Service Contract and a Joint Venture Oil and Gas Transaction

Introduction

Over the decades, different parties have entered into different types of contracts such as service contracts and joint ventures for disparate purposes in various nations throughout the world. Nonetheless, before settling on a particular type of contract, certain factors are considered so that the most applicable and effective type of contract is applied. For instance, the parties involved in the selection of a contract have to assess the ambiguity of the transaction. This paper will analyze joint venture and service contracts by defining these types of contracts, their merits and demerits as well as their application in Asia and Africa.

Joint Ventures Contract

Joint Venture Contract (JVC) assumes contrasting official explanations or vehicles such as a partnership or limited partnership. The evolution of JVC was instigated by the desertion of traditional Concession Agreements (CAs). The notion of the improved involvement in the search and utilization of natural resources was quite remarkable in the 1950s when CA was terminated. Many countries as well as OPEC argued that Concession Agreements limited the authority of the government in controlling their most essential source of economic affluence, oil. Furthermore, the doctrine of permanent sovereignty orated by United Nations (UN) proposal from 1952 to 1966 inspired the emergence of JVCs and Participation Agreements (PA).¹

Some experts have defined JVC as an agreement that enables two or more parties to transact business together without including the procedures that are followed in the establishment of other analogous entities. Under this contract, the participants share their skills, financial affluence, and experience to accomplish a particular project or mission. The participants also have a mutual liability. JVC is established for a sole project and hence, is terminated once the mission for its formation is achieved. One of the participants referred to as a joint venture operator is appointed to manage the daily activities of the agreement. A JVC creates an opportunity for a host nation to acquire relevant technology from a foreign oil firm, which may ultimately make its local oil company be independent.²

Since the parties in a JVC agree to work on a unified undertaking, they have to recognize and comprehend the ambitions, skills, and techniques in which their partners conduct business. If the stakeholders fail to understand these vital details of their partners, it is impractical to formulate an effective prenuptial agreement. The unimposing sensation rate of contemporary marriage is analogous to corporate ventures. The unrestricted nature of JVC is probably the reason why most countries (Nigeria excluded) and oil companies avoid using this type of contract as their primary agreement. Nigeria’s national oil firm preferred this type of agreement until it was unable to issue the capital effectively as agreed upon in the Joint Venture monetary pledge. This failure prompted the national oil company in Nigeria to start using alternative contracts. Currently, Production-Sharing Contracts (PSC) is the most popular form of agreement in Nigeria.³

A common feature of JVC is an extensive list of issues that must be addressed by the involved parties because the contract requires that the participants tackle certain issues before signing the contract. Nonetheless, the parties can agree to defer a potential dispute or impasse, especially if the agreement involves an equal share.⁴ JVC demands for a meticulous concession over a prolonged time to guarantee that every issue is tackled discreetly and that the stakeholders are aware of the channel through which they operate.

Joint ventures also include a number of stages that each party must observe.⁵ The planning phase of exemplifies the commercial foundations and mentions the stakeholders. In the second stage of formation, the formal and commercial compositions of the contract are built. When the contract gets to the operation stage, it is operated and monitored progressively. If the parties oblige to the provisions of the agreement and effectually accomplish their mission, the contract gets to the dissolution stage. During the dissolution period, the stakeholders follow certain procedures to terminate the JVC officially.⁶

Legal Vehicles for Forming a Joint Venture

Three fundamental elements are critical in the nature of the association between a country and the foreign oil firms. These elements are the variables of possession, regulation, and risk in the miscellaneous types of petroleum contracts. The manners in which the variables are transferred from a foreign oil company to a host nation are of great significance. For instance, if a host nation acquires more power to regulate the oil project, then it also gains most of the potential threats in the project. Countries in the Middle East have raised their share in oil projects from 25 per cent to 51 per cent and eventually to 100 percent with the absence of an analogous improvement of the power to regulate the operations and subsequently, their assumption of risk increased after the foreign oil companies shifted the risk to them. It is therefore necessary that host countries and foreign companies underscore the importance of these three elements as well as other issues such as fiduciary responsibilities that affect the legal vehicles that form joint ventures when discussing contracts.⁷

Contractual Joint Venture

One of the key requirements in JVC is the agreement between the co-venturers. Under the contractual joint venture, the association between the stakeholders as well as the composition of the joint venture are defined and executed through legal mechanisms referred to as Joint Operating Agreements (JOAs).⁸ In addition, no distinct legal entity is formed since the formal structure for the exploration, utilisation, and other operations are tackled by the JOA. Contractual joint ventures are one of the most popular types of joint ventures in the petroleum industry.

