International (Upstream) Petroleum Agreements. Negotiating a Petroleum Contract

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International (Upstream) Petroleum
Agreements.Negotiating a Petroleum Contract
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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

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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

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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

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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

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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
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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

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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

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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

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Conceding the barrel

• Royalty
• Investor gross income
• Investor profit tax
• Other taxes and duties
• Investor profit

Fixed
Variable
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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

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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

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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

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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

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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)

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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

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Service Contracts, Cont.

• Government share
• Contractor fee
• Contractor tax

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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.

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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.

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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.

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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).

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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

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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

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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.

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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

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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

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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)

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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

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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.

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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.

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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

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UNITISATION JOINT DEVELOPMENTDrilling at Oil
Creek 1861
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Interfering wells on adjoining leases
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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

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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

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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

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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

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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

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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

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Key Issues in Unitisation Agreements (2)

• Re-determinations - examples
• Number and Timing
• Unit Decision Making
• Non-unit operations
• Procedure

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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.

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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

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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

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Example Norway UK Delimitation Treaty
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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.

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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

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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

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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 ...

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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.

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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

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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

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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

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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