Business Finance in Less Developed Capital Markets

By Klaus P. Fischer; George J. Papaioannou | Go to book overview
share (usually 51/49 in favor of the host government). Although the operating company is jointly owned, all capital for exploration is finished by the foreign partner.

A service contract is used by the host government to hire or buy technical, financial, and commercial services from foreign oil companies. All petroleum deposits and products belong to the host country. A service contract stipulates a fixed payment for services rendered. No extra returns accrue to the company even if the undertaking is successful.

Under a production-sharing contract, the oil company is responsible for carrying on all exploration and development activities. If there is no commercial discovery, the loss is borne by the contractor. In each year, a specific percentage (40 percent in most production-sharing contracts) of crude oil produced is allotted for such reimbursement. The remaining portion of the production is to be shared in a proportion specified in the agreement.

4.
Blitzer, Lessard, and Paddock, 1984.
5.
All exploratory wells are assumed to be drilled by the oil company at a single point in time. The more realistic dynamic case in which the oil company drills sequentially based on conditional probabilities is not considered.
6.
A typical petroleum-production pattern includes (1) a production buildup period during which production is increasing each year as installed capacity is coming on stream; (2) a flat production period; and (3) a declining production period. Although these dynamic factors are not explicitly modelled in this study, V in (16.1) can be thought of as the present value of the stream of net cash flows involved in resource extraction.
7.
This assumption seems warranted if government and oil company share information and the company's interpretation of the exploration.
8.
Under the cash-bonus system, legislation fixes in advance all requirements that the company must fulfill. Competitive bidding on advance cash payments for the right to extract petroleum is used to encourage applicants to compete with one another, and the license is awarded to the highest bidder. The United States is the only country that uses this system regularly.
9.
Since f(V∣X) is a probability density function and probabilities over all events must sum to one, the right-hand side of (16.10) can be simplified to qF′(R).
10.
Borch ( 1962, p. 427) pointed out that G′(Ii)/F′(Ri) being constant is required for optimal risk sharing between the two contracting parties. The condition (16.12) could be optimal from the risk-sharing point of view if (1) the term fX(Vi∣X)/f(Vi∣X) in (16.12) is constant, or (2) the Lagrangian multiplier L2 for the second constraint in (16.11) is equal to zero, that is, the constraint is not binding. Holmstrom ( 1979, pp. 78-80) proved that both conditions are violated if the host government and the oil company have different objectives.
11.
Hyde and Markusen 1982.
12.
Broadman 1983, p. 25.

REFERENCES

Arrow Kenneth. ( 1970). Essays in the Theory of Risk-Bearing. Amsterdam: North-Holland.

Barrows Gordon H. ( 1983). Worldwide Concession Contracts and Petroleum Legislation. PennWell Publishing Company.

Blitzer Charles R., Donald R. Lessard, and James L. Paddock. ( 1984). "Risk-Bearing and the Choice of Contract for Oil Exploration and Development." Energy Journal 5, no. 1: 1-27.

-309-

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