Difference between Concession and Production Sharing Agreements

Why have Production Sharing Agreements replaced Concession Agreements for Exploration & Production Activity?

Introduction

Oil exploration and production remain a significant economic activity all over the world especially for the countries possessing the natural resource assets. Adoption of legal systems that govern the exploration and production of oil extracts had remained a subject of discussion over the years.  Nicot & Scalon, (2012) argues that he primary objectives for coming up with the governance rules were to increase the host governments control and participation in the future block as well as increasing governments’ take over the profits realized by the international oil companies. The then existing concession systems were viewed inappropriately of making full use of natural resources in the reserves obtained by IOSs. On the other side, production sharing agreements could enable host governments maximize their participation in production and at the same time maintaining interests of the international oil companies  With the discovery that the then existing concession agreement regime was not appropriate to benefit the host government, the conditions for exploring and producing oil extracts changed, an aspect triggering states to introduce the production sharing contracts. The thesis of this essay is to provide reasons and justifications behind host countries moving away from concession agreements and replacing the regime with production sharing agreements for oil exploration and production activities.  The paper also addresses the reasons behind IOSs acceptance to such a dramatic change in their share and profits from exploration and production activity in the resource richer nations.

Difference between Concession and Production Sharing Agreements

The division of the oil and gas between the home government and the international oil companies brings the primary difference between production sharing contracts and concession agreements as argued by Notteboom & Rodrigue, (2012). In the field of oil exploration and production, the main difference concerning the two regimes lies in the fiscal environment as explained below.

Concession Agreements

This is an arrangement that gives all production rights to the concessionaire while imposing commensurately higher tax and royalty rates. Under this regime, the federal government grants the IOCs exclusive exploration rights, development, and production roles for every commercial oil extract within the country , Talus, et al., (2012). Under the oil and gas production rights, concession systems allow the host country grant the contracting company the exclusive right to produce identify and manufacture hydrocarbons in a given location for a particular period in exchange for payment regarding taxations and royalties.

Reasons and Jurisdiction behind Host Governments Replacing Concession Agreements with PSAs

The Production Sharing Contracts

PSA is an agreement dividing production rights between the host government and the IOCs following a portion of cost recovery and imposes lower fees and income taxes on the contractor ,Yao, et.al.,(2008). The IOC assumes all costs and risks associated with exploitation and production of the mineral assets. The contract states that in the events of commercial discovery, the international oil company has a right to obtain a share from the production returns so that the contracting company can recover all costs and gain a return on the investments made.

Discovery of Large Oil Reserves

The world’s energy sector contain mineral assets and economically recoverable oil extracts in large quantities. Federal governments in the world value the market for oil and gas products. As per Psaraftis & Pallis, (2012), for guaranteeing maximization of economic outputs obtained from oil exploration and production, the government felt that the concession regime was not adequate to maintain this key states’ interest. For meeting legal needs of maximizing economic outputs realized by the IOCs, the production sharing system got introduced. In 1966, Production sharing agreements got adopted in the oil and gas industry and is currently used in Malaysia, Libya, Jordan, Guatemala, Qatar, China, Malta, Gabon, Philippines, and Bangladesh. Production sharing agreements play the role of attracting the interested multinational companies in the oil and gas industry to risk their capital and utilize technological know-how to develop appropriate reserves in the host country.

Production Rights Ownership

The production sharing contract states that the hydrocarbons produced remain the countries of origin’s property and that the producing nations transfer only the patent rights of conducting exploration and production operations for the minerals of the subsoil. As a matter of fact, the host government employs the IOC to carry out mineral exploitation and sets the costs associated with the reserves exploitation, Ciarreta & Nasirov, (2012). Additionally, after sharing the “cost oil” between the home state and international oil company, the remaining  “profit oil” is divided between the two parties as per the contractual conditions. The closer participation and control over oil and gas products by the host government has also resulted in changes in the policy of contractual agreements prioritized by the governments.

Infrastructure Development in the Home Country

Another reason behind production sharing contracts replacing concession agreements in the oil and gas production sector is that all infrastructure benefits get transferred to the home country without additional costs, under grant agreements, this does not apply since the IOCs enjoys exclusive productions rights over their infrastructure as per Wejermars, (2014) argument.  Therefore, governments prefer PSAs since the agreement allows the home country to acquire that information obtained by IOC back, for the IOCs are only permitted to utilize these technologies during their contractual period.

Why International Oil Companies Welcome the Change from Concession to PSAs

The Home Country Enjoys Overall Responsibility for Control and Management Operations

Despite the fact that the international oil companies remain responsible for routine daily operations of exploiting and producing oil products, the federal government enjoys the overall responsibility of control and management of the operations. Unlike concession agreements that give the IOCs a total control over their activities in the foreign market, the IOCs operate indirectly through its departments and agencies under the PSAs as per Odgaard & Delman, (2014). The home country enjoys the opportunity to either act as the organ granting production rights to the IOCs, or the agency granted the rights together with the international oil companies, and this is only possible under production sharing contracts.

