HYDROCARBON PRODUCTION SHARING CONTRACTS

DHARMENDRA KUMAR

DIRECTOROFFICE OF

PRINCIPAL DIRECTOR OF COMMERCIAL AUDIT-II, MUMBAI

OUTLINE

• BASIC E&P CONCEPTS

• GLOBAL E&P ARRANGEMENTS/MODELS

• E&P FISCAL REGIMES

• NELP INDIA AND INDIAN PRODUCTION SHARING CONTRACTS (PSCs)

• AUDIT AREAS

• AUDIT CHECKS

Oil (2012) Natural Gas (2012)

Proven

Reserve

Production Consumption Proven

Reserve

Production Consumption

Thousand million Barrels TCM BCM BCM

World 1668.9 80260 80757 187.3 2691.6 2689.3

Asia Pacific 41.5 7928 23446 15.5 323.2 367.7

2.5% 9.8% 28.9% 8.2% 12% 13.7%

India 5.7 819 2555 1.3 29.4 32.1

0.3% 1.0% 3.2% 0.7% 1.1.% 1.2%

World Hydrocarbon Statistics – BP Statistical Review 2013

Petroleum

• Petroleum – hydrocarbons in liquid form (viz. crude oil) – Hydrocarbon in gaseous form (viz. natural gas).

• associated natural gas (natural gas produced in association with crude oil)

– condensate (liquid hydrocarbons segregated from natural gas).

• Petroleum activities:– Upstream operations - Exploration and Production (E&P)– Midstream operations - storage, transportation and

related operations (often clubbed with downstream operations).

– Downstream operations - refining of crude oil, and marketing of petroleum and gas products.

Petroleum Exploration and Production (E&P)

Exploration Operations

Development Operations

ProductionOperations

Exploration Operations

Initial SurveysSeismic Surveys

Exploratory Well

• Discovery

• “Dry” well

Appraisal Wells

Commercial Discovery

Development of a field

• Commercial discovery

• Field Development Plan - for most efficient, beneficial and timely extraction of petroleum, keeping in view engineering, economic, safety and environmental considerations. It includes: – Drilling of production wells (for producing crude oil and gas);

– Drilling of injection wells (for injecting water or gas, in order to sustain or accelerate the production of hydrocarbons);

– Installation of offshore platforms and installations, for handling offshore production of oil and gas; and

– Laying of gathering lines, and installation of separators, tankages, pumps, artificial lift facilities, which are required to produce, process, store, and transport petroleum.

Production

• Production operations involve operations after the commencement of production from a developed field. This would typically involve, among others:– operation and maintenance of existing facilities;

– Work overs;

– plugging and abandonment of wells;

– improved oil recovery; and

– site restoration (after cessation of petroleum operations) etc.

E&P Arrangements/Models

Need for Contracting• Limitation of state – Risk capital• Growing demand of petroleum – expeditious E&P• Fluctuations in prices of petroleum – Risk sharing

mechanism• Technology and specialization

Purpose of contract• A contract for exploration and development of

petroleum refers as to how the produce of the earth is divided among the labours, owners of the capital and land owners (i.e. state).

Objective of State

– Development of the petroleum.

– Encourage private participation by leaving sufficient produce to them.

Objective of Contractor

– Reasonable ROR keeping in view the risk of exploration and lead time required.

– Access to new Supply of petroleum through the right to export a significant part of production.

Types of arrangements/models

• Concession arrangement

• Contractual arrangement

– Service Contracts

• Pure Service Contracts

• Risk Service Contracts

– Production sharing Contracts (PSC)

• Joint Venture arrangements

• Direct State Participation

Concession arrangement

• State enters into an agreement with the Contractor granting the right to use an identified area for exploration and production of petroleum

• Features

– Ownership of produce remains with contractor

– Management and control of the operations, risks associated with the operations and financing of operations are contractor’s obligation

– State got royalty in earlier contracts

– State started getting higher royalties and taxes as its bargaining power increases

– Administration is easy for state

– Against the concept of State’s sovereignty over natural resources

Contractual arrangements

• State keeps the right of ownership of produce

• Types: – Pure Service Contract

• Contractor provide service for a fee which can be paid in cash or kind

– Risk Service Contract• Contractor provide service for a fee and participate in the

profit

• Contractor bears the risk of operations and finances the operations

• Similar in nature to the Production Sharing Contract

– Production Sharing Contracts (PSC)

• Contract is entered into among State and/or NOC and the Contractor for exploitation of petroleum

• Indonesia, China, Sudan, Qatar, Bahrain, India, Philippines, Libya, etc.

Main features of PSC

• Ownership– Ownership of hydrocarbon remains with the State.

The Contractor receives a share of production to meet its cost and target Rate of Return (RoR)

• Fiscal devices– Cost Recovery Limit & Profit sharing are two

important devices– Other fiscal devices are Corporate Income Tax,

Royalty, Bonuses, State participation, profit related taxes, etc.

Benefits of PSC

• No Government Guarantee or Asset required

for security

• Private Investment

• Repayment to investor by Revenue stream and

Asset of the Project

• Ownership of Project return to Government

• Reasonable Rate of Return to Investor

Benefits of PSC (contd..)

• Project Serve the National Interest

• In Oil Sector, started in North Sea In 1970

• Reduce Government Budget

• Reduce Financial and Administrative burden

of Government

• Generate New Tax Revenue

• Attract Capital and New Technology

Joint Ventures

• State, through NOC, and Contractor share equity in the joint operations

• Partners share risk, costs and profits as per their Joint Venture agreement

• Ownership of produce remains with the State

• Concession or Contractual both arrangements can have Joint Ventures

• Joint ventures can be incorporated or unincorporated

• Incorporated Joint Ventures

– NOC and Contractor contribute equity to form a new company, which undertakes operations

– Board of Directors manages all operations

– Return is given in the form of dividend

• Unincorporated Joint Ventures

– Each partner is a separate legal entity

– Enters into Joint Operating Agreement (JOA)

– JOA defines right and obligation of partners

– Pakistan, India, South Korea, Denmark, etc.

Direct State Participation

• State through national oil company puts up all the capital for exploration and development, takes the risks, control the operations

• Hire the necessary technology and borrow the capital

• Ownership of produce remains with State

• E.g. – Nominated blocks with ONGC and OIL

Hybrid arrangement

• It has features of more than one model.

• E.g. – India has Unincorporated JVs having PSC with GoI

Features of International arrangements

Arrangement

Feature

Concession Production Sharing

Contract

Joint Ventures

Exploration

Risk

Contractor Contractor (incl. NOC, if

not carried)

Contractor

(incl. NOC)

Management

of Operations

Contractor State’s approval

required for crucial

decisions

Each

constituent

participate

Financing of

Operations

Contractor Contractor (incl. NOC, if

not carried)

Contractor

(incl. NOC)

Licensee Contractor NOC/ Contractor NOC/

Contractor

E&P FISCAL REGIMES

International fiscal regimes

Need for fiscal regimes

• Fiscal regimes refer to the forms in which the produce from the contract area is distributed among the land/acreage owner (State) and the Contractor.

• The conflicting objectives of the State and the Contractor and uncertainty of future outcome and prices have maily led to the development of several fiscal tools.

Fiscal tools

• Rentals– Levied during exploration phase– Lump sum or annual payment (Abu Dhabi – US$100,000/-

per year, Alberta – Canada $3/acre per year)– Increases over a time period (in India rental increases from

Rs.50 to 1000 per sq. km. per year within 5 year.

• BonusesSignature Bonus– Cash payment to the state at the time of signing of the

contract• Relatively small value• Through negotiations (in India in discovered field)• Through legislation

Fiscal tools

Production Bonus• State receives cash on achieving target of production

• State reaps benefit of increase in field size

• Through negotiations (in India in discovered field)

• Through legislation (Nigeria – 1% of previous year production)

• Linked to barrel of oil per day produced

• Linked to cumulative production achieved

Fiscal tools

• Royalty– It is the most commonly used fiscal tool for the State’s

revenue. Royalty can be divided into three types:– Fixed amount:

• It can be linked to per unit of production (in India Royalty on oil is Rs.528/ton, now 10% to 12.5% of the price)

– Fixed percentage: • It can be linked to sales value ( in India royalty on gas is 10% of

sales price)

Fiscal tools

– Sliding scale: Different variants of royalty based on sliding scale are prevalent in the world. Some of the examples are given as under:

• Level of field production, e.g. in China where royalty varies from 0% up to 50,000 tones/year to 12.5% over 1 MMT/year

• Level of well production, e.g. offshore California where royalty varies from 16.67% to 50% for production from 100 to 500 bopd.

Fiscal tools

• Cumulative production, e.g. offshore Morocco where it varies from 5% to 17.5% for 10 mmbbl to 50 mmbbl of oil produced.

