Oil And Gas Management: Concession And Product Sharing Agreements

Concession Regime

Write an essay on Oil and Gas Management.

 The growing nationalism in the oil producing countries has led the oil producing country’s host government gaining control over their mineral asset and taking a large economics rent from the International Oil Companies (IOC). Product Sharing Contracts (PSC) or PSA (Public Sharing Agreement) replaced the Concession type agreement due to dissatisfaction in the returns for the government.  The resources are utilized by the natural resource rich country for economics and social development (Ciarreta and Nasirov 2012). The reason for the government to make a contract with the foreign oil company is to develop and sell the product. Tordo et al. (2013) mentions the government mainly has three ways of natural resource development. Firstly, there might be a development, exploration and production of the state companies like that in Oman, Iran, Mexico and Saudi Arabia. Secondly, the natural resources are developed like that of the Canada, United States and Russia. Finally, a combination of both the type of contracts mentioned above may be used in Nigeria, Indonesia, Kazakhstan and Azerbaijan. According to Blackwill and O’Sullivan (2014), the terms of the contract will help in determining the revenue of the oil producing countries from the mineral resources. Thus in this paper we will see the differences in the concession and PSA form of contract , the reason for host countries to favor PSA and reasons for extracting higher amount of profit.

In order to regulate the petroleum industry, the concession regime was the first type of contract system developed and it is a form of contract is widely used globally. The concession type of arrangement is to explore oil through the exchange for payment in all costs and tax related to its operation. Under a concession agreement, there are exploration rights offered exclusively to the contract holders and production and development rights.  The companies in order to enter into an agreement through concession, needs to take part in the bidding process by NAP (National Agency of Petroleum). There is a transparent criterion of bidding when the points are allotted for the local content percentage, minimum program of work and proposed signature bonus (Esteves, Coyne and Moreno 2013). The company winning the bid will be given a concession contract. All the risks and costs are considered. The companies with concession agreement are given the right for 100% production and have the right for exporting the crude oil with some obligations like acquisition of local content and meeting national consumption (Forsyth 2014).  This type of contract helps the host country to grant the oil companies the right to explore and produce hydrocarbons from an area for certain time so that payment is received in the form of tax and royalties. Royalty is paid in the first barrel of oil before the profit is earned by contractor. The contract will be helpful for the holder, as he will be protected from any changes in the legislation of the petroleum industry (Wang and Krupnick 2013). All the costs are deducted against the income from sale of gas and oil.

Product Sharing Agreement

In general, the concession contract in the oil and gas industry has given the company the status of an owner and rights to keep the hydrocarbon. Exclusive rights are gained by the company to explore, making own expenses and becoming the owner (Ghandi and Lin, 2014).  This type of contract shows that in case of the concession type of regime, the state is not the owner of petroleum extracted.

The Product Sharing concept was introduced in Indonesia during 1966.  The concept is now used in the countries like Libya, China, Qatar, Syria, Egypt, Malaysia, Peru and many more. PSA is a contract between the oil producing country and the International Oil Companies (IOC) where in the latter bears all the risk and the cost of exploration and production of oil and gas. The IOC will have a return on the investment and production is shared so that the costs are recovered. The agreement involves dividing the oil rather than the money generated from the sale of oil (Haney and Pollitt 2013). There involves a direct participation of government in the process of decision-making.  The contractor gets 100% of the production after recouping the costs. The contractor after recovering the cost is going to split the production with the government. There is a larger share earned by the government before the contractor earns profit. The main reason for favoring PSA is to attract the multinational companies who are interested in risking capital and utilizing technology for the development of the Host country reserves (Kan and Tomson 2012). The strategic importance with respect to the exploration and production of hydrocarbon has helped in guaranteeing that a decent share of hydrocarbon ends up in the hands of the state.

The reason for the oil producing countries to replace concession agreements with the PSAs licenses are regarded as a much straight forward agreement when considering the bidding system with some basic terms (Khatib 2014). There is a need for restructuring the bidding system in the concession agreements. The following are reasons for product sharing agreements by oil producing country:

Over all mineral development:  The specific feature of the mineral industry is that the development and the exploration takes place at the area where the resource is located.  There is high risk involved in this type of venture, as it is difficult to decide upon the quality and existence of the reserves of minerals (Mansour and Nakhle 2016).  There is no assurance of profitability and since the resources are finite, there would be continuous acquisition of more deposits. The government looks into the welfare of the country, so the government is going to decide whether the resource is to be held privately or by the state. The objectives of the host country and the MNC oil companies is seen to clash as the oil companies are maximizing profit while the host government wants to maximize revenue. The foreign company takes up the risk about investment. With the successful exploration by IOCs, the position of the government will get strong (Mikesell 2016).  The increase in the marketing and geological knowledge will lead to improving upper hand of government. The PSA form of contract will lead to the development of the mineral sector and stimulates domestic exploration.

Reasons for PSA

Mineral Development and Ownership Rights:  There two types of contracting methods under PSA i.e. the competitive bidding and the bilateral negotiation. During a bilateral negotiation, the MNC oil companies approaches the government for the concession regarding the exploration, development and export of the resources.  This type of agreement helps the private contractor, but PSA helps the government in keeping open the payment based on the bonuses, royalties and financial incentives. Model contracts will help in publicizing and is available to the potential partners. The foreign firm and the National Oil Companies (NOC) carry out the negotiation. The reason for this is that the NOC has a more sound knowledge on the information of mineral deposits (Mitchell and Mitchell 2015). They are also less politically interfered and moreover expertise is going to get better with NOC taking the control. The resources of minerals are owned by the state who later decides whether the exploration and the development will be given to the public or the government companies. The exception related to the owning of the oil companies is related to the state.

