Their impact on the financing of petroleum projects
There is likely a major new development in the economics of the upstream petroleum sector. This is the growing influence of the Islamic (Shariah) law and its financial rules for the lawful, halal, conduct of commerce.
Muslims are now thought to comprise some 23 percent of the global population, about 1.62 billion persons, mainly majority Sunni, about 80 percent of the total but also a large minority Shia, some 20 percent1.
Many of these Muslims will be high net worth individuals, domiciled in lands adherent in part or in whole to the Islamic law. They may be desirous of deploying their individual savings in Sharia-compliant investments.
For this reason and faced with growing demand from the Muslim world it is evident that the practice of Islamic banking is growing, not only in the Moslem lands but also in some European capital cities, principally London, where Sharia–compliant commerce is a growing factor in the modern banking sector.
This article discusses Shariah-compliance, its distinct rules, the principles of Islamic economics and their effect on financial transactions as well as the results of a recent major conference in London on developments in Islamic financial practice.
The Arabic word Shariah means a road, that is the road to water: signifying an essential for life. This concept reveals the existential role of the Islamic law, its legal and constitutional precepts and its day-to-day workings in the everyday life of the pious Muslims2.
Islamic economics, finance and the issues discussed at the ninth World Islamic Economic Forum
Between Oct. 29 and 31, 2013, the World Islamic Economic Forum held its ninth annual conference in London. The WIEF, a Malaysia-based organization, provided a good deal of useful information on the workings of Islamic economics and finance. This conference, the first to be held outside the Muslim world, was attended by some 1,800 delegates, among them six Muslim heads of state, kings, emirs and presidents, one crown prince, six prime ministers including the prime minister of the United Kingdom David Cameron and the prime minister of Malaysia Tun Abdul Razak.
Perhaps the single most important new development to be revealed at the WIEF was the announcement by Prime Minister Cameron, that the U.K. government was about to issue a Shariah-compliant sukuk bond as part of its gilt-edged sovereign debt issues.
I shall explain the significance of this new development a little later on but at the moment I shall simply comment that the WIEF event has had three main impacts:
It reveals that Islamic finance (and its dependence on authoritative interpretations of the Islamic law) has achieved credibility so far as one major European government, the U.K., is concerned.
Secondly, it reinforces the importance of the City of London in developing links to the world Islamic community and its legion of investors seeking access to Shariah–compliant financial instruments, of this more below.
Thirdly, it also demonstrates the importance of building up a body of English-speaking knowledge about the Sharia and its growing impact in modern commerce so as to comment upon and to anticipate further developments in the important markets under the religious and cultural influence of Islam as well as those likely to be of interest to non-Muslim seekers of ethical investments.
Some of the themes developed by press reports have helped to ventilate two major concerns that attach themselves to the new forms of “non-conventional” finance under discussion.
The first of these must be the question of “who is qualified to rule whether this or that financial product does conform to the Islamic law?” An article in the Sunday Times by the reporter Iain Dey reveals that the development of the Islamic finance industries in Indonesia, Malaysia and in Singapore since the Asian financial crisis of the mid 1990s has been linked to two factors:
- a growing wish to disinvest in American Treasury securities by south-east Asian investors and those from the Arabian Gulf and
- the establishment of a group of Islamic scholars who are judged qualified to rule on this or that problem of the lawfulness of particular Islamic financial products. Sharia scholars now sit on the compliance committees of major banks in the City but it is clear that there is not universal agreement on all points.
The second concern has been raised by two prominent and Christian Britons. One is the Anglican former Bishop of Rochester the Right Reverend Michael Nazir-Ali and the other Lady Cox, prominent in her defense of the persecuted Christian church world-wide and concerns the exclusive constitutional position of British national law in our doctrine of parliamentary sovereignty.
Two types of UK Shariah–compliant financial instruments
The U.K. has already changed its laws so that Muslims are not disadvantaged when attempting to assume debt-finance to purchase a house. A mortgage-like investment is unlawful for Muslims because:
- it involves the payment of interest to a lender on the outstanding balance of the loan, and
- the risk of default is not shared equally between lender and mortgagee.
We can see that pledge of the reserves of an oilfield as collateral for a bank to provide project finance for development might not be lawful under Shariah law either because of the same objections. However new and applicable financial instruments have been drafted that are Sharia-compliant (there are many more than are cited here).
Purchase of a house by a Muslim in the UK
Instead of selling a mortgage an Islamic bank will acquire a house that the Muslim wishes to buy from a vendor, at a negotiated price. The bank will then sell the house to the Moslem purchaser at a higher price in tranches over time in a deal known as a diminishing partnership. Since there are effectively two property transactions involved in the process the Muslim purchaser in the U.K. would have been disadvantaged by having to make two payments of stamp duty. The British government has changed the law to recognize the apparent injustice.3
This method of finance satisfies three Islamic injunctions: the prohibition of the payment and receipt of interest, the sharing of risk by both parties and the avoidance of uncertainty.
According to Norton Rose Fulbright the diminishing partnership method may also be employed for the development of an asset.
In this process the financier contributes cash for development and the client contributes the physical asset. The client or a third party then holds the asset as agent on behalf of the partnership and undertakes to manage the assets to achieve the objectives of the partnership. The client agrees to pay down the financier’s share in the assets in installments at cost.
Each time the client buys a share of the financier’s share the latter’s percentage ownership of the assets diminishes and the client’s increases. At the same time as the repayment process is underway the client is effectively leasing the financier’s share of the asset in return for a periodic rental payment. As the outstanding balance of the asset owned by the financier decreases the rental payment decreases. After the client has purchased the financier’s entire share in the asset its title shifts to the client, the lease is terminated and the transaction is complete.
