Professional Documents
Culture Documents
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OilContracts
HowtoReadandUnderstandaPetroleumContract
ed.Version1.1
TimBoykett,MartaPeirano,SimoneBoria,HeatherKelley,ElisabethSchimana, AndreasDekrout.RachelOReilly2012.
AcataloguerecordforthisbookisavailablefromtheBritishLibrary. ISBN:5800086962958 TimesUpPress Industriezeile33b 4020Linz Austria Website:www.timesup.org Emailaddress:info@timesup.org Phone:+43732787804 BookSprintfacilitationby:AdamHyde Website:www.booksprints.net Emailaddress:adam@booksprints.net CoverDesign:MartaPeirano/JohannesGrenzfurthner ThisbookwasproducedusingBooktypefromSourcefabric.
Contents
II
Contents
HOWTOREADANDUNDERSTAND PETROLEUMCONTRACTS
Foreword
1 3
CONTEXT
PetroleumBasics TheLife&TimesofaPetroleumProject WhatisaPetroleumContract? OurFamilyofContracts TheAnatomyofPetroleumContracts
7 9 13 21 29 31
THEACTORSANDTHESCRIPT
TheStarsoftheShow TheRolesTheyPlay JointManagement TheOperator
37 39 45 57 63
THEMONEY
Maths,Myths,andMentallyWarmingUp
67 69
III
ECONOMICDEVELOPMENT?
HistoryandEvolution OilforInfrastructure TheroleoftheNationalOilCompany Employment,ProcurementandSocialWelfare
LAWYERSYAMMERINGON
Dealingwithdifferences Stabilisation Confidentiality
IV
APPENDICES
Glossary
193 195
VI
petroleum basics
Foreword
FOREWORD
Fromnowuntilthetimeyoufinishthissentence,another5,000barrelsofoilwill havecomeoutoftheground.Or10,000barrelsbytheendofthisone,worthabout amilliondollarsonworldmarketstoday.SupposewecreatedaWorldOil ProductionIndex(WOPI)asameasureofmoney,likealightyearindistance. WOPIwouldequalaspaciousCentralParkapartmentinaminute,themost expensiveskyscrapereverbuilt,BurjKhalifa,inamorning,andthenetworthof Facebook'sMarkZuckerbergintwoweeks. Or,alternatively,WOPIwouldsurpasstheGDPoftheDemocraticRepublicof Congo,acountryof70millionpeople,inadayandahalf,andtheentireannualaid budgettoAfricainfourdays.Itwould,infact,takeabouttwoweeksofWOPIeach yeartoeliminateabsolutepovertyamongthe1.3billionpeoplearoundtheworld whosubsistonlessthan$1.25adayeach.It'snotnewsofcoursethatoilgenerates alotofmoney.Butit'sgoodtogetahandleonjusthowmuch. Itispetroleumcontractsthatexpresshowthismoneyissplitandwhomakes whatprofits,justasitisthecontractsthatdeterminewhomanagesoperationsand howissuessuchastheenvironment,localeconomicdevelopment,andcommunity rightsaredealtwith.ThesharepriceofExxonMobil,thequestionofwhocarries responsibilityforDeepwaterHorizon,whetherUgandawillbeabletostop importingpetrol,andhowmuchitcoststoheatandlighthomesinmillionsof homestheseareissueswhichdependdirectlyonclausesinthecontractssigned betweenthegovernmentsoftheworldandtheoilcompanies. Formostofthe150yearsofoilproduction,thesecontractshaveremained hidden,nestedinabroadersecrecythatsurroundedallaspectsoftheindustry. Governmentsclaimednationalsecurityprerogatives,companiessaidcommercial sensitivityprecludedmakingthemavailable. Butthelastfewyearshaveseentheemergenceofthetheideathatthese contractsareofsuchhighpublicinterestthattheytranscendnormalconsiderations ofconfidentialityinbusiness,andshouldbepublished.Afewgovernmentsand companieshavepublishedcontracts.AcademicinstitutionssuchastheUniversity ofDundeeintheUKandNGOssuchastheRevenueWatchInstitutearejustnow, attheendof2012,beginningtocollectthecontractsthatareinthepublicdomain intodatabasessearchableovertheInternet. Contracttransparencyisthenaturalnextstageofthetransparencymovement. Theinitiativeswhichbeganinthe1990saround'ResourceCurse',leadingtothe creationoftheExtractiveIndustriesTransparencyInitiativein2002,havesucceded inopeningupapublicconversation.Governmentsandcompaniesnow acknowledgetheimportanceofopennessandethicalbusiness.CSRwasbornto counter'BloodDiamonds'.Butthereisasyetlittlesystematicpublicunderstanding
3
counter'BloodDiamonds'.Butthereisasyetlittlesystematicpublicunderstanding ofhowthesetitanicindustriesactuallywork.Activistsandjournalistssometimes penetratedarkcornersanduncoverkickbacksandsecretdeals,andoccasionally triggerapublicoutcrythateffectschange.Butpublicsuspicionremainshigh aroundtheworld,fueledlargelybythissecrecy.Indozensofcountriesaroundthe worldpublicdebatediscussioncontinueswiththemaindocumentsattheheartof thisindustryremainingabsent. Casualrhetoricabouthow"thegovernment"or"thestate"isbeingsosecretiveis nothelpfulbecauseitmisidentifiesandactuallyunderstatesthedegreeof dysfunctionalityandasymmetryofinformationthatcanexist.Thisisoften"deep state"stuff,belongingtoaworldofaidesandspecialadvisorswithilldefined roles,wheretheregularapparatusofthestatecanalsobeoutoftheloop.Inone country,seniordiplomatsinitsforeignministrylackthemostbasicunderstanding oftheindustrythatgenerates90percentofitsrevenuesandgovernsrelationswith itsneighbours,withwhomitsharessizeablefields.Inanother,thefinanceminister himselfhasbeendeniedaccesstothepetroleumcontractswhichdeterminehow muchrevenueheissupposedtocollectfrominternationaloilcompaniesand others.Inathirdcountryabidroundwentbad,andcontractsweredelayedfortwo years,becauseaphonecalltoclarifybasicdetailswasn'treturned.Ministersofthe economy,planningandenvironmentarerarelyconsultedabouthowcontractscan integrateintobroadergovernmentpolicy. Andyet,becauseofthepioneeringmovetopublishbysomegovernmentsand companies,thechancenowexiststobegintocreatepublicunderstandingof petroleumcontracts,basedonthosethatexistinthepublicdomain.Thisbookisa firstattempttorisetothatopportunity.Weaimtoreachatleasttenthousand peoplearoundtheworldwhomaybeengagedintheindustry,oringovernanceof ortransparencyactivismaroundit,butwhomaynothavehadthechancetogain professionalexposuretopetroleumcontractsandtheissuesofhowtheyare actuallynegotiated.Wehopetheywillincludepeopleinthepublicandprivate sectorsof50countries,journalistsandcivilservantsandlocalbusiness communitiesaswellaspromotingabroaderunderstandingofthenegotiating processwithinthecompaniesthemselves. Thesectionsofthebookareintendedtoleadthenonspecialistreaderthrougha logicalsequenceinunderstandingcontracts.SectionOnesetsthestagewith backgroundcontext.SectionTwo,whotheplayersare,establishestheformal partiestoapetroleumcontractandthenormalprovisionsofwhodoeswhatand whodecideswhataccordingtothecontract.SectionThree,'TheMoney',goesto theheartofthenegotiationanddealswithallthedifferentrevenuestreamsand toolsthatgointoconstructingevermorecomplexfinancialarrangements. Thenwedevotetwosectionstosubjectswhicharehandledincontractsbut ofteninpassingandatthelastminute.SectionFourdealswiththelinkages
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Foreword
ofteninpassingandatthelastminute.SectionFourdealswiththelinkages betweenthepetroleumindustryandeconomicdevelopmentasawholeinthe producingcountry,asdealtwithinthecontract,whileSectionFivelooksatclauses relatingtohealth,safetyandenvironmentalprotection.Finally,inSectionSix, LawyersYammeringOn,welookatpurelegalaspects,disputeandarbitration procedures. Wequoteliberallyfromafamilyofpetroleumcontractsthroughoutthebook thatcomefromeightcountriesAfghanistan,Azerbaijan,Brazil,Ghana,Indonesia, Iraq,LibyaandTimorLeste.Theywereselectedtorepresentvariousstructuresin contracts,stagesofdevelopmentofpetroleumindustryandmostofallbecausethey areinthepublicdomain.Othercontractsarereferredtofromtimetotime. Thisbookhasbeenwritteninfivedaysfromstarttofinish,usingtheBooksprint techniquepioneeredbyAdamHyde.Iamwritingthisforewordasitslastentryona FridayafternoonatSchlossNeuhasenlittlemorethan100hoursafterwesatdown tostoryboardit.Thisisbothasourceofprideandourfirstandlastdefencewhen ourcolleaguesandthebroadercommunitypointoutinaccuracies,gapsandother defects,aswehopetheywillandencouragethemtodo. TheBooksprintisacollaborativewritingtechniqueofastonishingpowerin whichcolleaguesconstantlybrainstorm,write,editandcopyediteachotherina workflowthatsomehowmanagestocombinehighfluiditywithstructure.But inevitablyinaprocessofsuchspeedtherewillbeunevenessanddifferenceintone andperhaps,atthemargins,insubstance,betweenonesectionandanother.Itisa workofcollectiveauthorshippublishedundertheCreativeCommonslicense,but thatdoesnotmeanthateveryoneofus,ortheaffiliationswerepresent,subscribes toeverystatementmade.Thisbookismoreteamworkthangroupthink. Thewritersofthisbookare:PeterEigen,founderofTransparencyInternational andfoundingchairofEITICindyKroonfromtheWorldBankInstituteHerbert M'cleodfromSierraLeoneSusanMaples,OfficeoftheLegalAdvisertoLiberian PresidentEllenJohnsonSirleafNurlanMustafayevfromthelegalaffairs departmentatSOCAR,Azerbaijan'sstateoilcompanyJayPark,alawyerfrom NortonRoseGeoffPetersNadineStillerfromtheGermanagencyforinternational cooperationGIZLynnTuryatembafromtheNGOInternationalAlertinUganda JohnnyWest,founderoftheOpenOilconsultancyandSebastianWinkler, DirectorEuropeforGlobalFootprintNetwork.Allworkonthebookwasprobono ormandatedbytheorganisationsweworkfor.Ifyouwanttoheareachofusinour ownwordstalkingabouttheproject,gotohttp://openoil.net/booksprint AdamHydeofSourceFabric(Booktype)andBookSprints.netfacilitatedthe BookSprintandLynnStewartdesignedthebookanditsartwork.Firstreaders,and copyeditorsweretheOpenOilteamofSteffiHeerwig,RobertMalies,ZaraRahman andLucyWallwork.
Wereceivedfinancialassistancetowritethisbookfrom:InternewsEurope,a mediadevelopmentorganisationbasedinLondonPetroleumEconomistmagazine (withnoeditorialinputourviewsandmistakesremainourown)andtheGerman FederalMinistryforEconomicCooperationandDevelopment(BMZ). Wewantthisbooktobethestartofabroaderpublicconversationabout petroleumcontracts.Itwillbealivingdocument,subjecttoconstantcritiqueon theWebandperiodicreview.Anyonecandownloaditatanytime,printandsellit, andadaptit.Pleasebearinmind,though,thatbecauseourworkisCreative Commonslicenseandavailabletoeveryone,thetermsofcopyrightsaythatyou inheritthetermsofthatlicenseandanyworkyoubaseonourswilllegallybe underCreativeCommonslicensetoo. Weaimforthebooktobecomethebasisforlocalisedversionswhichtakealook atpetroleumcontractscountrybycountry.Thereisnoreasonwhy,threeyearsfrom now,thereshouldn'tbe,foreverycountryintheworldwithapetroleumindustry (orhopingtodevelopone),aneditoriallyindependentandtechnicallyinformed bookputtogetherbyagroupofsympatheticbutobjectiveprofessionalsfroma rangeofdisciplineswhichanalysesthatcountry'scorecontracts,availabletothe publicfreeofcharge.Wewouldbedelightedtohelpmakethathappenwith anyoneinaproducingcountrywhohasaninterest. Wealsoaimtomakeitthebasisfortrainingcourses,portedtoallrelevant locationsandlanguages,whichbringafundamentalandholisticunderstandingof petroleumcontractstoamuchwideraudiencethanhashadthechancetoengage withthemsofar. Itisourbeliefthateventhoughthesecontractswerenotwrittenwiththepublic inmind,withalittleefforttheycanbeunderstoodtoalevelwhichenablesreal, matureandinformedpublicdiscussion.Wehopethatafterreadingthisbookyou willagree. JohnnyWest FounderOpenOil.net
context
Context
Context
PETROLEUM BASICS
Youputitinyourcar.Itheatsyourhouse.Fliesplanes.Onedaywemightbe beyondit,buttodaywearenot.Petroleum.Thematerialbehindthesecritical functionsthatliterallyfueltheworld,ismadeupofstringsofcarbonandhydrogen, knownashydrocarbons,formedfromthecompressionoforganicmatterover hundredsofmillionsofyears.Oldstuffthatdrivesthemodernage.Oil,gas,petrol, diesel,butanetheyallcomefromhydrocarbonsbeneaththeearth'ssurfacethatare thenarerefinedtomakethemmoreusefultous.Thisbookisaboutthecontracts thatmakefindingandproducingthesesubstancespossiblerightnow.
Generally we use 'petroleum' to mean both oil and gas, because both contain hydrocarbon compounds, and because they are often found in the same location. We will use this same terminology in this book.
Thefirstthingthatwillprobablycomeintoyourmindwhenyouthinkabout productsthatcouldbemadeoutofallthatpetroleumisprobablyfuel.However, therearenumerousothermaterialsandproductsthatcontainsoilorgas,e.g. toothpaste,candles,medicines,orevencomputers.Thisalsoexplainswhycurrently petroleumisofutmostimportancetoourlivestoday. Historically,petroleumcontractsweredesignedwithcrudeoilinmind,andthis continuestodominatethelogicandstructureofcontractstoday.Gashasonly recentlyalsobecomeavaluableresource.Astheoldindustrysayingwent:"What isworsethannotfindingoil?Findinggas!"Thisisnottrueanymore,asgas becomesincreasinglymarketable.Butnotallcontractsaroundtheworldhave,as yet,caughtuptothisreality. Naturalgas,orjustgas,isusuallyclassifiedwithincontractsaseithernon associatedgasandassociatedgas.Nonassociatedgasreferstogasreservoirsthat containonlygasandnooil,whereasassociatedgasisfoundtogetherwithcrude oil.Theimplicationsofthesecanbefarreachingandwillaffectenvironmental, social,political,fiscalandtechnologicalconsiderations.Countrieswithsignificant gasdepositswilltypicallyaddresstheseconsiderationsinfargreaterdetailsintheir contractsthancountrieswithprimarilycrudeoilreserves. EXAMPLE:In2011,88millionbarrelsofoilwereproducedperdayworldwide onebarrelisroughly160litresorabout44USgallons.317billioncubicfeet(bcf) ofnaturalgaswasproduceddaily.
Context
At the time of writing, in late 2012, trends were emerging to show that the rising price of oil has made it profitable for companies to invest increasingly in deep-sea operations. Declining revenue from shallow-water and onshore sources, as well as technical advances, have made deep waters more attractive, despite their cost.
Conventional Vs Unconventional
10
Petroleum Basics
Conventional Vs Unconventional
Flippingthroughthenewspapers,youreadaboutprotestersupsetabout "unconventional"oilbeingdevelopedonpristinefarmland.OrFranceis consideringbanningit.Butwhatisunconventionaloil?Forthatmatter,whatis conventionaloil?Thedistinctionbetweenconventionalandunconventional operationsreferstothemanner,easeandcostassociatedwithextractingthe petroleum. Conventionaloilextractionemploystraditionaloilwells,andunconventional, thenewandemergingtechnologiesandmethodologiesallowingaccesstomore inaccessiblereserves,suchasthosefoundinoilshaleandoilsands. Conventionalgasistypicallyfreegas trappedinrockformationsandis easiertoextract.Unconventionalgasreservoirsincludetightgas,coalbed methane,gashydrates,andshalegas(whichsitsinsandbeds).Drillingfor unconventionalgascanbemoreexpensivecomparedtoconventionalgas.The supplyofandinterestingasextractedfromunconventionalreservoirsisgrowing rapidly,mainlyduetotechnologicaladvances. ....butasofthewritingofthisbook,mostcontractsdonotprovidefortheunique attributesofunconventionalgas.
Thepriceofpetroleumisanotherheadlinegrabber.Weallknowitisoutthere,but weprobablydonotstoptothinkaboutthedetailstooterriblyoften. Whatdoes"Oilisat$100abarrellmean"?Alloil?Someoil?Theanswertothis is,"someoil". Petroleumisbeingboughtandsoldatmanydifferentpricesallovertheworld thoughtheytendtobecomparedor"benchmarked"offcertaincommonstandards. ForOil,WestTexasIntermediate(WTI)orBrentcrudesorblendsandcommonly used. ForGas,HenryHubbiscommon. Thesebenchmarks,whicharethepricesthatmaketheheadlines,areusedto determinethepriceofoilandgasproducedelsewhere.Thiswillbediscussedin moredetaillaterinthe"ValuingOil"chapter.
Future Pricing
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Future Pricing
The uncertainty that surrounds the future price of oil is something both contractors and countries are acutely aware of. They try to account for it in both financial systems and petroleum contracts so that stakeholders may profit from favourable market conditions and also be protected where those conditions change.
Thepriceofoilhas,historically,drivenfundamentalshiftsintheoilbusinessand thecontractsthatunderpinit.Inlate1960sand1970s,thefamousfirstwaveof nationalisationofnaturalresourcesledtothecreationofanewformofcontract TheProductionSharingContract. Nowadays,withthepriceofoilbeinghigh,thereisanincreasingmovementof peopleinresourcerichcountrieswantingvisualproofthattheirnaturalresources aredirectlybenefitingthem.Fromtheirpositionascitizensofthecountryand thereforeascoownersoftheresource,thereisacallforrenegotiationofcontracts andtheformationofnewcontractsthataddressthis. Whatdoesallofthismeanforoilcontracts,thesubjectofthisbook? Whoknows,istheshortanswer.Itwouldseemtosuggestthatthesearchfor petroleumwillcontinue,atleastintheshortterm,withdevelopingextraction technologies.Maybethiswillproduceaflurryofnewoilcontractsbetween companiesandgovernmentsthataddressthesenewmethodsofextraction.Butthey mightnot. Theoldestcontracts,fromthedaysofEdwinDrakeinPennslyvaniabackin 1859,didnotlookterriblydifferent,atthemostfundamentallevel,thanmanyof thecontractstoday.Isittimetoraceforward?Keepwhatwehavegot?A combinationofthetwo? Wedonotclaimtoknowanditprobablydependsonwhoyou'reasking,butwe dohopethatthisbookenablesyoutoengageinsuchadiscussionandask questionsthatcouldleadyoutoananswer.Thecontractsandlawsinthepetroleum sectorareoftenreformedforvariouspolicyreasonsandthisbookisdesignedto helpthereaderactivelyengageinthisprocess.
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Explore
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Explore
Seismic
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Exploration Drilling
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EXCERPT FROM GHANA PETROLEUM AGREEMENT WITH TULLOW, KOSMOS, AND SABRE MARCH 10, 2006:
"Exploration" or "Exploration Operations" means the search for Petroleum by geological, geophysical and other methods and the drilling of Exploration Well(s) and includes any activity in connection therewith or in preparation thereof and any relevant process and appraisal work, including technical and economic feasibliity studies, that may be carried out to determine whether a Discovery of Petroleum constitutes a Commercial Discovery
Evenwithconductingseismictohelpclimbtheconfidencescale,onemight needtodrillseveralexplorationwellstoestablishwhatisinfactbelowtheearth's surface.Onecommonlyusedcomparisontoexplorationdrilling(particularlyinthe deepoffshore)istryingtostickanextremelylongstrawinadrinkingbottlefrom thetopofaskyscraperandthendrinkfromit.Ofcourse,therearemanyareaswhere hydrocarbonsareknowntoexist,thoughtheymightnotbeevenlydistributed.In thesecasesseismicisstillneededtoincreasethechancesof'hittingthetarget'. Becausemostofususefuelinourcarswhichweseeasaliquid,manyofus envisionpetroleumtobeinlakelikepoolsbelowtheearth'ssurface.Infact,itis foundinspacesorcrackswithinrockformationsandneedsvarioustechniquesto extract(relievepressure,createpressure,etc).Onemightpictureaglasswithalot ofcrushediceandtryingtodrinkamilkshakefromit. Whilethereisnostandardamountoftimeonemightconductseismicstudies anddrillexplorationwellsintheworld,thesestudiesanddrillingandthe interpretationoftheresultsevenonaveryrapidscheduletakesmonthsatthevery lesatandmoreoftenaround24years.
Letusassumethat,luckyyou,youfoundhydrocarbonswhiledrillingyouhave "discovered"petroleum!Isthepaydaycoming?Mostlikely,notquiteyet.You mayhave"discovered"hydrocarbons,butthequestionthenbecomes,howmuch didyoufind?Enoughtomakeitworthwhile,"commerciallyviable"oreconomical todevelopandproduce?Whatyouwillneedtodonext:"appraise"thediscovery. Appraisingentailsmoredrillingandseismictoasseswhatyouhavediscovered, buttoagreaterdegreeofaccuracy.Itwillleadtomoredetailedgeological discoverywhilealsoinvolvingassessmentandreflectiononhowtobuildthe necessaryinfrastructuretoproducethepetroleumyou'vefound.Youwillwantto knowmoreabout: thechemicalcompositionofthevarioushydrocarbondeposits
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EXCERPT FROM GHANA PETROLEUM AGREEMENT WITH TULLOW, KOSMOS, AND SABRE MARCH 10, 2006:
"Discovery" means finding during Exploration Operations an accumulation of Petroleum not previously known or proven to have existed, which is recovered or recoverable at the surface in a flow measurable by conventional petroleum industry testing methods; "Appraisal Programme" means a programme carried out for the purposes of delineating the accumulation of Petroleum to which that Discovery relates in terms of thickness and lateral extent and estimating the quantity of recoverable Petroleum therein;
Develop
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Develop
Onceyouhaveexplored,discoveredandappraisedapetroleumdepositand determinedthatitisworththecosttogetitoutoftheground,thenextstageisto developinfrastructuretoextractit.Dependingonanumberoffactors,including geology,locationandlocalregulations,youwillneedtodeterminethebestwayto getyourhydrocarbonsoutofthegroundandtothemarket. Thiscanincludedecisionsabouthowmanywellstodrill(yes,therecanbemore thanone,therecanbemany!),whattypeofplatformyouwillbebuildingor whethertobuildaplatformatall.Increasingly,offshoreoildevelopmentsareusing boatlikestructurestoextractpetroleum,theFloatingProduction,Storageand Offloadingunitsor"FPSOs"inshort,ordifferentvarieties(eg.FPOs,orFPS's) whichdoonlysomeofthesefunctions. Thedevelopmentphaseisrarelylessthanseveralyears.Engineering,community andbusinessconsiderations,amongothers,allfactorintothetypeandscaleof infrastructurethatwillbeusedtoextractthepetroleum.Thisisthephasewhich requiresthemostamountofmoneyinthelifecycle(themost"capitalintensive"). Whileexplorationwelldrillingintheoffshoremightgetintothehundredsof millionsofdollars,complex,largescaledifficultenvironmentsfortheextractionof petroleumcanhittensofbillions!
Produce
EXCERPT FROM GHANA PETROLEUM AGREEMENT WITH TULLOW, KOSMOS, AND SABRE MARCH 10, 2006:
"Date of Commencement of Commercial Production" means in respect of each Development and Production Area, the date on which production of petroleum under a programme of regular production, lifting and sale commences;
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Abandon
Itisimportanttonotethatsignificantamountsofpetroleumwilllikelyremainin thegroundatthispoint.Thismaybebecausethefinancialsysteminplaceinthe countrymakescontinuedproductionuneconomicand/ortechnologicallythere doesnotcontinuetobecosteffectivemeansofproducingpetroleum.The environmentalissuesrelatedtoabandonmentarediscussedinthesection: Environmental,SocialandHealth&SafetyIssues,whileprojecteconomicsand theirimpactonproductionarediscussedinthesection:'TheMoney'. Otherfactorsthatmaycauseacontractortohaltorevenindefinitelycease operations,maynot,however,triggerthecontractualobligationtodecommision. Thesecouldincludesecurityconcerns,socialunrestorpoliticalinstability.These 'forcemajeure'eventswouldnotterminatethecontract,butcouldsuspendthe contractorsobligationuntiloperationswereabletoresume.
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In a number of countries, a contract, license or concession may cover several fields simultaneously. This means that, multiple areas, each at their own respective stage may be active under one contract.
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In this book, we will, from now on, use the term "petroleum contract" to refer solely to the Host Government Contract. Other terms will be defined as we go and all are listed in the Glossary for further reference.
Asmallminorityofcountrieswillnot,however,followthisapproachto petroleumextraction.Theymay,instead,managemostofextractionprocess themselves,thereforeremovingtheneedtopartnerwithanIOCandtheneedforthe HostGovernmentContract.ExamplesincludeSaudiArabia'sNationalOil CompanySaudiAramcoandMexico'sPemex.
Younowhaveapetroleumcontractinyourhands.Doyouhaveeverythingyou needtounderstandtherelationshipbetweenthegovernmentandthecontractorsby justreadingthroughthecontract?No. We'llsayitonceanditwillsurelybesaidagain:petroleumcontractsareonekey feature,livinginaconstellationorwebofotherlawsandregulationsaboveitand manyothersubcontractsandotherancillarycontractsarebelowit.Thesewillbe referredtobythecontractbutwillnotbeexplicitlydescribed,explainedorre written. Thisweboflawsandregulationsrelatingtopetroleumwithinaparticular countryisknownasa"petroleumregime".Thepetroleumregimecanbebest thoughtofasahierarchy,startingwiththeconstitutionoftherelevantcountryand endingwithpetroleumcontract.
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Constitution
Context
Contracts
Therearetwomainsystemsforawardingorwinningcontracts: CompetitiveBid:Giventhevalueofpetroleumtoday,manycountriesaward contractsbyholdinga'bidround'.Here,companiescompeteagainsteachotherby offeringthebesttermswithregardstooneormoredefinedvariablestowinthe contract. Adhocnegotiations:Hereaninvestorcomesunsolicitedandasksfora particularparceloflandandthennegotiatesacontractdirectly. Firstcome,firstserved:Alternatively,theremightbeanapplicationsystem andthefirstcompanythatappliesandpasseswhateverregulatoryhurdlesthestate mayhave,isthenawardedthecontractwithsomenegotiationsoverthetermsof thecontractusuallyinvolved. Thesystemforawardingcontractsinacountry(ordifferentareaswithinthat country)maydependonthecurrentstateofitspetroleumsector.ForexampleIs theregeologicaldataalreadyavailable?Isitaknownpetroleumproducingarea?Is thereinfrastructurealreadyinplacethatcouldbeusedforthisspecificblock?Hard
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thereinfrastructurealreadyinplacethatcouldbeusedforthisspecificblock?Hard toreacharea?
EXAMPLE: Peru's legal framework, allows for competitive bidding and Ad hoc. Although the country generally favors competitive bid rounds, if a contractor approaches with an interest in an area not currently under consideration, the country may choose to negotiate terms and award a contract directly.
