The analysis “A Snapshot of South Sudan’s Oil Sector,” has
been published by the Oil and Gas Council, the leading network of energy
executives in the world. This analysis is related to Africa Assembly 2018,
which is the largest African O&G finance and investment event. The Oil and
Gas Council will organize Africa Assembly 2018 on June 5-6 in Paris, France.
June 1,
2018
London,
United Kingdom
INTRODUCTION
According
to BP Statistical Review 2017, at the end of 2016 South Sudan had 3.5 billion
barrels of proven crude oil reserves, i.e., 0.2% of the world’s proven crude
oil reserves. However, South Sudan, which got its independence from Sudan in
July 2011, because of several problems, such as the lack of independent export
routes, border disputes with Sudan, and since December 2013 an ongoing civil
war, has not been able until now to consistently develop its oil industry; on
the contrary, its oil production is currently declining. As a matter of fact,
in July 2011, South Sudan was producing about 325,000 b/d, while production is now
about 135,000 b/d. In addition to the three above-mentioned main problems, part
of the reason for the oil-production decline is also linked to the mature
status of the oilfields in South Sudan’s Unity State and Upper Nile State.
All
the countries that rely consistently on natural resources always face difficult
challenges, and they must constantly find a balance between, on the one side, their
need to attract investment to explore and develop natural resources, and, on
the other side, their need to ensure that the government receives a fair share
of the countries’ resource wealth. To continue to develop its oil sector, South
Sudan must bring in both technical expertise and
financial resources, but, as a result of the above-mentioned problems, it’s not
easy to find additional investors. South Sudan’s petroleum fiscal framework is
based on production sharing contracts (P.S.C.s), and the country is currently
developing a model P.S.C. Moreover, South Sudan must pass additional
legislation concerning its hydrocarbons sector.
THE HISTORICAL CONTEXT AND THE
PRESENT PROBLEMS
That
the economic development of South Sudan would not be simple was clear well
ahead of the July 2011 independence from Sudan. History tells us that before
the independence from the United Kingdom in 1956 of what is today’s Sudan and
South Sudan, unrest was already emerging to the surface in southern Sudan.
After the 1956 independence, southern rebel groups started to fight against the
central government in Khartoum for the independence of southern Sudan. Two
civil wars ensued: The First Sudanese Civil War from 1955 to 1972
and the Second Sudanese Civil War
from 1983 to 2005. The second civil war ended with the Comprehensive Peace
Agreement (C.P.A.) between the government and the southern forces. The C.P.A.
established a timeframe for organizing a referendum for the independence of
southern Sudan. The referendum was held in January 2011, and then South Sudan
became independent in July 2011.
Despite the independence, problems for South Sudan
did not stop. In particular, for South Sudan the three main problems are the lack
of independent export routes, border disputes with Sudan, and since December
2013 an ongoing civil war. First, South Sudan,
which is a landlocked country, is obliged to export its crude oil via pipeline
through Sudan, which requires the payment of high transit fees—oil goes to Sudan’s
refineries and to Port Sudan on the Red Sea from where crude oil is shipped
almost exclusively to China. Some years ago, it was proposed the idea of
constructing a pipeline to Kenya or Djibouti (the latter option via Ethiopia).
However, because of South Sudan’s present declining crude oil production, it’s
difficult to build this second pipeline if there is not a guaranteed amount of
crude oil to ship through the pipeline.
In this regard, a few months after the
independence, South Sudan declared in January 2012 that it would shut down its
production because of disagreement with Sudan about oil transit fees—Sudan had
started to confiscate the oil passing through its territory. Later, the South
Sudan’s army together with Sudanese opposition forces occupied the Heglig
oilfield for about a week before Sudan took it back. This oilfield is administratively
located in Sudan, but it straddles the border between Sudan and South Sudan. Because
the occupying forces had destroyed part of the oilfield infrastructure, Sudan’s
oil production was temporarily reduced by 50%. Only in November 2012, was it
possible to find a solution defining oil transit fees and a compensation
measure for the lost production. Oil production restarted only in April 2013.
However, the problem of the transit/debt repayment
fee is a big problem for South Sudan. According to the agreement in 2012, South
Sudan was obliged to pay for 3.5 years to Sudan for each barrel of oil shipped
through the Sudanese territory $15 as debt repayment and $9.1 as transit fee for
the oil produced in Upper Nile State (Block 3 and Block 7) and $11 for the oil
produced in Unity State (Block 2 and Block 5A). With such a high amount of fees
paid to Sudan, for South Sudan low oil prices might really eat away at all the
profitability relating to its oil production activity. On top of this, it’s
important to underline that South Sudan’s two main crude oil blends, the Dar
blend (25.0 A.P.I. degrees and sulfur content of 0.11%) and the Nile blend (33.9
A.P.I. degrees and sulfur content of 0.06%) trade at a discount to Brent. While
the Nile blend trades at a small discount, the Dar blend is strongly discounted
because it trades at $7 to $10 less than the Brent’s price.
