Production Engineering II (PDB 3073)

Chapter 1 (Part 1)
Introduction of Petroleum Business
By :
Assoc. Professor Dr. Tarek Ganat
(tarekarbi.ganat@utp.edu.my)
Tel No : 05 368 7111

© 2013 INSTITUTE OF TECHNOLOGY PETRONAS SDN BHD

All rights reserved. No part of this document may be reproduced, stored in a retrieval system or transmitted in any form or by any
means (electronic, mechanical, photocopying, recording or otherwise) without the permission of the copyright owner.
 Overview

 Exploration & Production Business

 Exploration & Production Costs
 Petroleum Fiscal Regimes
 Production Sharing Contract Terms – Malaysian
Models
Q &A
 Learning Outcomes
At the end of this lecture, students should be able to :

To discuss all phases of the E & P Business in general.

To mention and explain different types of licensing

agreements.

To describe the major features of a Production Sharing

Contract.

To discuss the Malaysian models of the PSC Terms.

 Exploration & Production Business

 The Exploration &

Production (E&P)
business is responsible
for upstream oil and gas
activities that will build a
strong, sustainable
portfolio of assets to
support company growth.

 The E&P business focuses on high-margin projects that deliver significant

returns, cash flow and long-term value.

 One of E&P's key roles is to provide portfolio diversity with low-cost

conventional production, which helps balance against higher cost oil sands
production, particularly when crude prices are low.
Video Presentation
 High costs in
exploration &
development

140
Oil price High levels of
variations uncertainties
50
20
1980 2016

Internal
 Explore Appraise Develop Operate Abandon

Exploration Development Production

5-10 years 5-10 years 15-30 years

Internal
International (Upstream) Petroleum Agreement
negotiation Petroleum Contract
 Fiscal System

The two main families of fiscal system are:

1- Concessionary System: ( More commonly known these

days as Royalty /Tax (R/T) system).

2- Contractual Based” system: (Which include both production

sharing contracts (PSCs) and Service agreements (SAS)).
 Exploration & Production Business
Phases of Activities in the Petroleum Industry
ACQUISITION OF RIGHTS To obtain permission from government or relevant agency
before the drilling of Exploration wells.

These can be done through :

i. Concession [old style]

ii. Production License [new concession]
iii. Production Sharing Agreement
iv. Joint Venture
v. Service Contract
 Exploration & Production Business
Phases of Activities in the Petroleum Industry
ACQUISITION OF RIGHTS To obtain permission from government or relevant agency
before the drilling of Exploration wells.

EXPLORATION To search for oil and gas fields

These activities may constitute the following:

a. Gravity and Magnetic Surveys : Mapping of gravity and/or magnetic anomalies due to the
variations of the earth’s geological structures and
magnetic properties of rocks.

b. Seismic Survey : Seismic lines producing Coarse 2-dimensional seismic grid reflecting
the geophysical nature of the rocks etc.

c. Wildcat : The first exploration well drilled in green field with no offset well information
available to obtain data and prove hydrocarbon presence.
 Exploration & Production Business
Phases of Activities in the Petroleum Industry
ACQUISITION OF RIGHTS To obtain permission from government or relevant agency
before the drilling of Exploration wells.

EXPLORATION To search for oil and gas fields

APPRAISAL To determine the commercial significance of the discovery

and to shape the initial development plan for the field.
 Exploration & Production Business

EXPLORATION

Appraisal Phase EXPLORATION DRILLING

Dry
RESULTS
DISCOVERY

APPRAISAL
Appraisal drilling to define the extent of discovery
Data gathering to aid in the development studies
Development feasibility studies

Inconclusive
RESULTS QUIT

DEVELOPMENT
 Exploration & Production Business
Phases of Activities in the Petroleum Industry
ACQUISITION OF RIGHTS To obtain permission from government or relevant agency
before the drilling of Exploration wells.

EXPLORATION To search for oil and gas fields

APPRAISAL To determine the commercial significance of the discovery

and to shape the initial development plan for the field.

To formulate the Field Development Plan, install platforms /

DEVELOPMENT
facilities, drill and complete the development wells.
 Exploration & Production Business
Development Phase
The DEVELOPMENT of Production Concept and IMPLEMENTATION activities.

The objectives : To gain maximum recovery with minimum cost.

Factors to be considered in the development plan are:

i) Drilling requirements : Number of wells, well spacing and drainage pattern,

drilling program, completion strategy, etc.

ii) Production techniques and policy anticipated : Artificial lift needs, pressure
maintenance, etc.

iii) Facilities required : Drilling and Production

iv) Development time and cost expected.

 Exploration & Production Business
Phases of Activities in the Petroleum Industry
ACQUISITION OF RIGHTS To obtain permission from government or relevant agency
before the drilling of Exploration wells.

EXPLORATION To search for oil and gas fields

APPRAISAL To determine the commercial significance of the discovery

and to shape the initial development plan for the field.

