Effective Hydrocarbon Management: Lessons from the South
This book is the result of the first successful High-level Meetings on Oil and Gas Management held in Doha, Qatar in 2007, where participants unanimously agreed that a lack of capacity was the major challenge to the sustainable development of their emerging hydrocarbon sectors. Participants at the Meeting benefited from an open dialogue on various oil and gas issues, including good governance models, environment and climate issues as well as regulatory and policy issues. Following the 2007 Doha Meeting, this book was published in May 2009 as a compilation of the papers and presentations given at the Meeting. It serves as referencel for all persons in the oil and gas industry, particularly those of emerging oil- and gas-producing countries of the South.
This volume is a tool to enable effective management of oil and gas resources; an important component in helping achieve Millennium Development Goals, reducing poverty, promoting sustainable economic growth, encouraging democratic governance as well as mitigating the risks of civil conflict and fostering sound environmental management.
5. Kemal Derviç
Administrator
United Nations Development Programme
Nassir Abdulaziz Al-Nasser
Ambassador Extraordinary and Plenipotentiary
Permanent Representative
Permanent Mission of the State of Qatar to the United Nations
President of the High-Level Committee on South-South Cooperation
EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH v
FOREWORD
s
FOREWORD
Extreme fluctuations in international oil prices can be damaging to the economic performance of
hydrocarbon economies. While oil revenues alone are not the only determinant of sustainable and
equitable economic development – sound investments and solid macroeconomic and governance
policies are fundamental – managing the oil sector well in oil-exporting countries is especially crit-
ical during times of great oil price volatility.
This book is based on presentations made at the High-Level Meeting on Oil and Gas
Development hosted by the Government of Qatar in Doha in September 2007.That Meeting was
supported by the United Nations Development Programme, the United Nations Environment
Programme, the United Nations Economic Commission for Africa and the Canadian
International Development Agency and brought together senior officials from 42 countries in
Africa, Asia and Latin America. Those involved included countries with many years of oil and gas
experience as well as newly emerging petroleum economies.
The High-Level Meeting was intended as a first step towards initiating a process of ongoing
dialogue and exchange on this issue. As such, a limited number of topics were covered. The main
objective was to facilitate better management of the oil and gas sectors of the South and to address
the multiple challenges associated with single-resource economies, which are important in low-
income developing countries, many of which are in Africa.
This book is therefore an effort to continue the process of ongoing dialogue and collaboration
with new and emerging hydrocarbon economies and to ensure that oil revenues are used to sup-
port sustainable economic and social development.
It is hoped that this book will assist senior policy-makers in the new oil-producing economies
and other practitioners to better understand and address the complex challenges they face. We
look forward to further collaboration with them and other partners to provide tangible support for
the new and potential oil exporters as they seek to address the management and policy challenges
that lie ahead.
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6. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTHvi
ACKNOWLEDGEMENTS
ACKNOWLEDGEMENTS
This book is part of an ongoing effort by the Special Unit for South-South Cooperation, UNDP,
to assist the new and emerging oil- and gas-producing countries of the South to better manage
their hydrocarbon sectors and to use their oil and gas revenues effectively in achieving sustainable
human development.
The book is based on papers and presentations given at the High-Level Meeting on Oil and
Gas Development that was hosted by the State of Qatar in Doha from 8 to 10 September 2007.
The objective of the Meeting was to provide a venue for established and new oil-producing States
of the South to share their experiences, both good and bad, and lessons learned so as to enable the
new oil producers to improve the management of their oil sectors.
I would like to extend my sincere appreciation to a number of people who were instrumental
in convening the Meeting in Qatar as well as those who worked on compiling and editing this
book.
John O. Kakonge served as project manager for the High-Level Meeting and oversaw the
preparation of this volume. Without his tireless efforts and diplomatic skills, neither the Meeting
nor this book would have been possible.
Stephanie Levy of the Overseas Development Institute (ODI) in London brought immense
knowledge and skill to her task as lead editor for this book. Dr. Levy was assisted by Stacy Edgar,
Roo Griffiths, Jodie Keane and Steve Wiggins at ODI and David Bourn to peer review, enrich,
edit and integrate the various papers and presentations into a coherent whole.
Thomas Stephens was the lead consultant in helping to organize the Doha Meeting and
worked closely with the Special Unit and ODI in preparing this book.
Special thanks are also extended to Samuel Choritz, Stéphane Dujarric, Brooks Evans, Parviz
Fartash, Raja Kaul, Maria Netto, Timothy Scott and Minoru Takada of UNDP for their invalu-
able comments. In addition, Barbara Brewka and Vivian Nabeta reviewed the publication for the
Special Unit. Rachel Gruzen contributed immensely to overall administrative and logistical efforts
required to bring this book to successful fruition.
I would also like to thank the contributors whose papers and presentations at the Doha
Meeting formed the underlying framework and data for this book as well as the countries that
participated in the Meeting and that prepared National Issues Papers.
I hope that readers interested in this topic will find this book a useful tool for helping
developing countries to achieve effective and equitable oil-sector management.
Yiping Zhou
Director
Special Unit for South-South Cooperation
United Nations Development Programme
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7. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH vii
CONTRIBUTORS
Ibrahim Abdel Gelil, Ph.D.
UNEP Consultant
Professor, Arabian Gulf University,
Bahrain
Nasser Akhtar, Ph.D.
Program Manager
Bolivia Canada Hydrocarbon,
CIDA, Canada
Basel Al-Yousfi, Ph.D.
Deputy Director
UNEP Regional Office for West Asia,
Bahrain
Stacy Edgar, MSc
Research Assistant,
Overseas Development Institute,
London, United Kingdom
Roo Griffiths
Associate Editor, Overseas Development
Institute, London, United Kingdom
Michael Hopkins, Ph.D.
Professor, Middlesex University Business
School, United Kingdom, and CEO,
MHC International Ltd.,
London, United Kingdom, and
Geneva, Switzerland
Jodie Keane, MSc
Research Officer, Overseas Development
Institute, London, United Kingdom
Stephanie Levy, Ph.D.
Research Fellow
Overseas Development Institute,
London, United Kingdom
Salim Jorge Saud Neto, LLM
Attorney at Law
Squire Sanders & Dempsey, LLP,
Rio de Janeiro, Brazil
Alan Perry, MA
Attorney
Edwards, Angell, Palmer and Dodge,
LLP, London, United Kingdom
Thomas W. Stephens, Ph.D.
Managing Director
Prescient360 Group
Virginia, United States
Katim S. Touray, Ph.D.
International Development Consultant
Banjul, The Gambia
Steve Wiggins, Ph.D.
Research Fellow
Overseas Development Institute,
London, United Kingdom
CONTRIBUTORS
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8. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTHviii
ABBREVIATIONS AND ACRONYMS
ADB Asian Development Bank
AGU Arabian Gulf University
API American Petroleum Institute
AusAID Australian Aid for International Development
bcf Billion cubic feet
bcm Billion cubic metres
bpd Barrels per day
CAMRE Council of Arab Ministers Responsible for the Environment
CDM Clean Development Mechanism
CEDARE Centre for Environment and Development for the Arab Region
and Europe
CNPA Cambodian National Petroleum Authority
EIA Environmental impact assessment
EITI Extractive Industries Transparency Initiative
EMS Environmental management system
ERM Environmental risk management
EWURA Energy and Water Utilities Regulatory Authority
GCC Gulf Cooperation Council
GDP Gross domestic product
GEO Global Environment Outlook
GHG Greenhouse gas
GNP Gross national product
HDI Human development index
IDP Internally displaced person
ILO International Labour Organization
IMF International Monetary Fund
IMO International Maritime Organization
IOC International oil company
IPCC Intergovernmental Panel on Climate Change
IPIECA International Petroleum Industry Environmental Conservation
Association
ISO International Organization for Standardization
ABBREVIATIONS AND ACRONYMS
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9. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH
ABBREVIATIONS AND ACRONYMS
ix
ITOPF International Tanker Owners Pollution Federation Limited
JICA Japan International Cooperation Agency
LAS League of Arab States
LNG Liquefied natural gas
MDTF Multi-donor trust fund
mt Metric tonne
NGO Non-governmental organization
NOAA National Oceanic and Atmospheric Administration
NOC National oil company
NORAD Norwegian Agency for Development Cooperation
ODI Overseas Development Institute
OECD Organisation for Economic Co-operation and Development
OGP International Association of Oil and Gas Producers
OPEC Organization of Petroleum Exporting Countries
PPP Purchasing power parity
SADC Southern African Development Community
scf Standard cubic feet
SIRESE El Sistema de Regulación Sectorial (The System of Sector
Regulation)
STEPS Shell Tradable Emission Permit System
tcf Trillion cubic feet
toe Tonne of oil equivalent
TWh/yr Terawatt-hours per year
UNCED United Nations Conference on Environment and Development
UNCLOS United Nations Convention on the Law of the Sea
UNDESA United Nations Department of Economic and Social Affairs
UNDP United Nations Development Programme
UNEP United Nations Environment Programme
UNESCWA United Nations Economic and Social Commission for Western Asia
UNFCCC United Nations Framework Convention on Climate Change
USGS United States Geological Survey
YPFB Yacimientos Petrolíferos Fiscales Bolivianos
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11. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH 1
Introduction
A
s recent oil price fluctuations have shown, managing a new extractive industry
is a major challenge for many of the Governments in the developing world.The
past 30 years offer numerous examples of Governments that have not developed
institutions and regulatory frameworks that allow for an effective functioning of the
industry, including the use of oil and gas revenues to finance policies that are economi-
cally conducive to both growth and poverty reduction, or to weather the storms of oil-
price swings. Many economists have long studied the economic and political distortions
induced by the development of an oil- or gas-exporting industry. Most of the literature
on resource booms and the management of the hydrocarbon industry is very academic
and does not provide the practical solutions that are relevant to various situations. At the
same time, however, there is a growing body of practical experience and lessons learned
from current Southern hydrocarbon-producing economies that has not been widely
shared or disseminated. The experiences of these countries have the potential to help
new oil-producing Governments to understand and incorporate these lessons into their
own policies and programmes and to avoid mistakes of the past.
