5.4 Contracts and Licenses

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Transparency and Accountability

Policy, Legal and Contractual Framework

Sector Organization and Institutions

Fiscal Design and Administration

Revenue Management and Distribution

Sustainable Development

The formal characteristics of contracts and licenses matter, but the ways in which particular clauses reflect the risks and benefits of the blocks or areas that a government can offer are of crucial importance. Modern EI sector laws tend to give broad powers to governments to negotiate agreements with potential investors. In this way, negotiators are allowed to adjust terms to meet changing market conditions, weigh specific risks of new development areas and enhance their negotiating skills over time. Even the use of model contracts to standardize provisions and increase transparency will usually require negotiations about matters of detail in specific cases. As the name implies, a model contract is intended as a guide with general application in a particular EI regime. The responsibility which negotiators bear is therefore considerable. For those in need of guidance, some models have been developed by international experts which may serve as a starting point.[*]

5.4.1 Mining: Types of Licenses and Application Procedures

A small number of states, especially in Latin America where Chile is the most important example, grant a simple mining concession – which is a right to produce – through an application to a judicial proceeding.  The application must show technical and financial capacity.  However, the vast majority of mining states offer two main types of license for commercial- scale activities: a license to explore and a license to mine. In addition, these states will probably also offer some type of artisanal and small-scale mining (ASM) license or registration.  

The law and regulations will need to clearly stipulate the procedures for submitting license applications and the process by which mining rights will be issued and approved, including any technical and financial qualification requirements for applicants. Investors will expect the time period to be stipulated within which a license will either be issued or the applicant will be informed of the reasons as to why it is denied. They will also expect the license conditions to provide license holders with strong security of tenure for the license period, without which companies may not apply for licenses.[*]

 

5.4.2 Mining Licenses: Exploration

Most exploration licenses have an initial period in the range of two to four years with subsequent (repeat) extension periods of two to four years for a total license period generally in the range of 10 to 12 years.[*] This amount of time is generally considered necessary and resonable to allow for the identification and subsequent proof of an economic deposit that is viable for development. Some states grant exclusive licenses that will cover any and all minerals discovered.[*] Other states grant license for pre-specified minerals; in these cases, different companies may have licenses for different minerals on the same tract of land. However, the latter can result in conflicts of interest as different license holders may be permitted to explore on the same land area.

Whichever type of license is granted, a fundamental principle is that license holders are given the right to search for or exploit minerals on the basis of use. Typically, a license holder will lose provisions and rights under the license if the area is not developed. This is to ensure that mineral rights holders do not simply obtain the rights and then hold them for speculative purposes. ‘Use or lose’ can be implemented through a variety of mechanisms such as work requirements and obligations, time based relinquishment of a portion of the license area, or annual rental payments for holding a license area that progressively increase over time.

Another key principle is that exploration license holders be required to provide an annual summary report of their findings for land that they continue to hold. They are also required to provide full details of their exploration work and findings and their interpretation of the exploration data for land which is handed back from the license area. Termination provisions should apply in the event that companies fail to meet minimum expenditure requirements or provide required exploration information. However, all of the information received by government should be kept confidential and not made available to other parties until the license is surrendered (although earlier limits may apply).

License holders would also be required to restore any land that is disturbed during exploration activity. Penalties or sanctions would typically apply to companies that fail to comply. In cases where the license is surrendered or terminated, an in-migration management plan and a resettlement and compensation plan would also be mandated; these stipulations are both particularly important in the mining sector. A fully-fledged environmental impact assessment (EIA) is not generally required for exploration activities but governments may require that a scoping study of an EIA[*] be prepared for exploration activities. In most of the above respects, there are strong parallels with the practice found in the petroleum sector.

 

5.4.3 Mining Licenses: Exploitation

Mining exploration license holders expect an exclusive right to apply for the mining exploitation license and to receive the mining license subject to fulfillment of specific criteria required by the EI sector laws and regulations. The initial license term for exploitation licenses is generally in the range of 30 years for large deposits (or less if the deposit will be mined out in a shorter period) with one or possibly two extension periods depending on the size of the ore body.[*] Licenses are generally exclusive[*] and specify the main mineral products that will be or may be produced. The license should also give the license holder the exclusive right to exploit other minerals that may be found in the mining license area following approval and permits for such development.

