Structuring of innovative finance schemes for petroleum in Nigeria: Legal & tax issues

*Port Harcourt refinery.

*Port Harcourt refinery.

Oscarline Onwuemenyi

05 October 2015, Sweetcrude, Abuja – Since the advent of the petroleum industry in Nigeria, the major challenges have been how to effectively regulate the sector while at the same time ensuring that the government generate adequate revenue from the petroleum industry which is the bedrock of the economy of the nation as well as guarantee adequate financing for the sector.

Specifically, funding has been a major headache for Nigerian oil and gas industry, demonstrated by the inability of the government (Nigerian National Petroleum Corporation) to meet its cash call obligations in the subsisting joint venture agreements with international oil companies (IOCs).

The need for effective funding has become even more urgent in the face of a global trend towards lower petroleum prices, which has exacerbated the problem of access to capital for many indigenous exploration and production companies. Indeed, structured financing techniques in oil and gas-related project finance have grown more popular over the years. In particular, reserve based finance has played an important role in project finance by increasing oil and gas sponsors’ access to affordable financing from the capital markets and helping banks refinance their project loan exposures.

The challenges of funding for petroleum exploration and production in the country is what the book, “Structuring of Innovative Finance Schemes for Petroleum Production in Nigeria: Legal and Tax Issues,” written by Dr. Perisuo Dema, an oil and gas law juggernaut, aims to resolve. The book, which is published by the Centre for Petroleum and Mineral Law Research, offers a new insight into the unique nature of oil and gas financing and the inherent issues arising from the attempt to chart the cause for viable financing models for upstream petroleum projects in Nigeria.

Dr. Dema’s book is very timely, and it seeks to address very critical issues that impact on the growth and development of the Nigerian petroleum industry. Divided into eight chapters, the book conveys in a lucid and logical manner how the major transactional and legal issues can be resolved by the fund seeker. It further highlights the reasons for the limitations of traditional funding as a financing option for petroleum exploration and production, and sets out to critically delineate and discuss innovative funding schemes, primarily within the Nigerian legal framework, against an international and comparative legal framework.

In the early pages of the book, Dr. Dema draws out the need for a robust funding mechanism for oil and gas exploration and production. The book also illuminates how the various oil and gas regulatory and contractual arrangements in Nigeria influence the way in which the financing in the sector is operated.

In subsequent chapters of the book, the author examines the series of risks that are inherent in investment in the oil and gas industry. Specifically, issues of price volatility, interest rate, operational, and geological risks are giving proper treatment and explication. However, the book excludes deep discussion on exchange rate risks, which should be a topical issue putting into consideration the sharp rise in exchange rate in Nigeria. Nevertheless, appreciating the fact that the risks could have impact on the funding of oil and gas contracts, the book eschews how the risks are being borne by the parties and other stakeholders in the industry. However, the author sheds light on how the risks are allocated to the parties to the transactions and how legal interests could shift to the licensee.

Playing the role of an innovative thinker, the author proposes the quaint-sounding PIPAM (Participating Interest Percentage Assignment Memorandum) as a structured contractual mechanism, in other words, as a vehicle through which a participating interest holder in a petroleum acreage who is also a shareholder in the licensee company would be able to collaterise its shares as a floating charge in order to raise the requisite finance to pay for its proportionate work programme commitment without the fear that its intended financing deal would be frustrated because it’s would – be financier could opt out due to the unduly long period of waiting to obtain the statutorily prescribed consent of the Minister of Petroleum Resources as stipulated by Paragraph 14, Schedule 1, Nigerian Petroleum Act, 1969 and re-enforced by the courts in the case of Moni Pulo Limited vs Brass Petroleum Unlimited.

The author states that PIPAM is thus intended only for jurisdictions such as Nigeria where ministerial consent is a sin e qua non for effective assignment of a petroleum acreage licence or an interest therein, but where difficulties attend the obtaining of such consent.

PIPAM is being proposed in the book because Nigeria’s upstream petroleum sector is replete with complaints of delays in the grant of ministerial consent for transfer or assignment of interests in petroleum licenses.

Predicated on the foregoing, Dr. Dema writes that PIPAM is structured to be a floating charge which will require the deposit of the participating interest holder’s share certificate(s) for which a Memorandum of Deposit would be a part thereof and have the effect of creating a chose in action in favour of the creditor and not an assignment or transfer of participating interest.
He further states that it is only in the event that the participating interest holder is unable to meet up with its repayment obligation to the financier that PIPAM would then cease to operate and the creditor would at that juncture be entitled to approach a competent court for an order to recover its funds or such quantity of its debtor’s participating interest in the licensee’s petroleum acreage that is proportionate to the fair market value of its funds.

The recovery process may include an application for crystallization as prescribed under Section 178 of Nigeria’s Companies and Allied Matters Act for the participating interest of the debtor in the licence area that it has financed petroleum exploration and/or production from by converting the floating charge into a fixed charge as outlined in the British case of Re Crompton & Co Limited (1914) ILR 41 Cal 313.

