2. 2
Contracts
• A contract is an agreement entered into
voluntarily by two parties or more with the
intention of creating a legal obligation, which may
have elements in writing, though contracts can be
made orally.
• The remedy for breach of contract can be "damages"
or compensation of money. In equity, the remedy can
be specific performance of the contract or an
injunction. Both of these remedies award the party at
loss the "benefit of the bargain" or expectation
damages, which are greater than mere reliance
damages, as in promissory estoppel. The parties may
be natural persons or juristic persons, A contract is a
legally enforceable promise or undertaking that
something will or will not occur. The word promise
can be used as a legal synonym for contract, although
care is required as a promise may not have the full
standing of a contract, as when it is an agreement
without consideration
3. 3
Types of contracts
• Concession
• Joint Venture
• Service
• Production (Risk) sharing contract
4. 4
Concession contracts
• Contractor have exclusive rights to explore
, develop, sell and export oil/gas in
particular area over period of time
• Equity or Royalty/tax structure
• Maximum control to contractor
• Oldest and most widely used method
5. 5
Concession Contracts
• Advantages • Disadvantages
• If production occurs, govt. • Govt. may not know the full
earns royalty and/or profit potential through the
tax based on the commodity extensive exploration
price • Companies will be cautious in
• Successful bidders pay bidding for uncertain returns
bidding price (License fee (Virgin / non productive
/signature bonus) areas)
• Not suitable for countries
which seeks extensive
exploration work through
biddings
6. 6
Joint Venture
• Foreign/private companies and NOC‟s
involves in joint ventures
• Both pays/receives its share in the ratio of
their participating interest
• JV‟s pays royalties, income tax and some
part of Petroleum Revenue Tax (PRT)
• Low success rate, less commonly used
7. 7
Joint Venture contracts
• Advantages • Disadvantages
• Govt. is not alone in decision • Costs and risks both are
making /responsibility of the shared; Not suitable for
project exploration that involves huge
• Govt. can count on companies investment
expertise on the project • Responsibility also brings
• Govt. shares profit on the top liabilities such as
of the royalties and taxes environmental issues etc.
8. 8
Service Contracts
• Contractor pays for all the exploration and
development works
• Contractor works under government
mandate‟s and is paid for its works
• Government maintains ownership and title
of the reserves
• Most suitable for contractor for risk-free
operation and for states having producing
assets
9. 9
Service Contracts
• Advantages • Disadvantages
• Payment is made to service • Most of the companies
companies at predetermined reluctant to sell their services
rate for turnkey projects as their
profits are limited
• Not relevant to the
exploration ; but suitable for
production
10. 10
Production Sharing Contract (PSC)
• State companies enters in to PSC with
contractor company for a specified period of
time
• Contractor finances exploration and
development
• If successful contractor will recover it‟s cost
and earn profit by receiving a share of
production
• Royalties & income taxes are paid as
applicable
• Significant control to contractor but
contractual controls are with state
companies
11. 11
Production Sharing Contract (PSC)
• Advantages • Disadvantages
• Most attractive investment • Govt. has no/ltd. knowledge
model in inviting risk capital; about the field
govt. is on the safe side • Government may face conflict
• Successful in attracting of interest; It has to balance
foreign companies the desire for higher profit
• Unexplored areas can be through optimal
explored with no direct exploration/prodn. and
investment by the govt. regulatory concerns
• Contractor enjoys autonomy
and optimizes E&P to ensure
“cost recovery”
12. 12
Hybrid contracts
• Combination of
Concession, JV, PSC, Service types
• Efforts to build a world model faces
challenges such as diversities, different
specifications by different countries
13. 13
Hybrid contracts
• Advantages • Disadvantages
• Incorporates the best of • Complex, diversified model
available contract types • Difficult to estimate the
shares between government
and contractor in win-win
situations
• Extensive expertise and
negotiation skills required for
this type of contracts
14. 14
Comparative Analysis
Contract type Contractor Government
Concession All Risk/All Reward Reward is function
of Production and
Price
Service No Risk All Risk/All Reward
Joint Venture Share in Share in Risk &
Risk/Reward Reward
Production Sharing Risk in exploration Share in Reward
;Share in Reward
Hybrid Mixed Mixed
15. 15
Petroleum Fiscal Systems
Concessionary System (Also known as Permits, Lease or license) followed in
US, UK, Norway, Australia , New Zealand Contractual System (Title lies with the government)
Production Sharing Contracts (Kind)
Service Contracts (Cash) Followed in
India, Indonesia, Malaysia, Libya, Egypt, China, Vietnam, Thailand, Brunei
Pure Service Contracts Risk Service Contracts
Followed in Mexico, Iran, UAE, Kuwait, Saudi Arabia (fixed fee) Followed in Philippines, Ecuador (profit is shared)
16. 16
Scorecard
Type of Contract Number of Name of countries utilizing the
countries contract type
utilizing the
contract
type
Concession 59 UK, US, Norway, Australia, Canada, Peru,
Namibia, Thailand, Sudan, Ecuador,
Bahamas
Service 2 Iran, Qatar
