Unit 2

International and Comparative Petroleum Law and Policy

Petroleum Regimes

Author: Dennis Stickley

May 2010

Centre for Energy, Petroleum and

Mineral Law and Policy
Unit 2: Petroleum Regimes

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 Unit 2:Petroleum Regimes

Introduction

Objectives
This Unit discusses the types of petroleum regimes adopted
by Host Governments. Essentially, there are two distinct
approaches: (1) Concessions, including Leases and Licenses,
and (2) Contracts, including Production Sharing, Service
Contracts and Participation Agreements. Each of these
arrangements attempts to accomplish the same purpose –
the creation of a legal relationship between the State and an
international petroleum company for petroleum operations.

These petroleum regimes are conceptually different from each

other in the following respects:

ˆˆ State’s claim to the petroleum,

ˆˆ Level of control given to the international petroleum

company,
ˆˆ Mechanism for the division of petroleum production, and

ˆˆ Participation of national oil companies.

The various arrangements have borrowed concepts from each

other. This interchange has resulted in a new type of petroleum
regime – the Hybrid System, which contains characteristics of
each of the other petroleum regimes.

Learning outcomes
On completion of Unit 2 you should be able to:

ˆˆ Explain the differences between the various types of

petroleum regimes.
ˆˆ Apply concepts from other types of petroleum regimes to
the one you work in.

Contents
ˆˆ Overview of International Petroleum Regimes

ˆˆ Concessions

ˆˆ Leases and Licences

ˆˆ Participation Agreements

ˆˆ Production Sharing / Service Contracts

ˆˆ Hybrid Systems

ˆˆ Summary

ˆˆ Exercise

ˆˆ Answers to Exercise

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Unit 2: Petroleum Regimes

Overview of International
Petroleum Regimes These are two
basic arrangements
for petroleum
exploration and
According to a recent compilation, 148 countries have adopted developments –
their own petroleum regime. The breakdown is as follows: concessions and
contracts.
ˆˆ Concessions (Licenses & Leases) 59

ˆˆ Contracts 73

ˆˆ Hybrid Systems 16

In order to identify the particular type of petroleum regime the

following legal and economic criteria should be considered:

ˆˆ How does the State assert its legal control over

petroleum resources (see Unit 1)?
ˆˆ Is the balance between the interests of the Government
and the Contractor quantifiable so analytical models
can be used to forecast the economic outcome from
development over a term of 25 to 30 years?
ˆˆ Are the terms and conditions of the contract clear
and internally consistent to either avoid dispute in the
administration of the contract, or permit prompt and
independent resolution if differences arise?
ˆˆ Are the fiscal terms competitive with those being offered
in other countries with similar prospectivity?

? Why evaluate a petroleum regime?

In order to determine what are the obligations and rights of the

Host Governments and the international petroleum company.

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 Unit 2:Petroleum Regimes

Concessions
The first step in the administration of a petroleum regime by a
Host Government is to determine what areas will be offered to
international petroleum companies. After the Host Government
identifies an area that is suitable for exploration, in terms
of geologic prospectivity, it must determine the process for
allocating exclusive rights to an exploration area. There are three
procedures that States use for awarding rights to petroleum
resources:

ˆˆ Ad hoc where areas are awarded at the discretion of the

Host Government based on an expression of interest,
with terms to be negotiated.
ˆˆ Public Auctions where the operator is selected on
the basis of established criteria regarding fiscal terms
and minimum work obligations without application of
administrative discretion to negotiate.
ˆˆ Competitive Tender where each applicant submits an
offer in terms of exploration work programme, signature
bonus, and financial compensation. Several provisions,
such as State participation, may be left open for later
negotiation.
The allocation process is completed when an international
petroleum company is awarded the right to undertake petroleum
operations within the exploration area. Selection is based upon
the international petroleum company that presents the most
attractive proposal in terms of technical capability, investment
in work programme and financial return. Often, several
petroleum companies agree to form a joint venture with one
being designated as the Operator to manage the petroleum
operations. The manner in which the petroleum operations are
to be conducted will depend on the conditions of the petroleum
regime, which will be discussed in the following sections of this
Unit.

What are the advantages and disadvantages of

the three procedures for awarding exploration
rights?

Stickley (2006) ‘A Framework for

Negotiating & Documenting Petroleum
Industry Transactions’ pp 14-20 discussing
the different types of petroleum regimes.

