Over the years, many forms of exploration and production agreements have been developed by production agreements have been developed by governments throughout the world. The agreements can differ widely in terms of form, severity, and flexibility.
Although the different forms of agreements may provide similar results to each other under provide similar results to each other under assumptions of a given level of success, the results can differ markedly with variance from that level of success, both in terms of tempering downside exposure and limiting the upside opportunity.
A company should evaluate a potential exploration/ production opportunity and its related agreement production opportunity and its related agreement over a range of possible outcomes in assessing the prospect's overall attractiveness. prospect's overall attractiveness.
Four basic types of agreements between host governments and petroleum companies have been developed and are in use today:
service contracts, and
rate-of-return based taxation.
The first concessions were granted to the major oil companies in the early 1900s and contained provisions such as: provisions such as:
Large areas with no relinquishment provisions;
Long concession periods of up to 99 years;
No state participation in management;
Royalty paid on production tonnage;
Exclusive rights granted to the company on all facets of petroleum activities; and
Contractual provisions guaranteed for the duration of the concession.
Although the concession or tax/royalty system played a major role in the discovery and played a major role in the discovery and development of large petroleum reserves, conflicts between host governments and the oil companies, coupled with rising petroleum demand, led to changes in many basic petroleum agreements. In 1967 the first production sharing contract was signed with Indonesia. The government of Indonesia felt the production sharing system gave the country greater control of petroleum resources, and other countries followed with similar arrangements.
In the period between 1966 and 1980 service contracts also became common in various countries. In these cases, the international oil company acts as a contractor to explore for and develop reserves in return for a per barrel fee. With exploration in the 1980s turning to more frontier-type plays, an agreement was developed known as rate of return (ROR) based profit sharing. ROR fiscal regimes provide the international oil company concession-type provide the international oil company concession-type terms until a specified rate of return is achieved, at which point the oil company begins paying taxes in addition to normal concession income taxes.
These four basic types of contracts have differing effects on the foreign oil company returns from investments.