History related to petroleum contracts:  There has been increasing hostility and criticism received about the concession system, so the government introduced the PSA. In PSA, the whole risk is borne by the foreign company and the government enjoys the rewards. The ownership of the mineral resources is in the hands of the host country government. The sole bearer of risk is the IOCs, as it engaged in the development and the exploration of the mineral resources (Seelke et al. 2015). The IOCs supply the knowhow and the services. This type of contracts is also referred to as the risk service agreement. Thus, contracts are the only way through which oil can be explored. The country with large oil deposits depends on the extraction of oil. This is the reason government has increased interference in the oil sector.

The Public Service Commission helps the host government to get more amount of profit as the government would be keeping a part of the profit. The model of Angola is a good example of this, which takes into consideration the rate of returns (Thomas 2013). Prior to the host country, it is the government that decides on its share so that the costs of investment are recovered (Sovacool 2016). There is completeness and autonomy in PSCs. The main motivation of the government through the contract is to increase the level of profit and attract investment in the exploration and production. The professional support and the expertise needed is less? There is no risk of losses for the host government other than the cost of negotiating the contract. There might be loss of opportunity but there is no material loss when a project fails. The government can draft the PSA contract in such a way that it can bring another oil company. The added advantage is that it can have potential profits without making any type investment. When there is enactment of PSA into the law then there would be a legal security for the IOCs. The government points out that such type of approach will turn this type of agreement from a flexible to a fixed approach, which is amended through the approval of the parliament. PSA type of agreement is superior to that of the future and the present contracts with respect to the matter that is addressed. The government turns its rights to adopt the new regulation and law in the interest of the public if it affects the oil company’s right under the contract of PSA.

Mineral Development and Ownership Rights

Conclusion:

The government intends to maximize its revenue from the natural resources when it designs the fiscal system, but in turn provides incentives to the foreign investors. There is different type of contracts on which the oil industry depends. The PSA form of agreement is the most widespread type. Under this the IOCs receives that the share of the production in the form of rewards for the investment and work that is performed. The entire risk is borne by them along with the host government. The agreement is made prior the exploration the revenues of IOCs mainly comprise of the profit oil and the cost oil. The direct revenue sources for the government are the bonuses, profit oil, royalties, custom duties and indirect benefits. PSA tends to divide the production capacity and does not divide the profit out of the proceeds of the market. This shows that the cost is recovered when oil is produced.  In theory, the operations are controlled by the state The economic theory however suggest PSAs are inefficient contract forms as the IOCs does not receive marginal product. 

References:

Blackwill, R.D. and O’Sullivan, M.L., 2014. America’s Energy Edge: The Geopolitical Consequences of the Shale Revolution. Foreign Aff., 93, p.102.

Ciarreta, A. and Nasirov, S., 2012. Development trends in the Azerbaijan oil and gas sector: achievements and challenges. Energy Policy, 40, pp.282-292.

Esteves, A.M., Coyne, B. and Moreno, A., 2013. Local Content Initiatives: Enhancing the Sub-National Benefits of the Oil, Gas, and Mining Sectors.Rev. Watch Inst.

Forsyth, T., 2014. International investment and climate change: energy technologies for developing countries. Routledge.

Ghandi, A. and Lin, C.Y.C., 2014. Oil and gas service contracts around the world: a review. Energy Strategy Reviews, 3, pp.63-71.

Haney, A.B. and Pollitt, M.G., 2013. New models of public ownership in energy. International Review of Applied Economics, 27(2), pp.174-192.

Kan, A. and Tomson, M., 2012. Scale prediction for oil and gas production.Spe Journal, 17(02), pp.362-378.

Khatib, H., 2014. Oil and natural gas prospects: Middle East and North Africa. Energy Policy, 64, pp.71-77.

Mansour, M. and Nakhle, C., 2016. Fiscal Stabilization in Oil and Gas Contracts: Evidence and Implications.

Mikesell, R.F., 2016. Petroleum company operations and agreements in the developing countries. Routledge.

Mitchell, J.V. and Mitchell, B., 2015. States and Markets in the Oil Industry. In States and Markets in Hydrocarbon Sectors (pp. 17-39). Palgrave Macmillan UK.

Seelke, C.R., Villarreal, M.A., Ratner, M. and Brown, P., 2015. Mexico’s Oil and Gas Sector: Background, Reform Efforts, and Implications for the United States. Current Politics and Economics of the United States, Canada and Mexico, 17(1), p.199.

Sovacool, B.K., 2016. Countering a corrupt oil boom: Energy justice, Natural Resource Funds, and São Tomé e Príncipe’s Oil Revenue Management Law.Environmental Science & Policy, 55, pp.196-207.

Thomas, A.R., 2013. Impact of Shale Development on International and Domestic Oil and Gas Contracts, The. Global Bus. L. Rev., 4, p.1.

Tordo, S., Warner, M., Manzano, O. and Anouti, Y., 2013. Local content policies in the oil and gas sector. World Bank Publications.

Wang, Z. and Krupnick, A., 2013. A Retrospective Review of Shale Gas Development in the United States: What Led to the Boom?. Resources for the Future DP, pp.13-12.