Oil and Gas and Atlantic Oil - Essay Example

?Oil and Gas When there are optimal opportunities in the foreign markets, organizations breaking geographical and economical boundaries will enter those countries. However, before or during the entry, various factors in those countries will facilitate as well as impede the organization’s entry. One of the key factors is the government related legislative policies and other laws, which will influence the organization while selecting the entry mode. Selecting an optimum entry mode and aptly formulating the initial establishment process is half a battle won.1 This being the case, Atlantic Oil while entering Polenskya is planning to go for the production sharing agreement. This mode has both advantages and disadvantages, so apt clauses have to be incorporated into the agreement, to avoid any risks. After that, Atlantic Oil has to adopt feasible and effective funding options, and also have to carry out their operations without any negative impact on the environment. Production Sharing Agreements (PSA) – Advantages, disadvantages and Clauses A change to the dominant form of contract has occurred in the oil industry, with the previously followed concession agreement giving way to the production sharing agreement.2 Production sharing agreements (PSA) are a type of contract which is signed between the government, in this case Polenskya’s government, and the oil exploration company or Atlantic Oil, regarding the extraction process and the how the extracted oil and its profits can be shared. That is, as oil and gas deposits are usually owned by the country concerned, it is common for the country to enter into a production sharing agreement with an oil company, so the specific company can do the financial investment for the extraction process, extract the oil or gas, sell it and through it recover their initial investment, and then share the production as well as the profits with the government.3 With this agreement divided into two stages, recovery period and sharing period, the produced oil is also categorized into two categories, Cost Oil and Profit Oil. The Cost oil includes the produced oil or gas, which will be sold by the company themselves to recover their investments, while with the profit oil only the government and the contractor will share the profits.4 This PSA has both advantages and at the same time inherent disadvantages. Advantages One of the main advantages that will be garnered by Atlantic oil if they enter into a production agreement with Polenskya is the high degree of fiscal stability. That is, the tax structure which is in action during the signing of the PSA, as well as the certain tax concessions given to the Atlantic Oil by the government will be ‘future proof’. Thus, any overall tax changes brought on by the government in future will have no impact on the terms of the PSA, and thereby will not negatively impact the finances of Atlantic Oil. Although, certain corporate taxes are exempt from this cover, the bottom line is PSA guarantees Atlantic Oil sizable financial stability, whatever be the changes in the external environment. “The attraction of the production sharing system is that it provides the investor with a relatively stable regime in a complex and rapidly changing legal and political environment.”5 The other advantage of PSA is, it will be politically and socially more acceptable to Polenskya and in turn to Atlantic Oil as well. In countries like Polenskya, where there will be skepticism and also resistance to foreign companies, due to the mindset among the people that foreign companies will exploit the resources for their own benefits, without giving anything back to the local population.6 However, with PSA making the government the ‘co-owner’ of the operations, it will assure the people maximally and they will welcome and support Atlantic Oil completely without any apprehension of economic exploitation. Disadvantages At the same time, there are some disadvantages of this type of contract and the key one among them is the possibility of project or extraction failing after the upfront investments was made by the Atlantic Oil. Although, Atlantic Oil decided to enter Polenskya after doing good ground work, chances of failure are also there due to less than expected oil and gas deposits, practical problems in extracting as well as other political, social and environmental problems. In those scenarios, the upfront financial investment made by Atlantic Oil may not be recovered, and if recovered, it will only be in reduced numbers. All the exploration costs and the risks of the initial oil exploration have to be borne by the foreign corporation.7 In addition, there is also the risk of getting only less than expected oil production or Cost Oil, and that will impede or slow the recovery of the investment. Apart from that, low production can also make the Polenskya’s government to pressurize the company as they may get their share of the Profit Oil in a delayed manner. In those times, “the oil company does not get the initial slice and simply has to recoup its costs out of profit petroleum”.8 The other key disadvantage of PSA is