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Bargaining Power Balance between the Host States and the IOCs

Bargaining Power Balance between the Host States and the IOCs

The discovery of the much coveted natural resources such as oil for most countries
ignites extremely high national and personal dreams of riches and hopes of prosperous times.
This is escalated by the recent dramatic increases in the prices of oil. However, the process of
exploiting such prestigious resource is not without challenges to the host countries, most of
which are developing (Rassel, 2012, p. 797). The challenges mostly involve overcoming
commercial, legal, technical, and expertise requirements required in exploration and

Bargaining Power Balance 2
development (Guzman, 2010, p. 171). The key hurdles centre mostly on management issues
leading to the need to invite international companies with expertise and resources to help in the
exploitation and marketing of the energy resource. The major concern arises once the host
countries find that the international oil companies (IOC) often possess superior financial
resources, superior knowledge of the oil, and even more contract negotiating experience than
them (Rassel, 2012, p. 797). For instance, some companies such as Exxon Mobil have more
resources ($371 billion) than most of the countries they operate like Saudi Arabia whose entire
GDP is $ 281 billion (Peacock, 2010, p. 131). As such, negotiation and maintaining of the
contracts can be a heated affair.

Bargaining power is the relative ability of parties involved in a situation to exert
influence over each other in which if both parties’ posses equal footing in the involvement, then
they have equal bargaining power and unequal bargaining power if otherwise (Guzman, 2010, p.
171). As Rassel (2012, p. 797) notes, in negotiations, bargaining power can be conceptualized as
the capacity of one party to dominate the other as a result of its power, size, status, or influence,
or even through a combination of the different persuasion tactics. In most cases involving
negotiations between host countries and IOCs, unequal bargaining power is manifested by one
party, most often the IOCs.

Prospects of Relations between Host States and IOCs

The nature of the oil and gas industry is one in which large returns can be realized since
the commodity value in the market above the cost for maintaining the factors of production and
for earning profits. Conflicts between the host and the OIC more often emanate from the issue of
returns sharing (Shaw and Cooper, 2009, n.p). Bargaining between the host and the IOC

Bargaining Power Balance 3
determine the division of the rents that each party in the agreement is to receive (Rassel, 2012, p.
797). Although there is a divergent between the goals of the host and those of the IOC, there is
equally an array of complementarity and such a platform for each of the two sides to realize their
targets through cooperation (Guzman, 2010, p. 171). However, the challenge arises, as a result,
of the great discrepancy that exists in terms of resources; financial and expertise, between the
two parties whereby more often the IOC are better established than the host countries.

During the negotiation stage, for instance, IOC is highly motivated (Peacock, 2010, p.
131). The companies are likely to overlook the high initial cost involved in the development and
exploration even in the instance that they encounter several dry wells. They will, however, be
keen to recover all these costs rapidly once they have embarked on a successful production
(Shaw and Cooper, 2009, n.p). IOCs have a tendency of tailoring their negotiation style to suit
their interpretations of the political environments in countries they operate. Having been
accustomed to authoritarian regimes and civil strife in most of the countries they operate in, the
oil companies will most likely bring a self-protective, uncompromising, feisty attitude towards
negotiations (Guzman, 2010, p. 171). In such cases, the environmental and societal impacts of
the projects are ignored during negotiations a result of which is conflicts and breaching of
agreements in the after days. Oil contracts are the result of negotiations more so since they are
varied and complex.

According to Rassel (2012, p. 797), investors seek and require legal and institutional
stability especially in terms of political, societal inexperience in handling resources, and
institutional conflicts. Although most companies would wish to avoid such situations, oil
companies are more often forced by circumstances to operate in conflict zones since the

Bargaining Power Balance 4
resources are mostly fond in these countries (Shaw and Cooper, 2009, n.p). These emerging
countries normally do not possess sufficient domestic know-how be it financial, legal, or
technical, for the development, management, and implementation (Solimene, 2014, n.p). As a
result, they have to seek skilled and independent negotiators from the private sector, which is
seen as more lucrative and professionally challenging in order to counter this superior experience
that IOCs bring to the table.

Types of Contracts used in Oil and Gas production Agreements

Host governments are normally faced with the dilemma of the type of contractual system
to use in terms of the concession or license agreement, a joint venture, a PSC, or a service
agreement (Solimene, 2014, n.p). In concessions, the contracts grant the IOC a right to explore,
develop, and to export the oil extracted in a specific area for which the company has received the
exclusive production rights for a prescribed time. Economic and financial advisers and lawyers
are needed to structure the bidding system (Peacock, 2010, p. 131). The terms of license are
drafted by the host government in compliance with the applicable law. PSCs are agreements
signed by the government and the extraction company concerning how much of the resource
extracted each will receive (Vivoda, 2009, p. 517). The main difference between concessions and
PSCs is that in concessions, the degree of professional support and expertise required is not as
extensive as in the case of PSCs. There are also different commercial results achieved by each of
the two types of contracts; concession and PSAs. In PSAs, the host nation can earn a signing
bonus (Rassel, 2012, p. 797).

