Business and Corporation Law : Production Sharing Contract

Running Head: BUSINESS AND CORPORATION LAW 0
Oil and Gas contract law
3/18/2020
Student’s Name

Oil and Gas Contract Law 1
Contents
Outline and introduction..................................................................................................................2
Production Sharing Agreement........................................................................................................2
Features of PSC...............................................................................................................................4
Conclusion.......................................................................................................................................6
Bibliography....................................................................................................................................8
Books/Journals 8
Other Resources 8

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Outline and introduction
A contract is an important aspect of each business that decides the rights and liabilities of parties.
Contracts are required to be there to ensure that each party is working in a determined manner
and in case of a breach can be held accountable for penalties and other liabilities. An entity
enters into different types of contracts considering size, nature, business activity, industry
standards and other elements. The focus of the report is likely to be centered around “production
sharing contract”, which is a specific type of agreement in resource extraction companies. The
objective of the report is to understand the significance of such contracts and the reason for that
they are preferable in developing countries, To provide an outline of the report this is to state that
the same would contain features as well as the reason for the effectiveness of production sharing
contract (PSC) in developing counties. In addition to this, some real examples are alsos presented
in this report.
Production Sharing Agreement
To understand preference of PSC, it is important to understand meaning of PSC. This is to state
that PSC is a common type of contract that used to develop between resource extraction
company and government of the country in which the extraction work is being carried out1. This
agreement outlines how many shares each party will be entitled to receive out of extraction
activity. This kind of agreement is being significant in international petroleum operations and
becoming the most common form of contract between developing countries and international oil
companies. It is well known that the developing countries are financially as well as
technologically incapacitated hence in such a situation they engage international oil companies.
1 (Uk.practicallaw.thomsonreuters.com, 2020) <https://uk.practicallaw.thomsonreuters.com/4-502-1566?
transitionType=Default&contextData=(sc.Default)&firstPage=true&bhcp=1> accessed 18 March 2020.

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These companies rely upon non-financial as well as financial resources existed in the state
territory. Under PSC, the oil companies become agree to bear all the risks and to pay all the cost
and the host country is entitled to participate in the venture in the capacity of working interest
owners. Both the parties remain on profit in this way as companies do not receive any payment
from the government but recover their cost in the form of future production. Content of PSC
includes details like type of recoverable cost, type and limit of such recovery, the order of
recoverability and so on.
The role of PSC is crucial at present and has evolved as the most common type of contract after
its adoption in Indonesia in 1966.. During the period 1980 to 2001, the level of the national
population increased to 215 million from 147 million, a growth of 46%. Not only did the
population of the country increase rapidly but the GDP also increased by a rapid rate. Not similar
to the other countries, Indonesia has discovered the gas and oil industry and as a result a number
of international oil companies shown interest to penetrate the oil industry of the country. The
contracts of operations were developed in the form of PSC and therefore the country believed to
be the pioneer of such contracts. It is widely accepted that the development of PSC in the oil
industry started in Indonesia and inspired other developing countries to focus on this area. One of
the lead motives governments of developing countries is to maximize wealth and to earn revenue
from natural resources. This can be done through the fiscal system and work commitments with
international oil companies. Where on one side international oil companies want to maximize
their wealth by producing oil at the lowest possible rate, the governments of developing
countries have the aim to earn through royalties, taxes, and production sharing. Table 1 shows
the bonuses earned by developing counties through:-
Table 1: PSC bonuses in selected countries

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(Figures in $1,000,000)
Sources2
From the above it is clear that the developing countries are derive significant earning from
international oil companies and this is the reason that PSCs are popular and most preferred
contract in the short term, for not only Indonesia but also other developing countries like Nigeria,
Malaysia, Equatorial Guinea, and others also benefiting from subjective PSC
Features of PSC
As the significance of PSC is clear, features of the same are also required to be discussed. The
PSCs in developing countries have some basic characters that are as follow:-
 Parties:- this is a basic feature of PSC in the oil industry where one party is the oil
company and the other party is country
 Carry provision:- According to this the state does not remain under an obligation to
indemnify the oil companies as they do not receive any return on production.
 Relinquishment clause:- By the virtue of this clause, the international oil companies
become entitled to release part of the "exploration area” in phases. This creates and
2 Sani Saidu, ‘A Comparative Analysis of Production Sharing Contracts of Selected Developing Countries: Nigeria,
Indonesia, Malaysia, and Equatorial Guinea’ (2014) Journal of Finance and Accounting 34