Investors will expect to have the right for the license holder to assign the license to another party with consent of the government. This consent should be based on the new license holder meeting certain financial and technical capacity criteria.

Termination provisions will typically include failure to construct and operate the mine as approved or frequent, repeated, uncorrected and substantial HSE violations. Termination of a license by a government is usually considered a last resort and is always open to legal challenge. For this reason, the termination must be material to the mining license.

Another key issue is whether a bankable feasibility study[*] will be required before a mining license can be issued. In small states where licenses for large-scale mines may be issued only once every few years the government may require that a bankable feasibility study be completed and submitted with the license application. However, states with very large mining sectors and many mining license applications each year may issue the mining license on the basis of an application process that takes into account the technical and financial capacity of the applicant without formally requiring the submission of a bankable feasibility study.  

 

5.4.4 Mining: Operating Permits

In any case, environmental permits will also be needed to construct and operate a mine, and it is likely that a bankable feasibility study[*] will be required for environmental permitting. Other permits may include a production commencement approval or environmental, water use and land use permits (related to zoning and or conversion from other uses such as forestry and agriculture). Reporting requirements for mining license holders will include regular (monthly, quarterly and annual) reports regarding production, employment, sales, stockpiles, earth moving, tailings and safety performance. Reporting requirements will generally also include specifications on development and exploration activities as well as capital investment programs.

Model Mining and Development Agreement. In an interesting experiment, a group of mining lawyers analyzed about 60 mining agreements and produced a model mining development agreement or MMDA. This project identified clauses that were clearly written and that reflect a reasonable measure of balance between the interests of the host state and the interests of investors. The aim of the project was to identify clauses that constitute a form of international best practice in regard to mining agreements.

The MMDA project sought to provide solutions for states with gaps in their mining codes, whereby clauses from the MMDA could be included in supplementary private agreements on an ad hoc basis. The result is a collection of clauses that are representative of the kind of matters that would typically need to be addressed in an agreement for a mining project. It aims at providing a guide to drafters covering matters such as fiscal terms, tenure, rights and obligations, and community and sustainable development. The MMDA envisages a series of options that will assist the parties in a negotiation to identify the options that are best for them.

 

5.4.5 Petroleum: Contract Types

Three basic, alternative types of agreement govern the relationship between government and investors in upstream oil and gas operations: (1) concession agreements (a tax and royalty system); (2) production sharing agreements (PSAs); and (3) risk service agreements (RSAs). Typically, only concession agreements are found in the mining sector.

Concession Agreements.  The concession is the oldest of these three forms of agreement and date to the early 1900s. However, as the international petroleum and mining industries have evolved, the past 100 years have seen major adjustments of the concession agreement in favor of host states.[*] The modern concession provides host states with active roles in the management of their natural resources. This often occurs through the direct participation of NRCs in the development of a host state's EI sector.[*] 

Under a concession agreement, the investor is the direct concessionaire of the state, holding mining rights and owning 100 percent of the produced resource (but not the resource in the ground). This is particularly appealing to petroleum sector investors because it allows the investor to book[*] all the corresponding oil and gas reserves for financial reporting purposes.[*] The concessionaire bears all risks and funds all operations. Host state revenues under concession agreements generally consist of a royalty and an income tax, possibly including additional income taxes on the investor’s ‘excess’ or ‘windfall’ profits. As a result of these fiscal features (see Chapter 7) the concession agreement is often referred to as a tax and royalty agreement.

State equity participation in petroleum concession agreements usually occurs through the state’s NRC, where such participation is perceived as a means to increase revenues and boost control over operations (see Chapter 6).[*] In the mining sector, it is equally – if not more – common to find the state holding a direct minority equity stake through the mining or finance ministry rather than through a NRC. In spite of its negative historical connotations, the modern petroleum concession agreement continues to be used widely throughout the world. 

