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Understanding Extractive Industries-Cameron
Understanding Extractive Industries-Cameron
and Mining
ABOUT THE ONLINE
PLATFORM AND THIS
PUBLICATION
The Extractive Industries Source Book (EISB) is a free The online EI Source Book platform was conceived and
online interactive source (http://www.eisourcebook.org) launched by Michael C. Stanley, Global Lead for Extractive
that is built upon a coherent and incisive narrative analysis Industries at the World Bank, using a Development Grant
of the extractive sector as a whole, supplemented by hun- Facility (DGF) grant prepared to foster a partnership
dreds of downloads and other web resources, including between the World Bank Group and a Global Knowledge
specially commissioned reports, summaries, and briefs. The Consortium. This collaboration includes a group of policy
EISB provides end-users with technical understanding and centers in universities and other organizations, all focusing
practical options around oil, gas, and mining sector devel- on practical solutions to extractive industries challenges, led
opment issues. The end-user community using this resource by Professor Peter D. Cameron at the University of Dundee,
is diverse, and includes representatives of government, United Kingdom. This print version was made possible
industry, academic institutions, nongovernmental organi- through the many achievements of the online EI Source
zations, and individuals. Book to date.
Oil, Gas,
and Mining
A SOURCEBOOK FOR UNDERSTANDING
THE EXTRACTIVE INDUSTRIES
This work is available under the Creative Commons Attribution 3.0 IGO license (CC BY 3.0 IGO) http://creativecommons
.org/licenses/by/3.0/igo. Under the Creative Commons Attribution license, you are free to copy, distribute, transmit, and
adapt this work, including for commercial purposes, under the following conditions:
Attribution—Please cite the work as follows: Cameron, Peter D., and Michael C. Stanley. 2017. Oil, Gas, and Mining: A
Sourcebook for Understanding the Extractive Industries. Washington, DC: World Bank. doi:10.1596/978-0-8213-9658-2.
License: Creative Commons Attribution CC BY 3.0 IGO
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ISBN (paper): 978-0-8213-9658-2
ISBN (electronic): 978-0-8213-9961-3
DOI: 10.1596/978-0-8213-9658-2
Cover design: Bill Pragluski/Critical Stages
Library of Congress Cataloging-in-Publication Data has been requested.
CONTENTS
Foreword xi
Acknowledgments xiii
About the Authors xv
Abbreviations xvii
PART I
EXTRACTIVES FOR DEVELOPMENT
Chapter 1 Shifting Patterns of Demand and Supply 3
1.1 Introduction 3
1.2 The Demand for Knowledge 4
1.3 The Supply of Knowledge 8
1.4 Bridging the Knowledge Gap 10
1.5 Our Approach 14
1.6 Conclusions 15
Notes 15
References 16
Other Resources 17
Chapter 2 Extractives: Opportunities and Challenges for Development 19
2.1 Introduction 19
2.2 The Opportunities Arising from Resource Abundance 20
2.3 The Challenges 23
2.4 Understanding the Challenges: Changing Perspectives 27
2.5 Applying New Insights 29
2.6 Conclusions 30
Notes 31
References 33
Other Resources 37
Chapter 3 The Extractive Industries 39
3.1 Introduction 39
3.2 Common Features of the Industries 40
3.3 Key Differences of the Industries 42
3.4 EI Sector Dynamics 46
3.5 Conclusions 51
Notes 51
v
References 52
Other Resources 53
PART II
THE VALUE CHAIN APPROACH TO EXTRACTIVES
Chapter 4 Policy, Legal, and Contractual Framework 57
4.1 Knowledge Core 57
4.2 Getting Started: Facts of EI Life 58
4.3 Eight Key Challenges 60
4.4 Policy Priorities 61
4.5 Hydrocarbons and Mining Laws 66
4.6 Contracts and Licenses 73
4.7 The Award of Contracts and Licenses 90
4.8 Why Regulations Are Necessary 97
4.9 Investment Guarantees: Stabilization 99
4.10 Contract Negotiations 101
4.11 Disputes: Anticipating and Managing Them 102
4.12 Summary 106
4.13 Taking Action: Recommendations and Tools 107
Notes 108
References 111
Other Resources 114
Chapter 5 Sector Organization and Regulatory Institutions 115
5.1 Knowledge Core 115
5.2 Organization in the Public Interest 116
5.3 Special Issues 131
5.4 Summary and Recommendations 144
5.5 Practical Tools 145
Notes 145
References 146
Other Resources 148
Chapter 6 Fiscal Design and Administration 149
6.1 Knowledge Core 149
6.2 Key Fiscal Objectives 150
6.3 The Main Types of EI Fiscal Systems 154
6.4 Main Fiscal Instruments under a Fiscal Regime 155
6.5 Special EI Fiscal Topics and Provisions 166
6.6 EI Fiscal Administration 173
6.7 Summary and Recommendations 176
6.8 Action Tools 178
Notes 178
References 179
Other Resources 181
Chapter 7 Revenue Management and Distribution 183
7.1 Knowledge Core 183
7.2 Why Revenue Management is Difficult 184
7.3 Consume or Save? 185
7.4 Resource Funds and Their Popularity 189
7.5 Alternative Means of Addressing Fiscal Sustainability 196
7.6 Addressing Volatility: Stabilization Funds 198
7.7 Alternative Means of Addressing Volatility 200
7.8 Spending Choices and Use of Government Revenues 201
vi CONTENTS
7.9 Revenue Allocation and Subnational Issues 205
7.10 Summary and Recommendations 211
7.11 Practical Tools 211
Notes 212
References 214
Other Resources 218
PART III
TOWARD GOOD GOVERNANCE
Chapter 8 Transparency and Accountability 221
8.1 Knowledge Core 221
8.2 Definition and Scope 222
8.3 The Benefits of Transparency 223
8.4 Challenges and Special Issues 224
8.5 Transparency Initiatives 228
8.6 Emerging Global Norms and Standards 231
8.7 Conclusions 234
8.8 Action Tools 235
Notes 235
References 236
Other Resources 238
Chapter 9 Sustainable Development Implementation 239
9.1 Knowledge Core 239
9.2 Two Key Challenges 241
9.3 Challenge 1: Designing and Implementing Policies to Ensure That EI Sector
Investments Create Positive and Sustainable Impacts 242
9.4 Challenge 2: Environmental and Social Impacts 252
9.5 Tools: Legal and Regulatory 260
9.6 The Responses 269
9.7 Summary and Recommendations 281
Notes 283
References 285
Other Resources 289
Chapter 10 Why Governance Matters 291
10.1 Knowledge Core 291
10.2 What Is Governance? 292
10.3 Why Do Oil, Gas, and Mining Generate Specific Challenges? 292
10.4 Response 1: Appropriate and Adequate Rules 293
10.5 Response 2: Effective Implementation, Monitoring, and Enforcement 294
10.6 Response 3: Accountability—Stakeholder Consultation and Participation 295
10.7 Conclusions 297
References 297
Other Resources 298
BOXES
2.1 Changing Perspectives: Reframing the ASM Debate 22
3.1 Key Differences between the Petroleum and Mining Sectors 44
3.2 Features Specific to the Oil and Gas Sectors 45
3.3 Features Specific to the Mining Sector 46
3.4 Convergence of Mining and Hydrocarbons? 47
4.1 Sovereignty over Natural Resources 59
CONTENTS vii
4.2 Licensing across Shifting International Borders 64
4.3 Deep-Sea Mining 65
4.4 Local Benefit 81
4.5 Local Benefit: The Kazakhstani Experience 82
4.6 Contractual Provisions for Natural Gas 84
4.7 Model Mining and Development Agreement 88
4.8 Practices to Avoid 89
4.9 Geodata 91
4.10 The Four Main Forms of Stabilization Clause 100
4.11 Claims under Bilateral Investment Treaties (BITs) 104
5.1 Institutional Structure: The Ministry and the Regulatory Agency 118
5.2 Mining Participation 124
5.3 NRC Success Stories 125
5.4 Petroleum Technical Assistance to South Sudan 128
5.5 Petroleum Reform in Colombia 129
5.6 Petroleum Sector Reform in Brazil 130
5.7 Mining Sector Reforms 131
5.8 Unitization in Maritime Waters 136
6.1 Forms of State Participation 160
6.2 Angola’s PSC Fiscal Package for Petroleum 164
6.3 Elements for Action on Taxation of Transfer of EI Interest 165
6.4 Routine Tax Administration: Challenges 174
6.5 What a Well-Designed Fiscal Regime Must Do 177
7.1 Botswana and Chile: Experiences with Fiscal Rules 188
7.2 Savings Funds: Four Examples 194
7.3 Stabilization Funds: The Experience of Chile 199
7.4 Examples of Revenue-Sharing Formulas 206
8.1 Balancing Transparency Interests: Opposing Dodd-Frank 225
8.2 EIs and Social Accountability 227
8.3 The Seven Requirements of the EITI Standard 229
8.4 Civil Society–Led Initiatives 232
8.5 Private Sector–Led Initiatives 233
8.6 Summary: Transparency and Accountability 234
9.1 Liberia: Open Access Regime in Mineral Development Agreements 248
9.2 Objectives of the Parties to an Infrastructure Project 251
9.3 The Deepwater Horizon Oil Spill 253
9.4 Work of ASM-PACE Project: Artisanal and Small-Scale Mining (ASM)—Protected
Areas and Critical Ecosystems (PACE) 256
9.5 Reframing the ASM Debate: Integrating It into the EI Value Chain 258
9.6 Potential Opportunities Generated by ASM 259
9.7 Decommissioning and Environmental Protection Plans 268
9.8 Challenges Associated with Artisanal and Small-Scale Mining (ASM) 271
9.9 Essentials of a Good Environmental Protection Regime 272
9.10 Social Impacts: Special Issues 277
9.11 Goal Setting and Community Participation 278
10.1 Environmental and Social Institutional Arrangements 296
FIGURES
1.1 Share of Natural Resources Receipts in Government
Revenues (averages, 2000–11) 5
1.2 The EI Value Chain 11
2.1 Price of Oil, 1990–2015 23
2.2 Price of Coal and Iron Ore, 1990–2015 23
viii CONTENTS
2.3 Natural Gas Prices, 2000–2016 24
2.4 A Poor Record of Forecasting Oil Prices 24
5.1 State Organization of the Norwegian Petroleum Sector 117
6.1 Progressive, Proportional, and Regressive Fiscal Regimes 152
6.2 International Fiscal Competitiveness 153
6.3 State Participation and Efficient Taxation Compared 161
6.4 Example of a Production-Sharing Contract in Oil Production 164
8.1 How the EITI Works 229
TABLES
5.1 The Norwegian Approach: Dividing Institutional Governance Tasks and Responsibilities 116
5.2 Ugandan Regulatory and Institutional Framework 116
6.1 Possible Fiscal Mechanisms in Relation to Government Fiscal Progressivity Objective 158
7.1 Country Fiscal Rules 186
7.2 Country Oil Funds 190
9.1 World Bank Group Social and Environmental Standards 262
CONTENTS ix
FOREWORD
This new Sourcebook admirably illuminates the spectrum of Third, the management of the extractive sector, and the
integrated policy interventions necessary to transform natu- policies and practices of both governments and their private
ral resource wealth into sustainable development, ranging sector partners, determine the impacts of the extractive pro-
from the allocation of resource extraction rights to the use cesses on air and water quality, biodiversity, gender-based
and distribution of revenues. It recognizes and emphasizes and other forms of inequality, public health, and human
the importance of the political and institutional context. rights. In the past, extractive industries have often damaged
The Sourcebook ably breaks down the implications of the type the environment, created social tensions, and contributed to
of natural resource, describes the organization of the indus- poor governance through bribery, capital flight, and the waste
try, and provides illustrative examples and useful citations of resource rents. The SDGs provide key guideposts for
from the literature. sustainable management of extractive resources in relation to
This work is especially timely. In September 2015, the both people (with regard to inclusive processes and access
world’s governments adopted the 17 Sustainable to information, for instance) and the environment.
Development Goals (SDGs), defining the world’s shared Fourth, SDG 13—to take urgent action to combat cli-
agenda for sustainable development through 2030. Readers mate change and its impacts—will require a deep and rapid
of this Sourcebook will no doubt note that mineral and shift in how the world approaches its hydrocarbon resources.
energy resources play a major role across the 17 SDGs, and Known reserves of coal, oil, and gas greatly exceed the levels
that the SDGs offer a crucial orientation to the mining that can be burned in line with the Paris Climate Goal (part
sector. of SDG 13) of keeping global warming “well below 2
First, sustainable development depends on the minerals degrees C.” The world must therefore make a quick transi-
mined from the earth. The development and rapid scale-up tion to low-carbon energy and create effective and fair
and deployment of renewable energies will further increase mechanisms to share the adjustment burden. How will we
demand for a variety of minerals and metals. So too will handle the global challenge of which assets to strand, paying
the ubiquitous mobile Internet technologies, which utilize a particular attention to the needs of developing countries?
range of mineral products to enable our new global infor- How individual governments, companies, and the
mation society. world as a whole approach the management and gover-
Second, for mineral-rich countries, the rents generated nance of mineral and energy resources will be important in
from the extraction of their resources can fund public determining the success or failure of the SDGs. And yet,
investments in health, education, infrastructure, and other the complexities of harnessing natural resources for sus-
public goods that are critical for the achievement of the tainable development are great. Technical solutions are
SDGs. Strategic linkages from the extractive sectors to other complex and highly context specific; the political chal-
sectors of the economy can also help to advance employ- lenges are vast and made difficult by geopolitics and a
ment and innovation. tendency toward short-termism. Many of the social and
xi
environmental risks are large, difficult to calculate, and in the pages herein are controversial, and we and others will
perhaps irreversible in impact. not agree with all of the positions taken. In some cases, the
Fortunately, the past decade has seen a groundswell of controversy is made explicit; in others, the controversy is only
research and debate about how best to put natural resource implicit, and will be clarified by subsequent debate. The rap-
wealth at the service of sustainable development. The SDGs idly evolving nature of this field also means that some critical
have brought together governments, the private sector, civil topics, such as the implications of climate change for the
society, and academia in thoughtful and productive discus- future of hydrocarbon extraction, are not yet deeply explored.
sions about how to ensure that mineral and energy resources No doubt the Sourcebook will continue to evolve as the
help to advance the SDGs, and about the respective roles of debates over these topics intensify in the future.
each partner, nationally and globally. Given the breadth of the SDGs and the targets therein, as
To support these ongoing discussions, the authors of this well as the myriad challenges of natural resource gover-
Sourcebook have taken the critical step of beginning to assem- nance, the new Sourcebook and the community of research-
ble a knowledge consortium, bringing together research ers and practitioners that continues to grow around it will
institutions from around the world to share research on good help to shed light on the path ahead. Our work in achieving
practice and to mobilize expertise to address remaining and the SDGs is ongoing, and the Sourcebook will be an impor-
new “knowledge gaps.” Indeed, several of the topics covered tant new tool in our hands.
xii FOREWORD
ACKNOWLEDGMENTS
This Sourcebook has been sponsored by a Development Charles’ early work on the draft brought insights based on his
Grant Facility, under the Extractive Industries–Technical many years advising a diverse range of governments in all
Advisory Facility, a multidonor trust fund managed by the continents and contrasting circumstances on how to make
World Bank. The project has been managed by a consor- the most of their oil and gas resources. Both Charles and
tium headed by the Centre for Energy, Petroleum and Michael Stanley were able to draw upon and share their
Mineral Law and Policy (CEPMLP) at the University of direct experience in advising governments and their depth of
Dundee (U.K.). The final version of the Sourcebook was understanding of the corporate sector of oil, gas, and mining.
written by Peter D. Cameron, director of the Sourcebook This background contributed to elements of practicality and
project, drawing upon the important contributions of balance in the Sourcebook project that we have sought to
Charles McPherson, Honoré Le Leuch, and particularly carry over into this version.
Michael C. Stanley, Global Lead for Extractive Industries in Between the first and final drafts, the Sourcebook text
the World Bank’s Energy and Extractives Group. In his role was extensively reworked to address more thoroughly the
as the principal contact and adviser at the World Bank key issues in oil, gas, and mining. Each of several drafts
throughout the project, Michael provided a continuous was modified in response to comprehensive feedback and
flow of suggestions, advice, and assistance, not least by suggestions, sometimes delivered anonymously, as part of
mobilizing colleagues at the Bank and his many contacts in a peer review process. This circuit of writing, review, and
government and civil society around the world. revision was aimed at realigning our efforts to meet a
From the outset, a driver behind this Sourcebook has high quality standard across a broad subject, reflect
been to secure as much balance and independence in its diverse areas of specialized expertise, and produce a cohe-
content as possible. Strong input from a number of highly sive text. We have sought to avoid turning the Sourcebook
reputable policy and research centers, mostly linked to into an edited collection of discrete materials covering
universities, has been important to its establishment and various subjects and crossing disciplines, loosely organ-
further development. In many instances the substantive ized around the Value Chain concept. Rather, we believe
inputs are expressly acknowledged in the text itself but the this publication is a highly cohesive work centered
greatest contribution of all from these centers was proba- around the Value Chain core and, in its tone, avoids the
bly in the integrity and rigor of their work. It set a high “lecturing” approach in some writings on Good or Best
standard which was a constant source of inspiration to the Practice.
Sourcebook team. The final text benefited from the work of other contribu-
The first draft of this narrative text was prepared primarily tors on particular topics: Jon Hobbs (World Wildlife Fund)
by Charles McPherson, formerly senior adviser and manager and Rachel Perks (World Bank) ensured that the coverage
at the World Bank, technical assistance adviser in tax policy of artisanal and small-scale mining reflected the work in this
at the Fiscal Affairs Department of the International Monetary field by a variety of organizations over the past decade. Jon
Fund (IMF), and member of CEPMLP’s Global Faculty. advised us, too, about the latest trends in thinking about
xiii
sustainability issues. Jon was an important and constructive Columbia Center on Sustainable Investment (CCSI) and
critic of the treatment of sustainable development imple- Natural Resource Governance Institute (NRGI), have, in
mentation in the Extractive Industries Value Chain. pursuing their own unique studies and research, played a
Contributions on mining were made to the chapters in key role in alerting us to changes that we needed to make
part II by John Strongman, formerly a senior economist at in the text to provide users with knowledge that is fresh
the World Bank. The aim—and the challenge—was to com- and leading.
pare and contrast mining with oil and gas and, in that way, The Sourcebook’s subject matter crosses law, economics,
to make a real attempt to contribute to the growing litera- and resource management, so feedback from peer review by
ture on extractives. David Humphreys, another CEPMLP specialists played an important role in its development. The
Global Faculty, was invaluable in noting how the contrasts principal manner in which the text developed from its starting
between mining and hydrocarbons could be more sharply point was through the application of a very rigorous peer
drawn. Kasey McCall Smith played an important role in an review policy, coordinated by Kasey McCall Smith of the
earlier version of chapter 8 on transparency and accounta- University of Edinburgh. We are extremely grateful to the
bility, and Eddie Rich of the Extractive Industries anonymous reviewers and to those additional reviewers, such
Transparency Initiative was of enormous help in ensuring as Rolando Ossowski (formerly senior economist at the IMF),
that we updated the sections on that important initiative. Alan Gelb (senior fellow at the Center for Global Development),
The chapters on law, contracts, and sector organization Peter Roberts (editor, Journal of World Energy Law and
would have been poorer without the comments of Business), and Philip Daniel (formerly senior adviser to the
Paul Griffin, Honoré Le Leuch, and Peter Roberts, among Fiscal Affairs Department at the IMF), who generously pro-
the best lawyers and contract specialists anywhere in the vided advice and suggestions.
world. Armando Zamora contributed insights into regula- The Sourcebook project was supported at CEPMLP by
tion in Latin America, and Honoré Le Leuch shared his Daniel Gilbert, the research fellow for the project, and at the
insights into fiscal design. Any errors or shortcomings that World Bank by Noora Aarfa, Norma Garza, Paolo de Sa, and
remain are not in any way attributable to them. Peter van der Veen. Various CEPMLP students assisted from
During its more than three years of gestation, the time to time including Gaspar Andre, Marcia Ashong, Job
Sourcebook has had to take into account the fast pace of Kahigwa, Agostina Martinez, Babatunde Osadare, Georgia
debate on the role of extractives in development. It has Panagiotidou, and Mauro Amilton de Celestino Pedro. Peter
had to respond to the reshaping of challenges in under- Cameron is grateful to all his colleagues at CEPMLP for
standing oil, gas, and mining activities as the commodities their continuous and robust support, and to Qiumin Li and
downturn turned out to be longer and deeper than any- Alexander and Sophie Cameron, whose optimism about the
one had expected. It has been exciting to note how the future influenced the tone of this text. A special mention is
pace and trend of research has not slowed or weakened; on made for our friend Michael Levitsky, whose comments and
the contrary, it has become more detailed and more con- insights were helpful to the authors at the early stages of this
cerned with the uniqueness of country experiences, and it project and were much appreciated. At the production stage
has produced a greater diversity of tools and instruments we are most grateful for the work done by Patricia Katayama,
for applied knowledge than many could have expected. Janice Tuten, and Aziz Gökdemir. None of the above bears
The Sourcebook partner organizations, particularly the responsibility for the final text.
xiv ACKNOWLEDGMENTS
ABOUT THE AUTHORS
Peter Cameron is one of the world’s leading authorities on Michael Stanley serves as the global lead for extractive
hydrocarbons law and policy and European Union energy industries at the World Bank Group in Washington, DC.
law. He is a barrister and professor of international He provides leadership on the policies and practices that
energy law and policy and director of the Centre for Energy, guide the World Bank’s lending operations in oil, gas, and
Petroleum and Mineral Law and Policy at the University of mining worldwide and ensures that a diverse technical staff
Dundee in Scotland, United Kingdom. Cameron led the remains at the forefront of sector development issues.
consortium of universities and policy centers that created Stanley has worked in resource development for more
the Extractive Industries Sourcebook. He also serves as the than 30 years in both the commercial and public sectors, and
senior content adviser in the Extractives Hub project, has led projects in Latin America and the Caribbean, Europe
funded by the U.K. Department for International and Central Asia, Africa, South Asia, and East Asia and
Development. Pacific regions. He is widely recognized for his expertise in
Cameron has been an adviser or consultant to governments the formation of resource development policy that aligns
and to international organizations such as the World Bank, commercial and public sector investments with shared sus-
European Bank for Reconstruction and Development, United tainable outcomes, and also for his support of learning and
Nations, European Commission, and African Petroleum education initiatives for a diverse set of stakeholders.
Producers Association. He is the author or editor of more than Responding to the challenges of climate change, limited
a dozen books and over a hundred articles, including a study access to capital, increased geopolitical risk, and commodity
of stabilization issues, International Energy Investment Law: cycles, Stanley and his teams guide governments each day on
The Pursuit of Stability. He is also joint editor of the online resource development issues.
Encyclopedia of Mining and Energy Policy. He regularly appears Stanley holds degrees in geoscience (BSc, Western
as an expert witness in international arbitral disputes and University), mineral exploration (MSc, McGill University),
serves as an arbitrator in proceedings of the International and mineral economics and mining (PhD, University of
Centre for Settlement of Investment Disputes. Arizona) and is co-editor of the online Extractive Industries
In 2013 Cameron was elected a Fellow of the Royal Sourcebook, the open-source platform for the extractive
Society of Edinburgh. industries.
xv
ABBREVIATIONS
xviii ABBREVIATIONS
PART I
ChapterPatterns
Shifting Title of Demand and Supply
3
benefits are retained by a few and the costs are borne research has shown that there is nothing inevitable about
by many. They have been called a “resource curse.”5 either negative or positive links.7 A growing body of opin-
Development of the country in which the operations take ion, discussed in this and in the following chapters, argues
place may not necessarily follow large-scale investment, at that discoveries of oil, gas, or minerals can contribute posi-
least not in the sense that investment generates long-term tively to a country’s overall agenda for social and economic
development impacts. In some cases, the country may development if the challenges of resource management can
even become worse off, depending on the human develop- be met successfully within the constraints imposed by envi-
ment indicators used, particularly environment-related ronmental considerations. Many of those challenges are
indicators. This has led some to conclude that the discovery now thought to lie within the institutional or governance
and development of oil, gas, and minerals is not a blessing frameworks of the countries themselves. Governments and
at all or even a source of opportunities to accelerate eco- citizens in countries seeking to promote resource-led devel-
nomic and social development. opment must ask themselves, What should our priorities be
This debate has been thrown into sharp relief by the and what choices are open to us?
sudden end of the long commodities boom that benefited The first question they should address is whether oil, gas,
resource-rich countries during the early 2000s, when oil or other mineral exploitation is a good course of action or
and metal prices reached historic highs. The reversal in com- not. This is especially true in areas of high conservation
modity prices has underlined the vulnerability of this industry value. There will be some situations where environmental
to volatility, unpredictability, and periodic shocks. Preparation (or social and cultural) factors are so significant, or occa-
for downward swings as well as upward swings is an essential sions when the negative impacts cannot be reliably pre-
task for any existing or aspiring resource-rich state. dicted, that oil, gas, and mining must be considered an
If a single lesson has been learned from this debate, it is incompatible option and a cautious approach should be
the need for governance structures that can ensure that adopted.
short-term benefits are not obtained at the expense of long-
term sustainability. Yet many citizens will find that the chal-
1.2 THE DEMAND FOR KNOWLEDGE
lenges of natural resource management are ones for which
their governments are not well prepared. Not so very long ago, governments in many parts of the
Moving forward is more than a matter of installing or world were entirely dependent on international firms for
building “capacity.” It requires governments to understand the development of oil, gas, and mineral resources. The
how what is commonly described as “good practice” is con- assumption of control by sovereign states is quite recent, as
tinually modified and improved by research and compara- is their experience of designing and implementing their
tive analysis, to test fresh approaches in a country’s unique own policies addressing these resources.
context, and at the same time to persuade vested interests of For the first generation of states in the postcolonial
the need for change. In practical terms, governments in world, knowledge of the optimum practices for their oil,
resource-rich countries and countries that appear to have gas, and mineral industries was often not readily available.
good resource potential will often inherit legal and institu- As a result, these states were frequently dependent on and
tional frameworks for EI activity that need to be reformed. even had their policies shaped by the advice of international
In some countries, there may be only a patchwork of institutions and other outside bodies. Their legal and fiscal
contracts in place, hardly meriting the consistency and frameworks often reflected a colonial legacy or a reaction to
cohesion implied by the commonly used notion of a frame- it by pioneering new relationships with foreign investors
work. Policies that envisage long-term, resource-led devel- designed to increase the state share of the expected benefits.
opment will often have to be designed from scratch. Some of these innovations worked, such as the introduc-
In tackling these policy challenges, governments of tion of production sharing in the oil industry, and others
resource-rich developing countries will quickly become were less successful, such as the use of state-owned compa-
aware of the current wide range of opinions and perspec- nies in mining.
tives on resource-led development, bolstered by an impres- In the twenty-first century, on the crest of a wave of high
sive number of case studies and volumes of empirical data.6 prices and robust investment, a new generation of states
Some will caution them that negative economic, environ- joined or seemed about to join the club of petroleum and
mental, and social effects can outweigh the potential bene- mineral producers (see figure 1.1).8 The new arrivals have
fits of natural resource development. However, recent diverse origins: some states have emerged from armed
Tanzania
Philippines
Canada
United Kingdom
Lesotho
Brazil
Sierra Leone
Australia
Kyrgyz Republic
Ghana
Niger
Zambia
Namibia
Colombia
Uzbekistan
Côte d’Ivoire
Chile
Mauritania
Mongolia
Norway
Vietnam
Guinea
Russian Federation
Ecuador
Congo, Dem. Rep.
