Introduction

One of the key changes introduced to the Nigerian petroleum industry (the “Industry”) by the Petroleum Industry Act, 2021 (the "PIA" or “Act”) is the complete overhaul of the administration of marginal fields. Importantly, the PIA has categorized existing marginal fields under 2 transitional structures based on whether the marginal field is a producing field or a non-producing field. The new framework introduced by the PIA raises pertinent issues that require clarity. In this edition of our Newsletter, we discuss the new transitional framework and its impact on existing farm-out arrangements.

Transitional Framework for Marginal Fields under the PIA

The PIA seeks to create a more direct relationship between the marginal field holder (“Farmee”) and the Nigerian government ("Government”) by the mandatory conversion of the marginal field¹ to either a petroleum prospecting license (“PPL”) or a petroleum mining lease (“PML”), depending on whether the marginal field is producing or not. The PIA also provides that no new marginal fields will be declared under the Act² and that existing marginal fields will be transitioned under 2 main categories namely: (a) producing marginal fields; and (b) non-producing marginal fields - which have been further classified into non-producing marginal fields declared before 1 January 2021 which have been transferred to the Government, and non–producing marginal fields which have not been transferred to the Government by the holder of an oil mining lease (“OML”) within 3 years of the effective date of the PIA³ ("Effective Date”). 

A. Producing Marginal Fields

Under this category, a holder of a producing marginal field is permitted to continue operations based on the original royalty rates and terms of the existing farm-out agreements (“FOA”) entered with the farmor of the marginal field ("Farmor”) but is mandatorily required to convert to a PML⁴ ("Conversion”) within 18 months of the Effective Date ("Conversion Period”) to benefit from the new fiscal regime⁵.

A Farmee may, therefore, elect to convert to a PML at any time within the Conversion Period. However, in the absence of such election to convert during the Conversion Period, the marginal field will automatically be converted to a PML upon the expiration of the Conversion Period. Interestingly, the early Conversion to a PML is likely to be driven by the more favourable economics introduced under the new fiscal regime, as the reduced headline tax rates from 85%⁶ to around 47.5%⁷. 

Essentially, a producing marginal field that is converted to a PML appears to have been given special status as it stands to benefit from a lower hydrocarbon tax rate (i.e.,15%) compared to the 30% applicable to OMLs converted to PMLs. Nevertheless, while the tax changes seem clear, the applicable royalty rates require further scrutiny as the PIA allows producing marginal fields to retain the existing royalty rates.⁸

Furthermore, it is pertinent to note that the PIA has not provided a clear direction in relation to the cut-off period for which the terms of the FOA will cease to apply upon Conversion to a PML. It, therefore, seems that the operations of marginal fields under this category (i.e., marginal fields converted to PMLs) may be governed by a dual regime under the existing terms of the FOA and the provisions of the PML Model Lease⁹ embodying the relevant terms and conditions pursuant to the PIA¹⁰. Should this be the case, it will give rise to several regulatory and commercial issues and would beg the question of how any conflict between the terms of the FOA and the PIA will be resolved and, where applicable, to what extent the PIA provisions will supersede the commercial arrangements of the parties which had been agreed prior to the enactment of the Act.

B. Non-Producing Marginal Fields 

i. Non-Producing Marginal Fields declared before 1 January 2021

The PIA provides that non-producing marginal fields declared as such prior to 1 January 2021 shall be converted to a PPL and shall benefit from the fiscal terms for new acreage under the Act. Effectively, the recent 2020 Marginal Filed Bid Round (“MFBR”) awardees will fall under this category and the Nigerian Upstream Petroleum Regulatory Commission (the "Commission") has the authority to issue a PPL to such awardees (“PPL Awardees”)¹¹.

Amongst other constitutional documentation requirements, the Guidelines for Farm Out and Operations of Marginal Fields – 2020 (“Guidelines”) and the award letter¹², require an awardee to execute a FOA with the Farmor. While this has been the usual practice, the validity or relevance of the FOA to marginal fields under this category (i.e., non-producing marginal fields declared before 1 January 2021) has generated ongoing conversations among stakeholders. At this stage, it is important to examine the implication of the provisions of the PIA in relation to FOAs executed pursuant to the Guidelines and the award letter, particularly in relation to obligations that have been captured under the PIA.

