Sie sind auf Seite 1von 449

Muhammed Mazeel

Petroleum Fiscal Systems


and Contracts

Diplomica Verlag
Muhammed Mazeel
Petroleum Fiscal Systems and Contracts

ISBN: 978-3-8366-3852-4
Herstellung: Diplomica® Verlag GmbH, Hamburg, 2010

Dieses Werk ist urheberrechtlich geschützt. Die dadurch begründeten Rechte,


insbesondere die der Übersetzung, des Nachdrucks, des Vortrags, der Entnahme von
Abbildungen und Tabellen, der Funksendung, der Mikroverfilmung oder der
Vervielfältigung auf anderen Wegen und der Speicherung in Datenverarbeitungsanlagen,
bleiben, auch bei nur auszugsweiser Verwertung, vorbehalten. Eine Vervielfältigung
dieses Werkes oder von Teilen dieses Werkes ist auch im Einzelfall nur in den Grenzen
der gesetzlichen Bestimmungen des Urheberrechtsgesetzes der Bundesrepublik
Deutschland in der jeweils geltenden Fassung zulässig. Sie ist grundsätzlich
vergütungspflichtig. Zuwiderhandlungen unterliegen den Strafbestimmungen des
Urheberrechtes.
Die Wiedergabe von Gebrauchsnamen, Handelsnamen, Warenbezeichnungen usw. in
diesem Werk berechtigt auch ohne besondere Kennzeichnung nicht zu der Annahme,
dass solche Namen im Sinne der Warenzeichen- und Markenschutz-Gesetzgebung als frei
zu betrachten wären und daher von jedermann benutzt werden dürften.
Die Informationen in diesem Werk wurden mit Sorgfalt erarbeitet. Dennoch können
Fehler nicht vollständig ausgeschlossen werden und der Verlag, die Autoren oder
Übersetzer übernehmen keine juristische Verantwortung oder irgendeine Haftung für evtl.
verbliebene fehlerhafte Angaben und deren Folgen.
© Diplomica Verlag GmbH
http://www.diplomica-verlag.de, Hamburg 2010
Petroleum Fiscal Systems and Contracts

CONTENTS

1 CLASSIFICATION OF PETROLEUM FISCAL SYSTEMS....8


2 PROJECT EVALUATION ....................................................37
3 CONTRACTS .......................................................................44
4 GOVERNMENT AND OPERATOR TAKES, COSTS AND
TAXES..................................................................................69
5 PROJECT ECONOMICS .....................................................82
6 FINANCE............................................................................106
7 TAXES................................................................................121
8 FIELD DEVELOPMENT PLANNING .................................141
9 GEOPOTENTIAL OF THE GLOBAL EXPLORATION
MARKET ............................................................................155
10 DIFFERENT TYPES OF PETROLEUM FISCAL SYSTEMS
............................................................................................159
11 HIGH RISK COUNTRIES ...................................................290
REFERENCES ..........................................................................362
APPENDICES ...........................................................................364

1
Petroleum Fiscal Systems and Contracts

FIGURES
Figure 1.1 Classification of petroleum fiscal systems 8
Figure 1.2 Detailed classification of petroleum fiscal systems 10
Figure 1.3 Typical project contract conditions 11
Figure 1.4 Example concessionary system flow diagram 14
Figure 1.5 Example calculation of government and contractor take
15
Figure 1.6 Basic equations for royalty/tax systems 16
Figure 1.7 Concessionary system structure from the oil company
perspective 17
Figure 1.8 Basic equations for contractual systems 19
Figure 1.9 Example production sharing contract flow diagram 20
Figure 1.10 Production sharing contract structure from the
contractor’s perspective 21
Figure 1.11 Sample rate of return contract cash flow projection 23
Figure 1.12 Sample sliding scale royalty 26
Figure 1.13 Joint venture structure with a PSC 33
Figure 1.14 Typical joint venture in Russia 35
Figure 1.15 Three phase technical assistance contract (TAC) 36
Figure 2.1 Allocation of revenues from production 42
Figure 2.2 Tax Base Spectrum 43
Figure 4.1 Government and Contractor take 71
Figure 4.2 Division of the costs and profit 71
Figure 4.3 Changing fiscal terms 72
Figure 5.1 Profitability measures 88
Figure 5.2 Sensitivities of fiscal model 91
Figure 5.3 Influence diagram for typical stages in project
development 92
Figure 5.4 Value of information to demonstrate commerciality 94
Figure 5.5 Value of information for development optimization 95
Figure 5.6 Comparing options 96
Figure 5.7 Project definition 98
Figure 5.8 Cost probability curves 100
Figure 5.9 Accuracy of estimates through project development
101
Figure 6.1 Hierarchy of legislation and contractual agreements 107
2
Petroleum Fiscal Systems and Contracts

Figure 7.1 UK tax regime 123


Figure 8.1 Legal framework 142
Figure 8.2 PDO approval flow chart 145
Figure 8.3 PDO approval administrative process 145
Figure 10.1 Azerbaijani fiscal regime 174
Figure 10.2 Dubai fiscal regime 201
Figure 10.3 Egypt fiscal regime 207
Figure 10.4 Example Iraqi service contract 228
Figure 10.5 Ireland fiscal regime 232
Figure 10.6 Libyan fiscal regime 235
Figure 10.7 Malta fiscal regime 242
Figure 10.8 Morocco fiscal regime 246
Figure 10.9 Norway fiscal regime 260
Figure 10.10 Russian fiscal regime 267
Figure 11.1 Plentiful reserves in Iraq - oil comes to the surface in
many places 291
Figure 11.2 Location of auctioned licenses (map printed in The
Wall Street Journal) 323
Figure 11.3 Oil refinery near the village of Taq Taq in the
autonomous Iraqi region of Kurdistan 332
Figure 11.4 Production profile example for West Qurna 1 340
Figure 11.5 Comparison of Bid and Peter Wells' estimates of most
likely production profile for West Qurna 1 341
Figure 11.6 Iraqi crude oil production 343
Figure 11.7 Crude price variation 348
Figure 11.8 Cash flow for the TSC for West Qurna 1 (after Peter
Wells) 357
Figure 11.9 Cash flow for the KRG PSC for West Qurna 1 (after
Peter Wells) 357
Figure 11.10 Relative sensitivity of the TSC and the KRG PSC to
oil price (after Peter Wells) 358

3
Petroleum Fiscal Systems and Contracts

TABLES
Table 4.1 Contractor take, cost recovery limits and government
participation rates 74
Table 5.1 Present value of one time payment 87
Table 9.1 Recoverable conventional oil by region 156
Table 9.2 Examples of block sizes worldwide 158
Table 11.1 Main commercial terms of the Shamaran PSC for
Pulkhama oil field (after Peter Wells) 338
Table 11.2 Comparison of main terms of the TSC and the KRG
PSC (after Peter Wells) 356

4
Petroleum Fiscal Systems and Contracts

ACKNOWLEDGEMENTS

I would like to thank all the people who gave me their time and
their views on this book. I am particularly grateful for the helpful
suggestions, reviews and comments received from Rod Searle
and many others.

This book is the result of long years of work and experience in


different countries and fields. Special thanks are due to my small
family for the support to continue to write books and publications
which comes exclusively from them.

The revenue from this book will be donated to the sick cancer
children and help organizations.
Dr Muhammed Mazeel

5
Petroleum Fiscal Systems and Contracts

INTRODUCTION

This book has been written for those interested in petroleum


taxation and international negotiations, and the way to carry out
successful exploration and development projects. It examines the
petroleum fiscal systems that apply in different countries across
the world and how these systems govern the economics of
exploration and development for oil and gas. Examples are
included to give the reader a wide perspective on the
implementation of fiscal systems.

The petroleum fiscal system for a country is a combination of the


taxation structure established by legislation, together with the
contractual framework under which an international oil company
operates with the host government. Fiscal systems vary widely
between countries and in some countries there is more than one
system. The taxation structure may, for example, include royalty
payments. The contractual framework may be based on
concessionary arrangements or on service and production sharing
agreements.

The different types of fiscal system are classified and the factors
in these systems that govern exploration and development
economics are identified. The practical aspects of petroleum
taxation and the relationships between oil companies and
governments are examined in detail in a chapter that focuses on
the resultant contractor and government take under different fiscal
regimes. This book also provides descriptions of how exploration
development project economics are calculated and how projects
are planned and financed. Legal and operational aspects of
contractual and fiscal terms are also considered. Topics are
addressed from both industry and government viewpoints to give
an understanding of the aims and concerns of both sides.

Much of the material provided here was inspired by questions


most frequently asked on the subject. The best answers are
supported with specific examples and many of these are used
throughout the book.

6
Petroleum Fiscal Systems and Contracts

The summaries and analyses of various fiscal terms and contract


conditions are believed to be accurate, and every practicable
effort has been made to gather up-to-date information about the
current conditions in the countries cited. Examples of fiscal terms
used here are drawn from numerous public sources. Confidential
information has been carefully excluded.

A glossary is provided to help with industry jargon and non-


standardised terminology which can obscure some of the simple
concepts covered in this book.

7
Petroleum Fiscal Systems and Contracts

1 CLASSIFICATION OF PETROLEUM FISCAL


SYSTEMS

Petroleum fiscal systems whereby the owner of mineral resources


receives levies from the extraction company can be classified into
two main categories These are concessionary systems and
contractual systems as shown in Figure 1-1.

Petroleum Fiscal Systems

Concessionary Systems Contractual Systems

Service Production Sharing


Agreements Agreements

Pure Service Risk Service


Agreements Agreements

Figure 1.1 Classification of petroleum fiscal systems


(Ref. 7)

In most countries, except the United States of America, the owner


of the mineral resources is the government. In the USA, the
owners are private individuals or companies that pay taxes on
production to the state.

Worldwide, every country has developed its own petroleum fiscal


systems to be applied. Under concessionary systems, the
government will transfer title of the oil and gas to a company if
they are produced. The producing company then pays royalties
and taxes.

Contractual systems are in most cases either production sharing


agreements or service contracts. The private companies under

8
Petroleum Fiscal Systems and Contracts

contractual systems have the right to receive a share of


production or revenues from the sale of oil and gas in accordance
with a production sharing agreement (PSA) or a service
agreement (SA). The state companies either self produce or share
the production and selling of the oil or gas. Revenues then flow
into the finance ministries’ treasuries.

In most contractual systems, the facilities installed by the


contractor within the host government’s territory become the
property of the state either as soon as they are landed or upon
start up or commissioning. Sometimes, the asset or a facility does
not pass to the government until the expended costs have been
recovered. This transfer of title for asset facilities does not apply to
leased equipment or to equipment brought in by service
companies.

The difference between service contracts and production sharing


contracts depends on whether the contractor receives
compensation in cash or in crude. Under a production sharing
agreement, the contractor receives a share of production and
hence takes title to this crude. In a concessionary system, the
transfer of title occurs at the point of export instead of at the
wellhead. In a service contract, there is no issue of title since the
contractor gets a share of profits rather than production. Under
some service agreements, however, the contractor has the right to
purchase crude from the government at a discount. Despite the
differences between the systems the same economic results are
achieved.

When the contractor is paid a fee for conducting exploration and


production operations, then this system is a risk service contract.
The difference between risk and pure services contracts depends
on whether there is a fee on the profits or not. The pure service
contract is without risk in exploration and development.
Consequently, this is usually used by conservative nationalised
companies or by states that have capital but are lacking in
technology and management capability.

9
Petroleum Fiscal Systems and Contracts

The different fiscal systems are further illustrated in Figure 1-2,


showing the differing points of transfer of title and methods of
remuneration.

Classification of Petroleum Fiscal Regimes

Characteristics:

„Titel“ to Concessionary
Mineral Contractual Based
Resources: (Royality/Tax) Systems
(1) at the wellhead (1) Systems

„Reimbursement“
and Production Sharing Contracts
„Remuneration“ is Service Agreements „Titel“ to Hydrocarbons at the Export Point (1)
(2):
In „Cash“(2) In „Kind“ (2)

Peruvian Indonesian
Type Type
Division of
Service- Division of
„Gross
„Profit Oil“
„Remuneration“ Pure Service Hybrids Risk Service Production“
Is based upon: (3)
a Flat Fee (Pure) (3) a Flat Fee (pure) (3) Profit (Risk) (3)

Egyptian
Type
Unused Cost
Oil as seperate
category

Figure 1.2 Detailed classification of petroleum fiscal systems


(Ref. 7)

In addition to the concessionary and contractual systems, which


are the two most used systems, there are some further variations
that could be considered as types of fiscal system.

The joint venture is a variant fiscal/contractual system. It is used


where the national company and contractor company establish a
working interest arrangement. This is found in both concessionary
and contractual systems.

Technical assistance contracts (TACs) are sometimes used for


enhanced oil recovery (EOR) projects or restoration and
redevelopment managed under a production sharing agreement
or a concessionary system.

10
Petroleum Fiscal Systems and Contracts

Typical Contract Conditions


• Area Bonus
• Duration Government participation
• Relinquishment Ringfencing
• Exploration Obligation/(Work Commitment) Cost Recovery
• Royalty C/R Limit
• Depreciation Profit Oil Split
• Special Deductions R-Ratio
• Tax Credit Domestic Market Obligations
• Taxation Start of Production
Lease is returned
End of
Petroleum Asset Profile Recovery Production

Lease Exploration Development Production Closure Post-Closure

Petroleum Fiscal Systems


Relatively Regressive Systems Relatively Progressive Systems
(High Royalties, Bonuses, Low Cost (Income Tax and Royalty linked to
Recovery Limit, Ring Fencing,…) Volume or Value of Production,
Government take linked to
Production or Return on
Investment,…)

Discourage investment Encourage investment

Figure 1.3 Typical project contract conditions


(Ref. 15)

11
Petroleum Fiscal Systems and Contracts

CONCESSIONARY SYSTEMS

Under a concessionary system, the state government grants a


Concession or License to an international oil company (IOC) or a
consortium which gives rights for a fixed period to explore for and
produce hydrocarbons within a certain area (License Area or
Block). The IOC may be required to pay a signature bonus or a
license fee to the government to secure the Concession or
License. Thereafter, the government will obtain compensation
usually through royalty and tax payments when hydrocarbons are
produced.

Concessionary systems are used by around half of the countries


worldwide including the US, UK, France, Norway, Russia,
Australia, New Zealand, South Africa, Colombia, and Argentina.
These countries have fiscal regimes which vary widely in terms of
royalty and tax rates, tiers of taxation and other features such as
incentives to promote investment.

Examples of how concessionary arrangements work through


paying royalties and taxes to the state in different tiers are shown
in Figures 1-4 to 1-6. The first point of government tax may be
royalty in the start as in Figure 1-4. This may be followed by local
and federal level taxation on income after allowing for operating
costs, depreciation, depletion and amortisation. The cash flow
projection and the calculation of the net present value (NPV) and
internal rate of return (IRR) of a project needs to take account of
the full range of royalties and taxes to be applied.

Calculation of Government and Contractor Take

The concession agreement determines how profits will be shared


between the government take and the contractor’s take. The
balance between these is critical for investment in exploration and
development activities.

Figure 1-4 shows a typical model of how revenue is distributed


under a simple concessionary system. Royalties, deductions, and
taxation are subtracted sequentially. The royalty, in this case 40%

12
Petroleum Fiscal Systems and Contracts

of the gross revenues, comes right off the top. The balance
remaining after royalties is the net revenue. Certain deductions of
contractor’s costs are allowable from the net revenue. These
deductions include operating costs (Opex), depreciation,
depletion, and amortisation (DD&A) and intangible drilling costs
(IDCs). Most countries follow this DD&A format but will allow
different rates of depreciation or amortisation for various costs.
Some countries are liberal in allowing capital costs to be
expensed.

Revenue remaining after royalty and deductions is called taxable


income. In this example, it is subjected to two layers of taxation
with 10% provincial tax and 40% federal tax. Since provincial tax
is deductible against federal tax, the overall effective tax rate is
46%.

After tax deductions, the contractor share of profit is USD 6.48,


making a share of gross revenues of USD 18.48. This equates to
a contractor take of 47%. The profit in this example is USD 28
(USD 40 gross revenues minus USD 12 costs). This is different
from contractor’s profit margin, which in this example is 16.2%
(USD 6.48/USD 40).

13
Petroleum Fiscal Systems and Contracts

CONCESSIONARY SYSTEM FLOW DIAGRAM


One Barrel of oil = 40 USD

Contractor Share Royalties and Taxes

40%
Royalty USD 16

USD 24 (Net Revenue)

Deductions for Operating costs (Opex), Depreciation, Depletion and


Amortisation (DD&A), Intangible Drilling and Development Costs (IDCs),
etc.)

USD 12 USD 12 (Taxable Income)

Provincial Taxes for example 10% USD 1.2

USD 10.8

Federal Income Tax for example 40% USD 4.32

USD 6.48 Net Income after Tax

__
USD 18.48 USD 21.52

47% 53%

Figure 1.4 Example concessionary system flow diagram

Figures 1-5 and 1-6 further outline terminology and the hierarchy
of arithmetic for calculating contractor cash flow. This example
gives more of a financial perspective. The cash flow projection is
based on the assumption that some classes of capital cost are
intangible and are immediately deductible whilst tangible capital
costs are depreciated over five years. The development example
in Figure 1-5 is for a field with 50 MMbbl of recoverable oil. Total
capital costs (Capex) are USD 174 million and estimated
operating costs during the life of field (Opex) are USD 300 million.
Production of the field is expected to generate gross revenues of
14
Petroleum Fiscal Systems and Contracts

USD 2 billion based on an oil price of USD 40 per barrel.


Calculation of the respective takes comes from the cash flow
projection. The government take of 52% is derived from 40%
royalties plus 20% tax on net profit.

Gross Revenues USD 2 billion


Total costs - USD 474 million

Total profit USD 1.526 billion


Royalties 40% USD 610.40 million
Taxes 20% USD 183.12 million

Contractor take USD 732.48 million

Contractor Take 48% (732.48 ÷ 1.526)


Government Take 52%

Figure 1.5 Example calculation of government and contractor take

15
Petroleum Fiscal Systems and Contracts

Basic Equations for Royalty/Tax Systems

Figure 1-6 sets out the basic equations for calculating net cash
flow under a royalty/tax fiscal system.

Gross revenues = Total oil and gas revenues

Net revenues = Gross revenues – royalties

Net revenue (%) = 100% - Royalty rate (%)

Taxable income = Gross revenues - Royalties

- Operation costs
– Intangible capital costs
Deductions - Depreciation, Depletion and
Amortisation (DD&A)
– Investment credits (if allowed)
- Interest on financing (if allowed)
– Tax loss carried forward
- Bonuses

Net cash flow = Gross revenues


(after tax) - Royalties
- Tangible capital costs
- Intangible capital costs
- Bonuses
- Taxes

Figure 1.6 Basic equations for royalty/tax systems


(Ref. 7, 8, 9, 10)

16
Petroleum Fiscal Systems and Contracts

CONCESSIONARY SYSTEM STRUCTURE


OIL COMPANY PERSPECTIVE

Terminology USD/bbl Royalties, Costs, and Taxes

Wellhead price USD 40


-USD 16 40% Royalty

Net revenue USD 24


- USD 2.4 10% Provincial taxes
- USD 6 Operating costs
- USD 1.8 General and administrative costs
USD 13.8
Before -tax operating
income - USD 6.20 Depreciation, depletion and
amortisation

Before -tax net income USD 7.6


-USD 0.608 8% State income tax
USD 6.992
USD 2.38 34% Federal income tax
After-tax net income USD 4.62
+USD 6.2 Depreciation, depletion and
amortisation
- USD 2.5 Tangible capital costs
After-tax cash USD 8.32

Figure 1.7 Concessionary system structure from the oil company


perspective

17
Petroleum Fiscal Systems and Contracts

PRODUCTION SHARING CONTRACTS

Production sharing contracts or agreements (PSCs or PSAs) give


an international oil company (IOC) or consortium exploration and
production rights for a fixed period in a defined Contract Area or
Block. The IOC bears all exploration risks and costs in exchange
for a share of the oil or gas produced. Production is split between
the parties according to formulae in the PSC that may be fixed by
statute, negotiated, or secured through competitive bidding. If the
IOC does not find a commercial discovery, there is no
reimbursement of costs by the government.

The advantage to the host government of this system is that the


government will generally receive a large share of the oil or gas.
This can be sold and the revenue used according to the
government’s development programmes and economic needs.
Following the introduction of PSCs in Indonesia in the mid 1960s,
they are now also used in Malaysia, India, Nigeria, Angola,
Trinidad, the Central Asian Republics of the Former Soviet Union,
Algeria, Egypt, Yemen, Syria, Mongolia, China, and many other
countries.

Essentially, control of the oil remains with the state. National


companies are maintained to manage the resource whilst the
contractors have execution responsibility. Contractors are
required to submit a programme and a budget to be approved by
the national company. The type of contact depends on the level of
reserves and political economic aims of the host government.

It is important to note in such contracts both the level of


percentage of recovery of costs and also the way in which the
exploration or development costs may be recovered. If there is
costs recovery before sharing of production, the contractor is
allowed to recover the costs out of net revenues. The costs
recovery limit is the only true distinction between concessionary
systems and PSCs. The amount of revenues remaining after
royalty and cost recovery, is termed profit oil or profit gas. This is
the equivalent of taxable income in a concessionary system.
Within the service agreement, it would be termed the service fee

18
Petroleum Fiscal Systems and Contracts

rather than profit oil or gas. The contractor share of profit oil or
gas is taxed at the rate of sharing.

Basic Equations for Contractual Systems

Figure 1-8 sets out the basic equations for calculating net cash
flow under a product sharing contractual system (Ref. 7,8).

Gross revenue = Total oil and gas revenues


Net revenues = Gross revenue – Royalties
Net revenue (%) = 100% - Royalty rate (%)
Cost recovery = Operating costs
“Cost oil” + Intangible capital costs
+ DD&A (including abandonment costs)
+ Investment credits (if allowed)
+ Interest on financing (if allowed)
+ Unrecovered costs carried forward
Profit oil = Net revenue – Cost recovery
Contractor profit oil = Profit oil x Contractor percentage share
Government profit oil = Profit oil x Government percentage share
Net Cash flow = Gross revenues
(after tax) - Royalties
- Tangible capital costs
- Intangible capital costs
- Operating costs
+ Investment credits
- Bonuses
- Government profit oil
- Taxes
Taxable income = Gross revenues
- Royalties
- Intangible capital costs
- Operating costs
+ Investment credits
- Government profit oil
- DD&A (including abandonment costs)
- Bonuses (Not always deductible).

Figure 1.8 Basic equations for contractual systems

19
Petroleum Fiscal Systems and Contracts

The example in Figure 1-9 illustrates the way in which the


contractor and government shares may be calculated in a
production sharing contract.

PRODUCTION SHARING CONTRACT FLOW


DIAGRAM
One Barrel of Oil = USD 40
Contractor Share Government Share

20% Royalty USD 8


USD 32

Cost Recovery
[Operating Costs, Depreciation, Depletion and Amortization
(DD&A), Intangible Drilling and Development Costs (IDCs) ]
USD 16 40% (Limit)

USD 16
Profit Oil Split
USD 6.4 40%/60% USD 9.6
(Taxable)

- (USD 2.56) Taxes 40% + USD 2.56


USD 19.84 USD 20.16

49.6% 50.4%

Figure 1.9 Example production sharing contract flow diagram

Contractor Take

In Figure 1-9, with one barrel of oil worth 40 USD, the total profit is
USD 16. Considering the 20% royalty, profit oil split, and taxation,
the contractor share of profits is 20%, or USD 3.2. The presence
of a cost recovery limit forces some profit sharing under all
circumstances where production is achieved.

20
Petroleum Fiscal Systems and Contracts

PRODUCTION SHARING CONTRACT STRUCTURE


CONTRACTOR’S PERSPECTIVE

Terminology USD/bbl Royalties, Costs, Taxes and Sharing

Wellhead price USD 40


-USD 8 20% Royality
Net revenue USD 32
1 Local taxes (usually)

Cost recovery
-6 Operating costs
- 1.8 General and administrative costs
- 6.2 Depreciation, depletion and
amortization
Total cost recovery USD - 14
Profit oil USD 18 Sharable
Government share (60%) - USD 10.8 60%/40% Split in favor of
Government
Contractor share (40%) USD 7.2
-USD 3.6 50% Income tax
After-tax net income USD 3.6
+ USD 6.2 Depreciation, depletion and
amortization
- USD 2.5 Tangible capital costs
After-tax cashflow USD 7.3

Figure 1.10 Production sharing contract structure from the


contractor’s perspective

Cash Flow Projection

In the cash flow projection example illustrated in Figure 1-11 the


calculation of government and contractor takes can be seen. It is
necessary to define the royalty, cost recovery limit, DD&A, profit
oil split and taxes. The gross revenues, less the total costs, then
gives the total profit, less the government profit oil and taxes. The
results are the respective contractor take and government take.

21
Petroleum Fiscal Systems and Contracts

The PSC terms include:

Royalty = 0%
Cost recovery limit = 40%
DD&A = 5-year straight-line decline (SLD)
Profit oil split = 30% for the contractor
Taxes = 40%.

The development costs are all capitalised, and depreciation starts


when production begins. The last column, net cash flow, is the
undiscounted cash flow.

A Production Profile
B Oil Price
C Gross Revenue = A x B
D Intangible Capital Costs
E Tangible Capital Costs
F Operating Costs
G Bonuses are not cost recoverable but are tax deductible
H Depreciation of tangible Capital Costs: 5-Year Straight
Line Decline
I Contractor Cost Oil = D + F + H, if C is greater than zero:
Up to a maximum of 60% of C
J Total Profit Oil = C – J
K Contractor Profit Oil = J x 35%
L Tax Loss Carry Forward (see the Bonus G Column)
M Income Tax 45% = [(K) – (L)] x 45% if (K) – (G) – (L) >
(zero) then [(K) – (G) –(L)] x 45%, otherwise zero
N Contractor After–tax Net Cash Flow = (C) -(D) –(E) – (F) –
(G) –(J) + (K) –(M)

22
Figure 1.11 Sample rate of return contract cash flow projection

Petroleum Fiscal Systems and Contracts


Period Production Oil Price Gross Capital Expenditures Operating Costs Bonus DD&A Contractor Total Contractor Tax 45% Net
Revenues Exploration Development Over-/Workover Cost Profit Profit Income Cash
Wells G&G Drilling & G&A Capex Production Drilling & Facilities Pipelines Field Capex Total Total Opex Oil Oil Oil Tax Flow
Drilled Completion Exploration Wells Drilled Completion Development Development Capex
Years MMbbl $/bbl $MM $MM $MM $MM $MM $MM $MM $MM $MM $MM $MM $MM $MM $MM $MM $MM $MM $MM $MM
A B C D E F G H I J K L M N

23
Petroleum Fiscal Systems and Contracts

Basic Elements

There are two basic elements in the production sharing fiscal


structure. The first is the operational element and the second is
the revenue or production sharing element. Each of them have
national legalisation and contractual aspects. The national
legalisation aspects such as government participation, mediation,
insurance and ownership transfers are unchangeable in the
operational period, as are revenue factors (royalties, taxation,
depreciation rates, investment credit and domestic obligations).
The contract conditions, however, are negotiable. For example,
the oil ministry can negotiate the split of oil but cannot negotiate
the tax rate which is fixed. The oil companies are able to negotiate
the structure of production sharing contracts. Negotiable aspects
include the area of lease, work commitment, commerciality,
renouncement, bonus payments, cost recovery limits, and
production sharing percentages.

Work commitments are generally defined in terms of kilometres of


seismic data to be acquired and the number of wells to be drilled.
There are some cases, however, where only seismic
commitments are defined and drilling is optional.

Bonus Payments

Cash bonuses are sometimes paid upon finalisation of negotiation


and contract signing, or these will be paid when production
reaches a certain cumulative level. Sometimes part of the costs of
equipment is calculated as a bonus. Production bonuses may be
payable at the start of production or when a certain level of
accumulated production is achieved.

24
Petroleum Fiscal Systems and Contracts

Royalties

The basic concept of royalties which is similar under all fiscal


systems is that royalties are taken straight off the top of gross
revenues.

Many production sharing contracts (PSCs) do not have a normal


royalty because of the ownership issue. Payment of royalty
implies ownership on the part of the royalty payer but in a PSC the
contractor has no ownership at this stage. The primary reason
that this terminology is used is because of the hierarchy of the
arithmetic associated with royalties. Where PSCs do include a
royalty, this can typically range as high as 15%. A PSC royalty is
treated just as it would be under a concessionary system; it is the
first calculation made. The royalty level is clearly very important
and rates above 15% may be considered by the contractor as
excessive. Governments may now scale royalties accordingly to
the field size since it can be inefficient and counterproductive if
royalties are set too high.

Sliding Scales

A characteristic encountered in many petroleum fiscal systems is


the sliding scale (or progression of steps) used for royalties, taxes,
and various other items. The aim is to create a flexible system
with sliding scale terms so that as production rates increase,
government take increases. Terms can be set appropriately for
the development of varying sizes of field. Some contracts will
provide flexibility through a progressive tax rate. Others will tie
more than one variable to a sliding scale such as cost recovery,
profit oil split, and royalty. The most common approach is an
incremental sliding scale based on average daily production.

The following example, Figure 1-12, shows a sliding scale royalty


that steps up from 5% to 15% on portions of the daily production
rate. If average daily production is 20,000 bopd, the aggregate
effective royalty paid by the contractor is (10,000 bopd at 5% +
10,000 bopd at 10%).

25
Petroleum Fiscal Systems and Contracts

Sample Sliding Scale Royalty

Average Daily Production Royalty

First Part Up to 10,000 bopd 5%


Second Part 10,001 - 20,000 bopd 10%
Third Part Above 20,000 bopd 15%

Figure 1.12 Sample sliding scale royalty


(Ref. 7)

Production levels in sliding scale systems must be chosen


carefully. If rates are too high, then the system effectively does not
have a flexible sliding scale. In some situations steps of 50,000
bopd can be too high or conversely 10,000 bopd steps may be
too low. The choice should be determined by the anticipated size
of discoveries.

26
Petroleum Fiscal Systems and Contracts

SERVICE CONTRACTS

Many service agreement are identical to PSCs in all but the


method of payment, either by production sharing or profit sharing.
Many service agreements, however, have unique contract
elements that are used in calculating the service fee.

Pure Service Contracts

A pure service contract is one where the contractor carries out


exploration and/or development work on behalf of the host
government for a fee and the contractor bears no exploration risk.
This kind of contract is not used widely but may be used
sometimes, typically in the Middle East, where the state has
substantial capital but seeks only expertise. Examples exist in
Iran, Saudi Arabia, the Philippines and Kuwait.

The pure service contract is similar to contracts used in the oil


service industry with companies such as Halliburton and
Schlumberger where the contractor is paid a fee for performing a
service. Examples are contracts placed for drilling services,
development services and some exploration services. Drilling
service contracts may be let as pure service arrangements e.g.
whereby the contractor is paid on a footage basis while drilling
and on an hourly basis for completion and testing operations.

Risk Service Contracts

A risk service contract is radically different from a pure service


contract and bears little similarity to an oil service industry service
contract.

Under a risk service contract awarded by a host government, the


contractor provides all capital associated with exploration and
development of petroleum resources, bearing all the exploration
risk. If exploration is successful, the contractor is allowed to
recover costs through sale of the oil or gas and also receives a

27
Petroleum Fiscal Systems and Contracts

fee based on a percentage of the remaining revenues. This fee is


often subject to taxes.

As well as bearing exploration risk, the contractor does not get a


share of production. However, although there is no production
sharing or profit oil, the contract terms allow the contractor a share
of revenues similar to that derived from a share of production in a
PSC. The host government maintains ownership of the
hydrocarbons produced and the contractor does not acquire any
rights to oil and or gas unless the contractor is paid its fee in kind
as oil or gas. The contractor may also be given preferential rights
to purchase production from the government.

28
Petroleum Fiscal Systems and Contracts

OTHER FACTORS THAT INFLUENCE PRODUCTION


SHARING CONTRACTS

Rate Of Return Contracts

Some countries have developed progressive taxes or sharing


arrangements based on project rate of return (ROR). As with
sliding scale systems, the ROR system is used to ensure that
terms are flexible and that government take increases
appropriately with increased production. Unlike sliding scale taxes
and other attempts at flexibility based on production rates, ROR is
more progressive since it is based on a direct measure of
profitability. ROR systems take into account product prices, costs,
timing, and production rates. All these factors influence project
profitability.

Under an ROR contract, the government does not receive


payments until the contractor has recovered its initial financial
investment plus a predetermined threshold rate of return. The
government share is calculated by accumulating the negative net
cash flows and compounding them at the threshold rate until the
cumulative value becomes positive. When that happens,
additional resource rent taxes (RRT) are levied but the contractor
still receives some of the profits in excess of the threshold rate of
return.

Contracts with Factors

Some contracts use factors such as R, K, a and b factors.

The most common use of such a factors is found in Algerian,


Tunisian, Colombian and Peruvian contracts. In these contracts
the definitions are virtually identical:

29
Petroleum Fiscal Systems and Contracts

R factor = Accrued Net Earnings/Accrued Total Expenditures.

R= X/Y

Where:
X= Cumulative net revenue actually received by the
contractor. This equals turnover (gross revenues) for all
tax years less taxes paid.

Y= Total cumulative expenditure (exploration and appraisal


expenses and operating costs) actually incurred by the
contractor from the date the contract is signed.

Some variants on the use of R factors are given below. (Ref. 7)

Tunisian R Factor with Sliding Scale Taxation

R Factor Income Tax, Rate %


<1.5 50%
1.5-2.0 55
2.0-2.5 60
2.5-3.0 65
3.0-3.5 70
3.5+ 75

Colombian R Factor

R= X
(ID + A - B +( x C) + GO)

Where:
X= Accumulated earnings of the contractor
(ID + A - B +(  x C) + GO) = Accumulated Investment +
Accumulated Costs of the contractor
ID = 50% of cumulative gross development costs
A= Cumulative gross successful exploration costs
B= Cumulative successful exploration costs reimbursed by the
NOC (50% partner)

30
Petroleum Fiscal Systems and Contracts

C= Cumulative gross unsuccessful exploration costs


= Proportion of dry-hole costs reimbursed by NOC (a bid
item, maximum 50%)
GO = Contractor cumulative net operating costs including War
Tax payments and duties on imports.

Colombian Sliding Scale R Factor

Contractor Percentage
R Factor Participation
< 1.0 50%
1.0-2.0 50/R
2.0 + 25

In these contracts the R factor is based on a return on investment


(ROI). Once the contractor has received his costs plus 50%, or an
ROI of 150%, the tax rate increases from 50% to 55%. In some
respects it is similar to a rate of return (ROR) contract but a typical
ROR contract triggers on internal rate of return (IRR).

31
Petroleum Fiscal Systems and Contracts

JOINT VENTURES WITH GOVERNMENT PARTICIPATION

International oil companies often form joint venture (JV)


partnerships with industry partners to share risk and reward for
large scale or high risk ventures. Joint ventures may also be
formed with direct government participation.

In a pure joint venture, the host government and the contractor


would share equally in costs and risks but in practice the extent of
government participation varies. In most JVs with government
participation, the contractor oil company bears the costs and risks
of exploration so that the government is carried through
exploration. In some of the proposed Russian JVs which apply to
proven and well-delineated reservoirs there is a 100% carry for
the production association partner through development including
operating costs

Government participation has the effect of reducing the potential


rewards of exploration. Where the government actually pays its
share of JV costs, the government share of profits cannot be
considered as a tax on income. However, if government is carried
through exploration, government participation acts like a capital
gains tax. In extreme cases such as Russia where the contractor
pays all rehabilitation, development and operating costs, the
government share of JV profits constitutes an added layer of
taxation.

The contractor will recover exploration and development costs by


means of either cost recovery, deductions, or direct
reimbursement but there is an important difference of timing
between direct reimbursement and cost recovery.

Figure 1-13 illustrates an example of how a


contractor/government joint venture operates. Here, the
government through the national oil company is a 30% working
interest partner. The proceeds are divided under a PSC with a
60%/40% profit oil split in favour of the contractor group. The
contractor group here, however, includes the government as a
partner. Both partners receive their pro-rated share of cost oil and
profit oil is split according to working interest shares.

32
Petroleum Fiscal Systems and Contracts

Government
ForeignOil
National
Company
Oil Company

Exploration
Capital and
Technology
30% of
70% of 70%/30% Development
Development Joint Venture Capital
Capital Company

GrossRevenues
-Royalty
-Cost Recovery Prorated

Profit Oil
Split According 40%
to thePSC

60%

Remaining
Profit Oil 30%
Accordingto WI

70%

-Taxes

Contractor Net
Profit Oil After Tax

Figure 1.13 Joint venture structure with a PSC


(Ref. 2, 3, 7)

Figure 1-14 shows an alternative example for a typical Russian


JV.

33
Petroleum Fiscal Systems and Contracts

The Extent of Government Participation in a Joint Venture

The range of government participation can be characterised from


Light to Heavy:

Light - Pure Joint Venture


All Costs/risks shared
Very rare.

- Mauritania Type Participation


Government carried through exploration
Contractor recovers exploration costs
plus 50% uplift on government share.

- Typical Joint Venture


Government carried through exploration
Most Common
Contractor can recover exploration costs.

- Colombian Type Joint Venture


Government carried through exploration and
delineation.

- Full Carry
Government carried through exploration and
development
Not common.

Heavy - Russian Type of Joint Venture


Government carried through rehabilitation and
development, until it has cash flow from operation.

34
Petroleum Fiscal Systems and Contracts

National Government
Foreign Oil
Represented by
Company or
Local Production
Consortium
Association
50%/50%
Capital & Joint Venture
Proved &
technology Company
Probable
Reserves,
Gross revenues Equipment,
And
Personnel
-Direct Taxes and Costs
(a) Export Tarif (USD30-USD40/ton)
(b) Royalty (8%)
(c) Replacment of Minerals payment (10%)
(d) Pipeline tariffs (USD10-USD20/ton)
(e) Value Added Taxes
(f) Road Use Tax (18%)
(g) Mandatory (Currency) Conversion
(h) Local Taxes
(i) Social Obligations
= Net Proceeds from Export
- Operating Expenses and G&A
= Taxable Income
-Capital Expenditure Deduction (DD&A)
(Limited to 50% of taxable income-Russia only)
= Profits Tax Base
-32% profits Tax (20%-40% in various rrepublics)
= Net Income

Net Income 10%-30% BPO


50% APO

70%-90% BPO
50% APO
BPO 0 Before payout
APO = After payout
+Capital Expenditure Deduction
= Contractor After-tax Cash Flow

Figure 1.14 Typical joint venture in Russia


(Ref. 7)

35
Petroleum Fiscal Systems and Contracts

TECHNICAL ASSISTANCE CONTRACTS (TACs)

Technical assistance contracts (TACs) are commonly applied for


work on existing fields in production or abandoned fields with the
purpose of field rehabilitation, redevelopment, or enhanced oil
recovery (EOR) projects. The contractor will undertake to provide
capital and specialist expertise and will take over control of
operations including equipment and personnel if applicable.

If there is existing production, a production profile with a specified


decline rate is negotiated. Future production as defined by the
negotiated decline rate is exempt from the sharing arrangement
and goes directly to the government. Increased production above
the negotiated rate is deemed to be due to the contractor’s
technical assistance. This incremental production is normally
subject to a production sharing arrangement although TACs can
be found under a variety of systems. Figure 1-15 outlines a three
phase TAC. The decision to proceed is based on the technical
results of each previous phase.

Phase One: Feasibility Study


Bonus
Minimum work commitment
6 months to 1 year

Phase Two: Pilot Programme


Bonus
Minimum work programme
2-3 years

Phase Tree: Commercial Development


Bonus
Workovers
Drilling
Implement full-scale EOR etc.

Figure 1.15 Three phase technical assistance contract (TAC)

36
Petroleum Fiscal Systems and Contracts

2 PROJECT EVALUATION

An international oil company interested in a concession must first


collect sufficient data to make a valid project evaluation. This will
include regional and field data provided by the government.
Further information may be available from neighbouring fields.
Analysis of the geological data will indicate the expected
petroleum reserves and recoverable production.

INITIAL RESERVES ESTIMATION

The first reserves simulation may be made based on a GAP


model calculation, showing the primary possible oil or gas
reserves. From this basis the company can then calculate the
costs needed for the exploration and development project.

Gross reserve figures are used when discussing field size


thresholds for exploration and development. The contractor
entitlement on the basis of crude liftings is used in making a
financial evaluation. Establishing a significant financial evaluation
is dependent in part on cost recovery, which depends on oil
prices.

Initial reserve estimates are derived from seismic or other


geophysical and geographical data, together with the results of
exploratory drilling. Exploration wells provide information on flows,
thickness and other measurements from oil bearing strata which
form the basis for an initial estimate of reservoir size. The
reliability of reserves estimates is increased with data from further
wells drilled, further measurements and the start of production.
Reserves estimates may change over time due to depletion by
production or when further information on the field becomes
available. Reserve estimates for a country or a region comprise
an aggregation of estimates for fields in various stages of their
exploration or production life and can increase or decrease
continually.

37
Petroleum Fiscal Systems and Contracts

An estimate of the amount of oil in a field depends on the recovery


factor: the proportion of oil in a field that can be removed. Eden et
al. (1981) report recovery factors to average between 25 and
30%, but with a wide variance. For a particular reservoir, the
recovery factor depends on the conditions in the reservoir;
composition of the oil, particularly its specific gravity; and the
particular drive mechanism by which the oil will be extracted. The
oil may be naturally driven, or forced out by gas or water, or a
combination of these. Enhanced recovery methods such as
pumping water into the reservoir, re-injecting gas, hot water
injection, solvent injection and steam injection may be possible to
further increase recovery.

Maximum Efficient Rate

For each well or field there is a maximum efficient rate (MER) for
production so that the natural reservoir energy is not wasted and
that the reservoir is most efficiently drained. This is achieved
when the oil-water contact rises at an even rate along the bottom
of the reservoir and the gas-oil ratio is kept to a minimum. The
MER is typically an annual production rate of 3 to 8% of the
recoverable oil reserves.

In order to determine the MER for a given well or field, the


reservoir drive mechanism needs to be clearly understood and
tests run for potential and productivity. A potential test can be run
after a well has been completed, to measure the maximum gas
and oil that the well can produce in a 24-hour period. Potential
tests may also be run periodically during production and can be
required by some government regulatory agencies. Productivity
tests are used to determine the effect on the reservoir of different
production rates. Measurements of the fluid pressure at the
bottom of the well are taken when it is shut-in and then during
several different stabilised rates of production. These
measurements are used to calculate the absolute open flow rate
and the maximum production rate that the well can safely
produce.

38
Petroleum Fiscal Systems and Contracts

RESERVOIR SIMULATION

Reservoir simulation modelling can be used to assess the


potential of new fields or existing fields in production and inform
decisions on field investment. Improved simulation software,
including software that can be run on personal computers has
reduced the time and cost of building a reliable reservoir model of
a field but this remains a time-consuming and expensive task.

Reservoir simulation modelling is commonly applied in planning


the development of new fields. Models are used to determine the
optimum number and location of wells required, the type of well
completions to be used, requirements for artificial lift and the
expected production of oil, water and gas. Modelling is also used
in the continuing management of developed fields to provide
production forecasts and inform further field development
investment. The model can help in improving field oil recovery,
assessing options for re-injection of produced gas or water
injection to maintain reservoir pressure, or additional wells that
may be highly deviated or horizontal to maximise recovery. The
effects of hydraulic fracturing can be modelled with specialised
software and this data included in the reservoir simulation model.

Successful enhanced oil recovery (EOR) processes depend on


appropriate reservoir characteristics being present. Special
features in reservoir simulation modelling can represent EOR
processes such as miscible displacement by natural gas, carbon
dioxide or nitrogen and chemical flooding with polymer, alkaline,
surfactant, or a combination of these. Problems in some miscible
applications with smearing or dispersion of the flood front can be
assessed.

In heavy oil deposits, oil recovery may be improved by injecting


steam or hot water to reduce the oil viscosity. Processes that can
be modelled include steam soaks where steam is injected and
then oil produced from the same well, and steam flooding with
separate steam injectors and oil producers). Models can account
for heat transfer to the fluids present and the formation and the
subsequent property changes and heat losses outside of the
formation.

39
Petroleum Fiscal Systems and Contracts

Reservoir simulation has also been applied for modelling of coal


bed methane (CBM) production using a specialised CBM
simulator. This requires data for the fractured formation and also
data values for gas content at initial pressure, adsorption
isotherms, diffusion coefficient, and parameters to estimate the
changes in absolute permeability as a function of pore pressure
depletion and gas adsorption.

PRODUCTION PROFILE

Planning for the development and production phases are based


on the expected production profile. The production profile which
depends strongly on the mechanism providing the driving force in
the reservoir will determine the number and phasing of wells to be
drilled and the production facilities required.

In any new project, it is important that the time required from


starting exploration until first oil is as short as possible. Once first
oil is achieved with the first commercial quantities of hydrocarbons
flowing, the production phase commences and there is a positive
cash flow. Cash generated can be used either to pay back
exploration and development investment or for new projects.

COMMERCIALITY

Commercial profit in the petroleum industry is the difference


between the value of produced oil and gas and the costs of
exploration, development and operating. The resource owner,
usually the host government, will attempt to secure as much of
this commercial profit as possible through various methods in
contracts and regulations.

An important aspect of international exploration is the


determination of commerciality. This concerns whether or not
development of a discovery is economically viable. This can be a
contentious issue. By the time a discovery is made, substantial
sunk costs will have been expended in exploration and this can
influence the development decision. These sunk costs represent

40
Petroleum Fiscal Systems and Contracts

considerable value for the contractor which will accrue if the


development goes ahead through cost recovery, or as deductions.
Conversely, the government view the sunk costs as a liability,
since if cost recovery is too great, then the government may end
up with only a small percentage of the gross production,
depending upon the contractual/fiscal structure.

In some countries, the decision whether or not to commence


development operations rests solely with the contractor but in
other systems there is a defined commerciality requirement. To
meet the commerciality requirement, the contractor must
demonstrate that development will be economically beneficial for
both the contractor and government. Under many commerciality
clauses, a discovery cannot be developed unless it is granted
commercial status by the host government. The grant of
commercial status marks the end of the exploration phase and the
beginning of the development phase of contract. The government
criterion for obtaining commercial status is usually a fixed
percentage of gross take for government. However, with
progressive regimes the criterion may be based more on
profitability than gross revenues. If a marginal field is developed
under a progressive regime then the government share of
revenues could be both small and substantially delayed. The fiscal
systems with significant limits on the contractor’s access to gross
revenues may not need to set a commerciality requirement.
However, countries that have low royalties and no cost recovery
limits often protect themselves with a commerciality clause.

The first indication of commerciality comes from the first positive


reserve calculation. The estimated exploration and development
costs can be used to make the first draft assessment of field
commerciality or non-commerciality.

Figure 2-1 illustrates the allocation of revenue from oil and gas
production for costs and the division of profits. Government profit
is equal to gross revenue minus costs. This graph shows how
governments view the contractor share of profits as a cost.

41
Petroleum Fiscal Systems and Contracts

G P Government Take R
R E
R (Royality, Production Sharing, taxes, Government Participation)
N
O O T
S F
S I Company Take C
O
T
N
R

C T Operating Cost A
C
O O T
S T O
R T A RE
N
E L
R Development Cost T
V I
E E T
C C L
N
O O E
U M
E V S Exploration Cost E

S E T N
R T

Figure 2.1 Allocation of revenues from production


(Ref. 7, 14)

In order to get a viable project when there are high exploration


risks, the profit margin must be wide enough to outweigh the risks.
The basic concept of petroleum fiscal systems consists, therefore,
of calculations of the expected economic life of the field and the
sharing contract conditions. Reduction of exploration uncertainties
through the availability of information leads to competitive bidding
and finally to an efficient market.

Governments seek to obtain commercial profit at the time of


transferring rights through signature bonuses and during
production through contract financial conditions and regulations.
From the government viewpoint, there is a balance to be struck
between risk aversion, where bonuses and royalties are used, and
risk sharing, where taxation or production sharing concepts are
used. There are, for example, simple bonus tenders based on the
government’s concept of commercial profit but this type of
contract is highly risky for the contractor, especially if there is not
enough exploration information provided for the field. In such

42
Petroleum Fiscal Systems and Contracts

cases, taxation based on the profit from production is more


realistic.

A tax concept is illustrated in Figure 2-2. The preferred


government tax concept in the pre-discovery phase is the bonus
and commercial profit. In the post-discovery phase, the further
downstream from gross revenues a government levies taxes, the
more effective the system becomes.

TAX BASE SPECTRUM


Post Discovery Taxes Resources
Pre - Post-
Discovery Discovery Rent Taxes
Special
Bonuses Government Petroleum
& Participation Taxes
Repatriation
Rentals
Windfall Export
Royalties Severance & Provincial Federal or Excess Dividend
Ad Valorem & State Income Profits Withholding
Taxes Income Taxes Taxes Taxes Taxes

State Revenue
Discovery
Net
Gross Net Revenues Income
Taxable
Revenues Income
Regressive Progressive
The further downstream from gross revenues taxes are levied, the more progressive the system

Figure 2.2 Tax Base Spectrum


(Ref. 3, 6, 7)

43
Petroleum Fiscal Systems and Contracts

3 CONTRACTS

Governments are concerned to ensure that contract terms are


favourable and may choose to fix the key fiscal terms through
legislation. Under a fixed terms system, there is no negotiation of
the terms such as royalties, taxes and profit oil share; tenderers
may only negotiate such items as work programme, signature
bonus, or local content. Some governments, however, allow their
national oil company or oil minister to negotiate elements in the
system such as the profit oil split although negotiated deals have
greater potential for corruption than a transparent bid round.

Agencies such as the World Bank, the International Monetary


Fund or the UK Extractive Industry Transparency Initiative (EITI)
increasingly pressure governments and oil companies to have
open competition in awarding contracts and to disclose more
information on contract terms. These external bodies want
governments to be more transparent and allocate acreage on the
basis of public auctions.

In some cases countries seeking development interest do not


have sufficient geological potential to ensure that an open bid
round will yield sufficient or even any bids. As well as
governments fearful of a failed license round where no bids are
submitted, contractors can be reluctant to enter sealed bid
tendering for acreage that may not have clearly evident potential.
Consequently, negotiated deals may be favoured as an effective
way in which the government can test market interest as they
consider various proposals and offers (Ref. 7).

44
Petroleum Fiscal Systems and Contracts

KEY CONTRACT PROVISIONS

Work Programme

All contracts, whether on a royalties and taxes basis, a production


sharing bases or a service agreement, will have an agreed work
programme commitment. The contractor’s work commitment may
be backed by a bank guarantee.

Along with the signature bonus payable, the work programme for
exploration defined in the contract is critical to contractor’s risk. A
large proportion of exploration efforts are unsuccessful, with only
a 10 to 15% chance of going beyond the work commitment. Thus
negotiators focus attention on agreeing suitable work commitment
definition.

The work programme will often be subdivided into two or more


clearly defined phases. Each phase commitment will then usually
be defined as a quantity of seismic data to be acquired, processed
and interpreted, or as a number of wells to be drilled.

Transfer Pricing

Almost all agreements or petroleum laws prohibit transfer pricing


i.e. pricing of oil or gas in non-arms-length sales transactions
between associated companies. Governments may require that
the price be market-based by basing prices for oil or gas sales
that will be used for royalty and tax calculation purposes on an
agreed basket of market prices for marker crudes. Typical marker
crudes include Brent, Urals, Minas, Fatah, Saudi Light, and West
Texas Intermediate.

Royalty Determination

Systems vary widely in how many deductions are allowable when


calculating royalties. In some cases, no deductions at all are
allowed. The most lenient systems allow full net back deductions
for operating costs, depreciated development capital costs and

45
Petroleum Fiscal Systems and Contracts

capital costs for the transportation facilities to the point of sale,


which are the same basic components used for tariff
determination by regulated utilities. The wellhead price then would
be the price used for royalty and tax calculation purposes.

Taxes in Lieu

Agreements may include the provision that the national oil


company shall pay taxes for and on behalf of the contractor. This
is known as payment of taxes in lieu. Examples where production
sharing systems provide for payment of taxes “in lieu” out of the
national oil company’s share of profit oil can be found in Egypt,
Syria, Oman, Qatar, Trinidad, Philippines and other countries.

With taxes in lieu, contractor companies receive less than they


would have if they paid the taxes directly in cash. To compensate
for this, companies will gross-up the contractor share of profit oil
by dividing by (1-tax rate) and then book this engrossed
entitlement instead of the actual entitlement. (Ref. 7)

For example:

Contractor’s actual entitlement of expected proved barrels is:


20 MMbbl cost oil + 15 MMbbl profit oil = a total of 35 MMbbl

Host country’s tax rate is 40% but this tax is paid “in lieu” from the
NOC's share of profit oil.

Contractor would book the equivalent of:


20 MMbbl of cost oil + 25 MMbbl engrossed profit oil [15 MM/(1-
0.4)] = a total of 45 MMbbl.

The taxes in lieu approach is believed to provide a measure of


stability since if taxes go up it is already stipulated in the
agreement that the NOC will pay taxes However, this system
initially caused problems in the US with the tax credit system and
potential for double taxation. This led in 1976 to an IRS ruling that
forced Indonesia to issue its second generation PSC which
requires companies to pay taxes directly. Now the NOC provides

46
Petroleum Fiscal Systems and Contracts

the contractor with a tax receipt which can be reported to the IRS
to prove that taxes are actually being paid by the NOC.

Ring Fencing

Ring fencing is commonly used by most governments. Under a


ring fencing system, contractors or concessionaires are forced
either by regulations or contract terms to restrict all cost recovery
or tax deductions associated with a given license or field to that
particular cost centre. Thus a government prohibits consolidation
of accounts across different licenses or fields.

In practice, ring fencing means that exploration expenses in one


non-producing block cannot be deducted against income for tax
calculation purposes in another block. Similarly for a production
sharing contract, costs incurred in one ring fenced block cannot
be recovered from another block outside the ring fence. Although
ring fencing normally refers to an area or a field, it may also be
used for periods of time or for categories of costs. It can also
apply so as to clearly separate exploration and development
costs.

Stability Provisions

International oil companies face a major risk that a host


government may change legislation or rules affecting taxes or
royalties during the period after a discovery is made or during the
production period. In Western countries, other risks such as
political, commercial or social risk are often small yet the
possibility of fiscal changes remains a significant risk. In many
non-Western countries, companies encounter a wide range of
risks amongst which the risk of changing fiscal rules is most easily
controlled by the government.

Governments may choose to provide stabilising measures in their


agreements which offer some degree of guarantee against the
risk of fiscal changes.

47
Petroleum Fiscal Systems and Contracts

There are three main categories of stability provisions:

x Freezing Clauses
Freezing clauses in contracts will stipulate that the agreement
will be governed by the laws in place, including tax laws, at the
time of the agreement. This approach may be found in many
production sharing contracts but is commonly now being
replaced by alternative stability provisions.

x Equilibrium Clauses
These may also be known as economic equilibrium or
intangibility clauses. An equilibrium clause will typically state
that in the event of the government introducing a new measure
that has a negative financial impact on the contractor then the
profit oil split would be adjusted to maintain the economic
balance.

x Dispute Resolution Provisions


Clauses will state that resolution of disputes between parties
will be settled through international arbitration rather than in
the host country courts. The advantages of arbitration are that
it is usually cheaper than litigation in the courts and the
proceedings can be kept confidential unlike in a public court.
Three international arbitration bodies widely used are:
UNCITRAL (United Nations Commission on International
Trade Law), ICSID (International Centre for Settlement of
Investment Disputes), and the International Chamber of
Commerce (ICC).

48
Petroleum Fiscal Systems and Contracts

CONTRACT CONTENTS

An example of typical commercial terms within a contract that may


be used is set out in sections that follow. This example includes a
joint operating agreement.

Contract clauses presented here comprise:

x Contract terms
x Accounting procedure
x Joint account records and currency exchange
x Statements and billings
x Payments and advances
x Adjustments
x Audits
x Chargeable costs and expenditures
o Licenses, permits etc.
o Salaries, wages and related costs
o Employee relocation costs
o Transportation
o Offices, camps, utilities and miscellaneous facilities
o Material
o Services
o Damages and losses
o Insurance and claims
o Legal expenses
o Duties and taxes
o Parent company overhead
o Other expenditures
x Material
x Inventories
x Contract area.

49
Petroleum Fiscal Systems and Contracts

Contract Terms

Definitions:
define and describe terms of the contract.

Effective Dates and Term:


define the date of beginning and end of operation and production.
The financial liabilities which have accrued or been incurred for all
parties relate to this period.

Scope:
describes the purpose of the agreement and respectively the
rights and obligations of parties.

The Participation Interest:


ownership, obligations and liabilities.

Operator:
rights and duties of the designated operator.

Number of Employed:
necessary to conduct joint operation.

The Information Supply:


settlement of claims and law suits, limitation of liability of operator,
insurance, commingling of funds, resignation of operator and
removal of operator, appointment of successor and health, safety
and environment.

Operating Committee:
the establishment of an operating committee, powers and duties
of operating committee, authority to vote, subcommittees, notice
of meeting, content of meeting notice, location of meetings,
operator duties for meetings, voting procedure, record of votes,
minutes, voting by notice, effect of vote.

Work Programmes and Budgets:


exploration and appraisal, development, production, itemisation of
expenditures, contract awards, authorisation for expenditure
procedure, over expenditure of work programmes and budgets.

50
Petroleum Fiscal Systems and Contracts

Operation by Fewer than all Parties:


limitation of applicability, procedure to propose exclusive
operations, responsibility for exclusive operations, consequences
of exclusive operation, premium to participate in exclusive
operation, order of preference of operation, standby costs, special
consideration regarding deepening or sidetracking, use of
property, miscellaneous.

Default:
default and notice, operating committee meeting and data,
allocation of accounted defaults, remedies, survival, no right of set
off.

Disposition of Production:
right or obligation to take in kind, off take agreement for crude oil,
separate agreement for natural gas.

Abandonment:
abandonment of well drilled as joint operations, abandonment of
exclusive operations, abandonment upon ceasing operation.

Relinquishment, Extensions and Renewals:


relinquishment, extension of the term.

Transfer of interest or rights:


obligations and rights.

Withdrawal from Agreement:


right of withdrawal, partial or complete withdrawal, rights of a
withdrawing party, obligations and liabilities of a withdrawing
party, emergency, assignment, approvals, security and withdrawal
or abandonment by all parties.

Relationship of Parties and Tax:


relationship of parties, tax.

Confidential Information and Proprietary Technology:


confidentiality, continuing obligations, proprietary technology,
trades.

51
Petroleum Fiscal Systems and Contracts

Force Majeure:
obligations, notice.

Applicable Law and Dispute Resolution:


applicable law, dispute resolution.

General provisions:
conflicts of interest, public announcements, successors and
assigns, waiver, severance of invalid provisions, modifications,
headings, singular and plural, gender, counterpart execution,
entirety. (Ref. 7)

Accounting Procedure

The purpose of this Accounting Procedure is to establish the


principles of accounting which shall reflect the Operator’s actual
cost to the end that the Operator shall, subject to the provisions of
the Agreement, neither gain nor lose by reason of the fact that it
acts as Operator.

