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Oil And Gas Industry Legal Aspects Add in library

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Question:

Examine and evaluate the key areas and features that goverments should focus on during their negotiation process and in the drafting of contracts with the international oil companies?

 

Answer:

Introduction

Nations that are huge quantities of natural resources intend to use such resources so as to maintain their economic stability and to gather funds that would be used for various developmental processes. In order to do so, the governments of such countries engage into legal contracts with those oil companies that operate in the international oil market and perform various activities associated with the exploration, drilling and processing of such natural resources with the aim of selling the processed resources in the market.  The technical, economical and commercial aspects of such oil exploration processes are considered with great importance by both the parties: the government of the countries that are home to such resources and the organizations that are interested in the extraction or drilling procedures. However, both the parties need to put efforts in this sector as the process of agreeing on a contract for the exploration of the natural resources of any country is indeed a challenging task: the first challenge being the process of negotiation in itself.  In most of the developing countries,  including Mexico,  Bolivia and  Kazakhstan,  the natural resources like that of oil and natural gas are considered to be  the national assets, instead of being the property of any individual or private organization or entity.   The legal right over the surface land is not considered when the government of these nations claim their right over the natural resources that lay beneath the ground:  the constitutions of these countries are enshrined by laws that validate this process.  The nations that have large reserves of oil, natural gas or any other resources make a consistent effort in providing such benefits to the oil companies that  they participate in the process of  exploitation of these resources, using their expertise and technical or financial resources, in order to market the resources properly.  

Definition of Contract:

A contract can be defined as a deliberate and voluntary agreement between two or more parties, which is bound by the law. In general, contracts are well documented by the competent parties  that take part in the agreement, but might also be implied in some other form or be developed as verbal agreement. The fundamental elements of any valid contract are legality, capacity, consideration, and mutual assent. A contract is said to have a legal existence if and only if the following factual elements are present:

  • An offer that is being made by one party to another.
     
  • The evidence of the acceptance of the offer.
     
  • A promise regardingthe performance of any job
     
  • A mentionable  consideration
     
  • A time span within which the promised performance will be made
     
  • Various terms and conditions that are applicable to the process of fulfilling the above mentioned promises.
 

Setting the Parameters:

In spite of the large number of stakeholders associate with the process of exploiting  the  natural resources of  a nation and the  intense interests of these stakeholders, the government of these countries tend to not pay the proper attention that such negotiation processes demand . However,  since  the amount of resources that are in stake in such types of legal contracts, the governments of these nations delegate the task of managing the complex issues involved in the process of such negotiation processes to the experts of these domains: as for example, experienced and esteemed lawyers are appointed to look after the legal aspects of  these contracts, engineers and engineering firms are appointed to look after the technical aspects of the contracts being drafted (Langford, 2014).    

 Successful oil contracts are generally found to emerge out from the processes that involve direct negotiations.  However, it is found in general  that various complex issues are involved  the process of negotiating an oil extraction contract, as such negotiations are more often than not flourished by indecision: the indecisions being associated with the lack of knowledge of the location of probable oil field,  the lack of any estimation of the amount of oil that could be drilled out of  the oil wells and / or  the lack of capability of the  parties taking part in the contract to make predictions about the future of the market. However lawyers who have the expertise of negotiating such contracts are well aware of the fact that each and every other negotiation process includes certain weak points, the situation under which the  negotiation id being conducted or the terms and conditions of the contract being irrelevant:  the proper  and efficient utilization of the weak moment being the key to  creating a win-win situation for any organization. The various issues that are generally taken into consideration during the process of negotiating an oil contract include the probable costs associated with the operational activities of oil drilling, the fluctuations of the market, the probable size of the oil fields and the estimated quantity of oil and natural gases that could be drilled from the oil wells and so on and so forth.  The experience of domain experts, along with judgmental power are essentially required so as find out the priority and importance of each of these factors, such that a balanced contract can be prepared: however it should also be considered that no such contract is identical to another, as the importance and the priority of the above mentioned   factors keep on changing from time to time and from place to place.

