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The Oil and Gas Market in Paraguay

Despite the fact that Paraguay is surrounded by well-known hydrocarbon producing countries (Argentina, Brazil and Bolivia) whose hydrocarbon basins penetrate into Paraguay, at present Paraguay has no significant commercial oil and gas production and the country’s only refinery, Villa Elisa, located outside the capital of Asunción is now obsolete. Paraguay has five sedimentary basins or Sub-basins containing sediments ranging in age from Cambrian to Tertiary. To date, only 51 exploration wells, including the "Jacaranda X-1" and "Lapacho X-1" wells,  have been drilled in the entire country, nearly half of which have been reported to contain shows of oil and/or gas. Drilling activity in the country commenced in 1947 focusing primarily on the Carandayty Basin, the Pirity Basin, and the Paraná and Curupayty Basins. Management believes that an oil or gas discovery in the Pirity Basin could be developed, marketed and monetized using available infrastructure with alternative routes as shown below.

Paraguay Crude Oil Early Export Routes & Regional Transport Routes

 

 

 

Geographic, Economic and Political Factors

The Republic of Paraguay is a landlocked country located in central South America, covering an area of approximately 400,000 square kilometres. It is situated to the north-east of Argentina, south-west of Bolivia and west of Brazil. Democratic government was established in Paraguay in 1992 through a process of constitutional reform following the collapse of the Stroessner dictatorship. Paraguay has universal suffrage from the age of 18 and has had relatively free and fair elections since 1993. Bolivia contains large reserves of natural gas and currently supplies Argentina and Brazil via an existing and extensive network of pipelines. Argentina in turn exports gas to Chile, which is dependent upon energy imports, having only limited indigenous energy resources.

Bolivia and Argentina both produce from the same geological formations as exist in Paraguay. For over 70 years, Argentina has produced oil and natural gas from the same geological formations that underlie the Paraguayan Pirity Basin. Oil is being produced in the Olmedo Basin of Argentina near the border with Paraguay. Given the similar geological settings, and the fact that the bulk of the Paraguayan Pirity Basin is unexplored, the potential for large hydrocarbon reserves as exist in the neighboring countries would appear to be a possibility. The Pirity Basin is a large sedimentary basin located predominantly in northwestern Paraguay and northeastern Argentina. The Paraguayan Pirity Basin remains one of the world’s last minimally explored onshore hydrocarbon areas. Reprocessed seismic data since 2001, recent concepts in seismic stratigraphy and the analysis and interpretation of multiple data bases from several previous operators allowed for positive revisions to the geological model and hydrocarbon assessment of the Paraguayan Pirity Basin. The revisions confirmed five important aspects which indicate that potential commercial hydrocarbons are present in the Paraguayan Pirity Basin. They are:

a) adequate hydrocarbon sources;
b) reservoirs;
c) seals;
d) rapping mechanisms; and
e) migration timing.

Several factors render the Paraguayan Pirity Basin attractive for hydrocarbon exploration and development. These include larger and growing markets for hydrocarbon products both domestic and for export to countries such as Brazil, Argentina, Chile and Uruguay, significantly increased oil and gas prices since the early 1970’s, improved infrastructure in the Olmedo and decades of exploration success and production from the Olmedo Basin which is regionally down dip of the Paraguayan Pirity Basin and a positive change in the political climate. Additionally, new production techniques in the U.S. Permian Basin, the Canadian Montney area in Alberta and British Columbia and elsewhere demonstrate that formations having similar properties to those found in the Paraguayan Pirity Basin are commercially viable. Paraguay also has a favorable hydrocarbon law wherein concessions are granted and guaranteed by Congress. Tax laws for investment by foreigners offer benefits conducive to the high risk nature of oil and natural gas exploration and development.

The Regulatory Regime in Paraguay

In recent years, the Paraguayan Government has taken several initiatives to attract and secure foreign investment in the country. Accordingly, inward foreign direct investment flows have recovered substantially in the aftermath of the global financing crisis, rising from a low of $95 million in 2009 to $320 million in 2012. Overall, at the end of 2012, Paraguay’s inwards foreign direct investment stock stood at approximately $3.9 billion, a 48 percent increase from the 2009 level of $2.7 billion. To attract further foreign investment, Paraguay has enacted favourable hydrocarbon and tax laws which offer benefits conducive to the high risk nature of oil and natural gas exploration and development. While these measures have sought to attract the level of foreign investment required to explore and develop hydrocarbons in Paraguay, progress has been relatively slow.

Principal Applicable Legislation

In addition to the Concession Law, the Pirity Concession is governed by Paraguay’s legal framework relating to the oil and gas industry. That legal framework consists mainly of (i) the Hydrocarbons Law, regarding the prospecting, exploration and exploitation of petroleum and other hydrocarbons; and (ii) MOPC’s decree No. 6597, as amended (the “Regulatory Decree”), that contains the regulations with respect to the Hydrocarbons Law. Among other relevant laws and regulations that affect the Pirity Concession are the Paraguayan Civil Code, Paraguay’s Constitution (pursuant to which all hydrocarbon reserves belong to the Republic of Paraguay) and Paraguay’s tax laws. The MOPC is the governmental authority with responsibility for the regulation of the oil and gas exploration and production industry in Paraguay.

