This article has been written by Neha Sharma pursuing the Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho. This article has been edited by Prashant Baviskar (Associate, Lawsikho) and Dipshi Swara (Senior Associate, Lawsikho).
Oil and gas are among the important limited natural resources that need robust collective efforts between the users or rights holders and the developers for effective exploration, extraction, production, and processing. Initially, if we look at any typical oil and gas project, it can be divided into four key stages, firstly, Exploration wherein any company or government will look for oil/gas providers, or countries enriched with Oil and Gas resources and then will decide if the project is economically feasible and achievable or not. Secondly, after the exploration comes, the Development. This stage begins once the project has been considered and approved as economically viable, and then the appropriate infrastructure is arranged or developed or constructed to get the Oil and Gas out of the ground after search. Thirdly comes the stage of Production, wherein the oil/gas is produced and sold and the last stage of the oil/gas project comes abandonment wherein the company/government proceeds towards closing the project and abandoning the business project. So, for this whole cycle to be regulated and controlled properly along with certain obligations to be fulfilled by both the Parties, a Service Contract comes into play as a super savior.
Hence, this paper presents an insight into the service contracts in Oil and Gas Industry, Firstly, the paper explains the basic meaning and motive of the service contracts along with the definition of Service contracts in the context of the said Oil and Gas industry, then it moves towards explaining the in-depth analysis of Service Contracts and its types. Furthermore, the paper will also enlist certain essential clauses of any service agreement and also discusses the risks associated in absence of these contracts.
Service contracts in the Oil and Gas industry
The term “Service contract” is frequently used in the Petroleum Oil and Gas Industry and is also referred to as “drilling contract”. This Service contract in the oil and gas industry essentially is a long-term agreement between the government of a nation and an international corporation, where the corporation will explore or develop a certain oil or natural gas field for a predetermined amount. So, “service contract” is not an industry-specific contract. It is simply a bifurcation – ‘Service’ & ‘Contract’. It means that a contract between two parties that is agreed upon for the performance of a service by one party, and undoubtedly, a contract comes into existence with consideration, so for that service, the other party will be paying some amount to the former party. It is significant to have a written Service Contract properly executed between the parties especially when it’s an overseas promisor because the written agreement demarcates all the terms, conditions, obligations for both the parties for that particular work arrangement and such a contract not only provides transparency but also helps to prevent any future disputes that may occur without having any formal written agreement as it is known that oral contracts are very difficult to enforce in the court of law.
Types of service contracts in the oil and gas industry
If we generally talk about the major broad categories of agreements that are entered between the parties in the Oil and Gas sector, they are: Concession agreements, Production Sharing Agreements (PSA), Joint venture Agreements and Service Agreements.
Concession Agreements: These are also referred to as License Agreements and are among the oldest types of Oil and Gas contracts wherein more or less the system is like land ownership where the landowner (Lessor, i.e. the state or mineral rights owner) grants another entity or company (i.e., Lessee) exclusive rights to explore and own the resources and reserves.
Product Sharing Agreements (PSA): Unlike these concession agreements, the PSA does not confer a lessee with ownership over the oil or gas resources and reserves, in fact, the ownership and rights remain within the state. Nonetheless, this ownership is considerably partial.
Service Agreements: Alike a PSA and unlike a concession, a service contract or service agreement is one more type that doesn’t grant ownership of mineral resources and reserves, to an involved performing company. But now, unlike a PSA, the involved company is not really a lessee but a mere service contractor that does not have any right over the economic gains from oil or gas production. Specifically, a service contract gives the task or work to a company to develop a specific land area for prolific economic activity. This company provides capabilities for exploration, extraction, and processing of oil or gas, thus accepting payment from the state for providing such services.
Now further, these Oil and Gas Service Contracts have three subsets as well, the first type of contracts are the Pure service contracts and the others are Risk Service Contracts and Technical Assistance Contracts. These vary in their scope and, to some extent, in the possible parties that may enter into them.
Further types of classification
- Pure Service Contracts: Pure service contracts or Oilfield Service contracts are agreements or contracts for the facility of specific oilfield services, for instance, the most common types of pure service agreements are seismic contracts, drilling contracts, well services contracts, master services agreements, design and construction contracts, and procurement contracts. Under this arrangement, the host Government provides capital for exploration and production of resources and the contractor merely performs its predetermined agreed services and in return, is paid a flat fee for the services performed, whether or not there is discovery. These types of contracts prove to be very beneficial for the oil-producing countries having high petroleum deposits.
- Risk Service Contracts: Risk service contracts include a more comprehensive scope of services than the pure service contracts and these contracts actually represent the evolution of the service contracts from concession and PSA models. Herein, a host nation contracts with an oil company to explore and further develop its resources. The Company in this service contracts model, undertakes all managerial and technical tasks and bears all the financial and operational risks, in consideration for a prescribed fee rather than the share of profits earned or any interests or stake in the resources developed or services performed. Also, risk service contracts do not provide any guarantee regarding payment of fees for those situations where oil is not discovered or produced, unlike it was in the case of Pure service contracts. Rather, if the exploration results in no discovery, then without any doubt, the contractor or oil company will not be paid at all.