If any procedure established herein proves unfair or inequitable to


Operator or Non-Operators, the Parties shall meet and in good
faith endeavour to agree on changes in methods deemed
necessary to correct any unfairness or inequity.

In the event of a conflict between the provisions of this Accounting


Procedure and the provisions of the Agreement, the provisions of
the Agreement shall prevail.

The definitions contained in the Agreement shall apply to this


Accounting Procedure and shall have the same meanings when
used herein. In addition certain terms used herein are defined as
follows:

Accrual Basis shall mean that basis of accounting under which


costs and benefits are regarded as applicable to the period in

52
Petroleum Fiscal Systems and Contracts

which the liability for the cost is incurred or the right to benefits
arises regardless of when invoiced, paid or received.

Cash Basis shall mean that basis of accounting under which costs
and benefits are regarded as applicable to the period in which
they are actually paid or received in cash regardless of when the
liability for the cost was incurred or the right to benefit arose.

Controllable Material shall mean Material which in the petroleum


industry is subject to record, control and inventory.

Material shall mean and include any and all materials, machinery,
articles, equipment and supplies, acquired and held for use in the
Joint Operations.

Exclusive Operation Account shall mean the accounts maintained


by the Operator to record all expenditures, receipts and other
transactions of Parties participating in Exclusive Operations.

Joint Account Records and Currency Exchange

Each Party shall be responsible for maintaining its own accounting


records to comply with all its legal requirements and to support all
fiscal returns or any other accounting reports required by any
governmental authority in regard to the Joint Operations.

To enable each Non-Operator to maintain such accounting


records, the Operator shall provide each Non-Operator with such
accounting data and information related to Joint Operations and
other cost and expenditures incurred by Operator to perform as
Operator under the Contract and the Agreement as may be
necessary to enable such Non-Operator to fulfil any statutory
obligation to which it may be subjected, to the extent that such
data and information could reasonably be expected to be
available from the accounting records maintained by the Operator,
and the cost thereof shall be for the Joint Account.

Operator shall at all times maintain and keep true and correct
records of all costs and expenditures related to Joint Operations

53
Petroleum Fiscal Systems and Contracts

(and if applicable, Exclusive Operations) under the Contract and


the Agreement, as well as other data necessary or proper for the
settlement of accounts between the Parties hereto in connection
with their rights and obligations under the Agreement.

Operator shall maintain accounting records on an Accrual Basis


and in accordance with generally accepted accounting practices
used in the international petroleum industry and any applicable
statutory obligations of the Country of Operations as well as
provisions of the Contract and the Agreement.

The Joint Account records shall be maintained by Operator in US


Dollars and the country of operation valuta. Currency translations
for expenditures and receipts between the country of operation
valuta and US Dollars shall be recorded at the rate of exchange
fixed by the Central Bank of the country of operations. Amounts
received and expenditures made in currencies other than US
Dollars or country valuta shall be translated into US Dollars in
accordance with the provisions of the contract and operator’s
normal procedures. Conversions of currency shall be recorded at
the rate actually experienced in that conversion. Any gain or loss
resulting from the translation or exchange of currencies shall be
credited or charged to the Joint Account.

This accounting procedure shall apply, mutatis mutandis, to


Exclusive Operations in the same manner that it applies to Joint
Operations; provided, however, that the charges and credits
applicable to consenting parties to Exclusive Operations shall be
distinguished by a Exclusive Operation Account. For the purpose
of determining and calculating the remuneration of the consenting
parties to exclusive operations, including the premium for
exclusive operations, the costs and expenditures shall be
expressed in US Dollar currency (irrespective of the currency in
which the expenditure was incurred).

Operator shall provide Non-Operators with copies of tax receipt(s)


(certified if available) for any taxes paid by owner
company/government on behalf of the Parties, in accordance with
the Contract. (Ref. 7, 8, 9, 11, 12, 13)

54
Petroleum Fiscal Systems and Contracts

Statements and Billings

The Operator shall furnish monthly to each Non-Operator, no later


than the twenty fifth (25th) day of each month, or as otherwise
decided by the parties, statements of the costs, expenditures,
income and liabilities incurred (on an accruals basis) by the
Operator during the prior month, indicating by appropriate
classification the nature thereof, the corresponding budget
category, and the portion of such costs charged to each of the
Parties. (Ref. 7)

These statements shall contain the following information:

x Advances of funds received from each party,


x The share of each party of total expenditures and for each
category of expenditure,
x The current account balance of each party,
x Summary of costs, credits, expenditures and liabilities on a
current month, year-to-date and inception-to-date basis.
x Details of unusual charges and credits, including credit
adjustments to be separately identified.

Payments and Advances

If Operator so requests, each Non-Operator shall advance in US


Dollars its share of estimated cash requirements for the
succeeding month’s Joint Operations. Not less than fifteen (15)
days before the payment due date, the Operator shall make a
written request to Non-Operators and will give a tentative estimate
for the next two months cash requirements. The due date for
payment of such advances shall be set by Operator and shall not
be earlier than the sixth (6th) day of the month for which the
advances are required.

Should the Operator be required to pay any large sums of money


for the Joint Operations which were unforeseen at the time of
providing Non-Operators with their monthly estimated cash
requirements, the Operator may make a written request to Non-
Operators for special advances covering the Non-Operator’s
55
Petroleum Fiscal Systems and Contracts

share of such payments. Non-Operators shall make their


proportional special advance in US Dollars within ten (10) days of
receipt of such notice.

If a Non-Operator’s advances exceed its share of cash


expenditures, the next succeeding cash advance requirement,
after such determination, shall be adjusted accordingly. If after
such adjustment, a Non-Operator’s share proves to be less than
its cash advance, Operator shall refund such excess funds within
fifteen (15) days upon Non-Operator’s request provided that the
amount is in excess of a hundred or hundred fifty thousand U.S.
Dollars.

If Operator does not request cash advances from a Non-Operator


or if a Non-Operator’s advance is less than its share of cash
expenditures, the deficiency shall at Operator’s option be added to
subsequent cash advance requirements or be paid by Non-
Operator within ten (10) days following the receipt of the
Operator’s billing to Non-Operator for such deficiency.

Each Non-Operator shall deposit in the bank account designated


by Operator its share of the full amount of each such cash call,
without bank charges. Payments of advances or billings shall be
made on or before the due date. If these payments are not
received by the due date the unpaid balance shall bear and
accrue interest on a day to day basis at the Agreed Interest Rate,
and interest on bank balances should be credited to the Joint
Account. If failure to make such payments becomes a default
under the Agreement, the provisions of the Agreement shall apply.

The Operator shall open and maintain separate interest bearing


bank accounts and shall endeavour to maintain funds held for the
Joint Account at a level consistent with that required for the
prudent conduct of Joint Operations. Any interest earned by such
bank accounts shall be credited to the Parties in proportion to their
contribution to such accounts. (Ref. 7)

56
Petroleum Fiscal Systems and Contracts

Adjustments

Payment of any advances or billings shall not prejudice the right of


any Non-Operator to protest or question the correctness thereof;
provided, however, all bills and statements rendered to Non-
Operators by Operator during any Calendar Year shall
conclusively be presumed to be true and correct after twenty-four
(24) months following the end of such Calendar Year, unless
within the said twenty-four (24) month period a Non-Operator
takes written exception thereto and makes claim on Operator for
adjustment. Failure on the part of a Non-Operator to make claim
on Operator for adjustment within such period shall establish the
correctness thereof and preclude the filing of exceptions thereto or
making claims for adjustment thereon except for adjustments
arising out of third party claims or as statutorily required. The
provisions of this paragraph shall not prevent adjustments
resulting from physical inventory of Controllable Material or from
audit exceptions outside of this Agreement or from any claims
involving a third party, or Owner company/Government, or
adjustments required by statutory authority of the Government.

Audits

A Non-Operator, upon at least sixty (60) days advance notice in


writing to Operator and all other Non-Operators shall have the
right at its sole cost to audit the Joint Accounts and records of
Operator relating to the accounting hereunder for any Calendar
Year within the twenty-four (24) month period following the end of
such Calendar Year. Non-Operators must take exception to and
make claim upon the Operator for all discrepancies disclosed by
said audit within said twenty-four (24) month period.

Notwithstanding that such period of twenty four (24) months may


have expired, if evidence exists that Operator has been guilty of
fraud, the Non-Operators shall have the right to conduct further
audits in respect of any earlier periods and make further claims
arising from such audits.

57
Petroleum Fiscal Systems and Contracts

The right of audit includes the right of access during normal


business hours to all accounts and records pertaining to the Joint
Account maintained by the Operator. Where there are two or
more Non-Operators, the Non-Operators shall make every
reasonable effort to conduct a joint audit in a manner which will
result in a minimum of inconvenience to the Operator. The
Operator shall make every reasonable effort to co-operate with
the Non-Operators and will provide reasonable facilities and
assistance.

Audits of accounts and records pertaining to the joint account


which:
Relate to charges in accordance with the provisions or are
maintained by Affiliates of the Operator, (except where an Affiliate
of the Operator is conducting all or a substantial part of Joint
Operations on behalf of the Operator but it is expressly
understood that such costs related to tariffs of personnel will be
certified by independent auditors and not auditable by Partners´
auditors); or which relate to multi-field or multi-operator contracts
and contain information which the Operator considers to be
commercially sensitive (for example and without limitation,
itemised rates, prices, price structures and incentives); or
Which include information generally accepted as proprietary and
confidential shall not be subject to audit by the Non-Operators.

Notwithstanding, the Non-Operators shall be entitled to request


the Operator to provide a certificate, annually, from its statutory
auditors stating that the salary costs are consistent with the
payroll records; and the costs allocated have been correctly
charged to the Joint Account and in accordance with the
Operator's standard accounting policies and practices; and the
charges originating from Affiliates reflect a fair and equitable
allocation of costs and there is no duplication of overheads costs.

The cost of such certificate shall be for the joint account.

At the conclusion of each audit, the Parties shall endeavour to


settle all outstanding matters. Non-Operator conducting audit will

58
Petroleum Fiscal Systems and Contracts

submit a written report to the Operator and other Non-Operators


participating in the audit within three (3) months of the completion
of the audit. The report shall include all claims arising from such
audit together with comments related to the operation of the
accounts and records. The Operator shall reply in writing to the
report as soon as possible and in any event not later than three
(3) months following the receipt of the report.

All adjustments resulting from an audit will be recorded in the Joint


Account as soon as possible after agreement is reached between
Operator and Non-Operators. Any unresolved dispute arising in
connection with an audit shall first be referred to the Operating
Committee for resolution. If agreement is not reached at the
Operating Committee, the item or items in dispute shall be
submitted to arbitration in accordance with the Agreement.

Chargeable Costs and Expenditures

The Operator shall charge the Joint Account with all costs and
expenditures incurred by the Operator to perform as Operator in
connection with the Joint Operations and in accordance with the
approved Work Programmes and Budgets or otherwise authorised
under the Agreement. Such costs including all expenditures and
expenses of all kind and nature, whether accepted or not
accepted by Owner company as Petroleum Operations

59
Petroleum Fiscal Systems and Contracts

Expenditures under the Contract, shall include but not be limited


to:

Licenses, Permits, Etc.

All costs attributable to the acquisition, maintenance, renewal or


relinquishment of licenses, permits, contractual and/or surface
rights acquired for Joint Operations and bonuses paid in
accordance with the Contract and/or the Agreement.

Salaries, Wages and Related Costs

The actual cost of personnel employed by the Operator and its


Affiliates, who are directly engaged in Joint Operations, whether
permanently or temporarily assigned and irrespective of where
such personnel work, and not otherwise covered elsewhere.

Such costs shall include:


x Salaries and wages, including everything constituting the
employee’s total gross compensation.
x To the extent not included in salaries and wages, cost to
Operator of overtime, holiday, vacation, annual and
periodical leaves, travel time, training, sickness, disability
benefits, living and housing allowances, bonuses, and
other customary allowances applicable to the salaries and
wages chargeable hereunder.
x Cost to Operator for employees benefits, including but not
limited to employee group life insurance, medical
insurance, hospitalisation, pension, retirement and other
benefit plans of a like nature.
x Expenditures or contributions made pursuant to
assessments imposed by any governmental authority for
payment with respect thereto or on account of such
employees.
x Expenses incurred by employees and their families which
are paid or reimbursed by Operator in accordance with
applicable personnel policies.

60
Petroleum Fiscal Systems and Contracts

x Any other costs related to personnel in accordance with


Operator’s and/or its Affiliates standard personnel policies
or contractual agreements applicable to employees.

Actual cost of salaries, wages and related costs incurred by


Operator for personnel seconded from any Non-Operator.
Personnel contracted from third parties shall be charged at the
cost paid by Operator.

If employees are engaged in other activities different than those


performed by the Operator under the Contract and the
Agreement, the cost of such employees shall be allocated based
on written time sheet entries. The method of allocating personnel
and related costs including all support costs such as, but not
limited to rent, utilities, secretaries, computers, telephone and
other communications expenses, office maintenance, supplies
and depreciation, shall follow commonly accepted industry
practices of time sheets for cost allocation. (Ref. 7, 8, 16)

Employee Relocation Costs

Relocation costs to and from the Country of Operations or location


where the employees will reside or work, whether permanently or
temporarily assigned to the Joint Operations. Such relocation
costs shall include transportation of employees, families, personal
and household effects of the employee and family and all other
related costs in accordance with the Operator’s and its Affiliates’
usual practice. However, relocation costs of employees from the
Joint Operations to other foreign operations of the Operator or its
Affiliates, shall not be chargeable to the Joint Account unless such
foreign location is the point of origin of the employee.

Transportation

Transportation of Material necessary for the performance of Joint


Operations and other related costs including but not limited to
expediting, crating, dock charges, forwarder’s charges, surface
and air freight, customs clearance and other destination services.

61
Petroleum Fiscal Systems and Contracts

Transportation and related travel expenses of personnel as


required in the conduct of Joint Operations.

Offices, Camps, Utilities and Miscellaneous Facilities

The cost of establishing, maintaining and operating any offices,


sub-offices, camps, warehouses, housing, communication
systems and other utilities and facilities of the Operator and/or
Affiliates directly serving to the Operator to perform as Operator
under the Contract and the Agreement. If such facilities serve
operations in addition to the Joint Operations the costs shall be
allocated to the properties served on an equitable basis.

Material

The cost of Material purchased or furnished by the Operator to


perform under the Contract and the Agreement.

Equipment and Facilities Exclusively Owned by the Operator or its


Affiliates.

Use of equipment, facilities and utilities owned by the Operator


and its Affiliates shall be charged at rates commensurate with
costs of ownership and operation, provided such charges are
comparable to those then prevailing in the area of operations for
equipment and facilities available and which meet the
specifications and time requirements of the Joint Operations.

Services

Subject always to the provisions of the Agreement, the cost of


contractors, consultants and other services, equipments and
facilities provided by third parties including business oriented
Affiliates of any Party performing services for Operator other than
those covered elsewhere.

62
Petroleum Fiscal Systems and Contracts

The cost of services performed by the technical and professional


staff of the Operator’s Affiliates such as but not limited to
geophysical and geological studies and interpretation,
engineering, computing, data processing, legal, tax and other
services that may be required for the benefit of the Joint
Operations. Such services shall be charged at cost and shall be
supported by invoice records and time sheets (unless the services
were performed on a lump sum basis), which shall contain the
description of services performed and the time worked in relation
to the Joint Operation.

Damages and Losses

All costs and expenses necessary for the repair or replacement of


Joint Property resulting from damages and losses incurred by fire,
flood, storm, theft, accident, or any other cause. Operator shall
furnish Non-Operators written notice of damages and losses
incurred in excess of a couple of ten thousand U.S. dollars for
each incident as soon as practicable after a report thereof has
been received by the Operator. The Operator shall furnish to any
Non-Operator, in respect of any damage and loss, such
information and documentation as may be reasonably requested.

Insurance and Claims

Premiums for any insurance obtained by the Operator for the


benefit of the Joint Operations.

Expenditures incurred in settlement of all losses, claims,


damages, judgments, and other expenses for the benefit of Joint
Operations.

Credits for settlements received from insurance obtained by the


Operator for the benefit of the Joint Operations.

63
Petroleum Fiscal Systems and Contracts

Legal Expenses

All costs or expenses of litigation and legal services necessary or


expedient for the handling, investigation, defending and settling
litigation or claims arising by reason of Joint Operations, or which
are necessary to protect or recover Joint Property, including but
not limited to, attorneys’ fees, court costs, cost of investigation or
procuring evidence and amounts paid in settlement or satisfaction
of any such litigation or claims. Unless otherwise expressly
provided under this Agreement, costs or expenses of disputes
between the Parties shall not be charged to the Joint Account.

Duties and Taxes

All taxes, duties, assessments and governmental charges, of


every kind and nature, assessed or levied upon or in connection
with the Joint Operations, other than any that are measured by or
based upon the revenues, income or net worth of a Party, which
have been paid by the Operator for the benefit or on behalf of the
Parties.

Parent Company Overhead

Operator shall charge to the Joint Account a parent company


overhead which will cover services rendered by Operator’s parent
company for advice and assistance of a general nature which are
not provided for elsewhere in the Agreement.

Such charge shall be made each month on such month


expenditures at the percentage rate calculated on a year to date
basis for expenditures incurred attributable to the Joint Operations
in any Calendar Year, in accordance with the following:

64
Petroleum Fiscal Systems and Contracts

During Exploration and Appraisal (Ref. 7, 8, 9, 16)

Up to US$3-3,500,000. 3%

US$3-3,500,000 to 2%
US$5-6,000,000
US$6,000,000 to US$ 1%
15-17,000,000
In excess of US$ 1%
17,000,000

During Development and Production: 1%

A minimum amount of one hundred thousand U.S. dollars (US $


100,000) shall be charged per Calendar Year.

The expenditures used to calculate the parent company overhead


shall not include the charges; nor shall it include guarantee
deposits, pipeline tariffs, royalties and taxes on production or
revenue to the Joint Account paid by Operator, payments to third
parties in settlement of claims and other similar items. Credits
arising from any Governmental subsidy payments, disposition of
Joint Property and receipts from third parties for settlement of
claims shall not be deducted from the total annual expenditures in
determining such charge.

The indirect charge may be amended periodically by mutual


agreement between the Parties if, in practice, these charges are
found to be insufficient or excessive.

Other Expenditures

Any other expenditure not covered in this Accounting Procedure


and the Agreement which does not exceed Twenty to Thirty five
thousand dollars (US$ 25-35,000) in aggregate and which is
incurred by the Operator and/or its Affiliate exclusively for the
necessary and proper conduct of the Joint Operations. Any
expenditure in excess of such thirty five thousand dollars (US$
35,000) shall require the approval of the Operating Committee.

65
Petroleum Fiscal Systems and Contracts

Material

So far as it is reasonably practical and consistent with efficient


and economical operation, only such Material shall be purchased
for the Joint Account as may be required for the Joint Operations
and the accumulation of surplus stocks shall be minimised.

Material purchased from third parties for use in Joint Operations


shall be charged at net cost paid by the Operator or its Affiliates.
The price of Material purchased shall include but not be limited to
export broker’s fees, insurance, transportation charges, loading
and unloading fees, import duties, license fees and demurrage
and applicable taxes, less all discounts taken, including discounts
received by Operator from any long term contracts of Operator
with third party, if applicable .

Material required for Joint Operations shall be purchased directly


wherever practicable, except Operator may furnish such Material
from stocks held by Operator or any of its Affiliates or from other
operations conducted by Operator, in which case such Material
shall be charged as follows:

New Material (Condition “A”) shall be priced at the lesser of the


original cost thereof as described above or the current market
price for Material of similar quality supplied on similar terms.

Used material which is in sound and serviceable condition and


suitable for re-use without reconditioning shall be classified as
Condition “B” and priced at seventy-five per cent (75%) of new
Material.

Material which is not in sound and serviceable condition but which


is suitable for re-use after reconditioning shall be classified as
Condition “C” and priced at fifty per cent (50%) of new Material.
The cost of reconditioning shall also be charged to the Joint
Account provided the Condition “C” price, plus the cost of
reconditioning, does not exceed the Condition “B” price and
provided that Material so classified meets the requirements for
Condition “B” Material upon being repaired and reconditioned.

66
Petroleum Fiscal Systems and Contracts

Material which cannot be classified as Condition “B” or Condition


“C” shall be priced at a value commensurate with its use.

Operator does not warrant the Material charged to the Joint


Account beyond the manufacturers or supplier’s guarantee,
express or implied. In the case of any such Material which is
defective a credit shall not pass to the Joint Account until an
adjustment has been received by the Operator from the
manufacturer or supplier.

Credits for Material sold by Operator shall be made to the Joint


Account in the month in which it is sold.

Costs and expenditures incurred by Operator in the disposition of


Material shall be charged to the Joint Account.

Inventories

At reasonable intervals, but at least annually, inventories of


materials for Joint Operations shall be taken by Operator of
Controllable Material. Operator shall give Non-Operators written
notice at least thirty (30) days in advance of its intention to take
inventory, and Non-Operators, at their sole cost and expense,
shall each be entitled to have a representative present. Failure of
any Non-Operator to be represented shall bind such Non-
Operator to accept the inventory taken by Operator, who shall in
that event furnish each Non-Operator with a reconciliation of
overages and shortages. Inventory adjustments to the Joint
Account shall be made for overages and shortages. Any
adjustment equivalent to one hundred thousand US dollars (US$
100,000 US $) or more shall be brought to the attention of the
Operating Committee.

Whenever there is a sale or change of interest in the Agreement,


a special inventory may be taken by the Operator provided the
seller and/or the purchaser of such interest agrees to bear all the
expense thereof. In such cases, both the seller and the purchaser
shall be entitled to be represented and shall be governed by the
inventory so taken.

67
Petroleum Fiscal Systems and Contracts

Contract Area

The coordinates of the exploitation area are referenced, using the


datum of the coordinates plane X, Y and control point. The control
points of the perimeter show the area of exploitation, wells
distribution, gathering system and facilities. It is important to
mention that facilities are located in the area of exploitation. The
total exploration block and the location of the perimeter of the
exploitation inside that block are shown in a referenced figure.

68
Petroleum Fiscal Systems and Contracts

4 GOVERNMENT AND OPERATOR TAKES, COSTS


AND TAXES

ESTIMATION OF GOVERNMENT TAKE

Profits are divided into contractor take and government take,


meaning the percentage of profit to which each party is entitled.
The contactor’s percentage remaining after the government take
offers a significant measure for comparing profit between one
fiscal system and another. The relation between government and
contractor take depends on the percentage share of profits, the
quantity of oil in place, oil or gas prices, Capex and Opex costs
and taxes.

Under systems such as the Indonesian, Azerbaijan, Norway and


Iranian production sharing contracts with splits set in favour of
government, the contractor may still end up with a higher
production share percentage.

The calculation of government and contractor take percentages is


as follows: (Ref. 2, 4, 7, 8)

Operating income = Gross revenues minus


capital and operating
expenditure

Government income = All government income from


bonuses, royalties, other
taxes or production sharing
profits

Government Take (%) = Government income divided


by the operating income

Contractor Take (%) = 100 - Government Take (%)

69
Petroleum Fiscal Systems and Contracts

Flow analysis is used for calculating the percentage within


detailed economic modelling. Once cash flow for a proposal has
been modelled, the return percentage over the life of field can be
evaluated.

As an example:

Gross revenues = $ 10,000


Costs over the life of field = $ 4,000
Total profit = $ 6,000

Contractor share of profit = $ 2,500


Government share = $ 3,500

Contractor percentage = 41.67%


Government percentage = 58.33%.

In practice, however, when estimating percentages it is not always


easy to account for items such as cost recovery limits, investment
credits, royalty or tax free periods and domestic market
obligations (DMOs).

Figures 4-1 and 4-2 below illustrate the make up of government


and contractor takes. Figure 4-3 shows how fiscal terms have
changed over time so as to reduce the government take in some
countries whilst in other cases the government take has
increased. (Ref. 7, 8, 15)

70
Petroleum Fiscal Systems and Contracts

Goverment Take

Government/Contarct take

Take Definitions:
Economic Profit = Cumulative gross revenues less cumulative gross costs over life of the project (full-
cycle). Also referred to as cash flow.

Gvt. Take (%) = receipts from royalties, taxes, bonuses, production or profit sharing, and Gvt.
Participation, divided by total economic profit

Contractor take (%) = 1-Gvt. Take


= Contractor net cash flow divided by economic profit

Synonyms:
Contractor Take Government Take
Company take State take
Contractor marginal take Government marginal take*
Contractor share of profit Government share of profit
Contractor after-tax equity split Government after-tax equity split

* Marginal Government Take = Same as Gvt. Take but with costs assumed to be zero

Figure 4.1 Government and Contractor take


Goverment Take

Government/Contractor take

G P Government Take
R R (Royality, Production Sharing, taxes, Government Participation)
O O
S F
S I Company Take
T

C Operating Cost
O
S
R T
E
R Development Cost
V
E E
N C
U O
E V Exploration Cost
S E
R
Y

Figure 4.2 Division of the costs and profit

71
Petroleum Fiscal Systems and Contracts

Changing Fiscal Terms

REDUCED GOVERNMENT TAKE

Australia
Canada (Fed)
Italy
Morocco Australia
Canada (BC) Brazil
Netherlands Canada (AB) Indonesia Colombia
Colombia Indonesia
Norway Australia Canada (SK) Italy New Zealand
Namibia Kazakhstan
Peru Denmark India P.N.G. Norway
Nigeria (gas) Norway
Philippines Netherlands Netherlands Syria Peru
UK
Thailand Pakistan Peru UK Vietnam

1999 2000 2001 2002 2003 2004 2005

India Russia Ecuador Argentina Egypt Argentina Algeria


USA (GOM) Egypt Russia Netherlands Brazil Bolivia
Indonesia UK Nigeria Denmark Liby
Venezuela (d/w) Kazakhstan Nigeria (d/w)
Russia Pakistan Nigeria (gas)
Sudan Russia Venezuela

INCREASED GOVERNMENT TAKE

Figure 4.3 Changing fiscal terms

72
Petroleum Fiscal Systems and Contracts

ESTIMATION OF CONTRACTOR TAKE

The contractor or operator take can be calculated as percentages


in steps: (Ref. 7, 8)

The gross revenues are 100%.

1. Subtract the royalty percentage to give the percentage net


revenue.

2. Deduct capital and operation expenditures for the entity as


a percentage from net revenue.

3. Subtract government profit share, taxes, levies, etc. This


gives the contractor's share of profits.

4. Subtract the percentage of costs from gross revenues to


equal total profits.

5. Divide the contractor percentage of profits after income tax


by total profits. This is the contractor take percentage.

As an example calculation, for a contract with 20% royalty and


50% income tax, where project costs are 30% of gross revenues:

First step: 100% Gross revenue


-20 Royalty (20%)
80% Net revenue percentage

Second step: -30% Costs


50% Taxable revenues

Third step -25 Income tax (50%)


25% Contractor share after tax

Fourth step 100% (Gross revenue)


– 30 Costs
70% Total profits

73
Petroleum Fiscal Systems and Contracts

Fifth step 25% Contractor share after tax


/70 Total profits
35.9% Contractor percentage.

The contractor take percentages, cost recovery limits and


participation of selected systems are illustrated in Table 4-1

Contractor Cost Recovery Max % Govt


Country
Take, % Limit, % Participation,
Abu Dhabi 9-12 100 0
Albania 20-25 45 0
Angola 20 50 50
Australia 40-50 100 0
Brunei 28-30 100 50
Cameroon 14-16 ? 50
China 38-41 50-60 51
Colombia 30-37 100 51
Congo 30-35 100 50
Egypt 24-28 30-40 50
Gabon 20-25 40-55 10
India 30-42 100 30
Indonesia 11-13 80 15
Indonesia East 30-33 80 15
Ireland 75 100 0
Malaysia 14-19 50-60 15
Morocco 40-44 100 0
Myanmar 21-23 40 0
New Zealand 47-51 100 0
Nigeria 10-18 40 ?
Norway 18 100 ?
Papua New Guinea 30-35 100 22.5
Philippines 44-47 70 0
South Korea 36-40 100 0
Spain 60 100 0
Syria 18-22 25-35 0
Thailand 30-44 100 0
Timor Gap 26 90 0
USA 42-53 0
Vietnam 30 40 0

Table 4.1 Contractor take, cost recovery limits and government


participation rates

74
Petroleum Fiscal Systems and Contracts

COSTS AND TAXES

Cost Recovery

Cost recovery is the means by which the contractor recovers


exploration, development and operations costs out of gross
revenues.

Most production sharing contracts set a limit of between 30% and


60%. Once the original exploration and development costs are
recovered, operating costs comprise the majority of recovered
costs and at this stage, cost recovery may range from 15% to
30% of revenue.

Under a PSC, the contractor does not own the production and has
no taxable revenues at the point of cost recovery against which to
apply deductions. The government, therefore, uses the cost
recovery mechanism and then shares a portion of the remaining
production revenues to reimburse the contractor.

Most fiscal systems with cost recovery limits set them in the range
of 30% to 60% but higher limits such as 80% cost recovery may
be applied for the early phase of production. Concessionary
systems usually set no limit on cost recovery. Indonesia which
previously had no limit on cost recovery for many years now has a
20% limit. Low cost recovery limits can be significant for marginal
field developments. A cost recovery limit of 50% or less in a
marginal situation can have effectively the same impact on project
NPV and IRR as a 5 to10% point reduction in contract take.

Exceptionally, some PSCs may have no cost recovery but simply


set a share of production in favour of the government, depending
on the size of the discovery. In some cases, the government takes
its share right off the top, unaffected by deductions or cost
recovery requirements.

Another exception is illustrated in Figure 4-4. Here, the excess


cost oil goes directly to the government. The cost recovery limit is
40% but the contractor recovers eligible costs out of 21% of gross

75
Petroleum Fiscal Systems and Contracts

revenues in this example. The remaining 19% then goes directly


to the government and is not subject to the profit oil split. (Ref. 7)

THE EGYPTIAN-TYPE COST RECOVERY TWIST


ONE BARREL OF EGYPTIAN OIL $20

Contractor Share Government Share


10% Royalty $2
$18
Cost Recovery
(Operating costs, DD&A, IDCs, etc.)
40% Limit
$4.2
Remaining
Cost Recovery $3.8*
Here is the twist

Share Oil
$10
Profit Oil Split
$4 40%/60% $6
(Taxable)

($1.6) 40% Taxes $1.6


$6.6 $13.4

33% 67%
*It is possible that this excess cost oil could be subject to a seperate split ratehr than
going directly to the government.

Figure 4-4 Egyptian-type production sharing flow diagram

Tangible and Intangible Capital Costs

Fixed capital assets may be treated as tangible assets and


subject to depreciation. Intangible costs e.g. exploration and
development costs, however, can be treated differently under
different fiscal systems. Most systems require intangible costs to
be amortised (charged over a period of time) but under some
concession agreements intangible costs are not amortised. Many
accounting conventions treat intangible capital costs in the same
way as operating costs that are expended. Pre-production costs
under most systems are amortised beginning with production start
up. For all fiscal systems that require capitalisation of costs,

76
Petroleum Fiscal Systems and Contracts

depreciation rates are a significant limit to the rate of recovery of


capital costs.

Interest Cost Recovery

The cost of interest may sometimes be allowed as a deduction,


either as interest expended during construction or at a rate based
on cumulative unrecovered capital. Application of interest cost
recovery mechanisms can be similar to rate-of-return systems.

The amount of permitted interest cost recovery may be limited.


Methods of limitation include:

x limiting the interest recoverable itself, regardless of the actual


rate of interest rate incurred;
x setting a theoretical capitalisation cap such as a maximum
70% debt; or
x placing a capitalisation restriction based on a 2:1 debt/equity
ratio.

General and Administration (G & A) Costs

The contractor may be allowed to recover some home office


administrative and overhead expenses, known as G&A costs.
Non-operators are normally not allowed to recover such costs.
The amount of allowable G&A costs may be limited such as to a
percentage of the total petroleum costs each year, either as a flat
rate or on a sliding scale.

Sunk Costs

Past costs, including unrecovered costs or unused deductions,


that have not been recovered can often be carried forward and be
available for recovery in subsequent periods.

The four classes of sunk costs are:


x Tax Loss Carry Forward (TLCF)

77
Petroleum Fiscal Systems and Contracts

x Unrecovered Depreciation Balance


x Unrecovered Amortisation Balance
x Cost recovery Carry Forward.

Sunk costs are typically carried forward up to the beginning of


production. Many PSCs do not allow depreciation or amortisation
of pre-production costs prior to the beginning of production so that
there is no TLCF.

Decisions on field development economics or commerciality can


be affected significantly by exploration sunk costs. The
significance can be demonstrated through discounted cash flow
analysis if the field development cash flow projection is run with
and without sunk costs. The difference represents the present
value of the sunk cost position.

Abandonment Costs

Ownership rights of facilities are commonly assigned by the


contractor to the government upon commissioning or start up and
the government as asset owner is responsible for the cost of
abandonment. In practice, costs for future abandonment, are
recovered prior to abandonment and set aside in the form of a
sinking fund.

Profit Oil Split

The profit oil split is the division of profits between the government
take and the contractor take. The contractor take in most
countries ranges from 15% to over 55%. The split is determined
by governments but with regard to what oil companies may bear
in the market. When considering investment, oil companies will
assess, alongside the level of contractor take, factors including
the geopotential, costs, infrastructure and political stability.

78
Petroleum Fiscal Systems and Contracts

Government Participation

With government participation arrangements, the government


typically backs-in for a percentage at the stage when a discovery
has been made. Thus the contractor bears the cost and risk of
exploration whilst the government is carried through exploration.
The government may or may not repay the contractor for past
exploration costs. Any donation to capital and operating costs is
normally paid out of production. The level of government
participation in management can vary widely.

Contractors generally prefer no government participation. Joint


operations of any sort, especially between diverse cultures, can
have a negative impact on operational efficiency and later on the
economics.

The government participation percentage can range from 10% to


51%. Costs borne by the government vary but are usually only a
prorated share of development costs, often taken out of
production.

Investment Credits and Uplifts

Uplifts or investment credits, in many forms, act as incentives for


the contractor. An uplift allows the contractor to recover an
additional percentage of capital costs through cost recovery. For
example, an uplift of 10% on capital of $ 50 million would allow the
contractor to recover $60 million. Uplifts work in the same way in a
concessionary system. Uplifts are also a key aspect of rate of
returns contracts.

Domestic Market Obligations

Many contracts have obligations to supply the host country’s


domestic crude oil or natural gas requirements. The sales price to
the government is usually at a discount to world prices and the
government may also pay for the domestic crude in local currency

79
Petroleum Fiscal Systems and Contracts

at a predetermined exchange rate. Revenues from the sale of


domestic crude oil or gas are normally taxable.

Ring Fencing

Costs associated with a given block or license may be ring fenced


so that they must be recovered from revenues generated within
that block. This element of the system can have a huge impact on
recovery of costs of exploration and development.

Some countries require each contract to be administered by a


separate new company. This restricts consolidation and effectively
erects a ring fence around each license area. In some countries,
however, contractors are allowed to recover certain classes of
costs associated with a given field or license from revenues from
another field, or for exploration costs to cross the ring fence as
deductions against the PRT tax on older fields.

Reinvestment Obligations

Under some contracts, the contractor has an obligation to set


aside a specified percentage of income for further exploratory
work within a license. Taxes may be reduced when the contractor
has reinvested a certain portion of income.

Tax and Royalty Holidays

Tax and royalty holidays are often used to attract new or


additional investment. The holiday may begins on the effective
date of the contract or on a specific calendar date. Alternatively,
the holiday may begin at production start up.

Capital and Operating Expenditures

Prior to seeking declaration of Commercial Discovery in a field,


the oil company has incurred expenditure on exploration and

80
Petroleum Fiscal Systems and Contracts

appraisal. Expenditure will have included seismic survey in the


area, geology and geophysics activities for the whole area,
drilling, completion and testing of the exploration and appraisal
wells in the field, as well as general and administration costs.

Capital expenditure, or Capex estimates comprise costs for


exploration and appraisal, together with forecast capital
expenditure for the proposed development of the project.
Development costs may include land costs, local authority
contributions and related costs for permitting, taxes and duties,
customs clearances, financial charges and third party verification
costs.

Capital and operating expenditures are described further in


Chapter 5.

81
Petroleum Fiscal Systems and Contracts

5 PROJECT ECONOMICS

This chapter outlines ways in which economic analysis can be


used to assess and compare projects, and describes key inputs
and their characteristics.

Economic analysis looks objectively at the costs and revenues for


the lifecycle of a project. The basic economic modelling methods
can be used to assess development feasibility and to compare
alternative development options. The results of economic analysis
can form the basis of commercial agreements and support budget
proposals. Economics used for decision-making will generally look
forward, disregarding past expenditure and production except
where there may be tax effects from past expenditure.

ECONOMIC MODELLING

Economic models require a series of input data to describe a


particular development case. The model will generate output data
on field economics that can be assessed against benchmark
criteria and further analysed for sensitivities to changed variables.

Typical inputs include:


x the production profile; and
x estimates of capital expenditure (Capex) for field development
and operating expenditure (Opex) for life of field.

Typical outputs are:


x net cash flow;
x discounted cash flow; and
x profitability assessment.

The validity of an economic analysis in supporting investment


decisions depends on the quality of the input data used and
expert assessment of each aspect.

82
Petroleum Fiscal Systems and Contracts

Production Profile

Determination of the production profile depends upon subsurface


parameters but also takes account of:
x surface facility capabilities;
x design constraints;
x evacuation bottlenecks; and
x commercial matters, especially sales contracts.

Subsurface considerations include:


x expected reservoir size;
x fluid transmission characteristics; and
x modelled residual saturations.

Residual saturations indicate how much oil and gas will remain in
the reservoir. This will depend on the degree of pressure support
modelled from aquifers or gas expansion and the effect of any
reservoir pressure maintenance schemes. Estimates of the
technically possible ultimate recovery can be derived, taking
account of water ingress estimates and optimum well type and
placement. Wells may be vertical, horizontal or multilateral and
may be used for injection or gas lift as well as for production.

A production plateau rate or design off take rate can be estimated


from subsurface parameters and facilities constraints such as
pipeline ullage. The estimated rate may also be derived by
comparison with other bench marked developments. Production
rates at the end of field life, approaching abandonment, will
depend on the lowest flowing well pressure which the facilities can
handle and for a gas field this may depend on compression
facilities.

The production profile will be optimised through economic


analysis with sub-surface, engineering and commercial inputs.
Factors including production rate maintenance options need to be
considered and the production profile should reflect downtime of
wells and facilities which will reduce production volume over a
given period and prolong the duration of production.

83
Petroleum Fiscal Systems and Contracts

Capex

Capex estimates are prepared by facilities engineers working


closely with reservoir engineers, drilling engineers, cost
estimators, planners and contracts and procurement specialists.

The capital expenditure (Capex) required to develop a field


depends on the number and type of wells and the surface
facilities. The development concept for the wells and surface
facilities is based upon the design offtake rate and the reservoir
fluid composition, pressure and temperature conditions. Location
factors such as access to markets, the proximity of existing
pipelines and other infrastructure and environmental requirements
also affect the Capex. For economic optimisation, a number of
development and Capex options will be considered at the concept
selection stage.

The bulk of capital expenditure occurs in the development phase


and reaches a maximum prior to the start of production. However,
further capital expenditure may be required later to maintain field
production. The costs of later capital expenditure such as
additional wells, workovers and modified surface facilities should
be included in the Capex case to be modelled.

Opex

For the whole life of field economic assessment, operating


expenditure (Opex) must be considered alongside Capex to
determine the optimum development option.

The cost of Opex depends on the extent and complexity of the


facilities, together with geographic and logistical factors. At
concept selection stage, before facilities design, it may be difficult
to make a reliable assessment of Opex and an estimate bench
marked from other developments may be used instead. When
there is better definition of the development, the Opex estimate
can be refined with detailed manning, consumables and logistics
cost estimates, phased according to the development programme.

84
Petroleum Fiscal Systems and Contracts

Operating costs may change during the production period if


facilities need to be enhanced.

Opex includes:
x the contractor’s ongoing operating expenses;
x tariff payments for transportation and processing using other
company’s facilities; and
x royalties and tax payments due to the government.

Net Cash Flow

The net cash flow forms the basis for the economic analysis of a
project. Net cash flow is the difference between gross income and
the total expenditure. To enable understanding of cash flow over
time, reflecting phased variations in revenue and costs, net cash
flow is presented on an annualised basis.

Gross income is assessed from the expected volumes of


produced hydrocarbons and estimated future selling prices. Total
expenditure includes Capex and Opex, taxes, royalties (either as
cash or in kind through deductions from production). Estimates
allow for the effects of inflation and exchange rates.

Inflation Discounting and Present Value

To allow for the impact of inflation, the economic analysis needs


to compensate for the loss of purchasing power of a currency over
time. Future cash flow components of a project e.g. Capex, Opex
and revenues need to be escalated for inflation. These items are
then described as being in Money-of-the-Day (MOD). Budget
requests should normally be calculated in MOD terms. Since
project cash flow used in economic analysis requires costs and
expenditure to be presented in units of constant purchasing
power, the concept of Real Terms (RT) money with a constant
value is used. RT is based on a selected reference year.

The adjustment to MOD for inflation is different from the deflation


adjustment from MOD to RT. Deflation is based on the general

85
Petroleum Fiscal Systems and Contracts

inflation rate but inflation to MOD should account for any special
market influences for individual items such as market conditions
affecting contractor and supplier prices.

The RT cash flow is then discounted to reflect the cost of capital


i.e. nominal interest foregone on capital tied up in investment, and
also the exposure to future uncertainty and risk. Discount Rates
(DR) are used to determine this value of money over time, known
as Present Value (PV). (Ref. 7)

For example, the PV of one million USD in three years at a DR of


10% is:

1/1.10 x 1/1.10 x 1/1.10 = (1/1.10)^3 = 0.751, i.e. USD 0.751 MM.

Applying this concept to revenue, one million received each year


for three years has a PV (at 10% DR) of:

1/1.10 + (1/1.10)^2 + (1/1.10)^3 = 0.909 + 0.827 + 0.751 = 2.487,


i.e. USD 2.487 MM.

Table 5-1 below gives an example of how present value of a one-


off payment may be calculated. (Ref. 2, 3, 5, 7, 8, 9)

86
Petroleum Fiscal Systems and Contracts

1
_____________
Present Value of $1 =
(n - .5)
(1+i)
(Midyear discounting)

Period
(n) 5% 10% 15% 20% 25% 30% 35%
1 .976 .953 .933 .913 .894 .877 .861
2 .929 .867 .811 .761 .716 .765 .638
3 .885 .788 .705 .634 .572 .519 .472
4 .843 .717 .613 .528 .458 .339 .350
5 .803 .651 .533 .440 .366 .307 .259

6 .765 .592 .464 .367 .293 .236 .192


7 .728 .538 .403 .306 .234 .182 .142
8 .694 .489 .351 .255 .188 .140 .105
9 .661 .445 .305 .212 .150 .108 .078
10 .629 .404 .265 .177 .120 .083 .058

11 .599 .368 .231 .147 .096 .064 .043


12 .571 .334 .200 .123 .077 .049 .032
13 .543 .304 .174 .102 .061 .038 .023
14 .518 .276 .152 .085 .049 .029 .017
15 .493 .251 .132 .071 .039 .022 .013

16 .469 .228 .115 .059 .031 .017 .010


17 .447 .208 .100 .049 .025 .013 .007
18 .426 .189 .087 .041 .020 .010 .005
19 .406 .171 .075 .034 .016 .008 .004
20 .386 .156 .066 .029 .013 .006 .003

21 .368 .142 .057 .024 .010 .005 .002


22 .350 .129 .050 .020 .008 .004 .002
23 .334 .117 .043 .017 .007 .003 .001
24 .318 .106 .037 .014 .005 .002 .001
25 .303 .097 .033 .011 .004 .002 .001

Table 5.1 Present value of one time payment

87
Petroleum Fiscal Systems and Contracts

PROFITABILITY ASSESSMENT

Using cumulative cash flows, as illustrated in Figure 5-1,various


measures are used to assess profitability, including:

x discounted ultimate cash surplus, i.e. Net Present Value


(NPV);

x Profitability or Value to Investment Ratio (NPV/PV Capex);

x Unit Technical Cost (PV Capex + PV Opex/discounted


production);

x earning power or rate of return;

x exposure; and

x payout time.

+
USD MM

Cashflow

-
Years

Figure 5.1 Profitability measures

88
Petroleum Fiscal Systems and Contracts

Ultimate cash surplus or NPV is the most commonly used


measure of value. NPV is the amount of money ultimately
generated by an investment in a project whilst reflecting the loss
of liquidity and risk over time of the investment.

However, since NPV does not show the effectiveness of


investment per unit of Capex, the Profitability or Value to
Investment Ratio is a more useful measure to compare projects of
different size and scope.

Unit Technical Cost compares projects through a measure of cost


efficiency versus production.

Of less use for comparing projects, Earning Power is the discount


rate at which the NPV is zero, giving a cut off level to assess
project viability.

Exposure is the maximum amount that an investor would risk prior


to or just after commencement of production.

Payback is the time period an investor must wait to get a return on


investment.

89
Petroleum Fiscal Systems and Contracts

SENSITIVITIES

Economic analysis uses a number of input parameters including


reserves, sales prices, production, Capex and Opex which are
each subject to uncertainties. To assess the impact of input
uncertainties the parameters are each varied around their base
values to amounts appropriate to the uncertainty. The resultant
project base value is then the NPV of a case built on the assessed
P50 values, i.e. values where there is a 50% chance of the actual
outcome exceeding the value and a 50% chance of the outcome
being below the value.

Figure 5-2 below shows how variations in individual parameters


affect NPV in the form of a spider diagram. The parameters which
have the greatest effect on NPV are Capex and its phasing,
production availability and production delays. These are factors
that the project team can control to some extent.

To compare different parameters, it is important to use consistent


ranges of uncertainties e.g. the P90 and P10 values for each
parameter. For example, in Figure 5-2 reserves has the largest
range of uncertainty with the P90 being 35% below the base level
and giving a negative project NPV.

90
Petroleum Fiscal Systems and Contracts

+ Production

etc
70% 80% 90% 100%
USD MM

Revenue

Opex

-
Capex

Figure 5.2 Sensitivities of fiscal model

91
Petroleum Fiscal Systems and Contracts

CONCEPT EVALUATION AND SELECTION

At the early stages of concept evaluation there is significant


opportunity to maximise the value of a project and reduce
exposure in the design process. Careful consideration at this
stage can lead to improved project delivery, reducing Capex and
schedule, and project operability. The availability of good
subsurface information and commercial information is essential to
inform decision making. Unfortunately, there may only be limited
information available whilst there is business pressure to move
ahead towards the earliest production start-up without prolonged
appraisal and selection time.

The influence/time curve in Figure 5-3 illustrates how this


opportunity for optimisation is greatest before concept selection
and declines as the development solution is defined and
expenditure on facilities design and construction increases.

Development Phase
USD MM +

USD MM +

Exploration / Appraisal Phase

Years +

Figure 5.3 Influence diagram for typical stages in project


development

92
Petroleum Fiscal Systems and Contracts

Value of Information

In order to optimise a development project or prove its viability,


additional appraisal may be required to better define reserves,
well productivity or fluid properties and, therefore, reduce
uncertainties in the economic model. Economic justification for
further appraisal can be assessed through estimation of the Value
of Information (VoI). VoI is the difference in NPV of the project
measured with and without the additional information. If the
information will not change the NPV then the VoI is zero. The
Value of Appraisal (VoA) is the VoI less the cost of that appraisal.

When uncertainties are sufficient to leave a significant risk of


developing a sub-commercial field, appraisal may be required to
demonstrate commerciality and secure budget support. Similarly,
a commercial field may be left undeveloped without necessary
appraisal The value of information to demonstrate commerciality
is shown in Figure 5-4.

Whilst the NPV of a project may be increased through appraisal to


optimise development, the appraisal may delay the development
schedule and may introduce additional cost. For example, a small
oil field may be most economically developed using a tie-back to
an existing facility, but a larger field might be more profitably
developed via a stand-alone facility. The tie-back option may be
preferable due to a shorter time to start-up.

VoI appraisal = CoS x NPV (Reserves above economic cut-off) -


NPV (Reserves above)

VoA = VoI - PV appraisal costs

Where CoS = Chance of Success

93
Petroleum Fiscal Systems and Contracts

Discovery

Appraise

Develop
Develop

CoS

No Yes No Yes

NPV = 0 NPV = 0 NPV = 0 NPV (Reserves above


economic cut-off)

Figure 5.4 Value of information to demonstrate commerciality


(Ref. 16)

The diagram below in Figure 5-5 shows the value of information in


optimising development. Without appraisal, there is a wider range
of reserves uncertainty than with appraisal. The case shown on
the left might result in selection of a stand-alone facility whereas
on further appraisal it might be found that only a tie-back is
justified.

94
Petroleum Fiscal Systems and Contracts

Figure 5.5 Value of information for development optimization


(Ref. 16)

Option Selection Stage

Successful evaluation at the option selection stage depends upon


having good estimates of reserves, production rates, Capex and
Opex, whilst the definition of options is low. Input is needed from
experienced subsurface, facilities and commercial specialists.
Bench marking may assist the selection process by considering
similar reservoirs and similar development projects. Bench
marking may identify where the choices of scope of wells and
facilities have been successful and cost-effective or where
production problems have been encountered.

When assessing modifications to existing brownfield facilities,


reservoir information should be better defined with less
uncertainties. Decisions will focus on methods to develop existing
facilities. These may include improving reliability, debottlenecking,

95
Petroleum Fiscal Systems and Contracts

or maintaining or expanding production through additional wells or


compression.

A number of factors that are not fully included in the economic


model need to be considered alongside NPV in selecting a
preferred concept. Safety risks and environmental impact, political
considerations and technical uncertainty such as new technology
need to be taken into account. Other factors are the cost and cash
flow, as well as NPV, and possible future business opportunities.
Figure 5-6 illustrates option comparisons.

Figure 5.6 Comparing options


(Ref. 16)

96
Petroleum Fiscal Systems and Contracts

THE BASIS FOR DESIGN AND PROJECT SPECIFICATION


STAGES

After selecting the development concept, the concept is further


defined in the Basis for Design (BfD) and project specification
stages. Figure 5-7 illustrates the stages of project definition.

The development concept will have set out basic requirements


such as the planned number of wells, production rate, scope of
facilities and future development options. The concept is defined
through Front End Engineering and Design (FEED). The FEED
process may be split into two parts with a pre-FEED stage which
generates the BFD, followed by engineering to produce a Project
Specification.

At this stage of project definition, the project schedule and cost


estimates will be developed and the contract strategy for
procurement will be considered. Detailed economic models will be
used to support commercial negotiations, application for
government approval and to secure investment funding. The
models will be progressively updated as new information becomes
available. Alternative commercial scenarios may be modelled to
show the effects of tariffs and taxes.

97
Petroleum Fiscal Systems and Contracts

Basis for Design Project Specification

Description
Process design
ƒWhere/Why/When/How

Boundary Conditions Equipment/materials


ƒFeedstream/inlet conditions
ƒProduct and waste/conditions Layout/piping/structures/
ƒExisting facilities/performance Electrical/controls, etc.

Requirements
ƒSystem/interfaces
ƒRegulatory/HS&E/standards Project Specification
ƒDesign life/Operations performance

Basis for Design


Estimates:
-Capex (material take-offs)
-Opex
Estimates (coarse): -Availability/Production profile
-Capex/Opex/Production
-Price/Tax/Inflation
Commercial structures

Economic analysis Price/Tax/Inflation

Economic analysis

Figure 5.7 Project definition


(Ref. 16)

98
Petroleum Fiscal Systems and Contracts

COST ESTIMATION

Cost estimation will continue through the development phase,


using the best available data available at the time. Thus, in the
earliest stages of feasibility up to concept selection where there is
little scope definition, cost estimates may be based in part on
bench marked actual costs for similar developments in the same
region. Proprietary estimating tools are commonly used when
there is better definition as at the BfD stage. These apply historic
data such as material costs, construction activity durations, vessel
day rates, with factors for design, project management, insurance
and certification.

Once a project specification is developed for the facilities, cost


estimates can be developed for a defined work breakdown
structure, based on detailed estimates of design manhours,
material and equipment quantities to be procured, construction
manhours and project management resources. The resultant base
estimate will take account of current market conditions and
sensitivities for products and services. Generally, base estimates
will be made on a 50/50 basis i.e. there is an equal likelihood of
the estimate erring on the low side or the high side. A contingency
allowance is added to the base estimate to take account of
possible underestimation such as items within the scope which
are not fully defined or items that may have been overlooked.

A 50/50 estimate represents the best estimate from available


information but is subject to a range of uncertainty. This
uncertainty or measure of accuracy can be expressed in terms of
a 10/90 level where there is a 10% chance of the outturn cost
being below the estimated value, or as a 90/10 level where there
is a 10% chance of exceeding this value. The 90/10 value is
sometimes referred to as the overrun allowance (see Figure 5-8).

99
Petroleum Fiscal Systems and Contracts

Figure 5.8 Cost probability curves


(Ref. 16)

With increased project definition and knowledge of market


conditions, the level of uncertainty should reduce and the size of
the contingency allowance may also decrease.

Figure 5-9 shows how contingency and accuracy levels typically


vary through project development. It should be that in early
stages, option selection and BfD, Uncertainty ranges may be
either generic values which are commonly used in early project
stages, or probabilistic estimates based on cost-risk analysis.
Probabilistic estimates will usually not be used until the project
specification stage when there is greater definition of the project
scope and market factors.

100
Petroleum Fiscal Systems and Contracts

+100% to +30%

90/10

+50% to +20%
90/10
+30% to +10%
90/10

+20% to +5% 90/10

Expected Cost > 50/50 50/50

CONT 5%
CONTINGENCY 20%

CONTINGENCY 15%

CONT 10%
Base

-15% to -5% 10/90

Base
-20% to -10% 10/90
-30% to -15% 10/90

Engineering
Procurement
Construction -50% to -20%
Commissioning 10/90

Owners‘ Costs DEFINITION EXECUTION


Insurance SCREENING FEASIBILITY PROJECT PROJECT
Certification Select Basis for Design SANCTION CONTROL
Option Project Design &
Specification Procure

Figure 5.9 Accuracy of estimates through project development


(Ref. 16)

101
Petroleum Fiscal Systems and Contracts

INPUT CASE

When sufficient exploration and testing results are available, the


life potential of the field can be calculated and balanced against
the costs of exploration and estimated costs for the development
phase. This calculation is based on the full life cycle, taking
account of the expected production start date and the total period
of production, with all estimated costs for exploration,
development and operation.

The Capex and Opex of the field will be calculated from the
anticipated production profile, forecast sales prices, total revenues
and non-recoverable costs. The exploration Capex should be
escalated to present cost values.

Exploration expenditures will be itemised for:


x Drilled wells
x Seismic and reprocessing
x G&G and other studies.

The estimated expenditures of the development phase will


include:
x Drilled wells
x Facilities
x Pipelines
x Project management
x General administration.

The estimated Opex cost for the operating phase will comprise:
x Overhead costs
x Workover costs
x Fixed costs
x Variables costs.

The economic model for the life of field will include the following:
x Working interest of the contractor
x State participation and its back-in
x After back-in costs
x Reimbursable costs for discovered reservoirs

102
Petroleum Fiscal Systems and Contracts

x Deductions from the investors


x Investors’ shares calculated on the basis Pi = K + a - b
x “a” factor and Mbbl/d steps distribution
x Rn and “b” factor input
x Finance pipeline shrinkage
x Abandonment
x Taxes
x Royalty
x Depreciation of hydrocarbon law.

Depreciation will recognise the following costs:

Exploration
x Seismic
x G&G and other costs
x Drilling tangible
x Drilling intangible
x G&A.

Development
x Seismic
x Drilling tangible
x Drilling intangible
x Facilities
x Pipelines
x Terminal
x Operating costs.

The model should determine the percentage of approved


depreciation in accordance with the contract, taking account of:
x Investors’ maximum entitlement from total production
x Mother country guarantee
x Tax type and rate.

103
Petroleum Fiscal Systems and Contracts

OUTPUT OF ECONOMIC ANALYSIS

The output of calculations should enable the company to make a


declaration of commerciality.

The potential for commercial production is demonstrated by well


tests and quantified by reservoir simulation. Where the estimated
recoverable volumes from the field will clearly satisfy the criteria
for reserves, a declaration of commerciality may be made. Once
approval of a commercial discovery has been given by the
government, the field will then be justified for commercial
production.

Recovery Factors and P50 values for field production are derived
from reservoir simulation on the base case. P90 values give an
estimation of the lowest expected recovery (with a 90% probability
that this will be achieved or exceeded) and the P10 values
estimate the highest expected case (with a 10% probability of
exceedance). Minimum and maximum values can be selected by
setting technically reasonable limits.

The estimates of recoverable hydrocarbons will have a major


economic impact on the development decision. Economic
evaluation should use the same P50 production forecast as from
the simulation base case model. The P50 input of STOIIP should
closely match the simulation base case.

Economic analysis based on the lifecycle of a project is


fundamental for making effective decisions in the early stages of
the venture. The life of field analysis will enable assessment of the
viability of development and the value of additional appraisal. The
data will also support commercial negotiations, government
license applications and sourcing investment funding.

In the feasibility and concept selection stages, economic analysis


is particularly valuable in identifying opportunities to optimise the
project for maximum value and to avoid a poor investment. There
is a risk that a sub-optimal design solution is adopted in pursuing
early payback through the earliest possible start-up,. This might
result in reduced production capacity and deferred or lost

104
Petroleum Fiscal Systems and Contracts

production. The lack of sufficient field appraisal might lead to an


uneconomic development.

In order to draw valid conclusions from economic modelling, the


uncertainties and potential variations in key input parameters
need to be fully understood. Unreliable technical or commercial
data inputs can producing misleading data outputs.

105
Petroleum Fiscal Systems and Contracts

6 FINANCE

Working capital is required for developing an oil or gas field


through the life of field, including costs for: (Ref. 7, 16)
x Acquisition of the asset;
x Initial exploration, appraisal and preparation of a Field
Development Programme;
x Development;
x Ongoing capital expenditure and operating expenditure; and
x Abandonment of the field.

Typically in a larger oil company, projects may not go ahead


where a decision to sanction development depends on the project
economics meeting the company’s target internal rate of return on
the capital. Smaller companies may simply lack sufficient working
capital to fund field development. In either case there may be
opportunities for partnering with another company who will provide
development capital for a project but not the capital necessary to
decommission the field so that new external sources of capital
may be accessed.

106
Petroleum Fiscal Systems and Contracts

SOURCES OF PROJECT FUNDING

Economic modelling used to assess project viability will identify,


the amount of capital required and the likely return on capital
employed. Capital funding can be in the form of equity, debt or
other forms of third party financial support. Funding can come
from a variety of sources depending on the legal, regulatory and
contractual framework that applies (see Figure 6-1).

