“ Petroleum Development Arrangements in Nigeria’s Oil and Gas Sector” ESQ Oil and Gas Seminars 15 th and 16 th June

1. “Petroleum Development Arrangements in Nigeria’s Oil and Gas Sector”ESQ Oil and Gas Seminars 15th and 16th June 2011 by Dr Bayo Adaralegbe FCIArb (UK); FEI(UK); FCIS(UK); LL.M, Ph.D (Dundee) Partner & Head, Energy Group Babalakin & Co

2. Outline of Presentation • Various influences that shape the contractual framework of oil and gas activities • Various international petroleum development agreements in use; how they evolved and their conceptual differences • Various petroleum development agreements in use in Nigeria; the policies that shape their evolution, the statutory framework that provides a basis for them, and their conceptual differences • Changes to expect under the current reform processes in Nigeria’s petroleum industry-the Nigerian Content Act and the PIB

3. Influences that Shape Contractual Framework of Petroleum Development • Petroleum exploration and production activities influence petroleum development contract forms • These activities are borne out of fact that • ‘crude’ oil and ‘natural’ gas resources lie far below the Earth’s surface and therefore not easily accessible, unlike other natural resources • because hydrocarbon resources increase human life expectancy they are very significant in modern world and therefore affect their development

4. Extractive Nature of Resources as an Influence • Petroleum development activities require oil and gas resources to be first searched for through readings that are far from precise • If at all found, these resources have to be converted from ‘primary’ state to ‘secondary’ state for consumption by end user

5. Extractive Nature of Resources as an Influence • Extractive nature of oil and gas therefore results in different phases: • Exploration (seeking these natural resources based on data reading) • Production (getting them off the ground after finding them) • Transportation (moving them out of in situ state) • Processing (converting them from a natural state to a secondary state where they can be used) • Disposal (making them available to end user)

6. Effect of Resources on Modern Life as an Influence • Hydrocarbon resources mainly responsible for cooking, cooling, lighting, heating and transportation, apart from so many other uses • Referred to as ‘lifeblood’ of industrialisation for this reason • Such significance causes players from industrialised countries to dominate petroleum development activities globally, even though developing countries hold greater reserves

10. Effect of Resources on Modern Life as an Influence • Such significance also causes host countries to play direct role in development of petroleum activities for nationalistic and for economic reasons • This has resulted in an international political economy that has in turn had an effect on petroleum development arrangements

11. Contractual Framework of Petroleum Development Activities • Three main types of contract forms: • Upstream/ Exploration and Production contracts • ‘Petroleum Development Agreements’ • ‘International Petroleum Agreements’ • Field/Service contracts at exploration phase of activity • Contracts from production phase into midstream phase

12. Upstream/E and P Contracts • International law vests ownership of natural resources in sovereign state where it lies (UNGA Resolution 1803 of 1962) • Municipal laws of virtually all sovereign states vest ownership in sovereign state with notable exception of the US(s.44(3) of Nigerian Const) • Sovereign states therefore have to grant mining/mineral rights, typically to IOCs from industrialised countries for petroleum development

13. Participation Arrangements • Single mineral right holder rare due to capital and technology intensity of activities; third parties allowed to acquire participating/working interests in mineral rights through Operating Agreements(JOAs) • Necessitates appointment of one of JOA members as operator since they cannot all operate collectively • Farm outs also allowed for assignment of part of mineral right or participating interest for performance of obligation • Unitization agreement used for joint development where field straddles area belonging to more than one holders

14. Field/Service Contracts at Exploration Phase • A number of field/services contracts required at exploration phase: • Seismic Survey • Rig Contractor • Rig Services Contractors • Supply of equipment

15. Contracts from Production to Midstream Phase • A number of contracts also required from production to midstream phase • FPSO • Crude oil lifting • Crude oil transport • Crude oil sale • Decommissioning of well