Contractual joint venture (CJV) appears as an appropriate conservatory of JVC since underscores the instrument under which JVC is constructed. It is hence, anticipated that JOAs incorporate the several activities and associations of an oil and gas trade. CJV primarily hinges on a contract and is comparable to partnerships except for the fact that co-ventures take production in kind.⁹ In CJV, host countries and foreign oil firms jointly possess the materials and machineries of the venture and the output. This aspect implies that host nations and foreign oil companies have a direct possession of the venture, a factor that makes CJV more beneficial than joint venture corporations where parties have no direct possession. In the case of risks, CJV ensures that participants are evenly responsible for the project’s risks.

Joint Venture Corporation

Another viable legal vehicle that a joint venture can be established is the joint venture corporation.¹⁰ Under this legal vehicle, the corporate statutes of the host country regulate the joint venture agreement. The element of ownership depends on the stake the corporation as well as the percentage of each partners’ contribution. The corporation statutes will determine how much the foreign oil companies will own.¹¹ This aspect suggests that the stakeholders can only claim the benefits from the sales of the oil and gas but do not own the crude oil production. Since under this legal vehicle the host nation and the external oil firm have disparate legal entity in the ownership of the oil production, it does not suit countries that desire to have complete ownership of their wealth.¹²¹³

Furthermore, a Board of Directors (BOD) is formed to govern and control activities in the oil project. The BOD makes the final decisions for the corporation, which implies that both the host country and the foreign oil company only have indirect control of the oil project by selecting individuals who form the BOD.¹⁴ Moreover, the host state and the foreign oil firm merge, thus making the host to lose its original identity. Subsequently, countries that desire to preserve their original identity are likely to circumvent this legal vehicle. The only merit of the joint venture corporation is that the shareholders have a limited liability. However, in most scenarios the stakeholders are the guarantor of the loans taken to complete the projects and consequently, the shareholders’ capital may be used to settle its obligations.¹⁵

Joint Venture Partnership

This legal vehicle is subject to the rules and regulations of the pertinent nations. Though a partnership can be founded by either a written or an oral agreement, partners in an oil project prefer a written contract to avert any dispute that may arise. All the partners have complete ownership of the project including the machineries and amenities. In the case of control, the management is less rigid than that of a corporation. All the partners have identical privileges in governing the joint venture partnership.¹⁶ However, the partners should discreet to ensure that they incorporate the needs of every member. The probable demerit of this legal vehicle is that the partners have unlimited liability. The partners are directly liable for the numerous debts that are likely to be witnessed in the project. Though limited partnership can act as a solution to this impediment, it creates another demerit. Limited partnership reduces the authority partners have in managing the venture.

Advantages of JVCs on Part Government

Joint Venture agreements have a number benefits to the government of the host state. Since both the government and the foreign oil company work as a unit, they are able to share ideas and hence, make reliable decisions for the venture. The host country gains from the experience of the foreign oil company and acquires some of its technical expertise. Moreover, the host country earns revenues such as royalties and taxes from the venture.¹⁷

Demerits of JVCs on Part Government

Depending with the legal vehicle chosen by the stakeholders often have unlimited liability and hence mutually share the risks and cost incurred in the oil project. All parties are also accountable for possible liability such as environmental degradation. The process of forming the joint venture is normally tedious as the negotiation process is extensive. The extensive and delicate nature of JVC requires the incorporation of professionals in petroleum contracts, a factor that makes the shareholders to increase their expenditure.¹⁸

Service Contracts

Normally, the host states aspire to have more power in controlling the manner in which the resources that contribute to their economic affluence are explored and exploited. This aspiration to develop a form of agreement would ensure mutual association with foreign companies with regard to three variables- ownership, regulation, and risk- that has inspired many countries to adopt other types of petroleum agreements such as Production Sharing Agreements (PSAs) and Service Contracts (SCs). SCs enable host countries to exert control of their resources through the creation of private companies, which are compelled to observe certain delimited responsibilities.

