Preparation Eases Practical Problems Of First Work Abroad

A primer on exploring abroad-Part II

Richard A. Wasteneys
Andersen Consulting
Houston

Once a company has decided to seek exploratory opportunities in a country where it has not worked before, examined the strategic thinking behind its decision, based its tactical decisions on that strategy, and decided whether to generate its own prospects or farm into ventures offered by others, it must confront a host of practical problems that begin with preparations for the first visit to the country of interest.

This second of two related articles provides a practical guide for implementing the decision to explore for the first time in a country in which your company has little or no experience. It does not attempt an exhaustive treatment of the subject. Instead, it will highlight key issues, potential problems, and critical steps that may not be apparent for a company venturing into an unfamiliar country.

First visit

On your first fact-finding and introductory visit to a host country, you should consider making as many of the following contacts as possible:

• A local law firm. Your company's principal law firm in its home country can often recommend a reputable firm in the host country. If the host country has an established petroleum sector, a number of local firms may have some oil and gas expertise. In addition to providing legal and regulatory advice, a knowledgeable local firm can arrange meetings with key players in the local industry who might not be accessible otherwise.
• The local branch office of your customary accounting firm, for general financial and tax information, as well as for information specific to oil and gas operations and expatriate taxation.
• Petroleum ministry or national oil company or both. The purpose of this visit is twofold-to introduce your company and express your interest in upstream opportunities and to obtain authoritative information on acreage availability, basic contract terms, bidding requirements (if acreage awards are made by competitive bid), and a model contract of the type under consideration. Unless you represent a large and well-known company, do not expect to meet the petroleum minister or the director of the national oil company at this point. This will occur, if at all, only after they become aware of who you are and are convinced that you are a serious player rather than a browser.
• Petroleum regulatory agency (if separate from ministry), to get copies of laws and regulations governing E&P activities.
• Environmental ministry, to determine existing and proposed environmental legislation and regulations applying to E&P operations.
• The economic counselor of your home country's embassy, to make him or her aware of your intentions and to obtain relevant economic, political, or petroleum-related information.
• Local branches of any oil field service companies you intend to use or that you use in other countries. They can give you useful information on operating problems, logistics, and approximate service costs for inclusion in your economic model.
• Public utilities commission, if you are interested in generating power for sale to the national grid or in becoming a transporter or distributor of natural gas.

Beware of "fixers." In many countries there are numerous local "fixers" who will claim to be able to get you choice acreage, better contract terms, or both-for a substantial fee. These are to be avoided, if only because for each one who can be of real help there are dozens who can do nothing that you and your lawyers cannot do better.

U.S. companies in particular should avoid them, as they are a common source of Foreign Corrupt Practices Act (FCPA) problems. The most aggressive "fixers" have "scouts" in the government agencies you visit who will inform them of a company's presence in the country, so do not be surprised by uninvited approaches from people offering assistance.

Questions of advantage

In a country in which petroleum opportunities are generally regarded as attractive, do not expect to be alone in your efforts to obtain acreage. As in any competitive enterprise, an early evaluation of the competition is essential. Try to determine:

• Against what universe of companies are you competing for the acreage in which you are interested? Majors? National oil companies? Large independents? Niche-players?
• What distinguishes your company from its direct competitors in the eyes of the licensing authority or national oil company? Outstanding financial resources? Broad, well-recognized technical strength? Potential for technology transfer?
• Do you have relevant and demonstrable expertise in areas such as the following?

1. Operating experience in specific environments (e.g., hostile marine conditions, environmentally sensitive areas).
2. Niche expertise (e.g., overthrust exploration, deep-water development and production, enhanced recovery).
3. Ability to develop and operate marginal fields profitably.

• If your company offers no distinguishing competitive strengths, what can be done to make your bid more competitive?

Host country enticements

At some point, the host government will have to justify publicly any contract it enters with a foreign company.

If your company does not offer any enticements, what can you offer to make your proposal more attractive? Are you:

• Willing to staff the operation, including key positions, mainly with host-country nationals at an early stage?
• Willing to provide extensive training of host-country nationals?
• Willing to make infrastructure investments in the host country that may be only indirectly related to your project (e.g., schools, hospitals, roads, water supply)?
• Willing to offer the government a higher share of production or project revenues?

Applying for acreage

The procedure for applying for acreage varies considerably from country to country and may change from time to time in the same country.

