Effective hydrocarbon management 2009


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Effective Hydrocarbon Management: Lessons from the South

This book is the result of the first successful High-level Meetings on Oil and Gas Management held in Doha, Qatar in 2007, where participants unanimously agreed that a lack of capacity was the major challenge to the sustainable development of their emerging hydrocarbon sectors. Participants at the Meeting benefited from an open dialogue on various oil and gas issues, including good governance models, environment and climate issues as well as regulatory and policy issues. Following the 2007 Doha Meeting, this book was published in May 2009 as a compilation of the papers and presentations given at the Meeting. It serves as referencel for all persons in the oil and gas industry, particularly those of emerging oil- and gas-producing countries of the South.

This volume is a tool to enable effective management of oil and gas resources; an important component in helping achieve Millennium Development Goals, reducing poverty, promoting sustainable economic growth, encouraging democratic governance as well as mitigating the risks of civil conflict and fostering sound environmental management.

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Effective hydrocarbon management 2009

  2. 2. Copyright © UNDP 2009 All rights reserved ISBN: 978-0-9816619-2-6 Special Unit for South-South Cooperation United Nations Development Programme One United Nations Plaza New York, NY 10017 USA http://ssc.undp.org The views expressed in this publication do not necessarily reflect those of the United Nations, the United Nations Development Programme or governments. The designations employed do not imply the expression of any opinion whatsoever concerning the legal status of any country, territory or area, or its frontiers or boundaries. Photography/Images: Photo Selection: Vivian Nabeta Front Cover: geopaul, Don Farrall, Ron Watts Back Cover: Image courtesy of USGS National Center for EROS and NASA Landsat Project Science Office Graphic Design: Mary Zehngut 00_doha_book 5/4/09 6:09 PM Page ii
  3. 3. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH CONTENTS Foreword . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .v Acknowledgements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .vi Contributors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .vii Abbreviations and Acronyms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .viii Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1 Section 1: Legal and Regulatory Frameworks Chapter 1: Legal and Contractual Issues in Successful Hydrocarbon Development . . . . . . . . . . . . 9 Chapter 2: Legal Regulation and International Boundaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 Section 2: Institutions and Policy Changes for Effective Revenue Management Chapter 3: Macro Socio-economic Context and Challenges for Effective Hydrocarbon Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 Chapter 4: Institutional and Policy Challenges Facing Southern Hydrocarbon States . . . . . . . . 83 Section 3: Environmental Concerns for Southern Oil and Gas Producers Chapter 5: Environmental Management and South-South Cooperation: Priorities for the Arab States Oil and Gas Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 Chapter 6: Gas Flaring and Venting and Greenhouse Gas Emissions: A Sub-Saharan African Perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133 Annexes A: Doha Statement on South-South Cooperation for Effective Oil and Gas Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139 B: Economic and Social Comparisons of Single-resource Economies . . . . . . . . . . . . . . . . . . . . . . 142 C: What is EITI? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148 CONTENTS iii 00_doha_book 5/4/09 6:09 PM Page iii
  4. 4. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTHiv CONTENTS Boxes, Tables and Figures Chapter 1 Box 1.1: Regulatory frameworks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Box 1.2: The case of Bolivia: What is a “win-win” contract? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Table 1.1: Comparison of fiscal systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Table 1.2: Investment incentives in fiscal petroleum regimes, selected developing countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Table 1.3: Comparison between royalty and production-sharing regimes . . . . . . . . . . . . . . . . . . . . . . 22 Chapter 2 Box 2.1: International law: Oil and gas discoveries in the sea . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Box 2.2: International labour law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Box 2.3: International environmental law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 Chapter 3 Figure 3.1: Percentage change in GDP per capita, 1999-2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 Figure 3.2: Growth and single-resource dependency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 Figure 3.3: Natural resource dependency and life expectancy changes, 1992-2004 . . . . . . . . . . . 63 Figure 3.4: Twin requirements of economic growth and institutional change . . . . . . . . . . . . . . . . 69 Figure 3.5: Funding window and oil revenue allocation choices: The case of Azerbaijan . . . . . . 70 Table 3.1: Single-resource economies: Revenue management issues and strategies . . . . . . . . . . 80 Table 3.2: Examples of revenue management issues and strategies to address them . . . . . . . . . 81 Chapter 5 Table 5.1: Date of ratification/accession: Kyoto Protocol and the United Nations Framework Convention on Climate Change . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 Chapter 6 Figure 6.1: Natural gas production, venting and flaring in selected sub-Saharan African countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119 Figure 6.2: January to December global mean temperature over land and ocean . . . . . . . . . . . . 121 Figure 6.3: The Clean Development Mechanism project cycle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125 00_doha_book 5/4/09 6:09 PM Page II
  5. 5. Kemal Derviç Administrator United Nations Development Programme Nassir Abdulaziz Al-Nasser Ambassador Extraordinary and Plenipotentiary Permanent Representative Permanent Mission of the State of Qatar to the United Nations President of the High-Level Committee on South-South Cooperation EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH v FOREWORD s FOREWORD Extreme fluctuations in international oil prices can be damaging to the economic performance of hydrocarbon economies. While oil revenues alone are not the only determinant of sustainable and equitable economic development – sound investments and solid macroeconomic and governance policies are fundamental – managing the oil sector well in oil-exporting countries is especially crit- ical during times of great oil price volatility. This book is based on presentations made at the High-Level Meeting on Oil and Gas Development hosted by the Government of Qatar in Doha in September 2007.That Meeting was supported by the United Nations Development Programme, the United Nations Environment Programme, the United Nations Economic Commission for Africa and the Canadian International Development Agency and brought together senior officials from 42 countries in Africa, Asia and Latin America. Those involved included countries with many years of oil and gas experience as well as newly emerging petroleum economies. The High-Level Meeting was intended as a first step towards initiating a process of ongoing dialogue and exchange on this issue. As such, a limited number of topics were covered. The main objective was to facilitate better management of the oil and gas sectors of the South and to address the multiple challenges associated with single-resource economies, which are important in low- income developing countries, many of which are in Africa. This book is therefore an effort to continue the process of ongoing dialogue and collaboration with new and emerging hydrocarbon economies and to ensure that oil revenues are used to sup- port sustainable economic and social development. It is hoped that this book will assist senior policy-makers in the new oil-producing economies and other practitioners to better understand and address the complex challenges they face. We look forward to further collaboration with them and other partners to provide tangible support for the new and potential oil exporters as they seek to address the management and policy challenges that lie ahead. 00_doha_book 5/4/09 6:10 PM Page v
  6. 6. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTHvi ACKNOWLEDGEMENTS ACKNOWLEDGEMENTS This book is part of an ongoing effort by the Special Unit for South-South Cooperation, UNDP, to assist the new and emerging oil- and gas-producing countries of the South to better manage their hydrocarbon sectors and to use their oil and gas revenues effectively in achieving sustainable human development. The book is based on papers and presentations given at the High-Level Meeting on Oil and Gas Development that was hosted by the State of Qatar in Doha from 8 to 10 September 2007. The objective of the Meeting was to provide a venue for established and new oil-producing States of the South to share their experiences, both good and bad, and lessons learned so as to enable the new oil producers to improve the management of their oil sectors. I would like to extend my sincere appreciation to a number of people who were instrumental in convening the Meeting in Qatar as well as those who worked on compiling and editing this book. John O. Kakonge served as project manager for the High-Level Meeting and oversaw the preparation of this volume. Without his tireless efforts and diplomatic skills, neither the Meeting nor this book would have been possible. Stephanie Levy of the Overseas Development Institute (ODI) in London brought immense knowledge and skill to her task as lead editor for this book. Dr. Levy was assisted by Stacy Edgar, Roo Griffiths, Jodie Keane and Steve Wiggins at ODI and David Bourn to peer review, enrich, edit and integrate the various papers and presentations into a coherent whole. Thomas Stephens was the lead consultant in helping to organize the Doha Meeting and worked closely with the Special Unit and ODI in preparing this book. Special thanks are also extended to Samuel Choritz, Stéphane Dujarric, Brooks Evans, Parviz Fartash, Raja Kaul, Maria Netto, Timothy Scott and Minoru Takada of UNDP for their invalu- able comments. In addition, Barbara Brewka and Vivian Nabeta reviewed the publication for the Special Unit. Rachel Gruzen contributed immensely to overall administrative and logistical efforts required to bring this book to successful fruition. I would also like to thank the contributors whose papers and presentations at the Doha Meeting formed the underlying framework and data for this book as well as the countries that participated in the Meeting and that prepared National Issues Papers. I hope that readers interested in this topic will find this book a useful tool for helping developing countries to achieve effective and equitable oil-sector management. Yiping Zhou Director Special Unit for South-South Cooperation United Nations Development Programme 00_doha_book 5/4/09 6:10 PM Page vi
  7. 7. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH vii CONTRIBUTORS Ibrahim Abdel Gelil, Ph.D. UNEP Consultant Professor, Arabian Gulf University, Bahrain Nasser Akhtar, Ph.D. Program Manager Bolivia Canada Hydrocarbon, CIDA, Canada Basel Al-Yousfi, Ph.D. Deputy Director UNEP Regional Office for West Asia, Bahrain Stacy Edgar, MSc Research Assistant, Overseas Development Institute, London, United Kingdom Roo Griffiths Associate Editor, Overseas Development Institute, London, United Kingdom Michael Hopkins, Ph.D. Professor, Middlesex University Business School, United Kingdom, and CEO, MHC International Ltd., London, United Kingdom, and Geneva, Switzerland Jodie Keane, MSc Research Officer, Overseas Development Institute, London, United Kingdom Stephanie Levy, Ph.D. Research Fellow Overseas Development Institute, London, United Kingdom Salim Jorge Saud Neto, LLM Attorney at Law Squire Sanders & Dempsey, LLP, Rio de Janeiro, Brazil Alan Perry, MA Attorney Edwards, Angell, Palmer and Dodge, LLP, London, United Kingdom Thomas W. Stephens, Ph.D. Managing Director Prescient360 Group Virginia, United States Katim S. Touray, Ph.D. International Development Consultant Banjul, The Gambia Steve Wiggins, Ph.D. Research Fellow Overseas Development Institute, London, United Kingdom CONTRIBUTORS 00_doha_book 5/4/09 6:10 PM Page vii