Contrary to the contemporary concessions such as PSAs and JVCs, service contracts are seen one of the best channels that the host government can acquire complete administration of a venture.¹⁹ In this scenario, the host state only permits a foreign oil firm to enact a discreetly enclosed task. The firm cannot be apportioned the revenue yielded from the project. Hence, the controlled gained by the host state in the resource is insignificant.²⁰ The host government should provide most of the amenities and capital. However, this element is not normally applicable if the exploration risk capital is requisite as it is often used for minor venture. SCs fall into three major categories, viz. “risk service contract (RSC), pure service contract (PSC) and technical assistance contract (TAC)”.²¹

The RSC tackle is applicable in a scenario whereby the host state wants the private firms to assume all the risks of exploration. Two situations should transpire, viz. the foreign oil company can succeed in getting a commercially exploitable resource, or it can fail. If the company in successful in its venture, then it is reimbursed. However, if it fails in the mission, then it receives no payment. The foreign oil company is given minimal authority in governing the venture.²²

PSCs are similar to RSC but they are more definite. A firm is contracted to work on particular projects, and once the ventures are complete, they are remunerated. The host state bears all the risks and expenses that may arise in the project. Moreover, the company is also apportioned part of the interest received from the sales of the extracted oil. However, the capacity of TAC is contracted. Similar to other contracts, a private company is assigned delimited duty to perform and is later given fixed reparation. Nevertheless, under this contract, the oil firm is not apportioned part of any interest earned from the extracted resource. Notably, TAC is analogous to transnational public-private partnership, whereby the host state has most supreme member of the partnership.²³

Frequently, SCs are preferred in situations whereby a country wants to promote nationalism. The manner in which a state values its sovereignty plays a major role in determining the type contract the country chooses. However, it is crucial to note that choosing a contract relates directly to rhetorical desires as everything else. Many countries prefer service contracts because the host government more authority in governing the project. Although the SCs allow the host nations to control the oil fields autonomously, the search and extraction of crude oil usually incorporates several intertwined activities. This factor discourages co-venturers because they cannot assume all these activities.²⁴

Examples of Risk Service Contracts in Asia and Africa

In 2012, the Coastal Energy Company signed a RSC to work on a project that involved three trivial areas along the offshore of Peninsular Malaysia at a cost of three million dollars. The venture was estimated to last three years.²⁵ According to the agreement that Coastal signed with the Petroleum Nasional Berhad (PETRONAS), the company was to establish and generate oil in Banang, Kapal, as well as Meranti (KBM Clusrer). Furthermore, Coastal is anticipated to own seventy percent of the shares and claim thirty percent of the interest earned from the venture. Coastal has committed to finance the project in areas such as the drilling and extraction of the oil and in return, they get reimbursement fee whilst PETRONAS own the venture. The marginal fields that the firm will undertake the project are separate by about 20 kilometres with a depth of 60 meters of water. Although the main areas expected to be drilled are rich oil field of Miocene ancient sandstones, the company is also planning to drill other areas within the region it perceives to be rich in oil.²⁶

In Nigeria, Agip Energy and Natural Resources (AENR) have committed themselves to provide their services under the service contract (SC). The agreement was meant to cover the oil rich zones of Agbara and Okono. Since its integration in 1979, the Agip Energy and Natural Resources Company has formulated a number of objectives that it intends to accomplish in Nigeria. It intends to raise the amount of hydrocarbon production by ten percent and establish gas resources all over the incorporated ventures upstream as well as downstream. Furthermore, as it progresses with their activities it anticipates that its operation will not have a negative impact on the health, security as well as the environment of the Nigerian constituents. The company has also embarked on improving development agendas for social communities.²⁷

Iran has also employed RSC under the pseudonym of buy-back contracts in some of its oil projects, for instance, Conoco signed an RSC to extract oil in Sirri A and E fields. A comparison of RSC and Productions Sharing Contract reveals that under RSC the International Oil Companies are more susceptible and if the shareholders do not receive higher returns, their contribution in Iran is likely to be stagnant.²⁸ Furthermore, the RSC has no structures that ensure that risks associated with production rates as well as development expenses are reimbursed, a factor that discourages contractors. In case the expenses surpass the original agreement then the International Oil Company shoulders the additional costs, which the investment threats and minimises the interest that the investors could have received. A discreet scrutiny of these two types of contracts confirms that the main disadvantage of the RSC is that it offers no alternative for concession and PSC agreements. Hence, if the key objective of the Iran is to avert the foreign domination of their oil and gas resource, that goal is only achievable if Iran established investor-friendly choices.²⁹

