Hydrocarbons and ownership of natural resources in general have played a principal role in classifying civilizations throughout the history of man and especially over the past six decades in the whole world. Such role has changed the political and economic map of the world and has also set the aims and poles of power. The history of mankind has also evolved and developed laws and rules to preserve the treasures and natural resources of every nation within its geographical and political borders.
Within this context, the below brief study aims at presenting the developments made to legalize the use of natural resources with focus on hydrocarbons. The exploration and exploitation of oil and gas in general is one of the forms of using the natural resources of a state. In order to regulate such usage, most of the countries have developed different methods to achieve the best and optimum utilization. The 1907 Hague Convention for usage of oil and gas resources has set the initiative for the general rules for usage and ownership of hydrocarbons. The daily rapid market standards, technologies and changes in the industry made the initial idea develop and take more than one shape. States usually chose the methods of contracting with investors in natural resources “Host Government Agreements” based on a few factors mainly; the nature of Jurisdiction (Common Law, Civil Law or Islamic Shari’a), which would subsequently define the nature of ownership of natural resources. Such variances in application of methods of contracting may vary, yet would all capitalize on a unique aim, which strives to reach the best transfer of knowledge and optimum utilization of natural resources. Furthermore, the variation of methods of contracting usually considers the political and financial structure of states, with which the type of agreements for foreign investments in the oil and gas business started evolving to become a strong industry.
There are main parameters that need to be addressed to reserve the balance of the agreements and maintain the aim of contracting through the thorough understanding of the general structure for ownership of minerals:
A- Under the Common Law regimes
In many common law jurisdictions, the government owns all/a substantial portion of the subsurface mineral rights. Statutory regimes govern ownership rules, but where the statute is silent, courts will interpret and apply property law principles developed in the common law.
However, the oil and gas is “fugacious” (migratory) in nature, the quantities are unknown. There are three theories of ownership of oil and gas in place:
1- “Texas” theory: ownership of oil and gas in situ, subject to loss by migration due to rule of capture
2- “Oklahoma” theory: no ownership in situ, but title acquired upon production
3- “Nonownership” theory: owner of mineral right has only a license to capture, with ownership acquired upon capture.
The distinction between theories is significant only in relation to remedies for drainage. Common law has generated a complicated mix of case law, statutes and policies and principles that are applied in the absence of case law & statutes. Legislatures are increasingly seeking to codify these principles.
B- Under the Civil Law regimes
The applicable codes govern ownership of the mineral rights. Initial principles of Roman law provided that private property included ownership to center of the earth and to the sky. These concepts codified but most states have reserved subsurface rights to the state. No question exists regarding ownership of the oil & gas when the entire subsurface is owned by the state. The rights to develop granted by the state are typically by license.
Civil law courts are tending to have regard to precedent to address the fact that our complex world cannot easily be defined in a fixed civil code. So the differences between two approaches to the law are blurring.
C- Under Islamic Shari’a regimes
The Qur’an allows for private ownership of property, subject to: Rights of others and Public interest. Principles of ownership of minerals are not consistent among the different schools: Hanafi (minerals ownership follows land ownership), Shafie (hidden mineral ownership follows land, but unhidden minerals are not owned) and Maliki (all natural resources are state owned).
Where a mine is part of the state’s domain, the sovereign has Iqta, the right of the discretion to grant an exclusive concession, the royalty payable; the land may not be kept idle. Originally the agricultural grants and the principle is now taken to apply to mineral grants such as valid agricultural analogies exist for concessions, and production sharing contracts (share cropping). The taxation in Islamic Law mainly capitalizes on Zakat taxation at fixed rates. Yet the ruler may impose additional taxes, so long as it is based on the general rules of “equity and justice”.
However, oil and gas agreements have generally developed in common law jurisdictions. Civil law regimes lacked the concepts to address issues related to porous rock and fugacious substances. Many civil law regimes have therefore imported and codified concepts of oil and gas ownership from common law where these activities first occurred. But interesting issues still arise at the interfaces between common law and civil law jurisdictions (ie. UK/Norway, US/Mexico).
