How Oil Production Sharing Contracts Work

In a production sharing contract (“PSC”)  the host country’s government awards to an oil company (or group of companies, typically called the Contractor) the rights to explore in a specified area and following discovery of hydrocarbons in such area the right to produce such discovered resources. The Contractor initially bears the risk of finding hydrocarbons and the financial risk of the initiative and explores, develops and ultimately produces the field in accordance with the terms  of the PSC. When successful, the Contractor is permitted to use the money from produced oil sales, after payment of royalties owed to the host government, to recover its capital and operational expenditures, known as “cost oil”. The remaining money is known as “profit oil” and is split between the government and the Contractor. In some PSCs, changes in international oil prices or in the field’s production rate affect the company’s share of production.   

The contract term is frequently comprised of an Exploration Period and a Development Period each with a time frame and work commitments. The time frames can often be extended depending on the circumstances and approval of the host government.   In the event of a commercial discovery and subsequent delineation of the relevant field, the term for development and production can, for example, be 20 or more years with additional extensions possible. 

Often in PSC’s, the acreage included in the contract area and not converted into a producing field may be required to be relinquished at pre-agreed rates which can range from 25% - 100%, at the end of certain time periods.

The calculation of the oil revenue flow can be quite complicated – things to consider are royalties, cost recovery oil, profit oil, total profit oil (sharing based on “R Factor” which is a ratio of cumulative revenues to cumulative costs), production-based bonuses payable to the host government (sometimes called a “capacity building bonus”).

An outline of the Atrush PSC Revenue Flow of General Exploration Partners. Inc. (the wholly owned subsidiary of ShaMaran Petroleum Corp.) is shown below as an example.

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