Cambodia: The Global Petroleum Context: Opportunities and Challenges Facing Developing Countries

Insights for Action Initiative
The global petroleum context :

Opportunities and challenges
facing developing countries
Discussion Paper No. 6

2008
UNDP CAMBODIA
INSIGHTS FOR ACTION INITIATIVE
Background:
UNDP’s Insights for Action (IFA) initiative was developed and launched following a
2004 meeting between H.E. Prime Minister Hun Sen and UN Assistant Secretary General
and UNDP Asia Pacific Regional Bureau Director Dr. Hafiz Pasha. H.E. Prime Minister
Hun Sen delivered a challenge to UNDP, asking them to help identify innovative policy
responses to key development challenges.
The IFA initiative was created to undertake critical and timely policy research and to
facilitate policy dialogue among the Cambodian Government, Cambodian society and
Cambodia’s development partners.
Purpose:
The IFA initiative is aimed at generating innovative ideas and practical knowledge for
the effective implementation of the Government’s Rectangular Strategy. Special focus
is given to those aspects of the Rectangular Strategy with greatest scope for rapidly
advancing progress towards Cambodia’s Millennium Development Goals (CMDGs).
The project has three main components: Knowledge Generation, Knowledge Sharing,
and Knowledge into Action.
1. Knowledge Generation:
IFA generates valuable new knowledge and insights in several critical areas through
well-targeted research in collaboration with various government ministries and the
Supreme National Economic Council (SNEC), a cross-ministerial advisory committee
that reports directly to the Prime Minister.
2. Knowledge Sharing:
IFA has also been developing a range of knowledge sharing activities and modalities,
including the annual Cambodia Economic Forum (CEF), media conferences, website
development, and a series of Insights for Action publications.
3. Knowledge into Action:

In addition to the two main components, IFA also contributes to the further develop-
ment of national capacity, especially among researchers and policy makers, so that
they will gain from both “learning by doing” during the applied research process,
as well as benefitting from a transfer of valuable information and knowledge
generated by this initiative.
© 2009, UNDP Cambodia

Fuelling Poverty Reduction: Selected papers from the International Oil and Gas Conference
DISCLAIMER
The responsibility for opinions in this publication rests solely with the authors. Publication does not constitute an endorsement by the United
Nations Development Programme or the institutions of the United Nations system.
Fuelling Poverty Reduction
Selected papers from the
International Oil and Gas Conference
March 2008, Phnom Penh, Cambodia
UNDP Funded Discussion Paper No. 6

In cooperation with
Supreme National Economic Council
Cambodian National Petroleum Authority
Norad
Norwegian Petroleum Directorate
Petrad
TITLE
The global petroleum context
TABLE OF CONTENTS
I. The global petroleum context ................................................................................3

Global petroleum context:
Opportunities and challenges facing developing countries ...............................5
Arne Walther
Optimal macroeconomic policy in a resource boom: Selected key issues .......11
Robert Glofcheski
II. Pre-production challenges ...................................................................................17

Reliably assessing the resource base...................................................................19
Gunnar Søiland
Legal frameworks used to foster petroleum development ...............................25
Dr. William T. Onorato
International petroleum fiscal systems ...............................................................30
Daniel Johnston
How to negotiate the “right” petroleum contract ..............................................48
Jenik Radon
Establishing an effective regulatory authority: A comparative analysis ..........56
Ghazi Durrani
Progress in the development of a regulatory framework for petroleum
exploration and development and poverty eradication efforts in Uganda .....69
Ernest N. T. Rubondo
Pre-production negotiations for rights and production/revenue sharing ......71
Einar Risa
Overlapping claims ...............................................................................................80
Genoveva Josée da Costa
III. Costs/benefits of oil refineries and other downstream industries ....................83

Oil and gas development:
Papua New Guinea’s experience with downstream processing ........................85
Stanley Enn Alphonse
Costs and benefits of oil refineries and other downstream industries .............91
Sverre Brydoy
Maximising national content/local content ......................................................100
Willy H. Olsen
International experience in turning black gold into human gold...................114
Michael Hopkins
Appendix:
São Tomé and Príncipe Revenue Management Law ................................................137
UNDP Discussion Paper No. 6 i

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ACRONYMS
AAPG American Association of Petroleum Engineers

ANP Agência Nacional do Petróleo, Gás Natural e Biocombustíveis (Brazilian
National Agency of Petroleum, Natural Gas and Biofuels)
APEC Asia Pacific Economic Cooperation
BP British Petroleum
CA Competent authority
CNPA Cambodian National Petroleum Authority
CSR Corporate social responsibility
E&P Exploration and production
EEZ Exclusive economic zone
EITI Extractive Industry Transparency Initiative
EPC Engineering, procurement and construction
EPS Early production scheme
ERCB Energy Resources Conservation Board
ERR Effective royalty rate
FDI Foreign direct investment
FSU Former Soviet Union
GDP Gross domestic product
HFO Heavy fuel oils
HDI Human Development Index
HRD Human resources development
HSE Health, safety and environment
IEA International Energy Agency
IFC International Finance Corporation
IOC International oil company
JDA Joint development authority
JDZ Joint development zone
JMC Joint Ministerial Council
JV Joint venture
LPG Liquefied petroleum gas
MDGs Millennium Development Goals
MEPR Maximum efficient production rate
MMO Maintenance, modification and operation
MOPS Mean of Platts Singapore
NIEO New international economic order
NOC National oil company
NSDP National Strategic Development Plan (Cambodia)
NNPC Nigerian National Petroleum Corporation
NCSF National Content Support Fund (Nigeria)
NEEDS National Economic Empowerment and Development Strategy (Nigeria)
ODA Official development assistance
OECD Organization for Economic Cooperation and Development
UNDP Discussion Paper No. 6 iii

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OGRA Oil and Gas Regulatory Authority (Pakistan)

OPEC Organization of Petroleum Exporting Countries
ORC Oil-rich countries
PEAP Poverty Eradication Action Plan (Uganda)
PNG Papua New Guinea
PROMINP National industry mobilisation programme (Brazil)
PSA Production sharing agreement
PSC Production sharing contract
R/T Royalty/tax
SAMREF Saudi-Aramco Mobil Refining Company
SIRESE Superintendencia General del Sistema de Regulación Sectorial (Bolivia)
SLD Straight line decline
SME Small- and medium-sized enterprises
SPE Society of Petroleum Engineers
SPE-PRMS Petroleum Resources Management System
TVET Technical-vocational-educational training
UNCLOS United Nations Convention on the Law of the Sea
WTO World Trade Organisation
WPC World Petroleum Council
YPFB Yacimientos Petroliferos Fiscales Bolivianos (Bolivian State Petroleum Company)
iv UNDP Discussion Paper No. 6

FOREWORD
The first international petroleum conference of its kind was held in Phnom Penh,
Cambodia, from 26-28 March 2008. The conference theme, Fuelling Poverty Reduction
with Oil and Gas Revenues: Comparative Country Experiences, attracted a wide-range
of developing and developed country policy experts and practitioners who came
together to share their valuable expertise and practical experience. The organizing
partners included the Cambodia National Petroleum Authority (CNPA), the Supreme
National Economic Council (SNEC), the Government of Norway and the United Nations
Development Programme (UNDP).
The main purpose of the conference was to provide an open forum for participants
from Cambodia and a wide range of petroleum producing countries in which to share
international best practices aimed at helping inform participants about the effective
development of Cambodia’s and other countries’ emerging petroleum sectors. An
immense amount of valuable knowledge and experience were shared in 14 key subject
areas critical to petroleum sector development and to the achievement of sustainable
socio-economic development with long-term stability. The conference findings and
conclusions also had important implications for the development and management
of other non-renewable mineral resources in Cambodia.
Over 350 registered and more than 100 additional participants attended the conference,
including officials from the Royal Government of Cambodia, provincial governors, local
universities, Non-Governmental Organizations (NGOs) and other development partners,
media and private sector companies from Cambodia and throughout the world.
During the two-and-a-half days of discussion, experts from Europe, Asia and North
America, and made presentations, and seasoned policy makers and practitioners from
a range of developing countries – including Indonesia, Japan, Malaysia, Mongolia,
Papua New Guinea, São Tomé and Príncipe, Thailand, Timor-Leste and Uganda – made
presentations. Each provided valuable insights into how their governments had
approached petroleum development and management issues.
The conference proved to be an important forum for the Cambodian Government

and concerned stakeholders in which to learn from international experts and the
practical experiences of other countries. As resources belonging to all of a country’s
people, the effective use of petroleum and minerals represents an incredible
opportunity to both dramatically improve the well being of citizens and to sustain
economic growth. Moreover, as these are non-renewable natural resources, there is
only one chance to get things right.
UNDP Discussion Paper No. 6 1

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This series of papers presented at the conference details the main findings and key
conclusions of the speakers in a variety of areas. We hope that these valuable insights
will continue to inform helpful policy debate, decision-making and related action to fuel
poverty reduction and to achieve the Millennium Development Goals using oil and gas
revenues in the years ahead.
Please note that the conference presentations, papers, speeches, proceedings, and
other relevant information can be downloaded at: http://www.un.org.kh/undp/ifa.
2 UNDP Discussion Paper No. 6

I. The global petroleum context :

Opportunities and challenges facing developing
countries
Arne Walther
Ambassador/Senior Adviser
Ministry of Foreign Affairs of Norway
Former Secretary General, International Energy Forum
Optimal macroeconomic policy in a resource

boom: Selected key issues
Robert Glofcheski
Chief Resident Economist
UNDP Cambodia, Lao PDR, Viet Nam

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Opportunities and challenges facing developing countries
Arne Walther
Ambassador/Senior Adviser
Ministry of Foreign Affairs of Norway
Former Secretary General, International Energy Forum
The way that you choose to harvest your petroleum endowment for economic and
social benefit today and for future generations will also have an impact beyond your
national borders, contributing to the security of national and global energy supplies
in an increasingly interdependent and energy-hungry world at a time of heightened
energy security concerns around the world.
Defining issue
Energy security concerns continue to top the international political agenda. Why? Not
because energy is a goal in itself, which it isn’t, but because each and every country
needs energy as a means to reach its economic and social objectives. This is true for
energy importing, as well as exporting countries, industrialized as well as developing
countries. Energy also affects commercial and political relations between countries.
It fuels the world economy. Production and consumption of energy impact the global
environment. Energy influences, and is influenced by, international politics. Energy is
a challenge for the industry set to harness it, and a challenge for the national and
international leadership that would govern it. Energy goes to the very core of political,
economic and environmental interests of individual countries as well as those of the
global community.
It is not necessarily a blessing for a country to be endowed with petroleum resources.

It is how governments arrange for their resources to be extracted and how revenues
earned are used that determine the success or failure of being a petroleum-endowed
state. And notably for developing countries, the degree to which petroleum can fuel
the economic development necessary to lift a population out of poverty.
Petroleum activity has certainly been a blessing for my own country, Norway, an
industrialized country. Not least because the Norwegian oil saga could take-off in
the 1970s on the basis of a democratic, well-functioning society with established
political, legal and commercial institutions. The political desire was to go carefully
forward and not to let an oil bonanza overheat the economy or disrupt the traditional
pattern of Norwegian society. Claiming sovereignty and exercising national control,
we chose to set up a state oil company. We invited the international companies to
come and compete, acknowledging our need for their technological know-how and
venture capital. Imposing high taxes and tough conditions, Norway was also keen to
offer the international companies predictability in framework conditions to ensure
the long-term presence and commitment of the best international companies. And,
successive governments have sought national political consensus in developing and
adjusting coherent and transparent petroleum policies.

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Norway has attracted the very best of the international oil industry. Our production
and exports of the strategic oil and natural gas commodities were, and still are, welcomed
by our petroleum-importing partners in the Organization for Economic Cooperation
and Development (OECD) as a source of energy supply from within this grouping of
the main industrialized countries, offsetting fears of undue dependence on external
sources that could exacerbate energy insecurity. Norway prides itself on being a reliable
supplier of substantial amounts of oil and natural gas contributing to regional and global
energy security on a long-term basis.
Norway is now passing on its experience as an industrialized, petroleum-endowed

country in a special programme “Oil for Development” as part of our co-operation
with developing countries.
Increasing energy demand
The increase in global energy demand foreseen in the years ahead is substantial. The
resources are there, but timely investments of some US$20 trillion, half of this in
developing countries, are needed to meet projected demand over the next quarter of
a century. Energy scenarios to 2030 from the International Energy Agency (IEA) in Paris
and others project:
• Energy demand increasing by more than half over today’s level, most of the
increase coming in developing countries as they industrialize and their
economies grow.
• Fossil fuels remaining the primary sources of energy and accounting for four-
fifths of total demand today and as expected twenty years from now.
• Oil accounting for 32 percent, natural gas for 22 percent and coal for 28 percent
of the energy mix, these fossil fuels dwarfing the 5 percent share of nuclear, the
4 percent share of hydro and other renewables as well as the 9 percent share of
biomass and waste. Until recently, natural gas was seen to be the fastest growing
fossil fuel. Coal is now fastest growing with enormous reserves not least in China
and India.
• Global energy-related CO2 emissions are expected to grow correspondingly,
increasing by more than half from today’s level. Over three quarters of this
increase would come from developing countries.
The latest World Energy Outlook from the IEA expects the supply/demand balance in
the global oil market to remain tight. By 2015, the world would need 37.5 million
barrels per day of gross capacity additions, of which 13.6 million barrels per day to
meet increasing demand and the rest to replace decline in present fields of oil
production. The announced plans of the Organization of Petroleum Exporting
Countries (OPEC) and non-OPEC producers amount to only two-thirds of that, 25 mil-
lion barrels per day through to 2015. This means a substantial deficit to fill, an amount
exceeding the present production capacity of Saudi Arabia. This also underlines the
importance that Carbon Capture and Storage will have in meeting the global climate
challenge.

OPEC sees world oil demand rising this year to 87 million barrels per day from 79.3 million
barrels per day in 2003. The expected increase in developing countries in this period is
4.1 million barrels per day to 24.7 million barrels per day, to which China’s increase of
2.4 million barrels per day to 8 million barrels per day can be added. In comparison,
the increase in demand of the industrialized countries in the OECD will rise by a mere
0.8 million barrels per day to 49.4 million barrels per day this year.
OPEC figures show world oil supply has risen from 79.7 million barrels per day in 2003
to 84.8 million barrels per day at the start of this year. Non-OPEC developing countries
are expected to increase supply by 1.3 million barrels per day in relation to 2003 to 11.6
and China increasing theirs by 0.5 million barrels per day to 3.9. In comparison, OECD
supply is projected to decrease by 1.7 million barrels per day in 2003 to 20 million barrels
per day by the end of this year.
Heightened energy consciousness
A feature of our day, not least amplified by last year’s Nobel Peace Prize to Al Gore and
the Intergovernmental Panel on Climate Change as well as by the climate change
negotiations not far from here in Bali, is that energy and environmental uncertainties
are prompting countries and groups of countries around the world to re-think
fundamental policies. The challenges of energy security and climate change are
interlinked. Policies and measures to meet the climate change challenge should not
jeopardize energy security. And policies and measures for energy security should
not exacerbate climate change.
Add to that the political imperative of a developing country government to lift a

population out of poverty through economic development fuelled by increased use of
energy, which might have adverse climate and environmental effect both locally and
globally. Climate change affects everyone. And we know that the poorest developing
countries will be earliest and hardest hit.
But the policy tuning of one country to meet new challenges and to reduce its
particular energy uncertainties can also exacerbate uncertainties or create new ones for
others. International dialogue is needed both to avoid misunderstandings and to seize
new win-win opportunities.
Amid the uncertainties, there is a fundamental certainty. The world will need more
and cleaner energy, used in a more efficient way, accessible and affordable to a larger
share of the world’s population. The political challenge lies in operationalising this energy
imperative in a fair and sustainable way, through national policies as well as in bilateral,
regional and wider global co-operation.

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New energy era
Amid energy and environmental vulnerabilities and uncertainties, national policies will
evolve against a complex backdrop. To mention some elements:
• Increasing energy demand increases the need to improve energy efficiency, for
environmentally benign energy and to develop cost-efficient technology.
• Fossil fuels will remain paramount for quite some time, but with increasing
attention paid to the development of alternatives.
• Environmental and climate change concern will grow, not least in the public
domain.
• Substantial investments are needed and these can be facilitated by predictable
and equitable economic, fiscal and legal regulatory framework conditions.
• We will see increasing energy trade due to the geographical mismatch between
centres of oil and gas production and centres of consumption.
• We must consider vulnerability of energy production and supply to politically
motivated disruption, terrorist attack, technical mishap and forces of nature.
• Competition, if not scramble, for energy resources will increase, as will competition
among energy resources.
• Nations and groups of nations opting for policies of energy interdependence or
energy independence for their energy security. Resource nationalism.
• Increasing bilateral and regional cooperation to address immediate concerns
with longer-term economic and political implications.
• A new set of relationships between national and international oil companies is
in the making, the former controlling 80 percent of global proven reserves.
• International and national calls for good governance and transparency.
• Demands for equitable access to energy for the quarter of the world’s population
who do not have it today, but who want it for a better life tomorrow. Energy
poverty must be dealt with.
• The shift to Asia of global economic gravity with geopolitical and energy
implications.
Global energy policy interrelationship
At their eleventh biennial meeting in Rome next month, Energy Ministers will discuss
these and other issues in the International Energy Forum. Their informal global producer-
consumer dialogue transcends traditional political, economic and energy policy dividing
lines. Gathering under one global political umbrella, ministers not only of the petroleum-
exporting countries of OPEC and ministers of the industrialized, petroleum-importing
countries of the OECD/IEA, it also gathers ministers of countries outside these organiza-
tions, such as energy, economic and political power-houses Russia, China, India, Brazil,
South Africa and others, that will have increasing impact on the global scenario.
IEF ministers underscore that energy security is a shared global responsibility. Security
of demand of energy-exporting countries and security of energy supply for energy-
importing countries are two sides of the same energy security coin. Reduced market
volatility and prices at reasonable levels for both consumers and producers is their mantra
and shared interest.

At their IEF Ministerial two years ago, ministers expressed concerned over effects of high
oil price levels on the world economy, and especially on developing countries. They
attributed climbing oil prices to a number of factors, including increasing demand,
tight up- and down-stream capacities, non-industrial interventions and geo-political
developments, which increase market anxieties. Today, prices are even higher, at
inflation-adjusted historic highs, with increasing Middle East demand accompanying
that of China and India and the decreased value of the US dollar in relation to other
currencies.
IEF ministers call for a stepping up of investments across the energy chain to meet
the substantial increase in demand required for global economic growth and social
development. They urge accelerated development of cleaner fossil fuel technologies
along with alternative sources of energy and increased energy efficiency in a world that
would continue to rely strongly on its ample supplies of fossil fuels, oil, natural gas and
coal. They emphasize that improved access to markets, resources, technology and
financial services, bolstered by fair and transparent economic fiscal and legal regulato-
ry frameworks, and by good governance, are crucial for the long-term energy security
of both consumers and producers. They acknowledge the need to do something
about the shortage of skilled human resources throughout the industry.
They underscore, as did the G-8 Summit in St. Petersburg, the importance of
transparency and exchange of energy data for market predictability and investments,
reaffirming their commitment to the Joint Oil Data Initiative managed by the IEF
Secretariat with the support of the main international organizations dealing with
energy, in this part of the world the Asia Pacific Economic Co-operation (APEC). More
than 90 countries worldwide, accounting for more than 90 percent of global oil
production and demand are taking part in this unique international transparency
initiative.
Energy security in its more holistic, global and long-term perspective was the focus
theme of the United Nations Commission on Sustainable Development in 2006 and
2007, underscoring the importance of energy in meeting the Millennium Development
Goals. But the efforts of ministers to finalize a consensus document with goals and
targets in May last year failed, testifying to the political, economic and environmental
complexity of energy issues.
Multi-polar energy world
As global focus is being put on issues of energy security, we also see a surge in regional
energy cooperation in Asia and elsewhere. Regional and interregional cooperation in
a multi-polar energy world can provide stepping-stones to global approaches and
cooperation.
Let me highlight the importance of a new Asian energy identity sparked by a process
of Roundtables of Asian Energy Ministers launched by India in 2005. This process of
“energy regionalism”, under the IEF global umbrella, gathers ministers of the leading
Asian oil and natural gas importing countries in Asia and the West Asian oil and natural

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gas exporting countries in the Gulf. The latest Roundtable of Asian Ministers took place
in Riyadh in May last year hosted by the Energy Ministers of Saudi Arabia and Japan.
Ministers representing half of the world’s population, the bulk of the world’s remaining
proven reserves of petroleum and the greater part of surging energy demand expected in
the decades ahead are getting together and will have global impact, not only on energy
developments.
These Asian energy ministers recognize that with their global energy clout, the Asian
petroleum economy is integral to, and inseparable from the global petroleum
economy, while they also underscore their desire for market stability and that prices
be sustained at levels that encourage Asian consumers to increase their purchases of
Asian production on the one hand and which encourage Asian producers to invest in
Asian petroleum consuming nations on the other. They advocate interlocking the
interests of Asian petroleum-endowed countries with those of Asian petroleum-
importing countries through cross-national investments in the petroleum sector of the
other for win-win promotion of reciprocal energy security interests.
The intra-Asian petroleum link is already strong. Two-thirds of West Asia’s oil exports
are going eastwards in Asia and more than two-thirds of East Asian crude oil imports
coming from West Asian exporters. This interdependence is seen as a natural and
logical consequence of geography and economics.
West Asian ministers in the Gulf assure ministers of Asian oil-importing countries to
the East that they can depend on West Asia for their future security of supply. With Asia
already accounting for 40 percent of global energy demand and 60 percent of the
expected increase in demand by 2030, ministers emphasize the importance of
improving energy efficiency, in addition to stepping up investments in response to
expanding energy demand. Setting and implementing individual and voluntary energy
efficiency goals as well as developing new, environmentally benign energy technologies
to meet environmental concern are considered important.
Conclusion
Let me sum up with some main messages:

• Harvesting your petroleum resources can certainly, with the right policies, promote
domestic economic development, while also contributing to global energy
security.
• Energy, environment and economic development are interlinked and call for
holistic approaches.
• Energy is crucial for efforts to meet the Millennium Development Goals.
• Transparency, good governance and sustainability are key.
• As are win-win policies developed in international dialogue and co-operation.
• Energy is a defining issue of our age in national, regional and global contexts in
an interdependent world, where developing countries have such important
role to play.
• Their voices should be heard and interests taken into account in global
and regional discussions and efforts that determine our Common Global
Energy Future.

Optimal macroeconomic policy in a resource boom:

Selected key issues
Robert Glofcheski
Chief Resident Economist
UNDP Cambodia, Lao PDR, Viet Nam
As a result of the global commodity price boom, economic growth in a rapidly growing
number of developing countries is increasingly based on resource extraction type
industries (oil and gas, other minerals, rare timber, etc.). For developing countries rich
in natural resources, this presents major opportunities, but also some major challenges
and risks. At the macroeconomic level, this can present a special set of challenges for
leaders and policy makers in the countries concerned.
Key macroeconomic issues in a resource revenue boom
Key macroeconomic variables include: growth (both quantity and quality), employment
and unemployment, income and income distribution, poverty and equity, inflation and
exchange rate policy, foreign borrowing, and volatility/stability.
Growth
When reviewing the growth performance of any country, but especially in countries
reliant on resource extraction type activities, it is important to review both the quantity
of growth generated, and the quality of such growth.
Gross domestic product (GDP) is the most commonly available quantitative measure
of economic growth in developing countries. However, it has some major weaknesses as
a measure of performance in economies that are largely based on extraction of non-
renewable resources like petroleum and other minerals. Because extraction of natural
resources and their export are measured as production at market value, this shows
up as part of GDP growth even if the largest part of the income generated accrues to
interests outside the country concerned. In such cases, a better measure of growth in
income benefiting the developing country concerned would be national income
discounted for extraction/depletion of non-renewable natural resources (similar to
depreciation of other physical assets in national accounting) and ideally also adjusted
for environmental costs.
Regarding quality, growth should also be assessed in terms of employment generated

and net income creation, poverty reduction, equity, environmental impact, and more
generally, human development and wellbeing. After all, what is the point of extracting
and exporting resources if it is not mainly benefiting the people of the country.

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Paradox of plenty
As is now fairly well known, a review of the growth performance of developing

countries over the past 50 years has led to a somewhat surprising finding termed
the paradox of plenty. In this case, the paradox is that many low-income developing
countries that are rich in natural resources have generally performed poorly on a wide
range of development criteria compared to developing countries that are relatively
poor in natural resources. Such resource-rich developing countries have performed
more poorly in terms of economic growth, financial management, social development,
environmental preservation, poverty, equity and governance.
One need only compare the growth and development performance since the early
1960s of the relatively resource-poor Asian tiger economies (South Korea, Singapore,
Taiwan, Hong Kong) with the more resource-rich economies of Asia, Latin America and
Africa over the same period. More generally, economic research comparing income per
capita growth rates over long periods of time indicate that per capita income growth
in low-income resource-rich developing countries has been on average 30-50 percent
lower than in low-income resource-poor developing countries.
There are, of course, some exceptions like Botswana in Africa, or Malaysia in Southeast
Asia, but these are generally outnumbered by many far less successful experiences
elsewhere (Nigeria, Angola, Liberia, Sierra Leone, Equatorial Guinea, Ecuador, Venezuela,
Kazakhstan, the Philippines in the 1970s-80s, and many others). There are also, of course,
a number of highly developed economies that have also done well including Norway,
Alberta in Canada, and Alaska in the US, but their success is attributed to already having
well-developed institutions at the time petroleum was discovered and subsequently
extracted.
In addition, there are a few hopeful newcomers like Timor-Leste, that seem to have
done well in incorporating many of the best practices in resource-rich developing and
developed countries, while so far avoiding some of the worst practices.
It is also worth noting that among the weaker performers, there is also a great deal
of variation. Take for example oil-rich Indonesia compared with oil-rich Nigeria. Thirty
years ago Indonesia and Nigeria had similar per capita incomes, but today Indonesia’s
per capita income is four times that of Nigeria.
Indonesia managed to avoid some of the worst economic policy mistakes during
the 1970s and 1980s by investing heavily in agricultural productivity and rural
infrastructure, which in turn helped avert a narrowing of the economic sectors where
most Indonesians earned their livelihoods. As a result, poverty was also considerably
reduced from 1970 to the mid-1990s. However, Indonesia experienced other negative
consequences such as poor governance and corruption from such easy money derived
from oil and other sources of easy external finance like official development assistance
and (ODA) and corrupted foreign direct investment (FDI). Nevertheless, Indonesia still
performed much better than a country like Nigeria that experienced Dutch disease
combined with serious corruption.

During this same period both countries, especially Nigeria, experienced considerable
social and political instability, and neither can be considered success stories or models
for others.
A similar comparison can be made between the diamond rich countries of Botswana
and Sierra Leone. Botswana’s economy has grown at a fairly steady rate over much of
the past 30 years, and has averaged a relatively high 7 percent per annum over the past
20 years. In contrast, the Sierra Leone economy contracted by over 40 percent between
1971 and 2000 and has only begun the initial steps to recovery in recent years, although
the outlook remains tenuous.
One also observes considerable variation when comparing countries in terms of

human development (education, health, life expectancy and income per capita). For
example, Norway a major oil exporter consistently ranks at the top of the list in terms of
the human development index. At the same time, among the lowest ranked countries
are Yemen, Gabon, Equatorial Guinea, Congo, Angola and Nigeria.
In Venezuela, arguably the Latin American country richest in oil and other natural
resources, nearly half the population continues to live in poverty since the benefits of oil
have traditionally accrued to a minority elite.
In short, the shift towards growth based on the extraction of valuable natural
resources, especially non-renewable resources, can have a dramatic impact on the
quantity and quality of economic growth and other development results, although
a minority of countries seem to have defied the odds and managed to achieve much
better results than most others. In some of the worst cases, such natural resource
extraction based growth has dramatically impacted socio-economic stability.
Macroeconomic factors underlying the paradox of plenty
One of the main macroeconomic factors affecting growth performance and econom-
ic restructuring is the sudden foreign exchange revenue boom from petroleum and
other minerals if such revenues are spent on domestic goods and services, especially
consumption goods and services (or if such revenues are converted to domestic currency,
financial assets without sterilization by the central bank). This results in an appreciation
of the real exchange rate, which in turn tends to reduce the price competitiveness of
non-petroleum tradable goods and services, and eventually results in a contraction of the
non-petroleum tradable sectors (via reduced exports and increased import competition).
At the same time of course, the petroleum extraction sector expands, as do non-tradable
goods and services. This happens under various types of exchange rate regimes either
via adjustments in the nominal exchange rate and/or in the domestic inflation rate.
This is equally true for largely dollarized economies where the main adjustments would
occur via the domestic inflation rate.

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Of course, the contraction of the non-petroleum tradable sectors only matters if such
sectors play an important role in the country concerned. In most low-income developing
countries, the non-petroleum tradable sectors typically include agriculture,
manufacturing (such as garments), and tourism. Notably, these same sectors tend to
play a critical role in providing livelihoods, jobs and incomes for the vast majority of
people in low-income developing countries.
At the same time, large-scale extraction type industries tend to be capital intensive
and typically are not generators of sustainable livelihoods and employment. Therefore,
the expansion of extraction type industries and the contraction of non-petroleum
tradable sectors like agriculture, manufacturing and tourism can have serious
consequences for livelihoods and employment, poverty, equity and human wellbeing
more generally, unless of course such economic restructuring caused by a shift towards
extraction industries is offset by various types of compensatory measures.
This loss of competitiveness and eventual contraction of the non-petroleum tradable

sectors has been termed Dutch disease because of the Dutch experience following the
discovery of natural gas in the North Sea in the 1960s, which led to a surge in natural
gas revenues and a boom in consumption spending. As a result, manufacturing and jobs
growth went into decline, a decline that was later reversed by policies that promoted
broader based investment and growth.
In addition to a gradual shrinking of the sectors that generate livelihoods and

employment, developing countries that become reliant on resource extraction also tend
to face greater macroeconomic volatility and instability. This increased volatility and
instability is typically generated by unpredictable swings in the international prices of
commodities like oil, swings in the quantities extracted over time, and occasional swings
in the timing of payments made by petroleum and mining companies to governments.
Such volatility in finance can be further exacerbated if governments undertake foreign

borrowing against petroleum reserves. International banks are quite enthusiastic about
lending to oil-rich countries during an oil boom when it is least needed, but can suddenly
refuse to refinance and can demand net repayments when the oil boom subsides –
ironically when oil-exporting developing countries may be in greater need of the
finance.
Notably, the six most indebted countries in Africa are oil and mineral exporters. Similarly,
several oil-rich Latin American countries found themselves in deep debt following the
oil price collapse of the mid 1980s. The resulting swings in petroleum and mineral
revenues in turn impact government budgets and aggregate demand in the macro-
economy unless there are some stabilizing measures in place to moderate the volatility.
In a number of resource-rich developing countries, other sources of instability have

included rising inequalities exacerbated by growing corruption. If the non-petroleum
tradable sectors that go into decline, like agriculture and manufacturing, are also sectors
where livelihoods, jobs and incomes are more broadly distributed, then inequalities will
rise. Unless the benefits from petroleum revenues are also invested or spent so as to
safeguard or improve equity, this can lead to social unrest and political instability.

Minimising Dutch disease
There are several options for either avoiding or at least minimising this particular
economic disease.
First, it is important to note that it is not the revenues per se that cause the contraction
of the non-petroleum tradable sectors, but rather the spending of the revenues, and
more precisely, the pace and manner in which the revenues are spent. Therefore, if a
developing country is already enjoying high economic growth rates at the time of
petroleum discovery and extraction, one option for safeguarding such high growth rates
is to only spend that share of new petroleum revenues up to the economy’s absorption
capacity when Dutch disease begins to take effect, and save the remainder for the future.
For example, in the case of Cambodia, preliminary modelling results suggest that the
Cambodian economy could absorb up to an additional US$300 million per annum of
spending from such revenues, but beyond that Dutch disease begins to develop.
A second option would be to try and offset the loss of competitiveness from real
exchange rate appreciation in agriculture, manufacturing and tourism by petroleum
financed public investment spending that generates productivity gains in these
same tradable sectors. For example, public investments can be made in human
resource development (e.g. education, vocational training, etc.) and infrastructure that
increases productivity in the non-petroleum tradable sectors (e.g. investments in rural
electrification, irrigation, improved rural roads, extension services, etc.).
In the case of Cambodia, preliminary modelling results suggest that additional public
investments of up to US$300 million per annum aimed at increasing productivity in
agriculture via human resource development and enabling rural infrastructure would
seem to generate the highest returns largely because of the low capital intensity in
rural areas. Any additional spending above this amount would need to be on imports
of investment goods and services to offset upward pressure on the real exchange
rate. Such an investment strategy would seem to also minimise the likelihood of a further
narrowing of Cambodia’s already narrow economic base.
Notably, such investments would also be very much in line with Cambodia’s National
Strategic Development Plan (NSDP).
Yet another important and cost effective option that could be combined with the
option of carefully selected investments would be to also implement compensatory
adjustments to policies, laws, regulations and institutional effectiveness that increases
the productivity of the non-petroleum tradable sectors (agriculture, manufacturing,
tourism). Viet Nam’s experience with the Enterprise Law and the resulting private sector
business and employment boom provides a prime example of such possibilities.
The International Finance Corporation’s (IFC) Cost of Doing Business Survey provides
developing countries with valuable guidance on where efforts could generate the
highest returns in terms of increased productivity in the non-petroleum tradable
sectors. Notably, there seems to be fairly broad consensus based on a wide range of country

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experiences from Azerbaijan to Trinidad and Tobago that spending too much of the
revenues on domestic consumption goods increases the likelihood of real exchange
rate appreciation and acute Dutch disease effects. Spending on poorly chosen public
infrastructure projects would have the same impact. This latter might be considered
even worse than spending on consumption since no one would enjoy the benefits of
higher consumption and it could leave the economy with longer-term structural
imbalances. So part of the challenge would be selecting quality public investments
that increase productivity in the non-petroleum tradable sectors in order to safeguard
and increase employment, incomes, poverty reduction gains, equity and social stability.
Also worth noting, developing country experience over the past 50 years indicates
that virtually all developing country success stories, whether resource-rich or resource-
poor, were based on a foundation of broad based literacy and education. Therefore,
for developing countries with weak human resource capacities, a first priority should
be transforming natural resource wealth into human resource wealth. Such quality
investments can sustain a country’s socio-economic development to increasingly higher
levels well after the natural resource is depleted or after commodity prices eventually
collapse.
Spending on carefully selected domestic investment goods of course depends very

much on the capacity of the public sector to invest effectively. So in order to avoid
overwhelming such capacity, a strong case could be made for at least temporarily
saving or holding in reserve a share of the funds so that public sector investments
can be paced more in line with the public sector’s capacity to invest effectively, and
minimise waste and leakages. In many developing countries, this may well be one of
the strongest arguments for setting up a well-designed and transparent petroleum
fund or natural resource fund, especially in developing countries where institutional
capacities and public finance systems are still very weak. Such well-designed natural
resource funds can serve as at least a temporary partial fix while also undertaking
more comprehensive reform and development of the public finance system. Needless
to say, the aforementioned policy and investment options would also greatly support
the achievement of the Millennium Development Goals (MDGs).

