Bargaining Power Balance between the Host States and the IOCs
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Coursework Assignment Brief
| Semester: | Summer 2014
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| Module Code: | POG 220
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| Module Title: | Legal Aspects of Oil & Gas
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| Programme: | BSc (Hons) Oil and Gas Management
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| Level: | Level 5
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| Awarding Body: | University of Plymouth
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| Module Leader: | Vick Krishnan
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| Format: | An individually written assignment consisting of a written essay/report of 2,500 words. |
| Presentation: | Yes
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| Any special requirements: | All written work should be submitted on the Student Portal along with an acceptable Turnitin Report
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| Word Limit: | 2,500 words
YOUR WORK MUST BE SUBMITTED VIA THE STUDENT PORTAL. HARD COPY OR EMAIL SUBMISSION WILL NOT BE MARKED.
Word Limit Penalty for task 1 10% under / excess No Reduction 20% under / excess 5% Reduction 30% under / excess 10% Reduction 40% under / excess 15% Reduction 50% under / excess 20% Reduction Over 50% under / excess Half the total marks
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| Deadline date for submission: |
The deadline date for submission is 5.00 pm on Wednesday 13th August 2014.
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| Learning outcomes to be examined in this assessment (please note that this is not the assessment task) |
Knowledge and understanding: Demonstration of detailed knowledge of the legal framework of oil and gas industry and the implications of national, regional and international law.
Cognitive/intellectual skills: Ability to analyse a range of information and to synthesise ideas, selecting appropriate techniques of evaluation.
Key/Transferable skills: Ability to manage information towards a given purpose and understand the relevance in the analysis of legal problems.
Practical skills: Ability to apply given techniques to the solution of particular problems.
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| Percentage of marks awarded for module: | This assignment is worth 50% of the total marks for the module
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| Assessment Task: | An Individual Essay/Report
What bargaining powers exist between host states and international oil companies at the commencement stages of Exploration and Production. In this respect, critically evaluate the concept of “relative bargaining power” in the contractual relationship between host-governments and international oil companies.
You must support your answer with relevant and appropriate examples.
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| Assessment criteria | Explanatory comments on the assessment criteria | Maximum marks for each section | |||
| Content, style, relevance and originality | Relevant, accurate content, demonstrating academic and literary research, as necessary and required by the Assessment Task. | 50% | |||
| Format/Structure, Referencing and Bibliography
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Full text referencing and bibliography using the Harvard citation method | 10% | |||
| Constructive critical analysis, introduction, conclusion | Demonstrating the ability to critically analyse and/or evaluate the subject area. Emphasis will be placed on the ability to triangulate introduction, discussions and conclusion. Higher marks will be given to those that are able to introduce issues for further contextual exploration. | 40% | |||
General Guidance/Structure :-
You are required to develop a well presented and logically structured essay on the concept of ‘relative bargaining power’.
Basically you are evaluating the respective parties (Host States and IOC’s) bargaining powers and how the pre-contractual negotiations subsequently translate into a full blown E & P contract. Evaluate which party has more bargaining power and why is this so? Look at the following issues :-
(1) The asymmetry of information in the hands of the IOCs
(2) Their technical expertise, and
(3) They are financing the project development.
Compare this with concession agreements – how do these differ? Also look at royalty payments and returns, and see how these payments and returns affect the relative bargaining power of the parties.
You should aim to develop a number of competing arguments on the dynamics of the relationship between the host-governments and IOCs.
You are to provide a balanced view of the issues involved and whether contractual relationships are sustainable in the long-term in oil producing countries without strong legal frameworks for enforcing contracts.
A good structure and a coherent analysis which is supported with academic and literary evidence is very essential.
Marking Criteria for Task 1
| Indicative Grade | UK% marks | Characteristics. |
| Distinction | 70%+ | Very high standard of critical analysis using appropriate conceptual frameworks.
