Following Parliament’s adoption of the Revised Law on Petroleum in July, a working group was set up at the Ministry of Mining and Energy to develop the procedures and regulations to help implement the new law. G.Iderkhangai talks to a Senior Specialist in the Fuel Policy Department, A.Purev, to find out more.
Your work on the Revised Law on Petroleum has been much appreciated. Do you have a background in this field?I attended the Russian State Petroleum and Gas University in Ufa City in the Russian Federation, studying mining of petroleum and the use of deposits, and graduated from there as an engineer with a Master’s degree. I completed my Ph.D. at the Petroleum and Gas University in Moscow named after I.M.Gubkin with a thesis on “Increasing the output from mining thick petroleum and bitumen through heat technology.” Since my return home, I have been working at the Ministry of Minerals and Energy and the Ministry of Mining.
When the discussion of the draft of the Revised Law on Petroleum began in 2009, I joined the Working Group and worked extensively on the draft and the compendium. The Compendium of the Law on Petroleum was changed 2-3 times. Vast research was conducted on this and in collaboration with foreign experts, international experience and practices were studied. However, much time that could be spent on developing the compendium was lost because elections and formation of a new Government intervened.
How would you define the main objective of this law in brief?
The main objective of the Revised Law on Petroleum is regulating various issues of the sector through the harmonisation of the policy of the Government in the petroleum sector until 2017 and the policy in the minerals sector.
It was also necessary to amend the Law on Petroleum passed in 1991 to adapt it to later tax laws and other legislation. Another need behind the revision was to improve the competitiveness of the traditional petroleum sector and to attract and involve investors in the non-traditional petroleum sector. This latter includes natural bitumen, shale, oil sands and methane gas in coal layers. Non-traditional petroleum exploration and mining had until now lacked a legal regulatory framework.
How is the Revised Law an improvement on the 1991 Law? The 1991 Law had 3 chapters and 15 articles, while the Revised Law has 9 and 45 respectively. The exploration licence for petroleum used to be valid for 5 years, extendable twice by 2 years each and once by 5 years, thus keeping it effectively alive for 14 years. This has been brought down to 12 years, with an initial term of 8 years, liable to two extensions of 2 years each. The basic life of an exploration licence for non-traditional petroleum is 10 years, extendable once by 5 years. Earlier, neither an exploration nor a mining licence in the non-traditional petroleum had a specified validity period, for such work takes a longer time.
What about the mining period?The basic duration for a petroleum mining licence used to be 20 years, possible to extend twice by 5 years each, making a total of 30 years. The initial validity now is 25 years, possible to extend twice by 5 years each, bringing the total to 35 years. In terms of non-traditional petroleum, the duration is 30 years to begin with, with a potential to extend for 5 years, a total of 35 years. Moreover, the 1991 Law did not have any provisions on royalty fees, which used to be regulated by terms of individual agreements, and some agreements altogether omitted them. Now we have royalty fees of between 5% and 15%.
In non-traditional petroleum, the rates are between 5% and 10%, the specific percentage to be negotiated before the agreement is signed.
Earlier, companies not located in Mongolia were exempted from paying income tax, but local companies located had to pay. Now we have totally eliminated income tax in the petroleum sector. Since we shall have product sharing agreements as also royalty, income tax as such is unnecessary and has actually been replaced by the revenue accruing to the Government through sharing of production.
We now have many new regulations… It’s true that several significant regulations are now there. For instance, all matters regarding non-traditional petroleum and the basic terms and conditions for selecting the contractor, that earlier used to be covered by bilateral agreements, now have legally binding guidelines. Investors will be able to participate in the bid based on 12 basic criteria.
Also, the previous requirement of three reviews of an agreement by the Cabinet has now become just one, making for quicker decisions. We have also specified the time required for each step, so all parties know what to expect. The obligations of Government organisations have also become clearer.
The Cabinet will approve a model product sharing agreement that is being prepared. Will this incorporate good features of the various agreements now used in the petroleum sector? This is a new concept. The basic terms of any agreement will have to tally with those set out in the model to be approved.Other matters will remain open to further negotiations.
A Working Group is now preparing the draft of this model and its work will soon be finished. We are receiving advice and suggestions from the International Monetary Fund and from other international experts in the fields of petroleum, law and economy. We are also studying some highly esteemed Product Sharing Agreements used elsewhere.
