how exploration and development risks should be shared between the state and the Foreign oil corporations

Author: Iloka Benneth Chiemelie

Published: 24-October-2014

Introduction

Production-Sharing Agreement (PSA) is one of the basic forms of contractual agreement when it comes to petroleum exploration and development. Under the PSA setting, the state is the owner of the mineral resources and the state engages a foreign oil corporation (FOC) as their contractor to provide needed technical and financial services for exploring and development oils (Rowland, 1987). This research aims to understand how exploration and development risks should be shared between the state and the FOC.

Basic views on risk sharing in oil exploration and development

One thing is common in relation to present demand for energy – and that is the need to create sustainable energy supply. This is because the world is increasingly industrializing and growing in population, thus resulting to subsequent increase on energy demand. However, increase in depletion now means that exploration and development of new sources of energy is the only means of ensuring sustainability. For new exploration, there are a number of risks that explorers will face  and such risk include: 1) the probability of reliable sources being found, 2) the probably of such sources having enough oil to meet demands, and 3) the extent of investment that must be made in the course of exploring and developing new resources (Rowland, 1987; Seck, 1994; Smith, 1993; Singh, 1989; Stiglitz, 1989; Taverne, 1994; Kristen, 1999).

Considering these issues, I think that the FOCs need to bear full risk for exploration and development. The reason for such thought is that under the PSA contract, FOCs are normally allocated shares for new explorations – which means that if they measure success with new exploration and development, they will have some part of the daily oil output as their compensation. Such contracts can vary from decades to even life-time. Thus, the FOCs will not only cover their expenses, but be rewarded in millions (is not billions) of dollars as profit. This makes it understandable for them to bear all associated cost for new oil exploration and development. However, in cases where the expenses are huge, the government can also support them with necessary financial aids.

What happens when a host country decides to share risk with FOC?

When it comes to oil exploration and development, investment decision and strategic planning are carried out under high level of uncertainty. How risks involved in a project and how they are accessed as being potentially rewarding does justify the decision to take a given risk. A number of uncertainties need to be taken into consideration as they can have effect on the input variables. The major uncertainties in oil exploration and development include:

1.      Chances of discovering new resources

2.      Type of resource that will be discovered (oil or gas)

3.      Size of deposit

4.      Economic viability of such development

5.      Required technology

6.      Development in future price

7.      General political and economic risk (Kristen, 1999).

Thus, if the government (Host country) is to share these risks with the FOCs, it is necessary that the government determines the size of G&G to be explored and developed. The reasons are that:

1.      The government best understand areas with high potentials for success as their country-based geologists, and scientists might have been studying their landscape in the past decades.

2.      It will allow the government to allocate huge areas for exploration – thus increasing their chances for success and overall profitability if they measure success as more G&G can bring about more resources and a subsequent increase on supply power of the country.

Conclusion

Exploration and development of new energy sources is not easy. This is because a number of risks are associated with such tasks and chances for success are based on probability. Thus, the government should always be careful when allocating contracts and ensure that risks are significantly reduced for the host country. However, FOCs also need to take time to study the area prior to investment in order to ensure that their chances enjoying huge rewards are high.

References

Rowland, C., Hann, D. (1987). The Economics of North Sea Oil Taxation. London. Macmillan.

Seck, A. (1994). Oil & Gas Investments in Azerbaijan. Part 2: Economic 8r, Legal Profile of the Energy Sector. University of Dundee: Centre for Petroleum and Mineral Law and Policy.

Singh, N. (1989). Theories of Sharecropping. In: Bardhan, P. (ed). The Economic Theory of Agrarian Institutions. Oxford: Clarendon Press.

Smith, E.E. et a1 (1993). International Petroleum Transactions. Denver, Colorado: Rocky Mountain Mineral Law Foundation.

Stiglitz, J.E. (1989). Sharecropping. In: Eatwell, J./Milgate, M./Newman, P. (eds). Economic Development. The New Pelgrave. London: Macmillan. pp 308: 15.

Taverne, B. (1994). An Introduction to the Regulation of the Petroleum Industry. Laws, Contracts and Conventions. London: Graham & Trotman.

Kirsten, B. (1999). Production-Sharing Agreements: An Economic Analysis. Oxford Institute for Energy Studies. Available at: http://www.oxfordenergy.org/wpcms/wp-content/uploads/2010/11/WPM25-ProductionSharingAgreementsAnEconomicAnalysis-KBindemann-1999.pdf [Accessed on: 3/09/2014].