1. Dr. Mohammad Hedayati-Kakhki
Legal Aspects of the Oil and Gas Industry
Dr. Mohammad Hedayati-Kakhki

2. Introduction
There are two basic contract types between the State and IOCs; firstly is by giving concession licenses to the IOCs and secondly is by making contractual arrangement between the State and the IOCs.
The major differences between them are the levels of control granted to the IOCs, levels of involvement by the State, compensation and the reward sharing schemes.

3. Production Sharing Agreements
PSA system is the most dominant form of granting access to oil and gas exploration and development to IOCs on contractual basis.
The first concept for the production sharing was used in Bolivia in the beginning of the 50’s; it was then spread throughout the world and is now preferred system in 52 States
PSA, introduced in Indonesia in year 1966, was created under the influence of nationalistic feelings after its independence from Dutch colonialism.

4. Historical and Political background
In 1960 a new regulation in oil and gas was enacted which emphasizes that “Land, water and their containing natural resources are possessed by the State and are used for people's utmost wellbeing”
At first, the existing concessions were turned into contracts of work which was made between the NOC and IOCs. Bur still many people criticized that it was the same system in a different form.

5. Historical and Political background
In brief, the main principles of the first generation of PSAs are:
1) NOC is responsible for the management of petroleum operations. The IOC (as the Contractor) is responsible for the execution of the operations and provides the necessary funds.
2) The government hold the ownership of the oil and gas.
3) The Contractor furnishes all the necessary risk capital based on a mutually agreed Work Program, including technical assistance

6. Historical and Political background
4) Ownership of all project-related equipment brought by the Contractor will be passed to NOC upon being placed in service; the cost of this equipment is to be recovered as ‘Operating Cost’ and all geological and other field data become NOC’s property.
PSA treated both parties on the same side and shared the production; it means that the bigger production was produced, the larger the party’s profit, and it would benefit both parties equally

7. What is a PSA?
A PSA is a legal contract between a state and an investor willing to risk its capital on behalf of the state. If oil or gas is then discovered in economic quantities, the reward to the investor is the recovery of its cost of exploration and development as well as right to share in any future profits from the sale of the oil or gas.
A PSA defines the conditions for the exploration and development of natural resources from a specific area over a designated period of time.

8. Production Sharing Agreements
In summary:
A Production Sharing Agreement is a contract in which a state (owner of the subsoil) entrusts the investor to conduct prospecting, exploration and extraction of mineral resources within the confines of a defined subsoil area on a compensated basis and for an established time period during which the investor is obligated to conduct the indicated work at its own expense and own risk.

9. Production Sharing Agreements
Basic Elements:
Authorities retain the resources’ ownership
IOC is granted a pre-defined percentage of the petroleum output
Remainder of the output is nonetheless owned fully by the government party
State party is afforded the ability to involve themselves in certain stages
Most common types of contractual arrangement

10. Production Sharing Agreements
Key Concepts:
IOC carries the entire exploration risk
Government owns both the resource and the installations
IOC operates the oilfield
IOC may have to pay royalty levied on gross production
Royalty constitutes an immediate cash flow to the government

11. Production Sharing Agreements
Specific Features/Clause Types:
Parties
Taxation and Compensation
Bonuses
Environment
Stabilisation

12. Production Sharing Agreements
Export and Import Duties
Contract Duration & Commerciality
Work Programme
Price
Termination

13. Service Contracts
Under a service contract the foreign company performs a service to the national oil company
An IOC agrees, for a fee, to provide services or technical information relating to the development of oil and gas without, in most cases, the hosting government handing over control of the relevant area or resources to the IOC

14. Overview
Junseog defines a service contract as a contract where “...a private company agrees to perform certain specified services for the government ….in return for fixed payment….‟
It is also defined as: An agreement whereby a foriegn oil company to produce a country’s oil reserves on a simple fee basis. The state maintans sole rights over the reserves and the contractor is compansated by a fee per barrel plus cost recovery.
The service may be paid for on a cost plus or fixed sum basis, with no link to production; or it may be paid as a fixed (or variable) fee on volumes produced. In the latter case, the foreign company is responsible for operations

