Understanding International Petroleum Contracts

Prof. Dr. H.Z. Harraz Presentation
PETROLEUM LAWS:
TYPES OF INTERNATIONAL PETROLEUM CONTRACTS
Hassan Z. Harraz
hharraz2006@yahoo.com

© Hassan Harraz 2016 2
NEGOTIATING A PETROLEUM CONTRACT

Outline of Lecture
INTRODUCTION
I) EQUITY AND PRODUCTION SHARING
1) Preconditions for investment
2) Minimum Conditions for Investment 3) Establishing Petroleum Rights
3.1) Constitution
3.2) Petroleum law
3.3) Petroleum Regulations
II) FISCAL SYSTEM
1) Types of Petroleum Rights and Contracts Agreement
1.1) Royalty Tax Systems (R/T)
1.2) Production Sharing Contracts (PSCs)
1.2.1) Key Modern Elements of PSA/PSC
1.2.2) Characteristics Features of Production Sharing Contracts (PSCs)
1.2.3) PSC Advantage & Disadvantage for Host Countries
1.2.4) Summary: The Production-Sharing Agreement (PSA)
1.3) Service Contracts or Service Agreements (SA)
1.3.1) Fixed Fee - $/BBL
1.3.2) Fixed Fee – % of Costs—Uplift
1.3.3) Variable Fee – Percentage of Gross Revenues
1.4) Comparing Systems
III) EVALUATING KEY ELEMENTS OF AN OIL CONTRACT
IV) FISCAL STABILITY

What choices of petroleum 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 established by the
contract itself (impractical);
(4) transnational law such as UNIDROIT
Principles, or
(5) a combination of these.
 They may elect not to make a choice however, agreeing to
perform their contract in good faith

How to achieve the government’s share?
 The government’s share can be achieved by different instruments:
➢ Government share of equity of oil companies
➢ Production sharing agreements
➢ Fiscal instruments

I) EQUITY AND PRODUCTION SHARING
 Large-scale direct foreign investment requires clear legal, regulatory and fiscal regime.
 For exploration, investors need clear path to development and production after
discovery.
 For development, investors require security for very large investments.
 Need to settle which level of government grants title, value of rights and likely
environmental liabilities.
1) Preconditions for investment
2) Minimum Conditions for Investment
➢Promising geology
➢Security of tenure
➢Competitive fiscal regime
➢Fiscal and regulatory stability
➢Foreign exchange retention
➢Freedom to export investor’s share of petroleum
➢Freedom of operation and commercial structure
➢Stability in environmental management
➢Access to International Arbitration
➢Physical security

3) Establishing Petroleum Rights
Responsibilities
Legislature
Legislature
Ministerial
NOC /Regulatory
Authority
Legal Framework
• Constitution
• Petroleum Law
• Fiscal Legislation
• Regulations
• Contracts

3.1) Constitution ‫الدستور‬
 Constitutions typically reserve rights to resources in the ground to the state:
❖ National/federal or sub-national.
❖ exceptions with some private ownership in the USA and Canada.
 Sometimes all oil and gas activity is reserved to a state company (Mexico):
❖ Kuwait also establishes the right of the state to revenues and prohibits exploitation of resources by
foreigners.
 Constitution usually requires that use of resources must be governed by law (Iran).
3.2) Petroleum law
 Confirms right of the state to control over resources in the ground
 Governs the grant of petroleum rights:
➢ to whom (restrictions?)
➢ for what (exploration, development, production, ancillary rights)
➢ and by what means (licenses, contracts)
 Establishes regulatory authority (may be the Minister)
 Governs petroleum operations and sets power to make regulations
 May establish a national oil company, and define its powers
 May include scope of contracts, or provision for royalty
 Commonly includes fiscal provisions, though these may be better placed in the Tax Code.
3.3) Petroleum Regulations
 Power to make regulations governing operations will be established in the Petroleum Law, specific regulations may
cover:
➢ Health, safety, and environment (HSE)
➢ Licensing procedures, bidding rounds, and awards
➢ Forms of contract
➢ Technical aspects of operations

