While Governments may typically be the owner of the oil resources under the ground, they generally delegate the task of exploration and developing these resources to international oil companies. The relationship between the Government and the oil companies is regulated through the conclusion of a contract which caters for the rights and obligations of each of the parties.

There are a number of upstream contracts available when contracting with oil companies and other players in the industry. Certain contracts can be characterized as allowing the international oil companies a greater degree of control and profitability.

Concession or Licence Contract

As is the case with every other business, a licensee makes a profit and is required to pay taxes on any profit. There is therefore a need for a strong and well developed legal system when using license or concession contracts.

Unsurprisingly, these types of contracts are liked by oil companies as the oil recovered belongs to them. These contracts therefore allow for what is known as the “booking of reserves” and, in theory, there is no limit on profit that can be made by oil companies.

These kinds of contracts are seen more commonly in developed markets.

PSA

PSAs are typically used in countries with undeveloped legal systems. Host Governments like them as the ownership of the oil remains with the Government. The most popular examples are seen in the African continent and the Middle East.

Typically the Government share will increase as production increases.

Service Contracts

Host Governments use this type of long-term contractual arrangement in order to acquire the international oil companies’ expertise and capital, while still maintaining ownership of the oil. These are considered to be the least popular as it results in limitation on the profits derived and has a tendency to result in the destruction of the resource.

Examples can be seen in Mexico and Ecuador. A service Contract may either be ‘pure service contract’ or ‘risk service contract’.

• In a pure service contract, the oil company will perform the exploration and production in exchange for a flat fee, the recovery of their operational costs is guaranteed and will not be dependent the projects commercial viability.
• In contrast, risk service contracts the oil company’s recovery is directly linked to the commercial viability of the project.

Licences: General

An Exploration Licence is a non-exclusive exploration licence, granted in order for the licensee to carry out geoscientific surveys. A Production Licence on the other hand is a concession which grants an exclusive rights to conduct exploration drilling and production of oil and gas within a designated area. Production Licences are generally granted under licensing rounds and may include certain performance targets, standard conditions and requirements for relinquishment.

A license generally imposes certain obligations and restrictions on licencees. For example, these may include certain obligations to carry out work, restrictions on disposal and changes in control, operational standards, restrictions on flaring, payments of fees, royalties, bonuses and tax as well as liabilities taking into account the structure of the licencee.

PSAs: General

PSAs are concluded between oil companies and Governments and/or the appropriate state enterprise. A PSA determines and grants the rights to prospect, explore and extract mineral resources from a specific area over a specified period of time. PSAs are usually granted in terms of development phases and will often include similar obligations and conditions as licenses do in respect to required work plans and relinquishment rights.

Under a PSA the contractor will be responsible to provide for all funding of the exploration and production activity. In order for exploration to begin, a declaration of commerciality is required as a prerequisite.

Under a PSA, the state takes a share of the production through:

• Royalties
• Cost recovery
• Profit sharing