PUBLIC INTEREST ISSUES

OIL AND GAS PRoDUCTIoN IN THE PHILIppINES:

Fatima Alvarez Castillo

OIL AND GAS PRoDUCTIoN IN THE PHILIppINES: PUBLIC INTEREST ISSUES

Bantay Kita Occassional Paper Series No. 2012-01 A study commissioned by BanTaY KITa/ACTIon FoR EConoMIC ReFoRMs March, 2012 BANTAY KITA is a coalition of organization that advocates for transparency and accountability in the extractive industries. Office Address: Unit 1403 West Trade Center, 132 West Avenue, Quezon City, Philippines 1104 Telefax: (+632) 426-5632 Website: http://bantaykita.ph Email: secretariat@bantaykita.ph Writer: FaTIMa ALVaReZ CasTILLo Publication design and layout: R. JoRDan P. SanTos Send your comments, inquiries, write-ups, and contributions to: secretariat@bantaykita.ph/bantaykita@yahoo.com

PUBLIC INTEREST ISSUES

OIL AND GAS PRoDUCTIoN IN THE PHILIppINES:

Fatima Alvarez Castillo

Bantay Kita Occassional Paper Series No. 2012-01

OIL AND GAS PRoDUCTIoN IN THE PHILIppINES: PUBLIC INTEREST ISSUES

Bantay Kita Occassional Paper Series No. 2012-01 A study commissioned by BanTaY KITa/ACTIon FoR EConoMIC ReFoRMs March, 2012 BANTAY KITA is a coalition of organization that advocates for transparency and accountability in the extractive industries. Office Address: Unit 1403 West Trade Center, 132 West Avenue, Quezon City, Philippines 1104 Telefax: (+632) 426-5632 Website: http://bantaykita.ph Email: secretariat@bantaykita.ph Writer: FaTIMa ALVaReZ CasTILLo Publication design and layout: R. JoRDan P. SanTos Send your comments, inquiries, write-ups, and contributions to: secretariat@bantaykita.ph/bantaykita@yahoo.com

CoNTENTS
INTRoDUCTIoN.............................................................4 THE PRoDUCTIoN oF INDIgENoUS OIL AND GAS.............7 GoVERNANCE..............................................................13 THE MALAmpAYA GAS PRoJECT.....................................19 TRANSpARENCY AND PUBLIC INTEREST ISSUES..............24 REFERENCES................................................................26 ACKNoWLEDgEmENTS.................................................30

OIL AND GAS PRoDUCTIoN IN THE PHILIppINES: PUBLIC INTEREST ISSUES

INTRoDUCTIoN
OBJECTIVE AND SCoPE.
This paper is a scoping of public interest issues in Philippine oil and gas production. It is a preliminary examination of these issues for the use of Bantay Kita and other civil society organizations concerned with the extractive industries. The scoping was instructed by primary data from interviews with key informants and secondary datafrom relevant laws, reports from the Department of Energy (DOE), and other documents and literature. The scoping has some data limitations. Attempts to access data on exports and taxes paid by companies were unsuccessful. These were considered confidential by government agencies. Disaggregated data on the contribution of the industry to local employment was not available from the Department of Labor and Employment. The scoping presents descriptions of the industry and its contribution to domestic energy supply, the system governing the industry, some examples of impacts on local communities, a brief feature on the Malampaya gas project and a preliminary perusal of public interest issues in the industry.

SIGNIFICANCE.
Indigenous petroleum and other non-renewable resources are built up over centuries and form part of a nations wealth and can be a potent source for economic advancement. The exploitation and use of these resources has both short-term and long-term effects on the social, political and economic development of a country. Decisions on the exploitation and use of such resources are matters of public interest for present and future generations.

Fatima Alvarez Castillo

Transparency and accountability in the governance of resource extraction and use is necessary. Policy options have to target maximum benefits and the full potential that these resources can bring. Revenues earned from the extraction of these resources have to be managed and allocated with the public interest in mind. It is the governments mandate to ensure that such resources contribute to the national economy and the public benefit over the short-termfor the present generation, as well as over the long-termfor the benefit of future generations. It has been shown that the mere possession of abundant resources and their exploitation does not automatically result in a countrys development. The paradox known as the resource curse where resource-rich countries exhibited slower growth than countries that were not resource-rich has been demonstrated in Africa. Despite large investments in oil, Between 1970 and 1993, countries without oil saw their economies grow four times faster than those of countries with oil.1 Effective resource governance requires that citizens are able to hold their government representatives accountable for decisions and policy choices. Accountability to an informed public can mitigate the mismanagement of resource revenues. A well-informed public with the capacity to act can engage in constructive discussion about policy formulation and government oversight of resource wealth. Through public scrutiny, officials can be held to account for abuses of power for private gain.2 Governments do not always get their fair share of revenues. The Philippines is not unfamiliar with problems of corruption and
____. October 31, 2007. The Resource Curse: Why Africas Oil Riches Dont Trickle Down to Africans from http://knowledge.wharton.upenn.edu/article.cfm?articleid=1830 accessed February 20, 2012. 2 The Natural Resource Charter. The Natural Resource Charter from www.naturalresourcecharter.org accessed November 10, 2011.
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OIL AND GAS PRoDUCTIoN IN THE PHILIppINES: PUBLIC INTEREST ISSUES

agreements that are disadvantageous to the country. When lack of transparency and corruption are present, a government may fail to gain and allocate revenues from resource extraction for development objectives. The opaque behavior of corporations can make it difficult for the public to access critical information such as the amount of resources depleted by a company in a specific period and the amount of revenues earned. The two major players in the Philippine oil and gas industry, Chevron, and Shell, have been identified as among the most opaque in the world.3 Developed countries have recognized the need for companies engaged in resource extraction to practice transparency. In July 2010, the United States passed the Dodd-Frank Act. Among its many provisions is a requirement for the disclosure of payments made by mineral, oil and gas companies.4 Already in place is another international transparency standard, the Extractive Industries Transparency Initiative (EITI). The EITI process entails the reconciliation of company reports on payments made to governments with government reports on receipts from these companies. To date, there are 13 countries that comply with the EITI process and 20 more countries which have filed applications for EITI membership.5 Through research and its links with mining-affected communities, civil society organizations in the Philippines have learned much about the mining industry. However, there is as yet little knowledge on the oil and gas industry, another vital extractive industry with far-ranging and long-term effects on the economic well-being of Filipinos. This scoping was commissioned as a preliminary effort to inform civil society organizations on public interest issues in the oil and gas industry.

