Sunday, October 12, 2014

Mongolia's new Petroleum Law now in effect – key points of its investor-friendly incentives

In the latest effort by the Government of Mongolia (GoM) to increase foreign investment and accelerate economic activity, the  Great Khural, or Parliament, has adopted the Law of Mongolia on Petroleum.
The law is already in effect.
The new Petroleum Law is the first overall revision in this area since 1991.  Although the ultimate success of the Petroleum Law will depend on the terms of the licenses and production sharing contracts (PSC) that are approved by the GoM, its enactment is providing additional assurance to investors that Mongolia is eager to maintain and improve its position in the global economy.
THE LAW’S REACH
The Petroleum Law regulates all aspects of petroleum prospecting, exploration and exploitation within the territory of Mongolia.  Natural bitumen, oil shale, tar sand, gas-rich shale, gas sand and coal bed methane are all covered, in addition to conventional crude oil and natural gas.
Although the state will have ownership over petroleum, it will exercise this ownership by issuing licenses and by entering into a PSC with contractors.
KEY PROVISIONS
The Petroleum Law:
  • Authorizes exploration and exploitation licenses and PSCs
  • Covers conventional and unconventional crude oil and natural gas, including shale oil
  • Allows exploration for up to 8 years and exploitation for up to 25 years, plus extensions
  • Royalties vary from 5 percent to 15 percent, depending on the negotiated terms of the PSC and the type of hydrocarbon
  • Requires open bidding if applicants for exploration or exploitation licenses fail to reach agreement with the GoM on production sharing
  • Allows recovery of exploration and exploitation costs
  • Through corresponding amendments to various tax laws, license holders will enjoy an exemption from customs duties and value-added taxes
FINANCIAL OBLIGATIONS AND INCENTIVES
Development and operating costs
  • The contractor must pay all costs of prospecting and exploring for petroleum and of extracting it, including submitting an annual budget and proposed plan to the Petroleum Authority of Mongolia for approval and then performing in accordance with the approved plan
Employee salaries
  • Contractors must have equal salary scales and bonuses for domestic and foreign employees performing the same functions
Escrow account
  • Contractors must make a cash deposit equal to 3 percent of the exploration work for a year, or 1 percent of its profit-bearing oil during an exploitation phase for a year, respectively, into an escrow account annually
Environmental rehabilitation
  • Contractors must pay all expenses of environmental rehabilitation and demobilization when a PSC ends or is terminated. The Petroleum Authority will evaluate the performance of the contractor upon expiration of a PSC, or if an exploration or exploitation license is terminated. If the performance was satisfactory, the contractor is entitled to receive all of the funds in the escrow account. 
License fees
  • The annual license fee during the term of petroleum exploration is equal to US$3 per square kilometer of the contracted field. If an exploration license term is extended, the annual license fee is equal to US$8 per square kilometer.
  • The annual license fee during the term of petroleum exploitation is equal to US$100 per square kilometer. If an exploitation license is extended, the annual license fee is equal to US$200 per square kilometer.
Royalty payments
  • The amount of royalties for petroleum and natural gas is 5 percent to 15 percent of the crude oil or natural gas extracted. For unconventional petroleum, royalties are between 5 percent and 10 percent of the amount extracted.
Cost oil and profit oil
  • Up to 40 percent of the oil extracted in each year after deducting the oil from which the royalty is paid may be used to pay cost recoverable expenses of the contractor, including exploration costs, development costs, operating costs and dismantling costs. The oil remaining after deducting the royalty oil and the cost oil is considered the “profit oil” under the Petroleum Law. The profit oil is divided between the government and the contractor, as agreed in the PSC. 
Other fees
The Petroleum Law also specifies a variety of fees, including a service fee to increase the size of an exploration or exploitation area and a fee for transferring exploration or exploitation rights.
Existing PSCs
  • An existing license holder under the 1991 law without a PSC will need to enter into a PSC with the Petroleum Authority and agree on terms for royalties, cost oil and profit oil
  • An existing license holder with a PSC under the 1991 law will not need to change it unless the PSC does not have terms for royalty payments, in which case a royalty payment of at least 5 percent must be negotiated
  • It would be prudent for existing license holders under the 1991 law, with or without a PSC, to confirm their position with the Petroleum Authority
Corresponding amendments to the tax laws and customs duties
  • The Law on Corporate Income Tax exempts a PSC holder from income taxes derived from the sale of petroleum
  • A PSC holder is exempt from paying the otherwise applicable 20 percent tax when expatriating profits to a foreign holding company
  • The Law on Custom Tariffs and the Law on VAT exempt the following  from the otherwise applicable customs tariffs and VAT: imported facilities, equipment, tools, raw materials, chemicals, explosives and spare parts, for the exploration period and the first five years of the exploitation period
  • The Law on Custom Tariffs and the Law on VAT exempt the following from any customs tariffs and VAT: facilities, equipment and special construction materials imported for the construction of crude oil, coal, or shale oil processing plants until 2018
ROLES AND AUTHORITY OF GOVERNMENT ENTITIES
Although the Great Khural and local governments will have certain responsibilities under the Petroleum Law, the primary responsibilities will be carried out by the Cabinet, the Ministry of Mining and the Petroleum Authority.
GoM/Cabinet
  • Approval of a PSC between the license holder and the Petroleum Authority
  • Approval of any pipeline proposal by a PSC holder
  • If a petroleum exploration or exploitation field overlaps with an exploration or exploitation field of another mineral, the award will be determined by assessing the social and economic significance for each field and mineral 
Ministry of Mining
  • Issue and extend exploration and exploitation licenses
  • Approve reserve estimates and resource evaluation submitted by exploration license holders
  • Issue regulations pertaining to the implementation of the Petroleum Law
Petroleum Authority
  • Enter into prospecting contracts with potential contractors
  • Negotiate a PSC with a prospecting contract holder
  • Announce open bids for a field for exploration or exploitation
Local governments
  • Issue an opinion opposing any Petroleum Authority proposal for open bidding for licenses within the local government’s jurisdiction
  • Monitor fields granted under a license to ensure they are used for the correct purpose
  • But local governments are prohibited from requiring any investments that are not set forth in the PSC; demanding or requesting endowments, donations or assistance for purposes other than humanitarian purposes; or requiring financial assistance for the purpose of financing political activities
PROSPECTING AND EXPLORATION

