Understanding Production Sharing Contracts
Estimated reading time: 3 minutes
Production Sharing Contracts 2019
The Production Sharing Contract is one of the most significant form of legal contracts/agreement to be found in the oil and gas industry. The purpose of any contract is to establish the rights; duties and obligations of the parties are in terms of both performance and conduct.
By definition, a Production Sharing Contract (PSC), or Production Sharing Agreement (PSA), is a contract between one or more investors and the government in which rights to prospection, exploration and extraction of mineral resources from a specific area over a specified period of time are determined. In other words, a PSC is an agreement between the parties to a well and a host country regarding the percentage of oil and gas production each party will receive after the parties have recovered a specified amount of costs and expenses.
PSCs involve the granting of certain rights (exploration and production) from a Host Government to an International Oil Company (IOC) in order to search for and develop hydrocarbon resources. They are high value; represent a significant investment (for the IOC); tend more towards the longer term and often have a higher risk profile.
PSCs were developed mostly in Asia and in Africa, between the National Oil Companies (NOC) and the International Oil Companies (IOC) to develop new oil and gas fields, especially offshore fields for which the NOC had limited experience and financial resources.
The purpose of the PSC, compared with standard concessions contracts, is for the NOCs to keep some control on the development of the oil and gas field and transfer expertise to the NOC even though all the technology and strategic decisions to develop the field might be made by the IOCs.
Hence, most of the risks, if not all, related to the success of the exploration are left to the IOC.
The NOC and IOC are to define how they will share the costs and profits of the given oil and gas field from the beginning. Costs for the PSC include capital expenditures for the exploration, followed by the development and the operational expenditure when the project goes into normal operations.
A key aspect of a PSC includes the IOC taking most or all of the costs and risks during the exploration phase while the NOC will start or increase his contribution at the development phase and in normal operations. Hence, this provides an advantageous opportunity for the NOC to develop new reserves at no risks and limited costs.
In parallel, the PSC provides the necessary time to the NOC to take on the momentum to catch up on the management of such projects.
The profits are shared when the real production starts. The more the IOC will have contributed at the early stage of the exploration and development of the field, the more he may expect an higher share in return.
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