Nick Mathiason found that three of the worlds biggest corporations, Chevron, Exxon and Shell have among the highest number of international subsidiaries incorporated in high secrecy jurisdictions which allow company accounts and ownership details to be kept from the public. In Mathiason, N. Piping Profits, published by Publish What You Pay Norway (PWYP Norway), 2010. 4 The US Securities and Exchange Commission is still finalizing the Implementing Rules of the Dodd-Frank Act. 5 EITI. EITI Countries from http://eiti.org/countries accessed November 10, 2011.
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Fatima Alvarez Castillo

THE PRoDUCTIoN oF INDIgENoUS OIL AND GAS

DIsCoVERY oF REsERVEs
In 1896, the Smith Bell Company undertook oil exploration, drilling the Toledo-1 well in Cebu. However, it was not until the 1970s when large fields were opened by the government for exploration by the private sector and a number of oil and gas fields were discovered. From 1976 to 2000, several fields were discoveredthat of the Australian firm, Nido, the Camago-1 field of Occidental Petroleum, the West Limpacan field of Alcorn Philippines, and the smaller San Antonio onshore field in northern Philippines of the Philippine National Oil Company (PNOC). The Galoc field was discovered in 1981. The largest of these discoveries was the Malampaya field which was also discovered in 1990 by Occidental Petroleum but later sold to Shell. Out of 99 countries with proven oil reserves, the Philippines ranks number 65. Indonesia and Vietnam rank 28 and 44, respectively.6 Proven oil reserves of the Philippines amounted to 138 million barrels in January 2006.7 This is much less than the billions of barrels in reserves of its ASEAN (Association of Southeast Asian Nations) neighbors like Vietnam, Indonesia and Malaysia. Nevertheless, the development of its oil and gas reserves can reduce the countrys dependence on imports. The biggest reservoirs that have so far been identified by the Department of Energy are in offshore Palawan, the Sulu Sea and the Recto Bank.8

6 Central Intelligence Agency. The World Factbook: Oil-proved reserves from https://www.cia.gov/library/ publications/the-world-factbook/rankorder/2178rank.html accessed March 5, 2012. 7 Encyclopedia of Earth. September 23, 2008. Energy Profile of Philippines from http://www.eoearth.org/article/ Energy_profile_of_Philippines accessed March 4, 2011. 8 According to respondents from the Department of Energy, the Recto Bank reserve is much bigger than Malampaya. The Recto Bank reserve is adjacent to the Spratley Islands, that is claimed by China, Vietnam and the Philippines.

OIL AND GAS PRoDUCTIoN IN THE PHILIppINES: PUBLIC INTEREST ISSUES

FIGURE 1. MAP oF REsERVE EsTImATIoNs FoR THE PHILIPPINEs

Ilocos Shelf Area = 19,500 sq km., 60% offshore Wildcat well drilled = 1 Total resources: Undiscovered = 19 million bbl oil equivalent Gas makes up 100% of the total resources

West Luzon Area = 16,000 sq km., 95% offshore Wildcat wells drilled = none Undiscovered = 23 million bbl oil equivalent Gas constitutes 100% of the total resources

Cagayan Basin Area = 24,000 sq km., 80% onshore Wildcat wells drilled = none Discovered = 0.4 million bbl oil equivalent Undiscovered = 396 million bbl oil equivalent Gas constitutes 99% of the total resources

Mindoro-Cuyo Basin Area = 58,000 sq km., 90% offshore Wildcat wells drilled = 15 Total resources: 832 million bbl oil equivalent Discovered = 25 million bbl o. e. Undiscovered = 806 million bbl o. e. Gas makes up 7% of the total resources

Central Luzon Area = 16,500 sq km., 95% onshore Wildcat wells drilled = 17 Total resources: Undiscovered = 902 million bbl oil equivalent Gas has 100% share of the total resources

Bicol Shelf Area = 32,500 sq km., 60% offshore Wildcat wells drilled = 6 Total resources: Undiscovered = 44 million bbl oil equivalent Gas constitutes 100% of the total resources Southeast Luzon Area = 66,000 sq km., 55% onshore Wildcat wells drilled = 26 Total resources: Undiscovered = 301 million bbl oil equivalent Gas constitutes up 36% of the total resources

Northwest Palawan Area = 36,000 sq km., 100% offshore Wildcat wells drilled = 58 Total resources: 2,318 million bbl oil equivalent Discovered = 942 million bbl o. e. Undiscovered = 1,376 million bbl o. e. Gas and condensate make up 72% and 13%, respectively, of the total resources Reed Bank Area = 71,000 sq km., 100% offshore Wildcat wells drilled = 4 Total resources: Undiscovered = 440 million bbl oil equivalent Gas makes up 92% of the total resources

West Masbate-Iloilo Basin Area = 25,000 sq km., 60% offshore Wildcat wells drilled = 10 Total resources: Undiscovered = 5 million bbl oil equivalent Gas makes up 72% of the total resources

Visayan Basin Area = 46,500 sq km., 70% offshore Wildcat wells drilled = 143 Total resources: 1,260 million bbl oil equivalent Discovered = 0.5 million bbl o. e. Undiscovered = 1,259 million bbl o. e. Gas has 28% share of the total resources

Southwest Palawan Area = 44,000 sq km., 100% offshore Wildcat wells drilled = 23 Total resources: Undiscovered = 1,355 million bbl oil equivalent Gas shares 60% of the total resources

Agusan-Davao Basin Area = 33,000 sq km., 60% offshore Wildcat wells drilled = 3 Total resources: Undiscovered = 196 million bbl oil equivalent Gas makes up 70% of the total resources

East Palawan Basin Area = 92,000 sq km., 100% offshore Wildcat wells drilled = 4 Total resources: Undiscovered = 443 million bbl oil equivalent Gas constitutes 28% of the total resources

Sulu Sea Area = 115,000 sq km., 95% offshore Wildcat wells drilled = 17 Total resources: Undiscovered = 203 million bbl oil equivalent Gas makes up 36% of the total resources

Cotabato Basin Area = 14,000 sq km., 100% onshore Wildcat wells drilled = 10 Total resources: 158 million bbl oil equivalent Discovered = 5 million bbl o. e. Undiscovered = 152 million bbl o. e. Gas constitutes up 45% of the total resources

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Fatima Alvarez Castillo

FIGURE 2. OIL PRoDUCTIoN AND CoNsUmPTIoN IN THE PHILIPPINEs, 1986-2006*

400 350 300 250 200 150 100 50 0 1986 1990 1994 1998 2002 2006 1996 to 2000 No oil production Production Net imports Consumption

Thousand Barrels per Day

YEAR *January-September only Source: EIA International Energy Annual; Short-term Energy Outlook

OIL AND GAs PRoDUCTIoN.

