OIl Contracts

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How to read andunderstand them

OILCONTRACTS


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Oil ContractsHow to Read and Understand a Petroleum Contract

ed. Version 1.1


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Tim Boykett, Marta Peirano, Simone Boria, Heather Kelley, Elisabeth Schimana,Andreas Dekrout. Rachel OReilly 2012.

A catalogue record for this book is available from the British Library.

ISBN: 580-0-08-696295-8

Times Up PressIndustriezeile 33b

4020 LinzAustria

Website: www.timesup.orgE-mail address: [email protected]: +43 732 - 787804

Book Sprint facilitation by: Adam HydeWebsite: www.booksprints.netE-mail address: [email protected]

Cover Design: Marta Peirano/Johannes Grenzfurthner

This book was produced using Booktype from Sourcefabric.


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I V

7393

109115

123125

129133135

145147151155161167

171173181187

The Fiscal Toolkit

Fiscal Strategies and Solutions

Comparing ResultsHow big is the pie?

ECONOMIC DEVELOPMENT?History and Evolution

Oil for InfrastructureThe role of the National Oil Company

Employment, Procurement and Social Welfare

ENVIRONMENTAL, SOCIAL, AND HEALTH &SAFETY ISSUESIt's important isn't it?

Operational Etiquette

Before you start

When things go wrong

Cleaning up

LAWYERS YAMMERING ONDealing with differences

Stabilisation

Confidentiality


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APPENDICESGlossary


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V I


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petroleum basics

Foreword


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F O R E W O R D

From now until the time you finish this sentence, another 5,000 barrels of oil willhave come out of the ground. Or 10,000 barrels by the end of this one, worth abouta million dollars on world markets today. Suppose we created a World OilProduction Index (WOPI) as a measure of money, like a light year in distance.WOPI would equal a spacious Central Park apartment in a minute, the mostexpensive skyscraper ever built, Burj Khalifa, in a morning, and the net worth of Facebook's Mark Zuckerberg in two weeks.

Or, alternatively, WOPI would surpass the GDP of the Democratic Republic of Congo, a country of 70 million people, in a day and a half, and the entire annual ai budget to Africa in four days. It would, in fact, take about two weeks of WOPI eacyear to eliminate absolute poverty among the 1.3 billion people around the world

ho subsist on less than $1.25 a day each. It's not news of course that oil generatesa lot of money. But it's good to get a handle on just how much.

It is petroleum contracts that express how this money is split and who makeshat profits, just as it is the contracts that determine who manages operations and

how issues such as the environment, local economic development, and communityrights are dealt with. The share price of ExxonMobil, the question of who carriesresponsibility for Deepwater Horizon, whether Uganda will be able to stop

importing petrol, and how much it costs to heat and light homes in millions of homes -- these are issues which depend directly on clauses in the contracts signed between the governments of the world and the oil companies.

For most of the 150 years of oil production, these contracts have remainedhidden, nested in a broader secrecy that surrounded all aspects of the industry.Governments claimed national security prerogatives, companies said commercialsensitivity precluded making them available.

But the last few years have seen the emergence of the the idea that thesecontracts are of such high public interest that they transcend normal considerationsof confidentiality in business, and should be published. A few governments andcompanies have published contracts. Academic institutions such as the Universityof Dundee in the UK and NGOs such as the Revenue Watch Institute are just now,at the end of 2012, beginning to collect the contracts that are in the public domaininto databases searchable over the Internet.

Contract transparency is the natural next stage of the transparency movement.The initiatives which began in the 1990s around 'Resource Curse', leading to thecreation of the Extractive Industries Transparency Initiative in 2002, have succededin opening up a public conversation. Governments and companies nowacknowledge the importance of openness and ethical business. CSR was born to


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often in passing and at the last minute. Section Four deals with the linkages between the petroleum industry and economic development as a whole in the producing country, as dealt with in the contract, while Section Five looks at clause

relating to health, safety and environmental protection. Finally, in Section Six,Lawyers Yammering On, we look at pure legal aspects, dispute and arbitration procedures.

We quote liberally from a family of petroleum contracts throughout the book that come from eight countries - Afghanistan, Azerbaijan, Brazil, Ghana, IndonesiaIraq, Libya and Timor Leste. They were selected to represent various structures incontracts, stages of development of petroleum industry and most of all because theyare in the public domain. Other contracts are referred to from time to time.

This book has been written in five days from start to finish, using the Booksprin

technique pioneered by Adam Hyde. I am writing this foreword as its last entry on Friday afternoon at Schloss Neuhasen little more than 100 hours after we sat downto storyboard it. This is both a source of pride -- and our first and last defence whenour colleagues and the broader community point out inaccuracies, gaps and other defects, as we hope they will and encourage them to do.

The Booksprint is a collaborative writing technique of astonishing power inhich colleagues constantly brainstorm, write, edit and copy-edit each other in aorkflow that somehow manages to combine high fluidity with structure. But

inevitably in a process of such speed there will be uneveness and difference in toneand perhaps, at the margins, in substance, between one section and another. It is a

ork of collective authorship published under the Creative Commons license, butthat does not mean that every one of us, or the affiliations we represent, subscribesto every statement made. This book is more team work than group think.

The writers of this book are: Peter Eigen, founder of Transparency Internationaland founding chair of EITI; Cindy Kroon from the World Bank Institute; HerbertM'cleod from Sierra Leone; Susan Maples, Office of the Legal Adviser to LiberianPresident Ellen Johnson Sirleaf; Nurlan Mustafayev from the legal affairsdepartment at SOCAR, Azerbaijan's state oil company; Jay Park, a lawyer from Norton Rose; Geoff Peters; Nadine Stiller from the German agency for internationacooperation GIZ; Lynn Turyatemba from the NGO International Alert in Uganda;Johnny West, founder of the OpenOil consultancy; and Sebastian Winkler,Director Europe for Global Footprint Network. All work on the book was pro bonoor mandated by the organisations we work for. If you want to hear each of us in ourown words talking about the project, go to http://openoil.net/booksprint

Adam Hyde of SourceFabric (Booktype) and BookSprints.net facilitated theBook Sprint and Lynn Stewart designed the book and its art work. First readers, an

copy editors were the OpenOil team of Steffi Heerwig, Robert Malies, Zara Rahmanand Lucy Wallwork.


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We received financial assistance to write this book from: Internews Europe, amedia development organisation based in London; Petroleum Economist magazine(with no editorial input - our views and mistakes remain our own); and the GermanFederal Ministry for Economic Cooperation and Development (BMZ).

We want this book to be the start of a broader public conversation about petroleum contracts. It will be a living document, subject to constant critique onthe Web and periodic review. Anyone can download it at any time, print and sell it,and adapt it. Please bear in mind, though, that because our work is CreativeCommons license and available to everyone, the terms of copyright say that youinherit the terms of that license and any work you base on ours will legally beunder Creative Commons license too.

We aim for the book to become the basis for localised versions which take a look

at petroleum contracts country by country. There is no reason why, three years fromnow, there shouldn't be, for every country in the world with a petroleum industry(or hoping to develop one), an editorially independent and technically informed book put together by a group of sympathetic but objective professionals from arange of disciplines which analyses that country's core contracts, available to the public free of charge. We would be delighted to help make that happen withanyone in a producing country who has an interest.

We also aim to make it the basis for training courses, ported to all relevantlocations and languages, which bring a fundamental and holistic understanding of petroleum contracts to a much wider audience than has had the chance to engage

ith them so far.It is our belief that even though these contracts were not written with the public

in mind, with a little effort they can be understood to a level which enables real,mature and informed public discussion. We hope that after reading this book you

ill agree.

Johnny WestFounder OpenOil.net


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context

Context


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P E T R O L E U M B A S I C S

You put it in your car. It heats your house. Flies planes. One day we might be beyond it, but today we are not. Petroleum. The material behind these criticalfunctions that literally fuel the world, is made up of strings of carbon and hydrogenknown as hydrocarbons, formed from the compression of organic matter over hundreds of millions of years. Old stuff that drives the modern age. Oil, gas, petrol,diesel, butane - they all come from hydrocarbons beneath the earth's surface that arethen are refined to make them more useful to us. This book is about the contractsthat make finding and producing these substances possible right now.

G e n e r a l l y w e u s e ' p e t r o l e u m ' t o m e a n b o t h o i l a n d g a s , b e c a u s e b o t h

c o n t a i n h y d r o c a r b o n c o m p o u n d s , a n d b e c a u s e t h e y a r e o f t e n f o u n d

i n t h e s a m e l o c a t i o n . W e w i l l u s e t h i s s a m e t e r m i n o l o g y i n t h i s

b o o k .

The first thing that will probably come into your mind when you think about products that could be made out of all that petroleum is probably fuel. However,there are numerous other materials and products that contains oil or gas, e.g.toothpaste, candles, medicines, or even computers. This also explains why currently petroleum is of utmost importance to our lives today.