II) FISCAL SYSTEM ‫الضريبى‬ ‫النظام‬
The two main families of fiscal system are:
1) “Concessionary” systems (more commonly known these days as Royalty/Tax (R/T)
systems) and
2) “Contractual Based” systems {which include both Production Sharing Contracts
(PSCs) and Service Agreements (SAs)}.
The distinguishing characteristic of each is where, when, and if ownership of the hydrocarbons
transfers to the international oil company. Numerous variations and twists are found under
both the royalty/tax (concessionary) systems and the contractual-based approaches.
However, from a mechanical and financial point of view there are practically no differences
between the various systems. The hierarchy of arithmetic such as
(1) generation of production and revenue followed by
(2) royalty or royalty equivalent elements, followed by
(3) cost recovery, tax deductions or reimbursement ….etc and
(4) profits-based mechanisms such as profit-oil sharing and/or taxes are generally found
in almost all systems.

Who has “title” to mineral resources?
Under Royalty/Tax Systems title to hydrocarbons can
be transferred at the wellhead.
Is “reimbursement” and “remuneration”
in “cash” (Service) or in “kind” (PSC)?
With PSCs, title to hydrocarbons transfers at the export point.
Royalty/Tax
Systems
Contractual Based
Systems
Service Agreements
Indonesian Type
Peruvian Type
PSC
Unused cost oil“ullage” treated
as a separate category of profit oil.
Is remuneration based upon a flat
fee (Pure) or profit (Risk)?
Egyptian Type
PSC
Risk ServicePure Service
Production Sharing Contracts
What is shared? “gross production” (Peruvian type PSC)or
“profit oil” (Indonesian type PSC)
Figure 1: Classification of Petroleum Fiscal systems (or Hydrocarbon Legal Arrangements)

Main Differences Concessionary & Production Sharing Contracts (PSCs)
Features Concessionary PSCs
Ownership of resources Held by sovereign state Held by sovereign state
Title transfer point At the well head At the export point
Company entitlement Gross production less royalty Cost oil & gas + profit oil & gas
Entitlement percentage Typically 90% Typically 50-60%
Ownership facilities Held by the company Held by the state
Management & control
Typically less government
control
More direct government control
and participation
Government participation Less likely More likely
Ring fencing Less likely More likely

1) TYPES OF PETROLEUM RIGHTS AND CONTRACTS AGREEMENT
1.1) Concession (Tax-and-Royalty)Contracts
1.2) Product Sharing Contract/Agreement (PSC/PSA)
1.3) Service Contract
1.4) Comparing system
 What are the kinds of host State-investor agreements available and their characteristics?
 What are the arguments “for and against them”?
 Stabilization Clauses……!
 Unitization Agreements:
➢National Oil Company (NOC),
➢Host Company (HC)
➢International Oil Company (IOC),
 Contractor…!

Table 1: Types of Petroleum Rights & Contracts
Type of contract Cost
and risk
Exclusive right to
operate
Right to
production
License / concession {or
Concession (Tax-and-
Royalty) Contracts}
Private
company
Private company Private company
Joint venture {or
Participation/ Association
(or Arrangements)}
Private
company
Shared Shared
Production sharing {or
Product Sharing Contract/
Agreement (PSC/PSA)}
Private
company
State Shared
Service contract Private
company
State State

Forms of Petroleum Rights or Contracts
FORM FISCAL SYSTEM
 License or concession, with or
without an agreement (North Sea).
Tax and royalty
 License or concession with joint
venture (Nigeria, Venezuela).
Tax and royalty, participation terms
 Production sharing agreements
(Indonesia, Syria, Egypt, Angola).
Production sharing, perhaps with tax and royalty
 Service contracts (including risk
service contracts and buy-backs).
Fees, perhaps with production sharing
 Combination or hybrid
arrangements
Various

1.1) Royalty Tax Systems (R/T)
 Prior to the late 1960s R/T Systems, or Concessionary Systems were,
for all practical purposes, the only arrangements available.
 R/T systems are characterized by a number of features:
➢ Oil companies are contracted for the right to explore for
hydrocarbons.
➢ If a discovery is deemed to be commercial, the IOC has the right to
develop and produce the hydrocarbons.
➢ When hydrocarbons are produced the IOC will take title to its
share—gross production less the royalty—at the wellhead.
➢ Entitlement – Gross production less Royalty:
✓If the royalty is 10% the IOC can ‘lift’ 90% of production.
✓If the royalty is paid in cash, then the IOC can ‘lift’ 100% of
production.
➢ Exploration and production equipment is owned by the IOC.
➢ The IOCs pay taxes on profits from the sale of the oil.

