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Pakistan has had seven previous petroleum policies over the last two decades, with each successive policy providing more incentives to potential investors.
The crude oil production meets only about 20 per cent of the domestic demand, and the more abundant gas output has been overtaken by the ever-increasing demand.
The country is not traditionally a resource-rich country, but it does have significant potential in unexplored onshore and offshore frontiers. While there was a steady flow of upstream investment in the eighties and nineties, new investment over the last five years has dried up due to factors such as subsidised pricing, geopolitical concerns, and geological risks.
The Petroleum Policy 2012 provides for improved fiscal incentives to accelerate exploration and production on an emergency basis compared with the last few policies. However, there is still room for improvement before the fiscal regime can be considered competitive, considering the country’s geo-political and business risks.
Policy change: The 2012 Policy has come out with a few changes compared to 2009 Policy. The Windfall Levy Oil (WLO) and Windfall Levy Gas (WLG) charges have been reduced from 50 per cent to 40 per cent. The crude price range for applicability of WLO has also been moved up from $30-100/bbl range to $40-110/bbl. These changes are possibly due to the exorbitant nature of these charges in today’s high price environment, particularly for oil.
The minimum working interest that local companies are required to hold has been increased to 20 per cent from 15 per cent. This is an attempt to encourage local participation and to enable smoother transfer of technology and expertise. Additionally, the two renewal terms of an exploration license following the initial five year-term have been reduced to period of one year each, from the previous two years each. The extension period beyond these terms due to exceptional circumstances (like rig availability, security issues etc.) has also been reduced from 36 months to 24 months. This is ostensibly to discourage companies from inordinate delays to their work programmes, and to motivate them to aim at quicker completion of their committed activities.
One of the investor-friendly improvements in new policy is that the burden of pipeline construction costs has been moved from the producer to the SSGC and the SNGPL. Other administrative changes include the introduction of a mechanism for quality discount on sale of natural gas to government nominated buyers whereby producers would not be overly penalised.
For the purposes of gas pricing, the three onshore zones with different discount factors previously have been combined into one onshore zone, and the two previous offshore zones have been converted into three offshore zones with higher discount factors than before (based on well depth). The table below provides a brief snapshot on how the end prices vary under the 2012 and 2009 policies.
The government’s focus has been on providing greater incentives to offshore exploration. The new price formulae compared to the 2009 policy sees only a minor change in the end-consumer gas price for onshore areas, but there is a marked increase in the price resulting from offshore areas. In addition, the new policy allows “a bonanza of $1/mmbtu for the first three offshore discoveries,” which is presumably added on top of the end gas price.
Investment track record: Since Pakistan became a partner in the so-called ‘war on terror’ following the 9/11 attacks, it has faced serious security situation, which is not perceived as a safe investment climate. The government belatedly followed up its 2001 policy with improved 2007 and 2009 versions, but they still seemed to fall short of investors’ expectations. As a result, exploration and production activities over the last few years have seen a downward trend.
During 2009-10, 26 exploratory wells were drilled compared to 27 in 2008-09 and 2007-08. The number of development wells drilled during 2009-10 was 42 as against 59 during 2008-09 and 53 during 2007-08. Foreign direct investment (FDI) in the petroleum sector has fallen steadily, with 2010-11 FDI falling by 5.2 per cent over the previous year. In fact, no international oil company of note has started new operations over the last decade. Production has hovered around the 65,000bpd mark for oil and 4,000 mmcfd for gas for the past several years with no noticeable growth.
Fiscal analysis: The government formulated the latest policy to further increase exploration and production activities on a war footing basis, to seek a respite from the crippling oil import bills, and to ease domestic pains of the power and gas shortages.
For this purpose, the government also undertook extensive consultations with the private sector to incentivise domestic exploration of mineral resources.
On paper, however, there do not appear to be major fiscal improvements with regards to onshore exploration. The onshore end gas price allowed in both the 2009 and 2012 policies remains in the $6/mmbtu range (assuming a 110/bbl oil price). While one can understand the pressures the government faces in keeping domestic gas prices suppressed, there is significant disparity with international gas prices.
The price of LNG sold in the Far East averages $15/mmbtu. Even the negotiated price for gas import from Iran via the proposed Iran-Pakistan-India pipeline comes to $14.8/mmbtu (at 78 per cent oil parity of $110/bbl oil price). On top of this are the 12.5 per cent royalties and the 40 per cent corporate tax on net profits.
On oil, the squeeze on the economic rent is even higher as the windfall tax siphons off another 40 per cent at oil prices greater than $40/bbl, even though there are no forced subsidies on the prices at which oil is sold to the local refineries. It is estimated that the net government take is 63 per cent. This is much higher than the government takes in more stable fiscal regimes like that of UK (40 per cent), Trinidad (50-55 per cent), US Outer Continental Shelf (40-50 per cent ), Australia (60 per cent ), and South Africa (53 per cent).
Generally, high government takes are not recommended in cases of high-risk exploration, or for frontiers with modest geological potential, as it squeezes returns on investment and drives away potential investors. In offshore, despite better incentives, the government, government take averages around 50 per cent, which is still high considering the considerable risks, costs, and complexity a contractor faces during offshore exploration.
The new policy is currently pending consultation between the central and provincial governments but is expected to be notified in the first half of 2012. Due to the 18th Amendment’s Articles 161 and 172 (3) of the Constitution, the four provinces have a greater role in petroleum revenue collection and a voice in policymaking.
A policy under which the locals enjoy priority access to their resources augurs well for the future, if implemented in letter and spirit. Earlier exploration efforts in prolific frontiers like Balochistan had been frustrated because the locals were not seeing the trickle down effect of their exploited minerals.
Seismic and drilling crews saw frequent sabotage attacks, causing several lucrative blocks to be all but abandoned. Hopefully, better sense would prevail now and the high-potential Baluchistan blocks would be more accessible. Furthermore, the new policy does a commendable job encouraging of local companies/entities and gives adequate incentives in this regard.
In the current environment of a global recession and high E&P costs, the 2012 policy still falls short of being considered an investor-friendly regime that can compete for international investors’ valuable dollars and technology. When there are questions marks related to political stability, governance, and geological potential, investors seek a compensatory return on capital to counter the substantial risks.
Only when the government substantially reduces its share of the economic rent can it hope to attract serious investment in the upstream oil and gas sector to drive the country towards more self-sufficiency.
The writer is an energy-sector executive who has held strategy and negotiation roles at Shell and Repsol.