To formulate the Field Development Plan, install platforms /

DEVELOPMENT
facilities, drill and complete the development wells.

PRODUCTION To produce oil/gas from sub-surface to surface and to

separate gas/oil/water before oil is stored and gas is
processed.
 Exploration & Production Business
Phases of Activities in the Petroleum Industry
ACQUISITION OF RIGHTS To obtain permission from government or relevant agency
before the drilling of Exploration wells.

EXPLORATION To search for oil and gas fields

To determine the commercial significance of the discovery

APPRAISAL
and to shape the initial development plan for the field.

To formulate the Field Development Plan, install platforms /

DEVELOPMENT facilities, drill and complete the development wells.

To bring oil/gas from sub-surface to surface and to separate

PRODUCTION
gas/oil/water before oil is stored and gas is processed.

PROCESSING / EXPORT To condition the gas / oil and sell to customers.

 Exploration & Production Costs
 As with most investments, upstream
petroleum projects include the following
types of cash flow:

i. Revenue : Income from sales / services

ii. Capex : Project development
iii. Opex : Project running costs
iv. Taxes : Payments to Government

i. Revenue

 The basis of revenue is production.

 All income from the sale of goods and services is normally lumped together as
revenue
 Rate of production is constrained by facilities, reserve volume & geometry and
energy of the natural system.
 Exploration & Production Costs
Elements of production profile
Plateau phase
Build Up Phase
Decline phase
The phase of production from start to peak.
 It is the time when development wells are
being drilled and new wells are coming on
stream.
Economic limit
 Speed of build up is diminished by mechanical
drilling problems, or by unforeseen geological
problems in the reservoir.

Plateau Phase

It can dominate the economic performance of a project  must be properly planned.
 The higher the peak, the sooner average oil is produced.
 Higher rate means higher system capacity, more wells, larger pipes and vessels, more
platforms and more cost.
 Therefore, a balance between rate and reserves is important to ensure optimal
economics.
 Exploration & Production Costs
Elements of production profile (con’t)

Decline Phase

 It starts once production falls off plateau.

 The decline rate depends on reservoir
architecture and energy.

Economic Limit

 A condition of production comes to an end.

 Production is terminated for economic reasons.
 The operation cost is greater than revenue.
 Exploration & Production Costs
ii. Project Capex
For the Project Capital Expenditure, several stages of expenditure are involved:

 Exploration [pre discovery]

 geology
 Appraisal [ pre commercial decision]
 geophysics
 drilling  geology
 geophysics
 drilling
 well-testing
 Field Development
 drilling
 production wells  Field Modifications
 production facilities  more wells
 export facilities  injection facilities
 Abandonment
 artificial lift
 seal off wells
 removal of facilities
 Exploration & Production Costs
iii. Project Opex

It is often called Operating Cost.

Opex may include the following costs :

 Lease of facilities.
 Platform operation, maintenance and transportation cost.
 Workover operations on wells.
 Insurance and administration; such as salary.
 Exploration & Production Costs
iv. Petroleum Taxation

Why ?
 The petroleum industry is a popular target for
government.

 Petroleum industries are subject to a wide range

of fiscal systems.

 Therefore, it is important to understand the

impact of taxation on project economies.
Typical E&P Cash Flow Project Diagram
 Petroleum Fiscal Regimes
Licensing is the legal process by which the owner (government) of
subsurface mineral rights grants permission to a company to explore
for and to produce petroleum from a specific area.

There are a number of styles of licensing agreement, which have

been applied within the petroleum industry. The most common are as
follows:-

i. Concessionary System [Royalty Tax System (R/T)]

ii. Production License [new concession]
iii. Production Sharing Agreement
iv. Joint Venture
v. Service Contract
Type of Petroleum Rights & Contracts
 Differences between…

Features Concessions (R/T) Contracts

Ownership of resources Government Government

Title transfer point At the wellhead At the export point

Gross production less  Cost oil & gas + profit 

Company entitlement
royalty oil & gas

Entitlement % Typically 90% Typically 50‐60%

Ownership facilities Company Government

Direct government
Management & control Less government control
control & participation

Financial obligation Company 100% Company 100%

 Licensing Agreements: Concessionary System

i. Concessionary System

 A concession is an arrangement between a government and a

company, whereby the produced oil and gas becomes the property
of the company and the government receives various payments, in
the form of royalties, taxes, etc.
 The “old style” concessions, it was the only agreement available
,which predominated in the Middle East, were characterized by
large areas, long time periods and managerial freedom.
 This type of agreement was clearly inequitable and conceded
excessive control to the company.
 After World War Two, they were gradually replaced by Production
Licenses and by various forms of direct government involvement.
Concessionary System Or Royalty Tax System (R/T)
 Concessionary Regime

Total net profit for the barrel

of oil = USD 65 (100-35)

Net Take by Government =

USD 38 (20+18)

