Security creation under revenue sharing contracts

By Harsh Arora and Loveleen Singh, HSA Advocates

The government of India introduced private-sector participation in the oil and gas sector in 1992. The government came up with the New Exploration Licensing Policy (NELP) in 1997, to attract foreign and private participation in the exploration and production (E&P) of oil and natural gas. Under NELP’s production sharing contract (PSC), the contractor was entitled to recover 100% of its expenditure for carrying out E&P activities and the remaining product was subject to a split between the contractor and government. Under this model the contractor could inflate its costs, reducing the government’s share of production.

Harsh AroraPartnerHSA Advocates
Harsh Arora
HSA Advocates

In light of the observations and recommendations in a report on the PSC by the Rangarajan Committee, published in December 2012, the government came out with a new Hydrocarbon Exploration Licensing Policy (HELP) on 10 March 2016. HELP did away with the concept of 100% cost recovery for the contractor. Now, the government enters into a revenue sharing contract (RSC) with the contractor in relation to E&P of hydrocarbons.

Under NELP, exploration blocks were allotted on a yearly basis by way of competitive bidding, while under HELP bidders can apply and show interest in bidding throughout the year by submitting an expression of interest (EOI). The government will consider the EOI and if found advantageous, suitable and compliant with all requirements, will call for bids.

Under HELP, the government’s revenue will be determined separately for crude oil and natural gas in accordance with a two-dimensional production–price matrix (separate for on-land, shallow-water and deep-water areas and coal-bed methane), linked to the average daily production in a month and average oil and gas prices in that month. Additionally, under HELP, unlike NELP, the government issues a uniform licence for carrying out E&P activities for all types of hydrocarbons.

The government received EOIs for carrying out E&P activities on 55 blocks across the country in 2017. When the EOIs were placed for bidding in January 2018, Oil and Natural Gas Corporation (ONGC), Oil India, Cairn India, Vedanta and other upstream companies showed interest in the blocks and participated in the bidding. By 2 May, ONGC had bid for 37 blocks and Vedanta had bid for all 55. Once the blocks have been allotted to the successful bidder, infusion of funds will be required for undertaking E&P activities.

Loveleen SinghAssociatesHSA Advocates
Loveleen Singh
HSA Advocates

To obtain financial assistance from banks or financial institutions for performance of their obligations under an RSC, contractors need to create appropriate security in favour of the lender to secure the loan.

Under article 27 of the RSC any member of the contractor may create a charge on all or part of its participating interest for the purpose of financing, provided that such member: (a) remains solely liable for the performance of its obligations in relation to its participating interest under the RSC; (b) obtains prior consent of the government, from a national interest perspective, on the lenders from whom the finance can be raised; (c) gives notice to other parties (including the government) for the security creation and provides a certified copy of the instrument by which security has been created in favour of the lenders; (d) ensures that the security created will not affect the interest of other parties and where security creation imposes any liability on other parties the party that has created the security will indemnify the other parties; and (e) ensures that in case of a loan default, the lender or its nominee will be required to get the government’s approval before carrying out petroleum operations.

Earlier, upon the expiry or termination of a PSC, the government could obtain full title and ownership of the assets purchased by the contractor for carrying out the E&P activities. Now, under article 26 of the RSC, the contractor will retain sole title to such assets and can create a charge on its assets pertaining to petroleum operations in favour of a lender.

Article 16 of the RSC provides that the contractor must open an escrow account with a bank that is acceptable to the government. As dues of the government are to be paid from the escrow account, the government’s consent must be obtained for creating a charge on that account.

Additionally, in case of a foreign funding, the Foreign Exchange Management Act, 1999, also needs to be complied with.

As the loss of the cost recovery mechanism has made the E&P process less lucrative for contractors, it is necessary that government reduce its involvement in respect of financing and security creation to sweeten financing deals.

Harsh Arora is a partner and Loveleen Singh is an associate at HSA Advocates. HSA is a full-service firm with offices in New Delhi, Mumbai, Bengaluru and Kolkata.

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