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SPE 78594

Development of a Petroleum Contractual Strategy Model


N.B. Ramadan, Agip Oil Co., & Abdulrazag Y. Zekri, SPE, United Arab Emirates University
Copyright 2002, Society of Petroleum Engineers Inc.
th
Introduction
This paper was prepared for presentation at the 10 Abu Dhabi International Petroleum
Exhibition and Conference, 13-16 October 2002. Over almost a century and a half, oil has brought the best and
This paper was selected for presentation by an SPE Program Committee following review of
the worst out of our civilization. Of all energy sources, oil has
information contained in an abstract submitted by the author(s). Contents of the paper, as loomed the largest and the most problematic because of its
presented, have not been reviewed by the Society of Petroleum Engineers and are subject to
correction by the author(s). The material, as presented, does not necessarily reflect any central role, its strategic character, and its geographic
position of the Society of Petroleum Engineers, its officers, or members. Papers presented at
SPE meetings are subject to publication review by Editorial Committees of the Society of
distribution. The Petroleum industry has fueled the global
Petroleum Engineers. Electronic reproduction, distribution, or storage of any part of this paper struggles for political and economic primacy in the twentieth
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prohibited. Permission to reproduce in print is restricted to an abstract of not more than 300 century “ The Century of Oil ” and it will continue to do so as
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World energy demand forecasts show that oil will continue to
Abstract play a major role in the development of the world economy ,at
The development of a petroleum exploitation strategy is least in the foreseeable future. The total world energy demand
essential for any country, which needs to develop its in year 2010 ,under an energy savings scenario as reported by
indigenous petroleum resources, see Fig. 5. A petroleum the International Energy Agency1 ( IEA ) is 10,861 million
exploitation strategy is the series of policies relating to tons of oil equivalent , out of which , 41 % is from oil as
licensing, taxation, royalty, and general legal instruments i.e. shown in Fig. 1. The main objective of this project is as
contractual agreements, see Table 1 developed by the state in follows:
order to ensure the orderly development of petroleum The first objective of the research project is to undertake a
exploration and production. In the absence of a clear comparative analysis of the contemporary international and
petroleum exploitation strategy, the international oil Libyan petroleum exploitation agreements and assess their
companies would not be able to assess the political and suitability for the future in view of the rapidly changing
economic risks involved in any petroleum exploitation worldwide petroleum industry trends, as shown in Fig. 3 .
venture, no matter how low the technical risks are. The second objective of the research project is to
Since the International Oil Companies are major sources of analyze the process of the petroleum exploitation strategy
the intensive capital, and sophisticated technologies needed for development and apply the principles learned to formulate a
exploration and development of petroleum resources, it is petroleum contractual strategy model for Libya. Throughout
essential for a country to formulate a coherent and well the development of the research project, an extensive
balanced petroleum exploitation strategy. This should be Literature review has been undertaken. The review covered
consistent with its social and economic goals and at the same three integrated circles; the international petroleum
time allow the international oil companies to generate environment on the macro level, the Libyan petroleum
economic profits that in some way relate to the level of risk environment on the micro level and the petroleum exploitation
involved in obtaining these profits. This research project has strategy development process. The historical research on the
focused on the study of the different petroleum contractual development of the petroleum industry worldwide and in
agreements between host countries and international oil Libya has been extremely useful in identifying the past and
companies worldwide, and has culminated by the development future petroleum industry trends as recognized by number
of a contractual strategy model for the exploitation of the experts who researched and wrote on the multitude of related
petroleum resources. The development of the model has been topics. The research done by Dr. D . Fee on the development
preceded by a comparative and evaluative analysis of the of a general exploitation strategy model has been referenced
international and host country petroleum agreements. The extensively in the development of the Libyan exploitation
main features, advantages and disadvantages of each type have strategy model.
been summarized and tabulated. The suitability of the different The development of the Libyan petroleum contractual
agreements, in the view of the rapidly changing environment strategy model involved the review and analysis of the frame
of the petroleum industry, has been evaluated. A new work of the petroleum strategy development process , the
contractual model for the exploitation of petroleum resources definition of the set of the strategic key factors which have the
in the Middle East is developed in this project. The Model greatest influence on the strategy formulation and then
required the development of eight different strategies, which relating the different combinations of these strategic key
relate to the possible combinations of three strategic factors factors to selected strategies .The strategies were developed
that were found to be of the greatest importance. It has been based on the recommendations of the Fee model , modified to
proposed to use this model to evaluate and guide the conform with the latest world petroleum industry trends ,
development of the future Middle East petroleum exploitation taking into account the effect of the local social and
strategies.
2 N. B. RAMADAN, & ABDULG Y. ZEKRI SPE 78594

economic environment constraints. This development process investments.


