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Fiscal Risk Advancements in Petroleum Contracts

Study analysis of determination of fiscal risk implemented in several models of petroleum contracts, a study within licensing bid rounds contracting system of Iraq

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Fiscal Risk Advancements in Petroleum Contracts

  1. 1. Types of Petroleum Contracts Yasir Karam
  2. 2. Contents Introduction History of Contracts Concession Agreement Production Sharing Contract Joint Venture Service Contract Conclusion
  3. 3. Introduction Petroleum is strategic material so the understanding of agreements/fiscal systems for Int’l E&P is very important. There is no consistent approach to the establishment or implementation of international agreements/fiscal systems. Each country establishes the type of agreements/fiscal systems those best meet their sovereign need.
  4. 4. History of Contract Concession is originated from the E&P of petroleum in developing countries by international oil companies, dated from late of 19th century-under political control of European power. Production sharing contract was first employed by Indonesian GOE and a foreign oil company in 1966-under antipathy of people for foreign company and desire to control its national resources.
  5. 5. History of Contracts Service Contract was first introduced by Argentine government(YPF) between 1958 and 1961 in three types : drilling, development, exploration/development- financially unstable to obtain most advanced technology. Joint venture is introduced by Italian GOE, ENI and Egyptian and Iranian GOE in 1957-to participate in managerial decision.
  6. 6. Concession Agreement Concession Agreement(Royalty/Tax) grants the ownership of petroleum. Traditional concession is simple agreement consisted of only royalty(12.5%) payment based on the tonnage of crude oil produced in very large area with unreasonably long period.(50-60yrs)
  7. 7. Concession Agreement Modern Concession grants a fixed period(exploration:3-5yrs, exploitation : 30-40yrs) and, Government revenue is deprived mainly from royalties (11.5-14.5%) and net income or taxes.
  8. 8. Production Sharing Contract PSC doesn’t grant ownership, only grant right to receive a Share of production or, Revenues from the sale of oil and gas. In PSC, government revenue is composed of Government profit oil and Taxes.
  9. 9. Joint Venture Joint venture involves joint ownership of: assets and concession rights, a sharing of certain costs of operation, and net revenues. In joint venture, the private company is always designated as the operator, but GOE usually participate in management through a joint management committee, approves work program and budget.
  10. 10. Joint Venture Joint venture is not only contracted between company and government but also company to company. Joint venture can be found in Concession and PSC.
  11. 11. Service Contract Service contract is one under which a private company agrees to perform certain specified services for the government or a GOE in return for fixed payment(pure service, Technical Service Agreement, which have money but lack of the technical know-how) or probable profits(risk service). The difference between service and PSC is nature of payment-Cash or Crude.
  12. 12. Conclusion Concession agreement is generally used by the countries those are non producer and new comer in oil industry and want to encourage foreign investment in the development of their oil resources. So government grant ownership and make terms attractive to the investor.
  13. 13. Conclusion PSC is generally used by the countries whose people is very hostile to foreign companies (formerly ruled by other countries) and want to participate more actively in E&P, refinery, marketing and distribution. Service contract is same as PSC except the fee is paid by cash.
  14. 14. Conclusion Joint Venture is used by who want spread risk or short of capital and used in both concession and PSC. There is no superiority of contracts actually. The most important factor to determine the economic success is the structure of fiscal system(royalty, tax, cost recovery, etc) and the flexibility(ex. sliding scale, R factor) is becoming standard and beneficial to the host government and contractors.
  15. 15.
  16. 16. • When the contractor is paid a fee for conducting explora tion and production operations, then this system is a ris k service contract. • The difference between risk and pure services contracts depends on whether there is a fee on the profits or not. The pure service contract is without risk in exploration a nd development. • Consequently, this is usually used by conservative natio nalized companies or by states that have capital but are lacking in technology and management capability • In addition to the concessionary and contractual system s, which are the two most used systems, there are som e further variations that could be considered as types of fiscal system. • The joint venture is a variant fiscal/contractual system. I t is used where the national company and contractor co mpany establish a working interest arrangement. This is found in both concessionary and contractual systems.
