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ISSN Issue Published 1875-418X (Provisional) December 2010

Impact of 18th Constitutional Amendment on Future of Exploration and Production Industry of Pakistan by M. Arif

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Impact of 18th Constitutional Amendment on Future of Exploration and Production Industry of Pakistan by Muhammad Arif*

Background: In Pakistan, natural resources especially mineral oil and natural gas being part of the Federal Legislative List were exclusively owned and regulated by the Federal Government. However, under Article 161 of the Constitution net proceeds of the federal duty of excise on natural gas levied at well-head as well as the royalty collected by the Federal Government, have to be paid to the Province in which the well-head is situated. Under Article 158 of the Constitution, the Province in which a well-head of natural gas is situated has precedence over other parts of Pakistan in meeting the requirements from the well-head subject to the commitments and obligations of the Province producing the gas and other Provinces and areas as on the commencing day i.e. 14 August, 1973 or an earlier date in accordance with a notification by the President (Art 265). A vital change to this position has been effected through the promulgation of Constitution (Eighteenth Amendment) Act, 2010 (Act No. X of 2010), passed by the Senate of Pakistan on 15th April 2010 and assented to by the President on 19th April 2010, ( the Eighteenth Amendment) whereby New Article 172 (3) has been inserted pursuant to which ownership of oil and gas resources has been vested jointly and equally in the Federal Government and the relevant Provinces. Addition of Article 172(3) has triggered discussion on the modus operandi of implementation of the said constitutional change. One of the objectives of the Eighteenth Amendment being provincial autonomy and given that the petroleum industry is rightly perceived to be a profitable as well as highly paid job oriented industry, contrasting views as to the interpretation of the above Article are emerging and false expectations are being raised for division of regulatory, institutional as well as operational base as between the Federal Government and the Provinces. In view of the constitutional amendments relevant to the oil and gas industry, this paper seeks to find answers to the following questions: 1. Who has jurisdiction over legislative, regulatory and policy control of the oil and gas resources in Pakistan? Is there any contradiction in revised Article 172(3) and Article 161 of the Constitution?

2.

3. 4.

How should Article 172(3) be implemented within the ambit of the Constitution? Will the perception of investment risk in Pakistan increase if foreign investors are required to deal with the Provinces as well as Federal Government?

Legal Analysis:
1. Who has the jurisdiction over legislative, regulatory and policy control of the oil and gas resources in Pakistan? Revised Article 172 which is the key provision concerning oil and gas ownership is reproduced below for ease of reference: 172. Ownerless property. (1) Any property which has no rightful owner shall, if located in a Province, vest in the Government of that Province, and in every other case, in the Federal Government. (2) All lands, minerals and other things of value within the continental shelf or underlying the ocean beyond [within the] the territorial waters of Pakistan shall vest in the Federal Government. (3) Subject to the existing commitments and obligations, mineral oil and natural gas within the Province or the territorial waters adjacent thereto shall vest jointly and equally in that Province and the Federal Government. Insertion of the word beyond and deletion of the words within the in Article 172(2) demands an independent detailed analysis and assessment of implications which are not considered to be relevant for the sake of finding answers to the fundamental questions raised in this paper. The very title of the Article i.e. Ownerless Property is self explanatory. By virtue of Article 172(3), the ownership of mineral oil and natural gas, which were previously owned exclusively by the Federal Government, has now been vested jointly and equally in the relevant Province and the Federal Government. The ownership of property in any person does not in any way vest the legislative, regulatory, and policy control, which are separate functions, on the owner of the property as the said functions are distinct from ownership or the right to title. Powers relating to legislative, regulatory and policy are defined by the Constitution itself. By virtue of Sr. No. 51 of Part I of the Federal Legislative List, legislative, regulatory, management and administrative authority is vested in the Federal Government and the Federal Government, by virtue of entry regarding taxes on

mineral oil, natural gas and minerals for use in the generation of nuclear energy, exercises jurisdiction over the same. Moreover, Part-II of the said Federal Legislative List refers at Sr. No. 2 to mineral oil and natural gas, liquids etc. and as such institutional and policy control over the said mineral oil, natural gas, liquids etc. vests in the Federal Government. Retention of the said two entries, one at Sr. No. 51 of Part- I and two at Sr. No. 2 of Part II of Federal Legislative List clearly demonstrates the intent of the legislature to retain administrative, institutional and policy control on such resources with the Federal Government as per past practice. In view of the above, I am of the decided opinion that although pursuant to Article 172(3) ownership of mineral oil and natural gas now vests jointly and equally in the Provinces and the Federal Government, policy control and the legislative authority continues, by virtue of the Federal Legislative List, to vest in the Federal Government. Hence, there is no requirement or justification for any change in the existing institutional framework, which should remain intact, subject always to administrative improvements, wherever required, to ensure implementation of the revised Article 172 in letter and spirit.