Historically, petroleum contracts were designed with crude oil in mind, and thiscontinues to dominate the logic and structure of contracts today. Gas has onlyrecently also become a valuable resource. As the old industry saying went: "Whatis worse than not finding oil? Finding gas!" This is not true any more, as gas becomes increasingly marketable. But not all contracts around the world have, asyet, caught up to this reality.

Natural gas, or just gas, is usually classified within contracts as either non-associated gas and associated gas . Non-associated gas refers to gas reservoirs that

contain only gas and no oil, whereas associated gas is found together with crudeoil. The implications of these can be far reaching and will affect environmental,social, political, fiscal and technological considerations. Countries with significantgas deposits will typically address these considerations in far greater details in theicontracts than countries with primarily crude oil reserves.

EXAMPLE: In 2011, 88 million barrels of oil were produced per day worldwide;one barrel is roughly 160 litres or about 44 US gallons. 317 billion cubic feet (bcf)of natural gas was produced daily.

O f f s h o r e & O n s h o r e O p e r a t i o n s


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O f f s h o r e & O n s h o r e O p e r a t i o n s

Petroleum operations can be either onshore or offshore. Some countries haveseperate contracts for onshore and offshore, whereas others treat them differently

ithin the contract. In what might be one of the most straightforward terms used inthis book, onshore operations refer to operations taking place on land, whileoffshore, or subsea, operations take place in the sea and through the seabed.

The following diagram shows the three types of petroleum extraction and their comparative costs.

Offshore operations are more expensive than offshore operations because of thetype of facilities and structures required. Deep-water drilling is much moreexpensive than shallow-water drilling because the platforms are technically moredifficult to construct. These considerations are addressed in contracts by providingfinancial incentives (e.g. tax reductions) for those operations and stages of production that are more challenging, risk and costly to the contractor.

A t t h e t i m e o f w r i t i n g , i n l a t e 2 0 1 2 , t r e n d s w e r e e m e r g i n g t o s h o w

t h a t t h e r i s i n g p r i c e o f o i l h a s m a d e i t p r o f i t a b l e f o r c o m p a n i e s t o

i n v e s t i n c r e a s i n g l y i n d e e p - s e a o p e r a t i o n s . D e c l i n i n g r e v e n u e f r o m

s h a l l o w - w a t e r a n d o n s h o r e s o u r c e s , a s w e l l a s t e c h n i c a l a d v a n c e s ,

h a v e m a d e d e e p w a t e r s m o r e a t t r a c t i v e , d e s p i t e t h e i r c o s t .

C o n v e n t i o n a l V s U n c o n v e n t i o n a l


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C o n v e n t i o n a l V s U n c o n v e n t i o n a l

Flipping through the newspapers, you read about protesters upset about"unconventional" oil being developed on pristine farm land. Or France is

considering banning it. But what is unconventional oil? For that matter, what isconventional oil? The distinction between conventional and unconventionaloperations refers to the manner, ease and cost associated with extracting the petroleum.

Conventional oil extraction employs traditional oil wells, and unconventional,the new and emerging technologies and methodologies allowing access to moreinaccessible reserves, such as those found in oil shale and oil sands.

Conventional gas is typically free gastrapped in rock formations and iseasier to extract. Unconventional gas reservoirs include tight gas, coal bed

methane, gas hydrates, and shale gas (which sits in sand beds). Drilling for unconventional gas can be more expensive compared to conventional gas. Thesupply of and interest in gas extracted from unconventional reservoirs is growingrapidly, mainly due to technological advances.

....but as of the writing of this book, most contracts do not provide for the uniqueattributes of unconventional gas.

T h e P r i c e O f P e t r o l e u m

The price of petroleum is another headline grabber. We all know it is out there, but

e probably do not stop to think about the details too terribly often.What does "Oil is at $100 a barrell mean"? All oil? Some oil? The answer to thisis, "some oil".

Petroleum is being bought and sold at many different prices all over the worldthough they tend to be compared or "benchmarked" off certain common standards.

For Oil, West Texas Intermediate (WTI) or Brent crudes or blends and commonlyused.For Gas, Henry Hubb is common.

These benchmarks, which are the prices that make the headlines, are used todetermine the price of oil and gas produced elsewhere. This will be discussed inmore detail later in the "Valuing Oil" chapter.

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T H E L I F E & T I M E S O F A P E T R O L E U M

P R O J E C T

Petroleum doesn't last forever. It is a non-renewable resource. This fundamentallydrives the business decisions of companies, a key part of which is that most petroleum contracts are structured to contemplate the entire life span of a project,it's beginning, middle, and end. The key stages of a project's life (or "petroleumoperations") are:

explore to find it in the first place;develop the infrastructure to get it out;produce (and sell) the petroleum you've found;abandon when it runs out and clean up ("decommission")

Each of these stages is broken down and discussed in detail below.

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E x p l o r e

Petroleum is rarely found on the surface of the earth. One is very unlikely (thoughould be quite lucky) to step into a puddle of oil, though when this does occur it is

known as a "seep" which means what one would think it means: oil below theground has "crept up" from below the surface to "seep out" onto the surface. In theearly years of oil discovery, seeps were probably one of the best means to find oiland gas. And oil still does seep to the surface of the earth in many locations acrossthe globe. But a seep does not mean an oil boom. Nowadays, we use much morescientific and data-intensive means of finding petroleum beneath the surface of theearth.

S e i s m i c

Today, geological surveying methods known as seismic studies (or just "seismic")are usually the starting point of any oil exploration effort. The essence of seismicstudies are to use sound waves, shot down into the earth, to 'see' what isunderground. Although it is often said that one cannot be certain that petroleum isin a given location until a exploration well is drilled, taking seismic surveys helpincrease one's confidence that drilling - an expensive endeavour - in a particular location is worthwhile. In other words, seismic helps climb the 'confidence scale'.

Commonly found beneath the earth's surface are various types of rocks, water and salt, all of which react differently when hit with a sound wave. Large amountsof data are captured from this process and used to give an image of what lies beneath the earth's surface.


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As computer technology has improved, seismic has been able to handleincreasingly large quantities and complexity of data, though the cost of gatheringand interpreting this incures increasing costs. This is why you will see in somecontracts the type of seismic required (eg. 2D vs 3D), how many kilometers of

seismic is to be gathered ("shot" in industry jargon) and specifically that it must beinterpreted and the results provided to the host government.

E X C E R P T F R O M T I M O R - L E S T E J P D A S - 0 6 - 0 1 :

4 . 1 - I n e a c h C o n t r a c t Y e a r m e n t i o n e d b e l o w , t h e C o n t r a c t o r s s h a l l c a r r y o u t a n

E x p l o r a t i o n W o r k P r o g r a m m e a n d B u d g e t o f n o t l e s s t h a n t h e a m o u n t o f w o r k

s p e c i f i e d f o r t h a t C o n t r a c t Y e a r :

C o n t a c t Y e a r 1 : A c q u i s i t i o n , p r o c e s s i n g a n d i n t e r p r e t a t i o n o f 1 1 5 0 k m 2 D s e i s m i c

d a t a

E x p l o r a t i o n D r i l l i n g

If the seismic produces promising results - sometimes called a "lead" - then the next phase of exploration will typically be drilling an exploration well. Here, anextraordinarily large drill bit is cut into the earth's surface in order to bring up a

"core" or a cylindrical sample of that portion of the earth.


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E X C E R P T F R O M G H A N A P E T R O L E U M A G R E E M E N T W I T H T U L L O W , K O S M O S ,

A N D S A B R E M A R C H 1 0 , 2 0 0 6 :

" E x p l o r a t i o n " o r " E x p l o r a t i o n O p e r a t i o n s " m e a n s t h e s e a r c h f o r P e t r o l e u m b y

g e o l o g i c a l , g e o p h y s i c a l a n d o t h e r m e t h o d s a n d t h e d r i l l i n g o f E x p l o r a t i o n

W e l l ( s ) a n d i n c l u d e s a n y a c t i v i t y i n c o n n e c t i o n t h e r e w i t h o r i n p r e p a r a t i o n

t h e r e o f a n d a n y r e l e v a n t p r o c e s s a n d a p p r a i s a l w o r k , i n c l u d i n g t e c h n i c a l a n d

e c o n o m i c f e a s i b l i i t y s t u d i e s , t h a t m a y b e c a r r i e d o u t t o d e t e r m i n e w h e t h e r a

D i s c o v e r y o f P e t r o l e u m c o n s t i t u t e s a C o m m e r c i a l D i s c o v e r y

Even with conducting seismic to help climb the confidence scale, one mightneed to drill several exploration wells to establish what is in fact below the earth'ssurface. One commonly used comparison to exploration drilling (particularly in thedeep offshore) is trying to stick an extremely long straw in a drinking bottle fromthe top of a skyscraper and then drink from it. Of course, there are many areas wherehydrocarbons are known to exist, though they might not be evenly distributed. Inthese cases seismic is still needed to increase the chances of 'hitting the target'.