The Production-sharing Contract recognizes that ownership of the resource rests with the
citizens and not with private parties. Just like in the case of the licenses, the IOC develops,

Bargaining Power Balance 5
operate, and manage the oil field bearing all the operational and financial risks (Shaw and
Cooper, 2009, n.p). In this type of contract, the host state has a number of benefits. For instance,
depending on the period of depreciation, the host country can earn a greater share of oil proceeds
early. The profits are shared according to the agreed percentages and the IOC is obliged to pay
taxes (Vivoda, 2009, p. 517). However, this type of contract presents some challenges especially
in developing countries with large number of issues to be addressed and the less reliable legal
infrastructure. PSCs demand skilled negotiators and experts in legal, commercial, technical,
financial, and environmental areas (Solimene, 2014, n.p). This is a daunting challenge for host
countries with their dire lack of data and information than the IOCs. PCAs were introduced in
Indonesia in 1966 and have since been adopted by over 40 countries across the globe like India
and in Africa (Peacock, 2010, p. 131).

Rassel (2012, p. 797) postulates that a joint venture arises if parties wish to pursue a joint
undertaking with agreements on profit sharing as well as operational, financial, and management
risk allocations. Service agreements involve the contractor receiving a fixed payment
independent of the discoveries or oil prices. Management decisions key to the process tend to
remain within the government (Rassel, 2012, p. 797).

Across history the industry has been characterized by cyclical shifts in relation to the
balance of power between the host countries and IOCs, a feature that is reflective of the cyclical
nature of this industry (Shaw and Cooper, 2009, n.p). The host states were consequently able to
earn larger shares of the economic rent. In addition, these periods were characterized by very low
degrees of compatibility between the IOCs and the host countries. Besides, during the late 1980s
and 1990s, the relationship was more of cooperative with falling market prices, which resulted in

Bargaining Power Balance 6
the balance of power shifting to the IOCs (Solimene, 2014, n.p). As a result, there was higher
compatibility between the hosts and the IOCs and the balance of power now shifting to IOCs. In
a nutshell, this implies that the larger the rents for division, the more intensive the bargaining
relationship between the two parties becomes.

Arguing from the Vernon’s obsolescing bargaining model (OBM)’s perspective of the
relationship between the host and the IOCs, it is clear that the changing nature of the bargaining
relations is a function of resources, constraints, and goals on both sides (Pate, 2009, p. 347). As
discussed earlier in this paper, the initial stages of bargaining are seen to favour the IOCs, a
feature attributed to their established resource base when entering the relationship as opposed to
the less versed hosts mostly the developing nations that lack the same (Shaw and Cooper,
2009, n.p). However, as the relationship proceeds the IOC’s assets are turned into captives with
the bargaining power consequently shifting to the side of the host countries (Maniruzzaman,
2009, p. 79). Once the bargaining power is on the side of the host country, the government is at a
position to impose more conditions on IOCs ranging from higher asset expropriation to taxes.

Notably, the relationship between the host countries and the IOCs has since changed from
a confrontational one to a more cooperative (Shaw and Cooper, 2009, n.p). Besides, the shift in
the way governments addressed the issue of contracts was followed by the deregulation, and less
expropriation, and economic liberalization of the oil industry (Rassel, 2012, p. 797). Rassel,
(2012, p. 797) notes that there is another emerging scenario in which the IOCs are seen as
struggling to secure new oil reserves in the recent years, as a result, of increased competition.

Factors Affecting Bargaining Power between Host States and IOCs

Bargaining Power Balance 7
Largely, several factors that are firm-specific affect the bargaining power of IOCs either
as resources or constraints (Vivoda, 2009, p. 517). An IOC that has a reputable international
presence is likely to command greater bargaining power that has the potential to achieving
favourite investment terms in negotiations with the host state (Rassel, 2012, p. 797). Besides,
companies with poor records on environmental conservation, as is the case with the infamous BP
oil spill incident at the Gulf of Mexico, are less likely to attract good contracts to drill offshore
areas particularly without very adequate regulation in place (Shaw and Cooper, 2009, n.p).

An IOC’s reserve replacement acts s a key indicator of its bargaining power (Pate, 2009,
p. 347). Reserve replacement is a good indicator to the ability of the company to sustain and
expand their business in the coming days. As such it becomes an important measure of
performance and a key factor in showing the value of the company in the financial markets since
it measures the ability of the company to continue operating as a viable entity (Solimene, 2014,
n.p). In this effect, if the IOC is unable to do stock replacement annually, then it would be
perceived as performing poorly both in the market and in terms of its bargaining power
(Maniruzzaman, 2009, p. 79). Alternatively, if they are to reproduce all their products and
consequently secure access to additional reserves, then their bargaining power is enhanced
(Rassel, 2012, p. 797). The five major companies were able to replace 99.7 percent of oil they
produced between 1998 and 2002, seen as being at the break-even point while between 2003 and
2007 they were only able to replace 51.7 percent of the oil they produced (Shaw and Cooper,
2009, n.p).

