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OIL CONTRACTS

How to read and understand them

17

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

TheFiscalToolkit FiscalStrategiesandSolutions ComparingResults Howbigisthepie?

73 93 109 115 123 125 129 133 135

ECONOMICDEVELOPMENT?
HistoryandEvolution OilforInfrastructure TheroleoftheNationalOilCompany Employment,ProcurementandSocialWelfare

ENVIRONMENTAL,SOCIAL,ANDHEALTH& SAFETYISSUES 145


It'simportantisn'tit? OperationalEtiquette Beforeyoustart Whenthingsgowrong Cleaningup

147 151 155 161 167 171 173 181 187

LAWYERSYAMMERINGON
Dealingwithdifferences Stabilisation Confidentiality

IV

APPENDICES
Glossary

193 195

VI

petroleum basics

Foreword

How to Read and Understand Petroleum Contracts

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

How to Read and Understand Petroleum Contracts

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
4

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.

How to Read and Understand Petroleum Contracts

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.

Offshore & Onshore Operations


9

Context

Offshore & Onshore Operations

Petroleumoperationscanbeeitheronshoreoroffshore.Somecountrieshave seperatecontractsforonshoreandoffshore,whereasotherstreatthemdifferently withinthecontract.Inwhatmightbeoneofthemoststraightforwardtermsusedin thisbook,onshoreoperationsrefertooperationstakingplaceonland,while offshore,orsubsea,operationstakeplaceintheseaandthroughtheseabed. Thefollowingdiagramshowsthethreetypesofpetroleumextractionandtheir comparativecosts.

Offshoreoperationsaremoreexpensivethanoffshoreoperationsbecauseofthe typeoffacilitiesandstructuresrequired.Deepwaterdrillingismuchmore expensivethanshallowwaterdrillingbecausetheplatformsaretechnicallymore difficulttoconstruct.Theseconsiderationsareaddressedincontractsbyproviding financialincentives(e.g.taxreductions)forthoseoperationsandstagesof productionthataremorechallenging,riskandcostlytothecontractor.

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.

The Price Of Petroleum

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
11

Context

Future Pricing

Acriticalandheavilydebatedquestioniswhatwillthefuturepriceofpetroleum be?Unfortunately,thereisnosingleoreasyanswertothisquestion.Whatdrives oilpricesisasubjectofmuchdebateaboutglobaloilconsumption,economic growthpatterns,technologicalinnovation,andpoliticaldynamicsinoilproducing countries.Thisisnotthesubjectofthisbook,however,andwillbesomethingwe'll leavetotheexperts.

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.

Future Trends In Contracts

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.

12

THE LIFE & TIMES OF A PETROLEUM PROJECT


Petroleumdoesn'tlastforever.Itisanonrenewableresource.Thisfundamentally drivesthebusinessdecisionsofcompanies,akeypartofwhichisthatmost petroleumcontractsarestructuredtocontemplatetheentirelifespanofaproject, it'sbeginning,middle,andend.Thekeystagesofaproject'slife(or"petroleum operations")are: exploretofinditinthefirstplace developtheinfrastructuretogetitout produce(andsell)thepetroleumyou'vefound abandonwhenitrunsoutandcleanup("decommission") Eachofthesestagesisbrokendownanddiscussedindetailbelow.

Explore
13

Context

Explore

Petroleumisrarelyfoundonthesurfaceoftheearth.Oneisveryunlikely(though wouldbequitelucky)tostepintoapuddleofoil,thoughwhenthisdoesoccuritis knownasa"seep"whichmeanswhatonewouldthinkitmeans:oilbelowthe groundhas"creptup"frombelowthesurfaceto"seepout"ontothesurface.Inthe earlyyearsofoildiscovery,seepswereprobablyoneofthebestmeanstofindoil andgas.Andoilstilldoesseeptothesurfaceoftheearthinmanylocationsacross theglobe.Butaseepdoesnotmeananoilboom.Nowadays,weusemuchmore scientificanddataintensivemeansoffindingpetroleumbeneaththesurfaceofthe earth.

Seismic

Today,geologicalsurveyingmethodsknownasseismicstudies(orjust"seismic") areusuallythestartingpointofanyoilexplorationeffort.Theessenceofseismic studiesaretousesoundwaves,shotdownintotheearth,to'see'whatis underground.Althoughitisoftensaidthatonecannotbecertainthatpetroleumis inagivenlocationuntilaexplorationwellisdrilled,takingseismicsurveyshelp increaseone'sconfidencethatdrillinganexpensiveendeavourinaparticular locationisworthwhile.Inotherwords,seismichelpsclimbthe'confidencescale'.

Commonlyfoundbeneaththeearth'ssurfacearevarioustypesofrocks,water andsalt,allofwhichreactdifferentlywhenhitwithasoundwave.Largeamounts ofdataarecapturedfromthisprocessandusedtogiveanimageofwhatlies beneaththeearth'ssurface.

14

The Life & Times of a Petroleum Project

Ascomputertechnologyhasimproved,seismichasbeenabletohandle increasinglylargequantitiesandcomplexityofdata,thoughthecostofgathering andinterpretingthisincuresincreasingcosts.Thisiswhyyouwillseeinsome contractsthetypeofseismicrequired(eg.2Dvs3D),howmanykilometersof seismicistobegathered("shot"inindustryjargon)andspecificallythatitmustbe interpretedandtheresultsprovidedtothehostgovernment.

EXCERPT FROM TIMOR-LESTE JPDA S-06-01:


4.1 - In each Contract Year mentioned below, the Contractors shall carry out an Exploration Work Programme and Budget of not less than the amount of work specified for that Contract Year: Contact Year 1: Acquisition, processing and interpretation of 1150km 2D seismic data

Exploration Drilling

Iftheseismicproducespromisingresultssometimescalleda"lead"thenthenext phaseofexplorationwilltypicallybedrillinganexplorationwell.Here,an extraordinarilylargedrillbitiscutintotheearth'ssurfaceinordertobringupa "core"oracylindricalsampleofthatportionoftheearth.

15

Context

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.

Discover And Appraise

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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The Life & Times of a Petroleum Project

thechemicalcompositionofthevarioushydrocarbondeposits thequantityofreservesinthearea howtogetthesehydrocarbonsoutoftheground(ifthediscoveryisfoundtobe ofcommercialsignficance)

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;

Commerical Discovery Or Not?

Oncehydrocarbonshavebeenfoundinsufficientquantitiesandwithan economicallyviableextractioncost,thediscoverybecomesa"commercial discovery".Itisimportanttostressherethatacommercialdiscoveryisnota geologictermbutabusinessterm.Forthisreason,thelengthoftimeanappraisal takeswilllikelydependonsuchconsiderationsas: thebusinessconsiderationsofthecompanythathasfoundtheoil thelocallawsandregulationsthatdeterminetheprocessofdevelopment

EXCERPT FROM TIMOR-LESTE JPDA S-06-01:


"Commercial Discovery means a discovery of Petroleum that a Contractor declares commercial as contemplated in Section 4.10;

Develop
17

Context

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

Atlonglastperhapsadecadeafterthestartofexplorationoilorgaswillfinally flow.Asvariouswellscome'online',petroleumwillflowinincreasingquantitiesas production"rampsup".Atsomepoint,oncemostofthefirstmajordevelopmenthas beencompleted,tested,andrefinedforanybugsinthesystem,therewillbe "commercialproduction".Thisoccurswhenthepetroleumisfinallyflowingatthe expectedrateoveraperiodofamonthorso.Howlongwillproductionlast?Thisis affectedbymanyfactors,butprobablymostsignificantlybythesizeofthefind.

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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The Life & Times of a Petroleum Project

EXCERPT FROM TIMOR-LESTE JPDA S-06-01:


"Commercial Production" occurs on the first day of the first period of thirty (30) consecutive days during which production is not less than the level of regular production delivered for sale determined by the Ministry as part of the approval of, or amendment to, a Development Plan, averaged over no less than twenty-five (25) days in the period;

Abandon

Afteranywherefromaroundsevenyearsofproductionfromsmallerareastofifty yearsormorefromthegiants,itistimetotakeallofthe"steelandmetal"down, plugtheproductionwellsandrestoretheenvironmenttoitsoriginalstate.A commonalternativetothisiswherethecontractorturnstheassetsovertothestate sothatitcanthencontinueoperationsandeventuallyabondoningthemselvesata latertime.Theseprocessesaregenerallyreferredtoas"Decommissioning"or "Abandonment".

EXCERPT FROM TIMOR-LESTE JPDA S-06-01:


"Decommission" means, in respect of the Contract Area or part of it, as the case may be, to abandon, decommission, transfer, remove and/or dispose of structures, faciltiies, installations, equipment and other property, and other works, used in Petroleum Operations in the area, to clean up the area and make it good and safe, and to protect the environment

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.

19

Context

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.

20

WHAT IS A PETROLEUM CONTRACT?


Expertsestimatethatforalargenaturalresouceextractionproject,therewillbe wellover100contractstobuild,operate,andfinanceitallofwhichcouldfall underthebroadcategoryof'petroleumcontract'.Theremayalsobewellovera100 partiesinvolved,including: governmentsandtheirnationaloilcompanies(NOCs),e.g.Gazprom,Petronas internationaloilcompanies(IOCs),e.g.BP,Exxon,Chevron,CNOOC privatebanksandpubliclenders,e.g.JPMorgan,WorldBank engineeringfirms,drillingcompanies&rigoperators,e.g.Halliburton, Schlumberger,Technip transportation,refiningandtradingcompanies,e.g.Hess,Glencore,Trafigura, KochIndustries ...andmanymore Amongthesemanycontracts,themostimportantistheonebetweenthe governmentandtheIOCanditisthisconractthatwillbeaddressedinthisbook. Alloftheothercontractsmustbeconsistentwithanddependonthiscontract thesemightbecollectivelyreferredtoas"subsidiary","auxillary"or"ancillary" contracts. Thiscontractismostcommonlyreferredtobytheindustryasa"Host GovernmentContract"becauseitisacontractbetweenaGovernment(onthe behalfofthenationanditspeople)andanoilcompanyorcompanies(thatare beinghosted).Itisthroughthiscontractthatthehostgovernmentlegallygrants rightstooilcompaniestoconduct"petroleumoperations".Thiscontractappearsin countriesthroughouttheworldundermanynames: PetroleumContract Exploration&ProductingAgreement(E&P) Exploration&ExploitationContract Concession LicenseAgreement PetroleumSharingAgreement(PSA) ProductionSharingContract(PSA)

21

Context

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.

The Petroleum Regime

Younowhaveapetroleumcontractinyourhands.Doyouhaveeverythingyou needtounderstandtherelationshipbetweenthegovernmentandthecontractorsby justreadingthroughthecontract?No. We'llsayitonceanditwillsurelybesaidagain:petroleumcontractsareonekey feature,livinginaconstellationorwebofotherlawsandregulationsaboveitand manyothersubcontractsandotherancillarycontractsarebelowit.Thesewillbe referredtobythecontractbutwillnotbeexplicitlydescribed,explainedorre written. Thisweboflawsandregulationsrelatingtopetroleumwithinaparticular countryisknownasa"petroleumregime".Thepetroleumregimecanbebest thoughtofasahierarchy,startingwiththeconstitutionoftherelevantcountryand endingwithpetroleumcontract.

22

What is a Petroleum Contract?

Constitution

Theconstitutionwillestablishtheauthorityforagovernmenttomakeandenforce laws.Itmayalsoaddresstheownershipofthecountry'snaturalresourcesand,in thiscase,willtypicallystatethatresourcesareownedbycitizensofthenation,or heldfortheirbenefitbythecurrentgovernment.

Laws And Regulations


23

Context

Laws And Regulations

Thencomesthepetroleumlaw,whichcontainsspecificrulesrelatingtotherights andresponsibilitiesgrantedinthecontract.Otherlawswillalsoformanimportant partofthe"petroleumregime"including,forexample,environmentallaws,health andsafetylaws,taxlawsandlabourlaws.

EXCERPT FROM GHANA MODEL PETROLEUM AGREEMENT:


10.2 - The chargeable income of Contractor is determined under section 2 of the Petroleum Income Tax Law

Next,theremaybepetroleumregulations,whicharemadeinaccordancewith thepetroleumlaw.Aswemovedownthehierarchyfromtheconstitution,tolaws, topetroleumregulations,therulesrelatingtopetroleumexploitationwillbecome increasinglydetailedandspecific.

Contracts

So,thepetroleumcontractissimplyonepartoftheoverallpetroleumregimethat governspetroleumresources.Itis,however,thepartthatdefinestheparticularities andrightsthatareessentialtoanycompanywantingtoexploreandextractwithin thatcountry.

Awarding Petroleum 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
24

What is a Petroleum Contract?

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.

Types Of Petroleum Contracts

OftheseHostGovernmentContracts,therearethreeprincipaltypeswhichcanbe generallycharacterizedas: Concession:contractorownstheoilintheground ProductionSharingContract:contractorownsashareofoilonceitisoutthe ground ServiceContract:contractorreceivesafeeforgettingtheoil

Concessions
25

Context

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.

PSCs And Service Contracts

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.

Joint Ventures And Other Combinations


26

What is a Petroleum Contract?

Joint Ventures And Other Combinations

Anothertypeofarrangementthatissometimesconsideredtobeafourthtypeof petroleumcontractistheJointVenture.Thisinvolvesthestate,throughanational oilcompany,enteringapartnershipandworkingtogetherwithanoilcompanyor companies.Inthisarrangement,itisthejointventureitselfthatisawardedrightsto explore,develop,produceandsellpetroleum. Inrealityitisraretofindanycontractthatfitsentirelyintooneofthe descriptionsgivenaboveandismorelikelytotakeelementsfromeach.

Accessing Contracts From The Outside

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.

27

Context

28

OUR FAMILY OF CONTRACTS


Wehaveselecteda"bouquet"ofpetroleumcontractsthatareinthepublicdomain touseforillustrationpurposesthroughouttherestofthebook.It'stimetomeet them!

29

Context

30

THE ANATOMY OF PETROLEUM CONTRACTS


Generallyspeaking,contractstendtofollowtheorderinwhichthingswould happeninapetroleumproject.Aftertheintroductionssuchasthelistoftermstobe usedinthedocumenttheymoveontoexploration,followedbydevelopmentand appraisal.Upuntilthispointthereisnopietodivvyupandsotheclausesdeal withoperationalmanagementissues.Oncecommercialproductionbegins,fiscal termsfollowinthecontractasinreallife.Afterthatcomeissuessuchaslocal content,disputeresolutionandconfidentiality,andotherissueswhichmaybemore specifictoeachcontract. Intheverybackofthecontract,itiscommontoseetheAccountingProcedures forcalculatingcostoilintheannexesofacontractandvariousmodelformsofthe ancillarycontracts,likeaParentCompanyGuaranteeortheJointOperating Agreement.Thesearereferredtoas"Annexes","Appendices"or"Addenda"which arealladditionaldocumentsthatarereferredtointhecontractbutforsomereason oranother,thepartiesthoughtthecontractwouldflowbetterwithitasaseparate documentortheneedforthedocumentcameafterthepartieshadagreedtothe contract. Togetasenseofhowgenericthesecontractscanbe,let'slookattheeight contractsthatmakeupthe"familyofcontracts"wequotefrominthisbook.The tablebelowshowsthearticlenumbersdealingwithvariousearlystagesinthelife cycleoftheprojectandthetotalnumberofarticlesinthemainsectionofthe agreement.Iraqdoesn'thaveanyclausesrelatingtoexplorationbecausetheyare dealingwithsizablediscoveredfields.

31

Context

Chasing Issues From Clause To Clause

But,althoughthereisacertainlogicalsequencetothecontracts,youcanoftenend upchasingaparticularissuearoundthecontract,beingreferredbackwardsor forwardsfromoneclausetoanother.Ifyouhaveaparticularquestionyouwantto gettheanswerto,itcanfeelsometimeslikeyou'replayingagameofSnakesand Ladders(orforUSreaders,ChutesandLadders!)

Definitions And Block Capitals

Althoughitseemsevenmoreinaccessiblethanmanyotherpartsofthecontract,it isoftenagoodideatogetcomfortablewithArticle1,thelistofdefinitions.This doesthelegaljobofspecifyingwhattermsinusethroughoutthecontractactually mean.Itcansavealotoftime,forexample,torealisethattheterm"EffectiveDate" intheIndonesiancontractshasaspecificmeaningasdefinedbelow:

EXCERPT FROM INDONESIAN MODEL CONTRACT


1.2.10 - Effective Date means the date of approval of this Contract by the Government of the Republic of Indonesia in accordance with the provisions of the applicable law.

Italsohelpstoknowthenthatthistermisnowanapprovedorreservedterm whichwillappeareitherincapitals("EffectiveDate")orsometimesblockcapitals ("EFFECTIVEDATE")throughoutthecontract.

Getting Answers From Contracts: Let The Chase Begin!

Let'ssayyouwanttoknowhowlongtheIraqiServiceAgreementlasts:whendoes itstartandwhenwillitfinish.Isita10yearcontract,15?50?Onemightthink thiswouldbeaveystraightforwardclauseinacontract:"thiscontractlasts25 years."Itisrarelythatsimple,unfortunately.Youhavebeenwarned. Toansweranyquestion,you'llwanttostartatthetableofcontents(hopethat thereisone,theyareyourbestfriendotherwise,thechasehasjustbecomethat muchmoredifficult)andseewhichheadingwouldseemlikelytoansweryour question.Inourcase,"TermofContract"(Article3)seemsthemost promising.FlippingtoArticle3,wefindthefollowing:

32

The Anatomy of Petroleum Contracts

EXCERPT FROM IRAQI SERVICE AGREEMENT


3.1 This Contract shall come into force on the Effective Date. 3.2 The basic term of this Contract ("Term") shall be twenty (20) Years from the Effective Date. This term is extendable pursuant to Article 21 or elsewhere in this Contract. 3.3 No later than one (1) Year prior to this Contract's expiry date, Contractor may submit written request to ROC for an extension of the Term for a maximum period of five (5) Years, subject to newly negotiated terms and conditions.