PSAs.  Production-Sharing Agreements (PSAs) were introduced by Indonesia in the 1960s. Since that time, PSAs have become an increasingly popular means for petroleum contracting, especially among developing states. Under a production-sharing model, an agency appointed by the state – typically its NRC – is the concessionaire, and the investor is a contractor to the concessionaire whereby the concessionaire (the state) holds the mining rights, not the investor. The investor, however, as under concession agreements, bears all risks and funds all operations (unless there is state equity participation).

Revenue sharing between the host state government and the investor is determined by arrangements for sharing petroleum production volumes between the two, as spelled out in the PSA. The investor does not own total production, but only his entitlement under the PSA. As a result of these legal structures, the investor can only book a share of the total reserves.[*] The PSA contractor is normally required to pay income taxes on income derived from the PSA, which complicates administration (see Chapter 7 for a detailed description of PSA fiscal provisions, especially Figure 7.4).

Under PSAs, the state agency or National Oil Company (NOC) is directly involved in operational decisions either in its capacity as concessionaire or in its participation as a member of a joint operating committee with the investor. In a number of states, the NOC will participate in the project with an equity stake in the PSA. The advantages of the PSA include:

  • the investment risks are borne by the petroleum companies whilst the host state shares any profits arising from the project without sharing the risks;
  • from the perspective of the investor, if the PSA is enacted into law, it provides legal security for petroleum companies even though it limits the parties’ ability to modify same without parliamentary approval; and
  • it ensures “more direct government control and participation.[*]

 

On the other hand, the main disadvantage of the PSA is that the host state government may find its profit interests in conflict with its regulatory role when its own regulations raise the costs of a project under a PSA.[*] Furthermore, the host state government will tend to become legally responsible for abandonment if it acquires title to installations and structures through the PSA (but often the parties will tend to agree otherwise in the PSA).[*]

Concessions (especially modern tax and royalty systems) and PSAs differ in legal structure, ownership (and marketing) of production and related reserve booking possibilities but otherwise share many key attributes. 

RSAs. Risk Service Agreements (RSAs), like PSAs, tend to be a phenomenon limited to the petroleum sector and almost never apply to the mining sector. RSAs go beyond PSAs in asserting host state control. The state or NOC hires an investor as a contractor. The investor assumes all risks and costs and is reimbursed for its costs. The investor is also remunerated for the service it provides in accordance with a mutually agreed formula so long as commercial production targets are met.

The investor never obtains rights to the petroleum, however. Even produced petroleum when brought to the surface continues to belong entirely to the state. Reimbursement and remuneration are normally in cash, although in some states, the cash payment may be converted to an equivalent amount of petroleum by right.[*] The investor cannot book reserves if it is paid only in cash but is entitled to do so for payments in petroleum.

Most RSAs provide for a transfer of operatorship from the investor to the NOC at a given date prior to expiration of the contract. For states where host state sovereignty issues are emphasized, the RSA is a popular contractual choice.[*]  Investors, on the other hand, tend to resist RSAs when possible because they restrict access to petroleum ownership rights and also limit the economic upside potential available under typical remuneration formulas.  

From the investor’s perspective, the main advantage of the RSA is often thought to be that it enables the investor to gain access to produced petroleum on preferential terms. In states with large reserves, but where concession or PSA arrangements are unavailable, investors will still often agree to RSA arrangements in the hopes of developing a lucrative long-term relationship. However, for states with unexplored frontier areas the RSAs may be less attractive to potential investors because they tend to offer relatively too little return to the investor.[*]

Table 5.1 provides a picture of the worldwide incidence of the different contractual arrangements for petroleum operations. As can be seen, concession agreements (a tax and royalty system) and PSAs are widespread. The role of participation shares by NRCs is a subject discussed in Chapter 6.