Because most of us use fuel in our cars which we see as a liquid, many of usenvision petroleum to be in lake-like pools below the earth's surface. In fact, it isfound in spaces or cracks within rock formations and needs various techniques toextract (relieve pressure, create pressure, etc). One might picture a glass with a lotof crushed ice and trying to drink a milkshake from it.

While there is no standard amount of time one might conduct seismic studiesand drill exploration wells in the world, these studies and drilling and theinterpretation of the results even on a very rapid schedule takes months at the verylesat and more often around 2-4 years.

D i s c o v e r A n d A p p r a i s e

Let us assume that, lucky you, you found hydrocarbons while drilling; you have"discovered" petroleum! Is the pay day coming? Most likely, not quite yet. Youmay have "discovered" hydrocarbons, but the question then becomes, how muchdid you find? Enough to make it worthwhile, "commercially viable" or economicalto develop and produce? What you will need to do next: "appraise" the discovery.

Appraising entails more drilling and seismic to asses what you have discovered, but to a greater degree of accuracy. It will lead to more detailed geologicaldiscovery while also involving assessment and reflection on how to build the

necessary infrastructure to produce the petroleum you've found. You will want toknow more about:


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the chemical composition of the various hydrocarbon depositsthe quantity of reserves in the areahow to get these hydrocarbons out of the ground (if the discovery is found to beof commercial signficance)


A N D S A B R E M A R C H 1 0 , 2 0 0 6 :

" D i s c o v e r y " m e a n s f i n d i n g d u r i n g E x p l o r a t i o n O p e r a t i o n s a n a c c u m u l a t i o n o f

P e t r o l e u m n o t p r e v i o u s l y k n o w n o r p r o v e n t o h a v e e x i s t e d , w h i c h i s r e c o v e r e d

o r r e c o v e r a b l e a t t h e s u r f a c e i n a f l o w m e a s u r a b l e b y c o n v e n t i o n a l p e t r o l e u m

i n d u s t r y t e s t i n g m e t h o d s ;

" A p p r a i s a l P r o g r a m m e " m e a n s a p r o g r a m m e c a r r i e d o u t f o r t h e p u r p o s e s o f

d e l i n e a t i n g t h e a c c u m u l a t i o n o f P e t r o l e u m t o w h i c h t h a t D i s c o v e r y r e l a t e s i n

t e r m s o f t h i c k n e s s a n d l a t e r a l e x t e n t a n d e s t i m a t i n g t h e q u a n t i t y o f r e c o v e r a b l e

P e t r o l e u m t h e r e i n ;

C o m m e r i c a l D i s c o v e r y O r N o t ?

Once hydrocarbons have been found in sufficient quantities and with aneconomically viable extraction cost, the discovery becomes a "commercialdiscovery". It is important to stress here that a commercial discovery is not ageologic term but a business term. For this reason, the length of time an appraisaltakes will likely depend on such considerations as:

the business considerations of the company that has found the oilthe local laws and regulations that determine the process of development


" C o m m e r c i a l D i s c o v e r y m e a n s a d i s c o v e r y o f P e t r o l e u m t h a t a C o n t r a c t o r

d e c l a r e s c o m m e r c i a l a s c o n t e m p l a t e d i n S e c t i o n 4 . 1 0 ;

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D e v e l o p

Once you have explored, discovered and appraised a petroleum deposit anddetermined that it is worth the cost to get it out of the ground, the next stage is todevelop infrastructure to extract it. Depending on a number of factors, includinggeology, location and local regulations, you will need to determine the best way toget your hydrocarbons out of the ground and to the market.

This can include decisions about how many wells to drill (yes, there can be morethan one, there can be many!), what type of platform you will be building or

hether to build a platform at all. Increasingly, offshore oil developments are using boat-like structures to extract petroleum, the Floating Production, Storage andOffloading units or "FPSOs" in short, or different varieties (eg. FPOs, or FPS's)

hich do only some of these functions.

The development phase is rarely less than several years. Engineering, communityand business considerations, among others, all factor into the type and scale of infrastructure that will be used to extract the petroleum. This is the phase whichrequires the most amount of money in the life cycle (the most "capital intensive").While exploration well drilling in the offshore might get into the hundreds of millions of dollars, complex, large-scale difficult environments for the extraction of petroleum can hit tens of billions!

P r o d u c e

At long last - perhaps a decade after the start of exploration - oil or gas will finallyflow. As various wells come 'online', petroleum will flow in increasing quantities as production "ramps up". At some point, once most of the first major development has been completed, tested, and refined for any bugs in the system, there will be"commercial production". This occurs when the petroleum is finally flowing at theexpected rate over a period of a month or so. How long will production last? This isaffected by many factors, but probably most significantly by the size of the find.


A N D S A B R E M A R C H 1 0 , 2 0 0 6 :

" D a t e o f C o m m e n c e m e n t o f C o m m e r c i a l P r o d u c t i o n " m e a n s i n r e s p e c t o f e a c h

D e v e l o p m e n t a n d P r o d u c t i o n A r e a , t h e d a t e o n w h i c h p r o d u c t i o n o f p e t r o l e u m

u n d e r a p r o g r a m m e o f r e g u l a r p r o d u c t i o n , l i f t i n g a n d s a l e c o m m e n c e s ;


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" C o m m e r c i a l P r o d u c t i o n " o c c u r s o n t h e f i r s t d a y o f t h e f i r s t p e r i o d o f t h i r t y

( 3 0 ) c o n s e c u t i v e d a y s d u r i n g w h i c h p r o d u c t i o n i s n o t l e s s t h a n t h e l e v e l o f

r e g u l a r p r o d u c t i o n d e l i v e r e d f o r s a l e d e t e r m i n e d b y t h e M i n i s t r y a s p a r t o f t h e

a p p r o v a l o f , o r a m e n d m e n t t o , a D e v e l o p m e n t P l a n , a v e r a g e d o v e r n o l e s s t h a n

t w e n t y - f i v e ( 2 5 ) d a y s i n t h e p e r i o d ;

A b a n d o n

After anywhere from around seven years of production from smaller areas to fiftyyears or more from the giants, it is time to take all of the "steel and metal" down, plug the production wells and restore the environment to its original state. Acommon alternative to this is where the contractor turns the assets over to the stateso that it can then continue operations and eventually abondoning themselves at alater time. These processes are generally referred to as "Decommissioning" or "Abandonment".


" D e c o m m i s s i o n " m e a n s , i n r e s p e c t o f t h e C o n t r a c t A r e a o r p a r t o f i t , a s t h e c a s e

m a y b e , t o a b a n d o n , d e c o m m i s s i o n , t r a n s f e r , r e m o v e a n d / o r d i s p o s e o f

s t r u c t u r e s , f a c i l t i i e s , i n s t a l l a t i o n s , e q u i p m e n t a n d o t h e r p r o p e r t y , a n d o t h e r

w o r k s , u s e d i n P e t r o l e u m O p e r a t i o n s i n t h e a r e a , t o c l e a n u p t h e a r e a a n d m a k e

i t g o o d a n d s a f e , a n d t o p r o t e c t t h e e n v i r o n m e n t

It is important to note that significant amounts of petroleum will likely remain inthe ground at this point. This may be because the financial system in place in thecountry makes continued production uneconomic and/or technologically theredoes not continue to be cost-effective means of producing petroleum. Theenvironmental issues related to abandonment are discussed in the section:Environmental, Social and Health & Safety Issues, while project economics andtheir impact on production are discussed in the section: 'The Money'.

Other factors that may cause a contractor to halt or even indefinitely ceaseoperations, may not, however, trigger the contractual obligation to decommision.These could include security concerns, social unrest or political instability. These

'force majeure' events would not terminate the contract, but could suspend thecontractors obligation until operations were able to resume.


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I n a n u m b e r o f c o u n t r i e s , a c o n t r a c t , l i c e n s e o r c o n c e s s i o n m a y c o v e r

s e v e r a l f i e l d s s i m u l t a n e o u s l y . T h i s m e a n s t h a t , m u l t i p l e a r e a s , e a c h

a t t h e i r o w n r e s p e c t i v e s t a g e m a y b e a c t i v e u n d e r o n e c o n t r a c t .


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I n t h i s b o o k , w e w i l l , f r o m n o w o n , u s e t h e t e r m " p e t r o l e u m

c o n t r a c t " t o r e f e r s o l e l y t o t h e H o s t G o v e r n m e n t C o n t r a c t . O t h e r

t e r m s w i l l b e d e f i n e d a s w e g o a n d a l l a r e l i s t e d i n t h e G l o s s a r y f o r

f u r t h e r r e f e r e n c e .

A small minority of countries will not, however, follow this approach to petroleum extraction. They may, instead, manage most of extraction processthemselves, therefore removing the need to partner with an IOC and the need for theHost Government Contract. Examples include; Saudi Arabia's National OilCompany Saudi Aramco and Mexico's Pemex.

T h e P e t r o l e u m R e g i m e

You now have a petroleum contract in your hands. Do you have everything youneed to understand the relationship between the government and the contractors byust reading through the contract? No.

