An examination of the Songo Songo Project and the PanAfrican Energy Tanzania production sharing agreement

The Songo Songo Gas-to-Electricity Project has been part of the backbone of Tanzania’s energy sector since 2004, providing low cost natural gas to Tanzanian industries and low cost reliable power to Tanzanian consumers. Signed in 2001, the Songo Songo Project was the first of its kind in Sub-Saharan Africa and the first natural gas development in Tanzania. The project was initiated by the Government of Tanzania with technical and financial support from the World Bank and private sector partners: Songas Limited and PanAfrican Energy Tanzania Limited (PAET). PAET operates the entire Songo Songo project and is allowed (with TPDC to sell some of its gas to customers.  The Songo Songo project stands today as a major achievement for the Government of Tanzania and its project partners. Project approval required almost twenty years of intensive evaluation, negotiation and independent assessments to ensure the project was viable and fair for all parties.  Despite this, there has been, and continues to be, considerable scrutiny of the project.  The following seeks to address some of the common questions asked.

 

1. How does the Government of Tanzania earn revenue from the Song Songo project?

The Government of Tanzania (GoT) earns revenue both directly and indirectly from the project, through a range of taxes, fees and other obligations paid to TRA and local authorities, as well as a share of profits paid to the Tanzania Petroleum Development Corporation (TPDC). The sources of income are multiple and, as the answer to the question below shows, considerable.  Sources of revenue to the GoT include:

  • profits in relation to all gas sold, distributed through the profit-sharing mechanism within our PSA;
  • corporation tax; excise duty;
  • VAT; national and regional levies; and
  • VAT on sales.

 

2. Is the Songo Songo Project good or fair value to the people of the United Republic of Tanzania?  

Yes.  We firmly believe that it is a project that is of exceptional value to the people of Tanzania.  Songo Songo is the only natural gas development project in Tanzania with sufficient technical, operational and financial history by which to judge its success and real value. Since PAET started flowing gas in July 2004, and up to the end of June 2017 the gross revenue from the sale of Songo Songo gas was nearly US$800 million.  However, the (audited) costs incurred by PAET to achieve this – including capital investment, tariffs, operating and general & administrative (G&A) costs amounted to US$442 million. The revenue net of costs was therefore US$357 million. Of this net revenue, the Government and TPDC earned a US$244 million shareAdded to this, the sales of Songo Songo gas also generated for the Government additional VAT, Excise and other taxes of US$204 million.  When added to the share of net revenue to TPDC, the ‘economic rent’ in direct cash payments to the GoT as a result of producing Songo Songo natural gas is a considerable US$448 million (that is 80% of the net revenue), before considering any payments made to the GoT as a result of the power sales by Songas. At face value, PAET earned US$ 113 million or 20% of the total take over 13 years. However, PAET did not incur all the investor costs of the project as significant money was spent over these years by PAET’s parent in assisting and managing this project. Subtracting from PAET’s profit these additional parent company costs results in a net private investor profit of US$51 million, or 10% of the total take, while the GoT's share at US$448 million was 90%. Another cost to PAET to consider is the arrears owed to PAET by the parastatal electric company TANESCO, which as at December 31st, 2016 was US$101 million.  PAET has had to shoulder the burden of paying all the relevant taxes due to the GoT even though those invoices have not yet been paid.  The profit share due to PAET in relation to the arrears is nearly US$70 million. When considering that PAET has earned from the project US$113 million as shown above, and deducting PAET’s share of what it is still owed by TANESCO of US$70 million, then PAET has, to date, realized earnings of US$43 million. Beyond the direct cash payments to the GoT, the Songo Songo Project has had a significant positive impact on Tanzania’s economy. It has helped to increase energy supply security by reducing the national grid’s dependence on hydropower and importantly has also reduced the use of expensive imported liquid fuel for power generation and process heat production in major industries. From September 2004 to December 2016, we estimate that by substituting Songo Songo natural gas for more expensive liquid fuels Tanzania has saved over US$5 billion (around TZS 11.2 trillion at current exchange rates). We believe that the results speak for themselves. Examining actual results from the project, accrued over 13 years of operations, we believe that in any business model in any environment, an outcome that sees a Government earn a 90% share of net profits, and the private investor earn 10%, represents an exceptionally good deal for the people of Tanzania.  We believe that the historical economic results not only show that the project conceived and negotiated by the Ministry of Energy and Minerals (MEM) and the GoT not only achieved its intended outcome, but far exceeded the benefits to the GoT envisaged at the time.

