Licences and contracts for subsoil use

Quick refresher

In a concession (licence), the produced oil belongs to the company, and the state takes its share through payments: bonuses, royalty and taxes. In a production sharing agreement, the oil belongs to the state, and the contractor receives a part of it: cost oil, to recover its costs, and a share of profit oil. In a service contract, the contractor receives a fee, not oil.
The type of agreement does not set the government take: the same money can be collected through a royalty and a tax, or through production sharing. What differs is the timing of the payments, the reaction to price, the distribution of risk and the barrels that the company can count as its own.
In Kazakhstan, the subsoil use right to hydrocarbons arises only from a contract, either for exploration and production or for production, on a model form. A company gets it at an electronic auction, where the largest signature bonus wins. The national company can get it without an auction, in direct negotiations.
The exploration period is up to 6 years (18 for complex projects), and the production period is up to 25 years (up to 45 for large fields). Trial production after an extension of exploration (production from a few wells to test the field), and the preparatory period (a time to prepare the field for full production), shorten the longest production period. Production can be extended by up to 25 more years.
The obligations of the contract are: the work programme of the exploration period; an in-country value share of at least 70% in works and services; in the production period, 1% of production costs for training and for research and development, and 1% of investment for the development of the region; and elimination of the consequences of the work (closing the wells and restoring the site), with financial security (money set aside to pay for it).
The right under an exploration and production contract cannot be transferred in the first three years. Later it can be transferred only with the permission of the competent authority, and for strategic areas the state can buy it first.

Key relationships

\mathrm{CO}_t = \min\left(K_t;\ c\,R_t\right)

cost oil of the year: the costs to be recovered $K_t = K_{t-1}^{\text{r}} + C_t + O_t$ (the balance of past years plus the capital and operating costs of the year), but no more than the share $c$ of revenue $R_t$

G_t = s\,(R_t - \mathrm{CO}_t)

the state's share of profit oil; the contractor gets $\mathrm{CO}_t + (1 - s)(R_t - \mathrm{CO}_t)$

B_\text{start} = 3000 + 10\,(n - 300)\ \text{MCI}

the starting signature bonus of an exploration and production contract without approved reserves, for $n > 300$ blocks; up to 300 blocks it is 3,000 MCI (monthly calculation indices, the unit in which the law sets payments)

Common pitfalls

Thinking that production sharing always gives the state more than a concession: the rates decide, not the name of the agreement.
Thinking that at a high price the contractor under production sharing gets more barrels: less oil goes to recover costs, and its share in barrels falls.
Valuing an exploration area only by the signature bonus: the main money is in the work programme.
Planning to sell an interest right after the auction: in the first three years of an exploration and production contract, a transfer of the right is banned.

After this lesson you can

compare the concession (licence), the production sharing agreement, and the service and risk service contracts: who owns the produced oil, how the state gets its share, and who bears the risk
explain the ways of granting rights (the open-door procedure, licensing rounds, auctions, direct negotiations) and what is good and bad about each for the state and for the investor
describe the regime of Kazakhstan: contracts for exploration and production and for production, the electronic auction and direct negotiations with the national company, model contracts, the lengths of the periods, obligations, transfer of rights and termination
calculate the government take under a simple concession and a simple production sharing agreement for one project, and show how production sharing changes the “contractor's barrels” with the price
read the terms of an auction lot as an investor: how much money is needed to take part, what the contract obliges the user to do, and what the right to walk away from a well is worth

What a company gets under an agreement

The state as owner sells not the oil but the right to explore for it and produce it (The state and the subsoil: ownership of resources). The agreement sets out what this right is for and on what terms. Every subsoil use agreement, whatever it is called, answers the same questions.

The area and the periods. The borders by area and by depth, the stages (exploration, appraisal, production), and what happens to the part of the area where nothing was found.
Work obligations. The seismic surveys and wells that the company must carry out in the exploration period, so that the area is not held without use.
The oil produced. Who owns it, and at which point: at the wellhead or at the delivery point.
The state's money. Bonuses, royalty, taxes or a share of production, and, under production sharing, the rules for recovering costs.
Local participation. The share of the national company, the requirements for local personnel, goods and services, and social payments.
Rights to exit. Transfer of the right and of interests, pledge, and change of control of the company.
Stability and disputes. What happens when the laws change, the applicable law, and how disputes are settled.
The end of the agreement. The grounds for termination, the return of the area, and elimination of the consequences of the work with its financial security.

Three families of agreements

The concession, or licence, is the oldest form. The company gets the exclusive right to an area and becomes the owner of the produced oil. The state gets its share through payments: bonuses, royalty and income taxes. For example, the lessees of federal lands in the USA and the holders of licences on the British and Norwegian shelves work under this scheme: the company owns the produced oil and pays the state. The set of payments differs from country to country. The most important thing for the investor is the tax system: it sets the government take, the state's share of the project's income (Petroleum fiscal systems and taxation).

