62-67 | BUSI­NESS

Nairobi Law Monthly - - Contents - ELSIE OYOO

- Pe­tro­leum con­tracts - How in­sur­ers can get the youth aboard

Such agree­ments play such a piv­otal role in ex­plo­ration, and must clearly de­fine terms of en­gage­ment be­tween play­ers be­fore they can be re­flected on pa­per

Each pe­tro­leum sec­tor func­tions within an en­vi­ron­ment called a pe­tro­leum regime. At the top of this regime stands the con­sti­tu­tion of that coun­try. The rel­e­vant pe­tro­leum laws, poli­cies and reg­u­la­tions come in at the se­cond level, and af­ter th­ese, the pe­tro­leum con­tract fea­tures with the var­i­ous sub-con­tracts that de­pend on it. Only th­ese con­tracts can deal with the finer is­sues that may arise be­tween the State and the In­ter­na­tional Oil Com­pa­nies (IOCS) dur­ing ex­plo­ration. Th­ese con­tracts, es­pe­cially the pe­tro­leum con­tracts, form an in­te­gral part of ex­plo­ration.

The pe­tro­leum con­tract is deemed the most im­por­tant of the var­i­ous agree­ments as it reg­u­lates the re­la­tion­ship be­tween the state and the IOC in such a way that each party knows what to ex­pect from the other. In the worst case sce­nario, pe­tro­leum agree­ments safe­guard the in­ter­ests of each party from abuse by the other. The big­gest in­ter­ests in such agree­ments are nor­mally the ap­por­tion­ment of profit, risk and costs.

For in­stance, the pe­tro­leum con­tract acts as a buf­fer from the fi­nan­cial and political risks faced by the IOC. It gives them com­fort against volatile en­vi­ron­ments; gov­ern­ments may some­times cre­ate a sud­den change in law. They ad­di­tion­ally pro­tect IOCS from the ever fluc­tu­at­ing oil prices. States on the other hand, use con­tracts to get the rev­enue due to the coun­try. They also at­tempt to en­sure that pe­tro­leum wealth does more than im­prove the fi­nan­cial po­si­tion of the IOC and the Govern­ment it­self. For this rea­son, gov­ern­ments some­times work clauses into con­tracts that oblige IOCS to trans­fer tech­nol­ogy and act in an en­vi­ron­men­tally re­spon­si­ble man­ner.

Four main types of pe­tro­leum con­tracts have emerged since the be­gin­ning of mod­ern pe­tro­leum ex­plo­ration in the mid 1800s. They are the con­ces­sion, ser­vice, pro­duc­tion shar­ing and joint ven­ture agree­ments.

Con­ces­sions pre­dom­i­nated the early years of mod­ern pe­tro­leum ex­plo­ration. Though the use of the tra­di­tional con­ces­sion has gone down, a mod­ern form with more bal­anced pro­vi­sions for both par­ties has arisen. Coun­tries like Ar­gentina use this mod­ern con­ces­sion.

Un­der tra­di­tional con­ces­sions, the State do­nated own­er­ship of large tracts of land to IOCS, also called con­ces­sion­aires. This con­ces­sion meant much more in those days be­cause prop­erty in land fol­lowed the ad coelum doc­trine, that is, as Zoll­man in “the Law of the Air” put it, “he who owns the soil owns ev­ery­thing above and below, from heaven to hell.” Those who ne­go­ti­ated th­ese agree­ments had lit­tle con­scious­ness of sound en­vi­ron­men­tal prin­ci­ples which as­sert that nat­u­ral re­sources are the com­mon her­itage of mankind, both those present and those yet to be born. Strictly speak­ing, no one can place un­rea­son­able claims over nat­u­ral re­sources. The State still did man­age to ben­e­fit from con­ces­sions through roy­al­ties and rent paid by the ex­plor­ers.

In those ear­lier con­ces­sions, IOCS en­joyed the full ben­e­fit of pe­tro­leum ex­plo­ration but also bore the full risk for any pos­si­ble loss that may have oc­curred. As the deal was so good with just the ex­plo­ration, the IOCS were not mo­ti­vated to go fur­ther and pur­sue any other ob­jec­tives. By the 1950s how­ever, that had changed. Gov­ern­ments be­gan to limit the time and other rights the con­ces­sion­aire en­joyed. Cur­rently, the mod­ern con­ces­sion agree­ments are elab­o­rate doc­u­ments which pro­vide for aspects of the state-con­ces­sion­aire re­la­tion­ship, such as the sourc­ing

of goods and ser­vices for the pro­ject and en­vi­ron­men­tal mat­ters, among oth­ers.

Nige­ria re­flects the evo­lu­tion of con­ces­sions. It started off with con­ces­sions made on very broad terms. Af­ter in­de­pen­dence and ac­ced­ing to the Or­gan­i­sa­tion of Oil Ex­port­ing Coun­tries, Nige­ria cur­tailed the rights of IOCS un­der the con­ces­sions declar­ing the nat­u­ral re­sources the prop­erty of the state.

