Risk/Reward Contracts: Who Is at Risk?
Authors: Stokley C.O. 
Published: February 2015

The risk/reward business arrangement in the oil and gas industry is conceived of this way: the service company takes some risk associated with an operation and, in turn, receives a reward for a successful operation. The plan is often structured in such a way that the service company’s invoice (or at least a portion of it) is paid when tools and techniques perform as expected, and no payment is received for less than desirable performance (in the opinion of the operator).

But any contract or business deal, risk/reward or otherwise, must be based on a win-win concept for both the service company and the operator. Investing in a guaranteed principal, fixed-income vehicle (such as a bond or certificate of deposit) provides a defined reward with minimal risk. Increasing the financial risk, such as investing in stocks, must have the potential of increased reward. A risk/reward contract should meet these same criteria with low risk yielding smaller rewards than higher risk taking. High risk with low reward does not fit the win-win criterion.

Several recent examples show the odds some service companies are up against in trying to make risk/reward contracts favorable to all parties.

- In one well, in which undefined fluids appeared detrimental to the elastomer of a through-tubing bridge plug and subsequently resulted in failure of the tool, a risk/reward contract was offered for running the same tools in additional wells without any change to the well conditions, fluids or otherwise. After additional failures by other suppliers, discussions led to a risk/reward offer in which the well conditions will be altered to minimize elastomer deterioration and a price above standard charges will be paid for a successful run.

- In a case in which tools could not be run to the required setting depth because of restrictions (buckling) in the production tubing, the tools were recovered and charges presented to the operator, which refused payment. A risk/reward contract to run back in the same well was discussed—briefly!

- An innovative technique for multizone completion and production testing of exploratory wells was estimated to save up to U.S.$4 million in the testing phase alone. The resulting installations and test programs yielded a savings in excess of U.S. $2 million because of unexpected problems associated with tools and technique. The operator requested a reduced charge for tools and services that did not function as conceived without any reward to the service company for the cost savings associated with the innovative completion concept. The service company suggested a risk/reward arrangement in which a 20% reduction in charges would be acceptable if a 20% bonus were paid on the producing company’s cost savings. That offer was rejected.

- In a risk/reward cementing contract in which displacement mechanics and hydraulic bond are the critical components of a successful job, the operator first must provide a quality borehole if the cementing company has any chance for success. If the contract does not define and require the operator to provide a “quality borehole,” the service company is at risk with little or no chance for reward.