  8. 8. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTHviii ABBREVIATIONS AND ACRONYMS ADB Asian Development Bank AGU Arabian Gulf University API American Petroleum Institute AusAID Australian Aid for International Development bcf Billion cubic feet bcm Billion cubic metres bpd Barrels per day CAMRE Council of Arab Ministers Responsible for the Environment CDM Clean Development Mechanism CEDARE Centre for Environment and Development for the Arab Region and Europe CNPA Cambodian National Petroleum Authority EIA Environmental impact assessment EITI Extractive Industries Transparency Initiative EMS Environmental management system ERM Environmental risk management EWURA Energy and Water Utilities Regulatory Authority GCC Gulf Cooperation Council GDP Gross domestic product GEO Global Environment Outlook GHG Greenhouse gas GNP Gross national product HDI Human development index IDP Internally displaced person ILO International Labour Organization IMF International Monetary Fund IMO International Maritime Organization IOC International oil company IPCC Intergovernmental Panel on Climate Change IPIECA International Petroleum Industry Environmental Conservation Association ISO International Organization for Standardization ABBREVIATIONS AND ACRONYMS 00_doha_book 5/4/09 6:10 PM Page viii
  9. 9. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH ABBREVIATIONS AND ACRONYMS ix ITOPF International Tanker Owners Pollution Federation Limited JICA Japan International Cooperation Agency LAS League of Arab States LNG Liquefied natural gas MDTF Multi-donor trust fund mt Metric tonne NGO Non-governmental organization NOAA National Oceanic and Atmospheric Administration NOC National oil company NORAD Norwegian Agency for Development Cooperation ODI Overseas Development Institute OECD Organisation for Economic Co-operation and Development OGP International Association of Oil and Gas Producers OPEC Organization of Petroleum Exporting Countries PPP Purchasing power parity SADC Southern African Development Community scf Standard cubic feet SIRESE El Sistema de Regulación Sectorial (The System of Sector Regulation) STEPS Shell Tradable Emission Permit System tcf Trillion cubic feet toe Tonne of oil equivalent TWh/yr Terawatt-hours per year UNCED United Nations Conference on Environment and Development UNCLOS United Nations Convention on the Law of the Sea UNDESA United Nations Department of Economic and Social Affairs UNDP United Nations Development Programme UNEP United Nations Environment Programme UNESCWA United Nations Economic and Social Commission for Western Asia UNFCCC United Nations Framework Convention on Climate Change USGS United States Geological Survey YPFB Yacimientos Petrolíferos Fiscales Bolivianos 00_doha_book 5/4/09 6:10 PM Page ix
  11. 11. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH 1 Introduction A s recent oil price fluctuations have shown, managing a new extractive industry is a major challenge for many of the Governments in the developing world.The past 30 years offer numerous examples of Governments that have not developed institutions and regulatory frameworks that allow for an effective functioning of the industry, including the use of oil and gas revenues to finance policies that are economi- cally conducive to both growth and poverty reduction, or to weather the storms of oil- price swings. Many economists have long studied the economic and political distortions induced by the development of an oil- or gas-exporting industry. Most of the literature on resource booms and the management of the hydrocarbon industry is very academic and does not provide the practical solutions that are relevant to various situations. At the same time, however, there is a growing body of practical experience and lessons learned from current Southern hydrocarbon-producing economies that has not been widely shared or disseminated. The experiences of these countries have the potential to help new oil-producing Governments to understand and incorporate these lessons into their own policies and programmes and to avoid mistakes of the past. In September 2007, the State of Qatar hosted the High-Level Meeting on Oil and Gas Development: Sharing Experiences and Lessons within the Framework of South- South Cooperation for traditional and emerging hydrocarbon economies. The Meeting, held in Doha, was organized by the Special Unit for South-South Cooperation in the United Nations Development Programme (UNDP) and Qatar Petroleum in collabora- tion with the United Nations Environment Programme (UNEP), the United Nations Economic Commission for Africa (UNECA) and the Canadian International Development Agency (CIDA). Its objectives were to enable Southern countries to share their experiences in managing their oil and gas sectors and to discuss avenues for possi- ble future cooperation in this area. Government representatives from 42 producer coun- tries in Africa, Asia and Latin America attended the Meeting. Many made presentations on the challenges that they were facing in developing this often-substantial sector of their economies. The Meeting offered a unique opportunity for these Southern producers to directly exchange, share and learn from one another’s experiences on highly complex issues that are of critical importance to their present and future economic development. It was attended by senior government officials from ministries directly involved in the manage- INTRODUCTION 00_doha_book 5/4/09 6:10 PM Page 1
  12. 12. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH ment of the hydrocarbon sector as well as ministries of finance and planning, parliamen- tarians and representatives of national oil companies and donors agencies. Many partic- ipants were thus responsible for, or directly involved in, the development and manage- ment of their respective oil and gas sectors. This conference allowed policy-makers to share their experiences in dealing with comparable challenges in similar contexts. As the Meeting demonstrated, lessons from countries in similar circumstances are indeed more likely to be applicable. They offer a useful counterpoint and complement to ideas derived from theory and abstractions. The examples given by country representatives in their presentations were indeed more con- crete and the lessons more practical than the theoretical models and abstract analytical frameworks often found in the literature. The presentations also showed that, although policies must be tailor-made at the country level, some rules surrounding policy effec- tiveness seem to hold over time and place. They are also less prescriptive and judgmen- tal than the vast majority of the literature on the topic. In such cases, lessons and policy recommendations, because they are likely to be perceived differently, have the potential to be taken up and followed more effectively. The Meeting also demonstrated how South-South technical cooperation could be beneficial for all parties engaged. Again, similarities in political, institutional or economic context meant that technical knowledge gained by one country and new technology adoption are likely to be transferable to others. The process of gas flaring and venting is a good example of how South-South cooperation could have large economic benefits while also helping to reduce the impact of negative externalities of oil production on the environment and climate change. The conference aimed at stimulating cooperation and transfer of technology between Southern countries, which are likely to benefit both transferring and receiving countries. At the request of the conference participants, the Special Unit for South-South Cooperation has prepared this edited synthesis of presentations as a record of proceed- ings and for reference and wider dissemination among oil- and gas-sector stakeholders, including Governments, hydrocarbon companies and development partners. The Issues Development of the oil and gas sector is notorious for the risks and threats that it poses to economic and political stability, and the environment. Management of the sector is, thus, a major challenge for Governments and domestic institutions. Numerous studies 2 INTRODUCTION 00_doha_book 5/4/09 6:10 PM Page 2
  13. 13. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH 3 have examined the impacts of substantial new inflows of foreign investment on devel- oping economies. The emerging consensus on mitigating risk is basically twofold: (a) Governments should put in place institutions and regulatory frameworks that allow for transparent and efficient management of oil revenue; and (b) oil windfall should be directed towards productive investments in physical and human capital to prevent economic distortions and the occurrence of “Dutch disease” so that long-term equitable growth can be generated. If the windfall is not used for productive investment in physical or human capital, it is likely to create domestic inflation, increase the real exchange rate and therefore result in a loss of competitiveness. Unbalanced and slowed growth that results from these distortions has been heavily documented and analysed. The concept of “Dutch disease” has evolved in recent years to include not only macroeconomic parameters but also human development indicators. Recent history shows numerous cases of developing countries where human development indicators have worsened during the period of the oil and gas boom, with increased poverty and inequality – not to mention aggravated corruption and conflicts over the control of the windfall. Nigeria, for example, has received over $300 billion in oil revenue over the past 25 years but has an average per capita income that is less than $1 a day. Despite having been one of the major oil producers in the world for decades, Nigerian social indicators remain lower than those of sub-Saharan Africa as a whole and much worse than those of other regions of the developing world. This illustrates the meaning of the terminolo- gy “paradox of plenty” or “resource curse” often used in the literature. Such economic distortions can be avoided if the sector and the windfall that it generates are efficiently and properly managed. Because oil and gas booms raise expec- tations and increase the appetite for spending, the industry needs to be adequately and transparently regulated and supported by efficient and functional institutions. Similarly, economic distortions can be avoided if the revenue is used to finance produc- tive investment in both physical and human capital.This new funding opportunity should indeed support technology adoption and investment in education to increase domestic productivity in the medium and long terms and to prevent losses in competitiveness. Other productive investments that should be promoted include those in health, rural infrastructure, water and roads. Support to the agriculture sector where the majority of the poor work in Southern countries has also been proven to be particularly efficient, as the case of Indonesia illustrates. INTRODUCTION 00_doha_book 5/4/09 6:10 PM Page 3