After a year of negotiations (South Sudan wanted to
change the terms of the agreement), at the end of 2016, Sudan and South Sudan
extended the fee agreement for three other years. The agreement between the two
parties has not been released publicly, but according to some ministerial sources,
it appears that if oil prices are below $30 per barrel, South Sudan will pay
only the regular transit fees (a $9.1 transit fee for the oil produced in Upper
Nile State and a $11 transit fee for the oil produced in Unity State). But if
prices reach $61 or more, South Sudan must pay, in addition to the standard
transit fee, also the full $15 debt repayment fee. Instead, between the two
thresholds, South Sudan must pay a reduced debt repayment fee according to a
sliding scale.
Second, the border between Sudan and South Sudan at
certain locations, such as around the Abyei area and the Heglig oilfield, is
disputed. The reason is that in those areas oil fields straddle the border
between Sudan and South Sudan. The Abyei Area is an area of 4,072 square miles.
The 2004 Protocol on the Resolution of the Abyei Conflict accorded
"special administrative status" to the area. According to the
protocol, this area was declared, on an interim basis, to be at the same time
part of both Sudan and South Sudan. Instead, Heglig is a small town on the
border between Sudan’s South Kordofan State and South Sudan’s Unity State. Both
countries claim the Heglig area, but it’s presently administered by Sudan.
Third, the ongoing civil war, which started in
December 2013, between forces of the government (Sudan People's Liberation
Movement) and opposition forces (Sudan People's Liberation Movement in
Opposition). Several ceasefires have been reached since January 2014, but
nothing has resulted in a definitive and permanent agreement. In specific, the Compromise
Peace Agreement (C.P.A.), signed in August 2015, seemed to be the right one, but
then in July 2016 fighting started again. Currently, rebel in-fighting is a major
part of the fighting. According to the United Nations, in 2017 out of a
population of 12 million, there were 1.5 million people who had fled to
neighboring countries (primarily to Kenya, Sudan, and Uganda) and more than 2.1
million of people who were internally displaced. In addition, fighting occurs
in agricultural lands as well, and, as a result, this year, also during harvest
time in January, more than 5.0 million people did not have sufficient food to
eat. So, it’s almost sure that in the summer of 2018 half of the country’s
population will be on the brink of famine.
Recently, the United States and the international
community have increased theirs sanctions on South Sudan as a response to the
present chaotic destabilization in the African country. In February 2018, the United
States announced that it was implementing restrictions on the export of defense
articles and defense services into South Sudan. And then, in March 2018, the
United States imposed sanctions on 15 South Sudanese oil operators because
according to the United States money from these oil companies was used for
purchasing weapons and funding irregular militias, which undermine the peace,
security, and the stability of the country.
OIL
IMPORTANCE FOR SOUTH SUDAN’S ECONOMY
For
many developing countries that export raw commodities, commodities play a
substantial role in their economy, and South Sudan does not escape this
condition, and it is one of the most oil-dependent countries in the world. In
fact, South Sudan has an economy practically exclusively relying on the export
of crude oil. Harvard University’s Atlas of Economic Complexity shows that in
2016, 98.71% of South Sudan’s exports (for an amount of $1.39 billion) was categorized
as “petroleum oils, crude.” The remaining, but almost negligible, export
included other oil seeds and oleaginous fruits, dried leguminous vegetables, flour
and meals of oil seeds or oleaginous fruits, and
peanuts; vessels and other floating structures for breaking up (scrapping);
ferrous waste and scrap, and re-melting scrap ingots of iron or steel;
commodities not specified according to kind; and cotton, not carded or combed.
And, in the previous years after the independence, the percentage of crude oil
exports was more than 99%.
At the same time, oil accounts for 98% of the
government’s annual operating budget and 60% of the G.D.P. These
numbers tell that, apart from the petroleum sector, South Sudan’s economy is a
subsistence economy based on agriculture and humanitarian assistance. In
practice, for an economy so strongly dependent upon the export of a single raw
commodity, a reduction in production and/or a decline in the price of the
exported commodity has always a devastating impact. And, this is what happened
between 2014 and 2017, when in South Sudan oil production declined, and oil
prices were low on the international markets.
