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Closing the revenue loop: The true cost of Mozambique’s gas projects

Closing the revenue loop: The true cost of Mozambique’s gas projects

Mozambique EITI’s cost audit disclosures go beyond the requirements of EITI Standard, shedding light on the true cost of the country’s nascent liquefied natural gas projects.

Mozambique’s liquefied natural gas (LNG) projects have the potential to transform the country’s economic potential. Natural gas discoveries in the Rovuma Basin off the coast of northern Mozambique are among the most significant discoveries globally in the last two decades, with the potential to propel Mozambique to being one of the world’s leading natural gas exporting countries. In 2019, energy company Total reached a final investment decision (FID) of nearly USD 15 billion – the biggest ever in Africa – to develop the Mozambique LNG project in Offshore Area. Mozambique’s government estimates that it will receive between USD 35 billion to 64 billion from LNG projects, and currently has a stake in some of these through the state-owned company, Empresa Nacional de Hidrocarbonetos (ENH) yet these revenues are heavily influenced by both capital and operating costs, over which there is limited public oversight.

Tracking costs

The scale of investment required to bring Mozambique’s LNG projects to commercialisation is substantial. Capital and operating costs often make up the largest aspect of a company’s expenditures which, under a production sharing regime, can be recovered once production begins. According to an Oxfam study in Ghana, Kenya and Peru, oil and gas project costs amounted to almost half of gross petroleum revenues across these three countries.

Costs, while critical for developing extractives resources, can potentially reduce government revenues in the early phases of a project. A small misstatement of these costs can therefore have a material impact on the state’s share of profits. Cost recovery auditing can strengthen oversight, helping to ensure that only eligible and verified costs are claimed by companies.

Since 2014, civil society groups in Mozambique have been calling for cost recovery audits and their disclosures, arguing that limited oversight over exploration costs could jeopardise public revenue. Analysis of Mozambique’s production sharing contracts shows that there are provisions for cost recovery audits, although these are time-bound (the government has a right to audit project costs for each calendar year within three years). If the government exercises its rights to audit costs, some costs may be disallowed when they are deemed to be ineligible.

What’s at stake

With a state equity interest in the LNG projects, the state-owned enterprise ENH participates on the same terms as other joint venture partners once the project moves into the development phase. Once production begins, the state, through ENH, would pay its share of costs within the joint venture and secure its share of profit oil. To date, the Government of Mozambique has issued USD 2.2 billion in sovereign guarantee for ENH. In cases where these guarantees cover costs that are inflated, misallocated or ineligible, these could pose a fiscal risk for the state and, ultimately, Mozambiquan citizens. In identifying errors or discrepancies, cost recovery audits provide the government with critical information to mitigate such risks.

Findings from EITI reporting

Mozambique’s 2019 EITI Report includes disclosures of cost audits for the areas operated by energy companies ENI and Total under the production sharing agreement, covering the period of 2015 to 2017. The government subsequently published summaries of the audit reports in March this year via its petroleum regulatory authority website, and these have since been covered in national media.

The disclosures reveal that of approximately USD 2 billion in costs, USD 33 million (2%) was considered ineligible for recovery. Several costs were deemed as non-recoverable, including VAT, penalties related to withholding tax, employment disputes, expenditures related to corporate social responsibility and inflated costs. The audit reports further highlight inefficiencies in the audit process, including delays in accessing documents, submissions of irrelevant data and incorrectly labelled records. Crucially, the auditor noted that the scope of work was limited to assessing documents provided by companies to justify costs, rather than assessments of whether costs were fair or reasonable.

Building on these learnings, Mozambique’s petroleum regulator – the Institute of National Petroleum of Mozambique (INP) – noted that it intends to disclose cost audit reports for other exploration areas in the coming months and is preparing to conduct audits for the period covering 2018 to 2020. Regularising cost audit disclosures will raise new challenges for the government – such as possible disputes by contractors for disallowed costs that fall outside the three-year limited period stipulated in production sharing contracts. But these challenges are far outweighed by the potential benefits of cost audit transparency as Mozambique seeks to develop its LNG reserves, a commodity whose demand is all but certain to surge in the era of energy transition.