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Strategies for Managing Risk While Drafting Oil and Gas Contracts

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Posted: 03/10/2011
Strategies for Managing Risk While Drafting Oil and Gas Contracts
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Catastrophic events like the Macondo incident have underlined the risks that undepin oil and gas contracts, as well as the actualities of monetary, infrastuctural and human casualties that accompany those risks.

With risk management in the spotlight like never before, the following headings will go over three strategies that are currently used in limiting risks while creating oil and gas contracts in the current climate.

Conducting Extensive Due Diligence

As buyers, oil and gas companies comply with a common law – Caveat Emptor or Buyer Beware. This means that buyers should always examine their purchases thoroughly before going ahead with a transaction. Therefore, oil and gas companies need to exercise due diligence before signing contracts.

If oil and gas companies intend to buy assets, they should be aware of which liabilities will be transferred to them. Not all liabilities will be transferred during the time of prior ownership. Therefore, companies need to find out which liabilities they will receive and which ones they won’t.

While exercising asset due diligence, companies should find the Granting Document or its equivalent and spend their time on investigating transfer requirements. Companies should also discover whether the asset follows a licensing system or contract system, and find out the number of the land’s owners. Other necessary documents required while examining oil and gas assets are Service Contracts, Drilling Contracts, Equipment Leases, Tax information, evidence of title and Sellers Guarantee.

On the other hand, if shares are purchased instead, going over liabilities and prior contractual arrangements is a must. Companies should also find out whether a change of control requires notifying the government or partners and obtaining their consents. In addition, to make sure of making the right investment decision, oil and gas companies need to go over the following - Certificate for Good Standing, Articles of Incorporation, Charter and By-Laws of the company, annual reports and financial statements, and company books and records.

Ensuring Contractual Compliance

Some oil and gas companies do not give much attention to their contracts. As a result, they do not include every entity affected by the transaction. However, hidden in old contracts and long-forgotten complex agreements are terms and conditions that can turn costly for companies if not followed or utilized properly. By ensuring contractual compliance, companies will be able to save significant sums, enhance their operational performance, and improve their financial controls.

Contractual compliance will enable oil and gas companies to get rid of contract leakage, delivery and quality failures, poor incentives, bad planning and demand management, ill-informed buying, contract manipulation, and miscommunication. Therefore, value will be delivered to all the stakeholders and oil and gas companies will experience cost reduction in their procurement function. However, companies should keep in mind that contractual compliance is an on-going practice.

Oil and gas companies need to commit for a very long time to this process in order to gain its benefits. However, due to new processes automating the analysis of contract invoice data, companies will be relieved from tedious contract compliance inspections and will no longer suffer from duplicate, erroneous or excessive charges. Some systems also enable users to create customized queries to gather contract invoice data such as labor charges and cost allocations.

Communicating with Local Governments

Oil and gas companies should check the rules that govern businesses in the asset’s country. Most countries with oil deposits have added rules and regulations to their constitutions recently. For example, the government of Iraq has a few vague provisions that handle the control and distribution of its natural resources. However, the most notable step a local government has taken to protect its oil and gas resources is the enactment of the Nigerian Oil and Gas Industry Content Development Bill in 2010.

Since the 1950s, Nigeria has established its name as an oil country. It emerged as the 7th largest oil producer in the world and the third largest in Africa. However, in spite of these statistics, Nigeria hardly profited from its oil and gas sector because 90% of goods and services were needed and used for projects initiated by foreign countries.

Once the Nigerian Local Content Bill was enacted, the country was able to ensure itself of a cut from the oil and gas industry’s profits. This was done because the Act prescribes minimum thresholds for using Nigerian Content in any project. Plus, stakeholders are to give the Nigerian content significant consideration during project development, management and execution. Now, due to the act, all subsequent oil and gas arrangements, agreements and contracts are to be made in conformity with the provisions of this Bill.


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