Excellent understanding and exposition of relevant issues. Clearly structured and logically developed arguments. Good awareness of nuances and complexities. Substantial evidence of well-executed independent research. Excellent evaluation and synthesis of source material. Relevant data and examples, all properly referenced. |
| Merit | 69-60% | High standard of critical analysis using appropriate conceptual frameworks.
Clear awareness and exposition of relevant issues. Clearly structured and logically developed argument. Awareness of nuances and complexities. Evidence of independent research. Good evaluation and synthesis of source material. Relevant data and examples, all properly referenced. |
| Pass | 59-50% | Uses appropriate conceptual frameworks.
Attempts analysis but includes some errors and /or omissions. Shows awareness of issues but no more than to be expected room attendance at classes. Arguments reasonably clear but underdeveloped. Insufficient evidence of independent research. Insufficient evaluation of source material. Some good use of relevant data and examples but incompletely referenced. |
| Pass | 49-40% | Adequate understanding of appropriate conceptual frameworks.
Answer too descriptive and or any attempt at analysis is superficial containing errors and omission. Shows limited awareness of issues but also some confusion. Arguments not particularly clear. Limited evidence of independent research and reliance on a superficial repeat of class notes. Relatively superficial use of relevant data sources and examples and poorly referenced. |
| PASS MARK=40% | ||
| E | 39-30% | Weak understanding of appropriate conceptual frameworks. Weak analysis and several errors and omissions.
Establishes a few relevant points but superficial and confused exposition of issues. No evidence of independent research and poor understanding of class notes or no use of relevant data, sources and examples and no references. |
It is recommended that you review the requirements of the assignment before submitting your work.
Students should conform to the conventions of the above assessment format in the preparation of their assignments. The relevant assessment criteria have been stated to enable and guide students in the preparation of their work. Achievement of the learning outcomes and the application of relevant theories to the assessment task should be demonstrated.
SAMPLE ANSWER
Bargaining Power Balance between the Host States and the IOCs
The discovery of the much coveted natural resources such as oil for most countries ignites extremely high national and personal dreams of riches and hopes of prosperous times. This is escalated by the recent dramatic increases in the prices of oil. However, the process of exploiting such prestigious resource is not without challenges to the host countries, most of which are developing (Rassel, 2012, p. 797). The challenges mostly involve overcoming commercial, legal, technical, and expertise requirements required in exploration and development (Guzman, 2010, p. 171). The key hurdles centre mostly on management issues leading to the need to invite international companies with expertise and resources to help in the exploitation and marketing of the energy resource. The major concern arises once the host countries find that the international oil companies (IOC) often possess superior financial resources, superior knowledge of the oil, and even more contract negotiating experience than them (Rassel, 2012, p. 797). For instance, some companies such as Exxon Mobil have more resources ($371 billion) than most of the countries they operate like Saudi Arabia whose entire GDP is $ 281 billion (Peacock, 2010, p. 131). As such, negotiation and maintaining of the contracts can be a heated affair.
Bargaining power is the relative ability of parties involved in a situation to exert influence over each other in which if both parties’ posses equal footing in the involvement, then they have equal bargaining power and unequal bargaining power if otherwise (Guzman, 2010, p. 171). As Rassel (2012, p. 797) notes, in negotiations, bargaining power can be conceptualized as the capacity of one party to dominate the other as a result of its power, size, status, or influence, or even through a combination of the different persuasion tactics. In most cases involving negotiations between host countries and IOCs, unequal bargaining power is manifested by one party, most often the IOCs.
Prospects of Relations between Host States and IOCs
The nature of the oil and gas industry is one in which large returns can be realized since the commodity value in the market above the cost for maintaining the factors of production and for earning profits. Conflicts between the host and the OIC more often emanate from the issue of returns sharing (Shaw and Cooper, 2009, n.p). Bargaining between the host and the IOC determine the division of the rents that each party in the agreement is to receive (Rassel, 2012, p. 797). Although there is a divergent between the goals of the host and those of the IOC, there is equally an array of complementarity and such a platform for each of the two sides to realize their targets through cooperation (Guzman, 2010, p. 171). However, the challenge arises, as a result, of the great discrepancy that exists in terms of resources; financial and expertise, between the two parties whereby more often the IOC are better established than the host countries.
