Production sharing contract (PSC) is simply a contract between a Country or its National Oil Company (NOC) and a Foreign Oil Company (FOC); under this contract the country grants to the FOC the right to conduct Exploration and Production activities in a delimited area and for a limited time.
The FOC bears all the costs and the risks associated with the corresponding Exploration and Production activities. All of the hydrocarbons produced belong to the country.[1]
Since its introduction into the petroleum industry, production sharing contracts have been the toast of the oil and gas industry worldwide. It was introduced in Indonesia[2] as a politically motivated contractual arrangement which had the image of state control over the country’s petroleum resources, this was particularly important because nations were at that time struggling to have permanent sovereignty over their natural resources.
Countries such as Malaysia, Oman, Egypt, Libya, Angola, Peru, Philippians, Sudan and Thailand opted for production sharing contracts rather than traditional or modern concessions in their petroleum industries. Some countries currently operating PSCs in their petroleum subsectors are Argentina, Bangladesh, Bolivia, Cameroon, Chile, Egypt, Ethiopia, Malaysia, Vietnam, Yemen, Trinidad and Tobago, Equatorial Guinea, Georgia, India, Indonesia, Iraq, Kazakhstan, Madagascar, Nigeria, Peru, Russia, Thailand.[3]
Production sharing contracts were introduced into Nigeria following several contractual breaches in the joint venture agreements by the Nigerian National Petroleum Corporation (NNPC) specifically the inability of the government to meet its cash call obligations under the joint venture agreements.[4]
Features of Production Sharing Contract
Production sharing contract in Nigeria has some distinct features from other forms of contractual arrangements in the upstream petroleum subsector.
The first and the most important feature of a PSC is that the title of the oil and gas remains with the state and not the IOC. Although the oil and gas companies are given exclusive exploration and production rights over a stipulated acreage for a period of time, the oil and gas company is only seen as a contractor operating at sole risk and expense on behalf of the NOC, who really owns the petroleum products and shares from the profit without really making an investment or taking a risk.
Signature and production bonuses are a major feature of the production sharing contracts in Nigeria; in this system, these bonuses are paid to the federal government by the IOCs at various pre-agreed stages. Signature bonus is usually paid at the date of execution of the agreement,[5] while the production bonus is paid when the company has completed a certain agreed production threshold.[6]
Payments for Royalty called Royalty oil is another striking feature of the production sharing agreements in Nigeria, Royalty oil is the amount of crude allocated to the NNPC as payment each month for Royalties and rent due for the grant of a concession.
The royalty oil payment is backed by the provisions of Petroleum (Drilling and Production) Amendment Regulations 1969[7] for Onshore Royalty payments and the Deep Offshore Decree 1999[8] for offshore payments.
PSCs provide for a management committee which is similar to the operating committee under a Joint Venture Agreement. The management committee clause in a model NNPC production sharing contract provides that a management committee should be established within 30 days from the date of the execution of the contract.
The management committee should be made up of ten (10) persons appointed equally by the parties, five (5) from the NNPC and five (5) from the Contractor. The NNPC will appoint the chairman of the committee while the contractor will appoint its secretary who shall not be a member of the management committee.[9]
The duration of a Production Sharing Contract in Nigeria is for a thirty (30) year period commencing from the date of the PSC, the thirty years period is divided into two terms often (10) years for exploration activities also called the exploration phase and twenty (20) years for production of the petroleum products also called the production phase.[10]
Diagram 1 illustrates how the oil derived from the petroleum sharing contracts is divided
Diagram 1
The Nigerian experience under production sharing contracts.
Nigeria happens to have gained favourably from her Production Sharing Contract agreements a lot more than she did from the previous contractual arrangements. Her Production Sharing Contract arrangement is patterned in a way that she gets all of the benefits and contributes little or nothing to the projects in terms of capital and expenditure while still having title to her natural resources.
Nigeria merely takes her pre-agreed percentage share of the produced oil after the IOC has taken its cost of production in the form of cost oil. Currently, Statoil, Snepco, Esso, Elf, Nigerian Agip Exploration Ltd, Addax, Conoco and Petrobras, Chevron, Oranto Philips and Star Deep Water are operating the Production Sharing Contract in the country.[11]
Seeing as Nigeria is a technologically backward country (with due respect) lacking the requisite technology and technical/technological skills to embark in the exploration and production of her resources, the PSC has proved to be the best form of arrangement for the country since the technical expertise and the technology will be brought in wholly by the IOC without bothering the country with providing or purchasing same.
The PSCs have certain bonuses, some of which are payable even before the metal heats the ground. Some of these bonuses include signature bonuses, prospective bonuses, special bonuses, production bonuses and minimum financial commitments. These bonuses vary from contract to contract.
Nigeria also gains in the PSCs by way of local content improvement and development in the petroleum industry. The PSCs provide for a local content clause which expressly state areas in the exploration and production process that must be occupied by Nigerians, and areas where Nigerian products must be used rather than imported ones.
The PSC is a contractual agreement unlike the Concession, it, therefore, gives the country the freedom to amend the terms of the contract or even revoke the licenses of the contractors as she deems fit since the sovereignty of natural resources in a PSC still and will always remain with the country.[12]
Nigeria’s experience in the PSC contracts has not been all rosy and without its own challenges. The first problem with this mode of contract in Nigeria is that a contractor may decide to develop the most profitable part of the oil well and decide to abandon or ignore the less productive or most risky parts of the contract area.
