Introduction To Oil & Gas Contracts
The report has identified all the aspects of contract dealt in oil and gas industry. The report has taken various examples of real time and illustrated various risks associated with business in conducting the best interest of contracting parties. The report also seen there are various kinds of contracts and agreements which can be used to define contract legitimacy in the business agreements1. The report has taken advantage of numerous case law and instances where contract has played the best interest of contracting parties to ensure they are follow government rules and regulations. The contract terms must confer the profit and cost output of various businesses in the course of main contract obligations. The rules and regulations must seek how the profits will be divided and cost will be met out
Oil and gas markets are very volatile and risk prone. The associated risk which is perceived will bind numerous parties to follow a strict line of guidelines in availing best interest towards each party. To ensure they are protected and associated characteristics, contracts play an essential role in identifying best grievances and opportunities to each party. In oil and gas markets there are various kinds of players, they also faces same kind of risks e.g. mechanical breakdowns, unfavourable price fluctuations, other natural calamities1. The element of risk management is to allocate them among various institutions and industry participants. Such diversification will prevent and preserve the interests of market intermediaries on account of loss.
To mitigate such scenarios in O&G industry, there are 3 different kinds of contracts exists. They are;
Indemnity: Under indemnity, it is suggested that indemnifying party agrees to make a specific payment towards a party in the benefit of indemnity on occurrence of loss suffered by the indemnified. For instance, Farstad Supply V VS Enviroco, states that clause which holds both phrases “indemnify” and “hold harmless”. Indemnify not only works unilaterally but bilaterally as well. In bilateral indemnify, the risk allocation is bifurcated among two different parties. They hold equal majority of benefit and risk in contract obligations2.
Indemnity is an assorted concept it can be simple, mutual and separated. It can also be a combination of various service contracts as well. A well known contract is operated between operator and contractor indemnity3. In indemnity contracts, it holds protection against certain future loss. Such exclusion will be borne by paying a sum of money in compensation to other party. The liability broke from such scenario must entertain in O&G industry.
In the instance of indemnity, Deepwater Horizon, an oil rig which was exposed to an explosion and created huge oil spill in the history of U.S. On 20th April, an explosion in the main line of rig exploratory cavity turned into a massive firestorm for other killing a team of 11 members. The estimated loss was accounted for $200millions4. The contract was between Transocean and BP. The insurance cover could not handle the burn out of such huge losses.
But using any power of option, the contract term must follow a stratified regulatory power to protect public interest. While drafting any oil and gas contract, they need to understand two most important risks between the contracting parties. They are profit distribution and cost outlay incurred. But such risks are nominal, if they are backed by faulty information. The information lacks on the sides of extracting improper information and uncertainty of information. Such issues arises when there is insurability that when they will be discovering or how much cost it will incur to explore the reserves under a given period. The global prices are also a factor to identify various contract terms. The prices tend to fluctuate very second this affects the profitability and cost ratio for the company. The sustainability of business also gets affected there is only 1 % chance of exploring any suitable and compatible reserve. In contract government need to understand the risk perspective and based on that contract type is selected. They are concession agreements, production sharing agreements, joint venture and license agreements.
Concession agreements or license agreements are those agreements where they are provided with exclusive rights to explore, develop and sell the exports of shale reserves or natural resources at prevailing rates. Such licenses are provided for a fixed period of time. The bids are placed to earn license in the governing sides and other regulatory bodies have to ensure they follow all the necessary regulation and restrict any monopolistic trade practices etc1. such agreements are very simple and yet very acceptable and trustworthy in various sectors. Certain agreements are very unrealistic because all the bids are done on seismic concentrations.
They may prove very much false and such bids may become a loss for the company2. A case from Russia shows where drilling bore has reached to its maximum point but the research lagged to acknowledge the shale reserves is Kola Super-deep borehole3. The digged upto a point of 12,262 meters to search for natural resources, but they found no such reserves. Lastly this shows that, contract drafting for oil and gas industry is very complicated in when entertaining things in broad spectrum.
In lieu of avoiding high risk perspectives, Joint venture may include various partners from similar industry or different industry to achieve a single objective. A host government and private enterprise partnership is called as Joint venture4. The risk management is very lenient because the joint venture will diversify all the decisions and risk between partners. The joint venture will divide the profits and costs as well. The Loss making structure will be borne by both parties and this will affect the partnership to run long run. Production sharing agreements are also very demanding in this type of purchase.
Under PSA agreements, they provide a heavy dependency on the financial structure, they holds maximum percentage of cost. The foreign oil company and national oil company will join hands and for a fixed time period they will remain united to explore and divided the profits among different players as well5. Government will receive a part payment as royalty in form of revenue, after a certain time period the ratio of profit sharing will change and foreign corporations share will reduce in this time period. The portion of government will rises in the mean time. Government also receives a higher share on the taxes received by the foreign company on the payment of taxes. All financial and operational cost be carried out by the foreign companies6. The host government incurs the cost of negotiations, they also not entail any opportunity loss and they also do not incur any material loss, if project fails in the context.
In drafting a contract, they need to follow a specific accounting method to account profits in the business. The contract provision must satisfy all the notions and concepts before recording any profits in the business. They also need to understand the fact that, they had to undergo International accounting standards to design accounting principles to match the competing needs of oil and gas industry under various contract agreements. The expenses are incurred by the company will also entitled to get the remuneration on the costs as a result of tax credit in the total outlay7. The taxation and compensation will also get enriched, because any profit or expenses which are incurred must get benefit from tax deductions. These deductions will define how much they are entitled to receive at the earnest. The price strategy must satisfy all the needs of business in oil and gas sector8.
In any business contractual relationship is very necessary, establishing best interests of business and contracting parties. The contracting parties need to establish how well they are performing the activities in the ordinary course of transactions1. They are various instances where they various exposed to huge scam and calamities which were borne by the contracting parities. This makes contracting regulations more necessary to implement in such scenarios, to provide safeguard measures to meet out such uncertain liabilities. The report has covered all the immediate and long gone rules and regulations2. The rules and regulations must be prepared
- Blanchard, C., Iraq: Oil and Gas Legislation, Revenue Sharing, and U. S. Policy. (DIANE Publishing, 2010)
- Butte, G., A Model Oil and Gas Contract. (University of Texas, 1912)
- Chandra, V., Fundamentals of Natural Gas: An International Perspective. (PennWell Books, 2006).
- Favennec, J., Oil and Gas Legislation. (PennWell Books, 2008)
- Gallun, R., , Fundamentals of Oil & Gas Accounting. (Pennwell Books, 2008).