International Oil and Gas Law - Essay Example

?International Oil and Gas Law PG work 2009 Table of Contents   Introduction                 Question A.         Question B. Question C. Conclusion             Bibliography              Introduction Oil development is an expensive activity, which requires massive resources and skillful workers. Due to its nature, oil development is mainly handled by governments and a few oil and gas exploration and production companies that possess massive resources required in oil development. This paper will discuss issues of oil development in Urbania, a country with weak financial capability and which has been ruled by a dictator for many years. This will start by explaining the types of agreement that the government can enter into when the current term with an oil development company called Noble Oil expires and the reasons why such type of agreement could be suitable. Also, following oil discovery in Amazia, the paper will discuss how the Urbania should go about oil development in that region as well as give an advice on which company the government should work with. Finally, the paper will discuss the various types and sources of finance that are available for Urbania, considering that the country does not have adequate resources to fund oil development projects. A. What type of agreement should Urbania enter into for continued development of, and production from, the Western Plateau region, when the current concession expires? Be sure to give reasons for your recommendation. There are several fundamental agreements that can be made between the government of Urbania and Nobel Oil Company including the Joint Venture Agreement, concession, service contract and production sharing agreement.1 The government can decide to continue with the current concession agreement if it wants to guarantee the ownership of the oil resources of the company that will be granted the license. Technically, this ownership is enjoyed in exchange for royalty, which is usually estimated at a fixed rate on the quantity of oil produced. In some situations, the company can also enjoy tax exceptions and reduced custom duties in exchange for the extraction rights. This agreement will present Nobel Oil with a long duration of agreement with the government of Urbania, and it will be difficult for the government to include a ‘lock in’ clause such that it will be hard for any party to pull out for whichever reason. Nevertheless, this type of agreement comes with some disadvantages. For instance, a concession is a long-term agreement, which is usually faced with problems related to adjustment of financial commitments as a result of unexpected circumstances. 2 It will also be a disadvantage on the side of the licensed company because it will be required to pay higher amount of pre-oil discovery fee, and following the discovery of oil, the company is likely to pay very high amounts of royalties as well as income tax. The current rate of royalty is 16%, which will somewhat generate a substantial amount of revenue and hence a good reason for the government to retain concession when the current one expires. The concession contains relinquishment clauses, which could compel the Oil Company to either to discover commercial reserves; or following the discovery of commercial reserves within a certain period of time, relinquish usable portions of the concession back to Urbania government. The concession has an express work obligation of a limited period of time within which the Oil Company is expected to commence oil exploration and on discovery of commercial reserves, the company would be expected to develop oil in accordance with good oilfield practice. This means that the government will have some powers to control the activities of the oil company in a manner that ensures the company is following oil industry practices. The joint venture agreement is another option that Urbania government can put into considerations after the current concession expires. The joint venture is a very common agreement in oil extraction ventures3. However, this form of agreement will not be appropriate because the government of Urbania does not possess adequate expertise in the oil industry. Instead, the oil company that will be licensed could negotiate a license agreement from the government of Urbania, which will ensure that the company gets some rights to carry out their activities in return for a share of profits generated from the business. The oil company will be given a chance to carry out oil exploration and extraction in a production sharing model, which is commonly practiced by multinational oil companies undertaking their activities in developing countries.4 Considering that the international laws, which are related to the terms and operation of licenses, are not available in Urbania, the parties will have the freedom to choose their own heads of agreement as well as licensing team. It will be strategically important if the Oil Company can try to differentiate its production activities from the exploration activities and also try as much as possible to honor the international conventions and treaties that touches on its activities5. If this kind of philosophy is followed, the oil company would acquire a license from the government of Urbania, hence it will be granted permission to undertake a range of exploration activities including drilling of boreholes and wells as well as undertaking geographical, geochemical, and geophysical surveying.6 This will also include burial, directional surveying and gyroscopic and magnetic multishot.7 Perhaps the company that will be licensed will want to explore an extensive area and hence acquisition of a ‘frontier license’ will be very critical. This license will enable the company to have exploration rights in a very wide geographical area when it enters the agreement, although thereafter it will be required to renounce a good proportion of the area to the government.8. The Oil Company will benefit from such an arrangement since it will be able to enjoy exclusive rights for exploration within a wider geographical coverage, thereby increasing the probability of finding a commercially exploitable oil reserve. On the other hand, the Urbania government will benefit from this arrangement since it will still repossess the land that will be used for exploration. When repossessed, the government can still extend the exploration license to other companies and generate more income. In the license, there must be a provision stating that the government will allow the company to extract oil and sell it at wholesale, if the exploration turns positive. This means that the company that will be lucky to get the license will be able to sell oil without producing a tender, since it will be granted a priority production right. 