Production Sharing Contract

Prakhar MBA Energy & Environment 12020243008

Contents
History: Exploration & Production in India ............................................................................................. 2 Review of Production sharing Contract ................................................................................................... 2 Exploration & Development Period......................................................................................................... 3 Changes in minimum work programme (MWP) ..................................................................................... 3 Cost Petroleum & Production Sharing ..................................................................................................... 4 Authority of Management Committee .................................................................................................... 5 Quantification and Valuation of the Hydrocarbons Produced ............................................................... 5 Domestic Supply, Sale, Disposal & Export of Crude Oil& Condensate ................................................... 5 Force Majeure .......................................................................................................................................... 6 Conclusion ................................................................................................................................................ 6 Reference .................................................................................................................................................. 6

History: Exploration & Production in India

The exploration & production practices in India can be traced back to the year 1889, when the first ever oil field in India were discovered in Digboi, Assam. The oil discovery in India at the onset of Industrial revolution made it very important. The production was started within a year in 1890 which was once a world record. Until fifth and sixth decade of twentieth century Digboi was the only oil producing well in India. Efforts of state owned ONGC started to invest heavily in E&P activities and as a result, black gold was struck in mid of 1970s at Bombay high. And again struck in western offshore of Gujarat then in Krishna Godavari Basin again in Cauvery sea basin. This all was possible due to exploration & production efforts of ONGC and the government policies which were focused on oil production maximization. The oil & gas exploration in India has seen different regimes in the contracting and licensing side of the game. From nomination and royalty based regime to production sharing regime. Though both of them have their own merits and demerits, the people in industry see production sharing contracts (PSCs) or agreements more industry friendly option. The production sharing contract is basically a contract between the government and the contractor (single or consortium of multiple companies) for the purpose of exploration & production of hydrocarbons, namely, oil 7 natural gas. Though the PSCs also have its own demerits, bottlenecks and some drawbacks, in this report we will try to analyze the PSCs and see the issues related to them and the possible ways to overcome that.

Review of Production sharing Contract

The route of production sharing contracts was taken in order to expedite the process of oil & gas exploration, to invite foreign players to invest in E&P activities, enable the availability of latest technology in this field and also and provide a level playing field to the companies. The extent of use of PSCs in the E&P industry can be determined by the fact that currently 228 PSCs are into existence. There are few loopholes in PSC and both the parties to the contracts try to exploit these loopholes in the basic PSC structure to the fullest. Major areas where the tussle between the contractor and the government arise are: exploration & development period, changes in minimum work programme (MWP) due to externalities, cost petroleum, profit petroleum, authority of management committee and operational committee, quantification and valuation of hydrocarbons generated. Now we shall discuss these issues to have better understanding of the production sharing contract. 2

Exploration & Development Period

The exploration & development period mentioned in the production sharing contract are rigid & inflexible. This does not include the delays caused on the part of government agencies in providing the clearances and also the external factors like environment and other probabilities. Currently the exploration period is divided in two (2) phases, viz. initial exploration phase and subsequent exploration phase. The initial exploration phase is for four (4) years span in which the contractor has to perform the oil & gas exploration and try to calculate the area which consists of commercially viable reserves. The next phase or the subsequent exploration period which is for the period of three (3) years, is requested for by the contractor to do extensive exploration of the area having the substantial amount of gas reserves. In all the exploration phase consist of total of seven (7) years which on mutual consent of government and the contractor can be increased to the period of eight (8) years. The rigid timeline in the exploration period is a major cause of tussle between oil & gas exploring companies and the Government of India. The take of the private companies is that the strict timelines prohibit them from performing the extensive study of the area under consideration.

Relinquishment Area
Another major point of discord between the parties to the PSC is the relinquishment area. Relinquishment area is the area which the contractor has to forego after the oil discovery has been done. After the oil discovery the contractor is allowed to keep only the area in which the oil reserves are found and have to hand over the rest of the area to the government or the owner of the land. But in reality, most of the contractors are not willing to return the land, instead they want the government to give them rights to dig more wells in the area for exploration. This issue of relinquishment is also among one of the few current issue between the reliance led consortium and the GoI.

