4.10 Contract Negotiations

laws that result in heavier financial burdens. It has to be ratified by the parliament. If a development agreement is entered into, under section 49 of the same act, it may contain stability terms. This kind of agreement is also subject to ratification by parliament. In the hydrocarbons sector, both Timor-Leste and Nigeria have provided dedicated instruments for stabilization prior to investments being made, mostly in the natural gas sector. Some Latin American countries have provided for stabilization agreements that cover various kinds of investment including mining, oil and gas investments.

Asymmetry. A dimension of these clauses that governments may want to consider carefully before agreeing to them is their occasional asymmetry.

The fiscal stability clauses in many mining and petroleum agreements are asymmetric: protecting the contractor from adverse changes to the fiscal terms but passing on benefits of reductions in tax rates or other changes beneficial to the contractor, such as more liberal rules for cost recovery (Daniel and Sunley 2010, 417).

For Daniel and Sunley the asymmetry is a “one-way bet” that offers both protection and benefits to the investor. They provide an illustration of how this stability would operate by reference to the Kurdistan Model Production Sharing Contract of 2007. In addition to a right to negotiate an offsetting change if a package of government-initiated changes leaves the investor in an adverse economic position, this “would allow the contractor to request the benefit of any future changes. In effect the contractor could cherry pick a balanced tax reform package combining, say, lower tax rates with less favorable capital recovery rules” (Daniel and Sunley 2010, 422–23.) In other words, a fiscal stability clause can provide both a positive and a negative form of protection with respect to future state actions, with the positive element working to ensure that any available benefits occurring after the original agreement are brought into that contract to benefit the investor. This contrasts with the kind of fiscal stability offered by Timor-Leste in its tax stability agreement which, Daniel and Sunley (418) note, is an example of a “two-way bet”: it “fixes tax parameters in both directions— the contractor does not benefit from tax reductions.”

4.10 CONTRACT NEGOTIATIONS

As section 4.6 “Contracts and Licenses” suggests, contracts and licenses are diverse and sometimes complex. As a result, their negotiation, probably on the basis of a model, will require considerable expertise across disciplines, involving law, geology, engineering, and economics skills. Before any negotiations start, the government needs to give some thought to at least four features of EI contract negotiations in a modern setting:

1. Legacy matters. Negotiations rarely take place in a context that lacks a history of interactions with international companies. The country’s history of dealing with investors, and investors’ track record in dealing with the country, including any deals struck that appear in retrospect to have been made on bad terms for the state, influence any subsequent negotiation. 2. Extractives differ. Negotiations on oil exploration or mining exploration and their possible development will differ, sometimes involving complex issues of infrastructure development. If gas development is envisaged, it requires special knowledge of gas pricing, transportation, and marketing. 3. Capacity limits can be managed. In the face of capacity shortages, a government usually has no difficulty obtaining offers of outside help. The challenge is to identify offers that come from the best source. Best means the ideal fit with the government’s objectives and needs, rather than a rapid response. 4. Technology helps. The idea that negotiations always require face-to-face meetings does not fit the context of computers, Internet connections, and video conferencing. This influences the tasks of preparation, research, and reduces the number of on-site meetings of all of the parties.

In general, negotiating procedures tend to be complex and lengthy, covering potential investments for long-term projects in conditions of considerable uncertainty. Negotiations have different phases, from formulating strategic policies and regulatory frameworks to preparing for and carrying out negotiations for particular projects and monitoring and enforcing contracts. They typically address the sharing of economic rent between the investor and the host government and have significant economic development, environmental and social impacts. The government must carry out due diligence on its potential partners in what may be a long-term relationship.

Negotiations require special skills, particularly a grasp of both legal and economic issues, such as fiscal modeling, to explore the impacts of various fiscal options prior to making a choice. A major problem for most countries is the lack of capacity (specialized know-how, technical expertise, and

CHAPTER 4: POLICY, LEGAL, AND CONTRACTUAL FRAMEWORK 101