Energy Governance Weak Points

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Pre-Production Stage

Exploration Licenses

Oil and gas production often works in two stages, with licenses awarded to explore given regions at the initial stage, and then separate arrangements being made once oil or gas is discovered. Given that prediction is so difficult, and the potential rewards are so great, even the license to explore certain areas can present an opportunity for corruption. For example, in 1999 Nigeria granted a series of exploration licenses for offshore exploration to companies which did not have any experience in oil production.[1] In Libya meanwhile, it was lucrative exploration contracts which were at stake when BP faced an outcry in 2010 over links made by the press between the company and the release of Lockerbie bomber Ali al-Megrahi,[2] who was released on 'compassionate grounds' by the Scottish government. BP denies any lobbying that linked Libyan prisoners to commercial contracts.[3]

Production Awards

Once discoveries have been made, the right to produce presents a further opportunity for corruption. In some cases, the company which made the discovery has already agreed terms to go ahead and produce the oil. But especially in post-conflict countries, licenses may be obtained without due process. A 2004 review of companies extracting minerals in Liberia found that only 45 out of 70 operating companies were in possession of proper licenses.[4] In other cases, officials in host governments can use the threat of renegotiation or revocation of production rights to exhort illegal payments from companies. Many economists regard auctions as the best way to manage both corruption and asymmetry of information between governments and companies at the production award stage.[5] Nevertheless, corruption is possible even in the context of an auction process, since a company and a government official can collude over subsequent modifications and re-negotiations to the contract.

Production Stage

Import licenses, dues, levies

Once a company is producing in the country, the host government has a range of tools by which it can effectively change conditions for operating companies, which have now sunk large investments and so have incentives to keep producing even in the face of extra burdens. This is known to the economists as a "time-inconsistency" problem.[6] This ability to hold the company to ransom over its sunk investment can either be exploited for public interest - as when the government of Abdul Karim Qassem raised port fees in Basra Oil Terminal by 1200% overnight as part of its struggle with the Iraq Petroleum Company in the 1960s,[7] or it can be used for private gain by influential officials in the host government.

Among such blocking tools are licenses to import equipment needed to produce, such as has happened in Angola,[8] transit fees in ports and along pipelines, such as happened in the Iraqi industry when it fell into disagreement with neighbouring Syria, and more recently between Ukraine and Russia,[9] and changes in various forms of corporate and other taxes.

Support Service Contracts

The oil industry, in line with trends in the rest of the global economy over recent decades, has taken to outsourcing aggressively. This means that even when a top level operating license has been granted under public scrutiny through an auction process, the primary operator then issues contracts, which could be worth hundreds of millions of dollars, to other companies who in turn implement various activities to fulfil the contract with the host government. Since these contracts are between two private sector companies, they usually fall outside the scope of any governmental audit or integrity agency.[10]

Cost Recovery Accounting

Many oil contracts make provisions for an oil company to recover the heavy investment it has made to discover and then produce oil and gas. This is typically on a sliding scale over time, whereby a large portion of oil revenues are awarded to the company to cover their costs at the outset, but the proportion gradually diminishes over time.[11] Big oil companies often have sophisticated accounting methods at their disposal and can, for example, find ways to increase costs and decrease profits in one country with relatively high taxation, transferring the profits to another country where corporate taxes are lower. In some cases, multinational companies engage in complex transactions between several subsidiary companies across different legal jurisdictions. This is known as "transfer pricing", which can result in above market "costs", which they can then reclaim out of the oil revenues created by their production.[12]

All of these issues can be disputes between a host government and an oil company, as was seen in Indonesia in 2009-10 with cost recovery accounting.[13]

References

  1. Africa: Nigerian generals deny corruption”. BBC News, 10 May 1999.
  2. Libyan controversy adds to BP's woes”. Washington Post, 16 July 2010.
  3. A black cloud on the horizon for Anglo-American relations?”. The Economist, 21 July 2010.
  4. Corruption and the renegotiation of mining contracts”. U4, 30 November 2007.
  5. Managing the 'curse' of natural resources: charter offers guide for politicians”. The Guardian, 5 February 2009.
  6. Dynamic Inconsistency”. Wikipedia, retrieved 25 October 2011.
  7. Iraq: Post-World War II Through the 1970s”. US Library of Congress, retrieved 25 October 2011.
  8. Angola Trade Report”. US Trade Department, retrieved 25 October 2011.
  9. Q&A: Russia-Ukraine gas row”. BBC News, retrieved 25 October 2011.
  10. The oil service industry: Rigging the market”. The Economist, 23 June 2011.
  11. Glossary of Terms Used in Petroleum Reserves/Resources Definitions ”. Society of Petroleum Engineers, retrieved 25 October 2011.
  12. Cost Recovery And High Oil Price: How Can Host Governments Capture Adequate Revenue? A Case Study Of Nigeria”. CEPLMP, 04 June 2009.
  13. Indonesia to drop cost recovery cap”. Upstream Online, 05 January 2010.