The Fundamentals of Oil and

Gas Law:Legal Models for the

Development of Oil and Gas:

Dr Eddy Wifa
UWI Guest Lecture
INTRODUCTION AND LEARNING OUTCOMES

• Understand the state options in the development of

Hydrocarbons.

• The factors that influence that decision

• The legal interrelationship between the State
and the IOC
Legal options for the development of oil and gas
• Licensing
• PSA
• Joint Venture
• Service Contracts

• Conclusion (How it all connects)

THE POLITICAL ECONOMY
OF SPEED THEORY
 Key
characteristics
of oil and gas
• Concealed
• Difficult and very expensive to find
• No guarantee of success – geological risk
• Subject to price volatility – price risk
• Long lead-time between discovery and
production

• Owned or controlled by the state

• State must decide how exploration and
production will proceed
 Basic
state options
• National Oil Company (NOC)
• Involvement of International Oil Companies (IOCs)
• If involving IOCs, what sort of legal arrangements
must be made?
 What the
government
• Control of its hydrocarbons wants
• Investment to allow extraction
• Fair and reliable share of the value generated
• Maximum economic recovery of oil and gas
• Domestic security of supply (Energy security)
 What the IOC
wants
• Access to reserves (and to book as much as possible)
• Every day of production without replacement is a
day closer to being out of business
• Market focuses on production and reserves
• Consequent imperative to explore
• Consequent need to cover costs of failed exploration
from profits from successful projects (Diversification)
• Stability!
 Why does
the IOC want
• Risk stability?
• Geological
• Political
• Operational (HSE)
• Price
• Fiscal

• Investments endure for decades, so exposure to

risks is long-term and dynamic
 IOC efforts
to achieve
• Stabilisation clauses in arrangements with the state stability
• Freezing clauses
• Balancing clauses

• Fair?
• If arrangements properly drafted, IOC takes
considerable risk and state is protected from risk
• Stabilisation is, therefore, understandable – but it also
needs to be fair to the state
 State
options:
legal models
• Licence and Tax
• Production Sharing Contracts
• Service Contracts

• A Joint Venture with the NOC may also be

involved
Petroleum Licensing
 Licensing
• Authorisation to do something otherwise unlawful
• Petroleum usually reserved to the state
• Licence, therefore, required to explore produce
• Risk is borne by the licensee
• State exercises control via licence (and other instruments)
• State collects revenue via taxation (and possibly royalty)
• Ownership in oil/gas passes at the well
• Example: UK, Ireland
Why is a licence required?
• In practically every case, oil and gas are in the ownership or control of
the state, onshore and offshore

• The state will rely on the commercial sector to explore for and
produce hydrocarbons

• Commercial actors will require permission before they can begin

operations
What is a licence? (1)
• A licence is thus a permission or authorisation to do
something that would otherwise be unlawful – to
work with the state’s hydrocarbons

• Typically includes standard conditions setting out the

detail of its grant

• UK licence makes extensive use of Model Clauses (set

out in regulations)

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What is a licence? (2)
• UK’s licence has traditionally been regarded as a hybrid: part contractual,
part regulatory

• As a consequence, model clauses are incorporated into the licence as they

are at the time of the licence’s grant – there is no retrospective
amendment as revised model clauses are drafted for newer licences

• Thus, there is no one set of model clauses – a multiplicity are in play at any
one time

• It has proved to be a challenge to draft clauses for relationships lasting

decades...
Production Licences – award
• A discretionary system (though note the constraints, e.g. of EU law,
competition law etc.)

• Petroleum Act 1998, section 3

• Secretary of State may grant to such people as he sees fit licences “to search
and bore for, and get” petroleum whether in UK, territorial sea or UKCS for
such consideration as he sees fit on such terms as he shall see fit

• Production licences, therefore, cover exploration and production

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Criteria for award
• Technical and financial capability
• The way in which applicant proposes to carry out the work
• Price prepared to pay (if tenders invited)
• Any lack of efficiency and responsibility in respect of prior licences

(Hydrocarbon Licensing Directive Regulations 1995)

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Licensing Rounds
• Publicly announced
• Acreage available is specified or industry invited to identify
• Bids based on Work Programmes
• Decision based on marks scheme – but this is not determinative – the
system is discretionary
Model Clauses (1)

• Key typical licence provisions (2008 Model Clauses)