 

3. How does the Songo Songo PSA compare with Model PSAs?

The Model PSA is, by definition, a model. While the Model PSA is an important tool in guiding negotiations towards an agreed PSA, it cannot be applied blindly and the final terms will depend on the specific project risks and economics, as well as other factors.  Every project is different. Departure from some Model PSA conditions are justified and may be necessary to ensure the project can be commercially developed. The Songo Songo PSA contains some unique features that were necessary to ensure a fair deal for all parties given the objectives of the GoT to create a balanced and fair fully integrated gas-to-electric project and the prevailing economic and industry conditions at the time.  This resulted in a PSA which did not fully mirror the Model PSA which existed at the time, which renders a direct comparison to other PSAs and/or the Model PSA misleading.  Some of the unique characteristics of the Songo Songo agreements (including the PSA) are: Protected Gas (PG) -- although the PSA refers to the Songo Songo gas field as a whole, a significant portion of the Songo Songo gas reservoir is deemed to be PG.  PG is not available for use or for sale by PAET; however, it still must be produced by PAET for Songas (a company 41% owned by the GoT through TPDC and TANESCO).  Songas uses the PG for power generation and sells smaller quantities to one major industry (Tanzania Portland Cement Company (TPCC)).  Only after Songas receives the agreed quantities of PG can PAET and/or TPDC sell any other gas.  This ‘other’ gas is known as “Additional Gas” (AG) and can be sold (by PAET and/or TPDC) to other customers, or also to TANESCO, Songas or TPCC should they require more volumes than the PG alone.  PAET must produce and make available to Songas the PG volumes until the middle of 2024 when the Songas Power Purchase Agreement with TANESCO expires.  Profits from the use or sale of PG are for the benefit of Songas, TPDC and the GoT.  PAET receives no revenue in respect of PG. Since first production in September 2004 to the end of 2016, for every cubic foot of AG produced and sold by PAET and TPDC, one cubic foot of PG was produced by PAET on a no-cost/no-profit basis. The provision of PG by PAET at no cost enables TPDC to charge US$0.60/MMBtu to Songas for these volumes (producing some US$103 million in revenue to the GoT by way of TPDC between 2004-2016). In addition to providng the GoT with a significant source of revenue from PG, this structure enables Songas to be the lowest cost IPP supplier of power to TANESCO at US$0.065/kWh (all-in including capacity charges, energy charges, fuel, tariffs, gas infrastructure, operating costs and taxes), making Songas the cheapest thermal power station in East Africa. PG can be considered a Tanzania ‘domestic obligation’ which is provided by PAET for no revenue, whereas many other PSAs having a domestic obligation provide the investor with revenue from a discounted gas price. Revenues and costs in respect of the Songo Songo PSA deal with AG only. Considering this, a superficial review of the PSA can be misleading and the considerable benefits to the GoT from the production of PG by PAET should never be discounted. Additional Profits Tax.  The Songo Songo PSA includes a windfall tax called “Additional Profits Tax” (APT) which is a two-level escalating additional taxation based on cumulative returns on investment as a compensating measure to ensure that PAET does not achieve windfall profits from the project.

 

4. Why does the Songo Songo PSA allow PanAfrican Energy Tanzania higher maximum cost recovery rates than those proposed in the Model PSA?

The maximum recoverability of costs as a percentage of revenue as proposed by the 1995, 2004 and 2008 Model PSAs are 60%, 70% and 50% respectively.  The Songo Songo PSA allows cost recoverability up to 75% for PAET.  This does not mean that PAET is taking more costs back than it would have under a Model PSA, but rather it can recover the costs slightly faster, which again is by deliberate design of the GoT given the project economics. As stated above, the Model PSA is only a guide for negotiators to reach an agreed PSA, and any PSA’s final form will depend on a range of risks and factors.  The Songo Songo Project was ground breaking, however the risks and factors that defined the project were considerable: not least (i) that the project was the first of its kind in Sub-Saharan Africa; (ii) it was specifically designed to deliver stranded natural gas to electricity in an integrated project;  and (iii) specifically engineered to provide low cost, clean and reliable energy for industrial use in a region where there was virtually no existing processing and transportation infrastructure, support services or established markets.  The costs of implementing such a project was always going to be considerable, while there was considerable risk for the private sector developer and investor that markets might not actually emerge.  In this context, all aspects of the PSA were carefully and diligently negotiated, and evaluated by both the GoT and the private investors.  They were then approved by all parties to the agreement, to ensure all parties received a fair return on their investment and the people of Tanzania would receive the benefits of gas-fired power and industrial gas supply.  Our previous answer regarding whether the deal was fair to the GoT and the people of Tanzania makes an inarguable case based on the facts of producing gas for more than 13 years.  However, there has also been a far broader, tangible impact on Tanzania’s economy in terms of GDP growth, employment and indirect benefits from increased access to reliable electricity, as well as accelerated industrialisation due to the availability of natural gas facilitated by the Songo Songo Project.

