Production Sharing Contract (PSC)

Production Sharing Contract (PSC) is a term used in the Hydrocarbon industry and refers to an agreement between Contractor and Government whereby 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. Thus, PSC is a fiscal regime existing in the exploration and production of hydrocarbons.  

Production Sharing Contracts became widely adopted as part of the New Exploration and Licensing Policy (NELP) launched by the Government in 1997 for enhanced exploration of oil and gas resources in the country.

The Production Sharing Contracts (PSCs) under NELP are based on the principle of “profit sharing”.  When a contractor discovers oil or gas, he is expected to share with the Government the profit from his venture, as per the percentage given in his bid.  Until a profit is made, no share is given to Government, other than royalties and cesses. 

Thus, in production sharing contract (PSC), Government's take depends on biddable share of profit petroleum/ gas after allowing for cost recovery. In other words, PSC allows the contractor to recover his cost, before giving Government its share in the contractor's revenues, in case there is commercial discovery leading to production (Not all drilling leads to discovery of oil/gas). Thus, a certain proportion of the balance revenues of the contractor are shared with the Government.

The PSC regime has been changed with a revenue sharing contract model in 2016 through a Cabinet decision of the Government dated 10.03.2016. However, the new regime is applicable only for future contracts that would be awarded by the Government.

 

Source: Ministry of Petroleum and Natural Gas, accessed on 11 March 2016
Notes: Here, CBM stands for Coal Bed Methane and PEL and ML stands for Petroleum Exploration Licence (PEL) and Petroleum Mining Lease (PML): PEL is granted for a period of 7 years in onland /shallow water areas and for 8 years in deepwater and frontier areas for exploration activities as per PSC provisions under NELP. (This has been increased to 8 and 10 years respectively in the new fiscal regime adopted on 10.03.2016 – HELP or Hydrocarbon exploration and Licensing Policy) Petroleum Mining Lease (PML) is normally awarded for 20 years for producing Hydrocarbons as per The Oilfields Regulation & Development Act, 1948 and Petroleum &Natural Gas Rules, 1959. PEL/PML for offshore exploration & production operations is granted by the Union Government. In case of onland blocks, PEL/PML is granted by the concerned State Government on the basis of recommendation made by the Union Government for the awarded blocks.

 

Issues with PSC
As PSCs have progressed from the exploration stage to the development and production stage through successive NELP rounds, certain constraints have been observed in the working of the existing contractual and fiscal model of NELP, by both the Government and the Contractors. The existing PSC allows the contractor to recover his cost, before giving Government its share in the contractor's revenues, in case there is commercial discovery leading to production. A certain proportion of the balance revenues of the contractor are shared with the Government, based on the value of an investment multiple for each year. These are biddable parameters. This investment multiple is the ratio of cumulative net cash income to cumulative exploration & development cost. Government's share increases as the multiple increases, which happens when cumulative income increases at a rate higher than the rate of increase for cumulative cost.

In this structure, with primary and explicit focus on recovery of upstream costs, contractors lack the incentives to keep costs down. The Ashok Chawla Committee on Allocation of Natural Resources^[1] also observed that the system of investment multiple based profit sharing formula with cost recovery “gives incentive (to an operator) to increase his investment, or front-end his work plan in order to see that the threshold where Government’s profit take rises rapidly is not reached”. The report clearly points out the risks associated with this structure, especially, with a steep jump in profit sharing from one slab to another. Thus, this mechanism requires close, constant and micro monitoring by the Government to protect its take. This is perceived by contractors as interference in commercial decision-making, whereas the Government and her auditor - Comptroller and Auditor General of India (CAG)-, view it as legitimate and necessary. Since decisions are taken in a joint committee, called Management Committee (MC), having government and private party representatives, decisions get delayed and execution under the contract is hampered, resulting in  arbitrations, which in turn adversely affects the expeditious exploratory work.

Presently, there are separate policies and licenses for different hydrocarbons.  There are separate policy regimes for conventional oil and gas, coal-bed methane, shale oil and gas and gas hydrates^[2].  Different fiscal terms are also in force for allocation of acreages for exploration for different hydrocarbons.  However, when there is overlapping of resources in certain blocks, if separate contractual conditions govern these resources, then it would not be possible to explore these resources. Unconventional hydrocarbon resources such as shale oil and gas, which were not known and considered at the time when NELP contracts were awarded, are often present in the same area which is already under exploration, albeit in a different horizon and rock structure. It is very difficult to distinguish among shale gas, tight gas and conventional gas once the production takes place, however technology and cost involved in the operation of unconventional hydrocarbon is very different from the conventional hydrocarbon.  As such, for the current blocks under operation, exploration of these new resources interferes with the original bid evaluation criteria for government take, technical competence and minimum work programme committed. As such, the option available is to wait for the block to be relinquished or mining lease period to get over for exploration of these new resources.

Thus, some of the major issues/constraints in the existing PSC model are:

• Inadequate incentives for the operator to keep the cost low.
• Require constant & micro monitoring by the government to protect the government take leading to procedural delays and arbitrations. 
• Assessment of recoverable costs leads to dispute between the government and contractor. 
• Provide opportunity to operator to leverage/ manipulate Investment Multiple in their favor based on which profit sharing is determined. 

