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INTRODUCTION The activities related to exploration, development and extraction of oil and gas reserves are launched under different types of contracts, leases, and concessions permitted by the government of any country, the legal framework of which is established by the constitution of the country concerned1. Oil and gas legislations differ from one country to the other, as it is based on the purpose and the intent of regulating the assets of the concerned country. The main emphasis of every country is to continue with the control of its assets and to extract revenues for economic growth2. In order to exploit its resources and assets the State Government enters into a contractual relation with the International Oil Company which has the ability, technique and experience in the field of Oil and Gas business. Basically there are two types of contracts between State and International Oil Company. Firstly by providing concession license to the Oil Company and secondly by making a contractual arrangement which is known as Production Sharing Contract (PSA)3. Production Sharing Agreements are mostly used by the countries for the purpose of Oil and Gas exploration and development4. The significant difference between the above mentioned two types of contracts is the level of State participation and sharing schemes of compensations and profits/rewards. In the situation where the concession license is provided to the Oil Company, the Oil Company will have the ownership right on the production and the state government will be provided with the royalty payment and the income tax from the Oil Company, whereas in Production Sharing Agreement, the state will have the absolute ownership of Oil and Gas production, and the Oil Company will act as just the contractors, who provide the technical and financial assistance for different operations of the Oil exploration and development and in the end the production is shared between the Oil Company and the state and Oil Company according to the provision of the contract5.

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Kiluange Tiny : THE JDZ MODEL PSC: ALEGAL ANALYSIS. Energy Law Journal : PRODUCTION SHARING CONTRACTS, Published 18 Dec 2008 3 Pongsiri, Nutavoot. Partnerships in oil and gas production-sharing contracts. (Centre on Regulation and Competition (CRC),University of Manchester, UK, 2002), pp. 432. 4 Thomas W. Wlde, The Indonesian Production Sharing Contract, book review. 2003. OGEL. 5 Pongsiri, Nutavoot. Partnerships in oil and gas production-sharing contracts. (Centre on Regulation and Competition (CRC),University of Manchester, UK, 2002), pp. 433.

LLM: Oil and Gas Law-State Control (LS5045)

Student ID: 51123686

For the purpose of answering the outset question, this essay has been divided into four brief sections which are as follows: SECTION- 1 : PRODUCTION SHARING AGREEMENT IS BETTER SUITED FOR DEVELOPING COUNTRIES. As it is clear that the business in Oil and Gas industry is very expensive and full of high risks6. In such a scenario it becomes difficult for the developing countries to exploit their resources for economic development because they lack in experience, technical expertise and sufficient financial resources. Under the current structure of Production Sharing Agreement, state government appoints the Oil Company as a contractor to undertake the petroleum operations in the area specified in the contract. The Oil Company performs the operations at sole risk, at its own risk under the control of Host government. The Production Sharing Agreement allocates a portion of production to the Oil Company, to recover the cost they incur in the process, which is known as cost recovery. In order to highlight the significance of Production Sharing Agreement in context of developing countries we have to look into the basic features of Production Sharing Agreement which are as follows: Production Sharing Agreement is a contract between State party and foreign Oil Company7, where the state party hires the Oil Company to explore and extract Oil from its reserves because the state lacks in sufficient technical and financial aspects. It is a risk contract under which a foreign Company receives compensation for cost and profits in form of hydrocarbons. The remuneration of the contractor is made in kind i.e. by allocation of the share in production of the oil produced. It is to be noted that state has the ownership rights on the reserves, for which the Production Sharing Agreement is entered into. Thus Production Sharing Agreements are preferred because they protect sovereignty8.

Greg Gordon, John Paterson and Emre Usenmez (Editors), OIL AND GAS-CURRENT PRACTICES AND EMERGING TRENDS, Dundee University Press, Second Edition, 2011, Para. 12.12 7 Seminar : 3 for LLM : Oil and Gas Law: State control, Dated : 01.11.2011 8 Seminar : 3 for LLM : Oil and Gas Law: State control, Dated : 01.11.2011

LLM: Oil and Gas Law-State Control (LS5045)

Student ID: 51123686

The state remains the owner of Oil and Gas produced and the ownership of the production transfers only at the point of export.

