Clarifying the concept of ‘local content’ in petroleum sector

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In the recent past in Kenya, the debate on local content requirements has raised dust within and beyond the petroleum sector. With all the talk, we could do with some clarity on the related underpinning legal principles. The following extract of an interview with Professor Albert Mumma, Energy Law Lecturer at the University of Nairobi, offers some insight.

Thinking about the Petroleum (Exploration, Development and Production) Draft Bill, 2015, and the local content requirements, there has been disgruntlement among local communities. They claim they are not getting what they should out of the petroleum in their area, but companies are saying, “We are trying our best.” So, what is local content and what does the law have to do with it?
Local content refers to participation by citizens in economic activity and is often used in the context of investment by foreign companies in the exploitation of natural resources in a country. It is often given meaning through some kind of legislation to structure the nature of that participation, so that it is driven by the country at the national policy level rather than managed by investors.

What do you think about the provisions in the Petroleum Act as we have it, in comparison to the Draft Petroleum Bill and Draft Local Content Regulations?
The area of concern we most often see is dissatisfaction by members of the local community. It arises from the fact that they would like to see some benefit out of the exploitation of natural resources. They argue that the local community is entitled to benefit.

This is premised on the assumption that they have a certain right to natural resources in that locality. However, under the Constitution of Kenya 2010, ownership of natural resources is vested in the National Government. Specifically, under the Petroleum (Exploration and Production) Act, ownership of crude oil is vested in the National Government. There is no ownership right to natural resources vested in local communities.
These communities are unhappy nevertheless. So there has been a push for some share of benefits to be given to them and that issue is still not yet formalised within a specific legal framework that would define the extent of benefits they should get. A number of investors give some benefits to local communities on a case by case basis, most of it in the form of corporate social responsibility.

The Mining Act passed this year attempted to address this issue in the mining sector.  More broadly, a Bill was introduced in the Senate that talks about benefits-sharing in regard to natural resources. Moreover, for extractive activities, there is an environmental and social impact assessment, and mitigation measures.

Even if there is absence of provisions, it is still important that developers give some communities benefits for the reason that they do want some buy-into the investment. In Kinangop, the developer was forced to abandon an investment in a wind energy project because the local community was unhappy with it.  A legally strict interpretation of the law will not deliver to them the benefits they wish to obtain for an investment in petroleum. That discussion is slightly different from the concept of local content because local content does not specifically relate to the local community.

Any Novelties in the Draft Local Content Regulations, 2014?
The Draft Regulations address participation in a number of parameters. One is through employment opportunities. But it will be limited by the fact that often, there will not be the necessary technical qualifications among locals to enable them to fully benefit from those opportunities. There is also an expectation that investors will provide training opportunities for locals.

The second one is the opportunity for investment. The initial investment for this sector is very capital-intensive and putting together the financing for it is an exercise that often means foreign companies will start off this investment. One framework for investment by locals is that the foreigner goes into a joint venture with a local company.

The other is the requirement that foreign companies give some shares to local companies. An example of this is in South Africa through the Broad Based Black Empowerment Laws where they force companies to offer shares to black enterprises. However, there is a real risk that has manifested itself in South Africa, where the end result is a small elite club without an equitable mechanism for extending participation more widely. It may lead to the amassing of oil wealth in the hands of a few of local players.

The other has to do with provision of supplies, equipment and utilities: procurement. Within the Regulations, investors should give preference to sourcing of materials locally. It is expected that the local content of such material supplies will be up to 40 per cent, a significant proportion. This approach forces local suppliers to improve the quality of their supplies. However, sometimes, the opportunity is there but locals either lack the capacity to deliver or when they do deliver, the quality is not good enough. So it is an area that would require restructuring and preparation.

The weakness that one needs to address is that because these are private investors, there is no requirement in law that they competitively and openly source for their suppliers.

Should the investors be worried about possible over-regulation?
An investor would like a clear regulatory framework that operates without the opportunity for rent-seeking. The challenge that arises from local content regulation is that investors need to bring onto their side people who can open doors for them, and goes to looking at how they are playing the political game. When that is done, and there is the possibility, as the Regulations provide, of even criminalising certain activities, investors begin to worry that they could be blackmailed.

The other problem is that this is an area which takes investors beyond what they really wanted to do. Who are the local community members? Are they happy? To what extent are local communities benefitting from their investment? To what extent have they given some participation to locals in their shareholding? An example is the legal problems that have dogged Tatu City. They have a very minority shareholder, 1 per cent, who has totally tied them down. I don’t think investors will be terribly happy to take on board these issues.

How can we mitigate the obvious shortfalls of such Regulations?
I will deal with the potential for litigation first. When you give people some expectation that they have the right to benefit from an investment, they will try and ventilate and enforce those rights in the litigation process. Now, the Constitution 2010 opened up avenues for litigation to anybody, regardless of how unsubstantial their claim is. That litigation is a risk because it frustrates procurement and it will frustrate investment in this sector.

One area that should be protected is that which enables those who have a grievance to obtain injunctive orders. They do this more to apply pressure than anything else. On the whole, courts have been too liberal with giving injunctions.

Partly, the legislation is too open-ended on this question. There is no reason why it is not possible to say, “Fair enough, you litigate your issue, meanwhile the project continues; if you succeed, you will be paid damages.” To do that, the Government must look at setting up a Compensation Fund so that these guys can litigate and the investors do not bear the full risk. In places like Mauritius, they litigate, but the court does not give them injunctions. So they have managed to constrain this appetite of running for court orders.

The other problem that would lend itself to litigation is that we have abandoned the concept of locus. We don’t even have the concept of a busybody. Locus is the idea that, surely, you must demonstrate what your interest in this matter is. Imagine you are carrying out some project in Turkana, but someone, let’s call him an activist, who has nothing to do with Turkana, runs to court and gets an order. A fellow shoots up and says there is no community benefit. Is that fellow from that community? No one asks that.

Investors cannot figure out who they should be mollifying. Any number of these 40,000,000 people potentially is a beneficiary of their projects. We must spend some effort defining “local community” so that investors know who to deal with. We have reform on our lips that is hampered by stagnation in the law; blame it on Kenyan perfectionism!

We know we need a new law and regulations but we are not getting there. What is holding us back?
Every time you put forward a proposal, you have many people saying it is not good enough so it should not move ahead until it is perfected. I view law as evolutionary and do not think we should spend all our time perfecting a document. Then there is the difficulty that occasionally, you don’t have somebody who is clearly leading the process. So the Bills – and I mean that generally – stagnate.

The question on how to benefit from natural resources is a big one. People argue about almost every natural resource. To start us off, let’s begin by improving what we have.

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