First published in Norton Rose Fulbright's Shale gas handbook in 2013 (2nd edition published June 2015). The handbook is a global quick reference guide for all those involved in the exploitation of unconventional gas resources.
The Main Karoo Basin covers approximately 700,000km2 of the central part of South Africa. It is the erosional remnant of 100 million years of sedimentation in the heartland of the supercontinent known as Gondwana. This basin is where the majority of South Africa’s onshore fossil fuel reserves are located.
In the late 1960s, Soekor (now PetroSA) began onshore exploration for conventional oil accumulations as part of the national strategy to establish energy independence for apartheid South Africa. The exploration programme proved unsuccessful, Perceived low prospectively caused the Soekor focus to shift offshore, particularly to the Cape South East Coast, where several significant oil and gas discoveries were made subsequently.
The Soekor onshore exploration programme around the Cradock area had evidenced significant natural gas occurrences, both at the surface and at intervals in the deep boreholes, indicating an active petroleum system. At the time, natural gas was not a recognised fuel resource in South Africa.
The change in the US domestic situation, coupled with improvements in technology and the feasibility of exploitation, prompted the US Energy Information Agency (EIA) to commission a comprehensive evaluation of shale gas resources in several regions outside the US.
Extrapolating the old Soekor gas data, the US EIA identified three Ecca shale formations in South Africa – the Whitehill, the Prince Albert and the Collingham formations. In aggregate, this is an area of approximately 183,000km2 with potential for shale gas. Of particular interest is the Whitehill formation, which contains large tracts of organically rich, thermally mature black shales. The US EIA estimated a total recoverable resource of gas within the formations of 485 trillion cubic feet (TCF). This was perceived by the task team appointed by the South African Department of Mineral Resources to investigate the feasibility of shale gas production as a favourable scenario.
A key uncertainty in the prospectivity of the Whitehill formation is the intrusion of kimberlite dykes, dolerite dykes, and sills not found in gas-bearing shales elsewhere in the world. It is thought that the dolerite intrusions could have resulted in thermal degassing of the shale formation. It is also possible that the crystallised rock may provide conduits for, or barriers to, fluid migration (both groundwater and frack-fluid), which has significant environmental implications. This uncertainty is likely to continue until such time as exploration wells are drilled and hydraulically fractured, as part of a resource-confirmation process.
Graphic: Petroleum Agency of South Africa
The task team believes the US EIA report may have overstated the total organic carbon by weight value in the estimation of the Collingham and Prince Albert resources. Accordingly, in a ‘low-case’ scenario, that is an unfavourable scenario, the task team has significantly reduced the prospective extent of the resource in the Whitehill formation, and has excluded the Collingham and Prince Albert formations from consideration. Nevertheless, the task team still arrives at an estimate of approximately 30 TCF of technically recoverable shale gas in the Karoo Basin under such a ’low-case’ scenario.
The task team advises that the South African government can confidently decide on resource confirmation and exploitation, as 30 TCF remains a game changer for South Africa’s energy self-sufficiency and economic development.
The US EIA has revised its assessment of the South African resource a second time since publication of its revised report issued in June 2013. The revised assessment takes account of sill intrusions and the complex geology throughout the Karoo Basin, with this ‘unusual’ condition representing risk in the exploration for and production of shale gas in the region. Consequently, the US EIA has reduced the South African shale gas prospective area by 15 per cent and ‘significantly risked’ the remaining resource. On its desktop revision, the US EIA now estimates the South African resource to be of the order of 390 TCF.
The main legislation governing exploration for and exploitation of minerals and petroleum in South Africa is the Mineral and Petroleum Resources Development Act (MPRDA). The Department of Mineral Resources is the government authority responsible for the administration, control and management of petroleum resources and the regulation of petroleum exploration and production. Under the MPRDA, shale gas is defined as ‘petroleum’.
Until recently, the environmental regulation of petroleum exploitation was addressed in the MPRDA and the regulations promulgated under it. For historical reasons, minerals and petroleum exploitation were each subject to a special environmental regime. Recent amendments to the National Environmental Management Act, 1998 (NEMA) and the MPRDA have brought petroleum within the ambit of NEMA.
Applicants for exploration and production rights will need to secure an environmental authorisation in terms of NEMA as a condition for the grant of the exploration or production right.