Bolivia
Indonesia
Papua New Guinea
Malaysia
Mexico
Cameroon
Syrian Arab Republic
Kazakhstan
Myanmar
Botswana
Venezuela, RB
Trinidad and Tobago
Azerbaijan
Sudan
Chad
Qatar
Iran, Islamic Rep.
Timor-Leste
Yemen, Rep.
Algeria
United Arab Emirates
Nigeria
Congo, Rep.
Bahrain
Angola
Kuwait
Oman
Libya
Saudi Arabia
Equatorial Guinea
Iraq
Brunei Darussalam
0 10 20 30 40 50 60 70 80 90 100
Percent
Mining and petroleum revenue Mining revenue Petroleum revenue
The EI Value Chain emphasizes five distinct but related the others in that it is primarily policy based rather than
features in the sector management process (Alba 2009). rule based. It presupposes that a strategic choice has
Every resource-dependent state has to move through each already been made to exploit resources as the most sustain-
of these if resource-led development is to take place.13 They able scenario, with trade-offs and costs weighed in a trans-
cover (1) the establishment of a legal framework that will parent manner.
convey and enforce rights to investors within a broad policy There are two parts to the approach to implementa-
for development of publicly owned resources, (2) the insti- tion. First, because the resources are finite, states must ask
tutional organization of the sector and particularly the reg- whether policies should be designed so that future genera-
ulation and monitoring of operations in the public interest, tions benefit from their development. Are the resources to
(3) the design and collection of taxes and royalties, (4) rev- be developed rapidly without concern for possible spinoffs
enue management and distribution, and (5) the implemen- in infrastructure or other economic development? Or are
tation of sustainable development policies. these considerations to be built in to maximize benefits
The EI Value Chain concept allows the Sourcebook to over the long term and attempt a wider economic and
illustrate how good practice policy interventions must be social transformation? Second, it aims to capture environ-
made in an integrated manner if natural resource assets are mental and social impacts of oil, gas, and mining activi-
to be transformed into resource wealth along a sustainable ties. Although these are evident at earlier stages of the EI
path. Public policy decisions have to be made at the vari- Value Chain, where sustainability criteria should be devel-
ous points in the chain; sometimes it may resemble a deci- oped, they are likely to be weighted more to this end of the
sion chain. A failure in decision making at one stage in the chain, once production has commenced and revenues are
chain disrupts the sequence and affects the value of the flowing.
resource assets as they are transformed along the chain. Three features of our approach to the EI Value Chain in
Policy makers need to take a holistic approach to EI sector the Sourcebook should be noted:
development.
For each link of the EI Value Chain there are common 1. It includes a cross-cutting feature on transparency and
problems that arise and practices that have evolved to accountability to reflect their significance (see chapter 8).
address them. Knowledge of these problem-solving practices 2. It attaches enhanced significance to the establishment of
and their continuing evolution is the Sourcebook’s principal a legal and contractual framework (the rule of law), in
subject matter. Understanding entails more than an assem- contrast to some other versions of the value chain.14
bly and description of practices, instruments, and principles. 3. It emphasizes the need to ground the good practice rec-
It requires interpretation and contextualization for a proper ommendations of the Sourcebook in a political economy
understanding and appraisal. The dynamic of shifting public context—that is, the constellation of specific institu-
policy priorities in problem solving—sometimes in response tional and governance features that will shape the appli-
to international or regional developments—also has to be cation of good practice and require such practice to fit if
taken into account. it is to achieve its intended aim.
The fifth chevron—sustainable development
implementation—attempts to capture related policy con- In a recent study of results chains and logical frameworks
siderations that address the challenge of developing applied to the extractive industries, the authors emphasized
resources in a sustainable way. This chevron differs from the risks of their becoming “rigid frameworks (blueprints)
2.1 INTRODUCTION of the main themes in a very extensive and rich body of lit-
erature, in ways that might benefit those unfamiliar with it
The strategic character and macroeconomic significance
or who are unable to access much of it.1 It has no preten-
of the extractive industries (EIs) is not in doubt. They con-
sions to being more than an introduction.
cern economically crucial natural resources—oil, gas, and
Current thinking on the interaction between natural
minerals—located underground or beneath water and capable
resource policy and development policy is still evolving in the
of being extracted and marketed by human endeavor. Their
light of research and lessons from practice. The end of the
extensive applications in the modern, globalized economy are
long boom from around 2003 to 2012–13 has triggered
well known. Looking ahead, minerals from hard-rock mining
rethinking and fresh analysis. Further insights and policy
will provide critically important materials for more sustain-
recommendations can be expected. Changing perspectives
able economies of the future. The same cannot be said of oil
on mining over the past 15 years have significantly shifted the
and coal, even if a pragmatic approach suggests we may have
focus from large-scale, capital-intensive mining operations to
no choice but to continue their development.
the mining sector as a whole, including artisanal and small-
Chapter 2 reviews some of the dominant thinking about
scale mining, in assessments of sustainable futures. Other
the opportunities and challenges of resource-led develop-
examples of changing perspectives include diverse efforts at
ment and explains in detail the approach of the Oil, Gas,
integration of extractive industry investments into local com-
and Mining: A Sourcebook for Understanding the Extractive
munities and the regional economy. These efforts include, for
Industries. It charts the emergence of the “development
example, the design of local benefit policies on procurement
model,” which sees positive outcomes from EI activity if
and “resources-for-infrastructure” deals championed by
certain conditions are fulfilled. It also provides a summary
19
investors from various countries, including, notably, China. Figure 1.1 (chapter 1) depicts natural resources receipts in
(See the Angola model, discussed under “9.3 Challenge 1: 57 countries: oil, gas, and mining revenues made a significant
Leveraging EI Investments for Development” in chapter 9). contribution to the public finances of a growing number of
For the various governmental and nongovernmental countries from 2000 onward. In a study of 36 petroleum-rich
bodies now seeking to influence or shape their domestic countries, the portion of government revenues drawn from
extractive industries, familiarity with the themes in this oil and gas operations ranged from 10 percent to 97 percent,
body of research can be useful. They inform—sometimes with the average at 50 percent overall (Boadway and Keen
only implicitly—virtually all of the contemporary discus- 2010). A separate listing of 10 mining-rich countries showed
sion on policies for resource-led development. In effect, that mining’s share of total government revenue ranged
they set the parameters within which the initial strategic between 1 percent and 44 percent, averaging 11 percent over-
decision is made whether or not to engage in development all. Of the 35 countries most dependent upon mining, all but
through extraction. They also inform the design and choice Australia and the Republic of Korea can be classified as devel-
of specific operational techniques and instruments, such as oping countries, and of the top 70, no fewer than 63 are low-
decisions on the kind and scope of rights allocated to inves- income countries that could leverage their development
tors, the way in which they are awarded, and the appropri- prospects through mining (ICMM 2015).
ate schemes for sharing benefits among public and private The literature on resource development notes the many
parties. Their impact on our understanding of good practice states that have already benefitted from the development of
has influenced the approach taken by the Sourcebook. their petroleum and mineral resources. As Alan Gelb (2010)
comments, “Developing countries as a whole have been
remarkably successful in diversifying their economies and
2.2 THE OPPORTUNITIES ARISING FROM
their export structures.” In the 1960s, he writes, about
RESOURCE ABUNDANCE
80 percent of developing country exports were primary
Wealth on the scale experienced in some resource-rich states, commodities; 50 years later, almost 80 percent were indus-
both absolute and relative, can generate significant positive trial products. Some have become major industrial powers;
development outcomes. Even for states with modest abun- others have diversified within resource-based sectors (fresh
dance or prospects for petroleum or mineral deposits, the produce, fish, and tourism, for example). For developing
outcomes from resource development could be transforma- countries that are dependent on the export of minerals,
tive. The potential to attract significant investment also exists. however, it has proved harder to break free from depen-
In the first decade of the 21st century, investments in mining dence on their dominant resource. Indeed, the number of
were estimated at about US$80 billion, with much of this countries heavily dependent on minerals for fiscal revenue
destined for iron ore and copper. Investments in hydrocar- and exports appears to be increasing (Gelb, Kaiser, and
bons exploration and development by the largest 70 interna- Vinuela 2012). Even so, in terms of economic development
tional oil companies increased from US$315 billion in 2007 based on the extractive sector, there are undeniable success
to US$480 billion in 2011 (Ernst & Young 2012). stories, including selected states in the Middle East and
It is scale more than anything else that is the key to the North Africa, Colombia and Peru in South America, and
flow of revenues in the EI sector. For lower-income coun- Malaysia in Southeast Asia. In the mining sector, Chile,
tries, revenues resulting directly from the exploitation of Botswana, Brazil, Ghana, and South Africa are much-cited
resource wealth have the potential to exceed official aid flows examples of states that have used their resource wealth ben-
by a very wide margin. In principle, such revenues could eficially. In both India and China, the rapid pace of eco-
unlock the constraints of foreign exchange, savings, and nomic growth in recent years is largely attributable to their
public finance and support a broad range of social and physi- access to large amounts of inexpensive energy through coal
cal infrastructure priorities common to developing states. mining (which nonetheless internalizes environmental
These can include initiatives in the health, education, trans- externalities). In later chapters, the Sourcebook will elabo-
port, and telecoms sectors. Increased, well-designed public rate on some of these examples of positive development.
expenditure of resource revenues can promote both local Within this group, there are important differences in the
employment and local ownership in economic activities, development and diversification options open to countries in
contributing not only to economic diversification, growth, particular regions, a fact that has generated significant com-
and well-being but also to social and political stability. More ment. Export states of oil, gas, and other minerals can differ
and more countries face this prospect. in many respects, such as population, labor force and skills,
Artisanal and small-scale mining (ASM) has under- activity, then the focus of the agenda becomes
gone reframing by the international community over increasing productivity through technology, access
the past few decades (see chapter 9). This affects the to finance, and better organizational representation.
understanding of what ASM is, how it is organized, Policy choices may cover a range of these perspectives
and what type of activity it undertakes. The new depending on the national ASM demographic. The
framing has had significant impacts on approaches to first question to ask is whether the people wish to
resolving challenges that face this subsector, leading remain as miners or to leave for opportunities else-
to a variety of different approaches. For example, if where. New research suggests that many miners now
one considers ASM a poverty-alleviation strategy, consider such mining a profession (Hilson 2010;
then approaches typically focus on it as a develop- Hayes and Perks 2011). This has implications for the
ment opportunity, a practice in need of a policing design of policy.
exercise, or one requiring ways to transition practi- The challenge of the ASM sector becomes a question
tioners out of mining and into economic alternatives. of how one sees ASM in the first place: as an opportunity
By contrast, if ASM is considered a viable economic or a problem.
160 200
Technical factors
140
The three technical or nonpolitical factors most commonly 120 150
identified as contributing to the resource curse are (1) revenue 100
volatility, (2) the so-called Dutch Disease, and (3) resource 80 100
exhaustion. 60
40 50
20
Revenue volatility. The volatility of petroleum and min-
0 0
eral prices and hence a large proportion of revenues is well 1990 1995 2000 2005 2010 2015
documented, but arguably the challenges facing resource-
Coal Iron ore
rich economies of managing the long-term uncertainty of
commodity prices have been underestimated. For some Source: Index Mundi (www.indexmundi.com).
involve prices moving by as much as 40–80 percent for as long Indonesian liquefied natural gas
as a decade” (IMF 2015b, 2). Price forecasts in the resource Russian gas flowing to Germany
sectors have also been notoriously inaccurate (see figure 2.4). Source: IMF and World Bank 2017.
As a leading petroleum expert noted, “What is remarkable Note: Btu = British thermal unit.
120
2008
100 2014
Crude oil: US$ per barrel
80
2009
2006
60
40
2004
Actual prices
20 1996
2000
1998
0
1990 ’92 ’94 ’96 ’98 2000 ’02 ’04 ’06 ’08 ’10 ’12 ’14 ’16 ’18 2020
39
strategic investments aimed at securing future supplies of adverse changes when a major discovery is made and/or
energy and minerals. exploitation is under way (see chapter 4).
There are many aspects of this investor-state dynamism Conditions and assumptions that exist at the beginning of
that present challenges to policy advisers and decision mak- a project—at the time when laws are drafted and contracts
ers in resource-rich states. For example: awarded—are almost certain to change over the course of the
What kind of company or pattern of companies is best project investment. Initial decisions are usually made when
suited to achieve a country’s policy on extractives and develop- there is great uncertainty about the sector’s potential, based
ment generally? on what is known about the geology at the time of explora-
The choice is wide. Alongside long-established companies tion. There is also uncertainty about the future economics,
from the Organisation of Economic Co-operation and markets, risks, and politics that will affect the project. The
Development (OECD) countries, there are state-owned incentive for a state to revisit the terms of the initial bargain
enterprises from Malaysia, the Middle East, and the Republic struck is increased by the shift in bargaining power that
of Korea and new players from Brazil, China, India, and the occurs in the event of a commercial discovery and a sub-
Russian Federation, all making significant impacts. Significant stantial investment by the foreign investor.
diversity in industry ownership and financing structures has
emerged from the resulting South-South pattern of invest-
Sophisticated management and specialized
ment; the use of resource-for-infrastructure deals is one
technology
example of the latter. Moreover, the growing number of
so-called junior or mid-cap companies as investors means A second common feature is the dependence of the EI
that a focus by policy makers and their advisers on the “super- sectors on sophisticated management and specialized
major” companies that long dominated the EI sector is now technology.3 This dependence affects the development of
inappropriate. This diversity is also evident in the destinations host-state institutional capacity. States developing their EI
of investment, the points along the exploration-to-extraction sector must have sufficient institutional capacity to ade-
continuum and across energy and other mineral commodities quately oversee sector operations and for adopting the com-
(Barma, Kaiser, Le, and Vinuela 2012). A further element of petitive licensing, contractual, and fiscal regimes required to
complexity in investor-state relations is the international attract needed skills and technology (see chapter 5).
character of investment in the EI sectors. More than ever, The challenge here lies in finding ways of enabling a trans-
there are opportunities for investors to structure their opera- fer of expertise and sourcing of business to local firms in order
tions, on- and offshore, to take advantage of this context. As a to ensure a long-term benefit to the domestic economy.
result, national tax and regulatory authorities face challenges
in regime design, monitoring, and enforcement.
Asymmetric access to information
3.2 COMMON FEATURES OF THE INDUSTRIES Partly due to the complex management skills and technol-
ogy that characterize the EI sectors, governments are at an
Long, risky, and costly exploration
informational disadvantage vis-à-vis international inves-
and development
tors and operators (Stiglitz 1989; Nutavoot 2004). The
Each of the EI sectors is characterized by long, risky, government is likely to be informed about its future fiscal
costly, and very capital-intensive development.2 For oil intentions, but the private investor undertaking explora-
and gas, there is additionally a high cost at the exploration tion and development will probably be better informed
stage, with dry wells and resulting losses being common. about technical and commercial aspects of a project. This
A state that wishes to go it alone in the EI sector needs has important implications for the design of license or
significant financial resources and an economy with suf- contract award procedures, fiscal design, and fiscal admin-
ficient diversity to allay concerns about EI sector invest- istration as well as the engagement of outside technical
ment risk (Boadway and Keen 2010). States that, more assistance. It can also be the root of subsequent dissatisfac-
typically, choose to attract and rely on international tion by a government about the terms negotiated with
investment, need to have in place a legal, contractual, and investors by its predecessor(s) and trigger demands for a
fiscal regime that investors can understand and trust. review of those terms.
These states must also have a political track record that With increasing sources of competition in the EI sector,
provides investors with reasonable assurances against and the role of national resource companies, this is less of a
Resource exhaustion
Substantial rents
By their nature, oil, gas, and mining resources are nonre-
Both the petroleum and mining sectors are capable of gen- newable.4 They will eventually be exhausted. This distin-
erating very substantial economic rents. By rent is meant the guishes these industries from most, perhaps all others and
revenues in excess of all costs of production, including those presents policy makers with a number of important issues,
of discovery and development, as well as the normal return ranging from decisions on optimal rates of exploration,
to capital. The cost of extraction can be significantly less development, and exploitation (through fiscal regime
than the price that the resource can obtain on the market, design) to appropriate frameworks for macroeconomic
Box 3.1 Key Differences between the Petroleum and Mining Sectors
1. The overriding significance of exploration in invest- 3. Procedures for contract award and security of ten-
ment in the petroleum sector contrasts with mining ure differ (see chapter 4).
(linked to searching for oil in large sedimentary 4. Legal frameworks: detailed legislation is favored in
basics deep underground and related costs). In min- mining while similar detail is typically found only
ing, systematic drilling follows a slower, deductive in model contracts in the oil and gas sectors.
process of surveying and surface sampling over a 5. State-owned companies have been much less
relatively smaller area. prominent in the mining sector than in the hydro-
2. The scale of rents is often much higher in oil than carbons sector.
in mining. This is linked to a different structure of 6. The petroleum sector often uses a production-sharing
risk and reward, with oil having more of both. contract, which is nonexistent in the mining sector.
7. The prevalence of artisanal miners distinguishes (to establish production facilities and pipelines);
mining from petroleum and presents important mining has high capital costs but needs more
policy issues. people during production, ongoing equipment
8. Taxation in mining tends to favor royalty and investment, and continuous management of local
profits taxes, while in the petroleum sector the environmental impacts.
widespread use of production-sharing presents a 10. Mining is more fragmented and geographically
more complex picture, with a wider range of taxa- spread than oil; it has numerous products in differ-
tion rates being common, too. ent forms instead of a few relatively homogeneous
9. A different balance of capital and operating costs in products.
the oil industry makes costs higher at the front end
1. National resource companies remain popular in training programs to transfer skills and create
most oil- and gas-producing countries, more so employment.
than in the mining sector. 6. Stabilization clauses are commonly used in oil and
2. Usually, distinct laws will be made for oil and gas agreements.
gas activities and for the mining of other miner- 7. Natural gas discovery and development is com-
als. Inevitably, this difference in choice of legal monly treated differently from oil in the basic
design appears to suggest the existence of underly- agreement, with a longer period being given to the
ing differences between the two sets of extractive appraisal of a gas discovery and fiscal provisions
industries. being designed to reflect its different profitability.
3. In the oil and gas sector, a framework approach 8. Contract provisions may require priority alloca-
to legislation is often preferred, with a higher tion of gas to the domestic market and/or set con-
degree of reliance on a related model or standard ditions for the authorization of export sales.
contract for exploration and exploitation than in 9. Gas contracts contain detailed valuation clauses set-
mining. ting out how wellhead prices are to be determined.
4. Three types of agreement govern the relation- 10. In award procedures, it is a desirable and increas-
ship between a host government and investors in ingly common practice to prequalify applicants for
upstream oil and gas activities: the concession or awards.
license, the production-sharing agreement, and the 11. Where significant geological data are available and
risk service agreement. Only the first is commonly investor interest is high, a competitive auction is
found in mining. generally considered the best option for awarding
5. Most oil and gas agreements require the contrac- contracts.
tor to purchase a proportion of its needed goods 12. In the award of oil and gas rights, it is the work
and services in the host country from local sup- program that generally has the most influence in
pliers to promote linkages to the local economy. decision making, usually combined with a finan-
Similarly, they require a hiring preference for cial variable, such as a bonus, royalty, or profit/
nationals of the host country and the use of production share.
1. Access to land is the starting point for the mineral where there are strong indications of multiple
exploration and mining process. and competing interest.
2. Ownership of subsoil resources needs to be legally 8. Mining agreements should not:
specified. ■ Include fiscal terms preferential to particular
3. The state specifies mineral rights, generally either investors, most-favored-company provisions,
exploration or mining licenses, in exchange for or provisions for their own extension to cover
license holders undertaking exploration or devel- new areas
opment work. ■ Provide license holders with long-term explo-
4. Most exploration licenses for minerals contain ration rights (such as right lasting last longer
the presumption that a company finding any- than a decade)
thing will have the right of first refusal on its ■ Allow investor “land-banking”—there should
development. be an obligation to conduct substantive work
5. For mining, unlike for oil or gas, established ■ Tie up land far larger than the area to be mined
practice includes the offering of exploration on a during the expected life of the mine
first-come, first-served basis, due to a lack of both 9. Companies should not be made subject to unreason-
geological information and investor interest. able “use it or lose it” provisions, since they need to
6. However, there is now generally more data avail- be able to time their investments with regard to the
able and hence greater interest in obtaining explo- price cycle, not just the government’s fiscal needs.
ration licenses. 10. Large numbers of artisanal miners are common in
7. While first-come, first-served will continue to the mining sector of several developing countries.
be appropriate for areas that are largely unex- They are notably present in mining for gold and
plored, good practice is for a government to precious stones. Good practice lies in formaliza-
offer licenses on a competitive bidding basis in tion and legalization of certain types of artisanal
situations where geological data are available and and small-scale mining.
3.4 EI SECTOR DYNAMICS should be noted here as elsewhere. Trends in both sectors
seem to be encouraging some convergence. In box 3.4 there
Most accounts of the EI sector emphasize the wide diver-
is a summary of five developments that have, in the view of
sity of their structures, noting size and ownership patterns
one commentator, the effect of encouraging convergence.
and changing trends in them.7 These features continue to
As circumstances change, many investors are accus-
evolve. Research in recent years has explored the important
tomed to selling an interest, merging, or making other
role that national oil companies (NOCs) now play in the
acquisitions in their pursuit of value. Their decisions will
international oil and gas industry (Tordo, Tracy, and Arfaa
usually be made within a framework of corporate operations
2011; Victor, Hults, and Thurber 2012; Marcel 2005).8
that goes well beyond those of a single country, and justified
Similarly, there has been research into the role of new play-
to stakeholders who in the vast majority of cases are unlikely
ers in the global mining industry and into junior compa-
to reside in the country hosting the investment. These and
nies and their effectiveness, particularly at the exploration
other ways in which EI industries respond to exploration,
stage, where they are assumed to have an advantage and
development, and production in their international opera-
where they are increasingly in evidence, especially in
tions may be too little understood in host countries, with
Sub-Saharan Africa (Humphreys 2015).9 Some research
resulting negative effects on the design of public policies.
has been driven by the awareness among policy advisers
that such companies regularly employ the panoply of inter-
national taxation rules to maximize their advantage, pre-
Buying and selling assets
senting a challenge to governments in states with poorly
developed fiscal regimes.10 The typical ways that internationally operating companies
While there is plenty of evidence of the differences obtain access to new reserves need to be understood. Explora-
between mining and hydrocarbons, the dynamic factor tion activity is only one way for companies to gain access.
Chapter
Policy, Title and Contractual Framework
Legal,
57
4.2 GETTING STARTED: FACTS OF EI LIFE An exception to the default rule of state ownership of
natural resources is the complex mix of private and public
The world of legal and contractual relationships in the EIs is
ownership arrangements used in the United States. A sig-
shaped by two basic facts:
nificant proportion of lands are in private ownership, and
the owners are also the owners of the subsoil resources.
