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Focus: Mongolia's Law on Petroleum revised

24 December 2015

In brief: Mongolia has revised its Law on Petroleum which will operated in tandem with its 2005 Law on Petroleum Products. Partner Igor Bogdanich (view CV) and Consultant Manduul Altangerel look at the new law and what it will mean for companies prospecting and extracting petroleum products in Mongolia.  

 
 

How does it affect you?

  • There is a clearer framework of legal regulation for petroleum-related activities than before. The rules around licensing and the operations at each stage and the type of petroleum-related activities that are permitted and regulated have been clarified. This includes the role and scope of the government bodies involved in authorizing and enabling the relevant petroleum-related activities.
  • Contractors to Production Sharing Agreements concluded with the Government of Mongolia prior to 1 July 2014 are to remain unaffected with regards to key matters under the agreements.
  • Further implementing regulations and/or amendments to the new rules and procedures may be enacted as the new law is tested. 

Background

On 1 July 2014, the Parliament of Mongolia passed a new revised Law on Petroleum (the Revised Law). The Revised Law replaced the previous Law on Petroleum (the Previous Law) that had been in effect since 1991 – one of the oldest laws to remain in force since Mongolia established a market economy through its Constitution in 1992. The Previous Law had been a fairly generic regulatory document consisting of 15 brief articles and served as the underlying legal basis for the majority of the current projects that include exploration projects on 18 licence areas by 16 companies, 3 exploitation projects, and 8 projects at the negotiation stage for a Production Sharing Agreement as at 2015.1 The Revised Law aims to regulate matters pertaining to prospecting, exploration, and the exploitation of petroleum and unconventional petroleum.

Another law relevant to the petroleum industry in Mongolia is the Law on Petroleum Products, that was enacted on 1 July 2005, and that aims to regulate other oil-related activities such as importation, production, sales, transportation, storage of petroleum products and ensuring the safety of these activities. The Law on Petroleum Products remains in force.

This note focuses on the Revised Law.

Key points

Key regulations

The key areas for regulation under the Revised Law are prospecting, exploration, exploitation and transportation of petroleum and unconventional petroleum. The regulations are extensive when compared to that under the Previous Law.

  • Overall, prospecting activities may be initiated by means of entering into a prospecting agreement with the government agency in charge of petroleum affairs – the Petroleum Agency of Mongolia (PAM). At the completion of the prospecting stage, the entity conducting oil exploration and/or exploitation, ie the Contractor (as known under the Revised Law) may then apply to advance to exploration activities, by submitting a proposal for a Production Sharing Agreement (PSA), to be negotiated and entered into with the PAM.
  • The Contractor is also obliged to apply for, and obtain, an exploration licence from the Ministry of Mining, in order to obtain the authorization to conduct exploration work. In specific cases identified by the Revised Law, where the Contractor is unable or unwilling to advance to the exploration stage, or where the licence area or licence has become unavailable to that Contractor, the PAM must announce an open tender process to grant exploration rights for that specific licence area. A Contractor conducting exploration work must submit reserve assessment reports among other reports to PAM on completion of the assessment work.
  • In the case of, and upon, the approval and acceptance of a reserves assessment report by PAM, the Contractor may, if it chooses to advance to the exploitation stage, apply for an exploitation licence. Similar to the reasons for announcing an open tender for exploration work, PAM may announce an open tender on the relevant licence area if the Contractor has failed to submit its application for an exploitation licence within 90 days after the expiry of the term of the exploration licence.

These activities are further summarized below.

Prospecting

1. Under the Previous Law, prospecting (or 'prospection' as it is referred to in the Revised Law) and exploration stages were not seen as separate activities, and, as such, in the past, a 'contractor' entered into a production sharing agreement at the stage of ‘prospection and exploration’. The Previous Law provided a clear definition to the effect that an organization or a citizen of Mongolia or a foreign country could be a contractor. However, under the Revised Law, prospection is set out as an independent stage of petroleum-related activity, separate from that of exploration, and an agreement different to the PSA, serves as the basis of the authorization to carry out prospecting activities. Therefore, while the Revised Law requires that a Contractor (which is not a prospector, at the stage of prospection at least) be in the form of a ‘company’, in fact ‘prospection work [is required] be conducted by a legal entity based on an agreement entered into with the [PAM]’. There are no further provisions in the Revised Law that address or specify whether the entity (or even the company) may be a foreign entity, or is required to be registered in Mongolia.

2. The application for the right to conduct exploration work must include the following:

  • the location and size of the proposed prospection area;
  • general workplan for the prospecting work;
  • technical capacity, human resource capacity;
  • financial capacity and resources to finance the planned work; and
  • the annual prospection work plan and draft.

PAM is obligated to review and resolve the application within 30 days after receipt. In doing so, it is required to consider the following, as set out by the Revised Law:

  • the technical, technological, professional and financial capacity of the applicant;
  • whether the methods, methodology are consistent with international standards; and
  • environmental protection and rehabilitation plans.