 

5. Why does the Government’s share of profit reduce as your production increases, when the 1995 Model PSA recommends the opposite of this?

As mentioned previously, the Songo Songo PSA was negotiated freely and transparently, and scrutinized to ensure fairness to all parties.   Before signing the agreement, it under went several GoT reviews, as well as a fair value review undertaken by the Economic and Legal Advisory Services Division of the Commonwealth Secretariat.  The reviews concluded that on balance the project was a good deal for Tanzania. The profit sharing mechanism is as it is in the existing agreement was deliberately designed to work the way it does, and was agreed by all parties.  There are several reasons for the outcome: Once more here we must refer to the unique elements of the Songo Songo PSA and the requirement for PAET to produce volumes of PG, up to 45.1MMscfd on a no-loss, no-profit basis to ensure that Songas could generate and sell low-cost electricity to TANESCO.  This factor is unlike any other PSA in Tanzania (and in fact the vast majority of PSAs worldwide).  Any gas production from the Songo Songo field above these PG volumes is considered AG. At the time the PSA was negotiated there was little or no market for AG. The GoT saw an opportunity, not only to use gas to generate electricity but also to attract industries to the region.  As such, as the gas producer PAET was taking on considerable risk to develop markets for AG.  The GoT chose to incentivise the company with the contractual terms in the PSA to develop and optimise the Songo Songo field to produce gas above the PG volumes, which could then be made available to industries at prices competitive with liquid fuels (with crude oil around US$27/bbl. in 2001).  This is why the profit share mechanism sees the sharing ratios change in favour of PAET as production increases.  The mechanism was readily agreed by all parties, with the aid of in-depth analysis and advice provided by external expert advisors to the Government. Importantly here, PAET is not the only party that benefits from increased production.  While it is true that the GoT's percentage of the overall share decreases in stages as production increases, GoT's revenues actually increase, as the table below shows.  Increased production may lead to a smaller percentage share to the GoT, but it leads to a larger financial share overall as a larger sum of money is available for division.  As such, both parties are incentivised to ensure that production increases in line with demand.  This might be considered the optimal condition of any PSA; a situation where both sides of the agreement are compelled to do more. Notes: For 2015 and 2016 the chart shows Profit Gas share at 60:40 for accruals accounting purposes.  However, since the unresolved forced interconnection by TPDC at Ubungo PAET has continued to apply the 55:45 ratio as notified to the Ministry under Reference PAT/0352/16 dated 16th August 2016. A further factor which should be considered is that the GoT share under the terms of the PSA could be as high as 75% of revenues, while PAET’s share could only ever grow as high as 55%.  Before the 2015/2016 Songo Songo field development commenced, PAET was already selling AG at sufficient volumes that the profit share was at 55% to PAET and 45% to TPDC respectively. In other words, production volumes were already at a level that saw sharing at the highest level PAET could attain.  Any of the new volumes of AG which could have been sold following the field development would not have affected this ratio and would only have served to increase the total revenue to each party.  Despite this, at the request of TPDC, PAET undertook a significant capital investment of approximately US$70 million at PAET’s own risk to deliver this development programme.  Sales of this additional deliverability would not affect the profit share ratio in either PAET’s nor TPDC’s favour, but would dramatically increase the amount of revenue for the GoT.  Given that PAET has had comparatively low profits from the first 13 years of operations, PAET felt that these additional sales volumes would begin to bring its profits and returns up to the levels which were anticipated when the project began, and accordingly justified the US$70 million investment we made.

 

6. Production has not increased since you completed the US$70 million programme and so the Government has not enjoyed the gains you talk of.  Why is that?

Unfortunately, there are several reasons why PAET has not yet been unable to any of the newly available gas volumes since completing the programme.  Under the terms of the Songo Songo contract, agreement and approvals were required by a number of parties before these new quantities could be sold.    At the end of July 2017, PAET received the GOT's approval of the plan – the final step in the contractual process. In addition, the existing processing and transportation infrastructure to which PAET had access was largely contracted to capacity. The final reason we have not sold any of the additional volumes of gas is that PAET is not yet connected into the new national gas infrastructure (the NNGIP) owned and operated by TPDC on behalf of the Government, although PAET hopes this will be happen relatively soon now. Finally, PAET has been negotiating a new Gas Sales Agreement with TPDC.  Negotiations on this have lasted a number of years, but TPDC needs these volumes for a rapidly growing demand so we are quickly approaching a conclusion that will allow us to flow greater volumes. This will both increase PAET’s contribution to power generation and industrialisation in the country, as well as provide significant new revenue to the GoT.