Onepartofourquestionisquiteeasy:thetermofthecontractis20years. Butwhendoesitstart?3.1says"ontheEffectiveDate".Becausethetermis capitalized,wehavetogotothedefinitionsandseewhatitsays.

EXCERPT FROM IRAQI SERVICE AGREEMENT


Definitions section - Effective Date means the date on which all the conditions listed in Article 39 are satisfied.

ThisdefintionshootsustoArticle39:

EXCERPT FROM IRAQI SERVICE AGREEMENT


39 - This Contract shall enter into force upon (i) it being signed by the Parties, (ii) the Initial Production Rate being agreed on the Parties and (iii) ROC notifying and representing to Contractor in writing that ratification has occurred and the Contract is enforceable accordance with the Law.

Notaverystraightforwardanswer,butananswernonetheless.Uponthese "triggerevents"(wheneverthosemayoccur)thatpointwillbewhenthecontract willlastfor20years. Exceptfortheexceptions.3.2tellsusthatthetermisextendablepursuantto Article31.You'llwanttoflipbacktothetableofcontentstoseewhatthisarticle covers,whichis"ForceMajeure"which,insummary,isaconceptfoundinmany contracts(notjustpetroleum)thatallowsthesuspensionofacontractwhileso


33

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.

EXCERPT FROM IRAQI SERVICE AGREEMENT


Definitions section - "----" or "ROC" means an Iraqi State oil company operating the Field prior to the Effective Date.

Wehaveourgeneralanswer.ThecontractorwillneedtogototheStatetoget5 moreyearsforapossibletotalof25years. Soinordertounderstandthisshortarticle,wehavenowbeenreferredtoatleast 4otherotherlocationsinthedocumentforafairlygeneralanswerandwewould needtoreviewtheentiredocumentforaspecificanswer! Thisisquitenormal.Petroleumcontractsareinterwoveninthisway.Youcould spendquitealongtimefollowingthetrailofanissuefromoneclausetoanother relatedclauseanditisonlywiththepassageoftimethatyoubegintodevelopa senseofwhenitmakessense,foryourimmediatepurpose,tofollowthetrailand whenitistimetostop.

They're Not Perfect

Lastly,althoughitmightbesurprisingindocumentswhichhavebeenporedover formonthsandsometimesyearsbydozensofpeople,therearesometimesglitches. Someexamples:


The version of Ghana's agreement with Tullow, which is countersigned by both parties, goes straight from Article 23 to Article 25 in the Table of Contents.

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

34

The Anatomy of Petroleum Contracts

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.

Finally,evenifyouareonlyinterestedinoneagreement,itisworthspending thetimetoreadseveralotherstobegintogetasenseforwhatiscommonin petroleumcontractsandwhatmightbeofmorespecificinterestintheoneyouare lookingat.Theextraconfidenceandunderstandingyougainwillmorethanrepay thetimeandeffort.

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.

35

Context

36

petroleum basics

The Actors & the Script

The Actors and the Script

38

THE STARS OF THE SHOW


Ifthepetroleumcontractisthescript,thestarsoftheshowarethoseentitiesthat signthecontractandagreetobeboundbyitstermandconditions.Theyarewhat wecallthe"parties"tothecontract.Thepartiesareusuallythehostgovernment lineministryoritsstate/nationaloilcompany(NOC)ontheonehand,andanIOC oragroupofIOCs,ontheother.IOCsmaybereferredtoasthecontractor,the licenseeortheconcessionairedependinguponthetypeofthepetroleumcontract signed.FrequentlymorethanoneIOCisapartytothepetroleumcontract.Such groupofIOCsiscalleda"consortium".Eachofthecompaniesareanindividual partytothecontract,butaretreatedasoneentityandarecollectivelycalledthe "contractor",the"licensee"orthe"concessionaire".Fromthestate'sperspective,if theIOCstogetherfailtofulfilltheirobligationsthentheyareallatfault.Inlegal languagetheIOCsaresaidtohave"jointandseveralliability"fortheperformance ofthecontractor'sobligationsunderthecontract.

NOC's Multiple Roles

InadditiontotheNOCbeingpartytothepetroleumcontractonbehalfofthestate, thescriptmayrequiretheNOCtoplayanotherroleaswell.Thehostcountryand theIOCmayagreeonsomeformofstateparticipationintheproject.Inthisevent, theNOCwillbeapartytothepetroleumcontractaswellastherepresentativeof thestategrantingrightstotheotherparties.SometimesanaffiliateoftheNOCis establishedforthepurposeofrepresentingtheNOCinthedirectoperationsofthe project.Suchstateparticipationmaybebothoneofthefiscaltoolsavailabletothe stateasdiscussedinthesection:"'TheMoney'"andameanstopromotebroader nationaldevelopmentgoalsasdiscussedinthesection:"EconomicDevelopment".

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.
39

The Actors and the Script

countries,notBPtheparentcompany. Oftentheonlyassetofthisaffiliatecompanyisthefieldasdeterminedinthe petroleumcontracttowhichitisaparty.Thisexposesthecountry,andtherefore theotherpartiestothecontract,toalotofrisk.Thisisbecausethereareno availablefinancialresourcesonthiscompany'sbalancesheet,onlyoilinthe groundtocoveranycosts.Inordertomitigatethisriskthestatewilloftenrequirea companywithintheBPfamilyandwithmoreassetsandfinancialstrength(a "biggerbalancesheet")toguaranteethattheaffiliatecompanywillperformits obligations.Iftheaffiliatefailstoperformitsfinancialobligationsunderthe petroleumcontractthestatecanrequiretheparentcompanytostepintofulfillits affiliate'sobligations.

The Plot - Sneak Preview

Thechapter,"TheAnatomyofPetroleumContracts"setsoutthemainclauses containedinmostpetroleumcontractsandtheotherchaptersinthisbooktalkin somedetailaboutthethemainrightsandobligationsoftheparties.Petroleum contractswilloftensetoutaprovisionthatcapturesthefundamentalgrantofrights tothepartiesaswellastheassumptionofobligationsbytheparties.Thisprovision providesthekeygrantofrightsthatunderliestheentireperformanceofthe contract.Anexampleisgivenbelow:

EXCERPT FROM THE AZERBAIJAN AGREEMENT:


2.1 Grant of Exclusive Right. SOCAR hereby grants to Contractor the sole and exclusive right to conduct Petroleum Operations within and with respect to the Contract Area in accordance with the terms of this Contract and during the term hereof. .....

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:

40

The Stars of the Show

EXCERPT FROM THE BRAZIL MODEL AGREEMENT:


13.1 - "During the effective period of this Agreement and according to its terms and conditions, the Concessionaire shall have, except as contemplated in paragraph 2.6, the exclusive right to perform the Operations in the Concession Area, for this purpose being obliged to, at its own account and risk, make all investments and bear all necessary expenses, to supply all necessary equipment, machines, personnel, service and proper technology and to assume and respond for losses and damages caused, directly or indirectly, by the Operations and their performance, regardless of pre-existing fault, before the ANP, the Federal Government and third-parties, according to paragraphs 2.2, 2.3 and other applicable provisions of this Agreement."

Thisclausesetsoutanobligationontheconcessionairetomakeinvestments, bearallcosts,andprovideallnecessaryequipments,personnel,technology requiredfortheconductingofpetroleumoperations. Contractsalsoincludeprovisionsonrightsandobligationsofhostgovernments. Afterall,theyareapartytothecontract,too.Anexampleshowingtherightsofthe hostgovernmentisshownbelow:

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.

Thesamecontractalsoputsanumberofobligationsonthehostgovernment, suchasforthemtograntallnecessarypermitsandlicensesforconducting petroleumoperationsandopenbankaccounts,provideentryandworkpermitsfor employees,providepermitsforimportingequipmentandmaterials,provideaccess

41

The Actors and the Script

topipelines,preventhinderingtheconductingofoperations,etc. Thecontractswilllayoutadecisionmakingprocessthatwillbeused throughoutthelifeofthecontract.Thisenablesboththegovernmentandthe contractortofulfilltheirrespectiveobligations.Thisisessentiallyaseriesof proposals(bythecontractor)andapprovals(bythestate)aseventsunfold. Threebasicmechanismsareused: Yearlyworkprograms Plansforthepetroleumprojectphase CommitteesmakedecisionsandtheOperatorcarriesthemout Thechaptersthatfollowexplainalloftheseinmuchmoredetail.Thenext chapterdescribesthedecisionstobemadeineachphaseofthepetroleumproject. Thenextdescribeswhodoescommiteedecisionmakingprocess.Thelastdescribes howtheoperatorcarriestheseout.

Shifts In Power And Nationalisation

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
42

The Stars of the Show

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.

43

The Actors and the Script

44

THE ROLES THEY PLAY


WhatIOCsmustdo,when,where,how,andatwhatcost,constituteoneofthethe fundamentalareasinpetroleumcontracts.Toaddresstheseissues,petroleum contractsincludeimportantclausesrelatedto: thedefinitionofanareawhereexplorationandproductionwillbeconducted thesurrenderingofunusedpartsofsuchareabacktothegovernment workandfinancialcommittmentsduringeachphasesofpetroleumoperations evaluationofapetroleumfindinganddevelopmentofthefield annualworkprogrammesandbudgets dataandreportstobeprovidedtothegovernmenttoinformitandfacilitateitin thedecisionmakingprocess ...andmanymore

Where: Contract (Concession) Area Or Block

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:

45

The Actors and the Script

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."

Underthisclause,thesizeandmapoftheContractAreaisnegotiatedandagreed betweenthepartiesandattachedtothecontract.Inadditiontosuchclauses,the petroleumcontractstendtoexplicitlyexcludetherightsofoilcompaniestoany othernaturalresourcesoraquaticresourcesinthecontractareaexceptfortheright toexplore,developandproducehydrocarbons. Thesizeofthecontractareamayimpactwhathappensinit.Thelargerthe contractareais,themorelikelytherewillbemanyactivitiesgoingonit.

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
46

The Roles They Play

answeredwhenthecontractissignedsincewedonotyetknowwhethertherewill beanythingtoappraiseatall.Contractdetailsconcerningthedevelopmentorlater phasesareevenmorespeculativethepartiescouldn'tpossiblyknowhowmany wells,platforms,andwhattypewouldbeneededwithoutknowingwhatisinthe ground.Buttheydocreateprocessesforwhattheyhopewillresult:oilproduction.

What Happens During The Exploration Period

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.

47

The Actors and the Script

Minimum Work Obligations In Exploration Phase

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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The Roles They Play

EXCERPT FROM THE EQUATORIAL GUINEA MODEL PRODUCTION SHARING AGREEMENT:


"(a) obtain... all existing 2D and 3D seismic data and Well data at a purchase price of [___] Dollars ($[___]) and obtain from GESeis all existing 3D seismic and seabed logging data...and the Contractor shall undertake to interpret such information; (b) reprocess [____] kilometers of existing 2D seismic data and [___] kilometers of 3D seismic data; and (c)acquire [____] kilometers of new 3D seismic data. During the Second Exploration Sub-Period, the Contractor must drill a minimum of [___] Exploration Well[s] to a minimum depth of [_____] meters below the seabed. The minimum expenditure for this period shall be [___] Dollars ($[____])."

Undertheoutlinedmodel,thecontractorshallnotonlyacquireandinterpret certainseismicrequiredtodrillanumberofexplorationwellsandinvesttheagreed amountofrequiredfinancialcommitments.Suchfinancialcommitmentsareusually equivalentinvaluetotheestimatedcostsoftheminimumworkprogramswhichare stipulatedintheagreementforeachyear.Intheeventofthestipulationofthe definedamountoffinancialcommitment,thecontractormustsatisfyboththe minimumworkcommitmentandtheminimumfinancialcommitmentfora particularyear.Thus,iftheminimumfinancialcommitmenthasbeenmetbutthe minimumworkprogramhasnotbeencompleted,thecontractormustnevertheless completethatworkprogram.Conversely,iftheworkprogramiscompletedbutthe financialcommitmenthasnotbeenfullyexpended,thecontractorwillberequired toconductadditionalexplorationactivitiesuptothebalanceofthefinancial commitment.

Relinquishment
49

The Actors and the Script

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
50

The Roles They Play

Thereisaconsiderablevariationinrelinquishmentobligationsinworld petroleumcontracts.Thetimeperiodsforrelinquishmentshouldbeviewedinthe contextofthesizeofthecontractarea,theoveralllengthoftheexplorationperiod andthenatureoftheexplorationareaitself.Generally,suchobligationsaremore strictinpetroleumproducingcountrieswithprovenreservesthanincountrieswith alowerpotentialforoilproduction.Theareastoberelinquishedmayconstitute between50%and75%oftheoriginalcontractarea.Relinquishmentisusually madeintwoorthreesteps,say,25%eachtwoyear.

Discovery, Appraisal, Declaration Of Commerciality And Development

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:

51

The Actors and the Script

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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The Roles They Play

EXCERPT FROM THE THE AZERBAIJANI PSA:


4.4 - (i) proposals relating to the spacing, drilling and completion of all wells, the production and storage installations, and transportation and delivery facilities required for the production, storage and transportation of petroleum; and (ii) proposals relating to necessary infrastructure investments and use of Azerbaijan materials, products and services ; (iii) a production forecast for formation fluids for the entire contract Area by reservoir derived from individual well forecasts and an estimate of the investment and expenses involved; and (iv) an environmental impact and health and safety assessment; and (v) an estimate of the time required to complete each phase of the development programme.

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.

Annual Work Programs & Budgets


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The Actors and the Script

Annual Work Programs & Budgets

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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The Roles They Play

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."

Aswillbefullydiscussedinthenextchaptersanannualworkprogrammesand budgetswillgenerallybeapprovedbythejointmanagementcommitteeorthe relevantministry,asthecasemaybe.Acontrolonannualworkprogrammesand budgetsallowshostgovernmentstosupervisetheimplementationofageneral DevelopmentProgrammeand/orProductionProgrammeandthecostsassociated withsuchworks.

55

The Actors and the Script

56

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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The Actors and the Script

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
58

Joint Management

Decisionsofjointmanagementcommitteesmayrequiretheunanimousor majorityvoteofthepartiesoncertainissues.Intheeventthereisnomajority consensusofthepartiesinsuchavote,theremayariseadeadlock,withaneven numberofvotesoneachside.

Deadlock Built In - Who Has The Deciding Vote?

Onestrikingfeatureofmanyofthesemanagementcommitteesasspecifiedinthe contractsisthat,incredibly,theyavoidaddressingthequestionofwho(between thegovernmentandtheIOC)getstohavethedecidingvote.Ifyouhaveeverbeen onacommitteewhentherewassignificantdisagreementandnowaytovoteand moveon,theboatcanstarttorockwhenthereisdisagreementandnoclearwayto resolveitbyasimplevote. TheLibyancontractforexamplespecifiesacommitteeoffour,withtwofromthe companiesandtwofromthegovernment.Ghana'scontractwithTullowspecifies eightmembers,fourandfour.Butneithercontractactuallyspecifieswhattodoin thecaseofatie.

EXCERPT FROM THE LIBYAN EPSA STATES:


4.2 - In case of a deadlock, the Management Committee shall refer the matter to the senior management of the Parties. In case the Parties reach an agreement, the Management Committee shall convene and adopt a decision reflecting such an agreement.

Sowhathappensif"theParties"don'treachanagreement?Thiscontractdoesnot specify. TheKurdistanRegionalGovernment'scontractwithTalismanisevenmore complex.TheManagementCommitteehasfourmembers,twofromeachside,one ofthetwofromthegovernmentsideisthechairmanofthecommittee,andinthe eventofdeadlockonanyparticulardecision,

EXCERPT FROM THE KURDISTAN REGIONAL GOVERNMENT:


8.3 - Except as provided for in Article 8.4 and 8.5, in the event that no agreement is reached at the second meeting, the Chairman shall have the tie-breaking vote.

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The Actors and the Script

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".

Even More Ambiguity

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
60

Joint Management

ofinvestmentandlevelsofproductionandissuesrelatingtodomestic.Companies generallywanttoinvestaslittleaspossibleforanygivenlevelofproductionas, unsurprisingly,theiraimisprofitmaximisation.

61

The Actors and the Script

62

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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The Actors and the Script

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.

InIraq's2009serviceagreements,theJOCtypestructurespecifiedwasaField OperatingDivision,aunitwhichwasdetachedfromanexistingparentcompany ownedbytheIraqistate.Underthisstructure,ultimateauthoritylieswiththeIraqi state,butlowerleveldecisionsaredelegateddownwardstotheManagement Committeeandthentotheapprovedoperator,theFieldOperatingDivision.

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.

What Does The Operator Do?

Taking,againtheShahDenizPSA example,theobligationsoftheoperator arethePetroleumOperations,asoutlinedbelow:

64

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.

Reporting And Monitoring

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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The Actors and the Script

andthiscostsmoney,sothecontractsmayalsorequiretheIOCstosaveandkeep unusedcoresandsamplesfromwellsandmakethemavailable,aswellasalldata resultingfrompetroleumoperations,includinggeological,geophysical, engineering,welllogsandproductiondata,aswellasreports,analyses, interpretations,maps,andevaluations. Somecontractssupplyalotofdetailaboutwhatexactlythecompanyhasto provideforexample,intheShahDenizPSA itiswritten:

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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the money

The Money

68

MATHS, MYTHS, AND MENTALLY WARMING UP


Let'sfaceit:mostofusdonotdomathematicseveryday.Withcalculators, computers,andeconomistsaroundus,whydothemathsourselves?Formany,the lasttimewecontemplatedpercentagesandequationsandthelikemayhavebeen highschool.Butnumbersareunavoidableinthissectiononthefiscalregimeof petroleumcontracts,andactuallyitturnsoutthey'renottoobad.

The Origin Of The Maths

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.