Conceding the barrel

Advantages and Disadvantages of Concessions (Tax-and-Royalty) Contracts
Advantages Disadvantages
 Familiar legal status.  Psychological disadvantages:
➢ Foreign entity has control of national
patrimony.
➢ Affront to sovereignty of independent
nation.
 Simple calculations.
 Royalty ensures early and predictable
cash-flow to Government.
 Investor feels secure in rights to
resource in the ground.
 Practical disadvantages:
➢ Fiscal:
❖ Royalty is inflexible rent-sharing
instrument.
❖ General Income/Profits Tax may be
too low.
➢ Operational:
❖ Foreign company has free reign.

1.2) Production Sharing Contracts (PSCs/PSA)
 Production sharing agreements (PSAs) are a common type of contract signed between a government and a resource extraction
company (or group of companies) concerning how much of the resource (usually oil) extracted from the country each will receive..
 “Production Sharing Contracts (PSC) is an agreement between Contractor and Government whereby Contractor bears all exploration risks,
production and development costs in return for its stipulated share of production resulting from this effort. These costs are recoverable in case of
commercial discovery.
 A contractual agreement between a contractor (Oil/Gas Company) and a host government(or its NOC) 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”.
 In PSAs the country's government awards the execution of exploration and production activities to an oil company. The oil company
bears the mineral and financial risk of the initiative and explores, develops and ultimately produces the field as required. When
successful, the company is permitted to use the money from produced oil to recover capital and operational expenditures, known as
"cost oil". The remaining money is known as "profit oil", and is split between the government and the company, typically at a rate of
about 80% for the government, 20% for the company. In some PSAs, changes in international oil prices or production rate can affect the
company's share of production.
 PSAs could be a transitional phase or a permanent feature of the petroleum regime (as for example in Syria and Egypt).
 PSA allows investor participation while retaining national ownership of shares of petroleum produced:-
➢ Production shares
➢ Participating interests by NOC
 PSA passes risk to the investor
 PSA is familiar to petroleum industry
What is a PSC/PSA?

WHAT IS Production Sharing Contracts (PSC)?
Source : DGH website
© Hassan Harraz 2016

Where are PSC’s used?
➢A PSC similar to present PSCs in practice was
first implemented in Indonesia in 1960s.
➢The concept of production sharing is
ancient and widespread.
➢Farmers in the USA have been familiar
with the concept for decades.
➢The concept of the PSC as far as the oil
and gas industry is concerned was
conceived in Venezuela in the mid 1960s.
➢The first modern PSC was signed in 1966
between IIAPCO and Permina, Indonesia’s
NOC at the time.
➢India, China, Kazakhstan, Libya, Nigeria,
Algeria, Angola,
➢Mauritania, Egypt, Trinidad & Tobago and
Russia.
1.2) Production Sharing Contracts (PSCs/PSA)

International Scenario
PSC
Concession
Service contracts
Mix

1.2.1) Characteristics Features of Production Sharing Contracts (PSCs)
 The characteristic features of this pioneering agreement included:
➢ Title to the hydrocarbons remained with the State (Indonesia) {i.e., Any resources are owned by the
host country}.
➢ Permina maintained management control (Indeed, putting management control in the hands of
Permina is what really distinguished the PSC from the Indonesian predecessors).
➢ The Oil/Gas company is named as CONTRACTOR by the host country or its National Oil Company
(NOC) & is given exclusive E&P rights
➢ Contractor submitted work programs and budgets for approval.
➢ Profit oil split between company (contractor) and host country: Profit Oil Split (P/O) 65% / 35% in
favor of Permina.
➢ Contractor operates at sole risk and expense under the control of the host country
➢ Contractor bore the risk.
➢ Usually the contractor is allowed to recover all costs from the production from the Contract Area
under the Cost Recovery provisions.
➢ After Cost Recovery, the balance of production is shared on a predetermined % age split between
host country & contractor.
➢ Cost Recovery Limit was 40%.
➢ Taxes paid in lieu (i.e. Taxes paid for and on behalf of the IOC by Permina)
➢ Purchased equipment became property of Permina. {i.e., 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)}.
➢ Company Entitlement = Cost Oil + Profit Oil
➢ Term of contract is fixed so Government determines extensions.