Table 5.1: Incidence of Petroleum Contractual Arrangements

Region

(1) Tax-Royalty System

(2) PSAs

(3) Hybrid Arrangements
(shares elements of 1 and 2)

(4) RSAs

 

 

 

 

 

Africa
(48)

Central African Republic
Chad
Democratic Republic of Congo
The Gambia
Ghana
Mali
Morocco
Namibia
Niger
Senegal
Seychelles
Sierra Leone
Somalia
South Africa

Algeria
Benin
Republic of Congo
Cote d’ Ivoire
Egypt
Equatorial Guinea
Ethiopia
Eritrea
Guinea
Kenya
Liberia
Madagascar
Mauritania
Mozambique
Senegal
Sudan
Tanzania
Togo
Uganda
Zambia

Angola
Cameroon
Gabon
Guinea-Bissau
Libya
Nigeria
Tunisia

 

 

 

 

 

 Europe (21)

Austria
Bulgaria
Czech Republic
Denmark
Faroe Islands
France
Greece
Hungary
Ireland
Italy
Netherlands
Norway
Poland
Portugal
Romania
Spain
Turkey
United Kingdom

Albania
Croatia
Malta

 

 

 

 

 

 Far East (25)

Australia
Japan
New Zealand
Papua New Guinea
South Korea
Thailand

Bangladesh
Cambodia
China
India
Indonesia
Laos
Malaysia
Mongolia
Myanmar
Nepal
East Timor
Vietnam

Brunei
Pakistan

Philippines

 

Former Soviet Union
(11)

Latvia

Azerbaijan
Georgia
Turkmenistan
Ukraine
Uzbekistan

Kazakhstan
Kyrgyzstan
Russia

 

Latin America (20)

Argentina
Bolivia
Brazil
Chile
Columbia
Costa Rica
Ecuador
Falkland Islands
Peru
Venezuela

Aruba
Belize
Cuba
Guatemala
Guyana
Honduras
Panama
Suriname
Uruguay

Trinidad and Tobago

Chile
Ecuador
Mexico
Venezuela

Middle East
(11)

Neutral Zone
Saudi Arabia
United Arab Emirates

Bahrain
Israel
Jordan
Oman
Iran
Iraq

Qatar
Syria

Iran
Iraq
Kuwait

North America (3)

Canada
Greenland
United States

 

 

 

Total (143)

55

55

15

8

Source: Exxon-Mobil website. Available at: www.exxonmobil.com (last accessed 25 June 2012).

Concessions agreements are perhaps slightly more favored in industrialized states, while PSAs tend to be more popular in developing states. RSAs, the least common of the three contractual forms, tend to be found in those states with strong nationalistic leanings or a limited need for foreign expertise. In a number of states, hybrid approaches to contracting have been adopted.
 

5.4.6 Contract Provisions[*]

Contract labels – such as concession agreements, PSAs, or RSAs – can be misleading. What is far more important is their content and, apart from their distinguishing characteristics described below, all three petroleum contractual forms share many of the same basic provisions which are common to most mining agreements as well.[*]  

The following paragraphs highlight a selective, non-exhaustive, list of key contractual provisions, relating primarily to the conduct of operations, administrative, and commercial issues. Legal provisions, fiscal instruments and provisions, and valuation provisions are addressed in Chapter 7. Social and environmental provisions are addressed in Chapter 9.

Parties to the Contract. Normally, contracts are entered into by the state or the NRC (representing the state) on one part and the private investor (or investors) on the other. Where the state signs the contract it “accepts direct responsibility and unlimited liability” and “assume(s) contractual liability for exercising regulatory functions.”[*]

Exploration Provisions. Petroleum contracts specify an exploration term (six to eight years is typical) divided into phases with associated obligatory work programs and budgets and partial area relinquishment obligations.[*] Given the complexity of exploration and the characteristic paucity of technical data on deposition, exploration terms for mining are typically less demanding than for petroleum.

