Why do western companies give preference to psa contracts?

The Production Sharing Agreements (PSA) have the status of law. For the foreign companies, PSA is the only law regulating their activities in Azerbaijan. The Western companies give preference only to this form of the contract, which formally differs with significantly higher range of risks for the foreign companies, keener financial conditions and higher range of responsibilities for fulfillment of the contract's conditions, but is incomparable with wide independence in making decisions on current production and financial activities. Strictly speaking, the PSA fully satisfies the State as well because decrease of 'command' functions is compensated with practically full absence of problems and considerable increase of incomes to the national budget.

One of the essential items of the PSA in Azerbaijan for the old fields is the compulsory division of the produced oil into two parts - 'oil of local market' and 'oil of the world market'. The share of 'oil of local market' depends on the concrete conditions and dynamic of real oil production in the previous several years (up to establishment of JV or signing of PSA). This oil should absolutely be sold to the State with local currency according to the confirmed current internal prices. Only the oil being produced in excess of 'oil of local market' may be sold (in the world market or may be refined and sold as oil products). The profits from the sale of the oil or oil products should be directed towards covering expenses of the JV or operating company and sharing incomes between the partners.

The 'oil of local market' is naturally absent on the new fields (or new contracted blocks) where the oil was discovered and is produced as a result of activity of the operating company on the base of PSA (in such case, JV is not established in Azerbaijan). The produced oil is used to cover investments and operation expenses of the operating company. The remaining profit oil is distributed in accordance with the participation shares of the partners.

Distribution of the profit oil between the State and foreign company changes due to increase of the difference between the profits and expenses of the investor - from 50/50 (sometimes even 60/40 in favor of foreign partner) in the initial period of contract's validity to 90/10 in favor of State at the end of this period. Thus, from 1 April the share of Azerbaijan in Azerbaijan International Operating Company's developments of Azeri-Chirag-Guneshli fields increased to 75% from 50% as of the beginning of 2008.

The important moment in all kinds of agreements is that the associated gas being produced together with the oil (in excess of volume necessary for the field) should be transferred to the State Oil Company of Azerbaijan (SOCAR) free of charge.

According to the consent of the State Committee for Ecology and Control on Natural Resources Use, the Azerbaijani side includes keen conditions in the PSA with regards to fulfillment of requirements of security and environmental protection.

The State has the right to apply sanctions to the operating company for non-fulfillment of the contract's conditions, even to terminate the contract.

The decision bringing the PSA into force after being signed by the participants is approved by the Parliament in Azerbaijan. In addition, transformation of agreement on JV into PSA also should be approved by the Parliament.

The important omission in the national PSA, including Contract of Century, is the low protection of the interests of the Azerbaijani producers and service companies. The contracts do not contain any limitations on involvement of foreign sub-contractors, but only highlight priority of the local companies in summarizing the results of tenders. For instance, in Russia the contracts exactly contain requirements on compulsory use of local equipment and materials - 70%.

Key sources of Azerbaijan's profits within realization of PSA contracts seem to be as:

Revenues from profit oil falling on State's share;

Revenues from free associated gas;

Revenues from bonuses being paid by the contractors;

Revenues from acre yield payments;

Revenues from taxes being paid by the contractors;

Revenues from taxes being paid by the sub- contractors;

Revenues from re-assignment of participation shares;

Revenues from purchase of part of hydrocarbon share of subcontractor;

Revenues of leasing various facilities to subcontractor.

The revenues of the owner country from the hydrocarbon resources are not limited with these direct profits from oil contracts. In addition, the Country receives indirect profits from the development of service sector of economy and infrastructure, involvement of the Azerbaijani citizens and companies in realizing oil projects.

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