Production Sharing Contracts in India
A Retrospection
Presentation Outline
Petroleum Regulatory Framework Types of Agreements PSC in India Attributes of PSC International Practices Where We Stand Scope for Improvement Conclusions
Petroleum Regulatory Framework
The "Anna Karenia" Principle
The first sentence of Leo Tolstoy's novel "Anna Karenia" is:
"Happy families are all alike; every unhappy family is unhappy in its own way".
Oil & Gas Regulatory Regimes that foster investment are all alike. Every oil & gas regulatory regime that discourages investment does so in its own way.
Pillars of Oil & Gas Regulatory Regimes
A good oil & gas regulatory regime addresses certain major regulatory issues in a satisfactory way:
The right to monetize resources Fiscal and contract stability Enforceability of contract
A regulatory regime that falls on any one of these points puts its "investment favorability" at risk
Types of Agreements
A Comparative Study
Types of Agreements
Concessions Joint Ventures Service Contracts Production Sharing Contracts/Risk Sharing Contracts Hybrids
Concession
Contractor has exclusive rights to explore, develop, sell, and export oil/gas from a specified area for a fixed period of time.
"Equity" or "Royalty & Tax" structure
Maximum control to Contractor Oldest & most widely used
Joint Venture
Private/Foreign Companies and NOC from a Joint Venture Each JV partner pays/receives its share in proportion to its Participating Interest. JV pays royalty, income tax and usually some form of Petroleum Revenue Tax (PRT) Low success rate, less commonly used
Service Contract
Contractor pays all exploration and development costs Contractor works under government's mandate and is paid for its work Government maintains ownership and title of minerals. Most suitable for Contractor for risk-free operations and for States having Producing Assets
Hybrids
Combinations of Concession/JV/PSC, royalty, tax, cost oil/profit oil shares and fees etc. Efforts to develop a world model Hybrid agreement have been unsuccessful because structures are becoming
more diverse Host governments seeking structures that suit their particular needs.
Production Sharing Contract
State enters into a PSC with Contractor for a specified period Contractor finances exploration and development If successful, Contractor will recover its costs and earn a profit by receiving a share of production Royalty & Income Tax are paid as applicable. Significant control to Contractors, but Share has contractual controls.
Comparative Analysis of Agreements
Type of agreements Contractor Government
Concession All RiskAll Reward
Reward is a function of production & price
Joint Venture Share in risk & reward Share in risk & reward
Service Contract No Risk All RiskAll Reward
Hybrid Mixed Mixed
PSC Exploration RiskShare in reward
Share in reward
Usage of Contract Types
Type of agreements Number of countries utilizing this type
Concession 59
Joint Venture 31
Service Contract 2
Hybrid 16
PSC 40
Source: Macleed Dixon Workshop, 2007
Countries and Agreement Types
Type of Agreements
Countries Utilizing
Concession (59) UK, US, Norway, Australia, Canada, Peru, Namibia, Thailand, Sudan, Ecuador, Kuwait, Bahamas
Joint Ventures (31)Colombia, Cameroon, Netherlands, Pakistan
PSC (40) Egypt, Yemen, Angola, Indonesia, India, Guatemala, Sri Lanka
Service Contracts (2)
Iran, Qatar
Hybrid (16) Libya, China, Malaysia, Kenya, Tanzania, Gabon, Myanmar
Rights Agreements - Main Elements
Right contract is vital to a government's effort to reap the benefits of its natural resources Balance needed between country's and investor's interests Takes into consideration the communities or entities not party to the deal but who will be interested or affected
by it.
Approaches to Resource Exploitation
Many developed countries use unilateral licensing/leasing approach. Many developing countries use consensual approach and prefer mining agreements Political will of host country to develop resource is key and expressed through regulatory instruments,
contractual obligations, national policies and guidelines
Concession Agreements
Advantages Disadvantages
If production occurs, government earns royalties and/or profit tax. Both are based on the quantity produced and the price at which commodity is sold
Government may not realize full potential through possible extensive exploration
Successful bidder pays bidder price (usually license feed and/or signature bonus)
Companies will be cautious in bidding for uncertain returns in virgin/non-proven areas. Not suitable for countries seeking extensive exploratory inputs through bidding systems.