We'll say it once and it will surely be said again: petroleum contracts are one keyfeature, living in a constellation or web of other laws and regulations above it andmany other subcontracts and other ancillary contracts are below it. These will bereferred to by the contract but will not be explicitly described, explained or re-

ritten.This web of laws and regulations relating to petroleum within a particular

country is known as a "petroleum regime". The petroleum regime can be bestthought of as a hierarchy, starting with the constitution of the relevant country andending with petroleum contract.


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2 3

C o n s t i t u t i o n

The constitution will establish the authority for a government to make and enforcelaws. It may also address the ownership of the country's natural resources and, inthis case, will typically state that resources are owned by citizens of the nation, or held for their benefit by the current government.

L a w s A n d R e g u l a t i o n s


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L a w s A n d R e g u l a t i o n s

Then comes the petroleum law, which contains specific rules relating to the rightsand responsibilities granted in the contract. Other laws will also form an important part of the "petroleum regime" including, for example, environmental laws, healthand safety laws, tax laws and labour laws.

E X C E R P T F R O M G H A N A M O D E L P E T R O L E U M A G R E E M E N T :

1 0 . 2 - T h e c h a r g e a b l e i n c o m e o f C o n t r a c t o r i s d e t e r m i n e d u n d e r s e c t i o n 2

o f t h e P e t r o l e u m I n c o m e T a x L a w

Next, there may be petroleum regulations, which are made in accordance withthe petroleum law. As we move down the hierarchy from the constitution, to laws,to petroleum regulations, the rules relating to petroleum exploitation will becomeincreasingly detailed and specific.

C o n t r a c t s

So, the petroleum contract is simply one part of the overall petroleum regime that

governs petroleum resources. It is, however, the part that defines the particularitiesand rights that are essential to any company wanting to explore and extract withinthat country.

A w a r d i n g P e t r o l e u m C o n t r a c t s

There are two main systems for awarding or winning contracts:Competitive Bid : Given the value of petroleum today, many countries award

contracts by holding a 'bid round'. Here, companies compete against each other byoffering the best terms with regards to one or more defined variables to win the

contract.Ad hoc negotiations : Here an investor comes unsolicited and asks for a particular parcel of land and then negotiates a contract directly.

First-come, first-served : Alternatively, there might be an application systemand the first company that applies and passes whatever regulatory hurdles the statemay have, is then awarded the contract - with some negotiations over the terms of the contract usually involved.

The system for awarding contracts in a country (or different areas within thatcountry) may depend on the current state of its petroleum sector. For example; Isthere geological data already available? Is it a known petroleum producing area? Is


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there infrastructure already in place that could be used for this specific block? Hardto reach area?

E X A M P L E : P e r u ' s l e g a l f r a m e w o r k , a l l o w s f o r c o m p e t i t i v e b i d d i n g a n d A d

h o c . A l t h o u g h t h e c o u n t r y g e n e r a l l y f a v o r s c o m p e t i t i v e b i d r o u n d s , i f a

c o n t r a c t o r a p p r o a c h e s w i t h a n i n t e r e s t i n a n a r e a n o t c u r r e n t l y u n d e r

c o n s i d e r a t i o n , t h e c o u n t r y m a y c h o o s e t o n e g o t i a t e t e r m s a n d a w a r d a

c o n t r a c t d i r e c t l y .

N e g o t i a t i o n s

A country is likely to have a model petroleum contract, in a standard format andith standard clauses that can be any of the types of Host Government Contracts

listed in the next section. The extent to which the parties will negotiate or changethese clauses and terms will depend upon such issues as; the country's petroleumlaw, market environment and current political situation. Through the negotiating process, the terms may be negotiated significantly from what was in the originalmodel, or it may be only the numbers of one fiscal term on which the companies

ere bidding, such as a signature bonus that is filled in.Following negotiations, what was a government model contract will become a

signed contract with a particular company or several companies. With the signingof the contract, the company or companies are legally awarded the exclusive rightto explore and produce oil in the contract area.

T y p e s O f P e t r o l e u m C o n t r a c t s

Of these Host Government Contracts, there are three principal types which can begenerally characterized as:

Concession : contractor owns the oil in the groundProduction Sharing Contract : contractor owns a share of oil once it is out the

groundService Contract : contractor receives a fee for getting the oil

C o n c e s s i o n s


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C o n c e s s i o n s

Concessions are the "original" or oldest form of petroleum contract. First developedduring the oil boom in the United States in the 1800s, the idea was then exported tooil producing countries around the world by International Oil Companies (IOC).These contracts are based much more on a "land ownership" concept of oil that is based on the American system of land ownership. In the United States, thelandowner, generally speaking, has legal ownership rights of the earth directly below it (sub-surface) and the sky above it.

This would include oil if it was found below a private property owners land.Due to this historical origin, the concession similarly grants an area of land to acompany, though typically only the sub-surface rights to the land, and therefore, if that company finds oil below the surface, the company owns that oil. Under the

concession the contractor will also have the exclusive right to explore within theconcession area.How then, you may ask, does a country benefits from this form of contract? This

usually occurs through taxes and royalties, though a state may also hold shares inthe concession through its NOC in a Joint Venture with the contractor.

P S C s A n d S e r v i c e C o n t r a c t s

Production Sharing Contracts or PSCs and Service Contracts are different from

concessions, in that they do not give an ownership right to oil in the ground. Thisalso means that the state, being the owner of the resource in the ground, mustcontract a company to explore on its behalf.

Indonesia can be credited with the innovation of Production Sharing Contractsin 1966. The Indonesian government decided, as a 'nationalistic' move, to moveaway from concessioning to contracting. This was done so that the state retainedownership of the petroleum produced and only gave the international company theright to explore and take ownership (or legally speaking "title") to it once the petroleum was out of the ground.

This innovation came about at the same time as many petroleum producingcountries were gaining their independence and was part of the first wave of the so-called resource nationalism. Another key development during this time was theformation of OPEC (Organisation of Petroleum Exporting Countries) that led tofurther "re-balancing" of government-company relationships.

Under aService Contract , title does not transfer at all. Unlike a PSC, where theoil company is entitled to a share of any petroleum produced, under a ServiceContract, the oil company is just paid a fee.

J o i n t V e n t u r e s A n d O t h e r C o m b i n a t i o n s


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J o i n t V e n t u r e s A n d O t h e r C o m b i n a t i o n s

Another type of arrangement that is sometimes considered to be a fourth type of petroleum contract is theJoint Venture . This involves the state, through a nationaloil company, entering a partnership and working together with an oil company or companies. In this arrangement, it is the joint venture itself that is awarded rights toexplore, develop, produce and sell petroleum.

In reality it is rare to find any contract that fits entirely into one of thedescriptions given above and is more likely to take elements from each.

A c c e s s i n g C o n t r a c t s F r o m T h e O u t s i d e

The creation and execution of the petroleum laws, model contracts, and especiallythe negotiation of a signed or executed contract, all are primarily driven by the

executive branch of government. This will typically be the Ministry running the petroleum sector and perhaps some other ministries with relevant expertise such asthe Ministry of Finance.

Those outside of this 'inner circle', even in other government departments, havehistorically found petroleum contracts shrouded in secrecy. As a result, the peoplethat are interested, influenced, and affected by these industries, whether in producing or consuming countries often feel left out, in the dark, wondering wherethe money went or where the oil comes from and on what terms. And while acountry's constitution is public (we hope!) and the laws are too (if sometimes hard

to find), petroleum contracts are likely to be not easily accessible even if by lawthey should be.The range of potential stakeholders is huge, and their concerns too numerous to

list them here. While the majority of oil contracts today speak primarily about thefinancial and technical aspects of oil extraction, they are increasingly addressingconcerns of stakeholders that are not directly parties to the contract but are deeplyaffected by it. This is further addressed in the section: Economic development.

Our great hope is that the rest of the book, which is devoted to the content of petroleum contracts, will help to empower people to read and understand thesemulti-billion dollar contracts that fuel our world.


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O U R F A M I L Y O F C O N T R A C T S

We have selected a "bouquet" of petroleum contracts that are in the public domainto use for illustration purposes throughout the rest of the book. It's time to meetthem!


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T H E A N A T O M Y O F P E T R O L E U M

C O N T R A C T S

Generally speaking, contracts tend to follow the order in which things wouldhappen in a petroleum project. After the introductions such as the list of terms to beused in the document they move onto exploration, followed by development andappraisal. Up until this point there is no pie to divvy up and so the clauses deal

ith operational management issues. Once commercial production begins, fiscalterms follow in the contract as in real life. After that come issues such as localcontent, dispute resolution and confidentiality, and other issues which may be morespecific to each contract.

In the very back of the contract, it is common to see the Accounting Proceduresfor calculating cost oil in the annexes of a contract and various model forms of theancillary contracts, like a Parent Company Guarantee or the Joint OperatingAgreement. These are referred to as "Annexes", "Appendices" or "Addenda" whichare all additional documents that are referred to in the contract but for some reasonor another, the parties thought the contract would flow better with it as a separatedocument or the need for the document came after the parties had agreed to thecontract.