16. Contracts from Production to Midstream Phase • In specific case of gas development: • Gas gathering and processing • Gas balancing • EPC agreement for construction of infrastructure • Gas transportation • Pipeline transportation • LNG transportation • Gas sales

20. Model Contracts • Developed by various petroleum bodies and covering all phases • Avoid time spent on negotiations • Reduce transaction costs • Seek to achieve common standard in international industry thereby improving general efficiency • Model contracts said to require no more than 20% adaptation to peculiar situations

21. Professional Bodies that have Produced Model Contracts • Association of International Petroleum Negotiators(AIPN) • Canadian Association of Petroleum Landmen(CAPL) • American Association of Landmen (AAPL) • Leading Oil and Gas Industry Competiveness LOGIC(formerly Cost Reduction Initiative in the New Era, CRINE) • United Kingdom Offshore Operators Association(UKOOA) • Rocky Mountain Mineral Law Foundation(RMMLF)

22. Professional Bodies that have Produced Model Contracts • Petroleum Joint Venture Association(PJVA) • Petroleum Equipment Supplies Association (PESA) • International Association of Drilling Contractors (IADC) • Petroleum Services Association of Canada(PSAC) • Petroleum Accountants Society of Canada(PASC) • Council of Petroleum Accountants Societies (COPAS) • International Association of Geophysical Contractors(IAGC)

23. Petroleum Development Arrangements and how they Evolved • Country where petroleum development originated and international political economy shape types • Petroleum development agreements began in form of one paragraph Concession that granted mining/mineral rights over large areas and for long durations in the USA where land owners owned natural resources • Developing countries that at that time where under colonial rule, were influenced by this practice and granted concessions in return for royalty and tax when they began to find oil

24. Petroleum Development Arrangements and how they Evolved • After many of these countries came out of colonial rule UNGA Resolution 1803 of 1962 on ‘Permanent Sovereignty over Natural Resources’ was issued • This led to nationalistic tendencies of these courtiers • IOCs from developed countries were expropriated, especially in Latin America, Middle East and North Africa • OPEC was borne out of this nationalism

25. Petroleum Development Arrangements and how they Evolved • Developing countries could still not prevent IOCs from involvement in their natural resources due to lack of technical, managerial and financial capacity • Hence next best option: state participation emphasizing production, profit and control of countries over their natural resources towards economic development through • Better fiscal terms for the sovereign state • Industrialization • Technology transfer • Development of local content

26. Petroleum Development Arrangements and how they Evolved • Because of this constitution of many countries , especially Latin American and Middle East states, prevented foreigners from owning mineral/mining rights • Resulted in new arrangements where developing countries established NOCs vested with mineral/mining rights that were then contracted out to IOCs to develop

27. Petroleum Development Arrangements and how they Evolved • Risk Service Contracts emerged out of this where developing states engaged IOCs as contractors in respect of mineral/mining rights that they vested in their NOCs or Petroleum Ministries • Under this arrangement IOCs used their own capital expenditure and operating costs to explore for petroleum • IOCs only got reimbursed through a service fee if oil was produced • Sometimes IOCs were allowed to buy back part of oil produced as consideration for service

28. Petroleum Development Arrangements and how they Evolved • Production Sharing Contracts emerged out of this where developing states engaged IOCs as contractors in respect of mineral/mining rights that they vested in their NOCs or Petroleum Ministries • IOCs also used their capital expenditure and operating costs to explore for petroleum under this arrangement • Under this arrangement IOCs only got reimbursed through a share of the oil produced

29. Petroleum Development Arrangements and how they Evolved • Under this arrangement IOCs • First received ‘cost oil’ to cover costs and expenses limited to a percentage , and thereafter • IOCs and NOCs split the oil produced known as ‘profit oil’ to represent their return on investment

30. Types of Petroleum Development Arrangements • Concessions: used in 60 countries • Production Sharing Contracts : used in 41 countries • Risk Service Contracts: used in 4 countries • Participation Agreements? • Hybrid?

