Lebanon’s fiscal conundrum: what is a fair oil & gas share?

This article was written for the October 2017 edition of Executive Magazine.

As Lebanon prepares to open bids submitted in its first offshore licensing round, all sides – government, citizens and companies – aspire to a good deal, giving both parties of the exploration and production agreement a fair share.

But what is a good deal for Lebanon?

Both sides of the debate agree it is one that maximizes the State’s share, though they do not see eye to eye on what is the maximum achievable. For some, it is one that is competitive compared to other international opportunities that are comparable in nature. For others, it is one that maximizes the direct role of the State and demands an even greater share.

The intention is commendable, but it appears to suffer from a hint of populism. To put it simply, arguing Lebanon deserves a fair share implies the existence of a “share” to begin with. That share can only exist if the state contracts partners to explore for and produce potential resources. There are two parties to the deal. And the terms of that deal must be attractive enough for both sides to commit to signing a contract. If no contract is signed – say for lack of interest from oil and gas companies – the “share” vanishes, given the absence, at this stage, of indigenous capacity to conduct upstream operations.

Contrary to popular claims, perpetuated by a political class that is struggling to manage expectations – including its own – about yet-to-be discovered oil and gas resources, current market conditions are not favorable to deep-water exploration. Lebanon’s offshore area, the subject of this first licensing round, is mostly deep and ultra-deep waters. In other words, current conditions are not ideal for exploration in areas like the Lebanese offshore, and we must deploy efforts to persuade companies to come and bid. Part of the persuasion lies in Lebanon offering attractive fiscal terms.

The opponents of the legal regime governing the first licensing round argue that (1) the decree setting out the model exploration and production agreement (EPA) – approved by the cabinet in January 2017 –  conflicts with the 2010 Offshore Petroleum Resources Law by preventing the State from participating in the tender, thus distorting the system from an originally-intended production-sharing model to a profit-sharing model; and that (2) royalties and taxes, as set out in the EPA and Petroleum tax law are too low compared to a “global average”.

In fact, decree 43/2017 setting out the model EPA is in line with the Offshore Petroleum Resources law which states in Article 6 that the Council of Ministers may establish a National Oil Company “when necessary and after promising commercial opportunities have been verified”, which rules it out for the first licensing round since “commercial opportunities” cannot be verified ahead of exploration. Moreover, the facts that the state retains ownership of resources in the ground and a share of the produced petroleum (whether in cash or in kind) once the company recovers capital and operational expenditures means Lebanon’s chosen model contract is a classic production-sharing system. The distinction some wish to establish between a production-sharing model and a profit-sharing model is non-existent.

As for fiscal terms, the statement that they are too generous or too harsh generally depends on where you stand on the political ideology spectrum. Comparing them to a “global average” may seem to lend an air of seriousness and professionalism, but, in reality, it is closer to comparing apples to oranges given the diverse range of producers and countries aspiring to become producers and the fundamentally diverse environment they are in. One cannot compare an established producer to a country that has yet to discover commercial quantities of oil and gas. Similarly, one cannot compare countries or provinces where exploration is relatively cheap and easy to countries or provinces where it is expensive and complex. These are all elements that affect how attractive a country is to foreign companies. One way to compensate for Lebanon’s relative disadvantage (i.e., no proven reserves in both a high-cost drilling and high-risk political environment) is offering attractive terms for potential investors.

A more coherent approach would entail identifying a group of countries, or provinces, with similar basins (deep-water offshore), and a more or less comparable status (early exploration or production activity). Ideally, we would also add other elements: A local market that is comparable in size and the existence of little or no export infrastructure (which could delay the development of discovered fields if local market is not enough), in addition to the socio-political environment.

The above-described debate was successful in steering the discussion towards unreasonable demands and inflating expectations. Future licensing rounds will not necessarily be governed by the exact same legal framework. Future EPAs (and the royalties included in them – the subject of so much passionate debate) will not necessarily be the same. Fiscal terms are not set in stone. They may change in the future to adapt to new realities, though regulatory stability is important. Realism is the keyword, whether now or in the future.