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In the hydrocarbon sector, the term “Revenue Sharing Contract” (RSC) refers to a contract between a contractor and the government under which the contractor assumes all risks associated with exploration, production, and development in exchange for a predetermined share of the profits generated by the effort. RSC is a fiscal structure that applies to hydrocarbon exploration and production.
Contracts in this situation are “biddable revenue sharing” contracts. In other words, bidders would be compelled to include a share of revenue in their offers, and this will be a crucial factor in determining which bid wins. At two revenue levels known as “lower revenue point” and “higher revenue point,” they will quote a different share. By using linear interpolation, the revenue share for intermediate positions will be determined. Under this metric, the bidder who provides the Government with the largest net present value of revenue sharing will receive the highest score.
Due to the structural flaws of the then-current fiscal framework, Production Sharing Contracts, Through a Cabinet, revenue sharing agreements were agreed for all hydrocarbon explorations in India. Its resolution was dated on 10.03.2016. (PSC). The Revenue Sharing Contract is currently one of the part of the new fiscal system, known as HELP or Hydrocarbon Exploration and Licensing Policy, which was enacted on March 10, 2016. Prior to that, in 1997, revenue sharing models were used in the investigation of small and marginal fields as well as coal bed methane (CBM).
Revenue sharing Contract
A retailer pays a supplier a percentage of the sales the retailer makes in addition to the wholesale price for each unit purchased under a revenue-sharing agreement. Compared to the more traditional wholesale price contract, these arrangements are now increasingly common in the videocassette rental sector.
Article 12: Revenue share
12.1 “Revenue” for the purposes of determining the Government’s share of Revenue under this Contract shall be: (i) all amounts that are accruing to the Contractor, net of taxes on sales, on account of the Petroleum Produced and Saved from the Contract Area for the month;
(ii) Royalty for that Month calculated by applying the weighted average selling price for the relevant month at the Delivery Point. Revenue will be computed as per Appendix B of this Contract.
12.2 The Contractor shall pay the Government on a monthly basis, the Government’s Share of Revenue from the Revenue for such Month (as determined in accordance with Article 12.1) from the Contract Area, in accordance with the provisions of this Article 12.
Revenue sharing Contract: How has it replaced Production Sharing Contract in New Petroleum Agreements?
The controversial production sharing contracts (PSCs) will be replaced by a revenue-sharing system or output-linked contracts, according to the Ministry of Petroleum and Natural. The ministry posted a model revenue sharing contract (MRSC) on its internet in an effort to draw more private and foreign firms into the nation’s exploration business. The industry has until September 10 to comment on the MRSC. The government should advance to a revenue-sharing arrangement, according to an earlier recommendation made by the C Rangarajan committee.
Compared to the current PSCs, where the contractor first recovers his expenses before sharing profit with the government, a production-linked contract is reportedly more transparent. The auditor general and comptroller both criticised this model (CAG). The CAG has previously stated that PSCs encouraged businesses to increase costs in order to defer giving the government a larger portion of revenues. Companies would have to specify how much oil and gas they would share with the government at various phases of production as well as at various rates under the MRSC regime. The MRSC made clear that the contractor must calculate revenue “… under this contract, shall be undertaken by the contractor on an accrual basis regardless of the date such amount is either billed or received by the contractor; all amounts accrued in relation to petroleum produced and saved in a month (remaining after deducting royalty payments required to be made by the contractor, in the relevant month) shall be taken into account for determining the revenue; amounts attributable to petroleum produced and saved in a month.
The contract further said that the contractor must open and establish an escrow account with a bank that is acceptable to the government within a specific number of (but not stated) days of the contract’s execution. According to the MRSC, “the government’s revenue share of crude oil and/or natural gas shall be determined based on a two-dimensional production-price matrix, where the government’s revenue share with the contractor(s) shall be linked to the average daily production in a month and the average oil and gas prices in a month.
According to the production-price matrix, the government’s income share will be calculated separately for crude oil and natural gas by making reference to the relevant price range and production tranche.
