Fiscal design elements are important, but so are the means by which governments choose to allocate acreage or projects. As can be seen today, there is significant competition for a limited amount of exploration capital. At the same time, exciting acreage is hard to come by. If governments want to increase exploration activity in their countries, they have to offer terms commensurate with their geological potential, location, and political situation. Acreage has begun to take on more of the characteristics of a global commodity.
Furthermore, with more aggressive and specific relinquishment provisions in contracts, the market for acreage or projects is more dynamic and robust.
The means by which governments determine how to award licenses are extremely varied. Some governments have official “block offerings” or “license rounds” where blocks are awarded on the basis of competitive bids.
In competitive systems, there can be a lot of variation over what in fact is bid on (elements that become part of a contract or a system are usually either negotiated, statutory, or bid items; working out which way to do it is of huge concern to many governments).
In some cases, by allocating licenses in a competitive bid round, the International Oil Company (IOC) ultimately determines what the market could bear for the country’s blocks. This takes the burden of the fiscal design off of the National Oil Company (NOC) personnel and places it on the IOCs. This is possible – and profitable – because oil companies will suffer just about anything for highly prospective acreage or projects (Johnston 2006).
Take, for instance, Venezuela used a somewhat different approach. Venezuela launched its exploration round in 1996, putting 10 blocks up for bid. For all practical purposes, however, Venezuela had 10 separate license rounds, block-by-block. On Monday morning 22 January 1996, bids were opened for the first block only (the La Cieba block). These licenses were awarded on the basis of a single-parameter bid—a profits-based tax known as the “PEG.” Companies were to bid from zero to a maximum of 50%. Royalty and other fiscal elements were “fixed” (i.e. neither bidable nor negotiable). Ties were to be broken by a subsequent bonus bid round to follow the opening of the PEG bids within a few hours. This approach greatly reduced the chance that less-prospective blocks would receive no bid.
Nonetheless, two blocks did not receive a bid. The resulting Government Takes were around 92%. However, on the other end of the spectrum, in the Gulf of Mexico, licenses are awarded by the United States solely on the basis of a bonus bid (in practice, however, few countries worldwide extract such a large portion of rent through bonuses).
These are examples of competitive bidding systems. Nevertheless, other countries negotiate exploration rights one-on-one with companies. While companies typically prefer negotiated deals, these situations can be just as competitive as an official tender. It all depends, however, on the prospectivity of a block or area. When governments have good geology, they are more likely able to allow companies to bid the terms. Sealed bid license rounds (auctions) can be very beneficial for a government with highly sought-after acreage or projects.
There is considerable pressure these days from the World Bank, the International Monetary Fund, and bodies such as the Extractive Industry Transparency Initiative (EITI) for oil companies and governments to be more transparent. With these initiatives, there is a strong push for governments to allocate acreage on the basis of public auctions. This likely makes sense for acreage where there is a high potential for profit. The problem remains, however, that unless acreage is particularly interesting, the industry has been relatively unwilling to face the kind of magnified, head-on competition that a sealed bid type license round (like Libya) provokes. It is somewhat unrealistic to expect all governments to allocate all acreage and projects on the basis of sealed bids.
Many countries, even Nigeria and Kazakhstan, have some acreage and some projects that are not quite as exciting as others. When it comes to attracting IOC investment, allocation of such acreage becomes much more important with less-than-exciting prospects. One of the most difficult things for IOCs to contemplate is a direct heads-on competitive sealed-bid license round for non-spectacular acreage or projects. Countries are also likely to find that with less exciting prospectivity they will likely have to design terms themselves and allocate licenses in a user-friendly way.
In such cases a government may have no choice – negotiated deals may be the only option. Otherwise, they are likely to be disappointed with the level of exploration activity in their country – a common complaint. In such cases allocating licenses through negotiated deals can have its own advantages. Government officials (Energy Ministry or NOC) become aware of what the market can bear as they entertain various proposals and offers. Likewise, the lack of interest provides information too. There is nothing worse than a failed license round for a NOC official (Humphreys et. al 2007).
These considerations tend however to differ somewhat for different types of project. Competitive bidding tends to be more viable for frontier acreage or exploration acreage than for development projects or enhanced oil recovery projects. The greater the risk the greater the range of bids possible; as risk diminishes, such as in the case of development projects, the terms tend to be fairly fixed.
Beyond this, which method is best depending to a large extent on the bargaining power of countries and what they can expect IOCs to accept. IOCs most prefer negotiated deals (such as are employed in Colombia, Trinidad and Tobago, or Indonesia), followed by fixed-term contracts with work program bidding (as in UK, Norway, Australia, or New Zealand). Fixed terms contracts with bonus bidding cause more pain to IOCs. The least preferred form of bidding is the sealed bid round with terms bid (as in Venezuela, Libya). In situations in which prospects are good, competitive bidding may be optimal and much care should go into auction design. In situations in which governments are in a weak bargaining position, however, negotiated deals may be required.
Negotiated deals raise special challenges for negotiators. They also risk raising political economy concerns. In the context of negotiated deals, it can be hard for governments to keep both oil companies and citizens happy simultaneously, leading to suspicions of offensive deals. This is where transparency can have a dramatic impact. Overall, transparency is a vital part of the education process for both states and citizens and remains one of the best ways not only to control expectations at the outset but also to promote a healthy business environment over the life of the oil extraction relationship.