Advantages of Production Sharing Contracts
Estimated reading time: 5 minutes
Production Sharing Contracts 2019
A PSC (Production Sharing Contract), or PSA (Production Sharing Agreement), creates a contractual relationship between an IOC (International Oil Companies) and the host country, authorising the IOC to explore for and exploit hydrocarbons in a defined area and for a defined period.
By definition, a PSC is a contract between one or more investors and the host country 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.
The host country, as the owner of the hydrocarbons, hires the IOC as a contractor for the conduct of exploration and production work and the IOC incurs all the costs associated with the business of exploring for and producing hydrocarbons within the geographical area defined in the PSC. If a commercial discovery is not made, then these costs will not be recoverable by the IOC from the host country.
There are several pros and cons as to why some companies are adopting PSCs as the choice for the type of oil and gas agreements.
Advantages of PSCs
- Low risk for the host country
- Knowledge transfer from IOC to host country
- Various cost recovery strategies for both parties
- Low risk for the host country
Through PSCs, the host country is able to develop new reserves at no risks and limited costs. The host country does not need to make a significant amount of investment for exploration & production activities. After all, the IOC carries all operational and financial costs and risks.
- Knowledge transfer from IOC to host country
An IOC, by definition, produces oil and gas from several countries. Hence, when they enter the host country, they can transfer their expertise to the host country and the host country is able to learn from them. All technology and strategic decisions on the field are led by the IOCs.
- Various cost recovery strategies for both parties
When writing the PSCs, both parties must agree upon the best cost recovery strategy. The differences between the strategies are how the gross revenues are split and how the profit pool is shared between the two parties.
The 4 types are:
- Full cost recovery, deferred profit shares
- Full cost recovery, deferred profit shares, with first tranche hydrocarbons
- Capped cost recovery, simultaneous profit shares
- First tranche hydrocarbons, capped cost recovery, simultaneous profit shares.
However, PSCs do have the its drawbacks such as the complexity of writing these agreements. A lot of key factors need to be agreed upon prior to the signing. Given that only a small number of exploration efforts lead to a commercial discovery, the work commitment and financial obligations are crucial negotiation factors as they define the extent of the exploration risk. The host country will want to draft these with as much specificity as possible while IOCs prefer commitments that allow maximum discretion.
Read also: Understanding Production Sharing Contracts
Masterclass in Production Sharing Contracts (PSC) Exploration and Production Rights and Agreements is a 3-day training course. Participants in this course will gain valuable insights into the operations of the Oil and Gas Industry and the use of PSC in Exploration and Production stages of the Oil and Gas Industry. The life blood of the industry is to be found in the Oil and Gas contracts and forms the basis upon which the industry operates. Getting these contracts right is essential for the smooth running of a project.
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