To get a sense of how generic these contracts can be, let's look at the eightcontracts that make up the "family of contracts" we quote from in this book. Thetable below shows the article numbers dealing with various early stages in the life-cycle of the project and the total number of articles in the main section of theagreement. Iraq doesn't have any clauses relating to exploration because they aredealing with sizable discovered fields.


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C h a s i n g I s s u e s F r o m C l a u s e T o C l a u s e

But, although there is a certain logical sequence to the contracts, you can often endup chasing a particular issue around the contract, being referred backwards or

forwards from one clause to another. If you have a particular question you want toget the answer to, it can feel sometimes like you're playing a game of Snakes andLadders (or for US readers, Chutes and Ladders!)

D e f i n i t i o n s A n d B l o c k C a p i t a l s

Although it seems even more inaccessible than many other parts of the contract, itis often a good idea to get comfortable with Article 1, the list of definitions.Thisdoes the legal job of specifying what terms in use throughout the contract actuallymean. It can save a lot of time, for example, to realise that the term "Effective Date"

in the Indonesian contracts has a specific meaning as defined below:

E X C E R P T F R O M I N D O N E S I A N M O D E L C O N T R A C T

1 . 2 . 1 0 - E f f e c t i v e D a t e m e a n s t h e d a t e o f a p p r o v a l o f t h i s C o n t r a c t b y t h e

G o v e r n m e n t o f t h e R e p u b l i c o f I n d o n e s i a i n a c c o r d a n c e w i t h t h e p r o v i s i o n s o f

t h e a p p l i c a b l e l a w .

It also helps to know then that this term is now an approved or reserved termhich will appear either in capitals ("Effective Date") or sometimes block capitals

("EFFECTIVE DATE") throughout the contract.

G e t t i n g A n s w e r s F r o m C o n t r a c t s : L e t T h e C h a s e B e g i n !

Let's say you want to know how long the Iraqi Service Agreement lasts: when doesit start and when will it finish. Is it a 10 year contract, 15? 50? One might think this would be a vey straightforward clause in a contract: "this contract lasts 25

years." It is rarely that simple, unfortunately. You have been warned.To answer any question, you'll want to start at the table of contents (hope thatthere is one, they are your best friend - otherwise, the chase has just become thatmuch more difficult) and see which heading would seem likely to answer your question. In our case, "Term of Contract" (Article 3) seems the most promising. Flipping to Article 3, we find the following:


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E X C E R P T F R O M I R A Q I S E R V I C E A G R E E M E N T

3 . 1 T h i s C o n t r a c t s h a l l c o m e i n t o f o r c e o n t h e E f f e c t i v e D a t e .

3 . 2 T h e b a s i c t e r m o f t h i s C o n t r a c t ( " T e r m " ) s h a l l b e t w e n t y ( 2 0 ) Y e a r s f r o m t h e

E f f e c t i v e D a t e . T h i s t e r m i s e x t e n d a b l e p u r s u a n t t o A r t i c l e 2 1 o r e l s e w h e r e i n t h i s

C o n t r a c t .

3 . 3 N o l a t e r t h a n o n e ( 1 ) Y e a r p r i o r t o t h i s C o n t r a c t ' s e x p i r y d a t e , C o n t r a c t o r

m a y s u b m i t w r i t t e n r e q u e s t t o R O C f o r a n e x t e n s i o n o f t h e T e r m f o r a

m a x i m u m p e r i o d o f f i v e ( 5 ) Y e a r s , s u b j e c t t o n e w l y n e g o t i a t e d t e r m s a n d

c o n d i t i o n s .

One part of our question is quite easy: the term of the contract is 20 years.But when does it start? 3.1 says "on the Effective Date". Because the term is

capitalized, we have to go to the definitions and see what it says.


D e f i n i t i o n s s e c t i o n - E f f e c t i v e D a t e m e a n s t h e d a t e o n w h i c h a l l t h e c o n d i t i o n s

l i s t e d i n A r t i c l e 3 9 a r e s a t i s f i e d .

This defintion shoots us to Article 39:


3 9 - T h i s C o n t r a c t s h a l l e n t e r i n t o f o r c e u p o n ( i ) i t b e i n g s i g n e d b y t h e P a r t i e s ,

( i i ) t h e I n i t i a l P r o d u c t i o n R a t e b e i n g a g r e e d o n t h e P a r t i e s a n d ( i i i ) R O C n o t i f y i n g

a n d r e p r e s e n t i n g t o C o n t r a c t o r i n w r i t i n g t h a t r a t i f i c a t i o n h a s o c c u r r e d a n d t h e

C o n t r a c t i s e n f o r c e a b l e a c c o r d a n c e w i t h t h e L a w .

Not a very straightforward answer, but an answer nonetheless. Upon these"trigger events" (whenever those may occur) that point will be when the contract

ill last for 20 years.Except for the exceptions. 3.2 tells us that the term is extendable pursuant to

Article 31. You'll want to flip back to the table of contents to see what this articlecovers, which is "Force Majeure" which, in summary, is a concept found in many


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contracts (not just petroleum) that allows the suspension of a contract while so-called unforeseen events or "acts of God" like hurricanes or acts of war allow thecontract to be suspended until the event has resolved. So, this is one way in whichthe contract might be extended. But the last phrase of 3.2, "or elsewhere in thisContract" is where things get really ugly: this clause literally shoots you to theentire contract to hunt and see where else the contract might be extended.Depending on just how precise you need to be with your answer, your task mayhave just gotten a good bit longer.

If you're staying fairly general, 3.3 tells you that there could be a 5 year extension if the Contractor requests it from the ROC, which you would need to goto the definitions to find out what this is.


D e f i n i t i o n s s e c t i o n - " - - - - " o r " R O C " m e a n s a n I r a q i S t a t e o i l c o m p a n y o p e r a t i n g

t h e F i e l d p r i o r t o t h e E f f e c t i v e D a t e .

We have our general answer. The contractor will need to go to the State to get 5more years for a possible total of 25 years.

So in order to understand this short article, we have now been referred to at least4 other other locations in the document for a fairly general answer and we wouldneed to review the entire document for a specific answer!

This is quite normal. Petroleum contracts are interwoven in this way. You couldspend quite a long time following the trail of an issue from one clause to another related clause and it is only with the passage of time that you begin to develop asense of when it makes sense, for your immediate purpose, to follow the trail and

hen it is time to stop.

T h e y ' r e N o t P e r f e c t

Lastly, although it might be surprising in documents which have been pored over for months and sometimes years by dozens of people, there are sometimes glitches.Some examples:

T h e v e r s i o n o f G h a n a ' s a g r e e m e n t w i t h T u l l o w , w h i c h i s c o u n t e r s i g n e d b y b o t h

p a r t i e s , g o e s s t r a i g h t f r o m A r t i c l e 2 3 t o A r t i c l e 2 5 i n t h e T a b l e o f C o n t e n t s .

B r a z i l ' s c o n c e s s i o n a g r e e m e n t c o n f u s e s " n a t i o n a l " w i t h " n a t u r a l " i n t h e t a b l e o f

c o n t e n t s , s u m m a r i s i n g t h e c o n t e n t s o f C l a u s e E l e v e n a s " S u p p l y t o N a t u r a l

M a r k e t " . T h i s m a y r e f l e c t t h e f a c t t h a t t h e E n g l i s h i s a t r a n s l a t i o n a n d t h a t B r a z i l

s p e c i f i e s t h e o f f i c i a l l a n g u a g e o f c o n t r a c t s a s P o r t u g u e s e . T h e s e c o m p l e x


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s p e c i f i e s t h e o f f i c i a l l a n g u a g e o f c o n t r a c t s a s P o r t u g u e s e . T h e s e c o m p l e x

n e g o t i a t i o n s a r e o f t e n h a p p e n i n g t h r o u g h a l a n g u a g e b a r r i e r , w h i c h c a n g i v e r i s e

t o e r r o r s i n t r a n s l a t i o n .

Finally, even if you are only interested in one agreement, it is worth spendingthe time to read several others to begin to get a sense for what is common in petroleum contracts and what might be of more specific interest in the one you arelooking at. The extra confidence and understanding you gain will more than repaythe time and effort.

A l l e i g h t c o n t r a c t s w i d e l y q u o t e d i n t h i s b o o k a r e a v a i l a b l e o n t h e

I n t e r n e t , a l o n g w i t h m a n y o t h e r s . G o o d n e w s - y o u n o l o n g e r n e e d t o

s u b s c r i b e t o e x p e n s i v e l e g a l d a t a b a s e s t o b e g i n t o g e t a s e n s e f o r

h o w c o n t r a c t s a r e b u i l t .