has been broken down into two major steps : • The maximization of control over the operations of
1. Review and analysis of the International and Libyan the Company to ensure that the exploration and
petroleum industry in respect of: development programs entered into by the
• Historical development of major industry events and future companies are carried out to the best oil field
trends. practice.
• Petroleum arrangements: Contracts and fiscal terms. • The maximization of direct participation in
petroleum operational activities.
2. Development of the Libyan petroleum contractual strategy • The full exploitation of the local petroleum
model: production to the advantage of the country's
• Identifying the goals and objectives of the future Libyan evelopment.
petroleum exploitation strategy. • The assessment of importance of petroleum within
• Defining the key strategic factors, Table 2. an overall policy framework
• Developing strategy options that relate to the different
combinations of the key strategic factors. The Concerns and Objectives of the International Oil
The research draws on the large body of knowledge in Company
international literature written on the development of the The International Oil Companies need to be satisfied that
petroleum industry and also the Libyan petroleum certain conditions prevail and have some constrains, Fig. 3,
publications, legislation and petroleum agreements and the such s:
Libyan National Corporation reports and publications. -There must be a good probability of locating sufficient
Through the review and the evaluative analysis of the reserves or warrant production.
collected data and information, the conclusions and -The levels of political risk should be acceptable.
recommendations have been formulated and presented. -The legal framework by which the search for petroleum is
regulated should be firmly based.
-There should be a good possibility that any oil surplus to
The International Petroleum Arrangements
Arrangements between host countries and International local demand will be available for export.
petroleum companies have evolved over many decades -The situation with regard to repatriation of eventual
towards increasing host country involvement in petroleum profits should be clear.
operations (often through a Government Petroleum Company). The main objective of the International Oil Company can be
In addition, host countries have tended to take increasingly translated into one corporate goal, i.e. The creation of wealth.
large shares of gross profits; a trend especially noticeable after To create wealth in the oil industry, the oil company must earn
the dramatic price rises of 1973 and 1979. In some countries, more than its capital, therefore, it must meet the following
state oil companies are involved directly in the exploration and conditions:-
exploitation operations. However, following the oil price The net present value (NPV) of all the company’s exploration
collapse of 1986 there have been improvements in many and production ventures should be greater than zero and
contracts to encourage a lower gross profit environment. should be maximized. (The net present value is the combined
Among the advantages obtained by host countries in dealing value of future exploration and production cash outlays and
with International Oil Companies are: profits from production discounted to the present, the discount
factor used is normally the cost of capital). The NPV is
1.Avoiding the financial risks of petroleum normally related to the probability of success (Ps) by the
exploration. formula: Ps (discounted profit on exploration and
2.Obtaining the use of highly sophisticated development) > (1-Ps)(Discounted cost of failure).
technology (often transferred to host country The rate of return (ROR) it obtains on any particular project
nationals). should be maximized (greater than 15% normally) adjusted for
3.Financing of all phases of exploration and inflation. (The rate of return is the rate of interest for the
production. discounted values of the net revenues from the future
4.Obtaining marketing arrangements for produced exploration and production such that the present worth of the
discounted values is equal to investments)1,3.
hydrocarbons.

These advantages are obtained while the host country still Types of Petroleum Agreements
receives the lion `s share of gross profits. The International Two basic types of petroleum exploitation agreements are
companies in turn obtain exploration rights to large areas and, widely used around the world; Concession and Contract .The
when successful, may produce larger volumes at lower unit traditional concession is now considered outdated, but some
cost. developing countries still adopt variations of the old
agreement . The new version of the concession has been made
The Concerns and Objectives of the Host Country more flexible than the traditional one by introducing
The objective of the host countries is to maximize the benefits legislation to accommodate fluctuations of oil prices such as
of the state in terms of : petroleum revenue taxes (PRT), as was done in the UK and
Norway. Participation in Concessions, by host governments
through partial nationalization as in the case of Libya or as a
• The maximization of revenue from petroleum
part of the initial arrangement , as in the case of Indonesia ,
exploitation operations for the state while ensuring
led to the emergence of participation agreements or Joint
that the Oil Companies earn return on their
Ventures . Contracts can be divided into three categories:
SPE 78594 DEVELOPMENT OF A PETROLEUM COACTUAL STRATEGY MODEL 3