Some other examples of Islamic financial products
Kingdom of Bahrain US$350 million sukuk bond……presumably the proposed new UK government £200 million sukuk bond will be structured along the lines shown below……
- US$350 million Trust Certificates, sukuk al ijara, issued to investors as a Special Purpose Vehicle, by the CBB International Sukuk Company, owned by the Central Bank of Bahrain
- Sukuk proceeds received by Issuer
- Grant of one hundred year lease of land parcel to Issuer
- Payment of US$350 million advance rental of land parcel to Issuer
- Payment of semi-annual rental payments to Issuer
- Termination payment of US$350 million as redemption of sukuk payable on maturity or early dissolution
There are now fifty sukuk or Islamic bond listings on the London Stock Exchange totalling £21 billion in value4.
As everyone knows the petroleum industry is highly capital intensive. According to the Paris-based International Energy Agency the global energy sector will require investment of $17 trillion by the year 2030.
In the literature distributed at the conference there were some examples of major downstream petroleum projects financed under Islamic economic rules. The excellent pamphlets produced by Norton Rose Fulbright mentioned the Islamic lease financing of two new-build LNG tankers for Brunei Gas Carriers, the National Shipping Company of Saudi Arabia’s financing of six VLCCs, the Al Waha petrochemical project which saw the Shariah-compliant financing for the design, construction, commissioning, and operation of a poly-propylene plant and propane de-hydrogenation plant in Jubail, Saudi Arabia.
But what of Shariah-compliant upstream E and P risk finance?
Can a full cycle upstream E and P petroleum contract or project be structured so that its terms and their components are fully Sharia-compliant? As I am pointing out (in the sidebar) the grant of mining rights in the early days of the new Islamic empire certainly had the sanction of the prophet Mohammed himself.
So far as international petroleum agreements are concerned we have usually been in a state of flux. The original concessions transacted in the MENA countries in the early years of the twentieth century have largely given way to variants of the Indonesian Contractor (Production Sharing) model. We may recall the resistance to the new Indonesian PSA by the major IOCs in the 1960s but not by the smaller who recognized the potential attractiveness of this new contractual relationship. Now we can see a further shift of contractual terms with the adoption of the service contract model adopted in Iran, Iraq, Venezuela and Bolivia and soon maybe elsewhere.
However, living and working in Indonesia in 1974 as a young geologist this author can well recall the turmoil occasioned within the oil community by the interpretation placed by the American IRS on the tax-paid status of the American IOCs’ production shares. The difficulty turned upon the eligibility for a foreign tax credit of the notional Indonesian corporate tax deemed to have been paid by the IOC. There followed an effective rewriting by the Indonesian government of some of the economic clauses in the PSA.
When the original full cycle Middle Eastern upstream petroleum agreement was signed in 1901 between the Qajar shah of Persia (Iran) and the Englishman William Knox D’Arcy no objection was raised by the Shia Islamic scholars at the time. Neither was there in Saudi Arabia by the Sunni Hanbali, Wahabi ulama when the petroleum concession was transacted between King Abdul Aziz ibn Saud and the American CASOC, nor in Bahrain, Kuwait nor in Oman later on.
Therefore we may assume that there is nothing fundamentally objectionable in Islamic law to the idea of the grant of rights in petroleum to a domestic or foreign commercial oil company. Therefore it seems that Shariah-compliant risk capital could be found for such a venture if the terms are right. It is now up to the legal draftsmen, skilled in transactions according to the Islamic law to give us the means.
However it is important to recognize the existence of certain specifically Islamic taxes (there may be others): the zakat (a levy assessed on a percentage of wealth and designated for the relief of the poor) and the khums (a Shia tax designed to support the clergy).
These taxes may not find their exact European or North American equivalents.
It may be that divergences from the strict application of the Islamic law can be accommodated within the doctrine of darura, necessity. But this will require an authoritative ruling that this or that use of darura is eligible.
Michael Bunter is an English petroleum geologist with nearly fifty years international oilfields experience. He has lived and worked in the Moslem lands of north Africa, the Middle East, MENA and Asia (Libya, Malaysia, Indonesia, Egypt, the Sudan, Kuwait and Oman) and has published a number of papers on the Islamic law and its impact in the petroleum sector. Mr Bunter spent nearly ten years with the US oil company CONOCO in Indonesia, Malaysia, USA, Dubai and Egypt. He runs his own petroleum consultancy, B and R Co, and is an honorary lecturer at the University of Dundee.
- An important conference held in Jordan in November 2004 sponsored by King Abdullah II, (himself a direct descendent of the prophet Mohamed) and attended by over 200 Islamic scholars from over fifty countries, adopted the Amman Message. This legal ruling defined eight lawful Sunni and Shia schools, madhab, of the Moslem law and provided a ruling as to who is and who is not recognised as a Moslem. It also stipulated the conditions for the issuance of legal Moslem rulings, fatwa. In this connection it is a fact not generally remarked that the petroleum-rich portions of many of the Arabian Gulf countries fall very largely within their Shia –dominant areas….that is in southern Iraq, in Iran, also in Kuwait with its large Shia minority, Bahrain where Shia are the subordinate majority and also in the eastern Al Hasa province of Saudi Arabia with its large Shia population.
- In practice in Islam (as in the Mosaic law) there is no distinction between law and religion.
- NORTON ROSE FULBRIGHT, Islamic finance library, glossary of Islamic legal and other terms, distributed at the ninth WIEF, London, 2013 and also Innovations in Islamic Finance.
- The Arabic word sukuk, a lawful financial instrument, is cognate with the English/French word cheque which in turn derives from the Persian.