Let's Get Down To It

Now,togetsomeunderstandingofhowitworks,wehavetogetourhandsdirty. Thissectionstartsbybuildingfromthegroundup,runningthroughtherangeof fiscaltoolsthatareincurrentuseandwhichtogetherareusedtobuildafiscal regime.Next,inFiscalStrategiesandSolutions,weexaminesuchregimesintheir entiretyandhowtheyaddressparticulargoalsagovernmentmighthavein developingitspetroleumindustryornot.Thenwelookathowgovernmentsand theircitizenscanassesshowtheyaredoinginfiscalandfinancialtermsandfind thatdespitetheavailabilityofstatisticsitisnoteasilyreducibletoonefigure. Finally,weexplorehowoilispriced,anotheraspectwhichisnotasstraightforward asitmightsound.

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The Money

Aspeoplerightlydemandmoreinformationabouthownaturalresourcesare beingmanagedontheirbehalf,thereisatendencytograbwhateversnippetsof informationarearoundandtakeitforthewholepicture.Unfortunately,Thereisno onesinglenumberthatcanexplainthewholefinancialsituation.


EXAMPLE 1: if you hear that your state-owned oil company has a 25% share in a consortium, you might assume that your country is only getting a 25% share of revenues. This isn't necessarily true - the actual figure might be a lot higher. In many contracts, there are bonuses, gross royalties, profit oil, cost oil, state participation and all kinds of taxes that all contribute to the state's total benefits from the petroleum. If you hear a government has 70%, the first question you should ask is 70% of what? A percentage must always have a base, or the value of which the percentage is calculated. Saying your country gets 70% doesnt get you as far as you might want: what assumptions were used? When we will get this 70%? These are all questions that a percentage does not answer.

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

Lastly,theresoftenconfusionaboutthedifferencebetweenrevenuesand profits.Toclarify:aprojectgeneratesincome,forexamplethroughthesaleof crude.Aproject'sincomeissometimesalsoreferredtoasrevenues.Usually,there


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Maths, Myths, and Mentally Warming Up

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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72

THE FISCAL TOOLKIT


StatesandInternationalOilCompanies(IOCs)havemanyoptionsattheirdisposal tosharethevalueofoilandgasprojects.Let'scallthese'tools'thatthestateorIOC canusetodetermineafiscalpaymentthatismadetoeitherside.Together,these toolsmakeupa'toolkit'thatcanbeusedtodesignthefiscalregimetherulesfor managingmoneyinapetroleumcontract. ThebasicconcepthereisthatthestateandtheIOCneedtosharethe'divisible income'.Thisisthetermusedtodescribetheamountofmoneythatremainsafter thelifetimerevenuesofapetroleumprojectarereducedbythelifetimecostsofthe project.

Theshareofthedivisibleincomethatgoestothestateiscalled'government take'.TheremainderthatgoestotheIOCiscalled'investortake'or'contractortake'. Thischapterwilldescribeeachofthefiscaltoolsthatarecommonlyusedin petroleumcontracts.Thenextchapterwillthendescribehowstatesselectsomeof thesetoolstocreateapetroleumfiscalregimethatsharesthedivisibleincome.

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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.

Tools For Concessions, Production Sharing Contracts And Participation Agreements

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.

Tools For Risk Service Contracts

Thefiscalregimeforariskservicecontractisdistinctfromallotherpetroleum contracts.Thisisbecause,theelementofservicebytheIOCiswhatisbeing compensated.Inthese,unliketheagreementsmentionedabove,paymentflows fromthegovernmenttotheIOCforservicesrendered. So,withthiscontracttype,thegovernmentretainstheoverallrevenue,minus whattheypaytothecompaniestheservicecontractsimplydefinestermsand conditionsforcertainservicesthattheIOCcarriesout,forwhichitispaid. Governmentsnaturallyliketheideologybehindtheserviceagreementmodelasit reinforces,politicallyandfinancially,ahighdegreeofcontrolandcomplete


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The Fiscal Toolkit

reinforces,politicallyandfinancially,ahighdegreeofcontrolandcomplete ownershipoftheresource.Iraq'sserviceagreementsof200911,areanexampleof suchariskserviceagreement. Thereisonlyonetypeoffiscaltoolforriskservicecontracts,andthatisthe 'servicefee'whichmaybedefineddifferentlypercontract.

Description Of Individual Fiscal Tools

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.

ProductionBonusapaymentmadeatacertainpointintimeduringthelifeof thepetroleumcontract. Aproductionbonusmayoccuratthetimethatacommercialdiscoveryis declared,atthetimethatpetroleumproductionbegins,atadefinedproductionrate, oratadefinedquantityofcumulativeproduction.Anexampleofpayable


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oratadefinedquantityofcumulativeproduction.Anexampleofpayable productionbonusesisshownbelow.

EXCERPT FROM THE LIBYA EXPLORATION AND PRODUCTION SHARING AGREEMENT:


(a) an amount of one million US Dollars (US $1,000,000) to be paid in respect of each Commercial Discovery within thirty (30) days after Commercial Production Start Date of such Commercial Discovery; and (b) an amount of five million US Dollars (US $5,000,000) upon achieving cumulative production of one hundred million (100,000,000) Barrels of oil equivalent from each Commercial Discovery and thereafter, an amount of three million US Dollars (US $3,000,000) upon achieving each additional thirty million (30,000,000) barrels of oil equivalent.

Theproductionbonusprovidestothegovernmentafixedamountofrevenueata certainpointintime.Also,thisbonustendstoincreaseastheamountofproduction increases. Rentalafixedpaymentmadeonanannualbasisatthebeginningofthe calendaryearorcontractyear. Arentalmaytakeondifferentformsitcouldbeafixedamountforthecontract, orfixedamountpersquarekilometreofoperationsland,oranegotiatedamount.It maybepayableduringtheexplorationphase,theproductionphaseorboth.


in Ghana, there is a rental of $30 per km per km
2 2

during the first exploration period, $50


2

during the next exploration period, $75 per km


2

during the final

exploration period and $100 per km phases.

during the development and production

Therentalservesanumberofpurposes.Itprovidestothegovernmenta guaranteedannualincomeofaknownamount,whichhelpsinbudgetplanning, irrespectiveofchangingoilprices.Thegovernmentcancalculatetheexpected amountofrentalpaymentsitwillreceivebasedonthenumberofpetroleum contractsithasgrantedandtheareathattheycover.Thiscontributestothe government'sadministrativecostsofrunningthepetroleumoperation.Italso createsamildincentivefortheIOCtovoluntarilyrelinquishanyareawhereitdoes notintendtoconductexplorationactivity,permittingthegovernmenttoofferthat areatoothercompanies


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areatoothercompanies Rentalsareusedgloballyinconcessions,productionsharingcontractsand participationagreements.IOCsareoftenalsorequiredtopayadditionalamounts foraccesstothesurfaceforconductingpetroleumoperationssometimestothe privateoccupiersofthesurface,andsometimestothestate. Royaltyapaymentmadebyreferencetotheamountandvalueofpetroleum produced Aroyaltyisatraditionalfeatureofmanypetroleumcontracts.Aroyaltyis usuallycalculatedwithoutdeductionofanycosts.Therearevariousformsof calculatingroyalty,asoutlinedbelow.

Fixed Percentage Royalty

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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Theconceptofaslidingscaleisalsousedinrelationtoprofitshareswhichare discussedbelow.Thefollowingdescriptionofslidingscaleswillthereforebe applicabletothatfiscaltoolaswell.

Sliding Scale Royalty

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.

Anincreasinglycommonmethodforcreatingaslidingscalethatisdesignedto addressprofitabilityistheuseofwhatisreferredtoasthe'Rfactor'.'R'standsfor 'ratio',soanRfactorisaslidingscalethatemploysaratiooftwonumbersto determinearate.Intheoil&gasindustry,themostcommonRfactorisaratioof cumulativerevenuesdividedbycumulativecosts,asfollows: R=CumulativeProjectRevenues CumulativeProjectCosts Rislessthanonewhenapetroleumcontractfirstbegins.andtheIOCis incurringcostsbutdoesnotyethaveproductionso,whenprojectcostsare


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The Fiscal Toolkit

incurringcostsbutdoesnotyethaveproductionso,whenprojectcostsare greaterthanprojectrevenues R=1onceprojectrevenuesequalprojectcosts(atimewhichiscommonly referredtoas'payout') Rismorethanonewhenprojectrevenuesaregreaterthanprojectcosts,inthe productionphase AnRfactoristhenusedtocreateaslidingscaleroyaltyasfollows(usingPeruas anexample):


R-FACTOR: ROYALTY RATE: 0 < R < 1.0 1.0 < R < 1.5 1.5 < R < 2.0 R > 2.0 15% 20% 25% 35%

Therefore,aroyaltyratethatbeganat15%forinitialproduction(whentheR factorislessthanone,becausecostsaregreaterthanrevenues)wouldjumpbysteps to35%whentheIOChasreceivedoutofproductionrevenueanamountequalto twiceitscosts,whentheyareintheproductionphase.

Royalty Determination Point

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

Intheexampleabove,a10%royaltywouldbe$8.90ifdeterminedattheexport terminal,$8.50atthefieldterminaland$8.30atthewellhead.Insimilarsituations fornaturalgas,thedeductionsleadingtothevalueatthewellheadcanbeso significantthattheroyaltyissignificantlyreduced.

Royalty Determination

Aroyaltyistypicallypaidonallproductionfromthewell,buttherecanbesome exclusions,suchas: oil&gasventedorflared(wherepermitted) oil&gasreinjectedinthereservoir oil&gasusedinfieldoperations oil&gaslost(solongaslossesdidnotresultfromnegligentconduct)

Payment In Cash Or In Kind

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

Somestatesapplydiscountstothepriceatwhichoilistobesoldbypetroleum companiestothedomesticmarket.Thisobligationtoselltoadomesticmarketata discounthasthesameeconomiceffectonanIOCasaroyalty.


EXAMPLE: In Indonesia, there is a 'local market obligation' to sell 25% of production into the domestic market at 25% of the world oil price, following a five year holiday.

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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Nowlet'sexaminethedifferentwaysthatprofitoil/gassharesaredetermined, andcostoil/gaslimitsareestablished.Foreaseofreading,inthissectionwewill speakonlyof'profitoil'and'costoil'thesameconceptsapplyequallytogas.

Fixed Profit Oil Shares

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Fixed Profit Oil Shares

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

Sliding Scale Profit Sharing

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

15% 20% 25% 35%

Cost Oil

CostoilistheshareofproductionthatisallocatedtotheIOCtopermittheIOC torecoverthecostsithasincurredinconductingoperationsunderthepetroleum contract.Moststatessetalimitontheamountoftheproducedoilthatcanbe allocatedforcostrecoverythisiscalledthe'costoillimit'.


Cost oil limits can vary from 25% (as in Croatia), 40% (as in Equatorial Guinea and Tanzania), 50% (as in Gabon, Qatar and Congo (Brazzaville) and 90% (as in Cambodia and Madagascar).

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:

EXCERPT FROM THE GHANA MODEL FORM PETROLEUM AGREEMENT:


2.4 - "GNPC shall have a ten percent (10%) Initial Interest in all Petroleum Operations under this Agreement. With respect to all Exploration and Development Operations GNPC's Initial Interest shall be a Carried Interest. With respect to all Production Operations, GNPC's Initial Interest shall be a paid interest." "Carried Interest" is defined as: "an interest held by GNPC in respect of which Contractor pays for the conduct of Petroleum Operations without any entitlement to reimbursement from GNPC".

PursuanttoArticle2.4,theInitialInterestprovidesforstateparticipationfrom thestartofthecontractandthattheInitialInterestisaCarriedInterestwithrespect toExplorationandDevelopmentOperations.Thismeans,perthedefinitionof "CarriedInterest",thattheoilcompany(Contractor)willpaysuchcostsandhave norightofreimbursementthatis,itisafull/free/hardcarry.However,GNPCwill havetopayits10%shareofthecostsofProductionOperationsasstatedbythelast sentenceinArticle2.4above. InrelationtotheAdditionalInterest:

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EXCERPT FROM THE GHANA MODEL FORM PETROLEUM AGREEMENT:


2.5 - "In addition to the Initial Interest provided for in Article 2.4, GNPC shall have the option in respect of each Development and Production Area to contribute a proportionate share not exceeding [x]% of all Development and Production Costs in respect of such Development and Production Area....thereby acquiring an Additional Interest of up to [x]% in Petroleum Operations in such Development and Production Area. GNPC shall notify Contractor of its option with ninety (90) days of the Date of Commercial Discovery."

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:

EXCERPT FROM THE GHANA MODEL FORM PETROLEUM AGREEMENT:


2.9 - "elect to have the Contractor advance part or all of GNPC's total proportionate share of Development Costs as they are incurred..............Such advances shall be reimbursed with interest at the Specified Rate from GNPC's entitlement after recovery of Production Costs as provided in Article 10;"

ThisprovisionallowsthatGNPCcanbecarriedbytheContractorforits AdditionalInterestshareofdevelopmentcosts.Thelanguageisclearthatthisisan advance(oraloan)bytheContractorwhichwillbereimbursedbyGNPCwith interestoutofproductionafterrecoverybyGNPCofitsshareofproductioncosts. Thus,ifGNPCelectstobecarriedinthiswayunderArticle2.9thiswillbeapartial orasoftcarry.However,inrelationtotheAdditionalInterest,liketheInitial Interest,noneoftheseprovisionsrequireGNPCtopaybacktheContractorfora shareoftheexplorationcostspreviouslyincurredbytheContractor.So,inrelation toexplorationcosts,thereisafull/free/hardcarryfortheAdditionalInterestaswell


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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.

Other Profit-Based Taxes

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)

Other General Taxes

Moststateshaveavarietyofothertaxeswhichcapturerevenueforthestateina varietyofactivities.Thesearenottaxeswhichareuniquetotheoilindustrythey areintendedtoapplytoallcorporateentities: VATorvalueaddedtax importduties exportduties turnovertaxes industrialtaxes withholdingtaxes AnIOCneedstobeattentivetothefullvarietyoftaxesthatareapplicableina particularstatebeforeinvestingthere.Similarly,astateneedstobealerttothefact thatthesetaxes(andsometimesthebureaucracyinvolvedinadministeringthem) maytipthebalanceforaninvestorsothatapetroleumprojectceasestobe economic.
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economic.

Exemptions And Waivers

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:

Per Barrel Fee

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Per Barrel Fee


EXAMPLE: Iraq's Ministry of Oil has successfully awarded a series of risk service contracts in four bid rounds (called Technical Service Contracts, Development and Production Service Contracts or Exploration and Production Service Contract, depending on the round) which pays the contractor a fee per barrel of oil produced. These fees were as low as $1.15 per barrel to as high as $7.50 per barrel, which is remarkably low. However, the fields on offer in the first three rounds were all discovered areas, some of which were supergiant fields with over five billion barrels of oil reserves. The fees were further reduced by a 25% fully carried state participation and a 35% income tax; the government take for these contracts was as high as 99% in some cases. Also, the per barrel fee is reduced by up to 70% as the R factor increases from zero to 2.0, which further reduces the IOC take. The IOC fees are converted to barrels of oil which is delivered at an Iraqi export point. IOC costs are recovered out of 50% of incremental oil production.

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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ThepreviouschapterlistedthefiscaltoolsthatgovernmentsusewithIOCstoshare betweenthemtheincomefromapetroleumproject.Thischapterwilldescribehow thesetoolsareusedtocreatea'fiscalregime'underaparticularpetroleumcontract. Itisimportanttorememberthatthereareover500differentfiscalregimesinuse todaymorethanthenumberofcountriesintheworld!Somecountriesusemore thanonetypeoffiscalregime.Thisresultsfromthedifferentpetroleum opportunitiesthatexistinsomecountries,andthedifferentrisks,costsandrewards thatmaybegainedfromtheseopportunities.Forexample,offshoreoil&gas explorationtendstobemoreexpensivethanonshore,sothefiscalregimeneedsto beadjustedtoreflectthis.Naturalgasprojectshaveadifferentprice,cost, regulatoryandoperationalenvironment,sofiscaltermsforgastypicallyaremore generoustotheIOCthanforoil. We'regoingtogiveawaytheconclusionrightnow:thereisnosinglesystem thatistherightoneforeverysituation.Therearewidedifferencesingeological prospects,reservoirconditions,costs,prices,infrastructureandavailabilityof services.Attractiveinvestmentopportunitiescanexistineachjurisdiction,anda fiscalsystemthatworksinonejurisdictionmaynotworkinanother.

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.

Understanding Regressivity And Progressivity

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.

Corporateincometaxisaneutralfiscaltool,becausethetaxisappliedtoa corporation'snetincome(orprofit).Thetaxrateisthesame,regardlessofwhether thatprofitislargeorsmall.Fixedpercentageprofitsharingworksthesamewayit isalsoaneutralfiscaltool. Anexampleofafiscaltoolthatincreasesthestate'sshareofprofitswhen profitabilityincreasesisanRfactorroyaltyorprofitshare.IntheAzerbaijan


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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.

Profitability And The Fiscal Tools

Nowthatweunderstandtheconceptsofregressivityandprogressivity,andthe statecandecidehowitwantstoapproachthisissue,wecanassesswhichfiscal toolstouse.Hereisalistofthefiscaltoolsdescribedinthepreviouschapter,and whethertheyareregressive,neutralorprogressive: signaturebonus:veryregressive


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signaturebonus:veryregressive productionbonus:veryregressive fixedroyalty:regressive slidingscaleroyalty:progressive corporateincometax:neutral fixedprofitshare:neutral slidingscaleprofitshare:progressive stateparticipation:neutral profitbasedtaxes:progressive othergeneraltaxes:varies,butgenerallyregressive servicefeesystems:veryprogressive

Timing Of Petroleum Revenues

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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Servicefeesystemsarenotaseasilycategorizedbecausethegovernmentpays thecontractoraservicefeeretainsalltherevenues.Theimpactonthestateandthe investorvarieswiththeservicefeesystemthatischosen.

Risk For The State

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

Encouraging Initial Investment And Re-Investment

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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Fiscal Strategies and Solutions

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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dependsonringfencetreatment stateparticipation:disincentivetoinvestreinvestmentimpactdependson whetherstateoilcompanyiscarriedonthesubsequentinvestment profitbasedtaxes:neutralonincentivetoinvestreinvestmentimpactdepends onringfencetreatment

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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Fiscal Strategies and Solutions

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.

