Legal Aspects of Oil & Gas Industry Assignment Sample

Introduction - Legal Aspects of Oil & Gas Industry

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The bargaining power between both sides may differ in strength based on several factors. The host may be having a stronger bargaining power than the oil company or the other way round. The oil company's bargaining power is higher in cases where it has resources that are imitable and scarce. In this case, the government doesn't have another option to consider apart from the said company (McMillan and Waxman, 2007). Their bargaining power also increases when a company has better financial resources and capital. The international oil companies also have a high bargaining power in cases where the oil prices are low. This is likely to happen in case the other means of revenue generation by the host government is not able to meet its investment requirements. This means that it is in much need of money to drive its projects and now with the oil reserve, it invites the international oil company which takes advantage of the host country's situation. On the other hand, the host country can have a stronger bargaining power in case the oil prices are high. In this case, the host country may be selling a lot of oil already and generating enough revenue from the sales enough to drive its projects. Without much thirst of the money, the host country will, therefore, have a stronger bargaining power. An oil company can also be having higher bargaining power in case the host country is a developing one. When a country is developing it is usually in need of foreign direct investment to access better technology and better managerial skills. An oil company in this case with better technology and better managerial skills will have a strong bargaining power (Slaski, 2016).

The size of the oil reserve is also another factor that contributes to the bargaining power. A host government with large deposits of oil will have a stronger bargaining power compared to that of the international oil company. This is because of the larger the reserve, the longer it will last and the better profits (Vivoda, 2011a).

The location of the host country is also a great determiner of bargaining power. A country with ease of access when it comes to transporting the oil means that the profits will be more because it will cost less to transport. A good example is the use of water transport compared to land transport. Water transport is cheaper than land transport. A landlocked country will use land as a means of transport increasing the cost of production of crude oil thus minimizing the profits. The international oil companies will prefer a country with more potential profits for the same amount of oil produced. This makes such a country to possess stronger bargaining power because many companies will be willing to go and invest there.

An international oil company (IOC) can also have a better bargaining power than the host government in case it has a more profitable option elsewhere. The previous IOC contract with another country is also a determiner of its bargaining power. If the contract was not very much favorable to the company, the chances are that the next contract will also be unfavorable (Slaski, 2016). The same case also applies to the host country. If it had entered into contracts with other IOC that were not favorable to them (host country), it is likely that the next contract won't be very different from the previous (Eden & Molot, 2002). 

An IOC with a better international reputation also has a better bargaining power. For instance, a company like BP is known for oil spin in the Gulf of Mexico. This tarnishes its international reputation and thus it would have a lower bargaining power compared to other companies of the same caliber but have not committed such a mistake. A company which is a member of organizations such as the Extractive Industry Transparency Initiative also has a better bargaining power compared to the ones which are not a member of the same (Vivoda, 2011b). This is because such organizations increase the international reputation of a company.

An IOC with a potential of providing external markets for crude oil can also have a better bargaining power than the host country. For instance, Iran is banned from exporting its oil to the US market, but Iran still needs to sell its oil. An oil company that can be able to sell the Iranian's oil to the external market can have a better bargaining power than the Iranian government. Bargaining power of an IOC is also a factor of its country of origin. If the origin country is politically stable and economically powerful, then the company's bargaining power is likely to be stronger. This is because people tend to have a perception that the better the political and economical stability a country has, the better the services it can provide. The overall size of the company also dictates its bargaining power. Large companies like Shell, Total, Chevron, BP, ExxonMobil just to mention a few are said to have strong bargaining power compared to the host countries.

The bargaining power of a host government is also stronger than the IOCs whenever two or more companies can be able to offer the same service. This usually happens in a case where all the companies have good capital, better technology and access to markets as well. The government, in this case, will thus choose the company that will bring the most favorable outcome (Eden & Molot, 2002). A host country's bargaining power also becomes stronger if the resource is becoming scarce. For instance, there has been a perception that oil is becoming scarce as time progresses; this perception increases the bargaining power of the host country. Alternatively, the opposite is also possible when the oil is abundant; the IOCs have more bargaining power compared to the host country (Slaski, 2016). Host countries bargaining power can also increase if the countries with large deposits come together and agree to increase the taxes that would mean that their bargaining power would be stronger. An oil producing country with a growing domestic market for crude oil has a stronger bargaining power than the IOC. This is because the host country can choose to sell its oil products to the domestic customers and thus for the IOC to win the contract it will have to provide better profits than the domestic market.