 

7. Why doesn’t PanAfrican Energy Tanzania have a Royalty provision in the Songo Songo PSA, as is suggested in the 1995 Model PSADoesn’t this deprive the Government of revenue?

It is correct to state that PAET is not obliged to pay Royalties.  This is a position that was agreed through the negotiations that led to the Songo Songo PSA, and which were deemed to offer a fair return to all parties. It is worth remembering that unlike other PSAs the Songo Songo PSA divides gas into PG and AG, and sees TPDC recover revenue from three sources across both PG and AG, whereas PAET’s income streams are limited only to sales of AG.  TPDC’s revenue streams include:

  • Revenue as a beneficiary to sales of PG to Songas Ltd., as per the Gas Agreement Article III, Clause 3.1(b), which we estimate to 31 December 2016 at US$103 million in revenue to TPDC;
  • Revenue from TPDC’s share of AG sales, which is a further US$141 million (prior to the payment of US$62 million in Corporation Tax which is deducted from TPDC Profit Gas revenue);
  • TPDC is the exclusive beneficiary of revenue from the sale of condensate, a bi-product of the production of gas that takes place under the Songo Songo PSA, in accordance with Clause 6.8 of the Gas Agreement.

Considering this, within the context of the entire PSA and the considerable percentage of revenues paid to the Government, the inclusion of a Royalty payable by PAET would likely have necessitated other changes in the PSA to ensure PAET retained its already marginal share of revenues.

 

8. The Songo Songo PSA requires you to pay Additional Profit Tax (APT).  Why hasn’t PanAfrican Energy Tanzania paid this?

The issue of APT is allied to the previous discussion on Profit Gas sharing ratios.  While PAET’s Profit Gas share increases as production increases, the imposition of APT ensures that PAET’s share of revenue does not become so excessive as to render the Songo Songo PSA inherently unfair to the GoT.  While onerous on the private investor dealing with risk and return, APT is a fair and logical provision for Songo Songo. PAET is obliged to pay APT when due, a commitment we acknowledge and monitor throughout all financial operations to ensure we do not fail to pay when necessary.  However, execution of oil and gas operations in Tanzania is challenging and expensive, far more so than in regions with a well-established oil and gas industry.  Consequently, PAET’s costs are such that profits have never reached levels of investor returns whereby APT becomes applicable.  PAET has reported its APT calculations to TPDC and MEM through numerous mechanisms since production commenced.  Furthermore, PAET has its accounts audited annually by TPDC, the Tanzania Revenue Authority (TRA) and by external auditors.  While our financial statements accrue an estimate of future APT, at no stage to date has APT been considered current and payable.

 

9. Why is it that under the Songo Songo PSA, PanAfrican Energy Tanzania has the right of ownership of recoverable, movable assetsOnce costs of these assets are recovered, shouldn’t they become the property of the Government?

There are 18 other PSAs in Tanzania which have similar or identical provisions as the Songo Songo PSA, in relation to ownership of moveable assets.  To PAET’s understanding, negotiations for all such PSAs were based on the provisions of pre-existing Model PSAs.   The provisions are a small part of the wider provisions within the PSA and cannot be considered in isolation.  This provision is but one of many that form a balanced agreement that was deemed fair to all parties when finalised.  It is worth noting that PAET’s moveable assets in discussion here are all purchased through the PSA, solely for the purposes of delivering requirements under the PSA.  Further information on the mechanisms for transfer or disposal of fixed and moveable assets can be found at Article 17.1 of the Songo Songo PSA, available on our website. In a broader context, moveable assets have always been a very small part of the total assets of the project.

 

