Offshore oil and production sharing contracts

By Dulip Jayawardena

Oil exploration in Sri Lanka has a history which dates between 1966 and 1984, when the Soviet and Western entities concentrated on land and shallow offshore areas of the Cauvery Basin in the Gulf of Mannar.

During this period 18,000 kms of seismic data and seven exploratory wells were drilled. All the wells were dry, except the three wells drilled in Mannar Island by the Soviets, which encountered wet gas at several depths.

However, interest was again shown by US and Canadian companies after a flow of 1488 barrels/day were recorded from a test hole drilled in cretaceous sands on the Indian side 30 kms from one of the holes drilled on the Sri Lankan side.

In 2001, a license was awarded by the Ceylon Petroleum Corporation (CPC) to carry out off shore 2D seismic surveys in the Mannar Basin to TGS NOPEC. Between June- July 2001, 1100 kms of seismic data was recorded and processed by Western Geco.
Further analysis of the data by Dr Ray Shaw, team leader from the University of New South Wales (UNSW), which was awarded a contract by the ADB, concluded that the Gulf of Mannar Basin represents a new deep-water frontier region, which had promising indications of having significant oil and gas accumulations.

Further, the findings were presented by CPC at the South Asian Petroleum Society (SEPEX) Conference in December 2001 and with the confirmation of the findings of UNSW, TGS NOPEC carried out a further 7000 –8000 kms of seismic lines in the Gulf of Mannar Basin purchased by the government for US $ 8 million in 2006. However it is not clear as to the details of the data and the areas covered and whether TGS NOPEC is still holding to some of the data even after the agreement signed by CPC was annulled.

In 2003 the Petroleum Resources Act No. 26 of 2003 was legislated and the Petroleum Resources Development Committee (PRDC) and the Petroleum Resources Development Secretariat (PRDS) established that the PRDC had representation from relevant ministries and other agencies and chaired by the Secretary to the Ministry of Petroleum Resources.

The Director General heads the PRDS. It has been reported that eight off shore blocks have been demarcated and Block 1 in the north and Block 8 in the south have been awarded to India and China. Blocks 2, 3, and 4 will be subject to International Bidding.
It is also reported that the government has finalized a Production Sharing Contract (PSC) and a Taxation Regime for the award of the Blocks and it is not clear what the arrangements are for the Indian and Chinese Blocks.

Production Sharing Contracts (PSC)
A PSC is an arrangement between a contractor and the government whereby the contractor bears all the exploration costs, risks, development and production costs in return for an agreed share of production.

Such a contractual framework has three major areas that are paramount namely the constitution (ownership vested in the State Part 1 of the Act) tax law and petroleum legislation.

There is also Joint Operating Agreements (JOA) where the government agrees to share costs with a number of contractors.
Petroleum legislation in many countries is known to be too archaic and a comparison of the Petroleum Acts especially from developing countries will help to make appropriate amendments.

I shall very briefly give an overview of the relevant components of a PSC. It must be kept in mind the off shore areas of the Gulf of Mannar are in deep water with depths varying from 1000 to 3000 meters (3200 to 10000 feet) with no records of near shore prospects. Accordingly when PSCs are negotiated the risk factor has to be taken to serious consideration.

In a PSC, an Outline of the Scope that will include the parties and Definitions such as production date, commercial discovery etc has to be included as in a normal contract.

The Purchase of Data will define the data package (TGS NOPEC) the government purchased. Such costs could vary from US $ 10,000 to 100,000 depending on the quality.

The Duration, Relinquishment and Surrender will include the contract period and the percentage of area to be relinquished after a specific period. In Timor Leste it is 25 percent after 3 years and another 25 per cent after 6 years. And exploration is 6 years with a 4-year extension.

Work Programmes and Expenditures are important. The contractor is bound to carry out an agreed work programme with minimum expenditure levels. It is important that there should be a specific time period to start exploration that is usually under 12 months.
For example in Timor during the one year an expenditure of US $ 1 –4 million has to be spent which would include 3 D Seismic survey. During the 2-year costing US $ 0.5 to 8 million has to be for drilling. And in the third year 1-3 wells with a cost of US $ 20 million and the fourth year 1-4 wells costing US $ 6 – 30 million should be completed. Some of these holes may strike productive oil reservoirs.

Once a discovery is made the productive limits of the oil field have to be mapped and identified. This is important as the cost recovery of exploration and development are subject to “Ring Fencing” where such costs are confined to only one area and cannot be extended to another area within the same block or another license area where exploration was not successful. However development costs of more than one field may not be subject to “Ring Fencing”

Signature bonus is very unpopular with the oil industry but could be a part of competitive bidding.

Production bonus will stipulate a period and an amount of 10,000 barrels of oil per day (BOPD) if exceeded the government is entitled to US $ 2 million. However it will vary depending on the production and reserves together with the depletion rate.

The rights and obligations of the government (PRDC) have to be clearly spelled out and include access to data, monitor contractor’s work programme, right to appoint representatives to the management team if it is a JV, right to remove contractor’s employees and in certain instances use of equipment.

The rights and obligations of the contractor are also included such as fulfillment of all technical requirements, funds for the work programme, rights to sell or transfer its rights and interests to third parties, payment of taxes, submit weekly or monthly reports to PRDC, give preference to goods and services in host countries, provide access to operating areas to representatives of PRDC.
The other components that should be included in a PSC are valuation of petroleum exported by contractor for Production Sharing on an agreed split after recouping expenditure, payments in foreign currency, and net sales proceeds allocation. In this case some countries allow 100 per cent cost recovery for production but some allow anything between 80 –40 per cent depending on the prospectivity of the area. Exploration costs invariably are recovered in full.

Employment and training of local personnel are given in most PSCs. Another issue is that some PSCs stipulate that all equipment brought by the contractor become the property of the state oil company after the expiry of the contract

Common clauses such as “force majure” are also included. The most important clause in a PSC is arbitration on dispute settlement and includes non-judicial dispute resolution mechanisms such as ICSID (International Centre for Settlement of Investment Disputes) ICC (International Chamber of Commerce) UNCITRAL (United Nations Committee on International Trade Law) and AAA (American Arbitration Association). The government should be a party to such agreements.

The other components of a PSC are insurance, termination; provision for contract modification and abandonment. It is customary for the host government to bear the cost of removal and disposal of off shore oil platforms and structures. However UN ESCAP had initiated a removal regime for East and South East Asia where the contractor and the host government share the costs and includes legal, technical and financial guidelines. The cost of removal of a small oil platform will exceed US $ 3 million.

The normal exhibits of a PSC will include Description of Contract Area, Map of Contract Area, Accounting Procedure and Management Procedure.

It must be stated that PSCs will vary from country to country and also from known oil and gas bearing areas to unknown territories such as the Mannar Basin. It is up to the PRDC with the advice of its consultants to evolve a model PSC that would adequately address the challenges posed such as unknown territory, deep water and the absence of adequate data specially 3 D seismics. It must also be stated that only a few countries such as Norway have the technology to explore and operate oil and gas fields in deep water.

Finally I would also draw the attention of the government, that the PSC that is supposed to have been finalized and not in the public domain should be compatible with the Petroleum Resources Act No. 26 of 2003 specially Part V that spells out the Fiscal Provisions. I am not aware whether Regulations under this Act have been legislated and if so most of the fiscal and other arrangements in the PSC could have been included.

(The author is a retired Economic Affairs Officer of United Nations ESCAP who was in charge of the Marine Affairs Programme from 1990 to 2003 and can be contacted on fasttrack@eol.lk)