Oil Exploration, Development And Production; A Transparent Selection Process Of Oil Companies

There are various complex steps involved in selecting IOCs by HCs for exploration, development and production of hydrocarbons, viz., Negotiation and Bidding, as also the methods of awarding E&P rights through Licenses and Contracts, along with the evolution of Concessions which govern the E & P phases of petroleum projects. On evaluation, it can be seen that the Bidding process is the most competitive and transparent arrangement for awarding E & P rights to IOCs, and how 'resource nationalism' led to a shift in State policy towards Modern Concession Contracts.

Negotiations v Bidding

The techniques employed for awarding petroleum agreements differ across different jurisdictions, depending on a variety of factors, inter alia, geological prospects, economic status of HC, political stability, and policy objects. The two most common methods used to grant E&P rights to IOCs are Negotiations and Bidding.

Negotiations can be described as the process employed by HCs to negotiate the terms and conditions of engagement of IOCs for E & P purposes, and is usually found to be the go-to method when HCs are seeking flexibility in the terms of engagement, or are in need of special technology or expertise, or cases where time is of the essence. Negotiations are also utilized when HCs have a pre-determined IOC in mind, whom it wishes to engage on mutually agreed terms. This characteristic makes it akin to a 'concession' which is usually granted on the basis of one-one negotiation between HC and IOCs. One of the drawbacks associated with Negotiations is that it leads to a scenario where discussions often happen behind closed doors with little transparency.^[1]

Bidding, on the other hand, can best be described as an auction process basis which HCs elect the IOC for awarding E & P rights. There is a risk in any negotiated system that a valuable resource maybe disposed of without yielding maximum achievable returns^[2], thus, many HCs opt for Bidding process. Bidding is essentially of two types – Competitive and Discretionary Bidding.

In Competitive bidding, companies typically bid on fiscal terms such as royalty rates or cash bonuses offered to HCs. This form of bidding is suited for States whose main objective is to generate cash revenues. Competitive bidding can be further segregated into: -

Discretionary bidding, on the other hand, can be based on a number of variables and fulfilment of certain criteria such as minimum work programmes, minimum expenditure or royalty rates, technology sharing, imparting training to nationals, relinquishment of unexplored acreage, et al. Discretionary Bidding is most suited for States looking to balance and prioritize a wide range of objectives. Like its counterpart, Discretionary Bidding too can be segregated further into: -

It is relevant to note that most Licenses in the 21^st Century have been awarded utilizing the bidding process.^[3]

Thus, based on the preceding paragraphs, it can safely be concluded that bidding is a more transparent process which can be easily adopted under any legal regime, and provides for participation of large number of IOCs competing with each other for securing E&P rights.^[4] Another essential feature which provides succour to superiority of the Bidding system is that it emphasizes the proper preparation by HC of bidding procedure and drafting of related model contracts which provide efficiency to the process.^[5]

Characteristics Of Licensing And Contractual Systems

The structure of relationship between a HC and an IOC is usually determined on the basis of a License or Contract. It can be said that in principle there is no difference in the two mechanisms, but in theory, legal differences exist and need to be borne in mind.

A contract is an agreement between HC and IOC by virtue of which the IOC secures for itself the right to E&P petroleum. There are three main types of contractual systems, viz., Production Sharing Contracts (most popular), risk-service contracts and Joint Ventures. Set out below, in brief, are the primary characteristics of these models: -

The underlying philosophy of the contractual system is that the HC retains the title to the petroleum resources in situ as well as on production, while the IOC bears all the financial and operational liabilities and gets a share of the production as stipulated in the contract. Contract can also stipulate recovery of operational and capital costs (cost recovery oil), along with a split in profit oil as per the specified percentage therein. This is usually a characteristic of PSCs. Countries like Indonesia, India and China, et al, also levy royalties on produce, as well as tax on net profits generated within the HC.