31. Petroleum Development Arrangements: How they differ • In Risk Service and Production Sharing Contracts the IOC did not receive any reimbursement for their expenses or any return on their investment if no oil was produced • Hence both arrangements referred to as ‘sole risk’ • PSC and Risk Service Contract terms have to correspond, and mirror back terms under original mineral/mining rights of NOC in key areas such as area, duration, revocation , etc

32. Petroleum Development Arrangements: How they differ • In modern practise licences/leases have taken over from old concessions with significant modifications • Only limited areas now granted • Only shorter durations of between 20-30 years now granted • Sovereign state exercises direct control over petroleum development activities • In terms of which well to drill, when and pace of operations through a work programme • Better fiscal terms in favour of sovereign state • Periodic relinquishment of part of area granted

33. Petroleum Development Arrangements: How they differ • Industrialized states use licenses/leases more; PSCs and Risk Service used more in developing countries • PSCs more popular than Risk Service Contracts that are only common in countries that have a lot of capital at their disposal to pay for services • Some countries use all these arrangements simultaneously

34. Petroleum Development Arrangements: How they differ • Licenses/leases: • Exclusive right granted mineral/mining rights holder to explore for petroleum , and if found, to dispose of in consideration for royalty, rent and tax • In some countries a single license covers exploration and production phases; in others separate licenses for exploration phase; license granted for production phase only allowed when oil is found in commercial quantities • Mining /mineral rights granted conceptually similar to profit a’prendi in common law lease estate • Mining/mineral rights have both public and private law character • Mining/mineral rights vest legal title, but over petroleum resources produced at well head • Sovereign state continues to own natural resources in accordance with international law

35. Petroleum Development Arrangements: How they differ • Production Sharing Contracts • E and P Company undertakes petroleum development activities on behalf of holder of mining/mineral rights, typically NOC • E and P Company is contractor/operator, but not legal owner • Contractor bears sole risk of exploration activities

36. Petroleum Development Arrangements: How they differ • Risk Service Contracts • E and P Company undertakes petroleum development activities on behalf of holder of mining/mineral rights, typically NOC • E and P Company not legal owner • E and P Company bears sole risk of petroleum development activities

37. Petroleum Development Arrangements: How they differ • Rough conceptual analogy may be made between petroleum development arrangements and real estate projects: • License/lease can compare to legal title holder of land • PSC Contractor can compare with property developer who is compensated with rent of specific floors as who may have some equitable interest in property • Risk Service Contractor may be likened to contractor who develops property and who gets paid off for his services without any legal or equitable interest in the property

38. Petroleum Development Regime in Nigeria • Ownership of petroleum resources in Nigeria • “Notwithstanding the foregoing provision of this section the entire property in…shall vest in the Government of the Federation...”(s.44(3) Const.) • “The entire ownership and control of all petroleum in…shall be vested in the state ”(s. 1(1) Petroleum Act)

39. Petroleum Development Regime in Nigeria • Ownership over what area? • Nigeria as a coastal state: • Nigerian state vested with entire ownership and control of all petroleum in all lands (a)in Nigeria(b) under territorial waters of Nigeria(c) that forms part of the Continental Shelf (d) that forms part of the Exclusive Economic Zone of Nigeria(s. 1 of Act) • “...sovereign and exclusive rights with respect to the exploration and exploitation of the natural resources of the sea bed, subsoil and superjacent waters of the Exclusive Zone shall vest in the Federal Republic of Nigeria....” (s2(1) of the EEZ Act)

40. Petroleum Development Regime in Nigeria • Note A.G Fed. Vs A.G Abia & Ors to the effect that Nigerian states(political subdivision) do not have claim to offshore • Note NDDC Act enacted before this case which refers to “offshore of Nigeria Delta area”

41. Petroleum Development Regime in Nigeria • Petroleum Act is main statute that deals with petroleum resources and how they may be developed • Petroleum Act only provides for development of petroleum resources through phases of exploration, prospecting and production • Grants to companies registered in Nigeria separate rights for each phase through a license /lease regime