Legal/Regulatory/Contractual Framework

The Nation´s Constitution


Tax Law
Petroleum Legislation

Production Sharing Contract

Joint Operation Agreement

Figure 6.1 Hierarchy of legislation and contractual agreements


(Ref. 7, 15)

The selection of project funding sources will depend upon the


nature of the company carrying out the project and the inherent
level of risk. The scope of funds required may be solely for an
individual project or for a series of projects and may include the
costs of acquisitions.

A large international oil company may have sufficient working


capital to fund projects but will sometimes need to raise capital

107
Petroleum Fiscal Systems and Contracts

externally instead. If the company is publicly quoted it will have


access to the public capital markets and may fund a development
project by either a new issue of shares or by issue of a debt
instrument, which may or may not be convertible into equity. A
smaller company which may not be listed on an investment
exchange, however, will not have access to the public capital
markets and will seek funding either from banks or private equity.
Sources of private equity include specialist equity funds and
wealthy individuals.

The level of project risk can influence the choice of funding


source. If a project has low risk i.e. a high certainty of predicted
cash flow, debt funding with a comparatively low rate of return
may be preferred. Equity funding with an implicitly higher rate of
return better suits higher risk projects with uncertain future cash
flows.

Alternative types of funding structure may be used either as


investment in a company at a corporate level or as investment for
a specific project. Generally, corporate funding will raise capital for
a range of projects, acquisitions or other opportunities, rather than
a specific project.

Instead of directly raising equity finance, a company may choose


to set up a stand alone joint venture company with ownership of
the asset to be developed. The joint venture company will then
raise the necessary project equity or debt financing. This has the
effect of ring fencing funding liability solely to the stand alone
project company. This approach may be more expensive than
raising new equity or debt finance for the main oil company where
risk is spread over a wider range of assets and projects. This type
of funding may be preferred where the company seeking
investment does not wish to open up its general portfolio for
investment by outside parties or if other elements of its portfolio
are not seen as suitable investments by the relevant equity funds
and debt providers. Some investors, for example, may only
provide finance for European operations and may not be able to
invest in a company with interests elsewhere.

108
Petroleum Fiscal Systems and Contracts

Tax issues may have an effect on the corporate structure used for
the funding. The tax liabilities and reliefs applicable to a project
and its participants need to be considered in detail since these
can change the expected return on a project or even make the
project non-viable.

Funding for a project involves the investment of funds in the


project company to carry out the project either by equity or debt
funding. This investment may also be made in the form of a farm-
out or sale in which a third party bears project costs or under a
risk and reward contract where project risk is shared by a
contractor.

109
Petroleum Fiscal Systems and Contracts

EQUITY FUNDING

Equity funding involves the raising of share capital, either in the


form of ordinary shares or preference shares. Whilst ordinary
shares have no limit on the holder’s right of receiving returns,
preference shares have some form of limitation such as a fixed
redemption premium or a particular dividend or ‘coupon’ on the
share.

Companies do not usually raise equity funding to finance an


individual new project or acquisition since the process can be
costly and take a long time. The process may also be complicated
where there are uncertainties in an acquisition process and third
parties are involved through a JOA. There are some instances,
however, where small companies may seek equity funding for
individual acquisitions. The particular type of equity funding
required for a company’s venture will depend upon the projected
cash flows, duration and exit strategy for that project. For
example, if redeemable preference shares are issued, the time at
which these will be redeemable must be appropriately linked to
the company’s forecast cash flows.

Equity funding where investors expect a relatively high rate of


return may often be used in conjunction with an element of debt
finance where rates are lower. The higher returns for equity may
be justified because the equity providers are funding early stage
development work or exploration when banks are reluctant to lend
on normal terms. Thus, as an example, an overall rate of return on
a project of 5% may be half funded by debt finance and half
funded by equity finance yielding a return of 10% or more. The
viability of development projects may often depend on this method
of leveraging to gain a higher rate of return on equity.

Examples of equity funding instruments include:


x Ordinary shares
x Preference shares
x Options to subscribe
x Warrants
x Convertible debt instruments.

110
Petroleum Fiscal Systems and Contracts

Ordinary Shares

Ordinary shares in their simplest form have no preferred rights to


dividends and no guarantee of return of capital if a private
company is wound up. There is no minimum or maximum level of
return. Consequently, ordinary shares are most appropriate for
longer-term investments where the return to the equity provider is
expected to come out of a future sale or flotation of the company,
whereby those ordinary shares can be sold or traded.

Some ordinary shares have special class rights attached which


allow investors, for example, to control changes to the company’s
constitution or restrict the issue of further shares.

Convertible redeemable preferred ordinary shares (CRPOs) may


permit the holder to have the shares redeemed and may have
certain preferred rights as against the ordinary shareholders to
dividends or return of capital. They may also be capable of
conversion into ordinary shares on some specified condition.

Private company ratchets may be used, with the agreement of


institutional shareholders, to provide an incentive to management
shareholders in a company. Ratchets provide for varying equity
percentages of the shareholders, based on a performance bench
mark over the life of the investment such as the internal rate of
return. For example, the equity structure of a company may allow
all profits up to the specified internal rate of return are shared
between the investors and the management team in the ratio of
75/25 but that all profits in excess of that bench mark are shared
50/50. The ratchet acts to incentivise management teams to try to
achieve superior performance.

Preference Shares

Preference shares may provide a fixed rate of return or a floating


rate. The floating rate may be based upon the amount paid for the
preference share or on the profitability of the company.

111
Petroleum Fiscal Systems and Contracts

Preference shares may be redeemable so that the company can


choose to buy them back in the future, possibly with a premium on
redemption. Non-redeemable preference shares simply have a
preference nature through the preferred dividend or return of
capital on a winding-up.

Preference shares may also be convertible into plain ordinary


shares. Where conversion rights exist, the investor has the option
to take advantage if the value of plain ordinary shares becomes
greater than that of the preferences shares but also has the
downside protection if things go wrong that their investment ranks
ahead of any ordinary share capital.

Options to Subscribe

Companies may elect to grant options to subscribe. Options can


be granted either without limit of time or linked to trigger events at
which time the investor must either exercise their option or lose
the right. Trigger events may include a time limit, a target share
price to be reached, a future round of funding raised by the
company, or a sale or flotation. Options allow investors to hedge
their bets and only choose to participate if things are going well
and the options are profitable. From the company’s point of view,
options may also be attractive as they have the potential to
enhance the investor’s upside and therefore make the investor
perhaps less demanding on the terms of their initial cash
investment. A consequence of options is that the non-investor
shareholders give away some equity but only in the event of future
success of the company resulting in options being taken up.

Warrants

Warrants are normally issued by a company borrowing from an


investor as part of the funding package. They entitle the holder to
subscribe at a fixed price for a given number of shares on an
event occurring such as a flotation or when the price of ordinary
shares reaches a certain level.

112
Petroleum Fiscal Systems and Contracts

Convertible Debt Instruments

Convertible debt instruments operate like convertible preference


shares, offering investors downside protection. With a debt
instrument, however, the investor’s interest ranks ahead of all
classes of share in issue. Also, if the debt is secured, it can also
rank ahead of ordinary creditors. This element of downside
protection, may have some commercial value. With low risk
attached, the debt instrument would normally contain quite a low
rate of interest.

Equity Documentation

Legal documentation used in equity funding includes Articles of


Association and Investment Agreements.

The documentation for incorporation of a company includes a


Memorandum of Association stating the objects for which the
company was formed. This is accompanied by Articles of
Association which are rules by which a company is governed. The
articles set out the rights attaching to the different classes of
share, dividend rights, rights on a return of capital, board
composition and share transfer provisions. In a private company,
share transfer provisions will often include a general prohibition on
transfer of shares with exceptions such as for family members or
between members of the same group of funders. A pre-emption
mechanism will normally entitle the other shareholders to
purchase them in the event that a shareholder obtains permission
to sell.

The articles may include leaver provisions so that if a member of


the management team leaves the company he may be forced to
sell back his shares to the other shareholders. These may
operate, for example, on dismissal, resignation or death, or on a
shareholder’s bankruptcy or on a shareholder becoming disabled
or otherwise unable to work.

The articles may specify mechanisms for forcing a sale of the


company. Institutional investors with a majority of the voting rights

113
Petroleum Fiscal Systems and Contracts

will normally have a ‘drag along’ right to sell the entire issued
share capital of the company. Alternatively, ‘tag along’ rights
provide that the majority of shareholders cannot transfer or sell
their shares without the proposed buyer of the shares making an
offer to all shareholders on the same basis.

An Investment Agreement for equity funding is an agreement


between the shareholders of the company in which they agree
how the company is to be run.

The Investment Agreement will typically include:


x Description of the investment being made, methods of
subscription and the forms of securities to be issued.
x Amounts of funding to be provided by the institutional
investors and by the management team’s participation with
their own cash investment.
x Constitution of the board of directors and any non-executive
directors to be appointed.
x Conditions precedent to be met before the funding is provided
such as completion of the acquisition of an interest in a field.
x Warranties by the management team to the institutional
investors. Warranties will normally be limited in extent of
financial liability and duration.
x Covenants which prevent the management of the company
acting without the institutional investors’ consent such as in
exceeding borrowing limits, altering the share capital of the
company or the articles of association.
x Covenants requiring the management team to provide regular
management accounts and audited accounts to all
shareholders.

Loan Notes

Companies may raise a form of debt finance by issuing loan notes


to institutional investors. Loan notes are usually unsecured and
subordinate to any bank debt and so carry a fixed rate of interest
higher than bank debt to compensate the note holders for that
higher risk.

114
Petroleum Fiscal Systems and Contracts

Loan notes may have convertibility provisions allowing the holders


to convert their notes into fully paid shares in the issuing
company. In this way holders may converting relatively low risk
and low return loan notes into riskier but potentially more
profitable equity shares.

A Loan Note Instrument sets out the rights and obligations of the
issuer to the note holder, including interest payable, terms for
repayment and provisions for calling in of the debt in the event of
default.

115
Petroleum Fiscal Systems and Contracts

DEBT FINANCE

Provision of debt finance by a bank is subject to the bank being


satisfied that the borrower has sufficient projected cash flows to
service the debt. For financing an exploration or development,
bank is lending against the asset and must be confident of the
forecast cash flows to determine the level of debt which the bank
will be prepared to provide and the rate of interest to be charged.
Where the cash flows are more stable and predictable, the asset
will have a higher debt capacity and a lower rate of interest will be
charged. Generally, debt funding may be unsuitable for projects
with a high degree of uncertainty. It is unlikely to be appropriate
for exploration or development work pre-production unless it is to
be repaid out of existing cash flows from currently producing
assets.

Banks may also be reluctant to provide debt finance for projects


near the end of field life where abandonment liabilities may
outweigh future net cash flows from the asset.

Private Debt Funding

Debt funding not raised on the public capital markets is termed as


private debt funding whereby the borrower enters into a Facility
Agreement with a bank. For large amounts, the risk may
sometimes be spread across a syndicate of banks.

A bank debt facility may be divided into senior and junior facilities
where the senior debt is ordinarily secured and ranks first on any
insolvency of the debtor and junior or subordinated debt which
ranks after the senior debt. Junior facilities have a higher level of
risk and normally have a higher rate of interest. Typical rates of
interest may be 1 to 2.5% above base rate for senior debt against
a margin of 5% or more for subordinated debt.

Facility Agreements used for oil and gas projects may include a
borrowing base calculation. The borrowing base calculation is
carried out periodically to calculate the net present value of the
future cash flows expected and redetermine the amount which the

116
Petroleum Fiscal Systems and Contracts

borrower can draw under the facility. Changes to the level of field
reserves, market oil prices, Opex and abandonment costs can be
taken into account as development and production progresses.

Capital Market Funding – Debt Instruments and Bonds

High-yield bonds may be issued on private or public markets by a


company seeking substantial capital borrowing for a project or
wishing to refinance existing bank debt. High-yield bonds pay
fixed interest over the period of the term of the bond and are
repaid at the end of the term.

Types of debt instruments include:


x Commercial Paper;
x Bonds; or
x Medium Term Notes.

Commercial Paper is a short-term debt instrument usually


repayable within a year and not listed directly on a public market.
A Medium Term Note (MTN) is a debt instrument commonly used
for longer term working capital requirements. Commercial Paper
and MTNs will generally be issued under a Programme Platform
facility underwritten by investment banks or dealers. Bonds are
another type of debt instrument usually with a term of several
years.

Bonds and Medium Term Notes may be listed for trading on a


regulated market. They will be graded by a rating agency such as
Moody’s Investors Services, Standard & Poor’s Corporation and
Fitch Ratings based on the agency’s opinion of the issuer’s
creditworthiness and likelihood of the issuer defaulting. .

117
Petroleum Fiscal Systems and Contracts

FARM-OUT OR SALE

Farm-out or sale of an asset is another way of raising capital, as


an alternative to raising equity or debt funding.

A company that does not wish to raise all of the funds for a project
can farm-out part of the interest in a field. The farm-in party will
then bear some or all of the development costs. Similarly, a
company can sell the field interest entirely, making a profit on the
original acquisition cost, once some preliminary work has
identified a development opportunity,

CONTRACTOR EQUITY

Contractors sometimes enter into a risk/reward-type contract with


the oil company whereby the contractor bears some of the project
risk. A contractor such as a drilling contractor or a major service
companies will provide their manpower and equipment at reduced
rates in exchange for a higher fee on successful completion. The
shared risk is analogous to a form of equity funding for the project.

This form of funding can be beneficial particularly for a small oil


company where a large contractor company may have better
access to capital. It also allows the oil company to retain complete
ownership of the license, operatorship of the field and to book all
of the reserves as their own for reporting purposes, whilst using
third party contractors to bear some of the cost and risk of the
development. Risk is shared as in a farm-out but without the need
to sell reserves or take in a field partner.

118
Petroleum Fiscal Systems and Contracts

HEDGING

Regardless of the type of funding source, the project company


remains exposed to economic risks and may want to hedge these
risks. Hedging arrangements can be used to lay off risks that will
affect cash flow. These offer the project company a greater
assurance that the project will be successful but at the cost of
some upside potential. For example, hedging contracts may be
entered into to protect against adverse changes to oil prices or
debt interest rates. If oil prices turn out to be lower than assumed
or interest rates higher than assumed, part of this risk is borne by
the hedging counterparty. Conversely, should changes in these
factors be favourable, the project company has to share the
enhanced revenues with the hedging counterparty.

Hedging contracts are used to manage project financial risks.


Project finance arrangements are set up based on estimated cash
flows but there are inherent risks that outturn cash flows will be
adversely affected by changes such as a falling oil price or
increases in interest rates payable on debt finance. A wide range
of hedging arrangements are available on the capital markets to
manage these risks.

A straightforward type of hedging contract is where an oil


company wants to hedge against a fall in the oil price during a
development project.

An example would be where a company’s economic model for a


project is based on producing a certain quantity of oil per month
and has assumed a certain value in dollars for the sale price for oil
per barrel. There is a possibility that the oil price may rise higher,
yielding greater profit, or that the oil price may fall below this level
making the project lose money. To mitigate against the downside
potential, the company might enter into a hedging contract which
would effectively guarantee the target price. Whenever the oil
price falls below the target price, the hedging counterparty would
undertake to pay the company the difference between the target
and the actual price for a fixed production quantity. In return, the
oil company would pay the counterparty the difference whenever
the oil price exceeds the target price. Thus, the oil company is

119
Petroleum Fiscal Systems and Contracts

sure of its future revenue but foregoes the upside potential of


enhanced profits. This type of contract is based on a theoretical
fixed level of production and payments by either party are made in
relation to this quantity regardless of actual production quantities.
If there is a shortfall in production, the company remains liable to
make payments in periods of higher oil price.

This type of hedging contract can also be used to hedge against


risks of increased interest rates. Another common example is
protection against currency rate variations. An oil company might
incur field costs and hold debt in sterling while all its production is
sold in dollars.

Forward sales of production is another type of hedging. Instead of


selling production at the market spot oil price and bearing the risk
of falling prices, the company contracts to deliver oil in the future
at a fixed price. Although this mitigates the risk of a falling oil
price, the company becomes exposed to the risk of substantial
losses if there are production difficulties and it is unable to deliver
the oil as contracted. The company might seek to guard against
this subsequent risk by a further hedging arrangement.

Hedging Documentation

The International Swaps and Derivatives Association (ISDA)


produce the most commonly used documentation for hedging
agreements.

The ISDA form of Master Agreement may be used as an overall


agreement between a project company and a hedging
counterparty with individual hedging contracts put in place under
the Master Agreement. In some cases the Master Agreement
terms will require the project company to put up security, usually
in the form of a bank letter of credit, to cover the hedging
counterparty’s credit risk exposure.

120
Petroleum Fiscal Systems and Contracts

7 TAXES

This Chapter describes the United Kingdom’s fiscal regime for the
oil and gas sector. (2, 4, 6, 16, 17)

The UK taxation regime for oil and gas extraction in the North Sea
and the wider UK Continental Shelf (UKCS) area has evolved
over time with many changes being made. These changes have
removed the regressive royalty system and tended to a more
progressive system.

Since the removal of royalties in 2003, all direct taxes for oil and
gas companies operating in the UKCS are based on profits and
allow companies to recover all their major costs before tax is
charged. The tax rates are scaled with respect to the age and size
of a field so that the larger old fields pay greater tax than the
smaller new fields.

Major changes were introduced in 1975 at the time when the large
oil fields in the Northern North Sea were being brought into
production. Until then, the fiscal regime comprised Royalty
charged at 12.5% of the wellhead value of gross production and
Corporation Tax (CT) charged at 52% on companies’ taxable
profits. In 1975, a new tax, Petroleum Revenue Tax (PRT) was
introduced at 45% on the profits arising from individual fields. At
the same time, ring fencing was introduced for CT around a
company’s entire profits from the North Sea. These two elements
remain today but PRT is now limited to profits from larger, older
fields.

In the late 1970s and early 1980s, taxes were increased with
marginal tax rates reaching as high as 90%. This had the effect of
deterring development projects so the government reduced rates
once more and introduced reliefs including cross-field reliefs.
Royalty was abolished for some fields.

The tax regime was further reformed in 1993 when PRT was
abolished, together with the cross-field reliefs, for all ‘future’ fields.
The PRT rate was also reduced to 50%.

121
Petroleum Fiscal Systems and Contracts

In 2002 a new 10% Supplementary Charge (SC) was introduced


on ring fenced profits for CT whilst more generous CT investment
allowances were introduced. Royalty was finally abolished on all
fields with effect from 1st January 2003. The Supplementary
Charge was increased to 20% from 2006.

SUMMARY OF THE CURRENT TAX SYSTEM

Since 2003 when Royalty was abolished, three taxes currently


apply to profits from extracting oil and gas in the UKCS. For most
fields, however, only two of the taxes are applicable.

The taxes, as shown in Figure 7-1, are:

x Petroleum Revenue Tax (PRT). Charged at 50% on profits,


after allowances, from fields given development consent
before 16 March 1993. Due to the allowances available, PRT
is not actually paid on many such fields.

x Corporation Tax (CT). Ring Fence Corporation Tax (RFCT) is


charged at 30% on ring fenced profits from UKCS fields.

x Supplementary Charge (SC). Charged at 20% on ring fenced


profits but with financing costs allowed.

Since PRT is deductible for calculating CT and SC, the marginal


rate of tax for profits is:

x 75% (PRT, RFCT and SC) for PRT-paying fields; or

x 50% (RFCT and SC) for all other fields.

122
Petroleum Fiscal Systems and Contracts

Petroleum
Revenue
Tax

New UKCS
Fields Petroelum Existing
Taxes Fields

Corporation Tax
And
Supplementary
Charges

Figure 7.1 UK tax regime


(Ref. 16)

123
Petroleum Fiscal Systems and Contracts

Fiscal Policy

Policy and decisions on changing the fiscal regime are made by


the Chancellor of the Exchequer, advised by Treasury officials.
The regime is administered by a division of HM Revenue and
Customs (HMRC) known as the Large Business Service, Oil and
Gas (LBSOG). This was formerly called the Oil Taxation Office
(OTO). LBSOG is responsible for administering:

x All taxes on UK oil production; and

x the tax liabilities of:


o all oil companies with UK downstream operations;
o UK resident oil companies with overseas
operations, either upstream or downstream;
o non-resident contractors operating on the UKCS.

In recent years oil and gas taxation has raised substantial


amounts for the UK Treasury. In the year 2005/2006 North Sea
tax revenues totalled £9.6 billion and comprised around 22% of
UK corporate tax revenues for that year. The tax yield included £2
billion PRT, £5.6 billion CT and £2 billion SC,.

124
Petroleum Fiscal Systems and Contracts

PETROLEUM REVENUE TAX (PRT)

Basic Structure

The Oil Taxation Act 1975 introduced PRT as a tax on profits from
UK and UKCS oil and gas fields, except for gas sold to British Gas
under contracts made before 30 June 1975.

In 1993, PRT was restricted to fields first given development


consent before 16 March 1993. Fields developed since are
outside the scope of the tax and are described in the legislation as
‘non-taxable fields’.

Individual licensees are charged PRT at a rate of 50% on their net


income from the field in a six-month chargeable period. There are
various allowances that can be set against this liability. The tax is
based on individual fields so that the costs of developing one field
cannot be set against the profits of another. Field boundaries are
determined by the Department of Energy and Climate Change
(DECC) on the basis of geological criteria. The effect of a range of
special allowances is that PRT is paid mostly on the larger and
more profitable fields.

About 120 North Sea fields are potentially liable for PRT but as a
result of the available reliefs only around half of these are ever
likely to pay any PRT. The PRT collected is drawn from a small
number of fields and is predominately from just a few large fields.

PRT is calculated for each participator in the field for a six-month


chargeable period as follows:

‘positive amounts’ (income)


less ‘negative amounts’ (expenditure)
= ‘assessable profit’ or ‘allowable loss’

125
Petroleum Fiscal Systems and Contracts

‘assessable profit’
less ‘allowable losses’ (for other periods)
less ‘oil allowance’ (partial exemption, where applicable)
= taxable profit @ PRT rate

PRT payable = taxable profit x 50%

In some cases, the resultant tax payable may be capped by a


relief known as ‘Safeguard’.

Measurement of ‘Gross Profit’

The ‘positive amounts’ subject to PRT generally derive from


revenue from the sale of oil and gas which is described in the
legislation as the ‘gross profit’. The gross profit on ‘arm’s length’
sales of oil and gas on the open market can be assessed easily.
When, however, oil or gas is disposed in another way such as oil
taken for refining, the income to be taken into account for PRT is
the ‘market value’ of the oil or gas, as determined by LBSOG.

As well as disposals, account is also taken of 50% of the value of


production in stock at the end of the period less 50% of the value
of stock at the beginning.

The meaning of ‘arm’s length’ for sales of oil is closely defined to


exclude sales between connected companies. ‘Nomination
scheme’ rules control the amount of income that is taken into
account for arm’s-length sales on the forward market.

Valuation of Oil

The Finance Act 2006 introduced changes to the way oil is


valued. This does not apply for gas. The new system values each
cargo of oil around its delivery date or an appropriate date. This
replaces the previous monthly pricing basis.

Blends with a readily quoted price, such as Brent and Forties, are
valued differently. The price is determined from an average of

126
Petroleum Fiscal Systems and Contracts

published prices over a five-day period. For other blends, account


can be taken of how arm’s-length sales of oil of that kind would be
priced.

Companies which sell oil on the forward market can include an


additional amount from the sale of oil, called a ‘nomination
excess’, in the ‘gross profit’. The application of nominated excess
is controlled by LBSOG so that producers cannot enter into a
range of deals on the forward market and choose the most
favourable for tax.

Valuation of Gas

The PRT rules seek to ensure that gas is valued for tax at a
market price. If gas is sold to a related company, the gas is
valued for tax at the notional price that would have been payable
under an arm’s-length contract applied in the circumstances of the
actual disposal. The legislation requires a hypothetical contract to
be constructed between the seller and the buyer by reference to
similar arm’s-length contracts. The appropriate value may be
determined through negotiation with LBSOG.

Tariffs

In 1983, tariff receipts were brought within the scope of PRT.


Thus, tariff receipts for the use by third parties of field assets,
such as pipelines and treatment facilities, known in the legislation
as ‘qualifying assets’, and the full receipts from their disposal
became subject to PRT in PRT-liable fields.

There are some reliefs, however. The Tariff Receipts Allowance


exempts tariff receipts for the first 250,000 tonnes of throughput
per six-month chargeable period from each user field. No
allowance is due where the user field is outside the scope of PRT.
The Finance Act 2004 added an exemption for tariffs received
from 1 January 2004 under a contract entered into on or after 9
April 2003 in relation to a field receiving developmental consent
from that date or any older field that has not previously used a

127
Petroleum Fiscal Systems and Contracts

‘qualifying asset’. This exemption of new tariff business was


introduced to maximise the useful life of infrastructure and to
encourage the developmental of further UK fields in their vicinity.

Field Expenditure

All qualifying field expenditure, whether capital or revenue, is


allowable for PRT, in full as it is incurred.

Expenditure that qualifies as being field-based may include:


x exploration (up to 5km out from the field)
x appraisal
x production
x transportation (to the UK or the nearest reasonable delivery
place abroad)
x initial treatment and storage
x sales
x decommissioning the field at the end of its life.

Costs of acquiring or improving major terms of equipment used in


the field for the purposes listed above are also allowable for PRT
even if the assets are shared with other fields. In the case of a
cost-sharing agreement the expenditure would be apportioned
between fields. Expenditure on mobile assets such as drilling rigs
are allowable over their expected life.

Field expenditure that is not allowed for PRT includes:


x interest or other financing costs
x costs of onshore land, or onshore buildings that are used for
any downstream process.

Anti-avoidance provisions seek to prevent costs being transferred


from fields that are not PRT-liable or where PRT is not actually
paid into PRT-paying fields. Transactions between related
companies may be scrutinised to ensure assets are not written-up
to market value when transferred.

128
Petroleum Fiscal Systems and Contracts

Whilst some cross-field reliefs were allowed in the past, the only
current non field-related expenditure that may be claimed now is
research expenditure that has not been allowed in a field within
three years of the costs being incurred.

Supplement

Supplement is an allowance against PRT introduced as a


substitute for relief on interest or other financing costs.

A supplement or uplift of 35% is added to major capital


expenditure incurred to bring a field on stream or to improve the
rate of production or transportation. This applies for expenditure
incurred up to the end of the six-month chargeable period in which
the field reaches payback, when the cumulative cash flow of the
field becomes positive.

Oil Allowance Relief

Oil allowance relief and Safeguard protect small or economically


marginal fields from paying PRT.

Oil allowance exempts a ‘first slice’ of production from PRT. This


allowance is made after taking account of all expenditure relief
and losses but only so as to reduce the profit for the period to nil.

Oil allowance is given per six-month chargeable period, with a


cumulative limit over the life of the field of 20 times the allowance
per period, at three levels:

x 250,000 metric tonnes (cumulative limit of 5 million tonnes) for


fields given development consent before 1 April 1982;

x 125,000 metric tonnes (cumulative limit of 2.5 million tonnes)


for all Southern Basin fields and onshore fields given
development consent on or after 1 April 1982; and

129
Petroleum Fiscal Systems and Contracts

x 500,000 metric tonnes (cumulative limit 10 million tonnes)


for all other fields given developmental consent on or after
1 April 1982.

The oil allowance is allocated between the participators in


accordance with their share of the oil produced in the period. Oil
allowance ensures that some smaller fields do not have to pay
any PRT and is a significant allowance in fields that do pay PRT.

Safeguard Relief

Safeguard is a form of allowance which caps the PRT payable


and was introduced with the intention of ensuring that marginal
fields remained profitable. PRT is not payable if the ‘adjusted
profit’ of the field is less than 15% of accumulated capital
expenditure. If more, then the PRT cannot exceed 80% of the
excess. The ‘adjusted profit’ for safeguard is broadly the gross
profit less operating costs. The allowance is only available to
fields for periods until payback is reached plus half as many
periods again. Accordingly, the relief now has limited significance
in the UKCS.

Allowable Losses

Allowable losses may be carried backwards against assessable


profits of earlier periods, beginning with the latest such period, or
carried forwards against future profits until the losses are
exhausted.

For a field that has ceased production, losses are first carried
back to exhaust any profits of the participator for previous periods
and then any profits of participators that previously held the field
interest. Any balance left over after all such field profits are
exhausted becomes an ‘unrelievable field loss’ which may be
relieved against the profits of any other field of the loss-maker.
This is a rare exception to the strict field ring fence for PRT.

130
Petroleum Fiscal Systems and Contracts

Transfers of Field Interests

PRT is not payable on the profit on sales of license or field


interests. Similarly, the costs of acquiring interests is not allowable
against the tax.

When field interests are transferred, the current PRT position of


the old owner passes to the new owner. The new owner has
access to any expenditure relief not yet allowed, unused allowable
losses and the cumulative capital expenditure under the
Safeguard mechanism.

PRT Returns and Payment of Tax

Assessments are made for each six month chargeable period.


Periods end on 30th June and 31st December.

Returns of income are made separately from claims for


expenditure. Returns are made as follows:

x PRT2 return for each taxable field, within one month of the
end of each chargeable period. Return is made by the field
operator as the responsible person, giving:
- total amount of oil and gas produced from the field;
and
- each participator’s share.

x PRT1 return, within two months of the end of the chargeable


period. Return is made by each participator of all their income,
including revenues from all sales of oil and any tariff and
disposal receipts.

x PRT1A return, within two months of the end of the chargeable


period. Return is made by each participator, of all arm’s-length
sales during the period, not otherwise included in a PRT1
return, by each company in the participator’s group in each
type of crude.

131
Petroleum Fiscal Systems and Contracts

Expenditure is claimed separately from returns of income.


Expenditure that is allowed in an assessment has to be claimed
by the participators and agreed by LBSOG. There is, however, a
provisional allowance of 5% of gross profits that may be given
subject to later claw back.

The field Operator or responsible person will make a PRT30 claim


for most of the field expenditure, with sums allocated between the
participators. Participators can make individual PRT40 claims for
expenditure which is commercially sensitive, such as insurance
premiums. Expenditure claims will normally be submitted within
two months of the end of a 6-month chargeable period. This
enables expenditure to be agreed within the assessment which is
normally made not later than five months after the end of the
chargeable period.

PRT is paid by participators, and any repayment made, in stages,


as follows:

x A payment on account when the return of income is delivered,


two months after the end of the period, i.e. each 31st August
and 28th February. This payment is based on the participator’s
PRT6 calculation of the PRT payable for the period and may
include expenditure for the period which has not yet been
formally agreed.

x Six equal monthly instalments for the next chargeable period.


Each instalment equals one-eighth of the payment on account.

x When the assessment is finalised any excess of the final PRT


liability over the payment on account and instalments
becomes due, and any balance repayable. These final
payments or repayments are made with interest calculated
from the payment on account date.

132
Petroleum Fiscal Systems and Contracts

CORPORATION TAX AND SUPPLEMENTARY CHARGE

General Corporation Tax Rules

Corporation tax (CT) is charged on the net profits of all companies


operating in the UK. Although the UK continental shelf, outside of
the 12-mile territorial sea limit, is not part of the UK, profits from oil
and gas activities on the UKCS are subject to CT.

Oil and gas companies are subject to the general rules applicable
for CT but are treated differently in some respects. In particular,
through the ‘ring fence’ mechanism, additional tax is levied on
UKCS oil and gas profits. With effect from 1st April 2008, the main
rate of CT, for profits over £1.5 million, was reduced from 30% to
28%. This reduction, however does not apply to ring fence profits
which continue to be taxed at 30%.

Companies that are resident in the UK for tax purposes are


subject to CT on their worldwide profits. Non-resident companies
pay UK CT only on profits attributable to their UK permanent
establishment or fixed place of business. Special rules ensure that
any exploration or production related activity on the UKCS is
treated as being carried on through a permanent establishment in
the UK. Furthermore, companies are required to have a taxable
presence in the UK through which they conduct their offshore
operations as a condition of licenses for operating on the UKCS..

CT is charged on the amount of a company’s profits made in each


accounting period of the company. Company profits comprise:
x Trading profits - taxed on an accrual basis, generally in
accordance with the accounting treatment; and
x Capital gains - taxed on realisation of a gain.

Revenue expenditure, which is wholly and exclusively incurred for


the purpose of the business, is allowed in full against CT. Capital
expenditure or depreciation, however, are not allowable as
deductions but there is a system of capital allowances. Trading
losses can be set off against other trading profits or capital gains
made in the same, or a previous, accounting period. Losses may
also be carried forward and set off against future profits.

133
Petroleum Fiscal Systems and Contracts

A system of group relief allows a trading loss made by one group


member to be set off against the profits in an equivalent
accounting period of another.

Ring Fencing

The CT rules for oil companies treats UKCS oil and gas extraction
activities as a separate ‘ring fence’ trade. This prevents CT
chargeable on profits from UK oil being set off by costs or losses
arising from other activities. The ring fence is also used to
determine the tax base for charging a higher rate of CT on oil and
gas profits and for levying the special Supplementary Charge.

The ring fence means that only expenditure incurred for the ring
fence trade may be allowed against ring fence profits. Interest and
other financing costs are only allowed for finance used for UK oil
extraction activities or in acquiring UK oil rights. No deductions
can be made for losses arising from any activity of the company
outside the ring fence. Group relief is also not allowed for losses
which arise from activities outside the ring fence.

As under the general CT rules, ring fence losses may be carried


forward or back but may only be set off against ring fence profits.

Ring Fence Profits

Revenues arising from the disposal of UK oil or gas are subject to


the same rules for the application of CT as under the PRT regime,
even where the field is outside PRT.

The chargeable income is the actual price from arm’s – length


sales or the market value as determined by LBSOG in other
cases. Nomination excesses on forward sales are included as ring
fence income but with a deduction given against non-ring fence
profits to prevent double counting. Profits on the disposal of North
Sea assets are within the charge. Specific legislation also includes
tariff receipts for the use of North Sea assets which would not
otherwise be within the ring fence.

134
Petroleum Fiscal Systems and Contracts

Commencement of Trade

CT relief for any expenditure is only given after commencement of


trade. In this sense, exploration is not generally regarded as a
trade unlike production or development leading to production.

Commencement of trade will generally be accepted as when a


decision has been taken to proceed with the commercial
development of a discovery which will lead to production. Capital
expenditure incurred prior to commencement of trade, and
revenue expenditure incurred within seven years of
commencement, is treated as incurred on the first day of trading.

Revenue Expenditure Reliefs

Operating costs and overheads related to the production of oil are


allowable in full as they are incurred.

Revenue expenditure on research and development can qualify


for a special 125% relief. Exploration and appraisal activity,
however is specifically excluded from this special relief.

Capital Expenditure Reliefs

Ring fence oil and gas attract various capital allowances


treatment. These include:

x Research and Development Allowance (R&DA)


x Mineral Extraction Allowance (MEA) and
x Plant and Machinery Allowance (P&M).

135
Petroleum Fiscal Systems and Contracts

Under the R&DA scheme, capital costs of exploration and


appraisal activities are allowable in full in the year in which the
expenditure is incurred. Exploration and appraisal capital
expenditure up to the time a decision is made to develop a field is
also allowable. On disposal of assets treated as R&DA
expenditure, there is a balancing charge to claw back the value by
treating this as a trading receipt.

The capital costs of drilling development wells are allowable under


the MEA system. Exploration and appraisal costs may also qualify
here, as an alternative to the R&DA code. There is a 100% first
year allowance (FYA) for MEA expenditure incurred as part of a
ring fence trade. For expenditure on mineral assets such as
license costs, relief is available at 10% on a reducing balance
basis. MEA also applies to mineral exploration and access costs
where there has been transfer of a license interest and part of the
value is attributable to drilling expenditure incurred by the seller.
On disposal of assets representing MEA expenditure there is a
claw back of allowances, as for R&DA.
.
The P&M code allows for relief on all the major capital costs of
acquiring or building infrastructure such as platforms, treatment
facilities, pipelines, and other capital equipment used in oil and
gas production. There is a 100% FYA for P&M expenditure
incurred as part of a ring fence trade, except that which is incurred
on long-term assets with an expected useful life of more than 25
years where the FYA is 24%. P&M allowances may be clawed
back as a balancing charge on disposal of the assets. P&M
allowances may be transferred when assets are sold as part of
the transfer of a field interest but the allowance available to the
purchaser is limited to the cost of the assets to the vendor.

The costs of decommissioning offshore infrastructure in


accordance with an approved UK abandonment programme are
allowable in full under the P&M code. Where a North sea
company has ceased to trade and incurs decommissioning costs
within three days of the cessation, the company can claim a 100%
allowance in respect of the expenditure in its final trading period.
Losses arising from decommissioning can be carried back for set
off against profits in the preceding three years, instead of the

136
Petroleum Fiscal Systems and Contracts

normal one year. The costs of obtaining a bank guarantee or letter


of credit against future abandonment costs are also allowable in
full but not any sums set aside for future abandonment costs.

All 100% allowances for major capital expenditure, except for


post-trade cessation decommissioning, are only available in the
year the expenditure is incurred.

Ring Fence Expenditure Supplement

The Ring Fence Expenditure Supplement offers some assistance


to companies which have not yet commenced to trade and thus
cannot take advantage of the timing benefit of the 100%
immediate tax reliefs. The Supplement allows companies to carry
forward any unrelieved expenditure from one period to another.
This may be either as expenditure incurred before the trade
commences or as a trading loss.

The Supplement may be claimed for a maximum of six years and


since 1st January 2006 it has been set at a compound 6% per
annum.

Capital Gains

CT is chargeable on capital gains realised on the disposal of


UKCS assets. The capital gain is calculated as the difference
between the sale proceeds and acquisition costs plus any
enhancement expenditure. Gains on the disposal of assets used
in the ring fence trade, however, cannot be reduced by losses
arising outside the ring fence.

The chargeable gains may be reduced by an indexation allowance


which removes gains attributable to inflation. The gains may also
be deferred through rollover relief which encourages further
investment in the business. Rollover relief, however, is only
available if the sale proceeds are used to acquire other UKCS
assets. Special rules apply to North Sea assets acquired before
1982 and to license swaps.

137
Petroleum Fiscal Systems and Contracts

Transfer Pricing

Special market value rules apply for CT on the transfer of oil


between related companies as for PRT.

Transfer pricing rules on other transactions such as the provision


of services between related parties apply to oil companies as for
all others. Where the consideration paid does not represent a
genuine arm’s – length price then that price is to be substituted.

It should be noted for oil companies that the rules on transfer


pricing apply across the ring fence boundary, including
transactions within a single company where it carries on both ring
fence and non-ring fence activities. In such cases, the two types
of activities are treated as if they were separate businesses
carried on by separate companies under common control.
Transfer pricing adjustments for transactions that cross the ring
fence only operate in one direction so that they can be made only
where the substitution of an arm’s length price would increase ring
fence profits.

General transfer pricing rules for loans also apply to oil


companies. For oil companies, these are extended so as to apply
across the ring fence boundary. Excessive interest on such loans
is disallowed as a deduction in arriving at the assessable ring
fence profits. Corresponding adjustments may be made for the
lender. UK oil and gas financing is monitored by LBSOG to ensure
that interest on inter-company loans does not improperly reduce
ring fence profits.

Supplementary Charge

Supplementary Charge (SC) is an additional tax charged on the


profits of companies producing oil or gas in the UK or on the
UKCS. SC was introduced in 2002 at the rate of 10%. The rate
was later increased to 20% for profits arising from 1st January
2006.

138
Petroleum Fiscal Systems and Contracts

Profits subject to SC are calculated in the same way as for ring


fence corporation tax purposes except that no relief is available
for financing costs. Financing costs deducted for CT have to be
added back in when computing SC.

Administration and the timing of payments for SC are the same


way as for CT.

CT and SC Returns and Payment of Tax

Unlike for PRT, where the responsibility for making assessments


lies with HMRC, CT is self-assessed by the taxpayer.

All companies liable to CT must file a CT600 return within 12


months of the end of its accounting period, subject to penalties for
late filing. The return contains the company’s self-assessment for
CT. Oil companies with ring fence income also have to complete
supplementary pages showing the SC liability.

After filing the return, there is a 12 month period in which the


company may amend its return such as to modify allowances
claimed, During the same period, HMRC may initiate an enquiry
into the completeness and accuracy of the return, requesting
further information or undertaking a review of the company’s
records. At a later date, HMRC may also make a ‘discovery’
assessment if the return is found to be inadequate through
incomplete disclosure or fraudulent or negligent conduct.

Payment of CT is generally due 9 months and 1 day after the end


of the accounting period. Large companies, however, are required
to pay their estimated tax liability, in a series of instalments.
Companies with a 12-month accounting period generally pay CT
in four equal instalments, made in the seventh, tenth, thirteenth
and sixteenth months following the start of the period. This applies
to oil companies for tax on their non-ring fence profits, but tax on
ring fence profits, including SC, has to be paid by three equal
instruments in the seventh, tenth and thirteen months.

139
Petroleum Fiscal Systems and Contracts

Taxation for New Entrants

New entrants commencing operations on the UKCS will encounter


tax consequences depending on the method of entry. Any
company proposing to enter the UKCS is advised to make early
contact with the LBSOG to learn how proposed transactions are
likely to be treated under UK tax law.

When a new entrant purchases an existing company operating in


the UKCS through a share acquisition, the CT and PRT liabilities
will remain unaffected by the change of ownership if it continues
to trade as before. The new entrant company, however, will not be
able to claim allowance for financing costs on the purchase since
the interest would fail to meet a ring fence purpose.

Where a new entrant farms-in to an existing UKCS there are


important questions of CT and PRT liabilities to be determined,
including the extent to which acquisition costs and finance interest
will be allowable for CT and what level of debt in the company will
be permitted by the LBSOG. For a PRT-liable field, the PRT
position will be transferred and the new entrant can establish the
level of PRT payable or if a field where no PRT has been paid to
date will become liable to pay in the future.

140
Petroleum Fiscal Systems and Contracts

8 FIELD DEVELOPMENT PLANNING

Government consent is required to permit development of a new


oil or gas field. The field operator starts this process by submitting
a Field Development Plan or Programme (FDP) or its local
equivalent to the host country’s government. The FDP may be
accompanied by an Environmental Statement (ES) setting out the
environmental impact of the proposed development.

Field development planning is one of the core business processes


in the upstream oil and gas industry. It is essential that the
development proposed for a discovered field is based on full
evaluation of the subsurface reservoirs and careful planning of the
optimum surface facilities required. The planned development put
forward in the FDP should take account of all known information
about the reservoirs to estimate the quantity of hydrocarbons in
place and expected production profiles. The FDP should consider
the best practicable number, location and type of wells required
for economic production, the type and capacity of surface facilities
required for processing and transportation of the produced fluids.

The FDP will be based on information available at the time from


exploration and appraisal. Since there will be inherent
uncertainties in the reservoirs over the production life span of the
field, the FDP should include flexibility so that the development
may change from the original plan during implementation after
further appraisal or when initial production has commenced.

This chapter describes the typical example of the Field


Development Planning process that applies in Norway. (Ref. 14)

141
Petroleum Fiscal Systems and Contracts

FIELD DEVELOPMENT PLANNING IN NORWAY

The Norwegian system is controlled by the Norwegian Petroleum


Directorate (NPD) acting on behalf of the government ministry and
working within the legal framework shown in Figure 8-1.

Figure 8.1 Legal framework


(Ref. 14)

Field Development Planning Process

The government seeks to ensure that there is prudent production


of hydrocarbons. Accordingly, licensed operators are required to
ensure that:

x Production of petroleum takes place in such a manner that as


much as possible of the petroleum in place in each individual
petroleum deposit, or in several deposits in combination, will
be produced.

142
Petroleum Fiscal Systems and Contracts

x Production takes place in accordance with prudent technical


and sound economic principals and in such a manner that
waste of petroleum or reservoir energy is avoided.

x The licensee carries out continuing evaluation of production


strategy and technical solutions and takes the necessary
measures in order to achieve this.

If a licensed operator decides to develop a petroleum deposit, the


operator is required to submit a Plan for Development and
Operation of petroleum deposit (PDO) to the Ministry of Petroleum
and Energy for approval.

The PDO is a comprehensive document describing the various


aspects of a planned field development and the production
facilities. It needs to contain an account of economic aspects,
resource aspects, technical, safety related, commercial and
environmental aspects, as well as information as to how a facility
may be decommissioned and disposed of when the petroleum
activities have ceased.

Also required is a Plan for Installation and Operation (PIO). This is


a document that comprehensively describes the various aspects
of the plan for development and operation of facilities for transport
and utilisation of petroleum (i.e. pipelines and terminals).

The government seeks to achieve real influence through


development planning in order to achieve a maximised added
value for society. The development planning process is intended
to be an effective process for government approval which
evaluates development plans efficiently

143
Petroleum Fiscal Systems and Contracts

PDO Submission and Approval

Licensed operators are encouraged to enter into early dialogue


with the government prior to submitting a PDO. This will ensure
that the authorities’ considerations are properly included in the
field development during the early planning phase and assist an
efficient approval process.

Governmental interaction prior to PDO may include:

x Having an early dialogue with the operator.


x Gathering information by participation in license committee
meetings.
x Performing an Area Study to consider the effect of new
field development in a broader geographic perspective.
x Making in-house evaluations and investigating alternative
solutions or interpretations.
x Further meetings with the operator to influence decisions
or clarify questions.

Figures 8-2 and 8-3 below show a typical sequence of how a


discovery may be progressed through the development planning
process, and how the PDO review and approval process is
administered by the authorities.

144
Petroleum Fiscal Systems and Contracts

Figure 8.2 PDO approval flow chart


(Ref.14)

Figure 8.3 PDO approval administrative process


(Ref. 14)

145
Petroleum Fiscal Systems and Contracts

A PDO with a description of all important aspects of the


development must be submitted to the Ministry for approval when
a licensee decides to develop a petroleum deposit.

Key requirements for PDO submission are:

x The Ministry may require an impact assessment for effects on


the environment or other affected activities.

x Substantial contractual obligations must not be entered into or


construction work started until the PDO has been approved,
unless by consent from the Ministry.

x On application from the licensee, the Ministry may waive the


requirement to submit a PDO.

x The Ministry must be notified and approve any significant


deviation or alteration of the plan.

PDO Contents

The contents of a PDO will typically include:

x Appraisal history and development studies


x Production geology
x Reservoir technology
x Production and drilling technology
x Installation and facilities
x Operations and maintenance
x Economic analysis
x Safety and environment
x Project organisation and execution
x Removal of installations
x Future development and area planning.

146
Petroleum Fiscal Systems and Contracts

The content required in these sections and how they will be


evaluated for PDO approval are described below.

The Production Geology section of the PDO will address:

x Structural geology
x Stratigraphy and sedimentology
x Petrophysics
x Resource volume estimates.

Geoscientists evaluating the PDO will review the work done by the
operator and make some in-house evaluations and interpretation.
They will determine if the data quality and reservoir interpretation
are sufficiently mature for a development decision and whether
they agree with the conclusions in the PDO.

The Reservoir Technology section of the PDO will consider basic


reservoir data, the development scenario and production strategy.
It will address:

x Reservoir estimates
x Production profiles
x Estimate uncertainties
x Additional resources and future IOR measures
x Reservoir management.

Evaluation of the PDO reservoir technology plans will review the


work done by the operator, evaluating results from reservoir
simulations, discussing uncertainties and sensitivities with the
operator and making some in-house evaluations and
interpretations. The reservoir model may be adjusted or a new
model built.

147
Petroleum Fiscal Systems and Contracts

Evaluation will seek to ensure there is good reservoir


management through:

x Selection of a optimal production strategy with maximum


recovery
x A gas solution for oil fields
x Possibilities for acceptable recovery of marginal oil resources
in gas fields
x IOR measures are included in plans
x A reliable production profile
x Correlation between the reservoir model, production strategy
and production facilities.

The Production and Drilling Technology section of the PDO will


include:

x Drilling aspects
x Production chemistry aspects
x Well completion aspects.

The Installations and Facilities section of the PDO will include:

x Criteria for concept selection


x Production facilities
- Platform structures
- Topside arrangements
- Subsea facilities
- Process and auxiliary facilities
- Metering systems
- Storage and transport systems.
x Reliability or equipment “up-time”
x Constraints and possibilities for tie in of other fields
x Capital cost estimate.

Evaluation of the PDO technology and facilities plans will review


the basis for concept selection, evaluating the process leading up

148
Petroleum Fiscal Systems and Contracts

to concept selection, discussing issues of concern with the


operator and making in-house evaluations.

The purpose of the evaluation is to ensure:

x The selected concept enables good reservoir management


x Area considerations are sufficiently reflected in the concept
x Reliable estimates of schedule and of Capex and Opex costs
x Metering systems in accordance with regulations
x Use of best available techniques for environmental impact.

The Operation and Maintenance section of the PDO will address:

x Operating principles
x Organisation and manning
x Operating costs.

The Economic Analysis section of the PDO will contain:

x General economic assumptions and evaluation method


- Oil and gas price assumptions
- Currency development
- Tariffs – income and expenses
- Net Present Value (NPV) and Internal Rate of
Return (IRR)
x Results
- Pre-tax
- After tax
x Economic uncertainty evaluations for
- High/low oil and gas recovery
- Higher/lower Capex and Opex costs
- Delayed production start-up.

149
Petroleum Fiscal Systems and Contracts

The Safety and Environment section of the PDO will include:

x Safety considerations for the requirements of the Petroleum


Safety Authorities (PSA)
- Safety management
- Concept safety
- Working environment
- Emergency preparedness
x Environmental considerations for the requirements of the State
Pollution Control Agency
- Permits for emissions and discharges.

The Project Organisation and Execution section of the PDO will


include:

x Development phases
x Milestones
x Project organisation
x Manning
x Quality management.

150
Petroleum Fiscal Systems and Contracts

IMPACT ASSESSMENT

The Impact Assessment (IA) submitted with a PDO will present a


detailed assessment of the development’s impact over its full life
cycle on the environment, considering possible risks of pollution
and other activities that may be affected.

The purpose is to ensure that these effects are taken into account
when planning for the development. It will form a basis for the
authorities’ decision on approval of the PDO and any conditions
that may be attached to the approval. The evaluation process is
open to the public and interested parties have a right to comment.

Exemption from the impact assessment requirement may be


granted on application to the Ministry. This can be applicable for:

x Small developments
- <4,000 bbl oil/day or 500,000 m3 gas/day
- With no significant impacts on the environment or other
industries
x Where the impact assessment duty may already be fulfilled.

151
Petroleum Fiscal Systems and Contracts

PDO PROCESS BY THE AUTHORITIES

The Impact Assessment (when required) will be received by the


Ministry 2 to 3 months before submission of the PDO. The IA will
be subject to a consultation process with all relevant authorities,
institutions and groups.

The process for the PDO (or PIO) is:

x Submission received by the Ministry


x Consultation with the Petroleum Directorate, Ministry of
Labour and Social Administration, Petroleum Safety Authority
x White paper drafted by the Ministry in consultation with other
relevant ministries
x Proposition submitted for approval
- Approval by the Parliament if investments >1,5
billion USD, or
- Approval by the King in Council.

The roles of the Ministry of Petroleum and Energy are to:

x Receive the IA and PDO for review


x Co-ordinate evaluation of IA review with
- Other ministries
- Affected industries
- Interested organisations and groups.
x Co-ordinate evaluation of the PDO from
- The Petroleum Directorate
- Other ministries
x Consider the wider effect on society through
- socio-economic evaluations
- effects on employment
- impact on the activity level in offshore and onshore
industry
x Draft Royal Decree or Proposition to the Parliament

152
Petroleum Fiscal Systems and Contracts

The roles of the NPD are to:

x Ensure that the plans are consistent and that conclusions are
thoroughly evaluated and documented
x Ensure that all important aspects of the development are
included in the plan, in accordance with acts and regulations
x Focus on areas where there is a difference between what is
optimal for the society and what is optimal for the licensees so
as to
- Ensure an acceptable gas-solution for oil fields
- Ensure good oil recovery for gas fields
- Co-ordinate between other fields in the same area
- Utilise existing infrastructure
- Prepare for third party access
x Make recommendations and provide the best possible basis
for decision for the Ministry, Parliament and Government
x Document the NPD evaluations in a PDO evaluation report
x Present conclusions to the Ministry.

Exemption from the PDO requirement may be granted on


application for exemption to the Ministry. This may be applicable
for small deposits that:

x Are close to a deposit with an approved PDO


x Can be drilled and produced from facilities comprised by a
PDO
x Where co-ordination or unitisation agreements are in place
x Modifications should not result in increased risk to people,
environment, property or financial interests
x A satisfactory solution for gas marketing is in place

153
Petroleum Fiscal Systems and Contracts

NPD INTERACTION IN THE IMPLEMENTATION PHASE

The NPD will continue interaction with the licensed operator after
approval of the PDO in order to:

x Follow up conditions in the PDO approval


x Ensure that safety and the working environment are in line
with regulations
x Report discrepancies to the Ministry
x Obtain information through
- Licensee meetings
- Ad hoc meetings on project status.

Production Phase

During the production phase, the operator will be subject to


control by the authorities through:

x Approval of the production schedule by the Ministry


x Production permits for periods up to field lifetime
x Prohibition of burning of petroleum in excess of the quantities
needed for normal operational safety, unless approved by the
Ministry
x Production forecasts including expenses to be reported yearly
so that the NPD can make aggregated forecasts for use in
national planning.

Upon application from the licensee, the Ministry will stipulate, for
fixed periods of time, the quantities that may be produced,
injected or cold vented at all times. The approved quantities will
be based on the production schedule in the PDO, unless new
information on the deposit or other circumstances lead to
changes.

154
Petroleum Fiscal Systems and Contracts

9 GEOPOTENTIAL OF THE GLOBAL EXPLORATION


MARKET

The exploration potential for oil and gas varies for regions across
the world, both in overall size and the degree to which recoverable
oil remains to be discovered and produced. Table 9-1 shows a
comparison of regional geopotential.

Compared to other regions, the USA is a highly mature region for


oil exploration and development. There are, however, areas such
as Offshore East Coast, Florida and California and much of the
Alaska Arctic that remain little explored. Offshore Europe is now
also becoming very mature.

Much of the remaining world geopotential lies in the ‘international


sector’ outside Europe or North America. Field size distributions in
the rest of the world are far greater than what is available in
Europe or North America. Licenses are also larger with an
average block size of around 500,000 acres whilst frontier blocks
may be 3 to 4 million acres or more. The average discovery size
worldwide in recent years has been around 100 MMboe. Test
rates per well in the various international discoveries worldwide
average around 4,000 to 5,000 bopd for oil discoveries and 20 to
30 MMcfd for gas discoveries.

Exploration and development in the international sector may incur


greater costs than for domestic operations but the cost per barrel
achievable with economies of scale for larger discoveries can be
attractive.

Oil companies operating in the international sector face different


political and commercial risks where diverse cultural and social
differences affect business activities. International oil companies,
particularly those that are US based companies can experience
general hostility which may be increased through cultural,
economic, and religious factors.

155
Petroleum Fiscal Systems and Contracts

Original 1992 Billion


Region
% % bbl
Canada 1 6
Europe 2 1 14
Asia 6 4 44
Africa 7 6 61
United States 11 3 26
Latin America 11 12 120
Russia 12 6 57
Middle East 50 67 660

Table 9.1 Recoverable conventional oil by region

156
Petroleum Fiscal Systems and Contracts

Province/Block Acres km2


Gulf of Mexico 5,000 20
Qatar RDPSA 24,700 100
United Kingdom 57,600 233
New Zealand (PEP 38719 – Swift 1996) 87,840 356
Norway 102,400 415
Venezuela Lasmo Dacion EOR 106,000 429
Equatorial Guinea – grid blocks 125,000 506
Dutch North Sea 134,000 543
Sao Tome e Principe/Nigeria JDZ (average) 230,000 931
Venezuela – Gulf of Paria West 281,000 1,138
Trinidad Block 27 291,000 1,178
Trinidad Block 89/3 Offshore 311,000 1,259
Oman Conquest 343,300 1,390
MTJDA 370,500 1,500
Venezuela – La Ceiba 430,000 1,741
Turkmenistan Negit-Dag 5 444,600 1,800
Ecuador Block 19 (and others) 494,000 2,000
Bulgaria 500,000 2,024
China Bohai Bay Block 9/18 578,000 2,340
Vietnam Block 04-2 640,000 2,591
Belize 650,000 2,631
Gabon Offshore 700,000 2,834
Nigeria OPL 214 Deepwater 748,000 3,028
Angola Block 17 834,366 3,378
Cambodia 860,000 3,482
China Bohai Bay Block 11/19 934,000 3,781
Chile Onshore 1,235,000 5,000
Angola Block 32 1,405,000 5,688
Uganda 1,450,000 5,870
Cambodia 1,850,000 7,490
Uganda 2,200,000 8,907
Bangladesh Average Onshore 2,220,000 8,989

157
Petroleum Fiscal Systems and Contracts

Province/Block Acres km2


Greenland Shell 1996 2,340,000 9,474
Malaysia Block F Offshore 2,400,000 9,717
Bangladesh Block 21 Offshore 3,076,000 12,453
Myanmar Blocks M5 and M6 (average) 3,230,000 13,077
Pakistan – Badin Block 1977 4,416,000 17,878
Egypt Block G Central Sinai 4,500,000 18,218
Saudi Area A (Lukoil) 2004 7,400,000 29,960
New Zealand (PEP 38602 - Conoco) 12,000,000 48,583
Saudi Area C (Eni-Repsol) 2004 12,800,000 51,822
Indonesia North West Java (NWJ) 1966 14,000,000 56,680
Indonesia South East Sumatra (SES) 1966 32,000,000 129,550

Table 9.2 Examples of block sizes worldwide


(Ref. 2, 7, 8, 9)

158
Petroleum Fiscal Systems and Contracts

10 DIFFERENT TYPES OF PETROLEUM FISCAL


SYSTEMS

International oil and gas companies seeking to explore for and


develop the hydrocarbon resources are welcomed by most
governments in the world. Development and production activities
are seen to provide direct foreign investment, creating new jobs,
and infrastructure. The government gains new revenue and its
citizens benefit. Governments, therefore, try to encourage
exploration and development activity through their license rounds
and fiscal terms.

From the oil companies’ perspective, exploration and


development is costly and entails high risks. Substantial capital
has to be invested to obtain leases and conduct exploratory work
before reserves are found and there is any likelihood of a return. It
is possible that no worthwhile discovery of hydrocarbons will be
made. If reserves are found, they may turn out in development to
be less than expected or decline faster than geological conditions
suggest. There are also risks that the development project may
not be completed on time and within budget. Commercial risks
arise from oil price movements, currency exchange rates and
inflation. There is also the possibility that the government may try
to renegotiate the terms of the contract at a later date.

A successful petroleum fiscal system balances the interests of the


government and the oil companies. The government seeks to
maximise the wealth from its natural resources and obtain a fair
return to the state. For the oil company, an exploration and
development project must satisfy its economic criteria in terms of
profit, and also possibly in terms of knowledge gained or strategic
opportunity.