Negotiations
Acountryislikelytohaveamodelpetroleumcontract,inastandardformatand withstandardclausesthatcanbeanyofthetypesofHostGovernmentContracts listedinthenextsection.Theextenttowhichthepartieswillnegotiateorchange theseclausesandtermswilldependuponsuchissuesasthecountry'spetroleum law,marketenvironmentandcurrentpoliticalsituation.Throughthenegotiating process,thetermsmaybenegotiatedsignificantlyfromwhatwasintheoriginal model,oritmaybeonlythenumbersofonefiscaltermonwhichthecompanies werebidding,suchasasignaturebonusthatisfilledin. Followingnegotiations,whatwasagovernmentmodelcontractwillbecomea signedcontractwithaparticularcompanyorseveralcompanies.Withthesigning ofthecontract,thecompanyorcompaniesarelegallyawardedtheexclusiveright toexploreandproduceoilinthecontractarea.
Concessions
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Concessions
Concessionsarethe"original"oroldestformofpetroleumcontract.Firstdeveloped duringtheoilboomintheUnitedStatesinthe1800s,theideawasthenexportedto oilproducingcountriesaroundtheworldbyInternationalOilCompanies(IOC). Thesecontractsarebasedmuchmoreona"landownership"conceptofoilthatis basedontheAmericansystemoflandownership.IntheUnitedStates,the landowner,generallyspeaking,haslegalownershiprightsoftheearthdirectly belowit(subsurface)andtheskyaboveit. Thiswouldincludeoilifitwasfoundbelowaprivatepropertyownersland. Duetothishistoricalorigin,theconcessionsimilarlygrantsanareaoflandtoa company,thoughtypicallyonlythesubsurfacerightstotheland,andtherefore,if thatcompanyfindsoilbelowthesurface,thecompanyownsthatoil.Underthe concessionthecontractorwillalsohavetheexclusiverighttoexplorewithinthe concessionarea. Howthen,youmayask,doesacountrybenefitsfromthisformofcontract?This usuallyoccursthroughtaxesandroyalties,thoughastatemayalsoholdsharesin theconcessionthroughitsNOCinaJointVenturewiththecontractor.
ProductionSharingContractsorPSCsandServiceContractsaredifferentfrom concessions,inthattheydonotgiveanownershiprighttooilintheground.This alsomeansthatthestate,beingtheowneroftheresourceintheground,must contractacompanytoexploreonitsbehalf. IndonesiacanbecreditedwiththeinnovationofProductionSharingContracts in1966.TheIndonesiangovernmentdecided,asa'nationalistic'move,tomove awayfromconcessioningtocontracting.Thiswasdonesothatthestateretained ownershipofthepetroleumproducedandonlygavetheinternationalcompanythe righttoexploreandtakeownership(orlegallyspeaking"title")toitoncethe petroleumwasoutoftheground. Thisinnovationcameaboutatthesametimeasmanypetroleumproducing countriesweregainingtheirindependenceandwaspartofthefirstwaveoftheso calledresourcenationalism.Anotherkeydevelopmentduringthistimewasthe formationofOPEC(OrganisationofPetroleumExportingCountries)thatledto further"rebalancing"ofgovernmentcompanyrelationships. UnderaServiceContract,titledoesnottransferatall.UnlikeaPSC,wherethe oilcompanyisentitledtoashareofanypetroleumproduced,underaService Contract,theoilcompanyisjustpaidafee.
Thecreationandexecutionofthepetroleumlaws,modelcontracts,andespecially thenegotiationofasignedorexecutedcontract,allareprimarilydrivenbythe executivebranchofgovernment.ThiswilltypicallybetheMinistryrunningthe petroleumsectorandperhapssomeotherministrieswithrelevantexpertisesuchas theMinistryofFinance. Thoseoutsideofthis'innercircle',eveninothergovernmentdepartments,have historicallyfoundpetroleumcontractsshroudedinsecrecy.Asaresult,thepeople thatareinterested,influenced,andaffectedbytheseindustries,whetherin producingorconsumingcountriesoftenfeelleftout,inthedark,wonderingwhere themoneywentorwheretheoilcomesfromandonwhatterms.Andwhilea country'sconstitutionispublic(wehope!)andthelawsaretoo(ifsometimeshard tofind),petroleumcontractsarelikelytobenoteasilyaccessibleevenifbylaw theyshouldbe. Therangeofpotentialstakeholdersishuge,andtheirconcernstoonumerousto listthemhere.Whilethemajorityofoilcontractstodayspeakprimarilyaboutthe financialandtechnicalaspectsofoilextraction,theyareincreasinglyaddressing concernsofstakeholdersthatarenotdirectlypartiestothecontractbutaredeeply affectedbyit.Thisisfurtheraddressedinthesection:Economicdevelopment. Ourgreathopeisthattherestofthebook,whichisdevotedtothecontentof petroleumcontracts,willhelptoempowerpeopletoreadandunderstandthese multibilliondollarcontractsthatfuelourworld.
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ThisdefintionshootsustoArticle39:
Context
contracts(notjustpetroleum)thatallowsthesuspensionofacontractwhileso calledunforeseeneventsor"actsofGod"likehurricanesoractsofwarallowthe contracttobesuspendeduntiltheeventhasresolved.So,thisisonewayinwhich thecontractmightbeextended.Butthelastphraseof3.2,"orelsewhereinthis Contract"iswherethingsgetreallyugly:thisclauseliterallyshootsyoutothe entirecontracttohuntandseewhereelsethecontractmightbeextended. Dependingonjusthowpreciseyouneedtobewithyouranswer,yourtaskmay havejustgottenagoodbitlonger. Ifyou'restayingfairlygeneral,3.3tellsyouthattherecouldbea5year extensioniftheContractorrequestsitfromtheROC,whichyouwouldneedtogo tothedefinitionstofindoutwhatthisis.
Wehaveourgeneralanswer.ThecontractorwillneedtogototheStatetoget5 moreyearsforapossibletotalof25years. Soinordertounderstandthisshortarticle,wehavenowbeenreferredtoatleast 4otherotherlocationsinthedocumentforafairlygeneralanswerandwewould needtoreviewtheentiredocumentforaspecificanswer! Thisisquitenormal.Petroleumcontractsareinterwoveninthisway.Youcould spendquitealongtimefollowingthetrailofanissuefromoneclausetoanother relatedclauseanditisonlywiththepassageoftimethatyoubegintodevelopa senseofwhenitmakessense,foryourimmediatepurpose,tofollowthetrailand whenitistimetostop.
Brazil's concession agreement confuses "national" with "natural" in the table of contents, summarising the contents of Clause Eleven as "Supply to Natural Market". This may reflect the fact that the English is a translation and that Brazil specifies the official language of contracts as Portuguese. These complex
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specifies the official language of contracts as Portuguese. These complex negotiations are often happening through a language barrier, which can give rise to errors in translation.
All eight contracts widely quoted in this book are available on the Internet, along with many others. Good news - you no longer need to subscribe to expensive legal databases to begin to get a sense for how contracts are built.
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Context
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petroleum basics
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Other Actors
AnIOCwilloftenparticipateinapetroleumcontractthroughanaffiliatecompany ratherthantheultimateparentcompanyforvariousreasonssuchastax optimization,projectfinancingstructuring,foreigninvestmentprotectionregime structuringorlocallawrequirements.ThismakestheIOCthe"parent"company. Suchanaffiliatewillbeincorporatedinanotherjurisdictionthantheparent companyorthecountrythatisthepartytothepetroleumcontract. Forexample,BPPLCastheparentcompanysitsatthetopoftheBPgroupof companies.BPPLCistheentitythatpeoplehaveinmindwhenBPisreferredtoin themedia.BP'sinterestsinvariouscountriesareheldbyaffiliatecompaniessuchas BPExplorationAngola,BPEgyptCompany,BPEnergyBrazilandsoon.These affiliatecompanieswillbethepartiestothepetroleumcontractsintherelevant countries,notBPtheparentcompany.
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countries,notBPtheparentcompany. Oftentheonlyassetofthisaffiliatecompanyisthefieldasdeterminedinthe petroleumcontracttowhichitisaparty.Thisexposesthecountry,andtherefore theotherpartiestothecontract,toalotofrisk.Thisisbecausethereareno availablefinancialresourcesonthiscompany'sbalancesheet,onlyoilinthe groundtocoveranycosts.Inordertomitigatethisriskthestatewilloftenrequirea companywithintheBPfamilyandwithmoreassetsandfinancialstrength(a "biggerbalancesheet")toguaranteethattheaffiliatecompanywillperformits obligations.Iftheaffiliatefailstoperformitsfinancialobligationsunderthe petroleumcontractthestatecanrequiretheparentcompanytostepintofulfillits affiliate'sobligations.
Thisgrantofrightisthemainpurposeofthepetroleumcontract.Allotherrights andobligationsaresubordinatetoit.Theclausegivesthecontractortherightto conductthecomponentsofPetroleumOperations,whichare:exploration, appraisal,development,extraction,production,stabilisation,treatment, stimulation,injection,gathering,storage,buildingrailorroadsforloading facilities,buildingconnectingentrypointtorailnetworkortoexistingpipelines, handling,lifting,transportingpetroleumtothedeliverypointandmarketingof petroleumfrom,andabandonmentoperationswithrespecttoacontractarea. Thisgrantofrightsmaybemirroredbyasimilarstatementofobligations.An exampleisgivenbelow:
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EXCERPT FROM THE TURKMENISTAN MODEL PRODUCTION SHARING AGREEMENT FOR PETROLEUM EXPLORATION AND PRODUCTION IN TURKMENISTAN OF 1997:
Article 7 (a) full and complete access to the Contract Area and the right to inspect all assets, records and data owned or maintained by Contractor; (b) the right to receive and retain copies of all manuals and technical specifications, design documents, drawings, construction records, data, programs and reports; (c) the right to audit Contractors accounts; (d) the right to receive share of Petroleum.
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topipelines,preventhinderingtheconductingofoperations,etc. Thecontractswilllayoutadecisionmakingprocessthatwillbeused throughoutthelifeofthecontract.Thisenablesboththegovernmentandthe contractortofulfilltheirrespectiveobligations.Thisisessentiallyaseriesof proposals(bythecontractor)andapprovals(bythestate)aseventsunfold. Threebasicmechanismsareused: Yearlyworkprograms Plansforthepetroleumprojectphase CommitteesmakedecisionsandtheOperatorcarriesthemout Thechaptersthatfollowexplainalloftheseinmuchmoredetail.Thenext chapterdescribesthedecisionstobemadeineachphaseofthepetroleumproject. Thenextdescribeswhodoescommiteedecisionmakingprocess.Thelastdescribes howtheoperatorcarriestheseout.
Itisworthnoting,beforewediveintothedetails,thatthisisamarkedlydifferent relationshipbetweengovernmentsandcontractorsthanitwasahundredyearsago anditiscontinuingtoevolve.Whentheoilindustrybegantherewerenot provisionsthatallowedthestatetoshareinthedecisionmakingprocessin agreements.Theinternationalcompaniesenjoyedalmostcompleteoperational controlandmadealldecisionsabouthowandwhentoexplore,developand produceoilunderconcessioncontacts.Butasstatesbegantoasserttheirrightto ownershipandcontroloftheirnaturalresources,contractsbegantoincludeclauses stipulatingjointdecisionmakingprocesses.Thecontractgovernanceissueis generallyabouthow,bywhomandwhattypeofprojectdecisionsaremadeandthe controltoolsthehostgovernmentsortheirNOCshavetosuperviseandchecka properimplementationofthecontractandhaveavoteinkeyoperationalandother projectdecisions. Thisisakeythemethathascomeupanumberoftimesinthisbook:contracts reflectchangingtimesinthebargainingpowerandthedesiresofcountries.These profoundlyimportantandoftendeeplypoliticalissuesofglobalmagnitude manifestthemselvesinwhatmightotherwiselooklikeamundanepaperwork generatingclauseinapetroleumcontract.Infact,theseclausesarepartofthe fundamentalreshiftinginthebalanceofpoweroratleasttheattemptto.Someof thesedynamicsaredescribedinthechaptersthatfollowtohelpgivecontextto thesecontractclauses. Currently,thereistensionbetweenstateswishingtoasserttheirsovereigntyover naturalresourcesandcompanieswishingtomaintaincontrolovertheoperations. Theresult,then,isthatmostcontractssignedtodayrepresentacompromise.They
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Theresult,then,isthatmostcontractssignedtodayrepresentacompromise.They specifyjointmanagementstructuresandprocedures.Fromthestate'spointofview, oneoftheadvantagesofsuchjointdecisionmakingmechanismsistoincreaseits managementcontroloverpetroleumoperationsbythehostgovernment.Fromthe company'sview,thismanagementcontrolcandecreaseefficiency,increasecosts anddelayprofits.Butitcanalsofacilitatebetterrelationshipswiththestateover time. ButjustbecauseastatehasaNOCorhassetupajointmanagementcommittee, amorerobustandequaldecisionmakingprocessisnotguaranteed.Countries withoutNOCsormanagementcommitteescanexercisemanagementcontroland havediscussionswithIOCsandbejustaseffectiveatshapingtheirpetroleum sectorbyhavingtheskills,knowledgeandlawstoeffectthesegoals.Thissection doesnotdealwiththesesystemsinmuchdetailsincethefocusisonwhatcontracts dosay,andmanyofthemspendagooddealoftheirtextontheseissues.
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Thesizeanddefinitionofthecontract,or"concession",areaforthepotential explorationactivitywhichagovernmentmakesavailabletooilcompaniesisof crucialimportanceinmanyrespects.Oneoftheimportantreasonsisthat contractualrights,asgrantedtoanoilcompanyunderthepetroleumcontractis limitedtothecontractarea.Thismeansthatwhateveryouagreeuponinthe contract,isonlyapplicableinthecontractareadefinedinthecontractnowhere else. Anotherimportantreasonisthatthedeterminationofsizemayaffectthe likelihoodthattheIOCwillmakeacommercialdiscoverywithinthespecified area.Thesmallerthesizeofthecontractarea,thehigherthechancethatitwillbe onthesamegeologicaloilfield,orreservoir,asanothercontractarea.Thiscanlead tocomplications,asthetwopartiesthenhavetoworktogether,usuallythrough creatingaunitisationagreement,toextractthepetroleuminthemostefficientway. Somecountriesusestandardsizeofacreageinawardingcontracts(e.g.US,UK, Norway,Brazil,etc.).Mostofthesecountriesusuallyuseagriddingsystembased ongeographicalminutes.Thissystemallowsthecontract(concession)areatobe accuratelydefinedbyreferencetocoordinatesasdefinedbytheGreenwich MeridianLine.Unlikethecountrieswithpredeterminedsizeofcontract area/acreage,thesizeofthecontractareaissubjecttonegotiationsandagreement inothercountries.Forinstance,theTrinidadandTobagoDeepOnshoreModel ProductionSharingContractof2005servesanexampleforthelatteroption.The clause3ofthemodelcontract("ContractArea")stipulatesthefollowinggeneral characteristics:
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EXCERPT FROM THE TRINIDAD AND TOBAGO DEEP ONSHORE MODEL PRODUCTION SHARING CONTRACT OF 2005:
"3.1 - The Contract Area as of the Effective Date of the Contract comprises a total area of approximately --------------------- (---,---) hectares, as described in Annex A attached hereto and delineated in the map which forms part thereof."
When: Overview
Petroleumcontractsgenerallydividepetroleumoperationsintothreeperiods exploration,developmentandproductionphasesthroughvariousclauses,suchas, "ExplorationPeriod,DevelopmentPeriodandProductionPeriod"orvarietyof otherlanguages.Typically,eachofthesephaseshavedifferentlegal,operational andcommercialframeworksandassuch,thevariouspartiesinthecontracthaveto carryoutdifferentobligationsatspecifiedtimesthroughouttheprojectlifecycle. Thefirstpart,theexplorationphaseisabitunique.Thisistheonewherethe partieswillspecifyinsomedetailtheworkprogramstobecarriedoutineach explorationyear.Thisisbecauseexplorationactivitiesaretheonlyonesthatcanbe plannedandpredictedtoacertaindegreeofaccuracyatthetimeofnegotiatingand signingtheagreementasmentionedearlier,atthepointofsigningthecontract neitherpartycanbesurethatanythingfurtherthantheinitialexplorationphase willactuallyhappen. Inthediagramabove,youwillseethatthemostexplanationisgivenforthe explorationphase.Thatisbecausethereisoftenmorewrittenaboutitthanany otherphaseinthecontractitself. However,theyearlyactivitiestobeconductedlater,suchasphasesofappraisal, development,productionandabandonmentwillnotbespecificallyplanned, exceptataverygenerallevel,inthecontracts.Why?Becauseyoudonotknowif you'llevergetpasttheexplorationphase,butyou'recrossingyourfingersallthe same. Fortheappraisalphase,questionssuchas"Whatisthemostefficientand sensibleapproach?"and"Howmanyappraisalwellsneedtobedrilled?"cannotbe answeredwhenthecontractissignedsincewedonotyetknowwhethertherewill
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Hostgovernmentshaveaninterestinexpeditingtherateofexplorationand thoroughandrapidexplorationofthecontractareaandacreage.Fromthis perspective,theremayariseadifferenceofopinionbetweenthegovernmentand IOCs.Forexample,apetroleumcompany,whenacquiringexplorationrights,aims toretainmaximumfreedomofactioninrateandextentofexploration,minimumof obligationintermsofincurringexpendituresorcarryingoutexplorationwork. Theyarealsointerestedinpreservinggreaterfreedomtodetermineitspriorities amongtheareasinwhichitholdsexplorationrightsindifferentpartsoftheworld. Duetothesereasons,hostcountriescreatemechanismstostrikeaproperbalance betweentheinterestsofoilcompaniesandtheenergypolicyofthecountry.The mechanismswhichhostcountriesincorporateinagreementsaredesignedtoensure thatoilcompaniesacquiringexplorationrightsaredeterredfromsittingonthese areas.Theywantcompaniestodiligentlytocarryoutexploration,toincurthe expendituresnecessaryforthispurposeandtorelinquishareasprogressivelyuntil theentireareawouldberelinquishediftheagreedlevelofexplorationactivitywas notmaintainedorifattheendofthestipulatedexplorationperiodnocommercial discoveryismade.Thesemechanismsinclude(butnotlimitedto)thefollowing issuesinthepetroleumindustry: Timelimitsforexploration Relinquishmentrequirements Minimumworkandexpenditureobligations Approvalofannualexplorationworkprogramsandworkprogrambudgets Progressiveareafeesorrentals(discussedinthefiscalsectionofthisbook) SupervisionofexplorationworkbythegovernmentorNOC. Theexplorationperiodnormallystartsfromthedatewhenthecontractbecome bindingonthepartiesandcontinuesforanumberofyears,forexample,three(3)or moreyearswiththepossibilityoffurtherextensionforanadditionalperiodof1to 3years.Thelengthoftheinitialexplorationperiodshoulddependonthesizeand natureofthecontractarea.Thegovernmentshallbewearythatthelengthofthe term should be sufficient to carry out an efficient and adequate exploration program,butnotsolongastopermitthecontractortobeinactive.
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Governmentsgenerallyseektoobtainspecificminimumworkcommitmentsfor eachyearoftheinitialexplorationperiodwithdetaileddescriptionsofthe geologicalandgeophysicalworktobecarriedoutineachyear.Incountrieswhere therehavebeennopreviousdiscoveriesandwheretheinformationavailableis limited,itcanbequitedifficulttoobtainspecificdrillingcommitmentsduringthe initialexplorationperiod.Ineffect,seismicworkduringtheinitialexploration stagemayconstitutetheonlyworkcommitmentsforoilcompanies.Inthese situations,thecompanywillcommittoaminimumgeophysicalandgeological workprogram(aswellasminimumfinancialcommitmentstocarryoutsuchwork programs),savefordrillinganexplorationwellbeforethereisenoughpositive geologicalcertaintyaboutthefield. Incountrieswithrichgeologicalprospectivityandpreviouspetroleum discoveries,thesituationisdifferentasfarasthescopeofworkcommitmentsinthe explorationstageisconcerned.Thecoreofmostworkprogrammesistheobligation to"shoot",orrecord,aspecificnumberoflinekilometresofseismicandtodrill explorationorwildcatwells.Thedeterminationofworkprogrammeorexpenditure obligationisusuallysubjecttointensenegotiationsasthisphaseconstitutesmajor risksforoilcompaniesbeforemakingacommercialdiscovery.Thespecificationof thesetermsdependsonthecircumstancesofaparticularcaseandpetroleum prospectivityofthecountry.Theminimumexplorationworkprogramand expenditureanddrillingobligationsarekeypointsinpetroleumcontractssincea failureinexplorationterminatesthecontractfortheoilcompanyanditisnot compensatedforthereconnaissance,drillingandappraisalcostsandhencesuch costsconstituteasunkcost.Typically,IOCsinsistonlesserworkprogramand flexibleexpenditureobligationwithcarryforwardprovision. TheEquatorialGuineaModelProductionSharingAgreementmayservean exampleforthescopeofworkobligationstobecarriedoutbytheoilcompanyat theexplorationphase.PursuanttoArticle3ofthisAnoglacontract("Exploration WorkObligations")shalldofollowingminimumworkprogramatitsownriskand cost:
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Undertheoutlinedmodel,thecontractorshallnotonlyacquireandinterpret certainseismicrequiredtodrillanumberofexplorationwellsandinvesttheagreed amountofrequiredfinancialcommitments.Suchfinancialcommitmentsareusually equivalentinvaluetotheestimatedcostsoftheminimumworkprogramswhichare stipulatedintheagreementforeachyear.Intheeventofthestipulationofthe definedamountoffinancialcommitment,thecontractormustsatisfyboththe minimumworkcommitmentandtheminimumfinancialcommitmentfora particularyear.Thus,iftheminimumfinancialcommitmenthasbeenmetbutthe minimumworkprogramhasnotbeencompleted,thecontractormustnevertheless completethatworkprogram.Conversely,iftheworkprogramiscompletedbutthe financialcommitmenthasnotbeenfullyexpended,thecontractorwillberequired toconductadditionalexplorationactivitiesuptothebalanceofthefinancial commitment.
Relinquishment
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Relinquishment
Oneofthetechniquesforensuringthattheoilcompanycarriesoutexploration expeditiously,anddoesnot"lockup"thecontractarea,istorequiremandatory relinquishment,meaningsurrenderingtheunusedpartofthecontractareaorblock backtothegovernment.Toencouragerapidandthroughexploration,petroleum agreementsnormallycontainprovisionsforvoluntaryandmandatory relinquishmentorsurrenderofacreageorcontractareaclausessuchas "RelinquishmentoftheContractArea".Theaimofsuchaclauseinpetroleum contractsistoensurethattheIOCsurrenderstheunusedpartsofthecontractareaor blockbacktothegovernmentonatimelybasis.TheIndianModelProduction SharingContractforSeventhOfferofBlocksasof2007serveanexamplefor generalrelinquishmentobligationsunderpetroleumcontracts(Article4):
EXCERPT FROM THE INDIAN MODEL PRODUCTION SHARING CONTRACT FOR SEVENTH OFFER OF BLOCKS, 2007:
4 - "If at the end of the first Exploration Phase, the Contractor elects, pursuant to Article 3.4, to continue Exploration Operations in the Contract Area in the second Exploration Phase, the Contractor shall retain up to sixty per cent (60%) of the original Contract Area, including any Development and Discovery Area in not more than three (3) areas of simple geometrical shapes and relinquish the balance of the Contract Area prior to the commencement of the second Exploration Phase. Notwithstanding the provision of this Article 4.1, in the event the Development Areas and Discovery Areas exceed sixty per cent (60%) of the original Contract Area, the Contractor shall be entitled to retain the extent of Development Areas and Discovery Areas.
AttheendofthesecondExplorationPhase,theContractorshallretainonly DevelopmentAreasandDiscoveryAreas." Suchprovisionspreventpetroleumcompaniesfromlockingup large contractareaswhichtheydonotuseforexplorationwork. Inadditiontomandatoryrelinquishmentclauses,petroleumcontractsmayalso includevoluntaryrelinquishmentmechanismswhereastheoilcompanysurrenders apartofthecontractareabacktothegovernmenteventhoughthecontractdoes notrequireittodoso.Undervoluntarymechanism,thecontractorwillusually havetheopportunitytosurrendervoluntarilyanyoralloftheareaatanytime subjectonlytofulfillingtheworkcommitmentsandservinganadvancenoticeto thegovernment. Thereisaconsiderablevariationinrelinquishmentobligationsinworld
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Afterfindingapetroleumdiscoverybyapetroleumcompany,amappraisalperiod willtypicallycommence.Thisperiodallowsthecontractortodeterminethe commercialityofthediscoveryandtodetermineadevelopmentprocessifitthinks itwillbeworthproducing.Petroleumcontractsusuallyaddressthiscriticalissue through"DecisionofCommerciality","Discovery","Discovery,Developmentand Production",orsimilarclauses.Whilesomemajorpetroleumproducingcountries (e.g.China,Indonesia,Braziletc.)requireasayoftheNOCindeterminingthe commercialityofapetroleumfinding,othersleavethisissueentirelytothe discretionofpetroleumcompanies(e.g.Azerbaijan,India,Tanzania). Petroleum contracts usually provide that in the event of a petroleum finding petroleumcompanyshallnotifytheministryorNOCofsuchadiscoveryandits commercialitywithincertainperiodoftime.Inaddition,petroleumcompanyhasto submit all supporting information and data analysis. The Production Sharing Contract between The Government of the United Republic of Tanzania, and (hereinafter referred to as the Government ), The Tanzania Petroleum Development Corporation and ABC Oil Company as of 2004 provides for the followingmechanism(Article8:DiscoveryandDevelopment)intheeventwherea discoveryismadebythecontractor:
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EXCERPT FROM THE PRODUCTION SHARING CONTRACT BETWEEN THE GOVERNMENT OF THE UNITED REPUBLIC OF TANZANIA:
"(a) If Crude Oil is discovered in the Contract Area, Contractor will, within thirty days from the date on which evaluated test results relating to the discovery are submitted to TPDC, inform TPDC by notice in writing whether or not the discovery is in the opinion of Contractor of potential commercial interest. (b) If Contractor informs TPDC that, in its opinion, utilizing good oilfield practice, the discovery is of eventual commercial interest and TPDC agrees with such determination, then the Minister shall be advised to agree to allow the Contractor to retain the Discovery Block for the duration of the Exploration Licence and any renewal thereof..."