• A ‘R’ factor which represents ratio of Cumulative revenues over cumulative investment, e.g. Peru.

• Elapsed time, e.g. Canadian Arctic Royalty which starts at 1% and increases every 18 months with 1% point to a maximum of 5%.

• Gravity of oil, e.g. Guatemala Royalty is 5% at 15 degree API and slides upto 20% for 30 degree API

Fiscal tools

• Corporate Income Tax– Income Tax applicable to petroleum operations is

same as that applicable to other business activities in the country.

– A few country have separate tax rate for petroleum operations.

– A wide range of tax rate can be found world over ranging from 0% (Bahamas, Cayman Islands) to 77% (Gabon). The developed countries have tax rate between 30 to 40%.

Fiscal tools

• Profit Petroleum sharing

– Relatively a newer fiscal device.

– Profit petroleum sharing by State means a portion of oil, which is left after meeting all costs, operating exploration and development, and therefore called Profit petroleum, is directly shared by State with Contractor.

– The profit petroleum sharing ratio may be determined either by bidding or may be prefixed.

Fiscal tools

– Examples:

• Fixed percentage of profit petroleum split, e.g. Indonesian fixed rate of 71.15%

• Biddable percentage of profit petroleum based on a single trench or sliding scale

Fiscal tools

– Sliding Scale based on:

• Production rate of the Oil field/contract area e.g. China where State share varies from 5% up to 10,000 BOPD to 75% up to 200,000 BOPD.

• Cumulative production e.g. Angola where profit sharing varies between 55% up to 25 MM bbl to 19% over 100 MM bbls.

• ‘R’ factor e.g. India where it varies with post tax rate of return or investment multiple achieved by the company

• A combination of above three.

Calculation of Investment Multiple

• Investment Multiple = Net Cumulative Cash Inflow / Cumulative Investment

• Net Cash in flow= Cost petroleum + Profit petroleum+ all incidental income relating to petroleum –production cost - Royalty

• Investment = Exploration Costs + Development Costs

Note: Costs/expenditures which are not allowed in the a

Accounting procedure shall be disregarded.

Fiscal tools

• Cost Petroleum Recovery Limit

– Volume of production available to company to recover its cost.

– Used in association with Profit oil sharing.

– Delays recovery of cost of company

– Some of the examples are as under:

• Fixed percentage of production e.g. Libya has 35% cost recovery limit; India earlier had 20% cost recovery limit.

Fiscal tools

• Biddable percentage of production e.g. in India cost recovery limit can be bid up to 100% (from third round and onwards)

• Sliding cost recovery limit based on

• Production level e.g. North Korea where it starts from 60% at 50000 BOPD and ends at 50% at 100000 BOPD

• Price level e.g. in Oman where cost limit starts at 50% at Oil price of $ 17/bbl and goes down to 30% at oil price of $ 21/bbl

Fiscal tools

• Government Participation

– State increases revenue through direct participation

– State participates through NOC.

– The option to participate is generally at the stage of commercial discovery.

– In most of the cases State’s share of exploration cost is carried by Contractor, i.e. contractor pays all cost of exploration phase if State elects to participate in development programme

Fiscal tools

• State participation under carried interest provision is usually for a fixed percentage e.g.

– China 51%,

– India up to 40% under exploration (third round and onwards) and development rounds

• There are other forms of carried interest like

– Sliding scale participation e.g.

– Denmark where state has 20% participation up to production level of 50000 BOPD, which increases to 30% in case of production rises to 100000 BOPD.

Fiscal tools

• Special Profit related taxes– These tools were introduced in 1970s to tap the

windfall profits, which were resulted due to substantial increase in price of crude oil.

– The basic objectives, of such tools, were to allow the State to share the windfall profits along with Contractor.

– These are used in conjunction with other fiscal devices. Some examples are given below:

Fiscal tools

• Windfall Profit Tax (WPT) – This was introduced in United States. Arithmetically WPT can

be presented as

– WPT=Tax Rate* Production*(Market Price-Base Price)

• Petroleum Revenue Tax (UK)

• Hydrocarbon Tax (Norway & Denmark)

• Additional Profit Tax (APT) (Papua New Guinea)– It is linked to ROR

Indian Fiscal regime- main features

• Lease Rental

– Petroleum Exploration License (PEL)

– Levied during exploration period

– Initial fee Rs. 10000/-

– Security deposit of Rs. 100000/- before granting of PEL

– Yearly advance license fee increases from Rs. 50/- to 1000/- per sq km per year within 5 years

Indian Fiscal regime- main features

– Mining Lease (ML)

– Initial fee of Rs. 50000/-

– Security deposit of Rs. 200000/- for due observance of terms and condition

– Dead Rent of Rs. 25/- per hectare or part thereof for first 100 KM and Rs. 50/- per hectare or part thereof for exceeding 100 KM

– Dead Rent or Royalty, whichever is higher, shall be payable

Indian Fiscal regime- main features

• Royalty

– State has the most stable tool of revenue generation (upfront)

– Under NELP NOC’s and companies are at par

– Onshore: 12.5% on oil and 10% on gas

– Offshore: 10% for oil and gas both

– Royalty beyond 400 m isobaths is half the applicable rate for first seven years of commercial production

Indian Fiscal regime- main features

• Corporate Income tax– Production costs are written off in the same year

– Exploration and Drilling costs are depreciated in the same year

– Depreciation on other assets is allowed as per provision of Income Tax Act, 1961

– Losses from petroleum expenses can be set off against income from other businesses and vice versa

Indian Fiscal regime- main features

– The current tax rate as per Income Tax Act, 1961 are

• Domestic company tax rate 30%

• Foreign Company tax rate 40%

• Plus Surcharge

– Income tax holiday for first seven years of commercial production

Indian Fiscal regime- main features

• Cost Recovery limit– 20% fixed (Pre NELP)

– Biddable up to 100% under NELP

– Higher limit helps early recovery of costs

– Block-wise Ring fencing: Contract costs can be recovered from any field within the contract area

– Block-wise ring fencing encourages exploration

Indian Fiscal regime- main features

• Profit Petroleum Sharing– Sharing of profit petroleum between GOI and

Contractor is based on pre-tax investment multiples (IM) achieved by the contractor and is biddable

– IM achieved in a year is applied in subsequent year for distribution of profit petroleum

NEW EXPLORATION LICENSING POLICY

AND

PRODUCTION SHARING CONTRACTS (PSCs) IN INDIA

National Exploration Licensing Policy

(NELP)

• Up to 100% Foreign Investment.

• Bank Guarantee of 35% agreed annual work programme required during Exploration Phase.

• No signature, discovery or production bonus

• State Participation, or carried interest of National Oil Company not mandatory

National Exploration Licensing Policy

(NELP) (contd.)

• No customs duty on imports for Petroleum Operations.

• Cost Recovery up to 100%.

• Repatriation of Funds by Company permitted.

• Cost recovery and Profit Sharing biddable.

• Freedom of marketing of Oil and Gas in India.

National Exploration Licensing Policy

(NELP) (contd.)

• Deduction in Income Tax on Expenditure on Exploration and Drilling operations.

• For Offshore Royalty @ 10%, and Onshore @ 12.5% for Oil and 10% for Natural Gas.

• For Deep Water @5% for first seven years.

Laws of India for Upstream Petroleum

Sector.

• Constitution of India.

• Oil Fields (Regulation and Development) Act 1948.

• Petroleum and Natural Gas Rules1959.

• Territorial Waters, Continental Shelf ,Exclusive Economic Zone and Maritime Zones Act,1976.

• Environment (Protection) Act 1986.

• Water (Prevention and Control of Pollution) Act 1974 .

• Air ( Prevention and Control of Pollution ) Act 1981.

E & P asset life cycle – Risk and Reward

Rank Exploration:~4‐8 years

• 75%‐80% of the

prospects don’t crossthis stage

• Geologic, technology,environment , safety,regulatory and costrisk

project management

in anticipation ofprobabilistic reservesestimates

• In addition successful contractor iscontinuously exposed to reservoir andhydrocarbon price risk

• Success based on safe and optimalreservoir management

Development:~5‐6 years

• Technology,environment, safety,regulatory and costrisk

Production: ~10‐30years

• Technology, environmental, safety,regulatory and cost risk

Appraisal / Pre‐development: ~3

years

• 50% of discoveries

are commercial

• Geologic, technology, • Success based onenvironment, safety,regulatory and costrisk

• Success linked to GCFs • Volume estimates are • Huge capex incurredprobabilistic in nature(P10, P50, P90)

Cashflow

Opex + royalty +incremental capex

10‐15 explorationwells

2‐3 discoveriesappraised

1 field developedcommercially

Contractor to cover failed explorationcost from cash flow of developed field

E & P is the only probabilistic business with significant risk of failure

• Low proven reserve base

• Low prospectivity

• Operating in deep water

India is no Saudi Arabia,

Qatar or Venezuela

Overall Risk : HIGH

• Globally escalating deep

water costs

• Country risk premium

• India ‐ Shadow area for

Service companies

• Scarcity of skills and

infrastructure

Overall Risk : HIGH• Changing tax and fiscal

regime

• Long delays in approvals

• Shifting Government

interpretation of policy &

interventions

Overall Risk : HIGH

• Gas price determined by

Government and not a

competitive Arm’s Length

price

• Indirect subsidy using gas

price control

Overall Risk : HIGH

TEC

HN

ICA

LR

ISK

CO

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PR

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RIS

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REG

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CO

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Indian PSC – Change in risk spectrum

All risks borne by the contractor. GOI insulated from all risks.