The influence of private and market uncertainty on the economics


associated with a field under a Production Sharing Agreement
(PSA) may be analysed. The effects on measures such as net
present value, rate of return, or take that follow from changes in
one or more variables may be represented in tables or graphically

159
Petroleum Fiscal Systems and Contracts

for high and low case scenarios. This method is limited in its
usefulness. A comparative analytic framework is preferable.

The differences between the countries’ fiscal regimes are


illustrated through an analytical frame work in this chapter. A
modelling approach is used to derive relationships that specify
how the present value, rate of return, and take values vary as a
function of the system parameters.

160
Petroleum Fiscal Systems and Contracts

FISCAL REGIMES BY COUNTRY

The petroleum fiscal systems of countries are described in


Chapter 1.

The contractor percentages, exploration and development costs,


government takes and participation are summarised below for the
following selected systems (Ref. 2,3,4,5,6,7,8,9,10,11,12,13)

Albania Morocco
Algeria Myanmar
Angola New Zealand
Argentina Nigeria
Bangladesh Norway
Bolivia Pakistan
Brunei Papua New Guinea
Cameroon Philippines
China South Korea
Colombia Spain
Congo Syria
Egypt Thailand
Equatorial Guinea Timor
France Tunisia
Gabon Turkmenistan
Ghana United Arab Emirates (Abu
India Dhabi)
Indonesia United Kingdom
Ireland Uzbekistan
Ivory Coast Vietnam
Malaysia Yemen
Malta

161
Petroleum Fiscal Systems and Contracts

Examples in the form of flow diagrams are shown in Figures 10.1


to 10.10 below of fiscal regimes found in the following
jurisdictions:

x Azerbaijan
x Dubai
x Egypt
x Iraq
x Ireland
x Libya
x Malta
x Morocco
x Norway
x Russia.

162
Petroleum Fiscal Systems and Contracts

ALBANIA
Circa 1991

Area No restriction, designated blocks

Duration
Exploration 2 + 3 + 1.5 Years with discovery
Production 4-year development period + 20 years

Relinquishment 25% or 100% of no discovery

Exploration Obligations Seismic work programs offshore


Start within 3 months

Royalty Nil

Signature Bonus Nil

Production Bonus 25,000 bopd: $1.0 million


50,000 bopd: $1.0 million

Cost Recovery 45% limit

Depreciation 20%/year for 5 years

Profit Oil Split


(In favour of government) Approximately 60%/40%

Profit Gas Split Negotiable

Taxation 50% income tax

Domestic Market Obligation Nil

State Participation Nil

163
Petroleum Fiscal Systems and Contracts

ALBANIA possible example

Area No restriction, designated blocks

Duration
Exploration 3 + 3 Years with discovery
Production 5-year development period + 20 years
extended additional 5 years

Relinquishment 50% or 100% of no discovery

Exploration Obligations Seismic work programs offshore


Start within 8-12 months

Royalty Nil

Signature Bonus Nil

Production Bonus 25,000 bopd: $3.0 million


50,000 bopd: $3.0 million

Cost Recovery 45% limit to 100%

Depreciation 25%/year for 4 years

Profit Oil Split


(In favour of government) Approximately 55%/45%

Profit Gas Split Negotiable

Taxation 45-50% income tax

Domestic Market Obligation Yes

State Participation 0-25%

164
Petroleum Fiscal Systems and Contracts

ALGERIA
Royalty/Tax (Law No 86-14 of Aug 19, 1986)
Partnership Contracts & PSCs (Law No. 91-21 of Dec 4, 1991)

Area

Duration
Exploration 4 Years + 2-year extension
Production 12 Years from date of exploration permit

Relinquishment

Exploration Obligations

Royalty Zone N 20%


Area A 16.25%
Area B 12.25%
Under certain conditions the 20% royalty may be reduced in Areas A &
B.

Bonuses None for exploration permits


Negotiated for existing fields

Depreciation G&G Costs and dry holes 100%


Producing Wells 25%/year
Buildings & Facilities 20%/year
Pipelines 10%/year

Taxation (Income Tax) Zone N 85%*


Area A 75%*
Area B 65%*
Under certain conditions the 85% tax rate may be reduced in Areas A &
B.
The 1980 Amoco contract had 55% tax rate.
* Only valid with partnership contracts

Ring fencing

Domestic Market Obligation For gas, negotiated formula depends


on size of discovery

State Participation 51% at discovery to Sonatrach (NOC)


Carry through exploration + two
extension wells.

165
Petroleum Fiscal Systems and Contracts

ALGERIA possible example

Area

Duration
Exploration 4 Years + 3-year extension
Production 20-25 Years from date of exploration
permit

Relinquishment

Exploration Obligations Yes

Royalty Zone N 25%


Area A 18%
Area B 15%
Area C 12%
Area D 10%

Bonuses None for exploration permits


Negotiated for existing fields

Depreciation G&G Costs and dry holes 100%


Producing Wells 20-30%/year
Buildings & Facilities 30%/year
Pipelines 30%/year

Taxation (Income Tax) Zone N 85%*


Area A 75%*
Area B 65%*
Area C 55%
Area D 45%

Under certain conditions the 85% tax rate may be reduced in Areas A, B
and C.

Ring fencing Yes

Domestic Market Obligation For gas, negotiated formula depends


on the size of discovery

State Participation 51% at discovery to Sonatrach (NOC)


Carry through exploration + two/six
extension wells.

166
Petroleum Fiscal Systems and Contracts

ANGOLA
1989 Model PSC

Area Designated blocks

Duration
Exploration 5 Years (3 + 2 one-year extensions)
Production 20 Years

Relinquishment

Exploration Obligations

Royalty Nil

Signature Bonus Yes, & production & education bonuses

Cost Recovery 50% limit


Old contracts had 61% uplift for
development costs recovered over 6
years.

Depreciation 5-year straight line

Profit Oil Split Cumulative Split% Cumulative Split%


(Two examples) Production Govt/ Production Govt/
MMbbl Company MMbbl Company
Up to 25 60/40 Up to 25 45/55
25-50 70/30 25-75 70/30
50-100 80/20 75/175 80/20
Over 100 90/10 Over 175 90/10
on field by field basis

Taxation 50% income tax

Ring fencing Each license separate usually

Domestic Market Obligation Nil

Investment Uplift 40% of tangible capital costs

167
Petroleum Fiscal Systems and Contracts

Other Old contracts had $20/bbl (1987 price


cap).
Govt took excess above price cap
escalated by U.N. factor for
manufactured goods exports from
developed nations. 1992 price cap =
$35/bbl

State Participation Yes, back-in option for development


up to 51%-less in deepwater

168
Petroleum Fiscal Systems and Contracts

ANGOLA possible example

Area Designated blocks

Duration
Exploration 6 Years (4 + 2 one-year extensions)
Production 25 Years and 5 years extension

Relinquishment

Exploration Obligations Yes

Royalty Nil

Signature Bonus Negotiable for existing fields

Cost Recovery 60% limit recovered over 5 years

Depreciation 5-year straight line

Profit Oil Split Negotiable

Taxation 45-50% income tax

Ring fencing Nil

Domestic Market Obligation Nil

Investment Uplift 25% exploration costs and 33% of


development costs

169
Petroleum Fiscal Systems and Contracts

ARGENTINA
Royalty/Tax (1990)

Area Designated blocks

Duration
Exploration 3 Years with two 2-year extensions
Delineation 1 following discovery
Production 20 Years

Relinquishment

Exploration Obligations

Royalty 12%
5% marginal fields

Bonuses

Depreciation

Taxation (Profit Tax) 30%


1% sales tax
1% assets tax

Ring fencing

Domestic Market Obligation Yes

State Participation 15%-50% government option (old


contracts)

170
Petroleum Fiscal Systems and Contracts

ARGENTINA possible example

Area Designated blocks

Duration
Exploration 4 Years with two 2-year extensions
Delineation 1 following discovery
Production 20 Years and possible extension for 5
years

Relinquishment

Exploration Obligations Yes

Royalty 16%
7% marginal fields

Bonuses Negotiable for existing fields

Depreciation Dry holes 100%


Development costs 30%

Taxation (Profit Tax) 35%

Ring fencing Yes

Domestic Market Obligation Yes

State Participation 50%

171
Petroleum Fiscal Systems and Contracts

AZERBAIJAN

Area

Duration
Exploration 4 Years with two 2-year extensions
Production 25 Years

Relinquishment Yes

R Factor Negotiable

Exploration Obligations Yes

Royalty 10%
8% marginal fields

Bonuses Nil

Depreciation 60% of CAPEX and 100% OPEX

Taxation (Profit Tax) 25%

Ring fencing Yes

Domestic Market Obligation Nil

State Participation 33%

172
Petroleum Fiscal Systems and Contracts

AZERBAJAN possible example

Area

Duration
Exploration 3 Years with two 2-year extensions
Production 20 Years and 5 Years of extension

Relinquishment Yes

R Factor Negotiable

Exploration Obligations Yes

Royalty 12%
8% marginal fields

Bonuses None for exploration permits


Negotiated for existing fields

Depreciation 60% of CAPEX and 100% OPEX

Taxation (Profit Tax) 35%

Ring fencing Yes

Domestic Market Obligation Nil

State Participation 38%

173
Petroleum Fiscal Systems and Contracts

Azerbaijan Production Sharing Agreement Summary

Production

Cost Recovery

Remainder Cost Recovery

Profit Profit
Government Contractor

Figure 10.1 Azerbaijani fiscal regime


(Ref. 7)

174
Petroleum Fiscal Systems and Contracts

BANGLADESH
(1989)
Area Designated blocks

Duration
Exploration 4 Years + two 2-year extensions
Production 15 Years from date of 1st sale

Relinquishment After: 4 years 25%


6 years 50%
8 years 100% with no
discovery

Exploration Obligations 1 Well minimum

Royalty Nil

Signature Bonus No

Production Bonus 5,000 bopd: U.S.$ 0.5


million
10,000 bopd: 1.0 million
15,000 bopd: 1.5 million
20,000 bopd: 2.0 million

Cost Recovery Sliding Scale, bopd


Up to 5,000 40% Limit
5,001-10,000 35%
10,001 + 30%

Depreciation 10% year straight line

Profit Oil Split Production, bopd Split, %


(in favour of government) Up to 5,000 70/30
5,001-10,000 75/25
10,001.25,000 80/20
25,001-50,000 85/15
50,001 + 90/10

Profit Gas Split Negotiated

Taxation Nil, profit split is effectively


after-tax split

175
Petroleum Fiscal Systems and Contracts

Domestic Market Obligation Pro rata up to 25% at market price

State Participation Nil

176
Petroleum Fiscal Systems and Contracts

BANGLADESH possible example


Area Designated blocks

Duration
Exploration 3 Years + three 2-year extensions
Production 20 Years from date of 1st sale and 5
years extension

Relinquishment After: 2 years 25%


4 years 50%
6 years 100% with no
discovery

Exploration Obligations Negotiable

Royalty Nil

Signature Bonus Nil

Production Bonus 4,000 bopd: U.S.$ 0.5 million


8,000 bopd: 1.0 million
12,000 bopd: 1.5 million
16,000 bopd: 2.0 million

Cost Recovery Sliding Scale, bopd


Up to 5,000 33% Limit
5,001-10,000 30%
10,001 + 25%

Depreciation 10% year straight line

Profit Oil Split Production, bopd Split, %


(in favour of government) Up to 5,000 65/35
5,001-10,000 70/30
10,001.25,000 75/25
25,001-50,000 85/15
50,001 + 90/10

Profit Gas Split Negotiated

Taxation Nil, profit split is effectively


after-tax split

177
Petroleum Fiscal Systems and Contracts

Domestic Market Obligation Pro rata up to 25% at market price

State Participation Nil to 10%

178
Petroleum Fiscal Systems and Contracts

BOLIVIA
Operation, Association, and Service Contracts

Area Not to exceed 1 MM hectares in


traditional areas
Not to exceed 1.5 MM hectares in non-
traditional areas

Duration Maximum Term 30 years


Exploration 4 Years + 2 if gas is discovered
Production 24-26 Years depending on extension

Relinquishment Exploitation area following exploration


phase may not exceed 3 lots (60,000
hectares)

Exploration Obligations

Bonuses

Depreciation

Royalties 19% national tax based on gross


production
11% departmental participation royalty
1% national compensatory royalty

Taxation 40% net profits tax

Ring fencing

Domestic Market Obligation

State Participation

179
Petroleum Fiscal Systems and Contracts

BOLIVIA possible example


Operation, Association, and Service Contracts

Area Not to exceed 1 MM hectares in


traditional areas
Not to exceed 1.5 MM hectares in non-
traditional areas

Duration Maximum Term 30 years


Exploration 4 Years + 2 if gas is discovered
Production 24-26 Years depending on extension

Relinquishment Exploitation area following exploration


phase may not exceed 3 lots (60,000
hectares)

Exploration Obligations Negotiable

Bonuses Nil

Depreciation 100% exploration and 50% CAPEX

Royalties 15% national tax based on gross


production
11% departmental participation royalty
1% national compensatory royalty

Taxation 35% net profits tax

Ring fencing Yes

Domestic Market Obligation Yes

State Participation 25%

180
Petroleum Fiscal Systems and Contracts

BRUNEI
Royalty/Tax
From PetroAsian Business Report, March 1994

Area No limitations

Duration
Exploration 8 Years onshore, 17 offshore
Production Total of 38 years onshore, 40 offshore
30 year extensions may be available

Relinquishment 75% after exploration period


if discovery is made

Exploration Obligations B$4,000/km2 seismic or


B$12 million, whichever is greater,
in the first 4 years,
in the next 4 years at least B$8,000/km2

Royalty 12.5% onshore


10% for fields 3-10 nautical miles
offshore
8% for fields more than 10 miles offshore

Bonuses May be required-negotiable

Rentals B$15/km2 during the first 4 years


B$45/km2 thereafter

Cost Recovery Limit None

Depreciation

Taxation 55% petroleum income tax

Ring fencing

Domestic Market Obligation

State Participation State has option to take up to 50%

Other

181
Petroleum Fiscal Systems and Contracts

BRUNEI possible example

Area

Duration
Exploration 8 Years onshore, 17 offshore
Production Total of 38 years onshore, 40 offshore
30 year extensions may be available

Relinquishment 100% after exploration period


if discovery is made

Exploration Obligations Negotiable

Royalty 13% onshore


8% for fields 3-10 nautical miles offshore
6% for fields more than 10 miles offshore

Bonuses Negotiable

Rentals B$15/km2 during the first 5 years


B$45/km2 thereafter

Cost Recovery Limit None

Depreciation 100% exploration and 50% CAPEX

Taxation 60% petroleum income tax

Ring fencing Yes

Domestic Market Obligation No

State Participation 50%

182
Petroleum Fiscal Systems and Contracts

CAMEROON
(1990)

Area Designated blocks

Duration
Exploration 4 Years + three 4-year renewals
Production 25 Years

Relinquishment

Exploration Obligations

Royalty Sliding Scale:


Up to 50,000 tons/yr (1,000 bopd) 2%
50,001-400,000 tons/yr (7,700 bopd) 6%
400,001-700,000 tons/yr (13,400 bopd) 9%
700,001-1,000,000 tons/yr (19,000 bopd) 11%
Over 1,000,000 tons/yr 12.5%
Gas less than 300 billion m3/yr (29 MMcfd) 1%
more than 300 billion m3/yr 5%

Signature Bonus

Depreciation

Profit Oil Split Cumulative Production Split %


(in favour of Up to 15 MM tons (100 MMbbl) 60/40
government) 15-30 MM tons (200 MMbbl) 65/35
Over 30 MM tons (200+ MMbbl) 70/30

Taxation Sliding Scale, bopd


Up to 100,000 55%
100,001-200,000 65%
200,001 + 85%

Taxation 57.5% for petroleum companies

Ring fencing

Domestic Market Obligation

State Participation 50% state reimburses contractor


for exploration costs

183
Petroleum Fiscal Systems and Contracts

CAMEROON possible example

Area Designated blocks

Duration
Exploration 4 Years + three 4-year renewals
Production 25 Years and 5 Years extension

Relinquishment 100% after discovery

Exploration Obligations

Royalty Sliding Scale:


Up to 50,000 tons/yr (1,000 bopd) 3%
50,001-400,000 tons/yr (7,700 bopd) 8%
400,001-700,000 tons/yr (13,400 bopd) 9.5%
700,001-1,000,000 tons/yr (19,000 bopd) 12%
Over 1,000,000 tons/yr 12.5%

Gas less than 300 billion m3/yr (29 MMcfd) 1.5%


more than 300 billion m3/yr 6%

Signature Bonus Nil

Depreciation 100% of dry holes and 30% CAPEX

Profit Oil Split Cumulative Production Split %


(in favour of Up to 15 MM tons (100 MMbbl) 55/45
government) 15-30 MM tons (200 MMbbl) 60/40
Over 30 MM tons (200+ MMbbl) 70/30

Taxation Sliding Scale, bopd


Up to 100.000 52%
100.001-200.000 62%
200.001 + 80%

Taxation 60%

Ring fencing

Domestic Market Obligation

State Participation 40%

184
Petroleum Fiscal Systems and Contracts

CHINA Offshore PSC


From PetroMin Magazine, Dec. 1993

Area ?

Duration 30 Years
Exploration 7 Years
Production 15 Years + extensions with approval

Relinquishment ?

Exploration Obligations ?

Royalty
Oil, bopd Gas, MMcfd
Up to 20,000 0% Up to 195 0%
20,001-30,000 4% 195-338 1%
30,001-40,000 6% 338-484 2%
40,001-60,000 8% 484 + 3%
60,001-80,000 10%
80,001 + 12.5%
(bopd converted from tons/year at 7:1)
(MMcfd converted from MM m3/year at 35.3:1)

Pseudo-royalty 5% consolidated industrial and


Based on Gross Revenues commercial tax

Profit Oil Split (Negotiable) Example Split, %


Production Rate, bopd Govt/Contractor
Up to 10,000 10/90*
10,000-20,000 20/80
20,000-40,000 30/70
40,000-60,000 40/60
60,000-100,000 50/50
Over 100,000 60/40
* Some contracts start at 95% and slide to 45%.

Bonuses ?

Cost Recovery Limit 50%-62.5%


With 9% interest cost recovery on development costs

Depreciation 6-year SLD

185
Petroleum Fiscal Systems and Contracts

Taxation 30% income tax, (15% in Hainan


Province)
3% local income tax
10% surtax
Contractors must also pay vehicle and vessel usage, license tax and
individual income tax.

Ring fencing Yes, for cost recovery but not for


income tax purposes

Domestic Market Obligation No

State Participation Up to 51% upon commercial production

186
Petroleum Fiscal Systems and Contracts

CHINA Offshore PSC possible example

Area ?

Duration 30 Years
Exploration 7 Years
Production 15 Years + extensions with approval

Relinquishment ?

Exploration Obligations Negotiable

Royalty
Oil, bopd Gas, MMcfd
Up to 20,000 0% Up to 195 0%
20,001-30,000 4% 195-338 1.5%
30,001-40,000 6% 338-484 2.5%
40,001-60,000 8% 484 + 4%
60,001-80,000 10%
80,001 + 12.5%
(bopd converted from tons/year at 7:1)
(MMcfd converted from MM m3/year at 35.3:1)

Pseudo-royalty 5% consolidated industrial and


Based on Gross Revenues commercial tax

Profit Oil Split (Negotiable) Example Split, %


Production Rate, bopd Govt/Contractor
Up to 10,000 10/90*
10,000-20,000 20/80
20,000-40,000 30/70
40,000-60,000 40/60
60,000-100,000 50/50
Over 100,000 60/40
* Some contracts start at 95% and slide to 55%.

Bonuses ?

Cost Recovery Limit 50%-60%


With 9% interest cost recovery on development costs

Depreciation 6-year SLD

Taxation 30% income tax, (15% in Hainan

187
Petroleum Fiscal Systems and Contracts

Province)
3% local income tax
10% surtax
Contractors must also pay vehicle and vessel usage, license tax and
individual income tax.

Ring fencing Yes, for cost recovery but not for


income tax purposes

Domestic Market Obligation No

State Participation Up to 50%

188
Petroleum Fiscal Systems and Contracts

CHINA Onshore PSC


From PetroMin Magazine, Dec. 1993

Area ?

Duration 30 Years maximum


Exploration 8 Years (3 + 2 + 3)
Production 15 Years + extensions with approval

Relinquishment ?

Exploration Obligations ?

Bonuses ?

Royalty
Oil, bopd Gas, MMcfd
Up to 1,000 0% Up to 10 0%
1,001-2,000 1% 10-20 1%
2,001-3,000 2% 20-30 2%
3,001-4,000 3% 30-40 3%
4,001-6,000 4% 40-60 4%
6,001-10,000 6% 60-100 6%
10,001-15,000 8% 100-150 8%
15,001-20,000 10% 150-200 10%
20,001 + 12.5% 200 + 12.5%
(bopd converted from tons/year at 7:1)
3
(MMcfd converted from MM m /year at 35.3:1)

Pseudo royalty 5% CIC Tax based in gross revenues


Based on Gross Revenues Commercial Tax

Profit Oil Split (Negotiable) Example Split, %


Production Rate, bopd Govt/Contractor
Up to 10,000 10/90
10,000-20,000 20/80
20,000-40,000 30/70
40,000-60,000 40/60
60,000-100,000 50/50
Over 100,000 60/40

Cost Recovery 60% onshore


With 9% interest cost recovery on development costs

189
Petroleum Fiscal Systems and Contracts

Depreciation 6-year SLD

Taxation 30% income tax, (15% in Hainan


Province)
3% local income tax
10% surtax
Contractors must also pay vehicle and vessel usage, license tax and
individual income tax.

Ring fencing Yes

Domestic Market Obligation No

State Participation Up to 51% upon commercial production

190
Petroleum Fiscal Systems and Contracts

CHINA Onshore PSC possible example

Area ?

Duration 30 Years maximum


Exploration 8 Years (3 + 2 + 3)
Production 15 Years + extensions with approval

Relinquishment ?

Exploration Obligations ?

Bonuses ?

Royalty
Oil, bopd Gas, MMcfd
Up to 1,000 0% Up to 10 0%
1,001-2,000 1% 10-20 1.5%
2,001-3,000 2% 20-30 2.5%
3,001-4,000 3% 30-40 4%
4,001-6,000 4% 40-60 5%
6,001-10,000 6% 60-100 7%
10,001-15,000 8% 100-150 9%
15,001-20,000 10% 150-200 11%
20,001 + 12.5% 200 + 12.5%
(bopd converted from tons/year at 7:1)
3
(MMcfd converted from MM m /year at 35.3:1)

Pseudo royalty 5% CIC Tax based in gross revenues


Based on Gross Revenues Commercial Tax

Profit Oil Split (Negotiable) Example Split, %


Production Rate, bopd Govt/Contractor
Up to 10,000 10/90
10,000-20,000 20/80
20,000-40,000 30/70
40,000-60,000 40/60
60,000-100,000 50/50
Over 100,000 60/40

Cost Recovery 60% onshore


With 9% interest cost recovery on development costs

Depreciation 6-year SLD

191
Petroleum Fiscal Systems and Contracts

Taxation 30% income tax, (15% in Hainan


Province)
3% local income tax
10% surtax
Contractors must also pay vehicle and vessel usage, license tax and
individual income tax.

Ring fencing Yes

Domestic Market Obligation No

State Participation 50%

192
Petroleum Fiscal Systems and Contracts

COLOMBIA
Mid 1980s Association Contract, pre-1994

Area Various blocks

Duration 28 Years including exploration period


Up to 10 years for exploration

Relinquishment 50% at end of year 6


25% more at the end of year 8
Remainder is dropped at end of year 10 except commercial field and 5
km band.

Exploration Obligations Yes, negotiated

Royalty 20%
1990 War Tax 600-900 pesos/bbl fluctuating but based
on $1.00/bbl for 1st 6 years of production

Bonuses

Cost Recovery 100% No limit


The term “cost recovery“ is not used, but contractor collects all of gross
revenues except royalty (i.e. 80%) until payout.

Depreciation

Taxation 30% income tax


25% surcharge from 1993-97
effective rate 44%
(expected reduction to 36%)
Remittance Tax 12%-15%

Ring fencing No

Domestic Market Obligation Receives FMV 75% in U.S. $

193
Petroleum Fiscal Systems and Contracts

State Participation 50% carried interest


At back-in Ecopetrol reimburses 50% of
cost of successful wells
The government percentage of production increases with cumulative
production above 60 MMbbl.
Contractor
Cumulative Share of
Production, MMbbl Production, %
0-60 50
60-90 45
90-120 40
120-150 35
Over 150 30

194
Petroleum Fiscal Systems and Contracts

COLOMBIA possible example

Area Various blocks

Duration 30 Years including exploration period


Up to 8 years for exploration

Relinquishment 50% at end of year 6


25% more at the end of year 8
Remainder is dropped at end of year 8 except commercial field and 5 km
band.

Exploration Obligations Yes, negotiated

Royalty 20%
Tax

Bonuses Negotiable

Cost Recovery 100% No limit


The term “cost recovery“ is not used, but contractor collects all of gross
revenues except royalty (i.e. 80%) until payout.

Depreciation

Taxation 30% income tax


25% surcharge from 1993-97
effective rate 44%
(expected reduction to 36%)
Remittance Tax 12%-15%

Ring fencing No

Domestic Market Obligation Yes

195
Petroleum Fiscal Systems and Contracts

State Participation 50% carried interest


At back-in Ecopetrol reimburses 50% of
cost of successful wells
The government percentage of production increases with cumulative
production above 60 MMbbl.
Contractor
Cumulative Share of
Production, MMbbl Production, %
0-60 50
60-90 45
90-120 40
120-150 35
Over 150 30

196
Petroleum Fiscal Systems and Contracts

CONGO
Royalty/Tax (1993)

Area

Duration
Exploration 10 Years
Production 30 Years

Relinquishment

Royalty 14.5%-19% Oil (Negotiated)


9% Gas
The old royalty calculated on 80% of FOB price ranging from 6.5% at
1,000 bopd to 15% for 100,000 bopd. Gas 2%-5%.

Bonuses 250 MM CFA Francs at 30,000 bopd


625 MM CFA Francs at 75,000 bopd
may be capitalised and deducted

Depreciation 5-year straight-line decline

Taxation 55%

Domestic Market Obligation Not to exceed 30% of contractor's oil

Ring fencing Development area one ring fence

State Participation 50% Govt reimburses contractor out of


75% of govt net revenues with interest

197
Petroleum Fiscal Systems and Contracts

CONGO possible example

Area

Duration
Exploration 10 Years
Production 30 Years

Relinquishment

Royalty 20% Oil (Negotiated)


9% Gas
The old royalty calculated on 80% of FOB price ranging from 6.5% at
1,000 bopd to 15% for 100,000 bopd. Gas 2%-5%.

Bonuses Negotiable at 20,000 bopd


Negotiable at 60,000 bopd

Depreciation 5-year straight-line decline

Taxation 55-60%

Domestic Market Obligation Not to exceed 30% of contractor's oil

Ring fencing Development area one ring fence

State Participation 50% Govt reimburses contractor out of


75% of govt net revenues with interest

198
Petroleum Fiscal Systems and Contracts

DUBAI
Concession Agreement (Royalty/Tax System)

Area

Duration
Exploration 3 Years with two 2-year extensions
Production 25 Years

Relinquishment Yes

Exploration Obligations Yes

Royalty 20%
8% marginal fields

Bonuses Nil

Depreciation Drilling, Facilities and OPEX

Taxation (Profit Tax) 84%

Ring fencing Yes

Domestic Market Obligation Nil

State Participation 33%

199
Petroleum Fiscal Systems and Contracts

DUBAI possible example

Area

Duration
Exploration 4 Years with two 2-year extensions
Production 25 Years and 5 Years extension

Relinquishment Yes

Exploration Obligations Yes

Royalty 20%

Bonuses Negotiable for existing field

Depreciation Drilling, Facilities and OPEX

Taxation (Profit Tax) 75%

Ring fencing Yes

Domestic Market Obligation Nil

State Participation 30%

200
Petroleum Fiscal Systems and Contracts

Dubai Concession Agreement Summary

Royalty Gross Revenues Opex

Net Cashflow Depreciation

Income B.T.

Tax Taxable Income

Income A.T.

Figure 10.2 Dubai fiscal regime


(Ref. 7)

201
Petroleum Fiscal Systems and Contracts

EGYPT
Early 1980s
From: Petroleum Company Operations and Agreements in
Developing Countries,
Raymond F. Mikesell, 1984

Area Designated blocks

Duration ?

Relinquishment After each phase 25% of original area


All except development leases after exploratory period

Exploration Obligations Bid item


For each commercial discovery, contractor must drill an additional other
prospect.

Royalty 0% EGPC pays royalties and taxes


out of its share of profit oil

Signature Bonus $1-$5 MM

Production Bonus Yes

Cost Recovery 30% Limit

Depreciation 8-year SLD

Profit Oil Split Production, bopd Split, %


(In favour of government) Up to 90,000 80/20
90,000-140,000 82.5/17.5
140,000 + 85/15

Profit Gas Split Negotiated

Taxation Paid by government,


therefore profit oil split
is effectively an after-tax split

State Participation 50%/50% joint venture

202
Petroleum Fiscal Systems and Contracts

EGYPT
1986 Standard Model

Area Designated blocks

Duration
Exploration 8 Years maximum, 3 phases
After discovery 1-year delineation period
Production 20 Years

Relinquishment After each phase 25% of original area


All except development leases after exploratory period

Exploration Obligations Bid item


For each commercial discovery, contractor must drill an additional other
prospect.

Royalty 0% -10% Negotiated

Signature Bonus $2-$4 MM

Production Bonus $3 MM at 30,000 bopd


$5 MM at 50,000 bopd
$7 MM at 100,000 bopd

Cost Recovery 40% Limit Offshore, 30% Onshore

Depreciation 20%/year exploration & development


costs

Profit Oil Split Proposed in 1986 Split, %


(In favour of government) Production, bopd Newer Older
Up to 20,000 70/30 80/20
20,000-40,000 75/25 83/17
40,000 + 80/20 85/15
Most contracts continue to be based on standard flat 85%/15% split.

Profit Gas Split Negotiated

Taxation Paid by government,


therefore profit oil split
is effectively an after-tax split

State Participation Nil

203
Petroleum Fiscal Systems and Contracts

EGYPT possible example 1

Area Designated blocks

Duration ?

Relinquishment After each phase 25% of original area


All except development leases after exploratory period

Exploration Obligations Bid item


For each commercial discovery, contractor must drill an additional other
prospect.

Royalty 0% EGPC pays royalties and taxes


out of its share of profit oil

Signature Bonus $1-$5 MM

Production Bonus Yes

Cost Recovery 50% Limit

Depreciation 10-year SLD

Profit Oil Split Production, bopd Split, %


(In favour of government) Up to 90,000 80/20
90,000-140,000 82.5/17.5
140,000 + 85/15

Profit Gas Split Negotiated

Taxation Paid by government,


therefore profit oil split
is effectively an after-tax split

State Participation 51%/49% joint venture

204
Petroleum Fiscal Systems and Contracts

EGYPT fiscal possible example 2

Area

Duration
Exploration 3 Years with two 2-year extensions
Production 25 Years

Relinquishment

Exploration Obligations Yes

Royalty 14-22%

Bonuses Nil

Depreciation 50% and 100% OPEX with limit of 40%

Taxation (Profit Tax) 80%

Ring fencing Yes

Domestic Market Obligation Nil

State Participation 0

205
Petroleum Fiscal Systems and Contracts

EGYPT possible example 3

Area

Duration
Exploration 3 Years with two 2-year extensions
Production 25 Years

Relinquishment Yes

Exploration Obligations Yes

Royalty Nil

Bonuses Nil

Depreciation Drilling, Facilities 50% and 100% of


OPEX with limit of 40%

Profit Govt./Contractor 70/30 and 85/15%

Taxation (Profit Tax)

Ring fencing Yes

Domestic Market Obligation Nil

State Participation 0

206
Petroleum Fiscal Systems and Contracts

Egypt Production Sharing Summary

Production

Cost Recovery
Contractor

Remainder

Profit Profit
Government Contractor

Figure 10.3 Egypt fiscal regime


(Ref. 7)

207
Petroleum Fiscal Systems and Contracts

EQUATORIAL GUINEA
PSC ROR Contract
Area 125,000-acre grid blocks

Duration
Exploration 5 Years, 3 1-year/1-well extensions
Production 30 Years from commercial discovery
50 Years for gas

Relinquishment 40% at end of 3rd year


additional 20% before end of 5 th year

Exploration Obligations Drilling

Royalty 10%

Bonuses Signature $1 MM
Discovery $300,000 +
First Oil Sales $1 MM
Production Bonuses $2-$5 MM at 10,000-20,000 bopd ±

Surface Rentals $0.50-$1.00 per hectare ±

Cost Recovery Limit After paying royalty, no limit

Depreciation 25% per year (all costs)

Profit Oil Split (two examples shown here)


”Net Crude Oil“ after royalties and cost recovery

Contractor’s Contractor's
Pretax Contractor Pretax Contractor
Real ROR, % Share, % Real ROR, % Share, %
________________________ ________________________
Up to 30 100 Up to 20 100
30-40 60 20-40 80
40-50 40 40-60 50
over 50 20 over 60 10

Taxation 25% income tax 85%

Ring fencing

208
Petroleum Fiscal Systems and Contracts

Domestic Market Obligation If requested to do so, contractor


sells to government a portion of
net crude oil at market prices.

State Participation

209
Petroleum Fiscal Systems and Contracts

EQUATORIAL GUINEA possible example


Area 125,000-acre grid blocks

Duration
Exploration 5 Years, 3 1-year/3-well extensions
Production 30 Years from commercial discovery
50 Years for gas

Relinquishment 40% at end of 3rd year


additional 20% before end of 5 th year

Exploration Obligations Drilling negotiable

Royalty 10%

Bonuses Signature $1 MM
Discovery $300,000 +
First Oil Sales $1 MM
Production Bonuses $2-$5 MM at 10,000-20,000 bopd ±

Surface Rentals $0.50-$1.00 per hectare ±

Cost Recovery Limit After paying royalty, no limit

Depreciation up 2 year 25% per year (all costs)

Profit Oil Split (two examples shown here)


”Net Crude Oil“ after royalties and cost recovery

Contractor’s Contractor's
Pretax Contractor Pretax Contractor
Real ROR, % Share, % Real ROR, % Share, %
________________________ ________________________
Up to 30 100 Up to 20 100
30-40 60 20-40 80
40-50 40 40-60 50
over 50 20 over 60 10

Taxation 30% income tax 85%

Ring fencing

210
Petroleum Fiscal Systems and Contracts

Domestic Market Obligation If requested to do so, contractor


sells to government a portion of
net crude oil at market prices.

State Participation

211
Petroleum Fiscal Systems and Contracts

FRANCE
Late 1980s

Area Minimum 175 km2


after relinquishment

Duration
Exploration 5 Years +
maximum of two 5-year extensions
Production 5 Years + two 5-year extensions
for fields < 2.1 MMbbl
up to 50 years for large fields

Relinquishment After: 5 years 50%


Extension 12.5% (leaving 37.5%)

Exploration Obligations

Royalty Sliding Scale: Oil, %


Up to 1,000 bopd 0
1,001-2,000 6
2,001-6,000 9
6,001 + 12
Gas Royalty for production over 30 MMcfd = 5%

Signature Bonus

Cost Recovery Concessionary System, 100%

Depreciation

Taxation 50% income tax


Tax deferral/depletion allowance
23.5% of gross or 50% of net income
if spent on further exploration

State Participation Nil

212
Petroleum Fiscal Systems and Contracts

GABON
PSC (1989)

Area 0.1-1 million-acre blocks

Duration
Exploration 3 Years + 2-year extension
Production 20 Years

Relinquishment After: 3 years 25%


5 years 50%

Exploration Obligations 1-3 Well minimum

Royalty Sliding Scale:


Up to 10,000 bopd 5%
10,001-20,000 10%
20,001-40,000 15%
40,001 + 20%

Signature Bonus U.S.$0.5-$2 million

Production Bonus Startup: U.S.$ 1.0


million
10,000 bopd 1.0 million
20,000 bopd 2.0 million

Cost Recovery 55% Limit


40% older contracts

Depreciation 5-year straight line

Profit Oil Split Production, bopd Split, %


(In favour of government) Up to 5,000 65/35
5,000-10,000 70/30
10,001-20,000 73/27
20,001-30,000 75/25
30,001-40,000 80/20
40,000 + 85/15

Profit Gas Split Negotiated

213
Petroleum Fiscal Systems and Contracts

Taxation 56% income tax paid by government out


of contractor share of profit oil –
therefore profit oil split is effectively an
after-tax split

Domestic Market Obligation Up to 20% of profit oil sold at 75% of


market price, otherwise pro rata

State Participation 10% Working Interest

214
Petroleum Fiscal Systems and Contracts

GABON possible example

Area 0.1-1 million-acre blocks

Duration
Exploration 3 Years + 2-year extension
Production 20 Years and 5 years extension

Relinquishment After: 3 years 25%


5 years 50%

Exploration Obligations 1-3 Well minimum

Royalty Sliding Scale:


Up to 10,000 bopd 5%
10,001-20,000 10%
20,001-40,000 15%
40,001 + 20%

Signature Bonus U.S.$1-$3 million

Production Bonus Startup: U.S.$ 1.0 million


10,000 bopd 1.0 million
20,000 bopd 2.0 million

Cost Recovery 60% Limit

Depreciation 5-year straight line

Profit Oil Split Production, bopd Split, %


(In favour of government) Up to 5,000 65/35
5,000-10,000 70/30
10,001-20,000 73/27
20,001-30,000 75/25
30,001-40,000 80/20
40,000 + 85/15

Profit Gas Split Negotiable

Taxation 56% income tax paid by government out


of contractor share of profit oil –
therefore profit oil split is effectively an
after-tax split

215
Petroleum Fiscal Systems and Contracts

Domestic Market Obligation Up to 20% of profit oil sold at 75% of


market price, otherwise pro rata

State Participation 10% Working Interest

216
Petroleum Fiscal Systems and Contracts

GHANA
Royalty/Tax 1986 Vintage
ROR provision came later

Area

Duration
Exploration 7 Years
Production 18 Years (25 years including
exploration)

Relinquishment Negotiated

Exploration Obligations

Royalty 12.5%

Bonuses None or negotiated

Depreciation 20% per year (exploration +


development)

Taxation 50% local income tax

Additional Profits Tax After-tax


(Post-1986) ROR, % Rate, %
Up to 15 50
15-25 60
0ver 25 70

Ring fencing

Domestic Market Obligation At world prices

State Participation GNPC carried for 10% through


exploration
has option to increase participation
to majority interest during development

Other

217
Petroleum Fiscal Systems and Contracts

GHANA possible example

Area

Duration
Exploration 5 Years
Production 20 Years (25 years including
exploration)

Relinquishment Negotiated

Exploration Obligations

Royalty 10%

Bonuses None or negotiated

Depreciation up 2 year 20% per year (exploration +


development)

Taxation 55% local income tax

Additional Profits Tax After-tax


ROR, % Rate, %
Up to 15 50
15-25 60
0ver 25 70

Ring fencing

Domestic Market Obligation At world prices

State Participation GNPC carried for 10% through


exploration
has option to increase participation
to majority interest during development

218
Petroleum Fiscal Systems and Contracts

INDIA PSC
Early 1990s

Area ?

Duration
Exploration
Production

Relinquishment

Exploration Obligations

Royalty None

Bonuses None

Cost Recovery 100% No limit

Depreciation 4 Years

Profit Oil Split Investment Multiple


Cumulative Net Cash Flow ÷ Contractor
Exploration & Development Costs Share, %
0-1.5 100
1.5-2.0 90
2.0-2.5 85
2.5-3.0 80
3.0-3.5 75
over 3.5 60

Taxation 50%

Ring fencing Development costs are ring fenced


by field. Exploration costs are not.

State Participation 30% Back-in

219
Petroleum Fiscal Systems and Contracts

INDIA PSC possible example

Area ?

Duration
Exploration
Production

Relinquishment

Exploration Obligations

Royalty None

Bonuses None

Cost Recovery 100% No limit

Depreciation 4 Years

Profit Oil Split Investment Multiple


Cumulative Net Cash Flow ÷ Contractor
Exploration & Development Costs Share, %
0-1.5 100
1.5-2.0 90
2.0-2.5 85
2.5-3.0 80
3.0-3.5 75
over 3.5 60

Taxation 55%

Ring fencing Development costs are ring fenced


by field. Exploration costs are not.

State Participation 30% Back-in

220
Petroleum Fiscal Systems and Contracts

INDONESIA
Second Generation (Pre-1984)

Area No restriction, designated blocks

Duration
Exploration 3 Years
Production 20 Years

Relinquishment 25%
or 100% of no discovery

Exploration Obligations Multi-well commitments

Royalty Nil

Signature Bonus Various

Production Bonus Many variations, each contract is


different

Cost Recovery No limit

20% Investment credit applies


to facility, platform, pipeline costs;
is recoverable but taxable

Depreciation Oil 7-year double declining balance


going to straight line in year 5
Gas 7-year declining balance switching
to straight line in year 8

Profit Oil Split


(In favour of government) 65.9091% / 34.0909%

Profit Gas Split


(In favour of government) 20.4545% / 79.5455%

Taxation 56% income tax

Ring fencing Each license ring fenced

221
Petroleum Fiscal Systems and Contracts

Domestic Market Obligation After 60 months production from a field,


Contractor receives 20c/bbl for 25% of
oil

State Participation Up to 50% - Option seldom exercised

222
Petroleum Fiscal Systems and Contracts

INDONESIA
Fourth Generation (Post 1988-89)

Area No Restriction, designated blocks

Duration
Exploration 3 Years
Production 20 Years

Relinquishment 25%
or 100% of no discovery

Exploration Obligations Multi-well commitments

Royalty Nil

Signature Bonus Still exist, various

Production Bonus Many variations, each contract is


different

Cost Recovery 80% limit because of 1st tranche


petroleum of 20%
17% investment credit applies to facility,
platform, pipeline costs; is recoverable
but taxable

Depreciation Oil 25% declining balance with balance


written off in year 5
Gas 10% declining balance with balance
written off in year 8

Profit Oil Split


(In favour of government) 71.1574% / 28.8462%

Profit Gas Split


(In favour of government) 42.3077% / 57.6923%

Taxation 48% income tax

Ring fencing Each license ring fenced

223
Petroleum Fiscal Systems and Contracts

Domestic Market Obligation After 60 months production from a field,


contractor receives 10% of market price
for 25% of oil

State Participation Up to 50% in joint operating agreement


contracts

224
Petroleum Fiscal Systems and Contracts

INDONESIA possible example

Area No restriction, designated blocks

Duration
Exploration 3 Years + 2 years extension
Production 20 Years and 5 years extension

Relinquishment 30%
or 100% of no discovery

Exploration Obligations Drilling and seismic

Royalty Nil

Signature Bonus Various

Production Bonus Many variations, each contract is


different

Cost Recovery No limit

20% Investment credit applies


to facility, platform, pipeline costs;
is recoverable but taxable

Depreciation Oil 7-year double declining balance


going to straight line in year 5
Gas 7-year declining balance switching
to straight line in year 8

Profit Oil Split


(In favour of government) 60% / 40%

Profit Gas Split


(In favour of government) 20 / 80%

Taxation 55% income tax

Ring fencing Each license ring fenced

225
Petroleum Fiscal Systems and Contracts

IRAQ
Service Contract 2009

Production Target
1) 10 percent compared to the initial production rate as soon as possible.
2) The initial production rate is to be agreed by the companies and Iraq
on the day the contract is ratified or before, and will be calculated as the
average production rate over a 30 day period.
3) The firms must aim for sustained output, or "plateau production
target," for a period of seven years of 2.85 million barrels of crude and
natural gas liquids per day.

Minimum Work Obligations Include


1) Conduct 3D seismic and geographical surveys.
2) Drill 20 new production and 10 new injection wells.
3) Rehabilitate 130 wells.
4) Design and build two water re-injection plants.
5) Refurbish or construct additional field gathering and processing
facilities.

Expenses Include
1) Contractors must spend a minimum of $300 million implementing their
minimum work obligations.
2) Within 30 days of the deal being finalised the contractors must pay a
signature bonus of $500 million. The money is recoverable over 20
quarterly payments, payable from the ninth quarter following the quarter
in which the deal is ratified.
3) Companies must allocate a minimum of $5 million for a fund for
training Iraqis.
4) Their remuneration fee will be taxed up to 35 percent.

Remuneration
1) Companies may bid for the field (x) contract for remuneration of $2
per barrel for example.
2) They may receive only a fraction of the bid rate depending on their
performance in boosting output.
3) The value of the contract to companies and the speed they can
recover costs depends on how much they can boost production.
4) A formula for assessing performance measures output against a
projection of what output would have been without the contractor’s
investment. That formula assumes an annual decline in output of 5
percent per year would have taken place.

226
Petroleum Fiscal Systems and Contracts

5) Contractors may be paid in oil or cash. Iraq can choose to reimburse


the companies' supplementary costs in oil or cash, but the firms can
decide how their service fees are paid.
6) Recoverable supplementary costs incurred by contractors bear an
interest of 1 percent over the London Interbank Offered Rate (LIBOR)
until they are paid.

Duration
1) The field (x) oilfield service contract lasts for 20 years, but it can be
extended.
2) Contractors must submit a rehabilitation plan within six months of
ratifying the contract.
3) The contractors must establish in Iraq a "normal presence" --
personnel and equipment necessary to support field operations -- within
six months of the rehabilitation plan being approved or the contract could
be terminated.
4) The companies must submit an enhanced redevelopment plan, based
on knowledge gained from the field's initial rehabilitation, within three
years of the contract's ratification.

Further Opportunities
1) Discovered but undeveloped oil reservoirs at field (x) may be
produced under the contract, but will be subject to a separately agreed
remuneration fee.
2) Contractors will, for six years from the date the contract is ratified,
have the exclusive right to negotiate an agreement to explore for and
develop undiscovered potential reservoirs in field (x).

Contingency Provisions
1) Grounds for either party to declare force majeure include an act of
God, war (declared or undeclared), force of nature, insurrection, riot and
fire.
2) They also include in certain circumstances, for contractors only,
government orders or legislation.

227
Petroleum Fiscal Systems and Contracts

Iraq South Gas Development Agreement

JVC 15% tax


49% of
dividends
Assets
Matching •Repair existing assets Oil Ministry
Shell capital •Build new assets 51% investments Of Iraq
49% of •Training and Development
51% dividends
investment
Raw gas payments
Upstream
Raw gas

Revenues

Mo

LNG LPG NGL Dry gas LPG NGL

Export Domestic

Figure 10.4 Example Iraqi service contract


(Ref. 1)

228
Petroleum Fiscal Systems and Contracts

IRAQ – Kurdistan Regional Government (KRG)


Shamaran PSC for Pulkhama Oil Field

Duration:

Exploration period Initial term 5 years, extendable


by 2 years.
Development period Initial term 20 years, extendable
by up to two 5 year periods.

Bonuses Signature and capacity building


bonuses $45mn

Royalty 10%

Cost Recovery 40%

Profit Oil parameters factor: (0 to 1) 26%; (1 to 2)


sliding scale between 26 and
13%; (>2) 13%.

Exploration costs $72mn

Capital costs $508mn

Fixed operating costs $20mn/year

Variable operating costs $2/B

Reserves 250mn barrels

$65/B $80/B $100/B


Brent Brent Brent

Net Present Value at 10% $460mn $624mn $802mn


discount rate (NPV10)

Rate of Return (ROR) 34% 44% 56%

229
Petroleum Fiscal Systems and Contracts

IRELAND
Concession

Area Designated blocks

Duration

Relinquishment

Exploration Obligations

Royalty None

Bonuses

Cost Recovery 100% No limit

Depreciation 100%, all costs expensed

Taxation 25% tax on profits

Ring fencing

Domestic Market Obligation

State Participation

Other

230
Petroleum Fiscal Systems and Contracts

IRELAND possible example

Area Designated blocks

Duration

Relinquishment

Exploration Obligations

Royalty None

Bonuses

Cost Recovery 100% No limit

Depreciation 100%, all costs expensed include


abandonment

Taxation 25% tax on profits

Ring fencing

Domestic Market Obligation

State Participation

Other

231
Petroleum Fiscal Systems and Contracts

Ireland Royalty/Tax System Summary

Gross Revenues less Opex

Net Cashflow less Depreciation


Abandonment Allowances

Taxable Income less Tax

Figure 10.5 Ireland fiscal regime


(Ref. 7)

232
Petroleum Fiscal Systems and Contracts

IVORY COAST (Côte d'Ivoire)


1988 Vintage PSC

Area

Duration
Exploration 5 Years (3 periods: 2 + 1 + 2)
Production 25 Years + additional period of 10 years

Relinquishment 50% after 2nd period (end of 3rd year)

Exploration Obligations

Royalty None with PSCs

Bonuses Negotiated
Model contract mentions $12 MM

Cost Recovery 40%

Depreciation

Profit Oil Split Shallow Water Deepwater


< 1,000 m > 1,000 m
Contractor Contractor
Production bopd Share, % Share, %
Up to 30,000 52 60
30,001-50,000 48 56
50,001-100,000 38 54
100,001-120,000 32 54
more than 120,000 30 54

Taxation 50% maximum tax on profits


Set at 34% in 1993

Domestic Market Obligation Up to 15% or prorated share


Contractor receives 15% of FOB price

State Participation Varies between 10% and 60%. Fixed at


15% for deepwater (NOC Petroci)
After 1993 reduced to 10% with state
option for Up to 30% after discovery.

233
Petroleum Fiscal Systems and Contracts

LIBYA possible example

Area Designated blocks

Duration

Relinquishment

Exploration Obligations

Royalty None

Bonuses 1 million
>100 MMbbl 6 million USD
each additional 3 million USD

Cost Recovery 100% exploration and 50% development

Depreciation 100%, all costs expensed include


abandonment

Taxation 25% tax on profits

Ring fencing Nil

Domestic Market Obligation No

State Participation No

234
Petroleum Fiscal Systems and Contracts

Libya Royalty/Tax Concession Summary

less less
Gross Revenues Royalty Opex

less
Net Cashflow Depreciation

Income B.T.

Taxable Income less Tax

Income A.T.

Figure 10.6 Libyan fiscal regime


(Ref. 7)

235
Petroleum Fiscal Systems and Contracts

MALAYSIA
Late 1980s, Early 1990s
Area No restriction, designated blocks

Duration
Exploration 3 Years + 2-year extension
Development 2 Years + 2-year extension
Production 15 Years for oil/20 years for gas

Relinquishment No interim relinquishment

Exploration Obligations Seismic and multi-well commitments

Royalty 10%
0.5% Research Cess

Signature Bonus None (Older contracts had bonuses)

Production Bonus None (Older contracts had bonuses)

Cost Recovery 50% limit for oil/60% for gas

Depreciation 10% year straight line

Profit Oil Split Production, bopd Split %


(In favour of Up to 10,000 50/50
government) 10,001-20,000 60/40
20,001 + 70/30
All production in excess of 50 MMbbl 70/30

Profit Gas Split For first 2 TCF 50/50


(In favour of contractor) After 2 TCF produced 70/30

Taxation 25% duty on profit oil exported


(with 20% export tax exemption)
45% petroleum income tax

Ring fencing Each license ring fenced

Domestic Market Obligation Nil

State Participation Up to 15%

236
Petroleum Fiscal Systems and Contracts

MALAYSIA
1994

Area No restriction, designated blocks

Duration
Exploration 3 Years + 2-year extension
Development 2 Years + 2-year extension
Production 15 Years for oil/20 years for gas

Relinquishment No interim relinquishment

Exploration Obligations Seismic and multi-well commitments

Royalty 10%
0.5% Research Cess

Signature Bonus None (Older contracts had bonuses)

Production Bonus None (Older contracts had bonuses)

Cost Recovery 50% limit for oil/60% for gas

Depreciation 10% year straight line

Profit Oil Split Production, bopd Split %


(In favour of Up to 10,000 50/50
government) 10,001-20,000 60/40
20,001 + 70/30
All production in excess of 50 MMbbl 70/30

Profit Gas Split For first 2 TCF 50/50


(In favour of contractor) After 2 TCF produced 70/30

Taxation (Income Tax) 20% duty on profit oil exported


(with 50% export tax exemption)
40% petroleum income tax

Ring fencing Each license ring fenced


Also, gas development costs recovered from gas production, and oil
development costs recovered from oil production.

Domestic Market Obligation Nil

237
Petroleum Fiscal Systems and Contracts

State Participation Up to 15%

238
Petroleum Fiscal Systems and Contracts

MALAYSIA possible example


Area No restriction, designated blocks

Duration
Exploration 3 Years + 2-year extension
Development 2 Years + 2-year extension
Production 15 Years for oil/20 years for gas

Relinquishment No interim relinquishment

Exploration Obligations Seismic and multi-well commitments

Royalty 10%
0.5% Research Cess

Signature Bonus None (Older contracts had bonuses)

Production Bonus None (Older contracts had bonuses)

Cost Recovery 50% limit for oil/60% for gas

Depreciation 30% year straight line

Profit Oil Split Production, bopd Split %


(In favour of Up to 10,000 50/50
government) 10,001-20,000 60/40
20,001 + 70/30
All production in excess of 50 MMbbl 70/30

Profit Gas Split For first 2 TCF 50/50


(In favour of contractor) After 2 TCF produced 70/30

Taxation 25% duty on profit oil exported


(with 20% export tax exemption)
45% petroleum income tax

Ring fencing Each license ring fenced

Domestic Market Obligation Nil

State Participation Up to 30%

239
Petroleum Fiscal Systems and Contracts

MALTA
PSC 1988 Vintage

Area

Duration
Exploration
Production

Relinquishment

Bonuses Negotiable at 3 levels


Production, bopd
50,000
100,000
150,000

Royalty None

Cost Recovery No limit

Depreciation All costs 25% per year

Profit Oil Split Negotiable


(Example)
Production, bopd Contractor's
Share, %
Up to 50,000 75
50,000-100,000 70
over 100,000 60

Taxation 50% of contractors profit oil


Bonuses are not cost recoverable, but
they are tax deductible

Ring fencing

Domestic Market Obligation None

State Participation None

240
Petroleum Fiscal Systems and Contracts

MALTA possible example

Area Designated blocks

Duration
Exploration 3 Years + 2 year extension
Production 20 Years

Relinquishment

Bonuses Negotiable at 3 levels


Production, bopd
50,000
100,000
150,000

Royalty None

Cost Recovery Dry holes 100% and 50% CAPEX

Depreciation All costs 25% -30% per year

Profit Oil Split Negotiable


(Example)
Production, bopd Contractor's
Share, %
Up to 50,000 75
50,000-100,000 70
over 100,000 60

Taxation 50% of contractors profit oil


Bonuses are not cost recoverable, but
they are tax deductible

Ring fencing

Domestic Market Obligation None

State Participation None

241
Petroleum Fiscal Systems and Contracts

Malta Production Sharing Summary

Production

Cost Recovery
Contractor

Remainder

Profit
Income Tax
Government

Profit Income B.T.


Contractor

Income A.T.

Figure 10.7 Malta fiscal regime


(Ref. 7)

242
Petroleum Fiscal Systems and Contracts

MOROCCO
Concession (1983 License Round)

Area At least 500 and less than 5,000 km2

Duration
Exploration 4 Years + 2-3 4-year renewals
Production

Relinquishment 25% on first renewal


25% on second renewal
12.5% on third renewal

Exploration Obligations

Royalty Sliding Scale Rate, %


Up to 1,000 bopd 0
1,001-2,000 6
2,001-6,000 9
6,001-20,000 12
20,001 + 14
Total royalties may not exceed 12.5% of gross value of production

Bonuses
Rentals $2-3/1,000 acres/year initial period
$3-12/1,000 acres/year after 1st renewal
$12-25/1,000 acres/year after 2nd
renewal

Depreciation 5-year SLD

Taxation 48% profits tax

Special surtax after 4 years continued


production in excess of 7,500 bopd or 1
MMcfd gas. Tax is equal to the
difference between total taxes assessed
including royalties and rentals and
50% of net profits.
Ring fencing ?

Domestic Market Obligation None

State Participation None

243
Petroleum Fiscal Systems and Contracts

MOROCCO
Royalty/Tax (1986 with 1986 incentives)

Area

Duration
Exploration
Production

Relinquishment

Exploration Obligations

Royalty 12.5% of gross value of production after


first 4 MM tons (28 MMbbl) have been
produced

Bonuses Upon discovery negotiable


also production bonuses
not deducible for tax purposes

Depreciation 5-year DDB exploration capital


10-year SLD development capital

Taxation 52.8% effective tax rate

Special surtax based on profit/investment ratio


Assumed
Surtax, % Ratio
10 1.0
20 1.5
30 2.0
40 2.5
50 3.0

Ring fencing ?

Domestic Market Obligation None

State Participation 35% carried through exploration

244
Petroleum Fiscal Systems and Contracts

MOROCCO possible example

Area No restriction, designated blocks

Duration
Exploration 3 Years exploration + 2 year extension
Production 20 Years

Relinquishment

Exploration Obligations Seismic and drilling

Royalty 12.5% of gross value of production after


first 4 MM tons (28 MMbbl) have been
produced

Bonuses Upon discovery negotiable


also production bonuses
not deducible for tax purposes

Depreciation 5-year DDB exploration capital


10-year SLD development capital

Taxation 55% effective tax rate

Special surtax based on profit/investment ratio


Assumed
Surtax, % Ratio
10 1.0
20 1.5
30 2.0
40 2.5
50 3.0

Ring fencing ?

Domestic Market Obligation None

State Participation 30% carried through exploration

245
Petroleum Fiscal Systems and Contracts

Morocco Petroleum Agreement Summary

Bonus and Gross Revenue less Opex and Abandonment


Royalty

Net cashflow less Depreciation

Income B.T.

Tax Taxable Income

Income A.T.

