Stable Gains


Since the early 1970s when the oil shock sparked by the Arab oil embargo was followed by another extraordinary price rise at the end of the decade, contract renegotiation between African governments and international oil firms has become a recurring concern. Perceived excess profits for exploration companies, particularly during periods of high crude oil prices and declining exploration costs, are key drivers accentuating host government contract renegotiations. When circumstances changed radically, the industry again became the incubator for what has been dubbed a new wave of ‘resource nationalism.’

RENEGOTIATE AT YOUR OWN RISK: African countries need to decide if they want to follow the Venezuelan approach to contract renegotiation, which imposed new taxes and royalties on production, exports or windfall profits. It also mandated structural changes for all contracts in their energy industries, where operating service agreements, although structured as services contracts, were in substance anything but pure services contracts. They ceded control over petroleum operations in huge areas for 20 years, and compensation was based on the volume and value of production. Many of the services providers were effectively senior partners in the business, taking more than half the value of production on average. In some cases, the state-owned company actually lost money for each barrel of oil produced after accounting for the royalty owed to the state. Making matters worse, the contractors, claiming to be only services providers, argued that they were subject to the non-oil income tax rate of 34 percent rather than the rate applicable to oil producers, which was 50 percent.

TRUE COSTS: In Africa, in cases where PSCs are the contractual vehicle, the heart of the problem is always the concept of cost recovery, under which a large percentage of production, known as cost oil, is allocated off the top to the contractors to recover their costs. African governments should understand that securing long-term fiscal stability is a key priority for any international investor. The rule of law and the sanctity of contracts enable investors to determine the long-term profitability of a particular project and inform shareholders about likely dividends. Investors would be reluctant to invest in countries with significant high contractual and political risks.
Equatorial Guinea is lucky to be the archetype of contractual stability. I believe that current investors in the country’s energy industry – majors such as ExxonMobil, Marathon Oil, Pan Atlantic, Murphy, Ophir Energy, Hess and Noble Energy – are happy with their contractual arrangements with the government. Each country must make an individual decision, but if foreign investment is needed for operations then host countries will stand the risk of losing considerable progress in the development of their oil reserves due to frequent contract renegotiations.

Article reproduced with permission from