- Technical Assistance Contracts: Technical Assistance Contracts are often described as the modern upgraded form of Pure service contracts. Here, the contractor or the Oil company, not only provides exploration and production services but also transfers the requisite technology, technical services and also provides their own staff for running the project to the host nation. The host country is entirely responsible for the financing of the project. This type of contract appears closest to an international public-private partnership, in which the host Government has the maximum negotiating power.
Essential clauses of a service contract
Presently, every oil-producing country around the world wants to expand their control over natural resources and try to control this profitable sector by entering into contracts with resource-enriched nations. The Petroleum services sector involves high risk, huge expenses and investment and cannot be run by one party. By entering into an appropriate and well-drafted oil and gas service contract, the parties can reduce the risk in this sector and along with that it definitely benefits both- the contractors or the oil companies in the business and host nation itself, by distinctly defining the terms in the contract. As previously reiterated, written agreements or contracts undoubtedly provide transparency and enlist the responsibilities, liabilities, etc. for both the parties which ultimately benefits in avoiding disputes that could surface devoid of a formal written contract between the parties.
So, given below is a rough structure, as well as these, are counted among the most essential clauses that must be there in an oil and gas service contract.
- Scope/Object/Purpose of the Contract: After giving the appropriate ‘title’ to the contract that can be either ‘Pure Service Contract’ or ‘Risk Service Contract’ or any other subset of service contracts, and also after giving a proper description of the parties involved, the contract must proceed to describe the scope or object of the Agreement mentioning the scope of services that the contractor or oil company will be offering. If the Services to be offered are detailed enough and the agreement is for a longer period of time, then the details of services to be offered can be attached with the contract in annexures or schedules.
- Term of the Contract: All the service contracts should explicitly state the term of the contract, i.e., when the contract will begin and when will it end. This clause is essential because it makes clear when the contract will be effective.
- Payment Terms: Ascertaining the payment clause is a little more complicated, as it requires negotiation between the parties on several factors and especially in the case of Oil and Gas Service Contracts as each type is different, as in a Pure service contract the contractor can ask for an economic interest in the crude oil or for others there can be negotiations on cash amount. It is also agreed and mentioned under this clause whether the payments will be made in part or lump sum. And lastly, the parties mutually agree and mention the penalties in the event of late payments.
- Rights and Obligations of the Parties: This is the clause that elucidates the obligations, rights and duties of each party to the contract and is considered as one of the most significant clauses of the entire contract. It requires keen attention and observation, irrespective of oral agreements regarding the rights and duties between the parties, it still becomes essential to write out everything in the contract. Some examples of obligations that can be taken as a reference while drafting a service contract are as follows:
- The service provider shall be obligated under the agreement to perform all the operations defined in the scope of services and provide all the necessary technology and financing in connection with the operations.
- The service provider is legally bound to act persistently, safely and efficiently, compliant with good oilfield practices and international petroleum conservation principles.
- The service provider is also bound to perform the work in accordance with the specified timeline under this Agreement, which is mutually agreed upon between the Parties for the Project.
- Allocation of Risk, Liabilities and Indemnification: Under this clause, negotiations between the Parties are held and it is mutually decided which party or parties will be accountable for the risk and liability for any damages resulting from the loss, damage or destruction to any equipment or the site of exploration or any other possible term, otherwise decided between Parties. It is further agreed under this clause that each party will indemnify the other party from claims arising out of personal injury, illness, death, property loss or damage suffered by any of their employees. It is important to include this clause in the contract to avoid any future disputes that may lead to huge litigation costs.
- Confidentiality: This clause must be mentioned in the Agreement so that the Parties can protect all of its confidential information that has been shared between the Parties for business purposes because the receiving party can make misuse the confidential information of the Disclosing party, for instance, by leaking the trade secrets in the public or to any competing party. So, to avoid such situations, it’s always better to incorporate this clause in almost every contract.
- Governing Law and Dispute Resolution: In case of any future dispute that may arise between parties due to any reason, it’s always better to have the clause relating to- what law will apply, how the dispute will get resolved and by which dispute resolution method, these must be specified under this clause in the Service Contract.
- Termination: Sometimes, the breach, defaults and damages are of such severe nature that they may adversely affect the other party to the Contract. In such circumstances, including a termination clause permits either of the parties to terminate the contract (usually, with a specified period of notice).
And at last, the agreement must be properly signed by all the parties involved to ensure the proper execution of the Agreement.
Service agreements form a fundamental part of the business of Oil and Gas production and development as petroleum resources are essential for each and every nation. Additionally, the oil and gas sector is also necessary to maintain the industrial civilization, which is, in this era, a critical concern, as already oil accounts for a large percentage of the world’s energy consumption, and that’s why it is the world’s highest revenue-generating sector today. Irrespective of all problems and challenges, nations have come out strongly to control these valuable natural resources. Presently, nations have successfully emerged as the champions in the business, taking part in the production and distribution of oil products. The future of the oil sector is encouraging as more and more oil fields are being discovered.
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