Figure 10.8 Morocco fiscal regime


(Ref. 7)

246
Petroleum Fiscal Systems and Contracts

MYANMAR
First License Round 1989/1990

Area No restriction, designated blocks

Duration
Exploration 3 + 1 + 1 Years
Production 20 Years

Relinquishment 25% + 25%


or 100% if no discovery

Exploration Obligations Negotiable


(Initial Phase) U.S.$12-$88 million. Averaged U.S.$20
million

Royalty 10%
+ 0.5% for research & training

Signature Bonus U.S.$4.o-$7.5 million

Production Bonus Discovery: U.S.$1.0 million


10,000 bopd 2.0 million
30,000 bopd 3.0 million
50,000 bopd 4.0 million

Cost Recovery 40% limit

Depreciation 10%

Profit Oil Split Production, bopd Split, %


(In favour of government) Up to 50,000 70/30
50,001-100,000 80/20
100,001-150,000 85/15
150,001 + 90/10

Profit Gas Split Production, MMcfd Split, %


(In favour of government) Up to 300 70/30
301-600 80/20
601-900 85/15
901 + 90/10

247
Petroleum Fiscal Systems and Contracts

Taxation 30% income tax


Tax holiday first 3 years under Foreign
Investment Law

Domestic Market Obligation Pro rata: up to 20% of contractor’s share


of oil at U.S.$1/bbl

State Participation Nil

248
Petroleum Fiscal Systems and Contracts

MYANMAR possible example

Area No restriction, designated blocks

Duration
Exploration 3 + 1 + 1 Years
Production 20 Years

Relinquishment 25% + 25%


or 100% if no discovery

Exploration Obligations Negotiable


(Initial Phase) U.S.$12-$88 million. Averaged U.S.$20
million

Royalty 10%
+ 0.5% for research & training

Signature Bonus U.S.$4.o-$7.5 million

Production Bonus Discovery: U.S.$1.0 million


10,000 bopd 2.0 million
30,000 bopd 3.0 million
50,000 bopd 4.0 million

Cost Recovery 40% limit of CAPEX and 100% dry holes

Depreciation 30%

Profit Oil Split Production, bopd Split, %


(In favour of government) Up to 50,000 70/30
50,001-100,000 80/20
100,001-150,000 85/15
150,001 + 90/10

Profit Gas Split Production, MMcfd Split, %


(In favour of government) Up to 300 70/30
301-600 80/20
601-900 85/15
901 + 90/10

Taxation 30% income tax


Tax holiday first 3 years under Foreign
Investment Law

249
Petroleum Fiscal Systems and Contracts

Domestic Market Obligation Pro rata: up to 20% of contractor’s share


of oil at U.S.$1/bbl

State Participation Nil

250
Petroleum Fiscal Systems and Contracts

NEW ZEALAND, Concessionary


Proposed 1991 Crown Minerals Act (Awaiting ratification)

Area No restriction, designated blocks

Duration
Exploration 5 Years with 5-year extension
Production Life of the field

Relinquishment 50% after 5 years

Exploration Obligations Negotiable

Royalty (Hybrid) 5% ad valorem royalty (AVR)


or 20% accounting profits royalty (APR)
whichever is greater
Previously the royalty was a flat 12.5%
AVR

Signature Bonus Negotiable No

Cost Recovery No limit

Depreciation 20%

Taxation 33% income tax (resident companies)


15% withholding tax
38% income tax (nonresident
companies)

State Participation Nil (Previously was 11% carry


through exploration phase)

251
Petroleum Fiscal Systems and Contracts

NEW ZEALAND possible example

Area No restriction, designated blocks

Duration
Exploration 5 Years with 5-year extension
Production 25 Years

Relinquishment 50% after 5 years

Exploration Obligations Negotiable

Royalty (Hybrid) 5% ad valorem royalty (AVR)


or 20% accounting profits royalty (APR)
whichever is greater
Previously the royalty was a flat 12.5%
AVR

Signature Bonus Negotiable

Cost Recovery No limit

Depreciation 40%

Taxation 33% income tax (resident companies)


15% withholding tax
38% income tax (nonresident
companies)

State Participation 0-10%

252
Petroleum Fiscal Systems and Contracts

NIGERIA
PSC 1987, Ashland Contract

Area

Duration
Exploration
Production

Relinquishment

Exploration Obligations

Royalty 20%

Bonuses

Cost Recovery 40%

Depreciation

Profit Oil Split Production, bopd Split, %


(In favour of government) Up to 50,000 65/35
over 50,000 70/30
1986 terms guaranteed $2/bbl profit margin on equity crude.

Taxation 85%
65% during cost recovery
"while amortising preproduction costs“

Ring fencing

Domestic Market Obligation

State Participation

Others Some uplifts/investment credits

253
Petroleum Fiscal Systems and Contracts

NIGERIA
PSC New 1994 Terms

Area

Duration
Exploration
Production

Relinquishment

Exploration Obligations $24 million first 3 years


$30 million next 3 years
$60 million 10 additional years
Former requirement: $176 MM over 10 years

Royalty Water Depth, m Rate, %


Up to 200 16.667
200-500 12
500-800 8
800-1000 4
> 1000 0

Bonuses $2 million @ 10,000 bopd


$2 million @ 50,000 bopd

Cost Recovery Limit ? Under old contracts the limit was 40%.

Depreciation

Profit Oil Split Production, bopd Split, %


(In favour of government) Up to 100,000 55/45
100,001-200,000 60/40
over 200,000 62/38

Taxation 50%
Down from 85% under older contracts,
which had lower 65% rate during cost
recovery period.

Ring fencing

Domestic Market Obligation

254
Petroleum Fiscal Systems and Contracts

State Participation

Others 50% investment credit

255
Petroleum Fiscal Systems and Contracts

NIGERIA possible example

Area

Duration
Exploration 4 Years and 2 year extension
Production 25 Years and 5 year possible extension

Relinquishment

Exploration Obligations Negotiable

Royalty Water Depth, m Rate, %


Up to 200 16.667
200-500 12
500-800 8
800-1000 4
> 1000 0

Bonuses $2 million @ 10,000 bopd


$2 million @ 50,000 bopd

Cost Recovery Limit Dry holes 100% and development phase


40%.

Depreciation

Profit Oil Split Production, bopd Split, %


(In favour of government) Up to 100,000 55/45
100,001-200,000 60/40
over 200,000 62/38

Taxation 50%
Down from 85% under older contracts,
which had lower 65% rate during cost
recovery period.

Ring fencing

Domestic Market Obligation

State Participation No

Others 50% investment credit

256
Petroleum Fiscal Systems and Contracts

NORWAY
Concession

Area

Duration 30 Years
Exploration
Production Field specific

Relinquishment

Exploration Obligations

Royalty 0 (Post-1986)
Prior to 1986 royalty ranged from 8%-
14%

Bonuses None

Cost Recovery Limit 100%

Depreciation 6-year SLD Beginning in a year of


investment
Prior to 1986 ”when placed in service“

Taxation 28% income tax


30% special tax
The basis of the special tax is free
income, which is similar to ordinary
income tax basis but includes additional
deduction for 5% uplift on development
capital costs.

Ring fencing Not in upstream end

Domestic Market Obligation None

State Participation Statoil has option on up to 80% working


interest – no carry. Prior to 1986
government was carried through
exploration.

257
Petroleum Fiscal Systems and Contracts

Other Prior to 1986, 5% uplift on dev. cap. ex.


For 6 years, abolished.
0.7% tax capital tax = ad valorem tax on
book value of investments 15%
production credit (deduction)

258
Petroleum Fiscal Systems and Contracts

NORWAY possible example

Area

Duration 30 Years
Exploration 4 Years + 2 year extension
Production 20-25 Years

Relinquishment

Exploration Obligations Seismic and drilling

Royalty None

Bonuses None

Cost Recovery Limit 100%

Depreciation 6-year SLD Beginning in a year of


investment

Taxation 28% income tax


30% special tax
The basis of the special tax is free
income, which is similar to ordinary
income tax basis but includes additional
deduction for 5% uplift on development
capital costs.

Ring fencing Not in upstream end

Domestic Market Obligation None

State Participation 30%

259
Petroleum Fiscal Systems and Contracts

Norway Royalty/Tax System Summary

Gross Revenues Opex Abandonment

Net Cashflow Depreciation

Income B.T. 5% Uplift on Development


Capital Cost

Income B.T. SPT


Tax Base (before
CIT)

Income A.T.

Figure 10.9 Norway fiscal regime


(Ref. 7)

260
Petroleum Fiscal Systems and Contracts

PAKISTAN
Concession (Mid-1980s vintage)

Area Maximum 125 km2

Duration 20 Years onshore, 25 offshore

Relinquishment 25% after 4 years + 25% after 2 more

Exploration Obligations

Royalty 12.5% less annual rentals

Bonuses OXY had $1 MM at commercial


production
$1.5 MM at 5,000 bopd
$3 MM at 25,000 bopd
$5 MM at 50,000 bopd or boe Equivalent
(6:1)

Depreciation

Taxation 50%
55% maximum
Ring fencing

Domestic Market Obligation Pro rata

State Participation Government had option to acquire


25% working interest in OXY block
40% working interest in Badin block

261
Petroleum Fiscal Systems and Contracts

PAKISTAN possible example

Area Designated blocks

Duration 20 Years onshore, 25 offshore


Exploration 4 Years + 2 year extension
Production 20-25 Years

Relinquishment 25% after 4 years + 25% after 2 more

Exploration Obligations

Royalty 12.5% less annual rentals

Bonuses OXY had $1 MM at commercial


production
$1.5 MM at 5,000 bopd
$3 MM at 25,000 bopd
$5 MM at 50,000 bopd or boe Equivalent
(6:1)

Depreciation

Taxation 50%
55% maximum
Ring fencing

Domestic Market Obligation Pro rata

State Participation Negotiable

262
Petroleum Fiscal Systems and Contracts

PAPUA NEW GUINEA


Concession (ROR)

Area Graticular blocks


5 minutes longitude X 5 minutes latitude
9 km X 9 km graticules
Licenses may be 60-200 blocks
(approximately 1.25-4 million acres)

Duration
Exploration Under petroleum prospecting license
(PPL)
6 Years + 5-year extension for 50% of
area if work program complete
Production Under petroleum development license
(PDL)
25 Years with 20-year extension

Relinquishment Surrender 25% after first 2 years

Exploration Obligations Negotiated

Royalty 1.25%

Bonuses Negotiated

Cost Recovery Limit No limit


Company allowed to recover its
investment plus agreed rate of interest
U.S. AAA Bond rate + 5%.

Depreciation 8-year SLD


Some accelerated (4-year SLD) allowed
if target income is not met.

Taxation 50% Basic Petroleum (income) Tax


(BPT)
Exempt if target income test is not met
(25% of investment)
50% Additional Profit Tax (APT)
Resource Rent Tax based on 27% ROR
threshold test.

263
Petroleum Fiscal Systems and Contracts

Ring fencing

Domestic Market Obligation

State Participation 22.5% carried through exploration


State share of Development costs paid
out of State share of production

Other

264
Petroleum Fiscal Systems and Contracts

PHILIPPINES
Risk Service Contract early 1990s

Area Designated blocks

Duration
Seismic Option 1 Year
Exploration 10 Years maximum
Production 30 Years

Relinquishment

Exploration Obligations Negotiable


Two-well option after seismic

Royalty*
* Filipino Participation -7.5% (goes to contractor group)
Depends upon level of Filipino
ownership up to 30% onshore

Incentive Allowance (FPIA) up to 15% in deepwater qualifies for full


7.5% (FPIA)
Filipino Participation, % FPIA, %
Up to 15% 0
15-17.5 1.5
17.5-20 2.5
20-22.5 3.5
22.5-25 4.5
25-27.5 5.5
27.5-30 6.5
30 or more 7.5

Signature Bonus Negotiable

Production Bonus No

Cost Recovery 70% limit

Depreciation 10%

Profit Oil Split 60%/40%


(In favour of government) Contractor‘s 40% is a “service fee“

Taxation No, paid out of government share

265
Petroleum Fiscal Systems and Contracts

Ring fencing Cost recovery allowed on two or more


deepwater blocks

Domestic Market Obligation Pro rata

State Participation Nil (FPIA)

266
Petroleum Fiscal Systems and Contracts

RUSSIA

Russia Agreements Summary

Bonus Gross Revenues less Transportation Costs

Net Revenues
Export Duty
After transport

Net Revenues
After Export Duty

Net Revenues
less Operating Costs
After MET

Net Cashflow

Income B.T.

Income A.T.

Figure 10.10 Russian fiscal regime


(Ref. 7)

267
Petroleum Fiscal Systems and Contracts

SPAIN
Royalty/Tax

Area 10,000 to 40,000 hectares


24,700 to 98,800 acres

Duration
Exploration
Production 30 Years with two 10-year extensions

Relinquishment

Exploration Obligations

Royalty None

Bonuses Negotiable, unlikely

Depreciation Exploration and intangible costs


amortised over 4 years SLD
Most tangible costs capitalised 4 years
SLD
Platforms 8 years SLD
Pipelines 5 years SLD

Taxation (Income Tax) 40% income tax

Ring fencing

Domestic Market Obligation

State Participation None

Other 10% investment credit on tangible


capital costs
25% depletion allowance on gross
revenues if it is reinvested in Spain, but
limited to 40% of taxable income

268
Petroleum Fiscal Systems and Contracts

SOUTH KOREA
Concession

Area

Duration
Exploration
Production

Relinquishment

Exploration Obligations

Royalty 15%

Bonuses

Cost Recovery 100%, No limit

Depreciation

Taxation 50%

Ring fencing

Domestic Market Obligation

State Participation

269
Petroleum Fiscal Systems and Contracts

SYRIA
PSC

Area

Duration
Exploration
Production

Relinquishment

Exploration Obligations

Royalty 11%
1985 Pecten Group royalty is 12.5%

Bonuses Production Bonuses


50,000 bopd
100,000 bopd
Not recoverable 200,000 bopd

Cost Recovery Ceiling 35% of gross production less royalties.


1985 Pecten Group Cost Recovery
Ceiling 25% and unused cost oil goes
directly to government.

Depreciation Exploration capital and operating costs


expensed.
Development costs: 5 years SLD

Profit Oil Split Sample Ranges

Example Example Pecten


Production, bopd 1 % 2% 1985 %
Up to 25,000 22.5 25 21
25,001-50,000 21.36 24 21
50,001-100,000 20 19
100,001-200,000 18 19
over 200,000 13.35 15 15

Taxation Taxes paid by government on behalf of


contractor

Ring fencing

270
Petroleum Fiscal Systems and Contracts

Domestic Market Obligation

State Participation None

Others

271
Petroleum Fiscal Systems and Contracts

THAILAND
Royalty/Tax Contract early 1990s

Area Designated blocks

Duration

Relinquishment

Exploration Obligations

Royalty Rate, %
Up to 2,000 bopd 5
2,000-5,000 6.25
5,000-10,000 10
10,000-20,000 12.5
over 20,000 15

Signature Bonus Yes, $2-$5 million

Production Bonus No

Depreciation 5 Years for tangibles, intangibles 10


Years
for preproduction/postproduction
expenses

Taxation 50% income tax

Supplement Tax Special remuneration benefit (SRB)


Progressive rate from 0%-75%
Based generally upon ratio of annual petroleum profit ÷ by cumulative
depth in metres of all wells drilled in the block plus a constant –
1,000,000 m, for example

$/M SRB Rate


Less than $200 0%
200-580 1% per $10/m
580-1,340 40% + 1% per
$40/m
1,340-3,650 60% + 1% per
$154/m
over 3,650 75%

272
Petroleum Fiscal Systems and Contracts

Assuming 24 Thai Baht per U.S.$1.00.


The more drilling, the lower the tax: this is an unusual one.

Ring fencing ?

Domestic Market Obligation

State Participation ?

273
Petroleum Fiscal Systems and Contracts

TIMOR GAP
Zone of Co-operation, 1991-92 License Round
PSC Jointly Administered by Indonesia & Australia

Area Main blocks in Zone of Cooperation A


(ZOCA)
comprise 20-40 sub-blocks at 10 km²
each

Duration
Exploration 6 Years with option for 4-year extension
With development contract automatically
extends to 30 years

Committed Expenditures
Exploration First year seismic only $1-$4 MM
Second year 0-2 wells $5-$8 MM
Third year 1-3 wells $5-$21 MM
4th -6th year 1-4 wells $6-$30 MM

Relinquishment 25% after 3 years; another 25% after 6th


year

Royalty None

Bonuses

Cost Recovery 90% effective limit for 1st 5 years*


80% effective limit thereafter*
* 10% first-tranche petroleum (FTP) (similar to Indonesian FTP) after 5
years production reverts to 20% FTP

Depreciation 5-year SLD

Profit Oil Split


Contractor
Production, bopd Share, %
Up to 50,000 50
50,001-150,000 40
150,001-200,000 30
Natural Gas 50

274
Petroleum Fiscal Systems and Contracts

Taxation 48% effective tax rate (similar to


Indonesia)
Comprised of 35% income tax and 20%
withholding tax
Companies will lodge income tax returns with both countries. In each
country a 50% tax rebate will be given.

Ring fencing

Domestic Market Obligation Similar to Indonesian DMO


25% of pretax profit oil (after 60 months, 10% of market price)

State Participation None

Other 17% IC on eligible costs similar to


Indonesian IC
127% Investment credit (IC) for
` deepwater

275
Petroleum Fiscal Systems and Contracts

TUNISIA
Concession - New Hydrocarbon Laws, 18 June 1990

Area

Duration
Exploration
Production

Relinquishment

Exploration Obligations

Royalty R Factor Oil, % Gas, %


< .5 2 2
.5-.8 5 4
.8-1.1 7 6
1.1-1.5 10 8
1.5-2.0 12 9
2.0-2.5 14 10
2.5-3.0 15 11
3.0-3.5 15 13
3.5 + 15 15
R Factor = accrued net earnings/accrued total expenditures

Bonuses

Depreciation 30% per year (all investments)

Taxation
Income Tax
R Factor Rate, %
< 1.5 50
1.5-2.0 55
2.0-2.5 60
2.5-3.0 65
3.0-3.5 70
3.5 + 75

Ring fencing

Domestic Market Obligation Pro rata up to maximum 20%


DMO price = FOB price -10%

276
Petroleum Fiscal Systems and Contracts

State Participation
Contractor recoups state share Sample
of exploration costs out of R Factor Level, %
20% of state share of revenues. < 1.5 45
1.5 + 50

277
Petroleum Fiscal Systems and Contracts

TURKMENISTAN
“Joint Enterprise“ Contracts
Summarised from Oil & Gas Journal, Vol. 91, No. 6, Feb. 8, 1993
(pp. 38-39)

Area

Duration 25 years
with optional 10-year extensions

Relinquishment

Obligations Block
II $60 MM 5 years
III $50 MM 5 years
IV $50 MM 5 years

Royalty (Sliding scale)


Blocks II & III, boe/y Rate Block IV, boe/y Rate
Up to 3,649 0% Up to-7,299 0%
3,656-7,299 2 7,300-21,899 2
7,300-10,949 5 21,900-36,499 5
10,950-18,249 7 36,500-51,099 7
18,250 + 15 51,100 + 15

Bonuses Amount
Block Minimum Bid Reserves Group
II $15 MM $15.25 MM 230 MMbbl + 1.87 TCF Larmag/Noble
III $20 MM $20 MM 642 MMbbl + 2.16 TCF Eastpac/TMN
IV $30 MM $30 MM 230 MMbbl + 0.89 TCF Bridas

Depreciation ?

Production Sharing
Block
II 50% 50% split
III 10% 90% in favour of the
government
IV 30% 70% in favour of the
government
These quoted percentages are possibly
“after tax“?

278
Petroleum Fiscal Systems and Contracts

Taxation 35% in joint venture profits


Guaranteed against increases

Ring fencing ?

Domestic Market Obligation ?

State Participation 50% JV fully carried?

Other Net operating losses (NOL) carried


forward 5 years

279
Petroleum Fiscal Systems and Contracts

UNITED ARAB EMIRATES


(ABU DHABI)
Early Concessions

Area 1 MM + Acres

Duration
Exploration 2 Years
Production 33 Years

Relinquishment

Exploration Obligations Seismic Survey


+ 1 or more wells
Aggregate depth of 30,000 ft

Royalty Sliding Scale:


Up to 100,000 bopd 12.5%
100,001-200,000 16%
200,001 + 20%

Bonuses Commercial Discovery $5 MM


50,000 bopd $3 MM
100,000 bopd $6 MM
200,000 bopd $6 MM

Cost Recovery 100% No limit

Depreciation 5-year straight line

Taxation (Income Tax) Sliding Scale, bopd


Up to 100,000 55%
100,001-200,000 65%
200,001 + 85%

Ring fencing Each license separate

Domestic Market Obligation Nil

State Participation Some

Later modern contracts in Abu Dhabi followed the OPEC model:


20% Royalty
85% Tax

280
Petroleum Fiscal Systems and Contracts

UNITED KINGDOM
Concession, Early 1990s

Area Designated blocks

Duration
Exploration 18 Years
Production Field specific

Relinquishment

Exploration Obligations Bid, negotiated

Royalty Nil

Bonuses None

Cost Recovery Limit 100% No limit

Depreciation 25% declining balance

Taxation 33% Income tax


75% Petroleum revenue tax (PRT) on
net revenues after capital costs are
recovered.
Some limits for marginal fields
Also free oil allowance against PRT

Ring fencing Each license is ring fenced.


For PRT each field is ring fenced.

Domestic Market Obligation None

State Participation None

Other 35% uplift on some capital costs

281
Petroleum Fiscal Systems and Contracts

UNITED KINGDOM, Fiscal


Summary of 1983-84 changes:

Before After
1985 1985

INCOME $100 $100

Royalty 12.5% 0%
Abolished for projects
approved after April 1992

Net Revenue 87.5 100

PRT (75%) 65.62 0


Phase out by end of 1986

21.88 100
CORPORATE TAX 11.38 (52%) 35 (35%)

Contractor Share 10.5 65

GOVERNMENT TAKE 89.5% 35%

Current corporate tax rate in the UK is 30% which yields a “pure“ 70/30%
split in favour of contractor group for fields developed since 1982.

Amount of oil exempted from PRT doubled to 1 million metric tons per
year  20,000 bopd.
Cumulative limit  10 million metric tons (73 MMbbl).

In effect, on a field of 20,000 bopd or less, only tax is corporate tax of


30%.
No APRT, PRT, or royalty.

282
Petroleum Fiscal Systems and Contracts

UZBEKISTAN
Joint Ventures
1st License Round 1993

Area 10 Designated blocks

Duration
Exploration 7 Years
Production 23 Years

Relinquishment 25% after 4 years and 25% each year


thereafter

Maximum Work Commitments3 Wells on 9 blocks (2 on one block)


1,000-2,000 km seismic, Average 1,600

Royalty Bid item, maximum 10% (Fixed or sliding


scale)

Minimum Signature Bonus Average $1.1 million ($0-$2 MM)


Production Bonuses (bid item at 25, 50 and 100 M bopd)
Geodata Packages $30-$60.000

Cost Recovery Limit Bid Item Maximum 60%


Before and after recovery
of initial costs

Depreciation 5-year SLD

Profit Oil/Gas Splits Bid Items Gas


Oil bopd Split, % MMm3/Day Split,%
Up to 10,000 / Up to 5 /
10,001-25,000 / 5-10 /
25,001-50,000 / 10-15 /
50,001-75,000 / over 15 /
75,001 + /
Proposed level of contractor share to range from 20% to 30%

283
Petroleum Fiscal Systems and Contracts

Taxation Income tax 18% with 30% foreign


ownership
as low as 10% with > 30% foreign
ownership
as high as 35% with < 30% foreign
ownership
Possible 5-year holiday starting with
operations

Export Tax10% (Repatriation of profits


tax)
VAT 25% on goods & services except
G&G
Property tax 1%, 2-year exemption

The following yet to be determined by the Cabinet of Ministers


Tax on raw materials, excise charges,
land tax, and payment for use of natural
resources tax

Ring fencing

Domestic Market Obligation

284
Petroleum Fiscal Systems and Contracts

VIETNAM
From PetroMin Magazine, July 1991

Area No restriction, designated blocks

Duration
Exploration 3 + 1 + 1 Years
Production 20 Years

Relinquishment 25% to 35%


or 100% if no discovery

Exploration Obligations Minimum U.S.$50-$60 million


(Initial phase) or 3 exploration wells

Royalty Nil

Signature Bonus U.S.$0.5 million

Production Bonus Discovery: U.S.$ 2.5


million
50,000 bopd: 2.5 million
100,000 bopd: 3.5 million
150,000 bopd: 4.0 million

Cost Recovery 40% limit or


16% plus entitlement to purchase
29% to 40% of oil at discounted prices

Depreciation Not clear

Profit Oil Split Production, bopd Split, %


(In favour of government) Up to 15,000 67/33
15,001-30,000 72/28
30,001-70,000 76/24
70,001-100,000 80/20
100,001 + Negotiable

Profit Gas Split Negotiable

Taxation Taxes paid by Petrovietnam


profit oil split is effectively an “after-tax“
split

285
Petroleum Fiscal Systems and Contracts

Ring fencing Each license ring fenced

Domestic Market Obligation Nil

State Participation Nil

286
Petroleum Fiscal Systems and Contracts

VIETNAM
Fina/Shell Contract, 16 June 1988

Area Blocks 112, 114, 116

Duration
Exploration 5 Years + 6-month extension for drilling
Production 25 Years + 5-year extension

Relinquishment 24% at end of 3rd year


25% at end of 4th year
The whole of remaining areas relinquished after exploration period
except development areas.

Exploration First 3 years 10,000 km seismic or at least $6.5 MM


Obligations 3 wells or at least $8 MM per well
Fourth year 5,000 km seismic or at least $4 MM
2 wells or at least $8 MM per well
Fifth year 2 wells or at least $10 MM per well
The last wells in 4th and 5th years conditional upon results of first well. At
least one of first 4 wells to be at least 3,500 m deep.

Royalty Nil

Signature Bonus U.S.$1 million (deductible)

Production Bonus Startup: U.S.$1.0 million


(not deductible) 50,000 bopd: 2.0 million
75,000 bopd 3.0 million

Cost Recovery 38.5% limit (60% for gas)


Depreciation Not clear

Profit Oil Split Contractors Share


Gas same (6:1) Before After After
Payout Payout Threshold
Production bopd % % %
Up to 50,000 40 36 32
50,001-60,000 37.5 33.75 30
60,001-70,000 35 31.5 28
70,001-80,000 32.5 29.25 26
80,001-90,000 30 27 24
90,001-100,000 25 22.5 20
100,001 + 20 18 16

287
Petroleum Fiscal Systems and Contracts

Threshold volume is based upon a cumulative production level.

Taxation Taxes paid by Petrovietnam


Profit oil split is effectively an “after-tax“
split

Ring fencing Each license ring fenced

Domestic Market Obligation Government has option to take all at


market price

State Participation 15% ?

288
Petroleum Fiscal Systems and Contracts

YEMEN
(North Yemen)
Hunt Onshore PSC 1981

Area 12,600 km² (3 million acres ±)

Duration
Exploration
Production 20 Years

Relinquishment

Exploration Obligations

Royalty None

Bonuses

Cost Recovery Limit 30 %

Depreciation

Profit Oil Split 85%/15% in favour of the government

Taxation

Ring fencing

Domestic Market Obligation

State Participation

Other

Some of the newer contracts have roughly 40% cost recovery limit and
70%/30% profit oil split in favour of the government.

289
Petroleum Fiscal Systems and Contracts

11 HIGH RISK COUNTRIES

This chapter takes Iraq as a prime example of oil and gas


exploration and development in high risk countries.

Iraq has huge oil and gas reserves, with the second largest
proven oil reserves worldwide. The total reserves may be greater
than those of Saudi Arabia. It has been estimated that new
exploration will raise Iraq's reserves to over 300 billion barrels of
high grade crude oil that may be produced relatively cheaply.

However, Iraq has suffered decades of wars and political


turbulence. It is very risky to invest in a politically unstable country
and oil companies look for stability before making massive capital
investment. Now that Iraq has a measure of internal stability and a
democratic government, there is expectation that developments
will start to move ahead but there remain some difficulties for the
oil industry to move freely towards Iraq.

Four oil industry majors based in the US and the UK that were
excluded from Iraq with the nationalisation of 1972 are keen to
return. In the later years of the Saddam era, companies from
France, Russia, China, and elsewhere secured major production
sharing agreements whilst US and UK companies were unable to
participate. UN sanctions, backed by the US and the UK, however
made those contracts inoperable.

The situation has changed following the invasion and occupation


of Iraq in 2003. US and UK firms now expect to gain most of the
lucrative oil deals that will be made in the coming decades. The
new Iraqi constitution of 2005, influenced by US advisors,
contains guarantees of a major role for foreign companies.
International oil companies now hope to conclude Production
Sharing Agreements that will allow the companies to control many
fields, including the massive Majnoun field. This is subject to the
Iraqi Parliament passing a new oil sector investment law which will
allow foreign companies to assume a major role in the country.
The Iraqi cabinet first endorsed the draft law in February 2007 but,

290
Petroleum Fiscal Systems and Contracts

despite US threats to withhold funding as well as financial and


military support, the Parliament has not approved the legislation.

There is strong support amongst many Iraqis, including the oil


workers union, for continued control by a national oil company.

Figure 11.1 Plentiful reserves in Iraq - oil comes to the surface in


many places

291
Petroleum Fiscal Systems and Contracts

OPPOSITION TO THE IRAQI DRAFT OIL LAW

Comments by Mr Tariq Shafiq, one of the Drafters of the Law

There is widespread opposition to passing the Draft Oil Law. This


opposition extends to members of the drafting group of the new oil
law as illustrated by an unpublished article that was leaked to Al-
Ghad. In this article, a petroleum expert, Mr Tariq Shafiq, a former
founding director of INOC in 1964, and a key member of the
drafting committee of the 2007 Iraq Draft Oil Law, strongly
criticised the law which he had contributed to preparing. Mr Shafiq
also said that another member of the three-man drafting
committee shared his negative opinion. These comments added
to the already strong opposition among members and the country
as a whole.

Despite disagreeing with some of its contents, Al Ghad decided to


publish Tariq Shafiq’s observations. Al Ghad stated their view that
the observations point out severe shortcomings which will
threaten the interests of Iraqi citizens and subject Iraq’s source of
income to grave dangers, thereby making it illegal for Parliament
to discuss or approve the new legislation.

The writer explicitly says that some of the main shortcomings in


the third draft of the law are:

“Auditing and balancing are not possible to achieve with the


complexities of Iraqi politics. Granting rights are also subject to
foul play between political powers in the light of the current
circumstances in Iraq. What is more dangerous for the future of oil
and gas in Iraq is the transformation of power in administrating oil
and gas from the centre to the provinces.

Both me and my colleague Farooq Al Qassim, a geologist and


contractual affairs expert, have come to the conclusion that the
third draft of the oil and gas law is below our expectations
because of the main amendments it was subjected to, especially
clauses number 5, which stipulates the specialisations of the
authorities and number 6, which spell out how rights are granted.”

292
Petroleum Fiscal Systems and Contracts

The content of the March 2007 Al-Ghad article follows.

The Draft Oil Law - An Independent Point of View

1.0: Introduction

1.1: Iraq is expected to be the world’s greatest oil reserve, with


projected reserves exceeding 215 billion barrels. The amount of
oil which is accounted for is 115 billion barrels, keeping Iraq on a
par with Saudi Arabia. In addition, its exploration and excavation
are relatively cheaper – in fact Iraqi oil is the cheapest to extract in
the Middle East. Despite this, the recorded production average
has never exceeded 3.5 million barrels per day, despite the
passage of eight decades since the discovery of oil in Iraq.

Historically, Iraqi oil production has never been in line with the
huge reserves the country in sitting on, despite the low costs of
excavation. The known reserves allows for production levels to
reach 10 million barrels per day while at the same time
maintaining similar production levels for a decade. Therefore, the
priority in the next few months should be given to rehabilitating
existing facilities and developing new production lines instead of
investing in exploration and drilling.

Increasing production capabilities calls for a comprehensive


master plan which includes feasibility and technical studies of the
potential of all the oil fields. Social and economic development
should go hand in hand with developments in the oil sector and to
achieve this, centralised planning is paramount.

1.2: Historically the price of extracting a barrel of oil in Iraq is 50


cents (US $0.50) while the running costs of production range from
US $1 to US $2 for each barrel. For example, the price of
expanding the current production capacity by one million barrels
per day is estimated to cost US $3 billion while the overall
investment capital for producing one million barrels is US $6
billion. These figures could leap to US $4.5bn and US $9bn,
respectively, if we took into consideration the cost of security

293
Petroleum Fiscal Systems and Contracts

protection and increasingly expensive oil extraction equipment


over the previous two years.

1.3: Iraq’s oil refineries and production facilities are defunct,


destroyed, stolen or derelict because of the war. Production
dropped to about one million barrels per day in September 2003
from a pre-war level of 2.8 million barrels per day in March 2003.
Oil production in Iraq stood at about 2 million barrels at the
beginning of 2007. Of this, 1.5 million barrels are for export
purposes. The average production, however, continues to drop.

Iraq’s petroleum industry has been governed by the oil concession


deals signed at the beginning of the 70s. During the period of
nationalisation, other laws were put in place to manage the vast
resources and today the time has come to issue an oil law which
regulates the circumstances related to the oil and gas industry’s
plans and policies.

2.0: The Draft Oil Law

2.1: At the invitation of Iraqi Oil Minister, a draft law governing the
oil and gas industry in Iraq was drawn up by a panel of three oil
experts, which included myself. Together, we had international,
Middle Eastern and Iraqi experience spanning 120 years. The
Minister of Oil for the Province of Kurdistan was expected to join
us but that did not happen.

2.2: The Oil Draft Law was based on clauses 111 and 112 of the
new Iraqi constitution. It was also derived from clauses 2, 49, 109
and 110 which stipulated the authorities and responsibilities of the
central government, the provinces and governorates. To
understand the vagueness of those clauses, and to work in a
transparent manner, we sought the support of an independent
legal and consultative team, which explained to us the clauses in
the Iraqi Constitution related to oil and gas.

We expect a large segment of the Iraqi population, especially the


technocrats specialised in the petroleum industry, to vote in favour
of amending clauses 111 and 112, which are related to the

294
Petroleum Fiscal Systems and Contracts

ownership of oil and gas in the next revision of the clauses in the
Constitution.

2.3: The Oil Draft Law aims at achieving an optimum environment


for investment in the oil and gas industry as well as ensuring the
highest levels of return possible and unifying the Iraqi people and
nation.

The draft also contains stipulations for unifying the plans and
policies to include all the governorates and provinces through
consultation and participation with the Federal Oil Ministry. It also
makes provisions for the joint supervision of both the ministry and
other sectors for operations and production. All decision making
processes are also to be taken in an audited and balanced
method, to ensure transparency and accountability.

2.4: The draft law encourages the private sector and welcomes
international oil companies to work with and support the Iraqi
National Oil Company, especially in the areas of technology
transfer and providing technical and administrative training to
Iraqis. It also calls for specialised tenders to open the floor for
competition between the most technologically and financially
eligible international oil companies, which are selected by the Oil
Ministry in accordance with the first petroleum draft law, in a
transparent manner.

Negotiations regarding contracts and decision-making should take


place at the Federal Oil and Gas Council, through a team of
negotiators, who should take into consideration the informed
opinions of an independent consultancy team. It is noteworthy to
mention that the functions of those two aforementioned teams
have been redrafted in the third draft of the Oil and Gas Draft Law,
following negotiations between members of the Federal
Government and the Government of the Province of Kurdistan, as
will be clarified later.

2.5: The Iraqi National Oil Company will be an independent closed


national company, which will have allied companies working in the
different provinces linked to it administratively to guarantee

295
Petroleum Fiscal Systems and Contracts

coordination and administrative services. All explored oil fields will


be administered and operated by the Iraqi National Oil Company.

2.6: The Federal Oil Ministry will be in charge of supervision and


up coordination, in addition to drawing up plans and policies in
cooperation and with the participation of all the provinces.
However, the third revision of the Draft Law, transferred the
responsibility of negotiations from the Federal Oil and Gas Council
to the Government of the Province of Kurdistan for the region of
Kurdistan and to the Federal Oil Ministry for the rest of Iraq.

3.0: Negotiations

3.1: As mentioned earlier, the main goal of the first draft was to
ensure the success of the administration and organisation of the
oil and gas sectors in Iraq, as well as to achieve lucrative returns
and ensure the unity of the nation. The draft was written for the
benefit of our people as a whole, and was to be implemented on
all provinces equally. Therefore, the ongoing debate and
compromises being made on the goals and objectives of this law,
will weaken the administration, remain an obstacle to making the
utmost benefit of the development of the oil and gas industry and
adversely affect the interest of the Iraqi people. This is because
the draft law did not take into consideration keeping aside a
margin for negotiations and making compromises.

3.2: The Oil Ministry adopted the draft law mentioned above
without any changes. But since clashes between the sectarian
and ethnic divisions have reached their peak, the possibility for
any discussions now is for them to be conducted by the larger
parties, based on sectarian and ethical percentages, instead of
taking place in Parliament in an open and transparent manner. It
is a shame that this procedure was also adopted when taking the
Oil Draft Law into consideration.

Tough negotiations have taken place between the representatives


of the Province of Kurdistan and the remaining members of the
Ministerial Committee, which was formed to study and present
recommendations regarding the Draft Oil Law to the Cabinet.

296
Petroleum Fiscal Systems and Contracts

Once the Cabinet approves the amendments, the law will be


forwarded to Parliament for further study and approval.

3.3: The stance of the Province of Kurdistan, which is expressed


in their draft on the Oil Law, is based on a rather extremist
interpretation of the main clause 111, which they read as saying
that the oil and gas in Kurdistan belongs to its people only – and
not to all the people of Iraq. What the clause actually says is: Oil
and gas belongs to all the people of Iraq, in all the provinces and
governorates. The draft oil law penned by the Government of
Kurdistan leaves a lot of space for negotiation, while the Federal
law, as I have mentioned before, doesn’t have a provision for that.
As a result, any fundamental change in the Federal Draft Oil Law,
especially those clauses stipulating the power of the authorities
related to administration and decision making (The Federal
Council for Oil and Gas, the Independent Consultants Team and
the Negotiation Team), especially with regards to the exploration,
production and negotiation over oil and gas, will weaken the level
of auditing and balancing which is of utmost importance to
guarantee accountability and transparency and not subjecting the
interests of our people as a whole to a damaging settlement.

The temporary State Administration Law issued by the Coalition


Forces says that the Federal Government is charged with
consultancy and cooperation with the other provinces and
governorates in managing oil and gas resources to guarantee the
just distribution of their returns.

At the same time, the Constitution calls for consultation and


cooperation in managing petroleum resources. However, the
Federal Oil Draft Law has gone further than that as it stipulates
the participation of the provinces and governorates in the
management and decision-making processes related to these
resources. The clause was drafted in this manner to guarantee
the interests of the Iraqi people as a whole and in a manner which
ensures that these rights are not open to negotiation between the
Federal Government and the other provinces and governorates.

3.4: Negotiations did not seriously begin until after an agreement


was made on how to distribute the petroleum resources between

297
Petroleum Fiscal Systems and Contracts

the Federal Government and the provinces and governorates. But


those negotiations were slow and stumbling, and took a long time.
It was expected that the talks will be fast and serious, especially
when the Minister of the Province of Kurdistan announced at the
Oil Conference in London on December 8, 2006, that the stance
of his government regarding the clauses 111 and 112 has
changed and was now in line with that of the Federal Government.
He also added that the clauses of the Constitution could be
amended after a period of time which ensures that a suitable level
of trust has been cemented between the Kurds and the rest of the
Iraqi people.

Despite this announcement, it seems that the official stance of the


Province of Kurdistan has remained just as it was before the
negotiations, especially with regards to negotiating with oil
companies independently and without the approval of the Federal
Oil Committee.

The other hanging issue, is the large number of contracts closed


by the Government of Kurdistan with small companies which aim
at making quick and high profit (ranging from 60-100 per cent of
the overall capital) and in a manner which contradicts the clauses
of the Federal Oil Draft Law which is awaiting approval. However,
the Government of Kurdistan refuses to approve amendments to
the contracts by the Federal Oil and Gas Council in accordance
with the Federal Law to the date of writing this paper on February
17. The Federal Government is also insisting that this refusal has
no legal backing.

It is obvious that if the Government of the Province of Kurdistan


continues in its opposing stance, this will mean refusing clauses
111 and 112 and other Constitutional clauses related to this. This
will also encourage the other provinces to follow in their steps,
which may result in a serious precedence of the other provinces
and governorates signing contracts which may not be regularised
and which may be lacking in transparency and accountability. This
will have an adverse affect on auditing and balancing which are
emphasised in the Federal Oil Draft Law.

298
Petroleum Fiscal Systems and Contracts

It was mentioned recently that a compromise has been reached


which enables the Government of the Province of Kurdistan to
negotiate with companies in the presence of a representative from
the Federal Oil Ministry and that the deals are approved by the
Federal Oil Council. The Government of the Province of Kurdistan
will also be allowed to ‘correct’ existing agreements and contracts
and make them in line with the Federal Oil Draft Law, provided it
gets the approval of the Federal Oil Council. Despite the passage
of time, there is nothing to show that they have reached a quick
settlement. However, it remains to be seen if it has been written
with sufficient clarity which is not subject to misinterpretation as
was the case with the Constitution.

It is worth mentioning here the importance of drafting clearly


written laws which are not open to many interpretations. We
should also never give up the legal rights of the Federal Oil
Council to have the final say of accepting or rejecting parts or all
of the contracts being negotiated.

The contents of the third draft of the oil law which has been
approved by the ministerial negotiation council at the middle of
January has yet to be accepted by the Government of the
Province of Kurdistan, which is insisting on deferring its final
approval until reaching a complete agreement on the laws which
organise Ministry of Oil and the agencies related to it, as well as
the formation of the National Oil Company, the division of the oil
returns and a number of other provisions which there is no chance
to mention now.

The Government of the Province of Kurdistan has not given its


final approval yet as was mentioned before despite all the
fundamental changes which were made to the Federal Oil Draft
Law. The clauses which have been dropped from the draft law are
in effect fundamental clauses which guarantee professionalism,
transparency and accountability. Although the principles are there,
dropping the mechanism in which the auditing processes will take
place will lead to undesirable results given Iraq’s current
circumstances.

299
Petroleum Fiscal Systems and Contracts

There are a number of factors which do not guarantee an optimal


manner of regulating the oil industry. Among them are:

a. The Federal Draft Oil Law stipulated that the national oil
company should be a closed independent company, with
an independent financial and administrative structure. The
third draft makes provisions for unprofessional criteria in
appointing directors, which will limit the independence of
the company and its efficiency.

b. The third draft adopted exploration and drilling methods


which ensure their just geographical distribution over Iraq.
Despite the fact that social justice demands that, nature
has unfortunately not distributed the oil and gas fields
equally on all the provinces and governorates. Therefore,
adopting this principle should not adversely affect the
economic feasibility of exploration and drilling operations.

c. The role of the independent consultants’ office has been


weakened and its authorities have been restricted to
conducting studies of all that is related to the petroleum
industry and coming up with an annual report containing
their findings. Its authority is also restricted to the duties
handed to it by the Federal Oil and Gas Council which in
effect weakens the transparency of the process, especially
after the clause which stipulates that the annual report
should be published has been dropped. The duration of
the membership of the consultants has also been
decreased from five years to one year and that their
appointment is now subject to the approval of each and
every member of the Federal Oil and Gas Council, which
is something unheard of before.

d. The appointment of members of the Federal Oil and Gas


Council and the independent consultants is based on
sectarian and ethnical divisions, which is a grave
intervention of politics in the most vital economic
commodity which has a direct impact on the people
instead of ensuring professionalism and transparency as
criteria for appointment.

300
Petroleum Fiscal Systems and Contracts

e. The Federal Oil and Gas Council’s membership has been


expanded by about 20 to 30 members, making it more of a
discussion forum than a council to execute and make vital
decisions. The negotiation clause for the oil and gas
exploration contracts for the Federal Oil and Gas Council
has also been dropped and its duties given to the
Government of the Province of Kurdistan and the Ministry
of Oil. Our fears are that the other provinces and
governorates will seek similar rights, without taking into
consideration the ability of their organisations in dealing
with such an undertaking. This, in turn, will lead to
discrepancies in procedures, which will discourage
investors and not guarantee lucrative deals in negotiations.

f. It seems as if closing exploration and development deals


in the third draft law takes into consideration the
appearance of the contract rather their type and contents.
Despite the fact that the draft stipulates that the investor
should enjoy the necessary qualifications and that the
negotiations are conducted in a certain manner, taking into
consideration approved contract models, it does not stress
the importance of ensuring that the clauses in the contract
are the ones which have been approved. The Ministry of
Oil in the first draft has made it a must for the contractor
willing to invest to fulfil financial and technical criteria and
as a result it is illegal to review his qualifications after
winning the tender. It is more important for the Council and
its consultants to study the contract before it is closed to
guarantee the most returns to the Iraqi people in
accordance to the draft law.

g. As a result of all that, auditing and balancing are not


possible to achieve due to the complexities of Iraqi politics.
Granting rights are also subject to foul play between
political powers in the light of the current circumstances in
Iraq. What is more dangerous for the future of the
petroleum industry in Iraq is the transformation of power in
managing the oil and gas reserves from the centre to the
provinces. Both me and my colleague Farooq Al Qassim, a

301
Petroleum Fiscal Systems and Contracts

geologist and contractual affairs expert, have come to the


conclusion that the third draft of the oil and gas law is
below our expectations because of the main amendments
it was subjected to, especially clauses number 5, which
stipulates the specialisations of the authorities and number
6, which spell out how rights are granted.

4.0: Closing Observations

4.1: Without a centralised and unified policy, there will be


competitiveness and differences between the National Oil
Company (responsible for development operations and producing
oil which guarantees revenue for the state) and the provinces and
governorates (which will be responsible for exploration and drilling
for reserves not important to tap at present) as well as between
the provinces amongst each other. This will create envy between
those who have and those who don’t have oil and gas resources.
This will also lead to instability, which will adversely affect
investment and lead to further divisions among people instead of
unifying the population and the country.

The Constitution has made the Federal Government responsible


for the oil and gas resources and not any village, or governorate
or province. And the Federal Draft Oil Law insisted on the unity of
planning, strategic studies, execution of projects, supervision and
decision-making. All that should happen by the participation of the
provinces and governorates and not just by co-operation and
consulting with them.

4.2: Instability will lead to an uneven oil industry, and weakens the
seriousness of the National Oil Company, which has the
necessary capabilities to develop excavation and drilling. In turn,
this will lead to decreased investment and an increase in making
use of middlemen who give more promises than they fulfil. Also,
depending on small companies will not enable us to fulfil our
objectives, as such companies do not have the capacity to
develop Iraq’s gigantic oil fields.

302
Petroleum Fiscal Systems and Contracts

4.3: The National Oil Company was charged with the task of
carrying out the necessary rehabilitation of the infrastructure and
expanding the production capacities of the oil fields which have
been completely and partially developed, in addition to repairing
the damage caused by pumping large amounts of oil from the
reserves and developing newly discovered fields, with the help of
international oil companies to guarantee the use of advanced
technology.

This task is a top priority and takes precedence over excavation


operations, which will only add new oil to an existing oil reserve,
which we do not even need at present. Focusing on exploration
and excavation at this phase of Iraq’s political and economical
development will only lead to squandering the interests of the
future generations and emphasise the theory that the war was
waged for oil only.

4.4: There are a number of damaging trends today, of the size of


tsunamis, which can wreak damage of unseen proportions to
Iraq’s land and people at a time when insecurity and widespread
lack of law and order are the norm as well as the growing
numbers of murders, resulting from ethnic and sectarian divisions
in addition to crime.

4.5: State departments suffer from a lack of capabilities, an


absence of administrative work and sound administrative
practices as well as a decrease in investment and widespread
unemployment.

4.6: Everyone should stop at these dangerous trends and unite


and co-operate for the happiness of the country and its people,
considering this is a top priority. A strong and solid oil industry
would guarantee the necessary tools for political and economical
reforms and also provide a ripe environment for decreasing a lot
of the trends mentioned above to a large extent.

4.7: And last but not least, I would like to praise the stance of the
Ministry of Oil and all those involved in the negotiations from the
Federal Government who are in an unenviable situation because
of the stubborn attitude of the Government of the Province of

303
Petroleum Fiscal Systems and Contracts

Kurdistan, which is against the clauses in the Constitution which


govern the ownership and management of oil and gas resources
in Iraq. What is worse is that the Federal Government did not
provide its negotiators with the necessary support, at the time the
Government of Kurdistan gave its negotiators all the moral and
political support they needed.

4.8: Finally, I am calling for the return to the spirit which resulted in
the December 8 announcement made by the top Kurdish
negotiator as a faithful gesture from the people of Kurdistan to
work jointly for the benefit of all the people of Iraq.

Mahdi Al-Hafiz’s Opposition To Passing The Draft Oil Law

Dr Mahdi al-Hafiz’s, an MP, former Minister and Head of


Development Council Development, called in a memo for the
President and members of the Iraqi Parliament to implement the
demands of the Amman Seminar held by 50 Iraqi oil specialists.
He called on Parliament to stop the rush to legislate the Draft Oil
Law, and give the people and Parliament a decent opportunity to
study the draft and amend its serious shortcomings.

An Opinion Opposing the Existing Draft Iraqi Oil and Gas Law

Al-Ghad published, both in Arabic and English, the important


document, reproduced below by the prominent Iraqi oil expert, Mr
Fouad Qasim Al Amir. The document was a paper prepared by Mr
Al Amir, to be read at the Iraqi Oil Seminar, scheduled to be held
in Paris on 25 - 27, February 2008.

However, Mr Fouad Al Amir was unable to attend the Seminar


due to unforeseen circumstances beyond his control. The author
wished to have the paper available to those attending the
Seminar, and those who are interested in the Iraqi Oil problem,
especially those sympathetic to the rational and patriotic view
regarding that thorny problem.

304
Petroleum Fiscal Systems and Contracts

The article states:

“It is clear now, and we are at the end of the fifth year of
occupation, that the reasons announced by USA for the war were
completely untrue, and the main reason, which was not
announced, was Iraqi oil, a fact known for many who were
following the Iraqi affair then. A lot of articles, books, debates and
analyses were performed in the last five years, in USA and other
countries emphasising the oil reason. Here we are not going to
repeat this, but we are going to point out those that are connected
to this paper.

1-USA policy to develop Iraqi oil.

When Dick Cheney was the head (CEO) of Halliburton, he


addressed a number of big oil companies heads, at a meeting
held in 1999 at the “Institute of Petroleum”, reminding the oil
companies that by 2010, the oil industry will need extra (50)
million barrel daily MBD. The oil will be always a government affair
since 90% of world reserves are controlled by the oil national
companies. Middle East will remain the main supplier, since it has
two third of the world reserves and the cheapest to produce. (Of
course Cheney was ignoring Kyoto Treaty when he estimated the
extra need by 50 MBD, now it is maybe half of this figure since
Europe and Japan went ahead with applying the treaty). Then,
Cheney became USA vice president, and the oil file was his work
and interest. He formed what was called “Development Group”, or
“Cheney Basic Force”, that included the heads of the biggest
American energy companies. In March/2001 this group ended
what was called “National Energy Policy”, advising USA
Government to take initiative in the Middle East, pressuring their
governments to open their oil market for foreign investment.

So USA was preparing the political atmosphere alongside the


military preparation for the occupation of Iraq. State Department
took the initiative to prepare post war plans for Iraq future since
April 2002, by forming several groups, and the most important one
was “Oil & Energy” group, which included Iraqi expatriate experts
as well as foreign ones, chosen by the state department. This

305
Petroleum Fiscal Systems and Contracts

group, and after several meetings, between December 2002 and


April 2004, gave their advice which was that Iraq should be open
to oil companies very soon, and create the proper atmosphere to
attract foreign investment to work in accordance to PSAs
Production Sharing Agreements, and in flexible ways.

In 2004 the “International Tax & Investment Center ITIC” issued


its study “Oil and Iraq Future”, advising that the PSAs are the
proper legal and financial solution to ease the work for developing
Iraqi oil industry. The members of ITIC are about (110) company,
including oil giant companies like BP, Shell, Chevron, Exxon
Mobil, Halliburton, Conoco Phillips, and others.

So the Road Map for oil development of Iraq was put by USA and
oil companies, that is should go for PSAs before consulting the
real Iraqi experts or the Iraqi people. PSAs are one of the major
reasons for rejection the oil law, which endorsed those kinds of
agreements. PSAs are “risk contracts”, that is you may or may not
find oil or gas, and we are talking in Iraq about already well known
defined discovered oil fields, some of them are “elephant” fields,
without any “risk” whatsoever.

2-Oil Reserves and Needed Investment:

The importance of Iraq comes from its high oil reserves, and the
very good possibility of increasing it. It is now clear that there is
shortage of oil in the world, and the shortage will be more in
future, even with the application of “Kyoto Agreement” to control
global warming. We are not going here to infer in a debate
whether we have reached “Peak” stage of oil production, but
definitely we are near it.

There are different figures quoted for world oil reserves. Here we
are taking about “conventional oil”, which excludes bitumen and
sand tar. According to estimate of BP for 2005, the total of oil
reserves are about 1190 billion barrels, 67% of it in the ME, and
77% of it in Opec countries, which may be enough for nearly 40
years, assuming today’s consumption. Out of this reserve about
263 BB, 22% in Saudi Arabia, the biggest reserves in a single

306
Petroleum Fiscal Systems and Contracts

country. Then Iran, 132.5 BB, and Iraq 115 BB as the third
country. There is a lot of talk about exaggeration of Saudi oil
reserves.

Now the question arises; is the importance of Iraq coming only


from its 115 BB? To answer this, a lot of new evaluations and
studies have been done in many reputable institutes and
companies. “The Institute of Analysis of Global Security”, in a
report, issued on 12 May 2003, mentioned different figures. The
report said the “Petroleum Economic Magazine” estimated the
reserves as 200 BB. Also a study by “Federation of American
Scientists”, estimated it as 215 BB. The joint study of the “Council
of Foreign Relations” and “James Baker III Institute Rice
University” raised it to 220 BB. The “Center for Global Energy
Studies and Petrology & Associates” put it as 300 BB.

In a very recent study by HIS, issued in May 200, it said that it


was very easy to add another 100 BB, to raise the Iraqi reserves
to 215 BB. The study of the Iraqi expert Tarik Shafiq put it as 330
BB. As an example, the reserves of East Baghdad field was
always estimated as 11 BB. A very recent study done by one of
the very big companies, that restudied the previous information
and using new technologies, reached a new estimate as 15 BB.

So, we can easily say that USA has found the “Treasure “, which
may contain 25% of world oil reserves. They thought that by
occupying Iraq, the Iranian regime will fall easily, and the whole oil
will be in USA hands. But things did not go the way they wanted it.

The draft oil law included 4 annexes, the first 3 defined 78


discovered oil fields. The fourth annex, specified 65 exploration
blocks, a good number of them contain structures of high
possibility of finding hydrocarbon, but no well has been drilled.
Here, we should mention that in previous exploration in Iraq, 7 out
of 10 exploration wells were successful and oil or gas was found,
so the risk of not finding oil or gas in those blocks is very small.

Different studies, in USA and Iraq, just before the war and after it,
estimated the investment needed to raise oil export to 3.3 MBD
million barrel a day, (or to produce 4 MBD), as 4 B$ billion dollar,

307
Petroleum Fiscal Systems and Contracts

to be spent in 2-3 years. And also estimated the investment


needed to raise exports to 6.3 MBD, as 21 B$, to be spent in 4-5
years. Now some are talking about double of those estimates,
without any new real study, just to frighten some Iraqis that the
investments are very high and we have to accept sharing with
foreign companies. Even if we add 50% to the first estimates that
were done through proper studies, we will need 33 B$ to be spent
in 5-6 years, and production would be increased gradually.

The Iraqi expert, Tarik Shafiq, sent last spring a memorandum to


the Iraqi parliament, informing them that with existing reserves
115 BB, we could develop production gradually to 10 MBD, and
maintain it at this level for 10 years, and continue at this level for
another 10 years when production will start to decrease, and this
could be done without any need to discover another single barrel.
He compared the situation with Russia, where production is
9.5MBD, while oil reserves are only 74 BB.

3-Why the Insistence on Passing the Iraqi Oil Low Now?

The existing laws in Iraq allow all kinds of oil development, except
foreign sharing in Iraqi oil; which means that it would not allow
PSAs. But what USA wants and already planned, are PSAs. So a
law must be issued to satisfy their planning. This could be seen
from the pressure they are putting on the government and
parliament.

As for Iraqis objecting on passing the oil law now, including me,
we see no immediate need for it, since we can develop easily the
oil industry without it. We have the oil fields which can easily
produce 7 MBD, we have the investment needed for a gradual
properly planned development, we have the experience for such
works or we can rent it, and we can buy the technology if needed.
Also there is no problem in export of produced oil, as long as we
plan our gradual increase in production in coordination with
OPEC. Iraq is the only country which can fill the future shortage of
oil.

308
Petroleum Fiscal Systems and Contracts

As a matter of fact there is no need, in my opinion, for a big


immediate increase in oil production with the present oil prices.
Production should depend on the spending capability of Iraq, with
suitable money reserved to cope with unforeseen conditions and
to cover the value of our currency. Export of 3 MBD would give 88
B$ annually, and 5 MBD export would give 146 B$, assuming
price of oil as 80$ per barrel, and these amounts are quite
adequate for all required needs. Foreign investment should be
encouraged in the downstream industries like refineries and
petrochemical plants.

There would be a need for oil law later when safe and stable,
political and social, matured conditions are prevailing. There
would be a need for oil law to suit the new internal political
condition, since we have now a federal state, which needs
reorganisation in the oil industry structure. It should be
reorganised to emphasis central planning and decentralised
application of the plans. Foreign sharing should be clearly
prohibited, and approval of contracts should be under control of
the federal parliament and government, since it concerns all the
Iraqis and not a certain region. A law that includes above
mentioned conditions will help in avoiding chaos in the oil industry;
otherwise it may even cause international problems, like oil price
collapse which will harm Iraq. We should now act fast to pass a
law that re–establishes the Iraqi National Oil Company INOC
immediately.

Kurdistan Regional Government KRG acted on their own. Their


parliament passed their own oil and gas law, and they signed a
good number of contracts, nearly all of them are PSAs. Their
interpretation of the Constitution that they could do that, while
ours, and lot of other Iraqis and members of parliament, have
exactly the opposite interpretation , and consider that KRG oil law
and all oil contracts signed by them are unconstitutional and
illegal.

The Iraqi constitution was prepared and passed in a rushed


manner and under a lot of pressure to satisfy different factions’
requirements. This resulted in a constitution that contains a lot of
contradicting articles, especially that concern oil and gas. If we try

309
Petroleum Fiscal Systems and Contracts

to take it as a whole, and study it thoroughly to solve the


contradictions then, as I think, we will reach the same conclusion
mentioned above, i.e. PSAs are not allowed, and there should be
central planning in expansion including signing new production
contracts, production and export. If we do not reach this
conclusion and agree with KRG one, then we may see in future
several oil laws, and tens of oil production contracts signed with
foreign companies by Iraqi regions and governorates, ending in
chaos and possible collapse of the Iraqi oil industry with all its
consequences on the world oil market. There are several articles
in the constitution that reach clearly the same conclusions that we
reached, for example article 27 states that public property is
“sacrosanct “ and the duty of every Iraqi is to protect it. Oil and
gas are definitely the most valuable public property. Article 111
states that “oil and gas are owned by the people of Iraq in all the
regions and governorates“, which means that no region or
governorate can act independently and without the approval of the
federal parliament and government, also no foreigner can have a
share in Iraqi oil and gas. We all know that with PSAs, the foreign
companies consider their share as part of their assets to raise
their financial position. In any case we can proceed with this
argument furthermore, but this is not the place.

In conclusion, we can say that by passing the law, in the way it is


drafted and without taking our objections, mentioned above, into
consideration, then there will be further increase in the instability
of Iraq, and there will be great chaos not affecting Iraq only, but it
will cover all future world oil markets. There will be always huge
Iraqi public objection, causing the oil law to be very unstable, and
it will certainly be rejected and refused in the very near future. All
this will harm the Iraqi people severely.”