• term (duration) of the licence (perhaps including sub-
periods) (Model Clause 3 & ors)
• Payment of consideration (rental) (MC 12)
• obligation to surrender parts of the licence (MC 6)
• obligations to gather and provide information: measure,
monitor, etc (MCs 14, 15, 29, 30, 31)

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Model Clauses (2)
• obligation to unitise in the event that the reservoir straddles two (or more)
blocks (MC 28)
• the need to produce and work in accordance with a development plan (MC
17)
• power to compel exploration (MC 16)
• certain powers (whether adequate or not is another matter) to compel (and
govern the pace of) development and production activity (MC 17 and 18)
Production Licences – terms
• Modern standard licences (pre-Wood Review) have the following
terms:-

• 4 year initial term – exploration. If initial work programme completed and

50% of the acreage relinquished, then

• 4 year second term – development. If development and production plan

accepted and all acreage outside that producing area relinquished, then

• 18 year (extendable) third term – production.

NB since 2008, while this remained broadly the practice, the terms
were for negotiation
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Production Licences – general
• Relinquishment/surrender – a powerful tool for incentivising
exploration

• Recall that pre-existing licences have different terms and are not
retroactively altered by the new model clauses
Changing circumstances
• The development of the legal framework has been characterized by
“learning by doing”
• Exemplified by:
• Continuous modification of Model Clauses
• Retrospective legislation (Petroleum and Submarine Pipe-lines Act 1975)
• Creation and then sale of BNOC (Do you agree?)
• Continuous adjustment of fiscal arrangements
• This continued into what has been called the mature phase of the
UKCS
Characteristics of maturity
• Large geological structures explored and developed
• Large fields past the peak of production
• New discoveries
• smaller and economically marginal
• often dependent on existing infrastructure for viability
• Larger companies attracted elsewhere by better returns
• Frontier areas (west of UK) much more challenging
Mature Province Initiatives
• Licensing Variations
• Frontier Licence (open up new areas)
• Promote Licence (bring in new players)

• Initiatives based on Minister’s powers under licences introduced by

1975 Act
• Fallow Areas
• Stewardship

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Frontier licence (1)
• Introduced 2004: why?
• To encourage exploration of currently underdeveloped areas of the UKCS, areas, esp. west
of UK
• Representations from oil companies, PILOT Progressing Partnership Working Group
• Problems of the Atlantic Margin
• Technically and physically demanding
• Deep water
• Difficult geology (incl. difficulties in interpreting results)
• Less infrastructure
• Broad purpose of the licence
• Promote exploration by allowing the taking of a larger area at low cost and the dropping of
parts deemed surplus to requirements

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Frontier licence (2)
• Initial Term (exploration) of 6 years, not 4, divided into:
• 3-year term for preliminary evaluation at reduced rental, relinquish 75% of
area at end, no work programme obligations
• 3-year term at full rental, complete work programme by end, relinquish a
further 50% of what is left
• 6-year Second Term (development), relinquish all acreage outside
producing area by end
• Thereafter Third Term of 18 years in the normal way, (but, again, with
the possibility of extension) (production)

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 Frontier Licence (3)

• Few frontier licences (34) awarded so far, but given the large areas
covered by these licenses this does not mean they can be dismissed
as insignificant
• New 9-year frontier licence (3 + 6) in the 26th Round
Promote Licence (2)
• Initial term of 4 years divided into 2 two-year parts
• Part one – develop and find partner to work up a work programme. Rent
reduced by 90%.
• Part two – Complete the work programme, drill test well.
• If complete satisfactorily – converts to a traditional licence

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Impact of licensing variants
• Now an established feature of the UKCS licensing regime
• 21st: 35 traditional, 53 promote
• 22nd: 32 traditional, 58 promote, 7 frontier
• 23rd: 70 traditional, 78 promote, 6 frontier
• 24th: 79 traditional, 65 promote, 6 frontier
• 25th: 124 traditional, 41 promote, 6 frontier
• 26th: 150 traditional, 37 promote, 3 frontier
• 27th: 132 traditional, 29 Promote, 6 frontier

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Fallow Areas – context (1)
• PILOT PPWG report 2002
• 247 blocks where no significant activity for extended period
• 250 discoveries where no significant development work
• In many cases, good reasons
• In others, lack of progress reflected fact that UKCS competes with other areas
in industry’s list of priorities; certain assets were “on the back burner”

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Fallow Areas – context (2)
• Obviously undesirable for the national interest that potentially viable areas are
tied up un-utilised
• No (or minimal) revenue
• The possibility that the opportunity to produce will be lost as a result of infrastructure being
taken out of use
• But can’t simply take these areas back from licensees in the absence of a legal
right to do so
• As regards new licences, more stringent relinquishment provisions could be
introduced (from 2002 licensing round)
• For earlier licences - options
• Retroactive legislation in respect of previous licences?
• Voluntary approach?
• Hybrid?

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Fallow Areas – context (3)
• The hybrid approach was favoured
• Essentially voluntary
• But backed by Minister’s licence powers and discretion
• Guiding principles
1. A group of licensees doing all that a fully resourced and skilled group could
reasonably be expected to do should not be disadvantaged
2. No group should have reasonable grounds to feel that they had not been
given full opportunity to create value from their licence
• Expressed positively, but note the implicit threat

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Fallow Blocks (1)
• Defined in guidance as
• A block where the initial term of the licence has expired and there has been
no drilling, dedicated seismic or other significant activity for a period of three
years
• Process begins with classification by the Department
• Licensees have chance to comment before final classification is made
• Fallow blocks classified as
• Fallow A or
• Fallow B

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Fallow Blocks (2)
• Fallow A
• The current licensees are doing all that a technically competent group with
full access to funding could reasonably be expected to do to progress towards
activity
• Department accepts that there is nothing more the group can do – annual
review
• If a technical barrier to progress has been identified this may be notified to
industry bodies dealing with technical progress
• Fallow A status may also be accorded where Fallow B would otherwise apply,
where changes have occurred recently justifying a delay in the Department’s
classification as such

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Fallow Blocks (3)
• Fallow B
• The current licensees are unable to progress towards activity due to a
misalignment within the partnership, a failure to meet economic criteria
and/or other commercial barriers
• Department’s view is that the delay is not justified
• Process then has three broad options:
1. Use it
2. Sell to (or involve) someone who will
3. Relinquish to state

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Fallow Blocks (4)
• Fallow B (cont.)
• Licensee has three months to report adequately on intentions, failing which
block is listed as Fallow B for 1 year
• Licensee can market interest during that period or submit an activity plan – if
accepted, block is rescued and one year to carry out work
• Check at 9 months – any activity plan? If no, then any party failing in this
respect is expected to assign interest to co-licensees or 3rd parties with plans
• 12 months – no activity – licensee expected to relinquish – but on what basis?
MC 16 offers some assistance here, but does not appear to be sufficient

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Fallow Discoveries
• Similar ethos and approach to Fallow Blocks process, but aimed at
dormant discoveries
• Note that the period involved is longer – reflecting fact that work has
already been done and investment committed to this stage
• As regards underlying licence powers, MC 17 appears to be a weak
foundation
• Could this amount to uncompensated expropriation?

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Interim conclusions
• Petroleum Licence
• Permission to explore for and produce hydrocarbons in the ownership or
control of the state
• Traditionally regard as part contractual, part regulatory
• Despite the contractual element, the power of the state is very evident...
• ...not least in the initiatives designed to ensure its objectives are met as the
province matures