 Independent environmental impact studies
 Development Plan for regulatory approval
 Contractor incurs all exploration and development costs
 Cost recovered from agreed percentage of gross production
 Profit oil/gas shared on some basis taking account of cost and price changes.
 Contractor proceeds from PSA usually liable to income tax
 PSA provides for fiscal stability
 State can participate in the Contract through subsidiary company
1.2.2) Key Modern Elements of PSA/PSC

Cost Oil
Permits investor to recover capital and operating costs (but usually
not interest expense or financing charges).
Limit on Cost oil: 40 to 70 percent of production
Ensures early revenue.
Unrecovered costs carried forward and may be uplifted by an
interest factor.
Excess cost oil treated as profit oil.
Profit Oil
Level of daily production and price of crude oil
(Trinidad and Tobago).
R-factor: ratio of cumulative revenue to
cumulative costs (Azerbaijan).
Internal rate of return (Russia and Azerbaijan).
Million barrels % for government
<350 20
351 – 750 35
751 – 1,000 45
1 001 – 1,500 50
1,500 – 2,000 60
>2,000 to be negotiated
up to 25,000 bpd 61.5 % for government
25,000 – 50,000 bpd 71%
>50,000 bpd 80%
Split between government and investor
Split may depend on:
➢Level of daily production from each field (Sudan)
Cumulative production from the contract area (Nigeria
deep water off shore)

Production
Cost Oil Profit Oil Royalty
Investor,s
Portion
Government,s
Portion
Investor,s After
Tax Portion
Total Investor,s
Share
Total Government,s
Share
Profit Tax
Production Sharing
Illustration of Sharing under PSC

Illustration of Sharing under PSC
Sharing the Barrel

1.2.2) PSC Advantage & Disadvantage for Host Governments / Host Countries (HG)
Advantage Disadvantage
▪ All financial and operational risk rests with the
company.
▪ Government shares potential profit without making a
direct investment.
▪ PSA can be enacted into law to provide legal
security.
▪ Requires highly negotiation skills.
▪ Requires excellent data & information of the
oil & gas reserves in the particular field.
▪ Requires high degree of supervision on cost
of exploration, development and operation.
State Contractor Requires excellent regulatory management.
Title to hydrocarbons Stability
(fiscal regime is known)
Difficulty to enforce of social & environment
standard, beyond the contract terms.
Convenient Reserves can be `Booked’ Host country inexperience in some cases
Managed return Tried and tested all over
the world so is familiar.
Improperly supervised cost recovery may result
in “Gold-plating” or worse.
Flexibility in event of
volatile prices
Creates own law Even well-calibrated volumetric sliding scale
fails to account for high-cost fields.
Resource management Often “Impure”: mixed with royalty, tax, lease,
local market obligations, and/or carry of
government company.
Self contained

ALTERNATIVES TO PSC
Conces
sions
• Exclusive right to contractor
• Royalty and Tax structure and widely used
• Maximum control lies with contractor
Joint
Ventures
• JV between National Oil Company & Contractor
• Partners share proportionately
• JV pays Royalty & applicable taxes
Service
Contracts
• Risk and Ownership lies with government
• Government pays all costs
• Contractor gets only service fees
Hybrids
• Combinations of Concession /JV / PSC, royalty, tax,
share of cost oil or profit oil and fees etc.

