Petroleum Licensing and Contracting

6. Agreements between petroleum companies

Upstream contracts are often entered into by several companies acting together in a consortium, for the purposes of sharing risks, costs and financing. The relationships between them are governed under various types of agreements. These should always be aligned with the terms of the licence or contract awarded by the host country for the area concerned. 

Following the award of a licence or contract, one entity constituting a consortium may decide to assign, sell or transfer all or part of its interest to another company. Such a transaction is called a farm-out (by the assignor) or a farm-in (by the assignee). It is generally subject to the approval of the government or minister.

The following sections explain the types of agreements typically undertaken by petroleum companies, which are:

  • Joint operating agreements.

  • Joint ventures.

  • Farm out agreements.

  • State participation agreements.

  • Unitisation agreements.

Joint operating agreements (JOAs)

Due to the high level of risk in the upstream petroleum sector, companies often spread risk and costs by working together in a joint venture. This is generally done by all parties signing a joint operating agreement, often with the participation of the host state or its National Oil Company. This can give a country access to the technical expertise of International Oil Companies and allow participation in decision making. International Oil Companies and consortia may also be required by host state regulation to operate petroleum activities jointly. 

Joint ventures (JV)

A joint venture (JV) can be structured in two ways, either as an unincorporated JV or an incorporated joint venture. An unincorporated JV does not create a separate legal entity, and the relationships among its participants are governed under an unincorporated joint venture agreement. This is the most common structure used in international petroleum contracts, for example under Joint Operating Agreement (JOAs), as described above. Furthermore, the interest shares in a non-incorporated joint venture are undivided, and instead of the “JV” as a legal entity, a commonly assigned joint operator or a committee manages the operations.

Normally, before establishing a joint venture, the participants will acquire the petroleum right from the state. This might be acquired through a joint bidding procedure, or the ownership might be already vested in the participants of the JV. Ownership can be assigned to other participants if approved by the host state, prior to signing a joint bidding agreement. Generally, a confidentiality agreement is also signed, as parties often share sensitive technical data. 

State participation agreements

State participation agreements are signed between a state or its designated authority and companies to allow the state or a state-authority, a National Oil Company or an ad-hoc state entity established for this purpose, to commercially participate in the Joint Venture. The rationale for the host state is to be involved in decision making and benefit from the technical expertise of the International Oil Companies. State participation agreements also enable the activities of the Joint Venture to be supervised directly and ensure security of supply. As participation is on a commercial basis, this type of agreement is particularly popular in a high price environment.

In state participation agreements, the state becomes an investor and hence assumes risk and shares the profits from production and marketing derived from the applicable petroleum contract, like the other signatories of the joint operating agreement. State participation may be required by the host state’s regulations, as is the case in the Norway and the Netherlands or it could be voluntary. There is no state participation in the UK. State participation clauses may be inserted into the concession agreements or PSAs or they may be covered in other types of equity participation agreements.

Farm-out agreements

When one Joint Venture partner assigns a portion of undivided interests in an area to a newcomer or an existing partner, they use a “farm-out” agreement. The party which assigns its rights is often referred as the “farmor” and the recipient is called “farmer” or “farminee”. The assignment is generally made in return for compensation, commonly paid via commitments to fund specific work such as well drilling, but sometimes in cash. The farm-out may be signed at any stage, from exploration to production, but host states may limit or prohibit farm-outs for a period shortly after winning the bid. Whilst industry practices vary considerably on terms and conditions of different farm-out agreements, model farm-out agreements based on industry practice are available through the AIPN. 

Unitisation agreements

Most licences or petroleum agreements and national petroleum laws include provisions for unitisation. Unitisation is the joint exploitation as a unit of a given field crossing the borders of two licence or contract areas awarded by the host country.

Unitisation means joint operation and exploitation of an entire petroleum reservoir by different licensees or other exploitation right holders in an integrated manner and is governed by a unitisation agreement. Unitisation can be set up within a single state or between states that share a land or maritime border.

Unitisations of two licence or contract areas crossing the border of the two adjacent host countries is called an international unitisation. They are more complex than the national unitisation noted in this section as they combine multiple petroleum agreements governed by different jurisdictions. They generally require the signing of a treaty by the two countries.

When the location of a petroleum reservoir coincides with an international border, either state may order unitisation, since the principle of permanent sovereignty over natural resources means states have exploitation rights within their own territory. The UN Convention of the Law of the Sea (UNCLOS) establishes the principles for coastal states’ sovereign rights to explore their territorial waters and seabed and exploit their natural resources in the continental shelf. The Frigg agreements between the UK and Norway are examples of inter-state unitisation agreements.