The ser­vice agree­ment runs on dif­fer­ent prin­ci­ples al­to­gether. Whereas with con­ces­sions the IOC has own­er­ship of the land and the pe­tro­leum, un­der ser­vice agree­ments, the State re­tains own­er­ship of both. In a sense, you can liken an IOC ex­plor­ing un­der this con­tract to any other ser­vice provider. The Govern­ment con­tracts them to ex­plore for the pe­tro­leum in ex­change for the pay­ment of an agreed fee. While the ad coelum prin­ci­ple un­der­pinned con­ces­sions, ser­vice agree­ments hinge on the doc­trine of state sovereignty. Nat­u­ral re­sources are so im­por­tant to the state that it is un­ten­able to cede own­er­ship of them to for­eign­ers.

Un­der ser­vice agree­ments, the state many a time re­tains the risk but, in par­tic­u­lar cases, known as risk ser­vice agree­ment, the ex­plorer shoul­ders the whole weight of the risk. Ser­vice con­tracts can never come with the perks that con­ces­sions did. In fact, they were met with re­sis­tance by the IOCS. How­ever, as Gov­ern­ments have grown wiser, ser­vice con­tracts, and their variant, the pro­duc­tion shar­ing agree­ments, con­sti­tute the terms upon which the state will en­gage with IOCS in the ex­plo­ration of pe­tro­leum. Thus, IOCS have been forced to ac­com­mo­date them.

The pro­duc­tion shar­ing agree­ment (PSA) has In­done­sia to thank for its be­ing. Re­source na­tion­al­ism moved in tan­dem with the process of de­coloni­sa­tion in the 1960s. In this set­ting, states only of­fered a pro­duc­tion shar­ing agree­ment to ex­plor­ers in­stead of the full rights pre­vi­ously of­fered un­der con­ces­sions. PSAS give the con­trac­tor par­tial rights to the own­er­ship of the pe­tro­leum once it has been ex­tracted from the ground. As noted ear­lier, PSAS pos­sess fea­tures in com­mon with ser­vice agree­ment. They dif­fer from ser­vice agree­ments how­ever, in that the IOC can own part of the pe­tro­leum af­ter ex­trac­tion.

PSAS tend to be treated like one more law which reg­u­lates pe­tro­leum. In Kenya, for in­stance, there ex­ists a model PSA. Even the pro­posed pe­tro­leum laws pro­vide for a model PSA. Such treat­ment af­fects con­trac­tual ne­go­ti­a­tions in that it may be harder for IOCS to insert clauses that had been left out of the model PSA. For in­stance, once the Kenyan Govern­ment dis­cov­ered just how dis­ad­van­ta­geous sta­bil­i­sa­tion clauses could be to it, it scrapped them off from the stan­dard con­tracts.

De­spite the great prom­ise PSAS pos­sess, they also bring with them their own set of prob­lems such as the one men­tioned above. In short, as the re­la­tion­ship pro­gresses, some­times gov­ern­ments re­alise that they are not get­ting as much as they had bar­gained for. They thus can change the rules in the middle of the game as Rus­sia did – when it re­alised that it was not mak­ing as much as it could out of the pro­duc­tion shar­ing agree­ments, it amended the law gov­ern­ing PSAS, forc­ing IOCS to switch to an­other regime of ex­plo­ration or aban­don the ex­ploit al­to­gether. De­spite all this, PSAS are cur­rently the most com­mon type of pe­tro­leum con­tracts around the world.

The joint ven­ture agree­ment is the fourth type of pe­tro­leum con­tract. In it, the state, through its own na­tional oil com­pany, en­ters into a part­ner­ship with the IOC. This joint ven­ture is then awarded the right to ex­plore. Joint ven­ture agree­ments re­quire com­plex prepara­tory ne­go­ti­a­tions. How­ever, they en­able the state to ben­e­fit more di­rectly from the ex­per­tise of the IOC as they are work­ing in part­ner­ship with them. They also al­low the state more in­volve­ment in the ex­plo­ration.

Lit­er­a­ture on pe­tro­leum con­tracts points out that in prac­tice, it is dif­fi­cult to make clear cut dis­tinc­tions be­tween the dif­fer­ent con­tract types. This makes sense as the most im­por­tant thing is whether the con­tract ac­cu­rately cap­tures the rights and du­ties of the par­ties. Whether the play­ers achieve this by us­ing a con­tract type purely of one type or a hy­brid is of sec­ondary im­por­tance. Though cat­e­gori­sa­tion does serve its pur­poses of con­cep­tual clar­i­fi­ca­tion, all par­ties must con­cen­trate above all, on what the con­tracts con­tain. Would they rep­re­sent the in­ter­ests of the par­ties? Would they stand the test of time and volatile en­vi­ron­ments? Would they be struck out by ar­bi­tra­tors or the courts? Metic­u­lous work pro­duces doc­u­ments that an­swer to th­ese tests.

As a first step, the play­ers them­selves must clearly de­fine their re­la­tion­ship be­fore it can be re­flected on pa­per. The lawyers, in their turn, need a sound un­der­stand­ing of pe­tro­leum law in gen­eral and the spe­cific re­la­tion­ship which they need to cap­ture. Since pe­tro­leum con­tracts play such a piv­otal role in pe­tro­leum ex­plo­ration, they can­not be pre­pared on a trial and er­ror ba­sis. Re­gard­less of which form of agree­ment the play­ers choose, the con­tents of the doc­u­ment must be crafted to pro­tect that re­la­tion­ship and see it through to its log­i­cal end.^

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