  14. 14. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH Economic diversification is also critical to reducing a country’s dependence on oil and gas revenue as well as mitigating the risk of price fluctuation and preparing the economy for future resource depletion. Diversification also allows for a more balanced pattern of growth. Finally, monetary policy is a vital tool for mitigating the impact on inflation and on the real exchange rate. Only such targeted strategies could allow for a sustained, balanced and inclusive growth, with equitable resource allocation across social groups and across regions. The remedies for “Dutch disease” are, therefore, multiple and well known by econ- omists and practitioners. The challenge lies less in the strategy design than in the absorptive capacity of the domestic economy and the ability of the Government to maintain the quality and efficiency of its spending while increasing expenditure substantially and rapidly. Through South-South dialogue, the sharing of experiences and especially examples of successful responses to challenges could be particularly beneficial. Such exchanges between oil-producing countries can help stakeholders to choose among the range of possible policy options in order to identify those best suited to their own country context. These exchanges would be particularly relevant for new oil and gas producers. For these new entrants, guidance is commonly sought in three domains. First, what are the needs in terms of new institutions and regulatory frameworks? How can con- tracts with oil companies guarantee security and profitability to both the resource-rich country and the investor, given the high exploration risk and the capital-intensive nature of the hydrocarbon sector? How should existing regulations be modified to ensure both good governance and efficient development of the new industry? The second set of requests for advice relates to the use of the windfall. How can a windfall be used efficiently to finance policies that generate inclusive growth? How can oil or gas revenue be integrated into the budget and combined with fiscal revenue? How can it be used in a transparent way without distorting government objectives and priorities? How does it relate to existing national development strategies? What are the priorities and optimal sequencing for the spending of the windfall over time, given (a) the existing absorptive capacity of the economy, (b) the urgent needs and priorities in social sectors, and (c) the saving requirements for equity towards future generations? The third area of guidance requested relates to the domestic environmental impacts of the production of oil and gas. Governments face increasing pressure from the international community, civil society and the population living in areas surrounding 4 INTRODUCTION 00_doha_book 5/4/09 6:10 PM Page 4
  15. 15. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH 5 production sites to implement safeguards and measures to mitigate the negative externalities on the environment. Although various efforts have been made in the past decade, these have been generally insufficient to address the magnitude and complexi- ties of the challenges faced. The Book This book is organized in three sections that follow the structure of the Meeting ses- sions in Doha. These sections look successively at three dimensions of the management and policy challenge: (a) regulations and the institutional framework for effective devel- opment of the sector; (b) key issues and strategies for policy-makers on how to use the oil revenues efficiently; and (c) the potential environmental impact of oil and gas exploitation. The first section presents guidelines for policy-makers on institutional and regulatory frameworks to allow for the development of an oil and gas sector. Chapter 1 offers national governments advice for establishing an efficient legal, contractual and regulato- ry framework for the exploitation of their oil and gas. The chapter compares possible contractual structures, discussing options for ownership, production-sharing agreements and the different modalities for profit-sharing, taxes and fiscal regimes. Considering the possible aligned and opposite interests of the national government and international oil companies, the conditions for a “win-win” contract are examined. This is followed by an analysis of the key elements of an enabling institutional environment to promote private investment, local development and integrated development of the extractive sector. Because oil and gas reserves are often located at sea, the exploitation of hydrocarbon resources can generate maritime boundary disputes over the ownership of the reserves. In chapter 2, discussion turns to the legal and regulatory framework necessary to over- see the exploitation of such reserves. How can boundary disputes be resolved and how can a joint development agreement be set up? The chapter reviews existing joint devel- opment agreements and country cases to illustrate possible risks, stakes and solutions that have been found in the past between Governments and oil companies. The second section of this book provides an overview of the economic challenges that oil- and gas-exporting countries face and strategies that they could develop to over- come them. Chapter 3 presents evidence of the potential impact of oil and gas booms on growth. Through country comparisons, the occurrence of the resource curse in devel- oping countries is analysed, followed by the identification of what can be done to miti- INTRODUCTION 00_doha_book 5/4/09 6:10 PM Page 5
  16. 16. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH gate negative economic impacts. The chapter describes the key challenges in the man- agement of the resource windfall and uses country presentations from the conference to illustrate possible policy options to address them. Chapter 4 provides a summary and review of the country presentations made in Doha to examine how countries perceive and describe their challenges, reasons for the choice of management strategy and their performance over time. The variety of obsta- cles faced and of policy choices is striking, and the presentations demonstrate the wide range and complexity of the issues with which these Governments are confronted. The oil and gas sector plays an important role economically for many Southern pro- ducing countries, but it also constitutes a significant source of stress to the environment in these countries. The third section of the book explores the environmental impacts of oil and gas exploitation and introduces some avenues to mitigating them. In chapter 5, key environmental challenges are identified in major oil-producing countries in the Arab States region. In recent years, significant progress has been made in environmental com- mitment by Arab countries and in management practices by oil and gas companies. The chapter highlights the need for these countries to strengthen the capacity of national institutions to move towards sustainable development in the sector as well as the need to foster South-South cooperation. In chapter 6, the impacts of gas flaring and venting are reviewed. This is an issue often disregarded despite its being a source of substantial economic loss for producing countries as well as extremely damaging to the environment. This process is widely rec- ognized as a waste of energy for the oil-producing country, adversely affecting the envi- ronment and and exacerbating global warming. Transfer of technology between produc- ing countries could reduce or even suppress gas flaring, halt energy waste and generate large economic gains for countries involved. The chapter emphasizes the need for adop- tion of new technologies to allow for increasing the local energy supply. The conclusion summarizes the major recommendations derived from the papers and presentations that were encapsulated in the earlier chapters. Annex A presents the statement that participants at the 2007 High-Level Meeting on Oil and Gas Development formulated and approved to express their desire to see this initiative become a platform for future collaboration. Annex B contains data on the eco- nomic and social performance of single-resource economies, while information on the Extractive Industry Transparency Initiative (EITI), including EITI principles, criteria and the financing of EITI implementation, can be found in annex C. 6 INTRODUCTION 00_doha_book 5/4/09 6:10 PM Page 6
  17. 17. LEGALAND REGULATORY FRAMEWORKS S E C T I O N 1 00_doha_book 5/4/09 6:10 PM Page 7
  19. 19. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH Chapter 1: Legal and Contractual Issues in Successful Hydrocarbon Development 9 CHAPTER 1 Legal and Contractual Issues in Successful Hydrocarbon Development1 Introduction T his chapter examines how countries have successfully negotiated legal contracts for hydrocarbon exploration and production. It determines what “win-win” arrangements are both for the national governments and for the international hydrocarbon companies usually involved in exploration and production, i.e., what constitutes a “fair deal” between national governments and these companies. In the development of hydrocarbon projects, national governments and internation- al hydrocarbon companies often have a mix of aligned and opposing interests. Although both actors desire the maximum development possible for the industry, the internation- al oil companies (IOCs), as profit-seeking entities, generally favour the maximization of the net present value of their investments, which are, in general, considerable. Meanwhile, national governments regulate the industry and seek compensation for the use of State mineral resources, thus minimizing the net present value of the companies’ investments. This relationship is often complicated by the presence of national oil com- panies (NOCs). In most cases, State-owned firms are also profit-seeking, and their interests often align with the IOCs. The interests of NOCs may even be opposed to those of other branches of the same Government. In other cases, the NOCs align with the interests of the Government and are an instrument of policy. This chapter does not address such conflicts but focuses instead on the relationships between national govern- ments and IOCs. Finding the optimum balance between profitability/royalties and regulation is the key to a successful legal and contractual framework that can benefit both the host country and the investing companies. Certain factors, including the level of economic development, size of the territory, size and wealth of the population, and degree of diversification of the economy, can affect the performance of the hydrocarbon industry. Countries also differ 1 This chapter is mainly based on the report produced by Salim Jorge Saud Neto for the Special Unit for South-South Cooperation. It also includes contributions from Nasser Akhtar (CIDA) and Stacy Edgar (Overseas Development Institute (ODI)). 00_doha_book 5/4/09 6:10 PM Page 9
  20. 20. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH SECTION 1: LEGAL AND REGULATORY FRAMEWORKS in creditworthiness, ease of access to drill sites, capacity for internal financing and level of support for infrastructure. Although legal and contractual frameworks for the devel- opment of the hydrocarbon industry must vary depending on the characteristics of each host nation, the sharing of experiences between different national governments can help with the establishment of more efficient policies. While approaches may vary from country to country, the issues that they face are generally the same. This chapter analyses the general contractual framework used in the exploration and production industry and the main issues usually addressed in such contracts. In addition, it describes the legal structure commonly applied for the awarding and expropriation of exploration and production rights.Throughout, the chapter examines the methods avail- able to maximize IOC profits – thereby making investment attractive to such companies – while at the same time protecting host-nation sovereignty and interests. In particular, this chapter looks at the opposing interests at play in connection with the commonly implemented policies. The first section of this chapter presents an overall description of the contractual structure used in exploration and production.The second section offers an analysis of the main issues addressed contractually in hydrocarbon transactions, while the third section contains an overview of the methods for awarding exploration and production rights. The possibilities of forfeiture of exploration and production rights are the focus of the fourth section. The chapter concludes with suggestions for cooperative multilateral mechanisms that can assist with the implementation of such frameworks. Contractual Structure The contractual structure of hydrocarbon projects varies according to the laws applica- ble to the ownership of mineral resources in a relevant jurisdiction. In most cases, mineral resources are owned by the State. Exceptions to this exist in Canada, the United States and parts of Colombia where private ownership exists. Additionally, oil rents are generally the property of the State. However, countries differ on whether the IOC or the State owns the means of production, depending on their respective contractual structures. Countries that allow private ownership of mineral resources tend to have simpler contractual structures and, in some cases, minimal governmental interference other than that regarding the issuance of permits. Governments of jurisdictions where mineral resources belong to the State have a larger stake. Therefore, exploration and production 10 00_doha_book 5/4/09 6:10 PM Page 10
