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Advantages of Production Sharing Contracts

Industry Petroleum Oilfield Pump Jack Fuel Oil

Estimated reading time: 5 minutes

Industry Petroleum Oilfield Pump Jack Fuel Oil

Production Sharing Contracts 2019

 

A PSC (Production Sharing Contract), or PSA (Production Sharing Agreement), creates a contractual relationship between an IOC (International Oil Companies) and the host country, authorising the IOC to explore for and exploit hydrocarbons in a defined area and for a defined period.

By definition, a PSC is a contract between one or more investors and the host country in which rights to prospection, exploration and extraction of mineral resources from a specific area over a specified period of time are determined. In other words, a PSC is an agreement between the parties to a well and a host country regarding the percentage of oil and gas production each party will receive after the parties have recovered a specified amount of costs and expenses.

The host country, as the owner of the hydrocarbons, hires the IOC as a contractor for the conduct of exploration and production work and the IOC incurs all the costs associated with the business of exploring for and producing hydrocarbons within the geographical area defined in the PSC. If a commercial discovery is not made, then these costs will not be recoverable by the IOC from the host country.

There are several pros and cons as to why some companies are adopting PSCs as the choice for the type of oil and gas agreements.

 

Advantages of PSCs

  • Low risk for the host country
  • Knowledge transfer from IOC to host country
  • Various cost recovery strategies for both parties

 

  • Low risk for the host country

Through PSCs, the host country is able to develop new reserves at no risks and limited costs. The host country does not need to make a significant amount of investment for exploration & production activities. After all, the IOC carries all operational and financial costs and risks.

  • Knowledge transfer from IOC to host country

An IOC, by definition, produces oil and gas from several countries. Hence, when they enter the host country, they can transfer their expertise to the host country and the host country is able to learn from them. All technology and strategic decisions on the field are led by the IOCs.

  • Various cost recovery strategies for both parties

When writing the PSCs, both parties must agree upon the best cost recovery strategy. The differences between the strategies are how the gross revenues are split and how the profit pool is shared between the two parties.

The 4 types are:

  1. Full cost recovery, deferred profit shares
  2. Full cost recovery, deferred profit shares, with first tranche hydrocarbons
  3. Capped cost recovery, simultaneous profit shares
  4. First tranche hydrocarbons, capped cost recovery, simultaneous profit shares.

 

However, PSCs do have the its drawbacks such as the complexity of writing these agreements. A lot of key factors need to be agreed upon prior to the signing. Given that only a small number of exploration efforts lead to a commercial discovery, the work commitment and financial obligations are crucial negotiation factors as they define the extent of the exploration risk. The host country will want to draft these with as much specificity as possible while IOCs prefer commitments that allow maximum discretion.

 

Read also: Understanding Production Sharing Contracts

 


Regional Masterclass Production Sharing Contracts 2019 is a 3-day training course held from 21-23 October 2019 (Kuala Lumpur). This course has been specifically designed to provide the delegate with a clear insight into some of the central issues and mechanisms that define a PSC. The course is an immersive experience with case studies and exercises throughout. The delivery is through open; fluid dialogue – class discussion and knowledge sharing. The course trainer has 30 years’ of experience within the oil and gas industry, with over 17 years teaching experience including a number of universities across a wide range of subjects. He is a specialist in consulting within the domain of creating high performance teams.

 

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