42. Petroleum Development Regime in Nigeria: OEL • Oil Exploration License right to ‘undertake exploration for petroleum’ not exclusive • over compact area not exceeding 5000 sq miles for a duration to lapse by 31st Dec next; renewable 3 months before end of period for a period not exceeding 1 year

43. Petroleum Development Regime in Nigeria: OPL • Oil Prospecting Licence ‘exclusive right to explore and prospect for petroleum’ • Explore and prospect implies oil drilling operations • Since holder allowed to carry away and dispose of petroleum won during operations • OPL holder expected to drill to find oil in commercial quantities to be able to qualify for OML • over compact area not exceeding 1000 sq miles for a period not exceeding 5 years including renewal; in case of deep offshore minimum of 5 years aggregate of 10 years through amendment in Deep Offshore Act

44. Petroleum Development Regime in Nigeria: OML • Oil Mining Lease exclusive right to(a) ‘conduct exploration and prospecting operations’ (b) ‘win, get, work, store, carry away, transport, export’ (c) ‘otherwise treat petroleum discovered’ (Para 11 of First Schedule to Act • Note that section 2 of Act itself allows Minister to grant only rights to search for, win, carry away and dispose of petroleum • Right to export absent (a)from principal law that prescribes the scope of rights Minister may grant and(b) from specimen copy of OML in law • Is meaning of export consistent with ‘carry away’/’dispose of’? If not can schedule expand meaning in principal law? • In practise OML holder allowed to export

45. Petroleum Development Regime in Nigeria: OML • over compact area not exceeding 500sq miles for duration not exceeding 20 years • Note “All oil mining leases deriving from an oil prospecting licence shall be in compact blocks or units; and where more than one block or unit is so derived, each block or unit shall be the subject of a separate and distinct lease”(Reg. 293) Petroleum(Drilling and Production) Regulation) • 50% of area to be relinquished after 10 years of grant • OML may be renewed indefinitely • Note recent controversy over renewal of ExxonMobil’s blocks

46. Petroleum Development Regime in Nigeria: OML • Condition for grant of Oil Mining Lease: • Minister ‘may’ grant ‘only’ OPL holder an OML • If oil is found in commercial quantity (10,000 barrels per day) • If all conditions in licence satisfied • Two separate leases may be granted from single OPL(Oil Prospecting Licences (Conversion to Oil Mining Leases, ETC.) Regulations) • Note South Atlantic Petroleum v Min of Petroleum Resources

47. Position of Operator under Act • No specific provision under Act • Act seems to assume sole participation by mining/mineral right holder and assumes holder shall also be operator • Regulation 9 Petroleum (Drilling and Production) Regulation that states: “The holder of an oil exploration licence, oil prospecting licence or oil mining lease shall (a) appoint a manager resident in Nigeria to supervise the operations under the licence or lease”

48. Petroleum Development Arrangements in Nigeria • Statutory lease regime serves as source of contractual arrangements developed in response to government policy on hydrocarbon development • U-JVs created between IOCs (previously granted OMLs before advent of state participation) and NNPC on behalf of Nigeria to achieve state participation policy • PSCs created between NNPC (as OPL/OML holders) and IOCs to achieve state participation policy • Risk Service Contracts between NNPC (as OPL/OML holders) and IOCs to achieve state participation policy

49. Petroleum Development Arrangements in Nigeria • JOAs created between indigenous companies (as OPL/OML holders) and IOCs to achieve indigenous participation policy • Farm outs created between IOCs (as original OML holders) and NNPC under U-JV on one hand, and indigenous companies on the other, to achieve indigenous participation policy

50. U-JVs created pursuant to Lease Regime • Nigeria became OPEC member in 1970 • OPEC Charter provides for state participation for member states • Petroleum Act provides for: “Participation by the Federal Military Government in the venture to which the licensee or lessee relates, on terms to be negotiated” (Paragraph 34(a) of Act)