Modest quantities of oil were produced in the early part of 1990s. But, in 2002, there was a surge in domestic oil production as the Malampaya field produced 1,763,431 barrels of oil i.e., four times the amount produced in the previous year. In that year, Malampaya accounted for 87% of total domestic oil production. However, in the following year, Malampaya shifted the bulk of its operations to gas production. This caused the level of domestic oil production to drop to 0.07% of the quantity produced in 2000. (Figure 3) The Galoc Petroleum Company discovered another field in 1981. But, the presence of oil in commercial quantities was not determined until the late 1990s. The DOE approved Galocs development plan in 2006. From 2008 to 2010, Galoc became the biggest oil producer. In 2009, production by Galoc was 56.7% greater than Malamapayas peak production in 2002. However, by mid-2011, another corporation, Philodrill, produced almost 3.5 times more than the Galoc field from its Nido and Matinloc fields.9 Prior to 2002, gas production was limited to the smaller San Antonio field in northern Philippines. However, with the operation of the
9

DOE Portal. Petroleum Exploration History from www.doe.gov.ph/ER/oil.htm accessed February 17, 2012.

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OIL AND GAS PRoDUCTIoN IN THE PHILIppINES: PUBLIC INTEREST ISSUES

Malampaya deepwater gas-to-power project, gas production in 2003, shot up. Although production volume dipped in 2004 and 2006 due to adjustments in production technology, it rose more or less steadily throughout the decade. The Libertad field in Cebu, operated by Forum Gas made a small contribution to production. FIGURE 3. DomEsTIC OIL PRoDUCTIoN BY OIL FIELD
3000000 2500000 (Barrels of oil, Bbl) 2000000 1500000 1000000 500000 0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Malampaya Galoc Others

(Year)

FIGURE 4. DomEsTIC OIL PRoDUCTIoN, 2002-2010

3,500,000 3,000,000

(Barrels of oil, Bbl)

2,500,000 2,000,000 1,500,000 1,000,000 500,000 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Oil

(Year)

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Fatima Alvarez Castillo

FIGURE 5. DomEsTIC GAs PRoDUCTIoN, 2000-2010

160000

(Million cubic feet)

140000 120000 100000 80000 60000 40000 20000 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Gas

(Year)

CoNTRIBUTIoN To LoCAL ENERGY sUPPLY.

Prior to 2000 the countrys energy supply was largely sourced from geothermal, biomass10, coal, hydro, indigenous oil and gas, and imported coal and oil. Indigenous sources of energy accounted for 49% of total energy supply at the beginning of the decade. By 2010, indigenous sources of energy rose to 57.5% of total energy supply. Increases in oil and gas production within the decade were a major factor. Oil production volume in 2010 was 14 times greater than production volume in 2000. Gas production in the same period doubled and coal production quadrupled. In 2000, imported oil accounted for 41.3% of the countrys total energy supply. By the end of the decade, the share of imported oil in Philippine energy supply was 33.6%.

Biomass is biological material, often plant matter, used to produce energy or electricity, usually by combustion. Examples are wood or solid waste.
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OIL AND GAS PRoDUCTIoN IN THE PHILIppINES: PUBLIC INTEREST ISSUES

FIGURE 6. CoNTRIBUTIoN oF ImPoRTED OIL To ENERGY SUPPLY

45.00 40.00 35.00

(In percent)

30.00 25.00 20.00 15.00 10.00 5.00 0.00 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Oil

YEAR
Source: Table 14.1a Supply mix bysource, 2000 to 2010. NSCB, 2011 Philippine Statistical Yearbook

FIGURE 7. ENERGY SUPPLY MIX, INDIGENoUs Vs. ImPoRTED, 2000-2010.

70.00 60.00 50.00 (In percent) 40.00 30.00 20.00 10.00 0.00
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Indigenous Energy

Imported Energy

(Year)

Source: Table 14.1a Supply mix by source, 2000 to 2010. NSCB, 2011 Philippine Statistical Yearbook

FIGURE 8. MIX oF ENERGY SoURCEs AND SELF-sUFFICIENCY LEVELs, 2000 AND 2005
2000 Biomass 29.8% Geothermal 8.0% Hydro 5.3% Natural Gas 0.4% Local Coal 1.8% Imported Oil 45.4%

Local Oil 0.2%

Imported Coal 9.2% Total: 251.73 MMBFOE Self-sufficiency Level=45%

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Fatima Alvarez Castillo

2005

Biomass 16.8%

Other RE 0.2%

CME & Ethanol 0.6%

Imported Oil 37.3%

Geothermal 21.1% Imported Coal 9.6%

Hydro 5.1%

Natural Gas 4.0%

Local Coal 3.5%

Local Oil 1.8%

Total: 281.2 MMBFOE (40.6 MTOE) Self-sufficiency Level=53%

Source: DOE Energy Programs and Policies, 2006

The DOE projection is that by 2014, domestic oil and gas production will account for 3.8% and 8% respectively, of the countrys total energy supply. But not all of the locally produced oil is domestically consumed. While producers are required to market their production locally on a pro rata basis of their share in domestic oil production, export crude oil and condensates is allowed due to the lack of adequate processing facilities in the country. According to a DOE respondent, We dont have the facility. .our processing facility is not fit for the type of crude produced (besides) our crude is not enough for government to invest in a processing facility.11 At present, there are only two refineries owned by Petron and Shell although both have plans to upgrade their facilities.12