Joint Venture 31 Colombia, Cameron, Netherland, Pakistan
Production Sharing 40 Egypt, Yemen, Angola, Indonesia, Sri Lanka,
Guatemala, India
Hybrid 16 Libya, China, Kenya, Myanmar, Tanzania,
Malaysia
17. 17
Elements of Ideal Contract
• Vital for the government to reap the full
benefits of its natural resources
• Balance the interests of both investors and
country‟s needs
• Takes care of the considerations of
communities which are not part of the deal
but interested /will be affected by the
contract
18. 18
Parties
• For offshore areas – Grant of license and lease by
the Central Government
• For onshore areas – Grant of license and lease by
the State Government, with prior approval of the
Central Government
• Every license or lease granted to contain additional
terms and conditions as provided for in an
agreement between the Central Government and
the licensee or the lessee (the PSC)
• Where license or lease to be granted by a State
Government – merely an obligation to „consult‟ the
Central Government
19. 19
PSC Attributes
• Contact term
• Relinquishment
• Management committee
• Discovery, Development & Production
• Unit development
• Cost recovery & Production Sharing
• Taxes, Royalties & Rentals
• Domestic sources & Supply obligations
• Employment and training
• Title to assets
20. 20
Contractual Framework
BIDDER 1 Joint Bidding CONSORTIUM / Bid
Agreement GOVERNMENT
CONTRACTOR
BIDDER 2
License
BIDDER 3
Production Sharing
Contract
Work program & budget approvals
Exploration Activities
DISCOVERY
Notification to Government
Appraisal and testing
COMMERICAL
mining lease
Development and production
21. 21
Contractual Obligations
• At the expiry of any Exploration phase of the
exploration period provided that the Contractor
has completed the minimum work programme
for that exploration phase, the Contractor shall
have the option , exercisable by giving a written
notice to the Government at least 30 days prior
to the expiry of the relevant phase, either:
1. To proceed to next exploration phase.
2. To relinquish the entire contract area except
for any discovery area and any development
area and to conduct development operation
and production operation in relation to any
commercial discovery in accordance with the
terms of this contract.
22. 22
Relinquishment
• At the end of Exploration phase , the
Contractor shall retain only development
area‟s and discovery area‟s.
• At the end of each phase Contractor is liable
to relinquish part of unproductive block in
simple three geometrical shapes.
23. 23
Work Programme
• Contractor shall commence petroleum
operation not later than six months from
effective date.
• Work programme has mandatory work
programme and biddable work programme.
• The work programme consist of
geological, exploration ,geochemical
survey‟s, gravity magnetic survey‟s ,seismic
programme (2-D and 3-D) and drilling of
exploration wells.
24. 24
Work Programme
• Contractor require to mention the meterage it
will be drilling and will specify the basement
depth.
• A s soon as possible after the effective date and
thereafter within 90 days before
commencement of each following year , the
contractor shall submit to management
Committee the Work Programme and budget
relating to Petroleum operation to be carried
out during the relevant year . Work Programme
and budget for exploration period shall include
work sufficient to meet the relevant mandatory
Work Programme and minimum Work
Programme with respect to each Exploration
phase.
25. 25
PSC-Cash Flow structure
Production
Royalties
Value
Cost Petroleum Exploration
Production
Profit Petroleum
Development
Contractor Government’s
Government’s
Share Share
Take
Income Tax
Contractor’s
Take
26. 26
Joint Operating Agreement
• Within 45 days of effective date or such
longer period as maybe agreed to by
Government the company constituting the
contractor , shall execute a Joint Operating
Agreement.
• The said agreement shall be consistent with
the provision of this contract and shall
provide for ,among other things
1. Appointment ,resignation ,removal and
responsibility of the Operator.
2. Establishment of the Operating Committee
comprising of an agreed no of representative of
the companies chaired by a representative of the
Operator
27. 27
Joint Operating Agreement
3.Function of the said Operating Committee taking
into account the provisions of the Contract
, procedure for decision making , frequency and
place of meeting.
4. Contribution to cost , default , sole risk, disposal of
Petroleum and assignment as between the parties to
Joint Operating Agreement.
28. 28
Discovery , Development and Production
If and when a Discovery is made within the
Contract Area, the Contractor shall:
1. Forthwith inform the Management
Committee and Government of the
Discovery;
2. Promptly thereafter, but in no event later
than a period of thirty (30) days from the
date of the Discovery, furnish to the
Management Committee and Government
particulars, in writing, of the Discovery.
29. 29
Discovery , Development and Production
3 .Run tests promptly and in any case within
90 days from the date under Article 10.1 (a)
to determine whether the Discovery is of
potential commercial interest and, within a
period of sixty (60) days after completion of
such tests, submit a report to the
Management Committee containing data
obtained from such tests and its analysis
and interpretation thereof, together with a
written notification of whether, in the
Contractor‟s opinion, such Discovery is of
potential commercial interest and merits
appraisal.
