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Opinions of Tuesday, 10 February 2009

Columnist: Bonna, P.K. Opoku

Ghana & Her Oil Contracting

GHANA AND HER OIL CONTRACTING: PSA OR LICENSING?

INTRODUCTION

The ‘Oil and Gas Industry’ relies on many different forms of contracts, which include Concession, Licensing and Production Sharing Agreement. One of the most popular form these days is the ‘Production Sharing Agreement’ (PSA) which emerged in the 1960s from Indonesia after the Concession system used until then was seen as too generous and more favourable to the International Oil Companies[1]. “PSA” is a contractual arrangement between a Contractor or Foreign Oil Company (FOC) and a designated state enterprise – National Oil Company (NOC), authorising the contractor to conduct petroleum exploration and exploitation within a certain area in accordance with the rules of the agreement”[2] .PSA is a risk contract under which the FOC receives compensation for cost and profit in the form of hydrocarbons. The Foreign Oil Company is normally responsible for the funding of the exploration and exploitation work, although the state party holds the right to explore for and produce the hydrocarbons as Article 18 of ECT[3] and the United Nations Convention on the Law of the Sea (UNCLOS) 1982 gives sovereignty over energy resources to host nations. Under Concession and Licensing, the oil producing country may not be able to exert control over its oil and gas resources as the Foreign Oil Companies may get exclusive rights to search, bore for and get petroleum without any participation of the host country. The host country may only get the right to demand taxes in the form of royalties and income tax together with the licence fee and that may be the end as there would be no other control.

Ghana cannot afford to hand over this asset to Foreign Oil Companies. As it is happening in Nigeria and other developing countries.

WHY SHOULD GHANA SEEK FOR “PSA” IF IT WANTS TO MAINTAIN CONTROL AND MAXIMISE HER ECONOMIC RECORVERY OF THE HYDROCARDON RESOURCES?

The enthusiasm for PSA shown by Oil Producing Countries cannot only be described to the fact that sovereignty is upheld and maintained, for many developing countries, the fat that the state party is not primarily responsible for the funding of the petroleum operation is of great practical importance[4].  A ‘PSA’ offers developing countries lacking the financial resource and technical experience to build up a domestic petroleum industry on their own by given them the possibility to engage foreign oil companies and make use of the latter’s financial and technical capabilities and resources without having to grant them exclusive licences[5].

ADVANTAGES OF PSA

‘Production Sharing Agreement’ is favoured by states because it offers a new model to reject the ‘Mineral Concession’, which was seen as colonialist, and make attractive to nationalistic sentiments in producing countries, as they seem to give the symbolic function of ownership and control to the nation[6]. “PSA” provides the state with oil and gas in kind to supply its domestic needs.

 PSA also offers host governments the opportunity to levy royalties, (petroleum) income taxes, and in periods when price levels are high, excess profit taxes. In period of low oil prices, a government has the option to protect and support high cost domestic production by relieving the tax burden by abolishing royalties and excess profit taxes to reduce taxable income.[7] The concept is a profitable undertaking to states not only inviting taxation but also states participation in domestic production. States participation may be required to make sure that in the event that commercial petroleum enterprises show no interest in applying for an authorisation, petroleum operations are nonetheless undertaking, if the government concerned deems such operations to be in the public interest. In this case, maximum control over the hydrocarbons resources is maintained by the states.

‘PSA’ would help Ghana to stay very close to the contractors and their operations in order to: 

(I) Share in the decision making process in particular concerning development planning and investments in development,

(ii) Gain firsthand experience with the technical, administrative and commercial aspects of petroleum operations

(iii)    Supervise the implementation by the contractors of all non-technical and non-fiscal provisions of the authorisation, among which national interest provisions such as the employment and training of Ghanaians, the use in the operations of locally manufactured products and of the goods and services of local suppliers and

(iv)   Safeguard and protect the national interest[8].   Through PSA, Ghana would be able to make use of the presence of the FOCs for the purpose of bolstering and supporting the nation’s domestic industry generally. The Government can therefore insist on incorporating in her ‘PSA’ clauses aiming to promote the national economic interest. These clauses may consist of obligations imposed on the contractors, concerning training of personnel, transfer of technology, use of locally manufactured goods, use of local services and local sub-contractors and give preference to employing citizens of the state. The required training may take place within Ghana or abroad using the facilities of the contractors’ foreign affiliated companies. The required transfer of the technology would be for the benefit of Ghana and it would be expected to enable it to perform more efficiently the function assigned to GNPC under the rules of the agreement such as the supervisory body or participating in activities of a management committee or in the board of directors as of a joint operating company[9].