310
Petroleum Fiscal Systems and Contracts

OIL WORKERS’ RIGHTS

Statement by the President of the Oil Unions Federation in


Iraq

The President of the Oil Unions Federation in Iraq has written a


letter to the Iraqi Prime Minister, and to several leaders of oil
unions across the world. The letter (in Arabic) demanded
immediate removal of the Iraqi Government’s ban on Iraqi oil
workers’ rights to form their trade unions, which was originally
passed by the former Iraqi regime, by its decisions no. 150 and
151 in 1987.

The letter stated that the continuation of these decisions is


considered oppressive and a flagrant breach of the present Iraqi
Constitution, and of the human rights enjoyed by the great
majority of oil workers in the world. The Iraqi oil workers asserted
that they would continue their militant action to regain their rightful
democratic gains.

311
Petroleum Fiscal Systems and Contracts

IRAQI OIL EXPERTS PROTESTING AGAINST THE KRG OIL


AGREEMENTS

At the same time as the debate about the Iraqi Draft Oil Law,
there is concern about the actions of the Kurdish Regional
Government (KRG) which has already actioned oil agreements.

Sixty Iraqi oil experts, representing a broad political spectrum,


sent a letter in November 2007 to the Speaker and Members of
Iraqi Parliament and to the Iraqi Minister of Oil. The letter
(reproduced below) denounced the actions taken by the KRG in
signing production sharing agreements, including some outside
the territories of the KRG, and supporting the stance taken by the
Oil Ministry and the oil & gas parliamentary committee. This is an
example of growing solidarity among wide sections of Iraq society
against US occupation and against international oil companies
seen as seeking to deprive the Iraqi people of their natural
resources.

To the Speaker and Members of Iraqi Parliament


November 26, 2007

During the last few weeks, the region of Iraqi Kurdistan


announced on its website and through media that they had signed
nearly 15 production sharing agreements with foreign companies
without the prior approval of the Ministry of Oil or awaiting the
approval of a federal oil law.

The Minister of Oil has correctly declared on a number of


occasions that the Ministry consider all those agreements as
illegal and threatened that the Ministry will take legal action
against those companies as well as putting them in a black list
depriving them from participation in any future contracts with the
Oil Ministry. The Oil & Gas parliamentarian committee adopted a
similar position which is certainly the correct stance that must be
supported by all political and popular groups regardless of their
other politics to stand united against this deliberate and
dangerous action by the KRG.

312
Petroleum Fiscal Systems and Contracts

On another hand, the KRG actions were not only limited to a


policy of signing such contracts but in fact followed a more
dangerous step that has no legal or political standing whatsoever
and that is by overstepping on the rights of other components of
the Iraqi people when it awarded in some of those contracts
blocks that extend well beyond the boundaries of Iraqi Kurdistan
towards Ninewa, Tamim, Salah el-Deen and Diyala including the
one with the US Hunt Oil.

KRG also decided unilaterally to give one of its newly founded oil
companies the responsibility of developing Khurmala which is one
of the three domes of Kirkuk field. Two years ago, SCOP of the
Oil Ministry had recently completed the engineering &
procurement of all related materials and equipment and was about
to start construction activities but were not allowed to do so by
KRG.

The Iraqi oil professionals, who had previously warned in their


previous letters and declarations in February and July 2007 of the
danger of dividing the responsibility of negotiations and signing of
oil contracts and had asked for it to remain exclusively for the
Ministry and Iraq National Oil Company, they now consider the
steps by KRG as illegal.

It was also obvious that the signing of so many contracts within


only a few weeks indicates that KRG had continued negotiations
with foreign companies even while discussing the draft oil law and
regardless of the opinions and reservations of the other political
blocks and popular organisations.

The deliberate action by the authorities of Iraqi Kurdistan and


without any due considerations of other views and objections,
proves clearly that the position taken by the Iraqi oil professionals
previously was a correct one and they would like to confirm their
stance and declare their support for the stance taken by the
Minister of Oil and the Oil & Gas parliamentarian committee in
rejecting those contracts.

They also hope that the legislating bodies will also take into
considerations the vital comments made by the oil professionals

313
Petroleum Fiscal Systems and Contracts

on the various drafts of the oil law and ask them to rewrite it in
such a way that it guarantees the national rights of the Iraqi
people and not to rush into legislating the said law.

314
Petroleum Fiscal Systems and Contracts

IRAQI OIL AND GAS AGREEMENTS

Notes on the Draft Agreement between Shell and the Iraqi Oil
Ministry

Al-Ghad published an important study on the Draft Agreement


signed by between Shell and the Iraqi Oil Ministry.

The “Al-Amir - Shell Agreement Study” (in Arabic) is by the


prominent oil and gas expert Mr Fouad al-Amir. This study comes
during complex conditions in Iraq and an unprecedented world
economic crisis. In Iraq itself, the political situation has been
radically transformed by the now most famous pair of shoes in the
world that turned President Bush’s secret visit to Baghdad into an
international farce, and ignited a high tide of resentment and
determination to throw out the invaders. This was already
reflected by the rejection by the docile Iraqi Parliament of a new
draft Law regulating the presence of foreign troops in the country,
especially the British forces in Iraq.

In this new phase of US occupation of the country, the Draft Gas


Law already signed by the Iraq Oil Minister, comes as new
aggression to loot the huge gas reserves in Iraq. This timely study
by Fouad al-Amir throws new light on the latest attempt to loot the
country.

Iraqi Oil Ministry and Shell Oil Agreement

Al-Ghad published the confidential text (in English) of an


agreement signed by the Iraqi Ministry of Oil and Shell, and a
further document by the Oil Minister proposing surrendering South
Iraq Gas to Shell.

The Shell - Ministry of Oil secret agreement is more important and


far reaching than was expected. The scope of the agreement
covers the whole of gas resources in Southern Iraq. It gives the
impression that it would be a model for further control and
exploitation of the whole oil and gas resources of the country.

315
Petroleum Fiscal Systems and Contracts

The confidential Oil Minister agreement on gas investment comes


at a time of American efforts to force through the Status of Forces
(SOFA) military agreement on the Iraqi Parliament. Al-Ghad
comments that this shows the extent to which the US and
elements in the Iraqi government will go to deprive occupied Iraq
not only of its sovereignty but its extensive natural resources as
well.

Iraqi Lawmakers will Challenge

Iraq's parliamentary oil and gas committee accused the Oil


Ministry of handing a monopoly on Iraq's southern gas fields to
Royal Dutch Shell, and vowed to challenge a contract signed with
the firm. In a statement read out by senior committee member
Noor al-Deen al-Hiyali, the legislative body said there was a lack
of transparency in a flare gas contract the ministry signed with
Shell, which was not in Iraq's best interests. The Anglo-Dutch oil
giant is finalising details of a multibillion-dollar joint venture with
Iraq's state-run Southern Gas Company, before a final agreement
is signed.

A spokesman for the Oil Ministry said the committee had no legal
basis to challenge the deal which Shell says gives exclusive rights
to the joint venture to all natural gas collected as a by-product of
oil production in Basra fields. "Shell will be the sole company
entitled to deal or process gas in southern Iraq," the statement
said. "We call this a monopoly on Iraqi gas ... Shell will seize
everything." It added that if the Oil Minister does not respond to
their complaint, "we will resort to the constitution and adopt
procedures ... to safeguard Iraqi resources". Unless it challenges
the legality of the deal in court, there is little the oil and gas
committee can do to stop it, the ministry says. The committee said
it would summon the Minister of Oil to justify the Shell deal before
parliament. It expressed alarm that such a large deal could be
signed without any tendering process.

Gas produced as a by-product of oil extraction is currently flared


off in Iraq since no facilities exist to capture it. Iraq wants to use
most of the gas to generate electricity, then export surpluses. The

316
Petroleum Fiscal Systems and Contracts

committee said Shell would hold the country hostage to


international prices for this gas. Jihad said such concerns were
unfounded. "The oil ministry is acting by the book. There are laws
entitling us to strike deals to develop the oil industry," he said. He
added that the Oil Minister would be more than happy to appear
before parliament to discuss the contract, which he said was in its
preliminary stages. Any deal would require Shell to sell the gas to
Iraq at subsidised prices, he said. "We have a whole year to
discuss terms," he said.

BP

The longer-term link would help ensure that work undertaken


under the two-year service contracts would be in line with future
field development plans said Peacock.

Peacock said he was confident that the majors and Iraqi


negotiators would come up with a contract that gave an incentive
for firms to use all their skills and expertise, while at the same time
respecting political opposition in Iraq to deals that gave
companies a share in production.

The terms of the contracts could set the pace of oil field
development for years to come, he said. "I think it's important
acknowledging the political sensitivity of using barrels as a form of
reward," Peacock said. "That shouldn't be confused with giving up
national sovereignty over the ownership -- that's never in question.
The question is, do you want to use barrels or cash as a form of
reward? Whichever it is, I think, is going to be key for the long
term. It will determine how fast production can be realised and
how fast new developments can be brought on stream."

The service contract Iraq is negotiating is for the giant Rumaila oil
field in the country's south. The target to boost output by 100,000
bpd from the field was possible, although to do so in two years
would require an aggressive development plan, Peacock said.

The contracts call for larger project management roles in the fields
than the majors previously had. Aside from boosting production

317
Petroleum Fiscal Systems and Contracts

and long-term planning, the oil firms would be required to bring in


supplies to Iraq. Majors will supervise the work from outside of the
country as security concerns will prevent them from sending in
ground staff, at least initially.

The companies have studied the same fields and for years
provided training and technical assistance as they looked to
position themselves for any future contracts. "We've studied the
whole of the rest of the country, so we're waiting for what comes
next after the service agreements. And we have an opinion on
which bits we'd be more interested in," Peacock said.

Iraq and China Sign $3 Billion Oil Contract

Iraq has signed a $3 billion deal to develop a large Iraqi oil field.
This is the first major commercial oil contract in Iraq with a foreign
company since the 2003 US led invasion.

The Oil Ministry said that the 20-year agreement calls for the
state-owned China National Petroleum Corporation to begin
producing 25,000 barrels of oil a day and gradually increase the
output to 125,000 barrels a day.

The contract revamps a deal the Chinese company had reached


with Saddam Hussein in 1997 to develop the Ahdab oil field in
Wasit province, south of Baghdad near the border with Iran.
Unlike that deal, which called for China to share in the revenue,
the current contract is based on a fixed-fee structure.

Western oil companies have come close to reaching agreements


with the ministry to return to Iraq. Those smaller technical service
contracts involved giving advice on how to boost production. The
China deal is a service contract, which is more lucrative and
involves large scale development of the field.

The Ministry of Oil said the technical service contracts, which


were to be finalised on June 30, have been delayed as
negotiations continue with the Western concerns, including Shell,
BP and Exxon Mobil. Most of the major oil contracts are to be

318
Petroleum Fiscal Systems and Contracts

awarded in the next one and a half years through a process


involving 35 companies identified by the Oil Ministry.

Iraqi officials hope the deal with China "will refute all the rumours
that say the American companies are the only ones benefiting
from the American occupation." The contract also requires China
to build a major electrical station in the area to help boost Iraq's
overworked power grid. The deal required the approval of the Iraqi
cabinet, which the Oil Ministry expected shortly.

Service Contract Terms

The deals on offer are 20-year service contracts that offer a fixed
fee for work undertaken. They do not give foreign oil firms the
right to book reserves for accounting purposes, and they do not
give firms a share of production or profits. Big oil firms prefer
production sharing deals rather than service contracts.

Competing firms are only allowed to win one contract as a field


operator. They may participate in a maximum of three contract
areas in total, whether as lead operator or as members of
consortia. Final contracts were due to be signed in August.

Iraq has encouraged companies to form consortia to bid for the


contracts. The field operator, or lead contractor, must hold at least
30 per cent in the consortium. Partners must hold a minimum 5
per cent stake.

Bidding parameters

Companies will bid for oilfields against two parameters:


1. A fixed US dollar fee per barrel for increased oil
production.
2. The increased production target for each field, in barrels
per day. This target must be maintained for seven years.

Companies will bid for gas fields against two parameters:


1. A fixed US dollar fee per barrel of oil equivalent of gas
produced.

319
Petroleum Fiscal Systems and Contracts

2. The production target for the field, in million cubic feet per
day.

Equity Stakes

Competing companies and consortia will take a 75 percent stake


in new joint ventures formed with local units of Iraq's state oil firms
operating at the fields. Iraq will hold the remaining 25 percent.

But Iraq will not be investing in the programmes to boost output


from the fields, so winning bidders will foot the full cost of
development. Iraq will repay its 25 percent to oil firms with oil
produced from the fields.

Signature Bonuses

Baghdad shocked bidders by requesting $2.6 billion in signature


bonuses for the fields to plug gaps in the state budget due to the
decline in oil prices from last year's highs.

The country's oil minister later described the bonuses as soft


loans. Analysts say energy firms will recover the cost of the soft
loans through their bids. Under the contract terms, the bonuses
will accrue interest and be recovered as a supplementary cost
over a five year period, starting two years after the contract
becomes effective. Bonuses were due to be paid in September.

Payment

Contractors have the option to receive payment in cash or oil. The


contracts state Iraq would prefer to pay in export oil.

A maximum of half the revenues from increased production


achieved by the oil companies can be used to pay down service
fees. The size of the output boost would be judged against output
the fields would have achieved in theory without the service
contracts, called baseline production.

Supplementary costs will be recoverable from baseline


production. Supplementary costs include signature bonuses,

320
Petroleum Fiscal Systems and Contracts

clearing mines and cleaning up pollution at fields. Aside from


signature bonuses, supplementary costs would be paid soon after
the contract begins.

Decline Rate

Iraq has set a decline rate of 5 per cent per year to baseline
production to measure how much contractors boost production.
The exception is Bai Hassan, where the decline rate would kick in
10 years into the contract.

Government Revenue

Iraq has awarded a BP-led consortium the right to develop the


giant Rumaila oil field but failed to strike deals for seven oil and
gas fields as companies balked at the country's contract terms.
The outcome raised questions about how quickly Iraq could
rehabilitate its oil sector, which has suffered from years of war and
neglect. The country relies on oil sales for more than 90% of
government revenue.

Iraqi officials hailed the sole award for the Rumaila field, believed
to have 17 billion barrels in oil reserves. This will boost oil output
from the current 2.4 million barrels a day to more than four million
barrels a day, which was the ministry's goal.

"We're very pleased with what we've got, but we'll wait to see
what happens next," a BP spokesman said, alluding to criticism
from some lawmakers who have questioned the legality of the
deals. "We haven't signed any contracts yet."

The Iraqi oil ministry set aggressive pricing for the 20-year
technical-service contracts in which companies will be paid a fee
for boosting output. The oil ministry typically offered a maximum
bonus for any output beyond current levels at $2 a barrel for
several fields - a figure that proved a deal breaker, according to a
number of oil executives. Company bids ranged from about twice
that figure, in most cases, to more than 10 times the oil ministry
amount. "It's a losing proposition," one official at an Asian oil

321
Petroleum Fiscal Systems and Contracts

company said of the ministry's payouts. "It's not worth it for us to


pursue this."

Auction of Oil and Gas Field Contracts

At the end of June 2009 Iraq offered by auction contracts to run


eight giant oil and gas fields but encountered reluctance from
foreign companies over paying the high fees it wanted. Oil
companies also did not like the idea of getting paid a set fee for
every barrel produced. The industry typically signs contracts
which give it ownership of a portion of the oil pumped from the
ground. However, companies were willing to bid on the unusual
fee-for-service contracts because of the enormous size of Iraq's
reserves. Revitalising old oil and gas fields requires a large up-
front investment, and the companies wanted contracts that gave
them a chance for a good return. "We're not some non-profit
charity," said an executive at a Western oil concern involved in the
process. "The terms on offer were unrealistic."

Under the bidding conditions, the oil firms had to agree to the oil
ministry's per-barrel production bonus, and many declined to do
so. Because only one field was awarded, the Oil Minister
adjourned bidding early.

Six oil fields and two gas fields were up for bid, marking the
opening to Western companies of a sector Iraq nationalised in
1972. The Oil Minister gave the companies that scored the
highest points for bidding for each field a chance to resubmit their
bids. The points were based on the company's bonus proposal
and its peak-production standard for the field. The Iraqi cabinet
will consider revised proposals. It is unclear whether they will hold
another bidding process or if the oil ministry will compromise on its
terms.

"We're going to regroup first before we decide if we want to


change our offer," said one Western oil company official. The BP
plc group, which included China National Petroleum Co.,
submitted a bid of a $3.99 per-barrel bonus. Ultimately, the group
accepted the ministry's $2 a barrel payment.

322
Petroleum Fiscal Systems and Contracts

Figure 11.2 Location of auctioned licenses (map printed in The Wall


Street Journal)

Oil Giants To Sign Contracts With Iraq

In 2009, Iraq is preparing to allow four of the biggest western oil


companies to renew exploitation of the country's vast reserves for
the first time in almost four decades.

Iraq's oil ministry stepped up talks with BP, Exxon Mobil, Shell and
Total after the US vice-president, Dick Cheney, visited Iraq in
March, where he also pressed the government to revive efforts to
pass the hydrocarbon law that nationalist MPs were blocking. The
first contracts are expected to be signed shortly. Some 90% of
Iraq's budget comes from oil revenues.

323
Petroleum Fiscal Systems and Contracts

Iraq's oil minister, told the Guardian that the deals did not amount
to the privatisation of the country's oil. But the four companies are
heirs to the consortium given the concession to control Iraq's oil
by King Faisal, the foreign Sunni Arab whom the British imposed
on Iraq's majority Shia population after occupying the country
during the first world war. They lost their right to explore new fields
in 1961 after the monarchy was overthrown, and nationalisation
followed under the Ba'ath party.

There was no competitive bidding for the concessions, which are


to be awarded to the four giants plus Chevron and some smaller
companies. After the US-led invasion in 2003, the companies
supplied advisers and trainers to the oil ministry for free in the
hope of getting a foot in the door. The Russian company Lukoil
did the same but lost the contract for Iraq's largest undeveloped
field to Total and Chevron. Chinese and Indian firms also lost out.
Laws on how to develop Iraq's oil and share the profits between
its regions stalled in parliament in autumn 2008.

To calm nationalist fears, the contracts are limited to "technical


support" for two years. The companies will sell expertise and
equipment rather than providing capital and management control.
The aim is to increase production by 100,000 barrels a day in
each of the four fields.

But the deals, known as service contracts, are unusual, said Greg
Mutitt, co-director of Platform, an oil industry research group.
"Normally such service contracts are carried out by specialist
companies. The majors are not normally interested in such deals,
preferring to invest in projects that give them a stake in ownership
of extracted oil and the potential for large profits. The explanation
is that they see them as a stepping stone..." He said the
companies' lawyers had been insisting "on extension rights under
which each company would get first preference on any future
contract for the field on which it has worked".

324
Petroleum Fiscal Systems and Contracts

Iraq’s Technical Support And Production Service Contracts

The original objective of Iraq’s technical support contract (TSC)


was to provide a temporary solution allowing the Ministry of Oil to
expand production capacity and improve performance and
recovery, while the political debate went on between the Kurdistan
Regional Government (KRG) and the Iraqi federal government
about the conflict over distribution of power and decision-making
authority. In the meantime, the KRG has actively granted some
two dozen production sharing agreements (PSAs) and pursued oil
exploration and production operations without reference to the
federal government or the draft petroleum law in its modified
version, previously accepted by the KRG. The oil ministry’s
principled stand in this respect and with respect to other vital oil
plans and policy has gained the respect and approval of the bulk
of Iraq’s oil technocrats.

Some aspects of the plans and policy announced recently by the


Minister of Oil and the Prime Minister are alarming. They
contravene the draft petroleum law, which has been approved by
the Ministerial Committee and the Council of Ministers, and exhibit
management failures.

The Prime Minister’s call to form a National Council for


Reconstruction and Development, which may include the oil
sector, is in conflict with all draft versions of the petroleum law,
which places authority for the oil resource management with the
oil ministry, Iraq National Oil Company (INOC) and related
regional organisations. It is contrary to sound management
practices and highlights the Council of Ministers’ inability to
formulate overall policy and supervise the plans, policy and
performance of its ministries. It is tantamount to an admittance of
incompetence on the part of ministries and/or a tendency to
centralise decisions by the office of the Prime Minister.

The Ministry of Oil’s declared plans to tender long-term PSCs for


current producing fields infringes on INOC’s rights and scope of
work and appears to deviate from its past stance.

325
Petroleum Fiscal Systems and Contracts

The first draft petroleum law, adopted by the Ministry of Oil in full,
stipulated that INOC be earmarked to operate all the producing
and discovered fields. The approved draft of February 2008
adopted a compromise by dividing these fields into three
categories, of which only two were allocated to INOC, to
accommodate KRG, which still considered it unacceptable. To
restrict INOC’s options now and remove it from its role of the
operator is unwise and uncalled for, if not totally unsound policy.

INOC had been authorised, in accordance with all the different


versions of the petroleum law, to manage these fields and to call
for technical support as it sees fit from among consultants,
engineering and contracting firms or international oil companies
(IOCs). The oil ministry’s plan to grant PSCs with IOCs
undertaking the operator’s role, for a 20-year term and with 75%
participation, removes from INOC and/or the North and South
Companies the operator’s role and reverses a three-decade-old
practice, placing operatorship back into the hands of IOCs.

Already two regional companies have recently been founded, in


addition to the existing North and South Companies and KRG’s
own regional national oil company. If this plan is pursued further
and alleviates the need for INOC, it would form a nucleus for
uncoordinated and fragmented management of the oil and gas
resources. It would also facilitate adoption of the open-market
policy demanded by the US’s neoconservatives prior to the 2003
invasion, and more recently reiterated by one or two political
leaders, to the extent that it becomes a free-for-all for IOCs and
private enterprise to the detriment of Iraq’s domestic economy and
the unity of Iraq as a country and a nation.

If this plan is pursued, it would be a reversal of the first draft


petroleum law stipulation whereby INOC was tasked to
rehabilitate the infrastructure and build production capacity from
the 80 discovered producing fields through its profit-making
operating subsidiaries (50% owned by the regions and/or
provinces) incorporating the regions and provinces at board level,
to share in the management of the development sector and thus
unite, not fragment, the resource management of the nation.

326
Petroleum Fiscal Systems and Contracts

Neither the TSC nor the PSC model contracts of the Ministry of Oil
have yet been made public, nor have they been studied or
approved by a formal committee, such as the one postulated in
the Federal Oil and Gas Council and its professional think-tank, or
one made up of Iraqi oil professionals engaged by the Ministry of
Oil.

The ministry’s announcement of the use of long term PSCs in the


forthcoming tenders, following the application of TSCs for the old
super-giant producing oil fields, is incompatible with the
constitution and the latest draft petroleum law of February 2007,
adopted by the Council of Ministers and passed to the Council of
Representatives (Parliament). The highest return demanded by
the Constitution for Iraq’s most valuable natural resource, its oil
and gas assets, owned by the state, is best entrusted to an
enterprise accountable to the nation, which unites the nation and
operates in co-operation with IOCs on technology transfer and
related parameters, not the other way around by placing INOC
under de facto custody of IOCs and its joint management in
accordance with the PSCs. The PSCs theoretically preserve the
country’s sovereignty intact but it is their detailed terms which
decide whether this may or may not occur. It would have been
prudent for the Ministry of Oil to plan the development of
discovered but undeveloped fields, rather than the current
producing fields, while passing a law to launch INOC.

The federal government should no longer hold up legislating the


INOC draft law, which has been on the back burner for two years,
while it waits for the enactment of the draft petroleum law and
related oil revenue distribution among the Governorates, simply
on the dictation of the KRG, which has gone ahead with legislating
its own petroleum law and national oil company and granting a
dozen PSAs.

The original intention behind the TSC, as a temporary solution for


a year or two to increase the production capacity of current
producing fields by 500,000 b/d, would have been welcome had it
not been for its escalated cost, the negotiated approach taken, the
replacement of transparent tender specifications and competitive

327
Petroleum Fiscal Systems and Contracts

bidding, and the first right of refusal demanded by the IOCs in


addition to other attached benefits and privileges.

Memorandum of Understanding (MOU) holders have been given


the advantage over others in the process of pre-qualifying and
granting of contracts, thereby undermining the transparency and
credibility of the pre-qualification and competitive bidding process.
This is unjustifiable in the first place. MOUs were enacted on the
principle of no obligation or remuneration, yet IOCs have been
granted no-bid TSCs and some have even been ear-marked for
PSCs for particular fields and multi-billion dollar projects, on the
basis of negotiations instead of a bidding process.

It is regrettable that, despite criticism, the Ministry of Oil, like most


other Iraqi government establishments, has not yet managed to
adapt to a more open, transparent way of working. It is time that
the ministry built an organisation of sufficient capacity and
competence to be able to enlighten the public on the most vital
economic resource of the nation. Often oil policy, plans and
agreements are complicated. The absence of transparency, not
keeping the public informed and not encouraging debate by the
nation's oil technocrats, NGOs and civil society, invite unhealthy
speculation to the detriment of the government and national
interest.

The Ministry of Oil’s moves to activate the rehabilitation of the


infrastructure and enlarge production capacity are vital, but should
not have prevented an equally proactive move towards the
unitisation of the border fields, of which there are more than half a
dozen with Iran, Kuwait and Syria. With every day’s delay, there is
a huge loss of national wealth, potential damage to the
underground oil and gas resources and difficulties from having to
reverse the clock to extract lost assets. Iraqi skills could and
should have been used to complement the ministry’s dire need for
competent managerial personnel to assist in negotiations, to make
plans, and to decide policy and related managerial unitisation
issues.

Furthermore, many Iraqi oil professionals and expatriate


consultants are playing an important role in the Kurdistan and the

328
Petroleum Fiscal Systems and Contracts

international oil industry. Is it not time for the Ministry of Oil to


engage them to meet its own needs, to fulfil a vital role in
participating with IOCs holding PSCs or TSCs and particularly on
consultancy assignments involving sensitive national issues, such
as model contracts, bid specifications and evaluations?

The petroleum draft law demands ‘Local Content’ obligations from


foreign firms. However, experience demonstrates that foreign
firms are reluctant unless the Ministry of Oil also engages its own
nationals on terms commensurate with their counterpart foreign
consultants, and issues directives to IOCs to comply with the
same obligations regarding local content.

It is time that the Ministry of Oil borrowed a page from the book of
other major producers, such as Iran and Russia, where national
participation in accordance with local contracts, rules and
regulations is set at a minimum of 51%, and in Norway where it is
70%.

It is in the national interest to include and activate a local content


clause in consultants’ contracts, so they take on technically
qualified Iraqi consultants. Likewise, IOCs should provide
participation for Iraqi oil companies as shareholders from within,
and not limit the use of local content to sub-contracting local firms
to provide services from without.

It is regrettable that the Prime Minister has moved to establish this


National Council for Reconstruction and Development. Equally
regrettable is the fact that the Minister of Oil plans to award no-bid
TSCs exclusively to MOU holders and long-term PSCs for
currently major oil producing fields, while leaving on a slow track
the unitisation of the border oil fields and paying little attention to
applying the principles of local content. Clearly, the PM and the
Minister of Oil are ill-advised.

329
Petroleum Fiscal Systems and Contracts

Iraq Fails to Award Most Oil Contracts in Bid Round

Iraq fell short of its goal to assign development rights for six oil
and two natural gas fields in the bidding round. A service
agreement for the Rumaila oil field won by a BP Plc-led group was
the only contract awarded. Iraq wants to increase production more
than 60 percent from the fields on offer, potentially raising $1.7
trillion in profit over 20 years for the country, the Oil Minister said
in a speech broadcast on live television at the start of the round.
“What a fiasco,” said Rochdi Younsi, an analyst at Eurasia Group
in Washington, D.C. “It shows the discrepancy between Iraq’s
expectations and what companies were willing to offer.”

Companies including Exxon Mobil Corporation and Royal Dutch


Shell Plc failed to meet Iraqi terms as the government asked
bidders to cut their fees during a bidding ceremony, parts of which
were shown on state television. The Cabinet will meet to be
briefed on the licensing round by the Minister of Oil and to decide
how to attract investors for the oil deposits, a government
spokesman said on 30th June.2009.

BP and China National Petroleum Corporation won the


development contract for Rumaila, the largest of the eight fields in
the bidding round, as the country rejected bids for other licenses
in its first international tender for more than 30 years.

A total of 22 companies, out of 35 that Iraq pre-qualified to take


part in the round, made 15 bids for $16 billion worth of technical
service contracts. Iraq invited international oil companies back into
the country after kicking them out in 1972, when the party of late
dictator Saddam Hussein nationalised concessions. Iraq failed to
agree with companies for six sites, including the Kirkuk and West
Qurna oilfields, and received no bids for the Mansuriya natural
gas field, the second it offered. “Iraq wanted to squeeze the
margins as much as possible for investors, and they squeezed too
much,” said Samuel Ciszuk, an analyst at IHS Global Insight in
London. Whilst crude traded for more than $70 a barrel, the most
Iraq offered to pay to develop an oil field Tuesday was $4 per
barrel of additional output for Bai Hassan, with the lowest
remuneration fee $1.90 a barrel for West Qurna.

330
Petroleum Fiscal Systems and Contracts

A ConocoPhillips-led group, the only bidder for Bai Hassan,


offered to develop the oil field for $26.70 a barrel and refused to
agree to the terms sought by the government. The BP-led group
beat a bid from Irving, Texas-based Exxon and Malaysia’s
Petronas Carigali Sdn. Bhd. for Rumaila after improving their offer
by cutting oil production costs to be paid back over the life of the
contract. The group agreed to develop the field at a cost of $2 a
barrel after recovering investment, lower than the prices that BP
and Exxon initially bid, the ministry said in a statement. The
technical service contract will run for 20 years and can be
extended for another five, Beijing-based CNPC said in a
statement on its website.

“We’re satisfied with Rumaila,” the Oil Ministry, said after the
close of bidding. “It’s a big field and we gave the contract on our
terms.”

The BP group agreed to boost output at Rumaila, which now


produces 956,000 barrels of oil a day, to a plateau of 2.85 million
barrels of oil a day. BP’s initial bid for the remuneration fee was
$3.99 a barrel. Iraq is struggling to raise output and revenue from
crude sales after six years of conflict and prior sanctions
destroyed the economy and infrastructure. The government aimed
to boost oil output to 4 million barrels a day within five years, using
extra output from the fields in the round, from about 2.4 million
barrels now. US combat troops, under agreement with the Iraqi
government, have left the country’s cities in a step toward a
planned full withdrawal by the end of 2011.

During the bidding round, groups led by Italy’s Eni SpA and China
National dropped their proposals to develop the Zubair oil field in
southern Iraq after rejecting the maximum fee being offered.

Shell abandoned a bid to develop the Kirkuk, West Qurna oil field,
together with China Petroleum & Chemical Corporation and
Turkish Petroleum Corporation. Exxon and Shell withdrew their
offer to develop the West Qurna field in the country’s south after
being asked to reconsider their bid. Total SA and groups led by
OAO Lukoil, Repsol YPF SA and China National also bid for West

331
Petroleum Fiscal Systems and Contracts

Qurna.

Iraq later in 2009 plans to hold a second auction round for 11 oil
and gas fields with the aim to boost production to about 6 million
barrels a day by 2015. Saudi Arabia, the world’s biggest oil
producer in the Organisation of Petroleum Exporting Countries,
pumps about 8 million barrels of crude a day now.

Kurdistan Brands Iraq Oil Contracts as 'Unconstitutional'

Figure 11.3 Oil refinery near the village of Taq Taq in the
autonomous Iraqi region of Kurdistan

AFP reported that Iraq's autonomous Kurdish region hit out at


Baghdad, describing as "unconstitutional" oil and gas contracts
due to be awarded by the federal government at the end of June
2009.

The Iraqi oil ministry and Kurdistan are at loggerheads over how
international companies involved in the tapping of the nation's vast
energy reserves should be paid. Iraq's decision to award service
contracts differs from Kurdistan, where numerous profit-sharing
deals have been struck. A statement issued by the Kurdish
government said Baghdad's policy was "unconstitutional and
against the economic interests of the Iraqi people." "The regional
government of Kurdistan has made clear progress in increasing
Iraq's oil exports and oil revenues in a short time," it said. "This

332
Petroleum Fiscal Systems and Contracts

progress has been made by focussing on exploration and not on


existing fields, in line with the best practices of international
markets, and in accordance with the principles of the Constitution
of Iraq. "The regional government regrets that it cannot say the
same thing on the procedures taken by the Federal Ministry of Oil
of Iraq," the statement added.

Article 109 of Iraq's constitution says that oil and gas resources
must be developed "in a way that achieves the highest benefit to
the Iraqi people," in a way "consistent with market principles and
that best encourages investment." Iraq's Oil Minister has been
accused of taking an ultra-nationalist approach, possibly deterring
investment, by insisting that oil wealth, meaning profits, cannot be
shared with foreign companies. He has also come under criticism
from MPs who accuse him of mismanagement resulting in 10
billion dollars in lost revenue for a federal budget that is projected
to go into deficit.

The service agreement shortlist was first announced by Baghdad


in June 2008 and includes global energy giants Exxon Mobil,
Royal Dutch Shell, Chevron and Sinopec, as well as large Iraqi
state-owned operators. The oil ministry has since repeatedly
delayed announcing the bid winners. Although Iraq has the world's
third largest proven reserves of oil after Saudi Arabia and Iran,
development of the conflict-ravaged country's fields has been very
slow.

333
Petroleum Fiscal Systems and Contracts

IRAQ’S TECHNICAL SERVICE CONTRACT (TSC) AND


PRODUCTION SHARING CONTRACT (PSC)
AGREEMENTS – A GOOD DEAL FOR IRAQ?

Introduction

I would like to analyse some of the points of an article by Peter


Wells so as to see the differences in opinion and be able to
analyse the Iraqi contracts under available conditions. I agree
there is not enough available information to enable a third party to
fully evaluate the reservoir engineering and the economics of
contract parameters. However, I will use the same information as
Mr. Wells and go through the contracts from the engineering and
economic points of view.

In the model PSC agreement published by the KRG, commercial


terms are not precisely defined. I think this is done deliberately by
the KRG so that there is more room to manoeuvre when
discussing the parameters with contractors separately from case
to case. The Regional Ministry of Oil for Kurdistan, with the
leaders of KRG, have a free hand to evaluate the cases
geopolitically and financially and to decide from case to case
differently.

The KRG PSC with Shamaran Petroleum Corporation

A diverting item in the published costs is the payment of some


$7.5 MM to third party fees. This kind of payment is very common
in the project evaluation. Third party fees can mean many things,
such as studies, PMT and/or Miscellaneous costs. It is not
necessary to look in detail for this small portion in relation to the
concept and the whole revenue to the state of Iraq and Kurdistan-
Iraq.

Shamaran analysed reserves cases vary from 100 MM to 250 MM


barrels at oil prices from $65/bbl to $100/bbl (Brent). How and
which method is used to calculate this kind of reserves? Are these
reserves calculated by Shamaran or by a third party, possibly as a
feasibility study?

334
Petroleum Fiscal Systems and Contracts

Besides the calculations of the Regional Ministry of Oil KRG,


Shamaran should calculate the sensitivity parameters for the
KRG, illustrating the net present value (NPV) and the internal rate
of return (IRR). For example, using oil prices of 60, 70, 80, 90 100
and maybe120 USD/bbl. This variation (uncertainty) in the output
of the calculations can be apportioned, qualitatively and
quantitatively, to different companies. The uncertainty in
development Capex should be expressed for example as +?% at
basic condition, production -?% at basic condition and delay in
production start etc.

The production forecast is usually based on reservoir simulation


and summation of the individual well production profiles over the
field life. Which time period has been calculated here? The
maximum production of an individual well is limited by the
maximum efficiency rate (MER). There is no real information
about the case mentioned above.

Estimation should be made of expected production against project


capital expenditures (Capex) and operating expenditures (Opex)
for the field in the production period. The specific Capex and
specific Opex should be calculated here. The Opex should be
divided clearly into several units related to the tasks of the
operation; this is again not well defined.

Project Economics KRG PSC Criteria

Are the project economics calculated on a full cycle basis?. It is


important for the KRG to see the differences; this can also
increase or decrease the contractor’s IRR.

The input parameters mentioned in Table 11.1 below represent


the base input for the economics calculation. But have these costs
been escalated and, if so, which percentage of escalation has
been used? The applied crude price scenario is low and
unrealistic. It should be at least 30% greater in USD/bbl than the
proposed price, averaged for the entire project lifetime. I agree
here with Peter Wells it is a significant crude price windfall.

335
Petroleum Fiscal Systems and Contracts

The profitability of the investment is represented by the NPV of


the discounted future cash flows and the IRR. The applied
discount rate is 10%. NPV and IRR values until the end of
production period are illustrated in the table below as between 34-
56%. I agree that these numbers are too high and are not
comparable with any OPEC country.

The Recovery of Capital should be illustrated, showing how the


costs carried forward will be reduced and over what time period.

The costs estimated are exploration, appraisal and development


costs and operating expenditures (Opex) but are full-cycle or
forward costs calculated?

The exploration/G&G costs, drilling costs and G&A costs are not
clearly illustrated in the table below. The capital expenditure
(Capex) estimation should be very clearly specified in years for all
activities. The overall accuracy of the cost estimation and cost
contingency in the table are not clear. How are the proposed
GOSP and pipeline infrastructure cost estimates divided and what
are the estimates based on?

The G&A costs are based on how many persons and what rate?
The estimate is low and not realistic. It is expected that Workover
activities will be conducted during the field life but how has the
cost of intervention been calculated? The cost distribution of this
activity is also not clearly identified.

How are the Facilities Operation frame work and Crude Oil
Transportation defined? Which loading charge, pipeline charge
and lifting programme have been applied?. How are the fixed
operating costs calculated?. The table shows USD 20 MM/year.
Comparable cases in the Middle East are USD 25 MM/year for a
production of approximately 25000 bbl/day. Total variable Opex
costs are linked directly to the oil production quantity. How are
they calculated?

There are no charts or terms to show us the contract conditions of


the exploration and PSC agreement between KRG and Shamaran

336
Petroleum Fiscal Systems and Contracts

Oil Corporation. There is neither a development schedule nor an


economic-technical concept.

Therefore, the results of any comparison possible between the


two types of contract and the revenue from both contracts may be
poor. A very important issue to recognise is that the TSCs are
service contracts with no excess for the ownership of oil whilst the
PSC agreement allows the contractors to have the excess as a
partner ownership for the oil and gas.

337
Petroleum Fiscal Systems and Contracts

Exploration period Initial term 5 years, extendable by 2 years.

Development period Initial term 20 years, extendable by up to two 5


year periods.

Signature and capacity $45mn


building bonuses

Royalty rate 10%

Cost recovery ceiling 40%

Profit Oil parameters R factor: (0 to 1) 26%; (1 to 2) sliding scale


between 26 and 13%; (>2) 13%.

Exploration costs $72mn

Capital costs $508mn

Fixed operating costs $20mn/year

Variable operating costs $2/B

Reserves 250mn barrels

$65/B Brent $80/B Brent $100/B Brent

Net Present Value at $460mn $624mn $802mn


10% discount rate
(NPV10)

Rate of Return (ROR) 34% 44% 56%

Table 11.1 Main commercial terms of the Shamaran PSC for


Pulkhama oil field (after Peter Wells)

338
Petroleum Fiscal Systems and Contracts

The West Qurna 1 Project, Iraq

Reservoir Characteristics

Before we go into further analyses, we should look at the point


"the Ministry of Oil has published an estimate of reserves for the
project of 8.6 bn barrels”. With Peter Wells’ estimation of oil-in-
place of ~25bn barrels, this yields a recovery factor of ~35%. In
order to achieve the 25bn barrels, all information gathered from
seismic interpretation, geology and petrophysics should have
been compiled into three dimensional models for example. The
structural model provides all relevant information with respect to
the geometry of the field, and the property model describes
petrophysical properties, in particular porosity, permeability and
water saturation in three dimensions. The scope of static
modelling is the estimation of OIIP and to provide the initial static
data for the simulation of oil and water flow in a later stage. Is the
volumetric calculation based on the minimum and maximum
geostatic realisations of the porosity and which case is used?
Were uncertainties considered in the sensitivity analysis? Are
there test results available, comprising MDT evaluation, DST
results and PVT data. How is the exploitation concept described?
How is dynamic modelling used with calculated reserves and
expected production profiles?

The main reservoirs in the field (Mishrif and Yamama) are


carbonates with limited aquifer support. If the structure is flat and
the aquifer is far away from the main oil volume in Mishrif and
Yamama, that means no indication of an active aquifer. All these
causes necessitate foreseeing pressure maintenance with water
injection using a part of the produced water (if any) from separate
fields or treated sea water. Gas injection in my opinion is not an
alternative because Iraq needs gas for domestic consumers.

Production Profile

The production profile from ExxonMobil’s bid is for a plateau 2.325


MM bbl/d. The production profile from Peter Wells is 1 MM bbl/d
and from myself 1.5 MM bbl/d. The last two profiles provide stable
production profile plateaux for a long period. My point of view for

339
Petroleum Fiscal Systems and Contracts

example is to choose a production profile with different scenarios


as follows:

Production Profile Example for West Qurna 1, with


Recoverable Reserves 10.2 bn bbl and Decline Rate between 5
and 7%, Recovery factor approx. 45 to 50%
2

1.8

1.6

1.4

1.2

b/d
1

0.8

0.6

0.4

0.2

0
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31
years

Figure 11.4 Production profile example for West Qurna 1

340
Petroleum Fiscal Systems and Contracts

Figure 11.5 Comparison of Bid and Peter Wells' estimates of most


likely production profile for West Qurna 1

The objective of optimising reservoir management is to reach a


high and stable production rate in a short time and maintain this
for a long period. There are no long term benefits to reaching a
peak in seven years of production and then going into a decline.
Good reservoir management means advancing (accelerating)
production, increasing plateau rate, extending plateau life,
arresting (flattening) decline rate and finally enhancing post-
plateau production. The proposed possible production profile from
ExxonMobil illustrated in Figure 2 is not optimal. Middle East
OPEC oil fields have been developed with very conservative
production profiles – typically with a plateau rate (b/d) to reserves
(MM barrels) ratio of 50-80. This approach has advantages in
providing stable long term revenues, a long production life of the
field and a slow unfolding of reservoir problems. A plateau rate of
2.325mn b/d for West Qurna 1, even with reserves of 8.6, 15 and
25 bn barrels, represents plateau/reserves ratios of more than
270, 150 and 93 – comparable with many large non-OPEC oil
fields such as Forties in the UK North Sea. The recovery factor of
60% and the decline rate of 13% in comparison with other fields
worldwide are high. Here I agree with this point in the report.

341
Petroleum Fiscal Systems and Contracts

OPEC and Global Oil Supply-Demand

Addressing the World Petroleum Congress in Johannesburg,


Minister Ali Al-Na'imi on September 27, 2005, said Saudi
Aramco's oil output capacity of 15 MM bbl/d could be reached
before 2012. Na'imi then said Saudi oil reserves were
conservatively estimated. Using state-of-the-art technology, he
said, Saudi Aramco will "soon be able to boost our proved oil
reserves by 200 bn barrels" to more than 464 bn barrels. From
this announced ambition, there is no expectation for Iraq to boost
its production in the near future.

Figure 11.6 below illustrates how Iraqi oil production was not
stable over the years of war, sanctions and political turbulence.
Even in the period of democratic Iraq, there was still insufficient
regulation and laws to regulate the oil and gas wealth especially in
the main Iraq region. The Arab Gulf states in comparison are
politically stable and plan exploration and production of oil and
gas. Iraq needs to start a huge rebuilding process of the country.
Therefore, it does not need to wait for OPEC members to allow
space to produce more oil. The development oil and gas fields in
Iraq are very important.

342
Petroleum Fiscal Systems and Contracts

Figure 11.6 Iraqi crude oil production

The call on OPEC for Iraq’s oil production only rises above 2007
levels after 2014 and reaches some 42mn b/d in 2022. But there
are other world oil estimations which illustrate the demand for oil
in 2010, 2011, 2012 etc. reaching higher levels than expected.
Should the priority be to rise with Iraqi economics after long
sanctions and wars or that Iraq should respect the Oil Quote by
OPEC? And who should leave space to the other, the producer of
6-10-15 MM bbl/d or Iraq? I believe it is in the interest of all OPEC
countries to leave space for Iraq rather than an uneven
development of oil prices.

Plateau Rate Not Needed – Yet

Peter Wells’ report argues that the high plateau rate is neither
optimal, nor possible, nor necessary for Iraq. I think before any
discussion, we should look at why Iraq needs the high plateau
rate. Is the high production rate good for Iraqi economics? Is the

343
Petroleum Fiscal Systems and Contracts

high production good for the reconstruction of Iraq? Will the high
revenue help Iraqi people at this time? Is there political profit for
the Minister of Oil and his Prime Minister? Can the high
production put greater pressure on the KRG to limit those
exploration programmes? Will the high production be allowed and
accepted by the OPEC countries? Is the development of any
border field included? The answers to these questions will clarify
the direction of the Iraqi Government. Then we can here evaluate
if the high production plateau is worthwhile or not.

The report considers that Iran will be able to maintain production


capacity of 4-5 MM bbl/d up to 2018 and Iraq is expected to reach
production parity with Iran around 2014. After that, OPEC
constraints are likely to peg Iraq’s production to that of Iran until
2019 or 2018 in the most likely or high cases for ‘call-on-OPEC’
respectively. Therefore, the call on Iraq’s crude oil production is
forecast to be limited to 4-5 MM bbl/d between 2014 and 2018.

The planned development of Iraq’s southern oil fields and the cap
on production imposed by OPEC membership will severely impair
the ability of Iraqi Kurdistan to develop export capacity for its
newly discovered oil. Essentially, Kurdish oil will not be needed
until much later, and will cost the state more per barrel – partly
because of the requirement to build new infrastructure and partly
because of the “give away” terms of the KRG’s oil deals (see
comments above on the Shamaran contract and below). This will
likely increase the pressure from the Kurds for control of the
Kirkuk oil field. This is impossible because neither the US, Britain,
Turkey nor Iran will allow the Kurds to control either Kirkuk or oil
fields in Kirkuk. The US/Britain and other interests are bigger than
the ideology of any in the region.

Iraq has a problem with the border fields with Iran and Kuwait if
Iraq continues not to produce enough or at all from these fields
such as the Fakkah field whilst the neighbouring states are using
the fields with high and increasing capacity. Then the question is
should Iraq wait until 2014-2018 to raise to a higher production
rate?

344
Petroleum Fiscal Systems and Contracts

Besides all known circumstances in Iraq questioned above related


to the OPEC quote, technical, logistical, political turbulence and
safety problems currently make field development and oil
production difficult or at least not likely to proceed as planned. In
brief, to answer all these questions, Iraq needs high plateau rates.

Plateau Rate Not Possible

The difficulties listed in the report are real but cannot affect the
overall plan of production. The water supply is a challenge but this
can be delivered from the Iraqi Gulf or the Shatt al Arab. The
costs related to the pipelines and treatment facilities should be
included in calculations.

Gas availability from associated gas or any source is for Iraq


untouchable, it is needed at present for the domestic consumer
and for electricity generation exclusively. Whilst the joint venture
between Shell and the Ministry of Oil could offer increased gas
availability in the future, contracts have yet to be signed and there
are many controversies and constraints in the Iraqi media, experts
and parliaments. To implement this contract will not be easy for
Shell in the future. A solution for all companies that are interested
in future long term work in Iraq is to develop better and more
transparent conditions and terms for both sides.

The mobilisation of oil field equipment and all related materials


and support services needs more time than planned to be
operating in 2011. Facilities, pipelines, storage and ports are not
yet developed to serve the huge planned oil production. I
agree they are not the major issue which is that the call on Iraq’s
crude oil is likely to require much more modest production than
the mooted development plans

Aggressive Plan

If oil production grew substantially from 2010 to a simulated


date as aggressive development drilling brought new fields online
and drained more oil from established fields, Iraq oil gas

345
Petroleum Fiscal Systems and Contracts

production could be increased by 45% to 150% in 4 to 5 years.


The Iraqi oil production is expected to peak in 2017 with 2.325
MM bbl/d as shown in Figure 11.5. In 2023, production will have
declined 13%. This decline is due to a combination of factors
including high depletion rates, declining field sizes and reduced
drilling activity. In Figure 11.5 after 4 years, we estimate
production will average 1.5 MM bbl/d, a 5-7% decline from 2016.
This is in line with the 8% decline estimated by Peter Wells and
with other OPEC countries.

For example Norwegian production grew substantially from 1989


to 1997 as aggressive development drilling brought new fields on-
line and drained more oil from established fields. Norwegian oil
and liquid gas production increased 121% (1.8 million bopd) in
eight years or 10.4% per year. Since 1997, production growth has
been anaemic, growing only 1.7% in total or 0.6% per year.
Production actually declined slightly in 1998 and 1999 before
rebounding in 2000.

Norway has faced a 9.0% annual net depletion rate on the 14


fields operating in 1994 and still in service in 2000. The 10 largest
of those 14 fields experienced an 8.8% annual net depletion rate.
These 14 fields accounted for 89% of Norwegian production in
1994. By 2000, they only produced 41% of Norwegian production.
Even if production had remained flat at 2.7 million bopd, the core
1994 fields would only account for 50% of current production. This
represents a fairly significant decline over a seven-year period,
especially considering that two of the fields on-line in 1994
continued to show production growth during this timeframe.

The much lower reserve replacement costs and finding and


development costs of Latin America, Asia Pacific and especially
Africa and the Middle East, present a powerful attraction for E&P
companies looking for reserves and production growth.
Directionally, this is an indication of the larger fields available in
these regions and the often more benign operating environments.

346
Petroleum Fiscal Systems and Contracts

Constraints and Difficulties

As we mentioned above, Iraq has many problems related to the


high production plateau. Besides the technical difficulties, there
are safety problems. The Oil Ministry responsible people have
tried many times to use the Iraqi facilities near the border with
Iran. The Iranian forces fired on them to prevent production of oil
from the Iraqi side. Similarly on the Kuwait-Iraq border, Iraqi
territory and drilled wells are used until now only from Kuwait.
After many wars and international complications, Iraq lost control
of waters and territory to Kuwait and Iran. After the second Gulf
war, Iraq lost additional parts of its waters to Kuwait and Iran. One
was as a gift for Iran in order to ensure their non-involvement in
the second Gulf war and the other through US and UN
direction. Recently, Iran has claimed that the Khor al-Amaya
Terminal (KAAT) falls within Iranian territorial waters, and a similar
claim might also be made by Kuwait and Iran in respect of the
Basra Oil Terminal (BOT). There are other options including the
Iraq-Turkey export facilities which have spare capacity and are
currently used from Turkey. The Iraq-Syria pipeline system is also
used from Syria as is the Iraq-Saudi pipeline used from Saudi
Arabia. A possibility that is not planned is a pipeline through
Jordan and or Haifa, which is impossible at present.

Companies which might start production might find themselves


short of an export route. MEES has published an article in very
detailed form about the constraints to oil transport by Mr Issam Al-
Chalabi, which it is important to consider.

Crude Price Variation

The crude oil price is naturally affected mostly by the major


importers and exporters of crude oil. On a global scale, the major
oil importers are: the US – 27%; EU – 26%; Japan – 11%; China–
7%; South Korea – 4.5%, India – 3.5%. The major oil exporters
are: Middle East – 40%; Africa –15%; Russia – 14%, South
America – 7%; Canada – 4.5%; and Mexico – 4.5%. It is also
natural that besides the US during the last couple of years the
crude oil price is significantly influenced by the fast developing

347
Petroleum Fiscal Systems and Contracts

China and India. These economies have not only fast growth but
also great potential especially if the specific energy consumption
of their inhabitants is taken into account (for China -1.4 tpy per
capita; and for India – 0.6 tpy per capita) which is tenfold lower
than that in the leading countries like Canada (14.8 tpy per capita)
and the US (12.3 tpy per capita).

Figure 11.7 Crude price variation

Crude price variation over time is depicted in Figure 11.7. The


prognosis for future prices is prepared in an analogous way with
the preceding stages, giving a forecasted duration of the fifth
stage to be 10 – 11 years long. The border lines for range of
variation are defined on the base of the border lines observed
during the third stage. The same approach has been used for
defining the border lines of the sixth stage when the crude price
variation is expected to be low.

The fifth stage is forecasted to finish in 2010/2011. It cannot be


expected to finish earlier because of the following reasons:

• The human population increase is not expected to reduce in


such a short period of time;

348
Petroleum Fiscal Systems and Contracts

• The required new refining facilities to process crude oil for


meeting mankind needs are not expected to run earlier than 3-
4 years which automatically means that the fuel demand will
be high and in particular the crude price will keep on rising;

• The use of automotive hybrid engines is still in the very


beginning;

• The price of fuels/crude oil has not reached the required


highest level that will make projects associated with alternative
solutions for meeting the transport needs of the mankind
attractive.

In the share markets, trades are performed for 1.4 billion barrels
of oil per day but in reality we consume about 86 million barrels of
oil per day. These trade actions boost the oil price higher than it
would be otherwise. The whole development and related factors
and conditions anticipate higher oil prices. This means the
nominally flat oil price from the Shamaran company is not realistic.

349
Petroleum Fiscal Systems and Contracts

PROPOSED FEDERAL MINISTRY OF OIL SERVICE


CONTRACTS NOT IN THE BEST INTERESTS OF IRAQ.
KURDISTAN REGIONAL GOVERNMENT OPINION

The KRG believe the federal government should not proceed


with the service contract awards, for the following reasons:

The model demonstrates that the contracts are likely to be too


expensive, that they will not maximise value for Iraq, and that they
will provide incentives for the contractors to “gold plate” or
maximise costs, instead of being efficient in maximising
production. The contracts must be reconsidered. The federal
government will be paying more that it should for incremental
production, whether measured against international standards or
even against the “exploration” contracts of the KRG.

On an equivalent basis, international oil companies (IOCs) under


the proposed MoO contracts will receive, on average, twice as
much as the IOCs under the KRG contracts. This comparison is
all the more striking when bearing in mind that the KRG blocks are
both much smaller and are in respect of undiscovered reserves.

Pedro van Meurs thinks the service contracts are “corruption


inducing” because the terms of the contracts are not fixed. Both
contract types used by the federal government and KRG should,
like the international oil contracts and available parameters and
terms, have clear, fixed terms that continue for the life of the
contract. Any federal government contracts should also not be like
the KRG contracts because the aim is different, one is a TSC and
the other is a PSC agreement. These problems with the service
contracts and PSC agreement are in addition to the fact that there
is no constitutional or other legal basis for the contracts. The
federal government should not proceed with the service contract
awards. The Federal Ministry of Oil blacklisted any company
working in Kurdistan. There are many legally unclear matters and
sovereignty problems. Many national and international analyses
from different resources conclude that the contracts are being
rushed, perhaps to meet short-term political objectives and to
obscure past mistakes and failures.

350
Petroleum Fiscal Systems and Contracts

A full explanation of the KRG government view of the service


contracts:

The first projection is that the expected capital expenditure of


international oil companies (IOCs) for each field related to
incremental production is in the billions of dollars – on average $5
billion dollars per field over the first five years. However, according
to the analysis, the IOCs’ net cash-flows become positive for each
field after only the first three years of the contract. In other words,
the proposed contract provides for very rapid capital recovery, and
less initial cash-flow to the government of Iraq – Iraq is therefore
funding its own projects.

The second projection is that the net present value (NPV) at a


10% discount rate that the IOCs will receive under the service
contracts at first glance appears very low in relation to the NPV
retained by Iraq – only around 4% of the total NPV of each field
will inure to the IOCs. However, this low figure of 4% is deceptive
and the real figure must be explained and understood. It is
deceptive because the NPV10 calculations are made by
combining the base line current production of each field with the
incremental production that the IOCs are supposed to achieve for
that field. However, the IOCs in fact will need to spend very little
money to maintain the base line current production, apart from the
general operating costs. If the NPV calculations are more
accurately made by using only the incremental production
revenues and the related capital costs and operating costs, then
the NPV that the IOCs actually receive will be over 10% of the
total NPV of each field.

The third, and most revealing projection, is that the amount paid to
the IOCs for each barrel of incremental oil will, on average, be
$5.70, based on cumulative cash flows going to the IOCs, in
addition to the operating costs relating to the baseline production.
This works out to be approximately $2.20 per barrel on a NPV
basis when the cash flows are discounted in accordance with the
model’s discount rate of 10%. This payment to the IOCs is based
on the capital and operating costs that relate to the incremental
production, and is based on the model’s assumption that the

351
Petroleum Fiscal Systems and Contracts

incremental production fee is bid at $6.00 per barrel, and assumes


an oil price of $60 per barrel.

Implications: Contracts are too expensive and interests are


misaligned

There are several reasons why these contracts are failures. The
underlying planning for the contracts was poor. Some of the
planners apparently still subscribe to pre-2003 regime practices.
The planners also seem to lack relevant experience and their sole
motivation appears to be simply to maintain their own roles.
Because of the contractual structure, and the complexity of
administration, the interests of the IOCs and the federal
government are misaligned. The IOCs therefore have no option to
increase their revenues through greater efficiency and can only
achieve their returns through higher incremental production fees
and increased costs, instead of through efficiencies.

The contracts are, therefore, not in the best interest of Iraq – even
with the important budget needs. These will be long-term
contracts and need to be properly offered, reviewed, and
approved in accordance with the Constitution and an oil and gas
law that is in accord with the Constitution.

In the Kurdistan Region, by contrast, IOCs will, on average,


receive a “gross undiscounted profit” figure of just $1.58 (at NPV
of 10%) for each barrel of oil discovered and produced from any
large field discoveries – almost 40% less than $2.20 in the case of
MoO proposed contracts.

By assuming a modest exploration risk and setting the chance of


success of finding oil to as high as 70%, the profit figure,
discounted for risk, under the KRG contracts reduces to only
$1.10 per barrel of oil discovered and produced. The KRG figures
have been independently assessed in a private equity fund report
issued for investors by Tristone Capital (a Global Energy
Research country report on Kurdistan dated June 1 2009). On an
equivalent basis, therefore, IOCs under the proposed MoO
contracts will receive on average twice as much as the IOCs

352
Petroleum Fiscal Systems and Contracts

under the KRG contracts. This comparison is all the more striking
when bearing in mind that the KRG blocks are both much smaller
and are in respect of undiscovered reserves.

“Corruption inducing”

Pedro van Meurs has said that the service contracts are
“corruption inducing” because the terms of the contracts are not
fixed. Article 2 of the Contract permits the parties to change the
service fees after the Contract has been approved by the Council
of Ministers. Also, the contract provides that the service fees only
apply to the main reservoirs. These are the reservoirs that would
result in the Enhanced Production Target. However, the
Contractor can propose to develop, in addition to the main
reservoirs, further “discovered and undeveloped reservoirs”. This
would presumably result in a higher level of production. In order to
achieve the development of these additional reservoirs, the
parties can negotiate a revision of the service fees. Also,
additionally, unexplored reservoirs below a certain depth can be
explored based on a separate further agreement. It appears
therefore, that significant “add-ons” are possible to the Contract
after the Contract has been approved and signed.