that after the recovery of investment costs, the government could assume a major or even a more dominant role. They can do that by taking over key processes like decision making, marketing, etc., and unless apt provisions are there, they could eventually take over the project. “The percentage of the oil given to the foreign corporation progressively diminishes as the expenses are recouped by sale until eventually the whole project is taken over by the state oil corporation.”9 Clauses Considering these risks and other scenarios, it would be better for Atlantic Oil to incorporate certain clauses in its PSA with the Polenskya’s government. Although, they cannot entirely do away with the risk of losing its upfront investments due to various factors, Atlantic Oil can include a clause that gives it freedom to source its funds through any legal avenues. That is, the firm should be allowed to employ any funding options, which it deems apt, without any restrictions. The other clause that can be negotiated with the government is the recovering of the upfront costs through cost oil. The basis of that clause is that even if the production is less than expected, Atlantic Oil should have the right to share the profit oil only after they have recovered all the investments costs. The other key clause is regarding the joint management of the project including all the operational processes like marketing. “There is usually provision for joint management of the project with the state oil company”10 If this clause is incorporated, Atlantic Oil will have an equal say during key operational processes, and also during marketing and selling of the oil to the customers. Having prior experience, Atlantic Oil can market and set price aptly. Although, all these clauses can be incorporated only after negotiations, there is a good chance of including it because of Atlantic oil’s strong bargaining power. Host country government cannot assert control in relation to the foreign if they have weak bargaining power.11 That is, as Polenskya’s government is showing signs of instability due to the President’s illness and also as lacks prior knowledge and experience about the oil and gas sector, Atlantic Oil has the upper hand. Funding options and the associated political/commercial risks When the funding options for Atlantic oil to come up with the initial infrastructure for the exploration and extraction is focused, there appears some feasible avenues and that is supported by the earlier mentioned clause of freedom regarding funding options. Although, Atlantic Oil can utilize its own financial resources as the upfront investment, in case of shortfalls, they have to explore other avenues and one of the first options they can try is debt financing. Debt financing is an option that will be optimally used by MNCs to get a sizable source of funds, based on its credit strength. As Finnerty (2011) states, “the amount of debt that a firm or its project can raise is based on the project's expected capacity to service the debt from project cash flow, or simply its credit strength.”12 A project's credit strength derives from 1) the inherent value of the assets included in the project 2) the expected profitability of the project 3) the pledges of creditworthy given by Third parties or sponsors involved in the project.13 However, the disadvantage or commercial risk with this funding option is, due to PSA, Atlantic Oil would be taking full responsibility of the initial investment and the associated risks. This being the case, if the project fails or does not work out on expected lines, the firm’s interest payments will become a major burden, ‘eating up’ the recovery costs as well as the share of the profits.14 Thus, Atlantic Oil has to be much focused to make the project a success, to avoid the risks with debt financing. In addition, while going for this funding option, the firm should take into account currency of denomination, (although funding will be done in the currency in which the firms invoice their products, it would be better for them to choose a currency which is not susceptible to fluctuations), whether rate is fixed or floating, etc.15 The other funding option is raising equity in Atlantic Oil’s home market or country. With Polenskya not having strong financial institutions including international banking system, the possibility of finding strong local investors will be minimal. In addition, with government taking a major role, they will not favor indigenous private players. This being the case, it would be better for Atlantic Oil to find investors in its home market. This raising of finances through the option of equity sale would be beneficial to Atlantic Oil as it can first reduce its above mentioned financial risks related to upfront investments.16 However, the commercial risk with this option is that it would minimally dilute their hold and also sizably reduce their financial returns. The other possible but complicated and risky options for Atlantic Oil are, approaching the government for the buying of equity or even borrow from them. Offering the government a portion of the equity or asking them to lend money, can provide