  21. 21. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH Chapter 1: Legal and Contractual Issues in Successful Hydrocarbon Development 11 activities require more complex contractual structures. Countries that proscribe private ownership of mineral resources generally award exploration and production rights through concessions. Depending on policy, conces- sions can be awarded either directly to the IOC or to the NOC which, in turn, enters into a production-sharing agreement with the IOC. Alternatively, policy may require a national government not to award concessions and instead to explore an oil venture directly, employing an IOC to perform the technical tasks and sharing the production with such a company under a production-sharing agreement. A concession is an authorization for the exploration and development of hydrocar- bon resources. When awarded directly to an IOC, a concession and the respective con- cession agreements contain, in addition to authorization, a detailed description of the responsibilities of the concessionaire, limitations on production, royalty payments, and other provisions necessary for the implementation of national policy with respect to the hydrocarbon industry. If, for policy reasons, a concession is awarded to an NOC, the concession agreements tend to be much simpler in format and the relationship with the IOC is generally regulated by production-sharing agreements. Under this structure, the NOC is the concessionaire and the IOC is a service provider or a partner that is enti- tled to a share in the oil production. National governments that adopt such structures usually leave the implementation of their hydrocarbon policy in the hands of the NOC. The production-sharing agreement usually contains the provisions necessary for the contractual implementation of such policy. In the event that a national government does not have an NOC and, for policy reasons, does not intend to form one and cannot or does not desire to award concessions to an IOC, the Government undertakes the task of contracting exploration and produc- tion directly, not awarding concessions but employing IOCs as service providers to be awarded a share of production. In these service agreements, the national government implements national hydrocarbon policy directly and takes control of production, leav- ing little autonomy to the IOC. In countries with private ownership of mineral resources, oil companies enter into a lease agreement with the owner of the relevant land. Such lease agreements are private contracts initially set up without the involvement of a governmental body and establish the methods of compensating the landowner and limitations of the production. The national government is involved in this process through the awarding of operational per- mits to the oil company. 2 Although permits are usually less detailed than contracts, con- 2 In the event that mineral resources are on public land,a lease is entered into with the appropriate government body (national or local) and the government role will necessarily be more significant. 00_doha_book 5/4/09 6:10 PM Page 11
  22. 22. A regulatory framework for oil and gas development consists of answers to the following questions: What is regulated? Who should regulate the laws? How should the laws be regulated? The laws and regulations should provide clear standards and expectations for actions to be taken by those subject to regulation as well as the regulator. Additionally, a robust regulatory framework must include a well-thought-out enforcement scheme in which regulation is enforced consistently according to the criteria of a framework. The complex nature of oil and gas development requires careful consideration of the various aspects of the production chain: Upstream regulation includes the management of exploration,disbursement of oil and gas rights, the design of a fiscal regime (including the collection of royalties and the division of risk) and safeguards for proper ecological management during the exploration and production process. Midstream activity includes the technical and economic regulation surrounding the transport of oil or gas.Technical considerations include the construction, oper- ation and maintenance of pipelines as well as adherence to environmental and safety codes. Downstream activities include regulations for consumer protection and quality standards. ACTIVITIES UPSTREAM MIDSTREAM DOWNSTREAM EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH SECTION 1: LEGAL AND REGULATORY FRAMEWORKS 12 BOX 1.1 Regulatory frameworks Exploration Production Gas processing Transport by pipelines Petrochemicals Refining Storage Import Marketing Export 00_doha_book 5/4/09 6:10 PM Page 12
  23. 23. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH Chapter 1: Legal and Contractual Issues in Successful Hydrocarbon Development 13 Institutional mechanisms for regulating the oil and gas sector vary. However, these institutions should seek to enhance the confidence of investors and maximize trans- parency of the regulatory process. General principles to adhere to in the enforcement of regulation include: Ensuring that laws and regulations are well publicized; Issuing government guidelines clarifying the processes and rules and information letters providing interpretations of the laws and regulations; Fairly including all parties and emphasizing that everyone has a right to be heard; Publishing decisions, including the reasons for decisions; Providing an opportunity to appeal decisions; and Protecting commercial proprietary information. 3 Such listing of conditions in permits is not common,though. Source: N.Akhtar (2007),“Challenges of Effective Regulatory Compliance and Enforcement for Oil and Gas Development”,Paper presented at the High-Level Meeting on Oil and Gas Development, Doha, Qatar, 8-10 September 2007. Regulatory frameworks (continued) BOX 1.1 ditions can be established to ensure the implementation of relevant national policy in a manner similar to the implementation of policy by Governments with ownership inter- ests in mineral resources. 3 These conditions may be wide-ranging, including the manda- tory participation of an NOC in a venture, the requirement that any equipment be acquired locally or the inclusion of fire-safety and labour and environmental regulations. In all cases where national policy or best interests require NOCs to be involved in the production process, the IOC and NOC also enter into joint operating agreements, which delineate the tasks and responsibilities of the parties in all phases of the project. Such agreements generally also detail the decision-making process during the project. They differ from the production-sharing agreements in that they tend exclusively to regulate operational issues, leaving policy implementation to the latter. 00_doha_book 5/4/09 6:10 PM Page 13
  24. 24. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH SECTION 1: LEGAL AND REGULATORY FRAMEWORKS Although lease agreements, concessions, production-sharing agreements and joint operating agreements are usually designed to regulate specific aspects of the different phases of a hydrocarbon project, it is not uncommon for the agreements to overlap with regard to regulating certain issues. Accordingly, depending on the contractual structure adopted, certain agreements might be a combination of what, under other structures, would be two different agreements, e.g., concession agreements on concessions awarded directly to IOCs, which contain provisions of both concession and production-sharing agreements. 14 TABLE 1.1 Comparison of fiscal systems Source: D.Johnston (2007),"How to Evaluate the Fiscal Terms of Oil Contracts”,in Escaping the Resource Curse,M.Humphreys,J.Sachs and J.Stiglitz (eds.),New York: Columbia University Press. Royalty/tax systems 44% All types:exploration, development,enhanced oil recovery IOC No transfer Gross production less royalty oil At the wellhead Contractor 100% Yes,but not common No Low typically Typically around 90% High Production-sharing contracts 48% All types:exploration, development,enhanced oil recovery Government NOC “When landed”or upon commissioning Cost oil + profit oil Delivery point, fiscalization point or export point Contractor 100% Yes,common Usually High Usually 50-60^ Low to moderate Service agreements 8% All types but often non-exploration Government NOC “When landed”or upon commissioning None None Contractor 100% Yes,very common Sometimes High None (by definition) Low Global frequency (% of systems) Type of project Ownership of facilities Facilities title transfer IOC ownership of hydrocarbons (lifting entitlement) Hydrocarbon title transfer Financial obligation Government participation Cost recovery limit Government control IOC lifting entitlement IOC control 00_doha_book 5/4/09 6:10 PM Page 14
  25. 25. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH Chapter 1: Legal and Contractual Issues in Successful Hydrocarbon Development 15 Main Contractual Issues This section presents a description of the main contractual issues dealt with in the various types of hydrocarbon contracts and the aligned and opposing interests of IOCs and national governments with respect to such issues. Local Presence National governments often require IOCs to establish a local presence when engaging in hydrocarbon projects that subject them to the jurisdiction and taxation of the host State as well as to employ local management capable of interacting with local authorities. Project Assignment and the Regulation of Investors The awarding of hydrocarbon exploration and production rights is generally determined based on the particular qualifications of the recipient. However, IOCs might need restrictions to be lifted so that a financier can also be assigned the rights and obligations under a contract. Reducing restrictions allows greater flexibility in financing and affects the general profitability of a project through the maintenance of financing costs. IOCs may, in addition, need exceptions to assignments in the event that such companies lose interest in the project or they may wish to seek partners to develop the project jointly. In such cases, exceptions to the assignment restrictions can permit IOCs to divest their operations to, or seek partnerships with, an interested third party and, therefore, ensure the continuation of the project. However, the benefit of such arrangements for the implementation of the policy of a national government is questionable. Financiers are generally not qualified to operate in the hydrocarbon industry and their interests and those of the national government in a subsequent transfer may not be aligned. Although investors would favour no restrictions on assignments, in order to make their interests more easily transferable, the interests of national governments may require an assignee to have the same or better qualifications than the original oil company. 4 At the same time, such restrictions may limit the overall amount that can be obtained in a divestiture since the range of qualified bidders is reduced and, as a result, they impact on the assessment of risk and profitability margins of an investment. 4 In the event of a joint operation, the concerns of the national government might not be relevant as the original oil company would already have met the necessary qualifications. 00_doha_book 5/4/09 6:10 PM Page 15
