EI Sourcebook | 5.1 Policy Context

5.1 Policy Context

Experience suggests that to be effective, EI sector policies should be based on consultation with a broad base of stakeholders and should provide strategic direction and clarity on key sector issues.^[1] The resulting policy statements are often stand-alone documents, but they may also be found in summary form as preambles to sector legislation. A number of commonly addressed issues in policy design are listed below.^[2] Each issue is discussed in greater detail in this chapter, or in in Chapters 6 and 7.

Sovereignty and National Interest. Most states vest the ownership of subsoil resources in the state and do so in a distinct sector-specific law: a petroleum law or a minerals law.^[3] However, in many states there is some wording in their constitution or fundamental law that places ownership of such resources with the nation and its people.

An example of this is the wide-ranging statement of ownership that is included in the Constitution of Ghana. It reads: “[e]very mineral in its natural state in, under or upon any land in Ghana, rivers, streams, water courses throughout Ghana, the exclusive economic zone and any area covered by the territorial sea or continental shelf is the property of the Republic of Ghana and shall be vested in the President on behalf of, and in trust for the people of Ghana.”^[4] This constitutional provision grasps all the important areas of minerals in offshore waters, as well as, on and under land.

An exception to the default rule of state ownership of natural resources is the complex mix of private and public ownership arrangements used in the US. In the US, a significant proportion of lands are in private ownership and the owners are also the owners of the subsoil resources. It is notable that the recent discoveries and development of shale gas and oil have been made overwhelmingly in lands owned by private persons.^[5]

Although there has been extensive debate about the scope of the concept of permanent sovereignty over natural resources (PSNR), there has been little disagreement about its essential idea (see Box 5.1 below).^[6] Since the concept of PSNR vests all natural resources within the territory of a sovereign state, difficulties arise when the territory of a sovereign state is in dispute. More often than not, this concerns offshore waters.^[7]

The practical consequences of sovereign resource ownership depend on the policies that a state adopts for EI sector company participation.^[8] Where ownership of the resource is a highly sensitive political issue, particularly in post-colonial states, great care must be taken. This requires that contract and licensing models must be chosen in a manner that ensures their long-term legitimacy.

Policy statements relating to resource extraction usually start with an affirmation of sovereign rights over the ownership and development of petroleum or mineral resources. These statements typically call for the EI sectors to be developed in a manner consistent with the maximization of near-term benefits to, and long term interests of, the state and state development priorities. In states that have federal systems of government – such as Australia, Canada, Iraq or Nigeria, different approaches to the allocation of sovereign powers over petroleum activities and revenues have emerged. Some federal systems have chosen to devolve significant operational control to sub-governmental or private entities, while others have taken a more restrictive approach to the devolution of sovereignty authority over natural resources.

In a small number of mining states such as Argentina and Canada, the competent authority is not the national government but a sub-national entity. In these states, provincial authorities award licenses and impose taxes on exploration and mining activities.^[9] At the national level, a key question for policy makers relates to the manner in which the legal and constitutional frameworks constrain the discretion of national authorities in the design or allocation of contracts or licenses, and their subsequent operational control.

Sector Roles and Responsibilities. The roles of the sector ministry, its agencies, and the national resource company (NRC), if there is one, are of the greatest importance. These institutions are typically mandated to implement and oversee sector strategy. Other critical entities include the ministries of finance (taxation) and environment (social and environmental protection), and the revenue collection authority. These non-sector-specific entities are often tasked with achieving optimal operational benefits among the various sub-governmental or sector-specific agencies. In practice, this is very difficult to achieve and an overlapping competence is often found among state entities, creating potential for confusion (see discussion in Chapter 6).

National Resource Companies (NRCs). While not without controversy, NRCs remain popular in most petroleum-producing states, and also in a growing number of mineral-producing states. Their governance and roles, which may include both commercial and non-commercial objectives, is often the subject of separate legislation. Controversy tends to be sharpest in relation to the NRCs’ links to the host state, and there are different views about what kinds of relationship lead to the best outcomes in a particular state. To date, NRCs have been more common in the petroleum sector than in the mining sector (see Chapter 6 and 7).