Section 24 of NEMA empowers the Minister of Environmental Affairs to list activities that may not commence without an environmental authorisation. An environmental authorisation is granted on the basis of an assessment conducted in terms of the Environmental Impact Assessment Regulations. The Minister of Environmental Affairs has recently published for comment an updated version of the Environmental Impact Assessment Regulations together with updated listing notices, containing various exploration and production-related activities. The new environmental regime will commence once the final version of the regulations and listing notices are promulgated.
Under the new system, the Minister of Mineral Resources is the competent authority to grant environmental authorisations for activities related to exploration and production of shale gas. The Minister of Environmental Affairs will serve as the appeal authority.
The Minister of Mineral Resources has published draft technical regulations for petroleum exploration and exploitation (the Technical Regulations). The final version is expected to be promulgated in the first quarter of 2015. The Technical Regulations are intended to establish comprehensive technical and environmental standards for the conduct of hydraulic fracturing in South Africa. They govern, among other things, well design and construction, well abandonment, drilling fluid management of waste and management of water. They supplement existing regulation of environmental impact assessments.
Exploration and production rights granted under the MPRDA are limited real rights with respect to the land to which they relate. The holder of an exploration or production right is entitled to enter the land to which such a right relates, explore or produce for its own account on such land, and, subject to the National Water Act 1998, to use water from any natural water resource situated on such land.
Previously, mineral and petroleum rights in South Africa could be acquired and registered separately from the title to the land. However, the MPRDA vested South Africa’s mineral and petroleum resources in the people, with the State as custodian. The State grants the right to explore for and exploit these resources to third parties, and the State benefits through fiscal revenues. This is likely to change and it can be anticipated that there will be increased participation by the State in actual projects.
In accordance with the MPRDA, the holder of a petroleum right may access the land over which the right has been granted. A land owner may not preclude the holder of the right from entering their land. However, the holder of a right is obliged to notify and consult with the land owner or lawful occupier of the land before commencing exploration or production activities. The land owner may be entitled to compensation for any loss that they sustain by reason of the petroleum operations on their property.
The Petroleum Agency of South Africa (PASA) is the authority designated by the Minister of Mineral Resources to perform the functions in the MPRDA relating to the management and regulation of exploration and production rights. PASA’s mission is to promote exploration for onshore and offshore oil and gas resources and their optimal development on behalf of government. PASA regulates exploration and production activities, and administers the national petroleum exploration and production database.
Reconnaissance operations, technical cooperation studies, exploration operations and production operations may only be conducted within South Africa with the appropriate statutory authorisation as provided for in the MPRDA.
Applications for permits and rights
Applications for a reconnaissance permit (RP), technical cooperation permit (TCP), exploration right or production right must be submitted to PASA. Prescribed application fees are payable and the regulations specify the supporting documentation as to technical and financial capability that should accompany these applications.
The MPRDA does not confer any discretion upon PASA when accepting applications for such authorisations. PASA must accept applications for processing if the specified criteria are met. Once an application is accepted, PASA must process the application in terms of the provisions of the MPRDA and its regulations.
If the applicant complies with all the requirements stipulated under the MPRDA and the regulations, PASA is obliged to recommend to the minister that the application is accepted. The minister, in turn, has limited discretion. If the application is fully compliant with the requirements of the MPRDA and regulations, the Minister must approve it. However, the minister has a discretion in relation to the appropriateness of the proposed work plan, and/or the proposed social development obligations.
Once an application has been approved, the relevant permit is issued or the negotiation of the actual terms of the exploration or production right commences. ‘Negotiation’ is a misnomer, because the terms of the exploration or production right are standard. They are only departed from in exceptional circumstances and where such departure is in the interests of the State. Once the exploration right or production right has been notarially executed, there is a 60-day period to lodge the right for registration in the Mining Titles Registration Office. Failure to do so will cause the right to lapse.
Under the present framework, a first mover to apply for a right or permit over acreage not subject to any other applications, rights or permits is exclusively entitled to be granted that right subject to compliance with the requirements of the MPRDA. The holder of a TCP has an exclusive entitlement be granted an exploration right over the technical cooperation area, provided its application is compliant. In turn, the holder of an exploration right has an exclusive right to apply for and be granted a renewal of the exploration right or a production right over the exploration area.