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Wood Review
• June 2013, Secretary of State commissions “review of the regulation
and stewardship of the UK’s hydrocarbon reserves”
• November 2013, Sir Ian Wood published interim review
• December 2013, consultation ended
• February 2014, final review published
Wood Review
• Recommendations
• Tripartite approach to develop a shared strategy to maximise economic recovery of
hydrocarbons in the UK (MER UK Strategy)
• A new independent, arm’s length regulator
• Why?
• Enhanced powers for the new regulator
• What form? Mandatory? Facilitative?
• Sector strategies
• Exploration
• Asset stewardship
• Regional development
• Infrastructure
• Technology
• Decommissioning
Legal implementation
• Oil and Gas Authority (OGA)
• Established initially as an Executive Agency
• Now a government company with one shareholder, the Secretary of State
• Arm’s length?
Legal implementation
• The MER UK Strategy
• Made like a regulation
• Reads like a regulation
• But structured quite differently
• Central obligation
• Supporting obligations
• Required actions and behaviours
• These are non-hierarchical and subject to
• Safeguards
• But there is some lack of clarity
Legal implementation
• Central obligation
• “Relevant persons must, in the exercise of their relevant functions, take the
steps necessary to secure that the maximum value of economically
recoverable petroleum is recovered from the strata beneath relevant UK
waters.”
• Safeguards, including:
• No obligation imposed by or under this Strategy requires any person to make
an investment or fund activity (including existing activities) where they will
not make a satisfactory expected commercial return on that investment or
activity.
 PSA
• Risk contract in which contractor explores for
oil/gas and is only compensated in the event that
commercial discovery is made
• Costs reimbursed via initial tranche of produced
oil/gas (perhaps after royalty paid)
• Profit oil/gas then shared between state and
contractor as per contract
• Contractor usually also subject to tax on profits
• Example: Ghana, Uganda
Some key Terms of a PSA
• Exclusivity
• State’s view on speed of development
• Obligation during the exploratory phase
• Length of production period
• Cost recovery provisions
• Production sharing provisions
• Passing of title to oil and gas
• Stabilisation and renegotiation clauses
• Local content
• Dispute resolution arrangements
• Decommissioning
• Health, safety and Environmental considerations
• Confidentiality
Division of
produced
hydrocarbons
under PSA

Source: OpenOil
Stabilisation and Economic Equilibrium clause
• Classic freezing clauses
• Example: Art.27.3 Model 1994 PSA from Mauritania
“The Contractor shall not be subject to any legislative provision which
would give rise to an aggravation, whether directly or indirectly, in the
charges and obligations arising from this contract and from the
legislation and regulation in force on the date of signing this contract,
unless as mutually agreed upon by the parties”.
Art 33.3 Senegalese 2012 PSA
“No provision may be applied to the Contractor the purpose of which is
to directly or as a consequence thereof increase the charges and
obligations deriving from the systems mentioned in Chapter 7 of the oil
code, as these systems are defined by the legislation and regulations in
effect as of the date this Contract is signed, without prior agreement of
the parties”
Renegotiation clauses
• Kenyan 2008 PSA, Model clause 40(3)

“If after the effective date of this contract the economic benefits of a
party are substantially affected by the promulgation of new laws and
regulations, or of any amendments to the applicable laws and
regulations of Kenya, the parties shall agree to make the necessary
adjustments to the relevant provisions of this contract, observing the
principle of the mutual economic benefits of the parties”.
 Joint Venture
• NOC enters into JV with IOCs
• Right to explore, etc. is granted to JV
• NOC will have obligation to contribute to costs
under PSA
• NOC’s interest may be carried by IOCs
• State receives benefits via NOC’s share of revenue
and/or taxation
• Example: some projects in Nigeria
 Service
Contracts
• State contracts with commercial actors for
provision of specific services
• Payment is made for those services and is not
contingent on commercial discovery
• Variation on the pure Technical Service Contract
is the Risk Service Contract
• Latter incentivises contractor by allowing some
participation in upside
• Example: Mexico, Iraq
 Does it
matter?
• Economists say the state can achieve the same
result in terms of ultimate value extracted
whichever approach is used
• How is the decision made? What considerations
are relevant?
Comparison
of models Licence and tax PSA Service
Level of state control Potentially high, Potentially high, High
depends on terms depends on terms
Public perception of Lower Higher Highest
state control
Transfer of ownership At the wellhead At point stipulated by Remains with state
of hydrocarbons contract
State needs capital No No Yes
upfront?
Location of risk (if Licensee (IOC) Contractor (IOC) State
terms properly
drafted)
State participates? Possibly, but not Normally, but not Required
usually always
What the IOC gets Gross production less Cost oil plus share of Fee for service
any royalty oil/gas profit oil/gas
Stabilisation? Not usually More common NA
 Factors to
consider
• State’s access to capital
• State’s ability or desire to take and absorb risk
• State’s need to have control – or to signal control
• State’s preference in relation to timing of receipts
• Strength of state’s bargaining position
 Balance of
negotiating
• Depends upon power
• Prospectivity
• Extent and quality of existing seismic and other data
• Degree of existing development
• Perceived stability of host country
• Wider market conditions

• Where these factors are viewed positively by the IOC,

the government’s bargaining position will be stronger
 • How it all connects with the theme of
the course
• Capacity to absorb risk
CONCLUSION • Attachment to resources
• Other social responsibilities
• Finding a balance