  26. 26. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH SECTION 1: LEGAL AND REGULATORY FRAMEWORKS Cooperation with National Governments or NOCs The hydrocarbon policy of a national government may require that IOCs engage in exploration and production activities in direct cooperation with the national government or an NOC under production-sharing agreements. Such arrangements require that the exploration and production of mineral resources be performed exclusively by the State and be beneficial to the national government. At the same time, IOCs can generate hydrocarbon revenues that would not be available otherwise. Furthermore, collaboration with IOCs provides an opportunity for skill transfers and the improvement of human capital. The interaction between the technical and managerial employees of an IOC and those of the NOC can generate the transfer of technical know-how and experience. However, the operational costs of IOCs are generally increased by interaction with national governments or NOCs since additional layers of reporting are incorporated into the operation and time and resources must be dedicated to training. 5 Consequently, increased costs tend to reduce the profitability of the investment of an IOC. Partnership with Domestic Investors National governments’ economic development policies or national legislation may require that certain economic activities, including hydrocarbon activities, be performed by nationals of the host country. Such restrictions usually establish minimum amounts of equity to be held by domestic investors and define domestic investors as natural persons who are citizens of the host country. Forcing international companies to look for domestic partners may generate an influx of wealth and encourage entrepreneurship among the nationals of a country. If financing is not easily available, however, there might be a limited number of qualified investors, thus reducing the ability of foreign companies to operate in a country. Even when financing is easily available, the mandatory association with domestic investors may serve as a constraint for international companies, as it creates the need for more complex decision-making bodies and account-rendering mechanisms, thereby increasing operational costs. Use of Local Equipment and Labour In an attempt to spread the benefits of the development of the hydrocarbon industry to all sectors of a country, national governments may establish minimum requirements for 16 5 Even when NOC personnel are experienced in exploration and production activities,the use of different technologies and know-how will mean that training will be required. 00_doha_book 5/4/09 6:10 PM Page 16
  27. 27. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH Chapter 1: Legal and Contractual Issues in Successful Hydrocarbon Development 17 domestically manufactured equipment and domestic labour as a condition for the grant- ing of exploration rights. Such requirements can be a useful tool in providing qualifica- tions to the population of a country and strengthening the national industry but they can also have an impact on the operational costs of the IOC. When such minimum requirements are excessively high, the local population is not sufficiently qualified or the industry is not efficient, the operational costs involved can impact the profitability of an investment drastically. By definition, when a national government adopts such a policy, the local population is not sufficiently qualified and the industry is not as efficient as for- eign industry; otherwise, the IOC would go to the local industry for equipment and the local population for labour regardless of governmental requirements. The main task of national governments when adopting such minimum requirements is to determine the appropriate levels of local equipment and labour that could benefit the local economy and yet maintain the attractiveness of the project to IOCs. Many IOCs will often work with national governments to scale up the level of local content over time through targeted training and other incentive programmes, often encouraging small companies close to the site of operations to become more actively involved. Timing for Implementation Concession agreements and permits generally have deadlines for the implementation of various phases of hydrocarbon projects. Such deadlines are necessary to ensure that mineral resources are used adequately and to permit national governments to award exploration rights to other interested parties if the original investor fails to implement a project. Any deadline being imposed by a national government must be sufficiently real- istic for the implementation of all tasks of the respective phases of the project, including obtaining governmental permits and licences. The processing time of permits and licences can vary drastically in different regions – even within the same country – and the deadlines set in the documentation must take into account such discrepancies. Unrealistic deadlines in an ongoing project either will require amendments to the appli- cable documentation or may be considered a constructive expropriation and result in indemnification rights. More importantly, however, unrealistic deadlines may prevent serious investors from engaging in hydrocarbon projects, minimizing the financial returns of the national government and the effective implementation of the country’s hydrocarbon policies. 00_doha_book 5/4/09 6:10 PM Page 17
  28. 28. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH SECTION 1: LEGAL AND REGULATORY FRAMEWORKS Limitations on Production The first hydrocarbon contracts contained very loose definitions of the areas where rights were granted and almost no limitations to production. Such lack of regulation gave rise to a number of conflicts that resulted in case law limiting the activity of the oil companies. In jurisdictions where the development of the hydrocarbon industry is incip- ient, hydrocarbon contracts must contain clear and detailed definitions and limitations to afford the maximum level of security possible to potential investors. Although impos- ing limitations may seem to be opposed to the interests of the IOC, a clear and detailed legal or contractual framework can actually add value to a project; the security arising from the fact that the rules are known by all relevant parties and will not be changed can facilitate an IOC evaluation of the convenience of an investment and result in increased revenues for the national government. Destination of Production Production from hydrocarbon development may be directed to the domestic or inter- national market according to the needs of the national government. Directing the production to the domestic market can ensure the supply of crude oil, whereas sales on international markets can generate revenues for the host country. Depending on the contractual structure adopted, national governments or NOCs may have a share of the production and, according to the needs or policies of the country, may either sell their share to international companies or acquire the IOC share of the production. Contracts may provide for purchase or sale options to be exercised by the national government according to the country’s needs. Noting that a supply of oil will not guar- antee the supply of its by-products unless the host country has refining facilities or arrangements with crude oil-processing facilities located in other States, national governments tend to be more concerned with the sale of their share of the production than with the purchase of the share of the IOC. 6 The terms under which such sales or purchases are effected can impact (positively or negatively) IOC interests in investing in hydrocarbon projects; the use of the market conditions prevailing at the time of the sale or purchase will likely be impact neutral in the evaluation of a project. If the development of a country’s hydrocarbon industry is also oriented towards meeting the demands of the domestic market – and avoiding the risk of lack of supply – the national government or NOC may impose restrictions on the exportation 18 6 Revenues obtained with the sale of the national government or NOC share can be used for the purchase of the needed oil by-products if national governments or NOCs are in charge of their distribution. 00_doha_book 5/4/09 6:10 PM Page 18
  29. 29. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH Chapter 1: Legal and Contractual Issues in Successful Hydrocarbon Development 19 of hydrocarbons in the event of emergencies. Any restriction on the ability of IOCs to sell their production freely can generate contingencies to such IOCs 7 regardless of whether it is derived from contract limitations or from the law. The possibility of such restrictions being imposed – even if temporary – will be taken into account by IOCs when evaluating the convenience of their investment. In countries with large domestic markets, IOCs should already be interested in distributing the oil by-products domesti- cally, and the impact of interference of national governments, if limited to emergencies, should not adversely affect the IOC evaluation of hydrocarbon projects in material terms. The more frequently the restrictions are imposed – or are expected to be imposed – the larger the impact on the evaluation of the project. Labour and Environmental Regulations Hydrocarbon exploration and production are economic activities that, as with other eco- nomic activities, are subject to the general laws applicable in the host country. Accordingly, all labour and environmental regulations applicable to economic activities in general will be applicable to the hydrocarbon industry. To attract foreign investment, countries may adopt flexible legal regimes for certain industries or for activities located in specific regions. National governments must consider the convenience of adopting such structures in connection with the hydrocarbon industry vis-à-vis the general inter- ests protected by such regulations and determine which regulations should be lifted. Labour and environmental compliance is a source of expense in the development of any activity, and IOCs may favour lifting the application of such regulations as an incentive for investment. In countries where labour contracts tend to be regulated in detail by applicable legislation, compliance may impose costs in excess of what is usu- ally experienced in other markets. Similarly, obtaining environmental licences and com- plying with environmental conditions imposed by such licences may generate high costs that can adversely affect the profitability – and even feasibility – of projects. 8 National governments weigh the risks of not applying such internal regulations to the hydrocarbon industry and the impact on the implementation of their policies 9 that such actions can generate. 7 The production of oil companies is sometimes directed to the fulfilment of their obligations under certain supply agreements and the diversion of production can cause a default under such agreements. 8 National governments should consider the environmental impacts of hydrocarbon projects vis-à-vis local legislation prior to awarding projects to IOCs.If environ- mental restrictions and the costs of compliance might impact the feasibility of projects,national governments should avoid the development of such projects,as restrictive conditions in the issuance of environmental licences can be deemed constructive expropriation and give rise to indemnifications.It is suggested that national governments perform initial environmental assessments prior to the development of projects and avoid the development of projects that would require massive investments in environmental compliance unless market conditions would render such projects profitable regardless of the level of investment required. 9 Not merely hydrocarbon policies but also labour and environmental policies. 00_doha_book 5/4/09 6:10 PM Page 19