Joint Venture Agreements
Advantages Disadvantages
Government is not alone in the decision-making and responsibility for a project
Risk and costs are also shared. Country needs to share Risk Capital. Not suitable for countries needing huge investment on exploration.
Government can count on expertise of oil Company.
Responsibility also brings with it potential liability such as for environmental damage
Government share profit, on lop of taxes or royalties.
Service Agreements
Advantages Disadvantages
Payment is made for service Suitable for Producing Assets. Not much relevant for
at pre-determined rate exploration
Most energy companies reluctant to sell services and technology for a Turnkey Contract as earning is more limited
Hybrid Agreements
Advantages Disadvantages
Incorporates the best of Concession, JV, PSC, Royalty & Taxes
Diverse & Complex structures of Model. Difficult to estimate optimal Govt./Contractor's takes & achieve equilibrium for a win-win situation for both parties.
Requires expertise and negotiation skills
Production Sharing Contracts
Advantages Disadvantages
It is considered the most attractive investment model for inviting Risk Capital and has been successful in attracting foreign/private investment to get unexplored areas explored at no cost to the government.
Rigidity with regard to contractual provisions throughout the contract period.
No flexibility for adjusting to unplanned situations.
Contractor enjoys considerable autonomy in running the exploration and production operations & leaves no stone unturned to ensure exploration success in order to be entitled for *Cost Recovery.
Most energy companies reluctant to sell services and technology for a Turnkey Contract as earning is more limited
Production Sharing Contracts
Advantages Disadvantages
Allows for the recovery of invested sunk cost by the Contractors only in case of successful ventures
Government shares potential profits without having to make a direct investment.
Entire cost loaded on the Contractor till recovery commences.
PSC in India
Historical Background
First concept for PSC was introduced in Bolivia in 1950 PSCs were successfully implemented in Indonesia in 1966 PSC's are being widely used in more than 40 countries In India, first PSC was signed in 1993 for a Pre-NELP Block 190 Exploration PSCs have been signed so far PSC terms continuously improved in consecutive NELP rounds
Legal Framework
Constitution of India, 1950 The Oilfields (Regulation and Development) Act, 1948 The Petroleum and Natural Gas Rules, 1959 & Amendments
Territorial Waters, Continental Shelf, Exclusive Economic Zone and other Maritime Zones Act, 1976 Income Tax Act, 1961 Customs Act, 1962 Foreign Exchange Management Act, 1999 Environment Protection Act, 1986 Arbitration and Conciliation Act, 1996
Highlights of NELP PSC
Production Sharing Contracts signed with Government based on Pre Tax Investment Multiple (PTIM) Trenches. Low royalty rates - royalty is cost recoverable. No cess or customs duty. Liberal provisions for assignment of Interest and securitization of participating interest for raising project finance
allowed.
Highlights of NELP PSC
Freedom to contractor to market oil and gas in the domestic market at market determined price. Liberal set off of losses and carry forward provisions for income tax purposes including 7 years corporate tax
holiday. 100% cost recovery of Exploration & Development expenditure
Cost Recovery - Article 17 of-PSC
100% of all exploration and drilling expenditure is allowed each year (both capital and revenue). Expenditure incurred on development (other than drilling expenditure) and production activities Is allowed as
per the Act. Article 17 provides fiscal stability to both parties.
Royalty pegged to the market value at Well head value :
Crude oil
12.5% for on-land 10% for offshore Deepwater* : 5% for the first 7 years
Gas
10% for on-land and offshore Deepwater* : 5% for the first 7 years
Production Sharing Contract Attributes
Contract term Relinquishment Management Committee Discovery, Development & Production Unit Development Cost Recovery & Production Sharing Taxes, Royalties & Rentals Domestic sourcing & supply obligations Employment & training Title to assets
International Practices
International Practice
Governments want to know what the international practice is on many issues
Fiscal Regime Economic Regime Business/Contract terms Local benefits and opportunities
Contractors often want the same information
Useful in negotiating petroleum arrangements
Selected International Practice Review Issues
Governing Law Arbitration Management & Control Employment & Training of Local Nationals Procurement of Local Goods & Services Transfer of Technology Environmental Liability Minimum Work & Security stability
Is It Possible to identify "Best Practice"?
