The Nigerian National Petroleum Corporation (NNPC) has disclosed that it would renegotiate the fiscal terms of existing Production Sharing Contracts (PSCs) entered into with international oil companies (IOCs).
The review is aimed at bringing the PSCs in line with present day realities in the global oil and gas industry.
Production Sharing Contract (PSC)
In a PSC, the NNPC engages a competent contractor usually an International Oil Company (IOC) to carry out petroleum operations on NNPC’s wholly held acreage. The contractor undertakes the initial exploration risks and recovers his costs if and when oil is discovered in commercial quantities and extracted.
Primary Legal Regime regulating Production Sharing Contracts
DEEP OFFSHORE AND INLAND BASIN PRODCUTION SHARING CONTRACTS DECREE NO 9 1999 ACT. CAP. D3. LFN 2004.
This is in addition to the individual contracts signed with the individual companies.
History of production sharing contracts
Indonesia pioneered the first PSC in 1966 through Permina, the state oil company. The contract system was evolved due to the imbalance in the traditional concessionary system regarding Government Take.
Possible issues to be looked at in a Review of NNPC’s PSCs with IOCs
In reviewing a PSC, it might be wise to use a basic checklist that covers issues like; who are the Parties to the contract? What exactly, is the subject of the PSC? Is there a renegotiation clause? What are the triggers and have the conditions been fulfilled?
Amazing Fiscal Incentives
In 1993, Nigeria entered into deep water drilling and awarded over 20 oil blocks in the deep water to various IOC’s.
Nigeria was not very familiar with deep-water drilling and its possible yield. Thus the fiscal terms for deep offshore in Nigeria were unbelievably generous to point of occasioning loss to our national treasury. The PSC had an unbelievable graduated rate of royalty payment dependent on water depth.
The rates are as follows:
- 205-500 meters water depth: 12%
- 501-800 meters water depth: 8%
- 801-1,000 meters water depth: 4%
- Above 1,000 meters water depth: 0%
Considering the fact that these rates regulate deep water drilling, it was not particularly prudent on Nigeria’s part to have based the royalty rates on drilling depth, ignoring indices like production levels, oil prices etc. Even more alarming is the fact that deep offshore reserves are more prolific than land based reserves.
Interestingly, it was reported in 2005, that Oil and gas production began in the 200,000 barrels per day capacity Bonga field, Nigeria’s first deep-water development in water depths of over 1,000 metres.
It was also reported that Erha deep-water development, including the Erha field and Erha North satellite field, was completed in 2006.The fields are located approximately 97km offshore Nigeria, in water depths ranging from 1,000m to 1,200m.!
It was also reported that the Agbami-2 appraisal well was drilled in 4,800ft of water to a total depth of 15,683ft.
The Egina field lies within the block Oil Mining Lease OML 130 and covers an area of around 500 square miles. It is situated at a water depth of ranging from 1400m to 1,750m.
Thus it can be easily deduced that Bonga and the above mentioned deep water fields fall under the 1000 metre royalty rate of 0 (zero) percent!
The petroleum tax payable under the PSC arrangement was fixed at 50% flat rate of chargeable profits for the duration of the production sharing contracts against the rate of 85%, prescribed by the Petroleum Profit Tax Act operable in the Joint Venture arrangement.
Like every major energy contract, the PSC’s that Nigeria signed contains possible renegotiation clauses in case the project dynamics change for better or worse. In Nigeria’s case the project dynamics have changed for better, Deep water fields have proven to be quite prolific, a fact the IOC’s based on their vast deep water experience may have known from the world go.
Production Sharing: The PSC provides for how the International Oil Company (IOC)/contractor will recover his costs, the allowable percentage of recovery and how production will be shared. Common items found in PSCs are royalty oil, cost (recovery) oil and profit oil.
Tax: The PSC states the taxes that the International Oil Company (IOC)/contractor would be subjected to.
Enforcement of Abandonment/Decommissioning clauses
The PSC provides for a Decommissioning clause for each Development Area. This is quite commendable as the IOC is under obligation to properly clean up after operations.
Contractual Terms and Environmental Protection
There is a possibility that basic contract review and negotiation can help stem the tide of pollution and environmental degradation… by making sure we negotiate and include clauses that enact stringent conditions for environmental protection.
Contract terms are very important because they determine how much Nigeria as a producing country earns from it natural resources; and they can strengthen the regulatory power of government to enforce environmental, health and other standards, if standard legal and regulatory systems are not well established…
Agreed damages clause for pollution
There might be a need to insert a clause stipulating the minimum fine for every barrel spilled, especially after a certain period of grace.
Model PSC for Non-Associated Gas
The scheduled review might be a good opportunity to develop a model Production Sharing Contract for Non-Associated Gas fields. Which in turn might help kick start the much awaited natural gas revolution.
The funding arrangement is beneficial for an NOC participating in the project. The good thing is that even after production begins and the NOC is required to finance the project payments are made from crude oil production rather than cash. However the PSC’s did not make adequate provisions for times when oil prices rise. Thus governmental take did not rise in proportion to oil price.
Curbing Artificial Expenses
The IOC may decide to slow down the pace of production, be wasteful or extravagant in its exploitation especially when the operator knows his expenses would be fully met by the crude produced. Such behaviour is also called gold plating.
Social Normative Norms in Oil Pollution?
Lax enforcement of the law in the area of environmental degradation eventually results in whiplashes and hostility from the host communities targeted at the International Oil Company.
Conclusion
Renegotiating a Production Sharing Contract requires legal knowledge, foresight and common sense. The number of model clauses successfully incorporated modified in the renegotiated Production Sharing Contract depends largely upon negotiating power of the parties involved. Even so, the information contained in this piece will enlighten the Government and International Oil Company (IOC)/contractor as to some possible alternatives, and possibly foster frank discussion between the Government and the Oil Company.
Megathos Law Practice © 2015
