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Creative contracting models offer answers for Oilfield Services Companies

FOCUS: Oilfield services (OFS) companies should consider a wider range of contracting models and challenge traditional fixed-fee type strategies in order to survive and prosper, as the lower oil price squeezes margins in the exploration and production (E&P) industry.27 Jan 2017

The fall in oil prices since 2014, and the resulting tightening of capital budgets by E&P companies worldwide, has hit the OFS sector hard. No longer playing a leading role in resource exploration, many OFS companies are finding themselves forced to rethink their traditional business models. 

While some have opted for mergers and increased collaboration, others are now working more closely with international oil companies (IOCs) and national oil companies (NOCs). NOCs are typically less sensitive to short-term financial pressures and market sentiment, and continue to invest in long-term strategic projects. These companies are becoming more at ease in working directly with OFS companies, and often expect more complex solutions.

Incentive-based, risk / reward-sharing contracts offer promising opportunities for the OFS sector, but it is important to understand the benefits and drawbacks of each type of model. We have identified a spectrum of potential contract types, from the traditional "fixed-fee for service" through to what we have termed, "quasi-equity" and "equity" models. "Equity" in this context means the participating interest that is usually held by the E&P company under its petroleum contract with the host state. "Quasi-equity" therefore envisages the OFS company taking on more risk in return for a share in the production success of the oil and gas project.  

There is a range of equity and quasi-equity models that OFS companies may consider, depending on the jurisdiction involved, as summarised below.

Partnering

The term "partnering" covers a broad concept, and describes the long-term commercial relationship between the traditional E&P company and the OFS company. This model gives the E&P company certainty over rates and quality while the OFS company in return achieves assurance on its reward and, crucially, demand, without having to renegotiate new contractual terms for each piece of work.

Alliancing

Alliancing – popular in the North Sea industry during the 1990s – can be seen as a step up from partnering in terms of risk / reward. Alliancing also creates a long term relationship and requires close cooperation between the parties if it is to be successful. The parties align their interests so that both can enjoy the upside when the project is a success, often through a framework agreement setting out minimum conditions of satisfaction.

Integrated services contract

These contracts, which usually involve subcontracts with third parties while the OFS company remains as the single point of contact for the operator,  typically trade up-front discounts for higher bonus payments on the back end of the project, tied to improvements in well output. The OFS company will provide a greater range of services, and share in costs, but will not directly invest capital in the project. Schlumberger, for example, has successfully executed integrated service projects globally through its Integrated Project Management organisation since the mid-1990s.

Risk services contract (RSC)

Under an RSC, the OFS company develops, operates and maintains the field and assumes the execution risk. The resource holder remains the project owner and the OFS company is the service provider. Payment is based on the OFS company achieving set key performance indicators and will usually commence from first production and continue throughout the duration of the RSC. The RSC model allows the OFS company to add value through innovative design and cost-effective execution. These contracts are only available in certain jurisdictions, such as Malaysia, Iraq, under the technical service contract, and in Iran under the soon-to-be-launched Iranian petroleum contracts, for which Schlumberger has been the only western OFS company to pre-qualify.

Production enhancement contract (PEC)

In a further shift up the risk / reward spectrum, the PEC model is used to increase production from mature fields. Under the PEC, the OFS company assumes both execution and production risks, and its fees will be based on achieving certain production improvements. Fees are typically paid on a tariff-per-barrel of hydrocarbons produced basis. The OFS company does not own any of the petroleum reserves, but adds value based on its ability to increase production and improve project management.

Production sharing contract (PSC)

A PSC sees the state and the contractor sharing production from the asset, although the rights to the petroleum in the ground remain with the state. The contractor will assume execution, production, commodity price and market risks, and adds value through its surface and subsurface capabilities, project management and field management. The contractor will often act as the operator of the asset and is able to book reserves in its financial statements.

Although these contracts have generally been awarded to IOCs, there have been cases where OFS companies have contracted directly with states. The OFS company would have to fund the operations as well as carry them out and, under traditional PSCs, would be entitled to recover both its capital costs and on-going operating costs out of an allocated share of production, although not all categories of costs will be recoverable and costs are not recovered unless operations result in commercial discovery and development. The remainder of the production is then shared between the state and the OFS company, as well as any co-venturers.

While the potential reward under this type of contract is attractive, the risk is also high. Under a PSC, the OFS company assumes increased risk in terms of market and commodity prices. The PSC is generally used in developing countries, and the state may often require the contractor to use a minimum number of local staff, provide training and spend significant sums on local infrastructure.

Concession agreement

This model is now potentially open to OFS companies, and can be categorised as a true equity model, at the highest end of the risk / reward spectrum. Under a petroleum concession, such as a petroleum production licence in the UK continental shelf (UKCS), the owner of petroleum rights in an area grants those rights to another person. For the duration of the concession the concessionaire is permitted to explore for and produce petroleum in that area, and usually owns its share of all petroleum produced, except for any royalty payable. By way of example, Petrofac has recently acquired a participating interest in the petroleum production licence for the Greater Stella Area in the UKCS.

The opportunities set out above come with major challenges for OFS companies, and consideration should be given to issues such as the jurisdiction involved, increased risk management, local content requirements, and competition issues against, for example, local national OFS companies and traditional IOC customers.

Jason Rosychuk is an energy expert with Pinsent Masons and can be contacted for a copy of a Pinsent Masons toolkit on equity and quasi-equity models for OFS companies