1. How to read and understand an extractive industries contract 11 June 2014 Amir Shafaie

2. Presentation Outline 1. Legal Hierarchy and Extractive Contracts 2. Content and Typology of Agreements 3. Key questions to ask when reading an agreement A. Who are the parties? B. What is the scope? C. Financial obligations D. Work / operational obligations E. Social / environmental obligations F. “Legal” provisions – stabilization and dispute resolutioes?

3. 1. Legal Hierarchy: Extractive Contracts Contracts Regulations / Rules / Model Contract Policy / Legislation Constitution

4. Reality can be messier Legislation Regulations Contracts International Law ConstitutionPolicy Decrees Licenses

5. Example: State Participation in Timor Leste Constitution Legislation Regulations Contract Basic principle General parameters on timing, process, maximum % ??? Details on election, timing, terms

6. Licenses vs. Agreements LicenseAgreement Definition: time-bound right to explore and/or exploit to a company. Definition: document setting rights and obligations of government and company Form: often standardForm: generally negotiated, and more detailed Where: Norway, United Kingdom, United States, Peru… Where: widely used Related term: PermitRelated term: Contract

7. Licenses and Agreements Why agreements used? Insufficient detail in legal regime. Need for flexibility to accommodate specificities of a sector / project. But, important principles when using agreements, in order to facilitate negotiation and monitoring / enforcement: Still important to establish as many terms as possible in the law and regulations, rather than creating a new legal regime in each agreement; and Do not include in provisions contrary to law.

8. Which contracts / licenses are we talking about? Source: King & Spalding State Direct NOC sales (e.g. Long Term Sales Agreements)

9. 2. Content and Typology of Agreements Duration and extensions Work programme obligations Contract area and relinquishments Contractor rights, obligations and liabilities Discovery and appraisal Development and production Cost recovery, Fiscal terms/production sharing Measurement and valuation of petroleum Natural gas Management of Operations Approval of work programmes Confidentiality Change of ownership Environmental protection and safety Training Local content Bonus payments Abandonment of wells and installations Accounting procedures Company Guarantees Termination Governing law and arbitration Stabilisation

10. Types of Agreements e.g. UK, US, Norway, Libya, Tunisia e.g. Indonesia, Angola Libya, Tunisia e.g. Iraq, Iran OIL &MINERALS OIL ONLY

11. Types of Agreements Agreement TypeKey FeaturesExamples Concession (Royalty/Tax)Company owns 100% of the produced resource UK, US, Colombia, Brazil Production SharingProduced resource is split among government and company, company gets entitlement to recover costs plus some share of profit Indonesia, Azerbaijan, Angola Risk Service ContractGovernment retains ownership, companies are paid a fee Iran, Iraq, Mexico, Bolivia

12. Global Distribution of Agreements - Petroleum Courtesy Graham Kellas

13. Fiscal Regimes are Complex Courtesy Graham Kellas

14. Revenue from Sales Royalty: % of Gross Gross Revenue to Company Production Costs Profits Profit TaxAfter-Tax Profit Key Green = State Share Pink = Contractor Take-Home A B C D Concessions: Financial Flows

15. Concessions: Key Issues SubjectConcession Features Direction of PaymentsContractor pays government Distinguishing Government Revenue Streams Royalties and Income Taxes Other Possible Revenue StreamsBonus, Dividends from State Equity, Dividend Withholding Tax, Windfall Profits Tax, Fees Key Issues in System Design Setting appropriate royalty Tax rates and rules on deductions Providing some measure of progressivity AdvantagesSimplicity, appeal to investors DisadvantagesNo built-in progressivity, alignment of incentives

16. Production Sharing Contracts (PSCs) Total Oil Extracted Cost OilProfit Oil Sales by Private Companies Sales by National Oil Company (NOC) Profit Tax NOC keeps % of sales Remainder to State Treasury Royalty

17. Total Oil Produced Royalty: 10% to 20% After-Royalty Net : 80% to 90% Cost Oil Profit Oil Sales by Sonangol* Sales by Contractor Group Profit Tax 50% After-Tax Profit Key Green = State/Sonangol Share Pink = Contractor Take-Home * Profit Oil Split between Sonangol and Contractor varies by contract. Sonangol retains 10% of its revenues, reverts rest to Treasury. A B C D E PSA Financial Flows: Angola

18. PSAs: Key Issues SubjectPSA Features Direction of PaymentsContractor pays government taxes and (sometimes) royalties; Government gets share of petroleum; can market for revenue Distinguishing Government Revenue Streams Production share Other Possible Revenue StreamsRoyalties, Income Tax, Bonus, Dividends from State Equity, Dividend Withholding Tax, Windfall Profits Tax, Fees Key Issues in System Design Cost Recovery Rules System for Production Split Oversight of National Oil Company AdvantagesDirect government role in oil sales, alignment of incentives, easy to build in progressivity DisadvantagesIncreased potential for conflict of interest

19. Crude Gas Sales by YPFB IDH – 32% of Gross Royalty – 18% of Gross After-Royalty Net – 50% Recoverable Costs Distributable Profits after Costs YPFB Share* Contractor Share Profit Tax 25% After-Tax Profit Key Green = State/YPFB Share Pink = Contractor Take-Home * YPFB Share in Profits ranges from 1 – 72%, based on a formula incorporating profitability, production levels, and price A B C D E Service Contract Financial Flows: Bolivia

20. Service Contracts: Key Issues SubjectPSA Features Direction of PaymentsGovernment sells all petroleum, pays fee to contractor Distinguishing Government Revenue Streams Sale of production Other Possible Revenue StreamsRoyalties, Income Tax, Bonus, Dividends from State Equity, Dividend Withholding Tax, Windfall Profits Tax, Fees Key Issues in System Design Determination of Fee Cost recovery rules Oversight of National Oil Company Advantages High levels of government control over operations and petroleum Disadvantages Incentives for contractors may be inadequate (particularly upside); Increased potential for conflict of interest

21. Other types of agreements to be aware of Joint Venture Agreements Financing Agreements Sale / Offtake Agreements Construction / Commercial Agreements Infrastructure linked agreements Joint Operating Agreements (JOA’s) Unitisation Agreements

22. 3. Key Questions to Ask In your role within your country, what are the most important things you want to understand when you are negotiating or reading an agreement?

