Production Royalty Sliding Scales

Abstract

Oil companies are faced with investment decisions for projects that have to live on both the upside and downside of oil prices. Fiscal regimes are key factors in determining the success of investment decisions in an international oil and gas setting. The two common fiscal regimes are: concessionary and production sharing agreement (PSA). It is known that a sliding scale is used to capture uncertainties in reserves and production in order to exploit potential increases in both reserves and production. A production royalty sliding scale is a common part of most fiscal regimes. Three different methods for calculating a production royalty sliding scale are weighted, non-weighted and linear equations. Each method is evaluated under a PSA for an oil field. Results show that all three methods have an incentive to increase production. However, the increase in the undiscounted cash flow with weighted average is highest for the contractor, followed by the linear equation and then the non-weighted method. Government undiscounted cash flow is the lowest using the weighted average and the highest using the non-weighted average methods. Hence the weighted average favors the contractor while the non-weighted average favors the government. The authors conclude that the linear equation method performs better than the other two methods in terms of creating a win-win situation for both government and contractor.