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HOST GRANTING INSTRUMENTS: Does it matter?

Eduardo G. Pereira and Arina Terskikh[1]


Introduction


Host Government Instruments (“HGIs”) aim to regulate and manage exploration and production activities (“E&P” or “Upstream”), between the resource owner (typically the State) and oil and gas company or a consortium of oil and gas companies (typically International Oil Companies (“IOCs”)). HGIs could be divided between two types of systems. Regulatory and contractual based systems. Regulatory-based systems are the HGIs developed via regulations and are typically less flexible for negotiation. Two examples are licenses and public leases. Contractual based systems are the HGIs developed via contracts and they tend to allow more flexibility for negotiations. Common examples include the concession agreement, production sharing agreement(with and without cost recovery) and service contracts (with and without risks). Joint venture agreements are less common in modern times, but it might exist in some exceptional cases. Nevertheless, some HGIs might exhibit a duality between contractual and regulatory nature and/or hybrid forms between different contractual elements.


So, does it matter the type of HGI in place? Which one offers more control for the HG or IOC? Why HG change the relevant HGI they might offer? In order to answer these questions, we will analyse some of the key points in relation to a HGI namely: (i) ownership of resources, (ii) host government intervention and control, (iii) stability, (iv) confidentiality and transparency.

Ownership of Resources


Regarding the ownership of goods, equipment and data, there are four types of ownership: (i) host government property; (ii) property of the IOCs, but transferred to host government at some point (especially upon termination of HGIs); (iii) shared property between IOC and Host Government; and (iv) property of the IOCs. While ownership issues may not be directly linked to the HGI model, the type implemented creates different operating environments that lead to ownership questions. Under concession models the IOCs would usually take ownership of production, goods and equipment. In contrast, in PSCs, the property of the equipment and infrastructure installed/acquired by the IOCs are usually transferred to the host government (except for leased goods in some jurisdictions). Production is usually shared between HG and IOCs. Finally, in service contracts, the HG or its NOC is usually the operator of the field, and the IOCs are similar to service providers. Therefore, the host government owns the production, goods and equipment related to such contracts.

Host Government Intervention and Control


One of the critical issues is the level of intervention and control desired by the HG. For example, under the concession system, the State provides an instrument to make a legal arrangement with the concessionaire to develop oil and gas resources of the State. The instrument lays down the terms and conditions of the said arrangement, as well as rights and duties between the concessionaire and States under both public and private laws. The HG will grant exclusive rights to a concessionaire for hydrocarbon E&P in a given area over a specified period. Upon signing the agreement, the concessionaire has the right to conduct exploration and, if successful in making a commercial discovery, to develop it. Although the modern concession might entail certain discretion to oil and gas companies, it is not a “free pass” as it once was common under older concessions. The HGs have learned that retaining certain controls over their resources is in their best interest. For example, a HG often approves a field development plan before any production phase. Additionally, it can secure higher participation over the field production by either requesting the fiscal consideration to be paid in kind, or by establishing a domestic market obligation to secure supplies of oil and gas production for its nation, although the investor might consider national obligations negatively when deciding to enter a country. Developed countries often do not seek a complete ownership of oil and gas resources. This is why they tend to use a concession regime or a “variation” of it (i.e. license or lease). Developing nations tend to use a more “interventionist” approach to secure the ownership of their resources via production sharing contract or service contract or a hybrid form.


The fiscal system plays a key role on such process. The HG could decide to implement a royalty and/or tax regime without taking direct participation in the upstream business. Alternatively, the HG could take a more direct participation via a NOC and/or with sharing of the profit as well. Another option is for the government keep all of the production and pay a fee and/or costs to the IOCs. It should be noted that the role of the NOC varies from country to country. In some instances, the NOC might have more “power and control” than the actual government. In other cases, the NOC might have a purely commercial role, in which it could be involved from the exploration stage or after finding and developing a commercial discovery. Such involvement could be exercised via regulatory and compulsory procedures, or voluntarily by the decision of the relevant investors.


The Pursuit of Stability and the Ever-Changing Host Governmental Agreement


Given the long-term character of oil and gas petroleum agreements, IOCs are exposed to significant political risks. Throughout the existence of an HGI, governments, generations, and society change. This may lead to changes in the existent regulatory framework, the public perception regarding the presence of foreign investment or different expectations regarding the fate or outcome of the HGI itself. At the same time, advances in technology as well as increased awareness regarding industry practices risks of pollution, or changes in market prices that affect State revenues may play a more important part in public policies addressing environmental concerns and sustainable practices. These are factors with an adverse impact on the original terms of the HGI and the envisioned outcomes of the agreement, which might lead certain HGs to request renegotiations, unilateral amendments of the initial terms or even the complete repudiation of the HGI by way of expropriation or nationalization. However, in some cases (especially low oil prices) IOCs might request such renegotiation. Therefore, the pursuit of stability remains one of the top priorities of the petroleum industry.

There are several forms of stabilization clauses implemented in HGIs. Each serves a unique purpose and strikes a certain balance of stability such as freezing clause, economic equilibrium clause, intangibility clause and a hybrid clause. While there might be systemic differences between them, one cannot overlook the fact that "a significant number of HGs around the world do not offer a specific stabilization clause or any contract-based equivalent"[2] or, the more striking observation, that "this is the default situation among market states."[3] In other words, the same developed States making an issue of stability in transitional countries do not see any problem with the lack of stability within their own borders.

Confidentiality and Transparency


From the above it follows that when deciding which HGI to select it is important to have an awareness of the significant need for confidentiality involved in awarding such contracts, as well as an excellent working knowledge of the terms included in the contract, with particular attention paid to the fiscal element. The high level of confidentiality and, therefore, the apparent lack of transparency surrounding these contracts has become the center of some heated political debates, which include politicians, and members of society. The lack of transparency could potentially act as a cover-upfor corruption, which may exist under such levels of confidentiality or secrecy.

It is necessary for oil and gas contracts and regulations to become completely transparent and made public if claims of corruption and foul play are to be disproved. This is a difficult task for these contracts are traditionally extremely complex and parties are reluctant to disclose their terms, which could leave them open to corruption. In Norway, for example, the awarding of each license and the criteria used to establish the award is recorded in the public domain. It is only in these instances that the public can adequately judge the effectiveness and stability of the agreements as well as the decision-making of public servants and government officials who were involved in the creation of the contracts.


Conclusion


Although HGIs might possess different context and reputation what matters are the terms and conditions negotiated and implemented on such instruments. Any HGI could be tailored to address possible concerns from both HG and IOCs. A fair compromise should be taken in consideration to attract investors and protect public interest. But it is difficult to judge if any HGI is “bad” or “good” from its face value. Similarly, it is not the cover of the book which will tell the quality of the book nor the end of the story. This is why HG should consider what are they main concerns and desire and address these issues in the relevant HGI terms and conditions and re-consider before engaging in any expropriation or re-negotiation due to its serious implications.

[1] This article is based on Eduardo G. Pereira, Cătălin-Gabriel Stănescu, Wan Mohd Zulhafiz,Felipe Rodrigues Caldas Feres, Waniss Almashri Otman, Yanal Abul Failat,Aaron Koenck, Host Granting Instrument Models, Why Do They Matter And For Whom, 5 ONE J (Forthcoming). For a more in depth discussion on this topic please refer to this source and the sources those cited within. [2] Peter D. Cameron, International Energy Investment Law, the Pursuit of Stability 4 (Peter D. Cameron ed., 2010). [3] Ibid.

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