Some countries allow companies to nominate individual blocks at any time and then negotiate for them (e.g., Colombia). Some only offer groups of blocks in periodic competitive rounds (e.g., Ecuador). Countries that routinely offer acreage in competitive rounds generally do not allow nomination and subsequent negotiation of a block on a one-off basis, although Colombia and a few other countries still do both.

Either system may require applicants or bidders to purchase a package of technical data covering the desired block or blocks. This package may include detailed bidding conditions and procedures, model contracts, and so forth. The cost may be nominal if the technical data included are old or nonexistent or substantial if the package includes seismic data of recent vintage.

One-window process

In the "one-window" application and negotiation process where competitive bidding is not required, application may consist of submitting a map of the acreage blocks for which you are applying and filling out a number of forms. Expect also to provide copies of your company's annual reports, audited financial statements, and documentation of your operating experience.

Once you have submitted the forms, there may be a screening process to confirm your company's technical and financial solvency, during which additional information may be requested by one or more of the host-government agencies involved. You will then be expected to agree to an obligatory minimum work and expenditure program, usually including seismic acquisition and processing and the drilling of one or more exploratory wells.

A few countries still allow seismic options, under which the drilling of exploratory wells is optional depending on results of the seismic program. You may be required to post a bond for some percentage of the estimated cost of your obligatory minimum work program.

Bidding competitively

If you are bidding competitively, you will have to provide the same information, but certain of these elements may be scored numerically. For example, your financial strength and operating experience may be scored, both against any required minimums and against those of your competitors. Certain elements of your proposal will also form part of your bid. These will usually include one or more of the following:

• Minimum work program. This will be scored on its appropriateness to the project and the scope and cost involved. It usually must equal or exceed an established minimum and compare favorably with competing bids for the same block. In a few countries, this is the only bid item, in which case your work program must be the most extensive if it is to win.
• Government share. A number of countries now require that you bid the percentage of production, gross revenues, or royalty that will accrue to the host government, usually on a sliding scale for increasing rates of production, levels of cumulative production, or, in some cases, rate of return.
• Additional investment. Some countries require that bidders offer certain investments in infrastructure or environmental projects that may or may not be related to the proposed E&P project. A variant of this feature is the preference the venture will give to the use of goods and services having local content.
• Cash bonuses. These had all but disappeared in the 1980s. Unfortunately, they have reappeared recently in a few of the more geologically attractive producing countries. They can take the form of signature bonuses, discovery bonuses, production-level bonuses, or any combination of these. In one well-known example, the amount of the signature bonus is the key competitive element of the bid.

Negotiations

Whether or not acreage is awarded competitively, terms of the resulting contract must usually be negotiated. The host-country negotiators will try to improve on the terms of your offer or bid, and you will try to achieve changes that are critical or desirable under your particular strategy.

These negotiations can be relatively short and straightforward or protracted and arduous, depending on the agenda and attitudes of the negotiators. Whatever the overt goals of the host government may be, the individual negotiators and the agencies they represent will each have priorities which must be understood and addressed.

Contracts negotiated with a national oil company may contain a degree of operational detail approaching that normally found in joint operating agreements. Negotiable terms may include:

• Economic terms, including production or revenue split, royalty, pricing of production for tax and royalty purposes or for sale in the domestic market, treatment of investment and operating-cost recovery, and any obligatory sales to the local market. Some of these terms will have formed part of your bid, but there is nothing to prevent the negotiators from trying to improve on them to your detriment and their advantage. It is important that you have access to the economic model on which your original offer or bid was based to allow testing of alternatives as you negotiate.
• Operating terms, including total term of the contract and duration of exploration and exploitation periods, operatorship, decision-making processes, representation on various management and technical committees, mechanisms for approval of work programs and budgets, declarations of commerciality, disposition of oil and gas produced, preferential employment of nationals (both as a percentage of total work force and in key managerial and technical positions), training of nationals, conditions for assignment or farm-out, preferential use of local goods and services, notice requirements, acreage relinquishment requirements, force majeure, and arbitration. These negotiations vary depending on whether you are dealing with a national oil company or with the regulatory branch of a ministry. In either case, the agenda of the host negotiators will be to maximize their control over your operations and limit your freedom to act on your own initiative. In the least onerous case, the principal result will be to commit you If you are dealing with officials of a national oil company, do not be surprised if they propose to act as operator. This can usually be deflected on the grounds that your venture is spending its own money and the government company is not, but the demand is becoming more common.
• Environmental issues. These issues are becoming more important and more common. Expect environmental terms to be part of any contract, and negotiate their language carefully.
• Social issues. You should investigate the possible existence of native tribes in your contract area, as their presence can cause interminable delays in exploration or development programs and cost millions of dollars in standby time or delayed production. Although the model contract may not contain specific provisions for such situations, you may find it necessary to deal with the issue before you can commence operations.
• Other elements, including infrastructure investments or contributions to projects such as school, hospital, or road construction.

