How Does Petroleum Licensing Work Around the World?
Any person who wishes to undertake exploration, extraction, or production of petroleum is required to hold a valid licence in this regard. A robust licensing system is put into place to ensure clarity on the procedures and precautions for the work of petroleum exploration and production. It also helps to obtain certainty that the company or joint venture engaged has the appropriate technical and financial qualifications to undertake the job in a socially and environmentally responsible manner.
The licenses are awarded by the government after assessing and deciding on whether to explore and develop blocks of the petroleum sector. In some cases, direct negotiations are followed if competition in the bidding area is insufficient or if direct negotiations are stipulated by regulation. In such cases, having a model license that elaborates the terms of award would aid in having fair negotiations.
Potential investors must have their credentials vetted, in which a set of criteria is set to be fulfilled as a good practice for the award of the license. In the past, licenses have been awarded basis negotiations; however, in the interest of transparency, these practices have faded. The investor’s work commitment should be quantified in both physical and financial terms. Financial terms can be the minimum expenditure to be made.
The licence is usually allotted by the state. Allotment typically takes place in either competitive licensing rounds or an open door/direct negotiation approach. Under the licensing rounds, licenses may be allotted by way of competitive bidding or auction procedure. The procedural details can vary from country to country.
Most bids are made by consortiums of companies that pool together financial, technical, and commercial resources. Through this arrangement, they have a way to share risk and administrative costs as well. Competitive bidding is the method adopted when investor interest is forthcoming and geological knowledge is sufficient. In competitive bidding, the state is capable of properly evaluating each proposal and the biddable items under the tenders. Bidders are often more knowledgeable about the geology than those on the side of the state. This informational discrepancy can play against the state in a negative way. In competitive bidding, there is more transparency of the process and this is a major advantage. Prior to competitive bidding, a mutual interest agreement, a joint bidding agreement and a confidentiality agreement need to be signed. The confidentiality agreement acts to ensure sensitive information shared with the other participants is not shared unduly.
In an auction, the highest bidding party obtains the rights of exploration/production. A single term of the rights is used as the focus of the auction – for example royalty or the signature bonus. Different parameters used in the bidding process are:
- Signature bonus – The rights are granted to the investor who submits the highest upfront amount of cash. Revenue stays with the government irrespective of whether a discovery is made or not.
- Work programmes – The investor bids that they will complete certain exploration tasks and milestones within a specified amount of time that appears competitive to the government. The exploration costs incurred are usually recoverable and tax deductible.
- Royalty – The investor who offers the highest royalty rate is awarded the rights. Sometimes, payments are stated to be conditional upon commercial discovery and the future production that happens thereafter.
- Profit sharing – The highest share of the profit offered is paid attention, and that investor is awarded the rights.
- Bundled bidding – This option combines the criteria of development of infrastructure by the bidder with award of rights to exploration and production of petroleum. The bidder will be required, under the conditions of the license, to develop the local infrastructure around the area.
Open Door Method
Where geological information is limited and investor interest low, the host state may opt for an open door, first-come-first-served method of licensing. Certain preliminary criteria like qualification of applicant, evaluation of the application, and negotiations will be taken into account. The risk with an open door method is that, by holding considerable discretionary power, the government may not reveal the criteria for the award to all applicants. Therefore, this method often carries the weight of corruption and lack of transparency. The process can be salvaged by publishing the award criteria and having the proceedings supervised by an external body. Further, regulation can help improve transparency by providing for a procedure and documentation to carry out open door negotiations. The procedure could include the following considerations and guidelines:
- Whether specified blocks will be opened or not
- Contents to be included in the application
- What a satisfactory application looks like
- Appropriate negotiation practices
- If an application that follows an open-door policy triggers competitive application
Licenses are usually granted by the state for a prescribed period of time in accordance with legislation of that country. When the time specified by the license has elapsed and the company or joint venture has not made a discovery, the license needs to be surrendered. A similar fate awaits companies or joint ventures that do not fulfil the minimum requirements the government imposes as a precondition to holding the license. These minimum requirements include investment on seismic, minimum number of wells to be dug, and more. The surrendered license may be re-attributed in the next round or kept surrendered if the government believes that area of petroleum exploration holds little interest.
