Independence & Simplicity and the U.S. Shale Revolution
The dynamics of the oil industry have changed dramatically since the beginning of 2010. Because of the U.S. shale revolution, the U.S. is now a country with oil production rivaling that of Saudi Arabia and Russia. The fundamental shift in oil power has come as a direct result of investment in the technology of horizontal drilling and hydraulic fracturing of tight oil formations in the U.S. In 2010, U.S. production from tight oil shale formations were marginal in comparison to total U.S. oil production; however, tight oil now makes up 52 percent of all U.S. oil production.
(Click to enlarge)
The simplistic nature of the U.S.’ royalty/tax contracts fostered the growth in technology and the subsequent use of shale drilling resulting in a 64 percent increase in oil production from 2010 to 2016. Oil & gas royalty/tax contracts in the U.S. offer independent oil companies (IOC) the right to explore, produce, develop, and market their own resource provided they pay a royalty to landowners and government taxes.
Giving IOCs ownership over exploration and production generates predictability and allows companies to plan investments further into the future. Companies would only need to worry about their own financial capacity to invest in large projects and technologies which fosters technological shifts. Nearly 45 percent of all IOC contracts are structured as royalty/tax contracts like that in the U.S.
The Other Half of Oil
The remaining contracts between IOCs and petroleum-producing countries are in the form of production sharing contracts or agreements (PSC or PSA) and service agreements (SA). Around 48 percent of global contracts with petroleum-producing countries are in the form of PSCs and approximately 7 percent are SAs. Therefore, a majority share of oil production contracts are partially or fully controlled by petroleum-producing state owned companies referred to as national oil companies (NOCs).
Three Oil & Gas Contracts
There are 3 main forms of contracts that allow IOCs to participate in the exploration, production, development, and marketing of oil from a country:
1. The simplest contract is the royalty/tax contract where, after paying a landowner royalty and government tax, the company owns, risks, and controls the resource independent from an NOC.
2. Most oil production contracts are in the form of PSCs where risk is borne by IOCs, but control over operations and partial control over production is in the hands of the country’s NOC. PSCs often separates oil production in two categories: cost and profit oil. The NOC pays back IOC capital and operating costs through cost oil which is taken as a share of production. Unrecovered costs may be carried forward and excess cost oil is carried over to profit oil. Profit oil is the other share of production that is split between the NOC and IOC at the marketing stage.
3. The least used form of contracts globally are SAs where an IOCs act as a contractor to an NOC who owns and controls all operation and production. The IOC bears exploration and development risk. If successful, the IOC is paid back predetermined capital and operating costs and a fee for service is paid as a flat fee or percent of production, revenue, or profit.
(Click to enlarge)
The addition of state participation through NOCs makes IOC investment decisions dependent on the state and both must have aligned priorities. The structure of certain PSCs and SAs are over 30 years old, complex, and are not as competitive in a globalized marketplace for oil & gas investment.
Some petroleum-producing countries with PSCs and SAs are realizing that the complexities, rigidity, and lack of independence of their contracts are deterring investment decisions by IOCs; therefore, several countries are changing their contracts to attract capital. This capital helps secure future oil production from large projects and encourages companies to invest and expand on new technologies in the region.
(Click to enlarge)
According to the IEA, countries with predominantly royalty/tax contracts like those in the Americas continue to be the focus of investment. Regions in the Middle East and Africa, where significant PSC and SA contracts are used, are taking a much smaller piece of the global pie even as they have some of the largest oil reserves in the world.
Necessity Brings Change to Oil Contracts
Driven by a need for expertise and technology, NOCs rely on accumulating knowledge through partnerships and/or investments made by IOCs. To promote investment in technology, petroleum-producing countries with PSCs and SAs are providing more independence for IOCs through equity stakes and greater participation in oil & gas operations and production.
One of the examples of a changing investment climate is the Sultanate of Oman (“Oman”). Oman is one of the few Middle Eastern petroleum countries that has been on the cutting edge of new technologies leading to increased oil production from enhanced oil recovery (EOR) techniques. Oman’s oil production had faced declines from 2000 and, in 2004, Oman was forced to change its contracts between its NOC, Petroleum Development Oman (PDO), and IOCs to encourage investment in EOR technology and grow oil production. Related: Could This Be The Biggest NatGas Find Of The Decade?
In 2004, Oman renewed a contract with Royal Dutch Shell (“Shell” or RDS-A), 34 percent partner with PDO, for a block that now produces 70 percent of all oil and liquids production coming out of Oman: Block 6. Back in 2004, Shell’s Block 6 was set to expire in 2012; however, PDO extended the contract to 2044 due to the long-term nature of EOR projects that would be needed to increase production.
In 2005, Occidental Petroleum would sign a 30-year contract with the PDO to use EOR techniques to develop Block 53: the Mukhaizna Field. Occidental owns a 45 percent working interest in the project and brought significant steam flooding technology to the field. By 2015 production increased to 15 times 2005 levels. Other IOCs producing oil & gas resources in Oman include British Petroleum (BP), Total SA (TOT), Repsol SA, Reliance Industries, RAK Petroleum, Hunt Oil, and MOL Energy.