Afteradiscoveryfoundtobecommercialbythepetroleumcompanyasthe contractor,indevelopmentstage,asinthecaseofexploration,theobjectivesofthe oilcompanyandhostgovernmentregardingthetimelineandthescaleof investmentsneededtodevelopafieldcandiffer.Hostgovernmentsusuallyhavean interestinrapiddevelopmentofanyfieldwhichisdiscovered.Giventhelimited durationofthecontract,theoilcompanyalsohassuchaninterest.However,iffull freedomtodecidewhethertodevelopaparticulardiscoveryisleftentirelytothe oilcompany,therearepotentialrisksthatthepetroleumcompanycoulddeclineto investindevelopmentimmediatelybecauseofitsotherpriorityprojectsintermsof itsworldwideoperations.Therefore,inordertomitigatesuchpotentialriskthe contractsusuallytendtoputsometimelimitandotherrequirements(immediate supplyofinformationtothegovernment,formalapproval,etc). Intheeventthepetroleumcompanydeclaresafindingtobecommercial, petroleumcontractsusuallyprovidethatitpetroleumcompanyascontractormust prepareandsubmittotheMinistryorJointManagementforapprovalitsplanfor thedevelopmentandproductionofpetroleumfromthecontractarea("Field DevelopmentPlan"or"DevelopmentandProductionPlan"or"ExploitationPlan"). ThisPlanisalongrangeplanfortheefficientandpromptdevelopmentand productionofpetroleumfromthecontractarea.TheAzerbaijaniPSAmayservean exampleforsuchamechanism.UnderthisPSA(Article4.4.),theContractorwithin 30daysdaysfollowingcompletionoftheminimumworkprogrammethe petroleummustprepareandsubmittotheSteeringCommitteeforapprovalitsplan forthedevelopmentandproductionofpetroleumfromthecontractarea,which mustincludethefollowingcomponents:
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Inlightoftheaboveclause,theFieldDevelopmentPlanincludenotonly operationalandinfrastructureissues,butalsolocalcontentandESIAissueswhich arehugelyimportantforhostgovernments.Theapprovalmechanismof developmentprogrammesinacomparativeperspectiveisdiscussedinthenext sectionentitled"ContractGovernance". Inlightoftheimportanceofexplorationanddevelopmentforhostgovernments, oneoftheimportantissueistheconsequenceifpetroleumcompanyfailstocarry outtheworkcommitmentsduringtheexplorationanddevelopment.Tocounter suchrisks,petroleumcontractsmaystipulatethatintheeventthecontractorfailsto carryouttheexplorationworkprogrammeanddevelopmentprogrammewithina certainperiodoftime,exceptincaseofforcemajor,theMinistryorNOCusually hastherighttounilaterallyterminatethecontractandthecostsincurredduringthe exploration,developmentandbonusesarenotcostrecoverable. Ifattheendoftheinitialexplorationperiod(includinganyextensionperiod)no commercialdiscoveryhasbeenmade,thepetroleumcontractautomatically terminates.Asarule,thedevelopmentandproductionperiodbeginsfromthedate ofthenoticeofdiscoveryanditscommercialitysubmittedbytheoilcompanyto thegovernmentorNOCandcontinuesforanumberofyears,forexample,2530 years.Attheendofthecontract,theIOCstransferallpetroleumoperationsand assetsbacktothehostgovernmentorNOC,asthecasemaybe.Petroleum contractsshouldmakesurethatthereisenoughsecurityoftenure,meaningtheoil companyhasanautomaticdevelopmentandproductionrightsonceacommercial discoveryismadeattheexplorationphase.
Inadditiontothelongerrangeplansthatoccurduringtheappraisaland developmentphases,thecontractoristypically,thecontractorisobligedtosubmit aworkplanfortheactivitiesitwantsandthinksnecessarytoconductinthe comingyear.Agovernmentministryoragencywillthenreviewandapproveand ifthestatedoesnotapprove,thenitwillhaveasetamountoftimemodify,discuss, andcometoagreementwiththecontractor.Theseannualworkprogrammesand budgetsareoneofthecorepartsofpetroleumcontractsbecausetheygivethestate moreofaroleinthedecisionmakingprocessofwhatactivitieswillbeconducted eachyear.Petroleumcontractscallthese"WorkObligations","ExplorationWork Obligations","MinimumExpectedExplorationWorkCommittmentandExpected MinimumExplorationExpenditures","ProductionPeriodWorkProgramme", "AnnualWorkand"Budgets"amongothers.Regardlessofthedifferenceof terminologies,suchclausesdefineandregulatethecoreoperationalandfinancial issues,suchas,thescopeofworksandfinancialcommittmentstobecarriedoutby theIOCinaparticularyearduringeachphaseofthepetroleumcontract,meaning exploration,developmentandproductionphases. Nomatterwhatthisdocumentiscalled,itshoulddescribe,itembyitem,the petroleumoperationstobecarriedoutduringacalendaryear,forexample,how manywells(appraisal,developmentandproductionswells,asthecasemaybe)will bedrilled,pipelines,facilitiestobeconstructed,procurementplans,etc.Contracts usuallyrequirethesubmissionofworkprogrammestobeaccompaniedwith Budgets,meaningestimatesofexpendituresforcarryingoutinanannualwork programme.TheAngolaModelProductionSharingContractforDeepWater BlocksbetweenSONANGOLandInternationalCompaniesmayserveanexample forthisparticularcase(Article19DevelopmentandProductionWorkPlansand Budgest):
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EXCERPT FROM THE ANGOLA MODEL PRODUCTION SHARING CONTRACT FOR DEEP WATER BLOCKS
19"1.FromthedateofapprovaloftheplanreferredtoinArticle18,and thenceforthbyfifteen(15)AugustofeachYear(orbyanyotherdatewhich maybeagreed)thereafter,ContractorGroupshallprepareinaccordancewith professionalrulesandstandardsgenerallyacceptedintheinternational petroleumindustryadraftannualProductionPlan,adraftExplorationand ProductionWorkPlanandBudget(ifapplicable)andadraftDevelopment andProductionWorkPlanandBudgetforthefollowingCivilYearandmay, fromtimetotime,proposetoSonangolthatitsubmitamendmentstothe approvedWorkPlansandBudgetstotheconsiderationoftheMinistryof Petroleum."
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JOINT MANAGEMENT
Wehaveestablishedthatacommonmechanismtomanageactivitieswithinthe petroleumcontractistocreateacommittee,withrepresentativesfrombothstate (governmentorNationalOilCompany)andtheInternationalOilCompanies (IOCs).Thisallowsbothsides,intheory,tohaveasayindecisionsthatneedtobe madeahappycompromise. Differenttermsdescribingthisconceptinclude: JointManagementCommitteeIraq,Indonesia,Bangladesh,China,Ghana SteeringCommitteeAzerbaijan TechnicalConsultativeCommitteeGabon Despitethevaryingnames,thegeneralfunctionsofsuchacommitteeremain similararoundtheworld,andresponsibilitiesassignedtothemcanbefairlybroad, asillustratedbelow. Ifyouhavebeenonacommitteeofanysort,youwillhaveanideaofwhatthe generalnatureofthecommitteesusedinthepetroleumsector.Youhavemeetings, takenotes,approvethenotes,thenexecutethedecisionsmadeatthemeeting. Thereareproceduresforholdingemergencyvotesandmeetings.Budgetsare discussedandapproved.
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EXCERPT FROM THE IRAQI MODEL PRODUCING OIL FIELD TECHNICAL SERVICE CONTRACT AS OF 2009:
13.1 The Parties shall establish, within thirty (30) days from the Effective Date, a joint management committee, referred to herein as the "Joint Management Committee" or "JMC", for the purpose of general supervision and control of Petroleum Operations. 13.2 The JMC shall have the following duties and authorities related to Petroleum Operations: (a) review and recommendation of Plans and any Revisions thereof; (b) review and approval of annual Work Programs, Budgets and production schedules, and any Revisions thereof; (c) review and approval of operating procedures; (d) review and/or approval of the award of sub-contracts and purchase orders; (e) approval of training programs and Iraqization plans for developing Iraqi personnel; (f) supervision and control of the implementation of approved Plans and Work Programs and the overall policy of Operator; (g) review and approval of manpower strength and organisation chart of Operator; (h) review of Quarterly statements, annual accounts and other financial statements; (i) review of periodical and other reports submitted by Contractor or Operator and issue of comments and recommendations to ensure proper implementation of Petroleum Operations; and (j) recommendation of the appointment of the independent international auditor.
UnderthisIraqiclause,thejointcommitteenotonlysupervisesoperationsand financesbutalsooverseespersonnelandtrainingissues,localgoodsandservices andsubcontracts.Thisisn'talwaysthesame,howeverinotherclauses,thescope ofpowersofjointmanagementcommitteesmaybelimitedtothetechnicalaspects ofgettingoiloutoftheground. Jointmanagementcommitteesareusuallycomposedofanequalnumberof membersfromthehostgovernmentand/orNOC,andIOCs.Membersofthe committeegenerallychooseamongthemselveswhoholdsthepositionof Chairman,whichcanbeonarotationalbasisorpermanent. Decisionsofjointmanagementcommitteesmayrequiretheunanimousor
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Joint Management
Onestrikingfeatureofmanyofthesemanagementcommitteesasspecifiedinthe contractsisthat,incredibly,theyavoidaddressingthequestionofwho(between thegovernmentandtheIOC)getstohavethedecidingvote.Ifyouhaveeverbeen onacommitteewhentherewassignificantdisagreementandnowaytovoteand moveon,theboatcanstarttorockwhenthereisdisagreementandnoclearwayto resolveitbyasimplevote. TheLibyancontractforexamplespecifiesacommitteeoffour,withtwofromthe companiesandtwofromthegovernment.Ghana'scontractwithTullowspecifies eightmembers,fourandfour.Butneithercontractactuallyspecifieswhattodoin thecaseofatie.
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But,althoughthisclausetakenonitsownappearsasthoughitdoesaddressthis issue,notsofast! Thenextclause,Article8.4,saysArticle8.3doesnotapplyintheexploration period,andthatifnoagreementisreached"thentheproposalmadebythe contractorshallbedeemedadoptedbythemanagementcommittee." Andifthatweren'tcomplicatedenough,Article8.5thenlistselevenexceptions totherulethattheChairmanhasatiebreakingvote,includingprovisionsasvague as"anymatterhavingamaterialadverseeffectonPetroleumOperations". Soactually,theissueisn'tsolvedatall,andisleftforpartiestobattleout themselvesasandwhentheycometoit.Inrealitythereareanumberofwaysoutof deadlock.Oneisreferringthemattertotheseniormanagementoftheparties. Anotherwayistoappointanindependentexpertorarbitrationthrough mechanismsthatareestablishedseparatelyelsewhereinthecontract. Onemightreasonablyask:whydon'tthepartiesjustspecifyallofthisatthe outset?Governmentgetstiebreakingvoteortherehastobeunanimity?Thereis notoneanswerthatwouldholdforallcountriestheworldover,butasageneral matter,itgoesbacktothe"happycompromise"raisedattheveryoutsetofthis chapter.IOCswantmaximumflexibilityandcontrolovertheoperationsandhave thetechnicalandfinancialcapacitytocarrythemoutwhilegovernmentsalso wantcontrolandtoinfluencetheoperations,buttheydonothavethetechnical andfinancialresourcestodosothemselves.Deadlockanddisputeresolutionis whentheotherwisehappycompromise"hitsaroughpatch".
Thesecommittees,whatevertitletheychoosetogounder,don'tmeetonadaily basisitisusuallyspecifiedthattheycanbebroughttogetheratanytime,atthe requestofoneormoremembers,butthattheyshouldmeetatleasttwiceayear. Eachsideisallowedtobring'outsiders',ornoncommitteemembers,andusually membersneedtobenotifiedatleast20daysinadvance.Itmightbeusefultothink ofthemasashareholdersmeeting,oracompanyboard,thanwhatyoumight normallyimaginebytheterm'management'. Asyoumighthavebeenabletotellfromthis,thereisaninherentambiguityin theongoingrelationshipsbetweengovernmentsandinternationaloilcompanies thisalsocorroborateswhatmanylawyersandindustryprofessionalssayabout negotiationbeingpermanentintheoilindustry.Eventhoughyoucansignand agreeonacontract,therearemanypossibleeventsforwhichthedecisionmaking processisunclearifthepartieshaveseriousdisagreement.Partlythisisbecause,as writtenabove,atthetimeofwritingandnegotiatingthecontract,it'simpossibleto knowwhatmightormightnothappenduringthecontract'slifespan. Somecommonhotissuesformanagementcommitteesare,unsurprisingly,levels ofinvestmentandlevelsofproductionandissuesrelatingtodomestic.Companies
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THE OPERATOR
Theoperatoristheleadactortothejointmanagementcommittee'sdirectorthe onewholearnsthelines,putstheworkin,andshowsup,everynightofthe performance.Theonethatdoesallofthedaytodayrunningaround,andtheone whocarriesoutthose"petroleumoperations"wekeepmentioning.Afterallofthe decisionmakingatthepetroleumphaselevelandtheyearlylevelhasbeenmade, someonemustactuallyimplementthosedecisionsonadaytodaybasis.Enterthe stage:TheOperator. Broadlyspeaking,oilcompanieshavebeguntogrouptogetherinconsortiato bidforandmanagelargeproduction,ratherthangoingitalone.Amongthese companies,therewillbeonewhoisapprovedbythehostgovernmenttobethe operator. Theofficialtermsoutliningthisrolemaydifferslightlyfromonecontractto another(Operatorship,JointOperatingCompanies,TheRoleofOperator)butthe conceptisthesame.Inthefollowingexample,theoperatorisdiscussedinthe definitionsatthebeginningofthecontract.
EXCERPT FROM THE GHANA DEEPWATER TANO CONTRACT BETWEEN THE GHANAIAN GOVERNMENT AND TULLOW GHANA LIMITED:
1.50 - "Operator" means Tullow or such Party as may be appointed by Contractor with the approval of GNPC and the State, which approval shall not be unreasonably withheld or delayed;
WhereasinAzerbaijan,intheexamplegivenbelow,aJointOperatingCompany wasestablished.
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EXCERPT FROM AGREEMENT ON EXPLORATION, DEVELOPMENT AND PRODUCTION SHARING FOR THE SHAH DENIZ GAS PERSPECTIVE AREA IN THE AZERBAIJAN SECTOR OF THE CASPIAN SEA BETWEEN SOCAR AND A CONSORTIUM OF PSA AS OF 1996 (SHAH DENIZ PSA )
6.1 - "Joint Operating Company. Contractor shall as soon as practicable after the Effective Date form a Joint Operating Company, which may be incorporated or created outside of Azerbaijan but shall be registered in Azerbaijan in accordance with Azerbaijan law. Contractor shall have the right to substitute or to establish additional entities to undertake some or all of the responsibilities of the Joint Operating Company with respect to Petroleum Operations.
Contracts will often use the more generic term "contractor" when it is in fact the operator who will end up generating this work on behalf of all of the joint venture partners. The host government can, however, hold any of the IOCs financially responsible if the operator does not carry out their work.
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The Operator
EXCERPT FROM AGREEMENT ON EXPLORATION, DEVELOPMENT AND PRODUCTION SHARING FOR THE SHAH DENIZ GAS PSA AS OF 1996 " Petroleum Operations" means all operations relating to the exploration,
appraisal, development, extraction, production, stabilisation, treatment (including processing of Natural Gas), stimulation, injection, gathering, storage, handling, lifting, transportation of Petroleum up to the Delivery Point (but including any pipeline reversal and other operations beyond the Delivery Point as provided in the Article 10 and Appendix X) and marketing of Petroleum from, and abandonment operation with respect to, the Contract Area.
BybeingintheJointOperatingCompany,Azerbaijanisabletogainexpertise asitparticipatesintheprocessoftheoperatorproposingandthecommittee discussinghowitwillcarryoutitswiderangeofroles.Otherclauses(Article6) specifytargetlevelsfortheratioofAzerbaijaniswhoaretoworkintheoperating companyatdifferentstagesintheproject,risingto90%inprofessionalpositions afterfiveyearsoffulloperationsinafield.ThisgivesAzerisnotjustthe opportunitytolearnmanagementanddecisionmakingbutalsothecarryingoutof operations. InIraq's2009serviceagreements,theJOCtypestructurespecifiedwasaField OperatingDivision,aunitwhichwasdetachedfromanexistingparentcompany ownedbytheIraqistate.Underthisstructure,ultimateauthoritylieswiththeIraqi state,butlowerleveldecisionsaredelegateddownwardstotheManagement Committeeandthentotheapprovedoperator,theFieldOperatingDivision.
Withinthecontract,therearealsomechanismsinplacetoensurethattheoperator doeswhattheyaresupposedtodo.Keyprovisionsrelatingtooperationsarethe keepingofandaccesstorecordsabouteverythingthathappens.Tofindthese clauses,lookfortitleslike"DataandInformation","Reports","BooksandRecords" and"AccesstoPetroleumOperations",whichoutlineswhatkindsofinformation arekeptandsuppliedtothegovernment,aswellasensuringthatthegovernment hastherighttoinspectsuchdata.Likethegovernment,theothercompanieswill alsoreceivethesereports.They,too,areinterestedinmakingsuretheOperatoris carryingoutthepetroleumoperationsefficientlyandeffectively.Inthisrespect, theyarelikethegovernmentinthattheyareapartofthedecisionmakingprocess butdonotcarryoutthedaytodayoperations. Aspectsaddressedinthisdatamonitoringarenotjust(directly)aboutmoney, suchasaccountingandauditing.Petroleumextractionisincrediblydataintensive, andthiscostsmoney,sothecontractsmayalsorequiretheIOCstosaveandkeep
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EXCERPT FROM AGREEMENT ON EXPLORATION, DEVELOPMENT AND PRODUCTION SHARING FOR THE SHAH DENIZ GAS PSA AS OF 1996
7.1 e) "Contractor shall supply to SOCAR:(i) daily reports on drilling operations and weekly reports on field geophysical surveys as soon as they are available:(ii) within fifteen days after the end of each Calendar Quarter, a report on the progress of Petroleum Operations during the preceding Calendar Quarter coving: 1. a description of the Petroleum Operations carried out and the factual information obtained; 2. a description of the area in which the Contractor has operated; and 3. a map indicating the location of all wells and other Petroleum Operations ...."
Here,theterm"contractor"isused(asnotedabove),butitistheoperatorwhois taskedwithcarryingouttheseactivitiesonbehalfoftheIOCs. TheseclausesalsospecifythatrepresentativesofSOCARonlyhavetogive threedaysnoticeatanytimetocarryoutaninspectionof"PetroleumOperations", whichcouldeitherbecompanyofficesorinthefieldthis,ineffect,isawayof keepingtheoperatorontheirtoes. Onewordofwarning!Contractswilloftenusethemoregenericterm "contractor"whenitisinfacttheoperatorwhowillendupgeneratingthisworkon behalfofallofthejointventurepartners.Justbecausethecontractsaysthatthe Contractorwillcarryoutcertainactivitiesastheclauseabovedoes,itdoesnot meanthatallofthecompaniesthatcomprisethecontractorwillinfactcarrythem out.TheOperatorwillgenerallydothese.However,iftheOperatordoesnot,for somereason,carryouttheobligations,alloftheothercompanieswillbe responsibleforfulfillingthem.Thismaymeanfindinganewoperatororappointing anewoperatorfromamongthegroup,thoughthesesituationsarerelatively uncommon.
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Contractshaven'talwaysbeensonumericallychallenging.Inthedayswhenthe globaloilindustrywasdominatedbysevenmajoroilcompaniesknownasthe SevenSisters,themathematicsofanoilagreementwasaroyaltyasingle percentageofproductionvolumesorrevenueswithpricingreportedbythe companyitself.Inmanyways,thearithmeticgymnasticsthatyouneedtogo throughtodayinordertocalculatethemanydifferentrevenuestreamsinanoil projectareactuallyaresultofagovernmententeringthenegotiatingring,and becomingmoreassertive.They'vebeguntousemorecomplexwaystocreate additionalrevenuestreams,allofwhichkickinatdifferentmomentsintheproject's lifecycle. Thecomplexityofthenumbersinmoderncontractscomesfromcomplex politicalandeconomicrelationswithintheoilindustry.Theriseofresource nationalism,theincreasingnumberofstateownedoilcompanies,thevolatilityof oilprices,meansthatgovernmentstrytocaptureasbigashareofthemoneyas possiblewhilestillencouraginginvestorstocomeinandspendtheirownmoney onprojectsthatmightfailthroughnofaultoftheirown.Thesefactors,amongst others,contributetocomplexfiscalterms.
Now,togetsomeunderstandingofhowitworks,wehavetogetourhandsdirty. Thissectionstartsbybuildingfromthegroundup,runningthroughtherangeof fiscaltoolsthatareincurrentuseandwhichtogetherareusedtobuildafiscal regime.Next,inFiscalStrategiesandSolutions,weexaminesuchregimesintheir entiretyandhowtheyaddressparticulargoalsagovernmentmighthavein developingitspetroleumindustryornot.Thenwelookathowgovernmentsand theircitizenscanassesshowtheyaredoinginfiscalandfinancialtermsandfind thatdespitetheavailabilityofstatisticsitisnoteasilyreducibletoonefigure. Finally,weexplorehowoilispriced,anotheraspectwhichisnotasstraightforward asitmightsound.
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EXAMPLE 2: say we are in a state where the state oil company is taxed just as any other company working in the state. We have a 51% state participation rate- the state contributes 51% of costs, and gets 51% of benefits. If theres no discovery, there will be no benefits. Thats 51% of 0 dollars in benefits, which is 0 dollars for the state. In fact, as the state has to invest money for the costs incurred for exploration, it ends up paying money and not receiving any. Now let's assume that there is indeed a discovery, which generates 100 million dollars in benefits. That leaves 51% or 51 million dollars to the state oil company. In addition, if that 100 million dollars is taxed at 25% for corporate income tax (and remember, here the state company has to pay taxes just like the international companies) then the taxes paid to the government from the state oil company will be: 25% of the state owned oil company's share of benefits = 25% of 51 million dollars This is calculated by: 0.25 x 51 = 12.75 million dollars But don't forget, the government also gets taxes from the international oil companies, who have received the total benefits minus the state oil company share of 51%, that is, 49%. So government corporate income tax from the IOCs, given that it is taxed at 25%, is: 25% of the international oil company's share of benefits = 25% of 49 million dollars This is calculated by: 0.25 x 49 = 11.75 million dollars
crude.Aproject'sincomeissometimesalsoreferredtoasrevenues.Usually,there aremultiplewaysofreceivingrevenues,ormultiple'revenuestreams',whichcomes from,forexample,taxesandroyaltiesaswellasdirectprofits. Revenuesincludemoneyspentwhichareconsideredasnegativerevenuesas wellasmoneycomingin,positiverevenues.Profitsontheotherhand,are calculatedfromthetotalprojectincomeminustheprojectcosts Toaddtotherevenueconfusion,thegovernmentreceivesadditionalrevenues fromtheprojectintheformoftaxesandroyalties.Costsaretheexpenditureson equipment,salaries,etcincurredthroughouttheproject.Profitiswhatsleft overifcostsincurredandtaxesaredeductedfromtheproject'sincome.
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Don't worry if you don't understand all of the topics described below. This is an overall description of fiscal tools which could seem confusing to start with, but trust us! Your understanding of these issues will deepen as you begin to explore contracts on your own.
Thefiscalregimeofconcessions,productionsharingcontractsandparticipation agreementshaveonemainfactorincommon:eachofthemdefinepaymentsthatare madetothegovernment,bytheIOC.Thus,theIOCgetstokeeptheoverall petroleumrevenue,andsimplypaysoutwhateveritowestothegovernment. Fiscaltoolsinthesethreetypesofcontractsinclude: signaturebonus productionbonus rental royalty corporateincometax profitshare stateparticipation otherprofitbasedtaxes othergeneraltaxes(suchasimportduty,salestax,propertytax,excisetax, withholdingtax)
An entire fiscal regime for a particular concession, production sharing contract or participation agreement rarely uses just one of these tools. Far more commonly, it will be a combination of three or more - together they are used to create various financial flows, as decided upon by the host government.
Thedifferenttypesoffiscaltoolsaredescribedbelow.Theexamplesmerely illustratewaysinwhichatoolcanbeused.Thereareanumberofcaseswheretools areuseddifferently. SignatureBonusapaymentmadetothegovernmentatthetimethatthe petroleumcontractisgranted. Thesignaturebonusisfrequentlyadecidingfactorindeterminingwinningbids, whencompanieswanttobeawardedacontract.Itmaybenegotiated,orsetby legislation. Itcanvaryfromaslittleasafewthousanddollarsuptomanymillions.Signature bonusestendtobesmallforfieldswheregeologicaldataisrelativelypoorornon existent,andsoexplorationcostishigh.Conversely,signaturebonusesarehigh wherethereisgoodgeologicaldataandthusahigherchancethatexplorationwill besuccessful.
EXAMPLE: Angola once awarded an deep water offshore block with a $1.1 billion bonus, and the province of Alberta in Canada awarded an oil sands lease for $465 million. These are unusually high bids. In the new fields off the coast of West Africa, signature bonuses so far are much smaller.
A signature bonus doesn't depend on whether the IOC finds oil in commercial quantities or not - it is paid by the company to the government regardless, and as such, it involves no risk for the government. Signature bonuses can be found in all types of petroleum contracts, even in some risk service contracts like Iraq's Technical Service Contract. It is payment for the right to conduct operations under the petroleum contract.
The Money
oratadefinedquantityofcumulativeproduction.Anexampleofpayable productionbonusesisshownbelow.
areatoothercompanies Rentalsareusedgloballyinconcessions,productionsharingcontractsand participationagreements.IOCsareoftenalsorequiredtopayadditionalamounts foraccesstothesurfaceforconductingpetroleumoperationssometimestothe privateoccupiersofthesurface,andsometimestothestate. Royaltyapaymentmadebyreferencetotheamountandvalueofpetroleum produced Aroyaltyisatraditionalfeatureofmanypetroleumcontracts.Aroyaltyis usuallycalculatedwithoutdeductionofanycosts.Therearevariousformsof calculatingroyalty,asoutlinedbelow.
Themostcommonroyaltyisafixedpercentageofthepetroleumproduced.Early petroleumconcessionswouldfrequentlyestablisharoyaltytothestateor landowneroftwelveandahalfpercent(oroneeighth)oftheoil&gaswhichis produced.Cambodia,SyriaandTanzaniacontinuetochargeroyaltyatthisrate. Fixedroyaltiesoftenpercent(Gabon,Malaysia,Brazil,India)tofifteenpercent (CongoBrazzaville)arealsoquitecommonbutroyaltiesofaslowasonepercent andashighasthirtypercentcanalsobefound. Aroyaltytakesnoaccountofthecostsofexploring,developingorproducing oil&gas.Consequently,dependingonwhatthosecostsare,afixedroyaltyofsay, 12.5%,couldeasilyreducecompanyprofitsby25%ormore.Therefore,ifafixed royaltyistoohigh,aproducermayabandontheprojecteventhoughoil&gascan stillbeproduced. Fixedroyaltyratesmaybecommon,butincreasinglystatesarecreatingsliding scaleroyaltiesthatvarytheroyaltyratebasedonothercriteria.Aslidingscale royaltyratemaybecreatedusingthefollowing: leveloffieldproduction levelofwellproduction location cumulativeproduction productionrateandprice Rfactor internalrateofreturn othercriteriasuchaswaterdepth,oilgravity,orelapsedtime
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Slidingscalesareusedtoescalatetheroyaltybasedonafactorthattendsto predicttheprofitabilityofaproject.Oil&gasprojectstendtobemoreprofitable when: productionrateishigher pricesarehigher costsarelower costshavebeenrecovered Therefore,apetroleumprojectislikelytobeabletobearahigherroyaltyin thesecircumstances.Byusingthesefactorsasananalogueofprofitability,itis possibletocreateafiscalsystemthatisdesignedtogenerateahigherrateof governmenttakeasaprojectbecomesmoreprofitable.Thiscanhappenwithout measuringtheactualprofitabilityofaproject,whichisanadministrativelydifficult orexpensiveprocess.
in the US Gulf of Mexico, the royalty rate is a sliding scale based on the water depth in which the well is drilled: 0 200 meter - 16.7% royalty 200 400 meter - 16.7% royalty with a royalty holiday on the first 17.5 MMboe 400 - 800 meter - 12.5% royalty with a royalty holiday on the first 52.5 MMboe free over 800 meter - 12.5% royalty with a royalty holiday on the first 87.5 MMboe free The logic of this royalty structure is that the costs of drilling are higher in progressively deeper water, so the royalty needs to reduce to compensate for the increased cost.
