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Legal Aspects Of Oil And Gas Industry: Management Add in library

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Question:

Examine and evaluate the Legal Aspects of Oil and Gas Industry?

 

Answer:

Introduction

Discoveries of natural gas and oil resources give nations hope for the future prospect. International oil companies enter into contracts for exploration of natural gas and oil contracts with these nations that are rich in such resources. Though such nations may themselves explore the resources but many-a-times, they do not possess the required skill, expertise and most importantly the financial stability to undertake such a project. Thus, they try to magnetize the participation of the international oil companies. However, before entering into such contracts with the oil companies the governments of the host countries undergo a process of negotiation. These negotiations are very challenging. The said negotiations are all the more challenging because a lot is at stake with these negotiations. When oil resources are discovered in a country, the government acquires right over it notwithstanding the fact that the surface rights are owned by an individual. The nations that have oil resources tend to magnetize the participation of these oil companies for the exploration as these companies possess all the required skill, expertise, experience and financial backing to undertake such a project. The oil companies that have experience of negotiating such contracts mostly have the upper hand in the process of negotiation and are motivated to ensure profit maximization. Thus, it is essential for the governments to be extra-cautious in the negotiation process so as to be able to make as much revenue as possible out of these projects.

In this paper, we would analyze the various aspects of oil and natural gas negotiation and explore the issues involved.

Issues involved in the process of Negotiation

In order to give effect to the oil contracts, the government of the host countries and the international oil companies undergo direct negotiation. The attitude of the government during the process of negotiation is mostly very indecisive and such indecisiveness results from lack of technical knowledge, capability of predicting future as regards the oil fields and proper awareness about the oil fields. Thus, in order to be able to negotiate successfully it is imperative that the governments keep these factors in mind while undertaking such negotiation. The changing market for oil, the exploration cost, and the size of the oil field are significant factors that must be considered by the government while negotiating. Most of the time, the governments fail to give proper attention to these aspects and the oil companies end up taking advantage of the ignorance of the governments.  The following issues are important for giving effect to a successful contract and therefore they must be given proper consideration;

Interest of the Indigenous Communities

These oil exploration projects resulting out of contracts between the oil companies and the governments of the host countries affect various other groups of individuals who are not directly involved in the process. These groups are the local communities of the host countries. In fact, these communities are at the receiving end of the adverse effects of such projects. In fact, mostly the surface rights over the oil fields are owned by these local communities and thus they must be compensated by the oil companies for the disturbance and use of their property.  Thus, the interest of these groups must be considered by the governments while negotiating the terms of the contract (3 oil & gas contracts for Aker Kvaerner, 2007).

Transparency

The negotiation process must be transparent. These contracts would be accepted by the public if they are transparent. In order to be transparent, the contractual term must be disclosed. However, there are certain aspects that ought not be disclosed. When the negotiation process is transparent, it is possible to avoid corrupt practices that the negotiators might get involved into. If the contractual terms are made subject to public scrutinisation, the negotiators would not insert such terms in the contract that might be criticized by the public (Babusiaux, 2004).

Negotiators

The government makes up a team to undertake the negotiation process. This team consists of members from different fields. While making up this team of negotiators, the governments ought to be extra cautious. The process of negotiation must not be taken casually. In fact, negotiation is not just a process before entering into a contract but is an art. The negotiators must have the capability of making a distinction between the negotiable and nonnegotiable factors. Having made such a distinction they ought to pay greater attention to the negotiable factors (Bantekas, 2009). They must as well undertake good tactics for negotiation and must proceed on the basis of plans already formulated. The oil companies are far better equipped than the governments to negotiate these contracts so the government should take this negotiation process seriously and employ expert, negotiators. The negotiators must be from different fields, like legal, technical, etc and ought to possess the required skills to make a successful negotiation on behalf of the government. The principle underlying the negotiation is to reach at a mutually agreeable point where the interests of both parties are balanced. Only successful negotiators can achieve this goal.

Balancing Conflicting Interests

Conflict of interest is a common phenomenon while the terms of these type of contracts are negotiated. The Government, on the one hand, has to act as a business entity, the sole purpose of which is to maximize profits. On the other hand, it has to make the oil companies invest in the resources of the country so that the revenue of the country increases leading to an economic growth of the country (Bhattacharyya, 2009). The Government maximizes profits on the one hand and regulates its conduct on the other. The Government must be able to balance the conflicting interests while negotiating the terms of the contract.