Components of a Licensing Policy
The formulation of a state’s petroleum licensing policy should incorporate the following elements:
- Country-level identification of priorities of the state’s petroleum exploration and production – it is essential to consider the interests of industry as well as citizens
- Identification of exploration zones in the country; to go with each zone, exploration strategies and plans of action should be decided on
- Comparative review of the terms under which exploration and production of petroleum is being offered to the private sector
- Adjustment to fiscal, legal, regulatory, and contractual regimes in force based on review
- Strategize promotion of exploration and production opportunities internationally to attract the most qualified applicants or obtain additional investment from already-active companies in the country
Components of an Action Plan for Licensing of New Blocks
When formulating an action plan for licensing new blocks, consider the following points:
- Conducting a geological survey for the areas to be opened up to decide on areas to be opened up, to evaluate geological potential, and aid international promotional efforts
- Deciding on the areas to be opened up for exploration and prioritizing areas for allocation in rounds to be held
- Collation of geological information to be provided to applicant companies and joint ventures for perusal before the rounds
- Selecting the blocks to be opened for the round and the size of each block – the state may approach interested companies to point out the blocks they are most interested in to help them in the selection process
- Terms of reference of each round, including contractual and fiscal terms, and the procedure for submission of the applications
Mitigation of Risks in the Licensing Process
Investors are mostly concerned with the lack of transparency and regulatory uncertainty in the licensing process in the petroleum sector. Further, it is a capital investment venture where returns are only achieved after a significant time period. An assessment of risks prior to formulating the licensing rounds and model contracts will go a long way to mitigate some of these risks. Though an investor can avail of dispute resolution mechanisms or apply for compensation from the state, investors are usually averse to such measures. These procedures tend to throw a wrench in their business activities. Some of the risks to be assessed include:
- International competition for capital
- Investors’ familiarity with certain areas, whether inland or offshore
- New information that has emerged that might make a particular area attractive to investors
- Legal frameworks that increase certainty, a key factor that investors seek
Factors in Measurement of a Successful Licensing Policy
- Competitive environment: Where there is healthy competition among investors, it will likely result in the most favourable outcome for the state. Healthy competition also helps to regulate asymmetry of discrepancy of geological knowledge between investors and the state. This asymmetry often results in a disadvantage in negotiations for the state. It is also a disadvantage in the early stages of development of the extractives sector when data sharing norms are not established.
- Institutional capability: Governments need to ensure their ability to devise proper licensing rounds, seek out the most qualified investors, evaluate their contract proposals, etc. This will require adequate professional skills in the technical, legal, and commercial areas of the subject. Pending development of these skills by the government, it is advisable to seek the help of external experts.
Conflict Between National and International Law
Often, conflicts may arise when investors try to find loopholes in international laws to concoct a situation in the state of operation that is more favourable than what is permitted under that state’s legislation. To minimize the occurrence of such conflicts, governments can take the following measures:
- Clarify whether the investment regulations of the host state are applicable to investments in petroleum exploration and production. Usually investment in petroleum exploration and production forms are part of a different set of laws that address the industry specifically.
- Check the applicability of any bilateral or regional investment treaties entered into with other countries. Sometimes these treaties contain “fair and equitable treatment” clauses with the potential to be misused by entities in the petroleum sector, though they may not be applicable.
- Check the applicability of any double taxation avoidance agreements. These treaties may be misapplied for the purpose of undue tax benefits.
Licensing regulation should articulate the objectives and responsibilities of the various parties engaged in the licensing process. It should simultaneously aim to minimize abuse of power.
