Egyptian Concession agreement Model From a Legal Perspective

The following is a comprehensive, yet not exhaustive, analysis concerning the current concession agreement model utilized within the Egyptian oil and natural gas sectors.  The model is primarily utilized for petroleum exploration and exploitation.  Given that I have gained extensive legal insight working with these types of agreements, I respectively offer this analysis in an effort to examine the current model and constructively examine problems within the current agreements.  

There are several problematic legal issues that must be examined. The concession agreements in Egypt are issued by governmental entities within the petroleum sector (EGPC, EGAS and Ganope). These entities utilize different provisions and varying elements that are not directly related to the geographical area or nature of their activities. Why is this?  From a legal perspective the agreement model should be identical for the three entities in an effort to achieve standardization and efficiency for future development and progress. Standardization across the three entities can be achieved in two ways: first, the formulation of a high committee amongst the three entities to review the varying models and unify them into one model. Second, establish a Central Contracts Department in the Ministry of Petroleum to specialize in the standardization of all agreements and contracts utilized within the petroleum sector, provided that such a department will include and consider all areas of specialization related to petroleum activities. A Central Contracts Department may also be responsible for the contracts to be concluded by Egyptian Mineral Resources Authority (EMRA).

An additional issue within the current agreements model concerns the need to obtain government permission throughout a variety of project stages. After awarding an area, and signing the relevant concession agreement the contractor is often prohibited from actively working in the concession area due to required government authorization.  This causes project delays. In order to avoid penalties outlined within the concession agreement the contractor might claim for Force Majeure. To avoid such problems the Ministry of Petroleum must obtain all necessary governmental permission for any area, and announce these elements during the Bid Round process.

Another issue concerns the matter of cost recovery. According to the concession agreement, contractors shall first recover all sunk costs and expenditures related to achieving production.  However, and without a legal base, contractors face problems related to cost recovery because of categorization issues.  Meaning debts have been incurred related to achieving production but excluded by the Financial Control Department. A Ministerial Decree attached as an annex to the concession agreement would solve such problems. Such a decree would avert categorization problems related to cost recovery as the maximum value to be recovered for each item would be determined and stipulated in the annex to the Concession agreement. Provided that such an annex would be reviewed and amended each year in accordance with market rates and inflation.

Several other issues emerge from a legal perspective concerning the model concession agreements.  The first point concerns the fact that the name of the Egyptian concession agreement is not compatible with the legal nature of the agreement itself.  There are three main types of Petroleum Exploration and Production Agreements in the world.  The first type is a Production Sharing Agreement in which the state retains ownership of all natural resources, in the case of Egypt oil and natural gas. The contractor shall recover all expenses and expenditures upon achieving commercial production. The production shall be divided between the state and contractor in accordance with the percentages stipulated in the agreement. Mining rights are retained by the state or granted to its national company while the contractor shall have no mining rights. The most important issue concerns taxes and royalties.  Tangentially, it should be noted that from a legal perspective royalties are not a form of tax, rather a sum to be paid to the state for using and extracting mineral resources. The national company shall bear and pay from its share of production the royalty and contractor’s income tax. The second form of agreement is the concession agreement.  In such an agreement the contractor shall have the right of mining and own all petroleum whether underground or resulting from production. This form of agreement does not employ cost recovery mechanisms and the contractor is obligated to pay royalties and applicable income tax and other taxes applied by the state.  The state share in such a system is comprised of royalties and taxes paid by the contractor.  The third type of agreement is the Service Contract also known as Risk Service Contract in which the contractor shall provide the service of exploration and production for a fixed fee to be paid in cash without any right to the petroleum. In some countries the contractor fees are paid in volume of produced petroleum corresponding to the contractor fees.

The above definition highlights the disparity amongst the term usage and legal connotation. It is clear that there is a difference between the name of the Egyptian Model and its legal nature.  This may result in confusion and disparate legal application where legal meaning and application should be identical to avoid confusion. An additional example, subject to Article XXVII of the Egyptian Model the English and Arabic versions of the model shall have equal force in the case of arbitration.  However, the Arabic version refers to “OBLIGATIONS” whereas the English version refers to “CONCESSION”.  Efforts should be made to ensure consistent and identical usage of terms in both English and Arabic to ensure legal clarity.

