5. Types of upstream petroleum contracts with the state
Once the principles of the agreement have been determined, the model contract will need to be detailed to accommodate the specific issues and conditions relating to each project. Three basic, alternative types of agreement typically govern the relationship between government and investors.
These three types of agreement are explained in the sections that follow.
Under concession (or licence) agreements, the selected petroleum company or consortium carries out exploration activities. The company takes ownership of all production, when extracted, against payment of a royalty to the host state. The royalty could be in cash or kind. It could also be in the form of income tax on profits or other type of fees and contributions, including possibly an additional tax on profit when this exceeds a predefined threshold. This type of contract is known as a license and commonly gives the holder an exclusive right to explore and exploit petroleum, own and market the production and own the relevant equipment and installations.
Production sharing agreements
Production sharing agreements do not confer rights of ownership of petroleum production on the company or consortium that concludes the agreement. Instead, the company receives a share of the overall production. The balance of production belongs to the host state.
Under this type of agreement, therefore, the company or consortium provides technical expertise and capital and assumes project risk in return for exclusive rights to explore and produce oil and/or gas from the contract area. The host state generally owns the equipment and installations. Unless stated otherwise in the legislation or the production sharing agreement, the company also pays income tax on profits to the host state as well as any other taxes and contributions provided for in the legislation and the relevant contract.
Risk service agreements
Risk service agreements are the least-used agreement type among the three mentioned here. They have been used by states that take a nationalistic approach, or by countries like Venezuela, Iran or Iraq which have long-established petroleum production. Under this type of agreement, the host state merely hires the service of a petroleum company or consortium to benefit from its financial and technical expertise. The company or consortium assumes the risk and liability and is reimbursed by a service fee, usually paid in cash. An example of this type of agreement is Iran’s now defunct buy-back agreements, which eventually proved too onerous for any private sector investor to take up.
Examples of service agreements adopted and areas covered
Angola, Egypt, Kenya, Tanzania, Uganda, Mozambique are among the countries following the production sharing agreement model, while Ghana uses the exploration and production concession contract model.
All three types of petroleum agreements are usually signed between a petroleum company or consortium and government. They typically regulate the following areas: