International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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In exchange, it is entitled to a portion of the production, known as “cost oil”, the sale of which is intended to cover
its incurred expenses (capital and operating costs). The balance of production, known as “profit oil”, is then shared
in varying proportions, between the company or consortium, on the one hand, and the host country or state-owned
company, on the other hand.
Today, concession agreements and PSCs can coexist, sometimes in the same country or even on the same block. Even
though there are other contractual models, TOTAL’s license portfolio is comprised mainly of concession agreements.
On most licenses, the partners and authorities of the host country, often assisted by international accounting firms,
perform joint venture and PSC cost audits and ensure the observance of contractual obligations.
In some countries, TOTAL has also signed contracts called “risked service contracts”, which are similar to PSCs.
However, the profit oil is replaced by a defined or determinable cash monetary remuneration, agreed by contract,
which depends notably on field performance parameters such as the amount of barrels produced.
Oil and gas exploration and production activities are subject to authorization granted by public authorities (licenses),
which are granted for specific and limited periods of time and include an obligation to relinquish a large portion, or
the entire portion in case of failure, of the area covered by the license at the end of the exploration period.
TOTAL pays taxes on income generated from its oil and gas production and sales activities under its concessions,
PSCs and risked service contracts, as provided for by local regulations. In addition, depending on the country,
TOTAL’s production and sales activities may be subject to a number of other taxes, fees and withholdings, including
special petroleum taxes and fees. The taxes imposed on oil and gas production and sales activities are generally
substantially higher than those imposed on other industrial or commercial businesses.
5.1
How does a mineral lease work?
In most countries the government owns all minerals and rights over those minerals, but
in some other countries minerals and mineral rights can also be directly owned by
individuals. While these contracts are negotiated individually, and therefore each may
be different, they typically share a large number of common features, which are
discussed below:
(a) the
owner/lessor of the mineral rights retains a royalty interest, which entitles it to a
specified percentage of the mineral produced. The lessor is normally only required
to pay for its share of the severance taxes and the costs of getting the production into
a marketable state, but not for any exploration and development costs. The royalty is
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either payable in cash or payable in kind. Although the lessor is normally not
interested in receiving its royalty in kind, the option of receiving the royalty in kind is
often included for tax purposes;
(b) the lessee obtains a working interest under the mineral lease, which entitles it to
explore for, develop, and produce minerals from the property at its cost. The
working interest can be held by more than one party, in which case a joint
operating agreement needs to be executed (see 5.6 below);
(c) upon signing of the mineral lease agreement the lessee typically pays the lessor a
lease bonus or signature bonus, which is a one-off upfront payment in exchange
for the lessor’s signing of the mineral lease agreement;
(d) it is in the lessor’s interest for the lessee to explore the property as quickly as
possible. To ensure that the lessee does not delay exploration and development
unnecessarily, the following terms are typically included:
• most mineral leases define a primary term during which the lessee is required
to commence drilling;
• normally the lessee has a drill or exploration obligation that must be met
within a certain period. However, by paying delay rentals the lessee can defer
commencement of drilling or exploration; and
• the mineral lease will remain in force once the obligatory drilling/exploration
programme has been completed successfully and production commences, but
the lease will be cancelled if activities are suspended for a prolonged period;
(e) most mineral leases provide that the lessee and the lessor have the right to assign
their interest to another party without approval from the owner/lessor. This means
that both the lessee and the lessor can create new rights out of existing rights
(see 5.7 below);
(f) under many oil and gas lease contracts the lessee can be required to pay shut-in
royalties when a successful well capable of commercial production has been
completed, but production has not commenced within a specified time; and
(g) the lessor is typically not entitled to royalties on any minerals consumed in
producing further minerals from a property.
5.2
Concessionary agreements (concessions)
Concessionary agreements or concessions are mineral leases ‘under which the
government owning mineral rights grants the concessionaire the right to explore,
develop, and produce the minerals’.87 However, unlike a production sharing contract
(see 5.3 below), under a concessionary agreement, the extractive industries company
retains title to the assets constructed during the term of the concession. Furthermore,
the company bears all the risks and there is no profit sharing arrangement with the
government. Rather, the government is entitled to a royalty computed in much the same
way as a royalty under lease contracts.88 In addition, depending on the country’s fiscal
policies, the government will typically also collect taxes such as duties, severance or
production taxes, and income taxes.