10. Why hasn’t a Field Restoration Fund been established for Songo Songo?  Isn’t this a compliance issue under the PSA?

PAET is not actually obliged to establish an abandonment fund under the Songo Songo PSA, and is in no way non-compliant. However, we do understand why the question is being asked. Abandonment funds are found in many PSAs.  But most PSAs cover the economic life of a given field, which is not the case with the current term of the Songo Songo Licence.  Indeed, given the current reserves, the Songo Songo field is expected to continue producing far beyond the expiration of the current TPDC licence in October 2026. Despite the remaining term of the licence, the PAET has recently worked-over three offshore wells and drilled one new offshore well in the Songo Songo field.  We are likely to work over other wells between now and the end of the licence in 2026, and may yet carry out further development drilling and facilities work depending on the demand for gas, prices and other contract terms.  The GoT will continue to enjoy the benefits of the workovers, new wells and the dependable production of gas established by PAET for many years to come. Notwithstanding the fact PAET is not obliged to establish a fund for field restoration, it has on several occasions attempted to hold such discussions with TPDC.  It should be noted however that any future requirement to establish such a fund would once again unbalance the other provisions of the PSA and would necessitate remedy to ensure the project remains fair to all parties.  Moreover, the original five (5) production wells in the Songo Songo gas field and the Songo Songo gas plant are owned by Songas but operated by PAET.  PAET has drilled three (3) new wells in the Songo Songo gas field under the PSA.  Any agreement to set aside funds for abandonment field restoration would need to take this into consideration.

 

11. Does PanAfrican Energy Tanzania pay any taxes in Tanzania? 

Yes.  The tax system in Tanzania is complex, but for several years PAET has been recognised by TRA as the most compliant large taxpayer in the country.  It is something the company works exceptionally hard at getting right, and we are proud not only of our achievements, but of the considerable contribution made to Tanzania through taxes. Despite this, there have been suggestions that provisional corporate taxes paid by PAET are recovered from sales invoices of gas from TPDC, and that all other taxes are paid by TPDC.  These suggestions are inaccurate and misleadingFrom 2004 to 31 December 2016, PAET has paid a total of US$189.4 million in taxes and levies to the GoT, including US$61.6 million in corporate taxes plus US$127.7 million in VAT, Withholding Tax, Excise Tax and EWURA Levies. VAT and Excise Taxes of US$35.9 million associated with the sale of Protected Gas by TPDC to Songas have also been paid to the GoT from 2004 to the end of 2016. The following puts the quantum of PAET’s payments, either through taxes, levies or profit share mechanisms, into context.  Tanzanian authorities have recently reported that the entire group of mining companies in Tanzania paid a total of US$695 million in royalties and taxes as a result of operations in the country in 2009 to 2015.   By comparison, PAET alone paid some US$301 million in Profit Gas and taxes during that same period.  That is 43% of the total paid by the entire mining industry in Tanzania.  Considering PAET is a sole company within the energy sector, operating a single natural gas field, we believe that this comparison demonstrates the exceptional value of the Songo Songo PSA for the GoT.

 

12. Market and Market Research costs are downstream costs.  Why is PanAfrican Energy allowed to recover them under its PSA? 

Simply, the PSA defines recoverable Development Expenses to include: The cost of production, processing, storage, transport facilities such as pipelines, flow lines, gas plants, oil batteries, dehydration equipment and other production and process units, wellhead equipment, subsurface equipment, enhance recovery systems, offshore platform storage facilities and access roads for production activities; PAET developed and operates a downstream pipeline to transport gas to industrial customers.  The costs for this are, by the above definition, fully recoverable under the PSA. The Songo Songo PSA does not discriminate between upstream and downstream activities and this is by deliberate design of the GoT.  It is actually self-evident throughout the PSA that downstream activities were always considered to be integral to it.  While the primary aim of the agreement was to produce gas for electricity, the GoT considered a secondary and equally important aim was to promote industrial growth in Tanzania.  However, at the time PAET entered into this agreement there was no downstream industrial gas market or associated infrastructure in Tanzania.  To develop such markets the downstream network had to be constructed, mostly by PAET.  As such the development of a downstream operation was envisaged and accepted as necessary by all parties, and was therefore included for cost recovery.  If downstream costs had not been included for cost recovery it is highly likely that the project would not have been agreed at all.  It is inarguable that both TPDC (though its Profit Gas share) and the GoT have benefitted greatly from the downstream operations undertaken by PAET.

 

13. Your annual reports state you are in dispute with TPDC on these recoverable costs – for US$34 millionAre you going to resolve this?

This dispute has been outstanding since November 2012.  Through that period, using the dispute mechanisms provided in the PSA, together with TPDC, we have resolved a significant portion of the disputed amounts, with approximately US$20 million remaining in question from a very limited perspective.   The dispute was not whether the costs were legitimately incurred – that has been accepted by TPDC -- but rather whether such costs were fair and reasonable in the context in which they were incurred by PAET. Consequently, a ‘fair value review’ by an independent body was recommended, and PAET and TPDC agreed to appoint an expert to undertake such an audit, however, this process was suspended by TPDC Recently, TPDC contacted PAET to reinitiate the dispute.  This is an initiative that PAET warmly welcomes, as we firmly believe that the process will finally address the repeated questions pertaining to the inclusion or exclusion of downstream costs from recoverable costs.

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