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An African National Oil Company recently discovered a large onshore gas field around 200km inland from the Mediterranean coast. ExxonMobil has been approached by ANOC as the ideal company to conduct the field development. This will require the drilling of 150 wells, a field of infrastructure of pipelines, dehydration plants and condensate recovery facilities. It will also require a 220km pipeline network to the coast, a new Liquefied Natural Gas (LNG) terminal and specialized LNG vessels to ship the gas to the US East Coast.
Purpose of Proposal
ANOC has proposed a 25-year Product Sharing Contract with ExxonMobil. The company is to provide the US $8.0billion capital investment required for the project. This investment is estimated as a total of $2 billion per year for the first four years before any significant revenue is realized. The purpose of this proposal is to study the key components of this proposal is to describe the key components of the proposed PSC, with an evaluation of the key issues and risks of each component. The PSC will provide ANOC with an opportunity to share in the profits with no direct investment.
The contract is expected to last for 25 years, years 1-4 are for investment. ExxonMobil will be required to invest a total of $8.0billion. Production is supposed to commence in year 5, with estimated production being 2000mmscfpd continuously from the first year of production which will be the 5th year of the contract. For the first 4 years the field development will take place. ExxonMobil will provide funding and expertise for the drilling of wells, establishment of pipeline and transport networks to the US East Coast, the primary market. The estimated operating costs are US $200M/annum.
Signature bonus is the payment that ExxonMobil will be required to pay ANOC before field development commences. The signature bonus is only payable upon signing of this PSC. It is to be calculated automatically, to a total of around 5,000,000 Euros. This signature bonus forms the start of the PSC. ANOC will provide the limited investment model that limits the estimated risks of the capital investments. It will work well for ANOC because its expenditure of for the field development is zero. OPEC legislation requires that the signature bonus be not less than $30million.
This signature bonus will place ANOC and ExxonMobil as partners in the venture. This could create a conflict of interest and autonomous issues unless the PSC is structured to cover all areas of logistics. This however exposes ExxonMobil to the risk of having to cater for the sunk costs of the exploration. Petroleum Legislation also requires that ExxonMobil recognize the cost of the signature bonus as non tax deductible and an unrecoverable cost.
The royalties payable to ANOC will depend on the production levels realized. The fraction of oil production subject to royalty will be 0.00% and that of gas will be 100%. The daily production rate will be used as the base for the calculations. Oil production of 25,000bbls/day, 50, 000, 75,000, and 100,000 will attract a rate of royalties of 3%, 5%, 10% respectively. Gas production of 250,500, 750 and 1,000mmscfd will attract the same royalty rates as the corresponding rates in the oil calculations.
Production available for cost recovery
The payment of royalties will provide the basis of the R factor which will be used as the main way to keep track of the profits realized. ExxonMobil will only be required to pay royalties for the income that caters for the cost of production and operations. Any excess is shared with ANOC. This proposal is created on the pre-existing model of many PSCs around the world.
Allocation of profits
The profits are divided into two segments. ExxonMobil will pay royalties as a percentage of the total amount required to compensate the company for the costs of production. The local company share of revenue ratio to that of ExxonMobil is 1:9 across all parameters of the R-factor.
The overall taxes of ExxonMobil will include the taxable income segment of the revenue. The cumulative tax payable will be charged at 25.00% of the taxable revenue.
OTHER ASPECTS OF THE PSC
The PSC must include relinquishment clause. The total contract period is 25 years. It is divided into two major phases. The first phase is the investment period that will cover the first 4 years where ExxonMobil will invest $2billion each year with no returns. The 2nd phase covers years 5-25 and are the production years. ExxonMobil and ANOC will share the profits on the predetermined terms set above.
Of the two accounting standards applicable to the oil and gas sector, Standard Oil Accounting Procedures are the most applicable for this PSC because they are more sectors specific. The fact that the US is the primary market also means that there must be application of the US GAAP structures on full cost method. FAS 19 are about Financial Accounting and Reporting by Oil and Gas Producing companies. This method of accounting requires the company to structure its books of accounts using the full-cost method. It is also required as an accounting principle for ExxonMobil and ANOC to prepare Joint venture accents for the total revenues and royalties paid. This will provide the overall accounts for the PSC.
Foreign exchange will be earned from sale of the gas product in the US market via the East Coast. The total amount is to be calculated using the total cost per barrel in ï¿½ and $ discounted at 15%
While ANOC might prefer the PSC, there are several alternatives to the approach. These alternatives are
ï¿½ Service contract
These three alternatives are all applicable to the oil and gas sector.
In this agreement, the oil company is granted a license. It is legally known as the Concessionaire. The contract gives the right to market and sell the production with only deductions of royalty. The downside of this agreement is that the foreign oil company bears all costs and risk of exploration, development and production. The oil company bears all the risk and reward of exploration and production. The host government or company bears no risk, but the reward is the production function and a share in the revenues.
The service company, otherwise known as the Contractor, is the oil company. In the agreement, the contractor is responsible for all costs of exploration. These costs are then recovered if production is achieved and a portion of subsequent incomes on the basis of every barrel of oil produced. There is no risk in risk
and reward because the host government bears all the risk.