Thepointatwhichtheroyaltyistobedeterminedcanhaveasignificantimpact ontheamountofroyaltypaid.Royaltiescanbedeterminedat: thewellhead(commoninNorthAmerica) thefieldmeasurementpoint(commonoutsideNorthAmerica) blockboundary exportterminal Ifthepointofroyaltydeterminationisfurtheralonginthevaluechainfromthe pointatwhichthesaleofproductionoccurs(asiscommonlythecase),thenitis necessarytocalculatethevalueattheroyaltydeterminationpoint.Typicallythisis donebydeductingthecosttotransportandprocessoil&gasfromtheroyalty determinationpointtothepointofsale.Thiscanbemoredifficultthanitsounds, becauseoftenthesecostsarenotarm'slengthcostspaidtoathirdparty.Wherethe IOCownsthetransportationandprocessingfacilities,itisnecessarytoensurethat thesecostsarenotexcessiveanddonotincludeaprofitcomponentbeyonda reasonablereturnoninvestedcapitalgoods.
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EXAMPLE: Value at export terminal $ 89.00 per bbl Pipeline tariff $ 4.00 per bbl --------------------Value at field terminal $ 85.00 per bbl Processing tariff $ 2.00 per bbl --------------------Value at well head $ 83.00 per bbl
Royalty Determination
Astatemayopttoreceiveitsroyalty'inkind',whichmeansthatitcantake physicalpossessionofitsshareofactualpetroleumforitsroyalty.Astatethathas thecapabilitytomarketitsownproduction,oradesiretomakeuseofits productionshareforadifferentpurposethantheIOC(forexample,totakeittoa domesticuse)maychoosetodothis,anditcanbeausefulright.Insomecases, statesprefertotaketheirproductioninkindbecausetheycanactuallydoabetter jobthantheIOCofmarketingthestateshare.However,moststatesallowtheIOC tosellthestate'sroyaltyshareofproductionandacceptpaymentincashatthe valuethattheIOCobtained.Arighttotakearoyaltyinkindrequiresafewmonths' advancenoticetotheIOC,andforagasproject,itmaybeaonetimeelection.
Price Discounts
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Price Discounts
CorporateIncomeTaxataxonthenetincome(orprofit)generatedbya corporationfromtheactivitiesthatitconducts Itisbeyondthescopeofthisbooktodiscusstheconceptsofcorporateincome taxation.However,thereareanumberofattributesofcorporateincometaxation thatarerelevanttounderstandingtheoverallfiscalfeaturesofapetroleumcontract. Mostpetroleumfiscalregimesincludecorporateincometaxasoneofits features.TheunderlyingconceptisthatIOCs,likeanyothercorporatecitizen, shouldpayincometax(inadditiontootherpaymentsasdiscussedabove,because petroleumisastateownedresource).EveninIreland,whosefiscalregimefor petroleumoperationsiscomprisedsolelyofitscorporateincometax,IOCsare chargeda25%corporateincometaxwhereasothercompaniesinIrelandpayonly 20%. Corporatetaxratesapplicabletopetroleumactivitiesvarywidelyaroundthe world,fromalowofzeroinsometaxhavenstatestoahighof85%forcertain operationsinNigeria.However,moststatesimposeacorporatetaxintherangeof 25%to35%. Itisimportanttounderstandthatcorporatetaxationisadifferenttypeoffiscal featurecomparedtoroyalties,profitsharesandothertools.Corporateincometaxis determinedatthelevelofthecorporation,whereotherfiscaltoolsdeterminethe amountpayableatthelevelofthewell,thefieldorthepetroleumcontract. Consequently,corporateincometaxwillincludefeatureslikedeductionsfor depreciationandotherfeaturesofthecorporateincometaxregime.Theresulting taxcalculationcanthereforeyieldverydifferentresultsthanaroyaltya12.5% royaltyisverydifferentthana12.5%rateoftax. Somestatescreatespecialrulesforassessingcorporatetaxonoil&gas operations.
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An IOC may be required to calculate its corporate tax in a special way, such as on its petroleum sector operations only (as in Thailand); its upstream operations only (as in Pakistan); its offshore activities only (as in UK); its petroleum contract area only (as in Indonesia and Tunisia) or in each development area (as in Angola).
Thisconceptissometimesreferredtoas'ringfencing'theactivitiesoftheIOC aretaxedasthoughthereisaringfencearoundthedefinedarea. Ringfencingallowsthetaxregimetolookonlyattheactivitieswithinthering fence,sothatothergains,lossesorcostsoutsidetheringfenceareexcluded.We willseethisconceptusedinotherfiscaltoolsaswell.Theconverseofringfencing iscalled'consolidation',whereactivitiesacrossmultiplecontractareasaretreated onacombinedbasis.
Profit Sharing
Everyproductionsharingcontractincludesafiscaltoolthatdefinessomeofthe productionas'profitoil'or'profitgas'andsharesitbetweenthestateandtheIOC. Inordertounderstandtheseconcepts,let'sreturntotheunderlyingconceptofa productionsharingcontractwhichcreatesarelationshipwheretheIOCisa 'contractor'tothestate,andithasbeenhiredtoperformpetroleumactivitiesina contractareaownedbythestate.TheIOCexplores,andifsuccessfulexploration occurs,developsandproducespetroleum.Ithasincurredsomecostsindoingso.It isnecessarytodefineinthepetroleumcontract: costoil,whichistheshareofproductionthattheIOCwillreceiveforrecovery ofthecostsithasincurred,whichissubjecttoamaximumamount(the'costoil limit')and profitoil,whichistheshareofproductionremainingaftercostoilhasbeen deliveredtotheIOC. Iftheresultingproductionincludesgas,therewillalsobeacostgaslimitanda profitgasshare,whichoftenisadifferentlimitandshareowingtotheeconomicsof gasdevelopment. Thefollowingdiagramisavisualrepresentationofhowthetotalproductionis allocatedbetweentheIOCandthestateinaproductionsharingcontract:
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ThefirstgovernmenttocreatetheproductionsharingcontractwasIndonesia, wherethestateoilcompanyPertaminahadamonopolyforpetroleumexploration rightsandthereforeaconcessioncouldnotbeawarded.Pertaminadevelopedthe productionsharingcontractonthefollowingbasis:theIOCas'contractor'would receiverecoveryforcostsincurredoutofamaximumof40%ofproduction(the 'costoillimit'),andthebalanceofproductionwouldbesharedbetweenPertamina asto60%andthecontractorasto40%(the'profitoilshare').Allcapitaland operatingcostsarerecoveredfromamaximumof40%ofproduction.Anycostsin excessofthecostoillimitarerecoverableinfollowingmonthsinaperpetual carryforwarduntilfinallyrecovered.Ifcostsarelessthanthecostoillimit,the excessistreatedasprofitoilandsharedbythepartiesintheirrespectiveprofitoil shares.Inotherwords,thecostoilallocationtotheIOCisthelesserofthe40%cost oillimitandtheactualunrecoveredcosts. ThissimpleformulahaschangedanumberoftimessincefirstusedinIndonesia, andmanynewconceptshavebeencreatedtoshareprofitoilanddeterminethecost oillimit.Manystatesstillusefixedprofitoilshares,suchas: 40%inTimorLeste 50%intheThailandMalaysiajointdevelopmentzone 60%inthePhilippines
Profitsharingcanalsobedoneusingaslidingscaledesignedtoincreasethe state'sshareofprofitoilastheprojectattainsdifferentfiscalorproduction criteria.Aslidingscaleroyaltyprofitsharemaybecreatedusingthefollowing factors: leveloffieldproduction cumulativeproduction combinationoffieldandcumulativeproduction Rfactor combinationofRfactorandfieldproduction internalrateofreturn costlimit AnRfactorcanbeusedtocreateaslidingscaleprofitshare,asshownbelow (usingAzerbaijanasanexample): RFACTORPROFITOILTOGOVERNMENT
0 < R < 1.0 15%
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0 < R < 1.0 1.0 < R < 1.5 1.5 < R < 2.0 R > 2.0
Cost Oil
Thehigherthecostoillimit,thebetterfortheIOC,becauseitwillrecoverits investmentmorequickly.FastrecoveryofinvestmentismoreattractivetotheIOC andmeetsgovernmentobjectiveofattractingforeigninvestment. TimorLesteandGuatemalahavenocostlimitandnocostdepreciationrules,so intheorytheIOCcouldreceive100%ofproductionuntilcostsarerecovered.But bothofthesestatesaddaroyaltythatispayableincashorinkind,therebyensuring aminimumproductionsharetothestate. StateParticipationasafiscaltoolreferstocaseswherethestateparticipates inthepetroleumcontractasacocontractorwiththeIOC. Statessometimesparticipatedirectlyinoil&gasactivities,typicallythrougha stateornationaloilcompany(oftenreferredtoasa"NOC").Ineffect,thestateco investsintheexploration,developmentandproductionactivitiestogetherwiththe IOC.Ifthestateparticipatesinthiswayitisapartytothepetroleumcontractin twocapacities:astheowneroftheoilandgasresourceandgrantorofrightsunder thepetroleumcontractandasaninvestor. Therearethreeimportantquestionsthataffecttheroleofstateparticipationasa fiscaltool: Question1:howlargeapercentageoftheprojectwillthestateoilcompany have Question2:whendoesthestateoilcompanybegintoparticipate,and Question3:whatcostsoftheprojectwilltheNOCbear Answer1:moststatesestablishafixedpercentageforstateoilcompany participation,whichvariesfromalowof5%(asinBelize)or10%(asinIndonesia),
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toahighof50%(asinBruneiandTunisia)to60%(asinAbuDhabi). Answer2:whenthestateoilcompanyparticipationbegins,thiscanbefromthe startofthecontract.However,thechallengeforastateoilcompanyisoftenthe abilitytopayitsshareofthecosts,andthewillingnesstoassumetheexploration riskthattheactivitymaynotbesuccessful.Itisrarelyagoodideaforastatetotake alotofexplorationrisk,particularlyifitisnotawealthystate.Thischallengecan beaddressedintwoways.Onewayistogivethestateoilcompanyanoptionto participateintheproject,andtriggeringthatoptionatapointintimewhensomeor alloftheexplorationriskiseliminated.Therefore,manystateparticipationrights givetothestateoilcompanyanoptiontoparticipateuptoitsdesignatedshareat thepointofdeclarationofcommerciality,oruponapprovalofthedevelopment plan,forexample. Thesecondwayofmanagingthechallengeofthestate'sabilitytopayitsshare ofcostsisaddressedbyansweringthethirdquestion,astowhatcostswillthestate oilcompanybear. Answer3:Therearethreealternativeanswertothisquestionwhichdefinethe typeofstateparticipation.Theseare: 'fullequity'participation(asinNorway)inwhichthestateoilcompanybearsits shareofallcostsinfull 'partialcarriedinterest'inwhichtheIOCbears(or"carries")allofthecosts incurredpriortothestateoilcompany'selectiontoparticipatebut,followingthe electiontoparticipate,thereisarepaymentofsomeorallofthestateoil company'sshareofthecostsincurredbeforetheelectiontoparticipate(asin IndonesiaorUganda).Therepaymentmaybe,underaProductionSharing Contract,forexample,bywayoftheIOCreceivingpartofthestateoil company'sshareofproduction.Thisisalsoknownasa"soft"carryand 'fullcarriedinterest'inwhichtheIOCbears(or"carries")allofthecostsincurred priortothestateoilcompany'selectiontoparticipateandthereisnorepayment ofthestateoilcompany'sshareofthecostsincurredbeforetheelectionto participate(asinCameroon,ChadandTrinidad&Tobago).Thisisalsoknown asa"hard"orsometimesasa"free"carry. Inallcasesthestateoilcompanyisresponsibleforitsproportionofpetroleum operationscostsfollowingtheexerciseofitsoptiontoparticipate.Thesedifferent formsofcarrycanperhapsbebetterunderstoodbywayofanexample:
For these purposes we will look at the 2000 version of the Ghana model form Petroleum Agreement where the right of state participation is exercised by the Ghana National Petroleum Corporation ("GNPC"). Pursuant to this contract GNPC has both a state participation of 10% from the date that the contract is
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GNPC has both a state participation of 10% from the date that the contract is entered into (the "Initial Interest") and has an option to acquire a further state participation at the time of a commercial discovery (the "Additional Interest"). The Initial Interest is carried by the oil company in relation to all costs for exploration and development operations and is a full/free/hard carry. GNPC may elect that the Additional Interest is carried by the oil company in relation to the costs of development and production operations but, if it does so, it will be a partial/soft carry that is reimbursed. Taking a look at the relevant language in the example below in relation to the Initial Interest:
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GNPC'srighttoacquiretheAdditionalinterest(orinindustryjargonto"back in")arisesatthedateofcommercialdiscoveryandithas90daysfromthatdatein whichtoexercisesuchright.IfGNPCdoesnotexerciseitsrightinthespecified90 dayperioditwillnotacquiretheAdditionalInterest.Inexercisingsuchrightitis requiredtocontributea"proportionateshare"ofalldevelopmentandproduction costs.Accordingly,basedonlyonArticle2.5,theAdditionalInterestisnota carriedinterestfromthedateofitsacquisitionGNPChasunderArticle2.5topay itsshareofcostsinrelationtosuchinterest.However,Article2.9goesonto providethatGNPCmayonexercisingitsoptiontoacquireanAdditionalInterest also:
toexplorationcosts,thereisafull/free/hardcarryfortheAdditionalInterestaswell astheInitialInterest.GNPCisnotcarriedbytheContractorforeitheritsInitial InterestshareoritsAdditionalInterestshareofproductioncosts.Itmustbearthose itself,theassumptionbeingthatitwillbeabletoaffordtomeetitsshareofcosts sinceitwillbereceivingrevenueorashareofproductionatthatpoint. Apointofdetailinrelationtostateparticipationthatisrelevantparticularly wheretheparticipationisnotfromthecommencementofthepetroleumcontract butpursuanttotheexerciseofanoptiontoparticipatelater,iswhetherthestate participatesinallofthepetroleumoperationsundertheparticularcontractor,ona casebycasebasis,ineachcommercialdiscoveryorfield.LookingattheGhanaian exampleabove,itisclearthattheInitialInterestisinrespectof"allPetroleum OperationsunderthisAgreement".BycontrastGNPChastheoptiontoelectto acquireitsAdditionalInterestinrespectofeachdevelopmentandproductionarea onacasebycasebasis.ThisgivesGNPCsignificantflexibilityalthoughitalso increasesthecomplexityofadministeringtheagreementifthereismorethanone developmentandproductionareaundertheagreementandGNPCmakesdifferent electionsinrelationtothese. Thesignificanceofstateparticipationrightsinvolvesmorethanjustfiscal issues,sothisisdiscussedinmoredetailinlaterchapters.
Thepriceofoil&gasisvolatile.InJuly2008,thepriceofoilhitanalltime highof$147perbarrel.Onlysixmonthslater,inDecember2008,thepricehad plummetedto$35perbarrel.Oneofthechallengesofmanaginganoil&gas companyistobeabletodealwithpricesofoil&gasthatfluctuateinthisway financing,planningandinvestmentisverydifficultinsuchanenvironment. Pricevolatilityalsomakesdifficulttheproperadministrationofapetroleum sectorbythestate.Afiscalregimedesignedforaworldwherethepriceofoilhad neverexceeded$55perbarrel(inotherwords,theworldasitwasuntil2003)may notworkwellwhenthepriceis$100perbarrel,asithasbeenfortheyear precedingthepublicationofthisbook. Oneareawherepetroleumregulatorsareoftencriticisedisthatthefiscaltoolsdo notextractenoughrevenueforthestatewherethepriceofoilisveryhigh.Oil companiesareaccusedofearning'windfallprofits',andstateswanttotaxthat windfall. First,let'sunderstandtheterm'windfall'profit.Itisinfactaforestryterm.A lumberjackmustearnhiswagesbythehardlabourofcuttingdowntreesandtaking themtomarket.Occasionally,however,abiggustofwindwillknockdownmany treeswithoutanyeffortbythelumberjack.Thesetrees,referredtoas'windfall',can
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thenbeeasilysoldbythelumberjackwhohasjustmadeafortunatebutunearned profit. Thesamecanbesaidforoilcompanies.Whenthepriceofoilrisessignificantly, itishardtosuggestthatthisisan'earned'profit.Therearemanyreasonsadvanced byIOCstoretaintheseprofits,suchasthefactthattheypermitmorereinvestment tofindadditionalproduction.However,thehistoryofvolatileoilpriceshasled manystatestorequireanincreasedshareofpetroleumrevenueswhentheprofits riseabovecertainthresholds.Consequently,manystateshavecreatedprofitbased taxesthatwemustincludeinthefiscaltoolbox. Extraprofitbasedtaxesmaynotbenecessaryatallwheretheotherfiscaltools alreadyincludefeaturesthatgivethegovernmentalargershareofrevenuewhen petroleumoperationsbecomemoreprofitable.Slidingscalesystems,Rfactorsand 'internalrateofreturn'(IRR)featuresaredesignedtocaptureadditionalprofits.
EXAMPLES of profit based taxes include:
Brazil's 'special participation', which takes a larger share of 'net income' as the production rate increases Ghana's 'Additional Oil Entitlement', which gives a larger share of oil production as the IOC's rate of return increases Algeria's TEP of between 5% and 50% for oil prices over $30 per barrel (not applicable to new contracts under the new Hydrocarbon Law)
Moststateshaveavarietyofothertaxeswhichcapturerevenueforthestateina varietyofactivities.Thesearenottaxeswhichareuniquetotheoilindustrythey areintendedtoapplytoallcorporateentities: VATorvalueaddedtax importduties exportduties turnovertaxes industrialtaxes withholdingtaxes AnIOCneedstobeattentivetothefullvarietyoftaxesthatareapplicableina particularstatebeforeinvestingthere.Similarly,astateneedstobealerttothefact thatthesetaxes(andsometimesthebureaucracyinvolvedinadministeringthem) maytipthebalanceforaninvestorsothatapetroleumprojectceasestobe economic.
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economic.
Manystateshavecreatedafiscalregimethatisdesignedtocapturean appropriateshareoftheeconomicrentassociatedwithpetroleumoperationssothat theseadditionaltaxesareconsideredtobeunsuitableforpetroleumindustry operations.Therefore,itisnotuncommontoseethatspecialexemptionsarecreated forsomeofthesetaxesinsofarastheywouldapplytoIOCs.Forexample,IOCs importexpensivedrillingequipmentandothermaterialsintoastateaspartof conductingpetroleumoperations.Thedrillingequipmentmaylaterbeexportedout ofthestatewhendrillingoperationsarecompleted.Consequently,exempting drillingequipmentfromimportdutiesisquitecommon. Productionsharingcontractsstatethattitletoeveryassetthatispurchasedbyan IOCandincorporatedintoapetroleumoperationisautomaticallytransferredtothe state.ApplyingataxtoanIOCwhoimportstheassetthatwillimmediately becomeownedbythestatemakeslittlesense. ServiceFeesthecompensationpaidbyastatetoanIOCfortheperformance ofservicesunderariskservicecontract. Riskservicecontractsarenotinwideusearoundtheworldonlysevenstates usethem.Consequentlythereisonlyalimitedvarietyofservicefee systems.Fundamentally,therearethreetypes:
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Price Catalogue
EXAMPLE: Mexico's Multiple Service Contracts awarded in 2003 and 2004 involved a 'price catalogue' where each activity that the IOC performs (drilling wells, laying pipeline, operating wells, and so on) was priced in a catalogue attached to the contract. The IOC adds up the services performed by it during the month and submits an invoice. Payment is made in cash. This unusual structure was necessitated by Mexico's public works law. Mexico is now awarding contracts that utilize a per barrel fee, following changes to applicable legislation.
Fixed Compensation
EXAMPLE: Iran's Service Contract (commonly called a 'buyback contract') rewards the IOC for fulfilling development activities set out in a master development plan by paying a fixed, pre-negotiated remuneration fee once the work is completed. This remuneration fee is negotiated, and the basis of the negotiation is to pay a fee that is estimated to be a fraction (on the order of 15%) of the expected costs that the development project. Costs and the remuneration fee are paid out of production resulting from the field that the IOC developed pursuant to the master development plan.
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Strategies
Sowheretobeginwhencreating,reviewingorevaluatingafiscalregime?Let's rememberthattheobjectiveistosharethedivisibleincome(projectrevenues minusprojectcosts)betweenthestateandtheIOC.Oneapproachistoaskaseries ofstrategicquestionsaboutthegoalsthestatewantstoachieve,andthentousethe appropriatefiscaltoolstoachievethosegoals.Herearefourkeyquestionsthatcan helpastatetodefineitsstrategy: howshouldthefiscalregimetreatchangesintheprofitabilityofpetroleum operations whatisthetimingofthestate'sshareofthedivisibleincome? howmuchriskofsuccessofpetroleumoperationsisthestatepreparedtotake? towhatextentdoesthestatewanttoencourageinitialpetroleuminvestment andreinvestment? Wewillexamineeachoftheseissuesindividually.
Changing Profitability
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Changing Profitability
Thefluctuationofpetroleumprices,costsandproductionratesmeansthatthe profitabilityofoil&gasoperationschangesovertime.Fiscalsystemscanreactto thesechangesinoneofthreeways.Aregressivefiscalregimegivesthestatea lessershareofrevenueswhenprofitabilityincreases.Aneutralfiscalregimegives thestatethesameshareofrevenueswhenprofitabilityincreases.Aprogressive fiscalregimegivesthestateanincreasingshareofrevenueswhenprofitability increases. Itisimportanttostressthatthesearenotvaluejudgementsonthefiscalregime. Tosayastatehasaregressivefiscalregimeisnottosaythatisitold,antiquated andoutoftouchwithmodernreality.Theremaybegoodreasonsforacountryto chooseregressivefiscaltoolsthatresultinaregressivesystem.
Afewexamplesmaybeusefultoillustratetheseeffects.Thefirstaddressesa productionbonus.
EXAMPLE: In the Libyan petroleum contract described in the previous chapter, the IOC pays a bonus of $5,000,000 when 100,000,000 barrels of oil equivalent is produced. Whether that oil is sold at a price of $50 per barrel or $100 per barrel makes a big difference to the IOC's profitability of the project, but the government's revenues from the production bonus is unchanged by this fact. The IOC is required to pay the bonus, regardless of whether its operations are more profitable or even unprofitable. So, a production bonus of this type is regressive.
Afixedroyaltyisanothercaseinpoint.
EXAMPLE: In the US Gulf of Mexico case mentioned earlier, where a 16.67% royalty applies in shallow water, the government receives one-sixth of oil produced. If the price of oil goes up, oil & gas operations almost always become more profitable, because costs tend not to increase in precisely the same proportion. However, the government receives the same one-sixth share of production regardless of the price increase. While the government's share is more valuable because the price is higher, it will in fact represent a lesser share of the profitability of the activity in most cases.
profitabilityincreasesisanRfactorroyaltyorprofitshare.IntheAzerbaijan exampleinthepreviouschapter,thegovernment'sshareofprofitoilincreasesfrom 15%to35%asRgoesfromzerototwo.Whenoil&gasoperationsbecomemore profitable,theRfactorincreasesmorequickly,andthestate'sshareofprofits increases.Thisisanexampleofaprogressivefiscaltool. Afiscaltoolcanberegressive,neutralorprogressivewithrespecttothethree keyfactorsofpetroleumprofitability,whichareprice,costsandproductionrate.A slidingscaleroyaltythatincreasesastheproductionrategoesupisaprogressive featureintermsofproduction,butnotforpriceorcost.Aslidingscalebasedonthe priceofoilwouldbepriceprogressivebutnotcostorproductionprogressive. SlidingscalesusingRfactorsorinternalrateofreturnfocusonoverall profitability,andthereforetheytendtobeprogressiveacrossallthreefeatures.
Approaches To Profitability
Thequestionofwhatapproachtoprofitabilityshouldbeadoptedbyastateisan interestingquestion.Historically,themostcommontypesofpetroleumfiscaltools arebonuses,rentalsandfixedroyalties,whichareregressive.Butgovernments typicallyprefertotaxcorporationsinallareasofendeavouronaneutralbasis,and individualsonaprogressivebasis.SotaxingIOCsonaregressivebasisseems unusualwhencomparedtoothercitizens,corporateorindividual. Moreover,thefluctuatingprofitabilityoftheoil&gasindustryisboundtolead tosituationswhereanIOC'soperationsbecomeveryprofitableatsometimes duringthelongtermofapetroleumcontract.StatestendtobeirritatedwhenIOCs profitsgoupwhilethestate'sshareofthoseprofitsgodownorstaythesame.This factisoneofthereasonswhystatesoftenchangethefiscalregimeduringtheterm ofaninvestor'soperations,leadingtoinstabilityandfrictionbetweenstateand
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ofaninvestor'soperations,leadingtoinstabilityandfrictionbetweenstateand IOCs. Creatingprogressivefiscalfeaturesthatgiveastateanincreasingshareof profitabilityisonewaythatthisareaofpotentialfrictioncanbeaddressed.Ifa suitablyprogressivefiscalsystemexists,thenastateshouldbepleasedwhenoil industryprofitabilitygoesup,becausethestate'sshareofthoseprofitswillalsogo up. Twonotesofcautionareinorderwhendealingwiththisapproachto profitability.First,oilindustryprofitsdon'talwaysgouppricesandcostsgoup anddown.TherearetimeswhenanIOCsactivitiesmaybeunprofitable.Ifastate's shareofrevenuesdroptozeroinsuchcircumstances,thatcanalsobeirritatingtoa state,andthestatemaynotbereadilyabletodealwithsuchanabsenceofrevenue. So,thereisastrongcasetobemadeforregressivefiscaltoolsthatgenerate governmentrevenuewheneveroil&gasisproduced,andregardlessofwhetherthe activityisprofitable. Second,afiscalregimethattakesawaytoomuchofanincreaseinprofitability canresultinasituationwherethisactsasanincentivetoincreasecosts. Economistsrefertothisbehaviouras'goldplating',becausetheIOChasan incentivetoincurexcessivecosts(suchasanimaginaryplatingofthefacilitiesin gold)ornoincentivetoreducecosts.Aregimecanbetestedforitsgoldplatingby theuseofafinancialmodelifanincreaseincostsbyadollarresultsingovernment revenuesreducingbymorethanadollar,thenit'sagoldplate.Suchregimesmay alsocreateincentivestotheIOCtoreducetheproductionrateorsellproductionat adiscountedprice,whichhavesimilareffectsasgoldplating. GoldplatingresultsinamisalignmentoftheinterestsofthestateandtheIOC. FiscalsystemsworkbetterwhentheIOChasafinancialincentivetoachievethe sameresultasthestate,whichgenerallyistoincreaseproductionatthehighest priceandthelowestcosts. Moststateschooseavarietyoffiscaltoolsresultinginahybridsystem.When creating,reviewingorevaluatingafiscalregime,itisimportanttorecognizethe potentialimpactsofeachtoolinanenvironmentwhereprofitabilityfrequently changes.
signaturebonus:veryregressive productionbonus:veryregressive fixedroyalty:regressive slidingscaleroyalty:progressive corporateincometax:neutral fixedprofitshare:neutral slidingscaleprofitshare:progressive stateparticipation:neutral profitbasedtaxes:progressive othergeneraltaxes:varies,butgenerallyregressive servicefeesystems:veryprogressive
Eachofthefiscaltoolsdescribedinthepreviouschapterprovidesrevenuetothe governmentatadifferentpointinthelifetimeofapetroleumproject.Asignature bonusispayableatthetimethepetroleumcontractissigned,beforeproduction begins(andbeforeitisevenknowniftherewillbeproduction).Aproduction bonusmaybepayableatthetimethatproductionbeginsandthenatvarioustimes duringtheproductionphase.CorporateincometaxispayableonlyoncetheIOCis makingaprofit,whichusuallymeansthatitwillneedtohaverecoveredallofits costs.IRRbasedfiscaltoolstendtogeneratethemostincomeonlyaftertheIOC hasearnedagoodrateofreturn. Soeachofthesefiscaltoolscanbesaidtobe: 'frontendloaded',whichmeansthattheybegintoapplybeforetheIOChas recovereditscosts(inotherwords,thestatereceivesrevenuebeforetheIOCis makingaprofit) 'neutral',whichmeansthattheyapplyonlyupontheIOCrecoveringitscosts(so thestateprofitsonlywhentheIOCprofits) 'backendloaded',whichmeansthatthestate'sshareonlybecomessignificant aftertheIOCisinaprofitableenvironment Thestatetypicallychoosesthefiscaltoolbasedonwhenitwantstoreceivethe petroleumrevenue.Naturally,stateswantmoneysoonerratherthanlater,butIOCs wouldratherpaymoneylaterinthelifeoftheprojectonceprofitabilityhasbeen established.Consequently,thisisabalancingexercise.Themorethatisrequired tobepaidupfront,thelesscanbeexpectedasthebackend,andviceversa. Therearecertainparametersthathelptounderstandthechoiceofthefiscaltool, butthesearenotincludedinthepetroleumcontract.Onesuchparameteris the'discountrate'ofthegovernmentandtheIOC.
