The piece “Technical File with Grain Malunga: Production Sharing Agreements” featured below was initially published in Malawi’s Mining & Trade Review Issue Number 38 that is circulating this June 2016.

The full edition is available for download here. This monthly publication is edited by Marcel Chimwala.

TECHNICAL FILE

Production sharing agreement

by Grain Wyson Phillip Malunga FIMMM Mining and Environmental Management Expert

Abstract

Production Sharing Agreement (PSA) is a contract entered into between government and a private company wishing to explore, develop and produce petroleum. This agreement contains clauses that stipulate agreed upon methods for allocation of petroleum produced and payment of royalty and taxes due to government.

This paper tries to highlight the nature of PSA and how it can promote sustainable development.

Introduction

Production Sharing Agreement (PSA) is a contract that a state gives to a mining company or petroleum company to explore and develop a concession. This is on the understanding that natural resources are vested in the state on behalf of its citizens. The state can be represented by a State Owned Enterprise (SOE).

The state leaves all the expenditure for exploration and development in the company or may fully fund exploration and development of the resource and contract the company to develop and operate in exchange for part of the production. The PSA provides for the establishment of a joint committee where both parties are represented and which monitors the operations.

Drafting Principles

The principles for entering into this agreement are guided by the taxation and fiscal regime of the country; and the Petroleum Exploration and Production Act. PSAs are distinguished from other types of contracts in that the private company carries the entire exploration risk without compensation and that the state owns both the resource and the installations.

Production Sharing

The private company pays a royalty on gross production to the government. After the royalty is deducted, the company takes its pre-specified share of production for cost recovery. The remainder of the production (profit oil) is shared between government and the private company at an agreed share arrangement. The private company continues to pay income tax on its share of profit oil. This taxation framework incorporates incentive structures, risk and reward-sharing. The whole arrangement points to reimbursement of development capital and a fair share of the business profit to the private company. See Fig. 1 below.

The other state revenue will be in form of signature bonus, discovery bonus, production bonus, import and export tax and wind fall tax.  It is worthy noting that income tax is deducted on profit income. This tax becomes effective when the private company starts production and not during exploration and development.

In Africa mature or established economies can have between 60% and 80% share of the proceeds from an oil and gas project while new entries may get between 50 and 55% (Fig. 2).

Sustainability

PSAs are designed to maximize government revenue while at the same time to provide sufficient incentives to investors. The investor’s revenue is made up of cost oil and profit oil, while the government’s revenue comprises royalties, profit oil, bonuses, taxes, customs duties, and indirect benefits that arise from local content goods and services. The contract also determines who manages the operations and how issues of environment, local economic development and community rights are dealt with.

The project’s sustainability is measured through high return on investment for the investor. Government measures it through revenue generated, economic growth, infrastructure development and technology transfer while the community or citizens look at social investment (e.g. schools), environmental protection and economic benefits (e.g. employment).

Mineral resources can contribute to sustainable development through recognition of the fact that they are exhaustible, revenues or their prices are volatile and the resource industry is vulnerable to corruption and mismanagement. In this case there is need to establish future generation fund and/or stabilisation fund to address issues of national investment and governance of budget plan.

Conclusion

Production Sharing Agreements are a modern means of entering into agreement between state and investment companies in exploring, development and exploitation of oil and gas for the benefit of the two parties while understanding that the resources belong to the people. It is for this reason that all contracts should be transparent and accessible to the people.

The sharing agreement takes into account cost recovery and profit sharing while being mindful of environmental sustainability and local benefits for the local communities.

References

Anderson, R.O. (1984). Fundamentals of the Petroleum Industry. Norman: University of Oklahoma Press.

Beredjick, N/ Walde, T.W. (1988). Petroleum Investment Policies in Developing Countries. London: Graham & Trotman.

Dam, K.W. (1976). Oil Resources: Who Gets What How? Chicago: University of Chicago Press.

Open Oil. (2013). Oil Contracts – How to read and understand them.