Product Sharing Agreements and Risk Service Agreements as the main oil & gas deals

Production Sharing Agreement (PSA) is one of the tools for establishing legal relationship between host governments and International Oil Companies (IOC) for exploration, development and production of natural resources.

Roots of the PSAs goes back to 1960s and was first introduced in Indonesia. Before existence of the PSAs, the concession systems were in place which allowed IOCs to explore and extract hydrocarbons, and in return, required them to pay royalties and taxes to the host governments.

The concession agreements used to be concluded for extremely long terms (50-99 years as a rule) and for huge areas, vested property rights in the unproduced hydrocarbons to the IOCs and provided them with full discretion and control on the fields. All these features were clearly against the interests of host countries and as such concession agreements were scrutinized at different levels. Evolution of principle of permanent sovereignty over natural resources and specifically, adoption of United Nations General Assembly Resolution 1803 (XVII) dated 14 December 1962 – also regarded as the “landmark Resolution” – allowed the countries to abandon concession arrangement in favor of the PSAs.

PSAs, opening a door for IOCs to bring capital and expertise to the country, offers a number of fiscal and non-fiscal benefits for the host countries, not the least the followings:

  • The state’s share of the petroleum upon production
  • Certainty on division of production in a pre-determined manner
  • Income from petroleum taxation, including profit tax and royalties
  • Numerous bonus mechanisms paid to the state, such as signature bonus, production bonus, annual acreage fee
  • Low risk for the host country and the ability to learn from the IOC’s expertise on technology and strategic decisions
  • Holding title for the unproduced oil and gas
  • Development of infrastructure
  • Domestic oil and gas supply, etc.

Considering the lengthy time period required for exploration, development and subsequent production of the fields, oil and gas investments are categorized as long-term investments, and that is why PSAs are in general concluded for 25-30 years. The Agreement on Joint Development and Production Sharing for the Azeri and Chirag fields and the Deep Water portion of the Gunashli field in the Azerbaijan sector of the Caspian Sea signed in 1994 for 30 years and subsequently, extended until 2049 serves as a vivid example of the PSA from the local perspective.

While PSA is almost the most common form of upstream oil and gas deals, it is not the only available instrument in this area. The Risk Service Agreements (RSA) are gaining popularity and practical use, also in our country. The main difference between these contractual concepts is related to IOCs’ remuneration. As the PSA’s title suggests, the produced hydrocarbons are owned by the host country, but it is shared with the IOCs. On the other hand, under RSA framework, IOCs conduct petroleum operations in consideration of certain compensation payable to them. Although, in general, this compensation is meant to be in cash, in certain cases it can be agreed in kind in quantities of oil as well and hence, making these contractual regimes less distinct. In practice, the choice between PSA and RSA also depends on the maturity of the field. Nonetheless, the title of the agreement does not suffice for its interpretation, as its main contents can provide different regulation.

The local legislation for oil and gas operations is also of great importance. While some countries have dedicated petroleum laws, others set the regulation via different legislative acts. In Azerbaijan, the core regulations are combined mainly in the Law on Subsurface and the Energy Law. The former regulates the relations on exploration, efficient use and protection of the subsurface, ensures protection of interests of the state, subsurface users and citizens in such use. The latter in its turn, combines the most general legal bases of state regulation in oil & gas, as well as electricity spheres. Nevertheless, to ensure applicability and effectiveness of oil and gas deals, they are given a full force of law in Azerbaijan. Hence, the local legislation regulates those matters that are related to such contract, but not addressed therein.

It is also worth to mention that PSAs are not only applied in the oil and gas sector, but also used in a wider mining industry, including in exploration, development and production of gold mining areas. To make an example of this from Azerbaijan’s practice, we can refer to the Agreement on Exploration, Development and Production Sharing for the Prospective Gold Mining Areas: Kedabak, Gosha, Ordubad Group, Soutely, Kyzlbulag and Vejnaly Deposits.

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19 May, 2023