Focal Points of Oil and Gas Agreements & Bidding

By Constantinos Hadjistassou*, PhD

The discovery of fossil fuels in the Cypriot Exclusive Economic Zone (EEZ) in conjunction with vigorous interest from energy giants for hydrocarbons rights, during the second licensing round, constitutes a lifeline for the Cypriot economy.

Recent developments pertaining to the negotiations between the short-listed companies and the Cypriot Government for the concessions of offshore blocks 2, 3, 9, 10 and 11 raise the question if the customary international practices in the oil and gas industry are duly followed. But which are these international practices recommended under the circumstances which safeguard the national interests of the host country, promote transparency, ensure the profitability of the companies, and reinforce people’s confidence in political decisions?

The evaluation of the tenders submitted by the interested energy companies and joint ventures is usually based on the total bid value. In turn the total value of the bid consists of two attributes: the development plan, also known as the work program, of the prospective block and the signature bonus. The work plan comprises the number of wells to be drilled by the operator and the type and extent of seismic data to be undertaken, e.g., two- or three-dimensional seismic acquisitions and other technical issues. Other criteria include royalties, the company’s liquidity, the level of technical competency in pertinent developments the organization has completed (e.g., in ultra-deep water), the company’s reputation, national–strategic interests, the involvement of the organisation in the upstream (exploration and extraction) and downstream (transportation and distribution), competition, environmental matters, technology transfer, local content, etc. Local content refers to the development of local skills, the utilisation of local manpower, and local manufacturing.

Details of the successful tenders are usually made publicly available, thus strengthening the transparency of the adopted procedures. This practice makes it possible for competing companies to benchmark their bids against the winning offer while it renders prospective licensing rounds more attractive. The major development, in the Cypriot EEZ, which prompted considerable interest among oil and gas companies while raising the value of the bids was the discovery of the Aphrodite gas field. In parallel with deciphering the geological structure of this part of the Levantine basin, the availability of seismic data together with their interpretation reports, which the companies purchased from the Cypriot Ministry of Commerce, Industry and Tourism, have also contributed to the success of the second licensing round in a decisive manner. The traditionally friendly relations between Cyprus and neighbouring Arab countries were also a positive factor as well as the maritime delimitation agreements signed with Israel and Egypt. Of course luck cannot be neglected. Despite the relatively low probability of about 25% of striking hydrocarbons in a typical well a natural gas reservoir of approximately 200 billion cubic meters was discovered.

Leaking the tenders’ evaluation report to the media is definitely not a good exercise as it imperils the whole process, especially in the event that the country opts to award a concession to another bidder other than the highest one. In such cases, there is the risk that a company or consortium may legally challenge the decision or it will deter them from participating in future calls.

Negotiations between the host country and the energy companies usually spans several months. Granting an exploration license to a consortium practically marks the exploration phase of the quest for hydrocarbons. From a strategic perspective, considering the Turkish treats, the ideal tactic for Cyprus is to create a blend of companies and consortia with activities in both the upstream and downstream sectors with expertise in offshore hydrocarbon fields and access to world markets of oil and natural gas. Major independent and national oil companies usually enjoy the support of the country they are located at. In contrast to Israel, Cyprus had the luxury to choose among big players in the oil & gas sector, namely French Total and Italian ENI.

Best practices also dictate that hydrocarbons rights are granted to the best bidder. Take for example block 9 which attracted most of the bids during the second licensing round and is believed to conceal large volumes of hydrocarbons. If block 9 was awarded to another licensee other than the best bidder even small differences in the terms of the agreement between the two offers are likely to yield large differences in earnings for the State, which in the long run could amount to several hundreds of millions if not billions. Although a Government reserves the right to choose a bid inferior to the best received, such negotiations start from a lower base and the bargaining power automatically shifts in the hands of the company’s negotiators. Deviations from the preceding guidelines are permitted only when serious concerns surround the creation of companies with dominant market positions or insufficient capital to develop the oil and gas field(s).

At the societal level it is important to avoid politicising the matter and certainly the clash between the executive and the legislative branches of Government should be prevented. As it happens in the case of Cyprus, such a situation could only lead to unfavourable developments. Transparency and meritocracy are relatively easily ensured through sound procedures. For example, investment decisions in the pension fund of Norway where the proceeds from hydrocarbons are deposited, currently amounting to $650 billion, are posted on the internet and scrutinised by independent auditors.

Concurrently with the award of an exploration permission to a consortium, the Government is earns an agreed signature bonus usually in cash. The dominant types of petroleum agreements are the: (a) license agreement and the (b) contract agreement. Drawing from the previous experience with Noble Energy during the first invitation, it is almost certain that the Government will again grant contract agreements for all five blocks. This means that the company or consortium which wins the bid, assumes the role of the operator and with its own resources locates and extracts the hydrocarbons. Meanwhile, the Government owns the hydrocarbons resources and compensates the company for its expenditures including a reasonable level of profit either in commodities (hydrocarbons) or in cash. The best-known type of such an agreement is the production sharing agreement (PSA) or contract (PSC).

The Ministry of Commerce, Industry and Tourism has made publically available the (model) production sharing contract signed with Noble Energy. So far the percentages agreed regarding the recovery of hydrocarbons costs and production sharing have yet to be released. Agreeing on these percentages, in light of the work programme, is perhaps the most demanding part of the negotiation process. Prudent decisions can only be distilled from past experience.

*researcher at the University of Cyprus specialising on hydrocarbons and low-carbon energy technologies. Website: www.energysequel.com

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  • kasomoulis

    This article is enlightening to me on the procedural steps taken to secure an honest and open for everyone to know how it is conducted.

  • Cypriot

    The internet is an excellent way to inform the public about its finances and thus make the government more transparent. I can only hope that the technologically-retarded politicians in Cyprus will realise this potential.