-Production Sharing Contracts (Exploration and -The government oil company (participating in the
Production Sharing Agreement - EPSA / Development agreement)is usually 100% owned by the government.
Production Sharing Agreement - DPSA). -The joint venture company's risk is reduced , compared to
-Pure Service Contracts. a concession , through the principle of “carried interest”
-Risk Service Contracts. -The government oil company shares the costs in the
Participation in production sharing agreements is also possible equity proportion. Exploration costs may not be
and is found in some countries. A Hybrid Agreement reimbursed to the oil company, i.e., as it is the case in
resulting from the amalgamation of various elements of two or Libya and Norway . But when commercial discoveries
more of the above can be formulated2,3. Figure 4 shows the are made, the Government owned company has to
evolution of petroleum agreements. contribute in cash its share of the operating cost .The
state may be carried through the development phase , in
Concession Agreement which case the oil company assumes the financial risks
This is the oldest type of host country - oil company of the evelopment and it is paid later either in cash or in
agreement. The basis of a concession is that the state grants to oil for its expenses with interest . Normally, the farther
an Oil Company or a group of companies the right to carry out the state is carried the lower its share would be in the
various types of petroleum operations including exploration joint venture.
and development of indigenous oil resources within a given -The Government owned Company takes its share of
geographical area for a specified period of time. production in crude and may then sell the crude to its
The main features of the Concession Agreements are: partners or market the crude on its own5,6.
-The oil company, at its own risk and expense, generally has
the exclusive right to explore for and exploit petroleum Production Sharing Contract
reserves in the concession area. The concept of the production sharing contract evolved in
-The oil company owns the production from within the Indonesia in 1960 and since then it spread widely all over the
concession area ( as it is produced at the well head since world . Production sharing is carried out with the government,
reserves in the ground are traditionally owned by the state usually, through its state oil company. This appears to give a
except in the USA where , The legislation allows private greater degree of control over operation of the private
ownership of reserves in some states ) . contractor but in fact production-sharing contracts usually
-The oil company is free to dispose of it subject to its operate under the management of the risk-taking partner. The
contractual obligation to supply the host country’s domestic basic features of the contract are as follows:
market. -The International Oil Company is appointed by the host
-During the exploration and exploitation phases, the Oil country as the contractor for a certain area.
Company is subject to pay surface rentals to the host country. -The Oil Company operates at its sole risk and expense under
-The Oil Company, at the election of the host country, pays the control of the host country (normally through an
a royalty either in cash, production or combination of the operating agreement).
two. -Any production belongs to the host country.
-The Oil Company pays taxes to the host country on profits it -The state oil company gets a predetermined share of the
derives from the production. produced oil .The oil company is entitled to recovery of its
-The Oil Company owns the equipment and installations used costs out of the remaining production from the contractual
in the operations3,4. area. Cost recovery is not allowed in some earlier versions of
this contract (EPSA-I & EPSA-II ,in Libya).
Joint Venture Agreement -After cost recovery, the balance of production “ profit oil” is
The state may participate in the concession directly or through shared between the host country and Oil Company. Through
its own oil company through what is known as Joint Venture an formula which incorporates allowances for oil price
Agreement. . Through this agreement the host country shares fluctuations and unexpected increase in production rates
with the oil company the risk and expense of the development (EPSA- III , in Libya ).
and exploitation phases. Generally, the oil company will carry -The income of the Oil Company is liable to taxation. In some
the project solely through the exploration phase and may carry countries such as, Libya, the oil company is exempted from
the state oil company through the development phase, in payment of oil taxes.
which case the risks become higher on the international oil -Equipment and installation are the property of the host
company. The joint venture agreement evolved as a means to country , either at the outset of production or progressively in
address some of the deficiency inherent in the concession accordance with agreed upon amortization schedules7,8,9.
agreement. The primary aspect was to have a managerial say
in the day-to-day operations of the producing fields, therefore, Service Contracts
exercising control on a vital sector of their economy .The main The term Service Contract encompasses those various
characteristic of the Joint Venture Agreements are : contracts in which the host country contracts with a service
company or an International Oil Company for the performance
-The governments authority as a government and the of services related to the exploitation of petroleum resources.
government` rights as a participant in the venture are The two main types of service contracts are :
clearly separated. Pure Service Contract. This is a simple arrangement whereby
-The joint venture company is assigned a concession on the the Oil Company acts as a contractor in the performance of the
same terms as any other company, therefore it becomes a service to the host country to explore ,develop and produce
concessionaire through the joint venture ( This is if the petroleum resources at an agreed fee . This type of contract is
joint venture is in a concession). only used by countries with well established and large
4 N. B. RAMADAN, & ABDZAG Y. ZEKRI SPE 78594