Licencing, on the other hand, can be defined as the identification by the HC of potential (upstream) petroleum investment opportunities, their sub-division into discrete contract areas, and offering to IOCs by a suitable tendering process, and the establishment and negotiation of technical, financial and contractual terms and conditions (for award) consistent with their petroleum prospectivity.^[7] Often, non-exclusive licenses are conferred for geological and geophysical prospecting, while an exclusive license is usually conferred for exploration work that involves drilling, as well as for production operations. Licensing systems are often utilized in countries with relatively low reserves and high costs associated with offshore oil production, and the royalty/tax system dominates.^[8] The main characteristic of Licensing regime is that the title over petroleum produce is transferred from HC to IOC upon production (at well head), subject to an imposition of tax (royalty) in either cash or a share in production, and an income tax on the IOC's net profits earned in HC. Similar to the Contractual system, the IOCs bear all the financial liabilities in Licensing regimes in return for the right to access, own and deplete petroleum resources. It is also pertinent to note that Licenses are regulated by statutory instruments (for instance, under the Indian Petroleum Act 1934 r/w Oilfields Act 1948, Central Government formulates Rules and Regulations governing grant of mining leases) and, in most jurisdictions, licenses are perceived to be contractual arrangements.^[9]

Thus, it is observed that other than the facet of ownership of petroleum resources, the two aforestated regimes are very similar and the labelling a regime as Licensing or contractual is not decisive. However, for academic purposes, the nuanced legal differences must be recognized.

Old v Modern Concession Contracts

The period between early 19^th century and World War 1 saw the formation of the 'Seven Sisters' (Exxon, Shell, BP, Esso, Chevron, Texaco, Gulf) which monopolized global oil and gas operations in countries that were either colonies of western powers, or had some form of dependency status. The legal arrangement used in this era was the "old concessions contract", wherein the HC had title over oil resources in situ, which was conceded to the Concessionaire upon production in exchange for royalty payments. This regime was notorious for its 'sitting on concessions' character, where the IOC would often not conduct any operations for long periods of time.

Traditional/old concession contracts can be best illustrated by a reference to Persia's grant to W.K. Darcy in 1901. This grant shares the following common features amongst other old concession contracts: -

• The area of concession was quite large, covering the most petroleum-rich part of the HC territory.
• The term of the lease was very long, usually 60-75 years.
• The concessionaire was the exclusive owner of the petroleum produce, and could dispose it as deemed fit.
• Concessionaire was not obligated to perform minimum work obligations.
• Concessionaire was not compelled to explore and produce.
• Financial benefits accruing to the HC were minimal, and consisted primarily of royalties.^[10]

The major disadvantages for the HC were the non-involvement of HC in management of petroleum operations as well as handing over of title upon production, and this was seen as an affront to State's sovereignty. This led to a shift in regime and certain changes were made to the old concessions system.

Post the 1970s, new generation of concessions were evolved wherein the HC became more sophisticated in their dealing with the IOCs. The Modern Concession contracts provided the HCs a more assertive role in the management operations, better fiscal terms, and imposed minimum work obligations upon the IOCs. Additionally, concessionaires no longer had title over petroleum produce and were obligated to relinquish parts of acreage over stipulate time periods. Further, the area of land became smaller and the time frame became shorter in comparison to old concessions. Concessionaires were also required to train and employ nationals to the extent practicable. Financial benefits were enhanced based on a percentage of production and other forms of taxes and rental, license fees and various bonuses payable to HC. HCs were given more authority to review the proposals of the concessionaire and approve exploration budgets, work programmes, et al.^[11] Therefore, despite keeping the fundamentals intact, the terms which were most disadvantageous to the HCs were altered in the Modern Concessions regime. Awarding E&P rights to IOCs through a system of Bidding is most efficient, transparent and easier to operate as it can be easily assimilated into any legal regime according to the needs of the HC.

Author is an Advocate practicing in Delhi. Views are personal.