GoVERNANCE
LEGAL AND PoLICY FRAmEWoRK.
The basis for the countrys legal and policy regulation of the indigenous petroleum and gas industry is contained in the Constitution.13 It gives the government control and regulation of all natural resources and
Interview data from DOE respondents, January 2012. Marcon International Inc. Country Briefs Philippines from www.marcon.com accessed January 29, 2012. 13 Section 2. Article XII, 1987 Constitution
11 12

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OIL AND GAS PRoDUCTIoN IN THE PHILIppINES: PUBLIC INTEREST ISSUES

mandates the President to enter into agreements with foreign-owned corporations for the large-scale exploration and development of mineral and petroleum resources, based on their potential contributions to the economic growth and general welfare of the country. The policy framework for the development of indigenous energy sources is stated in the 1972 Presidential Decree (PD) 87 of President Marcos, also known as the Oil Exploration and Development Act. The major objectives stated in the Act are: (a) to yield the maximum benefit to the Filipino people as well as to government revenues for use in furtherance of national economic development, and (b) to assure participating foreign enterprises of just returns for providing the necessary services, financing and technology and fully assuming all exploration risks. Various executive and administrative orders during the time of Presidents Corazon Aquino, Fidel Ramos and Gloria Arroyo continued to address themselves to governance of the industry. Executive Order (EO) 556, issued by President Arroyo in 2006, banned farm-in and farm-out arrangements and instead strictly required public bidding for the awarding of all contracts.14 This EO invalidated a farm-in deal between Philippine National Oil Company (PNOC) and Mitra Energy to develop the Malampaya Oil Rim. While the bidding system is generally considered to yield superior results, the current Secretary of the DOE is seeking to amend EO 556, claiming that it has become a stumbling block for PNOC Exploration Corporation. In its efforts to tap partners for its projects.15 In 1992, RA 7638 created the Department of Energy (DOE). The DOE was given a two-fold mandate: (1) to develop competitiveness in the energy sector and make it attractive to foreign investors and (2) to ensure the compliance of such development with constitutional and legal provisions on environmental protection and countrywide electrification.

These arrangements are those negotiated between a license, contract or field holder with another party that may have funds but not enough hectarage or who, for other reasons, may be interested in participating in an operation. 15 Remo, Amy R. (Philippine Daily Inquirer) Feb. 27, 2012. DOE seeks easing of rules on govt oil exploration deals from http://business.inquirer.net/46537/doe-seeks-easing-of-rules-on-gov%E2%80%99t-oil-explorationdeals accessed March 5, 2012.
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Fatima Alvarez Castillo

TABLE 1. LAWs AND REGULATIoNs oN THE OIL AND GAs INDUsTRY

Law or Issuance Presidential Decree 87 (1972), The Oil Exploration and Development Act of 1972 Republic Act 7638 (1992), Department of Energy Act of 1992 Presidential Decree 1857 DOE Circular No. 2003-05-005 DOE Circular No. 2003-05-006 Executive Order No. 66 DOE Circular No. 2002-08-005 Description Provided the policy framework for the development of indigenous petroleum and enhanced energy security as well as to encourage the participation of the private sector. Created the Department of Energy and rationalized the organization and functions of government agencies related to energy Amended PD 87 by offering more fiscal and contractual incentives to service contractors with special reference to deepwater oil exploration Established procedures for the Philippine contracting round in petroleum prospective areas. Provided guidelines on the financial and technical capabilities required of a viable petroleum exploration and production company. Designated the Department of Energy as the lead agency in developing the natural gas industry. Set the interim rules and regulations governing the transmission, distribution and supply of natural gas. Required that the government and the private sector undertake environmental impact assessments of their project activities Detailed prescriptions on the management of air quality, water quality, land use, natural resources and waste. Provided details on Environmental Impact Statement (EIS) System.

Philippine Environmental Policy Act (Presidential Decree 1151), 1977 Philippine Environmental Code (P.D. 1152) Environmental Impact Statement System (P.D. 1586), 1986 National Integrated Protected Areas System Act of 1992

Provided for the establishment and management of national integrated protected areas system, defining their scope and coverage. Section 14 of the NIPAS Act specifies the survey of energy resources in protected areas solely for data gathering. Any exploitation and utilization of energy resources found within NIPAS areas shall be allowed only thru passage of law by Congress. Established implementing mechanisms to protect and promote the rights of indigenous cultural communities/indigenous peoples.

The Indigenous Peoples Rights Act of 1997 (Republic Act 8371)

Source: Department of Energy

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OIL AND GAS PRoDUCTIoN IN THE PHILIppINES: PUBLIC INTEREST ISSUES

CoNTRACTING RoUNDs.
In 2003, the DOE launched the Philippine Energy Contracting Round (PECR) system.16 The PECR altered the previous system where contractors applied and negotiated for areas in which they wanted to operate. Under the PECR, the DOE determined and offered areas for exploration and development. Periodic contracting rounds were subsequently undertaken in which the government offered prospective areas for bidding from interested private contractors. The fourth and most recent PECR was launched in June 2011 with a total offer area of over 100,000 square kilometers. On offer were 15 blocks with an average size of 6,700 kilometers. The single largest area that was offered was 8,400 kilometers in East Palawan.17 The Resource Development Bureau of the DOE prepares the documents for each PECR. It provides information on the prospects in each area and publicly posts the announcements for a PECR. Bid submissions are evaluated on the basis of their proposed work programs and the legal, technical and financial qualifications of the bidder. Information contained in bid submissions is confidential. Upon acceptance of a bid, the DOE awards a Service Contract (SC) to the Contractor. Service Contracts.18 Under the terms of a model Service Contract, the Contractor assumes all the risks and obligations to explore the contract area within a period of 7 years, with the possibility of a 3-year extension if necessary.19 Following the determination that oil is present in commercial quantities, the Contractor is granted the right to extract the resource for a period of 25 years, with possible extension periods up to a maximum of 50 years. The Contractor is allowed to deduct its operating costs for up to 70% of gross revenues. These operating costs are inclusive of costs incurred
Department Circular 2003-05-005 Petro Energy. October 16, 2011. PERC in DOEs 4th PECR Launching from http://petroenergy.com.ph/news/ perc-participates-in-does-4th-pecr/ accessed March 7, 2012. 18 Department of Energy website. Model Service Contract from http://www.doe.gov.ph/PECR2006/Petroleum%20 PECR%202007/petro.htm accessed October 3, 2011. 19 Section 2.34. Exploration Period. Model Service Contract.
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Fatima Alvarez Castillo