Is there a provision that requires regulation through an intergovernmental agreement? Yes, this will be needed in the event of the petroleum reserve and deposits that have been discovered cross the state border. There are oil fields and blocks that are spread across Mongolia and China. There are international norms of how to deal with and we want to formalise how the Governments of our two countries will come to an agreement.
What happens to reserves discovered in no man’s land? There are clear guidelines on what the Government should do about exploring, mining, and using petroleum and non-traditional petroleum in any area between the borders of two countries. This is an important provision.
The Border Protection Agency does not allow operations related to petroleum within 2 kms of the border. However, China has drilled holes right up to their side of the border. It is extremely important for us to find out what we have in the border areas, what the geological structure of the area is and where the reserves and the deposits are. Our country is mining our petroleum from the lower and higher Zuun Bayan and Tsagaan Tsav formations approximately from 900-2600 metres.
It is entirely feasible to drill horizontally from beyond the border and extract oil. Maybe this is what has been happening without any awareness on our part. But these are only suspicions without any evidence, and our job is to study matters thoroughly.
The law grants the privilege of entering into a product sharing agreement only to those with a non-traditional petroleum exploration agreement. Isn’t this giving a huge opportunity to investors? The special permit for exploring petroleum and non-traditional petroleum is to be granted for three years. This means a company will study and explore for three years and will have the privilege to seek a product sharing agreement if it feels there is possibility of finding petroleum there and making a profit. Since the law was passed, many investors have applied for exploration agreements because of this provision.
Apart from product sharing, international practice allows service agreements, royalty fees and such provisions governing investor-government relations. We feel product sharing offers us the highest benefits at the lowest risk. The investor bears 100% of the risk. If something is found, it will be shared with the Government; if nothing is found, there is no loss to the Government. In my understanding, it is most important that Mongolia does not bear any risk as we are going into the field without thorough research.
In the present state of affairs, product sharing agreements are the best for us. Maybe things will be different after 20-30 years, when we shall know much more about our underground wealth.
There was a provision in the draft of the revised law supporting national companies. Why was it taken out, in favour of “The contractor will give preference to taxpayers registered in Mongolia when choosing subcontractors and when purchasing goods and services required in its operations”? There indeed was a provision in the draft providing some advantages and rights to national companies. However, during reviews in the Cabinet and in Parliament, it was felt that we must not be seen to be too partial and the general opinion was to change to “taxpayers registered in Mongolia”, which would basically mean companies operating in Mongolia and meeting certain requirements.
Why did you specify that the contractor will pay equal salaries and incentives to foreign and local workers doing the same job?There are many disputes regarding salaries in companies operating in the petroleum sector. It is common for Mongolian and foreign engineers to have different salaries. Contractors are not very happy about this provision but they have no choice. But remember, this equality will apply to only those with the same level of skills. Our human resources have to be developed to match the skills of competent foreign experts.
Contractors with a product sharing agreement contribute to the state budget a certain amount of money to provide for a fund to train the human resources for this sector. Holders of bachelor’s and master’s degrees have been selected to study overseas in recent years. Inside the country, the Science and Technological University and the National University of Mongolia as well as a technical college in Dornod province are training specialists. Graduates need to undergo advanced training.
Many companies leave without proper rehabilitation after exploiting a deposit, though in recent years, gold companies have been doing some exemplary remedial work. How would you regulate this in the petroleum deposits?The main regulatory provision in the revised law forces the investor “to deposit 3% of the annual extraction expenses and 1% of the profits of the contractor during mining into an escrow account as guarantee for rehabilitating the environment and to demolish the constructions for the exploration and mining”.
The closing of the mine is referred to as “demolition”. As a collateral for this activity, it is specified in the law that monetary capital shall be deposited in an “escrow account”.
In the event a petroleum company leaves without properly conducting environmental restoration, the Government will be able to complete the work with assistance from another company with the money that is placed in the escrow account. If, however, the company carries out the remediation itself, it will be refunded the money put into the escrow account.
How does the new law regulate the issues related to overlapping fields? The revised law has several provisions on this matter.
The following is quite clear: “In the event of exploration and mining operations of crude oil, natural gas, non-traditional petroleum and minerals overlapping, the special permit holders will form agreements and will operate without causing hindrances in one another’s operations.”