II. Pre-production challenges

Reliably assessing the resource base
Gunnar Søiland
Director, International Cooperation
Legal frameworks used to foster petroleum development

Former Legal Adviser, Energy and Mining
World Bank
International petroleum fiscal systems

Daniel Johnston
International Petroleum Fiscal Expert
Managing Director, Daniel Johnston & Co., Inc.
How to negotiate the “right” petroleum contract

Jenik Radon
International Petroleum Contract Advisor
Professor, Columbia University
Establishing an effective regulatory authority:

A comparative analysis
Ghazi Durrani
Director, SVS Strategic Value Services
Alberta, Canada

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Progress in the development of a regulatory framework for

petroleum exploration and development and poverty
eradication efforts in Uganda
Ernest N. T. Rubondo
Assistant Commissioner, Petroleum Exploration and Production De-
partment
Uganda
Assessing Cambodia’s reserves

David Moffat
Manager, Exploration and New Ventures
Chevron Asia South Ltd.
Pre-production negotiations for rights and production/rev-

enue sharing
Einar Risa
International Petroleum Associates AS (IPAN)
Overlapping claims
Advisor on Joint Development Zone to the Minister of Natural
Resources and Environment
Ministry of Natural Resources and Environment, São Tomé and
Príncipe

Reliably assessing the resource base
Gunnar V. Søiland
Director, International Cooperation
Introduction
The basic challenge for any country with hydrocarbon potential must be to benefit
from the petroleum resources in a way that both generates economic growth and
welfare for the population in general, and is environmentally sustainable.
Petroleum plays – and will continue to play – an important role in a number of developing
countries. The oil and gas sector holds the promise of becoming a vital resource for
economic and social development. It has, however, in many cases proven difficult to
translate petroleum resources into improved welfare. The combination of large and
sudden inflows of revenues and the lack of relevant institutions and governance systems
increases the risk of corruption, rent-seeking, conflict, dependence and crowding out
of existing industries. As a result, many developing countries score conspicuously low
on the current generation of international development performance indices.
The Norwegian Oil for Development initiative assists countries with hydrocarbon
potential in their efforts to overcome these challenges. Several decades of oil and gas
experience have given Norway broad competence across the full cycle of petroleum
sector management processes. National control, strong institutions and well-educated
public servants have been important features of this process, but the involvement of
the international oil and gas industry has also been fundamental.
Drawing on this experience, Norway has provided assistance to the oil sector in
developing countries since the early 1980s. Norway cooperates with more than 15
countries, covering areas such as resource assessment, data management, licensing
and tendering processes, legal frameworks, administration and supervision mechanisms,
organisation of public/private interfaces on petroleum governance, local content and
industrial development, environmental challenges and revenue management issues,
including taxation and petroleum funds.
Resource management to maximise value
In order for efficient exploration and exploitation processes to maximise the social
value for the country, the country’s involvement and interest in all phases of these
activities must be structured to address the following areas:
• Pre-license phase
• Prospecting phase
• Exploration phase
• Field development planning phase

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• Development and construction phase

• Operational and production phase
• Transportation
• Final phase and clean-up
The goal is to maximise the economic value within each single phase and assure
that long-term value creation along the whole chain is satisfactory. In order to achieve
this, it is necessary to have a good understanding of the resource base and the costs
and benefits throughout the different phases of the petroleum sector.
In order to perform an analysis to evaluate the impact of different strategies and to

pursue future planning, a particular structure for petroleum resource management
must be developed. This structure must take into consideration the different elements
affecting the value of a particular petroleum province or several provinces seen in relation
to each other. The main point is to maximise the total value of the petroleum assets.
The following issues and challenges are part of the total resource management effort:
• Resource databases for optimal planning and extraction of petroleum resources
• Strategies for the licensing and tendering processes, evaluation, awarding, etc.
• Development/assessment of legal framework to govern petroleum exploration
and production
• Framework for exploration and production of petroleum
• Approaches to effective administration and supervisory mechanisms
• Approaches towards transparent regimes for licenses and contracts
• Systems for fiscal metering and tax reference pricing
• Framework conditions for, and effective management of, state oil companies and/
or alternative management models
• Framework conditions to attract international oil companies
• Policies to stimulate technology development and the involvement of local
industry
Resource assessment studies
A good understanding of the resource base is necessary to define policies and strategies
that will ensure optimal management of petroleum resources. The government should
be in control of the speed and extent of exploration drilling, field development, and
production level, and take measures necessary to protect the environment. These
decisions can only be made based upon some knowledge of the resource potential and
estimates for future production. In a field development situation a more sophisticated
approach to resource assessment is required to satisfy banks and investors.
It is important for the government to classify the resources. When resource volumes
are quoted, both governmental decision-makers and the industry should know
what is meant by different terms. There are several systems for petroleum resource
classification; the most widely used being the SPE/AAPG/WPC (Society of Petroleum
Engineers/American Association of Petroleum Engineers/World Petroleum Council).

This system was updated in 2007 and is now referred to as the SPE-PRMS (Petroleum
Resources Management System) system. In this system, resources are split into
Reserves, Contingent Resources and Prospective Resources and further subdivided
according to project maturity.
All available data should go into the resource evaluation, which will give an indication
of the hydrocarbon potential of the respective basins and a ranking of the areas in terms
of prospectivity. Where data is scarce, statistical methods and analogy studies should
be used to estimate a range of probable volumes – like Petroleum Systems Analyses or
play modelling1. In previously unexplored areas, the host country is well advised to do
geophysical and geological reconnaissance surveys prior to licensing. In areas where
exploration has been going on for some time, the assessment must be based on existing
data and methods like Discovery Process modelling may be used.
The authorities’ resource administration depends on access to information and

documentation from companies. In Norway the petroleum legislation has a large
number of special rules, which demand the licensee/operator to submit information.
In addition, the Petroleum Act contains a general rule stipulating that all material and
information that the licensee possesses, and that is related to activities according to the
Act, shall be available in Norway and may be requested from the Ministry free of charge.
Furthermore representatives from the Ministry and Norwegian Petroleum Directorate
have the right to be present as observers in the liaison committees established in
connection with the activities.
An active attitude towards petroleum data management is a prerequisite for efficient

decisions in the petroleum sector. It is important to organise all types of petroleum
data in a petroleum province in an efficient manner. The data, as such, represents an
asset in itself. I am here referring to the raw data related to:
• Seismic data
• Drilling data
• Cores
• Cuttings
• Oil samples, etc.
These data should be stored and accumulated over time and made efficiently and
easily available to the petroleum industry.
The government entity assessing the nation’s petroleum resources should have the
necessary hardware and software tools, methodologies and the necessary training in
using them. Data compilation, interpretation, basin modelling and resource inventory
generation are work-intensive and assistance from consultants and cooperating
institutions are often required.
1
A “play” is a family of geologically related fields, prospects and leads, all of similar geological origin and charged from a common
petroleum source.

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Countries are advised to continue active promotion to attract risk capital for a responsible
and technically up-to-date exploration of the yet unlicensed parts and in future
relinquished areas. If and when a discovery is made, the exploration and licensing
policy needs to be adjusted. One would then consider competitive licensing rounds,
revised block definitions and revised work programme requirements.
Based on good resource assessment, the government can define an exploration,

licensing and promotion strategy and prepare efficient promotion for their acreage.
Such preparations include:

• Model agreement
• Listing and price schedule of available data
• Technical evaluation report
• Definition of areas offered for licensing
• Information on infrastructure and contact point for oil companies
• Time schedule for licensing
• Requirements of applicants, including financial and technical requirements
• Definition of evaluation criteria
Area consideration
An integrated resource strategy in a province needs the correct balance between

exploring for new resources, developing an increasing portfolio of smaller fields and
improving the recovery from well established fields. It is important to identify which
resources are time critical and as such can only be developed within a given time frame.
Such time critical projects on marginal resources in a province will have to compete
with the industry’s global portfolio of projects.
Many large existing field installations in an area will, after a while, have greater capacities
than are required. The economic benefit of using this capacity to the phasing in of
smaller fields is substantial. In many cases the most economic strategy for increased
oil production will be to regard an area of larger fields, smaller discoveries and possible
future prospects as one unit and try to use the existing infrastructure in the production
of minor reserves within this unit. This strategy has a large efficiency potential, as it
will ensure an enhanced exploitation of the petroleum resources in the area, and also
lead to reduction in the total cost during the lifetime of the area. The government often
has to play an active coordinating role in order for several license groups to cooperate.
This is particularly challenging in a PSA-regime with strong ring fencing mechanisms.
Sometimes it may be necessary to make adjustments in the fiscal framework in order
to ensure optimal use of existing infrastructure by several interest groups.
Often, the same general type of reservoirs will exist over a greater area, and it will be
possible to draw on the experience gained by production from the first field in the area
and possibly refine the understanding and develop this further for the benefit of other
fields. In this way smaller, otherwise non-economical fields can be put into production on
a stand-alone basis.

Improving the recovery from an area can be enhanced by active cooperation among
the operators and the licensees in the area with respect to common use of data, common
development planning and sharing available processing and transportation capacity.
The specific challenge is to bring the smaller fields into production at a suitable time.
The timing can be very critical, not just with regard to the existing production facilities,
but also with regard to the influence on the production profile of the main fields and
possible extension of the lifetime and, therefore, increased recovery of these fields.
The plans for phasing in of smaller fields must further be made flexible enough so that
the uncertainties in the main field’s future production can be taken into account.
In some areas there might be challenging tradeoffs between production of gas or oil.
Should we use the gas to be exported to the market or should it first be used to increase
the oil production, either as gas-injection, gas-recirculation or as water alternating
gas projects? Adapting an integrated resource management strategy can, thus,
enhance total recovery in an area. The government needs to take an active role in
promoting sound investments towards enhanced recovery.
Level of activity and production
Results from comprehensive resource assessment studies form the basis for developing
cumulative production profiles for oil and gas for a given field, a given area, or for the
whole nation. The distribution of remaining discovered resources over time is important
to consider when discussing the level and timing of new exploration activities.
The implementation of available and new technologies in existing and future field
operations can enhance production rates and improve recovery. These opportunities
should be promoted through active involvement by the responsible government
agencies.
Dialogue and cooperation
It is very beneficial to include an open dialogue with the petroleum industry at an early
stage in order to obtain nomination for new concession areas (nomination process).
In this manner one obtains valuable information from several alternative geological
environments.
Just as the resource evaluation must form the basis for the government’s strategic
planning, it will also constitute the basis for the oil company’s analysis of possible
investment. Openness with data serves the purpose of promotion.
The petroleum resources in any petroleum province normally exist in both well known,
already producing areas, in less explored areas and in almost unknown, frontier areas.
The important question in a resource management context is “how do we hunt for
these resources in the most efficient manner?” We may have to develop different
strategies depending on the maturity and the prospectivity of the different provinces and
basins.

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In well-known areas with existing or planned infrastructure, it is important to explore

for “time critical resources”. These are resources that can easily be produced with
existing infrastructure. In such areas, private oil companies may contribute significantly
with new ideas. Improved recovery of existing fields is obviously part of this consideration.
In less known areas, where no infrastructure is planned, the blocks awarded for
exploration should be ranked according to prospectivity and “information value”. For
the authorities, new and vital information may be just as valuable as a discovery in an
established area, because it may be essential for the evaluation and promotion of other
areas.
In Norway, several initiatives have been taken to improve development efficiency

and increase the total value of petroleum assets though extensive cooperation between
authorities and oil companies. The initiatives relate systems for more cost-efficient
exploration and development, as well as methodology and administrative structures.
It is critical to create policy stability in the petroleum sector. This means that it is
necessary to have broad political consensus with respect to crucial petroleum policy
issues. Each industrial commitment will outlast a normal government term. Predictability
and reliability reduces risk and, thus, the cost of engaging the international petroleum
industry. Policy stability has to build on appropriate legislation, which regulates the
licensing, exploration, development, production and abandonment.
Closing remarks
Oil has been, still is, and will continue to be big business and involve large amounts
of money. It is also a strategic asset. There will always be a struggle for access to equity
between the different actors in the petroleum sector. One has to find the correct
balance between the national interest of the host country and the multinational
companies. It is important to create win-win situations between the country and the
companies. One should create an environment for cooperation and dialogue between
the government and foreign companies. It is extremely important in this process for
the host country to establish an efficient and competent public administration both
on the political and policy levels, as well as the technical and business levels. Both the
country and the multi-national companies will gain from this in the long run.
Petroleum is a key sector in many developing countries. However, given weak institutional
structures and lack of local competence to manage petroleum resources, it is a challenge
for many of these countries to avoid the “resource curse” and translate petroleum
resources and revenues into improved living conditions and sustainable economic
growth.

Legal frameworks used to foster petroleum development

International Energy Consultant/Arbitrator
Former Legal Adviser, Energy and Mining, World Bank
The goal in each country has always been to create socio-economic conditions that
will alleviate poverty through the wise and prudent use of its newfound petroleum
wealth, once it comes on stream. This is a very critical goal that can prove central to
a state’s continued sustainable growth and development. At the same time, we wish to
ensure that a host country’s newfound petroleum wealth proves to be a benefit to its
entire people, a true “resource blessing”.
In moving forward with the development of its petroleum sector, all host countries have
several key objectives. These always include:
1. Full and prompt exploration of prospective areas:
2. Fair sharing of the fiscal “pie” between the state and the contractor;
3. Protection of the environment;
4. Proper treatment of residents and communities affected by petroleum
development operations;
5. Training and education of the state’s citizens;
6. Purchase of local goods and services; and
7. Reasonable controls over development activity.
Foreign direct investors, such as international oil companies (IOCs) seek, for their part,
to explore and produce under a stable, predictable petroleum regime which allows
them the rights both to “monetize” their profits and to arbitrate their disputes, if any,
with the host country in a neutral, international forum. In considering whether to invest
naked risk capital (risk capital that is not covered in any manner; it is exposed to the
risk directly) in new greenfield (areas where there is little or no previous exploration
and not yet any developed petroleum deposits) exploration and production (E&P)
ventures, IOCs take a global view. Each company decides on its annual exploration
budget and then assesses available prospects worldwide. So Cambodia is not just
competing against its Southeast Asian neighbours, it is also competing against all of
the world’s prospective petroleum provinces.
The first consideration is, of course, geology. Does the host country under consideration
have an attractive hydrocarbon potential? Once affirmatively past that critical question,
the next key question is what is the nature of the country’s legal, fiscal and contractual
framework under which petroleum operations would be conducted? Is it stable,
predictable and fair? Does it have an investor-friendly legislative framework for the
petroleum sector and a track record of honouring its contractual obligations?

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Thus, in every new petroleum province there is, first and foremost, a fundamental
need for a well designed petroleum law to govern the development of the sector.
The petroleum law is always the cornerstone of a successful legal, contractual and fiscal
framework. It represents the legislative expression of the state’s petroleum policy and
it provides the legislative context for, and the rules governing, petroleum operations
in the host country. It is meant to regulate such operations, as they are carried by
domestic, foreign and international enterprises, and to define the principal administrative,
economic and fiscal guidelines for investment activities in the sector.
Experience shows that the cornerstone of effective petroleum legislative frameworks

for E&P operations is a short, but thorough, broad, generic petroleum law, which
encapsulates a petroleum policy designed to meet the unique needs of the host country.
Arriving at the terms of such a sector policy, to be enunciated in the law, should
entail broad consultation with the country’s Parliamentarians, as well as with the leaders
of its civil society. Enabling regulations and one or several variants of a model contract,
then, complement the law. Such frameworks provide both the host government and
IOC investors with a clear legal and contractual context within which to negotiate E&P
arrangements that are both mutually advantageous and developmental of the petroleum
resources of the host country.
In addition to the petroleum law, regulations and model contracts, the fiscal and tax
aspects of a complete petroleum legislative framework may either be detailed in the
petroleum law itself, separately set out in a companion petroleum revenue code, or
addressed as a separate chapter on petroleum revenue taxation in the general tax law –
any one of which would complete the legislative package.
The core rationale behind the preference for a brief, but thorough petroleum law is
that it is meant to cover all essential concepts necessarily required in a modern, enabling
petroleum law while not “setting them in concrete” through unnecessary over-detail.
In this legislative scheme, such detail is reserved for subsidiary instruments such as the
regulations and model contract, which should not be required to be submitted to the
legislature for amendment or change.
In addition, in my view, the best approach, whenever possible, is to package the legal,
contractual and fiscal regime for petroleum operations into a self-contained, coherent,
sector-specific legislative framework, or “carve out regime” consistent, however, with
both the overall legal system of the host country and with any applicable principles of
international law. This is a great incentive to attracting significant foreign investment
into the sector. Where an IOC is studying potential E&P investments in candidate
countries, given relatively equal petroleum-prospectivity, it will normally opt for the state
that has such a coherent regime in place for petroleum operations. This, in preference
to “piecing together” the legislative framework from provisions in both the petroleum
law and other necessarily related and relevant laws, such as those on foreign investment,
taxation, land use, environment and the like.
What, then, are the essential provisions of such a modern, broad, generic, enabling
petroleum law?

First is state property in its petroleum resources. Through its petroleum law the state
both asserts and confirms its ownership of all petroleum resources within its jurisdiction,
be they onshore, offshore or in their exclusive economic zone. This is the vast majority
practice in the world today, with practically no exceptions. Canada and the United States
each have private ownership of mineral rights, but in both cases, the largest landowners
and leasers of mineral rights are their provincial and federal governments.
Second is the establishment by law of a single, independent government agency – the

competent authority (CA) – with the exclusive mandate to implement petroleum sector
policy. It is meant to be the single point of contact or window for investors, the so-called
“one-stop shop”. Indonesia’s Migas and Brazil’s National Agency of Petroleum, Natural
Gas and Biofuels (ANP) are good examples. This agency represents the state in negotiations,
regulation and administration of the sector. It should be well staffed and strong in sectoral
expertise and experience, if possible, or such should be built through consensus and
institutional strengthening. The policy purpose of the CA is to separate the state’s
patrimony and licensing of its petroleum resources from the practical administration
of the sector. The government or its applicable ministry sets broad sector policy, while
the CA implements and administers it. With the establishment of the Cambodian National
Petroleum Authority (CNPA) in 1998, Cambodia has already taken a step in this direction.
Third, the law should address the various permitted forms of petroleum operations.
It should allow the state maximum flexibility to conduct such operations in the most
advantageous manner, be it through a private entity, an incorporated or unincorporated
joint venture, or through its national oil company (NOC), should it choose to establish
one. While such is neither necessary nor universally recommended, such countries as
China, Kazakhstan, Mexico, Azerbaijan, Viet Nam, Malaysia and Nigeria have done so with
varying degrees of success. All such operations should be conducted within recognized
international norms conducive to attracting foreign direct investment (FDI) into the
sector. Most states have adopted this flexible approach, with the notable exceptions
of Kuwait, Mexico and Iran, which do not permit FDI and still adhere to reasonably
unattractive service contracts. In addition, the petroleum law should mandate that
such operations only be carried out under a duly issued permit or license from the CA,
conforming to terms prescribed in the petroleum law and regulations.
Fourth, the petroleum law should authorize the CA to prepare and make available
several forms of model contracts as texts from which the state would be prepared to
negotiate with investors. Best practice would be to identify in the law the essential,
minimum provisions of any form of authorized petroleum agreement so as to establish
their legal basis, while, at the same time, leaving full details to the negotiation process.
This maintains maximum flexibility for the state. The law should also clearly set out the
CA’s role in such matters as negotiations, supervision, administration, relinquishments,
suspension and revocation for cause.
Fifth, the legal basis for the CA to make regulations under the law should be clearly
established. Such regulations themselves are never enacted under the law, but merely
authorised to be promulgated from time to time. This allows the CA maximum flexibility
and speed of action in response to changing circumstances, as they may arise. The areas

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in which regulations may be proposed and promulgated by the CA should be well

defined. In some cases it may be desirable to limit the authority of the CA to the
promulgation of only technical regulations, requiring that those which may touch on
either policy or revenue matters be subject first to an expedited inter-ministerial review
and approval process. However, within these parameters, a grant of broad authority
to the CA should also be included to enable it to make all other necessary regulations,
consistent with the petroleum law.
Sixth, the petroleum law should clearly set out the qualifications, rights and duties of
contractors who will conduct petroleum operations. Applicants must have the requisite
financial resources, technical competence and professional skills. In turn, if chosen, they
are to be guaranteed, inter alia, security of tenure, exclusivity in their license area, the
absolute right to proceed from exploration/commercial discovery to production and
development without further government consents and the right to monetize their
profits flowing from such development. Correlatively, contractors must report all
discoveries to the CA, present a suitable development plan and always use “best
international petroleum industry practices” in conducting petroleum operations.
Seventh, the law, or a separate petroleum revenue code referenced in the petroleum
law, should address key fiscal terms, such as the taxation of profits. The fiscal package
must be competitive with other similar worldwide investment opportunities. Much can
be said about the most desirable tax regime, but as broad objectives in the law, it should
strive to:
• Reduce uncertainty;
• Present a clear picture of the applicable regime;
• Limit negotiations on tax issues;
• Provide fair and equitable tax treatment for all investors;
• Avoid double taxation and assure home country foreign tax credits; and provide
for a reasonable period of tax stability; and
• Be a regime easily applied to any form of petroleum agreement selected.
Taxes should apply only to net profits, not to gross revenues. Best practice would be
to enumerate the applicable taxes in the law and to exclude all other taxes that are not
expressly included.
Countries with especially attractive tax/fiscal regimes include Spain, Argentina, the
Philippines, the UK, Australia and Peru. Countries with less attractive regimes include
Egypt, Malaysia, Yemen, Nigeria, Colombia, Venezuela, Kazakhstan and Azerbaijan.
The obvious conclusion is that the more attractive is the resource base, the tougher are
the fiscal terms. But this is quite normal in a competitive framework.
As part of the fiscal regime, the host country government may also wish to provide for
a percentage participation by the state, directly, or through locally owned entities,
carried through exploration.
Eighth, the petroleum law should address other key fiscal and operational provisions
such as free importation and permitting of goods used in petroleum operations,

guaranteed convertibility and overseas remittances of contractor’s funds at non-

discriminatory exchange rates, access to local capital markets and banking facilities,
split payrolls for expatriates and foreign sub-contractors, the right to retain profits abroad
from export sales of production, and the right to repatriate profits for the purposes of
paying dividends and interest on operational debt.
Ninth, there should be clear and positive provisions in the law to guarantee fiscal
stability. This is aimed at fairly mitigating the effects of new laws passed subsequent
to contracts that increase the economic burden on, or reduce the original rights and
duties of, contractors. Nothing may infringe on a state’s sovereign right to enact new
laws imposing safety, conservation or environmental standards to protect public safety,
but their economic consequences should be considered and adjusted through good-
faith mutual negotiations to restore the original benefit of the bargain.
Tenth, the petroleum law should have clear and unequivocal provisions mandating
best practice environmental protection measures. Contractors must take all necessary
steps to ensure conservation, safety of life and property, avoidance of waste, spoilage
and pollution, and protection of public health and safety. Best practice also requires
an environmental impact assessment before petroleum operations can commence.
Contractors, in turn, may wish to conduct their own environmental baseline studies
to limit their liability for any pre-existing negative conditions. Today, the World Bank’s
Environmental Guidelines applicable to the petroleum sector set the world’s standard
and are highly recommended for adoption by states and contractors.
Eleventh, to round out a modern, broad, generic, enabling petroleum law, various
other key matters should be briefly but expressly addressed. These include, inter alia:
international arbitration in a neutral forum, the absence of which can be a disincentive
deal-breaker; access to land to conduct petroleum operations; local content and
preferences; technology transfer; training and employment of nationals; local market
supply; unitization of overlapping deposits; special incentives for natural gas
development; and relationships to other, conflicting laws – the petroleum law always
takes precedence on all matters concerning petroleum operations. A well drafted
petroleum law also has an extensive definitions section at its beginning for clarity and
ease of ready reference.
In brief, then, these are the essential elements of a modern and successful petroleum
law. To succeed in attaining each host country’s own unique goals in its petroleum
sector, a good petroleum law is the first necessity. Just last year, together with a long-
time professional colleague and friend, I assisted in writing such a new petroleum law
for an emerging petroleum province in East Africa that has many similar issues and
concerns to those of Cambodia. We are confident that time will test this law and prove
it, once again, to be the most successful format to attract serious and sustained FDI
into the petroleum sector. With a similar such petroleum law, regulations and model
contract, variants to complement its already attractive hydrocarbon potential, it should
be certain that Cambodia will also enjoy similar success. I certainly hope so, as there is
still much to be done here to alleviate poverty and promote sustainable development
through the wise and prudent use of revenues from Cambodia’s newfound petroleum
wealth.

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International petroleum fiscal systems
Daniel Johnston
International Petroleum Fiscal Expert
Managing Director, Daniel Johnston & Co., Inc.
Overview
Different governments have different needs. They have different boundary condi-
tions, concerns and objectives. However they are almost all interested in enhancing
hydrocarbon exploration activity. And they are all interested in getting the best
possible deal for the exploration and exploitation of their natural resources.
There are two key steps in the development of a nation’s hydrocarbon resources:
1. Allocation Strategy – the design and execution of the process of attracting

exploration and exploitation investment, and
2. Fiscal System Design – design of the petroleum fiscal systems that will maximize
the value a nation expects from their natural resources, and offer a stable and fair
return to investors.
There are fundamental differences when it comes to exploration acreage or projects

on one hand and non-exploration projects (development or enhanced oil recovery
projects – EOR). When it comes to exploration, the division of profits (Take) is a central
focus. With development or EOR projects, the focus is more on internal rate of return
(IRR). The former, generally riskier for the investor, must provide a chance for the
investor to benefit from the up side in the event of a discovery. The latter, with less
risk, should provide a fair return on investment.
Many countries have a variety of acreage opportunities – onshore, offshore, and

deepwater – with varying risks. They also often have a number of projects with varying
degrees of opportunity and risk. The allocation strategy and fiscal system design must
adequately fit a project’s potential benefits and risks for the host government and the
investor.
Allocation strategies
A theme developed a few years ago stated that acreage has begun to take on more
of the characteristics of a commodity. There is much more acreage available today
than there was 25 years ago. In the past two decades, the Soviet Union became the
former Soviet Union (FSU) and much of Africa and the Eastern-block countries have
opened up. Furthermore, with more aggressive and specific relinquishment provisions
in contracts, the market for acreage or projects is more dynamic and robust. It is
appropriate to think of acreage as a commodity, and a global commodity at that.
Countries are competing with more than just their neighbours for capital and
technology, as well as for available equipment and personnel.

Governments have no control over what God has chosen to bequeath to them.
However, they do have some control over the industry’s perception regarding those
gifts. This becomes especially important if the government believes the industry has an
unfair view of the country’s potential.
The methods used by governments to award licenses are extremely varied. Most
governments, about 100 in 2006, have official “block offerings” or “license rounds”
where blocks are awarded on the basis of competitive bids. 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
depends on the prospectivity of a block or area. With less-than-exciting acreage, a
government may have no choice – negotiated deals may be the only option.
While allocation strategy is not as important as, for example, fiscal terms, it can add
an important dynamic for governments competing for capital and technology. When
Venezuela launched its exploration round in 1996, it put 10 blocks up for bid. However,
for all practical purposes, Venezuela had 10 separate license rounds, block-by-block.
The licenses were awarded on the basis of a single-parameter bid – a profits-based
tax known as the PEG. Royalty and other fiscal elements were “fixed” (i.e. neither biddable
nor negotiable). Ties were to be broken by subsequent bonus bid rounds on the
first block, La Ceiba. Eleven companies bid and nine tied. The tie was broken with a
bonus of US$103,999,999 from the Mobil/Veba/Nippon consortium. That afternoon,
the next license (Paria West) was awarded to Conoco under the same rules. This
approach magnified the already intense competition by awarding licenses individually.
The pool of bidders would potentially be reduced by only one group, if any, in each
round. This approach greatly reduced the chance that less-prospective blocks would
receive no bid. There were however, two blocks that did not receive a bid. The resulting
government “Takes” were around 92 percent.
On the other end of the spectrum, in the United States’ Gulf of Mexico, licenses are
awarded solely on the basis of a bonus bid. In fact, few countries worldwide extract
such a large portion of rent through bonuses.
Allocation considerations
Consideration in allocation include:

• Negotiated terms, fixed terms, or bid terms
• Block size and configurations
• Timing/duration/relinquishment provisions
• Work programmes
• Ring fencing
• Proactive marketing (road shows)
• Data availability (data fees, data rooms)
• Permitting requirements
• Signal theory (the image a country portrays)

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Different situations – different considerations
Enhanced Oil Development Exploration Frontier

Recovery Projects Acreage Acreage
Degree of Risk Medium-High Low High Highest
Block Size Field Smaller Large Very Large
Acres 4,000 or so 3,000-5,000 1-2 million + 3-4 million +
(km2) (16) (12-20) (8,000) (16,000)
Work Programme(s) 1) Feasibility 1) Appraisal Exploration Exploration
Study 2) Development Program Program
2) Pilot Program
3) Development
Focus of Negotiations/ IRR IRR Take Take

Analysis
Most Common Negotiated deals Negotiated deals Competitive Competitive
Allocation Strategy Bidding and other Bidding and other
means means
Negotiated terms, fixed terms, or bid terms
This issue is of huge concern to most governments. Many governments, through their
national oil company (NOC) or oil ministry, will “fix” the key fiscal terms (such as royalties,
profit oil share, and taxes). There is no bidding or negotiation of “fixed terms”.
There is considerable pressure these days from Non-Government Organizations (NGOs)

and 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 similar to the highly
publicized EPSA IV rounds in Libya in 2005.
The problem is that unless the 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. We believe that in many instances
it is naïve and unrealistic to expect all governments to allocate acreage and projects on
the basis of sealed bids.
Allocating licenses through “negotiated deals” can be efficient too. 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 NOC officials.
Elements that become part of a contract or fiscal system are usually either:
1. Negotiated
2. Statutory or fixed terms
3. Bid item

In 1998, 50 countries were offering acreage for oil and gas exploration and development.
By 2006, the number of countries had doubled to nearly 100 countries competing
for exploration and development capital, equipment, and manpower – equipment
and manpower were major bottlenecks.
The various contract terms, and allocation strategies used, reflect the mix of above
ground risk vs. geological potential, or down-hole risk. It is up to the governments
to present to potential investors, the best possible picture of a potential investment.
In other words, governments must “market” their acreage.
Block size
The choice of block size and configuration is an important consideration. For example,
with larger blocks there is the likelihood of a greater accumulation of sunk costs prior
to discovery. These costs are typically cost recoverable and/or tax deductible and
because of this, with larger accumulations of sunk costs, governments risk lower tax
revenues. With smaller blocks, governments can minimize or mitigate their exposure.
However, in frontier regions companies need larger tracts of acreage.
Another challenge is to configure the blocks or licenses in order to provide interesting

tracts instead of having just a few highly prospective blocks and others that will
attract little interest.
Block sizes range from small to huge. Typically, block sizes will be smaller in proven
geological provinces and much larger in frontier regions. The larger regions can require
considerable exploration expense. However, the oil company may be able to recover dry
hole and other exploration costs in one part of a block against a production in another
part of the block.

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Relinquishment
Relinquishment options are diverse and there is a full spectrum of methods employed,
ranging from almost no relinquishment (in the ordinary sense) to very aggressive
relinquishment requirements like we see in the Middle East. For example, in some
of these countries only a discovery will be retained and all other acreage will be
surrendered at the end of the final exploration stage. In Indonesia for many years,
oil companies could keep more than just development areas (discoveries) at the end
of the final official stage of exploration. This meant that if a company made an economic
discovery it could enjoy the opportunity to continue exploration in their remaining
acreage while they pursued development of their discovery.
Ring fencing
Ring fencing is a term used to describe situations where governments will not allow
companies to “consolidate” their operations from one license area to another. It means
that each license (typically) is treated as a separate cost centre for cost recovery and
tax calculation purposes. Thus, ring fencing limits cost recovery or deductions that can
be taken against production to the activity inside the ring fence. A number of countries
will automatically ring fence a discovery once it is made. This would disallow
deductions for exploration activity outside the initial discovery area. This kind of
treatment is becoming more and more common.
Ring fencing can protect a government from what might otherwise be a marginal or
sub-marginal discovery, by limiting the costs that can be cost recovered and/or deducted
against revenues generated by the discovery. However, it can be a negative incentive to
exploration companies.
Allocation objectives
The primary objective of acreage allocation is to increase exploration activity. There are
also secondary objectives and some license rounds are designed specifically to focus
on development projects and downstream projects or initiatives.
Downstream initiatives
Downstream initiatives are typically infrastructure projects tied to exploration or

development contracts. They were born from the desire of host governments to
participate in the upgrading, refining, and marketing of their resources. And, they are
sometimes employed to go around corrupt or inefficient government agencies.