within and outside the Philippines. They include, among others, surveys, tests and studies; construction and maintenance of equipment and facilities; administrative costs and home office overhead; transportation and handling costs related to the sale of production; as well as 2/3 of interest payments for the financing of the operation. Fortunately, these recoverable costs do not include transportation of product and processing and refining costs outside the country.20 The sharing system adopted by the Philippine government is such that it is entitled to 60% of net proceeds, i.e., after the recoverable operating costs have been deducted. The government has the option to receive its share in kind or on cash. The Contractor is entitled to retain 40% of the net proceeds. PD 87 and the SC explicitly state that Contractors are not exempt from and obliged to pay Philippine income taxes. However, the SC states that the income tax liability of the Contractor is to be paid from the 60% share of the government. Upon receipt of the government share the DOE pays the Contractors income tax to the Bureau of Internal Revenue (BIR). The amount paid to the DOE is greater than that retained by the Contractor. But after the DOE pays the 30% corporate income tax, it is actually left with less than the Contractor. Other privileges allowed to contractors are exemption from paying tariffs and other taxes on the importation of equipment and materials and the right to transfer part or all of rights under a Service Contract to another party, provided the DOE is informed. The Service Contract also states that all information on operations within a service area is confidential. Finally, Service Contracts contain provisions that purport to bind a Contractor to abide by Philippine laws on health, safety, environmental protection and respect for indigenous peoples rights. However, there are some gaps in complying with these provisions and failures to comply have led to opposition from some local communities and sectors.
20

Section 2.52. Operating Costs, Service Contract.

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BoX 1. JAPEX
Tanon Strait is a protected marine biodiversity area. But in 2005, under Service Contract number 46, the Japan Petroleum Exploration (JAPEX) began exploration activities in Tanon Strait, between Cebu and Bohol. Local fisherfolk, environmental and church groups objected to the operations of JAPEX asserting the lack of local community and stakeholder consultations, the destruction of marine sanctuaries and the consequent depletion of the fishermens catch. A report from the Central Visayas Fisherfolk Development Center (FIDEC) to the UN Special Rapporteur on the Right to Food, detailed the military harassment of protesters. In the opinion of DOE respondents, community consent is not legally required. According to them the DOE has conducted information and education activities among local fishing communities where they explained that the technology will not adversely affect them. In their opinion, the people are just stubborn. In 2008, local fishermen staged a protest action where they used their bancas to obstruct the operations of JAPEX. JAPEX eventually paid some of the fishermen for the damages for the loss of livelihood from reduced harvests. But FIDEC and another civil society organization PAMALAKAYA, have filed a case against JAPEX and the DOE to demand for the rehabilitation of the Strait.21

BoX 2. MoRo ANCEsTRAL DomAIN

In August 2011, the MILF (Moro Islamic Liberation Front) formally presented a request to Dean Marvic Leonen, head of the Government Peace Panel, to freeze all bidding and contracting for oil and gas exploration in areas that are being claimed by the MILF as Moro ancestral domains. In the absence of clear government action their request was reiterated in October 2011.22 Muhammad Ameen, head of the MILF secretariat was quoted as having said that freezing the bidding and contracting in the Sulu Sea and Liguasan Marsh23 would be an indication of the governments sincerity in the peace negotiations. We do not want these explorations to complicate the peace process and more importantly result in undue deprivation of our people for their rightful share in the natural wealth,..I hope the Aquino administration would listen to our peoples pleas. 24 In January 2012, the DOE announced the 4th PECR. The MILF reminded the government of its request for the freeze. At the time of the writing of this report, there has been no publicly reported response or action on the MILF petition.25

Pamalakaya Times. July 15, 2009. Fishers group ask Japex to set aside P20-billion for Taon Strait rehab from http://www.asianpeasant.org/content/ fishers-group-ask-japex-set-aside-p-20-billion-ta%C3%B1-strait-rehab accessed Jan 15, 2012. 22 Alcober, Neil A. (Manila Times). January 27, 2012. Stop Liguasan oil explorations, govt urged from http://www.manilatimes.net/index.php/news/ nation/15855-stop-liguasan-oil-explorations-govt-urged accessed January 27, 2012. 23 DOE respondents said that Liguasan Marsh is not included in the 4th PECR because it is a nationally protected biodiversity area. 24 Zambo Times. October 6, 2011. MILF calls for freeze of oil, gas exploration in Moro areas from http://www.zambotimes.com/archives/38504MILF-calls-for-freeze-of-oil,-gas-exploration-in-Moro-areas.html accessed October 10, 2011. 25 Ibid.
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THE MALAmpAYA GAS PRoJECT

The Malampaya Gas Project began commercial operations in 2001. It is owned by a consortium composed of Shell (45%), Chevron (45%) and the Philippine National Oil Corporation or PNOC (10%). With a capitalization of $4.8 billion, it is the single largest and most significant investment in the history of Philippine business.26 The Malampaya/Camago deepwater gas-to-power project is the biggest component of the Philippine Gas Project (PGP). About 2.5 trillion cubic feet of gas reserves have been discovered in the gas field. Its resource potential is projected to supply up to 400 million standard cubic feet of gas per day equivalent to 3,000 megawatts of baseload generating capacity.27 Aside from the production of gas, the project involved the construction of a 504-kilometer sub-sea pipeline from the offshore production site to an onshore gas plant which supplies three power stations in Sta Rita & San Lorenzo (owned by First Gas of the Lopez group) and Ilijan in Batangas (owned by NPC). At present, Malampaya natural gas provides approximately 2,700 megawatts/day of energy or 40% of Luzons power requirements.

TERms oF THE MALAmPAYA CoNTRACT.

