Abstract
This study examines the evolution and management of Production Sharing Contracts (PSCs) within the Nigerian oil and gas sector. As the industry shifts focus toward deep offshore and inland basin acreages, PSCs have assumed a position of prominence. The paper details the operational mechanics of these contracts—specifically the concepts of “Cost Oil” and “Profit Oil”—and evaluates the legal framework provided by the Deep Offshore and Inland Basin Production Sharing Contracts Act of 1999. By analyzing the fiscal incentives, royalty regimes, and the transfer of technical risk to contractors, the research highlights how PSCs alleviate the financial burden of cash calls on the host government while fostering long-term industrial growth.
The Framework of Production Sharing Contracts
The introduction of Production Sharing Contracts (PSCs) in the new offshore and inland basin acreages is gradually assuming prominence in the entire industry. As the name implies, PSCs focus on the sharing of the output of oil and gas operations in agreed proportions between the Oil Company, as a contractor to the government, and the National Oil Company (NOC), as the representative of government interests in the venture.
This form of contract originated in Indonesia in 1966 and was modelled along the lines of sharecropping in agriculture, where the owner of the land grants a farmer the rights to grow crops on his land and shares the proceeds with the farmer in agreed proportions after the harvest. Under a PSC, the contractor, usually a foreign oil company, bears the entire cost and risk of exploration activities, and only reaps the rewards after a commercial find.
Cost Oil vs. Profit Oil
In the event of a commercial discovery, the contractor recovers its costs fully from an allocation of oil referred to as “Cost Oil.” Allowance is also made from production for royalties, after which the remainder of the production, called “Profit Oil,” is shared in agreed proportions between the company and the government as represented by the NOC. The Oil Company thereafter pays income tax on its profits from the venture. The oil and all the installations remain the property of the host government throughout the duration of the contract.
The Nigerian Regulatory Environment
In Nigeria, this form of contractual arrangement is relatively new and covers mostly acreages in the shallow and deep offshore areas and the inland basins. The major operators in Nigeria are still largely the holders of the PSCs, but there have also been new entrants, made up of independent foreign oil companies, which enter into partnerships with indigenous companies to bid for oil blocks and thereafter operate in line with predetermined contractual arrangements.
In addition to the specific contracts signed with individual companies, the main law which regulates the operation of PSCs in Nigeria is the Deep Offshore and Inland Basin Production Sharing Contracts Act No. 9, Laws of the Federation of Nigeria, 1999. This law sets out the general framework for the operation of PSCs, including the applicable royalties, tax regimes, and the manner in which costs and profits are allocated between the parties.
Fiscal Provisions and Taxation
The 1999 Act provides for the following:
- Taxation: A flat rate of 50% tax on petroleum profits by PSC operators.
- Royalties: Variable regimes depending on water depth, ranging from 12% for depths of 200–500m to 0% for water depths in excess of 1,000m.
- Inland Basins: These acreages attract a flat royalty of 10%.
- Revenue: In addition to taxes, the government earns revenue from signature bonuses paid by oil companies upon successful bids.
Advantages and Drawbacks
Some of the advantages associated with PSCs include the relative flexibility in the management of operations and the fact that there is no financial burden on the host government. Even after a commercial find, the payment to the contractor is in oil, which does not attract any direct financial cost. Leveraging the technical know-how and experience of the companies, the government can focus its energies on other areas of the economy while trusting that the oil and gas industry will develop at an acceptable pace without the usual trappings of cash call constraints.
However, PSCs have some drawbacks, such as the risky nature of the operation. In the event of an unsuccessful operation, millions of dollars could be completely lost—unless local laws allow for costs from one acreage to be transferred to another, which is not always the case. Additionally, because the contractor is usually allowed a relatively unfettered hand to execute its programme, this could lead to allegations of “gold-plating” of costs. The long-term nature of transactions in the oil industry usually mitigates some of these difficulties. In recent times, there has been a conscious shift in the contractual structure of the oil and gas industry in Nigeria from Joint Operating Agreements (JOAs) to Production Sharing Contracts (PSCs).