• Angola – In the Angola 2006 offshore license round, Angola focused on signature
bonus bids and downstream investments. The license round brought huge
signature bonuses for Blocks 15, 17, and 18 – roughly US$1 billion for each block.
The downstream investment bids for Blocks 17 and 18 also brought in US$1 billion
for each of those blocks.
• Algeria – In Algeria’s latest license round in 2006, the government required

potential bidders to share equity in their marketing infrastructure with the
Algerian government.
“Access to reserves has become a very important aspect. It is no longer a question of

financing. We have the money, we have the market and we can always get the
technology we need… What we really need is access to downstream markets and
access to reserves. We are looking for the sustainability of reserves,” Khalil said.2
Marginal field development
There are only two things a country can do to increase production:

1. Improve the fiscal terms
2. Open previously unavailable acreage
Marginal field development is one way to increase production. There have been a
number of marginal field license rounds aimed specifically at development of known
and or potential reserves.
• Ecuador – Petroecuador Launched Tenders for eight marginal fields.3 The proven
reserves of the fields total 115 million barrels. Specifically, the fields with the
largest proven reserves are Frontera-Tapi-Tetete with 45.9 million barrels, Pucuna
with 24.3 million barrels and Puma with 14.2 million barrels.
• Indonesia – A marginal field is defined as an oil or gas reservoir that cannot be

exploited economically under the existing government of Indonesia policy and
available technology.4 Indonesia’s initial marginal field license round was intended
to stem production decline in order to maintain Indonesia’s OPEC export status.
• UK and Norway’s North Sea Code of Practice – The UK and Norway initiated
Codes of Practice systems intended to provide information about capacity
and terms for North Sea infrastructure. Their aim is to increase development
of marginal fields in the North Sea and maximize utilization of North Sea
infrastructure.
2
www.upstreamonline.com, 26 April 2007
3
BNamericas, Friday, 15 September 2006
4
Seminar on Marginal Field Development, Bandung, 2001

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• Texas – Among the best examples of successful marginal field incentives is the
Texas Railroad Commission’s stripper-well tax credits. “Currently over 60 percent
of Texas’ revenue comes from stripper-wells, which at 10 barrels of oil or less a
day are definitely marginal producers. The state has given tax credits and lowered
the tax regime as well as reduced the royalty on stripper-wells – and those efforts
have really paid off.”5
Job development and indigenous participation
• Brazil – Brazil initiated a marginal field license round primarily to generate 6000
energy sector jobs.
• Nigeria6 – The government called for applications from mainly indigenous
exploration and production companies. The government stated the fields had
collective reserves totalling about 1.3 billion barrels.
The government had embarked on the marginal field project with broad objectives,
which included:
• Expand the scope of participation in Nigeria’s oil industry and diversify the sources
of investment and the inflow of funds,
• Increase the oil and gas reserves base through aggressive exploration,
• Promote indigenous participation in the oil industry, thereby fostering
technological transfer,
• Provide opportunity to gainfully engage the pool of high-level technically
competent Nigerians in the oil and gas business that now exists,
• Expand production output capacity, and
• Enhance employment opportunities.
How governments protect themselves
Oil companies often state that they “bear all the risks”. This is simply not true.
Governments bear considerable risk and must take precautions to avoid risk. Some
of the means by which governments protect themselves include bonus requirements,
control of block size, design of relinquishment requirements, and control of costs and/
or deductions.
Bonuses
Bonuses are one way a government can ensure some revenue early on.
Block sizes
Smaller blocks can reduce the risk of excessive sunk costs.
5
http://www.aapg.org/explorer/2000/11nov/marginalfields.cfm
6
Alexander’s Gas & Oil Connections, Company News: Africa, volume 7, issue #14, July 2002

Cost recovery limits and/or royalties and effective royalty rates

Guarantee governments something each and every accounting period, and more
revenue in early years of production.
Relinquishment requirements
Properly designed will provide the host government greater control of acreage, and
will avoid “warehousing”, a situation where an oil company can “sit on” acreage and delay
development until the time best suits them (not necessarily the best time for the host
government). These problems arose in Alaska, Papua New Guinea, Namibia, Mozambique,
and other countries.
Royalties and/or cost recovery limits (effective royalty rates)

Guarantee governments something each and every accounting period, and more
revenue in early years of production.
Work programmes
Governments can protect themselves with work programme guarantees.
Fiscal system design
The design of a petroleum fiscal system is much more important than the type of
system used. Governments can achieve their fiscal objectives with whichever fiscal
system they choose as long as the system is designed properly. Improper design
can translate into money-left-on-the-table. Philosophical and political objectives of
course are another matter. The type of system used is much more important to the
International Oil Companies (IOCs). On one hand, the IOCs would prefer to work with
a fiscal system that allows them to “book more barrels”, but they also want a stable
environment. Usually a royalty/tax (R/T) system will allow them to book more barrels,
but a Production Sharing Contract (PSC) can provide more stability in many cases. The
IOCs are concerned with fiscal stability no doubt and who can blame them? But, more
and more these days, stability is less a function of fiscal system type, than design.
Beyond the division of profits, there is another important consideration. When

governments don’t receive a reasonable percentage of revenue (or production) each
and every accounting period, referred to as the effective royalty rate (ERR), an unhealthy
business environment arises.
Government concerns
With the exception of the United States, Canada, and a very few, old Spanish land
grants in Columbia, mineral rights belong to the state. And, in most countries, the
nation’s mineral wealth is considered a “Gift from God”. The result is that managing
a country’s mineral wealth is considered a “sacred trust”, even though, in many
situations, the nation’s mineral wealth benefits only a few people. In short, countries
with limited proven mineral wealth are seeking exploration activity and have limited

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leeway attracting it. Still, they want the best “terms” they can get. All countries have
their own unique boundary conditions, concerns and objectives. And, needs, traditions,
perspectives, perceptions, and politics differ as well. But, in general the major concerns
facing a country are:
1. Control over the country’s resources

2. The need to attract investment and to attract the right kind of company; even
if the financial conditions are not as good. Trinidad awarded a block to BHP
even though Talisman submitted a higher bid. The government was familiar and
comfortable with BHP.
3. Getting a large (and fair) share of the profits (Take) while keeping costs down.
4. Guaranteeing a certain share each accounting period (effective royalty rate and/
or minimum government take).
5. Maximum efficient production rate (MEPR) and/or maximum ultimate recovery.
Greater government control
Prior to the introduction of production sharing contracts, royalty/tax systems (R/T sys-
tems) or concessions were the only systems available to host governments. R/T systems
gave oil companies near complete control over practically everything.
In 1966, Indonesia introduced PSCs with the intent of providing the government with
greater control. PSCs introduced the term “contractor” and the concept that exploration
companies were “contracted” to work for the government.
• Indonesia – The Indonesians, starting in the 1960s, changed the world of fiscal
system design. They introduced production sharing contracts, the concept of
control, the concept that exploration companies are contractors and “work for
the government”. They also introduced the 85 percent/15 percent profit split
which later came to be known as the OPEC terms, and were considered to be fair.
Indonesia is probably 10 years ahead of most countries with respect to under
standing fiscal system design and analysis.
R/T systems PSC Service agreements

Types of projects All types All types All types, but often
non-exploration
Ownership of facilities Contractor group Government NOC Government NOC
Facility title transfer No transfer “When landed” or “When landed” or
when commissioned when commissioned
Group ownership of Gross production less Cost oil + profit oil None
hydrocarbons royalty oil
Hydrocarbon title transfer At the wellhead Delivery point or None
fiscalisation point
IOC lifting entitlement Typically about 90% Usually from 50-60% None (by definition)
Government participation Yes, not common Yes, common Yes, very common
Government control Very little More control Most control

Service Agreements represent ultimate control, but few countries have the capital
required to contract directly for services. Most Governments must rely on R/T Systems or
PSCs.
Government Take
• World average ≈ 70 percent
• Government Take is the common denominator – the government’s share of profits
• Economic profits (US$) = Gross revenue less gross costs, also referred to as cash
flow
• Government Take (%) = Government receipts from bonuses, royalties, taxes,
production or profit sharing, and government participation, divided by economic
profit
• Contractor Take (%) = 1 – Government Take
The Take statistic represents costs and revenues over the full life of the project or field.
It is as if we have collapsed all transactions into one accounting period. Although the
Take statistic is one of the most important metrics in the design and analysis of fiscal
systems, it has many weaknesses.
Cambodia
Barrows Alert/28 June 2006
2004 model contract terms
Duration Exploration – 3 stage 1 + possible extensions of 2 + 2 + 2 years

Production – 30 years + possible extension
Relinquishment All except producing areas after second extension
Bonus US$300,000 signature
Rentals US$10/square mile during Stage 1
US$20/square mile during extension 1
US$40/square mile during extensions 2 and 3
US$500/square mile during production
Fees US$1,000 fee for each extension or any adjustment to production permit
US$10,000 for production permit and extensions of production permit
US$15,000 for transfer of rights of operations
US$272,000 Administration fee
Royalty 12.5%
Cost recovery Maximum 90%
Profit oil split BOPD Contractor share
Up to 30,000 55%
> 30,000? 45%
For gas 60%
Depreciation
Taxation 25%
Ring fencing Yes
Government None
participation

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Take calculation 100.00 Gross Revenue

-12.50 Royalty (note: bonuses and rentals are ignored)
87.50
-30.00 Costs (assumed to be 30% of gross revenue)
57.50 Profit oil
-25.87 Government share of profit oil (note: 45% for field size of 50 million
31.62 barrels)
-7.90 Contractor share of profit oil
23.72 Tax (25%)
Contractor cash flow
Government = (royalty + profit oil + tax)/(gross revenue - costs)
take = (12.5 + 25.9 + 7.9)/(100 - 30)
= 66%
Comparisons like the one below are often presented, but rarely accompanied with the
assumptions made in the calculations to provide the graph.
This graph represents undiscounted Government Take and numerous assumptions.

As long as the weaknesses of Government Take statistics are understood, and the
weaknesses of generating graphs like this are understood, then the graph can be
useful. Otherwise, be careful.
One of the primary weaknesses of the Government Take statistic is that it does not tell
you anything about the timing of cash flow. The effective royalty rate (ERR) provides
information about the timing or front-end loadedness of cash flow to a government.
The ERR is a companion statistic to the Government Take statistic.

Effective royalty rate (ERR)
World average ≈ 20%
The ERR represents the minimum

percentage of Gross Revenue a
government can expect in any
accounting period. By definition, the
ERR assumes a worst case accounting
period, one in which the government
cannot expect taxes. This companion
statistic to the Government Take
statistic tells something of “how”
governments get their share of profits.
Savings index
World average ≈ 30%
The savings index is a measure (from

an undiscounted point of view) of how Here is what happens to a “dollar saved”
much a company gets to keep if it saves
A dollar saved means an extra dollar of profit oil.
a US$1.00. Because of great concern
on the part of both governments and US$1.00 Profit oil
companies about reducing costs, this sta- - 60 Government share
tistic is included to quantify somewhat 40 Taxable income
the incentive companies have to keep -12 30% income tax
US$0.28 Company cash flow
costs down. Only the profits-based fiscal
elements influence this statistic. Royalties
(based on production, not profits) have no
influence. The example R/T system has two profits-based mechanisms. A 60 percent
Special Petroleum Tax and a 30 percent Income Tax. Therefore, if the company saves
one dollar, there will be an added dollar of taxable income. The government gets 60
percent of that. The company therefore has US$0.40 on the dollar saved prior to
implementation of the Income Tax. With a 30 percent Income Tax, the company only
gets to keep 70 percent of the US$0.40. The savings index then is US$0.28 on the dollar
(saved), or 28 percent.
This index does not take into account present value discounting. The present value
effect is interesting and it often magnifies the oil company’s incentive to keep costs
down.

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Lifting entitlement
Lifting entitlement is primarily a western oil

company concern about how many barrels
can be “booked”, but is becoming more of a
concern to NOCs and governments.
World average for R/T Systems ≈ 70%

World average for PSCs ≈ 70%
Service Agreements = NA
Progressiveness
Progressive fiscal systems are inherently more stable because they are perceived to
be fairer. Oil producing countries have been attempting to design progressive fiscal
systems for decades – this is evident in the number of sliding scales that are included
in so many of the fiscal arrangements worldwide. Unfortunately, most sliding scales
did not increase Government Take when oil prices increased from US$20 per barrel to
US$80 per barrel in the last several years.
Most of the sliding scales were not truly progressive – they did not focus on profitability.
Fiscal system design today must ensure that Government Take is progressive – when
profitability increases, the government share of profits must increase.
Fairness
Until recently contracts between host governments and oil and gas exploration and
production companies seldom involved “the people”. This is changing. The “people”
of developing countries today are more aware of their rights. Supported by NGOs
and lending institutions, the people are demanding a “fair share” of the wealth
generated from a nation’s natural resources.
Government participation
Government participation is a controversial element of the Government Take statistic.

Government participation typically is the result of a government option (through the
NOC) to take up a working interest in the event of a commercial discovery. Over half of
the countries worldwide have this option. Once the government exercises the option it
then “pays-its-way” for development and operating costs from the commerciality point
forward just like any other working interest partner. Thus the government is “carried”
through the exploration and appraisal phase. It is also called a “back-in”. Around half
of the NOCs will reimburse their share of “past costs” after they “back-in”, the other half
do not. “Past costs” are defined as those costs incurred by the IOC after the “effective
date” of the contract up to the “commerciality date” when the NOC “backs-in”. The
main source of the controversy is the issue of whether or not it should be included in
the Take calculation? That is, “is it truly a rent extraction mechanism?”

One way to check if government participation should be included is to ask a simple

question: “does typical government participation (i.e. the ”back-in”) cause an international
oil company or foreign investor any financial pain?”
The answer is a resounding “yes”. And the pain is multidimensional. First of all, the value
of a discovery to an explorer will be reduced by almost exactly the amount of the
“carry” and secondly, the companies will not be able to “book” as many barrels.
Certainly there is a difference between, say, a 50 percent profits-based tax and a

government back-in option of 50 percent – both of which will guarantee the
government an added 50 percent share of profits. An oil company would happily
avoid both if it could. From a project cash flow point of view, companies will certainly
prefer 50 percent government participation to a 50 percent tax because at least with
participation, after the NOC backs-in, it “pays its way.” Just how different the financial
impact is between a 50 percent tax and a 50 percent back-in depends on profitability
and timing. As profitability increases, the back-in or participation element takes on
more of the characteristics of a pure tax or a royalty depending on the point at which
the government takes its share of production. While it is conceptually a bit abstract,
as costs relative to gross revenues approach zero (the ultimate in profitability), the back-
in begins to take on all of the characteristics of a tax.
Comparing two fiscal systems on the basis of government take alone is not a perfect
comparison if one system has participation and the other does not. This highlights one
of the key weaknesses of typical undiscounted government take statistics. However,
to simply ignore the participation element would be a greater misrepresentation.
When comparing fiscal terms for exploration rights, it is not appropriate to exclude
or ignore the participation element as the argument above suggests.
Over half of the counties with any respectable hydrocarbon potential have the option
to back-in at the point of commerciality.
The key aspects of government participation are:

• What percentage participation? Most range from 10% to 50%, average
is around 30%
• When does the government back in? Usually at commerciality
• How much participation in management? Large range
• What costs will the government bear? Usually their pro rata share of costs
• How does government fund its share of costs? Often out of up to a certain % of
government’s share of production
• Do governments reimburse “Past Costs”? Half do, half don’t
The financial effect of a government partner is similar to that of any working interest
partner with a few large exceptions. First, the government is usually carried through
the exploration phase and may or may not reimburse the contractor for past exploration
costs. Second, the government contribution to capital and operating costs is often paid
out of production. Finally, the government is seldom a silent partner.

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In Colombia, the government has the right to take up to 50 percent working interest
and will reimburse the contractor up to 50 percent of any successful exploratory wells.
In China, the government participation is 51 percent. This usually defines the upper
limit of direct government working interest involvement.
Should governments consider participation? Absolutely! Learn the processes.
Contractors prefer no government participation. This is not totally selfish, but stems
from a desire for efficiency as well as economy. Joint operations of any sort, especially
between diverse cultures can have a negative impact on operational efficiency.
Oil company concerns
Prospectivity
Oil companies are primarily interested in good prospectivity, which is becoming

increasingly scarce. In today’s environment, however, prospectivity is generally less
than exciting. A decade ago the average discovery sizes were on the order of 100 million
barrels. Today the average discovery sizes are half that, 50 million barrels.
Beyond prospectivity, oil companies are looking for fair, stable, and predictable fiscal
terms that will allow them to recover costs and share in profits. Fiscal terms, however,
are tough and generally unpredictable.
Fiscal terms
There is one way to check to see whether a country’s fiscal terms are too tough. Is the
government happy with the amount of exploration and investment in the country?
If not, then the fiscal terms are probably too tough.
• Papua New Guinea – PNG lowered their Take prior to the 2007 license round
to provide an incentive to oil exploration. Although the fiscal terms were some
of the lowest in the world, the 2007 license round was a failure. It takes more
than fiscal terms to attract investment.
Stability and stabilization clauses
Stability clauses came about following a wave of nationalizations during the 1970s,
primarily in Latin America. About that same time developing countries were proposing
a New International Economic Order (NIEO), promoting trade practices that favoured
developing countries. The ”Principle of Changing Circumstances’, and government’s
sovereign rights to change or nullify contract terms were destabilizing oil and gas
exploration and exploitation contracts.

Initially, stability clauses were designed to “freeze” contract terms as of the “effective date”
of a contract. But there is an inherent difficulty in “freezing” contractual terms, particularly
when a new government replaces the one that agreed to the contract terms. Problems
arise with original contracts when:
• Signed under any form of duress
• Agreed at a time when the government had little negotiating power
• Corruption is involved or suspected
• The opposition government attacked contracts or negotiations prior to coming
into power
• Circumstances change
• Contracts are viewed as unfair
Freezing contract terms from the “effective date” of the contract for, in many cases,
decades is simply too difficult. In many cases a host government NOC, or oil ministry,
may contract with a foreign oil company, but have no control over royalties or taxes.
Equilibrium clauses offer oil companies an economic balance. If something is changed
that has a negative impact on the oil company, another change will be made by the
NOC or oil ministry to bring the oil company back to economic equilibrium (back to
where they were prior to the change).
However, “freezing” clauses are slowly being replaced with “equilibrium” clauses,
which evolved in recognition of a government’s sovereign right to make changes.
Internationalization clauses
Internationalization clauses effectively define the law to which the contract must
conform, typically, international arbitration. A Vietnamese contract, circa 1962 provided
that: “The arbitrators shall base their decision on equity and the principle of international
law.”7
Taxes paid in-lieu
Taxes paid in-lieu – taxes paid by the national oil company for and on behalf of the oil
company offer additional stability. These clauses recognize that taxes may be changed,
often outside the authority of the NOC, but the tax change will not impact the oil
company. Contracts with these types of provisions represent some of the most stable
contracts in the world.
Taxes paid in-lieu are fairly common and occur in the Philippines, Syria, Oman, Egypt,
Trinidad and Tobago, and Algeria.
Stabilization clauses, internationalization clauses, and taxes paid in-lieu reduce

government control.
7
Association of International Petroleum Negotiators, First Draft, of AIPN Research Project (2005-6), on “Stabilization in Investment
Contracts and Change of Rules by Host Countries: Tools for O&G Investors”, Professor A F M Maniruzzaman

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Conclusions
In the world today, as before, there is significant competition for a limited amount of
exploration capital, available equipment, and personnel.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. Those terms must also meet the needs of the country –
poorer countries need to pay closer attention to “how” they will receive potential revenue.
They simply cannot wait years to receive a share of profits. The trade-offs can be daunting.
As important as fiscal design is, the means by which governments chose to allocate
acreage or projects is just as important. When governments have good geology, they
are more likely able to allow companies to “bid the terms” as they did recently in Libya.
However, with less exciting prospectivity they will likely have to design terms themselves
and allocate licenses in a user-friendly way. Otherwise they are likely to be disappointed
with the level of exploration activity in their country – a common complaint.
It is difficult for governments to simultaneously keep the oil companies and the citizens
happy. This is where transparency can have a dramatic impact. It is part of the education
process and one of the best ways to control expectations and promote a healthy business
environment.
Annex 1. Typical Contract Conditions
Area Block sizes range from extremely small for development/EOR projects to very
large blocks for exploration. Typical exploration block sizes are on the order of
250,000 acres (1,000 km2) to over a million acres (>4,000 km2).
Duration Exploration – typically three phases totalling 6-8 years
Production – 20 to 30 years, (typically at least 25 years)
Relinquishment Exploration – 25 percent after 1st phase, 25 percent of “original” area after 2nd
phase. This is most common but there is wide variation.
Exploration Includes seismic data acquisition and drilling. Sometimes contract
obligations requirements can be very aggressive in terms of money and timing – depends
on the situation. All blocks are different
Royalty World average is around 7 percent. Most systems either have a royalty or an
effective royalty rate (ERR) due to the effect of a cost recovery limit.
Profit oil split Unique to PSCs and some service agreements. Most profit oil splits
(approximately 55-60 percent) are based on a production-based sliding scale.
Others (around 20-25 percent) are based upon an “R” factor or ROR system.
Cost recovery limit Unique to PSCs and some service agreements. Average 65 percent. Typically
PSCs have a limit and most are based on gross revenues. Some (perhaps
around 20 percent) are based on net production or net revenues (net of
royalty). Over 20 percent have no limit (i.e. 100 percent).
Approximately half of the worlds PSCs have no depreciation for cost recovery
purposes (but almost all do for tax calculation purposes).

Taxation World average corporate income tax (CIT) is probably between 30-35 percent.
However, many PSCs have taxes paid “in lieu” – “for and on behalf of the
contractor” out of national oil company share of profit oil.
Depreciation World average is 5-year straight line decline (SLD) for capital costs. Usually
depreciation begins “when placed in service” or “when production begins”
whichever occurs later.
Ring fencing Most countries (55 percent) erect a ring fence or a modified ring fence (13
percent) around the contract area and do not allow costs from one block to
be recovered from another nor do they allow costs to “cross the fence” for tax
calculation purposes.
Government Typically the national oil company (or equivalent) is “carried” through
participation exploration. Approximately half of the countries with the option to participate
do not reimburse “past costs”.
Effective royalty rate The minimum government take for a given accounting period
Crypto taxes Crypto taxes are those costs and obligations the contractor must take on that
are not readily captured in the Take calculations.
Source: “International Petroleum Fiscal Systems”, PennWell Books (2001), Daniel Johnston

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How to negotiate the “right” petroleum contract
Jenik Radon
International Petroleum Contract Advisor
Professor, Columbia University
Introduction
The discovery of natural resources, particularly oil and natural gas, fuels the hopes of
accelerated economic growth and, correspondingly, greater prosperity for all. In reality,
however, in many resource-rich countries, natural resources have been more of a curse
and obstacle to development than a boon for the economy. The disappointing net
result was, among others, slower economic growth, higher potential for conflict and
higher rates of corruption.
Negotiating oil agreements with foreign oil companies is the first challenge with
which governments of natural resource-rich countries are confronted. The terms that
governments enter into with contractors will determine how much a government and
a country earns from its natural resources, and, not infrequently, whether a government
will have the regulatory authority to enforce environmental and health and other
standards that apply to the investors. All contracts must basically determine two key
issues: how profits are divided between the government and such companies, and
how their costs are to be paid for or recovered. The objective of any negotiation is to
find a reasonable and mutually acceptable balance between the interests of all parties
– that is, the interests of an investor and a government in the case of an oil agreement.
There are no objective or universal standards in determining the terms that balance
the interests of a company to minimize its financial risk when pursuing exploration
and development activities and those of a host country’s that wants to receive
competitive compensation for its natural resources without sacrificing its environment.
One of the first decisions that governments will have to make is on the type of contractual
system to follow, whether a concession or license agreement, a Joint Venture (JV), or a
Production Sharing Agreement (PSA), or possibility even a service agreement that sets
out the terms of the development process. Concession or license agreements have
been in use since colonial times when many of the natural resource-rich nations of
today were dependencies, colonies or protectorates of colonial powers. The modern
form of such agreements basically grants an oil company rights, often exclusive, to
explore, develop, sell and export oil or minerals extracted from a specified area for a
fixed period of time. This type of agreement is quite common throughout the world
and is used in nations as diverse as Kuwait, Sudan and Ecuador. There is no single
definition for JVs. A JV simply implies that two or more parties wish to pursue a
common purpose or undertake a joint undertaking in some still to be clarified form.
Given the open-ended nature of this type of structure, it is therefore not surprising
that JVs are not commonly used as the basic agreement between an oil company and
a host government. Nigeria is an exception where the national oil company favoured

this format until it could no longer meet its share or portion of a JVs agreed financial
commitments. New agreements in Nigeria are mostly PSAs. Due to the aforesaid
absence of compelling reasons for entering into a JV this article will not explore this
type of agreement any further. The production sharing agreement (PSA) is of recent
origin, having been first used in 1966 in Indonesia. Indeed, even though Indonesia
had proclaimed its independence since 1945, foreign oil companies’ petroleum activities
were still based on Dutch colonial mining law. Given the law’s imperialistic and colonial
origin, the government refused to grant new concessions but instead introduced
the “Indonesian formula”, now widely known as the PSA, where the state retains
ownership of the resources and negotiates a sharing of profits. A service agreement is,
in its essence, simple. It is a payment for services and the attendant know-how. But
the challenge is to find a company that has the capability and is willing to provide
the required services for comparatively less compensation than possible under the
other contractual arrangements.
There is no standard answer to the question of which type of agreement would serve
a government’s interests best. Each contract has advantages and disadvantages,
especially from a commercial point of view.
Certain contractual provisions
In the following sections some of the more common and significant provisions for
both concession, or license agreements, and PSAs are highlighted. This list is by no
means exhaustive and will depend on country factors such as the legal and regulatory
systems.
Parties: Any host government should carefully evaluate its role in the agreement. If it
chooses to enter into an agreement as a contractual party it inevitably also assumes
direct responsibility and unlimited liability. If the government, however, uses a state
owned enterprises as a contractual party, then it – assuming no special circumstances –
will limit its own liability to only those assets held by that enterprise.
The oil companies usually create or use a subsidiary to become a party to an agreement.
All too often this type of subsidiary is a special purpose subsidiary (e.g. created only
for oil exploration in a particular country) and will have no or only limited assets. As a
consequence, it will effectively not have the financial resources to stand behind its
commitments, especially damages resulting from environmental pollution. Therefore,
host governments should require a guarantee from the ultimate parent company of
the subsidiary or a host government will not have a reliable contractual counter-party,
namely a party with the resources to cover its potential liabilities if there should be
a breach of the agreement or simply an accident.
Accounting methods: What exactly a government will receive in royalties and/or

profit sharing is a function of how profits are accounted for. What complicates matters
though is the absence of universal international accounting standards. Although a set
of international accounting principles has been established by the International

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Accounting Standards Board, they are still in the process of being agreed upon and
adopted and they leave room for interpretation. In addition, a number of countries
have their own national accounting standards. But even if an acceptable system is
agreed upon, there is still serious potential for disagreement and dispute as accounting
standards are not exact and leave room for discretion and interpretation. Moreover,
accounting standards do not have provisions prohibiting, for example, any particular
type of expenses. Consequently, how certain expenses are to be treated should be
clarified in the contract. In addition, accounting standards also do not provide a
solution for intercompany pricing. Intercompany pricing is the price charged to one
company that is owned or controlled by another. The result is that intercompany pricing
can inflate costs to avoid taxation and, therefore, decreases government compensation.
Recovery of costs: Recovery of costs: The way a company accounts for its costs has a
direct impact on the taxes that company pays and the royalties it shares with the
government. How companies account for their costs determines what profits they
report. There are two types of costs: running or current costs and capital costs or
sunk costs. Current costs are expensed in the year in which they are incurred and are
therefore an immediate deduction from gross income and accordingly an immediate
reduction of profit. Capital costs are to be depreciated over a period of time in
accordance with generally accepted accounting principles, which need to be agreed
upon. From a government’s perspective, the faster the rate of depreciation, the lower
profit taxes, royalties or any other amount tied to profits or sharing will be during that
period. A company will of course seek to recover its costs as quickly as possible,
irrespective of the effect on profits in any year. By allowing a rapid depreciation of
capital investment, an oil company has also less to lose in the future if it should
discontinue operations, since it will already have recovered the majority of those costs.
Therefore, the appropriate depreciation period is a critical and highly negotiated, if not
contentious, issue.
Taxation or compensation: Income earned from the production and sale of natural
resources can account for the biggest portion of the government budget in some
countries. Countries also compete with each other through tax regimes so that high
taxes could drive companies out of the country. Therefore, a balance between
company and country interests needs to be sought. There are several different types
of taxes a host government can apply.
The first is a profit tax that can come in the form of corporate income tax. An inherent
disadvantage to administering profit tax regimes is that they require top expertise
and very thorough time-consuming examinations or audits. Tax inspectors will need
to collect and audit data about the volume of production and sales. Furthermore, this
tax does not compensate or take into account that the nation is in many nations the
owner of the oil. A profits tax is effectively only a tax on the profits earned from the
services and equipment utilized in converting the oil into a liquid or cash asset.
Therefore, the state still needs to be compensated for the “transfer” of the oil from
the state to a private party. If a profits tax system is used, a “super” or excess profits tax

should be taken into consideration as the price of the asset, the oil, is not a constant
and changes over time, and without such a tax, even an adjusted one, the state
would not receive its equitable share of any increased price for its asset, the oil, while
the costs to the oil company remain more or less constant. In short it is a much higher
tax over the agreed benchmark price of the oil.
Another tax often imposed on oil companies involved in the exploration and
production of natural resources is a royalty, or excise tax, which is normally a
percentage of the value of the production, although it can be a set fee based on
volume or quantity. This tax is often imposed in addition to other taxes. The advantage
of these taxes over corporate income taxes is that they are easier to administer and
that their collection does not have to wait until the project becomes profitable. On the
other hand, these taxes can be inefficient because they are a cost on production and
accordingly insensitive to profit. When the project is marginal or not competitively
profitable, the royalty or excise tax may discourage further investment.
Bonuses are another source of revenue, which is also easy to administer. A host country
can require a one-off payment before the company starts the exploration (signature
bonus), or continued fixed payments once production reaches a certain level
(production bonus). Bonuses are fixed payments and as such do not take into account
the success of the project nor the profitability of the production activities. In exchange,
bonuses are usually tax-deductible.
The question what the compensation rate should be cannot be answered in a vacuum.
Agreements with other countries can serve as a point of reference. Given that not all
of them are publicly available (see section on transparency below) and that political,
geographic and a host of other factors can vary largely among countries, comparability
across countries is complicated. One must not lose sight of the circumstance, however,
of the principle that profits are oil sales less expenses and all profits belong to the
state other than an agreed rate of return for the oil companies. These returns have to
be high enough to provide an incentive for oil companies to invest in development
and exploration particularly in marginally profitable projects.

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Country Case Study: Azerbaijan
Taxation of petroleum activities in Azerbaijan, for example, is set forth in the PSA.
In general, it stipulates that the government will receive between 20 to 80 percent of
oil rents, i.e. net of costs after financing charges and capital recovery. The share of
the Azeri government of profit oil is calculated according to the ratio of the project’s
cumulative receipts (cost recovery and profit oil) to its expenses incurred during a
specified period (the “R-factor”). When this ratio rises, the state’s share of profit oil
also increases. In addition the Azeri government derives revenues from royalties
(15-25 percent of oil output) and substantial bonuses, which vary by project (e.g. US$1
million/100 million barrels of crude oil). Finally, the company is subject to a corporate
income tax or profit tax. The contract with the government usually provides that the
tax rate cannot be raised during the term of the contract. If new or amending tax
legislation is introduced after a contract has been concluded, such new taxes do not
apply to the contracting parties.
Country Case Study: Norway
Norway designed a sophisticated system that adapts relatively well to the stage
of development of a project, and allows the government to obtain a significant
share of the oil rents. The tax rules are based on the ordinary corporation tax (28
percent) and the addition of a special petroleum tax (50 percent). Both taxes are
based on the companies’ net profits, and all expenses relevant for the activities
on the Norwegian continental shelf are tax deductible. Investments are favoured
by a high depreciation rate. In addition, an uplift allowance lets a company deduct
30 percent more than it invests against the special tax. Thus the Norwegian
petroleum tax system is favourable for marginally profitable projects.
Health and environment: Each government has an obligation to protect its

environment and its citizens’ health. Flaring of natural gas and oil spills are but two
examples of extraction related activities that negatively impact health and environment.
To the extent that externalities, in particular health and environment costs, including
the restoration of a development area to its original condition, are not fully borne by
the oil companies, the oil company receives public subsidies. Moreover, environmental
and health standards should not be left to contractual provisions. If environmental
and health standards are left to contractual provisions in PSAs and license-concession
agreements, environmental rules and regulations are likely to be ambiguous. As a
consequence of their contractual nature as opposed to a legislative or administrative
environmental statute or regulation, oil companies are in the undue position to interpret,
negotiate or even veto environmental standards. It is standard for an agreement to
provide that parties shall mutually interpret or agree on the meaning of unclear terms,
which means the consent of both parties is required. In case of disagreement, a court, and
not the parliament or the government, is the final arbiter of the meaning of a provision.

Reference to international standards should be avoided as they are at best norms or

guidelines, and not very precise. Instead, host governments and parliaments should
enact objective environmental regulations and statutes. Such environmental stan-
dards are only effective if they are enforced and if their violation has a cost that is high
enough to serve as a deterrent. In the European Union the so-called “polluter pays”
principle obliges the operator to take the necessary restorative measures when
environmental damages occur. Moreover, breaches of environmental legislation will
soon be considered as criminal offences and penalties will be applicable to natural
persons as well as companies.
Work programme: A work programme is a detailed plan showing how a company’s

exploration or development plan will be implemented. It can be hidden behind technical
and financial considerations and accordingly requires a great deal of expertise.
The major oil companies operate projects throughout the world. As a result, they view
each project separately and expect each project to be profit making in accordance
with an internally predetermined rate of return. Consequently, if the cost of development
of one project is deemed too expensive, especially in comparison to other projects
that the oil company is, or could be, developing in another part of the world, it may
seek to slow down the development of the more expensive project. However the
host government may well still be interested in pursuing the development of the
project because it is dependent on that project for oil revenues and it will still result
in earnings. The net result is that a work plan needs to specify and define clearly under
what circumstances a project must be pursued, can be delayed or even discontinued.
Stabilization: Stabilization clauses were introduced to minimize risks for oil companies
through contract provisions. In particular, they address political risks and consequentially
aim to preserve the political status quo. But in the process they also try to contractually
eliminate the normal dynamic changes within a society, especially in regulatory matters.
This type of clause is extremely disadvantageous for the government that “agrees” to it.
It “freezes” the legal and regulatory situation of the country for an extended period of
time and requires a host government that wishes to alter its legal framework to pay
compensation if such change has an impact on an investor. Stabilization clauses are
modern day contractual colonialism, which undermines the rule of law in a host country
by subjecting legislature and government to the terms of the contract.
Price: The compensation of the host government, whether in the form of taxes or
profit sharing, depends largely on how the market price for oil is determined. The only
objective method to calculate the selling price of oil is to use, as a starting point, the price
as established by the spot market in a particular region. Normally, a contract would
specify what prices would serve as a benchmark.
What should never be accepted as an objective price of oil is what related companies
pay to each other for this commodity. This price is determined internally, by related
companies, and not objectively or independently. The danger for governments that
tax companies based on the companies report of the price of oil sold to subsidiaries, is
that this price may be well be below market prices.

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Termination: Every agreement needs to address under what circumstances it can be

terminated. For example, contracts should be terminable in cases of repeated or
severe environmental damages. Termination should also result if companies are no
longer developing the field. At that point the host government could transfer the
contract to another company that is still willing to develop the field.
Governing law: Any contract needs to have a law which governs its interpretation and
a jurisdiction where disputes are settled. Parties can choose from two basic legal
systems: Common Law (e.g. UK) and Civil Law (e.g. continental European countries).
Most importantly, the country of choice should have a well-developed body of law.
In any event, regulatory matters, a prerogative and responsibility of every nation and
its government, should be subject to the laws of the host nation, although some
assurances need to be provided that these laws will not be arbitrarily changed, enforced
or interpreted. Under no circumstances should a foreign law, including its interpretation,
become the law of a host nation as this is a direct violation of the sovereignty of the nation
and puts the future of a nation in the hands of another country’s legislative body.
Contracts: Market conditions can change quickly. What initially appeared like a
reasonable deal can suddenly look like a giveaway of a nation’s wealth. Therefore,
contracts must ensure a sufficient degree of farsightedness to anticipate foreseeable
future developments. Such renegotiations are not only fair but also feasible. In times
of skyrocketing energy demand, host governments are in a far more comfortable
negotiation position than just a decade ago.
Outside experts: Developing nations normally do not have sufficient domestic

know-how or expertise for natural resource development. Host governments have to
rely on the oil and gas companies for their expertise as no number of government
officials, even if they had the expertise, can oversee every aspect of natural resource
development. Considering the obvious conflict of interest these industry experts are
facing, places a premium on the engagement of outside experts with respect to oil
contracts. These experts must be evaluated, selected, then managed and directed to
ensure that they are truly independent.
Transparency: Contracts and regulatory matters should be disclosed and made

public. Only the transparency of commercial, financial and environmental matters can
permit the public to judge the efficacy and soundness of these agreements and the
decision-making of public servants or politicians and can help prevent corruption. It should
be added that there is no compelling reason for confidentiality. Recent initiatives such
as Publish What You Pay, which focuses only on private parties to a contract, and the
Extractive Industries Transparency Initiative (EITI) have raised awareness of the
importance of transparency. In addition, long-term public acceptance of a transparent

contract adds to its long-term viability and, therefore, provides companies with more
certainty that their investments will be safe. Nevertheless, oil companies go too far in
their quest for stability if they require and permit fuller disclosure of oil agreements
by demanding that the host country’s parliament enact oil contracts into law, each
contract thereby being a one-off and a law unto itself. This tendency prevents a coun-
try from developing a coherent functioning legal system and also sets a dangerous
precedent for future contracts as it would almost inevitably serve as a model for
companies in other sectors, thereby further undermining the genesis of a coherent
legal system.
Conclusion
Energy agreements are complex, sophisticated and detailed. They are difficult to
draft, time consuming to negotiate and challenging to implement and oversee.
Consequently, governments need professional and experienced personnel, even more
so as oil companies are not just rich in financial resources, but rich in professional
resources as well.

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Establishing effective regulatory authority:

A comparative analysis
Ghazi Durrani
Director, SVS Strategic Value Services
Alberta, Canada
Introduction
In most countries, oil and gas resources are owned by the governments are responsible
for the development of these resources. The challenge these governments face is to
ensure that the development of resources is carried out in such a manner that their
citizens receive the maximum benefit.
The development of oil and gas resources requires large amounts of risk capital and
technical know-how. A developing country can attract international oil and gas
companies provided it has policies that provide incentives for long-term investments
in the sector and has credible institutions to implement these policies effectively. A
country must have both sound policies and effective institutions to attract investments.
While sound policies may be relatively easy to develop, credible institutions take a great
deal of time and concerted effort to develop.
It is generally accepted that regulations8 should be implemented by a regulatory body

at arm’s length from political influence in order to provide confidence to a private
investor. The paper will review best practices in establishing an effective regulator,
including the functions to be performed by a regulator, its governance, degree of
independence from the political influence and its control by the government, process
of regulation and relevant capacities for effective regulations.
We can learn about developing a credible regulator from the experience of four
countries: Pakistan, Bolivia, Brazil and Alberta (Canada). The first three countries have
recent experience in developing a regulator, while the last already has a regulator
with extensive experience in successfully regulating the sector. While it is helpful to
learn from the experiences of others, it is important to recognise the unique features
of each country, such as social, cultural, political, and economic environment and
experience in the sector.
Background
A number of factors have an impact on the establishment of effective regulators. These

include:
8
Regulations used here include a statute, which incorporate government’s policies.

Complex regulatory framework
Regulation of oil and gas development is complex because of the need to regulate a
large number of areas as well as differing attributes of subsectors (upstream, midstream
and downstream). The following graphic shows areas that need to be regulated for gas
development.
For oil and gas, the upstream subsectors are similar, but differ in transmission and
distribution. The upstream subsector lends itself to competition, while transmission and
distribution are natural monopolies. The role of a regulator in the upstream subsector is
to remove barriers to entry and to encourage competition. For the natural monopolies,
it is to control or restrict entry and regulate prices. Upstream regulation also includes
regulation for the effective management of reservoirs and avoidance of waste.
A government must develop regulations in a wide range of areas incorporating clearly

thought out policies, and the regulator must have the capacity to implement these
regulations effectively.
Attracting private capital
It is generally accepted that in order to attract private capital, a government must

have sound policies and establish credible regulatory bodies. These bodies should
have autonomy of regulatory action and limited political interference.