1. Every country, prospective or actual producer, vests
They are entitled to negotiate leases with companies to
ownership of oil, gas, and mining resources—when in
develop mineral resources. Recent discoveries and develop-
the subsoil—in the state, with very few exceptions, such
ment of shale gas and oil have been made overwhelmingly
as the United States.
in lands owned by private persons.6 Alongside this, there are
2. Development of oil, gas, and mining resources requires
extensive federal lands and offshore waters where public
translation of this legal fact into a series of coherent
ownership is the norm.
policy choices, contract forms, and fiscal instruments in
International law provides support for a close linkage
a distinct structure or framework.
between state sovereignty and natural resources. The first
expression of this in modern times was the 1958
Ownership
Convention on the Continental Shelf, made as new tech-
The first fact is always a given. Most countries vest the own- nology was becoming available to explore for offshore
ership of subsoil resources in the state on behalf of the hydrocarbons and eventually other minerals. The idea of a
people, either in their constitution or in a distinct sector- “permanent” state sovereignty over natural resources was
specific law: a petroleum law or a minerals law.2 This dec- comprehensively elaborated in United Nations (UN)
laration affects all aspects of the extractives regime and Resolution 1803 in 1962 (see box 4.1).7 This had its roots
makes its operation explicitly a matter of public policy, and in a postcolonial world, where hydrocarbons and other
one that the courts may be empowered to interpret. An mineral resources had initially been developed by foreign
example of this is the wide-ranging statement of ownership investors on terms highly unfavorable to the host states.
that is included in the constitution of Ghana. Its scope is The idea of sovereign ownership remains of fundamental
wide enough to grasp all the important areas where miner- importance (Schrijver 1997). It is nonetheless qualified by
als may be found, including offshore waters as well as on, a greater appreciation of the need for any central state to
and under, land: respect the interests of local communities, particularly in
areas affected by EI activities; the rights of indigenous
Every mineral in its natural state in, under or upon peoples who may have claims to sovereignty over natural
any land in Ghana, rivers, streams, water courses resources on their lands; and the obligations of states to
throughout Ghana, the exclusive economic zone and their neighbors in relation to transboundary environmen-
any area covered by the territorial sea or continental tal accidents. The latter requires the “polluting” state to
shelf is the property of the Republic of Ghana and notify and cooperate with neighboring states to mitigate
shall be vested in the President on behalf of, and in any damage.
trust for the people of Ghana.3 International law has also been active in addressing a
feature of state sovereignty over natural resources that
Where a special law is concerned, the declaration of own- assumed importance after UN Resolution 1803: the delimi-
ership might take a different approach. Two examples are: tation of territory, particularly offshore and inland waters,
for hydrocarbons but also deep-sea ocean spaces for mining
1. Mineral resources belong to the [Chinese] State. The (see box 4.3). The value of such space has vastly increased
rights of State ownership in mineral resources are exer- with the development of technology to explore for oil, gas,
cised by the State Council. State ownership of mineral and other minerals in ever-deeper waters. In a number of
resources, either near the earth’s surface or under- cases, the inability of states to resolve differences arising
ground, shall not change with the alteration of owner- from boundaries has led them to refer the disputes to inter-
ship or right to the use of the land which the mineral national courts and tribunals for independent resolution.
resources are attached to.4 Many other disputes remain unresolved and are potential
2. Title to, and control over, Petroleum in the Territory of sources of tension and conflict.8
Somalia are public property and are vested in Somalia, in Finally, we note the ownership issues that arise from the
trust for its people.5 fragmentation or breakup of states, as one part of a state
The doctrine of Permanent Sovereignty over Natural state by stating that in cases “where authorization
Resources was set out in the UN General Assembly [of the investment of foreign capital in the natural
Resolution 1803 (XVII) in 1962. Approved by capital- resources of the host State] is granted, the capital
exporting and capital-importing states alike, it states in imported and the earnings on that capital shall be gov-
article 1, “The right of peoples and nations to perma- erned by the terms thereof, by the national legislation in
nent sovereignty over their natural wealth and resources force, and by international law. . . . The profits derived
must be exercised in the interest of their national must be shared in the proportion freely agreed on, in
development and of the well-being of the people of the each case, between the investors and the recipient State.”
State concerned.” The resolution is nonbinding but However, Resolution 1803 does not empower the
represents good practice. state to make unilateral changes to its laws in order to
Resolution 1803 itself was developed at a time when negate the terms of a contract. Article 8 of Resolution
discussions about the New International Economic 1803 is clear on this point: “Foreign investment agree-
Order were robust and postcolonial development issues ments freely entered into by or between sovereign
framed the debates. This period came to an abrupt end States shall be observed in good faith.”
with the 1986 world oil price crisis. This crisis followed The doctrine of state sovereignty and sovereign
two oil price shocks in the 1970s, but unlike the sharp rights over energy resources also appears in article 18
escalations in prices in 1973 and 1979, the 1986 crisis of the 1994 Energy Charter Treaty. It has to be exercised
led to a dramatic fall in the price of oil, not unlike the in accordance with and subject to the rules of interna-
price fall in 2015. tional law. This doctrine is also an integral component
An important provision in Resolution 1803 can be of more recent discussions on the rights of indigenous
found in article 3, which expressly recognizes the sanc- peoples to access and control natural resources on
tity of the contract between the foreign investor and the indigenous lands.
elects to separate itself. South Sudan is a recent example of options and advice and recommendations based in “best
this, and Timor-Leste is another. The emergence of new practice.”
states from the end of the Soviet Union in the 1990s pro- An example of the flow in legal arrangements is found in
vides several other examples. Brazil. Article 176 of the constitution provides that “(1)
mineral deposits, whether exploited or not . . . form prop-
erty separate from the soil, for purposes of exploitation or
Development of a legal framework
use, and belong to the Union; and (2) unauthorized pros-
The second basic fact of legal and contractual relation- pecting or exploitation is prohibited.” Article 177(1) autho-
ships in the EIs is the need for states to develop a frame- rizes state-owned or private companies to search for and
work for investment and development of the resources. exploit hydrocarbons. Law 9,478/97 provides a licensing
Even where public ownership is clearly enshrined in the regime for the hydrocarbons activities, supplemented in
constitution or a special law, there needs to be supple- 2010 by a production-sharing agreement (PSA) regime for
mentary guidance on how ownership translates into a so-called presalt and strategic areas. As knowledge of the
regime for the award of rights, the terms on which the Brazilian offshore evolved, there was an elaboration of the
rights are held, and their duration, obligations, the form regime for the allocation of rights.
of contract, regulation of operations, institutional coordi- Where ownership of the resource is a highly sensitive
nation, and the distribution of revenues among the coun- political issue, great care must be taken by governments in
try’s citizens. This crucial step opens a Pandora’s Box of proposing or modifying the regime for resource develop-
multiple challenges and choices, with the final results— ment. The legacy of past choices will shape the policy con-
the framework of policy, law, and contract—being decided text of the present. In such countries, a key question will be,
through political bargaining in the country concerned. What is to be the role of state enterprises in future explora-
Government officials will often be faced with a plethora of tion and production of the resource? Alternatively, what
While award of rights to land areas can generally be joint venture with the contractor of the other state (for
made on the basis of certainty about boundaries example, the Japan–Republic of Korea JDZ). The third
between adjacent states, this is not always the case in is the Joint Authority approach, where both states dele-
maritime areas. Until the boundaries are clearly estab- gate power to a single body, which becomes responsible
lished under international law, investors will be unable for overall supervision of activities including the award
to make substantial commitments. One way of address- of rights in the JDZ (for example, the Nigeria–São Tomé
ing overlapping claims and providing a temporary and Príncipe JDZ and the Timor Sea JDZ). In Nigeria–
solution so that hydrocarbons activity can commence São Tomé and Príncipe’s case, the first round of licens-
and revenues shared is for states to agree on a Joint ing was held in 2003 and by 2013 US$400 million had
Development Zone (JDZ) or Area. been spent by contractors under five production-
International law allows for states to take provi- sharing contracts (PSCs) awarded in two rounds. Much
sional arrangements of a practical nature to develop of the government revenue has been in the form of sig-
the mineral deposit in a defined area under dispute nature bonuses and concession rentals. Revenues from
without foregoing their territorial sovereignty Timor-Leste’s JDZ have proven to be considerable.
(UNCLOS, articles 74, 83). In practice, with a projected The former JDZ contains transparency provisions
life of 30 to 50 years, a JDZ may prove more like a per- supplemented by the Abuja Joint Declaration on
manent solution in place of a delimited boundary. Transparency and Governance signed by Heads of State
There are more than 20 around the world. and Governments. The Authority is a member of the
There are three ways to establish a JDZ. The first is Extractive Industries Transparency Initiative. An envi-
to allow one state with expertise to manage the ronmental baseline study of the JDZ was undertaken in
resources on behalf of both states with sharing based 2006 and all activities are regulated according to envi-
on a preagreed ratio (for example, the Bahrain–Saudi ronmental guidelines applicable throughout the JDZ.
Arabia Agreement, 1958). Infrastructure/social projects have been carried out by
The second is for two states to joint venture and each Operators in communities in both countries and local
state nominates its own contractor which enters into a content rules applied.
revenue collection authority. These non-sector-specific where management and budgetary interference is common
entities are often tasked with achieving optimal operational or when there are different views about the kinds of rela-
benefits among the various subgovernmental or sector- tionships that lead to optimal outcomes in a particular
specific agencies. In practice, this is very difficult to achieve country context. Where a new NRC is envisaged, capacity
and an overlapping competence is often found among state building is inevitably an important issue. To date, NRCs
entities, creating potential for confusion (see discussion in have been more common in the petroleum sector than in
chapter 5). mining (see chapter 5 and chapter 6).
National resource companies. While not without con- Private sector participation. Participation of the pri-
troversy, NRCs remain popular in most petroleum- vate sector is one of the most important issues to be addressed
producing states and also in a growing number of in any sector policy statement. Among resource-rich states,
mineral-producing states. Their governance and roles, such participation is common, with notable exceptions
which may include both commercial and noncommercial being the petroleum sector in Mexico (public for 75 years
objectives, may be the subject of separate legislation, such as until 2014) and a number of Middle Eastern states.18 For
the Nigerian National Petroleum Corporation Law, or policy makers in many former colonial states, the historical
emerge from a merger of existing domestic companies, such memory of unhappy private sector involvements—even if
as the one that led to the creation of Pertamina in Indonesia, they occurred decades ago—play a significant role in shap-
or nationalization, as led to the creation of PDVSA in the ing the legal and contractual frameworks today.
República Bolivariana de Venezuela. Controversy tends to However, few states have found it possible to resist the
be sharpest in relation to the NRCs’ links to the host state, advantages of risk sharing, financing, and technical and
Technological advances are yielding access to mineral Developing states have preferential access to the area
deposits in the deep waters of the oceans. This frontier if they identify banked sites with known prospectivity.
for mining exploration involves licensing in waters Exploration licenses from the reserved banked sites
subject to national jurisdiction (exclusive economic have been granted to commercial companies spon-
zones or EEZs) and in international waters. The envi- sored by Nauru (2011), Tonga (2011), and Kiribati
ronmental and social impacts of such activities are not (2012). State sponsorship entails responsibility to
yet fully understood and a cautious approach is encour- monitor and control the operations. Apart from the
aged for such development. economic rent, the expected advantage is knowledge
In international waters, applications for rights are transfer. Already more than two dozen licenses have
granted by the International Sea-bed Authority (ISA) been granted to countries such as Brazil, China, India,
under the UN Law of the Sea Convention, which estab- Japan, and the Russian Federation.
lishes and governs the “area” beyond jurisdiction of A number of countries are also seeking to derive
coastal states for “the common heritage of mankind.” benefits from deep-sea mining in their EEZ as well as
The ISA has established a mining code and issued sev- in international waters. Papua New Guinea became the
eral sets of regulations on minerals. The code requires first state to award a seabed mining license in its
information on the proposed plan of work in a license national waters. Fiji is among the growing number of
application, to include a preliminary assessment of the Pacific Islands countries engaged in licensing, adopting
possible impact of the proposed activities on the a law to promote investment in this area: International
marine environment; a description of the proposed Seabed Minerals Management Decree 2013. The United
measures for prevention, reduction, and control of pol- Kingdom passed its Deep-Sea Mining Act in 2014. For
lution and other hazards, as well as possible impacts on the ISA National Legislation Database, see http://www
the marine environment; and a description of environ- .isa.org.jm/en/mcode/NatLeg.
mental baseline studies and rules relating to possible The marine mining industry has produced a volun-
environmental impact. Companies must enter into a tary code to address environmental protection issues—
contract with the ISA before receiving an exclusive the International Marine Minerals Society’s Code for
right to explore for or exploit the mineral resources of Environmental Management of Marine Mining, http://
the deep seabed. www.immsoc.org/IMMS_code.htm.
managerial skills transfer that comes with foreign partici- governments enter into agreements with private companies
pation. Norway, for example, had a very public debate on to explore and develop the resources at their own costs and
whether or not to open its petroleum sector to foreign risks. This option is particularly attractive where a govern-
investors and eventually decided to permit foreign ment or its NRC does not possess the essential technical
involvement for many of the reasons just given (Gylfason know-how and skills to develop the resources themselves
2004, 26–27). (Tordo 2007, 5–6).
Exploration. Although the exploration phase generates Local benefit. Policy statements increasingly outline
valuable information for the host government and inves- expectations with respect to local benefit as governments
tors, it remains a financially high-risk undertaking. Thus, seek to maximize impacts from resource development in the
the question about whether or not the government should wider economy. Local benefit requirements seek links
assume this risk is an important policy issue. Faced with the between core sector investments and operations, on the one
risks, governments have four basic options: they can (1) hand, and local employment and economic activities, on the
develop the resources themselves, (2) contract private petro- other. Policy makers are likely to experience strong pres-
leum and mining companies to develop the resources sures from local business or communities to promote such
for fees, (3) auction the right to develop the resources to a content. However, such pressures can present issues for
private company, or (4) adopt a combination of any of both host governments and foreign investors, as the neces-
the aforementioned alternatives. More often than not, sary skills for some petroleum and mining operations may
Local context and commitments to investors and 4.5 HYDROCARBONS AND MINING LAWS
civil society. The overall regime for the EI sector must, or
Key ideas
should be, sensitive to investors’ concerns about long-term
investment security. Where the context is one of past nation- 1. The building blocks of a legal framework for oil, gas, or
alization or frequent unilateral changes to contracts, inves- mining are laws, contracts (often model form con-
tors will usually expect the policy and related legal framework tracts), and implementing regulations. Often the laws
to signal a changed investment climate. Similarly, there are sector-specific, treating hydrocarbons and mining
needs to be a proactive communications approach to civil separately, but intermeshing with other domestic laws
■ Ownership of gas in the ground belongs to the state, as Petroleum and gas conclusion. It is unusual for a
with oil. petroleum law to include the activities of transportation,
■ Associated gas will be distinguished from nonassociated commercialization, and utilization. This is typically pro-
gas.23 vided for in a separate law, discussed in chapter 5. Indonesia
■ Licensing procedures are adapted so as to permit longer is one of the very few countries to adopt a law that covers
times for appraisal and for production than for oil, with both upstream and downstream sets of activities in a single
the right to authorize a specific retention license for law, the Oil and Gas Law of 2001.
Most petroleum and mining laws require that foreign Problems should be anticipated in the following
companies adopt some measure of preference for local four areas:
goods and services. In addition to the direct benefits to
1. Where certain goods and services are lacking in the
stakeholders (such as local businesses, entrepreneurs,
host country
and communities) through market diversification,
2. Where there is poor quality of domestic goods and
productivity, and access to business opportunities,
noncompliance with international standards and
capital, and technology, there are wider benefits typi-
safety requirements (as stated by foreign investors,
cally sought by such requirements: (1) increased
for example)
employment and skills, (2) increased domestic and
3. Where there is a practice of using local mediators as
foreign investment, (3) technology and knowledge
suppliers of goods, services, and other works instead
transfer from international resource companies,
of domestic manufacturers
(4) exports and foreign exchange, and (5) increased
4. Where there is a lack of employees with the appro-
government revenues.
priate qualifications
The definition of local benefit (often called local
content in the literature) is very important. Some states The design of a local benefit policy can also create
consider “local” companies to be those that are regis- problems in implementation. Take, for example, the
tered nationally rather than fully taking into account following provision mandated in Chad: licensees must
the degree of added value that these companies create “give priority to those goods and services available in
for participation by local individuals. Ideally, prefer- Chad insofar as their prices, qualities, quantities, deliv-
ence should be given to companies that are involved in ery terms and sales conditions compare to goods and
actual manufacturing activity as well as those with services available abroad and do not require the
significant ownership, management, and employment licensee to bear any kind of extra economic burden”
of local citizens. Companies within the “region” should (Tordo et al. 2013, 51).
also be treated as local. Provisions such as these are often insufficiently dis-
For companies as well as states this is a matter of seminated, monitored, and enforced. Moreover, it may
some sensitivity. Internationally operating compa- be difficult or impossible to compare factors such as the
nies prefer to work with contractors they are familiar reliability or performance quality of a local supplier of
with and to use their standard company procedures goods and services in relation to competing suppliers.
for holding tenders and procuring goods, services, Nonetheless, contracts may include fairly elaborate
and other work. Local companies will be unfamiliar, provisions on local benefit requirements that specify
at least initially, with such procedures. For certain criteria, including certification, to identify when mate-
kinds of activity, expertise is unlikely to be available rials are not available locally or at reasonably compa-
among domestic companies. Tensions can therefore rable quality standards. They may also involve a
be expected in the development of a local benefit monitoring system through the NRC or a specialized
policy. government agency or procurement office.
Stabilization. Stabilization clauses are offered as an invest- investor to negotiate a more favorable settlement in a dispute
ment promotion device, often because they are given by other with a host state that seeks to revise the terms of the original
states in the region also competing for investment capital. agreement (see section 4.9 and chapter 6). Therefore, any sta-
The guarantees they provide protect the investor’s contrac- bilization clause has to be well balanced and properly drafted
tual rights against adverse interference by the state through to protect the state’s interests in an appropriate manner.
legislative measures. Although such provisions may not stop
the government from exercising its legislative powers, stabili- Termination. The contract normally stipulates the circum-
zation clauses can mandate that a court or arbitration tribu- stances that permit either party to terminate the agreement
nal compensate the investor for any damage suffered. Aside (for example, when there is breach of a fundamental term by
from a strictly legal assessment of their value in formal pro- the other party). These can include a failure to carry out a
ceedings, stabilization clauses may enhance the ability of an work program or a breach of environmental obligations.
As Kazakhstan moves toward the status of a major oil to avoid paying higher taxes for the investments, giving
and gas producer, it has developed a policy on sourcing them an incentive to overstate their costs at the explo-
hydrocarbons-related work to Kazakhstani firms. Legal ration stage.
mechanisms have been put in place to require oil and In response, Kazakhstani content on goods is
gas companies (or “subsoil users”) to use local goods, defined as a percentage share of the cost of Kazakh-
works, and services in their operations and to increase origin materials and the producer’s expenses for goods
the proportion of Kazakhstani employees in their staff processed in Kazakhstan. For services, Kazakhstani
and in the staff of their contractors. The policy was first content is defined as an aggregate cumulative share
introduced into hydrocarbons legislation in 2004 with based on the cost of goods used for the performance of
the terms Kazakh manufacturer and Kazakh origin works, as well as the agreement value and/or payments
applicable to goods, works, and services. It had little to Kazakhstani employees. It also takes into account the
practical impact. The Kazakh Content Law of 2009 salary fund of the entity performing works or provid-
took a more robust approach to implementation and ing services. Among the key elements in the Kazakhstani
has proved effective. Virtually all of these provisions regime is an online registry of goods, services, and
migrated into a new Law on the Subsoil and Subsoil work in subsoil operations that allows the authorities
Use (2010). to monitor the operation of the procurement rules,
Why was this change necessary? When goods, according to the 2010 law. Quarterly reports by subsoil
works, and services were purchased from a foreign users ensure that this mechanism allows the authorities
supplier, the funds benefited non-Kazakhstani econo- to monitor fulfillment of obligations on content.
mies, often the same country of origin as the subsoil Calculation of the local benefit percentage is done by
user. All such expenses were treated as contributions to means of a uniform method. Certification of local ben-
the annual minimum level of investments that were efit is also used. There is also a long-term plan with
required under contracts between subsoil users and targets for local benefit set in percentage terms.
the state. Failure to meet this target could lead to uni- Violations of procurement rules are treated as a
lateral termination by the state. Finally, once produc- breach of the subsoil contract and the penalties may
tion was started, the subsoil users had the opportunity include termination of that contract.
Petroleum exploration and production contracts generally in support of oil operations to increase oil
signed with governments will typically include some or recovery through reinjection into the oil reservoir.
all of the following specific gas-related provisions: Disposal of associated gas provisions may (1) pro-
hibit or heavily fine gas flaring on environmental
1. Definitional provisions. Natural gas operations grounds, (2) allow the investor the right to commer-
typically are highly integrated but contain distinct cialize associated gas if possible, or (3) set terms for
segments: upstream, midstream, and downstream, the sale or delivery of associated gas to the state if so
each subject to a specific fiscal regime. Definitions requested by government.
are required to clarify the phase of operations to 5. Gas market provisions. Contract provisions may
which the contract applies, the point of delivery, and require priority allocation of gas to the domestic
the point of valuation, distinguishing upstream market and/or set conditions for the authorization
facilities from transportation pipelines and down- of export sales.
stream facilities. Definitions will cover associated 6. Gas pricing provisions. The typical absence of a
and nonassociated gas, condensate, and natural gas competitive upstream market for price reference
liquids. purposes and the integrated character of gas oper-
2. Appraisal of discovery provisions. Relative to oil, a ations necessitate that contracts contain a detailed
longer period is generally allowed for appraisal of a gas valuation clause (in addition to the oil valua-
natural gas discovery. Assessment of commercial tion clause) setting out how wellhead prices are to
potential generally takes more time given limited be determined for sale of the gas. Often govern-
domestic markets, the absence of competitive inter- ment approval of gas sales contracts, including
national markets, and the need to establish long- pricing, is required; there can be tensions as a
term sales agreements (based on a sufficient result between the imposition of a low price for
aggregation of gas reserves, before final commit- domestic consumption and a price based on fair
ments to development are made). A retention period market value, with damaging effects on long-term
mechanism may be included in the contract. investment.
3. Joint development provisions. Contracts may 7. Fiscal provisions. Gas operations are typically less
include obligations for joint development of gas dis- profitable than oil operations. Fiscal terms in con-
coveries and for the use of common infrastructure tracts are typically adjusted to reflect this distinction
where stand-alone development would be noncom- unless the fiscal regime is based on achieved profit-
mercial. It is similar to schemes designed to develop ability (in which case no adjustments are required).
a project as a single unit where the resource crosses a The past practice of leaving the negotiation of fiscal
boundary. terms until discovery or setting fiscal terms for gas
4. Associated gas provisions. Natural gas is often found equivalent to those for oil has largely been aban-
together with oil. The priority use of associated gas is doned (see chapter 6).
evident in Nigeria’s case. A large proportion of its associated being common in civil law countries and development
gas is still flared, with significant environmental and social agreement sometime used in others. The idea is the same:
costs. The reasons are rooted in the absence of appropriate it is a legal instrument that sets out rights and obligations
infrastructure for processing, transporting, or distributing of the investor and host state that are additional to the leg-
gas or for generating electricity. islation relevant to mining activities. Sometimes the con-
tent is in a standard form, sometimes it is individually
negotiated, and sometimes it is partly standardized and
Mining
partly negotiated.
Types of licenses and application procedures. The More often than not there are between two and three
vehicle used to transfer a right to a company or other legal kinds of licenses covering prospecting, exploration, and
entity to explore for and extract minerals is usually called exploitation (the mining regimes of Ghana, Côte d’Ivoire,
a license. The name can vary, however, with convention Tunisia, Turkey, and the Republic of Yemen are examples).
In an interesting experiment, a group of mining law- collection of clauses that are representative of the kind
yers analyzed about 60 mining agreements and pro- of matters that would typically need to be addressed
duced a model mining development agreement, or in an agreement for a mining project. The MMDA
MMDA. This project identified clauses that were aims to provide a guide for drafters covering such
clearly written and that reflected a reasonable mea- matters as fiscal terms, tenure, rights and obligations,
sure of balance between the interests of the host state and community and sustainable development. The
and the interests of investors. The aim of the project MMDA envisages a series of options that will assist
was to identify clauses that constitute a form of inter- the parties in a negotiation to identify the options that
national best practice in regard to mining agreements. are best for them.
The MMDA project sought to provide solutions for The final text and explanatory materials are available
states with gaps in their mining codes; clauses from at the Sourcebook website: http://www.eisourcebook
the MMDA could be included in supplementary pri- .org/2425_TheIBAModelMiningDevelopmentAgreement
vate agreements on an ad hoc basis. The result is a MMDAProject.html.
Contentious Issues. While laws and regulations may specify Government Commitments. A mining agreement can also
regulatory requirements, the procedures by which they are provide site-specific commitments by the government to
applied can also be very important. Mining agreements the investor and/or community of actions that the govern-
can also be used to spell out the details of procedures ment will take. This could include benefit-sharing actions
regarding actions that have potentially significant finan- (for example government support for mine-related voca-
cial implications or risks for both the investor (such as tional training programs or small business training pro-
expropriation and cancellation or suspension of a license) grams) or assurances for investors that are not in the
and the government (such as abandonment, closure, law—such as tax stabilization clauses if the government is
and reclamation). In this vein, agreements can also spell prepared to make such a concession.
At least five practices should be avoided, and if they are 4. Long-lived exploration rights: Mining agree-
present in mining development agreements they ments that provide license holders with long-lived
should be treated as a source of significant concern. exploration rights (such as rights lasting longer
than a decade) and that do not require substantial
1. Fiscal terms: Mining agreements that include fiscal
work activity or costs for holding land—so that the
terms that are more favorable to the investor than
license holder can “bank the land” for its own ben-
the fiscal terms in the law
efit, thereby denying the possibility of mineral
2. “Most-favored investor” provision: Mining agree-
development that could benefit the nation as a
ments that include a “most-favored investor” provision,
whole
entitling the company to any benefits subsequently
5. Land banking: Mining agreements that tie up very
granted to another investor
large amounts of land relative to the size of
3. Extension to other areas: Mining agreements that
the area to be mined during the expected life of the
contain provisions for their own extension to cover
mine—which again has the effect of enabling
new areas, a particularly bad practice when the
the license holder to bank the land for its own
terms are potentially unfavorable to government
benefit
(Sierra Leone had a bad example of this.)
“Effective acquisition, maintenance and dissemination large-scale efforts. The quantity of this information
of geodata can act as a magnet to investment and can (whether it is produced by a state or private investor)
enable governments to understand better their natural depends ultimately on the benefits and costs perceived
resources in order to manage them most effectively” by either party.
(BGS International 2102). If all of the benefits are not internalized by the gov-
The successful discovery of natural resources ernment, or if the returns associated with the collection
requires significant effort at the exploration stage. It of geoscientific data are prohibitively difficult to calcu-
also requires the application of sophisticated explora- late (due to perceived high levels of political, technical,
tion and exploitation technology. To attract foreign or security risks), a state may be left with less geoscien-
investment, a host government should try to limit tific information than it needs for efficient develop-
information uncertainties and asymmetries associated ment. A state should identify those policies required to
with its resource endowments. ensure that a sufficient amount of geosciences infor-
Many developing states lack the geosciences infor- mation is produced.
mation (geodata) necessary to undertake detailed land- A sufficient quantity and quality of geodata are
use planning. Because governments are faced with needed to ensure that a host state earns an equitable
budget constraints and pressures to provide critical portion of its natural resource wealth and to enable
services to their citizens, geodata is poorly maintained private investors to assess the geological prospects of a
and hard to access. Many governments find it difficult license area. In these situations, the state does not need
to justify the collection of geodata when the payoffs are expertise in assessing the value of the license area,
generally long-term in comparison with the country’s because the competitive tension created by a properly
immediate spending needs. managed auction process should ensure that the license
Geoscience information can be collected on an ad is fairly valued. For example, the government of Papua
hoc basis, resulting from a “lucky” discovery by arti- New Guinea has been skilled at utilizing such data col-
sanal miners or from more systematic, complex, and lection to promote investment in its EI sector.
as critical to success. The first is an environment where there authorities responsible for the contract award process.
is competition among potential investors. If this can be Pending their development, the authorities are generally
achieved, it can potentially result in the best outcome for encouraged to engage support from outside experts.
the state.
Competition among potential investors can also help
Award procedures
offset some of the asymmetry regarding access to informa-
tion that tends to disadvantage governments in licensing. Transparency is at the core of good practice when it comes
Investors are often better informed about a state’s geologi- to award procedures. Whether acting individually or as par-
cal prospects than their government counterparts. This is ticipants in a competitive bidding round, license applicants—
particularly true in the early stages of EI sector develop- on a nondiscriminatory basis—should be made fully aware
ment when data-sharing requirements have yet to be at the right time of the procedures to be followed. They
established. While problematic in the case of one-on-one should also be provided access to all available data, whether
bilateral negotiations over contract awards, this informa- on a free or purchase basis, and be informed of all applicable
tional disadvantage is largely nullified when informed legal and fiscal regimes (including model contracts).
investors are made to compete against each other (Cotula Documentation should also provide assurances that areas
2010, 18). offered for license are currently unlicensed and that proper
The second condition critical to success is institutional authority exists for their licensing.57 With the possible
capacity. Properly preparing a licensing round and evaluat- exception of specific technical data, this information should
ing potential investors and their contract proposals requires be available in the public domain. All of this reduces the risk
sophisticated professional technical, legal, and commercial that one investor or consortium may be unfairly favored
skills. These skills need to be acquired by host-government over another.
The substantive rights protected under a BIT usually by the courts of the host state (denial of justice, for
include the following: example).
The requirement of national treatment is a different
■ Fair and equitable treatment substantive right and aims to provide a level playing
■ National treatment field for foreign investors at least after the investment
■ Most favored nation treatment has been made. Typically, the foreign investor is given
■ Full protection and security treatment that is no less favorable than that accorded
■ Protection from expropriation by the host state to its own investors.
■ Umbrella clauses Another requirement commonly found in BITs is
that investments of nationals of either contracting
Many claims have included a reference to the fair and party shall enjoy full protection and security in the ter-
equitable treatment standard. Some of these concern ritory of the other contracting party. This is typically
the review of administrative decisions and the weight concerned with failures of the state to protect the inves-
given to legitimate expectations and due process. In tor’s property from actual damage caused by state
Occidental v. Ecuador (2004) the tribunal held that the officials or by the actions of others, where the state has
stability of the legal and business framework is an failed to carry out due diligence.
essential element of fair and equitable treatment; this An umbrella clause is a catch-all provision to cover
view was also supported in the CME v. Argentina case every kind of investment obligation of the host state.
(2005). Other cases support the view that in certain The clause brings obligations or commitments that the
circumstances the standard has limited application host state has entered into in relation to foreign invest-
only. There are other cases concerning the application ment under the protective umbrella of the BIT, and can
of this standard that involve the treatment of investors elevate contract claims to treaty claims.
The role of MIAs. The best known of these are the North
Arbitration
American Free Trade Agreement (NAFTA), the Energy
Charter Treaty (ECT), and the ASEAN Investment Arbitral proceedings are often complex and have become an
Agreement. In each case, investment disputes have arisen increasingly common forum for resolving disputes in the
under their provisions. NAFTA is concerned with trade petroleum and mining industries throughout the world.
generally, and the ASEAN Agreement is concerned with Since arbitration is a private mode of dispute settlement in
any legal disputes that may arise directly out of an invest- international commerce, in which the rules are agreed by
ment. By contrast, the ECT is concerned with energy only. the parties themselves, it is often assumed that it exists inde-
It was opened for signature in December 1994 and was rati- pendently of the national courts. In fact, there is a global
fied in 1998. Its aim is to establish “a legal framework in adjudication system in which international investment and
order to promote long-term co-operation in the energy other commercial disputes are “resolved by binding and
field” (article 2). The definition of “investment” is compre- final arbitration, as regulated, however, by national legisla-
hensive and lists specific asset types. tion and judiciaries” (Brower, Brower, and Sharpe 2003,
In recent years, the number of claims arising under the 415). It is crucial at all stages (design, proceedings, and set-
ECT has overtaken those registered under NAFTA. This is tlement) to be aware of this fact of enforcement and the role
largely due to claims against European governments for played by the New York Convention in making awards
changes made to their subsidy regimes for renewable energy enforceable through the local courts. The amounts awarded
resources. For EI matters, the ECT has been used for dis- by tribunals can be very large, amounting in some cases to
putes mainly involving East European and Central Asian billions of dollars. An investor can try to enforce a ruling in
states. Its provisions on the settlement of any investment the national courts of a third state where the host state has
disputes that may arise provide for the use of compulsory assets and have them seized or have bank accounts frozen.
arbitration against governments at the option of foreign If arbitration becomes a reality, it is essential to review
investors for alleged breaches of the investment agreements, the law governing the dispute and the method of arbitration
without the need to first exhaust local remedies. Moreover, chosen in the contract.
binding state-to-state arbitration is provided for in article
27. This involves the use of an ad hoc tribunal for disputes The arbitration agreement. The defining feature of arbi-
between states concerning the application or interpretation tration is that it is a form of justice based on the parties’
of the treaty. It is not restricted to the resolution of disputes agreement. The fundamental document for the jurisdiction
arising from investment issues. The dispute settlement pro- of the tribunal is the arbitration agreement, usually the arbi-
cedures may in fact be diverse, including international arbi- tration or dispute settlement clause in the hydrocarbons or
tration, and provide for final and binding solutions to many mining license or contract. This will set forth a description of
disputes. The rules and procedures governing transit dis- the disputes that will be subject to arbitration, the scope of a
putes in particular have been enhanced since ratification to tribunal’s authority, applicable law, language, and location of
minimize disruption when a dispute is taking place. A key the arbitration, whether it will be administered by an institu-
provision lies in article 26, which provides various options tion such as ICSID or the International Chamber of
to investors to take host governments to international arbi- Commerce (ICC), and may include rules and procedures to
tration in the event of an alleged breach of the treaty’s be followed.
ChapterOrganization
Sector Title and Regulatory
Institutions
5.1 KNOWLEDGE CORE emphasizes that any design requires periodic review consider-
ing experience gained and changing circumstances. Yesterday’s
The second chevron in the EI Value Chain, sector organization
success can become tomorrow’s failure.
and regulatory institutions, addresses institutional structures
Legacies from the past often complicate policy design.
and instruments that enable the transformation of natural
Only a very few countries will ever start development from
resources into wealth. It covers the state’s roles as supervisory
a blank slate; most will inherit structures created earlier and
authority, enforcer, and, in many countries, participant in
designed with different priorities. As a result, institutional
extractive activities. To those classic roles should be added a
redundancy, overlapping institutional mandates, and poor
new one: the state as facilitator of wide, sustainable develop-
coordination are common challenges. Some reform, reorga-
ment beyond the extractives sector. What are the best roles and
nization, or restructuring is almost always required, as is
responsibilities of government agencies for policy, legislation,
developing a cadre of personnel with specialist skills.
and practice to ensure that extractives are developed in the
Sometimes this transformation leads to dramatic plans to
public interest? The involvement of large amounts of private,
modify existing structures of governance, as has occurred in
often foreign capital in oil, gas, and mining activities means
Brazil and Mexico. Sometimes it involves more modest and
that structures and instruments should promote cooperation
focused programs of reform aimed at adapting existing
but also permit understanding by government of the range of
institutions to a more mature stage of resource develop-
relationships between private and state-owned entities.
ment, as in Norway and the United Kingdom. Often it is a
In recent years, widespread stakeholder discussion about
response to new knowledge and practices, such as those
institutional reform, both in countries with mature extractive
concerning the environment, safety, and transparency.
sectors and in those with emerging extractive activities,
115
Specific issues arise in the organization of oil, gas, and Table 5.1 The Norwegian Approach: Dividing
mining activities that require special attention. On the basis Institutional Governance Tasks and Responsibilities
of the agreements between states and investors (discussed in
Task Responsibility
chapter 4), many other agreements are concluded, covering,
for example, joint ventures and subcontracting for services Policy making Ministry/parliament
and supplies, for gas sales, and for transportation. The range
Legal framework Ministry/parliament
of agreements goes well beyond the scope of the Sourcebook.
However, the kind of governance that they establish is often Ownership to resources Ministry/regulator
investor led or driven by “industry best practices” devel-
oped over time and through experience in many different Collector of tax or share of Ministry/tax regulator/
production state-owned company
countries. An example is the widespread use of joint operat-
ing agreements in the hydrocarbons sector. Increasingly, the Regulatory work Independent regulator or
focus of governments on securing wide benefits from oil, government directorate
gas, and mining makes it necessary for them to understand
Commercial activities State-owned or private,
better these second order agreements and the investor-led national companies or
governance they establish. Some of the common topics will international oil companies
be examined in the second part of this chapter.
Source: Norwegian Petroleum Directorate.
The challenges of building government institutions are well Table 5.2 Ugandan Regulatory and Institutional
known. A central theme in much of the literature on devel- Framework
opment is the importance of capacity building, particularly Directorate of Petroleum in Supports policy formulation
Ministry of Energy and and licensing of acreage
to equip countries new to oil, gas, or mining development
Mineral Development
for the specialized tasks of oversight. A wide variety of edu-
cational programs has sprung up in centers around the Petroleum Authority of Regulates and monitors
world to meet the need for specialists. Yet if the goal is Uganda compliance of petroleum
operations
extractives-led, nationwide development, the kind of knowl-
edge needed by states goes beyond technical information; Uganda National Oil Moves the country’s
they need an understanding of the kinds of organizational Company Ltd. commercial interest in
production-sharing
structures that are typical in the oil, gas, and mining indus-
agreements forward
tries and the challenges that such structures present for
Creates joint ventures
oversight and partnership. Without sound knowledge of across the petroleum value
standard approaches to EI governance, and how government chain
interventions can fit into or modify them, government-
driven efforts to make the sector work properly to achieve Source: Petroleum Authority of Uganda
Stortinget (Parliament)
Government
Box 5.1 Institutional Structure: The Ministry and the Regulatory Agency
The sector ministry and the regulatory agency bear 4. An environmental and social unit that collaborates
most of the overall responsibility for management of with and provides support to the environmental
the extractives sector. and social authorities that oversee the sector
A well-designed sector ministry comprises the following: 5. An economics unit that analyzes the economics of
petroleum and mining companies operating in the
1. A unit responsible for issuing and overseeing sector
licenses, enforcing license conditions, and maintain- 6. A unit that promotes the sector at national and
ing an up-to-date public register of exploration and international events
production licenses that is easily accessible by all 7. Highly experienced and skilled staff to oversee large
interested parties petroleum and mining projects and to put the gov-
2. For mining, an artisanal and small-scale mining ernment on an equal footing with the management
(ASM) unit (in states with large ASM activity) and specialist staff of international companies and
3. An inspectorate with a strong presence at sector large investors
sites (This office inspects activities to assess compli- 8. Employment conditions and salaries sufficient to
ance with licensing conditions and health, safety, prevent the most highly skilled and experienced
and environmental regulations and performs pro- staff from being hired away by international
duction and technical audits.) companies
■ Reconnaissance
■ Exploration work program implementation
planning, including proposed legislation; (2) negotiation licenses, to which any interested parties may have access. The
and award of contacts or licenses; (3) calculation and collec- second is the Mining Inspectorate Office, which is typically
tion of royalties; (4) promotion of local benefits; (5) prepa- charged with ensuring compliance with licensing conditions
ration of regulations; (6) oversight and regulatory functions, and health and safety regulations. It also carries out produc-
with authority to delegate this responsibility; (7) coordina- tion and technical audits, which require a strong presence at
tion with other ministries, especially the ministries of commercial and artisanal mining sites. Third, also likely to
finance and economic planning; (8) governance of national play an important role is the Environmental and Social Unit,
resource companies (NRCs), sometimes in collaboration which provides support to the environmental and social
with the finance ministry; and (9) promotion of the sector authorities responsible for the sector; it also takes charge of
at national and international events. outreach to local communities and mining companies. This
For countries that discover petroleum deposits for the first unit can help improve the benefits of mining activities and
time, there is likely to be a provisional approach to the design mitigate the impacts, which often are felt most directly at the
of a ministry’s role, relying on an existing ministry until it is community level. Finally, within the sector ministry there
clearer what the size of the deposits is likely to be and there- may be a unit dedicated to engagement with artisanal and
fore what sort of organizational commitments are required. small-scale mining (ASM). This is likely to provide training
Although environmental and sustainable development to assist ASM productivity and health, safety, and environ-
issues are usually the responsibility of other ministries, mental performance.
small units charged with coordination of the sector and
environmental or social ministries are often found within Requirements for Effective Performance. If the sector ministry
the extractives sector ministry. is to work effectively with other ministries and agencies, there
will have to be an alignment of shared objectives; clarification
Mining Specifics. The sector ministry will typically include of mandates, competencies, and responsibilities; sharing of
four units that play important roles in mining. The first of knowledge; and a willingness to use memoranda of under-
these is the Mining Cadastre Office, which is responsible for standing or similar mechanisms to formalize working rela-
issuing and overseeing licenses, enforcing license conditions, tionships and to clarify potentially overlapping mandates,
and suspending, terminating for cause, or accepting relin- competencies, and responsibilities.
quishment of licenses. It is also responsible for maintaining Effective performance in the ministry is likely to be
an up-to-date and public register of exploration and mining enhanced by attention to five areas: (1) avoiding discretionary
Well-designed arrangements for a government to take 2. The decision-making powers of different share-
a minority equity role in private sector mining invest- holders regarding issues such as dividend deci-
ments will be based on a shareholder agreement that sions, budget approvals, senior management
addresses the following: appointments and remuneration, investment
programs, and raising new capital (including new
1. How the equity is funded (free equity, carried
debt)
equity, or paid-in equity) for both initial capital
3. Conditions under which ownership may change
expenditures and any subsequent needs (including
4. Shareholder responsibilities and obligations at the
covering cash flow shortages or funding sustaining
time of mine closure
capital expenditures or production expansions)
Some prominent examples of generally well-managed involving a license share for Statoil that was carried
and highly profitable and competitive NRCs include, through the exploration phase by the oil company
in mining, Chile’s Codelco and, in petroleum, Norway’s partners, and in the event of a commercial discovery
Statoil. the share rose to 51 percent of the license. It helped
Codelco was formed in 1976 to take charge of the Statoil to develop rapidly as a commercial enterprise.
state’s mining interests. It is 100 percent state owned, The primary goal from the outset was commercial effi-
with a board appointed by the president of Chile. ciency, and present and future role of Statoil to incom-
It accounts for 5 percent of gross domestic product, ing investors was clear. Extended public discussion of
25 percent of exports, and 17 percent of the budget. both structure and policies took place. The company’s
There is limited governmental interference and a high portfolio was later split in two, and all remaining ele-
degree of transparency. In spite of its incorporation of ments of preferential treatment were removed. In 2001
several elements of good governance, Codelco has Statoil was partly privatized. The state had no board
little control over its revenues, and there are tensions participation and the state’s direct participation in
between commercial and social functions, leading to licenses was held by a separate entity, the State Direct
inefficiencies. Financial Interest, in turn managed by another state
Norway’s state petroleum company, Statoil, was cre- entity operating on a nonprofit basis. The trend has
ated in 1972. It was granted preferential status in the been for state participation to become much lower to
licenses awarded to international oil companies, around 20 percent.
South Sudan was officially recognized as an inde- (MoFEP) in assuming certain core functions related
pendent state in July 2011. Since then, it has become to EI sector management and revenue management
the most petroleum revenue-dependent country in 2. Assist MoFEP in establishing a macroeconomic and
the world (with dependence at 98 percent of its fiscal policy framework that takes into account the
budget). challenges of extreme petroleum dependence
A grant of US$ 3.3 million was prepared by the
3. Assist relevant committees of the South Sudan
World Bank, working closely with the South Sudanese
Legislative Assembly to begin to carry out their account-
government and other key donors, such as Norway,
to address South Sudan’s urgent petroleum sector pri- ability function for the use of petroleum revenues
orities in three key areas. The grant would do the
following: In all cases, appropriate external expertise has been
carefully identified and will be twinned with selected
1. Assist the Ministry of Energy and Mining South Sudanese expertise for training and capacity
and Ministry of Finance and Economic Planning building purposes.
that those other agencies will be seriously disadvantaged in These experiences have generated a growing body of litera-
their engagement on EI sector issues. ture, which has relied heavily on case study analysis, sometimes
It is not unusual to find that some ministries or agencies are using political economy theory as a tool for analysis (Victor,
actively encouraging new investment while, at the same time, Hults, and Thurber 2012). Heller and Marcel (2012) have
others are in effect creating barriers (for example, in their rightly observed that much of the literature on the hydrocar-
approach to environmental permitting procedures). This can bons sector is heavily biased toward the experiences of large,
obviously create additional risks for investors and fewer ben- well-established oil producers, which have geological prospects
efits for government. As a practical matter, this can cause and institutional capacity levels that are very different from the
problems with issuing visas and work permits and providing context of administrative, human, and oil sector capacity con-
customs clearances and releases for goods and equipment. straints that typically characterize the new entrants. To build
Thus, there is great value in developing well-organized and capacity quickly, the governments concerned face the choice of
coordinated EI sector knowledge-sharing and information concentrating resources and responsibilities in a single institu-
flows. In particular, it is important that the EI sector ministry tion, such as an NRC or sector ministry, or to separate the
coordinates well with other government departments in order functions and lay the foundations for good governance.
to achieve effective oversight, regulation, and risk sharing
between government and investors (Alba 2009, 9). Hydrocarbons. Much of the reform effort in the hydrocar-
bons sector has been influenced by the Norwegian “separation
of functions” approach, whereby the commercial, regulatory,
Efforts at institutional reform
and policy functions of government are kept institutionally
An increasing number of countries have engaged in major distinct. Specialist institutions are created for each of these
reforms of their institutional structures responsible for oil, functions and given a limited mandate so that intragovern-
gas, and mining. From Indonesia and Mexico to Nigeria and mental roles are clear. Such an approach appears to have had
Algeria, there are examples of countries that have found their much success in Norway in resource management, but this
institutions inadequate to handle evolving national circum- provides no guarantee that it can be replicated in countries
stances, changing resource horizons, or market conditions. with very different political systems, population sizes, and
As a result, they have initiated, at a minimum, reviews of institutional structures. A major constraint is often a lack of
existing arrangements, and more ambitiously, programs of human capital, but so is a lack of institutional development,
sweeping institutional change. Some of these have succeeded, such as one might expect to find in a postconflict society. For
at least in part, and others have stalled or failed. example, in a study of several oil-producing countries and
After 30 years of resource administration by the variable shares of production. The royalty established
Colombian National Oil Company, Ecopetrol, which by the law is variable (5–25 percent) on a sliding scale
had been created in 1951 to operate the assets of the De according to average monthly production volumes by
Mares concession after its contractual ending, an insti- field. The additional contract-based shares of produc-
tutional reform was adopted by the government using tion are two tiered: one that is based on a sliding-scale
special powers granted by congress in 2003. function of international prices (calculated as a 30–50
Similar to Brazil, the reform separated the adminis- percent share of excess price over a base price) and
tration of the petroleum resources from Ecopetrol and another that is established as a bidding parameter in
created the National Hydrocarbons Agency (ANH) to competitive bidding rounds (x factor) as a percentage
undertake this role. The ANH was given sufficient of the net production of the operator after royalties
powers to design the most appropriate contractual and price-based production shares.
vehicle(s) to allow the operations of Ecopetrol or any The new contract could be described as a hybrid
other qualified third parties in exploration and pro- between concession and production sharing. Such a
duction under equal access. design allows for a variable capture of economic rent,
In December of 2006, Ecopetrol was further trans- as is the case with PSAs but without the complications
formed into a publicly owned and listed corporation of a joint administration. The state owns the resource
with direct participation of financial investors in its in the ground and transfers title of the operator’s share
ownership and decision making, with a limit of 20 at the wellhead, while retaining the state’s share
percent of its shares. through to the point of sale, which can be anywhere
The scope of the resource administration of the from the wellhead onward.
ANH is limited to the upstream end of the value chain. While reaffirming the sovereignty of the state over
The midstream activities continue to be regulated by its resources, the contract allows for a flexible and pro-
the Ministry of Mines and Energy, while, since December gressive capture of rent and a clean and simple admin-
2012, the regulation of downstream activities passed istration that avoids potential conflicts of interpretation
from the ministry to the already existing independent or cumbersome administrative procedures.
regulatory commission for electricity and gas. Ecopetrol, on the other hand, operates as a fully
The ANH adopted a new contractual vehicle in integrated petroleum company, listed in the Bogotá,
2014. It can be described in modern terms as a tax and New York, and Toronto stock exchanges, with strict
royalty license with additional state participations at and transparent governance and reporting systems.
Brazil’s organizational reform of its petroleum sector ■ It is 51 percent state owned with the remaining
(1997 onward) has provided clarity on roles and respon- shares listed on the stock exchange and subject to
sibilities and enhanced transparency and accountability. exchange requirements on transparency. Petro-
The roles for Petrobras (Brazil’s NRC for petroleum bras provides full disclosure of expenditures and
exploitation) are divided among the following entities: revenues that are held in public, audited accounts.
It coexists with more than 70 other upstream oper-
■ President: Approves fiscal targets for Petrobras ating companies.
■ Congress: Approves the investment budget for Petrobras ■ Private sector: Authorized to act alone or in joint
■ Ministry of Mines and Energy: Develops EI sector ventures with Petrobras
policy and the Petrobras budget
■ Agencia Nacional do Petroleo (ANP): Independent Since the large “presalt” discoveries in 2007, a different
regulatory agency that provides regulatory oversight approach has been adopted. Production-sharing con-
and royalty administration tracts instead of concessions were required for the
■ Ministry of Finance: Develops EI sector tax design and presalt areas, and Petrobras was made the exclusive
administration and proposes fiscal targets for Petrobras operator with a minimum of 30 percent stake in any
– Petrobras: Responsible for commercial petroleum consortium. Governance indicators for Brazil have
operations deteriorated since.
Botswana, Brazil, Chile, the Democratic Republic of Chilean Copper Commission (Cochilco), has enabled
Congo, and Zambia provide different models for both Codelco to remain one of the most highly profitable and
sustained success and reform. lowest cost mining companies in the world over many
Botswana has a 50/50 ownership of the highly prof- decades.
itable Debswana diamond operation with De Beers and In the mid-1970s, Gecamines in the Democratic
has played an active, commercial shareholder role Republic of Congo and ZCCM in Zambia were two of
while leaving management in the hands of De Beers. In the largest and most profitable copper producers in the
addition to its dividends as shareholder, the govern- world; both were state-controlled. However, a combi-
ment has also received substantial tax payments. nation of noncommercial roles, mismanagement, and
CVRD (now called Vale) has been a well-governed corruption led them to become noncompetitive in
and well-managed iron ore mining company in Brazil. their copper and cobalt mining production. Today,
It was taken to the stock market by the government and they produce one-fifth of their peak production of the
remains one of the world’s largest and most profitable 1970s. Both have now been restructured and reformed
iron ore exporters. and have divested much of their noncommercial roles
Chile has retained control and operation of much of to other government agencies. Most of their mineral
its copper resources through the 100 percent state-owned reserves have been auctioned to private investors who
Codelco. A strong shareholder role, undertaken in large are now assisting in the rebuilding of the mining sector
part by the technically competent and well-experienced in the Democratic Republic of Congo and Zambia.
In Papua New Guinea, the sector reforms were triggered (McMahon 2010, 22–23). The two key planks of the policy
by the clear need to rebalance sector organization in favor were a decentralized administration and a close involvement
of community rights, in the face of a perception among the of affected communities. Programs of capacity building were
Bouganville islanders that they bore all of the environmen- introduced for local and regional mining administrations.
tal and social costs but saw few of the economic benefits A separate initiative was to establish an institute for the study
(McMahon 2010, 16–17). Changes were made in the draft of gems, since the country has around 500,000 artisanal and
standard mining contract to address this, and institutional small-scale miners.
capacity was expanded. Spinoff businesses and joint ven- Box 5.7 summarizes key points about mining sector reform
tures between local and foreign companies resulted, formal- in several other countries.
ized in memoranda signed by mining companies and their
host communities. Further, both government and mining
5.3 SPECIAL ISSUES
companies supported the establishment of specific action
plans to support women in mining, with a gender desk set Because a growing number of governments desire to secure
up for each large mine. This gender focus led to women wide benefits from oil, gas, and mining activities, they have
playing important roles in the renegotiation of community developed an interest in better understanding the kind of sec-
benefits in memoranda of agreement for two of the most tor organization typically required after the grant of rights by
important mining areas, Ok Tedi and Lihir. the host government agreement to the investor(s). Many sec-
Separately, a new mining authority was established in ond order agreements are concluded by investors on this cru-
2006: the Mineral Resource Authority, charged with admin- cial foundation and often establish a kind of investor-led
istering the sector. It raises its own funding from sector governance, relying on decades of evolving industry practices.
levies and fees and is not subject to the kind of funding In this operational phase of extractives’ activities, the
shortages and staff constraints as its predecessor. Another host state still has an important monitoring role and will
agency was established to maintain the regulatory frame- often be present as a participant. Typically, it will either
work with substantial institutional capacity. become a party to arrangements such as a joint venture or it
Another example of mining reform is the program will need to understand them in order to perform its over-
that commenced in Madagascar in the late 1990s sight role. Of course, it can do both.