In September 2007, the State of Qatar hosted the High-Level Meeting on Oil and
Gas Development: Sharing Experiences and Lessons within the Framework of South-
South Cooperation for traditional and emerging hydrocarbon economies. The Meeting,
held in Doha, was organized by the Special Unit for South-South Cooperation in the
United Nations Development Programme (UNDP) and Qatar Petroleum in collabora-
tion with the United Nations Environment Programme (UNEP), the United Nations
Economic Commission for Africa (UNECA) and the Canadian International
Development Agency (CIDA). Its objectives were to enable Southern countries to share
their experiences in managing their oil and gas sectors and to discuss avenues for possi-
ble future cooperation in this area. Government representatives from 42 producer coun-
tries in Africa, Asia and Latin America attended the Meeting. Many made presentations
on the challenges that they were facing in developing this often-substantial sector of
their economies.
The Meeting offered a unique opportunity for these Southern producers to directly
exchange, share and learn from one another’s experiences on highly complex issues that
are of critical importance to their present and future economic development. It was
attended by senior government officials from ministries directly involved in the manage-
INTRODUCTION
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12. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH
ment of the hydrocarbon sector as well as ministries of finance and planning, parliamen-
tarians and representatives of national oil companies and donors agencies. Many partic-
ipants were thus responsible for, or directly involved in, the development and manage-
ment of their respective oil and gas sectors.
This conference allowed policy-makers to share their experiences in dealing with
comparable challenges in similar contexts. As the Meeting demonstrated, lessons from
countries in similar circumstances are indeed more likely to be applicable. They offer a
useful counterpoint and complement to ideas derived from theory and abstractions. The
examples given by country representatives in their presentations were indeed more con-
crete and the lessons more practical than the theoretical models and abstract analytical
frameworks often found in the literature. The presentations also showed that, although
policies must be tailor-made at the country level, some rules surrounding policy effec-
tiveness seem to hold over time and place. They are also less prescriptive and judgmen-
tal than the vast majority of the literature on the topic. In such cases, lessons and policy
recommendations, because they are likely to be perceived differently, have the potential
to be taken up and followed more effectively.
The Meeting also demonstrated how South-South technical cooperation could be
beneficial for all parties engaged. Again, similarities in political, institutional or economic
context meant that technical knowledge gained by one country and new technology
adoption are likely to be transferable to others. The process of gas flaring and venting is
a good example of how South-South cooperation could have large economic benefits
while also helping to reduce the impact of negative externalities of oil production on the
environment and climate change. The conference aimed at stimulating cooperation and
transfer of technology between Southern countries, which are likely to benefit both
transferring and receiving countries.
At the request of the conference participants, the Special Unit for South-South
Cooperation has prepared this edited synthesis of presentations as a record of proceed-
ings and for reference and wider dissemination among oil- and gas-sector stakeholders,
including Governments, hydrocarbon companies and development partners.
The Issues
Development of the oil and gas sector is notorious for the risks and threats that it poses
to economic and political stability, and the environment. Management of the sector is,
thus, a major challenge for Governments and domestic institutions. Numerous studies
2
INTRODUCTION
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13. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH 3
have examined the impacts of substantial new inflows of foreign investment on devel-
oping economies. The emerging consensus on mitigating risk is basically twofold:
(a) Governments should put in place institutions and regulatory frameworks that allow
for transparent and efficient management of oil revenue; and (b) oil windfall should
be directed towards productive investments in physical and human capital to prevent
economic distortions and the occurrence of “Dutch disease” so that long-term equitable
growth can be generated.
If the windfall is not used for productive investment in physical or human capital, it
is likely to create domestic inflation, increase the real exchange rate and therefore result
in a loss of competitiveness. Unbalanced and slowed growth that results from these
distortions has been heavily documented and analysed.
The concept of “Dutch disease” has evolved in recent years to include not only
macroeconomic parameters but also human development indicators. Recent history
shows numerous cases of developing countries where human development indicators
have worsened during the period of the oil and gas boom, with increased poverty and
inequality – not to mention aggravated corruption and conflicts over the control of the
windfall. Nigeria, for example, has received over $300 billion in oil revenue over the past
25 years but has an average per capita income that is less than $1 a day. Despite having
been one of the major oil producers in the world for decades, Nigerian social indicators
remain lower than those of sub-Saharan Africa as a whole and much worse than those
of other regions of the developing world. This illustrates the meaning of the terminolo-
gy “paradox of plenty” or “resource curse” often used in the literature.
Such economic distortions can be avoided if the sector and the windfall that it
generates are efficiently and properly managed. Because oil and gas booms raise expec-
tations and increase the appetite for spending, the industry needs to be adequately and
transparently regulated and supported by efficient and functional institutions.
Similarly, economic distortions can be avoided if the revenue is used to finance produc-
tive investment in both physical and human capital.This new funding opportunity should
indeed support technology adoption and investment in education to increase domestic
productivity in the medium and long terms and to prevent losses in competitiveness.
Other productive investments that should be promoted include those in health, rural
infrastructure, water and roads. Support to the agriculture sector where the majority of
the poor work in Southern countries has also been proven to be particularly efficient, as
the case of Indonesia illustrates.
INTRODUCTION
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14. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH
Economic diversification is also critical to reducing a country’s dependence on oil
and gas revenue as well as mitigating the risk of price fluctuation and preparing the
economy for future resource depletion. Diversification also allows for a more balanced
pattern of growth. Finally, monetary policy is a vital tool for mitigating the impact on
inflation and on the real exchange rate. Only such targeted strategies could allow for a
sustained, balanced and inclusive growth, with equitable resource allocation across social
groups and across regions.
The remedies for “Dutch disease” are, therefore, multiple and well known by econ-
omists and practitioners. The challenge lies less in the strategy design than in the
absorptive capacity of the domestic economy and the ability of the Government to
maintain the quality and efficiency of its spending while increasing expenditure
substantially and rapidly.
Through South-South dialogue, the sharing of experiences and especially examples
of successful responses to challenges could be particularly beneficial. Such exchanges
between oil-producing countries can help stakeholders to choose among the range
of possible policy options in order to identify those best suited to their own country
context. These exchanges would be particularly relevant for new oil and gas producers.
For these new entrants, guidance is commonly sought in three domains. First, what
are the needs in terms of new institutions and regulatory frameworks? How can con-
tracts with oil companies guarantee security and profitability to both the resource-rich
country and the investor, given the high exploration risk and the capital-intensive nature
of the hydrocarbon sector? How should existing regulations be modified to ensure both
good governance and efficient development of the new industry?
The second set of requests for advice relates to the use of the windfall. How can a
windfall be used efficiently to finance policies that generate inclusive growth? How can
oil or gas revenue be integrated into the budget and combined with fiscal revenue?
How can it be used in a transparent way without distorting government objectives and
priorities? How does it relate to existing national development strategies? What are the
priorities and optimal sequencing for the spending of the windfall over time, given (a)
the existing absorptive capacity of the economy, (b) the urgent needs and priorities in
social sectors, and (c) the saving requirements for equity towards future generations?