ALTERNATIVES TO PSC COMPARATIVE ANALYSIS
Type of
Agreements
Contractor Government No. of Countries
following
Concessions All risk
All reward
Reward is a function of
production & price
59
Joint ventures
Share in risk &
reward
Share in risk & reward 31
Service
contracts
No risk All risks
All rewards
2
Hybrid Mixed Mixed 16
PSC
Exploration risk
Share in reward
Share in reward 40
Source: Macleod Dixon Workshop, 2007

MAIN ELEMENTS IN A PSC
Main clauses in PSC are clauses relating to following:
1) Management Committee
2) Minimum Work Program (MWP)
3) Relinquishment
4) Cost Recovery & Profit Sharing

Functions of Management committee
➢ Approval of the annual Work Programme and Budget
➢ Approval of Commercial Discovery
➢ proposals for surrender or relinquishment
➢ Determination of a Development Area
➢ Appointment of auditors
➢ Claims or settlement of claims for cost recovery
➢ Proposal about abandonment plan/Site Restoration
Management
Committee
2 Govt.
nominees
One representative from each
company, if only one company,
then 2 representatives

Amount in USD
Onland Shallow water Deep water
Per well 10,00,000 30,00,000 60,00,000
Per sq.km. of 3D 5,000 1,500 1,500
Per line km. of 2D 2,500 1,000 1,000
2) Minimum Work Program (MWP)
➢Minimum Work Programme means with respect to Initial
Exploration Period, the Work Programme specified in the Model
Production Sharing Contract (MPSC).
➢Period for completion of MWP can be extended up to 6 months.
➢If the contractor fails to fulfil MWP, then liable to pay Liquidated
Damages as specified below:
Source: Model production sharing contract

3) Relinquishment

Production value
Cost Petroleum*
Profit Petroleum
Contractor’s
share
Government’s share
( Based on pre Tax
investment multiple)
iv) Development
iii) Exploration
ii) Production
i) Royalty
Income tax
Government’s
take
Contractor’s take
*Recovery sequence – Royalty, then production, then
exploration & finally development costs

IMPORTANCE OF PSC
• Under revenue sharing all costs are borne by contractor and
Government gets fixed portion of revenue from the beginning.
• The benefits of revenue sharing is:
▪ Government gets fixed share from the beginning.
▪ Increases cost consciousness in the industry.
▪ Speedy implementation of projects as there is no budgetary
approval requirement from ministry.

1.2.4) Summary: The Production-Sharing Contracts (PSCs)
 Terms of PSAs can be replicated in tax and royalty regimes, but PSAs allow
variation of economic terms for an area without amendment of fiscal legislation
 State can retain and dispose of its share of petroleum or make marketing
arrangements with Contractor
 State not obliged to find budget funds for costs unless it elects to take working
interest participation
 PSAs can be “ring-fenced” or not, depending upon the state’s preference for early
revenue or maximum pace of development
 A “Model” PSA provides a standard framework for competitive bidding over areas
to be awarded
 “Pay on behalf” arrangements for Contractor’s income tax provide built-in fiscal
stability
 Combination of PSA with tax permits investors to obtain tax credits at home;
minimizes cost to host country revenues.

1.3) Service Contracts or Service Agreements (SA)
 Service contracts or service agreements generally use a simple formula:
the contractor is paid a cash fee for performing the service of producing
mineral resources.
 All production belongs to the state.
 The contractor is usually responsible for providing all capital associated
with exploration and development (just like with R/T systems and
PSCs). In return, if exploration efforts are successful, the contractor
recovers costs through the sale of oil or gas plus a fee. The fee is often
taxable.
 These agreements can be quite similar to PSCs or R/T systems except
for the issue of entitlement.
 As mentioned earlier, other than the issue of entitlement, the Venezuelan
terms from the 1996 round look and sound just like a R/T system—it has
a royalty and taxes. But the Philippine SA uses the terminology and
structure of a PSC with a cost recovery limit and profit oil split.
 Following are examples of various Service Agreement fee structures.

Note that:
➢ Iraq (replaced by PSC).
➢ Iran (“Buy-back”, still popular for political reasons).
➢ Nigeria (being phased out).
➢ Americas:
✓ “Risk Service”: Brazil, Venezuela, Ecuador.
✓ “Pure” Service: Mexico

Service Contracts or Service Agreements (SA)

