EI Sourcebook | 5.6 The Award of Contracts and Licenses

5.6 The Award of Contracts and Licenses

5.6.1 Policy Issues and Objectives

Contract award decisions should come out of the overarching EI sector policy objectives listed in Section 3.1 above. Preliminarily, the following policy determinations should be made: (1) whether or not to explore and develop the EI sector, (2) at what pace the EI sector should be developed (if the answer to the first question is an affirmative), and (3) whether or not the private sector should participate. Very few states choose not to explore, given their development needs and the revenue potential of the petroleum sector in the event of success.^[60]

States, however, may show concern over the pace of petroleum exploration and development activity. This concern is often rooted in the following: revenue absorption capacity (see Chapter 8), infrastructure constraints, and or social and environmental and social risks. For example, in recent years Angola has carefully timed its petroleum licensing rounds to fit with its broader development concerns.

Nationalist sentiments and concerns for safeguarding sovereignty have made foreign private investor participation contentious in many resource-rich states.^[61] However, many states have found it possible to resist the advantages of risk sharing, financing, and technical and managerial skills transfer that comes with foreign participation. Norway, for example, had a very public debate on whether or not to open its petroleum sector to foreign investors; and eventually decided to permit foreign involvement for many of the reasons just given.^[62]

Once these major decisions have been taken, governmental authorities need to agree on exactly what is to be awarded, and to what end. Typically, awards are made for the exclusive right to explore, and, if certain conditions are satisfied, exploit any commercial discovery. The objective in designing the award process is to find the best candidate (for example, most efficient explorer and developer), maximize the potential revenues as a result of the award, and avoid any distortion of incentives to perform.

5.6.2 Constraints and Context

In designing and or conducting a licensing round, government authorities will face a number of constraints, both external and internal. Geology and price expectations, each critical to investor interest, tend to fall into the first category; there is not a great deal that the authorities can do about them. Some actions are possible, however. If uncertainty about geology is a factor, governments can, and good practice would encourage, preparation of comprehensive data packages based on existing data and the possible acquisition of limited new data.

New data, such as seismic or aeromagnetic data (see Box 5.4 below), might be acquired at the government’s expense, through donor support, or on a speculative basis by private investors acting on the government’s behalf and reimbursed through data sales. Depending on its nature and value, the data might be made freely available to potential investors, or sold to interested parties, or its purchase may in some cases be made mandatory as a condition for participation in the licensing round.

With respect to price expectations, governments may, if circumstances will allow flexibility on timing, choose periods of rising resource prices to launch a licensing round. Such periods are, however, likely to be periods of maximum competition among states for investor interest.

Internal constraints (such as matters over which the government might be expected to have control) will also have a major bearing on licensing prospects, and include issues of macroeconomic and political stability, and the types of legal, contractual, regulatory, institutional, and fiscal regimes a government chooses to adopt Chapters 7 and 8.

5.6.3 Conditions for Success

Turning from contextual considerations to the licensing process itself, a number of conditions have been demonstrated as critical to its success. The first of these conditions is an environment where there is competition among potential investors. If this can be achieved, it can potentially result in the best outcome for the state.

Competition among potential investors can also help offset some of the asymmetry regarding access to information that tends to disadvantage governments in licensing. Investors are very often better informed than their government counterparts as to a state’s geological prospects. This is particularly true in the early stages of EI sector development when data sharing requirements have yet to be established. While problematic in the case of one-on-one bilateral negotiations over contract awards, this informational disadvantage is largely nullified when informed investors are made to compete against each other.^[63]

A second condition critical to success is institutional capacity. Properly preparing a licensing round, and evaluating potential investors and their contract proposals are activities that require sophisticated professional technical, legal, and commercial skills. These skills need to be acquired by host government authorities responsible for the contract award process. Pending their development, the authorities are generally encouraged to engage support from outside experts.

5.6.4 Award Procedures

Transparency is at the core of good practice when it comes to award procedures. Whether acting individually, or as participants in a competitive bidding round, license applicants – on a non-discriminatory basis – should be made fully aware of the procedures to be followed. They should also be provided access to all available data, whether on a free or purchase basis, and be informed of all applicable legal and fiscal regimes (including model contracts). Documentation should also provide assurances that areas offered for license are currently unlicensed and that proper authority exists for their licensing.^[64] With the possible exception of specific technical data, this information should be available in the public domain.

It is desirable, and now increasingly common practice, that applications for awards should be prequalified.^[65] Bidders are prequalified to ensure that that they have the financial and technical capacity to undertake a substantial exploration or mine development program. Where geological information is limited, or not immediately encouraging, governments may decide to adopt an open door, first-come-first-served licensing procedure, or direct negotiation with a limited number of prequalified companies. Where significant geological data is available and investor interest is high, competitive auction is generally considered the best option.

5.6.5 Criteria for Award

Once the credentials of potential investors have been established, good practice favors setting a limited number of clearly specified criteria for the award of a license. Arguably, the most important of these is the investor’s work commitment, which should be specified in both physical terms and financial (or minimum) expenditure terms.

