Title: International (Upstream) Petroleum Agreements. Negotiating a Petroleum Contract
1International (Upstream) Petroleum
Agreements.Negotiating a Petroleum Contract
2Summary
- What are the kinds of host State-investor
agreements available and their characteristics. - What are the arguments for and against them?
- Stabilization Clauses
- Unitisation Agreements
- NOC-National Oil Company, HC-Host Company
- IOC- International Oil Company, Contractor
3TYPES OF CONTRACTS AGREEMENT
- PSC/PSA Product Sharing Contract/Agreement
- Concession (Tax-and-Royalty)
- Participation/Joint Venture/Association
- Service Contract
- WHAT IS A PSC/A?
- A contractual agreement between a contractor and
a host government whereby the contractor bears
all of the exploration costs and risks and the
development and production costs in return for a
stipulated share of the production resulting from
this effort
4THE PSC (1)
- All PSC regimes share one basic aim which is to
establish a balance between the host country take
and the contractor take - The Oil/Gas company is named as CONTRACTOR by the
host country or its NOC is given exclusive EP
rights - Contractor operates at sole risk and expense
under the control of the host country - Any resources are owned by the host country
- Usually the contractor is allowed to recover all
costs from the production from the Contract Area
under the Cost Recovery provisions
5THE PSC (2)
- After Cost Recovery, the balance of production is
shared on a predetermined age split between
host country contractor - Profits of companies comprising contractor are
taxable - Data, equipment facilities become the property
of the host country at some point (when brought
into the country, on construction, on completion
of costs recovery or at contract termination) - Term of contract is fixed so Govt determines
extensions. - WHERE ARE PSCS USED?
- India,China,Kazakhstan,Libya,Nigeria,Algeria,
Angola, - Indonesia,Mauritania,Egypt,Trinidad Tobago and
Russia
6Sharing the Barrel
- Royalty off-the-top
- Cost Recovery Oil (costs recoverable in year up
to maximum) - Treatment of excess Cost Oil
- Profit Oil
- Government share
- Contractor Profit Tax
- Contractor profit share
Fixed
Variable
7ADVANTAGES OF PSCS
- State
- Title to hydrocarbons
- Convenient
- Managed return
- Flexibility in event of volatile prices
- Resource management
- Self contained
- Contractor
- Stability (fiscal regime is known)
- Reserves can be booked
- Tried and tested all over the world so is
familiar - Creates own law
8DISADVANTAGES OF PSCS
- Host country inexperience in some cases
- Improperly supervised cost recovery may result in
gold-plating or worse - Even well-calibrated volumetric sliding scale
fails to account for high-cost fields - Often impure mixed with royalty, tax, lease,
local market obligations, and/or carry of
government company
9CONCESSION CONTRACTS
- Rights to oil and gas in the ground (jus in rem)
- Mining Code Licence Civil law Contract
- Fiscality usually
- Royalty percentage of gross (off-the-top)
production won and saved - Tax on Net Income
- other taxes and duties
10Conceding the barrel
- Royalty
- Investor gross income
- Investor profit tax
- Other taxes and duties
- Investor profit
Fixed
Variable
11Advantages of Concessions
- Familiar legal status
- Simple calculations
- Royalty ensures early and predictable cashflow to
Government - Investor feels secure in rights to resource in
the ground
12Disadvantages of Concessions
- Psychological disadvantages
- foreign entity has control of national patrimony
- affront to sovereignty of independent nation
- Practical disadvantages
- Fiscal
- Royalty is inflexible rent-sharing instrument
- General Income/Profits Tax may be too low
- Operational
- Foreign company has free reign
13PARTICIPATION/JOINT VENTURE ARRANGEMENTS
- Meaning of Participation
- real creation of new legal entity with
integrated staff - virtual NOC as sleeping partner
- Meaning of Joint Venture
- old creation of new entity
- now except in FSU, US-style unincorporated joint
operation FSU new project company
14PARTICIPATION Cont.
