A MILLENNIAL’S GUIDE TO ENERGY LAW – EPISODE 3 (OIL AND GAS CONTRACTS AND AGREEMENTS)
Nigeria faces the dilemma of enacting and implementing effective oil and gas policies that will help in meeting its national objectives and also encourage investment in the sector. As new trends emerge in the oil and gas sector, there arises the need for contracts that will protect the country’s interest and also that of its investors.
The earliest form of agreements was in form of concessions. These are the oldest form of contracts that begun during the 1800s oil boom in the United States and spread across the Middle East, starting with the oil boom in Saudi Arabia. Concession is the agreement which transfers certain interest in a property to another for a period of time. This is usually between a company and the state that owns the mineral resource; it is not a sale or purchase. The company is the ‘lessee’ and the state is the ‘lessor’. In the earliest form of concession, the oil company receives exclusive right to explore for petroleum and if petroleum was discovered, the company could produce and market the oil and gas. In exchange, the company paid specified costs and taxes. The duration of the concession was very long spanning over forty to seventy years over a vast area of land.
This early or traditional form of concession was not ideal because it favored the oil companies and the financial benefits expected to be realized by the oil producing countries from these companies were ludicrous. This led to a modern and more refined type of concession in which the area covered were reduced and the duration of ownership was cut to an initial period of twenty years.
- JOINT VENTURE AGREEMENT
The Joint venture agreement was introduced in 1986 following the global oil glut and was first executed in Nigeria in 1971. This contract governs onshore/shallow water projects. Under this contract, each of the partners of the Joint Venture has a duty to contribute financially to the magnitude of the percentages held in the contract towards the exploration and development of the oil and gas blocks. These contributions were known as ‘cash calls’.
All parties are entitled to a share of oil after fiscal deductions have been made, including royalties paid to government and petroleum profit tax. The Joint Venture agreements faced major problems when the government, through the NNPC, was unable to meet its obligations as a result of other pressures on its resources. Moreover, Nigeria’s oil and gas industry was expanding into shallow and deep offshore areas which saw the need to source for funding and technical expertise to hasten the scope of exploration activities in these deep offshore and inland basin areas. These led to the replacement of JOAs with Production Sharing Contracts as the new contractual regime.
- PRODUCTION SHARING CONTRACTS
This contract originated in Indonesia for agricultural contracts and has become very popular in the oil and gas sector, with several countries adopting it. The production sharing contract (PSC) was used by the Nigerian Government to do away with concessions and move towards contracts which emphasize the contractual status of the oil company. The PSC was first utilized in 1973, in a contract between the NNOC (now NNPC) and Ashland Oil Nigeria Limited.
The PSC is regulated by the Deep Offshore and Inland Basin Production Sharing Contract Act, Laws of the Federation of Nigeria 2004. The NNPC engages a contractor which is the oil company to carry out petroleum activities in Nigeria. The contractor bears the initial exploration risks and if oil is discovered and extracted, the contractor will be given a portion of the oil produced enough to reimburse its cost of production which is regarded as Cost Oil, and also payment of royalty which is fixed according to the location of the oil field. A portion will also be allocated as tax to the Nigerian Government referred to as Tax Oil. The remainder after these deductions shall be split among the parties by the ratio or percentage stated in their agreement (profit oil).
The reimbursement of the costs borne by the contractor only occurs if there is discovery of a commercial oil reserve. In the event where oil isn’t discovered, there will be no indemnification. The contractor is allowed to sell its portion of the production allocated to cost oil, tax oil, and its share of the profit but at the price fixed by the NNPC.
- SERVICE CONTRACTS
This was first introduced in Argentina in the 1950s. It has two subdivisions which are; Risk Service Contracts and Pure Service Contracts.
Risk service contracts are arrangements whereby the contractor provides the entire risk capital for exploration and production. If a discovery is made, the contract ceases to exist with no duty on both parties. If a commercial discovery is made, these expenses are recovered and the contractor is entitled to payment. Payment is made in cash, although an option to be paid in crude oil is included within the contract. The contracted company is solely responsible for taking up oil and gas exploration expenses and if no oil is found, the contractor bears the cost.
Pure service contract on the other hand sees all risk borne by the state and the contractor performs its required services and is paid a flat fee for this service. This is common in the Middle East countries.
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ABOUT THE WRITER
Karen Okoro is a graduate of Benson Idahosa University and the Nigerian Law School. She is passionate about Energy Law, particularly the Oil and Gas sector. She is also interested in Commercial Law. Karen believes young and prospective lawyers who explore the energy space can be groundbreaking professionals in the field and can help create better policies. Karen enjoys writing and traveling.