Production Sharing Agreements as a Form of International Cooperation N. Chebaeva, post-graduate student Supervisor Professor Dr. Igor B. Sergeev
Production Sharing Agreements PSA a contract, under which the state as the owner of mineral resources gives to a company as a contractor exclusive rights (on a paid basis) to explore and develop a deposit while providing technical and financial services. 1995 Federal Law On Production Sharing Agreements 1 One-stage sharing mechanism 2 Two-stage sharing mechanism
Production Sharing Agreements One-stage Mechanism Total output Agreement concluding Oil for distribution Rentals Investor s Oil Government s Oil Bonuses Investor s Net Profit Oil Taxes (no Income Tax) Total Investor Oil Federal Budget Regional Budget Total Government s Oil
Production Sharing Agreements Two-stage Mechanism (Modified Indonesian Model) Total output Agreement concluding Oil for distribution Royalty and Rentals Cost Oil Profit Oil Bonuses Investor s Profit Oil Government s Profit Oil Investor s Net Profit Oil Tax Oil Total Investor Oil Federal Budget Regional Budget Total Government s Oil
PSA at Russian Fields Sakhalin I June 1995, Exxon Neftegas Limited Business contractors: ExxonMobil (30%, USA); Rosneft (20%, Russia); ONGC (20%, India); SODECO (30%, Japan) Sakhalin II Kharyaga Oil Field July 1994, Sakhalin Energy Business contractors: Gazprom (50%+1, Russia); Royal Dutch Shell (27,5%-1, Netherlands and UK); Mitsui (12,5%, Japan); Mitsubishi (10%, Japan) December 1995, Total PPP Business contractors: Total PPP (40%, France); StatoilHydro (30%, Norway); Zarubezhneft (20%, Russia); Nenetsk Oil Company (10%, Russia) 30.12.1995 Federal Law On Production Sharing Agreements
Income Taxation under PSA for Foreign Investors One-stage mechanism Income tax is not paid, but implied into splitting shares Two-stage mechanism Tax Oil = Income tax In fact, double taxation With some international agreements double taxation can be avoided Only two-stage mechanism is appropriate for foreign investors
Principle diagram of PSA Technology and knowledge Production sharing Resources Partnership Experience Investor Govern ment Rights Governance Finance Risks Sharing Information Environment Ecological Third Parties Social Business
Investor Disadvantages Ø Lack of flexibility in resource management - Cannot change plans and project parameters without permission à difficulties in operation - Limits for foreign employees hiring and foreign subcontractors engaging - Government has an opportunity to limit export - Cannot dispose its property (in the project) without permission - Has to start work within a year after PSA subscription Ø Immaturity of institutional environment - Long, complicated and full of bureaucracy process of getting license, conditions elaboration, negotiation, approval, etc. - Complicated procedure of changing terms, passing out the license and dissolution - Functions and responsibility of governments bodies are not clear and distinguished Ø Lack of experience, examples and case studies Ø Limitedness of fields available for development under PSA Ø Auction system à Higher entry barriers Ø Individuals cannot be investors
Investor Advantages Ø Stabilizing proviso - terms and conditions are remain in force during the whole contract period and cannot be changed unilaterally - in case of legislation changes, which deteriorate investor s results, the terms of the PSA should be changed to compensate it - laws that limit investor s rights, stated in the PSA, don t extend over it Ø Disputes resolution in an international arbitration court. Opportunity to chose a court Ø Special tax regime Ø Cost oil as a recovery of expenses Ø Opportunity to delegate tax obligations to the operator of the PSA Ø Opportunity to keep accounting records in foreign currency Ø Stage-by-stage return of explored territories à disposal of assets not in use
Government Disadvantages Ø Partly loss of state immunity as it agrees to litigate Ø Stabilizing proviso à Absence of opportunity to litigate agreement s terms Ø Less financial results comparing with licensing, because of cost oil, which reduces profit oil and tax oil Ø Because of the auction system, there are no guarantee to accept the best project in the sense of technology and rational subsoil usage Ø The term and condition elaboration process is not clear, it causes corruption
Government Advantages Ø Special terms in a contract that provide rational subsoil usage and allow the government to regulate investor s activity - regulations that limit investor s opportunities to change plans and project conditions - rentals and royalty, the aim of which is to maintain the environment and compensate damages - the government can take back territories, that are used not rationally, as a part of investor s obligation of territory return Ø Opportunity to limit investor s production export in special cases. It can help to support domestic market in crisis situations Ø Involvement of new technologies into the sector, development of domestic technology and science Ø Opportunity to develop marginal or technologically difficult deposits
Third Parties 1. PSAs oblige investors to make payments to maintain the society (region development, region small people) 2. Limitation of foreign employees (20%) and foreign subcontractors (70% of all costs) involvement - advantage for domestic employees and subcontractors. Stabilizes the social atmosphere in the region, supports national economy. - disadvantage for foreign employees and subcontractors - can cause application of worse equipment and decrease project performance
Russian PSA and WTO Clause 7 of the Federal Law On Production Sharing Agreements states the limitation of foreign employees and subcontractors involvement Russian entities have prerogative right to participate in a project as subcontractors Cost of domestic materials and equipment should be no less than 70% of total costs for materials and equipment in a year. Items are considered as domestic, if they are produced by Russian entities or individuals at Russian territory with Russian materials and details (no less than 50%) The clause contradicts the first principle of the World Trade Organization - non-discrimination The Russian Federation became a member of the WTO on August 22, 2012 Amendments are still not introduced
Why PSA is important? Cases of application Technological difficulties Because of difficult conditions, special technologies are needed for efficient development of a field. Russian companies haven t access to these technologies or want to avoid them. PSA allows to attract those who can and are willing to overcome such difficulties Low profitability Development of marginal deposits under licensing is not interesting for investors. For such deposits PSA plays a role of a bridge into profitability.
Detecting Deterrents All PSAs currently active in Russia were signed before the introduction of the Federal Law On Production Sharing Agreements Possible deterrents are in norms of the Low. Significant differences between active PSAs terms and norms of the Law is in cost-oil limitation and pre-phase procedures Deterrents are in cost oil limitation or institutional environment Cost oil limits under norms of the Low are one of the most beneficial for investors in the world The first focus should be on institutional environment
Need to do The priority is not to attract investors, but attract investors with technologies, knowledge and experience. Alteration of the legislation is needed Abolishment of the double auction system and parliament approval. Increase control Mainly additional guarantees decreasing economic and political risks Simplify procedures Create additional incentives for investors Establishment of the company which will act on behalf of the government Specify functions and responsibility of state bodies Detect Steps Add obligations facilitating development of the sector and remove gaps and discrepancies in legislation Change conditions of international agreements Development of technical, technological issues and research Special attention to harmonize Russian legislation with International Law Revise conditions regarding double taxation
Conclusion v In general, production-sharing agreements are more beneficial and profitable for foreign investors than licensing. At the same time, they allow the government to develop complicated and marginal fields, attract technologies and knowledge in the sector v The main deterrent is underdeveloped institutional environment v Alteration of the legislation is needed
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