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Regarding regulatory bodies, Baldwin and Case9 state: “One reason for moving
towards agencies may be the perceived need to take issues ‘out of party politics’ either
in order to give continuity of policy development and long-term planning in a sector
or so as to achieve fairness in adjudication – so that, for instance, choices between
different applicants for licences will be seen to be made in a manner free from
suspicions of political bias.”
Agencies, furthermore, may be less prone than line ministries to interfere in day-to-day
commercial affairs and decisions that are viewed as properly managerial.
The degree of independence of the regulatory agency is determined by a number of

factors, including: the method of hiring the chairperson and the members of the
agency and causes for their dismissal; length of tenure; method of funding the agency;
powers for the agency to develop its regulations (quasi-judicial); and methods for
appealing the agency’s decisions to a court or a cabinet
The confidence of a private investor is further enhanced if the agency has transparent
processes including the use of public hearings for reaching decisions and providing
written reasons for these decisions.
Managing risks
International oil and gas companies assess a number of factors before making a decision
on whether or not to invest in a country. The factors vary depending on the company,
but an evaluation by any company will almost certainly include an assessment of
technical, legal, fiscal, and geo-political factors.
Technical factors include the potential for (and probability of ) discovering oil and
gas fields of the size required by the company, the nature of the oil and gas which is
likely to be discovered (e.g. light oil, heavy oil, dry gas, liquids-rich gas, etc.), the types
of geological plays and prospects, their susceptibility to modern exploration
technologies, their location within the country, proximity of infrastructure, etc.
Legal factors include an assessment of whether or not there has been legal stability
in the country, whether the law is generally friendly to foreign investment, and whether
or not the legal system is consistent with modern commercial operations. In particular,
the assessment would include an evaluation of the hydrocarbon law of the country
(including the issue of ownership of hydrocarbons). It would also include an evaluation
of the type, or types, of contract established by the hydrocarbon law under which
international companies are able to work in the country, as well as the stability of
those contracts. The company would also look into the credibility of the institutions
implementing the laws.
9
Understanding Regulations: Theory, Strategy and Practice, Oxford University Press, 1999. P. 69.

Fiscal factors include an evaluation of surface rentals, royalties, taxes, state participation,
and any other levies made by national, state or provincial, and other levels of government.
Ultimately, companies need to be assured that their investments will generate
commercial returns and that there will be long-term contractual stability so as to
allow them to realise those returns.
Geopolitical factors include an assessment of whether or not the company is allowed

to export some or all of the oil and gas it may discover. This will also involve an
assessment of the location, not only of the discoveries, but also of the country itself
with respect to potential markets, and of the company’s ability to sell into those markets.
The investor is also conducting a comparative analysis of these factors for a number
of countries, where it could invest. A host country is competing with others for
investment. Therefore, the host country should take steps to create an investment
friendly environment.
Pakistan case study
Pakistan has around 27 trillion cubic feet of natural gas reserves and small reserves of oil. The oil
and gas industry has been in operation since the early 1950s.
Until 1999, the government had tight control over the industry. It owned the national oil company
(NOC), two major natural gas transmission and distribution companies, a major petroleum
distribution company, and other interests in the sector. The Ministry of Petroleum and Natural
Resources was responsible for policy development, regulation of the sector, and was the owner/
manager of the government owned enterprises.
In 2000, the government embarked on an ambitious programme of privatization of government-

owned enterprises. Its actions have focused on promoting private investment in the upstream,
deregulating most of the market for petroleum products, and establishing a regulatory authority,
Oil and Gas Regulatory Authority (OGRA), under an ordinance promulgated on 28 March 2002.
The ordinance describes the powers and functions of OGRA include: granting licences for
regulated activities; promoting and ensuring efficient practices in transmission, distribution,
processing, refining, marketing, storage of petroleum and transportation of petroleum by
pipelines; promoting effective competition; ensuring provisions for open access; and resolving
conflicts among licensees, and between licensees and any person affected by regulated activity.
OGRA regulates midstream and downstream subsectors. The Ministry of Petroleum and Natural
Resources regulates other areas including the sale of oil and gas rights, signing of production
sharing contracts, administration of contracts, upstream regulation (conservation), collection
of royalties, and establishing prices. The Ministry is also responsible for development of policies
for the sector. The Ministry of Environment and the Ministry of Labour, respectively, handle
environmental and safety regulations.
OGRA has transparent processes. The ordinance allows for open hearings and, subject to
confidentiality requirements, its files are open to public inspection.
The Authority prepares its budget annually based on the procedures it has developed. Subsection
17(2) of the ordinance provides: “The budget prepared by the Authority shall be reviewed by a
Budget Committee consisting of one representative each of the Authority, the Federal Government
and the private sector nominated by the Federal Government. The private sector nominee shall
not have any conflict of interest in the Authority’s oversight of regulated activities.”

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Bolivia case study
Bolivia is one of the poorest countries in South America. Bolivia is now the second largest holder
of proven natural gas reserves in South America after Venezuela, but the first in terms of non-
associated gas (natural gas produced from a reservoir that does not contain significant quantities
of crude oil).
It instituted its unique brand of privatization known as capitalization in 1997. Capitalization

resulted in foreign investment in exploration, which was credited for the discovery of a seven-fold
increase in gas reserves. In 2004, Bolivia had natural gas reserves of 55 trillion cubic feet. Under the
capitalization scheme, the government ceded 50 percent of its shares and management control
of state companies to foreign investors in return for explicit investment commitments. These
commitments totalled US$1.7 billion to be spent within seven years. The remaining 50 percent of
the shares were to be transferred to a Bolivian pension fund.
Bolivia restructured its oil and gas sectors. The assets of the national oil and gas company,
Yacimientos Petroliferos Fiscales Bolivianos (YPFB) were sold and it became an upstream
regulator and also signed contracts on behalf of the government and managed those contracts.
The government passed a la establishing the regulator for the Sectoral Regulation System, No.
1600. The law provided for a regulator for the sector, Superintendencia General del Sistema de
Regulación Sectorial (SIRESE). Article 2 of the law states: “The General Superintendency and
the Sectoral Superintendencies as independent entities, are public judicial persons, with national
jurisdiction and technical, administrative and economic autonomy.”
SIRESE regulates midstream and downstream. The law provides the functions of SIRESE, which
include: granting licences for regulated activities; fostering competition and efficiency in the
regulated activities; and approving prices.
The Ministry of Hydrocarbons and Energy is responsible for policy development, collection of
royalties, and regulation of the environment, while the policies for environmental regulations
are developed by the Department of Environment.
In January 2006 the government nationalised the industry, resulting in changes in contracts,
fiscal systems and re-establishment of a vertically integrated national oil and gas company.
The role of a regulator is under review.

Brazil case study
Brazil is one of South America’s major producers and consumers of oil and gas. Its oil and gas
reserves are 11.25 billion barrels and 313 billion cubic metres, respectively.
In 1997, an amendment to the Brazilian constitution finished a 45-year state monopoly held
by Petrobras. The amendment allowed private investment in the sector.
The government established the National Agency of Petroleum, Natural Gas and Biofuels (ANP)
pursuant to the Law No. 9,478 implemented on 6 August 1997. ANP has a very broad mandate.
It does not include distribution of natural gas, which is regulated by the state regulators. The
law describes the functions of ANP, which include: implementing national policy for the sector;
preparing bids and granting concessions; regulating geological and geophysical surveys;
authorising refining, processing and transportation; fostering research and development of new
technologies for the sector; and collecting royalties.
The Ministry of Mines and Energy is responsible for the development of policies.
ANP has established transparent processes for decision-making. Article 17 of the law provides:
“The ANP decision-making process must obey principles of legality, impartiality, morality, and
publicity.”
Article 18 provides for a public process for resolution of conflicts among various parties in the
sector.
Alberta (Canada) case study
Under the Canadian constitution, provinces own their natural resources and are responsible
for their development. The Province of Alberta owns about 85 percent of the oil and gas resources
of Canada.
The sector is regulated by two quasi-judicial Boards – the Energy Resources Conservation Board
(ERCB) and the Alberta Utilities Commission (AUC). The former regulates upstream and the latter
transmission and distribution. Both agencies are quasi-judicial bodies.
The objectives of ERCB include: to conserve and prevent waste of resources; to control pollution
and ensure environmental conservation in the exploration, processing, development and
transportation of energy resources; and to ensure safe and efficient practices are observed in the
upstream sector and in transportation.
The objectives of the AUC include economic regulation and open access for the transmission
and distribution of natural gas. The Board members are not involved in the day-to-day operations.
They are involved in making decisions for the Board. Each Board is managed by a chief executive
officer.
Statutes for both Boards require them to establish transparent processes, hold hearings and
provide written decisions. The Boards have powers to make their own regulations.

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62
Table: Characteristics of regulators
FACTORS Pakistan Bolivia Brazil Alberta, Canada (two regulators)

Enabling law Oil and Gas Regulatory Law No. 1600: Sectoral Law No. 9,478 (ANP) Energy Resources Alberta Utilities
Authority Ordinance Regulation System Conservation Board Commission Act (AUCA)
(OGRA) (SIRESE) Act (ERCBA)
Areas regulated Midstream and Midstream and Upstream, conduct Upstream, Environment Transmission, distribu-
downstream downstream bidding, sign contracts, (delegated authority) tion, open access (for oil,
collect royalties, gas and electricity)
UNDP Discussion Paper No. 6

midstream, environment
Board governance Chairman and three Superintendent, five-year Director General and four Chairman and eight Chairman and eight
Members for four-year term; (may be reap- directors, four-year term members, five-year term members, five-year term
term (may be appointed pointed after lapse of five (may be reappointed) (may be appointed for (may be appointed for
for another term) years) another term) another term)
Nature of Board Managing Board One-person Executive Managing Board Executive Board Executive Board
Board
Degree of insulation Upon leaving the Board, Upon leaving the Board, No links with industry No requirement in the act No requirement in the act
from industry two-year quarantine or 2-year quarantine organisation in sector 12
earlier subject to written months preceding
approval of the govern- appointment, and
ment 12-month quarantine
upon leaving the Agency
Appointment process of Appointment process not Appointed by the President of Brazil after Lt. Governor in council Lt. Governor in council
the Board provided in the President from three senate approval appointment appointment
ordinance; appointed by persons recommended
the Cabinet division by the Senate based on
two-thirds of members
present
Minimum qualifications Provided in ordinance Provided in ordinance Not provided in law Not provided in statute Not provided in statute
and experience for
Board members
Table: Characteristics of Regulators (continued)
FACTORS Pakistan Bolivia Brazil Alberta, Canada (two regulators)

Budget source Fees, fines, proceeds Fees Government 50% Government 50% Government
from sale of information, allocation approved 50% Industry 50% Industry
reports, etc. by national congress
Signature bonus
Fees and penalties
Rent
Links to privatization High High until the end of High N/A (all private sector) N/A (all private sector)
programme 2005
Government’s control Publication of yearly Report to General Not provided in law Three-year plan and Three-year plan and
mechanism report Superintendent annual report (not in law) annual report (not in law)
Degree of High High High High High
independence
Ministry to which the Ministry of Cabinet Ministry of Hydrocarbons Ministry of Mines and Ministry of Energy Ministry of Energy
agency is linked Division and Energy Energy
Appeal of Board’s High Court General Superintendency Court Court Court
decision
Processes Transparent, open hearing Transparent, open hearing Transparent, open hearing Transparent, open hearing Transparent, open hearing
Exemption from civil Yes Yes Yes Yes Yes
service rules
Ability to make Yes Yes Yes Yes Yes
regulations
UNDP Discussion Paper No. 6

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63
Comparative analysis
There is significant similarity among the regulators from these four countries, such as:
• Established under special law

• Main objective is to attract private investments
• Independent from political interference
• Established outside the civil service rules, therefore, are able to hire the required
number of staff and pay them comparatively well to retain them
• Quasi-judicial bodies, which have transparent processes and are able to make
their regulations and rules
• Except for Bolivia, the Boards’ decisions are appealable to courts
• Budgets for all are partly or wholly met from sources other than the respective
government budget
• Board members are hired under a special process, which is rigorous and their
removal without cause is difficult
However, there are some differences that should be reviewed to establish best practices.
These include:
Upstream regulations
This area should receive close attention from the government, failing to do so
may endanger reservoirs. An effective organisation for upstream regulation requires
highly qualified and trained staff supported by a specialised information system.
In Brazil and Alberta, the regulators regulate this area. Both countries have effective
organisations. However, such is not the case for Pakistan and Bolivia. In Pakistan’s
case, upstream regulations are handled by the Ministry of Petroleum and Natural
Resources, which was not able to obtain and allocate adequate resources. In Bolivia,
YPFB regulates this area. It also does not get adequate resources for its functions.
The experience of Brazil and Alberta shows that this important function should be
regulated by a regulator instead of a line ministry.
One window regulation
This means that one regulator would regulate most of the regulatory areas. For
example, in Brazil and Alberta, the environment area is regulated by the same regulator
who regulates upstream.

In Pakistan’s case, the environment is regulated by the Ministry of Environment, and

safety by the Ministry of Labour. The upstream sector is regulated by three line
ministries who are short of required funds to effectively regulate the sector.
Furthermore, coordination among the three different regulators is difficult to achieve.
Industry also finds it costly to deal with multiple regulators.
Therefore, it would be effective to bring regulation of environment and safety under

the regulator.
Number of board members
Pakistan, Brazil and Alberta have more than one Board member, whereas Bolivia has
one Superintendent only. This has created the perception of a very powerful office
that is insensitive to the issues. This also does not allow the benefit of the expertise
of several members.
Having more than one member will enhance both the quality of the decisions and
public confidence in the Board.
Provision of qualifications in law
Pakistan and Bolivia provide the minimum qualifications and experience for Board
members in the law. This is helpful in avoiding appointment of under-qualified
persons. This is particularly helpful in countries where the Boards are being established
and hiring processes are not well established.
Management board vs. executive board
Pakistan and Brazil have Management Boards where the Board members participate
in the decision-making and also head various technical groups. Alberta and Bolivia
have Executive Boards. The Board members only participate in decision-making.
A CEO manages the organisation. This approach works well in Alberta, but may not
in developing countries, where the hearings may not be extensive leaving highly
qualified Board members underutilised. Therefore, the Management Board approach
is more effective.
Budget approvals
In Brazil, Bolivia and Alberta, although all or part of the budget is funded from sources
other than the government, it is approved by the respective government body.
In Pakistan, there is a committee consisting of one representative each from the line
ministry, OGRA, and industry. The industry representative is approved by the line
ministry and is expected to not have a conflict of interest.
This approach must be carefully reviewed as it may give the perception of a conflict
of interest.

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Contract signing and administration
In Pakistan and Alberta, contracts are signed and administered by the respective
line ministries. Conversely, in Brazil, this is done by the ANP, and in Bolivia by YPFB, an
oil and gas company.
It appears to function well in Pakistan, Brazil and Alberta. However, in Bolivia, this will
distract YPFB from becoming an operating company.
ANP, in Brazil, has implemented an open process in awarding contracts. It uses an

information system to keep parties informed on a real-time basis. This has contributed
to enhancing investor confidence in ANP.
Royalty collection
Line ministries in Pakistan, Alberta and Bolivia perform this function, while ANP does it
in Brazil.
This function can be performed well by a line ministry provided it is able to provide
reasonable resources. In Bolivia and Pakistan, there has been difficulty in obtaining the
necessary resources.
In summary, the four countries reviewed have been successful in establishing effective
regulators. There are a number of factors that have been identified as best practices.
The transparent processes used by a regulator are equally important in enhancing the
confidence of private investors.
Capacity requirements
The capacity needs of a regulator are dependent upon a number of factors, including:
the mandate of the regulator, its stage of development, and the knowledge and skills
of its staff. As well, the needs are at various levels: strategic, organisational, process
and resources including knowledge and skills of its staff. Therefore, without the
knowledge of the foregoing, it is difficult to provide specific comments. It is useful to
conduct an in-depth assessment of the needs and develop a capacity development plan.
A regulatory agency is a complex organisation requiring skills in many areas. Examples

of specific expertise all regulators must possess would be:
• Communication skills: the regulator must communicate with citizens and

regulatees regarding its role and the regulatory process. If this is a new approach,
then it is essential that an effective communications strategy be established.
• Negotiation skills, alternate dispute resolution and holding public hearings
• Legal skills, particularly in administrative law

There are a number of revenue sources for a regulator, particularly licence fees, etc.
and revenues from the sale of information. Therefore, there should be a unit in the
organisation that is able to systematically collect, store and sell the information.
If the regulator is responsible for the upstream sector, it must have expertise and
systems dealing with the highly technical area of conservation. The knowledge and
skills needed include reservoir engineering, geology, drilling and production
engineering, and expertise in unitization and production accounting. This area should
also establish a core laboratory and information regarding reservoirs.
In case the regulator is responsible for midstream and downstream, this is a very
broad area involving economic and technical regulations. The regulator should have
expertise in a number of areas, including economic and financial modelling, accounting
and auditing.
Establishing an effective regulator requires a well-planned approach and takes resources.
Conclusions
We have reviewed the regulatory agencies in four countries: Pakistan, Bolivia, Brazil
and Alberta. All four agencies have a common objective: to attract private sector
investment for resource development.
Their success in achieving this objective is dependent upon their independence from
political interference. This, in turn, depends on the system’s design and the processes
used in making decisions.
There are a number of common factors. However, the key factors include: a clear law;
independent source of budget; and exemption from civil service rules.
The regulators may advise the line ministry in the development of policies but their
primary role is the implementation of the regulatory framework.
Recommendations
A great deal goes into establishing an effective regulator. A clear vision for the sector
needs to be developed and should have support from the highest political levels.
A separate law establishing the sector needs to be established and should specify:
objectives for the regulator; the size of the Board (should be more than one member);
minimum qualifications and experience of the Board members; tenure for the Board
members – at least five years; a stringent hiring process; ability of Board members to be
hired for a second term; clear rules for direct and indirect involvement with industry
after leaving the Board (there should be a minimum two-year quarantine period
unless approved by the government); clear rules for dismissal of members; method
for appeal of the Board’s decision to a Court of Appeals; open and transparent processes;
and a Management Board set up.

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Among other issues to be taken into consideration are: the organisation’s structure
should not be provided in a statute; one window regulation including environmental
and safety regulations should in instituted; staffing needs to be exempt from civil
service rules; industry should not have any influence on the budgetary process; and
the regulator should have the ability to make its own regulations and upstream
regulations should be part of its mandate.
At least part of the budget should be funded from a source other than government.
However, when an agency is being established, government should provide funding for
at least three-years.

Progress in the Development of a Regulatory Framework

for Petroleum Exploration and Development and
Poverty Eradication Efforts in Uganda
Ernest N.T. Rubondo

Assistant Commissioner
Petroleum Exploration and Production Department
Uganda
Uganda began promoting its petroleum potential about 20 years ago. Serious
exploration work by oil companies on the ground started 10 years later, in 1998. Although
less than 10 percent of the area with potential for petroleum production has been drilled,
the exploration effort has been successful. There were four oil discoveries during 2006
and 2007 and appraisal of one of these discoveries has established that it can be
produced commercially. The country’s reserve base is currently estimated to be 300
million barrels of oil in place. We expect that the continuing exploration efforts will
lead to an increase in this reserve base.
Uganda is preparing to start an early production scheme (EPS) towards the end of
2009. The EPS, which will produce 4000 barrels of oil per day, will have a topping
plant for distillation/refining, which will produce heavy fuel oil (HFO), diesel and kerosene.
The HFO will be used to generate electricity and this is the main driver for the EPS
given the current severe shortage of electricity in the country. The diesel and kerosene
will be sold on the local market.
Uganda’s policy is that as more reserves are established in the country, medium- to large-
scale refining should be developed to supply national and regional demand, which is
estimated to be over 100,000 barrels of oil per day.
Uganda’s key government policy for the last 15 years has been poverty eradication,
which has been implemented through a Poverty Eradication Action Plan (PEAP). It has
been a requirement that all sector policies and plans fit into this overall policy. The plan
has had three five-year cycles and the last cycle will end this year when the country’s
key policy plan will be referred to as a National Development Plan.
PEAP has achieved some success, especially because poverty levels in the country fell
from over 60 percent when it started to about 30 percent now. This is still a high level
of poverty and therefore a challenge. Specific programmes under the National
Development Plan are being put in place to continue the fight against poverty.
Oil and gas issues in Uganda have been regulated under the country’s Energy Policy
and the Petroleum Law of 1985. The main objective of these instruments was to
promote the country’s petroleum potential and facilitate its exploration. This objective
has been achieved through capacity building of government personnel in the sector,
collection of geo-scientific data from the field and using this data to promote the
country’s potential to the oil industry.

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Issues in the sector have increased. Government therefore commenced the

formulation of a new and comprehensive National Oil and Gas Policy during 2006
and the cabinet approved it at the beginning of this year. This formulation process
took a period of about 18 months, during which intensive consultations were held
with stakeholders. The stakeholders who participated in this consultative process
included the ministers, community leaders, cultural institutions, development partners,
private sector organisations, academia and civil society, among others. It is hoped
that this extensive consultation process will facilitate early ownership of this policy by
stakeholders.
The goal of the policy is to use the country’s oil and gas resources to contribute to
poverty eradication and create lasting value to society. The policy identifies the
following issues in the country’s emerging oil and gas sector: institutional development;
size of reserves; oil and gas revenue management; impact of oil and gas activities on
other sectors of the economy and society; contribution of oil and gas resources to the
energy mix; investment promotion; national content; and public anxiety and
expectations
The policy sets out objectives and strategies to address these issues. The strategies
include formulation of a new petroleum law and another law for the management of
petroleum revenues. The new petroleum law is currently under formulation and it is
expected that the formulation of the revenue management law will start later this year.
It is intended that both laws will be in place before oil production starts.
The policy also requires that the functions of policy setting, regulation of the sector
and management of commercial interests in the sector are separated and put under
different institutions. The Ministry responsible for oil and gas will handle the policy
aspects, a petroleum authority will be created to regulate the sector and an oil company
will be formed to undertake the commercial interests of the state.
In conclusion, Cambodia and Uganda share a number of similarities in terms of plans,

expectations and anxieties surrounding the idea of fuelling poverty eradication using
oil and gas revenues.

Pre-production negotiations for rights and

production/revenue sharing
Einar Risa
International Petroleum Associates AS (IPAN)
Introduction
Internationally there are a number of cases where oil and gas have been discovered
in areas where there are no international boundaries or where the boundaries are
disputed. There are even more cases where there is a potential for petroleum
discoveries, but where exploration does not take place due to a lack of clarified
boundaries. Such lack of clarity implies a political risk level, perceived or real, which is
unacceptable to most serious oil companies.
Geology seldom coincides with political or legal boundaries, including concession or

contract areas. And geology is rarely taken into consideration when boundaries
are established, be they national boundaries or exploration block boundaries. But
geology is a very important factor in decisions taken by governments as well as industry
on questions related to maritime boundaries.
Settlement of overlapping claims related to maritime boundaries is important in

order to facilitate exploration and development in “grey zones”. It is also important to
ensure that an oil or gas field is developed and produced according to good oil field
practices in areas where discoveries have been made, but where a unitized development
is difficult or impossible because the field is located in an area where sovereignty issues
have not been settled. An oil and/or gas field is a complex mechanism. One can only
achieve an optimal result in terms of production if the field is treated as one.
State sovereignty
The basis for overlapping maritime claims is the concept of territorial sovereignty.
A state’s territory is described as that defined portion of the globe subjected to the
sovereignty of a state. That could be land, including its subsoil, which is permanently
above the low water mark. But it could also be water, like rivers, lakes, inland seas, the
territorial sea, its seabed and also the subsoil of this seabed. And finally, it also includes
the state’s airspace.
Only a state is sovereign over a defined territory and may thus exercise supreme
authority over that territory. Sovereignty takes different forms and it may be exercised
in different ways. Only a state has jurisdictional power in the territory over which it
has sovereignty. Another way of exercising sovereignty is the granting of mining rights,
which is particularly relevant in the context of overlapping claims. The right to tax
citizens and economic activities within its territory is another integral part of the
sovereignty concept. Boundaries define the extent of the state’s sovereignty over any
given territory.

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World history deals to a large extent with emperors’ and kings’ wars over territory.
In recent history we still find wars between countries over control of territory. The
Iraqi-Iranian war is one such case. In the petroleum context, sovereignty issues are most
often connected to overlapping maritime claims. The legal framework for maritime
territorial claims is, in addition to decided cases, the United Nations Convention on the
Law of the Sea (UNCLOS) of 1982. UNCLOS was a result of the UN Conference on the
Law of the Sea, which took place from 1973 to 1982. It was charged with studying ”the
peaceful uses of the seabed and ocean floor beyond the limit of national jurisdiction”.
UNCLOS describes the legal standards and methodology to resolve maritime disputes
accepted by most states. These standards and methodology are based on customary
international law, the Geneva Conventions of 1958 and maritime delimitation decisions.
Maritime delimitation
Three concepts in international maritime law, central to petroleum exploration and

production, are Territorial Sea, Exclusive Economic Zone (EEZ) and Continental Shelf.
UNCLOS Article 2 defines the Territorial Sea as follows:

1. The sovereignty of a coastal State extends, beyond its land territory and internal
waters and, in the case of an archipelagic State, its archipelagic waters, to an
adjacent belt of sea, described as the territorial sea.
2. This sovereignty extends to the air space over the territorial sea as well as to its bed
and subsoil.
3. The sovereignty over the territorial sea is exercised subject to this Convention and
to other rules of international law.
This means that that the coastal state has exclusive rights to the:
• Products of the territorial sea (e.g. fisheries)
• Resources from its subsoil (e.g. hydrocarbons)
The territorial sea extends 12 nautical miles from the “normal baseline”. If the territorial
seas of adjacent or opposite states overlap, the territorial sea extends to the “median
line”, subject to historic title and other special circumstances. Those historic
circumstances could be islands, historic fishing rights, navigable channels, etc.
The EEZ is defined in Part 5 of UNCLOS as an area beyond and adjacent to the
territorial sea. EEZ extends up to 200 nautical miles from the baseline. The coastal state
is here given rights and jurisdiction over its EEZ, which implies that it has exclusive
control over natural resources, including petroleum, and other economic interests in
the area. But other states have “rights and freedoms”. These rights and freedoms
include navigation and over-flight and the laying of submarine cables and pipelines.
Delimitation of the EEZ between states with opposite or adjacent coasts shall be made
by agreement between the parties on the basis of international law “in order to
achieve an equitable solution”. If no agreement can be reached within a reasonable
period of time, the states concerned shall resort to procedures provided for in the

Convention. In the meantime they are obliged to make every effort to enter into
provisional arrangements of a practical nature. During this transitional period the
states shall not do anything that could jeopardize or hamper the reaching of the final
agreement. Such arrangements shall be without prejudice to the final delimitation.
Establishment of Joint Development Zones (JDZ) could be such a provisional
arrangement. Where there is an agreement in force between the states concerned,
questions relating to the delimitation of the EEZ shall be determined in accordance
with the provisions of that agreement.
What is “an equitable solution?” To clarify this, decisions like North Sea cases have
been drawn upon. The general trend towards a single maritime boundary is to draw a
median line, but considering special circumstances.
The continental shelf of a coastal state comprises the seabed and subsoil of the
submarine areas that extend beyond its territorial sea throughout the natural
prolongation of its land territory to the outer edge of the continental margin, or to a
distance of 200 nautical miles from the baseline, where the outer edge of the
continental margin does not extend up to that distance. The continental shelf cannot
extend beyond 350 nautical miles from baseline, irrespective of the distance to the
outer edge of the continental margin.
Coastal states have basically the same exclusive rights over the Continental Shelf as
they have over the EEZ for purposes of exploring and exploiting natural resources.
The delimitation provisions and methodology are also basically the same as for the
EEZ, especially up to 200 nautical miles. Beyond 200 nautical miles, geographical
features are given added weight.
Causes of boundary disputes
There are a number of reasons why maritime boundary disputes arise. National pride
is one such reason. It almost seems inherent in being a national state that one wants
to extend one’s area of control as much as possible. Such a dispute involves
neighbouring states. And it often seems to be a question of national pride to secure
control over the largest area possible rather than accepting the neighbour’s control
as long as it is at all possible to muster arguments in support of one’s case, irrespective
of the strength of those arguments. The more forceful the arguments used by the
governments involved in the dispute are, the more difficult it is for a government
for domestic political reasons to enter into a compromise, especially if the issue is
high on the political agenda. This is particularly true in countries where the government
has to listen to its people.
When a new nation emerges, there is often disagreement as to the boundaries of this
new nation. Its government will in many cases try to argue for as extensive areas as
possible within its territory, while the country from which it emerges, will try to ”limit
the damage”. In a new nation, ideas like sovereignty, nationhood and other similar
symbols are often more politically important than in ”older” countries.

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Claims to natural resources, be they fish or subsoil resources, is possibly the most
important factor in maritime boundary disputes. And the economic value of these
resources makes it all the more important to address them. The cases are innumerable,
also in the Gulf of Thailand.
There are also historical factors like ancient claims going back hundreds of years, and
particular geographic features, like rocks, islands and the physical configuration of a
bay or a cape, which can be the basis for disputes.
UNCLOS and other parts of international law governing resolution of maritime disputes
are ambiguous enough on some issues to provide for the continuation of these
disputes. But more importantly, international law still has a long way to go to make
sure that the principles laid down in legal documents, are implemented. And there is
no question that we have seen a number of cases where the final outcome is not based
on the principles laid down in international law, but rather on who is most powerful,
politically and economically, and who carries most political clout.
Resolutions of disputes over overlapping claims
Why is a resolution important? Often disputes over overlapping claims contribute to

create difficult political relations between the countries in question. This could have
repercussions in other areas. It is therefore in the interest of all parties to have the
dispute solved. The most important factor in the resolution of these disputes is the
need to start exploration for oil and gas or to proceed with the development of a
field. Most serious oil companies are reluctant to spend money in areas where there
are unresolved disputes regarding overlapping claims. We have seen this in the Gulf
of Thailand in the area of overlapping claims between Cambodia and Thailand, as
well as in the Timor Sea. There are a number of other examples as well.
There are different ways of solving a dispute over overlapping claims:

• Enter into a boundary treaty
• Establish a JDZ
• Special agreement to refer to arbitration
• Unitization
Entering into a boundary treaty is in most cases the preferable approach to this
problem. Norway and the United Kingdom signed such a boundary agreement in 1965,
based on the median line principle. Another example is Australia and New Zealand,
which signed such an agreement in 2004. Australia has not settled the issue of its
maritime boundary with Timor-Leste, as Australia is not willing to accept the median
line principle.
As has been pointed out above, according to UNCLOS, if no agreement can be reached
within a reasonable period of time, the states concerned shall resort to procedures
provided for in the Convention. In the meantime they are obliged to make every
effort to enter into provisional arrangements of a practical nature. A JDZ is such a
provisional arrangement, which also creates an opportunity to continue efforts to seek
a solution to territorial and jurisdictional issues.

A number of JDZs with different names have been created. In this region, the
Thailand-Malaysia Joint Development Area has been established, administered by
the Malaysia-Thailand Joint Authority. Malaysia and Viet Nam have also entered into
an Agreement for the Exploration and Exploitation of Petroleum in a Defined Area of
the Continental Shelf Involving the Two Countries. This amounts to a JDZ. Other
examples are the Timor Sea Joint Petroleum Development Area (JPDA) established
by Australia and Timor-Leste and the agreement between Nigeria and São Tomé and
Príncipe to establish an EEZ.
If agreement between the parties is not reached, another solution could be to enter
into a special agreement to refer the issue to arbitration. Nigeria and Cameroon reached
such an agreement, and the parties did abide by the ruling of the arbitrator.
In cases where discoveries straddling established or disputed maritime boundaries

have already been made, unitization of a field or an area is often a good solution. In
The North Sea there are several fields straddling the maritime boundaries between the
UK and Norway. In order to secure an optimal exploitation of the fields, the two
governments as well as the two license groups on the respective sides of the
boundary have entered into unitization agreements allowing each field to be
developed as one, with one operator. Thus it is the characteristics of the reservoir that
determine how the field is developed, where the production wells are put, etc., and
not the location of the field in relation to a boundary. Another example is the Sunrise
field in The Timor Sea. The discovery was made in the early 70s, but the licensees were
not willing to move the development of the field further because the overlapping
claims of Australia and Timor-Leste to the entire field had not been resolved. Part of
the field is located within the Australia-Timor-Leste JPDA, but the largest part is located
outside of this area, in an area contested by the two countries. In January 2006
Timor-Leste and Australia entered into a Treaty on Certain Maritime Arrangements in
the Timor Sea. This basically settled the issue of overlapping claims for the area covered
by the Sunrise and Troubadour fields for a period of 50 years, allowing the license
partners to move forward. Whether they do so or not is a commercial and technical
question.
JDZs and unitized areas
Many countries have apparently found that the short- and medium-term solution to
the overlapping claims issue is the establishment of a JDZ. What, then, are the success
criteria for a JDZ?
We have to conclude that they vary a great deal, depending on the local and regional
circumstances under which the JDZ was created. There are two overriding criteria
that seem to be universal. One is to minimize conflict. The other is to facilitate exploration
of natural resources, in many cases oil and gas, and thereby hopefully increase
economic activity. Ultimately, this has to do with government revenue, employment
and the improvement of economic and social standards, in short development.

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What, then, are the factors that have a bearing on securing success, and on how one
should go about establishing a JDZ in the area?
Is there an established and agreed upon boundary? If there is, the parties will be
more likely to establish a unitized area than a JDZ proper. The distribution of income
will depend on how much of the oil and gas recovered or in place will be on which
side of the agreed boundary. And there are redetermination clauses, which make sure
that the most recent reservoir information is used to determine the distribution. The
unitized fields in the North Sea, like Frigg and Statfjord, are such examples.
One important factor influencing the way a JDZ or a unitized area should be organized
is whether there is just one or there are many fields discovered, and/or the potential
for further discoveries? If there is just one field and the potential for more discoveries
is rather limited, it would in most cases make sense to unitize just that one field. If
there are more fields and/or potential for more discoveries in the area, one might
choose to unitize that whole area or parts of it.
Is there a well functioning political system on one or both sides, which can be
expected to make the necessary decisions in relation to the JDZ? No matter what
form of organization is chosen, the parties to such an organization will, from time to
time, have to make decisions to move developments forward. Can the investors,
foreign or domestic, private or public, rely on these decisions being made, and being
reasonably rational in the sense that there are not too many hidden agendas
influencing those decisions.
One also has to take into consideration whether there is an established petroleum
regime on one or both sides. If there is not, it will have to be established. That takes
time and effort, and a number of issues will have to be sorted out between the
parties. If just one of the countries has established such a regime, or the two (or more)
countries have different regimes, one is faced with the same challenges. When the
Thailand-Malaysia Joint Development Area was established the two countries were
faced with the fact that they had totally different regimes. Thailand has a tax concession
system, while Malaysia has a production sharing system. A similar situation existed
when Australia and Indonesia in 1989 agreed to establish a Zone of Cooperation in
the Timor Sea in the area Indonesia claimed after they occupied formerly Portuguese
Timor. This area is basically identical to today’s JPDA between Australia and Timor-
Leste. Australia had a tax concession system, while Indonesia had a production
sharing system. In both the Timor Sea and the Gulf of Thailand they decided to
adopt a production sharing system for their respective joint areas, regimes that were
quite similar to those of Malaysia and Indonesia. A production sharing system implies
that a large part of the terms and conditions are governed by the contract/agreement
between the authorities and the contractors (oil companies), while in a tax concession
system more of these terms and conditions are spelled out in the authorities’ laws
and regulations.