The Revenues of the IOC are Subject to Taxation

There is no payment of royalties under the PSC regime as this is the case in concession arrangements. The central government’s take under the PSC rationale is royalty, which may be considered a complete indemnity for the oil exploration activity in the nation, Feng, et al., (2014). Unlike concession agreements, in the PSC policy, the IOCs bear the risks met as a compensation and have the right to divide the oil returns to the home state. Under the PSA regime, the HC incurs all expenditures to meet the services of the oil mined. The division of production returns between the HC nd the IOCs becomes a necessary source of revenue for the home government and is only applicable to the PSC arrangements.

Companies Get Entitled to Recover their Investment, Operation, and Maintenance Costs

Despite the fact that oil and gas extracts belong to the federal states, the international oil companies take risks of investing in the foreign markets. The host countries motivate the IOCs by also taking risks of the acquired profits by investing them in developing means of reaching the production sites destinations just as explained by Ovadia, (2014). The IOCs, therefore, get the security of recovering their invested funds with attractive returns. This aspect makes international oil companies accept a change from concession agreements that offer them exclusive production rights to PSAs since the management authorities of the companies to be assured of good returns in future years for the invested funds in the manufacture activities.

The IOCs Manage and Operate the Development of the Oil Field

Le Meur, et al, (2013) argues that under a PSA,  the oil companies have the ability to negotiate for a greater share of capital in case the host government fails to agree to the share capital. Also, the financial terms of the PSA conform to those of concession agreement. First and foremost,  the PSA arrangement permits foreign firms to manage and operate the development of the oil fields despite granting the home countries the right to own natural resources. In Weijermars et al., (2014), the IOCs resisted the gradual change from concession agreements for fear that this would create a precedent that would affect their licenses in other countries. However, the fact that PSAs spread in the world market as the common form of contracts for carrying out oil production, and that the IOCs had the authority over management of their operations while in the field, they had no choice but to comply.

Provision of a Legal Security for International Oil Companies

Under the PSA arrangement, the IOCs are protected by a flexible law that can be efficiently updated to address the issues raised by the two parties. In various cases, the PSC supersedes all the existing and potential regulations by the matter dealt with in the contract, Griffin & Treece, (2016). The IOCs get the favor of the host government in that the government is required to surrender its right and adopt new laws in the public interest if such regulations could severely impact any exploration and production rights of the international oil firm under the production sharing contract.

The production sharing agreements require foreign oil companies to pay the host country a signing bonus as soon as the contract gets put in action, by Kaufmann, (2011). It is contingent for the host government to gain following bonuses on certain exploration and development actions of the oil companies. In return, the host government uses part of proceeds to train citizens and offer commercial credit for local entrepreneurs as made possible under PSCs, Yao, et al., (2008). The fact that the government is the legitimate owner of the mineral resources, it has the right to control the significant share of the rents. Under circumstances where the IOCs investment n the HC succeeds, the government revenues directly raise without creating an adverse effect on the incentives explored and produced.

Mikesell, (2016) argued that the HC has a well-established tax system in that all rental incomes from oil and gas extracts cannot get effectively appropriated before the actual production process begins. The federal government has a significant concern about the way the burden of the tax will be imposed at different points in the exploration sector, Fattouh & Darbouche, (2010). Based on the level of investment risks as per the onshore or offshore factors and the geological factors, the higher the share of profits commanded by IOCs. The PSA contract is kept private and confidential between the two parties, it is not made public to the citizens, and this aspect makes the government succeed in exploring more returns from the profits made by the foreign company.

Conclusion

Oil and gas management is very significant to the parties involved in the exploration process. In the oil and gas production sector, different forms of contracts exist the main types being, concession agreements and production sharing agreement. Concession arrangement, the HC grants the FOCs exclusive production rights. The degree of professional support and expertise required to establish this agreement is complex than in the case of PSAs. Under the PSA regime, the IOC obtains a share of production as an award for its investment and operating expenditures and the work performed by sharing with the host government. However, PSAs considerably address the most important issues of ownership of oil reserves, a feature making the contract the most politically preferred in most developing nations. In the past, concession agreement was more preferred by governments but with the evolution of an arrangement that addresses both HC and IOC interests, PSAs remain the most attractive form of understanding. Therefore, federal governments and foreign companies should adopt a consistent utilization of professional sharing contracts rather than concession arrangements since PSAs have been proven to be the most favorable and fair agreement that addresses the interests of both parties.

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