Thailand introduces production sharing and service contracts to promote upstream oil and gas investment

Out-Law Analysis | 14 Jul 2017 | 10:34 am | 2 min. read

ANALYSIS: After more than a decade of inaction, the Thai government has introduced two new forms of petroleum contract in the hope of attracting upstream investors. 

Until now, the only form of petroleum contract available in Thailand was a concession agreement. Under this arrangement the petroleum in the ground is owned by the state until ownership transfers to the concessionaire at the wellhead. The prevalent industry view is that a concessionaire takes on a higher level of risk, although in return for a potentially greater reward, compared to other forms of petroleum contract. 

This type of concession agreement will continue to be available. However, under the Thai Petroleum Act which came into force on 23 June, Thailand's Ministry of Energy (MOE) will now be entitled to allow blocks to be exploited via a production sharing contract (PSC) or a service contract, based on criteria and rules that have yet to be published. Template PSC and service contracts will also be published. 

Under a PSC, the exploration and production (E&P) company essentially acts as a contractor to the state and is paid for its services through ownership of a certain percentage of the petroleum produced.  Unlike in a concession, the state would retain ownership over a portion of the petroleum after it has been produced. The company is also generally awarded a portion of production as reimbursement of its allowable operating costs, through a process known as cost recovery. The new Act limits the petroleum allocated to cover the company's costs to 50% of the total oil produced in that year, but with a right to carry over such unrecovered costs into subsequent years.

Under the service contract petroleum would belong exclusively to the state, with the E&P company performing services in return for payment tied to the success of the work. 

While PSC and service contract models are often viewed within the industry as shifting some of the risk of the low oil price onto the state, it is uncertain whether their introduction in Thailand will succeed in attracting much-needed upstream investment.  

A number of existing Thai concessions are scheduled to expire over the next decade. Thailand's MOE will be faced with a variety of fiscal packages applying to different blocks, which could impose an administrative burden. When implementing regulations are published, it will be interesting to see whether investors will be allowed to choose the form of contract although we think it more likely that the MOE will simply determine which contract type applies to a particular block. What we expect may happen is that expiring concessions with available production may be replaced by PSCs while new, and therefore higher risk, blocks are likely to be subject to the current concession agreement. Blocks that are currently marginal are expected to fall under the service contract regime to incentivise development of those discoveries, as has happened in Malaysia.

It appears that the new alternative forms of contract will be available under a long-delayed 21st round of petroleum bidding, which is currently scheduled for mid-2018.

Much depends on the details of these new regulations and templates, and what the Thai government ends up including in the alternative contracts. Opponents in Thailand of the current concession regime argue that it grants overly favourable terms to concessionaires, so there may be some pressure on the government to ensure the proposed forms of PSC and service contract offer less favourable fiscal terms to E&P companies.

There is still some optimism in the exploration and production industry that the new PSC regime will offer more favourable terms to attract investment to Thailand, given the current lower-for-longer oil price environment. However, developments in Indonesia suggest this may be misplaced. There, the industry was hopeful that a new "gross split" PSC would allow contractors to choose whether to adopt the gross split regime or continue with cost recovery, and many anticipated more favourable fiscal terms for most types of projects under the new system.  Unfortunately, this hasn't been the case: for most projects, the proposed new regime is less favourable to the contractor fiscally than the current system.

Steve Potter is an oil and gas specialist with Pinsent Masons MPillay, the Singapore joint law venture partner of Pinsent Masons, the law firm behind Out-Law.com.