•

•Contractor by signing the PSC agreed to undertake all technical & cost risksRegulatory risk & commodity price risk were a subsequent imposition

Contractor – Party 2

PSC operating framework

subsequent WP&Bs, annualproduction estimate and anyrevisions thereto

Audit Rights of GoI

• GoI has audit rights to see ifthe expenditures are inaccordance with WPB andaccounting procedure of PSC

C1 C2 C3

FRAMEWORK

Government

Production Sharing ContractGovernment ‐ Party 1

Management Committee

Govt. Nom. 1 Govt. Nom. 2

Govt. Interests Protected

Management Committee

• Reviews exploration WP&B& revisions thereto

• If discovery is commercial,reviews Appraisal Programwith WP&B & revisionsthereto

• Approves FDP and allo exploration operations,o appraisal,o DOC

• Approval functions wrto development operations

RESPONSIBILITIES

Government

• Petroleum resources be discovered &

exploited with utmost expedition inoverall interest of India

Management Committee (MC)• MC functions like a corporate board

with GoI nominee as Exec. Chairman• Its purpose is to facilitate operations• Advisory/ Review functions wrt

o auditor appointmento Party 1 approval is must for

proposal to pass

Operating Committee• Authorize / supervise Joint Operations• Properly explore / exploit Contract

Area

MC to function as a Corporate Board, to act in the best interests of the block

Operating Committee

C1 C2 C3

Contractor Parties

large discovery or high prices

discoveries whereas captures

PSC economics

Economic distribution under PSC

• Each Contract Area is ring fenced ‐unsuccessful cost from one block cannot be recovered from the other

• Contractor bears all exploration risk,i.e. in case of no commercial discovery,

all the loss is suffered by the Contractor

• Investment Multiple – commonly usedin the industry

o Defined as contractor ’s

cumulative net revenue divided byits cumulative investments

o

o

As the size of the pie increases, so does the share of the Government

PSC flow chart

GOIshare

(%)

10%

16%28%85%85%

Cont.share(%)

90%

84%72%15%15%

COST RECOVERY OIL

PRODUCTION REVENUE

IME.g. Block D6

IM < 1.51.5 < IM ≤ 22 < IM ≤ 2.52.5 < IM ≤ 3

IM ≥ 3

Contractor Revenue

90%10%

IM

PROFIT OIL

GOI’sProfit Oil

Cost Recovery Cap

•••

RoyaltyOpexExploration

• DevelopmentCapexXX%

YY%

Profit Oil

GoI profit share % increases withIM mechanism

the IM defines % to each

Protects Contractors downside

risks in case of small & marginal Contractor

windfall profits for GoI in case of aXX%

CorporateTax

unusedcost oil

P.S.C. Constituents

• Regulatory Provisions

• Financial Provisions & Disposition of

Production Provisions

• Cost Recovery, Profit Sharing, Taxes

Provisions

• Organizational & Co-operative Provisions

• Legal & Non-operational Provisions

Regulatory Provisions

• Description Of Area (Contract Area)

• Relinquishment Scheme

• Obligatory Exploration Programme &Expenditure Commitments

• Duration Of Contract

• Exploration Period

• Appraisal Period

• Development & Production Period

Regulatory Provisions

• Conduct of Operations (Modern International

Petroleum Industry Practice)

• Abandonment of Field

• Environment Protection& avoidance Of Pollution

• Training of Host Country manpower

• Transfer Of Technology

• Preference to Local goods, supplies & Services

Financial Provisions & Disposition of

Production Provisions.

• Contractor’s Share Disposal Rights.

• Type of Currency Used for Payments etc.

• Taxes and other Local Liabilities.

• Banking,Transfer of Funds abroad,Foreign

Currency Exchange.

• Insurance

Cost Recovery,Profit Sharing,Taxes

Provisions

• Contractor’s Take of Cost Petroleum

• Government Take of Petroleum

• Contractors Liability on Income Tax

• Economic Viability of Venture

Organizational & Co-operative Provisions

etc.

• Supervision ,Operatorship, and Co-operation

Between Contractor and State

• Control and Decision making to Investment

• Work Programme and Budget

• Declaration of Commercial Discovery

• Preparation of Development Plan

Legal & Non-operational Provisions

• Guarantees for fulfillment of Obligations

• Indemnities

• Ownership of Assets

• Assignment of Participating Interest

• Amendments, Ratification, and Termination

• Government Approvals

• Force Majure

Legal & Non-operational Provisions

• Governing Law

• Jurisdiction of Courts

• Dispute Resolution

Exploration Phases

• For Onland and Shallow water blocks, Exploration Periodshall not exceed seven Years

• For Deepwater Areas and Frontier Areas eight consecutiveContract Years

• Exploration Period consist of two Exploration Phases.:

– First Exploration Phase for a period not exceeding four (4) Contract Years

– Second Exploration Phase for a period not exceeding three (3) Contract Years .

• For deepwater and Frontier Area blocks, first Exploration Phase will have additional one (1) Contract Year.

Mining Lease

• For Twenty Years

• May be extended for Five years

Management committee

• Government shall nominate two (2) members.

• Each Company constituting the Contractor

shall nominate one (1) member

• If Contractor constitutes only one Company,

that Company shall have two (2) members.

Management committee

• Decisions of Management Committee by

unanimous vote.

• If unanimity not achieved, the decision shall

be by majority Participating Interest of seventy

percent (70%) or more with Government

representative’s positive vote.

OPERATORSHIP, JOINT OPERATING

AGREEMENT AND OPERATING COMMITTEE

• Functions under the Contract be performed by

the Operator

• Within forty five (45) days, the Companies

constituting the Contractor shall execute a

Joint Operating Agreement .

Audit Areas

Preparation for Audit• Clarity of mandate of SAI – Scope of audit vis-a-

vis contractual provision for Audit• Understanding of Fiscal Model in contract or

concession• Risk sharing mechanism between State and

Contractor• Understanding relationship between State and

Contractor/Operator• Understanding relationship between Operator

and other constituents of Contractor

Audit Areas (contd.)

• Understanding of terms of the contract

– Physical performance related (activities and deadlines)

• Minimum Work Programme (API, Exploratory drilling, well testing, Declaration of commerciality of discoveries, Discovery Appraisal Programme,)

• Field Development Programme

• Production and sale

• Contract management

Audit Areas (contd.)

– Financial performance related• Cost management (cost efficiency)

• Revenue management (revenue optimisation)

• Accounting (as per provisions of contract)

• Audit (as per provisions of contract and the laws of the land)

• Understanding of areas where contractor may be motivated to increase his ‘take’. (increase his benefits and transfer/minimise his risks)

Audit Checks

• Adherence to PSC Provisions

– Committed Programmes – work, expenditure and timeframe

– Timely submission of work programme and budget to Management Committee

– Timely submission of discovery and test notifications, appraisal programme, proposal for Declaration of Commerciality, and field development plan

– Production and maintenance

– Identifying customers, determination of price, transportation and custody transfer

– Maintenance and inspection of measurement meters

– Safeguards for assets

– Health, safety and environment

– Site restoration

• Financial Activities

– Accounting as per laid down procedures

– Recognition of costs – Exploration, development and production costs

– Calculation of cost petroleum, profit petroleum and investment multiple (‘R’ factor)

– Calculation of Royalty, taxes, surcharges, etc

– Use of custom exempted items for the intended purpose

• Procurement– Procurement as per laid down procedure

– No procurement of surplus, redundant items

– Procurement from the lowest of the technically qualified bidders

– Procurement and payments as per contract with vendors

– No post tender modifications

– Validity of change orders

– Accounting of stores only on consumption

• Vouching of invoices, shipping documents, GRN, and agreements

• Selection of Auditor and conduct of audit as per PSC provision

• Submission of accounts and other reports to Government/ Regulator as per PSC provision

• Adherence to Joint Operating Agreement by the Operator

THANK YOU

Case Study

Audit of Hydrocarbon Production Sharing Contracts

Background

With the reforms in the economy which took place in the 1990’s, Government of

India decided to liberalise the framework governing the oil and gas Exploration and

Production (E&P) sector, which has earlier been the sole preserve of the

Government Sector. After award of small and medium sized discovered and

producing oilfields as well as some exploratory blocks in the early 1990’s,

Government formulated the New Exploration Licensing Policy (NELP) in 1997 and

notified this policy in 1999. This policy had the objective of not only attracting private

capital to the E&P Sector but also introducing the technical expertise and efficiency

of global players in this field.