One of the objects of the MPRDA is to reform the petroleum industry and bring about equitable access to South Africa’s petroleum resources. The Minister of Mineral Resources has the right to facilitate assistance to historically disadvantaged South Africans (HDSAs), to enable them to participate in exploration and production operations. Section 1 of the MPRDA defines ‘historically disadvantaged South African’ to include juristic persons that meet certain conditions.
There are currently two charters that provide a framework for progressing empowerment of HDSAs in the context of mining, exploration and production.
The Mining Charter (the Broad-Based Socio-Economic Empowerment Charter for the South African Mining Industry) sets a target of 26 per cent HDSAA ownership of the mining industry, to be achieved over a period of 10 years. This period expired at the end of 2014 and, at the time of writing, the target has not been revised.
Liquid Fuels Charter
Under the Liquid Fuels Charter (the Charter for the South African Petroleum Liquid Fuels Industry Empowering Historically Disadvantaged South Africans in the Petroleum and Liquid Fuels Industry) an interest of not less than 9 per cent should be reserved for HDSAs in all exploration and production rights in the country’s offshore area. In practice, the 9 per cent has increased to 10 per cent.
The Minister of Mineral Resources currently applies the Liquid Fuels Charter to onshore and offshore exploration and production rights, although it is the Mining Charter that is envisaged in the MPRDA.
The award of an exploration or production right is conditional on compliance with the Liquid Fuels Charter. In the case of exploration rights, this condition operates as a discretionary requirement. In the case of production rights, it is a mandatory statutory requirement.
The way in which HDSAs earn or pay for the 10 per cent is not legislated. Therefore this is open to negotiations between applicants and the HDSA, subject to the ’unofficial approval’ of PASA.
Compliance with the Liquid Fuels Charter only becomes compulsory at the production stage. However, the holder of an exploration right must make a sincere attempt before or during the period of this right to find a suitable partner who is a HDSA to take up shareholding/equity.
The terms and conditions of the exploration right impose further duties relating to the employment of HDSAs, skills transfer and procurement.
Any person may apply for permits and rights under the MPRDA. However, the Companies Act requires foreign companies to register with the Companies and Intellectual Property Commission within 20 business days after they begin to conduct business in South Africa.
A foreign company is regarded as conducting business if that company is a party to one or more employment contracts within South Africa, or is engaging in a course of conduct, or has engaged in a course or pattern of activities within South Africa over a period of at least six months, such as would lead a person reasonably to conclude that the company intends to continuously engage in business in South Africa. In other words, if a foreign company is actively participating in exploration, it will at the very least be required to register as an external company.
In its current form, the MPRDA does not provide for a mandatory equity or interest to be held by the State in an exploration or production company or right. However, the terms and conditions of exploration and production rights must be approved by the Minister of Mineral Resources. As indicated, such terms are ‘negotiated’ between PASA and an applicant on the basis of PASA’s standard draft Exploration Right (Draft ER) and/or PASA’s standard draft Production Right (Draft PR).
The Draft ER and Draft PR provide for an option in favour of the State to acquire a maximum participating interest of 10 per cent. Upon the exercise of this option, the State becomes a party to any joint operating agreement in relation to the relevant production. It is required to contribute a proportionate share of the production costs and expenses, but is not required to contribute towards past expenses for any exploration or appraisal operations. The State does not pay any other amount for the acquisition of this 10 per cent interest through the exercise of the option.
Participants in petroleum operations in South Africa will be subject to income tax and royalties. The 10th Schedule to the Income Tax Act sets out the income tax rules applicable to oil and gas companies.
South Africa has numerous double tax treaties with other countries, many of which will reduce the taxes payable by petroleum companies.
In terms of the Royalty Act, an extractor of mineral resources must pay a royalty in respect of the transfer of any mineral resources extracted within South Africa. The royalty to be paid is calculated as a percentage of the gross sales of the extractor.
The fiscal stability provisions of the Income Tax Act and the Royalty Act provide that a person operating in the petroleum industry may elect that the income tax or royalty regime, as it was when the person obtained the operating rights, remains applicable for the duration of their petroleum operations.
Foreign nationals can freely transfer capital into South Africa. However, investments must be reported to the exchange control authorities and share certificates evidencing investments must be endorsed ‘non-resident’ so that dividends can be freely repatriated. Reserve Bank approval will also be required should any foreigners wish to invest by way of loan capital.
In addition to requiring applicants for exploration and production rights to obtain environmental authorisation for their operations, NEMA imposes several other obligations directed at environmental protection.
