Petroleum Economic Lectures (Prepared by Asst. Prof. Dr. Fadhil S.
Kadhim)
Petroleum Economic Lectures
Lecture 3
Asst. Prof. Dr. Fadhil S. Kadhim
Petroleum Economic Lectures (Prepared by Asst. Prof. Dr. Fadhil S. Kadhim)
2. Service Contracts
The Service Contract is a device that can be arranged for the requirements of
some oil producing countries in the sense of finance, technology, and experts. At
the same time, the foreign oil companies get access to the oil operations. The
merits of service contracts is given below;
1. A Service Contract ensures total ownership of the petroleum resources and all
assets with the host government while securing the cooperation of the Oil
Companies.
2. Economically, under Service Contracts, the host government gets the
maximum return than other petroleum contracts because the government has
exclusive power over production.
3. The fiscal system of Service Contracts is less complex than other petroleum
contracts, especially in terms of tax and royalty provisions, which are a
traditional area of dispute.
4. A Service Contract is simpler and clearer to manage as the supervisory process
and administrative mechanisms are reduced during execution of the contract
Petroleum Economic Lectures (Prepared by Asst. Prof. Dr. Fadhil S. Kadhim)
Service contracts could be classified into two general categories:
i) Pure Service Contracts
ii) Risk Service Contracts
A. Pure Service Contracts
A pure-service contract is an agreement between a contractor and a host
government that typically covers a defined technical service to be provided or
completed during a specific period of time.
The service company investment is typically limited to the value of equipment,
tools, and personnel used to perform the service. In most cases, the service
contractor's reimbursement is fixed by the terms of the contract with little
exposure to either project performance or market factors.
Payment for services is normally based on daily or hourly rates, a fixed turnkey
rate, or some other specified amount. Payments may be made at specified
intervals or at the completion of the service..
Petroleum Economic Lectures (Prepared by Asst. Prof. Dr. Fadhil S. Kadhim)
B. Risk Service Contracts
(RSCs) and “Pure Service Contracts” (PSCs). The distinction between the two is
blurred, however. In both the RSCs and PSCs, the FOC agrees to provide
services and knowhow, and to supply materials.
The difference between the two, according to a number of researchers, lies in the
type and method of remuneration. With our high quality information,
capabilities and our experienced team of oil and gas, we will help you to enter to
this agreement and provide all the necessary services for closing risk service
contracts The service fee can be calculated based on following formula;
TS = PR (INA) + R (P-C) Q
Where,
TS = Annual Service Fees ($), PR = Average Prime Rate (Fraction),
INA = Development & Production Costs Less Reimbursements,
P = Average International Crude Price ( $ / BBL ),
C= Production Costs ($ / bbl),
Q = Annual Production (MM bbls),
R= Average Profit Factor
Petroleum Economic Lectures (Prepared by Asst. Prof. Dr. Fadhil S. Kadhim)
3. Production Sharing Agreement (PSA)
“The PSA is a contractual arrangement between foreign contractors or FOC
and a designated state enterprise – National Oil Company (“NOC”), authorizing
the contractors to conduct petroleum exploration and exploitation” within a
certain area in accordance with the rules and conditions of the agreement.
The PSA is a risk contract under which the FOC receives compensation for cost
and profit in the form of hydrocarbons and “the FOC take them as earnings in
their accounting system and then the hydrocarbons that are subject to be taxed
by the pertinent tax authority.
We can provide our clients with well-considered commercial and technical
services throughout all phases– from idea to implementation – based on our
comprehensive experience for closing this contract.
Petroleum Economic Lectures (Prepared by Asst. Prof. Dr. Fadhil S. Kadhim)
Production Sharing Contract Flow Diagram
Petroleum Economic Lectures (Prepared by Asst. Prof. Dr. Fadhil S. Kadhim)
Production Sharing Contract
(Exercise)
Petroleum Economic Lectures (Prepared by Asst. Prof. Dr. Fadhil S. Kadhim)
Joint Ventures (Operating) Agreement
Any association of two or more entities, private or public companies, or a
combination of private and public may be identified as a Joint Venture (“JV”).
Generally a joint venture is composed of contractors and a National Oil Company
(“NOC”). Also, it is assumed that the underlying contract is mostly PSA issued to
the contractor by the government.
Contractor and NOC form a JV company on a 50/50 basis. The contractor
carries NOC (pays all of the costs) through the minimum exploration program
under the PSA. Management and other activities required by the PSA are
conducted by the JV. Micro-source provision of JV agreement to the oil and gas
industry comprises technical and commercial analyses and services to optimize
and develop this agreement in this field.
Petroleum Economic Lectures (Prepared by Asst. Prof. Dr. Fadhil S. Kadhim)
Comparison of the Different Contract Types
The concessionary and contractual systems are similar in many respects. The host
government may use the same fiscal tools (royalty, rental, tax) in order to capture
economic reward from the petroleum projects.
The main difference between these systems is the ownership of the petroleum.
According to the concessionary system the contractor owns the whole production,
while under the contractual system the contractor receives a share of production in
kind or in cash in return for services.
The host government may be responsible for the abandonment according to the
contractual system, while the contractor is always responsible for abandonment
according to the concessionary system.
Petroleum Economic Lectures (Prepared by Asst. Prof. Dr. Fadhil S. Kadhim)
The national oil company may pay the income tax on behalf of the contractor
under the contractual system, while the contractor pays tax under the
concessionary system.
It should be noted that sometimes the government participates in cost payments
when either a concessionary or a contractual system is installed. In this case the
contractor does not have 100% working interest in the project area and the
government achieves more rewards from the petroleum projects; such an
agreement is called a joint venture.
According to researchers the cornerstone of the fiscal system is the structure (for
example, applied tax rates or royalty rates) and not the type of the contract. This
means that it can not be easily claimed that one type is better than the other, and
each contract must be evaluated separately.
Petroleum Economic Lectures (Prepared by Asst. Prof. Dr. Fadhil S. Kadhim)
Investment Decisions
Investment decisions are among the most important decisions that
accompany/government can take:
Capital Intensive
Irreversible
High Risk/Uncertainty
The main objective of investment
1. Basic knowledge and techniques for performing investment analysis
2. Use the tools and concepts on petroleum investment projects
A field development project
An exploration project
3. Be able to understand the concepts used and do the economic calculations
needed in the case study.
Petroleum Economic Lectures (Prepared by Asst. Prof. Dr. Fadhil S. Kadhim)
The key factors central to investment decision-making in the oil and gas sector
include:
1. Cash Flow. The amount of annual investment that a company makes is
governed greatly by its cash flow (and the borrowing capacity this cash flow
will support). The following Figure shows that the annual cash flow from
operations track
closely with the E&P investment decision made by major oil and gas
Companies
2. Cost and Margin Expectations. The key variable for evaluating return on
investment is the economic margin, the difference between prices and costs.
As such, in addition to price expectations, an equally central investment factor
is expectations for changes in costs.
3. Portfolio of Opportunities. A third factor central to investment decisions in
the energy supply sector is the portfolio of upstream opportunities available to
individual companies, as well as to the overall industry. In recent years, a
number of major companies have used their cash flow to “buy back” company
stock, implying a lack of investment opportunities that would provide a higher
return on investment than their existing portfolio of past investments.
Petroleum Economic Lectures (Prepared by Asst. Prof. Dr. Fadhil S. Kadhim)
Petroleum Economic Lectures (Prepared by Asst. Prof. Dr. Fadhil S. Kadhim)
Petroleum Economic Lectures (Prepared by Asst. Prof. Dr. Fadhil S. Kadhim)
THE END OF LECTURE THREE
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