Private Sector Participation. Participation of the private sector is one of the most important issues to be addressed in any sector policy statement. Private sector participation in resource-rich states is common, with notable exceptions being the petroleum sector in Mexico and a number of Middle Eastern states.^[10] For policy makers in many former colonial states, the history of private sector involvement will play a significant role in determining (and often limiting) the present scope for private sector participation in the EI sector (see Box 5.1 below). ^[11]

Exploration. Although the exploration phase generates valuable information for the host government and investors, it nonetheless remains a financially high risk undertaking. Thus, the question about whether or not the government should assume this risk is an important policy issue. Faced with such risks, governments have basically four options: (1) they can develop the resources themselves; (2) contract private petroleum and mining companies to develop the resources for fees; (3) auction the right to develop the resources to a private company; or (4) adopt a combination of any of the aforementioned alternatives. More often than not, governments enter into agreements with private companies to explore and develop the resources at their own costs and risks. Often this option is necessary where a government or its NOC does not possess the essential technical know-how and skills to develop the resources themselves.^[12]

Box 5.1 Sovereignty over Natural Resources

Resolution 1803 itself was developed at a time when discussions about the New International Economic Order (NIEO) were robust, and post-colonial development issues framed the debates. This period came to an abrupt end with the 1986 world oil price crisis. This crisis followed two oil price shocks in the 1970s; but unlike the sharp escalations in prices in 1973 and 1979, the 1986 crisis contrasted with these earlier shocks in leading to a dramatic fall in the price of oil.

An important provision in Resolution 1803 can be found in Article 3, which expressly recognizes the sanctity of the contract between the foreign investor and the state by stating that: “[in] cases where authorization [of the investment of foreign capital in the natural resources of the host State] is granted, the capital imported and the earnings on that capital shall be governed by the terms thereof, by the national legislation in force, and by international law… The profits derived must be shared in the proportion freely agreed upon, in each case, between the investors and the recipient State...”

However, Resolution 1803 does not empower the state to make unilateral changes to its laws in order to negate the terms of a contract. Article 8 of Resolution 1803 is clear on this point: “[f]oreign investment agreements freely entered into by or between sovereign States shall be observed in good faith.”

This doctrine of good faith and pacta sunt servanda (agreements must be kept) is also reiterated in the Article 18 of the 1994 Energy Charter Treaty (ECT) . This doctrine is also an integral component of more recent discussions on the rights of indigenous peoples to access and control natural resources on indigenous lands.

Local Content. Policy statements increasingly outline expectations with respect to local content. Local content requirements seek definable linkages between core sector investments, and operations and local employment and economic activities. Policy makers are likely to experience strong pressures from local business or communities to promote such content. However, such pressure can present issues for both host governments and foreign investors as the necessary skills for some petroleum and mining operations may not be available in the state concerned (see Section 5.5).

Fiscal Objectives. The focus of intense attention at the detailed implementation level, fiscal objectives at the policy level typically emphasize both revenue sharing and safeguarding of incentives for efficiency and investment. These dual objectives are often simultaneously pursued and must be balanced against each other for optimal results. However, such a balance will be affected by global or regional market conditions and by perceptions about what is the ‘going rate’ in similar country contexts (see Chapter 7).

Revenue and Expenditure Management. As a result of a growing recognition of the particular challenges resource wealth can present to macroeconomic management, many policy statements issued by governments spell out intentions with respect to the saving and investment of resource revenues (including the possibility of resource funds), and to their expenditure. Examples of states that have developed policy statements in this regard include: Norway, Kuwait, Iran, Timor-Leste, Chile, and Papua New Guinea. Some of these policies are summarized in Chapter 8 herein.

Social and Environmental Concerns. Once neglected, strategies for protection of the social and physical environment now feature prominently in EI sector policy pronouncements. The focus often goes beyond ensuring mitigation of adverse consequences, and now frequently includes the promotion of net benefits and the distribution of those benefits between the poor and the elite, between men and women, and other disadvantaged groups such as the elderly and children (see Chapter 9). CommDev resources on Policy and Regulation have a strong focus on Social and Environmental Concerns.

Local Context and Commitments to Investors. The overall regime for the EI sector will have to be sensitive to investors’ concerns about long-term investment security. Where the context is one of past nationalization or frequent unilateral changes to contracts, investors will usually expect the policy and related legal framework to signal a changed investment climate.

Apart from the contextual factors at work, there is a general problem that is sometimes referred to as the obsolescing bargain.^[13] Once a large-scale investment is made in largely immovable assets, the investor faces a risk that the government may unilaterally change the terms of the investment regarding shareholder agreements, taxes and tax rates (increasing project-specific or sector-specific taxes) or in the most extreme case nationalizing a project. The risks are largest in states with small economies and only one large minerals or petroleum operation.

These risks can often be reduced by increased transparency and accountability related to a combination of national legislation and contracts that are binding under international law and arbitration. The ‘obsolescing bargain’ problem can also be reduced by commitment technologies such as shared commitments relating to private public partnerships for major infrastructure that supports the minerals and hydrocarbons operation. IFI funding of the project or its infrastructure can also reduce risk since there would be IFI sanctions on governments who do not keep their obligations under legal agreements to which IFI’s are signatories.

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