It is also relevant to take into consideration the relative size and power relationship be-
tween the countries involved. In cases where there is a power imbalance between the
two countries, whether due to differences in size or economic development, there is a
definite possibility that, even though they are formally equal, the strongest will be able
to disregard the interests of the weaker. Australia/Timor-Leste and Nigeria/São Tomée
Príncipe are examples of severe power imbalances. Thailand/Cambodia definitely
has the potential for a similar kind of imbalance. One has to be conscious of this element
when a JDZ or a unitized area is set up.
Even though two countries disagree strongly on where a certain boundary is going
to be agreed, it could be that the issue is much more important to one of the countries
than to the other. For a small country the issue could be perceived as decisive for its
future development. For the other it could be one of a number of international issues
of greater or smaller significance. A similar issue is the difference in importance to the
parties of a field development, a pipeline or some other installation related to or
determined by the realization of JZD or the unitization of a field or an area.
Finally, the most important factor in reaching an agreement and for success in its
implementation is the extent of mutual trust between the two countries and the two
governments.
Considerations for production and revenue sharing rights
What are the most important issues to be considered in connection with negotiations
for a solution to boundary dispute?
The distribution of the resources is often the most important issue to be solved in
such negotiations. There is no “right” answer to this question. A sharing of 50/50 might
sound intuitively correct. However, one has to take into consideration other elements
going into the equation, like:
• Will the establishment of the JDZ have an effect on the final settlement of the
overlapping claims dispute?
• Is the entire disputed area included in the JDZ?
• What is the history of the dispute?
• What is the relative size of one country to the other?
• Who will reap most of the downstream benefits?
• What valuation principles are going to be applied?
Malaysia and Thailand chose to share the resources 50/50, and the goal of cooperation
in their joint zone shall benefit the two countries equally. In the case of Nigeria and
São Tomé e Príncipe, Nigeria will receive 60 percent of the total oil and gas produced.
Exploration is underway, but no development decisions have been taken yet. It remains
to be seen who will benefit the most from such developments, but with Nigeria being
the biggest country, with an established oil industry and an infrastructure that can
receive the oil and gas, it is highly unlikely that we will see a balanced development
between the two. On the other hand, without the establishment of the JDZ, there
would probably not be any development of these resources at all.

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The Timor Sea Treaty between Australia and Timor-Leste, which sets up the JPDA,
specifies that 90 percent of the oil gas produced in the JPDA shall belong to Timor-Leste
and 10 percent to Australia. Before Timor-Leste’s independence, when the country
was occupied by Indonesia, a treaty between Australia and Indonesia covered
basically the same area, which divided the oil and gas 50/50. If we look at the total
revenue from the oil and gas activities, direct government revenue from the
production, be it from taxes or production sharing, is just one element. Other important
factors are the location of supply bases, which subcontractors use, the location of the
JDZ head office, where oil and gas is landed, where is it refined, etc. In the case of
the Timor Sea the 90/10 split in favour of Timor-Leste looks quite different when all
the activities emanating from oil and gas production in the JPDA are taken into
consideration. Depending on what elements are included in the calculations, it could
be that more JPDA generated income ends up in Australian than in Timor-Leste
government coffers. This shows the importance of focusing on issues in addition to
the income split. It includes the decision-making process within the JDZ institutions.
It also includes valuation principles, i.e. the pricing and tariff principles to be used in
connection with the sale and transport of the oil, and even more importantly, the gas.
Which elements in the upstream/downstream chain are going to reap what part of
the benefits?
The necessity for governmental control of the activities is no less in a unitized or joint
area than in an area controlled by one state. It is important to be able to decide who is
going to be operator, including approval rights for a change of operatorship. It is
important to have the possibility of requiring third party access to make sure that the
infrastructure built to develop natural resources belonging to the two countries
having established the JDZ or the unitized area can be utilized to the benefit of the
public interest.
Based on my own experience as head of Timor Sea Designated Authority, which

administers the JPDA and as a Timor-Leste member of the Timor Sea Joint Commission,
but also as an interested observer of the workings of other JDZs, I have drawn certain
conclusions regarding the governance of JDZs. In other words, how they should be
managed. I am fully aware of the fact that one has to take into consideration the
cultural setting in question, including the political and business culture, the situation
in which the JDZ was established, the size involved, and the importance to the parties, etc.
I still have a few pieces of advice:
• Have as many decisions as possible made on a non-political level. The major
decisions of principle should be made on a political level. Other decisions
should be left to the people who run the system, including the boards or commis-
sions set up to oversee the operations.
• Use a simple administrative model without too many hierarchical levels. Too
many levels slow down the decision-making process. That can be costly, and in
the final analysis those costs are paid for by the governments, because it
reduces efficiency, and thereby tax income.
• Have contractors/concession-holders deal with one or a limited number of
contact points.
• Avoid ”appeal rights” outside the JDZ decision-making structure.

Conclusion
In most cases it is in everybody’s interest to enter into the compromises necessary to

solve an overlapping claims dispute if releasing the area for use of its natural resources
is important. Often that means establishing a JDZ.

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Overlapping claims

Advisor on Joint Development Zone to the Minister of Natural Resources and Environment
Ministry of Natural Resources and Environment
São Tomé et Príncipe
São Tomé and Príncipe is a small island in the Gulf of Guiné and has been one of the
most active regions for oil exploration in the last decade where the poverty level is
very high and with a very weak institutional framework.
Overlapping claims issues are always important for the countries involved. The
Democratic Republic of São Tomé and Príncipe has had an interesting experience in
dealing with this situation. São Tomé and Príncipe and Nigeria have an overlapping
area of about 35,000 square kilometres that borders a Nigerian territory with very intense
hydrocarbon activity. Block 1 in the Joint Development Zone (JDZ) is only a few
kilometres south of Nigeria’s Akpo field, which is believed to contain reserves of about
1.5 billion oil equivalent barrels.
In 1998, São Tomé and Príncipe filed a territorial claim with the United Nations to
establish an Exclusive Economic Zone (EEZ) based on the median line principle stipulated
by the United Nations Convention on the Law of the Sea.
Nigeria contested the claim, arguing that the northern part of the proposed EEZ was
within Nigeria’s own EEZ.
In 1999, the Nigeria and São Tomé and Príncipe started negotiations on boundary
delimitation.
In 2000, after the ministerial and technical teams of both countries could not reach an
agreement on boundary delimitation, the two heads of state reached a consensus
and signed a joint political communiqué towards the establishment of a JDZ in the
overlapping claims area. The two countries agreed to work together to develop the
area and to benefit from any oil or gas discoveries that are made.
Political will was a crucial determinant in this process.
In 2001, São Tomé and Príncipe and Nigeria signed and ratified the Treaty for Joint
Development of petroleum and other resources in the maritime areas claimed by both
countries, which now constitutes the JDZ.
The key provisions of the Treaty grant Nigeria 60 percent and São Tomé and Príncipe
40 percent of all benefits and obligations arising from development activities carried
out in the JDZ. Its geographic coordinates define the JDZ, and the treaty will remain in
force for 45 years with a review after 30 years. Neither country had to renounce its own
claims to the zone.

Although the two countries did not renounce their claims to the zone, the Treaty
called for joint exploration of natural resources for a period of 45 years, unless otherwise
agreed after a review in the 30-year period.
The Joint Development Authority (JDA) for the JDZ, which is based in Abuja, Nigeria
with a liaison office in São Tomé and Príncipe, was created to manage the exploitation
of resources in the JDZ.
The JDA responds to the JMC (the Joint Ministerial Council of the Joint Development
Authority for the offshore Joint Development Zone between the Federal Republic of
Nigeria and D.R. São Tomé and Príncipe), comprised of four ministers or officials of
equivalent rank from each country.
The JMC is the ultimate decision-making body for the JDZ. Decisions taken by JMC
and JDA are made by consensus. If the JMC deadlocks, the dispute is referred for
resolution to the heads of state of the two countries.
In 2002, the JDA established under the treaty began operations with the inauguration
of four executive directors – two for São Tomé and Príncipe (commercial and
investment and non-hydrocarbon) and two for Nigeria (administration and finance,
and monitoring and inspection).
JDA launched the first licensing round in the JDZ in 2003, and the 2nd licensing round
in 2004. In 2005, JDA signed the first Production Sharing Contract (PSC) for Block 1 in
the JDZ, known as OBO1 (operated by Chevron). JDA signed PSCs for Blocks 2, 3 and
4 in 2006.
The signature bonuses from these blocks were shared by both countries – 60 percent
for Nigeria and 40 percent for São Tomé and Príncipe.
So far, our experience in dealing with overlapping claims areas has been interesting
and challenging in the sense of meeting international standards and governance
requirements, as well as in dealing with the burden of operating costs related to the
management of the JDZ. In terms of transparency, both heads of state signed the
Abuja Declaration that imposes transparency practices in all of the operations carried out
in the JDZ.
Oil production in the overlapping claims zone will begin in 2012. Until then, the state
parties will continue to finance the operating costs of the JDA.

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III. Costs/benefits of oil refineries

and other downstream
industries
Oil and gas development: Papua New Guinea’s
experience with downstream processing
Executive Manager, ICCC
Costs and benefits of oil refineries and other

downstream industries
Sverre Brydoy
Associate Partner
International Petroleum Associates AS, Norway
The development and role of national oil

companies
Willy H. Olsen
Advisor, INTSOK

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Oil and gas development:

Papua New Guinea’s experience with downstream processing

Executive Manager, ICCC
Introduction
Developing countries view the discovery of oil and gas as the opportunity to harness
tangible economic growth and development with a long-term view towards economic
self-sustainability and poverty reduction. The discovery of such resources also presents
the opportunity for downstream and other value-added activities in other segments
of the industry, as well as in the economies of these countries. One such example is
the development and construction of refineries to refine crude oil into various refined
petroleum products.
From the perspective of the state, while the discovery of oil and gas may present
endless opportunities for socio-economic development and overall economic well
being, these noble concepts will only be a dream if the government does not get the
initial contract negotiations relating to the development of these resources, including
any downstream investments, correct at the outset.
For the purposes of this conference, this paper presents Papua New Guinea’s (PNG)
experience in this regard, including some of the lessons learned and pitfalls identified
in the development of these resources, so that Cambodia (or any developing country
in such similar circumstance) can avoid them when extracting and developing their
oil and gas resources especially at the downstream level.
Development of refinery
Oil and gas were discovered in PNG in April 1986 by Chevron Texaco, with commercial
production commencing in June 1992. According to statistics provided by the
Department of Petroleum, the current rate of production is 50,000 barrels per day,
which adds up to about 18,250,000 barrels per annum. Total production volume from
June 1992 to February 2008 was 418,518,237 barrels with total estimated reserves
(proven reserves) from all existing fields at about 94,309 million barrels.
In terms of the downstream aspect, the government of PNG entered into an agreement
with InterOil Corporation to built and operate a refinery in PNG. The agreement was
made with the intention, among other things, of sourcing domestically produced crude
oil to eliminate the higher freight and transportation costs associated with imported
crude oil in order to ensure that refined petroleum products would be sold at affordable
prices within PNG. The actual experience, however, was far removed from this noble
intention.

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The refinery commenced operations in 2004, and has a total production capacity of
32,500 barrels per day (a speck in the ocean by world standards). However it is currently
operating at half of that capacity. The refinery itself is a “hydro-skimming” refinery that
was assembled in the US and brought into PNG. Whether the refinery components
are new or recycled is anybody’s guess. However, it appears likely that the refinery
was constructed from “second hand” and recycled components, adding higher
replacement and maintenance costs, as well as operational inefficiencies.
With respect to pricing, the agreement requires prices for the refined products to
be based on “Import Parity Pricing” based principally on Singapore posted prices
(average posted prices of seven refiners in Singapore, although it is now only three)
including the APRA freight rates, ocean losses and other costs necessary to land the
product if it were to be imported into the capital, Port Moresby. At the moment, the
refiner is requesting an amendment from the state to the pricing arrangement per
the agreement by substituting posted prices with Mean of Platts Singapore (MOPS),
although no provision exists in the agreement for such an amendment. The state
has agreed to adopt MOPS under a temporary arrangement while an internal review
of the agreement is undertaken. However, that was done after the refiner unilaterally
adopted and implemented prices based on MOPS without the consent of the state.
Even if the state is advised to adopt a position contrary to the refiner as a result of
that internal review, it is reasonable to conclude that the refiner would be adamant
about maintaining its position due, principally, to the agreement under which the state
is required to do everything possible to ensure that the refiner recovers its costs and
operates profitably, even though the refiner by this very deed may have breached
the agreement. The agreement, including the refiner’s entrenched position in the
wholesale and retail segments of the industry, now places the state in a very awkward
and weakened position.
This, therefore, to a large extent may seem to suggest that the state is guaranteeing
the commercial returns of the refiner at the expense of the economy, a riskless
enterprise with no investment and business risks. The other issue to consider is whether
the costs that the refiner seeks to recover are “efficient costs”.
Key elements of the agreement
Before commenting on the pitfalls, including lessons learned, it would be prudent to

provide an overview of some of the key elements in the agreement between PNG and
the refiner. In essence, the agreement provided for:
1. A 30-year monopoly for the refiner to supply refined petroleum products

(mainly diesel, petrol and kerosene) to the domestic market;
2. A 10-year tax holiday;
3. The state ensures that all fuel distributors source their supplies from the refiner;
and
4. Appropriate legislation would be passed to ensure the safety of the products as
well as environmental considerations.

On the whole, the agreement in itself is onerous and greatly favours the refiner. Even
without the benefit of hindsight, the state could have better negotiated the agreement
to at least make it more fair and equitable. However, this is all now academic.
Lessons learned
While PNG has had some success with downstream processing in other industries, the
experience in downstream processing of oil, and more particularly the establishment
of its first oil refinery, has been an eye opener and, in a sense, a disaster.
Put simply, PNG has the wrong refinery and the wrong technology in the wrong
location, which is further exacerbated by a lopsided and an onerous agreement, which
favours the refiner. The refiners entrenched position in both the wholesale and retail
segments of the industry has further strengthened its position insofar as the supply of
fuel products is concerned to which the state seems to be in a rather helpless position
even when the refiner acts contrary to the agreement.
Based on our experience, the following matters could be of relevance to Cambodia:
z Nature of protection, fiscal and tax incentives including the duration
The setting up of these downstream activities may involve the establishment of

monopoly-type arrangements (in our case the supply of fuel products to the
domestic market for 30 years and a 12-year tax holiday), which effectively prevents
the emergence of competition, and thus allows the incumbent monopoly to capture
economic rents and monopoly prices.The state can, to some extent, be involved in
the process of regulating prices to limit or prevent such arrangements, but this is a
second best outcome. Based on our experience, the critical issue for Cambodia is to
determine whether the downstream activities can be competitive without setting
up monopoly arrangements and causing cross subsidies.If this is not possible, then
negative economic impact on the economy is inevitable.
There is also the infant industry argument that some protection and single supply
arrangements must be put in place in order to get a new industry started.However,
this argument is only defensible if it can be demonstrated that the infant industry
support is for a limited time. If otherwise, the infant industry may not show any signs
of maturity over time and may do everything it can to retain the protection. In PNG’s
case, the refinery was given a 30-year protection on the domestic market, which is a
very long time. Countries need to be very careful when giving protection and special
monopoly cross subsidy support based on the infant industry argument.
In terms of government revenue, the refiner was given a 12-year tax holiday. Since
its operations, the refiner has recorded consecutive years of substantial accounting
loses. Under PNG taxation law, the financial losses can carried forward to offset tax
liabilities in subsequent financial years should a profit be realised. Otherwise, the
losses keep accumulating for tax purposes. This means that the refiner would not be
able to pay any tax for quite a while even when it makes any profit beyond the period

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of the tax holiday since the tax liabilities will be swallowed by the massive accumu-
lated losses.
z Competition issues and overall economic competitiveness
A relevant issue, based on our experience, is the impact of the development of

downstream activities on the competitive nature of the market in other areas,
including the economy overall.
This competition issue arises from the possible need for a cross subsidy or a hidden
subsidy in order to get the downstream and refinery activities going. We have already
seen this in PNG. Previously, refined products were imported into the major centres
in PNG at international prices plus freight. However, since the commencement of
operations of the refinery, the refiner gets the international price plus the freight,
and there still is a further freight cost to ship the product from Port Moresby to the rest
of the country. Hence, the final retail price includes two freight costs.
This problem was recognised at the time the deal was set up, and so it was agreed
to allow the mining companies, which are the major revenue generators for the
government, to be able to directly import their supplies, thus avoiding the higher cost
for the fuel oil they need.
The lesson learned by PNG as a small developing country is that we are invariably
dependent upon a limited number of exports for our income. These exports are in
the mineral, fishing, and agricultural areas where we are essentially price takers, not
price setters, at the mercy of prices determined on the international market. We don’t
have the flexibility to withhold our exports to buffer the prices as our production costs
increase. Our profits decrease because we don’t have the capacity to recover the high
costs.
PNG is also an importer of all the manufactured goods that it needs (with a few
exceptions and even here it imports the raw materials needed for the little bit of
manufacturing that it does). So we pay for our imports at a price that reflects the
cost of fuel overseas (that is, the price of fuel used in the production process is
included in the price that we pay for imported manufactured goods). Any attempt
by PNG to try to compete against these imported supplies is limited by the higher
cost of manufacturing in PNG due to the fact that the price of refined fuel is higher
because of the cross subsidy, particularly with freight costs.
To the extent that the prices for refined petroleum products are not internationally
competitive, PNG is expected to pay a higher price domestically to cross subsidise
these downstream activities, and these therefore impact on the competitiveness of
other parts of the economy and consumers in general. Now, if PNG had a stronger
economy, it could possibly carry this added cost, but of course it is not a strong
domestic economy in terms of being able to carry this additional cost.

These higher costs also act to discourage new competition from entering the
market, competition against imported products and competition in terms of the
domestic market itself.
z Nature and type of refinery
We have realised that a failure on our part during the negotiations was in not
determining the type and specification of the refinery that would be built and not
having those specifications stated in the agreement. We now realise that we have
the wrong refinery, which is not processing domestic crude but that processes, to a
larger extent, imported crude.
Ensure that the type of refinery (whether hydro-skimming or hydro-cracking) is

compatible and able to process domestic crude. Otherwise the massive costs of
imported crude will inevitably be passed on in the final prices, thus pushing additional
costs (apart from inflation) into the rest of the economy.
z Proper and competent advise and rigorous due diligence
People will say that the domestic processing of your own raw material is a good
thing. But before you can agree or disagree, you need to gather facts and make a
cost/benefit assessment. And you should not stop simply at including those things
that can be readily counted in financial terms. This is one of the problems with cost/
benefit evaluations. One needs to undertake a cost effectiveness valuation, which
looks at factors that cannot be readily measured in statistical terms, but are still
important to consider when making a decision.
Appropriately qualified and experienced advisors should be engaged by the state

for the purposes of the contract negotiations. They may come at a premium, however
it is better to pay the premium for competent advice in getting the contract right in
the first place, than to forgo such competent advice on the basis of cost considerations
at the outset.
We have also learned that one should not simply rely on cost/benefit assessments
that are based on a limited or short period of time. People will do these calculations
over, for instance, a 10-year period and say that the benefits outweigh the costs. But
you need to be able to look beyond this period, even if you can’t measure everything.
You must try to take into account all of the implications, including environmental and
pollution issues and considerations.
z Development should be internally driven
As a developing country, one of the critical issues that we now realise, and of which
should have formed the basis of our aspirations to have a refinery, was the question
of where we want to go and be in the next 20 years. Our ambition was not driven in
line with a long-term plan or vision for the industry, including the overall economy.

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We would also suggest that any argument that says we should remain in the
same condition and arrangements that existed before contact with Europeans
would be a silly and unrealistic approach. But there are some (usually expatriates
who have never lived through those times) who will argue this way. It is the “noble
savage” approach, and to be quite honest, it is paternalistic rubbish.
The people of Cambodia should have just as much opportunity as anyone else to
develop their country and improve their lives and expectations as anyone else.
The people of Cambodia, or of any other developing country, need to be able to
reach their own decisions on these issues. And that needs to be something that
is included in the cost/benefit assessment, something that reflects their priorities
and objectives, not those that come from others, no matter how well intentioned
they may be.
z Not everything promised will be realised
From our experience, developers and spin-doctors will argue that downstream
activity is going to create all sorts of new jobs and export opportunities. This is
the standard argument, and it may in some circumstances be correct. But one has
to look at these arguments very sceptically. For example, in our experience, the
refiner was promising all sorts of exports of refined products and this was going
to help reduce freight costs. We have seen nothing and are unlikely to see anything
at all. It was all unproven and will not occur.
All the additional employment that has been promised has not necessarily occurred,
or if it has occurred it has only diverted people away from possibly long-term
competitively viable jobs to jobs that depend on a continuation of the cross subsidy.
In the PNG context, where we would normally say there is a high level of
unemployment (or underemployment), the availability of labour would not be seen
as a constraint on these types of arrangements. But the problem is that we are not
just talking about any sort of labour. We are looking for skilled labour, and it is this
type of labour that is in short supply in PNG. Indeed, people are leaving the country
as fast as they can. We cannot keep the skilled labour, and so if we have any and
they are being employed in areas which are not necessarily fully competitive and
viable, we are diverting them away from other activities in the country where they
can make a net contribution without the need for cross subsidies.
Conclusion
To conclude, I agree with Professor Radon’s presentation in which he stated that

regardless of the good intentions of any developer of oil and gas resources, it is important
and imperative on the state to carefully negotiate the contract in the first place.
In our case, we didn’t get that correct and therefore we have locked ourselves in an
“onerous” agreement for the next 30 years. It is evident that this cardinal error is now
affecting our economy, including its overall competitiveness.

Costs and benefits of oil refineries and

other downstream industries
Sverre Brydoy
Associate Partner
International Petroleum Associates AS, Norway
Ever since Edwin Drake drilled the first successful oil well in Pennsylvania in 1859, the
black gold has fuelled a profound change in peoples’ lives. Modern societies today
are totally dependent on the many oil products that have evolved during 150 years of
commercial oil production. It is quite logical that developing nations also want to be
involved in the entire supply chain from crude source to customers and thereby secure
all the benefits. I’d like to give you some insight on how the downstream side of oil
business functions, and provide facts and trends that should be considered in investment
planning of new refineries or other downstream industries.
This chart depicts the system that is required to produce the crude offshore, bring it to
a refinery where it is converted to fuel products, ship the fuels to distribution terminals,
by truck to gasoline stations, and finally deliver the products to customers. This is simple
in principle, but there are thousands of these “systems” working in parallel and in
competition with each other. At least three interesting observations can be made from
this chart:
1. The “system” consists of hardware, and the oil is invisible. If seen, it usually means
an oil spill and a big problem. The customer is not interested in the product, which
he does not see, only in what it can do. He or she wants the car to run without
trouble at low cost. Trouble free operation is even more important for airlines and
for all of us. Customers get what they need because people in this downstream
chain focus on quality so the customers don’t have to worry.

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2. Another invisible is the reverse flow of money, which starts with billions of
customers and runs back through the system to pay for the services until most
ends up at the crude source. When I started in the oil business, more than 40 years
ago, the transactions between buyers and sellers in the oil chain were fairly simple.
Now it is a worldwide web of traders, banks, hedge funds, and others who want to
bet on which way the market is moving. Every deal is reported and prices posted
online within seconds. Price quotations for benchmark crudes and major products
in key refining centres get a lot of attention in the news media. For the professionals,
oil trading is similar to trading in shares and currencies, a level playing field with
free access.
3. The importance of geography is a third observation that should be made from

this chart. Nature placed the oil reserves where they are, and customers generally
stay put, but everything in between is flexible and fiercely competitive. The term
“parity” is important in the oil business. For example, if there is a shortage of
gasoline in the US and prices are higher than in Europe, gasoline will be moved
to the US provided the price difference between the US and Europe compensates
for the extra freight. In open markets, oil prices in all locations worldwide are in
parity when considering freight costs.
It is a well-known fact that oil is the biggest commodity in the world, in monetary
terms. In addition to fuelling modern society in all possible ways, oil has also fuelled the
growth of some of the biggest companies in the world, and changed the geopolitical
landscape. The oil business is about money – and money means power, be it to buy
military equipment or improve living conditions.
Another fact is that most major oil companies have elected to become fully integrated –
i.e. have control of the entire value chain from exploration and production of crude and
gas, which is referred to as the upstream, through refining, terminals and sales to
customers, which is called the downstream business. In fact, most of the major companies
have significantly more refining and sales capacity than crude production capacity, which
implies that they are net buyers of crude. One might, therefore, expect that profitable
investments in refineries and other downstream industries are what Americans would call
a no-brainer. The answer is not that simple, however.

The annual reports for two big companies show that the oil business is huge by any
standard. ExxonMobil turnover in 2006 was more than US$1 billion per day, and
reported earnings after tax were almost US$40 billion. Shell was close behind with
revenues of US$319 billion and earnings of US$26 billion.
Finding correct data for refinery earnings is difficult as most companies report
combined refining and marketing. If we assume, for reasons of simplicity, that half of
the reported downstream earnings are in refining, the above chart shows the relative
earnings contributions in US$ per oil equivalent barrel for upstream and refining.
These guesstimates for refinery earnings may be on the high side, but the key point is
the huge difference between upstream and downstream profits, even for the most
efficient companies. In Europe most drivers pay more than US$2 dollars per litre for
gasoline or diesel. When we asked visitors to the refinery what they believed our profits
were, most guessed US$0.10-0.20 per litre. The correct answer was roughly US$0.01, or
half a percent of the price at the pump, which surprised everyone.
The economic benefits for the country or state are even more skewed towards upstream
as tax rates in most cases are much higher on upstream earnings than downstream.
Still, Shell and ExxonMobil know what they are doing, and their refining capacity is
much higher than their crude production. The world’s largest crude producer, Saudi
Arabia, has also elected to invest heavily in export refineries and petrochemicals, so why
should other countries not make the most of it and gain additional supply security at
the same time?
Multi-billion dollar investments need to be treated with caution. History can teach us a
lot, and there are many examples of refinery investments that turned out to be unwise.
The European experience
Current demand growth in Asia and the Middle East is similar to Europe’s experience
in the late 1950s and 1960s when demand grew five to six percent per year as more families
could afford a private car and industry was rebuilt after the Second World War. At the time,
refining capacity was tight and new oil refineries were built at a rapid pace. I happened
to work in London as a supply planner and coordinator for Central Europe in 1972-73
when the first price shock hit, and the price of Arab light crude went from US$2.30
per barrel to US$10 or more almost overnight. This marked the beginning of a 30-year
worldwide glut in refining capacity, which at its peak was about 30 percent. Capacity is
finally fairly well balanced now, and with demand growing much faster in Asia than in the
rest of the world, it is fairly obvious in which region new refining capacity will be built.

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In the early 1970s, Exxon was running crude in 20 refineries in Europe, most of them
fully owned by the company. The number has now been reduced to nine. This period
was a clear case of survival of the fittest, to quote Darwin. The survivors are either large,
complex refineries in strategic locations with easy access to large markets and often
with integrated chemical plants, or niche refineries with some protection with unique
product specifications (for example, Scandinavia).
Typical characteristics of European Exxon refineries that did not make it through the
hard times, and were sold or shut down and demolished are:
• Small hydro-skimming refineries with no or low heavy fuel oils (HFO) conversion
and high unit cost (i.e. Whitegate, Kalundborg)
• Those in unfavourable locations due to changing circumstances (i.e. VLCC port in
Milford Haven, Wales, UK)
• Refineries based on local crude reserves which have been depleted
(i.e. Bordeaux)
• Competitive pressure from more efficient refineries and product transportation
(i.e. product supplies from Rotterdam/Antwerp replaced production from four
German refineries)
East African experience
Between 2000 and 2003, I had the pleasure of serving as refinery manager for SAMREF
(Saudi-Aramco Mobil Refining Company) in Yanbu, Saudi Arabia. This is a large and
extremely efficient export refinery with 400 kilo barrels per day crude capacity, a wide
range of modern conversion units, and with YANPET, one of the world’s biggest basic
chemicals plants as a neighbour.
To export products from Yanbu to Singapore and the Asian markets, the tankers exit
the Red Sea and enter the Indian Ocean. Landing the products in Mombasa or other
East African ports is clearly less costly than paying freight all the way to Singapore. With
competitive pressure from SAMREF and other Saudi refineries, it is not surprising that

the small plants in East Africa have either been shut down or are limping along at reduced
capacity.
Location and high transportation costs can, however, provide protection for a new
plant. A few months ago, I was conducting a refining workshop in Uganda. This country
has discovered oil around Lake Albert, which is 1,200 kilometres from the nearest
seaport. Transportation of oil products from the Indian Ocean to Uganda is very costly
at about US$10 per barrel. A new crude oil pipeline to the Indian Ocean will be very
costly to construct, and if crude reserves and product demand are sufficient, there may
be a viable economic case for a local refinery which will be protected from competition
by its remote location.
Refinery profitability
Refining is different from most other manufacturing industries. A car manufacturer

buys thousands of parts to build each car, whilst a refinery buys one raw material, crude
oil, to produce a range of different products, each with a different market value.
This chart shows IEA statistical data for average spot product prices and crude costs
in Singapore for the period 1994-2005. There is very little price difference (spread)
between the two main clean products, premium gasoline and gas oil/diesel, but HFO
is consistently priced below crude. The implication is that for each barrel of HFO
produced, there is an economic loss for the refinery. That is even truer for the crude
fractions that are consumed by the refinery. Fuel and loss is typically 2-3 percent of
crude feed for simple hydro-skimming refineries and 5-7 percent for cracker refineries.
As crude prices have gone from about US$20 per barrel to currently costs of about
US$90-100 per barrel, energy costs for refineries have quadrupled, and are now clearly
the highest element in operating costs.
The driving force for any refinery is to upgrade the crude oil to more valuable products.
As prices change, spreads relative to crude and spreads between clean and dirty prod-
ucts are watched on a daily basis. This is more important for a refiner than fluctuations in
crude price.

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To better display relations to crude, this chart shows product price spreads relative
to crude on the x-axis. Note the sharp increase in clean to dirty spreads during the last
few years when crude prices started to go up significantly. In addition to ship bunkers,
HFO is mainly used as energy for heavy industries and power generation, where coal,
gas and other alternative energy sources are readily available. For transportation fuels
like gasoline, jet fuel, and diesel, there are few alternatives, and the price sensitivity in
most markets is fairly low. Increased demand for transportation fuels pull up the market
price for crude, and the clean to dirty price spread increases. This is even more so for the
last couple of years, which are outside this chart. By the last quarter of 2007, the price of
crude had doubled to almost US$100 per barrel, and clean to dirty spreads in Singapore
increased to US$30-40 per barrel.
The implications for refineries are that simple hydro-skimming plants that produce large
quantities of HFO have a difficult time, and all new refineries need to have a conversion
unit, be it hydro-cracker or cat-cracker. This is evident from the next chart.

Refinery margins, in US$ per barrel, are defined as the value of all the products
minus the cost of crude, and minus refinery fuel, loss and other operating costs. It is an
indicator for the profit or loss of the refinery. Product prices and yields vary from one
refinery to the other, but a number of sources report typical refinery margins for different
refinery complexity in the three key locations, the US Gulf Coast, Rotterdam, and
Singapore. This chart shows IEA data for a typical hydro-skimming and hydro-cracking
refinery based on Singapore pricing. Until 2004, both refinery configurations were barely
able to break even. With increased demand for clean products and refining capacity in
balance since 2004, a typical hydro-cracking refinery is profitable, but hydro-skimmers
continue to lose money in a market with high clean to dirty price spreads. One can safely
conclude from this chart that any new refinery will need to have HFO conversion. Bear in
mind that IEA shows typical data, and refineries with better product yields or lower costs
will have better economics.
New refinery investments
The main purpose of most refineries is to serve local requirements with different oil
products. Refinery product yields are set within boundaries provided by unit
configurations and available crude oils. Products surplus to local needs will require
higher transportation costs and thus reduce refinery profits. The regional refining
industry mirrors market requirements.
AVERAGE SIZE
REGION REFINERIES, # CRACK/DIST RATIO
(kilo barrels per day)
North America 176 120 44%
Europe 135 127 25%
Middle East 42 167 13%
Asia and Oceania 155 143 14%
WORLD TOTAL 681 125 24%
From 2005 IEA data
After the shut down of many small refineries, worldwide average distillation capacity
stands at 125 kilo barrels per day fairly evenly distributed by region. Cracking capacity
is highest in North America where gasoline demand is about 50 percent of the total, and
demand for HFO less than 5 percent.
New refinery projects cost billions of dollars, and planning, engineering, procurement
and construction can often take five to ten years. Investors need to take account of new
market trends to ensure that the plant has the best configuration. In most Organisation
for Economic Cooperation and Development (OECD) countries, diesel oil is now the
favoured transportation fuel. During the last two years, demand for diesel increased
by about 1 million barrels per day, or 12 percent, while gasoline demand was almost
constant. In the same period, demand for HFO fell by 10 percent mainly due to
competition from coal and natural gas, while interest in nuclear power generation has
been revived to combat climate change.

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For a new refinery to be competitive and profitable, the following criteria need to be
considered:
• High capacity – low unit cost
• Residue conversion/cracker
• Strategic location – relative to market and crude source
• Environmental standards – products and community
• Flexible to changing conditions
Understandably, many developing countries with oil resources want a local refinery
and other downstream industries. A local refinery can be protected from competition
in a number of different ways (e.g. legislation, customs, import/export restrictions, hidden
subsidies from upstream revenues, etc.). Most such measures are, however, short-lived.
To ensure a sustainable refinery operation in the long run, a new plant needs to be
competitive and profitable on free market terms.
Other downstream industries
Oil and gas consists of different hydrocarbon molecules, which are like Legos – extremely
flexible building blocks which can be changed and rearranged to parts in thousands
of different products we all use daily. Demand for basic chemicals like polyethylene
and polypropylene continues to grow, and new capacity will be needed. The business is
cyclical, but these are high value products where product transportation costs are less
important than having a feedstock with good yields and attractive prices. Traditionally,
these products have been produced by steam-cracking liquefied petroleum gases (LPG)
and light naphtha, and from unsaturated light products from refinery cat-crackers.
More recently, basic chemicals plants have been located where natural gas and gas
condensates are available at more attractive prices than refinery streams. New fertilizer
plants are also drawn to locations where attractive supplies of associated gas and gas
condensate are available as feedstock. There are still incentives for co-location with a
refinery, but available feedstock will often be decisive in a cost/benefit analysis of where
a new unit should be located. Many end up in the Middle East where chemical feedstock
often provides the highest value for large supplies of gas and condensate.
Costs/benefits considerations for chemical plants and other downstream industries are
in principle similar to refineries, and each proposal needs to be evaluated separately.
Summary and conclusion
The oil business is very much about money, and the revenue stream from all sectors of
the business is the main benefit for the companies and countries involved. Most of this
revenue flows to the upstream sector, but refining and other downstream industries can
add significant value. Crude oil needs to be converted to transportation fuels, kerosene,
heating oil, and a number of different chemical products to be put to practical use in
a modern society. Supply security, access to new technology, know-how, and markets
create competencies with spin-off to other sectors. Process industry is not labour
intensive, but provides many opportunities for the service-sector. Ratios of three service,
or spin-off, jobs for each refinery job are common.

The downstream sector is extremely competitive, and managing energy consumption

and other operating costs are never-ending challenges for every refinery. The capital
costs and comparative advantage or disadvantage of location and refinery configuration,
which are built into the investment decision, are also very important for profitable and
sustainable operation in a very competitive business environment. Emissions to air
and water, and risk of oil spills or fires and explosions are also very important and have
to be managed accordingly.
Any new entry needs to have a thorough understanding of refining technology and
how a new plant will fit into the regional business environment. The main competitors
must be defined and analysed. With a professional approach and attitude, there are many
benefits to be gained from a successful project.

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Maximising national content/local content
Willy H. Olsen
Advisor, INTSOK-Norwegian Oil and Gas Partners
Introduction
Issues surrounding the development of a national industrial base in the hydrocarbon

sector are often described as national content or local content. The petroleum sector
may provide government with several linkages to achieve poverty reduction:
• Fiscal linkages
• Forward linkages, using the energy for domestic purposes
• Backward linkages, using the resources to develop an industrial base and national
content
• Community linkages with impact on local communities
The objective of local content programmes
Many petroleum-rich countries would like to make the oil and gas industry an
economic engine for job creation and growth. The ambition is to increase national
content by developing in-country capacity and indigenous capabilities to capture
more work in the oil and gas sector.
There is no simple answer to how a policy to enhance industrial development with a

basis in petroleum activities ought to be outlined. A prerequisite is to ensure than
decision makers at all levels share the goal of pursuing a policy that will contribute to
national wealth through industrial growth. Policy makers should be aware of the
trade-offs and the pitfalls that may be entailed in developing a policy to enhance
local content. A government agency should be authorised and allocated sufficient
resources to monitor and assist efforts to increase the participation of local industry
on a competitive, non-corrupt, basis. Governments should not instruct, but they
should challenge the oil companies to come forward with schemes they can commit
themselves to implement, and to be measured against.
The stakeholders have to include the government, the private sector, oil companies
and, not least, the education sector since education is a fundamental success criterion
for local content development. Access to skilled labour is critical for the implementation
of local content.