  30. 30. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH SECTION 1: LEGAL AND REGULATORY FRAMEWORKS Taxes Hydrocarbon exploration and production are economic activities that, as with other economic activities, are subject to the taxes and duties generally applicable in a host country. Since the hydrocarbon industry demands massive investment and the use of equipment not commonly produced in all the jurisdictions where hydrocarbon projects are developed, national governments of such jurisdictions may, as an incentive designed to attract foreign investment, create special tax regimes applicable to the industry. The impact of such special regimes is generally merely financial and, although they may reduce the revenues available to the national government, 10 they also reduce the impact of operational costs on the profitability of IOCs, increasing the net present value of their investment and thus making the host country more attractive. Special tax regimes applicable to the hydrocarbon industry may be established in contracts although, more usually, legislation is enacted in this regard. 11 Special regimes may be applicable to all taxes or import duties, but their effectiveness in creating a more favourable environment for the hydrocarbon industry is in the reduction in – or even exemption from – import duties on the equipment to be used in exploration and pro- duction. Such equipment is sometimes imported for short periods and then returned for use in other projects abroad; if import duties are levied, amounts can be considerable, owing to the high value of such equipment. The reduction in or exemption from income or other taxes applicable to IOCs can certainly increase the interest such companies may have in investing in a host country, but national governments must also consider the impact that a waiver of the revenues associated with such income or other taxes may have on their finances vis-à-vis increased economic activity. Limitation of Liabilities Commonly, in any business venture, such as the development of a hydrocarbon project, the parties involved will try to limit their liabilities. Although IOCs would prefer to have limitations of liability expressly stated in contracts, they can limit their liability by incorporating local entities – as usually required in connection with hydrocarbon projects – and taking advantage of local laws on limitation of liability of business organizations.The value of the assets of an IOC is generally high, but investments in host countries amount to only a small fraction of such assets; unless the assets located outside the host country can guarantee the obligations of the IOC, its liability will be limited to such a small fraction. 20 10 Revenues that would not otherwise be available if the hydrocarbon industry were not present. 11 Local legal regimes would,in general,not permit acts of the executive branch,such as administrative contracts,to overrule or create exceptions to tax legislation. 00_doha_book 5/4/09 6:10 PM Page 20
  31. 31. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH Chapter 1: Legal and Contractual Issues in Successful Hydrocarbon Development 21 Current Exemption expensingof of exploration imports of Unlimited and/or equipment loss Tax Accelerated Tax development andcapital carry Country holiday depreciation credit cost goods forward Other Angola X Cameroon X Gabon X Mozambique X Niger X Nigeria X X Bangladesh X Brunei Darussalam X Cambodia X Indonesia X X X Malaysia X X X Papua New Guinea X X Philippines X Thailand X Viet Nam X Egypt X Tunisia X X X Yemen X X Belize X Bolivia X X Chile X Guatemala X X X Guyana X Mexico X X Trinidad and Tobago X X X Venezuela (Bolivarian Republic of) X X Azerbaijan X X X Kyrgyzstan X Source: E.M.Sunley,T.Baunsgaard and D.Simard (2003),“Revenue from the Oil and Gas Sector:Issues and Country Experience”,inFiscal Policy Formulation and Implementation in Oil-Producing Countries,J.M.Davis,R.Ossowski and A.Fedelino (eds.),Washington,DC:International Monetary Fund (IMF),pp.153-183. Investment incentives in fiscal petroleum regimes, selected developing countriesTABLE 1.2 00_doha_book 5/4/09 6:10 PM Page 21
  32. 32. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH SECTION 1: LEGAL AND REGULATORY FRAMEWORKS The assets of an IOC in a given country might be sufficient to guarantee indemni- fication for any potential contractual liability but may be insufficient to indemnify the State or the general population in the event of environmental or other types of accidents. National governments may request that IOCs submit parent guarantees in connection with the development of hydrocarbon projects. This additional guarantee can provide national governments with the assurance of proper indemnification, but it also generates additional exposure – and thus costs – for IOCs. Alternatively or, more commonly additionally, risks can be mitigated with the purchase of insurance, at a cost. 12 All such costs adversely affect the profitability of an investment, and national governments must consider the convenience of adopting such requirements. Applicable Law As a general rule, laws applicable to contracts in the hydrocarbon industry are those generally applicable in the host country. Subject to the host-country conflict of laws, 22 TABLE 1.3 Source: Ibid. Risk/reward trade-off for the Government arising from various fiscal instruments Low risk/low reward Medium risk/medium reward High risk/high reward Tax/royalty regime Royalty Income tax that applies to all companies Resource rent tax Production-sharing regime There may be an explicit royalty or a limit on cost oil that functions as an implicit royalty Income tax that applies to all companies,which may be paid out of the Government’s share of production The determination of the amount of profit oil can be highly progressive and mimic a resource rent tax 12 The costs with insurance tend to be higher than the costs with a parent guarantee:in addition to the costs with the premium,insurance companies may impose a series of measures to mitigate risks. Comparison between royalty and production-sharing regimes 00_doha_book 5/4/09 6:10 PM Page 22
  33. 33. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH Chapter 1: Legal and Contractual Issues in Successful Hydrocarbon Development 23 rules and principles or any legal prohibition to the sovereignty of the host country (or an instrumentality thereof) entering into agreements governed by the laws of other jurisdictions, joint operation agreements might be subject to laws elected by the par- ties that are from outside the host country. Nonetheless, concession agreements and production-sharing agreements, owing to their nature, are generally subject to local constitutional and administrative principles and are necessarily governed by the laws of the host country. As a result of negotiations or as an incentive to attract foreign investment, hydro- carbon contracts may contain provisions that, as an exception to the general rules appli- cable in the host country, are contrary to prevailing laws. Since hydrocarbon agreements are acts of the executive branch, unless a legal mandate has been given to the appropri- ate governmental body, provisions contrary to the law will not prevail if not ratified by the legislative branch. Since the legislative process can be time-consuming, specific mandates can be awarded to the executive branch prior to the negotiation of contracts, or contract forms or provisions can be approved in advance by the legislative branch to overrule existing less favourable legislation. However, this option has potential risk in countries with poor governance. If contracts entered into with IOCs are subject to ratification, the transactional costs can be elevated and discourage investment. An IOC may want, in addition, to claim the protection of a bilateral investment treaty that may be in force between the company’s home country and the host country. Such treaties can afford an extra level of security for IOCs, with protection against arbitrary expropriation or the enactment of less favourable legislation, and thus improve the risk assessment of the country. Regardless of the availability of such a treaty, the legislative history of a country soliciting investments will likely be analysed by IOCs interested in investment opportunities. Those countries that adopt measures to guarantee the security of administrative contracts, such as concession or production-sharing agreements, will likely have a better assessment, resulting in better prospects for investment. Dispute Resolution International investors in general and IOCs in particular are suspicious of the ability of local judiciary branches to render exempt decisions in disputes between foreign investors and the sovereignty (or an instrumentality thereof) and tend to prefer the use of the courts of their own home countries or a neutral dispute-resolution panel. Most nation- al governments may be prevented by local legislation from submitting to the jurisdiction 00_doha_book 5/4/09 6:10 PM Page 23
  34. 34. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH SECTION 1: LEGAL AND REGULATORY FRAMEWORKS of other countries and the courts of such other countries may be prevented from rendering decisions with respect to other national governments based on principles of sovereign immunity. As such, most hydrocarbon agreements provide for arbitration as the preferred dispute-resolution mechanism. The use of arbitration in connection with hydrocarbon contracts affords security and transparency to the resolution of disputes between national governments and IOCs. As a result, this increases the prospects for investment by IOCs. Notwithstanding the choice of arbitration over the courts of the host country, the laws of the host country must grant validity and enforceability to arbitral awards or the use of arbitration can be rendered innocuous, reducing the security sought by IOCs and therefore discouraging their investment. Award and Forfeiture of Rights Award of Exploration and Production Rights Several methods exist for national governments to award exploration and production rights to IOCs. When awarding such rights, national governments should adopt procedures that can maximize competition and, as a result, maximize revenues for the national governments and for the implementation of their hydrocarbon policies. The organization of public bids for the development of hydrocarbon projects in specific areas is often the most efficient method of maximizing competition, as national governments are entitled to select those bids that better meet their needs. In such bids, specific valuation weights must be given to (a) the financial compensation payable directly to the national governments or NOC and (b) the level of implementation of the requirements imposed by national hydrocarbon policy. In this way, the national government can award exploration and production rights to those companies that reach the optimum balance between financial compensation and implementation of government policy. Such weights, when established at the beginning of the process, allow IOCs to maximize their profitability when preparing their bids and thus make the investment appear more attractive. 13 In areas where little or no exploration has occurred or in areas with little information available, however, a lack of interest may mean that public bids might not be effective in generating efficient competition. In such cases, and to the extent permitted by the appli- cable legislation, the direct solicitation of IOCs 14 tends to be the most effective manner 24 13 As noted, the requirements imposed by national hydrocarbon policies tend to generate increased costs and thus reduce the profitability of investment. Permitting oil companies to allocate their costs in the most efficient manner will enable the achievement of an optimum balance. 14 Usually with conditions that are generally more favourable to the IOC. 00_doha_book 5/4/09 6:10 PM Page 24