Atlantic Oil with minimal-interest finances. However, it could increase the political risks because it will increase the bargaining power of the government, and that will lead to their dominance. As it compromises Atlantic Oil’s strong position, the government will start influencing the various organizational processes including Atlantic Oil’s decision-making autonomy.17 Thus, Atlantic Oil has some feasible funding options, which has good advantages and also some commercial and political risks. Environmental Impacts As Atlantic Oil in the past received bad publicity about its projects damaging local environments, and importantly as it is in an already sensitive environment in Polenskya, it has to carry out effective measures to minimize or fully eliminate any negative environmental impacts. That is, the area of greatest oil potential is also home to an endangered species of animal which attracts many tourists from all over the world, and is also the home of a community of indigenous people who do agriculture. Thus, specific precautions have to be taken to safeguard these two key ‘parties’ during the surveying process and also the actual exploration process. The surveying process is normally done through the seismic survey which is carried out using reflected sound waves to produce a “scan” of the terrestrial and aquatic subsurface.18 The preparation for this survey involves installing the machines and other procedures and that will make negative modifications on the landscape. In addition, the tools used for this survey, like the guns on the aquatic subsurface and explosives or Vibroscis (heavy machinery) on the land can create huge noise pollution or disturbance to the humans as well as the animal species. These being the threats, Atlantic Oil should follow certain precautionary measures like line cutting in forested areas should be limited to the smallest width necessary, small jogs in the lines are often requested, guns and explosives of minimum intensity should be used, etc.19 Then, when the drilling and the exploration process starts, care should be taken not to contaminate the groundwater and also not pollute the environment with spills and blowouts. During ineffective drilling and the oil spill, there will be groundwater pollution, and it may not subside quickly, making negative impacts for years.20 Due to these threats, Atlantic Ocean has to carry out its exploration in a safe manner using optimal procedures and importantly by using advanced technologies. For example, “recent advances in horizontal drilling have enhanced directional drilling as a means of concentrating operations at one site” and thereby reducing negative ‘footprints’ on the environment. In addition, to avoid the opposition of the local interest groups, who may interfere with seismic and other operations, Atlantic Oil should follow all the above mentioned effective measures and should also have good community relations prior to the operations.21 Thus, Atlantic Oil to avoid any negative impacts on the environment near their operations in Polenskya has to act with extra care from the ethical and environmental perspective. If Atlantic Oil takes into consideration all the above discussed aspects regarding Production Sharing Agreement, funding options and environmental concerns, it can make an optimal entry into Polenskya and achieve good success. Bibliography Ahmed, Tarek and Nathan Meehan, Advanced Reservoir Management and Engineering, (Gulf Professional Publishing, 2011). Bragg, Steven M. Obtaining Debt Financing, (John Wiley & Sons, 2011). Cable, Vincent, Developing With Foreign Investment, (Routledge, 1987). Pearson, Margaret M., Joint Ventures in the People's Republic of China: The Control of Foreign Direct Investment Under Socialism, (Princeton University Press, 1992). Cordsen, Andreas, Mike Galbraith, John Peirce and Bob Adrian Hardage, Planning Land 3-D Seismic Surveys, (SEG Books, 2000). Finnerty, John D., Project Financing: Asset-Based Financial Engineering, (John Wiley & Sons, 2011) Johnson, Debra and Colin Turner, International Business: Themes and Issues in the Modern, Global Economy, (Routledge, 2010) Johnston, Daniel, International Petroleum Fiscal Systems and Production Sharing Contracts, (PennWell Books, 1994). Legere, Laura, ‘Impact of natural gas drilling environmental woes could linger’ (The Times Tribune, 20 June 2010) accessed on 5 May 2012. Madura, Jeff, International Financial Management (Cengage Learning, 2011) 531. Milligan, Mark R. ‘What are seismic surveys and how much “shaking” do they create?’ (Utah Geological Survey July 2004) accessed on 5 May 2012. Oda, Hiroshi, Russian Commercial Law, (Martinus Nijhoff Publishers, 2007). Overview of the oil and gas exploration and production process’ (Etech International) accesse d on 5 May 2012. Pearson, Margaret M. Joint Ventures in the People's Republic of China: The Control of Foreign Direct Investment Under Socialism, (Princeton University Press, 1992). Sornarajah, M, The International Law on Foreign Investment, (Cambridge University Press, 2010). Wood, Philip R. Project Finance, Securitisations, Subordinated Debt, (Sweet & Maxwell, 2007). Read More