Innovation in technique and growing knowledge of EI on one side of the delimitation line is exploitable,
potential have increased interest in maritime areas. wholly or in part, from the other side of the said
Beyond national land and territorial sea areas, interna- line, the Contracting Parties shall, after holding
tional law plays the key role. The UN Law of the Sea consultations, seek to reach agreement as to the
Convention (UNCLOS) confers sovereign rights on manner in which the structure or field shall be
coastal states “for the purpose of exploring and exploit- most effectively exploited and the manner in
ing, conserving and managing the natural resources.” A which the costs and benefits arising from such
coastal state’s sovereign rights to explore the seabed exploitation shall be apportioned (UK-Norway
and exploit its natural resources are treated as both Boundary Treaty 1965, art 4).
inherent and exclusive in the continental shelf regime.
This is stated clearly in article 77(1) and (2) of UNCLOS. These treaty arrangements are much easier to conclude
No one may undertake activities of exploration or if there is agreement between the states on the bound-
exploitation without the express consent of the coastal ary between them. In many maritime areas, however,
state. The exclusive nature of these rights prevents this is not the case. There are more than 200 maritime
them from being lost to another state in the absence of disputes ongoing around the world and more bound-
any express agreement to the contrary. Their exclusive ary disputes on land, creating significant disincentives
character is reaffirmed by article 81 UNCLOS, which to investment in prospective oil and gas deposits. As a
grants the coastal state the exclusive rights to authorize result, there have been efforts to develop joint develop-
and regulate drilling on the continental shelf for all ment arrangements that are provisional with respect to
purposes. They do not, therefore, depend on occupa- the boundary dispute but that allow hydrocarbon
tion, either express or notional, or on any express proc- activities to proceed. Examples of this are in the Joint
lamation by the coastal state. The rights cannot be lost Development Zone (JDZ) of Timor-Leste and Australia,
through neglect. and that between Nigeria and São Tomé and Príncipe.
Unitization can follow the conclusion of a bilateral The governance structure of JDZs differs from that of a
treaty between the relevant states. Such treaties fre- unitized development usually in the following manner:
quently include a mineral deposit clause such as the in the JDZ, a code is likely to be used with a separate
following: hierarchy and a dedicated administration; in unitized
development, there is likely to be a joint operating
If any single geological structure or petroleum agreement, with allocation of jurisdiction to existing
field . . . extends across the delimitation line and institutions, and material and procedural rules will
the part of such structure or field which is situated govern supervised conduct.
Transportation agreements are required to establish the Crossing borders, transit, and landlocked states.
rights and obligations of owners of a transportation system There is no single legal model for pipeline ownership when
(the transporter) and owners of the product to be trans- more than one country is involved. The two most common
ported (the shippers). It will normally contain three kinds of models are for each state to own each section of the pipeline
clauses: technical, commercial, and financial and legal. Only that is placed within its national frontiers: the connected
a few items in the second category are of importance.10 national pipelines model. Alternatively, a pipeline project
In one of the leading works on oil and gas agreements, may be developed as a single unit: the integrated pipeline
the writers of the chapter on transportation agreements, model. An example of the former is evident in the agree-
Brian Cassidy et al. (2008, 204), state that the provisions ment between Turkey and Iraq on oil transportation:
dealing with transportation charges or the tariff “are of
central importance in a transportation agreement.” Under Each of the two States guarantees to operate, main-
the subhead “What Would a Transporter Be Expected to tain, manage, and finance, and to provide all require-
Recover?” they state the following: ments for the part of the system located within its
own territory to transport Crude Oil through the
■ The main elements that the transporter would expect to pipeline across Iraqi and Turkish territories and to
recover through the tariff can be summarized as deliver into Ceyhan terminal on the Mediterranean
follows: shore.11
– The pipeline capital costs (e.g., construction related)
incurred mostly prior to the start date; The integrated pipeline model requires an intergovern-
– The pipeline operating costs (and other variable costs, mental treaty and agreements between the individual
for example spares), incurred during the life of the states and the pipeline company. The result is a mixture of
transportation agreement; and international law, commercial contracts, and domestic
– An element of profit. This assumes that the transpor- laws. The BTC pipeline is an example of this.
tation activity is a profit generating unit of its own, When a pipeline takes a commodity from country A to
separate from the other segments of a particular country B, but transits country C in the process, it is to be
project. expected that country C may levy a fee on the carriage, either
as compensation for providing a right-of-way or for services
The actual tariff structure adopted in a transportation rendered, such as protection or safety. There are no standard
agreement, however, may take several forms, according to rules applicable to transit fees and they tend to be based on
the authors. If, for example, it is a cost recovery structure, negotiation, once the principle of levying a fee has been
the charges will be related to the actual costs and in particu- accepted. Fees are usually the subject of pipeline agreements
lar the variable ones “incurred by the transporter during the entered into between the countries concerned and the owners
term of the transportation agreement. . . . The purpose of of the pipelines (which may involve the respective states or
Fiscal
ChapterDesign
Titleand Administration
149
knowledge and the instruments it offers. Even if a single Credibility and predictability of a fiscal regime
fiscal instrument could be described as “simple,” the fact
A recurring theme in the literature on fiscal design concerns
is that at the extraction phase, oil, gas, and mining tend to
the credibility of a fiscal regime.1 A fiscal regime must be
be subject to a variety of fiscal terms that can include roy-
credible to attract investment, but it also must be credible
alties, corporate income tax, windfall or additional profits
to the citizens of the country applying it. If not, it is likely
taxes, production sharing (although not in mining) when
to be challenged over the medium to long term. Linked to
selected, bonuses, fees or other contributions, and indirect
this credibility theme are the pressures on governments to
taxes. Having too many different tax instruments under a
demonstrate returns on publicly owned resources: they can
given tax regime gives a wrong signal to potential investors
act as a powerful incentive to adopt fiscal instruments that
on the effective tax severity and prevents a clear under-
deliver early revenues from resource development. Reducing
standing of the interaction between the various taxes. A
the frequency of changes to extractive fiscal legislation and
basic fiscal design rule is to try to minimize the number of
other mining and petroleum legislation will increase their
fiscal instruments and to focus on the most important
credibility for investors, who value stability. The fiscal
ones in terms of revenue capability.
regimes will also be considered more predictable for effec-
tive decision making.
Rewards and risk sharing derived from a fair
fiscal regime
Impact of different activities and contexts on
Designing a tax on rents from the extractive sector requires fiscal regimes
appreciation of some basic facts of EI life. In the vast Differences of approach and in fiscal regimes arise depend-
majority of cases, foreign investment will be required (see ing on whether the activity is oil, gas, or mining, even if they
chapters 1 and 3). The drivers to attract such investment share similarities as “extractives.” Differences will also
are well established. Governments provide mineral or emerge according to the context in which a fiscal regime is
petroleum rights to private sector companies, with the designed (or updated). For some countries, the existence of
expectation that the state will subsequently benefit from active contracts inherited from the past will constrain the
tax payments if commercial mines or fields are exploited. scope for change and force it to be incremental. (Examples
By receiving tax revenue, the government converts a can be found from mining in Guinea, Lao People’s
resource in the ground into both social and economic Democratic Republic, Sierra Leone, and Tanzania.) These
capital (Sunley, Baunsgaard, and Simard 2003, 153). differences are highlighted in this chapter, along with the
Correspondingly, private companies invest in exploration fiscal solutions to them.
and development projects when a fair fiscal regime applies, Some understanding of comparable country settings and
with the expectation of making a profit commensurate their tax regimes is also required, due to the number of
with the risks involved and their cost of capital. areas and conditions in which exploration and production
For both parties, there are potential rewards and risks, can take place and to the fact that investors favor those
and the balancing of those will determine ultimately what EI offering the more attractive tax treatment. Tax competition
sector development takes place and how beneficial it is to is a fact of life in the extractives sector, as in any sector.
the government, the investor, and the local community International tax issues can also be expected to play a part
(Stiglitz 2007; Date-Bah and Rahim 1987, 133n35). The in other ways, even if many of these are not peculiar to the
fiscal regime is a key determinant of how EI sector income extractives sector.2 Treaty shopping and transfer pricing can
is shared between the investor and the government. There is have significant impacts, especially in the context of
no model that would immediately lead one to conclude resource-rich economies.
what is a “fair” or “reasonable” share. However, there are Several web-based tools have been designed that have the
recognized guidelines and best practices to be followed potential to assist governments in addressing these fiscal design
when a country designs a fiscal regime and selects its terms challenges. Some are mentioned at the end of this chapter.
in hopes of establishing a regime considered fair by the
parties. Even after initial agreement, there is no guarantee
6.2 KEY FISCAL OBJECTIVES
that this sharing of benefits will be sustainable over the long
term, given the volatile and inherently uncertain investment Ideally, the design of an EI sector fiscal regime should reflect
life-cycle revenues. objectives stated in a government policy document that sets
90
80
70
60
50
40
ria
n
lia
r
a
06
08
ui ial
ia
qu
ca
st
oo
l
ra
go
ige
ib
G tor
Le
20
20
as
bi
a
er
am
st
An
ne
ag
am
-
ua
Au
am
or
na
na
N
ad
oz
Eq
ha
ha
m
C
M
Ti
G
G
b. Mining, AETR for selected states and a given project
100
AETR, at 15% discount rate
80
60
40
20
0
a
ia
ia
at a
Af outh
e
bi
re a
ru
rn an
an
bw
w
ib
an
ne
ur an
ive
Pe
ala
te Gh
w
am
Za
nt
nz
ric
ba
C Gh
ui
S
ts
M
Ta
G
N
m
Bo
Zi
ew
aN
Al
pu
Pa
Source: IMF fiscal analysis of resource industries (FARI) model hypothetical simulations (IMF/Ghana Ministry of Finance Seminar 2010.) The use of 2006
and 2008 for oil for Ghana refers to fiscal terms at the time of the Jubilee discovery (2006), and terms suggested as more appropriate to the reduced geo-
logical risk following that discovery (2008). Similarly, for mining in (b), “current” refers to what was applicable at the time of the IMF review, and “alterna-
tive” suggests how terms might be improved.
Note: AETR = average effective tax rate, the government’s share of the before-tax net present value, usually measured at the government’s assumed discount
rate. IMF (2012, 26) research on 16 petroleum and 11 mining regimes for a given project suggests that most petroleum regimes have a higher AETR and
include more progressive elements than do mining regimes. Panels (a) and (b) show standard international comparisons of AETR or “government take”
for a hypothetical oil and mining project only. Ranking may differ with other projects.
The trade-offs that governments face derive not only from fiscal regime and that a well-designed regime can address
inherent conflicts among the state’s different objectives each party’s concerns.
but also from the fact that investor objectives—in any
fiscal regime—may be at odds with the government’s. For
Stability of fiscal regime
example, an investor will always want to maximize its
return and minimize its risk, but the government may also An investor concern or objective that deserves particular
be trying to do just that for itself. Fortunately, both parties attention is the stability of the government’s fiscal regime. A
are now beginning to recognize what constitutes a fair long-standing investor fear is that at the end of a long and
Table 6.1 Possible Fiscal Mechanisms in Relation to Government Fiscal Progressivity Objective
Government take is responsive to:
Production
(daily or cumulative) Yes No No Partly No
Price
(price caps or base prices) No Yes No Partly No
Revenue
(price and production) Yes Yes No Partly No
Cost recovery
(uplifts and write-off rates) No No Yes Partly Partly
Simple indicators
(location, vintage, etc.) Partly Partly Partly No No
Governments have embraced state participation in partner’s interest through specified stages of a
their EI sectors in a variety of forms. project—exploration, appraisal, and possibly even
development—after which the NRC spends pari
1. Full participation interest. The state or its desig- passu with the private investor as under full partici-
nated national resource company (NRC) invests pation interest. The private investor may or may not
pari passu with the private sector from the start of be reimbursed for the funds advanced on behalf of
operations, by acquiring either an equity share in the state, with or without interest or a risk premium.
an incorporated joint enterprise (common in min- Where compensation does occur, it is typically paid
ing) or a participation interest in an unincorpo- out of the state’s interest in the project revenue.
rated joint venture (common in petroleum). 3. Free equity participation. This option is a simple
2. Carried participation interest. This may take several grant of an equity interest in an incorporated joint
forms. The most frequently encountered is the so- enterprise to the state without any financial obliga-
called partial carry during the early stages of a tion or compensation to the private investor. The
project. Under this approach, the private inves- state, however, receives a share in the joint enter-
tor “carries” or advances the costs of its NRC prise’s dividends pro rata to its equity interest.
18,000
16,000
US$ millions discounted at 15 percent
14,000
12,000
10,000
8,000
6,000
4,000
2,000
0
Angola Equatorial Guinea Cameroon Guinea Mozambique Timor-Leste
State equity Tax revenues
state participation. Nevertheless, the robust enthusiasm of advantage of discouraging excessive payments to nonresi-
many governments for state participation, particularly in dents as a means of shifting profits to lower tax jurisdictions
the hydrocarbons sector, is unlikely to be affected by such (see section 6.5). Withholding tax rates on payments to sub-
considerations. Some investors will continue to favor it too, contractors are typically set at relatively low levels, reflecting
because participation may help to develop a closer, long- the fact that they are levied on gross income.14 Treaties may
term cooperation with the country. also cap withholding rates in some cases, which is now a
major area of base erosion.
Production
Contractor’s after-tax
Profit tax
income
Angola’s fiscal regime for petroleum has gone 3. Corporate income tax (CIT) per project. A 50 percent
through several iterations since oil activity began. tax is levied on the investor’s adjusted profit oil
Tax-royalty systems are still applied on renewed con- share ring-fenced per development project. Capital
cessions, but production-sharing contracts (PSCs)— gains resulting from transfers are subject to CIT.
or in some cases risk-service contracts (RSCs)—have 4. State participation. Sonangol (Angola’s national
been applied to new contracts. The PSC package resource company) equity participation varies from
that has now emerged is generally regarded as repre- 0 to 20 percent (or a higher percentage) depending
senting good practice and includes the following on the contract.
components: 5. No royalty payable by the international oil company.
1. Signature bonus. Signature bonuses are included as Under these terms, the state’s share in benefits is
bid items in competitive licensing rounds. Angola’s decidedly progressive, while still allowing the investor
positive track record in honoring contracts and its to share in the upside. The resulting range of govern-
oil prospectivity have resulted in significant bonuses ment take is consistent with Angola’s prospectivity
in recent years. and take obtained in comparable states. Emphasis on
2. Production sharing. Investors are permitted allowable profits-based taxation provides an incentive to extended,
cost recovery of up to 50 to 65 percent of produc- broad-based development.
tion. Remaining profit oil is split for deepwater Application of the corporate tax allows investors to
projects according to a scale that escalates from claim foreign tax credits. Sonangol’s participation inter-
20 percent to 85 percent (or from 30 to 90 percent est has been kept at relatively modest levels, but a higher
in recent contracts) in the government’s favor rate may be provided for in the bidding terms. Angola’s
as a function of the investor’s actual achieved decision to seek external audit support has provided
profitability. protection of its interests in fiscal administration.
1. Define the different ways of transferring interests controlled subsidiaries) plus working interest
in licenses and contracts (because gains result in blocks
from direct or indirect transfers of interests). vi. Swaps of interest in licenses
These are: vii. Other forms of transfers: initial public offering
i. Farm-in/out in a block or contract and so forth
ii. Only a work commitment as compensation 2. Address the administrative approval of any proposed
iii. Cash compensation plus work commitment transfer, direct or indirect, in particular in cases
iv. Sale of a participating interest in a block for a where the transfer involves a predefined change of
cash consideration control in a subsidiary. Why does such approval
v. Sale combining shares in a subsidiary (a direct require an assessment of the tax consequences of the
subsidiary or a subsidiary in a chain of transfer?
(Box continues on the following page)
3. Define the gain or profit/loss related to a transfer exploration and production sector? This
and the ways to tax such gain or profit, taking into should normally be the case, especially to deal
account the following six considerations: with farm-in, swap of licenses, reinvestment in
i. Is the gain considered to be ordinary income the country, and so on.
subject to normal corporate income tax (CIT) or iv. What are the accounting issues for the transferor
at a different rate applicable to capital gains? and the transferee regarding acquisition costs?
What rate is applicable when activity is subject to v. Is there an impact of the cost of acquisition on
an additional profits tax? How should one allo- cost recovery under production-sharing con-
cate the transaction cost between several blocks? tracts? Should the acquisition cost not be a
ii. Why should gain be taxed? Why should the recoverable cost even when the transfer is sub-
value of the transaction take into account the ject to CIT?
applicable taxation on gain? vi. How should the impact of favorable double
iii. Does the petroleum tax legislation define a taxation treaties and international oil compa-
special gain taxation regime for the oil and gas nies’ tax planning strategies be mitigated?
6.5 SPECIAL EI FISCAL TOPICS AND In the case of gas, competitive markets currently exist
PROVISIONS only in the United States, the United Kingdom, and a few
Extractives fiscal prices other countries; readily observable prices for fiscal purposes
do not exist outside those markets and are often set on a
Price determination for fiscal purposes can be complicated project-by-project basis. Further, the marketing of natural
in the EI sectors. In all cases, the goal in tax administration gas and some minerals may be integrated all the way from
is to set or agree to a fair price for tax purposes as close as the petroleum field gate or agreed delivery point or mine
possible to that which would be realized in a genuine third- mouth through processing or smelting and transport all the
party, arms-length market sale. This is important for several way to final consumer with different tax regimes along the
reasons: integrated chain. Setting the value of the resource along that
chain will, as a result, have significant implications for total
1. To avoid fiscal revenue loss by underpricing of the fiscal revenues and their sharing among fiscal jurisdictions.
resource (see the section on Transfer Pricing below). Good practice generally calls for “netting” the price paid by
2. To avoid government overpricing of the resource to raise the final consumer back to the agreed field gate or delivery
revenues. point or mine mouth in such a way that fiscal valuation
3. To help ensure the availability of foreign tax credits to accrues at those points.
investors (see the subsection “Foreign Tax Credits in
Home Country”).
Transfer pricing and interest deductibility
The goal is most easily accomplished in the case of oil, Transfer pricing refers to the pricing of sales to, or pur-
where well-established international markets exist and ref- chases from, parties affiliated with the EI sector investor
erence price quotes, together with price adjustments for (Daniel et al. 2016, 42–110). It applies not only to the sale
crude oil quality and transport differentials, are almost con- of products and goods but also to the supply of services and
tinuously available. The fiscalization point (at the point of the terms and pricing of loans or credit instruments such as
export, ex-field, or another agreed point of delivery) must prefinancing arrangements. More than one half of all cross-
be agreed to by the parties but need not present particular border transactions carried out are likely to be between
difficulties as long as associated taxes or royalties are adjusted companies that are affiliated, so the importance of this
to reflect the choice made. Establishing fiscal prices for subject should not be underestimated (RWI et al. 2013, 96).
mining and natural gas is more problematic, because their Transfer pricing is considered abusive when underpricing a
market prices may be harder to identify or observe. sale or overpricing a purchase results in shifting profits
Chapter Title
Revenue Management and Distribution
7.1 KNOWLEDGE CORE Not the least of these is the probability that many citizens
will remain poor in spite of the large revenues from extrac-
Once extractive industry (EI) revenues have been generated
tive resources. Several commentators on revenue manage-
and collected, a government must decide on their manage-
ment have written variations of Arezki, Dupuy, and Gelb’s
ment and allocation. This is the fourth link in the EI Value
(2012, 1) warning, “The future is not without its dark side.”
Chain. Mismanagement of the wealth from oil, gas, and
Transparency and accountability are crucial to achieving
mining can lead, among other things, to social and eco-
success in revenue management and distribution. A lack of
nomic inequalities, the funding of corrupt practices, and
transparency in fiscal practices is likely to lead to substantial
intrastate, or even interstate, conflicts. The two overriding
costs and a loss of credibility (see chapters 2 and 8). Fiscal
options for this wealth are spending or saving, with deci-
transparency includes a clear assignment of roles and
sions required in appropriate channels or mechanisms for
responsibilities to different government bodies, the estab-
each. The sharing of resource revenues among levels of
lishment of an open budget process, publicly available
government and regions is increasingly common and
information, and assurances of data integrity.1
requires careful balancing of pros and cons. A challenge is
Revenue sharing schemes in particular need transpar-
to ensure that the approach adopted to revenue manage-
ency. Investors seek clarity about their relationships with
ment and distribution is one that can withstand the sharp
different levels of government and how payments are meant
falls and hikes in prices that the EI sector is prone to
to flow. Stability, predictability, and transparency of
experience.
resource revenue flows are a key part of their social license
The stakes are high. New EI income will relax pressures
to operate. It is important to ensure that resource revenue
on government budgets, but it also creates challenges.
183
sharing schemes within a country are workable: that is, effi- wages, consumption, and income will move on an upward
cient, fair, and transparent. Many countries enshrine their trajectory. As two leading development economists, Collier
sharing formula and implementing rules in legislation. and Venables (2008, 1) have noted, the question for gov-
ernments in such circumstances is “What is the optimal
consumption profile: i.e., what maximizes the present value
7.2 WHY REVENUE MANAGEMENT IS DIFFICULT
of the utility of consumption given available investment
Good practice in resource revenue management is increas- opportunities?”
ingly recognized, yet the experience of most resource-rich
states in this area has not been especially encouraging (see
The four main challenges
chapters 2 and 8). This suggests that there are continuing
problems in the implementation of resource revenue man- The importance of managing these revenues cannot be
agement good practice. As always, the lessons for avoiding exaggerated. Revenues from oil, gas, and mining are to a
common pitfalls have to be understood in context. Where large part concentrated in the public sector; how this
they appear relevant, they need to be adapted to fit the revenue should be spent and distributed across genera-
circumstances of the country concerned. Those circum- tions is key to any economic development. Yet, as one
stances include the level of development, nature of the recent study has noted, “tax authorities often lack the
resources and their size, fiscal dependence on resource rev- confidence and ability to handle it, and general tax
enues, institutional capacity, fiscal federalism, budget rigid- administration experts may feel unqualified to advise
ities, transparency levels, and capital scarcity. There can be them” (Calder 2014, 1).
no combining of the best lessons in a standard model that a Four areas of sensitivity lie behind this curious situation:
government can blindly follow.2 Recent research has under-
lined this.3 Indeed, many resource-rich countries have to 1. Volatility and uncertainty. This is by far the greatest chal-
overcome constraints in capacity before they can align lenge for a resource-rich economy. Any design of reve-
themselves with successful examples of revenue manage- nue management rules is complicated by the volatility
ment in the extractives sector. and uncertainty of resource receipts, which affect
A country in the developing world that has recently dis- resource wealth estimates as well as the government’s
covered large-scale natural resources likely starts with at cash flow. The literature on the so-called resource curse
least three important constraints: finds that much or all of the negative effect (where there
is one) can be attributed to increased volatility, which
1. A scarcity of capital, with an interest rate higher than the studies show to be very costly, (The literature is summa-
global rate, and limited access to international capital rized in chapter 2). This is exacerbated by the unimpres-
markets, possibly as a result of the country’s credit rating sive record of price forecasts and the limited information
2. An undersupply of public infrastructure in futures prices. There is also the uncertainty about
3. An investment climate that lacks incentives to private assessments of future reserves and prices to contend
investment with, as well as of current prices.