15. Primary Motivation
Seen as putting State contracting party or NOC in more “Sovereign” position
Contractor has no legal or economic interest in oil reserves or even production
Exploration or development risk: contractor compensated by “fee” based on either:
Investment, or
Barrels produced (sometimes above a baseline)

16. The General Features of Service Contracts
The role of the IOC is essentially to provide the HG/NOC with services and information to help the country develop its own oil resources e.g. the viability of a given field
The IOC may also be engaged to provide equipment and training employees to operate the petroleum facilities
The IOC in this kind of arrangement has been described as a ‘contractor’ or ‘hired hand’ working for ‘wages’

17. Types of Service Contracts
The main types of service contracts are the Pure Service contract, the Risk Service contract and the Technical Assistance contract.
In Pure Service Contracts, a contractor in return for a flat fee carries out specific exploration or development work. The state accepts all of the risks associated with the operation. The IOC’s scope of services is quite narrowly defined.

18. Pure Service Contracts
In most cases, the service company will only have to provide or pay for the equipment, tools, and personnel required for the operation.
Contractors usually possess advantages in terms of their technical ability or equipment, which provide incentives for the other party to enter into a contract for their services.
Reimbursement is usually fixed by the terms of the contract, and is generally not affected by either project performance or market factors.

19. Risk service contracts.
Risk service contracts address a situation where a host Government is seeking to use private companies to bear the risk of exploration.
Two scenarios: either commercially exploitable resources are identified or they are not.
If they are, then the company receives cash remuneration for its efforts in addition to a possible stake in the subsequent enterprise.
If resources are not found, then the company is out of pocket

20. Technical assistance contracts
The technical assistance agreement is one of several types of arrangements that can be used to take advantage of the multinationals’ technological and managerial expertise and capital resources while allowing the host country to maintain at least the appearance that its State oil company has control and ownership”

21. Technical Service Contracts
An example is the Iraqi Technical Service Contract in respect of the Rumaila Oil Field.
Article 2 is about the role of the IOCs and the scope of the contract. It states that:
This Contract is a Technical Service Contract for the rehabilitation of improved production and enhanced recovery of Petroleum from the Rumaila Oil Field in accordance with the provisions herein.

22. Legal Enforcement
In determining whether a Service Contract is legally enforceable within a particular jurisdiction, the Constitution of the country, as well as all other relevant legislation, including foreign investment laws, must be considered
Example of Iraq
Iraq Petroleum Law 2007 (drafted)

23. Service Contracts can be Classified by Manner of Payment
Day work (Contractor paid by day, generally without regard to progress) Footage (Drilling Contracts) Contractor paid by foot of hole drilled Turnkey (Contractor paid for completed project (in a drilling contract actual well completion is often separate) Lump Sum (Contractor paid for specific service or installation) Cost Plus (Contractor paid for cost of service or install plus a profit) Risk Service (Contractor paid, at least in part, based upon results)

24. Service Contracts
Features that may be encountered include: 
Payment of a bonus to the national government at the time the contract is signed
Payment of royalties to the national government as production occurs
Retention of ownership of the reserves by the national government (since the contractor is deemed to be providing a service)
All of the costs and risks related to exploration, development, and production being borne by the contractor
Operating costs and capital costs incurred by the contractor being recovered through payment of operating fees and capital fees
The government (through a state‐owned oil company) having the right to participate in operations as a working interest owner

25. Management of the Project in a Service Contract
The IOC is appointed as the operator for the operations/services under the services contract;
The host government (or its national oil company) is represented on the operating committee; and
Certain decisions (‘reserved decisions’) cannot be made by the operating committee without the agreement of the host government party.

26. Stabilisation Clauses
Overview
Stabilisation and Political Risk
Types of Clauses
Legal Effect
Enforcement
Investment legislation
Bilateral and Multilateral Treaties

27. Overview
The involvement of the state as a contracting party in a petroleum contract always raises the possibility of unilateral change by virtue of the state’s sovereign legislative power.
Foreign investors in natural resource development projects have always sought stability guarantees as protection from the unilateral exercise of state power to change the terms of the contract by legislation or administrative discretion.
The scope of a stabilisation clause may be either comprehensive or limited.