Different tranches of the production levels for onshore, shallow offshore, and deep-water have been proposed. In addition to quoting the quantity they will share with the government at various production levels, the companies would also quoting the quantity at various price levels, with bands for oil and gas of less than $100 per barrel, $100-125, $125-150, and more than $150 per barrel, and for millions of British thermal units of less than $6, $10, $14, and more than $14, respectively. Companies will be required to submit bids for the amount they will share with the government at various production levels and oil and gas price points. According to the contract, the contractor’s revenue share (sometimes known as the “contractor’s revenue share”) is the amount of revenue for the relevant month that is left over after subtracting the government’s revenue share.
The contract also stated that the government must notify the contractor in writing if India becomes self-sufficient in natural gas, crude oil, or condensate during any year. The contractor/each member thereof (if any) shall have the right to lift and export its participating interest share of crude oil and condensate and/or natural gas during the said period, subject to any other extant policy guidelines of the government applicable from time to time. In such a case, the domestic sale obligation shall be suspended for such period as may be specified by the government.
Difference between Production Sharing Contract and Revenue Sharing Contract
The idea of profit sharing, in which earnings are split between the government and the contractor after cost recovery, served as the foundation for production sharing contracts (PSC). Due to the profit sharing system, the government was forced to carefully examine the cost information provided by private parties, which resulted in several delays and disagreements. The government is unconcerned about the costs incurred under the new RSC regime, and will instead get a portion of the total proceeds derived from the sale of oil and gas, and other commodities. Contrary to the current Production Sharing Contract (PSC) fiscal model, where funds solely flow to the government only starts once all contract costs have been recovered (100% cost-recovery bid by the Contractor), the new system will perhaps start paying the government a share of revenue as soon as production begins. The suggested adjustments will result in a straightforward system with transparent pricing and production specifications. In addition to removing potential accounting problems and the motivation for gold plating, RSC is anticipated to maximize profit sharing based on cost recovery while minimizing government intervention. For a more thorough examination of the issues with PSCs, go here.
A frequent sort of contract between a government and a corporation engaged in resource extraction is a production sharing agreement, which specifies how much of the resource typically oil extracted from the nation will be distributed among the parties. The government of the nation grants an oil corporation the right to carry out exploration and production activities under production sharing agreements. The oil corporation explores, develops, and ultimately produces oil/gas from the field while taking on the initiative’s financial and mineral risk. When profitable, the business is allowed to use the proceeds from oil production to pay back capital and operating expenses. The government and the business negotiate the remaining funds.
Why Government favours Revenue Sharing Contract
Governments of nations that lack the knowledge and/or resources to develop their resources but want to entice major domestic and international corporations to do so may benefit from production sharing agreements. They can also be very lucrative contracts for the concerned oil firms. Because guarantees for the recovery of all sunk costs are crucial to luring oil majors with proprietary technologies, some experts favour the production sharing model for deep sea exploration. The PSA that is in place in India has drawn criticism from the Comptroller and Auditor General of India (CAG) because it encourages businesses to increase (gold plate) capital spending while lowering and delaying the government’s part.
In 2013, a panel with C Rangarajan as its chairman recommended switching to a revenue-sharing system that requires businesses to declare up front the amount of oil or gas they will share with the government starting on the first day of production. Under the new system, the businesses will have to specify how much oil and gas they will give the government at various phases of production and at various rates. Not wait till the end, that is. Hydrocarbon Exploration and Licensing Policy approved the RSC policy for all hydrocarbons in March 2016.
Security creation under Revenue Sharing Contract
In 1992, the Indian government made the oil and gas industry open to private sector investment. The New Exploration Licensing Policy, developed by the government in the year 1997, aims to increase private and international investment in oil and natural gas exploration and production (E&P). In accordance with the terms of NELP’s production sharing contract (PSC), the contractor was granted the right to recover 100% of the money it spent on E&P-related activities, and the leftover product was divided equally between the contractor and the government. In this scenario, the contractor could raise prices, lowering the government’s proportionate share of the final product.