JOINT OPERATING AGREEMENTS
This is an agreement between two or more companies, or host governmentsï¿½ national oil companies and foreign companies. The profits are shared on a pro-rata basis where the JOA includes terms and the limits of joint operations concerning conducting oil activates. In this form of agreement, there is agreed share in reward and risk of venture.
BENEFITS TO ANOC
To enhance the partnership with ANOC, ExxonMobil will enhance its company policy to fit in ANOCs wider aims. It will import technology from the US to enhance the oil infrastructure of the country. The building o the railway will also provide an ideal way of improving the infrastructure because it requires a well developed infrastructure.
One of the major tasks of the development of the project is the laying of a 140mile pipeline from the well to the Mediterranean Coast. It is budgeted at $1million per kilometer and 2% of planned operational expenditure. PIPECO is ideal for this contract with ExxonMobil because it meets all four of the scopes required for the job. These four scopes are Engineering Design, Procurement, Pipeline Construction and operations.
PIPECO is ideal for this job because it has the necessary expertise required to carry out and maintain the 250 km job. The company also has the necessary experience. PIPECO would provide the necessary experience in doing such a job having been involved in joint and individual contracts in Brazil and Georgia. The company has laid a total of 20,000 km of pipeline for both gas and oil across three continents. The company has a section of technical and design staff whose sole job is to provide technical advice for pipe lying in treacherous and densely populated areas.
To adequately cater for the scope required PIPECO will require
ï¿½ Adequate engineering prowess and experience in hard terrain. There is a wide array of equipment and machinery is designed for overcoming treacherous terrain. PIPECO has a total of 20 trenchers and padding machines. The padding machines have a screening scope of 8.4 square miles and a total moveable weight of 53.864 tonnes. the company also has extensive training for all personnel tasked with handling the pipeline either during the laying or for maintenance. While the moss of the pipeline could be flexible to cater for temperature fluctuations and increases in production, the sections of the pipeline going through the inhabited areas will be fixed and closely monitored using laser technology to minimize the risk of accidents or leaks. The primary pipe to be used will be the x80 pipe
ï¿½ Procurement: PIPECO will require an extensive contact network of pipe suppliers for the material required for this contract. To market itself as the ideal contracted, the quotations should also include the possibility of the pipe laying company procuring the pipes and material. The company also has a wide array of all-terrain moving equipment for use. The staff includes experts in environmental planning and management. To protect the lives and health of those living close to the pipeline, the designing team will keep the trenches as far from the people as is economically possible.
ï¿½ The company must have. The LNG terminal at the coast will have to be constructed simultaneously with the pipe. The extensive 250km pipeline will have to be dividing into two main segments, the open desert terrain and the densely populated areas. The company has also consulted for specialist installation techniques for areas that are densely populated and it is impossible to redirect the pipeline and keep on course. This means that the overall pipe laying job will be designed to take the course that has minimum disruption to human life.
ï¿½ PIPECO must use its prior experience in laying and maintaining pipelines. The technical staff must be adequately trained in all matters of field and control centre factors. The costs of this will be for the first five years of the operations, meaning that it will be an 8-10 year contract with possibility of renewal. Technical training takes a total of two years and includes extensive field work control centre internships and classroom training. The technicians are also taken thorough rigorous training in a modern control center simulator at the companyï¿½s headquarters.
PIPECO should consider schedule of rates and reimbursable forms of contract. The pipe laying is a part of the construction will require a schedule of rates to maintain PIPECOï¿½s worth and stability as the work begins. The second part, maintenance of the pipes is a service contract that should be handling as a reimbursable contract.
Schedule of rates provides ExxonMobil with an ideal way to maintain its investments within the first four years when no production is taking place. It will also keep PIPECO afloat as it handles the 250km job. The weakness of this is that it has a straining effect on ExxonMobils total budgets and investments. It is also possible that PIPECO will suffer from price fluctuations and the dynamic nature of petroleum production products. If the contacts do not adequately cater for these costs of production will harm the contractors economic position in a negative way because it might have to incur costs higher than the compensation catered for by the schedule of rates.
Reimbursable will give ExxonMobil a head start as they will pay after the work is done. It is however possible that it will cause a strain on PIPECO's total performance if it does not have a stable capital expenditure base. The contractor must then take into account the dynamic costs of a service contract, and this might not be ideal for ExxonMobil.
PIPECO will offer ExxonMobil an investment-based incentive scheme. The nature of this incentive scheme will be to provide ExxonMobil with a scheme where they get the value for the money they invest. The scheme will be modified to provide the company with effective cost-cutting ways. In this context, PIPECO will use machinery and cut back on costs of operation without jeopardizing the quality of the pipeline. With a workforce of at most 1,000 personnel on site, and a wide array of effective machinery, the cost of laying the pipeline would go down by about 5% per kilometer, saving the company about 125 million in the long run. The segmentation of the incentive scheme will also provide ExxonMobil with a way to keep the costs of operations and maintenance of the pipeline in the long run.