The fiscal regime for oil and gas in Nigeria has been a rather challenging aspect in the PSCs the PSCs provide for royalty payments according to the depth of the water where oil is found offshore. These provisions state that zero royalty should be paid on production activities conducted from depths of 1000 meter. This offshore clause in the PSCs has proved to be detrimental to Nigeria’s economic interests as about $60 billion have been lost by the country from all five deepwater oil fields[13] that came on-stream between 2005 and 2010.[14]
The extravagant nature of the IOCs is another major bane in the PSCs in Nigeria. The fact that what constitutes the cost of production is not clearly defined gives the IOCs the needed freedom to be extravagant in their spending knowing that the cost of those spending will be recovered as cost oil from the oil produced.[15] This is a huge disadvantage for the Host Country. For instance the discovery by the Senate that Shell petroleum spent about N602 billion in the development of the Bonga oil field.[16] This money was recovered from cost recovery oil.
Furthermore, the provision of renegotiation and an upward review of the sharing formula when oil prices hit a high of above 20 dollars per barrel in the PSC have not been used by the Nigerian government thereby creating room for huge losses from the proceeds of petroleum products.
These windfall profits favour the IOCs as it has no effects on the government’s net profit if the price of oil products increases, it thereby increases the profits of the IOCs and Nigeria does not get a lot from the said increase as the percentage of the profit belonging to Nigeria is fixed.
There is also the problem of local participation, it has been said that Nigeria lacks authentic local participation in the production of our oil and gas resources.[17] Although there exist several structures and legal provisions for the advancement of local content in Nigeria which should bring about technological and indigenous advancement in the sector, this has however not been the case. Not because of the lack of aborigines but for the lack of funding, commitment and the presence of corruption.
Relinquishment and title to assets
A Relinquishment clause is a clause in a PSC that obligates the IOC to relinquish some of the contract areas after a period of time if it is not being exploited or expected to be exploited in a short while. The entire leased area can also be relinquished when petroleum can no longer be produced from the leased area or the oil well is no longer profitable for the IOCs to produce petroleum from or at the expiration of the PSC contract.[18]
With regards to the Assets of the contractors, the PSCs provide that the assets used by the contractors in carrying out the production of petroleum resources vests in the state and it would remain so even after the conclusion of the contract.[19]
Title passes to the state in different stages and processes depending on the jurisdiction where the contract is carried out. In Nigeria, Angola and Indonesia title passing automatically upon purchase in, or importation into, the country[20]
It is pertinent to mention that the cost of the equipment will be included in the cost of production thereby recovered by the IOC in cost recovery oil; hence the equipment would have technically been bought by the Host state already.[21]
To avoid the obvious shortcoming that may arise from the title to the infrastructure, The IOCs tend to hire subcontractors who own this equipment or can hire same to carry out various activities on the leased area and where possible the IOCs may lease these infrastructures.
[1] Commercial Law Development Program, United States Department of Commerce (2015)
[2] Tengku Nathan Machmud, the Indonesian production sharing contract: an investor’s perspective (Kluwer law international, 2000), 43-88
[3] Retrieved 22/02/2018 from http://www.iea.usp.br/midiateca/apresentacao/welmakerjrpresal.pdf/
[4] Ag Ogun state v Ag Federation (2002)12 S.C. (PT.II)1
[5] Production sharing contract between Nigerian National Petroleum Corporation and 1.gas transmission and power limited 2. Energy 905 suntera limited 3. Ideal oil and gas limited covering block 905 Anambra Basin. At pg 12
[6] Retrieved on 9/02/2018 from www.energymixreport.com/the-nigerian-production-sharing-contract-an-overview/
[7] Section 61(1)(a)
[8] section 5
[9] Production sharing contract between Nigerian National Petroleum Corporation and 1.gas transmission and power limited 2. Energy 905 suntera limited 3. Ideal oil and gas limited covering block 905 Anambra Basin. Clause 7(3)(e)
[10] Retrieved on 9/02/2018from www.energymixreport.com/the-nigerian-production-sharing-contract-an-overview
[11] Retrieved 10/04/2018 from http://napims.com/dynamic.html.
[12] Ibid
[13] Shell’s Bonga, ExxonMobil’s Erha, Chevron’s Agbami, and Total’s Akpo and Usan fields
[14] Retrieved 6/03/2018 from https://www.thisdaylive.com/index.php/2017/08/07/kachikwu-nigeria-lost-60bn-to-non-enforcement-of-pscs-with-oil-majors/
[15] Omorogbe, Y. (1986) “Contractual Forms in the Oil Industry: The Nigerian Experience with Production Sharing Contracts” 20 J.W.T.L. (1986) p. 342
[16] The Guardian 1 st May, 2006: 1-4
[17] Wumi Iledare, Oil and the Future of Nigeria: Perspectives on Challenges and Strategic Actions for Sustainable Economic Growth and Development: presented at USAEE/IAEE Conference September 24-27 2006 pg 2
[18] http://www.allenovery.com/SiteCollectionDocuments/geiprogram.pdf retrieved on 22/02/2018
[19] ibid
[20] Ibid
[21] Y. Omorogbe (1997) Op.cit
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Written by: Bright Akpan
Bright Akpan is an Abuja based energy expert, legal practitioner and co-partner at Lawnergy Consults. He is currently working on chasing his PhD in Energy law. Bright is a lover of good novels. You can reach him via his email: brightakpan83@gmail.com
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