Changes in minimum work programme (MWP)

Minimum Work Programme is the plan of what work has to be done, how that has to be done with utilization of what resources and in how much time. The MWP is bound to change depending on the numerous probabilities, which include delay in clearances by government agencies, inaccuracies in geological data, environment and weather conditions, unavailability of extensive 2D and 3D seismological surveys and also revocation of clearances from a particular area. But the changes has to be approved by the Management Committee (MC). The problem 3

arise in the MC which has two members from the government who would usually look only at the cost aspect of the change but not at the inevitability or cost benefits at the later stage. Thus the changes in MWP is one point where the government and the contractor are always at the crossroads.

Cost Petroleum & Production Sharing

As per the usual PSCs, the contractor is allowed to recover all his costs that he has invested for oil and gas exploration and production. Recovering the invested costs by selling or having the full control of the oil or gas produced is called the cost petroleum. The hydrocarbon that is produced beyond the cost recovery of the contractor has to be shared between the contractor and the government. This shared petroleum is referred to as profit petroleum. After the cost petroleum, the contractor has to share the profits from the hydrocarbons with the government which is usually based on the calculations of the Pre Tax Investment multiple (PTIM). Basic concept of the PTIM based approach of petroleum sharing is that the higher is PTIM value is higher will be the take of the government from the profits. The below table will put more light on the concept: PTIM <1.5 >1.5 & <3.5 <3.5 30% 50% 80% Governments Take

The contractor, often in the calculation of the cost petroleum try to inflate their investment costs, resulting in reduction of their PTIM and thus preventing the government from taking what is rightfully and lawfully theirs and leading in loss of huge amount of revenue. Also, the PSC is only on the production sharing, the PSC do not give any clear mandate on how much to produce, thus the contractor, to gain from internationally fluctuating market price, also fluctuates their production of hydrocarbons depending on the prices. Thus there is need to formulate some

other approach where both the parties may have equitable sharing of profits without feeling that the contract is favoring the other side more.

Authority of Management Committee

The authority of management committee is an issue that is most contested and discussed between the parties to the production sharing contract. The opinion of the contractor is that the management committee should be there just as a supervisor or as an advisory body with no statutory powers to approve the budget or audit or question the applicability of a particular technology in the process, while the government differs on this. The government take is that the management committee has two members nominated by the government and rest other members are the representing the contractors, thus to ensure the fairness in the development of the field and also to ensure ethical business practices the management committee should be vested the powers of approval of budget and other important issues. The basic problem is that the members nominated by the government and the members nominated by the contractors have always their horns locked over the issue and since the management committee needs to take the decision unanimously, there is often delay in the decision making thus impacting the overall MWP of the project.

Quantification and Valuation of the Hydrocarbons Produced

The valuation and quantification of the hydrocarbons produced is a challenge for both the contractors and the government. The oil and gas prices in the international markets are very volatile and the pricing mechanism is too complex. The present system of pricing can be made more dynamic by taking into account the international price volatility and also change in production. The parties to the contract try to maximize their profits by either misquoting the production or by reducing their production, the contractors usually to increase their profits misquotes their production on the days when the market prices are high so as to earn more revenues in the international market.

Domestic Supply, Sale, Disposal & Export of Crude Oil& Condensate

In the wake to achieve the energy security, the government puts the sanctions on the contractor and forces him to sell the oil in the domestic market. This puts the undue pressure on the contractor and also reduces his cash flows as his profitability decreases. The obligation to sell and supply in the domestic market acts as deterrent for many foreign companies to take E&P projects in India.

Force Majeure
The requirement of force majeure clause is also very rigid. Currently it requires the contractor to apply for force majeure clause within seven (7) days of occurrence which is very less and rigid. There is a need to increase the time-limit for applying for force majeure so that valuation of loss and destruction can be done in a comprehensive manner.

Conclusion
The above points discussed are the major points of friction between the contractor and the government. This draft only speaks about the problems that I could understand in the Model Production Sharing Contract developed by Directorate General of Hydrocarbon in consultation with commonwealth secretariat, UK. The final report will also include the review of in-effect PSC and an international PSC.

Reference
Report of the committee on PSC mechanism in petroleum industry, Government of India, 2012 Model PSC, Ministry of Petroleum & Natural Gas, Government of India, 2009