The Absheron Project: Bp's Production Sharing Agreement in Azerbaijan

Abstract

This case is used in a Darden second-year elective in corporate finance, Corporate Financial Policies. It asks students to analyze the cash flows estimated for a production sharing agreement (PSA) between BP and the Azerbaijan government targeted for signing by year-end 2014. The primary relationship is a joint venture (JV) between BP and the State Oil Company of the Azerbaijan Republic (SOCAR). The JV is entitled to recover operating costs and capital costs from the proceeds of sales of the early production of the project and share profits earned from production, called the profit petroleum (PP), with Azerbaijan after the cost recoveries. Students are provided a detailed cash flow model for the project and for BP's equity investment and are asked to explain how the value estimates correlate with the risks assumed by the respective parties. This case is appropriate for students who have studied the principles of discounted cash flow and cost of capital. It is best positioned as part of a first-year MBA finance course as the last case in a module related to cash flow analysis. The case can also be taught in an MBA elective containing advanced corporate finance topics. It would be of special interest to students planning for a career related to energy, banking, or consulting, and also relevant for students interested in international business. Excerpt UVA-F-1753 Apr. 12, 2016 The Absheron Project: BP's Production Sharing Agreement in Azerbaijan Samira Bayramli, a recently promoted finance analyst in the Azerbaijan office of the global oil and gas company, BP, had a lot on her plate. It was November 2014 and Bayramli's office window at Port Baku afforded a picturesque view of the Caspian Sea. Earlier that week, Bayramli's supervisor had asked her to review a proposed structure for a new production sharing agreement (PSA), for which BP aimed to complete negotiations with the State Oil Company of the Azerbaijan Republic (SOCAR) by year end. This contractual agreement would define the cost and profit-sharing scheme between BP and Azerbaijan for the exploration, development, and production of the shallow-water offshore hydrocarbon fields surrounding the Absheron Peninsula (Exhibit 1). The contract structure was complex, and Bayramli wanted to understand the project's risks and rewards and how those were to be distributed between BP and the host country. Production Sharing Agreements A PSA was a contract in which an oil-producing state granted an international oil company (IOC) the exclusive right to explore and produce hydrocarbons (oil and natural gas) at a defined location called the “contract area.” PSAs were used to provide a legal framework for investment in developing countries that lacked the financial or technical capabilities to develop their own hydrocarbon reserves. The IOC bore all the financial, geological, and operational risk associated with the project and was obligated to undertake a minimum exploratory work program (geological/seismic studies and wells). If a commercial discovery occurred, then the IOC paid the full costs of the field's development. . . .