- Participation or Association NOT separate
contractual form - Government/NOC can participate in any of the
usual forms - Not theoretically compatible with PS but often
found (Algeria) - Association in francophone areas investor-NOC or
even investor-govt agreements
15SERVICE CONTRACTS
- Seen as putting State contracting party or NOC in
more Sovereign position - Contractor has no legal or economic interest in
oil reserves or even production - Exploration or development risk contractor
compensated by fee based on either - Investment, or
- Barrels produced (sometimes above a baseline)
16SERVICE CONTRACTS Cont..
- Iraq (replaced by PSC)
- Iran (buy-back, still popular for political
reasons) - Nigeria (being phased out)
- Americas
- Risk Service Brazil, Venezuela, Ecuador
- Mexico pure Service
17Service Contracts, Cont.
- Government share
- Contractor fee
- Contractor tax
18What Choices of Law are Possible?
- In designing a choice of law clause, the parties
may stipulate (1) one or more national laws such
as the law of one of the parties or of a third
party or a combination of national laws (2)
public international law (3) a legal system that
is sui generis and established by the contract
itself (impractical) (4) transnational law such
as UNIDROIT Principles, or (5) a combination of
these.
19Choices of Law are Cont...
- They may elect not to make a choice however,
agreeing to perform their contract in good faith
or to empower the tribunal to determine the
dispute ex aequo et bono or as amiable
compositeurs.
20Example 1
- LIBYA
- This Concession shall be governed by and
interpreted in accordance with the principles of
law of Libya common to the principles of
international law and in the absence of such
common principles then by and in accordance with
the general principles of law, including such of
those principles as may have been applied by
international tribunals.
21AZERBAIJAN
- This Agreement shall be governed and interpreted
in accordance with 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 (except for laws regarding
conflicts of laws). This Agreement shall also be
subject to the international legal principle of
pacta sunt servanda (agreements must be
observed).
22Stabilization-Definition
- In the context of an international petroleum
agreement, stabilization means - All of the mechanisms, contractual or
otherwise, which aim to subject the contract
provisions to specific economic and legal
conditions which the parties considered
appropriate at the time that the contract was
concluded
23Why is Stability an Issue? (1)
- For the investor
- Risk-reward relationship means that the investor
seeks an assurance of long-term stability to
secure reward for initial risk (if successful) - Vulnerability of large investments from
development stage with fixed infrastructure
(pipelines) - Weakness of investor in face of host government
determined to take unilateral action - History of petroleum industry shows threat is
real
24Why is Stability an Issue? (2)
- For the host government
- There are legitimate areas in which the State may
act unilaterally, such as in non-contractual
areas that are not subject to a stabilization
clause example the fiscal environment in the
UK N Sea has been unilaterally changed many times - Fashion/waves.
25Unilateral HG ActionExamples of Direct Action
- An increase in the applicable tax/royalty rate or
tax base - Imposition of new taxes/royalties
- Revisions to PSC calculation of cost
petroleum/profit split - Increase in of HG participation
- Change in allocation of management and control
over operations between HG and IOC - Increase in or imposition of restrictions on
IOCs right to monetise a discovery/right to
export/obligation to market petroleum within the
host country
26UNILATERAL HG ACTIONPOTENTIAL FOR INDIRECT ACTION
- Powers over local content
- Investors liability over project delay
- Use of environmental compliance powers (used in
Russia 2006-2007 these are not usually
stabilized)
- Changes to overall tax environment
- Approval for field development plan
- Powers to issue other permits
- States right to veto proposed annual budgets
27HOW TO STABILIZE?
- A favoured option - the Stabilization Clause
- i-FREEZING
- contract language which freezes the provisions
of a national system of law chosen as the law of
the contract as to the date of the contract in
order to prevent the application to the contract
of any future alterations of this system (Amoco
International Finance v Iran)
28Example
- Mozambique
- The Government will not without the agreement of
the contractor exercise its legislative authority
to amend or modify the provisions of this
Agreement and will not take, or permit any of its
political sub-divisions, agencies and
instrumentalities to take, any administrative or
other action to prevent or hinder the Contractor
from enjoying the rights accorded to it
hereunder - Chile
- The tax regime, benefits, privileges and
exemptions provided in any of the articles
hereof shall remain invariable for the duration
thereof
29ii-Economic Balancing
- The more popular modern approach to stabilization
in a petroleum agreement is to include a
provision which states that - If the host government adopts a measure
subsequent to the conclusion of the petroleum
contract in which the fiscal terms are stated,
that is likely to have damaging consequences to
the economic benefits for one or both of the
parties, a re-balancing will take place.