In order to ensure balanced and effective partnerships with global E&P Companies,

the Production Sharing Contracts (PSCs) between the Government and the private

players (referred to as ‘Contractor’) were revised. These contracts were structured

in such a fashion that the exploration risk viz. the cost incurred in searching for oil

and natural gas, without certainty of discovery, was to be borne by the private

contractors. The private contractors incur expenditure towards discoveries,

irrespective of the fact whether oil or gas is discovered or not. It is only when

hydrocarbons are discovered and assessed to be commercially viable, that the

contractor has the first rights on the revenue streams accruing from sales of oil and

gas till his costs are recovered. The balance revenue, termed as "Profit Petroleum",

is shared between the Government and the contractors, with the contractors

generally getting a higher share in the initial stages since he has to recover contract

costs. The Government share of revenues becomes significant only when the

production reaches substantial levels and the contractor has recovered his

accumulated capital cost. Further, under NELP, Government companies and private

players are treated at par.

The principle underlying the PSC model, under the NELP, as it currently stands,

involves a scale for profit sharing between the Government of India and the

contractor, based on a critical parameter – the Investment Multiple (IM). This is

essentially an index of the accumulated net cash flow to the contractor relative to the

accumulated expenditure on exploration and development activities. The objective

underlying the PSC is that ideally the operator would attempt to maximize

simultaneously both the government revenues and his own profit by minimizing

contract costs for any level of production.

In order to ensure that the expenditure proposed to be incurred as well as actually

incurred by the operator does not adversely affect the Government’s revenue

interests, the PSC contemplates the Management Committee (MC), chaired by a GoI

representative, as responsible for approving field development plans as well as

annual work programmes and budgets for development and production operations.

However, operational control of E&P activities would vest with the Operating

Committee, consisting of representatives of the contractors.

Audit arrangement in PSC

PSCs provide that the annual audit of accounts shall be carried out on behalf of the

Contractor by a qualified, independent firm of recognized chartered accountants,

registered in India and selected by the Contractor with the approval of MC and a

copy of audited accounts submitted to Government within 30 days of receipt thereof.

The Government shall have the right to audit the accounting records of the

Contractor in respect of Petroleum Operations as provided in the accounting

procedure. For the purpose of this audit, the Contractor shall make available to the

auditor all such books, records, accounts and other documents and information as

may be reasonably required by the auditor.

It is also provided in the accounting procedure that Government, after giving

advance notice to the Contractor, shall have the right to inspect and audit all records

and documents supporting costs, expenditures, expenses, receipts and income,

such as Contractor’s accounts, books, records, invoices, cash vouchers, debit notes,

price lists or similar documentation with respect to Petroleum Operations within 2

years from the end of a financial year.

The Government may undertake the conduct of the audit either through its own

representatives or through a firm of chartered accountants, registered in India or a

reputed consulting firm, appointed for the purpose by the Government and the costs

of audit in case of Government auditor(s) shall be borne by the Government, where

as for outside auditor(s), this shall be borne by the Contractor as a General and

Administrative Cost.

In conducting the audit, the Government or its auditors shall be entitled to examine

and verify, at reasonable times, all charges and credits relating to the Contractor's

activities under the Contract and all books of account, accounting entries, material

records and inventories, vouchers, payrolls, invoices and any other documents,

correspondence and records considered necessary by the Government to audit and

verify the charges and credits. The auditors shall also have the right, in connection

with such audit, to visit and inspect, at reasonable times, all sites, plants, facilities,

warehouses and offices of the Contractor directly or indirectly serving the Petroleum

Operations, and to physically examine other property, facilities and stocks used in

Petroleum Operations, wherever located and to question personnel associated with

those operations. Where the Government requires verification of charges made by

an Affiliate, the Government shall have the right to obtain an audit certificate from an

internationally recognized firm of public accountants acceptable to both the

Government and the Contractor, which may be the Contractor's statutory auditor.

CAG’s Audit Mandate

Comptroller and Auditor General (CAG) of India is empowered, under the provisions

of CAG’s (Duties, Powers and Conditions of Service) Act, 1971 read with CAG’s

Audit Regulations, 2007, to conduct performance audit of Ministry of Petroleum and

Natural Gas (MoPNG) including its technical and E&P regulatory arm, Directorate

General of Hydrocarbons (DGH).

Audit Objectives

The main objectives of the Audit of Hydrocarbon PSCs were to verify whether:

The systems and procedures of MoPNG and DGH to monitor and ensure

compliance by the operators and contractors of the blocks with the terms of the

PSCs were adequate and effective; and

The revenue interests of the Government (including royalty and GoI share of

profit petroleum) were properly protected, and adequate and effective

mechanisms were in position for this purpose;

The purpose of access to, and scrutiny of records of the operators was to verify whether the

Government’s revenue in the form of profit petroleum (current and future) and royalty was

correctly calculated, and its revenue interests were properly protected. Towards this larger

objective, it was intended to verify (based on access to operators’ records for the specified

accounting periods) whether:

Capital expenditure (capex), operating expenditure (opex), and net cash income

and individual items thereof were accurately and reliably reflected, and these

amounts were supported by adequate documentation;

The figures of individual items of capex/ opex were reasonable, and also

commensurate with original/revised budgets, plans, feasibility reports or other

similar documents; and

There was collateral evidence which would provide assurance regarding the

authenticity of goods and services procured and provided.

Major Audit Findings

Block A (Operator: XYZ)

The block A was awarded in the first NELP round in the year 2000. It has India’s

largest gas discoveries and also has a large oilfield discovery. Main audit findings

and recommendations are as follows:

1. Non-relinquishment of area and declaration of entire contract area as

discovery area

Articles 4.1 and 4.2 of the PSC stipulate phased relinquishment of areas, allowing

the contractor to retain a maximum of 75 percent and 50 per cent of the contract

area (including the discovery and development areas)1 after Exploration Phase-I and

Exploration Phase-II, before entering the next exploration phase. At the end of the

exploration period, the contractor is permitted to retain only the discovery and

development areas.

Audit found that contrary to the PSC provisions, the contractor was allowed to enter

the second and third exploration phases without relinquishing 25 per cent each of the

total contract area at the end of Phase-I and Phase-II. Subsequently, in February

2009, GoI also conveyed approval to treat the entire contract area of 7000 sq.km. as

‘discovery area’, thus enabling the operator to completely avoid relinquishment of

area.

2. Delay in notifying discoveries

In violation of PSC provisions, in the case of 65% of discoveries between 2002 and

2008, the operator had, without first furnishing the initial particulars of the discoveries

in writing to the MC and Government, directly given written notifications regarding

potential commerciality of the discoveries.

3. Non submission of appraisal programmes

Audit noticed that there was no appraisal programme in respect of 70% of the

discoveries, notably the biggest gas discoveries and oil discovery. The operator

moved directly from discovery to commercial discovery without an appraisal

programme. Besides being clearly in violation of the PSC provisions, lack of an

appraisal programme, duly reviewed by the MC in line with PSC provisions, for an

“adequate and effective appraisal” of the discovery may result in a high degree of

uncertainty regarding the reliability of the declaration of commercial discovery and

the consequential development plan, as well as the associated estimates of reservoir

reserves, production rates, development and production costs, etc.

4. Development and Procurement Activities in MA Field

The development of oil field in block A is a case of hasty decisions taken by the

operator to award various contracts to four companies of one group in order to start

development activities irregularly without waiting for approval of the proposals for

Declaration of Commerciality and Field Development Plan (FDP). Two of these four

companies were established just before issue of Request for Proposal (RFP). The

Operator awarded contracts at non-competitive rates without ensuring price

reasonability and following procurement procedure and other provisions of PSC in

letter and spirit. Audit also found serious deficiencies in the award, on a single

financial bid, of a 10 year hiring contract for US$ 1.1 billion for a Floating Production,

1 If the discovery and development areas exceed 75 percent/ 50 percent of the contract area, the contractor can retain the entire development and discovery areas.

Storage and Offloading (FPSO) vessel from ABC Ltd. The costs at which these

contracts were awarded, have been found unreasonable. By rejecting seven

competitive bids, no competition was left to ascertain reasonableness of quotes.