resource base . There are two categories of pure service different types of agreements. Concession and Production
contracts: Sharing, although dissimilar in concept and philosophy, could
-The service running parallel to but contractually unconnected be made to produce exactly the same net economic benefit to
with a purchase contract for part of the oil being produced the state under a specific combination of royalty, tax and
from the area of operations to which the service contract production share levels.
relates.
-The service contract not accompanied by any access to the oil The Development of a Petroleum Exploitation
being produced under such a contract. Strategy Model for Libya
The first step towards the development of the petroleum
Risk Service Contract. The risk service contract shares the exploitation model is to clearly identify the goals and
usual elements of duration, work obligation, etc. with objectives of the Libyan petroleum strategy and then proceed
concessions and production sharing contracts, but it differs in with the development of the different strategies associated
that it pays the Oil Company in cash not in crude oil, placing with the different combinations of the key strategic factors.
the risk of investment on the Contractor who provides the The goals and objectives of the future Libyan petroleum
capital for exploration and production. If a commercial exploitation strategy Should include the following essential
discovery is made the Contractor places the well on stream, points:
therefore, the Contractor may operate it by the state, or in
some cases. Capital is reimbursed with interest and a risk fee. 1. Increasing petroleum reserves by Intensifying exploration
The government monitors closely the operations of the activities in the areas which are under explored or in
contractor. frontier areas that were not covered by serious exploration
in the past.
Hybrid Agreement 2. Development of discovered reserves which have not been
This is a new development that is created from the put on production yet.
amalgamation of various elements of the previous agreements 3. Optimization of production from existing fields .
to suit the state's interests; negotiators of this type of contract 4. Maximization of the economic returns from the present
must be freed from the legislative restrictions9. and future petroleum exploitation projects and operations.
5. Development of a local petroleum service industry.
Worldwide Distribution of Petroleum Agreement 6. Reducing barriers to entry in front of International
The distribution of the different types of contract is not a petroleum service industry and enhancing competition
function of increasing or decreasing benefit to the state ,but in
through deregulation and liberalization.
my opinion it is a function of maturity of the state petroleum
7. Establishing good contacts with the Libyan financial
policies .
institutions.
Each petroleum province passes through several stages during
8. Establishing good contacts with the international world
its productive life. In the embryonic state exploration risk is
high and it may not be in the state` s interest to employ its financial institutions.
9. Development of efficient management information
available ,and usually severely restricted capital in high risk
systems.
ventures . Since the concession represents the lowest risk to
11.Technology transfer through training and involvement in
the state ,this form of agreement is generally applied during
the embryonic period . the petroleum operations.
As the province matures resulting in a consequent reduction in
exploration risk ,the operating companies can envisage levels The model Assumptions, Inputs, and Outputs
of state participation consistent with profit maintenance. The - The model divides Libya into units which can vary in size
state is in a position either to increase its direct involvement in depending on the contract area.
the petroleum exploitation process through participation or The model treats each unit separately in terms of the
conversely it may decide to employ solely fiscal means to appropriate strategy selection .For every unit the model
ensure optimum state benefit from resource exploitation. assumes that the petroleum reserve potential, and the
While there seem to be a logical progression from the technical, economic and political risks have been evaluated
Concession to Production Sharing and thence to one of the through the utilization of standard industry evaluation
more active types of Participation Agreement, This is not techniques and are available to be used as inputs for the
always the case. For example, the United kingdom now model.
operates quite successfully a highly regulated Concession - The model assumes that a proper economic evaluation of the
system after flirting with Participation, Joint Ventures, and exploitation venture has been done and the values of the
direct exploitation through the national oil company. associated economic parameters are known, i.e. CAPEX,
There is no reason why the state should be constrained to offer OPEX, IRR ,NPV , PAYOUT , P / I , etc.
only one specific type of agreement when it may be faced with - The model also assumes that the exploitation project has
a whole series of possible petroleum prospective properties . been presented to the NOC/ MINISTRY OF ENERGY / THE
Where as a Concession Agreement may be ideal for one GENERAL PEOPLE COMMITTEE and a decision has been
prospect, another prospect may be more consistent with a made concerning the allocation of the necessary investment
production sharing or Participation type Agreement .In funds i.e. whether the government is willing to finance the
selecting a particular type of petroleum agreement , the state project or not. If it is not intending to finance the project , it
should attempt to choose a series of mechanisms which will will need to give the go ahead to NOC to negotiate with
implement as fully as possible the goals and objectives of the International Oil Companies for the realization of the project .
state . The economic benefit to the state may be equal under • The Inputs of the model are the values assigned to the
SPE 78594 DEVELOPMENT OF A PETROLEUM CONTRACTUAL STRATEGYEL 5