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EXAMPLE: A poor government that has a very high need for money today probably has a high 'discount rate': it would prefer to have $1.00 of revenue today rather than $1.20 a year from now, an effective discount rate of over 20%. A rich government that has the ability to borrow funds at attractive
rates probably has a low discount rate, so if you offered it $1.05 a year from now, it would prefer that over $1.00 today, resulting in a discount rate of less than 5%.
IOCshavediscountratestoo,generallyinthe1015%rateorhigher,because theycanputtoday'sdollartousetogenerateaprofitinayear'stime.So,inthe balancingexerciseinvolvedinchoosingthetimingoftherevenue,logical behaviourwouldbeforwealthygovernmentstobackendloadtheirfiscalregimes, andpoorgovernmentstoprefertofrontendload.Sometimesthislogicprevails,but oftenitdoesnotforexample,thewealthyprovinceofAlberta,Canadahasa systemthatprefersupfrontpayments,whilePapuaNewGuineahasabackend loadedsystem. Hereishowthefiscaltoolsfitintothetimingscenario: signaturebonus:frontendload productionbonus:varies fixedroyalty:frontendload slidingscaleroyalty:varies corporateincometax:neutral fixedprofitshare:frontendloadtoneutral(dependingoncostoillimit) slidingscaleprofitshare:neutraltobackendload stateparticipation:neutral profitbasedtaxes:backendload othergeneraltaxes:varies
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IOCsgenerallybeartheriskofsuccessorfailureinpetroleumoperations. Managingandbearingexplorationrisk,capitalcostrisk,operatingcostriskand commoditypriceriskistheirstockintrade.Theissueforstatesindesigningtheir fiscalregimeis,howmuchofthisriskisthestatewillingtoshare? AstatecouldchoosetotakenoriskofpetroleumoperationsbysellingtoanIOC thelandonwhichpetroleumoperationsaretooccurforadefinedprice,without anyroyaltyorotherfuturepaymentobligation.Thestate'ssharewouldbe unaffectedbyexplorationsuccessorfailure,oilpricefluctuations,productionrate fluctuationsandchangestothecostenvironment.However,nostatetakesthis approachtopetroleumactivities.Everygovernmentdesignsafiscalsystemthat willcapturesomeoftheeconomicrentofasuccessfulpetroleumproject.Butthe designofthefiscalsystemcanaffecthowmuchoftheriskofsuccessorfailurethat thegovernmentispreparedtosharewiththeIOC.Forexample,ifagovernment receivesafixedroyaltyof12.5%,thestatedoesnotshareinthecostriskof petroleumoperations:itwillreceiveoneeighthofproduction,whethertheIOCs operationsareprofitableornot.AnIRRbasedprofitoilsharewillresultinthe governmentsharingalloftherisksoftheIOC'ssuccess,becauseitwillreceivea
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governmentsharingalloftherisksoftheIOC'ssuccess,becauseitwillreceivea significantshareofproductiononlyaftertheIOChasprofited.Somestatesmakeit astrategicnationalgoaltohaveadirectinvolvementinpetroleumoperations throughtheparticipationofastateoilcompany.Thisinvolvessharingmostorall oftherisksofpetroleumoperations.Theextenttowhichastatebearstheriskof successcanhaveanimpactonotherfeaturesofthepetroleumcontract.Ifthestate sharesinthecostrisk(forexample,throughastateoilcompanyparticipationora profitshare),thenthestatemaywantagreateroperationalorapprovalroleinthe coststhattheIOCplanstoincur,suchasajointmanagementcommittee.Hereis howthevariousfiscaltoolsstackupforstaterisksharingforexploration, productionrate,priceriskandcostrisk: signaturebonus:norisk productionbonus:explorationriskonly fixedroyalty:explorationriskonly slidingscaleroyalty:explorationrisk,andsomeorallofproductionrisk,price riskandcostrisk(dependingontheslidingscalefactor) corporateincometax:fullrisk fixedprofitshare:fullrisk slidingscaleprofitshare:explorationrisk,andsomeorallofproductionrisk, priceriskandcostrisk(dependingontheslidingscalefactor) stateparticipation:noexplorationriskallotherrisk profitbasedtaxes:fullrisk othergeneraltaxes:varies servicefeesystems:fullrisk
StatestypicallyareseekingtoencourageIOCstoinvestinpetroleumexploration, sothatoil&gascanbediscoveredandproduced.ThedecisionoftheIOCon whethertoinvestisafunctionoftheattractivenessofthegeologyintheblockthat isonoffer,andtheattractivenessofthefiscalregime.Thisissueneedstobe analysedintwoways:initialinvestment(or'standalone'investment)andre investment. Somefiscalregimesarebetterstructuredthanotherstomakeinitialinvestment attractive.Abigsignaturebonusisadisincentivetoinvest,becauseitrequiresthe IOCtopayupfrontfortherighttoexplore,beforeitknowsiftheblockhas commercialreserves.ThefundsthattheIOChasavailabletoconductexploration arereducedmaybetheamountspentonthesignaturebonuscouldhavebeenspent onanextrawellthatmighthavebeenasuccess.Conversely,aproductionsharing contractwithahighcostoillimitmeansthattheIOCcanrecoveritsexploration
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contractwithahighcostoillimitmeansthattheIOCcanrecoveritsexploration costs(includingunsuccessfulwellsthatprecedeadiscoverywell)beforethestate shareofrevenuesbecomessignificant. SomepetroleumcontractswillresultinIOCsinvestinginastateforthefirst time,andtheyanalysetheirinterestindoingsobyassessingtheattractivenessof thefiscalregimeona'standalone'basis.However,mostpetroleuminvestmentthat happensintheworldisinactivitiesbyanIOCinastatewheretheyalreadyhave petroleumoperations,ofteninadifferentblock.Insuchcases,theIOCwillassess thefiscalregimeonthebasisofitsoverallimpactonitsexistingandnew investment.ThisisimportantbecausesometimesIOCsareabletodeductthecosts ofanewinvestmentagainsttherevenuesandtaxespaidonanexistingfield.This makesreinvestmentmoreattractive.Anexamplemightbeusefulhere.
EXAMPLE: If an IOC has petroleum revenue in a state on which it is paying income tax at 35%, and the cost of an exploration well is deductible in calculating income tax, then the after-tax cost to the IOC of drilling a new $10,000,000 exploration well in that state is only $6,500,000. While the state suffers a reduction in its tax revenue as a result, the incentive for the IOC to re-invest in that state is significant. Success often begets success, so the IOC is likely to develop a larger business in that state, generating more government take, and will prefer to re-invest there rather than looking abroad.
Thiskindofreinvestmentincentivehappenswhenthefiscalregimeis 'consolidated'ratherthan'ringfenced'.Ringfencingwasdiscussedintheprevious chapter.Ringfencingtendstoreducetheincentivetoreinvest,while consolidationtendstoincreaseit. Thevariousfiscaltoolshavethefollowingimpactoninvestmentandre investment: signaturebonus:disincentivetoinvestandreinvest(unlessdeductibleagainst fiscalterm) productionbonus:neutral fixedroyalty:disincentivetoinvestandreinvest slidingscaleroyalty:neutralonincentivetoinvestreinvestmentimpact dependsonringfencetreatment corporateincometax:neutralonincentivetoinveststrongreinvestment incentivedependingonringfencetreatment fixedprofitshare:neutralonincentivetoinveststrongreinvestmentincentive dependingonringfencetreatment slidingscaleprofitshare:neutralonincentivetoinvestreinvestmentimpact dependsonringfencetreatment
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State Participation
Astate'srighttoparticipateinoil&gasoperationsisfrequentlyusedandhasboth socioeconomicandfiscalimpacts.Someofthesefiscalimpactsarenotalways clear,sofurtherexplanationisworthwhile. Stateparticipationhasthefollowingresultsonthefourstrategicconsiderations: ChangingProfitability:neutral Timing:neutral Risk:noexplorationrisk(wherecarried)allotherrisks InitialInvestmentandReinvestment:disincentivetoinvestreinvestment impactdependsonwhetherstateoilcompanyiscarriedonthesubsequent investment Thestate'sshareofprofitswillbethesameastheIOC'ssharebecausethestate oilcompany'sparticipatinginterestsharetypicallyisacoinvestmentbythestate oilcompanyandtheIOC.Forthesamereason,thetimingofthestate'sshareof revenuesisneutralaswell. Exceptfora'fullequity'stateparticipation,thestatedoesnotbearexploration risk,becausethetypicalstateparticipationrightisanoptionforthestateto participateatthetimeofacommercialdiscovery.Ifexplorationisunsuccessful, thenthestatedoesnotparticipate,andtheIOCbearsallthecostoffailure.If explorationissuccessful,thenthestatewillelecttoparticipate. Thisisaveryattractivefeatureforthestateit'sariskfreebetonexploration success.Somestateslikethissomuchthattheyseektoincreasethisasafeatureof thefiscalregime.Theproblemisthat,dependingonthepercentageofcarried participation,itcanhaveaseriouslynegativeimpactontheattractivenessofthe initialinvestmentbytheIOC.Let'suseasimpleexampletoexplainthis.
Let's imagine that you are entering a casino to play roulette, and the owner offers you a deal. Admission to the casino is free if you'll agree to give to the owner five percent of every winning bet you make. You need to make a decision: are you a good enough gambler to be able to afford to give up five percent of your winning bets, while bearing all of the cost of
your losing bets? Perhaps you are, and you enter the casino and play for
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your losing bets? Perhaps you are, and you enter the casino and play for the day. The next day, the owner offers a different deal: free admission to the casino costs fifty percent of every winning bet. Now your decision is
quite different. Paying for all of your losing bets while giving up fifty percent of the winning bets is too risky; there's not enough reward left to justify the risk. It's time to find another casino.
Solutions
Promoting Exploration
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Gas Development
Theeconomicsofgasexplorationanddevelopmenttendtobelessattractivethan foroil.Developmentcostsaretypicallymuchhigher,andproductionpricesare generallylower.However,manystatestreatbothtypesofresourceinthesame way,andgasdevelopmentisstunted.Thefollowingfiscalfeaturescanhelp: lowerroyaltyforgas highdepreciationratesforcorporateincometaxongaspipelinesandother facilities highcostgaslimits,lowerprofitgasshareforthestate exemptgasprojectsfromspecialtaxes exemptgasprojectsfromcarriedstateparticipation
Alignment
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Alignment
Whenconductingpetroleumoperations,itshouldcomeasnosurprisethatIOCs tendtobehaveinamannerthatisconsistentwiththeireconomicinterestsas establishedbythefiscalregimeinthepetroleumcontract.Therefore,itisimportant thatthefiscalregimeisdesignedsothatitencouragesIOCstoactinamanner whichisconsistentwiththeobjectivesofthestate.Unfortunately,manystates createfiscalregimesthatencouragebehaviourbyIOCsthatisinconsistentwith whatthestatewantstoachieve. Servicecontractsareparticularlychallenginginthisregard.Stateswantmoreoil productionatlowercostandhigherprices.Yetservicecontractstendtocreate structureswithminimalincentivetotheIOCtoincreasetheproductionrate,andno incentivetokeepcostslow. Thesamesituationarisesinothertypesofpetroleumcontractswherethefiscal regimeisexcessivelyprogressive.ThisleadstodistortionsinIOCbehaviourthere areexampleswhereundercertainconditionsapetroleumprojectmaybemore profitablewithhighercoststhanwithlowercosts,ortheincentivetoreducecosts issominimalthattheIOCtendsnottodoso.
Administration
Somefiscaltoolscallforgreateradministrationresourcesthanothers.Afixed royaltytendstobefairlyeasytoadministerafixedpercentageofproductionis owedtothestate.Allthatisrequiredisameterattherelevantdeliverypointto determinethestateshare.Ifthestatedoesnottakeitsshareinkindatthatpoint, thentheIOCaccountstothestatefortherevenuesitreceivesforthatshare. Productionsharingcontractstendtoinvolveahigherdegreeofadministration, becausethestateneedstobeconcernedaboutcosts.Authorizingexpenditures, accountingforcostsandauditingIOCactivitiesarenowrequired. Stateparticipationaddsanotherlayerofadministration.Thestateoilcompanyas acocontractornowisalsoinvolvedinapprovingactivitiesandexpenditures, accountingandauditing. Forstatesthathavethetechnical,administrativeandfinancialcapacityto administercomplexsystems,thesestructuresmaymakesense.Forthosestateswho donot,abetterapproachmaybetokeepadministrationsimple.
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'Conventional'oil&gasisfoundinsubsurfacereservoirsofporousrockwhere petroleumis'trapped'bythesurroundinggeology.Astheworld'sconventionaloil &gasresourcesarebecomingmorescarce,IOCsarefocusingmoreondeveloping andproducingoil&gasfrom'nonconventional'(sometimescalled 'unconventional')sources. Thismeansoil&gasproducedorextractedusingtechniquesotherthanthe conventionalmethods.Nonconventionaloil&gasproductionisalessefficient, moreexpensiveprocessandoftenhasgreaterenvironmentalimpactsthan conventionaloil&gasproduction. Onewaytolookatthisshifttononconventionalistocompareconventional petroleumresourcestothebestpartsofacow.(ApologiestovegansandIndians).
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COMPARING RESULTS
Aspreviouschaptershavedescribed,thereisawiderangeoffiscaltoolsandalmost limitlesswaysofcombiningthem,sothat,incombinationwithotherfactorswhich areuniquetoeachoilprojectsuchascostsofproductionandgeological prospectivity,eachcontractseemstoencompasswhatamountstoitsownfiscal ecosystem. Thechallengeinassessingandcomparingthemisthatpetroleumcontractseach havedifferentfiscaltermsthatcombine: amountspaidbeforeoilisdiscovered(signaturebonus,rental) fixedpaymentsmadewhenoilisdiscoveredandproduced(productionbonus) paymentsbasedonthequantityofproduction(fixedroyalty) paymentsthatadjustbasedonthequantity,typeorpriceofproduction(sliding scaleroyalty) paymentsbasedontheprofitabilityofthefield(fixedprofitoilandcostoil) paymentsthatadjustbasedontheprofitabilityofthefield(slidingscaleprofit oilandotherprofitbasedtools) paymentsthatarebasedontheprofitabilityoftheIOCconductingtheactivity (corporateincometax) provisionsthatputsthestateintothepositioncomparabletothatofanIOC (stateparticipation) Asanexampleofthechallengesinvolved,trytoselectwhichofthefollowing optionsisbestforthestate,orbestfortheIOC: OptionA: 1. 5%Royalty 2. 30%CorporateIncomeTax 3. ProductionSharingof40%infavoroftheGovernment 4. StateParticipationof15% 5. Withholdingtaxonservicesat5% 6. Withholdingtaxondividendsat5% 7. Withholdingtaxoninterestat5% 8. SigningBonus$20million OptionB: 1. 35%CorporateIncomeTax
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2. ProductionSharing60%infavoroftheGovernment 3. SigningBonus$30million OptionC: 1. 51%StateParticipation 2. 25%CorporateIncomeTaxRate 3. Signingbonus$60million Youmayhavealreadyguessedthatthereisnorightanswer.Eventhoughthere are8waysinwhichthestatecanreceivemoneyunderoptionA,itisnot necessarilythebestoption.Andwhataboutthosehigherproductionsharesand stateparticipationinBandC?Howdoweknowwhichoneismoreattractice, especiallywhencombinedwiththeotherfiscaltoold?Italldependsonwhether thereisadiscovery,andifso,thecosts,pricesandproductionratesoftheproject. Yetthereisaninevitabledesiretofindawaytocomparedifferentfiscalsystems. Asinformationflowsincreasearoundtheglobaloilandgasindustry,people naturallyseektoknowiftheyandtheirgovernmentaredoingOK,andtoboilthat downintoonesinglefigure.Howdoyouknowifyourcompetitive? Thewaythishastraditionallybeendoneisthroughametriccalled'government take',asdescribedabove.Governmenttakeisthepercentageofthedivisible income(lifetimeprojectrevenuesminuslifetimeprojectcosts)thestatewillreceive overthelifetimeoftheproject.
Governmenttakeissowellunderstoodthatanalystsproducechartsshowingthe relativetakesofover100countriesroundtheworld.Inthemappublishedin2012 byPetroleumEconomist(oneofthesponsorsofthisbook)andproducedby petroleumeconomistsDr.PedrovanMeursandBarryRodgers,countriesareranked bygovernmenttake,fromIreland(withatakeofunder40%)toIran,LibyaandIraq (wheregovernmenttakeisover90%).DoesthatmeanthatIrelandhasestablished excessivelygeneroustermsandtheMiddleEasterncountrieshavedoneabetter job?No,thisdifferencecanbeexplainedquitesimply:petroleumdiscoveriesin Irelandareverysmallandinvestorsarefew,whileIran,LibyaandIraqhavebeen blessedwithsomeofthebestpetroleumendowmentsintheworld,andIOCsare anxioustohaveanopportunitytoexplorethere. Theprincipalreasonthatonecountrycanhaveaverydifferentgovernmenttake thananotheristhatitisacompetitivesystemataninternationallevel:astatethat hasgoodgeologycandemandtoughertermsfromIOCs. Butbeforewethinkeverythinghasbecomeeasyandallweneedisgovernment take,thereareseverallimitationsontheusefulnessofitasameasure.Oneisthatit
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take,thereareseverallimitationsontheusefulnessofitasameasure.Oneisthatit isbasedonanassumedoilprice.Aswehaveseen,veryfewcontractsremain neutralwhenthepriceofoilchanges.Mostareeitherprogressive,meaningthe governmentearnsahigherpercentagewhenprofitsgoup,orregressive,meaning thereverse.Consequently,rankingsmaychangeunderdifferentpricescenarios. Second,therateofreturnisagainsttheexpectedtotalproductionoutofaproject andyetthatfigurealsochangesovertime.Itisquiteusualforprojectstobeginon thebasisofaknownamountofprovenreservesinacontractareabutforthose reservefigurestogoupduringthelifetimeoftheproject.Thisisbecause explorationismoresuccessfuloncethelocalgeologyisunderstood,aswellasthe factthatthereismoreincentivetoexplorenearexistingwellsbecausearouteto markethasalreadybeenbuilt.Soaprojectmightstartonthebasisitwasgoingto produce50millionbarrelsandendupproducing70millionbarrels.Or,conversely, theremaybeissuesofreservoirmanagement,ordisruptionswhichcause productiontodeclinefasterthanexpected. Thirdandmostimportantly,thegovernmenttakeistheestimateofwhat percentageofprofitwillbeoverthelifetimeoftheproject.Butthatcouldbe20 yearsormoreandfewgovernmentsareindifferenttowhentheygetthemoney.As wehaveseeninthepreviouschapter,thetimingofreceiptofthestate'sshareof revenuesvariesfromcountrytocountry. Thishasledtotheevolutionofadifferentmeasure,theEffectiveRoyaltyRate (ERR),whichtriestoworkouttheprofitagovernmentreceivesduringanygiven accountingperiod.TheERRisoftenmuchlowerthanagovernmenttakestatistic intheearlyyearsofaprojectbecauseofcostrecovery,thefactthattheoilcompany isrecoveringlargeamountsofcostssunkintodevelopingtheoilfieldsinthefirst place.
yet a Deutsche Bank analysis suggested that companies could earn an Internal
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yet a Deutsche Bank analysis suggested that companies could earn an Internal Rate of Return of between 10% and 20% in working on these projects because the agreements envisaged producing such large quantities of oil that costs will be recovered very quickly.
Itisbecomingmorecommonforstatestoincludeprogressivefeaturesinthe fiscalregimeofpetroleumcontractstocapturemoreofthisrent.Soinprinciple, governmenttakeandIRRcouldbothriseinsomecircumstances.Thezerosum gameisnotinevitable. Sofarsogood.Butthereisanotherveryimportantwayinwhichgovernments andcompaniesareofteninintensezerosumcompetitionoverfiscalterms.Because bothofthemareofteninterestedinhowmuchmoneytheycangetnoworasclose tonowaspossible.Thisisthetimingissue:willthestatereceiveitsshareof governmenttakeearlyorlateinthelifeoftheproject.Foracountrywhereoilis beingproducedbyanIOCthereispressuretoshowresultssoon.Inmanycases, though,theneedisalsourgentandpractical.Publicservicesandcivilservice payrollsroutinelydependonhavingmoneytospend,asyndromewhichis heightenedduringelectionsandotherpoliticalevents.Andyetthefirstyearsofthe projectarewhenacompanywillbeanxioustorecoveritsinvestmenttothatits IRRimproves.
Anotherfactorthatweighsagainstanysimplemetricistimeandexperience.By andlarge,governmentsstartwithlowtakebecauseofuncertaintyabouttheir geologicalandpetroleumendowmentandincreaseitovertime.Thelastfewyears suggestthatthelearningcurveisspeedingup.TheKurdistanRegional Government(KRG)ofIraq,forexample,andGhanaarejusttwojurisdictions wherethegovernmenthasincreaseditstakeconsiderablyinnewnegotiations withinthespaceoffiveyears,principallybecausetheyhavebeenproventobe petroleumstates. Sosometimescountriesmayneedtoignorethereductivenessofcomparing themselvesthroughasinglefigurelikegovernmenttake,anddefineapeergroup forthemselvesofothercountrieswhichtheyregardassimilarforavarietyof reasonse.g.theyareneighbours,orhavesimilarkindsof'prospectivity'amounts ofoilinthegroundandareatsimilarstagesofproduction.
Comparing Results
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Remember that crude oil can't itself be used for anything - first it needs to be refined into various products like petrol, diesel and butane.
Thedifferencebetweenhighandlowqualitycrudeoilsisintheamountof processingandrefiningneededtotransformtherawmaterialintousableproducts. Thelessrefiningneeded,thecheaperitistomaketherawcrudeoilintoavaluable product,whichiswhyweconsiderittobeofahigherquality.Thescaleof'sweet' to'sour'referstotheamountofsulphurcontainedintheoil.Sweetcrudeshavea lowsulphurcontent,sourcrudeshaveahighsulphurcontent.Asthesulphurhasto beremovedbeforeanythingusefulcanbemade,sweetoilismuchmorevaluable thansouroil.Therangeof'light'and'heavy'referstothedensityofoil,whichis measuredusingascaledevelopedbytheAmericanPetroleumInstitute,calledAPI gravity.ThehighertheAPInumber,thelowerthedensity,andthe'lighter'wesay thecrudeis.'Light'crudescanberefined,ordistilled,intohighervalueproducts than'heavy'crudes,soitisofhigherquality.Inthejargon,ithasabetterdistillate yield.Halfofabarrelofheavyoilmightendupastar,onlyusefulforpavingroads, withonlyasmallquantityofpetrolorgasolinethatcanbesoldtocarowners. Thereismoredemandforproductswhichcanbemadefromlightgradesofcrude oil,suchasdieselandgasoline.SeeGhana'sexampleofthisbelow.
EXCERPT FROM THE GHANA PETROLEUM AGREEMENT IN RESPECT OF THE DEEPWATER TANO CONTRACT AREA:
11.7 e - "If the quality of various Crude Oils produced from the Contract Area is different, segregated and sold separately, the Market Price shall be determined separately for each type sold and/or exported by Contractor only to the extent that the different quality grades remain segregated through to the point where they are sold, and if the grades of different quality are commingled into a common stream, Contractor and GNPC shall agree to an equitable methodology for assessing relative value for each grade of Crude Oil."
mergedprice.
Thedistancefromawellheadtoastorageterminalisoftenhundreds,sometimes eventhousandsofkilometers.Whatifthecompanysaystheyproducedamillion barrelsofoilinJulyfromthatfield,butthegovernmentsays,waitaminute,only 950,000barrelsturnedupattheport!Atcurrentmarketprices,fivemilliondollars havegonemissing. TheabovementionedGhanacontractthengoesontostatethatalthoughthe governmentcanorderinspectionatanytime,atthecompany'sexpense,the companycanclaimbacktheexpenseifthetestsshowtheoilinstorageattheend ofthelineisthesameaswasstatedinthecompany'srecords"withinacceptable tolerances".Itisnotclearinthecontractitselfwhatlevelof'tolerance'is acceptable.Companiesthatselloilmeters,whichcancosthundredsofthousandsof dollars,nowguaranteeaccuracytowithin0.15%oftotalvolume.Thereasonthere wouldbeanydiscrepancyatallrelatestotheprevioussectionanddifferentgrades ofcrudeoil.Theterms'light'and'heavy'areliteral,notfigurative.Soifyou'blend' severalgradesofcrudeoilwithdifferentphysicalweightsitwillbehardtoachieve absoluteaccuracyevenwithmoderntechnology. Thevulnerabilityofoilasavaluablecommoditycomingoutofoftenpoorand remoteareasleadstoemphasisbeingattachedtoanotherclauseincontractsrelated tovaluingpetroleum:specifyingthehandoverpoint,orpointofvaluation. Sometimesthisisatthefielditself,sometimesattheotherendofthepipelineand sometimesintoastoragetank,dependingwhocontrolsit.
The Money
InmanyProductionSharingContracts,itistheInternationalOilCompanies(IOCs) whoareresponsibleforsellingtheoiloninternationalmarkets.Mostbigoil companiesworkateverystagefromthewellheadtothepetrolstationandcan thereforerefinethecrudethemselvesandthensellitattheirgasstations.Besides that,theyhavegoodaccesstointernationalmarketsforsellingthecrude.National oilcompaniestypicallydon't,althoughsomeMiddleEasternproducerswithlong historiesofoilproductionfeelverycomfortablesellingtheirownoil. TheagreementswhichgovernmostofLibyanproduction,forexample,saythat theIOCshavetoacceptavaluationoftheirshareofoilbasedonwhattheLibyan stateitselfhasbeenabletosellitforoninternationalmarkets.Luckilyforoil companies,theLibyanstatecanusualllysellthecrudeforthesamepricetheIOCs wouldsellitfor.