The five types of HGCs (Host Government Contracts) recognized internationally are:
1- Concession Agreements (60 countries have adopted)
2- Joint Venture Agreements (20 countries have adopted)
3- Production Sharing Agreements (41 countries have adopted)
4- Service Contract Agreements (4 countries have adopted)
5- The collateral form is a Hybrid type (16 countries have adopted)
Concession Agreements
Also known as permit, lease or license; The “equity” or “royalty & tax” structure is amongst the oldest & most widely used in UK, US, Norway, Thailand, Australia. The concessions holder of concession receives all of the oil & gas production, subject to obligation to pay royalties & taxes. The State generally does not receive oil production in excess of that which it purchases for domestic supply requirement. Export right to production is often given which provides for the maximum control to IOC (International Oil Companies).
Joint Venture Agreements (JV)
It is not really a form of petroleum grant, a JV involves participation by another company, typically a national oil company (NOC) coownership structure akin to “partnership” applies arises through nationalization, participation requirements of a concession or other grant JV may be incorporated or unincorporated. NOC pays its share of expenditures, although it may be carried through the exploration and development phase. NOC and IOC each receive a share of production in proportion to their equity contributions. IOC pays royalty income tax. The Joint venture creates the economic incentives of concession by giving IOC an equity stake but provides control to the NOC through coownership Structure.
Production Sharing Agreement (PSC)
The State delegates exploration and development rights to Competent Authority (possibly a national oil company). The CA enters into a PSC with IOC where IOC, acting as Contractor, finances and conducts exploration and development. If such activities are successful, IOC will recover its costs and earn a profit by receiving a share of production Costs which are recovered from “Cost Recovery Oil” which is generally limited to a fixed percentage of production. The production not used for cost recovery is called Profit Oil. Profit Oil is shared between the State and IOC on either a fixed ration or variable share based on production volumes. However, a “pure” PSC involves no income tax or royalties; but in many cases, income tax still applies; royalty sometimes apply significant control to IOC, but NOC has contractual controls Indonesia, Malaysia, Libya, Egypt, China & others use PSCs.
Service Contract Agreements
IOC pays all exploration and development costs and recovers these expenditures through a discounted crude purchase price, cash payments, or productions take. State retains entire production upside, although it may grant a negotiated sliding share of oil. Produced service fee generally is not affected by the price of the produced oil & gas. Performance incentives to IOCs exist by encouraging higher production, sometimes with additional fees at higher production thresholds. Performance incentive also exists to reduce operating costs, and sometimes capital costs, most suitable for riskfree operations, less relevant to exploration. IOCs are generally subject to income tax. IOCs generally dislike being a service Contractor to the State. Thus, this form of contract is infrequently used. Limited to Mexico, Iran, Oman; formerly used in Venezuela; proposed for Kuwait.
Hybrid
“Hybrid” Host Government Contracts; some states “mix and match” different features of the four types of Host Government Contracts to create new “blended” flavors, these are referred to as “hybrid” HGCs. The most common is to add a “state participation” feature to a host government contract host. Governments are increasingly introducing hybrids of these structures. These involve combinations of royalty, tax, JV participation, cost oil/profit oil shares and fees. The efforts to develop a world model host government agreement have foundered because structures are becoming more diverse. Host governments usually seek structures that suit their particular needs. IOCs are not necessarily prepared to accept similar fiscal terms in different countries.
In order to determine the best or preferred type of host government contracts, we need to answer two questions: Who has the exclusive right to explore & produce? Who owns the oil & gas that results from successful operations? The answer to these questions permits to categorize the types of contracts. The two described attributes of the four key types of HGCs are the only features that define these contracts. All other features are interchangeable such as: Degree of state control, Local goods & services, Employment & training and Stability.
Hence, the perception of increased state control and investor interest is not necessarily a feature of the contract type in all respects other than the right to receive oil & gas production and the fee structure, all host government contracts contain many common terms such as: term, relinquishment, domestic sourcing & supply obligations, operating/management committee, fiscal stability, local employment & training, title to assets, development plan and performance guarantees.
In general what the investor in the field of exploration of minerals would always need to satisfy before putting his feet into any investment is; the attractive Geology – cooperative fiscal terms – a strong and balanced petroleum regime.
By Marwan Al Ashaal, Attorney at Law