An applicant for an environmental authorisation must, before the environmental authorisation is issued, make financial provision (in the form of insurance, bank guarantee, trust fund or cash) for rehabilitation, closure and ongoing post-decommissioning management of negative environmental impact of the exploration or production operations. The Minister of Mineral Resources is also empowered to determine that a portion of the financial provision is retained following the closure of the operations in order to cover latent or residual environmental impacts.
NEMA also confirms that rights holders are responsible for any environmental damage, pollution or ecological degradation resulting from their operations and provides for criminal liability in certain circumstances, including personal liability in the case of company directors under certain circumstances.
In 2014, Parliament passed the Mineral and Petroleum Resources Amendment Bill, 15 of 2013 (the Bill) and referred it to the President for assent. The President has not assented to the Bill but has instead referred it back to the National Assembly, the lower house of Parliament, on the basis of various constitutional reservations. The National Assembly must now reconsider the Bill and decide whether to pass it with our without amendments or to rescind it.
The Bill proposes broad changes to the current regulatory framework for both conventional and unconventional petroleum resources. Most of the provisions that affect the petroleum industry will require the promulgation of regulations for their implementation.
The most significant amendments proposed pertain to State participation in exploration and production projects. If the bill is brought into operation, the State would have the right to acquire a 20 per cent ‘free carried interest’ in all new exploration and production rights, from the effective date of such rights. Free carried interest is an ‘interest allocated to the State in exploration or production operations without any financial obligation on the State’. In addition to the free carried interest, the State may acquire a further unlimited interest either through acquisition at an agreed price or through a production-sharing agreement. The Bill does not cover what the case would be where parties cannot agree on the price.
The Bill defines a production-sharing agreement as ‘an agreement between the State and the petroleum company on how the extracted resource will be shared between the State and the petroleum company’. The terms and conditions of the production sharing agreement have not been published by the State.
In May 2010 and August 2010, Bundu Gas & Oil Exploration (Pty) Ltd and Falcon Oil & Gas Ltd lodged applications for exploration rights in the south-central and central parts of the Karoo Basin. The ministerial decision on these applications are pending.
In December 2010, Shell Exploration Company BV lodged three applications for exploration rights over three discrete blocks across the south-central part of the Great Karoo Basin. Two applications were accepted by PASA on December 13, 2010 and the third was accepted on December 14, 2011.
In February 2011, the Minister of Mineral Resources imposed a moratorium on the processing of new applications for permits and rights over the Karoo Basin. The moratorium provides that the applications received before the imposition of the moratorium were not affected by it. A few weeks later, the minister announced a further non-statutory moratorium on the processing of existing applications for exploration rights, pending the findings of the government task team.
The task team reported to the minister in mid-2012. In September 2012, the Cabinet announced that it endorsed the task team's recommendation of proceeding with limited exploration for shale gas, in order to confirm the South African resource, subject to strict monitoring and augmentation of the current regulatory framework.
The technical regulations on petroleum exploration and exploitation were first published for comment in October 2013. They are intended to prescribe good international petroleum industry practices and standards and were formulated following consultation with regulatory authorities in mature shale gas regions. They make provision for full disclosure of frack-fluid composition.
The regulations follow from a recommendation by a government task team established by the Department of Mineral Resources (DMR). The task team recommended that the government authorise initial hydraulic fracturing subject to the condition, among others, that the regulatory framework is augmented by appropriate regulations, controls and coordination systems.
Hydraulic fracturing has been declared a ‘controlled activity’ under the National Water Act: no one may undertake hydraulic fracture operations in South Africa without having obtained a water use licence. This is granted only if the applicant can demonstrate that there is sufficient water available to undertake the activity concerned, and that such use will not have a deleterious impact on the South African water resource.
The February 2011 moratorium has expired and a further moratorium was imposed on February 3, 2014. This excludes from its ambit the three applications for exploration rights that were submitted prior to February 1, 2011, subject to the proviso that no hydraulic fracturing will be permitted until the technical regulations have been published.
It is clear from South Africa's National Development Plan and the DOE Determination on the Baseload IPP Procurement Programme that the State intends to forge ahead with exploration for and production of shale gas in the Karoo Basin. In light of the State's apparent intention to implement a competitive rights application process, this should lead to opportunities for future participation by other interested parties. The President's statement at the State of Nation address on February 12, 2015 noted that Eskom has been instructed to switch from power generation by diesel to gas.