Legal Aspects of Oil Management

Question: Examine and evaluate the key areas and features that governments should focus on during their negotiation process and in the drafting of contracts with the International Oil Companies. Answer: Introduction Resource rich nations intend to use their natural resources for the purpose of securing funds for their development process. In doing so, the governments enter into contracts with international oil companies to explore, develop their resources. The oil companies as well as the government put a lot of efforts in order to understand the commercial and technical aspects of oil exploration. The very first challenge which the governments face is the negotiation process. Countries like Kazakhstan, Bolivia, Mexico and various other developing countries consider their oil and natural gas resources as assets belonging to the country as a whole and not to any private individual or entity. No matter whosoever owns the surface land and associated rights, the oil and gas resources are owned by the government and this very fact is enshrined in the laws of the nations. Nations which are rich in oil and natural gas resources try to magnetize the participation of the oil companies which possesses ade quate expertise and resources so as to exploit and properly market their resources. But while negotiating they face several problems as these companies are far more experienced in negotiating these type of contracts and also their knowledge about oil exploration is much high. In the process of negotiation the oil companies appear to be extremely motivated. They make every possible effort to reduce costs. The oil companies tend to tailor their process of negotiation depending on the political situation in the impugned country. The attitude of the oil companies in the negotiation process is generally found to be inflexible, aggressive and cynical. As far as the governments are concerned, negotiating contracts in the proper manner is essential. Three options are available to the governments for development of their natural resources. These include; creation of state companies for exploration, production and development. For instance countries like, Mexico, Oman, Saudi Arabia, Venezuela have done so; inviting foreign companies to explore their resources and in the process develop them, as in the case of Russia, Canada, United Kingdom. They may as well use a combination of these two ways. Countries like Kazakhstan, Nigeria and Indonesia have done so. Setting the Parameters Governments do not pay adequate attention to the negotiation process in spite of the intense interest and size of the stake holders. As far as the producing nation is concerned, a lot is at stake with these types of contracts. Governments generally engage experts to handle the complex issues in these types of contracts; like, lawyers for their knowledge of the legal field, engineers for their technical knowledge etc (Langford, 2014). Oil contracts emerge out of direct negotiations. There are various complex issues involved in an oil contract. Negotiations generally flourish on indecision. Such indecision is the result of lack of awareness of the probable oil find, the alienation of the negotiating partner or the incapability to make future predictions. Good negotiators are well aware that whatever the situation might be there is always a weak point, if made proper use of the said weak moment there is a high probability to win. While negotiating oil contracts various issues must be considered. These include; the dynamic nature of market, the exploration costs, the probable size of the fields etc. This is a never ending list. Expertise and judgmental power is needed to determine the priority of each and every issue and then to be able to strike a balance so that none of the contracts are identical to each other. Issues involved in the Negotiation Process The issues which arise during negotiation process may be put under two heads; one is the conflict zone and the other includes the factors which are not generally paid heed to during negotiation process. These factors are the environmental, social, political and economic. The company spends almost 90-90% time in this zone. This is the zone where the company feels in control and recruits skilled personnel (Radon, 2012). Dealing with the indigenous communities Apart from the two principal contracting parties, i.e., the oil companies and the governments, the oil negotiations are of great significance to various other groups or individuals. These groups include, owners of the surface land, many a time indigenous communities as they nowadays they have started demanding compensation for the disturbance and use of their property. Though such groups are not formally part of the said negotiation process yet their demands have to be taken into consideration while negotiating. The demands of the local communities have to be settled through these negotiation processes. They generally ask for either compensation or jobs offers. The oil companies usually make commitments to engage local labor and also to render support in development of the local communities (Likosky, 2009). These negotiations are invariably time consuming at the same time intense. These negotiations are many a time heated as well. Factor of Time The negotiations of oil contracts are to a great extent dependent on time responsive factors like present condition of the market in connection with the price of oil, the prevailing political and economic situation in the host country as well as on the probability as to how such factors would vary in future. Thus an oil contract must include such terms which would be able to survive the challenge of time by way of anticipation of foreseeable as well as unforeseeable demands and changes. For instance, Norway, which was known for its instability had to introduce tax regimes favorable to the oil companies so as to allure the oil companies to come and invest in the uncertain and geographically challenging terrains. But Norway did not endanger its future by making these tax regimes permanent and increased the taxes within three years. There is one simple solution to deal with the problem of insufficient arrangement in the ever changing situations; to ensure that the contracts are more rea ctive to the changing circumstances. With time domestic conditions prevailing in a country also tend to change (HM Government, 2013). The stability clause has to be drafted in such manner that the oil company may be compensated for the changes which take place in the laws, rules and regulations of a country. For instance, a country is made to comply with a new environmental policy the cost of oil exploration and development would increase consequently. The oil companies in such cases would have to be exempted from the compliance of such law and if in case such exemption is not possible, the government would have to reimburse the oil companies for the cost of compliance. The stability clauses are used by the oil companies to exclude the application of the laws of the host country. Even the jurisdiction of the courts of the host country is not applicable to these clauses. Expert Negotiators In order to select the personnel who would represent the negotiating team the government faces various problems. Negotiation is no less than an art which requires giving effect to a plan, good tactics as well as the ability to segregate negotiable factors like compensation from non negotiable factors like matters concerning regulation, considering and addressing the concerns of the oil companies. It is evident that the oil companies are under any circumstance in a better position as regards skill, finance and preparedness while negotiating with the governments. On the other hand, the resource rich developing nations do not possess adequate technical, financial or legal knowhow. The nations must treat the negotiations as an investment and attempt to hire independent, skilled as well as dedicated negotiators so as to be on the same footing as the