following strategic key factors: the petroleum developments. The total technology i.e. the
• The level of petroleum resources in the unit area. ( process, equipment and personnel skills, associated with
HIGH or LOW ) petroleum exploitation has been increasing in complexity
• The level of technology needed for the project. ( HIGH especially since the advent of offshore petroleum exploitation.
or LOW ) Future technologies such as enhanced oil recovery, require the
• The level of access to capital. ( HIGH or LOW ) services of highly skilled chemists and engineers and at
• The output is the selection of the strategy option that is present are in the hands of the few rather than the many.
considered by the model to best suite the given The level of technological advancement of a country plays a
combination of key strategic factors given as inputs . significant role in the development of a petroleum exploitation
strategy. Technology acts as a restriction on the options
Redefining the Key strategic Factors available to a government in deciding the optimal policy.
In a country like Libya the level of technology in general is
The three key strategic factors need to be defined to better
quite low and the reliance is high on foreign expertise to
relate to and reflect the Libyan petroleum industry
support the highly technical projects of the petroleum industry.
environment, but without losing their essence in the overall
Foreign technical support is not always available even if
framework of the general model. The three key strategic
enough financial resources are allocated to pay for the
factors can be redefined as follows:
services, due to the US embargo and UN sanctions, Therefore
Level of Petroleum Resources: The level of petroleum
the type of the technology, which is needed for the specific
resources in the area unit is the most important key strategic
factors since the attitude towards the International Oil project, dictates the strategy which the country can adopt. If
companies is very much dependent on the value assigned to the technical know how needed for the specific project does
this factor , in the sense of aggressiveness , willingness to not fall into the domain of embargo, the alternatives available
offer incentives and other negotiation strategy concerns . are more. But if the type of technology falls under embargo,
The model requires that the level of petroleum resources of an then the options would be either limited or none existent.
Therefore, the value assigned to this factor depends on
area is assigned a binary value (High or Low). This value can
whether it is possible to import the technology at affordable
be assigned based on a proper technical property evaluation
work , i.e. if it is located in a good part of one of the well cost or develop it in the country or not.
known sedimentary basins such as the Sirte basin where The model requires that a binary value (HIGH or LOW) is
tremendous successful exploration and exploitation activities assigned to this factor depending on the level of the most
have taken place. The rating of this factor is expected to be important technology needed for the project. A classification
“High” , but if the area is in the Kufra basin where little of some technologies used in the production of petroleum
available, the factor is expected to have a “Low” value. In should be developed by the specialists to categorize the
order to properly evaluate the resources potential of an area , different technologies. The value ‘low’ would apply to those
different types of information must be available to the technologies, which cannot be developed in Libya and are
exploration specialists , such as : difficult to acquire from the international market due to
• Geological information about the basin, such as basin sanctions or extremely high costs.
development , source rock and reservoir rock ,structural ‘High’ would mean that the technology can easily be acquired
elements, migration ,tectonics , etc. from international suppliers or developed locally. The
• Geological information about the interest area and its meaning given here to this factor has been modified a little as
location in the basin. compared to the definition given to this factor in the “FEE
• Biogenetic information to assess possible types of model”, but the implication on the strategy is the same. (if the
hydrocarbons. country` s level of technology is too low to handle the project
= the technology needed for the project can be considered
• Analogies derived from similar locations.
High as seen by the local industry.)
• Exploration history and statistical evaluations about the
basin. Access to Capital
• Range of possible sizes of recoverable reserves. Since no meaningful relationships exist between the Libyan
• Range of well productivity. government and the major international financial institutions,
• Quality of the crude oil and the gas oil ratio . which are the source of investment capital around the world,
• Subsurface depth of the reservoir. Libya has no choice but to rely on its own resources for
• Water depth for offshore reservoirs. financing its exploration and exploitation projects. Therefore,
• Rate of production decline. the value given to this factor can be either high or low
These different types of information are then processed depending on whether or not the government allocates
through specialized techniques to give the best estimates of sufficient funds for the project. If the government changes its
reserves in that area or unit. economic policies in the future and its relationships with the
world financial institution such as the world bank are again re-
Level of Technology established the value given to this factor will also depend on
The search for and exploitation of petroleum resources the response of these organizations to the needs of the
involves the application of many disparate technological skills. individual project. The ability of the government to allocate
Geologists, geophysicists and specialized computer personnel funds for investment in the local petroleum exploitation
are required for prospect evaluation through geological and project is effected by the following factors:-
seismic surveys. The International Oil Prices : Depressed oil prices at present
The full range of engineering skills, both oil related and and low price forecasts for the next years , make it inevitable
general are used in the exploration and exploitation phases of for the government to reduce its funding of the petroleum
6 N. B. RAAN, & ABDULRAZAG Y. ZEKRI SPE 78594

