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  • 1. 1Are Production Sharing Contracts Modern Concession Agreements byAnother Name? Valentine Ataka**Valentine Ataka is an Advocate of the High Court of Kenya, a commentator on Law and Policyon Energy. He is an LLM Candidate in Oil and Gas Law (RGU-2013)
  • 2. 2Are Production Sharing Contracts Modern Concession Agreements byAnother Name?IntroductionProduction Sharing Contracts (PSCs) have become more of a fad in Oil and Gascontracting since their emergence in the late 1960s1. They have gradually replacedthe classical Concessions which were seen to be unduly skewed in favour of IOCs.On the other hand there are a number of countries that have continued to useConcession Agreements albeit in a modified form- what I describe here as ModernConcessions.As it turns out, on a measure of government control, benefit drawn by the IOC anddivision of obligations, modern Concessions are very similar to PSCs. There arehowever some menial differences which are discussed below. The discussion relieson available models from Brazil2, Angola3, Kenya4, Kurdistan5and Egypt6.1First recorded use was in Indonesia in 19662Brazilian Ministry of Mines and Energy ‘Model Concession Agreement for Exploration,Development and Production of Oil and Natural (Clause 2.4)’http://www.eisourcebook.org/cms/Brazil,%20Model%20Concession%20Agreement,%20ANP%2010th%20Rnd,%202008.pdf accessed 12thApril 20133EI Source Book ‘Model Angolan Production Sharing Contract’http://www.eisourcebook.org/cms//files/attachments/policy-legal-contractual-regulatory/Angola%20-%20Model%20of%20PSA%202008.pdf accessed 12thApril 20134EI Source Book ‘Republic of Kenya Model production Sharing Contract’http://www.eisourcebook.org/cms/Kenya%20Model%20Production%20Sharing%20Contract.pdf accessed 12thApril 20135EI source Book ‘Model Production Sharing Contract for Exploration and Production inKurdistan’‘http://www.eisourcebook.org/cms/Iraqi%20Kurdistan%20draft%20Model%20Production%20Sharing%20Contract.pdf accessed 12thApril 20136Egyptian Gas Holding Company ‘Concession Agreement FOR Gas and Crude Oil Explorationand Exploitation’ (2005 Model)http://www.egas.com.eg/BidRound2012/MODEL_AGREEMENT_2012_new.pdf accessed 23rdMarch 2013
  • 3. 3Similarities in the Development aspects of the Concession and the PSAPartiesIn a concession as well as a PSC, the IOC enters into the contract with an NOCacting on behalf of the government. For example in Brazillian Concessions, the ANPis the opposite party while in the Angola PSCs the government is represented in thecontract by SONANGOL. An interesting variation is the Kenyan PSC where theMinistry in charge of energy signs the Contract and the National Oil Corporation hasno role defined under the contract.Security for performanceIn both forms of contracting the concessionaire or the contractor is required toprovide some form of security to guarantee the performance of the developmentwork under the contract. The Angolan model PSA requires the IOC to provide afinancial guarantee not later than 30 days before execution of the agreement.Clause 15 of the Brazilian Concession requires the lodging of security in the form ofirrevocable letters of credit, guarantee insurance or Oil pledge Agreement.Reversal of ownership of installationsUnder both regimes, once the contract expires, the ownership of the installation(i.e. infrastructures, equipment and all wells) reverts freely to the HG. Howeverthe Concessionaire/contractor may also be required to decommission theinstallations at its own costs. Under the Norwegian Concession regime, installationsare to revert only if they are in good and safe working condition, failing which theIOC would be liable to pay compensation to the state. Similarly under the AngolanPSC, within 60 days of expiry of the contract the contractor is to hand over to theNOC all the installations
  • 4. 4RelinquishmentIn both systems the IOC is obliged to progressively either relinquish or reducethe contract area held by it for purposes of exploration. This is a governmentmechanism used to ensure progressive and optimal development of the grantedfields. Article 3 of the Kenyan Model PSC provides for progressive surrender of thecontract area. A similarly progressive relinquishment model is in the EgyptianConcession (Article V).Oversight over Development ProcessUnder both regimes, the government is usually not directly involved in thedevelopment processes. The NOC and the IOC usually constitute an E&P oversightbody to report to the respective parties. For instance under Article IV of theEgyptian Concession, a Joint Exploration Advisory Committee is to be established toreview and give such advice as it deems appropriate with respect to the proposedExploration work program and budget while under Article 31 of the Angolan PSC, aJoint Operating Committee is established.Differences in Development aspectsOwnership of Oil resourcesUnder Concession agreements the resources belong to the government only to theextent that it is still in the reservoir. Once oil is extracted, for example under theBrazilian concession, the title transfers wholly to the concessionaire7. On theother hand under a PSC the ownership of the resources at all times remainswith the government. Article 2.1 of the Kurdistan Model PSC is categorical thatthe government is the sole owner of the petroleum.7See Clause 2.4 of the Brazilian Concession model
  • 5. 5Similarities in the fiscal aspectsBonusesIn both cases, the contractor/concessionaire is expected to pay a signature bonusand/or a production bonus. The signature bonus is paid o the governmentbefore the contract is signed. The production bonus kicks in when a predeterminedthreshold in production is met. The nature of the bonus and its status for thepurposes of tax or costs deductions may vary.For example Article XI of the Egyptian Model Concession provides for developmentlease, development lease extension, training and assignment bonuses in addition tosignature and production bonuses. The Kurdistan Region Model PSA provides forboth signature and production bonuses at Article 6 and 32 respectively.Under the Egyptian concession model the bonuses are not deductible for taxpurposes. Similarly under the Angolan PSC the contractor cannot recover bonusespaid as costs.RoyaltiesThe concept of royalty payment was originally intended under concessions todeliver compensation in kind to the ultimate owner of the resources i.e. thestate8. This is why it is predominantly used in Concessions. However some PSCs,for example Article 24 of the Kurdistan Model, require the payment of Royalties.The Royalty is usually worked out on the basis of a percentage of the oil and gasproduced. For example, under Annex V of the Brazilian Model Concession the IOC isto pay in the amount of 10% of Oil and Natural Gas produced in each Field withinthe Concession Area from the respective Production Start-up dates.8M.R Oliveira, ‘The Overhaul of the Brazilian Oil and Gas Regime: Does the Adoption of aProduction Sharing Agreement Bring Any Advantage Over the Current Modern ConcessionSystem’ (OGEL, Vol 8 issue 3, 2010)
  • 6. 6Since royalties are by nature payments irrespective of tax, they are generally notdeductible for the purposes of tax or calculation of recoverable costs in either formof contracting.Minimum Work ObligationBoth under a Concession and a PSC, the IOC is expected to submit and comply witha program indicating work to be accomplished under each phase. The KurdistanPSC for instance provides for the obligation under Clause 9.2 of while the BrazillianConcession Agreement provides for the same at Clause 15.Differences in Fiscal aspectsCost RecoveryThis is only known to the PSC regime whereby the contractor has the right torecover its costs by taking a proportion (known as cost oil), not exceeding a certainpercentage (cost recovery limit), of the annual production within the contract area.The limit is fixed at a minimum of 55% and a maximum of 70% in the KurdistanModel PSC depending on the quality (gravity) of oil produced.Concessions regimes have their own systems of cost relief. For instance the costrecovery mechanism under the Brazilian concession regime is represented bydepreciation, amortisation and deduction of capital and operating cost againsttaxable income and special participation fee.9Sharing of Profit OilThis is only found in PSCs. It is the portion of the production that is left once thecost oil has been deducted and is shared between the government and the IOC onthe basis of a predetermined formula. A number of countries now have productionsharing mechanisms, based on the rate of return (or other assessment of9Oliveira Ibid
  • 7. 7profitability) to the contractor on a given date. Examples of such countries areLiberia, Libya, Equatorial Guinea Tunisia, India, and Azerbaijan.Income GenerallyUnder the PSC the government draws financial benefit mainly through a share inthe production and not profits as the case is with the Concession. Under aConcession regime the host government seeks its share of the rent throughtaxation, bonuses and royalties only.Income tax is chargeable in both regimes. However as pointed out by Oliveira, itsweight in a Concession regime is much greater than in the PSA regime as it is themain source of revenues to the government. On the other hand, in a PSA the role ofincome tax is outweighed by the government profit oil.Venn diagram comparison of Concessions and PSCs (by Author)CONCESSION PSCExploitation of Early Concessions by Oil CompaniesConcessions in their classical form have in the past dues to their lopsided natureused by IOCs to great advantage especially in the Middle East.-HG share in profit-IOC owns oilHG share in production--HG owns oil-cost oil-profit oil- Similar parties- Bonus& Royaltypayment- Relinquishmentof fields-Minimum workObligation-Income tax- Performanceguarantee-Assets revert toHG
  • 8. 8An example is the 1901 DArcy Concession obtained by William D’Arcy from theShah of Persia to explore 500,000 sqm of land for duration of 60 years10. In returnthe company had to pay a US$ 100,000 bonus, a 16 percent royalty, and give thegovernment a share worth US$ l00, 000 in the company. Similarly, the 1933contract between the King of Saudi Arabia and Standard Oil of California specifiedthat the foreign contractor had to pay 50,000 pounds of gold to the King in returnfor a concession covering 500,000 sqm for a 66 year period. The Abu Dhabiconcession of 1939 granted a consortium of five major oil companies the right toexplore the entire country for 75 years.However beginning 1950s onwards the classical Concessions have either beenrenegotiated or abandoned altogether with governments realizing their lopsidednature. For example under an original concession between Saudi Arabia andARAMCO the HG was to receive 21% per barrel at a time when the barrel sold forover US$2. The Saudi government forced a renegotiation requiring profits to beshared fifty-fifty, and requiring payment of royalty. The Iran and Iraq concessionsunderwent similar changes. Also introduced were changes in taxation. In additionOPEC, after its foundation in 1960, sought to readdress control over production andprices by changing the balance of bargaining power in favour of the producingcountries and away from the majors11.Which of the two offers Economic leverage to an IOC?The modern Concession has evolved to such nature that beyond the ownership andlevel of control, it is no better or worse than a PSC. Both regimes contemplateroyalties, taxes, bonuses, etc. and some form of cost recovery. Even though in a10Paul Lunde, A king and a Concession, Saudi ARAMCO World, Vol 35 No 3 1984http://www.saudiaramcoworld.com/issue/198403/a.king.and.a.concession.htm accessed15th April 201311Daniel Yergin, The Prize: The Quest for Oil, Money & Power (Simon& Schurster, 2008)p126
  • 9. 9concession the IOC has exclusive rights to develop and owns the extracted oil, thepayment of royalty, bonuses and taxes the rates of which the government mayadjust at will negates the chance of any economic advantage to the IOC. Thereforefrom an IOCs point of view, whichever system is used, it should decide to makeinvestment only if at the negotiation it foresees a profitable outcome taking intoaccount its own particular economic standards and methods of calculation ofpayments which are specific to contracts and cannot be generalised as a matter ofform12.12Johnston, Daniel, International Petroleum Fiscal Systems And Production SharingContracts (Tulsa, Okla. : PennWell Books, 1994), pp. 39.