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Boosting Foreign Investment in Oil and Gas Exploration and Development in Vietnam

8 December 2011
Mayer Brown Article

Vietnam has seen dramatic economic growth in recent years. Left behind by neighboring countries that enjoyed booming economies much earlier, Vietnam is finally taking steady steps toward becoming an economic power in Asia. With a population of 91 million and a well-trained workforce with diligent work habits, Vietnam has huge potential for further economic growth.

Cheap labor costs, one of the driving forces behind Vietnam’s economic growth, have attracted global manufacturers of consumer products that seek production bases in Asia. Some manufacturers are concerned about increasing labor costs in China and are considering shifting their production bases to Vietnam or establishing new bases in the country. For example, there has been a growing appetite for investment in Vietnam by Japanese manufacturers, who have been suffering from a record-high strong Yen aggravated by a chronic shortage of power after the March 2011 earthquake and tsunami.
The Vietnamese government has done a good job in providing support and comfort to these foreign investors. A new Investment Law and an Enterprise Law was enacted in 2006 in an effort to level the playing field for both foreign and domestic investors in Vietnam.

The Investment Law and its implementing legislation have provided a clearer pathway for licensing of foreign investment projects, while the Enterprise Law and its implementing legislation have added corporate structures and a governance system similar to those available in US jurisdictions.

Additionally, Vietnam’s accession to the World Trade Organization (WTO) in 2007, which required Vietnam to make certain changes to its legal regime in order to provide the necessary protections for foreign investors, brought further reforms to Vietnam’s banking, land, competition, anti-corruption and bankruptcy laws, to list a few. Other legislative reforms also provide certain comfort to foreign investors.

Under the Investment Law and relevant foreign exchange laws, foreign investors are permitted to purchase foreign currency to remit profits abroad. Vietnam has also abolished its profit remittance tax. In addition, the nation’s Securities Law was recently amended to provide clearer guidelines for foreign investors acquiring shares in Vietnamese companies. A new arbitration law was also enacted this year, providing a more attractive dispute resolution forum with international standards and procedures similar to those found in more developed arbitration centers such as Singapore.

With regard to the infrastructure necessary for industrial activities, consistent power supply is key. The construction of new power plants is, in itself, a challenging task in Vietnam; but securing fuels for existing and planned power plants is also becoming a critical issue.

Approximately one-third of Vietnam’s power is generated by gas-fired power plants, and the government has laid out even more aggressive plans for the use of gas for power generation. According to the National Gas Master Plan, issued 30 March 2011, gas-fired power generation in southern Vietnam is expected to triple, reaching 22 to 29 billion cubic meters (BCM) by 2025, compared to approximately 8 BCM in 2010. But from where will this gas be obtained?

Current proven and probable gas reserves in Vietnam do not seem to match the nation’s rapidly growing gas demand. In order to fill the gap, the Ministry of Industry and Trade is studying the possibility of importing liquefied natural gas (LNG). Ultimately, LNG import may be necessary if there is no alternative, but it is an expensive option. Before resorting to LNG, the Vietnamese government should consider exploiting its own indigenous oil and gas reserves to the fullest extent possible. Conventional wisdom within the international oil and gas industry is that Vietnam’s oil and gas reserves are currently under-exploited.

There is an upside regarding oil and gas reserves in Vietnam—especially in its offshore areas—if appropriate exploration activities are conducted systematically. The Vietnamese government needs to consider how it can encourage foreign oil and gas companies to participate in exploration activities in Vietnam. To promote oil and gas exploration and development activities, a comprehensive Petroleum Law was first enacted in 1993 and was subsequently amended in 2000 and again in 2008.

A model production sharing agreement was published in 2005. The law provides transparency and predictability of oil and gas activities in Vietnam; however, it has not provided enough incentive to attract many foreign investors to engage in risky oil and gas exploration activities. An easy solution is to provide more favorable fiscal terms to foreign investors under applicable production sharing agreements, but this course of action is not a likely scenario. Oil and gas reserves are valuable national assets and, therefore, fiscal terms may not be easily compromised.

The more practical approach is to assure oil and gas companies fair market price of discovered gas so that they have a reasonable expectation of gas commercialization. This is particularly important because the geology in Vietnam is considered heavily gas-prone. Approximately 90 percent of produced gas in Vietnam is used for power plants, and gas sales prices to power plants virtually determine the economics of Vietnam’s gas development projects.

Unfortunately, the Vietnamese government maintains a power development policy that mandates low electricity prices to help support industrial activities. Accordingly, gas sales prices to power plants must be set lower because they are calculated back from the electricity prices. There is no functional gas market in Vietnam, moreover, and gas sales prices to power plants must be negotiated and approved by the government on a project-by-project basis.

In addition, there is little coordination between Vietnam’s power sector and its gas sector to achieve common objectives toward competitive energy supply. For now, it seems that the gas sector generally gives way in favor of the power sector. The Vietnamese government needs to recognize both the potential upside of its own gas reserves and the importance of encouraging gas-exploration activities.

In order to do so, the government needs to facilitate a reasonable expectation of gas commercialization among foreign investors by allowing them to sell their discovered gas at fair market prices. Without that assurance, foreign investors will hesitate to risk drilling wells into gas-prone hydrocarbon reserves in Vietnam out of concern that discovered gas will have to be shutin or otherwise abandoned.

Government planners should take the lead in coordinating a balance between the gas and power sectors for their fair share of sacrifice. In this regard, the international oil and gas industry is carefully watching progress at the southwest Vietnam gas development project led by the Chevron consortium.

A heads of agreement for the gas development project’s front-end engineering and design work was signed by the consortium in 2009. However, the consortium has yet to issue a final investment decision. It is reported that the Vietnamese government insists upon lower gas sales prices for existing and newly constructed gas-fired power plants in southern Vietnam. In that case, the consortium may not be able to justify the economics of the gas development project.

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