Nigeria adopts various types of petroleum contracts in its oil and gas industry. The popular ones are the joint venture agreement, risk service contracts, pure service contracts and production sharing contracts (PSC). Production sharing contract has, however, continued to gain popularity because of the enormous benefits it offers to the contracting parties.
Production sharing contracts are a form of petroleum contract which involves a host country and an oil company whereby the former allows the latter to conduct petroleum exploration, exploitation and production within a certain area based on the agreement between the parties. Usually, the host country, through its National oil company, enters into an agreement with an international oil company in respect of this because the oil company has the necessary technological techniques, equipment and expertise to search for, win and carry out petroleum operations.
In this type of contract, the ownership of the petroleum in situ still lies with the host country. However, at the production stage, the petroleum is divided between the parties to the contract in the agreed ratio.
Production Sharing Contracts in the Nigerian oil and gas industry
The first petroleum sharing contract in Nigeria was signed on the 12th of June 1973. This contract was between the Nigerian National Oil Corporation (NNOC) and Ashland Oil (Nigeria) Company. This contract was argued to have been lopsided in favour of the oil company and at the detriment of Nigeria. It has been argued that Nigeria did not gain as it ought to have because the contract was poorly negotiated. Hence, the importance of adequate knowledge of the contract in order to properly negotiate can not be overemphasized.
In Nigeria, the basic law regulating PSC is the Deep Offshore and Inland Basin Production Sharing Contracts Act which was amended in 2019. The Act defines production sharing contracts to mean any agreement made between the Corporation or the holder and any other petroleum exploration and production company or companies for the purpose of exploration and production of oil in the Deep Offshore and Inland Basins.
An example of existing PSC in Nigeria is the arrangement between Nigerian National Petroleum Corporation and Addax Petroleum Exploration Nigeria Ltd (APENL), Nigerian Agip Oil Company Limited (NAOC), Agip Energy and Natural Resources (AENR), Shell Nigeria Exploration & Production Company Ltd (SNEPCo), etc.
Production sharing contracts in Nigeria mostly span for a period of 30 years and it has various models. However, notwithstanding these models, some basic elements are common in most PSCs. For example, the host country continues to own the petroleum in situ, the host country’s national petroleum corporation will possess the management control; the oil company provides the operating cost for the exploration, the oil company bears the risk in the petroleum operations and the parties agree on a particular sharing formula based on production sharing rather than profit sharing. These are often known as production splits.
This refers to the process of sharing the petroleum produced during the course of the petroleum operations based on the agreement between the parties. Basically, oil is usually divided into four types of categories. They are:
Royalty oil: royalty oil is the volume of oil that represents the amount of royalty to be allocated to the host country as the owner of the petroleum in situ.
Tax oil: this refers to the amount of oil that equals the total amount required to cover the Petroleum profit tax required to be paid.
Cost oil: the quantum of this cost oil is normally allocated to the oil company that takes the risks and incurred the cost for the petroleum operations.
Profit oil: profit oil is usually obtained after the cost of oil, tax oil and royalty oil have all been deducted. It refers to the volume of crude oil that is regarded as the profit that has been derived from petroleum operations. It is allocated to each party in accordance with the terms of the Production Sharing Contract.
Advantages of Production Sharing Contracts
One of the advantages of a production sharing contract is that it allows the parties to agree on certain terms such as the training of the citizens in the host country, transfer of technology, scholarships and job opportunities for citizens, etc. This. with no doubt, has led to the growth and development of the host country.
Also, production sharing contracts allow the oil company to offer its technological skills to enhance oil exploration and production in the host country.
Disadvantages of Production Sharing Contracts
A basic disadvantage of this form of petroleum contract is that it requires high skills and expertise during the negotiating phase by contracting parties. Additionally, this form of contract can easily encourage wastage by oil companies who already know that no matter what, they are going to recoup their expenses and still derive some benefits from the profit oil based on the sharing formula.
Adequate knowledge is required by the parties, especially the host country, about this form of contract. This will help to ensure that the contract is not lopsided in favour of a party and at the detriment of another.
Furthermore, measures should be put in place by the host country to prevent wastage of resources by the oil companies.
The host country should leverage this contract to help it foster economic, social and technological development by making provisions for these terms in the production sharing contract.
Production sharing contract is a viable means of petroleum exploration and operations, which, if properly carried out, will enormously benefit the host country and the oil company. Hence, both parties should ensure that they possess adequate knowledge of the contract before beginning the negotiation process. Additionally, the above recommendations should also be followed to ensure that the parties are able to get the best out of the contract.