The government released a new Hydrocarbon Exploration Licensing Policy (HELP) on March 10, 2016, in response to the findings and suggestions of the Rangarajan Committee’s report on the PSC, which was released in December 2012. The idea of contractor cost recovery at 100% was abandoned by HELP. Now, in regard to the exploration and production of hydrocarbons, the government and the contractor enter into a revenue-sharing contract (RSC).
Revenue Sharing Models for Hydrocarbon Exploration in India prior 2016
Although CBM production didn’t begin until 2007, India’s contracts under the Coal Bed Methane (CBM) Policy of 1997 used to provide for biddable revenue sharing based on production-linked payments. While the central government will receive the payout based on production an ad-valorem basis, the state governments will get ad-valorem royalties at the current rate. PLP for various production slabs is an item that is up for bid.
Marginal field explorations also use the revenue sharing contract (RSC) model. Based on a revenue-based linear scale, this revenue sharing approach. The contractor must pay the Government’s portion of the biddable revenue (net of royalty or post-royalty). The price of the Indian Basket of Crude Oil as determined by the Petroleum Planning and Analysis Cell upon monthly basis will serve as the minimum price for the purpose of calculating government revenue. If the final bid price exceeds the cost of the government’s cut in the Indian Basket of Crude Oil would be determined using the final bid price. The RSC policy was implemented across all hydrocarbons in March 2016.
Revenue Sharing Model in case of Gas Exploration post 2016
Regarding fresh gas production from deep-, ultra-, and high-pressure, high-temperature regions, Price Freedom has been extended to contractors under the new fiscal system known as Hydrocarbon Exploration and Licensing Policy, which was enacted by the Government in the year 2016. The policy allows for pricing flexibility for both current discoveries that have not yet begun commercial production as of January 1, 2016, as well as for upcoming discoveries. However, a cap based on the landed cost of alternative fuels has been set in order to protect the interests of the consuming sector and take into account the flaws in Indian gas markets. The maximum price shall be the least expensive of the cost of imported fuel oil and LNG import landing price are the weighted average import prices for replacement fuels.
Every six months, the ceiling will be calculated. The four previous quarters of price data with a quarter’s delay must be used. In order to protect government revenue, the government’s share will be determined using the higher of the current global price of the crude oil or the real price. The pricing regime that presently applies to all gas fields in production will continue to apply to them.
The Rangarajan Committee proposed a revenue-sharing model in 2012
In 2012, the Committee examined the production sharing contract system and proposed that it be replaced with a fixed, price-sensitive scale mixed with an incremental production-based sliding scale. A bidder will in a bid matrix present various revenue shares percentage for various levels of price and production ranges, which is to say that the bids will be made in this manner. Both in terms of production volume and price level, the bids must be progressive. For each sector, there would be a separate production tranche, and pricing bands will be determined by current and historical price trends. After careful consideration and taking into account the historical data that is now accessible for Indian geological basins, production and price bands must be properly constructed. There shouldn’t be many complaints about how strict the restrictions are because enterprises having the ability to compete for government contracts at various output levels and pricing tiers. This allows bidders to take the fiscal parameters of the contract into account. Furthermore, the Committee further suggested that there should be no requirement of minimum government share, leaving the bidder free to offer even a non-zero portion in order to reduce the risk of E&P businesses. The Contractor will be free to bid on his share of production, which will represent his cost recovery. Additionally, the Committee suggested adding a clause allowing for royalty rates to be bid on, starting at zero, in order to greatly encourage deep-water exploration, which is very risky and expensive. The suggested approach was essentially a production-level payment royalty-tax structure. In order for the government’s share, which was determined through competitive bidding, to be able to benefit from price increases and/or unexpected reserve discoveries, the marginal rate of appropriation had to be non-linear, increasing with output and changing upwards for price increases. Many nations, including the Columbia, US and a number of resource-rich African countries, are adopting this model with some adjustments. Contractors are typically not allowed to overestimate their revenue or production over a certain point because doing so harms their market reputation, goodwill, and stock prices.