During the negotiation stage, for instance, IOC is highly motivated (Peacock, 2010, p. 131). The companies are likely to overlook the high initial cost involved in the development and exploration even in the instance that they encounter several dry wells. They will, however, be keen to recover all these costs rapidly once they have embarked on a successful production (Shaw and Cooper, 2009, n.p). IOCs have a tendency of tailoring their negotiation style to suit their interpretations of the political environments in countries they operate. Having been accustomed to authoritarian regimes and civil strife in most of the countries they operate in, the oil companies will most likely bring a self-protective, uncompromising, feisty attitude towards negotiations (Guzman, 2010, p. 171). In such cases, the environmental and societal impacts of the projects are ignored during negotiations a result of which is conflicts and breaching of agreements in the after days. Oil contracts are the result of negotiations more so since they are varied and complex.
According to Rassel (2012, p. 797), investors seek and require legal and institutional stability especially in terms of political, societal inexperience in handling resources, and institutional conflicts. Although most companies would wish to avoid such situations, oil companies are more often forced by circumstances to operate in conflict zones since the resources are mostly fond in these countries (Shaw and Cooper, 2009, n.p). These emerging countries normally do not possess sufficient domestic know-how be it financial, legal, or technical, for the development, management, and implementation (Solimene, 2014, n.p). As a result, they have to seek skilled and independent negotiators from the private sector, which is seen as more lucrative and professionally challenging in order to counter this superior experience that IOCs bring to the table.
Types of Contracts used in Oil and Gas production Agreements
Host governments are normally faced with the dilemma of the type of contractual system to use in terms of the concession or license agreement, a joint venture, a PSC, or a service agreement (Solimene, 2014, n.p). In concessions, the contracts grant the IOC a right to explore, develop, and to export the oil extracted in a specific area for which the company has received the exclusive production rights for a prescribed time. Economic and financial advisers and lawyers are needed to structure the bidding system (Peacock, 2010, p. 131). The terms of license are drafted by the host government in compliance with the applicable law. PSCs are agreements signed by the government and the extraction company concerning how much of the resource extracted each will receive (Vivoda, 2009, p. 517). The main difference between concessions and PSCs is that in concessions, the degree of professional support and expertise required is not as extensive as in the case of PSCs. There are also different commercial results achieved by each of the two types of contracts; concession and PSAs. In PSAs, the host nation can earn a signing bonus (Rassel, 2012, p. 797).
The Production-sharing Contract recognizes that ownership of the resource rests with the citizens and not with private parties. Just like in the case of the licenses, the IOC develops, operate, and manage the oil field bearing all the operational and financial risks (Shaw and Cooper, 2009, n.p). In this type of contract, the host state has a number of benefits. For instance, depending on the period of depreciation, the host country can earn a greater share of oil proceeds early. The profits are shared according to the agreed percentages and the IOC is obliged to pay taxes (Vivoda, 2009, p. 517). However, this type of contract presents some challenges especially in developing countries with large number of issues to be addressed and the less reliable legal infrastructure. PSCs demand skilled negotiators and experts in legal, commercial, technical, financial, and environmental areas (Solimene, 2014, n.p). This is a daunting challenge for host countries with their dire lack of data and information than the IOCs. PCAs were introduced in Indonesia in 1966 and have since been adopted by over 40 countries across the globe like India and in Africa (Peacock, 2010, p. 131).
Rassel (2012, p. 797) postulates that a joint venture arises if parties wish to pursue a joint undertaking with agreements on profit sharing as well as operational, financial, and management risk allocations. Service agreements involve the contractor receiving a fixed payment independent of the discoveries or oil prices. Management decisions key to the process tend to remain within the government (Rassel, 2012, p. 797).