The production sharing agreement between the government and the Malampaya consortium provides for a 60%-40% sharing of net proceeds from the sale of the product between the former and the latter. Under Service Contract No. 38, the Consortium is authorized to market the governments share of natural gas to NPC as well as to additional buyers.28 The terms of engagement between the Consortium (Seller of the gas) and NPC and First Gas (the Buyers) are contained in the Gas Sale and Purchase Agreements (GSPAs). Between December 1997 and April 1998, there were three GSPAs entered into by the Consortium on the
Administrative Order 381, President Ramos, February 17, 1998. Executive Order 254, President Ramos, June 30, 1995. 28 Administrative Order 381, President Ramos, February 17, 1998.
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sale and purchase of the gas produced from the Camago-Malampaya fields: one GSPA with NPC, and two with First Gas. The GSPA with NPC contains a fixed Take-or-Pay- Quantity (TOPQ) provision. NPC is obliged to pay for a given volume of natural gas tendered for delivery by Shell whether the quantity is taken by NPC or not. However, Administrative Order 381, states that quantities paid for but not taken by NPC (referred to as annual deficiencies) be made available to NPC without additional charge. Nevertheless, when a downturn in demand for electricity occurs, NPC undertakes the risk of not recovering its costs on time because it is forced to make advance payments. The TOPQ creates a number of complications, which affect all parties. The TOPQ affects NPCs cash flow since it is constrained to pay for quantities it is unable to take or market. But the agreement is such that the Malampaya Consortium must receive these payments. Ironically, the Malampaya Consortium created a $350 million Deferred Payment Facility, as a line of credit for NPC to draw upon for TOPQ payments that are due the Consortium. In turn, the Philippine government committed to earmark funds from the government share of net proceeds to repay the funds drawn from the consortiums Deferred Payment Facility (DPF). In addition, the government has committed not to seek purchase price reductions for gas from the project. In contrast, the GSPAs with First Gas require price reductions whenever a third party provides a lower price. Typically, the Service Contract with the Malampaya Consortium also authorizes its income taxes to be deducted from the 60% government share. From 2003 to 2009, this amounted to PhP 53.140 billion.29 As in other SCs, the Malampaya Consortium is allowed to deduct up to 70% of its operating costs from its gross revenues. In has been estimated by a Shell Philippines Exploration (SPEX) official that by 2006, all of its investment in Malampaya would be recovered.30. Respondents from
29 Salaverria, Leila B. (Philippine Daily Inquirer). September 18, 2010. COA: Govt shortchanged by P53B in Malampaya project from http://newsinfo.inquirer.net/breakingnews/nation/view/20100918-293024/COA-Govtshortchanged-by-P53-B-in-Malampaya-project November 30, 2011. 30 Flores, Alena Mae. (Manila Standard). March 29, 2006. Shell set to recover $2B Malampaya investment. http:// www.accessmylibrary.com/article-1G1-143811106/shell-set-recover-2b.html accessed March 7, 2012.

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DOE estimated that full cost recovery will be achieved within the first 10 years of operation. The service contract for the project will expire in 2024. The consortium has applied to the DOE for a 15-year extension of the contract until 2039. It plans to make an additional investment of $950 million.31 The DOE is reportedly studying the application for extension although according to a top DOE official, the continued operation of the Malampaya gas field is a critical component in the countrys long-term program to ensure energy security in the country.32

THE MALAmPAYA FUND.

The Department of Energy and the Bureau of Treasury maintain a special account termed Fund 151, for non-tax revenues from oil, gas, geothermal and other energy projects. It is part of the yearly revenue program submitted to Congress in support of the Budget Proposal. It has been reported that by late 2011, Fund 151 had PhP 161.838 billion. Of this amount, PhP 151.12 billion was collected from the Malampaya project.33 The fund is meant for expenditure on energy development projects and other purposes approved by the President. The current administration has so far charged PhP2.87 billion against the Fund: a) PhP 2 billion to avert power shortages in off-grid areas by providing for the fuel requirements of the NPC- Small Power Utilities Group; b) PhP 450 million to support jeepney and tricycle drivers affected by rising oil prices through the Pantawid Pasada program; and c) PhP 423 million to purchase a cutter, the USS Hamilton, to strengthen security around the perimeter of the Malampaya Project.34
_____. Malampaya Consortium remits $1.134 billion to government. http://www.doe.gov.ph/news/2012-0124-Malampaya%20Consortium.htm accessed March 7, 2012. 32 Remo, Amy R. (Philippine Daily Inquirer). October 4, 2011. DOE: Malampaya gas project remains crucial to ensuring stable power in Luzon from http://newsinfo.inquirer.net/70417/doe-malampaya-gas-project-remainscrucial-to-ensuring-stable-power-in-luzon accessed November 30, 2011. 33 Philippine Daily Inquirer. October 18, 2011. Legislator urges govt to use Malampaya funds to buy back Petron from http://business.inquirer.net/25621/legislator-urges-gov%E2%80%99t-to-use-malampaya-funds-to-buyback-petron accessed November 30, 2011. 34 Department of Budget and Management. July 5, 2011. Budget Secretary Abad Clarifies nature of malampaya Fund from http://www.gov.ph/2011/07/05/budget-secretary-abad-clarifies-nature-of-malampaya-fund/ accessed March 5, 2012.
31

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BoX 3. FUND EXPENDITURE UNDER THE ARRoYo ADmINIsTRATIoN

Under the Arroyo Administration, P 19.64 billion was disbursed from the Malampaya Fund to national government agencies. However, only P250 million or 1.27 percent was used for an energy-related project: the electrification of 211 villages in 2006. . In 2006, P1 billion for the Armed Forces Modernization Fund; 2) in 2008, P4 billion for the Department of Agriculture; 3) in 2009, a total of P14.39 billion to various agencies, including: P7.07 billion for the Department of Public Works and Highways; P2.14 billion for the Philippine National Police; P1.82 billion for DA; P1.4 billion for the National Housing Authority; and P900 million for the Department of Agrarian Reform.6

In January 2012, the DOE proposed to the Joint Congressional Power Commission to use part of the Malampaya Fund to pay for the stranded debts of NPC. The maturing debts of NPC stand at $1.7 billion.35 As of May 2011, the Fund balance was PhP 79.48 billion. However, the Malampaya group reportedly turned over to President Aquino a check for over a billion US Dollars in January 2012.36 Local Government Share. Local government units (LGUs) are entitled to 40% of the gross collection derived by the national government from the taxes, royalties and fees from its share in any co-production, joint venture or production-sharing agreement in the utilization and development of the natural resource within their territorial jurisdiction.37 Respondents from civil society in Palawan claim that the Malampaya field belongs to Palawan because it lies in the sea between Kalayaan Island, a municipality of Palawan and the province main island. Kalayaan Island is about 230 kilometers while Malampaya is 80 kilometers from the main island of Palawan. Marcos presidential decree (1978) that created this municipality states that the sea between Kalayaan and the main island belong to Palawan.38
35 Anonuevo, Euan Paulo C. (The Manila Times). February 18, 2012. Malampaya proceeds eyed for Napocor from http://www.manilatimes.net/index.php/business/top-business-news/17404-malampaya-proceeds-eyedfor-napocor accessed February 28, 2012. 36 Bordadora, Norman. (Philippine Daily Inquirer). January 21, 2012. Govt gets $1.1-B share from Malampaya project from http://newsinfo.inquirer.net/131653/govt-gets-1-1-b-share-from-malampaya-project accessed February 28, 2012. 37 Local Government Code of 1991, Section 290. 38 Kilusan Love Malampaya. (n.d) Executive Summary of Malampaya Gas Project Profile. Puerto Princesa City.