The discussion of ‘competitive tendering’ in

Walde & Nidi (1994) pp 61-69.

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Unit 2: Petroleum Regimes

Concessions can be classified as either ‘Classic’ or ‘Modern’.

A Classic Concession gives total control over petroleum
operations to the concessionaire. The Host Government accepts
financial benefits in the form of bonuses, royalties and taxes.
A Classic Concession takes the form of an agreement that has The basic difference
between concessions
three characteristics: and contracts lies
in the role played by
ˆˆ Assumption of risk by the international petroleum the Host Government
company, in overseeing
operations.
ˆˆ The international petroleum company has unfettered
control of petroleum operations, and
ˆˆ The Host Government receives a royalty based upon the

“
value of production.
In the Concession agreement the State government assigns the A concession in the
right to the contracting company to explore and develop defined wider sense may
be defined as a
areas for mineral (petroleum) resources in return for a share of
synallagmatic act by
the proceeds (royalty) and taxes. The contracting companies which a State transfers
compete for concession rights in a number of ways, including: the exercise or rights
signature bonus, royalties, and tax arrangements. or functions proper
to itself to a private
Early Concessions involve grants of development rights over person… which in turn
… gains a privileged
huge areas of land for relatively lengthy periods of time (99 position vis-à-vis other
years). An example of this type of Concession would be the private law subjects

”
Agreements between Petroleum Concession Ltd and the within the jurisdiction
Sultan of Muscat and Oman [1937]. Several characteristics of the State.
of the Classic Concession such as the huge areas, periods Encyclopedia
of commitment, lack of state control and royalty limits were of Public
International Law
criticized as a form of ‘colonialism’. Vol. 18, p.100

Duval et al ‘International Petroleum

“
Exploration and Exploitation Agreements’
(2009) pp 41-45.
[T]he first half of
this Century was
characterised by the
As a result of these excesses, the Modern Concession, such granting of concessions

”
as the Petroleum License adopted in the U.K. and elsewhere in to the major American
the Commonwealth, was developed to minimize objections. In and European oil
companies
North America, Canada and the U.S., adopted the Oil and Gas
Gao (1994) p.11
Lease. Leases were used to grant exploration rights for oil and
gas on both private and public lands. These forms of the Modern
Concession are discussed in the material that follows.

Whether Concessions are compatible with

national sovereignty over petroleum resources
as discussed in Unit 1?

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 Unit 2:Petroleum Regimes

Leases and Licences

Leases and
Licenses are
The Oil and Gas Lease is a multi-stage agreement. The primary used in Common
term (5-10 years) is for exploration activities unless the Lessee Law systems
either makes a successful discovery, which allows the lease to where interests in
property are well-
be held by production, or expires at the end of the term. As an defined.
alternative, the lease may be held for an extended term by the
payment of rental in lieu of a royalty from actual production. The
owner of the mineral interest grants the right to hold the area for
an initial term subject to payment of bid bonuses and rentals,
and for so long thereafter as there is production and royalties

“
(as a fraction of production), are paid. This approach is used
primarily in Canada and the United States by both private and Operating obligations
governmental landowners. were implied by courts

”
under a prudent
operator standard.
In this type of petroleum regime, the focus is on property rights
Smith, et al (1993),
in the mineral estate. The Lessee may have an interest in the p.276
petroleum in-place in addition to production. Where the full scope
of the obligations and rights between Leasor and Lessee is not
contained in the conditions of the Lease, courts have imposed
implied covenants. The State regulates the conduct of petroleum
operations under its ‘police powers’. The Leasor receives a

“
royalty (usually 1/8th) based on the value of production.
The license
A License is a more restrictive form of the Modern Concession. arrangements retain
Initially, a governmental authority grants an Exploration License a strong regulatory
to a specific area on behalf of the State. Title to petroleum is flavour, both by reason

”
transferred to the Licensee only when it has been extracted. formal rule laid down
If petroleum is discovered, the unrelated area is surrendered. at the instigation
of the Parliament,
The Licensee is granted a Development License to produce for
and by reason of the
a specified period of years. Petroleum operations under either content of the licenses
License are conducted according to a pre-approved programme themselves...
of work that includes collection of seismic data and a minimum Daintith and
number of exploration or development wells. Willoughby (1977),
p.26
In some regimes, such as the UK, the License is contractual in
nature, with petroleum regulations incorporated by reference.
Other regimes, such as Norway and Demark, rely on legislation
to define the conditions of the License without an agreement.
Royalties and taxes are imposed on rates of production. This
approach is also used in Australia, New Zealand, France,
Morocco and Thailand. The majority of provisions in a license
are not subject to negotiation with international petroleum
companies and are referred to as ‘standard terms’.