2. Absorptive capacity. There are consequences to spending
To make the starting point even more challenging, there decisions. If revenues are spent at once, the price of plant
is likely to be a difficult issue with managing expectations, machinery and equipment that enable production will
both of the public and of the government. Inflated expecta- be driven up, imposing stress on transport systems, for
tions tend to exert pressure for overly rapid spending. The example. Future nonresource sectors with good pros-
problems that contribute to depressed private investment, pects will be pushed to one side, appearing less attractive
or a poor credit rating, are mainly institutional and political by comparison, with the effect of reducing learning and
and will not be solved in any direct way by the injection of future growth. The problem is associated with volatility
resource funds. because absorptive capacity constraints are most tested
From these inauspicious circumstances, the country when revenues and spending are high, although the issue
with new discoveries has the prospect of making high- can also apply over a longer cycle.
return investments and putting its economy on a growth 3. Exhaustion. In theory, the exhaustibility of oil, gas, and
path that will involve capital deepening with the rate of other mineral resources raises intergenerational issues
return converging to the world rate. At the same time, and reveals a need for balance between government
tutional document. Some countries like Peru and Botswana Expenditure rule (2003)
Colombia have fiscal rules in this sense. Others like Supranational rules—Central African
Trinidad and Tobago have preferred “ad hoc rules which Economic and Monetary Community
(CEMAC) (2002, 2008)
may not have taken specific issues such as household wel-
fare and fiscal stability, into account” (Primus 2016, 5). Cameroon Budget balance rules (2002, 2008), Debt
Those that do have them use various types of rules or rule (2002)
combinations of them, but essentially a set of fiscal rules
Chad Supranational rules—CEMAC (2002, 2008)
comprises numerical rules designed to guide and bench-
mark performance against quantitative indicators (such as Chile Budget balance rule (2001)
the fiscal balance of debt) and procedural rules intended
Colombia Budget balance rule (2012), Expenditure
to establish transparency, coverage, and accountability rule (2000)
requirements (IMF 2007b, 17). See table 7.1 for a recent
list of countries and their fiscal rules. Congo, Rep. of Supranational rules—CEMAC (2002, 2008)
The five kinds of fiscal rules found in practice are the
Côte d’lvoire Supranational rules—West African
following:5 Economic and Monetary Union (WAEMU),
Budget balance rule (2000), Debt rule
1. The balanced budget rule. Sometimes called “hand to (2000)
mouth,” in this rule all annual oil receipts are spent while Ecuador Expenditure rule (2010), Budget balance
the government’s overall financial position is kept in rule (2003), Debt rule (2003)
balance. For example, in Mongolia the structural deficit
may not exceed more than 2 percent of gross domestic Equatorial Guinea Supranational rules—CEMAC (2002, 2008)
product (GDP). (The disadvantages are that it tends to Gabon Supranational rules—CEMAC (2002, 2008)
privilege current over future generations in terms of
their share of consumption of extractives wealth and it Indonesia Budget balance rule (1967), Debt rule
(2004)
may subject governments to boom-and-bust cycles in
the international markets.) Mali Supranational rules—WAEMU (2000)
2. The debt rule. This sets a limit on public debt as a per-
centage of GDP. For example, in Indonesia there is a Mexico Budget balance rule (2006), Expenditure
rule (2013)
requirement that total and local government debt should
not exceed 60 percent of GDP. Mongolia sets the ceiling Mongolia Expenditure rule (2013), Budget balance
of public debt at 40 percent of GDP. rule (2013), Debt rule (2014)
3. The expenditure rule. This sets a limit on spending, in
Niger Supranational rules—WAEMU (2000)
absolute terms or terms linked to the level of growth rate
or percentage of GDP. For example, Botswana has a ceil- Nigeria Budget balance rule (2007)
ing on the expenditure-to-GDP ratio of 40 percent, and
Norway Budget balance rule (2001)
Peru has a statutory limit on real growth current expen-
diture of 4 percent. Peru Budget balance rule (2000, 2003, 2009),
4. The revenue rule. This sets a ceiling on the use of overall Expenditure rule (2000, 2003, 2009, 2013)
revenues or revenues from oil, gas, or minerals. For
Russian Expenditure rule (2013)
example, in Ghana a statutory limit is set on the amount Federation
of oil and gas revenues that may enter the budget; this
may not exceed 70 percent of revenue averaged over a Venezuela, RB Fiscal rules embedded in Organic Law for
the Public Finances (2000)
seven-year period. The rest of the revenue has to be saved
in a stabilization fund or a fund for future generations.
Source: Adapted from IMF 2015a, 6, table 1.5.
5. The permanent income hypothesis (PIH) rule. With this
rule, decisions on spending oil, gas, or mineral revenues
Botswana Chile
Botswana has implemented medium-term national Chile introduced an informal fiscal rule in 2001. The
development plans (NDPs) closely linked to the budget rule calls for maintaining a structural central govern-
process for decades. A six-year NDP sets broad fiscal ment surplus over the economic and copper price
objectives and associated policy actions. It has contrib- cycles. It is seen as a useful signal to financial markets,
uted to the implementation of a longer-term strategy indicating sensitivity to the risks of procyclical
that has helped contain spending during periods of spending. The successful implementation of the rule is
revenue buoyancy and led to overall surpluses for most seen in large measure as due to low debt and high
of the past two decades. The framework has incorpo- policy credibility, the result of past prudent policies
rated goals for the overall balance and a type of golden and good institutions.
rule, where nonmineral revenue should at least cover The rule was enshrined in the Fiscal Responsibility
noninvestment recurrent spending. This rule has been Law in 2006. This law adopted a target of 1.0 percent of
adhered to in most years, except for a few in the early GDP positive surplus, which was reduced in May 2007
2000s, when fiscal deficits emerged. to 0.5 percent effective in 2008 and further to 0.0 per-
Due to the global financial and economic crisis, the cent of GDP in 2009. This has advantages for business
mining sector contracted by 46.2 percent in 2009, cycle stabilization, because further asset accumulation
while the nonmining sector grew at 4.9 percent, with would require higher taxes and/or lower spending
the net effect on overall GDP of −7.9 percent. In 2010 today relative to the future, which would induce inter-
and 2011, real mining GDP recovered only partially temporal effects in consumption and investment
and is still well below the prerecession levels, while (Kumhof and Laxton 2009).
growth in the rest of the economy resumed at rates However, the implementation of the rule in recent
yielding overall GDP growth similar to the rates lead- years has revealed certain challenges, and in May 2010
ing up to the global financial crisis (Botswana 2013). the government established a high-level commission to
Their Sustainable Budget Index rule in NDP 10 recommend reforms that could make the rule more
reserves mineral revenue for capital spending, leaving effective (Dabán 2011).
only nonmineral revenue to finance recurrent spend- Further, the administration (2010–14) specified a
ing (IMF 2012). target path (to converge to 1 percent of GDP struc-
While the fiscal position has been under some strain, tural deficit by 2014). A second-generation structural
continued commitment to prudent fiscal policies and balance rule was published in 2011 (available in
medium-term planning put Botswana in a strong posi- Spanish at http://www.dipres.gob.cl/594/w3-article
tion to face important medium-term challenges. -81713.html).
Transparency International governance indicators, both response to a revenue windfall could be inefficient if coun-
countries have significantly higher levels of governance tries do not have adequate absorptive capacity, creating
and institutional quality than most resource-rich supply bottlenecks and reductions in the quality of admin-
countries. istration and implementation. The spending path needs to
be set at a rate that is efficient for the economy.
Experience of both expenditure smoothing to address
Absorptive capacity
volatility concerns and a gradual expenditure build-up in
While in many circumstances it may be desirable to make a the face of absorptive capacity constraints suggests that part
significant allocation of EI sector revenues to spending, and of any resource revenue windfall should be allocated to sav-
especially to domestic investment,8 the effectiveness of that ing (Iimi 2006). However, this depends on a number of
spending will depend to a large degree on the absorptive factors, including the size of the windfall relative to budget
capacity of the resource-rich economy and the govern- expenditure and the potential to increase absorptive
ment’s institutional capacity. A rapid rise in spending in capacity. Saving of resource revenues may also be justified
Azerbaijan State Oil Fund of Azerbaijan Republic SOFAZ 1999 Stabilization and saving
Iran, Islamic Rep. National Development Fund 1999 Oil stabilization and development
Kazakhstan National Fund of the Republic of Kazakhstan 2000 Stabilization and saving
NFRK
Mexico Oil Revenues Stabilization Fund of Mexico 2000 Stabilization and saving
Nigeria Nigeria Sovereign Investment Authority 2004, 2011 Stabilization and saving
Papua New Guinea Sovereign Wealth Fund 2011 Stabilization and development
Russian Federation Reserve Fund (Former Oil Stabilization Fund) 2004 Stabilization
National Wealth Fund Saving
Trinidad and Tobago Heritage and Stabilization Fund 2000 Stabilization and saving
Only a portion of oil revenues is deposited into the fund. Fund finances are subject to a regular external
fund. For example, corporate income taxes from oil audit by the Auditor General.
companies go straight into the budget. External managers have been hired to cover specific
It has two unusual features. The principal of the investment mandates.
fund is to be invested permanently and cannot be spent The Fiscal Management Act of 2013 created the
without a popular vote. This is a highly unusual feature contingency account as a stabilization fund to provide
of a fund. A further unusual feature is that income from budget financing in those years when expenses exceed
the fund is to be used for inflation-proofing the capital revenues. The 2013 budget adjusted the new deposit
and paying dividends annually to citizens; this has had rule by depositing the first Can$5 billion in resource
the effect of limiting any attempts to broaden the scope revenue in the Contingency Account. In subsequent
of the fund. years, all or some of any fiscal surpluses will be depos-
The determination of individual dividends or direct ited into the Contingency Account. The Alberta
cash payments is made according to a formula set out Treasury determines the portion of fiscal surpluses to
in legislation and does not reflect current oil prices but be deposited into the account. The size of the
instead is based on a five-year average of earnings on a Contingency Fund cannot fall below Can$5 billion.
number of securities. The net income of the fund will no longer be with-
The legislation determines ways that payments flow drawn after fiscal year 2017/18, and will instead be
in and out of the fund, leaving little room for even retained in the fund using a graduated process.
legislative discretion. The primary requirement is that One of the objectives of the fund is to save oil
the real value of the capital is maintained. revenues for future generations. Yet despite produc-
The model is rigid as a result: it is unable to respond tion and historically high prices at times from 1987
to changing state needs or a decline in oil production. to 2012, only two relatively small deposits were made
Internal and external managers are used. Investments into the fund over this period. This is due to the lack
are always made outside of the state. of a deposit rule. In 2013, the Alberta government
Operation of the Fund exhibits a high degree of finally instituted a set of fiscal rules with long-term
transparency; quarterly and annual reports are savings and fiscal stabilization objectives in mind.
produced.
Kazakhstan
Alberta, Canada
The National Fund was established in 2000 as an
The Heritage Savings Trust Fund was set up in 1976 account of the government held at the national bank.
but has evolved considerably since the 1990s. Initially Oil and mining revenues due to the government are
it had goals of economic diversification and social first paid to the finance ministry and then paid into the
improvement, but these were abolished after percep- fund according to a strict formula.
tions of limited success. Instead the fund was restruc- The fund has a savings and a stabilization function
tured into a financial investment fund with the goal of and payments are made into two separate portfolios to
maximizing return subject to acceptable risk. reflect this. A reference price for oil is determined for a
It is required to invest much of its assets within the five-year period, and this determines baseline budgeted
province as part of developing the local economy but oil revenues. Ten percent of these are paid into the
also invests savings outside the province. savings account quarterly and 90 percent are retained
The fund has been de facto decoupled from the oil for the budget. Excess revenues above the budgeted
economy and is now a portfolio of financial assets amount are paid into the stabilization account; deficits
with returns being used to pay down provincial debt. below the reference price are withdrawn from the sta-
Quarterly reports are made by the provincial finance bilization account. Mining payments have a separate
minister summarizing investments to the legislature and reference price. The finance ministry sets benchmarks
the public; annual reviews of the fund’s performance for the fund and the central bank reports to the minis-
ensure compliance with the regulations governing the try on fund performance against the benchmarks.
(Box continues on the following page)
All major decisions concerning management and ment programs. This amount can be adjusted by 15 per-
altering of rules on payments in and out of the Fund cent through legislation.
have to be made by the president. The balance of the fund cannot fall below 20 per-
Accountability is lower than usual in such funds cent of GDP in a given fiscal year. If it does, the short-
and there is little oversight or transparency of fall is to be covered by cutting the fixed annual transfer
information. by the amount needed to cover the difference.
Since 2010, Presidential Decree no. 962 introduced A further change was made in November 2014, in
the most recent rule. Annual transfers are fixed at response to a drop in oil prices: withdrawals of US$3
US$8 billion per year, which can now be used to fund billion a year will be made from 2015 to 2017 to develop
current budget expenditures in addition to develop- transport, energy, industrial, and social infrastructure.
Sources: NRGI and CCSI 2014; Davis et al. 2001; Bacon and Tordo 2006.
Fungibility. Critically, savings funds suffer from a prob- 7.5 ALTERNATIVE MEANS OF ADDRESSING
lem of fungibility. They receive a share of revenues that are FISCAL SUSTAINABILITY
automatically put away for future generations. However, for
Assessing long-term fiscal sustainability is challenging in
this to be effective, they need to lead to higher government
resource-rich economies due to the exhaustibility of the
savings in the aggregate. If, instead of this outcome, the gov-
resource and therefore the revenue from its production.
ernment does not reduce its expenditure and borrows to
Although this affects all countries with resources, it is much
finance the gap left by revenue that has been diverted into
more of a concern for countries with limited resources and
the fund, the aggregate savings are unaffected. What hap-
shorter resource horizons, like Cameroon, Uganda, and the
pens is that savings fund assets are merely offset by govern-
Republic of Yemen. In such cases, there is a need to focus
ment debt (Davis et al. 2001). A way of solving this is to
on how government expenditures can be sustained once
change the paradigm and, instead of having a rigid accu-
resource revenues come to an end. If there is no framework
mulation rule, require the fund to finance the budget: the
in place for fiscal sustainability, there will be considerable
fund receives budget surpluses and finances budget deficits.
uncertainty about how long a government can sustain its
This model has been adopted by Chile, Norway, and Timor-
current spending and tax practices and other promised
Leste. While it may appear that these arrangements remove
expenditures. For countries with longer resource horizons,
the disciplining effect of a savings fund and lead to a loss of
the main objective of fiscal policy is how to manage revenue
the automatic mechanism for saving, in fact, as noted, the
volatility as the price of the resource fluctuates. Whether or
disciplining effects of a savings fund can be illusory as long
not government spending can be sustained is a less immedi-
as the government can borrow.
ate question for them.
An argument against a fiscal policy that aims at accumu-
There have been various studies in recent years including
lating “excessively” large savings funds is that investment in
several by the IMF on the fiscal response of petroleum-rich
domestic social and physical infrastructure can yield poten-
developing states to oil booms.12 They have demonstrated
tially much higher returns; the resulting incremental growth
that while the prospect of long-term fiscal sustainability was
(if achieved for a sustained period) may, for many states,
improving in many states, that prospect is being seriously
come to dwarf the income from holding resource wealth in
jeopardized by short-term policies and behavior that sharply
financial assets. This argument must be qualified, however,
increased non-oil fiscal deficits through tax cuts or dra-
by taking into account the absorptive capacity of the
matic escalation of expenditures. This results in signifi-
domestic economy and institutions and the need for pre-
cantly increased vulnerability to future revenue shocks from
cautionary balances, which can be large.
One very important innovation of Chile is the use of the Economic and Social Stabilization Fund made the
independent professional committees to issue a projec- previous year, are deposited into the Economic and
tion for long-term copper prices—vital for revenue Social Stabilization Fund.
forecasting—which helps to depoliticize them. Funds from the Pension Reserve Fund can be used
Chile established two funds in 2006, the Pension only to pay for pension and social welfare liabilities.
Reserve Fund to help finance pension and social wel- Until 2016, the previous year’s return on the
fare spending and the Economic and Social Stabilization Pension Reserve Fund could be withdrawn. From 2016
Fund to help overcome fiscal deficits when copper onward, annual withdrawals from the Pension Reserve
revenues decline unexpectedly. The funds are governed Fund cannot be greater than a third of the difference
by a strong set of deposit and withdrawal rules under- between the current year’s pension-related expendi-
pinned by a fiscal rule that has the effect of smoothing tures and 2008 pension-related expenditures, adjusted
spending over time. for inflation.
The Economic and Social Stabilization Fund is Chile’s Structural Balance Rule allows for estimat-
a countercyclical tool that aims to smooth govern- ing fiscal revenues for budget planning and, therefore,
ment expenditures, allowing the government to whether withdrawals are needed from the Economic
finance fiscal deficits in times of low growth and/or and Social Stabilization Fund.
low copper prices and to pay down public debt when Funds can be withdrawn from the Economic
necessary. and Social Stabilization Fund at any time in order to
While external audits are made public, compliance fill budget gaps in public expenditure and to pay
with the rules is not assessed by a formal oversight down public debt. However, withdrawals are subject
body like a multistakeholder committee or indepen- to the structural balance rule. Funds can be with-
dent fiscal council. drawn, at the discretion of the Minister of Finance,
The funds are very transparent. Information on to finance annual contributions to the Pension
fund managers, returns on specific investments, and Reserve Fund.
how deposits and withdrawals are calculated is publicly The Economic and Social Stabilization Fund’s
available. investment policy is to maximize the fund’s value in
A minimum of 0.2 percent of the previous year’s order to partially cover cyclical reductions in fiscal
GDP must be deposited in the Pension Reserve Fund revenues while maintaining a low level of risk.
annually. If the effective fiscal surplus exceeds this The Economic and Social Stabilization Fund invests
amount, the deposit amount can rise to a maximum of in portfolios with a high level of liquidity and low
0.5 percent of the previous year’s GDP. The fund is credit risk and volatility in order to ensure that
capped at 900 billion Unidades de Fomento (approxi- resources are available to cover fiscal deficits and avoid
mately US$1.4 billion as of February 2017). Deposits significant losses in the fund’s value.
can be financed with funds from the Economic and Funds are invested in fixed-income assets in reserve
Social Stabilization Fund at the discretion of the min- currencies that typically do well in financial crises.
ister of finance. Sovereign investments are made exclusively in German,
Any remaining fiscal surplus after deposits to the Japanese, and U.S. government bonds.
Pension Reserve Fund are made, minus any funds used The fund has adopted a passive management invest-
for public debt repayments or advance payments into ment policy since May 2011.
becomes very important. Any procedures set down for In practice, the focus on a reference price has proven to
doing this will be highly dependent on price forecasts. In be very difficult due to the stochastic process driving
some countries, such as Chile (see box 7.3) and São Tomé resource prices: there does not appear to be a meaningful
and Príncipe, a formula is used to determine the reference long-term average price, and resource prices do not tend to
price. This avoids arbitrary decisions that may favor the revert to anything. Further, there are problems due to the
current spending plans of the ruling groups and result in a fungibility of money: the government can undo in the bud-
depletion of the stabilization fund. get what it is trying to achieve in the fund.
governments. Of the land rent, 20 percent is allocated Oil-producing states receive 13 percent of revenues
for the central government, while the remaining from the oil produced in their state, in addition to
80 percent is shared among the provinces (16 percent) standard revenue allocations. The current vertical allo-
and the producing districts (64 percent). The arrange- cation formula, based on Presidential Executive order,
ment for the shared revenue from royalty is similar, is as follows:
with 32 percent for producing districts and 32 percent Federal government: 52.68 percent
equally divided among the nonproducing districts State government: 26.72 percent
within the province (article 14 Law 33/2004). Local government: 20.60 percent
Iraq Sudan
The federal government as well as producing provinces Net oil revenues are split equally between the govern-
and regions are given the authority to manage oil and ment of Sudan and the government of South
gas extracted from present oil and gas fields. This is Sudan, with 2 percent of oil revenue reserved for the
conditional on the distribution of revenues in propor- producing states in accordance with their proportion
tion to the population distribution and specification of of production (Comprehensive Peace Agreement,
a share for previously disadvantaged areas (Constitution, Wealth Sharing Protocol Arts 5.5–5.6).
article 112.1). Since independence, South Sudan appears to be
Articles 17 to 20 of Iraq’s 2009 Budget Law out- continuing this practice. The National Legislative
line the country’s current revenue-sharing arrange- Assembly passed the Petroleum Law in April 2012 and
ments. “Sovereign expenditures” for the Council of in 2013 passed a petroleum revenue management bill.
Representatives, the administration of the national cabi- The latter states that counties in oil-producing states
net, the Ministry of Foreign Affairs, the Ministry of are to receive 3 percent of net petroleum revenues.
Defense, oil export production, and other national gov-
ernment functions are prioritized. Of the remaining
hydrocarbon revenues, 17 percent is allocated to the República Bolivariana de Venezuela
Kurdistan Regional Government and the remainder is
The constitution requires 15–20 percent of the national
allocated to national ministries in other governorates
budget to be transferred to the states (article 167.4),
(both hydrocarbon producing and nonhydrocarbon
and special shares are envisaged for states with hydro-
producing) in proportion to the population distribution
carbons and mining activities (article 156.16).
and specific needs. The 2010 budget also includes a pro-
Of the total, 80 percent is assigned to states, while
vision that will deliver US$1 to producing governorates
municipalities receive 20 percent.
for each barrel of oil and refined fuel they produce.
Until 2009, three main mechanisms served to
Source: Blanchard 2010. decentralize public spending:
3. Intergovernmental Decentralization Fund: This Fund (FCI) was created. This fund does not have a rule
consisted of the distribution of no less than 15 per- for allocations. Instead, its income sources are decided
cent of the income collected from the value-added by the executive, the subnational levels of government,
tax (VAT) to subnational levels of government; and other sources defined by law.
42 percent of this amount went to state govern- The Federal Government Council decided to dis-
ments, 28 percent to municipalities, and 30 percent tribute the FCI funds in the following manner: 35
to communal councils. percent for communal councils, 37 percent for states,
and 28 percent for municipalities. The 65 percent for
In 2010, the Intergovernmental Decentralization Fund states and municipalities is distributed considering
was eliminated, and the Inter-Territorial Compensation population and a relative development index.
five years.33 Iraq, Sudan, and the República Bolivariana de Example: Nigeria. One consequence of a growing depen-
Venezuela have also adopted formulas but, as illustrated in dence on EI revenue at the expense of alternatives over time
box 7.4, these are different in character. is evident from Nigeria. The local authorities have become
The approach taken in Indonesia merits comment. It increasingly dependent on the federal authorities, and not
was expressly designed to counter centrifugal tendencies only for a share of revenue (they have become increasingly
and support the organizational integrity of the country by unable to generate revenue internally from alternatives
meeting demands from regions and local communities for such as agricultural produce). The federal government has
a large measure of control over resource revenues. Under assumed more responsibilities from the states and local gov-
the scheme set up by Law 33/2004, the central government ernments on matters such as environment, defense, security,
makes transfers quarterly, based on estimated profits for and transportation. This leads to the federal government
the current quarter and with an adjustment for the differ- arguing for a greater share of the revenues to discharge
ences between projected and actual profits in the previous these responsibilities. State authorities have also annexed
quarter transfers. Some delays have been reported in the allocations that are intended for local government councils,
transfers, a familiar concern among subnational authorities. the next layer of government down the chain (Idelare and
There is also a transfer of oil and gas revenue indirectly to Suberu 2012).
subnational governments through a general allocation
transfer that forms the largest transfer to subnational Example: Peru. Dissatisfaction with the distribution
entities. This is based on forward estimates. However, of mining revenues in Peru led to the establishment of a
“There is an incentive for the central government to under- mechanism for direct distribution of mining revenue from
estimate the revenue by assuming a low oil price” (Agustina the central government to subnational government enti-
et al. 2012, 14). An effect of the regime is to create a signifi- ties. The Canon Minero Law (2004) allows 50 percent of
cant disparity across provinces and districts. For mining corporate income tax collected from mining companies
revenues, the amounts are much smaller and comprise land to be earmarked in this way. The distributed amounts
rents and royalties, which are shared between central and are to be spent on projects contributing to sustainable
subnational governments, such as Papua New Guinea. The development by districts, provinces, and departments.
locations are often remote, and so mining has a significant Its impact has been primarily on infrastructure projects,
impact on local development and generates employment but for provincial governments these revenues have been
for many local people. However, recent research has found “transformational” for their revenue base (WGC 2011, 14).
the effect of the resource-sharing scheme to be one of Its effectiveness is nonetheless dependent on sound gover-
creating significant disparity among provinces in terms of nance and public fiscal management. It also requires an
revenue sharing per capita. appropriate administrative capacity at the subnational
These are among the most frequent concerns about revenue A source of potential concern about subnational manage-
sharing. Sharing ought to be automatic on the basis of the ment is the considerable fluctuation in revenues that
agreed principles and formula, but in practice the fear of results from the overall budgetary process and commodity
subnational governments that the payments will not be prices. An IMF study, which concluded that revenues
made in a timely fashion from the central account is often should be fully centralized, included in its reasoning a con-
well founded. Their lack of trust in the central government cern about precisely this factor: revenue sharing between
may extend to fears of political interference and a lack of central and subnational levels transmits volatility in com-
transparency about their share of the revenues (although the modity prices to the subnational level (Ahmad and Mottu
problem may also be attributable to institutional weak- 2002). Some mechanism needs to be put in place to mini-
nesses). This has been a factor in negotiations about revenue mize the potential for unpredictability in fiscal transfers to
sharing in Indonesia, Iraq, and Sudan. One solution may be subnational governments, which are likely to be less well
to outsource the collection and sharing of revenues to a third placed to manage the macrofiscal risks because of their less
party rather than leave them to the ministry of finance and/ diversified revenue base. A formula also needs to be found
or treasury. An alternative approach to revenue sharing is to that shares the spending and saving decisions across all
assign certain taxation powers to different levels of govern- levels of government in a way that gives subnational gov-
ment. In Argentina, Brazil, Canada, and Sudan, for example, ernments confidence that savings made in their name will
the state or provincial governments have the right to directly not be expropriated.
collect certain types of revenues (for example, royalties, fees, Delays in investing in projects and reduced levels of gov-
and excise or production taxes), leaving others to be col- ernment service may be a consequence. In their review of
lected by the central authority (for example, corporate the results of revenue sharing, the authors of a study on the
income taxes and export charges). Revenues can be distrib- Indonesian approach note, “The biggest danger remains
uted by the particular level of government as it deems appro- that of heightened expectations concerning public services
priate or according to its own set of rules. This has the and improving living standards being unfulfilled. This
advantage of circumventing the distrust that often exists could create a political backlash” (Agustina et al. 2012, 30).
8.1 KNOWLEDGE CORE become more accountable and resource revenues will be
There is no alternative better spent, to the advantage of the countries concerned. It
has become a cornerstone of good practice that EI compa-
Investors and governments in resource-rich countries now nies increasingly must comply with or face strict penalties.
have no choice but to engage with evolving new interna- In light of the large sums of money involved with EI sector
tional norms and standards on transparency and account- activities, it is hardly surprising that it has led to high and
ability. Legal norms are being adopted in the home states of pervasive levels of corruption all along the EI Value Chain.1
many large extractives firms that require them to meet Advocates of greater transparency argue that it provides safe-
transparency standards. Governments are increasingly guards against many of the powerful incentives for corruption,
becoming engaged with the requirements of the Extractives such as high entry costs, the multiplicity of parties involved, the
Industries Transparency Initiative (EITI). technological complexity of resource development, complex
revenue accounting, and traditions of sector secrecy.2
Transparency and accountability are now thought to be critical
Why?
to combat these and permit the efficient and prudent manage-
The poor record of governance in many resource-rich states ment of natural resources and their revenues throughout the EI
and its damaging effects on their development have encour- Value Chain. For that reason, the Sourcebook treats them as a
aged a consensus around transparency as a policy response. cross-cutting topic. Transparency can limit the opportunities
The guiding idea behind the new norms, standards, and for misuse of power and corruption, while accountability can
legal rules is that if more information is available to the ensure that those entrusted with the management of public
public, governments and extractive industries (EIs) will resources are held responsible for their actions or inactions.