After awarding four major contracts, FDP was submitted for approval of MC having

contracted costs as budgeted costs. It is important to mention here that MC does not

have any control, as per PSC provisions, over the bid evaluation and contract award.

Similarly, it was seen that the Work Programme and Budget for 2007-08 was

delayed and submitted on actual basis after incurring the expenditure of US$ 808

million. No details were provided thereof. MC, however, gave post-facto approval.

This not only raises doubts over the control effectiveness of MC but also the

weaknesses in-built in the PSC provision.

5. Deficiencies in Procurement procedure

During scrutiny of the operator’s records, audit came across instances, where

multiple vendors were pre-qualified. However, when technical bids were received, all

vendors (except one) were rejected, and the contract was finally awarded on a single

financial bid.

In our opinion, such disqualification of vendors on technical grounds, after a pre-

qualification process and bidders’ meetings for technical clarifications, limits the

competitiveness which is not in accordance with the spirit of the procurement

procedure given in the PSC. In many cases, it resulted in no competing financial

bids, and the contract was awarded on the basis of a single financial bid. In such a

situation, the letter and spirit of the MC’s role at the pre-qualification stage is vitiated.

1

Check list for PSC Audit based on Model Production Sharing Contract :

Article Check list

Accounting

Procedure

1. Whether there is a proper Accounting Procedure to classify

costs, expenditures and income and to define which costs

and expenditures shall be allowable for cost recovery and

profit sharing and participation purposes;

2. Whether the Accounting Procedure specifies the manner in

which the Contractor's accounts shall be prepared and

approved and addresses numerous other accounting related

matters.

3. Whether the Contractor, within ninety (90) days of the

Effective Date of the Contract, submitted to and discussed

with the Government, a proposed outline of charts of

accounts, operating records and reports, outlining each of

the categories and sub-categories of costs and income , in

accordance with generally accepted accounting standards

and recognized accounting systems and consistent with

normal petroleum industry practice and procedures for joint

venture operations.

4. Whether, within ninety (90) days of receiving the above

submission, the Government provided written notification of

its approval

5. Whether the Contractor and the Government agreed on the

outline of charts of accounts, records and reports within one

hundred and eighty (180) days from the Effective Date of

the Contract.

6. Whether the Contractor prepared and maintained

memorandum joint venture accounts adapted from

Schedule VI of the Companies Act, 1956 ,to indicate the

recoverable costs, value of petroleum produced and saved,

cost petroleum, profit petroleum, etc.

7. Whether the Contractor made the following regular

statements relating to the Petroleum Operations - :

(i) Production Statement ( as per Section 5 of Accounting

Procedure).

(ii) Value of Production and Pricing Statement (as per Section 6 of

the Accounting Procedure).

(iii) Statement of Costs, Expenditures and Income (as per Section 7

of the Accounting Procedure).

(iv) Cost Recovery Statement (as per Section 8 of the Accounting

Procedure).

(v) Profit Sharing Statement (as per Section 9 of the Accounting

Procedure)

(vi) Local Procurement Statement (as per Section 10 of the

Accounting Procedure)

(vii) End of Year Statement (as per Section 11 of the Accounting

2

Procedure).

(viii) Budget Statement (as per Section 12 of the Accounting

Procedure).

8. Whether all sums due under the Contract were paid within

forty five (45) days from the date on which the obligation to

pay was incurred as per Article 1.7.2 of the Accounting

Procedure.

9. Whether the Interest on overdue payments was compounded

daily at the applicable LIBOR rate plus two (2) percentage

points as per Article 1.7.3 of the Accounting Procedure

10. Whether all transactions giving rise to revenues, costs or

expenditures credited or charged to the accounts were

prepared, maintained or submitted and conducted at arms

length under Article 1.8 of the Accounting Procedure

Accounting

Procedure

Audit

Exceptions

11. Whether the audit exceptions under Article 1.9 of the

Accounting Procedure were made by the Government in

writing and notified to the Contractor within one hundred

and twenty (120) days following completion of the audit.

12. Whether the Contractor submitted the reply to the audit

exceptions within 120 days of the receipt of such notice of

audit exceptions.

13. Whether the Contractor failed to answer a notice of

exception within 120 days. In such case, whether the

exception was considered as prevailing and deemed to

have been agreed to by the Contractor.

14. Whether, all agreed adjustments resulting from an audit and

all adjustments required by prevailing exceptions under

Section 1.9.5 were promptly made in the Contractor's

accounts and any consequential adjustments to the

Government's entitlement to Petroleum were made within

thirty (30) days therefrom along with interest due for late

payment under Section 1.7.3.

15. If any amount is claimed as due to the Government

resulting from the audit exception but not accepted or settled

by the Contractor, then whether the Contractor deposited

such claimed amount in an escrow account to be opened

with a financial institution, failing mutually agreed

agreement, with State Bank of India, within thirty (30)

days from the date when the amount was disputed by the

Contractor

Article 3

License and

Exploration

period

16. Whether the Exploration Period was for a period not

exceeding seven (7) consecutive Contract Years consisting

of Initial Exploration Period and Subsequent Exploration

Period.

17. Whether the Initial Exploration Period consisted of first four

consecutive Contract Years with provision to proceed to the

Subsequent Exploration Period of maximum three

consecutive years.

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18. Whether the Contractor completed the Minimum Work

Programme at the end of the initial Exploration Period

19. Whether the Contractor opted to proceed to the Subsequent

Exploration Period by committing drilling of one additional

exploratory well each year in Contract Area (in case of

onland and shallow water blocks) / one additional

exploratory well in 3 years in Contract Area (in case of deep

water blocks) , on presentation of the requisite guarantees as

provided for in Article 29

20. Whether the Contractor opted to relinquish the entire

Contract Area except for any Discovery Area and any

Development Area and to conduct Development Operations

and Production Operations in relation to any Commercial

Discovery in accordance with the terms of the Contract

21. If at the end of the Initial Exploration Period, the Minimum

Work Programme for that period was not completed,

whether the time for completion of the said Minimum Work

Programme was extended for a period necessary to enable

completion thereof but not exceeding six (6) months,

22. Whether the extension for completion of Minimum Work

Programme was given on technical or other good reasons

for non-completion of the Minimum Work Programme and

whether the Management Committee gave its consent to the

said extension

23. If no Commercial Discovery had been made in the Contract

Area by the end of the Exploration Period, whether the

Contract was terminated

Article 4

Relinquishment

24. At the end of the Initial Exploration Period, whether the

Contractor exercised the option to relinquish entire area

after completion of Minimum Work Programme or

proceeded to the Subsequent Exploration Period and

retained the block by committing to carry out drilling of one

well each year in Contract Area ( in case of onland and

shallow water blocks)/one well in 3 years in Contract Area

(in case of deepwater blocks).

25. Whether the entire area (excluding Discovery and

Development area) was relinquished at the end of 7

consecutive years of Exploration Period.

Article 5

Work

Programme

26. Whether during the currency of the Initial Exploration

Period , as per Article 3.2, the Contractor completed the

following stipulated Work Programme:

(a) a seismic programme consisting of the acquisition, processing

and interpretation of 2D/ 3D seismic data in relation to the

exploration objectives;

(b) Drilling of exploration wells

27. In the event that the Contractor failed to fulfill the

Mandatory Work Programme or Minimum Work

4

Programme or additional Work Programme committed

during the Initial Exploration Period or subsequent

Exploration Period or in the event of early termination of the

Contract by the Government for any reason whatsoever,

whether each Company constituting the Contractor paid to

the Government, within sixty (60) days following the end of

the Initial Exploration Period or Subsequent Exploration

Period or early termination of the Contract, as may be the

case, its Participating Interest share for an amount which

shall be equivalent to Liquidated Damages as specified in

the Contract

28. Whether the Work Programme and Budget relating to the

Petroleum Operations to be carried out during the relevant

year were submitted to the Management Committee within

ninety(90) days before commencement of each following

year

Article 6

Management

Committee

29. Whether the Management Committee meetings were held

at least once every six (6) months during the Exploration

Period and thereafter at least once every three (3) months or

more frequently at the request of any member.

30. Whether the matters required to be submitted to the

Management Committee for review and approval as per the

PSC were submitted to the Management Committee and

duly approved

Article 7

Joint Operating

Agreement

31. Whether within forty five (45) days of the Effective Date or

such longer period as may be agreed to by the Government,

the Companies constituting the Contractor executed a Joint

Operating Agreement

32. Whether the Operator provided to the Government a copy of

the duly executed Joint Operating Agreement within thirty

(30) days of its execution date or such longer period as may

be agreed to by the Government

33. Whether any change in the operatorship was effected only

with the consent of the Government

Article 10

Discovery,

Development,

Production

34. When a Discovery was made within the Contract Area,

whether the Contractor forthwith informed the Management

Committee and Government of the Discovery; and

promptly thereafter, but in no event later than a period of

thirty (30) days from the date of the Discovery, furnished to

the Management Committee and Government the

particulars, in writing, of the Discovery; and ran tests

promptly and in any case within 90 days from the date under

Article 10.1 (a), to determine whether the Discovery was of

potential commercial interest and, within a period of sixty

(60) days after completion of such tests, submitted a report

to the Management Committee containing data obtained

from such tests and its analysis and interpretation thereof,

5

together with a written notification of whether, in the

Contractor's opinion, such Discovery was of potential

commercial interest and merits appraisal.

