20 th April 2016 Nusantara Ballroom, Dharmawangsa Jakarta

Options for State Control of Hydrocarbons Professor John Paterson

Concealed Difficult and very expensive to find No guarantee of success – geological risk Subject to price volatility – price risk Long lead-time between discovery and production Owned or controlled by the state State must decide how exploration and production will proceed Key characteristics of oil and gas

National Oil Company (NOC) Involvement of International Oil Companies (IOCs) If involving IOCs, what sort of legal arrangements must be made? Basic State Options

Control of its hydrocarbons Investment to allow extraction A fair and reliable share of the value generated Maximum economic recovery of hydrocarbons Domestic security of supply What the government wants

Access to reserves (and to book as much as possible) Every day of production without replacement is a day closer to being out of business Market focuses on production and reserves Consequent imperative to explore Consequent need to cover costs of failed exploration from profits from successful Stability! What the IOC wants

Risk Geological Political Operational Price Fiscal Investments endure for decades, so exposure to risks is long-term Why does the IOC want stability?

Licence and Tax Production Sharing Service Contracts Each may also involve a joint venture with the NOC How is the decision made? State Options: legal models

An authorisation to do something that would otherwise be unlawful Petroleum usually reserved to the state Licence therefore required to explore, etc. State exercises control via licence Collects revenue via royalty and taxation Ownership in oil passes at the well Example: UK, Ireland Licensing

A risk contract in which contractor explores for oil and is only compensated in the event that commercial discovery is made Costs reimbursed via initial tranche of produced oil Profit oil then shared between state and contractor as per contract Contractor usually also subject to tax on profits Example: Ghana, Uganda PSA

NOC enters into JV with IOCs Licence is granted to JV NOC will have obligation to contribute to costs under PSA NOC’s interest may be carried by IOC State receives benefits via NOC’s share of revenue and/or taxation Example: some projects in Nigeria Joint Venture

State contracts with commercial actors for provision of specific services Payment is made for those services and is not contingent on commercial discovery Variation on the pure Technical Service Contract is the Risk Service Contract Latter incentivises contractor by allowing some participation in upside Example: Mexico, Iraq Service Contracts

Economists tell us that the state can achieve the same result in terms of ultimate value extracted whether a licence and tax system is used or a production sharing system But there are other considerations… Does it matter?

Licence and taxPSAService Level of state controlPotentially high, depends on terms High Public perception of state control LowerHigherHighest State needs capital upfront? No Yes Location of risk (if terms properly drafted) Licensee (IOC)Contractor (IOC)State Govt participates?Possibly, but not usually NormallyRequired Transfer of ownership of hydrocarbons At the wellheadAt point stipulated by contract Remains with state What the IOC getsGross production minus any royalty oil Cost oil plus share of profit oil Fee for service Comparison of Models

State’s access to capital State’s ability or desire to take and absorb risk State’s need to have control – or at least to signal control State’s preference in relation to timing of receipts Strength of state’s bargaining position Factors to consider

Need to preserve the relationship between state actor and contractor over the long term Flexibility to cope with complexity and uncertainty generated by risk matrix and duration Recognition of the importance of reciprocity A cooperative stance on the part of both parties Recognition of the link with wider social considerations Does this imply a very particular understanding of the sanctity of contract? What must a PSA reflect?

The foregoing desirable characteristics closely map the key features of Ian Macneil’s influential theory of relational contracting Relational vs Discrete Contracts

Fiscal terms: building in self-adjustment (sliding scales, R-Factor) Stabilisation: shift from classic freezing to economic equilibrium and renegotiaion Clauses encouraging parties to engage with each other in a spirit of cooperation Do PSAs reflect relationality?

Whatever variability we may find in practice, is it not the case that the very nature of the physical operations that are the subject of PSAs calls for a relational approach in all cases? Does this mean that we should consider writing relational norms more explicitly into such agreements? What would that mean in Indonesia? Conclusions

THANK YOU