If the parties are unable to reach an agreement, the Government will prioritize the projects in terms of their importance to society and the economy and will allow only one of the projects to continue its operation. The selected special permit holder will pay compensation to the other special permit holders for the expenses they incurred.
What happens when a coal mining company discovers natural gas? First, it will notify the Department of Petroleum. If the company decided to use the gas, it may proceed to mining. However, since there will be an issue with the special permit, the company needs to obtain a special permit for mining natural gas. If it is unable to mine the gas itself, it may use subcontractors. We are preparing more detailed procedures.
Another provision that caught my attention says the Government will purchase as a priority measure at the international market price the petroleum from refineries built locally. Why was this needed?Let’s take it that the the contractor gets 60% of the petroleum and the Government 40%. The provision gives us the privilege to purchase part or all of the 60% from the contractor before anyone else.
At the beginning of our conversation, I mentioned that the terms and criteria for selecting contractors are now included in the law. I would like to further elaborate on this. The 12 basic criteria include: percentage allocated to the Government from the profitable petroleum, percentage of royalty tax, percentage of the limit on petroleum incurring cost, amount of investment made in exploration, amount of capital to be spent on remediation of the environment, amount of training incentive, amount of incentive on signing the agreement, amount of incentive for launch of mining, amount of incentive on increasing the output from mining, amount of incentive for developing the local community, support for the representative office activities, and other beneficial terms to propose to the Government.
Investors can put their numbers on these 12 criteria and enter the bid for selection. The selected entity will negotiate with the Government and will enter into an agreement.
Have you received any complaints from investors after the draft was approved? It was evident that the investors had high expectations, and their hopes have not been belied by the revised law. We have been receiving many requests for agreements on exploring non-traditional petroleum. Therefore we do not see any great dissatisfaction with the revised law. Of course it is not possible to have 100% satisfaction.
When you operate in the petroleum sector, a lot of things depend on trust and goodwill between the Government, the investor, and the local community. It is important to look at the interests of all parties and I feel the current law protects the interests of all.
Product sharing agreements were previously seen as unsustainable. Now, however, following amendments to the General Law on Tax that ensure stability of tax rates from the time an agreement is signed, investors feel supported and protected.
Support for investors is seen in another provision related to the Customs Tariff and Tax Law and the Law on VAT. It says, “Specialised machinery, equipment, appliances, raw materials, chemicals and explosives, parts and mobile accomodations imported by the contractors or subcontractors to be used in operations related to petroleum and non-traditional petroleum during the time of exploration and the first 5 years of mining will be exempt from customs duties and the VAT.” The words “the first 5 years of mining” were included because once the exploration operation is completed, there is major development work prior to mining. This will provide major support for the investors.
However, investors might not be very happy with “The contractor shall complete the transactions related to the investment and the sales revenue through commercial banks registered in Mongolia and the transactions shall be showed openly and transparently in the financial reports.”
That is correct. This provision has not been received well by investors. Contractors usually complete their financial transactions overseas. This is a provision to monitor this matter. We are compensating for some of the expenses incurred by the contractors with our oil and verifying their expenses. There is need to carefully review all transactions in relation to expenses.
The need for the companies operating in the petroleum sector to make their operational expenditure as clear as possible and to include details in their financial activity reports has been specified in the law. It is not possible to tell how well the provision will be implemented, but I believe it has been the first step on our part.
What provisions are there to support the local communities?There are several. For instance, 30% of the royalty receipts will be allocated to the local development common fund and the other 70% will go to the state budget.
Similarly, 10% of the special permit fees will go to the soum or the district, 20% to the province or the capital city of the area, and 70% to the state budget. Additionally, it is the legal responsibility of the contractors to have the mining special permit holder to voluntarily sign an agreement to protect the environment and to provide support to local development. There might be misunderstandings and lack of local support for the operations; there might be environmental issues or disagreements on the specifics of the types and duration of donations and aids. Everything should be clearer if an agreement is made right at the beginning.
The law also enables the local community to cooperate with and to be involved in the activities of the commission to review the outcome of the demolition of the petroleum deposit and remedial activities.
It was quite bold to strengthen the principle of accountability in the petroleum sector. Article 44 seems to be entirely about accountability, right?The earlier law did not have any articles or provisions regarding accountability, while Article 44 allows the confiscation of researched material and levying of heavy fines in the event an exploration operation is conducted without proper agreements with administrative organisations.
