The Philippines thwarts its upstream aims [NGW Magazine]

The Philippines has formally unveiled its offer to investors of petroleum service contracts (PSCs) covering 14 pre-determined blocks. By May, it should be possible to tell if the country’s bid for a fresh flow of dollars has been a success.

The energy minister Alfonso Cusi struck a cautious note however in an interview with NGW, saying late last year: “There are still crucial policy fixes that we need to work on, if we want to achieve success in this round of our petroleum contracting.”

About 18 companies had already sent letters of interest in submitting bids, he said, adding that they had a few questions regarding the government’s future energy policy that they required answering before they were ready to do so. 

The new exploration and production (E&P) tenders are under what the current administration calls the Philippines conventional energy contracting program (PCECP). As well as the familiar use of pre-determined areas (PDAs) it also allows year-round submission of proposals on areas that the investors find of interest. 

The PDAs comprise 14 service areas along six basins in various parts of the country – stretching over 73,576.66 km2 of both shallow and deep-water seismic and drilling prospects within East Palawan, Cagayan, West Luzon, Sulu Sea, Cotabato and Agusan-Davao basins.

The application period is for 180 days starting November 21, 2018 and investors can inspect the data package and application documents from the DOE with a non-refundable fee of peso 200,000 ($3,800). And for the ‘nominated areas’, investor-applicants can submit their preferred petroleum block/s to the DOE; with the nominating party initiating the required publication of its preferred area at its own expense. The application fee is also peso 200,000, but it will be subject to a 60-day challenge period --  wherein the challenger posts a fee of peso 1mn.

At least three policies are on the energy ministry’s list of documents that need to be amended. One is an executive order that will reinstate farm-in and farm-out deals in petroleum service contracts. A second is concerned with the politically sensitive issue of lifting the moratorium on petroleum exploration in the conflict areas within South China Sea (or the West Philippine Sea). A third is the resolution of the arbitration case relating to the tax claims against the Shell-operated Malampaya gas field project.

Cusi said these issues had to be settled if the country is to garner successful offers in its fresh round of petroleum contracting. He said: “We have at least six months leeway for those concerns that are within government control – such as the amendments to the executive order 556 and the lifting of the force majeure on the exploration moratorium.” 

Executive Order 556 was issued in 2006 – during administration of Gloria Macapagal Arroyo – and that was a presidential fiat then requiring the conduct of bidding if a state-owned company like the Philippine National Oil Company – Exploration Corporation (PNOC) intended to appoint a partner or offloading interests (shareholdings) in its PSCs. By far, that’s a deviation from the conventional industry practice of farm-in and farm-out of interests in service contracts. 

“That had been a barrier to investment entry especially for two service contracts – the one being eyed by CNOOC (China National Offshore Oil Corporation) in SC 57 and Spanish firm Repsol for SC 59 – so we have already forwarded the recommended EO amendments to the office of the president,” Cusi said. 

He added: “We are hoping that the new EO will be signed soon because that will pave the way for exploration activities at service contracts 57 (in the northwest Palawan basin) and 59 (West Balabac block in southwest Palawan basin)…and that will also support other farm-in and farm-out activities eventually even in the new exploration blocks that we are offering.”

Regarding the lifting of the moratorium on exploration prohibition in the West Philippine Sea, Cusi is counting on a positive decision from the foreign affairs ministry and on the pledge made by the president, Rodrigo Duterte, to accede to the recent plea of PXP Energy Corporation for the moratorium to be finally lifted.

Once that is decided, PXP Energy, which is run by the Filipino business magnate Manuel Pangilinan may begin drilling activities at Service Contract 72. The block straddles Recto Bank offshore west of Palawan and is estimated to have resource potential that could match the commercial-scale gas discovery at Malampaya.

PXP Energy wants to work with its new upstream partners CNOOC and Dennison Holdings Corp, which is owned by Davao businessman and friend of Duterte, Dennis Uy.

The Philippine government is likewise pushing for the crafting of a joint legal framework that will govern seismic and exploration activities by Chinese and Filipino firms primarily in petroleum blocks straddling ‘conflict areas’ within the West Philippine Sea (WPS) or South China Sea.

A memorandum of understanding on this particular diplomatic concern was signed during the state visit by China’s president, Xi Jinping, in November 2018. But it was more perceived as a “lame document” because it just calls for a study of options on joint oil and gas exploration – nothing concrete on the steps that must be taken by both governments. 

In December, Cusi formally wrote to his counterpart at China’s national energy administration, asking if the two sides could sit down and start negotiations on the proposed joint exploration framework. So far this request has gone unanswered.

Donato Marcos, undersecretary of the Philippine energy department, disclosed that they received close to 10 letters of intent on prospective applications for petroleum blocks within the West Philippine Sea, “but we opted not to process them until we can concretise [firm up] an agreement with China on joint exploration.”