THE OIL COMPANIES IN SOUTH SUDAN
Most
of South Sudan’s proven oil reserves are in the Mugland Basin and in the Melut
Basin, which straddle the border between Sudan and South Sudan. However, as in many
other African countries, hydrocarbons exploration has been quite limited, and a
large part of South Sudan’s territory is still unexplored for oil and gas—additional
exploration is required, but it needs high expertise and important financial
resources because of the difficult geographic conditions of part of the
territory (for instance, the Sudd). As of today, the associated natural gas is
primarily flared or reinjected—the country has 3 trillion cubic feet of proven
natural gas reserves.
In
South Sudan there are currently three main oil consortia:
1 — Greater Pioneer Operating Company (G.P.O.C.),
which comprises China’s C.N.P.C (40%), Malaysia’s Petronas (30%), India’s
O.N.G.C. (25%), and South Sudan’s Nilepet (5%).
2
— Dar Petroleum Operating Company (D.P.O.C.), which
comprises C.N.P.C. (41%), Petronas (40%), Nilepet (8%), China’s Sinopec (6%),
and Egypt’s Tri-Ocean Energy (5%)
3
— Sudd Petroleum Operating Company (S.P.O.C.),
which comprises Petronas (67.9%), O.N.G.C. (24.1%), and Nilepet (8%)
A
simple look at the companies involved shows that most of the investors in South
Sudan’s oil sector are primarily Asian oil companies. This is due to the
difficulties in the 1980s and 1990s between Sudan’s government (when South
Sudan was still part of Sudan) and the United States. These difficulties forced
Western oil companies (for instance, U.S. Chevron, Canada’s Talisman, and
Austria’s O.M.V.) out of Sudan, so the Asian companies filled the vacuum left
by the Western companies.
G.P.O.C. is the operator at Block 1 (Unity field,
Toma field, and Munga field), Block 2 (Heglig field and Bamboo field), and
Block 4 (Diffra field and Neem field). D.P.O.C. is the operator at Block 3 and
Block 7 (Palogue field and Adar-Yale field). S.P.O.C. is the operator at Block
5 (Mala field and Thar Jath field). G.P.O.C. produces exclusively the Nile
blend, while D.P.O.C. and S.P.O.C. produce the Dar blend.
In any case, these Asian companies are not presently
investing in South Sudan as much as they should. Without consistent investments
in both enhanced oil recovery (E.O.R.) and in new exploratory activity, South
Sudan’s production could become less than 100,000 b/d in just a few years. According
to the World Bank, on current reserve estimates, oil production is expected to
reduce progressively in the coming years and to become insignificant by 2035.
Good news is that in March 2018, Petronas extended its contract to explore and
produce oil and gas in Block 3 and Block 7 as part of the D.P.O.C. consortium. At
the same time, Petronas committed to invest in the resumption of production at
the conflict-hit Unity field (Block 1A), which, together with other oil fields,
had been shut down in 2013 because of fighting activities in the area.
It’s important to underline that the D.P.O.C.
consortium is the only one of the three main operating consortia in South Sudan
that continued with its oil production at its fields while fighting made the
other two production areas, the S.P.O.C. and G.P.O.C., inaccessible to the
operators. Some months ago, the government of South Sudan conducted security
surveys in relation to the S.P.O.C. and G.P.O.C., areas, and then it declared
that they are once again safe for oil operations. The improved conditions on
the two areas was verified by a security risk assessment conducted by a private
sector contractor.
SOUTH SUDAN’S PETROLEUM FISCAL
REGIME
In
South Sudan, the Ministry of Petroleum and Mining is the institution managing
the petroleum sector. Instead, the National Petroleum and Gas Commission (N.P.G.C.)
is the main policymaking and supervisory body. Among its main tasks there is to
approve the petroleum agreements on behalf of the government. The Nile
Petroleum Corporation (Nilepet) is South Sudan’s national oil company. Until
today, Nilepet has had a limited role in the on-the-ground oil operations
because of its limited technical expertise and limited financial resources.
Nilepet has very small stakes in the operating consortia.
There
are three main legal documents that define the structure of South Sudan’s
petroleum fiscal framework: South Sudan’s Transitional Constitution, the 2012 Petroleum
Act, and the 2013 Petroleum Revenue Management Act. In 2012, South Sudan passed
the 2012 Petroleum Act, which defines in a general manner South Sudan’s
petroleum fiscal regime. Additional legislation must be enacted—a model production
sharing contract (P.S.C.) is under development. South Sudan’s petroleum fiscal
system is based on P.S.C.s. Many oil blocks were already allocated by the Sudan
Government before South Sudan became independent in July 2011.