Indonesia'scontractsenvisageamoreintermediatesituation.Indonesiaisan establishedoilproduceranditsstateownedcompanyPertaminahasasalesand marketingdivision.Ontheotherhand,theagreementfrom1998withUnocal Ganal,saystheshareoftheoilofPertaminawillbevaluedatwhateverthe contractorcouldsellitforonworldmarkets.ButifPertaminaisabletofindabetter priceonthemarketitself,thenUnocalhastoeithermeetthepriceorallow Pertaminatomarkettheoilitself.Itlookslikethecontractorwilldomostofthe selling,butPertaminawillkeepthemontheirtoes. Innewpetroleumproducingcountries,thecompanywilltypicallydomostof theselling.Thereforegovernmentssometimesfinditusefultoincludeaclausein thecontractthatspecifiesthewayofcalculatingthepriceoftheircrudeoil.Thisis knownasaformulapricing.
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EXCERPT FROM AFGHANISTAN'S 2011 CONTRACT WITH THE CHINESE NATIONAL COMPANY CNPC:
11.1 - The Formula Price for the Liquid Hydrocarbons produced and saved from any Field in the Contract Area in any Month shall be determined in accordance with the following formula: P = U + (B-U) * (1 + 0.15139 * AP-B - 0.1434 * S P-B - T D)
Ouch!Don'tworry,it'snotnecessarytounderstandallofthat.Here'swhatthe lettersmean: P=Priceofthecrudeproducedfromthisfield B=PriceofBrent,acrudeoilthatcomesfromtheNorthSea U=PriceofUrals,acrudeoilfromRussia APB=referencestothegradeofAfghancrude,asmeasuredontheAPIIndex theS,TandDarenotreallyimportantforthepurposeofthisexample Sotheformulabasicallysaysthatthepartiesagreetopricethiscrudeoilpartly byitsAPIgradeandpartlyagainstwhateverBrentandUralsoilsellsforonworld markets.ThehigherthequalityoftheAfghancrudecomparedtothequalityof BrentandUrals,thehigheritispriced. BrentandUralsinthiscaseactas'benchmarkcrudes'.Therearethousandsof gradesofcrudeoilaroundtheworldandinmanycasestheygetbenchmarked againstBrent,Urals,orthelikes.Youmayneverseetheactualpriceofeachofthe existingcrudes.Theirpriceisreferredtoassimply"Brentminus$7.15",for example,or"Uralsplus$3.42". ThisAfghanagreementassumesthatthecontractorwillselltheoil.Butit providesanassurancetothegovernmentthatthereisabaselinevaluetotheoilthat thegovernmentcanworkifneeded.Therearedozensofaccountingfirmsor petroleumeconomistswhodounderstandtheformulaabove,andwillbeableto tellthegovernmenttheamountofmoneythecrudeshouldhavebeensoldforat eachpointintime. Usingan"arm'slength"standardisanotherwaythepartiestothecontract sometimesdealwithcalculatingthepriceagainstwhichthecrudeshouldbesold. Transferpricingmayhappenwhen,forexample,asubsidiarycompanybuysorsells crudethatispricedartificiallyhighorlowtoorfromitsparentcompany. Companieswillwanttodothatforaccountingpurposes,sothattheycanmakesure thatthehighestprofitisbookedinthejurisdictionwiththelowesttaxonprofits. Byincludingaclauserequiringarm'slengthpricingofthecrudethegovernment
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Naturalgasisoftenfoundwithoil.Foralongtimetherewasnoperceived commercialvalueforgas,upuntilacoupleofdecadesago.Thereisonekey differencebetweenoilandgas:theirtransportation.Howdoyougetalotof (potentiallyflammable)gasfromoneplacetoanother?It'salotharderthan transportingliquidoil,whichcanbeloadedintotrucksortankers.Gascanbe transportedthroughpipelines,oritcanbeliquefiedandtransportedinsimilarways aspetroleumusingspecialvesselsandtrucks.Unfortunatelytheliquification processisveryexpensive.Thismeansthateventhoughperceptionshavechanged aboutthecommercialvalueofgas,therearestillmanysituationsinwhichitis foundwithoil,or'associated'asthejargonhasit,butitisnotcapturedtosell.In manycases,thegasis'flared'intotheair,orusedtoincreaseordecreasepressurein thewelltogetthecrudeoutbetter.Petroleumclausestypicallyrequirethe contractortoassesshowmuchgasthefieldcontainsandassessifandhowitwill usethegas,forexamplebybuildingapipelineorapowerplant.Sothediscovery ofgascancomplicatethefielddevelopmentplanandmightdelaythestartof production.Contractssometimesalsohavelanguageonflaringanditspotential consequencesfortheenvironmentandsafety.Pricesforgasaredeterminedlocally andnointernationalgaspricesexist.
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Broadening Objectives
EXCERPT FROM THE PREAMBLE OF THE 2012 KURDISTAN REGIONAL GOVERNMENT PSC:
"A. The Government has determined that this Contract will facilitate the development of the petroleum wealth of the Kurdistan Region in a way that achieves the highest benefit to the people of the Kurdistan Region and Iraq and will promote the economic development of the Kurdistan Region and Iraq and the social welfare of the people of the Kurdistan Region and Iraq".
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Thiscanbyseenthroughaplethoraofrecentregionalandglobalinitiatives callingforagreaterroleofthepetroleumindustrytostimulatenationaleconomic development.Forinstance,atagloballeveltheNaturalResourceCharterwithits twelvepreceptsprovidesasetofprinciplesforgovernmentsandsocietiesonhow tobestharnesstheopportunitiescreatedbyextractiveresourcestocontributetothe country'soveralldevelopment.Thesepreceptsareunderlinedbyillustrativecase studiessuchasNorway'spathtoinclusiveandsustainabledevelopmentthrougha comprehensiveresourcedevelopmentstrategyandinstitutionspromoting democracyandeducationforlongtermdevelopmentandcompetitiveness. Anexampleofsuchaninitiativeattheregionallevelintheminingsectoristhe AfricaMiningVision.Thisprovidesacontinentwidestrategyaimedatadvancing thecontributionofminingtoeconomicdevelopment.Theydothisbycreating refiningcapacitywhereeconomicallyviable,strategicallylinkinginfrastructure createdintheoilandgassectortoothersectorsoftheeconomy,buildingthe capacityofthelocalworkforceandlocalcompaniestoparticipateinthepetroleum sector,andbyspendingtherevenuesonstrategicsectorsthatspurlongtermgrowth andcompetitiveness.Thisrequiresalotofgovernmentcapacityintermsof strategicplanning,activeinvolvementinimplementationoftheplans,andthe monitoringprogress. Anothertendencymayreflectedinthecontracts,oratleastinthenegotiation rounds,isthedesireofproducinggovernmentsnolongerjustwanttoexporttheir petroleumbuttoretainanincreasingpartofittohelpsatisfytheirnationalenergy demand,andtoaddeconomicvaluebyrefiningthecrudeinthehostcountryif economicallyviable.MostcontractshaveaprovisionstatingthattheGovernment canrequiretheoilcompaniestosupplyaproportionoftheirpetroleumtotheState incertaincircumstances,orrequirenationalenergydemandtobefulfilledfirst beforeexportingcrudeispermitted.Manynewpetroleumproducingcountriesare discussingwhetherornotitiseconomicallyviabletorefinethecrudebefore exportingit. Countriesareincreasinglylinkinguporworkingtogetherwiththeirneighbours. Inthefutureoilcontractsmightbeusedtostimulateandtakeadvantageofregional tradingblockswhichwillcreatelargermarkets,especiallyamongstcountrieswith smallereconomiesandlabourforces.Thiswouldexpandthepotentialmarketfor localcontentfromonecountrytoseveralmore,whichcouldstimulateindividual countriestospecializeinthosegoodsandservicestheyproduceordevelopmost productively.Itcouldalsocreateregionalinfrastructurelinkages,oritmightbean argumenttodeveloprefiningcapacityinonecountryifthecrudesuppliedbyits neighbouringcountriescanberefinedthereaswell.Implementationofsuchplans willrequireproperregionalplanningandthecooperationofgovernments. Oilforinfrastructuredealsarearecentphenomenontospureconomic developmentandwillbediscussedinalaterchapter.Thesameholdstrueforlocal
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Insum,theoilforinfrastructuredisplaysthefollowingcharacteristics: Itisavisibledemonstrationofthetransformationofassetsinthegroundto investmentsabovethegroundandonethatcanyieldbenefitsforfuture generationswhowillbeabletousetheinfrastructurebuilt.However,the governmentmustensurethatthequalityofworksisuptostandardssothatthe infrastructurewilllastforawhile Thespeedwithwhichtheinfrastructureisproducedreducesthecosttothehome countrycomparedtothecostsnormallyassociatedwithdevelopingalarge infruastructureproject.Usuallyfundsneedtobemobilizedandpartofthe contractmightgotowasteduetocorruptpractices.However,thetermsofthe agreementmustincludestandardsanddeadlinesaswellassanctionsincasethe workisofpoorqualityornotdeliveredontime. Thehostcountrymustcalculatecarefullythelikelyprojectionsandlongterm trendsforthepetroleumreserveagainstwhichtheinfrastructureworkis 'mortgaged'andobtainasmuchdetailaspossibleonitssize,accessibility,and
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Stateparticipationdoes,insomesense,changethenatureoftherelationship betweenthestateanditscontractorpartnersfrom'statecontractor'to'contractor contractor'.Stateparticipationcreatesanopportunityforthestateoilcompanyto operateonamoreequalfootingwiththeinternationaloilcompanies.Inoil countriesthathavenothadoilforverylongandwithmorerecentlyestablished NOC's,itislikelythatthestate'sparticipationunderthepetroleumcontractwillbe ofaminorityshare,andthattheNOCwillnotbetheoperator.However,theNOC shouldbeapartytoanyjointoperatingagreementwhichwillsetouthow petroleumoperationsshouldbeconductedbetweenthecontractorparties. Suchcontractshavetheirowngovernancearrangementsandarediscussedinthe section:TheActorsandtheScript.AsaparticipantinthesearrangementstheNOC mayhavegreatervisibilityofandanopportunitytoscrutinisedecisionsrelatingto theconductofpetroleumoperations.Itcanprovideinformationonthepetroleum operationsthatwouldnototherwisebeavailable.Totheextentthatthestate's interestisnot"carried"butitispayingitsshareofcosts,thestatehas"skininthe game"whichmayalteritsperspectiveandprovideincentivestofindandproduce oil.Sosomeoftheincentivesofthegovernmentandoilcompaniesarebetter alignedifthestateoilcompanyparticipates.Otherfactors,suchascuttingcostson environmentalprotectionbytheoilcompanies,mightnotbeintheinterestofthe state.
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state. StateparticipationinanoilandgasdevelopmentviaaNOCmayalsoprovide theNOCwithopportunitiestoinvolveitspersonnelintheconductofpetroleum operationsthroughsecondmentstotheoperatorand/orthroughparticipationin trainingprogrammesthattheoperatorhasinplaceforitsownemployees.Thisis oftenspecifiedinthecontractunderprovisionsaboutlocalcontentand/ortraining. Thisisaimedatprovidesomeformofknowledgetransferandcapacitybuilding. MoreambitiousarrangementsmayinvolvepersonnelfromaNOCworking alongsidetheirinternationaloilcompanycounterpartsand"learningbydoing". Ultimately,theNOCmayacquiretheabilitytooperatebothwithinitsown jurisdictionandabroad. ThecreationanddevelopmentofaNOCasthevehicleforstateparticpationalso providesemploymentopportunitieswithintheNOCandtheabilitytodrivegreater "localcontent"intermsofdirectingpurchaseoflocalgoodsandservices.Seethe chapter'Procurement,EmployementandSocialWelfare'forfurtherinformation.
Possible Disadvantages
Onepotentialdisadvantageofstateparticipationisthattheinvestmentrequiredby thestatetoparticipateinthepetroleumprojectismoneythatcouldhavebeenspent onotherthings.Fromanationaleconomicdevelopmentperspective,the investmentinstateparticipationandanNOCneedstobeweighedagainstthe advantagesofputtingthatinvestmentelsewhereintheeconomy. ThesecondpotentialdisadvantageisthatstateparticipationthroughanNOC maycomplicatetherelationshipofthestateanditscontractors.Inanumberof countries,theNOCmaybeplayingtheroleofacommercialenterprisetobe regulatedbythestateand,atthesametime,bethebodythatisentrustedwith regulatingthepetroleumsector.Thereisacleardangerofaconflictofinterestin thisscenario.Evenwheretheregulatoryfunctioniscarriedoutbythegovernment andtheMinistryofPetroleumandnotbytheNOC,themereexistenceofaNOC alongsidetheregulatorcancreatethepossibilityfor"turfwars".
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Withthistypeofgenerallanguagethechallengearisesonhowtomonitorif companyhascompliedwiththeobligation.Somecontractsthereforespecifya percentageofrequiredlocalpersonnelthecompanywillneedtoemploy.Thisis sometimesbrokendownperjobcategory,andsometimesthepercentageincreases overtime.Thiscanbeproblematicgiventhatthepercentagesmighthavebeen chosenarbitrarily.Itisoftendifficulttohaveagoodsenseofwhatpercentageis realisticandachievable.Anotherissueisthatcontractsveryoftendonotspecify thebasewhichwillbeusedtocalculatethepercentage.Aretalkingabouta percentageofparttimeorfulltimeemployees,fulltimeequivalents,orwoulda generalheadcountsuffice?
An interesting example of the way in which the government has thought about local content targets is Brazil. Up until the 1990s the state-owned company Petrobras had a monopoly over the petroleum sector in Brazil. It was subsequently privatised and from then onwards it competed with international petroleum companies for petroleum blocks in Brazil. But with international petroleum companies the number of foreign employees increased, and the government of Brazil realized that Petrobras had always hired local employees and contracted local goods and service providers. So the government decided that international petroleum companies should contract and employ the same percentage of local content as Petrobras had done in the past. This system worked well up until the point that the demand for Brazilian employees and goods and services became higher than the supply. The international petroleum companies could not comply with both their work obligations as well as their local content requirements. As a response, the Brazilian regulator temporarily relaxed the requirements.
EXCERPT FROM THE GHANA PETROLEUM AGREEMENT IN RESPECT OF THE DEEPWATER TANO CONTRACT AREA:
21 - "... Contractor shall submit to GNPC [the NOC] an employment plan with number of persons and the required professions and technical capabilities prior to the performance of Petroleum Operations."
Training Of Nationals
Manycontractsalsoaddresstherequirementforthecompanytotrainnationalsin oneormorewaysoutlinedbelow: trainnationalsinordertoemploythemdirectlyinthefuture trainexistingemployeestotakeonjobsthatrequirehigherqualificationsand moreskills trainemployeesofthenationalpetroleumcompany Sometimesafundissetupintowhichthecompanydisbursesanagreedamount ofmoneythatisusedfortrainingpurposes.Manytimesitthenremainsunclear fromthecontractwhoisresponsibleforconductingthetrainingandmanagingthe fund.Sometimesthecompanyisrequiredtotransferfundstothenationalpetroleum companyfortrainingpurposes,implyingthatthenationalpetroleumcompanyis responsibleforconductingthetraining.Insomecasesinwhichthecompanyis responsibleforconductingtraining,itisrequiredtosubmitatrainingprogramfor approval.Someexamplesaregivenbelow:
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EXCERPT FROM INDONESIA'S PRODUCTION SHARING CONTRACT FOR THE GANAL BLOCK:
12 - " (...) after commercial production commences the Contractor will undertake the schooling, and training, of Indonesian personnel for labor and staff positions including administrative and executive management positions. The Contractor shall also pay for costs and expenses for a program to train Pertamina's [the NOC] personnel. Such costs and expenses shall be included in Operating Costs."
EXCERPT FROM AFGHANISTAN'S PRODUCTION SHARING CONTRACT FOR THE AMU DARYA BASIN:
20.2 - "The contractor shall be required to establish a programme ... to train personnel of the Ministry to undertake skilled and technical jobs in Hydrocarbons Operations. Such programme shall include provisions for involving representatives of the Ministry in the preparation of the Work Programmes and Work Programme Budgets." The contract continues saying that - in order to pay for the training - the contractor has to spend fifty thousand US$ in the first year, and this amount will be increased by 5000 US$ annually in the years thereafter. Training costs shall be recoverable. A brief training program with log frame for implementation is included in the appendix of the contract.
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EXCERPT FROM GHANA'S PETROLEUM AGREEMENT REGARDING THE DEEPWATER TANO CONTRACT AREA
20.1 - "In the acquisition of plant, equipment, services and supplies ... Contractor shall give preference to materials, services and products produced in Ghana ... if [they] ... meet standards generally acceptable to international oil and gas companies and supplied at prices, grades, quantities, delivery dates and other commercial terms equivalent to or more favourable than those at which [they] ... can be supplied from outside Ghana."
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EXCERPT FROM AFGHANISTAN'S PRODUCTION SHARING CONTRACT FOR THE AMU DARYA BASIN
21.2 - "Locally produced or available equipment, materials and supplies shall be deemed equal in price to imported items if the local cost of such locally produced or available items at the Contractor's operating base in Afghanistan is not more than fifteen percent (15%) higher than the cost of such imported items before Customs duties but after transportation and insurance costs have been added."
EXCERPT FROM GHANA'S PETROLEUM AGREEMENT FOR THE DEEPWATER TANO CONTRACT AREA
20.2 - "... price comparisons shall be made on a c.i.f [Cost, Insurance and Freight] Accra delivered basis."
Butmostcontractsdonotincludethesepricespecifications,nordotheyspecify whateffortsthecompanyshouldmaketofindsuitablelocalgoodsandservice providers.Thegovernmentorthenationalpetroleumcompanycouldplayan importantrolehere.Forinstance,somegovernmentsprovidethecompanywitha listofqualifiedlocalgoodsandserviceprovidersandtheIOCisonlyallowedto contractcompaniesincludedonthelist. Onthisnote,inBrazil,thecontractdoesincludetheobligationofthecontractor to"keepitselfupdatedaboutBrazilianSupplierscapableofmeetingsupplyneeds, throughtradeassociations,tradeunionsorotherinformedsources"whileatthe sametime,thepetroleumsectorregulatorregisters'certifiers',i.e.companiesthat providecertificatestolocalgoodsandserviceprovidersinorderforthemtobeable toparticipateinthesupplychainfortheindustry.Petroleumcompaniesareonly allowedtoprocurefromcertifiedsuppliers.Further,somecontractsspecifyatarget intheformofapercentageforprocuringlocalgoodsandservices.Forexample,in Libyatheoperatorisrequiredtospend50%oftheapprovedbudgetonlocalgoods andservices. Anotherissueariseswiththedefinitionof'local'or'national'goodsandservice providers.Whenisacompanyconsideredtobeanationalcompany?Isitwhenits shareholdersarefromthehostcountry?Isitwhenithasanoffice,orits headquartersinthehostcountry?Isitwhenthemembersofitsboardofdirectors wereborninthehostcountry,orshouldthemajorityoftheworkforcebefromthe hostcountry?Isitwhenthegoodsandservicesareactuallyproducedinthehost
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hostcountry?Isitwhenthegoodsandservicesareactuallyproducedinthehost country?Contractsusuallydonotdefinewhat'local'or'national'means,which mightcreatedifferencesininterpretationofthetermtothepartiestothecontract. InKazakhstantheterm'national'isclearlyspecified.Acompanywithmorethan 50%foreignshareholdingisconsideredasforeignandthereforeexcludedfrom participationinpublicprocurementtenders,unlessitfulfilsallofthefollowing criteriamakingita'nationalproducer': thecompanyisresidentofKazakhstan thecompanyproducesfinishedproductsinKazakhstan nolessthan85%ofitsemployeesareofKazakhstannationality InLibyathecontractspecifiesthatthecontractorisobligedtoprocuregoods andservices'available'locally,whichloosensthedefinitionsubstantivelyasit doesnotrequirethegoodstobeproducedinLibya,nordoesitrequireLibyan ownershipofthecompanythatproducesthegoodsandservices.InBrazil,onlythe 'valueadded'tothegoodorserviceinBrazilcountsasacontributiontonational content. Somecontractsrequirelocalcontentorlocalprocurementplanstobedeveloped bythecompany,approvedbythegovernment,andinsomecasesincludedinthe company'sannualworkplan.Thiswaythegovernmentcanbettermonitorand overseewhateffortsthecompanyismakingtocomplywiththelocalcontract provisions.AnexampleisAfghanistan:
EXCERPT FROM AFGHANISTAN'S PRODUCTION SHARING CONTRACT ON THE AMU DARYA BASIN
21.1 - "The Contractor shall, upon request of the Ministry, develop local preference targets and specific plans to meet such requests. Such plans shall be provided as part of the Contractor's Work Program to be approved by the Ministry ..."
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ThisBrazilclausehasnotalwaysbeeneffectiveinservingitspurpose.For example,aninternationalpetroleumcompanydeliberatelyincludinghigherlocal contentratesinitsbiddingdocumentsthanitcouldrealisticallyachieve,resulted inthecompanywinningthebidbutfailingtoachieveitslocalcontent requirement.Thecompanywaspreparedtopaytheresultingfine,whichcompared toitsprofitsfromthefieldwasarelativelysmallamounttopay. Includingprovisionsrequiringtheprocurementoflocalgoodsandservice companiesdoesnotmeanthatthisautomaticallyleadstoacontributionto economicdevelopmentorthecompetitivenessofthecountry.InNigeriathelocal contentrequirementsofpartneringwithaNigeriancompanyhaveleadto corruptionandthecreationofshellcompanies.Effectivelocalcontent implementationrequireslotsofplanning,implementationandmonitoringeffortsof thegovernment.
Social Welfare
Asmentionedbefore,socialwelfareisnotincludedintheterm'localcontent'.In fact,veryfewcontractsincludeclausesonsocialwelfare.Socialwelfareclauses refertoeffortscompaniestakeinordertoprovidebenefitstocommunitiesaffected bytheirpetroleumoperations.Therelationshipbetweencompaniesandthesociety inwhichtheyoperateisacriticalfactorintheirabilitytocontinuetooperate effectively.Thisissometimescalledthecompany's'sociallicensetooperate'. Mostcompaniesaddresssocialwelfareissuesintheirvoluntarycorporatesocial responsibility(CSR)programs.Socialwelfareissuesareincreasinglycoveredunder nationalandinternationallaw.Therearealsonumerousgoodpracticeand standardsintheareaofcorporatesocialresponsibility,suchastheInternational OrganizationforStandardization's(ISO)guidelines26000onsocialresponsibility andtheSocialResponsibilityWorkingGroupoftheGlobalOilandGasIndustry AssociationforEnvironmentalandSocialIssues(IPIECA).Theseprovidegood practiceonhumanrights,socialimpactassessmentsandcommunityoutreach.The IFCPerformanceStandardsincludestandardsonengagingwithindigenous peoples,socialimpacts,andculturalheritage,forexample. Sometimessocialwelfareistakenupinthecontract.Forinstance,theProduction SharingAgreementofLiberiaatClause29.3includeslanguageonsocialwelfare programmesalthoughitdoesnotdefinewhat'socialwelfare'meansexactly.The
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Economic Development?
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context
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operationsbyassessingwhatimpactssuchoperationsmayhaveandestablishinga baselineagainstwhichactualimpactscanbemeasured(suchasrequirementsfor environmental(andsocial)impactassessments,baselinestudiesandrequirements toobtainnecessaryenvironmentalapprovalsandpermits).Thereshouldthenbea provisiondesignedtoensurethat,whereharmarises,oilcompaniestake responsibilityforsuchharmandareabletomeetthecostsofmitigatingsuchharm, includingrequirementsforinsuranceandallocationofliability.Inmostcontracts thereisalsoaprovisiondesignedtoensurethat,attheendofpetroleumoperations, theenvironmentis,sofaraspossible,returnedtothestateitwasinbefore petroleumoperationsstarted,whichisreferredtoas"decommissioning"or abandonment". Howpetroleumcontractsaddressthesefourareasisdealtwithinmoredetailin thefollowingfourchaptersofthissection.Inrelationtotherequirementtocomply withapplicablelaws,whetherornotthisexpresslyreferstolawsrelatingtothe environment,itwillrequirethattheoilcompanyconductspetroleumoperationsin accordancewithenvironmentallawsandregulationstotheextentthattheyare relevanttosuchoperations.Thequestionastowhetherthiswillensureadequate protectionfortheenvironmentwillthendependsolelyonwhetherthecountryin whichtheoilcompanyisoperatinghasinplacesuitableenvironmentallawsand regulationsandthecapacitytomonitorandenforcecompliancewiththem. Whilsttheobligationtocomplywithlawsisrelativelystraightforward,the requirementtocomplywith"industrystandards"ismorechallenging,sincewhat constitutesindustrystandardsisaquestionthatdoesnothaveasimpleorsingle answer.Sometimesthecontractmaytrytodefinetheobligationtocomplywith industrystandardsatlength.TwoexamplesofthisaretheIraqimodelform TechnicalServiceContractandthe2012ModelPSCoftheGovernmentofthe KurdistanRegionofIraq.TheIraqimodelformTSCrequirestheoilcompanyto:
EXCERPT FROM IRAQI MODEL FORM TSC: 41.1(a) - "adopt Best International Petroleum Practices in conducting and
monitoring is Petroleum Operations......"
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TheKurdistanPSCprovidesatClause37.1thattheoilcompanymustcomply with"BestPractices"thataredefinedas:
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OPERATIONAL ETIQUETTE
Petroleumcontractsarefullofrequirementsfortheoilcompanytoconductits operationsinaccordancewith'petroleumindustrygoodpractice'or'accepted standards'aslaidoutintheearliersection.Butwhatarethesegoodpracticeand standards?Goodquestion.Contractshardlyeverspecifythepracticeorstandard thecompanyneedstoadhereto,sohowdoyouknowwhichonetoapply?Well, youdon'tinfact.Isn'tthathelpful?Itsabitlikenotknowingtheetiquetteor behaviourrequiredinaparticularsocialsituationwhatonepersonmayconsider appropriatemayoutrageanother. Thequestionorassumptionofthepartiesastowhichstandardsandpractice(or etiquette)applyisveryoftenapointofdisputewellafterthecontracthasbeen signed,exactlybecausethecontractdoesnotspecifytheapplicablepractice.The differenceinacceptedpracticebetweenthepartieshasproventobeproblematic particularlywherenewindustryplayersornontraditionalcompaniesareinvolved. Eventhoughhardlyanycontractscurrentlydoit,itwouldbeadvisabletospellout theapplicablepracticeorstandards. Asnotedinthesectionabove,mostcontractsstatethatthecompanyhasto adheretonationallegislation(sometimesthespecificlawsaredefinedandother timestheyarenot)aswellasapplypetroleumindustrygoodoracceptedpractice. Somecontractsthencontinuestatingthatthemoststringentrequirementsshouldbe applied,withoutstatingwhichstandardorpracticeisthemoststringent.Inthe eventthatthereisnosectionofthecontractspecificallyaddressingthe environment,genericobligationstocomplywith"applicablelaws"and"industry standards"maynonethelessbefoundinasectionthatlistsoutgenerallythe obligationsoftheoilcompany. Thissectionprovidesanoverviewofassociationsandgroupsthatrecommend practiceandprovidestandardsonsocial,environmental,andhealth&safetyissues. Thismightprovideguidancefortheinclusionofreferencetospecificpracticeor standardsincontracts. Thereareanumberofindustryassociationsthathavedevelopedbestpractice guidanceaddressinghealth,safety,socialandenvironmentalissues.Petroleum companiescanvoluntarilyjointheseassociationsandmostofthemajorpetroleum companiesaremembersoftheseassociations.Someoftheseassociationsare:the InternationalPetroleumIndustryEnvironmentalConservationAssociation (IPIECA),theAmericanPetroleumInstitute(API),andtheInternationalOiland GasProducersAssociation(OGP).Theassociationscoverissuessuchas Biodiversity,ClimateChange,MarineEnvironment,Decommissioning,Human Rights,SocialResponsibility,andWater.
