Production Sharing Contracts (PSCs) are a type of contractual arrangement between a government and a foreign oil company (or companies) for the exploration, development, and production of oil and gas resources. The PSC regime has become the most popular legal arrangement in the developing world for governing upstream operations. Several factors contribute to its popularity, which I will explore below.

PSCs allow the contractor to recover its costs (known as ”cost oil”) before the profits are shared. This provision reduces the financial risk for the contractor, making investments in challenging environments more attractive.

After cost recovery, the remaining oil (profit oil) is shared between the contractor and the state. The sharing ratio is typically negotiable and may be designed to favor the state as production levels increase, ensuring that the host country benefits more as the project becomes more profitable.

Many PSCs include provisions that mandate the use of local labor, goods, and services. This not only supports the local economy but also ensures that the host country benefits beyond just the financial revenues from the resources.

PSCs often include requirements for the foreign contractor to transfer technology and knowledge to the host country, helping to build local expertise and capacity in the oil and gas sector.

To protect the contractor from adverse changes in law or fiscal terms after the contract is signed, PSCs may include stabilization clauses. These clauses can provide a level of certainty and security for the contractor, making the investment more predictable.

Countries like Indonesia, Malaysia, and Nigeria have successfully utilized PSCs to manage their oil and gas sectors. These countries have attracted significant foreign investment, developed their resources effectively, and generated substantial revenue through the PSC framework.

The flexibility inherent in PSCs allows for a balance between the state’s desire for revenue and control over its resources and the contractor’s need for a profitable and secure investment. This balance has been critical in ensuring long-term partnerships between states and foreign oil companies.

PSCs have proven adaptable to different legal, economic, and geological contexts, which is one reason for their widespread adoption. They can be modified to reflect changes in market conditions, technological advancements, or shifts in national policy, ensuring their continued relevance.

PSCs can be highly complex, requiring extensive negotiation to balance the interests of the state and the contractor. This complexity can lead to prolonged negotiations and delays in project implementation.

The detailed nature of PSCs and the significant sums involved can lead to disputes between the host country and the contractor. Disputes may arise over cost recovery, profit-sharing, taxation, or changes in the regulatory environment.

PSCs are often sensitive to oil price fluctuations. In periods of low prices, contractors may struggle to recover costs, leading to reduced profit oil for the state. Conversely, high prices may lead to windfall profits for the contractor, potentially causing political tensions.

Despite stabilization clauses, the long-term nature of PSCs makes them susceptible to changes in the fiscal regime. Governments may seek to renegotiate terms when they perceive that they are not receiving a fair share of revenue, leading to instability and uncertainty.

The negotiation and management of PSCs in some countries have been marred by corruption, leading to deals that are not in the best interest of the state. This risk is particularly high in countries with weak governance and regulatory frameworks.

The popularity of PSCs in the developing world can be attributed to their ability to balance the interests of both the state and foreign investors while ensuring that resource ownership remains with the host country. The flexibility, revenue generation potential, and risk-sharing mechanisms inherent in PSCs make them attractive to countries with limited financial and technical resources. However, while PSCs have generally provided a robust and effective framework for governing the exploration, development, and production of oil and gas, they are not without their weaknesses. The complexity, potential for disputes, and fiscal instability associated with PSCs require careful management to ensure that they remain a viable and fair arrangement for both parties.