By Shaden Esam Aldine
There are many good business reasons to participate in a Joint Venture (JV). One of these reasons is partnering with a business that has complementary abilities and resources. The issue that resonates across the oil and gas industry globally, however, is which legal framework can be more beneficial to the parties involved.
A JV can be established between a host country (HC) or a National Oil Company (NOC) and an International Oil Company (IOC) through a Joint Operational Agreement (JOA). JOAs, that define the framework of JVs, can be classified into service contracts and production sharing contracts.
Service Contracts vs. Production Sharing Contracts
In order to attract and sustain IOCs for joint ventures in the MENA region, forms of agreements play a major role. The difference between service contracts (SC) and production sharing contracts (PSC) define the issue of ownership of oil and gas resources, the extent of HC’s supervision over business processes and structures, control of operations and the nature of remuneration for involved IOCs, according to Valentine Ataka’s study on Features and Merits of PSC and SC.
Under the SC scheme, the HC has absolute ownership of the oil through its NOC and supervises operations executed by IOCs. The IOC becomes a service contractor retained for its services and is paid a fixed fee. In some cases, the IOC’s payment is in the form of a priority to purchase oil at a discounted rate i.e. buy-back.
On the other hand, according to PSC, the IOC is more of a partner in the venture. It gains shares in the oil output and controls operations. Remuneration is also different in the PSC regime. The IOC is entitled to a share in crude output. As the contracts specify, the contractor is at any time entitled to recover any petroleum costs incurred, affirmed Valentine Ataka in the above-cited study.
Yet, under the Libyan Exploration and Production Sharing Agreement (EPSA-IV), NOCs normally take around 80% – 90% of the oil and gas production, while the foreign company must recover capital and its operating costs, and eventually is enabled to start making profit first from the remaining share in production – between 10% to 20%, wrote George Booth and Dr. Admir Kordvani in an article ‘Understanding the Libyan Oil & Gas Production Sharing Agreement Framework’, published by Clyde and Co law firm.
Another key factor to take into account regarding the agreement framework is the level of risk to which IOCs are exposed. The IOC bears all the risk with no fall-back for recovery in the event that the venture does not yield a profit under the SC arrangement. But PSCs define that the risk is shared between the IOC and the HC.
Furthermore, under the PSC, the IOC has control over the operation either directly or through a joint operating body e.g. the joint operating committee in which it is represented. This is likely to minimize government’s interference and reduce conflicts over the interest of all parties involved in any oil and gas project. On the other hand, under the SC arrangement, the IOC has little or no control over its own operations; thereby it may jeopardize its technical integrity.
In this brief comparison, it appears that the PSC may be a safer investment structure. As positive sentiments over PSC emerged, some MENA countries sought to adopt this model for its investors.
In the case of Libya, favorable terms of the country’s ESPAs were deemed suitable and therefore expanded, as opposed to the most recent situation in the country when only Wintershall enjoyed ESPA regime. Following the application of ESPAs on new actors, the Libyan National Oil Corporation’s Chairman, Mustafa Sanallah persuaded Total to recommit to Libyan onshore exploration and production. However, it is worth mentioning that ESPAs were due to be reviewed on an industry-wide basis in 2014, but the Libya Dawn’s takeover of Tripoli halted such discussions. The development in the North African country is therefore pending.
Joint Operating Agreement
When it comes down to JVs, so called Joint Operating Agreements (JOA) shape JVs’ activities in exploration and production of oil and gas resources. The JOA provides a set of rules and regulations, which govern operations of involved parties for the duration of the JV. The core interest of JOAs is to provide mechanisms that would protect the business project and minimize any threats to the stability and longevity of the joint venture projects. Conceptually, the JOA represents a ‘constitution’ or reference for joint venture for liabilities, transfer of interests, accounting procedures, dispute resolution, and withdrawal procedures.
In making the decision about a more beneficial contracting regime – SC or PSC – HCs are seeking to attract technology and skill force into their country to boost their hydrocarbon production. Yet, currently, 37% of oil and gas companies have considered or are considering introducing Joint Operating Agreements into their business plan, as some statistics have revealed.
Perplexities of JOAs
Leaning towards a business model of IOC and HC/NOC partnership through JVs brings with it some perplexities, nonetheless.
It has been estimated that some 60% of JOAs, regardless of whether SC or PSC, fail to start or fade away within five years of their existence. “There are many reasons for these failures, but a majority of agreements fail when one party tries to command control,” Eng. Ahmed Saleh, Artificial Lift Senior Field Engineer at Schlumberger – REDA Production Systems, said in an interview with Egypt Oil&Gas.
“However, unwanted consequences can be avoided by a well-drafted agreement, representing precisely the parties’ intentions, rights and duties,” he noted. The role of JOA is to have precisely this affect. “The job of the JOA is to ease the tension and use the voting rights to make decisions and keep the peace,” said Eng. Ahmed Saleh.
On a more positive tone, there are many examples of NOC-IOC partnerships that have delivered positive results and served to add value to all stakeholders in many areas of the world and many segments of the industry e.g. E&P, transport, conversion, and retail.
As the IOCs are always in search for a viable and sustainable investment framework, JVs under the PSC regime are seen as a viable tool to achieve this as it is more likely to result in better returns, as opposed to SCs. Even though, there still remain crucial aspects to evaluate in considerations over the application of SCs or PSCs as a defining framework for JOAs. Countries in the MENA region are in need of swiftly amending these regulations regarding upstream JVs, especially the issues of exploration and production sharing costs, cost recovery process, and energy market competition.