Understanding the Somali–Turkey Hydrocarbon Agreement in Simple Break Down

Somalia has entered into a Production Sharing Agreement (PSA) with Turkey for oil exploration and production. This agreement outlines the relationship between the Somali government and Turkish companies and is a crucial part of Somalia’s oil industry development. However, there has been some confusion around what these agreements really mean for the Somali people, especially when it comes to how revenue is shared. To clarify, let’s break down the agreement with some simple examples and figures.

 

The Key Points of the Agreement

The PSA between Somalia and Turkey specifies several financial mechanisms that govern how oil revenue is divided. Some of the most important mechanisms are:

1. Royalty: This is a percentage of the production that Somalia receives directly, in either cash or kind (oil).
2. Cost Recovery: This clause allows the Turkish companies to recover the costs they spend on exploring, drilling, and producing oil, but only up to a certain ceiling — typically 90% of total production. (90% cost recovery ceiling means the contractor can recover up to 90% of the total revenue after deducting royalties, and this allows the contractor to recover its costs more quickly).
3. Profit Split: After cost recovery, the remaining profit is split between Somalia and Turkey, based on an agreed-upon ratio.

Let’s now break down these concepts using a practical example of $100 million in total oil revenue.

Example: $100 Million Oil Revenue

Let’s assume that the total revenue from oil production for a given year is $100 million. Here’s how this would be divided according to the PSA.

1. Royalty: Somalia’s Share

First, Somalia gets its royalty, which is typically 5% of the total production. This is paid directly to Somalia.

5% of $100 million = $5 million
Somalia receives $5 million as royalty — either in cash or kind (oil).

This means that $5 million is already accounted for, and the remaining revenue to be distributed is $95 million.

2. Cost Recovery: Turkey’s Expenses

Next, Turkey is allowed to recover the money it has spent on oil exploration, drilling, production and security. The PSA allows for cost recovery up to 90% of the total revenue.

If Turkey spent $60 million on these activities during the year, it could recover that full amount. However, if the cost for that year exceeds 90% of the total revenue, such as if the costs amount to $120 million, Turkey would only be able to recover up to the ceiling of 90% of the total revenue.

Cost recovery = $60 million

So, Turkey takes $60 million for its expenses, leaving $35 million to be shared between Somalia and Turkey.

3. Profit Share: Dividing the Remaining Revenue

Now that the royalty and cost recovery have been accounted for, the remaining $35 million is split between Somalia and Turkey. The specific ratio of the profit split will vary, but for this example, let’s assume:

[This 50/50 split is an example based on a simplified assumption. In reality, the Production Sharing Agreement (PSA) will use a sliding scale mechanism, where the profit split changes depending on factors such as production volume, rate of return, or years of operation. For example, Somalia’s share will increase as production grows or investment is recovered].

• Somalia gets 50%
• Turkey gets 50%

So, the profit split looks like this:

Somalia gets 50% of $35 million = $17.5 million
Turkey gets 50% of $35 million = $17.5 million

4. Corporate Income Tax (30%) on Turkey’s Profit Share

After the profit split, Turkey pays a 30% corporate income tax on its $17.5 million profit share. This is a standard tax Somalia charges companies earning from its natural resources.

• 30% of $17.5 million = $5.25 million paid to Somalia as tax
• Turkey’s net profit = $17.5M - $5.25M = $12.25 million

Final Breakdown: What Does Somalia Get?

Here’s the final breakdown of how the $100 million in revenue would be split between Somalia and Turkey:

Type	Somalia Gets	Turkey Gets
Royalty (5%)	$5.0 million	—
Cost Recovery	—	$60.0 million
Profit Share (50%)	$17.5 million	$17.5 million
Corporate Income Tax	$5.25 million (from Turkey)	–$5.25 million
Total	$27.75M	$72.25M

Although Turkey’s total share appears much larger at $72.25 million, the majority of that amount ($60 million) is cost recovery, meaning it’s not profit, but simply reimbursing what Turkey already spent on exploration, drilling, infrastructure, and security.

Only $12.25 million of Turkey’s total is actual net profit after paying tax.

Common Misunderstandings

Many people mistakenly believe that Somalia only gets 5% of the total revenue, thinking this refers to the entire revenue share. However, the 5% royalty is only a small part of the whole arrangement, and Somalia’s share of the profit is much higher — in this case, $27.75 million out of $100 million.

Additionally, there is often confusion about the cost recovery ceiling of 90%. Some people think Turkey will take 90% of the total revenue, but in reality, this 90% only applies to the cost recovery, not the entire profit share. After Turkey has recovered its expenses, the remaining profit is shared according to the agreed percentage.

Could Somalia Have Done Better?

Absolutely. While the current agreement does provide Somalia with significant revenue, there is always room for improvement. There are many aspects that could be fine-tuned to ensure that Somalia gets a better deal.

However, that’s a topic for another discussion, and I plan to explore these possibilities in a future post.

Is Turkey Getting Such Privileges?

Some might ask, "Why is Turkey getting so much from this agreement?" The answer lies in the political and security situation in Somalia, as well as Turkey's large investment in the project.

Somalia is not yet fully stable politically, and there are significant security and geological risks involved, as there has never been any oil production in the country before. For Turkey, the potential rewards are high, but so are the risks. That’s why they need to recover their costs and get a larger share of the profits to justify the massive financial commitment they’ve made.

Furthermore, Turkey has been involved in sending resources, including naval support, to ensure security in the areas they want to explore. This commitment adds to the high risk they are taking on in Somalia, which is why they get a larger portion of the revenue — it’s a high-risk, high-reward scenario for them.

 

Conclusion

The Somali-Turkey PSA is a complex agreement, and it’s important to fully understand how the revenue is split and what each party gets out of the deal. While Somalia gets a fair share, the realities of political instability and security risks mean that Turkey has to recover its costs and take a larger share of the profits to justify its massive investments.

There are a couple of factors that could naturally reduce the cost recovery in the long term:

1. After the first few years, the cost will reduce because the unit development cost (UDC) which is typically much higher than the unit production cost (UPC) will decrease as production ramps up. This will naturally reduce the total amount Turkey needs to recover.
2. Taking over our security: If Somalia could take on more responsibility for its own security, this would help reduce the costs that Turkey currently incurs, particularly related to naval and other security measures they are providing. By handling our own security, we could lower the amount Turkey needs to recover, which would allow a greater share of the profits to stay within Somalia.

But understanding these details is the first step in making sure the oil revenue is being handled in the best way possible for everyone involved.

Below is a simple diagram illustrating the revenue flow under the PSA: