1. PRODUCTION SHARING AGREEMENT
BY
Grain Malunga
Mineral Resources and Environmental Management Expert
Abstract
Production Sharing Agreement (PSA) is a contract entered into between government and a private company
wishing to explore, develop and produce petroleum. This agreement contains clauses that stipulate agreed
upon methods for allocation of petroleum produced and payment of royalty and taxes due to government.
This paper tries to highlight the nature of PSA and how it can promote it can promote sustainable
development.
Introduction
Production Sharing Agreement (PSA) is a contract that a state gives to a mining company or petroleum
company to explore and develop a concession. This is on the understanding that natural resources
are vested in the state on behalf of its citizens. The state can be represented by a State Owned
Enterprise (SOE).
The state leaves all the expenditure for exploration and development in the company or may fully
fund exploration and development of the resource and contract the company to develop and operate
in exchange for part of the production. The PSA provides for the establishment of a joint committee
where both parties are represented and which monitors the operations.
Drafting Principles
The principles for entering into this agreement are guided by the taxation and fiscal regime of the
country; and the Petroleum Exploration and Production Act. PSAs are distinguished from other types
of contracts in that the private company carries the entire exploration risk without compensation and
that the state owns both the resource and the installations.
Production Sharing
The private company pays a royalty on gross production to the government. After the royalty is
deducted, the company takes its pre-specified share of production for cost recovery. The remainder
of the production (profit oil) is shared between government and the private company at an agreed
share arrangement. The private company continues to pay income tax on its share of profit oil. This
taxation framework incorporates incentive structures, risk and reward-sharing. The whole
arrangement points to reimbursement of development capital and a fair share of the business profit
to the private company.
The above explanation can be structured as below;

2. Production Sharing Agreement [Grain Malunga, May 2016]
Figure 1: Production Sharing Structure
The other state revenue will be in form of signature bonus, discovery bonus, production bonus, import
and export tax and wind fall tax. It is worth noting that income tax is deducted on profit income. This
tax becomes effective when the private company starts production and not during exploration and
development.
Figure 2: Total Government share of revenue from a project (Source: Mohammed A. Adam)
Private
Company
Gross
Production
Cost Recovery Profit Oil
Private
Company Share
Profit Income Tax
State Share
Royalty
State

3. Production Sharing Agreement [Grain Malunga, May 2016]
Figure 2 shows the share governments have in implementing PSAs. In Africa mature or established
economies can have between 60% and 80% share of the proceeds from an oil and gas project while new
entries may get between 50 and 55%.
Sustainability
PSAs are designed to maximize government revenue while at the same time to provide sufficient incentives
to investors. The investor’s revenue is made up of cost oil and profit oil, while the government’s revenue
comprises royalties, profit oil, bonuses, taxes, customs duties, and indirect benefits that arise from local
content goods and services. The contract also determines who manages the operations and how issues of
environment, local economic development and community rights are dealt with.
The project’s sustainability is measured through high return on investment for the investor, government
measures it through revenue generated, economic growth, infrastructure development and technology
transfer while the community or citizens look at social investment (e.g. schools), environmental protection
and economic benefits (e.g. employment).
Mineral resources can contribute to sustainable development if through recognition of the fact that they
are exhaustible, revenues or their prices are volatile and the resource industry is vulnerable to corruption
and mismanagement. In this case there is need to establish future generation fund and/or stabilisation
fund address issues of national investment and governance of budget plan.
Conclusion
Production Sharing Agreements are a modern means of entering into agreement between state and
investment companies in exploring, development and exploitation of oil and gas for the benefit of the two
parties while understanding that the resources belong to the people. It is for this reason that all contracts
should transparent and accessible to the people.
The sharing agreement takes into account cost recovery and profit sharing while being mindful of
environmental sustainability and local benefits for the local communities.
References
Anderson, R.O. (1984). Fundamentals of the Petroleum Industry. Norman:
University of Oklahoma Press.
Beredjick, N/ Walde, T.W. (1988). Petroleum Investment Policies in Developing
Countries. London: Graham & Trotman.
Dam, K.W. (1976). Oil Resources: Who Gets What How? Chicago: University of
Chicago Press.
Open Oil. (2013). Oil Contracts – How to read and understand them.