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International (Upstream) Petroleum Agreements. Negotiating a Petroleum Contract

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Title: International (Upstream) Petroleum Agreements. Negotiating a Petroleum Contract


1
International (Upstream) Petroleum
Agreements.Negotiating a Petroleum Contract
2
Summary
  • 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

3
TYPES 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

4
THE 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

5
THE 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

6
Sharing 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
7
ADVANTAGES 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

8
DISADVANTAGES 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

9
CONCESSION 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

10
Conceding the barrel
  • Royalty
  • Investor gross income
  • Investor profit tax
  • Other taxes and duties
  • Investor profit

Fixed
Variable
11
Advantages 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

12
Disadvantages 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

13
PARTICIPATION/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

14
PARTICIPATION 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

15
SERVICE 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)

16
SERVICE 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

17
Service Contracts, Cont.
  • Government share
  • Contractor fee
  • Contractor tax

18
What 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.

19
Choices 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.

20
Example 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.

21
AZERBAIJAN
  • 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).

22
Stabilization-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

23
Why 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

24
Why 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.

25
Unilateral 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

26
UNILATERAL 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

27
HOW 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)

28
Example
  • 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

29
ii-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.

30
Example(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.

31
Force 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

32
UNITISATION JOINT DEVELOPMENTDrilling at Oil
Creek 1861
33
Interfering wells on adjoining leases
34
1. 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

35
THE 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

36
The 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

37
But
  • 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

38
Solutions 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

39
2. 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

40
Key Issues in Unitisation Agreements (2)
  • Re-determinations - examples
  • Number and Timing
  • Unit Decision Making
  • Non-unit operations
  • Procedure

41
DISCRETIONARY 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.

42
NON-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

43
4. 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

44
Example Norway UK Delimitation Treaty
45
Frigg 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.

46
Frigg (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

47
Frigg (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

48
Frigg (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 ...

49
Frigg (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.

50
Frigg (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

51
Frigg 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

52
Frigg 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

53
Frigg - 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
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