PRODUCTION SHARING AGREEMENT BY

Grain Malunga

Mineral Resources and Environmental Management Expert

Abstract Production Sharing Agreement (PSA) is a contract entered into between government and a private company

wishing to explore, develop and produce petroleum. This agreement contains clauses that stipulate agreed

upon methods for allocation of petroleum produced and payment of royalty and taxes due to government.

This paper tries to highlight the nature of PSA and how it can promote it can promote sustainable

development.

Introduction Production Sharing Agreement (PSA) is a contract that a state gives to a mining company or petroleum

company to explore and develop a concession. This is on the understanding that natural resources

are vested in the state on behalf of its citizens. The state can be represented by a State Owned

Enterprise (SOE).

The state leaves all the expenditure for exploration and development in the company or may fully

fund exploration and development of the resource and contract the company to develop and operate

in exchange for part of the production. The PSA provides for the establishment of a joint committee

where both parties are represented and which monitors the operations.

Drafting Principles The principles for entering into this agreement are guided by the taxation and fiscal regime of the

country; and the Petroleum Exploration and Production Act. PSAs are distinguished from other types

of contracts in that the private company carries the entire exploration risk without compensation and

that the state owns both the resource and the installations.

Production Sharing The private company pays a royalty on gross production to the government. After the royalty is

deducted, the company takes its pre-specified share of production for cost recovery. The remainder

of the production (profit oil) is shared between government and the private company at an agreed

share arrangement. The private company continues to pay income tax on its share of profit oil. This

taxation framework incorporates incentive structures, risk and reward-sharing. The whole

arrangement points to reimbursement of development capital and a fair share of the business profit

to the private company.

The above explanation can be structured as below;

Production Sharing Agreement [Grain Malunga, May 2016]

Figure 1: Production Sharing Structure

The other state revenue will be in form of signature bonus, discovery bonus, production bonus, import

and export tax and wind fall tax. It is worth noting that income tax is deducted on profit income. This

tax becomes effective when the private company starts production and not during exploration and

development.

Figure 2: Total Government share of revenue from a project (Source: Mohammed A. Adam)

Private Company

Gross Production

Cost Recovery Profit Oil

Private Company Share

Profit Income Tax

State Share

Royalty

State

Production Sharing Agreement [Grain Malunga, May 2016]

Figure 2 shows the share governments have in implementing PSAs. In Africa mature or established

economies can have between 60% and 80% share of the proceeds from an oil and gas project while new

entries may get between 50 and 55%.

Sustainability PSAs are designed to maximize government revenue while at the same time to provide sufficient incentives

to investors. The investor’s revenue is made up of cost oil and profit oil, while the government’s revenue

comprises royalties, profit oil, bonuses, taxes, customs duties, and indirect benefits that arise from local

content goods and services. The contract also determines who manages the operations and how issues of

environment, local economic development and community rights are dealt with.

The project’s sustainability is measured through high return on investment for the investor, government

measures it through revenue generated, economic growth, infrastructure development and technology

transfer while the community or citizens look at social investment (e.g. schools), environmental protection

and economic benefits (e.g. employment).

Mineral resources can contribute to sustainable development if through recognition of the fact that they

are exhaustible, revenues or their prices are volatile and the resource industry is vulnerable to corruption

and mismanagement. In this case there is need to establish future generation fund and/or stabilisation

fund address issues of national investment and governance of budget plan.

Conclusion Production Sharing Agreements are a modern means of entering into agreement between state and

investment companies in exploring, development and exploitation of oil and gas for the benefit of the two

parties while understanding that the resources belong to the people. It is for this reason that all contracts

should transparent and accessible to the people.

The sharing agreement takes into account cost recovery and profit sharing while being mindful of

environmental sustainability and local benefits for the local communities.

References

Anderson, R.O. (1984). Fundamentals of the Petroleum Industry. Norman:

University of Oklahoma Press.

Beredjick, N/ Walde, T.W. (1988). Petroleum Investment Policies in Developing

Countries. London: Graham & Trotman.

Dam, K.W. (1976). Oil Resources: Who Gets What How? Chicago: University of

Chicago Press.

Open Oil. (2013). Oil Contracts – How to read and understand them.