FINANCIAL PROVISIONS GOVERNING PETROLEUM EXTRACTION

The problem of allocating financial benefits forms the focal point of the relationship between foreign company and host government. The various arrangements by which host governments seek to increase their revenue from company activities, and the practices employed by companies to defend their share of profits, are hence the subject of this chapter.

Whatever method is used to divide income, whether it be royalties, income taxation or production sharing, difficulties over allocation lie at the centre of all contract negotiations. The results of these methods, as indicated by the royalty or tax rates achieved or the division of production arrived at, were set out in the previous chapter. Yet behind these financial flows are various additional factors which have to be taken into consideration in determining the balance of financial advantage between company and government.

Indeed an assessment of relative bargaining power only from the actual outcome of the bargaining process, even though set out in the contracts agreed upon by both sides, can and almost certainly will prove to be, in effect, a misleading rather than an accurate indication of how financial profits and other benefits from the extractive operation are likely to be allocated. Actual rates alone cannot indicate the full picture of the allocation of financial benefits and risks, where the financial transactions involved attain such levels of complexity as are possible within the scope of a transnational relationship.

The experience of Indonesia in the development of its petroleum industry underscores the differences in outlook and objectives which must be appreciated in any analysis of the interaction between transnational companies and local host governments. Both oil companies and the Indonesian government have been preoccupied with achieving an accommodation of interests which could provide a viable basis for cooperation over the extractive process. Yet what the Indonesian example also shows is that, while there may appear to have been a basic shift in favour of the host government in the content of agreements for oil extraction, when one begins to examine the precise terms and operational conditions of these agreements, it has at the least to be questioned if this presumed shift in favour of the host government has in fact occurred.

There may indeed be a trend towards an apparent new accommodation between foreign company and host government, but this does not mean that the latter has necessarily secured a markedly greater share of the benefits from the extractive operation. Preoccupation with obtaining formal ownership and control over the extractive operation has not meant that real control has in fact been exercised. Formal ownership may of course be desired as an end in itself, and is a legitimate objective if it serves to confirm the host government's authority. But there remain significant problems for the host government if it wishes to achieve effective control over the use of its oil resources.

INDONESIAN ATTITUDES TO FOREIGN INVESTMENT

In looking at successive Indonesian governments, the range of opinion to be found on the issue of foreign investment is not extreme. Considering the wide spectrum of Indonesian politics, a surprising degree of consensus obtained on the need for external economic support of some kind. Practically all Indonesian leaders, whatever their political background, held an almost implicit assumption that considerable foreign aid and investment was necessary, indeed indispensable, for national development. While most politicians were strongly inclined to change the structure of the economy, which had been shaped by the previous Dutch colonial administration, they had to reconcile national feeling with an underlying if contradictory regard for the importance of foreign investment in maintaining essential export earnings.

This dichotomy of attitudes had two effects. First, while efforts to remove foreign economic influence and to radically reorder the economy became a constantly reiterated theme of Indonesian political leaders, there was a tacit acceptance of foreign enterprise. Actual policies dealing with foreign firms were to prove much milder than public statements made in respect of them. Thus political conditions encouraged a divergence between the general tenor of public rhetoric and the actual concerns of the government of the day.

Secondly, while there was considerable public debate concerning the conditions under which foreign firms should be allowed into the country, their actual terms of operation were set by the limits of the economic structure.

THE EXTRACTIVE OPERATION AS PART OF OVERALL DEVELOPMENT

Integrating the contribution of the petroleum sector with general plans for economic development has become a matter of growing concern to producer governments in charge of significant petroleum industries. In examining the terms of Indonesian oil agreements, we are here concerned with those provisions which are aimed at compelling the foreign company to engage in activities which directly benefit the wider national economy. In so doing, the government's attempts at asserting its authority over the extractive process through various control and supervisory measures will also be assessed.

Despite the notable increases in the world price of crude oil since 1973, producer countries have not necessarily believed that they have profited from the rise in value of their resources to a commensurate extent in terms of material benefits for their domestic society and economy. What host governments have wanted goes beyond seeking still higher prices for petroleum products or improved terms of trade between raw material prices and the prices of imported manufactured goods. They require a broader range of benefits, not necessarily quantifiable in financial terms, which derive from extractive operations within their economies. Such attendant benefits are by no means a novelty. Many producer governments have, for some time already, taken various limited measures aimed at widening and increasing the contribution to development made by foreign petroleum companies.