Choosing partners

Unless you are a very large company, at some point before or after signature of your contract with the host government you will inevitably consider spreading your risk to some extent. Since your choice of partners can greatly affect the efficiency of your operation, certain factors should be kept in mind.

Each working-interest partner should be a solvent company capable not only of meeting its share of budgeted obligations and cash calls, but of bearing unexpected costs such as those of equipment delays, drilling hazards, and union problems. Don't put your company in the position of having to carry an insolvent partner.

Potential partners should be chosen from among companies whose managements have a visceral as well as an intellectual understanding of the risks and problems unique to foreign E&P. It will save a lot of argument at operating-committee meetings if you don't have to explain and justify every nuance of the operation to a partner who has never worked outside his home country.

A number of producing countries now have competent and aggressive private-sector petroleum companies. A carefully chosen local partner can help you avoid the pitfalls of doing business in that country and may bring local geological or operating experience to the table. In addition to financial solvency, be sure that your due diligence addresses any political baggage a potential partner may have. An otherwise well-managed local company can make a disastrous partner if its political or regulatory relationships are antagonistic.

Insist that you, as operator, arrange adequate blow-out, pollution, and general liability insurance for the entire working interest as a joint-account expense. You and your partners will be jointly and severally liable under the host-government contract in any case.

A few oil field service companies are increasingly willing to share the risks in E&P ventures. Specific arrangements range from strategic alliances with operators to their direct participation as working-interest owners. Some of the larger service companies have created subsidiaries that undertake and operate E&P ventures on their own. An operator seeking foreign partners, and particularly partners that may have specialized technical or geographic expertise the operator lacks, should not overlook this possibility.

As is probably the case in your home country, potential partners (and the host government) will probably look with suspicion on an operator that tries to reduce its working interest below about 25%. Working-interest owners generally prefer that the operator's exposure be at least comparable to their own.

Initiating operations

Assuming that you have successfully negotiated and signed your contract, and that you will act as operator, certain logistical and housekeeping chores must be performed as you begin your work program.

If you are considering a venture in a country in which personal or operational security is a serious problem, you should retain a reputable international security consultant during the early planning stages of the project. Such consultants can advise you on overall security, office space, expatriate housing, precautions regarding children's schooling, in-country travel, union problems, and problems specific to the field areas where you will conduct operations. The earlier such consultants are engaged, the more effective they can be. They are much better at helping you avoid dangerous situations in the first place than they are at dealing with an incident that has already occurred.

In foreign assignments, how well you provide for the needs of expatriate spouses and families can be a key element in maintaining a smoothly running operation. The problem of expatriate housing varies widely depending on the country or city. Members of the local expatriate community are the best sources of advice and referrals on neighborhoods, schools, rental prices, and normal security issues.

In a country in which security is a serious problem, you should choose neighborhoods and housing for your expatriate employees with the advice of your security consultant. Generally, apartment buildings with their own security are preferable to single-family houses. The diplomatic quarter of most capitals in developing countries may be a preferred location because the local police tend to patrol it heavily but should be chosen with care because it may be the first place a kidnapper or a terrorist would look for a high-profile target.

Staffing

Staffing should usually be done in lock-step with the progress of operations. You will certainly want a resident manager (with secretarial and accounting support) in-country as soon as your contract is signed, but there is no point in loading up with facilities engineers, for example, before you even begin your seismic program.

Supervision of seismic acquisition, processing, and interpretation can all be done by consultants and home-office staff on temporary assignment if your contract allows it, and the resulting costs are usually recoverable or chargeable. Engineering and geological supervision of exploratory drilling can also be outsourced. Most permanent staffing decisions can be deferred until the decision to develop a commercial discovery is made.

Many operators understandably prefer to fill key positions in a foreign operation with their own employees or with expatriate consultants of known capabilities and experience. At one time, this was a widely accepted practice. Depending on where you are operating, however, this may be both unnecessary and undesirable.