In some jurisdictions, the government may retain the option to participate in the project
as a working interest owner in the property. In this case, the company initially holds
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100% of the working interest. If the project is successful and reserves are found, the
national oil company or entity representing the government becomes a working interest
owner and will pay for its proportionate share of the investment.
5.3
Traditional production sharing contracts
A production sharing contract (PSC) or production sharing arrangement (PSA) is a
contract between a national oil company (NOC) or the government of a host country
and a contracting entity (contractor) to carry out oil and gas exploration and
production activities in accordance with the terms of the contract, with the two
parties sharing mineral output.89 While these arrangements have historically been
more commonly found in the oil and gas sector, similar types of arrangements do exist
in the mining sector.
In such countries the ownership of the mineral reserves and resources in the ground
does not pass to the contractor. Instead, the contractor is permitted to recover its costs
and share in the profits from the exploration and production activities. Although the
precise form and content of a PSC may vary, the following features are likely to be
encountered in traditional oil and gas PSCs:90
<
br /> (a) the government retains ownership of the reserves and resources and grants the
contractor the right to explore for, develop, and produce the reserves;
(b) the government is often directly involved in the operation of the property, either
by way of an operating committee that comprises representatives of the contractor
and the government or NOC, or by requiring the contractor to submit its annual
work programme and corresponding annual budget to the government or NOC for
approval. The contractor is responsible to the NOC for carrying out operations in
accordance with contract terms;
(c) upon signing of the PSC the contractor pays the government a signature bonus,
which is a one-off upfront payment in exchange for the government’s signing of
the PSC;
(d) the contractor pays the government a production bonus upon commencement of
production and when the average production over a given period first exceeds a
threshold level;
(e) the government is entitled to a royalty payment that is calculated as a percentage
of the net production (i.e. net of petroleum lost, flared or re-injected) and which is
payable in kind or in cash at the option of the government. The royalty rate
applicable is not necessarily a fixed percentage, but may depend on the production
volume or destination of the production (e.g. different rates may apply to crude oil
and gas that is exported);
(f) the contractor provides all financing and technology necessary to carry out
operations and pays all of the costs specified;
(g) the contractor is typically required to bear all of the risks related to exploration
and, perhaps, development (i.e. the government does not have a working interest
during the exploration and development phases);
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(h) the contractor is frequently required to provide infrastructure, such as streets,
electricity, water systems, roads, hospitals, schools, and other items during various
phases of activities. Additionally, the contract customarily requires the contractor
to provide specified training of personnel. Infrastructure and training costs may or
may not be recoverable from future production by the contractor;91
(i) the contractor may have a domestic market obligation that requires them to meet,
as a priority, the needs of domestic oil and/or gas consumption in the host country.
Alternatively, the contractor may be required to sell oil and/or gas to the NOC at
the official oil or gas price;
(j) the contractor is normally committed to completing a minimum work programme
in each of the phases of the project, which generally needs to be completed within
a specified period. If the work is not performed, the contract may require the
unspent amount to be paid in cash to the government;
(k) a PSC normally requires relinquishment of a certain percentage of the original
contract area by the end of the initial term of the exploration period. A further
reduction is typically required by the end of the exploration period. The
government can negotiate a new contract with another party for the continued
exploration of the surrendered acreage. Any data and information relating to the
surrendered area often becomes the exclusive property of the government;
(l)
equipment that is acquired for the development and production activities normally
becomes the property of the government or NOC;
(m) operating costs and specified exploration and development costs are recoverable
out of cost recovery oil, which is a specified percentage of production revenues
after the royalty payment each year. The PSC specifies whether particular types
of cost are recoverable or non-recoverable. Recoverable costs not recovered by
the contractor in the current period can be carried forward to the following
reporting period for recovery purposes;
(n) revenues remaining after royalty and cost recovery are called profit oil. Profit oil
is split between the government and the contractor on a predetermined basis;
(o) many PSCs provide that the income tax to which the contractor is subject is
deemed to have been paid to the government as part of the payment of profit oil
(see 19.2 below); and
(p) some PSCs give the contractor the right to set up a decommissioning reserve fund
which enables the contractor to recover the costs associated with future
decommissioning and site restoration. In cases where the PSC terminates before
the end of the life of the field, the government is typically responsible for
decommissioning and site restoration.