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develops the competition, hence enable efficient as well as speedy development of
exploration.
 National interest provisions:- This is also an important feature of PSC when such contract
develops in developing countries. These provisions protect the economic as well as social
wellbeing of the countries. Capacity building, technological transfer, and local content
policy are some of the elements of this provision.
 Profit oil:- This clause can be understood as the motive of the contract in its entirely. It
reflects the share of state on exploration once the oil companies have covered their
baseline costs. Based on the terms decided between the parties and mentioned in PSC,
and the oil companies and the nation state share the remaining proceeds.
 Cost oil:- The last feature of PSC in developing countries focuses on the cost factor. The
cost oil refers to the portion of produced oil which is applied by the operator in order to
recover cost defined under PSC on an annual basis3.
There are exclusive features of PSC that do not exist in general contracts.
Different developing countries have a number of PSC with different international oil companies
where basic features remain the same. The reason for the effectiveness of such a contract also
increased wherein 2017, Indonesia has taken a significant step and eradicate the "cost recovery
regime" for PSC. Based on dividend gross production a new economic structure between the oil
and gas industry was developed in 20174. Governments of developing countries are used to
develop PSCs on a daily basis. Such contracts contain different conditions and terms related to
3 '6 Features Of Production Sharing Contracts | Opus Kinetic' (Opus Kinetic, 2020)
<https://www.opuskinetic.com/2019/10/features-of-production-sharing-contracts/> accessed 18 March
2020.
4 'Indonesia’S New Gross Split PSC | ERCE' (ERCE, 2020) <https://www.erce.energy/news/indonesias-new-gross-
split-psc> accessed 18 March 2020.

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the percent of share, time limit, provisions related to the renewal of contract and others. For
instance, recently, the Indonesian government has signed 20 year PSC for corridor block. The
contract has been signed with units such as Repsol SA, ConocoPhillips, and PT Pertamina. As
per the terms of this contract, companies have rights over 48.5% oil and 53.5% gas produced
from the block5. Such terms clearly reflect that the country, as well as companies, are going to
benefit from such a contract. These contracts have features such as carry provision; cost oil, and
profit oil. Similarly, in Malaysia many PSC contracts have been developed with different
companies like Petronas Carigali, TOTAL E&P and Enquest Petroleum6. These contracts are
successfully running over the years and are effective. Terms of each contract may vary from
another but conclusively they have led to positive results are therefore are successful. For
instance in Malaysia, these contracts can provide a "more equitable partnership” for Petronas as
well as a contractor of the same.
Conclusion
PSC are an important area of discussion with the development of time and industrialization.
They are effective and preferred for every country; however the significance of the same
enhances whenever it comes to developing countries. The reasons have already been discussed as
such a contract fulfills the basic demand of the country and creates a way of additional earning
and wealth. In conjunction with this, the report outlined some features of PSC such as parties,
Relinquishment clause, Carry provision and some others. Some real examples of PSC have been
5 'Indonesia Signs 20-Year Production Sharing Contract For Corridor Block' (U.S., 2020)
<https://www.reuters.com/article/lng-indonesia-corridor/indonesia-signs-20-year-production-sharing-contract-for-
corridor-block-idUSL4N27R2LE> accessed 18 March 2020.
6 'List Of Upstream Operators In Malaysia (PSC Contractors) | Nrgedge' (NrgEdge, 2020)
<https://www.nrgedge.net/article/1533632238-list-of-upstream-operators-in-malaysia-psc-contractors> accessed 18
March 2020.

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placed and discussion over every one of them leads to the same conclusion that PSC is the most
preferred contractual arrangement between the international oil company and state.

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Bibliography
Books/Journals
Saidu Sani, 'A Comparative Analysis of Production Sharing Contracts of Selected Developing
Countries: Nigeria, Indonesia, Malaysia, and Equatorial Guinea' (2014) Journal of Finance and
Accounting 34
Other Resources
(Uk.practicallaw.thomsonreuters.com, 2020) <https://uk.practicallaw.thomsonreuters.com/4-
502-1566?transitionType=Default&contextData=(sc.Default)&firstPage=true&bhcp=1>
accessed 18 March 2020
'6 Features Of Production Sharing Contracts | Opus Kinetic' (Opus Kinetic, 2020)
<https://www.opuskinetic.com/2019/10/features-of-production-sharing-contracts/> accessed 18
March 2020
'Indonesia Signs 20-Year Production Sharing Contract For Corridor Block' (U.S., 2020)
<https://www.reuters.com/article/lng-indonesia-corridor/indonesia-signs-20-year-production-
sharing-contract-for-corridor-block-idUSL4N27R2LE> accessed 18 March 2020
'Indonesia’S New Gross Split PSC | ERCE' (ERCE, 2020)
<https://www.erce.energy/news/indonesias-new-gross-split-psc> accessed 18 March 2020
'List Of Upstream Operators In Malaysia (PSC Contractors) | Nrgedge' (NrgEdge, 2020)
<https://www.nrgedge.net/article/1533632238-list-of-upstream-operators-in-malaysia-psc-
contractors> accessed 18 March 2020