23. A. Who are the parties? « The Company » can mean… A publicly-listed international company; A privately-held international company; A national oil company from another country; A national subsidiary of an international company; An offshore entity controlled by an international company; A joint venture composed of multiple actors

24. A. Who are the parties? « The Government » can be represented by… A Ministry; A regulatory agency; A national oil company;

25. How to identify the Parties…and why it matters How? 1.The declarations / parties section at the beginning of the contract 2.The description of the shareholding of the company (sometimes in the contract or the shareholder register) But, this has limitations… Why? Capacity - financial, technical, environmental, etc. Anti-corruption Source for more information on the project (website, EITI, stock market disclosures, etc.)

26. Who are the Parties? An Example Who are the parties in the Ghanaian example? Do you see any possible points for concern / further investigation? Where could you find more information on these companies?

27. B. What is the scope? Use the table of contents to get a lay of the land…..

28. C. What financial obligations does the agreement include? 3. Who has the responsibility for monitoring/ enforcing? 1. What is the Obligation? 2. Is the rule in the country’s interest? 4. Where can I find data on enforcement?

29. C. What financial obligations does the agreement include? 1. What is the Obligation? How do the fiscal terms in the contract interact with the law? What has to be paid? When? To whom?

30. Example – Gold royalties in Afghanistan and Liberia What do these clauses establish? Who? What? When? How do these two royalty systems differ from one another? Can we say which is better?

31. Example – Cost Oil in Azerbaijan What does this clause establish? How might this provision be significant in analyzing the overall balance of the fiscal benefits between the contractor and the state?

32. Example – Model Production Sharing Agreement in Trinidad & Tobago Say that oil is at $120 per barrel and this field is producing 60,000 barrels per day. How would we determine the profit oil split between the government and the contractor (i.e. which box would you be in)? Does this example tell us anything about the importance of adaptability in designing contract regimes?

33. D. What work obligations does the agreement include? 3. Who has the responsibility for monitoring/ enforcing? 1. What is the Obligation? 2. Is the rule in the country’s interest? 4. Where can I find data on enforcement?

34. Obligations within the exploration phase Government objectives: Ensure the development of a serious work plan during exploration Avoid speculation and non-investment that freezes attractive areas

35. Speculation – Hyperdynamics in Guinea

36. Investment decisions – Shell Exploration projects Source: Shell Five-Year Fact Book, 2005 – 2009: http://www- static.shell.com/static/investor/downloads/financial_information/reports/faoi/faoi_2009.p dfhttp://www- static.shell.com/static/investor/downloads/financial_information/reports/faoi/faoi_2009.p df

37. Minimum investment requirements Number of Wells: Gabon Contrat Vaalco First exploration sub- period: 1 well Second exploration sub-period: 1 well, 200 km of 2D seismic Expenditure: Liberia Model Contract: During every exploration sub-period: « The contractor shall carry out a minimum work programme at a cost of no less than ____ Million Dollars…. »

38. Relinquishment – East Timor Model Production Sharing Contract Relinquishment of : 25% at end of 3rd contract year 25% at end of 5th contract year Voluntary relinquishment Limitations on relinquished areas and non-relinquished areas Original Area End of year 3 End of year 5

39. Example – Work Obligations in Ghana What are the work obligations facing the contractor in this project during the Initial Exploration Period?

40. E. What social / environment obligations does the agreement include? Types of social obligations Local content (employment, training, goods & services) Consultation with communities, obligations to relocate / indemnify Commitments to develop socially significant infrastructure

41. Examples – Environmental obligations of Rumaila Technical Services Agreement Article 9.17 - All appropriate and necessary measures to safeguard the environment and prevent or minimise the effect of pollution Article 24.6 – Maintain insurance agains environmental damage and injury Article 41 – Protection of the environment Best International Petroleum Industry Practices and comply with Law Environmental Impact Studies (baseline and impact, with guidelines) submitted as part of Redevelopment Plan Article 42 – Site restoration and decommissioning

42. F. How does the agreement interact with future changes in law? What happens in case of dispute between the parties? Stabilization Dispute Resolution/ Arbitration

43. State as sovereign vs. state as party to contract Public Law Private Law

44. Stabilization Clauses What are these clauses? What is their purpose? Are there different variations? What are the differences between the stabilization clauses in from Azerbaijan andMongolia in the handout?

45. International Arbitration What are these clauses? What is their purpose?

46. Example – Arbitration in Afghanistan Who will arbitrate any unresolved dispute? Under what rules? Where?

47. Resources – Tools for assistance http://openoil.net/contr acts-booksprint/ http://www.resourcecontracts.org/blog/g uides-to-contract-terminology.html http://www.revenuewatch.or g/sites/default/files/RWI_En forcing_Rules_FR12.pdf

48. Thank you / Questions? ashafaie@resourcegovernance.org