Contracts are an essential part of the oil and gas industry and nearly every aspect of this industry results in formation of one or other contract. The exploration and production activities also require different contracts to be formed. Broadly, there are four key kinds of contracts which can be drawn in the oil and gas industry. These four include the product sharing contracts, the joint venture contracts, the concession type contracts and lastly, the service contracts (Gandi and Lin, 2014). When it comes to the exploration and production (E&P) contracts, the product sharing agreement/ contract is deemed as the best form of contract. The governments can chose amongst the different contracts in order to delegate the work of extraction and exploration of oil. The contractual form is changed on the basis of nations and yet, the most common contract remains product sharing agreement (Ing, 2014). In the following parts, an attempt has been made to show that there is no form of contract which is better than the product sharing agreement, particularly for the E&P contracts in the oil and gas industry. In this regard, the different advantages and disadvantages of this the product sharing agreement would particularly be highlighted.
The Production Sharing Agreements (PSAs) are deemed as the most common kind of contractual arrangement for the oil and gas industry’s E&P activities. The state is deemed as the owner of mineral resources in PSA and engages with the foreign oil companies (FOCs) as a contractor for providing the financial and technical services for the development and exploration operations. The government represents the state traditionally, or the state is represented through one of its own agencies like the NOC, i.e., the National Oil Company (Bridge and Billon, 2017). The entitlement to a stipulated share of oil is acquired by FOC, which is produced as a reward for the risk which is undertaken and for the services which are rendered. However, the state remains the owner of these petroleum products which are produced subject to the entitlement of the contractor to their share of production. The government or their NOC have the option usually for participating in the different features of the E&P process. Along with this, the PSAs provide for the joint committees to be established in a frequent manner in which there is representation of parties and the operations are monitored (Mikesell, 2016).
In 1966, the PSAs were introduced for the very first time in Indonesia (Duval et al, 2009). Once the independence was attained, a nationalistic feeling was running high and the foreign companies, along with their concessions transformed into a bull’s eye for hostility and criticism. As a response to this, the government denied the grant of new concessions. For overcoming the succeeding stagnation in the oil development, which was deemed as a drawback for the firms of the nation and of other nations, the new petroleum legislation was brought forward. The PSAs became acceptable as the government upheld the nation ownership of the resources. Even though the same was initially opposed by the companies, as they did not want to invest their capital in an enterprise which they could not manage. Even a more important fact was that the FOCs did not want to form a precedent which could have an impact over their concessions at some other place. Hence, the very first PSA was signed by the independent FOCs who depicted a higher willingness of compromising and accepting the terms which the giants had turned down. This was a very nice opportunity for such independents to gain access to high quality crude oil and break the dominance of industry giants (Bindemann, 1999).
Product Sharing Agreements as the most common form of contract in the industry
The PSAs are differentiated from the other forms of contracts, in two prominent ways. The first manner is that the FOC conducts the complete exploration risk. Where no oil is found, the company does not get any kind of compensation. And secondly, the government is the owners of the installations and the resources. When the very basic form of any PSA is analysed, four key properties are highlighted. The royalty is paid by the foreign partner to the government on the gross production (Hogan and Sturzenegger, 2010). Once the royalty is deducted, the FOC gets the entitlement to a pre defined share of production for the recovery of cost. The rest of the production, which is often referred to as the profit oil, then gets shared amidst the FOC and the government in a defined share. Following this, the contractor is required to pay the income tax over the share of the profit oil. Over a period of time, the PSA have been changed in a substantial manner and they adopt different forms. There is a need of balancing between the rewards and the risk, along with the division of profits amongst the contracting parties (Bret-Rouzaut and Favennec, 2011).
In order to prove that the product sharing agreement is actually the best form of contract, there is a need to highlights is different advantages and also the disadvantages, to get a fair view. The international experience of PSA shows that there are both positive and negative aspects of it. A key advantage of the PSA regime is that the host nations are able to get their hand over the profit efficiently as they get to keep a part of production, the profit oil, and also the share of the FOC is transferred to FOC at wellhead. This can be proved through the Angolan model which takes into consideration, the manner of use of the ROR, i.e., the rate of return. Though, before the host nation is able to take their share, the FOC get the right of taking the share of the produced oil for recovering the costs of investments, which includes the operational expenses cost and the cost of capital. This share is also taken from the cost oil, which is the oil exploited (Goldthau and Witte, 2010).
