Foreign oil companies that have control over the critical production inputs required by a host country are likely to enjoy some degree of influence in the negotiation of terms. A package of oil production factors such as technology and funds is an essential input in oil production (Ghandi, 2001, p60). These factors give a company negotiation powers from the business and legal points of view. Therefore, many foreign oil and gas companies incur zero risks before committing themselves to exploration projects. There is always the propensity of the leverage moving in favor of the host nation after that. By investing in oil exploration, a foreign oil company acquires a risk and a tangible stake in the outcome. The completion of oil exploration, construction of oil rig and start of production causes foreign oil and gas companies to lose leverage and bargaining strength. This is because it is then easier for host nations to get technology and funds to proceed with oil production.
Gordon (2010) says that in the course of oil exploration, the host country climbs a learning curve as the local skills and capabilities strengthen. The host country does nurture skills and skilled leaders who can enhance negotiations. There is a reduced reliance on the supply of labor and technology from the prospecting foreign oil and gas companies. The more the company is exposed, the higher the likelihood of the government to make demands (Hunter, 2015, p46). In simplified terms, the bargaining power that rested on the oil companies slides towards the host nation. The process culminates into divestiture or nationalization of projects by the host country. At this point, the host nation will be demanding for transfer of technology. However, the prospecting foreign oil companies have vested interests on protecting the transfer of technology since this is a critical input (Picton-Turbervill, 2014, p53). The transfer of technology is a bargaining clout that many companies are not willing to throw away.
As an alternative, domestic distribution offers the host countries an entry point in the management of the oil industry. For example, national oil companies in Iran and Indonesia took marketing from foreign oil companies (Fatouros, 2008, p15). These smaller parts of production processes are taken up consecutively over the years until intricate export-oriented refineries are taken over. Another factor that multinational companies use as leverage is infrastructure. They get power over the production process since they have requisite infrastructure. The host countries have limited managerial skills and the companies, on the other hand, use this to increase their bargaining power when providing essential services.
Commodity-producer alliances and groups such as the OPEC model have offered producer countries more influence over the management of the oil industry (Vielleville 2008). The logic for the formation of such models is premised on the fact that a group is more powerful than divided individual nations. Joining forces enables countries to increase leverage on the oil production processes in their countries. Many countries have achieved control on production and pricing, which has forced oil-producing corporations to surrender their vestiges of ownership rights (Fabrikant, 2005, p25). However, it should be understood that the extent to which the oil-producing companies control their production and pricing varies based on their bargaining power and political agenda.
It is true that none of the oil producing states are independent of the foreign oil companies as many value their relationship (Joseph, 2004, p46). Although the host countries are prepared to concede a lasting role in their oil industry, they may struggle to realize control over their interests in the global industry. At such a point, nationalist sentiments on natural resources arise, although the term is filled with psychological and emotional undertones. Resource nationalism is made of the concerns of the domestic people on the development of the wealth. The term is embodied in permanent sovereignty concept over natural resources. The doctrine asserts that each country should exercise control over its economic activities and natural resources (Birnie et al., 2009).
Resource nationalism has been used by host governments to achieve their policy objectives. However, some countries have failed to pursue orderly assumptions on exercising their power in controlling the oil industry (Ghandi, 2001, p59). They have ceded control in managing exploration of natural resources in their jurisdiction. In some cases, they have been able to force oil companies to beat a retreat. However, resource nationalization has mostly been used by the host country to blame foreign oil companies for their failures. Many countries blame multinational companies when they are unable to run their affairs smoothly (Picton-Turbervill, 2014, p28). They have been convenient scapegoats owing to anti-foreign attitudes that have swept investments, thus destroying the mutual relationship that existed between the foreign oil companies and the host nations.
In the begging of the 20th century, many countries begun granting multinational companies generous concession and low royalties paid to the governments. However, many developing nations have reversed the situation (Hunter, 2015, p76). There have been terminations of agreements on concessions and confiscation of the assets that had connections to the concessions. As a result, these countries face challenges that include lack of leadership and direction. For instance, Venezuela took over 32 oil fields as part of its “stabilization policy” and forced six multinational companies to renegotiate their trade agreements.
In the face of increasing demand for foreign investments, the pendulum swung again in favour of foreign companies. Many countries agreed to sign agreements to advertise their countries as business and investment-friendly (Picton-Turbervill, 2014, p49). There has been no equal distribution of profits by the multinationals to host country. This is because the host countries have relinquished their lands, awarding offshore corporations concessions on their territorial waters, and legislations that give oil companies more power. Much of these political changes have been attributed to corruption, lack of infrastructure, ignorance, or technological advances. Many countries do not have specialists who can negotiate on behalf of their countries (Vielleville, 2008, p10).
