how to read and understand an extractive industries contract 11 june 2014 amir shafaie
TRANSCRIPT
How to read and understand an extractive industries contract
11 June 2014Amir Shafaie
Presentation Outline
1. Legal Hierarchy and Extractive Contracts2. Content and Typology of Agreements3. Key questions to ask when reading an agreement
A. Who are the parties? B. What is the scope?C. Financial obligationsD. Work / operational obligationsE. Social / environmental obligationsF. “Legal” provisions – stabilization and dispute resolutioes?
1. Legal Hierarchy: Extractive Contracts
Reality can be messier
Legislation
RegulationsContracts
International Law
ConstitutionPolicy Decrees
Licenses
Example: State Participation in Timor Leste
Constitution
Legislation
Regulations
Contract
Basic principle
General parameters on
timing, process, maximum %
???
Details on election, timing,
terms
Licenses vs. AgreementsLicense Agreement
Definition: time-bound right to explore and/or exploit to a company.
Definition: document setting rights and obligations of government and company
Form: often standard Form: generally negotiated, and more detailed
Where: Norway, United Kingdom, United States, Peru…
Where: widely used
Related term: Permit Related term: Contract
Licenses and Agreements
Why agreements used?• Insufficient detail in legal regime.
• Need for flexibility to accommodate specificities of a sector / project.
But, important principles when using agreements, in order to facilitate negotiation and monitoring / enforcement:
• Still important to establish as many terms as possible in the law and regulations, rather than creating a new legal regime in each agreement; and
• Do not include in provisions contrary to law.
Which contracts / licenses are we talking about?
Source: King & Spalding
State Direct NOC sales (e.g. Long Term Sales Agreements)
2. Content and Typology of Agreements
• Duration and extensions• Work programme obligations• Contract area and relinquishments• Contractor rights, obligations and liabilities• Discovery and appraisal• Development and production• Cost recovery, Fiscal terms/production sharing• Measurement and valuation of petroleum• Natural gas• Management of Operations• Approval of work programmes• Confidentiality
• Change of ownership• Environmental protection and
safety• Training• Local content• Bonus payments• Abandonment of wells and
installations• Accounting procedures• Company Guarantees• Termination• Governing law and arbitration• Stabilisation
Types of Agreements
e.g. UK, US, Norway, Libya, Tunisia
e.g. Indonesia, AngolaLibya, Tunisia e.g. Iraq, Iran
OIL &MINERALS OIL ONLY
Types of Agreements
Agreement Type Key Features Examples
Concession (Royalty/Tax) Company owns 100% of the produced resource
UK, US, Colombia, Brazil
Production Sharing Produced resource is split among government and company, company gets entitlement to recover costs plus some share of profit
Indonesia, Azerbaijan, Angola
Risk Service Contract Government retains ownership, companies are paid a fee
Iran, Iraq, Mexico, Bolivia
Global Distribution of Agreements - Petroleum
Courtesy Graham Kellas
Fiscal Regimes are Complex
Courtesy Graham Kellas
Revenue from Sales
Royalty: % of Gross Gross Revenue to Company
Production Costs
Profits
Profit Tax After-Tax ProfitKey
Green = State Share
Pink = Contractor Take-Home
A
B
C
D
Concessions: Financial Flows
Concessions: Key Issues
Subject Concession Features
Direction of Payments Contractor pays government
Distinguishing Government Revenue Streams
Royalties and Income Taxes
Other Possible Revenue Streams Bonus, Dividends from State Equity, Dividend Withholding Tax, Windfall Profits Tax, Fees
Key Issues in System Design • Setting appropriate royalty• Tax rates and rules on deductions• Providing some measure of
progressivity
Advantages Simplicity, appeal to investors
Disadvantages No built-in progressivity, alignment of incentives
Production Sharing Contracts (PSCs)
Total Oil Extracted
Cost Oil Profit Oil
Sales by Private Companies
Sales by National Oil Company (NOC)
Profit Tax NOC keeps % of sales
Remainder to State Treasury
Royalty
Total Oil Produced
Royalty: 10% to 20%
After-Royalty Net : 80% to 90%
Cost Oil Profit Oil
Sales by Sonangol*
Sales by Contractor Group
Profit Tax 50%
After-Tax Profit
Key
Green = State/Sonangol Share
Pink = Contractor Take-Home
* Profit Oil Split between Sonangol and Contractor varies by contract. Sonangol retains 10% of its revenues, reverts rest to Treasury.