The country of origin of the IOC has a direct impact on their bargaining power relative to
a given host country. This is so because of the different political, colonial, historical, and cultural

Bargaining Power Balance 8
factors. The political climate is likely more accepting for an IOC from a home country with
stronger historical ties and greater cultural proximity (Vivoda, 2009, p. 517). Such ties are an
important source of better perception of the reputation of the IOC by the host government
because of the perceived closer fit between the management approaches of the company with
what is common locally. The institutional distance has implications on the company’s legitimacy
capacity in the host state (Maniruzzaman, 2009, p. 79). Institutional distance in this effect refers
to the similarities or differences between the regulatory, normative and cognitive institutions of
the two nations (Shaw and Cooper, 2009, n.p). When the institutional distance is high, the host
government is likely to perceive of the IOC stereotypically, which is likely to affect the
relationship between the two parties negatively making it difficult for them to reach a consensus
(Rassel, 2012, p. 797). For example, in the case when the government of the U.S. engages in
negotiations concerning American-based IOCs with host governments, the support tends to
weaken the IOCs due to the high institutional distance in terms of the unfriendly anti-American
cultural and political context of the host nations (Vivoda, 2009, p. 517).

Legal frameworks governing oil exploration are complex, multi-layered, and in most
cases, contain components that are ambiguous. Contractual relationship between the host
government and the IOCs is undoubtedly affected by the intertwinement and complexities of the
various legal, institutional, constitutional, policy, and agency systems (Rassel, 2012, p. 797). The
system of these prerequisite requirements that govern the oil and gas sector policy and
exploration consequently impacts on its developement and implementation which entails several
aspects and stages each of which has distinct with legislative and legal instruments
(Maniruzzaman, 2009, p. 79). There exists a considerable degree of legal uncertainties,
disparities, and ambiguities that lower the legal predictability in Oil and Gas contractual

Bargaining Power Balance 9
arrangements (Solimene, 2014, n.p). This has, in some cases, generated serious rifts and tension
between the two parties as is the case in Iraq in 2008/9. The Iraqi oil and gas industry witnessed
a period of changes of contracts with new elements in the legal and governing framework (Iraq
Oil & Gas Report’ 2013, p. 45). The Iraqi service contracts form an important milestone in
shaping future relationship between host countries and IOCs.


Most host states seek IOCs in order to access the managerial and technological skills they
have to offer. The degree of managerial and technological skills that an IOC possesses vis-a-vis
the host country can be taken as the key factor promoting their bargaining power. The main
rationale behind this concept is that the superior and complex managerial and technological skills
make it difficult for the hosts to engage with the IOCs because these developing countries have a
shortage of the same (Maniruzzaman, 2009, p. 79). In this case, therefore, the host’s bargaining
power is more when it has valuable natural resources desired by the IOCs. Notably, countries
that have smaller reserves are less likely to attract a lot of IOCs. For instance, the more
established IOCs may have more interest to invest in the more established countries such as
Saudi Arabia and Russia as compared with Egypt and Malaysia. The rationale in this argument is
on the basis of reserve longevity and potential profitability.

Bargaining Power Balance 10


Guzman, AT 2010, ‘International Soft Law’, The Journal Of Legal Analysis, 2, p. 171

‘Iraq Oil & Gas Report’ 2013, Iraq Oil & Gas Report, 1, pp. 1-99

Maniruzzaman, Pm 2009, ‘The Issue Of Resource Nationalism: Risk Engineering And Dispute
Management In The Oil And Gas Industry’, Texas Journal Of Oil, Gas, And Energy Law,
5, p. 79.

Bargaining Power Balance 11
Pate, TJ 2009, ‘Evaluating Stabilization Clauses in Venezuela’s Strategic Association
Agreements for Heavy-Crude Extraction in the Orinoco Belt: The Return of a Forgotten
Contractual Risk Reduction Mechanism for the Petroleum Industry’, The University Of
Miami Inter-American Law Review, 40, p. 347.

Peacock, B 2010, ”A virtual world government unto itself’: uncovering the rational-legal
authority of the IOC in world politics’,Proceedings: International Symposium For
Olympic Research, p. 318.

Rassel, S 2012, ‘The Necessity For National Federations To Stand Up For
Themselves’, Michigan State University Journal Of International Law, 20, p. 797.

Shaw, T, & Cooper, A 2009, The Diplomacies Of Small States : Between Vulnerability And
Resilience, Basingstoke [England]: Palgrave Macmillan.

Solimene, F 2014, ‘Political risk in the oil and gas industry and legal tools for
mitigation’, International Energy Law Review, 2

Vivoda, V 2009, ‘Resource Nationalism, Bargaining and International Oil Companies:
Challenges and Change in the New Millennium’, New Political Economy, 14, 4, p. 517.

Vivoda, V 2011, ‘Bargaining Model for the International Oil Industry’, Business & Politics, 13,
4, pp. 1-36

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