The relationship of the Farmee and the Farmor under the Farm-out Agreement

Generally, the relationship between the Farmor as the license holder and the Farmee as the awardee of a marginal field is established by an FOA. Typically, the FOA provides for the terms and conditions of the farm-out arrangement and the scope of the relationship between both the Farmee and Farmor. The FOA is usually for an initial term of 60 months, subject to renewal unless terminated.¹³

Following the execution of the FOA, the Farmee assumes the entire rights and obligations of the farmed-out area covered by the marginal field award. An example of such obligations may include overriding royalty interest (ORRI), decommissioning and abandonment costs, host community development and relations, and environmental issues, amongst others.

However, the issuance of PPLs to awardees¹⁴ raises an important question about the Farmor and Farmee's future relationship. Generally, a PPL is expected to reflect the autonomy of the Farmee from the Farmor as concerning operations within the farmed-out area. The PPL grants certain exclusive rights and provides certain compliance requirements with the terms and conditions of the license¹⁵. As a result, the grant of a PPL to an awardee suggests that the PPL may render certain terms and elements of the FOA redundant by virtue of the application of the PIA. Examples of such redundant terms are considered as follows: 

• Overriding Royalty Interests Payments

Generally, the Farmee is obligated to make ORRI payments to the Farmor under the FOA, in accordance with the Guidelines. The ORRI is usually expressed as a percentage of the Farmee's daily production over a month. Therefore, a landlord-tenant relationship could be distilled from the relationship between the Farmor and the Farmee, with the ORRI being the “rental” payment for the use of the farmed-out land for a set period. 

However, with the introduction of the PPL, the "landlord" and "tenant" relationship between the Farmor and Farmee has effectively been terminated as the PPL Awardee now derives an independent and exclusive right to operate the farmed-out area from the PPL, with limited exceptions¹⁶. As a result, it may be argued that the introduction of the PPL has eliminated the ORRI payments to the Farmor under this category of marginal fields.

• Decommissioning and Abandonment

The Guidelines state that an equitable portion of the cost of abandonment must be negotiated as part of the FOA and the Farmee must set aside an agreed percentage of its budget (in an escrow account, trust fund, or equivalent security) or put in place a performance bond for eventual abandonment.

Under the PIA, a lessee and licensee are required to set up, maintain and manage a decommissioning and abandonment fund held by a financial institution that is not an affiliate of the lessee or licensee in the form of an escrow account accessible by the regulators¹⁷ under the provisions of the escrow agreement and where funds have been accrued prior to the Effective Date, such funds are expected to form part of the decommissioning and abandonment fund established under the Act. 

To this extent, a PPL Awardee may be required to, in addition to the decommissioning obligations under the FOA, comply with the above provisions of the PIA by setting up a separate decommissioning fund for the farmed-out area in accordance with the terms set out in the Act.¹⁸ However, we anticipate that from a practical perspective, it is likely that the decommissioning obligations under the FOA will be aligned with the obligations under the PIA. 

• Host Community Development

According to the Guidelines, a Farmee is responsible for community development efforts, as well as managing interfaces and interactions in the farmed-out area, as part of its field development and operating plan. In contrast, the PIA makes it mandatory for a settlor to incorporate a host community development trust fund (“Fund”), for the benefit of the host communities for which such settlor is responsible within 12 months. To this extent, a settlor is defined under the Act as a holder of an interest in a PPL or PML whose area of operations is located in or appurtenant to any community or communities.¹⁹ Therefore, a PPL Awardee would be required to set up a Fund for the benefit of the community within the farmed-out area.

Based on the foregoing, it would appear that the provisions of the PIA are sufficient to govern the operations of a PPL Awardee within the farmed-out area and as such, the negotiation of an FOA (as envisaged under the Guidelines) may have become obsolete to contracting under this category. However, certain terms of the FOA may remain relevant and must be negotiated to ensure a smooth handover of the farmed–out area in relation to the transfer of field data, liability protection, indemnity and the handling, processing and transportation of crude.