Review of PSCs shows the incredible breadth and variety of provisions that appear in Contracts "Best practice" cannot always be identified Needs, desires and interests of host governments and Contractors can vary greatiy depending on the situation Contractors prepared to accept a provision in one jurisdiction that they will not accept in others The needs and interests of host governments vary from country to country
Where We Stand
Scope of Improvement
Grant of Improvement
In the case of onshore PSCs :
1. Delays in post contract clearances 2. Procurement of mining leases from the State Government seen as a major bottle neck
Though 'concurrence' already received, States should be better involved by
1. Involvement at bidding stage 2. Involvement as confirming parties to contacts with regard to ONLAND Environmental Clearances & Licensing
Unit Development
Article 12 - 'Joint Development Plan' - where there is a common reservoir in two contract areas to safeguard against (1) capture and consequent competitive drilling along the lease lines; and (2) for securing more effective recovery
Internationally-Unit Operating Agreement to develop a common reservoir as a single unit. Each party owns all unit property and utilized petroleum in undivided shares in proportion to unit equity On discovery, parties will enter in to ancillary agreements - (1) data exchange (2) joint studies etc, leading to a
penultimate pre utilization agreement On establishment of a 'Commercial Discovery', parties will enter in to the 'utilization agreement' which
supersedes the 'pre unitization agreement' Issues and options:
o Typically protracted, lengthy negotiations. If no unitization agreement within time period-Government intervention. To mitigates against this :
1. Incorporation of principles of pre unitization agreements in the MPSC 2. Time limits 3. Pre-set criteria 4. First Technical & then Financial Determination
Environment and Abandonment
Abandonment Plan All payouts to be cost recoverable Site Restoration Scheme involves annual contributions based on the estimated pay outs at abandonment Issues
o Need to examine alternatives such as securing payment obligations by guarantees etc. o Protection from 'absolute liability' ?
National Economic Interest Provisions
Local employment Local goods, services and resources Technical assistance agreements Data transfer Issued and options
o Contracts in Malaysia and China-strong emphasis on NEIPs o Incentivizing compliance with non mandatory NEIPs - cost recoverable vs. non cost recoverable
Dispute Resolution
Governing law is India law Best efforts to settle disputes Certain matters reserved for determination by Expert Issues and options
o Expert is not arbitrator, Decisions - enforceable ? o Arbitration covers only matters other than those referred to expert o Possible options include :
1. Marketing decision of expert a 'binding agreement' 2. Only resource to expert decision - arbitration
Discovery & Production Testing
"Discovery means finding, during Petroleum Operations, of a deposit of Petroleum not previously known to have existed, which can be recovered at the surface in a flow measurable by conventional petroleum engineering testing methods".
Article 10.2 of PSC may be modified to include "Drill Steam Test or Modular Dynamic Tester" (MDT) for Production Testing of Deepwater Exploratory wells
In view of high cost/non-availability of deepwater rigs
Already in practice in GM & recognized by MMS/SEC
Achievements Under PSC Regime (As on 01.04.2008)
Discoveries 93
In-Place Reserves 1619 MMT
Investment US$ 14 Billion
Cumulative Production OIL : 47 MMT
GAS : 58 BCM
Profit Petroleum & Royalty paid to centre
Rs. 22,250 Crores
Cess Rs. 4278 Crores
Deepwater Success First commercial oil production commenced w.e.f 17.09.2008
Conclusions
Indian PSC is considered to be Progressive & investor friendly PSC gives greatest kick to exploration. Hence best suited for accelerated exploration, like in India having large
unexpected area needing extensive exploration and risk capital PSC enables exploration at no cost to Government "Cost Recovery" acts as incentive to continue exploration till success is achieved Contractor ids for higher work & investment commitments helping large scale exploration Existing Framework of the contract may not require major modifications Suggested modifications need further deliberations for possible improvements All business/commercial interactions desirable only through DGH
