Since oil ownership is based upon the sovereignty principle, International Oil Companies (IOC’s) are required to enter into concession agreements with the sovereign state in order to acquire the exclusive right to operate, maintain and conduct investments in public utilities for a certain number of years. Accordingly, there are many advantages such agreements bring, such as the fact that the State receives royalty payments and income tax from the IOC’s (Farhan, 2008, p. 1). In addition to this, IOC’s bear all the risks associated with exploration and production activities (Bonnefoy and Nouel, 2005, p. 69) which is beneficial for those countries who pose a higher risk. Furthermore, the financing of the projects is also transferred to the oil companies so that the sovereign state does not have to secure the costs and little effort is required from the host state. This is exemplified by the concession agreement entered into between the Saudi Arabian government and a Japanese IOC, which illustrates how host states are able to control the production of oil a lot better (McDougal and Burke, 1962, p. 571). Important discoveries were thus made by the Japanese IOC which would not have been effectuated had the Product Sharing Agreement not been entered into.
There are some disadvantages to this, nonetheless, which includes the fact that the oil companies are given managerial and decision-making rights. Accordingly, IOC’s thus have complete control over the production of the oil, which is detrimental to the sovereign state as this allows oil companies to fix the prices of oil (Sornarajah, 2010, p. 74). The sovereign state therefore has no say as to how the oil companies ought to be managed and only a proportion of the oil price is transferred to the state. This could mean that the state does not generate as much profits as the IOC’s do as they are provided with a significant amount of discretion as to how its development activities ought to be conducted. This can in fact be detrimental in certain instances, which would have an overall effect upon the host state. For instance, there may be a situation whereby IOC’s do not undertake economically effective exploration and development activities (Inkpen and Moffett, 2011, p. 219). This would ultimately affect the host state and would prevent any profits from being generated.
Product Sharing Agreement (PSA)
The main difference that arises in relation to concession agreements and PSA’s, however, is the amount of state involvement. Accordingly, in PSA’s the state will own the entire oil and gas production and will thus have a greater say in how the oil is produced and managed (Cotula, 2012, p. 21). IOC’s thereby act as contractors by providing technical and financial services for the operations that are to be conducted. In return, the production of oil will thus be shared between the state and the IOC in accordance with the provisions of the PSA. The PSA system is the most effective system for developing host states to use as they receive higher returns as well as being provided with greater control over the management and production of oil. Financial and operational risks also lie with the IOC’s, which is further beneficial for host states and the mere costs of negotiations is lost if anything goes wrong.
Conversely, it has been said that the “theoretical flexibility of the PSA as an all-in-one document is a disadvantage” (Radon, 2012, p. 71) because of the fact that a premium is placed upon professional negotiations. Accordingly, the host state may be less knowledgeable than the IOC’s, which will be of significant detriment to underdeveloped countries that lack the resources certain IOC’s may have. In addition, whilst the host state will be involved in the decision making, its input is likely to be menial (Machmud, 2000, p. 21). Being a contractual relationship, PSA’s are also considered detrimental to the state on the basis that they will often “bind the government for many years without changing tax and regulation as they extract the oil and make profits” (Farhan, 2008, p. 1). This will enable IOC’s to predict and maintain the stability of their organisation.
Consequently, the main difference that exists between concession agreements and PSA’s is the relationship that exists between IOC’s and the host state. Thus, whilst the state remains superior in concession agreements, the relationship between IOC’s and the state becomes equal when entering into a PSA. PSA’s are therefore more effectively used by countries that are still developing since they often have high extraction costs as well as high risks. As such, it makes more sense to enter into a PSA since IOC’s will refrain from production if the agreement is not considered profitable. Whilst the state may be tied to the PSA for a long period, it often makes more sense to enter into this type of agreement if it is to be used as an effective foreign investment tool. An example of this can be seen in relation to the PSA that was entered into by Iraq. Whilst some would say that sovereignty was lost by this (Carbon Web, 2006, p. 1), other would disagree and instead argued that Iraq’s PSA has helped to instil foreign investment into a state that has been significantly damages as a result of conflict (Behn, 2007, p. 2).
Overall, it is evident that both concession agreements and PSA’s have many advantages and disadvantages. However, whilst concession agreements allow the host state to have greater control as to how the production and management of oil is maintained, PSA’s are likely to be more profitable and better suited to the needs of developing countries. This is clearly evident by the effects in which PSA’s have had on Iraq since PSA’s have enabled foreign investment to be provided, which is a vital tool for undeveloped countries. Thus, without foreign investments, developing countries will be unlikely to advance economically, which signifies the importance PSA’s have upon these types of governments. Nevertheless, because the host state will have less control over the production and management of oil processes, this agreement will not always be workable.
Behn, D. (2007) Sharing Iraq’s Oil: Analyzing Production-Sharing Contracts under the Final Draft Petroleum, Centre for Energy, Petroleum and Mineral Law Policy, [Online] Available: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=976407 [08 January 2013].
Bonnefoy, N. and Nouel, G. L. (2005) Petroleum Legal Regimes in the Gulf of Guinea, Euro Money Year Book.
Carbon, Web. (2006) About Product Sharing Agreements, [Online] Available: http://www.carbonweb.org/showitem.asp?article=58&parent=4&link=Y&gp=3 [Accessed 08 January 2013].
Cotula, L. (2012) How to Scrutinise a Product Sharing Agreement, A Guide for the Oil and Gas Sector Based on Experience from the Caspian Region, [Online] Available: pubs.iied.org/pdfs/16031IIED.pdf [08 January 2013].
Farhan, M. (2008) Production Sharing Contract: A Comparison with Concessionary System from the Political, Financial and Functional Point of View, Energy Law Journal, [Online] Available: http://myenergylaw.blogspot.co.uk/2008/12/production-sharing-contract-comparison.html [08 January 2013].
Inkpen, A. C. and Moffett, M. H. (2011) The Global Oil & Gas Industry: Management, Strategy & Finance, PenWell Books.
Machmud, T. N. (2000) The Indonesian Production Sharing Contract: An Investors Perspective, Kluwer Law International.
McDougal, M. S. and Burke, W. T. (1962) The Public Order of the Oceans: A Contemporary International Law of the Sea, Martinus Nijoff Publishers.
Radon, J. (2012) The ABC’s of Petroleum Contracts: Licence-Concession Agreements, Joint Ventures, and Production-Sharing Agreements, Covering Oil, [Online] Available: openoil.net/wp/wp-content/…/12/Chapter-3-reading-material1.pdf [08 January, 2013].
Sornarajah, M. (2010) The International Law on Foreign Investment, Cambridge University Press, 3rd Edition.
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