35. Whether the Contractor prepared and submitted to the

Management Committee , within one hundred and twenty

(120) days of such notification, a proposed Appraisal

Programme with a Work Programme and Budget to carry

out an adequate and effective appraisal of such Discovery

36. Whether the proposed Appraisal Programme was reviewed

by the Management Committee within thirty (30) days after

submission thereof pursuant to Article 10.3

37. Whether the Contractor in respect of a Discovery of Crude

Oil advised the Management Committee by notice in writing

within a period of eighteen (18) months for onland and

shallow water blocks and thirty (30) months for deep water

blocks from the date on which the notice provided for in

Article 10.1 (c) was delivered, whether such Discovery

should be declared a Commercial Discovery or not. If the

Contractor was of the opinion that Crude Oil had been

discovered in commercial quantities, whether the proposal

was submitted to the Management Committee for review

that the Discovery be declared a Commercial Discovery. In

the case of a Discovery of Gas, whether the provisions of

Article 21 of the PSC were duly complied with

38. If the Contractor declared the Discovery as a Commercial

Discovery after taking into account the advice of the

Management Committee as referred in the Article 10.6,

whether the Contractor submitted to the Management

Committee, a comprehensive Plan of Development of the

Commercial Discovery, within two hundred (200) days of

the declaration of the Discovery as a Commercial

Discovery.

39. Whether the proposed development plan submitted by the

Contractor pursuant to Article 10.7 was approved by the

Management Committee within one hundred and ten (110)

days of submission thereof or eighty (80) days of receipt of

any additional information requested by the Management

Committee.

40. Whether the Work Programmes and Budgets for

Development and Production Operations were submitted to

the Management Committee as soon as possible after the

approval of a Development Plan under Article 10.8 and

thereafter not later than 31st December each Year in respect

of the Year immediately following.

41. Whether the Contractor determined the ‘Programme

Quantity’ with the approval of the Management Committee,

not later than the fifteenth (15th) of January each Year, in

respect of the Year immediately following commencement

6

of Commercial Production.

42. Whether the Programme Quantity for any Year was taken to

be the maximum quantity of Petroleum based on

Contractor's estimates, as approved by the Management

Committee, which can be produced from a Development

Area consistent with modern oilfield and petroleum industry

practices and minimising unit production cost, taking into

account the capacity of the producing Wells, gathering lines,

separators, storage capacity and other production facilities

available for use during the relevant Year, as well as the

transportation facilities up to the Delivery Point.

Article 11

Petroleum

Exploration

License

43. Whether the Contractor submitted an application for grant

of License in respect of the Contract Area, as early as

possible, but not later than fifteen (15) Business Days from

the date of execution of the Contract

Article 13

Measurement

of Petroleum

44. Whether the methods and appliances generally accepted and

customarily used in modern oilfield and petroleum industry

practices for measurement of petroleum were approved by

the Management Committee and the Government.

45. Whether the Government at all reasonable times, inspected

and tested the appliances used for measuring the volume and

determining the quality of Petroleum

Article 14

Protection of

Environment

46. Whether the Contractor employed modern oilfield and

petroleum industry practices and standards including

advanced techniques, practices and methods of operation for

the prevention of Environmental Damage in conducting its

Petroleum Operations;

47. Whether the Contractor took necessary and adequate steps

to prevent Environmental Damage and, where some adverse

impact on the environment was unavoidable, whether the

Contractor took necessary steps to minimise such damage

and the consequential effects thereof on property and people

48. Whether the Contractor ensured adequate compensation for

injury to persons or damage to property caused by the effect

of Petroleum Operations

49. Whether the Contractor complied with the requirements of

applicable laws and the reasonable requirements of the

Government from time to time.

50. Whether the Contractor notified the Government, in writing,

of the measures and methods finally determined by the

Contractor for protection of the Environment and whether

such measures and methods were reviewed from time to

time in the light of prevailing circumstances.

51. Whether the Contractor caused a person or persons with

special knowledge on environmental matters, to carry out

two environmental impact studies – before Exploration and

before Development

52. Whether the part of the study relating to drilling operations

7

in the Exploration Period was approved by Government

before the commencement of such drilling operations.

53. Whether the second of the aforementioned studies was

completed before commencement of Development

Operations and was submitted by the Contractor as part of

the Development Plan, with specific approval of

Government being obtained before commencement of

Development Operations

54. Whether the Contractor , prior to conducting any drilling

activities, prepared and submitted for review by the

Government contingency plans for dealing with Oil spills,

fires, accidents and emergencies, designed to achieve rapid

and effective emergency response.

55. On expiry or termination of this Contract or relinquishment

of part of the Contract Area, whether the Contractor

removed all equipment and installations from the

relinquished area or former Contract Area in a manner

agreed with the Government pursuant to an abandonment

plan and performed all necessary Site Restoration in

accordance with modern oilfield and petroleum industry

practices

Article 15

Recovery of

Cost Petroleum

56. Whether the Contractor recovered the Contract Costs out of

a percentage of the total value of Petroleum produced and

saved from the Contract Area in the Year in accordance with

the provisions of the PSC Article relating to recovery of

Cost Petroleum

57. Whether within ninety (90) days of the end of each Year, a

final calculation of the Contractor's entitlement to Cost

Petroleum, based on actual production quantities, costs, and

prices for the entire Year as reflected in audited accounts

under Article 25.4.3, was undertaken and any necessary

adjustments to the Cost Petroleum entitlement was agreed

upon between the Government and the Contractor within

thirty (30) days and made within thirty (30) days thereafter.

58. Whether for the purposes of allowing cost recovery under

Article 15 read with Section 3 of the Accounting Procedure,

the cost estimates given by the Contractor in the bid

documents towards the Minimum Work Programme in the

Initial Exploration Period was taken as Bench Mark.

59. Whether any material difference over the Bench Mark was

allowed for cost recovery only by the Government on the

recommendation of the Management Committee, duly

agreeing that the difference was due to change in

circumstances after the Contract came into effect

Article 16

Production

Sharing of

Petroleum

60. Whether the party’s share of profit petroleum was calculated

in accordance with the provisions of the PSC and the

Government received its share of Profit Petroleum on the

basis of option exercised by it, i.e., either in cash or in kind

8

61. Whether the amount of Profit Petroleum to be shared

between the Government and the Contractor was determined

for each Quarter on an accumulative basis.

62. Whether, pending finalization of accounts, Profit Petroleum

was shared between the Government and the Contractor on

the basis of provisional estimated figures of Contract Costs,

production, prices, income and any other income or

allowable deductions and on the basis of the value of the

Investment Multiple achieved at the end of the preceding

Year.

63. Whether all such provisional estimates were approved by

the Management Committee

64. Whether, within ninety (90) days of the end of each Year, a

final calculation of Profit Petroleum based on actual costs,

quantities, prices and income for the entire Year was

completed and any necessary adjustments to the sharing of

Petroleum were agreed upon between the Government and

the Contractor within thirty (30) days and made within thirty

(30) days thereafter.

65. Whether the Profit Petroleum due to the Government was

deposited with “Pay & Accounts officer or its successor,

Ministry of Petroleum & Natural Gas, Government of India,

Shastri Bhavan, New Delhi by 10th of the Month following

each Quarter

66. Whether the Profit Petroleum due to the Contractor in any

Year from the Contract Area was divided amongst the

Parties constituting the Contractor, in proportion to their

respective Participating Interest.

Article 17

Taxes,

Royalties,

Rentals, Duties

etc

67. Whether the Companies (Leasee) paid Royalty to the

Government (Lessor) at the applicable rates as stipulated in

Article 17.4 of the PSC.

68. Whether the royalty amount due to the Government was

paid latest by the end of the succeeding Month.

69. Whether the Customs Duty exemption was sought in respect

Machinery, plant, equipment, materials and supplies

imported by the Contractor and its Subcontractors solely and

exclusively for use in Petroleum Operations under the

Contract or similar contracts with the Government where

customs duty had been exempted.