The discussion of petroleum licenses in

Daintith et al (1992), pp981.

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Unit 2: Petroleum Regimes

Participation Agreements
The pros and
In a contractual petroleum regime, the Host Government enters
cons of state
into a negotiated agreement with an international petroleum participation are the
company. Under a Participation Agreement, the objective is basis of endless
to allow the State (usually through a national oil company) to debate.
participate either as an equity partner or joint participant under
one of the following approaches:

ˆˆ Working Interest: the State is regarded as a private

participant, sharing all risks and contributing its share of
costs, usually after a discovery is made.
ˆˆ Carried Interest: the cost of State participation is funded
(‘carried’) by the international oil company with costs
recovered from production.
ˆˆ Free Equity: the State receives a share in the discovery
without obligation for contribution.

“
In an equity joint venture the State and the international
petroleum company hold shares in the operating entity with State participation in
petroleum operations
the contract. The contractual approach, where the individual and production has
participants hold a percentage or ‘working interest’ in the long been a key driver

”
contract area, is more prevalent. in the petroleum policy
of many oil-producing
Joint ventures with such participation rights began to appear states.
in the Middle East in the late 1950’s. The first of such Duval et al (2009),
p.103
agreements were reached in Iran with Amoco (now BP). Under
the Participation Agreement the Host Government formed an
operating company with the international petroleum company.
The State held 50 percent or slightly less of the equity in the
venture. Government shares in excess of 51 percent became
common after the 1973 agreement between Lybia and
Occidental Petroleum. Some countries, such as Indonesia, have
modified their Production Sharing Contracts to create an option
for participation by the national oil company.

? In your opinion, should a State participate in

all stages of Petroleum operations?

Duval et al ‘International Petroleum

Exploration and Exploitation Agreements’
(2009) pp101-105 on the different forms
of Participation Agreements

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 Unit 2:Petroleum Regimes

Production Sharing / Service

Contracts
The production
sharing contract
The Production Sharing Contract (PSC) covers a specific area was first used in
and its terms are inclusive of the obligations and rights of the Indonesia in 1960.
Host Government and the international petroleum company
(‘Contractor’). Although written as a contract, a PSC is both a
commercial and a regulatory document. Regulation-by-contract
means that the State does not need to adopt specific regulations
to implement its petroleum law.

Production is divided between the State and the Contractor

according to a formula that first allows for the Contractor to
recover costs. Most PSC’s restrict the amount of production or
revenue for cost recovery. Revenue or production remaining
after cost recovery is ‘profit petroleum’, which is divided between
the Contractor and the Host Government according to a formula.
Frequently the profit sharing split is according to a sliding-scale
with the flexibility to adjust to economic conditions. Sliding-scales

“
are adjusted according to such factors as cumulative production
thresholds, prices, water depth, and the type of petroleum (oil Out of dissatisfaction
or natural gas). When a sliding-scale is applied to incremental with the work contract,
production, each daily tranche of production is accounted for which was not much
separately. A Host government imposes taxes, sometimes of an improvement

”
royalties, as part of the fiscal terms for a PSC. This approach is over the concession
agreement, there
used in South East Asia including Indonesia, China, Bangladesh, arose another form
and Vietnam of arrangement, the
production sharing
The production is split between the State government, usually contract.
through its national oil company (NOC), and the Contractor. This Gao (1994), p.66
shared fraction of the production from the project is designated
as ‘profit petroleum’. Profit petroleum is the residual production
after the Contractor is reimbursed for operating costs, the
carried portion of the NOC’s obligations, the Contractor’s capital
investment, exploration expenditures, interest, and other eligible
allowances.

Duval et al ‘International Petroleum

Exploration and Exploitation Agreements’
(2009) pp69-72 on the obligations under
a PSC.

?
From the standpoint of the Host Government,
what advantages do PSC’s or other Contracts
have over Concessions?

