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| ISBN-13: | 9781787421530 |
|---|---|
| Publisher: | Globe Law and Business |
| Publication date: | 12/01/2018 |
| Sold by: | Barnes & Noble |
| Format: | eBook |
| Pages: | 402 |
| File size: | 4 MB |
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CHAPTER 1
Petroleum contracts: licences, concessions, production-sharing agreements and service contracts
Jubilee Easo Eversheds Sutherland
1. Introduction
It is predominantly the case that hydrocarbon resources in the soil and the subsoil, in interior waters and in the territorial sea, on the continental shelf and in the exclusive economic zone are typically the province of the state. However, many states with significant hydrocarbon resources do not have easy access to risk capital and lack the technical expertise to explore and develop the hydrocarbon resources located in their territory. The task of exploring for and developing these hydrocarbon reserves is often delegated by the state to an international oil company (IOC) (sometimes acting in conjunction with a nominated domestic participant) that possesses the specialist expertise and financial resources necessary to undertake the task. The relationship between the state and the IOC must then be regulated by some type of legal instrument or contractual framework that specifies the rights and obligations of each party. This chapter discusses the four most important regimes developed to govern such a relationship: the licence, the concession, the production-sharing agreement (PSA) and the service contract. The reality is that many regimes are hybrids and it is not always possible to have a rigid demarcation.
At the heart of each of these regimes is the desire to address the tensions inherent in the relationship between the state and the IOC. Broadly speaking, these tensions can be divided into two categories: the allocation of risk between the parties and the provision of incentives to the IOC to accomplish the state's objectives.
The upstream hydrocarbons sector is faced with physical, commercial and political risks at every stage of the exploration and production process. While these risks are no different in nature from those that arise in other economic spheres, the oil and gas sector is distinctive in terms of the significant levels of investment required for the exploration and production of oil and gas, and the often high degree of uncertainty surrounding the ability to profit from such investment. Prior to attempting to extract hydrocarbons from the subsoil, seismic exploration and exploratory drilling must be carried out, and sufficient reserves must be found to make the project commercially viable. Unfortunately, more often than not, a commercial discovery will not occur, in which case it will not be possible to recover the exploration costs. Even if a commercial discovery is declared, significant uncertainty surrounds the actual cost at which the hydrocarbons can be extracted, developed and produced. History is witness to the dramatic fluctuations in the international price of hydrocarbons. The high cost of extraction and production and the fluctuations in the price of hydrocarbons together translate into risk with respect to the profitability of the venture.
Generally, under every prevailing form of upstream concession regime, it is the IOC that shoulders the brunt of the exploration risks. However, the regimes vary in how they define ownership of the hydrocarbons and the legal nature of the instrument granting rights to the IOC. The four upstream regimes also differ in how quickly the exploration costs can be recovered by the IOC at the production stage, and in the ways in which they allocate other risks between the state party and the IOC.
The type of upstream regime that a state chooses will depend on its own boundary conditions, geology, the extent of competition among IOCs, the degree of risk at each stage of the production process and the extent to which the host government, as the custodian of the petroleum resources, is able or willing to relinquish its sovereign rights. The state will naturally be more willing to bear the exploration risks arising from less challenging fields, while delegating to the IOC the more significant risks associated with speculative fields. A typical example of this is Brazil, where the finance minister made a case for a move from a concession system to a PSA system following significant deep-water discoveries in 2007. The concession system, he argued, worked for the state party when it was unclear whether and how much oil was present; he went on to comment: "Now there is no longer any risk – we know the oil is there, so the picture has changed."
Under all four upstream regimes, one risk that an IOC entering into a relationship with a state party cannot ignore is the fact that the IOC's counterparty is a sovereign state and can therefore use a number of legal and regulatory instruments effectively to expropriate entire fields or blocks, or reduce the revenue received by the IOC from such fields or blocks. The state party can, for example, decide to change the laws retrospectively, increase taxation or refuse to issue export permits.
Historically, the more profitable the venture becomes for the IOC, the higher the sovereign risk is perceived to be. This is either because any resource or field-related uncertainties have been resolved favourably or because the IOC has managed to negotiate favourable conditions in the contractual arrangements. For example, following the oil price shock in 1973, the Indonesian government realised that under the existing PSAs, the IOCs were earning substantial profits. As a result, the Indonesian government introduced new economic terms – reworked in its favour – applicable both to future PSAs and, significantly, to existing PSAs. This, to some extent, is unsurprising. When the proceeds received by IOCs turn out to be substantial, governments will tend to feel that the state's wealth is being unfairly appropriated by the IOCs. In such circumstances, the political and/or reputational consequences of appearing as an unreliable business partner will seem comparatively less significant for the host government. From the perspective of the IOC, the existence of sovereign risk can lead to a catch-22 situation in which it is invited to bear the potential downsides inherent in the exploration and production of hydrocarbons while simultaneously taking the risk that the upside may not be as significant as it expected.
While a certain amount of sovereign risk is unavoidable, there are contractual and legal provisions aimed at limiting its extent. Regardless of the upstream licence or contractual regime governing the relationship, the IOC will want to ensure that stabilisation provisions afford a certain degree of protection against future opportunistic behaviour by its sovereign counterparty.