70. Whether the Government exercised the right to inspect the

records and documents of the physical item or items for

which an exemption had been provided pursuant to Article

17.5 to determine that such item or items were being or had

been imported solely and exclusively for the purpose for

which the exemption was granted

71. Whether the Contractor paid annual license charges and

rental fees and other charges under the Rules as per PSC

provision

9

Article 18

Domestic

Supply, Sale,

Disposal and

Export of

Crude Oil and

Condensate

72. Whether, within sixty (60) days prior to the commencement

of production in a Field, and thereafter no less than sixty

(60) days before the commencement of each Year, the

Contractor prepared and submitted to the Parties a

production forecast setting out the total quantity of Crude

Oil that it estimates can be produced from a Field during the

succeeding Year, based on a maximum efficient rate of

recovery of Crude Oil from that Field in accordance with

modern oilfield and petroleum industry practices.

73. Whether, within thirty (30) days prior to the commencement

of each Quarter, the Contractor informed the estimate of

production for the succeeding Quarter

74. Whether the Crude lifting procedure and Crude sales

agreement based on generally acceptable international terms

was agreed upon by the Contractor with buyer(s) no later

than six (6) months or such shorter period as may be

mutually agreed between the Contractor and buyer(s) with

the consent of Government prior to the commencement of

production in a Field.

Article 19

Valuation of

Petroleum

75. Whether the value of Crude Oil, Condensate and Natural

Gas was based on the price determined as per PSC

Article/Provision

76. Whether each Company constituting the Contractor

separately submitted to the designated nominee of the

Government, within fifteen (15) days of the end of each

Delivery Period, a report containing the actual prices

invoiced in their respective Arms Length Sales for any

Crude Oil.

77. Whether any price or pricing mechanism agreed by the

Parties pursuant to the provisions of this Article was

changed retrospectively

Article 21

Natural Gas

78. Whether Natural Gas produced from the Contract Area was

valued for the purposes of the Contract as follows :

(a) Whether Gas which was used as per Article 21.2 or flared

with the approval of the Government or re-injected or sold

to the Government pursuant to Article 21.4.5 was ascribed a

zero value;

(b) Whether Gas which was sold to the Government or any

other Government Nominee was valued on the terms and

conditions actually obtained including pricing formula and

delivery; and

(Explanation: This provision would apply only when the sale is

made to the Government or Government nominee under the

provisions of the Contract)

(c) Whether Gas which was sold or disposed of otherwise than

in accordance with paragraph (a) or (b) was valued on the

basis of competitive arms length sales in the region for

10

similar sales under similar conditions.

Article 23

Local Goods

and Services

79. Whether, within sixty (60) days after the end of each Year,

the Contractor provided the Government with a report

outlining its achievements in utilising Indian resources

during that Year in accordance with Section 10 of Appendix

C to the Contract.

Article 24

Insurance and

Indemnification

80. Whether the Contractor during the term of the Contract,

maintained and obtained insurance coverage for and in

relation to Petroleum Operations for such amounts and

against such risks as are customarily or prudently insured in

the international petroleum industry in accordance with

modern oilfield and petroleum industry practices

81. Whether the Contractor, within two months of the date of

policy or renewal, furnish to the Government, certificates

evidencing that such coverage is in effect.

Article 25

Records,

Reports,

Accounts and

Audit

82. Whether, based on generally accepted and recognised

accounting principles and modern petroleum industry

practices, record, books, accounts and accounting

procedures in respect of Petroleum Operations were

maintained on behalf of the Contractor by the Operator.

83. Whether the Contractor submitted to the Government

regular Statements and reports relating to Petroleum

Operations as provided in Appendix-C of the Model PSC

84. Whether the annual audit of accounts was carried out on

behalf of the Contractor by an independent firm of

Chartered Accountants, registered in India in accordance

with the generally accepted auditing and accounting

practices in India.

85. Whether the appointment of auditor and the scope of audit

had the prior approval of the Management Committee

86. Whether the Contractor submitted the audited accounts to

the Management Committee for approval within sixty (60)

days from the end of the Year.

87. Whether the Management Committee considered and

approved the auditor's report within thirty (30) days after the

submission of such report.

88. Whether the copy of the auditors report was submitted to the

Government within thirty (30) days after the approval of the

Management Committee.

89. Whether the Government exercised the right to audit the

accounting records of the Contractor in respect of Petroleum

Operations as provided in the Accounting Procedure.

Article 26

Inspection,

Data,

90. Whether the Contractor provided the Government, free of

cost, all data obtained as a result of Petroleum Operations

under the Contract including, but not limited to, geological,

11

Confidentiality,

Inspection,

Security

geophysical, geochemical, petrophysical, engineering, Well

logs, maps, magnetic tapes, cores, cuttings and production

data as well as all interpretative and derivative data,

including reports, analyses, interpretations and evaluation

prepared in respect of Petroleum Operations.

91. Whether the Contractor furnished the Government with full

and accurate information and progress reports relating to

Petroleum Operations (on a daily, Monthly, Yearly or other

periodic basis) as the Government may reasonably require

92. Whether the Government exercised its right to inspect any

aircraft or ship used by the Contractor or a Subcontractor

carrying out any survey or other operations in the Contract

Area

Article 27

Title to

Petroleum,

Data and Asets

93. Whether the equipment and assets no longer required for

Petroleum Operations during the term of the Contract were

sold, exchanged or otherwise disposed of by the Contractor,

and the proceeds of sale were credited to Petroleum

Operations as provided in Appendix C of the PSC.

94. Whether prior written consent of the Management

Committee was obtained for each such transaction in excess

of US$ 50,000 (Fifty thousand United States Dollars) or

such other value as may be agreed from time to time by the

Management Committee

Article 28

Assignment of

Participating

Interest

95. Whether prior written consent of the Government was

obtained by the Contractor for assignment, or transfer of a

part or all of its Participating Interest

96. Whether the assignee provided an irrevocable, unconditional

bank guarantee from a reputed bank of good standing in

India, acceptable to the Government, in favour of the

Government, for the amount specified in Article 29.3 of the

PSC, in a form provided at Appendix-G;

97. Whether the assignee provided a parent financial and

performance guarantee issued by the guarantor which

furnished the guarantee pursuant to Article 29 in respect of

the assignor Party's obligations under the Contract in favour

of the Government, of the performance of such Affiliate

assignee of its obligations under this Contract;

Article 29

Guarantee

98. Whether each of the Companies constituting the Contractor

procured and delivered to the Government within thirty (30)

days from the Effective Date of this Contract an

irrevocable, unconditional bank guarantee from a reputed

bank of good standing in India, acceptable to the

Government, in favour of the Government, for the amount

specified in Article 29.3 and valid for four (4) years, in a

form provided at Appendix-G of the PSC;

99. Whether financial and performance guarantee in favour of

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the Government from a Parent Company acceptable to the

Government, in the form and substance set out in Appendix-

E1, or, where there is no such Parent Company, the financial

and performance guarantee from the Company itself in the

form and substance set out in Appendix-E2 of the PSC was

provided by each of the Companies constituting the

Contractor

100. Whether a legal opinion from its legal advisors, in a

form satisfactory to the Government, to the effect that the

aforesaid guarantees have been duly signed and delivered on

behalf of the guarantors with due authority and is legally

valid and enforceable and binding upon them is submitted

101. Whether each of the Companies constituting the

Contractor procured and delivered to the Government before

the expiry of the Initial Exploration Period an irrevocable,

unconditional bank guarantee from a reputed bank of good

standing in India, acceptable to the Government, in favour

of the Government, for the amount specified in Article 29.3

and valid for the Subsequent Exploration Period opted by

the Contractor, in a form provided at Appendix-G, in cases

where the Contractor elects to retain the Contract Area

during the Subsequent Exploration Period by committing to

drill additional Exploration Wells after completing the

Minimum Work Programme under Article 3.4 (a),

102. Whether the amount of the guarantee referred to in

Articles 29.1 (a) and 29.2 of the PSC is the amount equal to

seven and one half percent (7 ½ %) of the Company's

Participating Interest share of the total estimated

expenditure in respect of Minimum Work Programme

including Mandatory Work Programme or additional Work

Program as the case may be, to be undertaken by the

Contractor in the Contract Area during the Initial or

Subsequent Exploration Period

103. If any of the documents referred to in Article 29.1

was not delivered within the period specified therein,

whether the Contract was terminated by the Government

upon ninety (90) days written notice of its intention to do so.

Article 31

Force Majuere

104. Whether the Party claiming suspension of its

obligations on account of Force Majeure, promptly, within

seven (7) days after the occurrence of the event of Force

Majeure, notify the Management Committee in writing

giving full particulars of the Force Majeure, the estimated

duration thereof, the obligations affected and the reasons for

its suspension

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Additional Points to be examined in addition to the check list while conducting

Audit of Production Sharing Contract (PSC)

Relinquishment

1. Was the delay in relinquishment, if any, attributable to the Operator or

the Regulatory agencies?