Types of Contracting Arrangements
Once the license has been awarded, arrangements will have to be made for the form of the agreement between the state and investors. Three types of agreements may occur that lay out the terms of the relationship between the government and investors. They are as follows:
Concession agreements result in ownership of all production by the petroleum company or consortium. In turn, the company pays a royalty to the state. The royalty may be in cash, in kind, in the form of additional taxes on profits, or some other kind of fee or contribution. Typically, the company has the right to explore, exploit, market, and own the petrol, as well as own its equipment and infrastructure. Ghana uses this model.
Production Sharing Agreements
Under production sharing agreements, the company does not own the entire output of production. Instead, they agree to take a share of the production output, while the government can set conditions on the balance share. The arrangement usually takes the form of the government supplying the equipment and infrastructure but retaining ownership thereof. The company supplies technical know-how and capital and shoulders the risk of the project. Unless otherwise agreed, the company also pays income tax on profits to the government in addition to any other fees and contributions required by law and under the contract. Angola, Egypt, Tanzania and Mozambique use this form.
Risk Service Agreements
Risk service agreements are typically suggested by governments of countries that take a nationalistic approach or by countries with established petroleum production stances, such as Venezuela or Iraq. The country’s government merely hires the services of the company or consortium in order to leverage on its technical expertise and capital. The company is compensated for its services with a service fee and assumes the project risk as well. Iran used to use buyback agreements, which eventually proved too much of a liability for any private investor to take up.
The must-have’s of these contracts are features like exploration, appraisal, development, production, abandonment, conduct of operations, confidentiality, contractor qualifications, health and safety, environmental, reclamation, decommissioning, liability, local goods and services, training and employment, taxation, foreign exchange, ownership and assignment of rights, and more.
Types of Consortium Agreements
Petroleum companies may pool their resources in the form of one of the following agreements to expand access to awards. This diffuses the risk associated with the petroleum sector, as well as allows companies to spread out the costs. These formations may also be required by legislation of the state for the purpose of operating petroleum activities in a joint manner:
A joint venture may be an incorporated or unincorporated entity. The most common structure used in petroleum contracts are unincorporated joint ventures. No separate legal entity is formed, and activities are governed under an unincorporated joint venture agreement. There are no separable interest shares. The operations are managed by a commonly appointed joint operator or committee. A confidentiality agreement is usually signed because sensitive technical data is often shared.
State Participation Agreements
State participation agreements enable a state or a state-appointed authority or an ad-hoc entity created for the purpose to commercially participate in the joint venture. The intent is to allow the state to participate in the decision making process and benefit from the technical know-how of the petroleum companies. This type of agreement is popular in high price environments, as participation happens on a commercial basis. The state becomes an investor and a risk-taking partner.
When one party of the joint venture assigns a portion of the undivided interest in an area to an existing partner or a new party, they may do so by way of a farm-out agreement. Under these agreements, the assigning party is termed the “farmor” and the recipient the “farmer” or “farminee.” In return for the assignment, compensation in the form of commitments to fund certain work or cash is typically exchanged.
Unitisation is the joint operation of a petroleum reservoir by various licensees or right holders in an integrated manner governed by a unitisation agreement. Licenses or petroleum agreements very often include provisions for unitisation. Unitisation refers to exploitation that crosses the borders of more than one license or contract area awarded by the state. Unitisations that cross over into another adjacent host country is called an international unitisation. A treaty signed by both countries usually accompanies this arrangement.
Recent Global Openings
In 2019, there were 28 licensing rounds opened up across the global oil and gas sector. Africa and Asia made up the highest volume of licensing rounds in terms of the number of countries. Eight Asian countries and five sub-Saharan African countries hosted one round each. Africa opened up about 220,000 square kilometres, mostly offshore, with Asia releasing blocks smaller in size with fewer blocks released. Lease Sale 252 in the United States offered the largest volume of acreage at approximately 317,000 square kilometres.