The third area of guidance requested relates to the domestic environmental impacts
of the production of oil and gas. Governments face increasing pressure from the
international community, civil society and the population living in areas surrounding
4
INTRODUCTION
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15. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH 5
production sites to implement safeguards and measures to mitigate the negative
externalities on the environment. Although various efforts have been made in the past
decade, these have been generally insufficient to address the magnitude and complexi-
ties of the challenges faced.
The Book
This book is organized in three sections that follow the structure of the Meeting ses-
sions in Doha. These sections look successively at three dimensions of the management
and policy challenge: (a) regulations and the institutional framework for effective devel-
opment of the sector; (b) key issues and strategies for policy-makers on how to use the
oil revenues efficiently; and (c) the potential environmental impact of oil and gas
exploitation.
The first section presents guidelines for policy-makers on institutional and regulatory
frameworks to allow for the development of an oil and gas sector. Chapter 1 offers
national governments advice for establishing an efficient legal, contractual and regulato-
ry framework for the exploitation of their oil and gas. The chapter compares possible
contractual structures, discussing options for ownership, production-sharing agreements
and the different modalities for profit-sharing, taxes and fiscal regimes. Considering the
possible aligned and opposite interests of the national government and international oil
companies, the conditions for a “win-win” contract are examined. This is followed by an
analysis of the key elements of an enabling institutional environment to promote private
investment, local development and integrated development of the extractive sector.
Because oil and gas reserves are often located at sea, the exploitation of hydrocarbon
resources can generate maritime boundary disputes over the ownership of the reserves.
In chapter 2, discussion turns to the legal and regulatory framework necessary to over-
see the exploitation of such reserves. How can boundary disputes be resolved and how
can a joint development agreement be set up? The chapter reviews existing joint devel-
opment agreements and country cases to illustrate possible risks, stakes and solutions
that have been found in the past between Governments and oil companies.
The second section of this book provides an overview of the economic challenges
that oil- and gas-exporting countries face and strategies that they could develop to over-
come them. Chapter 3 presents evidence of the potential impact of oil and gas booms
on growth. Through country comparisons, the occurrence of the resource curse in devel-
oping countries is analysed, followed by the identification of what can be done to miti-
INTRODUCTION
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16. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH
gate negative economic impacts. The chapter describes the key challenges in the man-
agement of the resource windfall and uses country presentations from the conference to
illustrate possible policy options to address them.
Chapter 4 provides a summary and review of the country presentations made in
Doha to examine how countries perceive and describe their challenges, reasons for the
choice of management strategy and their performance over time. The variety of obsta-
cles faced and of policy choices is striking, and the presentations demonstrate the wide
range and complexity of the issues with which these Governments are confronted.
The oil and gas sector plays an important role economically for many Southern pro-
ducing countries, but it also constitutes a significant source of stress to the environment
in these countries. The third section of the book explores the environmental impacts of
oil and gas exploitation and introduces some avenues to mitigating them. In chapter 5,
key environmental challenges are identified in major oil-producing countries in the Arab
States region. In recent years, significant progress has been made in environmental com-
mitment by Arab countries and in management practices by oil and gas companies. The
chapter highlights the need for these countries to strengthen the capacity of national
institutions to move towards sustainable development in the sector as well as the need
to foster South-South cooperation.
In chapter 6, the impacts of gas flaring and venting are reviewed. This is an issue
often disregarded despite its being a source of substantial economic loss for producing
countries as well as extremely damaging to the environment. This process is widely rec-
ognized as a waste of energy for the oil-producing country, adversely affecting the envi-
ronment and and exacerbating global warming. Transfer of technology between produc-
ing countries could reduce or even suppress gas flaring, halt energy waste and generate
large economic gains for countries involved. The chapter emphasizes the need for adop-
tion of new technologies to allow for increasing the local energy supply.
The conclusion summarizes the major recommendations derived from the papers
and presentations that were encapsulated in the earlier chapters.
Annex A presents the statement that participants at the 2007 High-Level Meeting
on Oil and Gas Development formulated and approved to express their desire to see this
initiative become a platform for future collaboration. Annex B contains data on the eco-
nomic and social performance of single-resource economies, while information on the
Extractive Industry Transparency Initiative (EITI), including EITI principles, criteria
and the financing of EITI implementation, can be found in annex C.
6
INTRODUCTION
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18. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH
SECTION 1: LEGAL AND REGULATORY FRAMEWORKS
8
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19. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH
Chapter 1: Legal and Contractual Issues in Successful Hydrocarbon Development
9
CHAPTER 1
Legal and Contractual Issues in Successful
Hydrocarbon Development1
Introduction
T
his chapter examines how countries have successfully negotiated legal contracts
for hydrocarbon exploration and production. It determines what “win-win”
arrangements are both for the national governments and for the international
hydrocarbon companies usually involved in exploration and production, i.e., what
constitutes a “fair deal” between national governments and these companies.
In the development of hydrocarbon projects, national governments and internation-
al hydrocarbon companies often have a mix of aligned and opposing interests. Although
both actors desire the maximum development possible for the industry, the internation-
al oil companies (IOCs), as profit-seeking entities, generally favour the maximization of
the net present value of their investments, which are, in general, considerable.
Meanwhile, national governments regulate the industry and seek compensation for the
use of State mineral resources, thus minimizing the net present value of the companies’
investments. This relationship is often complicated by the presence of national oil com-
panies (NOCs). In most cases, State-owned firms are also profit-seeking, and their
interests often align with the IOCs. The interests of NOCs may even be opposed to
those of other branches of the same Government. In other cases, the NOCs align with
the interests of the Government and are an instrument of policy. This chapter does not
address such conflicts but focuses instead on the relationships between national govern-
ments and IOCs.
Finding the optimum balance between profitability/royalties and regulation is the key
to a successful legal and contractual framework that can benefit both the host country and
the investing companies. Certain factors, including the level of economic development,
size of the territory, size and wealth of the population, and degree of diversification of the
economy, can affect the performance of the hydrocarbon industry. Countries also differ
1 This chapter is mainly based on the report produced by Salim Jorge Saud Neto for the Special Unit for South-South Cooperation. It also includes contributions from
Nasser Akhtar (CIDA) and Stacy Edgar (Overseas Development Institute (ODI)).
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20. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH
SECTION 1: LEGAL AND REGULATORY FRAMEWORKS
in creditworthiness, ease of access to drill sites, capacity for internal financing and level
of support for infrastructure. Although legal and contractual frameworks for the devel-
opment of the hydrocarbon industry must vary depending on the characteristics of each
host nation, the sharing of experiences between different national governments can help
with the establishment of more efficient policies. While approaches may vary from
country to country, the issues that they face are generally the same.
This chapter analyses the general contractual framework used in the exploration and
production industry and the main issues usually addressed in such contracts. In addition,
it describes the legal structure commonly applied for the awarding and expropriation of
exploration and production rights.Throughout, the chapter examines the methods avail-
able to maximize IOC profits – thereby making investment attractive to such companies
– while at the same time protecting host-nation sovereignty and interests. In particular,
this chapter looks at the opposing interests at play in connection with the commonly
implemented policies.
The first section of this chapter presents an overall description of the contractual
structure used in exploration and production.The second section offers an analysis of the
main issues addressed contractually in hydrocarbon transactions, while the third section
contains an overview of the methods for awarding exploration and production rights.
The possibilities of forfeiture of exploration and production rights are the focus of the
fourth section. The chapter concludes with suggestions for cooperative multilateral
mechanisms that can assist with the implementation of such frameworks.
Contractual Structure
The contractual structure of hydrocarbon projects varies according to the laws applica-
ble to the ownership of mineral resources in a relevant jurisdiction. In most cases,
mineral resources are owned by the State. Exceptions to this exist in Canada, the
United States and parts of Colombia where private ownership exists. Additionally,
oil rents are generally the property of the State. However, countries differ on whether
the IOC or the State owns the means of production, depending on their respective
contractual structures.
Countries that allow private ownership of mineral resources tend to have simpler
contractual structures and, in some cases, minimal governmental interference other than
that regarding the issuance of permits. Governments of jurisdictions where mineral
resources belong to the State have a larger stake. Therefore, exploration and production
10
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21. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH
Chapter 1: Legal and Contractual Issues in Successful Hydrocarbon Development
11
activities require more complex contractual structures.
Countries that proscribe private ownership of mineral resources generally award
exploration and production rights through concessions. Depending on policy, conces-
sions can be awarded either directly to the IOC or to the NOC which, in turn, enters
into a production-sharing agreement with the IOC. Alternatively, policy may require a
national government not to award concessions and instead to explore an oil venture
directly, employing an IOC to perform the technical tasks and sharing the production
with such a company under a production-sharing agreement.
