Panama Oil Exploration: Some Considerations

1. INTRODUCTION

Oil companies started exploring certain regions of Panama since 1917. Some of them were the Royal Dutch Shell Company. British Controlled Oil Fields Ltd., Gulf Oil Company, the Texas Company, Cities Service Company and Sinclair Oil Corporation.

Explorations and drillings were performed by several of these companies from 1918 through 1928 in the regions of Chiriqui, Bocas del Toro and Darien. During 1938, the Sinclair Oil Corporation conducted geophysical investigations in the region of Colon.

Oil exploration has been regulated since 1904, but it was not until Panama enacted Law No. 19 of 1953 that certain clear rules were established for the oil business. Almost immediately thereafter, the Panama American Petroleum Corporation started an extensive exploration program in the Provinces of Cocle, Herrera, Los Santos and Veraguas. In 1958, Champlin Oil and Refining Company jointly with Corporacion Petrolera S.A. explored the region of the Chiriqui Lagoon and, at that same time, Unocal explored the Sixaola River.

At the end of 1970, Mobil Exploration began evaluating the Gulf of Panama and two other companies, Corvus S.A. and Plaris S.A., initiated an exploration program in the region of the Gulf of Panama near the coast of Darien.

In the legislation side, certain improvements were needed, and Law No. 8 of 1987 (hereinafter the "Petroleum Law") was enacted to cope with modern techniques and problems of oil exploration, exploitation, transport and refining in Panama. This article intends to highlight the most important aspects of said law in the oil exploration sector.

2. PRELIMINARY EVALUATIONS

The Ministry of Commerce and Industry, through its Department of Hydrocarbons, is in charge of promoting joint geophysical evaluations to be financed by those companies interested in entering into operating agreements. These companies shall enter into an agreement with the Ministry in respect of such evaluations.

Any companies meeting the requirements of Article 20 of the Petroleum Law may request a permit to the Department of Hydrocarbons to conduct geological, geochemistry or geophysical explorations with the purpose of finding an area of interest. A permit may be granted for up to 24 months.

Under Article 20 of the Petroleum Law, the Department of Hydrocarbons may promote a bidding procedure and will select interested companies based upon their financial strength, technical knowledge and experience to carry out the operation in which it is interested.

Within the confidentiality period of two (2) years, the company beneficiary of the permit will have a first option to enter into an operating agreement for the exploration and exploitation of a block inside the area of interest. However, the Department of Hydrocarbons shall decide whether to enter into said agreement or promote said bidding procedure, in which the beneficiary of the permit can elect to participate. If the Department of Hydrocarbons opts to promote the bidding procedure, all participants shall obtain a copy of the evaluation report from the beneficiary of the permit. The total purchase price of such report will be calculated based upon the cost of all different exploration work performed, plus an amount not exceeding 30% thereof.

3. EXPLORATION

In land and inland waters, the exploration area will consist of a block with a maximum surface of 200,000 hectares. In the sea, a block shall have a maximum surface of 300,000 hectares. Blocks will be divided in lots not exceeding 5% of its surface. A concessionary may enter into an operating agreement for up to two (2) blocks.Under the respective agreement, the concessionary shall complete a Minimum Exploration Program covering the projected work, investment and costs, and including all or any of the following evaluations:

Geology

Magnetometry

Gravimetry

Seismic acquisitions

Drilling

Other prospection methods

Exploration concessions are granted for a period of five (5) years, extendable for a period of two (2) years. This extention will only be granted pursuant to the presentation of an Additional Minimum Exploration Program.

4. OPERATING AGREEMENTS

Under the Petroleum Law, the Republic of Panama in the operating agreements makes no guarantee or representation as to the existence, quantity or quality of oil within its territory. The concessionary shall undertake all the risk, cost and liability arising from its operations and shall contribute all the capital, machinery, equipment, materials, personnel and technology for its activities. The concessionary can partially or totally assign its rights with the prior authorization of the Department of Hydrocarbons and can sub-contract certain operations with the previous notification to the same institution.As mentioned before, if the selection made by the Department of Hydrocarbons following the bidding procedure falls in a foreign corporation, it is required that said corporation must be established as a legal entity or a branch pursuant to Panamanian law, which recognizes several forms of juridical persons, including :

General partnerships

Limited partnerships

Cooperative companies

Corporations (including joint venture corporations)

Branches of foreign corporations

Notwithstanding the above, the two (2) most advisable forms to structure an oil exploration operation are a Corporation (or subsidiary) or a Branch of a Foreign.

The Petroleum Law states that Panamanian personnel shall enjoy preference to be hired in oil exploration operations. Nevertheless, the concessionary may hire foreign technical personnel with the previous permission of the Ministry of Labor and further to the percentages allowed by the Labor Code.

All concessionaries and their sub-contractors can purchase goods and contract services abroad, when those goods and services are not available in Panama or do not fulfil the specifications used by the oil industry.

All concessionaries have the right to refining, transporting through a pipeline, warehousing, selling and exporting its extracted oil.

5. TAX INCENTIVES

The main tax incentives to oil exploration and exploitation concessionaries are:

Total exemption from taxes, duties and other levies related to the importation of machinery, equipment, spare parts and other materials required for the development of its operations.

Total exemption from income tax during the first five (5) years of production or until the recuperation of its total initial investment. As of the 6th year, there are other income tax incentives subject to certain parameters to be further discussed with your legal counsel.

Accelerated depreciation of assets.

Loss carry forward for three (3) years after the fiscal period in which they were originated.

6. JURISDICTION AND APPLICABLE LAW

Any controversies arising from the execution, performance or termination of oil exploration operating agreements or concerning geological, geochemistry or geophysical exploration permits, which cannot be solved by mutual agreement, shall be decided by the Courts of the Republic of Panama in accordance with its applicable law, without recourse to any diplomatic claims.