Will Lebanon's oil and gas gamble pay off?

Lebanese officials said the decision to take over Novatek's 20 percent share of a consortium licensed to explore offshore oil and gas blocks was necessary for the state to profit if significant reserves of natural gas are found.

Will Lebanon's oil and gas gamble pay off?

The exploration ship Tungsten Explorer off the coast of Lebanon, on Feb. 25, 2020. (Credit: AFP/File)

BEIRUT — With the end of maritime border negotiations between Lebanon and Israel reportedly in sight, the Lebanese government announced last week that it would take over the 20 percent share vacated by Russian company Novatek, which had pulled out of a consortium licensed to explore two offshore oil and gas blocks.

Lebanese officials said the decision was necessary to allow exploration to continue and that the state stands to profit from its 20 percent share if — as many are hoping — significant reserves of natural gas are found.

But some analysts say it is a risky proposition, since cash-strapped Lebanon could end up on the hook for millions of dollars without any return on its investment if the drilling fails to turn up gas.

The contract for exploration in the areas known as Blocks 4 and 9 requires three parties in the consortium at all times. If one of the parties withdraws, the Lebanese state has the right to take over the vacant shares.

Under the contract, Lebanon could also have opted to take a 0.01 percent share and allocate the rest of Novatek’s share between French energy giant Total and Italian firm ENI, the other two partners in the consortium. However, Lebanon opted to take the full 20 percent. This means it is liable for 20 percent of the costs and is eligible to get 20 percent of the benefits, if there is a discovery.

The Energy Ministry explained in a decree issued on Sept. 13 that it made the decision to take over Novatek’s share based on the recommendation of the Lebanese Petroleum Administration, noting that holding the 20 percent share would effectively “enhance the country’s petroleum capacities.”

“There’s a potential for the discovery of resources, and therefore, depending on the size of discovery, the value of the shares will be affected,” caretaker Energy Minister Walid Fayad told L’Orient Today. “In a nutshell, it just gives the state more flexibility in deciding the way forward.”

He added, “The state is always open to receiving partners in the efforts to develop the resource … At the same time, what we are after is always trying to maximize the opportunity for the state. We want to be in a position to benefit ourselves as well, meaning for the development of the country.”

The already-completed drilling in Block 4, which cost about $60 million, did not turn up any significant gas reserves. The exploration of Block 9 — which is on hold pending the outcome of the maritime border negotiations, as part of it lies in disputed territory — is expected to cost roughly the same amount, officials said, meaning that Lebanon’s 20 percent share of the cost would be about $12 million or, as Fayad told L’Orient Today, between $10-15 million.

Laury Haytayan, a Lebanese oil and gas expert, said taking over Novatek’s share may have been the “only solution” to allow drilling to move forward, but noted the gamble on the state’s part.

“The percentage is worth whatever it is worth. If there is a discovery … then they would make gains,” she said. “They’re after the easy bucks, easy money, but on the reverse of the coin, there might be nothing and then all of this is a gamble for nothing.”

Diana Kaissy, a senior energy governance specialist and member of the advisory board of the Lebanese Oil and Gas Initiative, an NGO promoting transparency in the sector, said opting to become a commercial partner in the exploration is a “high risk investment.”

“It’s less than a 17 percent [probability] to find gas from the very beginning and even if we do, there is a cost also attached to development and production,” she said. “How will Lebanon pay for this?”

Fayad said the government must “examine the options” to pay for Lebanon’s portion of the bill, but from his perspective, the sum is not a major burden.

“I would think it's not a big amount, given the prospects we are talking about,” he said.

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An energy sector source familiar with the discussions, who spoke on condition of anonymity because he was not authorized to speak publicly, said there are several options under consideration for Lebanon to cover its share of the costs. However, the final decision on which method to pursue, he said, would need to be made by the cabinet once a new government is formed, as a caretaker government would not have the authority to make such a decision.

The first option is for Lebanon to ask Total and ENI to carry the costs during the exploration phase on the condition that Lebanon would reimburse them in the event that there is a discovery, he said.

The government could also dip into a $45 million pot of funds that came from the sale of seismic survey data. Under the Offshore Petroleum Resources Law, these funds should be deposited in a sovereign wealth fund, but since no such fund has yet been created, the seismic survey proceeds are now held in an account at Banque du Liban held jointly by the Energy Minister and the head of the ministry’s oil facilities division.

However, the source said, these funds are considered to be “lollars” or “Lebanese dollars,” which are withdrawn in lira at an exchange rate lower than the market rate. To use them for the drilling costs would require BDL to agree to convert part of the amount to “fresh” dollars that can be withdrawn at their full USD value. A BDL spokesperson did not respond to a request for comment.

A third option is to find another partner to take over some, or all, of Lebanon’s share, the source said.