A
B
C
D
E
PSA Financial Flows: Angola
PSAs: Key IssuesSubject PSA Features
Direction of Payments Contractor pays government taxes and (sometimes) royalties;Government gets share of petroleum; can market for revenue
Distinguishing Government Revenue Streams
Production share
Other Possible Revenue Streams Royalties, Income Tax, Bonus, Dividends from State Equity, Dividend Withholding Tax, Windfall Profits Tax, Fees
Key Issues in System Design • Cost Recovery Rules• System for Production Split• Oversight of National Oil Company
Advantages Direct government role in oil sales, alignment of incentives, easy to build in progressivity
Disadvantages Increased potential for conflict of interest
Crude Gas Sales by YPFB
IDH – 32% of Gross Royalty – 18% of Gross
After-Royalty Net – 50%
Recoverable Costs
Distributable Profits after Costs
YPFB Share*
Contractor Share
Profit Tax 25%
After-Tax Profit
Key
Green = State/YPFB Share
Pink = Contractor Take-Home
* YPFB Share in Profits ranges from 1 – 72%, based on a formula incorporating profitability, production levels, and price
A
B
C
D
E
Service Contract Financial Flows: Bolivia
Service Contracts: Key IssuesSubject PSA Features
Direction of Payments Government sells all petroleum, pays fee to contractor
Distinguishing Government Revenue Streams
Sale of production
Other Possible Revenue Streams Royalties, Income Tax, Bonus, Dividends from State Equity, Dividend Withholding Tax, Windfall Profits Tax, Fees
Key Issues in System Design • Determination of Fee• Cost recovery rules• Oversight of National Oil Company
Advantages High levels of government control over operations and petroleum
Disadvantages Incentives for contractors may be inadequate (particularly upside); Increased potential for conflict of interest
Other types of agreements to be aware of
• Joint Venture Agreements• Financing Agreements• Sale / Offtake Agreements• Construction / Commercial Agreements• Infrastructure linked agreements• Joint Operating Agreements (JOA’s)• Unitisation Agreements
3. Key Questions to Ask
In your role within your country, what are the most important things you want to understand
when you are negotiating or reading an agreement?
A. Who are the parties?
A. Who are the parties?
How to identify the Parties…and why it matters
How?1.The declarations / parties section at the beginning of the contract2.The description of the shareholding of the company (sometimes in the contract or the shareholder register)
But, this has limitations…Why?•Capacity - financial, technical, environmental, etc.•Anti-corruption •Source for more information on the project (website, EITI, stock market disclosures, etc.)
Who are the Parties? An Example
Who are the parties in the Ghanaian example? Do you see any possible points for concern / further investigation?
Where could you find more information on these companies?
B. What is the scope?
Use the table of contents to get a lay of the land…..
C. What financial obligations does the agreement include?
3. Who has the
responsibility for
monitoring/ enforcing?
1. What is the
Obligation?
2. Is the rule in the
country’s interest?
4. Where can I find data on
enforcement?
C. What financial obligations does the agreement include?
1. What is the
Obligation?
• How do the fiscal terms in the contract interact with the law?
• What has to be paid?• When?• To whom?
Example – Gold royalties in Afghanistan and Liberia
What do these clauses establish?• Who?• What?• When?
How do these two royalty systems differ from one another? Can we say which is better?
Example – Cost Oil in Azerbaijan
What does this clause establish?
How might this provision be significant in analyzing the overall balance of the fiscal benefits between the contractor and the state?
Example – Model Production Sharing Agreement in
Trinidad & Tobago
Say that oil is at $120 per barrel and this field is producing 60,000 barrels per day. How would we determine the profit oil split between the government and the contractor (i.e. which box would you be in)?
Does this example tell us anything about the importance of adaptability in designing contract regimes?
D. What work obligations does the agreement include?
3. Who has the
responsibility for
monitoring/ enforcing?
1. What is the
Obligation?
2. Is the rule in the
country’s interest?
4. Where can I find data on
enforcement?
Obligations within the exploration phase
Government objectives:•Ensure the development of a serious work plan during exploration•Avoid speculation and non-investment that freezes attractive areas
Speculation – Hyperdynamics in Guinea
Investment decisions – Shell Exploration projects
Source: Shell Five-Year Fact Book, 2005 – 2009: http://www-static.shell.com/static/investor/downloads/financial_information/reports/faoi/faoi_2009.pdf
Minimum investment requirements
Relinquishment – East Timor Model Production Sharing Contract
Relinquishment of :•25% at end of 3rd contract year•25% at end of 5th contract year •Voluntary relinquishment•Limitations on relinquished areas and non-relinquished areas
Original Area
End of year 3End of year 5
Example – Work Obligations in Ghana
What are the work obligations facing the contractor in this project during the Initial Exploration Period?
E. What social / environment obligations does the agreement include?
Examples – Environmental obligations of Rumaila Technical Services Agreement
• Article 9.17 - All appropriate and necessary measures to safeguard the environment and prevent or minimise the effect of pollution
• Article 24.6 – Maintain insurance agains environmental damage and injury
• Article 41 – Protection of the environment• Best International Petroleum Industry Practices and comply
with Law• Environmental Impact Studies (baseline and impact, with
guidelines) submitted as part of Redevelopment Plan
• Article 42 – Site restoration and decommissioning
F. How does the agreement interact with future changes in law? What happens in case of dispute between the parties?
Stabilization
Dispute Resolution/ Arbitration
State as sovereign vs. state as party to contract
Stabilization Clauses
What are these clauses?
What is their purpose?
Are there different variations?What are the differences between the
stabilization clauses in from Azerbaijan andMongolia in the handout?
International Arbitration
What are these clauses?
What is their purpose?
Example – Arbitration in Afghanistan
Who will arbitrate any unresolved dispute?
Under what rules?
Where?
Resources – Tools for assistance
http://openoil.net/contracts-booksprint/
http://www.resourcecontracts.org/blog/guides-to-contract-terminology.html
http://www.revenuewatch.org/sites/default/files/RWI_Enforcing_Rules_FR12.pdf