  17. 17. • It is important to note in such contracts both the level of percentage of recovery of costs and also the way in which the exploration or development costs may be rec overed. • If there is costs recovery before sharing of production, the contractor is allowed to recover the costs out of ne t revenues. The costs recovery limit is the only true dis tinction between concessionary systems and PSCs. • The amount of revenues remaining after royalty and co st recovery, is termed profit oil or profit gas. This is the equivalent of taxable income in a concessionary system • Within the service agreement, it would be termed the s ervice fee
  18. 18. Profit oil Sharing Triggers • Production – Daily rate – Absolute volume • Rate of return (ROR) • R-factors
  19. 19. • Cumulative revenues/Cumulative cost • Cumulative Revenue-Cumulative Opex/cumula tive Capex • Cumulative Revenue – Cumulative Profit Share /Cumulative Investments + Cumulative Opex • Cumulative net income/Cumulative Costs
  20. 20. RiskRiskRiskRisk Frequency CoefficientsFrequency CoefficientsFrequency CoefficientsFrequency Coefficients Magnitude coefficientsMagnitude coefficientsMagnitude coefficientsMagnitude coefficients Index Risk Type Diameter Pressure Distance Constant Error Diameter Pressure Distance Constant Error Coeff of var 1 External corrosionExternal corrosionExternal corrosionExternal corrosion 0.0027 0.0005 0.0029 0.0018 0.0006 32.00 0.75 21.00 42.31 64.75 20% 2 Internal corrosionInternal corrosionInternal corrosionInternal corrosion 0.0065 0.0057 0.0024 0.0044 0.0068 39.84 1.08 104.18 1.30 28.58 12% 3 Damages by thirdDamages by thirdDamages by thirdDamages by third partiespartiespartiesparties 0.0014 0.0010 0.0063 0.0032 0.0032 116.32 0.18 0.30 12.19 8.22 45% 4 FloodingFloodingFloodingFlooding 0.0054 0.0070 0.0025 0.0041 0.0074 2.35 0.61 102.26 22.38 32.78 70% 5 Earthquakes, landslidesEarthquakes, landslidesEarthquakes, landslidesEarthquakes, landslides 0.0034 0.0068 0.0072 0.0058 0.0052 3.45 0.62 116.52 100.14 31.50 300% 6 Operational stoppagesOperational stoppagesOperational stoppagesOperational stoppages 0.0032 0.0038 0.0045 0.0034 0.0002 117.68 0.47 95.83 24.44 37.10 9% 7 UnplannedUnplannedUnplannedUnplanned maintenancemaintenancemaintenancemaintenance 0.0015 0.0074 0.0038 0.0002 0.0032 10.09 0.67 93.08 39.66 23.48 62% 8 Design errorsDesign errorsDesign errorsDesign errors 0.0019 0.0039 0.0005 0.0035 0.0027 4.75 0.92 3.45 23.00 91.80 35% 9 Sabotage, vandalismSabotage, vandalismSabotage, vandalismSabotage, vandalism 0.0022 0.0058 0.0037 0.0056 0.0063 2.09 0.58 124.76 3.23 100.10 250%
  21. 21. Probabilities of severe weather events by month (column H) Month Means Coefficient of variation Random (normal) seasonality index Probability of severe weather Seasonality factor Seasonally adjusted probability 1 0.485 20.52% 0.613 4.73% 0.568 4.18% 2 0.507 17.36% 0.620 4.79% 0.575 4.23% 3 0.712 10.77% 0.810 6.26% 0.751 5.53% 4 0.961 5.48% 1.028 7.95% 0.953 7.02% 5 1.201 4.60% 1.271 9.82% 1.179 8.68% 6 1.396 2.87% 1.448 11.19% 1.342 9.88% 7 1.501 2.33% 1.546 11.95% 1.434 10.56% 8 1.459 2.85% 1.512 11.69% 1.402 10.33% 9 1.303 3.27% 1.358 10.49% 1.259 9.27% 10 1.067 5.23% 1.139 8.80% 1.056 7.78% 11 0.829 7.11% 0.904 6.99% 0.838 6.17% 12 0.579 15.08% 0.691 5.34% 0.641 4.72% Summary 1.000 12.940 1.000 1.000 7.36% RiskGeneral distribution of length (days) of a given severe weather event Min days 0 Max days 10 Historical data on 215 events in 8 years Days 1 2 3 4 5 6 Frequency 48 86 58 15 6 2 Typical length 4 -2 0 2 4 6 8 10 12
  22. 22. • Countries allocating exploration acreage around the worl d: • 1994 - 50 countries • 1998 - 48 countries • 2006 - 98 countries • The new mix of acreage includes frontier acreage, • marginal fields, enhanced oil recovery projects, heavy oi l, oil sands, deep water, stranded gas, anything that will burn. Exploration acreage has become a commodity