30. 30
Cost petroleum and Profit petroleum
• Profit petroleum – total value of product saved from
a particular contract area – calculated in specified
manner
Use of investment multiple
Contractors bid on IM
Complex proportions are intended to make sharing
of oil more favorable to the Government at higher
production levels
• Cost petroleum linked to volume of petroleum
produced and saved and „contract costs‟
Control over costs – a legitimate state concern
31. 31
Fiscal System
• What is a petroleum fiscal system?
• Fiscal system is primarily concerned with
the division of profits between the
government and the contractor. Though
both the parties target to maximize their
share, it is in their collective best interests to
divide profits such that both parties earn
reasonable rates of return.
36. 36
Cash Bonus
• A form of key money given by the company
that wants to conduct exploration
• Amount will be specified by law but
normally fixed by negotiations
• Paid before any discovery but amount
stipulates in future time
• Bonus amount varies according to the hopes
offered by the exploration acreage
37. 37
Royalties
• Royalties on petroleum and gas, coal and
most minerals are payable on an ad
valorem (value) basis. These are essentially
calculated as a percentage of the value of the
mineral or petroleum as determined by the
Minister.
• Royalties are generally assessed as a
percentage of the wellhead value of
production.
38. 38
Royalty Calculation
• Royalties are levied at a rate between 10% to
12.5%of the wellhead value (depending on
the jurisdiction involved)
• Wellhead value =
Sales value of all Transport & processing
petroleum products – cost of raw products from
sourced from the well wellhead to market
39. 39
Petroleum income tax
• Petroleum Income Tax (PT) is a direct
tax, levied annually on net profit of a
“petroleum taxpayer”, who is carrying out
the business of petroleum exploration and
production.
• The rates, penalties, surcharge, etc. are
different from that of Corporate Income tax
• The term „petroleum taxpayer‟ covers
anybody who:
• Holds a concession under petroleum law or has a
joint interest in it
• Purchases crude oil produced by any
concessionaire, all of which is intended for export
40. 40
Cash surplus / Cash deficit
cash surplus = gross revenue- expenditure
= gross revenue - capex - opex - royalty- tax
production = 12 MMbbl
oil price = $20/bbl
Capex= $80 m
opex = $15m
royalty rate = 16.66%
tax rate = 70%
Assume that the only previous capex had been $120 m, spent
in the previous year, with 25% straight line capital
allowance, thus;
capital allowance in this year = 0.25 x $120 m+ 0.25 x $80 m
= $50 m.
Revenue = production x oil price
= 12 MMbbl x $20/bbl = $240 m
41. 41
Cash surplus / Cash deficit
capex = $80 m
opex = $15 m
Technical cost = $95 m (capex+opex)
Royalty = revenues x royalty rate
= $240 m x 0.1666 = $40 m
Fiscal costs = royalty + opex + capital allowance
= $40m+$15m+$50m
= $105 m
Taxable income = revenue- fiscal costs
= $240m-$105m
=$135m
Tax = taxrate x taxable income
= 0.70x$135m
= $94.5 m
42. 42
Cash surplus / Cash deficit
• cash surplus = revenues - capex - opex -
royalty - tax
= $240-80-15-40-94.5m
= $10.5 m
• host government take = tax+ royalty
= $94.5+40m
= $134.5 m
43. 43
Authorization For Expenditure (AFE)
• Prior to incurring any expenditure or
incurring any commitment for work the
Operator prepares an authorization for
expenditure (AFE).
• The Joint Operating agreements contains
provisions for seeking approval of ventured
partner before undertaking certain specified
activities through authorization for
expenditures.
• If the operating committee approves an AFE
for the work , the operator is authorized to
conduct the works under the terms of
operating agreements.
44. 44
Authorization For Expenditure (AFE)
• The AFE proposed by the operator usually
contains the particular of the work with
reference to the approved work programme
and budget, best estimate of the total
funds, proposed work schedule, time table
of expenditure and any other supporting
information for any type of decision.
45. 45
Cash Call
• In order to fund the operation of Joint
Venture , the operator raises cash call on
other ventured partners in accordance with
their participating interest.
• Cash calls are raised for their expenditure
(as per the approved work programmes
, budgets and AFE‟s) and for currencies in
which the money is spend
• A cash call is operators estimate on the
amount required from the parties to enable
the operator to make cash payment less
cash receipt in the relevant period.
Royalty is a share of the revenue free and clear of all costs of developmentand production. The royalty is paid to the owner of the mineral interest under the land associatedwith the well. In the United States, the mineral interest can be “severed” from the surfaceownership so that the person who owns the surface may not have any interest in the mineralsand may not receive any income from a well. In rare cases the owners of the working interestwill own the minerals and, in that case, there is no royalty. Typical royalty rates in the U.S.range from 1/8 (12.5%) to 25% of the production. Royalties in other countries can range fromzero to more than 30%