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History of Contracts
Production Sharing Contract
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.
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.
History of Contracts
Service Contract was first introduced by
Argentine government(YPF) between 1958
and 1961 in three types : drilling,
financially unstable to obtain most
Joint venture is introduced by Italian GOE,
ENI and Egyptian and Iranian GOE in
1957-to participate in managerial decision.
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)
Modern Concession grants a fixed
: 30-40yrs) and,
Government revenue is deprived mainly
from royalties (11.5-14.5%) and net income
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
Government profit oil and
Joint venture involves joint ownership of:
a sharing of
certain costs of operation, and
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.
Joint venture is not only contracted
between company and government but
also company to company.
Joint venture can be found in Concession
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
The difference between service and PSC is nature
of payment-Cash or Crude.
Concession agreement is generally used
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.
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
Service contract is same as PSC except the
fee is paid by cash.
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
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.
• 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
• 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
• 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.
• 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
• 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
Profit oil Sharing Triggers
– Daily rate
– Absolute volume
• Rate of return (ROR)
Probabilities of severe weather events by month (column H)
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
Days 1 2 3 4 5 6
Frequency 48 86 58 15 6 2
Typical length 4
• Countries allocating exploration acreage around the worl
• 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
Exploration acreage has become a commodity
Fiscal System Design - and Host Government
• 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
• Maximum Efficient Production Rate (MEPR) or Maximum
Government Take is the common denominator -
division of profits is ‘a’ key concern.
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.
• 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
Positive Aspects of Cost Recovery
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