Conclusion

Though all the petroleum agreements have a similar intent, they are disparate when it comes to the ownership of the oil fields, the level of regulations over operations, as well as the role of the national oil company in bearing the risks incurred in the project. JVC is a relationship of individuals or firms that participating in a mutual mission and each participant gets a portion of the outcome. In the case of SCs, the company is contracted to perform delimited tasks and is remunerated after the project but the host state maintains ownership of the project. The most suitable contract to choose for the contract between 50- 250 million dollars would be a service Contract. Nonetheless, this choice will rely on the capability of the host country to provide for the relevant facilities coupled with bearing all the potential risks.

References

Bina, C, ‘Petroleum and Energy Policy in Iran’, Economic and Political Weekly, vol. 44, no. 1, 2009, pp. 19-23.

Bret-Rouzaut, N & J Favennec, Oil and Gas Exploration and Production: Reserves, Costs, Contracts, 3rd edn, TECHNIP, Paris, 2011.

Coastal Energy, Offshore Malaysia, 2012. Web.

Heaton, P, ‘Oil for What: Illicit Iraqi Oil Contracts and the U.N. Security Council’, The Journal of Economic Perspectives, vol. 19, no. 4, 2005, pp. 193-206.

Kuhn, M, & M Jannatifar, ‘Foreign Direct Investment Mechanisms and Review of Iran’s Buy-Back Contracts: How far has Iran gone and how far may it go’, World Journal Law Bus, vol. 10, no. 1093, pp.21-25.

Low, LA, PM Norton & DM Drory, International Lawyer’s Deskbook, 2nd edn, American Bar Association, Illinois, 2003.

Mazeel, MA, Petroleum Fiscal Systems and Contracts, Verlag, Hamburg, 2010.

Mincato, V, Field Trip to Nigeria, 2002. Web.

Footnotes

1. LA Low, PM Norton & DM Drory, International Lawyer’s Deskbook, 2nd edn, American Bar Association, Illinois, 2003, p. 21.
2. N Bret-Rouzaut & J Favennec, Oil and Gas Exploration and Production: Reserves, Costs, Contracts, 3rd edn, TECHNIP, Paris, 2011, p. 35.
3. V Mincato, Field Trip to Nigeria, 2002, p.2
4. P Heaton, ‘Oil for What: Illicit Iraqi Oil Contracts and the U.N. Security Council’, The Journal of Economic Perspectives, vol. 19, no. 4, 2005, pp. 193-206.
5. Low, Norton & Drory, op.cit., p. 27.
6. Mazeel, op.cit. p. 38.
7. Ibid, p. 40.
8. C Bina, ‘Petroleum and Energy Policy in Iran’, Economic and Political Weekly, vol. 44, no. 1, 2009, pp. 19-23.
9. Heaton, op.cit. pp. 193-206.
10. Bret-Rouzaut & Favennec, op.cit. p.98.
11. Low, Norton & Drory, op.cit., p. 30.
12. M Kuhn & M Jannatifar, ‘Foreign Direct Investment mechanisms and review of Iran’s buy-back contracts: How far has Iran gone and how far may it go’, World Journal Law Bus, vol. 10, no. 1093, p.21.
13. Bina, op.cit., pp. 19-23.
14. Mazeel, op.cit., p. 43.
15. Low, Norton & Drory, op.cit., p. 36.
16. Heaton, op.cit., pp. 193-206.
17. Low, Norton & Drory, op.cit., p. 36
18. Bret-Rouzaut & Favennec, op.cit., p.50.
19. Mazeel, op.cit., p. 38.
20. Bina, op.cit., pp. 19-23.
21. Low, Norton & Drory, op.cit., p. 27.
22. Coastal Energy, Offshore Malaysia, 2012. Web.
23. Kuhn, & Jannatifar, op.cit., pp.21.
24. Heaton, op.cit., pp. 193-206.
25. Coastal Energy, op.cit., p.1.
26. Kuhn, & Jannatifar, op.cit., p.21.
27. Mincato, op.cit p.1
28. Bina, op.cit., pp. 19-23.
29. Heaton, op.cit., pp. 193-206.