In a production sharing agreement (PSA), the oil stays the property of the state. The contractor explores and develops the field at its own expense and at its own risk, and receives a part of the production. First comes cost oil, which pays back its costs, usually up to a set share of production in a period. The rest, profit oil, it shares with the state in agreed proportions, which often depend on the volume of production or on the profitability of the project. The contractor becomes the owner of its share at an agreed point. Such agreements first appeared in Indonesia in the 1960s (the first in 1966) and then spread to many countries.

In a service contract, the contractor works for a fee and receives no oil. In a pure service contract, it bears almost none of the risk of exploration, development and price. In a risk service contract, the contractor finances the work, and receives the fee, for example per barrel of production, only if the project succeeds. These contracts are chosen by countries where the law does not allow oil to be passed into the ownership of foreign companies.

How the three families work

Question: Whose is the produced oil
Concession (licence): the company's
Production sharing: the state's; the contractor gets its share
Service contract: the state's

Question: How the state is paid
Concession (licence): bonuses, royalty, taxes
Production sharing: a share of profit oil, often bonuses and taxes as well
Service contract: all production, less the contractor's fee

Question: Who risks the money for exploration
Concession (licence): the company
Production sharing: the contractor
Service contract: in a risk service contract the contractor, in a pure one the state

Question: What the company shows as reserves
Concession (licence): its share of production
Production sharing: its share by the sharing formula
Service contract: in a risk service contract, a share by economic interest; in a pure one, nothing

Question	Concession (licence)	Production sharing	Service contract
Whose is the produced oil	the company's	the state's; the contractor gets its share	the state's
How the state is paid	bonuses, royalty, taxes	a share of profit oil, often bonuses and taxes as well	all production, less the contractor's fee
Who risks the money for exploration	the company	the contractor	in a risk service contract the contractor, in a pure one the state
What the company shows as reserves	its share of production	its share by the sharing formula	in a risk service contract, a share by economic interest; in a pure one, nothing

Under the PRMS system (the Petroleum Resources Management System), reserves are shown by the one who bears the risk and receives income from production (Classification of reserves and resources).

Cost oil

\mathrm{CO}_t = \min\left(K_{t-1}^{\text{r}} + C_t + O_t;\ c\,R_t\right)

where:

$\mathrm{CO}_t$ cost oil of year $t$ in money terms, US$ million
$K_{t-1}^{\text{r}}$ costs not recovered by the end of the previous year, US$ million
$C_t,\ O_t$ capital and operating costs of the year that are to be recovered (the notation of the lesson Cash flow model of an oil and gas project), US$ million
$c$ the cost recovery limit: the largest share of the year's revenue that can go to recover costs, fraction
$R_t$ value of the year's production: production multiplied by price, US$ million

Units: US$ million (or barrels, by dividing by the price)

Holds when

This is how the simple production sharing of the example works. Real agreements have different limits for different costs, uplifts on recoverable costs (extra percentages added to them), and special rules for bonuses and abandonment.
What is not recovered this year is carried to the next: $K_t^{\text{r}} = K_{t-1}^{\text{r}} + C_t + O_t - \mathrm{CO}_t$ .

The recovery limit guarantees the state profit oil from the first year of production, even while costs are not yet recovered. The contractor gets its investment back gradually.

Sharing of profit oil

\mathrm{PO}_t = R_t - \mathrm{CO}_t,\qquad G_t = s\,\mathrm{PO}_t,\qquad E_t = \mathrm{CO}_t + (1 - s)\,\mathrm{PO}_t

where:

$\mathrm{PO}_t$ profit oil of the year, US$ million
$G_t$ the state's share, US$ million
$E_t$ everything that the contractor is entitled to (its entitlement): cost oil and its share of profit oil, US$ million
$s$ the state's share of profit oil, fraction

Units: US$ million

Holds when

In the example, the share is constant and there are no other payments. Often it is made to rise in steps, with the volume of production or with the ratio of the contractor's accumulated income to its costs.

In barrels, the contractor is entitled to $E_t/P$ : the higher the price $P$ , the fewer barrels it takes to recover the same costs.