The key objective of any upstream regime between the state and the IOC is the provision of adequate incentives for both parties – especially for the IOC. An IOC will not be adequately motivated to explore a field efficiently unless it is entitled to a certain level of benefit from a discovery. Different regimes deal with this issue in different ways, but the key economic factors from the IOC's perspective are the fiscal terms and the minimum work commitments imposed upon it. The work commitments represent the minimum level of financial commitment on the part of the IOC, and the fiscal terms represent the revenues that the IOC will be able to earn from production in the event of a discovery and the ability to recover its costs. The level of royalty, taxation and profit sharing imposed by the state will determine whether a field that is a technical success is also a commercial success for the IOC. Additionally, the IOC will be keen to ensure it has the ability to book barrels – that is, to report the results of exploration to its shareholders.
It is often also the case that the state party is interested in accomplishing certain objectives through its business relationship with the IOC that are not strictly related to the maximisation of the proceeds from the extraction of hydrocarbons. These objectives may include some or all of:
• the transfer of technology from the IOC to the host government;
• the earning of foreign exchange;
• the promotion of direct and indirect local employment; and
• the retention of a certain percentage of hydrocarbons for the local market.
These objectives may conflict with the interests of the IOC, and will need to be disclosed and included in the applicable contractual arrangement if the IOC is to be motivated to achieve them. Of course, these secondary objectives may come at a cost, as they may limit the ability of the IOC to carry on its main activity in the most economically efficient manner and could even dissuade it from pursuing its application to be awarded the concession. Each of the regimes discussed below can, in principle, incorporate clauses addressing these secondary objectives. However, certain regimes allow the state to pursue such objectives more effectively, as the state is more directly involved in the extraction process.
2. Licences
A licence (referred to in some countries as a lease) is essentially a permission granted by a state to an IOC (as licensee) to exploit a certain geographical area in return for a fee, a royalty and/or taxation. All hydrocarbons are owned by the state while they are in the ground. Although reserves in-ground can be booked, ownership of any hydrocarbons extracted transfers to the licensee at the wellhead. Therefore, the licence grants the licensee a proprietary right over the hydrocarbons at the point of extraction and any profits obtained by the licensee from sale of the hydrocarbons are taxed by the state.
The fiscal regime that applies to a licence typically involves a combination of a royalty (on gross production), regular income tax that is applicable to all companies and a special petroleum tax to capture a larger share of the profits of the profitable discoveries. Except where there is a royalty element, it is a profit-based regime, with IOCs having the ability to 'deduct' their costs for the purposes of calculating their taxable income.
The licensing regime is a relatively free market regime under which the licensee bears most of the risk, but enjoys a significant share of the benefits and is allowed to pursue its interests with relative freedom subject to environmental, timing and other constraints imposed by the terms and conditions of the licence. The United Kingdom, Canada, Norway and Russia are the main countries that use or have used a licensing regime to grant access to their hydrocarbon resources.
The conditions of the licence are usually reflected in legislation. Notwithstanding this fact, licences are considered to be contractual instruments rather than regulatory instruments in most countries. This has important legal consequences for the licensee, as contractual relationships cannot generally be amended unilaterally, whereas regulatory instruments are subject to unilateral amendment by the state. The licence usually references underlying petroleum legislation and tends to be used in countries that have a well-developed business, tax and petroleum legislative regime.
2.1 UK licensing regime
In the United Kingdom, the Department of Energy and Climate Change and the secretary of state were together responsible for energy policy, regulation of UK petroleum resources and oversight and implementation of the licensing regime. This changed in 2014 with the creation of the Department of Business, Energy and Industrial Strategy (BEIS) and a new regulator – the Oil and Gas Authority – responsible for licensing on behalf of the secretary of state and BEIS.
The licence takes the form of a deed, under which the licensee is bound to observe the conditions of the licence. Secondary legislation contains these conditions (known as model clauses), which govern issues such as the grant of rights, the implementation of development plans, working methods, measurements and work programmes, and the relinquishment of a certain proportion of the licence area. Licences are usually awarded in licensing rounds, although out-of-round licences may be granted in certain circumstances.
Licences may be granted to one or more licensees; however, legally the licence is held collectively by the licensees, which are jointly and severally liable in respect of obligations arising under, and operations conducted pursuant to, the licence.
BEIS currently issues two types of offshore licence: the exploration licence and the production licence. An offshore exploration licence allows the licensee to carry out seismic surveys in a particular area and to undertake shallow drilling. Offshore exploration licences are usually granted for a period of three years, with the possibility of extension for a further three years.