The main obstacles to development of national content can be summarised as:

• Lack of domestic manufacturing, fabrication and service capabilities to support
the oil and gas sector
• Lack of adequate power, water and other infrastructure to support an expanded
manufacturing base
• Cumbersome bureaucratic obstacles to the development of small- and medium-
sized enterprises
• Underdeveloped capital markets
The result is that a substantial proportion of the equipment and expertise must be
imported.
The energy sector is highly capital intensive, but does not create that many jobs, and
many developing countries do not have the resources, human or financial, to develop
a productive energy sector. For example, only 5 percent of contracts for goods and
services in the energy sector go to African companies. The majority of the projects,
from infrastructure to exploration, go to foreign companies.10
Norway, the UK and Malaysia were among the new petroleum producers in the 1970s.
All three countries developed local content policies.
An important policy objective for the Norwegian government was to lay the basis
for developing a competent and viable petroleum-related industry. Transfer of
expertise from abroad and the build-up of domestic operations were important
elements in the early Norwegian petroleum policy. The country now has a competitive
petroleum industry, embracing a large number of suppliers and operations covering
most stages of the value chain from exploration via development, to production and
decommissioning.
Norway started with a strong industrial base, a globally competitive shipping industry,
shipyards and marine expertise. A strong processing industry developed based on
electricity from the many waterfalls around the country, and a well educated population.
None of the developing petroleum producing countries has the same basis for
implementing their policies.
The Norwegian policy was based in its Petroleum Law. The Petroleum Ministry
monitored the oil companies’ procurement strategies and ensured that local
companies were provided with an opportunity to compete for work in the oil and
gas sector. The national oil company (NOC), Statoil, had a significant role in implementing
the policies and growing domestic capacity.
10
www.unctad.org Energy finance – building local capacity

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The focus on local content diminished in the late 1980s and continued to do so through
the 1990s. The main reasons were the industry’s ability to compete globally, the growth
in globalisation and international trade agreements, and lower oil prices.
Norway and the UK also had to drop their local content requirements as a response
to European Union procurement regulations. The lower price of oil forced governments
and oil companies to focus on reducing costs to ensure that the petroleum sector
could remain commercially viable.
The rapid increase in the price of oil over the last five years has resulted in a renewed
focus on the development of local/national content. Many hydrocarbon-rich countries
have neither been able to use their resource base for economic growth nor to diversify
their economies. They have had to adapt local content policies as a way of creating
jobs and adding value to petroleum sector activities.
Some have developed legislation and regulations, while others have set up guidelines
for the oil companies. Production sharing contracts/agreements have always had
general rules on providing local firms opportunities as long as they are competitive in
price, quality and deliveries, but many contracts are now setting clearer targets for the
growth of local employment and local suppliers.
Their challenge is a narrow industrial base where the manufacturing sector accounts
for a small share of a countries’ national product, and only a small fraction of its exports.
The technology level is weak or often non-existent. The local firms’ ability to meet the
stringent health, safety and quality standards required by the oil companies are weak.
Linkages in the economy
Governments need to clarify the sector’s objectives beyond local/national content.

For almost all petroleum-producing governments, the key objective is to maximise fiscal
linkages in order to fund central government activities. How much of the revenue
generated by the oil sector should be reinvested to expand the capacity to produce
more oil and generate/earn more revenue? For the government, this may translate
into defining a clear, long-term fiscal rule to appropriate revenues to be used for non-oil
purposes.
Governments may also have to set broad targets for expanding supply capacity, the
general role and long-term fiscal contribution of the private sector, domestic energy-
pricing principles, and the share of production allocated to domestic energy markets.
The policies cannot be identical since the situation will differ from country to country
and the policies will have to reflect the differing circumstances.
Some governments are looking at developing local refining capacity, while others are
engaged in lively debates over gas reserves. Should gas be exported or used domestically
to fuel industrial development? Petroleum-rich countries tend to have different policy
objectives, but a common feature is the focus on national interest, often to reduce the
risks of revenue decline to government.

Forward linkages are a function of downstream operational efficiency, the pricing

policies for domestic oil and gas products, and the optimised use of gas reserves.
Government policy should encourage greater competition in the downstream sector,
which by definition requires greater private sector involvement. Private sector
involvement downstream tends to be much less politically sensitive than in the
upstream sector since the financial contributions from downstream are far smaller
compared to the windfalls from upstream. But we have seen in countries like Nigeria
that privatisation of inefficient refineries can become extremely controversial.
A major issue in many petroleum-producing countries is the pricing of domestic oil

products. Subsidy levels often remain high. Low domestic prices, even where costs are
being covered, can lead to excessive domestic consumption and the likelihood of high
levels of smuggling.
The presence of gas reserves tends to create a debate over whether to use them for
domestic or export purposes, which again reflects a lack of strategic vision for the sector.
Backward linkages involve the employment of nationals, the development of local

content, and the nature of the NOC’s national mission. The petroleum sector is seen as
a major national employer. This obligation in a capital-intensive sector can lead to
substantial inefficiencies.
Local content requirements have been popular as a way to improve industrial capacity.
It has been anticipated that when foreign investors purchase a certain percentage of
their inputs from local firms, they will transfer knowledge and technology to their
suppliers in order to improve the quality and reduce the costs, but governments often
forget that it is a major challenge for local firms to reach the standards and the quality
required by the oil companies. The oil companies should be challenged to assist in
education and training policies to improve the pool of skilled labour from which the
oil sector can draw and to assist in developing the standards required in the upstream
sector.
Experience from countries that have implemented obligations to increase local content
in petroleum sector procurement, suggests that decisions about local content are best
left to the discretion of the NOC rather than to regulatory enforcement. Regulations
are important, but we have seen examples where regulatory enforcement is counterpro-
ductive because it encourages mechanisms to circumvent the regulations, or it leads to
more corruption.
The definition of national content
The policy must provide clear definitions outlining methods to identify and quantify
local content to ensure that only those activities that add value and increase
capabilities are included. Employment as well as direct and indirect value added should
be considered separately. Employment should be distinguished from sourcing of goods
and services from local vendors. Local labour and sources of inputs for those local
vendors should be identified as well.

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Nigeria, one of the countries that in recent years has tried to implement a local
content policy, has been engaged in an extensive debate since 2001 on how to define
local content and concluded with the following definition:
Nigerian content means the quantum of composite value added or created in the
Nigerian economy by a systematic development of capacity and capabilities through
the deliberate utilization of Nigerian human and material resources and services in
the Nigerian petroleum industry. Such goods and services must be within acceptable
quality, health, safety and environmental standards in order to stimulate the
development of indigenous capabilities.
The emphasis is on value-added in the country, job creation, investments in local

facilities, and stimulating indigenous capabilities, but de-emphasizing ownership,
indigenisation and protectionism. The focus in the definition on acceptable quality,
health, safety and environmental standards is of fundamental importance to the
international oil and gas industry.
National content will be measured by aggregating the value of the contracts given to
locally based companies and then stripping out the costs of imports during the
execution of the contract.
The definition of national content should not contradict the World Trade Organisation’s
(WTO) Agreement on Trade-Related Investment Measures, where members agree
not to enforce policies that require the purchase or use by an enterprise of products
of domestic origin or from any domestic source, whether specified in terms of particular
products, in terms of volume or value of products, or in terms of a proportion of volume
or value of its local production.
The Nigerian definition is to a large degree in line with similar definitions in other
countries that have implemented local content policies over the last 30 years – countries
like Brazil, Malaysia, Norway, and the UK – where the focus has been on value-adding
and value creation, rather then indigenous ownership.
President Lula in Brazil initiated a new local content drive in 2003 launching a national
industry mobilisation programme (PROMINP) to strengthen the competitiveness of
locally based companies, increase local employment and wealth. The programme is
addressing the issues systematically, casting its net widely, and also looking at the
framework for investors.
The petroleum sector has never been the major engine of growth in Malaysia, but
the NOC, Petronas, has been a driving force in the establishment and development
of an industrial cluster with petrochemicals at its core on the east coast, a previously
underdeveloped region. Petronas is now a formidable player in the Malaysian economy.
The production sharing contracts (PSCs) in Malaysia have targets for training people
and developing local content. The Malaysian PSCs required international oil companies
(IOCs) to procure equipment, facilities, goods, materials and services locally unless

approval is given by Petronas to source internationally. Oil companies have also been
required to employ suitable Malaysian personnel and needed approval by Petronas
to employ expatriates. In the mid 1990s, the local content figure was around 70 percent.
The move towards deeper water, and the globalization trend, has in recent years led
to more platforms and equipment being fabricated abroad.
At times, the Norwegian share was above 70 percent, calculated as value added in
manpower and monetary values. Ownership of the company was of less interest, what
mattered was where the work was carried out. Domesticating engineering and design
work has been an important strategy in Norway and paved the way for project design
that enabled even smaller Norwegian companies to be involved in large and complex
technological projects.
We have seen from experience in successful companies, that local content regulations
can and will bring foreign investors into the country to invest and set up their own
activities. Oil companies get their traditional suppliers to invest in local capacity to
serve the operators. Local content regulations have been less efficient in developing
the indigenous supplier base.
The potential barriers
The oil industry is a global industry. It consists of a few major oil companies, a growing
group of smaller independents that are expanding into international markets from
their home bases, and a growing number of NOCs that are also becoming international
players. The largest companies are present in more than 100 countries, ExxonMobil in
almost 200.
Oil companies will try to meet the aspirations and objectives of national content policies,
but the traditional view of the oil companies is that they will add most value to society
when they concentrate on delivering the most cost-efficient operations, finding the
technological solutions that yield the highest returns, and when they continuously
improve their performance. The oil companies emphasise that local content will have to
make business sense.
The responsibility of oil companies should be directed to implementing business

strategies that will contribute to industrial development on a competitive basis. Oil
companies have access to a large number of potential activities that could be used to
strengthen the domestic industrial base:
• Designing contracts and specifications to fit the structure of local businesses

• Technology transfer programmes, from training local staff to research and
development cooperation with domestic companies and universities
• Encouraging joint bidding by local and foreign firms
• Supplier development programmes
• Financial agreements for local companies to compensate for an inferior domestic
financial system
• Training and assisting local companies to meet demands for certification

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Oil companies should develop their national content plans as an integral part of
their development projects. They should sit down with governments and local
authorities to identify opportunities and challenges, evaluate the risks and try to find a
mutual understanding of the way forward. It is important to get all stakeholders aligned.
The global oil industry has streamlined its supply chain to improve efficiencies and
reduce costs. Oil companies have rationalised their supplier base and often enter into
long-term contracts and closer relations with a selected group of companies from a base
of qualified suppliers.
Contracts between oil companies and their suppliers frequently involve a chain of
subcontractors, organised around the flow of materials from source of supply to finished
products, after-sales services and often also recycling. The supply chain may also involve
transport, communications, finance and other specialised support functions.
Suppliers must either be able to offer full service engineering, procurement and
construction (EPC) contracts, or specialise in niche segments. Companies that want to
supply the oil companies must meet stringent health, safety and environment (HSE),
and quality assurance standards, often beyond the capacity of small indigenous compa-
nies around the world.
The streamlined supply chain can be a substantial hurdle for local suppliers trying to
promote their goods and services. The supply chain approach taken by the major oil
companies and their contractors is however the most efficient, and it is the best
practice industry standard today.
Most oil companies accept that local content is a driver they will have to use, even
if it entails a reasonable extra cost, but they will strongly underline that the project has
to make financial and business sense. We have seen in recent years a few examples of
how international oil companies are trying to adapt to local requirements.
BP’s Cannonball platform project in Trinidad and Tobago is a recent example of how
oil companies are making steps towards building an offshore platform locally. The
fabrication was done locally for the first time. Local content for the whole project is
still under 40 percent. Constructing Cannonball with significant local content did entail
a cost premium – BP’s estimate is some US$10 million more than to import the same
platform from a foreign construction yard. The hope is to reduce this premium in years
to come through the construction of other platforms.
Sometimes local firms do not have the required capabilities. Projects in water depths
of more than 1,000 metres in West Africa require the most advanced technological
solutions. The oil companies will source the projects from the world’s leading contractors.
Sonangol, the national oil company of Angola, has had a clear strategy for several years
to increase local contributions, step-by-step, and, together with international firms, has
invested in supply bases and fabrication facilities to build up local capacity.

The growing role of the contractors
A high proportion of capital and operations expenditures in an oil and gas project are
managed by a handful of lead engineering service contractors. The service companies
and suppliers may account for 80-90 percent of the cost of producing a barrel of oil.
The lead contractors in countries like Nigeria and Timor-Leste may have to include a
National Content Development Plan as part of their bid for a contract. The plan will be
one of the key indices for technical qualification of the bidder and the approved plan
will be an integral part of the contract.
International contractors and suppliers are now adjusting their strategies to meet
the oil companies’ requirements. One example is FMC Technologies, which has been
awarded the contract for subsea installations on the Agbami project in Nigeria. FMC
has built its own facilities in the country and will transfer substantial engineering
work as well as fabrication and logistics to its new facilities. In addition, FMC will initiate
technical training for local engineers.
The oil companies are the responsible operators, but the contractors and the service
providers will often undertake local content implementation. They are the companies
on the ground and in day-to-day contact with the majority of employees, suppliers
and subcontractors. They often represent an underutilised resource for enhancing
the positive local economic impact of upstream oil and gas projects.
In many developing oil-producing countries, the local supply and service industries
are fragmented with limited competence and ability to match the strength of the
foreign companies. Many of the indigenous companies are young and small in size
with the average manpower level being less than fifty. They have no access to cutting
edge technology or information on job opportunities. The indigenous companies
lack to a large extent insights into opportunities and oil operators’ requirements. Many
of the smaller firms also lack the resources to carry out meaningful liaison activity
with the operators. Expanding relations with international suppliers and contractors
should also benefit indigenous companies.
Pay attention to pitfalls and trade-offs
There are several caveats to be aware of when pursuing a policy of enhancing local
content. In order to generate wealth, local content should be promoted on a
competitive basis, and not primarily on protective measures.
There may be a case for government intervention in order to lower local industries’
barriers to entry. Closely knit international supply chains combined with widespread
use of framework contracts, long-term service contracts and centralised procurement
may constitute a formidable barrier to entry for local suppliers. When such contracts
are anti-competitive, there is a case for regulations limiting the scope and duration
of the contracts and providing an opening for more competitive practices.

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Business may also face local barriers to entry, which effectively prevent the
enhancement of local content. Such locally generated barriers are lack of, or poor,
infrastructure, inefficient business licensing procedures, slow and inefficient pre-
qualification and certification procedures, skills shortages, strict regulations on labour
migration, and lack of access to credit.
These are shortcomings that increase local companies’ costs enormously, and these
are areas where government clearly has a role to play. Focusing on providing and
maintaining the necessary infrastructure, improving education and health services,
and having a transparent regulatory framework would help to make the local supply
industry more competitive.
Protection of local companies is no assurance of industrial success. In fact, there are

several pitfalls to be aware of.11 The only reason to accept higher costs from an
economic point of view is to consider it as an investment that will pay off with time,
but having money to play with tends to weaken prudence and normal procedures of
due diligence.
If it is possible to acquire industrial capabilities that will generate future value, higher
costs at present may be justified. If not, the supply industry will eat from the oil wealth
instead of adding value to it. It is important to remember that it is often more popular
in a local business community – and among local politicians – to have protection
introduced than to have it abolished.
There is also a risk that local suppliers will crowd out other, more viable industries in
other sectors that have a larger potential for employment creation than the upstream
petroleum industry. Thus, it is important to pay due regard to cost efficiency, even
in a context where local content is in focus.
The experience from local content requirements in the upstream petroleum sector
as well as other industries indicates that developing a local supply chain may be
successful if combined with exposing the local suppliers to the discipline of market
competition after a relatively short period of protection.
Lack of competition, insufficient competence and/or weak regulations, on the other

hand, have led to high costs, brought environmental damage, and sub-standard
technology. If the minimum level of local content is beyond the actual capacity of
the local industry, waivers will be necessary. This may easily create a situation of
bureaucratic delays in operations as applications for exemptions are being processed.
It may also prepare the ground for increased corruption aiming at avoiding such delays.
The lesson to be drawn from this pool of pitfalls is that local content does not
necessarily have to benefit industrial growth or national wealth. It will only benefit
society if industrial development is competitive by international standards, which
11
The SNF report of 2003 on enhancing the capacity in the Nigerian oil and gas sector has an extensive discussion on the
pitfalls and the trade-offs

means that the participating companies will have to pass the test of the market after
temporary protection. If not, requirements of local content will most likely only
benefit some individuals at the expense of society. This will most likely be the case
if protection should become permanent.
The multiplier impacts from petroleum sector activity
Expenditure on procurement can act as a multiplier for local economic development,

contributing to employment, skills strengthening, supplier and local enterprise
development. Some countries have done research to assess the multiplier effects of
investments in the petroleum sector, but most assessments are based on anecdotal
evidence.
In the case of the construction of the export pipeline for Caspian oil from Baku via
Tbilisi in Georgia to Ceyhan in Turkey, the multiplier effect may be worth more than
US$1 billion over the life of the project.
Another example is the Chad-Cameroon project where some 2,000 companies were
involved in the large construction project. Most of them had never before been
engaged in an oil or gas project.12
Norway is one of the countries where researchers have evaluated the multiplier
effects from oil and gas investments, but it is important to remember that the
activity level in Norway is substantial, the level of education is high and the industry
is technologically very advanced.
• Norway is producing more than 4 million barrels of oil and gas equivalents.
• The investment level in the oil and gas sector has recently been around
US$12-14 billion annually.
• Oil and gas represent around 50 percent of total export revenues.
• Oil and gas represent some 25 percent of GDP and the sector is the largest investor
in the economy.
• Local content in the project phase is around 50 percent, substantially higher in
the market for modification, maintenance and operations where local content
is above 80 percent.
• Some 85,000 people are directly employed in the oil and gas sector. Half of the
employment is in the contractor and supplier sector.
• Activities in the petroleum sector do employ some 150,000-200,000 people
indirectly. The impact of activities in the petroleum sector has resulted in rapid
expansion of the service sector, transport, hotels, restaurants, shopping centres
and in the public service sector. In addition, the oil industry is a major user of
advanced information technology solutions. There is strong linkage between
the ITC sector and the oil sector.
12
Caspian Development Web site

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• Significant investments in research and development have strengthened the

universities and the research and development sector. The large yards along
the coastline have a cluster of companies delivering a large number of products
and services.
The oil companies are required by the government to deliver a major economic
impact assessment as part of all proposals for new field development as well as an
environmental impact assessment. The assessments have to address the technologies
that will be used in the project, the potential suppliers in Norway and internationally,
the direct employment impact in the local communities influenced by the develop-
ment, as well as the indirect impact locally and nationally. The companies will make an
estimate of how much of the goods and services can be acquired in the local
communities, nationally and internationally. The impact assessments are transparent
and made available to all stakeholders.
The companies are using a multiplier effect of 2-2.5 in their economic impact
assessments required for all projects before approval by the government or parliament.
The Norwegian Bureau of Statistics has, however, seen a multiplier effect as high as
3 in some cases.
It is important to emphasise that many companies in the non-oil sector are struggling
as a result of activities in the petroleum sector. The oil sector, where salary levels are
higher than in most other industries, often attracts the best candidates from
universities. The petroleum sector influences the value of the Norwegian currency
and can hamper the competitiveness of the non-oil sector in international markets.
A sniff of the Dutch disease is not unusual.
Policy options and instruments
Many oil-producing countries have, over the years, tried to strengthen the role of
local companies in the oil and gas sector, but have struggled to succeed. One example
is Nigeria where policy measures have been in place, which legally should have
made it possible to increase manufacturing value addition in the country in general,
as well as in the oil industry, but they have had very limited effects. The volatility of
the oil and gas sector has not helped either.
The new Nigerian Content Strategy is based on a number of specific guidelines that
will expand the engineering, fabrication and manufacturing capacity in the country.
In addition, the production sharing contracts have strengthened the requirements
for training and value creation in Nigeria. The guidelines are developed in dialogue
with the oil industry, but the Nigerian National Petroleum Corporation (NNPC) makes
the final decisions.

A Nigerian Content Consultative Forum with representation from the oil and gas
industry, the organised private sector, bankers and the Nigerian Society of Engineers
is discussing the strategy and plans for increasing local involvement. The Forum
holds monthly working sessions, and eight working committees for the different
segments of the industry have been appointed.13
One of the major challenges for local suppliers is access to finance. Many smaller
domestic companies have little experience dealing with financial institutions. They
have no, or a limited, track record with a lender and they will often have to pay high
interest rates on their loans, undermining further their competitiveness. In addition,
the local banking and insurance sector lacks liquidity or capacity to fund major
projects, underwrite industry risks and support local participation.
Nigeria saw financing as one of the main obstacles to forming local content and
established a National Content Support Fund (NCSF) to support local companies.
The fund is intended to provide local companies with a lifeline to grow and compete
for work in the industry, generate employment and GDP growth.
NNPC initiated a major programme of mapping the gaps that need to be filled to
meet the local content ambitions by collating historic data and five-year projections
for new industry projects and operations. The local suppliers, manufacturers and
service providers have responded to an extensive questionnaire. 14 The analysis
recommended 24 capacity building projects to bridge the existing gaps identified.
Thousands of new engineers and welders were required and one of the priorities to
enable growth of local content was human resource development.
A major joint Norwegian-Nigerian study was initiated in 2002 to “assess the enabling
environment for private sector development in the Nigerian upstream petroleum
industry and recommend ways of increasing and improving the capabilities of Nigerian
supply and services companies”.15 The result of the study is a programme to strengthen
the capacity of Nigerian fabricators to work in the oil sector. A joint training
programme aims to strengthen the fabricators’ management processes and quality
assurance systems. Lessons from several countries indicate that the main problem for
the local firms is their weak management processes and systems, which will make them
unacceptable for work in the oil sector.
Perception surveys by independent organisations like Transparency International

suggests that high levels of corruption exist in the oil industry, and the risks are often
seen in supplier selection and contract administration across the supply chain for
large- and small-scale contracts, in recruitment and in other administrative processes.
Most international oil companies and international contractors have sharpened their
codes of conduct in recent years and set out the rules in greater detail. An independent
13
The information on the guidelines has been provided by NNPC’s Nigerian Content Division.
14
The analysis was presented by NNPC in Abuja, April 2006
15
The study was commissioned by the Norwegian Agency for Development Cooperation and the Norwegian Ministry for Petroleum
and Energy under the custody of four oil industry related Nigerian Government organisations; The Office of the Advisor to the
President on Petroleum and Energy, DPR, NNPC and its subsidiary, NAPIMS. INTSOK was engaged to organise the study.

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and transparent system to pre-qualify companies and ensure arms-length relations

with the ministries, the national oil companies and the regulators, could reduce the risk
of corruption. The independent qualification system is increasingly used globally to
streamline pre-qualification and make the contracting process transparent. Besides
forming a database of eligible contractors for the oil companies to choose from, such
a register would also facilitate the efforts of foreign companies to find a local partner.
It can be a basis for enhancing local content on a competitive basis as well as to promote
the industrial linkages that are crucial to achieving industrial growth.
Realistic expectations from national content policies
Targets for domestic content must be set at realistically achievable levels. If the targets
are too high, waivers will be sought, thereby undermining their very purpose.
Absent waivers, excessively high targets will encourage corruption in the form of
shell companies and hidden accounting to exaggerate local content. A target set to
guarantee business for all local vendors will not lead to quality and capacity
improvements. Such a guarantee may enrich certain vendors while the policy is in
place, but will not benefit the workers or the economy as a whole.
Nigeria set targets of 45 percent local content in 2006 and 70 percent in 2007.
Obtaining them would require a more rapid industrialization and steeper learning
curve than seen anywhere in the world to date. No oil-producing country has been
able to sustain a local content level of 70 percent. That level could create substantial
problems in the local economy in periods of less investment, either due to lower oil
prices or lack of new commercially viable discoveries. It will just increase dependency
on the petroleum sector and undermine the non-oil sector.
The market for maintenance, modification and operation (MMO) tends to be

underestimated. The contracts are smaller and less visible. They seldom reach the
front pages of the newspapers and the political agenda in the same way as the large
development projects. Experience from most oil- and gas-producing countries shows
that local companies‘ share of the MMO market is significant and far higher than the
project markets. The MMO market is sustainable long-term – often lasting for 15-30
years, whilst the projects are short-term, 3-5 years. Local companies are close to the
management of the facilities and can train and develop their people and organisations
to handle the MMO work, ensuring a gradual development of the national petroleum
industry.
Concluding remarks
Oil-producing countries with a long-term perspective need a strategy to develop the

local supply industry through programmes aimed at narrowing the technology gap
between domestic and foreign companies, and seeking assistance from the oil
companies and leading contractors to implement the programme. Strengthening the
technological level could also be fundamental for linkages to the non-oil sector.

The most important factor for enhancing local content is to remove and reduce
barriers for locally based companies and to attract foreign investment. That will
require policies that will stimulate the general business climate in the country.
Commitment to transparency in national content policies is fundamental. Disclosing

benefits and costs of local content policies is important to avoid corruption.
It is also important to remember that it is not costless to implement local content

initiatives since badly enforced local content policy can impede economic growth
and consume wealth rather than create value. To harvest the benefits of local
content, countries have to create an industrial and political environment to enhance
industrial competence development that is competitive by international standards
and avoids the risk of permanent protection, corruption and red tape.
Maximising the benefits of local content is not the same as simply maximising local
content.

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International experience
in turning black gold into human gold
Michael Hopkins
Managing Director, MHC International Ltd.
Introduction
A salutary lesson comes from Spain16 when it was a single resource economy. At the
end of the 15th century, Spain had become the main power in the world once it had
defeated the Mores in Andalusia, discovered America and contributed to the collapse
of several great Mesoamerican and South-American civilizations. It began to exploit
gold and silver mines in South America. As a result, the quantity of precious metals
in Spain was multiplied by eight within less than a century. Obviously, this had many
macroeconomic effects, such as an increase in domestic prices as a result of the
higher demand for goods and services and the rise in imports as a consequence of
the decline of competitiveness of Spanish products linked to the rise in domestic
prices. Because the Spanish were buying all their products outside Spain, the Spanish
real economy declined and this decline reinforced the will of the people to buy
foreign goods. This vicious circle was fuelled by the continuous influx of gold and
silver from the Americas. Slowly but surely, the real economy was being destroyed
and conflicts for the share of the metallic rent appeared. Spain was no longer a united
and powerful empire. At the end of the 18th century, Spain had totally collapsed.
Spain was the richest and most powerful nation at that time. It was therefore very
confident in its future, but could not prevent itself from dramatically collapsing. The
real problem with positive shocks on natural resources is not the macroeconomic
effects, but the progressive disappearance of the real economy, in other words, the
progressive destruction of the production capacities of the nation. When the positive
shock is no longer beneficial, this destruction really appears, but it is too late. What
is important is that a rent economy (an economy which fortunately obtains wealth) is
not a long-term solution, contrary to an entrepreneurial economy (in which innovation
and effort create wealth).
What is meant by black gold to human gold?
The phrase “converting black gold to human gold” was coined by the author during
his work with UNDP Azerbaijan to develop that country’s oil sector. UNDP Azerbaijan
took this phrase as their flagship emphasis for nearly a decade. Not only a slogan,
UNDP made significant progress in convincing Azerbaijani policy makers and the
president to launch a number of programmes and policies to promote human gold.17
16
I am grateful to Remi Jedjab for pointing this out to me when we worked on Azerbaijan together
17
See the author’s full report on http://www.mhcinternational.com/corporate-social-responsibility/id/international-development.html

Clearly, oil (black gold) can have both positive and negative effects. The former provides
a government with a savings surplus, but may also, if policy is not imaginative, raise
the exchange rate and/or costs in the non-oil sector where up to 97 percent of the
labour force is employed.18 This means that low skill products will not be internationally
competitive and, consequently, unemployment and under-employment in the non-oil
sector will result.
It is difficult to promote employment in the non-oil private sector for a whole host of
institutional and economic reasons. One of the main fears is that price levels will rise
(the so-called Dutch disease). Consequently, the promotion of low-tech small- and
medium-scale businesses, where normally in a growing economy most new employment
is created, is a risky strategy.
A key solution to this problem is to train oil-rich countries’ (ORC) nationals in new,
and advanced, skills (human gold). A massive injection of resources into human skills
development would, therefore, help to move the non-oil sector up towards
internationally competitive standards. Care, of course, has to be taken that use of oil
funds for this purpose is not brought onshore too rapidly and therefore lead to
exchange rate over-valuation. Consequently, oil receipts must be used for investment
projects, as far as possible, with a large overseas component.
The international experience
Here 44 single resource exporting economies are examined and it is found that,
while there are many single resource countries that have mismanaged their economies,
some countries have done well. Overall, single resource exporting countries have a
very mixed record of success and failure. In addition, the paper examines five countries
in more depth as a way of pinpointing useful lessons that might be of relevance for
policy makers in similar situations. The five countries are Norway and Chile (success),
Trinidad and Tobago (promising), Nigeria (unsuccessful) and Kazakhstan (challenged). The
examination of these five counties shows that good governance and transparency, along
with sound macroeconomic management, are clear keys to success.
There has already been considerable discussion among national policy makers about
how best to use oil revenues. Policy makers have likewise become familiar with the
terms, oil curse and Dutch disease to describe what has happened to the many single
resource economies (largely oil- and gas-based economies) that have mismanaged
their economies, and experienced negative growth along with worsening poverty
and greater income inequality.
18
Due to the capital intensive nature of oil and gas exploration and production

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On the other hand, some single resource countries have managed their resource
revenues well and significantly expanded their economies, promoted non-single
resource sectors, and lowered poverty and income inequality. Yet many, if not most,
such countries have found that oil and gas wealth does not necessarily mean full
employment. The Gulf States have shown how difficult this has been and have offered
the solution of public employment. With larger populations, the hyper-rich Gulf model
is not an option. It is imperative, therefore, that such countries develop their non-oil
economy where most of their population lives and works. The oil and gas sector, and
related industries, are largely capital intensive and therefore not great providers of
employment.
Thus there are a number of key concerns for ORCs. The main ones are:
• Exchange rate appreciation and price inflation (Dutch disease)
• Unbalanced economic growth and increasing unemployment
• Social and equity problems
• Peak oil
• Corporate social responsibility (CSR) and public-private partnerships
• Blessing or curse: danger signs to look out for
Exchange rate appreciation (Dutch disease)
The price effects of oil and gas surplus exporting economies are significant. If there
is a large balance of trade surplus, with exports very much larger than imports,
something that characterises many such countries, then a number of effects occur.
First, the exchange rate starts to rise because foreign investors prefer to hold the
currencies of surplus trade economies since they are backed up with a surplus of
foreign exchange in the domestic banking system. When demand increases for a
currency, then its price (i.e. exchange rate) starts to rise. Second, imports become
relatively cheaper and start to crowd out domestically produced traded goods that
become relatively more expensive. Third, the non-oil economy starts to decline as
domestic production falls having a negative impact on employment.
This model is known as the Dutch disease following the experience in the
Netherlands over 1959-1975. In 1959, a large reservoir of natural gas was discovered.
By 1976, gas revenues amounted to US$5.5 billion. The state received the bulk of the
oil revenues and proceeded to spend most on its welfare system, leading to a strong
Guilder (the Dutch currency at that time) and inflation. Quickly, the manufacturing
sector became unable to compete with foreign products. It declined sharply, with
employment in manufacturing decreasing by 16 percent. The government had to
borrow money to save jobs and maintain its welfare commitments, and by 1982 its
budget deficit was 7 percent of gross domestic product (GDP).
These negative effects can be avoided through judicious economic management

that focuses on diversifying the economy and massive investment in human capital
coupled with a certain amount of capital sterilisation in an oil fund offshore. Unfortunately,
most emerging economies experiencing major windfall gains have too weak a system
of economic management to handle the negative effects and oil and gas becomes
more of a curse than a blessing.

Unbalanced economic growth
Public expenditure rises rapidly as large revenues from taxation on oil and gas
production enter public coffers. These expenditures are often spent on prestige
construction projects. In many such countries, the construction lobby increases with
its increased wealth leading to even more construction. In some cases, notably in the
Gulf States, the construction boom leads to increased use of unskilled imported
labour since the local labour force is sheltered by a now rich government and prefers
not to work in unsavoury conditions. The country then inherits a growing foreign
labour force that, eventually, starts to crowd the indigenous population out of skilled
jobs.
Another effect of trade surplus and exchange rate appreciation is the increase in
imports since they are cheaper than domestically produced goods. The Corden model19
of traded and non-traded goods shows a decline in the domestic traded goods
sector leading to a reduction in employment possibilities. First the domestic traded
goods sectors become uneconomic as prices rise, and then these price rises feed into
the non-traded goods sectors since they need traded goods to survive and so a knock-
on effect occurs. Unemployment starts to rise as rising wages make imports more
and more important and domestic demand starts to fall.
Of course, the oil and gas sector rises in terms of GDP very quickly. However, because
this sector is highly capital intensive, needing little unskilled labour, and few, but
highly qualified labour, it can only directly employ 3-4 percent of the labour force.
Consequently, economies tend to move in an unbalanced manner with output in the

country dominated by two sectors – oil and gas, and construction – while other sectors
suffer.
Social and equity problems
Many of the countries in the South face social problems such as high un- and under-
employment, low life expectancy because of disease, low wages and incomes, poverty,
low school enrolment rates, poor and inappropriate skills training and poor governance.
Increasing revenues from oil and gas can help to address the resource issues and, in some
cases, resolve them completely if properly managed.
19
Why does a dramatic increase in wealth have this paradoxically negative consequence? The economic understanding of this
dilemma was first discussed in 1982 by two economists, W.M. Corden and J. Peter Neary (J Peter Neary and W Max Corden, 1982,
Booming Sector and De-industrialisation in a Small Open Economy, Economic Journal, 92). These economists analyzed the problem
by dividing an economy experiencing an export boom into three sectors: the booming export sector (from oil or minerals), the
lagging export sector (both two traded goods sectors) and the non-traded goods sector, which essentially supplies domestic
residents and typically includes retail trade, services, and construction. Cordon and Neary argued that when a country catches
“Dutch disease”, the traditional export sector, such as agriculture or manufacturing, gets crowded out by the other two sectors. Since
Cordon and Neary’s original research, the failures of resource-led growth have been investigated extensively in economic literature.
One of the most comprehensive empirical studies was done by Jeffery Sachs and Andrew Warner, 1997, Natural Resource Abundance
and Economic Growth, National Bureau of Economic Research, Working Paper 5398.

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However, the international record has been poor. One of the main problems is
management, both because countries do not have the skills in managing large
inflows of public revenue and because of corruption. There is no easy answer to either
dilemma. Skilled management with unbiased allocation of monies is difficult for
public managers raised on low salaries and poor morale. Salary and efficiency raises
are key, but mean less public employment not more. When the private sector is
struggling to increase production in the face of growing competitive imports leading to
lower unemployment, reducing public sector employment is normally avoided. So yet
another oil trap is formed.
Closely related to poor public management is corruption. It starts in innocuous ways.

