By Peter Reat Gatkuoth
EPSA in many countries is considered as legal structure or Exploration agreement used by the host government (NOC) and the IOC (international Oil Companies). It is a means for fulfilling contractual obligations between a host country and a foreign oil producing country. For example; prior to the end of 2020, the South Sudanese Government signed incomplete six-year Exploration Production Sharing Agreement with South Africa for an untapped exploration of Block B2.
Block B2 was once part of a 120,000 square kilometers area known as Block B, which was divided into three licenses in 2012 and is thought to be rich in hydrocarbons although very little drilling has been done there. The block lies in greater Jonglei State. This will be the first time South Sudan par-takes in such an agreement. It is therefore a topic of curiosity for the public. Hence, the scope of this paper explores the origin of EPSAs, their anatomy, the benefits involved and the possible critical issues that South Sudan has to look out for.
On the whole and in developing nations with considerable hydrocarbon reserves, neither the government nor private firms have the necessary skills, tools and/or funding to fully exploit and develop their natural resources alone. Because of this, they begin looking for ways to attract international capital or collaborate with foreign enterprises in a variety of capacities. The distribution of income and the risk sharing between the parties are the most important considerations for both oil firms and the government when it comes to such an agreements (Muttitt, 2005). Unlike the normal assumption of economic theory, which holds that everyone pursues their own interests, the most significant element of contract theory is that the purposes of the principal and the agent are similar or coincide with one another. If both parties desired the same outcome, the principal may delegate all authority to the agent. Although this is true in theory, it is not the case in practise. In its most basic form, the principal seeks to pay as little as possible, and the agent seeks to perform as little work as possible. Game theory is used in the development of contract theory tools. A mathematical model was used to prove that all parties in a contractual contact either win or lose in the work of John Nash on non-zero-sum games according to his findings (Muttitt, 2005).
In general, win-win contracts are used to describe approaches for everyday life, politics, business and research in which stakeholders have certain overlapping interests and in which all stakeholders have the potential to benefit from the method. A set of concepts, methods and instruments that enable a diverse group of interdependent stakeholders to build a win-win set of shared commitments is often defined as a set of contracts. Individuals or organisations who are interdependent on one another are referred to as stakeholders. According to the general rule, mutual satisfaction means that the parties do not obtain all they want, but they may be reasonably certain that they will receive whatever it was to which they had agreed upon (Muttitt, 2005).
Shared commitments are more than just good intentions; they are also a set of conditions that have been carefully articulated and studies. It is essential to clearly define any contingent liabilities in order to ensure that all parties to the agreement understand what they are agreeing to. The primary purpose of win-win collaboration is to come to an agreement on a set of mutually satisfying agreements that will serve as the foundation for the project’s requirements, restrictions and strategies.
Participants in win-win collaborations are characterised by their eagerness to learn about their partner’s objectives as well as their emphasis on obtaining mutual benefits and strengthening long-term partnerships in business (Muttitt, 2005). When two parties work together for mutual benefit, they strive to improve quality, increase value, achieve higher efficiency and secure resources, with the ultimate goal of establishing long-term competitive advantages. When all of the win conditions are covered by the agreements and there are no outstanding issues, the stakeholders have achieved win-win outcomes.
The Exploration and Production Sharing Agreement (EPSA) was born out of the desire to find a win-win solution (EPSA). Essentially, EPSA is a means for fulfilling contractual obligations between a host country and a foreign oil producing country (FOC). Floating offshore companies (FOCs) assume the function of the agent who should have the structure to balance the HC inalienable right to control the behaviour of oil corporations with the company’s ability to take whatever actions it deems necessary or appropriate.
