Factors Affecting Legal Aspects of Oil & Gas Industry Bargaining

This essay delves into the legal aspects of the oil and gas industry, with a specific focus on the dynamics of bargaining power between host governments and international oil companies (IOCs). It identifies key factors that influence the relative bargaining strength of each party before entering into contr...Read More

Legal Aspects of Oil & Gas Industry A229625
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LEGAL ASPECTS OF OIL & GAS INDUSTRY A229625
Table of Contents
Introduction.................................................................................................................................................3
Understanding the Relative Bargaining Power............................................................................................3
Conclusion...................................................................................................................................................9
References.................................................................................................................................................10

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LEGAL ASPECTS OF OIL & GAS INDUSTRY A229625
Introduction
The ability of parties in a situation, for instance, an oil contract to exercise influence over each
other is called bargaining power. Before oil companies get into a contract to explore and produce
a natural resource in an individual foreign country, the company must have agreed upon some
things with the host government. The main reason of having these agreements is to ensure that
both parties share the profits from the oil equitably. However, during the negotiations so as to
enter into the contract, the oil company may feel as if it is being charged too much tax whereas
the government feels like it's charging too little tax. The citizens may also feel like no tangible
benefits are coming from the taxes paid by the companies (McMillan and Waxman, 2007). In
this essay, the primary focus is to understand factors that affect the relative bargaining power of
the host government and the oil company bidding to enter into the contract.
Understanding the Relative Bargaining Power
Before the host government and the international oil get into a contract, certain conditions
determine the bargaining power of both parties. For the oil company to have a bargaining power
which will generate enough profits for its sustainability, it must have resources that are valuable,
rare, and not easily imitable and lack equivalent substitutes (Eden & Molot, 2002). In other
words, either the oil company or the host government must possess something that the other
party wants e.g. the raw materials, capital, technological knowhow, managerial skills just to
mention a few. Without these entry conditions, it is not possible to have a mutual benefit
between the two parties.
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.

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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

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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.

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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

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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

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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

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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.

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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.