Time

Time responsive factors are predominantly present in oil contracts. For instance, oil prices keep varying from time to time, the political and social conditions of the country that possesses the natural resources. The drafting of the oil contracts must be made in such a manner that these factors may be varied accordingly. The terms of the oil contract must be such that they survive the test of time (Bindemann, 2000). The terms should be such that the changes may be made in future on the basis of the future demands, whether foreseeable or unforeseeable. Thus, the oil and natural gas contracts must be responsive to changing circumstances. Norway, for instance, made its tax regime profitable for the oil companies so as to entice their participation to their geographically challenging terrain.

 

Types of Contracts

There are various types of contacts that the governments and the international oil companies can enter into for exploration of the oil and natural gas. These contracts may be discussed as follows;

Joint Venture Agreement

The government and the oil companies may elect to enter into a joint venture for the exploration of the natural resources. But before plunging into such a decision, both parties must be well aware of the goals, interests and mode of conducting business of each other.  Since under a joint venture agreement the parties work together, it is essential that they have knowledge about these aspects of each other or else it would not be possible to make the joint venture successful. The parties ought to be consensual on these aspects. As the joint venture agreements are open-ended, nether of the parties are very eager to enter into such contracts.

However, these agreements are advantageous for the governments as they can rely on the oil companies for decision making. Moreover, the government shares profits with the companies under this type of agreement (Khannanova, Nizamova and Kantor, 2015).

The disadvantage of entering into this type of agreement, from the perspective of the government is that they have to share the risks along with the companies. The government participates directly in the process of oil exploration under this type of contract (Ghandi and Lin, 2014).

Production Sharing Agreements (also referred to as PSA)

Under this type of contracts, the responsibilities associated with the development and managing of the oil resources lies with the oil companies. Even the risks associated with the exploration process are to be borne by the companies. The government earns signing bonus by giving the oil companies the right of exploration. The operational expenses and the costs of exploration are compensated to the company by the government, and the remaining profit is divided between the parties as per the agreed proportion. The taxes are paid by the oil companies. In order to make this type of agreements successful, the legal framework of the host country must be comprehensive enough. In case, the legal framework is not worth relying on, the terms of the contracts would operate as law (Jennings, 2002).

Licensing or Concession Agreements

Under this type of contract, the oil companies are given right of exploration for a specified period. During this period, the said oil company would have the exclusive right of exploring, selling and exporting the resources extracted. Generally, right sunder this type of contract is granted by way of auction. The governments draft the terms of the contract and then opens up bidding for the oil companies. The company that emerges to be the highest bidder gets the exclusive exploration rights. The highest bidder amount is paid by the oil company to the government of the host country as licensing fees. Even if production does not take place, yet the government retains the said licensing fees. If production takes place, the host country receives income tax as well as royalty (Mahmud and Russell, 2002).

These licensing agreements are the best suited to serve the interest of the host countries.

Service Agreements

Service agreements are also entered into by the parties along with the above types of agreements. The purpose of this type of agreement is to enable disbursement. However, this type of agreement is not very popular with either party to the contract because they do not turn out to be very useful in the long run.

 

Important Terms of the Contracts

The following important terms must be incorporated in every oil and natural gas exploration contract;

Description of the premises

There must be a complete legal definition of the premises leased to the companies for the exploration work. If there is more than one field to be explored, then two different contracts must be entered into.

Limiting the contractual term

The contract should explicitly lay down whether the contract is for exploration of oil or natural gas or other minerals.

Royalty Clause

From the perspective f the government, the most important is the royalty clause. The mode of payment and well as the time of payment of the royalty to the government must be clearly provided in the contract (Marshall, 2003).

Post Production Costs

Since, post production issues are frequently litigated upon by the parties, it is imperative that the mode of dealing with the post production costs must be clearly laid down in the contract (Tade, 1989). 

Plan of Work

The oil companies have a tendency of delaying and shelving not so profitable projects. Thus, the contract must contain an exhaustive list of circumstances under which a project may be shelved or delayed. It must also be specifically stated that apart from the stated circumstances, a project cannot be shelved or delayed for any other reason (Martin, 2009).

Stabilization Clause

Governments should refrain from inserting stabilization clauses in the contract because such clauses make the laws of the host country inapplicable to the provisions of the contract.

 

Vision of the Government behind Negotiation

The oil companies are very must profit motivated, and they attempt to minimize costs and maximize profits as much as possible. The governments have to consider the development of the country while it negotiates the contractual terms with the oil companies. The Government must have the following as its vision and mission behind the undertaking of such projects;

Employment

A lot of man power is required to give effect to oil or natural gas exploration project. The Government should try to make the oil companies employ local manpower. This would lead to economic stability in the host country as many people would be employed. In case, unemployment is taken care of then the country would have a good financial standing. The company would also be able to benefit from such an arrangement as it will be spared the expenses of engaging outside labour (Mosburg, 1983).