2. Were the delays in relinquishment due to procedural or substantive

reasons, i.e., due to non and/ or delayed submission of documents

required to be submitted as per PSC provisions.

Discovery and Development

1. Did the contractor make discoveries in the contract area after

expiry/conclusion of the Exploration period?

2. Were the discoveries in the contract area made during appraisal period

through exploration?

3. Were the discoveries in the contract area during Development phase

through exploration?

4. Whether Exploratory Area, post discovery, applied for by the operator

for conversion into Mining Lease, was commensurate with aerial extent

of the discoveries.

5. Whether the Regulator has ensured that Development Areas are proposed

to be delineated strictly in terms of PSC provisions considering the

number and size of discoveries i.e. size of Development areas vis-à-vis

size & number of discoveries?.

6. Did the Development Areas include excess area?

7. Whether the development work commitments detailed in the PSCs were

completed as per the provisions of the PSC? If not so, the shortfall in

terms of deferment of production of oil and gas, and its impact on IM and

GoI Profit Petroleum including the impact on royalty and Cess due to

delay in completion of the development work commitments should be

quantified and stated in the audit exceptions.

8. Whether the declaration of new discovery was made as per the provisions of

the PSC? If not so, the same should be stated in the audit exceptions

Cost Recovery

1. Whether the operator had made commitment to third parties or incurred

costs without the approval of WP&B by the Management Committee?

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2. Whether the operator has claimed cost recovery of items still lying in

store/inventory and not consumed?

3. Whether the operator has claimed cost recovery of expenditure incurred

on exploration activities (a) after expiry of exploration phase (b) carried

out in the relinquished area (c) not approved by the MC?

4. Whether the cost recovery limit as stipulated in the PSC had been

adhered to by the JV? If not so, the excess cost recovery made by the JV

and its impact on the GoI take should be quantified and stated in the audit

exceptions

Procurement of Goods and Servicers

1. Whether the contracts had been awarded as per the procedure laid down in

the Joint Operating Agreements (JOA) ? If not, the deviation to the JOA

may be commented. The excess expenditure, if any, due to deviation from

JOA procedures should also be quantified and stated in the audit exceptions.

2. Whether contracts were awarded on Nomination or single bid basis?

3. Whether the contracts were awarded without assessing reasonability of

rates?

4. Whether the contracts were extended beyond contractual provisions?

5. Whether extension of contract was truly justified in terms of operational

requirements?

6. Whether the extension of contract beyond contractual provisions was

approved by the Competent Authority/Operating Committee/Management

Committee ?

7. Whether economies of scale in terms of reduction in rates were factored

while seeking extension of contracts?

8. In case of repeated extensions of contract, whether extension was used as a

tool to award contracts on Nomination basis ?

9. Whether the projects were awarded in time? Whether the projects were

executed as per the time schedule given in the contract? If not, the reasons

for delay in award and execution of contract, along with the impact of the

delays on the Government take should be quantified and stated in the audit

exceptions.

10. Whether the payments made by the JV to the contractors for providing

services/materials etc to the JV were as per the terms of the contract

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between the JV and the contractor? If not, the impact of the same should be

quantified and stated in the audit exceptions

Items procured against Essentiality Certificate (EC) issued by DGH

1. Whether the items procured by the operator against ECs had been properly

utilized for intended purpose as per PSC provisions?

2. If such items are lying unused, what is the quantum of custom duty

exemption availed by the operator while importing these items as per PSC

provisions? Whether the custom duty so availed by the operator has been

worked out and paid to the Government as per PSC provisions?

Determination of Well Head value :

The MoPNG in August 2007 notified the norms to determine wellhead price of

gas for the purpose of royalty. As per the notification, per unit of post wellhead

cost was to be determined based on the actual post wellhead expenditure reported

in the previous years audited accounts. Further, oil industry development cess,

depreciation expenses, income tax, surcharge thereon, education cess and profit

petroleum were not to be allowed as post wellhead costs.

Whether the JV was calculating the post wellhead costs as per the above

notification and further clarifications issued by the MoPNG?

Whether the deficiencies in calculation of wellhead value in contravention to the

MoPNG’s notifications along with the impact of the same on Government take

were quantified and stated in audit exceptions.

Pricing of gas/oil sales from the contract area

Whether the pricing of oil and gas had been done as per the terms of the PSC? If

not, the reasons and the impact of the same on the Government take if any,

should be quantified and stated in audit exceptions

Oil and Gas Sale agreement

Whether the agreement for sale of oil and gas hsd been entered into by the JV

with the buyer as per the terms of the PSC? If not, the reasons for the delays may

be brought out in audit exceptions

Inventory

1. Whether there was any difference between the drilling inventory as per

inventory records (computerized or manual records) and the trial balance.

The impact of difference, if any, may be quantified and stated in the audit

exceptions.

2. Whether the sparable inventory had been disposed off in time by the JV?

If not so, the impact of the same on inventory carrying cost as well as on

the GoI take should be quantified and stated in the audit exceptions.

Booking of payments made to expatriates and support staff

Whether the time spent by the expatriates and support staff for non-JV activities

has been allocated to the non-JV activities by the JV? The financial impact in

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case of incorrect allocation should be quantified and stated in audit exceptions.

Insurance

1. Whether the premium paid for insurance policy taken jointly for the JV

and non-JV activities has been segregated and only the premium which

was related to JV activities has been booked in JVs accounts? If not, the

financial impact of the premium paid on non-JV activities should be

quantified and stated in the audit exceptions

2. Whether, the premium paid by the JV Partners for offshore package

policy included any adjustments to be carried out (such as changes in

meterage of wells drilled etc), as per the Package policy. If the

adjustments as per the package policy were not carried out by the JV, the

same should be quantified and stated in audit exceptions

3. Whether each contractor of the JV was securing separate insurance to

cover its interest for offshore installations with different types of risks to

a different extent, resulting in non-uniformity in coverage and premium.

In such case, the same should be stated in the audit exceptions. (The

MoPNG in February 2007 instructed DGH to formulate a standardized

policy for insurance coverage for consideration by Government; however,

no such policy was formulated by DGH.)

Notional Income Tax

As per the provisions of the PSC, “if any change in or to any Indian Law, rule or

regulation by any authority resulted in a material change to the economic

benefits accruing to any of the parties to the contract after the effective date of

the contract, the parties shall consult promptly to make necessary revisions and

adjustments to the contract in order to maintain such expected benefits to each of

the parties”.

Whether the Government as a party to the contract had invoked the above clause

to safeguard its interest due to change in law? If not, the impact on the

Government take should be quantified and stated in audit exceptions.

Determination of Abandonment cost

As per the PSC, the JV had to determine the abandonment cost for the fields in

order to determine the point at which the abandonment provision has to be made.

Whether the JV has determined the abandoned costs as per the PSC? The

deviations/ non compliance if any, should be stated in the audit exceptions

Submission of bank guarantee and performance guarantee

Whether the contractor had submitted the bank guarantee and performance

guarantee as per the PSC Provisions? The deviations/ non compliance if any,

should be stated in the audit exceptions

17

Additional points for Check list based on Study Design Matrix prepared before

commencement of PSC Audit :

1. Whether the clearances were obtained from Ministry of Environment and

Forests/Ministry of Defence/Forest/Fisheries Department before NIO

2. Whether the procedure for selection of Block was laid down and documented

3. Whether the process of contracting was fair, transparent, competitive and in

accordance with policy objectives

4. Whether the records, as required to be submitted to DGH by the Contractor as

per the terms of the PSC, were submitted to DGH by the Operator of the

Blocks in respect of JV operations in compliance with the provisions of the

PSC

5. Whether various reports/statements from operators to DGH as per the

provisions of the PSC were submitted in time by the Operator to DGH, so as

to examine as to whether monitoring mechanism of DGH was adequate and

effective to ensure adherence to the PSC provisions so as to protect the interest

of the Government

6. To review Management Committee Meetings/Operating Committee Meetings

and periodical reports submitted by the Operators to DGH, so as to examine as

to whether various provisions of PSC were complied with, in order to ensure

that exploration/development activities were being carried out within the

approved program/schedule.

7. Whether there was any change in PSC conditions after its signing, whether the

same was justified and documented, and what was the impact thereof on the

overall Government take

8. To examine basis of approval of gas/crude pricing formula, appraisal program,

development program and its subsequent revision at a later stage, if any, to

ensure transparency in decision making process in the DGH

9. Whether the Capital expenditure was duly analysed to determine any

possibility of gold plating of expenditure and its impact on Government Take

in case of Blocks under development/production

10. Whether the Government Take (PP, levies etc) were realized in time and

completely

11. Whether the Relinquishment and the Penalty provisions had been followed

uniformly