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petroleum basics

The AcTors &The scripT


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T H E S T A R S O F T H E S H O W

If the petroleum contract is the script, the stars of the show are those entities thatsign the contract and agree to be bound by its term and conditions. They are what

e call the "parties" to the contract. The parties are usually the host governmentline ministry or its state/ national oil company (NOC) on the one hand, and an IOCor a group of IOCs, on the other. IOCs may be referred to as the contractor, thelicensee or the concessionaire depending upon the type of the petroleum contractsigned. Frequently more than one IOC is a party to the petroleum contract. Suchgroup of IOCs is called a "consortium". Each of the companies are an individual party to the contract, but are treated as one entity and are collectively called the"contractor", the "licensee" or the "concessionaire". From the state's perspective, if the IOCs together fail to fulfill their obligations then they are all at fault. In legallanguage the IOCs are said to have "joint and several liability" for the performanceof the contractor's obligations under the contract.

N O C ' s M u l t i p l e R o l e s

In addition to the NOC being party to the petroleum contract on behalf of the statethe script may require the NOC to play another role as well. The host country andthe IOC may agree on some form of state participation in the project. In this event,

the NOC will be a party to the petroleum contract as well as the representative of the state granting rights to the other parties. Sometimes an affiliate of the NOC isestablished for the purpose of representing the NOC in the direct operations of the project. Such state participation may be both one of the fiscal tools available to thestate as discussed in the section: "'The Money'" and a means to promote broader national development goals as discussed in the section: "Economic Development".

O t h e r A c t o r s

An IOC will often participate in a petroleum contract through an affiliate company

rather than the ultimate parent company for various reasons such as taxoptimization, project financing structuring, foreign investment protection regimestructuring or local law requirements. This makes the IOC the "parent" company.Such an affiliate will be incorporated in another jurisdiction than the parentcompany or the country that is the party to the petroleum contract.

For example, BP PLC as the parent company sits at the top of the BP group of companies. BP PLC is the entity that people have in mind when BP is referred to inthe media. BP's interests in various countries are held by affiliate companies such aBP Exploration Angola, BP Egypt Company, BP Energy Brazil and so on. These

affiliate companies will be the parties to the petroleum contracts in the relevant


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countries, not BP the parent company.Often the only asset of this affiliate company is the field as determined in the

petroleum contract to which it is a party. This exposes the country, and thereforethe other parties to the contract, to a lot of risk. This is because there are noavailable financial resources on this company's balance sheet, only oil in theground to cover any costs. In order to mitigate this risk the state will often require acompany within the BP family and with more assets and financial strength (a"bigger balance sheet") to guarantee that the affiliate company will perform itsobligations. If the affiliate fails to perform its financial obligations under the petroleum contract the state can require the parent company to step in to fulfill itsaffiliate's obligations.

T h e P l o t - S n e a k P r e v i e w

The chapter, "The Anatomy of Petroleum Contracts" sets out the main clausescontained in most petroleum contracts and the other chapters in this book talk insome detail about the the main rights and obligations of the parties. Petroleumcontracts will often set out a provision that captures the fundamental grant of rightsto the parties as well as the assumption of obligations by the parties. This provision provides the key grant of rights that underlies the entire performance of thecontract. An example is given below:

E X C E R P T F R O M T H E A Z E R B A I J A N A G R E E M E N T :

2 . 1 G r a n t o f E x c l u s i v e R i g h t . S O C A R h e r e b y g r a n t s t o C o n t r a c t o r t h e s o l e a n d

e x c l u s i v e r i g h t t o c o n d u c t P e t r o l e u m O p e r a t i o n s w i t h i n a n d w i t h r e s p e c t t o t h e

C o n t r a c t A r e a i n a c c o r d a n c e w i t h t h e t e r m s o f t h i s C o n t r a c t a n d d u r i n g t h e

t e r m h e r e o f . . . . . .

This grant of right is the main purpose of the petroleum contract. All other rightsand obligations are subordinate to it. The clause gives the contractor the right toconduct the components of Petroleum Operations, which are: exploration,appraisal, development, extraction, production, stabilisation, treatment,stimulation, injection, gathering, storage, building rail or roads for loadingfacilities, building connecting entry point to rail network or to existing pipelines,handling, lifting, transporting petroleum to the delivery point and marketing of petroleum from, and abandonment operations with respect to a contract area.

This grant of rights may be mirrored by a similar statement of obligations. Anexample is given below:


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E X C E R P T F R O M T H E B R A Z I L M O D E L A G R E E M E N T :

1 3 . 1 - " D u r i n g t h e e f f e c t i v e p e r i o d o f t h i s A g r e e m e n t a n d a c c o r d i n g t o i t s t e r m s

a n d c o n d i t i o n s , t h e C o n c e s s i o n a i r e s h a l l h a v e , e x c e p t a s c o n t e m p l a t e d i n

p a r a g r a p h 2 . 6 , t h e e x c l u s i v e r i g h t t o p e r f o r m t h e O p e r a t i o n s i n t h e C o n c e s s i o n

A r e a , f o r t h i s p u r p o s e b e i n g o b l i g e d t o , a t i t s o w n a c c o u n t a n d r i s k , m a k e a l l

i n v e s t m e n t s a n d b e a r a l l n e c e s s a r y e x p e n s e s , t o s u p p l y a l l n e c e s s a r y e q u i p m e n t ,

m a c h i n e s , p e r s o n n e l , s e r v i c e a n d p r o p e r t e c h n o l o g y a n d t o a s s u m e a n d

r e s p o n d f o r l o s s e s a n d d a m a g e s c a u s e d , d i r e c t l y o r i n d i r e c t l y , b y t h e

O p e r a t i o n s a n d t h e i r p e r f o r m a n c e , r e g a r d l e s s o f p r e - e x i s t i n g f a u l t , b e f o r e t h e

A N P , t h e F e d e r a l G o v e r n m e n t a n d t h i r d - p a r t i e s , a c c o r d i n g t o p a r a g r a p h s 2 . 2 ,

2 . 3 a n d o t h e r a p p l i c a b l e p r o v i s i o n s o f t h i s A g r e e m e n t . "

This clause sets out an obligation on the concessionaire to make investments, bear all costs, and provide all necessary equipments, personnel, technologyrequired for the conducting of petroleum operations.

Contracts also include provisions on rights and obligations of host governmentsAfter all, they are a party to the contract, too. An example showing the rights of thehost government is shown below:

E X C E R P T F R O M T H E T U R K M E N I S T A N M O D E L P R O D U C T I O N S H A R I N G

A G R E E M E N T F O R P E T R O L E U M E X P L O R A T I O N A N D P R O D U C T I O N I N

T U R K M E N I S T A N O F 1 9 9 7 :

A r t i c l e 7

( a ) f u l l a n d c o m p l e t e a c c e s s t o t h e C o n t r a c t A r e a a n d t h e r i g h t t o i n s p e c t a l l

a s s e t s , r e c o r d s a n d d a t a o w n e d o r m a i n t a i n e d b y C o n t r a c t o r ;

( b ) t h e r i g h t t o r e c e i v e a n d r e t a i n c o p i e s o f a l l m a n u a l s a n d t e c h n i c a l

s p e c i f i c a t i o n s , d e s i g n d o c u m e n t s , d r a w i n g s , c o n s t r u c t i o n r e c o r d s , d a t a ,

p r o g r a m s a n d r e p o r t s ;

( c ) t h e r i g h t t o a u d i t C o n t r a c t o r s a c c o u n t s ;

( d ) t h e r i g h t t o r e c e i v e s h a r e o f P e t r o l e u m .

The same contract also puts a number of obligations on the host government,such as for them to grant all necessary permits and licenses for conducting

petroleum operations and open bank accounts, provide entry and work permits for employees, provide permits for importing equipment and materials, provide access


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to pipelines, prevent hindering the conducting of operations, etc.The contracts will lay out a decision making process that will be used

throughout the life of the contract . This enables both the government and thecontractor to fulfill their respective obligations. This is essentially a series of proposals (by the contractor) and approvals (by the state) as events unfold.

Three basic mechanisms are used:

Yearly work programsPlans for the petroleum project phaseCommittees make decisions and the Operator carries them out

The chapters that follow explain all of these in much more detail. The next

chapter describes the decisions to be made in each phase of the petroleum project.The next describes who does commitee decision making process. The last describeshow the operator carries these out.

S h i f t s I n P o w e r A n d N a t i o n a l i s a t i o n

It is worth noting, before we dive into the details, that this is a markedly differentrelationship between governments and contractors than it was a hundred years agoand it is continuing to evolve. When the oil industry began there were not provisions that allowed the state to share in the decision-making process in

agreements. The international companies enjoyed almost complete operationalcontrol and made all decisions about how and when to explore, develop and produce oil under concession contacts. But as states began to assert their right toownership and control of their natural resources, contracts began to include clausesstipulating joint decision making processes. The contract governance issue isgenerally about how, by whom and what type of project decisions are made and thecontrol tools the host governments or their NOCs have to supervise and check a proper implementation of the contract and have a vote in key operational and other project decisions.