1.3.1) Fixed Fee - $/BBL
A $/BBL fee-based formula is used in the Joint Ventures in Nigeria, a few contracts in
Abu Dhabi, and as part of Kuwait’s proposed Operating Service Agreement (OSA).
A simplified example is as follows:
➢ First, the IOC conducts operations in much the same way it would in virtually any fiscal
system. For performing these services (in this example) the IOC is able to recover its
costs (assumed to average $4.00/BBL) out of revenues and is also paid a $2.00/BBL fee
for conducting operations. The example below shows how this simple arrangement
looks at $20.00/BBL and $60.00/BBL oil prices.
Notice: with this structure the
system is “progressive”, as oil
prices go up (or as profitability
goes up) Government Take also
goes up.
Scenario 1
($20 / BBL)
Scenario 2
($60 / BBL)
A Gross Revenues ($/BBL) $20.00 $60.00
B Fee $2.00/BBL - 2.00 - 2.00
C Net Revenue 18.00 58.00
D Assumed Costs - 4.00 - 4.00
E Government Profit (Cash Flow) 14.00 54.00
Company Cash Flow [B] 2.00 2.00
Government Take [E/(A-D)] 87.5% 96.4%
Company Take [B/(A-D)] 12.5% 3.6%

1.3.2) Fixed Fee – % of Costs—Uplift
Another type of fee-based approach like that found in Iran under the “Buy-backs” and
proposed in Iraq under what is called a “Squeeze PSC” provides the IOC a means of
recovering costs plus a fixed fee that is a function of the anticipated costs.
The example here assumes the IOC will be reimbursed for costs of $4.00/BBL plus an uplift of
say 50% (of those costs).
➢ This is a simple example but it serves our purposes.
➢ The IOC would conduct operations in much the same way as with other petroleum
operations.
➢ The example here shows how this arrangement would look with oil prices of $20.00/BBL
and $60.00/BBL. A difference is that for a given % higher costs translate into a higher
percentage for the oil company.
Notice this system is also “progressive”, as oil prices go up (or as profitability goes
up) Government Take goes up. Iran (“Buy-back”, still popular for political reasons).
Scenario 1
($20 / BBL)
Scenario 2
($60 / BBL)
B IOC cost recovery (Reimbursement) - 4.00 - 4.00
C IOC Fee 50% of costs (Remuneration) - 2.00 - 2.00
D Government Profit (Cash Flow) 14.00 54.00
C Company Cash Flow 2.00 2.00
Government Take [D/(A-B)] 87.5% 96.4%
Company Take [C/(A-B)] 12.5% 3.6%

1.3.3) Variable Fee – Percentage of Gross Revenues
Another type of fee-based approach (very rare) provides the IOC with a direct share of revenues
from which, hopefully, it would be able to recover its costs and make a profit.
This type of arrangement in its classic form would be referred to as the “Peruvian model.”
Another variation is the Filipino Participation Incentive Allowance (FPIA) which allows the
contractor group a 7.5% “incentive” if there is sufficient “Filipino Participation.” This 7.5%
allowance is based on gross revenues.
A simple example here assumes the IOC will receive 25% of gross revenues. The IOC conducts
operations in much the same way it would under almost all petroleum systems.
The example below shows how this simple arrangement looks at $20.00/BBL and $60.00/BBL oil
prices.
Notice with this structure the system is “regressive”. As oil price or profitability goes up, Government
Take goes down.
This is because while the IOC is guaranteed 25% of gross revenues (almost like a negative
royalty) the Government is guaranteed 75%, like a large royalty.
Royalties are notorious for being regressive, especially large royalties.
Scenario 1
($20 / BBL)
Scenario 2
($60 / BBL)
B IOC Fee 25% of Gross Revenues - 5.00 - 15.00
C Government Profit (Cash Flow) 15.00 45.00
D Assumed Costs - 4.00 - 4.00
F Company Cash Flow (B-D) 1.00 11.00
Government Take [C/(A-D)] 93.75% 80.4%
Company Take [F/(A-D)] 6.25% 19.6%

1.4) Comparing Systems
 There are numerous sources or references that make little
distinction between PSCs and SAs other than differences regarding
the transfer of title to hydrocarbons (discussed earlier).
 This difference in ownership structure—where, when, and if
ownership of the hydrocarbons is transferred to the IOC—is one of
the distinguishing characteristics of petroleum fiscal systems.
 With an R/T system title transfers to the IOC at the wellhead; the
IOC takes title to gross production less royalty oil.
 For a PSC title transfers at the export point or fiscalization point.
The IOC takes title to cost oil and profit oil.
 With Service Agreements, there is no transfer of title to
hydrocarbons. This directly impacts an IOC’s ability to book barrels.