9 Furthermore, if the company operates for a longer term, it has a good chance of enjoying a monopoly over the wells that it drills. Monopoly will be very important for the company since large amount of resources will be spent such that suitable sites for extraction can be identified as well as operating and installing the ancillary and required equipment such as storage silos, refineries, roads, and pipelines used to transport oil to the seaports10 Since a lot of resources will be used, the company needs an assurance that other companies will not compete with it once oil is discovered. In order to ensure that its monopoly is guaranteed, a short term license, which is renewable for successful terms, can be appropriate. In all the terms that will be licensed, the conditions of the rights will remain the same including a requirement to relinquish 50% of the production site at the end of the first term and then relinquishing all at the end of the second term apart from the extraction site.11 Notably, the government can refuse to renew the license if any of these conditions are not met; therefore, it will be very important to comply with all of them.12 Ideally, Urbania government would want to ensure that all the researches, which are licensed, are fully exploited and hence the government may want to set some conditions stipulating the minimum production quantities. Furthermore, if a production license is secured by the company and then reserves are not fully exploited, then the government would fail to enjoy the amount of royalties that were contemplated when the deal was originally signed and hence the it would find it important to invite other companies in the venture in order to compensate for the lost royalties – of course, Nobel Oil would not want to lose its interest to other companies with massive resources and hence it will be important to remain very committed to ensure exploitation of the oil wells. It will also be very important to note that there is another alternative whereby, the Urbania government can acquire an upstream interest in the venture by paying Nobel Oil to extract oil on its behalf; an arrangement that is not very common in oil exploration and production. According to Davis, by obtaining a license, the petroleum companies do not own the resources which are exploited. Instead, they compensate for their interests through a combination of profit sharing and cost recovery. In most cases, the national governments are usually the clients.13 Even thought the Urbania government could not be in a position to pay Nobel Oil Company before the extraction process is begun - the government could allow the company to use some amount of oil to cater for the costs of extraction and some amount of profits from the oil extraction. Even though the government and the Nobel Oil have signed an acquisition of production license, which will grant Nobel a right to extract wholesale oil in return for a fee or obtain an upstream interest in return for cost and profit, the terms of the agreement between the two parties will technically remain the same. B. How should Urbania proceed with the proposed oil development in the Amazia Forest region and how should it decide which oil company to work with? Apparently, a new and potentially large oil reserve has been discovered in the Amazia Forest area, which is situated on the Eastern coastal area of Urbania, but this area is also home to a large community of indigenous people. Urbania government should start by licensing the most suitable oil exploration and production company to work with, and then monitor its activities particularly ensuring that a conflict does not arise between the indigenous people and the oil company. Therefore, establishment of oil production in this area should begin with a seismic study, in order to investigate the way of life of the people who live here and any other factor that can influence oil production in Amazia. The data that is collected should be reviewed in the subsequent four to six months.14 Oil exploration in Forest ecology is an ecologically sensitive area and hence the managers of the company should be encouraged to put in place strategies that can help overcome environmental challenges of working in the forest. Alternatively, Urbania can hire an experienced seismic contractor to conduct an extensive field study. The seismic contractors should be reminded to contact the indigenous communities before commencing their work in this area. This will also involve going to each village and asking the community what they want. For example, if the local people ask for schools or clinic, the government should make efforts to provide those resources, provided it is reasonable and economically viable to do so. Urbania should also be ready to face opposition from the indigenous community due to the devastation caused on their resources such as trees and wildlife. Strategies should be devised so if such an opposition arises, it could be easy to amicably deal with the people. To avoid conflict with the local people, the government could ensure that a proportion of proceeds from oil production levy go to indigenous communities. Also, the community can be allowed to choose their own representative who could be airing their grievances with the Urbania Government as well as the oil exploration company representatives. Some of the major objectives that Urbania should aim at achieving to ensure conflict-free resource development in Amazia includes designing a plan that can guarantee a lasting welfare of Amaza’s indigenous communities and lessening of the environmental and social impacts of oil production in this region. This should be accompanied by an extensive environmental impact assessment in order to provide a ground for future production and development of oil in Amazia. The government should ensure that oil development in this region does not interfere with the livelihood of the indigenous residents including minimizing damages on their habitat. This strategy will be important in order to protect the image of the company in the eyes of these residents as well as avoid possible legal suits. Ensuring balance of these issues is a daunting task that the government has to bear with considering that the rights of the indigenous communities have to be balanced with that of the government and the Oil Exploration Company. 