E&P Companies: Executives of Turnkey Contracts in the Upstream Oil and Gas Industry

With the exploration of oil and gas in the last century and last decades, providing a suitable infrastructure with the highest efficiency of these God-given resources to explore and produce oil and gas was given secondary priority and oil-producing countries were seeking to produce and make use of these underground resources rapidly. Therefore, considering the fact that this profitable industry was novel in every country and the business atmosphere was just established, at first, governmental companies took responsibility of management and operations to make access to exploration, extraction, and production of oil and gas. Afterwards, pioneer countries’ governmental companies in this industry, applied their service, knowledge and experience in exploration and production of oil and gas in other oil-rich companies of the world. Thus, it was necessary for governmental companies to modify their structure at the international level in order to release themselves from the hindering restrictions of merely governmental companies and to carry out trade and investment in this field more openly. In essence, oil and gas industry is a risky, but profitable industry. Based on an economic principle, higher profit equals higher risk tolerance and the higher one’s capability of tolerating risk in investment, the higher their chance of gaining more profit. Therefore, at the beginning of oil and gas discovery in the world, companies capable of accepting higher risk, enjoyed higher profits and became the first specialized E&P companies in the upstream oil and gas industry, carrying out exploration, production and exploitation of this profitable material. In other words, there are companies active in specific sectors of oil and gas industry, which are subject to high risk; however, they gain tremendous profit and remuneration from the exploration, production, exploitation, and marketing of various types of oil and gas products. Furthermore, E&P companies are those companies that carry out all oil and gas activities ranging from the exploration of the potential reserves of crude oil or natural gas for the first transformation to transferring the extracted product in order to refine the hydrocarbon derivatives in the upstream oil and gas industry.

Regardless of technical actions E&P companies carry out, in order for the companies to do business two factors are critical: investment and management. Although oil and gas industry is profitable, it is costly too and in order to access the final product, that is the oil, the gas, and the gas condensates, massive investment should be made in the underground and the ground levels. In addition to investment, a strong management and persistence should dominate the factors affecting the performance of oil operations, including directing investment, natural factors, human resources, business practices, etc. so that the final product can be accessed with the highest productivity and the lowest price. This should be done in a way that not only the expenses are compensated for, but also based on the contractual procedures, the E&P company can make a profit in this field. Thus, obtaining results and access to an oil and gas field, commercially valuable for the owner, is the main requirement to gain profit for E&P companies. The owners of oil and gas resources in the world and governments possessing oil had primarily started their work by taking the risk of access to oil and gas reservoirs.

However, after some time and after better identification of risks in this industry, they decided to allocate more payments to the other side of the contract, which were mostly E&P governmental or private companies. Therefore, the owners of reservoirs or their representatives, operating in the form of National Oil Companies (NOC), wanted to use contracts in which in addition to taking advantage of the contractor’s “financial and technical services”, the “risk” of reaching the final product was simultaneously transferred to the contractor. Consequently, in order to serve this aim and achieve the final product with the desired characteristics of the client, the “management” of oil operations should be assigned to the contractor. Therefore, contracts with the nature of “turnkey” were formed in the upstream oil and gas industry. “Exploratory” and “Drilling” contracts were among the first scopes in which these contracts were made. The following are the features of “turnkey” contracts:

A) Clients use turnkey contracts to limit the inherent risks in drilling wells. Certainly, a contractor takes more significant risks in the turnkey contracts than other contracts and the client takes the least risk. Turnkey contract is the only approach to cover the financial expenses of the operation. It suggests that the clients have the necessary flexibility to implement an efficient and effective operation and manage their resources. The ability to stabilize costs and transfer risk has increasingly made turnkey contracts more attractive for the clients.

B) If the contractor faces any problems while on exploration or drilling operation based on a turnkey method and cannot gain access to the depth specified in the contract, the contractor will not be paid.

C) This approach is taken by clients incapable of supplying suitable and sufficient financial resources, but in possession of suitable resources for exploitation. In this case, the client makes a contract with various turnkey contractors and these contractors receive all their expenses after the completion of the drilled wells in the future. The obvious benefit for both sides of this contract is that the wells are drilled, extraction operation is carried out appropriately, and resources are considered as “reservoirs” for all the operation.

contracts should be capable of investment in this sector. In addition, they should implement these contracts by tolerating higher risks so that they can achieve greater profits by precise and proper management of commercial and technical operations. This structure is exclusively in possession of nongovernmental and private E&P companies, which have the possibility of decision-making and management of their own resources and they carry out business. Fortunately, in the last few years, using “turnkey” contracts has become widespread among Iranian governmental clients. Nonetheless, due to the lack of E&P companies in Iran, these contracts were mostly implemented by governmental companies or subsidiaries of non-governmental public institutions. Since the client and contractor companies were governmental, close attention has not been paid to making contracts with real stipulations and their implementation.

Fortunately, with the creation of E&P companies, which are not affiliated to the government, and the need for these companies to enter all executive operations of oil upstream industry including exploration, production, development, and exploitation based on the general conditions approved by the Cabinet of Ministers in August 2016, the text of “turnkey” contracts should also be reviewed. In addition, the rights and commitments of the client and the contractor, corresponding to the nature of the contracts, and the conditions requiring the contractor to gain the final product with the desired characteristics should change. As a result of this, on the one hand, if an Iranian company tolerates a risk, it can obtain a predictable profit at the beginning of the contract. On the other hand, the client, who has accepted to pay remuneration more than contracts signed in the past in the upstream fields, can reach his desired aim, which is the final high-quality product.

In conclusion, this should be noted that governmental clients should consider the fact that as in the cost estimation of the project, each technical component has a price, the total of which constitutes the client’s final estimate of the project, stipulating the “requirement” of reaching the result and the guarantee if the client’s desired product is not reached has a separate price from other technical components of the project. This price increases the overall price of a turnkey project in comparison with other similar projects. Not considering this factor in the final cost of a turnkey contracts overshadows other requirements of the contract; it would be nothing more than signing and implementing a simple contract although we called it a turnkey project.

Author: Mostafa Baharizade

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