Exploration and Production Sharing Agreement
One of the most important legal contracts in the oil and gas business is the production sharing agreement, which is one of the most common types of legal contracts. Every party utilises it as a tool to get a speedy return on their investments and to increase revenue as much as feasible while distributing the risks equally. PSAs got their beginnings in Asia and Africa, when national oil corporations (NOCs) and international oil companies (IOCs) sought to collaborate on the development of new gas and oil fields particularly offshore, in order to reduce costs and increase efficiency. They are now being utilised more frequently with horizontal drilling and for unit-line or leased-line allocation wells and among other things (Ahmadov, et.al, 2012). Producing Shared Agreements (PSAs) are legal contracts that are entered into between one or more investors and any government entities in order to outline the rights, duties and obligations of each party in connection with mineral exploration, development and production in a specific location and for a specific period of time. It is common for agreements to be reached between the host country, where the minerals are situated and the parties wishing to drill and operate in that country. The contract limits the percentage of oil and gas output that each party receives once a specific amount of cost and the expense has been recovered by all parties. PSAs offer specific rights such as exploration and production, to an international oil firm from the host government in exchange for the corporation prospecting and developing resources (Ahmadov, et.al, 2012).
The IOC assumes the majority of the expenditures and hazards associated with exploration. The contribution of the NOC begins or grows after minerals are discovered and the site is turned into a production unit capable of carrying out regular business operations. The PSA is the most advantageous to the NOC since it allows them to establish momentum for project management throughout the time period. Furthermore, the NOC can explore and develop new fields and reservoirs with little risk and expense to itself.
Origin of EPSAs
When resource exploitation entered a new phase in the mid-20th century, the conventional techniques of resource control were more incompatible with post-colonial realities. Many newly independent countries adopted nationalisation measures that resulted in the cancellation of IOC concessions since they were considered as discriminatory at the time of their independence (Ahmadov, et.al, 2012). These countries such as Saudi Arabia, Iran and Venezuela, which had already been producing hydrocarbons for many decades, concentrated on establishing their national oil companies (NOCs) while keeping IOCs out. In low- and middle-income countries that had not yet begun to exploit their hydrocarbon resources, the options of establishing NOCs and excluding IOCs and their technological know-how were not viable possibilities. At the same time, by consenting to traditional concessions, these governments did not want to be perceived as openly ceding control over their natural resources to third parties. PSAs were created to fill this void. EPSAs were originally utilised in Indonesia in the 1960s. They are now used all over the world. They were signed between IOCs and PERTAMINA which is the Indonesia’s state-owned oil and gas corporation (Ahmadov, et.al, 2012).
What distinguishes these contracts is that the parties involved share in the production of the hydrocarbons that are produced while transferring ownership of the unproduced oil to the government. The PSA is still in use today in relationships between international oil companies and several resource-rich countries (or their state-owned enterprises) for the exploration, development and production of hydrocarbons. The concept of shared production serves as the underlying basis of these types of contractual arrangements. Because of the time horizons involved in oil field development, most PSAs are signed for a term of 25 to 30 years, though they can be extended for longer periods of time.
As soon as the firms have made the required investments and extracted the necessary oil, the resources are divided among those who signed the contract, with the state’s portion often going to the state-owned enterprise (SOE) that was selected in the contract (often an NOC). When a number of firms are involved in a project, it is possible for one of them to be allocated the responsibility for the project’s operational management (Ahmadov, et.al, 2012). In most cases, the largest investor is tasked with this responsibility and he or she will be in charge of the project’s operational management as well as the resolution of any difficulties or conflicts that may emerge.
A distinction is typically made between technical and commercial operational management. The former is primarily concerned with the actual field development process, whereas the latter is concerned with regulating financial settlements and relations between the parties in relation to production sharing calculations. With regard to PSAs, the state is typically represented by a NOC that assumes two responsibilities: first, that of contractor with a relevant share in the contract; and second, that of representing the state’s interests and getting its portion of the profits oil on the state’s behalf. This varies from nation to country and is determined by the way in which the PSA was negotiated as well as the amount of equity that the NOC has in the particular project in question (Ahmadov, et.al, 2012).
Many public-private partnership (PSA) rules mandate that the NOC own a controlling stake in the project (50 percent plus one share). Owning a 50 percent ownership in a project, on the other hand, typically necessitates a large expenditure on the part of the NOC, a consideration that can lower the amount of profit initially realised by the state as the NOC recovers its capital investment expenses (Ahmadov, et.al, 2012).