221
Limits to this focus 8.2 DEFINITION AND SCOPE
Transparency is not an end in itself. To be effective, it must Under a broad definition to encompass its many objectives,
be combined with effective stakeholder dialogue in order to transparency refers to the degree to which information is
achieve accountability. Improving transparency and available to outsiders that enables them to have an informed
accountability requires multiple measures, both voluntary voice in decisions and to assess the decisions made by
(among many stakeholders) and mandatory (regulatory). insiders. Transparency issues in the EI sector are diverse and
For several years, global norms and standards have been relate to laws and regulations, policies, administration, rev-
emerging, but wide differences exist in the weight given to enues, expenditures, and other factors. While this list might
them by particular players and in their manner of imple- apply to all economic sectors, its coverage is especially sig-
mentation. Voluntary initiatives led primarily by civil soci- nificant in the EI sectors of states with heavy dependence on
ety or international agencies have forged ahead of mandatory EI revenues. Indeed, the International Monetary Fund
measures for many reasons. In the case of both types of (IMF) considered the differences to be so significant that, in
measures, questions that arise in the shaping of global 2007, it published a supplement to its Manual on Fiscal
norms and standards include the following (IMF 2007b): Transparency, setting out a more detailed set of guidelines
specific to the EI sector (IMF 2007c), and in May 2016 it
■ What is an appropriate level of contract disclosure? published a revised draft code for fiscal transparency in the
■ How can host-state and investor-state transparency natural resources sector. It adapts the entire code to the
requirements be balanced? needs of natural resource producing countries.
■ What is the best way to engage citizens more directly in pol- The sheer size of natural resource rents for many states,
icy formulation and monitoring processes and outcomes? combined with the technical complexity and the volatility of
the transaction flows, means that transparency issues are
especially important to the good governance of the EI sector
What does cross-cutting mean?
(see chapter 2 and chapter 3). For example, Nigeria, Africa’s
Transparency and accountability are cross-cutting topics largest oil producer, experienced financial discrepancies in
because they apply to all segments along the EI Value Chain. excess of US$8 billion between what companies reported
They call for the following: paying and what governments reported receiving between
2009 and 2011, due largely to missing payments resulting
■ Transparency around the decision to extract from incorrect fuel subsidy deductions.3 These discrepancies
■ Transparent and competitive procedures for issuing were revealed following Nigeria’s effort to strengthen the
licenses and allocating mineral or hydrocarbon explora- management of its EI sector projects across the EI Value
tion or production rights in the design of legal, contractual, Chain by implementing an EI sector-specific transparency
and policy frameworks initiative, the EITI,4 through its own Nigeria Extractive
■ Competent and noncorrupt institutions with clear and Industries Transparency Initiative (NEITI), which was made
nonoverlapping mandates in the regulation and moni- law in 2007 by the National Assembly.5 NEITI focuses on
toring of operations promoting due process and transparency to remediate defi-
■ Publicly reported fiscal regimes that avoid nonpublished ciencies revealed by EI sector audits. These efforts include
special deals and minimize tax avoidance and evasion in continuing comprehensive audits of the EI sector, developing
the collection of taxes a revenue-flow interface among government agencies,
■ Transparent revenue management improving oil and gas metering infrastructure, developing a
■ Transparent and participatory budgeting based on develop- uniform approach to cost determination, building capacity
ment priorities across Nigeria’s regulatory agencies and civil society, and
improving overall governance of its EI sector.6 Nigeria was
If there is a lack of transparency at any point in the EI Value certified as EITI compliant in March 2011, demonstrating a
Chain, a spread of misinformation may result, sowing mis- successful move toward stronger, more transparent gover-
trust in the management of the resources. In turn, this can nance of its EI sector despite the unique challenges presented
lead to instability and, ultimately, to conflict. These topics by EI projects.7 However, the recent revelations about miss-
are, therefore, dealt with in the individual chapters on the EI ing payments confirm that local EITI legislation alone will
Value Chain as well as in the following material. not result in the benefits of transparency. The Nigerian
Finance
Democracy
Lenders and credit rating agencies have a strong interest in
Transparency plays a key role in building more stable and transparency, and serious government commitments to
accountable institutions to counter the poor governance transparency can improve access to both commercial and
that characterizes most autocratic regimes. If the EI Value concessional finance (World Bank 2009, 2). Research by the
Chain is properly husbanded, EI projects have the opportu- IMF and others has found a significant positive correlation
nity to facilitate the transition to democracy (Ross 2012). between transparency and credit ratings (Glennerster and
The transparency of government actions and rights of citi- Shin 2008).
zens to access information is generally seen as fundamental
to the functioning of a democratic society. The essence of
8.4 CHALLENGES AND SPECIAL ISSUES
representative democracy is informed consent, which
requires that information about government policies and The major challenge to progress on transparency comes from
practices be disclosed. Informed democratic debate can, entrenched interests—those with a significant stake in avoid-
among other things, help determine priorities in the alloca- ance of transparency to advance their personal or political
tion and expenditure of resource revenues. agendas. The low scores of resource-rich developing states in
transparency assessments suggest the seriousness of this chal-
lenge: on one measure, only 11 out of 58 resource-abundant
Human rights
countries have satisfactory standards of transparency and
Access to information may be a fundamental human right accountability (Westenberg and George-Wagner 2015). In
in itself, but is also a core principle necessary for the realiza- addition to the obstacle of entrenched interests, a number of
tion of many other human rights, such as political and civil special, more technical issues have arisen relating to the
rights (for instance, freedom of speech) and social and eco- implementation of transparency. A number of examples that
nomic rights (for instance, the right to an adequate educa- relate primarily to resource revenue transparency follow.
tion). The right of access to information is the focus of at
least one international convention, the 1998 Aarhus
Mandatory versus voluntary
Convention on Access to Information, Public Participation
in Decision-making and Access to Justice in Environmental Admittedly, information disclosure, a key benefit of transpar-
Matters, but it is also recognized in a multitude of other ency, is complicated by the various standards of mandatory or
international agreements including, but not limited to, the voluntary disclosure.12 The various principles put forward by
1992 Rio Declaration on Environment and Development, the IFC, the IMF, and others are primary examples of volun-
principle 10, and the 2007 International Convention for the tary information disclosure standards except on the occasion
Protection of All Persons from Enforced Disappearance, that they are integrated specifically in a contract. This is also
article 12. Each of these instruments has resonance in EI the approach adopted by the EITI (see section 8.5). Critics
sector projects. Where this right is missing or not enforced, object that this approach lets the most recalcitrant country
as is the case in many developing countries, the resource performers off the hook (although the EITI showed its teeth by
curse beleaguers EI development across the value chain suspending four countries in early 2017 for noncompliance)
(Wenar 2008, 21 et seq.). and instead advocate mandatory transparency on the part of
In 2013, the American Petroleum Institute (API) section 1504. In a summary judgment, the District
filed a civil action against the U.S. Securities and Court of Washington, DC, vacated the initial
Exchange Commission (SEC) challenging its rule disclosure rule promulgated by the SEC, holding that
implementing section 1504 of the Dodd-Frank Wall the SEC rule would harm investors due to the
Street Reform and Consumer Protection Act. The “fundamentally miscalculated” lack of discretion in
API is an association of EI sector actors, including the rule’s current form. The SEC proposed a new rule
BP, Chevron, ExxonMobil, and Shell, among many in December 2015, which was subsequently struck
others. A primary argument advanced by API was down by the U.S. Congress. It is important to note
that some information required under the new that there is no unified corporate position on this
reporting procedures should be confidential and that matter in the oil, gas, or mining industries, with a
the SEC should have greater discretion as to what number of companies (BHP Billiton, Rio Tinto,
entered the public domain. The argument reflected Statoil and Tullow, for example) providing detailed
comments made during legislative debate on disclosures for some time.
engagement can succeed only if government and companies operational and marketing decisions are likely to be more
are willing to facilitate civil society participation. difficult for civil society to engage with.
Where companies and governments do encourage civil
society participation, effective engagement will also need
International financial institution conditionality
civil society to be objective and constructive and to have
realistic expectations about outcomes. Issues regarding the Often it is suggested that loans or support from interna-
minimization of negative local community impacts from tional financial institutions (IFIs) like the World Bank or
mining operations may improve rapidly from civil society IMF be conditioned on credible government commitments
engagement; issues relating to a mining company’s to transparency programs such as the EITI. The IFIs have
s
its natural resources.
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NATURAL
RESOURCES PUBLIC
BENEFIT
VALUE CHAIN
1. Effective oversight by the multistakeholder group 5. A credible assurance process applying international
2. Timely publication of EITI reports standards
3. EITI reports that include contextual information 6. EITI reports that are comprehensible, actively pro-
about the extractive industries moted, publicly accessible, and contribute to public
4. The production of comprehensive EITI reports that debate
include full government disclosure of extractive indus- 7. A multistakeholder group that takes steps to act on
try revenues and disclosure of all material payments to lessons learned and reviews the outcomes and
government by oil, gas, and mining companies impact of EITI implementation
improving technical aspects of the EITI reporting process, on these recommendations and highlight the potential and
such as reporting templates or data collection for EITI importance of considering EITI recommendations in the
reports, rather than improving extractive sector governance. countries that have not yet done so.
Failure to implement recommendations has too often con- The EITI was essential in turning around EI sector
tributed to lost opportunities for impact and reform. administration in Nigeria. Other countries such as Ghana,
There is increasing documentation on how EITI report- Liberia, and Norway have also achieved EITI compliance,
ing has highlighted shortcomings in government systems and there are many candidate countries working toward
and recommended actions for improvements (EITI 2016b). satisfying the EITI Standard. EITI reports from the recently
The stories illustrate the impact in countries that have acted confirmed EITI-compliant Peru show that since the country
Supply chain due diligence has the potential to do more Several initiatives have explored the prospect of
than remove illicit material from supply chains. As in certification as a tool for stimulating sustainable devel-
other commodities, “ethical trade” in the EIs can help opment in ASM communities—using procurement
protect the rights of artisanal and small-scale mining from artisanal miners that agree to adopt some basic
(ASM) communities and ensure they get a fair return for standards as a tool for retailers to assure consumers of
their labor. It can also influence the standards of the provenance of their products and, of course, to
environmental, health, and social performance in these establish a market niche.
communities and the welfare of the people working at One of the leaders in this field is the Alliance for
mine sites. It generally promotes sustainable development Responsible Mining (ARM). ARM focuses on fair trade
and acts to counter the poverty and vulnerability of the standards that provide a market niche for small-scale
miners. Ethically based certification assures buyers that producers and develops standards following the ISEAL
minerals are mined, processed, and traded in ways that do Code of Good Practice for standard formulation.
not compromise defined ethical standards. The terms ARM has partnered with the Fairtrade Labeling
attached to such schemes illuminate their focus: fair trade, Organization—FLO—in developing and field testing
ethical, green, sustainable, development, responsible, of a Fairtrade and Fairmined standard for gold from
origin, fair mined and fair made, and so forth. artisanal and small-scale mining.
The private sector has also undertaken initiatives to The iTSCi system supports companies wishing to
protect specific commodities. Chief among these are maintain trade with responsible supply chain actors in
the International Tin Research Institute’s iTSCi the Democratic Republic of Congo and adjoining
(International Tin Supply Chain Initiative) and the countries. iTSCi has three components: chain of cus-
World Gold Council’s Conflict Free Gold Standard. tody data collection (traceability), risk assessment, and
iTSCi is a joint initiative of traceability and due independent third party audits.
diligence for cassiterite from Central Africa that assists More recently the World Gold Council engaged
upstream companies (from mine to the smelter) to in an extensive consultation exercise to develop a
institute the measures necessary to conform to the Conflict-Free Gold Standard, an industry-led approach
OECD’s Due Diligence Guidance. Its focus includes to combat the potential misuse of mined gold to fund
small and medium-size enterprises, cooperatives, and armed conflicts. The intention is to promote respon-
artisanal mine sites. It is designed for use by industry sible mining practices throughout the gold-mining
but with oversight and defined roles for government industry and to protect the (large-scale) legitimate
officials in keeping with the OECD Due Diligence suppliers in conjunction with other schemes, such as
Guidance. It also takes into account the recommenda- the Kimberly Process. The idea is that gold produced in
tions of the UN Security Council to expand due conformance with the Conflict-Free Gold Standard
diligence to include criminal networks as well as would provide confidence that it has been extracted in
armed groups and to include violations of the asset a way that does not cause, support or benefit unlawful
freezes and travel bans on sanctioned individuals and armed conflict or contribute to serious human rights
entities. abuses or breaches of international humanitarian law.
and the ILO Convention 169: the Indigenous and Tribal IFIs
Peoples Convention.
International financial institutions have taken a growing
interest in governance issues in recent years. The Equator
Principles framework,29 a credit risk management frame-
Donors
work for determining, assessing, and managing risk in proj-
Donors, too, have taken specific actions. An example is the ect finance, is based on the IFC Performance Standards and
Policy and Performance Standards on Social and hence includes some transparency requirements for Equator
Environmental Sustainability (IFC 2011), introduced in Principle Financial Institutions,30 although the principles
2006 by the IFC with updated standards coming into effect focus primarily on after-the-contract issues such as com-
in 2012. The standards apply to all investment projects, munity engagement and consultation and government-
including those in the EI sector. The aim is to minimize the mandated reporting rather than licensing procedure or
impact on the environment and affected communities. The contract disclosure. The Equator Principles have now been
standards have been extended to cover more governance adopted by 79 financial institutions in 31 countries and, de
issues, such as transparency requirements, and include facto, have become an industry standard.
phased-in requirements for disclosure of EI contracts. There is significant scope for cooperation and learning
Several states are progressing toward contract transparency from related programs that have a wider or a different focus
by mandating that contracts be publicly available, as in than on the EIs. Several initiatives that focus on better gover-
Niger, where the new constitution requires publication of nance of natural resources focus on forestry, for example, and
all EI contracts in the official gazette (Heller 2011).27 face similar challenges to the EI sector. Sharing learning experi-
Another example is the IMF (2007a) Code of Good Practices ences across the natural resource sectors is undoubtedly bene-
on Fiscal Transparency. This sets out robust requirements ficial. Moreover, there is also potential to learn from broader
for all member governments to inform the public about the anticorruption or good governance initiatives. An example of
use of public goods, which includes natural resources.28 that would be the efforts to strengthen procurement and
Chapter Title
Sustainable Development Implementation
9.1 KNOWLEDGE CORE meets the needs of the present without compromising the
ability of future generations to meet their own needs.” It is
Implementing sustainable development requires stakeholders
now often associated with the United Nations Sustainable
to take a big-picture approach to extractives investment. They
Development Goals, a set of 17 aspirational goals with
have to consider strategically the environmental and social as
targets set between them (United Nations 2015, 13).1 With
well as the economic aspects of development. The integrity of
their emphasis on water, gender, and climate change, the
ecosystems and areas rich in biodiversity need to be protected,
goals are relevant to many of the issues in this chapter, even
and the interests of poor, vulnerable, and marginalized com-
if they are couched in rather general terms.
munities need to be recognized in the planning of resource
The implementation of sustainable development (the pro-
development if it is to be truly sustainable. This cannot be left
cess of getting to the common goal of sustainability) is less
to project-planning stages, when investments are committed
well defined and more a series of optional tracks. There are
and plans are well advanced. That is the road to costly delays
various ways of contributing to sustainability, and the way
(even cancellations) caused by conflicts with authorities,
that exploitation of nonrenewable natural capital contributes
communities, and other members of civil society.
is known as nonrenewable natural capital conversion.
Although sustainable development means different things to Essentially, extractives-led investment is a transformation
different people, the generally accepted definition is from of one class of assets—finite, nonrenewable natural capital
the Brundtland Commission (1987, 41): “Development that in the form of oil, gas, or minerals—into financial, human,
239
social, manufactured, or other forms of capital. The capital result in net positive outcomes. These concepts are not easy
conversion in the extractives sector must contribute to the to convert into practical figures in the implementation of
creation of more sustainable opportunities and livelihoods truly sustainable extractives. Considerable research is under
if the sector is to have any legitimacy in the sustainable way into the metrics of these concepts to give them more
development agenda. The process should trigger the kind of practicality. Some stakeholders suggest that where there is
economic and social development that generates wider much doubt about the potential to achieve sustainability
effects and proves sustainable beyond the horizon set by the goals from an investment, the resource should be left in the
resources themselves. ground.
In this process the extractives companies can be seen as Managing the transformative effects of oil, gas, and min-
development partners, especially for countries where devel- ing development so that the balance remains a positive one
opment and poverty reduction are most urgent. During for the long term will benefit from an awareness of the lat-
the capital conversion process (mining, drilling, refining, est research and thinking about how to conduct extractive
smelting, and so forth), actions need to be managed in ways industry (EI) activity in a sustainable manner. This is an
that minimize negative environmental and social impacts and area that is rapidly evolving, with contributions from the
maximize benefits in these areas. If this does not happen, citi- private sector as well as civil society, international organiza-
zens will increasingly see extractives development as a tions, policy institutes, and government practice. For many
Faustian bargain in which the gains prove temporary and states, such thinking will be useful only when adapted to
unsustainable, and the long-term costs will impede the ability their unique country contexts, integrated into policies
of the environment to sustain ecological and human welfare. developed, and approved by the government concerned.
Sustainable development entails balancing and the inter-
play among social, economic, and environmental values.
Policies and rules
Often these values may seem to conflict with each other in
the short term. For example, industrial growth might con- In the EI Value Chain framework, the “Implementation of
flict with protecting renewable natural resources. However, sustainable development policies” chevron differs from
responsible use of oil, gas, and mineral resources now will the other four in at least two ways. First, elements of sus-
help ensure that there are resources available for human tainable development are woven throughout the chain,
well-being and sustained economic growth far into the especially in the first chevron. It does not simply follow on
future. This confronts decision makers with difficult chal- from the previous chevrons. Second, in certain areas such
lenges, often involving trade-offs. as environmental, health, and safety impacts, the notions
of “good practice,” which have been used throughout the
Sourcebook, and “good-fit practice” are insufficiently
Cross-cutting themes
demanding when one is designing a response to a specific
The challenges of sustainability arise at all stages of extrac- problem. They may have to be replaced by the more
tives operations, from the activities examined in the first demanding standard of “best practice,” although for
chevron of the EI Value Chain in chapter 4 of the Sourcebook health and safety there already should be no option but to
to those analyzed under the fourth chevron in chapter 7. pursue best available practice.
It is quite wrong and contrary to current good practice to
view sustainability policies as matters that can be left to a
Governance
later stage, once production is well under way. Policies need
to be thought through and designed at the very outset to For all countries, a strengthening of governance, institu-
address these challenges, and they need to be capable of tions, laws, and regulatory policies is critical if sustain-
evolving as development unfolds. able development policies are to be effective. How the
benefits are accrued, leveraged, and distributed requires
attention to management and oversight. Securing the
The role of research in sustainable development
consent of communities in this process requires the
Theoretically, the need is to ensure that extractives invest- establishment of mechanisms for consultation and
ments have, over their life, at least not a net loss to human cooperation. These challenges and their implications are
and environmental welfare. Further, they should aspire to examined in chapter 10.
“The Government shall, in consultation with the “Such third party access and use shall be at no cost to
Concessionaire, and on reasonable notice to the the Concessionaire and all related costs shall be borne by
Concessionaire, authorize third parties’ use of excess the third party.
capacity of the Railroad (including the portion of the “In the event that the Government believes that the
Railroad located within the Concession Area) and the Concessionaire is withholding third party access to
Port Facility, provided that the Concessionaire confirms the Railroad or the Port Facility in contravention of
that excess capacity exists and third party use of such this Agreement, the Government may request a review
excess capacity does not unreasonably interfere with the of the Concessionaire’s decision not to grant access.
efficient and economic conduct of the Operation. [empha- The review shall be heard by the Committee described
sis added] below.
“The technical and commercial terms for such third “There shall be constituted a Committee with five
party use of the excess capacity of the Railroad and the (5) members. Two (2) members of the Committee shall
Port Facility shall be mutually agreed to, in good faith, be appointed by the Government and two (2) members
among the Government, the Concessionaire and such shall be appointed by the Concessionaire. The final
third parties in accordance with applicable use and member shall be appointed jointly by the Government
International Standards, it being understood that third and the Concessionaire. The Committee shall hear and
parties shall be treated on a nondiscriminatory basis. A review all complaints regarding third party access to,
formula to proportionately share the revenue fees to be and third party modernization or expansion of, the
derived from such third party use of the Railroad shall be Railroad and shall forward its recommendations
agreed upon in good faith between the Government and together with an explanation of its rationale for such
Concessionaire. recommendations, to the Parties to this Agreement.”
■ Have operational control over rail network, not prevent the development of key projects
including access ■ Preserve possibility that marginal deposits can
Secondary
■ Have access to cash flow from third parties for: Third Parties’ Objectives
– Recovery of portion of capital cost ■ Have bankable access rights:
development, such as economic diversification, regional investment feasibility perspective, but taking into consider-
integration, increased trade, and improved livelihoods. ation socio-economic and environmental factors, as well as
On the negative side, however, such corridors have the the protection of critically important areas of high conser-
potential to open up areas to illegal trade in forest and wild- vation value in situ” (IRCI 2015, 2).
life products, create barriers to migration routes, and risk The idea behind this critique is that such corridors
introducing invasive, alien species that can act as carriers of require an integrated approach. For example, investment
diseases or replace indigenous species (Hobbs and Kumah and policy decisions should build in adaptation to pre-
2016). They also take years to develop, due to the phasing of dicted impacts of climate change and should be screened
extractives projects because they are not built in isolation for compatibility with a sustainability vision. From the very
but must compete for funding and interest with all other outset, a corridor project needs comprehensive baseline
forms of economic activity. Price volatility will impact on information that identifies the sensitive areas that need to
the extractive activities in the meantime. Initial experience be protected (Hobbs and Kumah 2016). They require
suggests the expected benefits are still far from being development coordinated among multiple branches of gov-
achieved.20 ernment, in conjunction with the private sector, communi-
One study has noted, “Concerns exist that to-date cor- ties, and civil society organizations. With this level of
ridors have not been properly planned by governments, that integration, a resource corridor project should be driven by
infrastructure investments have taken place with little or no best practices and should be able to protect the integrity of
strategic consideration to environmental degradation and the ecosystem.
climate change resilience, and that this will ultimately
reduce the positive economic and social development Shared Use. A strong determinant of resource corridor
impact of the corridors. For this to change, the corridors definition is the potential for shared use of infrastructure.
need to be planned not only from an infrastructure and There are two ideas at work in the notion of shared use.
A major oil spill occurred in 2010 in U.S. territory in The financial consequences of the spill are still being
the Gulf of Mexico and led to a loss of 53,000 barrels of managed. BP created a US$20 billion escrow account
oil a day for many weeks. The spill covered 6,500 on June 16, 2010, and the cost of response measures
square kilometers and involved 5 million barrels of oil. was at least US$8 billion.
The source, the Deepwater Horizon field, was operated There is no international legal framework in place
by BP under a joint operating agreement with Anadarko to deal with the question of liability arising from pol-
Petroleum and Mitsui Oil Corporation. The owner of lution following a blowout. In the past, international
the rig was Transocean and the cementing contractor law on environmental pollution has usually been
was Halliburton Oil Well Cementing Company. The concerned with oil pollution from tankers. As a result
blowout began on April 20, 2010, and the well was of this lacuna, it is left to national laws to deal with
capped on July 15, with well cementing completed by this matter. Such laws vary enormously, both in the
August 5, 2010. The resources required to remove over way that the law itself deals with it and with the way
800,000 barrels of oil liquid and 265,000 barrels by contractual indemnities are interpreted and enforced,
controlled burns comprised 28,400 personnel, more or not.
than 4,000 vessels, and dozens of aircraft.
Common issues
Social impacts
Community Relations. Given the high impact of extractives
Social impacts from the EIs vary according to the life cycle projects on the surrounding area, there have been instances
of the project. They can be positive as well as negative— when relations between investors and governments with
positives can include job creation, education and skills local communities have been fraught with tension. Without
development, fostering of urban and trade centers, and a so-called social license to operate, or the free and informed
investment in the improvement of local infrastructure and consent of the communities concerned, the risk is that the
services. The challenge is to ensure that these positive project will become hard and even impossible to run. Oil
impacts are sustainable. operations in the Niger Delta are an infamous example of
Box 9.5 Reframing the ASM Debate: Integrating It into the EI Value Chain
Shifts in policy articulations of artisanal and small-scale mineral legislation and policy starting in the late 1980s
mining (ASM) have generally corresponded to specific and into the mid- 1990s. This legislative reform focus
political and economic global periods. Pelon and Martel- was accompanied in several instances by technical
Jantin (quoted in De Sa, Perks, and La Porta 2013) pro- assistance, such as small grant programs or credit and
pose that since the postcolonial period, the position of loan schemes to establish more viable small-scale min-
ASM within mineral policy has transitioned from one ing operations. Furthermore, specific ASM government
of “isolation” to “integration.” Such a transition was departments or agencies, typically under the umbrella of
evidenced first by a firmer inclusion of ASM in national the ministry concerned with mining, were established or
further supported to provide advisory and technical minerals and conflict management between ASM and
services to artisanal and small-scale operators. large-scale operations were critically raised alongside
Such a mineral-development-centered approach concerns over child labor reduction and women’s
toward ASM further evolved in the late 1990s to one of socioeconomic disenfranchisement (Pelon and Martel-
poverty-alleviation and development. This approach Jantin quoted in De Sa, Perks, and La Porta 2013).
took advantage of the Millennium Development Goals Earlier concerns from the 1970s and 1980s, such as
framework. By aligning ASM more closely to the improving environmental standards, appropriate tech-
poverty-alleviation agenda, ASM support strategies nology, security of tenure, and access to finance
changed significantly. Nongovernmental organizations remained highlighted agenda items. It was also an era
and even large-scale mining companies became more in which the World Bank hosted a multidonor trust
critical agents of intervention, with reduced visibility of fund for ASM, called Communities and Small-Scale
government institutions. Issues such as fair trade Mining (CASM).