The legal context of a host country can also have a negative effect on the bargaining power of the country. For instance, if the host country does not offer any investment protection to an international oil company which is willing to work with the country for a long term, this will mean that fewer companies will be willing to work in the country lowering its bargaining potential. The bargaining power of a host country can also be affected negatively if there has been a legal battle over some terms and conditions in the past between the host country and international oil companies.

The international environment and interdependence affect the way a host government exercises its power to the oil companies affecting its bargaining power. Some international agreements agreed between nations can favor the IOCs strengthening their bargaining power. Multilateral organizations also have rules which play a big part in limiting the bargaining power of a host country. The power to bargain can also be affected by the financial state of the host country. For example, a country with a huge external debt demands higher FDI, but it may have limited freedom to bargain because of the conditions from international financial organizations or international banks. There are also some treaties that are there in the oil industry that give the IOCs more confidence while bargaining. Examples include; multilateral treaties, bilateral investment treaties, political risk insurance among others. These agreements make it possible for the IOCs to recover compensation from the host governments in case they suffer losses from expropriation. With such agreements, the host government is thus cautious when dealing with the IOC, and this fear can reduce its bargaining potential.

A host country that is a member of international organizations such as the Organization of the Petroleum Exporting Countries (OPEC) has a stronger bargaining power. This is because one of the reasons why OPEC was formed is to share the pricing formulas information. It was also formed to help come up with strategies that might favor the host countries regarding negotiations. The way a host country depends on the foreign direct investment can also affect its bargaining power negatively. This is usually in the case when the country is in fear that it may push away future investors if it pushes the IOC too hard. The host country's political system can also affect its bargaining power. For instance, decentralized democratic governments are said to be more vulnerable that they can be influenced by domestic groups while centralized governments are not easily influenced. The list of the factors that affect the bargaining power of both the IOC and the host country is endless, but our main focus has been the most occurring and trending factors that influence the bargaining power.

Having considered all the factors that surround their potential contract, the two parties then sit down and bargain with a goal of reaching an agreement. If no agreement is reached, then there is no contract, and the IOC does not enter the country. If an agreement is reached, it means the IOC and the host country will enter into a contract, and the outcome is known as a cooperative bargaining outcome. This outcome, however, is bound by terms and conditions agreed upon. In case the IOC is the one that came out with the stronger actual bargaining power relative to the host country, then the investment terms and conditions and preferable bargaining outcome will be in its favor. However, this also depends on the negotiating skills and capabilities of both parties' negotiators. An IOC may be having stronger actual bargaining power, but the preferred bargaining outcome favors the host government just because the government officials were more experienced and with better-negotiating skills than the IOC negotiators.

Conclusion

The starting point of a potential bargaining is where the two parties show interest in each other's distinct resources. During the process, the goal is to reach an agreement where both parties benefit. In this case, each party works hard to reach an agreement that is maximizing its profits. However, as seen above, there are many factors which determine the amount of share each party receives. During this process, each party will learn about the other party's strengths and weaknesses as well as strategic preferences (Vivoda, 2011a). If the bargaining process goes as planned, the parties reach an agreement and later enter into a contract that benefits them.

References

• Eden, L. and Molot, M.A. (2002) ‘Insiders, outsiders and host country bargains', Journal of International Management, 8(4), pp. 359–388. doi: 10.1016/s1075-4253(02)00095-9.
• McMillan, M. and Waxman, A. (2007) Profit sharing between governments and multinationals in natural resource extraction: Evidence from a firm-level panel. Available at: http://emerald.tufts.edu/~mmcmilla/papers/ProfitSharing.pdf (Accessed: 24 November 2016).
• Slaski, X. (2016) Multinational oil firms and host country bargaining power in Latin America. Available at: http://scholar.princeton.edu/sites/default/files/aslaski/files/slaski_jmp.pdf (Accessed: 24 November 2016).
• Vivoda, V. (2011a) ‘Bargaining model for the international oil industry', Business and Politics, 13(4). doi: 10.2202/1469-3569.1384.
• Vivoda, V. (2011b) ‘Bargaining model for the international oil industry', Business and Politics, 13(4). doi: 10.2202/1469-3569.1384.