Stateparticipationrightsworkinasimilarway.Theeconomicimpacttothe IOCofacarriedparticipationaffectswhattheeconomistscallthe'maximum sustainablerisk'.Ifyoutakeawaytoomuchoftheexplorationincentive,it'ssimply notworthplayingthegame.Thisiswhyacarriedinterestforthestateisa disincentivetoinvest,andthelargerthecarriedinterest,thegreaterthe disincentive.Itisalsoadisincentivetoreinvestifthestateoilcompanyisalso carriedonthereinvestmentactivities.Nevertheless,thisisafiscalfeaturethatmore statesareadopting.

Solutions

Nowthatwehavesurveyedthestrategicissuesandtheimpactthatvariousfiscal toolshaveonthosestrategies,let'slookatsomepossibleobjectivesthatastate mighthaveandanalysethehowthefiscaltoolsshouldbeusedtoattainthose objectives.Thefollowinganalysisisalsousefulforreadersofapetroleumcontract toassesstheextenttowhichaparticularpetroleumcontractissuitablydesignedfor itsstatedobjective.

Promoting Exploration

Ifastatewantstoencourageexplorationactivity,thefiscalpackageshouldinvolve thefollowingfeatures: lowornosignaturebonus lowrentalduringexplorationphase fulldeductibilityofexplorationexpendituresundercorporateincometax highcostoillimitinproductionsharingcontract avoidcarriedinterestsforstateparticipation

Promoting Cost-Effective Operations

Somestatespreferaprofitbasedtaxationsystemthatisprogressiveandbackend loaded.WhattheyoftenfindisaresultwhereIOCsincurhighcosts.Ifastate wantstoencouragecosteffectiveoperationstomaximizeprofits,thefiscalregime should:

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avoidIRRbasedslidingscales avoidRfactorsystemswithhighmarginaltaxratesonprofitoil avoidupliftswheretheIOCisentitledtoadeductionofgreaterthan100%of anycost Also,servicecontractstendnottopromotecosteffectiveoperations,becausethe IOChasnofinancialincentivetominimizecostundermostservicefeestructures.

Marginal Field Development

Somestatesneedtomanageproductionfrommarginalfieldsorpetroleumbasins thataremature.Thefollowingfiscaltoolsareappropriate: useslidingscaleroyaltiesbasedonproductionrates allowhighdepreciationratesfordevelopmentcosts allowfullconsolidationforcorporateincometax avoidhighfixedroyalties allowhighcostoillimits(ornoneatall) utilizeIRRandRfactorsystems

Gas Development

Theeconomicsofgasexplorationanddevelopmenttendtobelessattractivethan foroil.Developmentcostsaretypicallymuchhigher,andproductionpricesare generallylower.However,manystatestreatbothtypesofresourceinthesame way,andgasdevelopmentisstunted.Thefollowingfiscalfeaturescanhelp: lowerroyaltyforgas highdepreciationratesforcorporateincometaxongaspipelinesandother facilities highcostgaslimits,lowerprofitgasshareforthestate exemptgasprojectsfromspecialtaxes exemptgasprojectsfromcarriedstateparticipation

Alignment
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Fiscal Strategies and Solutions

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.

The Shift To Non-Conventional

Thereisasignificantmovementinthepetroleumindustryinthepastdecadethatis resultingingrowingfocuson'nonconventional'petroleumresources.Thishasthe potentialforsignificantchangeinpetroleumregimesandcontracts.

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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).

Conventionaloil&gasislikethetenderloinandsirloinit'sthe'steak'ofthe petroleumcow.Itiscomparativelyeasierandlessexpensivetofindanddevelop, andit'sthetastiestparttoo.However,justasweeatotherpartsofthecow,thereare otherpartsofthepetroleumcowthatcanproduceoil&gastoo.Shalegas,coalbed methane,oilsands,ultraheavyoilcanalsobeproduced. However,justasthebrisketandshankofacowcannotbecookedlikeasteak, weneeddifferent'recipes'tomaketherestofthepetroleumcowattractive. Differentfiscaltermsarerequiredinordertomakeattractivethesemorecostly,and


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Fiscal Strategies and Solutions

Differentfiscaltermsarerequiredinordertomakeattractivethesemorecostly,and oftenlessvaluableresources.Also,differenttenureregimesareoftenrequired. Thisisthetrendinadvancedpetroleumstatestoday.TheprovinceofAlberta, Canadahasfivedifferentfiscalregimestomakeinvestmentattractiveforits conventionaloil&gas,oilsands,heavyoil,coalbedmethaneandshaleresources. Otherstatesarefollowingthistrend.

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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.

Government Take Comparisons

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.

Is The Take A Zero-Sum Game? Yes And No

Popularperceptiontendstoseethesplitofmoneybetweenagovernmentandan IOCasazerosumgame.ThemoreIget,thelessyoudo. Butitisimportanttorealisethatcompaniesaremostlyguidedbydifferent measuresthan'contractortake'.OnesuchmeasureistheInternalRateofReturn (IRR).TheIRRisusedtomeasureandcomparetheprofitabilityofinvestments.The higheraproject'sIRR,themoredesirableitistoundertaketheproject.Contractor takeandIRRareverydifferentcalculations.


EXAMPLE: Iraq's technical service agreements grant IOCs a service fee (after tax) of as little as $1 per barrel, which with oil hovering around the $100 per barrel level in the years through 2010-12 would be as little as one percent contractor take. And

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.

Peer Group Assessment

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.

Is It All About The Money, Anyway?


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Is It All About The Money, Anyway?

Thischapterhasbeenallaboutnumbersandmoney,andassumedthatthisisatthe heartofthenegotiations.Wehaveseen,andwillseeagain,thatthisisashort sightedviewtotakeforastate,whichhasmanyintereststoreconcilein negotiatingexploitationofitsnaturalresources,notonlymoney.

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114

HOW BIG IS THE PIE?


Inordertodecidewhogetswhat,youhavetoknowhowbigthepieis.That'swhy everycontractspendstimelayingoutwhatoilandgasisworthinsomedetail. Knowinghowmuchoilisproducedandsoldiscrucialindeterminingthesizeof thepieaswell.Gettingagoodideaofhowbigthepieiscanbequitecomplicated forthefollowingreasons: Abarrelofoilisnotabarrelofoilisnotabarrelofoil.Somecrudeoilisworth considerablymorethanotheroilforeitherchemicalormarketingreasons. Alotcanhappenonthewayfromthewellheadtotherefineryorshipping terminal.ThinkofNigeriawhereillegaltappingintothepipelinetodivertcrude onitswaytotheseahasbecomevirtuallyinstitutionalisedasitsowneconomic sector. Sometimescompanieshavemuchmoreexperienceandaccesstothe internationalmarketswhichdefinethepriceofoilthangovernments.Thecould leavegovernmentsatadisadvantageincalculatinghowmuchtheyshouldbe getting.Thissometimesleadstothedefinitionoftwowaysofpricingtheoil, whichcanbecategorizedasarm'slengthpricingandformulapricing. Governmentsoftenwantpartofthecrudeoilfortheirownuse.Companieswant tosellasmuchoftheoutputaspossibleforthehighestpricepossible.This potentialconflictofinterestisdealtwithinclausesmentioningwhatis sometimesknownasdomesticmarketobligation. Naturalgas,oftenfoundwithoil,throwscomplicatesthings,sincethese contractshavebeendesignedwithoilinmind. Let'slookateachofthoseinturn.

Different Grades Of Crude Oil

Thequality(or'grade')ofcrudeoilcanmakeasmuchasa50%differenceinits valueoninternationalmarkets.Thereareahostofchemicalfactorsaffectthevalue ofoil,buttherearetwomainvariables:sweetnessandheaviness. Themostvaluablecrudeis'light'and'sweet'.CountrieslikeLibyaarelucky enoughtohavethistypeofcrude.Legendhasitthatyoucouldtaketheoilstraight outofthegroundandputitinthetankofyourcaranditwouldgo,atleastfora while.Attheotherendaregradesofcrudeoilwhichare'heavy'and'sour',suchas thoseproducedbyIranandVenezuela.

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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."

TheGhanaianclauseaboveillustratesthatthequalityofcrudeoilcoulddiffer significantlyevenwithinonelicensearea.Onewellmaycontaingoodquality crude,anotherwellmightcontainlessgoodqualitycrude.Ideallyyouneedtokeep trackofhowmuchofeachtypeofoilwentdownthepipeline.Buthow?The contractwillusuallysaythatyoueitherbuildinfrastructuretokeepthemseparate andagreeawaytocalculatethepriceforeach,oryoumixthemandagreeona mergedprice.


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How big is the pie?

mergedprice.

Something Happened Along The Way?

Sometimesevenhowmuchoilhasbeenproducedcanbeopentodispute.Contracts dealwiththisinclausesaddressingthe'metering',ormeasuring,oftheamountof oilatvariousstagesintheproductionprocess.

EXCERPT FROM GHANA'S AGREEMENT WITH TULLOW:


11.1 - Crude Oil shall be metered or otherwise measured for quantity... for all purposes of this Agreement. Any Party may request that measurements and tests be done by an internationally recognised inspection company

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.

Selling The Crude: Arms Length And Formula Pricing


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Selling The Crude: Arms Length And Formula Pricing

InmanyProductionSharingContracts,itistheInternationalOilCompanies(IOCs) whoareresponsibleforsellingtheoiloninternationalmarkets.Mostbigoil companiesworkateverystagefromthewellheadtothepetrolstationandcan thereforerefinethecrudethemselvesandthensellitattheirgasstations.Besides that,theyhavegoodaccesstointernationalmarketsforsellingthecrude.National oilcompaniestypicallydon't,althoughsomeMiddleEasternproducerswithlong historiesofoilproductionfeelverycomfortablesellingtheirownoil. TheagreementswhichgovernmostofLibyanproduction,forexample,saythat theIOCshavetoacceptavaluationoftheirshareofoilbasedonwhattheLibyan stateitselfhasbeenabletosellitforoninternationalmarkets.Luckilyforoil companies,theLibyanstatecanusualllysellthecrudeforthesamepricetheIOCs wouldsellitfor.

EXCERPT FROM EPSA IV MODEL AGREEMENT:


12.3.1 - For the purposes of determining the value of Crude Oil received by Second Party, the montly weighted arithmetic average of the market price realized by the First Party on the world market (in arms length trading between non-Affiliates) for the same Crude Oil or similar crude shall be applied.

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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Byincludingaclauserequiringarm'slengthpricingofthecrudethegovernment makessurethattransferpricingcannotoccur.Byreferingtoanarm'slength standardinthecontract,thepartiesareacknowledgingthatrelatedparty transactionsoccurandthatisfine,solongasthecountrystillgetsafairpriceforthe oilsold. Oilmightbevaluedatthepriceitisactuallyboughtifitisbeingsoldtonon affiiliatesofthesellingcompany,alsoreferredtoasindependentthirdparties.In thiscase,thepartiesmightusethispricesinceitshouldrepresentanarm'slength fairmarketpriceforthecrude.

Domestic Market Obligation


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Domestic Market Obligation

Manycontractsincludeaprovisionthatallowsthegovernment,ornational companies,tobuythecrudeonewayoranotherbeforeitisexported.Thisisknown asDomesticMarketObligation.TaketheexamplefromAfghanistan:

EXCERPT FROM THE AFGHAN CONTRACT:


12.1 - The Contractor shall give preference to purchases by Afghan nationals and companies, provided that such purchases are at prices that are not less than the price for Arms Length sales...

Generallyspeaking,companiescanbenervousofdomesticmarketobligations. Thisisbecausetheobligationisarestrictiononhowmuchoilandgascanbesold onworldmarketsagainstinternationalprices.Domesticmarketobligationscan sometimesresultinthesellingofcrudetothestateagainstatapricebelow internationalprices,therebynegativelyaffectingcompanyrevenues.Statesonthe otherhandoftenregarddomesticmarketobligationclausesasveryvaluable becausetheywanttoensurethatitsowneconomyhasenoughcrudewhenitneeds it.Inordertoreassurethecontractorthatpriceswon'tdroptoomuchcomparedto internationalmarketprices,aprovisionensuringarm'slengthpricingisincluded.


EXAMPLE: Indonesia's DMO, is notorious among oil companies since it states that, from a point five years into production, the company has to sell a quarter of the oil it produces at only a quarter of the world market price.

Natural Gas Is Not Easy


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Natural Gas Is Not Easy

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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Economic Development?

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HISTORY AND EVOLUTION


Asdiscussedearlier,oilandgastogetherconstitutethelargestsourceofenergyfor themodernworld.However,intheirnaturalstate,theyareonlyfoundincertain partsoftheworld.Intheearlyyearsthedemandindevelopedcountriesfar exceededlocalsupplies,whileindevelopingcountriesthesupplyfarexceededthe demand.Inaddition,oilproducingdevelopingcountriesdidnothavethe infrastructureforrefiningthecrude,northemarketsforabsorbingtherefined products. Asaresult,thestructureoftheindustrywaslargelyshapedbysupplyand demandconditions:oilproducingdevelopingcountriesmainlyexportedcrudeto thelargerdevelopedcountries'markets,whereprocessingtookplaceandthefinal productsweresold.Thecontractualtermsmainlyfocusedonfiscaltermsand financialgains,whichreflectedthispreferenceforobtainingrevenuesfrom royaltiesandtaxesratherthanproductionsharing.

Broadening Objectives

Inrecentyears,populationsofmanyoilproducingstateshavebeendemandinga greatercontributionfromthenaturalresourcesectortothewelfareandthe developmentoftheircountries.Many(new)developingoilproducingstatesare startingtorealisethatthepetroleumsectorcancontributemuchmoretotheir overalldevelopmentthansolelythroughrevenues.

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".

Generallyspeaking,thecontractualprovisionsreflecttheseobjectives,for examplebyfocusingonincreasingtheparticipationofthelocalworkforce,and usinglocalgoodsandservicecompaniesinthepetroleumsectorinorderto increaseemploymentandtobuildexperienceandcompetitivenessinthelongrun. Theseprovisionsareoftenreferredtoas"localcontent"andwillbeelaboratedlater.

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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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developmentandwillbediscussedinalaterchapter.Thesameholdstrueforlocal contentaswellasthepossiblenonfiscalbenefitsthroughstateownedpetroleum companies.Thesocalleddomesticmarketobligationisanothertoolthatcanbe mentionedhere.ItismentionedinanumberofcontractsrequiringtheIOCtosell someoftheexploitedpetroleuminthehostcountryoftenconstitutingacrucial contributiontothenationaltoenergysupply.Thisprovisionisdealtwithfurtherin thechapter"Howbigisthepie?".

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OIL FOR INFRASTRUCTURE


Anewphenomenonistheexchangeofoilforinfrastructure.Thismeansthatthe hostcountrygivesupsomepartsoftraditionaltaxessuchasroyalties,withholding taxes,corporatetaxesetc.inexchangeforphysicalworksintheformofbuilding roads,railways,telecommunicationsorairports.Chineseinvestors,usuallywith backingfromtheirgovernment,haveledthismovement.Unfortunately,verylittle informationisavailableonthedetailsoftheprovisionsofagreementscoveringthis typeofdeals.Throughthesedealsthegovernmentisabletoprovideitscitizens withmajorinfrastructureworksinashortperiodoftime,sometimesfarbefore petroleumproductionstarts.Thiscanbeanimportantreasonforagreeingtoanoil forinfrastructuredeal,especiallywhenelectionsareontheirway.Inaddition,ifthe infrastructureisstrategicallybuilt,itcanenhancetheeconomicdevelopmentofthe countrybyconnectingmarketsandreducingtransportationcosts.Repaymentof thedebtforbuildingtheinfrastructureisnotmadefromearnedincomebutfrom potentialearnings.However,thewayinwhichthesepotentialearningsare calculatedandthewayinwhichanydifferencesbetweenprojectpetroleumprices andactualonesareincorporatedisnotclear.Fromthegovernmentpointofview,a comparisoncouldbemadewithusingacreditcardwhiletheinterestrateforpay backisunknown.

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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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Oil for Infrastructure

'mortgaged'andobtainasmuchdetailaspossibleonitssize,accessibility,and qualitytobesureitisgettingafairdeal.Differencesbetweenactualand predictedfuturecrudepricesandtheeffectonthevalueofthedealshouldbe includedaswell. Thegovernmentshouldmakesurethatfeasibilitystudiesaswellas environmentalandsocialimpactassessmentsareconductedforthework,asthey wouldbeifthegovernmenthadprocuredtheworkitself.

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132

THE ROLE OF THE NATIONAL OIL COMPANY


ThechapterontheFiscalToolkitinthisbookdealswithstateparticipationbya stateoilcompanyasoneofthefiscaltoolsastatecanuseforsharingtheprofitsof anoilandgasproject.However,astaterarelyestablishesastateoilcompany merelytoincreaseitsshareofthepie.Astateoilcompanymaybeavehicletohelp deliverother,broaderdevelopmentgoals.Thestatemayseetheestablishmentofa stateoilandgascompanyasameanstocreatelocalemploymentandacquiring technicalknowhowontheoilandgassector. Therearemanyexamplesofstateoilcompanies:SaudiAramco,Statoil, Petronas,PetrobrasandCNOOCtonameafew.Stateoilcompaniescomeinall shapesandsizesandareestablishedwithdifferingobjectivesinmind.Thereisa significantamountofliteratureontheprosandconsofpursuingnational developmentgoalsthroughastateoilcompany.Thepurposeofthischapteristo showthatstateoilcompaniesmaybeavehiclethroughwhichstatescanpursue otherbenefitsthanmerelyfinancialones.