Petroleum contracts invariably provide the investor with both a right to explore and – in the event of successful appraisal of a commercial discovery – develop, produce and benefit economically from it. In contrast, mining contracts often separate out the two activities, with success in the former not necessarily guaranteeing rights with respect to the latter.[*] However, there may be presumption of continuation dependent on demonstration of technical and financial capacity and an acceptable mine development plan.

Development Provisions.  The right to development is usually conditioned on approval by government authorities of a comprehensive development and production plan. Development and production plans normally will include annual work programs and budgets, and provisions for abandonment or decommissioning of mining or petroleum projects at the end of the project's lifecycle (see Chapter 9).

Contracts can, and often do, provide for a development phase ranging from 30 to 40 years. Detailed provisions are often made for the right to build, possibly own, and operate essential infrastructure.[*] The issues relating to public infrastructure used in the mining sector is the subject of a good practice note and brief available on the Source Book website.[*]
 
Normally, the investor is required to conduct the exploration and development expeditiously and in accordance with stipulated work obligations; otherwise, the investor will surrender the rights to the host state government so that the rights can be awarded to another potential investor. The host state government may also require bank guarantees to ensure that the work obligations are fulfilled and that the resources are exploited in a sustainable manner.[*]

Conduct of Operations Provisions. This contractual provision obliges the investor to conduct all operations in accordance with good practices as generally applied in the EI sector. Petroleum contracts often make reference to ‘good oil field practice,’ which is a widely a recognized term, connoting, inter alia, the use of sound international practices with due attention to conservation of the resource, safety and protection of the environment.

Force Majeure Provisions. Contracts excuse an investor from performance obligations under the conditions of force majeure.[*] The relevant clause defines what is meant by force majeure, typically events beyond the investor’s control, which make it impossible or at least very difficult to perform. The clause may list qualifying events which, in addition to natural events, may include unwarranted government interference or changes in law adversely affecting the investor.

Control and Inspection Provisions. Control over investor operations may be exercised by the relevant EI sector ministry, its technical agency or possibly, although not ideally, the NRC (see Chapter 6). The contract will normally require host state government approvals of exploration and appraisal programs and budgets, the development and production plan, and annual work programs and budgets.   

Submission of Information Provisions. Provisions related to the supply of information to the host state government have become increasingly important given government interest in being more directly involved in EI sector operations. The investor is typically required to submit – on a timely basis – all information and data generated by, prepared, or obtained in the conduct of operations. This is critical not only to supervision of the investor’s contractual obligations, but also to host state understanding of its existing and potential petroleum or mineral resource base.  

Data Ownership and Confidentiality Provisions. This is an extremely contentious area. Investors consider both the ownership and confidentiality of the data they generate or acquire as vital to their commercial interests.[*] Host states, on the other hand, see ownership as critical to the building of a national data repository to inform their decisions on EI sector issues. This includes the right to release data as essential to the promotion of exploration and development interests. Contractual provisions, outside of a few industrialized states, now assign ownership to the host state while allowing the investor to retain copies of paper or electronic data and samples of physical data, subject to confidentiality requirements.[*] Often, contracts will impose time limits on confidentiality. In these cases, confidentiality requirements are normally stipulated to terminate when the relevant contract ends, when an investor relinquishes its rights under the contract, or for some shorter period as specified in the contract (such as five years).[*] 

In terms of confidentiality, technical data is of enormous commercial and strategic importance. However, beyond technical and physical data, confidentiality may extend to financial data and other information generated under the contract and even to the contract itself (see Chapter 4).

Ownership of Assets Provisions. Treatment of the ownership of assets in petroleum contracts varies depending on the contract type. Under concession agreements, the investor retains ownership at least until the end of the concession at which point it may be transferred to the host state government along with funding for its eventual decommissioning.[*]  

Under PSAs, the transfer of ownership of assets from the investor to the host state government usually occurs earlier than under a concession agreement, ranging from the time when the assets are installed to the time when the investor has recovered its costs. The operative provision under both types of agreement is that the investor retains the use of the assets, without charge, during the life of the contract.   

Assignment Provisions. This clause describes the conditions and approvals required for the assignment, sale or transfer of contract interests. The clause covers both direct and indirect transfers, including share transactions that result in a change of control.