15 Essentially, the company that is selected will have to undertake a very careful and tactical approach to avoid possible conflict with the local people. However, the oil company can benefit from the knowledge that the indigenous people have in regards to their environment; for example they can advise the company about the geography of the area as well as possible impacts of the exploration on the local environment.16 The indigenous community is likely to get a lot of benefits if oil production and exploration are established in this area, and the government should ensure that the people who live here acknowledge such benefits. These include the creation of jobs as well as business opportunities.17 The oil company that will be licensed can improve its image by helping the local communities participate in these opportunities. This can be achieved if the company ensures a continuous communication with the local community as well as establishment of networks and associations that empowers the local community. 18 The government should make sure that wildlife ecosystem is preserved, which will help in building a positive image of the oil company. The government will also have a responsibility to ensure that the tourism sector is promoted and that it is not adversely affected by the activities of oil exploration and production.19 To ensure a strategy that will safeguard the habitat, while still optimizing on the prevailing opportunities, the government will have to consult with all the stakeholders that is involved.20 Deciding on which company to work with in Amazia Forest region is a daunting task that the government of Urbania has to put up with considering that this region has a very sensitive forest ecosystem and due to the fact that it is home to many indigenous people who could complicate oil development process if their resources are going to be interfered with. However, it will be very important to ensure that the company, which is licensed has a first-hand and lengthy experience in oil development and foreign licensing. Furthermore, the choice of the company to work with should depend on the objectives that the government wants to achieve. For example, if the government is keen on ensuring environmental conservation, then working with Phillips Petroleum, which was recently fined in Ruritania for breaches of Ruritanian environmental laws, could be detrimental; unless the government is reassured that the company has established very strong policies to avoid violation of environmental laws. It is very important for the government of Urbania to base its choice of the company to work with on its type. There are three major types of oil exploration and production firms including diversified, independent and major firms. 21The major firms participate in all segments of oil exploration industry including transportation, production, exploration, refining and marketing. These companies usually possess large staffs experienced in different fields such as drilling and geology and they also own their own drilling tools. The government can opt for this type of firm in order to consolidate all the activities in one entity, which is perhaps cheaper and more efficient. Diversified firms are a bit smaller than their major counterparts. Although they also take part in most of the industry segments, their activities in oil and gas are somewhat reduced. This type can also be an option if the government is not able to license a major company for any reason. The independent firms carry their activities on even much smaller scales and they major in exploration and production of oil and gas. The government may opt to leave these types of firms if it will be hard or expensive to hire firms to carry activities required in other segments that these firms do not offer. C. On the basis that Urbania would not be able to completely fund out of its own resources any development project, what types and sources of financing may also be available? Since it is clear that Urbania government does not have adequate resources to fund this project, Nobel Oil will be required to seek for a variety of financing options from outside Urbania. 22 The two ideal sources of financing in this case include equity and balance sheet assets. 23 Equity in this case includes funds secured in return for a share in the oil company while balance sheet assets include funds that are secured by fixed and floating charges against the company’s assets, real and corporeal or through project finance. 24 Also, a direct finance could be provided by the project sponsors. The sponsors can as well fund the project indirectly by acting as guarantors for bank loans made to the company. 