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Fatima Alvarez Castillo

During Pres. Corazon Aquinos administration, Palawan received P165M from the national government as its share in revenues from the Nido and other oil fields. But in 1992, the DOE stopped giving Palawan its share from the West Linapacan field claiming that it was located outside the maritime boundary of the province. In 1998, President Ramos, through AO 381, ordered that the province be allotted $2 billion (25%) annually for 20 years from the total government share of $8.1 billion. Other arguments that affected the share of the province subsequently arose. In June 1998, Secretary Francisco Viray of the DOE wrote Palawan Governor Salvador Socrates requesting a deferment of 50% of the share that was due the province. The reason stated was that the national government needed to augment its funds for payment of NPCs TOPQ obligations.39 In 2003, then-President Gloria Arroyo asserted that Malampaya was outside Palawans boundary. At the same time, she declared that the province be granted financial assistance drawn from the Malampaya proceeds. Local politicians, Governor Joel Reyes, Representative Alvarez and Representative Mitra, agreed to an interim agreement that the assistance extended to the province be divided among the province and the congressional districts of Alvarez and Mitra. No public consultations were held and civil society groups in Palawan objected to the agreement as a manipulative tool to secure the loyalty of local politicians for the 2004 presidential elections.40 Palawan has been claiming its 40% share of proceeds from Malampaya. There is a pending petition before the Supreme Court on whether or not the Camago-Malampaya gas fields are within the territorial waters of Palawan. Finally, the Local Government Code (LGC) mandates local government to spend its share on local development and livelihood projects. It requires that a minimum of 80% of this amount be spent to reduce the cost of electricity in communities.41
Kilusan Love Malampaya. (n.d) Executive Summary of Malampaya Gas Project Profile. Puerto Princesa City. Interview data with Kilusan Love Malampaya respondents. 41 LGC of 1991, Section 294
39 40

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OIL AND GAS PRoDUCTIoN IN THE PHILIppINES: PUBLIC INTEREST ISSUES

In November 2011, the Commission on Audit (COA) recommended the filing of graft charges against former Governor Joel Reyes and members of the Provincial Bids and Awards Committee for irregularities in the use of almost PhP 3 billion in Malamapaya funds. Questionable transactions identified by the COA reports were those that appeared to favor certain contractors and over 200 infrastructure projects including day care centers that cost about PhP 30 million.42

TRANSpARENCY AND PUBLIC INTEREST ISSUES

The decline in imported oil and increase in the contribution of indigenous gas and oil to local energy supply is undoubtedly a positive development. However, there is no indication that this has in any way had a positive influence on the relatively high cost of energy in the country. The framework by which the industry is governed is itself a question of public interest. The package of incentives granted to the oil and gas industry is considered to be among the most competitive in the world. The question arises as to whether or not these incentives are as advantageous to the country as they are to private investors in the industry. Another question is whether or not 70% cost recovery is too generous. Or if it is true that the Malampaya Consortium will recover its investment within a 10-year period. Further research will bear out if this is or is not an unusually short recovery period for such large investments. The industry is governed by a Law which expressly states that Contractors are not exempt from Philippine income taxes. The Service Contract likewise asserts the same. However, the very same Service Contract
Anda, Redempto D. (Philippine Daily Inquirer). November 9, 2011. COA: Sue ex-gov for Malampaya abuse from http://newsinfo.inquirer.net/90737/coa-sue-ex-gov-for-malampaya-abuse accessed November 30, 2011.
42

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effectively cancels this out by making income taxes chargeable to the government share. In effect, the 60-40 sharing scheme which makes it appear that the share of the resource owner is larger than that of the private contractor is deceptive. After payment of the Contractors income tax, the amount left to the government as its share is actually less than the 40% retained by the Contractor. The reasoning behind the regulatory framework is faulty. It confuses the roles of government as resource owner or equity partner with that of the government as a taxing power. Service Contract No. 38 was entered into after take-or-pay arrangements were already being criticized by civil society organizations. The presence of this provision in the SC plus the guaranteed sale price even when market conditions change, puts a severe strain on NPC and other government resources. Considering these provisions, how can it be said that the Contractor fully assumes market risks? The presence of a large Fund for which only Presidential approval is necessary to effect disbursements is too open to the possibility of corruption and rent-seeking from vested interests. This applies to the proceeds of government at both the national and local levels. Mechanisms to ensure that these gains are employed for the development of the industry, as they are meant to, are lacking. Lastly, avoidance and/or resolution of conflicts between local communities and sectors and energy projects need to be addressed and provided for in the regulatory regime of the industry.

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REFERENCES:
Alcober, Neil A. (Manila Times). January 27, 2012. Stop Liguasan oil explorations, govt urged from http://www.manilatimes.net/index. php/news/nation/15855-stop-liguasan-oil-explorations-govturged accessed January 27, 2012. Anda, Redempto D. (Philippine Daily Inquirer). November 9, 2011. COA: Sue ex-gov for Malampaya abuse from http://newsinfo. inquirer.net/90737/coa-sue-ex-gov-for-malampaya-abuse accessed November 30, 2011. Anonuevo, Euan Paulo C. (The Manila Times). February 18, 2012. Malampaya proceeds eyed for Napocor from http://www.manilatimes. net/index.php/business/top-business-news/17404-malampayaproceeds-eyed-for-napocor accessed February 28, 2012. Bordadora, Norman. (Philippine Daily Inquirer). January 21, 2012. Govt gets $1.1-B share from Malampaya project from http://newsinfo. inquirer.net/131653/govt-gets-1-1-b-share-from-malampayaproject accessed February 28, 2012. Central Intelligence Agency. The World Factbook: Oil-proved reserves from https://www.cia.gov/library/publications/the-world-factbook/ rankorder/2178rank.html accessed March 5, 2012. Department of Budget and Management. July 5, 2011. Budget Secretary Abad Clarifies nature of malampaya Fund from http://www.gov. ph/2011/07/05/budget-secretary-abad-clarifies-nature-ofmalampaya-fund/ accessed March 5, 2012. Department of Energy website. Service Contract from http://www. doe.gov.ph/PECR2006/Petroleum%20PECR%202007/petro.htm accessed October 3, 2011.