In an increasing number of petroleum-producing countries, experienced national geoscientists, engineers, and financial and administrative people are available and should be given serious consideration even if your contract does not require it.

If you engage staff at the pace required by operations, you'll only need enough room for the resident manager, a secretary, and an accountant during the exploration phase. A few empty offices to be used by itinerant home-office staff and consultants should also be provided. If possible, choose your offices in a section of town served by an adequate number of telephone lines or you might wait weeks or months before a working telephone system can be installed. Look for or provide your own standby electrical power, and install adequate surge protectors and back-up capacity for computers and surge protectors for peripheral equipment.

If you are in a country in which personal security is a problem, keep that in mind when choosing office space. Avoid high-profile, luxurious, and ground-floor office space and prominent displays of your corporate name or logo. Look for buildings that provide effective 24-hr security or in which you can provide your own security easily.

Services and supplies

In most producing countries outside the developed world, "just-in-time" supply in the oil fields is somewhere in the future. Although a number of producing countries manufacture oil field goods, very few make a full range of equipment or materials of the kind and quality needed for oil field development and production. To the extent that these must be imported, lead times can be critical. Careful planning can help you avoid costly standby time for contract equipment such as drilling rigs.

Turnkey drilling contracts are still unusual in foreign environments. Under most day-work contracts, the operator will be expected to provide all consumables, including fuel, mud, chemicals, drill bits and cement, tubular goods (except drillstring tubulars), and ancillary services. Before beginning a series of wells, all procurement should be done with realistic lead times in mind. Customs clearance, local transportation, and warehousing should be arranged well in advance of the arrival of materials. Provide enough additional materials to meet operational contingencies such as unplanned strings of casing, fishing jobs, side-tracks, and the need to drill replacement wells. You aren't likely to be able to pick up the phone and call the local supply store if you get into trouble.

Major providers of oil field services are represented in most producing countries. Assuming that quality, price, contract terms, and availability are approximately equal, it is usually advantageous to use a contractor that is already domiciled in the host country. Its local-office overhead will be built into its bid, but that will probably be less than the one-time cost of establishing a temporary office just for your project.

In addition, a domiciled company will already be a local taxpayer, freeing you from the obligation to withhold local tax on your payments to them. They should also be expected to arrange their own customs clearances, expatriate visas, and income taxes.

In a number of countries the oil workers' unions are quite militant. Many of them have grown up within national oil companies, where they exert considerable influence on management through their political ties and are accustomed to getting their way. The demands of such a union may appear totally unreasonable to a foreigner unaccustomed to dealing with them, and it is wise to engage competent professional advice in doing so.

Unions usually show an interest in a new venture only after a commercial discovery is made, although your service contractors may enjoy their attentions somewhat earlier.

While most such unions are just hard-nosed and nationalistic, in a few countries they have ties to guerrilla groups and do not hesitate to threaten and use sabotage or violence as bargaining tools. Your security consultant can advise you if this is the case.

Gas, environmental issues

An unexpected natural gas discovery used to be one of the nightmares of explorers in developing countries in which there was no local gas market, or in which the domestic gas price was nominal. This is changing in a number of areas, largely as a result of the growing demand for electrical power in countries in which economic growth outstrips current or projected generating capacity.

A number of previously noncommercial gas discoveries are being developed specifically to supply gas-fired electric power plants, which can be built for about one third of the cost per kilowatt of new hydroelectric capacity. Many of the oil companies in these ventures are investors in the power plant, as well as in the gas field, and look to the sale of power to the national grid for a significant part of their revenues and profit.

The key to intelligent pursuit of such an opportunity is the careful evaluation of the local electricity market, as well as of the regulations and economics governing private-sector generation and sale of power. This should be done prior to committing exploration funds in any basin known to be gas-prone, especially if the local market for gas is limited or gas prices are unattractive.

The environmental safeguards applied in your project, and how well they are documented, can be absolutely critical to the long-term success of the operation. Such problems were once important only in North America and western Europe, but today you must assume that you will be held to standards approaching or exceeding those in the U.S. in almost any country in the world.

Rain forest and marine areas are currently the most sensitive, but all areas are covered by some form of environmental regulation. If these regulations are not enforced today, you should assume that they will be by the time you are ready to abandon a field.

Whatever your contract or the law may require in terms of initial baseline surveys of your contract area, it is in your company's interest to exceed the minimum requirements in this regard. Before you begin operations, get the government to acknowledge every instance of existing environmental damage, health, or safety risk you can document. This may save you millions of dollars in subsequent claims.

