In many countries production sharing contracts and

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In many countries production sharing contracts (and sometimes concessions agreements) provide for limits on the percentage of crude oil production that can be used for cost recovery. 89 After deduction of royalties, a percentage of the remaining revenue is used to recover costs. If costs exceed the cost recovery limit, the difference is carried forward for recovery in subsequent periods. 90 Most production sharing contracts allow for unlimited carry forward. Not all costs are recoverable for the purpose of cost recovery. 91 The relevant accounting rules are generally set in the contract or in the petroleum law. Advantages and Disadvantages to Host Governments The cost recovery limit ensures that in each accounting period the government will have a share of production. Cost recovery limits are less regressive than royalties. From an adminis- trative standpoint, it is more difficult to monitor cost recovery limits than royalties. Effect on Investment Decisions In PSCs that have a cost recovery limit, this would normally range between 40-60 percent (Johnston 1994). Cost recovery limits have an effect on a project’s return on investment similar to a royalty. Low cost recovery limits can be quite discouraging for the development of marginal fields. 88 Cost recovery is a concept commonly applicable to contractual arrangements. 89 Concessionary systems normally do not have a cost recovery limit. 90 If recoverable costs are below the cost recovery limit in some countries, excess cost oil goes directly to the government (see for example Egypt and Syria). 91 Normally, cost recovery includes operating costs, expensed capital costs, depreciation and depletion allowance, interest on financing, investment uplift, abandonment cost fund, and unrecovered costs carried over from previous years, but there are exceptions. Table 18. Profit Oil Split 92 How do they work? In production sharing contracts profit oil (or profit gas) is the revenue that remains after deduc- tion of royalty and cost recovery. 93 In most cases the profit oil is split according to a sliding scale defined on the basis of agreed parameters (these may include average daily production, cumulative volume of production, crude oil prices, value of production, R-Factor, and RoR). The profit oil (or profit gas) split between the host government and the investor is often negotiable. 94 Advantages and Disadvantages to Host Governments Sliding scale profit oil splits are flexible arrangements that allow the government to provide a suitable fiscal package to a particular project without changing the overall fiscal framework. There appears to be a preference among governments for sliding scale profit oil based on production rates. Although these are easier to calculate than sliding scale profit oil based on R-factors or RoR, they are insensitive to changes in the price of crude oil and natural gas.
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