States use production-sharing contracts to offer attractive terms to investors and free themselves from the budgetary burden of having to finance as in 100% state-owned operations or in true joint ventures and association contracts. In PSA, Contractors are required to submit their annual work programmes and budgets for scrutiny and approval by the state. This would enable GNPC to get a fore knowledge of the contractors’ annual work programmes and their financial capabilities and make sure that they go according to the programmes submitted, without which, may lead to a breach of ‘good oil field practice’ upon that, Ghana may hold the right to terminate their contracts. If there are ambiguities in the work programmes submitted, Ghana (GNPC) has every right to make amendments to suit the interest of the state[10]. In this case a contractor may not be able to stop production or reduce production without the consent of GNPC unlike that of licensing and other types of oil and gas contracts.   Furthermore, most ‘PSA’ contracts stipulate a minimum exploration and production periods with possible extensions. It is a common practice that at the end of each phase the contractors (FOC) have to relinquish a certain percentage of the total contract area back to the state. This in one-way or the other, forces the Foreign Oil Companies to make optimum use of the hydrocarbons found in any given licence area for the mutual benefits of themselves and the host nation in general.  PSA may also be used as an economic and legal arrangements allowing for an optimum distribution of mining rent between states as owner of the subsoil resources and the FOCs developing a specific field .PSA amounts not to a preferential tax regime but to a different rent-based tax treatment for subsoil use that yields greater revenue to states[11].

 Under PSA, Ghana would be able to transfer to the contractors (FOC) only exclusive rights to conduct exploration and production activity involving a given subsoil area but would not transfer rights to such subsoil areas to them in either ownership or lease and so all production would be the property of Ghana[12]. The Foreign Oil Companies (FOCs) would only perform work for Ghana as contractors at their own expenses and risks and would take compensation from Ghana as a payment not in money but with a portion of the oil and gas if any. As a result, Ghana would not have to bear any commercial risks in the production of the hydrocarbons but would receive a substantial part of any oil and gas that would be produced by the contractors (FOCs). What makes PSA even more attractive to oil producing countries is the accessibility to properties. After the contractors finish work, all the machinery used for the oil and gas production become the property of the host country. Hence, Ghana (GNPC) would be able to acquire these capitals in the form of machinery when the Foreign Oil Companies contracts come to an end without necessarily having to buy them with its “very scarce financial resources”. PSA would enable Ghana to exert maximum control of her hydrocarbon resources.

  THE ARGUMENT ON PSA

However, the above are not always the case. States do not always achieve their desired maximum control over their hydrocarbons resources under PSA due to many factors.

First, states have the objective of maximizing their revenue through their share of the production, royalties, and (petroleum) income taxes and at the same time want to maintain control of the hydrocarbon resources under the agreement without having to take any financial risk. Contractors (FOCs) also have the aim of recovery cost and maximise their share of the profit oil. Therefore, their relative success will depend on their negotiation skills and their bargaining powers.

If Ghana’s (GNPC) negotiation skills and bargaining powers are weak and does not use “more qualified” professionals in the field during the contract stage, the desire of exerting maximum control over its hydrocarbons resources may not be achieved.

Furthermore, the awareness among different branches of the government and members of the public about the substance of PSA, its place among other subsoil use arrangements and the machinery of implementing its project may be low in Ghana to achieve the desired control. Not only that, scarcity of investment in the state and in the extracting industry which depends to a substantial extent of fluctuating oil price and the position of the states national capital market may also be a contributing factor[13]. Besides, change of governments and ministerial reshuffles, at state agencies may also result in the departure of professionals familiar with PSA and its implementations and their replacement by newcomers without such knowledge can be a disadvantage to Ghana. All these were some of the contributing factors that for example forced Russia to lose control over her hydrocarbons resources under the contract signed between the Russian government and Shell in the Sakhalin II [14].

Typical PSA ensures that Oil Companies undertake their investments at their own risk, however, in Sakhalin II, most of the risks were carried out by the Russian state because the oil and the gas fields have already been discovered by Russia before the PSA was signed; removing the exploration risk from the onset.

Moreover, revenue distribution for Sakhalin II between Russian government and Shell’s consortium (SEIC) was at a grossly unfair level. The contract terms defined in the 1994 Production Sharing Agreement (PSA) between ‘SEIC’ and the Russian Federation placed the Russian state at a significant disadvantage. As contract, PSA can be changed only by mutual agreement between the contactor (FOC) and the state party on the agreement. However in the Russian’s case, ‘SEIC’ was able to radically alter the standard PSA mechanism and transferred most of the risks of construction over spend and change in the oil/gas price to the Russian government[15]. The ‘Sakhalin II’ PSA was structured in such a way that the Russian government receives nothing apart from a small royalty until both the costs and a specified profit for Shell have been deducted[16]. The result was that Shell’s profits were guaranteed, while Russian state effectively carries all the risk of the cost overruns. Despite all these problems, Russia did not also have the right to revoke, amend or even renegotiate the contract. Meanwhile, the contract effectively lasts for an indefinite period of time, with an initial period of 25 years, followed by a right for the company to renew it for further periods of five years in perpetuity without consent required by the Russian government[17]. In 1971, Peruvian government also signed a PSA contract with an international Petroleum industry. Under the terms, the production made available by the contractor was divided into two equal shares between the Peruvian National State Oil Company and the Contractor, but the contractor’s only liability was the payment of income tax. Peru also could not exert so much control of her hydrocarbon resources under its contract after about 14 years due to some mistakes on her part.[18].