In addition to inconsistent term usage discussed above, an additional problem emerges concerning the current agreement model utilized in the Egyptian petroleum sector.  The problem concerns royalty and income tax. In the Egyptian Model the national company (EGPC, EGAS or Ganope) pays, from its share of production, state royalties of 10 percent of total production and the contractor’s income tax of 40.55 percent to the state. This model was employed as a means to attract international petroleum companies to work and invest in Egypt.  The system is still utilized today.  The system results in heavy losses within the petroleum sector as the state bears and pays a great subsidization to the sector every year.

In many countries such as Pakistan, Guinea, Brunei, China, and Nigeria contractors are obligated to pay royalties to the state ranging from 5 percent up to 18.5 percent. In general, within a Production Sharing system the contractor usually pays income tax in addition to other taxes applied by the state.  Such systems are applied in Indonesia, India, Guinea, Pakistan, Oman, Angola, Brunei and Jordan.  In such cases taxes range from 25 to 55 percent.

Under the current royalty and income tax system utilized in Egypt, the petroleum sector paid the sum of 6.2 billion USD for 2011 production.  By applying alternative models the sector will save money and reduce subsidization.  If royalties are deducted from the total production quantity, before any distribution, the petroleum sector will save about 3 billion USD. If the contractor’s income tax is reduced to 20 percent, equal to all other types of companies in Egypt, the petroleum sector will save about 4.2 billion USD.

An additional area that is problematic under the current model concerns various types of wells. Under the current model (Article IV specifically) the difference between an exploratory well and an appraisal well is not clearly defined.  Without clearly defining the difference and utility of each well, petroleum companies have the opportunity to count the appraisal well within the obligated exploratory wells to be drilled according to the work program. This will impact the number of exploratory wells and consequently affect contractor obligations under the agreement. 

The issue of unitization is also a problem under the current model agreement. The unitization provision (Article IV) of the Egyptian Model contends with reservoirs extending to adjacent areas held by the same contractor. Neither the agreement model nor Law 66 of 1953 (as amended) can deal with alternative cases of unitization.  Meaning, neither the law nor the agreement model is equipped to contend with the instance of a reservoir extending to an adjacent area which is not granted to any contractor (free area), or an adjacent area located beyond the state boundaries in another state.  The problem concerns how the petroleum sector will deal with such cases when provisions are absent.

The issue of well abandonment is also a concern as related to the current agreement model. Neither the current agreement model nor Law 66 of 1953 (as amended) includes any provision regulating the abandonment of wells.  This is a problem as the lack of abandonment guidelines can contribute to circumstances where wells may not have been plugged appropriately.  Meaning, well needs to be plugged in a manner that isolates the fresh water zones thereby permitting salt-water intrusion.  Inappropriately abandoned wells could lead to disaster and could potentially blow up without warning as leaking gas combined with the oil could create an extreme fire hazard.  Firm regulations need to be included in the current agreement model in order to prevent environmental hazards.

The last point that warrants mention concerns the issue of expert assessment. Disputable issues as related to the agreement model are often referred to an external expert in an effort to achieve resolution. However, the model does not include provisions that clearly define the role and legal parameters of the expert. The agreement model needs to clearly contend with the appointment of experts, how to interpret and apply decisions of expert and how to calculate relevant expert fees. In the case that disagreements arise concerning the appropriate sell price for crude oil (Article VII) either party may enlist an arbitrator to determine the appropriate market sell price. Conflict may arise due to the absence of regulation regarding the expert.  Meaning, considering the lack of expert regulation parties might enlist an expert that demonstrates a lack of impartiality stemming from experience or connections within the industry.  Legally speaking only evidence submitted by the parties should be under consideration during arbitration. Yet, when an expert is employed, inevitably evidence submitted by the parties will be considered, however other peripheral evidence and experience may come into play, and the expert may retain evidence from other outside experts.  This is a slippery slope.  To ensure impartiality the current agreement model needs to contain guideline regulating the usage of experts as a means of conflict resolution.

The abovementioned is a brief overview of legal points that need to be addressed in the model agreements utilized in Egypt petroleum sector.  In conclusion, I believe that the petroleum sector needs to change the production-sharing model to the service contract model particularly in the realm of development leases that will be relinquished upon the expiration of the current agreements.  This will ensure full development and production of such areas. The concession agreement model in regard to deep-water exploration should be changed to reflect an income tax over the current rate in addition to the continued payment of applicable royalties.

By Essam Taha


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