This is a critical stage of negotiations, especially for governments in developing countries. The Pre-negotiation stage refers to the period during which a government identifies a particular project or investment and conducts feasibility studies and impact assessments. Before this stage, the government may wish to undertake research on potential investors to understand issues such as the depth of their expertise, their policy for engaging with local communities, their approach to and track record on social responsibility, their safety record and, importantly, their financial capabilities. This due diligence process is particularly important if the national mining and petroleum codes are not comprehensive, as in this case gaps will be governed by the contract/licence terms, based on the outcome of the negotiations.
If there is to be a tender process, tender documentation is prepared at this stage. An important aspect of the tender and pre-negotiation process is analysis of all fiscal terms (royalties, production share, corporate taxes, etc.). These ultimately determine whether governments will manage to reap benefits from their resources.
Governments may consider engaging legal counsel to ascertain which areas of the investment are non-negotiable, avoiding a lock-in situation where the state have no room for manoeuvre for policy change. It is also important to ensure there is adequate flow of information among the different government agencies and departments involved in the negotiation, to provide a uniform government position to the investor.
3.1 Feasibility studies
Many states request feasibility studies from investors prior to awarding exploitation permits. This enables states to assess the technical, legal and economic strengths of a project and determine the likelihood of an operation becoming successful. It also allows the state to gather crucial information on a project’s geological assets and its likely cost and risk profile, thereby enhancing the position of the state at the negotiations.
3.2 Impact assessments
Extractives sector development carries environmental, health and social risks that need to be assessed and mitigated prior to project development. In countries where environmental and social protection frameworks are not adequately developed, investors are exposed to increased risk which they may seek to mitigate through the voluntary application of international and corporate standards for environmental, health and social and human rights performance, including impact assessments.
Impact assessments may also be included as a requirement under tender documents if this process was employed or otherwise covered under the investment contract. Incorporating this requirement may support governments in developing a sustainable extractives sector. Whatever the scope and regulatory basis for impact assessments, it is advisable for states to monitor these processes closely, in the interest of improving transparency and increasing government’s understanding of the potential risks associated with the investment.
Moving beyond the traditional scope of impact assessments
The scope of impact assessments has broadened in recent years. For example, in response to emission reduction commitments under the 2015 Paris Agreement on Climate Change, some countries are starting to call for climate change impact assessments to be undertaken. In addition, the scope of impact assessments now frequently goes beyond the pre-investment and operation stage to include closure and decommissioning plans, which have not always been adequately considered in the past.
3.3 Tender and Procurement Processes
The procedure for allocation of mineral rights is typically based either on a non-competitive process or a tender process. In the petroleum sector, licenses are generally awarded on a competitive basis by negotiated bid or auction. Competition among potential investors can enhance the outcome for the state and help offset some of the asymmetry regarding access to information. This process Is not however widespread in mineral contracts, where negotiations on operating contracts typically follow a period of exploration activity and resource identification funded by the company concerned.
Some countries have tender processes that allow for direct procurement or direct negotiation as a general option in contracting. In others, direct procurement is only allowed in special circumstances, such as in emergency situations. The optimal procurement process depends on a range of factors. Competitive bidding is not necessarily best practice in all situations.
The 2015 Africa Oil Governance Report found that despite increasing adoption of competitive and open bidding procedures, the norm in most of Africa is either to engage in direct negotiations or to put in place mechanisms to trigger direct negotiations. For instance, in Angola, the Minister is required to declare proposals for direct negotiations through public notice, but can commence negotiations with the company if, within fifteen days from the date of the notice, no other entity declares an interest in the area in question.
The circumstances under which direct procurement is permitted should be made very clear in national law. An efficient procurement procedure would employ open data standards to ensure revenue received by governments is disclosed and transparency and accountability are enhanced. An open data standard is a set of specifications (or requirements) for how some sets of data should be made publicly available.
3.4 Assembling a negotiation team
In preparing a negotiation position it is important that government develops an understanding of the culture of the company investing in the resource, as well as its financial position. As extractives sector negotiations increasingly include cross-sectoral elements and require a detailed understanding of sustainable development goals to align negotiation outcomes with development planning, a negotiation team representing legal, political, operational, finance, geological as well as environmental, technical and economics disciplines may offer the best chance of success and ensure that investment is aligned with national and sector development goals.
Where the required capacity is not available in government, reaching out to an external advisor or to local experts is advisable, accompanied by a due diligence process to assess the expert’s eligibility. There is also the question of authority and mandate to consider, and whether the negotiation team has equal authority to its counterpart to negotiate and ratify the final agreement.
3.5 Developing a negotiation position
Prior to the start of negotiations, it is valuable to know the “bottom line”, the worst and best-case scenarios of the outcome of negotiations, and the best and worse alternatives. A government would particularly benefit from developing a ‘Best Alternative to a Negotiated Agreement (BATNA)’. BATNA is a term that derives from a best seller book, Getting to Yes: Negotiating Without Giving In. BATNA is described as the standard against which any proposed agreement should be measured. The book advises that knowing your BATNA would protect you both from accepting terms that are too unfavourable and from rejecting terms it would be in your interest to accept. Indeed, in extractives sector negotiations, it would be advisable to gather an understanding of the likely positions and concerns of all stakeholders, including local communities, alongside the relevant ministries, to determine an appropriate BATNA.
When developing a negotiating position, it is important to understand the government’s negotiating strength, which may vary depends on the context and whether the project is a new, greenfields project, or an existing development, which requires increased recovery and reduction of costs. The duration of the project and the level of regulatory intervention of the host state will also have an impact on costs and is an issue to be considered in developing a negotiating position.
Governments will derive benefit from understanding any legacy matters and from knowledge of relevant geological data, global market conditions, capacity limits and the power, water, technologies and transportation infrastructure requirements. The interdependency of project economics and fiscal terms to determine future government and investor revenues also needs to be thoroughly investigated.
Knowing the business and financial capability of the investor is a key factor too: an investigation into the annual reports, public record and previous dealings of the company is a good place to start. There are various cases where governments have contracted with ‘briefcase’ companies without carrying out proper due diligence, only for these companies to prove to be speculators that would then seek to sell contracts, or worst still prove to be unable to perform the contracts undertaken.
A comprehensive awareness of industry terminology is another element to consider at the pre-negotiations stage (and preferably even earlier). There are reliable oil, gas and mining glossaries but for each different transaction it is useful to know which set of specific terms are the most relevant. The Extractives Hub recommends this glossary of terms used in the trading of oil and gas, utilities and mining commodities, which endeavours to fulfil this function.
3.6 Stabilisation clauses
At the start of negotiations, investors may request clauses that guarantee fiscal, legal, and/or regulatory regime stability throughout the life span of the project or until such time that the investment sunk costs are recovered. These are not always granted, and there is debate about whether agreeing to stabilisation clauses is always in the interests of states. Stabilisation clauses limit government’s freedom to implement changes to law and policy at a later date, but governments sometimes agree to the inclusion of stabilisation clauses in contracts at an early stage in negotiations with the aim of attracting capital investment, particularly if such investment is scarce and neighbouring countries offer them. For some large investments such as those concerning Liquefied Natural Gas (LNG) spell out, long-term undertakings about stability are likely to be essential.
Since such undertakings are usually treated with great respect by international arbitral tribunals, caution needs to be exercised before they are offered, and care taken with drafting their scope and term. Generally, the need to offer such guarantees diminishes with successful discoveries.
Additional information on this point is available in the dispute resolution topic.