A concession is an authorization for the exploration and development of hydrocar-
bon resources. When awarded directly to an IOC, a concession and the respective con-
cession agreements contain, in addition to authorization, a detailed description of the
responsibilities of the concessionaire, limitations on production, royalty payments, and
other provisions necessary for the implementation of national policy with respect to the
hydrocarbon industry. If, for policy reasons, a concession is awarded to an NOC, the
concession agreements tend to be much simpler in format and the relationship with the
IOC is generally regulated by production-sharing agreements. Under this structure, the
NOC is the concessionaire and the IOC is a service provider or a partner that is enti-
tled to a share in the oil production. National governments that adopt such structures
usually leave the implementation of their hydrocarbon policy in the hands of the NOC.
The production-sharing agreement usually contains the provisions necessary for the
contractual implementation of such policy.
In the event that a national government does not have an NOC and, for policy
reasons, does not intend to form one and cannot or does not desire to award concessions
to an IOC, the Government undertakes the task of contracting exploration and produc-
tion directly, not awarding concessions but employing IOCs as service providers to be
awarded a share of production. In these service agreements, the national government
implements national hydrocarbon policy directly and takes control of production, leav-
ing little autonomy to the IOC.
In countries with private ownership of mineral resources, oil companies enter into a
lease agreement with the owner of the relevant land. Such lease agreements are private
contracts initially set up without the involvement of a governmental body and establish
the methods of compensating the landowner and limitations of the production. The
national government is involved in this process through the awarding of operational per-
mits to the oil company.
2
Although permits are usually less detailed than contracts, con-
2 In the event that mineral resources are on public land,a lease is entered into with the appropriate government body (national or local) and the government role
will necessarily be more significant.
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22. A regulatory framework for oil and gas development consists of answers to the
following questions:
What is regulated?
Who should regulate the laws?
How should the laws be regulated?
The laws and regulations should provide clear standards and expectations for actions
to be taken by those subject to regulation as well as the regulator. Additionally, a robust
regulatory framework must include a well-thought-out enforcement scheme in which
regulation is enforced consistently according to the criteria of a framework.
The complex nature of oil and gas development requires careful consideration of the
various aspects of the production chain:
Upstream regulation includes the management of exploration,disbursement of oil
and gas rights, the design of a fiscal regime (including the collection of royalties
and the division of risk) and safeguards for proper ecological management during
the exploration and production process.
Midstream activity includes the technical and economic regulation surrounding
the transport of oil or gas.Technical considerations include the construction, oper-
ation and maintenance of pipelines as well as adherence to environmental and
safety codes.
Downstream activities include regulations for consumer protection and quality
standards.
ACTIVITIES
UPSTREAM MIDSTREAM DOWNSTREAM
EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH
SECTION 1: LEGAL AND REGULATORY FRAMEWORKS
12
BOX 1.1 Regulatory frameworks
Exploration
Production
Gas processing
Transport by
pipelines
Petrochemicals
Refining
Storage
Import
Marketing
Export
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23. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH
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13
Institutional mechanisms for regulating the oil and gas sector vary. However, these
institutions should seek to enhance the confidence of investors and maximize trans-
parency of the regulatory process. General principles to adhere to in the enforcement of
regulation include:
Ensuring that laws and regulations are well publicized;
Issuing government guidelines clarifying the processes and rules and information
letters providing interpretations of the laws and regulations;
Fairly including all parties and emphasizing that everyone has a right to be heard;
Publishing decisions, including the reasons for decisions;
Providing an opportunity to appeal decisions; and
Protecting commercial proprietary information.
3 Such listing of conditions in permits is not common,though.
Source: N.Akhtar (2007),“Challenges of Effective Regulatory Compliance and Enforcement for Oil and Gas Development”,Paper presented at the High-Level
Meeting on Oil and Gas Development, Doha, Qatar, 8-10 September 2007.
Regulatory frameworks (continued) BOX 1.1
ditions can be established to ensure the implementation of relevant national policy in a
manner similar to the implementation of policy by Governments with ownership inter-
ests in mineral resources.
3
These conditions may be wide-ranging, including the manda-
tory participation of an NOC in a venture, the requirement that any equipment be
acquired locally or the inclusion of fire-safety and labour and environmental regulations.
In all cases where national policy or best interests require NOCs to be involved in
the production process, the IOC and NOC also enter into joint operating agreements,
which delineate the tasks and responsibilities of the parties in all phases of the project.
Such agreements generally also detail the decision-making process during the project.
They differ from the production-sharing agreements in that they tend exclusively to
regulate operational issues, leaving policy implementation to the latter.
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Although lease agreements, concessions, production-sharing agreements and joint
operating agreements are usually designed to regulate specific aspects of the different
phases of a hydrocarbon project, it is not uncommon for the agreements to overlap with
regard to regulating certain issues. Accordingly, depending on the contractual structure
adopted, certain agreements might be a combination of what, under other structures,
would be two different agreements, e.g., concession agreements on concessions awarded
directly to IOCs, which contain provisions of both concession and production-sharing
agreements.
14
TABLE 1.1 Comparison of fiscal systems
Source: D.Johnston (2007),"How to Evaluate the Fiscal Terms of Oil Contracts”,in Escaping the Resource Curse,M.Humphreys,J.Sachs and J.Stiglitz (eds.),New York:
Columbia University Press.
Royalty/tax systems
44%
All types:exploration,
development,enhanced
oil recovery
IOC
No transfer
Gross production less
royalty oil
At the wellhead
Contractor 100%
Yes,but not common
No
Low typically
Typically around 90%
High
Production-sharing
contracts
48%
All types:exploration,
development,enhanced
oil recovery
Government NOC
“When landed”or
upon commissioning
Cost oil + profit oil
Delivery point,
fiscalization point or
export point
Contractor 100%
Yes,common
Usually
High
Usually 50-60^
Low to moderate
Service agreements
8%
All types but often
non-exploration
Government NOC
“When landed”or
upon commissioning
None
None
Contractor 100%
Yes,very common
Sometimes
High
None (by definition)
Low
Global frequency
(% of systems)
Type of project
Ownership of
facilities
Facilities title
transfer
IOC ownership of
hydrocarbons
(lifting entitlement)
Hydrocarbon title
transfer
Financial obligation
Government participation
Cost recovery limit
Government control
IOC lifting entitlement
IOC control
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15
Main Contractual Issues
This section presents a description of the main contractual issues dealt with in the
various types of hydrocarbon contracts and the aligned and opposing interests of IOCs
and national governments with respect to such issues.
Local Presence
National governments often require IOCs to establish a local presence when engaging
in hydrocarbon projects that subject them to the jurisdiction and taxation of the
host State as well as to employ local management capable of interacting with local
authorities.
Project Assignment and the Regulation of Investors
The awarding of hydrocarbon exploration and production rights is generally determined
based on the particular qualifications of the recipient. However, IOCs might need
restrictions to be lifted so that a financier can also be assigned the rights and obligations
under a contract. Reducing restrictions allows greater flexibility in financing and affects
the general profitability of a project through the maintenance of financing costs. IOCs
may, in addition, need exceptions to assignments in the event that such companies lose
interest in the project or they may wish to seek partners to develop the project jointly. In
such cases, exceptions to the assignment restrictions can permit IOCs to divest their
operations to, or seek partnerships with, an interested third party and, therefore, ensure
the continuation of the project.
However, the benefit of such arrangements for the implementation of the policy of
a national government is questionable. Financiers are generally not qualified to operate
in the hydrocarbon industry and their interests and those of the national government
in a subsequent transfer may not be aligned. Although investors would favour no
restrictions on assignments, in order to make their interests more easily transferable, the
interests of national governments may require an assignee to have the same or better
qualifications than the original oil company.
4
At the same time, such restrictions
may limit the overall amount that can be obtained in a divestiture since the range of
qualified bidders is reduced and, as a result, they impact on the assessment of risk and
profitability margins of an investment.
4 In the event of a joint operation, the concerns of the national government might not be relevant as the original oil company would already have met the
necessary qualifications.
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Cooperation with National Governments or NOCs
The hydrocarbon policy of a national government may require that IOCs engage in
exploration and production activities in direct cooperation with the national government
or an NOC under production-sharing agreements. Such arrangements require that the
exploration and production of mineral resources be performed exclusively by the State
and be beneficial to the national government. At the same time, IOCs can generate
hydrocarbon revenues that would not be available otherwise. Furthermore, collaboration
with IOCs provides an opportunity for skill transfers and the improvement of human
capital. The interaction between the technical and managerial employees of an IOC and
those of the NOC can generate the transfer of technical know-how and experience.
However, the operational costs of IOCs are generally increased by interaction with
national governments or NOCs since additional layers of reporting are incorporated into
the operation and time and resources must be dedicated to training.
5
Consequently,
increased costs tend to reduce the profitability of the investment of an IOC.