It seems that such “add-ons” would be beyond the scope of the


scrutiny of the Council of Ministers and thus cannot be subject to
competition because the Contractor will have been selected and
the Contract signed. This can lead to national constitutional
complications. It could open the door widely for a rigged bid
process. It would enable a bidder to make a winning bid with
unrealistically low service fees based on a tacit agreement with
certain government or state company officials to increase the
service fees later. This feature of the contract is therefore
“strongly corruption inducing”. Besides the mentioned point of
view, the happiness of the initiator of the so called service
contracts can be rapidly exhausted. This can also make legal
complications with the IOCs. The service contracts should be
clearly explained for the parliament and approved in order to avoid
an unfortunate end.

353
Petroleum Fiscal Systems and Contracts

I do not think that a meaningful contract comparison between


main Iraq and the Kurdistan Region of Iraq is possible. The aims
of both contracts are different. The type and condition parameters
are different. Each contract has its own weak points that should
be eliminated and strong points that should be developed in the
interests of the whole of Iraq and the IOCs.

Comparison of the Ministry of Oil’s TSC for West Qurna 1


with the KRG’s PSC

The economic model calculation done by Peter Wells


mathematically meets with criteria of the proposed parameters.
The figures for Capex USD 25 bn, Opex USD 25 bn, oil price
USD 60 and IRR 15%, practically are neither correctly estimated
nor really comparable with the PSC agreement of KRG. A
theoretical example is possible. The sensitivity analysis, with the
effects of different oil prices on the contractor NPV10, match for
both contracts, corresponding to the parameters and contracts
condition accordingly. In both contracts there are similar data
gaps which can lead to different and higher sensitivities but keep
the same shape as in the report. There are different parameters
for each contract, different conditions and aims.

There are many advantages and disadvantages in both contracts


(TSC and PSC). The calculated state take for both contracts
briefly shows the mentioned results but, after considering other
previously mentioned facts, can lead quickly to other results that
are positive to the PSC and less attractive to the TSC. If all the
proposed points from Peter Wells and Pedro van Meurs are
realised, then we have inappropriate/unworthy terms from both
contracts (TSC and PSC) for main Iraq and Iraqi Kurdistan.

354
Petroleum Fiscal Systems and Contracts

Technical Service KRG Production


Contract Sharing Contract
20 years extendable to 25 25 years extendable
Duration
years. to 30 years.
Bonuses Signature bonus of Signature bonus of
$400mn cost recoverable $400mn and
as Supplementary Fees production bonuses
from 10% of gross not cost recoverable.
revenues from baseline
production.
Cost Recovery Remuneration Fee per Cost recovery from
Barrel (RFB) and cost 45% of gross
recovery allowed from revenues from
50% of gross revenues incremental
with cost recovery taking production after
preference. deducting Royalty.
Remuneration RFB $1.90 per R factor applied to
Fee/Profit Oil incremental barrel. profit oil.
RFB reduced by R factor R = cumulative
sliding scale as costs are contractor
recovered. income/cumulative
R = cumulative contractor contractor.
income/cumulative 0<R<1: profit oil
contractor costs. share 10%.
0<R<1: 100% of fee. 1<R<2: sliding scale
1<R<1.25: 80% of fee. between 10 and 8%.
1.25<R<1.5: 60% of fee. R>2: profit oil share
1.5<R<2: 50% of fee. 8%.
2<R: 30% of fee.
There is a penalty for
underperforming on the
plateau rate: RFB is
multiplied by the
Performance Factor (net
production/bid plateau
rate). This is not applied if
the government orders
lower production or if
production is limited by
access to external
infrastructure.
Carry Full carry of all costs and Full carry of costs and
25% of remuneration fee 25% of profit oil to

355
Petroleum Fiscal Systems and Contracts

Technical Service KRG Production


Contract Sharing Contract
to Regional Operating state entity.
Entity.
Taxation 35% tax rate levied on net Tax paid from state
remuneration fee after profit oil.
deduction of 25% carry.
None 10% on gross
revenues.
Baseline 2009 production 280,000 2009 production
production b/d, 5% decline rate 280,000 b/d, 5%
thereafter. decline rate
thereafter.
US $ inflation
3% 3%
rate
Cost inflation
5% 5%
rate
Capex (money
$25bn $25bn
of the day)
Opex (money of
$25bn $25bn
the day)
Base Case
Parameters:
Oil price (Brent
$60/B $60/B
flat nominal)
Contractor
0 0
NPV10
Contractor Real
Rate of Return 15% 15%
(RROR)
State take,
money of the $444bn $436bn
day
State take, % 99% 97%

Table 11.2 Comparison of main terms of the TSC and the KRG PSC
(after Peter Wells)

356
Petroleum Fiscal Systems and Contracts

Figure 11.8 Cash flow for the TSC for West Qurna 1 (after Peter
Wells)

Figure 11.9 Cash flow for the KRG PSC for West Qurna 1 (after
Peter Wells)

357
Petroleum Fiscal Systems and Contracts

Figure 11.10 Relative sensitivity of the TSC and the KRG PSC to oil
price (after Peter Wells)

Conclusion

The economic model calculation done by Peter Wells


mathematically meets with criteria of the proposed parameters.
The sensitivity analysis, different oil prices to the contractor
NPV10, for both contracts match, corresponding to the
parameters and contracts condition accordingly. But this is not a
real estimation. There are different parameters for each contract,
different conditions and aims. There are many advantages and
disadvantages in both contracts (TSC and PSC). The calculated
state take for both contracts briefly shows the mentioned results
but, after considering other mentioned facts, can lead quickly to
other results that are positive to the PSC and less attractive to the
TSC.

The different deals done by the oil ministry (service contracts),


should be done on a constitutional or other legal basis. The
federal government should move forward with a proper

358
Petroleum Fiscal Systems and Contracts

constitutionally based oil and gas law and revenue sharing law
and draw up new contracts based on the best international advice
and practices. In the petroleum fiscal systems the service
contracts are similar to the PSC agreement in such a guide.
Therefore, they should be in any case approved from the
parliament, especially for long terms service contracts with
possible development of new virgin reservoir layers as mentioned
in the published TSCs. The producing fields need only short term
services; that is a combination of consultants, companies and
national oil techno-management. The proposed Iraq national oil
company (INOC) will have limited access to control the oil
production in the explored field after the TSC deals. New venture
exploration opportunities which need high investment capital and
risks are worthy of discussion, involving the IOCs.

If the KRG has the right to award this kind of contract, this is
another political issue that should be clarified between the main
Iraq and KRG. The constitution contains paragraphs on the
severity of Iraqi Kurdistan, territory of the main Iraq and handover
the rights of exploration of wealth resources to the provinces.
Main Iraq politicians are conscious of the possible future
separation of Iraqi-Kurdistan as an independent state. KRG
advisedly manoeuvre the time of separation so as to gain more
territory and financial support from main Iraq. The future of main
Iraq requires a road map strategy for the border with Turkey after
separation of Kurdistan. All of these controversial issues should
be solved by the politicians of the main Iraq and KRG. The KRG
PSC agreements should be evaluated against this background.

Shamaran should calculate the sensitivity parameters for the


KRG, illustrating the NPV and IRR for different scenarios, taking
into consideration the development Capex, production and delay
in production start etc. The applied discount rate is 10%. NPV and
IRR values until the end of production period are between 34-
56%. These numbers are too high and are not comparable with
any OPEC country.

The claims and problems related to the land and water borders
with Iran, Saudi Arabia, Kuwait, Syria and Jordan should be fully
discussed and resolved with the respective countries. The future

359
Petroleum Fiscal Systems and Contracts

Iraqi Federal Government should create a special Minister


position supported by historical, legal, geographical, geological,
water, strategy and military staff to resolve and determine Iraqi
sovereignty under national and international law.

From various reports published in different media, I believe there


is a kind of sword fighting between the Federal Oil Ministry and
KRG. Each side expresses displeasure and complains about the
other’s contracts. It is in the interests of both parties to cooperate
even when KRG plans to have its own state until the unknown
future. Both the Regional Ministry of Oil Kurdistan and the Federal
Ministry of Oil Iraq should shape contracts in a way to serve all
sides equitably. This should minimise the possible corruption and
annoyance of the nation. Clean business will produce long term
deals with IOCs and politically stable development of the
resources and the country. The IOCs should press to have solid
contract conditions to avoid any inconvenience and confrontation
with future Governments of the country.

It is important for Iraq to produce more oil and gas to reduce the
gap in the economy and improve development of the whole
country. There are questions, however, concerning
safety, logistics and the infrastructure.

It is quite possible that Iraq will have a confrontation with OPEC


members such as Saudi Arabia whilst lran will continue to exert
pressure on the Government of Iraq.

Plateau production rates forecast in the the bid for West Qurna 1
may not be realised in the time mentioned in the contracts
until 2017.

Production capacity in southern Iraq will leave little room for


significant exports of new oil from the KRG area. The KRG are
aware of this situation after the Ministry of Oil award of a number
of TSCs to the international oil companies. Thus, the KRG
strategy is to include many Turkish companies in field
development. This close cooperation and the support of Turkey
gives the KRG an alternative to break away from Iraqi and OPEC
constraints.

360
Petroleum Fiscal Systems and Contracts

In the Shamaran PSC, the contractor’s rate of return of more than


30% for oil prices greater than $65/B is excessive by international
comparison. Secondly, the KRG PSC delivers too great a windfall
profit to the contractor at higher oil prices.

In the case of the West Qurna 1 project, if we take into account


the complaints and possibilities mentioned by Peter Wells and
Pedro van Meurs, a contract based on the KRG PSC would not be
greatly inferior to the TSC used by the Ministry of Oil.

At the base case of $60/bbl, the TSC delivers $8bn more in


revenue to the state than the KRG PSC. At oil prices of $100/bbl
this revenue difference raises to $14bn. Unlike the KRG PSC, the
TSC very effectively caps the contractor’s revenue, rate of return
and net present value at higher oil prices. This is based on
unconfirmed estimation.

The current situation in Iraq remains unresolved without an


established centralised and unified policy on how oil and gas
resources should be exploited in the national interest. The
optimum type of contract and the contract parameters that will
best maximise benefit for the Iraqi people remain the subject of
discussion.

To illustrate the legal framework of PSAs under the KRG, the


Petroleum Act of Kurdistan is presented as Appendix 1.

361
Petroleum Fiscal Systems and Contracts

REFERENCES

1. Al-Ghad, www.al-ghad.org

2. Barrows, G H. 1993. Worldwide Concession Contracts and


Petroleum Legislation. Tulsa, Okla.: PennWell Books.

3. Bunter, M A G. 2002. The Promotion and Licensing of


Petroleum Prospective Acreage. The Hague: Kluwer Law
International.

4. Dermann, A. International Oil and Gas Joint Ventures: A


Discussion with Associated Form Agreement, Section on Natural
Resources, Energy, and Environmental Law. Monograph Series
Number 16, The American Bar Association, 1992.

5. Dur, S. Negotiating PSC Terms. Production Sharing Contracts


Conference Proceedings, AIC Conferences, Houston, March
1994.

6. Eden, R D et al. 1981:

7. Iraq Petroleum

8. Johnson, D. The Production Sharing Concept. PetroMin


Magazine-Singapore, August 1992: 26-34.

9. Johnston, Daniel: International petroleum fiscal systems and


production sharing agreements contracts.

10. Mian, M A. 2002. Project Economics and Decision Analysis,


Vol. 1 Deterministic Models. Tulsa, Okla.: PennWell Books.

11. Pulsipher, Allan G and Kaiser, Mark J : Fiscal System Analysis


Concessionary and Contractual Systems, 2004

12. Smith, D. 1993. Methodologies for comparing fiscal systems,


Petroleum Accounting and Financial Management Journal 13
(2):76—83 Deoitte.2005. Oil and gas Survey, 2004-2005. 13.

362
Petroleum Fiscal Systems and Contracts

Prepared for the Aberdeen and Grampian Chamber of Commerce


http:/www.agcc.co.uk/policy

13. Smith, D.: Comparison of Fiscal Terms in the Far East, South
America, North Africa and C.I.S. Oil and Gas Production-Sharing
Contracts (PSCs), Concession and New Petroleum.

14. Svalheim, Stig M : Field Development Planning, An example


from Norway, PPM Workshop, Manila 15th March 2005.

15. Tordo, Silvana : Fiscal Systems for Hydrocarbons, World Bank


Working Paper.

16. John Wils and Ewan Neilson, The Technical and Legal Guide
to the UK oil and Gas Industry

363
Petroleum Fiscal Systems and Contracts

APPENDICES

Appendix 1 - Petroleum Act of Kurdistan

Appendix 2 - Abbreviations and Acronyms

Appendix 3 - Glossary

364
Petroleum Fiscal Systems and Contracts

APPENDIX 1 - PETROLEUM ACT OF KURDISTAN

The final draft of the Petroleum Act of the Kurdistan Region of Iraq
is presented in the following section.

The Act comprises the following sections:

Preamble
Chapter I Definitions and General Provisions
Chapter II The Ministry
Chapter III The Public Authorities
Chapter IV Co-operation with Federal Authorities
Chapter V Anti-Corruption Provisions
Chapter VI Authorisations
Chapter VII Conduct of Petroleum Operations
Chapter VIII Contract Terms
Chapter IX Local Participation
Chapter X Unitisation
Chapter XI Resolution of Disputes
Chapter XII Public Information
Chapter XIII Regulations and Directions
Chapter XIV Penalty Provisions
Annex A Revenue Sharing
Annex B Restructuring of the Industry in Iraq
Annex C Regional Role of Federal Institutions

365
Petroleum Fiscal Systems and Contracts

PETROLEUM ACT OF THE KURDISTAN REGION OF IRAQ


FINAL DRAFT FOR SUBMISSION TO THE PARLIAMENT OF
KURDISTAN

Subject to approval by the Council of Ministers 9 September 2006

PREAMBLE

Whereas, the Parliament is the legislative authority of Kurdistan


and consists of the representatives of the people chosen through
free and fair elections,
Whereas, the Parliament wishes to develop the petroleum wealth
of Kurdistan in a way that achieves the highest benefit to the
people of Kurdistan and all of Iraq, using the most advanced
techniques of market principles and encouraging investment,
consistent with Article 112 of the Constitution of Iraq,
Whereas, Kurdistan law is the supreme law of Kurdistan, except
with regard to a matter wholly within the exclusive jurisdiction of
the Government of Iraq, as enumerated in Article 110 of the
Constitution of Iraq,
Whereas, the supremacy of Kurdistan law is recognised by
Articles 115 and 121 of the Constitution of Iraq,
Whereas, the development of petroleum wealth in Kurdistan shall
be consistent with Articles 111 and 112 of the Constitution of Iraq,
concerning oil and gas resources, and
Whereas, the Government of Kurdistan has established, by Act of
the Parliament, a Ministry of Natural Resources in Kurdistan, with
responsibility for all natural resources except for water, and
forestry,
The Parliament enacts as follows:

366
Petroleum Fiscal Systems and Contracts

CHAPTER I - DEFINITIONS AND GENERAL PROVISIONS

ARTICLE 1: CITATION

This Act may be cited as the “Petroleum Act”.

ARTICLE 2: DEFINITIONS

In this Act:

“Access Authorisation” means an authorisation granted pursuant


to Article 29 of this Act;

“Act” means this Petroleum Act, as amended or modified from


time to time, and regulations made and directions given under it;

“Affiliate” means, as regards any of the companies or entities


constituting a Contractor, a company or other
legal entity which:
a) controls an entity constituting the Contractor; or
b) is controlled by an entity constituting the Contractor; or
c) controls or is controlled by a company or entity which controls
an entity constituting the Contractor;

“Asset” means any item of immovable property, whether public or


private;

“Associated Natural Gas” means any gaseous Petroleum


produced in association with Crude Oil under reservoir conditions;

“Authorisation” means an Access Authorisation, a Petroleum


Contract, a Prospecting Authorisation or any agreement made in
respect of such an Authorisation or Contract;

“Authorised Area” means the area that is from time to time the
subject of an Authorisation;

367
Petroleum Fiscal Systems and Contracts

“Authorised Person” means:


a) in respect of a Petroleum Contract, a Contractor; and
b) in respect of any other Authorisation, the Person to whom the
Authorisation has been granted;

“Constitution of Iraq” means the permanent constitution of Iraq


approved by the Iraqi people in the general referendum of 15
October 2005;

“Contract Area” means the Authorised Area under a Petroleum


Contract;

“Contractor” means a Person with whom the Ministry has made a


Petroleum Contract;

“Control” means direct or indirect control of the majority of the


voting rights at the shareholders meetings or their equivalent;

“Crude Oil” means all liquid hydrocarbons in their unprocessed


state or obtained from Natural Gas by condensation or any other
means of extraction;

“Current Field” means a Petroleum Field which has been in


commercial production prior to 22 August 2005, 22 August 2005
being the date on which the text of Article 112 of the Constitution
of Iraq was agreed;

“Decommission” means, in respect of the Authorised Area or a


part of it, as the case may be, to abandon, decommission,
transfer, remove and/or dispose of structures, facilities,
installations, equipment and other property, and other works, used
in Petroleum Operations in the Authorised Area, to clean up the
Authorised Area and make it good and safe, and to protect the
environment;

“Delivery Point” means the point, after extraction, at which the


Crude Oil and Natural Gas is ready to be taken and sold,
consistent with international practice, and the point at which a
Person may acquire title to Petroleum in accordance with Article 5
of this Act;

368
Petroleum Fiscal Systems and Contracts

“Discovered Petroleum” means Petroleum encountered in a


Reservoir in a Contract Area which has not previously been found,
and which is recoverable at the surface in a flow measurable by
accepted petroleum industry testing methods;

“Disputed Territories” means the disputed territories including


Kirkuk referred to in Article 58 of the Law of Administration for the
State of Iraq for the Transitional Period and Article 140 of the
Constitution of Iraq;

“Environment Fund” means the fund, administered by the


Government, to which Contractors are required to contribute
pursuant to the terms of a Production Sharing Contract, as
specified in Article 42 of this Act;

“Federal Petroleum Committee” means any institution established


by the Government of Iraq with competencies set out in Annex B
of this Act;

“Future Field” means a Petroleum Field that was not in


commercial production prior to 22 August 2005, and any other
Petroleum Field that may have been, or may be, discovered as a
result of subsequent exploration;

“Good Oil Field Practice” means such practices and procedures


employed in the petroleum industry worldwide by prudent and
diligent operators under conditions and circumstances similar to
those experienced in connection with the relevant aspect or
aspects of the Petroleum Operations, principally
aimed at ensuring:
(i) conservation of Petroleum resources, which implies the
utilisation of adequate methods and processes to maximise the
recovery of hydrocarbons in a technically and economically
sustainable manner, with a corresponding control of reserves
decline, and to minimise losses at the surface;
(ii) operational safety, which entails the use of methods and
processes that promote occupational security and the prevention
of accidents;

369
Petroleum Fiscal Systems and Contracts

(iii) environmental protection, that calls for the adoption of


methods and processes which minimise the impact of Petroleum
Operations on the natural environment;

“Government” means the Government of Kurdistan, which holds


office under the Constitution of Kurdistan;

“Government of Iraq” means the Federal Government of the


Republic of Iraq, which holds office under the Constitution of Iraq;

“Governorate” has the same meaning as in the Constitution of


Iraq;

“Inspector” has the meaning in Article 38 of this Act;

“Kurdistan” means the Kurdistan Region of Iraq recognised by the


Constitution of Iraq pursuant to Article 117 of that Constitution,
and shall include any Disputed Territories where the citizens in
those Disputed Territories, in the referendum required by Article
140 of the Constitution of Iraq, decide that those Disputed
Territories are to be part of Kurdistan;

“Minister” means the person appointed by the Prime Minister of


Kurdistan, and approved by the Parliament, to direct the Ministry;

“Ministry” means the Ministry of Natural Resources of Kurdistan;

“Model Production Sharing Contract” means a model Petroleum


Contract that may be promulgated and revised from time to time
by the Ministry, which contains, inter alia, an element of
commercial risk undertaken by the Contractor in exchange for a
share of production, and which may be used as the basis for
negotiations for a Petroleum Contract between the Government
and Persons who have expressed an interest in carrying out
Petroleum Operations;

“Natural Gas” means all gaseous hydrocarbons and inerts,


including wet gas, dry gas, casing head gas and residue gas
remaining after the extraction of liquid hydrocarbons from wet gas,
but not Crude Oil;

370
Petroleum Fiscal Systems and Contracts

“Operator” means an Authorised Person or other Person named in


an Authorisation to manage Petroleum Operations;

“Other Contract” means any contract other than a Petroleum


Contract;

“Parliament” means the Parliament of Kurdistan;

“Person” means a natural person, a corporation or other legal


entity, whether local or foreign, or public or private;

“Petroleum” means:
(i) any naturally occurring hydrocarbon, whether in a gaseous,
liquid or solid state;
(ii) any mixture of naturally occurring hydrocarbons, whether in a
gaseous, liquid or solid state, excluding coal; or
(iii) any Petroleum (as defined in paragraphs (i) and (ii) above)
that has been returned to a Reservoir;

“Petroleum Contract” means a contract, license, permit or other


authorisation made or given pursuant to Article 28 of this Act;

“Petroleum Field” means a Reservoir or group of Reservoirs within


a common geological structure or feature from which Petroleum
may be commercially produced under the prevailing technical and
economic conditions;

“Petroleum Operations” means activities in Kurdistan and in


Disputed Territories where Kurdistan is a party to the dispute, for
the purposes of:
(i) prospecting for Petroleum;
(ii) exploration for, development, exploitation, marketing,
transportation, refining, storage, sale or export of Petroleum; or
(iii) construction, installation or operation of any structures,
facilities or installations for the development, exploitation,
transportation, refining, storage, and export of Petroleum, or
decommissioning or removal of any such structure, facility or
installation;

371
Petroleum Fiscal Systems and Contracts

“Prospecting Authorisation” means an authorisation granted


pursuant to Article 27 of this Act;

“Public Authority” means the Kurdistan Exploration and Production


Company (KEPCO), the Kurdistan National Oil Company (KNOC),
the Kurdistan Oil Marketing Organisation (KOMO), the Kurdistan
Organisation for Downstream Operations (KODO), the Kurdistan
Oil Trust Organisation (KOTO), and any other company or
organisation established by law for activities related to Petroleum
Operations;

“Public Officer” means a civil servant, including a member or


employee of a Public Authority, a member of the Parliament or a
member of Government;

“Region” means the Kurdistan Region, or any other Region of Iraq


which may be created pursuant to Article 118 and 119 of the
Constitution of Iraq, and laws passed under that Constitution;

“Reservoir” means a subsurface rock formation containing an


individual and separate natural accumulation of producible
Petroleum characterised by a single natural pressure system;

“Royalty” means the percentage of Petroleum produced and


saved from the Contract Area allocated for the Government;

“State Oil Marketing Organisation” or “SOMO” means any


organisation established by the Government of Iraq to export and
market produced Petroleum that falls within the authority of the
Government of Iraq, pursuant to Article 112 of the Constitution of
Iraq;

“State Oil Trust Organisation” or “SOTO” means any organisation


established by the Government of Iraq to receive revenues from
petroleum operations that fall within the authority of the
Government of Iraq pursuant to Article 112 of the Constitution of
Iraq;

372
Petroleum Fiscal Systems and Contracts

“Well” means a perforation in the earth’s surface dug or bored


through subsurface rock formations for the purpose of exploring
for, inspecting or producing Petroleum; and

“Wellhead” means the point where the Well and associated


systems intersect the earth’s surface.

ARTICLE 3: TERRITORIAL SCOPE OF ACT

This Act applies to the territory of Kurdistan and Disputed


Territories where Kurdistan is a party to the dispute.

ARTICLE 4: MATERIAL SCOPE OF ACT

Section 1: This Act applies to Petroleum Operations, whether


carried out by public companies or by private sector companies,
whether Iraqi-owned or foreign.

Section 2: All activities related to Petroleum Operations in


Kurdistan, and in Disputed Territories where Kurdistan is a party
to the dispute, shall be governed by this Act.

Section 3: Pursuant to Article 115 and Section 3 of Article 121 of


the Constitution of Iraq, no legislation or other law, and no
agreement, contract, memorandum of understanding or other
instrument shall have application to Petroleum Operations in
Kurdistan or in those Disputed Territories where Kurdistan is a
party to the dispute, except with the express agreement of the
Government and pursuant to the provisions of this Act.

ARTICLE 5: TITLE TO PETROLEUM AND GOVERNMENT


RIGHTS

Section 1: Petroleum in Kurdistan is owned by the people of


Kurdistan, in a manner consistent with Article 111 of the
Constitution of Iraq. Revenue derived from such Petroleum shall

373
Petroleum Fiscal Systems and Contracts

be shared with all the people of Iraq, pursuant to Article 112 of the
Constitution of Iraq and this Act.

Section 2: The Ministry shall oversee and regulate all Petroleum


Operations, pursuant to Article 115 of the Constitution of Iraq and
in a manner consistent with Article 112 of the Constitution of Iraq.
The Government may license Petroleum Operations to third
parties to maximise timely returns from the oil and gas resources
of Kurdistan.

Section 3: The Ministry shall oversee and regulate the marketing


of all extracted Petroleum from the Delivery Point, where that
Petroleum has been extracted from Petroleum Operations.

Section 4: The Government shall receive all revenue derived from


all Petroleum Operations for the benefit of the people of Kurdistan
subject to Article 17 and Annex A of this Act, and consistent with
Article 112 of the Constitution of Iraq.

Section 5: A Person may acquire title to Petroleum only at the


Delivery Point.

ARTICLE 6: INFRASTRUCTURE AND DOWNSTREAM


ACTIVITIES

Section 1: All infrastructure used directly or indirectly for


Petroleum Operations currently located in Kurdistan, including but
not limited to Assets for production, refining, transportation
including pipelines, valve stations, pump stations, compressor
stations and associated installations, and distribution, including all
centres and buildings, shall be overseen and regulated by the
Ministry to optimise Petroleum production in Kurdistan.

Section 2: All downstream Petroleum Operations, including


refining, transportation, storage, and the production of
petrochemicals, shall be administered by the Ministry.

Section 3: All infrastructure referred to in Section 1 of this Article


shall be available, pursuant to the provisions of this Act, to the

374
Petroleum Fiscal Systems and Contracts

Government of Iraq and to all other producing Regions and


Governorates for the benefit of all the people of Iraq, to integrate
with Iraq national policy for export and distribution.

Section 4: The main pipeline network shall also be available to


any Persons lawfully conducting Petroleum Operations in Iraq,
and such access shall be agreed by the Ministry on terms to be
defined by contract.

375
Petroleum Fiscal Systems and Contracts

CHAPTER II - THE MINISTRY

ARTICLE 7: GENERAL COMPETENCIES

Section 1: The Ministry is the competent organ of the Government


to administer Petroleum Operations. The responsibilities of the
Ministry include, but are not limited to, the formulation, regulation
and monitoring of Petroleum Operation policies, as well as the
administration, planning, implementation, supervision, inspection,
auditing and enforcement of all Petroleum Operations by all
Persons and all activities relating thereto, including the marketing
of Petroleum.

Section 2: The Ministry is responsible for negotiating, agreeing


and executing all Authorisations, including Petroleum Contracts,
entered into by the Government, as well as for amending the
terms of any Authorisation to ensure that Petroleum Operations
are carried out for the benefit of the people of Kurdistan.

ARTICLE 8: PUBLIC AUTHORITY REGULATION

Section 1: The Ministry is responsible for regulating the operations


of:
(a) the Kurdistan Exploration and Production Company (KEPCO),
as set out in Article 12 of this Act;
(b) the Kurdistan National Oil Company (KNOC), as set out in
Article 13 of this Act;
(c) the Kurdistan Oil Marketing Organisation (KOMO), as set out
in Article 14 of this Act;
(d) the Kurdistan Organisation for Downstream Operations
(KODO), as set out in Article 15 of this Act, and
(e) the Ministry is also responsible, under the supervision of the
Parliament, for overseeing the operations of the Kurdistan Oil
Trust Organisation (KOTO), as set out in Article 17 of this Act.

Section 2: The Ministry may recommend the creation of, and


regulate the operations of, other Public Authorities for gas
exploration, production and for the supply and procurement of

376
Petroleum Fiscal Systems and Contracts

services to facilitate the effective running of Petroleum


Operations.

ARTICLE 9: ENCOURAGEMENT OF INVESTMENT

Section 1: The Ministry shall encourage public and private sector


investment in Petroleum Operations in a manner that ensures
efficient management of the natural oil and gas resources to
provide maximum timely returns to the people of Kurdistan.

Section 2: The Ministry shall encourage the construction of all new


downstream operations and plants, including pipelines and
refineries, to be built, where possible, by, or in partnership with,
the private sector.

ARTICLE 10: ORGANISATION OF THE MINISTRY

Section 1: The Minister may organise the Ministry, and appoint


such staff as he may deem necessary, including Directors-
General, Officers, and advisers from Kurdistan, other parts of Iraq,
or foreign advisers, in any way that is compatible with modern
standards and management structures.

Section 2: All present organisations, offices, centres and


institutions directly or indirectly under the authority and control of
the Government that have responsibilities for Petroleum
Operations in Kurdistan shall be appropriately organised or
reorganised by the Minister, taking into account the
responsibilities set out in this Chapter.

Section 3: All present organisations, offices, centres and


institutions directly or indirectly under the authority and control of
the Government that have responsibilities for Petroleum
Operations in the Disputed Territories shall come under the joint
control of the Ministry and the designated authorities of the
Government of Iraq, and may be organised or reorganised at the
joint discretion of the Minister and the designated authorities of
the Government of Iraq, until such time as the future of the

377
Petroleum Fiscal Systems and Contracts

Disputed Territories is decided in the referendum required by


Article 140 of the Constitution of Iraq.

Section 4: All positions in the Ministry shall be filled on the basis of


appropriate qualifications, capability and experience.

Section 5: The Minister shall, wherever possible, fill available


positions with citizens of Kurdistan and other citizens of Iraq.
Where necessary, persons who are not citizens of Iraq may be
employed or retained by the Ministry.

Section 6: The Ministry may establish representative offices


outside Kurdistan to promote investment in Kurdistan Petroleum
Operations.

ARTICLE 11: EXERCISE BY THE MINISTRY OF ITS POWERS


AND FUNCTIONS

The Ministry shall exercise its powers and discharge its functions
under this Act, including under Authorisations made hereunder, in
such a manner as:
(b) to ensure sound resource management;
(c) to ensure that Petroleum is developed in a way that
minimises damage to the natural environment, is
economically sustainable, promotes further
investment and contributes to the long-term
development of Kurdistan; and
(d) is reasonable and consistent with Good Oil Field
Practice.
Before exercising any such power or discharging any such
function, the Ministry may give opportunity to Persons likely to be
affected to make timely representations to it, and shall give
consideration to such relevant representations received by it,
provided that the interests of the people of Kurdistan are not
thereby adversely affected.

378
Petroleum Fiscal Systems and Contracts

CHAPTER III - THE PUBLIC AUTHORITIES

ARTICLE 12: ESTABLISHMENT AND COMPETENCIES OF


KEPCO

Section 1: The Kurdistan Exploration and Production Company


(KEPCO) is hereby established.

Section 2: KEPCO is a public company.

Section 3: Members of the Board of KEPCO, including the Chief


Executive Officer, shall be appointed by the Government, and
approved by a two-thirds majority of Parliament. Members shall be
independent of the Ministry, and shall have petroleum or other
appropriate technical and management qualifications.

Section 4: Subject to an agreement pursuant to Article 22 of this


Act, an additional Board member may be appointed by the
designated institution of the Government of Iraq.

Section 5: KEPCO may, subject to the approval of the


Government on a case by case basis:
(a) compete for Authorisations for Future Fields;
(b) enter into joint ventures and similar contractual
arrangements, whether in Kurdistan, in other Regions and
Governorates of Iraq or abroad; and
(c) create operating subsidiaries for particular
Petroleum Operations in respect of Future Fields.

Section 6: KEPCO shall be governed by this Act, the regulations


issued by the Ministry, and other applicable laws and rules.

ARTICLE 13: ESTABLISHMENT AND COMPETENCIES OF


KNOC

Section 1: The Kurdistan National Oil Company (KNOC) is hereby


established.

Section 2: KNOC is a public company.

379
Petroleum Fiscal Systems and Contracts

Section 3: Members of the Board of KNOC, including the Chief


Executive Officer, shall be appointed by the Government, and
approved by a two-thirds majority of Parliament. Members shall be
independent of the Ministry, and shall have petroleum or other
appropriate technical and management qualifications.

Section 4: Subject to any agreement pursuant to Article 22 of this


Act, an additional Board member may be appointed by the
designated institution of the Government of Iraq.

Section 5: KNOC shall be responsible for operating Current


Fields.

Section 6: Subject to the approval of the Government, KNOC may


enter into joint ventures with reputable and experienced
international petroleum companies for Petroleum Operations to
enhance production from Current Fields, to maximise early
returns. Subject to an agreement pursuant to Article 22 of this Act,
such a joint venture will also be subject to the approval of the
appropriate institution of the Government of Iraq.

Section 7: KNOC may, subject to the approval of the Government


on a case by case basis, compete for Authorisations for Future
Fields.

Section 8: KNOC shall be governed by this Act, the regulations


issued by the Ministry, and other applicable laws and rules.

ARTICLE 14: ESTABLISHMENT AND COMPETENCIES OF


KOMO

Section 1: The Kurdistan Oil Marketing Organisation (KOMO) is


hereby established.

Section 2: KOMO is a public company.

Section 3: Members of the Board of KOMO shall be appointed by


the Government. The Chairman of KOMO shall be the Minister.

380
Petroleum Fiscal Systems and Contracts

Section 4: KOMO shall be governed by this Act, the regulations


issued by the Ministry, and other applicable laws and rules.

Section 5: KOMO shall market and/or regulate the marketing of


the Government’s share of Petroleum from Petroleum Operations,
and may, with the agreement of a Contractor to a Production
Sharing Contract, market the Contractor’s share of Petroleum.

ARTICLE 15: ESTABLISHMENT AND COMPETENCIES OF


KODO

Section 1: The Kurdistan Organisation for Downstream


Operations (KODO) is hereby established.

Section 2: KODO is a public company.

Section 3: Members of the Board of KODO, including the Chief


Executive Officer, shall be appointed by the Government, and
approved by a two-thirds majority of Parliament. Members shall be
independent of the Ministry, and shall have petroleum or other
appropriate technical and management qualifications.

Section 4: The Ministry may assign some of its downstream rights


in respect of Petroleum Operations to KODO.

Section 5: KODO shall be governed by this Act, the regulations


issued by the Ministry, and other applicable laws and rules.

Section 6: KODO shall manage all current infrastructure related to


Petroleum Operations referred to in Article 6 of this Act, and shall
make available such infrastructure, including the main pipeline
network, to the Government of Iraq and to all other producing
Regions and Governorates to integrate with Iraq national policy for
export and distribution.

Section 7: KODO, subject to the approval of the Government, may


compete for Authorisations, may in its own right create operating
subsidiaries for particular Petroleum Operations, and may enter

381
Petroleum Fiscal Systems and Contracts

into joint ventures, and similar contractual arrangements, whether


in Kurdistan, or in other Regions and Governorates.

Section 8: KODO may enter into partnership with international oil


companies or with the local private sector for new downstream
Petroleum Operations, subject to the approval of the Government.

Section 9: KODO may license the management of such


infrastructure to third parties with the approval of
the Ministry.

ARTICLE 16: APPLICATION OF COMPANY LAW

KEPCO, KNOC, KOMO, and KODO shall each be subject to the


general company law of Kurdistan, and held accountable as
commercial enterprises and subject to the same rules, regulations
and obligations.

ARTICLE 17: ESTABLISHMENT AND COMPETENCIES OF


KOTO

Section 1: The Kurdistan Oil Trust Organisation (KOTO) is hereby


established.

Section 2: KOTO is supervised by the Parliament.

Section 3: Members of the governing body of KOTO shall be


nominated by the Council of Ministers and approved by the
Parliament, and the powers and accountabilities of its members
shall be defined in detail by law.

Section 4: Consistent with Article 115 of the Constitution of Iraq,


all revenues from Petroleum Operations that are the subject
matter of this Act may be received by KOTO on behalf of the
people of Kurdistan, subject to Article 19 of this Act and any
agreement pursuant to Article 22 of this Act.

382
Petroleum Fiscal Systems and Contracts

Section 5: All revenues from Petroleum Operations that shall be


remitted by the Government of Iraq to Kurdistan shall be received
by KOTO on behalf of the people of Kurdistan.

Section 6: KOTO shall maintain two accounts: one for revenues


from Petroleum Operations in respect of Current Fields (the
Current Fields Account); and one for revenues from Petroleum
Operations in respect of Future Fields (the Future Fields Account).
Both accounts shall be part of the general revenue of Kurdistan
under the authority of the Parliament.

Section 7: The Current Fields Account and the Future Fields


Account shall be subject to independent audit, and such audit
shall be available to the public. In all other respects KOTO shall
discharge its responsibilities consistent with the Principles and
Criteria of the Extractive Industries Transparency Initiative (EITI)
as set out in the EITI Source Book of March 2005.

383
Petroleum Fiscal Systems and Contracts

CHAPTER IV – CO-OPERATION WITH FEDERAL


AUTHORITIES

ARTICLE 18: STRATEGIC POLICY FORMULATION

The Government shall, together with the Government of Iraq,


formulate strategic policies to develop the Petroleum wealth of
Iraq in a way that achieves the highest benefit to the Iraqi people
using the most advanced techniques of market principles and
encouraging investment, consistent with Article 112 of the
Constitution of Iraq.

ARTICLE 19: REVENUE SHARING

The Government shall share revenues from Petroleum Operations


pursuant to the provisions of Annex A of this Act, and subject to
Article 22 of this Act.

ARTICLE 20: RESTRUCTURING OF THE INDUSTRY IN IRAQ

The Government shall cooperate with the Government of Iraq to


restructure the petroleum industry of Iraq pursuant to Annex B of
this Act, and subject to Article 22 of this Act.

ARTICLE 21: REGIONAL ROLE OF FEDERAL INSTITUTIONS

The Government shall agree that the two upstream federal


institutions referred to in paragraph (f) of Annex B of this Act shall
have a role in Kurdistan, subject to Article 22 of this Act.

ARTICLE 22: CONDITIONAL CO-OPERATION

Section 1: Without prejudice to Kurdistan’s constitutional rights,


the co-operation of the Government referred to in Articles 19, 20
and 21 of this Act is conditional upon the Government of Iraq

384
Petroleum Fiscal Systems and Contracts

(a) concluding an agreement with the Government on revenue


sharing, distribution and administration of extracted Petroleum as
set out in Annex A of this Act,
(b) restructuring the petroleum industry of Iraq pursuant to Annex
B of this Act, and
(c) accepting the role for federal institutions in the Regions
pursuant to Annex C of this Act.

Section 2: If the conditions set out in Section 1 of this Article are


not met in full within three (3) months of the date of entry into
force of this Act, then, consistent with this Act, including Articles 4,
5 and 6 of this Act, and consistent with the rights of Kurdistan as
specified in the constitution of Iraq, Kurdistan shall retain
exclusive control of Petroleum Operations, including marketing. In
those circumstances, Kurdistan shall also retain exclusive
management and control of Petroleum revenues from Petroleum
Operations, which shall be administered by KOTO pursuant to
Section 7 of Article A1, and Section 8 of Article A2, of Annex A of
this Act.

385
Petroleum Fiscal Systems and Contracts

CHAPTER V - ANTI-CORRUPTION PROVISIONS

ARTICLE 23: RESTRICTIONS TO RIGHTS OF PUBLIC


OFFICERS

Section 1: A Public Officer shall not acquire, attempt to acquire or


hold:
(a) an Authorisation or an interest, whether direct or indirect, in an
Authorisation; or
(b) a share in a corporation (or an Affiliate of it) that holds an
Authorisation, unless as part of a nondiscriminatory
transparent process of privatisation of a Government-owned
company.

Section 2: Any instrument that grants or purports to grant, to a


Public Officer, an interest, whether direct or indirect, in an
Authorisation shall, to the extent of the grant, be void.

Section 3: The acquisition or holding of an Authorisation, interest


or share by the minor children or spouse of a Public Officer shall
be deemed to be an acquisition or holding by the Public Officer.

Section 4: The Minister shall require, by regulation, that all Public


Officers be subject to the filing of financial disclosure statements,
which, in the case of senior Public Officers, shall be made public.

Section 5: The laws of Kurdistan concerning corruption shall apply


to all Public Officers.

ARTICLE 24: APPLICATION OF CORRUPTION LAWS

Section 1: If any Authorisation obtained in violation of the laws of


Kurdistan, including laws concerning corruption, the Authorisation
is void ab initio.

Section 2: An Authorised Person who is in breach of the laws of


Kurdistan concerning corruption may lose the Authorisation or part
of the Authorisation and a clause to this effect shall be included in
all Authorisations.

386
Petroleum Fiscal Systems and Contracts

ARTICLE 25: CRIMINAL LAW

A Person who is in breach of the laws concerning corruption may


be prosecuted according to the applicable laws of Kurdistan.

387
Petroleum Fiscal Systems and Contracts

CHAPTER VI – AUTHORISATIONS

ARTICLE 26: DIVISION INTO PARCELS OF LAND

For the purposes of this Act, the territory of Kurdistan, or parts of


the territory of Kurdistan, shall be divided into parcels of land by
the Ministry from time to time, and shall be defined by Universal
Transverse Mercator (UTM) and Geographic co-ordinates.

ARTICLE 27: PROSPECTING

Section 1: The Ministry may grant a Prospecting Authorisation, in


respect of a specified area, to a Person or a group of Persons.

Section 2:
(a) A Prospecting Authorisation grants a right to perform
geological, geophysical, geochemical and geotechnical surveys in
the Authorised Area.
(b) The Prospecting Authorisation may require the Authorised
Person to report on the progress and results of such prospecting,
and to maintain confidentiality with respect to such prospecting.
(c) Nothing in a Prospecting Authorisation authorises the holder to
drill a Well or to have any preference or right to make a Petroleum
Contract.

Section 3: Prior to granting a Prospecting Authorisation in respect


of an area that is the subject of an existing Authorisation, the
Ministry shall give written notice to the holder of the existing
Authorisation.

Section 4:
(a) The holder of a Prospecting Authorisation may surrender it at
any time by written notice to the Ministry, provided that the
Authorised Person has fulfilled all its obligations thereunder.
(b) If the holder has not complied with a condition to which the
Prospecting Authorisation is subject, the Ministry may terminate it
by written notice to the holder.

388
Petroleum Fiscal Systems and Contracts

ARTICLE 28: EXPLORATION AND DEVELOPMENT

Section 1: The Ministry may conclude a Petroleum Contract for


exploration and development in respect of a specified area, with a
Person or a group of Persons, provided that if a group, such group
enters into a joint operating agreement approved by the Ministry
under Article 35 of this Act. The Person, or a group of Persons,
may include Kurdistan and other Iraqi companies, as well as
foreign oil companies.

Section 2: Petroleum Contracts may be based on a Model


Production Sharing Contract, or on other contracts which the
Ministry considers to provide good and timely returns to the
people of Kurdistan. The fiscal terms to be contained in a
Production Sharing Contract are specified in CHAPTER VIII of this
Act. In no circumstances shall a Petroleum Contract guarantee a
rate of return to the Contractor.

Section 3: In order to be eligible to enter into a Petroleum


Contract, a Person must demonstrate:
(a) the financial capability, and the technical knowledge and
technical ability, to carry out the Petroleum Operations in the
Contract Area, including direct experience in carrying out similar
petroleum operations; and
(b) a record of compliance with principles of good corporate
citizenship, and a commitment to the Ten Principles of the Global
Compact, launched by the United Nations on 26 July 2000.

Section 4:
(a) Without prejudice to Article 29 of this Act, a Petroleum
Contract grants to the Contractor the exclusive right to conduct
Petroleum Operations in the Contract Area.
(b) The Petroleum Contract may be limited to Crude Oil, Natural
Gas or other constituents of Petroleum.

Section 5:
(a) A Contractor shall give written notice to the Ministry within forty
eight (48) hours whenever any Petroleum is encountered in its
Authorised Area.

389
Petroleum Fiscal Systems and Contracts

(b) The Contractor shall provide in a timely manner such


information relating to the Discovered Petroleum as requested by
the Ministry.

Section 6: A Petroleum Contract shall oblige the Contractor to


carry on Petroleum Operations only in accordance with work
programs, plans and budgets approved by the Ministry.

ARTICLE 29: ACCESS

Section 1:
(a) The Ministry may grant an Access Authorisation, in respect of
a specified area, to a Person or a group of Persons.
(b) The Ministry may not grant an Access Authorisation in respect
of an area that is the subject of a Petroleum Contract or a
Prospecting Authorisation until it has taken into account any
Submissions made by the holders of such Authorisations in such
a way that there is no undue interference with the rights of that
other Authorised Person.

Section 2:
(a) An Access Authorisation, while it remains in force, authorises
the holder to do one or more of the following:
(i) construct, install and operate structures, facilities and
installations; and
(ii) carry out other works;
as specified in the Authorisation in the Authorised Area.
(b) Nothing in an Access Authorisation authorises the holder to
drill a Well.

Section 3:
(a) An Access Authorisation:
(i) may be surrendered by the holder by written notice to the
Ministry, provided that the Authorised Person has fulfilled all its
obligations thereunder; and
(ii) may be terminated by the Ministry at any time by written notice
to the holder, if the holder has not complied with a condition to
which the Authorisation is subject.

390
Petroleum Fiscal Systems and Contracts

(b) The Ministry shall provide written notice of the surrender or


termination to any Authorised Person in whose Authorised Area
operations were authorised to be carried on by the Access
Authorisation concerned.

Section 4: The Ministry may give a direction to the holders of


Access Authorisations and to other Authorised Persons regarding
the coordination of their respective Petroleum Operations.

ARTICLE 30: THIRD PARTY ACCESS

Every Petroleum Contract and Access Authorisation shall require


that third party access be granted on reasonable terms and
conditions.

ARTICLE 31: INVITATIONS AND AWARDS

Section 1:
(a) The Ministry may invite, by public notice, applications for
Authorisations.
(b) The Ministry may, where it is in the public interest to do so,
elect to award Authorisations through direct negotiation.
(c) The invitation may stipulate that applications be submitted in
Kurdish, Arabic, or English.

Section 2:
(a) An invitation shall specify the area of the Authorisation, the
proposed activities, the criteria upon which applications will be
assessed, the applicable fees to be paid with the application, and
the date and the manner in which the applications may be made.
(b) Unless the invitation otherwise states, the Ministry may choose
not to award an Authorisation to any of the applicants.

Section 3:
(a) An application for an Authorisation shall include proposals for:
(i) securing the health, safety and welfare of persons involved in
or affected by the Petroleum Operations;

391
Petroleum Fiscal Systems and Contracts

(ii) protecting the environment, preventing, minimising and


remedying pollution, and other environmental harm from the
Petroleum Operations;
(iii) training of, and giving preference in employment in the
Petroleum Operations to, citizens of Kurdistan and other citizens
of Iraq; and
(iv) the acquisition of goods and services from Persons based in
Kurdistan and other parts of Iraq.
(b) An Authorisation awarded to an applicant obliges it to comply
with its proposals set out in Section 3(a) of this Article.

Section 4: The Ministry shall not grant an Authorisation in respect


of an area until it has given due consideration to all applications
made in response to, and in compliance with, an invitation.

Section 5: The Ministry shall not grant an Authorisation with a


value greater than fifty million United States Dollars (USD
$50,000,000.00) or, any Authorisation which is a Production
Sharing Contract, until it has:
(a) received a formal report from a Contract Evaluation
Committee, whose members shall be approved by Parliament;
and
(b) obtained the approval of the Council of Ministers.

392
Petroleum Fiscal Systems and Contracts

CHAPTER VII – CONDUCT OF PETROLEUM OPERATIONS

ARTICLE 32: WORK PRACTICES

Section 1: Production of Petroleum shall take place:


(a) in such a manner that as much as possible of the Petroleum in
place in each individual Petroleum deposit, or in several deposits
in combination, will be produced;
(b) in accordance with Good Oil Field Practice and sound
economic principles; and
(c) in such a manner that waste of Petroleum or reservoir energy
is avoided.

Section 2: Contractors shall carry out regular evaluation of


Petroleum production strategy and technical solutions and shall
take the necessary measures in order to achieve the objectives of
Section 1 of this Article.

ARTICLE 33: PETROLEUM EXPLOITATION

Section 1: The existence of Petroleum Authorisations in force in a


given area does not prevent permissions for the exploration and
exploitation of mineral substances other than Petroleum, provided
that such other activity does not seriously hinder the proper
performance of the Petroleum Operations.

Section 2: In the event that exercise of the rights and obligations


referred to in Section 1 of this Article are incompatible, the
Ministry shall decide which of the rights and obligations shall
prevail and under what terms, without prejudice to any
compensation which may be due to the holders of the rights
thereby overridden.

393
Petroleum Fiscal Systems and Contracts

ARTICLE 34: RESTRICTIONS ON EXERCISE OF RIGHTS

Section 1:
(a) An Authorised Person shall not exercise any of the rights
granted under an Authorisation or under this Act for the following
or similar cases:
(i) on any public Asset without the consent of the responsible
authority;
(ii) on any private Asset of the Government without the consent of
the responsible authority; or
(iii) on any private Asset without payment of fair and reasonable
compensation to the owner.
(b) The owner of any Asset in an Authorised Area retains rights to
the use of its Asset except in so far as the use interferes with
Petroleum Operations.
(c) An Authorisation may limit or otherwise control the use by an
Authorised Person of public infrastructure, and the consumption of
other natural resources, including trees, sand, gravel, rock and
water.
(d) An Authorisation does not constitute a waiver of the obligation
to seek the written consent of responsible authorities.

Section 2:
(a) The Authorised Person is liable to pay fair and reasonable
compensation if, in the course of Petroleum Operations, it:
(i) disturbs the rights of the owner of any Asset, or causes any
damage thereon; or
(ii) demonstrably interferes with any other lawful activities.
(b) If the value of any benefits have been enhanced by the
Petroleum Operations because of violations under Section 2(a) of
this Article, compensation payable in respect of such rights shall
not exceed any amount which would be payable if the value had
not been so enhanced.

Section 3: A fair and reasonable compensation under this Article


shall be estimated and decided by the Ministry, after having
considered representations by interested parties. The Authorised
Person shall be entitled to arbitration by an independent
international expert appointed by the Minister and the Authorised
Person.

394
Petroleum Fiscal Systems and Contracts

ARTICLE 35: APPROVALS

Section 1: Any joint operating agreement, any lifting arrangement


and any agreement related to the Petroleum Operations, as well
as any changes to such agreements, shall be subject to prior
approval by the Ministry.

Section 2:
(a) Any changes in Control of an Authorised Person shall be
subject to prior approval by the Ministry which shall not be
unreasonably withheld or delayed.
(b) Where a change in Control occurs without the prior approval of
the Ministry, the Ministry may terminate the applicable
Authorisation.
(c) For the purposes of Section 2(a) of this Article, change in
Control includes a Person ceasing to be in Control (whether or not
another Person becomes in Control), and a Person obtaining
Control (whether or not another Person was in Control).

Section 3: Except with the prior written consent of the Ministry, or


as explicitly provided in the terms of the Authorisation, no
assignment, transfer, conveyance, novation, merger,
encumbrance or other similar dealing in respect of an
Authorisation shall be of any force or effect.

ARTICLE 36: JOINT AND SEVERAL LIABILITY

If there is more than one Authorised Person in respect of a


particular Authorisation, the obligations and liabilities of the
Authorised Person under an Authorisation are the obligations and
liabilities of them all, jointly and severally.

ARTICLE 37: TITLE TO DATA

Section 1: Kurdistan shall have title to all data and information,


whether raw, derived, processed, interpreted or analysed,
obtained pursuant to any Authorisation.

395
Petroleum Fiscal Systems and Contracts

Section 2: Notwithstanding Section 1 of this Article, Authorised


Persons may retain copies of such data and information and freely
use some or all for the duration of a relevant Authorisation but
shall have no title to such data after the termination of the
Authorisation.

Section 3: Data and information acquired during the course of


Petroleum Operations may, with the permission of the Ministry, be
freely exported by Authorised Persons provided that the Ministry
may require that an original, or in the case of a core, rock, fluid or
other physical sample, a usable portion of the original, of all data
and information, both physical and electronic, be kept in
Kurdistan.

ARTICLE 38: AUDIT AND INSPECTION

Section 1: The Ministry may appoint a person to be an inspector


for the purposes of this Act (an “Inspector”). The Inspector, who
shall be an official of the Ministry, will have the powers and rights
provided to him in the regulations.

Section 2: On request, an Authorised Person shall make its books


and accounts available to the Ministry for auditing.

ARTICLE 39: TERMINATION OF AUTHORISATIONS

Section 1:
(a) Termination of an Authorisation for any reason is without
prejudice to rights and obligations expressed in this Act or the
Authorisation to survive termination, or to rights and obligations
accrued thereunder prior to termination, and all provisions of an
Authorisation reasonably necessary for the full enjoyment and
enforcement of those rights and obligations survive termination for
the period so necessary.
(b) The Ministry shall have the power to terminate an
Authorisation as set out in the Authorisation.

396
Petroleum Fiscal Systems and Contracts

Section 2: If there is more than one Authorised Person in respect


of a particular Authorisation and circumstances arise in which the
Ministry may terminate an Authorisation, the Ministry may elect to
terminate an Authorisation only in respect of those Authorised
Persons whose acts or omissions have led to such circumstances,
and shall so notify the remaining Authorised Persons.

Section 3: In the event that the Ministry elects to terminate an


Authorisation pursuant to Section 2 of this Article, the interest of
those Authorised Persons whose Authorisation has been
terminated shall revert to the Ministry and shall be used for the
best interests of the people of Kurdistan.

ARTICLE 40: INDEMNIFICATION OF THE GOVERNMENT AND


MINISTRY

Section 1: An Authorised Person shall defend, indemnify and hold


harmless the Government and Ministry from all claims by third
parties resulting, directly or indirectly, from Petroleum Operations.

Section 2: An Authorised Person shall, unless the Ministry is


satisfied, after consultation with the Authorised Person, that the
potential liability under Section 1 of this Article can be covered by
other means, maintain insurance in respect thereof on a strict
liability basis for such amount as the Ministry requires from time to
time.

ARTICLE 41: DECOMMISSIONING AND RESTITUTION

Section 1: An Authorised Person shall Decommission on the


earlier of:
(a) termination of the Authorisation; and
(b) when no longer required for Petroleum Operations;
and, in either case:
(i) except with the consent in writing of the Ministry and in
accordance with the conditions of the consent; or
(ii) unless the Authorisation otherwise provides.

397
Petroleum Fiscal Systems and Contracts

Section 2: Without prejudice to any criminal liability, a Person who


engages in Petroleum Operations other than pursuant to an
Authorisation shall:
(a) make restitution to Kurdistan of an amount equal to the market
value of Petroleum developed, exploited or exported, together
with late payment interest thereon at a rate not to exceed the legal
rate of interest to be determined by the Ministry;
(b) either forfeit all infrastructure and equipment used in engaging
in those Petroleum Operations, or remove such infrastructure and
equipment or be liable for the payment of the costs of such
removal; and
(c) clean up pollution resulting from those Petroleum Operations,
or reimburse the costs of clean-up to Kurdistan;
cumulatively or not, as is determined to be appropriate by the
Ministry in order to place Kurdistan in the position in which it
would have been were it not for the Petroleum Operations
engaged in other than pursuant to an Authorisation.

Section 3: The liabilities under Section 2 of this Article of Persons


who, together, are engaged in, or have engaged in, Petroleum
Operations are the liabilities of them all, jointly and severally.

398
Petroleum Fiscal Systems and Contracts

CHAPTER VIII - CONTRACT TERMS

ARTICLE 42: PRODUCTION SHARING CONTRACT TERMS

Section 1: The terms defined in Sections 2, 3 and 4 of this Article


shall apply to any Contractor, whether local or foreign.

Section 2: The terms of a standard Production Sharing Contract


shall include the following:
(a) An initial exploration term of a maximum of five (5) years,
divided into two sub-periods, of three (3) years and two (2) years,
extendable on a yearly basis for up to a maximum total of seven
(7) years;
(b) relinquishment of twenty-five percent (25%) after the initial
exploration term, with a further twenty-five percent (25%) of the
remaining area at the end of each renewal period. If these
percentages of relinquishments can only be achieved by including
part of the area of a discovery, these percentages shall be
reduced to exclude the discovery area. Voluntary relinquishment
at the end of each Contract year is permitted;
(c) an exploration commitment, which shall be negotiable, usually
involving the purchase and interpretation of all existing data,
including seismic data, where available, and seismic acquisition
in the first sub-period, with exploration drilling in the second sub-
period and a well in each of the annual extensions;
(d) a development period, following discovery, to be twenty (20)
years, with an automatic right of a five (5) year extension, with
possible further extensions to be negotiated;
(e) Royalty, with a minimum rate at seven point five percent
(7.5%) for oil with a gravity up to twenty (20) degrees American
Petroleum Institute (API), eight point five percent (8.5%) for oil up
to thirty (30) degrees API, and ten percent (10%) for oil over thirty
(30) degrees API, and with a minimum rate of five percent (5%)
for Natural Gas, increasing based on daily production, and paid in
accordance with Article 45 of this Act;
(f) cost recovery from a portion of production, to a maximum not
exceeding seventy percent (70%) for oil with a gravity up to
fourteen (14) degrees American Petroleum Institute (API), sixty-
five percent (65%) for oil between fourteen (14) and twenty (20)
degrees API, sixty percent (60%) for oil between twenty (20) and

399
Petroleum Fiscal Systems and Contracts

thirty (30) degrees API, and fifty-five percent (55%) for oil over
thirty (30) degrees API, and with a maximum rate of seventy
percent (70%) for Natural Gas;
(g) production sharing from remaining production after Royalty
and allowable cost recovery according to a formula which takes
into account cumulative revenues and cumulative petroleum costs
and provides the Contractor with reasonable returns; but that
formula shall not guarantee a rate of return to the Contractor;
(h) annual surface rental during exploration phases;
(i) Government participation for a direct working interest in
development and production with participation terms which must
be fixed and defined in each Contract, and which shall be kept to
a minimum;
(j) a commitment to the payment of a prescribed amount into an
Environment Fund, to be administered by the Government for the
benefit of the natural environment of Kurdistan, and
(k) provisions for securing the health, safety and welfare,
environmental protection, training, and acquisition of goods and
services, consistent with international standards and with the
proposals made pursuant Section 3 of Article 31 of this Act.