Even in situations where the provisions of a PSC are fairly straightforward at first sight,
it may be rather complicated to calculate the entitlement of each of the parties involved
as is illustrated in the example below.
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Example 39.3: Production sharing contract
An oil and gas company (contractor) entered into a PSC that includes the following terms:
• the oil and gas company pays for all exploration costs;
• the government is entitled to:
• 15% royalty on the production;
• severance tax of USD 2.50 per barrel;
• USD 5 million production bonus when average production first exceeds 25,000 barrels per day; and
• 10% of the profit oil;
• operating expenses are recoverable before exploration costs;
• development costs are recoverable after exploration costs;
• cost recovery oil is capped at 45% of the annual production; and
• the national oil company (NOC) and the contractor have a 51% and 49% working interest, respectively.
How should the production be allocated between parties, assuming the following for 2018?
• annual production in 2018 is 10 million barrels;
• recoverable operating costs in 2018 are USD 25 million;
• the average oil price in 2018 is USD 100/barrel (this amount is used to convert any amount calculated
in monetary units i.e. USD, back into volumetric units i.e. barrels of oil);
• during 2018 average production exceeded 25,000 barrels per day for the first time;
• unrecovered exploration costs at the beginning of 2018 were USD 180 million; and
• unrecovered development costs at the beginning of 2018 were USD 275 million.
Contractor
NOC
Barrels
(49%)
(51%) Government
bbls
bbls bbls
Production in 2018
a
10,000,000
Royalty
15% of 10,000,000 =
b
1,500,000
1,500,000
Severance tax
10,000,000 × $2.50 ÷ $100 =
c
250,000
250,000
Cost oil
Operating costs
$25,000,000 ÷ $100 =
d
250,000
122,500
127,500
Exploration cost
$180,000,000 ÷ $100 =
e
1,800,000
1,800,000
Development cost
$275,000,000 ÷ $100,
but capped at 2,450,000
f
2,450,000
1,200,500
1,249,500
T
otal cost oil
45% of 10,000,000 =
g
4,500,000
Production bonus
$5,000,000 ÷ $100 =
h
50,000
50,000
Profit oil: a – b – c – g – h =
i
3,700,000
Government profit oil
10% of 3,700,000 =
j
370,000
370,000
Working interest in profit oil
3,700,000 – 370,000 =
k
3,330,000
1,631,700
1,698,300
Total: (b + c + g + h + i) 10,000,000
4,754,700
3,075,300 2,170,000
Unrecovered development costs
$275,000,000 – (2,450,000 × $100) =
$30,000,000
$14,700,000
$15,300,000
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The above example illustrates not only that calculating an entity’s share in the
production of the current period requires a detailed knowledge of the PSC’s provisions,
but also that calculating the contractor’s share of the remaining reserves requires a
number of assumptions.
The reserves and production that the parties are entitled to varies depending on the
oil price. Had the average oil price in 2018 been $50/barrel the parties’ entitlements
would have been as follows: Contractor 5,540,400 barrels, NOC 2,019,600 barrels and
Government 2,440,000 barrels. The quantity of reserves and production attributable
to each of the parties often reacts to changes in oil prices in ways that, at first, might
seem counterintuitive.
It is important to note that the type and nature of contracts emerging continue to evolve.
New contracts have some attributes of PSCs, but do differ from the traditional PSC. We
discuss these in more detail at 5.5 below.
5.4 Pure-service
contracts
A pure-service contract is an agreement between a contractor and a host government
that typically covers a defined technical service to be provided or completed during a
specific period of time. The service company investment is typically limited to the value