Apart from this, the PSAs are deemed as self-containing. This means that the PSAs have the entirety and the autonomy which gives away with the necessity of external regulatory organ. Generally, this model is preferred by the FOCs in such nations where there is low institutional maturity as they feel more protected, there is an absence of transparency, there is vagueness in the legal system of the host nation and there is a risk of political instability (Bremmer and Keat, 2010). This is particularly true for the nations which have an unorganized tribunal system as is present in Indonesia and Angola. However, when it comes to the organized nations where the FOCs feel more secure, as is the case of Brazil and Norway, the same cannot be deemed as a positive aspect of the PSA (Brannsten, 2010).
Features of Production Sharing Agreements
When the positive aspects of the PSAs are considered, there is a need to point out the example of the Brazilian Government for changing their regime. The main motivation of the Brazilian government is that the Government intake of profit was increased and the attractiveness of investing in the E&Ps is maintained. Apart from this, the host nations do investments in the E&P phases and also establish the additional presence of the host nation in the activity through Petro-Sal, which is a new public agent. This also allows the government’s control in the different phases of production, in addition to the destination of petroleum. Lastly, the destination of the petroleum is maintained, particularly in the chances of Petro bras participation in new blocks (Brannsten, 2010).
Amongst the most prominent negative aspects of PSAs is that it involves complexities where there are two different systems adopted in an area, and an example of this is the sub salt area in Brazil. Where the concession regime continues to be applicable in certain blocks, the application of PSAs gives rise to difficulties owing to the two parallel systems. As a result of this, there is a need for two different regulatory frameworks where the objective is essentially the same, and this gives rise to certain challenges. Apart from there, there is also the drawback of difficulty in the harmonization after the two different regulatory models are adopted. The PSAs also are hard to inspect and to control, particularly for the government as it becomes difficult to calculate the profit oil and the cost oil. Thus, the calculation of profits and its division in different parts pose another challenge (Brannsten, 2010).
In the PSAs, all of the operational and the financial risks are present with the FOCs and the host nation’s government gets the additional advantage by getting to share the possible profits even when they do not make any investment, till the time the government agrees to share the profits (Easo, 2015). For the host governments, the PSAs present the drawback in the sense that it puts the premium over the highly professional negotiations, and particularly when the government is required to gain an access to the legal, technical, commercial, environmental and financial expertise. This proves feasible only for some of the oil-rich nations, in comparison to the other nations (Radon, 2006).
Another form of contract is the service contracts. A PSA has a number of advantages in comparison to the service contract. In a PSA, the FOC gets the major control over the operations, giving them a key role in the state’s oil policies. However, this is not the case for the service contracts as the host government gets the sole control on the operations conducted and the FOCs are only required in certain segments of the production process. In PSA, the host government and the FOC can bear the financial risk in a joint manner; however, in service contracts, the FOC have to bear all the financial risk associated with the operations. In the PSA, a substantial share in the oil profits is held by the FOC, whilst in the service agreements, the FOCs are only entitled to a fixed amount which is agreed at the negotiation time. Lastly, when the term of the PSA comes to an end, the FOC gets to negotiate the terms for reinvesting the host State’s operation assets. The service contracts do not have this leverage as the entire operation gets back to the host government upon the end of the contractual period (Benjamin, 2014).
Advantages of Product Sharing Agreements
The widespread usage of the PSAs shows that these contracts are quite efficient when it comes to the institutional arrangement for the sharing of risks, even when they are deemed as inefficient in the economic theory terms. The fact of the matter is that the PSAs are not greatly effective in terms of the economic theory and that the other regimes can also get the very same results, which is often the argument cited for switching from the PSA, along with stating that this regime is motivated in a political manner, instead of being economically motivated. However, the study conducted in this regard, for the subsalt field of Brazil is a leading example of no drastic changes being obtained in regulatory or economic parts of the operations. And the only change would be made is the increased complexity in the system, owing to the need of altering the system, instead continuing with the present regime (Brannsten, 2010).
Thus, on the basis of this discussion it becomes very clear that when it comes to the choice of choosing an E&P contract, the best choice is the product sharing agreement. In order to establish this, the discussion touched on the very basics and the origins of the PSAs, followed by which its different advantages and disadvantages, particularly in practical context were discussed. These clearly highlighted that there are more benefits of opting for this system as the host nations get added advantages under PSAs. The PSAs allow the host government to make profits even without making any investments and even maintains control. When this agreement was compared to the service contracts, which is another possible form of contract which can be selected by the parties, the different advantages of the PSAs highlighted the need for deeming the PSAs as the best form of contract for the E& P contracts when it comes to the oil and gas industry.
References
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