28. Stabilisation and Political Risk
Risk that political and/or financial instability in host state or government action may adversely impact the continued existence of the project or its capacity to generate revenue.
Stabilization clauses are inserted in most petroleum contracts to avert any party from taking independent decisions to alter, abrogate or terminate the contract entered into by both parties.

29. Example Art. 17(2) of the Federal Law of Russia:
In the event that, during the period of validity of the agreement, the legislation of the Russian Federation, the legislation of constituent entities of the Russian Federation and legal acts of local government bodies establish norms which deteriorate the commercial results of the investor under the agreement, amendments shall be made to the agreement which guarantee the investor the commercial results which it could have received under the legislation of the Russian Federation the legislation of constituents entities of the Russian Federation and legal acts of local government bodies which were in force at the time of concluding the agreement.

30. Stabilisation Clauses
By a stabilisation clause, the state accepts that the existing and future laws would not affect the contractual terms agreed upon with the investor and retaining the stability and rationality of contracts by protecting the investor from any unilateral, unaccepted actions
In recent years, most host states see stabilisation clauses as means to attract investors and make available a constructive atmosphere for them to invest in their petroleum industry; that is to say, they accept stabilisation as a means to assure the investors of their loyalty.

31. Stabilisation Clauses
Example 1: the Aminoil-Kuwait Concession No alteration shall be made in the terms of this Agreement by either the Sheikh or the Company except in the event of the Sheikh and the Company jointly agreeing that it is desirable in the interest of both parties to make certain alterations, deletions or additions to this Agreement.

32. Stabilisation Clauses
Example 2: Production Sharing Contract between Pertamina and Conoco provides: This contract shall not be annulled, amended or modified in any respect except by the mutual consent in writing of the parties

33. Types of Stabilisation Clauses
Freezing Clauses
Prohibition on unilateral changes or Intangibility clauses
Balancing clauses or Economic equilibrium
Allocation of burden clauses
Hybrid clauses

34. Freezing Clauses
Designed to freeze the laws that apply to the relevant project to those applicable at the time initial investment agreement is executed
Full freezing clauses provide that all laws, both fiscal and non-fiscal, are frozen, usually for the duration of the project
Limited freezing clauses are designed to protect investor from changes to specific areas, usually fiscal changes (royalties often excluded)

35. Example of a Freezing Clause
The Investor and its Sub-Contractors shall not be subject, in relation to the Project Activities, to any Tax (including, export duties and taxes, VAT and capital gains taxes), which is not expressly provided for in this Contract.
By virtue of this Agreement, the Investor and its Direct Sub-Contractors shall benefit in relation to the Project Activities, from the stabilisation of the Fiscal and Customs Regime in force on the date of execution of the Agreement throughout the term of this Contract. *
*Agreement between the Republic of Guinea and Global Alumina Corporation in relation to the Sangaredi Alumina Refinery, 2004

36. Intangible clause
An intangible clause denotes that contracts will not be modified or abrogated except by the mutual consent of the contracting parties.
clauses do not contain an explicit waiver of legislative sovereignty but rather seek to prevent unilateral modifications of contract by the host state.
Example: this contract shall not be annulled, amended or modified in any respect, except by the mutual consent in writing of the parties hereto.

37. Balancing Clauses
Permit host State to change its laws (including those applicable to the project) but for such changes to trigger a “rebalancing” of the agreement to restore the (economic) equilibrium of the original deal
Full vs. limited balancing clauses
Usually provide for the parties to negotiate changes required to restore the agreement’s original economic stability

38. Hybrid Clauses Combination of freezing and balancing clauses
Parties to negotiate a basis to relieve the investor from negative effects
Pay compensation or agree that changes in law do not apply to particular project

39. Legal Effect Sovereign powers and expropriation
Restrict the administrative power of the State
But the very nature of the sovereignty of the State gives it the power to grant rights which it is prohibited from breaching
Under international law, States may expropriate property provided it is legitimate to do so
Public purpose, non-discriminatory, due process, adequate compensation

40. Enforcement
State itself should be bound by stabilisation clause (use of State entities as party to investment agreement (e.g. PSC or Joint venture Contracts) may not bind State
Local law requirements (host State to comply with laws and regulations of that State to ensure the investment agreement (and hence stabilisation clause) is binding on it
Preferable for agreement containing the stabilisation clause to be ratified by an Act of Parliament so it has the force of law