  23. 23. Fiscal System Design - and Host Government concerns; • Control over the countries natural resources. • Attract exploration investment & the right investors. • Receive a fair share of profits - large Take • Keep costs down • Guarantee revenue each accounting period (Effective Royalty Rate) • Maximum Efficient Production Rate (MEPR) or Maximum Ultimate Recovery
  24. 24. Government Take is the common denominator - division of profits is ‘a’ key concern. Take Definitions Government Take (%) = Economic profit ($) = • Government receipts from bonuses, royalties, taxes, pr oduction or profit sharing, and Government participatio n, divided by Economic profit. • Gross revenue less gross costs. • Also referred to as cash flow. • Contractor Take ($) = 1 - Government Take.
  25. 25. Rent Model ContractorEntitlementRent
  26. 26. • The sole risk of exploration is borne by the IOC, the HC ther efore benefits when there is successful exploration • The IOC (in most cases) is only entitled to recover costs und er the PSC from a portion of production from the area subje ct to the contract (ringfenced), this is of benefit to the HC in that costs are not • The cost ceiling is designed to ensure that the HC can have i ts share of profit oil as soon as production commences. The benefit if this is essential as a late return on revenues from production would be politically difficult to justify. • A limit to the recoverable costs shields the HG from having t o pay for frivolous expenses by the IOC. • Finally, the PSC has a relatively simpler fiscal regime compar ed to the royalty/concession system, thus, the HG usually do es not have to spend time and resources designing complex taxation rules Positive Aspects of Cost Recovery
  27. 27. Negative Impact of Cost Recovery • The cost recovery is therefore designed to benefit the HC. However, even with cost reco very, the potential for the IOC to be over compensated is real. Often times a badly stru ctured fiscal regime can lead to abuse by the contractor. • This has been the case for many developing nations whose petroleum industries have b een of little benefit in terms of spurring economic growth. To couple this with an ineffici ently run IOC, bad resource management and lack of social and environmental awarene ss49, could spell more disaster for the HC. A recent report funded by the European Uni on describes the extent to which a badly structured PSC in Kazakhstan‟s Kashagan field proved more of a detriment to the government and the local communities. • Greg Muttitt, who authored the report, commented that, the research reveals the exten t to which oil companies took advantage of Kazakhstan‟s weakness in the 1990s (a tim e of very low oil prices).50 The dispute arose after ENI the French IOC involved in the d ispute, released a statement projecting costs to be higher than they had envisaged, the ultimate costs (amounting to a projected loss of over $20 billion dollars) would thereby be borne by the HC through cost recovery • Furthermore, the design of the cost recovery structure can lead to huge contractor take in times of high oil prices which could then lead to contract instability disputes with the HG who is intent on finding ways to curtail the take by the IOC. For example in 2008, in an effort to increase government revenues at a time of high public scrutiny, the Indone sian Energy and Mineral Resources Ministry proposed a regulation to eliminate 17 expe nses contractors could claim under the „cost recovery mechanism,‟52 the Energy Minist ry later issued a press release amid dropping oil prices stating its intent on abandoning the proposed caps on cost recovery. This decision was no less influenced by Indonesia‟ s inability to attract new investment to develop its oil fields