Worked exampleConcession and production sharing on one field

Given (assumed data)

Project: a small field from the economics examples: 12 million bbl over 7 years, capital costs of US$160 million in the first three years, operating costs of US$6 million a year plus US$5/bbl, abandonment of US$12 million; price US$50/bbl
Investor's rate: 10% (real), flows in the middle of the year
Teaching concession: royalty 10% of revenue, income tax 20%
Teaching production sharing: cost recovery limit 60% of revenue, the state gets 35% of profit oil, no other payments; abandonment is not recovered

Solution

The rent of the project, which is the NPV (the value today of the future cash flows) of the flow before payments to the state at 10%, is 175.45 million dollars, or 326 million dollars without discounting (resource rent). Both regimes divide it.
Concession: the discounted payments to the state are 75.32 million dollars, which is 42.9% of the rent. Without discounting, they are 115.6 of 326, or 35.5%. The investor's NPV is $175.45 - 75.32 = 100.13$ million dollars, and the internal rate of return is 29.6%.
Production sharing, year 3: revenue is 80 million dollars, the costs waiting to be recovered have built up to $50 + 90 + 20 + 14 = 174$ million dollars, and the limit is $0.6\cdot80 = 48$ . Cost oil is 48, profit oil is $80 - 48 = 32$ , the state gets $0.35\cdot32 = 11.2$ , and the contractor gets $48 + 20.8 = 68.8$ million dollars, or $68.8/50 = 1.376$ million bbl of the 1.6 produced. 126 million dollars stay unrecovered. The costs are fully recovered in year 6.
Production sharing over the whole life: the state gets 74.25 million dollars of discounted payments, which is 42.3% of the rent. Without discounting, it gets 118.3, or 36.3%. The contractor's NPV is $175.45 - 74.25 = 101.20$ million dollars, and its rate of return is 30.5%.
The contractor's barrels under production sharing: 9.63 million bbl of 12, which is 80%. At a price of US$60/bbl, they are 9.33 million bbl.
At a price of US$60/bbl, the state's share of the rent is 38.3% under the concession and 39.6% under production sharing. At US$40, it is 55.2% and 50.5%.

Answer: At US$50/bbl, both regimes give the state almost the same share of the rent, 42.9% and 42.3%. Under production sharing, the contractor is entitled to 9.63 million bbl of the 12.

What it means. The terms of production sharing here are chosen on purpose so that at the base price the state's share is the same, and yet the regimes are not alike. Production sharing gives the contractor more money in the first years (cost oil) and gives the state more later. Without discounting the state gets more, and on discounted flows a little less. With no royalty on revenue, the state's share under production sharing falls less when the price rises and rises less when it falls. And the main thing for reporting: under a concession the produced oil belongs to the company, but under production sharing its “barrels” depend on the price. At US$60/bbl there are 0.30 million fewer of them, although production is the same, so the reserves that the company can show also move with the price. How tax regimes work, and how to compare how progressive they are (whether the state's share rises as profit rises), is covered in the lesson Petroleum fiscal systems and taxation. The data in this example are assumed for illustration.

CalculatedThe state's share of the rent of the example project (discounted flows at 10%) at prices from US$40 to US$80/bbl: the concession (royalty 10%, tax 20%) and production sharing (cost recovery limit 60%, 35% to the state). At US$50/bbl the shares almost coincide: 42.9 and 42.3%.

CalculatedThe oil that the contractor is entitled to under the teaching production sharing agreement at different prices (production is 12 million bbl at any price). Below US$36.4/bbl, the recovery limit does not let the contractor recover all its costs, and its share in barrels is constant. Above that, it falls as the price rises.

How states allocate areas

Open door (a first-come procedure): the area goes to the first applicant that meets the requirements. It is quick and cheap for the state and fits unattractive territories, but it does not show what the area is worth.
Licensing rounds with bidding on work programmes: the state offers a package of areas, and companies compete on the volume of work they promise and on their qualifications. The state gets exploration, not money upfront.
Bonus auctions: the largest cash bonus wins. This is transparent, and the state receives part of the rent at once. But the company pays it before it knows whether there is any oil, and it builds this risk into its bid (Expected monetary value and preference theory).
Direct negotiations: the terms are agreed with one company, often a national one, or for complex and strategic projects. This is flexible, but not transparent, and it is not tested by the market.

Competition at a tender has a reverse side, the winner's curse. If many companies value the same uncertain area, the winner is usually the one who overvalued it (Geological and technical uncertainty of a project). So companies lower their bid compared with their own estimate, and the state insures itself with mandatory work and guarantee deposits.

Kazakhstan: auction and direct negotiations

Under the Subsoil Code, the subsoil use right arises from a licence or a contract (Article 20). Licences are issued for the geological study of the subsoil, for exploration and production of solid minerals, for production of widespread minerals, for the use of underground space, and for artisanal mining (Article 30). For hydrocarbons, only a contract is signed, for exploration and production or for production (Article 35). Under the contract, the Republic, represented by the competent authority, the Ministry of Energy, grants the right for a period, and the subsoil user carries out the work at its own expense and at its own risk. Areas are granted only from the State Subsoil Fund Management Programme, either at an auction or to the national company in direct negotiations (Article 110). One area is granted when a contract is signed. The exploration territory is no more than 2,400 blocks, and in poorly studied territories 500 (Articles 35, 110). A block is a cell of the state grid with sides of one geographic minute (1/60 of a degree; Article 19).