(Click to enlarge)
Oman’s current EOR technology surpasses progress made in certain Western EOR projects in Canada and the U.S. Oman’s Amal Solar Steam (MIRAAH) project with GlassPoint Solar is the first successful EOR project in the world to commercially produce steam for EOR production by harnessing energy from the sun to heat water. Additionally, Oman’s Qarn Alam is the largest and first EOR project that injects steam into a heavy oil bearing fractured carbonate rock reservoirs (referred to as thermally assisted gas-oil gravity drainage (TAGOGD)) and produces 25,000 barrels per day.
Changing Oil Contracts – Continued
Like Oman, necessity in attracting investment capital from IOCs has led several petroleum-producing countries to change and/or consult with IOCs for changes to contracts. The two largest recent changes have been the opening of Mexico’s oil & gas resources to IOCs and the change in the Islamic Republic of Iran’s (“Iran”) oil & gas contracts with IOCs.
Mexico and Iran had falling production from 2011 to 2015. Mexico was facing heavy oil competition (pun intended) in the U.S. market and Mexico’s NOC, Petr?leos Mexicanos’ (PEMEX), had been unable to invest and sustain oil and gas production and expand exploration and drilling technology. On the other hand, Iran’s National Iranian Oil Company (NIOC), the countries NOC, faced declines in IOC investment in field development because of sanctions imposed on the country in 2010. Even as Iranian oil production has climbed back up to 2011 levels, the country has missed out on vital IOC investment from 2010-2015.
(Click to enlarge)
Mexico Tears Down its Walls
In August 2014, Mexico opened bidding rounds for IOC investment and has since received bids from Exxon (XOM), Chevron (CVX), BP Plc (BP), Noble Energy (NBL), Royal Dutch Shell (RDS-A), Statoil (STO), Total (TOT), BHP Billiton (BHP), and Anadarko (APC). Mexico is promoting IOC investment through several types of contracts including royalty/tax contracts, production sharing contracts, and service agreements. Mexico hopes that IOC investment in oil & gas infrastructure, exploration & production, and technology will help Mexico compete in the U.S. oil market.
Iran’s Post-Sanction Re-shuffle
Iran had US$50 billion in IOC investment from 1995 to 2005 through SAs called buy-back contracts. Once sanctions were imposed in 2010, IOCs had halted and exited oil & gas exploration and production activity in the country. After emerging from most sanctions, Iran is now looking to boost production through re-inviting European and Asian oil & gas companies to invest in oil & gas fields, infrastructure, and technology. Iran has change its SA based buy-back contracts to a hybrid contract that resembles more of a PSC.
In a buy-back contract the NIOC and IOC would agree upon a capital expenditure limit borne by the IOC. The IOC would recover capital expenditures, operating costs, borrowing costs, and a fixed rate of return fee agreed upon between the NIOC and IOC once the field is brought to production. Shortfalls on the contracts included the limited term of the contract of 5 to 10 years, no resource ownership, a lack of flexibility on cost overruns, and fixed fee returns regardless of field complexity.
The new NIOC Iran Petroleum Contract (IPC) has made progress in addressing short falls on buy-back contracts. Terms on IPCs last over 25 years and includes ownership of resources. Capital expenditures are flexible and have yearly budget and work plans. IOCs are paid a fee for service that increases with the complexity of the field and those payments can be made as flat fees or a share of production. Related: Oil Price, Sanctions Weigh On Russian Stocks, Moscow Unfazed
Iran announced the tender of 14 oil & gas blocks in February 2017 for the summer of 2017. IOCs will be open to bid for blocks under the new IPC designed to attract new investment and technology. According to Iran’s Oil Minister Bijan Namdar Zanganeh, Royal Dutch Shell (RDS-A), Total (TOT), Eni (E), Petronas, Gazprom, Lukoil, and OMV are all prequalified for tenders under the new IPC.
Certainty, Independence, and Technology
As countries like Oman, Mexico, and Iran move to open their contracts to promote IOC independence and investment, more countries that need increasing oil production are modifying their existing PSC and SAs. Since 2014, Egypt has opened dialogue with IOCs through Egypt’s Brownfield Committee and is discussing changes to existing PSCs to promote investment in EOR technology. Additionally, since 2010, Kuwait’s NOC, Kuwait Oil Company (KOC), has invited IOCs, Shell and BP, to help increase Kuwaiti oil production to 4 million barrels per day by 2020 through EOR based service agreement contracts known as enhanced technical service agreements (ETSA).
In a globalized economy, the fight for investment capital from IOCs is taking a front seat for petroleum-producing countries looking to increase oil production. While some closed petroleum-producing countries invest in technology learned from around the world, partially open petroleum countries with PSCs and SAs are working to expand terms, modify investment requirement, and increase IOC ownership in operations and production. Attracting capital and benefitting from investment in technology is essential for petroleum-producing states to continue growing production, and perhaps, create their own U.S. shale-type oil revolution.
By Omar Mawji for Oilprice.com
More Top Reads From Oilprice.com:
- Why It Isn’t Game Over For Canada’s Oil Sands
- Oil And Gas IPOs Return Amid Oil Price Recovery
- Trump To Undo Fuel Efficiency Standards