Possible Non-Fiscal Benefits

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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Localcontentisatermwhichisincreasinglyusedinpetroleumcontractsensuring thatthecompanyishiringlocallabourandprocuringlocalgoodsandservicesfrom thehostcountryinsteadofusingimportedgoodsandservicesorforeignworkers. Insteadofusingthetermlocalcontent,ahandfulofcontractsreferto'national content',becausetheterm'localcontent'oftenbringstomindamuchmore localizedgeographicalarea,i.e.theprojectaffectedareainsteadofthehostcountry ingeneral.Tocutalongstoryshort,thetermsareusedinterchangeablyandcover thesameissues. Oftenitisassumedthatsocialwelfareissuesorcorporatesocialresponsibility (CSR)considerationsarealsoincludedinlocalcontent.Thisisnotthecase.Social welfareisdealtwithattheendofthischapter. Severalcountrieshavedevelopedlocalcontentpoliciesandlaws.Forexample, GhanahasaLocalContentandLocalParticipationPolicy(2010)specifictothe petroleumsector.Kazakhstaninsteadtakesamoregeneralapproachtolocal contentrequirementsbyincludingitinitsProcurementLaw.BrazilandNigeria havealsodevelopedlocalcontentlegislation. Manycountriesdonot,ornotonly,addresslocalcontentissuesinlegislation, butaddressthemdirectlyinpetroleumcontracts.Eveniflocalcontentlegislation doesexist,localcontentisoftenstilladdressedinthecontractwithmore specificity. However,notallcontractsincludelocalcontentsections,evenifthereisno localcontentlawinplace.Contractsgenerallydonotdiscusslocalcontentinmore detailthanacoupleofsentences.Below,youwillfindabriefoutlineaboutthe generalcharacteronlocalcontentprovisions.

Use Of Local Labour

Therequirementtouselocallabourcanbechallengingincountrieswherehigh leveleducationisminimalareandwherethepetroleumsectorisrelativelynew.An additionalcomplicationisthatcomparedtoothersectors(i.e.agriculture, manufacturingortextileindustry),petroleumoperationsarenotlabourintensive industries.Therefore,oftenyouwillfindanphraselike"...wherequalified personnelisavailable..."ortherequirementtoprovidetrainingwiththeaimof employingpeopleinthefuture.Thisisillustratedbytheexamplebelow.

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EXCERPT FROM THE AFGHAN AMU DARYA BASIN CONTRACT


20.1 - "The Contractor agrees to as far as possible train and employ qualified Afghan nationals ... and ... will undertake the schooling and training ... for staff positions, including administrative and executive management positions. The Contractor will require its contractors and subcontractors to do the same. (...)."

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.

Inaddition,statingspecificjobcategoriessuchasskilled,unskilled,technical, administrative,clerical,management,etc.canleadtodifferencesininterpretationof whatthesemeanandthequalificationsneeded.Definitions,interpretationsand requirementsforthesejobcategoriesoftendifferbetweendifferentpartsofthe world. Somecontractsdonotfurtherexpandonthelocallabourrequirementstoaddress howcompliancewillbemonitored.Theresultoftenisthatinthiscasethe


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howcompliancewillbemonitored.Theresultoftenisthatinthiscasethe requirementwillnotbemonitoredatall.Somecontractsdohavemonitoring provisions,inwhichthecompanyisrequiredtosubmitalocalcontentor employmentplan,whichthenrequiresgovernmentapproval.Sometimesthe contractrequirestheemploymentplantobeincludedintheAnnualWorkPlan.

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.

Use Of Goods And Services

Thegoalofusinglocalgoodsandservicesinthepetroleumsectorisaimedat stimulatingthelocaleconomyandcreatinginternationalcompetitivenessinthe longrun.Itismeantforlocalcompaniestogainskillsandexperience. Thewayinwhichrequirementsfortheuseoflocalgoodsandservicesare usuallyframedincontractsisalongthefollowinglines:thecompanyhastogive preferencetolocalgoodsandservices,providedthatthesearesimilartoimported goodsandservicesinqualityandprice.Thisisillustratedbythefollowing examples:

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EXCERPT FROM EAST TIMOR'S PRODUCTION SHARING CONTRACT FOR AREA A


21.1 - "... the Contractors shall draw to the attention of suppliers based in TimorLeste, in such manner as the Ministry agrees, all opportunities for the provision of goods and services for Petroleum Operations."

EXCERPT FROM AFGHANISTAN'S AMU DARYA BASIN PRODUCTION SHARING CONTRACT


21.1 - "...the Contractor shall give preference to goods that are produced or available in Afghanistan and services that are rendered by Afghan nationals and companies, provided that such goods and services are similar in quality, quantity and price to imported foreign goods and services and available at the time."

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."

Theseclausescanbechallengingincountriesnewtothepetroleumsectorandin countrieswherethemanufacturingandservicessectorsareunderdevelopedandnot competitive.Inthesecases,goodsandservicesmightnotbeavailableatall,orif theyareavailabletheymightcostsawholelotmoreoritwilltakemoretimeto deliverthem,whichcanhaveimplicationsforthecostsanddeliverytimeofthe project.Somecontractsallowthelocalgoodsandservicestobeabitmore expensivethantheimportedgoodsbyacertainpercentage(whichisusually10 15%).Othercontractsrefertoapplyingarm'slengthtransactionsinorderto comparetrueandactualmarketvalues.Twoexamplesaregivenbelow:

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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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Employment, Procurement and Social Welfare

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 ..."

Veryfewcontractsspecifytheconsequencesfornotadheringtolocalcontent clauses.Thismeansthatabreachoflocalcontentrequirementswillbedealtwithin similarwaysasotherbreachesofthecontract.Anexampleofacontractthatdoes includeaclauseontheconsequencesofbreachinglocalcontentrequirementsis givenbelow.

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Economic Development?

EXCERPT FROM BRAZIL CONTRACT


20.7 - If the relevant percentages are not achieved, the Concessionaire shall pay an "amount equal to 2 (two) times the value of the purchases from Brazilian Suppliers that would have been required to achieve the required Percentage."

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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Employment, Procurement and Social Welfare

programmesalthoughitdoesnotdefinewhat'socialwelfare'meansexactly.The contractrequiresthecompanytoprovidespecificamountsoffundingforsocial welfareprograms.Theexpensesarerecoverablecostsandthesocialwelfare programstobeimplementedneedtobemutuallyagreeduponbythestateandthe contractor.InPakistanpetroleumcontracts,thecompanyisrequiredtoallocate minimumamountsofexpenditureonsocialwelfareprogramsduringthe explorationandproductionphases.Thefundsneedtobespentto'givelasting benefittothecommunities',andanyprogramsneedtobeagreedwiththelocal community.

143

Economic Development?

144

context

Environmental, Health & Safety & Social Issues

Environmental, Social, and Health & Safety Issues

146

IT'S IMPORTANT ISN'T IT?


Howdopetroleumcontractsaddressconcernsrelatingtothepotential environmentalandsocialimpactsarisingfromtheconductofpetroleumoperations andtheneedtoconductsuchoperationsinasafemannerwithregardtoemployees, theenvironmentandlocalcommunities? Perhapssurprisinglygiventheimportanceoftheseissues,petroleumcontracts oftendonotdealwiththeminanygreatdetail.Thisreflectsthesubsidiary importancehistoricallyattachedtotheseissueswhencomparedwiththecore concernsoffindingandmonetisingpetroleum.Asarecognitionoftheimportance ofsocialandenvironmentalissuesinanoverallsustainabledevelopmentcontext hasgrown,soisanobservabletrendforpetroleumcontractstoaddressthemwith greaterspecificity. Socialandenvironmentalissues,totheextentaddressed,areoftenlumped togetherundertherubricof"Environment,HealthandSafety"orjust "Environment".Thismeansthatthehealthandsafetyandsocialimpactprovisions, iftheyexist,maybedifficulttolocateinthecontract.Inpart,thisreflectsthe realitythat,rightlyornot,environmentalconcernsgetsignificantlygreater attentioninpetroleumcontractsthanconcernsrelatingtohealthandsafetyand socialimpacts. Thefieldofsocialimpactsisanemergingarea.Suchimpactsinclude,for example,increasesinthepriceoflocalgoodsandservices,immigrationintothe projectareacausingpressureonlocalpublicservicesandthespreadofinfectious diseases,resettlementandcompensation,potentialhumanrightsimplications, impactsonlivelihoodgeneratingsectorssuchasfisheriesandagricultureand particularimpactsonindigenouspeoplesandvulnerablegroups.Sofarthereare currentlyfewexamplesofpetroleumcontractsdealingexplicitlywithsocial impacts. Whilstthepetroleumcontractmaynotcontainextensiveprovisionsinrelation totheseissuesallhopeisnotlost.Onehastolookalsoatlawsandregulationsthat containrulesrelatingtotheenvironmentandhealthandsafetytogetafullpicture oftheobligationsonanoilcompanyintheseareas.Sometimestheapplicable environmentallawrequiresattentiontobepaidtopotentialsocialimpactsofthe project.Internationalstandardsandgoodpracticeusuallydoincludesocialissues. Thereareseveralprovisionsinpetroleumcontractsthatindirectlyaddresssocial, environmentalandhealth&safetyissues.Forexample,ataminimumthecontract willrequirepetroleumoperationstobeconductedinaccordancewithapplicable lawsandacceptedindustrystandardsorpractices.Thereisusuallyaspecific provisiondesignedtopreemptanyharmthatmaybecausedbypetroleum operationsbyassessingwhatimpactssuchoperationsmayhaveandestablishinga
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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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It's important isn't it?

EXCERPT FROM IRAQI MODEL FORM TSC:

generally accepted in the international petroleum industry as being good, safe,


"all those uses and practices that are, at the time in question, economical, environmentally sound and efficient in exploring for, developing, producing, processing and transporting Petroleum. They should reflect standards of service and technology that are either state-of-the-art or otherwise economically appropriate to the operations in question in respect of new facilities and should be applied using standards in all matters that are no less rigorous than those used by the Companies in other global operations."

TheKurdistanPSCprovidesatClause37.1thattheoilcompanymustcomply with"BestPractices"thataredefinedas:

EXCERPT FROM THE KURDISTAN PSC:


37.1 - "standards that are no less stringent than the best practices, methods and procedures in carrying out Petroleum Operations consistent with a reasonable degree of prudence, as evidenced by the best practice of experienced operators in the exploration, development and production of Petroleum principally aimed at ensuring: ..... (b) operational safety, including the use of methods and processes that promote occupational security and the prevention of accidents; (c) environmental protection and worker safety, including best methods and processes which minimise the impact of Petroleum Operations on the environment; ..... (h) that equipment is operated at all times in a manner compliant with Applicable Law, applicable Permits, and this Contract, in accordance with all manufacturers' warranties, and in a manner safe to workers, the general public, the environment, plant and Assets; ......"

Theselengthydefinitionscontrastwith,forexample,theAngolanmodelform PSCandthe2000GhanaianmodelPetroleumAgreementwhichhaveshorterform formulations.TheAngolanmodelformPSChasnoarticlethatisspecificto

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Environmental, Social, and Health & Safety Issues

environmentalissuesbutincludesinArticle14(whichsetsoutgenerallythe obligationsrelatingtotheconductofPetroleumOperations)ageneralrequirement toact"inaccordancewithprofessionalrulesandstandardswhicharegenerally acceptedintheinternationalpetroleumindustry".The2000Ghanaianmodel PetroleumAgreementincludesinArticle17(whichdealswith"Inspection,Safety andEnvironmentalProtection")atArticle17.2thattheoilcompanyshall:

EXCERPT FROM THE HE 2000 GHANAIAN MODEL PETROLEUM AGREEMENT:


17.2 - "take all necessary steps, in accordance with accepted Petroleum industry practice, to perform activities pursuant to the Agreement in a safe manner and shall comply with all requirements of Governing Law, including labour, health, safety and environmental laws regulations issues by the Environmental Protection Agency".

Whetherornotthecontractusesalongerorashorterdefinition,asthetextin boldindicates,theyall,tosomedegreeoranother,refertosomethingthatis acceptedwithintheindustry.Thisbegsthenextquestionwhichiswhatcanbe consideredtobegenerallyaccepted.Thisisdealtwithinthenextchapter.

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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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Environmental, Social, and Health & Safety Issues

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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developedstandardsforhealthandsafety. Rarelydocontractsmakereferencetospecificstandardsorgoodpractice.One exampleistheDevelopmentandProductionSharingAgreementoftheGunashli fieldinAzerbijan,inwhichtheannexreferstoHealthandSafetystandardsby stipulatingthatthecontractor...

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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BEFORE YOU START


Eitherthecontractortheenvironmentallegislationwillrequirethecompanyto identifyandadequatelymitigatepotentialenvironmental(andsocial)impactsit mightcause.Inordertoestablishtheenvironmental(andsocial)conditions prevalentbeforeanyfieldworkstarted,theenvironmentalandsocialrisksofthe petroleumproject,andhowtheseriskscanbemanaged,thecompanyshouldbe requiredtosubmitseveraldocumentsthatrequiretheapprovalofthegovernment departmentoragencyresponsibleforenvironment.Socialrisksandimpactsarestill relativelynewandsomecountriesand/orcontractsdonotincorporatethistypeof riskintherequirementsforanalysingpotentialimpacts,eventhoughoperations canhavetransformationalimpactsoncommunities.Internationalstandardsdo requiresocialissuestobeincorporated,andseveralenvironmentallawsmention socialissuesaspartoftherequirements.Usually,approvalofatleastoneofthese documents(thebaselineassessment)hastobegrantedbeforethecompanycanstart anyfieldwork.Thedocumentsinclude:

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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Environmental, Social, and Health & Safety Issues

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.

Impact Assessment And Mitigation Measures

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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Before you start

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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process,andcancauseseveregrievancesatthecommunitylevelifnotwell handled.InternationalstandardssuchastheIFCPerformanceStandardsandWorld BankOperationPolicy4.12coverresettlementandcompensationaswell.

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 (...)."

Sometimes,usuallyincountrieswherethereisnoseparategovernmententity responsibleforenvironmentalissues,themanagementplanisincludedinthefield developmentplansothatapprovaloftheMinistryofPetroleumortheNationalOil Companyisrequired.Occasionally,thecontractrequiresthemanagementplanto beincludedintheAnnualWorkPlan,sothatapprovalofthegovernmentorjoint managementcommitteeisrequired.Annualreportsonenvironmentalimpactsand managementareusuallyrequiredtobesubmittedforreviewbythecompanytothe responsiblegovernmentagency.

Who Conducts The Assessments?

Bestpracticesrequireexperiencedandqualifiedexperts,tobecontractedbythe company,toconducttheassessments.Sometimesthehostcountrygovernment,the environmentalagency,ortheNationalPetroleumCompanyhastoapprovethe expertbroughtforwardbythecompanytoconducttheassessments. IntheexamplebelowfromAzerbaijan,thenationalpetroleumcompanyis involvedinselectingtheconsultingfirmthatwillconducttheimpactassessment.It willalsohaveadirectinvolvementinthestudy:


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Before you start

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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advancetoconsidertheimpactstheoperationmighthaveonthem,andthatthey havegiventheirconsentfortheprojecttostart.EventhoughFPICisrequiredby internationalstandardssuchastheIFCPerformanceStandards,thetermor requirementisusuallynotincludedinthepetroleumcontractand/orlaw.

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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WHEN THINGS GO WRONG


Ifthingsgowrongandthepetroleumoperationscauseharmtotheenvironment, peopleorproperty,whoisresponsibleforfixingit?Andwhopaysforit? Intermsofresponsibility,thecontractorisprimarilyresponsiblefortheconduct ofpetroleumoperations.Withoutapetroleumcontractsayinganymore,this responsibilityshouldextendtoactivitiesnecessarytomitigateorresolve environmentaldamageorharmtopeopleorproperty.Therewilllikelybelawsthat addresstherequirementforthecompanycausingthedamageorharmtorestorethe damagedoneand/orcompensatethosewhohavesuffered.Thegeneralobligations inthecontractwillstatethatthecompanyneedstocomplywithapplicablelawor performpetroleumoperationsinaccordancewithindustrystandardsorbest practice.Thiswillimporttheobligationtocomplywiththoseenvironmentalor healthandsafetylawsorstandardsorbestpracticesinsofarastheyrequire mitigationorremediationstepstobetaken.Thecontractmayhaveprovisionsthat setouttheresponsibilityoftheoilcompanyincaseofdamageorharm.For example,intheIraqmodelTechnicalServiceContract,Article41.11(a)statesthat:

EXCERPT FROM THE IRAQ MODEL TECHNICAL SERVICE CONTRACT:


41.11 - "In the event of an emergency, accident, oil spill or fire arising from Petroleum Operations affecting the environment, Operator shall forthwith notify ROC and Contractor and shall promptly implement the relevant contingency plan and perform such site restoration as may be necessary

accordance with Best International Petroleum Industry Practices."

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

in accordance with accepted Petroleum industry practice, promptly take

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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EXCERPT FROM THE IRAQI MODEL TECHNICAL SERVICE CONTRACT:


41.5 - "...all costs incurred towards protection of or damage to the environment shall be treated as Petroleum Costs."

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:

EXCERPT FROM BRAZILIAN CONCESSION AGREEMENT:


"The concessionaire shall provide and maintain in effect, during the whole term of this Agreement, and without causing a limitation to the Concessionaire's liability, insurance coverage executed with a competent company, for all cases requested by the applicable legislation, as well as to comply with the determination by any competent authority regarding assets and personnel

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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When things go wrong

example,ifamajorinternationaloilcompanyformsalocalcompanytoenterintoa petroleumcontract,thegovernmentofthehostcountrywillinsomeinstances requirethattheinternationaloilcompanyguaranteestheperformanceand obligationsofthelocaloilcompany.Ifthelocaloilcompanycannotpaythecosts ithastopayincaseofenvironmentaldamageorharmcaused,thegovernmentcan requirethattheinternationaloilcompanypaysforit,byincludingaparent companyguarantee.Thenonlyifthecostsaretoogreatforeventheinternational oilcompanytocoveranditgoesbankruptasaresult,thenthegovernmentisleftto pickupthepiecesandmeetthecosts.

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166

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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Environmental, Social, and Health & Safety Issues

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:

EXCERPT FROM THE GHANAIAN MODEL PETROLEUM AGREEMENT:


17.3 - "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, and shall provide for the safe completion or abandonment of all boreholes and wells".

TheIraqimodelTSCissimilarlybrief,providingatArticle42thattheoil companypreparesaproposalforapprovalrelatingtositerestorationand decommissioning"aroundmidTerm" andonexpiryorterminationofthecontract itshall:

EXCERPT FROM THE IRAQI MODEL TSC AGREEMENT:


42 - "remove all equipment and installations from the relinquished area or former Contract Area in a manner agreed with ROC pursuant to an abandonment plan".