The electronic hydrocarbon auction

1
Application for an auction
An interested person asks for an area from the Programme to be put up. The ministry considers the application for 20 working days and publishes notices at most four times a year, except for areas in poorly studied territories (Article 94).
2
Notice
It states the area and the kind of operations, the minimum requirements for the work of the exploration period and their estimated cost, the starting signature bonus, the amounts of contributions for training, research and development and the development of the region, the minimum in-country value, and the length of the exploration period. Applications are accepted for two months from the day of publication (Article 95).
3
Application to take part
It is submitted through the platform of the electronic auction operator, with an electronic signature. The applicant needs a participation fee of 100 MCI (it is not refunded) and a guarantee deposit: two starting bonuses for an exploration and production contract, one for a production contract. The applicant must not be in liquidation, reorganisation or bankruptcy, and must have no tax arrears. It confirms that it has the money for the minimum exploration programme, and, for offshore areas, experience of work on the shelf (Articles 93, 95, 96).
4
Admission
The application is considered in 10 working days, and shortcomings can be corrected in 3 working days. Admission is refused, among others, to anyone whose contract the ministry terminated early in the last three years, or who did not pay the bonus after an earlier win. It is also refused if the right would threaten national security, including through a concentration of rights (Article 97).
5
Bidding
The largest signature bonus wins (Article 100). If the only registered participant is the one who started the auction, the auction is cancelled and a contract is signed with it at the starting bonus (Article 99). If fewer than two participants are registered on the day of bidding, the auction is declared not held and is not repeated (Article 101). The exception is poorly studied territories: there, the only admitted participant wins by paying the starting bonus (Articles 100, 101).
6
Contract
The winner has 20 working days to pay the bonus and to submit a signed contract on the model form with a work programme not smaller than the minimum. The ministry has another 20 working days to sign. If the winner is late, it loses the right and the guarantee deposit, and the contract is offered to the participant with the second bid, at its own price (Articles 95, 100). The results can be challenged in court within three months (Article 102).

Direct negotiations are possible only with the national company in the field of hydrocarbons, a joint-stock company created by decision of the Government, whose controlling stake belongs to the state or the national managing holding (Article 103). It receives areas from the part of the Programme that is set aside for it, if it applies within three years from the day the territory was included in the Programme. Otherwise the territory is put up for auction. Areas from the “auction” part of the Programme are available to it only as long as nobody has applied for an auction. It may work together with a strategic partner, which finances exploration or reimburses the signature bonus. For large fields the share of the national company in the contract must be at least 50%. Negotiations take two months, with a possible extension, and the bonus is set by their result. The right it gets cannot be transferred for two years, except to organisations in which the national company holds at least half of the voting shares (Articles 103–105).

Worked exampleAn auction lot through the eyes of an investor

Given (assumed data)

Lot: No. 2, the Begimbet-1 area, for exploration and production: 852 blocks, 2010.92 km²
Minimum programme under the notice: reprocessing of earlier 2D data, 2D seismic (a survey along lines that gives cross-sections of the rock) of at least 300 line km in 3 years, at least one well in 4 years; the programme is estimated at US$2 million
MCI for 2026: 4,325 tenge (KZT)
Exchange rate used: 500 tenge to the dollar (assumed)

Solution

The starting bonus under the Tax Code for an area without approved reserves: $3000 + 10\cdot(852 - 300) = 8520$ MCI, or $8520\cdot4325 = 36{,}849{,}000$ tenge. This is the amount stated in the notice.
Before applying: a guarantee deposit of $2\cdot36{,}849{,}000 = 73{,}698{,}000$ tenge and a participation fee of $100\cdot4325 = 432{,}500$ tenge, 74,130,500 tenge in all. The guarantee deposit is returned if the participant does not win (to the second bidder, after the winner has paid). The participation fee is not returned.
If the area is won: within 20 working days, the final bonus, which is not less than the starting one, and a signed contract with a work programme not smaller than the minimum. Before work starts: security for eliminating the consequences of exploration (a guarantee, a pledge of a bank deposit or insurance) for the sum from the exploration work project. The project itself is due within a year of the contract date.
The scale: the starting bonus at the assumed rate is about 73.7 thousand dollars, which is 3.7% of the estimate of the minimum programme. For an exploration area, the main money is the work, not the bonus.
The obligations of the production period (1% for training and for research and development, 1% of investment for the development of the region, in-country value) arise only on a discovery and the move to production. They are taken into account in the value of success.