Table 2: Summarizes the differences between Fiscal Systems.
R/T Systems PSCs SAs
Global Frequency
(% of Systems )
44% 48% 8%
Type of Projects
All types: Exploration,
Development, EOR
All types: Exploration,
Development, EOR
All types but often non-
exploration
Ownership of Facilities International Oil Company Government NOC Government NOC
Facilities Title Transfer No transfer
“When landed” or upon
commissioning
“When landed” or upon
commissioning
IOC Ownership of
Hydrocarbons (Lifting
entitlement)
Gross production less
royalty oil
Cost oil + profit oil None
Hydrocarbon Title
Transfer
At the wellhead
Delivery Point,
Fiscalization Point or
Export Point
None
Financial Obligation Contractor 100% Contractor 100% Contractor 100%
Government
Participation
Yes but not common Yes, common Yes, very common
Cost Recovery Limit No Usually Sometimes
Government Control Low Typically High High
IOC Lifting Entitlement Typically around 90% Usually from 50-60% None (by definition)
IOC Control High Low to Moderate Low

Table 3: summarize the fiscal terms associated with these different systems
Global Sample
Sample of top 20th
Percentile (Based
on Prospectivity)
PSC R/T PSC R/T
Number of Systems 72 64 19 6
Government Take 70% 59% 78% 80%
Government. Participation
36
countries
29
countries
12
countries
5
countries
Royalty Rate 5% 8% 5% 11%
Effective Royalty Rate 23% 8% 29% 11%
Ringfenced Systems 75% 30% 90% 33%
Lifting Entitlement 63% 92% 55% 89%
Savings Index 39% 56% 30% 37%
Cost Recovery Limit 65% N/A 62% N/A
Systems with ROR or “R” factors 17% 25% 26% 16%
Source: International Petroleum Fiscal Systems Data Base, © Daniel Johnston, PennWell 2001

III) EVALUATING KEY ELEMENTS OF AN OIL CONTRACT
 With the exception of the United States, Canada, and a very
few old Spanish land grants in Colombia, mineral rights
belong to the State. And, in most countries the nation’s
mineral wealth is considered a ‘Gift from God.’ The result is
that managing a country’s mineral wealth is considered a
‘sacred trust’ even though, in many situations, the Nation’s
mineral wealth benefits only a few people.
 Countries with limited proven mineral wealth are seeking
exploration activity and have limited leeway attracting it.
Still, they want the best ‘terms’ they can get. All countries
have their own unique boundary conditions, concerns, and
objectives. And, needs, traditions, perspectives,
perceptions, and politics differ as well. But in general the
major concerns facing a country are:

1) Getting a large (and fair) share of the profits (Take) while keeping costs down
2)Guaranteeing a certain share each accounting period (Effective Royalty Rate and/or Minimum
Government Take)
3)Obtaining, but not exceeding the Maximum Efficient Production Rate (MEPR)
4)Maintaining a high degree of Control over the country’s resources
5)Attracting investment and the right kind of company even if the financial conditions appear not
as good. (Trinidad awarded a block to BHP even though Talisman submitted a higher bid. The
government was familiar and comfortable with BHP)
Oil companies meanwhile want to explore in regions where there is a reasonable chance of finding oil
and gas. They want to deal with stable governments, and prefer contract ‘terms’ that will provide a
potential return-on-investment that is commensurate with the associated risks. They are also
interested in (or rather obsessive about) “booking barrels.” Indeed in the eyes of Wall Street, oil
companies are measured by their ability to replace production and by finding costs. If they can book
more barrels their ‘reserve-replacement-ratio’ benefits and their finding costs go down. And they are
measured on finding and lifting costs and reserve replacement. This can be confusing and frustrating
since the ability to book barrels and the amount of barrels a company can book strongly depends on
the type of system and various other illogical elements. We look at some determinants of a
company’s ability to book barrels towards the end of this section
The contract is the best indicator of how well these different goals have been met. There is however
no single clause or number that you can look at in a contract to work out if the country or the
company (or neither or both) got a good deal. Rather evaluating the contract requires examining a
series of conditions, the most important of which are summarized in Table 4. Despite the multiplicity
of goals on the part of governments and contractors, and the range of issues to be negotiated, a
number of attempts have been made to create single measures to summarize the value of a contract.
II) EVALUATING KEY ELEMENTS OF AN OIL CONTRACT…(cont.)