sector projects in order to sustain its ability to support the rest related to similar strategies recommended by the “ FEE
of the economy. This fact limits the number of available Model” specifically tailored to suit the Libyan petroleum
exploitation strategy options .Under this economic industry environment considering the extensive analysis
environment, the state oil companies will only be able to which has been undertaken in the course of this research .
undertake low investment projects directly. Libya is a mature petroleum state, since extensive petroleum
The Capital Costs of the Project : The size of investment resources have already been established, but because of
needed for the development of a field may be very high and declining production and low oil prices, Libya does not have
therefore, prohibitive to government participation in its good access to capital Since The main policy objective of the
development. There are different factors which lead to high country is to insure that the maximum benefit is derived from
capital project costs, some of which are attributed to the the exploitation of a limited resource. The exploitation policy
project nature itself such as the case of development of must , therefore ,be aimed at maximizing the revenues to the
reservoirs which contain very corrosive fluids or reservoirs state and ensuring that petroleum exploitation acts like an
which require highly sophisticated production technologies engine in developing a local industry. Since Libya does not
such as secondary and enhanced oil recovery techniques. The have a well-developed industrial sector, According to the
other very important factor is location of the project which general model , A Production Sharing Agreement will satisfy
may require a very expensive production and transportation many of the state ` s socioeconomic and political objectives.
infrastructure especially if the location of the field is in deep The EPSA model has been implemented in Libya since 1974
offshore waters or very remote frontier desert areas. ,but it has not been as successful in finding sizable reserves
Government’s Investment Priorities: Since the government’s and bringing them on production as the concession agreement
responsibilities cover a wide range of activities in all walks of has been in the Sirte basin during the 1950 `s and 1960 ` s.
life such as health service, education, industry, defense , etc., The main reason for this unimpressive performance of the
the competition of these sectors is at its most especially when EPSA is its lack of enough incentives to justify the high risks
the funds available to the government from oil sales is reduced involved in the exploration and development of the other
due to low international oil prices or declining production. areas.
The oil sector unfortunately finds itself competing with some The problem now lies in the fact that Libya is a big country
very powerful sectors even to secure the most essential funds and previous exploitation activities have been concentrated
needed to cope with its absolute minimum commitments not to mainly in the Sirte basin , and to a less extent in the Ghadames
mention high investment projects, which are needed to fully and Murzuk basins leaving the rest of the country under
exploit the national petroleum resources. The effectiveness of explored. The latent high exploration risks and high
the oil sector through the Ministry of Energy in convincing the development costs associated with these areas require a
government to invest in the oil industry is a detrimental factor completely different approach.
in the shaping up of the future Libyan petroleum exploiting The other major problem is that the mature fields in the Sirte
strategy. basin have now reached a stage where secondary and
enhanced oil recovery methods are essential to optimize their
The Development of the Strategy Options productivity and increase their recovery .These elaborate
The possible combinations of the key strategic factors can be schemes require high technology which is very costly , The
related to similar strategies recommended by the “ FEE EPSA III model in this case can still be useful , but it may
Model” specifically tailored to suit the Libyan petroleum give too much benefit to the International Oil Company since
industry environment considering the extensive analysis exploration risks are not there anymore. The fact that all the
which has been undertaken in the course of this research . big fields in the Sirte Basin are operated by National Oil
Libya is a mature petroleum state, since extensive petroleum Companies ads to the problem, in the sense that the
resources have already been established ,but because of investment capital has to come from the NOC . The other
declining production and low oil prices, Libya does not have problem with using the EPSA Model in these fields is that the
good access to capital. majority of them are originally operated through joint ventures
Since The main policy objective of the country is to insure that with US companies which departed in 1986 , but are still in
the maximum benefit is derived from the exploitation of a contract with NOC under a “Stand Still Agreement” . These
limited resource. The exploitation policy must , therefore ,be agreements have tied up these areas and prevented NOC from
aimed at maximizing the revenues to the state and ensuring adopting more aggressive exploitation strategies because of
that petroleum exploitation acts like an engine in developing a legal and political reasons. The following strategy options
local industry. Since Libya does not have a well-developed have been developed to deal with these different problems and
industrial sector , According to the general model , A support the decision makers in selecting the appropriate
Production Sharing Agreement will satisfy many of the state ` exploitation strategy:
s socioeconomic and political objectives. The EPSA model has
been implemented in Libya since 1974 ,but it has not been as Strategy Level of Level of Access to
successful in finding sizable reserves and bringing them on Resources Technology Capital
production as the concession agreement has been in the Sirte A Low Low Low
basin during the 1950 `s and 1960 ` s. The main reason for
this unimpressive performance of the EPSA is its lack of This situation is the worst possible one since it is associated
enough incentives to justify the high risks involved in the with an area with a low level of resources that requires a high
exploration and development of the other areas . level of technology , in addition to the low availability of
The problem now lies in the fact that Libya is a big country sufficient investment funds. This situation applies to most of
and previous exploitation activities have been con The the new unexplored areas , or areas of negative previous
possible combinations of the key strategic factors can be exploration results. The government in this case has no option
SPE 78594 DEVELOPMENT OF A PETROLEUM CONTRACTUAL STEGY MODEL 7

but to involve an international oil company to bare the ultimate Production Sharing in a later phase when oil is
financial and technical risks. Since the risks are high for the discovered. This type of contract is called Hybrid contract.
international oil companies, the government` s strategy should The Kufra basin can be taken as example for this case . Similar
provide incentives that will attract these companies into incentives as in the previous two cases need to be
investing in the development of the petroleum resources in incorporated.
these areas . The recommended agreement model in this case
is a Concession with Royalty that would be based on profit or Strategy Level of Level of Access to
Sliding scale or related to production and a rate of return Resources Technology Capital
based taxation system. Some tax breaks and exemptions would D Low High High
be very useful in reducing the financial risk of the
International Petroleum Companies during the exploration In this situation the funds are available and the technology is
phase. The EPSA agreement would not be a suitable strategy either locally available or can be easily acquired, but the risk
option in this situation. Negotiating an EPSA agreement for of low resources is still there. Although for a country in this
an area with low resource potential and high technical risks situation (combination D in the general model ) a highly
would be very hard because of the difficulty the International regulated Concession agreement would be recommended ,
Oil Company would face in convincing the negotiators of the but considering the Libyan situation the recommended
NOC to accept a production share which is lower than the arrangement would be a Joint Venture Agreement , because
level they are used to get in higher potential areas . The NOC of the same reasons discussed in B above the geological risk
negotiators would be in a very difficult position later if the is still high for the government to work alone but risk can be
International Oil Company finds larger reserves than those shared with the International Oil Company to encourage them
estimated by the specialists during the time of negotiations . to participate , since the government have in this case the
They may even be subject to prosecution if the key issue of funds needed to at least finance its share of the joint venture.
high risk is not well perceived by the authorities. This attitude Since the priority of the government investment policies in the
may either cause the competent International Oil Company to foreseeable future is not expected to be directed towards this
decline leaving the stage to mediocre companies or if they type of high risk areas , as in the case of strategy - B above ,
accept , they may recalculate at later time the viability of the this scenario is just a hypothetical one under the present
venture after only meeting a small part of their commitment , petroleum industry environment.
and withdraw or ask for renegotiating to improve their returns.
In this regard the concession would give a sense of security
since the agreement is based on the petroleum law , and Strategy Level of Level of Access to
therefore they will be concentrating more on negotiating extra Resources Technology Capital
benefits to the state in terms of bonuses , technical transfer E High Low Low
,etc.
This situation is associated with an area of high potential but
the technology needed is not available and the necessary funds
Strategy Level of Level of Access to are not available to the government.
Resources Technology Capital A Production Sharing Agreement with a carried state
B Low Low High investment in the development and exploitation phases
designed primarily to maximize economic returns to the state
This situation is not very much different from strategy (A) and transfer technology to the local staff would be appropriate.
except in terms of availability of investment funds, but the risk The Murzuk basin area would be an example of this case.
is still too high for the government to do the job alone. This strategy is primarily recommended for exploration
The most suitable strategy in this case is for the government to ventures. A risk service agreement would be very suitable for
share some of the risks to encourage international company enhancing the production of existing mature fields or for the
participation through a Joint Venture Agreement. The development of discovered and not developed reserves
objective here is to get access to the technology and share the ,especially those under a stand still agreement . These risk
high exploration risk with a competent partner. The terms service agreement can be between the operator and an
should still be generous enough in a similar way as in the case International oil company on behalf of the parties to the joint
of strategy (A) above because of high risk. Since the priority venture (meaning ,the US companies ) assuming that this is
of the government investment policies in the foreseeable legally viable and acceptable to all parties .
future is not expected to be directed towards this type of high
risk areas due to already discussed reasons , this scenario is Strategy Level of Level of Access to
just a hypothetical one under the present petroleum industry Resources Technology Capital
environment but if the economic environment changes to the F High Low High
better this is may be a viable .
Strategy Level of Level of Access to This situation is associated with an area with high level of
Resources Technology Capital resources that requires the incorporation of high technology
C Low High Low which is not locally available but the government in this case
This situation is still not favorable for the government because can allocate the necessary funds to undertake the project. The
of low potential and lack of funds. Therefore , despite the best strategy in this case would be a Pure Service Contract
availability of the needed technology locally there is still a with an international oil company that would import the
need for foreign capital. The most convenient contractual needed technology and utilize it to develop the petroleum
arrangement in this case would be a Concession and an resources for the National Oil Company.
8 N. B. RAAN, & ABDULRAZAG Y. ZEKRI SPE 78594

The government in this case will gain the full access of the when the primary objective is to maximize the
petroleum products and will pay the International Company economic returns without much importance given to
the cost of its services. All the exploration, Technical, and technology transfer and control .(Scenarios : H) .
financial risks are born by the National Oil Company. 3. The risk service agreement is seen to have a good
Economically, this strategy yields the maximum economic potential in the enhancement of productivity of
return for the country as long as the government is willing to existing productive reservoirs, especially in areas
invest some of its financial resources into economically viable operated by the National Oil Companies . This type
projects of the local oil industry. This type of contract has not of contracts is believed to be compatible with the
been used in Libya, but there is a great potential for using it in “Stand still Agreements” between the departed US
the development of discovered fields with low technical risks . companies and NOC , which of course needs to be
investigated and confirmed from a legal point of
Strategy Level of Level of Access to view .
Resources Technology Capital
G High High Low Refrences
1. Dr. D. Fee , Petroleum Exploitation Strategy , Belhaven
This situation applies to an area with a high level of petroleum Press ,1988.
resources and for which the technology is available but the 2. S.B. Katz ,Types of Petroleum Contracts : Their History
funds needed to undertake the project are limited or can not be and Development, (The Business of Petroleum
allocated by the government. Exploration - Ch.24) ,AAPG , 1992, pp.297-305.
The low access to capital is a severe restriction on the country 3. Gordon H. Barrows , Worldwide Concession Contracts
`s ability to pursue the exploitation of the petroleum resources and Petroleum Legislation , Pennwell Publishing
alone or pay for the services . Seeking financial assistance Co,1983 ,pp.1-33.
from International Financial Institutions and then undertaking 4. Barrows, Trends in Petroleum E & P Contracts
the project directly through the national oil company would be Worldwide ,OGLTR 7,1992 , pp.1-4.
a viable solution to the problem , but this may not be possible 5. Sidney Moran , Analysis of International Oil and Gas
under the prevailing circumstances . The state in this case Contracts ,( The Business of Petroleum Exploration -
may benefit from a Risk Service contract with an international Ch.25) , AAPG , 1992 , PP.307-309.
Oil Company which may be willing to provide the investment 6. C. L. McMichael , and E. Young ,Effect of Production
and take the risk in return for access to crude oil supplies . For Sharing and Service Contracts on Reserve Reporting ,
the projects within the financial capability of the state, the SPE 37959 ,1997, pp. 55-59.
national oil company may undertake the project alone. 7. G.K. Kellas , and Susan Hodgshon , Risk Sharing in
Exploration and Production Contracts, SPE 28209 ,1994 .
8. H.E. Lechner and R.F. Altenberger , Comparative
Strategy Level of Level of Access to Economics of Exploration and Production Contracts and
Tax Regimes Applied to Expected Oil Prospects, SPE
Resources Technology Capital
28208,1994.
9. Dr. K. Malik ,International Petroleum Agreements and
H High High High
Negotiations, AGIP Executive Course ( Not published
),1990.
This is the best available situation where the national oil
companies should undertake the exploitation activities alone
and bare all the risks to benefit from the high rewards. A
highly regulated concession can be an option, as an alternative
but this option has to be carefully evaluated in terms of
economic returns to the state since technology transfer is not a
priority objective, because the technology is already available
or can be made available at reasonable costs, locally.