3. The term of the agreement to conduct prospecting activities may be up to three years as determined by PAM, and the Revised Law prohibits novation of the prospection agreement to third parties.

Based on the recommendation issued by PAM on the results report of the prospection work, the prospector may submit a proposal to enter into a PSA with respect to the area of prospection.

Exploration

Exploration rights comprise a PSA; and the associated exploration licence.

There are two ways through which an entity may acquire exploration rights:

  • based on the prospection work, the Contractor proposes to enter into a PSA as discussed above; or
  • through participating and winning an open tender for exploration.
Exploration rights based on prospecting work

Where an applicant is advancing from the prospection to the exploration stage, the draft PSA is proposed by the prospector and negotiated with PAM. Once the PSA is entered into, the prospector who is now the Contractor, is required to apply for an exploration licence, and provide the following documents to PAM:

  • a copy of the PSA;
  • an environmental impact assessment;
  • an annual work plan; and
  • Proof of deposit of money equal to 3 per cent of the exploration expenses for that year, or in respect of an exploitation stage, 1 per cent of the profit oil2 to be allocated to the Contractor, as a guarantee to fulfill environmental rehabilitation obligations and the decommissioning of exploration or exploitation buildings and facilities (the Guarantee Deposit).
Exploration rights based on open tender process for exploration areas

PAM must announce an open tender process for exploration rights under the following circumstances:

  • where the exploration work was state-funded or the areas were specifically defined by the state administrative organization;
  • the prospector refused to enter into a PSA;
  • a previous exploration licence-holder's licence was revoked, or the licence area was returned;
  • the licence area was returned upon expiry of the term of the exploration licence; or
  • the exploration licence was revoked on specific grounds set by law.

Once the tender is announced through PAM's website and other media (eg the daily press), the general period for accepting bids is set out by the Revised Law to be up to 60 days. The PAM exercises authority in determining and announcing the closing date of bids within five days after accepting the first bid. PAM will evaluate which bid is the most beneficial to the government. The Revised Law provides detailed provisions with respect to the documents required to be submitted in a bid, and other procedural aspects of the open tender process.

The winning bidder is then entitled to enter into negotiations for a PSA and apply for an exploration licence.

The period of an exploration licence may be up to eight years and can be extended twice for up to two years at a time by PAM. The start date of the term of the exploration licence is defined by the date of the PSA. The Revised Law provides detailed requirements in respect of an application for an extension of the exploration licence.

Transitioning to the exploitation stage

The Contractor must complete a reserves evaluation and estimate in compliance with the requirements set out by the Revised Law, and have it reviewed by PAM, considered by the Minerals Professional Council of the Ministry of Mining, and approved by the Ministry of Mining, at least 90 days prior to the expiration of the exploration term.

Exploitation

Following the decision of the Ministry of Mining to allow the petroleum reserve, the Contractor has 30 days to submit a formal application to conduct exploitation activities.

Like exploration rights, exploitation rights also require an exploitation licence, to be issued by the Ministry of Mining. Furthermore, an entity may acquire exploration rights in the following ways:

  • based on its exploration work, the Contractor may apply for exploitation rights; or
  • through participating and winning an open public tender for exploitation of the reserve.
Exploitation rights based on exploration work

Where the Contractor is moving from the exploration stage to the exploitation stage, it is entitled to apply for an exploitation licence. The Revised Law specifies the following documents must be submitted with the application:

  • the decision of Ministry of Mining registering the petroleum reserve;
  • a draft of the work plan and budget;
  • a mining operations plan;
  • a detailed environmental impact assessment current for the exploitation period;
  • an image on which the coordinates of the corner points of the exploitation area are marked in degrees and seconds on a topographical map of a design proposed by the competent state agency; and
  • the Guarantee Deposit.
Exploitation rights based on open tender selection process for exploitation areas

PAM may announce an open tender process for exploitation rights in the following circumstances:

  • the exploration licence-holder did not apply for an exploitation licence;
  • where the exploration work and the reserves study was state-funded;
  • a previous exploitation licence-holder's licence was revoked, or the licence area was returned;
  • the licence area was returned on expiry of the exploitation licence; or
  • the exploitation licence was revoked pursuant to a court decision.

The Ministry of Mining selects the winning bidder of any tender and PAM enters into negotiations for a PSA.

The period of an exploitation licence may be up to 25 years, which can be extended twice for up to five years at a time by PAM.

The Revised Law provides detailed requirements in particular to the procedures relating to unconventional petroleum.

PSA

The Revised Law requires that any draft PSA to be proposed by the Prospector applying to advance to the exploration stage, reflect the following items:

  • the percentage of profit oil allotted to the Government;
  • the percentage of royalties;
  • the limit of the percentage of cost oil;
  • the amount of proposed exploration investment;
  • the amount of funds spent on environmental rehabilitation;
  • the amount of premium for training/instruction;
  • the amount of a bonus for signing the contract;
  • the amount of a bonus for commencement of extraction;
  • the amount of a bonus for increasing the extraction;
  • the amount of bonus funds allocated for local development;
  • operational support of the representative office; and
  • any other profitable conditions proposed to the Government.