Across history the industry has been characterized by cyclical shifts in relation to the balance of power between the host countries and IOCs, a feature that is reflective of the cyclical nature of this industry (Shaw and Cooper, 2009, n.p). The host states were consequently able to earn larger shares of the economic rent. In addition, these periods were characterized by very low degrees of compatibility between the IOCs and the host countries. Besides, during the late 1980s and 1990s, the relationship was more of cooperative with falling market prices, which resulted in the balance of power shifting to the IOCs (Solimene, 2014, n.p). As a result, there was higher compatibility between the hosts and the IOCs and the balance of power now shifting to IOCs. In a nutshell, this implies that the larger the rents for division, the more intensive the bargaining relationship between the two parties becomes.
Arguing from the Vernon’s obsolescing bargaining model (OBM)’s perspective of the relationship between the host and the IOCs, it is clear that the changing nature of the bargaining relations is a function of resources, constraints, and goals on both sides (Pate, 2009, p. 347). As discussed earlier in this paper, the initial stages of bargaining are seen to favour the IOCs, a feature attributed to their established resource base when entering the relationship as opposed to the less versed hosts mostly the developing nations that lack the same (Shaw and Cooper, 2009, n.p). However, as the relationship proceeds the IOC’s assets are turned into captives with the bargaining power consequently shifting to the side of the host countries (Maniruzzaman, 2009, p. 79). Once the bargaining power is on the side of the host country, the government is at a position to impose more conditions on IOCs ranging from higher asset expropriation to taxes.
Notably, the relationship between the host countries and the IOCs has since changed from a confrontational one to a more cooperative (Shaw and Cooper, 2009, n.p). Besides, the shift in the way governments addressed the issue of contracts was followed by the deregulation, and less expropriation, and economic liberalization of the oil industry (Rassel, 2012, p. 797). Rassel, (2012, p. 797) notes that there is another emerging scenario in which the IOCs are seen as struggling to secure new oil reserves in the recent years, as a result, of increased competition.
Factors Affecting Bargaining Power between Host States and IOCs
Largely, several factors that are firm-specific affect the bargaining power of IOCs either as resources or constraints (Vivoda, 2009, p. 517). An IOC that has a reputable international presence is likely to command greater bargaining power that has the potential to achieving favourite investment terms in negotiations with the host state (Rassel, 2012, p. 797). Besides, companies with poor records on environmental conservation, as is the case with the infamous BP oil spill incident at the Gulf of Mexico, are less likely to attract good contracts to drill offshore areas particularly without very adequate regulation in place (Shaw and Cooper, 2009, n.p).
An IOC’s reserve replacement acts s a key indicator of its bargaining power (Pate, 2009, p. 347). Reserve replacement is a good indicator to the ability of the company to sustain and expand their business in the coming days. As such it becomes an important measure of performance and a key factor in showing the value of the company in the financial markets since it measures the ability of the company to continue operating as a viable entity (Solimene, 2014, n.p). In this effect, if the IOC is unable to do stock replacement annually, then it would be perceived as performing poorly both in the market and in terms of its bargaining power (Maniruzzaman, 2009, p. 79). Alternatively, if they are to reproduce all their products and consequently secure access to additional reserves, then their bargaining power is enhanced (Rassel, 2012, p. 797). The five major companies were able to replace 99.7 percent of oil they produced between 1998 and 2002, seen as being at the break-even point while between 2003 and 2007 they were only able to replace 51.7 percent of the oil they produced (Shaw and Cooper, 2009, n.p).
The country of origin of the IOC has a direct impact on their bargaining power relative to a given host country. This is so because of the different political, colonial, historical, and cultural factors. The political climate is likely more accepting for an IOC from a home country with stronger historical ties and greater cultural proximity (Vivoda, 2009, p. 517). Such ties are an important source of better perception of the reputation of the IOC by the host government because of the perceived closer fit between the management approaches of the company with what is common locally. The institutional distance has implications on the company’s legitimacy capacity in the host state (Maniruzzaman, 2009, p. 79). Institutional distance in this effect refers to the similarities or differences between the regulatory, normative and cognitive institutions of the two nations (Shaw and Cooper, 2009, n.p). When the institutional distance is high, the host government is likely to perceive of the IOC stereotypically, which is likely to affect the relationship between the two parties negatively making it difficult for them to reach a consensus (Rassel, 2012, p. 797). For example, in the case when the government of the U.S. engages in negotiations concerning American-based IOCs with host governments, the support tends to weaken the IOCs due to the high institutional distance in terms of the unfriendly anti-American cultural and political context of the host nations (Vivoda, 2009, p. 517).
