Mar 9, 2017

An Overview of Oil and Gas Contracts| Anemuyem Akpan & Uduak Nsungwara

The public and private arrangements under which oil production is authorised have gone through a variety of phases since the emergence of petroleum as an internationally traded commodity in the middle decades of the last century (Smith, 1991). International oil companies (IOCs) and host states (HSs) have over the years adopted various schemes of arrangement to project and protect their interests. The relationship between the IOCs and the HSs forms the substratum of the petroleum industry and is accountable for the birth of various types of contracts in industry.

It is through these contracts that IOCs acquire the right to embark on Exploration and Production (E&P) projects within the territory of the HSs. In particular, they define, in case, commercial petroleum discoveries are developed and exploited, how the production, income and risks will be allocated between the government and the investor.

Types of E&P Contracts
1. Concession
2. Production Sharing Contract
3. Joint Venture
4. Service Contract

1. Concession
Under this form E&P contract, the government grants the IOC ( concessionaire) the exclusive right natural resources in a given area for a specified period of time, in exchange for payment of royalties and taxes (Cotula, 2010). Contemporary practice indicates the modification of concession agreement to ensure greater participation by host states. This modification finds expression in modern concession contracts. In practice, allows for varying shades of government supervision and participation.

2. Production Sharing Contract
Production sharing contract (PSC) is a distinct petroleum arrangement that has been developed by many countries in the exploration and production of their petroleum resources as it guarantees the sovereign right of the state over these resources and meet their economic desires by providing capital and technology for their production ( Ogunleye, 2015).

Introduced by Indonesia in 1966, in opposition to the one-sided classical concession regime, this form of E&P arrangement offer HSs greater participation in E&P projects. PSC arrangements are resorted to when HSs seeks to reduce their financial obligations in E&P projects, while not losing ownership and participatory rights. The entirety of commercial risks is borne by the IOC who executes the project on behalf of its self and the HS represented by its National Oil Company (NOC).

On the project becoming economically viable, both parties, both parties take their share of the oil in accordance with the formula laid out in the law or contract. Royalty oil is first allocated to the NOC in accordance with agreed quantum. Cost oil which represents an IOC’s operating cost is then allocated to the contractor. Tax oil, being the balance of oil after deducting royalty and cost oil is then allocated to the NOC. The residue ( being what is left after the above deductions is then shared between the IOC and NOC as profit oil according to the terms of the PSC.

3. Joint Venture Contract
Under this arrangement, both the IOC and the NOC contribute to funding E&P operations in the proportion of the JV equity holdings, and generally receive crude oil in the same ratio (KPMG, 2014). A JVC creates a partnership agreement, in which both parties interests somehow are balanced by jointly bearing the rights and obligations in the petroleum operations (Ghadas & Karimsharif, 2014).

A key feature and requirement in a JVC is that the HS should be able to participate in the venture by meeting its full financial obligation. The inability of most HSs to meet this requirement perhaps informs the resort to PSC. For example, the PSC regime currently obtainable in Nigeria was a reaction of the government its inability to discharge its financial obligations in many of its JVs.

JVCs can be created either by contract or by incorporation. Within the regime, the joint venture is created and managed through contractual agreements of the parties. Both parties own the equipment and facilities of the project, as well as the oil and gas productions (Al-Emadi, 2010). In the alternative, a separate legal entity is formed with venture partners as shareholders with the objective of carrying out E&P as set out by the JVC.

4. Service Contract
Where a state ( as is the case with most oil producing states) lack technological capabilities to exploit its resources), it may contract IOC to provide highly technical E&P services in return for payment of a pre-determined fee. This is arrangement is referred to as Service Contracts. Here, the IOC undertakes to explore for petro carbons at its own risk and expense on behalf of the NOC and by which it is reimbursed and remunerated in cash depending on the success of the exploration (Guirauden, 2004).

This scheme of arrangement can be categorised into either ‘pure service contract’ or ‘risk service contract’. IOCs in pure service contract execute the E&P project in exchange for a flat fee. Recovery of their operational cost is not tied to the commercial viability of the project. An example of this is a contract to construct at oil platform offshore. Once construction is completed and payment is made to the IOC, the service contract comes to an end.

Risk service contract incorporates an undertaking on the part of the IOC to bear all the attendant risk of exploration, development and production of oil and gas. The reimbursement of the IOC is predicated on the commercial viability of the project. Once there is a declaration of commercial productivity, the company has a right to be paid for its services and to additional compensation for the risk it has undertaken (Smith, 1991).

The evolution of oil and gas contracts reflects decades of struggle by HSs to obtain favourable financial conditions and the desire of IOCs to maximise their profits. The choice of a particular scheme should not be informed its wide international acceptance and applicability. Rather, attention should be paid to factors like finance, technology, political environment etc.
Currently, it may appear as though oil and gas contracts have achieved apotheosis. However, opportunities the development of newer schemes remain limitless. As events around continue to re-shape the oil and gas industry, affecting prices, fiscal policies and legal regimes, a new type of oil and gas contract may just be in the waiting.

Smith, Ernest (1991) From Concessions to Service Contracts, 27 Tulsa Law Review 493-524.
Leuch Honore , ‘Recent Trends in Upstream Petroleum Agreement : Policy, Contractual, Fiscal and Legal Issues ‘ in Andreas Goldthaw (ed) ‘ The Handbook of Global Energy Policy.
Cotula L, (2010). Investment Contracts and Sustainable Development; How to make Contracts for Fairer and more Sustainable Natural Resources Investment (1st ed) International Institute for Enviroment and Developmemt
Ogunleye Taiwo, (2015), A Legal Analysis of Production Sharing Contract Agreements in the Nigerian Petroleum Industry,5 Journal of Energy Technologies and Policy
KPGM Professional Services Nigeria (2014) Nigeria’s Oil and Gas Industry Brief.
Ghadas Zuhairah & Karimsharif Sabah, (2014) Types and Features of International Petroleum Contracts. 4 South East Asia Journal of Contemporary Business, Economics and Law, 34-40
Al-Emadi Talal(2010) Joint Venture Contracts (JVCs) among Current Negotiated Petroleum Contracts: A Literature Review of JVCs Development, Concept and Elements.Geo. J. Int’l Law: The Summit 645-667.
Guirauden, D. (2004). Legal, Fiscal and Contractual Framework. In J.-P. F.-R.-R. Denis Babusiaux, & N. F.-P. Bret-Rouzaut (Ed.), Oil and Gas Exploration and Production; Reserves, Costs and Contracts (3rd Edition ed., pp. 170-210). Paris, France: Editions Technip.

Disclaimer: This article is only intended to provide general information on the subject matter and does not by itself create client/attorney relationship between readers and the authors. Specialist legal advice should be sought about the readers’ specific circumstances when they arise.

Anemuyem Akpan & Uduak Nsungwara

Anemuyem Akpan is a Lagos-based Legal Practitioner. For feedback, send an sms/mail to08063624048,

Ed’s Note – This article was originally published here.