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Unit 2: Petroleum Regimes

Like the PSC regimes, the relationship between the Host

Government and the international petroleum company is
embodied in a comprehensive agreement. Unlike the PSC,
the State conveys none of the oil and gas produced to the
contractor, and may place restrictions on the right of the The service contract
is intended to
Contractor to buy a portion of production. Rather, the Contractor provide maximum
is paid a fee for his risk and expertise from the revenue derived national control
from production. As the owner, the State retains powers of over petroleum
management and control of development, while the foreign development.
petroleum company works as a contractor often under the
supervision of the NOC.

There are three variants of the Service Contract:

ˆˆ Pure Service Contract: the Contractor is at-risk for all

operations and is paid a fee,
ˆˆ Technical Assistance Agreement: the Contractor acts
as adviser to the NOC and is compensated from the
proceeds of production, and
ˆˆ Risk-Service Contract: the Contractor is compensated
through production and also has the right to purchase the

“
State’s share.
The concept
The first two types of agreement (Pure Service and Technical underlying the service
Assistance) are less attractive to international petroleum contract was slow to
companies because there is no right to production or the be accepted and did

”
proceeds from its sale. The Risk-Service contract was not gain favour until
1976 when Brazil
developed to induce international petroleum companies to bear opened its offshore
the entire risk of exploration by giving the Contractor the right to areas for international
purchase the production at a discounted price. This approach participation under
is common in South America including Brazil, Colombia what is known as the
and Ecuador. It is used in the Philippines with provisions for “risk service contract.
production sharing. Gao (1994), p.105

The discussion of Service Contracts in Gao

(1994) pp 105-141.

Whether there is a relationship between the

use of Service Contracts and sovereignty over
petroleum resources?

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 Unit 2:Petroleum Regimes

Hybrid Systems
Over recent
The distinction between petroleum regimes that are solely
years there has
concessional or contractual has blurred as States adjust terms been a trend
to attract international petroleum companies. This has resulted towards similarity
in so-called ‘Hybrid’ systems that combine elements of the two in petroleum
arrangements.
different petroleum regimes.

Like contractual regimes, a Hybrid system also incorporates

various regulatory features in addition to commercial terms. At
the same time, there will be a petroleum authority to oversee
the conduct of petroleum operations, which is similar to the
License. Operating rights are divided into two stages, exploration
and development, as is the case in a Lease. For example,
the petroleum regime in Papua New Guinea utilises both a
Development License and a Participation Agreement.

“
List which elements of the petroleum regimes
discussed in this Unit, you would combine to ’The political objective
create a Hybrid system. of the hybrid contract
(HC) is to retain
sufficient national

”
control over petroleum
resources without
adversely affecting
foreign investment.
Gao (1994), p.143

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Unit 2: Petroleum Regimes

So to
summarise

Petroleum regimes may be classified either as a Concession or

Contract. Modern Concessions include Leases and Licenses,
while contractual regimes include Production Sharing Contracts,
Participation Agreements and Service Contracts. Classification
goes beyond the title of the document and includes such factors
as the degree of control held by the State, the fiscal system
for allocating production and other obligations and rights of the
parties. The trend has been to incorporate features of both types
of petroleum regimes to create so-called Hybrid systems.

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 Unit 2:Petroleum Regimes

Exercise
1. List three features of each of the following petroleum
regimes:

Concessions

Contractual

Hybrid

2. Which petroleum regime would you adopt for your

country. What are your reasons?

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Unit 2: Petroleum Regimes

Answers to Exercise
The following are answers to the questions on the previous
page:

1. Features of the three petroleum regimes are as follows:

Concessions

–– The international petroleum company has sole control

over petroleum operations.
–– Duration of rights does not depend upon a discovery.

–– The State receives a fixed royalty based on

production.
–– Concessions cover large areas.

Contracts

–– All rights and obligations are contained in a contract

document.
–– Duration of rights is in stages, with production
required to extend the contract from the primary term.
–– State has more control over the conduct of petroleum
operations.
–– Revenue is shared with State.

–– Contractor bears all risk and cost.

–– National Oil Company may participate in operations.

Hybrid

–– A combined commercial and regulatory system that

incorporates all of the above features.

2. The suitability of each approach will depend on the

circumstances of each country. Please post the reasons
you selected a particular petroleum regime on the VLE
discussion board.

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