Apart from some exceptions, everywhere the State is the owner of the natural resources in its territory.
Therefore, the exploration for oil and gas, being natural resources, entails the execution of agreements between the Oil Companies and the local governments.
Such agreements are governed by a proper contract setting out different items: the area, the duration, the work and/or expenditure commitments, the possible taxation and/or the sharing of production.
Whilst in some countries the contracts are governed by petroleum laws and actual negotiations do not take place, in others, many issues are negotiable from time to time.
The model agreement is somewhat linked to the petroleum history and to the evolution of the producing countries' attitude vis-a-vis the oil activity in their territory.
At the beginning, the contracts were concession agreements, characterized by a long duration, very large areas (which, at times, covered the entire country) and lack of precise expenditure commitments by the Oil Companies. Production royalties and income taxes were paid to the host governments.
In the 1960s, the concession agreements were marked by stricter provisions and a general increase in the taxation level. Afterwards, the producing countries' state-owned oil companies were associated with the Oil Companies, with the consequent sharing of both production and profits. In the 1970s, the production sharing agreements were devised, thereby conceptually superseding the previous models. Thanks to this type of contract, the Oil Companies are sheltered from nationalizations since they do not own assets, but they acquire legal rights by virtue of the activity they carry out.
Today, the production sharing agreement is very popular and in many countries it is the only possible contract, whereas in others, the concession agreements are still in use, even though in different forms.
The expenditures and the risks related to exploration are always fully borne by the Oil Company which may recover such costs only from the production obtained from discoveries. Furthermore, the agreement provides for a work and/or expenditure commitment to be undertaken in a limited number of years (2 or 3 years), with the possibility of extending such periods of time.
When the production phase is reached, the agreement's basic elements, i.e. the Cost Recovery Oil and the Profit Oil, generate an economic return for the Oil Company.