Pursuing and developing exploration project opportunities in Latin America

Projects

APPLICABLE LEGISLATION IN PARAGUAY

Introduction (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 779/95, 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 779/95, 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 779/95 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 779/95 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 779/95 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 779/95 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 779/95 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 779/95, 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).

Environment and Safety Regulation in Paraguay

The Company and others in the oil and gas industry are subject to various levels of government regulation relating to the protection of the environment in the countries in which it operates. The Company believes that its operations in Paraguay fully comply in all material respects with applicable environmental laws.

The Paraguayan Environmental Agency is the “Secretaria del Ambiente (SEAM)”. The Environmental License for the Pirity Block was originally awarded by SEAM on June 2, 2008 (DOC DGCCARN No 2005/08) and renewed by SEAM on September 6, 2012 (DOC DGCCARN No 2633/12). Petro-Victory, LLC handled the environmental license to President Energy, as Operator, immediately after the execution of the Farm-out Agreement and the Joint Operating Agreement (JOA). All the operating procedures at the Pirity Block field have been in full compliance with the general regulations and guidelines administered by SEAM which regulates the HSE Activities of the Operator at the site. All Operator’s activities at the site are permanently governed and monitored by the Operator’s own HSE Policy.

Environmental legislation imposes, among other things, restrictions, liabilities and obligations in connection with the generation, handling, storage, transportation, treatment and disposal of hazardous substances and waste and in connection with spills, releases and emissions of various substances to the environment. As well, environmental laws regulate the qualities and compositions of the products sold and imported. Environmental legislation also requires that wells, facility sites and other properties associated with the Company’s operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities. In addition, certain types of operations, including exploration and development projects, may require the submission and approval of environmental impact assessments. Compliance with environmental legislation can require significant expenditures and failure to comply with environmental legislation may result in the imposition of fines and penalties and liability for clean-up costs and damages.

Access to the Pirity Concession

The Hydrocarbons Law 779/95 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 779/95 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.