In addition, the Revised Law provides the following general rules regarding production sharing:

Licence fees

For exploration work, the contractor must pay for licence fees of US$3 per square km per year. If the exploration period is extended, the fee increases to US$8 per sq. km. For exploitation work, the licence fee is US$100 per sq.km. and where extended, the fee is double the amount (US$200 per square km). The Revised Law provides further details as to the allocation of the funds accrued from the licence fee to various levels of national budgets. Furthermore, a fine of one-third of the total fee payable is set to be imposed for every day of any overdue payment.

Royalties

The percentage range for royalties will be referenced to 5-15 per cent of the crude oil/natural gas extracted.

Cost recovery expenses and cost oil

All expenses incurred in relation to the petroleum activities are provided under the Revised Law to be borne by the Contractor. Cost recovery expenses are to be verified by the state audit authority and recovered by the allocation to the Government of the petroleum percentage set forth in the PSA. The cost oil is defined to be up to 40 per cent of the petroleum remaining from the total extracted oil less the petroleum equivalent to the royalty payment. Once the term of exploitation ends, the contractor will not be granted the portion of cost recoverable expenses that remain unrecovered. Furthermore, the Revised Law specifies that licence fees, royalties, other payments, incentives and services fees do not constitute cost recovery expenses.

Production sharing

The Revised Law provides that profit oil sharing shall be governed by the PSA.

Other payments, incentives and services fees

Other items such as bonuses for signing the contract, for commencement of extraction, for increasing extraction, and for training, are defined by the PSA as proposed by the Contractor.

However, the service fees for increasing a licence area are clearly set in the Revised Law: to increase the size of an exploration area, a fee equal to US$10,000, for an exploitation area US$25,000, is to be paid by the Contractor to the state budget, respectively.

The Revised Law includes further provisions with regards to fees payable for the transfer of rights and obligations of a Contractor at various stages of the petroleum extraction project.

Model PSA template

On 16 March 2015, by Resolution 104, the Government adopted a new Model Template for a PSA to be entered into between PAM and the Contractor on conducting petroleum exploration and exploitation activities. While the Model Template PSA is an extensive document that appears to comprehensively cover the key matters addressed by the Revised Law, its binding nature is not clear. The Model Template is required to be compliant with the law. In practice, most agreements of which model templates have been adopted by the Government largely follow the model, but it is understood that specific provisions have been known to be tailored to the individual project/matter.

Transportation

The Revised Law also provides regulation around petroleum measurement and price, storage and transportation. Specifically, it provides that petroleum may be transported via railways, designated auto-vehicles or transmission pipelines. The Contractor may build industrial-purposes transmission lines in the exploitation area, which shall remain the Contractor’s property during the term of the PSA. The PSA shall govern the issue of the title to the pipelines, after the expiry of the agreement.

The Contractor may also apply to the PAM to build commercial transmission pipelines. The Government is authorized by the Revised Law to resolve such application.

Reporting and monitoring

The Revised Law specifies specific deadlines, procedures around submitting various reports, and test results in relation to assays, rock samples, and primary data, including financial reporting, auditing and verification.

Title of assets and property

The title of technical equipment, tools, goods and material, and immovable property brought into the territory of Mongolia for the purposes of exploration and/or exploitation of petroleum and non-traditional oil is set by the Revised Law to be resolved as set out in the PSA.

Other matters

Other issues such as insurance, dispute resolution, overlapping of licence areas, and discovery of other resources have been generally addressed by the Revised Law. The Revised Law also includes a relatively detailed liability section for various violations of an administrative nature (non-compliance with regulatory rules) ranging from conducting prospection work without entering into the PSA with PAM, to failure of a exploitation licence-holder to fulfill a domestic processing plant with raw materials, with a range of administrative penalties such as imposition of a fine equal to the monthly minimum wage (currently 192,000 MNT or US$96) multiplied by 5-450 times depending on the nature of the violation, suspension of the licence for five years, to a fine of 50 per cent of the profits earned from the illegal activities to confiscation of property.

Retroactive application

The Revised Law identifies specific matters relating to payments, expenses, cost recovery, and production within PSAs entered into force under the Previous Law to continue to apply as before.'

 Disclaimer

This Focus is non-exhaustive, non-Mongolian legal commentary only. It has been prepared by international lawyers (who are not Mongolia qualified) based upon an unofficial English translation of the Law.

This paper is not intended to be, and must not be, relied upon for the purposes of Mongolian legal advice. If you have any questions or wish to discuss this Focus further, please contact any of the people below.

Footnotes
  1. See the PAM website, accessed 1 December 2015.
  2. 'Profit oil' is defined as '…petroleum divided between the Government and a contractor after deduction of the petroleum specified in clauses 4.1.26 (royalties) and 4.1.32 (cost oil) of this law from the total petroleum measured at a delivery point' (Article  4.1.33, Petroleum Law of Mongolia (2014). 

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