Under the Hydrocarbons Law, the exploration concession or phase for any exploratory block has a duration of four years. The exploration phase is extendable for an additional two years. The holder of the concession must select one or more exploration lots within the exploration concession area. Exploration lots are awarded in areas of 40,000 hectares each, up to a maximum area of 800,000 hectares.

If exploitable reserves are discovered during the exploration phase, an exploitation concession may be awarded. The Hydrocarbons Law provides that the exploitation or development concession or phase has a duration of twenty years. The exploitation phase is extendable for an additional period of ten years. The holder of the concession must select one or more exploitation lots. Exploitation lots have a surface of no less than 20 hectares and no more than 5,000 hectares.

Paraguay’s Tax-Royalty System

The Hydrocarbons Law provides a tax-royalty system governing an exploitation concession’s initial exploitation phase of twenty years, which may be extended by ten years. The following is a summary of certain provisions of the Hydrocarbons Law regarding taxes and royalties.

Except for fees collected for certain governmental public utilities and services, prospecting and exploration activities are exempt from all national, departmental and municipal taxes, including the applications for prospecting permits and concessions, as well as the related contracts.

During the exploitation phase, the concession holder shall pay the Paraguayan government the following fees:

  • An initial fee of $0.30 per hectare;

  • An annual exploitation fee per hectare as follows:

    • From the 1st through the 5th year: $0.20

    • From the 6th through the 10th year: $0.60

    • From the 11th through the 15th year: $1.60

    • From the 16th through the 20th year: $2.00

During the exploitation phase, the concession holder shall pay the Paraguayan government the following royalties:

  • With respect to the gross production of crude oil:

    • From 100 barrels per day to 5,000 barrels per day: 10 percent

    • From 5,001 barrels per day to 50,000 barrels per day: 12 percent

    • Above 50,001 barrels per day: 14 percent

  • With respect to gaseous, compressed and liquefied hydrocarbons: 12 percent of total gross production; provided, however, that no royalty shall be paid for gas that is returned to the reservoir, or used in the enhancement of petroleum production, or gas that cannot be used, which must be burned in special burners.

The Hydrocarbons Law allows a mineral depletion of 15 percent of the gross value of the annual production of oil, natural gas and by-products, after subtracting transportation expenses. Mineral depletion is limited to 50 percent of PHRSL’s annual net profits. Assets used for exploitation activities are subject to straight line depreciation at a 25 percent annual rate. Intangible drilling costs can be expensed or, at the option of the concessionaire, capitalized and depleted upon starting commercial exploitation, at an annual percentage depletion rate of 20 percent. The Hydrocarbons Law also provides for import duty exemptions for materials used in the exploration, exploitation, transportation and marketing of hydrocarbons and hydrocarbon products.

In accordance with Article 49 of the Hydrocarbons Law, as amended by Article 2 of Law No. 3,119/06, the holder of an exploitation concession must pay corporate income tax in Paraguay on net income at the rate applicable to business corporations in general. Accordingly, PHSRL’s annual net income, if any, will be subject to corporate income tax at a 10 percent rate. In addition, a distribution by PHSRL of dividends to local shareholders will be subject to corporate income tax at a 5 percent rate, and a distribution of dividends to foreign shareholders will be subject to corporate income tax at a 15 percent rate (to be withheld by PHSRL from the dividend payment).

Requirements to Provide Assistance and Equipment

Articles 46 and 47 of the Regulatory Decree, based on Article 58 of the Hydrocarbons Law, require the Company to provide, at its sole expense, certain assistance, training and equipment to government inspectors and technicians monitoring the Company’s operations and MOPC employees involved in the hydrocarbons industry. These requirements include a four-wheel drive all-terrain vehicle, a field office for supervision of operations, certain computer equipment, training courses for MOPC employees, and the domestic and international promotion of Paraguay’s oil bearing potential. Fulfilling these requirements may result in a significant expense to the Company. According to the Company’s Paraguayan counsel, Paraguay’s Supreme Court has ruled, with respect to other concessions in Paraguay, including with respect to a concession on the Pirity Basin, these requirements to be unconstitutional. These rulings of the Paraguayan Supreme Court are case specific and do not apply to the Pirity Concession. Nevertheless, based on those precedents, the Company has appealed these requirements, but a successful resolution cannot be assured.

Access to the Pirity Concession

The Hydrocarbons Law gives the holder of an exploration concession an “easement” to enter onto the concession block and conduct the activities necessary to carry out its obligations under the related concession agreement. Other than the Pirity Concession, no additional permits or permissions with respect to the real property upon which the Company conducts operations is required. However, Title XIII of the Hydrocarbons Law affords landowners certain protections. The holder of the concession must also notify the land owner or occupant of the work to be conducted. The holder of the concession must compensate the owner or occupant of the land for any damage resulting from the concession. If the owner or occupant deems the compensation amount to be inadequate, an appeal can be filed with the appropriate court.