The Oil Company pays the royalty, recovers the cost of operation and then shares the remaining production with the government.

The Oil Company provides all the equipments and technology and bears the cost of operation and risk.

The ownership of the equipments, which were brought by the contractor for the operations, is passed to the state after the successful completion of operation.

Besides all the advantages mentioned above, Production Sharing Agreement treats both the parties on the same side and share the production equally. It means bigger the production, larger the partys share of profit and it would benefit both the parties equally. The essence of Production Sharing Agreement is to grow the ability of National Oil companies of the state to become as big and efficient as International Oil companies9. Therefore, we can say that the concept of Production Sharing Agreement is mostly preferred by the developing countries which have potential Oil reserves but they lack in technical and financial aspects and with Production Sharing Agreement, the problem of financial resources and technical expertise can be solved by these countries. SECTION- 2 : FISCAL COMPONENTS OF PRODUCTION SHARING CLAUSE In Production Sharing Agreement, the main characteristics from the point of view of State Government is to attract investment and capture the maximum possible economic rent and the basic structure of Production Sharing Agreement is constructed for earning maximum economic rent for the state10. The Fiscal components of Production Sharing Agreement can be divided into the following categories11: 1. Royalties: Under the Petroleum regulations, the contractor must pay the royalties on the production of the crude oil in the operation in the are specified in Production
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Energy Law Journal : PRODUCTION SHARING CONTRACTS, Published 18 Dec 2008 Johnston, D., International Petroleum Fiscal Systems and Production Sharing Contract, 6 (Tulsa, Oklahoma, USA: PennWell Publishing Company, 1994) 11 Seminar : 4 for LLM : Oil and Gas Law: State control, Dated : 08.11.2011
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LLM: Oil and Gas Law-State Control (LS5045)

Student ID: 51123686

Sharing Agreement12. Royalties are not regarded as tax but as a reward to the owner/state for giving its rights to the Oil Company for performing the operations.

2. Bonuses: In Production Sharing Agreement there are three kind of bonuses. a) Signature Bonus: They are offered in the bidding process and paid when the Production Sharing Agreement is signed. These bonuses are one-off payments to the state government for licences. But many Oil companies do not prefer the signature bonuses as they may be misused by the state government and also because of the economic risk involved in the operation. It is the payment made to the host government by the Oil Company for finalizing the block/area commercially, before initializing the operation. b) Discovery Bonuses: The concept of discovery bonuses is very less common and is rarely found in Production Sharing Agreement. It is one-off payment which is made when the discovery of the Oil reserve is made13. c) Production Bonuses: These are one one-off payment when the production of Oil and Gas starts14. It is based on the cumulative amount of production of crude Oil in the contract area. These bonuses are not recoverable as cost oil, but are deductable for Tax purposes.

3. Cost Recovery: One of the most common features of Production Sharing Agreement is cost recovery. It is needed by the contractor to recover the cost of exploration, development and all other operations carried out in the process of exploring Oil and Gas. This cost is recovered out of the gross revenue. Cost recovery is limited to 80% of the available oil production after deductions of the royalties. 4. Profit Oil: It is equivalent to the taxable income15. It is predetermined allocation of production after cost oil split between the contractor and the state government. The contractor share of profit is subject to tax. The remaining profit after the cost oil is split typically at the rate of about 80% for government and 20% for the Oil Company.

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Kiluange Tiny : THE JDZ MODEL PSC: ALEGAL ANALYSIS. Seminar : 4 for LLM : Oil and Gas Law: State control, Dated : 08.11.2011 14 Ibid. 15 Seminar : 4 for LLM : Oil and Gas Law: State control, Dated : 08.11.2011

LLM: Oil and Gas Law-State Control (LS5045)