  35. 35. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH Chapter 1: Legal and Contractual Issues in Successful Hydrocarbon Development 25 of commencing the development of the hydrocarbon industry and creating general awareness of the possibilities in the region. 15 Once exploration – and possibly produc- tion – is already under way, public bids can become an efficient method for awarding rights. International cooperation can also be useful in the initial development of unexplored areas of countries with no or little hydrocarbon tradition by association with traditional oil countries and the implementation of joint offers. For the success of such international ventures, it is essential to take into account the proximity and similarity of the two countries and the hydrocarbon rights being offered to avoid internal competition. Forfeiture of Exploration and Production Rights In several circumstances, national governments, in the implementation of their hydro- carbon policies, will desire or need to stop IOCs from conducting certain hydrocarbon exploration and production activities.To create an investment-friendly environment, the situations in which a national government can effectively remove an international investor, through expropriation or owing to a default by the investor of its obligations under a concession or a contract, should be clearly established in legislation or the relevant contract. National governments establishing and abiding strictly by such rules permit IOCs to assess the risks in connection with their investment and increase the prospects for foreign investment. The use of regulatory instrumentalities to implement national hydrocarbon policy, 16 to audit contracts and to apply applicable legislation in the event that an investor forfeits its rights under a contract for default or the national interests require the expropriation of an investment, adds transparency to the process. It also ensures that the application of law is not considered an arbitrary act by a national government, which could deter further investment by IOCs. In fact, national governments can cooperate in this regard by establishing transnational regional regulatory bodies which, at a share of the costs of maintaining a national body, could implement standardized procedures. These not only could be more easily analysed by IOCs interested in a region but also would likely not be subject to internal shifts in policy of specific member countries, creating a more reliable environment. 15 NOCs rather than national governments can be used in direct solicitation of investment in the event that applicable legislation would prevent national govern- ments from engaging in such activities. 16 Such instrumentalities are more efficient in providing transparency and security to the implementation of national hydrocarbon policy when their personnel have a technical background and cannot be removed by the national governments as a result of political changes. 00_doha_book 5/4/09 6:10 PM Page 25
  36. 36. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH SECTION 1: LEGAL AND REGULATORY FRAMEWORKS 26 In the past two decades, management of the oil and gas sector has oscillated dramatically, trending towards privatization in the 1990s and towards nationalization post-2005. As the holder of the second-largest natural gas reserves, estimated at 27 trillion cubic feet of nat- ural gas and 0.86 billion barrels of oil, Bolivia has seen its production increase substantially over the past few years;the country is currently producing 440 billion cubic feet of gas and 17.5 million barrels of oil annually. It currently exports about 360 billion cubic feet of gas annually to Argentina and Brazil, making it an important source of revenue for the country and a politically sensitive sector. The Government of Bolivia passed a series of laws in the early 1990s aiming to privatize the oil and gas sector.Privatization Law 1330 of April 1992 authorized public-sector institu- tions,entities and enterprises to transfer their stocks to individuals and companies,nation- al or foreign. Two further laws, Sectoral Regulatory System (SIRESE) Law 1600 of October 1994 and Hydrocarbon Law 1689 of May 1996, also amended practices within the sector. In particular, the Superintendence of Hydrocarbons was established as an independent regulator for midstream and downstream production, and the State oil company, Yacimientos Petrolíferos Fiscales Bolivianos (YPFB), was privatized. Since 2005,Bolivia has experienced a reversal in policy and has implemented a number of reforms nationalizing the oil and gas sector.Hydrocarbon Law 3058 of May 2005 and the Supreme Decree of May 2006 nationalized all oil and gas resources – from extraction to sale. In particular, these laws nationalized YPFB and reasserted its role in all aspects of the oil and gas production chain. Additionally, Hydrocarbon Law 3058 provides for YPFB to be responsible also for upstream regulations,as in the predecessor law.Midstream and down- stream regulatory functions remain the responsibility of SIRESE.Enforcement mechanisms, however, remain undefined in the current legal frameworks. According to current law,permits and authorizations for any exploration activities must be granted by the Ministry of Hydrocarbons and Energy, whereas bids for adjudication of exploration areas must be awarded by the State oil company,YPFB.Current regulations also establish that exploration and production must be carried out through YPFB by signed contracts, as provided for in Law 3058 and confirmed by the recent signing of 44 different operation contracts with private oil companies. BOX 1.2 The case of Bolivia: What is a “win-win” contract? 00_doha_book 5/4/09 6:10 PM Page 26
  37. 37. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH Chapter 1: Legal and Contractual Issues in Successful Hydrocarbon Development 27 These reforms have profound implications for private firms working in the Bolivian oil and gas sector and demonstrate how the stability of the regulatory framework is often influenced by domestic politics.As a potential solution,Jenik Radon (2007) emphasized the inclusion of social and environmental concerns in contracting with oil companies. Social considerations are important because the perception of unfairness may lead to instability or upheaval in the political system that can affect the oil and gas sector. By taking into account social-justice questions earlier on,dramatic regulatory changes might be avoided. Sources: N.Akhtar (2007),“Challenges of Effective Regulatory Compliance ...”;and J.Radon (2007),“How to NegotiateYour Oil Agreement”in M.Humphreys,J.Sachs and J.Stiglitz (eds.),Escaping the Resource Curse,NewYork:Columbia University Press. Conclusion The key to the successful development of the hydrocarbon industry is achieving the opti- mum balance between the implementation of the policies of national governments and assuring security and profitability for the investments of IOCs. Owing to the massive investments required and the high risk associated with the industry, national governments often cannot develop a successful industry without the assistance of IOCs. Equally, IOCs need national governments to award authorization to explore the resources available in their country and make their profits possible.The legal and contractual framework adopt- ed by national governments for the hydrocarbon industry is an essential factor in the suc- cess of its development. National governments can cooperate among themselves in such ventures, at a mini- mum by sharing their experiences and expertise acquired in the development of their own industries. The establishment of transnational agencies can also help countries to share some of the development costs and adopt tested successful policies. The Organization of Petroleum Exporting Countries (OPEC) is likely the best-known cooperation mecha- nism in connection with the hydrocarbon industry, but South-South cooperation can go beyond the coordination of unified petroleum policies to secure fair and stable prices and regular supply to the markets. Either through the expansion of OPEC activities or through the establishment of new regional transnational bodies, countries can cooperate among themselves, e.g., in the establishment of unified regulations and regulatory bodies The case of Bolivia: What is a “win-win” contract? (continued) BOX 1.2 00_doha_book 5/4/09 6:10 PM Page 27
  38. 38. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH SECTION 1: LEGAL AND REGULATORY FRAMEWORKS that, not being subject to shifts in policy in specific member countries, can add reliabil- ity to the system and help to attract investment. In any event, regardless of whether they are implemented by national governments or international agencies, contractual provisions have an often-neglected impact on the value of investments by private companies and the effectiveness of implementation of government policies. Engineering effective contractual and legal frameworks can both afford security and profitability to the investing international hydrocarbon companies as well as protect the sovereignty of the State hosting the investment and the interests of the respective national government. Countries intending to develop their hydrocarbon industry should pay close attention to the opposing interests of national government and IOCs and regulate such interests more generally with laws and more specifically in the contracts to be entered into with the IOCs. An effectively designed contractual, legal and regulatory framework can generate increased wealth for the hydrocarbon States as reliable frameworks are critical to attracting foreign investment for the development of a country’s mineral resources. Conversely, inadequately tailored contracts and unreliable legal and regulatory frame- works can generate losses for both the State and the investors in connection with exist- ing investment and discourage new investments. In fact, efficiently tailored legal and contractual frameworks are often revealed as the most efficient tools that a national government has for the successful development of the hydrocarbon industry. Having the capacity to design and implement such frameworks either directly or in cooperation with other national governments is essential for a country’s success in such ventures. 28 00_doha_book 5/4/09 6:10 PM Page 28
  39. 39. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH Chapter 2: Legal Regulation and International Boundaries 29 CHAPTER 2 Legal Regulation and International Boundaries17 Introduction A ll legal and regulatory frameworks for oil and gas industries must deal with a large variety of issues, such as licensing regimes, profit-sharing, fees, royalties, taxation, drilling, reporting, information, confidentiality, intellectual property, official approvals, environment, health and safety and security. Specific rules can vary considerably from one country to the next and, even within a country, special rules can exist for particular regions or areas, especially where the location is particularly sensitive or subject to a particular political or legal regime. Since the areas adjoining internation- al boundaries are frequently governed by special rules to some extent, these boundaries give rise to a wide range of particular problems for those concerned with the regudation of national oil and gas industries. Although energy prices are not in truth ever-rising, the overall trend in recent years has been sharply upward. Despite its implications, the world’s response to global warm- ing has been very slow. Demand for hydrocarbons continues to rise, while many existing reserves are rapidly being depleted. As a result of such circumstances, international boundary issues have increasingly preoccupied politicians in recent years as well as the oil and gas sector itself, of course. It seems inevitable that such issues, already diffi- cult to resolve, will become even more highly charged as time goes by, at least for the foreseeable future. This chapter is designed to introduce some of the most important practical problems that arise when legal and regulatory frameworks need to be established for oil and gas industries at or near international boundaries. The legal and regulatory role of the State and its judiciary system in such issues is discussed, followed by a series of brief case studies to illustrate how, in practice, some of the most important issues have been dealt with in recent years. We also look in detail at political will and judgment, and costs involved in setting up a legal and regulatory framework. 17 This chapter is mainly based on the Doha High-Level Meeting report by Alan Perry (Edwards Angell Palmer & Dodge),with contributions from Stacy Edgar and Stephanie Levy (ODI). 00_doha_book 5/4/09 6:10 PM Page 29
