Service contracts are long-term frameworks used by the host governments or state-owned oil companies to organize their working relationship with international oil companies (IOCs) and benefit from their expertise, capital and know-how. This is applied without the government’s need to hand over the field, allowing it to preserve its ownership rights.
Although still uncommon in Egypt, applying service contracts for brownfield operations have been subject of debate to enhance production prospects and the profitability of Egypt’s mature fields. One of the main motivations behind the move towards applying service contracts is the sovereignty concerns that are solved by using this type of agreement.
Why are Service Contracts an Option?
There are many contract types used for production recovery in mature fields; one of them is the production-sharing contract (PSC), under which IOCs have the decision-making power over the field, in addition to handling the redevelopment operations needed.
Working under PSCs has been proved to be inefficient in certain cases, as host governments have a lower potential for having proper supervisory, regulatory and operating roles over the IOCs, bringing, therefore, sovereignty concerns, in addition to the tax code or some institutional deficiencies that could prevent the host governments from getting rents from IOCs.
The absence of political willpower and public support have also increased the difficulty of applying PSCs. “The cost of mature fields in terms of dollars per barrel is significantly higher than new fields, so it requires a tailored model to adopt and consider this condition,” Mahmoud Wazery, Bed-1 Production Manager at WEPCO said. Due to this cost, working under PSCs, although beneficial in certain aspects, is not the best approach to address the difficulties of redeveloping the mature fields.
On the other hand, working under service contracts represents a key incentive for companies to invest in the late-stage sites, where IOCs agree to a pre-determined return in lieu for sharing the profits, and the host government remains the true owner of the field and its production.
“This type of contract is a simplified tool for purchasing and constructing activities. IOCs do not need to comply with the normal approval cycle to purchase materials and equipment which shall be used for production,” Wazery added. Therefore, IOCs can rapidly order and purchase the required materials to avoid wasting time and to achieve high production levels.
“Adding to that, IOCs are prone to apply their worldwide approved techniques, so they will be capable of using such a valid contract with the service company rather than waiting for signing new contracts with different parties,” Wazery added.
Considering this, the main driving factor attracting both governments and IOCs to adopt this model is the ability of not handing field ownership and the produced crude oil to foreign countries. At the same time, it regulates their responsibilities to be only focused on exploration and production (E&P) operations while allowing IOCs to benefit from their expertise and technologies in operating these field types, which subsequently enables IOCs to bring new technologies into the sector, as they have the freedom to experiment innovative technologies.
Service Contracts Drawbacks
Although working under service contracts represents an efficient method to deal with the redevelopment dilemma, its framework is adjusted for potential losses in profits. Service contracts have terms and conditions that establish that if a company succeeds in increasing production from the field, it takes a percentage of the production profit; but if it does not succeed, it does not receive any share, not even from what the company has spent on the process.
Therefore, adopting the profit maximization policy is highly recommended for reducing losses when production increase fails or do not achieve the expected results. In order to apply profit maximization, operators are required to review and update decisions over time depending on the ideal needed quantity and new drilling plans based on oil market price forecasts, estimated reserves, required capital and operation cost, as well as other determinant factors.
However, IOCs’ remuneration is predetermined to the production profile for the whole lifetime of the service contract, disregarding the dynamic profit maximization policy, which will still cause profit losses and make the contract framework economically inefficient if one of the variables considerably decline.
Another issue related to applying service contracts is “the lack of vision or the long-term plan [needed while applying this contract type] as the [main] priority [for IOCs] was signing oil sharing contracts to get advanced cash money to support economic deficiency,” Wazery said.
“So, we need to standardize different models of service contract to adopt different and variable cases of oilfields to encourage the IOCs to invest [in these late-stage site],” he added. An alternative to adjust service contracts in a way that overcomes or mitigates drawbacks is by applying bundled services contracts. In this case, the contract model is not entirely opposed to PSCs, but complementary.
Mediterra is one of the companies that have proven the positive prospects of service contracts in mature fields. The company entered into a service contract in 2017 for the Sudr Matarma and Asl mature fields in the Gulf of Suez.
Since it took over the fields, the company drilled 11 appraisal and development wells, one exploration well, and completed 38 workover, recompletion and testing projects. Production has increased rapidly from around 1,750 barrels of oil per day (b/d) in August 2018 to more than 4,500 b/d in the end of November 2018.
Under the contract, Mediterra had to pay a signing bonus and make a work commitment for the first three years. The company succeeded in optimizing production within only nine to ten months after signing the contract. The Egyptian General Petroleum Corporation (EGPC) agreed to pay the company a small fee after the fields reach baseline production. Any amount above the baseline is shared between EGPC and Mediterra according to the agreed upon terms in the contract.
Kuwait Energy Egypt is another company with a successful story to tell. In the past 10 years, the company managed to produce 27 million barrels of oil from its concession in the Gulf of Suez and drill 15 wells, five of which were producible.
It is worth noting that, in many cases, production optimization through service contracts comes with the autonomy given to IOCs to choose best practices and new technologies without having to go through bureaucratic and time-consuming processes for governmental approval. Additionally, it gives the contractors the freedom to manage the brownfield in their own way to control the overheads and introduce any method needed by the company to operate the field. In a larger scale, this practice can help, in the long-term, to enrich the country’s oil and gas sector with new engineering and geological technologies and know-how.
How to Expand Service Contracts?
In order to amplify the benefits of applying service contracts and expanding its usage, Taha believes companies should not start from scratch. “We have to consider the global experiences and find the specialized companies to implement long and short-term plans for brownfield development,” he said. For this, “the information availability and analysis for development must be carried out by qualified teams and in a professional way,” in order to increase transparency and encourage companies to invest.
In addition, the government can cooperate with IOCs to maximize production from these fields; this cooperation can happen through bundled service contracts. “Incentive fees for each produced barrel and integrated facility networks with different companies is crucial to avoid the need to construct new facilities for each field,” consequently reducing costs and increasing revenues, Wazery pointed out.
Considering the collected benefits, looking at services contracts as an alternative to redevelop Egypt’s brownfields also permits the country to gradually improve the sector’s expertise. In order to avoid profit losses, however, Egypt must consider the necessary incentives to encourage companies to invest, especially from the government side.