Production Sharing Agreement Cost Recovery: Understanding the Basics
If you’re in the oil and gas industry, you’ve probably heard of Production Sharing Agreements (PSAs) and how they are used to govern exploration, development, and production of natural resources. But what exactly is cost recovery in a PSA, and why is it important?
In a PSA, the government or the state owns the oil or gas reserves, while a private company or a consortium explores and produces them. The costs of exploration and development are typically borne by the private company. Cost recovery refers to the process by which the private company recovers its costs from the oil or gas it produces.
The cost recovery mechanism in a PSA is usually designed to incentivize the private company to invest in exploration and development while ensuring that the government receives a fair share of the profits. There are several types of cost recovery mechanisms, including:
1. Cost Oil
Under this mechanism, the private company recovers its costs by taking a portion of the oil or gas it produces as payment. For example, if the company’s costs are $100 million, and it produces 1 million barrels of oil, it may take 10% of the oil produced (100,000 barrels) as payment. The remaining 90% belongs to the government or the state.
2. Cost Gas
This mechanism is similar to cost oil, but instead of taking oil, the private company takes a portion of the gas produced as payment. The same principles apply.
3. Profit Oil
Under this mechanism, the private company recovers its costs from the profits it makes after deducting the government’s share of the production. For example, if the company’s costs are $100 million, and it produces 1 million barrels of oil, and the government’s share is 50%, the company would deduct $500,000 from its profits before calculating its share.
4. Production Linked Bonus
This mechanism provides a bonus to the private company based on the amount of oil or gas it produces. The bonus is intended to cover the company’s exploration and development costs. The bonus may be in the form of additional oil or gas, cash, or a combination.
It is worth noting that cost recovery is subject to certain limitations and conditions, such as a limit on the percentage of costs that can be recovered in a given year, a maximum recovery period, and a cap on the amount of profits that can be deducted from costs.
In conclusion, cost recovery is a fundamental aspect of PSAs that determines how private companies recover their exploration and development costs from the oil or gas they produce. It is important to understand the different cost recovery mechanisms and how they are applied to ensure a fair and balanced agreement between the private sector and the government or the state.