Explained: Production Sharing Contracts (PSCs)

Reading time: 8-10 minutes.

The outbreak of COVID-19 virus has adversely affected the world. In the middle of lockdown, the whole world has stopped. The industries are shut, transportation is stopped and roads are empty. This pause has affected the oil prices in the world as very negligible consumption of oil and natural gas is being carried out. For the first time in history, the oil price has gone into negative. The commerce of extraction and distribution of oil and natural gas is not that simple. There are special agreements between the Government of a country and the oil extracting company. These agreements are known as “Production Sharing Contracts” i.e. PSCs. This lockdown has changed the equations of this industry.

Therefore, the Ministry of Petroleum and Natural Gas has formed a panel to review the PSCs. The committee is established to review existing PSCs and to suggest changes in them.

Significance of this development:

The industry has requested to the Government to extend the existing PSCs till the end of 2021. These contracts are due for renewal in September, 2020. The people in industry have requested to reduce royalties and cess on extraction of natural resources for the financial year 2020-2021 and coming years.

The committee is focusing on domestic production and good increase in investment in this industry.  According to Mr. Dharmendra Pradhan, Minister of Petroleum and Natural Gas, the committee will focus on some major policy reforms for domestic players. Therefore, this is a great opportunity for Indian companies to come into this sector and for investors to invest. Ultimately, this will boost our economy.

What are PSCs?

Production Sharing Contract (PSC) is a term used in the oil and natural gas industry and refers to an agreement between contractor and the Government whereby the contractor bears all exploration risks, production and development costs in return for its stipulated share of (profit from) production resulting from this effort. The costs incurred by the contractor are recoverable in case of commercial discovery.

These contracts are common in Asia as there are many reserves especially in the Middle-East Asia. The PSC was first time used in Bolivia in 1950 for agricultural purposes. Later on, it was used in Indonesia in 1960 for extraction of natural resources. It became famous as soon as the reserves in the Middle-East were found.

Salient features:

The Production Sharing Contracts are special type of contracts used in oil and natural gas extraction industry. Following are the features of PSC:

Parties:

It is a contract between – 

the Government (in whose country the extraction is taking place)

the contractor(s) (company which will actually extract and produce)

Cost oil and profit oil:

The costs and amounts invested in these projects are huge. Therefore, the contractor is allowed to reimburse himself all the cost incurred. Such initial production is known as “cost oil”. The income after deducting cost oil is shared between the Government and contractor. It is known as “profit oil”.

Provisions for natural interest:

Generally, the contractors in this industry have capitalist theory. Thus, PSCs restrict them to extract after some point of time. Also, there are restrictions on production for protection of environment.

Royalty to the Government:

This contract binds the contractor to pay certain amounts to the Government as a “royalty” as he is utilizing and exploiting the resources of that country.

Tax on profit oil:

The contractor is liable to pay the tax on “profit oil” and not on cost oil. It is a general practice to decide the rate of tax in advance in the contract itself.

Legal provisions regarding it:

The first legal provision regarding PSCs is Article 297 of the Indian Constitution.It states that-  

“All lands, minerals and other things of value underlying the ocean within the territorial waters, or the continental shelf, or the exclusive economic zone, of India shall vest in the Union and be held for the purposes of the Union”.

The Constitution declares the ownership of the above mentioned natural resources with the Union of India. Therefore, the Central Government, in the name of the President, can enter into the contract.

Further some other laws and rules provide for extraction and exploitation of natural resources. They are as follows-

Oilfields (Regulation and Development) Act, 1948:

This Act provides for regulation of oilfields and for the development of mineral oil resources. It provides for exploitation of natural resources in public interest. It allows the Central Government to make amendments and repeal any rules and notifications as it may think fit.

Petroleum and Natural Gas Rules, 1959:

These rules were first introduced in 1959 and were amended in 2003. According to these rules, the Central Government is allowed to make any further rules or amendment thereof. Some important definitions like “bore hole”, “coal bed methane”, condensate” are provided under these rules.

Territorial Waters, Continental Shelf, Exclusive Economic Zone and other Maritime Zones Act, 1976:

This Act provides for certain matters relating to the territorial waters continental shelf, exclusive economic zone and other maritime zones of India. It provides for some important concepts like “contiguous zone”, “continental shelf”, “exclusive economic zone” etc. This Act also empowers the Central Government to make rules relating to matter with maritime water.

Critical analysis:

As mentioned earlier, PSCs are special contracts used in the particular industry. This contract has many aspects. Some of the important aspects are as follows:

This contract provides for interest sharing ratio between the parties i.e. the Government and contractor. Generally, the major share is given to the Government.

The most important thing in any contract is “period” or “duration” for which such contract will remain in force. It provides for a period for which the contractor is entitled to exploit the natural resources. It also provides for Minimum Work Programme of the contract which the contractor must complete.

There is a clause for relinquishment. It provides for relinquishment of the developing area by the contractor after certain stage.

It obligates the contractor to commence the work programme within six months of the “effective date”. “Effective Date” means the later of the date on which this Contract is executed by the Parties or the date of issue of License or date from which License has been made effective by the Central Government as the case may be.

There shall be a Management Committee comprising-

Two members representing the Government.

One member representing each contracting company; where there is only one contractor, two members from such company.

 The contractor shall operate as per the directions given by the Government complying this contract. No change in the contract shall be done without the consent of the Government.

The contractor shall have the right to use, free of charge, such quantities of petroleum produced as are reasonably required for conducting petroleum operations in the contract area in accordance with generally accepted modern oilfield and petroleum industry practices.

The Government reserves the right to itself, or to grant to others the right, to prospect for and mine minerals or substances other than petroleum within the contract area.

It is the duty of the Government to assist the contractor. The Government or its nominee shall use their good offices, when necessary, to assist the contractor in procurement or commissioning of facilities required for execution of Work Programmes including necessary approvals, permits, consents, authorisations, visas, work permits, Licenses including Licenses and Leases, rights of way, easement, surface rights and security protection at the Contractor’s cost, required pursuant to this Contract and which may be available from resources within its control.

Further, if and when a discovery is made within the contract area, the contractor shall forthwith inform the Management Committee and Government of the discovery and promptly run tests to determine whether the Discovery is of potential commercial interest and, within a period of sixty (60) days.

Apart from this, it has provisions for environment protection, payment of taxes and royalties, domestic supply and sale, termination of contract etc.

Conclusion:

Many economists have predicted recession and depression in the economy all over the world in the coming days. The developed countries have enough funds and provisions for such disasters. On the other hand, under-developed and poor countries will get financial packages from international organizations like the World Bank (WB), the World Health Organisation (WHO) and the International Monetary Fund (IMF). It is a big question in front of developing countries like India, Brazil etc. as they would not get financial assistance as that of under developed countries.

Therefore, establishing the committee by the Ministry of Petroleum and Natural Gas to review PSCs is a great step taken for betterment this industry.

Author: Shilpa Ramesh Walvekar from D.Y.Patil Law College, Pimpri, Pune.

Editor: Avani Laad from Symbiosis Law School, Pune.

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