In order to avoid this difficulties, PSAs are sometimes arranged so that the NOC contribution is ‘carried’ by other consortium members and the government reimburses the NOC contribution from its part of the profits from the oil. EPSAs are currently in use in a number of resource- rich countries including the United States. During the development of hydrocarbon projects in Central Asia and on the African continent, they have gained a lot of attention. But because of the PSA’s complexity as well as its inability to deal with the enormous price swings of oil in recent years, some people are opposed to its continued use in the future.
Anatomy of the EPSA
The mechanism for profit sharing between the host country and the oil company lies at the heart of an EPSA. If you do not understand how this process works, it will be hard to evaluate the distribution of costs and advantages between the parties. Taxes and royalties are typically less significant in EPSAs than they are in concessions (Paterson, 2019).
The Taxes and royalties are the principal sources of revenue for a host government derived from its hydrocarbon resources when a concession is granted. EPSAs, on the other hand, are unique in that they establish a form of partnership between the corporation and the host country, with the oil being shared. As a result, in public-private partnerships, the terms for sharing the oil produced are an important method for influencing the amount of revenue received by the host government (Paterson, 2019).
Even in its most basic formulation, the calculation of the amount of “profit oil” to be split between the parties is straightforward. By removing the cost of oil and royalties from the total amount of oil, profit oil may be calculated. Therefore, the initial investment and ongoing maintenance costs associated with production can be subtracted (the cost oil) before the residual oil produced (the profit oil) is divided into two shares: the IOC share and the host state share (Paterson, 2019).
Regarding oil expenses, the party or parties investing capital in an EPSA project recover their costs at a rate that has been agreed upon in the contract with the EPSA. Each EPSA has its own rate, which differs from one to another. Depending on the EPSA, capital investors may be able to recover 100 percent of their exploration and development expenditures before being required to share profit oil with non-capital investing parties such as the host state or a non-operating company (NOC). Other production sharing agreements (PSAs) allow for profit oil to be earned from the very beginning of production (Paterson, 2019).
As a percentage of total production, the quantity of cost oil that can be used to recover initial capital investment expenses is stipulated in these situations. The parties to the EPSA agree to divide the revenues of production in the form of crude oil rather than in monetary terms. As a result, the state receives a portion of the earnings in the form of a portion of the extracted oil, which it is free to sell at its discretion. This appears to make financial connections between businesses and the government simpler, but as we will see later, it can sometimes represent a barrier to the development of transparent financial relations (Paterson, 2019).
In a three-stage EPSA process, the investor’s portion of the distribution oil is subject to a tax on its share of the profit oil, which is calculated on the investor’s share of the profit oil. There are no taxes levied on the creation of goods in a two-stage EPSA process. Consider the following example: some EPSAs allow the state to keep a bigger share of the profits from oil sales; however, in exchange for the larger stake, all taxes are waived. If such an option is allowed, the government will soften the concern for taxes, waived other tangible requirement and increase the profit share.
Benefits of EPSAs
There is a significant advantage to using this form of oil and gas agreement or tax structure since it is straightforward. Comparisons between negotiating and public service announcements and potentially problematic service contracts are made. Simply described, a concession is advantageous to a state or mining rights holder because of the ease with which the transaction is executed. The national oil company (NOC) of the host country employs an international oil firm (IOC) to do exploration and production activity at its own expense (Paterson, 2019).
If no hydrocarbons are discovered for instance, the NOC suffers little to no loss and owes nothing to the IOC. The Oil firms usually give the muscle and know-how in countries where the oil and gas industry is underdeveloped, while the host country supplies the physical location for the operations. Because only a tiny percentage of exploration efforts result in commercial discoveries, work commitments and money commitments are critical bargaining variables because they specify the extent to which exploration risk is to be assumed by the parties involved.
The host country will want them to be as explicit as possible, whereas the International Oil Companies (IOC) prefers promises that allow for the greatest amount of flexibility. It is therefore theoretically possible to construct a concession contract using the American notion of land ownership, according to which surface and subterranean resources belong to the recognised landowner. Under the terms of a certain concession contract, the landowner grants exclusive rights to another company or corporation to explore and develop the resources and reserves on his or her property (Paterson, 2019).