30Example(Egypt)
- In case of changes in existing legislation or
regulations applicable to the conduct of
Exploration, Development and production of
Petroleum, which take place after the Effective
Date, and which significantly affect the economic
interest of this Agreement to the detriment of
CONTRACTOR or which imposes on CONTRACTOR an
obligation to remit to the A.R.E. (Arab Republic
of Egypt) the proceeds from sales of CONTRACTORs
Petroleum, CONTRACTOR shall notify EGPC (the NOC)
of the subject legislative or regulatory measure.
In such case, the Parties shall negotiate
possible modifications to this Agreement designed
to restore the economic balance thereof which
existed on the Effective Date.
31Force Majeure
- For the purposes of this Agreement, Force
Majeure shall mean circumstances which were
beyond the reasonable control of the Party
concerned and shall include strikes, lockouts and
other industrial disturbances. - TAKE OR PAY
32UNITISATION JOINT DEVELOPMENTDrilling at Oil
Creek 1861
33Interfering wells on adjoining leases
341. Why does unit development happen?
- Geological character of petroleum fugacious
character it moves like a wild animal and so
can be captured - Initial response the rule of capture
- US case of Brown v Spillman
- If an adjoining owner drills his own land and
taps a deposit of oil or gas, extending under his
neighbours field, so that it comes into his
well, it becomes his property
35THE RULE OF CAPTURE
- The owner of a tract of land acquires title to
the oil and gas which he produces from wells
drilled thereon, although it may be proved that
part of such oil and gas migrated from adjoining
lands. - In practice complex issues arise even in US law
directional drilling under anothers property is
trespass, not capture
36The Law of the Sea Act 77 the Rule of Capture
- The coastal State exercises over the continental
shelf sovereign rights for the purpose of
exploring it and exploiting its natural resources - The rights referred to (above) are exclusive in
the sense that if the coastal State does not
explore the continental shelf or exploit its
natural resources, no one may undertake these
activities without the express consent of the
coastal State - The natural resources referred to in this Part
consist of the mineral and other non-living
resources of the seabed and subsoil
37But
- Problems of proof
- How much oil was there in place?
- Is there a forum for a dispute?
- State to State
- Company to Neighbouring State
- Company to Company
38Solutions Definitions
- Purposes of Unitisation
- The Unit Agreement
- Oil versus Gas (note US differences)
- Area, depth and number of fields
- Voluntary and compulsory unitisation
- Adaptability to changing circumstances
392. Key Issues in Unitisation Agreements (1)
- Unit Area and Extension
- Unitised Substances
- Effect of Unitisation
- Timing
- Passmark
- Tract Participations their determination
- Unit Interests
- Technical basis of determination
40Key Issues in Unitisation Agreements (2)
- Re-determinations - examples
- Number and Timing
- Unit Decision Making
- Non-unit operations
- Procedure
41DISCRETIONARY UNITIZATION CLAUSES
- Thailand (1971 Petroleum Act)
- Section 72. For the purpose of the conservation
of petroleum resources or of good petroleum
industry practice, in case where concessionaires
have their production areas covering the same
petroleum reservoir, the Minister shall have the
power to require such concessionaires to produce
petroleum under the unit operation. - Angola (1997 Production Sharing Agreement)
- Art. 27(1). In the event of there being
petroleum deposits, capable of commercially
viable development which extends beyond the
contract area, and where other entities have
agreements for the exploration and production of
petroleum with a similar unitization provision,
SONANGOL may . . . require that the petroleum in
those deposits should be developed and produced
in mutual co-operation.