Answer: To take part in the bidding for the area, 74,130,500 tenge must be paid in (432,500 tenge of it is not refundable). The starting bonus is 36,849,000 tenge, about 3.7% of the estimate of the mandatory work programme.

What it means. An investor values an area not by the bonus but by the whole chain: the money to take part, the bonus, the work programme and its flexibility, the chance of a discovery, and the value of success with the obligations of the production period. The limit of a bid at an auction is the expected value of the area before the bonus (Expected monetary value and preference theory). How this limit is affected by the right to walk away from drilling after the seismic survey is explained in the advanced part of the lesson (the right to walk away from a well). The sums are from the auction notice. The exchange rate is assumed.

The contract: forms, periods and terms

Contracts are drawn up on model forms approved by the competent authority. They may depart from the forms only in the cases and within the limits that the Code provides (Article 36). For hydrocarbons there are five forms: a contract for exploration and production; for production; for exploration and production on a complex project; for production on a complex project; and for exploration and production on an area within poorly studied territories. The contract is signed in Kazakh and Russian (for complex projects with foreign participation, in English too, if the subsoil user wishes), and the applicable law is the law of the Republic of Kazakhstan.

Complex projects are offshore projects in the Kazakhstan sector of the Caspian Sea, and onshore projects with at least one of these features: reserves of unconventional hydrocarbons; the top of the accumulation at an absolute depth (measured from sea level) of at least 4,500 m; hydrogen sulfide in the reservoir fluid of 3.5% or more; abnormally high reservoir pressure, with the ratio of reservoir pressure to hydrostatic pressure (for water of density 1000 kg/m³) of 1.5 or more; a non-structural trap (a trap that is not formed by the bending or breaking of the rock layers). Onshore gas projects also count, if the oil-saturated part is no more than 25% of the volume of hydrocarbons in the accumulation (Article 36). They have their own periods, tax terms and requirements.

The longest periods of a hydrocarbon contract

Period: Exploration
How long: up to 6 years; for a complex project 18 (9 + 6 + 3)
Conditions: counted from the registration of the contract; in poorly studied territories the initial period is 3 years

Period: Extension of exploration for appraisal
How long: up to 3 years for each accumulation; all exploration no more than 9 years
Conditions: by an addition to the exploration work project; blocks outside the contours of the accumulation are excluded

Period: Extension for trial production
How long: up to 3 years
Conditions: by the trial production project; it shortens the longest production period

Period: Preparatory period
How long: up to 3 years
Conditions: only with reserves that have passed the state expert review; it shortens the longest production period

Period: Production
How long: up to 25 years; for large fields up to 45
Conditions: with reserves that have passed the expert review and a field development plan

Period: Extension of production
How long: up to 25 years
Conditions: on application with a development plan for the period of extension

Period	How long	Conditions
Exploration	up to 6 years; for a complex project 18 (9 + 6 + 3)	counted from the registration of the contract; in poorly studied territories the initial period is 3 years
Extension of exploration for appraisal	up to 3 years for each accumulation; all exploration no more than 9 years	by an addition to the exploration work project; blocks outside the contours of the accumulation are excluded
Extension for trial production	up to 3 years	by the trial production project; it shortens the longest production period
Preparatory period	up to 3 years	only with reserves that have passed the state expert review; it shortens the longest production period
Production	up to 25 years; for large fields up to 45	with reserves that have passed the expert review and a field development plan
Extension of production	up to 25 years	on application with a development plan for the period of extension

The Subsoil Code, Articles 116–120. Complex projects: 9 years for the initial exploration stage, 6 for the appraisal stage and 3 for trial production, then 25 or 45 years of production.

SchematicThe longest periods of an exploration and production contract (not a complex project). Trial production after an extension of exploration, and the preparatory period, shorten the production period. So the term of the contract without an extension of production is up to 34 years, and for a large field up to 54 years. Production can be extended by up to 25 more years.

Return of territory. When exploration is extended, the blocks outside the contours of the discovered accumulations are excluded from the area. At the end of the exploration period, the exploration area is considered returned to the state, except the production area that has been fixed for the subsoil user (Articles 107, 117).
A special extension of exploration. Once, exploration can be extended beyond the usual limits by no more than 3 more years, if the seismic surveys and drilling under the programme have been carried out and there are no unresolved violations. The subsoil user places 750,000 MCI in an escrow account for the work of this extension, and the longest production period is shortened by the same time (Article 117).
The production period and the plan. The production period is set by the first development plan. If a later plan makes profitable production longer, the term in the contract does not change because of it: an extension is needed (Article 119).
Extension and new rules. The application to extend production is submitted no later than a month before the end of the period (for large fields, six months before the contract expires). If the production period was at least 20 years, then at the extension the terms of the contract are brought into line with the legislation at the date of the extension (Article 120).

