Chasing the Oil Price: 5 State-of-the-Art Issues in every Upstream Oil and Gas Contract
In upstream oil and gas contracts, there is a need to balance the public private partnership between host country and operator. As the price of oil and gas fluctuates and causes market volatility there is a need to revisit some of the key issues that affect these contracts.
Of course, “one suit does not fit all” and the power balance between the parties will vary according to the natural resource wealth and expertise of the workforce of the host country. This is an important aspect which will determine the choice of type of contract and the specific terms that will govern the relationship between the parties. The host country will want to maximize revenue and the operator will want to minimize risk, but how does one do this?
The 5 State of the Art Issues to cope with today’s price volatility that need to be included in Upstream Oil and Gas Contracts are as follows:
1. Price Volatility and Fiscal Stabilization
Fiscal regimes form the lifeblood of the oil and gas industry and fiscal stabilization clauses are key in upstream oil and gas contracts. Getting it right is all important to both host country and operators. Several governments attempt to modify their fiscal terms as a result of changes in oil prices, in particular when prices rise. According to the World Bank, more than 30 countries revised petroleum contracts, or entire fiscal regimes, between 1999 and 2010 – a period which witnessed major changes in the price of oil. Each party’s bargaining power is determined by the price of oil. Typically, when the oil price is high, the government has the upper hand; when the prices are moving lower the operator companies have the upper hand. However, parties need certainty and therefore upstream contracts must provide for stabilization clauses.
2. The Evolution of Contractual Stabilization Devices
Stability clauses can relate to: host country control over production, labour; the environment; obligation to provide local infrastructure; and the possibility of nationalization. How can “Fiscal Stability Clauses” (FSCs) be used? Generally, they are used for taxes, royalties, duties on imported material and capital equipment, excises, value added tax (VAT) or Goods & Service Tax (GST).
3. Economic Equilibrium Clauses
In order to have equilibrium, there must be fair share. But what constitutes a ‘fair share’ of the resource rent which is fundamentally unstable, due to volatility in oil and gas prices, unpredictable geology, and global competition for scarce capital and know how. Full Economic Equilibrium Clauses protect against the financial implications of all changes of law, by requiring compensation or adjustments to the deal to compensate the investor when any changes occur. However, Limited Economic Equilibrium Clauses protect against financial implications of some limited set of changes in law or after specified costs are incurred. They require compensation or adjustments to the deal to compensate the investor only when the covered changes occur.
4. Freezing Clauses
Full Freezing Clauses freeze both fiscal and non-fiscal law with respect to investment for the duration of the project. Limited Freezing Clauses freeze a more limited set of legislative actions. Exemptions are required as well.
5. Contract Re-negotiation Clauses – when are they needed?
Basically, re-negotiation clauses are needed when there are price changes and changes in production levels which are caused by external factors. Further, any unfair clauses causing imbalance between the parties as to risk and reward or having ambiguous contract terms would also require re-negotiation. However, the main driver for re-negotiation clauses in upstream oil and gas contracts is ultimately the oil price and price volatility it seems is here to stay, so we need to address this in all upstream contracts or suffer the serious consequences of failing to do so.
PetroKnowledge’s intensive 5-day training course on Modern Practices in Oil & Gas Contracts, Licensing, Production Rights, Legislation and Agreements will provide a modern framework for understanding, determining and setting out stakeholder rights and obligations in Oil & Gas Contracts. Join this training workshop in London and gain a competitive advantage.