Conclusions
1. The EPSA-III contractual model seems to be an
acceptable form of petroleum exploitation agreement
in terms of flexibility since it incorporates
mechanisms which react well to the changing crude oil
prices and level of production. It is recommended for
high resource potential areas with high technical risks.
(Scenario E)
2. The concession is still considered a viable model , it is
recommended for low potential high risk areas
(scenario A ). This would require amendment of the
petroleum law no.25 of 1955 to again permit the
concession agreement under a new more flexible fiscal
regime which includes profit related Royalty and
Taxes , and other risk level related incentives .The
concession is also a possible option for the situations
SPE 78594 DEVELOPMENT OF A PETROLEUM CONTRACTUAL STEGY MODEL 9

TABLE 1- THE VARIOUS TYPES OF AGREEMENTS IN OPERATION IN VARIOUS COUNTRIES

Region Concession (Royalty & Production Sharing Risk Service


Income Tax)

North America Canada / USA

Latin America Argentina , Bahamas Bolivia , Guatemala Brazil , Chile


Barbados , Costa Rica Guyana , Honduras Colombia
Paraguay , Surinam Panama , Uruguay Ecuador
Trinidad Peru

Europe Austria , Bulgaria Albania


Denmark , France CIS
Germany , Greece Rumania
Greenland , Ireland Yugoslavia
Italy , Malta
Netherlands , Norway
Poland , Portugal
Spain , Sweden
Turkey , UK

Africa Cameroon , Chad Algeria , Angola


Congo , Gambia Benin , Burundi
Ghana , Guinea Bissau Ivory Coast , Egypt
Mali , Morocco Eq. Guinea , Ethiopia
Namibia , Niger Gabon , Guinea
Nigeria , Senegal Mauritania , Kenya
Seychelles , Sierra Leone Libya , Mozambique
Somalia , South Africa Sudan , Tanzania
Tunisia , Zaire Togo , Zambia

Middle East UAE Bahrain , Jordan


Palestine Oman , Qatar
Syria , Yemen

Far East/Australia Australia , Brunei Bangladesh , China Philippines


Cambodia , Fiji India , Indonesia
New Zealand , Pakistan Laos , Malaysia
Papua New Guinea Mongolia , Myanmar
South Korea , Thailand Nepal , Sri Lanka
Vietnam

TABLE 2- THE POSSIBLE COMBINATIONS OF THE KEY STRATEGIC FACTORS

Combination Level of Resources Level of Access to


Technology Capital

A Low Low Low


B Low Low High
C Low High Low
D Low High High
E High Low Low
F High Low High
G High High Low
H High High High
10 . B. RAAN, & ABDULRAZAG Y. ZEKRI SPE 78594

Others

Solid

Type of Energy
Hydro

Nuclear

Oil

Gas

0% 10% 20% 30% 40% 50%


Percentage

Figure 1- IEA energy demand outlook in year 2010

Markets
Enviromental

Petroleum
Industry

Institutional
Technical

Figure 2- A changing world

Competition Week Oil Environmental Inadquate Customer


Prices Cost Contact quality

Oil
Company

Figure 3- Constraints on the international oil companies


SPE 78594 DEVELOPMENT OF A PETROLEUM ONTRACTUAL STEGY MODEL 11

Oil Concession EPSA


New
Concessions/JV EPSA/JV
Concession

Figure 4- Evolution of petroleum agreements

Goals & Objectives Petroleum Industry


Environment

Elements Of Exploitation Strategy

• Level Of Royalty
• Level Of Taxation
• Type Of Exploration Agreement
• Licensing Policy

Criteria For Strategy Selection

• Historical Performance
• Level Of Technology
• Level Of Resources
• Access To Capital
• International And Institution Lending Policy
• Oil Price
Oil Company Exploitation Strategy

Figure 5- Petroleum exploitation strategy development process