"I realise that some of my criticisms may be mistaken; but to refuse to criticize judgements for fear of being mistaken is to abandon criticism altogether... If any of my criticisms are found to be correct, the cause is served; and if any are found to be incorrect the very process of finding out my mistakes must lead to the discovery of the right reasons, or better reasons than I have been able to give, and the cause is served just as well." -Mr. HM Seervai, Preface to the 1st ed., Constitutional Law of India.

Thursday, December 20, 2012

Relationship between Operator and the Non-Operators in Petroleum Operations

In the last post, we had discussed the decision of the Delhi High Court in HLS Asia Ltd. V. Geopetrol International Inc. & Ors where it was held that although the Non-Operators may not have been party to the contract between the Operator and the Contractor which contains the arbitration clause, they would be necessary parties to the arbitral proceedings in light of the interrelationship between the Operator and the Non-Operators as the members of the Consortium in terms of the Production Sharing Contract (JOA) and the Joint Operating Agreement (JOA). This series of short posts discusses this interrelationship between the Operator and Non-Operators. In this post, the concept of Operatorship in general is analysed.
Concept of Joint Operations:
Petroleum exploration is a highly risky business. Typically, such a company will encounter the following risks:
  • Geological risks- risk of not finding any petroleum in commercially viable quantities
  • Financial risks- risk that exploitation of the commercially viable quantities of petroleum is far complicated and therefore costlier than initially estimated or change in the economic laws of the host nation drastically increasing the costs to be expended
  • Political risks- instability in the region such as civil war, riots, etc thereby resulting in loss of investments.
The business is characterised by high input costs, and when there is commercial discovery, huge profits. Considering the high risks and costs, it is common for two or more parties to share the risks inherent in the business. The term “Contractor” in the Indian context is employed to collectively denote the companies engaged in petroleum exploration. Although the risk is shared, the same is always not equal. Each Party comprising the Contractor generally commits itself only to a certain amount of risk in the exploration project. Consequently, it is entitled to the reward only to the extent of the percentage of the risk shared. Such percentage is known as Participating Interest. Thus, all the rights and all obligations of whatsoever nature including privileges, entitlements, duties, penalties, etc are shared between the consortium members in accordance with their Participating Interest percentage. The percentage of Participating Interest held is recorded in the PSC as well as in the JOA.
Relation between Operator and Non-Operators:
In order to conduct the petroleum operations smoothly and in a focussed manner, a member of the consortium, usually the party having the highest participating interest and resources, is nominated as the Operator. The Operator is responsible for performing virtually all the operations, obtain approvals, comply with laws, employ contractors, and do all activities necessary to perform the petroleum operations. In performing these obligations, the Operator acts not only on behalf of itself but also on behalf of the Non-Operators. The Operator is also authorised to enter into contracts on behalf of the consortium. Thus, the Operator, apart from acting on its behalf, also acts for, or, represents the Non-Operators in dealings with third persons.
Although the Operator is authorized to act as the agent of the Non-Operators, the contours of such authority are delineated by the JOA. In addition, a body called the Operating Committee consisting of representatives of all members of the consortium (typically) is constituted to supervise the functioning of the Operator. Certain important actions in conducting petroleum operations require express authorization from the Operating Committee. Three possibilities exist as regards approval of Operating Committee for awarding contracts:
  1. the JOA authorizes the Operator to award contracts without the approval of the Operating Committee,
  2. the JOA authorizes the Operator to award only contracts below a specific value without the approval of the Operating Committee, and
  3. the JOA requires all contracts to be approved by the Operating Committee. In such cases, the Operator is bound to follow relevant procedure, as applicable. If no consent is taken when the JOA makes it mandatory, the Non-Operators would be entitled to refuse to share the costs and risks for such contracts.
Since the Operator is authorized to enter into contracts to conduct petroleum operations, it is expected that claims or legal proceedings may be initiated against the Operator. Generally, the Operator is authorized to represent the members of the consortium in defending legal proceedings. In doing so, the Operator is mandated to obtain the approval and direction of the Operating Committee in proceedings with such legal proceedings. Costs expended for defending the said proceedings are shared by the members proportionate to their Participating Interest. However, the Non-Operators are not prohibited from appointing their own counsel, in which case, the resultant costs are borne by the Non-Operators. In case a claim is initiated against a Non-Operator by a third party in respect of the petroleum operations, the Non-Operator is entitled to defend the same but in consonance with the directions of the Operating Committee and the costs expended for the same would be shared as per the Participating Interest.
In all, while performing the role of Operator, whether in conducting petroleum operations or in dealing with the government or third parties for the purposes of petroleum operations, the Operator acts as agent for the Non-Operators. Consequently, the general principles of the law of agency are applicable. It may be noted that the JOA grants restricted authority to the Operator to act as agent. Such authority is also circumscribed by the directions of the Operating Committee as provided by the JOA. Thus, subject to the JOA, the Operator is entitled to all the rights of an agent available under law. Such rights include the right to be indemnified by the Non-Operators against consequences of acts which are lawful and acts done in good faith, right to retain expenses incurred and his remuneration from moneys collected by him on behalf of principal, etc. At the same time, the Operator is, subject to the JOA, obligated to perform the duties of an agent as per law.
The above discussion generalises the concept of Operatorship prevailing in the petroleum industry. In the next post, the concept of Operatorship as found in some of the standard formats of agreements used in the petroleum industry would be discussed.