This is a key theme that has come up a number of times in this book: contractsreflect changing times in the bargaining power and the desires of countries. These profoundly important and often deeply political issues of global magnitudemanifest themselves in what might otherwise look like a mundane paperwork generating clause in a petroleum contract. In fact, these clauses are part of thefundamental re-shifting in the balance of power--or at least the attempt to. Some of these dynamics are described in the chapters that follow to help give context tothese contract clauses.

Currently, there is tension between states wishing to assert their sovereignty over natural resources and companies wishing to maintain control over the operations.


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The result, then, is that most contracts signed today represent a compromise. Theyspecify joint management structures and procedures. From the state's point of view,one of the advantages of such joint decision-making mechanisms is to increase itsmanagement control over petroleum operations by the host government. From thecompany's view, this management control can decrease efficiency, increase costsand delay profits. But it can also facilitate better relationships with the state over time.

But just because a state has a NOC or has set up a joint management committee,a more robust and equal decision making process is not guaranteed. Countries

ithout NOCs or management committees can exercise management control andhave discussions with IOCs and be just as effective at shaping their petroleumsector by having the skills, knowledge and laws to effect these goals. This section

does not deal with these systems in much detail since the focus is on what contractdo say, and many of them spend a good deal of their text on these issues.


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T H E R O L E S T H E Y P L A Y

What IOCs must do, when, where, how, and at what cost, constitute one of the thefundamental areas in petroleum contracts. To address these issues, petroleumcontracts include important clauses related to:

the definition of an area where exploration and production will be conductedthe surrendering of unused parts of such area back to the governmentwork and financial committments during each phases of petroleum operationsevaluation of a petroleum finding and development of the fieldannual work programmes and budgetsdata and reports to be provided to the government to inform it and facilitate it inthe decision-making process...and many more

W h e r e : C o n t r a c t ( C o n c e s s i o n ) A r e a O r B l o c k

The size and definition of the contract, or "concession", area for the potentialexploration activity which a government makes available to oil companies is of crucial importance in many respects. One of the important reasons is thatcontractual rights, as granted to an oil company under the petroleum contract is

limited to the contract area. This means that whatever you agree upon in thecontract, is only applicable in the contract area defined in the contract- nowhereelse.

Another important reason is that the determination of size may affect thelikelihood that the IOC will make a commercial discovery within the specifiedarea. The smaller the size of the contract area, the higher the chance that it will beon the same geological oil field, or reservoir, as another contract area. This can leadto complications, as the two parties then have to work together, usually throughcreating a unitisation agreement, to extract the petroleum in the most efficient way

Some countries use standard size of acreage in awarding contracts (e.g. US, UK, Norway, Brazil, etc.). Most of these countries usually use a gridding system basedon geographical minutes. This system allows the contract (concession) area to beaccurately defined by reference to coordinates as defined by the GreenwichMeridian Line. Unlike the countries with predetermined size of contractarea/acreage, the size of the contract area is subject to negotiations and agreementin other countries. For instance, the Trinidad and Tobago Deep Onshore ModelProduction Sharing Contract of 2005 serves an example for the latter option. Theclause 3 of the model contract ("Contract Area") stipulates the following generalcharacteristics:


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M i n i m u m W o r k O b l i g a t i o n s I n E x p l o r a t i o n P h a s e

Governments generally seek to obtain specific minimum work commitments for each year of the initial exploration period with detailed descriptions of the

geological and geophysical work to be carried out in each year. In countries wherethere have been no previous discoveries and where the information available islimited, it can be quite difficult to obtain specific drilling commitments during theinitial exploration period. In effect, seismic work during the initial explorationstage may constitute the only work commitments for oil companies. In thesesituations, the company will commit to a minimum geophysical and geological

ork program (as well as minimum financial commitments to carry out such work programs), save for drilling an exploration well before there is enough positivegeological certainty about the field.

In countries with rich geological prospectivity and previous petroleumdiscoveries, the situation is different as far as the scope of work commitments in theexploration stage is concerned. The core of most work programmes is the obligationto "shoot", or record, a specific number of line kilometres of seismic and to drillexploration or wildcat wells. The determination of work programme or expenditureobligation is usually subject to intense negotiations as this phase constitutes major risks for oil companies before making a commercial discovery. The specification of these terms depends on the circumstances of a particular case and petroleum prospectivity of the country. The minimum exploration work program andexpenditure and drilling obligations are key points in petroleum contracts since afailure in exploration terminates the contract for the oil company and it is notcompensated for the reconnaissance, drilling and appraisal costs and hence suchcosts constitute a sunk cost. Typically, IOCs insist on lesser work program andflexible expenditure obligation with carry forward provision.

The Equatorial Guinea Model Production Sharing Agreement may serve anexample for the scope of work obligations to be carried out by the oil company atthe exploration phase. Pursuant to Article 3 of this Anogla contract ("ExplorationWork Obligations") shall do following minimum work program at its own risk andcost:


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4 9

E X C E R P T F R O M T H E E Q U A T O R I A L G U I N E A M O D E L P R O D U C T I O N S H A R I N G

A G R E E M E N T :

" ( a ) o b t a i n . . . a l l e x i s t i n g 2 D a n d 3 D s e i s m i c d a t a a n d W e l l d a t a a t a p u r c h a s e

p r i c e o f [ _ _ _ ] D o l l a r s ( $ [ _ _ _ ] ) a n d o b t a i n f r o m G E S e i s a l l e x i s t i n g 3 D s e i s m i c a n d

s e a b e d l o g g i n g d a t a . . . a n d t h e C o n t r a c t o r s h a l l u n d e r t a k e t o i n t e r p r e t s u c h

i n f o r m a t i o n ;

( b ) r e p r o c e s s [ _ _ _ _ ] k i l o m e t e r s o f e x i s t i n g 2 D s e i s m i c d a t a a n d [ _ _ _ ] k i l o m e t e r s o f

3 D s e i s m i c d a t a ; a n d

( c ) a c q u i r e [ _ _ _ _ ] k i l o m e t e r s o f n e w 3 D s e i s m i c d a t a .

D u r i n g t h e S e c o n d E x p l o r a t i o n S u b - P e r i o d , t h e C o n t r a c t o r m u s t d r i l l a

m i n i m u m o f [ _ _ _ ] E x p l o r a t i o n W e l l [ s ] t o a m i n i m u m d e p t h o f [ _ _ _ _ _ ] m e t e r s

b e l o w t h e s e a b e d . T h e m i n i m u m e x p e n d i t u r e f o r t h i s p e r i o d s h a l l b e [ _ _ _ ]

D o l l a r s ( $ [ _ _ _ _ ] ) . "

Under the outlined model, the contractor shall not only acquire and interpretcertain seismic required to drill a number of exploration wells and invest the agreedamount of required financial commitments.Such financial commitments are usuallyequivalent in value to the estimated costs of the minimum work programs which arstipulated in the agreement for each year. In the event of the stipulation of thedefined amount of financial commitment, the contractor must satisfy both theminimum work commitment and the minimum financial commitment for a particular year. Thus, if the minimum financial commitment has been met but theminimum work program has not been completed, the contractor must neverthelesscomplete that work program. Conversely, if the work program is completed but thefinancial commitment has not been fully expended, the contractor will be requiredto conduct additional exploration activities up to the balance of the financialcommitment.

R e l i n q u i s h m e n t


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R e l i n q u i s h m e n t

One of the techniques for ensuring that the oil company carries out explorationexpeditiously, and does not "lock up" the contract area, is to require mandatoryrelinquishment, meaning surrendering the unused part of the contract area or block back to the government. To encourage rapid and through exploration, petroleumagreements normally contain provisions for voluntary and mandatoryrelinquishment or surrender of acreage or contract area clauses such as"Relinquishment of the Contract Area". The aim of such a clause in petroleumcontracts is to ensure that the IOC surrenders the unused parts of the contract area or block back to the government on a timely basis. The Indian Model ProductionSharing Contract for Seventh Offer of Blocks as of 2007 serve an example for general relinquishment obligations under petroleum contracts (Article 4):

E X C E R P T F R O M T H E I N D I A N M O D E L P R O D U C T I O N S H A R I N G C O N T R A C T F O R

S E V E N T H O F F E R O F B L O C K S , 2 0 0 7 :

4 - " I f a t t h e e n d o f t h e f i r s t E x p l o r a t i o n P h a s e , t h e C o n t r a c t o r e l e c t s , p u r s u a n t

t o A r t i c l e 3 . 4 , t o c o n t i n u e E x p l o r a t i o n O p e r a t i o n s i n t h e C o n t r a c t A r e a i n t h e

s e c o n d E x p l o r a t i o n P h a s e , t h e C o n t r a c t o r s h a l l r e t a i n u p t o s i x t y p e r c e n t ( 6 0 % )

o f t h e o r i g i n a l C o n t r a c t A r e a , i n c l u d i n g a n y D e v e l o p m e n t a n d D i s c o v e r y A r e a i n

n o t m o r e t h a n t h r e e ( 3 ) a r e a s o f s i m p l e g e o m e t r i c a l s h a p e s a n d r e l i n q u i s h t h e

b a l a n c e o f t h e C o n t r a c t A r e a p r i o r t o t h e c o m m e n c e m e n t o f t h e s e c o n d

E x p l o r a t i o n P h a s e . N o t w i t h s t a n d i n g t h e p r o v i s i o n o f t h i s A r t i c l e 4 . 1 , i n t h e e v e n t

t h e D e v e l o p m e n t A r e a s a n d D i s c o v e r y A r e a s e x c e e d s i x t y p e r c e n t ( 6 0 % ) o f t h e

o r i g i n a l C o n t r a c t A r e a , t h e C o n t r a c t o r s h a l l b e e n t i t l e d t o r e t a i n t h e e x t e n t o f

D e v e l o p m e n t A r e a s a n d D i s c o v e r y A r e a s .