  PROTECTION FOR THE INTERNATIONA OIL COMPANIES

Moreover, the Energy Charter Treaty[19] also acts as a check on states and does not allow them to some extent to exert so much control over their hydrocarbons resources. For example, Article 10[20] provides for a variety of protections for foreign investment, which include general protection, discrimination against (FOC), expropriation and freedom to transfer their funds. It also enables an investor to make claims against a host state in case of a breach of an obligation relating to investment protection. It provides a choice for contractors to use either a domestic court or international arbitration as a forum for dispute resolution when conciliation fails[21]. Again, PSA allows FOCs to recover its cost once development commences even if the project is not profitable without taking into consideration the economic and financial positions of the state. In this case, if the cost recovery is too great, it may represent a liability for the state as it may reduce its share of gross production, this can play a role in the state’s losing its control of her hydrocarbons resource to foreign investors.   CONCLUTION

‘PSA’ is favourable to states especially those with transition economies like Ghana because; It does not transfer subsoil right in either ownership or lease from the states to the Foreign contractors. It gives high revenue to states without necessarily taking any commercial risks. It also makes it possible for the host states to acquire properties in the form of machinery for the oil and gas production after the contract comes to an end, thereby enabling the oil producing states to exert maximum control of their hydrocarbon resources unlike that of licensing and concession.

However, ‘PSA’ is an empty vessel; its success in Ghana would depend on what Ghana would put in the agreement. Therefore, for Ghana to achieve her desired maximum control over the hydrocarbons resources and maximise her economic recovery, extra care must be taken not to lose foresight when entering into such agreements. Until Ghana or GNPC is very much aware of the substance and the machinery of PSA implementations, it should not be in a rush to enter into such agreements because the contract would be too late for a re-negotiation.

Author: PK Opoku Bonna, LL.B

The author is Currently pursuing Master of Laws Degree (LL.M) in OIL & GAS Law in Great Britain

Bibliography

[1] B. Kirsten, “Production Sharing Agreements: An Economic Analysis”, Oxford Institute for Energy Studies, WPM 25, October 1999.

[2] Prof Bernard Taverne, “Production Sharing Agreement in Principle and in Practice” in M.R. David (editor), Upstream oil and Gas Agreement, 1996, p.44 [3] Article 18 (1), (2) and (3) of the Energy Charter Treaty 1998. See also, The 1958 Convention on the Continental Shelf.

[4] B. Tavern, “Production Sharing Agreement in Principle and in Practice” in M.R. David (editor), Upstream oil and Gas Agreement, 1996, p.57

[5] B. Tavern, “Production Sharing Agreement in Principle and in Practice” in M.R. David (editor), Upstream oil and Gas Agreement, 1996, p.58

[6] T.W. Walde, “Editorial, Volume III, Issue # 01, March 2005”, OGEL, (2005), www.ogel.org (last visited 30/10/2008)

[7] Tavern, “Government Petroleum Policies”: Petroleum, Industry and Government,” 2nd edition, 2008, chapter 4.

[8] Tavern, “Government Petroleum Policies”: Petroleum, Industry and Government,” 2nd edition, 2008, chapter 4.

[9] Prof B. Taverne, “Production Sharing Agreement in Principle and in Practice” in M.R. David (editor), Upstream oil and Gas Agreement, 1996, p.75

[10] Prof Bernard Taverne, “Production Sharing Agreement in Principle and in Practice” in M.R. David (editor), Upstream Oil and Gas Agreement, 1996, p.75   [11] Bindemann, Kirsten, “Production Sharing Agreements: An Economic Analysis”, Oxford Institute for Energy Studies, WPM 25, October 1999, p.29.   [12] See http://www.abdn.ac.uk/webctnotes (visited on the November 10, 2008) [13] Dr. A Konoplyanik, “The fight against PSAs in Russia; who is to Benefit and why Not the State?” (2003) I.E.L.T.R., issue 10, ps.279-280   [14] A. Konoplyanik, “The fight against PSAs in Russia; Who is to Benefit and why Not the State?” (2003) I.E.L.T.R., issue 10, p.278   [15] A. Konoplyanik, “The fight against PSAs in Russia; Who is to Benefit and why Not the State?” (2003) I.E.L.T.R., Issue 10, p.278

[16] Dr Ian Rutledge, “The Sakhalin II PSA - A Production ‘Non-Sharing’ Agreement, Analysis of the Revenue Distribution”; Sheffield Energy and Resources Information Services (SERIS), November 2004.

[17] See www.globalpolicy.org/security/oil/2006/lorussiamistake.htm [18] Prof Bernard Taverne, “Production Sharing Agreement in Principle and in Practice” in M.R. David (editor), Upstream Oil and Gas Agreement, 1996, p.61   [19] ECT, which was signed in 1994 and came into force in 1998.

[20] Energy Charter Treaty 1998, Art 10

[21] Energy Charter Treaty 1998, Art 26

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