The characteristics of major natural resource projects—their longevity, scale and capital requirements, social and environmental impacts, specialized and demanding technology, exposure to commodity market risks—mean that development may be most efficiently achieved in cooperation with partners possessing significant financial capacity and which have the necessary technical and managerial skills. To attract such partners while still securing full value for the country's resources requires carefully designed fiscal and licensing policies or contractual terms.
Well-designed fiscal regimes should allow the government to share in profitability and to have some minimum revenue stream in all production periods. This implies that the regime contain both a royalty levied on a value or physical basis linked to production and a charge linked with profitability. The latter may be achieved through corporate or entity income tax, perhaps at a special resource sector rate and possibly supplemented with additional taxes linked to particularly high returns. Enforceability and administration will be enhanced if these fiscal elements are linked, when possible, to variables that are observable and verifiable, such as world prices.
An alternative to the royalty/income tax system is the use of production sharing arrangements, especially common in the petroleum industry, in which output is 'shared' between the investor and the government. Production sharing arrangements can be designed to provide a minimum revenue stream in all production periods by limiting the rate of cost recovery. They can also provide a form of progressive income taxation through the use of “R” factors and other devices altering the sharing of output between the investor and the government.
Fiscal Stability and Changing Circumstances. Given the long-term and capital-intensive nature of major natural resource projects, governments need to provide investors with a stable environment that provides a reasonable opportunity for realizing expected returns. In addition, investors need to be protected from confiscatory government action. Contractual stability can be enhanced by provisions which respond to changing circumstances—both anticipated and unanticipated—so as to preserve an equitable balance between the parties, reducing the incentives to seek renegotiation or for the government to make abrupt changes in the fiscal rules applicable to existing investors. If the government does provide some form of contractual assurances regarding taxation or royalties, it needs to ensure that such provisions are limited so that the state remains free to regulate other areas of concern, such as labor, health and safety, environment, security, and human rights, through generally applicable law. This is especially important given the long-term nature of many resource contracts.
Social and Environmental Impacts. Projects have social and environmental impacts. There may also be legacy impacts from prior exploitation of natural resources or other activities in the same region. Well-designed regulations or contractual terms must specifically identify the nature of these impacts, how to avoid or mitigate them, and how to compensate those injured by the remaining risks. Responsibility for legacy impacts needs to be carefully assigned. Typical tools include baseline studies to determine current status, development impact studies, and remediation and closure provisions at the end of project life.
Management and Technology. Efficient natural resource extraction requires the deployment of technology and management capabilities that governments may seek from their partners. Granting of licenses should require demonstration of such capabilities, and, where bidding is employed, eligibility should be limited to entities which have demonstrated their possession of, or access to, such capabilities.
Allocation of Risk. Natural resource projects are subject to many risks: future commodity prices; uncertainties about the quality and quantity of the resource base; developing technology; input prices; and external or domestic political developments. These risks must be assessed and assigned. Typically, investors are the best party to bear operational or market risk since they can better manage or control it; governments should bear the political risks. Even where the investor is the best bearer of the risk, governments and investors must take account of political perceptions if, in the future, the allocation of risk can lead to situations in which the investor appears to be making disproportionate gains.
Knowing the Investor. Governments and investors are engaged in a long-term relationship, and it is important that a government knows with whom it is dealing and that the investor has the management, technical and financial capabilities to carry out its obligations. Investors should be required to disclose those persons and entities directly or indirectly exercising management rights or holding beneficial interests. These requirements should extend throughout the life of the investment.
Clear Rules and Transparency. Governments and investors are generally better served if there are clear rules applicable to all investors in similar circumstances. Transparency and uniform rules help ensure that operators know that treatment is non-discriminatory, reduce opportunities for corruption, and may reduce the demand by individual investors for special treatment. Uniformity does not mean that new projects must be subject to the same rules or contractual provisions as older projects. Policies, rules and contracts for new projects should reflect current government priorities and lessons learned from older projects as well as the prevailing economic environment.
Administration. Licensing, fiscal and contractual regimes need to account for the evolution of the government’s administrative capacity. Audit is critical in all periods, including initial stages in which losses are being incurred that will be offset by future income. Employment of outside auditors should be considered when domestic administrative capacity is still being built. Requiring certifications from the investor’s senior company officials with respect to output, financial data, and related party transactions may enhance compliance. Administration may also be facilitated if key parameters are measured relative to observable and verifiable variables such as world prices.
Enforceability. Because of the long-term nature of the investment and the relationship between the government and the investor, contracts and regimes need to have flexible mechanisms for resolving disputes and adjusting for changed circumstances. Where disputes cannot be resolved at the business level, governments and investors need to have clear legal remedies. If domestic legal institutions are thought inadequate, access to international arbitration should be provided for the in-country investor and its identified shareholders.