Licensing procedure
  • An application to prospect for petroleum must be submitted to the Petroleum Authority and a contract to prospect for petroleum can be made for a period of up to three years.
  • Following the conclusion of prospecting work, a contractor may request to enter into a PSC for exploration within 60 days from the date the Petroleum Authority issues its assessment of the contractor’s report on the results of its prospecting work.
  • The contractor must submit a PSC for exploration to the Petroleum Authority covering the percentage of profit oil allotted to the GoM; the percentage of royalties; the limit of the percentage of cost oil; the amount of exploration investment; the amount of funds spent on environmental restoration; the amount of bonus payments for instruction/training, signing the contract, beginning extraction, and certain other items. The Petroleum Authority must hold negotiations regarding the PSC within 60 days of receipt of the submitted PSC and submit the finally agreed draft to the Ministry of Mining.
  • The Ministry of Mining will review the draft PSC, and if it considers the draft contract appropriate to conclude, it will deliver its proposal to this effect to the Cabinet, and the Cabinet will have the final authority to issue a decision, which it is required to do within 60 days of receipt of the Ministry of Mining proposal.
  • If the Cabinet has approved a contractor for a PSC for exploration, the Petroleum Authority must conclude a PSC within 30 days, and the contractor must then submit an application for an exploration license to the Ministry of Mining with a copy of the PSC; an environmental impact assessment; and a draft of the project and work plan.
  • The Ministry of Mining will issue or extend the term of an exploration license, and will hold an open bidding under the conditions described below.
Exploration term

