Management costs during the implementation of production sharing agreements

During hydrocarbon production, geological exploration work programs under production sharing agreements have an approved budget.

Drilling operations in oil fields are heterogeneous in their specifics, therefore an individual approach to the investor is maintained in terms of verifying the costs incurred by him.

However, having formally completed the geological study work program, the investor reflects in the submitted report the share of administrative costs, which many times exceed the drilling work performed.

Although the other party to the deal-sharing agreement cannot count on expecting results from drilling operations in the future while paying millions in employee costs for the investor.

To avoid excess administrative costs (management costs), preventing conflicts, we advise the investor to consider that:

1) management costs must be borne by a capital asset;

2) management costs must have an investment return;

3) the assessment of costs is carried out at cost in relation to investment benefits.

That is, management costs have an economic purpose.

In the history of investment activity, there have been attempts to distinguish the cost of retaining managers from the cost of management decisions made by managers.

The courts have proposed a narrow interpretation of the term «management costs».

In «Capital and National Trust Ltd v Golder» (1949) 31 TC 265 the Court of Appeal interpreted the phrase as including costs incurred in making management decisions but excluding costs incurred in carrying them out.

The interpretation was rejected by the House of Lords in «Sun Life Assurance Society v Davidson» (1958) 37 TC 330.

Quote: «I completely reject the distinction which is attempted to be drawn between management and conduct of business, confining the former to the principal management» (Lord Somerwell).

Therefore, an investor should objectively, in the context of an investment business, consider whether the costs were incurred in connection with that asset.

For these purposes, it is immaterial what form the costs took.