If there are native tribes in your area, you may have to negotiate separately with them for permission to operate in their territory, even though the host government may tell you this is unnecessary. If you should be asked to provide any social or other services or facilities for tribes in your contract area, it is worthwhile to consult respectable academic opinion on any possible ill effects this may be perceived to have and to document any advice on which you decide to act. The general rule in this regard is "no good deed goes unpunished."

Oil field security

In a number of countries, the government cannot maintain even a minimal degree of law and order in rural areas. The results of this condition can range from sporadic demonstrations or disorder to outright control of an area by guerrilla bands or drug cartels. The latter condition clearly poses serious risks to any field operation, including murder, kidnapping, sabotage, interrupted production, and environmental damage caused by oil spills.

Operations in such an area should be undertaken only after careful consultation with your own security advisers and with the relevant security services and authorities in the host country. (In dealing with local authorities, remember that if the host government could effectively guarantee the security of your personnel and your installations, the problem would not exist in the first place.)

With competent professional advice the risks of operating in such areas can often be reduced, but they can never be eliminated. Whether the remaining levels of risk are acceptable to your company and your employees is a matter that only you and they can decide.

In the majority of sensitive areas, however, problems and risks are not nearly so severe. Unrest generally results from local dissatisfaction with the number or quality of social services provided by the government. A number of companies have operated successfully in such areas by combining a very low corporate profile with a program of social investment. Comparatively small sums can pay significant dividends in terms of avoided interruptions of production or more serious problems.

The most obvious of these social investments is the employment of local residents in the operation itself. While this must be done with care to avoid creating a completely new set of problems, it is often the most effective way of creating goodwill and establishing some identity of interest between the company and the local community.

Other measures that can be effective include construction and part-time staffing of a small medical clinic, construction of a primary school, subsidy of teacher salaries and equipment budgets, or a scholarship program for the secondary or university education of local children. The total annual cost of such a program is almost certainly less than the cost of shutting in production from time to time because of social unrest.

Social programs of this kind should only be undertaken with the approval of the relevant agencies of the host government, since what you propose may conflict with some existing policy or initiative in the area. Keep your initiatives as low-key as possible to avoid embarrassing the government or provoking turf battles among competing bureaucracies.

Field abandonment

It may seem premature to begin planning for abandonment even as you set up a new operation. Yet better planning at the outset might have minimized some of the problems experienced recently by companies that have either abandoned a field or handed it over to the national oil company when their contract expired.

Handing over an operation to the national oil company is not enough to get a company off the hook, even if no claim is made against it at the time. Every drop of oil spilled before or after the transfer of operations will eventually be blamed on the relinquishing operator. It also appears that decommissioning an obsolete installation in the manner least harmful to the environment will not insulate an operator from attack if a vocal interest group can generate news coverage for itself by raising the issue.

These risks cannot be eliminated entirely, but they can be reduced by prudent operations. An operator that has spilled oil, polluted groundwater, or left a well suspended should repair any damage before relinquishment. Terrain and vegetation should be restored to something approximating original condition where it is practical to do so.

If you had the foresight to perform and document an environmental baseline study before you began operations, do an equally rigorous one at the time of abandonment or relinquishment. If at all possible, try to have the results endorsed by both the national oil company (if you are handing over operations) and by the ministry responsible for the environment. Negotiate and remediate or discharge any damage claims when they are made, rather than leaving this to future governments that may use the issue to discredit a predecessor.

Document the entire process, including government approvals, negotiations, settlements, and payments or remediations, as carefully as possible. Make sure that all documentation is indexed, organized, and filed in your home office's law department.

Abundant opportunities

Worldwide opportunities for E&P ventures are more abundant today than ever before. Regions and countries previously closed to foreign petroleum companies now welcome foreign investment in their upstream sectors. An increasing number of companies are involved in or considering upstream projects outside their home countries.

The risks, problems, and issues peculiar to foreign E&P have always been numerous and today are perhaps more critical than ever to the success of any program of foreign investment. Companies whose foreign experience is limited, or whose strategy includes broadening their foreign focus to include areas previously avoided or ignored, should give careful consideration to the specific risks and issues discussed above in deciding where to invest and how to go about it. A carefully structured approach to the development of a portfolio of such opportunities, taking real risks and expected rewards into account, is the only prudent way to approach new or expanded foreign activity.

The Author