Partnership with Domestic Investors
National governments’ economic development policies or national legislation may
require that certain economic activities, including hydrocarbon activities, be performed
by nationals of the host country. Such restrictions usually establish minimum amounts
of equity to be held by domestic investors and define domestic investors as natural
persons who are citizens of the host country.
Forcing international companies to look for domestic partners may generate an
influx of wealth and encourage entrepreneurship among the nationals of a country. If
financing is not easily available, however, there might be a limited number of qualified
investors, thus reducing the ability of foreign companies to operate in a country. Even
when financing is easily available, the mandatory association with domestic investors
may serve as a constraint for international companies, as it creates the need for
more complex decision-making bodies and account-rendering mechanisms, thereby
increasing operational costs.
Use of Local Equipment and Labour
In an attempt to spread the benefits of the development of the hydrocarbon industry to
all sectors of a country, national governments may establish minimum requirements for
16
5 Even when NOC personnel are experienced in exploration and production activities,the use of different technologies and know-how will mean that training will
be required.
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17
domestically manufactured equipment and domestic labour as a condition for the grant-
ing of exploration rights. Such requirements can be a useful tool in providing qualifica-
tions to the population of a country and strengthening the national industry but they
can also have an impact on the operational costs of the IOC. When such minimum
requirements are excessively high, the local population is not sufficiently qualified or the
industry is not efficient, the operational costs involved can impact the profitability of an
investment drastically. By definition, when a national government adopts such a policy,
the local population is not sufficiently qualified and the industry is not as efficient as for-
eign industry; otherwise, the IOC would go to the local industry for equipment and the
local population for labour regardless of governmental requirements. The main task of
national governments when adopting such minimum requirements is to determine the
appropriate levels of local equipment and labour that could benefit the local economy
and yet maintain the attractiveness of the project to IOCs. Many IOCs will often work
with national governments to scale up the level of local content over time through
targeted training and other incentive programmes, often encouraging small companies
close to the site of operations to become more actively involved.
Timing for Implementation
Concession agreements and permits generally have deadlines for the implementation
of various phases of hydrocarbon projects. Such deadlines are necessary to ensure that
mineral resources are used adequately and to permit national governments to award
exploration rights to other interested parties if the original investor fails to implement a
project. Any deadline being imposed by a national government must be sufficiently real-
istic for the implementation of all tasks of the respective phases of the project, including
obtaining governmental permits and licences. The processing time of permits and
licences can vary drastically in different regions – even within the same country – and
the deadlines set in the documentation must take into account such discrepancies.
Unrealistic deadlines in an ongoing project either will require amendments to the appli-
cable documentation or may be considered a constructive expropriation and result in
indemnification rights. More importantly, however, unrealistic deadlines may prevent
serious investors from engaging in hydrocarbon projects, minimizing the financial
returns of the national government and the effective implementation of the country’s
hydrocarbon policies.
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Limitations on Production
The first hydrocarbon contracts contained very loose definitions of the areas where
rights were granted and almost no limitations to production. Such lack of regulation
gave rise to a number of conflicts that resulted in case law limiting the activity of the oil
companies. In jurisdictions where the development of the hydrocarbon industry is incip-
ient, hydrocarbon contracts must contain clear and detailed definitions and limitations
to afford the maximum level of security possible to potential investors. Although impos-
ing limitations may seem to be opposed to the interests of the IOC, a clear and detailed
legal or contractual framework can actually add value to a project; the security arising
from the fact that the rules are known by all relevant parties and will not be changed can
facilitate an IOC evaluation of the convenience of an investment and result in increased
revenues for the national government.
Destination of Production
Production from hydrocarbon development may be directed to the domestic or inter-
national market according to the needs of the national government. Directing the
production to the domestic market can ensure the supply of crude oil, whereas sales on
international markets can generate revenues for the host country. Depending on the
contractual structure adopted, national governments or NOCs may have a share of the
production and, according to the needs or policies of the country, may either sell their
share to international companies or acquire the IOC share of the production.
Contracts may provide for purchase or sale options to be exercised by the national
government according to the country’s needs. Noting that a supply of oil will not guar-
antee the supply of its by-products unless the host country has refining facilities
or arrangements with crude oil-processing facilities located in other States, national
governments tend to be more concerned with the sale of their share of the production
than with the purchase of the share of the IOC.
6
The terms under which such sales or
purchases are effected can impact (positively or negatively) IOC interests in investing
in hydrocarbon projects; the use of the market conditions prevailing at the time of the
sale or purchase will likely be impact neutral in the evaluation of a project.
If the development of a country’s hydrocarbon industry is also oriented towards
meeting the demands of the domestic market – and avoiding the risk of lack of
supply – the national government or NOC may impose restrictions on the exportation
18
6 Revenues obtained with the sale of the national government or NOC share can be used for the purchase of the needed oil by-products if national governments or
NOCs are in charge of their distribution.
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19
of hydrocarbons in the event of emergencies. Any restriction on the ability of IOCs to
sell their production freely can generate contingencies to such IOCs
7
regardless of
whether it is derived from contract limitations or from the law. The possibility of such
restrictions being imposed – even if temporary – will be taken into account by IOCs
when evaluating the convenience of their investment. In countries with large domestic
markets, IOCs should already be interested in distributing the oil by-products domesti-
cally, and the impact of interference of national governments, if limited to emergencies,
should not adversely affect the IOC evaluation of hydrocarbon projects in material terms.
The more frequently the restrictions are imposed – or are expected to be imposed – the
larger the impact on the evaluation of the project.
Labour and Environmental Regulations
Hydrocarbon exploration and production are economic activities that, as with other eco-
nomic activities, are subject to the general laws applicable in the host country.
Accordingly, all labour and environmental regulations applicable to economic activities
in general will be applicable to the hydrocarbon industry. To attract foreign investment,
countries may adopt flexible legal regimes for certain industries or for activities located
in specific regions. National governments must consider the convenience of adopting
such structures in connection with the hydrocarbon industry vis-à-vis the general inter-
ests protected by such regulations and determine which regulations should be lifted.
Labour and environmental compliance is a source of expense in the development of
any activity, and IOCs may favour lifting the application of such regulations as an
incentive for investment. In countries where labour contracts tend to be regulated in
detail by applicable legislation, compliance may impose costs in excess of what is usu-
ally experienced in other markets. Similarly, obtaining environmental licences and com-
plying with environmental conditions imposed by such licences may generate high
costs that can adversely affect the profitability – and even feasibility – of projects.
8
National governments weigh the risks of not applying such internal regulations to the
hydrocarbon industry and the impact on the implementation of their policies
9
that such
actions can generate.
7 The production of oil companies is sometimes directed to the fulfilment of their obligations under certain supply agreements and the diversion of production can
cause a default under such agreements.
8 National governments should consider the environmental impacts of hydrocarbon projects vis-à-vis local legislation prior to awarding projects to IOCs.If environ-
mental restrictions and the costs of compliance might impact the feasibility of projects,national governments should avoid the development of such projects,as
restrictive conditions in the issuance of environmental licences can be deemed constructive expropriation and give rise to indemnifications.It is suggested that
national governments perform initial environmental assessments prior to the development of projects and avoid the development of projects that would require
massive investments in environmental compliance unless market conditions would render such projects profitable regardless of the level of investment required.
9 Not merely hydrocarbon policies but also labour and environmental policies.
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Taxes
Hydrocarbon exploration and production are economic activities that, as with other
economic activities, are subject to the taxes and duties generally applicable in a host
country. Since the hydrocarbon industry demands massive investment and the use of
equipment not commonly produced in all the jurisdictions where hydrocarbon projects
are developed, national governments of such jurisdictions may, as an incentive designed
to attract foreign investment, create special tax regimes applicable to the industry. The
impact of such special regimes is generally merely financial and, although they may
reduce the revenues available to the national government,
10
they also reduce the impact
of operational costs on the profitability of IOCs, increasing the net present value of their
investment and thus making the host country more attractive.
Special tax regimes applicable to the hydrocarbon industry may be established in
contracts although, more usually, legislation is enacted in this regard.
11
Special regimes
may be applicable to all taxes or import duties, but their effectiveness in creating a more
favourable environment for the hydrocarbon industry is in the reduction in – or even
exemption from – import duties on the equipment to be used in exploration and pro-
duction. Such equipment is sometimes imported for short periods and then returned for
use in other projects abroad; if import duties are levied, amounts can be considerable,
owing to the high value of such equipment. The reduction in or exemption from income
or other taxes applicable to IOCs can certainly increase the interest such companies may
have in investing in a host country, but national governments must also consider the
impact that a waiver of the revenues associated with such income or other taxes may
have on their finances vis-à-vis increased economic activity.