Legal frameworks governing oil exploration are complex, multi-layered, and in most cases, contain components that are ambiguous. Contractual relationship between the host government and the IOCs is undoubtedly affected by the intertwinement and complexities of the various legal, institutional, constitutional, policy, and agency systems (Rassel, 2012, p. 797). The system of these prerequisite requirements that govern the oil and gas sector policy and exploration consequently impacts on its developement and implementation which entails several aspects and stages each of which has distinct with legislative and legal instruments (Maniruzzaman, 2009, p. 79). There exists a considerable degree of legal uncertainties, disparities, and ambiguities that lower the legal predictability in Oil and Gas contractual arrangements (Solimene, 2014, n.p). This has, in some cases, generated serious rifts and tension between the two parties as is the case in Iraq in 2008/9. The Iraqi oil and gas industry witnessed a period of changes of contracts with new elements in the legal and governing framework (Iraq Oil & Gas Report’ 2013, p. 45). The Iraqi service contracts form an important milestone in shaping future relationship between host countries and IOCs.
Conclusion
Most host states seek IOCs in order to access the managerial and technological skills they have to offer. The degree of managerial and technological skills that an IOC possesses vis-a-vis the host country can be taken as the key factor promoting their bargaining power. The main rationale behind this concept is that the superior and complex managerial and technological skills make it difficult for the hosts to engage with the IOCs because these developing countries have a shortage of the same (Maniruzzaman, 2009, p. 79). In this case, therefore, the host’s bargaining power is more when it has valuable natural resources desired by the IOCs. Notably, countries that have smaller reserves are less likely to attract a lot of IOCs. For instance, the more established IOCs may have more interest to invest in the more established countries such as Saudi Arabia and Russia as compared with Egypt and Malaysia. The rationale in this argument is on the basis of reserve longevity and potential profitability
References
Guzman, AT 2010, ‘International Soft Law’, The Journal Of Legal Analysis, 2, p. 171
‘Iraq Oil & Gas Report’ 2013, Iraq Oil & Gas Report, 1, pp. 1-99
Maniruzzaman, Pm 2009, ‘The Issue Of Resource Nationalism: Risk Engineering And Dispute Management In The Oil And Gas Industry’, Texas Journal Of Oil, Gas, And Energy Law, 5, p. 79.
Pate, TJ 2009, ‘Evaluating Stabilization Clauses in Venezuela’s Strategic Association Agreements for Heavy-Crude Extraction in the Orinoco Belt: The Return of a Forgotten Contractual Risk Reduction Mechanism for the Petroleum Industry’, The University Of Miami Inter-American Law Review, 40, p. 347.
Peacock, B 2010, ”A virtual world government unto itself’: uncovering the rational-legal authority of the IOC in world politics’,Proceedings: International Symposium For Olympic Research, p. 318.
Rassel, S 2012, ‘The Necessity For National Federations To Stand Up For Themselves‘, Michigan State University Journal Of International Law, 20, p. 797.
Shaw, T, & Cooper, A 2009, The Diplomacies Of Small States : Between Vulnerability And Resilience, Basingstoke [England]: Palgrave Macmillan.
Solimene, F 2014, ‘Political risk in the oil and gas industry and legal tools for mitigation’, International Energy Law Review, 2
Vivoda, V 2009, ‘Resource Nationalism, Bargaining and International Oil Companies: Challenges and Change in the New Millennium’, New Political Economy, 14, 4, p. 517.
Vivoda, V 2011, ‘Bargaining Model for the International Oil Industry’, Business & Politics, 13, 4, pp. 1-36
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