 

Revisions proposed in the existing model of PSC
Considering the above constraints experienced in the present PSC format and differences in fiscal and contractual regime for oil & gas and Coal Bed Methane (CBM), it is now proposed that the award of acreages for hydrocarbon exploration & production in future will be under a uniform licensing policy covering all types of hydrocarbons, with new fiscal terms and open international competitive bidding, thereby ensuring ease of operation for Exploration and Production (E&P) companies. The uniform license will enable the contractor to explore conventional and unconventional oil and gas resources such as shale gas/oil, tight gas, gas hydrates and any other resource to be identified in future, which is fit for commercial exploitation, simultaneously under the overall contractual regime applicable from time to time. A decision has been taken to this effect on 10.03.2016^[3].

Rangarajan Committee^[4] in 2012 recommended that PSC should be replaced with a revenue sharing model. Unlike in the existing fiscal model of Production Sharing Contract (PSC), where profit petroleum to the Government commences only when all contract costs have been recovered (in case of a 100% cost-recovery bid by the Contractor), in the new system, share of revenue to the Government will commence from the very first day of production. The proposed changes will lead to a simple and transparent system, with easy-to-monitor parameters of production and price. This will ensure that Government gets progressively higher revenue, as the contractor earns more, and will also safeguard government interest in case of a windfall arising from a price surge or a surprise geological find. Further, the Management Committee will no longer go into issues relating to approval of budget or procurement issues and the private operators will have a more hassle-free operational environment. Government adopted a variant of the revenue sharing contract model on 10.03.2016 under the new fiscal regime for hydrocarbon exploration and production called, HELP or Hydrocarbon Exploration and Licensing Policy.

1. Expert Committee on Allocation of Natural Resources (CANR), headed by former Finance Secretary, Shri Ashok Chawla, was constituted by Government on the recommendations of the Group of Ministers in January, 2011, to recommend measures required for enhancing transparency, effectiveness and sustainability in utilisation of natural resources, and submitted its report on 31 May, 2011. The Expert Committee was mandated to (a) identify key natural resources being allocated by Government; (b) examine the efficacy and suitability of existing legal and regulatory framework and rules being employed in the allocative processes; and (c) recommend measures for enhancing their sustainability and improving transparency and effectiveness of the allocative processes.

2. Unconventional Hydrocarbons are Coal bed methane, Gas Hydrates, Oil sands, shale oil etc. Coal bed Methane (CBM), is an eco-friendly natural gas, stored in coal seams, generated during the process of the coalification (the degree of change undergone by coal as it matures from peat to anthracite). CBM exploration and exploitation has an important bearing on reducing the green house effect and earning carbon credit by preventing the direct emission of methane gas from operating mines to the atmosphere. Further, extraction of the CBM through degassing of the coal seams prior to mining of coal is a cost effective means of boosting coal production and maintaining safe methane level in working mines.

Gas hydrates are naturally occurring, crystalline, ice-like substances composed of gas molecules (methane, ethane, propane, etc.) held in a cage-like ice structure. (clathrate). Hydrates are a concentrated form of natural gas compared with compressed gas, but less concentrated than liquefied natural gas. It is estimated that a significant part of the Earth's fossil fuel is stored as gas hydrates, but as yet there is no agreement as to how large these reserves are. They are found abundantly worldwide in the top few hundred meters of sediment beneath continental margins at water depths between a few hundred and a few thousand feet and mainly in permafrost areas.

Oil sands or Tar Sands refers to crude trapped in sands in a semi solid form, mixed with sand and water. Tar Sands contain bitumen - a kind of heavy crude oil. They are found in Canada and Venezuela.

shale Oil is found in shale source rock that has not been exposed to heat or pressure long enough to convert trapped hydrocarbons into crude oil.

Oil Shales are usually fine-grained sedimentary rocks containing relatively large amounts of organic matter from which significant quantities of shale oil and combustible gas can be extracted by destructive distillation. The product thus generated is known as synthetic crude or more simply, syncrude. Oil shales are not technically shales and do not really contain oil. They are relatively hard rocks called marls - composed primarily of clay and calcium carbonate- containing a waxy substance called kerogen. The trapped kerogen can be converted into crude oil using heat and pressure to simulate natural processes.  Included in most definitions of oil shale, either stated or implied, is the potential for the profitable extraction of shale oil and combustible gas or for burning as a fuel.

Tight Oil: Although the terms shale oil and tight oil are often used interchangeably in public discourse, shale formations are only a subset of all low permeability tight formations, which include sandstones and carbonates, as well as shales, as sources of tight oil production. Within the United States, the oil and natural gas industry typically refers to tight oil production rather than shale oil production, because it is a more encompassing and accurate term with respect to the geologic formations producing oil at any particular well.

3. Shale Gas policy and revisions to CBM policy were approved during 2013 to enhance utilization of new sources of hydrocarbon. New Shale Gas Policy opens up exploration by national oil companies and amended CBM Policy allow Coal India LTD (CIL) and its subsidiaries, to undertake exploration & exploitation of CBM gas in areas allotted to them under mining lease (Source: PIB release of MoPNG dated 24 January 2014).

4. The report of the committee set up under the chairmanship of Dr C. Rangarajan, Chairman, Economic Advisory Council to the Prime Minister, to look into the Production Sharing Contract Mechanism in petroleum industry was submitted in December 2012. Major recommendations such as moving to revenue sharing model from current cost recovery, in order to reduce continuous cost monitoring by the government, setting up of inter-ministerial committee for fast decision making, new gas pricing formulae for linking domestic gas price with international gas prices etc were made by the Committee.

Also See

• Hydrocarbon Exploration and Licensing Policy (HELP)
• New Exploration Licensing Policy (NELP)
• Revenue Sharing Contract (RSC)
• Open Acreage License Policy (OALP)

Contributed by

• Ms. Rose Mary K. Abraham (IES 2006)
• Email- rosemary.a@nic.in