Corporate Social Responsibility (also referred to as CSR)

The oil companies must be made to render its CSR during the tenure of the exploration project. The CSR responsibilities borne by the domestic companies may be made compulsory for the international oil company (Oil and gas exploration and production: reserves, costs, contracts, 2005). The rules of CSR which are applicable to the domestic companies could be made applicable to the oil companies. In case, such provisions are not strictly incorporated the companies would try and evade the CSR (Thornton, 1912).

Sustainable Development

At present sustainable development is an important concept that must be kept in mind by the government while negotiating the terms of oil and natural gas exploration contract. Governments should limit the extent up to which the oil companies may use the resources (OIL AND GAS: New Contracts, 2008). Since these natural resources deplete with continued usage, the usage should be limited so that it gets the time for regeneration.

 

Dispute Resolution Mechanism

The contract should lay down the mechanism for dispute resolution in case the parties get involved in a dispute. The parties have various options available for dispute resolution. The traditional mode of dispute resolution is the court proceedings, but the parties may as well decide to go for dispute resolution mechanisms that do not involve the technicalities of the formal court proceedings, like, arbitration. In fact, mostly parties opt for arbitration in case of international contracts as in the case of international transactions problem arises as regards applicable laws (Pongsiri, 2004). As a consequence enforceability of the terms of the contract becomes difficult. Mediation, conciliation may also be modes of dispute resolution. These processes are not very formal, and the parties have a say over a lot of issues, like the place of arbitration, arbitrators, etc. However, in court proceedings none of these factors are within the reach of the parties and thus they cannot mould them as per their convenience. International Commercial Arbitration are adopted by the parties in most cases. The procedures are not very complicated, and the parties have control over a lot of aspects (Razavi, 1989).

Conclusion

From the aforesaid discussion, we may conclude that the negotiation of oil and natural gas contracts with the international oil companies is a very complicated process that requires through research and proper consideration of several factors. Since the oil companies have a tendency to minimize costs and maximize profits the governments should ensure that they are also able to mobilize maximum profits. Since everything is dependent upon proper negotiation, the government should take the negotiation process seriously and take into consideration all the above factors so as to emerge as successful negotiators.

 

References

3 oil & gas contracts for Aker Kvaerner. (2007). Pump Industry Analyst, 2007(8), p.3.

Babusiaux, D. (2004). Oil and gas exploration and production. Paris: Editions Technip.

Bantekas, I. (2009). Oil and Gas Production Contracts. The Journal of World Energy Law & Business, 2(3), pp.263-264.

Bhattacharyya, S. (2009). Oil and Gas Production Contracts, Volume 1. 1st ed.20094Edited by Anthony Jennings. Oil and Gas Production Contracts, Volume 1. 1st ed. . London: Sweet and Maxwell, Thomson Reuters (Legal) Limited 2008. , ISBN: ‐978‐1‐84703‐750‐3 ix +398 pp. Int J of Energy Sector Man, 3(4), pp.428-430.

Bindemann, K. (2000). The response of oil contracts to extreme price movements. Oxford: Dept. of Economics [Oxford University].

Ghandi, A. and Lin, C. (2014). Oil and gas service contracts around the world: A review. Energy Strategy Reviews, 3, pp.63-71.

Jennings, A. (2002). Oil and gas exploration contracts. London: Sweet & Maxwell.

Mahmud, M. and Russell, A. (2002). Evidence that the terms of petroleum contracts influence the rate of development of oil fields. OPEC Review, 26(1), pp.21-44.

Marshall, A. (2003). Negotiating Transcendence. Ethnologies, 25(1), p.5.

Martin, T. (2009). Oil and Gas Exploration Contracts. The Journal of World Energy Law & Business, 2(2), pp.173-174.

Mosburg, L. (1983). Contracts used in oil and gas operations. Oklahoma City, Okla.: Institute for Energy Development.

Oil and gas exploration and production: reserves, costs, contracts. (2005). Choice Reviews Online, 42(07), pp.42

OIL AND GAS: New Contracts. (2008). Africa Research Bulletin: Economic, Financial and Technical Series, 45(3), pp.17792B-17792C.

Pongsiri, N. (2004). Partnerships in oil and gas production‐sharing contracts. International Journal of Public Sector Management, 17(5), pp.431-442.

Razavi, H. (1989). The new era of petroleum trading. Washington, D.C.: World Bank.

Tade, J. (1989). Drafting indemnity provisions in oil and gas contracts. [Chicago, Ill.]: Section of Natural Resources, Energy, and Environmental Law, American Bar Association.

Thornton, W. (1912). The law relating to oil and gas. Cincinnati: W.H. Anderson.

Khannanova, A., Nizamova, G. and Kantor, O. (2015). Opec In The Terms Of Oil Prices’ Reduction. OGBUS, (3), pp.590-611.

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