LECTURE WEEK 3: OIL AND GAS LAW. Course Lecturer:

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1 LECTURE WEEK 3: OIL AND GAS LAW Course Lecturer: Kato Gogo Kingston, PhD Associate Professor of Energy & Natural Resources Law: Oil and Gas Faculty of Law, Rivers State University, Nigeria Kato Gogo Kingston, CRUDE OIL STREAM TRANSACTIONS The entire activity which propels oil and gas transactions are often classified into three broad categories namely: 1. Upstream 2. Midstream 3. Downstream In Nigeria, there are no specified transactions in the midstream however, activities that would normally be classified as midstream services are fused into the downstream. Such activities include storage; marketing; and transportation of the products. (a) UPSTREAM TRANSACTIONS The term upstream is used to describe the largest form of investment in the crude oil and natural gas sector. The business in the upstream involves all the activities that are within exploration and production ( E & P ) of the natural gas and crude oil. The examples of upstream activities are: Surveying; Prospecting or searching to discover new oil reservoirs; Drilling; Explosive detonation; Construction of oil and gas facilities on land and in the sea such as rigs; Maintenance of rigs; Conveying of equipment; Construction of pipelines and storage facilities 1

2 (b) DOWNSTREAM TRANSACTIONS Downstream investments are not as expensive as the activities classed under the upstream. It is the government of each country that determines the activities classified as upstream or downstream. In Nigeria some of the activities classed under the downstream by the federal government of Nigeria are: Crude oil refining; Conversion of natural gas into liquid for exports; Production of liquefied petroleum and gas conversion equipment such as cylindrical tubes; durable plastic and metal valves; and, digital pressure regulators. Storage; Marketing; and Transportation of the products 2

3 TYPES OF OIL AND GAS INTERESTS Interests in this perspective are bundles of rights pertaining to crude oil and natural gas. The owner of such rights may wish to convey the whole of a part to another. It is very rare to wholly convey ownership rights of mineral lands to another. The most common transactions in that regard is by way of contract which permits a non-owner of crude oil land to extract the crude oil and share the proceeds with the land owner. There are three major types of oil and gas interests as follows: 1. Surface Interest (Surface rights) 2. Minerals Interests 3. Royalty Interests SURFACE INTEREST The holder of the surface interest or surface rights is not allowed to drill and extract any mineral including crude oil. He can enjoy the use of the land except that he cannot drill for minerals. What this mean is that, Mr David can own Number 30 Aba Road, Port Harcourt hence, he can build and construct houses on it but another person or superior power owns the minerals underneath the same land, etc. For example, in Nigeria, all those persons that presume that, they own lands are only surface rights owners whilst the government is the mineral rights owner. MINERALS INTERESTS The mineral interest owner can sometimes be the surface rights owner. Where the two interests are in the hands of separate persons, the mineral interest owner has superior powers of the land. For example, in Texas and Pennsylvania (United States), the laws permit the separation of the surface and mineral estates whereby ownership of the surface can be separated from the ownership of the minerals. 3

4 Chartiers Block Coal Co. v. Mellon 25 A. 597 (Pa. 1893), HELD...the surface of the land may be separated from the different strata beneath it, and there may be as many different owners as there are strata... Under the traditional common-law rules of severed estates, the mineral estate is considered dominant to the surface estate. ROYALTY INTERESTS Royalty interests are the right to receive some financial proceeds or fees from parties that are committed to do so by some form of agreement or contract. Many circumstances give rise to royalty interest. For example, an author of a book can enter into an agreement with the publishers on how much fee he will receive per number of sales of the book. 1 Royalty agreements are futuristic in nature because, the royalty agreement is often based on speculation of future accumulation of income. It is common with intellectual property related business and the oil and gas production. 2 In the oil and gas production situation, the royalty arises from the future production or revenues from leasehold, which may be stripped from the original owner of the asset. The main features of royalty interest are that, the fee simple recipient of the royalty fee has: (a) A share of the revenue of the production free of production costs; (b) No right to conduct business on the property leased property; (c) No right to interfere with the subsisting lease; and, (d) No right to lease the benefits. HOW TO TRANSFER OIL AND GAS INTERESTS IN NIGERIA In many cases, the rules governing the transfer of mineral interest are provided in the regulatory framework of the relevant state institution. The mineral interest holders possess the right to collect the financial proceeds for minerals covered by the mineral interest, including royalty payments, bonuses, rents etc. 1 Kato Gogo Kingston, Oil and Gas Laws: A Guide for International Practitioners. Germany: LAP Lambert Academic Publishers, ibid 4

