Efficient use of lifting and transportation capacity requires planning. By nominating to the operator acceptance of their entitlements, the parties confirm that they have arranged the required offtake capacity in time to lift their entitlements in accordance with the operator’s schedule. Unless there is sufficient storage available to the operator between the production wellheads and the delivery point, a failure to offtake may require the operator to reduce or cease production altogether.
The nomination process gives the operator advance warning of any such hiatus, as well as giving the parties an opportunity to challenge the operator if they think that the entitlement calculations are misstated. The information should also enable the investing parties to keep track of their past lifting performance, indicating whether they are in an overlifted, underlifted or balanced position compared to their respective accrued entitlements.
The expectation is that the parties will simply nominate lift for their full entitlements, subject to operational variations. The agreement under the lifting nominations should not encourage the parties to make a fair and honest statement of what they actually expect to lift; indeed, read together with the article of Right and Obligation To Take In Kind, it could be argued that nomination of anything less than the full entitlement would be a breach of this principle.
In the interests of avoiding production curtailment, it might be more prudent if the operator received an accurate forecast of each party’s ability to lift, and indeed their ability to overlift, so that it can match up overlifters and underlifters in its proposed delivery schedule for the relevant period. An alternative formulation would be for the parties to be required to provide a ‘good faith’ estimate of their expected ability to lift their entitlements, ‘without prejudice’ to their obligation to take their entitlements in full.
Fully termed lifting agreements commonly provide a mechanism by which each party’s entitlement is adjusted for each period to take into account that party’s record on underlifting and overlifting, and it will be the adjusted entitlement which the operator notifies to the parties as their ‘entitlement for nomination’. This enables the operator to automate the mitigation of overlifts and underlifts as required by the conditions of the agreement.
Adjustment for Overlifting and Underlifting
The conditions for over- and underlifting recognizes the difficulty of prescribing any particular scheduling regime for these reasons, which is why it permits the parties ‘otherwise to agree’.
These regulations briefly touch on the most controversial issue in the negotiation of any lifting agreement. As discussed previously, each party is entitled and obliged to take its entitlement, representing its share of production arising from its participating interest in the joint venture.
Any overlifting or underlifting constitutes a deviation from that principle. An overlifter takes title to the crude oil it lifts as an overlift, just as it takes title to the crude oil it lifts as its entitlement. It, therefore, accelerates its cash flow to the extent of the overlifted volumes it sells. By contrast, the underlifter defers its cash flow, because it makes up for its failure to lift its entitlement when first made available by overlifting a volume equal to the previous underlift at a later date, taking title to and selling the overlifted volumes.
If the parties are equally exposed to transportation and marketing risks and take the view that anyone of them is just as likely as any other lifter to find itself unable to lift its Entitlement when due for reasons beyond its control, they may have no need to ‘punish’ an underlifter, and deter it from further underlifting.
In this case, the parties might provide that the compensatory overlift bringing the underlifter back into balance with its entitlement can be scheduled shortly after the underlift, whilst allowing the underlifter time to arrange for the extra transportation capacity it may need. This would minimize the deferral of cash flow the underlifter incurs.
The alternative regime would provide that its compensatory overlift is postponed by several months, if not several years so that the impact of its subsequent overlift is deferred to the point of being financially immaterial to the other lifters. This regime may be attractive to parties which have invested in transportation infrastructure or booked capacity in a third-party pipeline with an onerous ship or pay obligations, and do not want to have their lifting entitlements reduced in future to allow underlifters to catch up.
Other interested parties may be prepared to take the risk that transportation capacity will be available as and when needed, relying on the more conservative parties which have invested in firm transportation capacity to overlift when their luck runs out. The meaning of ‘timely’ can, therefore, lead to severe misalignment in lifting agreement negotiations (Fowler 2018).
Under- and overlifts may also have an impact on the allocation of cost hydrocarbons and profit hydrocarbons, in cases where the government oil and gas company is responsible for lifting the government’s share of profit hydrocarbons. In many jurisdictions, the government’s share of profit hydrocarbons is treated as a tax payable by the joint venture parties and the fiscal authorities may refuse to accept that the joint venture parties are unable to pay that tax in kind if the government oil and gas company fail for any reason to lift.
After all, the government’s share of profit hydrocarbons is likely to be defined as a percentage of overall production; if the joint venture parties are not permitted to overlift at all viz a` viz the government share, and the fiscal authorities insist that the government’s share of profit hydrocarbons is delivered in lockstep with the joint venture parties’ liftings, then production must logically cease altogether if the government oil and gas company is unable to lift any profit hydrocarbons. This alone can be a good reason for the joint venture parties to agree to take and monetize the government’s profit hydrocarbons alongside their own entitlements.
Under- and Overlifting for Natural Gas
This describes the process of overlifting by one lifter in the event that any other lifter cannot take its entitlement of natural gas. In order to prevent the imbalance from becoming unmanageable, the amount of underlift or ‘make up natural gas’ is limited to a chosen proportion of monthly natural gas production and the right to make up natural gas is lost if it is not exercised within a chosen number of months or years.
Optional Provision: #1
If it is unacceptable for an underlifter permanently to lose its right to take any underlifted entitlement if it has not lifted it within the defined number of months or years in dealing with the Disposition of Natural Gas, this provision allows for the overlifting party or parties to cash out the underlifter to the extent of each overlifting parties’ corresponding overlift.
Optional Provision: #2
In order further to prevent any imbalance from becoming unmanageable, no party may overlift in excess of an agreed percentage of its participating Interest share.
The future disposition of Guyana’s natural gas must signal a difference between the treatment of natural gas lifting compared to crude oil lifting; the terms of the agreement must grant any party not in default the right to take more natural gas than its participating interest share (or properly entitlement).
This flexibility is to be encouraged because it enhances the ability of the joint venture to maintain stable natural gas offtake and possibly to increase natural gas production to meet buyer demand, but the natural gas balancing agreement will also need to address how each party will signal its desire to overlift, and how other parties will agree to underlift accordingly. The agreement should anticipate that the investing parties will be nominating their respective entitlements – and not nominating to overlift.