The subsoil user's obligations and liability

The work programme of the exploration period: the volumes, kinds and timing of work. It is part of the contract (Articles 36, 100).
In-country value: preference for Kazakhstani personnel; at least 70% in the works and services bought in a calendar year, except complex projects in the Kazakhstan sector of the Caspian; purchases under the rules of the authorised body (Articles 28, 36).
Contributions in the production period: from the second year, 1% of the production costs of the previous year for training Kazakhstani personnel, 1% for research and development or digitalisation, and 1% of investments under the contract for the social and economic development of the region (Article 129).
The domestic market: oil produced in the exploration period and in the preparatory period is all supplied to the domestic market, except the subsoil user's own technological needs and permitted flaring (Articles 118, 123). The state has the right to buy hydrocarbons first, at a price not higher than the price of the subsoil user's own deals, less the costs of transport and sale (Article 121).
A large discovery: if the initial geological reserves are more than 100 million t of oil or 50 billion m³ of gas, the contract includes one of these obligations: for processing, for modernisation, for supplying raw materials for processing in Kazakhstan, or for another investment or social project (Article 119).
Elimination of consequences: the subsoil user eliminates the consequences of the work, and the obligation does not disappear when the contract ends. It is secured in exploration by a guarantee, a pledge of a bank deposit or insurance, and in production by a pledge of a bank deposit that is topped up in proportion to production under the development plan (Articles 54, 55, 126).

Liability. For breach of its obligations, the contract provides for a penalty, but paying it does not release the user from the obligation itself. The ministry gives written notice of the breach and a time to fix it. For physical volumes of work, this is up to six months. If the financial obligations for the year are less than 30% fulfilled, or work is carried out without security for elimination of consequences, it is up to three months. For everything else it is a month (Article 133).

Early termination. The contract is ended unilaterally (by one side, without the other's agreement), for example, on a court decision banning the activity, for work without design documents that have been approved and have passed expert review, or for transferring the right without permission, if this threatens national security. The ministry may terminate the contract if a violation of the financial obligations (less than 30% in a year) or of the security for elimination is not put right, or if there are more than two violations of other obligations. The contract ends two months after the notice. The termination can be challenged in court within the same two months, and then the term is suspended (Article 106). How the state may review the terms for strategic areas is covered in the lesson on resource ownership.

Transfer of rights, exit from the project and termination

A ban for three years. The right (or an interest) under an exploration and production contract for hydrocarbons cannot be transferred in the first three years of its life. Neither can the interests and shares of a company if this contract is its only one (Articles 40, 42). A right that the national company got in direct negotiations cannot be transferred for two years, except to organisations in which it holds at least half of the voting shares. Such a transfer is not covered by the three-year ban (Articles 40, 103).
Permission. A transfer of the right, of an interest in it, and of objects connected with the right needs the permission of the competent authority (Articles 41, 44). These objects are the interests and shares of the subsoil user and of those who can determine its decisions, except shares traded on an exchange. Permission is not needed in some cases. One is a transfer within a group where one person holds at least 99% (if the acquirer is not registered in a state with a preferential tax regime). Others are deals with the Government, a national holding or the national company. Permission is also not needed if the buyer of interests or shares of the subsoil user (or of whoever influences its decisions) ends up owning less than 25% of its capital.
Time and refusal. The application is considered for a month, and for large fields and strategic areas for three months, with the recommendation of an expert commission. For strategic areas, a check by the national security bodies is added. Permission is refused if the transfer threatens national security, including through a concentration of rights in one person or a group of persons from one state, if the deal is banned by the Code, or if the state has used its priority right. Permission is valid for a year (Article 45).
The priority right. For strategic areas, the state may buy the right or interest that is being sold ahead of everyone else. It does so through the national holding or the national company, at a price no worse than the one in the application (priority right; Articles 43, 46).
Control and pledge. A change in the make-up of those who directly or indirectly control the subsoil user (who hold more than 25% of the shares or votes, receive more than 25% of the net income, or determine decisions under the contract) must be reported within 30 calendar days (Article 47). Giving a hydrocarbon right, or the shares of controlling companies, as a pledge (security for a loan) needs permission. A loan secured by such a pledge must go to subsoil use purposes or to further processing in Kazakhstan that the contract provides for (Article 121).

Selling part of an interest to a partner in return for financing the work is a farm-out. It is one of the main ways to share exploration risk (Risk reduction and diversification). In Kazakhstan, such a deal is also a transfer of an interest, and the same rules apply to it: the ban in the first three years, the permission and the priority right.

