Finding the right approach
Pitching the terms at the right level can be a precarious business. Set the terms too low and the Government Share may not appear fair if large discoveries are made and/or prices return to high levels. This could prompt retroactive changes to terms and create an environment of fiscal instability. But demand too much and companies will not turn up, wasting the government's time, money and reputation in a failed licensing round.
Bidding fiscal terms
Some governments try to get round this by making a key element of the fiscal terms a bidding variable. Mexico, for example, makes licence awards based on the royalty or profit share rates that are bid for different blocks. This can establish the true market rate for the areas, but it can also carry risks.
Some companies may bid unrealistic rates in order to secure the licence, with a view to re-negotiating them later. Or they may have simply not done any economic assessment. Either way the government has a dilemma: accept the highest bid and expect to have to re-licence or ne-negotiate later because the terms will not support economic development of discoveries. Or refuse the high bid and award to a company with a lower, workable bid. The latter is difficult to explain to the public, which may well cry foul and accuse the regulator of corruption. And the process gets more complex when multiple variables are included as bid items, as they have been in several African countries.
Does transparency constrain flexibility?
The alternative is to bring discussions about the fiscal terms behind closed doors. This allows the government to negotiate a deal with the company it likes best for each block. This might follow an open licencing process where companies have to meet certain criteria and minimum commitments on future work. The preferred company is then invited to negotiate a commercial agreement. Or the government can simply enter direct negotiation with interested companies from the outset. However, this is the least transparent approach.
Adjusting to a new transparency
Of the 148 jurisdictions reviewed in our recently published fiscal study, half award licences through bid rounds, 30% directly negotiate terms with companies and the remainder operate a combination of the two policies. Public scrutiny of commercial agreements has increased in recent years and transparency has become a goal for many governments. But this also creates hurdles to getting the right terms.
Fair share, prospectivity, costs, transparency, competitiveness. All have to be considered when deciding on a licensing and fiscal policy and there are pros and cons to each approach. Those that get the balance right will be the winners.