The government only needs to keep an eye on the production and price parameters, unlike the current Production Sharing Contract fiscal model, where the government receives a share of the profits from the very first day of production. Additionally, since the Management Committee won’t be involved in budget approval or procurement concerns anymore, private operators will operate in a less complicated setting. Additionally, it was claimed in keeping with the government’s overarching goals of improving oil field operations efficiency and conserving finite hydrocarbon resources by giving contractors more incentives to save costs. In contrast to what the Committee recommended, the government has adopted a variation of the revenue sharing model under the new system, known as Hydrocarbon exploration and Licensing Policy
- Coal bed Methane an environmentally benign natural gas called methane (CBM) is produced during the coalification process and stored in coal seams. Because CBM exploitation and exploration prevent methane gas from running mines from being released directly into the atmosphere, they have a significant impact on lowering the greenhouse effect and obtaining carbon credits. Additionally, a cost-effective way to increase coal production and maintain a safe methane level in operating mines is to extract CBM by degassing the coal seams prior to mining the coal.
- If the contractors are directly involved in an arbitration or lawsuit on gas pricing, covering existing discoveries that have not started commercial production as of January 1, 2016, this policy guideline will only take effect once the arbitration or litigation, as well as any related legal proceedings, are resolved or withdrawn.
- Developed under the direction of Dr. C. Rangarajan, Chairman, Economic Advisory Council to the Prime Minister, the committee’s report on the Production Sharing Contract Mechanism in the Petroleum Industry was submitted in December 2012. The Committee made a number of significant recommendations, including establishing an inter-ministerial committee for speedy decision-making, changing the current cost recovery model to a revenue sharing model in order to reduce the government’s ongoing cost monitoring, and new gas pricing formulas that link domestic gas prices with international gas prices, among others.
Advantages of Revenue Sharing Contract
- Shared Achievement: A revenue sharing investment’s main advantage is that its design enables members to concentrate on shared success. Sustainable revenue generation is the shared objective of management and shareholders.
- Fixed Interest is less than % of Revenue: Revenue sharing takes a percentage of an investment’s gross revenue as opposed to the typical debt structure, which has a fixed interest rate. This implies that your company’s bottom line is less affected when a slower-than-expected revenue month occurs.
- Maintain Authority: A revenue sharing arrangement gives business owners the chance to keep complete control of their organization. No further revenue must be paid to the investor once the Repayment Cap has been reached, and the entrepreneur still retains complete ownership and control over the company’s course.
- Potential for Investment: The range of potential investments is wider with revenue growth at the forefront because businesses will be judged on their capacity to produce sizable profits and cash flow rather than being candidates for an IPO or strategic acquisition. This increases the likelihood that startups will receive funding and enables businesses to expand at a sustainable rate rather than chasing valuations.
- Simpleness: Sharing in the profits simplifies equity. Capital providers are merely debtors rather than business proprietors. As a result, firms can concentrate on creating growth that is lucrative and sustainable because there is a clearer direction. Success may be measured considerably more easily when the emphasis is on revenue growth rather than future acquisition indicators.
Advantages in Oil & Gas Sector
- Only the exploration company’s revenue and output should be subject to government examination.
- The exploration company’s budget and expenses do not require micromanagement or control.
- Consequently, there is little regulatory burden and doing business is simple.
- While giving the operator more freedom, administrative discretion is significantly reduced.
Revenue sharing contract is better due to the structural flaws of the production sharing contract, because of the then cjurrent fiscal framework. Its advantage is that Contract in these situations are specifically based on biddable revenue sharing. And, consequently there is just little regulatory burden it becomes simple to do business. And, it is seen that revenue sharing model gives more freedom to the operator, and thus the discretion of the administrative department is significantly reduced.
This article is authored by Shravani Gupta, 4th year BA LLB student at University of Petroleum and Energy Studies, Dehradun.
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