Net Take by Contractor =

USD 27 (100-20-35-18)

Illustration of the Concessionary Regime Flow Diagram

 Licensing Agreements: Production Sharing Contracts 

• Production sharing agreements are common type of contract signed between a 
government and a resource extraction company (or group of company) 
concerning how much of the resource (oil or gas) extracted from the country 
each will receive.
• A contractual agreement between the company and the host government (NOC) 
whereby the contractor bears all of the exploration costs and risk and the 
development and production costs in return for stipulated share of the 
production resulting from this effort.
• The government a wards the execution of exploration and production activities 
to an oil company. 
• When successful, the company is permitted to use the money from produced oil 
recover capital and operational expenditures known as “Cost oil”. The remaining 
money is known as “ Profit Oil” and is split between the government and the 
company. Typically at rate of about 80% for the government  (NOC) and 20% for 
the company. In some cases, the company and the NOC form a separate
company for the purpose of development. This arrangement is a form of
Joint Venture.
 Licensing Agreements: Production Sharing Contracts 

ii. Production Licenses [new concessions]

 Modern production licenses [new concessions] offer much more

control to government.
 Prospective areas are divided into many small blocks to increase
competition and to reduce government dependence on any single
company.
 Blocks are subject to relinquishment to encourage development.
Licenses relate to shorter time periods.
 Companies must compete for licenses on financial or technical
basis.
 Development plans are subject to government approval.
 Revenues are subject to realistic levels of taxation.
Production Sharing
 PSC Cash Flow Diagram
 Profit oil is the remaining revenue after cost recovery and royalty.
 Assume that cost recovery ceiling is
set at 50% of gross revenue.

 Total Profit = USD 40

 Profit Split = 30/70

 40% tax rate on taxable income

 Contractor’s Entitlement = USD 62

(50+12)

 Contractor’s Net Profit After Tax =

Illustration of the PSC Flow Diagram USD 7.2 (0.6*12)

 Net Take by Government = USD

42.8 (10+28+4.8)
 Licensing Agreements: Service Contracts or Service Agreement (SA)

• Service contracts generally use a simple formula:
 The contractor is paid a cash fee performing the service of 
producing mineral resources.
 All production belongs to the stat. The company receives no
equity in the project.
 The contractor is usually responsible for providing all the capital 
associated with exploration and development (same as R/T and 
PSCs).
 If exploration efforts are successful, the contractor recovers 
costs through the sales of oil or gas plus a fee. The fee is often 
taxable.
 Service agreement is quite similar to R/T and PSCs systems 
except for the issue of entitlement.
 Differences between…

Features PSC Service contract

Project type All types, often non‐
All types
exploration
Facilities ownership Government Government
Company entitlement None, may have
Cost oil + profit oil preference right to 
purchase
Entitlement % ~ 50‐60% None
Hydrocarbon transfer Delivery/ export point None
Financial obligation Contractor 100% Contractor 100%
Government participation Common Very common
Cost recovery Usually Sometimes
Government control High High
 Licensing Agreements
Key Differences – Transfer of Tittle of Hydrocarbons

 With Concessions or Licenses, the title transfers at the wellhead. The IOC 
is entitled to gross production minus royalty oil.

 With PSCs title transfers at the export point or “fiscalization point”. The 

IOC is entitled to cost oil and profit oil.

 With Service Contract title does not transfer. The Government is entitled 
to the total hydrocarbon production.
Summarizes the Differences between Fiscal Systems
Optimal Fiscal Considerations
 Review of previous lecture

Group discussion (prepare for the next lecture)

The class is to be divided into 4 groups each group is to
nominate one member to present their discussion result of
the followings:

The first group: Fiscal system in general

The second group: Concession fiscal system.
The third group: Production sharing agreement
The fourth group: Service contract
 Production Sharing Contract – The Malaysian Model 

 Petroleum exploration in Malaysia started at the beginning of the 20th

century in Sarawak.
 Oil was first discovered in 1909 and first produced in 1910.
 A national oil company, PETRONAS, was incorporated to serve as the
Government’s instrument to take charge of petroleum matters and to
exercise, on behalf of the country, its sovereign rights over its own oil and
gas resources.
 PETRONAS opted to adopt the Production Sharing mechanism to manage
the exploration, development and production of the nation’s petroleum
resources.
 Prior to 1975, petroleum concessions were granted by state governments,
where oil companies have exclusive rights to explore and produce
resources. The companies then paid royalties and taxes to the government.
Production Sharing Contract – The Malaysian Model 

Evolution of Malaysian PSC

Production Sharing Contract – The Malaysian Model 
 THANK YOU
© 2013 INSTITUTE OF TECHNOLOGY PETRONAS SDN BHD
All rights reserved. No part of this document may be reproduced, stored in a retrieval system or transmitted in any form or by any means (electronic,
mechanical, photocopying, recording or otherwise) without the permission of the copyright owner.
 Q & A 
Session