At the end of the second Exploration Phase, the Contractor shall retain only

Development Areas and Discovery Areas." Such provisions prevent petroleum companies from locking uplarge

contract areas which they do not use for exploration work.In addition to mandatory relinquishment clauses, petroleum contracts may also

include voluntary relinquishment mechanisms whereas the oil company surrendersa part of the contract area back to the government even though the contract doesnot require it to do so. Under voluntary mechanism, the contractor will usuallyhave the opportunity to surrender voluntarily any or all of the area at any timesubject only to fulfilling the work commitments and serving an advance notice tothe government.


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E X C E R P T F R O M T H E P R O D U C T I O N S H A R I N G C O N T R A C T B E T W E E N T H E

G O V E R N M E N T O F T H E U N I T E D R E P U B L I C O F T A N Z A N I A :

" ( a ) I f C r u d e O i l i s d i s c o v e r e d i n t h e C o n t r a c t A r e a , C o n t r a c t o r w i l l , w i t h i n t h i r t y

d a y s f r o m t h e d a t e o n w h i c h e v a l u a t e d t e s t r e s u l t s r e l a t i n g t o t h e d i s c o v e r y a r e

s u b m i t t e d t o T P D C , i n f o r m T P D C b y n o t i c e i n w r i t i n g w h e t h e r o r n o t t h e

d i s c o v e r y i s i n t h e o p i n i o n o f C o n t r a c t o r o f p o t e n t i a l c o m m e r c i a l i n t e r e s t .

( b ) I f C o n t r a c t o r i n f o r m s T P D C t h a t , i n i t s o p i n i o n , u t i l i z i n g g o o d o i l f i e l d

p r a c t i c e , t h e d i s c o v e r y i s o f e v e n t u a l c o m m e r c i a l i n t e r e s t a n d T P D C a g r e e s w i t h

s u c h d e t e r m i n a t i o n , t h e n t h e M i n i s t e r s h a l l b e a d v i s e d t o a g r e e t o a l l o w t h e

C o n t r a c t o r t o r e t a i n t h e D i s c o v e r y B l o c k f o r t h e d u r a t i o n o f t h e E x p l o r a t i o n

L i c e n c e a n d a n y r e n e w a l t h e r e o f . . . "

After a discovery found to be commercial by the petroleum company as thecontractor, in development stage, as in the case of exploration, the objectives of theoil company and host government regarding the timeline and the scale of investments needed to develop a field can differ. Host governments usually have aninterest in rapid development of any field which is discovered. Given the limitedduration of the contract, the oil company also has such an interest. However, if fullfreedom to decide whether to develop a particular discovery is left entirely to theoil company, there are potential risks that the petroleum company could decline toinvest in development immediately because of its other priority projects in terms of its world-wide operations. Therefore, in order to mitigate such potential risk thecontracts usually tend to put some time limit and other requirements (immediatesupply of information to the government, formal approval, etc).

In the event the petroleum company declares a finding to be commercial, petroleum contracts usually provide that it petroleum company as contractor must prepare and submit to the Ministry or Joint Management for approval its plan for

the development and production of petroleum from the contract area ("FieldDevelopment Plan" or "Development and Production Plan"or "Exploitation Plan").This Plan is a long range plan for the efficient and prompt development and production of petroleum from the contract area. The Azerbaijani PSA may serve anexample for such a mechanism. Under this PSA (Article 4.4.), the Contractor within30 days days following completion of the minimum work programme the petroleum must prepare and submit to the Steering Committee for approval its planfor the development and production of petroleum from the contract area, whichmust include the following components:


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E X C E R P T F R O M T H E T H E A Z E R B A I J A N I P S A :

4 . 4 - ( i ) p r o p o s a l s r e l a t i n g t o t h e s p a c i n g , d r i l l i n g a n d c o m p l e t i o n o f a l l w e l l s , t h e

p r o d u c t i o n a n d s t o r a g e i n s t a l l a t i o n s , a n d t r a n s p o r t a t i o n a n d d e l i v e r y f a c i l i t i e s

r e q u i r e d f o r t h e p r o d u c t i o n , s t o r a g e a n d t r a n s p o r t a t i o n o f p e t r o l e u m ; a n d

( i i ) p r o p o s a l s r e l a t i n g t o n e c e s s a r y i n f r a s t r u c t u r e i n v e s t m e n t s a n d u s e o f

A z e r b a i j a n m a t e r i a l s , p r o d u c t s a n d s e r v i c e s ;

( i i i ) a p r o d u c t i o n f o r e c a s t f o r f o r m a t i o n f l u i d s f o r t h e e n t i r e c o n t r a c t A r e a b y

r e s e r v o i r d e r i v e d f r o m i n d i v i d u a l w e l l f o r e c a s t s a n d a n e s t i m a t e o f t h e

i n v e s t m e n t a n d e x p e n s e s i n v o l v e d ; a n d

( i v ) a n e n v i r o n m e n t a l i m p a c t a n d h e a l t h a n d s a f e t y a s s e s s m e n t ; a n d

( v ) a n e s t i m a t e o f t h e t i m e r e q u i r e d t o c o m p l e t e e a c h p h a s e o f t h e d e v e l o p m e n t

p r o g r a m m e .

In light of the above clause, the Field Development Plan include not onlyoperational and infrastructure issues, but also local content and ESIA issues whichare hugely important for host governments. The approval mechanism of development programmes in a comparative perspective is discussed in the nextsection entitled "Contract Governance".

In light of the importance of exploration and development for host governmentsone of the important issue is the consequence if petroleum company fails to carryout the work commitments during the exploration and development. To counter such risks, petroleum contracts may stipulate that in the event the contractor fails tocarry out the exploration work programme and development programme within acertain period of time, except in case of force major, the Ministry or NOC usuallyhas the right to unilaterally terminate the contract and the costs incurred during theexploration, development and bonuses are not cost recoverable.

If at the end of the initial exploration period (including any extension period) no

commercial discovery has been made, the petroleum contract automaticallyterminates. As a rule, the development and production period begins from the dateof the notice of discovery and its commerciality submitted by the oil company tothe government or NOC and continues for a number of years, for example, 25-30years. At the end of the contract, the IOCs transfer all petroleum operations andassets back to the host government or NOC, as the case may be. Petroleumcontracts should make sure that there is enough security of tenure, meaning the oilcompany has an automatic development and production rights once a commercialdiscovery is made at the exploration phase.

A n n u a l W o r k P r o g r a m s & B u d g e t s


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A n n u a l W o r k P r o g r a m s & B u d g e t s

In addition to the longer range plans that occur during the appraisal anddevelopment phases, the contractor is typically, the contractor is obliged to submita work plan for the activities it wants and thinks necessary to conduct in thecoming year. A government ministry or agency will then review and approve; andif the state does not approve, then it will have a set amount of time modify, discuss,and come to agreement with the contractor. These annual work programmes and budgets are one of the core parts of petroleum contracts because they give the statemore of a role in the decision making process of what activities will be conductedeach year. Petroleum contracts call these "Work Obligations", "Exploration Work Obligations", "Minimum Expected Exploration Work Committment and ExpectedMinimum Exploration Expenditures", "Production Period Work Programme",

"Annual Work and "Budgets" among others. Regardless of the difference of terminologies, such clauses define and regulate the core operational and financialissues, such as, the scope of works and financial committments to be carried out bythe IOC in a particular year during each phase of the petroleum contract, meaningexploration, development and production phases.

No matter what this document is called, it should describe, item by item, the petroleum operations to be carried out during a calendar year, for example, howmany wells (appraisal, development and productions wells, as the case may be) will be drilled, pipelines, facilities to be constructed, procurement plans, etc. Contractsusually require the submission of work programmes to be accompanied withBudgets, meaning estimates of expenditures for carrying out in an annual work programme. The Angola Model Production Sharing Contract for Deep Water Blocks between SONANGOL and International Companies may serve an examplefor this particular case (Article 19 Development and Production Work Plans andBudgest):


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E X C E R P T F R O M T H E A N G O L A M O D E L P R O D U C T I O N S H A R I N G C O N T R A C T F O R

D E E P W A T E R B L O C K S

19 - "1.From the date of approval of the plan referred to in Article 18, andthenceforth by fifteen (15) August of each Year (or by any other date whichmay be agreed) thereafter, Contractor Group shall prepare in

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