Below
there is a list of the main, but still very generic, features of the 2012 Petroleum
Act:
—Art. 7 (Principles and Objectives) 1
affirms that petroleum existing in its natural state in the subsoil of the
territory of South Sudan shall be owned by the people of South Sudan and
managed on their behalf by the government.
—Art. 17 (Reconnaissance Licenses) 2 affirms
that a reconnaissance license grants a non-exclusive right to undertake data
collection (including seismic surveying), processing, interpretation and
evaluation of petroleum data in the area stipulated in the license.
—Art. 17 (Reconnaissance Licenses) 3 affirms
that if deemed necessary to establish a commercial basis for an exploration
survey in a block or portion of a block, the Ministry of Petroleum and Mining shall
announce an open, transparent, non-discriminatory and competitive public tender
for an exclusive reconnaissance license in an area not already covered by a
reconnaissance license.
—Art. 18 (Tendering Procedure and
Qualification Requirements) 1, affirms that exploration, development, and
production of petroleum shall be carried out in accordance with the terms of
petroleum agreements, the 2012 Petroleum Act, and any other applicable
law.
—Art. 18 (Tendering Procedure and
Qualification Requirements) 2 affirms that petroleum agreements shall be
entered after an open, transparent, non-discriminatory and competitive tender
process conducted in accordance with applicable law governing public
procurement.
—Art. 20 (Incorporation and Organization
Requirements) 1 affirms that an entity entering into a petroleum agreement
shall be incorporated and registered as a company in South Sudan in accordance
with the applicable law. This company shall be incorporated as a single-purpose
company exclusively for petroleum activities in South Sudan.
—Art. 25 (Term) 1 affirms that a
petroleum agreement may be entered into for a period not exceeding 25 years.
—Art. 26 (Exploration Period) 1 affirms that
petroleum agreements shall provide for an exploration period not exceeding six
years from the effective date of the agreement.
—Art. 26 (Exploration Period) 2 affirms
that the exploration period shall consist of a first commitment period and up
to two optional commitment periods as determined in the petroleum agreement.
—Art. 33 (Restrictions on Flaring and
Venting) 1,2, and 3 affirm that gas flaring or venting is prohibited,
unless specifically authorized or in the event of an emergency. Investors are
therefore obliged to invest in necessary facilities in order to utilize any gas
they produce.
—Art.
68 (Fees) 1 affirms that a contractor shall pay surface rental fee for the
contract area retained under a petroleum agreement as prescribed in the
regulations.
—Art. 69 (Royalties and Bonuses) affirms
that a contractor shall pay such bonuses or royalties as may be prescribed in
regulations or as agreed in a petroleum agreement.
—Art. 70 (Taxes and Customs) affirms
that a person conducting petroleum activities in South Sudan shall pay taxes
and customs duties in accordance with the applicable law.
—Art. 71 (Production Sharing in Petroleum
Agreements) affirms that production sharing shall be as agreed in a
petroleum agreement. The Ministry of Petroleum and Mining shall develop a model
petroleum agreement in cooperation with the Ministry of Finance and Economic
Planning.
Presently,
there are no ring-fencing rules in South Sudan. The corporate income tax (C.I.T.)
is variable according to the magnitude of the investor’s business. If the
business has a turnover of up to 1 million South Sudanese pounds, of up to 75
million South Sudanese pounds, or of 75 million South Sudanese pounds or more,
the C.I.T. tax rate will be 10%, 20%, and 25%, respectively. These rates apply
to income deriving from oil and gas operations. Taxable income consists of
worldwide income for resident companies minus the allowed deductions. For
companies that are not resident in South Sudan, taxable income consists of only
the profits sourced in South Sudan minus the allowed deductions.
The incurred exploration costs
are deductible over the useful life of the asset. The deduction is based on the
actual costs incurred, the units extracted, and the estimated total extractable
units. The incurred losses can be carried forward for five years, but carryback
is not available. A loss from oil and gas operations can be offset against any
profits available during the successive five-year period.
The Investment Promotion Act
provides for various tax incentives, including capital allowances ranging from
20% to 100% of eligible expenditure, deductible annual allowances ranging from
20% to 40% and depreciation allowances ranging from 8% to 10%. A foreign tax
credit is granted to any resident company paying foreign taxes on income from
business activities outside South Sudan.