  40. 40. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH SECTION 1: LEGAL AND REGULATORY FRAMEWORKS Impact of Boundary Problems on Legal and Regulatory Frameworks Uncertain Boundaries A Government’s hope of establishing any kind of oil and gas industry depends on the outcome of a first-order boundary issue. In regulatory terms, this means simply that, depending on the dispute outcome, the oil or gas field in the area of overlapping national claims may or may not fall wholly or partially within the national legal and regulatory framework. In other cases, the industry will exist anyway and the importance of the boundary issue is secondary. In any event, those responsible for such frameworks need to factor in relevant boundary problems and their implications. The fundamental uncertainty brought about by a first-order boundary dispute is essentially that, until the respective rights of the neighbouring States have been decided, either by agreement or by an authoritative legal ruling, acts and omissions relating to the disputed area that are carried out or permitted by one of the States under its own national legal and regulatory framework may in due course turn out to have infringed the rights of the adjoining State. It is easy to say that Governments should avoid provocative actions, but this can only be a guide, not an absolute and inflexible rule. If, for example, there is only a small chance that a particular act will infringe the rights of the neighbouring State but the economic price of suspending or abandoning the action in question is extremely high, a Government will obviously have to make a judgment, deciding (perhaps only provisionally) whether it is reasonably safe to proceed and, if it does, what precautions to take. Such considerations may affect the design of the national legal and regulatory framework long before negotiations between the two States have even begun. Boundary difficulties relating to oil and gas deposits exist on land but are particular- ly acute at sea. These are issues of States’ rights in international law. In principle, States have a right to a territorial sea up to 12 nautical miles wide, an exclusive economic zone up to a further 188 nautical miles and possibly continental shelf rights even beyond 200 nautical miles (see the United Nations Convention on the Law of the Sea (UNCLOS), 1982, Parts II and V). Where two or more States have overlapping claims, their maritime boundaries normally must to be delimited by agreement between them on the basis of the equitable principles applicable under international law (Articles 15, 74 and 83). 18 A large number of international maritime boundaries remain to be delimited by this 30 18 Also see R.Kolb (2003),CaseLawonEquitableMaritimeDelimitation:DigestandCommentaries,The Hague:Martinus Nijhoff;and International Labour Organization (ILO),“ThePromotionofGoodIndustrialRelationsinOilandGasProductionandOilRefining”(ILOdocumentTMOR/2002/11).ReportfordiscussionattheTripartite Meeting on the Promotion of Good Industrial Relations in Oil and Gas Production and Oil Refining, Geneva, 2002. Available at: http://www.ilo.org/ public/english/dialogue/sector/techmeet/tmor02/tmor-n.pdf (accessed 29 August 2008). 00_doha_book 5/4/09 6:10 PM Page 30
  41. 41. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH Chapter 2: Legal Regulation and International Boundaries 31 BOX 2.1 International law: Oil and gas discoveries in the sea 1945 Truman Proclamation The first assertion of a State over marine resources, the Proclamation states that “the Government of the United States regards the natural resources of the subsoil and sea bed of the continental shelf beneath the high seas but contiguous to the coasts of the United States as appertaining to the United States, subject to its jurisdiction and control”. The Proclamation is often cited as a precedent in States claiming the authority to regulate the contents of their surrounding waters. 1956 United Nations Convention on the Law of the Sea (UNCLOS I) UNCLOS I produced four treaties that served as predecessors to the current treaty, which was amended in 1982: Convention on the Territorial Sea and Contiguous Zone (entry into force: 10 September 1964); Convention on the Continental Shelf (entry into force: 10 June 1964); Convention on the High Seas (entry into force: 30 September 1962); and Convention on Fishing and Conservation of Living Resources of the High Seas (entry into force: 20 March 1966). Of these four treaties, the Convention on the Continental Shelf is the most referred to in joint development agreements because this is the most common location for disputed oil and gas discoveries; the Convention serves as the legal guide for determining who has claim to what. 1970 United Nations General Assembly Resolution 2749 (XXV) Serving as a legal framework for international regulation of the seabed and ocean floor,the Resolution puts forth a set of principles for guiding State action, especially with regard to exploration and exploitation of resources. 1982 United Nations Convention on the Law of the Sea (UNCLOS II) An amended version of earlier UNCLOS treaties, the 1982 Convention did not enter into force until 1994.The treaty includes specified definitions for different categories of water- ways (internal waters, territorial waters, archipelagic waters, contiguous zone, continental shelf,exclusive economic zone) and measurements for determining a State’s claim to each. The treaty also established the International Seabed Authority and the International Tribunal for the Law of the Sea. Countries differ on their adherence to these definitions based on whether or not they have ratified the Convention. 00_doha_book 5/4/09 6:10 PM Page 31
  42. 42. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH SECTION 1: LEGAL AND REGULATORY FRAMEWORKS process, and some pose considerable technical difficulties.This means that, in many cases, a State’s own view as to the boundaries of its territorial sea, continental shelf or exclusive economic zone is not accepted by neighbouring States and their licensees. The resulting issues, sometimes amounting to disputes, are ultimately to be resolved either by negotia- tion or by litigation. These processes sometimes last for decades or fail altogether. Until the issues are resolved and often even afterwards, they can give rise to serious regulatory problems for the industry. Disputes about international boundaries occur in all parts of the world but are perhaps at their most acute in semi-enclosed seas bordered by several States, although they also arise in relation to seas that are virtually fully enclosed, such as the Black Sea, the Mediterranean and the Caspian. 19 Two good examples of semi-enclosed seas are the South China Sea and the Gulf of Thailand, but there are many more, notably in Latin America and the Gulf. Where several coastal States border the waters in question, the result is usually a complex mesh of overlapping claims. In a perfect world, prompt regional negotiation on a sensible basis would be followed by regional agreements sorting out all the important issues. The States concerned could then proceed confidently with organizing, regulating and promoting their oil and gas industries and other economic activities in the waters in question. Unfortunately, experience shows that comprehensive regional agreements involving a number of key players are extremely hard to arrange. Many academic and other commentators who write about these issues invariably regret this, normally adding their own sometimes naïve but often perfectly sound suggestions about how progress might be made. However, that comprehensive regional agreements are extremely hard to engineer is not really surprising, given what is potentially at stake. In the absence of comprehensive regional agreements, individual States sometimes try to reach bilateral agreements with one or more other States or even to reach multilateral agreements on specific aspects of the wider problems. Either way, even this approach tends to be quite difficult either because the more important problems are so closely interconnected or because, even where they are not, issues of balance and leverage may make it impossible to resolve one problem on a definitive and unconditional basis without solving another at the same time. Quite frequently, there is still room for disagreement on national rights even though a land or maritime boundary has been delimited or is at least the subject of a measure of agreement between the affected States. These disagreements often extend to their licensees, especially where NOCs are concerned. The scope for disagreement is particu- 32 19 It is in fact debatable whether the Caspian is truly a sea,a term not defined by UNCLOS,or whether from a legal perspective it should be treated as a gigantic lake. 00_doha_book 5/4/09 6:10 PM Page 32
  43. 43. EFFECTIVE HYDROCARBON MANAGEMENT: LESSONS FROM THE SOUTH Chapter 2: Legal Regulation and International Boundaries 33 larly broad when deposits actually straddle the international boundary or where it is thought that they might. In such cases, what is done on one side of the boundary can have major adverse consequences for the holders of corresponding rights on the other side. Public international law (which in essence is the law of interstate relations) is not silent on this subject, but on many of the most important issues, its provisions are uncertain and leave considerable room for doubt. This means that even well-informed Governments remain in a state of uncertainty. At its most serious, such uncertainties can have very grave consequences. Saddam Hussein’s alleged grievances about oil and gas activity on the Kuwaiti side of the international boundary were said to have been a significant cause of the first Gulf War. It was illegal under the United Nations Charter for Iraq to attempt to resolve the issue using armed force, but if applicable international law were more precisely articulated, Governments such as those of Iraq and Kuwait would know much more clearly whether any particular grievance is or is not legally justified and could adjust their behaviour accordingly. A number of commentators assert that, in this field, a “rule of capture” operates in international law. An issue between States about the actual position of their undelimited maritime boundary is essentially a dispute about how far each State’s “territory” and jurisdiction extend. Territorial disputes have always been considered first-order interstate questions since they directly affect the size of the State and its power, prestige, economy and tax base. For these reasons, first-order questions have, at least in the past, frequently led to war. Although, mercifully, armed clashes between States are relatively rare features of oil and gas disputes, it is useful to make a working distinction between disputes of this nature and second-order issues that crop up, often in a routine way, between Governments of neighbouring States on all kinds of issues that govern the relationship, from visa issues to environmental ones, from economic regulation to security problems. It is also important to note that first-order boundary issues are certainly not the only international problems that affect the design of legal and regulatory frameworks. All Governments must also factor in compliance with the international rules governing a range of second-order issues that might otherwise cause bilateral or multilateral difficul- ties and disputes. Such issues range from coastal zone management and international waterway regimes to security and environmental concerns. Furthermore, boundary questions of both the first and second order give rise to further layers of uncertainty, all of which can have an impact on the design of a framework. 00_doha_book 5/4/09 6:10 PM Page 33