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Besidestheseglobalpetroleumassociationsthereareseveralregionaland nationalpetroleumassociationsofwhichpetroleumcompaniescanbeamember, suchasARPEL(RegionalAssociationofOil,GasandBiofuelsSectorCompanies inLatinAmericaandtheCaribbeean)andAPPEA(AustralianPetroleum ProductionandExplorationAssociation).Thesecoversimilargroundinpublishing goodpracticeguidanceonsocialandenvironmentalsustainabilityissues. Companiesoftenrefertothefactthattheyarefollowingtheguidanceandstandards providedbyoneormoreoftheseassociationsontheirwebsite,oftencoveredunder theHealth,SafetyandEnvironmentorCorporateSocialResponsibilitytab. Inaddition,totheseprivatesecorassociationstherearealsoregionalinter governmentalgroupingssuchastheAfricanPetroleumProducersAssociation (APPA).Theyserveasaplatformforpetroleumproducingcountriestocooperate, collaborate,shareknowledgeandcompetences,includingonenvironmentaland socialmatters.Noneoftheguidanceprovidedbytheseassociationsismandatory forgovernmentstofollow. TheInternationalOrganisationforStandardization(ISO)hasdeveloped industrywidestandardsonenvironmentalmanagement(ISO14000)forcontrolling environmentalimpactandimprovingenvironmentalperformance.ISO31000 providesstandardsonriskmanagement.CompaniescangetcertifiedformanyISO standards,includingISO1400and31000.ISOstandard26000providesguidance onsocialresponsibility,althoughitdoesnotprovidetheoptionforcertification. ISOhasaTechnicalCommittee(TC67)specificallydedicatedtosettingstandards forthepetroleumindustryregardingmaterials,equipmentandstructures used.TC67hasdevelopedabout150standardswhichareincreasinglybeingtaken upbytheabovementionedassociations.Again,thesestandardsarevoluntaryand itisuptoacompanytoadoptthesestandardsand/orgetcertificied. TheGlobalReportingInitiativeprovidesaframeworkcompaniescanuseto reportoneconomic,environmental,socialandgovernanceperformance.The reportingframeworkiscomplementedbysectorguidelinesonoil&gaswhich covers: Localcontent Volumeandcharacteristicsofestimatedprovedreservesandproduction Renewableenergy Assessmentandmonitoringofrisksforecosystemservices Policies,programsandprocessestoinvolveindigenouscommunities Existenceofemergencypreparednessprograms Decommissioningofsites TheUnitedNationsGlobalCompacthavedevelopedtenuniversallyaccepted principlesfromsomeofthekeyUNConventionsintheareasofhumanrights,
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Operational Etiquette
principlesfromsomeofthekeyUNConventionsintheareasofhumanrights, labour,environmentandanticorruption.CompaniescansignontotheUNGlobal Compactandwillthanneedtoreportannuallyontheprogressmadein implementingtheseprinciples.Again,thisisavoluntaryinitiative.Eventhoughto datesome8700businessescoveringmorethan130countriesapplytheUNGlobal Compactprinciples,thereislittleparticipationfrompetroleumcompaniesinthis initiative. TheUnitedNationshasalsodevelopedtheUnitedNationsVoluntaryPrinciples onSecurityandHumanRights(UNVPs),whichareincreasinglyreferredtoin naturalresourcecontractsunderclausesthatdiscusstheprovisionofsecurityforthe projectarea.Companiesoftenmakeuseofprivateorpublicsecurityforcesto protecttheiroperations.Insomecountries,especiallyconflictaffectedones,theuse ofsecurityforceshasledtoallegedhumanrightsabuses.TheUNVPsguide companiesinmaintainingthesafetyandsecurityoftheiroperationswhilealso ensuringtherespectforhumanrights.TheUNVPsrequireariskassessment coveringtheidentificationofsecurityrisks,thepotentialforviolenceinthearea, thehumanrightsrecordofthestateanditssecurityforces,andananalysisofpastor currentconflictinthearea.Guidanceisalsoprovidedonthewayinwhich companiescanpromotehumanrightscomplianceofpublicandprivatesecurity forces. Companieswantingtoaccessfundingfromfinancialinstitutionswill increasinglyneedtodeliveronenvironmentalandsocialsustainabilitystandards. Forinstance,theInternationalFinanceCorporation(IFC)whichispartoftheWorld BankGrouphasdevelopedeightPerformanceStandardsinthefieldofenvironment andsustainbility,whichcompaniesreceivingfundingfromtheIFCneedtocomply with.TheIFCstandardsincluderequirementsondevelopingsocialand environmentalbaselineandimpactassessmentsaswellasmanagementplans, protectingindigenouspeoplesandculturalheritage,providingasafeworking environment,landacquisitionandresettlement,preventpollutionanduseenergy efficiently,andprotectthehealth,safetyandsecurityofcommunities.These standardsareincreasinglyalsotakenupbyRegionalDevelopmentBanks,suchas theInterAmericanDevelopmentBank(IADB),AfricanDevelopmentBank (AfDB).TheIFCPerformanceStandardsareincorporatedintheEquatorPrinciples aswell,whichareappliedby75privatelyownedfinancialinstitutionsworldwide. Acompanywishingtoaccessfundingfromthesebankswillneedtodemonstrate compliancewiththesestandards. Thereareseparatestandardsforhealthandsafetyissues.TheOilIndustry InternationalExplorationandProductionForum,IPIECA,theInternational AssociationofDrillingContractors,andtheInternationalAssocationof GeophysicalContractorsareseveralexamplesofassociationsandgroupsthathave developedstandardsforhealthandsafety.
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EXCERPT FROM DEVELOPMENT AND PRODUCTION SHARING AGREEMENT OF THE GUNASHLI FIELD IN AZERBIJAN:
shalltakeintoaccountthefollowinginternationalsafetyandindustrial hygienestandardsinconductingitsPetroleumOperations:(A)OilIndustry InternationalExplorationandProductionForum(E&PForum)Reports Safety(B)InternationalAssociationofDrillingContractors(IADC) DrillingsafetyManual(C)InternationalAssociationofGeophysical Contractors(IAGC)OperationsSafteyManual(D)ThresholdLimited ValuesforChemicalSubstancesintheWorkEnvrionmentAmerican ConferenceofGovernmentalIndustrialHygienists.
Thecontractfurtherstatesthatthemostappropriatestandardrelativetothe CaspianSeaecosystemshouldbeapplied.
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Baseline Assessment
ABaselineAssessmentdescribesandevaluatestheenvironmentalandsometimes socioeconomicconditionswithintheprojectaffectedareaatthestartofthe project.Thisdatawillbeusedasabaselineinordertodetermineactualand potentialimpactsofthepetroleumoperationsintheenvironmentandsocial circumstances.Itcollectsandanalysesdataonwaterquality,floraandfauna, atmosphericcompositions,compositionandlivelihoodsofsurrounding communities,etc. TherequirementtoconductaBaselineAssessmentissometimesmentioned separatelyineitherthecontractortheenvironmentallegislation,andothertimesit islistedaspartoftherequiredenvironmentalimpactassessment(suchasunder internationalstandards).Sometimesabaselineassessmentisnotrequiredatall. Ideally,baselineassessmentsshouldbeconductedbeforeanyfieldworkhas started.Sometimes,however,thecontractonlyrequiresabaselinetoconducted togetherwiththeimpactassessmentatthepointwhereacommercialdiscoveryis madeandthecompanyisalreadypreparingforfielddevelopmentandproduction. Someexamplesareshownbelow.
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EXCERPT FROM THE AMU DARYA BASIN EXPLORATION AND PRODUCTION SHARING CONTRACT OF AFGHANISTAN:
23 - "Prior to the commencement of Hydrocarbons Operations in a Designated Field [...] the contractor shall undertake and complete a Baseline Environmental Assessment of the Designated Field [...] consistent with International Best Practices and applicable laws [...] ."
EXCERPT FROM THE AGREEMENT FOR THE AZERI AND CHIRAG FIELDS IN AZERBAIJAN:
"In order to determine the state of the environment in the Contract area the Contractor shall cause an environmental baseline study to be carried out".
ThecontentofthebaselinestudyisthendescribedintheAppendixofthe contract.
BasedontheBaselineAssessment,thecompanyisthenrequiredtopredictpossible risksandimpactstheprojectmighthaveontheenvironmentalandsocialsituation. Theimpactassessmentwillincludeadescriptionoftheprojectapplicable legislationandinternationalstandardsbaselinedataimpactandriskidentification andanalysisconsideredalternativestothesourceoftheimpacts(suchasplant design)andmitigationmeasuresormanagementactionstooffsetorminimizeeach oftherisksandimpactsidentified. Thecontentoftheenvironmentalimpactassessmentisusuallydefinedinthe environmentallegislation.Ifitisn't,ornoenvironmentallegislationexists,the contractshouldincludeinformationonthecontentofanenvironmentalimpact assessment.Forexample,theAgreementfortheAzeriandChiragfieldsin Azerbaijanliststherequiredcontentofthebaselineandimpactassessmentsat Appendix9.Alternatively,acontractcanrefertointernationalstandardssuchas thosesetbytheGlobalOilandGasIndustryAssociationforEnvironmentaland SocialIssues(IPIECA)andthePerformanceStandardsoftheInternationalFinance Corporation(IFC),whichincluderequirementsforthecontentofsocialand environmentalimpactassessments.Theimpactassessmentshouldbecompletedas earlyintheprojectcycleaspossible,butinanycasebeforethedevelopmentphase starts. Becauseoftheirhighrisknature,impactassessmentsforpetroleumprojects
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Becauseoftheirhighrisknature,impactassessmentsforpetroleumprojects shouldconsiderallrelevantsocialandenvironmentalrisksandimpacts.This includesimpactsonthefollowing: Livelihoodsandincomesofaffectedcommunitieswithintheprojectarea Flora,fauna,andbiodiversity,bothonshoreandoffshore(ifapplicable) Lossofaccesstolandandseabycommunities Communityhealthandsafety Securityissues Labor Effects on hunting/fishing yields Disturbances caused by high noise levels Biodiversity Air/water quality Conflict and Human Rights Land Acquisition Resettlement and compensation Cultural Heritage
EXCERPT FROM THE AMU DARYA BASIN EXPLORATION AND PRODUCTION SHARING CONTRACT OF AFGHANISTAN
23 - "In the course of the Hydrocarbons Operations, the Contractor shall consider, investigate, assess and manage the impact of the Hydrocarbons Operations on the environment and the socio-economic conditions of any Person who might directly be affected thereby."
Anotherimportantandrelatedaspecthereistheoneonland.Proceduresfor acquiringlandtoconductoperationsareusuallycoveredinseparatelawsorinthe petroleumprojectunderclausestitled"OccupationofLand"or"LandAcquisition", orsimilartitles.Thegovernmentisresponsibleforhandingovergovernment ownedlandtothecompany,andthecompanyisusuallyresponsiblefor resettlementprocessesorcompensationrequiredforprivatelyownedland,although somecontractsstateinvolvementofthegovernmentinclearingprivatelyowned landaswell.Thecostsacompanymightincurinthecompensationand resettlementprocessaresometimesmaderecoverable.Inmanydeveloping countrieslandownershipisasensitiveissueandlandtitlesarenotwell documented.Thisoftenleadstoproblemsanddelaysinthelandacquisition process,andcancauseseveregrievancesatthecommunitylevelifnotwell
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Management Plan
Companieshavemanagementsystemsandstandardsforenvironmental(andsocial) performance.Environmental(andsocial)managementplansarebasedontherisks andpotentialimpactsidentifiedintheimpactassessment,andinclude:a descriptionofthesignificanceandcharacterofimpactsproposedactionsthe companywilltaketopreventorreducenegativeimpactadescriptionofthe expectedeffectsoftheproposedactionsandhowthesuccessoftheproposedaction willbemeasuredwhointhecompanyisresponsibleforexecutingtheproposed actionswhentheproposedactionswilltakeplace.TheInternationalOrganization forStandardization(ISO)hasastandardwithrequirementsforenvironmental managementplans,forwhichcompaniescangetcertified. TheGhanaDeepwaterTanocontractdoesnotincludemuchdetailon assessmentsandmanagementplansbecausetheseissues,includingsocialaspects, arecoveredintheEnvironmentalAct.Itdoesmakeareferencetomanagement plansatArticle17.3:
"Contractor shall provide an effective and safe system for disposal of water and waste oil, oil base mud and cuttings in accordance with accepted Petroleum industry practice (...)."
willalsohaveadirectinvolvementinthestudy:
EXCERPT FROM THE AGREEMENT FOR THE AZERI AND CHIRAG FIELDS IN AZERBAIJAN
26.4 - "... an environmental baseline study (...) to be carried out by a recognized international environmental consulting firm selected by Contractor, and acceptable to SOCAR. SOCAR shall nominate representatives to participate in preparation of the study in collaboration with such firm and Contractor representatives."
Who Approves?
Often,whenthereisanenvironmentallaw,aseparategovernmentaldepartmentor agencyiscreated(inmanycountriesthisistheenvironmentalprotectionagency). Thisgovernmententityisresponsibleforreviewingthebaseline,impact assessment,andmanagementplan.Ifthegovernmententityapprovesofthe company'sassessmentsandproposedmitigationmeasuresitissuesan environmentalpermit,whichallowsthecompanytostartfieldworkoroperations. Ifthereisn'tanenvironmentallawandspecificgovernmententityresponsiblefor environmentalissues,oftentheNationalPetroleumCompanyorthepetroleum ministryisresponsibleforapproving(insteadofissuingapermit)the environmentalassessmentandmanagementplansproposedbythecompany.Inthe ProductionSharingContractofAzerbaijan,thecontractor,togetherwiththe NationalPetroleumCompanypreparesanenvironmentalbaselineandimpact assessment.Asubcommitteeresponsibleforhandlingenvironmentalissuesunder theJointManagementCommitteethendesignsanannualmonitoringprogramand reviewsitsresults. Internationalgoodpracticeandlegislationinsomecountriesdonotonlyaddress therequiredcontentofimpactassessments,theyalsorequireacertainlevelof communityconsultationstobepartoftheprocessbywhichimpactsare determined.Thisisoftentheonlychancetheaffectedcommunitieshavetoprovide inputintotheprocessandproject.Therequirementsregardingthedepthand usefulnessofthesecommunityconsultationsareoftendebated.Itoftenremains unclearifcommunitieshavehadarealvoiceintheprocess,whethertheyare adequatelyrepresented,andiftheirconcernsareincorporatedthecompany's assessmentandmanagementplans.SomeInternationalgoodpracticesinclude'Free, Prior,andInformedConsent'(FPIC)asaprerequisiteforthestartofpetroleum operations,meaningthataffectedcommunitieshavetohavehadsufficienttimein advancetoconsidertheimpactstheoperationmighthaveonthem,andthatthey
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Monitoring
Monitoringtheimplementationofthemanagementplanaswellasassessingthe qualityofthebaselineandimpactassessmentsdependsonthecapacityofthe responsiblegovernmententityaswellasitspowertoraiseobjectionsand, therefore,potentiallydelaytheprocess.Manycountriesconsidertheenvironmental andsocialimpactsofminorimportanceandseethebaselineassessment,impact assessmentandmanagementplansmerelyasaboxtickingexercisesthatcangetin thewayofdevelopingtheresource,andgeneratingrevenues,asquicklyas possible.Inmanycountries,theenvironmentalprotectionagencyhaveissued environmentalpermitsandresponsiblegovernmententitieshaveapproved documentswithoutanyobjectionsorrequestforreviewofthesubmittedimpact assessmentsandmanagementplans.Theannualreportsaboutenvironmentalissues andmanagementsubmittedbythecompanyareoftennotreadorcommentedon.
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in
IntheGhanaian2000modelformPetroleumAgreement,Article17.5statesthat:
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EXCERPT FROM THE THE GHANAIAN 2000 MODEL FORM PETROLEUM AGREEMENT:
17.5 - "....if Contractor's operations result in any other form of pollution or otherwise cause harm to fresh water, marine, plant or animal life, Contractor shall
all measures to control the pollution, to clean up Petroleum or other released material or to repair, to the maximum extent feasible, damage resulting from any such circumstances."
Ashasbeenpreviouslydiscussed,therequirementtotakeactionsinaccordance with,intheaboveexamples,"BestInternationalPetroleumIndustryPractices"and "acceptedPetroleumindustrypractice"raisessomequestionsastoexactlywhatthe oilcompanyneedstodotofulfilitsobligationstoremedydamageorharmbutthe contractdoessettletheresponsibilityontheoilcompanytotakeaction. Sowhopaysforthemeasurestaken?Inshortwhoultimatelybearsthecosts incurredresultingfromanaccident. Thecostsformeasurestakentoresolvedamageorharmdonefallunderthecosts ofthegeneralpetroleumoperations.Anoilcompanywilltypicallyrecoverthe costsresultingfromanaccidentthroughitspetroleumoperationsinonewayor another.Thistakesdifferentformsdependingonthetypeofcontract. Inaconcessioncontract,suchcostswillbedeductiblefromrevenuesfrom petroleumsalesforthepurposesofdeterminingtaxableprofits.Inaproduction sharingcontract,theoilcompanywillbeentitledtoashareofproducedpetroleum torecoveritscosts.Inaservicecontract,thefeepaidtotheoilcompanywill includeacomponenttocoveritscosts. Iftheoilcompanyisultimatelyreimbursedforthecostsitincurstomitigateany damagecausedorharmdone,oneperspectiveisthattheoilcompanydoesnot directlyorfully,payforthemitigationorremediationactivities.Totheextentthat thecostsreimbursedrepresentsrevenuethattheStatewouldotherwisehave received.Itmaybesaidthatthestateindirectlypaysforsuchmeasures,orthatthe stateandtheoilcompanysharethecostssinceexpendituresreducerevenue availabletobothparties. Theprinciplethatcostsincurredinmitigationorremediationofenvironmental damageorharmtopeopleorpropertyarepetroleumcoststhatarerecoverableis oftenexpresslystatedinthepetroleumcontract.Forexample,theIraqimodel TechnicalServiceContractArticle41.15providesthat:
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However,petroleumcontractsoftencontainoneimportantqualificationor exceptiontotheprinciplethatsuchcostsaretreatedaspetroleumcosts.Thisis illustratedbylookingatthefulltextofArticle41.15oftheIraqiModelService Contractwhichstatesasfollows: " ExceptforcasesofGrossNegligenceandWilfulMisconductonthepartofthe Contractorand/orOperator,allcostsincurredtowardstheprotectionofor damagetotheenvironmentshallbetreatedasPetroleumCosts". ThisqualificationorexceptionisalsoillustratedbytheGhanaian2000model PetroleumAgreementinwhichthelastsentenceofArticle17.5statesthat:
EXCERPT FROM THE GHANAIAN 2000 MODEL PETROLEUM AGREEMENT: 17.5 - "If such release or pollution results from the gross negligence or wilful misconduct of Contractor, the cost of subcontract clean-up and repair
activities shall be borne by the Contractor and shall not be included as Petroleum Cost under this Agreement."
So,wherepollutionordamageresultsfromthe"grossnegligence"or"wilful misconduct"oftheContractorthecostsarenotpetroleumcostsbutarepaidbythe contractor(theoilcompany)itself.Thequestionthenbecomes:Whatis"gross negligence"or"wilfulmisconduct"? Thisisacomplexareaoflawtowhichthereisnoeasyorsingleanswer.The definitionofwhatconstitutes"grossnegligence"or"wilfulmisconduct"mayvary fromcountrytocountryanddependsonthelawthatgovernstheparticular petroleumcontract.Thebasicprincipleishowever,thatfortheoilcompanytobear thecostsitselfitsbehaviourmusthavefallensignificantlyshortofthestandard expectedorrequiredbythepetroleumcontractorlaw.Ameremistakewillnot constitute"grossnegligence"or"wilfulmisconduct".Thefactthatthenegligence hastobe"gross"andthemisconduct"wilful"makesitapparentthatnotjustany negligenceormisconductbytheoilcompanywillbesufficienttomakeitbearthe costsitself. Intheeventofasignificantorcatastrophicenvironmentalmishaporaccident
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thisquestionwillbeofcommensuratelysignificantimportance.Anexampleofthis isthe2010DeepwaterHorizon/MacondospillintheGulfofMexico.Thecritical questioninrelationtothepotentialliabilityofthecompaniesinvolvedinthe accidentwas/iswhethertheywere"grosslynegligent"ornot. Howdoesthepetroleumcontracthelpensurethatthecostsformitigationand restorationaremet?Petroleumcontractswillcontainprovisionsthatrequiretheoil companytotakeoutnecessaryinsurances.Thisobligationmaybeaverygeneral one,suchasanobligationtotakeoutinsurancesthatshall"coverthetypesof exposurethatarenormallycoveredintheinternationalpetroleumindustry" . Sometimescontractsstatemorespecifictypesofrequiredinsurancecoversuchas "includingbutnotlimitedtodamagetoequipment,installationsandthirdparty liabilities".Itisraretofindarequirementthatexpresslyrequiresanoilcompanyto haveenvironmentalinsurance.Onsuchexamplewherethisisthecaseisthe BrazilianConcessionAgreementwhichstatesthat:
and its performance, protection of the environment, relinquishment and abandonment of areas, removal and reversion of assets."
relating to the Operations
Insurancecoveringenvironmentaldamagereducesthefinancialriskstowhich thestateandcompanyareexposed.Butthisassumesthatsuchinsuranceis available.ThechallengehereisthatsincetheGulfofMexicooilspillin2010itis increasinglydifficulttoidentifyinsurancecompanieswillingtoinsurepetroleum companiesforthesetypesofenvironmentalrisks,astheyaredifficulttoevaluate andestimate. Whetherornotinsurancecoverisavailable,iftheoilcompanyisasmall companywithoutsignificantassetsorbalancesheetstrength,orasmallsubsidiary ofabigoilcompany,thepetroleumcontractmightincludeotherwaysofensuring thattheoilcompanycanmeetandpayforitsobligationsunderthepetroleum contractgenerally,includingenvironmentaldamageorharmdone. Petroleumcontractsthereforeoftenrequirethataformalguaranteeisprovidedby aparentcompanyoftheoilcompany,orfromafinancialinstitution.So,for example,ifamajorinternationaloilcompanyformsalocalcompanytoenterintoa
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CLEANING UP
Eventuallyanoilorgasfieldwillcometotheendofitseconomiclife,meaning thatitisnolongerprofitabletocontinueproducingoilorgasfromthefield(cf.the firstsectiontoreadmoreaboutthelifecycle).Atthatpointanoilcompanyis typicallyrequiredto"decommission"or"abandon"thefield.Theuseoftheterm "abandon"isamisnomersincetheobligationsoftheoilcompanyarenotatallto simplywalkawayfromthefield.Infact,quitethereverse.Theobligationoftheoil companyistoremovethefacilitiesandinfrastructurethatitbuiltforthepurposes ofproducingandtransportingtheoilorgasand,sofaraspossible,toreturnthe naturalenvironmenttothestateitwasinbeforepetroleumoperationscommenced. Accordingly,mostcontractsandparticipantsintheoilandgasindustrynowrefer to"decommissioning"ratherthan"abandonment"althoughthetwotermsreferto thesamething. Atthetimethatapetroleumcontractisenteredintotheissueof decommissioningmaynotbeattheforefrontoftheparties'minds,sincesuch activitiesmaynotberelevantforanothertwentytothirtyyears(dependingonthe lengthofthecontractandthesuccessornotinfindingcommercialquantitiesofoil and/orgas).Additionally,inanynewoilandgasproducingjurisdictiontheissue ofdecommissioningisunderstandablynotamajorpreoccupationasopposedtothe businessofstimulatingexplorationandgettingtoproduction.Onemightcompare, forexample,theearlystageoilandgasindustryinGhanaorUgandawiththevery matureindustryintheUnitedKingdom.Thereareover500platformswith associatedpipelinesandotherinfrastructureintheUnitedKingdom,thecostof removingwhichhasbeenputbyOil&GasUKatover28.7billionby2040.A petroleumcontractand/orrelatedlegislationneedstoprovidefortheobligationto decommissionanoilorgasfield,thecostofwhichmaybesignificant,particularly inrelationtoanoffshoreoilorgasfield. Withsuchhighcosts,akeyconcernrelatedtoanobligationtodecommissionan oilorgasfieldistoensurethattheoilcompanyisabletopayforit.Bydefinition, thisprocessofdecommissioningcomesatapointintimewhenanoilcompanyis nolongermakinganysignificantprofitfromthefield.Accordingly,thecostsof decommissioningcannotbemetfromtherevenuethatisgeneratedfromthesaleof oilorgasfromthefield.SohowdoestheGovernmentensurethatdecommissioning activitieswillbepaidfor?Themechanismthathasbeendevelopedandistypically usedtodealwiththisistoensurethat,fromacertainpointintimeduringthelifeof theoilorgasfield,theoilcompanystartscontributingtoafundwhichwill accumulateand,atheendofthelifeofthefield,beavailabletopayforthecostof decommissioning.Thesecontributionsaremadewhilsttheoilcompanyis generatingaprofitfromthefieldandcanaffordtoputmoneyasidetomeetthe
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generatingaprofitfromthefieldandcanaffordtoputmoneyasidetomeetthe futurecosts.Todeterminehowmuchmoneyneedstobeputinthisfund,theoil companywillneedtoprepareadecommissioningplanwhichwillsetoutthe activitiesthatneedtobeundertakentodecommissiontherelevantfieldandthe estimatedcostsofthoseactivities.Byupdatingtheplanonaregular(perhaps annual)basis,theestimatedcostsarekeptcurrent.Insomejurisdictions,insteadof puttingcashintoafund,anoilcompanymaybeabletoprovidesecurityforits financialobligationsinrelationtodecommissioning,suchasabankletterofcredit. Aswithothermattersrelatingtotheenvironment,therearewidedivergencesin thedegreetowhichpetroleumcontractsexpresslydealwiththisissueof decommissioning.TheGhanaianmodelPetroleumAgreementatArticle17.3 merelyprovidesthattheoilcompanywill:
Cleaning up
requirementtosubmita"DecommissioningPlan"aspartoftheDevelopmentPlan, arequirementto,fromacertainpointintime:
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petroleum basics
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Sometimes,beforethepartiescandecidewhetherornotoneofthemhasnot donewhattheysaidtheywoulddo,theymayhaveanargumentoverthe interpretationoftherelevantprovisionofthecontract!Notwithstandingallthe timeandeffortputintonegotiatingandwritingthecontractthereisalwaysscope fordisagreementaboutwhatparticularprovisionsactuallymean.Infact,an importantfactaboutpetroleumcontractsthatmaycomeasasurprisetooutsidersis howoftentheyincludeprovisionstonegotiateonematterortheotheratsomelater stage. "Goodfaith"seemstobeacriticalwordinghere.Andanexampleofphrasesthat postponeadecision(cf.examplesbelow). Inourfamilyofcontracts,wehaveforexample:
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WiththecontractcomesanappendixofAccountingProceduresreferredtointhe maincontract.
andanotherexamplefromIraq
deliberatelyinaparticularprovisionastheonlywaytoreachagreementofall partiesinagiventimeframe"Wecan'tresolvethiscompletelynowsolet'suse placeholderlanguage".Insuchcaseseachpartymightgiveitsownmeaningtothe clauses,differenttotheotherside's,andtheymayormaynotbeawarethatthe otherparty'sinterpretationofthatclauseisdifferent. Thisclearlyinvolvesariskofdisagreementanddisputeatsomepointintime. Anotherphrasefrequentlyusedincontractsbutwhichcansetthepartiesupfor disagreement,isanobligationto"usereasonableefforts"orto"deliverinatimely manner"todosomething.Althoughthelawmayprovidesomeguidanceastowhat "reasonableefforts"or"deliverinatimelymanner"requires,therewill,inanygiven situation,bescopeforargumentastowhetherwhathasbeendoneconstitutes "reasonableefforts"or"timelymanner".Thenagaintherearereferencesto "generallyacceptedinternationalpractices". Manycontractsstipulatethatcontractsneedtobe"prudent"and"diligent".Of ourfamilyofcontracts,six(Azerbaijan,Brazil,Indonesia,Iraq,LibyaandTimor Leste)present25usesoftheword"diligent"andeightoftheword"prudent".Itis lefttocourtstodecidewhatmeaningshouldbeattachedtowordswhich,tothe outsider,looknebulousandsubjective. Generally,disputesarisewhenoneparty'sinterpretationofaprovisionresultsin theotherpartyhavingtospendmoremoneyorgetlessmoneythanitbelievesit shoulddo,orwhereonepartybelievesthattheother'sinterpretationsoractions deprivesitofasignificantbenefitorrightthatitwasentitledto. Thepetroleumcontractwillalwayshaveasectionthatsetsouttherulesforhow thepartieswillresolveorsettledisagreements.Thismightbereferredtoasthe "DisputeResolution"sectionorasthe"Arbitration"sectionorsomethingsimilar. Thereareanumberofdifferentmechanismsavailabletoresolvecontractual disputes,including: partiesreachingagreementontheresolutionthemselves usingaformalmediationprocess engaginganexperttomakeadeterminationoftheissueindispute legaladjudicationofthedispute/arbitration Sometimesacontractmayincludealloftheseprocessesinahierarchystarting withanobligationforthepartiestotrytoreachanagreementthemselvesand endingwithsubmissiontotherelevantlegaladjudicationprocess.Intheexample below,ahierarchyisprovidedasfollows,
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EXCERPT FROM THE IRAQI MODEL FORM TECHNICAL SERVICES CONTRACT IN ARTICLE 37:
"ThePartiesshallendeavourtosettleamicablyanydispute(the"Dispute") arisingoutoforinconnectionwithorinrelationtothisContractorany provisionoragreementrelatedthereto." "Wherenosuchsettlementisreachedwithinthirty(30)daysofthedate whenonePartynotifiestheotherPartyoftheDispute,thenthemattermay, asappropriate,bereferredbythePartiestotheirseniormanagementfor resolution." Wherenosuchsettlementisreachedwithinthirty(30)daysofsuchreferral tomanagement,anyPartytotheDisputemayreferthematter,as appropriatetoanindependentexpertor,bygivingsixty(60)daysnoticeto theotherParty,referthemattertoarbitrationasstipulatedhereunder". IfanyDisputearisesbetweenthePartieswithrespecttotechnicalmatters, suchDisputemay,attheelectionofeitherParty,bereferredtoan independentexpert("Expert"fordetermination". "AllDisputesarisingoutoforinconnectionwiththisContract,otherthan thoseDisputesthathavebeenfinallysettledbyreferencetoeithersenior managementorExpert,shallbefinallysettledundertheRulesof ArbitrationoftheInternationalChamberofCommercebythreearbitrators appointedinaccordancewithsaidRules."