THE PROBLEM OF PERCEPTION

Investment by foreign firms in less-developed countries tends to give rise to political tensions which are the product of corresponding perceptions held by companies and host governments of a manifest imbalance in their respective bargaining strengths, whether economic or political. It is argued here that the problems arising from this sense of ‘imbalance’ are largely of a political nature and can only be resolved through the development of an underlying political consensus providing a basis on which common interests can coalesce, that is, constructive reciprocal relations between the purveyors of capital and technology on the one hand and the proprietors of natural resources and labour on the other. Economic concerns and market forces are in a sense peripheral to the issue. What matters most is the development of a convergence of interests, and the evolution of a shared perspective over principles and practices. Such a perspective requires the transformation of the narrow sectarian sense of confidence in the ‘rightness’ felt by each party into a genuine sense of partnership within broader more inclusive dimensions.

In stating that the problem is one of perceptions, it should be realised that this expresses itself in very basic dilemmas over choice of appropriate policy and attitude. Multinational firms are generally regarded by host governments as increasingly important actors in contemporary international affairs. Yet, faced with the difficult task of formulating policies to deal with their activities, there is an even greater inability to agree on what impact it is that such firms are supposed to have on the host countries within which they operate.

THE STRUCTURE OF THE INDUSTRY

The governmental organisation and domestic structure set limits to the types of contract which a host government may set out to secure. The host government has to know what arrangements are possible to achieve and would be practicable in effect when bargaining with foreign companies. The governmental configuration, so far as it affects foreign oil companies, is therefore examined here. But in the Indonesian case, a further consideration comes into the picture. For in dealing with the oil companies, the government came to find that its principal weakness has been its ineffective authority, which derived from the autonomous status of the governmental body charged with responsibility for petroleum concerns. The problem of the state oil company's accountability to the central government therefore requires special attention, an issue of especial relevance to host governments which delegate responsibility for mineral affairs to organs not under direct government control. Finally, given such confines, any settlement which may be arrived at will also reflect the ability of the government side to negotiate effectively and to employ to maximum advantage those resources available to it. So beyond the government's formal configuration, its approaches to negotiation will have to be dealt with for a complete understanding of the host government's situation.

It is often the case for host governments that the skilled personnel and technical and financial resources necessary to effectively negotiate and administer contracts are not available in sufficient number.

DISPUTE SETTLEMENT WITHIN AN EVOLVING PROCESS OF CONTRACT RELATIONS

After having examined the division of financial benefits within Indonesian oil contracts, their development provisions and the authority which the government attempts to assert over the extractive process, it has still to be asked how valid these terms are likely to remain. It is therefore important in examining the formal contract to assess how both parties are likely to respond to its terms over the long run, how adherence to existing terms can be maintained, and what is likely to lead to changes in the contractual relationship. Such issues of contractual change and negotiation are addressed in this chapter.

If the negotiating framework surrounding the petroleum-extractive operation is regarded as part of a dynamic process, in which a changing pattern of government–company relations gives rise to shifts in the bargaining positions of both sides, it would then seem inevitable that dissatisfaction over the governing set of contract terms will arise. Pressure for an improvement of terms from governments keen to maximise their returns from oil extraction has resulted not only from the extensive changes over the long term in the global environment of the international oil industry; nor can it be ascribed solely to any specific local development which might have strengthened the host government's bargaining hand. Quite apart from these factors, pressure for change is inherent in the nature and development of the extractive operation as it moves from one stage of activity to another.

THE SEARCH FOR APPROPRIATE MODELS

The relationship between host state and foreign corporation has been the central concern of this analysis. This contractual relationship is only part of a triangular framework of which the foreign company's home country forms the third apex, and this factor has at times worked to shape the considerations of the other two actors. However, the scope of their concerns goes beyond this basic structure to encompass other such triangular frameworks formed by contractual relationships which are perceived to be relevant. The vast majority of the community of states act as hosts for transnational corporations, establishing contractual relationships whose terms may become the points of reference for later contract agreements between companies and governments, whether as a result of the investor attempting to secure contract terms equivalent to those agreed before for fear of establishing a precedent, or of the host government seeking new ways to increase its bargaining power. A more complex construct is required to reflect all the relevant extraneous facts for any particular contractual negotiation. It would prove too unwieldy for productive analysis. Nevertheless, in considering the problems faced by both foreign investor and host government in negotiating any one contract, the wider considerations posed by those features of other investment agreements which the negotiating parties regard as relevant, do have to be taken into account.

Contract negotiations take place within a system which is essentially bilateral in nature, with no overall framework such as exists theoretically in a free market in which the behaviour of other market participants provides relevant information and induces competition among buyers and sellers.