Oil and Gas Farm-out Agreement in Oman
Energy, Utilities, Mining and COP28
Yanal Abul FailatSenior Associate,Corporate Commercial
Chelsea PollardAssociate,Banking & Finance
Farm-out (or farm-in) agreements are a common and important tool for oil and gas companies to manage the risks and costs of exploration and production activities. They allow a company (farmor) to transfer some or all of its rights and obligations under a host government instrument, whether in the form of a licence or contract, to another company (farmee), usually in exchange for cash or work commitments. In Oman, farm-out agreements are subject to the Oil and Gas Law, which was issued by Royal Decree No. 8/2011 (the “Petroleum Law”), and the approval of the Government of the Sultanate of Oman (the “Government”), acting through, the Ministry of Energy and Minerals (the “MEM”). This article provides a high-level overview of farm-out agreements in Oman, covering their legal and regulatory framework, key features and issues, and challenges and benefits for the parties involved.
The legal basis for oil and gas exploration and production in Oman is the Petroleum Law, which regulates the activities related to surveying, exploring, developing and exploiting petroleum resources in Oman and defines the rights and obligations of the Government and exploration and production of oil and gas companies. The Petroleum Law requires a concession agreement, typically in the form of an exploration and production sharing agreement (“EPSA”), to be concluded between the Government and the concessionaire(s) for carrying out these activities. The EPSA grants the concessionaire the exclusive right to explore and produce oil and gas in a specified area, subject to certain terms and conditions.
One of the critical conditions of the EPSA in the context of a farm-out transaction is that the concessionaire can only transfer its rights or obligations under the EPSA with the prior approval of the Government/MEM. This applies to any transfer or change of control, including farm-out agreements, considered a partial or total assignment of the concessionaire’s interest. Therefore, any farm-out agreement relating to an Omani EPSA must be consistent with the EPSA and the Petroleum Law terms and obtain the consent of the MEM and the issuance of a royal decree to be effective.
Farm-out agreements in Oman can take different forms and structures depending on the stage of development, the parties' objectives, and the asset's nature. Generally, farm-out agreements can be classified into three types:
exploration farm-outs, which occur when the farmor transfers part of its interest in an exploration area to the farmee, who agrees to perform certain work obligations, such as drilling a well or conducting a seismic survey;
appraisal farm-outs, which occur following the discovery of hydrocarbons but where the extent of such discovery has not been determined; and
development farm-outs occur when the farmor transfers part of its interest in a proven or producing area to the farmee, who agrees to pay a cash consideration or a share of the development costs.
The Petroleum Law and the practices of the MEM and the industry in Oman influence the key provisions and characteristics of farm-out agreements in Oman. Some of the main issues that need to be addressed in farm-out agreements are:
Consideration: The consideration for the farm-out can be cash, work obligations, or a combination of both. The amount and timing of the consideration may depend on the achievement of certain milestones, such as the completion of a work program, the declaration of a commercial discovery, or the commencement of production. The consideration may also be subject to adjustments or clawbacks in case of changes in the reserves, costs, or prices.
Transfer of interest: The transfer of interest from the farmor to the farmee can be structured as a present or a future assignment. A present assignment means that the farmee acquires the interest immediately upon the execution of the farm-out agreement, subject to the approval of the Government and the issuance of a royal decree. A future assignment means that the farmee acquires the interest only upon fulfilling certain conditions, such as completing the work obligations or declaring a commercial discovery. The choice of the transfer mechanism may have implications for the rights and liabilities of the parties, as well as the tax and accounting treatment of the transaction.
Required consents: As mentioned above, any farm-out agreement in Oman requires the approval of the MEM and the issuance of a royal decree to be effective. The parties must apply the MEM, along with the relevant supporting documents, such as the farm-out agreement, the corporate approvals of the parties, and where applicable, a draft parent company or bank guarantee to be provided/procured by the farmee to guarantee the farmee’s share of payments and/or performance under the EPSA. The MEM may impose certain conditions or requirements for granting its approval. Pre-emption rights under the relevant joint operating agreement (a “JOA”) may apply where the concessionaire comprises more than one party or whether the Government has exercised its state-participation right under the EPSA. The approval process may take several months, depending on the complexity, the parties involved, and the significance of the transaction.
Some EPSAs mandate that the farmor pay an assignment bonus before securing governmental approval for the transfer. This bonus serves to compensate the Government for the change in concession interest. While certain EPSAs specify the bonus amount explicitly, in others, the amount is not predetermined. In such cases, the farmor must negotiate the bonus amount with the Government/MEM. Typically, the stage of operations (e.g., exploration, appraisal, or development) influences this amount.
Information rights: The farmee may require access to certain information and data related to the farm-out area. The farmor may agree to provide such information, subject to the execution of a confidentiality agreement and compliance with the Petroleum Law and the EPSA. The EPSA typically imposes certain restrictions or obligations on the disclosure and use of such information, such as the protection of the state's interests, the confidentiality of the data, and the payment of fees.
Warranties: The farmor may provide certain warranties or representations to the farmee regarding the farm-out area, such as the validity and compliance of the EPSA, the accuracy and completeness of the information, the absence of encumbrances or disputes, and the environmental and social performance. The farmee may rely on such warranties or representations to mitigate the risks and uncertainties associated with the farm-out area. The warranties or representations may be subject to certain limitations or exclusions, such as the duration, the scope, the materiality, and the remedies.