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____. DOE Circular No. 2003-05-005. ____. DOE Circular No. 2003-05-006. ____. DOE Circular No. 2002-08-005. DOE Portal. Petroleum Exploration History from www.doe.gov.ph/ER/oil. htm accessed February 17, 2012. EITI. EITI Countries from http://eiti.org/countries accessed November 10, 2011. ____. Executive Order No. 66. Encyclopedia of Earth. September 23, 2008. Energy Profile of Philippines from http://www.eoearth.org/article/Energy_profile_of_Philippines accessed March 4, 2011. Flores, Alena Mae. (Manila Standard). March 29, 2006. Shell set to recover $2B Malampaya investment. http://www.accessmylibrary. com/article-1G1-143811106/shell-set-recover-2b.html accessed March 7, 2012. Kilusan Love Malampaya. (n.d) Executive Summary of Malampaya Gas Project Profile. Puerto Princesa City. Local Government Code of 1991. _____. Malampaya Consortium remits $1.134 billion to government. http://www.doe.gov.ph/news/2012-01-24-Malampaya%20 Consortium.htm accessed March 7, 2012.

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Marcon International Inc. Country Briefs Philippines from www. marcon.com accessed January 29, 2012. ____. National Integrated Protected Areas System Act of 1992. Natural Resource Charter. The Natural Resource Charter from www. naturalresourcecharter.org accessed November 10, 2011. Pamalakaya Times. July 15, 2009. Fishers group ask Japex to set aside P20-billion for Taon Strait rehab from http://www.asianpeasant. org/content/fishers-group-ask-japex-set-aside-p-20-billionta%C3%B1-strait-rehab accessed Jan 15, 2012. Petro Energy. October 16, 2011. PERC in DOEs 4th PECR Launching from http://petroenergy.com.ph/news/perc-participates-in-does-4th-pecr/ accessed March 7, 2012. Philippine Daily Inquirer. October 18, 2011. Legislator urges govt to use Malampaya funds to buy back Petron from http://business.inquirer. net/25621/legislator-urges-gov%E2%80%99t-to-use-malampayafunds-to-buy-back-petron accessed November 30, 2011. ____. Presidential Decree 87, The Oil and Exploration and Development Act of 1972. ____. Presidential Decree 1151, Philippine Environmental Policy Act of 1977. ____. Presidential Decree 1152, Philippine Environmental Code of 1977. ____. Presidential Decree 1586, Environmental Impact Statement System of 1986. ____. Presidential Decree 1857. ____. Republic Act 7638, Department of Energy Act of 1992.

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____. Republic Act 8371, The Indigenous Peoples Rights Act of 1997. Remo, Amy R. (Philippine Daily Inquirer). Feb. 27, 2012. DOE seeks easing of rules on govt oil exploration deals from http://business.inquirer. net/46537/doe-seeks-easing-of-rules-on-gov%E2%80%99t-oilexploration-deals accessed March 5, 2012. Remo, Amy R. (Philippine Daily Inquirer). October 4, 2011. DOE: Malampaya gas project remains crucial to ensuring stable power in Luzon from http://newsinfo.inquirer.net/70417/doe-malampayagas-project-remains-crucial-to-ensuring-stable-power-in-luzon accessed November 30, 2011. Remo, Amy R. (Philippine Daily Inquirer). January 25, 2012. Firms eyeing oil, gas blocks get bid deadline extension from http://business. inquirer.net/41269/firms-eyeing-oil-gas-blocks-get-bid-deadlineextension accessed January 30, 2012. Salaverria, Leila B. (Philippine Daily Inquirer). September 18, 2010. COA: Govt shortchanged by P53B in Malampaya project from http:// newsinfo.inquirer.net/breakingnews/nation/view/20100918293024/COA-Govt-shortchanged-by-P53-B-in-Malampayaproject November 30, 2011. ____. October 31, 2007. The Resource Curse: Why Africas Oil Riches Dont Trickle Down to Africans from http://knowledge.wharton.upenn. edu/article.cfm?articleid=1830 accessed February 20, 2012. Zambo Times. October 6, 2011. MILF calls for freeze of oil, gas exploration in Moro areas from http://www.zambotimes.com/archives/38504MILF-calls-for-freeze-of-oil,-gas-exploration-in-Moro-areas.html accessed October 10, 2011. 1987 Philippine Constitution

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ACKNoWLEDgEmENTS
Ms. Margarita (Maita) Gomez provided insights, data and guidance during the research and writing of the report. Professor Oscar Evangelista, Engineer Caesar Ventura and Dr. Jose Antonio Socrates of Kilusan Love Malampaya shared in depth discussion on Malampaya issues and provided copies of pertinent documents not easily accessed from government agencies. Professor Edel Bober, Chairman of the Petroleum Engineering Department of Palawan State University and Mr. Jun Saturay of the UP National Institute of Geological Studies gave a briefing on the technical aspects of oil and gas exploration. Director Ismael Ocampo, Atty. Benju Gagni and Ms. Thelma Cerdena of the Department of Energy, as key informants. Dean Peter Lee U linked the researcher to Ms. Zenaida Monsada of the Department of Energy who sent general data on oil and gas exports. Mr. Nomar Postre, Mr. Ding Calalang, Mr. Lawrence Go and Mr. Carlo Manalansan assisted in the research and field work.

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ABoUT THE AUTHoR

FaTIMa ALVaReZ CasTILLo is a UP Centennial and Full Professor of Political Science at the College of Arts & Sciences, University of the Philippines Manila.

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