Inalmostallcases,thepartieswillasamatterofcommonsensetrytoresolve disputesthemselvesfirst,irrespectiveofwhetherornotthethecontractrequires themtodoso.It'sfarcheaperandlessprejudicialtotherelationshipthancallingin outsiders.Itisonlywhenthatappearstobeimpossiblethattherearisesneedto resorttotheotherdisputeresolutionmechanisms.Certaindisputesthatareofa moreobjectivenaturelendthemselvestoexpertdetermination,forexamplearound thevaluationofoil,wherecleardataareavailablefrommarkets,andother accountingmatters.Thecontractmayspecifytheappointmentofanexpertforsome issueswhichwilltypicallybeofatechnicalnatureandthereforesuitablefor objective,expertdetermination.Disputesthatinvolvesubjectiveissuesof interpretationofthemeaningofpartsofthecontractarenotsuitableforexpert determination.
Arbitration
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Arbitration
Arbitrationistheprocessusedinpetroleumcontractsforresolvingdisputesthat havenototherwisebeenresolved.Unlessacontractincludesprovisionsrequiring thepartiestouseanarbitrationprocess,thedisputewouldusuallybesettled throughthecourtsoftherelevantcountryorcountries.Arbitrationisastepshortof actualcourtaction.Fortheparties,particularlyoilcompanies,itcarriestwomain advantagesoveranactualcourtsystem.First,itisnotinthecourtofthecountry thattheyhaveadisputewith.Second,arbitrationproceduresare,intheory, confidential. Theissueofwhereanarbitrationtakesplaceisnaturallysensitive.Mediaand thepublicinhostcountriesoftenfeelthattheshiftinjurisdictionawayfromtheir countryisanaffront.Butcompaniesworrythatthecourtsystemoftheir governmentpartnermaybesubjecttopoliticalpressure.Howeveritisimportantto understandthatthefactthatthearbitrationistakingplaceoutofthecountryis separatefromthequestionofwhichcountry'slawwillbeused.So,ifadispute arisesunderapetroleumcontractinGhana,thenGhanaianlawappliestothe contract,andanarbitrationprocesswoulddecidethedisputeapplyingGhanaian lawevenifthearbitrationprocessiscarriedoutinadifferentcountry.The arbitrationprocessbeingcarriedoutinadifferentcountryisseenasaneutralorfair processbytheoilcompanycomparedtosettlingthedisputeintheGhanaian courts. Whilsthostcountrycitizensmayfindthesuggestionthattheircourtsarenot impartialorfairsomewhatinsulting,therealityisthatinmanyjurisdictionsthe courtprocessmaynotbeindependent,ormaybeslow,andinternationalinvestors generally(notjustoilcompanies)prefernottotakethatrisk. Typicalfeaturesofanarbitrationprovisioninacontractare: Provisionthatthearbitrationbeconductedinaccordancewiththerulesofa particulararbitrationorganisation.Thereareanumberofrecognised internationalarbitrationorganisationseachofwhichhaveasetofrulesthatwill applytothearbitrationprocess.Differentruleshavecertainprosandcons,an examinationofwhichisbeyondthescopeofthisbook,butthebetterknown andoftenusedonesincludetheUNCITRALRules,theLondonCourtof InternationalArbitrationRules("LCIA"),theInternationalChamberof CommerceRules("ICC")andtherulesoftheInternationalCentreforSettlement ofInvestmentDisputes("ICSID") Provisionofwherethearbitrationistotakeplace.Thismightbereferredtoas the"seat"ofthearbitration.Often,a"neutral"venueischosen,beingonethatis notinthecountrywithwhichthecontractismadeandnotinthecountryfrom whichtherelevantoilcompanyoritsparentorganisationcomesfrom.Choices ofindependentvenuesmightinclude,forexample,Paris,LondonorStockholm.
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ofindependentvenuesmightinclude,forexample,Paris,LondonorStockholm. ItisimportanttonotethatthisdoesnotmeanthatFrench,EnglishorSwedish lawwillbeappliedtothedisputeinsteadoftherelevantgoverninglawofthe contract.Sometimesthechosenvenueisindeedlocatedinthecountrywherethe oilcompanyoritsparentcomesfrom.Forexample,therecentarbitration involvingtheGovernmentofUgandaandHeritageOil,aLondonhead quarteredandlistedcompanywasbeingconductedinLondon,thelocation specifiedbytherelevantpetroleumcontract Provisiononthenumberofarbitratorsthatwilldeterminethedispute. Frequentlythiswillbethree.Thisallowseachpartytoselectonearbitratorand thentojointlyappointathirdorforthethirdtobeappointedpursuanttothe relevantarbitrationrules.Althoughallofthearbitratorsshouldbeimpartialand objective,ifonlyonearbitratorisusedthereisagreaterpotentialforonepartyto feelthatthearbitrationprocessisnotfair Provisionforthelanguageinwhichthearbitrationshouldbeconducted,which wouldnormallybeamajorinternationallanguagethathassome(historical) relationshiptothecountrytowhichthedisputerelatessuchasEnglish,French, SpanishorPortuguese. Provisiononwhopaysforthearbitration.Usuallytheexpensesofanarbitration areborneequallyamongtheParties. Lookingatthecontractsthathavebeenusedtoprovideexamplesinthisbook andhowtheydealwithdisputeresolutionwefindthattheyallreferdisputesthat cannotbeotherwisesettledtoarbitrationandhavearbitrationprovisionsas follows:
ThegoverninglawclauseinAzerbaijanstates:
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ThegoverninglawclauseinAzerbaijanstates:
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180
STABILISATION
Stabilisation,theprovisionsthatinternationalcompaniesusetosecureguarantees againstchangesintheconditionsortheinvestmentenvironmentwithinwhicha contractwasnegotiated,isanissuesuretoprovokeheateddebateswhenever includedininvestmentagreements.Petroleumcontractsarenoexception.
Why Stabilize?
Thebasicprinciplethatsuchclausesareintendedtoaddressfromtheoilcompany perspectiveisthatthecontractstermsandconditionswereagreedupononthebasis ofthelawsoftherelevantcountryastheyexistedatthetimeofnegotiationsand shouldthereforenotbechangedunilaterallybyoneparty(thestate).Butina projectwherebillionsofdollarsmaybeinvestedinaprojectwithanexpected25 yearlifecyclealotcouldhappen. Governmentscanriseorfallthroughelections,orevenrevolutions,societyand economicdevelopmentneedsandthelegalenvironmentcanchange fundamentally,aswellastheinternationalcontext.Thecompanytherefore endeavoursto"stabliise"thetermsofitsinvestmentbywritingintothecontract provisionswhichpreventoverallchangesinthelegal,financial,environmentaland socialrequirementsinthecountryofoperationsfromaffectingtheiroperations. Breachingthatprovisionthen,willentitlethecompanytousuallygenerous compensation. Countries,ofcourse,seeitcompletelydifferently,morelikeaninfringementof sovereignty.Astabilisationprovisioninapetroleumcontractshouldtherefore neveractuallyhavetheeffectofpreventingchangedlawsofthecountryfrom applyingtothecontract.Howeversuchchangesinacountry'slawsmayhavean adverseeffectontheeconomicsandprofitabilityoftheproject,andsincenobody canchallengeasovereigncountry'srightstochangeitslawsatanytime,the companyisinageneralsensealwaysatapossibledisadvantageinwhatisforthem acommercialrelationshipwithacommercialcounrterpart. Whatastabilisationclauseinacontractmightsay,then,isifthecountry changeditslawsinawaythataffectstherelevantpetroleumcontract,thiswouldbe abreachoftheprovisionandgivetheoilcompanyarighttoclaimcompensation forsuchabreach.Alternatively,thechangedlawswillnotapplytothecontract.
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Stabilisation
Enteranewandimprovedstabilisationclause,nowknownas"equilibrium" provisions. Theaimofanequilibriumprovisionissimilartoastabilisationprovision,minus thepoliticalstingtopreservetheoveralleconomicpositionof(typically)theoil companyor(sometimes)thegovernmentwithoutbeingseentoinfringe sovereignty.Theprincipleisthatoneofthepartiesisadverselyimpactedbya changeinlaw,bothpartiesseektoagreetochangestothepetroleumcontractthat willrestoretheoriginalfinancialposition.Thecompanygetsthesamereassurance butthelocusofchangehasbeenmovedinsidethecontract.Thecontractnowsets upitsownrenegotiationonthisissuegiventherecognisedtrigger,leavingthe widerbodyofregulationsandlawsinthecountryoutofthepicture. Forexample,ifthecountryamendsitstaxlawandtaxesimposedontheprofits oftheoilcompanyareincreasedby10%,thepartieswouldseektoagreean amendmenttosomeothertermsofthepetroleumcontracttocompensatetheoil companyfortheincreasedtaxithastopay,forexample,byincreasingtheprofitoil itreceivesorareductionintheroyaltyrate.Theremightstillbehagglingoverthe numbers,since,aswehaveseen,eachfiscaltoolhasitsownproperties.Youcan adjustaroyaltyratetoexactlycompensateforariseincorporatetaxatacertain pricepointofcrudeoil,forexample,butyoumaylosethatcorrespondenceifprices moveupanddown.Butthisistechnicalquibbling(lawyersyammeringon?)atthe margins.Theessentialstingofthechangeinlawwillhavebeenremovedforthe company. Sothepartiesagreetorenegotiate.Butiftheycan'tagreeanamendmenttothe contract,thentheequilibriumclausemayprovideabasisfortheoilcompanyto seekcompensation.Inthiscasetheultimateeffectmaybesimilartothatofa stabilisationprovisionasdescribedabove. Note:Equilibriumclausesareoftenquiteshort.Thatdoesn'tmeanthattheyare notimportant. Someexamplesinclude:
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Lookcloselyandyouwillseethatthesecondexampleofferstheoilcompany lessprotectionthanthefirst.Thefirstexampleappliesto"anychangeinthe provisionsofanyLaw"which"adverselyaffects[anyof]theobligations,rights"of bothparties.Thiskindofbroadandgenericlanguageissometimesreferredtoasa "freezing"clause.ThesecondexampleappliesonlyifthechangeinLaw"adversely andsubstantially"affectsthe"financialinterests"onlyofthecontractor.Theburden ofproofishigher.Inadditionthestabilisationisconfinedtowhatmayproducea changeinfinancialinterestsonly. Civilsocietygroupssometimescomplainaboutfreezingclausesasinthefirst exampleabove,onthegroundsthatsuchaclausecanhaveanimpactona government'sroomtopassnewsocialandenvironmentallaws,forexampleon healthandsafety,labourandemploymentrights,theprotectionoftheenvironment andculturalheritage,andhumanrights.Fromalawyer'sperspectivethedifference betweenthetwoclausesmaynotbeasgreatasitappearsatfirstglance,sinceeven withamorerestrictedclausesuchasinthesecondexampleacompanycouldargue thatstricterormorecomprehensivesocialandenvironmentallawsresultinahigher costofcompliance.If,ontheotherhand,thecontractatitsinceptionrequiredthe companytoapplyinternationalpracticeorstandardsforitssocialand environmentalpractices,thenastabilisationorequilibriumclausewouldnotapply unlessnewsocialandenvironmentallawswerepassedwhicharemorestringent thaninternationalbestpractice.Thecountrywouldthenhaveassureditselfafloor
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Stabilisation
Onafinalnote,stabilisationorequilibriumprovisionsmaynotalwaysbeina clauseconvenientlylabelled"Stabilisation"or"Equilibrium".Inthefamilyof contractsusedinthisbook,forexample,Azerbaijanhasaclause(23)called "ApplicableLaw,EconomicStabilisationandArbitration",whileinGhanaitslips inunderArticle26.4"Miscellaneous".Othercontractshavereferencestothe principlescatteredacrossthecontract,inclausesdealingwithgoverninglaw, disputeresolutionormiscellaneousprovisionsoreveninenvironmental,taxor subjectspecificprovisions. Oftenbutnotalwaystowardstheendofthecontract. Happyhunting!
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186
CONFIDENTIALITY
Letusgobacktowherewebegan.Thisbookaimstodescribeoilcontracts,the issuestheygovern,thehistorythatshapesthemandtheworldtheylivein,in broadlyneutralterms.Weseeavalueinexplainingwithouttakingsides.Theone exceptiontothatneutralityiscontracttransparency.Thisbookactivelyseeksto promotecontracttransparencyasanemergingnormwhichwillimprove governanceoftheoilandgasindustryaroundtheworld.Letusnowexplainwhy, takingalookattheconfidentialityclausesthemselvesinthecontracts. Opponentsofcontracttransparencyadvancetwomainarguments.First,that contractsascurrentlywrittenforbidit.Andsecond,thatitwouldharmtheir interests.Let'stakeeachofthoseinturn.
Breach Of Contract
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Heavy!Exceptfornoticethattherestrictionsapplyto"informationanddata" anddonotexplicitlymentionthecontractitself.Isthecontractpartofsuchdata andinformation?Somecontractsdospecifythat,butmostdon't.Opponentsof contracttransparencyoftenarguethattheprovisionsofcontractsthemselves preventpublicationbutwecanseefromtheactualwordingthatthisis,atthevery least,opentointerpretation.Terabytesofinformationaregeneratedduringthe lifetimeofapetroleumprojectthesedays,fromseismicdataandinterpretationat theexplorationstagetocoresamplesandanalysisfromdrilling,towelllogsand tradingdatageneratedbygettingthestuffoutofthegroundandsellingit.Thisis moreclearlydataandinformationdefinedintheseclausesratherthanthecontract itself.
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Confidentiality
itself. Butinaddition,allthesearticlesthengoontospecifypermittedexceptionsto theruleofsecrecy.Thesetypicallyarewheninformationisalreadyinthepublic domainorthereisadisputewhichhasgonetoarbitration.Orwhen(asinthecase ofGhana)thestateoilcompanywantstobriefanyconsultant,ortoattractother investorstonearbyareas,orthecompanyneedsabankloanorforanotherfinancial transaction.AndinfactthisiswhathappenedinthecaseoftheGhanacontract whichisafinal,signedandinitialledagreementyoucanfindontheInternet. Otheragreementsstarttodifferentiatebetweentheobligationsofthecompanies andthoseofthestate.Backin2001,forexample,Brazil'smodernconcession agreementimposesthestrictestoftermsonthecompany.
TheobligationsontheBraziliangovernment,asrepresentedbyANP,are somewhatmorerelaxed:
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Followingthis,ithasa"TradeSecrets"clause:
Confidentiality
countriesoftheworld.
Harmful To Interests
Perhapsthemostwidelymadeandunchallengedclaimforconfidentialityis thatitprotectscommerciallysensitiveinformation.Butthisclaimisonlythe beginningofananalysis,nottheend.Everything,fromtheexistenceofacontract, toillegalbribes,tomostofwhatisdisclosedundersecuritiesregulations,couldbe classifiedascommerciallysensitive . Ascanbeseenfromthecontractsprofile,though,manycontractshavebeen publishedintheirfinalformGhana'sagreementwithTullow,TimorLeste'swith Eni,Azerbaijan'swithBP,andAfghanistan'swithCNPC.Nothingdramatichas happened. Theotherthingisthatmanymorecontractsarepublishedalreadyinhighcost commercialdatabasesusedwithintheindustry.Someofthewritersofthisbook haveaccesstothosedatabaseswhichcontainhundredsofcontractsthatarestill consideredtobe"secret".Companiesmaybeworriedaboutcommercial competitiongainingaccesstosensitiveinformationbutthemostwidelystated objectionstoconfidentialityclausesinvolvethecaseofastatewantingtoattract otherinvestorstootherblockstheircompetitorsprecisely.Butitisinfact commercialcompetitorswhohavemostaccesstothesecontractsinthefirstplace.
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192
context
Appendices
APPENDICES
194
GLOSSARY
API Gravity Index
Appraisal Well
Associated Gas
Back-In Right
195
APPENDICES
Benchmark Crude
Blending
Block
Blowout
Booking
196
Glossary
Booking
Brent Crude
Bunkering
Theillegalremoval,ortheft,ofoilfromaPIPELINEorotherdistributionsystem. BunkeringissometimesassimpleasdrillingaholeinaPIPELINEandcollecting theoilinadrum.Morecomplexoperationsinvolveequippingtankerswithfalse bottomstoconcealextralegalshipments,ortomakeunauthorisedshipmentsfrom wellsitestoragetanks.BunkeringisachronicissueinNigeriaandIraq,althoughit existsinmanyothercountries."ThetheftofoilknowninNigeriaas bunkering alongwithfraudintheallocationofacontroversialfuel subsidy,maytogetherhavecostthestateUS$14billionin2011."Financial Times2010
197
APPENDICES
Commerciality
Completion
Thefinalstageintheinstallationanddevelopmentofanoilorgaswell, enablingittobeginproducing,oftentakenonbyoilfieldSERVICECOMPANIES.
Concession
Liquidfuelssuchasethane,butaneandpentane,whicharepresentinthemixof NATURALGASwhenitcomesoutoftheground.Theseliquidsarecondensedout ofgasbeforetheyareshippedbyPIPELINEandcapturedforseparatesale.Also knownasnaturalgasliquids(NGLs).Seealso:WETGASconsortiumAgroupof companieswhichjoinforcestopursueajointproject,andmaysubmitjointbidsfor projectsduringaLICENSINGROUND.Thetrendintheoilindustryoverthelast generationisforcompaniestocollaboratemoreandmore,onacasebycasebasis, formingconsortia,tosharetheriskofprojectswhichdemandeverhighamountsof investment.Seealso:JOINTVENTURE,PROJECTFINANCING,WORKING INTEREST
Contingent Resources
198
Glossary
Contingent Resources
Cost Recovery
Cracking
Crude Blends
Crude Oil
199
APPENDICES
Crude Oil
Depletion
Development Well
Diesel
200
Glossary
Discovery Well
seeWILDCATWELL
Downstream
Drilling Mud
Dry Well
Dubai Crude
Dutch Disease
Elephant Field
201
APPENDICES
Elephant Field
AfieldwithRESERVEStotallingover1billionbarrels.Seealso:GIANT FIELD
Energy Security
Farmout Agreement
202
Glossary
Fracking
seeHYDRAULICFRACTURING
Fuel Oil
Futures Contract
Giant Field
Groundwater
Heavy Oil
Horizontal Drilling
203
APPENDICES
Horizontal Drilling
Hydraulic Fracturing
LIBOR
204
Glossary
LIBOR
TheLondonInterbankOvernightRate,arateofinterestoftenusedinthe financialtermswhichgovernoilcontracts.
Licensing Round
Light Oil
Liquefaction
Conversionofgasestoliquidform,usuallyforeaseofstorageand/ortransport. liquefiednaturalgas(LNG)NATURALGASwhichhasbeenconvertedintoliquid formbycoolingittoapproximately162C(260F),foreaseofstorage andtransport.Thisexpensiveprocessisusedwhenagaspipelineisunavailableto transportthegasproducedtothemarketplace.ThefirstLNGplantwasbuiltin Algeriain1962.Qataraccountsfor25percentofglobalLNGproduction.LNG's marketpositionhasbeenchallengedinrecentyearsbytheexplosivegrowthin SHALEGASinsidetheUnitedStates,leadingtorecalculationsofhowmuchgas theUS,onceseenasamajorLNGmarket,willimportinfutureyears.Seealso: LIQUEFACTION
Local Content
205
APPENDICES
Local Content
Metering
Natural Gas
Primarilymethane.Itoccursnaturallyandisusedasafuel.
seeCONDENSATES,NATURALGAS
Non-Associated Gas
206
Glossary
Offshore
Oil Sands
Oil-Backed Loan
OPEC
207
APPENDICES
OPEC
TheOrganizationofthePetroleumExportingCountries,acartelformedin1961 throughwhich12memberstatesagreeonasharedquotafortheproductionand saleofpetroleum.OPECisintimatelylinkedtotheriseofRESOURCE NATIONALISMandtheindustryinallofitsmemberstatesisdominatedby NATIONALOILCOMPANIES.Asof2012,OPECproducedabout40percentof theworldsoil.Withitslargeshareofglobalproduction,OPEChasbecome effectiveindeterminingthepriceofoiloninternationalmarkets,buttherecanbe sharpdivergenceofinterestsbetweenitsvariousmembers,whoareallindifferent situationsasregardstheirstateofDEPLETIONanddegreeofDEPENDENCYon oilrevenues.Seealso:SWINGPRODUCERoperatorThecompanywithina CONSORTIUMwithoveralldecisionmakingauthorityatanoperationallevelon anoilorgasproject,usuallyalsowiththegreatestfinancialstake.Seealso:JOINT VENTURE,WORKINGINTEREST
Petrochemicals
ChemicalsderivedfromPETROLEUMorotherfossilfuels,largelyusedinthe plasticsindustry.Therearecurrently4,000chemicalsclassifiedaspetrochemicals.
Petrodollar
Petroleum
Thetermofarttodenotebothcrudeoilandpetroleumproductsproducedby REFINING.Theterms"oil"and"petroleum"aresometimesusedinterchangeably.
Pipeline
Plateau Production
208
Glossary
Plateau Production
Play
Possible Reserves
Pre-Salt
Probable Reserves
Profit Oil
209
APPENDICES
Profit Oil
Project Financing
Proven Reserves
Recovery Rate
Refining
Rent
210
Glossary
Rent
Arevenuestreamthataccruesaboveandbeyondanormaleconomicreturnon activityorprofit.TheconceptwasfirstdevelopedbyeconomistsAdamSmithand DavidRicardointhe18thand19thcenturies.Itdominatestheeconomicsofthe globaloilindustrybecauseofsharplyvaryingcostsofproductionforacommodity soldatroughlythesameprice.Forexample,itcouldcostUS$5toproduceabarrel ofoilinLibyaand$60insomefieldsinCanada,yetbothsellforthesameprice, meaningthemarginsaremassivelydifferent.Economistsdifferentiatebetweenrent andanormalreturnoncapital,orprofit,andarguethatitshouldbetreated differently.Rentencouragesrentseeking,anintegralpartoftheconceptof RESOURCECURSE.
Reserves
Reserves-Production Ratio
Resource Diplomacy
Resource Nationalism
211
APPENDICES
Resource Nationalism
Resources
Resource Curse
Royalties
Royalty Interest
212
Glossary
Royalty Interest
Sedimentary Basin
Geologically,areaswheretherehavebeenhugedepositsoforganicmatter millionsofyearsagowhichmaythenhavebecomecompactedand'cooked'intooil andgas.Becauseofcontinentalshiftsandothergeologicalmovements,suchareas cannowbedeepinlandeveniftheywereoriginallyunderwater.Forexample,the TexasandOklahomaoilfieldsoftheUnitedStatesarepartofasedimentarybasin formedinwhatwasanextendedGulfofMexicowhileinLibyaoilbearing formationsoftheSirteBasinextendathousandkilometresinland,intotheSahara desert.Seealso:CAPROCK,ANTICLINE"ThesedimentarybasinsinNew Zealandthatarelikelytocontainoilandgasareyoung(lessthan80millionyears old)."EncyclopediaofNewZealand2012
Seismic Survey
Service Companies
213
APPENDICES
Service Companies
Service Contracts
Seven Sisters
Shale Gas
Signature Bonus
214
Glossary
Sour Oil
CRUDEOILGRADESwhichhavehighsulphur,decreasingtheirmarketvalue, incontrasttoSWEETOIL.
Spot Market
Spudding
Theverystartofthedrillingprocessatanewwellbygettingridofanybitsof rock,dirtorothersediment.
Subsoil Rights
Super-Giant Field
seeGIANTFIELD
Supermajor
Sweet Oil
CRUDEOILGRADESwhichhavelowsulphur,increasingtheirmarketvalue, incontrasttoSOUROIL.
Swing Producer
215
APPENDICES
Swing Producer
Tight Hole
Adrillingwellaboutwhichallinformationiskeptconfidential,mostoftenused forAPPRAISALWELLS.
Transit Fees
Transparency
Unitisation
216
Glossary
Unitisation
Unproven Reserves
AnumbrellatermforPROBABLERESERVESandPOSSIBLERESERVES.see RESERVES
Upstream
Well Completion
seeCOMPLETION
Wet Gas
Wildcat Well
217
APPENDICES
Wildcat Well
Working Interest
218
This is the first book about oil contracts for non-experts. It was written in a five-day booksprint by a group of corporate lawyers, government negotiators and development specialists. We all use or produce oil but the contracts that make it all possible have been secret. Until now...
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