Student ID: 51123686

5. Sharing of Profits: The Oil production sharing between the parties take place after royalties, cost recovery and tax. Therefore, its becomes evident from the above mentioned facts on Fiscal components in Production Sharing Agreement, that it has a relatively simpler fiscal regime if compared to other legal arrangements, as a result of which the state does not have to spend time and resources for the purpose of designing complex taxation rules and regulations. SECTION- 3: USE OF RENEGOTIATION CLAUSE In any contractual relationship, there are certain circumstances where there are possibilities of non-performance of any obligation. Such situations are called contractual risks and they may arise in exploration and production operations and may lead to call for renegotiation of the agreement16. In order to protect the original contractual equilibrium and fairness, it seems just and fair that parties should have a right and duty to renegotiate the obligations in long term contracts like Production Sharing Agreement. Renegotiation basically occurs in natural resource sector between the state party and the Oil Company. The main reason for renegotiation is that the long term nature of investment contracts makes it vulnerable from the future events, which the parties could not expect at the time of drafting and entering into such contract17. It is inserted in Production Sharing Agreement, as one of the legal method for renegotiation. Its main function is to provide a mechanism for amending the originally agreed terms and conditions of the contract. It offers protection to both the parties in situations where damage/hardship is caused to any of the parties by change of circumstances or provisions which were there in original contract. From the point of view of developing countries, the renegotiation clause is a significant part of Production Sharing Agreement, because when an economically and technically weak country is entering in Production Sharing Agreement for exploiting its reserves with help of

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Liang Peng, RENEGOTIATION CLAUSES IN INVESTMENT CONTRACTS, Dt: 27 July 2011 Piero Bernardini, Adaptation in Oil and Gas Investments, Oxford Journals, Vol.1, Issue 1, Pp.98-112

LLM: Oil and Gas Law-State Control (LS5045)

Student ID: 51123686

Oil companies, and later on the state discovers that there is much more available in the resources than what was finalized in the contract. In such circumstances, to avoid any mutual disagreement and for successful completion of Production Sharing Agreement on mutual consent of the parties, the renegotiation clause comes into action. The main purpose of renegotiation clause is to maintain equilibrium of interest of parties to the Production Sharing Agreement. SECTION- 4: CONCLUSION From the above mentioned averments made in the essay, it becomes evident that Production Sharing Agreement is best suited for developing economies than alternative legal arrangements for exploitation of hydrocarbons, because these developing economies lack in the technical expertise and finances to exploit and develop their natural resources. Therefore with the help of Production Sharing Agreement, they attract the foreign Oil companies to enter into the contractual relationship with them and allows them to explore and extract the natural resources. Moreover the Fiscal policy, of Production Sharing Agreement also favours the state government because without putting their own resources, manpower, technology and finances the state government gets the revenues, taxes and share in profits, and that too without loosing the ownership of the area of concerned operation specified in Production Sharing Agreement. Finally as far as the renegotiation clause is concerned, it is beneficial for the developing state, because it prevents the state government from loss and also enables it to change the original terms/provisions of the original contract, but after negotiations with the Oil Company. To conclude with, I would like to say that the Production Sharing Agreement can be very profitable agreement for both the developing country and for the oil companies as well.

LLM: Oil and Gas Law-State Control (LS5045)

Student ID: 51123686

BIBLIOGRAPHY TEXTBOOKS 1. Greg Gordon, John Paterson and Emre Usenmez (Editors), Oil and Gas-Current Practices and Emerging Trends, Dundee University Press, Second Edition, 2011. 2. Johnston, D., International Petroleum Fiscal Systems and Production Sharing Contract, 6 (Tulsa, Oklahoma, USA: PennWell Publishing Company, 1994) 3. Pongsiri, Nutavoot. Partnerships in oil and gas production-sharing contracts. (Centre on Regulation and Competition (CRC),University of Manchester, UK, 2002). 4. Richard Barry, Joint Venture: The Management of International Oil Operations.

JOURNALS 1. Energy Law Journal : Production Sharing Contracts, Published 18 Dec 2008. 2. Liang Peng, Renegotiation Clauses in Investment Contracts, Dt: 27 July 2011 3. Piero Bernardini, Adaptation in Oil and Gas Investments, Oxford Journals, Vol.1, Issue 1, Pp.98-112. 4. Thomas W. Wlde, The Indonesian Production Sharing Contract, book review. 2003. OGEL.

LLM: Oil and Gas Law-State Control (LS5045)

Student ID: 51123686

WORD COUNT This Essay contains 2108 words including footnotes.

LLM: Oil and Gas Law-State Control (LS5045)

Student ID: 51123686