Limitation of Liabilities
Commonly, in any business venture, such as the development of a hydrocarbon project,
the parties involved will try to limit their liabilities. Although IOCs would prefer to
have limitations of liability expressly stated in contracts, they can limit their liability by
incorporating local entities – as usually required in connection with hydrocarbon projects –
and taking advantage of local laws on limitation of liability of business organizations.The
value of the assets of an IOC is generally high, but investments in host countries amount
to only a small fraction of such assets; unless the assets located outside the host country can
guarantee the obligations of the IOC, its liability will be limited to such a small fraction.
20
10 Revenues that would not otherwise be available if the hydrocarbon industry were not present.
11 Local legal regimes would,in general,not permit acts of the executive branch,such as administrative contracts,to overrule or create exceptions to tax legislation.
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21
Current Exemption
expensingof of
exploration imports of Unlimited
and/or equipment loss
Tax Accelerated Tax development andcapital carry
Country holiday depreciation credit cost goods forward Other
Angola X
Cameroon X
Gabon X
Mozambique X
Niger X
Nigeria X X
Bangladesh X
Brunei Darussalam X
Cambodia X
Indonesia X X X
Malaysia X X X
Papua New Guinea X X
Philippines X
Thailand X
Viet Nam X
Egypt X
Tunisia X X X
Yemen X X
Belize X
Bolivia X X
Chile X
Guatemala X X X
Guyana X
Mexico X X
Trinidad and Tobago X X X
Venezuela (Bolivarian
Republic of) X X
Azerbaijan X X X
Kyrgyzstan X
Source: E.M.Sunley,T.Baunsgaard and D.Simard (2003),“Revenue from the Oil and Gas Sector:Issues and Country Experience”,inFiscal Policy Formulation and
Implementation in Oil-Producing Countries,J.M.Davis,R.Ossowski and A.Fedelino (eds.),Washington,DC:International Monetary Fund (IMF),pp.153-183.
Investment incentives in fiscal petroleum regimes, selected
developing countriesTABLE 1.2
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The assets of an IOC in a given country might be sufficient to guarantee indemni-
fication for any potential contractual liability but may be insufficient to indemnify the
State or the general population in the event of environmental or other types of accidents.
National governments may request that IOCs submit parent guarantees in connection
with the development of hydrocarbon projects. This additional guarantee can provide
national governments with the assurance of proper indemnification, but it also generates
additional exposure – and thus costs – for IOCs. Alternatively or, more commonly
additionally, risks can be mitigated with the purchase of insurance, at a cost.
12
All such
costs adversely affect the profitability of an investment, and national governments must
consider the convenience of adopting such requirements.
Applicable Law
As a general rule, laws applicable to contracts in the hydrocarbon industry are those
generally applicable in the host country. Subject to the host-country conflict of laws,
22
TABLE 1.3
Source: Ibid.
Risk/reward trade-off for
the Government arising from
various fiscal instruments
Low risk/low reward
Medium risk/medium reward
High risk/high reward
Tax/royalty regime
Royalty
Income tax that applies
to all companies
Resource rent tax
Production-sharing regime
There may be an explicit royalty or a
limit on cost oil that functions as an
implicit royalty
Income tax that applies to all
companies,which may be paid out of
the Government’s share of production
The determination of the amount
of profit oil can be highly progressive
and mimic a resource rent tax
12 The costs with insurance tend to be higher than the costs with a parent guarantee:in addition to the costs with the premium,insurance companies may impose a
series of measures to mitigate risks.
Comparison between royalty and production-sharing regimes
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23
rules and principles or any legal prohibition to the sovereignty of the host country
(or an instrumentality thereof) entering into agreements governed by the laws of other
jurisdictions, joint operation agreements might be subject to laws elected by the par-
ties that are from outside the host country. Nonetheless, concession agreements and
production-sharing agreements, owing to their nature, are generally subject to local
constitutional and administrative principles and are necessarily governed by the laws
of the host country.
As a result of negotiations or as an incentive to attract foreign investment, hydro-
carbon contracts may contain provisions that, as an exception to the general rules appli-
cable in the host country, are contrary to prevailing laws. Since hydrocarbon agreements
are acts of the executive branch, unless a legal mandate has been given to the appropri-
ate governmental body, provisions contrary to the law will not prevail if not ratified by
the legislative branch. Since the legislative process can be time-consuming, specific
mandates can be awarded to the executive branch prior to the negotiation of contracts,
or contract forms or provisions can be approved in advance by the legislative branch to
overrule existing less favourable legislation. However, this option has potential risk
in countries with poor governance. If contracts entered into with IOCs are subject to
ratification, the transactional costs can be elevated and discourage investment.
An IOC may want, in addition, to claim the protection of a bilateral investment treaty
that may be in force between the company’s home country and the host country. Such
treaties can afford an extra level of security for IOCs, with protection against arbitrary
expropriation or the enactment of less favourable legislation, and thus improve the risk
assessment of the country. Regardless of the availability of such a treaty, the legislative
history of a country soliciting investments will likely be analysed by IOCs interested in
investment opportunities. Those countries that adopt measures to guarantee the security
of administrative contracts, such as concession or production-sharing agreements, will
likely have a better assessment, resulting in better prospects for investment.
Dispute Resolution
International investors in general and IOCs in particular are suspicious of the ability of
local judiciary branches to render exempt decisions in disputes between foreign investors
and the sovereignty (or an instrumentality thereof) and tend to prefer the use of the
courts of their own home countries or a neutral dispute-resolution panel. Most nation-
al governments may be prevented by local legislation from submitting to the jurisdiction
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of other countries and the courts of such other countries may be prevented from
rendering decisions with respect to other national governments based on principles of
sovereign immunity. As such, most hydrocarbon agreements provide for arbitration as
the preferred dispute-resolution mechanism.
The use of arbitration in connection with hydrocarbon contracts affords security and
transparency to the resolution of disputes between national governments and IOCs. As
a result, this increases the prospects for investment by IOCs. Notwithstanding the
choice of arbitration over the courts of the host country, the laws of the host country
must grant validity and enforceability to arbitral awards or the use of arbitration can be
rendered innocuous, reducing the security sought by IOCs and therefore discouraging
their investment.
Award and Forfeiture of Rights
Award of Exploration and Production Rights
Several methods exist for national governments to award exploration and production
rights to IOCs. When awarding such rights, national governments should adopt
procedures that can maximize competition and, as a result, maximize revenues for the
national governments and for the implementation of their hydrocarbon policies. The
organization of public bids for the development of hydrocarbon projects in specific areas
is often the most efficient method of maximizing competition, as national governments
are entitled to select those bids that better meet their needs. In such bids, specific
valuation weights must be given to (a) the financial compensation payable directly to the
national governments or NOC and (b) the level of implementation of the requirements
imposed by national hydrocarbon policy. In this way, the national government can award
exploration and production rights to those companies that reach the optimum balance
between financial compensation and implementation of government policy. Such
weights, when established at the beginning of the process, allow IOCs to maximize their
profitability when preparing their bids and thus make the investment appear more
attractive.
13
In areas where little or no exploration has occurred or in areas with little information
available, however, a lack of interest may mean that public bids might not be effective in
generating efficient competition. In such cases, and to the extent permitted by the appli-
cable legislation, the direct solicitation of IOCs
14
tends to be the most effective manner
24
13 As noted, the requirements imposed by national hydrocarbon policies tend to generate increased costs and thus reduce the profitability of investment.
Permitting oil companies to allocate their costs in the most efficient manner will enable the achievement of an optimum balance.
14 Usually with conditions that are generally more favourable to the IOC.
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25
of commencing the development of the hydrocarbon industry and creating general
awareness of the possibilities in the region.
15
Once exploration – and possibly produc-
tion – is already under way, public bids can become an efficient method for awarding
rights. International cooperation can also be useful in the initial development of
unexplored areas of countries with no or little hydrocarbon tradition by association
with traditional oil countries and the implementation of joint offers. For the success
of such international ventures, it is essential to take into account the proximity and
similarity of the two countries and the hydrocarbon rights being offered to avoid
internal competition.
Forfeiture of Exploration and Production Rights
In several circumstances, national governments, in the implementation of their hydro-
carbon policies, will desire or need to stop IOCs from conducting certain hydrocarbon
exploration and production activities.To create an investment-friendly environment, the
situations in which a national government can effectively remove an international
investor, through expropriation or owing to a default by the investor of its obligations
under a concession or a contract, should be clearly established in legislation or the
relevant contract. National governments establishing and abiding strictly by such rules
permit IOCs to assess the risks in connection with their investment and increase the
prospects for foreign investment.
