Risk:reward sharing contracts in the oil industry: the effects of bonus:penalty schemes

Partnering and alliancing among oil companies and their contractors have become common in the oil industry in recent years. The risk:reward mechanisms established very often incorporate bonus/penalty schemes in relation to agreed base values. This paper examines the efficiency requirements of such schemes. The effects of project cost and completion risks on the risk:reward positions of field investors and contractors with and without bonus/penalty schemes are examined with the aid of Monte Carlo simulation analysis. The schemes increase the total risk for contractors and have consequence for their cost of capital and optimal risk-bearing arrangements within the industry.