Any resource regulatory system is based either on licences directly obtained from a government or on contracts for work to be en¬tered into with a designated state enterprise. The licence or concession system is ap¬plied and practised in industrialised coun¬tries, whereas the system of work contracts is exclusively used in developing countries. The adoption by developing countries of work contracts in lieu of licences has made it possible for foreign direct investors to be¬come involved and engaged in petroleum and mining operations in those countries.

By : Lex arbitri

Any resource regulatory system is based either on licences directly obtained from a government or on contracts for work to be en¬tered into with a designated state enterprise.

The licence or concession system is ap¬plied and practised in industrialised coun¬tries, whereas the system of work contracts is exclusively used in developing countries.
The adoption by developing countries of work contracts in lieu of licences has made it possible for foreign direct investors to be¬come involved and engaged in petroleum and mining operations in those countries.

Licence or Concession Contracts

The most common form of agreement for ongoing exploration and development rights is the concession. This was the principal in¬strument for leasing acreage through the mid-1950s.

In the concession-type of agreement the host government assigns the right to the re¬source company to explore and develop sur¬face defined areas for petroleum or mineral resources in return for a share of the proceeds (royalty) and taxes. The resource companies compete for concession rights in a number of ways, including bonus (front end payment), royalties and tax arrangements. The reliance placed on a given approach to granting the award varies among countries.

Originally a concession area might include a whole country or province. Since the lat¬ter part of the 1950s host countries reduced these rights from the original very large areas to blocks of much smaller size. Agreements of this type were in effect in some 120 coun¬tries. Most countries in Europe and America still utilise the concession methods, including the US, Canada, Norway, the Netherlands, West Germany, Trinidad and the UK. The in¬dividual concession areas are limited in size, averaging perhaps, in the case of petroleum, 2,000ha to thousands of square kilometres each. Companies may be permitted to as many areas as they wish to obligate them¬selves to undertake.

In the concession-type agreement, the for¬eign direct investor has a simple equity inter¬est in the project. Such agreement stipulates that the Domestic or Foreign Direct Investor will pay all of the exploration, development and operating expenses. The investor also pays royalties on the value of the production, and income taxes on net earnings. The roy¬alties taken from gross revenue (or produc¬tion) are commonly within the range of zero to 20%, although Canada’s province of Alberta has extracted royalties as high as 43%. The royalty arrangement forms a floor under the government’s take. Royalties can usually be taken in cash or kind (oil or minerals) at the host government’s option.

Under the terms of a petroleum licence the licensee becomes the owner of the petroleum at the moment the petroleum flows into the well – i.e. at the moment the petroleum is “Caught” by the licensee, in accordance with the ancient “rule of capture”.

A licence is not only a simple transfer of title to petroleum. The elaborate conditions and the list of rights and obligations lend a strong contractual aspect of the transfer and thus to the licence. It should be added that under some legislations a contract has to be approved by the body of people’s representa¬tives and thereby achieves the status of a formal law.

Production Sharing Contracts/Agreements (PSC/PSA)

In a PSC agreement, the investor becomes a contractor. PSC agreements normally pro¬vide that the costs and risks through develop¬ment for production are to be borne by the contractor and recovered from a negotiated fraction of production. The remaining pro¬duction is shared, or divided according to an agreed formula, and income taxes are levied on the contracting company’s profits.

As in a concession contract, the company is granted the right to explore for oil, gas or minerals and develop any commercial dis¬coveries. Unlike the basic type of conces¬sion agreement, however, the production is split between the host government, usually through its national resource company (NOC or NMC), and the contractor.

Using petroleum as an example, this shared fraction of production from the project is designated as “profit oil”. The profit oil is the residual of the production after first reimburs¬ing the contractor for his operating costs, car¬ried portion of the host government’s obliga¬tions, operators capital investment, allowed exploration expenditures, interest and other allowances not previously covered from what is termed “cost oil”.

Some of the items chargeable to cost oil have agreed annual maximums, with the sur¬plus carried forward to the next year. In the author’s experience, the definition and quan¬tum of cost recovery has been a major dis¬pute area.

Under the terms of a work contract, the contractor is compensated for his efforts in cash or kind (oil or minerals). If being com¬pensated in kind, part of the production is de¬livered to the contractor at an agreed point of delivery, usually the point of export. At such, the contractor becomes the owner of the re¬source, similarly as any other buyer of the resource would become an owner of that re¬source. Up to that point the ownership of the resource rests either with the State or, after being caught in the borehole or mined, with the state enterprise concerned in its capacity as the only authorised petroleum or mineral agency.

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