25 Usually, the project sponsors may opt to bring many players on-board, including the national oil companies, the government, a consortium of project financiers, and commercial lending institutions – this is done in order to mitigate the project risk. According to Razazi, the projects that are developed in the some countries are commonly known to manage project risks by involving a multiple of players. Also, involvement of local partners is usually a common financing tendency in oil and gas industry, such as whereby gas and state oil companies are involved in the hydrocarbon sector.26 Considering that the arrangement is likely to involve a multiple of participants, a wide range of legal and financial instruments will be employed in order to regulate the complex and multidimensional relationships between the parties. As shared by Ravazi, in regards to oil and gas financing in some countries, use of the full financial tool is a common trend especially for the oil and gas projects. As such, with a wider range of financial instrument and a large number of project partners, the process of preparing for the project becomes very complex. 27 Apparently, not many small and medium size oil companies finance their activities from internal sources only. Many of them prefer getting a backing from the external investors. The external investors come from a variety of industries including banks, oil and gas companies, pipeline companies and financial service just to mention but a few.28 When the external financing comes from oil and gas companies, then some active interest in the operator’s wells has to be left to these companies. In essence, oil and gas companies usually come together in order to share their resources with the aim of managing a common pool of problems. To cut down on transaction costs, companies with complementary assets such as transmission lines, drilling equipments and input supplies can decide to share their resources.29 Conclusion When the current license with the Noble Oil expires, the government will have to consider a variety of factors in order to choose a type of agreement that best suits its objectives. Two of the major types of agreements are common in oil and gas industry has been discussed in this paper, and the reasons why the government should adopt any of them have been given. Essentially, the type of agreement that the government chooses is based on factors such as royalty, term of contract, availability of resources and the degree of ownership among many others. Following discovery of large deposits of oil in Amazia, which is a forested region inhabited by a large indigenous community, the government will have to consider the interest of the local people to ensure success of the project. This will include supporting them with social amenities and convincing them why such a project is important because if this is not, the community is likely to result into rebellious actions, which will largely hamper implementation of oil development in this region. The government will have to consider a variety of factors when deciding on which company to work with in this region. This will include assessing whether the potential companies have good environmental conversation policies and best practices in general.30 Lastly, the paper has discussed the variety of sources of finance that would be available to fiance oil development, considering that Albania does not have enough resources to finance the project. The most viable sources, as discussed, will mainly be sourced from outside the country, which will include teaming up with other entities which have an adequate financial base. Bibliography: Abele F, The Smartest Steward? Indigenous People and Petroleum-Based Economic Development in Canada’s North’ In G B Doern (ed.), Canadian energy policy and the struggle for sustainable development (University of Toronto Press, Canada, 2005) Abele F, The Smartest Steward? Indigenous People and Petroleum-Based Economic Development in Canada’s North’ In G B Doern (ed.), Canadian energy policy and the struggle for sustainable development (University of Toronto Press, Canada, 2005) Babusiaux D, Oil and gas exploration and production: reserves, costs, contracts (2nd edition, Editions Ophrys, U.S.A., 2007). Bentekas, I, J Paterson and M Suleimanov, Oil and gas law in Kazakhstan: national and international perspectives (Kluwer Law International Publishing, London, 2004). Buljevich EC and Y S Park, Project financing and the international financial markets (Springer Publishing, London, 1999). Davis JD, The changing world of oil: an analysis of corporate change and adaptation (Ashgate Publishing Limited, U.S.A., 2006). Department of Energy and Climate Change (UK), Oil and Gas’ (2010) [Online] accessed 25 December 2012. DIANE Publishing, Oil and gas technologies for the Arctic and deepwater (DIANE Publishing, London, n.d.). Dzienkowski JS, Chapter6 'Concessions, Production Sharing and Participation Agreement for Developing a country's Natural Resources' in Smith (Dzienkowski &Others International Petroleum Transactions, 2000). Gao Z, Environmental regulation of oil and gas (Kluwer Law International, London, 1998). Johnson AD, Mexico Tax, Law and Business Briefing: 2005 (World Trade Executive Incorporated Publishing, U.S.A., 2005). Khan IM and M R Islam, True sustainability in technological development and natural resource management (Nova Publishers, U.S.A., 2006). Matz LM and P Neu, Liquidity risk measurement and management: a practitioner's guide to global best practices (John Wiley and Sons Publishing, London, 2007). Mikkelsen A, Arctic oil and gas: sustainability at risk? (Taylor and Francis Publishing, London, 2008). Nevitt PK and F J Fabozzi, Project Financing (7th edition, Euromoney Books, U.S.A., 2000). Razavi H, Financing Oil and Gas Projects in Developing Countries’ Finance and Development (June 1996) [Online] < http://www.imf.org/external/pubs/ft/fandd/1996/06/pdf/razavi.pdf> accessed 25 December 2012. Sahay B, Pressure regimes in oil and gas exploration (Allied Publishers, U.S.A., 1999). Taverne, B, Petroleum, Industry and Governments: A Study of the Involvement of Industry and Governments in the Production and Use of Petroleum (2nd edition, Kluwer Law International, London, 2008). Terterov M and J Reuvid, Doing Business with Estonia (GMB Publishing Ltd., London, 2005). Vinter GD and G Price, Project Finance: A Legal Guide (3rd edition, Sweet and Maxwell Publishing, London, 2006). Wood PR, Project Finance, Securitisations, Subordinated Debt, Volume 5 (2nd edition, Sweet and Maxwell Publishing, 2007). Wright CJ and R A Gallun, Fundamentals of Oil and Gas Accounting (5th edition, PennWell Books, U.S.A., 2008). Read More