Governments generally need to contract with private or external companies that have the expertise required for the stages of resource development, from exploration through to extraction and decommissioning. Such contracts have to secure maximum value to host country citizens while at the same time ensuring that adequate incentives are provided to investors and that exploration and production are undertaken efficiently. The context of natural resources makes the contractual relationship complex. The relationship is likely to be long term, perhaps lasting thirty years or more over the life of a project. There are numerous uncertainties regarding geology, costs and technology, resource prices and the capabilities of firms and of government. Government is likely to be at an informational disadvantage, knowing relatively little about technical matters and perhaps having little or no experience in the complex negotiations that are characteristic of the resource sectors. Competition can play an important role in addressing these disadvantages. Competition can be enhanced by good prior geological information and open bidding processes.
Open and transparent competition for contracts and development rights is the key to ensuring maximum value and integrity. Competition between firms that are technically and financially competent has the effect of ensuring that government gets maximum value as firms compete to offer winning terms. Competition need not simply be on price, but competition on too many variables erodes transparency and increases administrative cost. In all cases competition should be on the basis of clear and transparent rules, this minimizing the possibility of back-room deals and abuse of discretion.1
The prospects for delivering these benefits are enhanced if a number of conditions are met.
Terms should be set in law to the greatest extent possible. Setting policy in law increases public input and support, enhances stability for the investor, ensures uniform treatment and reduces opportunities for gaming and side-dealing.
As much information as possible should be made public prior to award of contracts. This includes the fiscal regime under which firms will be operating; there is a wide range of options for the design of the regime and these are discussed further below. It also includes geological knowledge; publicly available findings of advanced survey work are likely to be beneficial in drawing firms into the bidding process.
The process for allocating the contracts between competing firms needs to be carefully designed. Where practical, auctions are generally the preferred mode, both on grounds of transparency and securing maximum value. They are likely to require pre-selection of bidders in order to ensure that all are reputable and technically qualified, and to limit the numbers entering the bidding round. The true beneficial owners of the firm should be known to prevent conflicts of interest and authorities steering business to firms in which they may have a share. The auction itself needs careful design, both in terms of selecting the bidding variables (e.g. royalty rate, production share, work program or profits tax) and the design of the auction process.
There may be an advantage in unbundling the contract into separate parts. For example, certain activities, e.g., limited seismic acquisition and interpretation, could be subject to separate contracting from the letting of exploration rights.
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