A second energy sector source, who also spoke on condition of anonymity, said that under the current arrangement, the government can farm out its share at any point. If Lebanon had opted to take only a 0.01 percent share, the rest of the participating interest would go to the Total and ENI and legally exploration could still go forward, he said.

The broader oil and gas picture

The question of the Novatek shares is only part of the complicated landscape that is the oil and gas sector in Lebanon.

The laws governing the oil and gas industry in Lebanon are generally comprehensive, with some gaps, though many have not yet been implemented in practice, said Carine Tohme, a board member of the Lebanese Association for Taxpayers Rights and Information (ALDIC).

Three primary laws govern Lebanon’s oil and gas sector: The Offshore Petroleum Resources Law (Law no. 132/2010), which sets the pillars of the legal framework of the oil and gas sector; the Law for Tax Provisions related to petroleum activities (Law no. 57/2017), which tackles all taxes in relation to the sector, including income tax on petroleum activities and workers’ wages; and the Law Enhancing Transparency in the Petroleum Sector (Law no. 84/2018), which deals with transparency across all the spectrum of activities and aims at combating fraud and corruption.

While the Offshore Petroleum Resources Law states that revenues from the oil and gas sector should be deposited in a sovereign wealth fund, draft laws to establish such a fund have not been voted on yet.

While Lebanon has the laws to tackle corruption in the oil and gas sector, according to experts, their lack of implementation comes down to law enforcement and governance, both of which have had fundamental shortcomings in the country.

Assaad Thebian, executive director of Gherbal Initiative — an NGO that aims to monitor the work of Lebanese administrations through the right of access to information — told L’Orient Today that Gherbal regularly requests information from Lebanon’s multiple administrations that manage the oil and gas sector. These include the Directorate General of Oil, which operates within the energy ministry, the Lebanese Petroleum Administration, the Litani River Authority, which has three plants for producing energy using water resources, Electricite du Liban and Electricite du Zahle.

“Some of them have been cooperative and some of them have not,” Thebian said.

He noted the Lebanese Petroleum Administration has gone public with some of the contracts signed between the state and the oil companies, but “there are some contracts that we still don’t have.” He added that the LPA is still operating according to their 2020 budget.

“Even if there is utmost transparency in sharing data, it does not necessarily mean that we are protected as citizens and that we can eliminate the prospect of corruption in this sector,” Thebian added. “Corruption in Lebanon is persistent via many routes, especially with the absence of judicial independence and accountability and with the persistence of the quotas and the sectarian mentality.”

In event the gas and oil exploration turns out to be profitable, Lebanon will collect petroleum royalties from the total production, which are payments made by the companies to the Lebanese government for the oil and gas extracted, Tohme explained.

The companies’ net income is subject to profit sharing with the state, as outlined in the exploration and production agreement. On top of that, Lebanon imposes a 20 percent tax on the income of the rights holders, a higher rate than corporate taxes in the country.

“There are several tax exemptions to encourage the sector in Lebanon, but, in general, there is a chain of taxes to be collected and enforced,” she said.

And finally, the companies that hold petroleum rights pay “area fees” to the state, which give them the right to “use the petroleum area.”

“So when we heard [politicians] hoping to use oil and gas profits to give the depositors their money back, they were referring to the 20 percent of the profit’s taxes settled by the companies and other taxes,” Tohme explained.

The stakeholders and their roles in the oil and gas sector

The Lebanese cabinet legislates the public policies in the oil and gas sector while the Energy Minister monitors their implementation. The Lebanese Petroleum Administration, a self-governed public institution mandated to plan, supervise and manage Lebanon’s petroleum sector, has a consultancy role by which it arranges contracts between the state and the oil companies, monitored by the Energy Minister.

The Finance Ministry handles the industry’s taxes, settled by the companies, whether Lebanese or non-Lebanese, that have petroleum rights and which are required to establish a company branch in Lebanon. The Finance Ministry is also obligated to publish any data it handles, namely data related to taxes.

The Environment Ministry has a role in the petroleum sector, albeit a legally vague one, according to Tohme. The role involves carrying out an environmental assessment to determine the impact of oil drilling and exploration activities on the environment, which was completed two years ago.

The Law Enhancing Transparency in the Petroleum Sector (Law no. 84/2018) stipulates civil society’s role, which includes supporting transparency, monitoring the law’s implementation, demanding data sharing, and taking legal action in the event of any violations of the transparency law, such as evidence of corruption.

Correction: A previous version of this article incorrectly stated that if Lebanon had taken only a 0.01 percent interest and ENI and Total did not bring in a third qualify rights holder, the exploration could not go forward. Legally, the exploration could continue in this case.

BEIRUT — With the end of maritime border negotiations between Lebanon and Israel reportedly in sight, the Lebanese government announced last week that it would take over the 20 percent share vacated by Russian company Novatek, which had pulled out of a consortium licensed to explore two offshore oil and gas blocks.Lebanese officials said the decision was necessary to allow exploration to...