Upstream Oil and Gas Exploration Government Regimes and Concessions
In the Upstream Oil and Gas Exploration lesson we will discuss the various oil and gas concessions and contract elements including the government take, different agreement variations, and fiscal regimes.
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The Government Take
A strong, competitive world market exists in oil and gas concessions and contract rights, with federal, provincial, and state host governments offering acreage and hundreds of E&P companies looking for opportunities.
International host governments also try to achieve maximum benefit beyond direct payments and royalties from any oil and gas activities. These additional benefits might include training and technology transfer, new jobs for both technical professionals and plant workers, and the development of local manufacturing and service capabilities to support projects.
However, the key benefit for most host governments is the stream of revenues that is associated with local production of oil and gas, called government take.
Government take is really the “price” that E&P operators are willing to pay for exclusive access to concessions or contract rights for exploration and development.
This price depends on market forces. Often the supply of concessions by host governments is limited and the demand for concessions by operators varies depending on budgets and the crude oil price outlook.
Oil and Gas Agreement Variations
Host governments typically use three different types of oil and gas arrangements in working with operators.
Concessions. Concessions usually have royalties and corporate income tax as their main components. However, other payments to the government may be applicable such as bonuses, rentals, special petroleum or windfall profit taxes, property taxes and export duties.
Under these concessions, the operators are granted exclusive rights to exploration and production of the concession area and own all oil and gas production, subject only to the royalty. The royalty has to be provided in cash or kind to the government.
Production Sharing Contracts. Under production sharing agreements the NOC, or the host government directly, enters into a contract with the operator. Here, the operators finance and carry out all petroleum operations and receive an amount of oil or gas for the recovery of their costs and a share of the profits. Sometimes production sharing contracts also require other payments to the host government such as royalties, corporate income tax, windfall profit taxes, etc.
Risk Service Contracts. Under risk service contracts, the E&P operators finance and carry out petroleum projects and receive a fee for this service which could be in cash or in kind. The fees typically permit the recovery of all or part of the operator’s costs and some type of profit component.
A subset of risk service contracts is called a Technical Services Agreement, or TSA. These are contracts where the oil companies are paid to perform consulting services. E&P operators do not manage the projects and do not make any investments.
Note that the government take can be exactly the same under any of the three arrangements depending on how they are structured.
Fiscal Systems and Regimes Vary
Another term often used in host country arrangements is the fiscal system or regime. This term applies to all forms of payment to host governments in cash or in kind, such as bonuses, royalties, corporate income taxes, in-kind profit oil shares, windfall profit taxes, property taxes, and export duties.
It also includes any fees paid by the government to service contractors under each type of oil and gas arrangement.
Governments have considerable influence over when and how fast to extract petroleum resources. The fiscal system determines how risks and profits are shared between the government and the investor.
Host country resources can be extracted and converted into financial assets only once, and are depleted over time. An important objective is to maximize the revenue to the government that can be effectively utilized in the long run. Achieving this objective depends on many factors, including:
- the government’s ability to attract qualified investors
- the timing of production
- oil and gas price movements
- the government’s capacity to spend revenue productively.
Periods of high oil prices often lead to increased resource nationalism, restricted access, “restructuring” of contract terms and tightening of fiscal terms by host governments. Rapid price declines can sometimes reverse these restrictive policies.
Related Resources:
What is the difference between Upstream and Downstream?
Drilling Wells for Oil and Gas and Offshore Drilling