liquid Fuels Charter may seem somewhat benign in relation to the far more onerous Mining Charter:  9% BEE equity divestiture  Vague employment equity and BEE procurement requirements ●This is appropriate in a high risk, capital intensive industry in a geologically uncertain area ●Social objects of the MPRDA are linked to the grant and conversion of rights under the MPRDA

Issues arising from the MPRDA’s regulatory framework and the draft Exploration Rights (“ER”) and Production Rights (“PR”) Legislative stability Fiscal stability ●Royalties ●Tax Transitional Arrangements Onerous empowerment requirements

ER/PR: Legislative Stability Holder will be subject to the “applicable laws” of South Africa, as amended from time to time. This will include all new legislation and legislation to be passed in the future which may adversely affect the holder’s rights Holder is subject to all laws The ER/PR may now be affected by any legislative amendments which are enacted after the conclusion of the ER/PR, thus potentially affecting the rights granted to the holder

ER/PR: Fiscal stability - royalties Draft Mineral and Petroleum Royalty Bill, 2006 (“the Draft Bill”):  if enacted in current form, a royalty rate of 1.5% (deeper than 500 metres) and 3% (shallower than 500 metres) will be imposed on oil and gas production  The issue is not so much that of the royalty rate payable under the draft Bill, but rather whether the rate will remain at the rate it is at in the draft Bill  the industry has endeavored to include a “walk-away” provision in the ER, under which the holder may terminate the ER without liability or suspend the ER until the royalty legislation is enacted

ER/PR: Fiscal stability - taxation Holder will be liable for income tax in accordance with the “applicable laws”, as defined The Tenth Schedule to the Income Tax Act, 1962 came into force on 7 February It empowers the Minister of Finance, after consulting the Minister of Minerals and Energy, to guarantee that the provisions of the Tenth Schedule will continue to apply for the duration of the ER/PR  tax rate applicable (29 percent for residents and 32 percent for non-residents) over the duration of right  Secondary tax on companies (“STC”) limited to 5 percent and no STC payable if dividends arise from an OP26 right  foreign entities can decide on the currency used in calculating tax payable  A “windfall tax” has been mooted, but not finalised

ER/PR: Onerous empowerment requirements PR: Holder must comply with 26% BEE equity divestiture requirements of the Mining Charter by 2014, or a new Liquid Fuels Charter to be adopted in terms of the MPDRA Narrower scope to employ non-South African citizens Holder must implement a programme for the recruitment, training and employment of historically disadvantaged South Africans Holder is required to effect payments to the Upstream Training Trust

Conclusion (1) Need to create investment certainty and an attractive investment environment  A lack of clarity and regulatory certainty may deter investment  South Africa is not the Gulf of Guinea. It has to compete with resource-rich oil and gas jurisdictions. This will only be successful if investors are given adequate incentives  Look to other jurisdictions: ●Kenya’s regulation of oil exploration. Strong security of tenure and active investment schemes aimed at promoting foreign investment and terms of the licences are negotiable.

Conclusion (2) Need to create security of tenure for holders of existing old order rights ●The ER/PR could provide for financial guarantees by the South African government in the holders’ favour in the event of legislative or fiscal changes which are detrimental to the holder ●In a capital intensive, high risk industry, the ER/PRs should provide for more reasonable empowerment requirements to stimulate investment ●Kenya has shown how to incentivise investment in a geologically uncertain area

Conclusion (3) The National Treasury is alive to the need for certainty and stability in the oil and gas industry in South Africa, as is evident from the fiscal stability provisions contained in the Tenth Schedule to the Income Tax Act PASA and the DME need to reflect a similar intention in finalising the draft ER and PR in the next six weeks