Section 3: For any Production Sharing Contract that the Ministry


considers to involve an unusually high element of commercial risk
(such as a Production Sharing Contract involving frontier
exploration) or to require an unusually high amount of up-front
capital (such as major integrated upstream and downstream
projects), the minimum Royalty percentage stated in Section 1(e)
of this Article may be reduced to zero percent (0%) and the cost
recovery percentage stated in Section 1(f) this Article may be
increased to one hundred percent (100%).

Section 4: For any Production Sharing Contract that the Ministry


considers to involve an unusually low element of commercial risk
(such as a Production Sharing Contract for a Contract Area in
which there is Discovered Petroleum), a Royalty percentage up to
the maximum, and a cost recovery percentage down to the
minimum, may be applied.

Section 5: Any Production Sharing Contract shall clearly define


the applicable terms with respect to Associated and non-

400
Petroleum Fiscal Systems and Contracts

Associated Natural Gas in such a manner to facilitate the


development of a gas industry in Kurdistan and in Disputed
Territories where Kurdistan is a party to the dispute. Those terms
shall include provisions for the optimal utilisation of surplus
volumes of produced Natural Gas, and terms to minimise the
flaring of Natural Gas.

ARTICLE 43: OTHER CONTRACTS

The Ministry may enter into Other Contracts, which may include
service contracts, field management contracts, guaranteed rate of
return contracts, supply and installation contracts, construction
contracts, consulting contracts, or any other types of contracts
that the Ministry may from time to time require to efficiently
manage the Petroleum resources of Kurdistan. Such Other
Contracts may contain some element of risk to reward the
contractor for performance, timely completion, and achieving high
value targets.

ARTICLE 44: TAXATION

Section 1: Contractors, Authorised Persons and other Persons


associated with Petroleum Operations may be liable for Kurdistan
taxes, including:
(a) surface tax;
(b) personal income tax;
(c) corporate income tax;
(d) customs duties and any other similar taxes;
(e) windfall profits or additional profits tax; and
(f) any other tax, levy or charge expressly included in its
Petroleum Contract or this Act.

Section 2: The Petroleum Contract shall clearly state the taxation


liability of a Contractor. This provision shall apply notwithstanding
a commitment by the Government to pay that liability on behalf of
the Contractor and to issue taxation certificates to the Contractor
to that effect.

401
Petroleum Fiscal Systems and Contracts

Section 3: The Parliament shall, in due course, promulgate a


Petroleum Operations Taxation Act.

Section 4: Pursuant to Article 115 and Section 2 of Article 121 of


the Constitution of Iraq, Kurdistan taxes shall be the only taxes
that apply to Petroleum Operations.

ARTICLE 45: ROYALTY PAYMENT

Section 1: Contractors with a Production Sharing Contract shall


pay a Royalty to the Government in the amount set forth in their
Petroleum Contract. Unless the Royalty has been fixed at zero
percent (0%) pursuant to Section 3 of Article 42 of this Act, those
Production Sharing Contracts shall provide for levels of Royalty
increasing above the minimum rate defined in Section 2 of Article
42 of this Act based on incremental daily production rates.

Section 2: The volume of Petroleum constituting the Royalty shall


be calculated directly by applying the percentage specified in the
Petroleum Contract for a given level of daily production to the total
amount of Petroleum produced and saved as from the date the
relevant level of daily production is reached.

Section 3: The Royalty may be required by the Ministry to be paid


in kind or in cash, fully or partially. Unless otherwise required, it
shall be understood that the Ministry has elected to receive the
Royalty in full and in cash and the Royalty shall be paid at least
quarterly or more frequently as provided for in the applicable
Petroleum Contract.

Section 4: When the Ministry elects to receive the Royalty in cash,


the producing Contractor shall pay such Royalty on the basis of
the selling price of the Petroleum.

402
Petroleum Fiscal Systems and Contracts

ARTICLE 46: DISPUTED TERRITORIES

Section 1: The Ministry may enter into Petroleum Contracts for


Petroleum Operations in Disputed Territories where the Minister
concludes after consultation with other governmental authorities in
Kurdistan that it is likely that the citizens in those Disputed
Territories, in the referendum required by Article 140 of the
Constitution of Iraq, will decide that those Disputed Territories are
to be part of Kurdistan.

Section 2: The Ministry may, together with the Government of


Iraq, jointly manage Petroleum Operations in Disputed Territories
until such time as the future of the Disputed Territories is decided
in the referendum required by Article 140 of the Constitution of
Iraq.

Section 3: In the event of a decision of the citizens of those


Disputed Territories in the referendum required by Article 140 of
the Constitution of Iraq, that those Disputed Territories are to be
part of Kurdistan, Petroleum Operations in those Disputed
Territories may the subject of any agreement pursuant to Article
22 of this Act.

Section 4: A Petroleum Contract concluded pursuant to Section 1


of this Article shall include an undertaking by the Ministry that in
the event of a decision of the citizens of those Disputed Territories
in the referendum required by Article 140 of the Constitution of
Iraq, that those Disputed Territories are not to be part of
Kurdistan:
a) the Petroleum Contract shall be transferred to the Government
of Iraq or to the adjacent Region or Governorate, as appropriate,
and
b) if the Government of Iraq does not accept the contract terms
previously agreed with the Government, the Contractor shall be
indemnified by the Government for fair value in reliance upon
the Petroleum Contract.

403
Petroleum Fiscal Systems and Contracts

ARTICLE 47: KURDISTAN CONSUMPTION REQUIREMENTS

All Contractors are obliged to sell and transfer to the Government,


upon written request of the Ministry, any amounts of Petroleum
that the Government shall deem necessary to meet Kurdistan
internal consumption requirements. The sales price of Petroleum
shall be established pursuant to the applicable Petroleum
Contract, or in the absence thereof, fair market value.

ARTICLE 48: GOVERNMENT AND CONTRACTOR RETURNS

Section 1: When concluding any Petroleum Contract, the Ministry


shall conduct its own inquiry into the likely Contractor
compensation from the proposed Petroleum Operations, to ensure
that the return to the people of Kurdistan and all of Iraq is
maximised, but allows the Contractor terms which are fair and
consistent with international standards.

Section 2: Where the Ministry is concluding a Petroleum Contract


for areas that contain proven Petroleum, the Ministry shall ensure
that the Petroleum Contract provides adequate returns for the
Government, while allowing a reasonable return to the Contractor.

404
Petroleum Fiscal Systems and Contracts

CHAPTER IX - LOCAL PARTICIPATION

ARTICLE 49: LOCAL CONTENT

Section 1: Authorised Persons shall give priority to partnering with


competent local companies owned by Persons from Kurdistan and
other parts of Iraq. Such a local partner must:
(a) be a bona fide company not related to any Public Officer,
directly or indirectly;
(b) have adequate resources and capacity to add value to the
Petroleum Operations carried out by the Authorised Person, and
(c) must be approved by the Ministry, according to clear criteria
which the Ministry shall prescribe by regulation.

Section 2: Authorised Persons shall give preference to the


employment of Kurdistan and other Iraqi personnel to the extent
such personnel have the requisite qualifications, competence and
experience required to perform the work.

Section 3: Authorised Persons shall give priority to the purchase


of local products and services from Kurdistan and other parts of
Iraq, wherever they are competitive in terms of price, quality and
timely availability.

ARTICLE 50: TRAINING AND TECHNOLOGY TRANSFER

Section 1: An Authorisation shall include a clearly defined training


program for local employees of the Authorised Person, which may
be carried out in Kurdistan or in foreign countries, and may
include scholarships and other financial support for education.

Section 2: An Authorisation shall include, where possible, a


commitment by the Authorised Person to maximise knowledge
transfer to the people of Kurdistan, and to establish in Kurdistan
any necessary facilities for technical work, including the
interpretation of data.

405
Petroleum Fiscal Systems and Contracts

ARTICLE 51: CONTRACTOR OFFICES IN KURDISTAN

A Contractor shall maintain an office in Kurdistan.

406
Petroleum Fiscal Systems and Contracts

CHAPTER X – UNITISATION

ARTICLE 52: UNITISATION OF RESERVOIRS WITHIN


KURDISTAN

Section 1: If a Reservoir lies entirely within Kurdistan, any


unitisation of the Reservoir shall be the responsibility of the
Ministry.

Section 2: The unitisation of Reservoirs within Kurdistan shall be


consistent with international standards in the petroleum industry.

Section 3: If a Reservoir lies partly within a Contract Area, and


partly in another Contract Area,
(a) The Ministry may require by written notice the Contractors to
enter into a joint unitisation agreement for the Reservoir with each
other for the purpose of securing the more effective and optimised
production of Petroleum from the Reservoir; and
(b) if no joint agreement has been reached within a reasonable
period of time from receipt of written notice stated in paragraph (a)
above, the Ministry shall decide on the unitisation, and the
Contractors will be entitled to independent arbitration pursuant to
the provisions of Article 55 (Resolution of Disputes) of this Act.

Section 4: If a Reservoir lies partly within a Contract Area and


partly in an area that is not the subject of any other Petroleum
Contract:
(a) The Ministry may require by written notice the Contractor to
enter into a joint unitisation agreement for the Reservoir with the
Ministry for the purpose of securing the more effective and
optimised production of Petroleum from the Reservoir; and
(b) if no agreement has been reached within a reasonable period
of time from receipt of written notice as required in paragraph (a)
above, the Ministry shall decide on the unitisation, and the
Contractor shall be entitled to independent arbitration, or the
decision shall be according to the conditions of the Petroleum
Contract where such a process is provided for under the Contract.

Section 5: Without limiting the matters to be dealt with in the


unitisation agreement, any agreement reached shall define the

407
Petroleum Fiscal Systems and Contracts

amount of Petroleum in each area covered by the unitisation


agreement, and shall appoint the Operator responsible for
production of the Petroleum covered by the unitisation agreement.

Section 6: The Ministry may approve the development or


exploitation of Petroleum from the Reservoir only after it has
approved or decided the unitisation agreement.

Section 7: Any changes to the unitisation agreement shall be


subject to prior approval by the Ministry.

ARTICLE 53: UNITISATION OF RESERVOIRS ACROSS A


KURDISTAN BOUNDARY, BUT WITHIN IRAQ

Section 1: If a Reservoir lies across a Kurdistan border into other


areas that are part of Iraq, the unitisation of the Reservoir shall be
the responsibility of the Ministry.

Section 2: For any Reservoir described in Section 1 of this Article,


the Ministry shall endeavour to reach agreement with the
Government of Iraq to manage the Reservoir as a single entity for
development purposes.

Section 3: Any such agreement shall achieve the highest benefit


to the people of Kurdistan and all of Iraq using the most advanced
techniques and market principles to encourage investment,
consistent with Article 112 of the Constitution of Iraq.

Section 4: In reaching such an agreement, the Ministry shall, if


necessary, submit with the Government of Iraq the matter to
arbitration by an independent international expert to be appointed
by the Minister and representatives of the Government of Iraq.

Section 5: Such an agreement may specify that the unitised


Reservoir be administered by a joint management body which
shall comprise representatives of the Ministry and the
Government of Iraq.

408
Petroleum Fiscal Systems and Contracts

ARTICLE 54: UNITISATION OF RESERVOIRS ACROSS


INTERNATIONAL BORDERS

Section 1: If a Reservoir lies across a Kurdistan border into areas


that are part of the domain of a neighbouring country, the
unitisation of the Reservoir shall be the responsibility of the
Ministry.

Section 2: For any Reservoir described in Section 1 of this Article,


the Ministry shall endeavour to reach agreement with the
neighbouring country to treat the Reservoir as a single entity for
management and development purposes.

Section 3: Any such agreement shall lead to a complete equitable


benefit for both parties from the exploitation of Petroleum from the
Reservoir.

Section 4: If it becomes necessary, the Ministry shall assign to the


Government of Iraq the right to represent the interests of
Kurdistan in any such agreement.

Section 5: Any agreements leading to the exploitation of


Petroleum from such a Reservoir shall require the prior approval
of the Ministry and ratification by the Parliament and the President
of Kurdistan.

409
Petroleum Fiscal Systems and Contracts

CHAPTER XI - RESOLUTION OF DISPUTES

ARTICLE 55: RESOLUTION OF DISPUTES

Section 1:
(a) The Ministry may inquire into and decide on processes to
resolve all disputes involving Persons engaged in Petroleum
Operations, including disputes:
(i) among the Persons themselves, where agreements between
them do not specify a dispute resolution mechanism; or
(ii) in relation to other parties (other than the Government) not so
engaged.
(b) The Ministry may refuse to decide any dispute referred to it
and, if it does so, it shall notify the parties to the dispute in writing.
(c) The Ministry may, taking into account all relevant
circumstances, give any direction which may be necessary for the
purpose of giving effect to its decision in proceedings pursuant to
this Article, including ordering the payment, by any party to a
dispute, to any other party to the dispute of such compensation as
may be fair and reasonable.

Section 2:
(a) If a dispute arises relating to the interpretation and/or
application of the terms of an Authorisation between an
Authorised Person and the Ministry, the parties shall attempt to
resolve that dispute by means of negotiation.
(b) If the dispute cannot be resolved by negotiation, either party
may submit the dispute to arbitration.
(c) Any arbitration between the Ministry and an Authorised Person
shall be conducted, by agreement between the Parties, in
accordance with:
(i) the 1965 Washington Convention, or the regulations and rules
of the International Centre for the Settlement of Investment
Disputes (ICSID) between States and Nationals of other States; or
(ii) the rules set out in the ICSID Additional Facility adopted on 27
September 1978 by the Administrative Council at the ICSID
between States and Nationals of other States, whenever the
foreign entity does not meet the requirements provided for in
Article 25 of the Convention; or

410
Petroleum Fiscal Systems and Contracts

(iii) the Arbitration Rules of the United Nations Commission on


International Trade Law (UNCITRAL); or
(iv) the arbitration rules of the London Court of International
Arbitration (LCIA); or
(v) such other rules of recognised standing (as agreed by the
Parties, in respect of the conditions for implementation, including
the method for the designation of the arbitrators and the time limit
within which the decision must be made).
(d) The obligations of the Ministry and the Authorised Person
under the Authorisation shall continue pending the resolution of
any matter submitted to arbitration.

ARTICLE 56: EXEMPTION FROM OR VARIATION OF


CONDITIONS

The Ministry may exempt an Authorised Person from complying


with the conditions of its Authorisation, and may also agree to vary
or suspend those conditions, either with or without conditions and
either temporarily or permanently.

411
Petroleum Fiscal Systems and Contracts

CHAPTER XII – PUBLIC INFORMATION

ARTICLE 57: PUBLICATIONS BY MINISTRY

Section 1: The Ministry shall publish:


(a) notice of the grant of Authorisations,
(b) invitations for applications for Authorisations; and
(c) notice of the termination of Authorisations.

Section 2: The Ministry shall publish invitations for applications for


Authorisations in the media, in such manner as is required by
regulation.

Section 3: Publications of the Ministry required by this Act shall,


wherever possible, be issued on a searchable website maintained
by the Ministry.

ARTICLE 58: INFORMATION AVAILABLE TO PUBLIC

Section 1:
(a) The Ministry shall make available to the public:
(i) details of all Authorisations and amendments thereto, whether
or not terminated;
(ii) details of exemptions from, or variations or suspensions of, the
conditions of an Authorisation; and
(iii) copies of all unitisation agreements.
(b) The Ministry shall make available to any member of the public,
within a reasonable period of time of a request having been made
by that person, summary details of:
(i) the Authorisations (and amendments, whether or not
terminated) and unitisation agreements;
(ii) an approved Development Plan;
(iii) all assignments and other dealings consented to in respect of
Authorisations, subject to commercial confidence as to the
commercial terms.
(c) The Ministry shall make available to the public, within a
reasonable period of time of a request having been made, the
summary details pertaining to Petroleum Operations.

412
Petroleum Fiscal Systems and Contracts

Section 2: Within ten (10) business days of a request having been


made, the Ministry shall publish brief reasons for:
(a) granting an Authorisation subsequent to an invitation;
(b) granting an Authorisation without inviting applications;
(c) approving a Development Plan under a Petroleum Contract;
(d) granting an exemption from, or agreeing to a variation or
suspension of, the conditions of an Authorisation; and
(e) making any decision or granting any approval that, under an
Authorisation, requires publication.

Section 3:
(a) Companies shall report on their compliance with requirements
under the Act and Authorisations in such manner and detail as
required by their Authorisation and as provided by regulation.
(b) The Ministry shall make available such reports to the public.

Section 4: The Ministry and Public Authorities shall make


available to the public such reports by Authorised Persons on
payments relating to Petroleum Operations made to the
Government of Kurdistan as are required by law.

Section 5: The information contemplated in this Article shall be


available to any Person on payment of the required fee, to be
provided by regulation.

413
Petroleum Fiscal Systems and Contracts

CHAPTER XIII – REGULATIONS AND DIRECTIONS

ARTICLE 59: REGULATIONS

Section 1: The Ministry may make regulations under this Act


relating to the following:
(a) graticulation of the territory of Kurdistan;
(b) Petroleum exploration and production;
(c) the use and disclosure of data, information, records and
reports;
(d) the measurement and sale or disposal of Petroleum;
(e) health and safety;
(f) protection and restoration of the environment;
(g) resources management;
(h) structures, facilities and installations;
(i) the clean-up operations and other appropriate methods to
remedy and remove the effects of the escape of Petroleum;
(j) abandonment and decommissioning;
(k) the control of movement into, within and out of Kurdistan of
persons, aircraft, vehicles and any other man-made structures;
(l) work programs and budgets;
(m) the control of tariffs charged for any third party access;
(n) the auditing of an Authorised Person and of its accounts and
records;
(o) reporting by Authorised Persons on compliance with
obligations set out in the Act and Authorisations, including in
relation to:
(i) the training and employment of Kurdistan citizens and other
citizens of Iraq,
(ii) procurement of Kurdistan and Iraqi goods and services,
(iii) occupational health and safety, and
(iv) environmental protection.
(p) fees to be paid, including by applicants for Authorisations,
Authorised Persons, and Persons wishing to inspect the public
register; and
(q) any other matters relating to this Act.

Section 2: The Ministry shall publish regulations.

414
Petroleum Fiscal Systems and Contracts

ARTICLE 60: DIRECTIONS

In addition to its power to give directions under Article 28


(Exploration and Development) of this Act and Article 55
(Resolution of Disputes) of this Act, the Ministry may give
directions to an Authorised Person:
(a) relating to any matter set out in Article 59 of this Act; or
(b) otherwise requiring compliance with this Act or an
Authorisation.

415
Petroleum Fiscal Systems and Contracts

CHAPTER XIV – PENALTY PROVISIONS

ARTICLE 61: GENERAL LAW

The provisions of this Chapter are without prejudice to criminal


and civil liability under the general law of Kurdistan.

ARTICLE 62: UNAUTHORISED ACTIVITIES

Section 1: Whoever engages in any Petroleum Operations other


than pursuant to an Authorisation shall be prosecuted and may
face punishment under the laws of Kurdistan.

Section 2: Notwithstanding the provisions of Section 1 of this


Article, the Ministry may also impose a financial penalty
appropriate to the damage and inconvenience caused.

ARTICLE 63: DANGER TO PEOPLE, PROPERTY AND


ENVIRONMENT

Whoever, by conduct that contravenes the provisions of this Act,


endangers the life or physical integrity of a person, endangers any
property of high value, or gravely endangers the environment,
may be punished by:
(a) Appropriate punishment under the laws of Kurdistan and the
punishment level shall depend on whether the conduct and the
creation of the danger are malicious, or arising from negligence;
(b) Appropriate fine by the Ministry appropriate to the danger
caused.

ARTICLE 64: HINDERING THE EXERCISE OF POWERS BY


THE INSPECTOR

Section 1: Whoever, directly or indirectly, in any measure or by


any means, hinders, or leads someone else to hinder, the
exercise of powers and rights by the Inspector, may be punished

416
Petroleum Fiscal Systems and Contracts

under the laws of Kurdistan, and attract financial penalty by the


Ministry.

Section 2: An attempt to hinder may be punishable under laws of


Kurdistan.

ARTICLE 65: MISLEADING INFORMATION

Whoever, in, or in connection with, any application under this Act,


knowingly or recklessly gives information that is materially false or
misleading; or in any report, return or affidavit submitted under
any provision of this Act or an Authorisation pursuant to this Act,
knowingly or recklessly includes or permits to be included, any
information which is materially false or misleading; may be
punished under the laws of Kurdistan and may also attract
financial penalty by the Ministry.

ARTICLE 66: ACCESSORY PENALTY FOR NON-


COMPLIANCE WITH REGULATIONS OR DIRECTIONS

Section 1: Where a Person fails or neglects to comply with a


regulation to which Article 59 of this Act refers, and/or with a
direction to which Article 60 of this Act refers, the Ministry may
cause to be done all or any of the things required by the regulation
or direction to be done at the cost and expense of that Person.

Section 2: Costs and expenses incurred by the Ministry under the


previous paragraph, together with interest thereon at a rate to be
determined by the Ministry, shall be a debt due to the
Government.

ARTICLE 67: ACCESSORY PENALTIES

In relation to the crimes provided for in the Act, the following


accessory penalties may be applied:
(a) Temporary deprivation of the right to participate in public
tenders concerning Petroleum Operations, in particular those

417
Petroleum Fiscal Systems and Contracts

regarding Authorisations and the procurement of goods and


services;
(b) Embargo of any construction works, in such cases as they
may result in irreversible damage to relevant public interests;
(c) Disability, up to a maximum of two (2) years, of the exercise of
activities, if the Person has, within the period of one (1) year
starting from the date of the first contravention, contravened this
Act, or regulations or directions issued thereunder;
(d) Termination of Authorisations;
(e) Good conduct bond;
(f) Disability of rights to subsidies awarded by public entities or
services;
(g) Publication of the sentence; and/or
(h) Other writs of prevention which are adequate taking into
account the circumstances of the case in question.

ARTICLE 68: LIABILITY OF LEGAL PERSONS,


CORPORATIONS AND OTHER LEGAL ENTITIES

Section 1: Legal persons, corporations or any other legal entities,


including those without juridical personality, are liable for
contraventions provided for in this Chapter when committed by its
organs or representatives in its name.

Section 2: The liability is excluded where the agent has acted


against express orders or instructions properly issued.

Section 3: The liability of the entities mentioned in Section 1 of this


Article does not exclude the individual liability of the respective
agents.

Section 4: The entities mentioned in Section 1 of this Article are


jointly and severally liable, as provided for in civil law, for the
payment of any fines or compensations, or for the fulfillment of
any obligations, derived from the facts or with incidence on
matters covered by the scope of this Act.

418
Petroleum Fiscal Systems and Contracts

ARTICLE 69: FINES TO LEGAL PERSONS, CORPORATIONS


AND OTHER LEGAL ENTITIES

Section 1: In the case of legal persons, corporations or any other


legal entities, including those without juridical personality, the daily
rate for fines corresponds to an amount between five United
States Dollars (USD $5.00) and ten thousand United States
Dollars (USD $10,000.00), as determined by the Ministry, taking
into account the economic and financial situation and burdens of
the legal person, corporation or other legal entity.

Section 2: If the fine is applied to an entity without juridical


personality, its payment will be guaranteed by the entity’s assets
and, in the event of non-existence of such assets or under-
capitalisation, jointly and severally, the assets of each of the
associates.

ARTICLE 70: INSPECTION

It is the competency of the Ministry and the Inspector, as well as


any other organs of the public administration to whom such
competency is delegated, in accordance with law and regulations,
to ensure the inspection of compliance with the provisions of this
Act, without prejudice to competencies which the law confers
upon other public entities.

ARTICLE 71: EXTRAJUDICIAL WRIT OF EXECUTION

For purposes of coercive collection under general law, a


certification issued by the Ministry in relation to a debt constituted,
or amount due, as a result of the application of the provisions of
this Act, which is not paid within a reasonable period to be
determined by the Ministry, and which shall be notified in writing to
the debtor, constitutes an extrajudicial writ of execution.

419
Petroleum Fiscal Systems and Contracts

ARTICLE 72: SUBSIDIARY LEGISLATION

The general criminal law of Kurdistan, both substantive and


adjectival, as well as relevant administrative legislation, are
applicable in a subsidiary manner, with the required adaptations,
to the extent necessary to give effect to the provisions of this
Chapter.

ARTICLE 73: TRANSITIONAL PROVISIONS: KURDISTAN


AGREEMENTS

Section 1: Consistent with Article 141 of the Constitution of Iraq,


all agreements related to Petroleum Operations concluded by the
Government since 1992 remain in force, and the Ministry may
review such agreements to bring them into conformity with this
Act.

Section 2: The Ministry may review all agreements related to


Petroleum Operations concluded by the Government after 15
October 2005 and prior to the date of entry into force of this Act to
bring them into conformity with this Act.

Section 3: The fiscal terms of agreements referred to in Sections 1


and 2 of this Article may remain in force, if the Ministry at its sole
discretion concludes that such fiscal terms are reasonable, taking
into consideration the historical risks taken by the parties to such
agreements.

Section 4: For the purposes of this Article, “agreements” includes


any contracts, licenses, permits, memoranda of understanding, or
any other legal acts or dealings of any sort.

ARTICLE 74: TRANSITIONAL PROVISIONS: GOVERNMENT


OF IRAQ AGREEMENTS

Section 1: The Ministry shall consult the Government of Iraq and


review all agreements concluded by the Government of Iraq prior
to the date of entry into force of this Act with respect to Petroleum

420
Petroleum Fiscal Systems and Contracts

Operations located in Kurdistan, to bring those agreements into


conformity with this Act. Such agreements shall be invalid unless
they come under the exclusive control of the Government. If
deemed necessary by the Government, those agreements may
remain in force with some continuing technical and administrative
assistance from the Government of Iraq, to be approved by the
Government.

Section 2: The Ministry shall consult the Government of Iraq and


review all agreements concluded by the Government of Iraq prior
to the date of entry into force of this Act with respect to Petroleum
Operations located in Disputed Territories where Kurdistan is a
party to the dispute, to bring those agreements into conformity
with this Act. Such agreements may remain valid provided they
are jointly managed between the Government and the
Government of Iraq subject to an agreement pursuant to Article 22
of this Act, until such time as the future of the Disputed Territories
is decided in the referendum required by Article 140 of the
Constitution of Iraq.

Section 3: For the purposes of this Article, “agreements” includes


any contracts, licenses, permits, memoranda of understanding, or
any other legal acts or dealings of any sort.

ARTICLE 75: NEW AGREEMENTS

For the avoidance of doubt, any agreements related to Petroleum


Operations located in Kurdistan or Disputed Territories where
Kurdistan is a party to the dispute that are concluded after the
date of entry into force of this Act shall be invalid unless approved
by the Government and concluded according to this Act.

ARTICLE 76: ANNEXES

The Annexes of this Act are integral parts of this Act, and may be
amended by the Minister with the approval of the Council of
Ministers.

421
Petroleum Fiscal Systems and Contracts

ARTICLE 77: INTERPRETATION

Section 1: Notwithstanding the jurisdiction of the courts of


Kurdistan, the Ministry shall have authority to resolve all questions
related to the interpretation of this Act and the regulations.

Section 2: All legislation inconsistent with the provisions of this Act


is hereby revoked.

ARTICLE 78: ENTRY INTO FORCE

This Act enters into force upon publication in the Official Gazette
of Kurdistan.

422
Petroleum Fiscal Systems and Contracts

ANNEX A UNDER ARTICLES 19 AND 22 OF THIS ACT:


REVENUE SHARING

ARTICLE A1: CURRENT FIELDS REVENUES

Section 1: Notwithstanding the provisions of Article 5 and Article


17 of this Act, and consistent with Article 112 of the Constitution of
Iraq, the Government may, subject to Section 2 of this Article,
enter into agreements with the Government of Iraq for all
revenues from Petroleum Operations from Current Fields to be
directly received by the SOTO on behalf of the Government of
Iraq.

Section 2: Consistent with Article 112 of the Constitution of Iraq,


any agreement concluded pursuant to Section 1 of this Article
shall clearly require SOTO by law, on behalf of the Government of
Iraq, to:
(a) distribute AA percent of the total revenues received by the
Government of Iraq from Current Fields in Iraq to KOTO; and
(b) distribute, for a period of N years, an additional BB percent of
the total revenues received by the Government of Iraq from
Current Fields in Iraq to KOTO, which amount is an allotment for a
specified period in recognition that Kurdistan is a damaged region
which was unjustly deprived of revenues by the former regime;
and
(c) define the percentage share of revenues for Kirkuk and each
of the other Disputed Territories where Kurdistan is a party to the
dispute (collectively being CC% for all the areas that, under the
referendum required by Article 140 of the Constitution of Iraq, are
likely to agree to become part of Kurdistan); and
(d) clearly define the percentage share for the Government of
Iraq, for each Region other than Kurdistan, and each
Governorate, in a manner consistent with Article 112 of the
Constitution of Iraq.

Section 3: The symbols “AA”, “BB” and “CC” represent fair and
reasonable percentages, and the symbol “N” represents a fair and
reasonable period of time. The percentages represented by “AA”,
“BB”, “CC” and the period “N” are to be determined in the
agreement and are to be acceptable to the Government.

423
Petroleum Fiscal Systems and Contracts

Section 4: Consistent with Articles 112 and 140 of the Constitution


of Iraq, any agreement concluded pursuant to this Article shall
clearly require SOTO, on behalf of the Government of Iraq, to add
the percentage share of revenues for Kirkuk and all other
Disputed Territories where Kurdistan is a party to the dispute to
the percentages stated in Section 2(a) and (2(b) of this Article at
such time as any of those Disputed Territories become part of
Kurdistan.

Section 5: Any agreement concluded pursuant to this Article shall


also require SOTO to pay all payments due to any Authorised
Person operating in Kurdistan and the Disputed Territories under
the applicable terms of the Authorisation, including any payment
for Petroleum lifted.

Section 6: If an agreement pursuant to this Article is in force, the


Government may, with the approval of Parliament, license the
Government of Iraq to regulate the marketing of extracted
Petroleum from Current Fields after the Delivery Point, for a fee or
any other arrangement.

Section 7: Consistent with Article 115 of the Constitution of Iraq, if


an agreement pursuant to this Article is at any time not in force, or
if payments to KOTO are withheld for any reason, KOMO may
carry out all sales of Petroleum from Current Fields in Kurdistan
and Disputed Territories where Kurdistan is a party to the dispute,
and, pursuant to Article 17 of this Act, KOTO may retain all
proceeds in the Current Fields Account. In those circumstances,
KOTO will determine the extent of Kurdistan’s entitlement to the
proceeds of the sale of Petroleum from Current Fields in all of Iraq
and, where the proceeds are greater than the entitlement, pay the
net balance to SOTO. In determining the net balance, the
percentage of revenues payable to SOTO shall be based on the
formula [1-(AA + BB + CC)] as the case may be.

Section 8: Royalties, signature bonuses and interim bonuses, and


taxes where applicable, shall constitute revenue for the purposes
of this Act.

424
Petroleum Fiscal Systems and Contracts

ARTICLE A2: FUTURE FIELDS REVENUES

Section 1: Notwithstanding the provisions of Article 5 and Article


17 of this Act, and the supremacy of Kurdistan law as recognised
by Article 115 of the Constitution of Iraq, the Government may, at
its discretion and subject to Section 2 of this Article, enter into
agreements with the Government of Iraq for revenues from
Petroleum Operations from Future Fields to be directly received
by SOTO on behalf of the Government of Iraq.

Section 2: Any agreement concluded pursuant to Section 1 of this


Article shall have an initial term of five (5) years. Such an
agreement shall be automatically renewed for further terms of five
(5) years, unless terminated by the Government for breach of the
terms of the agreement.

Section 3: Any agreement concluded pursuant to Section 1 of this


Article shall clearly require SOTO by law, on behalf of the
Government of Iraq, to:
(a) distribute XX percent of the total revenues received by the
Government of Iraq from Future Fields in Iraq to KOTO; and
(b) distribute, for a period of N years, an additional YY percent of
the total revenues received by the Government of Iraq from Future
Fields in Iraq to KOTO, which amount is an allotment for a
specified period in recognition that Kurdistan is a damaged region
which was unjustly deprived of revenues by the former regime;
and
(c) define the percentage share of revenues for Kirkuk and each
of the other Disputed Territories where Kurdistan is a party to the
dispute (collectively being ZZ% for all the areas that, under the
referendum required by Article 140 of the Constitution of Iraq, are
likely to agree to become part of Kurdistan); and
(d) clearly define the percentage share for the Government of
Iraq, for each Region other than the Kurdistan, and each
Governorate, in a manner consistent with Article 112 of the
Constitution of Iraq.

Section 4: The symbols “XX”, “YY” and “ZZ” represent


percentages, and the symbol “N” represents a period of time, to

425
Petroleum Fiscal Systems and Contracts

be accepted by the Government. The percentages represented by


“AA”, “BB”, “CC” and the period “N” are to be determined in the
agreement.

Section 5: Consistent with Article 140 of the Constitution of Iraq,


any agreement concluded pursuant to this Article shall clearly
require SOTO, on behalf of the Government of Iraq, to add the
percentage share of revenues for Kirkuk and all other Disputed
Territories where Kurdistan is a party to the dispute to the
percentages stated in Section 2(a) and 2(b) of this Article at such
time as any of those Disputed Territories become part of
Kurdistan.

Section 6: Any agreement concluded pursuant to this Article shall


also require SOTO to pay all payments due to any Authorised
Person operating in Kurdistan and the Disputed Territories under
the applicable terms of the Authorisation, including any payment
for Petroleum lifted.

Section 7: If an agreement pursuant to this Article is in force, the


Government may, with the approval of Parliament, license the
Government of Iraq to regulate the marketing of extracted
Petroleum from Future Fields after the Delivery Point, for a fee or
any other arrangement. Any such license shall have an initial term
of five (5) years, and shall be automatically renewed for further
terms of five (5) years, unless terminated by the Government for
breach of the terms of the license.

Section 8: Consistent with Article 115 of the Constitution of Iraq, if


an agreement pursuant to this Article is at any time not in force, or
if payments to KOTO are withheld for any reason, KOMO may
carry out all sales of Petroleum from Future Fields in Kurdistan
and the Disputed Territories, and, pursuant to Article 17 of this
Act, KOTO may retain all proceeds in the Future Fields Account.
In those circumstances, KOTO will determine the extent of
Kurdistan’s entitlement to the proceeds of the sale of Petroleum in
all of Iraq from Future Fields and, where the proceeds are greater
than the entitlement, pay the net balance to SOTO. In determining
the net balance, the percentage of revenues payable to SOTO

426
Petroleum Fiscal Systems and Contracts

shall be based on the formula [1-(XX + YY + ZZ)] as the case may


be.

Section 9: Royalties, signature bonuses and interim bonuses, and


taxes where applicable, shall constitute revenue for the purposes
of this Act.

ARTICLE A3: ACCOUNTING BETWEEN KURDISTAN AND


IRAQ

Section 1: All moneys owed by the Government to the


Government of Iraq pursuant to Articles A1 and A2 of this Annex
shall be accounted for monthly and paid to the Government of Iraq
within seven (7) days of the end of each calendar month.

Section 2: Any agreement concluded pursuant to Articles A1 and


A2 of this Annex shall specify that, where moneys are owing by
the Government of Iraq to the Government, they shall be
accounted for monthly and paid to the Government within seven
(7) days of the end of each calendar month.

Section 3: Any agreement pursuant to Articles A1 and A2 of this


Annex shall be without prejudice to the entitlement of Kurdistan,
pursuant to Section 3 of Article 121 of the Constitution of Iraq, to
an equitable share of non-petroleum federal revenues, including
revenues to be distributed by a commission described in Article
106 of the Constitution of Iraq.

ARTICLE A4: AGREEMENTS WITH OTHER REGIONS AND


GOVERNORATES

The Government may enter into an agreement described in


Articles A1 and A2 of this Annex with other Regions and
Governorates.

427
Petroleum Fiscal Systems and Contracts

ANNEX B UNDER ARTICLES 20 AND 22 OF THIS ACT:


RESTRUCTURING OF THE INDUSTRY IN IRAQ

Notwithstanding the rights of Kurdistan as set out in this Act, and


in Articles 111, 112 and 115 of the Constitution of Iraq, the
Government shall permit the Government of Iraq to participate in
the administration of Petroleum Operations in Kurdistan in the
terms set out in Annex C of this Act, provided that the
Government of Iraq:
(a) concludes agreements with the Government on Petroleum
revenue sharing in the terms specified in Annex A of this Act; and
(b) concludes an agreement with the Government on a federal
policy on downstream activities, particularly with respect to
exports; and
(c) guarantees the free use and availability of foreign exchange for
all Authorised Persons; and
(d) establishes by law a Federal Petroleum Committee, which
shall have
(i) Regional and Governorate representation, and unanimous
decision-making procedures; and
(ii) competency to develop strategic policies for Iraq’s petroleum
sector to achieve the highest returns to the Iraqi people, examine
all Iraq petroleum policy, to investigate allegations of corruption,
and other appropriate competencies; and
(iii) competency to establish quotas, within the overall quota for
Iraq agreed with the Organisation of the Petroleum Exporting
Countries (OPEC), for the federal institutions set out in paragraph
(f) below, and quotas for the producing Regions and
Governorates; and
(iv) competency, under the supervision of the Council of
Representatives, to oversee SOTO, which shall receive all
revenues from petroleum activities in Iraq to which the
Government of Iraq is entitled; and
(e) concludes an agreement with the Government on the
regulatory role of the Iraq Ministry of Oil, including the
administrative role of the Ministry of Oil in relation to SOMO,
OPEC membership, and any other competencies that should
appropriately be assigned to it; and

428
Petroleum Fiscal Systems and Contracts

(f) establishes by law two federal institutions for upstream


activities, one for Current Fields, and another for the exploration
and development of Future Fields, and
(g) establishes by law a third federal institution for all petroleum
activities other than exploration and production, with a view to
restructuring and modernising those activities with the
involvement of the private sector; and
(h) establishes by law that the Boards of Directors of each of the
federal institutions referred to in paragraphs (f) and (g) above
consist of the Chief Executive Officers of any Regional and
Governorate petroleum companies, including in the case of
Kurdistan, KEPCO and KNOC, as well as independent
professionals, and with the Chief Executive Officers of the three
federal institutions to be appointed by the Council of
Representatives of Iraq.

429
Petroleum Fiscal Systems and Contracts

ANNEX C UNDER ARTICLES 21 AND 22 OF THIS ACT:


REGIONAL ROLE OF FEDERAL INSTITUTIONS

Provided that the Government of Iraq concludes agreements for


revenue sharing pursuant to Annex A of this Act, and satisfies the
conditions set out in Annex B of this Act, the Government shall
agree that the two upstream federal institutions referred to in
paragraph (f) of Annex B of this Act shall have competency to:
(a) prepare and allocate in a fair manner budgets and production
targets within the overall OPEC quotas to each Region and
Governorate; and
(b) assist with the preparation of field development plans in each
Region and Governorate; and
(c) appoint a member to the governing body of Regional and
Governorate public petroleum companies, including in the case of
Kurdistan, KEPCO and KNOC; and
(d) jointly with the Regions and Governorates, prepare sample
model Authorisations, including contracts for services and risked
Petroleum Contracts to be entered into by Regional and
Governorate petroleum companies, including in the case of
KEPCO and KNOC, Production Sharing Contracts, provided that
any such model Authorisation be acceptable to the Government;
and
(e) in the case of the federal institution for Current Fields, and
under license from the Government, together with the Regional or
Governorate petroleum company, jointly approve Production
Sharing Contracts or any short term or long term Petroleum
Contracts of a similar nature for Current Fields; and where such
license shall have an initial term of five (5) years, and shall be
automatically renewed for further terms of five (5) years, unless
terminated by the Government for breach of the terms of the
license; and
(f) in the case of the federal institution for Future Fields, provide
advice on Petroleum Contract terms and conditions, but only
where requested to do so by the Regional or Governorate
petroleum company, and with the Regional or Governorate
petroleum company retaining exclusive power to negotiate and
approve any such Petroleum Contract.

430
Petroleum Fiscal Systems and Contracts

APPENDIX 2 - ABBREVIATIONS AND ACRONYMS

$/bbl Dollars per Barrel


$/boe Dollars per Barrel of Oil Equivalent
$/bopd Dollars per Barrel of Oil per Day
$/Mcf Dollars per Thousand Cubic Feet of gas
$/Mcfd Dollars per Thousand Cubic Feet of gas per Day
API American Petroleum Institute
B Billion
bbl Barrel (crude or condensate), 42 U.S. Gallons
bcf Billion Cubic Feet of gas
BfD Basis for Design
boe Barrels of Oil Equivalent
bopd Barrels of Oil Per Day
BTU British thermal Unit
Capex Capital Expenditures
CBM Coal Bed Methane
CT Corporation Tax
DD&A Depreciation, Depletion, and Amortisation
DDB Double Declining Balance Method
DECC Department of Energy and Climate Change
DMO Domestic Market Obligation
DO Domestic Obligation
DR Discount Rate
E&P Exploration & Production
EBO Equivalent Barrels of Oil (see boe)
EOR Enhanced Oil Recovery (see IOR)
EPIC Engineering, Procurement, Construction, and
Installation
ES Environmental Statement
FDP Field Development Plan or Programme
FEED Front End Engineering Design
FOB Free On Board
G&A General and Administrative Expenses
G&G Geological and Geophysical
HMRC Her Majesty’s Revenue and Customs
IA Impact Assessment
IDC Intangible Drilling and Development Costs
IOC International Oil Company
IOR Improved Oil Recovery

431
Petroleum Fiscal Systems and Contracts

IRR Internal Rate of Return


JOA Joint Operation Agreement
JV Joint Venture
KRG Kurdistan Regional Government
LBSOG Large Business Service, Oil and Gas
MEA Mineral Extraction Allowance
MER Maximum Efficient Rate
MM Million
Mbbl Thousand Barrels
Mcfd Thousand Cubic Feet of gas per Day
MMbbl Million Barrels
MMcf Million Cubic Feet of gas
MTN Medium Term Note
NOC National Oil Company
NPV Net Present Value
Opex Operating Expenses
OTO Oil Taxation Office
PDO Plan for Development and Operation
PIO Plan for Installation and Operation
PRT Petroleum Revenue Tax
PSA Production Sharing Agreement (same as PSC)
PSC Production Sharing Contract (same as PSA)
PV Present Value
R&DA Research and Development Allowance
RFCT Ring Fence Corporation Tax
ROI Return on Investment
ROR Rate of Return
RRT Resource Rent Tax
RSC Risk Service Contract
RT Real Terms
SA Service Agreement
SC Supplementary Charge
SLD Straight Line Decline
STOIIP Stock Tank Oil In Place
TAC Technical Assistance Contract
TCM Technical Committee Meeting
UKCS United Kingdom Continental Shelf
VoA Value of Appraisal
VoI Value of Information

432
Petroleum Fiscal Systems and Contracts

APPENDIX 3 - GLOSSARY

Amortisation
An accounting convention designed to emulate the cost or
expense associated with reduction in value of an intangible asset
(see Depreciation) over a period of time. Amortisation as a non-
cash expense. Similar to depreciation of tangible capital costs,
there are several techniques for amortisation of intangible capital
costs.
x Straight Line Decline (SLD)
x Double Declining Balance (DDB)

Arbitration
A process in which parties to a dispute agree to settle their
differences by submitting their dispute to an independent
individual or group for settlement. Each side of the dispute
chooses an arbitrator, and those two choose a third. The third
arbitrator acts as the chairman of the tribunal which then hears
and reviews both sides of the dispute. The tribunal then renders a
decision that is final and binding.

Capitalisation
All money invested in a company including long term debt
(bonds), equity capital (common and preferred stock), retained
earnings, and other surplus funds.

Capitalise
(1) In an accounting sense, the periodic expensing (amortisation)
of capital costs through depreciation or depletion.
(2) To convert an (anticipated) income stream to a present value
by dividing by an interest rate, as in the dividend discount model.
(3) To record capital outlays as additions to asset value rather
than as expenses.
Generally, expenditures that will yield benefits to future operations
beyond the accounting period in which they are incurred are
capitalised – that is, they are depreciated at either a statutory rate
or a rate consistent with the useful life of the asset.

433
Petroleum Fiscal Systems and Contracts

Cash Flow
(1) Net income plus depreciation, depletion, and amortisation and
other non-cash expenses. Usually synonymous with cash
earnings and operating cash flow.
(2) An analysis of all the changes that affect the cash account
during an accounting period.

Commercial Discovery
In popular usage, the term applies to any discovery that would be
economically feasible to develop under a given fiscal system. As a
contractual term, it often applies to the requirement on the part of
the contractor to demonstrate to the government that a discovery
would be sufficiently profitable to develop from both the
contractor’s and government’s points of view. A field that satisfied
these conditions would then be granted commercial status, and
the contractor would then have the right to develop the field.

Concession
An agreement between a government and a company that grants
the company the right to explore for, develop, produce, transport,
and market hydrocarbons or minerals within a fixed area for a
specific amount of time. The concession and production and sale
of hydrocarbons from the concession is then subject to rentals,
royalties, bonuses, and taxes. Under a concessionary agreement
the company would hold title to the resources that are produced.

Consortium
A term that applies to a group of companies operating jointly,
usually in a partnership with one company as operator in a given
permit, license, contract area, block, etc.

Contractor
An oil company operating in a country under a production sharing
contract or a service contract on behalf of the host government for
which it receives either a share of production or a fee.

434
Petroleum Fiscal Systems and Contracts

Depletion
(1) Economic depletion is the reduction in value of a wasting asset
by the removal of minerals.
(2) Depletion for tax purposes (depletion allowance) deals with the
reduction of minerals resources due to removal by production or
mining from an oil or gas reservoir or a mineral deposit.

Depreciation
An accounting convention designed to emulate the cost or
expense associated with reduction in value of an asset due to
wear and tear, deterioration, or obsolescence over a period of
time. Depreciation is a non-cash expense. There are several
techniques for depreciation of capital costs:
x Straight Line Decline
x Double Declining Balance
x Declining Balance
x Sum of Year Digits
x Unit of Production (see Unit of Production)

Direct Tax
A tax that is levied on corporations or individuals – the opposite of
an indirect tax, such as a value-added tax (VAT) or sales taxes.

Disposal
This term usually refers to transportation and sales of crude or
gas from the field.

Dividend Withholding Tax


A tax levied on dividends or repatriation of profits. Tax treaties
normally try to reduce these taxes whether they are so named or
simply operate in the same manner as a withholding tax.

Double Taxation
(1) In economics a situation where income flow is subjected to
more than one tier of taxation under the same domestic tax
system – such as state/provincial taxes, then federal taxes, or
federal income taxes and then dividend taxes

435
Petroleum Fiscal Systems and Contracts

(2) International double taxation is where profit is taxed under the


system of more than one country. It arises when a taxpayer or
taxpaying entity resident (for tax purposes) in one country
generates income in another country. It can also occur when a
taxpaying entity is resident for tax purposes in more than one
country.

Economic Rent
The difference between the value of production and the cost to
extract it. The extraction cost consists of normal exploration,
development, and operating costs as well as a sufficient share of
profits for the industry. Economic rent is what the governments try
to extract as efficiently as possible.

Entitlements
The shares of production to which the operating company, the
working-interest partners, and the government or government
agencies are authorised to lift. Entitlements are based upon
royalties, cost recovery, production sharing, taxation, working-
interest percentages, etc. Generally, legal entitlement equals
Profit Oil plus Cost Oil in a PSC.

Equity Oil
Usually this term refers to oil or revenues after cost recovery (or
cost oil). It is also referred to as profit oil or share oil–terms that
are most often associated with PSCs. Generally speaking, the
analogue to equity oil in a concessionary system would be pretax
cash flow. Like pretax cash flow, equity oil may also be subject to
taxation.

Excise Tax
A tax based either on production, sale, or consumption of a
specific commodity such as tobacco, coffee, gasoline, or oil

Expense
(1) In a financial sense, a non-capital cost associated most often
with operations or production

436
Petroleum Fiscal Systems and Contracts

(2) In accounting, costs incurred in a given accounting period as


expenses and charged against revenues. To expense a particular
cost is to charge it against income during the accounting period in
which it was spent. The opposite would be to capitalise the cost
and charge it off through some depreciation schedule.

Fiscal System
Technically, the legislated taxation structure for a country
including royalty payments. In popular language, the term includes
all aspects of contractual and fiscal elements that make up a
given government-foreign oil company relationship.

Foreign Tax Credit


Taxes paid by a company in a foreign country may sometimes be
treated as taxes paid in the company’s home country. These are
creditable against taxes and represent a direct dollar-for-dollar
reduction in tax liability. This usually applies to foreign income
taxes paid and credited against home-country income taxes.
Other taxes which may not qualify for a tax credit may
nevertheless qualify as deductions against home-country income
tax calculation.

Government Take
The total government share of profit oil or revenues not
associated with cost recovery. Same as government after-tax
equity split and government marginal take.

Incentives
Fiscal or contractual elements emplaced by host governments
that make petroleum exploration or development more
economically attractive. Includes such things as:
x Royalty holidays
x Tax holidays
x Reduced government participation
x Lower government take
x Investment credits/uplifts
x Accelerated depreciation.

437
Petroleum Fiscal Systems and Contracts

Indirect Tax
A tax that is levied on consumption rather than income (see Direct
Tax). Examples of indirect taxes include value-added taxes, sales
taxes, or excise taxes on luxury items.

Intangible Drilling and Development Costs (IDCs)


Expenditures for wages, transportation, fuel, fungible supplies
used in drilling and equipping wells for production.

Intangibles
All intangible assets such as goodwill, patents, trademarks, un-
amortised debt discounts, and deferred charges.

Investment Credit
A fiscal incentive where the government allows a company to
recover an additional percentage of tangible capital expenditure.
For example, if a contractor spent $10 million on expenditures
eligible for a 20% investment credit, then the contractor would
actually be able to recover $12 million through cost recovery (see
Uplift). These incentives can be taxable. Sometimes the
investment credit is mistakenly referred to as an investment tax
credit.

Joint Venture
The term applies to a number of partnership arrangements
between individual oil companies or between a company and a
host government. Typically an oil company or consortium
(contractor group) carries out sole risk exploration efforts with a
right to develop any discoveries made. Development and
production costs then are prorated between the partners, which
may include the government.

License
An arrangement between an oil company and a host government
regarding a specific geographical area and petroleum operations.
In more precise usage, the term may apply to the development
phase of a contract after a commercial discovery has been made
(see Permit).

438
Petroleum Fiscal Systems and Contracts

Lifting
The amount of crude oil an operator produces and sells, or the
amount each working-interest partner (or the government) takes.
The liftings may actually be more or less than actual entitlements
which are based on royalties, working-interest percentages, and a
number of other factors. If an operator or partner has taken and
sold more oil than it was actually entitled to, then it is in an
overlifted position. Conversely if a partner has not taken as much
as it was entitled to it is in an underlifted position (see Nomination
and Entitlements).

Nomination
Under a lifting agreement the amount of crude oil a working-
interest owner is expected to lift. Each working-interest partner
has a specific entitlement depending upon the level of production,
royalties, their working interest, and their relative position(i.e.,
underlifted or overlifted), etc. Each working-interest partner must
notify the operator (nominate) the amount of its agreement, the
nomination may be more or less than the actual entitlement (see
Liftings and Entitlements).

Operating Profit (or loss)


The difference between business revenues and the associated
costs and expenses exclusive of interest or other financing
expenses, and extraordinary items, or ancillary activities.
Synonymous with net operation profit (or loss), operating income
(or loss), and net operating income (or loss).

Permit
In a loose sense the term is used to describe any arrangement
between a foreign contractor and a host government regarding a
specific geographical area and petroleum operations. In a more
precise usage, the term may apply to the exploration phase of a
contract before a commercial discovery has been made (see
License).

Present Value
The value now of a future payment or stream of payments based
on a specified discount rate.

439
Petroleum Fiscal Systems and Contracts

Prime Lending Rate


The interest rate on short-term loans that banks charge to their
most stable and creditworthy customers. The prime rate charged
by major lending institutions is closely watched and is considered
a benchmark by which other loans are based. For example, a less
well-established company may borrow at prime plus 1%.

Production Sharing Agreement (PSA)


This is the same as a Production Sharing Contract (PSC). While
at one time usual, the term Production Sharing Contract is
becoming more common.

Production Sharing Contract PSC)


A contractual agreement between a contractor and a host
government whereby the contractor beats all exploration costs
and risks and development and production costs in return for a
stipulated share of the production resulting from this effort.

Progressive Taxation
Where tax rates increase as the basis to which the applied tax
increases. Or where tax rates decrease as the basis decreases.
The opposite of regressive taxation.

Rate of Return Contract


Sometimes referred to as a Resource Rent Royalty. The
government collects a share of cash flows in excess of the return
required to generate investment. The government share is
calculated by accumulating negative net cash flows at a specific
threshold rate of return, and once the accumulated value
becomes positive, the government takes a specified share.

Reinvestment Obligations
A fiscal term that requires the contractor/operator to set aside a
specified percentage of profit oil or income after-tax that must be
spent on domestic projects such as exploration.

440
Petroleum Fiscal Systems and Contracts

Resource Rent Tax


Some economists refer to additional profits taxes as a resource
rent tax. Australia has a specific tax based upon profits which is
referred to as resource rent tax (RRT) (see Rate of Return
Contract). Normally the RRT is levied after the contractor or oil
company has recouped all capital costs plus a specified return on
capital that supposedly will yield a fair return on investment.

Relinquishment
A contract clause that refers to how much contract or license area
a contractor must surrender or give back to the government during
or after the exploration phase of a contract. Licenses are usually
granted on the basis of an initial term with specified provisions for
the timing and amount of relinquishment prior to entering the next
phase of the contract. Also referred to as exclusion of areas.

Ring fencing
A cost centre based fiscal device that forces contractors or
concessionaires to restrict all cost recovery and/or deductions
associated with a given license (or sometimes a given field) to that
particular cost centre. The cost centres may be individual licenses
or on a field-by-filed-basis.
For example, exploration expenses in one non-producing block
could not be deducted against income for tax calculations in
another block. Under a PSC, ring fencing acts in the same way:
cost incurred in one ring fenced block cannot be recovered from
another block outside the ring fence.

Royalty Holiday
A form of fiscal incentive to encourage investment and particularly
marginal field development. A specified period of time in years or
months, during which royalties are not payable to the government.
After the holiday period, the standard royalty rates are applicable
(see Tax Holiday).

441
Petroleum Fiscal Systems and Contracts

Sliding Scale
A mechanism in a fiscal system that increases effective taxes
and/or royalties based upon profitability or some proxy for
profitability, such as increased levels of oil or gas production.
Ordinarily each tranche of production is subject to a specific rate,
and the term incremental sliding scale is sometimes used to
further identify this.

Sunk Costs
There are a number of categories of sunk costs:
x Tax Loss Carry Forward (TLCF)
x Unrecovered Depreciation Balance
x Unrecovered Amortization Balance
x Cost Recovery Carry Forward
These costs represent previously incurred costs that will ultimately
flow through cost recovery or will be available as deductions
against various taxes (if eligible).

Tax Holiday
A form of fiscal incentive to encourage investment. A specified
period of time, in years or months, during which income taxes are
not payable to the government. After the holiday period, the
standard tax rates apply.

Tranche
Usually a quantity or percentage of oil or gas production that is
subject to specific criteria. (1) The Indonesian first tranche
production (FTP) of 20% means that the first 20% of production is
subject to the profit oil split and taxation, and this tranche of
production is not available for cost recovery. (2) Sliding scale
terms typically subject different levels of production (tranches) to
different royalty rates, tax rates, or profit oil splits.

442
Petroleum Fiscal Systems and Contracts

Transfer Pricing
Integrated oil companies must establish a price at which upstream
segments of the company sell crude oil production to the
downstream refining and marketing segments. This is done for the
purpose of accounting and tax purposes. Where intra-firm
(transfer) prices are different than established market prices,
governments will force companies to use a marker price or a
basket price for purposes of calculating cost oil and taxes.
Transfer pricing also refers to pricing of goods in transaction
between associated companies.

Uplift
Common terminology for a fiscal incentive whereby the
government allows the contractor to recover some additional
percentage of tangible capital expenditure. For example, if a
contractor spent $10 million on eligible expenditures and the
government allowed a 20% uplift then the contractor would be
able to recover $12 million. The uplift is similar to an investment
credit. However, the term often implies that all costs are eligible
where the investment credit applies to certain eligible costs. The
term uplift is also used at times to refer to the built-in rate of return
element in a rate of return contract.

Value Added Tax


A tax that is levied at each stage of the production cycle or at the
point of sale. Normally associated with consumer goods. The tax
is assessed in proportion to the value added at any given stage.

Withholding Tax
A direct tax on a foreign corporation by a foreign government. The
tax is levied on dividends or profits remitted to the parent
company or to the home country, as well as interest paid on
foreign loans.

443
Petroleum Fiscal Systems and Contracts

Working Interest
The percentage interest ownership a company (or government)
has in a joint venture, partnership, or consortium. The expense-
bearing interests of various working-interest owners during
exploration, development, and production operations may change
at certain stages of a contract or license. For example, a partner
with a 20% working interest in a concession may be required to
pay 30% of exploration costs but only a 20% share of
development costs. With government participation, the host
government usually pays no exploration expenses but pays
prorated development and operating costs and expenses.

444
Petroleum Fiscal Systems and Contracts

THE AUTHOR

Dr Muhammed A. Mazeel Al-Aboudi has worked for many years in


the international sector of the oil and gas industry in several
countries.

He studied at the Mines and Geology Faculty - Department of


Petroleum Engineering of the University of Belgrade (Diploma in
Engineering), the Escuela Superior de Minas in Madrid, Spain
(Credit in Applied Geophysics Engineering) and the University of
Clausthal-Zellerfeld in Germany. He was awarded a PhD in
Petroleum Engineering by the Technical University Clausthal.

Dr Mazeel has been employed in European oil companies. He has


also worked as Director General of the Iraqi Drilling Company
(IDC) and Director General for the Oil Products Distribution
Company (OPDC). At the same time, he was the oil industry
adviser to the Iraqi Prime Minister Dr Ibrahim Al-Jaafari. Dr
Mazeel introduces the IDC in the international Association of
Drilling Contractors (IADC) and was formerly the head of the
steering committee with GALP ENERGY.

He is the Author of many papers on petroleum engineering for the


Society of Petroleum Engineers (SPE), the Canadian Institute of
Mining (CIM), Middle East Economy Survey (MEES) and the
German Oil, Gas and Coal Magazine (EEZ). His next books, on
Formation Damage, Exploration Strategy of own State companies

445
Petroleum Fiscal Systems and Contracts

and Iraq Constitution-Petroleum Resources Legislation and


International Policy are in editing and will be published soon.

Dr Mazeel founded the oilgasline.com website; Iraq Research and


Development Centre; and Iraqi Institutes for Infrastructure,
Economics and Environmental Reforms.

Dr Mazeel lectures at the University of Baghdad for Master


Students and also lectures for international courses in Gas
Production Engineering, Reservoir Management, Cost Estimation
and Petroleum Economics. He is the initiator of a co-operation
agreement between the University of Baghdad and the University
of Clausthal.

446
Unser gesamtes Verlagsprogramm
finden Sie unter:
www.diplomica-verlag.de

Diplomica Verlag

Das könnte Ihnen auch gefallen