The contract ends when its term expires, by agreement of the parties, when the whole area is given up, or early, on the grounds in the Code (Article 38). From the day it ends, the area is considered returned to the state. The ministry decides whether to eliminate the consequences of the work, to mothball the area for a future subsoil user, or to hand it over to the national company in trust management (Article 107). Elimination must start no later than six months after the right ends, and its obligations outlive the contract itself (Articles 54, 126).

Terms and symbols

Concession (licence): An agreement or permit under which the company owns the produced oil and pays the state bonuses, royalty and taxes.
Production sharing agreement: An agreement under which the oil belongs to the state, and the contractor receives cost oil and a share of profit oil.
Cost oil: The part of production that pays back the contractor's costs, usually within a set share of the production of the period.
Profit oil: Production less cost oil; the state and the contractor divide it.
Risk service contract: An agreement under which the contractor finances the work and receives a fee only on success, but not the oil.
Exploration and production contract: In Kazakhstan, a contract in which the exploration period is followed by a preparatory period (if needed) and the production period.
Signature bonus: A one-off payment for acquiring the subsoil use right; at a hydrocarbon auction, the largest one wins.
Guarantee deposit: Security for the payment of the bonus at an auction: two starting bonuses for an exploration and production contract, one for a production contract.
Objects connected with the subsoil use right: The interests and shares of the subsoil user and of those who can determine its decisions; their transfer needs permission, just as the transfer of the right itself does.

Common mistakes and misconceptions

Wrong

“At an auction in Kazakhstan, the best work programme wins.”

In fact

The largest signature bonus wins. The notice sets the minimum work programme and its estimate, and the winner must carry out at least that.

Wrong

“Production sharing is better for the state than a concession.”

In fact

The rates decide. In the example of the lesson, the terms are chosen so that at US$50/bbl the state's share of the rent is almost the same, about 43% and 42%. What differs is the timing of the payments, the reaction to price and which barrels belong to the company.

Wrong

“The main money for an exploration area is the signature bonus.”

In fact

For an exploration area without approved reserves, the starting bonus is small: in the example of the lesson, about 3.7% of the estimate of the minimum programme. The main obligations are the work. The bonus is large where reserves are approved: it is calculated from their value.

Wrong

“After winning an auction, the interest can be sold to a partner at once.”

In fact

In the first three years of an exploration and production contract, transfer of the right and of an interest is banned. Later the permission of the competent authority is needed, and for strategic areas the state has a priority right.

Wrong

“If the seismic survey found nothing, the company still has to drill.”

In fact

On an ordinary area, it can refuse a well from the programme if the seismic survey is done and the application is submitted in the first three years, by returning the whole area. On a complex project, the right to return the area after any kind of work also lasts three years.

In depth: advanced detail

The right to walk away from a well: what it is worth

The right to return an area after the seismic survey, without drilling the mandatory well, turns the work programme from a rigid obligation into a sequence of decisions. Its value can be estimated with a decision tree (Decision trees and the value of information): the investor pays for the seismic survey in any outcome, and for the well only if the survey has found a prospect (a place where oil may be trapped) worth drilling.

Worked exampleThe expected value of a lot with and without the right to walk away

Given (assumed data)

Seismic survey with reprocessing: US$0.6 million; finds a prospect to drill with a probability of 0.3 (the investor's estimate)
The well: US$1.4 million; a discovery at the prospect with a probability of 0.4; with no prospect there is no chance
Value of a discovery: US$25 million: the NPV of its development at the investor's rate, with taxes and the obligations of the production period (assumed)
Bonus: not included: we are looking for how much can be paid for it; we do not discount the time difference between the costs

Solution

The overall chance of a discovery: $0.3\cdot0.4 = 0.12$ .
If we must drill in any case: $0.12\cdot25 - 0.6 - 1.4 = 1.00$ million dollars.
With the right to walk away, the well is drilled only if a prospect is found. The value of drilling a prospect is $0.4\cdot25 - 1.4 = 8.60$ million dollars, and the expected value of the lot is $-0.6 + 0.3\cdot8.60 = 1.98$ million dollars.
The price of the right: $1.98 - 1.00 = 0.98$ million dollars. This is the cost of the well that is not drilled in 70% of cases: $0.7\cdot1.4 = 0.98$ .
The largest bonus at which the expected value is not negative: 1.98 million dollars. At 500 tenge to the dollar, this is 990 million tenge, or 228,902 MCI, which is 26.9 times the starting bonus.

Answer: The right to walk away from the well adds 0.98 million dollars of expected value. With these estimates, the investor can offer a bonus of up to 990 million tenge.