This corporation is in charge of supplying the capital and capacity required for the exploration, extraction or production of oil or gas reserves as well as the processing of those deposits. The host country is able to build up a new reserves without taking any risks and at a relatively low cost. It is not necessary for the host country to make major investments in exploration and production activities. After all, the International Oil Companies (IOC) is responsible for all operational and financial costs and hazards. There is a significant advantage to using this form of oil and gas agreement or tax structure since it is straightforward (Paterson, 2019).
Contrary to joint ventures (JVs) and high-risk service contracts, negotiations are less complicated. The simplicity of the agreement is why a concession is provided to the owner of state or mining rights. It is theoretically possible to construct an EPSA contract on the basis of the American notion of land ownership according to which surface and subterranean resources belong to the recognised landowner. In a specific EPSA contract, the landowner grants exclusive rights to another company or corporation to explore and hold natural resources and reserves on the property. This corporation is in charge of supplying the funds and expertise required for the exploration, extraction or production of oil or gas reserves as well as the processing of those deposits. As defined by the International Mineral Resources Institute (IMRI), an EPSA is a contract between one or more investors and a host government that grants the rights to discover, develop and exploit mineral resources in a specific area for a specific length of time. One of the most notable advantages of a production sharing agreement is that the lessor is not required to make major capital investments in order to participate (Paterson, 2019).
Key Issues in EPSAs
Nature of EPSAs
An EPSA is a type of agreement in which a government or non-governmental organisation (NOC) authorises fulfilling contractual obligations to explore and develop one or more onshore or offshore blocks or areas, without granting title to the hydrocarbons in the ground and on terms that provide for the contractor to recover its costs through the extraction and sale of hydrocarbons from the relevant blocks; if any and for the parties to share any remaining production on a defined basis (Fonseca, 2017).
As a result of such agreements, the state or national oil company (NOC) typically has no payment obligations while the contractor bears the risk associated with the exploration and development of the block (including the risk that no or no commercial quantities of hydrocarbons will be discovered) which can be very significant particularly when the block is located in deep or ultradeep offshore waters. Payments of royalties or taxes in respect of any production resulting from the relevant block are almost always required to be made in addition.
Cost Recovery Disputes
Cost recovery disputes are prevalent, and they frequently involve concerns such as which expenditures are recoverable, from which production and when they should be recovered. Determining the amounts of profit output that each party is authorised to take or lift from the block and sell as a result of such disagreements might have far-reaching effects. Conflicts of this nature can quickly escalate into high-value over lifting disputes, in which one party to the EPSA argues that another party has lifted and sold more than the amount of production to which it was contractually entitled (Fonseca, 2017).
Reliance Industries Ltd and others vs Union of India for example established that, subject to a ceiling referred to as the cost recovery limit, the contractor could recover development costs by lifting and selling expensive petroleum, but only to a limited extent (CRL). Development expenses were one of the inputs used in establishing the investment multiple as well as the corresponding shares of profit petroleum that each partner was entitled to lift and sell on the basis of the investment multiple in question (Fonseca, 2017).
The parties were at odds about which costs should be considered development costs for the purposes of this agreement. It was the contractor’s contention that the correct input was all development costs as defined by the EPSAs specifically “those costs and expenditures incurred in carrying out development operations, as classified and defined in section two of the Accounting Procedure and allowed to be recovered in accordance with section three of the Accounting Procedure.”
Contrary to this, India asserted and the arbitral tribunal agreed, that the relevant input should only include development expenses that were less than the CRL cap and not those that were greater than the cap, with the latter costs being borne by the claimants in this case. This decision had the effect of increasing the amount of net profitable production when calculating the investment multiple because the cost deduction amount was capped and thus smaller, with the result that India was entitled to a greater share of profit petroleum than under the contractor’s interpretation (Fonseca, 2017).
Any steps taken as to explore and make any enquiry has to be approved by the host authorities. EPSAs must be approved or ratified by the local government in several countries according to the modern regulations in place. In the context of EPSAs or related agreements such requirements might give rise to contractual disputes over whether the requisite permits have been received, and therefore whether termination rights have accrued or if fiscal incentives offered by the EPSA are effective and among the other things (Fonseca, 2017).