Box 5.4: Geodata

The successful discovery of natural resources requires significant effort at the exploration stage. It also requires the application of sophisticated exploration and exploitation technology. To attract foreign investment, a host government should try to limit information uncertainties and asymmetries associated with its resource endowments.

Many developing state often lack the geosciences information (geodata) necessary to undertake detailed land-use planning. Faced with budget constraints and pressures to provide critical services to their citizens, many governments find it difficult to justify the collection of geodata when the payoffs are generally long-term in comparison with the country’s immediate spending needs.

Geoscience information can be collected on an ad hoc basis, resulting from a ‘lucky’ discovery by artisanal miners to more systematic, complex, and large-scale efforts. The quantity of this information (whether it is produced by a state of private investor) depends ultimately on the benefits and costs perceived by either party.

If all of the benefits are not internalized, or alternatively, if the returns associated with the collection of geoscientific data are prohibitively difficult to calculate (due to high perceived levels of political, technical, or security risks), a sub-optimal amount of geoscientific information may be produced Therefore, the primary aim should be to identify those policies required (if any) to ensure that an efficient amount of geosciences information is produced.

A minimum quantity and quality of geosciences information will be a prerequisite for ensuring that host states earn an equitable portion of its natural resource wealth; and so that private investors can assess the geological prospects of a particular license area. In these situations, the state does not need expertise in assessing the value of the license area since the competitive tension created by a properly managed auction process should ensure that the license is fairly valued. For example, the government of Papua New Guinea (PNG) has been skilled at utilizing such data collection to promote investment in its EI sector.

In petroleum contract awards, work program is generally considered to be controlling, and it must be performed even if resultant expenditures exceed the minimum.^[66] In mining contracts awards, it is not always possible to be very specific about the work to be performed and therefore giving priority to work programs may not be appropriate. In most petroleum licensing procedures, the work program and expenditure commitments are combined with financial and fiscal variables (such as bonuses, royalties, or production shares). For reasons discussed in Chapter 6, the last of these is probably preferable, on efficiency grounds.

Sometimes a third variable may be added, but where awards are based on more than one variable, applicants or bidders need to be told the relative weights the authorities have assigned to each variable for selection purposes. Ideally, the variables selected should be relatively easily assessed, not only by the authorities, but also by observers of the award process. Adding variables related to contributions to local infrastructure and or local content – whether by direct participation in the award or through commitments to local suppliers – can make bid evaluation difficult even if the potential political and developmental appeal of such variables is strong.

5.6.6 Competitive Bidding of Mineral Rights

While statutory requirements are the typical approach to the award of petroleum or mineral rights, today there is generally more geological data available and greater interest in obtaining exploration rights than in past decades. Thus, the open tender approach is now under review in a number of states, particularly where more than one company is applying for a license for the same tract of land.^[67]

While open tenders will continue to be appropriate for areas that are largely unexplored, areas where good geological data is available and where there are strong indications of interest from more than one potential applicant, governments should instead offer licenses on a competitive bidding basis. Where deposits have been previously explored and new development and production rights are being offered, competitive bidding should be used. There are successful examples of this in Peru and Afghanistan.

Two examples of such a situation are: first, when land is released by a NRC back to the government for licensing to private inventors; and second, when a license holder hands back land for which more detailed geological data has been provided to the government. In both cases, there may be several investors competing for the same license, and in these cases, only competitive bidding should be used.^[68] However, in the case that land is offered for competitive bid and there is only one qualified bid then that bid would of course be the winner.

Good practice calls for a transparent competitive bidding process that can be accomplished by ensuring access to all qualified bidders and having standardized bidding documents that include: (1) all available geological information; (2) confirmation that the land is unlicensed; (3) details of applicable legal regime and procedures; and (4) full details of the rights that will be granted to the winning bidder.

On this subject of granting mineral rights, it should be noted that a comprehensive review by the Centre for Sustainability in Mining and Industry (CSMI) of the University of Witwatersrand^[69] on this topic was specially commissioned in the form of a Good Practice Note, as are various country reports (e.g. for Algeria). This Good Practice Note contains a comprehensive Appendix with specific country regulations that permit comparisons to be made.

5.6.7 Mining Bidding Criteria

Single bidding criterions (usually an upfront cash premium with staged payments) are simpler to apply than multiple bidding criteria. A single bidding criterion can be either (1) an upfront premium or (2) the value of the work program to be undertaken. In either case, the winning bidder should submit a bankable feasibility study within a given time period or risk forfeiting the license.

If a set of multiple bidding criteria are used, then factors such as upfront cash payment, conditional payment and or minimum exploration expenditure can be combined. This can be achieved through an equation that creates a numerical value. However, any combination that includes a work program evaluation will involve subjective judgments on the part of an evaluation committee that is evaluating the work program. In the case that mining exploration is being competitively bid, it is quite rare that an upfront cash premium or a future payment is used because mining companies do not see sufficient value to bid such a payment. Typically, however, an exploration work commitment will be competitively bid. Relevant considerations include the following:

cash bonus bidding, which is generally considered to be less efficient in frontier areas;

use of area-wide licensing in which the government takes into consideration the bidders’ expression of interest in other areas; and

market segmentation, which takes into consideration the bidders’ technical and financial capability to pursue different types of exploration activities.^[70]

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