What it means. The limit of the bid rests entirely on the investor's estimates: the chances, the value of a discovery and the costs. A slightly more pessimistic view of the chance of a prospect or of the value of a discovery cuts it several times over. Different companies see different limits, and the one whose limit is higher wins the bidding. This is also where the risk of overpaying comes from. The expected value is also neutral to risk (it ignores how much a company fears losses): a small company, for which 2 million dollars is a noticeable sum, will offer less (Expected monetary value and preference theory). The right to walk away is valuable for exploration areas with a low chance: the more likely an empty seismic survey is, and the more expensive the well, the more valuable the possibility of leaving. All the numbers of the example, except the work programme from the notice, are assumed.

Connections to other topics

The state and the subsoil: ownership of resources — the state as owner of the subsoil, the rent, stability of terms and strategic areas.
Classification of reserves and resources — why a company's reserves depend on the type of agreement and the length of the production period.
Expected monetary value and preference theory — how the risk of exploration is taken into account in auction bids.
Decision trees and the value of information — sequential decisions: seismic survey, drilling, the right to leave.
Cash flow model of an oil and gas project — how the terms of an agreement enter the cash flow of a project.
Petroleum fiscal systems and taxation — royalties, taxes and production sharing in detail; the progressivity of regimes.
State regulation of field development — development plans, their expert review and state control.
Risk reduction and diversification — farm-out, partnerships and a portfolio of areas.

Check yourself

1
Under what document does a company in Kazakhstan get the right to explore for and produce oil?
1. A.Under a production sharing agreement
2. B.Under a licence for exploration
3. C.Under a permit of the local executive body
4. D.Under a contract for exploration and production or for production
Show the answer
Correct answer: D. Under a contract for exploration and production or for production
For hydrocarbons, the subsoil use right arises only from a contract (Articles 20, 35 of the Subsoil Code). Licences are issued for other operations. No new production sharing agreements have been signed since 2009, although those signed earlier remain in force.
2
An area of 1,200 blocks with no approved reserves is put up for an exploration and production auction; the MCI is 4,325 tenge. What is the starting bonus, and how much must be paid in before applying?
Show the answer
The bonus is $3000 + 10\cdot(1200 - 300) = 12{,}000$ MCI, or $12{,}000\cdot4325 = 51{,}900{,}000$ tenge. The guarantee deposit is two starting bonuses, 103,800,000 tenge, plus the participation fee of 100 MCI, 432,500 tenge. In all, 104,232,500 tenge, of which only 432,500 tenge is not returned.
3
In the example of the lesson, a contractor under production sharing is entitled to 9.63 million bbl at US$50/bbl and to 9.33 million at US$60, although production is the same. Why?
Show the answer
The contractor's costs are recovered with cost oil in money terms. At a higher price, the same dollar of costs covers fewer barrels, so the cost oil in barrels is smaller. The profit oil, which is divided in constant shares, is larger. The total for the contractor in barrels goes down. So the reserves that it shows under such an agreement also fall when the price rises.
4
A company won an auction and registered an exploration and production contract in March 2027. When can it sell half of its interest to a foreign partner?
1. A.In a year, without permission, if the partner is not from an offshore jurisdiction
2. B.At once, if the partner pays the market price
3. C.Never: interests in such contracts are not sold
4. D.Not before March 2030, and only with the permission of the competent authority
Show the answer
Correct answer: D. Not before March 2030, and only with the permission of the competent authority
In the first three years of an exploration and production contract, transfer of the right and of an interest is banned (Article 40). After that the permission of the competent authority is needed (Articles 44, 45), and if the area is strategic, the state may use its priority right. The exceptions to the need for permission cover mainly transfers within a group and deals with the state and the national company.
5
The winner of an auction did not pay the bonus within 20 working days. What happens?
1. A.It is given another 20 working days
2. B.The auction is declared invalid and held again
3. C.It loses the right to the contract and its guarantee deposit, and the contract is offered to the participant with the second bid, at its own price
4. D.The contract is signed, and the bonus is recovered through the courts
Show the answer
Correct answer: C. It loses the right to the contract and its guarantee deposit, and the contract is offered to the participant with the second bid, at its own price
The winner loses the right to sign the contract, and its guarantee deposit goes to state revenue. Within three working days the right is offered to the participant that bid the next largest bonus, and it will pay its own bid. If it also fails to meet the conditions, the area is put up for auction again (Articles 95, 100).
6
At US$50/bbl the state's share is the same under the concession and under the production sharing agreement of the example. Why does that not make them equal for the investor?
Show the answer
They differ in the timing of payments (production sharing returns costs to the contractor sooner and gives the state its share later). They differ in the reaction to price (with no royalty on revenue, the state's share under production sharing changes less with the price: at US$40/bbl it is lower, and at US$60 higher, than under the concession). They differ in the ownership of the oil and in the reserves that the company can show (under production sharing its barrels fall as the price rises). For the investor, risk and reporting matter too, not only the share at one price.

Updated: 17 October 2026