An In-Depth Review of what Genel Energy Signing the Farm-Out with CPC Corp Means to Somaliland’s Oil Industry. We will highlight the various possible challenges, benefits, and opportunities associated with the potential Drilling of crude Oil in Somaliland.
Preface
Hold your horses, our great people! As soon as the Farm-out deal between M/s Genel Energy as the holder of the Production Sharing Contract (PSC) and the CPC Corp of Taiwan as a new joining investor is announced, we jumped to speculation and hot debates, driven by the excitements and some critics; fuelled by our usually CAD & CAANO hot-blooded! It’s customary that hydrocarbon deals and especially in developing countries, raise such public interest and soon becomes the talk of the town. Therefore, this new farm-out deal is further aggravated by the fact that CPC Corp is from Taiwan, the recently found friend of Somaliland that proved to be a capable and delivering friend to yet-to-be-recognised Somaliland; hence deal attracted more scrutiny and debate in Social Media.
Despite the recent world trend shifting towards greener/renewable energy ( a zero-net carbon future), Oil and gas majors indicate to cut their future investment in newer oil frontier / investment beyond 2030, yet, Oil remains the best available energy resource for all nations. They can be refined into petroleum products that people use daily for many different purposes. Its uses include but are not limited to heating buildings, propelling vehicles, and producing electricity. Furthermore, raw petroleum is used as a feedstock to create commodities such as plastics, polyurethane, and other end-user goods in the industrial sector. Its price alone, which is heavily monitored, can help us gauge what is going on in the world economy, reveal countries’ economic standing, and significantly influence what might happen in the future. As such, countries with non-renewable resource wealth face both an opportunity to propel themselves to further heights & greater prosperity for current and future generations or the risk of suffering associated with all the challenges it brings, such as economic instability, social conflict, and long-lasting environmental damage.
On 15th December 2021, OPIC Somaliland Corporation (OSC), the subsidiary of CPC Corp, the Taiwan State-owned oil supplier, signed a farm-out agreement with the United Kingdom-based oil company Genel Energy relating to the SL10B13 block in Somaliland. This marked a momentous day for the nation of Somaliland, who have finally gained some traction into their dealing of the “Production Sharing Contract” signed with Genel Energy sometime back in August 2012. Genel previously held a 100% working interest (Genel alone will cover the expenses and costs to develop or operate the wells), but OSC will now receive a 49% working interest in the block for a cash consideration of 49% of all Genel’s historic back costs, plus a cash premium widely speculated to be the necessary due diligence Genel took when they have been awarded the exploration license. It is important to note that the working interest rests solely on the costs to cover the expenses to develop and operate the Drilling of wells and not to be confused with the production sharing contract that is already established between Somaliland and Genel.
At the outset, a Production Sharing Contract (PSC), also sometimes known as the Production Sharing Agreement (PSA) is one of the latest and most commonly used types of a contract signed between a government, the host nation and a resource extraction company (or group of companies). It is regarding the percentage of the production of the resource (usually Oil) extracted from the country that each will receive after the cost of exploration, development and operation is recouped by the extracting company. Farmout deal is a subset agreement between the Oil extracting company that holds the PSC/PSA agreement and another newer investor, most likely another Oil and Gas company that wants to join the PSC holder by investment against percentage share of what the former PSC/PSA was entitled.
Farmout is usually done, so the PSC holder gets more finances available to them by allowing other parties to share the cost against the percentage share of the PSC holder; in this case, CPC acquires 49% of Genel share. The host government here Somaliland share is not impacted at all, and in fact, it is a positive as more funds are available for work programs of the PSC like Seismic, Drilling of wells and development. For Somaliland, the deal means re-assurance that this PSC’s work program will finally be executed and Drilling of oil wells is indeed possible now.
It is proven that Somaliland has significant underexplored potential. The block SL10B13 is highly prospective with over 5 billion barrels of untapped resources of Crude Oil from the 2D seismic data completed in January 2018 Genel. The two field partners (OSC and Genel) will now work together to plan exploration drilling in this block and start the Drilling of the block at the earliest by 2023. Now that we know the fruition of the prospect is coming along very well, it is up to the nation and the people of Somaliland to decide how best to manage such resource wealth. With proper planning and coordination within the different ministries of Somaliland, particularly the Ministry of Finance, we will ensure we do not squander revenues from such finite resources.
As Extractive Resources Economists, we found that the optimal solution for Somaliland would be to follow and engage in the Natural Resource Charter carefully. The Natural Resource Charter is a global initiative to assist governments and societies of countries rich in non-renewable natural resources to effectively govern these finite resources to foster economic growth, advocate the welfare of the population now and in the future, and maintain the environmental sustainability. Such guidance can ensure rich- Somaliland to best benefit from this new potential resource wealth can follow such guidance to ensure they are not alone in facing the challenges with effectively managing the wealth generated by crude Oil, but instead draw on the accumulated experiences to learn from history and avoid making the mistakes of the past.