The objective of PIPAM is thus to help a significant aggregation of the participating interest holders of a petroleum acreage

Risks could also be allocated in accordance with the existing licensing and operating regimes for petroleum production in Nigeria. Thus, the book further addresses the issue of making a choice between equity finance and debt finance as well as the legal barriers that may arise from equity finance.

A very important idea in the book is the utilisation of reserve based finance, borrowing based finance and Islamic finance, particularly ‘Sukuk’, and the risks arising from them as well as the attendant allocation of the risks, which is germane to any project finance arrangement. The section concludes by raising a poser on the utilisation of the instrumentalities of multilateral investment guarantees and bilateral investment treaties in guaranteeing contractual obligations arising from project finance.

Upon providing a distinction between royalty interest from mineral interest, the chapter went ahead to examine critically the technique for the determination and segregation of the overriding royalty interest from the royalty interest and the determination of the working interest. Furthermore, the chapter presents how the special purpose vehicle for a reserve based finance arrangement can be established.

The key aspects are the petroleum reserve based finance plan, structure securitisation plan, circumstances for refusal of approval and matters arising from the conditions for petroleum licencing, tax compliance issues, novation of contracts, and how the special purpose vehicle may be subjected to were also discussed in the chapter. Of critical observation in the discourse on the requirement for the consent of the petroleum minister before an assignment can be made in particularly as it pertains to Participating Interest Percentage Assignment Memorandum. In connection to this is due authorisations by the parties, requirement for mandate letter and written special resolution as well as the geological asset valuation report.

A fundamental importance in project financing is cash flow. Thus investors and lenders are usually unwilling to finance projects which by their nature will result in negative cash flow or value fluctuations. Bearing this in mind, the book in chapter four makes a case for a thorough evaluation of the reserve based finance asset. Chiefly considered in the book are, accounts receivable; future production flow; fair market value estimation; estimation of the net present value of the future net revenue; ascertainment of the producing reserves; and projected volumetric production payment.

Adding value to the discussion is the reference to American and Nigerian cases that have come to play in reserve based petroleum production finance and utilisation of equity shares as collateral for debt financing. Prospects and challenges of the above parameters of evaluation were analysed in the text, particularly the impediments arising from the vesting of ownership of petroleum on the government as well as the requirement of ministerial consent before an assignment of interest in petroleum can be made in Nigeria.

In concluding the chapter, the author calls for:
“i. enactment of a reserve base finance law that gives pre-eminence to future flow receivables; ii. classification of bankruptcy laws as it pertains to securitising oil and gas assets; and iii. establishment of indigenous credit rating agencies which would reduce the cost of the securitisation process.

The last three chapters of the book assess and proffer measures to be put in place in form of a legal framework to enhance robust funding of upstream petroleum projects in Nigeria. It gives an analysis of the utilisation of the instrumentalities of master trust as a special purpose vehicle for funding petroleum projects in Nigeria. It further enumerates the origin and concept of the master trust; the various trust agreements and their possible application in Nigeria. Lessons from other sample jurisdictions on how master trusts have also been used as special purpose vehicles for petroleum production were reviewed.

The book draws examples from other jurisdictions, making particular reference to the Mexican Pemex Project Funding Master Trust, a Mexican master among others. Furthermore, the role of Securities and Exchange Commission and the likely impediments that may emanate from the current petroleum regime and the Petroleum Industry Bill (PIB) owing to the fact that the existing law in Nigeria are inadequate to effectively allow the operation of master trust. The book advocates the development of a legal framework to address effective utilisation of master trust in funding petroleum investments.

The book is quite assertive on the utilisation of the sovereign wealth fund, the pension fund and ‘Sukuk’ as the principal financiers of the master trust. The book demystifies the conception that the sovereign wealth fund is utilised for funding projects and ventures other than oil and gas production. The author supports his assertions with examples of the Norwegian and Abu Dhabi Sovereign Wealth Funds being involved in petroleum production financing. It further tilts in support for the Islamic law non – interest approach to project finance which is a novel approach to Nigeria until recently.

The concluding chapter is illustrative in nature, pooling the strings together and making a case for the appropriate measure to be taken to address the dearth of funding of petroleum investments in Nigeria. On the whole, the book calls for the development of robust legal framework for funding of upstream petroleum projects as the current legal regime as well as the anticipate Petroleum Industry Bill are lacking in affirmative provisions for project financing and securitisation.

The book would, however, have been further enhanced by condensing some paragraphs together rather than a composition of very short paragraphs in some sections of the book. On the whole, the author has presented in a crystal manner legal and tax issues arising from project financing in the Nigerian upstream petroleum sector.

It is noteworthy that Dr. Dema’s book is the first of its kind in these climes, a veritable trailblazer, and the ideas it proposes and projects would be revolutionary to the management of the petroleum industry. It is a timely intervention for the Nigerian oil and gas industry that has struggled for direction and organisation after more than 60 years.

It is therefore most highly recommended to officials of the Nigerian Government, the judiciary, law makers, multinational and national oil companies, lawyers, tax experts and key players in the banking and stock exchange sectors, transaction advisors, journalists, researchers interested in the field of oil and gas finance, and the academia. The book would also be of benefit to students in the field for petroleum upstream finance. Countries seeking to develop a robust funding model for their oil and gas sector would find this book very useful.

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