2.

Is there any contradiction in revised Article 172(3) and Article 161 of the Constitution? Article 161 of the Constitution which has also been altered by Eighteenth Amendment, now reads as under:

161. Natural gas and Hydro-electric power.- (1) Notwithstanding the provisions of Article 78,(a) the net proceeds of the Federal duty of excise on natural gas levied at well-head and collected by the Federal Government and of the royalty collected by the Federal Government, shall not form, part of the Federal Consolidated Fund and shall be paid to the Province in which the well-head of natural gas is situated; (b) the net proceeds of the Federal duty of excise on oil levied at well-head and collected by the Federal Government, shall not form part of the Federal Consolidated Fund and shall be paid to the Province in which the well-head of oil is situated.

Article 78 reads as under: 78. Federal Consolidated Fund and Public Account._

(1) All revenues received by the Federal Government, all loans raised by that Government, and all moneys received by it in repayment of any loan, shall form part of a consolidated fund, to be known as the Federal Consolidated Fund. (2) All other moneys a. Received by or on behalf of the Federal Government; or b. Received by or deposited with the Supreme Court or any other court established under the authority of the Federation; shall be credited to the Public Account of the Federation. In my view the new revised Article 161 is contradictory to the revised Article 172. Whereas the revised Article 161 provides for the payment of 100% of the royalty on natural gas to the Provinces, under the revised Article 172 ownership of the said resources vests in and is to be shared equally between the Federal Government and the Provinces. In order to understand the contradiction, one needs to understand the concept of royalty. The term royalty has been variously defined but the general meaning of the term is a payment made for use of property. As the property in question is to be equally shared, payment of 100% royalty and Federal Excise Duty on natural gas to the Provinces is contradictory to the provisions of Article 172(3). Given that 50% of the other government receipts are to be shared by the Federal Government equally with the relevant Provinces, it only makes patent sense that royalty and Federal Excise Duty should also be shared equally between the Federal Government and the Provinces. Now a question may arise as to why 100% of the Royalty was previously paid to the Provinces under Article 161 when 100% ownership of oil and gas resources was with the Federal Government. The simple answer may be that it was an economic arrangement for giving a boost to the uplift and economic development of the relevant Provinces from where oil and gas resources were discovered and produced, which rationale is no longer valid in view of the new Article 172(3). It may be noted here that Article 161 is silent as to the treatment of royalty on crude oil, which would hence be dealt with in keeping with the provisions of the revised Article 172(3) and be shared equally between the Federal Government and the Provinces. In my opinion, the case of natural gas should also be the same and Article 161 should be appropriately amended.

3.

How should Article 172(3) constitutional provisions?

be

implemented

within

the

ambit

of

As the jurisdiction over the legislative, regulatory, institutional framework clearly vests under the Constitution with the Federal Government, implementation of Article 172(3) read in conjunction with the Federal Legislative List and Article 161, can be effectively, efficiently and appropriately done without any significant restructuring of the regulatory and institutional regime.

Accordingly, legislative, regulatory, institutional and policy control should remain with the Federal Government as per the existing institutional framework and all institutions, public sector entities and regulatory authorities should continue to operate as before. However, to give effect to the spirit of the revised Article 172, adjustment may be made to the composition of boards of institutions having impact on major decisions relating to the oil and gas industry with a view to providing an increased role to the Provinces in decision making. To give effect to the above suggestion, it may be appropriate to upgrade the status of the office of Director General Petroleum Concession to that of Petroleum Regulatory Board with appropriate representation to the Provinces on such Board, which would report directly to the Federal Ministry of Petroleum and Natural Resources. The entire administrative costs of this Board could be met from the total State take prior to disbursement of the share of the relevant Provinces in the State take, which could even be made to the Provinces on monthly basis to enable them to maintain cash flow and pace of economic development. The suggestion for maintaining existing institutional framework through the office of DGPC or its enhanced status as Petroleum Regulatory Board is supported by the following: 1. The constitutional amendment does not require creation of independent regulatory framework by the Provinces for management of same small size industry which is being efficiently and effectively managed through the office of DGPC. Creation of any parallel institutional framework would result in duplication of efforts at the Federal and Provincial levels. Since the Governments carried interest has been eliminated effective 2001, and there is no possibility of reinforcing such carried interest provision in future, and protection has been provided under Article 172(3) to the existing commitments and obligations, there is no economic justification for creation of any other additional institution by the Provinces which would eat into the already limited revenue resources.