Condition Description
Area
Block sizes range from extremely small for development/EOR projects to very large blocks for exploration.
Typical exploration block sizes are on the order of 250,000 acres (1,000 km2) to over a million acres (>4,000 km2).
Duration
Exploration - Typically 3 Phases totaling 6 to 8 years.
Production - 20 to 30 years, (typically at least 25 years)
Relinquishment
Exploration 25% after 1st Phase, 25% of “original” area after 2nd Phase This is most common but there is wide
variation.
Exploration
Obligations
Includes seismic data acquisition and drilling. Sometimes contract requirements can be very aggressive in terms of $
and timing – depends on the situation. All blocks are different
Royalty
World average is around 7%. Most systems either have a Royalty or an Effective Royalty (ERR) due to the effect of a
cost recovery limit.
Profit Oil Split
Unique to PSCs and some Service Agreements. Most profit oil splits (approximately 55-60%) are based upon a
production-based sliding scale. Others (around 20-25%) are based upon an “R” factor or ROR system.
Cost Recovery Limit
Unique to PSCs and some Service Agreements. Average 65% Typically PSCs have a limit and most are based on
gross revenues. Some (perhaps around 20%) are based on net production or net revenues (net of royalty). Over 20%
have no limit (i.e. 100%). Approximately half of the worlds PSCs have no depreciation for cost recovery purposes (but
almost all do for tax calculation purposes).
Taxation
World average Corporate Income Tax (CIT) is probably between 30-35%. However, many PSCs have taxes paid “in
lieu” – “for and on behalf of the Contractor” out of National Oil Company share of profit oil.
Depreciation
World average is 5 year Straight Line Decline (SLD) for capital costs. Usually depreciation begins “when placed in
service” or “when production begins” whichever occurs later.
Ringfencing
Most countries (55%) erect a “Ringfence” or a modified ringfence (13%) around the contract area and do not allow
costs from one block to be recovered from another nor do they allow costs to “cross the fence” for tax calculation
purposes.
Government
Participation
Typically, the national oil company (or equivalent) is “Carried” through exploration. Approximately half of the countries
with the option to participate do not reimburse “past costs”.
Crypto taxes are those costs and obligations the contractor must take on that are not readily captured in the Take
What’s in an oil contract?

IV) FISCAL STABILITY
Fiscal stability clauses are wide-spread in petroleum contracts to solve problems deriving from:
 the large size and the sunken nature of the initial investment;
 long payback and profitability period;
 a lack of credibility that the host country will not change the fiscal rules (“Sovereign risk”).
Approach to Fiscal Stability
Frozen law: fiscal stability guaranteed by reference to laws in force on the effective date of the
agreement;
 May bestow unintended benefits to contractor;
 Agree to negotiate to maintain economic
 equilibrium if there are any adverse changes;
 Should fiscal stability be a one-way street?
❖ Appropriate offsetting change will depend on assumptions regarding future
revenue and costs.

Why is Stability an Issue?
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.
For the Host Government (HG)
▪ 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
North Sea has been unilaterally changed many times.
▪ Fashion/waves.

Unilateral Host Government (HG) Action
Direct Action Indirect 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
International Oil Company (IOC);
 Increase in or imposition of
restrictions on IOC’s right to
monetise a discovery/right to
export/obligation to market
petroleum within the host country.
 Changes to overall tax
environment;
 Approval for field development
plan;
 Powers to issue other permits;
 State’s right to veto proposed
annual budgets;
 Powers over local content;
 Investor’s liability over project
delay;
 Use of environmental compliance
powers (used in Russia 2006-
2007; these are not usually
stabilized).

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 vs Iran)
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”.
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.
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 CONTRACTOR’s 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 there
of which existed on the Effective Date.”

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Understanding International Petroleum Contracts

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