 

Issues that arise in the process of negotiation

The different issues that are associated with the negotiation process can be classified as:

  • The factors are not considered suing the negotiation process, like that ofenvironmental and social issuesand
     
  • The conflict zone .

In the following section, various other significant factors have been discussed:

  • Time Factor

Time- responsive factors are considered to be crucial for the process of negotiating oil contracts: such factors include -

  • The price of crude oil in the international market
     
  • Socio-political and economic condition of the country and
     
  • The inter-dependencyof the above mentioned factors

Oil contracts should be drafted such that the contracts are able to incorporate the various changes that these factors go through from time to time (Babusiaux, 2004).

  • Indigenous Communities

The various indigenous communities who are socially and economically affected by the oil contracts drafted in between the governments of the nations and the oil companies, demand for compensations:  the interests of these groups should be considered by the government during the negotiation process (Bantekas, 2009)

  • Transparency

The indigenous  communities of the nation are able to accept the legal contracts between the government and the oil companies only when the various terms, conditions and prices that are quoted in the contracts are disclosed to the public: thus the  a minimum level of transparency should be maintained during the process of negotiating an oil contract (Bhattacharyya, 2009).

  • Conflict of Interest

 As the government of the nation is considered as one of the parties involved in the oil contract, chances are there that a conflict of interest might be noticed on the part of the government during the negotiation process, as on one hand the government tries to maximize the profit of the nation, while on the other hand the government has to consider the interests of the various indigenous communities of the country (Bindemann, 2000).

  • Expert Negotiators

The process of extraction of oil and/ or natural gases involves various economical, legal, technological and environmental aspects (Cardella, n.d.). The government must employ experienced domain experts to look after these aspects of the oil contracts, as the international oil employ such experts so as to conduct the negotiation process (Crump, n.d.).

 

Types of Oil Contract

The various types of oil contracts that might occur in-between the government and the oil companies have been discussed in this section:

License Agreements

Through the process of License Agreements or Concession Agreements, the oil companies earn the exclusive rights of developing infrastructure, exploring oil fields, extract the oil, and sell the oil in the international market, for a stipulated period of time. The company pays a license fee to the government, which the government retains notwithstanding production. Ehen the production starts, the company pays income taxes and royalty to the government. Thus such contracts put the government in the advantageous position (Ghandi and Lin, 2014).

Production Sharing Agreement (or ‘PSA')

Such types of agreements ensure that the various risks and liabilities that are associated with the production of oil are borne by the company:  they must also compensate the government in form of payment of capital investments and the expenses associated with the operations (Jennings, 2002).  After the deduction of the above mentioned amount from the profit, the remaining amount is equally divided among the government and the companies. The company pays for various taxes from its own share of profit (Mahmud and Russell, 2002).

Joint Venture Agreement

In such agreements, the profit gathered by the process of exploration of oil and natural gases is shared by both the parties that are involved in the contract: the government and the oil company that is involved in the operational activities of drilling of oil. The government also has to take the burden of risks that are associated with the process of oil extraction.

However, the government is relieved of the task of taking decisions regarding the operations of the oil fields as this part of the operational activity is considered as the responsibility of the oil companies (Marshall, 2003).  Thus it can be said that   such types of agreements mandate the participation of  the  government in  the process of oil extraction.

Service Agreements

The government and the oil companies an also participate in a contract that would facilitate the process of disbursement. However, such service agreements are generally not common in the field of oil and natural gas  exploration (Martin, 2009).

Terms of Contract

The following terms are generally incorporated in any oil contract:

Plan of Work

When companies realize that a particular plan might not be profitable for them, they tend to delay or shelve the projects. A possible safeguard that the government can introduce against such strategies implemented by the oil companies is that they can clearly state those circumstances only under which the companies will be allowed to shelve or delay the (Mosburg, 1983).