Transfers require the approval of relevant governmental authorities. The main purpose for requiring government approval is to ensure that any assignee meets the government’s financial and technical requirements for participation in the contract. Tax implications relating to the assignment of contractual rights may also have to be assessed (see Chapter 7). To avoid arbitrariness on the part of the governmental authorities, assignment clauses often stipulate that approval will not be ‘unreasonably withheld.’[*]

Foreign Exchange Provisions. These provisions cover investor rights and obligations with respect to the recording of foreign exchange transactions and to the retention of foreign exchange earnings outside the host state. The foreign investor will seek to ensure that funds earned within the host state are convertible at a non-discriminatory market rate of exchange.

Foreign exchange provisions also seek to ensure that funds are remittable at the foreign investor’s discretion to the overseas parent company or its shareholders. Such provisions will also seek to ensure that the remittance is governed by rules that both parties will adhere to for the duration of the contract. Most developing states provide full foreign exchange remittance guarantees.

Auditing and Accounting Provisions. These contractual provisions mandate that the investor maintain books and accounts in conformity with national or international norms and grants the host state government with the right to conduct audits.  

Qualification of Contractor Provisions. Some petroleum contracts require the investor to conduct business through a locally incorporated company for tax purposes and other legal reasons. This is an area of key concern to a host state since internationally operating companies are usually highly sophisticated in ensuring that their operations are structured so as to minimize their tax liability.[*]

HSE Provisions. This provision requires the contractor to conduct operations in conformity with the host state’s health, safety and environmental laws and regulations as might be enacted from time to time (see Chapter 9).

Reclamation and Decommissioning Provisions. Some petroleum contracts vest responsibility for reclamation, repairing or decommissioning of sites in the contractor. Other types of contractual provisions in the category require funds to be deposited into a dedicated account each year to cover the reclamation, decommissioning, and abandonment costs (see Chapter 9).

Local Goods and Services Provisions. Most petroleum contracts require the investor to purchase their goods and services from within the host state, provided both quality and price are competitive and subject to availability. The reasoning behind local content provisions is to promote linkages between the EI sector and the local economy. See Section 5.5 (Local Content).

Training and Local Employment Provisions. Most petroleum contracts require the foreign investor to give preference to nationals who have the requisite skills for employment in the EI sector. These provisions normally also require that the investor conducts training programs with a view to promote local employment (see Section 5.5).

Stabilization Provisions. Stabilization clauses protect the investor’s contractual rights against adverse interference by the state through legislative measures. Although such provisions may not stop the government from exercising its legislative powers, stabilization clauses can nonetheless mandate that a court or arbitration tribunal compensate the investor for any damage suffered. Aside from a strictly legal assessment of their value in formal proceedings, stabilization clauses may enhance the ability of an investor to negotiate a more favorable settlement in a dispute with a host state which seeks to revise the terms of the original agreement (see Chapter 7).

Termination Provisions. The petroleum contract should stipulate the circumstances that permit either party to terminate the agreement (for example, when there is breach of a fundamental term by the other party).

5.4.7 Focus on Natural Gas Contracts

Once neglected in petroleum contracts, natural gas now receives considerable attention related to its uses within petroleum operations (gas re-injection and gas flaring) but also, and importantly, as stand-alone natural gas development and commercialization contracts.

Export gas, whether by pipeline or in the form of liquefied natural gas (LNG), can generate substantil revenues. Domestic gas commercialization has enormous potential in terms of direct economic ben,efit, economic diversification, and local content through power generation and or industrial consumption.  Box 5.3 below outlines some of the modern contractual provisions that relate especially to natural gas and a specially commissioned paper is available, Good Practice Note on Upstream Natural Gas; see also accompanying brief. It identifies present and desired good or best practice with respect to natural gas exploration and development activities (upstream). It pays particular attention to upstream gas policies, licensing, legal, contractual and regulatory oversight requirements and fiscal regimes.

 

 

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