42NON-DISCRETIONARY UNITIZATION CLAUSES
- Indonesia (Government Decree 35, 2004)
- A Contractor is required to conduct unitization
if it is proven that its reservoir extends into
another Contractors Work Area. - China (Model Contract 1995)
- 11.7 In the event of an oil field and/or gas
field straddling a boundary, CNPC shall arrange
for the contractor and the neighbouring parties
to work out a unitized overall development
program for such oilfield and to help negotiate
the relevant provisions thereof
434. Cross-border or International Unitisation
- What does it mean? Example of Frigg
- International law requirements - UNCLOS
- Intergovernmental agreements
- Border in dispute or not
- Cross-border unitisation agreement
44Example Norway UK Delimitation Treaty
45Frigg Gas Field North Sea
- Frigg
- Discovered 1971(Norwegian licence)
- Seismic survey demonstrated extension into UK
- Norwegian operator (Elf) and UK operator (Total)
agreed to conduct all pre-unitisation work
jointly from late 1971 - Unitisation negotiations commenced 1972, and
preliminary studies concluded with 57 of the
field on the Norwegian side and 43 on the
UK-side.
46Frigg (2)
- The problems began
- National laws considered obstacle for joint
development - UK operator wanted to develop the UK side
independently, while the Norwegian Government
called for a parallel development - UK appraisal well was dry
47Frigg (3)
- Differing views
- UK side
- reservoir contained between 240 and 285 Bcm
(approx. 3 Tcf) gas - between 52 and 55 of the reservoir was on the
NCS - Norwegian side
- reservoir contained between 234 and 291 Bcm gas
- between 65 and 66 of the reservoir was on the
NCS - Difference mainly based upon seismic
interpretation and location of trap
48Frigg (4)
- Attempts at solving the problem
- A joint work group established
- Agreed to shoot new seismic profiles from
discovery well - Norwegian Government renounced the demand for a
parallel development - French licensees agreed to unitise, but insisted
on development of the UK part first, which would
require the landing of the gas in St. Fergus
(UK). - Norwegian government agreed in January 1973 to
land the gas in St. Fergus - But the field determination issue was still
unresolved ...
49Frigg (5)
- The solution
- Although the joint work group consisted of
engineers and geologists, the company loyalty
prevented an agreement - All parties then agreed to hire consultants, and
the US-based firm DeGoyler MacNaughton was
contracted - All parties, incl. representatives from the
Norwegian and UK Governments met with the
consultants on 18 May 1973 in order to further
specify the objective - The consultant would determine the boundaries of
the reservoir, estimate the total volume of gas
and determine the Norwegian/UK tract
participation by 30 September 1974 - All partners agreed to accept the result the
consultants came up with. The Norwegian and the
UK Governments said they would await the results
before accepting.
50Frigg (6)
- Unitisation Agreement
- signed 9 July 1973
- recognised the field as one unit
- the respective licencees final participating
share dependant upon the consultants report - Development approved by UK and Norwegian
Governments 1974
51Frigg the key role of experts
- Experts involvement
- Frigg partners agreed that another 4 wells had to
be drilled before the reserves and the split
could be determined. - Following the drilling of the additional wells
(1975 and 1976) the expert - DeGoyler
MacNaughton - finalised its report. - The report was delivered 14 February 1977
- the reservoir contained 268.658 Bcm gas
- 60.82 of the gas was contained in the Norwegian
tract - 39.18 of the gas was contained in the UK-tract
52Frigg the key role of experts (cont)
- Following extensive reviews of DeGoyler
MacNaughtons report by other - independent -
experts (Core Laboratories), the Norwegian
Government accepted the reserves and split. UK
Government likewise. Letters were exchanged 12
December 1977 - By then, the field was both approved for
development and had started production
53Frigg - conclusions
- Key findings from this experience
- Early development facilitated by
- alignment between licensees and respective
governments - pragmatic approach by governments and licensees
- mitigation planning (experts, redetermination)
- unitisation agreement based upon preliminary
reserves estimates and split