Inneithercaseisthereanymentioninthecontractofarequirementtosetaside moniesinadecommissioningfundalthoughthismaybearequiredfeatureofany decommissioningplanagreedinthethecaseoftheIraqiTSC. Bycontrast,theKenyanmodelPSCincludesatArticle42somefourandahalf pagesofprovisionsrelatingtoabandonmentanddecommissioningincludinga requirementtosubmita"DecommissioningPlan"aspartoftheDevelopmentPlan,


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Cleaning up

requirementtosubmita"DecommissioningPlan"aspartoftheDevelopmentPlan, arequirementto,fromacertainpointintime:

EXCERPT FROM THE KENYAN MODEL PSC AGREEMENT:


42 - "book sufficient accruals for future abandonment and decommissioning operations to cover the expenses which are expected to be incurred under the Decommissioning Plan".

Theamountsaccruedmustbepaidintoaseparateinterestbearingaccountto ensurethattheyareavailabletopayfordecommissioningactivities.Theoil companyisentitledtorecoveramountsthatitsetsasideaspetroleumcosts. LikewiseClause38oftheKurdistan2012modelPSChasrelativelyextensive provisionsrelatingtodecommissioningobligationsincludingarequirementto:

EXCERPT FROM THE KURDISTAN 2012 MODEL PSC AGREEMENT:


38 - "undertake Decommissioning Operations in accordance with Best Practices, Applicable Law, an Approved Decommissioning Plan and approved Decommissioning Work Programs and Budgets"

andanobligationto"establishasegregatedfundinthenameofthe GovernmentatafinancialinstitutionsatisfactorytotheGovernmentand undersuchescrowortrusttermsastheGovernmentmayrequire,topayfor DecommissioningOperationsandsiterestoration".

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170

petroleum basics

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172

DEALING WITH DIFFERENCES


Ifonethingiscertainaboutapetroleumcontractitisthat,atsomepoint,thetwo partieswilldisagree.Thedisagreementmaybeaboutwhethertheyhavedonewhat theysaidtheywouldinthewaytheypromisedtoandwithinthetimeframethey agreedon.

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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EXCERPT FROM THE LIBYAN EPSA


13.5.2 - "shall proceed in good faith to negotiate a gas sales agreement incorporating the principles set forth in Article 13.4" This is used as and when associated gas is produced as a result of an agreement which is essentially for oil. Another example states:

EXCERPT FROM AZERBAIJAN:


15.2.(cd) - "SOCAR and Contractor shall diligently negotiate each such Supplemental Agreement (and the relevant Sales Agreement) in good faith".

WiththecontractcomesanappendixofAccountingProceduresreferredtointhe maincontract.

EXCERPT FROM AN APPENDIX OF ACCOUNTING PROCEDURES


"if any of such methods prove to be unfair or inequitable to the Contractor then the Parties will meet and in good faith endeavour to agree on such changes as are necessary to correct any unfairness or inequity"

andanotherexamplefromIraq

EXCERPT FROM IRAQ'S SERVICE AGREEMENT


2.3 - "Discovered but undeveloped reservoirs, as defined in Annex D, may be developed and produced under this Contract but shall be subject to a separately agreed remuneration fee which the Parties undertake to, in good faith, agree".

Sometimes,then,onmajorissues,thecontractstatesanagreementtoagreeata laterdate,withtheexplanationthat"Wehaven'tgottheinformationtodiscussthis now".Agoodexampleisgas,whattodowithunknownreservoirsthecompany mightstumbleacrosswhenexploringforoil.Othertimes,anambiguityisleft deliberatelyinaparticularprovisionastheonlywaytoreachagreementofall


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Dealing with differences

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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Dealing with differences

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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Dealing with differences

ThegoverninglawclauseinAzerbaijanstates:

EXCERPT FROM AZERBAIJAN JOINT DEVELOPMENT AND PRODUCTION SHARING CONTRACT:


"shall be governed and interpreted in accordance with the principles of law common to the law of the Azerbaijan Republic and English law, and to the extent that no common principles exist in relation to any matter then in accordance with the principles of the common law of Alberta, Canada..."

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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.

What, Exactly, Are Companies Wary Of?


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What, Exactly, Are Companies Wary Of?

Changesthatacompanymightseektoguardagainstincludechangesinthefiscal regimelikeincreasesinexistingtaxesorortheimpositionofnewones.Orthere couldbechangestolawsthataffecttheconductofpetroleumoperations,suchas labourlaw,forexample,imposingmorestringentoradditionalrequirements.The compensationclaimedwouldbeequaltothedifferencebetweentheexpected returntotheoilcompanyunderthepetroleumcontractbeforethelawchangedand theexpectedreturnafterthelawchanged.Anexampleofastabilizationprovision isgivenbelow.

EXCERPT FROM A PRODUCTION SHARING COMPANY (GHANA 2000):


26.2 - "......As of the Effective Date of this Agreement and throughout its Term, the State guarantees the Contractor the stability of the terms and conditions of this Agreement as well as the fiscal and contractual framework hereof specifically including those terms and conditions and that framework that are based upon or subject to the provisions of the laws and regulations of Ghana (and any interpretations thereof) including without limitation the Petroleum Income Tax Law, the Petroleum Law, the GNPC Law and those other laws, regulations and decrees that are applicable hereto. This Agreement and the rights and obligations specified herein may not be modified, amended, altered or supplemented except upon the execution and delivery of a written agreement executed by the Parties. Any legislative or administrative act of the State or any of its agencies or subdivisions which purports to vary any such right or obligation shall, to the extent sought to be applied to this Agreement, constitute a breach of this Agreement by the State."

Noproblemunderstandingwhygovernmentsandcitizensofoilproducing countriesdon'tlikestabilisationclauses.Fromthegovernment'sperspective,anoil companyinvestingintheircountryshouldtaketheriskofachangeinlawsince settingitsownlawsisoneofthefundamentalrightsofasovereignstate.Forthis reason,governmentswillresistangenericstabilizationprovision.Infact,whilst stabilizationclausesexistinolderpetroleumcontracts,theyarebecoming increasinglyrare.Theseclausesareoftenreferredtoas"freezingclauses"because theyfreezethelawinplaceatthetimethecontractissigned.

The 'Middle' Ground


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Stabilisation

The 'Middle' Ground

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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EXCERPTS FROM VARIOUS MODEL PETROLEUM CONTRACTS:


"Without prejudice to other rights and obligations of the Parties under the Agreement, in the event that any change in the provisions of any Law, decree or regulation in force in [country] occurs subsequent to the signing of this Agreement which adversely affects the obligations, rights and benefits hereunder, then the Parties shall agree on amendments to the Agreement to be submitted to the competent authorities for approval, so as to restore such rights, obligations and forecasted benefits." "....if after the Effective Date, the financial interests of Contractor are adversely and substantially affected by a change to the Law which was in force on the Effective Date, or by revocation, modification or non-renewal of any approvals, consents or exemptions granted to Contractor pursuant to this Contract (other than as a result of Gross Negligence or Wilful Misconduct of Contractor or Operator) the Parties shall, within ninety (90) days, agree on necessary adjustments to the relevant provisions of this Contract in order to maintain Contractor's financial interests under this Contract reasonably unchanged."

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
184

Stabilisation

thaninternationalbestpractice.Thecountrywouldthenhaveassureditselfafloor ofcomplianceacrossarangeofissueswithouttheconcernoftriggeringthese clauses. Somejurisdictions,likeLibya,don'tofferanyformofstabilisationor equilibriumclause,andthere'sevenoneexamplewherean"antistabilization" clauseisincludedinamodelpetroleumcontract:

EXCERPT FROM LIBYAN MODEL PETROLEUM CONTRACT:


"The introduction of new Applicable Law or change of Applicable Law will not entitle the Contractor or any Contractor Entity to any rights to any alteration to the terms of this Contract or any claims against the Government under this Contract."

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

Whenyoulookupclose,theideathatcurrentnegotiatedagreementsrequirethe contractstostaysecretisactuallyamyth.Mostgovernmentsaroundtheworld couldpublishmostoftheirpetroleumcontractstodaywithoutanydangerofbeing inbreachofcontract.Furthermore,manycontractsgetratifiedbyparliamentand shouldthereforebeautomaticallyinthepublicdomain.Unfortunatelyinpractice thisisnotoftendone. Everycontractwefeatureinthebookdealswiththeissueofwhatcanbe publishedandwhatcan'twhocanreleasewhatinformationunderwhat conditions.Andsomeofthemseemquiterestrictive.Someexamples:

EXCERPT FROM THE IRAQI TECHNICAL SERVICE AGREEMENT:


33.1 - "All information and data obtained in connection with or in relation to this Contract shall be kept confidential by the Parties and their Affiliates and shall not be disclosed or communicated to any third party without the other Party's prior written consent."

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EXCERPT FROM AZERBAIJAN'S PSA WITH THE CONSORTIUM LED BY BP:


27.1a - Subject to the provisions of this Contract, each Party agrees that all information and data of a technically, geologically or commercially sensitive nature acquired or obtained relating to Petroleum Operations and which on the Effective Date is not in the public domain or otherwise legally in the possession of such Party without restriction on disclosure shall be considered confidential and shall be kept confidential.

EXCERPT FROM GHANA'S CONTRACT WITH TULLOW:


16.4 - All data, information and reports including interpretation and analysis supplied by Contractor pursuant to this Agreement, including without limitation, that described in Articles 16.1, 16.2 and 16.3 shall be treated as confidential and shall not be disclosed by any Party to any other person without the express written consent of the other Parties.

EXCERPT FROM TIMOR LESTE'S PSA WITH CONOCOPHILLIPS:


15.6 - The Ministry shall not publicly disclose or make available, other than as required by the Act or for the purpose of the resolution of disputes under this Agreement, any data or information mentioned in Section 15.1 until the earlier of: (i) five (5) years after it was acquired by the Contractors; and (ii) this Agreement ceasing to apply in respect of the point at or in respect of the point at which it was acquired.

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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itself. Butinaddition,allthesearticlesthengoontospecifypermittedexceptionsto theruleofsecrecy.Thesetypicallyarewheninformationisalreadyinthepublic domainorthereisadisputewhichhasgonetoarbitration.Orwhen(asinthecase ofGhana)thestateoilcompanywantstobriefanyconsultant,ortoattractother investorstonearbyareas,orthecompanyneedsabankloanorforanotherfinancial transaction.AndinfactthisiswhathappenedinthecaseoftheGhanacontract whichisafinal,signedandinitialledagreementyoucanfindontheInternet. Otheragreementsstarttodifferentiatebetweentheobligationsofthecompanies andthoseofthestate.Backin2001,forexample,Brazil'smodernconcession agreementimposesthestrictestoftermsonthecompany.

EXCERPT FROM BRAZIL'S MODERN CONCESSION AGREEMENT


33.1 - All and any data and information produced... shall be confidential and therefore, shall never be disclosed by the Concessionaire without the prior written consent of ANP... the undertakings of paragraph 33.1 shall remain in full force and effect and shall survive the termination or recession of this Agreement, for any reason whatsoever.

TheobligationsontheBraziliangovernment,asrepresentedbyANP,are somewhatmorerelaxed:

EXCERPT FROM THE BRAZILIAN GOVERNMENT AGREEMENT, AS REPRESENTED BY ANP


The ANP undertakes not to disclose any data and information obtained as a result of the Operations and which regards the part(s) of the Concession Area retained by the Concessionaire, except when such disclosure is necessary for compliance with legal provisions, which are applicable to the ANP or with the purposes for which the ANP was created.

Sowhilethecompanyshould"never"discloseanything"foranyreason whatsoever"ANPcandiscloseanythingtocomplywiththepurposesforwhichit was.That'saprettybroadexception. Libya'sEPSAIVagreementsof2005havealongclauserelatingto confidentialitybuteveryprovisionappliestothe"SecondParty"thecompany.


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confidentialitybuteveryprovisionappliestothe"SecondParty"thecompany. The"FirstParty",thegovernmentofLibyaasrepresentedbytheNationalOil Corporation,hasnoobligationswhatsoeverstatedinthecontract. Finally,Afghanistan'sagreementwithCNPCin2011istheonlycontractinthe suitewhichdoesn'thaveaconfidentalityclause.Insteadithasatransparency clause.

EXCERPT FROM AFGHANISTAN'S AGREEMENT WITH CNPC IN 2011:


33.1 - The Ministry shall have the right to keep a copy of this Contract in the Hydrocarbons Register, publish and keep publicly available and distribute to provincial offices such information and reports on the Contract, related documents and the Contractor as is required pursuant to the Hydrocarbons Law, any regulations issued thereunder and internationally accepted norms relating to transparency in the extractive industries,including production and financial data concerning all revenues from income taxes, production shares, royalties, fees and other taxes and other direct or indirect economic benefits received by the Ministry and all amounts paid by the Contractor under or in relation to this Contract.

Followingthis,ithasa"TradeSecrets"clause:

EXCERPT FROM AFGHANISTAN'S AGREEMENT WITH CNPC IN 2011:


33.2 - Notwithstanding the above, if such information concerns technical devices, production methods, business analyses and calculations and any other industrial and trade secrets and are of such a nature that others may exploit them in their own business activities, the Ministry may approve that such information may rightfully be subject to confidentiality for a certain period of time.

Sotheprincipleisestablishedtheotherwayround.Everythingshouldbepublic, unlessaspecificreasonisstatedastowhyitshouldbeprivate. Thisisasitshouldbe.Italsoconformstotheemergingnormsoffreedomto informationlegislationwhichhavebeenpassedtoprovideaccessforcitizensto informationheldbythestatein90countriesoutofthe196officialindependent countriesoftheworld.


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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.

An Open Oil Industry

Thebenefitstopublishingcontractsarehigh.Itwillfurtheracceleratethelearning curveofgovernmentsinnegotiatingcontractsinthefutureandallowquicker acquisitionofpeergroupknowledge.Itwillallowinformedpublicdebatethatis lesslikelytoflareuponmererumour,andencourageamorematurerelationship betweentheIOCs,governmentsandtheirpublics.

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192

context

Appendices

APPENDICES

194

GLOSSARY
API Gravity Index

AsystemofmeasurementdevelopedbytheAmericanPetroleumInstituteused worldwidetodenotehow"light"or"heavy"agradeofCRUDEOILis.Thehigher theAPIindexthelighterthecrudeoilis,sothat"light"crudes(suchasLibyan)are 35andabove,heavygrades(suchasIranian)arebelow30.Superheavy grades(suchassomegradesfromVenezuela)arebelow20.Seealso:HEAVY OIL,LIGHTOIL

Appraisal Well

AppraisalwellsaredrilledafterSEISMICSURVEYSandaDISCOVERY WELLhaveshownsomeoilorgasispresent,inordertodetermineifthefindisbig enoughtobeacommercialdiscovery.Seealso:WILDCATWELL, DEVELOPMENTWELL,SHOWING,COMMERCIALITY

Associated Gas

Naturalgasmixedup,or"associated",withoilinarockstructureandproduced atthesametimeastheoil.Sometimesthegasisdissolvedwithintheoilbut separatesasitcomesuptothesurface.Foralongtime,suchgaswastreatedasa wasteproductdisposedofbyFLARINGorVENTING.Seealso: NONASSOCIATEDGAS,LIQUIDPETROLEUMGAS

Back-In Right

Afeatureofoilandgascontractsthatallowsaparty,oftenagovernment,to acquireanequityparticipationonceacommercialdiscoveryhasbeenmade withoutcarryingtheriskofexploration.Seealso:COMMERCIALITY"The PresidentofGuineaBissaucalledfor33%backinrightsfortheStateintoall mineralprojectsinordertoestablishalargeandfundableNationalMining Company."BrianMenellGroup2010

Barrels Of Oil Equivalent (Boe)

195

APPENDICES

Barrels Of Oil Equivalent (Boe)

Awayofmeasuringenergyproductionorconsumptionacrossdifferentenergy sources.OtherhydrocarbonslikeNATURALGASandcoalandoccasionallyeven renewablesaremeasuredfortheamountofenergytheyproducecomparedtoa barrelofoil.

Barrels Per Day (Bpd)

Thestandardwayofmeasuringoilproduction.Abarrelisabout42USgallons or158litres,thoughtheexactnumbervariesaccordingtoCRUDEOILGRADES. Theworldcurrentlyconsumesaround90millionbarrelsofoiladay,aquarterofit intheUnitedStates.

Benchmark Crude

Oilsagainstwhichotheroilsarepriced,eitheratdiscountorpremiumdepending ontheCRUDEOILGRADES.Therearethreeprimarybenchmarkcrudeswhich serveinthedifferentoilmarketsoftheworld:BRENTCRUDE,WESTTEXAS INTERMEDIATE(WTI),andDUBAICRUDE.

Blending

canhappeneitherinPIPELINESorattheREFININGstagewhereacompany mayseektobeproducingaparticularmixoffuelproductsinresponseto fluctuatingmarketdemand.

Block

MethodusedtodesignateanareaoflandwhichcouldbemadeupofseveralOIL FIELDS,whichdividesuplandintoworkableareasforseparateCONSORTIAor companiestoworkon.

Blowout

ThesuddenanduncontrolledreleaseofCRUDEOILorNATURALGASfroma wellwhenpressurecontrolsystemsfail.Thisriskcanbemitigatedbyusingablow outpreventer(BOP),howeveronlyasalastlineofdefencetoshutoffthetopofa wellandpreventaGUSHER.Itwasablowoutwhichwasresponsibleforthe DeepwaterHorizonoilspillintheGulfofMexicoin2010.

Booking

196

Glossary

Booking

TheprocessbywhichRESERVESareaddedtothebalancesheetofanoil company.Thisisacrucialpoint,asreservesformkeyassetsforthecompany.Oil companiessuchastheSUPERMAJORSwhohaveshareslistedonmajorstock marketsmustconformtoregulationsconcerninghowtheybookoilandgasassets. RoyalDutchShelltriggeredaglobalscandalin2004whenitwasforcedtoadmit thatithadoverbookedmanyofitsassets.