For example, a construction firm that receives a big building contract will become
wealthy and powerful very quickly. In the next tender for business, a few well
chosen words in the right place will lead to yet another contract and so on. The problem
is that the contractor now does not have to ensure good quality since the overseer
has been paid off. The project is finished, another is started and so on. One does not
have to look far in developing countries (nor in richer ones) to see the results of this
process as new highways become potholed and cracks appear almost overnight in
brand new buildings.
Meanwhile those close to the oil and gas sector, those involved in corrupt practices
and others who have windfall gains, dominate the economy more than they ever
have before leading to a steadily widening gap between the haves and the have-nots.
The income distribution worsens and inequalities rise in the country.
Peak oil
Yet another problem confronts the macroeconomic and social situations of oil and
gas producers as well as consumers. Some argue that the oil price will continue to
rise as resources decline. For instance, The International Energy Agency (IEA), the
industrialised countries’ energy watchdog, recently warned of an oil supply crunch
within five years as a result of accelerating consumption growth and output falls in
mature areas, such as the North Sea, and long delays in new production projects. On
the other hand, the recent sharp increase in OPEC’s investment could reduce the risk
of oil demand outstripping supply and lessen long-term oil price pressures.
However, the IEA estimates that OPEC will have to supply about 36.2 million barrels
per day in five years, from today’s 31.3 million barrels per day. That would reduce the
oil cartel’s spare capacity to 1.6 percent of global demand, down from 2 percent in
2007.20
20
OPEC steps up oil and gas search”, Javier Blas, Financial Times, London, July 31 2007

What is likely to happen is that as prices rise, consumers will substitute with alternative
products. The problem is that it takes time to find new products and re-engineer the
necessary technologies, especially given that the price of oil and gas has been
relatively low until now. New substitutes will be more expensive for a time before mass
demand turns around to accept them. It could well take several decades without
foresight and major investment by the major consumers, before new technologies
both appear and are adopted. Eventually, consumers will make the substitute and
this could be followed by a massive decline in the fortunes of oil and gas producers.
Yet another problem is that rapidly rising prices, fuelled by newcomers such as India
and China, could lead to a rapid rise in world interest rates and a major recession. Such
a recession would also harm the oil and gas producers who have geared up to produce
at a high rate and have their economies highly dependent on a high price of oil. For
instance, some estimates believe that an oil price at less than US$50 a barrel could cause
a collapse in Iran which has used its oil revenues to bolster its social welfare system to
such an extent that its real economy is in poor shape.
Corporate social responsibility (CSR) and public-private partnerships
There is, of course, heavy involvement of large multinational companies in oil and gas
exploration and production. To a certain extent their role is increasingly being taken
over by national oil companies (NOCs), which can be either private or public. Given
the latter’s importance to the economy they are quite often in state or quasi-state hands.
The question of excess profits has often been raised. The notion of CSR can help in
redressing the balance. Simply put, CSR means treating the stakeholders of a company
in a responsible manner – stakeholders can be either internal (Board, owners, shareholders,
managers, employees) or external (customers, suppliers, local communities, government,
the natural environment, regulatory authorities, and the media). In practice to date,
one of the outcomes of CSR has been the Extractive Industries Transparency Initiative
(EITI) that looks at the tax contributions of oil and gas companies to countries. Yet
another has been the publishing of social and sustainability reports that monitor the
treatment of the various stakeholders.
In the Middle East, CSR has often meant corporate philanthropy and very little else.
But large companies such as Shell and BP have gone much further than purely CSR
since they are keen to see that the non-oil and gas sectors do not suffer as production
of oil and gas increases rapidly since this, in turn, leads to economic and social effects
that eventually harm their reputation and ability to produce – the case of Nigeria is
well-known. Both companies have launched studies to examine the sustainability of
nations in which they work with a view to assisting governments in a variety of ways –
education and training and even public-private sector partnerships to promote
economic growth in the non-oil sector.

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Is oil a blessing or a curse?
A number of commentators have judged that, if not handled carefully, oil and gas
revenues can be more of a curse than a blessing. Perhaps the main concern is that
reliance on a single resource could lead to a rent economy (i.e. an economy that obtains
its wealth fortuitously and, therefore, is not a long-term solution to development
problems, in contrary to an entrepreneurial economy in which innovation and effort
create wealth).
There are a number of danger signs to look out for to prevent the great fortune of
newly discovered resources becoming a curse. These are:
• Dutch disease
• Currency appreciation
• Uncontrolled inflation
• Output declines in agriculture and manufacturing (tradeables)
• Bottlenecks for skilled labour, infrastructure, utilities, real estate
• With significantly increased public investment, quality of public spending
deteriorates rapidly
• Inability to spend efficiently (results) and effectively (least cost)
• Exaggerated role of government in addressing problems at the expense of using
market mechanisms
• More difficult to make policy changes as significantly larger oil revenues arrive
But, in general, most poor countries would welcome an oil and gas bonanza.
Consequently, it is essential for those that have had such fortune to avoid the nine
deadly pitfalls listed just above.
Lessons from other single resource economies21
Lessons from single resource economies show that there have been more failures
than successes, and only a few single resource economies are truly integrated into
the global economy.22 The resource curse is thus often associated with single resource
economies, notably in the petroleum and mining sectors.
But what exactly does the resource curse look like in terms of basic economic data and
other socio-economic indicators and how prevalent is it? What can be learned from the
economic and social performance of different single resource countries?
As the tables in the Annex demonstrate, the 44 countries represent a wide range of very
different economic performance and social conditions. Single resource economies
are found in all regions – in Europe, Africa, Asia, North and South America, and the
Middle East. As the tables show, not all of the countries have performed badly, but
21
This section draws upon work performed by Tom Stephens, Remi Jedjab and Michael Hopkins in 2006 for UNDP and Azerbaijan
Government – for a full report see http://www.un-az.org/undp/publications.php
22
Single resource does not necessarily mean only oil and gas. It includes minerals such as copper and diamonds, as well as agricul-
tural commodities such as coffee and tea.

the comparisons clearly suggest that there have been a number of notable
unsuccessful states – Nigeria, Angola, Gabon, Libya, Saudi Arabia, Chad, Democratic
Republic of Congo, Venezuela and Algeria. Between 1999 and 2005, 10 of the 44
countries had both a lower GDP per capita and a lower UNDP Human Development
Index (HDI) ranking (a composite indictor for social wellbeing).
Several countries have shown a drop of more than 10 points in their social indicators
as measured by their UNDP HDI ranking – in some instances, even when GDP per
capita increased. These include Cameroon, Chad, Democratic Republic of Congo,
Ecuador, Nigeria, Suriname, Trinidad and Tobago, Venezuela and Zambia. The sharp
declines may be a result of multiple factors, political instability and civil war, regional
economic recession, the HIV/AIDS pandemic (Botswana and Zambia), as well as
inability to address underlying macroeconomic distortions.
While there are fluctuations in the economic and social performance of countries,
most observers often highlight certain countries – Norway, Chile, the Gulf States of
Qatar and Dubai, Botswana, and Mexico – as having been successful in meeting the
single resource challenge. Chile and particularly Mexico are notable for their
diversification away from dependence on a single resource commodity for foreign
exchange. Oil exports in Mexico now account for only 13.6 percent of foreign exchange
earnings, while Chile’s copper exports are down to 53.9 percent of export earnings.
Still other countries have what might be called uncertain outcomes with respect to
how their economies will benefit or not. In this group, we include Ecuador, Peru,
Equatorial Guinea, Kazakhstan and Azerbaijan because the longer-term economic and
social ramifications from their single resource dependence are still not clear. For
Azerbaijan, Kazakhstan and Equatorial Guinea, poverty inequality remains a significant
problem, despite significant improvements in per capita GDP growth.
How do single resource economies compare with the successful emerging market
countries like China, Costa Rica, Korea, Malaysia, Singapore and Thailand? By and large,
the six comparator countries have performed similarly to the better performing
single resource economies. Of all the countries, China stands head and shoulders
above all the countries with an average of over 10 percent per capita growth per year
between 1995-2006 and an HDI ranking moving up 13 places in just six years. China’s
average annual inflation rate was only 1.6 percent between 1995-2006. At the same
time, China’s GDP per capita is the lowest among the six comparator counties at a
still modest US$5,000 in 2000. By comparison, Korea shows impressive gains in per
capita GDP of over US$4,000 between 1999-2005, surging to nearly US$18,000 in 2005.
This translates into average annual GDP growth per capita of 5.79 percent between
1995-2006. Singapore has the second highest per capita GDP of all countries in 2005
at US$24,481 (behind Norway), which surpasses even the per capita GDP of the Gulf
States of Bahrain, Qatar, and the United Arab Emirates (UAE). Five of the six
comparator countries have adult literacy rates of over 90 percent. And the sixth
county, Malaysia, has an adult literacy of almost 89 percent. Only 10 of the single
resource economies have adult literacy rates over 90 percent.

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The three graphs below capture the essence of the wide-ranging economic
performance of single resource economies and their degree of dependence on single
resource exports for foreign exchange earnings.

In Graph 2, the performance of these countries tracks not only percentage change in
GDP per capita but also dependency on single resource exports for foreign exchange
earnings. There seems to be no consistent pattern that more highly dependent
economies perform better or worse than those countries that are less dependent on
a single resource for export earnings. This would suggest that success is not a measure
of resource dependency or not, but how the overall economy is managed, regardless of
the source of export earnings.
Graph 3 uses a wider data set and shows that single resource dependency has a slight
negative effect on life expectancy changes over time. Since it is more difficult to
extend life for higher-income countries than for lower-income countries, we have
taken a log of life expectancy to compensate for this effect. Nevertheless, one can see
that life expectancy at birth, on average, reduces over time with single resource
dependency. This is not surprising since life expectancy is the ultimate development
indicator taking into account all other development indicators. As might be expected,
rapid growth that ensues from a single resource is not easily shared. One might expect
that income distribution worsens as wealth gets concentrated in a few hands, and
employment does not necessarily grow since the single resource economy is often
one where the lead sector, the single resource, is capital intensive, but not labour
intensive. Worsening income distribution would be correlated, and even a determinant
of, worsening life expectancy. The trend, however, is not inevitable as countries such
as Viet Nam and UAE have shown.

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Selected examples from five countries
Here, a more detailed comparison is made of five countries, two of which are
considered successful single resource economies (Norway and Chile), one a promis-
ing single resource economy (Trinidad and Tobago), and one country (Nigeria) often
classified as unsuccessful in managing its oil revenues wisely. As the previous tables
demonstrate, the 44 countries represent a wide range of very different economic
performance and social conditions. As the tables show, not all of the countries have
performed badly, but the comparisons clearly suggest that there have been a number
of notable unsuccessful states – Nigeria, Angola, Gabon, Libya, Saudi Arabia, Chad,
Democratic Republic of Congo, Venezuela and Algeria. Between 1999 and 2005, ten
of the 44 countries had both a lower GDP per capita and a lower UNDP HDI ranking (a
composite indictor for social wellbeing).

Norway
By any measure, Norway has done exceedingly well in managing its oil resources. Norway is
the world’s seventh largest petroleum-producing nation and Western Europe’s most important
source of natural gas. In 2003, oil and gas exports accounted for more than 50 percent of the
country’s total exports of goods and services. From an overall socio-economic perspective, Norway
ranks number one on the UNDP Human Development Index and has one of the highest per
capita GDP rates in the world. Norway’s successful economic management is demonstrated by
three key indictors for 2005: a 1.6 percent change in the consumer price index, short-term inter-
est rates of 2.2 percent, and an unemployment rate of 4.6 percent, one of the lowest in Western
Europe.
In 2005-2006, oil and gas output and changes in their prices have greatly affected Norway’s
trade flows. The petroleum sector continued to contribute more than one half of total export
revenues, but high oil prices pushed up the merchandise trade surplus to US$50.1 billion in 2005,
beating the previous record of US$33.6 billion in 2004.
GDP growth accelerated to 3.8 percent year a year in the second quarter of 2006, up from 3.6
percent in the first quarter. However, declining oil production saw total GDP growth slip to 2.1
percent year on year, down from 2.7 percent in the first quarter, with overall GDP growth expected
to be 2.4 percent in 2006, compared to 2.3 percent in 2005. High oil prices are boosting the trade
and current-account surpluses, with the latter expected to be close to 19 percent of GDP in 2006,
before narrowing slightly in 2007 as a result of higher interest rates and lower investment growth.
Over the next two years, the Norwegian Government has indicated its plan to target more public
spending towards local government, health and education and to a programme of employment
creation in the public sector.
Norway has gained considerable praise for the way in which it sequestered much of its oil
revenue in a petroleum fund, officially renamed the Government Pension Fund in January 2006.
The Fund was set up in 1990 to be used for future health and pension benefits. The fund is
administered by the Norwegian Central Bank and reached a portfolio value of US$245 billion
in the first quarter of 2006, making it one of the largest in the world. The fund value is expected
to actually exceed the Norwegian economy in 2007. Since 1998, the fund has been allowed to
invest up to 50 percent of its portfolio in the international stock market.
Norway’s Pension Fund is not without controversy and has generated a great deal of internal
political debate. Two issues are of note to other ORCs: first, whether Norway should have used
more of its current oil revenues to solve current problems instead of putting aside such a large
portion of oil revenues for future use, and, second, whether the high exposure of the Fund to
international stock market volatility is financially safe or risky to the long-term valuation of
the Fund.
Policy lessons from Norway for ORCs
ORCs can learn from Norway’s strong observance of law and its economic management of
its oil revenues. Of course, most ORCs will have to use a higher portion of their oil revenues
for current development challenges, rather than investing for the future. It is clear, however,
that Norway protected its economy by sequestering a large percentage of its oil revenues in
the Government Pension Fund and protecting it from short-term government temptation to
withdraw from the Fund.

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Chile
Chile is one of the major copper-producing countries of the world. With a population of 16
million people, Chile underwent a period of significant political turmoil in the 1970s and early
1980s, but has managed to make major economic and social strides in the last 20 years. In addition
to sound economic policies and substantial investments in human capital development, Chile
strongly encouraged the non-oil sectors, especially agriculture and the service sectors, turning
Chile into the most dynamic economy in South America and it is exporting agriculture products
as far away as North America, Europe and Japan.
Fast growing GDP per capita and targeted social programmes enabled poverty rates to fall
dramatically. Social indicators such as enrolment in primary schools, youth literacy, infant
mortality, and life expectancy improved considerably, reaching levels close to those of industrialised
nations. Households are also relatively well covered by social protection programmes.
During the 1990s, solid fiscal management and a deepening of reforms improved the investment
climate and helped to diversify the economy. Trade liberalisation triggered significant export
diversification into forestry, wines, fruits, and other agro-based products. As a result, Chile
decreased its dependence on copper and grew at a solid 6.8 percent per year until 1999, when it
was affected by the East Asian crisis. Since then, Chile has avoided recession and restored growth.
Despite its economic success over the past two decades and its ability to deal with the effects
of the regional economic recession that hit Latin America in the early 2000s, Chile is now
facing another kind of problem – more common to single resource economies. Within the last
year, Chile has felt increasing pressure on its economy as the rising world price for copper has
resulted in the appreciation of the currency with a tangible threat of making Chile’s agriculture
exports more expensive and thus less internationally competitive. The government has sought
to address this problem, by among other policies, increasing the levels of copper revenues that
are sequestered off-shore.
Policy lessons from Chile for ORCs
Chile’s message is to note the long-term commitment that Chilean policy makers have made
to using investments wisely so as to encourage the non-oil sectors and improve social capital,
and to promoting sound macroeconomic and governance policies, a process that is ongoing.
Nigeria
Although Nigeria is a country of very vibrant and entrepreneurial people, most observers
would agree that Nigerian leaders squandered more than US$200 billion in oil revenues over
the last 25 years. Nigeria is a poorer country today than it was 25 years ago. It continues to rank
in the lowest 20 percent of countries according to UNDP’s HDI. Corruption remains a rampant
problem that is only beginning to be addressed by the Nigerian Government. Crumbling
infrastructure and abandoned buildings constructed in the early oil boom years are a painful
reminder of the inefficient and short-sighted approach of the then Nigerian Government in
trying to spend their way into sustainable development. Despite its oil revenues, Nigeria is also
a highly indebted country with outstanding public loans equal to 28.5 percent of GDP in 2003.
Nigeria has also been unsuccessful in addressing the significant regional inequalities and
demonstrating clear transparency in how oil revenues were being allocated among and within
state and local governments, issues that have resulted in political instability in many regions
of the country.

The need for economic reform has topped the current government’s policy agenda, the
centrepiece of which has been the National Economic Empowerment and Development
Strategy (NEEDS). This Strategy runs until 2007, with the aim of diversifying the economy away
from its dependence on oil. Tackling corruption has also been given a high profile. Despite
the administration’s commitment to reform, progress has continued to be held back by strong
vested interests opposed to change.
In current economic terms, Nigeria’s real GDP growth is projected to slow to only 4.1 percent in
2006, largely because political unrest in the Delta region has constrained oil production, but
GDP growth is expected to rebound in 2007-08 as oil production recovers in the second half of
the year and political uncertainty associated with national elections dies away. Exports are
dominated by oil, with the trade surplus estimated at US$34.8 billion in 2005. With oil prices
forecast to remain relatively high against a background of rising production, substantial trade
surpluses are forecast for 2007-11. Real GDP growth of 5.5 percent is forecast for 2007 and 5.3
percent in 2008.
Policy lessons from Nigeria for ORCs
Perhaps the most significant lesson from Nigeria’s experience relates to the added difficulties
of tackling major policy changes if they are not addressed at a very early stage and if the rule
of law is corrupted. By not addressing underlying policy and governance issues early on,
Nigeria faced the much more difficult task of making the same kinds of policy changes at a
later stage.
Kazakhstan
Kazakhstan began to receive the benefits of its oil reserves four to five years ago. The
Kazakhstan Government has given high policy importance to maintaining fiscal prudence,
achieving economic diversification, and managing the exchange rate in the face of large
hard-currency inflows. Of these goals, that of diversifying Kazakhstan’s production base is the
hardest to attain. The government tends to pursue interventionist policies for the promotion of
favoured enterprises, obstructing the free functioning of market mechanisms.
In 2005, total Kazakh exports on a customs basis were worth US$28 billion and imports US$17
billion. Russia is still Kazakhstan’s main trading partner, and is the major source of imports
and a leading market for exports. This is partly the result of Kazakhstan’s difficulty in moving up
the value-added ladder, which makes the country unable to compete in western markets. Instead,
the bulk of Kazakh exports to the West consist of raw materials, particularly oil and metals.
In 2007, the government loosened fiscal policy, but high oil prices will ensure that the state budget
remains in surplus in the medium-term. Annual average consumer prices were forecast to rise by
over 8 percent in 2007-08, despite efforts by the National Bank of Kazakhstan to combat inflation.
Rapid import growth will dampen the rate of economic expansion, but the average annual real
GDP growth rate in 2007-08 is expected to remain above 9 percent, driven by the imminent start
of production at the Kashagan oilfield.
Policy lessons from Kazakhstan for ORCs
Kazakhstan inherited significant amounts of infrastructure and assets from the Soviet era and
has a well-educated population. It faces the challenge of addressing regional imbalances and
preventing a further erosion of human capital and infrastructure. The challenge for both
countries is less one of availability of resources, as one of effectiveness and efficiency in the use of
public and other resources to, among other things, rehabilitate and expand the infrastructure base
and adapt the education system to the needs of a modern and fast-evolving market economy.

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The following three issues can be deduced from the global analysis of 44 countries,
and more detailed analysis of five countries presented in this paper:
1. Single resource economies face considerable risks in assuring sustainable

economic and social development. Prudent investments and vigilant attention
to sound macroeconomic and governance policies are common threads found
in successful countries. This is particularly notable in our short overview of
Norway and Chile.
2. Even successful single resource economies, however, must continually adjust

and calibrate their policies in the face of changing international market prices
for their commodity exports.
3. An important lesson from some of the unsuccessful single resource economies

is the dangers of not confronting the difficult economic and structural barriers
and impediments to more efficient and equitable growth. By not addressing
these underlying issues early in the boom years, these issues become more
entrenched and more difficult to forcefully address in later years. This often leads
to increasing social inequality and the marginalization of the non-oil or non-
mining sectors.
Components of a national human resources development strategy
What could a human gold strategy look like to avoid most problems that ORCs face?
Briefly, it is a national human resources development (HRD) strategy that should be
structured as flexibly as possible, to maximise efficiency, and be accountable for clear
actions across a specified timeframe. It is worth noting that fragmented quick-fix
projects are unlikely to build and sustain effective solutions over the longer-term without
institutional mechanisms in place to foster, manage, and monitor progress towards
explicitly stated, targeted goals. ORCs need a cohesive, integrated HRD strategy that is:
• Integrated and cross-sectoral, maximising all the advantages of public/private

cooperation already begun.
• Empirically-based, facilitating production of outputs, information and analyses
from labour force and employer surveys as well as census data, arranged, classified
and formatted in ways that planners can respond to, and with corresponding
information on educational offerings and attainments that can inform
entrepreneurs/investors on the availability of skills.
• Substantively relevant (information-based, building civic, economic, socio-
cultural and sustainability literacy).
• Enhances lifelong learning by making information publicly available on adult
education and training, and by supporting institutional initiatives that open
up opportunities for adult “recycling” through appropriate post-secondary
institutions, both public and private.
• Flexible and adaptable to changing national economic conditions.
• Contextually sensitive to, and well networked with regional and global labour mar-
kets and post-secondary educational institutions.

• Manageable, with strong leadership, and essential, but minimal, formal and insti-
tutionalised legislative, administrative, and fiscal structures to be effective.
• Sustainable (cost effective, market oriented and built to provide continuity).
• Socially assertive (i.e. well-supported at regional and local levels and on the ground
with strong public outreach and accountability mechanisms).
• Has a well-developed, accelerated skill development programme.
In addition to these broad conclusions, five other observations for ORCs are:
1. For the immediate future, as much new oil monies as possible should be
allocated to a state oil fund until the government is clear on how it wants to
use these revenues and can ensure that deployed revenues will be used in a
cost-effective manner.
2. Normally, public education systems create a large number of secondary

educated young people who find it very difficult to obtain jobs. They lack
the necessary skills, but at the same they cannot easily find jobs even with the
skills they do have. More coordination, information and analysis are required
to better understand and address the supply of educated labour and its current
and anticipated demand.
3. There is normally a need for more strategic, inter-ministerial cooperation and

coordination, particularly between ministries involved in skills formation, and
between the public and private sectors, parents and students in charting new
courses for HRD.
4. Across most, if not all, ORCs skills development has been subsumed into
discredited public vocational education systems. Thus a more integrated
response is required with public/private cooperation, supply and demand
analyses, in addition to more flexible technical-vocational-educational training
(TVET) to rapidly raise skills so as to make the non-oil sector competitive
internationally.
5. Human resource development can play a leading role in creating self-sustaining

economic development (a virtuous circle). The experiences of countries that
have successfully employed such a strategy, such as the Republic of Ireland,
strongly suggest that creating a skilled work force is a necessary pre-condition.
However, human resource development alone is not sufficient for success. It
is necessary to ensure that competitive export industries are able to spring up
and ensure the employment of the skilled workers that have been created.
This requires creating economic conditions where potential investors are not
deterred by, for example, lack of access to export markets, entrenched monopolies
or governance problems. Of course, failure to ensure a suitable environment
for such employment to be generated could result in the creation of a skilled
work force with only poor prospects of employment.

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Chart 1 provides a schematic of a typical country that has recently found major oil and
gas resources.23 The country starts out around point A with relatively low skills and
productivity (for instance, entrepreneurial ability and market orientated skills), yet a
relatively high price level compared with neighbouring countries – the line C-D.
Because of oil, leakages into the system have steadily, albeit slowly, worked their
way in, and are raising prices and appreciating the exchange rate. We hope, anyway,
that wages would rise to provide a higher standard of living along the line C-D. Averages
are misleading, of course, and the oil sector could push the economy along C-D while
the majority of people in the non-oil and gas sector do not benefit. With relatively
high prices, and low productivity in the non-oil and gas sector, this exacerbates the
unemployment problem.
Since wages decrease more slowly than they increase, one cannot expect a sudden
drop in the overall price level. The possibility of devaluation is clearly not an option for
the foreseeable future. Some adjustment occurs as workers realise they cannot ask for
wages above market levels and as imports are steadily replaced by domestic production
– especially agricultural products.
21
Drawn from Michael Hopkins: ‘Structural employment problems with a focus on wages’, (ILO, Geneva in Jobs after war edited
volume by Eugenie Date-Bah, ILO, Geneva, 2003)

From Chart 1, it can be seen that there is a continuing need to raise human capital in
the country. Technical and advanced skills are key to this. Thus, what is required, as
Chart 1 illustrates, is a continuing effort to raise skills to meet the relatively high levels
of wages expected or being forced into the economy by a slow, but sure Dutch disease.
The funds for human skill development will increasingly have to come from the oil and
gas bonanza that is starting to flow. It will require the government to take serious
and active steps to ensure that much of the available resources released by oil are
channelled into HRD.
If the above strategy is followed, the country will move to point B where prices and
wages will start to meet the level of productivity and skill in the society. It is not
certain when this point will be reached, but it will be at least five years, more likely 10-15
years, simply because the skill level must increase significantly.
At point B and after, the economy will start to be in equilibrium between productivity
and price level and the economy will follow a balanced development path. More
particularly, the non-oil and gas sector will absorb skilled labour at an adequate rate.
At this point wages will start to rise along with productivity.
There are, of course, other concerns. Simply getting the prices right will not be
enough on its own to ensure future human development. An equitable distribution
of income is necessary and could be disturbed if too much power is concentrated in
the hands of a few. This could happen for instance through concentration of economic
power into the hands of the few, especially in the oil and gas sector and a few niche
markets such as imports of luxury goods. Government should resist major asset
redistributions while the fragile economy receives its huge, and necessary, dose of
human capital injection. To counter moves in that direction, a continuing and major
effort is required to involve the grassroots of the country in education and skills training,
as well as basic education and community participation in local decisions. These
latter moves, of course, are not market determined and so the government with its
international partners, including its oil partners, will have to make a determined and
consistent effort to raise human capital levels for many years to come.
What are the risks? These exist. However, human capital once acquired is not easily
lost. Consequently, human capital formation is also a defensive strategy and therefore
less risky than other strategies.
Another major risk is what will happen to effective demand? By effective demand is
meant what is required to create demand (i.e. money in people’s hands that will be
spent on domestic goods and services and not so much on imports). Increased skills
at grassroots and higher levels of the economy will lead to increased investment in
non-oil activities.

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On the other hand, the approach delineated so far is essentially a supply side
approach. Classical economic theory (Say’s law) tells us that supply creates its own
demand. For this supply side approach to work, active engagement is required to
promote rapid accumulation of human skills through vocational and technical training,
informally, formally and through on-the-job training. But it cannot just be assumed
that effective demand for goods and services will rise automatically. To promote effective
demand will also require efforts in a number of areas, such as housing and urban
development, non-farm rural development, grassroots mobilization and socio-economic
development, labour-based public works, microfinance, small- and medium-sized
enterprises (SME) private sector development, and niche private sector markets.
Conclusion
From a macroeconomic perspective, ORCs cannot simply spend their way into sustained
and balanced economic growth. Strategic investments are certainly necessary, but
the overriding concern must be one of investment prudence and understanding the
expected benefits, potential risks, and long-term implications of different kinds of
investment decisions and spending alternatives. In this vein, considerable emphasis
on using oil revenues to significantly expand human capital development and skills
formation is required. This is the basis for turning “Black Gold into Human Gold.”

Annex

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Appendix:
São Tomé and Príncipe Revenue Management Law

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SÃO TOMÉ AND PRÍNCIPE REVENUE MANAGEMENT LAW
Excerpt from Escaping the Resource Curse, Humphreys, Sachs, and Stiglitz, Columbia
University Press, 2007 (unofficial translation*)
NATIONAL ASSEMBLY
Law No. 8/2004
Oil Revenue Law
Preamble
The Democratic Republic of São Tomé and Príncipe shall soon be starting to receive oil
revenues resulting from the exploitation of its oil resources. Related to this reality are
complex strategic matters that must be anticipated, resolved and regulated so that
such revenues can foster progress and sustainable social and economic development
in São Tomé and Príncipe.
Based on these principles, this law is adopted, guided by two fundamental ideas.
The first idea is centred on the payment and management of oil revenues. An attempt
was made to address the concerns shown by the international experience taking into
account the national reality and the need for the São Toméan people to make strategic
decisions regarding their future.
For that purpose an account is established – the National Oil Account – in which all oil
revenues shall be deposited directly, and mechanisms are introduced which are intended
to ensure that such revenues will not be used indiscriminately. Thus, limits are set forth
for the use of the oil revenues, such limits not excluding, however, the need to make
decisions about spending on priority sectors on which expenditures will focus and the
respective revenue allocation.
Similarly, this law introduces mechanisms to prevent the revenues being channelled
to other accounts. Revenues may only be deposited in the State Treasury Accounts or
in accounts established for that specific purpose in the name of the State, as authorized
by the National Assembly.
This law establishes quantitative and qualitative limits on the amount of oil revenues
that shall be used for annual budgetary expenditures. The quantitative limits define,
in certain breadth, the maximum amount of annual expenditures to be financed by
oil revenues. The qualitative limits determine the basic principles for the calculation of
the annual expenditures within the maximum fixed limits, as follows: (I) planned and
forecasts of future revenues; and (II) absence of distortions in the economy.
The finite nature of oil resources was also taken into account, as well as the need to
introduce mechanisms that will allow São Tomé and Príncipe to face the post-petroleum
era with minimum economic distress. For that purpose, a reserve sub-account was
established – the Permanent Fund of São Tomé and Príncipe – in which part of the oil

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revenues shall be deposited, and whose use shall be strictly conditioned, except for
the earnings generated from investments of its funds. Thus, it is intended for the São
Toméan people to continue to benefit from the yields generated by the investments
of the reserve sub-account even after the oil resources come to an end.

The management and investment of the oil revenues are assigned to an Investment
and Management Committee, which is the institution with the authority ascribed by
law for that purpose. The Investment and Management Committee shall act pursuant
to the prudent investor rule, the principles established by this law and by the
management and investment policy.
This law introduces mechanisms to ensure the effective management and investment
of oil revenues, and establishes different priorities according to their allocation. All
revenues allocated to finance public expenditure shall be managed aiming for
immediate liquidity, while the revenues deposited in the permanent fund shall be
managed for medium- and long-term profitability. The management and investment
policy, which will guide revenue management and investment, shall reflect these
principles.
The second fundamental idea of the law is centred on oil revenue management
auditing, transparency and oversight mechanisms, which are considered to be of great
importance to ensure that this law be enforced according to its objectives.
Two annual audits of the oil accounts, in which the oil revenues shall be deposited,
shall be carried out: one by the Auditor General and the other by an internationally
recognized international auditing firm.
The law establishes clear transparency and publicity rules with respect to all acts and
documents related to the oil activity. On one hand, mechanisms are introduced that
limit the confidentiality of contracts concerning oil resources or oil revenues, mandatory
registration and disclosure is introduced for all documents and information related to
the oil sector. On the other hand, all people have ample rights to access the information.
The law also creates a Petroleum Oversight Commission, with independence and
administrative and financial autonomy to ensure its effectiveness, with oversight,
investigative and sanctioning powers.
Finally, this law clarifies that its dispositions apply to the Joint Development Zone; it
establishes a range of irreconcilable conflicts with regard to the exercise and placement
in positions in the bodies created by the law; and it aggravates by one third, in their
minimums, the penalties established by the general law to punish behaviours that
violate the provisions of this law.
In these terms, the National Assembly sets forth, pursuant to Article 97(b) of the
Constitution, the following:

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Chapter I
Definitions and Scope of Application
Article 1
(Definitions)24
1. For the purpose of this law:

a) “Administration” or “State Administration” – shall mean the direct, indirect,
autonomous or independent administration of São Tomé and Príncipe, including
all ministries, entities, agencies, departments, offices, institutes, services, support
services to the sovereignty bodies, as well as local and regional branches of
the state and all their services, departments and all entities, companies and
production unities controlled, in whole or in part, directly or indirectly, by the
central, regional or local administration.
b) “National Petroleum Agency” – shall mean the governmental legal entity with
authority to regulate the national petroleum industry;
c) “Official” or “State Administration Official”– shall mean any individual occupying
any position in, employed by, contracted by or otherwise acting on behalf of
or representing the State Administration, including ministers, directors,
administrators, managers, attorneys-in-fact, commissioners or concessionaires
of any entities controlled by the Public Administration;
d) “Year” – shall mean the period between January 1st and December 31st.
e) “Business Association” – shall mean any permanent association of entrepreneurs
or professionals created in order to defend and promote their business or
professional interests;
f) “Joint Development Authority” – shall mean the collective body established for
the purposes described in the Treaty.
g) “Central Bank”– shall mean the Central Bank of São Tomé and Príncipe, as established
by Law No.8/92, dated as of August 3, 1992.
h) “Custody Bank” – shall mean any financial institution, or its branches or agencies,
in an international foreign center, which is rated the highest by two internationally
recognized risk analysis agencies, able to receive and hold cash balances in an
internationally convertible currency, act as the custodian itself or by an Official,
keep operation records of the National Oil Account, and provide to the public,
directly or through competent entities, the information subject to the transparency
principle under the terms of this law;
i) “Approved Bank” – shall mean any foreign commercial bank, or its branches or
agencies, in an international financial center, which is rated the highest by two
internationally recognized risk analysis agencies.
j) “Management and Investment Committee” – shall mean the committee organized
to ensure the management of the Oil Accounts and the investment of the oil
revenues deposited in such accounts;
24
Translator’s Note: For the purpose of this translation, the terms and expressions defined in this Article are listed in the same order
as they appear in the original Portuguese language alphabetical order.

k) “Petroleum Oversight Commission” – shall mean the independent organization

that ensures the oversight of all the activities related to the national oil resources
and revenues;
l) “Oil Accounts” – shall mean the National Oil Account and the Permanent Fund of
São Tomé and Príncipe, when collectively referenced;
m) “Treasury Account” – shall mean any account or sub-account referred to as
Public Treasury Account, established by the Treasury with the Central Bank,
pursuant to Decree No. 51/96, dated as of October 29, 1996;
n) “National Oil Account” – shall mean the account established and held by the
Central Bank with the Custody Bank, pursuant to this law;
o) “Oil Contracts” – shall mean transaction instruments having Oil Resources or Oil
Revenues as an object.
p) “Abuja Joint Declaration” – shall mean the declaration regarding transparency
and good governance signed on June 26, 2004 by the Presidents of the
Federative Republic of Nigeria and the Democratic Republic of São Tomé and
Príncipe.
q) “State” or “São Toméan State” – shall mean the Democratic Republic of São
Tomé and Príncipe, as defined in article 1 of the Constitution;
r) “Permanent Fund” or “Permanent Fund of São Tomé and Príncipe” – shall mean
the sub-account established with the Custody Bank, with the purpose of
establishing a permanent savings reserve, pursuant to paragraph 1 of Article 3,
and to Article 10 of this Law;
s) “Public Registration and Information Office” – shall mean the public registration
and information service, as defined in Article 18 of this law;
t) “Natural gas” – shall mean all hydrocarbons that are gaseous at atmospheric
pressure and temperature;
u) “Approved Foreign Government” – shall mean the government of any foreign
country or any agency or instrumentality of such foreign government, which is
rated the highest by two internationally recognized risk analysis agencies;
v) “Production Commencement” – shall mean the date on which the commercial
production of hydrocarbons shall commence in any block of the national
territory, including the Exclusive Economic Zone and the Joint Development
Zone.
w) “Hydrocarbons” – shall mean the hydrocarbons as defined in the Treaty, the
Treaty Regulations, and sub-paragraph (m) of Article 1 of the Oil Activities Law;
x) “Oil Activities Law” – shall mean Law No. 4/2000, dated as of August 23, 2000,
and all amendments thereto;
y) “State General Budget” – shall mean the State General Budget as defined in
Law No.1/86, dated as of December 31, 1986;
z) “Non-Governmental Organizations” – shall mean any association, organization,
legal entity, foundation, institution or company and other bodies deemed as
legal entities represented in São Tomé and Príncipe, non-for-profit, that
predominantly pursue scientific, cultural, charitable, aid, social solidarity, social
and economic development, human rights protection, environmental protection
goals, and other related goals;

