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Production sharing agreement (PSA)

Production sharing agreements or production sharing contracts are one of a number of legal structures used between countries with oil & gas reserves and international oil companies keen to develop those reserves

Production sharing agreement (PSA)

Production sharing agreements (PSAs) got their start in Asia and Africa, where the national oil companies and the international oil companies wanted to partner up to develop new gas & oil fields

PSA is a contract between one or more investors and the government in which rights to prospection, exploration & extraction of mineral resources from a specific area over a specified period of time are determined.

According to the terms of a standard PSA, the government hires the investor(-s) as a contractor for the extraction of mineral resources, but the government still retains ownership of the resources.
The investors administer the business at their own expense and risk sharing with the government part of the production output in accordance with the agreement.

PSAs come in 4 types:
  • Full cost recovery, deferred profit shares
  • Full cost recovery, deferred profit shares, with 1st tranche (1/3 of awarded) hydrocarbons
  • Capped cost recovery, simultaneous profit shares
  • 1st tranche hydrocarbons, capped cost recovery, simultaneous profit shares
PSAs also vary in how they deal with the profit shares.
The share ratios could be set as fixed percentages for the lifetime of the PSA or as a progressive scale designed to increase the state's participation levels as the underlying project attains greater levels of daily production.

In order to ensure that the international oil company is «working the land», the PSA will prescribe the minimum work and expenditure commitments.
Given that only a small number of exploration efforts actually lead to a commercial discovery, the work commitment and financial obligations are crucial negotiation factors as they define the extent of the exploration risk.
States will want to draft these with as much specificity as possible while international oil companys prefer commitments that allow maximum discretion.

PSAs can be complicated.
Parties often disagree about various parts of the contract.
Because both parties are trying to maximize revenue and minimize risk, it isn’t surprising that agreements that seemed pretty clear at signing receive differing interpretations from a party under stress.

Some of the arguments stem from the amount of time the agreements are in place.
Personnel and process changes on both sides can change the understanding of the contract language.
Changes in fiscal practices or political problems in-country can create other issues.
Non-aligned operating or subcontractor agreements and economic cycles cause a few.