Job creation. The global employment gap has spurred mineral benefit distribution is equally an important
renewed discussions on how jobs are defined and question when concerned with ASM.
created. Of note in these discussions is evidence of the Renewed bilateral partnerships to assist national
predominance of the informal sector as a main arena for governments in ASM formalization. The work of the
employment at present. Artisanal and small-scale min- Communities and Small-Scale Mining (CASM) proj-
ing (ASM) participation has grown from 10 million in ect and its partners over the past decade helped to
1999 (ILO 1999) to potentially upward of 20 million to generate an increase in national government demand
30 million (Buxton 2013). This increase, largely still in for ASM technical assistance programs. Such assis-
informal employment, provides a rich policy ground for tance would entail capacity-building programs by
promoting a good job agenda. This agenda focuses on international financial institutions and bilateral part-
making available the necessary knowledge and techno- ners to address outstanding constraints facing ASM in
logical resources to increase productivity coupled with mineral development. For instance, seven countries
provision of social protection and fair labor standards. have specific ASM pillars in active World Bank proj-
Rural development. Linked to the job agenda is ects. The Africa Governance Initiative provides
ASM’s added value as part of rural livelihood diversifi- national governments with mining experts to build
cation strategies (Banchirigah and Hilson 2010; internal ministry capacity, including capacity to
Maconachie and Hilson 2011), meaning the manner in address ASM in such countries as Rwanda. The
which ASM is pursued alongside other income oppor- International Finance Corporation is extending its
tunities by individuals and families. Development business advisory service tools to include an ASM
research has demonstrated how ASM assists rural checklist for baseline studies for its investment part-
households in building more dynamic and resilient ners. In 2012 the Kimberley Process adopted the ASM
livelihood strategies portfolios by, for instance, dove- for Development framework, to be implemented by
tailing ASM and farming economies. It furthermore is its member states. The African Union recognized
a stimulus for trade and subsidiary business develop- ASM formalization as one of its six areas of engage-
ment around mine sites, similar to activity around ment under its 2011 Africa Mining Vision. Other
industrial or larger-scale mining operations. The ques- bilateral partners include GIZ, AusAid, and CIDA,
tion of links—how mining interplays with other who work not only with national governments but
aspects of local economies—and how to promote more equally with nongovernmental organizations and
integrated rural development strategies to capture regional governmental institutions.
Environmental assessment Screen early for impacts. Select instruments to assess, Affected groups and NGOs as early as
minimize, and mitigate adverse impacts. possible.
Natural habitats Provide no support to projects that degrade critical Consult local people in planning, designing,
habitats. Support projects that affect noncritical habitats and monitoring projects.
only if no alternatives are available and mitigation
measures are in place.
Indigenous peoples Ascertain presence of indigenous peoples. Design Conduct informed prior consultation and
policies based on expected impact and reflective of obtain broad community support.
indigenous peoples’ cultural preferences.
Involuntary resettlement Avoid where feasible. Assist those displaced in improving Resettlers and expected host community;
or restoring their living standards. Displaced persons incorporate views in resettlement plans.
should share in project benefits.
Disputed areas Ensure that claimants to disputed area have no objection. No public consultation; claimants informed.
Compliance standards Standards are most effective when they are achievable
and set in line with good international practice. If they are
Many countries set compliance standards for environmen-
unrealistically strict, the risk is that they will become mean-
tal impacts. International institutions also set these for
ingless given the institutional capacity limitations of most
environment and social aspects of projects.34 In addition to
developing countries. Equally, if they are too lax, good
the World Bank’s safeguard policies, directed at the identi-
enforcement will not accomplish very much. Indeed, it is
fication and mitigation of potentially adverse environmen-
the lack of effective enforcement that is the key issue in ESIA
tal and social consequences of projects supported by the
regulation. The best results are achieved when compliance
bank, the IFC has a set of policy and performance stan-
standards are well set and the capacity to implement them
dards on social and environmental sustainability. These
is put in place.
have become the global benchmark for managing environ-
mental and social risk by financial institutions. There has
also been uptake of these standards by private banks
Human rights frameworks
through the Equator Principles, a risk management frame-
work for determining, assessing and managing environ- Protection of human rights has become an important mat-
mental and social risk in projects.35 Its aim is to provide a ter for international legal frameworks,36 both in the sense of
minimum standard for due diligence to support responsi- hard legal rules such as the International Covenant on Civil
ble risk decision making. Further, there is a series of and Political Rights, the International Covenant on
International Standards Organization (ISO) standards on Economic, Social and Cultural Rights, and International
environmental management, including the highly influen- Labour Organisation conventions. More recently, standards
tial standard ISO 14001 Environmental Management have been developed that are expressly targeted at the con-
Systems. These standards have been widely adopted by duct of business by extractives companies. The most impor-
national standards organizations. Although voluntary, tant such event in recent years is the development and
they are a condition for obtaining IFC funding and can adoption of the United Nations Protect, Respect and
serve as a reference point for the definition of good prac- Remedy Framework (the Framework) in 2008, which seeks
tice in oil, gas, and mining activities (Wagner and to provide principles to guide states and businesses in pro-
Armstrong 2010). tecting and respecting human rights.37
Access to suitable deposits and security of tenure: system have proven to be a suitable starting point for
Whereas small-holder farmers can gain recognized providing Rwanda mining cooperatives with entry
communal rights to land, small-scale miners must level capital that could serve as a replication model
conform to the same principle established for indus- elsewhere (Perks 2012).
trial mining operations. This principle, often enshrined Environmental, social, and labor standards: The
in national law, confers sole ownership rights to the lack of enforced standards in most ASM areas remains
state of all mineral endowments found within its given one of the subsector’s largest and most critical areas of
territory. The state then has the right to lease prospec- criticism. Despite efforts by international agencies
tive mining areas to third parties capable of extracting such as the International Labour Organisation or the
these resources. Given the potential contribution such World Bank to develop mine site standards, few coun-
endowments can make to national development— tries have sufficient mechanisms in place to enforce
whether through export earnings, taxes, or, to a and monitor adherence. ASM marginalization explains
lesser extent, employment and subsidiary business further the lack of appropriate incentives and capacity
development—it is natural that the state would wish to mine in a more environmentally and socially sensi-
to control extractive activities. However, it can lead to tive manner. Without effective formalization of the
a situation in which permit areas are prioritized for sector, adhering to industry standards remains eco-
industrial mining. The effect of this is to leave arti- nomically unattractive for many operators.
sanal and small-scale miners with few suitable areas to Market links: The International Institute for
work, forcing encroachment onto industrial conces- Environment and Development estimates that 15–20
sions, or worse, into protected areas such as national percent of global minerals and metals derive from
parks and reserves. When artisanal zones or areas are ASM (Buxton 2013, 3). Although globalization of
established, they often are an afterthought and prove mining processes is not new, it has led to new sourc-
to have few valuable resources suitable for small-scale ing of raw materials in resource-rich but also more
development. isolated areas of Sub-Saharan Africa, Latin and South
Enforcement of mining codes and legislation: America, and Southeast Asia. This more pronounced
While governments have made significant strides in penetration of mineral buyers and small investors
integrating ASM into legal instruments such as min- into isolated regions of the world gives rise to further
ing codes and legislation, there is still abundant work concerns over how ASM is affected by these markets
needed to enforce these instruments and to make demands and how it accordingly responds. Piloted
people aware of the rights and opportunities con- efforts to model clean supply chains, or fair trade
ferred on them by legislation. Furthermore, there minerals, are reemerging as a means to diffuse the
is continued need to strengthen the government insti- principle of responsibility across the supply chain—
tutions responsible for promoting ASM through companies, manufacturers, smelters, buyers and
capacity-building programs. traders, and national governments. It is yet to be seen,
Adequate market conditions: There is a critical however, whether such initiatives will be capable of
gap that leads to the undercapitalization of mineral driving deep structural change needed to the sector,
assets. In the absence of robust financing options, as noted in the formalization framework.
many ASM operations rely on prefinancing arrange- Natural resource management and biodiversity:
ments with buyers, which have both benefits and The global rise in specific mineral prices, such as gold,
disadvantages. has precipitated recent pockets of mining rushes
Access to finance: Whether access is through small worldwide. Some of these environments include previ-
revolving loan facilities, self-savings groups, local ously untouched places that are ecologically sensitive,
banks, local finance markets, or mining federations, including protected areas and critical ecosystems such
this remains a significant policy challenge, requiring a as arctic landscapes (Greenland), tropical rainforests
much more robust and coordinated effort with other (Brazil and Gabon), and coral reefs (the Philippines).
national ministries and the private sector to widen Environmental impacts of mining methods—such as
options. Lessons from Rwanda’s village banking clear-cutting forests, river dredging, or use of toxic
chemicals—are compounded by livelihood practices ban mercury use in countries presents a renewed
that support mining populations—gathering firewood, opportunity to tackle its use in ASM. However, the
hunting for food, or trading goods. Furthermore, on a environmental agenda surrounding ASM must be
global scale, artisanal and small-scale forms of gold integrated into broader governance discussions, as
production remain the biggest environmental chal- often environmental degradation caused by ASM
lenge due to mercury use. The Minamata Convention occurs within a vacuum of government regulation and
on Mercury 2013 to further limit and in some cases presence.
If well designed, a regime will provide for the following: ■ The establishment of financial assurance mecha-
nisms needed to ensure that sufficient funds are
■ Coverage of both the mineral or hydrocarbon in place for plant removal and disposal and land
operation and all related infrastructure reclamation and rehabilitation at the time of closure
■ Environmental permits that cover key impacts such and decommissioning—they should also require
as water use and waste water discharge quality, waste that reclamation and restoration be built into the
storage and disposal, atmospheric emissions, and noise production plan to take place on a progressive basis,
■ Community hearings open to the public where all in which case there is less to do during closure and
data collection, impact assessments, and manage- decommissioning
ment plans are presented as part of the approval ■ Penalties that are clearly stipulated for violations of
process—final, approved documents should be pro- requirements and compliance standards, and com-
vided to communities pensation set out for harmed parties where needed,
■ Participatory community monitoring that can help all of which should be commensurate with the seri-
reduce community concerns ousness of the violation
■ Identification of assets for handover at an early ■ Environmental audits and surveys of any legacy
stage and setting up of arrangements for them to be issues from past operations as well as identification
jointly operated and maintained by the community of environmental risks and action priorities and
agency or organization that will receive them mobilization of any funding required
technology can be stimulated to produce energy solutions Oil and gas. In the field of petroleum sector governance,
using local renewable energy sources. a distinct initiative should be mentioned. Given the impres-
In this context, companies have an interest in drawing sive track record and global influence of the Norwegian
on industry good practice standards and generally becom- approach to resource governance, it is perhaps unsurpris-
ing proactive; this includes working with communities to ing that the Government of Norway should have supported
build the skills necessary for resource employment and the a Petroleum Governance Initiative (PGI) with the World
provision of goods and services. At the same time, compa- Bank. Based on three pillars (transparency and revenue
nies are able to draw on the growing body of standards and management, environmental sustainability and community
soft-law mechanisms that require a voluntary response development). It provides support to countries undertak-
from the players for compliance. A summary of the essen- ing oil and gas activities by assisting in the implementation
tials of a good environmental protection regime is con- of appropriate governance frameworks. Environmental
tained in box 9.9. implications are considerable: organizing support for
There are a number of special social risks and benefit- 7. Fully protect citizen populations by law, but even
sharing opportunities that require very close attention. in countries where this is not applicable, companies
These require tripartite engagement among the inves- should respect the rights and culture of indigenous
tor, the government, and the community—not just the peoples and only undertake exploration or mining
community leaders and elite but representatives of the activity only if they have well-documented evidence
most vulnerable groups, such as women and youth. that their activities have the broad consent of all
Well-designed social mitigation measures will do concerned peoples
the following: 8. Ensure that petroleum and mineral operations offer
real economic development opportunities
1. Include the identification of established legal and
customary community residents and users and their Well-designed benefit-sharing arrangements will
assets, crops, and livelihoods at the earliest stage include the following activities:
practical so that they can be identified separately
from any newcomers who might arrive as news of a 1. Developing a shared understanding among the
potential development spreads government, the company, and the community
2. Specify mandatory requirements related to mitigating of how benefits can be increased, improved, and
social risks such as community notification, informa- shared and including related commitments in
tion dissemination, and community consultation the development agreement among the three
3. Ensure that any involuntary resettlement takes parties
place according to applicable laws, guidelines, and 2. Preparing and implementing community economic
agreements in an acceptable manner to those being development plans supported by job-skills training
resettled, with acceptable forms of replacement or programs, microfinance schemes, and agreements
compensation for lost land, dwellings, crops, and with the company regarding community programs,
livelihoods local employment, local procurement, and sourcing
4. Require the preparation of in-migration manage- of goods and services—all linked to the community
ment plans and management plans for any commu- economic development plan
nity-related health and safety impacts and for site 3. Building the local capacity (government and com-
security arrangements munity) to both plan and effectively implement EI
5. Ensure that social audits take place if required sector projects with good accountability in order to
6. Undertake initiatives to reduce the dependency avoid elite capture of the benefits
of the community on the mineral or petroleum 4. Identifying opportunities for growth through
operation to avoid the community collapsing when resource clusters and or resource growth corridors,
production ceases (including developing economic where mineral and petroleum development can
activities that will survive cessation) contribute to broader regional growth
4. Adequate mitigation of potential impacts that may companies have chosen to follow IFC PS7 explicitly, while
adversely affect local living conditions, including land others have adopted their own specific policies and stan-
reclamation, environmental protection, safety, and crime dards and others still have approached the issue by means
of implementing broader human rights and community
Another social consideration that should be taken into relations policies (IPIECA 2011b). The mining industry
account is EI development’s impacts on salaries and taxes. has had extensive experience in this area. Its association,
ICMM, adopted the “Position Statement on Mining and
Indigenous peoples. The leading guidance in this area is Indigenous Peoples” in 2008, updated it in 2013, and subse-
IFC Performance Standard 7 on Indigenous Peoples (PS7), quently launched a Good Practice Guide: Indigenous Peoples
as updated in 2012 (IFC 2012b). It applies to any private and Mining to support its members in implementing the
sector project that seeks IFC financing. Some oil and gas underlying vision and particular commitments set out in
Community participation in addressing social and A well-designed consultation and consent regime will
environmental impacts and concerns has been main- do the following:
streamed to all aspects of EI sector management,
impact assessment, and mitigation plans. Community 1. Specify regulatory requirements for a high degree of
and institutional capacity to enforce good practice are information disclosure and dissemination, notifica-
critical to success. tion, and consultation at the local level prior to
EI sector projects can have significant environmen- decision-making points—for example, starting at the
tal and social impacts that need to be identified, moni- exploration stage and continuing through project life
tored, managed, and mitigated. A regulatory and or 2. Ensure very close collaboration and cooperation
audited oversight approach is often needed. between the environmental and social authorities
However, in countries with a large EI sector and and EI sector ministries and agencies in view of the
effective capacity, an approach placing more responsi- nature of the risks involved
bility on operators (those with a good track record 3. Require full EIAs and SIAs or combined ESIAs includ-
working within agreed codes of conduct) may be ing baseline assessments and associated ESMPs) to
equally effective and more practical. The key is to have be prepared for all commercial-scale investments
an outcome-oriented approach to reducing and man- and submitted for verification and approval
aging risks while maximizing development benefits. 4. Include separate consultations with women, youth,
A well-designed environmental and social regime will and other potentially vulnerable and disadvantaged
do the following: groups and rather than limiting consultation to just
the local male leaders and elite
1. Have environmental standards and compliance 5. Require that information be provided to local
criteria that are in line with good international groups in a form that is readily accessible and
practice, including the environmental and social understandable
requirements of international finance institutions, 6. Encourage company officials to develop trust-
particularly the IFC performance standards building relationships with leaders of a broad range
2. Give particular attention to monitoring and report- of local community groups, to include effective
ing arrangements, including public reporting of, grievance mechanisms
and government verification of, company-reported 7. Give due consideration to cross-border and/or
environmental and social data regional and global environmental protection issues
8. Provide direct support, and encourage others (such
Given that most of EI development impacts take place as donors) to provide support, to communities for
at the local level, a second key principle is that develop- capacity building so that communities can respond
ment should have broad-based community support effectively in an informed manner to information
and prior informed consent of the local population. received from companies
the position statement (ICMM 2013, 2015). This compre- Land acquisition and resettlement. Resettlement or land
hensive guide highlights good practice principles and pro- displacement tends to be influenced by expectations about
vides examples of how mining companies have addressed consultation with the affected communities and support for
particular challenges. resettled people. International companies now subscribe to
In addition to corporate policies there are reporting the IFC’s Performance Standard 5 on Land Acquisition and
guidelines for companies such as the Global Reporting Involuntary Resettlement (IFC 2012a), which sets out an
Initiative,54 which has reporting requirements for compa- express framework for consultation, planning, implemen-
nies that operate in areas where there are indigenous peo- tation, and monitoring of resettlement, including income
ples. Companies with express recognition of policies and restoration. There may be international rules or standards
initiatives to respect and promote the rights of indigenous that are relevant to resettlement of peoples that governments
peoples include BHP Billiton, Newmont, Rio Tinto, and have to take note of. Individual companies may well develop
Xstrata. tools, polices, and standards within their suite of global
Chapter
Why Title
Governance Matters
10.1 KNOWLEDGE CORE The second idea in the Sourcebook is that every country
not only is sovereign but also has a unique combination of
Through the chapters of the Sourcebook, two ideas have
circumstances with respect to oil, gas, and mining activity
recurred, sometimes implicitly and sometimes explicitly.
and potential, and that governance will ultimately be shaped
The first is that without good governance many, perhaps
by this national constellation of factors. It includes demog-
most of the benefits of extractive resource development are
raphy, geology and resource abundance, policy choices,
unlikely to be gained. Governance is about procedural
the legacy of previous extractive activity, local capacity, the
matters, like decision making and communication pro-
level of industrial development, and links to international
cesses; capacity measures, such as sector organization,
organizations such as the Organization of the Petroleum
resources, and the degree of professionalization; and
Exporting Countries (better known as OPEC) and the
objective-setting and rule-making. The quality of govern-
World Trade Organization. The legal framework and the
ment is critical for making sound decisions in the extrac-
political system are other, critically important factors.
tives sector. However, the Sourcebook approach has been to
Even among countries that are neighbors, or in many
treat governance “as a government’s ability to make and
respects similar, this rich tapestry of governance drivers
enforce rules, and to deliver services, regardless of whether
ensures that what constitutes good governance in one
that government is democratic or not” (Fukuyama 2013).
country may be quite inadequate for another. Moreover, it
In this sense, its approach could be described as infrastruc-
will evolve over time, sometimes in unexpected ways. In
tural or technocratic, in contrast to those approaches
the world of oil, gas, and mining activity, the integrity of
to governance that have a more political orientation
national choice has long been sanctioned by the doctrine
(for example, Barma et al. 2012).
291
that every country enjoys permanent sovereignty over its never be complete and can at best be a contribution to a
natural resources in international law. rapidly evolving and complex subject matter.
Generalizing about the quality of government is still pos-
sible despite this diversity. Since governance issues arise at
10.2 WHAT IS GOVERNANCE?
each stage of the Extractive Industry (EI) Value Chain, there
is a vast pool of common experience on which governments Key elements in any definition of governance of the oil, gas,
can draw in a comparative way as a source of good practice. and mining industries include the following:
It could assist in answering questions about how to make Appropriate and adequate content of rules. What are the
rules of law more effective, how to make decision making basic rules that guide activities in a society? These would
more inclusive, how to make political arrangements more include development policies as well as the laws and regula-
stable, how to make fiscal regimes more predictable, and tions that are adequate in coverage and appropriate in detail
how to make bureaucracies more efficient. In any of these to manage the demands of a given society or community.
enquiries it will be found that where transparency and Effective implementation, monitoring, and enforcement of
accountability are given a high priority the outcomes are rules. How does a country ensure that actors, both within
usually beneficial. These are important indicators of good and outside government, have the capabilities, resources,
governance. Once they are in place in a country, the chances and information to effectively implement, monitor, and
improve for achieving the desired outcomes: poverty reduc- enforce policies, laws, and regulations?
tion, a more equitable distribution of benefits, better pro- Accountability of actors making the rules. Who determines
tection of rights, greater retention of value, protection of the the rules and how is this authority conferred and employed?
environment, and a strong economy. With bad governance, Governance arrangements must allow stakeholders to hold
such improvements are highly unlikely. decision makers accountable for their conduct, the rules
For oil, gas, and mining activities, it seems that the qual- they make, and how these rules are implemented.
ity of governance is particularly important. These activities In sum, these elements suggest that good governance
raise particular challenges to governance that are perhaps requires getting the rules right and getting the implementa-
less prominent, less frequent, or less intense in other indus- tion right by means of a process with legitimacy. These ele-
tries. In other words, they need specific attention and are ments are critical if the benefits of private sector investment
not well addressed by business as usual. Second, the number in the development of publicly owned resources are to be
and variety of countries engaged in extractive resource fully realized by all the parties involved in oil, gas, and min-
development has grown so that the need for knowledge of ing development.
good governance within the EI Value Chain is greater than
ever. Bodies such as the Natural Resource Governance
10.3 WHY DO OIL, GAS, AND MINING GENERATE
Institute, using a dedicated tool or Index, argue that there is
SPECIFIC CHALLENGES?
a deficit of good governance in oil, gas, and mining in many
countries around the world (NRGI 2016). The challenges lie in two areas: the particulars of oil, gas,
In the following short sections, issues relevant to gover- and mining investments and the movement of investors in
nance challenges are examined and recommendations these industries into new countries and regions. Typically,
given about actions that could lead to improvements in the features of such investment that create difficulties in
governance in the extractives sector. It should be noted that governance are the following:
the Sourcebook’s approach to governance is broader in
scope than some other initiatives, such as the Extractive ■ Their “enclave” character can limit the width of their
Industries Transparency Initiative, which focuses largely impact but at the same time create an intense local foot-
on revenues; the United Nations Guiding Principles, which print, particularly when the activity is on land rather
concern human rights; or the International Monetary than offshore. The investors tend to be weakly integrated
Fund’s Code of Good Practices on Fiscal Transparency, into the domestic economy and not covered by the host
which is concerned with fiscal processes. These have been country’s mechanisms for checks and balances.
discussed in the Sourcebook chapters, as have many other ■ The high rents that these investments generate bring
initiatives taken by companies, associations, and civil soci- temptations with them. This allows key officials to
ety groups. The Sourcebook approach has aimed at compre- extract illegal payments from companies and for compa-
hensiveness, but it is acknowledged that any such effort will nies to bribe officials to obtain privileges. The agencies
Environmental protection and closure issues are com- petroleum investments, with a strong presence on
mon to many countries, and good regulatory frameworks the ground at EI sector operations and in nearby
are generally available. Thus, the fundamental issue is not communities.
so much the design of environmental legislation and 2. Ensuring that the institutional arrangements and
regulation, but more the capacity of the environmental capacity are in place so that any serious environ-
agency to monitor and enforce the laws and regulations. mental or community incidents can be controlled
Without adequate enforcement capacity, even the rapidly and investigated thoroughly with results
best-designed regulations will be largely ineffective. disseminated to communities and actions taken to
With good capacity, even general environmental pro- prevent any reoccurrence.
tection requirements can result in significant reduction 3. Developing strong coordination and collaboration
of environmental hazards and risks. between the environmental and social authori-
A key principle is that institutional strengthening of ties and the EI sector authorities in reviewing and
the environmental authority is generally the most crucial approving
issue for countries with large mineral or petroleum proj- a. environmental and social impact assessments,
ects. Social issues involve both mitigation of risks and b. environmental and social management and
enhancement of local benefits, such as local monitoring plans, and
procurement. c. environmental and social monitoring arrange-
A second key principle is that social issues are best ments and results, especially for states with
addressed by a social ministry, because social issues are limited environmental and social capacity, and
less amenable than environmental impacts to scientific with staff with only limited experience or little
measurement and compliance criteria. They require knowledge of minerals and petroleum projects
different skills sets from environmental issues. and their impacts.
A ministry for women can also be very effective in 4. Supporting and facilitating civil society partici-
addressing social issues. In many developing countries, pation in environmental and social monitoring,
women are often more aware of both social risks and which can lead to many more positive environ-
opportunities. mental and social impacts if mandatory processes
Building strong and sufficient government capacity ensure that all stakeholders and interested parties
for environmental and social issues involves the have unrestricted access to environmental and
following: social performance data and to key documents
(such as environmental and social impact assess-
1. Having the necessary budget, employment condi- ments and environmental and social management
tions, and capabilities to hire and retain sufficient plans that specify compliance criteria and the
well-qualified and experienced staff to address the obligations and commitments of the investors and
environmental and social impacts of mineral and operators).
contribute to the process, playing different but comple- drafting legislation as enforcing, and managing these.
mentary roles: Consultation with each group affected by its actions will
increase the likelihood of their acceptance and sustain-
1. Parliament. Ideally responsive to, and representative of, the ability. Investor home-country governments can also
differing strands of public opinion, parliaments or legisla- play an important role in promoting or enforcing good
tures can play a unique role in identifying consensus poli- governance practice on the part of their companies.
cies and legislation. They should be consulted on all key 3. Industry. Beyond the investment and commercial opera-
issues, but at the same time expected to participate through tions roles, oil, gas, and mining sector industries should
the legislative and parliamentary oversight processes. be reaching out to the societal groups their operations
2. The Executive. The executive arm of a resource-rich gov- most affect, with consultations and informational pro-
ernment has a central role—in preparing policies and grams on their plans and performance. They should