The use of regulatory instrumentalities to implement national hydrocarbon policy,
16
to audit contracts and to apply applicable legislation in the event that an investor forfeits
its rights under a contract for default or the national interests require the expropriation
of an investment, adds transparency to the process. It also ensures that the application
of law is not considered an arbitrary act by a national government, which could deter
further investment by IOCs. In fact, national governments can cooperate in this regard
by establishing transnational regional regulatory bodies which, at a share of the costs of
maintaining a national body, could implement standardized procedures. These not only
could be more easily analysed by IOCs interested in a region but also would likely
not be subject to internal shifts in policy of specific member countries, creating a more
reliable environment.
15 NOCs rather than national governments can be used in direct solicitation of investment in the event that applicable legislation would prevent national govern-
ments from engaging in such activities.
16 Such instrumentalities are more efficient in providing transparency and security to the implementation of national hydrocarbon policy when their personnel have
a technical background and cannot be removed by the national governments as a result of political changes.
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SECTION 1: LEGAL AND REGULATORY FRAMEWORKS
26
In the past two decades, management of the oil and gas sector has oscillated dramatically,
trending towards privatization in the 1990s and towards nationalization post-2005. As the
holder of the second-largest natural gas reserves, estimated at 27 trillion cubic feet of nat-
ural gas and 0.86 billion barrels of oil, Bolivia has seen its production increase substantially
over the past few years;the country is currently producing 440 billion cubic feet of gas and
17.5 million barrels of oil annually. It currently exports about 360 billion cubic feet of gas
annually to Argentina and Brazil, making it an important source of revenue for the country
and a politically sensitive sector.
The Government of Bolivia passed a series of laws in the early 1990s aiming to privatize
the oil and gas sector.Privatization Law 1330 of April 1992 authorized public-sector institu-
tions,entities and enterprises to transfer their stocks to individuals and companies,nation-
al or foreign. Two further laws, Sectoral Regulatory System (SIRESE) Law 1600 of October
1994 and Hydrocarbon Law 1689 of May 1996, also amended practices within the sector.
In particular, the Superintendence of Hydrocarbons was established as an independent
regulator for midstream and downstream production, and the State oil company,
Yacimientos Petrolíferos Fiscales Bolivianos (YPFB), was privatized.
Since 2005,Bolivia has experienced a reversal in policy and has implemented a number
of reforms nationalizing the oil and gas sector.Hydrocarbon Law 3058 of May 2005 and the
Supreme Decree of May 2006 nationalized all oil and gas resources – from extraction to
sale. In particular, these laws nationalized YPFB and reasserted its role in all aspects of the
oil and gas production chain. Additionally, Hydrocarbon Law 3058 provides for YPFB to be
responsible also for upstream regulations,as in the predecessor law.Midstream and down-
stream regulatory functions remain the responsibility of SIRESE.Enforcement mechanisms,
however, remain undefined in the current legal frameworks.
According to current law,permits and authorizations for any exploration activities must
be granted by the Ministry of Hydrocarbons and Energy, whereas bids for adjudication of
exploration areas must be awarded by the State oil company,YPFB.Current regulations also
establish that exploration and production must be carried out through YPFB by signed
contracts, as provided for in Law 3058 and confirmed by the recent signing of 44 different
operation contracts with private oil companies.
BOX 1.2 The case of Bolivia: What is a “win-win” contract?
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Chapter 1: Legal and Contractual Issues in Successful Hydrocarbon Development
27
These reforms have profound implications for private firms working in the Bolivian oil
and gas sector and demonstrate how the stability of the regulatory framework is often
influenced by domestic politics.As a potential solution,Jenik Radon (2007) emphasized the
inclusion of social and environmental concerns in contracting with oil companies. Social
considerations are important because the perception of unfairness may lead to instability
or upheaval in the political system that can affect the oil and gas sector. By taking into
account social-justice questions earlier on,dramatic regulatory changes might be avoided.
Sources: N.Akhtar (2007),“Challenges of Effective Regulatory Compliance ...”;and J.Radon (2007),“How to NegotiateYour Oil Agreement”in M.Humphreys,J.Sachs
and J.Stiglitz (eds.),Escaping the Resource Curse,NewYork:Columbia University Press.
Conclusion
The key to the successful development of the hydrocarbon industry is achieving the opti-
mum balance between the implementation of the policies of national governments and
assuring security and profitability for the investments of IOCs. Owing to the massive
investments required and the high risk associated with the industry, national governments
often cannot develop a successful industry without the assistance of IOCs. Equally, IOCs
need national governments to award authorization to explore the resources available in
their country and make their profits possible.The legal and contractual framework adopt-
ed by national governments for the hydrocarbon industry is an essential factor in the suc-
cess of its development.
National governments can cooperate among themselves in such ventures, at a mini-
mum by sharing their experiences and expertise acquired in the development of their own
industries. The establishment of transnational agencies can also help countries to share
some of the development costs and adopt tested successful policies. The Organization of
Petroleum Exporting Countries (OPEC) is likely the best-known cooperation mecha-
nism in connection with the hydrocarbon industry, but South-South cooperation can go
beyond the coordination of unified petroleum policies to secure fair and stable prices and
regular supply to the markets. Either through the expansion of OPEC activities or
through the establishment of new regional transnational bodies, countries can cooperate
among themselves, e.g., in the establishment of unified regulations and regulatory bodies
The case of Bolivia: What is a “win-win” contract? (continued) BOX 1.2
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SECTION 1: LEGAL AND REGULATORY FRAMEWORKS
that, not being subject to shifts in policy in specific member countries, can add reliabil-
ity to the system and help to attract investment.
In any event, regardless of whether they are implemented by national governments
or international agencies, contractual provisions have an often-neglected impact on the
value of investments by private companies and the effectiveness of implementation of
government policies. Engineering effective contractual and legal frameworks can both
afford security and profitability to the investing international hydrocarbon companies as
well as protect the sovereignty of the State hosting the investment and the interests of
the respective national government. Countries intending to develop their hydrocarbon
industry should pay close attention to the opposing interests of national government and
IOCs and regulate such interests more generally with laws and more specifically in the
contracts to be entered into with the IOCs.
An effectively designed contractual, legal and regulatory framework can generate
increased wealth for the hydrocarbon States as reliable frameworks are critical to
attracting foreign investment for the development of a country’s mineral resources.
Conversely, inadequately tailored contracts and unreliable legal and regulatory frame-
works can generate losses for both the State and the investors in connection with exist-
ing investment and discourage new investments. In fact, efficiently tailored legal and
contractual frameworks are often revealed as the most efficient tools that a national
government has for the successful development of the hydrocarbon industry. Having the
capacity to design and implement such frameworks either directly or in cooperation with
other national governments is essential for a country’s success in such ventures.
28
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39. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH
Chapter 2: Legal Regulation and International Boundaries
29
CHAPTER 2
Legal Regulation and International
Boundaries17
Introduction
A
ll legal and regulatory frameworks for oil and gas industries must deal with a
large variety of issues, such as licensing regimes, profit-sharing, fees, royalties,
taxation, drilling, reporting, information, confidentiality, intellectual property,
official approvals, environment, health and safety and security. Specific rules can vary
considerably from one country to the next and, even within a country, special rules can
exist for particular regions or areas, especially where the location is particularly sensitive
or subject to a particular political or legal regime. Since the areas adjoining internation-
al boundaries are frequently governed by special rules to some extent, these boundaries
give rise to a wide range of particular problems for those concerned with the regudation
of national oil and gas industries.
Although energy prices are not in truth ever-rising, the overall trend in recent years
has been sharply upward. Despite its implications, the world’s response to global warm-
ing has been very slow. Demand for hydrocarbons continues to rise, while many existing
reserves are rapidly being depleted. As a result of such circumstances, international
boundary issues have increasingly preoccupied politicians in recent years as well as
the oil and gas sector itself, of course. It seems inevitable that such issues, already diffi-
cult to resolve, will become even more highly charged as time goes by, at least for the
foreseeable future.
This chapter is designed to introduce some of the most important practical problems
that arise when legal and regulatory frameworks need to be established for oil and gas
industries at or near international boundaries. The legal and regulatory role of the State
and its judiciary system in such issues is discussed, followed by a series of brief case
studies to illustrate how, in practice, some of the most important issues have been dealt
with in recent years. We also look in detail at political will and judgment, and costs
involved in setting up a legal and regulatory framework.
17 This chapter is mainly based on the Doha High-Level Meeting report by Alan Perry (Edwards Angell Palmer & Dodge),with contributions from Stacy Edgar and
Stephanie Levy (ODI).