Brent Crude

TheleadingglobalbenchmarkforAtlanticbasincrudes,itisusedtopricetwo thirdsoftheworld'sinternationallytradedcrudesupply.Brentisalight,sweet crudeproducedintheNorthSea,whichusuallytradeswithinafewdollarsofWTI. Seealso:BENCHMARKCRUDE

British Thermal Unit (Btu)

Aunitusedtodescribetheamountofenergyreleasedwhendifferentfuelsare burned,withcoalproducing25millionBtuofenergypertonandoilproducing5.6 millionBtuperBARREL.

Bunkering

Theillegalremoval,ortheft,ofoilfromaPIPELINEorotherdistributionsystem. BunkeringissometimesassimpleasdrillingaholeinaPIPELINEandcollecting theoilinadrum.Morecomplexoperationsinvolveequippingtankerswithfalse bottomstoconcealextralegalshipments,ortomakeunauthorisedshipmentsfrom wellsitestoragetanks.BunkeringisachronicissueinNigeriaandIraq,althoughit existsinmanyothercountries."ThetheftofoilknowninNigeriaas bunkering alongwithfraudintheallocationofacontroversialfuel subsidy,maytogetherhavecostthestateUS$14billionin2011."Financial Times2010

Coal Bed Methane (CBM)

NATURALGASfoundincoalbedsduringundergroundminingoperations. Sometimesreferredtoascoalseamgas(CSG),itisalreadyinsignificantproduction intheUnitedStatesandCanada,andenormousresourcesareproveninAustralia andChina.Globally,itmakesamodestcontributiontotheENERGYMIXbutthis isexpectedtoincrease.Seealso:UNCONVENTIONALENERGYSOURCES

197

APPENDICES

Commerciality

Alegaltermwidelyappliedincontractstodescribeasituationinwhich hydrocarbonreservesexistinsufficientquantitiestojustifyfurtherinvestmentto bringafieldtoproduction.Fromthemomentanoperatingcompanydeclares commerciality,asetofregulatoryandfiscalconditionskicksin.Seealso: RESERVES,APPRAISALWELL,GIANTFIELD"Furtherdrillingwillberequired toestablishthecommercialityoftheblockSL200701001discovery."Petroleum Economist2011

Completion

Thefinalstageintheinstallationanddevelopmentofanoilorgaswell, enablingittobeginproducing,oftentakenonbyoilfieldSERVICECOMPANIES.

Concession

Aleaseagreementbywhichanoilcompanycanenjoytheexclusiverightto produceoilinanygivenarea,asownershipoftheoilistransferredfromthenatural owner,suchasthestateorlandowner,totheleaseholderattheWELLHEAD. Concessionswereusedwidelyintheearlydaysoftheoilindustryandcametobe viewedassymptomaticofexploitationbyIOCS,particularlytheSEVENSISTERS, andwerereplacedinmanycountriesbyPRODUCTIONSHARING CONTRACTS.Butsomecountries,suchastheUnitedKingdomandNorway,still operatethemtoday.Seealso:SERVICECONTRACT

Condensates, Natural Gas

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

RESOURCESestimatedtobepotentiallyrecoverablebut,atagivendate,not commerciallyviable.Thereisacknowledgedlackofclaritywithintheindustry betweencontingentresourcesandUNPROVENRESOURCES.

Cost Recovery

PartofaPRODUCTIONSHARINGAGREEMENTwhichallowsIOCstoclaim andrecovertheinvestmentstheymadetoexplore,developandstartproducingoil. Theimportantpointtonoteisthatcostrecoverycomesbeforeanysplitofprofits. Costrecoverycanoftenreachbillionsofdollars.Itisusuallycappedatacertain percentageofthevalueofproductioninanygivenyear.Costrecoverycanbecome apointofcontentionbetweencompaniesandgovernmentssincegovernmentsare oftenunabletoverifythereasonablenessofcostssubmittedbytheIOCswiththeir sophisticatedaccountingandhundredsofglobalaffiliates.Suchdisputeshave recentlyoccurredinIndonesia,IndiaandIraq.SeealsoPROFITOIL,COSTOIL

Cracking

Asecondstagerefiningprocesswhichhasbecomewidespreadinthelast20 years.AfterFRACTIONALDISTILLATIONhasproducedarangeofcommercially valuablefuelproducts,therearebyproductsliketarandbitumen.Sincedemandfor theseislimited,crackingisappliedtoconvertthemintomoreindemandproducts, suchasgasolineanddieseloil,bysubjectingthemtohightemperaturesand pressures.Thetermischemicalinorigin,astheprocessinvolvesbreakingupor "cracking"thelongerHYDROCARBONchainsinthelowervalueproductsinto theshorteronesinfuelproducts.

Crude Blends

AmixtureofdifferentCRUDEOILGRADESdesignedtoraisethevalueofthe grades.Forexample,acertaingradeofHEAVYOILmaynotbesocommercially valuablealone,butwhenmixedwithLIGHTOILtheblendproducedmaybemore valuablethanthevalueoftheinitialvolumesofindividualheavyandlightcrude, sooverall,thecommercialvalueisincreased.

Crude Oil

199

APPENDICES

Crude Oil

Afossilfuelformedfromorganicmaterialovermillionsofyearsandextracted directlyfromtherockswhereitisfound,whichcanbefurtherprocessedinto variousfuelsandPETROCHEMICALproductsforconsumers.NATURALGASis oftenfounddissolvedintheoil.Seealso:PETROLEUM,PETROLEUM PRODUCTS,ASSOCIATEDGAS

Crude Oil Grades

Thequalitiesofoilfromaparticularfieldwhichdeterminethestepsneededto processitintousableproductsanditsmarketability.Crudeoilscanbe"light"or "heavy"dependingontheirAPIGRAVITYINDEX.Theycanalsobe"sour"ifthey containalotofsulphuror"sweet"iftheydonot.Beyondthesemajor characteristics,whichdictateacrudegrade'smarketvaluewhensoldagainst BENCHMARKCRUDES,theresomanyothercharacteristicsthateverycrudecan bechemically"fingerprinted".Seealso:LIGHTOIL,HEAVYOIL

Depletion

ThedeclineinproductionthatbeginstoappearinoilreservoirsasRESOURCES becomeexhausted.Globaldepletioniscurrentlyestimatedatbetween3%and5% peryear.Theimpactcanbemanagedbyimplementingsuitable'depletionpolicies' suchasENHANCEDOILRECOVERY.Seealso:HUBBERTCURVE,PEAK OIL,PLATEAUPRODUCTION."Themostimportantdepletionpolicy instrumentshavebeenthefrequencyinlicensingrounds,awardsoflicenses,and useofthefiscalsystem."ChathamHouse2010

Development Well

Awelldrilledatanexistingoilfieldwhichisalreadyproducing.Manyfields requirecontinuousdrillingofnewwellstomaximiseproduction,anddevelopment wellscanfaroutnumbertheWILDCATWELLSthatweremadetodiscoverthe resourceinthefirstplace.

Diesel

OneofaseriesofPETROLEUMPRODUCTSproducedoutofCRUDEOIL duringFRACTIONALDISTILLATION,commonlyusedtopowerourcarsasa heavieralternativetoPETROLusingaspecialcompressionengine.Dieselisalso widelyusedbymilitaryvehicles.


Discovery Well

200

Glossary

Discovery Well

seeWILDCATWELL

Downstream

Theseriesofoperationsthattakeplaceonceoilhasbeenfoundandproduced outofthewellhead.Sometimesdividedintomidstreamanddownstream,with transportandtheREFININGprocesstakingplacemidstreamandmarketingand distributionoccurringinthedownstreamphase.Seealso:UPSTREAM, INTEGRATEDENERGYCOMPANY"ConocoPhillipsannounceditwould separateitsprofitable'upstream'oilexplorationandproductionbusinessfromthe lowmargindownstream jobsofrefiningandmarketing."Economist2011

Drilling Mud

Amixtureofclay,waterandchemicalspumpeddownawelltomakedrilling moreeffective,bylubricatingandcoolingthemechanismandflushingrock cuttingstothesurface.Alsoknownas'drillingfluids'.

Dry Well

Awellwhichisdrilledbutfailstoproduceoilorgasincommerciallyviable quantities.SometimesknownasaDRYHOLE.Seealso:COMMERCIALITY, APPRAISALWELL,DEVELOPMENTWELL

Dubai Crude

OneofthreeglobalBENCHMARKCRUDEoils.AlsoknownasFateh,itis producedintheUnitedArabEmiratesandwasformanyyearstheonlyCRUDE OILGRADEintheMiddleEastfreelytradedontheSPOTMARKET.

Dutch Disease

AfactorintheRESOURCECURSE,sonamedafterthecrisisfollowinglarge gasdiscoveriesintheNetherlandsinthe1960s,wherebylargeinflowsofforeign PETRODOLLARScanhavedamagingconsequencesforaneconomy.Asthelocal currencyappreciates,theproducingcountry'snoncommodityexportsbecomeless competitiveonworldmarkets,andinflationcanoccuronthedomesticmarket.

Elephant Field

201

APPENDICES

Elephant Field

AfieldwithRESERVEStotallingover1billionbarrels.Seealso:GIANT FIELD

Energy Security

Theconceptthatenergyissoessentialtomoderneconomiesthatgovernments needtoplantoensuresecurityofaccess,evenwhentheindustryitselfisinthe handsoftheprivatesector.Thisofteninvolvestryingtodiversifyenergysources. Forexample,theUSAseekstodiversifyfromMiddleEasternoil,orEuropefrom Russiangas.

Enhanced Oil Recovery (EOR)

AsetoftechnologiestoincreasetheRECOVERYRATEofaproducingfield andoffsetDEPLETION.Methodscanincludeinjectingnaturalgas,chemicals,or waterintoafieldtoincreasepressure,aswellasHORIZONTALDRILLING.They accountforanincreasinglyimportantpartofglobaloilproduction.Seealso: DEPLETION

Environmental Impact Assessments (EIA)

Carriedoutbycompaniesbeforebeginningaprojecttoidentifyanypossible environmental,socialoreconomicimpacts,bothpositiveandnegative,andany measuresneededtomitigate.Contractsnowoftenspecifytheimplementationof suchstudiesbutalthoughvariousbestpracticeinitiativesexistatagloballevel suchasthoseoftheGlobalReportingInitiativeinAmsterdamortheInternational PetroleumIndustryEnvironmentalConservationAssociation(IPIECA)inLondon, theyarerarelyspecifiedincontract.EIAsarerarelymadepublic,existingasa documentheldbetweencompaniesandhostgovernments.

Farmout Agreement

Thesaleofrightstoadiscoveryonceoilhasbeenstruck.Alsoknownasa'farm down',thisisacommonpracticeamongsmallerexplorationcompaniesfundedby seedandventurecapitalbutwhocannotthenbearthecostsofgettingtheoiloutof thegroundalone.The'farmee'usuallypaysthe'farmor'asumonsignature,and bearsaproportionofoperationalcosts.Theremayormaynotbeanagreementfor thefarmeetobeinvolvedinactualproductionactivities.SeealsoWORKING INTEREST


Fracking

202

Glossary

Fracking

seeHYDRAULICFRACTURING

Fuel Oil

Oneoftheheavier,moreviscousproductsobtainedfromtheFRACTIONAL DISTILLATIONofcrudeoil.Fueloilmostlyhasindustrialusesinenginesand furnaces.

Futures Contract

Anagreementbetweentwopartiestobuyandsellaspecifiedquantityof CRUDEOIL,withthepriceagreedtoday,andthedeliveryandpaymenttotake placeataspecifieddateinthefuture.Themaincrudeoilfuturesmarketsarethe NewYorkMercantileExchange(NYMEX)andtheIntercontinentalExchange (ICE).FuturescombinewiththeSPOTMARKETtoformtheoveralltrading environmentforoilandgas.

Giant Field

SometimesdefinedintermsofRESERVES(exceedingonebillionbarrels)and sometimesintermsofproductionoutput(exceeding100,000BARRELSPER DAY).Evenlargersupergiantfieldsaregenerallythosewhosereservesexceedfive oreventenbillionbarrels.Howeverthedefinitionsremaincontested.Seealso: ELEPHANTFIELD

Groundwater

Waterheldinrocksbeneaththewatertable.Itcanbepollutedordepleted duringthedrillingprocess,particularlyHYDRAULICFRACTURING.Seealso: ENVIRONMENTALIMPACTASSESSMENT

Heavy Oil

MoreviscousgradeofcrudeoilwithalowerAPIGRAVITYthanLIGHTOIL. Productionofheavyoilisbecomingmorecommonaroundtheworlddespite greaterextractionandprocessingcosts,becauselightoilsupplieshavedwindled. Extraheavyoil,suchasthatfoundintheOrinocobeltofVenezuela,isgenerally definedashavinganevenlowerAPIGravityof7to11.Seealso:OILSANDS

Horizontal Drilling

203

APPENDICES

Horizontal Drilling

Atypeofdirectionaldrillingwhichallowsdrillerstoaccesspocketsofreserves thatarehardertoreachbyaverticalwell,oftenusedasacosteffectivetechniqueat OFFSHORElocations.In1990,IraqileaderSaddamHusseinaccusedKuwaitof usinghorizontaldrillingtostealIraqioilanduseditasapretexttoinvadeinthe firstGulfWar.Seealso:ENHANCEDRECOVERY

Hydraulic Fracturing

AlsoknownasFRACKING,itinvolvesshootingwater,sandandother compoundsatrockstructuresatsuchhighvelocitythattheyproducesmall fracturesthroughwhichCRUDEOILandNATURALGAScanthenbeextracted. ThedevelopmentoffracturingintheUnitedStatessince2005hasledtoamassive increaseinSHALEGASproduction,despiteenvironmentalandsafetyconcerns associatedwiththeprocedure.Seealso:ENHANCEDOILRECOVERY

Integrated Energy Company

Acompanyactiveinallstagesofthevaluechain,fromexplorationthrough productiontoshippingandrefining,todistributionandretailmarketingoffuel products.MostSUPERMAJORSareintegratedenergycompanies.

International Oil Company (IOC)

Aprivatesectoroilcompanywithoperationsinmanycountries.Thelargest IOCsareSUPERMAJORSandthelargesthistoricallyweretheSEVENSISTERS. ThetermisoftenusedincontrasttoNATIONALOILCOMPANIES,stateowned entitiescreatedafterwavesofRESOURCENATIONALISMinthe1960sand 1970sledtonationalisationofthesectorinmanycountries.

Joint Venture (JV)

Awellestablishedfeatureoftheoilandgasindustrywherebytwoormore companiesagreetoshareprofit,lossandcontrolinacertainproject,commoninthe 'UPSTREAMsectorwhereprojectscanbetoobigforasinglecompanytofinance onitsown.Partnerscanbefromboththepublicandprivatesectors."JVsarea usefulwayofgainingthebenefitsofcollaborationwithouttheeconomicand politicalriskassociatedwithamergerorotherbusinesscombination."Ernst& Young2011

LIBOR

204

Glossary

LIBOR

TheLondonInterbankOvernightRate,arateofinterestoftenusedinthe financialtermswhichgovernoilcontracts.

Licensing Round

Aneventatwhichoilandgasacreageisopenedupbyagovernmentto competingbidsbyexplorationandproductioncompaniesorconsortiums.Licenses arethenawardedtothemostattractivebid.CompetitiveandTRANSPARENT licensingroundsareseenaskeytoefficientmanagementofanation'sresourcesand areoftenimplementedbyusingauctionswhichpubliclystatethecriteriaunder whichbidswillbejudged.Seealso:BLOCK,WORKINGINTEREST

Light Oil

LightcrudeoilismadeupofsmallermoleculesthanHEAVYCRUDEOILand thereforeproducesahigherpercentageofcommerciallyvaluableproducts(like gasolineanddiesel)whenrefined,thusfetchingahigherpriceonglobalmarkets. Seealso:GRADESOFCRUDEOIL,HEAVYOIL

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

Thepurchasingoflocalgoodsandservicesandtraininganddevelopmentof nationalstaffasaresultofoilproductionwiththegoal,fromthehostgovernment side,ofmaximisingbroadereconomicgrowthasaresultoftheoilindustryand buildingnationalexpertisewhichovertimeallowsfullnationalcontrolofthe industry.Localcontentisoftenanegotiationpointbetweencompaniesand governmentsstipulatedinthetermsofcontracts.Brazilissometimesseenasoneof themostsuccessfulexamplesoflocalcontentapplication.

Metering

Measuringtheamountofoilorgasproducedoutofawellorflowingdowna PIPELINEforcommercialpurposes.Meterscannowmeasuremanydifferent CRUDEOILGRADESflowingdownonepipetoupto0.15percentaccuracy.See also:BUNKERING

National Oil Company (NOC)

Astateownedoilexplorationandproductioncompany,usuallyusedincontrast totheideaofIOCS.Becauseofthewaveofnationalisationscausedby RESOURCENATIONALISM,theNOCsnowrepresent18outofthebiggest20 oilcompaniesintheworld,measuredintermsoftheiroilandgasassets.Some NOCsarerunoncorporatisedlinesandhavestartedtocompeteinternationally, notablyCNPCfromChina,Algeria'sSonatrach,PetronasfromMalaysiaand PetrobrasfromBrazil.PetrobrasandColombia'sEcopetrolalsohaveminority privatesectorshareholders.

Natural Gas

Primarilymethane.Itoccursnaturallyandisusedasafuel.

Natural Gas Condensates

seeCONDENSATES,NATURALGAS

Non-Associated Gas

NATURALGASfoundinreservoirswherenoliquidHYDROCARBONSare presentorwherenosignificantquantitiesofliquidhydrocarbonsexist.Contrasts withASSOCIATEDGAS.