5 In Nigeria, the federal government is the holder of the mineral interest, hence, it transfers such rights to multinational oil corporations through the following means: a) Concessions or licenses; b) Production sharing contracts (or agreements) c) Profit sharing Contracts d) Risk-service contracts e) Joint venture agreements CONCESSIONS OR LICENSES In oil and gas law, a concession agreement is a negotiated contract between the oil company and the government, which gives the oil company the right to capture crude oil and natural gas in situ (at a specified geographical location) within the government's jurisdiction, subject to certain conditions. It is called concessions, because it grants the oil company the rights to possess the oil and gas for the whole duration specified in the contract. Under concession contracts and licenses, the oil companies are often given special rights to capture crude oil and gas in return, they are required to pay royalties, taxes, and fees to the government. PRODUCTION SHARING CONTRACTS NIGERIA In this type of agreement, where the parties are oil firm on the one hand and the government on the other hand, the oil company is the operating party obligated to develop and produce the oil and gas from a specified geographic area or oil fields. The oil company first recovers their capital and operating expenditure before sharing the profits with the government. The risk here is that, the oil firm may not be transparent in declaring the actual value of the crude oil it produces. Where this happens, the government gets very marginal revenue from the transaction 5

6 REVENUE SHARING CONTRACTS In this type of agreement, the oil firm is obligated to develop the oil and gas fields, however, the revenue is shared between the government and Oil Company from every consignment of the oil produced starting with the first consignment. The implication of this type of agreement is that, many oil firms will not want to be a party to the contract. Where they chose to enter into the contract, they may not wish to invest huge capital into the transaction. RISK SERVICE CONTRACTS In risk sharing contracts, the oil company bears all the exploration and production costs. In return, where the exploration process yields successful outcome, the government permits the oil company to sale the crude oil and to recover their expenditures from the proceed of the sale. In addition, the government also pays the oil company a fee based on a percentage of the remaining revenues. JOINT VENTURES (JV) Crude oil joint venture typically involves two or more oil companies entering into partnership agreement for joint development of jointly or separately held oil prospecting licences or oil mining leases and facilities. Each of the partners in a joint venture contributes to the costs, shares the benefits and liabilities of the operations in accordance with its proportionate equity (unitised value) interest in the venture. In Nigeria, currently, there are seven major joint ventures controlling 97.5% of the crude oil in Nigeria. Each joint venture (JV) operates under separate Operating Agreement (JOA) with the representing the Federal government. As a supplementary agreement to the JV agreement, the Joint Operating Agreement (JOA) often contains the following: a) Operatorship and obligations; b) Work programme, plans and expenditure; 6

7 c) Authority of operating (management) committee and its subcommittees (exploration, technical, finance, services, engineering, production, and public affairs); d) right of assignment by either party; e) Commencement date, scheduling and lifting procedures; f) Accounting procedures; g) Dispute settlement procedures; h) project, contract procedures; and i) Communication procedures. Table 1: List of current Oil & Gas JVs in Nigeria Partners 1 Shell Agip Elf 2 Mobil 3 Chevron 4 Agip Philips 5 Elf 6 Texaco Chevron 7 Pan Ocean Equity Interest 30% 5% 10% 55% 40% 40% 20% 20% 40% 20% 20% 40% Operator Shell 58 Mobil 4 Chevron 16 Agip No. of OMLs N/A Elf 14 Texaco 6 Pan Ocean 1 SHELL JV A joint venture operated by Shell accounts for more than forty percent of Nigeria s total oil production (899,000 barrels per day (bpd) in 1997) from more than eighty oil fields. The joint venture is composed of (55 percent), Shell (30 percent), Elf (10 percent) and Agip (5 percent) and operates largely onshore on dry land or in the mangrove swamp. Chevron JV A joint venture between (60 percent) and Chevron (40 percent) has in the past been the second largest producer (approximately 400,000 bpd), with fields located in the Warri region west of the Niger river and offshore in shallow water. It is reported to aim to increase production to 600,000 bpd. 7

8 Mobil JV A joint venture between (60 percent) and Mobil (40 percent) operates in shallow water off Akwa Ibom state in the southeastern delta and averaged production of 632,000 bpd in 1997, making it the second largest producer, as against 543,000 bpd in Mobil also holds a 50 percent interest in a Production Sharing Contract for a deep water block further offshore, and is reported to plan to increase output to 900,000 bpd by Oil industry sources indicate that Mobil is likely to overtake Shell as the largest producer in Nigeria in few years, if current trends continue. Agip JV A joint venture operated by Agip and owned by (60 percent), Agip (20 percent) and Phillips Petroleum (20 percent) produces 150,000 bpd mostly from small onshore fields. Elf JV Texaco JV A joint venture between (60 percent) and Elf (40 percent) produced approximately 125,000 bpd during 1997, both on and offshore. Elf and Mobil are in dispute over operational control of an offshore field with a production capacity of 90,000 bpd. A joint venture operated by Texaco and owned by (60 percent), Texaco (20 percent) and Chevron (20 percent) currently produces about 60,000 bpd from five offshore fields. 8