Under an offshore production licence, the licensee has the exclusive right to explore for and subsequently exploit hydrocarbons in the geographical area covered by the licence. Three different types of production licences are issued, depending on the characteristics of the particular field. Traditional licences – the most common type – apply to well-known, not too deep areas and to applicants with proven technical and financial capabilities. 'Promote' licences are designed to enable smaller companies to obtain a production licence before proving those capabilities, whereby the licensee is required to pay only 10% of the traditional fee in the first two years and can bypass some of the more stringent licensing requirements. Such licences therefore allow new players to join the search for hydrocarbons more easily. Finally, 'frontier' licences are intended to encourage exploration in areas that are remote or in deep water. The licensee is required to pay only 10% of the traditional rate, but must then relinquish 75% of the licensed area after the initial exploration. The 29th licensing round also signalled the launch of a new type of offshore production licence called the 'innovate' licence, which will replace all other types of offshore production licences and will be used for all future licensing rounds. The main difference between the innovate licence and older licences is the duration of the initial and second phase and the flexibility that licensees will have in determining the length of each phase
For onshore exploration and production activities, a petroleum exploration and development licence is required. This is similar in form to the offshore production licence and includes model clauses and three distinct development phases.
There are two different means through which the United Kingdom gets a return from the production of petroleum (onshore and offshore): annual rentals payable under each licence and taxes on the profits derived from petroleum production. Until the Finance Act 2016 was enacted, there were three main elements of taxation: petroleum revenue tax, ring-fence corporation tax and supplementary charge. However, on 16 March 2016 the chancellor of the exchequer announced a permanent reduction in the petroleum revenue tax rate to 0% with effect from 1 January 2016.
The two remaining elements of the tax regime are as follows:
• Ring-fence corporation tax: This is the normal UK corporation tax with the exception of a ring-fence to prevent taxable profits from hydrocarbon extraction being reduced by losses from other activities or by excessive interest payments. The current rate of ring-fenced corporation tax is 30%.
• Supplementary charge: Since April 2002, a supplementary charge has been applied to a company's ring-fenced profits, without deducting costs of debt finance. In 2011 the UK government raised the rate of the supplementary charge from 20% to 32% to take into account what it felt were unexpected profits for oil and gas companies active in the United Kingdom. Following various fiscal reviews, the supplementary charge has been reduced a number of times and is currently 10%.
2.2 Norwegian licensing regime
In Norway, the Petroleum Act of 1996 provides the legal framework for the licensing system that regulates petroleum activities. The Ministry of Petroleum and Energy is the body with the authority to award licences. Following the submission of applications in each licensing round, the ministry allocates each licence to an individual licensee or group of licensees. An operator of the consortium, responsible for carrying out day-to-day activities under the terms of the licence, is then appointed by the ministry. Licensees are currently only awarded acreage for which they have submitted complete plans.
Each licence provides exclusive rights for the exploration and exploitation of hydrocarbons in the relevant geographical area and includes terms and conditions supplementing those of the Petroleum Act. The licence is awarded for an initial exploration period of up to 10 years. Certain minimum exploratory activities, including seismic surveys and/or shallow drilling, must be carried out during this initial period. Following exploitation, the licensee can only retain areas in which it plans to start production. A licensee which hasfulfilled the work commitment and the conditions otherwise applicable to the individual licence may demand that the licence be extended after the expiry of the initial period. The extension period is stipulated in the licence and generally may be up to 30 years (although in some cases may be up to 50 years).
(Continues…)
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Table of Contents
Preface,
Renad Younes,
Ashurst LLP,
Petroleum contracts: licences, concessions, production-sharing agreements and service contracts,
Jubilee Easo,
Eversheds Sutherland,
Boundary delimitation and hydrocarbon resources,
Mhairi Main Garcia,
Dentons,
Joint operating agreements,
Priya Shah,
Ashurst LLP,
Unitisation and unitisation agreements,
Danielle Beggs,
Dentons UK and Middle East LLP,
Christopher Thomson,
Dentons,
Financing upstream developments,
Nicholas Ross-McCall,
CMS,
Huw Thomas,
Ashurst LLP,
Trans-boundary pipeline development and risk mitigation,
William E Browning,
Infrastructure Development,
Partnership LLP,
Thomas Dimitroff,
Infrastructure Development,
Partnership LLP;,
Roland Berger GmbH,
LNG - overview and project essentials,
Daniel Reinbott,
Ashurst LLP,
Shale gas,
George Antonopoulos,
Vivek Bakshi,
Dentons Canada LLP,
Jennifer Morrissey,
Dentons US LLP,
Gas sales agreements,
Daniel O'Neill,
Tullow Oil plc,
Crude oil sale and purchase agreements,
Alistair Feeney,
Holman Fenwick Willan LLP,
Shipping arrangements,
Denys Hickey,
39 Essex Chambers,
Farm-outs,
Julia Derrick,
Ashurst LLP,
Gas processing,
Nina Howell,
King & Spalding,
Decommissioning of upstream oil and gas facilities,
Mark Osa Igiehon,
Aberdeen Commercial/Oil & Minerals Group and University of Aberdeen Centre for Energy Law,
Oil and gas projects and human rights,
Jennifer Zerk,
Jennifer Zerk Consulting,
Oil and gas disputes,
Mark Clarke,
James Hart,
White & Case LLP,
Introduction to downstream projects,
Anne Marie Wicks,
White & Case LLP,
LNG to power projects,
Philip Thomson,
Ashurst LLP,
About the authors,