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Impact of Boundary Problems on Legal and Regulatory Frameworks
Uncertain Boundaries
A Government’s hope of establishing any kind of oil and gas industry depends on the
outcome of a first-order boundary issue. In regulatory terms, this means simply that,
depending on the dispute outcome, the oil or gas field in the area of overlapping
national claims may or may not fall wholly or partially within the national legal and
regulatory framework. In other cases, the industry will exist anyway and the importance
of the boundary issue is secondary. In any event, those responsible for such frameworks
need to factor in relevant boundary problems and their implications.
The fundamental uncertainty brought about by a first-order boundary dispute
is essentially that, until the respective rights of the neighbouring States have been
decided, either by agreement or by an authoritative legal ruling, acts and omissions
relating to the disputed area that are carried out or permitted by one of the States under
its own national legal and regulatory framework may in due course turn out to have
infringed the rights of the adjoining State. It is easy to say that Governments should
avoid provocative actions, but this can only be a guide, not an absolute and inflexible
rule. If, for example, there is only a small chance that a particular act will infringe the
rights of the neighbouring State but the economic price of suspending or abandoning
the action in question is extremely high, a Government will obviously have to make a
judgment, deciding (perhaps only provisionally) whether it is reasonably safe to proceed
and, if it does, what precautions to take. Such considerations may affect the design of
the national legal and regulatory framework long before negotiations between the two
States have even begun.
Boundary difficulties relating to oil and gas deposits exist on land but are particular-
ly acute at sea. These are issues of States’ rights in international law. In principle, States
have a right to a territorial sea up to 12 nautical miles wide, an exclusive economic zone
up to a further 188 nautical miles and possibly continental shelf rights even beyond 200
nautical miles (see the United Nations Convention on the Law of the Sea (UNCLOS),
1982, Parts II and V). Where two or more States have overlapping claims, their maritime
boundaries normally must to be delimited by agreement between them on the basis of the
equitable principles applicable under international law (Articles 15, 74 and 83).
18
A large number of international maritime boundaries remain to be delimited by this
30
18 Also see R.Kolb (2003),CaseLawonEquitableMaritimeDelimitation:DigestandCommentaries,The Hague:Martinus Nijhoff;and International Labour Organization
(ILO),“ThePromotionofGoodIndustrialRelationsinOilandGasProductionandOilRefining”(ILOdocumentTMOR/2002/11).ReportfordiscussionattheTripartite
Meeting on the Promotion of Good Industrial Relations in Oil and Gas Production and Oil Refining, Geneva, 2002. Available at: http://www.ilo.org/
public/english/dialogue/sector/techmeet/tmor02/tmor-n.pdf (accessed 29 August 2008).
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Chapter 2: Legal Regulation and International Boundaries
31
BOX 2.1 International law: Oil and gas discoveries in the sea
1945 Truman Proclamation
The first assertion of a State over marine resources, the Proclamation states that “the
Government of the United States regards the natural resources of the subsoil and sea bed
of the continental shelf beneath the high seas but contiguous to the coasts of the United
States as appertaining to the United States, subject to its jurisdiction and control”.
The Proclamation is often cited as a precedent in States claiming the authority to regulate
the contents of their surrounding waters.
1956 United Nations Convention on the Law of the Sea (UNCLOS I)
UNCLOS I produced four treaties that served as predecessors to the current treaty, which
was amended in 1982:
Convention on the Territorial Sea and Contiguous Zone
(entry into force: 10 September 1964);
Convention on the Continental Shelf (entry into force: 10 June 1964);
Convention on the High Seas (entry into force: 30 September 1962); and
Convention on Fishing and Conservation of Living Resources of the High Seas
(entry into force: 20 March 1966).
Of these four treaties, the Convention on the Continental Shelf is the most referred to
in joint development agreements because this is the most common location for disputed
oil and gas discoveries; the Convention serves as the legal guide for determining who has
claim to what.
1970 United Nations General Assembly Resolution 2749 (XXV)
Serving as a legal framework for international regulation of the seabed and ocean floor,the
Resolution puts forth a set of principles for guiding State action, especially with regard to
exploration and exploitation of resources.
1982 United Nations Convention on the Law of the Sea (UNCLOS II)
An amended version of earlier UNCLOS treaties, the 1982 Convention did not enter into
force until 1994.The treaty includes specified definitions for different categories of water-
ways (internal waters, territorial waters, archipelagic waters, contiguous zone, continental
shelf,exclusive economic zone) and measurements for determining a State’s claim to each.
The treaty also established the International Seabed Authority and the International
Tribunal for the Law of the Sea. Countries differ on their adherence to these definitions
based on whether or not they have ratified the Convention.
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process, and some pose considerable technical difficulties.This means that, in many cases,
a State’s own view as to the boundaries of its territorial sea, continental shelf or exclusive
economic zone is not accepted by neighbouring States and their licensees. The resulting
issues, sometimes amounting to disputes, are ultimately to be resolved either by negotia-
tion or by litigation. These processes sometimes last for decades or fail altogether. Until
the issues are resolved and often even afterwards, they can give rise to serious regulatory
problems for the industry.
Disputes about international boundaries occur in all parts of the world but are
perhaps at their most acute in semi-enclosed seas bordered by several States, although
they also arise in relation to seas that are virtually fully enclosed, such as the Black Sea,
the Mediterranean and the Caspian.
19
Two good examples of semi-enclosed seas are the
South China Sea and the Gulf of Thailand, but there are many more, notably in Latin
America and the Gulf. Where several coastal States border the waters in question,
the result is usually a complex mesh of overlapping claims. In a perfect world, prompt
regional negotiation on a sensible basis would be followed by regional agreements sorting
out all the important issues. The States concerned could then proceed confidently with
organizing, regulating and promoting their oil and gas industries and other economic
activities in the waters in question. Unfortunately, experience shows that comprehensive
regional agreements involving a number of key players are extremely hard to arrange.
Many academic and other commentators who write about these issues invariably regret
this, normally adding their own sometimes naïve but often perfectly sound suggestions
about how progress might be made. However, that comprehensive regional agreements
are extremely hard to engineer is not really surprising, given what is potentially at stake.
In the absence of comprehensive regional agreements, individual States sometimes try
to reach bilateral agreements with one or more other States or even to reach multilateral
agreements on specific aspects of the wider problems. Either way, even this approach
tends to be quite difficult either because the more important problems are so closely
interconnected or because, even where they are not, issues of balance and leverage
may make it impossible to resolve one problem on a definitive and unconditional basis
without solving another at the same time.
Quite frequently, there is still room for disagreement on national rights even though
a land or maritime boundary has been delimited or is at least the subject of a measure of
agreement between the affected States. These disagreements often extend to their
licensees, especially where NOCs are concerned. The scope for disagreement is particu-
32
19 It is in fact debatable whether the Caspian is truly a sea,a term not defined by UNCLOS,or whether from a legal perspective it should be treated as a gigantic lake.
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33
larly broad when deposits actually straddle the international boundary or where it is
thought that they might. In such cases, what is done on one side of the boundary can have
major adverse consequences for the holders of corresponding rights on the other side.
Public international law (which in essence is the law of interstate relations) is not silent
on this subject, but on many of the most important issues, its provisions are uncertain and
leave considerable room for doubt. This means that even well-informed Governments
remain in a state of uncertainty. At its most serious, such uncertainties can have very grave
consequences. Saddam Hussein’s alleged grievances about oil and gas activity on the
Kuwaiti side of the international boundary were said to have been a significant cause of
the first Gulf War. It was illegal under the United Nations Charter for Iraq to attempt
to resolve the issue using armed force, but if applicable international law were more
precisely articulated, Governments such as those of Iraq and Kuwait would know much
more clearly whether any particular grievance is or is not legally justified and could adjust
their behaviour accordingly. A number of commentators assert that, in this field, a “rule
of capture” operates in international law.
An issue between States about the actual position of their undelimited maritime
boundary is essentially a dispute about how far each State’s “territory” and jurisdiction
extend. Territorial disputes have always been considered first-order interstate questions
since they directly affect the size of the State and its power, prestige, economy and tax
base. For these reasons, first-order questions have, at least in the past, frequently led to
war. Although, mercifully, armed clashes between States are relatively rare features of oil
and gas disputes, it is useful to make a working distinction between disputes of this nature
and second-order issues that crop up, often in a routine way, between Governments of
neighbouring States on all kinds of issues that govern the relationship, from visa issues to
environmental ones, from economic regulation to security problems.
It is also important to note that first-order boundary issues are certainly not the only
international problems that affect the design of legal and regulatory frameworks.
All Governments must also factor in compliance with the international rules governing a
range of second-order issues that might otherwise cause bilateral or multilateral difficul-
ties and disputes. Such issues range from coastal zone management and international
waterway regimes to security and environmental concerns. Furthermore, boundary
questions of both the first and second order give rise to further layers of uncertainty, all
of which can have an impact on the design of a framework.
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