Stabilization Clause

The oil contracts should be drafted in  such  a way that  the stabilization clauses are not included in the contracts, as such clauses restrict the implementation of the legislative clauses of a nation in the operational activities of  the oil companies (Oil and gas exploration and production: reserves, costs, contracts, 2005).

Parties

The oil contracts should also be drafted in such a way that the government in itself does not become a ‘party’ in the oil exploration contracts: this strategy is taken so as to not bear any direct and/ or unlimited liability of the contract. On the other hand, the government can participate in the contract by the process of making the government enterprise a direct party involved in the contract (OIL AND GAS: New Contracts, 2008).

 

Government Mission in the process of negotiation

The government should consider the development of the country as the sole interest and mission during the process of negotiating any oil contract with international oil corporations. The government should also try to include such clauses in the contracts that would ensure that the resources of the companies are utilized properly so as to develop the infrastructure of the country (Pongsiri, 2004). The following section provides some insight into those factors that the government should consider during the negotiation process:

  • Employment

Oil exploration projects require large number of manpower: the government should include such clauses in the oil contracts by which the oil corporations would employ the members of the indigenous community in their projects (Razavi, 1989).

  • Sustainable Development

Since oil and gas are non-renewable sources of energy, the government must look out for the fact that the oil companies are not given the permission to extract natural resources at such rates which might result in fast depletion of these resources.

  • Corporate Social Responsibility (CSR)

The government should ensure that the oil companies perform their CSR during the time when they operate in the host country (Thornton, 1912).

Mechanism for Dispute Resolution

The various mechanisms that are generally used for the process of dispute resolution must be unambiguously stated in the contract being drafted. The most common methods of dispute methods, as mentioned in oil contracts are:

  • The parties that are involved in any oil contract that approach any court of law in case of disputes:however it should also be considered that most court proceedings are highly time consuming processes (Tade, 1989).
     
  • International Commercial Arbitration laws can also be used so as to resolve disputes regarding those contracts that are signed between international oil companies and governments of various nations .

Conclusion and Recommendation

Very often, the governments of those  countries, that have large reserves  of natural resources like coal, oil and natural gas,  face several problems during the process of negotiating the nature and the clauses of the contract that are to be made  with these companies: as most of the organizations that are associated with the process of extraction of  oil and natural gases operate in the international domain and specialize in this particular sector, they are much  more experienced in such negotiating process that  are used to determine the  type of contract being  made and the clauses  that are being mentioned in the contracts.  Such companies indulge in all necessary procedures that would lead to the reduction of costs on the part: they often tailor their negotiation strategies according to the political, economical   and social conditions that prevail in the impugned country. During the negotiation process, very often than not, the oil companies express such behavioural traits that might be easily considered as cynical, inflexible and aggressive.  Therefore, it becomes essential for the governments of these nations to well strategies the policies and procedures that would be used in the processing of negotiating such contracts. The three most commonly used strategies that nations rich in natural resources adapt so as to negotiate contracts with the oil corporations are:

  • Forming indigenous state owned companies that would be responsible for the process of exploration of natural resources, processing of the crude resources and proper marketing of the products. Countries like Venezuela, Mexico, Saudi Arabia and Oman use such strategies to exploit their natural resources.
     
  • Inviting international oil companies to participate in the process of exploiting the natural resources. Countries like United Kingdom, Canada and Russia employ such strategies to collect funds for their developmental procedures.
     
  • Employing a combination of the above mentioned strategies, as done by companies like Indonesia, Nigeria and Kazakhstan.

It is recommended that the  governments of other nations should chose one of the above mentioned strategies, that would be suitable for the socio-economic and  political culture of the nation, so as to engage in oil contracts with international oil companies.

 

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].

Cardella, E. (n.d.). Negotiating Flexible Prices. SSRN Electronic Journal.

Crump, L. (n.d.). Negotiating Climate Change. SSRN Electronic Journal.

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.42-4042-42-4042.

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.

Soyer, B. and Tettenborn, A. (n.d.). Offshore contracts and liabilities.

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.

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