The Natural Resource Charter & How Can It Be Applied to Somaliland
The Charter consists of 12 precepts divided into three groups due to the nature of transforming extractive resources into sustained prosperity involves the government decision-making and the implementation of good policy decisions with oversight from the citizens of the nation and the international community. If squandered/mismanaged, it can impose severe threats to a country, and as such, it is the responsibility of the government to manage for the current and future generations.
The Precepts are presented in a linear fashion, beginning with exploration and discovery, then getting a good deal for the country: followed by managing revenues and ending with proper investment of revenues for the long term. All the following precepts will be directly related to Somaliland’s status in its extractive sector.
Group 1: Domestic Foundations for Resource Governance
Precept 1
Resource management should secure the most significant benefit for citizens through an inclusive and comprehensive national strategy, a clear legal framework, and competent institutions.
In this precept, we focus on the need for a national strategy the government of Somaliland must make while considering the long-term vision as such oil extractive projects can take many years. The strategy must be translated into a clear and coherent institutional framework. Competent institutions of this country, such as the ministries of energy and minerals, finance, planning, and beyond must have a unified common objective. The role of each ministry must be well defined to avoid conflict of interest and gaps in responsibilities.
Precept 2
Resource governance requires the government to be transparent and accountable
Corruption is rampant in many countries, particularly in Africa. Somaliland must avoid falling into this category and learn from the mistakes of countries such as Nigeria who are perceived as one of the world’s most corrupt countries due to the large opaque operations in the oil industry. An indispensable prerequisite for accountability is transparency. Disclosing information allows for national accounting and monitoring of the oil sector, revenue management and expenditure, and rules across the whole decision chain. Now many countries have freedom of information laws mandating all governments’ public information unless disclosure is prohibited by law. Somaliland could join/apply to be a member of the EITI (Extractive Industries Transparency Initiative) who set the global standard for the good governance of oil, gas, and mineral resources
Group 2: The Chain of Economic Decisions Required to Manage Resources for Prosperity
Precept 3
The government should encourage efficient exploration and production operations
Genel has already fulfilled the exploration case, who have done their due diligence on exploring the land for potential hydrocarbons. The challenge now remains for the government of Somaliland to ensure production operations between Genel and OSC (OPIC Somaliland Corporation) are carried out efficiently within a comprehensive national strategy and to establish a legal and regulatory framework.
Precept 4
Tax regimes and contractual terms should enable the government to realise the total value of its resources consistent with attracting necessary investment and should be rigid to changing circumstances
The development of the Somaliland Oil Industry may provide employment and other returns. Still, its principal benefit is to generate government revenue to support the country’s development and support the well-being of its people. It will require a well-designed fiscal system to develop the necessary income for the government to act as a catalyst for a better chance. We understand the earliest PSC/PSA agreements of Somaliland lack a clause for the Capital Gain Tax, and Somaliland may therefore not benefit from the hundreds of millions on this deal. To overcome recurrence, we think the country’s tax regime that is a subset of the constitution could be added a capital gain taxes to rectify such early days oversights. This could allow the government to receive a portion of this legally. Some PSC contracts might use ring-fencing (contractors avoiding cost recovery/tax deductions on failed blocks from income in other blocks). Also, the need to prevent tax incentives is crucial. Ensure the government has competent tax administration and implement tax avoidance rules.
Precept 5
The government should pursue local benefits and account for, mitigate, and offset resource extraction projects’ environmental and social costs.
The Drilling of Oil can incur high environmental and social costs. Organisms (plants and animals) and local people will be disturbed as a result of the drilling process. However, these same projects can have the potential to generate benefits for the local communities through employment. Resource Management will be required to minimise the damage of the affected areas while enhancing the benefits.
Precept 6
The need for a National Oil Company
The formation of a National Oil Company (NOC) here in Somaliland can be a crucial component to harness the development potential of its extractive resources. They can support the growth of the domestic industry, which in Somaliland’s case is heavily underutilised and underdeveloped. However, suppose the roles of the NOC are assigned inappropriately or due to nepotism. In that case, it can pose a considerable risk to the country, and it can destroy rather than create value for its citizens, a phenomenon of which there are many examples. Proper and qualified personnel must be selected based on merit and skills.
Precept 7
The government should invest revenues to achieve optimal and equitable outcomes for current and future generations
The Somaliland government must now decide how to allocate the potential gains from oil extraction. Choices could be the following but are not limited to:
- National Budget (which was already implemented in the Somaliland Petroleum Act 2019)
- Use them to pay off debts from an imbalance of trade that might drive the Somaliland Currency up
- Use them to contribute to the Natural Resource Funds for future generations (which was already implemented in the Somaliland Petroleum Act 2019)
- Retain/Allocate revenues to the National Oil Company ( There is currently no National Oil Company in Somaliland)
Precept 8
The government should smooth domestic spending of revenues to prepare for revenue volatility
Revenue Volatility is often a cause of concern for countries that rely exclusively on their extractive industries. Since future revenues are uncertain (due to the volatility in oil prices), governments risk over-spending on poorly planned projects and sharp spending reductions when production or prices fall. The most logical solution is to reduce the revenue dependence on resource extraction. Recent trends of resource-rich countries such as Emirates and Qatar have diversified into other sectors such a Media, Telecom, Tourism, etc. In Somaliland’s case, other sectors are not developed and thus lacking. A wise sage would be to quickly accumulate the revenues and properly devise a strategy to support other sectors of the nation, whether tourism, good manufacturing, fishing, etc.
Alternatively, the government may be able to insure against downturns in revenues in the form of financial hedging contracts to protect themselves against commodity price uncertainty.
Precept 9
The government should use revenues as an opportunity to increase the efficiency of public spending at the national and sub-national levels.
Resource Revenues are not everlasting, and as a result, they provide both a dilemma and an opportunity for governments to increase their capacity to absorb further investments and public spending. Without proper and sound management, the inflows of revenues can harm rather than help a country. The ever-looming disaster synonymously known as “The Resource Curse” in the extractive industry can threaten the livelihood of a nation. Thus, improving public spending and introducing robust rules for new spending projects is imperative.
Precept 10
The government should facilitate private sector investments to diversify the economy and to engage in the extractive industry
Similar to Precept 8, using the resource revenues to grow the domestic economy remains imperative. It is to be duly noted that a large capital inflow without government intervention might lead to an increase in the Somaliland domestic currency – a phenomenon widely known as “Dutch Disease”.
First, a conducive environment for private investment must be set up. The government should encourage business growth without targeting any specific industry. Two sectors are worth mentioning- construction and finance in the former, buildings and other structures such roads, hospitals, etc. All these infrastructures are severely lacking in Somaliland, and probably a chunky bit of the revenue should go there.
A sound financial sector is also vital. As domestic firms grow, they look to grow and increase their investment. They will eventually encounter two immediate constraints. First, the domestic firms in Somaliland will not be able to acquire the necessary upfront capital for investment due to a weak financial sector. Second, planned output for the coming year will exceed the sales of the previous year; as a result, and firms will require more significant working capital financing. For both these reasons, demands for funds from the Somaliland financial sector.
Group 3: International Foundations for Resource Governance
Precept 11
Companies should commit to the highest environmental, social, and human rights standards and sustainable development
The only two companies operating here, Genel (ever-present since 2012) and OSC (recent), should take steps that go beyond minimum legal requirements to respect the environment of Somaliland, social and human rights standards, avoid corruption and contribute to sustainable development outcomes. Any wrongdoings from the companies will result in heavy fines and penalties as stipulated in the Somaliland Petroleum Act 2019.
Precept 12
Governments and international organisations should foster a high standard to support sustainable development
Like Precept 11, despite the best efforts of a resource-rich country, it may still not be enough if the international community does assist the development of nations’ resources. Organisations such as the World Bank and IMF (International Monetary Fund) can aid financially or through governments’ experience. There are many such organisations Somaliland could contact to promote and ensure extractive industry projects comply with human rights, environmental standards, train the local workforce, and reduce corruption.
Conclusion
All in all, the process of extracting, refining, and then using the by-products of Oil for internal use or export will require a sheer number of people. The industry built around oil drilling and the Oil itself creates exponential jobs in many sectors, including shipping and transportation. In Somaliland’s case, it has the strategic advantage of having the port in Berbera that will offer a pathway to international markets for exports needed to boost the overall GDP of the nation that is suffering an imbalance of trade due to their imports exceeding its exports. The oil drilling that is expected to commence in Somaliland by 2023 is expected to boost economic growth by reducing the import of foreign Oil. Necessary due diligence has to begin on how to best manage these finite yet potentially rewarding resources. The government should not sit down idly and instead start implementing comprehensive strategies that will best manage it. This is a lifetime chance to propel us to further heights before the impending climate change rhetoric takes place and destroys all the progress we made up to this point. All precepts must be adhered to achieve sustainable growth from our extractive industry.
Jointly co-authored by Mohd Feysal Hawar and Mohamoud Feysal Hawar, both Oil and Gas Management Graduates, specialising in Oil and Gas Fiscal Regimes, Oil and Gas Economists, Trainers & Consultants on all the Extractive Fiscal Regimes.