Examples of such include the case of Monde Petroleum S A v Westernzagros Ltd, in which the parties were unable to agree on whether the applicable EPSA had become fully effective and enforceable. The Court of Appeal upheld the first instance decision that the EPSA had not become fully operational and enforceable at the relevant time because the confirmation and support letter had not been received, based on a proper interpretation of the relevant agreement as a whole and in light of the commercial background known to the parties at the time when that agreement was executed (Fonseca, 2017).
Stabilization and Economic Equilibrium
Changing local laws, rules or policies after the EPSA has been signed is another common issue in EPSA disputes. This situation results in the legal, political or economic basis on which the parties contracted becoming unsustainable, which leads to EPSA conflicts. In many EPSAs, stabilisation or economic equilibrium clauses are included to deal with situations of this nature. Under these clauses, an EPSA contractor whose rights under the EPSA are materially and adversely affected by a change in law or policy can request that the EPSA be modified in order to neutralise the effects of the change. If the parties are unable to reach an agreement on whether such a change has happened or on the necessary adjustments to the EPSA, the matter may be referred to an arbitral tribunal (if the EPSA provides for this) for resolution. The arbitral tribunal may then be able to evaluate whether or not a change of the necessary kind has happened and, if so, whether or not appropriate amendments to the EPSA should be implemented (Fonseca, 2017).
The pursuit of large revenues alone will not ensure sustainable development. If revenues are spent in an inefficient manner, they are of little value. Economic factors are essential, but so are social and environmental considerations. Furthermore, when managing a country’s oil and gas sector, it is critical to remember that a country’s oil resources belong to both current and future generations. There is a slew of important aspects that must be agreed upon before signing the contract. As a result of the tiny number of commercial discoveries made as a result of exploration activities, commitment to work and financial commitments are critical bargaining issues since they determine the level of exploration risk. The host country will want them to be as explicit as possible, whereas the International Oil Companies likes promises that allow for the greatest amount of flexibility. EPSAs are often long-term contracts with a fixed price. This, combined with the complexity of EPSAs and their relationship with local laws, implies that there is a significant possibility that high-value conflicts shall arise at some time during the term of the contract. Disputes over the EPSA might arise for a variety of reasons and some of which are discussed above. These issues highlight the significance of thorough and detailed drafting (including the all-important arbitration clause) while the EPSA is being negotiated. However, the fundamental tools of keeping the agreements intake is to respect the host country and the agreement signed as tools for expanding and gain more profits. Disrespecting the government or host country minimize future prospects and gains. Better understand and compromises can bring more cooperation and possible future exploration in different blocks or prospects.
Biography of the writer
Gatkuoth is a South Sudanese and a member of North Jonglei State. He has been working under the Minister of Petroleum in South Sudan for the last few years. He has served in various departments in Oil & Gas industry particularly in Nile Drilling and Dar Petroleum Operating Company. He has been a Section Head for Policy and Services (DPOC), Section Head of Material Management (DPOC), Manager of Technical Services (DPOC), Manager of General Services (DPOC), Director for General Services/Administration (Nile Drilling and Services) under Nile Petroleum Corporation and currently Human Resource Manager in DPOC. Prior to the abovementioned positions, Gatkuoth served in various organizations and institutions in Ethiopia, Western and Central Canada before returning back home. He has BA, Sociology (Concordia University), MA, Int’l Law and Human Rights (University for Peace), LLM, Oil and Gas Law (UCU), Master of Public Policy (U of Juba); MSc, Environmental Health and Safety Management (UCU), MBA in Oil and Gas Management (UCU – Candidate) and PhD Student in Leadership and Policy, Niagara University, New York (Dual Campuses, Canada and USA). Please reach him at [email protected] for any questions and enquiry.
Paterson, J., 2019. Production Sharing Agreements in Africa: Sovereignty and Relationality. In Ethiopian Yearbook of International Law 2018 (pp. 119-147).Springer, Cham.
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