A petroleum exploration term is up to 8 years, and the Petroleum Authority may extend this period twice by up to 2 years for each extension. For unconventional petroleum, the exploration term is up to 10 years, and this may be extended once by up to 5 years.
Open bidding process for exploration
The Petroleum Authority will announce open bidding for exploration under the following conditions:
  • Prospecting was performed with government funding or the fields were specified by the Petroleum Authority
  • An entity that performed prospecting refuses to conclude a PSC
  • An entity that already received an exploration license failed to perform exploration and returned the field, or its license was terminated due to repeated violations
  • The exploration license expired and the field was returned or
  • As otherwise provided in the law.
Reserve estimates
  • If petroleum is discovered from an exploration well during exploration work, the contractor must notify the Petroleum Authority within 15 days and register the well.
  • Crude oil extracted through extraction testing may be sold or exported, and the amounts of applicable royalty and profit oil are to be regulated by the PSC.
  • A contractor must submit the reserve estimate to the Petroleum Authority 90 days before the expiry of the exploration term for review.
EXPLOITATION
Licensing procedure
  • A contractor may apply for an exploitation license within 30 days of the Ministry of Mining issuing a decision accepting the reserves. An exploitation license must have been obtained in order to start exploitation, and the issuance of the license is the start of the exploitation period. The following documents are required when applying for an exploitation license:
    • a decision of the Ministry of Mining registering the petroleum reserve
    • a draft of the work plan and budget for the respective year
    • an exploitation operations plan
    • a detailed environmental impact assessment for the exploitation period
Exploitation term
  • A petroleum exploitation term can be up to 25 years. The Petroleum Authority may extend it twice by up to 5 years for each extension. An unconventional petroleum exploitation term can be for up to 30 years, and the Petroleum Authority may extend it once by up to 5 years.
Open bidding process for exploitation
If a contractor fails to submit an application for engaging in exploitation within 90 days after the end of the exploration period, the PSC will be terminated and the field will be put out for open bidding.  In addition, open bidding will be announced for an exploitation area under the following conditions:
  • an exploration license holder refuses an exploitation license after receipt of a decision of the Ministry of Mining regarding the reserve
  • exploration has been performed and a reserve established with state funding
  • a previous exploitation license holder refused to carry out exploitation and returned the field
  • termination of an exploitation license due to illegal activities by the holder of the license, and the field has reverted back to the state
  • upon expiration of the exploitation license term and the field has reverted back to the state or
  • a judicial judgment terminated the exploitation license.
WHEN CAN A PSC BE TERMINATED?
A PSC may be terminated by a Cabinet decision on the following grounds:
  • the contractor caused serious harm to the well-being of the population, environment, livestock or wild animals
  • documents submitted by the contractor during the application or the contract negotiation process were illegal
  • false data, information, or reports on petroleum operations submitted by the contractor have caused a material harm to the nation
  • the contractor illegally transferred its rights and obligations to carry out exploration or exploitation operations to third parties or
  • the contractor failed to perform its contractual obligations.
STATES OF EMERGENCY
  • If a state of emergency is declared in Mongolia, the GoM may use the petroleum allotted to a contractor, together with buildings and facilities, equipment and machinery, and will pay “just compensation”
FUTURE MONGOLIAN REFINERY
  • In the event a petroleum refinery is installed within the territory of Mongolia, the government will have the right to preemptively purchase petroleum products for the refinery which are allocated to a contractor in accordance with a PSC
DISPUTE RESOLUTION
  • Any property or petroleum operations disputes between the Petroleum Authority and a contractor is authorized to be decided in the courts of Mongolia. 
SANCTIONS
  • A state inspector may impose administrative sanctions on a contractor for violating the Petroleum Law or related regulations.
  • If a license holder has committed the same violation repeatedly, or repeated a violation after two previous administrative penalties, or if a court imposes criminal liability on a license holder, the license may be revoked by the Petroleum Authority. In that case, an entity formed by the license holder, its executive officers or directors, or any equivalent legal entity with the same founders or shareholders, will not be granted another license for a period of five years.
*Battushig Batsuren, a 2014 graduate of Chicago-Kent College of Law, is scheduled to be sworn in as a member of the Illinois Bar in November 2014.

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