Oil project imparts concerns of windfall for foreign companies at Korea's expense

Under current laws, foreign contributors to deep-sea mining and extraction projects can walk away with up to 88 percent of the profit.

Vitor Abreu, founder of U.S. consulting firm ACT-GEO, speaks at a press briefing to explain Korea's potential oil discovery at a governmental complex in Sejong on June 7. [YONHAP]

With the government planning to attract foreign investment in the development of a large oil and gas exploration project off Korea’s east coast, concerns have grown over a potential national wealth outflow under the current law.

The laws in place allow foreign companies participating in deep-sea resource development in Korea to claim more than 88 percent of the extracted resources.

Foreign investment is deemed inevitable in the east coast project, said the Ministry of Trade, Industry, and Energy as well as sources within the resource development industry on Tuesday.

The exploratory drilling alone, which is necessary to confirm the exact volume of the discovery, is projected to cost at least 500 billion won ($361.8 million). Given the high-risk, high-return nature of the business, risk distribution is essential.

Reluctance from the National Assembly, especially from the opposition parties, to cooperate on funding further pushes the government toward foreign investment.

The government has also acknowledged the difficulty in securing the necessary deep-sea development technology, which requires drilling over 1 kilometer (0.62 miles) below the sea, solely through domestic companies.

Such involvement by outside entities, however, has prompted concerns over a potential national wealth outflow under the current law, as the fees that can be collected in exchange for participation by foreign companies in exploration projects are low.

Article 18 of the current Submarine Mineral Resources Development Act mandates that the holder of rights to mine underwater must pay royalties to the Energy Ministry for the extraction of minerals from the designated site.

These royalties are capped at 12 percent of the sales price of the oil and gas produced, after deducting processing, storage and transportation costs. This structure allows foreign companies to pocket more than 88 percent of the value of extracted production.

Previously, Australia's Woodside Energy explored the 6-1 and 8 mining blocks, which include seven potential sites, with the Korea National Oil Corporation (KNOC) on a 50:50 equity basis, but withdrew due to internal reasons.

After absorbing Woodside's share, the government continued further investigations with input from the U.S. consulting firm ACT-GEO. After discovering a prominent site with an estimated value of around 2,000 trillion won, full-scale development began.

If Woodside had not withdrawn and succeeded in exploration leading to commercial production, simple calculations suggest that company could have earned around 880 trillion won.

“The current laws are structured this way because, in the past, it was necessary to lower entry barriers to attract foreign investment, as large oil and gas field investment candidates would not have participated as they do now,” Second Vice Minister of Energy Choe Nam-ho said.

On the contrary, when the KNOC participated in overseas oil and gas fields, it paid royalties or taxes equivalent to around 70 percent of production to the host government.

Major oil-producing countries typically take between 85 and 90 percent of production from foreign companies, Lee Chul-gyu, a professor at Kangwon National University and former executive of the Energy & Mineral Resources Development Association of Korea noted.

The Energy Ministry is pushing to amend the law to increase the royalty rate against the backdrop of this situation. One discussed approach is to raise the royalty rate when global oil prices soar at the time of production.

Additionally, the Energy Ministry is considering establishing legal grounds for requiring foreign companies to pay additional fees at key stages in the progress, such as the signing of a contract upon confirming the exact reserves through exploratory drilling, and when commencing commercial production.

Implementing measures to impose additional charges if a foreign company’s profit exceeds a certain level is also seen as another way to prevent an outflow of national wealth.

The government plans to hold a "road show" soon to attract foreign companies interested in the project.

Kim Dong-sub, the CEO of the KNOC, held a briefing on the progress of attracting foreign investment on the Wednesday. Energy Minister Ahn Duk-geun will hold a meeting with KNOC executives and industry experts to focus on strategies to lure foreign investment on Friday.

BY KIM MIN-JOONG, CHOI HAE-JIN [choi.haejin@joongang.co.kr]