oil companies in the negotiation process. But the oil rich developing countries often overlook the importance of engaging expert negotiators for the negotiation process. Oil contracts invariably require expert advice as they cover a wide range of complicated factors. The aim of the oil contracts should be to reach mutually agreeable and reasonable balance between the interests of the investor company as also the nation concerned. It may be stated that expert advice is the mantra for being able to make successful negotiations. Conflict of Interest In negotiating these types of contracts the government often faces conflict of interest. On one hand the government is expected to act as the protector of public interest by using its regulatory powers. The government is also required to create an investment friendly environment so as to magnetize investors which in turn would create employment and render economic growth (Haley, 2004). On the other hand being the signatory to a commercial oil contract the government acts as a business personnel with the intention of profit maximization. Thus the government on the one hand intends to maximize profits from oil negotiations and at the same time it has to find objects for its own regulations. This type of problem though may be manageable in a developed nation it might not be so in the case of developing nations. Transparency It is expected of the negotiators to maintain transparency in the process of negotiation. Transparency is in fact deemed to be the key aspect to increase public acceptability of contracts. Transparency in this context includes, disclosing the contractual terms as well as the consideration paid there under though certain matter must remain confidential for a specific duration of time. Transparency also serves as a way for doing away with corruptions associated with these contracts. It is transparency which prevents government officials to incorporate or accept to such terms in the oil contracts which might face criticism from the citizens (Brinsmead, n.d.). Form of Contract The form or the type of contract is a critical decision for the government. There are four types of contract which the government and the international oil companies may elect to adopt while making the agreement. These have been discussed as follows; Joint Ventures A joint venture comes into existence when two or more parties intend to enter into a joint venture undertaking. It is essential for the ones who are parties to a joint venture to understand the ways by which each conduct their business, their goals as well as interests. In the absence of such understanding it is almost impossible to come up with a joint venture agreement. Since joint ventures are open ended contracts, oil companies as well as the government of the host countries are less likely to enter into a joint venture agreement. Advantages for the government: In case a government of a host country enters into a joint venture agreement the only advantage it can avail of is that it does not have to make decisions all by itself and it has the liberty to count on the expertise of oil companies. In fact under this type of contract the government shares profits along with the oil company. Disadvantage: There is a flip side to this sharing process. Along with profits, costs and risks must also be shared. Thus under this type of contract the government of the host country happens to participate directly in the process of oil extraction. Production-Sharing Agreements (Also Referred To As PSA) The major characteristic of PSA is that under these type of agreements the oil ownership rests with the citizens of the host country and not with private entities. But the management and operation of the oil fields along with the associated risks rests with the oil companies. The terms regarding finances in a PSA are almost similar to that of a licensing agreement. The government of the host country is entitled to earn a signing bonus but such bonus is generally waived so as to earn profits in future. Under this type of agreement the government of the host country must reimburse the oil company as operating expenses. Recovery of costs for the current expenditure is immediate whereas the recovery of costs for capital investment is done over a period of many years. The oil companies usually have to bear taxes which fall under its share but the governments of the host countries often waive such taxes and are included in the governments share of profits. The success of a PSA would depend upon the accuracy of the legal framework of the host country. Advantages for host government: All risks under this type of agreement rests with the oil companies. Apart from the cost of negotiation the host government would not have to risk any other losses. Even if an oil exploration project fails the government of the host country does not have to bear losses. These type of contracts enable the government of the host country to earn profits without having to make investments unless it does so with its own accord. Disadvantages for host government: The very nature of the PSA is that it is an inclusive document and this very nature serves as a disadvantage for the host government. License or Concession Agreements These agreements have been introduced in the early 1900s. These are primarily one sided contracts. In the present times such contracts serve to grant the oil companies exclusive rights for exploration, development, sale as well as export of minerals and oil for a specified time period. The oil companies offer the host countries signing bonus for acquiring such rights. These contracts are often opted forms of contracts. Advantages: From the view point of a developing country the advantages of this type of contracts are considerable. These type of contracts are far more straightforward as compared to other forms of contracts. The extent of export support and advise required for entering into this type of contracts are also comparatively less. Disadvantages: The prime disadvantage of this type of contract from the viewpoint of a developing country is its commercial aspect. The bidding process is generally similar to an auction. The oil companies have to take risks regarding the price for the license. Service Agreements Over and above the above type of contractual arrangements service agreements may as well be entered into. The essence of this type of agreement is that it provides disbursement for particular services and tasks. This type of agreement would not be very useful for the long run. Terms of Contract Certain provisions common to all the above types of agreements have been discussed as under; Parties When one of the parties is the government, the choice of parties must be made carefully. In case the host government becomes a direct party it has to bear unlimited liability as well as direct responsibility. But the said liability may be restricted if one of the government enterprises is made a party. Work Program The oil companies tend to slow down the projects which it considers to be comparatively expensive. Thus the host government must insist on such a work plan which unambiguously lays down the circumstances under which a project may be delayed or shelved. Stabilization Stabilization provisions, if incorporated, proved to be highly disadvantageous for the oil companies as it makes the legal system of the country ineffective and the government may have to pay compensation to the investors. Termination The contract must unambiguously specify the circumstances under which the contract would be terminated. Conclusion At present the oil producing nations must invariably possess the professional know-how for negotiating oil contracts with the international oil companies. The negotiation process must at the same time be open. The companies have to make the oil companies feel secure as to the fact that they would be treated fairly. A sense of fair return and fair treatment would I the long run prove to be beneficial for the international oil companies in this competitive market.