During the past few years, there has been an exploration boom of hydrocarbon resources in the Eastern part of the black continent of Africa which is considered as the new frontier region of oil and gas in the world. Some countries discovered huge reserves of gas such as Tanzania, while others have found oil such as Kenya and Ethiopia.

Somalia is the latest country in the region to take significant steps towards exploring petroleum resources in its offshore areas. Though efforts of the government of Somalia to revive its hydrocarbon sector had started in 2008, the predecessor of the incumbent federal government led by former president Hassan Sheik Mohamud accelerated the process by awarding seismic survey agreements and a production sharing agreement through direct negotiations to Spectrum Geo, now acquired by TGS,  and Soma Oil and Gas respectively.

On 7th of February 2019, an event organized jointly by the government of Somalia and Spectrum Geo is held in London. Major oil companies were invited, and the aim of the event was to market petroleum resources in the offshores of Somalia. The geological data collected from Somalia’s offshore areas, fiscal terms to engage with oil companies for the development of petroleum resources and the procedure for awarding oil contracts were presented during the event.

The aim of this article is to review the fiscal terms developed by the government of Somalia to engage with oil companies interested in the oil and gas sector of Somalia. The article first provides a quick overview of the fiscal instruments, and then examines their strengthens and weaknesses as a package, and proceeds to challenges that Somalia could face in implementing its fiscal regime.

a)     Signing bonus:

The government of Somalia starts to receive initial revenues through signing bonus payable by the companies. The amount of the signing bonus, which is one-time payment, is two million dollars payable upon signing the contract. Other fiscal terms will come into effect when oil and gas are discovered by the contractor and declared their commerciality. This enables the government of Somalia to receive revenues at an early stage of developing petroleum resources from every block that is awarded to a contractor.

b)     Production Royalty:

Production Royalty is the second fiscal element that comes into effect. The rate of production royalty is determined by the level of production and the price of the barrel of oil in international markets jointly. The amount of the royalty which Somalia could receive ranges between 5% to 15% depending on the production level and the price of the oil. However, the major concern arises from some of the tranches on production volumes, particularly oil, that royalty rate is based. They appear to be large for a country which starts now to explore its petroleum resources in its offshores. It seems that there is an assumption that the oil fields will be large enough to accommodate some of those big tranches. Nevertheless, it can backfire and could prove to have no value in the event of marginal and average fields, and consequently effect adversely the revenues which the government expects or predicts to generate from its petroleum resources through royalty.

c)     Cost Recovery and profit oil:

Extracting minerals beneath the surface or seabed is not an easy task. It requires huge financial investment and technical expertise, and that is why governments often look for foreign investment. The bulk of investment is incurred at an early stage of the project particularly during exploration and development stages.  However, the investor recoups the costs incurred when revenues start to flow in the event that discovery is successful. Oil companies receive specific percentage of the oil produced to recover costs incurred in exploring, developing and producing petroleum resources. In the case of Somalia, the limit of the cost recovery is 70% of the produced oil less royalty.  This means that oil companies can recover their costs as early as possible, depending on size of the oil field, which is attractive.

The remaining oil, after royalty and cost oil, is called profit oil. Somalia offers to the oil companies a percentage of profit sharing that moves from 70% to 90%. This means that the share of Somalia from the profit oil moves from 10% to 30%. From the perspective of investors, this is a very generous offer to oil companies, however, it may not be helpful to the government of Somalia in terms of revenue maximization where it can reduce the total government take below the global average which is at least 65% as per the advice of International Monetary Fund.

d)     Corporate Income Tax

In addition to previous fiscal instruments, governments use different tax instruments to maximize their revenues from their resources. One of the key tax instruments used by governments is income corporate tax which targets investor’s profits. The production sharing contract model developed by the government of Somalia imposes an income corporate tax with the rate of 30%. In addition to income corporate tax, there is an employee taxation on foreign and local employees with different rates of 10% and 5% respectively.

The fiscal regime of Somalia is highly attractive, and if it proves successful in its implementation, it could lead more exploration in Somalia. However, there are challenges which Somalia could encounter during the implementation of the fiscal regime that may hinder its ability to capture a fair share of revenues. These challenges are the low rates of taxes and the absence of institutional capacity to administer the fiscal regime effectively.

First, the government of Somalia may end up a small share of the revenues considering the low rates of taxes which the fiscal regime allocates to it.  It is understandable that a frontier country like Somalia needs to offer something attractive to oil companies to encourage exploration investment. However, it should not concede too much to oil companies in return of investing in its petroleum sector. It is not a good policy decision to extract a depletable resources just to end up a small share of the revenues which you need it desperately.

Second, the administration of the fiscal regime is another challenge to Somalia. Resource-rich countries face formidable challenges in revenue collection from oil companies which often use financial malpractices to maximize their profits and minimize revenues that should accrue to governments. Many countries, particularly in Africa, have lost millions of dollars as tax revenues for their inability to prevent such malpractices.

Somalia is not a safe haven from these abuses, and it is extremely vulnerable to suffer from them. The reason for that is the absence of adequate legal framework and institutional capacity that can prevent such abuses. The capacity of revenue collection authorities of Somalia is impaired, and the government faces daunting challenges to collect taxes due to the local companies in Mogadishu. It is not clear how such authorities which are struggling with local companies will be able to collect revenues from international oil companies that are more complex, well financed, and resourced, and at the same time have the incentives to use all that for their own benefit.

In conclusion, the Federal Government of Somalia is putting considerable effort to attract private investment, and strongly promotes the petroleum sector in international platforms through the Ministry of Petroleum and Mineral Resources. This can be deduced from the conduct of the government and related policy documents such as the production sharing contract model which all indicate that attracting private investment into the petroleum sector is the standing policy of the current government. However, it is recommendable to the government of Somalia to put in place an effective resource taxation framework and strengthen its institutional capacity before engaging with international oil companies in order to realise the full value of its resources. If there is an immediate policy that calls for the development of petroleum resources; adequate preparations for proper management of these resources should also be there.

By Mohamed Ganboon

The author is a lawyer with particular specialty of petroleum law and policy.

Tweets @MohamedGanboon

Courtesy: Hiraan