According to Catton (2013), the developments in the oil sector can be described and perceived as a microcosm on the increased awareness by developing countries to develop control over their natural resources and an increased their appetite for higher benefits for their resources. They have imposed power by imposing conditions on the oil companies to enhance their influence. These measures have enacted been through negotiations, suggestions, requests, amendments, nationalization, and boycotts. Other countries have emphasized on continued cooperation between the host countries and investors (Lindøe, 2015, p59). Host countries have pursued enrichment of the political elites through corrupt deals while the oil companies increase their profit margin. The factors responsible for increased handing over powers to oil companies include changes, in attitude, political changes, progress in technology, and changes in the allocation of power.
Fatouros (2008) says that the changes in political regimes in many countries have transformed the operation of the oil industry in the respective countries. The oil industry is unique, owing to the challenges in starting and managing exploration. There are huge investment requirements for research, prospecting, exploration, and extraction of the resource (Ichniowski, 2008, p17). Higher qualification and skill value makes it impossible for some countries to manage the industry. Moreover, the importance attached to oil as a single product in regional countries increases its value. There is a unique history between the multination corporation, and host countries are factors that make oil industry unique and different from other industries (Talus, 2013, p86). The reference on challenges in foreign investment or technological problems is used as an excuse and distorting the focus on the problems facing the oil industry.
Talus (2013) posits that many oil and gas producing countries have shown increased interest in implementing service type contracts than the production sharing contracts in the exploration and development of natural gas and oil. The service contract is a contractual framework that is long term and governs the relationship between oil companies and host countries. Foreign oil companies are given the power and mandate to explore oil on the behest of the host country. They do that at specified fees. In many cases, the host countries do not cede control on their natural resources (Korr, 2001, p56).
The legal challenges that arise from the oil concessions are related to the incidental interpretation on the implementation details. The main driving factor towards the service contracts is attributable to sovereignty issues and control over global oil prices by foreign oil companies since countries have found that service type contracts address their sovereignty concerns. These have been reflected on the increased need for expertise and capital capabilities, as well as, changes in legislation on issues related to petroleum regulations and laws (Vielleville, 2008, p16). Countries such as Iran, Kuwait, and Venezuela were the first to adopt the service contracts in the early 90s. In the recent past, Ecuador, Bolivia, Mexico, and Turkmenistan have adopted this contract. International companies supply the host countries with capital investment and technology (Kerr, 2007, p53). The service contract is different from the traditional approaches on compensation methods, field ownership rights, operatorship in the field, and rights in producing crude, as well as, the level of risks to be incurred.
In this contract, issues of sovereignty occur as the contracts give companies the power to make a decision on exploration. They decide on exploration, development, and other operations which affect the industry in the long run (Picton-Turbervill, 2014, p73). Another concern is the lower ability of governments to provide oversight over the operations of multinational companies. This is because of the complex regulatory, operatorship, and supervisory roles. Additionally, host countries face institutional deficiencies and the tax code as they cannot collect rent from multinational companies. The lack of public support and political will owing to the institutional challenges of service contracts makes them impossible to implement. These contracts are better placed in solving sovereign issues, but they face problems such as huge losses in profits.
The cooperation between oil producing nations has not been solid as many countries have developed competition with each other (Talus, 2013, p29). The presence of host countries or presence of national oil companies increases competition. There have been increased needs to develop a strong economic structure between developing countries and other oil nations. This is attributable to the need for a viable business environment. Many companies have been accused of keeping developing countries hostage and lack of respect for the country’s sovereignty (Vielleville, 2008, p20). They have requisite capital and technological know-how, which gives them leverage in the oil industry. The projects require substantial resources and capital hence the need for commitment by the host countries of non-interference. The oil companies have forced governments to sign long term contracts.
In summary, international laws allow countries to nationalize their resources but compensate the investor for the expropriated property. The respect for contractual obligations does not hinder the government from adopting regulations. They are given powers to police the oil industry even when their measures can have economic ramifications on the industry. Many countries have, as a result, breached contractual terms through stabilization clauses which give the government freedom to changethe regulatory and legislative arrangements as stipulated in the agreement.
Posted under ‘Legal aspects of oil and gas industries: How host-governments concede control or sovereign rights over their countries’ natural resources to foreign oil companies
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