Amid a global energy transition, the oil and gas industry still leads the energy industry as the top provider of energy in the world. Its importance to the energy mix (combination of the different energy sources used to meet energy needs) directly responds to the rapid increase in oil consumption these past few years- leading to more exploration activities to meet this demand.
Oil and gas resources are typically owned by the state so the job of exploration and sometimes the production of these resources are usually given to an International Oil Company (IOC) along with the state’s oil company. Petroleum contracts are used to regulate these relationships and can vary depending on the needs of the country.
Like many other resource-rich countries, Nigeria has struggled with adopting a contract that serves both its interest and that of the IOCs. It is evident in its inability to harness its resources effectively and amplify revenue. However, this does not mean that Nigeria has not been successful in particular oil contracts. It has certainly come a long way from concession agreements to petroleum contracts that now allow the development of its oil and gas reserves while guaranteeing IOCs return on their investments.
Leases and Licenses
Through the Department of Petroleum Resources (DPR), the government grants rights to companies to explore or produce oil within well-defined areas for a limited period- known as leases and licenses.
Earlier this year, the NNPC signed some agreements with the Nigerian subsidiaries of Shell, Total, Exxon and Eni, to renew their Oil Mining Lease (OML) 118 for an extra 20 years. Petroleum contracts manage the processes within these leases and licenses.
Upstream operations consist of exploration and production activities that are governed by four main types of contracts. These contracts differ from each other in terms of government participation, profit sharing and resource control. In Nigeria, the government participates and is represented in these agreements by its national oil company, NNPC.
Contract Types
Service Contract
The simple premise of a service contract is the development of resources by the IOC in exchange for remuneration by the government. In this arrangement, the IOC is merely a contractor as it never owns the oil at any point. It promotes sovereignty over the nation’s resources and has garnered popularity in Middle Eastern countries like Iraq and Kuwait, however, not Nigeria. There are only a few service contracts in operation, which include OML 116 by Agip Oil Company.
Pure Risk Contracts
In pure risk contracts, the IOCs are remunerated to take the sole exploration risk and only recover their costs if the phase is successful. Therefore, the IOC accepts the entire financial risk with the reward of keeping any oil found and produced. They are only obligated to make tax and royalty payments as required by law.
This contract arrangement puts the host country in a position to use the IOCs managerial and technological expertise, incurring a low-risk percentage while reaping the rewards. There are currently a few active pure risk contracts in Nigeria. In practice, this arrangement includes mostly local oil companies operating in partnership with IOCs under “sole risk”.
Joint Venture Contracts
NNPC defines this contract as “the basic, standard agreement between the NNPC and its operator”. As the name implies, it is an agreement between the government and oil companies where parties pool resources to cover exploration and production costs while both parties split the rewards. There is usually a balanced risk-sharing formula agreed to by the parties, alongside capital and production sharing based on the parties’ equity share.
With six active contracts, joint ventures are considerably popular in Nigeria and are responsible for most of its oil production. In Nigerian joint venture contracts, the IOCs are usually the operators with explorations funded by both IOCs and NNPC in the proportion of their participation interests.
The NNPC is entitled to an undivided interest based on its majority participatory interest. However, its operation in Nigeria has become problematic due to the inability to meet annual cash call requirements. A cash call is a request by the operator to the parties to pay their share of expenses (operating or capital).
Production Sharing Contracts
Production Sharing Contracts (PSC), were created to fix the issues of the joint venture contracts and also attract foreign investment. A similar arrangement to the service contract, where the IOCs are invited by the government through the NOC to come and explore for oil and sometimes produce.
Here, the IOC bears the exploration and development costs and is reimbursed for its expenses from production. Subject to an agreed production share, the remaining production is then shared between the IOC and NNPC. Ownership and control of national resources remain with the government, and the IOCs become contractors and bear most of the risk. The PSC is now the preferred contractual arrangement in Nigeria with 32 arrangements currently active.
The more you look, the less you see
The Nigerian energy sector has always been somewhat unclear to a larger population of its citizens, partially due to fluctuating policies, poorly drafted clauses within the contracts and secrecy.
Choosing a petroleum contract is contingent on specific considerations; however, the PSC has demonstrated transparency over the other agreements and no challenging payment requirements.
A precise combination of the different contracts is needed to maximise the sector’s potential. Oil contracts are complex, leaving them open to manipulation and corruption. Given the nation’s history with these abuses, these contracts should also be disclosed and made accessible to the public.