Indemnities: Indemnities in farm-out agreements typically involve one party, often the farmor, agreeing to compensate or protect the other party, the farmee, against certain specified losses or liabilities. These can arise from pre-existing breaches of the EPSA, environmental claims from previous operations, undisclosed encumbrances, inaccuracies in the provided information, or prior tax liabilities. Conversely, the farmee may indemnify the farmor against post-transfer liabilities or breaches of the agreement. The scope and terms of indemnities, including any limitations or caps, are shaped by negotiations and the assessed risks.
Default provisions: The farm-out agreement may include certain provisions to deal with the event of default by either party, such as the failure to pay the consideration, the failure to perform the work obligations, the breach of the warranties or representations, or the insolvency of a party. The default provisions may specify the consequences and the remedies for the defaulting party, such as termination of the agreement, forfeiture of the interest, damages, specific performance, and, where applicable, the reassignment of the farm-out interests back to the farmor or another designated entity should a default by the farmee occur following the legal assignment of the farm-out interests. The default provisions may also provide for the notification and cure of the default and the arbitration or litigation of the disputes
Force majeure: The farm-out agreement may include a force majeure clause to address the situation where either party is prevented or hindered from performing its obligations due to circumstances beyond its reasonable control. The force majeure clause may define the scope and the duration of the force majeure event, as well as the obligations and the rights of the parties, such as the notification, the mitigation, the suspension, or the termination of the agreement. The force majeure clause may also allocate the risk and the cost of the force majeure event between the parties, depending on the event's nature and impact.
During a farm-out transaction, the farmor and farmee work together to negotiate and finalise several key documents, inter alia:
JOA and JOA Novation: If the farmor holds the entire participating interest, a JOA becomes essential after the farm-out to divvy up this interest. Ideally, this is negotiated simultaneously with the farm-out agreement. If a pre-existing JOA is present, a novation agreement will be required, pursuant to which the farmee agrees to adhere to and be bound by the terms of the relevant JOA.
Tripartite Transfer Agreement: Given that EPSAs are administrative contracts, a tripartite novation agreement becomes necessary to transfer farm-out interests properly. This agreement involves the Government (continuing party), transferor, and the buyer entity (transferee).
Security: If the Farmee lacks robust financial grounding, it might need to furnish security frequently via a parent company guarantee. This security affirms the farmee’s responsibilities under the farm-out and JOA. In Oman, an added security layer towards governmental obligations is often mandated. The farmee might then have to offer direct security or draft agreements with existing concessionaires.
The tax treatment of farm-out agreements in Oman depends on the nature and structure of the transaction, as well as the applicable tax laws and regulations. The main tax issues that may arise in this context are:
Income tax: Oman imposes a 55% income tax rate on the taxable income of oil and gas companies, which is deductible from the government's share of oil production under the EPSA. The income tax implications of a farm-out agreement would depend on whether the transaction is considered as a sale or an exchange of assets and whether the parties recognise any gain or loss.
VAT: Oman introduced a 5% VAT on most goods and services in April 2021, with some exemptions and zero-ratings for certain supplies. The VAT treatment of a farm-out agreement would depend on whether the transaction is considered a supply of goods or services and whether it falls within the scope of the exemptions or zero-ratings.
Other payments and levies: Oman imposes other payments and levies on the oil and gas sector, such as signature bonuses, annual acreage rental payments, data storage costs, discovery bonuses, and national training fund levies. These payments and levies are not deductible as cost oil under the EPSAs and may affect the economic viability of a farm-out agreement. The parties to a farm-out agreement need to consider how these payments and levies are allocated and shared between them and whether they are subject to VAT.
Farm-out agreements in Oman present both challenges and benefits for the parties involved, as well as for the Government and the industry. Some of the challenges are:
Regulatory uncertainty: The Petroleum Law is relatively new, and some of its provisions are not yet well-tested in many cases or disputes. The law may also be subject to amendments or interpretations by the Government, or the courts or additional circulars issued to concessionaires that are not publicly available, which requires a farmee to significantly rely on a farmor’s warranties and representations and elicit information to properly due diligence the regulatory implications relating to an EPSA and the relevant farm-out area. The parties may face difficulties or delays in obtaining the required approvals or consents from the MEM or other authorities, especially if the transaction involves sensitive or strategic assets or interests.
Operational complexity: The farm-out area may involve complex or challenging geological, technical, or environmental conditions, which may increase the risk and the cost of the exploration and production activities. The parties may also encounter operational issues or disputes with the other contractors, the service providers, or the local communities, which may affect the project's performance or profitability. The concessionaires may need to comply with various rules and standards regarding the health, safety, and security of the workforce and the facilities, the protection and restoration of the environment, and Omanisation and other local content obligations.
Financial volatility: The oil and gas industry is subject to fluctuations and uncertainties in the global, regional and Omani markets, which may affect the supply and demand, the prices and costs, and the revenues and profits of the products. The parties may face difficulties or losses in financing, budgeting, or hedging their activities or investments, especially in times of low or unstable prices or margins. The parties may also be exposed to various taxes and duties, such as income tax, import duty, or royalties, which may reduce their net income or cash flow.
Farm-out agreements are pivotal in enabling oil and gas companies operating in Oman to realise their exploration and production aspirations. Governed by the Petroleum Law and subject to the Government's approval, these agreements establish the framework for transferring rights and obligations between parties. The intricacies of these agreements, combined with challenges like regulatory uncertainties and operational complexities, underscore the significance of comprehensive legal support. Thus, for parties venturing into farm-out transactions in Oman, it is paramount to engage legal counsel skilled in cross-border oil and gas dealings, along with experts attuned to the local nuances of the Omani legal and regulatory landscape.
For further information,please contact Yanal Abul Failat and Chelsea Pollard.
Published in November 2023