As mentioned above, the direct relationship the PIA seeks to create between the Farmee and the Government through the issuance of a PPL effectively ends the leasehold relationship between the Farmor and Farmee - the FOA being the core of this relationship. However, while it may seem that the FOA may have become obsolete, it is our view that the Farmor and the Farmee may be required to negotiate certain terms (as identified above) which remain relevant to the operation of the farmed-out area under the FOA in other associated agreements and that the Commission should mandate the negotiation of such agreements within a specified period. 

ii. Non – Producing Marginal Fields held by an OML holder not transferred to the Government within 3 years of the effective date of the PIA

Under this third category, the PIA provides that, for a marginal field that has not been transferred to the Government within 3 years of the Effective Date, the holder of the OML shall:

1. provide a field development plan for the marginal field to the Commission;
2. farm-out the field with the consent of the Commission; or
3. relinquish the field in accordance with the provisions of the Act.²⁰

However, where none of the conditions above are fulfilled within the specified timeframe set out by the Commission, such fields will automatically be relinquished to the Government.²¹ Consequently, the Commission, under a new bid round, is authorised to issue a PPL for the marginal fields that have been so relinquished to the Government under this category.

It is important to note that under the second condition above, the PIA envisages the creation of a Farmor-Farmee relationship between the holder of an OML and the Farmee thus, providing for a continuation of the leasehold relationship between the parties under this category²².

Conclusion

From the foregoing, the PIA marks a turning point in the administration of marginal fields in the Industry. Currently, the Guidelines and award letters of the MFBR require the PPL Awardees to negotiate and execute an FOA within a specified timeline. With the uncertainty that comes with this process, it is hoped that more guidance and clarity will be provided on a variety of issues through regulations, guidelines, and amendments.

Disclaimer: This newsletter is not intended to be relied upon as a legal opinion. If you require legal advice on any of the topics discussed here, please contact us.

1. PIA defines a marginal field as: “a field or discovery which has been declared a Marginal Field prior to 1st January 2021 or which has been lying fallow without activity for seven years after its discovery prior to the effective date"
2. Section 94(9) of the PIA
3. The PIA came into effect on the 16 of August 2021
4. Note that all existing OPLs and OMLs would be automatically converted to PPLs and PMLs upon their expiration. However, the PIA allows holders of OPLs and OMLs under the current regime to voluntarily covert them to PPLs or PMLs, within 18 months respectively.
5. Section 94 (1) of the PIA
6. It is worth mentioning that in 2006, the Department of Petroleum Resources (“DPR”) issued a letter outlining a revised tax rate for marginal fields from the Petroleum Profit Tax (PPT) rate of 85% to 55%. However, the Federal Inland Revenue Service (FIRS) refused to apply this 55% tax rate for lack of statutory backing as it believed that a mere DPR letter could not overtake the provisions of the Petroleum Profit Tax Act.
7. 47.5% translates to hydrocarbon tax at 15%, companies’ income tax at 30% and tertiary education tax at 2.5%.
8. The royalty rates are usually stated in the defunct DPR’s Award Letter
9. A Model Lease under the Act means a standard petroleum mining lease with terms and conditions adopted for a specific licensing round and may contain contractual provisions in a model contract attached to or incorporated in the model lease.
10. Section 85 (1) of the PIA
11. Section 94 (2) of the PIA
12. The award letter was historically issued by the DPR to the awardee
13. Guidelines for Farm Out and Operations of Marginal Fields – 2020
14. Section 94(2) of the PIA
15. Section 72 of the PIA
16. Section 72 (1) (a) provides that a PPL holder shall have the exclusive right to drill exploration and appraisal wells and non-exclusive right to carry out petroleum exploration operations within the area provided for in the licence
17. The Nigerian Upstream Petroleum Regulatory Commission and the Nigerian Downstream Petroleum Regulatory Authority
18. Section 233 of the PIA
19. Section 235 of the PIA
20. Section 94 (4) (a-c) of the PIA
21. Section 94 (6) of the PIA
22. Section 94 (4) (b) of the PIA