Juan Carlos Zepeda
President Commissioner
CNH
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Insight

Contracting Model Selection

Wed, 01/21/2015 - 09:55

In the run-up to the first bidding phase of Round One, doubts circled among leading global operators as to which contract models would be chosen. Juan Carlos Zepeda Molina, President Commissioner of CNH, answers the question simply. “Two types of contracts will be seen in this bidding process: licenses and production-sharing contracts,” he says. The main difference between these contracts is that licenses see a company pay a percentage of its revenue to the government, while production-sharing contracts mean that companies only pay a percentage of profits. However, they present a significantly different risk balance so the authorities will evaluate which type of contract is most suitable on a field-by-field basis. According to Zepeda Molina, the advantage of production-sharing contracts is that their structure can better recognize costs and allow for certain deductions, which means CNH could charge companies in a more efficient way. Any variation in costs would also be incorporated into the contract with the profit levels being adjusted. “Charging based on profits is more efficient but more complex as well since it involves more administrative costs and monitoring on our side. However, this means we will achieve better results in terms of economic efficiency,” explains Zepeda Molina. In answer to industry concerns, he also states that the alternative would see the government take a percentage of the operators’ gross revenue. That solution might be easier to administrate but it transfers all the cost risk to the companies. “In production-sharing contracts, the contract is adjusted for any movement in costs, so we take a share of the actual profit. It is more complex in its administration and the government will be more hands-on in the process.”

In order to ensure the industry is satisfied with its contracting choices, CNH has also sought out advice from the private oil and gas sector. Consequently, various improvements have been made to the bidding terms and to the contracts themselves. Zepeda Molina says that a return-based adjustment mechanism has been put in place that will enable companies to receive relatively high profit split until a 15% internal rate of return is reached. “As soon as a project starts generating high levels of return, this mechanism kicks in and starts increasing the profit share of the government. However, one of the adjustments made in the new version of the contract is that this mechanism was changed to be more gradual. The fiscal terms were modified to allow higher returns to the companies when a project is really successful,” states CNH’s President Commissioner. As a result of the feedback, CNH also modified the work commitment, referring to the amount of work that authorities demand from companies having won the blocks. Originally, this work commitment measured the investment made in terms of dollars, meaning that companies are forced to invest a minimum amount or financial resources in the exploration phase of their contracts. Now, CNH has changed this to focus more on actual exploration activities. In doing so, the regulator introduced a concept used in other countries called a work unit, which obliges companies to carry out a certain number of work units that have an equivalent in terms of activity. “We changed the concept from simply measuring the money being spent to a requirement for actual work. Furthermore, there were other changes in terms of administrative procedures. We imposed time limits that will govern CNH’s consideration and approval of development plans. This will help CNH’s role become clearer and its activities faster,” concludes Zepeda Molina, recapping the ways in which CNH has been attentive to private sector concerns.