2.

3.

In so far as companies established by the Federal Government are concerned, these are independent entities and the revised Article 172 does not impact on such companies. Government Holdings (Pvt) Limited which is controlled by the Federal Government will continue to look after existing commitments and obligations accrued prior to 19th April 2010 both in the offshore as well as the previously admissible government carried interest in onshore concessions. As GHPLs capacity has been enhanced to effectively manage mandatory local company participation, it should continue to assume increasing role.

Likewise, no change in upstream E&P Companies such as OGDCL, PPL or Mari Gas is necessitated pursuant to the revised Article 172. It may be noted that there is no bar on the Provincial Governments from establishing independent Provincial Exploration and Production Companies on the pattern of OGDCL to acquire exploration acreage through competitive bidding and acquire mandatory participation of such local companies on full cost sharing basis as provided for under the 2001, 2007 and 2009 Petroleum Policies. Such companies could also be named as co-licensees along with Government Holdings Private Limited, in the Production Sharing Agreements concerning offshore areas within territorial waters. However, GHPL would continue to be the exclusive licensee for offshore areas falling beyond territorial waters. For the comfort of foreign investors exploration and production licenses and execution of Petroleum Concession Agreements and issuance of sovereign guarantees should continue in the name of the President notwithstanding the division of ownership of natural resources between the Federal Government and the Provincial Governments. For the sake of state sovereignty and national integrity and securing foreign investment, it is imperative that the role of President in the existing petroleum licensing regime is maintained without any dilution. After removal of anomaly between Articles 158, 161 and 172, there will be a need for extensive and comprehensive review of all mechanisms and procedures for development of a viable system for equitable and fair division and distribution of profits or income earned between the Federal Government and the Provinces on the basis of equality in keeping with the provisions of the revised Article 172.

4.

Will the perception of investment risk in Pakistan increase if foreign investors are required to deal with the Provinces as well as Federal Government? Countrys existing regulatory framework is considered to be one of the best among Asian countries and owing to the stability of commercial terms backed by Presidential guarantees the present regime is considered to be the only positive under the currently prevailing law and order situation, terrorism and transparency and governance issues. Any shift in the existing framework and any requirement for investors to deal with the Provincial as well as Federal Governments will undoubtedly be viewed by investors as an increased investment risk. The complexity of dealing with different Provinces will be further heightened in the case of exploratory blocks falling in more than one Province and in numerous districts. Any dilution in sovereign guarantees and stability of fiscal terms already executed with the foreign and local investors under binding instruments could bring future investment to a grinding halt. It is therefore imperative that the status

quo is maintained and no step is taken which will, instead of improving the present perception about the investment climate enhance the risk perception.

Conclusions:
The revised constitutional provision will have no immediate impact on the industry but the manner in which effect is given to the provision and reforms are undertaken to develop an equitable mechanism for sharing of statutory receipts emanating from the local exploration and production of oil and gas resources could have a serious impact, which needs to be carefully formulated with a view to achieving harmony and efficiency keeping in mind foreign investor risk factor. This can be best achieved by retaining the existing regulatory framework with the legislative, policy and administrative control in the hand of the Federal Government, subject to participation by the Provinces in the decision making process through representation on Federal oil and gas regulatory bodies. Preferably, The management of petroleum resources should continue to be exercised by the Federal Government through the Director General Petroleum Concessions and after adjustment of administrative costs, fifty percent of the net revenue earned in the shape of rentals, fees, royalties, taxes, etc., should be paid to the relevant Provinces. Government controlled companies i.e. GHPL and OGDCL should continue to function without any change or interruption and the role of President should be retained and all sovereign guarantees should be issued in the name of the President.

*** Mr. Muhammad Arif is working as Manager (Legal & Commercial) in Ocean Pakistan Limited formerly Orient Petroleum International Inc. over last five years. Prior to that he has worked with Oil and Gas Development Company Limited for about 20 years with diversified experience in marketing, commercial, corporate affairs, legal and joint ventures. He is an MBA from the University of Strathclyde, LLM (Petroleum Law and Policy) from the University of Dundee and also holds Post Graduate Diploma in Petroleum Exploration and Production Economics from the University of Oxford, UK. He has written numerous articles on petroleum policies and regulatory reforms. His most valuable contribution to the industry is his co-authored (with Dr. Sohaib Qadar) book Energy Law Encyclopedia published by Kluwer Law International, Netherlands in 1996 which he is currently updating. The views expressed here does not represent the views of his past or present employer in any way and have been expressed in his personal capacity as a professional.