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aa) “Unrestricted Part of the National Oil Account” – shall mean the balance of the
National Oil Account, excluding the Permanent Fund of São Tomé and Príncipe;
bb) “Person” – shall mean any individual or legal entity, whether national or foreign,
resident or non-resident of São Tomé and Príncipe;
cc) “Petroleum” or “oil” – shall mean all hydrocarbons that are liquid at atmospheric
pressure and temperature;
dd) “Management and Investment Policy” – shall mean the document containing
the management and investment rules for the Oil Revenues deposited in the Oil
Accounts, pursuant to the principles set forth in this Law;
ee) “Expected Average Prices” – shall mean the price calculated according to paragraph
1(a) of Article 7 of this law;
ff ) “International Reference Prices” – shall mean, for the period of ten25 years as from
the Production Commencement Year, the official price of hydrocarbons publicly
rated by the Brent FOB Sullom Voe, and, and for the seventh26 year after Production
Commencement and subsequent years, the actual sale price of crude oil in São
Tomé and Príncipe, including the sales of hydrocarbons of the Joint Development
Zone;
gg) “Oil Production” – shall mean the commercial production of oil or any other
hydrocarbon in the Exclusive Economic Zone or in the Joint Development Zone;
hh) “Field Development Program” – shall mean the detailed document, which, pursuant
to the Treaty, the Treaty Regulations or Oil Revenue Law, as the case may be, is
submitted by an oil operator for the establishment, construction and operation of
facilities and services for the recuperation, processing, storage and transportation
of hydrocarbons in the contracted operator’s block;
ii) “Oil Revenue” – shall mean any payment or payment obligation owed by any Person
to the State, directly or indirectly, with respect to the oil resources of São Tomé and
Príncipe, including, but not limited to:
I) Any and all payments from the Joint Development Authority arising out of
hydrocarbon-related activities developed in, or in connection with, the
Joint Development Zone,
II) All payments arising out of activities related to Exclusive Economic Zone
Oil Resources, namely, but not limited to São Tomé and Príncipe’s share
of crude oil and gas sales; signature bonuses and production bonuses;
royalties; rents; proceeds from sale of assets; taxes; fees; duties and customs
taxes; public service fees; net profits of state-owned oil companies;
revenues from State share rights in oil contracts; crude oil sales; commercial
activity resulting from transaction of oil, gas, or refined products; return
on investments of the oil revenues; any and all payments generated
in connection with the commercial production of hydrocarbons;
III) Other revenues of analogous nature or revenues deemed as having an
analogous nature by law.
25
Translator’s Note: Discrepency between periods in first and second clauses in original.
26
Id.

jj) “Extraordinary Oil Revenue” – shall mean, for the period after the Oil Production
Commencement, any signature bonus or any other payment, including the
payments received from the Joint Development Zone related to an area that is not
yet in production;
kk) “Oil Resource” – shall mean any deposit, block or area where hydrocarbons can
be found, regardless of its commercial potential, within the national territory,
including the Exclusive Economic Zone, and pursuant to the terms of the Treaty, in
the Joint Development Zone;
ll) “Prudent Investor Rule” – shall mean that in performing any investment transactions
or services, the agent shall ensure high quality and efficiency standards, and shall
discharge his or her duties protecting the legitimate interests of the State with
the diligence of a discerning and orderly manager, pursuant to the risk sharing
principle and the safety of the investments, in accordance with the investment
rules approved by the Management and Investment Committee pursuant to this
Law;
mm) “Operation Rules” – shall mean the document containing the operation rules for
the Oil Accounts;
nn) “Treaty Regulations” – shall mean the regulations approved by the competent
authorities in accordance with the Treaty;
oo) “Royalties” – shall mean the liquidated revenues from the sale or disposition of
crude oil or natural gas, as defined in the Treaty, in the Treaty Regulations and in
the Oil Activities Law;
pp) “Long Term Real Rate of Return” – shall mean the rate calculated pursuant to
paragraph 4 of Article 8 of this law;
qq) “Service Fee”– shall mean any charges for Oil Accounts administration, management
and maintenance services, as well as by the investments of the Oil Revenues
deposited in such accounts;
rr) “Treaty” – shall mean the treaty dated as of February 21, 2001, between The
Federative Republic of Nigeria and The Democratic Republic of São Tomé and
Príncipe concerning the Joint Development Zone for petroleum and other
resources;
ss) “Union” – shall mean any permanent workers association formed to defend and
promote their social-professional interests;
tt) “Expected Present Value of Future Oil Revenues” – shall mean, for any period, the
amount calculated pursuant to paragraph 1(c) of Article 7 of this law;
uu) “Annual Funding Amount” – shall mean the amount to be transferred to the
Treasury Account pursuant to this Law;
vv) “Joint Development Zone” – shall mean the area defined for the purposes of the
Treaty;
ww) “Exclusive Economic Zone” – shall mean the maritime area as defined by Law No.
1/98, dated as of March 31, 1998;

TITLE
2. The terms listed above may be used in the singular or in the plural, provided the ad-
equate alteration, unless the context clearly indicates otherwise.
Article 2
(Scope of Application)
This law shall regulate the payments, management, use and oversight of oil revenues
resulting from oil operations in the entire national territory, including its terrestrial and
maritime areas, including the Exclusive Economic Zone and the Joint Development Zone
created by the Treaty.
Chapter II
Oil Accounts
Section I
General Provisions
Article 3
(Establishment of Oil Accounts)
1. The Central Bank, acting in the name of the State, shall establish and hold the Oil
Accounts with a Custody Bank selected by the Government pursuant to this law.
2. The Central Bank shall deliver to the Custody Bank upon execution of the Oil
Accounts opening and management agreement the Operation Rules, which
shall be an integral part of such agreement, and the Treasury Account number
into which the Annual Funding Amount shall be transferred.
Article 4
(Prohibition on Liens or Encumbrances)
1. Any and all acts are prohibited by the State or its Officials if such acts directly or
indirectly create, permit, assume, or promise the existence of public loans,
public bonds, security interests or any other liens or encumbrances relating to the Oil
Accounts or any other Oil Resources, whether existing or future, or related thereto.
2. The prohibition contained in paragraph 1 above shall not apply to financial charges
in connection with the maintenance and management of the Oil Accounts maturing
no more than one year after the date on which such lien is initially incurred.
3. Any attempt to violate paragraphs 1 and 2 above shall be null and void.
Article 5
(Operation Rules)
1. All transfers out of and in to the Oil Accounts shall be effected electronically.
2. The Central Bank shall prepare and present to the Government, who will submit
to the National Assembly for approval by statute the Operation Rules of the Oil
Accounts, which shall include:
a) Authorization for transactions and transfers between the National Oil Account
and the Permanent Fund;

b) Deadlines for transfers to the Oil Accounts;

c) Certification, registration and proof of transactions;
d) Authorizations for Oil Accounts investment transactions;
e) Payment of fees, commissions, emoluments, and other Service Fees for bank
services and operations;
f ) Other rules regarding deposits and remittance of oil revenues to the State.
3. Oil Accounts debt transactions will require signature of the following persons:
a) President of the Republic;
b) Prime-Minister;
c) Director of the Treasury and Patrimony;
d) Director of International Transactions of the Central Bank;
4. The contract referred to in paragraph 2 of Article 3 above shall provide that no
transfer of the Oil Revenues deposited in the Oil Accounts may be effected to
any bank account that is not held in the name of the São Toméan State, or any
other account not authorized by a law approved for that purpose by the National
Assembly.
Section II
National Oil Account
Article 6
(Deposits)
1. All monies owed to the State as Oil Revenue shall be deposited directly into the
National Oil Account by the Persons liable to pay such monies. The Central Bank
and other institutions that are currently or in the future in charge of the matter
shall approve all necessary regulations and instructions.
2. Any Oil Revenue shall be considered paid by the Persons when fully and effectively
deposited in the National Oil Account.
Article 7
(Forecast of the Oil Revenues)
1. No later than June 30 of each Year, the National Petroleum Agency shall calculate
and make public:
a) The expected average price of the oil barrel which shall be the average
international reference price of Brent FOB Sullom Voe publicly quoted in the
10 prior years, which reference price shall be adjusted by a price differential
resulting from the difference in quality between Brent and the different types
of São Tomé and Príncipe oil. The expected future average price for natural
gas shall be the reference future average price adopted in natural gas contracts
and adjusted pursuant to the terms set forth for oil.
b) The expected future sales of hydrocarbons by or on behalf of the State,
based solely in the production in the blocks under production or commercial
development and consistent with the production estimates updated by the
block operators.

TITLE
c) The Expected Present Value of Future Oil Revenues, as estimated by the sum
of the revenues deposited in the National Oil Account during the previous
twelve months ending on June 30 of such Year, plus the expected revenues
for all future Years, with the proper discounts. Expected future revenues shall
be estimated using the expected average future price of oil and natural gas, as
defined in paragraph (a) and the expected future hydrocarbons sales, as
defined in paragraph (b) of this article. A rate of not less than 7% shall be used to
discount expected future revenues.
2. The National Petroleum Agency shall submit the calculations in writing to the
President of the Republic, the National Assembly, the Government, the Governor
of the Central Bank, the Petroleum Oversight Commission, and shall effect the
respective registry.
3. Within 30 days from the date of submission of the calculations by the National
Petroleum Agency pursuant to this Article, the Petroleum Oversight Commission
shall check if the calculations were done according to the provisions of this law.
Article 8
(Determination of and Limits on the Annual Funding Amount)
1. The Government shall include in the proposed State General Budget an Annual
Funding Amount that shall be transferred out of the National Oil Account for
the expenditures set forth in Article 9 of this law, and which shall only be transferred
out of the National Oil Account to the Treasury Account after the definitive approval
of the State General Budget.
2. The Annual Funding Amount for 2005 will be as set forth in the National State
Budget as approved by the National Assembly.
3. In the following years, the Annual Funding Amount shall be subject to the following
limits:
a) Starting in 2006, for each Calendar Year until the end of the first Year after the
Production Commencement, the Annual Funding Amount shall not exceed the
greater of the following amounts:
I) 20% of the balance of the National Oil Account on December 31, 2005, as
estimated by the Central Bank;
II) 20% of the total estimated balance of the National Oil Account at the end
of previous Year, as estimated by the Central Bank;
III) Each Year, after the date of announcement of commercial hydrocarbon
discovery and after the assurance of production, the amount equal to
the total forecast balance for the National Oil Account at the end of the
immediately preceding Year, as estimated by the Central Bank, divided
by the number of remaining years until the end of the first Year after the
expected Production Commencement Year.
b) For each Year starting with the second Year after the Production Commence-
ment, the Annual Funding Amount shall not exceed be lesser of the following
amounts:

I) An amount equivalent to the sum of:

A) The Long Term Real Rate of Return multiplied by the balance of the
Permanent Fund on June 30 of the previous Year, and
B) The Long Term Real Rate of Return multiplied by the Expected Present
Value of Future Oil Revenues on June 30 of the previous Year.
I) An amount equivalent to the sum of:
A) The Long Term Real Rate of Return multiplied by the balance of the
Permanent Fund on June 30 of the previous Year, and
B) The balance of the unrestricted part of the National Oil Account on June
30 of the previous Year.
4. For the purpose of this Article, the Long Term Real Rate of Return shall be the
Real Rate of Return expected on a portfolio composed of assets proportionate to
the assets held in the Permanent Fund during the same period. The Long Term
Real Rate of Return shall never exceed 5%. The inflation adjustment shall use the
variation rates of the official price indexes of the currencies in which the Permanent
Fund asset portfolio is invested.
Article 9
(Allocation of the Annual Funding Amount)
1. The allocation of the Annual Funding Amount shall be decentralized with respect
to sectors and territory, and aimed at the elimination of poverty and the improve-
ment of the quality of life of the São Toméan people, the promotion of good
governance, and social and economic development. In addition, such allocation
shall be used, namely, to strengthen the efficiency and effectiveness of the State
Administration, to ensure a harmonious and integrated development of the
Country, a fair sharing of the national wealth, the coordination between economic
policy and social, educational and cultural policies, rural development, preservation
of the ecological balance, environmental protection, the protection of human
rights, and equality among citizens before the law.
2. The Annual Funding Amount may only be used pursuant to the policies and
actions defined in a national, regional or local development plan and a national
poverty reduction strategy.
3. Should the policies, plans and strategies referred to in paragraph 2 above not
be in place, the Annual Funding Amount shall be allocated essentially and in
first priority for the education, health, infrastructure and rural development
sectors, as well as in the strengthening of the State’s institutional capacity, as
proposed by the Government and approved by the National Assembly.
4. An amount not less than 7% of the Annual Funding Amount shall be annually
reserved to the public expenditures of the Autonomous Region of Principe.
5. An amount not less than 10% of the Annual Funding Amount shall be annually
reserved for the State share of local budgets, and shall be distributed pursuant
to the Local Finance Law.
6. The allocation of the reserves provided in this article shall be part of the State
General Budget. The National Assembly shall approve budgetary and accounting
procedures and mechanisms that are sufficient to ensure efficient monitoring of
such use.
7. The proposals for the allocation of the Annual Funding Amount shall be
accompanied by explanatory reports.

TITLE
Section III
Permanent Fund of São Tomé and Príncipe
Article 10
(Permanent Fund)
1. No later than the first Production Commencement Year, the Central Bank shall
establish a sub-account of the National Oil Account that shall constitute the
Permanent Fund, and whose transactions may only be effected pursuant to the
following paragraphs.
2. No later than January 31 of each year starting in the second Year after the
Production Commencement, and after the transfer from the National Oil Account
of the Annual Funding Amount and the Service Fees owed, the balance of the
National Oil Account on June 30 of the previous Year shall be transferred to the
Permanent Fund.
3. After the Production Commencement, any Extraordinary Oil Revenue deposited
in the National Oil Account shall be transferred to the Permanent Fund within 30
days from the date of such deposit.
4. No later than January 31, as from the second Year after the Production Commence-
ment, an amount not greater than the amount set forth in subparagraphs (b)(I)(A)
and (b)(II)(A) of paragraph 3 of Article 8 of this law may, if necessary, be transferred
from the Permanent Fund to the National Oil Account for the payment of the Annual
Funding Amount.
5. Any and all transfers of Oil Revenues deposited in the Permanent Fund in
violation of paragraph 4 above shall be prohibited and shall be null and void,
without prejudice to the transfers explicitly and exclusively authorized for
investments pursuant to the Operation Rules and the Management and
Investment Policy.
Section VI
Management and Investment of the Oil Accounts
Article 11
(Management principles and rules)
The management and investments of the Oil Revenues deposited in the Oil Accounts
shall be the responsibility of a Management and Investment Committee, which shall
act according to the Prudent Investor Rule, following the principles and rules set forth
in this law and in the Management and Investment Policy.
Article 12
(Management and Investment Committee)
1. A Management and Investment Committee shall be established, chaired by the

Minister of Planning and Finance and also including the Governor of the Central
Bank as the deputy chair, and three other members, one appointed by the
President of the Republic and the other two appointed by the National Assembly,
one of the latter appointed by the opposition parties.

2. The Persons appointed by the President of the Republic and the National
Assembly shall be nationals, individuals or legal entities, resident or legally
represented in São Tomé and Príncipe, and shall have proven previous experience
in managing international investment portfolios.
3. Each one of the members appointed by the President of the Republic and the
National Assembly shall serve a two-year term commencing on the date of the
respective appointment, renewable only once for an identical period.
4. In case of vacancy, the new member shall commence a new term.
5. The Management and Investment Committee may only meet if the majority of
its members is present, and decisions shall depend upon the affirmative vote of
at least three of its members.
6. The members of the Management and Investment Committee, with the exception
of the Minister of Planning and Finance and the Governor of the Central Bank,
shall be paid a fee to be fixed by the Government, and shall receive no other
remuneration other than reimbursement of previously authorized expenses.
7. The Management and Investment Committee shall establish its internal operating
rules, subject to the approval of the National Assembly.
8. The State General Budget shall include an allocation for the annual budget of
the Management and Investment Committee.
Article 13
(Management and Investment Policy)
1. The Management and Investment Committee shall design and propose to the
Government, which shall submit it for approval by the National Assembly, the
Management and Investment Policy which shall meet on the following objectives:
a) Sufficient investment liquidity to ensure the availability of cash for the Annual
Funding Amount;
b) Maximum profitability of the Permanent Fund of São Tomé and Príncipe,
subject to specified levels of acceptable risk for the investment horizon;
c) Transparent, modern and diversified management of the financial assets
that are part of the investment portfolio of the Oil Accounts.
2. The Management and Investment Policy shall apply to each one of the Oil
Accounts and shall include, at a minimum:
a) The types of permitted investments, including categories of assets and
instruments;
b) Minimum required ratings and classifications for permitted high-risk
investments, based on classifications proposed by expert firms of international
reputation;
c) The rules relating to asset diversification by sector and issuer;
d) The rules to determine and monitor market risks, notably currency risks and
interest rates risks;
e) The acceptable level of market value fluctuation during the term of the
investment;
f ) The rules established to ensure sufficient liquidity according to the Annual
Funding Amount requirements.

TITLE
3. The National Oil Account investments shall be held only in internationally

convertible currency, in the form of the following instruments:
a) Cash bank deposits with an Approved Bank;
b) Negotiable direct obligations issued by any Approved Foreign Government;
c) Securities issued or directly guaranteed or insured by any Approved Foreign
Government, maturing no later than two years after the date of acquisition,
provided that the full faith and credit of such Approved Foreign Government is
pledged in support thereof;
d) Bankers’ acceptances, and floating rate certificates of deposit issued by the
Approved Bank, maturing no later than two years after the date of acquisition;
e) Investment funds, the assets of which shall comprise securities of the type
described in sub-paragraphs (a) and (c) above, regardless of the maturity date
of such assets;
f ) Other financial instruments of similar risk, profitability and liquidity to the ones
referred to in the preceding sub-paragraphs, as approved by the Management
and Investment Committee.
4. The Management and Investment Committee may delegate to managers
specialized in investments the operational aspects of their powers and duties.
5. It is prohibited to invest the Oil Revenues deposited in the Oil Accounts in
investments domiciled27 in São Tomé and Príncipe, or in any investments controlled
directly or indirectly, totally or partially, by any national Person, whether or not
resident of São Tomé and Príncipe, or who falls within the circumstances described
in paragraph 1 of Article 30 of this law.
Chapter III
Auditing
Article 14
(Annual Audits)
1. The management and activity of the National Oil Account, including all investments,
deposits, withdrawals and transfers, shall be subject to two annual audits, one by
the Auditor General and the other, external and independent, by an international
auditing firm, and such audits shall be concluded within six months of the end of
each audited Year.
2. The audits referred to in paragraph 1 above shall assess compliance with this
law and with other laws relating to the financial administration of the State, the
Investment Policy, the Operation Rules, as well as all other rules relating to the
Oil Accounts management and operation in the previous Year, namely, any
investments, deposits, withdrawals and transfers.
3. Audit reports shall be simultaneously sent to the President of the Republic, the
National Assembly, to the Government, to the Petroleum Oversight Committee,
to the São Tomé and Príncipe’s Solicitor’s Office and to the Public Registration and
Information Office, within 30 days upon completion, under the terms of this article.
27
Translator’s Note: Original Portuguese version refers to “investments domiciled” (sic.) in the country, likely meaning investments
“located” in the country or “companies” domiciled in the country.

4. The reports mentioned in paragraph 3 of this Article shall include, necessarily, all
documents, notes and observations that contribute to the full understanding of
such reports.
Article 15
(Selection of the Auditing Firm)
1. The auditing firm shall be selected by the Petroleum Oversight Commission

pursuant to competitive public procurement open to internationally recognized
accounting firms with international experience.
2. Without prejudice to the requirements of paragraph 1 above, the competing
audit firms shall present proof of their technical competence to audit corporations
listed in official stock markets, according to international auditing and accounting
standards.
3. The provisions of Article 22 shall be applicable accordingly.
Article 16
(Public Debate)
1. After the beginning of each legislative session, the National Assembly shall schedule
and debate, in separate plenary sessions, according to its internal organization:
a) General policy concerning hydrocarbons, to which members of the Government
shall be present to answer the Deputies’ questions and clarification requests;
b) The Oil Accounts audit reports, to which the ministries in charge of finance
and hydrocarbons matters, the members of the Management and Investment
Committee, the Governor of the Central Bank, the President of the Auditor
General, the President and the members of the Petroleum Oversight
Commission, one administrator from the external auditing firm that should
have participated in the audit, the Executive-Director of the National Petroleum
Agency, shall all be present and shall have the right to address the floor.
2. The topics mentioned in paragraph 1 above shall be discussed with civil society
in public sessions organized by the Petroleum Oversight Commission prior to the
debates at the National Assembly.

TITLE
Chapter IV
Public Integrity
Section I
Transparency and Publicity
Article 17
(Transparency)
1. All payments, management, use and investment of Oil Revenues or Oil Resources
shall be subject to the transparency principle.
2. The transparency principle implies disclosure of, and public access to, namely:
a) Payments and respective receipts, management, and debit and credit
transactions, as well as balances of the Oil Accounts;
b) The agreement for the opening and management the Oil Accounts entered
into between the Central Bank and the Custody Bank;
c) The distribution of revenues arising out of the oil activity carried out in the
Joint Development Zone;
d) The Operation Rules of the Oil Accounts and any amendments thereto;
e) The forecast of Oil Revenues prepared by the National Oil Agency;
f ) All liens and encumbrances levying on the Oil Accounts, as permitted under
paragraph 2 of Article 4;
g) Reports and other audit-related documents prepared by the Auditor General
and the auditing firm with respect to the management and execution of the
Oil Accounts;
h) The Investment Policy concerning the Oil Accounts;
i) The annual report of the Petroleum Oversight Commission;
j) All budgets that benefit from transfers from the Annual Funding Amount,
including the State General Budget and the Joint Development Authority
Budget;
k) All contracts relating to the participation of the State or any enterprise or
entity owned or controlled in whole or in part by the State, the scope of
which directly or indirectly concerns activities related to Oil Resources or
Oil Revenues;
l) Conflict matters as described in Article 30, as well as related lawsuits and
sanctions.
3. All activities subject to the transparency principle shall be made public through
a website in the Internet for inquiry purposes.
Article 18
(Public Registration and Information Office)
1. A Public Registration and Information Office shall be established, where all

documents and information about activities related to Oil Resources and to the
management of the Oil Revenues mentioned in the previous Article shall be filed,
compiled, kept and made available to the public.

2. The documents and information referred to above shall be submitted for filing
purposes to the entity in charge of the organization and maintenance of the
Public Registration and Information Office, by the entities of the State Administra-
tion or Persons responsible for the elaboration, submission, receipt or approval
of such documents and information, within ten business days of the occurrence of
the event subject to registration.
3. The organization and maintenance of the Public Registration and Information
Office shall be under the responsibility of the National Assembly.
4. A special law shall regulate the establishment and operation of the Public
Registration and Information Office.
Article 19
(Publicity and Access to Information)
1. Information subject to transparency shall be conveyed in such a way that an

addressee with basic comprehension and knowledge can apprehend its meaning
and scope, and such information shall:
a) Be presented in the Portuguese language;
b) Be complete, whole, clear, objective, truthful and current;
c) Be of universal and free access.
2. Without prejudice to the universal and free access to information, the Government
shall regulate the forms of public disclosure and access, and shall establish the
fees for the provision of certificates, shipping or copies, as well as the time for the
information to be obtained and the guarantees of the public access to information.
Section II
Oil Contracts
Article 20
(Confidentiality Clauses)
1. Confidentiality clauses or other mechanisms included in Oil Contracts or in any

other transaction instrument concerning any Oil Revenue or Oil Resource that
prevent or attempt to prevent access to documents and information pursuant
to Article 17 of this law shall be null and void, and contrary to public policy.
2. Information concerning proprietary industrial property rights shall be exempted
from the scope of mandatory disclosure to the extent that confidentiality in such
cases is protected by a national law, by the Treaty, by the Treaty Regulations or by
any an international law.
3. In no case shall the provision of the above paragraph apply to any financial
information.
4. Any Person intending to avail itself of the protection granted in the above
paragraph shall have the burden to prove its right to confidentiality protection
pursuant to the rules of evidence applicable to documents contained in the Civil
Code.

TITLE
Article 21
(Implicit contract clauses)
1. All Oil Contracts or other transaction instruments concerning Oil Resources or

Oil Revenues shall contain, and in the absence thereof shall be construed to imply,
the following provisions:
a) “No loan, reward, advantage or benefit of any kind has been given to any
Official or to any person for the benefit of such Official or person or third
parties, as consideration for an act or omission by such Official in connection
with the performance of such person’s duties or functions or to induce
such Official to use his or her position to influence any acts or decisions
of the Administration with respect to this Agreement. Any breach of this
representation shall cause this Agreement to be invalid and voidable by the
State Administration”;
b) “The validity and effectiveness of this agreement shall be subject to the full
compliance with all applicable administrative procurement rules relating to
State contracting.”
c) “This Agreement is elaborated and filed in the Portuguese and English
languages, in case of non-conformity, the Portuguese language version shall
prevail”;
d) “This Agreement shall be made public and a copy hereof shall be provided
to the Public Registration and Information Office within 10 days from its
execution”.
Article 22
(Public Competition)
1. All Oil Contracts or other transaction instruments to be entered into with the
State Administration concerning Oil Resources or Oil Revenues, services relating
to Oil Resources or in any way related to the oil sector or related activities, shall
be preceded by public competitive tender pursuant to general law.
2. In the absence of legislation applicable to public tender, Oil Contracts or any other
instruments mentioned in paragraph 1 above shall be approved by the Petroleum
Oversight Commission prior to execution.
3. All Oil Contracts or other transaction instruments mentioned in paragraphs 1 and 2
above shall be made public by the State or by any Person, no less than ten days prior
to execution, without prejudice to the terms of paragraphs 2, 3 and 4 of Article 20.
4. Oil contracts and other transaction instruments entered into in violation of this
Article shall be considered void and without any effect, without prejudice to the
liability of Officials and Persons perpetrating such violation.
5. The provisions of this Article shall not exempt any Person or State Administration
Official of any legal obligation, except those obligations that are not consistent
with this Article.

Chapter V
Ensuring Public Oversight and Enforcement
Section I
Petroleum Oversight Commission
Article 23
(Establishment of the Petroleum Oversight Commission)
1. A Petroleum Oversight Commission having legal entity status and administrative

and financial autonomy shall be established to ensure the permanent oversight of
all payment, management and use of the Oil Revenues and Oil Resources.
2. The Petroleum Oversight Commission shall be composed of eleven members,
appointed or elected as follows:
a) One member appointed by the President of the Republic;
b) Three representatives of the National Assembly, one necessarily appointed
by the parliamentary groups from the opposition;
c) One counselor judge with at no less than five years of professional experience,
appointed by the Superior Judiciary Council;
d) One representative from the Autonomous Region of Principe;
e) Two representatives from local governments;
f ) One representative from Business Associations;
g) One representative from the Unions;
h) One representative from Non-Governmental Organizations.
3. The decisions of the Petroleum Oversight Commission shall require the affirmative
vote of at least six of its members.
4. The organic law regulating the Petroleum Oversight Commission shall regulate the
form of appointment and dismissal of the members of the Petroleum Oversight
Commission, the duration of their terms, their compensation, and internal rules and
conflicts of interests, as well as the organization and operation of the Petroleum
Oversight Commission.
Article 24
(Authority and Powers of the Petroleum Oversight Commission)
1. Without prejudice to the oversight powers provided by the law to other government
bodies, the Petroleum Oversight Commission shall have the authority to oversee
the compliance of all activities with this law, namely:
a) The verification and regularity of the expenditures of the Annual Funding
Amount;
b) Management and investment of Oil Revenues, including the exchange
operations to the credit and debit of the Oil Accounts and their respective
flow of funds in accordance with the Operation Rules and the criteria defined
in the Investment Policy;
c) The enforcement of the transparency rules;
d) The external auditing firm’s audit;
e) The certification of the Production Commencement date.

TITLE
2. To carry out its duties, the Petroleum Oversight Commission shall have the power to:
a) Request relevant information and documents from any Person;
b) Inquire about violations of any nature related to oil resources or oil revenues;
c) Initiate investigations and inquiries based on its own knowledge or on third
parties’ complaints of irregularities or violations of the requirements of this
law;
d) Carry out searches, inspections, and seizure of any documents or personal
property that are the object, tool, product of any infraction, or that are
necessary to the opening of the respective process;
e) Present reports that may include detailed description of any act subject to
oversight, the investigation process, and inquiries initiated and closed, as
well as recommendations as to the appropriateness of the adoption of new
procedures;
f ) Hear, judge and enforce administrative proceedings and minor infractions
consisting of violations of this law;
g) Report to the competent authorities any irregularities or apparent violations
of the provisions of this law that are subject to disciplinary, civil or criminal
sanctions;
h) Act as a party to judicial actions.
Section II
Ensuring the Enforcement of the Law
Article 25
(Mechanisms for law enforcement)
The mechanisms to ensure the enforcement of this law shall be defined by a special
law, which shall regulate, in particular, the civil, criminal, and administrative
responsibilities for acts performed in violation of the requirements of this law.
Article 26
(Public Prosecutor’s Office and Police Authority)
1. Upon knowledge of violation of this law, the Public Prosecutor’s Office shall on
its own motion initiate judicial action to enforce the responsibilities of Officials or
Persons pursuant to the Public Prosecutor’s Office’s organic law, as well as criminal,
civil, and other applicable law.
2. Police authorities shall cooperate as may be requested by the Petroleum Oversight
Commission in the exercise of its oversight functions.

Article 27
(Injunctions)
1. At any time prior to the issuance of a final decision, a governmental body with
decision-making authority shall on its own motion, or upon request, issue any
necessary injunction in case of a justifiable fear of grave injury to the public interest
which would be difficult to repair.
2. Any decision to issue or amend any injunction shall set out the grounds therefore
and the term of any injunction shall be fixed.
3. The grounds for the revocation of any injunction shall also set out the grounds
therefore.
4. The appeal of injunctions shall stay the effectiveness of the appealed decisions,
except when the appellate body shall determine otherwise.
5. Except as expressly provided otherwise, any injunction shall expire:
a) When a definitive decision is made;
b) If the fixed term of the injunction or its extension has expired;
c) If the deadline for a definitive decision has elapsed;
d) If the injunction is revoked by a judicial decision that becomes res judicata.
Article 28
(Court actions)
1. Any Person whose rights are protected under this law may appeal final decisions
made by any Administration body to judicial courts with jurisdiction.
2. Any appeal filed pursuant to paragraph 1 above shall stay the appealed decision
unless such stay results in grave injury to public interest and the court so declares
in a reasoned decision.
3. In the case of appeal of decision made by the Petroleum Oversight Commission
in the exercise of its oversight power, it is presumed that any stay of any Petroleum
Oversight Commission’s decision constitutes grave injury to public interest.
Chapter VI
Final Dispositions
Article 29
(Joint Development Authority)
1. Without prejudice to the provisions of the Treaty, the provisions of this law shall
apply to all Oil Revenues of the State arising out of the Joint Development Zone
and all State Administration Officials or any other Person employed, hired, or
otherwise acting on behalf of or representing the São Toméan State Administration
in the Joint Ministerial Council or in the Joint Development Authority.

TITLE
2. In particular, such Persons and Officials mentioned in paragraph 1 above shall act
so as to implement, jointly with the Federative Republic of Nigeria, the Abuja Joint
Declaration as applicable to the Joint Development Authority.
3. All information that shall be made public pursuant to the Abuja Joint Declaration
shall also be made public in accordance with paragraph 3 of Article 17 and
paragraph 2 of Article 18 of this law.
4. In no case shall the State make any financial contribution to the budget of the
Joint Development Authority or carry out any other obligation under the terms
of the Treaty, without the approval of the National Assembly.
Article 30
(Conflicts)
1. No Person may be appointed or stay in office if such Person holds, directly or

indirectly, on its own or through a third party, any economic, financial,
participatory or other interest in activity related to Oil Revenues, or if such Person
serves on boards, or is a representative, attorney-in-fact, agent or commissioner
of, or otherwise represents any Person in which the Oil Revenues deposited into
the Oil Accounts are held or invested.
2. Any Person in a situation described in paragraph 1 of this Article shall refuse his
or her nomination, or shall resign from the position he or she has been appointed
to, as the case may be.
3. Any person or entity who nominates, appoints, accepts or serves terms with the
State Administration having knowledge of a conflict as described in paragraph 1
of this Article shall be punished with a fine equivalent to three times the amount
such Person earned as compensation from the time he or she engaged in such
activity until the time the conflict was uncovered.
4. Any Official who, due to the interest or resulting from his or her appointment,
receives directly or through a third party, by any way or nature, an economic
advantage from the violation of the provisions of this Article, will be punished
with a fine equivalent to three times the economic advantage received.
5. In addition to the fines prescribed in this Article, the Official shall disgorge to
the State the amount equivalent to the economic benefit including all proceeds
earned by him or her or by a third party in connection with the violation.
6. Attempted violations shall always be punishable with a fine equivalent to half of
the fine established for the consummated illegal act.
Article 31
(Violation of the law)
1. Until the law defined in Article 25 is approved, and without any prejudice to the
penalties explicitly prescribed by this law, any violations of this law that constitute
either a crime or a misdemeanor shall have their minimum terms increased by
one third if related to Oil Resources or Oil Revenues.
2. For the purposes of this law, the daily fine is equivalent to the amount of three
national minimum wages in effect at the time when the action or omission occurs.

3. Any violations of the mandatory provisions of this law shall be void and shall
not bind or produce any legal effect against the State, except for the rights of
bona fide third parties, as provided for and protected under applicable law, and
the liability of Officials.
Article 32
(Secondary Application)
Matters not specifically addressed in this law or in regulations pursuant to this law shall
be subject to the rules applicable to analogous matters specifically subject to this law and
regulations pursuant to this law. In the absence or insufficiency of rules in this law and in
regulations pursuant to this law, such matters shall be subject, by secondary application,
to the provisions of the Oil Activities Law.
Article 33
(Effectiveness)
This law shall become effective five days after its publication in the Official Gazette.
Approved by the National Assembly of São Tomé and Príncipe on November 26, 2004. –
The acting President of the National Assembly, Jaime Jose da Costa.
Promulgated on December 29, 2004.
For publication.
The President of the Republic, Fradique Bandeira Melo de Menezes.

TITLE
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Cambodia
United Nations Development Programme
No. 53, Pasteur Street
P.O. Box 877
DECEMBER 2008
Phnom Penh
Cambodia
www.un.org.kh/undp

Cambodia: The Global Petroleum Context: Opportunities and Challenges Facing Developing Countries

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Cambodia: The Global Petroleum Context: Opportunities and Challenges Facing Developing Countries

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Insights for Action Initiative

The global petroleum context :

Discussion Paper No. 6

3. Knowledge into Action:

© 2009, UNDP Cambodia

March 2008, Phnom Penh, Cambodia

UNDP Funded Discussion Paper No. 6

I. The global petroleum context ................................................................................3

II. Pre-production challenges ...................................................................................17

III. Costs/benefits of oil refineries and other downstream industries ....................83

UNDP Discussion Paper No. 6 i

AAPG American Association of Petroleum Engineers

UNDP Discussion Paper No. 6 iii

OGRA Oil and Gas Regulatory Authority (Pakistan)

iv UNDP Discussion Paper No. 6

The conference proved to be an important forum for the Cambodian Government

UNDP Discussion Paper No. 6 1

2 UNDP Discussion Paper No. 6

I. The global petroleum context :

Optimal macroeconomic policy in a resource

UNDP Discussion Paper No. 6 3

Opportunities and challenges facing developing countries

It is not necessarily a blessing for a country to be endowed with petroleum resources.

UNDP Discussion Paper No. 6 5

Norway is now passing on its experience as an industrialized, petroleum-endowed

Increasing energy demand

6 UNDP Discussion Paper No. 6

Heightened energy consciousness

Add to that the political imperative of a developing country government to lift a

UNDP Discussion Paper No. 6 7

New energy era

Global energy policy interrelationship

8 UNDP Discussion Paper No. 6

Multi-polar energy world

UNDP Discussion Paper No. 6 9

Let me sum up with some main messages:

10 UNDP Discussion Paper No. 6

Optimal macroeconomic policy in a resource boom:

Key macroeconomic issues in a resource revenue boom

Regarding quality, growth should also be assessed in terms of employment generated

UNDP Discussion Paper No. 6 11

As is now fairly well known, a review of the growth performance of developing

12 UNDP Discussion Paper No. 6

One also observes considerable variation when comparing countries in terms of

Macroeconomic factors underlying the paradox of plenty

UNDP Discussion Paper No. 6 13

This loss of competitiveness and eventual contraction of the non-petroleum tradable

In addition to a gradual shrinking of the sectors that generate livelihoods and

Such volatility in finance can be further exacerbated if governments undertake foreign

In a number of resource-rich developing countries, other sources of instability have

14 UNDP Discussion Paper No. 6

Minimising Dutch disease

UNDP Discussion Paper No. 6 15

Spending on carefully selected domestic investment goods of course depends very

16 UNDP Discussion Paper No. 6

II. Pre-production challenges

Legal frameworks used to foster petroleum development

International petroleum fiscal systems

How to negotiate the “right” petroleum contract

Establishing an effective regulatory authority:

UNDP Discussion Paper No. 6 17

Progress in the development of a regulatory framework for