Offshore

206

Glossary

Offshore

Thedrillingofwellsintotheseabed.Offshoredrillingbeganinthenineteenth centuryandsignificantproductionwasachievedonVenezuela'sLakeMaracaibo inthe1920sbutmoderntechniquesbeganintheGulfofMexicointhe1940s. Offshoreisgenerallyregardedasdrillingthattakesplaceonthecontinentalshelfin lessthan200metresofwater,butinrecentyearsdeepoffshorehasevolvedwith drillinginwaterdeeperthan2,000metres.Offshoreisoftencontroversialbecause ofenvironmentalrisksbutisagrowingcomponentofglobalproductionandis particularlysignificanttoproductioninBrazil,WestAfrica,theGulfofMexico andincreasinglytheLevantinebasin.Seealso:PRESALT

Oil In Place (OIP)

CRUDEOILestimatedtoexistinafieldorareservoir.Notallthatoilwillbe extracted,however,becauseofthepropertiesofarockformation.Theexact percentagewilldependontheRECOVERYRATE.

Oil Sands

AnUNCONVENTIONALENERGYSOURCE,madeupofamixtureofsand, waterandBITUMEN.Usualtechniquescannotbeappliedhereandextraction oftenresemblesminingmorethanconventionaldrilling,usingtechniquesthatare farmoreenergyandcapitalintensive.Oilsandshaveonlyrecentlybeenincluded intheworldsoilreservesduetohighoilpricesandtechnologicaladvances.The largestdepositscurrentlyknownaretheAthabascatarsandsinCanada.Seealso: HEAVYOIL

Oil-Backed Loan

Aloaninwhichfutureoilrevenuesarepledgedascollateralbyaproducing country.AprominentfeatureofChineseengagementinresourcerichAfrican countriessuchasAngolaandNigeria,andoftenusedtofinancelargeinfrastructure projects."IftheGovernmentofSouthSudanfeelsthatoilbackedloansare currentlynecessarytopreventeconomiccollapse,itiscriticalthatrobust protectionsareputinplacetominimizefuturecostsandconsequences."Global Witness2012oilfieldservicecompaniesseeSERVICECOMPANIES

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

SinceoilsalesaregenerallydenominatedinUSdollars,petrodollarsarethe fundsfromoilsales.Thedollardenominationhashadimplicationsforlinkages betweentheoilindustryandtheUSeconomywhichhasledsomeproducers, notablyVenezuelainrecentyears,todebateendingit.petrolOrgasoline,oneof thekeyproductsofcrudeoilusedmostlyfortransport.

Petroleum

Thetermofarttodenotebothcrudeoilandpetroleumproductsproducedby REFINING.Theterms"oil"and"petroleum"aresometimesusedinterchangeably.

Pipeline

Apipe,usuallyunderground,usedtotransportoilorgasoverlongdistances. Althoughpipelinescanbeconstructedunderwatermostoiltransportbyseaisdone bytankers.Becausepipelinesaresoexpensiveandsignificantonesoftencross multiplenationalborders,pipelinenegotiationsofteninvolvecomplexgeopolitics.

Plateau Production

208

Glossary

Plateau Production

Keepingproductionoutofamatureoilfieldsteadyforanumberofyears.This usuallyinvolvesusingENHANCEDOILRECOVERYtechniquestomitigate DEPLETION.

Play

Aslangtermcommonlyusedintheindustryforaninvestmentdecision. "InternationalplayersaretakingacloserlookatAustralia'sCooperbasinshale play."PetroleumEconomist2012

Possible Reserves

Havea10percentcertaintyofbeingproduced.CombinedwithPROVEN RESERVESandPROBABLERESERVESintheindustryterm3P.Seealso: RESERVES

Pre-Salt

Oilandgasdepositsthatarefoundbeneathhugelayersofsalt,deepintherocks. Presaltdepositscouldnotbeexploitedcommerciallyuntilrecentlybecauseof technologicallimitationsbutnowrepresentasignificantportionofprojectedfuture finds.ThemostfamouspresaltregionisBrazil'sTupifield,under2,000metresof waterandafurther5,000metresofsalt,sandandrock.Seealso:OFFSHORE

Probable Reserves

Havea50percentcertaintyofbeingproducedundercurrentmarketconditions. ProbableandPROVENRESERVESareoftencombinedinadefinitionknownas 2P,whichisthemostcommonwaytoassesstheamountofoilafieldislikelyto produce.Seealso:RESERVES

Production Sharing Contract (PSC)

Anagreementbetweenacompanyandahostcountryonthepercentageofoil eachpartywillreceiveafterspecifiedcostsandexpenseshavebeenpaidunder COSTRECOVERY.UnderaPSC,thecompanygenerallygivesthestatecash paymentsintheformofROYALTIESandincometax.Alsoknownasaproduction sharingagreement(PSA).Seealso:CONCESSION,SERVICECONTRACT

Profit Oil

209

APPENDICES

Profit Oil

Theportionofrevenuesdividedupbetweenparticipatingpartiesandahost governmentinaPRODUCTIONSHARINGCONTRACT,oncetheoperatorhas recovereditsinvestmentbydeductingCOSTOILproduction."Astheprofitoilis splitbetweenthecompaniesandthestate,thecostofallowableexpenditures ispassedontothestateintheformofreducedprofitoil."CivilSocietyCoalition onOilinUganda2010

Project Financing

Arrangementsforcapitallinkedtoindividualproductionprojects.Even SUPERMAJORoilcompaniesusefinancingfrombanksandfinancialinstruments suchasbondsextensivelybecauseoftheincreasinglycapitalintensivenatureof oilexplorationandproduction.GlobalinvestmentinUPSTREAMhasrisenfrom aboutUS$100billionin2000toabout$600billionin2011,alevelwhichthe industryanticipatesislikelytoholdorriseinthenextdecade.

Proven Reserves

Classifiedashavinga90percentcertaintyofbeingproducedatcurrentprices, withcurrentcommercialtermsandgovernmentconsent,andarealsoknownin industryas1P.Seealso:RESERVES

Recovery Rate

Theamountofoilthatwillbeextractedcomparedtotheamountofoilinplace. Historicallyratesof25percentwerecommonbutratesarenowrisingto50percent andabovebecauseofextensiveuseofENHANCEDOILRECOVERY.

Refining

Processeswhichconvertcrudeoilandgasintousableproducts,suchas FRACTIONALDISTILLATIONandCRACKING.Refiningisahugeindustryin itsownrightbutwithvolatileprofitmarginsinrecentyearswhichhavecaused someINTEGRATEDENERGYCOMPANIEStoconsidergettingoutofit.

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

AsubsetofoilandgasRESOURCES,whicharecommerciallyviabletoextract. Definitionsusedaroundtheworldstilldiffersomewhatbutthereisincreasing standardisationunderaseriesofdefinitionsproducedbytheUSSocietyof PetroleumEngineers(SPE).Reservesarefurtherdividedintothesubcategories: PROVENRESERVES,PROBABLERESERVES,ANDPOSSIBLERESERVES. Classificationofreservescanbecrucialtothevalueofacompany,asitisakey wayforacompanytoshowitsassetsthroughBOOKINGRESERVES.

Reserves-Production Ratio

Thenumberofyearsacountrycancontinueproducingatitscurrentrategiven thelevelofitsPROVENRESERVES.BP'sStatisticalAnalysisfor2012estimated theglobalR/Pratioat54years.AtoneendofthespectrumaretheUnitedStates, NorwayandtheUnitedKingdomwithrespectively10,nineandsevenyears productionleft.Attheother,SaudiArabiahas65yearsleft,Kuwait97yearsand Iran99years.

Resource Diplomacy

Theuseofstatediplomacytonegotiateaccesstonaturalresources.Forexample, theUnitedStateshasusedresourcediplomacyintheGulf,andChinais increasinglyusingitinAfrica.

Resource Nationalism

211

APPENDICES

Resource Nationalism

Thepoliticalfeelingthatcontrolofnaturalresourcesshouldbeinthehandsof thecountrieswhichownthem.Resourcenationalismgrewintheoilindustryasa resultofdominancebytheSEVENSISTERSandledtothecreationofOPECand nationalisationoftheindustryinmanycountries,leadingtotheriseofthe NATIONALOILCOMPANIES.

Resources

Allquantitiesofpetroleumwhichareknowntoexistincludingthosewhichare not,atthattime,consideredtobecommerciallyviabletoextract.Thiscanchange astechnologydevelopsandwithhigheroilprices.Forexample,theOILSANDS werepreviouslyclassifiedasRESOURCESbutarenowRESERVES.

Resource Curse

Thetheorythatnaturalresourcewealthcansometimesparadoxicallycreate negativedevelopmentoutcomesinproducingcountries,duetoweakened governmentinstitutions,neglectofotherkeysectorsoftheeconomy(knownas DUTCHDISEASE),corruption,highincomeinequalityandpollution.Sometimes calledthe'paradoxofplenty'.Seealso:RENTS"Theresourcecurseisnot inevitable.What'sneededistransparencyandaccountability."Petroleum Economist2011

Royalties

Apercentageshareofproduction,orofthevalueoftheproductionwhichgoes tothegovernmentregardlessoftherateofproductionorcoststotheoperator. Royaltyratesoftenchangeincrementallyasproductionincreases.Incalculating revenueflowsfromanoilproject,royaltiestakeprecedence,withothercategories suchasCOSTOILandPROFITOILsubordinate.CONCESSIONtypecontractsare almostentirelybasedonroyalties.

Royalty Interest

212

Glossary

Royalty Interest

IncontrastwithaWORKINGINTEREST,theownershipofaportionof revenuesproducedfromanoperationwithoutbearingtheongoingproduction costs.Seealso:ROYALTY,PRODUCTIONSHARINGCONTRACT"It's generallyrecommendedthatinvestorswithoutdeeppocketsandasolidworking knowledgeofoilandgasexplorationstickwithlimitedliabilityroyaltyinterests." Investopedia

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

Technologysimilartoultrasoundusedtobuildapictureofundergroundrock structuresduringearlystageoilandgasexploration.Seismicworksbysendingout soundpulsesandusingthemeasurementsofhowandwhentheyreturntoestimate rockstructures,sincedifferentkindsofrockofferdifferentlevelsofresistancetothe signals.CombinedwithinformationfromanAPPRAISALWELLthesesurveys formthebasisforfurtherinvestmentdecisions.Seismicdatahasincreased exponentiallyinrecentyearswiththedevelopmentofdataacquisitionand interpretationtechnology.Seealso:ANTICLINE,SOURCEROCK, COMMERCIALITY

Service Companies

213

APPENDICES

Service Companies

Oilcompanieswhichdoeverythingbutactuallyownorbidonresourceswith governments.Theoilindustryhasbeensubjecttooutsourcingsincethe1980s meaningthatSUPERMAJORSoftencontractlargepartsoftheiroperationsto servicecompanies.Thelargest,suchasSchlumbergerandHalliburton,employtens ofthousandsofemployeesandcanwinsinglefieldcontractsworthhundredsof millionsofdollars.

Service Contracts

Anagreementwherebyaforeignoilcompanyiscontractedtoproducea country'soilreservesonasimplefeebasis.Thestatemaintainssolerightsoverthe RESERVES,andthecontractoriscompensatedbyafeeperbarrel,plusCOST RECOVERY.Seealso:PRODUCTIONSHARINGCONTRACT,CONCESSION

Seven Sisters

Atermcoinedinthe1950stodescribetheoilcompanieswhichdominatedthe earlyyearsoftheglobaloilindustry.TheywereAngloPersianOilCompany(now BP),GulfOil,StandardOilofCalifornia(Socal)andTexaco(nowChevron),Royal DutchShell,StandardOilofNewJersey(Esso)andStandardOilCompanyofNew York(Socony)(nowExxonMobil).Seealso:INTERNATIONALOILCOMPANY

Shale Gas

NATURALGASformedfrombeingtrappedwithinshalerockformations currentlythesourceof20percentofUSnaturalgasproductionduetotheincrease inHYDRAULICFRACTURING,orFRACKING,andpredictedtoincreasein importanceinthefuturebytheEIA.showing,oilorgasWhenacompany announcesthatoilhasbeenfoundinanexploratorywell.Explorationcompanies oftenuseshowingstomakedramaticpublicannouncementstoboosttheirprofile 51JARGONBUSTER:GLOSSARYandshareprice,butashowingdoesnot necessarilymeanthatCOMMERCIALITYwillbedeclared.

Signature Bonus

Lumpsumofmoneypaidupfrontbycompaniestogovernmentsuponsigninga PRODUCTIONSHARINGCONTRACTorCONCESSIONagreement.Sometimes usedasthedecidingfactorinatiebreakerbetweenbidders."Underthelastbid roundinLibya,Occidentalpaid$1billionasasignaturebonus"


Sour Oil

214

Glossary

Sour Oil

CRUDEOILGRADESwhichhavehighsulphur,decreasingtheirmarketvalue, incontrasttoSWEETOIL.

Spot Market

Theglobalmarketwhereoilcanbetradeddynamically.Beforethespotmarket appearedinthe1970s,oilwastradedlargelyinlongtermfixedcontracts.Butnow asingleshipmentofoilcanbetradeduptotentimesfromthetimeitleavesa producingcountrytothetimeitreachesport.

Spudding

Theverystartofthedrillingprocessatanewwellbygettingridofanybitsof rock,dirtorothersediment.

Subsoil Rights

Whoownsresourcesundertheground.Inmanycountries,subsoilrightsbelong tothestatewhichiswhythestatedevelopsanoilindustrywhendepositsare found.IntheUnitedStates,bycontrast,subsoilrightsattachtothelandownerat thesurface,whichiswhattriggeredoilrushesinTexas,Oklahoma,andelsewhere.

Super-Giant Field

seeGIANTFIELD

Supermajor

Theworld'slargestpubliclyownedoilandgascompaniesandthemodernday equivalentoftheSEVENSISTERS,consideredtobeBP,Chevron,ExxonMobil, RoyalDutchShellandTotal,withConocoPhillipssometimesalsoincluded.See also::INTERNATIONALOILCOMPANY

Sweet Oil

CRUDEOILGRADESwhichhavelowsulphur,increasingtheirmarketvalue, incontrasttoSOUROIL.

Swing Producer

215

APPENDICES

Swing Producer

Acountrywhichhasproductioncapacitysignificantlyabovewhatitsactual levelsofproductionare,allowingittoraiseproductionovernightandtherefore lowermarketprices.SaudiArabiahasbeenthesoleswingproducerforthelast30 years.OthercountriessuchasIraqandLibyasometimesdebateasimilarrole.tar sandsseeOILSANDS

Tight Hole

Adrillingwellaboutwhichallinformationiskeptconfidential,mostoftenused forAPPRAISALWELLS.

Transit Fees

Feeschargedbyacountrytoallowoilorgastobetransportedacrossitsterritory, eitherbypipelineorthroughshippingchannelssuchastheSuezandPanama Canals.

Transparency

Improvedaccesstoinformationsuchasrevenues,pricesandcontractterms, helpingto'followthemoney'andpreventcorruption.Transparencyfirstemergedas ahighprofilenorminthe1990sasissuesofgovernancecametodominatethe globaldebateondevelopment.Agrowingmovementdemandinggreater transparencyintheoilandgasindustrycentresaroundtheEITIinitiative.Seealso: RENTANDRENTSEEKING"Transparencyofpaymentsmadefromacompanyto agovernmentcanhelptodemonstratethecontributionthattheirinvestmentmakes toacountry."EITI

Unconventional Energy Sources

Anyresourcesaccessedbymeansotherthantheconventionaloilwellmethod. Thisisanumbrellatermthatshiftsovertime,butcurrentlyusedtorefertosources suchasSHALEGAS,COALBEDMETHANEandOILSANDS."Whilethese reservesmayholdthekeytothefutureoilsupply,companiesmustdealwiththe additionaltime,costandresourcesittakestoextracttheunconventionaloil." FinancialTimes2010

Unitisation

216

Glossary

Unitisation

Thewayasingleoilbearingrockformationisdividedbytwocountrieswhenit straddlesaborder.ForexampletheUnitedKingdomandNorwayhavea unitisationagreementintheNorthSea.Unitisationrequiresagreedborders,but sincetheoilcouldbesuckedfromonesideofthebordertotheotheralsogoes beyondittorequireagreementandcooperationongeologicalstudiesand productionfigures.

Unproven Reserves

AnumbrellatermforPROBABLERESERVESandPOSSIBLERESERVES.see RESERVES

Upstream

Thecapitalintensive,highriskhighrewardinitialstagesoftheindustry involvingexplorationandproduction.Seealso:MIDSTREAM,DOWNSTREAM, INTEGRATEDENERGYCOMPANY

Well Completion

seeCOMPLETION

West Texas Intermediate (WTI)

TheUScrudeoilBENCHMARK,traditionallytradingwithinafewdollarsof BRENTCRUDE.ItisaLIGHTOILwithalowsulphurcontent,soitisconsidered tobeahighqualitycrude.Seealso:BENCHMARKCRUDES

Wet Gas

NATURALGAScontainingotherhydrocarbonsthatcondenseasthegasrises tothesurfaceandlowertemperaturesthanexistedinthereservoir.Typically,wet gascontainslessthan85percentmethane.Thenaturalgasliquidsaregenerally separatedfromthemethanetoensurethatthenaturalgassenttoconsumershasa consistentthermalenergycontentthoughwetgasissometimesmorevaluablethan DRYGAS,astheliquidsarethemselvessellablecommoditiessuchasbutane.See also:DRYGAS,CONDENSATES

Wildcat Well

217

APPENDICES

Wildcat Well

AnexploratorywellintorockstructuresnotknowntocontainoilRESOURCES, underconditionsoflittleornogeologicalcertainty.Ahighrisk"makeorbreak" venturefordrillingcompanies.Ifthewellisinafieldthathasnotproducedbefore itisknownasa"newfieldwildcat".Ifitismorethan3kilometresawayfromany producingwellitiscalleda"rankwildcat".Ifthewelldiscoversoil,itisknownas the"discoverywell"ofthatfield.Seealso:APPRAISALWELLDEVELOPMENT WELL

Working Interest

Thepercentagestaketakenbyacompanyinanoilorgasoperation,wherethey areliableforaproportionoftheongoingoperatingcostsbutalsohasaclaimtoa shareoftheprofits.ThiscontrastswithaROYALTYINTEREST.Seealso: PRODUCTIONSHARINGCONTRACT,COSTRECOVERY

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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