There also is a provision that allows income to be confiscated and fines imposed if exploration and mining operations are conducted in a territory where such activities are restricted or prohibited.
Income will also be confiscated if reports are not submitted within the specified time to the government administrative organizations and the mining work exceeds 180 days. If the samples of the rocks and the primary materials are lost or destroyed, they have to be replaced and a fine equivalent to 50-100 times the minimum monthly wages will be levied.
There are several provisions covering transfer or rights and obligations. The rights of a party with an exploration agreement may not be transferred. The exploration shall be conducted within three years. In the event the party fails, it is not necessary to transfer the exploration licence to another party.
The matter of verifying the expenses liable for compensation is also important. Previously this was reviewed and verified by the Petroleum Administration but there were many complaints of lack of transparency. Now the verification will be the responsibility of the National Audit Authority. If deemed necessary, an independent professional organization may also be asked to carry out the verification.
Since the product sharing agreement is signed with the Government, the transfer of rights and obligations will be the responsibility of the Government also. There is a specific provision which states, “The contractor may not transfer the rights and obligations of the product sharing agreement in full or in parts more than or equal to one third of the agreement without the permission of the Government.”
What separate procedures are being developed at this moment?With the main provisions specified in the law the view of the Ministry of Legal Affairs was that there was no need for a procedure for implementing the law. Still, it is appropriate to regulate certain issues that may be deemed professional with separate procedures. Currently, 15 procedures and the model agreement are being developed. At the Government level, 3-4 procedures will be passed. These include: procedure on payment, allocation and spending of the royalty fees and the special permit payment, and procedure for registration and estimation of petroleum etc.
In relation to finance, there are many issues that cannot be regulated by the law alone, such as the receipt of reserves and reports, conferment of professional ranks and titles etc. Therefore the Working Group is working to develop the relevant procedures.
American lawyers advised us that there is need for clarifying some provisions related to dispute settlement with procedures. We need to work on this matter with careful attention.
The procedure regulating the activities relevant to the exploration and mining of non-traditional petroleum has been submitted to the Cabinet for review and approval. If I may add here, a fund for developing the petroleum sector was specifically added to the Special Government fund. This fund will be made up of 3% of the revenue form petroleum. With the help of this fund, we will be able to enhance out national capacity for conducting exploration. Although the provision stating that national companies will be supported was changed significantly during review, at least this fund will be used for training the people in this sector and assisting them to conduct certain activities themselves.
In our petroleum sector, there is no drilling team of our own and a team from China comes to do the job. Nearly all activities such as digging the hole, carrying out the carotage survey, increasing the output and stabilizing the pressure in the layer are being performed by foreigners as Mongolians are unable to do them. Most Mongolians employed at PetroChina are working in mining or on ordinary ground jobs, and not holding specialized posts. There is urgent need for advanced training to enhance human resources in the petroleum sector. I can only hope that the fund for developing the petroleum sector will help national companies and national workers, for it is my opinion that it is wrong to be always dependent on foreigners.
The present arrangement in the petroleum sector is that 75% will be foreign workers and 25% local. The percentage of Mongolians must go up but at this moment we do not have the trained manpower to fill more skilled slots. Indeed, a draft provision calling for gradual decrease in the number of foreign workers had to be taken out as this was an issue that was to be regulated by a separate law. Now we need to shift our focus to the fund for developing the petroleum sector. The terms of reference for the fund are currently being developed.
PetroChina was under the scanner about how it had been conducting pilot mining operations for years on end. The law now specifies that such operations cannot continue for more than 180 days. There cannot be production under the name of pilot phase. After these 180 days, the company will start mining, after assessing whether or not their geophysical survey had been thorough enough, and what potential the hole holds. This is a bit different in the case of non-traditional petroleum. Although it is not specified in the law, there will be procedures detailing the pilot phase mining of non-traditional petroleum.
In general, in non-traditional petroleum, there are cases where the exploration and the mining can be conducted simultaneously, while in the case of the traditional petroleum, once exploration is completed, the reserve is determined and the mining operation launched. While traditional petroleum requires large investment in exploration, non-traditional petroleum requires larger investment during mining than during exploration. In this regard, there are issues that need to be paid attention to, to be specified in the procedures and to be reviewed.
Finally, there is an urgent need for specialized trainings for human resources in the petroleum sector.