Elsewhere, the Malampaya tax case is beyond the government’s control: the case has been heard by the supreme court but no decision made yet (see below).

Production sharing options on costs

Presidential Decree 87 (PD 87) is the enabling law that prescribes the fiscal incentives for oil and gas exploration ventures in the Philippines.

And while the fiscal incentives regime under that edict had fuelled a number of successful finds, including the Malampaya gas and Galoc oil fields, Cusi noted that some of its provisions are no longer attuned to the investment climate of the present. 

He said PD 87 has never been revised or amended; so while the country’s neighbours have fiscal systems that have been brought up to date, its own are no longer fit for purpose.

He said it was highly likely that the 60:40 production sharing arrangement will remain in place but that the country was looking at options on how to make the cost recovery scheme more enticing for contractors. 

Cusi said they have been examining Indonesia’s experience in this sphere – fundamentally the “gross split revenues” that the southeast Asian neighbour introduced in 2017. According to the Philippine energy secretary, proposals to modify the cost recovery scheme “might make sense given the very low prospectivity and the very high-risk nature of investing in our petroleum blocks.

“The Philippines’ petroleum prospectivity is low compared with our southeast Asian neighbours, who are oil producers,” Cusi said, adding: “This could also be one of the reasons for the decline in petroleum exploration activities in our country.” 

Energy ministry data shows that a total of just 23 wells have been drilled in all the petroleum basins in the country over the past 10 years. That puts the Philippines behind Myanmar which has seen 29 wells drilled in the past decade; while Vietnam had 43 wells drilled. The more mature market of Malaysia had 81; Thailand, 594; and Indonesia, 903. 

Cusi said that the low prospectivity deters upstream companies from investing as there is no assurance that the expenses incurred, which are in millions of dollars, will ever be recovered if their activities are fruitless.

Duterte promises policy stability

While fixes are being pushed on the “weak points” of the industry’s policies, Duterte has given his word on policy stability that the investors would be able to lean on – primarily the foreign companies who will be risking millions to billions worth of dollar-investments.

“We make sure that when investors come, they come here for the long term. The PCECP and all other petroleum exploration and development undertakings are the priority of my administration, so the DOE and the entire Philippine government will go above and beyond to make doing business in the country easier and more attractive,” he said.

That strikes a chord with the demands of the Petroleum Association of the Philippines, expressed during the November 22, 2018 launch of the PCP. 

Making no bones about it, the PAP chairman Rolando J Paulino Jr said that “investing in the oil and gas industry is not cheap and it’s not unrisky, so our call to the government is to make fiscal terms stable.”

The seriousness of the plea has prompted the Philippine government to consider excluding the upstream oil and gas industry from the recommended wide-ranging reform of the national investment incentives. The Duterte administration’s second such overhaul is in danger of stifling the flow of further capital into the energy sector.

Cusi said the energy ministry had discussed the matter with the finance ministry, telling it that investors would vote with their feet, just when the energy ministry wanted the international oil companies to look at the petroleum blocks that the government has put up for tender. 

Given the government’s to-do list yet in crafting the corrective measures for the E&P sector, it is worth watching if the Philippines would be able to corner the targeted investment dollars at the deadline of tender submission by May 2019.

Malampaya tax demands are a red light

The international arbitration that the Malampaya partners – led by Anglo-Dutch major Shell – have brought against the government is not going to reassure would-be investors.

The state’s auditing agency says it is owed pesos 53bn-worth of ‘unpaid taxes” from the start of the field’s commercial operation in November 2002 

The estimates were only up to 2009; and if the calculation is adjusted up to 2016, the tax claims could go as high as P146.8bn, according to the auditor’s decision in May last year. Shell had fiercely contested the amount due.

Cusi admitted the gas field project’s tax case is a major handicap to the government’s invitation for fresh round of investments in the upstream petroleum sector. “Our reputation for changing the rules in the middle of the game – that is creating uncertainties and we certainly have difficulty explaining that to the investors,” he said. 

The filing of the arbitration case was initiated by the Malampaya consortium before the International Chamber of Commerce in Singapore in 2017 – and the public hearings were concluded September last year. “From the completion of the hearings, we are expecting decision after six months,” Shell Philippines CEO Cesar Romero said, which means a ruling will likely be rendered in first quarter this year.

A parallel dispute resolution proceedings on the Malampaya tax case was also sought at the International Centre for Settlement and Investment Disputes at the World Bank Group in Washington DC pursuant to the prescriptions of the Philippines-Netherlands Bilateral Investment Treaty. And another case was filed in August 2018 at the Philippine Supreme Court seeking clarity on the fiscal regime that shall be employed in tax treatment of revenues from commercially producing oil and gas fields in the country.

Judicial verdicts on the tax case of the country’s biggest gas field will have serious implications on all other investments in the Philippine petroleum industry, because all of its awarded service contracts are bound by the same rules and contractual terms.